Accounting Tools for Business Decision Making, 5th Edition BY Kimmel, Weygandt, Kieso
Email: Richard@qwconsultancy.com
CHAPTER 1 Introduction to Financial Statements Learning Objectives 1. 2. 3. 4. 5.
Describe the primary forms of business organization. Identify the users and uses of accounting information. Explain the three principal types of business activity. Describe the content and purpose of each of the financial statements. Explain the meaning of assets, liabilities, and stockholders’ equity, and state the basic accounting equation. Describe the components that supplement the financial statements in an annual report.
6.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item
LO
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Item
LO
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Questions 1. 2. 3. 4. 5. 1. 2. 3.
1 1 1 2 2 1 2 3
K K K C C K K K
6. 7. 8. 9.
4. 5.
2 3 4 4
4 4, 5
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10. 11. 12. 13.
4 4 4 4
C K C AP
14. 15. 16. 17.
5 5 5 5
K K AP C
18. 19. 20. 21.
6 6 6 5
K C K C
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Brief Exercises 6. 4, 5 K 7. 4 K
8. 9.
5 5
AP AP
10. 11.
5 6
K K
4.
6
C
Do It! Review Exercises 1.
1
C
2.
3
K
3.
4,5
AP
Exercises 1. 2. 3. 4.
1, 2, 4, 6 3 3, 4 4
K C C AP
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9.
4, 5
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15.
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6. 7. 8.
4 4 4, 5
AP AP C
10. 11.
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Problems: Set A 1.
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K Problems: Set B
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Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
1-1
5
1-2
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K
(For Instructor Use Only)
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
.
Description
Difficulty Level
Time Allotted (min.)
1A
Determine forms of business organization.
Simple
15–20
2A
Identify users and uses of financial statements.
Simple
15–20
3A
Prepare an income statement, retained earnings statement, and balance sheet; discuss results.
Moderate
40–50
4A
Determine items included in a statement of cash flows, prepare the statement, and comment.
Moderate
30–40
5A
Comment on proper accounting treatment and prepare a corrected balance sheet.
Moderate
40–50
1B
Determine forms of business organization.
Simple
15–20
2B
Identify users and uses of financial statements.
Simple
15–20
3B
Prepare an income statement, retained earnings statement, and balance sheet; discuss results.
Moderate
40–50
4B
Determine items included in a statement of cash flows, prepare the statement, and comment.
Moderate
30–40
5B
Comment on proper accounting treatment and prepare a corrected income statement.
Moderate
40–50
(For Instructor Use Only)
1-3
ANSWERS TO QUESTIONS 1.
The three basic forms of business organizations are (1) sole proprietorship, (2) partnership, and (3) corporation.
2.
Advantages of a corporation are limited liability (stockholders not being personally liable for corporate debts), easy transferability of ownership, and ease of raising funds. Disadvantages of a corporation are increased taxation and government regulations.
3.
Proprietorships and partnerships receive favorable tax treatment compared to corporations and are easier to form than corporations. They are also owner controlled. Disadvantages of proprietorships and partnerships are unlimited liability (proprietors/partners are personally liable for all debts) and difficulty in obtaining financing compared to corporations.
4.
Yes. A person cannot earn a living, spend money, buy on credit, make an investment, or pay taxes without receiving, using, or dispensing financial information. Accounting provides financial information to interested users through the preparation and distribution of financial statements.
5.
Internal users are managers who plan, organize, and run a business. To assist management, accounting provides timely internal reports. Examples include financial comparisons of operating alternatives, projections of income from new sales campaigns, forecasts of cash needs for the next year, and financial statements.
6.
External users are those outside the business who have either a present or potential direct financial interest (investors and creditors) or an indirect financial interest (taxing authorities, regulatory agencies, labor unions, customers, and economic planners).
7.
The three types of business activities are financing activities, investing activities, and operating activities. Financing activities include borrowing money and selling shares of stock. Investing activities include the purchase and sale of property, plant, and equipment. Operating activities include selling goods, performing services, and purchasing inventory.
8.
(a) Income statement. (b) Balance sheet. (c) Income statement.
9.
When a company pays dividends, it reduces the amount of assets available to pay creditors. Therefore, banks and other creditors monitor dividend payments to ensure they do not put a company’s ability to make debt payments at risk.
10.
Yes. Net income does appear on the income statement—it is the result of subtracting expenses from revenues. In addition, net income appears in the retained earnings statement—it is shown as an addition to the beginning-of-period retained earnings. Indirectly, the net income of a company is also included in the balance sheet. It is included in the retained earnings account which appears in the stockholders’ equity section of the balance sheet.
11.
The primary purpose of the statement of cash flows is to provide financial information about the cash receipts and cash payments of a business for a specific period of time.
1-4
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(For Instructor Use Only)
(d) Balance sheet. (e) Balance sheet. (f) Balance sheet.
Questions Chapter 1 (Continued) 12.
The three categories of the statement of cash flows are operating activities, investing activities, and financing activities. The categories were chosen because they represent the three principal types of business activities.
13.
Retained earnings is the net income retained in a corporation. Retained earnings is increased by net income and is decreased by dividends and a net loss.
14.
The basic accounting equation is Assets = Liabilities + Stockholders’ Equity.
15.
(a) Assets are resources owned by a business. Liabilities are amounts owed to creditors. Put more simply, liabilities are existing debts and obligations. Stockholders’ equity is the ownership claim on net assets. (b) The items that affect stockholders’ equity are common stock, retained earnings, dividends, revenues, and expenses.
16.
The liabilities are (b) Accounts payable and (g) Salaries and wages payable.
17.
(a) Net income from the income statement is reported as an increase to retained earnings on the retained earnings statement. (b) The ending amount on the retained earnings statement is reported as the retained earnings amount on the balance sheet. (c)
The ending amount on the statement of cash flows is reported as the cash amount on the balance sheet.
18.
The purpose of the management discussion and analysis section is to provide management’s views on its ability to pay short-term obligations, its ability to fund operations and expansion, and its results of operations. The MD&A section is a required part of the annual report.
19.
An unqualified opinion shows that, in the opinion of an independent auditor, the financial statements have been presented fairly, in conformity with generally accepted accounting principles. This gives investors more confidence that they can rely on the figures reported in the financial statements.
20.
Information included in the notes to the financial statements clarifies information presented in the financial statements and includes descriptions of accounting policies, explanations of uncertainties and contingencies, and statistics and details too voluminous to be reported in the financial statements.
21.
Using dollar amounts, Tootsie Roll’s accounting equation is: Assets $857,856,000
=
Liabilities $191,921,000*
+
Stockholders’ Equity $665,935,000
*$58,355,000 + $133,566,000
.
(For Instructor Use Only)
1-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1-1 (a)
P
Shared control, resources.
tax
advantages,
increased
(b)
SP
Simple to set up and maintains control with founder.
(c)
C
Easier to transfer ownership and raise funds, no personal liability.
BRIEF EXERCISE 1-2 (a) (b) (c) (d) (e)
4 3 2 5 1
Investors in common stock Marketing managers Creditors Chief Financial Officer Internal Revenue Service
BRIEF EXERCISE 1-3 O F F O I
(a) (b) (c) (d) (e)
Cash received from customers. Cash paid to stockholders (dividends). Cash received from issuing new common stock. Cash paid to suppliers. Cash paid to purchase a new office building.
BRIEF EXERCISE 1-4 E R E E D R E NSE C 1-6
(a) (b) (c) (d) (e) (f) (g) (h) (i)
Advertising expense Service revenue Insurance expense Salaries and wages expense Dividends Rent revenue Utilities expense Cash purchase of equipment Issued common stock for cash. .
(For Instructor Use Only)
skills
and
BRIEF EXERCISE 1-5 BURNETT COMPANY Balance Sheet December 31, 2014 Assets Cash ............................................................................... Accounts receivable ..................................................... Total assets ...................................................................
$22,000 71,000 $93,000
Liabilities and Stockholders’ Equity Liabilities Accounts payable.................................................. Stockholders’ equity Common stock ...................................................... Retained earnings ................................................. Total liabilities and stockholders’ equity ....................
$65,000 $18,000 10,000
28,000 $93,000
BRIEF EXERCISE 1-6 IS BS BS BS BS IS IS BS BS IS
(a) (b) (c) (d) (e) (f) (g) (h) (i) (j)
Income tax expense Inventory Accounts payable Retained earnings Equipment Sales revenue Cost of goods sold Common stock Accounts Receivable Interest expense
BRIEF EXERCISE 1-7 IS BS SCF BS
.
(a) (b) (c) (d)
Revenue during the period. Supplies on hand at the end of the year. Cash received from issuing new bonds during the period. Total debts outstanding at the end of the period.
(For Instructor Use Only)
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BRIEF EXERCISE 1-8 (a) $90,000 + $230,000 = $320,000 (Total assets) (b) $170,000 – $80,000 = $90,000 (Total liabilities) (c) $800,000 – 0.25($800,000) = $600,000 (Stockholders’ equity)
BRIEF EXERCISE 1-9 (a) ($800,000 + $150,000) – ($500,000 – $80,000) = $530,000 (Stockholders’ equity) (b) ($500,000 + $100,000) + ($800,000 – $500,000 – $70,000) = $830,000 (Assets) (c) ($800,000 – $80,000) – ($800,000 – $500,000 + $110,000) = $310,000 (Liabilities) BRIEF EXERCISE 1-10 A L A A SE L
(a) (b) (c) (d) (e) (f)
Accounts receivable Salaries and wages payable Equipment Supplies Common stock Notes payable
BRIEF EXERCISE 1-11 (d) All of these are required.
1-8
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(For Instructor Use Only)
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 1-1 (a) Easier to transfer ownership: corporation (b) Easier to raise funds: corporation (c) More owner control: sole proprietorship (d) Tax advantages: sole proprietorship and partnership (e) No personal legal liability: corporation DO IT! 1-2 (a) Issuance of ownership shares is classified as common stock. (b) Land purchased is classified as an asset. (c) Amounts owed to suppliers are classified as liabilities. (d) Bonds payable are classified as liabilities. (e) Amount earned from selling a product is classified as revenue. (f) Cost of advertising is classified as expense. DO IT! 1-3 MARSH CORPORATION Income Statement For the Year Ended December 31, 2014 Revenues Service revenue ........................................... Expenses Rent expense ............................................... Advertising expense .................................... Supplies expense ........................................ Total expenses .................................. Net income ..........................................................
.
(For Instructor Use Only)
$25,000 $10,000 4,000 1,700 15,700 $ 9,300
1-9
DO IT! 1-3 (Continued) MARSH CORPORATION Retained Earnings Statement For the Year Ended December 31, 2014 $ –0– 9,300 9,300 2,500 $6,800
Retained earnings, January 1 .................................. Add: Net income .................................................... Less: Dividends ....................................................... Retained earnings, December 31 ............................ MARSH CORPORATION Balance Sheet December 31, 2014 Assets Cash .......................................................................... Accounts receivable ................................................ Supplies .................................................................... Equipment................................................................. Total assets ..............................................................
$ 3,100 2,000 1,900 26,800 $33,800
Liabilities and Stockholders’ Equity Liabilities Notes payable.................................................... Account payable ............................................... Total liabilities ........................................ Stockholder’s equity Common stock .................................................. Retained earnings ............................................. Total stockholders’ equity ..................... Total liabilities and stockholder’s equity ................
1-10
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(For Instructor Use Only)
$ 7,000 5,000 $12,000 15,000 6,800 21,800 $33,800
DO IT! 1-4 (1) Description of ability to pay near-term obligations: MD&A (2) Unqualified opinion: auditor’s report (3) Details concerning liabilities, too voluminous to be included in the statements: notes (4) Description of favorable and unfavorable trends: MD&A (5) Certified Public Accountant (CPA): auditor’s report (6) Descriptions of significant accounting policies: notes
.
(For Instructor Use Only)
1-11
SOLUTIONS TO EXERCISES EXERCISE 1-1 (a) (b) (c) (d) (e) (f) (g) (h)
8. 1. 6. 7. 3. 2. 5. 4.
Auditor’s opinion Corporation Common stock Accounts payable Accounts receivable Creditor Stockholder Partnership
EXERCISE 1-2 (a)
Answers will vary.
Abitibi Consolidated Inc. Cal State—Northridge Stdt Union
Borrow money from a bank
Investing Purchase long-term investments Purchase office equipment
Oracle Corporation
Sale of bonds
Purchase other companies
Sportsco Investments
Payment of dividends to stockholders Distribute earnings to partners Sale of stock
Purchase hockey equipment
Grant Thornton LLP
Southwest Airlines
1-12
Financing Sale of stock
.
(For Instructor Use Only)
Purchase computers Purchase airplanes
Operating Sale of newsprint Payment of wages and benefits Payment of research expenses Payment for rink rentals Bill clients for professional services Payment for jet fuel
EXERCISE 1-2 (Continued) (b) Financing Sale of stock is common to all corporations. Borrowing from a bank is common to all businesses. Payment of dividends is common to all corporations. Sale of bonds is common to large corporations. Investing Purchase and sale of property, plant, and equipment would be common to all businesses—the types of assets would vary according to the type of business and some types of businesses require a larger investment in long-lived assets. A new business or expanding business would be more apt to acquire property, plant, and equipment while a mature or declining business would be more apt to sell it. Operating The general activities identified would be common to most businesses, although the service or product would differ. EXERCISE 1-3
Accounts payable Accounts receivable Equipment Sales revenue Service revenue Inventory Mortgage payable Supplies expense Rent expense Salaries and wages expense
.
(For Instructor Use Only)
(a) L A A R R A L E E E
(b) O O I O O O F O O O
1-13
EXERCISE 1-4 MOLINA CO. Income Statement For the Year Ended December 31, 2014 Revenues Service revenue ...................................................... Expenses Salaries and wages expense.................................. Rent expense .......................................................... Utilities expense ..................................................... Advertising expense ............................................... Total expenses ................................................ Net income ......................................................................
$58,000 $30,000 10,400 2,400 1,800 44,600 $13,400
MOLINA CO. Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1 .......................................................... Add: Net income............................................................................. Less: Dividends ............................................................................... Retained earnings, December 31 ....................................................
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(For Instructor Use Only)
$67,000 13,400 80,400 6,000 $74,400
EXERCISE 1-5 (a)
MERCK AND CO. Income Statement For the Year Ended December 31, 2014 (in millions) Revenues Sales revenue ................................................. $38,576.0 Expenses Cost of goods sold ......................................... $ 9,018.9 Selling and administrative expenses ............ 8,543.2 Research and development expense ............ 5,845.0 Income tax expense ....................................... 2,267.6 Total expenses ............................................ 25,674.7 Net income .............................................................. $12,901.3 MERCK AND CO. Retained Earnings Statement For the Year Ended December 31, 2014 (in millions) Retained earnings, January 1 ................................. Add: Net income ................................................... Less: Dividends ...................................................... Retained earnings, December 31 ...........................
$43,698.8 12,901.3 56,600.1 3,597.7 $53,002.4
(b) The short-term implication would be a decrease in expenses of $2,922.5 ($5,845 X 50%) resulting in a corresponding increase in income (ignoring income taxes). If all other revenues and expenses remain unchanged, decreasing research and development expenses would produce 22.7% more net income ($2,922.5 ÷ $12,901.3).
.
(For Instructor Use Only)
1-15
EXERCISE 1-5 (Continued) The long-term implications would be more difficult to quantify but it is safe to predict that a reduction in research and development expenses would probably result in lower sales revenues in the future. Pharmaceutical companies are usually able to charge higher prices for newly developed products while lower cost generic versions usually replace older products. Decreasing research and development activities will probably mean fewer new products. The stock market’s initial reaction might be positive since Merck’s net income would increase significantly. Such a reaction would probably be very short-lived as more knowledgeable investors reviewed Merck’s financial statements and discovered the cause of the increase.
EXERCISE 1-6 DEVITO INC. Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1 ................................. Add: Net income....................................................
$130,000 225,000* 355,000 65,000 $290,000
Less: Dividends ...................................................... Retained earnings, December 31 ........................... *Service revenue ..................................................... *Total expenses ....................................................... *Net income .............................................................
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(For Instructor Use Only)
$400,000 175,000 $225,000
EXERCISE 1-7 (a) Grant Corporation is distributing nearly all of this year’s net income as dividends. This suggests that Grant is not pursuing rapid growth. Companies that have a lot of opportunities for growth pay low dividends. (b) Remington Corporation is not generating sufficient cash provided by operating activities to fund its investing activities. Instead it generates additional cash through financing activities. This is common for companies in their early years of existence. EXERCISE 1-8 (a)
A SE E E A A A R L L R E
Cash Retained earnings Cost of goods sold Salaries and wages expense Prepaid insurance Inventory Accounts receivable Sales revenue Notes payable Accounts payable Service revenue Interest expense
(b)
MOTTE INC. Income Statement For the Year Ended December 31, 2014 Revenues Sales revenue ...................................... Service revenue ................................... Total revenues.................................. Expenses Cost of goods sold .............................. Salaries and wages expense .............. Interest expense .................................. Total expenses .................................
.
(For Instructor Use Only)
$584,951 4,806 $589,757 438,458 115,131 1,882 555,471 1-17
Net income ..................................................
1-18
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(For Instructor Use Only)
$ 34,286
EXERCISE 1-9 First note that the retained earnings statement shows that (b) equals $27,000. Accounts payable + Common stock + Retained earnings = Total liabilities and stockholders’ equity
$5,000 + a + $27,000 = $62,000 a + $32,000 = $62,000 a = $30,000 Beginning retained earnings + Net income – Dividends = Ending retained earnings
$12,000 + e – $5,000 = $27,000 $7,000 + e = $27,000 e = $20,000 From above, we know that net income (d) equals $20,000. Revenue – Cost of goods sold – Salaries and wages expense = Net income
$85,000 – c – $10,000 = $20,000 $75,000 – c = $20,000 c = $55,000 EXERCISE 1-10 (a) Service revenue ............................................ Sales revenue ............................................... Total revenue ........................................ Expenses ...................................................... Net income .................................................... (b)
$132,000 25,000
FLINT HILLS PARK Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1 ................................................. Add: Net income.................................................................... Less: Dividends ......................................................................
.
$157,000 126,000 $ 31,000
(For Instructor Use Only)
$ 5,000 31,000 36,000 9,000 1-19
Retained earnings, December 31 ...........................................
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(For Instructor Use Only)
$27,000
EXERCISE 1-10 (Continued) FLINT HILLS PARK Balance Sheet December 31, 2014 Assets Cash ................................................................... Supplies ............................................................. Equipment.......................................................... Total assets .......................................................
$
8,500 5,500 114,000 $128,000
Liabilities and Stockholders’ Equity Liabilities Notes payable ............................................ Accounts payable ...................................... Total liabilities .................................... Stockholders’ equity Common stock ........................................... Retained earnings ...................................... Total liabilities and stockholders’ equity .........
$50,000 11,000 $ 61,000 40,000 27,000
67,000 $128,000
(c) The income statement indicates that revenues from the general store were only about 16% ($25,000 ÷ $157,000) of total revenue which tends to support Joe’s opinion. In order to decide if the store is “more trouble than it is worth,” I would need to know the amount of expenses attributable to the general store. The income statement reports all expenses in a single category rather than separating them into camping and general store expenses to correspond with revenues. A break down into two categories would help me decide if the general store is generating a profit or loss. Even if the general store is operating at a loss, I might recommend retaining it if campers indicated that the convenience of having a general store on site was an important amenity in selecting a camp ground.
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(For Instructor Use Only)
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EXERCISE 1-11 (a)
SE E E A L E L A R L SE E
Retained earnings Cost of goods sold Selling and administrative expenses Cash Notes payable Interest expense Bonds payable Inventory Sales revenue Accounts payable Common stock Income tax expense
(b)
KELLOGG COMPANY Income Statement For the Year Ended December 31, 2014 (in millions) Revenues Sales revenue ........................................... Expenses Cost of goods sold ................................... Selling and administrative expenses ...... Income tax expense ................................. Interest expense ....................................... Total expenses.................................. Net income .......................................................
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(For Instructor Use Only)
$12,575 $7,184 3,390 498 295 11,367 $ 1,208
EXERCISE 1-12 (a)
DYCKMAN CORPORATION Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash received from customers ...................... $ 50,000) Cash paid to suppliers.................................... (16,000) Net cash provided by operating activities..... $ 34,000) Cash flows from investing activities Cash paid for new equipment ........................ (28,000) Net cash used by investing activities ............ (28,000) Cash flows from financing activities Cash received from lenders ........................... 20,000 Cash dividends paid ....................................... (8,000) Net cash provided by financing activities ..... 12,000 Net increase in cash ............................................... ) 18,000 Cash at beginning of period .................................. 12,000 Cash at end of period ............................................. $ 30,000
(b) As a creditor, I would feel reasonably confident that Dyckman has the ability to repay its lenders. During 2014, Dyckman generated $34,000 of cash from its operating activities. This amount more than covered its expenditures for new equipment but not both equipment purchases and dividends.
.
(For Instructor Use Only)
1-23
EXERCISE 1-13 (a)
SOUTHWEST AIRLINES Statement of Cash Flows For the Year Ended December 31, 2014 (in millions) Cash flows from operating activities Cash received from customers ......................... Cash paid for goods and services .................... Net cash provided by operating activities ........ Cash flows from investing activities Cash paid for property and equipment ............. Net cash used by investing activities ............... Cash flows from financing activities Cash received from issuance of long-term debt ................................................. Cash received from issuance of common stock ................................................ Cash paid for repurchase of common stock ..... Cash paid for repayment of debt ....................... Cash paid for dividends ..................................... Net cash used by financing activities ................ Net increase in cash ................................................. Cash at beginning of period ..................................... Cash at end of period ...............................................
$9,823 (6,978) $2,845 (1,529) (1,529) 500 144 (1,001) (122) (14) (493) 823 1,390 $2,213
(b) Southwest reported $2,845,000,000 cash from operating activities but spent $1,529,000,000 to invest in new property and equipment. Its cash from operating activities was sufficient to finance its investing activities. Southwest supplemented the cash from operating activities by issuing long-term debt and additional shares of common stock. It used excess cash to repurchase stock, pay down debt, and pay dividends. In total, it generated more cash from operating activities than it paid for investing and financing activities resulting in a net increase in cash for 2014.
1-24
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(For Instructor Use Only)
EXERCISE 1-14 EDMINSON COMPANY Balance Sheet December 31, 2014 Assets Cash .............................................................................. Accounts receivable .................................................... Supplies ........................................................................ Equipment .................................................................... Total assets ..................................................................
$18,000 12,000 9,500 40,000 $79,500
Liabilities and Stockholders’ Equity Liabilities Accounts payable................................................. Stockholders’ equity Common stock ..................................................... Retained earnings ................................................ Total liabilities and stockholders’ equity ...................
$16,000 $40,000 23,500*
63,500 $79,500
*$31,500 – $8,000
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(For Instructor Use Only)
1-25
EXERCISE 1-15 All dollars are in millions. (a) Assets Cash ........................................................................................... $ 2,291.1 Accounts receivable ................................................................. 2,883.9 Inventory ................................................................................... 2,357.0 Equipment ................................................................................. 1,957.7 Buildings ................................................................................... 3,759.9 Total assets ............................................................................... $13,249.6 Liabilities Notes payable ........................................................................... $ 342.9 Accounts payable ..................................................................... 2,815.8 Mortgage payable ..................................................................... 1,311.5 Income taxes payable ............................................................... 86.3 Total liabilities ........................................................................... $ 4,556.5 Stockholders’ Equity Common stock .......................................................................... $ 2,874.2 Retained earnings ..................................................................... 5,818.9 Total stockholders’ equity........................................................ $ 8,693.1 (b)
Assets $13,249.6
=
Liabilities $4,556.5
+
Stockholders’ Equity $8,693.1
(c) Nike has relied more heavily on equity than debt to finance its assets. Debt (liabilities) financed 34% of its assets ($4,556.5 ÷ $13,249.6) compared to equity financing of 66% ($8,693.1 ÷ $13,249.6).
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(For Instructor Use Only)
EXERCISE 1-16 (a)
Assets $110,000 (a)
= = =
Liabilities $70,000 $40,000
+ +
Stockholders’ Equity (a)
(b)
Assets (b) (b)
= = =
Liabilities $120,000 $180,000
+ +
Stockholders’ Equity $60,000
(c)
Beginning Stockholders’ Equity $40,000(a)
+
Revenues –
+
215,000 $ 90,000
– –
Expenses
– Dividends
=
165,000 (c) (c)
– (c)
= = =
Ending Stockholders’ Equity $60,000 $60,000 $30,000
(d)
Assets $150,000 (d)
= = =
Liabilities (d) $80,000
+ +
Stockholders’ Equity $70,000
(e)
Assets $180,000 (e)
= = =
Liabilities $ 55,000 $125,000
+ +
Stockholders’ Equity (e)
(f)
Beginning Stockholders’ Equity $70,000 (f)
+
Revenues –
+ =
(f) $140,000
–
Expenses
– Dividends
=
80,000
– 5,000
=
Ending Stockholders’ Equity $125,000(e)
EXERCISE 1-17 (a) (b) (c) (d) (e) (f)
.
Financial statements Auditor’s opinion Notes to the financial statements Financial statements Management discussion and analysis Not disclosed
(For Instructor Use Only)
1-27
SOLUTIONS TO PROBLEMS PROBLEM 1-1A
(a) The concern over legal liability would make the corporate form a better choice over a partnership. Also, the corporate form will allow the business to raise cash more easily, which may be of importance in a rapidly growing industry. (b) AI should run his business as a sole proprietor. He has no real need to raise funds, and he doesn’t need the expertise provided by other partners. The sole proprietorship form would provide the easiest form. One should avoid a more complicated form of business unless the characteristics of that form are needed. (c) The fact that the combined business expects that it will need to raise significant funds in the near future makes the corporate form more desirable in this case. (d) It is likely that this business would form as a partnership. Its needs for additional funds would probably be minimal in the foreseeable future. Also, the three know each other well and would appear to be contributing equally to the firm. Service firms, like consulting businesses, are frequently formed as partnerships. (e) One way to ensure control would be for Jack to form a sole proprietorship. However, in order for this business to thrive it will need a substantial investment of funds early. This would suggest the corporate form of business. In order for Jack to maintain control over the business he would need to own more than 50 percent of the voting shares of common stock. In order for the business to grow, he may have to be willing to give up some control.
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(For Instructor Use Only)
PROBLEM 1-2A
(a) In deciding whether to extend credit for 30 days, The North Face would be most interested in the balance sheet because the balance sheet shows the assets on hand that would be available for settlement of the debt in the near-term. (b) In purchasing an investment that will be held for an extended period, the investor must try to predict the future performance of Amazon.com. The income statement provides the most useful information for predicting future performance. (c) In extending a loan for a relatively long period of time, the lender is most interested in the probability that the company will generate sufficient income to meet its interest payments and repay its principal. The lender would therefore be interested in predicting future net income using the income statement. It should be noted, however, that the lender would also be very interested in both the balance sheet and statement of cash flows—the balance sheet because it would show the amount of debt the company had already incurred, as well as assets that could be liquidated to repay the loan. And the company would be interested in the statement of cash flows because it would provide useful information for predicting the company’s ability to generate cash to repay its obligations. (d) The president would probably be most interested in the statement of cash flows since it shows how much cash the company generates and how that cash is used. The statement of cash flows can be used to predict the company’s future cash-generating ability.
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(For Instructor Use Only)
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PROBLEM 1-3A
(a)
HIGHTOWER SERVICE CO. Income Statement For the Month Ended June 30, 2014 Revenues Service revenue ............................................... Expenses Salaries and wages expense........................... Supplies expense ............................................ Maintenance and repairs expense .................. Advertising expense ........................................ Utilities expense .............................................. Total expenses ......................................... Net income ................................................................
$7,500 $1,400 1,000 600 400 300 3,700 $3,800
HIGHTOWER SERVICE CO. Retained Earnings Statement For the Month Ended June 30, 2014 Retained earnings, June 1 ....................................................... Add: Net income .................................................................... Less: Dividends ....................................................................... Retained earnings, June 30 .....................................................
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(For Instructor Use Only)
$ 0 3,800 3,800 1,400 $2,400
PROBLEM 1-3A (Continued) HIGHTOWER SERVICE CO. Balance Sheet June 30, 2014 Assets Cash ........................................................................... Accounts receivable ................................................. Supplies ..................................................................... Equipment ................................................................. Total assets ...............................................................
$ 4,600 4,000 2,400 26,000 $37,000
Liabilities and Stockholders’ Equity Liabilities Notes payable .................................................... Accounts payable .............................................. Total liabilities ............................................ Stockholders’ equity Common stock................................................... Retained earnings ............................................. Total liabilities and stockholders’ equity ....................
$12,000 500 $12,500 22,100 2,400
24,500 $37,000
(b) Hightower had a very successful first month, earning $3,800 or 51% of service revenues ($3,800 ÷ $7,500). Its net income represents a 17% return on the initial investment ($3,800 ÷ $22,100). (c) Distributing a dividend after only one month of operations is probably unusual. Most new businesses choose to build up a cash balance to provide for future operating and investing activities or pay down debt. Hightower distributed 37% ($1,400 ÷ $3,800) of its first month’s income but it had adequate cash to do so and still showed a significant increase in retained earnings.
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(For Instructor Use Only)
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PROBLEM 1-4A
(a) Wenger Corporation should include the following items in its statement of cash flows: Cash paid to suppliers Cash dividends paid Cash paid to purchase equipment Cash received from customers Cash received from issuing common stock WENGER CORPORATION Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash received from customers ........................ $132,000) Cash paid to suppliers ...................................... (104,000) Net cash provided by operating activities ....... $28,000) Cash flows from investing activities Cash paid to purchase equipment ................... (12,000) Net cash used by investing activities .............. (12,000) Cash flows from financing activities Cash received from issuing common stock .... 22,000) Cash dividends paid.......................................... (7,000) Net cash provided by financing activities ....... 15,000) Net increase in cash ................................................ 31,000) Cash at beginning of period.................................... 9,000 Cash at end of period .............................................. $40,000 (b) Wenger Corporation’s operating activities provided $28,000 cash which was adequate to fund its investing activities ($12,000) and make ($7,000) of dividend payments.
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(For Instructor Use Only)
PROBLEM 1-5A
(a) 1.
Since the boat actually belongs to Bill Jensen—not to Merando Corporation—it should not be reported on the corporation’s balance sheet. Likewise, the boat loan is a personal loan of Bill’s— not a liability of Merando Corporation.
2.
The inventory should be reported at $25,000, the amount paid when it was purchased. Merando Corporation will record $36,000 as revenues when the inventory is sold.
3.
The $10,000 receivable is not an asset of Merando Corporation— it is a personal asset of Bill Jensen.
(b)
MERANDO CORPORATION Balance Sheet December 31, 2014 Assets Cash ......................................................................... Accounts receivable ............................................... Inventory .................................................................. Total assets .............................................................
$20,000* 40,000* 25,000* $85,000*
Liabilities and Stockholders’ Equity Liabilities Notes payable ..................................................... Accounts payable ............................................... Total liabilities ......................................................... Stockholders’ equity ............................................... Total liabilities and stockholders’ equity ...............
$15,000 30,000
* $45,000* 40,000** $85,000*
**$50,000 – $10,000 **$85,000 – $45,000 (Total assets minus total liabilities)
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(For Instructor Use Only)
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PROBLEM 1-1B
(a) Randy should run his business as a sole proprietor. He has no real need to raise funds, and he doesn’t need the expertise provided by other partners. The sole proprietorship form would provide the easiest form. One should avoid a more complicated form of business unless the characteristics of that form are needed. (b) The fact that the combined business expects that it will need to raise significant funds in the near future makes the corporate form more desirable in this case. (c) The concern over legal liability would make the corporate form a better choice over a partnership. Also, the corporate form will allow the business to raise cash more easily, which may be of importance in a rapidly growing industry. (d) One way to ensure control would be for Marty to form a sole proprietorship. However, in order for this business to thrive it will need a substantial investment of funds early. This would suggest the corporate form of business. In order for Marty to maintain control over the business she would need to own more than 50 percent of the voting shares of common stock. In order for the business to grow, she may have to be willing to give up some control. (e) It is likely that this business would form as a partnership. Its needs for additional funds would probably be minimal in the foreseeable future. Also, the two know each other well and would appear to be contributing equally to the firm. Service firms, like consulting businesses, are frequently formed as partnerships.
1-34
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(For Instructor Use Only)
PROBLEM 1-2B
(a) In purchasing an investment that will be held for an extended period, the investor must try to predict the future performance of 24/7 Fitness. The income statement provides the most useful information for predicting future performance. (b) In deciding whether to extend credit for 60 days Xerox would be most interested in the balance sheet because the balance sheet shows the assets on hand that would be available for settlement of the debt in the near-term. (c) The president would probably be most interested in the statement of cash flows since it shows how much cash the company generates and how that cash is used. The statement of cash flows can be used to predict the company’s future cash-generating ability. (d) In extending a loan for a relatively long period of time the lender is most interested in the probability that the company will generate sufficient income to meet its interest payments and repay its principal. The lender would therefore be interested in predicting future income using the income statement. It should be noted, however, that the lender would also be very interested in both the balance sheet and the statement of cash flows—the balance sheet because it would show the amount of debt the company had already incurred, as well as assets that could be liquidated to repay the loan. And the company would be interested in the statement of cash flows because it would provide useful information for predicting the company’s ability to generate cash to repay its obligations.
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(For Instructor Use Only)
1-35
PROBLEM 1-3B
SHAW’S GARDEN Income Statement For the Month Ended May 31, 2014
(a)
Revenues Service revenue .................................. Expenses Maintenance and repairs expense ..... Salaries and wages expense .............. Advertising expense ........................... Insurance expense .............................. Total expenses ............................. Net income ..................................................
$10,400 $2,100 1,900 1,800 400 6,200 $ 4,200
SHAW’S GARDEN Retained Earnings Statement For the Month Ended May 31, 2014 Retained earnings, May 1 ......................................................... Add: Net income ..................................................................... Less: Dividends ....................................................................... Retained earnings, May 31 .......................................................
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(For Instructor Use Only)
$ 0 4,200 4,200 1,600 $2,600
PROBLEM 1-3B (Continued) SHAW’S GARDEN Balance Sheet May 31, 2014 Assets Cash ........................................................................ Accounts receivable .............................................. Equipment .............................................................. Total assets ............................................................
$10,800 8,400 58,800 $78,000
Liabilities and Stockholders’ Equity Liabilities Notes payable ................................................. Accounts payable ........................................... Total liabilities ........................................ Stockholders’ equity Common stock ................................................ Retained earnings ........................................... Total liabilities and stockholders’ equity .............
$26,000 4,400 $30,400 45,000 2,600
47,600 $78,000
(b) Shaw’s Garden was very profitable during its first month of operations. Net income of $4,200 represents a 9.3% return on the $45,000 investment as well as 40.4% of service revenues ($4,200 ÷ $10,400). (c) Many companies choose to “reinvest” in themselves by building up a larger balance in retained earnings rather than distributing dividends as soon as income is earned so Shaw’s Garden decision might be seen as risky. Lenders might view such an action negatively since Shaw’s Garden owes $26,000 in notes payable. On the other hand, the company still “retained” more than 62% of its earnings ($4,200) and it had adequate cash to cover the $1,600 dividend.
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(For Instructor Use Only)
1-37
PROBLEM 1-4B
(a) Preacher Corporation should include the following items in its statement of cash flows: Cash paid to suppliers Cash dividends paid Cash paid to purchase equipment Cash received from customers Cash received from issuing bonds payable PREACHER CORPORATION Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash received from customers........................ Cash paid to suppliers ..................................... Net cash provided by operating activities ...... Cash flows from investing activities Cash paid to purchase equipment .................. Net cash used by investing activities.............. Cash flows from financing activities Cash received from issuing bonds payable ... Cash dividends paid ......................................... Net cash provided by financing activities ....... Net increase in cash ................................................ Cash at beginning of period.................................... Cash at end of period ..............................................
$162,000 (154,000) $8,000 (20,000) (20,000) 40,000 (2,000) 38,000 26,000 11,000 $37,000
(b) Operating activities provided $8,000 cash, which was not adequate to cover $20,000 needed for investing activities and $2,000 of dividend payments. Preacher issued $40,000 of bonds payable to fund these cash payments and increase its year-end cash balance.
1-38
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(For Instructor Use Only)
PROBLEM 1-5B
(a) 1.
The $3,000 of revenue that the company earned in 2013 should not be included in the 2014 revenues. Instead, the $3,000 should be added to the beginning balance of retained earnings to correct for the omission in 2013.
2.
Since the corporation did not incur or pay the $10,000 of rent expense, it should not be included in the income statement. Including the $10,000 as an expense misstates the corporation’s net income and presents misleading results.
3.
Including the $6,000 as vacation expense misstates the corporation’s net income.
(b)
WALTERS CORPORATION Income Statement For the Year Ended December 31, 2014 Revenue ($40,000 – $3,000)* .................................................... Expenses Insurance expense ........................................................... Net income ................................................................................
$37,000 7,000 $30,000
*John incorrectly included revenue of $3,000 in 2014. This revenue should have been reported in 2013.
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(For Instructor Use Only)
1-39
CCC1
CONTINUING COOKIE CHRONICLE
(a) Natalie has a choice between a sole proprietorship and a corporation. A partnership is not an option since she is the sole owner of the business. A proprietorship is easier to create and operate because there are no formal procedures involved in creating the proprietorship. However, if she operates the business as a proprietorship she will personally have unlimited liability for the debts of the business. Operating the business as a corporation would limit her liability to her investment in the business. Natalie will in all likelihood require the services of a lawyer to incorporate. Costs to incorporate as well as additional ongoing costs to administrate and operate the business as a corporation may be costly. Also, her taxes would be higher if she incorporates. (b) Yes, Natalie will need accounting information to help her operate her business. She will need information concerning her cash balance on a daily or weekly basis to help her determine if she can pay her bills. She will need to know the cost of her services so she can establish her prices. She will need to know revenue and expenses so she can report her net income for personal income tax purposes, on an annual basis. If she borrows money, she will need financial statements so lenders can assess the liquidity, solvency, and profitability of the business. Natalie would also find financial statements useful to better understand her business and identify any financial issues as early as possible. Monthly financial statements would be best because they are more timely, but they are also more work to prepare. (c) Assets: Cash, Accounts Receivable, Supplies, Equipment, Prepaid Insurance Liabilities: Accounts Payable, Unearned Service Revenue, Notes Payable Revenue: Service Revenue Expenses: Advertising Expense, Supplies Expense, Rent Expense, Utilities Expense, Insurance Expense
1-40
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(For Instructor Use Only)
CONTINUING COOKIE CHRONICLE (Continued) (d) Natalie should have a separate bank account. This will make it easier to prepare financial statements for her business. The business is a separate entity from Natalie and must be accounted for separately. (e) I recommend that Natalie keep the car as a personal asset and pay for all costs personally. She should keep track of how many miles she drives for business purposes versus personal use and determine the percentage of business use versus personal use. She should keep track of all costs of owning and operating her car including such things as fuel, insurance, registration, and repairs and maintenance. Then she can multiply the percentage of business use by the total cost of owning and operating her car to calculate the amount of expense the business can record for travel. The business will record this as an expense. Natalie can either reimburse herself for these business expenses by taking cash out of the business to pay for these costs or she can treat it as an investment in the business. [Note to instructors: This last question is fairly complex and there are income tax considerations. This suggested solution does not cover all of the issues that should be considered. The intent is just to ensure students begin to think about how to deal with a fairly common issue for self-employed people.]
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(For Instructor Use Only)
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BYP 1-1
FINANCIAL REPORTING PROBLEM
(a) Tootsie Roll’s total assets at December 31, 2011 were $857,856,000 and at December 31, 2010 were $857,959,000. (b) Tootsie Roll had $78,612,000 of cash at December 31, 2011. (c) Tootsie Roll had accounts payable totaling $10,683,000 on December 31, 2011 and $9,791,000 on December 31, 2010. (d) Tootsie Roll reported total revenues in 2011 of $532,505,000 and in 2010 of $521,448,000. (e) Tootsie Roll’s net income decreased by $9,125,000 from 2010 to 2011, from $53,063,000 to $43,938,000.
1-42
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(For Instructor Use Only)
BYP 1-2
COMPARATIVE ANALYSIS PROBLEM
(a) (amounts in thousands) 1. Total assets 2. Net property, plant and equipment 3. Total revenue 4. Net income
Tootsie Roll Industries, Inc. $857,856
The Hershey Company $4,412,199
$212,162 $532,505 $ 43,938
$1,559,717 $6,080,788 $ 628,962
(b) Both companies are profitable. Hershey’s total assets and total revenues suggest that it is a substantially bigger company than Tootsie Roll. Hershey’s total assets are more than five times as big as those of Tootsie Roll and its total revenues are more than 11 times as big as those of Tootsie Roll.
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(For Instructor Use Only)
1-43
BYP 1-3
RESEARCH CASE
(a) The ideas that the Public Company Accounting Oversight Board proposed for expanding the role of auditors in “passing judgement on more of what a company does and says” include weighing in on the quality of a company’s disclosures in its earnings releases and commenting on what the company says in its Management’s Discussion and Analysis section of its annual report. (b) Many people were surprised by the fact that many of the financial institutions that failed or required government support received “clean” audit opinions shortly before they announced their troubles. This caused some people to think that auditors should reveal more specific information. (c) The proposed Auditor’s Discussion and Analysis report would include information about the auditor’s views on the company’s use of judgments, estimates and accounting policies. The auditor would also discuss whether it believes the company’s financial reporting practices are aggressive. (d) It is likely that auditors would have mixed opinions of these proposals. On-the-one-hand, the expansion of the auditor’s role would create new revenue opportunities for auditors. However, the expansion of duties could very well create additional tension between the auditor and the client. Since the company is actually the one that hires the auditor, auditors might be reluctant to reveal too much. Also, many of these new duties appear to be less clearly defined than expressing an opinion on whether statements are presented in accordance with GAAP. This lack of clearly defined criteria could increase the auditor’s legal exposure.
1-44
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(For Instructor Use Only)
BYP 1-4
INTERPRETING FINANCIAL STATEMENTS
(a) Creditors lend money to companies with the expectation that they will be repaid at a specified point in time in the future. If a company is generating cash from operations in excess of its investing needs, it is more likely that it will be able to repay its creditors. Not only did Xerox actually have negative cash from operations, but all of the cash it received in order to meet its cash deficiency was from issuing new debt. Both of these facts would be of concern to the company’s creditors, since it would suggest it will be less likely to be able to repay its debts. (b) As a stockholder you are interested in the long-term performance of a company and how that translates into its stock price. Often during the early years of a company’s life its cash provided by operations is not sufficient to meet its investment needs, so the company will have to get cash from outside sources. However, in the case of Xerox, the company has operated for many years and has a wellestablished name brand. The negative cash from operations might suggest operating deficiencies. (c) The statement of cash flows reports information on a cash basis. An investor cannot get the complete story on the company’s performance and financial position without looking at the income statement and balance sheet. Also, investors would want to look at more than one year’s worth of data. The current year might not be representative of past or future years. (d) Xerox is a well known company. It has a past record of paying dividends. Its management probably decided to continue to pay a dividend to demonstrate confidence in the company’s future. They may have felt that by not paying the dividend for the year they would send a negative message to investors. However, by choosing to pay a cash dividend the company obviously weakened its cash position, and decreased its ability to repay its debts.
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(For Instructor Use Only)
1-45
BYP 1-5
REAL-WORLD FOCUS
Answers to this question will differ depending on the companies chosen by the student, and the year. We provide the following solution for Tootsie Roll for the year ended December 31, 2011. (a) During the year ended December 31, 2011, Tootsie Roll reported net income of $43.9 million. (b) During the year ended December 31, 2011, Tootsie Roll reported sales of $532.5 million. (c) The “Industry” label on the left side of the Profile site tells us that Tootsie Roll is in the Confectioners industry. (d) Companies also in this industry would include The Hershey Company, Cosan Ltd., Paradise Inc., Imperial Sugar Co., and Rocky Mountain Chocolate Factory Inc. (e) We chose Imperial Sugar Co. During the year ended September 30, 2011, Imperial reported sales of $848.0 million and net loss of $53.4 million.
1-46
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(For Instructor Use Only)
BYP 1-6
DECISION-MAKING ACROSS THE ORGANIZATION
(a) The Report of Independent Accountants indicates that PriceWaterhouse Coopers LLP performed the audit of Tootsie Roll’s financial statements. (b) The Consolidated Statement of Earnings, Comprehensive Earnings and Retained Earnings states that its earnings per share were $0.76 in 2011. (c) Note 9 indicates that net sales in foreign countries were $41,184,000 in 2011. (d) Earnings from operations were $57,966 in 2011 compared to $64,710 in 2010, a decrease of $6,744. Earnings from operations includes $29 and $3,364 in certain deferred compensation expenses in 2011 and 2010, respectively. As discussed above, these deferred compensation expenses relate to changes in deferred compensation liabilities resulting from corresponding changes in the market value of trading securities and related investment income that hedge these liabilities. Adjusting for these deferred compensation expenses, operating earnings were $57,995 and $68,074 in 2011 and 2010, respectively, a decrease of $10,079 or 14.8%. This decrease in earnings from operations principally reflects significantly higher ingredient costs and resulting lower gross profit margins, as well as higher freight and delivery expenses. Management believes this comparison after adjusting for changes in deferred compensation is more reflective of the underlying operations of the company. (e) Per the Five Year Summary of Earnings and Financial Highlights, Net Sales in 2007 were $492,742,000. (f) The Shareholders’ Equity section of the Consolidated Statement of Financial Position states that 40,000,000 shares were authorized. (g) Per the Consolidated Statement of Cash Flows, $16,351,000 was spent on capital expenditures. (h) Note 1 states that depreciation is based on “useful lives of 20 to 35 years for buildings.” (i) Per the Consolidated Statement of Financial Position, raw materials and supplies were $21,236,000 in 2010.
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(For Instructor Use Only)
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BYP 1-7
COMMUNICATION ACTIVITY
To:
Lori Milner
From:
Student
I have received the balance sheet of Philco Company, Inc. as of December 31, 2014. The purpose of a balance sheet is to report a company’s financial position at a point in time. It reports what the company owns (assets) and what it owes (liabilities) and the net amount attributed to owners (equity). A number of items in this balance sheet are not properly reported. They are: (1) The balance sheet should be dated as of a specific date, not for a period of time. Therefore, it should be stated “December 31, 2014.” (2) Equipment should be below Supplies on the balance sheet. (3) Accounts receivable should be shown as an asset and reported between Cash and Supplies on the balance sheet. (4) Accounts payable should be shown as a liability, not an asset. Therefore, it should be reported in the liability section, after note payable. (5) Liabilities and stockholders’ equity should be shown separately on the balance sheet. Common stock, Retained earnings, and Dividends are not liabilities. (6) Common stock, Retained earnings, and Dividends are part of stockholders’ equity. The Dividends account is not reported on the balance sheet but is subtracted from beginning retained earnings to arrive at the ending balance. A correct balance sheet is as follows:
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(For Instructor Use Only)
BYP 1-7 (Continued) PHILCO COMPANY, INC. Balance Sheet December 31, 2014 Assets Cash ............................................................................... Accounts receivable ..................................................... Supplies ......................................................................... Equipment ..................................................................... Total assets ...................................................................
$ 9,000 6,000 1,000 18,000 $34,000
Liabilities and Stockholders’ Equity Liabilities Notes payable ....................................................... Accounts payable................................................. Total liabilities ............................................... Stockholders’ equity Common stock ..................................................... Retained earnings ................................................ Total liabilities and stockholders’ equity ................... *Retained earnings ...................................................... *Less: Dividends ......................................................... *Ending retained earnings ...........................................
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(For Instructor Use Only)
$10,000 4,000 $14,000 12,000 8,000*
20,000 $34,000
$10,000 2,000 $ 8,000
1-49
BYP 1-8
ETHICS CASE
(a) Investors rely on auditors to perform an independent assessment of a company. If the auditor owns stock in that company, he or she might not be able to act in an independent and impartial manner. (b) There are pros and cons to this argument. On the positive side, it could be argued that as long as a person has no direct relationship with a client company, that person will not influence the findings of the work. However, a counter argument is that an influential partner within a firm, who had a investment in a client that he or she didn’t work on, might be tempted to try to influence the findings of the audit if he or she feared that the findings were going to negatively affect the value of his or her investment. (c) The fact that four firms have become so big means that prohibiting employees of those accounting firms from buying stock in clients of the firm would bar those employees from investing in roughly 25% of publicly traded firms. Some have argued that such restrictive rules would create undue hardship, and unfairly restrict the investment options of these people. They also argue that in such a large organization it is increasingly unlikely that an individual who does not work on a particular audit will be able to influence the outcome of that audit. As a consequence, rules that focus on restricting investments by those employees actually involved in the audit of a client may be most reasonable and most effective. (d) Answers to this question will vary. This is a particularly difficult issue since the rule effectively eliminates the individual’s control over their investment portfolio. They did nothing wrong when they bought the shares, but now they are being forced to sell when it is not advantageous. (e) The management of PricewaterhouseCoopers noted that auditor independence is vitally important to the audit function. If investors don’t think the auditor is independent of the client they will lose faith in auditing, which would have dire consequences for securities markets. Therefore, it was important that the firm make a bold, unambiguous response to address this problem. 1-50
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(For Instructor Use Only)
BYP 1-9 (a)
ALL ABOUT YOU
Answers to the following will vary depending on students’ opinions. (i)
This does not represent the hiding of assets, but rather a choice as to the order of use of assets. This would seem to be ethical. (ii) This does not represent the hiding of assets, but rather is a change in the nature of assets. Since the expenditure was necessary, although perhaps accelerated, it would seem to be ethical. (iii) This represents an intentional attempt to deceive the financial aid office. It would therefore appear to be both unethical and potentially illegal. (iv) This is a difficult issue. By taking the leave, actual net income would be reduced. The form asks the applicant to report actual net income. However, it is potentially deceptive since you do not intend on taking unpaid absences in the future, thus future income would be higher than reported income. (b)
Companies might want to overstate net income in order to potentially increase the stock price by improving investors’ perceptions of the company. Also, a higher net income would make it easier to receive debt financing. Finally, managers would want a higher net income to increase the size of their bonuses.
(c)
Sometimes companies want to report a lower income if they are negotiating with employees. For example, professional sports teams frequently argue that they cannot increase salaries because they aren’t making enough money. This also occurs in negotiations with unions. For tax accounting (as opposed to the financial accounting in this course) companies frequently try to minimize the amount of reported taxable income.
(d)
Unfortunately many times people who are otherwise very ethical will make unethical decisions regarding financial reporting. They might be driven to do this because of greed. Frequently it is because their superiors have put pressure on them to take an unethical action, and they are afraid to not follow directions because they might lose their job. Also, in some instances top managers will tell subordinates that they should be a team player, and do the action because it would help the company, and therefore would help fellow employees.
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(For Instructor Use Only)
1-51
BYP1-11
CONSIDERING PEOPLE, PLANT AND PROFIT
(a)
The 5 aspirations relate to the company’s goals related to sustaining its business, its brands, its people, its community and the planet.
(b)
The annual reports discussed in the chapter report on a company’s financial results and financial position. Financial annual reports have a format and content that follows requirements specified by accounting regulators. The primary contents of a financial annual report is the company’s financial statements, which are audited by independent accountants. The Clif Bar & Company Annual Report describes the company's goals and results related to its 5 aspirations. The report does not follow a prescribed format, but instead can take whatever form, and include any content that the company chooses. The report is not audited by an outside body.
(c)
i.
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Support sustainable food and agriculture: Purchased 170 million pounds of organic ingredients since the company’s inception. ii. Embrace zero waste business practices: Caddies are 100% shrink-wrap free and made from 100% recycled paperboard. iii. Promote climate action and renewable energy: Installed largest “smart” solar array in North America that provides nearly all of its electrical needs. iv. Conserve natural resources, protect wild places: Planted 40,000 trees in partnership with American Forests.
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(For Instructor Use Only)
IFRS CONCEPTS AND APPLICATION
IFRS1-1 The International Accounting Standards Board, IASB, and the Financial Accounting Standards Board, FASB, are two key players in developing international accounting standards. The IASB releases international standards known as International Financial Reporting Standards (IFRS). The FASB releases US standards, referred to a Generally Accepted Accounting Standards or GAAP. IFRS1-2 Accounting standards have developed in different ways because the standard setters have responded to different user needs. In some countries, the primary users of financial statements are private investors; in others the primary users are taxing authorities or central government planners. IFRS1-3 A single set of high-quality accounting standards is needed because of increases in multinational corporations, mergers and acquisitions, use of information technology, and international financial markets. IFRS1-4 Currently the internal control standards applicable to Sarbanes-Oxley (SOX) apply only to large public companies listed on U.S. exchanges. If such standards were adopted by non-U.S. companies, users of statements would benefit from more uniform regulation and U.S. companies would be competing on a more “even” playing field. The disadvantage of adopting SOX would be the additional cost associated with its required internal control measures.
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(For Instructor Use Only)
1-53
IFRS1-5
(a) (b) (c) (d) (e)
1-54
INTERNATIONAL FINANCIAL REPORTING PROBLEM
Grant Thornton UK LLP Note 3.10 states that straight line depreciation is used for freehold buildings at a rate of 2% per period. A 2% rate indicates a 50 year life. 1000 Highgate Studios, 53-79 Highgate Road, London, NW5 1TL The company reports in sterling (pounds). The company operates in Confectionary which had sales of L85,861 and Natural Snacks which had sales of L49,137.
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(For Instructor Use Only)
CHAPTER 2 A Further Look at Financial Statements Learning Objectives 1. 2. 3.
Identify the sections of a classified balance sheet. Identify tools for analyzing financial statements and ratios for computing a company’s profitability. Explain the relationship between a retained earnings statement and a statement of stockholders’ equity. Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet. Use the statement of cash flows to evaluate solvency. Explain the meaning of generally accepted accounting principles. Discuss financial reporting concepts.
4. 5. 6. 7.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item 1. 2. 3. 4. 5.
1 1 1 1 1
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Item
K K C C K
LO
6. 2, 4, 5 7. 2, 4, 5 8. 4 9. 4, 5
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
C K C C
Questions 10. 4, 5 K 11. 2, 4, 5 C 12. 6 K 13. 6, 7 K
14. 15. 16. 17.
7 7 7 6
C C C C
18. 19. 20.
7 7 1
C C C
7 7
K K
11.
7
K
7
K
10. 11.
4 4, 5
AP AP
12. 13.
7 7
K C
7.
2, 4, 5
8.
6, 7
E
AP
2, 4, 5
8.
6, 7
E
AP
Brief Exercises 7. 6 K 8. 7 K
1. 2. 3.
1 1 2
K AP AP
4. 5. 6.
3 4 4, 5
1.
1
AP
2.
1
K 9. AP 10. AP Do It! Review Exercises AP 3. 4, 5 K 4.
1 1 1
Exercises 7. 2 AP 8. 1, 3, 4 AP 9. 4 AP
1. 2. 3. 1. 2.
1. 2.
.
LO
1 1 1 1 1, 3
1 1, 3
AP AP AP AP AP
AP AP
(For Instructor Use Only)
4. 5. 6. 3. 4.
3. 4.
1, 3 2, 4, 5 1, 3 2, 4, 5
AP AP AP AP
AN AP AN
Problems: Set A 5. 2, 4, 5 AP 6. 2, 4, 5 AP Problems: Set B 5. 2, 4, 5 AP 6. 2, 4, 5 AP
7.
2-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
2-2
Description
Difficulty Level
Time Allotted (min.)
1A
Prepare a classified balance sheet.
Simple
10–20
2A
Prepare financial statements.
Moderate
20–30
3A
Prepare financial statements.
Moderate
20–30
4A
Compute ratios; comment on relative profitability, liquidity, and solvency.
Moderate
20–30
5A
Compute and interpret liquidity, solvency, and profitability ratios.
Simple
10–20
6A
Compute and interpret liquidity, solvency, and profitability ratios.
Moderate
15–25
7A
Compute ratios and compare liquidity, solvency, and profitability for two companies.
Moderate
15–25
8A
Comment on the objectives and qualitative characteristics of financial reporting.
Simple
10–20
1B
Prepare a classified balance sheet.
Simple
10–20
2B
Prepare financial statements.
Moderate
20–30
3B
Prepare financial statements.
Moderate
20–30
4B
Compute ratios; comment on relative profitability, liquidity, and solvency.
Moderate
20–30
5B
Compute and interpret liquidity, solvency, and profitability ratios.
Simple
10–20
6B
Compute and interpret liquidity, solvency, and profitability ratios.
Moderate
15–25
7B
Compute ratios and compare liquidity, solvency, and profitability for two companies.
Moderate
15–25
8B
Comment on the objectives and qualitative characteristics of accounting information.
Simple
10–20
.
(For Instructor Use Only)
ANSWERS TO QUESTIONS 1.
A company’s operating cycle is the average time that is required to go from cash to cash in producing revenue.
2.
Current assets are assets that a company expects to convert to cash or use up within one year of the balance sheet date or the company’s operating cycle, whichever is longer. Current assets are listed in the order in which they are expected to be converted into cash.
3.
Long-term investments are investments in stocks and bonds of other companies where the conversion into cash is not expected within one year or the operating cycle, whichever is longer and plant assets not currently in operational use. Property, plant, and equipment are tangible resources of a relatively permanent nature that are being used in the business and not intended for sale.
4.
Current liabilities are obligations that will be paid within the coming year or operating cycle, whichever is longer. Long-term liabilities are obligations that will be paid after one year.
5.
The two parts of stockholders’ equity and the purpose of each are: (1) Common stock is used to record investments of assets in the business by the owners (stockholders). (2) Retained earnings is used to record net income retained in the business.
6.
(a) Lorie is not correct. There are three characteristics: liquidity, profitability, and solvency. (b) The three parties are not primarily interested in the same characteristics of a company. Short-term creditors are primarily interested in the liquidity of the company. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company.
7.
(a) Liquidity ratios: Working capital and current ratio. (b) Solvency ratios: Debt to assets and free cash flow. (c)
Profitability ratio: Earnings per share.
8.
Debt financing is riskier than equity financing because debt must be repaid at specific points in time, whether the company is performing well or not. Thus, the higher the percentage of assets financed by debt, the riskier the company.
9.
(a) Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. (b) Profitability ratios measure the income or operating success of a company for a given period of time. (c)
.
Solvency ratios measure the company’s ability to survive over a long period of time.
(For Instructor Use Only)
2-3
Questions Chapter 2 (Continued) 10.
(a) The increase in earnings per share is good news because it means that profitability has improved. (b) An increase in the current ratio signals good news because the company improved its ability to meet maturing short-term obligations. (c)
The increase in the debt to assets ratio is bad news because it means that the company has increased its obligations to creditors and has lowered its equity “buffer.”
(d) A decrease in free cash flow is bad news because it means that the company has become less solvent. The higher the free cash flow, the more solvent the company. 11.
(a) The debt to assets ratio and free cash flow indicate the company’s ability to repay the face value of the debt at maturity and make periodic interest payments. (b) The current ratio and working capital indicate a company’s liquidity and short-term debtpaying ability. (c)
12.
Earnings per share indicates the earning power (profitability) of an investment.
(a) Generally accepted accounting principles (GAAP) are a set of rules and practices, having substantial support, that are recognized as a general guide for financial reporting purposes. (b) The body that provides authoritative support for GAAP is the Financial Accounting Standards Board (FASB).
13.
(a) The primary objective of financial reporting is to provide information useful for decision making. (b) The fundamental qualitative characteristics are relevance and faithful representation. The enhancing qualities are comparability, consistency, verifiability, timeliness, and understandability.
14.
Jantz is correct. Consistency means using the same accounting principles and accounting methods from period to period within a company. Without consistency in the application of accounting principles, it is difficult to determine whether a company is better off, worse off, or the same from period to period.
15.
Comparability results when different companies use the same accounting principles. Consistency means using the same accounting principles and methods from year to year within the same company.
16.
The cost constraint allows accounting standard-setters to weigh the cost that companies will incur to provide information against the benefit that financial statement users will gain from having the information available.
17.
Accounting standards are not uniform because individual countries have separate standardsetting bodies. Currently many non-U.S. countries are choosing to adopt International Financial Reporting Standards (IFRS). It appears that accounting standards in the United States will move toward compliance with IFRS.
2-4
.
(For Instructor Use Only)
Questions Chapter 2 (Continued) 18.
Accounting relies primarily on two measurement principles. Fair value is sometimes used when market price information is readily available. However, in many situations reliable market price information is not available. In these instances, accounting relies on historical cost as its basis.
19.
The economic entity assumption states that every economic entity can be separately identified and accounted for. This assumption requires that the activities of the entity be kept separate and distinct from (1) the activities of its owners (the shareholders) and (2) all other economic entities. A shareholder of a company charging personal living costs as expenses of the company is an example of a violation of the economic entity assumption.
20.
At December 31, 2011 Tootsie Roll’s largest current asset was Cash and Cash Equivalents of $78,612, its largest current liability is accrued liabilities of $43,069 and its largest item under other assets was trademarks of $175,024. (Note: amounts are in thousands)
.
(For Instructor Use Only)
2-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 2-1 CL Accounts payable CA Accounts receivable PPE Accumulated depreciation PPE Buildings CA Cash IA Goodwill
CL Income taxes payable LTI Investment in long-term bonds PPE Land CA Inventory IA Patent CA Supplies
BRIEF EXERCISE 2-2 MORALES COMPANY Partial Balance Sheet Current assets Cash ......................................................................................... Debt investments .................................................................... Accounts receivable ............................................................... Supplies ................................................................................... Prepaid insurance ................................................................... Total current assets ........................................................ BRIEF EXERCISE 2-3
Net income — Preferred dividends Average common shares outstanding $220 million – $0 = = $.66 per share 333 million shares
Earnings per share =
BRIEF EXERCISE 2-4 ICS DRE IRE DRE
2-6
(a) (b) (c) (d)
Issued new shares of common stock Paid a cash dividend Reported net income of $75,000 Reported net loss of $20,000
.
(For Instructor Use Only)
$10,400 8,200 14,000 3,800 2,600 $39,000
BRIEF EXERCISE 2-5 Working capital = Current assets – Current liabilities Current assets Current liabilities Working capital
($102,500,000 201,200,000 ($ 98,700,000)
Current ratio: Current assets $102,500,000 = Current liabilities $201,200,000
= .51:1 BRIEF EXERCISE 2-6 (a) Current ratio
$262,787 = 0.89:1 $293,625
(b) Debt to assets
$376,002 = 85.5% $439,832
(c) Free cash flow
$62,300 – $24,787 – $12,000 = $25,513
BRIEF EXERCISE 2-7 (a) True. (b) False. BRIEF EXERCISE 2-8 (a) (b) (c) (d) (e) (f) (g) (h) .
Predictive value. Confirmatory value. Materiality Complete. Free from error. Comparability. Verifiability. Timeliness.
(For Instructor Use Only)
2-7
BRIEF EXERCISE 2-9 (a) Relevant. (b) Faithful representation. (c) Consistency. BRIEF EXERCISE 2-10 (a) (b) (c) (d)
1. 2. 3. 4.
Predictive value. Neutral. Verifiable. Timely.
BRIEF EXERCISE 2-11 (c) SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 2-1 LONYEAR CORPORATION Balance Sheet (partial) December 31, 2014 Assets Current assets Cash .................................................................. Accounts receivable......................................... Inventory ........................................................... Supplies ............................................................ Total current assets ............................... Property, plant, and equipment Equipment ......................................................... Less: Accumulated depreciation— equipment .............................................. Total assets...............................................................
2-8
.
(For Instructor Use Only)
$ 13,000 22,000 58,000 7,000 $100,000 180,000 50,000
130,000 $230,000
DO IT! 2-2 IA CL NA CL LTI CL
Trademarks Notes payable (current) Interest revenue Income taxes payable Debt investments (long-term) Unearned sales revenue
CA PPE PPE SE NA LTL
Inventory Accumulated depreciation Land Common stock Advertising expense Mortgage payable (due in 3 years)
DO IT! 2-3 (a)
2014
2013
($80,000 – $6,000) = $1.29 (40,000 + 75,000)/2
($40,000 – $6,000) = $0.97 (30,000 + 40,000)/2
Benser’s profitability, as measured by the amount of income available for each share of common stock, increased by 33 percent (($1.29 – $0.97)/$0.97) during 2014. Earnings per share should not be compared across companies because the number of shares issued by companies varies widely. Thus, we cannot conclude that Benser Corporation is more profitable than Matile Corporation based on its higher EPS in 2014. (b)
2014
2013
Current ratio
$54,000 = 2.45:1 $22,000
$36,000 = 1.20:1 $30,000
Debt to assets ratio
$72,000 = 30% $240,000
$100,000 = 49% $205,000
The company’s liquidity, as measured by the current ratio improved from 1.20:1 to 2.45:1. Its solvency also improved, because the debt to assets ratio declined from 49% to 30%. (c) Free cash flow
2014: $90,000 – $6,000 – $3,000 – $27,000 = $54,000 2013: $56,000 – $6,000 – $1,500 – $12,000 = $36,500
The amount of cash generated by the company above its needs for dividends and capital expenditures increased from $36,500 to $54,000. .
(For Instructor Use Only)
2-9
DO IT! 2-4 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.
2-10
Monetary unit assumption Faithful representation Economic entity assumption Cost constraint Consistency Historical cost principle Relevance Periodicity assumption Full disclosure principle Materiality Going concern assumption Comparability
.
(For Instructor Use Only)
SOLUTIONS TO EXERCISES EXERCISE 2-1 CL CA PPE PPE CA CL IA CL
Accounts payable Accounts receivable Accumulated depreciation—equip. Buildings Cash Interest payable Goodwill Income taxes payable
CA CA PPE LTL CA PPE CA
Inventory Stock investments Land (in use) Mortgage payable Supplies Equipment Prepaid rent
EXERCISE 2-2 CA Prepaid advertising PPE Equipment IA Trademarks CL Salaries and wages payable CL Income taxes payable SE Retained earnings CA Accounts receivable LTI Land (held for future use)
.
(For Instructor Use Only)
IA Patents LTL Bonds payable SE Common stock PPE Accumulated depreciation—equipment CL Unearned sales revenue CA Inventory
2-11
EXERCISE 2-3 THE BOEING COMPANY Partial Balance Sheet December 31, 2014 (in millions) Assets Current assets Cash ....................................................................... Debt investments .................................................. Accounts receivable ............................................. Notes receivable ................................................... Inventory ............................................................... Total current assets ...................................... Long-term investments Notes receivable ................................................... Property, plant, and equipment Buildings ............................................................... Less: Accumulated depreciation—buildings ..... Intangible assets Patents................................................................... Total assets...................................................................
2-12
.
(For Instructor Use Only)
$ 9,215 2,008 5,785 368 16,933 $34,309 5,466 21,579 12,795
8,784 12,528 $61,087
EXERCISE 2-4 H. J. HEINZ COMPANY Partial Balance Sheet April 30, 2014 (in thousands) Assets Current assets Cash .................................................. Accounts receivable ........................ Inventory........................................... Prepaid insurance ............................ Total current assets..................
$ 373,145 1,171,797 1,237,613 125,765 $ 2,908,320
Property, plant, and equipment Land .................................................. 76,193 Buildings .......................................... $4,033,369 Less: Accumulated depreciation— Buildings .................................. 2,131,260 1,902,109 Intangible assets Goodwill .................................................. Trademarks ............................................. Total assets ............................................
.
(For Instructor Use Only)
3,982,954 757,907
1,978,302
4,740,861 $ 9,627,483
2-13
EXERCISE 2-5 DONOVAN COMPANY Balance Sheet December 31, 2014 Assets Current assets Cash ..................................................... Accounts receivable ........................... Prepaid insurance ............................... Total current assets ................................... Property, plant, and equipment Land ..................................................... Buildings ............................................. Less: Accumulated depreciation— buildings .................................. Equipment ........................................... Less: Accumulated depreciation— equipment ................................ Total assets .................................
$11,840 12,600 3,200 $ 27,640 61,200 $105,800 45,600 82,400
60,200
18,720
63,680
185,080 $212,720
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................... Current maturity of note payable ........ Interest payable .................................. Total current liabilities ................ Long-term liabilities Note payable ($93,600 – $13,600)....... Total liabilities ............................. Stockholders’ equity Common stock .................................... Retained earnings ($40,000 + $6,020*) ............................ Total stockholders’ equity .......... Total liabilities and stockholders’ equity ...........................................
$ 9,500 13,600 3,600
*Net income = $14,700 – $780 – $5,300 – $2,600 = $6,020
2-14
.
(For Instructor Use Only)
$ 26,700 80,000 106,700 60,000 46,020 106,020 $212,720
EXERCISE 2-6 TEXAS INSTRUMENTS, INC. Balance Sheet December 31, 2014 (in millions) Assets Current assets Cash ......................................................................... Debt investments ..................................................... Accounts receivable ................................................ Inventory .................................................................. Prepaid rent.............................................................. Total current assets ......................................... Long-term investments Stock investments ................................................... Property, plant, and equipment Equipment ............................................................... Less: Accumulated depreciation—equipment ..... Intangible assets Patents ..................................................................... Total assets .....................................................................
$ 1,182 1,743 1,823 1,202 164 $ 6,114 637 6,705 3,547
3,158 2,210 $12,119
Liabilities and Stockholders’ Equity Current liabilities Accounts payable .................................................... Income taxes payable .............................................. Total current liabilities ..................................... Long-term liabilities Notes payable .......................................................... Total liabilities .......................................................... Stockholders’ equity Common stock ......................................................... Retained earnings.................................................... Total stockholders’ equity ............................... Total liabilities and stockholders’ equity.......................
.
(For Instructor Use Only)
$1,459 128 $ 1,587 810 2,397 2,826 6,896 9,722 $12,119
2-15
EXERCISE 2-7
(a) Earnings per share =
Net income — Preferred dividends Average common shares outstanding
2014 :
$66,176,000 – 0 = $ 1.01 (66,282,000 + 64,507,000) / 2
2013 :
$54,587,000 – 0 = $ .78 (73,139,000+ 66, 282,000) / 2
(b) Using net income (loss) as a basis to evaluate profitability, Callaway Golf’s income improved by 21% [($66,176 – $54,587) ÷ 54,587] between 2013 and 2014. Its earnings per share increased by 29% [($1.01 – $0.78) ÷ $0.78]. (c) To determine earnings per share, dividends on preferred stock are subtracted from net income, but dividends on common stock are not subtracted.
2-16
.
(For Instructor Use Only)
EXERCISE 2-8 (a)
BARFIELD CORPORATION Income Statement For the Year Ended July 31, 2014 Revenues Service revenue............................................. Rent revenue ................................................. Total revenues ....................................... Expenses Salaries and wages expense ........................ Supplies expense .......................................... Depreciation expense ................................... Total expenses....................................... Net loss .................................................................
$66,100 8,500 $74,600 57,500 15,600 4,000 77,100 $ (2,500)
BARFIELD CORPORATION Retained Earnings Statement For the Year Ended July 31, 2014 Retained earnings, August 1, 2013 ...................... Less: Net loss ..................................................... Dividends .................................................. Retained earnings, July 31, 2014 .........................
(b)
$34,000 $2,500 4,000
6,500 $27,500
BARFIELD CORPORATION Balance Sheet July 31, 2014 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Total current assets .............................. Property, plant, and equipment Equipment ..................................................... Less: Accumulated depreciation— equipment ...................................... Total assets ...........................................................
.
(For Instructor Use Only)
$29,200 9,780 $38,980) 18,500 6,000
12,500) $51,480) 2-17
EXERCISE 2-8 (Continued) (b)
BARFIELD CORPORATION Balance Sheet (Continued) July 31, 2014 Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................................ Salaries and wages payable ........................... Total current liabilities ................................. Long-term liabilities Notes payable .................................................. Total liabilities .............................................. Stockholders’ equity Common stock ................................................. Retained earnings ............................................ Total stockholders’ equity ........................... Total liabilities and stockholders’ equity ...............
$ 4,100 2,080 $ 6,180 1,800 7,980 16,000 27,500 43,500 $51,480
$38,980 = 6.3 :1 $6,180 $7,980 Debt to assets ratio = = 15.5% $51,480
(c) Current ratio =
(d) The current ratio would not change because equipment is not a current asset and a 5-year note payable is a long-term liability rather than a current liability. The debt to assets ratio would increase from 15.5% to 39.1%*. Looking solely at the debt to assets ratio, I would favor making the sale because Barfield’s debt to assets ratio of 15.5% is very low. Looking at additional financial data, I would note that Barfield reported a significant loss for the current year which would lead me to question its ability to make interest and loan payments (and even remain in business) in the future. I would not make the proposed sale unless Barfield convinced me that it would be capable of earnings in the future rather than losses. I would also consider making the sale but requiring a substantial downpayment and smaller note. *($7,980 + $20,000) ÷ ($51,480 + $20,000)
2-18
.
(For Instructor Use Only)
EXERCISE 2-9 (a)
Beginning of Year
End of Year
Working capital
$3,361 – $1,635 = $1,726
$3,217 – $1,601 = $1,616
Current ratio
$3,361 = 2.06:1 $1,635
$3,217 = 2.01:1 $1,601
(b) Nordstrom’s liquidity decreased slightly during the year. Its current ratio decreased from 2.06:1 to 2.01:1. Also, Nordstrom’s working capital decreased by $110 million. (c) Nordstrom’s current ratio at both the beginning and the end of the recent year exceeds Best Buy’s current ratio for 2011 (and 2010). Nordstrom’s end-of-year current ratio (2.01) exceeds Best Buy’s 2011 current ratio (1.21*). Nordstrom would be considered much more liquid than Best Buy for the recent year. *(see text, pg. 57) EXERCISE 2-10
$60,000 = 2.0: 1 $30,000 Working capital = $60,000 – $30,000 = $30,000
(a) Current ratio =
$40,000* = 4.0: 1 $10,000** Working capital = $40,000 – $10,000 = $30,000
(b) Current ratio =
*$60,000 – $20,000
**$30,000 – $20,000
(c) Liquidity measures indicate a company’s ability to pay current obligations as they become due. Satisfaction of current obligations usually requires the use of current assets. If a company has more current assets than current liabilities it is more likely that it will meet obligations as they become due. Since working capital and the current ratio compare current assets to current liabilities, both are measures of liquidity. .
(For Instructor Use Only)
2-19
EXERCISE 2-10 (Continued) Payment of current obligations frequently requires cash. Neither working capital nor the current ratio indicate the composition of current assets. If a company’s current assets are largely comprised of items such as inventory and prepaid expenses it may have difficulty paying current obligations even though its working capital and current ratio are large enough to indicate favorable liquidity. In Grienke’s case, payment of $20,000 of accounts payable will leave only $5,000 cash. Since salaries payable will require $10,000, the company may need to borrow in order to make the required payment for salaries. (d) The CFO’s decision to use $20,000 of cash to pay off accounts payable is not in itself unethical. However, doing so just to improve the year-end current ratio could be considered unethical if this action misled creditors. Since the CFO requested preparation of a “preliminary” balance sheet before deciding to pay off the liabilities he seems to be “managing” the company’s financial position, which is usually considered unethical. EXERCISE 2-11 2014
$925,359 = 2.30 : 1 $401,763 $179,061 (b) Earnings per share = $0.87 205,169 (c) Debt to assets ratio $554, 645 = 28.2% $1, 963, 676
(a) Current ratio
(d) Free cash flow
2013
$1,020,834 = 2.71: 1 $376,178 $400,019 = $1.85 216,119 $527, 216 $1, 867, 680
= 28.2%
$302,193 – $265,335 – $82,394 $464,270 – $250,407 – $80,796 = ($45,536) = $133,067
(e) Using the debt to assets ratio and free cash flow as measures of solvency produces deteriorating results for American Eagle Outfitters. Its debt to assets ratio remained constant from 2013 to 2014. However, its free cash flow decreased by 134% indicating a significant decline in solvency. (f) In 2013 American Eagle Outfitters’s cash provided by operating activities was greater than the cash used for capital expenditures. It was generating plenty of cash from operations to cover its investing needs. In 2014, American Eagle Outfitters experienced negative free cash flow. This deficiency could have been covered by issuing stock or debt. 2-20
.
(For Instructor Use Only)
EXERCISE 2-12 (a) (b) (c) (d) (e) (f)
2 6 3 4 5 1
Going concern assumption Economic entity assumption Monetary unit assumption Periodicity assumption Historical cost principle Full disclosure principle
EXERCISE 2-13 (a) This is a violation of the historical cost principle. The inventory was written up to its fair value when it should have remained at cost. (b) This is a violation of the economic entity assumption. The treatment of the transaction treats Sal Garcia and Garcia Co. as one entity when they are two separate entities. The cash used to purchase the truck should have been treated as part of salaries and wages expense. (c) This is a violation of the periodicity assumption. This assumption states that the economic life of a business can be divided into artificial time periods (months, quarters, or a year). By adding two more weeks to the year, Garcia Co. would be misleading financial statement readers. In addition, 2014 results would not be comparable to previous years’ results. The company should use a 52 week year.
.
(For Instructor Use Only)
2-21
SOLUTIONS TO PROBLEMS PROBLEM 2-1A YAHOO! INC. Balance Sheet December 31, 2014 (Amounts are in millions) Assets Current assets Cash ..................................................... Debt investments ................................ Accounts receivable ........................... Prepaid rent ......................................... Total current assets .................... Long-term investments Stock investments .............................. Property, plant, and equipment Equipment ........................................... Less: Accumulated depreciation— equipment....................................... Intangible assets Goodwill .............................................. Patents ................................................ Total assets.................................................
$2,292 1,160 1,061 233 $ 4,746 3,247 1,737 201 3,927 234
1,536 4,161 $13,690
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................... Unearned sales revenue .................... Total current liabilities ................ Long-term liabilities Notes payable ..................................... Total liabilities .......................... Stockholders’ equity Common stock .................................... Retained earnings ............................... Total stockholders’ equity .............. Total liabilities and stockholders’ equity ................................................... 2-22
.
(For Instructor Use Only)
$
152 413 $ 565 734 1,299 6,283 6,108 12,391 $13,690
PROBLEM 2-2A
TRESH CORPORATION Income Statement For the Year Ended December 31, 2014 Revenues Service revenue .................................................... Expenses Salaries and wages expense ............................... Depreciation expense ........................................... Insurance expense ............................................... Utilities expense ................................................... Maintenance and repairs expense ....................... Total expenses .............................................. Net income ....................................................................
$68,000 $37,000 3,600 2,200 2,000 1,800 46,600 $21,400
TRESH CORPORATION Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1, 2014 .............................................. Add: Net income .......................................................................... Less: Dividends ............................................................................. Retained earnings, December 31, 2014 ........................................
.
(For Instructor Use Only)
$31,000 21,400 52,400 12,000 $40,400
2-23
PROBLEM 2-2A (Continued) TRESH CORPORATION Balance Sheet December 31, 2014 Assets Current assets Cash ....................................................................... Accounts receivable ............................................. Prepaid insurance ................................................. Total current assets ...................................... Property, plant, and equipment Equipment ............................................................. Less: Accumulated depreciation—equipment... Total assets...................................................................
$10,100 11,700 3,500 $25,300 66,000 17,600
48,400 $73,700
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ................................................. Salaries and wages payable................................. Total current liabilities .................................. Stockholders’ equity Common stock ...................................................... Retained earnings ................................................. Total stockholders’ equity ............................ Total liabilities and stockholders’ equity ....................
2-24
.
(For Instructor Use Only)
$18,300 3,000 $21,300 12,000 40,400 52,400 $73,700
PROBLEM 2-3A
(a)
RAMIREZ ENTERPRISES Income Statement For the Year Ended April 30, 2014 Sales revenue ....................................................... Expenses Cost of goods sold ....................................... Salaries and wages expense ....................... Interest expense ........................................... Depreciation expense ................................... Insurance expense ....................................... Income tax expense ...................................... Total expenses ....................................... Net income ............................................................
$5,100 $1,060 700 400 335 210 165 2,870 $2,230
RAMIREZ ENTERPRISES Retained Earnings Statement For the Year Ended April 30, 2014 Retained earnings, May 1, 2013 ........................... Add: Net income ................................................. Less: Dividends ................................................... Retained earnings, April 30, 2014 ........................
.
(For Instructor Use Only)
$1,600 2,230 3,830 325 $3,505
2-25
PROBLEM 2-3A (Continued) (b)
RAMIREZ ENTERPRISES Balance Sheet April 30, 2014 Assets Current assets Cash ...................................................... Stock investments ................................ Accounts receivable............................. Inventory ............................................... Prepaid insurance ................................ Total current assets...................... Property, plant, and equipment Land....................................................... Equipment ............................................. $2,420 Less: Accumulated depreciation—equipment.................. 670 Total assets..................................................
$1,270 1,200 810 967 60 $4,307 3,100 1,750
4,850 $9,157
Liabilities and Stockholders’ Equity Current liabilities Notes payable .................................................... Accounts payable ............................................. Salaries and wages payable ............................. Income taxes payable ....................................... Total current liabilities .............................. Mortgage payable.............................................. Total liabilities............................................ Stockholders’ equity Common stock .................................................. Retained earnings ............................................. Total stockholders’ equity ........................ Total liabilities and stockholders’ equity ...............
2-26
.
(For Instructor Use Only)
$ 61 834 222 135 $1,252 3,500 4,752 900 3,505 4,405 $9,157
PROBLEM 2-4A
(a) Bosch Company’s net income for 2014 is $248,000 ($1,800,000 – $1,175,000 – $283,000 – $9,000 – $85,000). Its earnings per share is $3.10 ($248,000 ÷ 80,000 shares outstanding). Fielder’s net income for 2014 is $142,200 ($620,000 – $340,000 – $98,000 – $3,800 – $36,000). Its earnings per share is $2.84 ($142,200 ÷ 50,000 shares outstanding). (b) Bosch appears to be more liquid. Bosch’s 2014 working capital of $340,875 ($407,200 – $66,325) is more than twice as high as Fielder’s working capital of $156,620 ($190,336 – $33,716). In addition, Bosch’s 2014 current ratio of 6.1:1 ($407,200 ÷ $66,325) is higher than Fielder’s current ratio of 5.6:1 ($190,336 ÷ $33,716). (c) Bosch appears to be slightly more solvent. Bosch’s 2014 debt to total assets ratio of 18.6% ($174,825 ÷ $939,200)a is lower than Fielder’s ratio of 22.5% ($74,400 ÷ $330,064)b. The lower the percentage of debt to assets, the lower the risk is that a company may be unable to pay its debts as they come due. Another measure of solvency, free cash flow, also indicates that Bosch is more solvent. Bosch had $12,000 ($138,000 – $90,000 – $36,000) of free cash flow while Fielder had only $1,000 ($36,000 – $20,000 – $15,000). $174,825 ($66,325 + $108,500) is Bosch’s 2014 total liabilities. $939,200 ($407,200 + $532,000) is Bosch’s 2014 total assets.
a
$74,400 ($33,716 + $40,684) is Fielder’s 2014 total liabilities. $330,064 ($190,336 + $139,728) is Fielder’s 2014 total assets.
b
.
(For Instructor Use Only)
2-27
PROBLEM 2-5A
(a) (i)
Working capital = $458,900 – $195,500 = $263,400.
(ii) Current ratio =
$458,900 = 2.35:1. $195,500
(iii) Free cash flow = $190,800 – $92,000 – $31,000 = $67,800 (iv) Debt to assets ratio =
$395,500 = 38.2%. $1,034,200
(v) Earnings per share =
$153,100 = $3.06. 50,000 shares
(b) During 2014, the company’s current ratio increased from 1.65:1 to 2.35:1 and its working capital increased from $160,500 to $263,400. Both measures indicate an improvement in liquidity during 2014. The company’s debt to assets ratio increased from 31.0% in 2013 to 38.2% in 2014 indicating that the company is less solvent in 2014. Another measure of solvency, free cash flow, increased from $48,700 to $67,800. This suggests an improvement in solvency, thus we have conflicting measures of solvency. Earnings per share decreased from $3.15 in 2013 to $3.06 in 2014. This indicates a decline in profitability during 2014.
2-28
.
(For Instructor Use Only)
PROBLEM 2-6A
2013 (a) Earnings per share.
$60,000 = $2.00 30,000 shares
2014
$70,000 = $2.12 33,000 shares
(b) Working capital. ($20,000 + $62,000 + $73,000) – $70,000 = $85,000
($28,000 + $70,000 + $90,000) – $75,000 = $113,000
(c) Current ratio.
$155,000 = 2.2:1 $70,000
$188,000 = 2.5:1 $75,000
(d) Debt to assets ratio.
$160,000 = 23.4% $685,000 (e) Free cash flow. $56,000 – $38,000 – $15,000 = $3,000 (f)
.
$155,000 = 20.4% $760,000 $82,000 – $45,000 – $20,000 = $17,000
Net income and earnings per share have increased, indicating that the underlying profitability of the corporation has improved. The liquidity of the corporation as shown by the working capital and the current ratio has improved slightly. Also, the corporation improved its solvency by improving its debt to assets ratio as well as free cash flow.
(For Instructor Use Only)
2-29
PROBLEM 2-7A
Ratio
Target Wal-Mart (All Dollars are in Millions)
(a)
Working capital
$17,488 – $10,512 = $6,976
$48,949 – $55,390 = ($6,441)
(b)
Current ratio
1.66:1 ($17,488 ÷ $10,512)
.88:1 ($48,949 ÷ $55,390)
(c)
Debt to assets ratio
68.9% ($30,394 ÷ $44,106)
60.0% ($98,144 ÷ $163,429)
(d)
Free cash flow
$4,430 – $3,547 – $465 = $418
$23,147 – $11,499 – $3,746 = $7,902
(e)
Earnings per share
$2.86 =
(f)
The comparison of the two companies shows the following:
$2,214 774
$3.39 =
$13,400 3,951
Liquidity—Target’s current ratio of 1.66:1 is much better than WalMart’s .88:1 and Target has significantly higher working capital than Wal-Mart. Solvency—Wal-Mart’s debt to assets ratio is about 13% less than Target’s and its free cash flow is much larger. Profitability—Earnings per share should not be used to compare profitability between companies because of the difference in the number of shares outstanding. However, Wal-Mart’s profitability as measured by net income is more than 6-times that of Target.
2-30
.
(For Instructor Use Only)
PROBLEM 2-8A
(a)
Accounting information is the compilation and presentation of financial information for a company. It provides information in the form of financial statements and additional disclosures that is useful for decision making. The accounting rules and practices that have substantial authoritative support and are recognized as a general guide for financial reporting purposes are referred to as generally accepted accounting principles (GAAP). The biotechnology company that employs Sue will follow GAAP to report its assets, liabilities, stockholders’ equity, revenues, and expenses as it prepares financial statements.
(b) Sue is correct in her understanding that the low success rate for new biotech products will be a cause of concern for investors. Her suggestion that detailed scientific findings be reported to prospective investors might offset some of their concerns but it probably won’t conform to the qualitative characteristics of accounting information. These characteristics consist of relevance, faithful representation, comparability, consistency, verifiability, timeliness, and understandability. They apply to accounting information rather than the scientific findings that Sue wants to include.
.
(For Instructor Use Only)
2-31
PROBLEM 2-1B STARBUCKS CORPORATION Balance Sheet September 30, 2014 (Amounts are in millions) Assets Current assets Cash ................................................................ Debt investments ........................................... Accounts receivable ...................................... Inventory ......................................................... Prepaid rent .................................................... Total current assets............................... Long-term investments Stock investments ......................................... Property, plant and equipment Equipment ...................................................... Less: Accumulated depreciation— equipment .................................................. Intangible assets Goodwill .......................................................... Total assets .............................................................
$281 157 288 692 278 $1,696 280 3,036 145
2,891 477 $5,344
Liabilities and Stockholders’ Equity Current liabilities Notes payable ................................................. Accounts payable.................................................. Unearned sales revenue ............................... Total current liabilities .......................... Long-term liabilities Notes payable ................................................. Bonds payable ............................................... Total long-term liabilities ...................... Total liabilities .................................... Stockholders’ equity Common stock ............................................... Retained earnings .......................................... Total stockholders’ equity ......................... Total liabilities and stockholders’ equity ............. 2-32
.
(For Instructor Use Only)
$ 1,468 391 297 $2,156 550 354 904 3,060 40 2,244 2,284 $5,344
PROBLEM 2-2B
MUELLER, INC. Income Statement For the Year Ended December 31, 2014 Revenues Service revenue .................................................... Expenses Salaries and wages expense ............................... Depreciation expense ........................................... Maintenance and repairs expense ....................... Utilities expense ................................................... Insurance expense ............................................... Total expenses .............................................. Net income ....................................................................
$51,000 $34,000 4,300 2,600 2,100 1,800 44,800 $ 6,200
MUELLER, INC. Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1 ...................................... Plus: Net income......................................................... Less: Dividends ........................................................... Retained earnings, December 31 ................................
.
(For Instructor Use Only)
$14,000 6,200 20,200 2,600 $17,600
2-33
PROBLEM 2-2B (Continued) MUELLER, INC. Balance Sheet December 31, 2014 Assets Current assets Cash ..................................................................... Accounts receivable ........................................... Prepaid insurance ............................................... Total current assets .................................... Property, plant, and equipment Equipment ........................................................... Less: Accumulated depreciation ..................... Total assets.................................................................
$ 6,100 2,900 2,400 $11,400 30,000 7,600
22,400 $33,800
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................................... Salaries and wages payable............................... Total current liabilities ................................ Stockholders’ equity Common stock .................................................... Retained earnings ............................................... Total stockholders’ equity .......................... Total liabilities and stockholders’ equity ..................
2-34
.
(For Instructor Use Only)
$ 7,200 3,000 $10,200 6,000 17,600 23,600 $33,800
PROBLEM 2-3B
(a)
VERN CORPORATION Income Statement For the Year Ended April 30, 2014 Revenues Sales revenue ............................................... Expenses Salaries and wages expense ....................... Depreciation expense .................................. Income tax expense ..................................... Rent expense ................................................ Interest expense ........................................... Total expenses ...................................... Net income ....................................................
$20,450 $5,840 3,200 700 660 350 10,750 $ 9,700
VERN CORPORATION Retained Earnings Statement For the Year Ended April 30, 2014 Retained earnings, May 1, 2013........................... Plus: Net income ................................................ Less: Dividends ................................................... Retained earnings, April 30, 2014 .......................
.
(For Instructor Use Only)
$13,960 9,700 23,660 2,800 $20,860
2-35
PROBLEM 2-3B (Continued) (b)
VERN CORPORATION Balance Sheet April 30, 2014 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Prepaid rent ................................................... Total current assets ............................ Equipment ............................................................. Less: Accumulated depreciation— equipment .................................................. Total assets ...........................................................
$20,955 10,150 380 $31,485 24,250 6,600
17,650 $49,135
Liabilities and Stockholders’ Equity Current liabilities Accounts payable.......................................... Income taxes payable ................................... Interest payable ............................................. Total current liabilities ........................ Notes payable ....................................................... Total liabilities ..................................... Stockholders’ equity Common stock .............................................. Retained earnings ......................................... Total stockholders’ equity .................. Total liabilities and stockholders’ equity ............
2-36
.
(For Instructor Use Only)
$ 3,100 300 175 $ 3,575 4,700 8,275 20,000 20,860 40,860 $49,135
PROBLEM 2-4B
(a)
Wise’s net income is $215,000 ($900,000 – $450,000 – $150,000 – $10,000 – $75,000). Its earnings per share is $.43 ($215,000 ÷ 500,000 shares). Omaz’s net income is $74,000 ($450,000 – $225,000 – $130,000 – $6,000 – $15,000). Its earnings per share is $.37 ($74,000 ÷ 200,000 shares).
(b) Wise’s 2014 working capital of $470,000 ($700,000 – $230,000) is over 4 times as high as Omaz’s working capital of $105,000 ($180,000 – $75,000). And Wise’s 2014 current ratio of 3.0:1 ($700,000 ÷ $230,000) is higher than Omaz’s current ratio of 2.4:1 ($180,000 ÷ $75,000). (c) Omaz appears to be less solvent. Omaz’s 2014 debt to assets ratio of 34% ($265,000 ÷ $780,000)a is slightly higher than Wise’s ratio of 29% ($430,000 ÷ $1,500,000)b. The lower the percentage of debt to assets, the lower the risk that a company may be unable to pay its debts as they come due. Omaz’s free cash flow is only $26,000 ($46,000 – $20,000) compared to $125,000 ($180,000 – $50,000 – $5,000) for Wise. More free cash flow indicates that Wise will be better able to finance more capital expenditures without taking on more debt. $265,000 ($75,000 + $190,000) is Omaz’s 2014 total liabilities. $780,000 ($180,000 + $600,000) is Omaz’s 2014 total assets.
a
$430,000 ($230,000 + $200,000) is Wise’s 2014 total liabilities. $1,500,000 ($700,000 + $800,000) is Wise’s 2014 total assets.
b
.
(For Instructor Use Only)
2-37
PROBLEM 2-5B
(a) (i) Current ratio =
$302,600 = 2.0:1. $148,700
(ii) Working capital = $302,600 – $148,700 = $153,900. (iii) Debt to assets ratio =
$258,700 = 34%. $763,900
(iv) Free cash flow = $61,300 – $42,000 – $10,000 = $9,300. (v) Earnings per share =
$99,200 = $1.53. 65,000
(b) During 2014, Divine’s current ratio decreased from 2.4:1 to 2.0:1 and its working capital dropped from $178,000 to $153,900. Both measures indicate a slight decline in liquidity during 2014. Divine’s debt to assets ratio increased from 31% in 2013 to 34% in 2014 indicating that the company is less solvent in 2014. Using another measure of solvency, free cash flow, we see that Divine’s solvency has not improved during 2014. Earnings per share increased from $1.35 to $1.53 in 2014. This 13% increase indicates better profitability in 2014.
2-38
.
(For Instructor Use Only)
PROBLEM 2-6B
2013
2014
(a) Earnings per share.
$113,000 = $.35 320,000 shares
$100,000 = $.27 370,000 shares
(b) Working capital. ($30,000 + $55,000 + $73,000) – $65,000 = $93,000
($50,000 + $80,000 + $74,000) – $88,000 = $116,000
(c) Current ratio. $158,000 = 2.43:1 $65,000
$204,000 = 2.32:1 $88,000
(d) Debt to assets ratio.
$135,000 = 21.8% $619,000 (e) Free cash flow. $178,000 – $45,000 – $13,000 = $120,000 (f)
.
$178,000 = 22.2% $802,000 Free cash flow. $165,000 – $85,000 – $20,000 = $60,000
The underlying profitability of the corporation as measured by earnings per share has declined. The overall liquidity of the corporation has dropped as shown by the slight decrease in the current ratio. Also, the corporation appears to be increasing its debt burden as its debt to assets ratio increased slightly indicating a decrease in solvency. Comparing free cash flow, we find a drop in this measure of solvency also.
(For Instructor Use Only)
2-39
PROBLEM 2-7B
Ratio
Home Depot Lowe’s (All Dollars are in Millions)
(a)
Working capital
$14,674 – $12,706 = $1,968
$8,686 – $7,751 = $935
(b)
Current ratio
1.2:1 ($14,674 ÷ $12,706)
1.1:1 ($8,686 ÷ $7,751)
(c)
Debt to assets ratio
60.0% ($26,610 ÷ $44,324)
47.9% ($14,771 ÷ $30,869)
(d)
Free cash flow
$5,727 – $3,558 – $1,709 = $460
$4,347 – $4,010 – $428 = ($91)
(e)
Earnings per share
$2.38 =
(f)
$4,395 1,849
$1.90 =
$2,809 1,481
The comparison of the two companies shows the following: Liquidity—Home Depot’s current ratio of 1.2:1 is slightly better than Lowes’ 1.1:1 and Home Depot has significantly higher working capital than Lowe’s. Solvency—Home Depot’s debt to assets ratio is about 25% more than Lowe’s but its free cash flow is much larger. Profitability—Home Depot’s earnings per share is about 25% higher than Lowe’s.
2-40
.
(For Instructor Use Only)
PROBLEM 2-8B
(a)
The primary objective of financial reporting is to provide information useful for decision making. Since Yocum’s shares appear to be actively traded, investors must be capable of using the information made available by Yocum to make decisions about the company.
(b) The investors must feel as if the company will show earnings in the future. They must recognize that information relevant to their investment choice is indicated by more than Yocum’s net income. (c)
.
The change from Canadian dollars to U.S. dollars for reporting purposes should make Yocum’s more comparable with companies traded on U.S. stock exchanges.
(For Instructor Use Only)
2-41
CCC 2-1
CONTINUING COOKIE CHRONICLE
(a) The balance sheet reports the assets, liabilities, and stockholders’ equity of a company at a specific date. The income statement presents the revenues and expenses and resulting net income or net loss of a company for a specific period of time. The retained earnings statement summarizes the changes in retained earnings for a specific period of time. Finally, the cash flow statement provides information about the cash inflows and cash outflows for a specific period of time. (b) By looking at the balance sheet and the cash flow statement and calculating liquidity ratios, we can measure a company’s short term ability to pay its obligations. Liquidity ratios include the calculation of working capital (current assets minus current liabilities) and current ratio (current assets divided by current liabilities). (c) By looking at the balance sheet and the cash flow statement and calculating solvency ratios we are able to measure a company’s ability to survive over a long period of time. These solvency ratios include debt to assets (total liabilities divided by total assets) and free cash flow (cash provided by operations minus dividends paid and capital expenditures). (d) By looking at the income statement we can determine if Biscuits is profitable. If revenues earned by Biscuits exceed expenses incurred, then Biscuits is profitable. Profitability ratios can measure a company’s ability to generate earnings over a period of time. One profitability ratio is earnings per share (net income minus preferred dividends divided by average common shares outstanding). (e) By looking at the balance sheet we can determine if Biscuits has any debt. By looking at the balance sheet and cash flow statement and calculating solvency ratios we are able to determine whether a company has the ability to repay its long-term debt. Profitability ratios will help in determining whether a company is able to pay its interest expense. The more profitable the company the better able it is to repay its longterm obligations as well as the amount of interest it is paying on its debt.
2-42
.
(For Instructor Use Only)
CONTINUING COOKIE CHRONICLE (Continued) (f)
By looking at the statement of cash flows we can determine whether Biscuits has paid any dividends to its shareholders.
(g) Be aware that financial statements of Biscuits provide a historical perspective of what has already taken place. The financial statements may prove to be a good indicator of what will happen in the future but remember that is not necessarily guaranteed. Consumer tastes change and as a result the demand for Biscuits’ product may also change. There are other issues that Natalie must consider as well. Does she have the ability to meet the demands of Biscuits? Will she be able to produce 1,500 dozen cookies a week? Does she have enough staff to enable her to do so? Does she have a large enough oven to do so? Does she have enough cash to pay her staff, purchase supplies, and cover operating expenses until she receives payment from Biscuits?
.
(For Instructor Use Only)
2-43
BYP 2-1
FINANCIAL REPORTING PROBLEM
(a) Total current assets were $212,201,000 at December 31, 2011, and $235,167,000 at December 31, 2010. (b) Current assets are properly listed in the order of liquidity. As you will learn in a later chapter, inventories are considered to be less liquid than receivables. Thus, they are listed below receivables and before prepaid expenses. (c) The asset classifications are similar to the text: (a) current assets, (b) property, plant, and equipment, and (c) other assets. (d) Total current liabilities were $58,355,000 at December 31, 2011, and $58,505,000 at December 31, 2010.
2-44
.
(For Instructor Use Only)
BYP 2-2
(a)
COMPARATIVE ANALYSIS PROBLEM
($ in thousands)
Hershey Company
Tootsie Roll
1. Working capital
$2,046,558 – $1,173,775 = $872,783
$212,201 – $58,355 = $153,846
2. Current ratio
$2,046,558 ÷ $1,173,775 = 1.7:1
$212,201 ÷ $58,355 = 3.6:1
3. Debt to assets ratio
$3,539,551
$191,921 *
= 80.2%
= 22.4%
$4,412,199
$857,856
4. Free cash flow
$580,867 – $323,961 – $304,083 = ($47,177)
$50,390 – $16,351 – $18,407 = $15,632
5. Earnings per share
$628,962 – 0
$43,938 – 0
220,688
= $2.85
= $0.76
57,892
*$58,355 + $133,566
(b) Liquidity Hershey Company appears much more liquid since it has about $719 million more working capital than Tootsie Roll. But, looking at the current ratios, we see that Tootsie Roll’s ratio is more than two times as large as Hershey’s. Solvency Based on the debt to assets ratio, Tootsie Roll is more solvent. Tootsie Roll’s debt to assets ratio is significantly lower than Hershey’s and, therefore, Tootsie Roll would be considered better able to pay its debts as they come due. Comparing free cash flow, Tootsie Roll generates much more excess cash than Hershey―$15.6 million versus negative free cash flow of $47 million. Profitability While earnings per share cannot be used to compare profitability between companies, Hershey’s net income is more than 14-times as great as Tootsie Roll’s.
.
(For Instructor Use Only)
2-45
BYP 2-3
RESEARCH CASE
(a) Many large companies, big accounting firms, and accounting standard setters tend to favor a switch to IFRS because they believe that global accounting standards would save companies money by consolidating their bookkeeping. They also believe it would make it easier to raise capital around the world. In addition, investors would have less trouble comparing companies from different countries. They also feel that having international accounting standards would lead to an improvement in the enforcement of securities laws. (b
Many small companies are opposed to switching to IFRS because (1) they say that the switch would be very costly, and (2) because they don't have operations outside of the U.S., so they see any benefit to their company of using international standards.
(c) It has been suggested that IFRS lacks standards that are specific to utility companies that U.S. GAAP contains. (d) Condorsement (a word invented by the SEC) represents a combination of convergence and endorsement. Under condorsement, U.S. standard setters would continue to work with international standard setters to try to reduce differences in standards. In addition, as new international standards are issued, U.S. standard setters would review those standards and consider whether to endorse them by absorbing them into U.S. GAAP.
2-46
.
(For Instructor Use Only)
BYP 2-4
INTERPRETING FINANCIAL STATEMENTS
(a) The percentage decrease in Gap’s total assets during this period is calculated as: $7,065 – $8,544 = 17.3% $8,544
The average decrease per year can be approximated as: 17.3% = 4.3% per year 4 years
(b) Gap’s working capital and current ratio decreased (2007), increased (2008 and 2009) and then decreased (2010) during this period, indicating a decline, an improvement and then another decline in liquidity. The current ratio is a better measure of liquidity because it provides a relative measure; that is, current assets compared to current liabilities. Working capital only tells us the net amount of current assets less current liabilities. It is hard to say whether a given amount of working capital is adequate or inadequate without knowing the size of the company. (c) The debt to assets ratio suggests that Gap’s solvency didn’t change much during the period. Debt to assets was .39 in 2006, rose to .45 in 2007 and then came back down to .42 in 2010. (d) The earnings per share suggests that Gap’s profitability improved significantly from 2006 to 2010, increasing from $0.94 to $1.89. However, based on the years shown, it appears that earnings varied a great deal during this period.
.
(For Instructor Use Only)
2-47
REAL-WORLD FOCUS
BYP 2-5 Answers will vary depending on the company chosen and the date. BYP 2-6 Answers will vary depending on the company chosen and the date.
2-48
.
(For Instructor Use Only)
BYP 2-7
DECISION MAKING ACROSS THE ORGANIZATION
The current ratio increase is a favorable indication as to liquidity, but alone tells little about the prospects of the client. From this ratio change alone, it is impossible to know the amount and direction of the changes in individual accounts, total current assets, and total current liabilities. Also unknown are the reasons for the changes. The working capital increase is also a favorable indication as to liquidity, but again the amount and direction of the changes in individual current assets and current liabilities cannot be determined from this measure. The increase in free cash flow is a favorable indicator for solvency. An increase in free cash flow means the company can replace assets, pay dividends, and have “free cash” available to pay down debt or expand operations. The decrease in the debt to assets ratio is a favorable indicator for solvency and going-concern prospects. The lower the percentage of debt to assets, the lower the risk that a company may be unable to pay its debts as they come due. A decline in the debt to assets ratio is also a positive sign regarding going-concern potential. The increase in net income is a favorable indicator for both solvency and profitability prospects although much depends on the quality of receivables generated from sales and how quickly they can be converted into cash. A significant factor here may be that despite a decline in sales the client’s management has been able to reduce costs to produce this increase. Indirectly, the improved income picture may have a favorable impact on solvency and going-concern potential by enabling the client to borrow currently to meet cash requirements. The earnings per share increase is a favorable indicator for profitability. A 109% (from $1.15 to $2.40) increase indicates a significant increase in net income and provides a favorable sign regarding going-concern potential.
.
(For Instructor Use Only)
2-49
BYP 2-8
COMMUNICATION ACTIVITY
To:
F. P. Fernetti
From:
Accounting Major
Subject:
Financial Statement Analysis
(a) Ratios can be classified into three types, which measure three different aspects of a company’s financial health: 1.
Liquidity ratios—These measure a company’s ability to pay its current obligations.
2.
Solvency ratios—These measure a company’s ability to pay its long-term obligations and survive over the long-term.
3.
Profitability ratios—These measure the ability of the company to generate a profit.
(b) 1.
Examples of liquidity measures are: Working capital = Current assets – Current liabilities Current ratio =
2.
Current assets Current liabilities
Examples of solvency measures are: Debt to assets ratio =
Total liabilities Total assets
Free cash flow = Cash provided by operating activities – Capital expenditures – Cash dividends
2-50
.
(For Instructor Use Only)
BYP 2-8 (Continued) 3.
Example of profitability measure: Earnings per share =
Net income − Preferred dividends Average common shares outstanding
(c) There are three bases for comparing a company’s results: The bases of comparison are:
.
1.
Intracompany—This basis compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years.
2.
Industry averages—This basis compares an item or financial relationship of a company with industry averages (or norms).
3.
Intercompany—This basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies.
(For Instructor Use Only)
2-51
BYP 2-9
ETHICS CASE
(a) The stakeholders in this case are: Boeing’s management; CEO, public relations manager, Boeing’s stockholders, McDonnell Douglas stockholders, other users of the financial statements; especially potential investors of the new combined company. (b) The ethical issues center around full disclosure of financial information. Management attempted to “time” the release of bad news in order to complete a merger that would have been revoked if cost overruns had been disclosed as soon as management became aware of them. (c) The periodicity assumption requires that financial results be reported on specific, pre-determined dates. The full disclosure principle requires that all circumstances and events that make a difference to financial statement users must be disclosed. (d) It is not ethical to “time” the release of bad news. GAAP requires that all significant financial information be released to allow users to make informed decisions. (e) Answers will vary. One possibility: Release the information regarding cost overruns as it became available. Describe the causes of such overruns and explain how Boeing would address them (probably by improving production methods to eliminate the inefficiencies alluded to in the text). (f)
2-52
Investors and analysts should be aware that Boeing’s management will probably “manage” information in the future in ways that will interfere with full disclosure.
.
(For Instructor Use Only)
BYP 2-10
ALL ABOUT YOU
Answers will vary.
.
(For Instructor Use Only)
2-53
BYP 2-11
FASB CODIFICATION ACTIVITY
(a) 1.
Current assets is used to designate cash and other assets or resources commonly identified as those that are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business.
2.
Current liabilities is used principally to designate obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets, or the creation of other current liabilities.
(b) Access FASB Codification 210-20-45 A right of set off exists when all of the following conditions are met:
2-54
1.
Each of two parties owes the other determinable amounts.
2.
The reporting party has the right to set off the amount owed with the amount owed by the other party.
3.
The reporting party intends to set off.
4.
The right of set off is enforceable at law. As a result, a company may not offset accounts payable against cash on its balance sheet.
.
(For Instructor Use Only)
BYP 2-12
PEOPLE, PLANET AND PROFIT
(a)
The existence of three different forms of certification would most likely create confusion for coffee purchasers. It would difficult to know what aspects of the coffee growing process each certification covered. Similarly, if there were multiple groups that certified financial statements, each with different criteria, it would be difficult for financial statement users to know what each certification promised.
(b)
The Starbucks certification appears to be the most common in that area. It has the advantage of having a direct link to the Starbucks coffee market. Although it does not guarantee that Starbucks will buy its coffee, it is a requirement that must be met before Starbucks will buy somebody’s coffee. Note that the article states that the Starbucks certification “incorporates elements of social responsibility and environmental leadership, but quality of coffee is the first criteria.” The Smithsonian Bird Friendly is considered to have the strictest requirements and, as a result, appears to be the least common.
(c)
The certifications have multiple objectives including organic farming as a means to protect bird species, biodiversity and wildlife habitat. Some included requirements are to improve workers’ living conditions, such as providing running water in worker housing, child labor regulations and education requirements. As mentioned above, the Starbucks certification has the potential financial benefit of making Starbucks a potential customer, which can stabilize farmers’ earnings. Certifications can also be financially beneficial because companies can benefit from the positive public relations effects of either producing or buying coffee produced using sustainable practices.
.
(For Instructor Use Only)
2-55
IFRS CONCEPTS AND APPLICATION
IFRS 2-1 The statement of financial position required under IFRS and the balance sheet prepared under GAAP usually present the same information regarding a company’s assets, liabilities, and stockholders’ equity at a point in time. IFRS does not dictate a specific order but most companies list noncurrent items before current. Differences in ordering are Statement of Financial Position presentation Noncurrent assets Current assets Equity Noncurrent liabilities Current liabilities
Balance Sheet presentation Current assets Noncurrent assets Current liabilities Noncurrent liabilities Stockholders’ equity
Under IFRS, current assets are usually listed in the reverse order of liquidity. IFRS 2-2 No, in a recently completed project on the conceptual framework, the two boards agreed on the objective of financial reporting and a common set of desired qualitative characteristics. IFRS 2-3 IFRS uses Share Capital—Ordinary rather than Common Stock and statement of financial position rather than balance sheet.
2-56
.
(For Instructor Use Only)
IFRS 2-4 RUIZ COMPANY Partial Statement of Financial Position Current assets Prepaid insurance................................................................... Supplies .................................................................................. Accounts receivable ............................................................... Debt investments .................................................................... Cash......................................................................................... Total .................................................................................
£ 3,600 5,200 12,500 6,700 15,400 £43,400
IFRS 2-5 WIDMER COMPANY Partial Statement of Financial Position December 31, 2014 Property, plant and equipment Equipment ................................................... Less: Accumulated depreciation .............. Long-term investments Share investments...................................... Current assets Inventories .................................................. Accounts receivable ................................... Debt investments ........................................ Cash............................................................. Total assets ........................................................
.
(For Instructor Use Only)
CHF21,700 5,700
CHF16,000 6,500
2,900 4,300 120 13,400
20,720 CHF43,220
2-57
IFRS 2-6 COLE BOWLING ALLEY Statement of Financial Position December 31, 2014 Assets Property, plant, and equipment Land ............................................... Buildings ....................................... Less: Acc. depr.—buildings ......... Equipment ..................................... Less: Acc. depr.—equipment ....... Current assets Prepaid insurance ......................... Accounts receivable ..................... Cash ............................................... Total assets ..........................................
$64,000 $128,800 42,600 62,400 18,720
86,200 43,680 4,680 14,520 18,040
$193,880
37,240 $231,120
Equity and Liabilities Equity Share capital—ordinary .............................. Retained earnings ($15,000 + $3,440*) ...... Non-current liabilities Notes payable ............................................. Current liabilities Current portion of notes payable............... Accounts payable ....................................... Interest payable .......................................... Total equity and liabilities..................................
$100,000 18,440
$118,440 83,880
13,900 12,300 2,600
28,800 $231,120
*Net income = $14,180 – $780 – $7,360 – $2,600 = $3,440
IFRS 2-7 It is possible to compare liquidity and solvency for companies using different currencies. The ratios that are used to do so, such as the current ratio and debt to total assets, indicate relative amounts of assets and liabilities rather than absolute monetary values.
2-58
.
(For Instructor Use Only)
IFRS 2-8 INTERNATIONAL COMPARATIVE ANALYSIS PROBLEM
Differences in the format of the statement of financial position (balance sheet) used by Zetar and Tootsie Roll include the following:
1. 2. 3.
4.
5.
6.
7.
.
Zetar
Tootsie Roll
Non-current assets listed first Goodwill listed before property, plant and equipment Current assets are shown in reverse order of liquidity with cash being last Current liabilities are subtracted from current assets to show net current liabilities/assets Total liabilities are subtracted from total assets to show net assets The equity section uses Share capital and Share premium
Current assets listed first Property, plant, and equipment listed before goodwill Current assets are shown in order of liquidity with cash being first No similar amount appears
Reporting currency is £ (pounds)
(For Instructor Use Only)
No similar amount appears
The equity section uses Common stock and Capital in excess of par value Reporting currency is $ (dollars)
2-59
CHAPTER 3 The Accounting Information System Learning Objectives 1. 2. 3. 4. 5. 6. 7. 8. 9.
Analyze the effect of business transactions on the basic accounting equation. Explain what an account is and how it helps in the recording process. Define debits and credits and explain how they are used to record business transactions. Identify the basic steps in the recording process. Explain what a journal is and how it helps in the recording process. Explain what a ledger is and how it helps in the recording process. Explain what posting is and how it helps in the recording process. Explain the purposes of a trial balance. Classify cash activities as operating, investing, or financing.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy
.
Item
LO
BT
Item
LO
BT
1. 2. 3. 4. 5.
4 1 1 1 2
C C C K K
6. 7. 8. 9. 10.
3 3 3 3 3
C C C K K
1. 2. 3.
1 1 1
C AP AP
4. 5. 6.
3 3 5
1.
1
C
2.
2, 3
1. 2. 3. 4.
1 1 1 1
C AP AP AP
5. 6. 7.
1 3, 5 3
1. 2. 3. 4.
1 1 1 4, 5
AP AP AP AP
5.
1. 2. 3. 4.
1 1 1 4, 5
AP AP AP AP
5.
(For Instructor Use Only)
5, 6, 7, 8
5, 6, 7, 8
Item
LO
BT
Item
LO
BT
16. 17. 18. 19. 20.
5 5 5 6 8
K K AP C C
21. 22.
7 8
K AN
K 9. C 10. AP Do It! Review Exercises C 3. 4, 5 AP 4. Exercises AP 8. 5 AP 12. AP 9. 4, 5 AP 13. C 10. 7, 8 AP 14. 11. 1, 5, 7 AP
5 7
AP AP
11. 12.
8 8
AP AP
6, 7
AP
5, 8 7, 8 5, 8
AP AP AP
15. 16. 17. 18.
8 8 3 9
AN AP K AP
19.
9
AP
9.
8
AN
9.
8
AN
AP
AP
Item LO BT Questions 11. 3 K 12. 3 K 13. 3 K 14. 3 K 15. 4 K Brief Exercises 7. 4 C 8. 4 C
Problems: Set A 6. 5, 6, 7, 8 AP
Problems: Set B 6. 5, 6, 7, 8 AP
7. 8.
7. 8.
8 5, 6, 7, 8
AN
8 5, 6, 7, 8
AN
AP
AP
3-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
3-2
Description
Difficulty Level
Time Allotted (min.)
1A
Analyze transactions and compute net income.
Moderate
40–50
2A
Analyze transactions and prepare financial statements.
Moderate
40–50
3A
Analyze transactions and prepare an income statement, retained earnings statement, and balance sheet.
Moderate
50–60
4A
Journalize a series of transactions.
Simple
20–30
5A
Journalize transactions, post, and prepare a trial balance.
Simple
30–40
6A
Journalize transactions, post, and prepare a trial balance.
Moderate
40–50
7A
Prepare a correct trial balance.
Moderate
30–40
8A
Journalize transactions, post, and prepare a trial balance.
Moderate
40–50
9A
Analyze errors and their effects on the trial balance.
Moderate
30–40
1B
Analyze transactions and compute net income.
Moderate
40–50
2B
Analyze transactions and prepare financial statements.
Moderate
40–50
3B
Analyze transactions and prepare an income statement, retained earnings statement, and balance sheet.
Moderate
50–60
4B
Journalize a series of transactions.
Simple
20–30
5B
Journalize transactions, post, and prepare a trial balance.
Simple
30–40
6B
Journalize transactions, post, and prepare a trial balance.
Moderate
40–50
7B
Prepare a correct trial balance.
Moderate
30–40
8B
Journalize transactions, post, and prepare a trial balance.
Moderate
40–50
9B
Analyze errors and their effects on the trial balance
Moderate
30–40
.
(For Instructor Use Only)
ANSWERS TO QUESTIONS 1.
The system of collecting and processing transaction data and communicating financial information to decision makers is known as the accounting information system.
2.
Yes, a business can enter into a transaction in which only the left side of the accounting equation is affected. An example would be a transaction where an increase in one asset is offset by a decrease in another asset. An increase in the equipment account which is offset by a decrease in the cash account is a specific example.
3.
Accounting transactions are the economic events of the company recorded by accountants because they affect the basic accounting equation. (a) The death of a major stockholder of the company is not an accounting transaction as it does not affect the basic accounting equation. (b) Supplies purchased on account is an accounting transaction because it affects the basic accounting equation. (c) An employee being fired is not an accounting transaction as it does not affect the basic accounting equation. (d) Paying a cash dividend to stockholders is an accounting transaction as it does affect the basic accounting equation.
.
Decrease assets and decrease stockholders’ equity. Increase assets and decrease assets. Increase assets and increase stockholders’ equity. Decrease assets and decrease liabilities.
4.
(a) (b) (c) (d)
5.
An account consists of three parts: (a) the title, (b) the left or debit side, and (c) the right or credit side. Because the alignment of these parts resembles the letter T, it is referred to as a T account.
6.
Disagree. The terms debit and credit are synonymous with left and right, respectively.
7.
Terry is incorrect. The double-entry system merely records the dual (two-sided) effect of a transaction on the accounting equation. A transaction is not recorded twice; it is recorded once, and must affect two or more accounts to keep the basic accounting equation in balance. In other words, for each transaction, debits must equal credits.
8.
Misty is incorrect. A debit balance only means that debit amounts exceed credit amounts in an account. Conversely, a credit balance only means that credit amounts are greater than debit amounts in an account. Thus, a debit or credit balance is neither favorable or unfavorable.
9.
(a) Asset accounts are increased by debits and decreased by credits. (b) Liability accounts are decreased by debits and increased by credits. (c) The common stock account is decreased by debits and increased by credits.
(For Instructor Use Only)
3-3
Questions Chapter 3 (Continued) 10.
(a) (b) (c) (d) (e) (f) (g)
Accounts Receivable—debit balance. Cash—debit balance. Dividends—debit balance. Accounts Payable—credit balance. Service Revenue—credit balance. Salaries and Wages Expense—debit balance. Common Stock—credit balance.
11.
(a) (b) (c) (d) (e)
Accounts Receivable—asset—debit balance. Accounts Payable—liability—credit balance. Equipment—asset—debit balance. Dividends—stockholders’ equity—debit balance. Supplies—asset—debit balance.
12.
(a) Debit Supplies and credit Accounts Payable. (b) Debit Cash and credit Notes Payable. (c) Debit Salaries and Wages Expense and credit Cash.
13.
(a) (b) (c) (d) (e) (f)
14.
Normal balances for accounts in Tootsie Roll’s financial statements: Accounts Receivable—debit; Income Taxes Payable—credit; Sales—credit; Selling, Marketing, and Administrative Expenses— debit.
15.
The basic steps in the recording process are: (1) Analyze each transaction in terms of its effect on the accounts. (2) Enter the transaction information in a journal. (3) Transfer the journal information to the appropriate accounts in the ledger.
16.
(a) The debit should be entered first. (b) The credit should be indented.
17.
(a) No, debits and credits should not be recorded directly in the ledger. (b) The advantages of using the journal are: (1) It discloses in one place the complete effect of a transaction. (2) It provides a chronological record of all transactions. (3) It helps to prevent or locate errors because the debit and credit amounts for each entry can be readily compared.
18.
(a) Cash ........................................................................................................ 12,000 Common Stock................................................................................. (Issued stock for cash)
Cash—both debit and credit entries. Accounts Receivable—both debit and credit entries. Dividends—debit entries only. Accounts Payable—both debit and credit entries. Salaries and Wages Expense—debit entries only. Service Revenue—credit entries only.
(b) Prepaid Insurance .................................................................................... Cash................................................................................................. (Paid one-year insurance policy) 3-4
.
Kimmel, Accounting, 5/e, Solutions Manual
12,000
800 800
(For Instructor Use Only)
Questions Chapter 3 (Continued) (c)
Supplies................................................................................................... Accounts Payable ............................................................................ (Purchased supplies on account)
1,800
(d) Cash ........................................................................................................ Service Revenue .............................................................................. (Received cash for services rendered)
7,500
1,800
7,500
19.
(a) The entire group of accounts maintained by a company, including all the asset, liability, and stockholders’ equity accounts, is referred to collectively as the ledger. (b) The chart of accounts is important, particularly for a company that has a large number of accounts, because it helps organize the accounts and identify their location in the ledger.
20.
A trial balance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove the mathematical equality of debits and credits after all journalized transactions have been posted. A trial balance also facilitates the discovery of errors in journalizing and posting. In addition, it is useful in preparing financial statements.
21.
The proper sequence is as follows: (b) Accounting transaction occurs. (c) Information is entered in the journal. (a) Debits and credits are posted to the ledger. (e) Trial balance is prepared. (d) Financial statements are prepared.
22.
(a) The trial balance would balance. (b) The trial balance would not balance since the debits would be $720 higher than the credits.
.
(For Instructor Use Only)
3-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 3-1
(a) (b) (c)
Assets + + –
Liabilities + NE NE
Stockholders’ Equity NE + –
BRIEF EXERCISE 3-2
Cash (1)
+$60,000
(2)
–9,000
(3)
+13,000
Assets = Liabilities + Stockholders’ Equity Accounts Accounts Bonds Common Retained + Receivable + Supplies = Payable + Payable + Stock + Earnings +$60,000 –$9,000
Paid div.
–$13,000
(4)
+$3,100
+$3,100
BRIEF EXERCISE 3-3 Assets Cash (1)
–$286,176
(2)
+137,590
+ Inventory +
Equipment
=
Liabilities
=
Accounts Payable
+
Stockholders’ Equity
+
Common Stock
+
Retained Earnings
+$286,176 +$137,590
(3)
+$68,480
Issued stock
+$68,480
BRIEF EXERCISE 3-4
(a) (b) (c) (d) (e) (f)
3-6
Accounts Payable Advertising Expense Service Revenue Accounts Receivable Retained Earnings Dividends
.
(For Instructor Use Only)
Debit Effect Decrease Increase Decrease Increase Decrease Increase
Credit Effect Increase Decrease Increase Decrease Increase Decrease
Normal Balance Credit Debit Credit Debit Credit Debit
BRIEF EXERCISE 3-5
June 1 2 3 12
Account Debited Cash Equipment Rent Expense Accounts Receivable
Account Credited Common Stock Accounts Payable Cash Service Revenue
BRIEF EXERCISE 3-6 June 1 2 3 12
Cash ..................................................................... Common Stock ............................................
5,000
Equipment ........................................................... Accounts Payable........................................
1,100
Rent Expense ...................................................... Cash .............................................................
740
Accounts Receivable .......................................... Service Revenue ..........................................
700
5,000 1,100 740 700
BRIEF EXERCISE 3-7 The basic steps in the recording process are: 1.
Analyze each transaction. In this step, source documents are examined to determine the effects of the transaction on the accounts.
2.
Enter each transaction in a journal. This step is called journalizing and it results in making a chronological record of the transactions.
3.
Transfer journal information to ledger accounts. This step is called posting. Posting makes it possible to accumulate the effects of journalized transactions on individual accounts.
.
(For Instructor Use Only)
3-7
BRIEF EXERCISE 3-8 (a) Basic Analysis
(b)
Debit-Credit Analysis
Aug. 1
The asset Cash is increased; the stockholders’ equity account Common Stock is increased.
Debits increase assets: debit Cash $10,000. Credits increase stockholders’ equity: credit Common Stock $10,000.
4
The asset Prepaid Insurance is increased; the asset Cash is decreased.
Debits increase assets: debit Prepaid Insurance $1,500. Credits decrease assets: credit Cash $1,500.
16
The asset Cash is increased; the revenue Service Revenue is increased.
Debits increase assets: debit Cash $900. Credits increase revenues: credit Service Revenue $900.
27
The expense Salaries and Wages Expense is increased; the asset Cash is decreased.
Debits increase expenses: debit Salaries and Wages Expense $620. Credits decrease assets: credit Cash $620.
BRIEF EXERCISE 3-9 Aug. 1 4 16 27
3-8
Cash ...................................................................... Common Stock .............................................
10,000
Prepaid Insurance ................................................ Cash ..............................................................
1,500
Cash ...................................................................... Service Revenue...........................................
900
Salaries and Wages Expense .............................. Cash ..............................................................
620
.
(For Instructor Use Only)
10,000 1,500 900 620
BRIEF EXERCISE 3-10
5/12 5/15
5/5
Cash 1,600 2,000
Service Revenue 5/5 5/15
3,800 2,000
Accounts Receivable 3,800 5/12 1,600
BRIEF EXERCISE 3-11 YEAGER COMPANY Trial Balance June 30, 2014 Cash ............................................................................ Accounts Receivable ................................................. Equipment .................................................................. Accounts Payable ...................................................... Common Stock ........................................................... Dividends .................................................................... Service Revenue ........................................................ Salaries and Wages Expense .................................... Rent Expense .............................................................
.
(For Instructor Use Only)
Debit $ 5,400 3,000 13,000
Credit
$ 1,000 18,000 1,200 8,600 4,000 1,000 $27,600
$27,600
3-9
BRIEF EXERCISE 3-12 CINELLI COMPANY Trial Balance December 31, 2014 Cash ............................................................................ Prepaid Insurance ...................................................... Accounts Payable ...................................................... Unearned Service Revenue ....................................... Common Stock ........................................................... Retained Earnings ...................................................... Dividends .................................................................... Service Revenue......................................................... Salaries and Wages Expense .................................... Rent Expense .............................................................
3-10
.
(For Instructor Use Only)
Debit $20,800 3,500
Credit
$ 2,500 1,800 10,000 6,600 5,000 25,600 14,600 2,600 $46,500
$46,500
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 3-1 Assets = Accounts Cash + Receivable = (1) (2)
+ +
Common Stock
+$20,000 +$20,000
Stockholders’ Equity Retained Earnings + Revenues – Expenses – Dividends +$20,000
–20,000
(3) (4)
Liabilities Accounts Payable
–$1,800
+$1,800 –3,000
–$3,000
DO IT! 3-2 Joel would likely need the following accounts in which to record the transactions necessary to ready his photography studio for opening day: Cash (debit balance) Supplies (debit balance) Notes Payable (credit balance)
Equipment (debit balance) Accounts Payable (credit balance) Common Stock (credit balance)
DO IT! 3-3 Each transaction that is recorded is entered in the general journal. The three activities would be recorded as follows: 1. 2.
3.
Cash.......................................................................... Common Stock .................................................
8,000
Supplies ................................................................... Accounts Payable ............................................ Cash ..................................................................
950
8,000 550 400
No entry because no transaction has occurred.
DO IT! 3-4
4/1 4/3 4/30
.
(For Instructor Use Only)
Cash 1,900 4/16 3,400 4/20 4,500
500 300
3-11
SOLUTIONS TO EXERCISES EXERCISE 3-1 1. 2. 3. 4. 5. 6. 7. 8. 9.
Increase in assets and increase in stockholders’ equity. Decrease in assets and decrease in stockholders’ equity. Increase in assets and increase in stockholders’ equity. Increase in assets and increase in stockholders’ equity. Decrease in assets and decrease in stockholders’ equity. Increase in liabilities and decrease in stockholders’ equity. Increase in assets and decrease in assets. Increase in assets and decrease in assets. Increase in assets and increase in liabilities.
EXERCISE 3-2 Assets Cash (1)
+
Liabilities
+
Accounts Payable
Common Retained Earnings + Stock + Revenues – Expenses
+40,000
+$40,000
(2) (3)
+$30,000
+$30,000 –$4,000
+$19,000
(5)
+5,000
(6)
–8,000
(7)
–30,000
Rent Expense
+$19,000
Service Revenue
+5,000
Service Revenue –8,000
Utilities Expense
–1,300
Advertising Expense
–30,000
(8)
+1,300 +12,000
–12,000
$15,000 +
$7,000
+
$30,000
$52,000
3-12
Issued Stock
–$ 4,000
(4)
(9)
Stockholders’ Equity
=
Accounts Receivable + Equipment =
.
(For Instructor Use Only)
=
$ 1,300
+
$40,000 +
$24,000 –
$52,000
$13,300
EXERCISE 3-3
. Kimmel, Accounting, 5e, Solutions Manual
Cash
(For Instructor Use Only)
(1)
+$100,000
(2)
+45,000
(3)
–60,000
(4)
+16,000
Assets Accounts + Receivable + Supplies +
Equipment
Liabilities Accounts Bonds = Payable + Payable
+ Common + Stock
Stockholders’ Equity Retained Earnings + Revenues – Expenses – Dividends
+$100,000
Issued Stock
+$45,000 +$60,000 +$16,000
(5) (6)
=
+$4,700
+$4,700
–5,200
(7)
–$5,200 +$10,000
3-13
(8)
–28,000
(9)
–11,000 $ 56,800 +
Service Revenue
Rent Expense
+10,000
Service Revenue –28,000
Salaries and Wages Expense –$11,000
$10,000
+
$4,700
$131,500
+
$60,000
$4,700
+
$45,000 +
$100,000 +
+$26,000 –
$131,500
$33,200
–
$11,000
Dividends
EXERCISE 3-4 (a)
1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Stockholders invested $20,000 cash in the business. Purchased equipment for $5,000, paying $1,000 in cash and the balance of $4,000 on account. Paid $750 cash for supplies. Earned $9,500 in revenue, receiving $4,100 cash and $5,400 on account. Paid $1,500 cash on accounts payable. Paid $2,000 cash dividends to stockholders. Paid $800 cash for rent. Collected $450 cash from customers on account. Paid salaries of $3,000. Incurred $300 of utilities expense on account.
(b) Issued common stock ............................................................ Service revenue ...................................................................... Dividends ................................................................................ Rent expense .......................................................................... Salaries and wages expense .................................................. Utilities expense ..................................................................... Increase in stockholders’ equity............................................
$20,000 9,500 (2,000) (800) (3,000) (300) $23,400
(c) Service revenue ...................................................................... Rent expense .......................................................................... Salaries and wages expense .................................................. Utilities expense ..................................................................... Net income ..............................................................................
$ 9,500 (800) (3,000) (300) $ 5,400
3-14
.
(For Instructor Use Only)
EXERCISE 3-5 COLAW COMPANY Income Statement For the Month Ended August 31, 2014 Revenues Service revenue ....................................................... Expenses Salaries and wages expense .................................. Rent expense ........................................................... Utilities expense ...................................................... Total expenses ................................................. Net income .......................................................................
$9,500 $3,000 800 300 4,100 $5,400
COLAW COMPANY Retained Earnings Statement For the Month Ended August 31, 2014 Retained earnings, August 1 ............................................................ Add: Net income ............................................................................. Less: Dividends ................................................................................ Retained earnings, August 31 ..........................................................
$ 0 5,400 5,400 2,000 $3,400
COLAW COMPANY Balance Sheet August 31, 2014 Assets Current assets Cash .......................................................................... Accounts receivable ................................................ Supplies .................................................................... Total current assets .............................................. Equipment..................................................................... Total assets ...........................................................
$15,500 4,950 750
Liabilities and Stockholders’ Equity Current liabilities Accounts payable..................................................... Stockholders’ equity Common stock ......................................................... $20,000 Retained earnings .................................................... 3,400 Total liabilities and stockholders’ equity ....
.
(For Instructor Use Only)
$21,200 5,000 $26,200
$ 2,800 23,400 $26,200 3-15
EXERCISE 3-6
3-16
(a)
. (For Instructor Use Only)
Account Debited (b) (c) Specific Account Effect
(d) Normal Balance
(a) Basic Type
Account Credited (b) (c) Specific Account Effect
Transaction
(a) Basic Type
(d) Normal Balance
1.
Asset
Cash
Increase
Debit
Stockholders’ Equity
Common Stock
Increase
Credit
2.
Asset
Equipment
Increase
Debit
Asset
Cash
Decrease
Debit
3.
Asset
Supplies
Increase
Debit
Liability
Accounts Payable
Increase
Credit
4.
Asset
Accounts Receivable
Increase
Debit
Stockholders’ Equity
Service Revenue
Increase
Credit
5.
Stockholders’ Equity
Advertising Expense
Increase
Debit
Asset
Cash
Decrease
Debit
6.
Asset
Cash
Increase
Debit
Asset
Accounts Receivable
Decrease
Debit
7.
Liability
Accounts Payable
Decrease
Credit
Asset
Cash
Decrease
Debit
8.
Stockholders’ Equity
Dividends
Increase
Debit
Asset
Cash
Decrease
Debit
EXERCISE 3-6 (Continued) (b) General Journal Trans. 1. 2. 3. 4. 5. 6. 7. 8.
Account Titles Debit Cash .................................................................... 15,000 Common Stock ...........................................
15,000
Equipment .......................................................... 10,000 Cash ............................................................
10,000
Supplies.............................................................. Accounts Payable ......................................
300
Accounts Receivable ......................................... Service Revenue ........................................
3,700
Advertising Expense ......................................... Cash ............................................................
200
Cash .................................................................... Accounts Receivable .................................
1,100
Accounts Payable .............................................. Cash ............................................................
300
Dividends ........................................................... Cash ............................................................
400
Credit
300 3,700 200 1,100 300 400
EXERCISE 3-7 Oct. 1
.
Debits increase assets: debit Cash $30,000. Credits increase stockholders’ equity: credit Common Stock $30,000.
2
No accounting transaction.
3
Debits increase assets: debit Equipment $3,800. Credits increase liabilities: credit Accounts Payable $3,800.
(For Instructor Use Only)
3-17
EXERCISE 3-7 (Continued) Oct. 6
Debits increase assets: debit Accounts Receivable $10,800. Credits increase revenues: credit Service Revenue $10,800.
10
Debits increase assets: debit Cash $140. Credits increase revenues: credit Service Revenue $140.
27
Debits decrease liabilities: debit Accounts Payable $700. Credits decrease assets: credit Cash $700.
30
Debits increase expenses: debit Salaries and Wages Expense $3,000. Credits decrease assets: credit Cash $3,000.
EXERCISE 3-8 General Journal Date Oct. 1 2
No entry.
3
Equipment ......................................................... Accounts Payable .....................................
6 10 27 30
3-18
Account Titles Debit Cash................................................................... 30,000 Common Stock ..........................................
3,800
Cash................................................................... Service Revenue .......................................
140
Accounts Payable ............................................. Cash ...........................................................
700
Salaries and Wages Expense........................... Cash ...........................................................
3,000
(For Instructor Use Only)
30,000
3,800
Accounts Receivable ........................................ 10,800 Service Revenue .......................................
.
Credit
10,800 140 700 3,000
EXERCISE 3-9 General Journal Date May 4 7 8 9 17 22 29
.
Account Titles Accounts Payable............................................. Cash ...........................................................
Debit 700
Accounts Receivable ....................................... Service Revenue .......................................
6,800
Supplies ............................................................ Accounts Payable .....................................
850
Equipment ......................................................... Cash ...........................................................
1,000
Salaries and Wages Expense .......................... Cash ...........................................................
530
Maintenance and Repairs Expense ................. Accounts Payable .....................................
900
Prepaid Insurance ............................................ Cash ...........................................................
1,200
(For Instructor Use Only)
Credit 700 6,800 850 1,000 530 900 1,200
3-19
EXERCISE 3-10 (a) Oct. 1 10 Bal.
Cash 30,000 Oct. 27 140 30 26,440
700 3,000
Accounts Payable Oct. 27 700 Oct. 3 Bal.
3,800 3,100
Common Stock Oct. 1 Bal.
30,000 30,000
Accounts Receivable Oct. 6 10,800 Bal. 10,800
Oct. 3 Bal.
Equipment 3,800 3,800
Service Revenue Oct. 6 10,800 10 140 Bal. 10,940 Salaries and Wages Expense Oct. 30 3,000 Bal. 3,000
(b)
CROFOOT REAL ESTATE AGENCY Trial Balance October 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Equipment .......................................................... Accounts Payable .............................................. Common Stock ................................................... Service Revenue ................................................ Salaries and Wages Expense ............................
3-20
.
(For Instructor Use Only)
Debit $26,440 10,800 3,800
3,000 $44,040
Credit
$ 3,100 30,000 10,940 . $44,040
EXERCISE 3-11 (a) Assets
=
Accounts Cash
+
Sept. 1
+$20,000
5
–3,000
8
Receivable
Liabilities Accounts
+ Equipment =
Payable
Stockholders’ Equity
+ Common +
Stock
Retained Earnings + Revenues
–1,200
25
–4,000
30
–500 $ 11,300 +
Exp.
–
Div.
+$20,000 +$9,000
Issued stock
+$ 6,000
+$18,000
14
–
+$18,000
Ser. Rev. –$1,200
Salar. Exp.
–4,000 –$500 $18,000 $38,300
+
$9,000
=
$ 2,000+
+
$20,000
..
+
$18,000
–
$1,200
–
Dividends
$500
$38,300
(b) General Journal Date Sept. 1 5
8 14 25 30
.
Account Titles Cash ................................................................ Common Stock .......................................
Debit 20,000
Equipment....................................................... Accounts Payable ................................... Cash.........................................................
9,000
Accounts Receivable ..................................... Service Revenue .....................................
18,000
Salaries and wages expense ......................... Cash.........................................................
1,200
Accounts Payable .......................................... Cash.........................................................
4,000
Dividends ........................................................ Cash.........................................................
500
(For Instructor Use Only)
J1 Credit 20,000 6,000 3,000 18,000 1,200 4,000 500
3-21
EXERCISE 3-11 (Continued) (c)
Bal.
Cash 20,000 9/5 9/14 9/25 9/30 11,300
9/8 Bal.
Accounts Receivable 18,000 18,000
9/1
9/5 Bal.
9/25
3-22
3,000 1,200 4,000 500 9/30 Bal.
.
(For Instructor Use Only)
20,000 20,000
Dividends 500 500 Service Revenue 9/8 Bal.
Equipment 9,000 9,000 Accounts Payable 4,000 9/5 Bal.
Common Stock 9/1 Bal.
18,000 18,000
Salaries and Wages Expense 9/14 1,200 Bal. 1,200 6,000 2,000
EXERCISE 3-12 (a) Date Apr. 1
4
7
12
15
25
29
30
.
General Journal Account Titles and Explanation Debit Cash .................................................................. 15,000 Common Stock.......................................... (Issued stock for cash) Supplies ............................................................ Accounts Payable ..................................... (Purchased supplies on account)
5,200
Accounts Receivable ....................................... Service Revenue ....................................... (Billed clients for services rendered)
3,400
Cash .................................................................. Service Revenue ....................................... (Received cash for revenue earned)
700
Salaries and Wages Expense .......................... Cash ........................................................... (Paid salaries)
800
Accounts Payable............................................. Cash ........................................................... (Paid creditors on account)
3,500
Cash .................................................................. Accounts Receivable ................................ (Received cash in payment of account)
800
Cash .................................................................. Unearned Service Revenue ...................... (Received cash for future services)
900
(For Instructor Use Only)
Credit 15,000
5,200
3,400
700
800
3,500
800
900
3-23
EXERCISE 3-12 (Continued) (b)
WHEELING GARDENING COMPANY, INC. Trial Balance April 30, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Accounts Payable .............................................. Unearned Service Revenue ............................... Common Stock ................................................... Service Revenue ................................................ Salaries and Wages Expense ............................
3-24
.
(For Instructor Use Only)
Debit $13,100 2,600 5,200
Credit
$ 1,700 900 15,000 4,100 800 $21,700
$21,700
EXERCISE 3-13 (a) Aug. 1 10 31 Bal.
Cash 8,000 Aug. 12 1,700 600 9,100
Accounts Receivable Aug. 25 3,400 Aug. 31 Bal. 2,800
Aug. 12 Bal.
5,000 5,000
Common Stock Aug. 1 Bal.
8,000 8,000
Service Revenue Aug. 10 25 Bal.
1,700 3,400 5,100
1,200
600
Equipment 6,200 6,200
(b)
Notes Payable Aug. 12 Bal.
EBERLE INC. Trial Balance August 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Equipment .......................................................... Notes Payable .................................................... Common Stock .................................................. Service Revenue ................................................
Debit $ 9,100 2,800 6,200
$18,100
.
(For Instructor Use Only)
Credit
$ 5,000 8,000 5,100 $18,100
3-25
EXERCISE 3-14 (a) Oct. 1
10
10
20
20
3-26
.
Cash ............................................................... Common Stock ...................................... (Issued stock for cash)
7,000
Cash ............................................................... Service Revenue .................................... (Received cash for services provided)
980
Cash ............................................................... Notes Payable ........................................ (Issued note payable for cash)
8,000
Cash ............................................................... Accounts Receivable ............................. (Received cash in payment of account)
700
Accounts Receivable .................................... Service Revenue .................................... (Billed clients for services provided)
920
(For Instructor Use Only)
7,000
980
8,000
700
920
EXERCISE 3-14 (Continued) (b)
KEISLER CO. Trial Balance October 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Equipment .......................................................... Notes Payable .................................................... Accounts Payable .............................................. Common Stock .................................................. Dividends ........................................................... Service Revenue ................................................ Salaries and Wages Expense ............................ Supplies Expense .............................................. Rent Expense .....................................................
Debit $15,730 1,020 220 3,000
Credit
$ 8,000 1,500 9,000 300 2,700 500 180 250 $21,200
$21,200
EXERCISE 3-15 Error 1. 2. 3. 4. 5. 6.
.
(a) In Balance No Yes Yes No Yes No
(For Instructor Use Only)
(b) Difference $400 — — 300 — 36
(c) Larger Column Debit — — Credit — Credit
3-27
EXERCISE 3-16 (a)
3-28
BASTIN DELIVERY SERVICE Trial Balance July 31, 2014 Debit
Credit
Cash ($98,370 – Debit total without Cash $85,946) ..................................................................$12,424 Accounts Receivable ................................................. 13,400 Prepaid Insurance ...................................................... 2,200 Equipment .................................................................. 59,360 Accounts Payable ...................................................... Salaries and Wages Payable ..................................... Notes Payable (due 2015) .......................................... Common Stock .......................................................... Retained Earnings ..................................................... Dividends ................................................................... 700 Service Revenue ........................................................ Salaries and Wages Expense .................................... 7,428 Maintenance and Repairs Expense .......................... 1,958 Insurance Expense .................................................... 900 $98,370
$ 8,400 820 28,450 40,000 5,200
.
(For Instructor Use Only)
15,500
$98,370
EXERCISE 3-16 (Continued) (b)
BASTIN DELIVERY SERVICE Income Statement For the Month Ended July 31, 2014 Revenues Service revenue ................................................. Expenses Salaries and wages expense ............................ Maintenance and repairs expense ................... Insurance expense ............................................ Total expenses ............................................... Net income ............................................................
$15,500 $7,428 1,958 900 10,286 $ 5,214
BASTIN DELIVERY SERVICE Retained Earnings Statement For the Month Ended July 31, 2014 Retained earnings, July 1 ..................................... Add: Net income ................................................. Less: Dividends ................................................... Retained earnings, July 31 ...................................
.
(For Instructor Use Only)
$ 5,200 5,214 10,414 700 $ 9,714
3-29
EXERCISE 3-16 (Continued) BASTIN DELIVERY SERVICE Balance Sheet July 31, 2014 Assets Current assets Cash.................................................................... Accounts receivable .......................................... Prepaid insurance.............................................. Total current assets ....................................... Equipment ............................................................. Total assets ....................................................
$12,424 13,400 2,200 $28,024 59,360 $87,384
Liabilities and Stockholders’ Equity Current liabilities Accounts payable .............................................. Salaries and wages payable ............................. Total current liabilities ................................... Notes payable........................................................ Total liabilities ................................................ Stockholders’ equity Common stock .................................................. Retained earnings ............................................. Total stockholders’ equity ............................. Total liabilities and stockholders’ equity .....
3-30
.
(For Instructor Use Only)
$ 8,400 820 $ 9,220 28,450 37,670 40,000 9,714 49,714 $87,384
EXERCISE 3-17
Account Accounts payable Accounts receivable Common stock Depreciation expense Interest expense Interest income Inventories Prepaid expenses Property and Equipment Revenues
(a) Normal Balance Debit or Credit Credit Debit Credit Debit Debit Credit Debit Debit Debit Credit
(b) Balance Sheet or Income Statement Balance sheet Balance sheet Balance sheet Income statement Income statement Income statement Balance sheet Balance sheet Balance sheet Income statement
EXERCISE 3-18 1. 2. 3. 4. 5. 6. 7. 8. 9.
Financing activity Operating activity Operating activity Non-cash event Financing activity Non-cash event Operating activity Investing activity Non-cash event
EXERCISE 3-19 1. 2. 3. 4. 5. 6. 7. 8. 9.
.
Financing activity Financing activity Investing activity Operating activity Non-cash event Operating activity Non-cash event Operating activity Financing activity
(For Instructor Use Only)
3-31
3-32 (a)
DEDONDER TRAVEL AGENCY INC. Assets
. 2.
–900
3.
–3,400
Rent Expense
–200
Advertising Expense
+$3,400
4.
+$200
5.
–500
6.
+3,000
7.
–400
8.
–200
9.
–1,800
10.
+9,000
–9,000
$34,800 +
$
+$500
+$9,000
+$12,000
Service Revenue
–$400
Dividends
–200
–1,800
0
+
$38,700
$500
+
$3,400
=
$
0
+
$30,000 +
$12,000
$38,700
–
$2,900
Salaries and Wages Expense
–
$400
PROBLEM 3-1A
–$900
SOLUTIONS TO PROBLEM 3-3A
Cash +$30,000
Retained Earnings Common Stock + Revenues – Expenses – Dividends +$30,000
OLUTIONS TO PROBLEMS
(For Instructor Use Only)
1.
Stockholders’ Equity
= Liabilities +
Accounts Accounts + Receivable + Supplies + Equipment = Payable +
PROBLEM 3-1A (Continued) (b) Service Revenue ...................................................... Expenses Salaries and Wages Expense .......................... Rent Expense ................................................... Advertising Expense ........................................ Net Income ................................................
$12,000 $1,800 900 200
2,900 $ 9,100
OR Revenues.................................................................. Less: Expenses....................................................... Net Income ...............................................................
.
(For Instructor Use Only)
$12,000 2,900 $ 9,100
3-33
3-34 (a)
FINZELBERG CONSULTING INC.
. Assets (For Instructor Use Only)
Date
Cash
=
Liabilities
Accounts Notes Accounts Common Retained Earnings + Receivable + Supplies + Equipment = Payable + Payable + Stock + Revenues – Expenses – Dividends
May 1 +$15,000 2
Stockholders’ Equity
+
+$15,000
–600
3
+$500 –150
9
+1,400
12
–200
15 –2,500
20
–500
23
+1,200
26
+5,000
29
–200
30
–180
–150
Advertising Expense
+$500
+$1,400
Service Revenue –$200
+4,200
17
Rent Expense
+4,200
Dividends Service Revenue
–2,500
Salaries and Wages Expense
$18,270 +
–500 –1,200 +$5,000 +$2,000
+1,800 –180
$3,000
+
$23,770
$500
+
$2,000
=
$5,000 +
$1,800
+
$15,000 +
$23,770
$5,600
–
$3,430
Utilities Expense –
$200
PROBLEM 3-2A
5
–$600
PROBLEM 3-2A (Continued) (b)
FINZELBERG CONSULTING INC. Income Statement For the Month Ended May 31, 2014 Revenues Service revenue ($1,400 + $4,200)................ Expenses Salaries and wages expense ........................ Rent expense ................................................. Utilities expense ............................................ Advertising expense ..................................... Total expenses....................................... Net income ............................................................
(c)
$5,600 $2,500 600 180 150 3,430 $2,170
FINZELBERG CONSULTING INC. Balance Sheet May 31, 2014 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Supplies......................................................... Total current assets .............................. Equipment ..................................................... Total assets............................................
$18,270 3,000 500
Liabilities and Stockholders’ Equity Current liabilities Notes payable ............................................... $ 5,000 Accounts payable ......................................... 1,800 Total current liabilities .......................... Stockholders’ equity Common stock .............................................. 15,000 Retained earnings ($0 + $2,170 – $200) ....... 1,970 Total liabilities and stockholders’ equity..................................................
.
(For Instructor Use Only)
$21,770 2,000 $23,770
$ 6,800 16,970 $23,770
3-35
3-36 (a)
CINDY BRAUN INC. Assets
=
Liabilities
Stockholders’ Equity
+
. (For Instructor Use Only)
Accounts Notes Accounts Common Retained Cash + Receivable + Supplies + Equipment = Payable + Payable + Stock + Earnings + Revenues– Expenses – Dividends July 31 Bal. Aug. 1
$4,000 +
$2,500 +
+1,100
–1,100
4
–2,700
9
+3,600
15
–700
19
–2,450
–700
26
+5,000
+
$5,000
=
$4,200
+
$6,200
+ $1,600
–2,700
+1,800
+$5,400
+4,000
+3,300 –$1,400
Salaries and Wages Expense
–700
Rent Expense
–350
Advertising Expense –$700
Dividends
+$5,000
31
–380
+380 $7,150 +
Service Revenue
$3,200 +
$500
$19,850
+
$9,000
=
$5,000 + $5,180
+
$6,200
+ $1,600
$19,850
+
$5,400 –
$2,830 –
Utilities Expense $700
PROBLEM 3-3A
23
$500
PROBLEM 3-3A (Continued) (b)
CINDY BRAUN INC. Income Statement For the Month Ended August 31, 2014 Revenues Service revenue................................................ Expenses Salaries and wages expense ........................... Rent expense .................................................... Utilities expense ............................................... Advertising expense ........................................ Total expenses.......................................... Net income ...............................................................
$5,400 $1,400 700 380 350 2,830 $2,570
CINDY BRAUN INC. Retained Earnings Statement For the Month Ended August 31, 2014 Retained earnings, August 1 .................................................... Add: Net income...................................................................... Less: Dividends ........................................................................ Retained earnings, August 31...................................................
.
(For Instructor Use Only)
$1,600 2,570 4,170 700 $3,470
3-37
PROBLEM 3-3A (Continued) CINDY BRAUN INC. Balance Sheet August 31, 2014 Assets Current assets Cash ................................................................ Accounts receivable ...................................... Supplies .......................................................... Total current assets ................................ Equipment....................................................... Total assets .............................................
$7,150 3,200 500 $10,850 9,000 $19,850
Liabilities and Stockholders’ Equity Current liabilities Notes payable ................................................. Accounts payable........................................... Total current liabilities............................ Stockholders’ equity Common stock ............................................... Retained earnings .......................................... Total liabilities and stockholders’ equity ...................................................
3-38
.
(For Instructor Use Only)
$5,000 5,180 $10,180 6,200 3,470
9,670 $19,850
PROBLEM 3-4A
Date Mar. 1
3
5
6
10
18
19
25
.
Account Titles and Explanation Cash ................................................................. Common Stock......................................... (Issued stock for cash)
Debit 50,000
Land.................................................................. Buildings .......................................................... Equipment ........................................................ Cash .......................................................... (Purchased Arnie’s Golf Land)
23,000 9,000 6,000
Advertising Expense ....................................... Cash .......................................................... (Paid for advertising)
1,200
Prepaid Insurance ........................................... Cash .......................................................... (Paid for one-year insurance policy)
2,400
Equipment ........................................................ Accounts Payable .................................... (Purchased equipment on account)
5,500
Cash ................................................................. Service Revenue ...................................... (Received cash for revenue earned)
1,600
Cash (100 X $25) .............................................. Unearned Service Revenue ..................... (Received cash for coupon books sold)
2,500
Dividends ......................................................... Cash .......................................................... (Payment of cash dividend)
500
(For Instructor Use Only)
Credit 50,000
38,000
1,200
2,400
5,500
1,600
2,500
500
3-39
PROBLEM 3-4A (Continued) Date Mar. 30
30
31
3-40
Account Titles and Explanation Salaries and Wages Expense......................... Cash ......................................................... (Paid salaries expense)
Debit 800
Accounts Payable ........................................... Cash ......................................................... (Paid creditor on account)
5,500
Cash................................................................. Service Revenue ..................................... (Received cash for revenue earned)
900
.
(For Instructor Use Only)
Credit 800
5,500
900
PROBLEM 3-5A (a) Date Apr. 1
Debit 118,000 0
1
No entry—not a transaction.
2
Rent Expense .................................................. Cash .......................................................... (Paid monthly office rent)
900
Supplies ........................................................... Accounts Payable .................................... (Purchased supplies on account from Burlington Company)
1,300
Accounts Receivable ...................................... Service Revenue ...................................... (Billed clients for services rendered)
1,900
Cash ................................................................. Unearned Service Revenue ..................... (Received cash advance for future service)
700
Cash ................................................................. Service Revenue ...................................... (Received cash for service performed)
2,800
Salaries and Wages Expense ......................... Cash .......................................................... (Paid monthly salary)
1,500
Accounts Payable ........................................... Cash .......................................................... (Paid Burlington Company on account)
300
3
10
11
20
30
30
.
Account Titles and Explanation Cash ................................................................. Common Stock ........................................ (Issued shares of stock for cash)
(For Instructor Use Only)
Credit 18,000
900
1,300
1,900
700
2,800
1,500
300
3-41
PROBLEM 3-5A (Continued) (b) 4/1 4/11 4/20 Bal.
Cash 18,000 4/2 700 4/30 2,800 4/30 18,800
900 1,500 300
4/10 Bal.
Accounts Receivable 1,900 1,900
4/3 Bal.
Supplies 1,300 1,300
4/30
Accounts Payable 300 4/3 Bal.
4/2 Bal.
1,300 1,000
Unearned Service Revenue 4/11 700 Bal. 700
3-42
Common Stock 4/1 Bal.
18,000 18,000
Service Revenue 4/10 4/20 Bal.
1,900 2,800 4,700
.
(For Instructor Use Only)
Salaries and Wages Expense 4/30 1,500 Bal. 1,500 Rent Expense 900 900
PROBLEM 3-5A (Continued) (c)
FOYLE ARCHITECTS INC. Trial Balance April 30, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Accounts Payable .............................................. Unearned Service Revenue ............................... Common Stock .................................................. Service Revenue ................................................ Salaries and Wages Expense ............................ Rent Expense .....................................................
.
(For Instructor Use Only)
Debit $18,800 1,900 1,300
Credit
$ 1,000 700 18,000 4,700 1,500 900 $24,400
$24,400
3-43
PROBLEM 3-6A
(a) & (c) Cash 10/1 Bal. 19,200 10/15 10/5 1,300 10/20 10/17 600 10/29 10/31 Bal. 17,300
1,200 1,900 300 400
Retained Earnings 10/1 Bal. 11,000 Bal. 11,000
Accounts Receivable 10/1 Bal. 2,600 10/5 1,300 10/10 5,100 Bal. 6,400
10/1 Bal. Bal.
Supplies 2,100 2,100
10/1 Bal. Bal.
Equipment 8,000 8,000
10/20
Accounts Payable 1,900 10/1 Bal. Bal.
Common Stock 10/1 Bal. 15,000 Bal. 15,000
10/29 Bal.
Service Revenue 10/10 10/17 Bal.
4,800 2,900
Unearned Service Revenue 10/1 Bal. 1,100 Bal. 1,100
.
(For Instructor Use Only)
5,100 600 5,700
Salaries and Wages Expense 10/15 1,200 Bal. 1,200
10/31 Bal.
3-44
Dividends 300 300
Utilities Expense 400 400
PROBLEM 3-6A (Continued) (b) Date Oct. 5
10
15
17
20
29
31
.
Account Titles and Explanation Cash ................................................................. Accounts Receivable ............................... (Received collections from customers on account)
Debit 1,300
Accounts Receivable ...................................... Service Revenue ...................................... (Billed customers for services performed)
5,100
Salaries and Wages Expense ......................... Cash .......................................................... (Paid employee salaries)
1,200
Cash ................................................................. Service Revenue ...................................... (Performed services for customers)
600
Accounts Payable............................................ Cash .......................................................... (Paid creditors on account)
1,900
Dividends ......................................................... Cash .......................................................... (Payment of cash dividend)
300
Utilities Expense .............................................. Cash .......................................................... (Paid utilities)
400
(For Instructor Use Only)
Credit 1,300
5,100
1,200
600
1,900
300
400
3-45
PROBLEM 3-6A (Continued) (d)
SOLIS COMPANY Trial Balance October 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Equipment .......................................................... Accounts Payable .............................................. Unearned Service Revenue ............................... Common Stock ................................................... Retained Earnings.............................................. Dividends ............................................................ Service Revenue ................................................ Salaries and Wages Expense ............................ Utilities Expense ................................................
3-46
.
(For Instructor Use Only)
Debit $ 17,300 6,400 2,100 8,000
Credit
$ 2,900 1,100 15,000 11,000 300 5,700 1,200 400 $35,700
$35,700
PROBLEM 3-7A
SWISHER CO. Trial Balance June 30, 2014 Cash ($3,090 – $780 + $870) .............................. Accounts Receivable* ....................................... Supplies ($800 – $340) ....................................... Equipment ($3,000 + $340) ................................ Accounts Payable ($3,686 – $206 – $260) ........ Unearned Service Revenue ............................... Common Stock .................................................. Dividends ($800 + $600) .................................... Service Revenue ................................................ Salaries and Wages Expense ($3,600 + $700 – $600)..................................... Utilities Expense ................................................
Debit $ 3,180 3,910 460 3,340
Credit
$ 3,220 1,200 9,000 1,400 3,480 3,700 910 $16,900
$16,900
*$3,190 + $780 – $870 – $90 + $900
.
(For Instructor Use Only)
3-47
PROBLEM 3-8A
(a) & (c) 3/1 Bal. 3/9 3/20 3/31 3/31 Bal.
3/31 Bal.
3/1 Bal. Bal.
3/1 Bal. Bal.
3-48
2,000 10,900 500 5,000 3,800
Accounts Receivable 750 750
3/1 Bal. Bal.
3/10
Cash 16,000 3/2 9,900 3/10 8,300 3/12 750 3/20 20,000 3/31 32,750
Land 38,000 38,000 Buildings 22,000 22,000 Equipment 16,000 16,000 Accounts Payable 10,900 3/1 Bal. 12,000 3/2 8,000 Bal. 9,100
.
(For Instructor Use Only)
Common Stock 3/1 Bal. Bal.
80,000 80,000
Service Revenue 3/9 3/20 3/31 Bal.
9,900 8,300 20,000 38,200
Sales Revenue 3/31 Bal.
1,500 1,500
3/12 Bal.
Advertising Expense 500 500
3/2 3/20 Bal.
Rent Expense 10,000 5,000 15,000
Salaries and Wages Expense 3/31 3,800 Bal. 3,800
PROBLEM 3-8A (Continued) (b) Date Mar. 2
Debit 10,000
No entry—not a transaction.
9
Cash ................................................................. Service Revenue ...................................... (Received cash for admissions)
9,900
Accounts Payable ($8,000 + $2,900) .............. Cash ......................................................... (Paid creditors on account)
10,900
9,900
10,900
11
No entry—not a transaction.
12
Advertising Expense ....................................... Cash ......................................................... (Paid advertising expenses)
500
Cash ................................................................. Service Revenue ...................................... (Received cash for admissions)
8,300
Rent Expense .................................................. Cash ......................................................... (Paid film rental)
5,000
Salaries and Wages Expense ......................... Cash ......................................................... (Paid salaries expense)
3,800
20
20
31
(For Instructor Use Only)
Credit 8,000 2,000
3
10
.
Account Titles and Explanation Rent Expense .................................................. Accounts Payable .................................... Cash ......................................................... (Rented films for cash and on account)
500
8,300
5,000
3,800
3-49
PROBLEM 3-8A (Continued) Date Mar. 31
31
Account Titles and Explanation Debit Cash .................................................................. 750 Accounts Receivable ....................................... 750 Sales Revenue (15% X $10,000) ................. (Received cash and balance on account for concessions)
1,500
Cash .................................................................. 20,000 Service Revenue ....................................... (Received cash for admissions)
(d)
20,000
SEQUEL THEATER INC. Trial Balance March 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Land .................................................................... Buildings ............................................................ Equipment .......................................................... Accounts Payable .............................................. Common Stock ................................................... Service Revenue ................................................ Sales Revenue .................................................... Advertising Expense.......................................... Rent Expense ..................................................... Salaries and Wages Expense ............................
3-50
Credit
.
(For Instructor Use Only)
Debit $ 32,750 750 38,000 22,000 16,000
Credit
$
500 15,000 3,800 $128,800
9,100 80,000 38,200 1,500
$128,800
PROBLEM 3-9A
.
Error 1.
(a) In Balance No
(b) Difference $600
(c) Larger Column Debit
2.
Yes
None
N/A
3.
Yes
None
N/A
4.
No
$680
Credit
5.
Yes
None
N/A
6.
Yes
None
N/A
7.
No
$900
Debit
8.
Yes
None
N/A
(For Instructor Use Only)
3-51
3-52
(a)
HYMAN INC. Assets = Liabilities + Stockholders’ Equity Retained Earnings Accounts Accounts Common + Receivable + Supplies + Equipment = Payable + Stock + Revenues – Expenses – Dividends
Cash .
+$30,000
2.
–10,000
3.
–700
4.
–300
+$30,000
+$10,000
Rent Expense
–750
Advertising Expense
+$300
5.
+$750
(For Instructor Use Only)
6.
+8,000
7.
–500
8.
–1,000
–1,000
Salaries and Wages Expense
9.
–140
–140
Utilities Expense
10.
11.
+$8,000
+$2,000
+1,000
–1,000
$26,360 +
$1,000
.
Service Revenue
–$500
+2,000
+
$37,660
3-52
–$700
(For Instructor Use Only)
$300
+
$10,000
=
$750
+
$30,000 +
$10,000
$37,660
Dividends
Service Revenue
–
$2,590
–
$500
OLUTIONS TO PROBLEMS PROBLEM 3-1B
Kimmel, Accounting, 5/e, Solutions Manual
1.
PROBLEM 3-1B (Continued) (b) Service Revenue ($8,000 + $2,000) ......................... Expenses Salaries and Wages Expense .......................... Advertising Expense ........................................ Rent Expense ................................................... Utilities Expense .............................................. Net income ................................................
$10,000 $1,000 750 700 140
2,590 $ 7,410
OR Revenues.................................................................. Less: Expenses....................................................... Net income ...............................................................
.
(For Instructor Use Only)
$10,000 2,590 $ 7,410
3-53
3-54
(a)
WALZ SERVICE INC.
. Date
Cash
June 1
$20,000
2
–2,000
3
–600
Stockholders’ Equity
+
$20,000 +$10,000
+$8,000 –$600
+$3,000
Rent Expense
+$3,000
Service Revenue
–300
–$300
12 15
Liabilities
Retained Earnings Accounts Notes Accounts Common + Receivable + Supplies + Equipment = Payable + Payable + Stock + Revenues – Expenses – Dividends
5 9
=
+$240 +1,000
+$240
–1,000
(For Instructor Use Only)
17
–200
+200
20
+1,500
23
–1,000
26
–180
29
–240
30
–750 $17,430 +
Dividends
Advertising Expense
+1,500
Service Revenue
–1,000 –180
Utilities Expense
–750
Salaries and Wages Expense
–240
$2,000
+
$29,670
$240 +
$10,000 =
$7,000 +
$200
+ $20,000 +
$4,500 – $1,730
$29,670
–
$300
PROBLEM 3-2B
Kimmel, Accounting, 5/e, Solutions Manual
Assets
PROBLEM 3-2B (Continued) (b)
WALZ SERVICE INC. Income Statement For the Month Ended June 30, 2014 Revenues Service revenue ($3,000 + $1,500)................ Expenses Salaries and wages expense ........................ Rent expense ................................................. Advertising expense ..................................... Utilities expense ............................................ Total expenses....................................... Net income ............................................................
(c)
$4,500 $750 600 200 180 1,730 $2,770
WALZ SERVICE INC. Balance Sheet June 30, 2014 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Supplies ......................................................... Total current assets .............................. Equipment ..................................................... Total assets ............................................
$17,430 2,000 240 $19,670 10,000 $29,670
Liabilities and Stockholders’ Equity Current liabilities Notes payable ................................................ Accounts payable ......................................... Total liabilities........................................ Stockholders’ equity Common stock .............................................. Retained earnings* ........................................ Total liabilities and stockholders’ equity ..................................................
$7,000 200 $7,200 20,000 2,470
22,470 $29,670
*($0 + $2,770 – $300)
.
(For Instructor Use Only)
3-55
3-56 (a)
THYME COMPANY
.
Assets
=
Liabilities
+
Stockholders’ Equity
Bal.
$9,000 +
(For Instructor Use Only)
Sept. 2.
–3,400
5.
+1,200
8.
–1,000
13.
+2,300
17.
–600
22.
–2,250
$1,700 +
$600
+
$5,000
=
+ $10,000 + $2,700
–3,400 –1,200 +5,100
+4,100
+8,300
+$10,600
+220 +5,000 $10,250 +
Service Revenue
–$600
26. 30.
$3,600
$8,800 +
$600
$29,750
+ $10,100 =
+$5,000 $5,000 + $4,520
+ $10,000 + $2,700
$29,750
+ $10,600 –
Dividends
–$900
Salaries and Wages Expense
–1,100
Rent Expense
–250
Advertising Expense
–220
Utilities Expense
$2,470
–
$600
PROBLEM 3-3B
Kimmel, Accounting, 5/e, Solutions Manual
Accounts Notes Accounts Common Retained Cash + Receivable + Supplies + Equipment = Payable + Payable + Stock + Earnings + Revenues – Expenses – Dividends
PROBLEM 3-3B (Continued) (b)
THYME COMPANY Income Statement For the Month Ended September 30, 2014 Revenues Service revenue................................................... Expenses Rent expense ....................................................... Salaries and wages expense .............................. Advertising expense ........................................... Utilities expense .................................................. Total expenses............................................. Net income ..................................................................
$10,600 $1,100 900 250 220 2,470 $8,130
THYME COMPANY Retained Earnings Statement For the Month Ended September 30, 2014 Retained earnings, September 1 .............................................. Add: Net income ...................................................................... Less: Dividends ........................................................................ Retained earnings, September 30 ............................................
.
(For Instructor Use Only)
$ 2,700 8,130 10,830 600 $10,230
3-57
PROBLEM 3-3B (Continued) THYME COMPANY Balance Sheet September 30, 2014 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Supplies ......................................................... Total current assets ............................... Equipment...................................................... Total assets ............................................
$10,250 8,800 600 $19,650 10,100 $29,750
Liabilities and Stockholders’ Equity Current liabilities Notes payable ................................................ Accounts payable.......................................... Total current liabilities........................... Stockholders’ equity Common stock .............................................. Retained earnings ......................................... Total liabilities and stockholders’ equity ..................................................
3-58
.
(For Instructor Use Only)
$ 5,000 4,520 $ 9,520 10,000 10,230
20,230 $29,750
PROBLEM 3-4B
Date Apr. 1
4
8
11
Land ................................................................. 250,000 Cash.......................................................... (Purchased land for cash) Advertising Expense ....................................... Accounts Payable .................................... (Incurred advertising expense on account)
1,200
Salaries and Wages Expense ......................... Cash.......................................................... (Paid salaries)
3,000
13
Prepaid Insurance ........................................... Cash.......................................................... (Paid for one-year insurance policy)
7,200
Dividends ......................................................... Cash.......................................................... (Payment of cash dividend)
600
Cash ................................................................. Service Revenue ...................................... (Received cash for services provided)
6,000
Cash (100 X $90) .............................................. Unearned Service Revenue ..................... (Received advance for future services)
9,000
25
(For Instructor Use Only)
100,000
250,000
3,000
No entry—not a transaction.
20
Credit
1,200
12
17
.
Account Titles and Explanation Debit Cash ................................................................. 100,000 Common Stock ........................................ (Issued stock for cash)
7,200
600
6,000
9,000
3-59
PROBLEM 3-4B (Continued) Date Apr. 30
30
3-60
Account Titles and Explanation Cash ................................................................ Service Revenue ..................................... (Received cash for services provided)
Debit 7,900
Accounts Payable........................................... Cash ......................................................... (Paid creditor on account)
400
.
(For Instructor Use Only)
Credit 7,900
400
PROBLEM 3-5B (a) Date May 1
Debit 100,000
No entry—not a transaction.
3
Supplies ........................................................... Accounts Payable .................................... (Purchased supplies on account)
800
Rent Expense .................................................. Cash .......................................................... (Paid office rent)
1,400
Accounts Receivable ...................................... Service Revenue ...................................... (Billed client for services provided)
2,500
Cash ................................................................. Unearned Service Revenue ..................... (Received an advance for future services)
4,200
Cash ................................................................. Service Revenue ...................................... (Received cash for service performed)
3,300
Salaries and Wages Expense ......................... Cash .......................................................... (Paid salaries)
2,500
Accounts Payable ($800 X 50%) ..................... Cash .......................................................... (Paid creditor on account)
400
11
12
17
31
31
(For Instructor Use Only)
Credit 100,000
2
7
.
Account Titles and Explanation Cash ................................................................. Common Stock ........................................ (Issued stock for cash)
800
1,400
2,500
4,200
3,300
2,500
400
3-61
PROBLEM 3-5B (Continued) (b) 5/1 5/12 5/17 Bal.
Cash 100,000 5/7 4,200 5/31 3,300 5/31 103,200
5/11 Bal.
Accounts Receivable 2,500 2,500
5/3 Bal.
Supplies 800 800
5/31
1,400 2,500 400
5/7 Bal.
Accounts Payable 400 5/3 Bal.
800 400
Unearned Service Revenue 5/12 4,200 Bal. 4,200 Common Stock 5/1 100,000 Bal. 100,000 Service Revenue 5/11 5/17 Bal.
3-62
.
Salaries and Wages Expense 5/31 2,500 Bal. 2,500
2,500 3,300 5,800
(For Instructor Use Only)
Rent Expense 1,400 1,400
PROBLEM 3-5B (Continued) (c)
ROYCE CONSULTING Trial Balance May 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Accounts Payable .............................................. Unearned Service Revenue ............................... Common Stock .................................................. Service Revenue ................................................ Salaries and Wages Expense ............................ Rent Expense .....................................................
.
(For Instructor Use Only)
Debit $103,200 2,500 800
Credit
$
400 4,200 100,000 5,800
2,500 1,400 $110,400 $110,400
3-63
PROBLEM 3-6B
(a) & (c) 7/1 Bal. 7/8 7/11 Bal.
Cash 15,532 7/9 10,189 7/14 7,320 7/30 7/31 20,464
2,100 4,810 5,267 400
Accounts Receivable 7/1 Bal. 10,536 7/8 10,189 7/22 4,700 Bal. 5,047
7/1 Bal. 7/17 Bal.
Supplies 3,592 720 4,312
7/1 Bal. Bal.
Equipment 25,950 25,950
7/14
Common Stock 7/1 Bal. Bal.
Accounts Payable 4,810 7/1 Bal. 15,800 7/17 720 Bal. 11,710
Retained Earnings 7/1 Bal. 13,000 Bal. 13,000
7/31 Bal.
(For Instructor Use Only)
7,320 4,700 12,020
Maintenance and Repairs Expense 7/30 386 Bal. 386 Salaries and Wages Expense 7/9 2,100 7/30 3,114 Bal. 5,214
7/30 Bal.
.
Dividends 400 400 Service Revenue 7/11 7/22 Bal.
Unearned Service Revenue 7/1 Bal. 1,810 Bal. 1,810
3-64
25,000 25,000
Utilities Expense 1,767 1,767
PROBLEM 3-6B (Continued) (b) Date July 8
9
11
14
17
22
30
31
.
Account Titles and Explanation Cash ................................................................. Accounts Receivable ............................... (Received cash on account)
Debit 10,189
Salaries and Wages Expense ......................... Cash.......................................................... (Paid salaries)
2,100
Cash ................................................................. Service Revenue ...................................... (Received cash for services provided)
7,320
Accounts Payable ........................................... Cash.......................................................... (Paid creditors)
4,810
Supplies ........................................................... Accounts Payable .................................... (Purchased supplies on account)
720
Accounts Receivable ...................................... Service Revenue ...................................... (Billed for services provided)
4,700
Salaries and Wages Expense ......................... Utilities Expense ............................................. Maintenance and Repairs Expense ................ Cash.......................................................... (Paid for various expenses)
3,114 1,767 386
Dividends ......................................................... Cash.......................................................... (Payment of cash dividend)
400
(For Instructor Use Only)
Credit 10,189
2,100
7,320
4,810
720
4,700
5,267
400
3-65
PROBLEM 3-6B (Continued) (d)
AMERICAN DRY CLEANERS Trial Balance July 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Equipment .......................................................... Accounts Payable .............................................. Unearned Service Revenue ............................... Common Stock ................................................... Retained Earnings.............................................. Dividends ............................................................ Service Revenue ................................................ Maintenance and Repairs Expense .................. Salaries and Wages Expense ............................ Utilities Expense ................................................
3-66
.
(For Instructor Use Only)
Debit $20,464 5,047 4,312 25,950
Credit
$11,710 1,810 25,000 13,000 400 12,020 386 5,214 1,767 $63,540
$63,540
PROBLEM 3-7B
LINDBERGH COMPANY Trial Balance May 31, 2014 Cash ($5,340 + $350 – $441) ...................................... Accounts Receivable ($2,750 – $180 – $240) ........... Prepaid Insurance ($700 + $100) ............................... Supplies ($0 + $350) ................................................... Equipment ($9,000 – $350) ........................................ Accounts Payable ($4,100 – $100 + $350 – $240)..... Income Taxes Payable ............................................... Common Stock ($5,700 + $600) ................................. Retained Earnings ...................................................... Dividends ($0 + $600) ................................................. Service Revenue ($7,690 + $270) .............................. Salaries and Wages Expense ($4,200 + $500) .......... Advertising Expense ($1,100 + $441) ........................ Income Tax Expense ($900 + $100) ...........................
.
(For Instructor Use Only)
Debit $ 5,249 2,330 800 350 8,650
Credit
$ 4,110 850 6,300 6,000 600 7,960 4,700 1,541 1,000 $25,220
$25,220
3-67
PROBLEM 3-8B
(a) & (c) 4/1 Bal. 4/9 4/25 4/30 Bal.
Cash 6,300 4/2 5,700 4/10 3,000 4/12 170 4/29 4/30 6,660
1,800 3,200 410 1,900 1,200
4/10
4/10 4/30 Bal.
Accounts Receivable 170 170
4/30 Bal.
4/1 Bal. Bal.
4/1 Bal. Bal.
4/1 Bal. Bal.
3-68
Prepaid Rent 1,200 1,200 Land 10,000 10,000 Buildings 58,000 58,000 Equipment 6,000 6,000
.
(For Instructor Use Only)
4/12 Bal.
Accounts Payable 1,200 4/1 Bal. 4/20 Bal.
2,300 750 1,850
Mortgage Payable 2,000 4/1 Bal. 38,000 Bal. 36,000 Common Stock 4/1 Bal. Bal.
40,000 40,000
Service Revenue 4/9 4/25 Bal.
5,700 3,000 8,700
Sales Revenue 4/30 Bal.
340 340
Advertising Expense 410 410
PROBLEM 3-8B (Continued) Rent Expense 1,800 750 2,550
4/2 4/20 Bal.
Salaries and Wages Expense 4/29 1,900 Bal. 1,900
(b) Date Apr. 2
Debit 1,800
No entry—not a transaction.
9
Cash ................................................................. Service Revenue ...................................... (Received cash for admissions)
5,700
Mortgage Payable ........................................... Accounts Payable ........................................... Cash ......................................................... (Made payments on mortgage and accounts payable)
2,000 1,200
5,700
3,200
11
No entry—not a transaction.
12
Advertising Expense ....................................... Cash ......................................................... (Paid advertising expenses)
410
Rent Expense .................................................. Accounts Payable .................................... (Rented film on account)
750
Cash ................................................................. Service Revenue ...................................... (Received cash for admissions)
3,000
20
25
(For Instructor Use Only)
Credit 1,800
3
10
.
Account Titles and Explanation Rent Expense .................................................. Cash ......................................................... (Paid film rental)
410
750
3,000
3-69
PROBLEM 3-8B (Continued) Date Apr. 29
30
30
Account Titles and Explanation Salaries and Wages Expense ........................ Cash ......................................................... (Paid salaries expense)
Debit 1,900
Cash ................................................................ Accounts Receivable ..................................... Sales Revenue (17% X $2,000) .................. (Received cash and balance on account for concessions)
170 170
Prepaid Rent ................................................... Cash ......................................................... (Paid cash for future film rental)
1,200
(d)
1,900
340
1,200
ROXY THEATER INC. Trial Balance April 30, 2014 Cash .................................................................... Accounts Receivable ......................................... Prepaid Rent ....................................................... Land .................................................................... Buildings ............................................................ Equipment .......................................................... Accounts Payable .............................................. Mortgage Payable .............................................. Common Stock ................................................... Service Revenue ................................................ Sales Revenue .................................................... Advertising Expense.......................................... Rent Expense ..................................................... Salaries and Wages Expense ............................
3-70
Credit
.
(For Instructor Use Only)
Debit $ 6,660 170 1,200 10,000 58,000 6,000
Credit
$ 1,850 36,000 40,000 8,700 340 410 2,550 1,900 $86,890
$86,890
PROBLEM 3-9B (a) Correct: 2, 7 Incorrect: 1, 3, 4, 5, 6, 8 (b)
.
Error
(1) In Balance
(2) Difference
(3) Larger Column
1.
No
$270
Credit
3.
No
$880
Credit
4.
Yes
None
N/A
5.
Yes
None
N/A
6.
Yes
None
N/A
8.
No
$5,000
Credit
(For Instructor Use Only)
3-71
CCC3
CONTINUING COOKIE CHRONICLE
(a) General Journal Date Nov.
8
Account Titles No journal entry required.
8
No journal entry required.
8
Cash ............................................................ Common Stock ....................................
500
Supplies ...................................................... Cash .....................................................
95
Supplies ...................................................... Cash .....................................................
125
Equipment................................................... Common Stock ....................................
300
Cash ............................................................ Notes Payable ......................................
2,000
Equipment................................................... Cash .....................................................
900
11 14 15 16 17
95 125 300 2,000 900
No journal entry required.
25
Cash ............................................................ Unearned Service Revenue.................
60
Cash ............................................................ Service Revenue ..................................
100
.
(For Instructor Use Only)
Credit
500
18
29
3-72
Debit
60 100
CONTINUING COOKIE CHRONICLE (Continued) Date Nov. 30 30 30 30
Account Titles Website ....................................................... Accounts Payable ...............................
Debit 600
Prepaid Insurance ...................................... Cash .....................................................
1,200
Accounts Receivable ................................. Service Revenue..................................
300
Utilities Expense ........................................ Accounts Payable ...............................
50
Credit 600 1,200 300 50
(b) Cash Nov. 8 500 Nov. 11 Nov. 16 2,000 Nov. 14 Nov. 25 60 Nov. 17 Nov. 29 100 Nov. 30 Nov.30 Bal. 340 Accounts Receivable Nov. 30 300 Nov. 30 Bal. 300 Supplies Nov. 11 95 Nov. 14 125 Nov. 30 Bal. 220 Prepaid Insurance Nov. 30 1,200 Nov. 30 Bal. 1,200
.
(For Instructor Use Only)
95 125 900 1,200
Equipment Nov. 15 300 Nov. 17 900 Nov. 30 Bal. 1,200 Website Nov. 30 600 Nov. 30 Bal. 600 Accounts Payable Nov. 30 Nov. 30 Nov. 30 Bal.
600 50 650
Unearned Service Revenue Nov. 25 60 Nov. 30 Bal. 60 Notes Payable Nov. 16 2,000 Nov. 30 Bal. 2,000
3-73
CONTINUING COOKIE CHRONICLE (Continued) Common Stock Nov. 8 Nov. 15 Nov. 30 Bal.
500 300 800
Service Revenue Nov.29 Nov.30 Nov.30 Bal.
100 300 300
(c)
Utilities Expense Nov. 30 50 Nov. 30 Bal. 50
COOKIE CREATIONS INC. Trial Balance November 30, 2014 Cash ........................................................................ Accounts Receivable ............................................. Supplies .................................................................. Prepaid Insurance .................................................. Equipment............................................................... Website ................................................................... Accounts Payable .................................................. Unearned Service Revenue ................................... Notes Payable ......................................................... Common Stock ....................................................... Service Revenue..................................................... Utilities Expense.....................................................
3-74
.
(For Instructor Use Only)
Debit $ 340 300 220 1,200 1,200 600
Credit
$ 650 60 2,000 800 400 50 $3,910
$3,910
BYP 3-1
FINANCIAL REPORTING PROBLEM
(a) Account Common Stock Accounts Payable Accounts Receivable Selling, Marketing, and Administrative Expenses Prepaid Expenses Net Property, Plant, and Equipment Net Product Sales
Increase Side Right/Credit Right/Credit Left/Debit
Decrease Side Left/Debit Left/Debit Right/Credit
Normal Balance Credit Credit Debit
Left/Debit Left/Debit
Right/Credit Right/Credit
Debit Debit
Left/Debit Right/Credit
Right/Credit Left/Debit
Debit Credit
(b) 1. 2. 3.
Cash is increased. Cash is decreased. Cash is decreased.
(c) 1. 2.
Cash is decreased or Interest Payable is increased. Cash is decreased or Notes (or Mortgage) Payable is increased.
.
(For Instructor Use Only)
3-75
BYP 3-2
(a) 1. 2. 3. 4. 5.
COMPARATIVE ANALYSIS PROBLEM
Tootsie Roll Accounts Receivable Net Property, Plant, and Equipment Accounts Payable Retained Earnings Net Product Sales
debit debit credit credit credit
1. 2. 3. 4. 5.
Hershey Company Inventories Provision for Income Taxes Accrued Liabilities Common Stock Interest Expense
debit debit credit credit debit
(b) The following other accounts are ordinarily involved:
3-76
1.
Increase in Accounts Receivable: Service Revenue or Sales Revenue is increased (credited).
2.
Decrease in Notes Payable: Cash is decreased (credited).
3.
Increase in Machinery: Notes Payable is increased (credited) or Cash is decreased (credited).
4.
Increase in Interest Revenue: Cash or Interest Receivable is increased (debited).
.
(For Instructor Use Only)
BYP 3-3
RESEARCH CASE
(a) The reason the Green Bay Packers’ issue an annual report is because they are a publicly owned, nonprofit company. They issue the report to the more than 100,000 shareholders who hold shares. None of the other teams are publicly owned, so they have no obligation to make their financial information available except to their small group of owners. (b) At the time that the article was written the owners of the NFL teams and the players’ labor union were negotiating a new contract. Knowing how profitable the NFL teams are would be useful information for the players to know so that they would have a better sense of how much the teams could afford to play. The Packers are obviously a “small market” team, they are not necessarily representative of teams in general. However, the Packers’ annual report does give the players some sense of the profitability of other teams. (c) Since some of the cost of the stadium that the Packers play in is covered by taxpayers, the county and state government has an interest in the team’s finances. (d) The Packers’ revenues increased during recent years. However, because the cost of players’ salaries increased at a faster rate than revenues, the Packers’ operating profit actually declined.
.
(For Instructor Use Only)
3-77
BYP 3-4
INTERPRETING FINANCIAL STATEMENTS
CHIEFTAIN INTERNATIONAL, INC. (a) One of the primary advantages to Chieftain of having no long-term debt is that there is room for growth through the use of debt and the company’s financial risk is greatly reduced. Another advantage is that profitability is enhanced when there is no interest expense. A possible disadvantage is that the company could expand more and earn a greater return if the growth had been financed with long-term debt. (b) An advantage to Chieftain from having a large cash balance is that cash is available to finance such things as the drilling of new wells and the investment in new technology. New opportunities may be seized and expansions may be undertaken at the time most advantageous for the business. A disadvantage is that cash earns little or no interest. A higher rate of return might be generated on excess cash by some other type of investment. (c) Accounts payable, as purchases on credit, represent interest-free loans. Business enterprises don’t pay cash unless the supplier requires immediate payment. Nearly all exchange transactions are conducted on 30-day or more credit.
3-78
.
(For Instructor Use Only)
BYP 3-5
REAL-WORLD FOCUS
(a) CPAs work in public accounting, business and industry, government, and education. (b) A CPA needs: strong leadership, communication skills, tech know-how, business savvy. (c) Salary ranges are: $51,500 – $74,250 during the first three years for a CPA at a large firm; $189,750 – $411,000 for Chief Financial Officer at a large corporation.
.
(For Instructor Use Only)
3-79
BYP 3-6
DECISION MAKING ACROSS THE ORGANIZATION
(a) May 1
Cash ............................................................... Common Stock ......................................
15,000 15,000
5
Correct.
7
Cash ............................................................... Unearned Service Revenue ..................
500
Supplies ......................................................... Accounts Payable..................................
1,500
Equipment ..................................................... Cash .......................................................
800
Dividends ....................................................... Cash .......................................................
400
Cash ............................................................... Service Revenue ....................................
154
Maintenance and Repairs Expense ............. Accounts Payable..................................
75
9 14 15 20 31
500 1,500 800 400 154 75
(b) The error in the entries of May 14 and May 20 would prevent the trial balance from balancing. (c) Net income as reported ......................................... Add: 5/9, Supplies expense................................. $1,500 5/15, Salaries and wages expense (dividends paid) ......................................................... 400 Less: 5/7, Unearned service revenue .................. Correct net income ................................................ (d) Cash as reported.................................................... Add: 5/9, Purchase on account ........................... 5/20, Transposition error ............................
3-80
.
(For Instructor Use Only)
$ 4,500
1,900 6,400 500 $ 5,900 $12,475
$1,500 9
1,509 $13,984
BYP 3-7
COMMUNICATION ACTIVITY
To:
Accounting Instructor
From:
Accounting Student
Re:
Steps in Recording Process
In the first transaction, bills totaling $6,000 were sent to customers for services provided. Therefore, the asset Accounts Receivable is increased $6,000 and the revenue Service Revenue is increased $6,000. Debits increase assets and credits increase revenues, so the journal entry is: Accounts Receivable ............................................................ Service Revenue ............................................................ (Billed customers for services provided)
6,000 6,000
The $6,000 amount is then posted to the debit side of the general ledger account Accounts Receivable and to the credit side of the general ledger account Service Revenue. In the second transaction, $2,000 was paid in salaries to employees. Therefore, the expense Salaries and Wages Expense is increased $2,000 and the asset Cash is decreased $2,000. Debits increase expenses and credits decrease assets, so the journal entry is: Salaries and Wages Expense ............................................... Cash................................................................................ (Salaries paid)
2,000 2,000
The $2,000 amount is then posted to the debit side of the general ledger account Salaries and Wages Expense and to the credit side of the general ledger account Cash.
.
(For Instructor Use Only)
3-81
BYP 3-8
ETHICS CASE
(a) The stakeholders in this situation are: • • •
Jennifer VanPelt, assistant chief accountant. Users of the company’s financial statements. BIT Company.
(b) By adding $1,000 to the Equipment account, that account total is intentionally misstated. By not locating the error causing the imbalance, some other account may also be misstated by $1,000. If the amount of $1,000 is determined to be immaterial, and the intent is not to commit fraud (cover up an embezzlement or other misappropriation of assets), Jennifer’s action might not be considered unethical in the preparation of interim financial statements. However, if Jennifer is violating a company accounting policy by her action, then she is acting unethically. (c) Jennifer’s alternatives are:
3-82
1.
Miss the deadline but find the error causing the imbalance.
2.
Tell her supervisor of the imbalance and suffer the consequences.
3.
Do as she did and locate the error later, making the adjustment in the next quarter.
.
(For Instructor Use Only)
BYP 3-9
ETHICS CASE
(a) Employees in the rail unit accelerated revenue in each of the fourth quarters from 2000 to 2003. That is, revenue that should have been reported in the first quarter of a year was instead reported in the fourth quarter of the previous year. (b) One possible motivation for engaging in this activity is that bonuses are frequently based on annual results. If it appeared that the rail unit was not going to meet the performance level required for bonuses, the employees may have shifted the revenue recognition forward on these sales in order to boost annual results to meet performance targets. (c) The employees were fired. In addition, the matter was being investigated by the Securities and Exchange Commission (SEC). (d) To restate financial statements means to actually issue new financial statements to replace those that were previously issued. We are told that, for example, 2002 revenue was overstated by $158 million, and net income was overstated by $22 million. While these numbers seem large, to GE they are immaterial. $22 million was less than 0.2% of the company’s net income. As a percentage of GE’s total results the errors are not large enough to change investors’ evaluation of the company.
.
(For Instructor Use Only)
3-83
BYP 3-10
ALL ABOUT YOU
We address the issue of contingent liabilities in greater detail in Chapter 10. Our primary interest in this exercise is to engage students in a discussion regarding the general nature of the financial statement elements (assets, liabilities, equity, revenues and expenses). (a)
By taking out the bank loan your friend has incurred a liability. You do not have a liability unless your friend defaults, or unless it becomes clear that he will default. The loan application may, however, require you to disclose any guarantees that you have signed, since they represent potential liabilities.
(b) Accounting standards have specific requirements regarding accounting for situations where there is uncertainty regarding whether a liability has been incurred. Those standards require an evaluation of the probability of an amount being owed. Without going into detail regarding those standards, the basic idea is that if it is probable that you will owe money, then you should accrue a liability. If it is not probable, but it is possible that you will owe money, then you should disclose facts regarding the situation. The most important point is that this event has the potential to materially impact your finances, and therefore you have a responsibility to disclose it to the bank in some form. (c)
3-84
Losing your job would not create a financial liability, although it would most certainly reduce your revenues. You are obviously concerned that you might lose your job, but you don’t have specific information that would suggest that it will happen. Therefore, you probably don’t have an obligation to disclose this information to the bank. However, unless you are relatively certain that you would be able to find suitable employment relatively quickly, you might want to wait until your job situation has stabilized before pursuing a loan of this size.
.
(For Instructor Use Only)
IFRS 3-1
CONCEPTS AND APPLICATION
In deciding whether the U.S. should adopt IFRS, the SEC should consider the following: • • • • • •
Whether IFRS is sufficiently developed and consistent in application Whether the IASB is sufficiently independent Whether IFRS is established for the benefit to investors The issues involved in educating investors about IFRS The impact of a switch to IFRS on U.S. laws and regulations The impact on companies including changes to their accounting systems, contractual arrangements, corporate governance, and litigation • The issues involved in educating accountants, so they can prepare statements under IFRS
.
(For Instructor Use Only)
3-85
IFRS 3-2
INTERNATIONAL FINANCIAL REPORTING PROBLEM
Account Share capital Goodwill Borrowings and overdrafts Amortisation of intangible assets Derivative financial asset
3-86
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Financial Statement Consolidated Balance Sheet Consolidated Balance Sheet Consolidated Balance Sheet Consolidated Income Statement Consolidated Balance Sheet
(For Instructor Use Only)
Position in Financial Statement Equity Non-current assets Current and Non-current liabilities After Gross profit and before Operating profit Current assets
CHAPTER 4 Accrual Accounting Concepts Learning Objectives 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Explain the revenue recognition principle and the expense recognition principle. Differentiate between the cash basis and the accrual basis of accounting. Explain why adjusting entries are needed, and identify the major types of adjusting entries. Prepare adjusting entries for deferrals. Prepare adjusting entries for accruals. Describe the nature and purpose of the adjusted trial balance. Explain the purpose of closing entries. Describe the required steps in the accounting cycle. Understand the causes of differences between net income and cash provided by operating activities. Describe the purpose and the basic form of a worksheet.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO
BT
Item
LO
BT
Item LO BT Questions
Item
LO
BT
Item
LO
BT
C
9.
4
C
16.
5
K
23.
6
C
30.
7
K
1.
1
2.
1
K
10.
4
C
17.
5
AN
24.
2
C
31.
8
K
3.
1
C
11.
4
K
18.
5
AP
25.
6
C
32.
8
K
4.
1
AP
12.
4
K
19.
4, 5
K
26.
7
K
33.
8
C
5.
3
C
13.
1
C
20.
4, 5
K
27.
7
C
34.
8
C
6.
3
C
14.
1
AN
21.
5
C
28.
7
C
35.
10*
K
7.
3
C
15.
5
C
22.
5
C
29.
7
K
36.
10*
K
8.
4
K
AP
10.
6
AP
13.
7
K
Brief Exercises 1.
2, 9
C
4.
4
AP
7.
4
2. 3.
3
C
5.
4
AP
8.
5
AP
11.
6
AP
14.
7
AP
3
AN
6.
4
AP
9.
6
AN
12.
6
K
15.
8
K
7
AP
17.
6
AP
18.
7
AP
Do It! Review Exercises 1.
4
AP
2.
5
AP
3.
6
C
4.
Exercises 1.
1
C
5.
2, 9
AP
9.
4, 5
AP
13.
2.
1
K
6.
2, 4, 5, 9
AP
10.
4, 5
AP
14.
7
AP
3.
1
C
7.
2, 3, 9
C
11.
4, 5
AP
15.
4, 5, 6
AN
AP
8.
3, 4, 5
AN
12.
1, 4, 5, 6 AP
16.
4, 5, 6
AP
4. 2, 4, 5, 9
.
(For Instructor Use Only)
1, 4, 5, 6 AN
4-1
Summary of Questions by Learning Objectives and Bloom’s Taxonomy (Continued) Problems: Set A 1.
2, 4,9
AP
3. 4, 5, 6, 7
AP
5.
4, 5
AP
2.
4, 5,6
AP
4. 4, 5, 6, 7
AP
6.
4, 5
AN
7.
4, 5, 6
AP
8. 4, 5, 6, 7, 8
AP
7.
4, 5, 6
AP
8. 4, 5, 6, 7, 8
AP
Problems: Set B 1.
2, 4,9
AP
3. 4, 5, 6, 7
AP
5.
4, 5
AP
2.
4, 5, 6
AP
4. 4, 5, 6, 7
AP
6.
4, 5
AN
4-2
.
(For Instructor Use Only)
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
.
Description
Difficulty Level
Time Allotted (min.)
1A
Record transactions on accrual basis; convert revenue to cash receipts.
Simple
20–30
2A
Prepare adjusting entries, post to ledger accounts, and prepare adjusted trial balance.
Simple
40–50
3A
Prepare adjusting entries, adjusted trial balance, and financial statements.
Simple
50–60
4A
Prepare adjusting entries and financial statements; identify accounts to be closed.
Moderate
40–50
5A
Prepare adjusting entries.
Moderate
30–40
6A
Prepare adjusting entries and a corrected income statement.
Moderate
30–40
7A
Journalize transactions and follow through accounting cycle to preparation of financial statements.
Moderate
60–70
8A
Complete all steps in accounting cycle.
Moderate
70–80
1B
Record transactions on accrual basis; convert revenue to cash receipts.
Simple
20–30
2B
Prepare adjusting entries, post to ledger accounts, and prepare an adjusted trial balance.
Simple
40–50
3B
Prepare adjusting entries, adjusted trial balance, and financial statements.
Simple
50–60
4B
Prepare adjusting entries and financial statements; identify accounts to be closed.
Moderate
40–50
5B
Prepare adjusting entries.
Moderate
30–40
6B
Prepare adjusting entries and a corrected income statement.
Moderate
30–40
7B
Journalize transactions and follow through accounting cycle to preparation of financial statements.
Moderate
60–70
8B
Complete all steps in accounting cycle.
Moderate
70–80
(For Instructor Use Only)
4-3
ANSWERS TO QUESTIONS 1.
(a) Under the periodicity assumption, an accountant is required to determine the effect of each accounting transaction on a specific accounting period. (b) An accounting time period that is one year in length is referred to as a fiscal year.
2.
The two generally accepted accounting principles that pertain to adjusting the accounts are: The revenue recognition principle, which states that revenue should be recognized in the time period in which the performance obligation is satisfied. The expense recognition principle, which states that expenses be matched with revenues in the period when the company makes efforts to generate those revenues.
3.
The law firm should recognize the revenue in April. The revenue recognition principle states that revenue should be recognized in the accounting period in which the performance obligation is satisfied.
4.
Expenses of $4,700 should be deducted from the revenues in April. Under the expense recognition principle efforts (expenses) should be matched with results (revenues).
5.
No, adjusting entries are required by the revenue and expense recognition principles.
6.
The financial information in a trial balance may not be up-to-date because: (1) Some events are not journalized daily because it is not useful or efficient to do so. (2) The expiration of some costs occurs with the passage of time rather than as a result of recurring daily transactions. (3) Some items may be unrecorded because the transaction data are not known.
7.
The two categories of adjusting entries are deferrals and accruals. Deferrals consist of revenues collected before services are provided and expenses paid before they are incurred. Accruals consist of revenues for services performed prior to collection and expenses incurred prior to payment.
8.
In a prepaid expense adjusting entry, expenses are debited and assets are credited.
9.
No. Depreciation is the process of allocating the cost of an asset to expense over its useful life. Depreciation results in the presentation of the book value of the asset, not its fair value.
10.
Depreciation expense is an expense account whose normal balance is a debit. This account shows the cost that has expired during the current accounting period. Accumulated depreciation is a contra asset account whose normal balance is a credit. The balance in this account is the depreciation that has been recognized from the date of acquisition to the balance sheet date.
11.
Equipment ............................................................................... Less: Accumulated depreciation—equipment .........................
$15,000 7,000
$8,000
12.
In an unearned revenue adjusting entry, liabilities are debited and revenues are credited.
13.
The sale of a three-year maintenance contract on December 29, 2013 will have no effect on the 2013 income statement but receipt of $100,000 on December 29, 2013, 2014, and 2015 will increase an asset, Cash, and a liability, Unearned Service Revenue. As Ace Technologies provides service to its customer during 2014, 2015, and 2016, the liability will decrease and revenue will be recognized. Accrual accounting rules require that revenue be recognized as the performance obligation is satisfied rather than when cash is received.
4-4
.
(For Instructor Use Only)
Questions Chapter 4 (Continued) 14.
This promotion plan sounds like a bad idea for two reasons: (1) GAAP requires that the sale of a gift card be recorded as Unearned Sales Revenue (a liability) rather than Sales Revenue. Revenue recognition is delayed until the gift card is used or expires. Steve’s plan will not help the company meet its target revenue unless customers use the cards by year-end. (2) Selling a $50 card for $45 will probably not help the company meet its target net income. Although this promotion may result in additional sales revenue as the cards are used, the income resulting from the cards will be much less than usual since they eliminate $5 of normal gross profit.
15.
An asset is debited and a revenue is credited.
16.
An expense is debited and a liability is credited.
17.
Net income was understated $270 because prior to adjustment revenues are understated by $780 and expenses are understated by $510. The difference in this case is $270 ($780 – $510).
18.
The entry is: Jan. 9 Salaries and Wages Expense ....................................... Salaries and Wages Payable ........................................ Cash ....................................................................
5,100 1,100 6,200
19.
(a) Accrued revenues. (b) Unearned revenues. (c) Accrued expenses.
(d) Accrued expenses or prepaid expenses. (e) Prepaid expenses. (f) Accrued revenues or unearned revenues.
20.
(a) Salaries and Wages Payable. (b) Accumulated Depreciation. (c) Interest Expense.
(d) Supplies Expense. (e) Service Revenue. (f) Service Revenue.
21.
Disagree. An adjusting entry affects only one balance sheet account and one income statement account.
22.
Tootsie Roll reports Accounts Receivable. This suggests that it records revenue when it has delivered goods, even though it hasn’t received payment. If it used a cash basis it wouldn’t record revenue until cash was received, and it would therefore not establish receivables.
23.
Financial statements can be prepared from an adjusted trial balance because the balances of all accounts have been adjusted to show the effects of all financial events that have occurred during the accounting period.
24.
(a) Information presented on an accrual basis is useful because it reveals important information about the relationship between efforts and results. This information is useful in predicting future results. Trends in revenues and expenses are thus more meaningful. (b) Information presented on a cash basis is useful for predicting the future availability of cash. Cash basis financial statements provide useful information about a company’s sources and uses of cash.
25.
The amount shown in the adjusted trial balance column for an account equals the account balance in the ledger after adjusting entries have been journalized and posted.
.
(For Instructor Use Only)
4-5
Questions Chapter 4 (Continued) 26. (1) (2) (3) (4)
(Dr) Individual revenue accounts and (Cr) Income Summary. (Dr) Income Summary and (Cr) Individual expense accounts. (Dr) Income Summary and (Cr) Retained Earnings (for net income). (Dr) Retained Earnings and (Cr) Dividends.
27. Financial information is used by managers to direct and evaluate a company’s performance. The sooner such information is made available; the sooner changes can be made to get a company “back on track”. A “virtual close” speeds up the reporting process and allows managers to react much faster to changing economic conditions. 28. Income Summary is a temporary account that is used in the closing process. The account is debited for expenses and credited for revenues. The difference, either net income or net loss, is then closed to Retained Earnings. 29. The post-closing trial balance contains only balance sheet accounts. Its purpose is to prove the equality of the permanent account balances that the company carries forward into the next accounting period. 30. The accounts that will not appear in the post-closing trial balance are: Depreciation Expense; Dividends; and Service Revenue. 31. The steps that involve journalizing are (1) journalize the transactions, (2) journalize the adjusting entries, and (3) journalize the closing entries. 32. The three trial balances are the (1) trial balance, (2) adjusted trial balance, and (3) postclosing trial balance. 33. Earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income. Such action is undertaken to help a company meet target financial numbers. Quality of earnings indicates the level of full and transparent information that a company provides to users of financial statements. 34. Examples of ways a company can manage earnings include the following. Use of “one-time” items to prop up earnings numbers. A company may decide to sell property that has appreciated in value in order to record a gain on the sale. Such a gain will increase the current year’s net income but future income will probably not include a similar increase. Inflating revenue in the short-run to the detriment of the long-run. A company may implement changes in its promotion activities near the end of an accounting period to boost year-end revenues. Offering a special rebate or a two–for–one package is likely to increase sales for the time the promotion runs but usually results in lower sales in subsequent periods. Savvy customers may even postpone purchases until special deals are available. Recording improper adjusting entries. Some adjusting entries require estimates and judgment to properly recognize revenue and match expenses. By recognizing revenue “sooner” and delaying the recognition of expenses, earnings can be overstated in early periods and understated in subsequent periods. This type of management is most prevalent with multi-year contracts and prepaid expenses. *35. The worksheet is a working paper designed to make it easier to prepare adjusting entries and financial statements. *36. The columns of the worksheet from left to right are two columns each for the trial balance, adjustments, adjusted trial balance, income statement, and balance sheet. 4-6
.
(For Instructor Use Only)
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 4-1
(a) (b) (c) (d) (e) (f)
Cash $–100 0 0 +800 –2,500 0
Net Income $0 –20 +1,300 0 0 –600
BRIEF EXERCISE 4-2 (a) Prepaid Insurance—to recognize insurance expired during the period. (b) Depreciation Expense—to allocate the cost of an asset to expense during the current period. (c) Unearned Service Revenue—to account for unearned revenue for which services were provided during the period. (d) Interest Payable—to recognize interest accrued but unpaid on notes payable during the current period. BRIEF EXERCISE 4-3 Item
(1) Type of Adjustment
(2) Accounts Before Adjustment
(a)
Prepaid Expenses
Assets Overstated Expenses Understated
(b)
Accrued Revenues
Assets Understated Revenues Understated
(c)
Accrued Expenses
Expenses Understated Liabilities Understated
(d)
Unearned Revenues
Liabilities Overstated Revenues Understated
.
(For Instructor Use Only)
4-7
BRIEF EXERCISE 4-4 Dec. 31
Supplies Expense ........................................... Supplies ...................................................
Supplies 8,800 12/31 12/31 Bal. 1,100
7,700
12/31
7,700 7,700
Supplies Expense 7,700
BRIEF EXERCISE 4-5 Dec. 31
Depreciation Expense ..................................... Accumulated Depreciation— Equipment ............................................
2,750 2,750
Accumulated Depreciation— Equipment 12/31 2,750
Depreciation Expense 12/31 2,750
Balance Sheet: Equipment ................................................................. Less: Accumulated depreciation—equipment.......
$22,000 2,750
$19,250
BRIEF EXERCISE 4-6 July 1 Dec. 31
Prepaid Insurance ........................................... Cash .........................................................
12,400
Insurance Expense ($12,400 X 6/24) .............. Prepaid Insurance ...................................
3,100
Prepaid Insurance 7/1 12,400 12/31 12/31 Bal. 9,300
4-8
.
3,100
(For Instructor Use Only)
12/31
12,400
Insurance Expense 3,100
3,100
BRIEF EXERCISE 4-7 July 1 Dec. 31
Cash .................................................................. Unearned Service Revenue .....................
12,400
Unearned Service Revenue ............................. Service Revenue ($12,400 X 6/24) ...........
3,100
Unearned Service Revenue 12/31 3,100 7/1 12,400 12/31 Bal. 9,300
12,400 3,100
Service Revenue 12/31
3,100
BRIEF EXERCISE 4-8 (a) Dec. 31 (b) (c)
31 31
Interest Expense ...................................... Interest Payable ................................
300
Accounts Receivable ............................... Service Revenue ...............................
1,700
Salaries and Wages Expense .................. Salaries and Wages Payable ............
780
300 1,700 780
BRIEF EXERCISE 4-9 Account
(1) Type of Adjustment
(a)
Accounts Receivable
Accrued Revenues
Service Revenue
(b)
Prepaid Insurance
Prepaid Expenses
Insurance Expense
(c)
Equipment
Not required
(d)
Accum. Depreciation— Equipment
Prepaid Expenses
(e)
Notes Payable
Not required
(f)
Interest Payable
Accrued Expenses
Interest Expense
(g)
Unearned Service Revenue
Unearned Revenues
Service Revenue
.
(For Instructor Use Only)
(2) Related Account
Depreciation Expense
4-9
BRIEF EXERCISE 4-10 RAVINE CORPORATION Income Statement For the Year Ended December 31, 2014 Revenues Service revenue .................................................... Expenses Salaries and wages expense ................................ Rent expense ........................................................ Insurance expense................................................ Supplies expense.................................................. Depreciation expense ........................................... Total expenses .............................................. Net income ....................................................................
$32,000 $14,000 3,900 1,800 1,500 1,000 22,200 $ 9,800
BRIEF EXERCISE 4-11 RAVINE CORPORATION Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1 ......................................................... Add: Net income ............................................................................ Less: Dividends .............................................................................. Retained earnings, December 31 ...................................................
BRIEF EXERCISE 4-12 Account (a) (b) (c) (d) (e) (f) (g)
4-10
Accumulated Depreciation Depreciation Expense Retained Earnings (beginning) Dividends Service Revenue Supplies Accounts Payable
.
(For Instructor Use Only)
Balance Sheet Income Statement Retained Earnings Statement Retained Earnings Statement Income Statement Balance Sheet Balance Sheet
$17,200 10,400 27,600 6,000 $21,600
BRIEF EXERCISE 4-13 The accounts that will appear in the post-closing trial balance are: Accumulated Depreciation Retained Earnings (ending) Supplies Accounts Payable BRIEF EXERCISE 4-14 (a) July 31
Closing Entries Service Revenue ..................................... Income Summary ............................. (To close revenue account)
16,000 16,000
Income Summary .................................... Salaries and Wages Expense .......... Maintenance and Repairs Expense ......................................... Income Tax Expense ........................ (To close expense accounts)
11,900
Income Summary .................................... Retained Earnings ............................ (To close net income to retained earnings)
4,100
Retained Earnings ................................... Dividends .......................................... (To close dividends to retained earnings)
1,300
8,400 2,500 1,000
4,100
1,300
(b) Retained Earnings 1,300 7/1 Bal. 20,000 4,100 7/31 Bal. 22,800 .
(For Instructor Use Only)
4-11
BRIEF EXERCISE 4-15 The proper sequencing of the required steps in the accounting cycle is as follows: 1. 2. 3. 4. 5. 6. 7. 8. 9.
4-12
(c) (e) (i) (d) (h) (b) (g) (f) (a)
Analyze business transactions. Journalize the transactions. Post to ledger accounts. Prepare a trial balance. Journalize and post adjusting entries. Prepare an adjusted trial balance. Prepare financial statements. Journalize and post closing entries. Prepare a post-closing trial balance.
.
(For Instructor Use Only)
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 4-1 1.
2.
3.
4.
Insurance Expense ....................................................... Prepaid Insurance .................................................. (To record insurance expired)
300
Supplies Expense ......................................................... Supplies .................................................................. (To record supplies used)
1,600
Depreciation Expense .................................................. Accumulated Depreciation—Equipment .............. (To record monthly depreciation)
200
Unearned Service Revenue .......................................... Service Revenue ..................................................... (To record revenue for services provided)
4,000
300
1,600
200
4,000
DO IT! 4-2 1.
2.
3.
Salaries and Wages Expense ....................................... Salaries and Wages Payable ................................. (To record accrued salaries)
1,100
Interest Expense ($20,000 X .09 X 1/12) ...................... Interest Payable ...................................................... (To record accrued interest)
150
Accounts Receivable ................................................... Service Revenue ..................................................... (To record revenue for service provided)
1,600
1,100
150
1,600
DO IT! 4-3 Income statement: Service Revenue, Utilities Expense Balance sheet: Accounts Receivable, Accumulated Depreciation, Notes Payable, Common Stock.
.
(For Instructor Use Only)
4-13
DO IT! 4-4 Dec. 31 Income Summary ..................................................... 36,000 Retained Earnings ............................................ (To close net income to retained earnings)
36,000
Dec. 31 Retained Earnings ................................................... 22,000 Dividends .......................................................... (To close dividends to retained earnings)
22,000
4-14
.
(For Instructor Use Only)
SOLUTIONS TO EXERCISES EXERCISE 4-1 The revenue recognition principle requires that companies recognize revenue in the accounting period in which the performance obligation is satisfied. (a) Since the sales effort is not complete until the flight actually occurs, revenue should not be recognized until December. Southwest Airlines should recognize the revenue in December when the customer has been provided with the flight. (b) Sales revenue should be recognized at the time of delivery. (c) Revenue should be recognized on a per game basis over the season from April through October. (d) Interest revenue should be accrued and recognized by RBC evenly over the term of the loan. (e) Revenue should be recognized when the sweater is shipped to the customer in September.
EXERCISE 4-2 (a) (b) (c) (d) (e) (f) (g) (h)
8. 1. 7. 3. 6. 4. 2. 5.
Going concern assumption. Economic entity assumption. Full disclosure principle. Monetary unit assumption. Materiality. Periodicity assumption. Expense recognition principle. Historical cost principle.
EXERCISE 4-3 (a) (b) (c) (d) (e) (f) .
Revenue recognition principle. Periodicity assumption. No violation. Going concern assumption. Historical cost principle. Economic entity assumption. Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
4-15
EXERCISE 4-4 $ 33,640 + 3,400 – 2,800 + 1,300 – 1,460 – 2,000 + 2,400 – 1,400 + 1,100 $ 34,180
Cash basis earnings. Accounts receivable arise from sales that have been made, thus revenue must be recognized for balance outstanding at the end of the current year. Accounts receivable collected in current year, for sales made in previous year must be deducted from earnings. Supplies on hand at year end should be set up as an asset rather than expensed, this increases earnings. Supplies on hand at the end of the previous year should be expensed this year, this decreases earnings. Wages owing at the end of the current year should be accrued, thus reducing earnings. Wages owed at the end of the previous year should not be deducted from the current year’s earnings, thus increasing earnings. Other unpaid amounts owed at the end of the current year should be accrued, thus reducing earnings. Other unpaid amounts owed at the end of the previous year should not be deducted from the current year’s earnings, thus increasing earnings. Accrual basis earnings.
EXERCISE 4-5 (a) Service Revenue – Operating Expenses – Insurance Expense Net Income
Cash Basis $22,000 12,000 2,400 $ 7,600
Accrual Basis $28,000 15,800 — $12,200
(b) The accrual basis of accounting provides more useful information for decision makers because it recognizes revenues when the performance obligation is satisfied and expenses when incurred.
4-16
.
(For Instructor Use Only)
EXERCISE 4-6 (a)
KAFFEN COMPANY Income Statement For the Six Months Ended April 30, 2014 Revenues Service revenue ($32,150 + $540) ................... Expenses Income tax expense ......................................... Salaries and wages expense ($2,600 + $420). Depreciation expense [($9,200 ÷ 4) X 6/12] .... Rent expense ($1,225 – $175) ......................... Utilities expense .............................................. Advertising expense ........................................ Total expenses .......................................... Net income ...............................................................
(b)
$32,690 $10,000 3,020 1,150 1,050 970 375 16,565 $16,125
KAFFEN COMPANY Balance Sheet April 30, 2014 Assets Current Assets Cash ............................................................... Accounts receivable ..................................... Prepaid rent ................................................... Total current assets ............................... Property, plant, and equipment Equipment ..................................................... Less: Accumulated depreciation—equipment .......................... Total assets ............................................ Liabilities and Stockholders’ Equity Current Liabilities Salaries and wages payable......................... Stockholders’ equity Common stock .............................................. Retained earnings ......................................... Total stockholders’ equity .............. Total liabilities and stockholders’ equity ...................................................
.
(For Instructor Use Only)
$27,780 540 175 $28,495 9,200 1,150
8,050 $36,545
$
420
$20,000 16,125 36,125 $36,545 4-17
EXERCISE 4-7 (a) Event 180-day financing for customers
Cash Accounting Revenue is recorded as cash is received.
Accrual Accounting Revenue is recorded as it is earned. VidGam records revenue (and a receivable) as soon as services are provided but may wait up to 180 days to receive cash.
Payment to equipment suppliers upon delivery of goods
Equipment expense is Equipment is recorded recorded as an as an asset and expense as soon as depreciated. equipment is received and paid for.
Prepayment for 2 years of insurance coverage
Insurance expense is recorded as soon as payment is made.
One month’s salaries owed at year-end
No salary expense is Salary expense is recorded until salaries recorded as employees are paid. perform work. Amounts owed at year-end would be recorded as a liability.
Prepayment is recorded as an asset and recognized as an expense as time passes.
Proper accrual accounting would require adjusting entries for depreciation, prepaid insurance and accrued salaries.
4-18
.
(For Instructor Use Only)
EXERCISE 4-7 (Continued) (b) Accrual accounting rules require that revenue be recognized as a company performs services and expenses be matched with the revenue they help produce. Receipt or payment of cash does not influence the calculation of net income. VidGam has provided many services during the year and thus has positive net income. Since VidGam allowed its largest customers to take up to 180 days to pay, but was forced to pay cash for all purchases, it is likely that the company has very little cash at yearend. New companies frequently experience cash shortages because they extend credit to attract customers but are unable to receive credit from their suppliers. As time passes, the cash supply should increase as payments on accounts receivable come in and offset current purchases. EXERCISE 4-8 Item
(1) Type of Adjustment
(2) Accounts Before Adjustment
(a)
Accrued Revenues
Assets Understated Revenues Understated
(b)
Prepaid Expenses
Assets Overstated Expenses Understated
(c)
Accrued Expenses
Expenses Understated Liabilities Understated
(d)
Unearned Revenues
Liabilities Overstated Revenues Understated
(e)
Accrued Expenses
Expenses Understated Liabilities Understated
(f)
Prepaid Expenses
Assets Overstated Expenses Understated
.
(For Instructor Use Only)
4-19
EXERCISE 4-9 1.
2. 3. 4. 5.
Mar. 31
31 31 31 31
Depreciation Expense ($280 X 3) ................. Accumulated Depreciation— Equipment .........................................
840
Unearned Rent Revenue .............................. Rent Revenue ($12,400 X 1/2) ...............
6,200
Interest Expense ........................................... Interest Payable.....................................
400
Supplies Expense ......................................... Supplies ($3,000 – $850) .......................
2,150
Insurance Expense ($400 X 3)...................... Prepaid Insurance .................................
1,200
840 6,200 400 2,150 1,200
EXERCISE 4-10 1. 2. 3.
Jan. 31 31 31
31 4. 5.
4-20
31 31
.
Accounts Receivable .................................... Service Revenue ...................................
760
Utilities Expense ........................................... Accounts Payable .................................
450
Depreciation Expense .................................. Accumulated Depreciation— Equipment .........................................
400
Interest Expense ........................................... Interest Payable.....................................
500
Insurance Expense ($24,000 ÷ 12) ............... Prepaid Insurance .................................
2,000
Supplies Expense ($1,750 – $550) ............... Supplies .................................................
1,200
(For Instructor Use Only)
760 450
400 500 2,000 1,200
EXERCISE 4-11 1.
2. 3.
4. 5. 6. 7.
Oct. 31
31 31
31 31 31 31
Supplies Expense ......................................... Supplies ($2,500 – $500)...................................
2,000
Insurance Expense ....................................... Prepaid Insurance .................................
100
Depreciation Expense .................................. Accumulated Depreciation— Equipment .........................................
75
Unearned Service Revenue ......................... Service Revenue ...................................
800
Accounts Receivable ................................... Service Revenue ...................................
280
Interest Expense ........................................... Interest Payable ....................................
70
Salaries and Wages Expense ...................... Salaries and Wages Payable ................
1,400
2,000 100
75 800 280 70 1,400
EXERCISE 4-12 GARSKA CO. Income Statement For the Month Ended July 31, 2014 Revenues Service revenue ($5,500 + $700) ............................. Expenses Salaries and wages expense ($2,100 + $360) ........ Supplies expense ($900 – $200) ............................. Utilities expense ...................................................... Insurance expense .................................................. Depreciation expense .............................................. Total expenses ................................................. Net income ....................................................................... .
Kimmel, Accounting, 5/e, Solutions Manual
$6,200 $2,460 700 500 350 150
(For Instructor Use Only)
4,160 $2,040 4-21
EXERCISE 4-13 Answer
Computation
(a) Supplies balance = $1,350
Supplies expense Add: Supplies (1/31) Less: Supplies purchased Supplies (1/1)
(b) Total premium = $6,240
Total premium = Monthly premium X 12; $520 X 12 = $6,240
Purchase date = May 1, 2013
(c) Salaries and wages payable = $1,760
Purchase date: On Jan. 31, there are 3 months coverage remaining ($520 X 3). Thus, the purchase date was 9 months earlier on May 1, 2013.
Cash paid Salaries and wages payable (1/31/14) Less: Salaries and wages expense Salaries and wages payable (12/31/13)
(d) Unearned service revenue = $2,950
Service revenue Unearned revenue (1/31/14) Cash received in Jan. Unearned revenue (12/31/13)
4-22
.
(For Instructor Use Only)
$ 950) 700) (300) $1,350)
$2,500 1,060 3,560 1,800 $1,760
$4,000 750 4,750 1,800 $2,950
EXERCISE 4-14 Jan. 31 31
31
Service Revenue .................................................. Income Summary .........................................
4,000
Income Summary ................................................. Salaries and Wages Expense ...................... Supplies Expense ........................................ Insurance Expense ......................................
3,270
Income Summary ................................................. Retained Earnings........................................
730
4,000 1,800 950 520 730
EXERCISE 4-15 (a) July 10 14 15 20
(b) July 31
31 31 31
.
Supplies ........................................................ Cash .......................................................
200
Cash .............................................................. Service Revenue ...................................
3,800
Salaries and Wages Expense ...................... Cash .......................................................
1,000
Cash .............................................................. Unearned Service Revenue ..................
600
Supplies Expense ......................................... Supplies .................................................
750
Accounts Receivable ................................... Service Revenue ...................................
500
Salaries and Wages Expense ...................... Salaries and Wages Payable ................
1,000
Unearned Service Revenue ......................... Service Revenue ...................................
900
(For Instructor Use Only)
200 3,800 1,000 600
750 500 1,000 900
4-23
EXERCISE 4-16 Aug. 31 31 31 31 31 31
Accounts Receivable ........................................... Service Revenue ..........................................
600
Supplies Expense ................................................ Supplies ........................................................
2,000
Insurance Expense .............................................. Prepaid Insurance ........................................
1,500
Depreciation Expense ......................................... Accumulated Depreciation—Equipment ....
1,200
Salaries and Wages Expense.............................. Salaries and Wages Payable .......................
1,100
Unearned Rent Revenue ..................................... Rent Revenue ...............................................
1,000
600 2,000 1,500 1,200 1,100 1,000
EXERCISE 4-17 BERE COMPANY Income Statement For the Year Ended August 31, 2014 Revenues Service revenue .................................................... Rent revenue ......................................................... Total revenues ............................................... Expenses Salaries and wages expense ................................ Rent expense ........................................................ Supplies expense.................................................. Insurance expense................................................ Depreciation expense ........................................... Total expenses .............................................. Net income ....................................................................
4-24
.
(For Instructor Use Only)
$34,600 13,100 $47,700 18,100 10,800 2,000 1,500 1,200 33,600 $14,100
EXERCISE 4-17 (Continued) BERE COMPANY Retained Earnings Statement For the Year Ended August 31, 2014 Retained earnings, September 1, 2013 .......................................... Add: Net income ............................................................................ Less: Dividends .............................................................................. Retained earnings, August 31, 2014 ..............................................
$ 5,500 14,100 19,600 2,800 $16,800
BERE COMPANY Balance Sheet August 31, 2014 Assets Current Assets Cash........................................................................ Accounts receivable .............................................. Supplies ................................................................. Prepaid insurance.................................................. Total current assets ....................................... Equipment .............................................................. Less: Accum. depreciation—equipment............... Total assets .................................................... Liabilities and Stockholders’ Equity Current Liabilities Accounts payable .................................................. Salaries and wages payable ................................. Unearned rent revenue .......................................... Total current liabilities ................................... Stockholders’ equity Common stock ....................................................... Retained earnings.................................................. Total stockholders’ equity ......................... Total liabilities and stockholders’ equity .....
.
(For Instructor Use Only)
$10,900 9,400 500 2,500 $23,300 16,000 4,800
11,200 $34,500
$ 5,800 1,100 800 $ 7,700 10,000 16,800 26,800 $34,500
4-25
EXERCISE 4-18 Aug. 31
31
31 31
4-26
Service Revenue ............................................. Rent Revenue .................................................. Income Summary ....................................
34,600 13,100
Income Summary ............................................ Salaries and Wages Expense ................. Rent Expense .......................................... Supplies Expense ................................... Insurance Expense.................................. Depreciation Expense .............................
33,600
Income Summary ............................................ Retained Earnings ...................................
14,100
Retained Earnings .......................................... Dividends .................................................
2,800
.
(For Instructor Use Only)
47,700 18,100 10,800 2,000 1,500 1,200 14,100 2,800
SOLUTIONS TO PROBLEMS PROBLEM 4-1A (a)
(b)
1. Cash ..................................................................... 19,000 Accounts Receivable .................................... 19,000 2. Unearned Sales Revenue ................................... 23,000 Sales Revenue ............................................... 23,000 3. Cash ..................................................................... 44,000 Unearned Sales Revenue.............................. 44,000 Unearned Sales Revenue ($44,000 – $20,000) ........................................... 24,000 Sales Revenue ............................................... 24,000 4. Accounts Receivable .......................................... 151,000 Service Revenue............................................ 151,000 5. Cash ..................................................................... 136,000 Accounts Receivable ($151,000 – $15,000) ... 136,000 Cash received with respect to fees and dues 1. Collection of 2013 dues $ 19,000 3. Sale of tickets 44,000 5. Collection of 2014 dues 136,000 $199,000
Cash 1. 19,000 3. 44,000 5. 136,000 2014 Bal. 199,000 Accounts Receivable 2013 Bal. 19,000 4. 151,000 1. 19,000 5. 136,000 2014 Bal. 15,000
2. 3. .
Service Revenue 4. 151,000 2014 Bal. 151,000 Sales Revenue 2. 23,000 3. 24,000 2014 Bal. 47,000
Unearned Sales Revenue 2013 Bal. 23,000 23,000 3. 44,000 24,000 (For Instructor Use Only)
4-27
2014 Bal. 20,000
4-28
.
(For Instructor Use Only)
PROBLEM 4-2A (a) Date 2014 June 30
1. 2.
30
3.
30
4.
30
5.
30
6.
30
7.
30
Account Titles
Debit
Supplies Expense ...................................... Supplies ($2,000 – $720) ....................
1,280
Utilities Expense ........................................ Accounts Payable ..............................
180
Insurance Expense .................................... Prepaid Insurance ($2,880 ÷ 12 months) ......................
240
Unearned Service Revenue ....................... Service Revenue ................................
4,100
Salaries and Wages Expense ................... Salaries and Wages Payable .............
1,250
Depreciation Expense ............................... Accumulated Depreciation— Equipment ......................................
250
Accounts Receivable ................................. Service Revenue ................................
3,900
Credit
1,280 180
240 4,100 1,250
250 3,900
(b)
6/30 Bal.
Cash 6,850
Accounts Receivable 6/30 Bal. 7,000 6/30 3,900 6/30 Bal. 10,900
.
(For Instructor Use Only)
6/30 Bal. 6/30 Bal.
Supplies 2,000 6/30 720
Prepaid Insurance 6/30 Bal. 2,880 6/30 6/30 Bal. 2,640
1,280
240
4-29
PROBLEM 4-2A (Continued) Equipment 6/30 Bal. 15,000 Accumulated Depreciation— Equipment 6/30 250 6/30 Bal. 250 Accounts Payable 6/30 Bal. 6/30 6/30
4,230 180 4,410
Salaries and Wages Payable 6/30 1,250 6/30 Bal. 1,250 Unearned Service Revenue 6/30 4,100 6/30 Bal. 5,200 6/30 Bal. 1,100 Common Stock 6/30 Bal. 22,000 Service Revenue 6/30 Bal. 8,300 6/30 4,100 6/30 3,900 6/30 Bal. 16,300
4-30
.
(For Instructor Use Only)
Salaries and Wages Expense 6/30 Bal. 4,000 6/30 1,250 6/30 Bal. 5,250 Rent Expense 6/30 Bal. 2,000 Depreciation Expense 6/30 250 6/30 Bal. 250 Insurance Expense 6/30 240 6/30 Bal. 240 Utilities Expense 6/30 180 6/30 Bal. 180 Supplies Expense 6/30 1,280 6/30 Bal. 1,280
PROBLEM 4-2A (Continued) (c)
LUMAS CONSULTING Adjusted Trial Balance June 30, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Prepaid Insurance .............................................. Equipment .......................................................... Accumulated Depreciation—Equipment .......... Accounts Payable .............................................. Salaries and Wages Payable ............................. Unearned Service Revenue ............................... Common Stock .................................................. Service Revenue ................................................ Salaries and Wages Expense ............................ Rent Expense ..................................................... Depreciation Expense ....................................... Insurance Expense ............................................ Utilities Expense ................................................ Supplies Expense ..............................................
.
(For Instructor Use Only)
Debit $ 6,850 10,900 720 2,640 15,000
Credit
$
250 4,410 1,250 1,100 22,000 16,300
5,250 2,000 250 240 180 1,280 $45,310
$45,310
4-31
PROBLEM 4-3A
(a) 1. May 31 2. 3.
31 31
31
4.
5. 6.
31
31 31
Insurance Expense ................................. Prepaid Insurance ...........................
450
Supplies Expense ................................... Supplies ($2,600 – $1,050) ..............
1,550
Depreciation Expense ($3,600 X 1/12) ..................................... Accumulated Depreciation— Building ........................................ Depreciation Expense ($3,000 X 1/12) ..................................... Accumulated Depreciation— Equipment ....................................
450 1,550 300 300 250 250
Interest Expense ..................................... Interest Payable [($36,000 X 6%) X 1/12] ................
180
Unearned Rent Revenue......................... Rent Revenue ..................................
2,500
Salaries and Wages Expense ................. Salaries and Wages Payable ..........
900
180 2,500 900
(b)
5/31 Bal.
Cash 2,500
Prepaid Insurance 5/31 Bal. 1,800 5/31 5/31 Bal. 1,350
5/31 Bal. 5/31 Bal.
Supplies 2,600 5/31 1,050
Land 5/31 Bal. 15,000
4-32
.
(For Instructor Use Only)
1,550
450
PROBLEM 4-3A (Continued) Building 5/31 Bal. 70,000
Mortgage Payable 5/31 Bal. 36,000
Accumulated Depreciation— Building 5/31 300 5/31 Bal. 300
Rent Revenue 5/31 Bal. 9,000 5/31 2,500 5/31 Bal. 11,500
Equipment 5/31 Bal. 16,800 Accumulated Depreciation— Equipment 5/31 250 5/31 Bal. 250 Accounts Payable 5/31 Bal.
4,700
Unearned Rent Revenue 5/31 2,500 5/31 Bal. 3,300 5/31 Bal. 800 Salaries and Wages Payable 5/31 900 5/31 Bal. 900 Interest Payable 5/31 5/31 Bal.
.
(For Instructor Use Only)
Common Stock 5/31 Bal. 60,000
180 180
Salaries and Wages Expense 5/31 Bal. 3,000 5/31 900 5/31 Bal. 3,900 Utilities Expense 5/31 Bal. 800 Advertising Expense 5/31 Bal. 500 Interest Expense 5/31 180 5/31 Bal. 180 Insurance Expense 5/31 450 5/31 Bal. 450
4-33
PROBLEM 4-3A (Continued) Supplies Expense 5/31 1,550 5/31 Bal. 1,550 Depreciation Expense 5/31 300 5/31 250 5/31 Bal. 550 (c)
SOLO HOTEL Adjusted Trial Balance May 31, 2014 Cash .................................................................... Supplies .............................................................. Prepaid Insurance .............................................. Land .................................................................... Building .............................................................. Accumulated Depreciation—Building .............. Equipment .......................................................... Accumulated Depreciation—Equipment .......... Accounts Payable .............................................. Unearned Rent Revenue .................................... Salaries and Wages Payable ............................. Interest Payable ................................................. Mortgage Payable .............................................. Common Stock ................................................... Rent Revenue ..................................................... Salaries and Wages Expense ............................ Utilities Expense ................................................ Advertising Expense.......................................... Interest Expense ................................................ Insurance Expense ............................................ Supplies Expense .............................................. Depreciation Expense ........................................
4-34
.
(For Instructor Use Only)
Debit $ 2,500 1,050 1,350 15,000 70,000
Credit
$
300
16,800 250 4,700 800 900 180 36,000 60,000 11,500 3,900 800 500 180 450 1,550 550 $114,630
$114,630
PROBLEM 4-3A (Continued) (d)
SOLO HOTEL Income Statement For the Month Ended May 31, 2014 Revenues Rent revenue ................................................... Expenses Salaries and wages expense .......................... Supplies expense ............................................ Utilities expense .............................................. Depreciation expense ..................................... Advertising expense ....................................... Insurance expense .......................................... Interest expense .............................................. Total expenses......................................... Net income ..............................................................
$11,500 $3,900 1,550 800 550 500 450 180 7,930 $ 3,570
SOLO HOTEL Retained Earnings Statement For the Month Ended May 31, 2014 Retained earnings, May 1 ...................................... Add: Net income .................................................. Retained earnings, May 31 ....................................
.
(For Instructor Use Only)
$
0 3,570 $3,570
4-35
PROBLEM 4-3A (Continued) SOLO HOTEL Balance Sheet May 31, 2014 Assets Current Assets Cash ................................................... Supplies............................................. Prepaid insurance ............................. Total current assets .................. Property, plant, and equipment Land ................................................... Building ............................................. Less: Accumulated deprec.—Building .......................... Equipment ......................................... Less: Accumulated deprec.—equipment ...................... Total assets ...............................
$ 2,500 1,050 1,350 $
4,900
15,000 $70,000 300 16,800
69,700
250
16,550
Liabilities and Stockholders’ Equity Current Liabilities Accounts payable ........................................... $ 4,700 Salaries and wages payable .......................... 900 Unearned rent revenue .................................. 800 Interest payable .............................................. 180 Total current liabilities ............................ Long-term Liabilities Mortgage payable ........................................... Total liabilities ......................................... Stockholders’ equity Common stock ............................................... 60,000 Retained earnings .......................................... 3,570 Total stockholders’ equity ............... Total liabilities and stockholders’ equity ...................................................
101,250 $106,150
$
6,580 36,000 42,580
63,570 $106,150
(e) The following accounts would be closed: Rent Revenue, Salaries and Wages Expense, Utilities Expense, Advertising Expense, Interest Expense, Insurance Expense, Supplies Expense, Depreciation Expense. 4-36
.
(For Instructor Use Only)
PROBLEM 4-4A (a) Sept. 30 30 30 30 30 30 30
Accounts Receivable .................................... Service Revenue ....................................
600
Rent Expense ................................................ Prepaid Rent ..........................................
900
Supplies Expense ......................................... Supplies .................................................
1,020
Depreciation Expense................................... Accum. Depreciation—Equipment .......
350
Interest Expense ........................................... Interest Payable .....................................
50
Unearned Rent Revenue ............................... Rent Revenue ........................................
200
Salaries and Wages Expense ....................... Salaries and Wages Payable ................
600
(b)
900 1,020 350 50 200 600
WOLF CREEK GOLF INC. Income Statement For the Quarter Ended September 30, 2014 Revenues Service revenue............................................... Rent revenue ................................................... Total revenues ......................................... Expenses Salaries and wages expense .......................... Rent expense ................................................... Supplies expense ............................................ Utilities expense .............................................. Depreciation expense ..................................... Interest expense .............................................. Total expenses......................................... Net income ..............................................................
.
600
(For Instructor Use Only)
$14,700 900 $15,600 9,400 1,800 1,020 470 350 50 13,090 $ 2,510 4-37
PROBLEM 4-4A (Continued) WOLF CREEK GOLF INC. Retained Earnings Statement For the Quarter Ended September 30, 2014 Retained earnings, July 1, 2014 ................................................ Add: Net income ...................................................................... Less: Dividends ........................................................................ Retained earnings, September 30, 2014 ...................................
$
0 2,510 2,510 600 $1,910
WOLF CREEK GOLF INC. Balance Sheet September 30, 2014 Assets Current Assets Cash ............................................................... Accounts receivable ..................................... Supplies ......................................................... Prepaid rent ................................................... Total current assets ............................... Property, Plant and Equipment Equipment...................................................... Less: Accumulated depreciation— equipment .......................................... Total assets ............................................
$ 6,700 1,000 180 900 $ 8,780 15,000 350
Liabilities and Stockholders’ Equity Current Liabilities Notes payable ................................................ $ 5,000 Accounts payable.......................................... 1,070 Unearned rent revenue ................................. 800 Salaries and wages payable ......................... 600 Interest payable ............................................. 50 Total current liabilities........................... Stockholders’ equity Common stock .............................................. 14,000 Retained earnings ......................................... 1,910 Total stockholders’ equity ................. Total liabilities and stockholders’ equity .................................................. 4-38
.
(For Instructor Use Only)
14,650 $23,430
$ 7,520
15,910 $23,430
PROBLEM 4-4A (Continued) (c) The following accounts would be closed: Service Revenue, Rent Revenue, Salaries and Wages Expense, Rent Expense, Utilities Expense, Depreciation Expense, Supplies Expense, Interest Expense, Dividends. (d) Interest of 12% per year equals a monthly rate of 1%; monthly interest is $50 ($5,000 X 1%). Since total interest expense is $50, the note has been outstanding one month.
.
(For Instructor Use Only)
4-39
PROBLEM 4-5A
1.
2.
3.
4.
4-40
Dec. 31
Dec. 31
Dec. 31
Dec. 31
.
Insurance Expense ....................................... Prepaid Insurance ................................. [($9,600 ÷ 3) = $3,200 [($7,200 ÷ 12/18) = 4,800 $8,000]
8,000
Unearned Rent Revenue .............................. Rent Revenue ........................................ [[Nov. 5 X $5,000 X 2 = 50,000 [Dec. 4 X $8,500 X 1 = 34,000 $84,000]
84,000
Interest Expense ........................................... Interest Payable ($40,000 X 7% X 3/12) .........................
700
Salaries and Wages Expense ...................... Salaries and Wages Payable ................ [5 X $600 X 3/5 = $1,800 [3 X $700 X 3/5 = 1,260 $3,060]
3,060
(For Instructor Use Only)
8,000
84,000
700 3,060
PROBLEM 4-6A
(a) 1. June 2. 3.
4.
5.
6.
7.
.
30 30 30
30
30
30
30
(For Instructor Use Only)
Rent Revenue ................................... Unearned Rent Revenue ........
57,000
Supplies Expense............................. Supplies ($8,200 – $1,800)......
6,400
57,000 6,400
Insurance Expense ($14,400 X 3/12).............................. Prepaid Insurance...................
3,600
Maintenance and Repairs Expense ........................... Utilities Expense............................... Advertising Expense ........................ Accounts Payable ...................
4,450 215 110
Salaries and Wages Expense ($300 X 4) ....................................... Salaries and Wages Payable ................................. Interest Expense ($14,000 X 6% X 2/12) .................... Interest Payable ..................... Income Tax Expense ........................ Income Taxes Payable ...........
3,600
4,775 1,200 1,200 140 140 13,400 13,400
4-41
PROBLEM 4-6A (Continued) (b)
ASTROMECH TRAVEL COURT Income Statement For the Quarter Ended June 30, 2014 Revenues Rent revenue ($212,000 – $57,000) ...................... $155,000 Expenses Salaries and wages expense ($80,500 + $1,200) ............................................... $ 81,700 Income tax expense .............................................. 13,400 Maintenance and repairs expense ($4,300 + $4,450)................................................. 8,750 Supplies expense .................................................. 6,400 Advertising expense ($3,800 + $110) ................... 3,910 Insurance expense ................................................ 3,600 Depreciation expense ........................................... 2,700 Utilities expense ($900 + $215)............................. 1,115 Interest expense .................................................... 140 Total expenses ...................................................... 121,715 Net income............................................................. $ 33,285
(c)
The generally accepted accounting principles pertaining to the income statement not recognized by Jessica were the revenue recognition principle and the expense recognition principle. The revenue recognition principle states that revenue is recognized when the performance obligation is satisfied. The cash payments of $57,000 for summer rentals have not been earned and, therefore, should not be reported as income for the quarter ended June 30. The expense recognition principle dictates that efforts (expenses) be matched with accomplishments (revenue) whenever it is reasonable and practicable to do so. This means that the expenses should include amounts incurred in June but not paid until July, and any other costs related to the operations of the business during the period April–June. The difference in reported expenses was $29,515 ($121,715 – $92,200). The overstatement of revenues ($57,000) plus the understatement of expenses ($29,515) equals the difference in reported income of $86,515 ($119,800 – $33,285).
4-42
.
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
PROBLEM 4-7A
(a), (c) & (e) Cash 11/1 Bal. 2,790 11/8 11/10 1,800 11/20 11/12 3,700 11/22 11/29 750 11/25 11/30 Bal. 3,840
1,220 2,500 480 1,000
Accounts Receivable 11/1 Bal. 2,910 11/10 1,800 11/27 900 11/30 Bal. 2,010 Supplies 11/1 Bal. 1,120 11/30 11/17 1,300 11/30 Bal. 1,100
1,320
Equipment 11/1 Bal. 10,000 11/15 3,600 11/30 Bal. 13,600 Accumulated Depreciation— Equipment 11/1 Bal. 500 11/30 250 11/30 Bal. 750
.
(For Instructor Use Only)
11/20
11/30
Accounts Payable 2,500 11/1 Bal. 2,300 11/15 3,600 11/17 1,300 11/30 Bal. 4,700 Unearned Service Revenue 500 11/1 Bal. 11/29 11/30 Bal.
400 750 650
Salaries and Wages Payable 11/8 620 11/1 Bal. 620 11/30 480 11/30 Bal. 480 Common Stock 11/1 Bal. 10,000 11/30 Bal. 10,000 Retained Earnings 11/1 Bal. 3,000 11/30 Bal. 3,000
4-43
PROBLEM 4-7A (Continued) Service Revenue 11/12 3,700 11/27 900 11/30 500 11/30 Bal. 5,100 Depreciation Expense 11/30 250 11/30 Bal. 250 Supplies Expense 11/30 1,320 11/30 Bal. 1,320
4-44
.
(For Instructor Use Only)
Salaries and Wages Expense 11/8 600 11/25 1,000 11/30 480 11/30 Bal. 2,080 Rent Expense 11/22 480 11/30 Bal. 480
PROBLEM 4-7A (Continued) (b) General Journal Date Nov. 8
10 12 15 17 20 22 25 27 29
.
Account Titles Salaries and Wages Payable .......................... Salaries and Wages Expense ......................... Cash .........................................................
Debit 620 600
Cash ................................................................. Accounts Receivable ..............................
1,800
Cash ................................................................. Service Revenue ......................................
3,700
Equipment ....................................................... Accounts Payable....................................
3,600
Supplies ........................................................... Accounts Payable....................................
1,300
Accounts Payable ........................................... Cash .........................................................
2,500
Rent Expense .................................................. Cash .........................................................
480
Salaries and Wages Expense ......................... Cash .........................................................
1,000
Accounts Receivable ...................................... Service Revenue ......................................
900
Cash ................................................................. Unearned Service Revenue ....................
750
(For Instructor Use Only)
Credit
1,220 1,800 3,700 3,600 1,300 2,500 480 1,000 900 750
4-45
PROBLEM 4-7A (Continued) (d) & (f)
RIJO EQUIPMENT REPAIR Trial Balances November 30, 2014
Cash ............................................ Accounts Receivable ................. Supplies ...................................... Equipment .................................. Accumulated Depreciation— Equipment Accounts Payable ...................... Unearned Service Revenue ....... Salaries and Wages Payable ..... Common Stock........................... Retained Earnings ..................... Service Revenue ........................ Depreciation Expense................ Supplies Expense ..................... Salaries and Wages Expense ... Rent Expense ............................. (e) Nov. 30
30
30
30 4-46
.
Before Adjustment Dr. Cr. $ 3,840 2,010 2,420 13,600 $
After Adjustment Dr. Cr. $ 3,840 2,010 1,100 13,600
500 4,700 1,150
$
750 4,700 650 480 10,000 3,000 5,100
10,000 3,000 4,600
250 1,320 1,600 2,080 480 480 $23,950 $23,950 $24,680 $24,680
1. Supplies Expense ........................................... Supplies ($2,420 – $1,100) ......................
1,320
2. Salaries and Wages Expense ........................ Salaries and Wages Payable ..................
480
3. Depreciation Expense .................................... Accum. Depr.—Equipment .....................
250
4. Unearned Service Revenue ........................... Service Revenue .....................................
500
(For Instructor Use Only)
1,320
480
250
500
PROBLEM 4-7A (Continued) (g)
RIJO EQUIPMENT REPAIR Income Statement For the Month Ended November 30, 2014 Revenues Service revenue............................................... Expenses Salaries and wages expense .......................... Supplies expense ............................................ Rent expense ................................................... Depreciation expense ..................................... Total expenses......................................... Net income ..............................................................
( $5,100) $2,080 1,320 480 250 4,130) $ 970
RIJO EQUIPMENT REPAIR Retained Earnings Statement For the Month Ended November 30, 2014 Retained earnings, November 1 ........................... Add: Net income .................................................... Retained earnings, November 30 .........................
.
(For Instructor Use Only)
$3,000 970 $3,970
4-47
PROBLEM 4-7A (Continued)
RIJO EQUIPMENT REPAIR Balance Sheet November 30, 2014 Assets Current assets Cash ................................................................... Accounts receivable ......................................... Supplies ............................................................. Total current assets ................................... Property, plant and equipment Equipment.......................................................... Less: Accumulated depreciation— equipment .............................................. Total assets ................................................
$ 3,840 2,010 1,100 $ 6,950 13,600 750
12,850 $19,800
Liabilities and Stockholders’ Equity Current liabilities Accounts payable.............................................. Unearned service revenue ................................ Salaries and wages payable ............................. Total current liabilities............................... Stockholders’ equity Common stock .................................................. Retained earnings ............................................. Total stockholders’ equity .................... Total liabilities and stockholders’ equity .......................................................
4-48
.
(For Instructor Use Only)
$ 4,700 650 480 $ 5,830 10,000 3,970 13,970 $19,800
PROBLEM 4-8A
(a) General Journal Date July 1 1
3 5 12 18 20 21 25 31 31
.
Account Titles Debit Cash .................................................................. 12,000 Common Stock..........................................
12,000
Equipment ......................................................... Accounts Payable ..................................... Cash ...........................................................
8,000 6,000 2,000
Supplies ............................................................ Accounts Payable .....................................
900
Prepaid Insurance ............................................ Cash ...........................................................
1,800
Accounts Receivable........................................ Service Revenue .......................................
3,700
Accounts Payable ............................................. Cash ...........................................................
1,500
Salaries and Wages Expense .......................... Cash ...........................................................
2,000
Cash .................................................................. Accounts Receivable ................................
1,600
Accounts Receivable........................................ Service Revenue .......................................
2,500
Maintenance and Repairs Expense ................. Cash ...........................................................
290
Dividends .......................................................... Cash ...........................................................
600
(For Instructor Use Only)
Credit
900 1,800 3,700 1,500 2,000 1,600 2,500 290 600
4-49
PROBLEM 4-8A (Continued) (b), (e) & (h) Cash 7/1 12,000 7/1 7/21 1,600 7/5 7/18 7/20 7/31 7/31 7/31 Bal. 5,410
2,000 1,800 1,500 2,000 290 600
7/18
Accounts Payable 1,500 7/1 7/3 7/31 Bal.
Salaries and Wages Payable 7/31 400 7/31 Bal. 400
Accounts Receivable 7/12 3,700 7/21 1,600 7/25 2,500 7/31 1,700 7/31 Bal. 6,300
7/3 7/31 Bal.
Supplies 900 7/31 320
Prepaid Insurance 7/5 1,800 7/31 7/31 Bal. 1,650
7/1 7/31 Bal.
580
150
Equipment 8,000 8,000
Accumulated Depreciation— Equipment 7/31 180 7/31 Bal. 180
4-50
.
(For Instructor Use Only)
6,000 900 5,400
Common Stock 7/1 12,000 7/31 Bal. 12,000
7/31
Retained Earnings 600 7/31 7/31 Bal.
7/31 7/31 Bal.
7/31 7/31
7/31
Dividends 600 7/31 0
Income Summary 3,600 7/31 4,300 7/31 Bal. Service Revenue 7,900 7/12 7/25 7/31
4,300 3,700
600
7,900 0
3,700 2,500 1,700
7/31 Bal.
.
(For Instructor Use Only)
0
4-51
PROBLEM 4-8A (Continued) Maintenance and Repairs Expense 7/31 290 7/31 290 7/31 Bal. 0 Supplies Expense 7/31 580 7/31 7/31 Bal. 0
580
Depreciation Expense 7/31 180 7/31 7/31 Bal. 0
180
4-52
.
(For Instructor Use Only)
Insurance Expense 7/31 150 7/31 7/31 Bal. 0
150
Salaries and Wages Expense 7/20 2,000 7/31 2,400 7/31 400 7/31 Bal. 0
PROBLEM 4-8A (Continued) (c) & (f)
CLEAN WINDOW WASHING INC. Trial Balance July 31, 2014
Cash ................................................... Accounts Receivable ........................ Supplies ............................................. Prepaid Insurance ............................. Equipment ......................................... Accumulated Depreciation— Equipment ..................................... Accounts Payable ............................. Salaries and Wages Payable ............ Common Stock .................................. Dividends ........................................... Service Revenue ............................... Maintenance and Repairs Expense.. Supplies Expense ............................. Depreciation Expense ....................... Insurance Expense ........................... Salaries and Wages Expense ...........
.
(For Instructor Use Only)
Before Adjustment Debit Credit $ 5,410 4,600 900 1,800 8,000
After Adjustment Debit Credit $ 5,410 6,300 320 1,650 8,000 $
180 5,400 400 12,000
$ 5,400 12,000 600
600 6,200
7,900
290
290 580 180 150 2,000 2,400 $23,600 $23,600 $25,880 $25,880
4-53
PROBLEM 4-8A (Continued) (d) General Journal 1. 2. 3. 4. 5.
Date July 31 31 31 31 31
(g)
Account Titles Accounts Receivable ....................................... Service Revenue ........................................
Debit 1,700
Depreciation Expense...................................... Accumulated Depreciation—Equipment.....
180
Insurance Expense ($1,800 X 1/12) ................. Prepaid Insurance ......................................
150
Supplies Expense ($900 – $320) ..................... Supplies ......................................................
580
Salaries and Wages Expense .......................... Salaries and Wages Payable .....................
400
1,700 180 150 580 400
CLEAN WINDOW WASHING INC. Income Statement For the Month Ended July 31, 2014 Revenues Service revenue ................................................ Expenses Salaries and wages expense ........................... Supplies expense ............................................. Maintenance and repairs expense .................. Depreciation expense ...................................... Insurance expense ........................................... Total expenses .......................................... Net income ...............................................................
4-54
Credit
.
(For Instructor Use Only)
$7,900 $2,400 580 290 180 150 3,600 $4,300
PROBLEM 4-8A (Continued) (g)
CLEAN WINDOW WASHING INC. Retained Earnings Statement For the Month Ended July 31, 2014 Retained earnings, July 1...................................... Add: Net income ..................................................
$
0 4,300 4,300 600 $3,700
Less: Dividends ................................................... Retained earnings, July 31 ...................................
CLEAN WINDOW WASHING INC. Balance Sheet July 31, 2014 Assets Current assets Cash ................................................................. Accounts receivable ....................................... Supplies ........................................................... Prepaid insurance ........................................... Total current assets ................................ Property, plant, and equipment Equipment ....................................................... Less: Accumulated depreciation .................. Total assets ..............................................
$ 5,410 6,300 320 1,650 $13,680 8,000 180
7,820 $21,500
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ........................................... Salaries and wages payable ........................... Total current liabilities ............................ Stockholders’ equity Common stock ................................................ Retained earnings ........................................... Total stockholders’ equity ................. Total liabilities and stockholders’ equity ....................................................
.
(For Instructor Use Only)
$ 5,400 400 $ 5,800 12,000 3,700 15,700 $21,500
4-55
PROBLEM 4-8A (Continued) (h) Date July 31
General Journal Account Titles and Explanation Service Revenue ............................................. Income Summary ....................................
Debit 7,900
7,900
31
Income Summary ............................................ 3,600 Salaries and Wages Expense ................. 2,400 Supplies Expense ................................... Depreciation Expense 580 Maintenance and Repairs Expense........ 290 Depreciation Expense ............................. 180 Insurance Expense ................................. 150
31
Income Summary ............................................ Retained Earnings ...................................
4,300
Retained Earnings .......................................... Dividends .................................................
600
31
(i)
4,300 600
CLEAN WINDOW WASHING INC. Post-Closing Trial Balance July 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Prepaid Insurance .............................................. Equipment .......................................................... Accumulated Depreciation—Equipment .......... Accounts Payable .............................................. Salaries and Wages Payable ............................. Common Stock ................................................... Retained Earnings..............................................
Debit $ 5,410 6,300 320 1,650 8,000
.
(For Instructor Use Only)
Credit
$
$21,680
4-56
Credit
180 5,400 400 12,000 3,700 $21,680
PROBLEM 4-1B (a) 1. 2. 3.
Cash ................................................................. Accounts Receivable ...............................
20,000
Unearned Service Revenue............................. Service Revenue ......................................
10,000
Cash ................................................................. Unearned Service Revenue .....................
40,000
Unearned Service Revenue ($40,000 – $17,000) ........................................ Service Revenue ...................................... 4.
5.
(b)
20,000 10,000 40,000 23,000 23,000
Accounts Receivable....................................... Service Revenue ($190,000 – $10,000 – $23,000) .............
157,000
Cash ................................................................. Accounts Receivable ($157,000 – $18,000) ..............................
139,000
Cash received with respect to fees: 1. Collection of accounts receivable .................. 3. Gift certificates ................................................ 5. Partial collection of fees receivable ...............
157,000
139,000 $ 20,000 40,000 139,000 $199,000
T-account (not required)
Bal. 4. Bal.
Accounts Receivable 20,000 157,000 1. 20,000 5. 139,000 18,000 Service Revenue 2. 10,000 3. 23,000 4. 157,000 Bal. 190,000
.
(For Instructor Use Only)
Unearned Service Revenue Bal. 10,000 2. 10,000 3. 40,000 3. 23,000 Bal. 17,000 1. 3. 5. Bal.
Cash 20,000 40,000 139,000 199,000 4-57
4-58
.
(For Instructor Use Only)
PROBLEM 4-2B (a) Date 2014 1. May 31 2.
31
3.
31
4.
31
5.
31
6.
31
7.
31
Account Titles
Debit
Supplies Expense........................................ Supplies................................................
1,000
Utilities Expense.......................................... Accounts Payable ................................
300
Insurance Expense...................................... Prepaid Insurance ($3,600 ÷ 36 months) .......................
100
Unearned Service Revenue ........................ Service Revenue ($4,000 – $1,500) .....
2,500
Salaries and Wages Expense ..................... Salaries and Wages Payable [(2/5 X $600) X 2 employees] ..........
480
Depreciation Expense ................................. Accumulated Depreciation— Equipment ......................................
200
Accounts Receivable .................................. Service Revenue ..................................
1,500
Credit
1,000 300
100 2,500
480
200 1,500
(b)
5/31 Bal.
Cash 7,500
Accounts Receivable 5/31 Bal. 3,000 5/31 1,500 5/31 Bal. 4,500
.
(For Instructor Use Only)
5/31 Bal. 5/31 Bal.
Supplies 2,500 5/31 1,500
Prepaid Insurance 5/31 Bal. 3,600 5/31 5/31 Bal. 3,500
1,000
100
4-59
4-60
.
(For Instructor Use Only)
PROBLEM 4-2B (Continued) Equipment 5/31 Bal. 12,000 Accumulated Depreciation— Equipment 5/31 200 5/31 Bal. 200 Accounts Payable 5/31 Bal. 5/31 5/31 Bal.
3,500 300 3,800
Salaries and Wages Payable 5/31 480 5/31 Bal. 480 Unearned Service Revenue 5/31 2,500 5/31 Bal. 4,000 5/31 Bal. 1,500 Common Stock 5/31 Bal. 19,100
Salaries and Wages Expense 5/31 Bal. 4,000 5/31 480 5/31 Bal. 4,480 Rent Expense 5/31 Bal. 1,500 Depreciation Expense 5/31 200 5/31 Bal. 200 Insurance Expense 5/31 100 5/31 Bal. 100 Utilities Expense 5/31 300 5/31 Bal. 300 Supplies Expense 5/31 1,000 5/31 Bal. 1,000
Service Revenue 5/31 Bal. 7,500 5/31 2,500 5/31 1,500 5/31 Bal. 11,500
.
(For Instructor Use Only)
4-61
PROBLEM 4-2B (Continued) (c)
OKENDO CONSULTING Adjusted Trial Balance May 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Prepaid Insurance .............................................. Equipment .......................................................... Accumulated Depreciation— Equipment ....................................................... Accounts Payable .............................................. Salaries and Wages Payable ............................. Unearned Service Revenue ............................... Common Stock ................................................... Service Revenue ................................................ Salaries and Wages Expense ............................ Rent Expense ..................................................... Depreciation Expense ........................................ Insurance Expense ............................................ Utilities Expense ................................................ Supplies Expense ..............................................
4-62
.
(For Instructor Use Only)
Debit $ 7,500 4,500 1,500 3,500 12,000
Credit
$ 200 3,800 480 1,500 19,100 11,500 4,480 1,500 200 100 300 1,000 $36,580
$36,580
PROBLEM 4-3B
(a) 1. Aug. 31 2. 3.
4. 5. 6. 7.
31 31
31 31 31 31
Insurance Expense ($500 X 3) ............... Prepaid Insurance ..........................
1,500
Supplies Expense ($4,300 – $900) ........ Supplies ..........................................
3,400
Depreciation Expense............................ Accum. Depr.—Buildings ($6,600 X 1/4)................................... Accum. Depr.—Equipment ($4,000 X 1/4)...................................
2,650
Unearned Rent Revenue ........................ Rent Revenue .................................
4,000
Salaries and Wages Expense ................ Salaries and Wages Payable .........
600
Accounts Receivable ............................. Rent Revenue .................................
1,600
Interest Expense .................................... Interest Payable [($120,000 X 6%) X 1/12] .................
600
1,500 3,400
1,650 1,000 4,000 600 1,600
600
(b) Cash 8/31 Bal. 24,600
Accounts Receivable 8/31 1,600 8/31 Bal. 1,600
.
(For Instructor Use Only)
8/31 Bal. 8/31 Bal.
Supplies 4,300 8/31 900
Prepaid Insurance 8/31 Bal. 5,400 8/31 8/31 Bal. 3,900
3,400
1,500
4-63
PROBLEM 4-3B (Continued) Land 8/31 Bal. 40,000
Interest Payable 8/31 8/31 Bal.
Buildings 8/31 Bal. 132,000
Mortgage Payable 8/31 Bal. 120,000
Accumulated Depreciation— Buildings 8/31 1,650 8/31 Bal. 1,650 Equipment 8/31 Bal. 36,000
6,500
Unearned Rent Revenue 8/31 4,000 8/31 Bal. 6,800 8/31 Bal. 2,800 Salaries and Wages Payable 8/31 600 8/31 Bal. 600
4-64
.
(For Instructor Use Only)
Common Stock 8/31 Bal. 100,000
8/31 Bal.
Accumulated Depreciation— Equipment 8/31 1,000 8/31 Bal. 1,000 Accounts Payable 8/31 Bal.
600 600
Dividends 5,000 Rent Revenue 8/31 Bal. 80,000 8/31 4,000 8/31 1,600 8/31 Bal. 85,600
Salaries and Wages Expense 8/31 Bal. 53,000 8/31 600 8/31 Bal. 53,600 Utilities Expense 8/31 Bal. 9,400 Maintenance and Repairs Expense 8/31 Bal. 3,600
PROBLEM 4-3B (Continued) Insurance Expense 8/31 1,500 8/31 Bal. 1,500
Depreciation Expense 8/31 2,650 8/31 Bal. 2,650
Supplies Expense 8/31 3,400 8/31 Bal. 3,400
Interest Expense 8/31 600 8/31 Bal. 600
.
(For Instructor Use Only)
4-65
PROBLEM 4-3B (Continued) (c)
DEATH VALLEY RESORT Adjusted Trial Balance August 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Prepaid Insurance .............................................. Land .................................................................... Buildings ............................................................ Accumulated Depreciation—Buildings ............ Equipment .......................................................... Accumulated Depreciation—Equipment .......... Accounts Payable .............................................. Unearned Rent Revenue .................................... Salaries and Wages Payable ............................. Interest Payable ................................................. Mortgage Payable .............................................. Common Stock ................................................... Dividends ............................................................ Rent Revenue ..................................................... Salaries and Wages Expense ............................ Utilities Expense ................................................ Maintenance and Repairs Expense .................. Insurance Expense ............................................ Supplies Expense .............................................. Depreciation Expense ........................................ Interest Expense ................................................
4-66
.
(For Instructor Use Only)
Debit $ 24,600 1,600 900 3,900 40,000 132,000
Credit
$
1,650
36,000 1,000 6,500 2,800 600 600 120,000 100,000 5,000 85,600 53,600 9,400 3,600 1,500 3,400 2,650 600 $318,750
$318,750
PROBLEM 4-3B (Continued) (d)
DEATH VALLEY RESORT Income Statement For the Three Months Ended August 31, 2014 Revenues Rent revenue ................................................. Expenses Salaries and wages expense ........................ Utilities expense ............................................ Maintenance and repairs expense ............... Supplies expense .......................................... Depreciation expense ................................... Insurance expense ........................................ Interest expense ............................................ Total expenses....................................... Net income ............................................................
$85,600 $53,600 9,400 3,600 3,400 2,650 1,500 600 74,750 $10,850
DEATH VALLEY RESORT Retained Earnings Statement For the Three Months Ended August 31, 2014 Retained earnings, June 1 ................................... Add: Net income ................................................. Less: Dividends ................................................... Retained earnings, August 31..............................
.
(For Instructor Use Only)
$
0 10,850 10,850 5,000 $ 5,850
4-67
PROBLEM 4-3B (Continued) DEATH VALLEY RESORT Balance Sheet August 31, 2014 Assets Current assets Cash .......................................... Accounts receivable ................ Supplies .................................... Prepaid insurance .................... Total current assets ........... Property, plant, and equipment Land .......................................... Buildings.................................. Less: Accum. depr.—bldgs. ... Equipment ................................ Less: Accum. depr.—equip. .. Total assets .......................
$ 24,600 1,600 900 3,900 $ 31,000 40,000 $132,000 1,650 36,000 1,000
130,350 35,000
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ....................................... $ 6,500 Unearned rent revenue ............................... 2,800 Interest payable........................................... 600 Salaries and wages payable ....................... 600 Total current liabilities .......................... Long-term liabilities Mortgage payable ....................................... Total liabilities ....................................... Stockholders’ equity Common stock ............................................ 100,000 Retained earnings ....................................... 5,850 Total stockholders’ equity .............. Total liabilities and stockholders’ equity ................................................. (e)
4-68
205,350 $236,350
$
10,500 120,000 130,500
105,850 $236,350
The following accounts would be closed: Rent Revenue, Salaries and Wages Expense, Utilities Expense, Maintenance and Repairs Expense, Supplies Expense, Depreciation Expense, Insurance Expense, Interest Expense, Dividends. .
(For Instructor Use Only)
PROBLEM 4-4B
(a) Dec. 31 31 31 31
31 31 31
Accounts Receivable ................................... Service Revenue ...................................
3,000
Supplies Expense......................................... Supplies ................................................
2,400
Insurance Expense....................................... Prepaid Insurance.................................
1,560
Depreciation Expense .................................. Accumulated Depreciation— Equipment ..........................................
5,000
Interest Expense .......................................... Interest Payable ....................................
560
Unearned Service Revenue ......................... Service Revenue ...................................
1,900
Salaries and Wages Expense ...................... Salaries and Wages Payable ................
820
(b)
2,400 1,560
5,000 560 1,900 820
ABDULLA ADVERTISING AGENCY Income Statement For the Year Ended December 31, 2014 Revenues Service revenue............................................... Expenses Salaries and wages expense .......................... Depreciation expense ..................................... Rent expense ................................................... Supplies expense ............................................ Insurance expense .......................................... Interest expense .............................................. Total expenses......................................... Net income ..............................................................
.
3,000
(For Instructor Use Only)
$62,500 $9,820 5,000 4,350 2,400 1,560 560 23,690 $38,810 4-69
PROBLEM 4-4B (Continued) ABDULLA ADVERTISING AGENCY Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1 ............................. Add: Net income ................................................
$ 5,500 38,810 44,310 10,000 $34,310
Less: Dividends .................................................. Retained earnings, December 31 ........................ ABDULLA ADVERTISING AGENCY Balance Sheet December 31, 2014 Assets Current assets Cash ................................................................. Accounts receivable ....................................... Supplies........................................................... Prepaid insurance ........................................... Total current assets ........................... Property, plant, and equipment Equipment ....................................................... Less: Accumulated depreciation— equipment ............................................ Total assets ........................................
$11,000 19,000 7,000 1,790 $38,790 $60,000 30,000
Liabilities and Stockholders’ Equity Current liabilities Notes payable ................................................. $ 8,000 Accounts payable ........................................... 2,000 Unearned service revenue ............................. 3,100 Salaries and wages payable .......................... 820 Interest payable .............................................. 560 Total current liabilities ....................... Stockholders’ equity Common stock ................................................ 20,000 Retained earnings........................................... 34,310 Total stockholders’ equity ............. Total liabilities and stockholders’ equity ................................................. 4-70
.
(For Instructor Use Only)
30,000 $68,790
$14,480
54,310 $68,790
PROBLEM 4-4B (Continued) (c) Service Revenue, Salaries and Wages Expense, Depreciation Expense, Rent Expense, Supplies Expense, Insurance Expense, Interest Expense, Dividends. (d) Interest is $56 per month or .7% of the note payable ($56 ÷ $8,000). .7% X 12 = 8.4% interest per year. (e) Salaries and Wages Expense, $9,820, less Salaries and Wages Payable 12/31/14, $820 = $9,000. Total payments, $10,000 – $9,000 = $1,000 Salaries Payable 12/31/13.
.
(For Instructor Use Only)
4-71
PROBLEM 4-5B
1.
2.
3.
4.
4-72
Dec. 31
Dec. 31
Dec. 31
Dec. 31
.
Insurance Expense ....................................... Prepaid Insurance ................................. [($11,400 ÷ 3) = $3,800 ($8,800 ÷ 2 X 6/12) = 2,200 $6,000]
6,000
Unearned Rent Revenue .............................. Rent Revenue ........................................ [Nov. 5 X $6,000 X 2 = 60,000 Dec. 4 X $7,500 X 1 = 30,000 $90,000]
90,000
Interest Expense ........................................... Interest Payable..................................... ($20,000 X 9% X 5/12)
750
Salaries and Wages Expense ...................... Salaries and Wages Payable ................ [4 X $480 X 4/5 = $1,536 2 X $600 X 4/5 = 960 $2,496]
2,496
(For Instructor Use Only)
6,000
90,000
750
2,496
PROBLEM 4-6B
(a) 1. April 30 2. 3. 4.
5.
6. 7.
.
30 30 30
30
30 30
(For Instructor Use Only)
Service Revenue ........................................ Unearned Service Revenue .................
75,000
Supplies Expense ...................................... Supplies ($9,800 – $2,600) .....................
7,200
Insurance Expense ($12,000 ÷ 12 X 3) ........ Prepaid Insurance ................................
3,000
Advertising Expense ................................. Maintenance and Repairs Expense .......... Utilities Expense ........................................ Accounts Payable ................................
80 2,560 530
Salaries and Wages Expense ($1,380 X 3) .......................................... Salaries and Wages Payable...........
75,000 7,200 3,000
3,170 4,140 4,140
Interest Expense ($15,000 X 8% X 3/12) ..... Interest Payable....................................
300
Income Tax Expense ................................. Income Taxes Payable .........................
15,200
300 15,200
4-73
PROBLEM 4-6B (Continued) (b)
TUTORS-PLUS TEST PREP Income Statement For the Quarter Ended April 30, 2014 Revenues Service revenue ($240,000 – $75,000) .................. Expenses Salaries and wages expense ($92,000 + $4,140) ............................................... Income tax expense .............................................. Supplies expense .................................................. Advertising expense ($6,400 + $80) ..................... Maintenance and repairs expense ($1,700 + $2,560)................................................. Insurance expense ................................................ Depreciation expense ........................................... Utilities expense ($1,300 + $530) .......................... Interest expense .................................................... Total expenses ...................................................... Net income.............................................................
(c)
$165,000 $96,140 15,200 7,200 6,480 4,260 3,000 2,400 1,830 300 136,810 $ 28,190
The generally accepted accounting principles pertaining to the income statement not recognized by Jan were the revenue recognition principle and the expense recognition principle. The revenue recognition principle states that revenue is recognized when the performance obligation is satisfied. The cash payments of $75,000 for summer classes have not been earned and, therefore, should not be reported as income for the quarter ended April 30. The expense recognition principle dictates that efforts (expenses) be matched with accomplishments (revenue) whenever it is reasonable and practicable to do so. This means that the expenses should include amounts incurred in April but not paid until May, and any other costs related to the operations of the business during the period February– April. The difference in reported expenses was $33,010 ($136,810 – $103,800). The overstatement of revenues ($75,000) plus the understatement
4-74
.
(For Instructor Use Only)
of expenses ($33,010) equals the difference in reported income of $108,010 ($136,200 – $28,190).
.
(For Instructor Use Only)
4-75
PROBLEM 4-7B
(a), (c) & (e)
8/1 Bal. 8/5 8/12 8/29 8/31 Bal.
Cash 6,040 8/10 1,200 8/20 2,800 8/22 780 8/25 2,420
3,120 2,000 380 2,900
Accounts Receivable 8/1 Bal. 2,910 8/5 1,200 8/27 3,130 8/31 Bal. 4,840
8/1 Bal. 8/17 8/31 Bal.
Supplies 1,030 8/31 860 960
930
Equipment 8/1 Bal. 10,000 8/15 2,000 8/31 Bal. 12,000 Accumulated Depreciation— Equipment 8/1 Bal. 600 8/31 320 8/31 Bal. 920
4-76
.
(For Instructor Use Only)
8/20
8/31
Accounts Payable 2,000 8/1 Bal. 8/15 8/17 8/31 Bal.
2,300 2,000 860 3,160
Unearned Service Revenue 800 8/1 Bal. 8/29 8/31 Bal.
1,260 780 1,240
Salaries and Wages Payable 8/10 1,420 8/1 Bal. 1,420 8/31 1,540 8/31 Bal. 1,540 Common Stock 8/1 Bal. 10,000 8/31 Bal. 10,000 Retained Earnings 8/1 Bal. 8/31 Bal.
4,400 4,400
PROBLEM 4-7B (Continued) Service Revenue 8/12 8/27 8/31 8/31 Bal. Depreciation Expense 8/31 320 8/31 Bal. 320
2,800 3,130 800 6,730
Salaries and Wages Expense 8/10 1,700 8/25 2,900 8/31 1,540 8/31 Bal. 6,140 Rent Expense 8/22 380 8/31 Bal. 380
Supplies Expense 8/31 930 8/31 Bal. 930
.
(For Instructor Use Only)
4-77
PROBLEM 4-7B (Continued) (b)
General Journal
Date Aug. 5 10
12 15 17 20 22 25 27 29
4-78
Account Titles Cash ................................................................. Accounts Receivable...............................
Debit 1,200
Salaries and Wages Payable .......................... Salaries and Wages Expense ......................... Cash .........................................................
1,420 1,700
Cash ................................................................. Service Revenue ......................................
2,800
Equipment ....................................................... Accounts Payable ....................................
2,000
Supplies ........................................................... Accounts Payable ....................................
860
Accounts Payable ........................................... Cash .........................................................
2,000
Rent Expense .................................................. Cash .........................................................
380
Salaries and Wages Expense ......................... Cash .........................................................
2,900
Accounts Receivable ...................................... Service Revenue ......................................
3,130
Cash ................................................................. Unearned Service Revenue.....................
780
.
(For Instructor Use Only)
Credit 1,200
3,120 2,800 2,000 860 2,000 380 2,900 3,130 780
PROBLEM 4-7B (Continued) (d) & (f)
D & D REPAIR SERVICES Trial Balances August 31, 2014
Cash............................................ Accounts Receivable ................. Supplies ..................................... Equipment .................................. Accumulated Depr.— Equipment ............................... Accounts Payable ...................... Unearned Service Revenue ....... Salaries and Wages Payable ..... Common Stock .......................... Retained Earnings ..................... Service Revenue ........................ Salaries and Wages Expense ... Rent Expense ............................. Supplies Expense ...................... Depreciation Expense ............... (e) Aug. 31
31
31
31
.
Before Adjustment Dr. Cr. $ 2,420 4,840 1,890 12,000 $
After Adjustment Dr. Cr. $ 2,420 4,840 960 12,000
600 3,160 2,040
$
920 3,160 1,240 1,540 10,000 4,400 6,730
10,000 4,400 5,930 4,600 380
6,140 380 930 320 $26,130 $26,130 $27,990 $27,990
1. Supplies Expense........................................... Supplies ($1,890 – $960).........................
930
2. Salaries and Wages Expense ........................ Salaries and Wages Payable ..................
1,540
3. Depreciation Expense .................................... Accum. Depr.—Equipment.....................
320
4. Unearned Service Revenue ........................... Service Revenue .....................................
800
(For Instructor Use Only)
930
1,540
320
800 4-79
PROBLEM 4-7B (Continued) (g)
D & D REPAIR SERVICES Income Statement For the Month Ended August 31, 2014 Revenues Service revenue .............................................. Expenses Salaries and wages expense ......................... Supplies expense ........................................... Rent expense .................................................. Depreciation expense .................................... Total expenses ........................................ Net loss...................................................................
($6,730) $6,140 930 380 320 7,770) ($1,040)
D & D REPAIR SERVICES Retained Earnings Statement For the Month Ended August 31, 2014 Retained earnings, August 1 ................................. Less: Net loss ....................................................... Retained earnings, August 31 ...............................
4-80
.
(For Instructor Use Only)
$4,400 1,040 $3,360
PROBLEM 4-7B (Continued)
D & D REPAIR SERVICES Balance Sheet August 31, 2014 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Supplies ......................................................... Total current assets .............................. Property, plant and equipment Equipment ..................................................... Less: Accumulated depreciation— equipment .......................................... Total assets ............................................
$ 2,420 4,840 960 $ 8,220 12,000 920
11,080 $19,300
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................................... $ 3,160 Unearned service revenue.................................. 1,240 Salaries and wages payable ............................... 1,540 Total current liabilities ................................ Stockholders’ equity Common stock .................................................... 10,000 Retained earnings ............................................... 3,360 Total stockholders’ equity .......................... Total liabilities and stockholders’ equity .........................................................
.
(For Instructor Use Only)
$ 5,940
13,360 $19,300
4-81
PROBLEM 4-8B (a) General Journal Date Mar. 1 1
3 5 14 18 20 21 28 31 31
Account Titles Debit Cash ................................................................... 15,000 Common Stock ..........................................
15,000
Equipment ......................................................... 8,000 Accounts Payable ..................................... Cash ...........................................................
5,000 3,000
Supplies............................................................. 2,000 Accounts Payable .....................................
2,000
Prepaid Insurance............................................. 2,400 Cash ...........................................................
2,400
Accounts Receivable ........................................ 3,700 Service Revenue .......................................
3,700
Accounts Payable ............................................. 2,000 Cash ...........................................................
2,000
Salaries and Wages Expense........................... 1,750 Cash ...........................................................
1,750
Cash ................................................................... 1,600 Accounts Receivable ................................
1,600
Accounts Receivable ........................................ 4,200 Service Revenue .......................................
4,200
Maintenance and Repairs Expense ................. Cash ...........................................................
350
Dividends .......................................................... Cash ...........................................................
Credit
350
900 900
4-82
.
(For Instructor Use Only)
PROBLEM 4-8B (Continued) (b), (e) & (h) Cash 3/1 15,000 3/1 3/21 1,600 3/5 3/18 3/20 3/31 3/31 3/31 Bal. 6,200
3,000 2,400 2,000 1,750 350 900
3/18
Accounts Payable 2,000 3/1 3/3 3/31 Bal.
Salaries and Wages Payable 3/31 1,080 3/31 Bal. 1,080
Accounts Receivable 3/14 3,700 3/21 1,600 3/28 4,200 3/31 200 3/31 Bal. 6,500
3/3 3/31 Bal.
Supplies 2,000 3/31 280
Prepaid Insurance 3/5 2,400 3/31 3/31 Bal. 2,000
3/1 3/31 Bal.
1,720
Retained Earnings 900 3/31 3/31 Bal.
3/31 3/31 Bal.
Dividends 900 3/31 0
2,550 1,650
900
400
Equipment 8,000 8,000
(For Instructor Use Only)
Common Stock 3/1 15,000 3/31 Bal. 15,000
3/31
Accumulated Depreciation— Equipment 3/31 250 3/31 Bal. 250 .
5,000 2,000 5,000
3/31 3/31
3/31
Income Summary 5,550 3/31 2,550 3/31 Bal. Service Revenue 8,100 3/14 3/28 3/31 3/31 Bal.
8,100 0
3,700 4,200 200 0
4-83
PROBLEM 4-8B (Continued) Maintenance and Repairs Expense 3/31 350 3/31 350 3/31 Bal. 0 Supplies Expense 3/31 1,720 3/31 3/31 Bal. 0
1,720
Depreciation Expense 3/31 250 3/31 3/31 Bal. 0
250
(c) & (f)
400
Salaries and Wages Expense 3/20 1,750 3/31 2,830 3/31 1,080 3/31 Bal. 0
GEOG CLEANERS Trial Balance March 31, 2014
Cash ..................................................... Accounts Receivable .......................... Supplies ............................................... Prepaid Insurance ............................... Equipment............................................ Accumulated Depreciation— Equipment ......................................... Accounts Payable ............................... Salaries and Wages Payable .............. Common Stock .................................... Dividends ............................................. Service Revenue.................................. Maintenance and Repairs Expense .... Salaries and Wages Expense ............. Depreciation Expense ......................... Insurance Expense .............................. Supplies Expense................................
4-84
Insurance Expense 3/31 400 3/31 3/31 Bal. 0
.
(For Instructor Use Only)
Before Adjustment Debit Credit $ 6,200 6,300 2,000 2,400 8,000
After Adjustment Debit Credit $ 6,200 6,500 280 2,000 8,000 $
250 5,000 1,080 15,000
$ 5,000 15,000 900
900 7,900
350 1,750
8,100
350 2,830 250 400 1,720 $27,900 $27,900 $29,430 $29,430
PROBLEM 4-8B (Continued) (d) Date March 31
1. 2.
31
3.
31
4.
31
5.
31
(g)
General Journal Account Titles Accounts Receivable ............................. Service Revenue ............................
Credit 200
Depreciation Expense ........................... Accumulated Depreciation— Equipment ...................................
250
Insurance Expense ................................ Prepaid Insurance ($2,400 ÷ 6)......................................
400
Supplies Expense .................................. Supplies ($2,000 – $280) ................
1,720
Salaries and Wages Expense ............... Salaries and Wages Payable .........
1,080
250
400 1,720 1,080
GEOG CLEANERS Income Statement For the Month Ended March 31, 2014 Revenues Service revenue................................................ Expenses Salaries and wages expense ........................... Supplies expense ............................................. Insurance expense ........................................... Maintenance and repairs expense .................. Depreciation expense ...................................... Total expenses.......................................... Net income ...............................................................
.
Debit 200
(For Instructor Use Only)
$8,100 $2,830 1,720 400 350 250 5,550 $2,550
4-85
PROBLEM 4-8B (Continued) GEOG CLEANERS Retained Earnings Statement For the Month Ended March 31, 2014 Retained earnings, March 1 .................................. Add: Net income ..................................................
$
0 2,550 2,550 900 $1,650
Less: Dividends .................................................... Retained earnings, March 31 ................................
GEOG CLEANERS Balance Sheet March 31, 2014 Assets Current assets Cash ................................................................ Accounts receivable ...................................... Supplies .......................................................... Prepaid insurance .......................................... Total current assets ................................ Property, plant, and equipment Equipment....................................................... Less: Accumulated depreciation— equipment........................................ Total assets .............................................
$6,200 6,500 280 2,000 $14,980 8,000 250
7,750 $22,730
Liabilities and Stockholders’ Equity Current liabilities Accounts payable........................................... Salaries and wages payable .......................... Total current liabilities............................ Stockholders’ equity Common stock ............................................... Retained earnings .......................................... Total stockholders’ equity .................. Total liabilities and stockholders’ equity ...................................................... 4-86
.
(For Instructor Use Only)
$ 5,000 1,080 $ 6,080 15,000 1,650 16,650 $22,730
PROBLEM 4-8B (Continued) (h) Date Mar. 31 31
31 31
General Journal Account Titles and Explanation Debit Service Revenue ............................................... 8,100 Income Summary ......................................
8,100
Income Summary.............................................. 5,550 Salaries and Wages Expense ................... Supplies Expense ..................................... Insurance Expense ................................... Maintenance and Repairs Expense ......... Depreciation Expense...............................
2,830 1,720 400 350 250
Income Summary.............................................. 2,550 Retained Earnings ....................................
2,550
Retained Earnings ............................................ Dividends...................................................
(i)
900 900
GEOG CLEANERS Post-Closing Trial Balance March 31, 2014 Cash .................................................................... Accounts Receivable.......................................... Supplies .............................................................. Prepaid Insurance .............................................. Equipment ........................................................... Accumulated Depreciation—Equipment ........... Accounts Payable ............................................... Salaries and Wages Payable.............................. Common Stock ................................................... Retained Earnings ..............................................
Debit $ 6,200 6,500 280 2,000 8,000
(For Instructor Use Only)
Credit
$
$22,980
.
Credit
250 5,000 1,080 15,000 1,650 $22,980
4-87
CCC4
CONTINUING COOKIE CHRONICLE
(a) General Journal Date Dec.
1 5
8 9 15 16 19 23
23 23 28
4-88
Account Titles No journal entry required.
Debit
Cash ................................................................ Unearned Service Revenue ........................... Service Revenue ......................................
90 60
Cash ................................................................ Accounts Receivable...............................
300
Cash ................................................................ Unearned Service Revenue.....................
750
Accounts Payable .......................................... Cash .........................................................
50
Accounts Payable .......................................... Cash .........................................................
600
Cash ................................................................ Unearned Service Revenue.....................
60
Cash ................................................................ Accounts Receivable ..................................... Service Revenue ......................................
3,000 1,000
Supplies .......................................................... Cash .........................................................
1,250
Salaries and Wages Expense ........................ Cash .........................................................
800
Dividends ........................................................ Cash .........................................................
500
.
(For Instructor Use Only)
Credit
150 300 750 50 600 60
4,000 1,250 800 500
CONTINUING COOKIE CHRONICLE (Continued) (d) Date
Account Titles
(1) Dec. 31 (2) 31
(3) 31 (4) 31 (5) 31 (6) 31 (7) 31 (8) 31 (9) 31 (10) 31
.
Supplies Expense ............................................ Supplies ..................................................... Depreciation Expense ($1,200 ÷ 5 X 2/12) .......................................... Accumulated Depreciation— Equipment ...............................................
Debit 45
45
40 40
Amortization Expense ($600 ÷ 24)................... Website ......................................................
25
Interest Expense ($2,000 X .09 X 1.5/12) ......... Interest Payable .........................................
23
Insurance Expense ($1,200 ÷ 12) .................... Prepaid Insurance .....................................
100
Accounts Receivable ....................................... Service Revenue........................................
450
Supplies Expense ............................................ Supplies .....................................................
1,025
Utilities Expense .............................................. Accounts Payable .....................................
75
Salaries and Wages Expense ($8 X 7) ............ Salaries and Wages Payable ....................
56
Unearned Service Revenue ($750 X 3/5) ......... Service Revenue........................................
450
(For Instructor Use Only)
Credit
25
23
100
450
1,025
75
56
450 4-89
CONTINUING COOKIE CHRONICLE (Continued) (b), (d), and (g) Cash 340 12/15 90 12/16 300 12/23 750 12/23 60 12/28 3,000 1,340
11/30 Bal. 12/5 12/8 12/9 12/19 12/23 12/31 Bal.
Accounts Receivable 11/30 Bal. 300 12/8 12/23 1,000 12/31 450 12/31 Bal. 1,450
Supplies 220 12/31 1,250 12/31 400
11/30 Bal. 12/23 12/31 Bal.
Prepaid Insurance 11/30 Bal. 1,200 12/31 12/31 Bal. 1,100
Equipment 11/30 Bal. 1,200 12/31 Bal. 1,200
4-90
.
(For Instructor Use Only)
50 600 1,250 800 500
Accumulated Depreciation— Equipment 12/31 40 12/31 Bal. 40
11/30 Bal. 12/31 Bal.
300
45 1,025
100
12/15 12/16
Website 600 12/31 575
25
Accounts Payable 50 11/30 Bal. 600 12/31 12/31 Bal.
650 75 75
Interest Payable 12/31 12/31 Bal.
23 23
Salaries and Wages Payable 12/31 56 12/31 Bal. 56 Unearned Service Revenue 12/5 60 11/30 Bal. 60 12/31 450 12/9 750 12/19 60 12/31 Bal. 360 Notes Payable 11/30 Bal. 2,000 12/31 Bal. 2,000
CONTINUING COOKIE CHRONICLE (Continued) Common Stock 11/30 Bal. 12/31 Bal.
12/31
Retained Earnings 500 12/31 3,211 12/31 Bal. 2,711
12/31
Dividends 500 12/31 0
1,070
40
Income Summary 2,239 12/31 5,450 3,211 12/31 Bal. 0
Interest Expense 12/31 23 12/31 12/31 Bal. 0
23
Service Revenue 11/30 Bal. 400 12/5 150 12/23 4,000 12/31 450 5,450 12/31 450 12/31 Bal. 0
Insurance Expense 12/31 100 12/31 12/31 Bal. 0
100
Amortization Expense 12/31 25 12/31 12/31 Bal. 0
25
Utilities Expense 11/30 Bal. 50 12/31 75 12/31 12/31 Bal. 0
.
Supplies Expense 12/31 45 12/31 12/31 1,025 12/31 Bal. 0 Depreciation Expense 12/31 40 12/31 12/31 Bal. 0
12/28 12/31 Bal.
12/31 12/31
800 800
Salaries and Wages Expense 12/23 800 12/31 56 12/31 856 12/31 Bal. 0
(For Instructor Use Only)
500
125
4-91
CONTINUING COOKIE CHRONICLE (Continued) (c) COOKIE CREATIONS INC. Trial Balance December 31, 2014 Debit Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Prepaid Insurance .............................................. Equipment........................................................... Website ............................................................... Unearned Service Revenue ............................... Notes Payable ..................................................... Common Stock ................................................... Dividends ............................................................ Service Revenue................................................. Utilities Expense................................................. Salaries and Wages Expense ............................
4-92
.
(For Instructor Use Only)
Credit
$1,340 1,000 1,470 1,200 1,200 600 810 2,000 800 500 4,550 50 800 $8,160
$8,160
CONTINUING COOKIE CHRONICLE (Continued) (e)
COOKIE CREATIONS INC. Adjusted Trial Balance December 31, 2014 Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Prepaid Insurance .............................................. Equipment .......................................................... Accumulated Depreciation—Equipment .......... Website ............................................................... Accounts Payable .............................................. Salaries and Wages Payable ............................. Unearned Service Revenue ............................... Notes Payable..................................................... Interest Payable.................................................. Common Stock ................................................... Dividends ............................................................ Service Revenue ................................................ Utilities Expense ................................................ Salaries and Wages Expense ............................ Supplies Expense .............................................. Depreciation Expense ........................................ Amortization Expense........................................ Interest Expense ................................................ Insurance Expense ............................................
.
(For Instructor Use Only)
Debit $1,340 1,450 400 1,100 1,200
Credit
$
40
575 75 56 360 2,000 23 800 500 5,450 125 856 1,070 40 25 23 100 $8,804
$8,804
4-93
CONTINUING COOKIE CHRONICLE (Continued) (f)
COOKIE CREATIONS INC. Income Statement For the Two Months Ended December 31, 2014 Revenue Service revenue ......................................... Operating expenses Supplies expense ...................................... Salaries and wages expense .................... Utilities expense ........................................ Insurance expense .................................... Depreciation expense ............................... Amortization expense ............................... Interest expense ........................................ Total operating expenses ................ Net income ..........................................................
$5,450 $1,070 856 125 100 40 25 23 2,239 $3,211
COOKIE CREATIONS INC. Retained Earnings Statement For the Two Months Ended December 31, 2014 Retained earnings, November 1 ............................................ Add: Net income .................................................................... Less: Dividends ..................................................................... Retained earnings, December 31 ..........................................
4-94
.
(For Instructor Use Only)
$
0 3,211 3,211 500 $2,711
CONTINUING COOKIE CHRONICLE (Continued) COOKIE CREATIONS INC. Balance Sheet December 31, 2014 Assets Current Assets Cash ........................................................... Accounts receivable ................................. Supplies ..................................................... Prepaid insurance ..................................... Total current assets ......................... Property, plant and equipment Equipment ................................................. Less: Accumulated depr.—equip. ........... Intangible assets Website ...................................................... Total assets ........................................................
$1,340 1,450 400 1,100 $4,290 1,200 40
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ..................................... $ 75 Unearned service revenue........................ 360 Salaries and wages payable ..................... 56 Total current liabilities ..................... Long-term liabilities Notes payable ............................................ 2,000 Interest payable ......................................... 23 Total liabilities .................................. Stockholders’ equity Common stock .......................................... 800 Retained earnings ..................................... 2,711 Total stockholders’ equity ............... Total liabilities and stockholders’ equity .............................................
.
(For Instructor Use Only)
1,160 575 $6,025
$ 491 2,023 2,514
3,511 $6,025
4-95
CONTINUING COOKIE CHRONICLE (Continued) (g)
31 31
31 31
Service Revenue .............................................. Income Summary ....................................
5,450
Income Summary ............................................. Supplies Expense ................................... Salaries and Wages Expense ................. Utilities Expense ..................................... Insurance Expense ................................. Depreciation Expense ............................. Amortization Expense............................. Interest Expense .....................................
2,239
Income Summary ............................................. Retained Earnings ...................................
3,211
Retained Earnings ............................................ Dividends .................................................
500
(h)
5,450 1,070 856 125 100 40 25 23 3,211 500
COOKIE CREATIONS INC. Post-Closing Trial Balance December 31, 2014 Debit Cash ........................................................................... Accounts Receivable ................................................ Supplies ..................................................................... Prepaid Insurance ..................................................... Equipment.................................................................. Accumulated Depr.—Equip. ..................................... Website ...................................................................... Accounts Payable ..................................................... Salaries and Wages Payable .................................... Unearned Service Revenue ...................................... Notes Payable ............................................................ Interest Payable ......................................................... Common Stock .......................................................... Retained Earnings .....................................................
$1,340 1,450 400 1,100 1,200 $
.
(For Instructor Use Only)
40
575
$6,065
4-96
Credit
75 56 360 2,000 23 800 2,711 $6,065
BYP 4-1
FINANCIAL REPORTING PROBLEM
(a) Items that may result in adjusting entries for deferrals are: a. b.
Prepaid expenses. Accumulated depreciation.
(b) Accrual adjusting entries are often made for other income (i.e., interest) and provision for income taxes (income tax expense), as well as interest expense on bank loans and bonds. (c) Depreciation expense was $19,229,000 in 2011 and $18,279,000 in 2010. Accumulated depreciation was reported in the balance sheet as a deduction from total Property, Plant, and Equipment, at cost. (d) The statement of cash flows (at the bottom) reports income taxes paid in 2011 of $16,906,000. The income statement reports income tax expense of $16,974,000.
.
(For Instructor Use Only)
4-97
BYP 4-2
COMPARATIVE ANALYSIS PROBLEM
Accounts that provide evidence of the use of accrual accounting are: Balance Sheet
Income Statement
(a) Hershey Company 1. Accounts receivable—trade 2. Prepaid expenses 3. Accrued income taxes 4. Accrued liabilities
1. 2. 3. 4.
Sales Insurance (or supplies) expense Income tax expense Miscellaneous expense
1. 2. 3. 4. 5.
Insurance (or supplies) expense Depreciation expense Sales Miscellaneous expense Income tax expense
(b) Tootsie Roll 1. Prepaid expenses 2. Accumulated depreciation 3. Accounts receivable—trade 4. Accrued liabilities 5. Deferred income taxes and Liability for uncertain tax positions
4-98
.
(For Instructor Use Only)
BYP 4-3
RESEARCH CASE
(a) They recalculated earnings per share to the 1/10 cent, rather than to the penny, for nearly 500,000 earnings reports. In doing this, they determined that the number of times that the digits 2, 3 or 4 appeared in the 1/10th place was significantly lower than what should occur. (Each of these digits should appear 10 percent of the time.) (b) The average company in the study would boost its earnings per share by 1/10 of a cent if it increased net income by $31,000. (c) The authors cite adjustments to inventory valuation, or adjustments made to the company’s estimate of how many of its accounts receivable will go bad as examples of items that could be easily adjusted to achieve higher earnings. Adjustments such as these involve considerable judgment. That is, reasonable people could easily disagree about the value of inventory, or the likelihood that customers won’t pay amounts that are owed. As a consequence, as long as the adjustments can be defended as being reasonable, they aren’t considered to be illegal. (d) An earnings restatement occurs when a company is required to issue new financial statements because those that were originally issued were considered to be in error. The authors found that companies that were required to restate earnings or were charged with accounting violations were also less likely to have a 4 in the 1/10th place. This would suggest that they were more likely to engage in earnings management in order to be able to round up to the next highest cent. (e) It is suggested in the article that in the stock market, if a company misses its estimated earnings per share number, even by a penny, its stock price can decline significantly. Similarly, if it exceeds the estimated earnings per share number, even it is only a penny, its stock price can increase significantly.
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(For Instructor Use Only)
4-99
BYP 4-4
INTERPRETING FINANCIAL STATEMENTS
LASER RECORDING SYSTEMS (a)
Laser Recording is handling legal expense via an accrued expense adjustment. This is explained by the fact that accrued professional services increased during the year.
(b)
Each of the three adjustments is an accrued expense adjustment. Since this type of adjustment increases expenses, net income is decreased by each adjustment.
(c)
In recording accrued interest, Laser Recording debited Interest Expense and credited Interest Payable.
4-100
.
(For Instructor Use Only)
BYP 4-5
REAL-WORLD FOCUS
(a) The SEC was created by Congress after the stock market crash of 1929. The SEC was created to restore investor confidence in our capital markets by providing more structure and government oversight. (b) Division of Corporation Finance. The Division of Corporation Finance oversees corporate disclosure of important information to the investing public. Corporations are required to comply with regulations pertaining to disclosure that must be made when stock is initially sold and then on a continuing and periodic basis. The Division’s staff routinely reviews the disclosure documents filed by companies. The staff also provides companies with assistance interpreting the Commission’s rules and recommends to the Commission new rules for adoption. Division of Trading and Markets. The Division of Trading and Markets establishes and maintains standards for fair, orderly, and efficient markets. It does this primarily by regulating the major securities market participants: broker-dealer firms; self-regulatory organizations (SROs), which include the stock exchanges and the National Association of Securities Dealers (NASD), Municipal Securities Rulemaking Board (MSRB), and clearing agencies (SROs that help facilitate trade settlement); transfer agents (parties that maintain records of stock and bond owners); and securities information processors. (A self-regulatory organization is a member organization that creates and enforces rules for its members based on the federal securities laws. SROs, which are overseen by the SEC, are the front line in regulating broker-dealers.) Division of Investment Management. The Division of Investment Management oversees and regulates the $15 trillion investment management industry and administers the securities laws affecting investment companies (including mutual funds) and investment advisers. In applying the federal securities laws to this industry, the Division works to improve disclosure and minimize risk for investors without imposing undue costs on regulated entities. Division of Enforcement. The Division of Enforcement investigates possible violations of securities laws, recommends Commission action when appropriate, either in a federal court or before an administrative law judge, .
(For Instructor Use Only)
4-101
BYP 4-5 (Continued) and negotiates settlements on behalf of the Commission. While the SEC has civil enforcement authority only, it works closely with various criminal law enforcement agencies throughout the country to develop and bring criminal cases when the misconduct warrants more severe action. Division of Risk, Strategy, and Financial Innovation Overview. The Division of Risk, Strategy, and Financial Innovation (RSFI) was created in September 2009 to intergrate financial economics and rigorous data analytics into the core mission of the SEC. The Division is involved across the entire range of SEC activities, including policy-making, rule-making, enforcement, and examination. As the agency’s “think tank,” RSFI relies on a variety of academic disciplines, quantitative and non-quantitative approaches, and knowledge of market institutions and practices to help the Commission approach complex matters in a fresh light. RSFI also assists in the Commission’s efforts to identify, analyze, and respond to risks and trends, including those associated with new financial products and strategies. Through the range and nature of its activities, RSFI serves the critical function of promoting collaborative efforts throughout the agency and breaking through silos that might otherwise limit the impact of the agency’s institutional expertise. (c) The Chief Accountant is the principal adviser to the Commission on accounting and auditing matters. The Office of the Chief Accountant also works closely with domestic and international private-sector accounting and auditing standards-setting bodies (e.g., the Financial Accounting Standards Board, the International Accounting Standards Board, the American Institute of Certified Public Accountants, and the Public Company Accounting Oversight Board), consults with registrants, auditors, and other Commission staff regarding the application of accounting standards and financial disclosure requirements, and assists in addressing problems that may warrant enforcement actions.
4-102
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(For Instructor Use Only)
BYP 4-6
(a)
GROUP DECISION CASE
LINCOLN PARK Income Statement For the Quarter Ended March 31, 2014 Revenues Rent revenue ($83,000 – $21,000) ................ Expenses Salaries and wages expense [$27,600 + ($290 X 3)] ............................ Advertising expense ($4,200 + $110) ........... Supplies expense ($4,500 – $600) ................ Maintenance and repairs expense ($2,800 + $1,040) .................................... Insurance expense ($7,200 X 3/12) .............. Utilities expense ($1,500 + $240) .................. Depreciation expense ................................... Interest expense ($20,000 X 7% X 3/12) ....... Total expenses....................................... Net income ............................................................
$62,000 $28,470 4,310 3,900 3,840 1,800 1,740 800 350 45,210 $16,790
(b) The generally accepted accounting principles pertaining to the income statement that were not recognized by Judy were the revenue recognition principle and the expense recognition principle. The revenue recognition principle states that revenue is recognized when the performance obligation is satisfied. The revenue of $21,000 for summer rentals has not been recognized and, therefore, should not be reported in income for the quarter ended March 31. The expense recognition principle dictates that efforts (expenses) be matched with results (revenues) whenever it is reasonable and practicable to do so. This means that the expenses should include amounts incurred in March but not paid until April. The difference in expenses was $8,310 ($45,210 – $36,900). The overstatement of revenues ($21,000) plus the understatement of expenses ($8,310) equals the difference in reported income of $29,310 ($46,100 – $16,790).
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(For Instructor Use Only)
4-103
BYP 4-7
COMMUNICATION ACTIVITY
(a) Accrual-basis accounting records the events that change an entity’s financial statements in the periods in which the events occur, rather than in the periods in which the entity receives or pays cash. Information presented on an accrual-basis is useful because it reveals relationships that are likely to be important in predicting future results. Conversely, under cash-basis accounting, revenue is recorded only when cash is received, and an expense is recognized only when cash is paid. As a result, the cash-basis of accounting often results in misleading financial statements. (b) Politicians might desire a cash-basis accounting system over an accrualbasis system because if an accrual accounting system is used, it could mean that billions in government liabilities presently unrecorded would have to be reported in the federal budget immediately. Currently, the federal government is facing a huge budget deficit. The recognition of these additional liabilities would make the deficit even worse. This is not what politicians would like to see and be held responsible for. (c) Dear Senator, It is my understanding, after having taken a beginning course in accounting principles, that the federal government uses a cash-basis accounting system rather than an accrual-basis accounting system. I am shocked at such a practice! There must be billions of dollars of liabilities hidden in many contracts that have not been recorded because they haven’t been paid yet. I realize that the deficit would dramatically increase if we were to implement an accrual system, but in all fairness, we citizens should be given a more accurate picture of what our government is up to. Sincerely, CONCERNED STUDENT
4-104
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(For Instructor Use Only)
BYP 4-8
ETHICS CASE
(a) The stakeholders in this situation are: • • •
Mark Trane, controller. The president of Eaton Company. Company stockholders and potential stockholders.
(b) 1.
It is unethical for the president to place pressure on Mark to misstate net income by requesting him to prepare incorrect adjusting entries.
2.
It is customary for adjusting entries to be dated as of the balance sheet date although the entries are prepared at a later date. Mark did nothing unethical by dating the adjusting entries December 31.
(c) Mark can accrue revenues and defer expenses through the preparation of adjusting entries and be ethical so long as the entries reflect economic reality. Intentionally misrepresenting the company’s financial condition and its results of operations is unethical (it is also illegal).
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(For Instructor Use Only)
4-105
BYP 4-9
ALL ABOUT YOU ACTIVITY
The following is a personal balance sheet using the classified presentation. Note that the earnings from the part-time job as well as the tuition costs are not listed since neither of those items is an asset, liability, or equity item. Assets Current assets Cash ................................................................. Money market account ................................... Certificate of deposit ....................................... Accounts receivable from brother .................. Total current assets .................................
$1,200 1,800 3,000 300
Property, plant, and equipment Automobile ...................................................... Video and stereo equipment .......................... Home computer ............................................... Total assets ..............................................
7,000 1,250 800
$ 6,300
9,050 $15,350
Liabilities and Owner’s Equity Current liabilities Current portion of automobile loan ............... Current portion of credit card payable .......... Total current liabilities............................. Long-term liabilities Student loan .................................................... Automobile loan .............................................. Credit card payable ......................................... Total long-term liabilities ........................ Total liabilities....................................
4-106
$1,500 150 $ 1,650 5,000 4,000 1,650 10,650 12,300
Equity M. Y. Own, Capital ($15,350 – $12,300) ..........
3,050
Total liabilities and equity ...................
$15,350
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(For Instructor Use Only)
BYP 4-10
FASB CODIFICATION ACTIVITY
(a) Revenue earned by an entity from its direct distribution, exploitation, or licensing of film, before deduction for any of the entity’s direct costs of distribution. For markets and territories in which an entity’s fully or jointly-owned films are distributed by third parties, revenue is the net amounts payable to the entity by third party distributors. Revenue is reduced by appropriate allowances, estimated returns, price concessions, or similar adjustments, as applicable. (b) Compensation is reciprocal transfers of cash or other assets in exchange for services performed.
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(For Instructor Use Only)
4-107
IFRS CONCEPTS AND APPLICATION
IFRS4-1 GAAP and IFRS both require companies to record transaction (and revenues) in the period in which events occur. Both prohibit cash-basis accounting and both apply the periodicity assumption. GAAP has more than 100 rules dealing with revenue recognition while IFRS uses a single standard. Under IFRS, revenue recognition is based on the probability that the economic benefits associated with the transaction will flow to the company and the revenues and costs must be capable of being measured reliably. GAAP states that revenue is recognized when it is realized or realizable and earned. IFRS4-2 IFRS uses the term income to encompass both revenues and gains. GAAP defines income as the net difference between revenues and expenses. In addition, GAAP classifies revenue as the economic benefit that arises from an entity’s normal operating activities and gains as the benefits associated with activities outside the normal sales of goods and services. Under IFRS, expenses include both those costs incurred in the normal course of operations and losses that are not part of normal operations. In contrast, GAAP classifies costs associated with activities outside the normal sales of goods and services as losses.
4-108
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(For Instructor Use Only)
IFRS 4-3
INTERNATIONAL FINANCIAL REPORTING PROBLEM
(a) Note 3.7 indicates that revenue is measured as the fair value of consideration received or receivable for the goods sold less any discounts or rebates. (b) Note 3.7 states that a sale occurs when the goods sold are delivered to a customer and title to the goods passes to the buyer. (c) Zetar Plc could have adjustments for deferrals such as: Depreciation expense, Amortisation of intangible assets, Deferred tax asset. (d) Zetar Plc could have adjustments for accruals such as: Finance costs (interest expense) and Finance income (interest revenue).
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(For Instructor Use Only)
4-109
CHAPTER 5 Merchandising Operations and the Multiple-Step Income Statement Learning Objectives 1. 2. 3. 4. 5. 6. 7. *8.
Identify the differences between a service company and a merchandising company. Explain the recording of purchases under a perpetual inventory system. Explain the recording of sales revenues under a perpetual inventory system. Distinguish between a single-step and a multiple-step income statement. Determine cost of goods sold under a periodic system. Explain the factors affecting profitability. Identify a quality of earnings indicator. Explain the recording of purchases and sales of inventory under a periodic inventory system.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
1. 2. 3. 4. 5. 6.
1 1 1 1 1 3
C C C C AP C
7. 8. 9. 10. 11.
3 3 3 3 2
K AP C C AP
Questions 12. 4 AP 13. 3 C 14. 4 C 15. 4 K 16. 1 K
17. 18. 19. 20. 21.
4 2 2 5 5
K K K K K
22. 23. 24. 25. 26.
6 6 6 7 8*
K C AN C AP
6 6
AP AP
12. 13.
7 8*
C AP
5
AP
10. 11.
5 5
AP AP
12. 13.
7 8*
C AP
Problems: Set A 5. 4 AP
7.
4, 5
AP
9.
5, 8*
AP
6.
8.
4, 5, 6
AN 9.
5, 8*
AP
1. 2. 3.
1, 4 2, 3 3
AP AP AP
4. 5. 6.
2 4 4
1.
2
AP
2.
3
Brief Exercises AP 7. 5 AP 10. AP 8. 5 AP 11. AP 9. 5 C Do It! Review Exercises AP 3. 4 AP 4.
2, 3 4 4, 6
Exercises 7. 4, 6 AP 8. 4, 6 AP 9. 4, 6 C
1. 2. 3. 1. 2.
3 2, 3 2 2, 3, 4, 6 2, 3
AP AP AP
4. 5. 6. 3.
AP AP
1.
4.
2, 3, 4 4, 6
AP AP AP
AP AP
4
AP
Problems: Set B 5. 4 AP
2, 3, 3. 2, 3, 7. 4, 5 AP AP 4 AP 4, 6 2. 2, 3 AP 4. 4, 6 AP 6. 4 AP 8. 4, 5, 6 AN *Continuing Cookie Solutions for this chapter are available online.
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(For Instructor Use Only)
5-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Journalize, post, prepare partial income statement, and calculate ratios.
Simple
30–40
2A
Journalize purchase and sale transactions under a perpetual system.
Moderate
20–30
3A
Journalize, post, and prepare trial balance and partial income statement.
Simple
30–40
4A
Prepare financial statements and calculate profitability ratios.
Moderate
40–50
5A
Prepare a correct multiple-step income statement.
Complex
20–30
6A
Journalize, post, and prepare adjusted trial balance and financial statements.
Moderate
40–50
7A
Determine cost of goods sold and gross profit under a periodic system.
Moderate
40–50
8A
Calculate missing amounts and assess profitability.
Moderate
20–30
*9A
Journalize, post, and prepare trial balance and partial income statement under a periodic system.
Simple
30–40
1B
Journalize, post, prepare partial income statement, and calculate ratios.
Simple
30–40
2B
Journalize purchase and sale transactions under a perpetual inventory system.
Moderate
20–30
3B
Journalize, post, and prepare trial balance and partial income statement.
Simple
30–40
4B
Prepare financial statements and calculate profitability ratios.
Moderate
40–50
5B
Prepare a correct multiple-step income statement.
Complex
20–30
6B
Journalize, post, and prepare adjusted trial balance and financial statements.
Moderate
40–50
7B
Determine cost of goods sold and gross profit under a periodic approach.
Moderate
40–50
8B
Calculate missing amounts and assess profitability.
Moderate
20–30
*9B
Journalize, post, and prepare trial balance and partial income statement under a periodic system.
Simple
30–40
5-2
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(For Instructor Use Only)
ANSWERS TO QUESTIONS 1.
(a) Disagree. The steps in the accounting cycle are the same for both a merchandising company and a service company. (b) The measurement of income is conceptually the same. In both types of companies, net income (or loss) results from the matching of expenses with revenues.
2.
The components of revenues and expenses differ as follows:
Revenues Expenses
Merchandising Sales revenue Cost of Goods Sold and Operating
Service Fees, Rents, etc. Operating (only)
3.
Under a periodic inventory system the company does not keep track of how many units are on hand. Instead it takes a physical count at the end of the period to determine ending inventory and cost of goods sold. Under a perpetual system the company adjusts its inventory account each time it purchases or sells inventory. Thus it always has a record of its available inventory. Having knowledge of inventory balances helps a company avoid lost sales due to “stock-outs” as well as carrying too much inventory on hand (which results in additional storage and handling costs). The purchasing department can make better decisions with the aid of perpetual inventory records.
4.
(a) The income measurement process is as follows: Sales Revenue
Less
Cost of Goods Sold
Equals
Gross Profit
Less
Operating Expenses
Equals
Net Income (Loss)
(b) Income measurement in a merchandising company differs from a service company as follows: (a) sales are the primary source of revenue and (b) expenses are divided into two main categories: cost of goods sold and operating expenses. 5.
Sales revenue.......................................................................................................... Cost of goods sold ................................................................................................... Gross profit ..............................................................................................................
$100,000 70,000 $ 30,000
6.
Agree. In accordance with the revenue recognition principle, sales revenues are generally considered to be recognized when the goods are transferred from the seller to the buyer; that is, when the exchange transaction occurs. The recognition of revenue is not dependent on the collection of credit sales.
7.
(a) The primary source documents are (1) cash sales—cash register tapes and (2) credit sales— sales invoice. (b) The entries are: Debit Cash sales—
.
(For Instructor Use Only)
Cash ................................................................... Sales Revenue ............................................
XX
Cost of Goods Sold ............................................. Inventory .....................................................
XX
Credit XX
XX
5-3
Questions Chapter 5 (Continued)
Credit sales—
8.
July 19
Accounts Receivable........................................... Sales Revenue ............................................
XX
Cost of Goods Sold ............................................. Inventory .....................................................
XX
Cash ($800 – $8) .......................................................................... Sales Discounts ($800 X 1%)........................................................ Accounts Receivable ($900 – $100) ......................................
XX
XX 792 8 800
9.
Shipping unwanted goods to customers is generally considered unethical behavior. In addition, if proper accounting is applied, in most cases it won’t achieve the desired result of increasing sales. If it is expected that the unwanted goods will be shipped back to the seller, then they should not be treated as sales in the first place. (Note: The practice of shipping more goods than were ordered in order to meet sales goals and get rid of extra inventory is referred to as channel stuffing.)
10.
In most industries returns are not significant, and they are therefore accounted for as they occur. When returns are expected to be significant, the company should make an adjusting entry at the end of the period to estimate the amount of returns that will result from the period’s sales, so that revenues will not be overstated during the period.
11.
July 24
Accounts Payable ($1,900 – $300) ............................................... Cash ($1,600 – $32).............................................................. Inventory ($1,600 X 2%) ........................................................
1,600 1,568 32
12.
Gross profit .................................................................................................... Less: Net income .......................................................................................... Operating expenses.......................................................................................
13.
Its current terms of 1/10, n/30 means that customers get a 1% discount if they pay within 10 days, otherwise they have to pay the full amount within 30 days. If they switch to 2/10, n/45 customers would get a 2% discount for paying within 10 days, otherwise they have to pay the full amount in 45 days. By offering 2%, more of Lou’s customers would likely pay within the 10 day period. Management would have to determine whether it is worth the additional cost to be paid quicker. Also, by extending the full payment period from 30 to 45 days, Lou would end up receiving its money even later from its slow payers.
14.
The gain on the sale of the plant represents a one-time gain. That is, it won’t be recurring next year. If you eliminate the effect of this one-time gain, then the company’s income actually declined by $5 million relative to the prior year. When predicting future earnings investors frequently place little weight on non-recurring events such as this.
15.
There are three distinguishing features in the income statement of a merchandising company: (1) a sales revenues section, (2) a cost of goods sold section, and (3) gross profit.
16.
The normal operating cycle for a merchandising company is likely to be longer than for a service company because inventory must first be purchased and sold, and then the receivables must be collected.
5-4
.
(For Instructor Use Only)
$560,000 230,000 $330,000
Questions Chapter 5 (Continued) 17. Tootsie Roll uses the term gross margin. It breaks down gross margin into two components, product gross margin and rental and royalty gross margin. Total gross profit decreased by $4,784,000. 18. Of the merchandising accounts, only Inventory will appear in the post-closing trial balance. 19. Businesses most likely to use a perpetual inventory system would include automobile dealerships, equipment supply companies, and other companies selling products having a high unit-value. With automation, perpetual systems are becoming increasingly cost-effective. 20. Accounts Purchase Returns and Allowances Purchase Discounts Freight-In
(a) Added/Deducted Deducted Deducted Added
(b) Normal Balance Credit Credit Debit
21. (a) X = Purchase returns and allowances and Y = Purchase discounts, or vice versa. (b) X = Freight-in. (c) X = Cost of goods purchased. (d) X = Ending inventory. 22. Profitability is affected by gross profit ‘as measured by the gross profit rate’ and by management’s ability to control operating expenses, as measured by the profit margin. 23. Factors affecting a company’s gross profit rate include selling products with a higher (or lower) “markup,” increased competition that results in lower selling prices, and price increases or decreases from suppliers. 24. Gross profit represents the amount by which sales exceeds cost of goods sold. In order for the company to be profitable, gross profit must exceed the company’s operating expenses. Before the selling price is cut, the company should do a careful analysis estimating what its gross profit and operating expenses would be if more units were sold at a lower selling price. In addition, a big concern is what the likely reaction of competitors will be. If competitors also cut their price, then volume will not increase, and the company’s net income will be lower. 25. George Mallein should calculate the company’s quality of earnings ratio. This is calculated by dividing net cash provided by operating activities by net income. A measure significantly below 1 would suggest that the company might be using aggressive accounting techniques to recognize income early. *26. July 24
.
Accounts Payable ($1,900 – $400) .................................. Cash ($1,500 – $30) ............................................... Purchase Discounts ($1,500 X 2%) ........................
(For Instructor Use Only)
1,500 1,470 30
5-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 5-1 (a) (b) (c) (d) (e) (f)
Sales = $181,500 ($71,900 + $109,600). Cost of goods sold = $41,200 ($71,200 – $30,000). Gross profit = $38,000 ($108,000 – $70,000). Operating expenses = $17,900 ($30,000 – $12,100). Operating expenses = $8,500 ($38,000 (from c) – $29,500). Net income = $63,400 ($109,600 – $46,200).
BRIEF EXERCISE 5-2 Gerish Company Inventory .............................................................. Accounts Payable ........................................
900
Mangus Company Accounts Receivable ........................................... Sales Revenue ..............................................
900
Cost of Goods Sold ............................................. Inventory .......................................................
900
900 590 590
BRIEF EXERCISE 5-3 (a) March 2 2 (b)
6 6
(c)
5-6
12
.
Accounts Receivable ....................... Sales Revenue .........................
800,000
Cost of Goods Sold .......................... Inventory ..................................
540,000
Sales Returns and Allowances ....... Accounts Receivable ..............
140,000
Inventory ........................................... Cost of Goods Sold .................
94,000
Cash ($660,000 – $13,200) ............... Sales Discounts ($660,000 X 2%) .... Accounts Receivable ($800,000 – $140,000) ..........
646,800 13,200
(For Instructor Use Only)
800,000 540,000 140,000 94,000
660,000
BRIEF EXERCISE 5-4 (a) March 2 (b) (c)
6 12
Inventory........................................... Accounts Payable ...................
800,000
Accounts Payable ............................ Inventory..................................
140,000
Accounts Payable ($800,000 – $140,000) .................... Cash ($660,000 – $13,200) ...... Inventory ($660,000 X 2%) ......
800,000 140,000 660,000 646,800 13,200
BRIEF EXERCISE 5-5 ALVARADO COMPANY Income Statement (Partial) For the Month Ended October 31, 2014 Sales Sales revenue ($300,000 + $150,000) ..................... Less: Sales returns and allowances ..................... Sales discounts ............................................ Net sales ......................................................................
$450,000 $19,000 5,000
24,000 $426,000
BRIEF EXERCISE 5-6 As the name suggests, numerous steps are required in determining net income in a multiple-step statement. Item
Section
Gain on disposal of plant assets Cost of goods sold Depreciation expense Sales returns and allowances
Other revenues and gains Cost of goods sold Operating expenses Sales revenues
.
(For Instructor Use Only)
5-7
BRIEF EXERCISE 5-7 Beginning inventory .................................................. Add: Purchases ....................................................... Cost of goods available for sale ............................... Less: Ending inventory ............................................ Cost of goods sold ....................................................
$ 67,000 380,000 447,000 50,000 $397,000
BRIEF EXERCISE 5-8 Purchases .................................................................. Less: Purchase returns and allowances ................ Purchase discounts ...................................... Net purchases............................................................
$404,000 $13,000 9,000
Net purchases............................................................ Add: Freight-in ........................................................... Cost of goods purchased .........................................
22,000 $382,000 $382,000 16,000 $398,000
BRIEF EXERCISE 5-9 Net sales .................................................................... Beginning inventory .................................................. Add: Cost of goods purchased* ............................. Cost of goods available for sale ............................... Less: Ending inventory ............................................ Cost of goods sold .................................................... Gross profit ................................................................ *Information taken from Brief Exercise 5-8.
5-8
.
(For Instructor Use Only)
$612,000 $ 60,000 398,000 458,000 90,000 368,000 $244,000
BRIEF EXERCISE 5-10 (a) Profit margin = $32,500 ÷ $250,000 = 13.0% The profit margin measures the extent by which selling price covers all expenses. In this case 87% of sales revenues cover all expenses (cost of goods sold, operating expenses, and other expenses) leaving 13% of revenues as net income. Or, for every dollar of net sales, the company earns $0.13 in net income. (b) Gross profit rate = ($250,000 – $150,000) ÷ $250,000 = 40.0% The gross profit rate measures the margin by which selling price exceeds cost of goods sold. In this case, 40% of sales revenues remain (after deducting cost of goods sold) to cover all other expenses and produce net income. Or, for every dollar of net sales, the company generates $0.40 in gross profit. BRIEF EXERCISE 5-11 (a) Profit margin = $68,000 ÷ $800,000 = 8.5% The profit margin measures the extent by which selling price covers all expenses. In this case, 91.5% of sales revenues cover all expenses (cost of goods sold and operating expenses) leaving 8.5% of revenues as net income. Or, for every dollar of net sales, the company earns $0.085 in net income. (b) Gross profit rate = ($800,000 – $520,000) ÷ $800,000 = 35.0% The gross profit rate measures the margin by which selling price exceeds cost of goods sold. In this case, 35% of sales revenues remain (after deducting cost of goods sold) to cover operating expenses and produce net income. Or, for every dollar of net sales, the company generates $0.35 in gross profit.
.
(For Instructor Use Only)
5-9
BRIEF EXERCISE 5-12 The quality of earnings ratio is calculated by dividing net cash provided by operating activities by net income. For Moritz Corporation this would be $221,200 ÷ $346,000 = .64. This is significantly less than 1, which suggests that the company may be using aggressive accounting techniques in order to recognize income early. The factors that are causing net income to differ from net cash provided by operating activities should be examined. *BRIEF EXERCISE 5-13 (a) March 2 (b)
6
(c)
12
Purchases ......................................... Accounts Payable ...................
800,000
Accounts Payable ............................ Purchase Returns and Allowances ...........................
95,000
Accounts Payable ($800,000 – $95,000) ...................... Cash ($705,000 – $14,100) ...... Purchase Discounts ($705,000 X 2%) ....................
800,000
95,000 705,000 690,900 14,100
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 5-1 Oct. 5
Oct. 8
5-10
Inventory .................................................................... Accounts Payable ............................................. (To record goods purchased on account)
5,000
Accounts Payable...................................................... Inventory............................................................ (To record return of defective goods)
640
.
(For Instructor Use Only)
5,000
640
DO IT! 5-2 Oct. 5
Oct. 8
Accounts Receivable ................................................ Sales Revenue .................................................. (To record credit sales)
5,000
Cost of Goods Sold................................................... Inventory ........................................................... (To record cost of goods sold on account)
3,000
Sales Returns and Allowances ................................ Accounts Receivable ........................................ (To record credit granted for receipt of returned goods)
640
Inventory .................................................................... Cost of Goods Sold .......................................... (To record scrap value of goods returned)
240
5,000
3,000
640
240
DO IT! 5-3 VOGT CORP. Income Statement For the Year Ended December 31, 2014 Sales Sales revenue .............................................. Less: Sales returns and allowances .......... Net sales ............................................................. Cost of goods sold ............................................ Gross profit ........................................................ Operating expenses .......................................... Income from operations .................................... Other revenues and gains ................................. Other expenses and losses .............................. Income before income taxes ............................. Income tax expense ........................................... Net income .........................................................
.
(For Instructor Use Only)
$592,000 40,000 $552,000 156,000 396,000 186,000 210,000 12,700 (13,300)
(600) 209,400 62,820 $146,580
5-11
DO IT! 5-4 (a) Cost of goods purchased $161,400: Purchases – Purchase returns and allowances – Purchase discounts + Freight-in $162,500 – $3,600 – $5,900 + $8,400 (b) Cost of goods sold $165,170: Beginning inventory + Cost of goods purchased – Ending inventory $31,720 + $161,400 – $27,950
5-12
.
(For Instructor Use Only)
SOLUTIONS TO EXERCISES EXERCISE 5-1 (a) (1) April 5 (2) April 6 (3) April 7 (4) April 8 (5) April 15
Inventory.......................................... Accounts Payable ...................
28,000
Inventory.......................................... Cash .........................................
700
Equipment ....................................... Accounts Payable ...................
30,000
Accounts Payable ........................... Inventory ..................................
3,600
Accounts Payable ($28,000 – $3,600)......................... Cash ($24,400 – $488) ............. Inventory [($28,000 – $3,600) X 2%] .....
28,000 700 30,000 3,600 24,400 23,912 488
Accounts Payable ($28,000 – $3,600) .... Cash .................................................
24,400
Inventory ....................................................... Accounts Payable .................................
1,650
Inventory ....................................................... Cash .......................................................
50
Accounts Payable ......................................... Inventory ................................................
66
Accounts Receivable .................................... Sales Revenue .......................................
690
Cost of Goods Sold ...................................... Inventory ................................................
520
(b) May 4
24,400
EXERCISE 5-2 Sept. 6 9 10 12
.
(For Instructor Use Only)
1,650 50 66 690 520
5-13
EXERCISE 5-2 (Continued) Sept. 14 14 20
Sales Returns and Allowances ..................... Accounts Receivable .............................
45
Inventory......................................................... Cost of Goods Sold ................................
34
Accounts Receivable ..................................... Sales Revenue ........................................
760
Cost of Goods Sold........................................ Inventory .................................................
570
45 34 760 570
EXERCISE 5-3 (a) (1) Dec. 3
Accounts Receivable ................... Sales Revenue ......................
500,000
Cost of Goods Sold ...................... Inventory ...............................
330,000
Sales Returns and Allowances ... Accounts Receivable ...........
25,000
Cash ($475,000 – $4,750) ............. Sales Discounts [($500,000 – $25,000) X 1%] ..... Accounts Receivable ($500,000 – $25,000) .........
470,250
Cash ..................................................... Accounts Receivable ($500,000 – $25,000) ................
475,000
(2) Dec. 8 (3) Dec. 13
(b) Jan. 2
500,000 330,000 25,000
4,750 475,000
475,000
EXERCISE 5-4 (a) June 10 11
5-14
.
Inventory ................................................. Accounts Payable ...........................
9,000
Inventory ................................................. Cash .................................................
400
(For Instructor Use Only)
9,000 400
EXERCISE 5-4 (Continued) June 12 19
(b) June 10
Accounts Payable........................................ Inventory...............................................
600
Accounts Payable ($9,000 – $600).............. Cash ($8,400 – $252) ............................ Inventory ($8,400 X 3%) .......................
8,400
Accounts Receivable .................................. Sales Revenue .....................................
9,000
Cost of Goods Sold ..................................... Inventory...............................................
5,000
600 8,148 252 9,000 5,000
11
No entry
12
Sales Returns and Allowances ................... Accounts Receivable ...........................
600
Inventory ...................................................... Cost of Goods Sold .............................
310
Cash ($8,400 – $252) ................................... Sales Discounts ($8,400 X 3%) ................... Accounts Receivable ($9,000 – $600)..................................
8,148 252
19
600 310
8,400
EXERCISE 5-5 HODGES COMPANY Income Statement (Partial) For the Year Ended October 31, 2014 Sales Sales revenue .................................................... Less: Sales returns and allowances ............... Sales discounts ...................................... Net sales ....................................................................
$900,000 $22,000 13,500
35,500 $864,500
Note: Freight-out is a selling expense.
.
(For Instructor Use Only)
5-15
EXERCISE 5-6 (a)
ZHOU Co. Income Statement For the Month Ended January 31, 2014 Sales Sales revenue ............................................. Less: Sales returns and allowances ........ Sales discounts .............................. Net sales ............................................................. Cost of goods sold ............................................ Gross profit ........................................................ Operating expenses Salaries and wages expense ..................... Rent expense .............................................. Insurance expense ..................................... Freight-out .................................................. Total operating expenses................... Income before income taxes ............................. Income tax expense ........................................... Net income .........................................................
(b) Profit margin =
$370,000 $20,000 8,000
28,000 342,000 212,000 130,000
60,000 32,000 12,000 7,000 111,000 19,000 4,750 $ 14,250
$14,250 = 4.2% $342,000
Gross profit rate =
$130,000 = 38.0% $342,000
EXERCISE 5-7 (a) Yanik Company
5-16
Sales ..................................................................................... *Sales returns and allowances ($90,000 – $84,000) ............ Net sales ...............................................................................
$ 90,000) (6,000) $ 84,000)
Net sales ............................................................................... Cost of goods sold .............................................................. *Gross profit ..........................................................................
$ 84,000) (58,000) $ 26,000)
.
(For Instructor Use Only)
EXERCISE 5-7 (Continued) Gross profit .......................................................................... Operating expenses ............................................................ *Net income ...........................................................................
$ 26,000) (14,380) $ 11,620)
Nunez Company *Sales ($100,000 + $5,000) .................................................... Sales returns and allowances ............................................. Net sales ...............................................................................
$105,000) (5,000) $100,000)
Net sales ............................................................................... *Cost of goods sold ($100,000 – $40,000) ........................... Gross profit ..........................................................................
$100,000) (60,000) $ 40,000)
Gross profit .......................................................................... *Operating expenses ($40,000 – $17,000) ........................... Net income ...........................................................................
$ 40,000) (23,000) $ 17,000)
*Indicates missing amount (b)
Yanik
Nunez
Profit margin
$11,620 ÷ $84,000 = 14%
$17,000 ÷ $100,000 = 17%
Gross profit rate
$26,000 ÷ $84,000 = 31%
$40,000 ÷ $100,000 = 40%
(c) Nunez has a higher profit margin than Yanik. Each dollar of net sales by Nunez results in 17 cents of net income compared to only 14 cents for Yanik. Nunez also has a higher gross profit rate. For each dollar of Nunez’s net sales, 60 cents is required to cover cost of goods sold leaving 40 cents to cover other expenses and produce net income. Yanik’s gross profit of .31 indicates that only 31 cents of each dollar of net sales is available to cover other expenses and produce net income.
.
(For Instructor Use Only)
5-17
EXERCISE 5-8 (a)
GAVIN COMPANY Income Statement For the Year Ended December 31, 2014 Sales Sales revenue .............................. Less: Sales discounts ................. Net sales .............................................. Cost of goods sold ............................. Gross profit ......................................... Operating expenses Salaries and wages expense ...... Depreciation expense ................. Utilities expense .......................... Total operating expenses ................... Income from operations ..................... Other revenues and gains Interest revenue........................... Other expenses and losses Loss on disposal of plant assets .............................. Interest expense .......................... Income before income taxes .............. Income tax expense ............................ Net income ..........................................
$2,210,000 160,000 $2,050,000 987,000 1,063,000 465,000 310,000 110,000 885,000 178,000 65,000 83,500 71,000
154,500 88,500 25,000 $ 63,500
(b) Profit margin: $63,500 ÷ $2,050,000 = 3% Gross profit rate: $1,063,000 ÷ $2,050,000 = 52% (c) During the current year Gavin had a loss on the sale of property, plant, and equipment of $83,500. This loss is not part of operating income, and it is most likely a non-recurring event, meaning that we wouldn’t expect it to happen again next year. If we ignore this loss, then Gavin Company’s net income would have been $147,000 ($63,500 + $83,500) and its profit margin would have been 7.2% ($147,000 ÷ $2,050,000). Therefore, while the loss is not good news, it is less of a concern than a similar drop in income from operations.
5-18
.
(For Instructor Use Only)
EXERCISE 5-9 (a)
THE CLOROX COMPANY Income Statement For the Year Ended June 30, 2014 (amounts in millions) Sales Sales revenue .............................................. Less: Sales returns and allowances .......... Net sales ............................................................. Cost of goods sold ............................................ Gross profit ........................................................ Operating expenses Advertising expense .................................. Salaries and wages expense ..................... Research and development expense........ Rent expense .............................................. Depreciation expense ................................ Utilities expense ......................................... Total operating expenses .................. Income from operations .................................... Other expenses and losses Interest expense ......................................... Loss on disposal of plant assets .............. Income before income taxes ............................. Income tax expense ........................................... Net income .........................................................
$5,730 280 $5,450 3,104 2,346 499 460 114 105 90 60 1,328 1,018 161 46
207 811 276 $ 535
(b) Gross profit rate: $2,346 ÷ $5,450 = 43.0% Profit margin: $535 ÷ $5,450 = 9.8% The gross profit rate indicates that about 57 cents of each dollar of net sales is required to cover the cost of goods sold, leaving about 43 cents to cover all remaining expenses and produce net income. The profit margin indicates that each dollar of net sales results in about 10 cents of net income.
.
(For Instructor Use Only)
5-19
EXERCISE 5-9 (Continued) (c)
THE CLOROX COMPANY Income Statement For the Year Ended June 30, 2014 (amounts in millions) Sales Net sales* ........................................................... $6,813 Cost of goods sold** .......................................... 3,880 Gross profit ........................................................ 2,933 Operating expenses Advertising expense*** .............................. $839 Salaries and wages expense ..................... 460 Research and development expense ........ 114 Rent expense .............................................. 105 Depreciation expense ................................ 90 Utilities expense ......................................... 60 Total operating expenses................... 1,668 Income from operations .................................... 1,265 Other expenses and losses Interest expense ......................................... 161 Loss on disposal of plant assets .............. 46 207 Income before income taxes ............................. 1,058 Income tax expense ........................................... 360 Net income ......................................................... $ 698 *$5,450 + (.25 X $5,450) **$3,104 + (.25 X $3,104) ***$499 + $340 Gross profit rate: $2,933 ÷ $6,813 = 43.1% Profit margin: $698 ÷ $6,813 = 10.2% The gross profit rate remained nearly unchanged at 43.1%. This result would be expected since advertising expenses are not part of cost of goods sold. The profit margin increased from 9.9% to 10.2% because net income increased nearly 30% ($161 ÷ $537) while net sales rose only 25%. It appears that the marketing department’s plan has merit. If the expected increases in sales materialize, net income will increase $161 million ($698 – $537).
5-20
.
(For Instructor Use Only)
EXERCISE 5-10 Inventory, September 1, 2013 ................................... Purchases .................................................................. Less: Purchase returns and allowances ................ Net purchases ........................................................... Add: Freight-in ....................................................... Cost of goods purchased ......................................... Cost of goods available for sale............................... Inventory, August 31, 2014 ....................................... Cost of goods sold ............................................
$ 18,700 $154,000 5,000 149,000 8,000 157,000 175,700 (21,000) $154,700
EXERCISE 5-11 (a) $1,420 ($1,500 – $80) (b) $1,550 (1,420 + $130) (c) $1,490 ($1,800 – $310) (d) $40 (e) $190 (f) $120
($1,080 – $1,040) ($1,230 – $1,040) ($1,350 – $1,230)
(g) $7,700 (h) $640 (i) $8,750 (j) (k) (I)
($290 + $7,410) ($8,050 – $7,410) ($700 + $8,050)
$5,000 ($49,530 – $44,530 from (I)) $1,300 ($43,590 – $42,290) $44,530 ($42,290 + $2,240)
EXERCISE 5-12 (a) Earnings have high quality if they provide a full and transparent depiction of how a company performed. (b) One indicator of earnings quality is the quality of earnings ratio which is net cash provided by operating activities divided by net income. For Dorcas Corporation this is $23,200 ÷ $45,300 = .51. This is significantly lower than 1, which indicates that the company might be using aggressive accounting techniques in order to accelerate the recognition of net income.
.
(For Instructor Use Only)
5-21
EXERCISE 5-12 (Continued) (c) In order to identify potential aggressive accounting techniques one should examine the factors that are causing net income to differ from net cash provided by operating activities. Many of these differences would be due to adjusting entries used for accrual accounting. The fact that the company’s Accounts Receivable balance is increasing so rapidly is a possible concern because it might suggest that the company is recording credit sales that really aren’t sales. For example, it might be shipping goods to customers that the company didn’t order. This would cause sales to increase, but since the customers probably won’t ever pay, it would cause the balance in accounts receivable to build up. *EXERCISE 5-13 (a) (1) April 5 (2) April 6 (3) April 7 (4) April 8
(5) April 15
(b)
5-22
May 4
.
Purchases .......................................... Accounts Payable.....................
27,000
Freight-In ............................................ Cash ..........................................
1,200
Equipment .......................................... Accounts Payable.....................
30,000
Accounts Payable .............................. Purchase Returns and Allowances .............................
3,600
Accounts Payable ($27,000 – $3,600) ........................... Cash ($23,400 – $468) .............. Purchase Discounts [($27,000 – $3,600) X 2%] ...... Accounts Payable ($27,000 – $3,600) ........................... Cash ..........................................
(For Instructor Use Only)
27,000 1,200 30,000
3,600 23,400 22,932 468 23,400 23,400
SOLUTIONS TO PROBLEMS PROBLEM 5-1A
(a) General Journal Date May 1 2
5 9
10
11 12 15 17
.
Account Titles Debit Inventory ........................................................... 8,000 Accounts Payable .....................................
Credit 8,000
Accounts Receivable ........................................ 4,400 Sales Revenue ...........................................
4,400
Cost of Goods Sold .......................................... 3,300 Inventory ....................................................
3,300
Accounts Payable ............................................. Inventory ....................................................
200 200
Cash ($4,400 – $88) ........................................... 4,312 Sales Discounts ($4,400 X 2%) ........................ 88 Accounts Receivable ................................
4,400
Accounts Payable ($8,000 – $200) ................... 7,800 Cash ........................................................... Inventory ($7,800 X 1%) ............................
7,722 78
Supplies............................................................. Cash ...........................................................
900 900
Inventory ........................................................... 3,100 Cash ........................................................... Cash ................................................................... Inventory ....................................................
230
Inventory ........................................................... 2,500 Accounts Payable .....................................
(For Instructor Use Only)
3,100 230 2,500
5-23
PROBLEM 5-1A (Continued) General Journal Date May 19 24
25 27
29
31
Account Titles Debit Inventory ........................................................... 250 Cash ...........................................................
250
Cash................................................................... 5,500 Sales Revenue ...........................................
5,500
Cost of Goods Sold .......................................... 4,100 Inventory ....................................................
4,100
Inventory ........................................................... Accounts Payable .....................................
800 800
Accounts Payable ............................................. 2,500 Cash ........................................................... Inventory ($2,500 X 2%) ............................ Sales Returns and Allowances ........................ Cash ...........................................................
124
Inventory ........................................................... Cost of Goods Sold ...................................
90
.
(For Instructor Use Only)
2,450 50 124 90
Accounts Receivable ........................................ 1,280 Sales Revenue ........................................... Cost of Goods Sold .......................................... Inventory ....................................................
5-24
Credit
1,280
830 830
PROBLEM 5-1A (Continued) (b) Cash 5/1 Bal. 8,000 5/10 5/9 4,312 5/11 5/15 230 5/12 5/24 5,500 5/19 5/27 5/29 5/31 Bal. 3,496
7,722 900 3,100 250 2,450 124
Accounts Receivable 5/2 4,400 5/9 4,400 5/31 1,280 5/31 Bal. 1,280 Inventory 5/1 8,000 5/2 5/12 3,100 5/5 5/17 2,500 5/10 5/19 250 5/15 5/25 800 5/24 5/29 90 5/27 5/31 5/31 Bal. 5,952
5/11 5/31 Bal.
5/5 5/10 5/27
.
3,300 200 78 230 4,100 50 830
Common Stock 5/1 Bal. 8,000 5/31 Bal. 8,000 Sales Revenue 5/2 4,400 5/24 5,500 5/31 1,280 5/31 Bal. 11,180 Sales Returns and Allowances 5/29 124 5/31 Bal. 124 Sales Discounts 5/9 88 5/31 Bal. 88 Cost of Goods Sold 5/2 3,300 5/29 5/24 4,100 5/31 830 5/31 Bal. 8,140
90
Supplies 900 900
Accounts Payable 200 5/1 8,000 7,800 5/17 2,500 2,500 5/25 800 5/31 Bal. 800
(For Instructor Use Only)
5-25
PROBLEM 5-1A (Continued) (c)
WATERS HARDWARE STORE Income Statement (Partial) For the Month Ended May 31, 2014 Sales Sales revenue .................................................... Less: Sales returns and allowances ............... Sales discounts...................................... Net sales .................................................................... Cost of goods sold ................................................... Gross profit ...............................................................
(d) Profit margin: ($2,828 – $1,400) ÷ $10,968 = 13.0% Gross profit rate: $2,828 ÷ $10,968 = 25.8%
5-26
.
(For Instructor Use Only)
$11,180 $124 88
212 10,968 8,140 $ 2,828
PROBLEM 5-2A
June 1 3
6 9
15 17
20 24
.
Inventory .............................................................. Accounts Payable........................................
1,040
Accounts Receivable .......................................... Sales Revenue .............................................
1,200
Cost of Goods Sold ............................................. Inventory ......................................................
720
Accounts Payable ............................................... Inventory ......................................................
40
Accounts Payable ($1,040 – $40) ....................... Cash ............................................................. Inventory ($1,000 X .02) ...............................
1,000
Cash ..................................................................... Accounts Receivable ..................................
1,200
Accounts Receivable .......................................... Sales Revenue .............................................
1,200
Cost of Goods Sold ............................................. Inventory ......................................................
730
Inventory .............................................................. Accounts Payable........................................
720
Cash ..................................................................... Sales Discounts ($1,200 X .02) ........................... Accounts Receivable ..................................
1,176 24
(For Instructor Use Only)
1,040 1,200 720 40 980 20 1,200 1,200 730 720
1,200
5-27
PROBLEM 5-2A (Continued) June 26
28
30
5-28
Accounts Payable ............................................... Cash.............................................................. Inventory (720 X .01) ....................................
720
Accounts Receivable .......................................... Sales Revenue .............................................
1,300
Cost of Goods Sold ............................................. Inventory ......................................................
780
Sales Returns and Allowances........................... Accounts Receivable ...................................
130
Inventory .............................................................. Cost of Goods Sold .....................................
80
.
(For Instructor Use Only)
713 7 1,300 780 130 80
PROBLEM 5-3A
(a) General Journal Date Apr. 5 7 9 10
12 14
17 20
21
.
Account Titles Inventory ........................................................... Accounts Payable .....................................
Debit 1,500
Inventory ........................................................... Cash ...........................................................
80
Accounts Payable............................................. Inventory....................................................
200
Accounts Receivable ....................................... Sales Revenue...........................................
1,340
Cost of Goods Sold .......................................... Inventory....................................................
820
Inventory ........................................................... Accounts Payable .....................................
830
1,500 80 200 1,340 820 830
Accounts Payable ($1,500 – $200) ................... 1,300 Cash ............................................................... Inventory ($1,300 X 3%) ............................. Accounts Payable............................................. Inventory....................................................
30
Accounts Receivable ....................................... Sales Revenue...........................................
810
Cost of Goods Sold .......................................... Inventory....................................................
550
Accounts Payable ($830 – $30)........................ Cash ........................................................... Inventory ($800 X 1%) ...............................
800
(For Instructor Use Only)
Credit
1,261 39 30 810 550 792 8
5-29
PROBLEM 5-3A (Continued) Date Apr. 27
Account Titles Debit Sales Returns and Allowances ........................ 80 Accounts Receivable ................................
30
Credit
Cash ................................................................... 1,220 Accounts Receivable ................................
80 1,220
(b) 4/1 Bal. 4/30 4/30 Bal.
Cash 2,500 4/7 1,220 4/14 4/21 1,587
80 1,261 792
Accounts Receivable 4/10 1,340 4/27 80 4/20 810 4/30 1,220 4/30 Bal. 850
4/1 Bal. 4/5 4/7 4/12
4/30 Bal.
4/9 4/14 4/17 4/21
5-30
Inventory 3,500 4/9 1,500 4/10 80 4/14 830 4/17 4/20 4/21 4,263
Accounts Payable 200 4/5 1,300 4/12 30 800 4/30 Bal.
.
(For Instructor Use Only)
200 820 39 30 550 8
1,500 830
0
Common Stock 4/1 Bal. 4/30 Bal.
6,000 6,000
Sales Revenue 4/10 4/20 4/30 Bal.
1,340 810 2,150
Sales Returns and Allowances 4/27 80 4/30 Bal. 80 Cost of Goods Sold 4/10 820 4/20 550 4/30 Bal. 1,370
PROBLEM 5-3A (Continued) (c)
FLINT HILLS PRO SHOP Trial Balance April 30, 2014 Cash ........................................................................ Accounts Receivable ............................................. Inventory ................................................................ Common Stock ...................................................... Sales Revenue ....................................................... Sales Returns and Allowances ............................. Cost of Goods Sold ...............................................
Credit
6,000 2,150 80 1,370 $8,150
$8,150
Sales Sales revenue ..................................................................... Less: Sales returns and allowances ................................ Net sales ..................................................................................... Cost of goods sold .................................................................... Gross profit ................................................................................
$2,150 80 2,070 1,370 $ 700
(d)
.
Debit $1,587 850 4,263
FLINT HILLS PRO SHOP Income Statement (Partial) For the Month Ended April 30, 2014
(For Instructor Use Only)
5-31
PROBLEM 5-4A
(a)
LAMBERT DEPARTMENT STORE Income Statement For the Year Ended November 30, 2014 Sales Sales revenue .................................. Less: Sales returns and allowances ............................ Net sales ................................................. Cost of goods sold .................................. Gross profit .............................................. Operating expenses Salaries and wages expense .......... Rent expense ................................... Advertising expense ....................... Depreciation expense ..................... Utilities expense .............................. Insurance expense .......................... Freight-out ....................................... Total operating expenses ....... Income from operations .......................... Other revenues and gains Gain on disposal of plant assets.... Other expenses and losses Interest expense .............................. Income before income taxes .................. Income tax expense ................................ Net income ...............................................
5-32
.
(For Instructor Use Only)
$904,000 20,000 884,000 614,300 269,700 $117,000 34,000 33,500 13,500 10,600 9,000 6,200 223,800 45,900 2,000 5,000 42,900 10,000 $ 32,900
PROBLEM 5-4A (Continued) LAMBERT DEPARTMENT STORE Retained Earnings Statement For the Year Ended November 30, 2014 Retained earnings, December 1, 2013 ..................................... Add: Net income ..................................................................... Less: Dividends ....................................................................... Retained earnings, November 30, 2014 ...................................
$14,200 32,900 47,100 12,000 $35,100
LAMBERT DEPARTMENT STORE Balance Sheet November 30, 2014 Assets Current assets Cash...................................................... $ 8,000 Accounts receivable ............................ 17,200 Inventory .............................................. 26,200 Prepaid insurance................................ 6,000 Total current assets...................... $ 57,400 Property, plant, and equipment Equipment ............................................ $157,000 Less: Accumulated depreciation— equipment ................................. 68,000 89,000 Total assets ................................... $146,400
.
(For Instructor Use Only)
5-33
PROBLEM 5-4A (Continued) LAMBERT DEPARTMENT STORE Balance Sheet (Continued) November 30, 2014 Liabilities and Stockholders’ Equity Current liabilities Accounts payable ............................................ $26,800 Salaries and wages payable ............................ 6,000 Total current liabilities .............................. Long-term liabilities Note payable due 2018 .................................... Total liabilities ........................................... Stockholders’ equity Common stock ................................................. 35,000 Retained earnings ............................................ 35,100 Total stockholders’ equity ........................ Total liabilities and stockholders’ equity ......................................................
$ 32,800 43,500 76,300
70,100 $146,400
(b) Profit margin: $32,900 ÷ $884,000 = 3.7% Gross profit rate: $269,700 ÷ $884,000 = 30.5% (c) Revised net income = Current net income + increase in gross profit – increase in operating expenses $14,743 = $32,900 + $40,443 – $58,600 Revised net sales = Current net sales + .15 (current net sales) $1,016,600 = $884,000 + $132,600 Revised gross profit = Current gross profit + $40,443 $310,143 = $269,700 + $40,443 Revised profit margin: $14,743 ÷ $1,016,600 = 1.5% Revised gross profit rate: $310,143 ÷ $1,016,600 = 30.5%
5-34
.
(For Instructor Use Only)
PROBLEM 5-4A (Continued) This plan increased net sales and gross profit but did not change the gross profit rate. This is not surprising since the proposed change affects selling expenses rather than cost of goods sold. An increase in sales would increase the dollar amount of cost of goods sold but not cost of goods sold as a percentage of sales dollars. The plan decreased net income by $18,157 ($32,900 – $14,743) or 55%. Since net sales increased 15% and net income decreased 55%, the profit margin decreased from 3.7% to 1.5%. A 55% decrease in net income combined with the smaller profit margin indicates that the proposal should not be adopted.
.
(For Instructor Use Only)
5-35
PROBLEM 5-5A
SUNDBERG COMPANY Income Statement For the Year Ended December 31, 2014 Sales Sales revenue....................................... Less: Sales returns and allowances ................................ Sales discounts ........................ Net sales ............................................... Cost of goods sold ...................................... Gross profit .................................................. Operating expenses Salaries and wages expense* ............. Freight-out ............................................ Rent expense ($24,000 – $6,000)......... Advertising expense ............................ Utilities expense .................................. Depreciation expense .......................... Total operating expenses ............ Income from operations .............................. Other revenues and gains Rent revenue ........................................ Other expenses and losses Interest expense .................................. Income before income taxes ...................... Income tax expense .................................... Net income ................................................... *($80,000 + $6,000 + $3,000 + $47,000)
5-36
.
(For Instructor Use Only)
$911,000 $28,000 18,000
46,000 865,000 555,000 310,000
136,000 33,000 18,000 13,000 12,000 10,000 222,000 88,000 4,000 2,000 90,000 22,500 $ 67,500
PROBLEM 5-6A
(a) Dec. 31
31 31
Depreciation Expense .............................. Accumulated Depreciation— Buildings ....................................... Accumulated Depreciation— Equipment .....................................
15,000
Interest Expense ...................................... Interest Payable ................................
4,500
Income Tax Expense ................................ Income Taxes Payable .....................
24,000
8,000 7,000 4,500 24,000
(b) Accumulated Depreciation—Buildings 12/31 Bal. 60,000 12/31 8,000 12/31 Bal. 68,000 Accumulated Depreciation—Equipment 12/31 Bal. 40,500 12/31 7,000 12/31 Bal. 47,500 Depreciation Expense 12/31 15,000 12/31 Bal. 15,000
.
(For Instructor Use Only)
Interest Expense 12/31 4,500 12/31 Bal. 4,500 Interest Payable 12/31 4,500 12/31 Bal. 4,500 Income Tax Expense 12/31 24,000 12/31 Bal. 24,000 Income Taxes Payable 12/31 24,000 12/31 Bal. 24,000
5-37
PROBLEM 5-6A (Continued) (c)
CUSTOMER CHOICE WHOLESALE COMPANY Adjusted Trial Balance December 31, 2014 Cash ............................................................... Accounts Receivable .................................... Inventory ........................................................ Land ............................................................... Buildings ....................................................... Accumulated Depreciation— Buildings.................................................... Equipment ..................................................... Accumulated Depreciation— Equipment ................................................. Notes Payable ............................................... Accounts Payable ......................................... Interest Payable ............................................ Income Taxes Payable .................................. Common Stock .............................................. Retained Earnings......................................... Dividends ....................................................... Sales Revenue............................................... Sales Discounts ............................................ Cost of Goods Sold....................................... Salaries and Wages Expense ....................... Utilities Expense ........................................... Maintenance and Repairs Expense ............. Advertising Expense..................................... Insurance Expense ....................................... Depreciation Expense ................................... Income Tax Expense..................................... Interest Expense ........................................... Totals......................................................
5-38
.
(For Instructor Use Only)
Debit $ 31,400 37,600 70,000 92,000 200,000
Credit
$
68,000
83,500 47,500 54,700 17,500 4,500 24,000 160,000 67,200 10,000 922,100 6,000 709,900 51,300 11,400 8,900 5,200 4,800 15,000 24,000 4,500 $1,365,500
$1,365,500
PROBLEM 5-6A (Continued) (d)
CUSTOMER CHOICE WHOLESALE COMPANY Income Statement For the Year Ended December 31, 2014 Sales Sales revenue ............................................. Less: Sales discounts............................... Net sales ............................................................. Cost of goods sold ............................................ Gross profit ........................................................ Operating expenses Salaries and wages expense ..................... Depreciation expense ................................ Utilities expense ......................................... Maintenance and repairs expense ............ Advertising expense .................................. Insurance expense ..................................... Total operating expenses .................. Income from operations .................................... Other expenses and losses Interest expense ......................................... Income before income taxes ............................. Income tax expense ........................................... Net income .........................................................
$922,100 6,000 916,100 709,900 206,200 $51,300 15,000 11,400 8,900 5,200 4,800 96,600 109,600 4,500 105,100 24,000 $ 81,100
CUSTOMER CHOICE WHOLESALE COMPANY Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1 ............................................... Add: Net income .................................................................. Less: Dividends .................................................................... Retained earnings, December 31..........................................
.
(For Instructor Use Only)
$ 67,200 81,100 148,300 10,000 $138,300
5-39
PROBLEM 5-6A (Continued) CUSTOMER CHOICE WHOLESALE COMPANY Balance Sheet December 31, 2014 Assets Current assets Cash ............................................... Accounts receivable...................... Inventory ........................................ Total current assets ................ Property, plant, and equipment Land................................................ Buildings ........................................ Less: Accum. depreciation— buildings ............................. Equipment ...................................... Less: Accum. depreciation— equipment .......................... Total assets .............................
$ 31,400 37,600 70,000 $139,000 92,000 $200,000 68,000 83,500
132,000
47,500
36,000
Liabilities and Stockholders’ Equity Current liabilities Notes payable .................................................. $ 15,000 Accounts payable............................................ 17,500 Income taxes payable ..................................... 24,000 Interest payable ............................................... 4,500 Total current liabilities .............................. Long-term liabilities Notes payable ($54,700 – $15,000) ................. Total liabilities ............................................ Stockholders’ equity Common stock ................................................. 160,000 Retained earnings ............................................ 138,300 Total stockholders’ equity ......................... Total liabilities and stockholders’ equity .......................................................
5-40
.
(For Instructor Use Only)
260,000 $399,000
$ 61,000 39,700 100,700
298,300 $399,000
PROBLEM 5-7A ERMLER DEPARTMENT STORE Income Statement (Partial) For the Year Ended November 30, 2014 Sales Sales revenue .......................... Less: Sales returns and allowances .................... Net sales ......................................... Cost of goods sold Inventory, Dec. 1, 2013 ............ Purchases ................................ Less: Purchase discounts ..... Purchase returns and allowances ............ Net purchases.......................... Add: Freight-in ...................... Cost of goods purchased ....... Cost of goods available for sale....................................... Less: Inventory, Nov. 30, 2014 ............... Cost of goods sold ........... Gross profit.....................................
.
(For Instructor Use Only)
$902,000 20,000 882,000 $ 41,300 $613,000 $7,000 6,760
13,760 599,240 5,060 604,300 645,600 36,200 609,400 $272,600
5-41
PROBLEM 5-8A (a) (a) Cost of goods sold = Sales revenue – Gross profit = $96,890 – $67,800 = $29,090 (b) Net income = Gross profit – Operating expenses = $67,800 – $63,640 = $4,160 (c) Merchandise inventory = 2012 Inventory + Purchases – CGS = $13,000 + $25,890 – $29,090 = $9,800 (d) Cash payments to suppliers = 2012 Accounts payable + Purchases – 2013 Accounts payable = $5,800 + $25,890 – $6,500 = $25,190 (e) Sales revenue = Cost of goods sold + Gross profit = $28,060 + $59,620 = $87,680 (f) Operating expenses = Gross profit – Net income = $59,620 – $3,510 = $56,110 (g) 2013 Inventory + Purchases – 2014 Inventory = CGS Purchases = CGS – 2013 Inventory + 2014 Inventory = $28,060 – $9,800 [from (c)] + $14,700 = $32,960 (h) Cash payments to suppliers = 2013 Accounts payable + Purchases – 2014 Accounts Payable = $6,500 + $32,960 [from (g)] – $4,600 = $34,860 (i) Gross profit = Sales revenue – CGS = $82,220 – $26,490 = $55,730 (j) Net income = Gross profit – Operating expenses = $55,730 – $52,870 = $2,860
5-42
.
(For Instructor Use Only)
PROBLEM 5-8A (Continued) (k) 2014 Inventory + Purchases – 2015 Inventory = CGS Inventory = 2014 Inventory + Purchases – CGS = $14,700 + $24,050 – $26,490 = $12,260 (I) Accounts payable = 2014 Accounts payable + Purchases – Cash payments = $4,600 + $24,050 – $24,650 = $4,000 (b)
No. A decline in sales does not necessarily mean that profitability declined. Profitability is affected by sales, cost of goods sold and operating expenses. If cost of goods sold or operating expenses decline more than sales, profitability can increase even when sales decline. However, in this particular case, sales declined with insufficient offsetting cost savings to improve profitability. Therefore, profitability declined for Yang Inc.
Gross profit rate Profit margin
.
(For Instructor Use Only)
2013 2014 $67,800 ÷ $96,890 $59,620 ÷ $87,680 = 70.0% = 68.0%
2015 $55,730 ÷ $82,220 = 67.8%
$4,160 ÷ $96,890 = 4.3%
$2,860 ÷ $82,220 = 3.5%
$3,510 ÷ $87,680 = 4.0%
5-43
*PROBLEM 5-9A
(a) Date Apr.
5-44
General Journal Account Titles and Explanation 5 Purchases ......................................................... Accounts Payable ..................................
Debit 1,500
1,500
7 Freight-In .......................................................... Cash ........................................................
80
9 Accounts Payable ............................................ Purchase Returns and Allowances ....................................
200
10 Accounts Receivable ....................................... Sales Revenue........................................
1,340
12 Purchases ......................................................... Accounts Payable ..................................
830
14 Accounts Payable ($1,500 – $200) .................. Cash ($1,300 – $39) ................................ Purchase Discounts (1,300 X 3%) ...................................
1,300
17 Accounts Payable ............................................ Purchase Returns and Allowances ....................................
30
20 Accounts Receivable ....................................... Sales Revenue........................................
810
21 Accounts Payable ($830 – $30) ....................... Cash ($800 – $8) ..................................... Purchase Discounts............................... ($800 X 1%) ....................................
800
.
(For Instructor Use Only)
Credit
80
200 1,340 830 1,261 39
30 810 792 8
*PROBLEM 5-9A (Continued) Date Apr.
Account Titles and Explanation 27 Sales Returns and Allowances ........................ Accounts Receivable ..............................
Debit 80
30 Cash ................................................................... Accounts Receivable ..............................
1,220
Credit 80 1,220
(b) Cash 4/1 Bal. 2,500 4/7 4/30 1,220 4/14 4/21 4/30 Bal. 1,587
80 1,261 792
Accounts Receivable 4/10 1,340 4/27 80 4/20 810 4/30 1,220 4/30 Bal. 850 Inventory 4/1 Bal. 3,500 4/30 Bal. 3,500
4/9 4/14 4/17 4/21
.
Accounts Payable 200 4/5 1,500 1,300 4/12 830 30 800 4/30 Bal. 0
(For Instructor Use Only)
Common Stock 4/1 Bal. 6,000 4/30 Bal. 6,000 Sales Revenue 4/10 1,340 4/20 810 4/30 Bal. 2,150 Sales Returns and Allowances 4/27 80 4/30 Bal. 80 Purchases 4/5 1,500 4/12 830 4/30 Bal. 2,330
5-45
*PROBLEM 5-9A (Continued) Purchase Returns and Allowances 4/9 200 4/17 30 4/30 Bal. 230
Purchase Discounts 4/14 4/21 4/30 Bal.
4/7 4/30 Bal.
39 8 47
Freight-In 80 80
(c) FLINT HILLS PRO SHOP Trial Balance April 30, 2014 Debit Cash .................................................................. Accounts Receivable ....................................... Inventory ........................................................... Common Stock ................................................. Sales Revenue .................................................. Sales Returns and Allowances ........................ Purchases ......................................................... Purchase Returns and Allowances ................. Purchase Discounts ......................................... Freight-In ...........................................................
5-46
.
(For Instructor Use Only)
Credit
$1,587 850 3,500 $6,000 2,150 80 2,330 230 47 80 $8,427
$8,427
*PROBLEM 5-9A (Continued) (d) FLINT HILLS PRO SHOP Income Statement (Partial) For the Month Ended April 30, 2014 ____________________________________________________________ Sales Sales revenue .......................... Less: Sales returns and allowances .................... Net sales .................................. Cost of goods sold Inventory, April 1 ..................... Purchases ................................ Less: Purchase returns and allowances ............ Purchase discounts. .... Net purchases ......................... Add: Freight-in ...................... Cost of goods purchased ....... Cost of goods available for sale ........................................ Less: Inventory, April 30 ....... Cost of goods sold .............. Gross profit .............................
.
(For Instructor Use Only)
$2,150 80 2,070 $3,500 $2,330 $230 47
277 2,053 80 2,133 5,633 4,263 1,370 $ 700
5-47
PROBLEM 5-1B (a) General Journal Date Apr. 2 4
5 6 11
13
14 16 18 20
5-48
Account Titles Inventory ........................................................... Accounts Payable .....................................
Debit 8,700
Accounts Receivable ........................................ Sales Revenue ...........................................
6,000
Cost of Goods Sold .......................................... Inventory ....................................................
3,700
Freight-Out ........................................................ Cash ...........................................................
200
Accounts Payable ............................................. Inventory ....................................................
400
Accounts Payable ($8,700 – $400) ................... Cash ........................................................... Inventory ($8,300 X 2%) ............................
8,300
Cash................................................................... Sales Discounts ($6,000 X 2%) ........................ Accounts Receivable ................................
5,880 120
Inventory ........................................................... Cash ...........................................................
4,700
Cash................................................................... Inventory ....................................................
500
Inventory ........................................................... Accounts Payable .....................................
5,500
Inventory ........................................................... Cash ...........................................................
180
.
(For Instructor Use Only)
Credit 8,700 6,000 3,700 200 400 8,134 166
6,000 4,700 500 5,500 180
PROBLEM 5-1B (Continued) General Journal Date Apr. 23
26 27
29
30
.
Account Titles Cash .................................................................. Sales Revenue...........................................
Debit 8,300
Cost of Goods Sold .......................................... Inventory....................................................
5,580
Inventory ........................................................... Cash ...........................................................
2,300
Accounts Payable ............................................. Cash ........................................................... Inventory ($5,500 X 2%) ............................
5,500
Sales Returns and Allowances ........................ Cash ...........................................................
180
Inventory ........................................................... Cost of Goods Sold...................................
120
Accounts Receivable........................................ Sales Revenue...........................................
3,980
Cost of Goods Sold .......................................... Inventory....................................................
2,500
(For Instructor Use Only)
Credit 8,300 5,580 2,300 5,390 110 180 120 3,980 2,500
5-49
PROBLEM 5-1B (Continued) (b) Cash 4/1 Bal. 10,000 4/5 4/13 5,880 4/11 4/16 500 4/14 4/23 8,300 4/20 4/26 4/27 4/29 4/30 Bal. 3,596
200 8,134 4,700 180 2,300 5,390 180
Accounts Receivable 4/4 6,000 4/13 6,000 4/30 3,980 4/30 Bal. 3,980
4/2 4/14 4/18 4/20 4/26 4/29 4/30 Bal.
4/6 4/11 4/27
Inventory 8,700 4/4 4,700 4/6 5,500 4/11 180 4/16 2,300 4/23 120 4/27 4/30 8,544
Accounts Payable 400 4/2 8,300 4/18 5,500 4/30 Bal.
3,700 400 166 500 5,580 110 2,500
.
(For Instructor Use Only)
Sales Returns and Allowances 4/29 180 4/30 Bal. 180
Sales Discounts 4/13 120 4/30 Bal. 120
Cost of Goods Sold 4/4 3,700 4/29 4/23 5,580 4/30 2,500 4/30 Bal. 11,660
4/5 4/30 Bal. 8,700 5,500 0
Common Stock 4/1 Bal. 10,000 4/30 Bal. 10,000
5-50
Sales Revenue 4/4 6,000 4/23 8,300 4/30 3,980 4/30 Bal. 18,280
Freight-Out 200 200
120
PROBLEM 5-1B (Continued) (c)
KREY DISTRIBUTING COMPANY Income Statement (Partial) For the Month Ended April 30, 2014 Sales Sales revenue ..................................................... Less: Sales returns and allowances ................ Sales discounts....................................... Net sales ............................................................. Cost of goods sold .................................................... Gross profit ................................................................
$18,280 $180 120
300 17,980 11,660 $ 6,320
(d) Profit margin: ($6,320 – $3,000) ÷ $17,980 = 18.5% Gross profit rate: $6,320 ÷ $17,980 = 35.2%
.
(For Instructor Use Only)
5-51
PROBLEM 5-2B April 1 3
6 9
12
13
20 24 26
28
30
5-52
Inventory (190 X $6) ............................................ Accounts Payable ........................................
1,140
Accounts Receivable (40 X $10) ......................... Sales Revenue ............................................. Cost of Goods Sold (40 X $6) ............................. Inventory ......................................................
400
Accounts Payable ............................................... Inventory ......................................................
90
Accounts Payable ($1,140 – $90) ....................... Inventory ($1,050 X .02) ............................... Cash..............................................................
1,050
Cash ..................................................................... Sales Discounts ($400 X .03) .............................. Accounts Receivable ...................................
388 12
Accounts Receivable (25 X $12) ......................... Sales Revenue ............................................. Cost of Goods Sold (25 X $6) ............................. Inventory ......................................................
300
Inventory (200 X $6) ............................................ Accounts Payable ........................................
1,200
Cash ..................................................................... Accounts Receivable ...................................
300
Accounts Payable ............................................... Inventory ...................................................... Cash..............................................................
1,200
Accounts Receivable (160 X $10) ....................... Sales Revenue ............................................. Cost of Goods Sold (160 X $6) ........................... Inventory ......................................................
1,600
Sales Returns and Allowances........................... Accounts Receivable ................................... Inventory .............................................................. Cost of Goods Sold .....................................
120
.
(For Instructor Use Only)
1,140 400 240 240 90 21 1,029
400 300 150 150 1,200 300 12 1,188 1,600 960 960 120 72 72
PROBLEM 5-3B (a) General Journal Date Apr. 4 6 8
10 11 13
14 15 17 18
.
Account Titles Debit Inventory ........................................................... 980 Accounts Payable ..................................... Inventory ........................................................... Cash ...........................................................
60
Accounts Receivable ........................................ Sales Revenue ...........................................
750
Cost of Goods Sold .......................................... Inventory ....................................................
480
Accounts Payable ............................................. Inventory ....................................................
130
Inventory ........................................................... Cash ...........................................................
300
Accounts Payable ($980 – $130) ...................... Cash ........................................................... Inventory ($850 X 2%) ...............................
850
980 60 750 480 130 300 833 17
Inventory ........................................................... 1,300 Accounts Payable ..................................... Cash ................................................................... Inventory ....................................................
50
Inventory ........................................................... Cash ...........................................................
60
Accounts Receivable ........................................ Sales Revenue ...........................................
660
Cost of Goods Sold .......................................... Inventory ....................................................
440
(For Instructor Use Only)
Credit
1,300 50 60 660 440
5-53
PROBLEM 5-3B (Continued) Date Apr. 20 21
27 30
Account Titles Debit Cash .................................................................. 500 Accounts Receivable ................................ Accounts Payable............................................. 1,300 Cash ........................................................... Inventory ($1,300 X 3%) ............................ Sales Returns and Allowances ........................ Accounts Receivable ................................
30
Cash .................................................................. Accounts Receivable ................................
550
Credit 500 1,261 39 30 550
(b) 4/1 Bal. 4/15 4/20 4/30 4/30 Bal.
Cash 3,500 4/6 50 4/11 500 4/13 550 4/17 4/21 2,086
Accounts Receivable 4/8 750 4/20 4/18 660 4/27 4/30 4/30 Bal. 330
4/1 Bal. 4/4 4/6 4/11 4/14 4/17 4/30 Bal.
5-54
Inventory 1,700 4/8 980 4/10 60 4/13 300 4/15 1,300 4/18 60 4/21 3,244
.
(For Instructor Use Only)
60 300 833 60 1,261
500 30 550
480 130 17 50 440 39
4/10 4/13 4/21
Accounts Payable 130 4/4 850 4/14 1,300 4/30 Bal.
980 1,300 0
Common Stock 4/1 Bal. 4/30 Bal.
5,200 5,200
Sales Revenue 4/8 4/18 4/30 Bal.
750 660 1,410
Sales Returns and Allowances 4/27 30 4/30 Bal. 30
PROBLEM 5-3B (Continued) Cost of Goods Sold 4/8 480 4/18 440 4/30 Bal. 920
CONNORS’ TENNIS SHOP Trial Balance April 30, 2014
(c)
Cash ........................................................................ Accounts Receivable ............................................. Inventory ................................................................ Common Stock ...................................................... Sales Revenue ....................................................... Sales Returns and Allowances ............................. Cost of Goods Sold ...............................................
Credit
$5,200 1,410 30 920 $6,610
$6,610
Sales Sales revenues ................................................................... Less: Sales returns and allowances ................................ Net sales ..................................................................................... Cost of goods sold .................................................................... Gross profit ................................................................................
$1,410 30 1,380 920 $ 460
CONNORS’ TENNIS SHOP Income Statement (Partial) For the Month Ended April 30, 2014
(d)
.
Debit $2,086 330 3,244
(For Instructor Use Only)
5-55
PROBLEM 5-4B (a)
PARKER DEPARTMENT STORE Income Statement For the Year Ended December 31, 2014
Sales Sales revenue....................................... Less: Sales returns and allowances ................................ Net sales ...................................................... Cost of goods sold ...................................... Gross profit .................................................. Operating expenses Salaries and wages expense ............... Depreciation expense .......................... Utilities expense .................................. Insurance expense............................... Maintenance and repairs expense ...... Total operating expenses ............ Income from operations .............................. Other revenues and gains Gain on disposal of plant assets ........ Other expenses and losses Interest expense .................................. Income before income taxes ...................... Income tax expense .................................... Net income ...................................................
$626,000 8,000 618,000 412,000 206,000 $111,000 23,400 11,000 8,400 6,200 160,000 46,000 4,300 7,000 43,300 15,000 $ 28,300
PARKER DEPARTMENT STORE Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1 .......................................................... Add: Net income ............................................................................. Less: Dividends ............................................................................... Retained earnings, December 31 ....................................................
5-56
.
(For Instructor Use Only)
$19,200 28,300 47,500 15,000 $32,500
PROBLEM 5-4B (Continued) PARKER DEPARTMENT STORE Balance Sheet December 31, 2014 Assets Current assets Cash................................................... Accounts receivable ......................... Inventory ........................................... Prepaid insurance............................. Total current assets .................. Property, plant, and equipment Land .................................................. Buildings ........................................... Less: Accumulated depreciation— buildings ................................ Equipment ......................................... Less: Accumulated depreciation— equipment .............................. Total assets ...............................
$ 30,000 43,500 43,000 2,400 $118,900 50,000 $140,000 52,500 100,000
87,500
42,600
57,400
194,900 $313,800
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ................................................. Mortgage payable ................................................. Salaries and wages payable ................................ Interest payable .................................................... Total current liabilities .................................. Long-term liabilities Mortgage payable ($62,500 – $20,000) ................ Total liabilities ............................................... Stockholders’ equity Common stock ...................................................... Retained earnings................................................. Total stockholders’ equity ............................ Total liabilities and stockholders’ equity ....
.
(For Instructor Use Only)
$ 73,300 20,000 3,500 2,000 $98,800 42,500 141,300 140,000 32,500 172,500 $313,800
5-57
PROBLEM 5-4B (Continued) (b) Profit margin: $28,300 ÷ $618,000 = 4.6% Gross profit rate: $206,000 ÷ $618,000 = 33.3% (c) Revised net income = Current net income + increase in gross profit – increase in operating expenses $51,000 = $28,300 + $50,500 – $27,800 Revised net sales = Current net sales + .25 (current net sales) $772,500 = $618,000 + $154,500 Revised gross profit = Current gross profit + $50,500 $256,500 = $206,000 + $50,500 Revised profit margin: $51,000 ÷ $772,500 = 6.6% Revised gross profit rate: $256,500 ÷ $772,500 = 33.2% This plan increases net sales and gross profit but barely changes the gross profit rate. This is not surprising since the proposed change affects selling expenses rather than cost of goods sold. An increase in sales would increase the dollar amount of cost of goods sold but not cost of goods sold as a percentage of sales dollars. The plan increases net income by $22,700 ($51,000 – $28,300) or 80%. Since net sales increases only 25% and net income increases 80%, the profit margin rises from 4.6% to 6.6%. An 80% increase in net income indicates that the proposal has considerable merit and should be adopted.
5-58
.
(For Instructor Use Only)
PROBLEM 5-5B
WRIGHT COMPANY Income Statement For the Year Ended December 31, 2014 Sales Sales revenue ...................................... Less: Sales returns and allowances ............................ Sales discounts ........................ Net sales ...................................................... Cost of goods sold ...................................... Gross profit.................................................. Operating expenses Salaries and wages expense .............. Freight-out............................................ Rent expense ($20,000 – $2,000) ........ Utilities expense .................................. Advertising expense ............................ Depreciation expense .......................... Total operating expenses ............ Income from operations.............................. Other revenues and gains Interest revenue ................................... Other expenses and losses Interest expense .................................. Net income ...................................................
$972,000 $ 46,000 12,000
58,000 914,000 548,000 366,000
152,000 20,000 18,000 16,000* 12,000 4,000 222,000 144,000 4,000 3,000 $145,000
*($13,000 + $3,000)
.
(For Instructor Use Only)
5-59
PROBLEM 5-6B (a) Nov. 30 30
30 30
Supplies Expense ................................... Supplies ($8,800 – $4,000)...............
4,800
Depreciation Expense ............................. Accumulated Depreciation— Equipment ....................................
20,000
Interest Expense ..................................... Interest Payable ...............................
4,400
Income Tax Expense ............................... Income Taxes Payable ....................
3,000
4,800
20,000 4,400 3,000
(b) Supplies 11/30 Bal. 8,800 11/30 11/30 Bal. 4,000
4,800
Supplies Expense 11/30 4,800 11/30 Bal. 4,800 Accumulated Depreciation— Equipment 11/30 Bal. 41,000 11/30 20,000 11/30 Bal. 61,000 Depreciation Expense 11/30 20,000 11/30 Bal. 20,000
5-60
.
(For Instructor Use Only)
Interest Expense 11/30 4,400 11/30 Bal. 4,400 Interest Payable 11/30 4,400 11/30 Bal. 4,400 Income Tax Expense 11/30 3,000 11/30 Bal. 3,000 Income Taxes Payable 11/30 3,000 11/30 Bal. 3,000
PROBLEM 5-6B (Continued) BUSE’S FASHION CENTER Adjusted Trial Balance November 30, 2014
(c)
Cash ............................................................... Accounts Receivable .................................... Inventory ....................................................... Supplies ......................................................... Equipment ..................................................... Accumulated Depreciation— Equipment ................................................. Notes Payable ............................................... Accounts Payable ......................................... Interest Payable ............................................ Income Taxes Payable .................................. Common Stock ............................................. Retained Earnings ........................................ Dividends ...................................................... Sales Revenue .............................................. Sales Returns and Allowances .................... Cost of Goods Sold ...................................... Salaries and Wages Expense ....................... Advertising Expense .................................... Utilities Expense ........................................... Maintenance and Repairs Expense ............. Freight-Out .................................................... Rent Expense ................................................ Supplies Expense ......................................... Depreciation Expense .................................. Interest Expense ........................................... Income Tax Expense .................................... Totals .....................................................
.
(For Instructor Use Only)
Debit $ 37,700 33,700 43,000 4,000 143,000
Credit
$
61,000 62,000 17,800 4,400 3,000 80,000 30,000
12,000 757,200 6,200 505,400 110,000 26,400 14,000 12,100 11,700 24,000 4,800 20,000 4,400 3,000 $1,015,400
$1,015,400
5-61
PROBLEM 5-6B (Continued) BUSE’S FASHION CENTER Income Statement For the Year Ended November 30, 2014
(d)
Sales Sales revenue .......................................... Less: Sales returns and allowances .... Net sales .......................................................... Cost of goods sold ......................................... Gross profit ..................................................... Operating expenses Salaries and wages expense .................. Advertising expense ............................... Rent expense ........................................... Depreciation expense ............................. Utilities expense ...................................... Maintenance and repairs expense ......... Freight-out ............................................... Supplies expense .................................... Total operating expenses................ Income from operations ................................. Other expenses and losses Interest expense ...................................... Income before income taxes .......................... Income tax expense ........................................ Net income ......................................................
$757,200 6,200 751,000 505,400 245,600 $110,000 26,400 24,000 20,000 14,000 12,100 11,700 4,800 223,000 22,600 4,400 18,200 3,000 $ 15,200
BUSE’S FASHION CENTER Retained Earnings Statement For the Year Ended November 30, 2014 Retained earnings, December 1, 2013 ........... Plus: Net income ........................................... Less: Dividends ............................................. Retained earnings, November 30, 2014 .........
5-62
.
(For Instructor Use Only)
$30,000 15,200 45,200 12,000 $33,200
PROBLEM 5-6B (Continued) BUSE’S FASHION CENTER Balance Sheet November 30, 2014 Assets Current assets Cash................................................. Accounts receivable ....................... Inventory ......................................... Supplies .......................................... Total current assets ................ Property, plant, and equipment Equipment ....................................... Less: Accumulated depreciation— equipment ............................. Total assets .............................
$37,700 33,700 43,000 4,000 $118,400 $143,000 61,000
82,000 $200,400
Liabilities and Stockholders’ Equity Current liabilities Notes payable .................................................... Accounts payable .............................................. Interest payable.................................................. Income taxes payable ........................................ Total current liabilities ............................... Long-term liabilities Notes payable ($62,000 – $24,000).................... Total liabilities ............................................ Stockholders’ equity Common stock ................................................... Retained earnings .............................................. Total stockholders’ equity ......................... Total liabilities and stockholders’ equity ......................................................
.
(For Instructor Use Only)
$24,000 17,800 4,400 3,000 $ 49,200 38,000 87,200 80,000 33,200 113,200 $200,400
5-63
PROBLEM 5-7B
ALMA’S DEPARTMENT STORE Income Statement (Partial) For the Year Ended December 31, 2014 Sales Sales revenue ........................ Less: Sales returns and allowances .................. Net sales ....................................... Cost of goods sold Inventory, January 1 .............. Purchases .............................. $456,000 Less: Purchase discounts.... $12,000 Purchase returns and allowances ........... 6,400 18,400 Net purchases ........................ 437,600 Add: Freight-in..................... 7,200 Cost of goods purchased...... Cost of goods available for sale ..................................... Less: Inventory, December 31 ............... Cost of goods sold ......... Gross profit ...................................
5-64
.
(For Instructor Use Only)
$702,000 8,000 694,000 $ 40,500
444,800 485,300 48,300 437,000 $257,000
PROBLEM 5-8B
(a) 2013
2014
2015
16,000 146,900 162,900
$ 11,300 155,700 167,000
$ 16,400 139,200 155,600
Less: Ending inventory Equals: CGS
11,300 $ 151,600
16,400 $150,600
14,200 $141,400
Sales revenue Less: CGS Gross profit
2013 $229,700 151,600 $ 78,100
2014 $227,600 150,600 $ 77,000
2015 $220,000 141,400 $ 78,600
Beginning accounts payable Plus: Purchases Less: Payments to suppliers Ending accounts payable
2013 $ 17,000 146,900 135,900 $ 28,000
2014 $ 28,000 155,700 159,000 $ 24,700
2015 $ 24,700 139,200 127,000 $ 36,900
34.0%
33.8%
35.7%
Cost of goods sold: Beginning inventory Plus: Purchases Equals: CGAS
$
(b)
(c)
(d) Gross profit rate
No. Even though sales declined in 2015 from each of the two prior years, the gross profit rate increased. This means that cost of goods sold declined more than sales did, reflecting better purchasing power or control of costs. Therefore, in spite of declining sales, profitability, as measured by the gross profit rate, actually improved.
.
(For Instructor Use Only)
5-65
*PROBLEM 5-9B (a) Date Nov.
5-66
General Journal Account Titles 5 Purchases ......................................................... Accounts Payable ..................................
Debit 1,600
7 Freight-In .......................................................... Cash ........................................................
90
9 Accounts Payable ............................................ Purchase Returns and Allowances ....................................
350
10 Accounts Receivable ....................................... Sales Revenue........................................
1,000
12 Purchases ......................................................... Accounts Payable ..................................
945
14 Accounts Payable ($1,600 – $350) .................. Purchase Discounts............................... ($1,250 X 2%) Cash ($1,250 – $25) ................................
1,250
17 Accounts Payable ............................................ Purchase Returns and Allowances ....................................
45
20 Accounts Receivable ....................................... Sales Revenue........................................
1,330
21 Accounts Payable ($945 – $45) ....................... Purchase Discounts............................... ($900 X 1%) Cash ($900 – $9) .....................................
900
.
(For Instructor Use Only)
Credit 1,600 90
350 1,000 945 25 1,225
45 1,330 9 891
*PROBLEM 5-9B (Continued) Date Nov.
Account Titles 27 Sales Returns and Allowances ........................ Accounts Receivable ..............................
Debit 150
30 Cash ................................................................... Accounts Receivable ..............................
1,900
Credit 150 1,900
(b) Cash 11/1 Bal. 3,300 11/7 11/30 1,900 11/14 11/21 11/30 Bal. 2,994
90 1,225 891
Accounts Receivable 11/10 1,000 11/27 150 11/20 1,330 11/30 1,900 11/30 Bal. 280 Inventory 11/1 Bal. 4,700 11/30 Bal. 4,700
11/9 11/14 11/17 11/21
.
Accounts Payable 350 11/5 1,600 1,250 11/12 945 45 900 11/30 Bal. 0
(For Instructor Use Only)
Common Stock 11/1 Bal. 8,000 11/30 Bal. 8,000 Sales Revenue 11/10 1,000 11/20 1,330 11/30 Bal. 2,330 Sales Returns and Allowances 11/27 150 11/30 Bal. 150 Purchases 11/5 1,600 11/12 945 11/30 Bal. 2,545
5-67
*PROBLEM 5-9B (Continued) Purchase Returns and Allowances 11/9 350 11/17 45 11/30 Bal. 395 Purchase Discounts 11/14 11/21 11/30 Bal.
Freight-In 11/7 90 11/30 Bal. 90
25 9 34
(c) WINONA SPORTS Trial Balance November 30, 2014 Debit Cash .......................................................................... Accounts Receivable ............................................... Inventory ................................................................... Accounts Payable..................................................... Common Stock ......................................................... Sales Revenue .......................................................... Sales Returns and Allowances ................................ Purchases ................................................................. Purchase Returns and Allowances ......................... Purchase Discounts ................................................. Freight-In ...................................................................
5-68
.
(For Instructor Use Only)
Credit
$ 2,994 280 4,700 $
–0– 8,000 2,330
150 2,545 395 34 90 $10,759
$10,759
*PROBLEM 5-9B (Continued) (d) WINONA SPORTS Income Statement (Partial) For the Month Ended November 30, 2014 _______________________________________________________________ Sales Sales revenue ............................ Less: Sales returns and allowances...................... Net sales .................................... Cost of goods sold Inventory, November 1 .............. Purchases .................................. Less: Purchase returns and allowances .............. Purchase discounts ..... Net purchases............................ Add: Freight-in ......................... Cost of goods purchased ......... Cost of goods available for sale ........................................... Inventory, November 30 ............ Cost of goods sold ............... Gross profit ................................
.
(For Instructor Use Only)
$2,330 150 2,180 $4,700 $2,545 $395 34
429 2,116 90 2,206 6,906 5,196 1,710 $ 470
5-69
COMPREHENSIVE PROBLEM SOLUTION
(a)
Dec. 6
8 10
13 15 18
20 23
27
5-70
Salaries and Wages Payable ....................... Salaries and Wages Expense ...................... Cash ......................................................
1,000 600
Cash .............................................................. Accounts Receivable............................
1,900
Cash .............................................................. Sales Revenue ......................................
6,300
Cost of Goods Sold ...................................... Inventory ...............................................
4,100
Inventory ....................................................... Accounts Payable .................................
9,000
Supplies ........................................................ Cash ......................................................
2,000
1,600 1,900 6,300 4,100 9,000 2,000
Accounts Receivable ................................... 12,000 Sales Revenue ......................................
12,000
Cost of Goods Sold ...................................... Inventory ...............................................
8,000 8,000
Salaries and Wages Expense ...................... Cash ......................................................
1,800
Accounts Payable ........................................ Cash ...................................................... Inventory ($9,000 X .02) ........................
9,000
1,800
Cash .............................................................. 11,640 Sales Discounts ($12,000 X .03) .................. 360 Accounts Receivable............................
.
(For Instructor Use Only)
8,820 180
12,000
COMPREHENSIVE PROBLEM SOLUTION (Continued) (c)
Dec. 31
Salaries and Wages Expense ....................... Salaries and Wages Payable ................
800
Depreciation Expense................................... Accumulated Depreciation— Equipment ...........................................
200
800
200
Supplies Expense ......................................... 1,700 Supplies ($3,200 – $1,500) .................... Income Tax Expense..................................... Income Taxes Payable .......................... (b) & (c) Cash 12/1 Bal. 7,200 12/6 12/8 1,900 12/15 12/10 6,300 12/20 12/27 11,640 12/23 12/31 Bal. 12,820
Supplies 12/1 Bal. 1,200 12/31 12/15 2,000 12/31 Bal. 1,500
.
(For Instructor Use Only)
200 200
General Ledger
1,600 2,000 1,800 8,820
Accounts Receivable 12/1 Bal. 4,600 12/8 1,900 12/18 12,000 12/27 12,000 12/31 Bal. 2,700 Inventory 12/1 Bal. 12,000 12/10 12/13 9,000 12/18 12/23 12/31 Bal. 8,720
1,700
4,100 8,000 180
1,700
Equipment 12/1 Bal. 22,000 12/31 Bal. 22,000 Accumulated Depr.—Equipment 12/1 Bal. 2,200 12/31 200 12/31 Bal. 2,400
12/23
Accounts Payable 9,000 12/1 Bal. 4,500 12/13 9,000 12/31 Bal. 4,500
Salaries and Wages Payable 12/6 1,000 12/1 Bal. 1,000 12/31 800 12/31 Bal. 800 Income Taxes Payable 12/31 12/31 Bal.
200 200
5-71
COMPREHENSIVE PROBLEM SOLUTION (Continued) Common Stock 12/1 Bal. 15,000 12/31 Bal. 15,000 Retained Earnings 12/1 Bal. 24,300 12/31 Bal. 24,300 Sales Revenue 12/10 6,300 12/18 12,000 12/31 Bal. 18,300 Sales Discounts 12/27 360 12/31 Bal. 360 Cost of Goods Sold 12/10 4,100 12/18 8,000 12/31 Bal. 12,100
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(For Instructor Use Only)
Depreciation Exp. 12/31 200 12/31 Bal. 200 Salaries and Wages Expense 12/6 600 12/20 1,800 12/31 800 12/31 Bal. 3,200 Supplies Expense 12/31 1,700 12/31 Bal. 1,700 Income Tax Expense 12/31 200 12/31 Bal. 200
COMPREHENSIVE PROBLEM SOLUTION (Continued) (d)
BOLINE DISTRIBUTING COMPANY Adjusted Trial Balance December 31, 2014 Cash ................................................................... Accounts Receivable ........................................ Inventory ........................................................... Supplies ............................................................. Equipment ......................................................... Accumulated Depreciation—Equipment ......... Accounts Payable ............................................. Salaries and Wages Payable ............................ Income Taxes Payable ...................................... Common Stock ................................................. Retained Earnings ............................................ Sales Revenue .................................................. Sales Discounts ................................................ Cost of Goods Sold .......................................... Depreciation Expense ...................................... Salaries and Wages Expense ........................... Supplies Expense ............................................. Income Tax Expense ........................................
(e)
CR.
$ 2,400 4,500 800 200 15,000 24,300 18,300 360 12,100 200 3,200 1,700 200 $65,500
$65,500
BOLINE DISTRIBUTING COMPANY Income Statement For the Month Ending December 31, 2014 Sales revenue.................................................... Less: Sales discounts ..................................... Net sales ............................................................ Cost of goods sold ........................................... Gross profit ....................................................... Operating expenses Salaries and wages expense .................... Supplies expense ...................................... Depreciation expense ............................... Income before income taxes ............................ Income tax expense .......................................... Net income ........................................................
.
DR. $12,820 2,700 8,720 1,500 22,000
(For Instructor Use Only)
$18,300 360 17,940 12,100 5,840 $3,200 1,700 200
5,100 740 200 $ 540 5-73
COMPREHENSIVE PROBLEM SOLUTION (Continued) BOLINE DISTRIBUTING COMPANY Retained Earnings Statement For the Month Ended December 31, 2014 Retained earnings, Dec. 1.............................................. Add: Net income........................................................... Retained Earnings, Dec. 31 ...........................................
$24,300 540 $24,840
BOLINE DISTRIBUTING COMPANY Balance Sheet December 31, 2014 Assets Current assets Cash............................................................ Accounts receivable .................................. Inventory .................................................... Supplies ..................................................... Total current assets .............................
$12,820 2,700 8,720 1,500
Property, plant, and equipment Equipment .................................................. Less: Accumulated depreciation ............. Total assets .......................................................
22,000 2,400
$25,740
19,600 $45,340
Liability and Stockholders’ Equity
5-74
Current liabilities Accounts payable ...................................... Salaries and wages payable ..................... Income taxes payable ................................ Total current liabilities .........................
$ 4,500 800 200
Stockholders’ equity Common stock ........................................... Retained earnings...................................... Total stockholders’ equity ................... Total liabilities and stockholders’ equity ........
15,000 24,840
.
(For Instructor Use Only)
$ 5,500
39,840 $45,340
BYP 5-1
FINANCIAL REPORTING PROBLEM
(a) Percentage change in total revenue: 2010 to 2011 ($532,505 – $521,448) ÷ $521,448 = + 2.1% Percentage change in net income: 2010 to 2011 ($43,938 – $53,063) ÷ $53,063 = (17.2)% (b) Profit margin: 2009 2010 2011
$53,157 ÷ $499,331 = 10.6% $53,063 ÷ $521,448 = 10.2% $43,938 ÷ $532,505 = 8.3%
The profit margin decreased slightly in 2010 but declined by 19% in 2011. (c) Gross profit rates: 2009 2010 2011
$175,817* ÷ $495,592 = 35.5% $167,815** ÷ $517,149 = 32.5% $163,144*** ÷ $528,369 = 30.9%
The gross profit rate decreased in both 2010 and 2011 due to an increasing cost of goods sold. *($495,592 – $319,775) **($517,149 – $349,334) ***($528,369 – $365,225)
.
(For Instructor Use Only)
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BYP 5-2
COMPARATIVE ANALYSIS PROBLEM
(a)
Tootsie Roll
$43,938 (1) Profit margin
Hershey Company
$628,962 = 8.3%
$532,505 (2) Gross profit (000’s)
(3) Gross profit rate
$163,144 = ($528,369 – $365,225)
$163,144
= 30.9%
$528,369 (4) Operating income (000’s)
$57,966
(5) Percent change in operating income
$57,966 – $64,710 $64,710
$6,080,788
= 10.3%
$2,531,892 = ($6,080,788 – $3,548,896)
$2,531,892
= 41.6%
$6,080,788 $1,055,028
= –10.4%
$1,055,028 – $905,298
= +16.5%
$905,298
(b) Hershey’s higher profit margin suggests that it was better at turning sales dollars into net income. Its gross profit rate suggests that Hershey can command a higher markup on its goods or that it is better at controlling its cost of goods sold. Tootsie Roll’s operating income decreased 10.4% while Hershey’s increased by 16.5%. A major reason for Tootsie Roll’s decline in operating income was due to cost of goods sold increasing more than net sales.
5-76
.
(For Instructor Use Only)
BYP 5-3
RESEARCH CASE
(a) Wal-Mart experienced an increase in sales during the year. However, to get this increase in sales the company had to aggressively reduce its price. Such deep discounting reduced the amount of gross profit, the amount by which the selling price exceeded cost. This resulted in a lower gross profit rate. (b) Saks Fifth Avenue sells high-end goods to wealthier customers. It said that its increased gross profit rate is explained by the fact that it was able to reduce “promotional activity” during the period. That is another way of saying that it didn’t have to discount goods as much in order to sell them. It said that the amount of “full-price” sales increased throughout the year. (c) Macy’s attributed the decline in its gross profit rate to a free-shipping promotion and markdowns on cold-weather gear. In this chapter the cost of shipping goods to customers is treated as a selling expense called freight-out which is included in operating expenses. That is, freight-out is subtracted out in the section of the income statement below gross profit (see Illustration 5-11 on p. 245). Therefore, an increase in shipping costs would reduce the profit margin ratio, but it would not affect the gross profit rate. So, while markdowns on coldweather gear would reduce the gross profit rate, increased shipping costs to customers would not. (d) An increase in same store sales means that the stores that were in existence in the previous period experienced an increase in sales. Sometimes a company experiences an increase in sales revenue because it increased the number of stores it has. Other times the number of stores stays the same, but the amount of sales at each existing store increases. In the first case, because the company’s operating costs would increase due to having more stores, the increase in sales might not result in an increase in the profit margin ratio. However, if same store sales increase, it is less likely to be accompanied by a big increase in operating costs, thus it is more likely that the profit margin ratio will increase.
.
(For Instructor Use Only)
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BYP 5-4
INTERPRETING FINANCIAL STATEMENTS
(a) Carrefour (Euros) ( € 70, 486 – €54, 630)
Gross profit rate
€ 70, 486
Wal-Mart (Dollars) =
($256,329 – $198, 747) $256, 329
= 22.5%
22.5%
The ratio is the same for each company, indicating that they have similar markups on the cost of their products. (b) Profit margin ratio
€1,738 ÷ €70,486 = 2.5%
$9,054 ÷ $256,329 = 3.5%
Wal-Mart is renowned for its efficiency—this is what has caused it to dominate its U.S. competitors. It would appear from this data that it is also more efficient in its ability to generate net income from each dollar of sales than Carrefour. (c)
Current ratio
€14,521 ÷ €13,660 = 1.06:1
$34,421 ÷ $37,418 = .92:1
Debt to assets ratio
€29,434 ÷ €39,063 = .75
$61,289 ÷ $104,912 = .58
Both companies report low current ratios. This is not surprising since in recent years most large companies have tried to reduce costs and increase profitability by limiting the amount of current assets that they hold. However, Wal-Mart’s current ratio is less than 1:1 and might be cause for further investigation. The debt to assets ratio reveals that Carrefour relies more heavily on debt financing. This reduces Carrefour’s solvency and makes Carrefour more susceptible to swings in the economy. This could reduce its ability to compete head-to-head with Wal-Mart.
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.
(For Instructor Use Only)
BYP 5-4 (Continued) (d) Ratios improve our ability to compare these two companies that report financial information using different currencies. However, other factors can still reduce our ability to compare them. Different accounting standards in the two countries might result in dramatically different results under the same circumstances. Also, differences in laws, such as bankruptcy laws, can affect the results. For example, if French bankruptcy laws favor shareholders more than U.S. bankruptcy laws, then it would be prudent for a French company to rely more on debt financing than a U.S. company.
.
(For Instructor Use Only)
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BYP 5-5
REAL-WORLD FOCUS
Answers will vary depending on the company and article chosen by the student.
5-80
.
(For Instructor Use Only)
BYP 5-6
DECISION MAKING ACROSS THE ORGANIZATION
(a) (1)
MEGA MART DEPARTMENT STORE Projected Income Statement For the Year Ended December 31, 2015 Net sales [$700,000 + ($700,000 X 4%)] .... Cost of goods sold ($728,000 X 75%)* ...... Gross profit ($728,000 X 25%)** ................ Operating expenses Selling expenses ................................ Administrative expenses ................... Total operating expenses ........... Net income..................................................
$728,000 546,000 182,000 $100,000 20,000 120,000 $ 62,000
**Alternatively: Net sales, $728,000 – gross profit, $182,000. **25% = ($140,000 ÷ $700,000) + 5%. (2)
MEGA MART DEPARTMENT STORE Projected Income Statement For the Year Ended December 31, 2015 Net sales ..................................................... Cost of goods sold ..................................... Gross profit ................................................ Operating expenses Selling expenses ................................ Administrative expenses ................... Net income..................................................
$700,000 560,000 140,000 $68,000* 20,000*
88,000 $ 52,000
*$100,000 – $30,000 – ($40,000 X 40%) + ($700,000 X 2%) = $68,000. (b) Sue’s proposed changes will increase net income by $42,000. Jeremy’s proposed changes will reduce operating expenses by $32,000 and result in a corresponding increase in net income. Thus, if the choice is between Sue’s plan and Jeremy’s plan, Sue’s plan should be adopted. While Jeremy’s plan will increase net income, it may also have an adverse effect on sales personnel. Under Jeremy’s plan, sales personnel will be taking a cut of $16,000 in compensation [$60,000 – ($30,000 + $14,000)].
.
(For Instructor Use Only)
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BYP 5-6 (Continued) (c)
MEGA MART DEPARTMENT STORE Projected Income Statement For the Year Ended December 31, 2015 Net sales ............................................................. Cost of goods sold ............................................ Gross profit ........................................................ Operating expenses Selling expenses ........................................ Administrative expenses ........................... Total operating expenses................... Net income .........................................................
$728,000 546,000 182,000 $68,560* 20,000* 88,560 $ 93,440
*$68,000 + [2% X ($728,000 – $700,000)] = $68,560. If both plans are implemented, net income will be $73,440 ($93,440 – $20,000) higher than the 2014 results. This is an increase of over 360%. Given the size of the increase, Jeremy’s plan to compensate sales personnel might be modified so that they would not have to take a pay cut. For example, if sales commissions were 3%, the compensation cut would be reduced to $8,160 [$60,000 – ($30,000 + ($728,000 X 3%))]. (d) A variety of factors might be presented by the student. For example, increasing the quantity of inventory purchased will increase warehousing and other costs of inventory. It will also increase the risk of holding obsolete or out-of-fashion inventory. Cutting salespersons’ salaries and making them more dependent on commissions might actually be viewed favorably by the sales staff if they have the potential to increase their total compensation. Reduced store deliveries may anger customers, especially if competitors provide more frequent service.
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(For Instructor Use Only)
BYP 5-7
COMMUNICATION ACTIVITY
(a), (b) President Surfing USA Co. Dear Sir: As you know, the financial statements for Surfing USA Co. are prepared in accordance with generally accepted accounting principles. One of these principles is the revenue recognition principle, which provides that revenues should be recognized when the performance obligation is satisfied. Typically, sales revenues are recognized when the goods are transferred from the buyer to the seller. At this point, the sales transaction is completed and the sales price is established. Thus, in the typical situation, revenue on the surfboard ordered by Shafer is recognized at event No. 8, when Shafer picks up the surfboard. The circumstances pertaining to this sale may seem to you to be atypical because Shafer has ordered a specific kind of surfboard. From an accounting standpoint, this would be true only if you could not reasonably expect to sell this surfboard to another customer. In such case, it would be proper under generally accepted accounting principles to recognize sales revenue when you have completed the surfboard for Shafer. Whether Shafer makes a down payment with the purchase order is irrelevant in recognizing sales revenue because at this time, you have not done anything to earn the revenue. A down payment may be an indication of Shafer’s “good faith.” However, its effect on your financial statements is limited entirely to recognizing the down payment as unearned revenue. If you have further questions about the accounting for this sale, please let me know. Sincerely,
.
(For Instructor Use Only)
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BYP 5-8
ETHICS CASE
(a) Andrea Tabares, as a new employee, is placed in a position of responsibility and is pressured by her supervisor to continue an unethical practice previously performed by him. The unethical practice is taking undeserved cash discounts. Her dilemma is either follow her boss’s unethical instructions or offend her boss and maybe lose the job she just assumed. (b) The stakeholders (affected parties) are: Andrea Tabares, the assistant treasurer. William Parks, the treasurer. Northshore Stores, the company. Creditors of Northshore Stores (suppliers). Mail room employees (those assigned the blame). (c) Andrea’s alternatives: 1. Tell the treasurer (her boss) that she will attempt to take every allowable cash discount by preparing and mailing checks within the discount period—the ethical thing to do. This will offend her boss and may jeopardize her continued employment. 2. Join the team and continue the unethical practice of taking undeserved cash discounts. 3. Go over her boss’s head and take the chance of receiving just and reasonable treatment from an officer superior to William. The company may not condone this practice. Andrea definitely has a choice, but probably not without consequence. To continue the practice is definitely unethical. If Andrea submits to this request, she may be asked to perform other unethical tasks. If Andrea stands her ground and refuses to participate in this unethical practice, she probably won’t be asked to do other unethical things—if she isn’t fired. Maybe nobody has ever challenged William’s unethical behavior and his reaction may be one of respect rather than anger and retribution. Being ethically compromised is no way to start a new job.
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(For Instructor Use Only)
BYP 5-9
ALL ABOUT YOU ACTIVITY
In order for revenue to be recognized the performance obligation must be satisfied. In this case Midwest has an obligation to provide goods with a value equal to the gift card. That obligation is not fulfilled until one of two things happens: Either the customer redeems the card for goods, or the card expires. Until either of those events occurs Midwest cannot record revenue.
.
(For Instructor Use Only)
5-85
BYP 5-10
FASB CODIFICATION ACTIVITY
(a) 1. Inventory is the aggregate of those items of tangible personal property that have any of the following characteristics: a. Held for sale in the ordinary course of business b. In process of production for such sale c. To be currently consumed in the production of goods or services to be available for sale. The term inventory embraces goods awaiting sale (the merchandise of a trading concern and the finished goods of a manufacturer), goods in the course of production (work in process), and goods to be consumed directly or indirectly in production (raw materials and supplies). This definition of inventories excludes long-term assets subject to depreciation accounting, or goods which, when put into use, will be so classified. The fact that a depreciable asset is retired from regular use and held for sale does not indicate that the item should be classified as part of the inventory. Raw materials and supplies purchased for production may be used or consumed for the construction of long-term assets or other purposes not related to production, but the fact that inventory items representing a small portion of the total may not be absorbed ultimately in the production process does not require separate classification. By trade practice, operating materials and supplies of certain types of entities such as oil producers are usually treated as inventory. 2. A customer is a reseller or a consumer, either an individual or a business that purchases a vendor’s products or services for end use rather than for resale. This definition is consistent with paragraph 280-10-50-42, which states that a group of entities known to a reporting entity to be under common control shall be considered as a single customer, and the federal government, a state government, a local government (for example, a county or municipality), or a foreign government each shall be considered as a single customer. Customer includes any purchaser of the vendor’s products at any point along the distribution chain, regardless of whether the purchaser acquires the vendor’s products directly or indirectly (for example, from a distributor) from the vendor. For example, a vendor may sell its products to a distributor who in turn resells the products to a retailer. The retailer in that example is a customer of the vendor.
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(For Instructor Use Only)
BYP 5-10 (Continued) (b) 330-10-35-15 Only in exceptional cases may inventories properly be stated above cost. For example, precious metals having a fixed monetary value with no substantial cost of marketing may be stated at such monetary value; any other exceptions must be justifiable by inability to determine appropriate costs, immediate marketability at quoted market price, and the characteristic of unit interchangeability.
.
(For Instructor Use Only)
5-87
IFRS CONCEPTS AND APPLICATION
IFRS5-1 Expenses may be classified by “nature” or by “function”. The “nature-ofexpense” classification organizes expenses by type of expense, such as salaries, depreciation, rent, or supplies. The “function-of-expense” classification presents expenses by type of business activity. Examples would include cost of goods sold, selling, administrative, operating, and non-operating. IFRS5-2 By function By nature By nature By function By nature By nature By function
Cost of goods sold Depreciation expense Salaries and wages expense Selling expenses Utilities expense Delivery expense General and administrative expenses
IFRS5-3 REINSCH COMPANY Comprehensive Income Statement For the Year Ended 2014 (in thousands of euros) Net income ............................................................................... Unrealized gain related to revaluation of buildings .............. Unrealized loss non-trading securities .................................. Items not recognized on the income statement .................... Total comprehensive income ........................................
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.
(For Instructor Use Only)
€150 € 10 (35) (25) €125
IFRS5-4
INTERNATIONAL FINANCIAL REPORTING PROBLEM
(a) Zetar uses a multiple step format. The income statement isolates gross profit, operating profit, and profit from continuing operations before taxation rather than simply showing total revenues less total expenses to arrive at net income. (b) Zetar uses Finance Costs rather than Interest Expense on its income statement. (c) Zetar’s tax rate is approximately 29% (£1,656/£5,635). (d) Zetar’s income statement shows Adjusted results, Adjusting items, and Total amounts for revenue and expense items. Note 3.23 indicates that Zetar considers the adjusted results and adjusted EPS to provide additional useful information on its performance. It goes on to list a number of unusual items that it has adjusted for on its income statement. One-off items are listed as part of the adjustments group. One-off items are non-recurring material costs or revenues of an unusual nature that have been excluded from the Adjusted results on the income statement in order to provide a more consistent measure of underlying performance.
.
(For Instructor Use Only)
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5-90
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(For Instructor Use Only)
CHAPTER 6 Reporting and Analyzing Inventory Learning Objectives 1. Describe how to classify inventory and inventory quantities. 2. Explain the basis of accounting for inventories and apply the inventory cost flow methods under a periodic inventory system. 3. Explain the financial statement and tax effects of each of the inventory cost flow assumptions. 4. Explain the lower-of-cost-or-market basis of accounting for inventories. 5. Compute and interpret the inventory turnover ratio. 6. Describe the LIFO reserve and explain its importance for comparing results of different companies. *7. Apply the inventory cost flow methods to perpetual inventory records. *8. Indicate the effects of inventory errors on the financial statements.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO
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DO IT! Review Exercises 1.
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Problems: Set A 1. 2.
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Problems: Set B 1. 2. .
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(For Instructor Use Only)
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6-1
*Continuing Cookie Solutions for this chapter are available online.
6-2
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(For Instructor Use Only)
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Determine items and amounts to be recorded in inventory.
Moderate
15–20
2A
Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis.
Simple
30–40
3A
Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost in a periodic inventory system and assess financial statement effects.
Simple
30–40
4A
Compute ending inventory, prepare income statements, and answer questions using FIFO and LIFO.
Moderate
30–40
5A
Calculate ending inventory, cost of goods sold, gross profit, and gross profit rate under periodic method; compare results.
Moderate
30–40
6A
Compare specific identification, FIFO, and LIFO under periodic method; use cost flow assumption to influence earnings.
Moderate
20–30
7A
Compute inventory turnover and days in inventory; compute current ratio based on LIFO and after adjusting for LIFO reserve.
Moderate
20–30
*8A
Calculate cost of goods sold, ending inventory, and gross profit for LIFO, FIFO, and moving-average under the perpetual system; compare results.
Moderate
30–40
*9A
Determine ending inventory under a perpetual inventory system.
Moderate
30–40
1B
Determine items and amounts to be recorded in inventory.
Moderate
15–20
2B
Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis.
Simple
30–40
3B
Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost in a periodic inventory system and assess financial statement effects.
Simple
30–40
4B
Compute ending inventory, prepare income statements, and answer questions using FIFO and LIFO.
Moderate
30–40
5B
Calculate ending inventory, cost of goods sold, gross profit, and gross profit rate under periodic method; compare results.
Moderate
30–40
Copyright © 2013 John Wiley & Sons, Inc.
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
6-3
ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number
Description
Difficulty Level
Time Allotted (min.)
6B
Compare specific identification, FIFO, and LIFO under periodic method; use of cost flow assumption to influence earnings.
Moderate
20–30
7B
Compute inventory turnover and days in inventory; compute current ratio based on LIFO and after adjusting for LIFO reserve.
Moderate
20–30
*8B
Calculate cost of goods sold, ending inventory, and gross profit under LIFO, FIFO, and moving-average under the perpetual system; compare results.
Moderate
30–40
*9B
Determine ending inventory under a perpetual inventory system.
Moderate
30–40
6-4
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(For Instructor Use Only)
ANSWERS TO QUESTIONS 1. Agree. Effective inventory management is frequently the key to successful business operations. Management attempts to maintain sufficient quantities and types of goods to meet expected customer demand. It also seeks to avoid the cost of carrying inventories that are clearly in excess of anticipated sales. 2. Inventory items have two common characteristics: (1) they are owned by the company and (2) they are intended to be sold to customers in the ordinary course of business. 3. Just-in-time inventory management is the practice of manufacturing or purchasing inventory “just-intime” to fill a sales order. Since inventory quantities are kept at very low amounts, just-in-time management reduces the costs associated with carrying inventory as well as the risk of obsolescence. 4. Taking a physical inventory involves actually counting, weighing, or measuring each kind of inventory on hand. Retailers, such as hardware stores, generally have thousands of different items to count. This is normally done when the store is closed. Jill will probably count items and mark the quantity, description, and inventory number on prenumbered inventory tags. 5. (a) (1) (2)
The goods will be included in Millar Company’s inventory if the terms of sale are FOB destination. The goods will be included in Branyan Corporation’s inventory if the terms of sale are FOB shipping point.
(b) Millar Company should include goods shipped to a consignee in its inventory. Goods held by Millar Company on consignment should not be included in inventory. 6. Inventoriable costs are $3,015 (invoice cost $3,000 + freight charges $75 − purchase discounts $60). 7. The primary basis of accounting for inventories is cost in accordance with the historical cost principle. The major objective of accounting for inventories is the proper determination of net income in accordance with the expense recognition principle. 8. Actual physical flow may be impractical because many items are indistinguishable from one another. Actual physical flow may be inappropriate because management may be able to manipulate net income through specific identification of items sold. 9. The major advantage of the specific identification method is that it tracks the actual physical flow of the goods available for sale. The major disadvantage is that management could manipulate net income. 10. No. Selection of an inventory costing method is a management decision. However, once a method has been chosen, it should be consistently applied. 11. (a) FIFO, (b) Average-cost, (c) LIFO.
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(For Instructor Use Only)
6-5
Questions Chapter 6 (Continued) 12. Long Company is using the FIFO method of inventory costing, and Windsor Company is using the LIFO method. Under FIFO, the latest goods purchased remain in inventory. Thus, the inventory on the balance sheet should be close to current costs. The reverse is true of the LIFO method. Long Company will have the higher gross profit because cost of goods sold will include a higher proportion of goods purchased at earlier (lower) costs. 13. Espinosa Corporation may experience severe cash shortages if this policy continues. All of its net income is being paid out as dividends, yet some of the earnings must be reinvested in inventory to maintain inventory levels. Some earnings must be reinvested because net income is computed with cost of goods sold based on older, lower costs while the inventory must be replaced at current, higher costs. Because of this factor, net income under FIFO is sometimes referred to as including “phantom profits.” In addition, Espinosa is also depleting cash more quickly under FIFO because FIFO results in higher income tax payments. 14. George is partially correct. In a period of inflation, FIFO produces higher net income because the lower unit costs of the first units purchased is matched against revenues. A switch from LIFO to FIFO will thus produce higher net income and a larger bonus for George, which he perceives as being “better off”. It is more difficult to determine if the company would be “better off” if it used FIFO instead of LIFO. Using FIFO would mean higher reported income and higher inventory values which investors usually interpret as “better” results. On the other hand, the higher net income reported with FIFO would mean higher bonus and income tax expenses. Since both of these items require cash, switching to FIFO may leave the company with an inadequate amount of cash to meet normal operating needs. 15. When prices are increasing, LIFO results in higher cost of goods sold, and lower income relative to FIFO. Because LIFO income is lower the company pays lower taxes, which results in higher cash flows. The quality of earnings ratio is net cash provided by operating activities divided by income. The use of LIFO will increase the numerator (net cash provided by operating activities) and decrease the denominator (net income), both of which increase the value of the ratio. 16. Tootsie Roll uses LIFO for U.S. inventories and FIFO for foreign inventories. LIFO is not allowed in most countries outside the U.S., therefore Tootsie Roll uses a different method for foreign inventories. 17. Alison should know the following: (a) A departure from the cost basis of accounting for inventories is justified when the value of the goods is no longer as great as its cost. The writedown to market should be recognized in the period in which the price decline occurs. (b) Market means current replacement cost, not selling price. For a merchandising company, market is the cost at the present time from the usual suppliers in the usual quantities. 18. Rondeli Music Center should report the TVs at $350 each for a total of $1,750. $350 is the current replacement cost under the lower-of-cost-or-market (LCM) basis of accounting for inventories. A decline in replacement cost usually leads to a decline in the selling price of the item. Valuation at LCM is conservative. 19. Lower-of-cost-or-market can be applied after any of the cost flow assumptions has been used, including LIFO, FIFO, average-cost, or specific identification.
6-6
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(For Instructor Use Only)
20. Freight-out expense is not a cost associated with purchasing goods, so it should not affect cost of goods sold. It is an expense incurred to sell goods already purchased, so it should be reported as a selling expense. Questions Chapter 6 (Continued) 21.
Dipoto Company should disclose (1) the major inventory classifications, (2) the basis of accounting (cost or lower-of-cost-or-market), and (3) the costing method (FIFO, LIFO, or average).
22.
An inventory turnover that is too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory outages may also cause customer ill will and result in lost future sales.
23.
The LIFO reserve is a required disclosure for companies that employ LIFO. It is the difference between ending inventory using LIFO and ending inventory if FIFO were used instead. Ignoring a large LIFO reserve when analyzing a company can distort any comparisons that an analyst might try to make with a company’s competitors that used FIFO.
*24. Disagree. The results under the FIFO method are the same but the results under the LIFO method may be different. The reason is that the pool of inventoriable costs (costs of goods available for sale) is not the same. Under a periodic system, the pool of costs is the goods available for sale for the entire period, whereas under a perpetual system, the pool is the goods available for sale up to the date of sale. *25. In a perpetual inventory system, the average is a moving average of goods available for sale after each purchase. In a periodic inventory system, the average is a weighted average based on total goods available for sale for the period. *26. (a) Marshall Company’s 2013 net income will be understated $5,000; (b) 2014 net income will be overstated $5,000; and (c) the combined net income for the two years will be correct.
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(For Instructor Use Only)
6-7
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 6-1 (a) Ownership of the goods belongs to the consignor (Tiffee). Thus, these goods should be included in Tiffee’s inventory. (b) The goods in transit should not be included in the inventory count because ownership by Tiffee does not occur until the goods reach the buyer. (c) The goods being held belong to the customer. They should not be included in Tiffee’s inventory. (d) Ownership of these goods rests with the other company (the consignor). Thus, these goods should not be included in the physical inventory. BRIEF EXERCISE 6-2 (a) The ending inventory under FIFO consists of 200 units at $9 for a total allocation of $1,800. (b) The ending inventory under LIFO consists of 200 units at $6 for a total allocation of $1,200. BRIEF EXERCISE 6-3 Average unit cost is $7.917 computed as follows: 300 400 500 1,200
X X X
$6 $8 $9
= $1,800 = 3,200 = 4,500 $9,500
$9,500 ÷ 1,200 = $7.917 The cost of the ending inventory is $1,583 (200 X $7.917).
6-8
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(For Instructor Use Only)
BRIEF EXERCISE 6-4 (a) FIFO would result in the highest net income. (b) FIFO would result in the highest ending inventory. (c) LIFO would result in the lowest income tax expense (because it would result in the lowest taxable income). (d) Average cost would result in the most stable income over a number of years because it averages out any big changes in the cost of inventory. BRIEF EXERCISE 6-5 Cost of goods sold under: LIFO
FIFO
Cost of goods available for sale Less: Ending inventory Cost of goods sold
$6 X 100 $7 X 200 $8 X 140 $ 3,120 $ 1,160* $ 1,960
$6 X 100 $7 X 200 $8 X 140 $ 3,120 $ 1,400** $ 1,720
*(100 X $6) + (80 X $7)
**(140 X $8) + (40 X $7)
Purchases
Since the cost of goods sold is $240 ($1,960 – $1,720) less under FIFO that is the amount of the phantom profit. It is referred to as “phantom profit” because FIFO matches current selling prices with old inventory costs. To replace the units sold the company will have to pay the current price of $8 per unit, rather than the $6 per unit which some of the units were priced at under FIFO. Therefore, profit under LIFO is more representative of what the company can expect to earn in future periods.
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(For Instructor Use Only)
6-9
BRIEF EXERCISE 6-6 (a) LIFO results in a higher quality of earnings ratio. (b) FIFO results in higher phantom profits. (c) FIFO results in higher net income. (d) LIFO results in lower taxes. (e) FIFO results in lower net cash provided by operating activities. BRIEF EXERCISE 6-7 Inventory Categories Cameras Camcorders DVDs Total valuation
Cost $12,500 9,000 13,000
Market $13,400 9,500 12,200
LCM $12,500 9,000 12,200 $33,700
The lower-of-cost-of-market value is $33,700. BRIEF EXERCISE 6-8 Inventory turnover:
Days in inventory:
$349,114 $349,114 = = 2.54 times ($119,035+ $155,377) ÷ 2 $137,206
365 =144 days 2.54
BRIEF EXERCISE 6-9 2014 ending inventory using LIFO ............................ 2014 LIFO reserve....................................................... 2014 ending inventory assuming FIFO .....................
6-10
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(For Instructor Use Only)
$46,850,000 30,346,000 $77,196,000
*BRIEF EXERCISE 6-10 (1) FIFO June 1 sale: Aug. 27 sale:
Cost of Goods Sold 25 units @ $10 = $250 25 units @ $10 = $250 5 units @ $15 = 75 325 $575 (2) LIFO
June 1 sale: Aug. 27 sale:
25 units @ $10 = 30 units @ $15 =
Cost of Goods Sold $250 $450 $700
(3) MOVING-AVERAGE June 1 sale: Aug. 27 sale:
Cost of Goods Sold 25 units @ $10 = $250 30 units @ $12.727* = 382 $632
* [(50 – 25) X $10]+ (30X $15) 55 units
*BRIEF EXERCISE 6-11 The understatement of ending inventory caused cost of goods sold to be overstated $7,000 and net income to be understated $7,000. The correct net income for 2014 is $99,000 ($92,000 + $7,000). Total assets in the balance sheet will be understated by the amount that ending inventory is understated, $7,000.
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(For Instructor Use Only)
6-11
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 6-1 Inventory per physical count .................................................. Inventory out on consignment ............................................... Inventory sold, in transit at year-end ..................................... Inventory purchases, in transit at year-end ........................... Correct December 31 inventory .............................................
$300,000 28,000 0 13,000 $341,000
DO IT! 6-2 Cost of goods available for sale = (3,000 X $5) + (8,000 X $7) = $71,000 Ending inventory = 3,000 + 8,000 – 9,400 = 1,600 units (a) FIFO: $71,000 – (1,600 X $7) = $59,800 (b) LIFO: $71,000 – (1,600 X $5) = $63,000 (c) Average-cost: $71,000/11,000 = $6.455 per unit 9,400 X $6.455 = $60,677 DO IT! 6-3 The lowest value for each inventory type is: Small $61,000, Medium $260,000, and Large $152,000. The total inventory value under the lower-of-cost-ormarket approach is the sum of these figures, $473,000. DO IT! 6-4 2013 Inventory turnover
2014
$1,200,000 $1,425,000 = 6.3 = 9.5 ($170,000 + $210,000)/2 ($210,000 + $90,000)/2
Days in inventory
365 ÷ 6.3 = 57.9 days
365 ÷ 9.5 = 38.4 days
The company experienced a very significant decline in its ending inventory as a result of the just-in-time inventory. This decline improved its inventory turnover ratio and its days in inventory. Also, its sales increased by 19%. It is possible that this increase is the result of a more focused inventory policy. It appears that this change is a win-win situation for Defoor Company.
6-12
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(For Instructor Use Only)
SOLUTIONS TO EXERCISES EXERCISE 6-1 Ending inventory⎯physical count................................................ 1. No effect−title passes to purchaser upon shipment when terms are FOB shipping point .............................. 2. No effect−title does not transfer to Gallup until goods are received .......................................................... 3. Add to inventory: Title passed to Gallup when goods were shipped ........................................................ 4. Add to inventory: Title remains with Gallup until purchaser receives goods .............................................. 5. Subtract from inventory: The goods did not arrive prior to year-end. The goods,therefore, cannot be included in the inventory .................................................................... Correct inventory ...........................................................................
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(For Instructor Use Only)
$275,000 0 0 25,000 51,000 (42,000) $309,000
6-13
EXERCISE 6-2 Ending inventory-as reported .......................................................
$740,000
1.
Subtract from inventory: The goods belong to Mather Corporation. Knight is merely holding them as a consignee. .................................................. (228,000)
2.
Add to inventory: The goods belong to Knight as soon as they are shipped (December 28). .........................................................................
40,000
Subtract from inventory: Office supplies should be carried in a separate account. They are not considered inventory held for resale. ..............................
(17,000)
Add to inventory: The goods belong to Knight until they are shipped (Jan. 1). ................................................
29,000
Add to inventory: Houchins Sales ordered goods with a cost of $6,000. Knight should record the corresponding sales revenue of $10,000. Knight’s decision to ship extra “unordered” goods does not constitute a sale. The manager’s statement that Houchins could ship the goods back indicates that Knight knows this over-shipment is not a legitimate sale. The manager acted unethically in an attempt to improve Knight’s reported income by over-shipping. ..........................................................................
44,000*
Subtract from inventory: GAAP requires that inventory be valued at the lower of cost or market. Obsolete parts should be adjusted from cost to zero if they have no other use. ..........................
(50,000)
3.
4. 5.
6.
Correct inventory .......................................................................... *($50,000 – $6,000)
6-14
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(For Instructor Use Only)
$558,000
EXERCISE 6-3 (a) Do not include—Mateo does not own items held on consignment. (b) Include in inventory—Mateo still owns the items as they were only shipped on consignment. (c) Include in inventory—Shipping terms FOB destination means that Mateo owns the items until they reach the customer. (d) Do not include in inventory—Because the shipping terms are FOB shipping point, ownership has transferred to the customer. Mateo should record this amount as a sale on the income statement. (e) Do not include in inventory—Because the shipping terms are FOB destination, Mateo does not own the goods until they arrive at Mateo’s premises. (f) Include in inventory—Shipping terms FOB shipping point means that ownership transferred at the time of shipping and therefore, Mateo owns the goods in transit. (g) Do not include in inventory. Record as Supplies on the balance sheet.
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(For Instructor Use Only)
6-15
EXERCISE 6-4 FIFO Beginning inventory (12 X $100) .................................. Purchases Sept. 12 (45 X $103) ................................................ Sept. 19 (50 X $104) ................................................ Sept. 26 (20 X $105) ................................................ Cost of goods available for sale ................................... Less: Ending inventory (20 X $105) + (5 X $104) ....... Cost of goods sold ........................................................ Date 9/1 9/12 9/19
Units 12 45 45 102
PROOF Unit Cost $100 103 104
LIFO Cost of goods available for sale ........................................... Less: Ending inventory (12 X $100) + (13 X $103) ............ Cost of goods sold ................................................................ Date 9/26 9/19 9/12
Units 20 50 32 102
PROOF Unit Cost $105 104 103
$ 1,200 $4,635 5,200 2,100
11,935 13,135 2,620 $10,515 Total Cost $ 1,200 4,635 4,680 $10,515 $13,135 2,539 $10,596 Total Cost $ 2,100 5,200 3,296 $10,596
AVERAGE-COST $13,135 ÷ 127 = $103.425 weighted-average unit cost Cost of goods available for sale ........................................... Less: Ending inventory (25 X $103.425) .............................. Cost of goods sold ............................................................... Units 102 6-16
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(For Instructor Use Only)
PROOF Unit Cost $103.425
$13,135 2,586 $10,549 Total Cost $ 10,549
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(For Instructor Use Only)
6-17
EXERCISE 6-5 (a) FIFO Beginning inventory (30 X $9) ......................................... Purchases May 15 (25 X $10) ....................................................... May 24 (38 X $11) ....................................................... Cost of goods available for sale (93 units) ..................... Less: Ending inventory [(93 – 74) X $11] ....................... Cost of goods sold ...........................................................
$270 $250 418
668 938 209 $729
PROOF Date 5/1 5/15 5/24
Units 30 25 19 74
Unit Cost $ 9 10 11
Total Cost $270 250 209 $729
(b) LIFO Cost of goods available for sale ................................................. Less: Ending inventory (19 X $9) .............................................. Cost of goods sold ......................................................................
$938 171 $767
PROOF Date 5/24 5/15 5/1
6-18
Units 38 25 11 74
.
(For Instructor Use Only)
Unit Cost $11 10 9
Total Cost $418 250 99 $767
EXERCISE 6-5 (Continued) (c) AVERAGE-COST $938 ÷ 93 = $10.086 weighted-average unit cost Cost of goods available for sale................................................... Less: Ending inventory (19 X $10.086) ........................................ Cost of goods sold ........................................................................
$938.00 191.63 $746.37
PROOF Units 74
Unit Cost $10.086
Total Cost $746.36*
*$.01 rounding difference. EXERCISE 6-6 (a) FIFO Cost of Goods Sold (#1012) $52 + (#1045) $48 = $100 (b) It could choose to sell specific units purchased at specific costs if it wished to impact earnings selectively. If it wished to minimize earnings it would choose to sell the units purchased at higher costs–in which case the Cost of Goods Sold would be $100. If it wished to maximize earnings it would choose to sell the units purchased at lower costs–in which case the cost of goods sold would be $88 ($40 + $48). (c) The FIFO method provides a more appropriate balance sheet valuation and reduces the opportunity to manipulate earnings. (The answer may vary depending on the method the student chooses.)
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(For Instructor Use Only)
6-19
EXERCISE 6-7 (a)
(1) FIFO Beginning inventory (120 X $5) ................................. Purchases June 12 (370 X $6) ............................................... June 23 (200 X $7) ............................................... Cost of goods available for sale................................ Less: Ending inventory (200 X $7) + (30 X $6) ........ Cost of goods sold .....................................................
$ 600 $2,220 1,400
3,620 4,220 1,580 $2,640
(2) LIFO Cost of goods available for sale................................ Less: Ending inventory (120 X $5) + (110 X $6) ...... Cost of goods sold .....................................................
$4,220 1,260 $2,960
(3) AVERAGE-COST Cost of Goods Total Units Weighted-Average Available for Sale ÷ Available for Sale = Unit Cost $4,220 690 $6.116 Ending inventory (230 X $6.116) $1,407 Cost of goods sold (460 X $6.116) $2,813 or $4,220 – $1,407 = $2,813 (b) The FIFO method will produce the highest ending inventory because costs have been rising. Under this method, the earliest costs are assigned to cost of goods sold, and the latest costs remain in ending inventory. The LIFO method will produce the highest cost of goods sold for Eggers Company. Under LIFO the most recent costs are charged to cost of goods sold and the earliest costs are included in the ending inventory. (c) The average-cost ending inventory ($1,407) is higher than LIFO ($1,260) but lower than FIFO ($1,580). For cost of goods sold, average cost ($2,813) is higher than FIFO ($2,640) but lower than LIFO ($2,960). (d) The simple average would be (($5 + $6 + $7)/3) = $6. However, the average cost method uses a weighted average unit cost, not a simple average of unit costs. 6-20
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(For Instructor Use Only)
EXERCISE 6-8 (a) Sales ...................................................................... Cost of goods sold ............................................... Operating expenses (including depreciation) .... Income before income taxes ............................... Income tax expense ............................................. Net income ............................................................ (b) Sales ...................................................................... Less: Cash paid for inventory purchases .......... Cash paid for operating expenses ($27,000 – $10,000) ................................. Cash paid for income tax.......................... Net cash provided by operating activities .......... (c) Net cash provided by operating activities .......... ÷ Net income ......................................................... Quality of earnings ratio ......................................
LIFO $86,000 38,000 27,000 21,000 6,300 $14,700
FIFO $86,000 29,000 27,000 30,000 9,000 $21,000
LIFO $86,000 32,000
FIFO $86,000 32,000
17,000 6,300 $30,700
17,000 9,000 $28,000
LIFO $30,700 $14,700 2.09
FIFO $28,000 $21,000 1.33
LIFO results in a higher quality of earnings ratio because, assuming rising prices, it results in lower taxes, and thus higher net cash provided by operating activities. This increases the numerator of the ratio relative to FIFO. Also, LIFO results in lower net income, which decreases the denominator of the ratio relative to FIFO. Both effects result in a higher quality of earnings ratio.
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(For Instructor Use Only)
6-21
EXERCISE 6-9 Inventory at Market Lower-of-CostLower-of-CostCost/Unit Value/Unit or-Market Units or-Market Cameras: Minolta Canon Light Meters: Vivitar Kodak Total
$170 145
$158 152
$158 145
5 7
$ 790 1,015
125 120
114 135
114 120
12 10
1,368 1,200 $4,373
EXERCISE 6-10 2012
2013
2014
$18,038 ($1,926 +$2,290) ÷ 2
$20,351 ($2,290 +$2,522) ÷ 2
$20,099 ($2,522+$2,618) ÷2
$18,038 =8.6 times $2,108
$20,351 =8.5 times $2,406
$20,099 =7.8 times $2,570
Days in inventory
365 = 42.4 days 8.6
365 = 42.9 days 8.5
365 = 46.8 days 7.8
Gross profit rate
$39,474 – $18,038 = 54.3% $39,474
$43,251 – $20,351 = 52.9% $43,251
$43,232 – $20,099 = 53.5% $43,232
Inventory turnover
The inventory turnover decreased by approximately 10% from 2012 to 2014 while the days in inventory increased by a similar amount (10%) over the same time period. Both of these changes would be considered unfavorable since it’s better to have a higher inventory turnover with a corresponding lower days in inventory. PepsiCo., Inc.’s gross profit rate decreased by 1.5% from 2012 to 2014.
6-22
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(For Instructor Use Only)
EXERCISE 6-11 (a) Inventory turnover
$16,255 $16,255 = = 5.98 ($3,042 + $2,397) ÷ 2 $2,719.5
Days in inventory
365 = 61 days 5.98
(b) Based on data presented: Current ratio $30,857 ÷ $12,753 = 2.42 : 1 After adjusting for LIFO reserve: Current ratio ($30,857 + $1,367) ÷ $12,753 = 2.53 : 1 (c) After adjusting for the LIFO reserve, Deere’s current ratio increases from 2.42 : 1 to 2.53 : 1. Deere’s liquidity looks slightly better after the adjustment. *EXERCISE 6-12 (a) Date June 1
Purchases
June 12
(370 @ $6) $2,220
FIFO Cost of goods sold
Balance (120 @ $5) $ 600 (120 @ $5) (370 @ $6)
June 15 June 23
(120 @ $5)
$ 600
(290 @ $6)
$1,740
(200 @ $7) $1,400
(80 @ $6) $ 480 (80 @ $6) (200 @ $7)
June 27
(50 @ $6)
$2,820
$1,880
$ 300 (30 @ $6) $2,640
(200 @ $7)
$1,580
Ending inventory: $1,580. Cost of goods sold: $2,640. .
(For Instructor Use Only)
6-23
*EXERCISE 6-12 (Continued)
Date Purchases June 1 June 12 (370 @ $6) $2,220 June 15 June 23
LIFO Cost of Goods Sold
(370 @ $6) (40 @ $5)
$2,220 $ 200
(50 @ $7)
$ 350 $2,770
Balance (120 @ $5) $ 600 (120 @ $5) $2,820 (370 @ $6) (80 @ $5) $ 400 (80 @ $5) $1,800 (200 @ $7) (80 @ $5) $1,450 (150 @ $7)
(200 @ $7) $1,400
June 27
Ending inventory: $1,450. Cost of goods sold: $2,770.
Date
Purchases
Moving-Average Cost of Goods Sold
June 1 June 12
(120 @ $5) (370 @ $6) $2,220
June 15 June 23
Balance (490 @ $5.755) $2,820
(410 @ $5.755) $2,360* (80 @ $5.755) (200 @ $7) $1,400
June 27
$ 460*
(280 @ $6.643*) $1,860 (50 @ $6.643) $ 332* (230 @ $6.643) $1,528 $2,692
*rounded Ending inventory: $1,528. Cost of goods sold: $2,692.
6-24
$ 600
.
(For Instructor Use Only)
*EXERCISE 6-12 (Continued) (b) FIFO gives the same ending inventory and cost of goods sold values under both the periodic and perpetual inventory system. LIFO and moving-average give different ending inventory and cost of goods sold values under the periodic and perpetual inventory systems. (c) The simple average would be [($5 + $6 + $7) ÷ 3] or $6. However, the moving-average method uses a weighted-average unit cost that changes each time a purchase is made rather than a simple average.
.
(For Instructor Use Only)
6-25
*EXERCISE 6-13 Date 9/1 9/5 9/12
FIFO Cost of Goods Sold
Purchases
9/19 9/26
(8 @ $100)
$
(4 @ $100) (44 @ $103)
$ 4,932
(45 @ $103) $4,635
9/16
Balance (12 @ $100) $1,200 800 (4 @ $100) $ 400 (4 @ $100) (45 @ $103) $5,035
(50 @ $104) $5,200 (20 @ $105) $2,100
9/29
(1 @ $103) (45 @ $104)
$ 4,783 $10,515
(1 @ $103) (1 @ $103) (50 @ $104) (1 @ $103) (50 @ $104) (20 @ $105) (5 @ $104) (20 @ $105)
$ 103 $5,303 $7,403 2,620
Ending inventory = $2,620
Date 9/1 9/5 9/12
Purchases
9/26
(45 @ $103) (3 @ $100)
$ 4,935
(20 @ $105) $2,100 (20 @ $105) (26 @ $104)
Ending inventory = $2,596
6-26
$
(50 @ $104) $5,200
9/29
.
(For Instructor Use Only)
Balance (12 @ $100) $1,200 800 (4 @ $100) $ 400 (4 @ $100) (45 @ $103) $5,035
(8 @ $100) (45 @ $103) $4,635
9/16 9/19
LIFO Cost of Goods Sold
(1 @ $100) (1 @ $100) (50 @ $104) (1 @ $100) (50 @ $104) (20 @ $105)
$ 4,804 (1 @ $100) $10,539 (24 @ $104)
$ 100 $5,300 $7,400
$2,596
*EXERCISE 6-13 (Continued) Date 9/1 9/5 9/12 9/16 9/19 9/26 9/29
Purchases
MOVING-AVERAGE Cost of Goods Sold
Balance (12 @ $100) $1,200 (8 @ $100) $ 800 (4 @ $100) $ 400 a (45 @ $103) $4,635 (49 @ $102.755) $5,035 (48 @ $102.755) $ 4,932* (1 @ $102.755) $ 103 (50 @ $104) $5,200 (51 @ $103.980)b $5,303 (20 @ $105) $2,100 (71 @ $104.268)c $7,403 (46 @ $104.268) $ 4,796* (25 @ $104.268) $2,607 $10,528
Ending inventory = $2,607 *Rounded a 5,035 ÷ 49 = $102.755 b 5,303 ÷ 51 = $103.980 c 7,403 ÷ 71 = $104.268 *EXERCISE 6-14 Beginning inventory................................................... Cost of goods purchased .......................................... Cost of goods available for sale................................ Less: Corrected ending inventory ........................... Cost of goods sold ..................................................... a
2013 2014 $ 20,000 $ 28,000 164,000 175,000 184,000 203,000 28,000a 42,000b $156,000 $161,000
$30,000 – $2,000 = $28,000 $37,000 + $5,000 = $42,000
b
.
(For Instructor Use Only)
6-27
*EXERCISE 6-15 (a) Sales..................................................................... Cost of goods sold Beginning inventory .................................... Cost of goods purchased ............................ Cost of goods available for sale ................. Less: Ending inventory ($40,000 – $8,000).............................. Cost of goods sold ............................. Gross profit..........................................................
2013 2014 $210,000 $250,000 32,000 173,000 205,000
32,000 202,000 234,000
32,000 173,000 $ 37,000
55,000 179,000 $ 71,000
(b) The cumulative effect on total gross profit for the two years is zero as shown below: Incorrect gross profits: Correct gross profits: Difference
$45,000 + $63,000 = $108,000 $37,000 + $71,000 = 108,000 $ 0
(c) Dear Mr./Ms. President: Because your ending inventory of December 31, 2013 was overstated by $8,000, your net income for 2013 was overstated and net income for 2014 was understated by $8,000. In a periodic system, the cost of goods sold is calculated by deducting the cost of ending inventory from the total cost of goods you have available for sale in the period. Therefore, if this ending inventory figure is overstated, as it was in December 2013, the cost of goods sold is understated and therefore net income will be overstated by that amount. Consequently, this overstated ending inventory figure goes on to become the next period’s beginning inventory amount and is a part of the total cost of goods available for sale. Therefore, the mistake repeats itself in the reverse. Thank you for allowing me to bring this to your attention. If you have any questions, please contact me at your convenience. Sincerely, 6-28
.
(For Instructor Use Only)
SOLUTIONS TO PROBLEMS PROBLEM 6-1A
(a) The goods should not be included in inventory as they were shipped FOB shipping point and shipped February 26. Title to the goods transfers to the customer February 26. Aber should have recorded the transaction in the Sales Revenue and Accounts Receivable accounts at the sales price. (b) The amount should not be included in inventory as they were shipped FOB destination and not received until March 2. The seller still owns the inventory. No entry is recorded. (c) Include $500 in inventory. (d) Include $400 in inventory. (e) $750 should be included in inventory as the goods were shipped FOB shipping point. (f)
The sale will be recorded on March 2. The goods should be included in inventory at the end of February at their cost of $280.
(g) The damaged goods should not be included in inventory. They should be recorded in a loss account since they are not saleable.
.
(For Instructor Use Only)
6-29
PROBLEM 6-2A
(a) COST OF GOODS AVAILABLE FOR SALE Date March 1 5 13 21 26
Explanation Units Beginning inventory 2,500 Purchase 2,000 Purchase 3,500 Purchase 5,000 Purchase 2,000 Total 15,000
Unit Cost $ 7 8 9 10 11
Total Cost $ 17,500 16,000 31,500 50,000 22,000 $137,000
(b) FIFO (1)
Ending Inventory Unit Total Date Units Cost Cost March 26 2,000 $11 $22,000 21 1,000 10 10,000 3,000* $32,000
(2) Cost of Goods Sold Cost of goods available for sale $137,000 Less: Ending inventory 32,000 Cost of goods sold $105,000
*15,000 – 12,000 = 3,000 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost March 1 2,500 $7 $ 17,500 5 2,000 8 16,000 13 3,500 9 31,500 21 4,000 10 40,000 12,000 $105,000
6-30
.
(For Instructor Use Only)
PROBLEM 6-2A (Continued) LIFO (1)
Ending Inventory Unit Total Date Units Cost Cost March 1 2,500 $7 $17,500 5 500 8 4,000 3,000 $21,500
(2) Cost of Goods Sold Cost of goods available for sale $137,000 Less: Ending inventory 21,500 Cost of goods sold $115,500
Proof of Cost of Goods Sold Unit Total Date Units Cost Cost March 26 2,000 $ 11 $ 22,000 21 5,000 10 50,000 13 3,500 9 31,500 5 1,500 8 12,000 12,000 $115,500 AVERAGE-COST (1) Ending Inventory (2) Cost of Goods Sold Cost of goods $137,000 ÷ 15,000 = $9.133 available for sale $137,000 Less: Ending Unit Total inventory 27,399 Units Cost Cost Cost of goods sold $109,601 3,000 $9.133 $27,399 (c) (1) As shown in (b), FIFO produces the highest inventory amount, $32,000. (2) As shown in (b), LIFO produces the highest cost of goods sold, $115,500.
.
(For Instructor Use Only)
6-31
PROBLEM 6-3A
(a)
COST OF GOODS AVAILABLE FOR SALE Date
Explanation
Units
Unit Cost
Jan. 1 Feb. 20 May 5 Aug. 12 Dec. 8
Beginning inventory Purchase Purchase Purchase Purchase Total
100 600 500 400 100 1,700
$ 8 9 10 11 12
Total Cost $
800 5,400 5,000 4,400 1,200 $16,800
(b) FIFO (1) Date
Ending Inventory Unit Units Cost
Dec. 8 Aug. 12
100 100 200*
$12 11
Total Cost
(2) Cost of Goods Sold Cost of goods available for sale $16,800
$1,200 1,100 $2,300
Less: Ending inventory Cost of goods sold
*1,700 – 1,500 = 200 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost Jan. 1 Feb. 20 May 5 Aug. 12
6-32
100 600 500 300 1,500
.
$ 8 9 10 11
(For Instructor Use Only)
$
800 5,400 5,000 3,300 $14,500
2,300 $14,500
PROBLEM 6-3A (Continued) LIFO (1) Date Jan. 1 Feb. 20
Ending Inventory Unit Units Cost 100 100 200
$8 9
Total Cost
(2) Cost of Goods Sold Cost of goods available for sale $16,800
$ 800 900 $1,700
Less: Ending inventory Cost of goods sold
1,700 $15,100
Proof of Cost of Goods Sold Unit Total Date Units Cost Cost Dec. 8 Aug. 12 May 5 Feb. 20
100 400 500 500 1,500
$12 11 10 9
$ 1,200 4,400 5,000 4,500 $15,100
AVERAGE-COST (1) Ending Inventory (2) Cost of Goods Sold Cost of goods $16,800 ÷ 1,700 = $9.882 available for sale $16,800 Less: Ending Unit Total inventory 1,976 Units Cost Cost Cost of goods sold $14,824 200 $9.882 $1,976 Proof of Cost of Goods Sold 1,500 @ $9.882 = $14,824* *Rounded up $1 (c) LIFO results in the lowest inventory amount for the balance sheet, $1,700. FIFO results in the lowest cost of goods sold for the income statement $14,500. .
(For Instructor Use Only)
6-33
PROBLEM 6-4A
(a)
TINKER, INC. Condensed Income Statements For the Year Ended December 31, 2014 Sales ..................................................................... Cost of goods sold Beginning inventory .................................... Cost of goods purchased ............................ Cost of goods available for sale ................. Less: Ending inventory .............................. Cost of goods sold ...................................... Gross profit .......................................................... Operating expenses ............................................ Income before income taxes .............................. Income tax expense (28%) .................................. Net income ........................................................... a
FIFO LIFO $750,000 $750,000 35,000 35,000 468,500 468,500 503,500 503,500 132,300a 116,400b 371,200 387,100 378,800 362,900 124,000 124,000 254,800 238,900 71,344 66,892 $183,456 $172,008
(25,000 @ $4.20) + (7,000 @ $3.90) = $132,300. (10,000 @ $3.50) + (22,000 @ $3.70) = $116,400.
b
(b) Answers to questions: (1) The FIFO method produces the inventory amount that most closely approximates the amount that would have to be paid to replace the inventory because the units are costed at the most recent purchase’s cost. (2) The LIFO method produces the net income amount that is a more likely induction of next period’s net income because the costs of the most recent purchases are matched against sales. (3) The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence.
6-34
.
(For Instructor Use Only)
PROBLEM 6-4A (Continued) (4) There will be $4,452 additional cash available under LIFO because income taxes are $66,892 under LIFO and $71,344 under FIFO. (5) The illusionary gross profit is $15,900 ($378,800 – $362,900) under FIFO. Under LIFO, Tinker Inc. has recovered the current replacement cost of the units ($387,100), whereas under FIFO, it has only recovered the earlier costs ($371,200). This means that under FIFO, the company must reinvest $15,900 of the gross profit to replace the units used. Answer in business-letter form: Dear Tinker Inc. After preparing the comparative condensed income statements for 2014 under the FIFO and LIFO methods, we have found the following: The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchases. This method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. There will be $4,452 additional cash available under LIFO because income taxes are $66,892 under LIFO and $71,344 under FIFO. There exists an illusionary gross profit of $15,900 ($378,800 – $362,900). Under LIFO, you have recovered the current replacement cost of the units ($387,100) whereas under FIFO you have only recovered the earlier costs ($371,200). This means that under FIFO, the company must reinvest $15,900 of the gross profit to replace the units used. Sincerely,
.
(For Instructor Use Only)
6-35
PROBLEM 6-5A
Cost of Goods Available for Sale Date Explanation October 1 Beginning inventory 9 Purchase 17 Purchase 25 Purchase
Ending Inventory in Units
Units 60 120 100 70 350
Unit Cost $24 26 27 29
Total Cost $1,440 3,120 2,700 2,030 $9,290
Sales revenue
Units available for sale Sales (100 + 60 + 110) Units remaining in ending inventory
350 270 80
Date October 11 22 29
Units 100 60 110 270
Unit Price $35 40 40
Total Sales $ 3,500 2,400 4,400 $10,300
(a) (1) LIFO (i) Ending inventory October 1 60 @ $24 = $1,440 9 20 @ $26 = $ 520 80 $1,960
(ii) Cost of goods sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
(iii) Gross profit Sales revenue Cost of goods sold Gross profit
(iv) Gross profit rate Gross profit $2,970 = 28.8% Net Sales $10,300
6-36
.
$10,300 7,330 $ 2,970
(For Instructor Use Only)
$9,290 1,960 $7,330
PROBLEM 6-5A (Continued) (2) FIFO (i) Ending inventory October 25 70 @ $29 = $2,030 October 17 10 @ $27 = $ 270 80 $2,300 (iii) Gross profit Sales revenue Cost of goods sold Gross profit
$10,300 6,990 $ 3,310
(ii) Cost of goods sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
$9,290 2,300 $6,990
(iv) Gross profit rate Gross profit $3,310 = =32.1% Net sales $10,300
(3) Average-Cost Weighted-average cost per unit:
(i) Ending inventory 80 @ $26.543 = $2,123* *rounded to nearest dollar (iii) Gross profit Sales revenue Cost of goods sold Gross profit
$10,300 7,167 $ 3,133
Cost of goods available for sale Units available for sale $9,290 =$26.543 350 (ii) Cost of goods sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
$9,290 2,123 $7,167
(iv) Gross profit rate Gross profit $3,133 = =30.4% Net sales $10,300
(b) LIFO produces the lowest ending inventory value, gross profit, and gross profit rate because its cost of goods sold is higher than FIFO or average-cost.
.
(For Instructor Use Only)
6-37
PROBLEM 6-6A
(a) (1) To maximize gross profit, Wooderson Gems should sell the diamonds with the lowest cost. Sale Date March 5
Cost of goods sold 150 @ $310 $ 46,500 30 @ $350 10,500 170 @ $350 59,500 220 @ $375 82,500 570 $199,000
March 25
Sales Revenue 180 @ $600 $108,000 390 @ 650 570
253,500 $361,500
Gross profit $361,500 – $199,000 = $162,500 (2) To minimize gross profit, Wooderson Gems should sell the diamonds with the highest cost. Sale Date March 5 March 25
Cost of goods sold 180 @ $350 $ 63,000 330 @ $375 123,750 20 @ $350 7,000 40 @ $310 12,400 570 $206,150
Sales Revenue 180 @ $600 $108,000 390 @ 650 253,500 570 $361,500
Gross profit: $361,500 – $206,150 = $155,350 (b) FIFO Cost of goods available for sale March 1 3 10
Beginning inventory Purchase Purchase
Goods available for sale Units sold Ending inventory
6-38
.
(For Instructor Use Only)
150 @ $310 200 @ $350 330 @ $375 680
$ 46,500 70,000 123,750 $240,250
680 570 110 @ $375
$41,250
PROBLEM 6-6A (Continued) Cost of goods available for sale – Ending inventory Cost of goods sold Gross profit:
$361,500 – $199,000 = $162,500.
(c) LIFO Cost of goods available for sale (from part b) – Ending inventory 110 @ $310 Cost of goods sold Gross profit:
$240,250 41,250 $199,000
$240,250 34,100 $206,150
$361,500 – $206,150 = $155,350.
(d) The choice of inventory method depends on the company’s objectives. Since the diamonds are marked and coded, the company could use specific identification. This could, however, result in “earnings management” by the company because, as shown, it could carefully choose which diamonds to sell to result in the maximum or minimum income. Employing a cost flow assumption, such as LIFO or FIFO, would reduce record-keeping costs; FIFO would result in higher income, but LIFO would reduce income taxes and provide better matching of current sales revenue with current costs.
.
(For Instructor Use Only)
6-39
PROBLEM 6-7A
(a) Inventory turnover
$166,259 ($13,921+ $14,939)÷2
$166,259 =11.5 times $14,430 Days in inventory
365 =31.7days 11.5
(b) Current ratio
$60,135 =.86:1 $70,308
(c) Current assets using LIFO LIFO reserve Current assets assuming FIFO
Current ratio
$60,135 1,423 $61,558
$61,558 =.88:1 $70,308
(d) The current ratio was slightly higher in (c) compared to (b) because current assets (i.e., inventory) are larger in (c).
6-40
.
(For Instructor Use Only)
*PROBLEM 6-8A (a) Sales: Date January 6 January 10 January 30 Total sales
180 @ $40 50 @ $45 130 @ $48
$ 7,200 2,250 6,240 $15,690
(1) LIFO Date January
Purchases 1
January January
2 6
(100 @ $22) $2,200
January
9
(75 @ $24) $1,800
(100 @ $22) $3,800 (80 @ $20)
January 10 January 23
Cost of goods sold
(50 @ $24) $1,200 (100 @ $25) $2,500
January 30
(100 @ $25) (25 @ $24) $3,200 (5 @ $20) $8,200
Balance (160 @ $20) $3,200 (160 @ $20) $5,400 (100 @ $22) (80 @ $20) $1,600 (80 @ $20) $3,400 (75 @ $24) (80 @ $20) $2,200 (25 @ $24) (80 @ $20) (25 @ $24) $4,700 (100 @ $25) (75 @ $20) $1,500
(i) Cost of goods sold: $8,200. (ii) Ending inventory = $1,500. (iii) Gross profit = $15,690 – $8,200 = $7,490.
.
(For Instructor Use Only)
6-41
*PROBLEM 6-8A (Continued) (2) FIFO Date January
1
January
2
January
6
January
Purchases
Cost of goods sold
(100 @ $22) $2,200 (160 @ $20) (20 @ $22)
9
$3,640
(75 @ $24) $1,800
January 10
(50 @ $22)
January 23
$1,100
(100 @ $25) $2,500
January 30
(30 @ $22) (75 @ $24) (25 @ $25)
$3,085
Balance (160 @ $20) $3,200 (160 @ $20) (100 @ $22)
$5,400
(80 @ $22)
$1,760
(80 @ $22) (75 @ $24)
$3,560
(30 @ $22) (75 @ $24)
$2,460
(30 @ $22) (75 @ $24) (100 @ $25)
$4,960
(75 @ $25)
$1,875
$7,825
(i) Cost of goods sold: $7,825. (ii) Ending inventory = $1,875. (iii) Gross profit = $15,690 – $7,825 = $7,865. (3) Moving-Average: Date January 1 January 2 January 6 January 9 January 10 January 23 January 30
Purchases
Cost of goods sold
(100 @ $22) $2,200 (180 @ $20.769) $3,738* (75 @ $24) $1,800 (50 @ $22.335) $1,117 (100 @ $25) $2,500 (130 @ $23.634) $3,072 $7,927
a
$5,400 ÷ 260 = $20.769 b $3,462 ÷ 155 = $22.335 *Rounded
c
Balance (160 @ $20) $3,200 a (260 @ $20.769) $5,400 (80 @ $20.769) $1,662 (155 @ $22.335)b $3,462 (105 @ $22.335) $2,345 (205 @ $23.634)c $4,845 (75 @ $23.634) $1,773
$4,845 ÷ 205 = $23.634
(i) Cost of goods sold: $7,927. (ii) Ending inventory = $1,773. (iii) Gross profit = $15,690 – $7,927 = $7,763.
6-42
.
(For Instructor Use Only)
*PROBLEM 6-8A (Continued) (b) LIFO
FIFO
MovingAverage
$15,690
$15,690
$15,690
8,200
7,825
7,927
Gross profit
$ 7,490
$ 7,865
$ 7,763
Ending Inventory
$ 1,500
$ 1,875
$ 1,773
Gross profit: Sales – Cost of goods sold
In a period of rising costs, the LIFO cost flow assumption results in the highest cost of goods sold and lowest gross profit. FIFO gives the lowest cost of goods sold and highest gross profit. The moving-average cost flow assumption results in amounts between the other two. On the balance sheet, FIFO gives the highest ending inventory (representing the most current costs); LIFO gives the lowest ending inventory (representing the oldest costs); and moving-average cost results in an ending inventory falling between the other two.
.
(For Instructor Use Only)
6-43
*PROBLEM 6-9A (a) (1)
FIFO Cost of Goods Sold
Date Purchases July 1 (7 @ $ 62) $434 6 (5 @ $62) $310 11 (3 @ $ 66) $198 14
(2 @ $62) (1 @ $66) $190
21 (4 @ $ 71) $284 27 (2)
(2 @ $66) (1 @ $71) $203
LIFO Cost of Goods Sold
Date Purchases July 1 (7 @ $ 62) $434 6 (5 @ $ 62) $310 11 (3 @ $ 66) $198 14 (3 @ $ 66) $198 21 (4 @ $ 71) $284 27
6-44
(2 @ $ 66) $132 (2 @ $ 66) (4 @ $ 71) $416 (3 @ $ 71) $213
MOVING-AVERAGE Cost of Date Purchases Goods Sold Balance July 1 (7 @ $ 62) $434 (7 @ $62) $434 6 (5 @ $62) $310 (2 @ $62) $124 11 (3 @ $ 66) $198 (5 @ $64.40)* $322 14 (3 @ $64.40) $193 (2 @ $64.40) $129 21 (4 @ $ 71) $284 (6 @ $68.83)** $413 27 (3 @ $68.83) $206*** (3 @ $68.83) $207*** *$322 ÷ 5 = $64.40. **$413 ÷ 6 = $68.83. ***rounded
(3)
(b)
Balance (7 @ $ 62) $434 (2 @ $ 62) $124 (2 @ $ 62) (3 @ $ 66) $322
(3 @ $ 71) $213
Balance (7 @ $ 62) $434 (2 @ $ 62) $124 (2 @ $ 62) $322 (3 @ $ 66) (2 @ $ 62) $124 (2 @ $ 62) $408 (4 @ $ 71) (2 @ $ 62) $195 (1 @ $ 71)
The highest ending inventory is $213 under the FIFO method.
.
(For Instructor Use Only)
SOLUTIONS TO PROBLEMS—SET B PROBLEM 6-1B
(a) Include $1,000 in inventory. The goods should be included in inventory as they were shipped FOB destination and were not received by the customer until April 1. Title to the goods transfers to the customer April 1. (b) Include $620 in inventory. The amount should be included in inventory as the goods were shipped FOB shipping point March 28. Sun, the buyer, owns the inventory as soon as it is shipped. (c) Exclude the goods from Sun’s inventory. The consigned goods are owned by Frederick Inc. No entry is recorded. (d) Include $380 in inventory. (e) Exclude from inventory as the goods were shipped FOB destination and not received until April 3. The seller still owns the inventory. No entry is recorded. (f)
.
The returned goods should be included in inventory and removed from cost of goods sold at $400. Sales returns and allowances should be increased and accounts receivable reduced by $640.
(For Instructor Use Only)
6-45
PROBLEM 6-2B
(a) Date June
COST OF GOODS AVAILABLE FOR SALE Explanation Units Unit Cost Beginning inventory 1,200 $3 Purchase 4,000 3 Purchase 7,500 5 Purchase 4,000 6 Total 16,700
1 3 18 29
(b)
FIFO (1)
Ending Inventory Unit Total Date Units Cost Cost June 29 4,000 $6 $24,000 18 2,200 5 11,000 6,200* $35,000 *16,700 – 10,500 = 6,200 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost June 1 1,200 $3 $ 3,600 3 4,000 3 12,000 18 5,300 5 26,500 10,500 $42,100
6-46
Total Cost $ 3,600 12,000 37,500 24,000 $77,100
.
(For Instructor Use Only)
(2) Cost of Goods Sold Cost of goods available for sale $77,100 Less: Ending inventory 35,000 Cost of goods sold $42,100
PROBLEM 6-2B (Continued) LIFO (1)
Ending Inventory Unit Total Date Units Cost Cost June 1 1,200 $3 $ 3,600 3 4,000 3 12,000 18 1,000 5 5,000 6,200 $20,600
(2) Cost of Goods Sold Cost of goods available for sale $77,100 Less: Ending inventory 20,600 Cost of goods sold $56,500
Proof of Cost of Goods Sold Unit Total Date Units Cost Cost June 29 4,000 $6 $24,000 18 6,500 5 32,500 10,500 $56,500 AVERAGE-COST (1) Ending Inventory (2) Cost of Goods Sold Cost of goods $77,100 ÷ 16,700 = $4.617 available for sale $77,100 Less: Ending Unit Total inventory 28,625 Units Cost Cost Cost of goods sold $48,475 6,200 $4.617 $28,625* *Rounded (c) (1) As shown in (b), due to rising prices, FIFO produces the highest inventory amount, $35,000. (2) As shown in (b), due to rising prices, LIFO produces the highest cost of goods sold, $56,500.
.
(For Instructor Use Only)
6-47
PROBLEM 6-3B
(a)
COST OF GOODS AVAILABLE FOR SALE Date
Explanation
Units
Jan. 1 Jan. 24 Apr. 12 Aug. 19 Nov. 30
Beginning inventory Purchase Purchase Purchase Purchase Total
200 800 400 600 350 2,350
(b)
$ 6 7 8 9 10
$ 1,200 5,600 3,200 5,400 3,500 $18,900
FIFO (1) Date
Ending Inventory Unit Units Cost
Nov. 30 Aug. 19
350 100 450*
$10 9
Total Cost
(2) Cost of Goods Sold Cost of goods available for sale $18,900
$3,500 900 $4,400
Less: Ending inventory Cost of goods sold
*2,350 – 1,900 = 450 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost Jan. 1 Jan. 24 Apr. 12 Aug. 19
6-48
Unit Cost Total Cost
200 800 400 500 1,900
.
$6 7 8 9
(For Instructor Use Only)
$ 1,200 5,600 3,200 4,500 $14,500
4,400 $14,500
PROBLEM 6-3B (Continued) LIFO (1) Date Jan. 1 Jan. 24
Ending Inventory Unit Units Cost 200 250 450
$6 7
Total Cost
(2) Cost of Goods Sold Cost of goods available for sale $18,900
$1,200 1,750 $2,950
Less: Ending inventory Cost of goods sold
2,950 $15,950
Proof of Cost of Goods Sold Unit Total Date Units Cost Cost Nov. 30 Aug. 19 Apr. 12 Jan. 24
350 600 400 550 1,900
$10 9 8 7
$ 3,500 5,400 3,200 3,850 $15,950
AVERAGE-COST (1) Ending Inventory (2) Cost of Goods Sold Cost of goods $18,900 ÷ 2,350 = $8.042 available for sale $18,900 Less: Ending Unit Total inventory 3,619 Units Cost Cost Cost of goods sold $15,281 450 $8.042 $3,619 (c) Due to rising prices, LIFO results in the lowest inventory amount for the balance sheet, $2,950. FIFO results in the lowest cost of goods sold for the income statement $14,500.
.
(For Instructor Use Only)
6-49
PROBLEM 6-4B (a)
WEIGEL INC. Condensed Income Statements For the Year Ended December 31, 2014
Sales ............................................................................ Cost of goods sold Beginning inventory ............................................ Cost of goods purchased ................................... Cost of goods available for sale......................... Less: Ending inventory ....................................... Cost of goods sold .............................................. Gross profit ................................................................. Operating expenses ................................................... Income before income taxes ..................................... Income tax expense (30%) ......................................... Net income .................................................................. a
FIFO LIFO $900,000 $900,000 16,000 16,000 470,500 470,500 486,500 486,500 42,550a 37,050b 443,950 449,450 456,050 450,550 185,000 185,000 271,050 265,550 81,315 79,665 $189,735 $185,885
(5,000 @ $4.83) + (4,000 @ $4.60) = $42,550. (4,000 @ $4.00) + (5,000 @ $4.21) = $37,050.
b
(b) Answers to questions: (1) The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchase’s cost. (2) The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. (3) The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. (4) There will be $1,650 additional cash available under LIFO because income taxes are $79,665 under LIFO and $81,315 under FIFO.
6-50
.
(For Instructor Use Only)
PROBLEM 6-4B (Continued) (5) The illusionary gross profit is $5,500 ($456,050 – $450,550) under FIFO. Under LIFO, Weigel Inc. has recovered the current replacement cost of the units ($449,450), whereas under FIFO, it has only recovered the earlier costs ($443,950). This means that under FIFO, the company must reinvest $5,500 of the gross profit to replace the units used. Answer in business-letter form: Dear Weigel Inc. After preparing the comparative condensed income statements for 2014 under the FIFO and LIFO methods, we have found the following: The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchases. This method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. There will be $1,650 additional cash available under LIFO because income taxes are $79,665 under LIFO and $81,315 under FIFO. There exists an illusionary gross profit of $5,500 ($456,050 – $450,550). Under LIFO, you have recovered the current replacement cost of the units ($449,450) whereas under FIFO you have only recovered the earlier costs ($443,950). This means that under FIFO, the company must reinvest $5,500 of the gross profit to replace the units used. Sincerely,
.
(For Instructor Use Only)
6-51
PROBLEM 6-5B
Cost of Goods Available for Sale Date Explanation May 1 Beginning inventory 6 Purchase 15 Purchase 24 Purchase
Ending Inventory in Units Units available for sale
Units 40 110 70 60 280
Unit Cost $20 23 25 26
Total Cost $ 800 2,530 1,750 1,560 $6,640
Sales revenue 280
Sales (90 + 40 + 80) Units remaining in ending inventory
210 70
Date May
7 18 30
Units 90 40 80 210
Unit Price $32 37 38
Total Sales $2,880 1,480 3,040 $7,400
(a) (1) LIFO (i) Ending inventory May 1 40 @ $20 = $ 800 6 30 @ $23 = 690 70 $1,490
(ii) Cost of goods sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
(iii) Gross profit Sales revenue Cost of goods sold Gross profit
(iv) Gross profit rate Gross profit $2,250 = 30.4% Net sales $7,400
6-52
.
$7,400 5,150 $2,250
(For Instructor Use Only)
$6,640 1,490 $5,150
PROBLEM 6-5B (Continued) (2) FIFO (i) Ending inventory May 24 60 @ $26 = $1,560 15 10 @ $25 = 250 70 $1,810
(ii) Cost of goods sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
(iii) Gross profit Sales revenue Cost of goods sold
(iv) Gross profit rate Gross profit $2,570 = = 34.7% Net sales $7,400
Gross profit
$7,400 4,830
$6,640 1,810 $4,830
$2,570
(3) Average-Cost Weighted-average cost per unit:
(i) Ending inventory 70 @ $23.714 = $1,660*
(ii) Cost of goods sold Cost of goods available for sale Less: Ending inventory Cost of goods sold
*rounded to nearest dollar (iii) Gross profit Sales revenue Cost of goods sold Gross profit
cost of goods available for sale units available for sale $6,640 = $23.714 280
$7,400 4,980
$6,640 1,660 $4,980
(iv) Gross profit rate Gross profit $2,420 = = 32.7% Net sales $7,400
$2,420
(b) LIFO produces the lowest ending inventory value, gross profit, and gross profit rate because its cost of goods sold is higher than FIFO or average cost.
.
(For Instructor Use Only)
6-53
PROBLEM 6-6B
(a) (1) To maximize gross profit, Limex Watches should sell the watches with the lowest cost. Sale Date July 5 July 28
Cost of goods sold 180 @ $420 $ 75,600 40 @ 420 16,800 200 @ 450 90,000 240 @ 480 115,200 660 $297,600
Sales Revenue 180 @ $700 $126,000 480 @ 720 345,600 660 $471,600
Gross profit $471,600 – $297,600 = $174,000 (2) To minimize gross profit, Limex Watches should sell the watches with the highest cost. Sale Date July 5 July 28
Cost of goods sold 180 @ $450 $ 81,000 350 @ $480 168,000 20 @ $450 9,000 110 @ $420 46,200 660 $304,200
Sales Revenue 180 @ $700 $126,000 480 @ 720 345,600 660 $471,600
Gross profit: $471,600 – $304,200 = $167,400 (b) FIFO Cost of goods available for sale July
1 2 14
Beginning inventory Purchase Purchase
Goods available for sale Units sold Ending inventory
6-54
.
(For Instructor Use Only)
220 @ $420 200 @ $450 350 @ $480 770
$ 92,400 90,000 168,000 $350,400
770 660 110 @ $480
$52,800
PROBLEM 6-6B (Continued) Cost of goods available for sale – Ending inventory Cost of goods sold Gross profit:
$471,600 – $297,600 = $174,000.
(c) LIFO Cost of goods available for sale (from part b) – Ending inventory 110 @ $420 Cost of goods sold Gross profit:
$350,400 52,800 $297,600
$350,400 46,200 $304,200
$471,600 – $304,200 = $167,400.
(d) The choice of inventory method depends on the company’s objectives. Since the watches are marked and coded, the company could use specific identification. This could, however, result in “earnings management” by the company because, as shown, it could carefully choose which watches to sell to result in the maximum or minimum income. Employing a cost flow assumption, such as LIFO or FIFO, would reduce record-keeping costs; FIFO would result in higher income, but LIFO would reduce income taxes and provide better matching of current sales revenue with current costs.
.
(For Instructor Use Only)
6-55
PROBLEM 6-7B
(a)
2014 $130,460 ($10,017 + $10,121) ÷ 2
Inventory turnover
$130,460 = 13.0 $10,069 Days in inventory
365 = 28.1 days 13
(b) Current ratio
$54,243 = 1.08 : 1 $50,218
(c) Current assets using LIFO LIFO reserve Current assets assuming FIFO
Current ratio
2014 $54,243 1,100 $55,343
$55,343 = 1.10 : 1 $50,218
(d) The current ratio was slightly higher in (c) compared to (b) because current assets (i.e., inventory) are larger in (c).
6-56
.
(For Instructor Use Only)
*PROBLEM 6-8B
(a) Cost of goods available for sale: Inventory Purchases January 2 January 9 January 23 Sales: Date January 6 January 10 January 30 Total sales
140 units @ $14
$1,960
120 units @ $15 85 units @ $17 100 units @ $20 445 units
1,800 1,445 2,000 $7,205
150 @ $30 70 @ $35 110 @ $42
$ 4,500 2,450 4,620 $11,570
(1) LIFO Date January
Purchases 1
January January
2 6
(120 @ $15) $1,800
January
9
(85 @ $17) $1,445
(120 @ $15) $2,220 (30 @ $14)
January 10 January 23
(70 @ $17) $1,190 (100 @ $20) $2,000
January 30
.
Cost of goods sold
(For Instructor Use Only)
(100 @ $20) $2,170 (10 @ $17) $5,580
Balance (140 @ $14) $1,960 (140 @ $14) $3,760 (120 @ $15) (110 @ $14) $1,540 (110 @ $14) (85 @ $17) (110 @ $14) (15 @ $17) (110 @ $14) (15 @ $17) (100 @ $20) (110 @ $14) (5 @ $17)
$2,985 $1,795
$3,795 $1,625
6-57
*PROBLEM 6-8B (Continued) (i) Cost of goods sold: $7,205 – $1,625 = $5,580. (ii) Ending inventory = $1,625. (iii) Gross profit = $11,570 – $5,580 = $5,990. (2) FIFO Date January
1
Purchases
January
2
January
6
January
9
Cost of goods sold
(120 @ $15) $1,800 (140 @ $14) (10 @ $15)
$2,110
(85 @ $17) $1,445
January 10
(70 @ $15)
January 23
$1,050
(100 @ $20) $2,000
January 30
(40 @ $15) (70 @ $17)
$1,790
Balance (140 @ $14) $1,960 (140 @ $14) (120 @ $15)
$3,760
(110 @ $15)
$1,650
(110 @ $15) (85 @ $17)
$3,095
(40 @ $15) (85 @ $17)
$2,045
(40 @ $15) (85 @ $17) (100 @ $20)
$4,045
(15 @ $17) (100 @ $20)
$2,255
$4,950
(i) Cost of goods sold: $7,205 – $2,255 = $4,950. (ii) Ending inventory = $2,255. (iii) Gross profit = $11,570 – $4,950 = $6,620. (3) Moving-Average: Date January 1 January 2 January 6 January 9 January 10 January 23 January 30
Purchases (120 @ $15) $1,800
(150 @ $14.462) $2,169* (85 @ $17) $1,445 (70 @ $15.569)
$1,090*
(100 @ $20) $2,000 (110 @ $17.538) $1,929* $5,188
a
$3,760 ÷ 260 = $14.462 b $3,036 ÷ 195 = $15.569 *Rounded
6-58
Cost of goods sold
.
(For Instructor Use Only)
c
Balance (140 @ $14) $1,960 a (260 @ $14.462) $3,760 (110 @ $14.462) $1,591 (195 @ $15.569)b $3,036 (125 @ $15.569) $1,946 (225 @ $17.538)c $3,946 (115 @ $17.538) $2,017*
$3,946 ÷ 225 = $17.538
*PROBLEM 6-8B (Continued) (i) Cost of goods sold: $7,205 – $2,017 = $5,188. (ii) Ending inventory = $2,017. (iii) Gross profit = $11,570 – $5,188 = $6,382. (b) Gross profit: LIFO
FIFO
MovingAverage
$11,570
$11,570
$11,570
5,580
4,950
5,188
Gross profit
$ 5,990
$ 6,620
$ 6,382
Ending Inventory
$ 1,625
$ 2,255
$ 2,017
Sales – Cost of goods sold
In a period of rising costs, the LIFO cost flow assumption results in the highest cost of goods sold and lowest gross profit. FIFO gives the lowest cost of goods sold and highest gross profit. The moving-average cost flow assumption results in amounts between the other two. On the balance sheet, FIFO gives the highest ending inventory (representing the most current costs); LIFO gives the lowest ending inventory (representing the oldest costs); and moving-average cost results in an ending inventory falling between the other two.
.
(For Instructor Use Only)
6-59
*PROBLEM 6-9B (a) (1)
FIFO Cost of Goods Sold
Date Purchases Balance Feb. 1 (12 @ $150) $1,800 (12 @ $150) $1,800 6 (9 @ $150) $1,350 (3 @ $150) $ 450 11 (8 @ $168) $1,344 (3 @ $150) (8 @ $168) $1,794 14 (3 @ $150) (2 @ $168) $ 786 (6 @ $168) $1,008 21 (6 @ $182) $1,092 (6 @ $168) $2,100 (6 @ $182) 27 (4 @ $168) $ 672 (2 @ $168) (6 @ $182) $1,428 (2)
MOVING-AVERAGE Cost of Date Purchases Goods Sold Balance Feb. 1 (12 @ $150) $1,800 (12 @ $150) $1,800 6 (9 @ $150) $1,350 (3 @ $150) $ 450 11 (8 @ $168) $1,344 (11 @ $163.091)* $1,794 14 (5 @ $163.091) $ 815*** (6 @ $163.091) $ 979 21 (6 @ $182) $1,092 (12 @ $172.583)** $2,071 27 (4 @ $172.583) $ 690*** (8 @ $172.583) $1,381*** *$1,794 ÷ 11 = $163.091. **$2,071 ÷ 12 = $172.583. ***rounded
(3)
LIFO Cost of Goods Sold
Date Purchases Balance Feb. 1 (12 @ $150) $1,800 (12 @ $150) $1,800 6 (9 @ $150) $1,350 (3 @ $150) $ 450 11 (8 @ $168) $1,344 (3 @ $150) $1,794 (8 @ $168) 14 (5 @ $168) $ 840 (3 @ $150) (3 @ $168) $ 954 21 (6 @ $182) $1,092 (3 @ $150) (3 @ $168) $2,046 (6 @ $182) 27 (4 @ $182) $ 728 (3 @ $150) (3 @ $168) $1,318 (2 @ $182)
6-60
.
(For Instructor Use Only)
(b) The highest ending inventory is $1,428 under the FIFO method. COMPREHENSIVE PROBLEM SOLUTION
(a)
Dec. 3 5
7
17 22
31
.
Inventory (4,000 X $0.72) ........................... Accounts Payable ..............................
2,880
Accounts Receivable (4,400 X $0.90)........ Sales Revenue ....................................
3,960
Cost of Good Sold ..................................... Inventory (3,000 X $0.60) + (1,400 X $0.72)..................................
2,808
Sales Returns and Allowances ................. Accounts Receivable .........................
180
Inventory..................................................... Cost of Good Sold ..............................
150
Inventory (2,200 X $0.80) ........................... Cash ....................................................
1,760
Accounts Receivable (2,000 X $0.95)........ Sales Revenue ....................................
1,900
Cost of Goods Sold (2,000 X $0.72) .......... Inventory .............................................
1,440
Salaries and Wages Expense .................... Salaries and Wages Payable .............
400
Depreciation Expense................................ Accumulated Depreciation— Equipment ........................................
200
Income Tax Expense.................................. Income Taxes Payable .......................
215
(For Instructor Use Only)
2,880 3,960
2,808 180 150 1,760 1,900 1,440 400
200 215
6-61
COMPREHENSIVE PROBLEM SOLUTION (Continued) (b)
General Ledger
Bal. Bal. Bal.
Bal.
Cash 4,800 3,040 Accounts Receivable 3,900 3,960 1,900 9,580
Bal.
Inventory 1,800 2,880 150 1,760 2,342
Bal.
Equipment 21,000
Bal.
180
Bal.
3,000 2,880 5,880
Income Taxes Payable
6-62
.
(For Instructor Use Only)
Retained Earnings Bal. 17,000
2,808 1,440
Salaries and Wages Payable 400 Bal. 400
Bal.
10,000
Sales Revenue
Accumulated Depreciation—Equipment Bal. 1,500 200 Bal. 1,700 Accounts Payable Bal.
Common Stock Bal.
1,760
215 215
Bal.
Bal.
Cost of Goods Sold 2,808 1,440 4,098
Bal.
Depreciation Expense 200 200
3,960 1,900 5,860 150
Salaries and Wages Expense 400 Bal. 400 Sales Returns & Allowances 180 Bal. 180
Bal.
Income Tax Expense 215 215
COMPREHENSIVE PROBLEM SOLUTION (Continued) (c)
HARRISEN COMPANY Adjusted Trial Balance December 31, 2014 Cash ............................................................... Accounts Receivable .................................... Inventory ....................................................... Equipment ..................................................... Accumulated Depreciation—Equipment ..... Accounts Payable ......................................... Salaries and Wages Payable ........................ Income Taxes Payable .................................. Common Stock ............................................. Retained Earnings ........................................ Sales Revenue .............................................. Sales Returns & Allowances ........................ Cost of Goods Sold ...................................... Salaries and Wages Expense ....................... Depreciation Expense .................................. Income Tax Expense ....................................
(d)
CR.
$ 1,700 5,880 400 215 10,000 17,000 5,860 180 4,098 400 200 215 $41,055
$41,055
HARRISEN COMPANY Income Statement For the Month Ending December 31, 2014 Sales revenue............................................. Less: Sales returns and allowances ........ Net sales ..................................................... Cost of goods sold .................................... Gross profit ................................................ Operating expenses Salaries and wages expense ............. Depreciation expense ........................ Income before income tax ......................... Income tax expense ................................... Net income .................................................
.
DR. $ 3,040 9,580 2,342 21,000
(For Instructor Use Only)
$5,860 180 $5,680 4,098 1,582 400 200
600 $982 215 $ 767 6-63
COMPREHENSIVE PROBLEM SOLUTION (Continued) HARRISEN COMPANY Balance Sheet December 31, 2014 Assets Current assets Cash........................................................ Accounts receivable .............................. Inventory ................................................ Total current assets ......................... Property, plant, and equipment Equipment .............................................. Less: Accumulated depreciation— Equipment .................................. Total assets ...................................................
$ 3,040 9,580 2,342 $14,962 21,000 1,700
19,300 $34,262
Liabilities and Stockholders’ Equity
6-64
Current liabilities Accounts payable .................................. Salaries and wages payable ................. Income taxes payable ............................ Total current liabilities .....................
$ 5,880 400 215
Stockholders’ equity Common stock ....................................... Retained earnings ($17,000 + $767)...... Total stockholders’ equity ............... Total liabilities and stockholders’ equity ....
10,000 17,767
.
(For Instructor Use Only)
$ 6,495
27,767 $34,262
COMPREHENSIVE PROBLEM SOLUTION (Continued) (e) FIFO Method
Beg. Inventory Dec. 3 purchase Dec. 17 purchase
Units 3,000 4,000 2,200 9,200
Unit Cost $0.60 $0.72 $0.80
Cost of Goods Available for Sales $1,800 2,880 1,760 $6,440
Ending Inventory
Cost of Goods Sold
Dec. 17 2,200 X $0.80 = $1,760 Dec. 3 800* X $0.72 = 576 3,000 $2,336
Cost of goods available for sale Less: Ending inventory Cost of goods sold
$6,440 2,336 $4,104
*(9,200 – 4,400 + 200 – 2,000) – 2,200 (f)
.
LIFO Method Ending Inventory
Cost of Goods Sold
Dec. 1
Cost of goods available for sale Less: Ending inventory Cost of goods sold
3,000 X $0.60 = $1,800
(For Instructor Use Only)
$6,440 1,800 $4,640
6-65
BYP 6-1
FINANCIAL REPORTING PROBLEM
(Note: All dollar amounts are in thousands) (a) Inventories were $71,760 ($42,676 + $29,084) in 2011 and $56,652 ($35,416 + $21,236) in 2010. (b) Inventories increased $15,108 in 2011. Using 2010 as the base year, the increase was approximately 26.7% ($15,108 ÷ $56,652). In 2011, inventories were approximately 33.8% of current assets ($71,760 ÷ $212,201). (c) Product cost of goods sold was: 2011, $365,225; 2010, $349,334; and 2009, $319,775. In 2011, product cost of goods sold was 69.1% of net product sales ($365,225 ÷ $528,369).
6-66
.
(For Instructor Use Only)
BYP 6-2
COMPARATIVE ANALYSIS PROBLEM
(a)
Tootsie Roll 1. Inventory turnover
$3,548,896
$365,225
($56,652* + $71,760**) ÷ 2 ($648,953 + $533,622) ÷ 2 $365,225 $64,206
*($35,416 + $21,236)
2. Days in inventory
Hershey Company
= 5.7 times
$3,548,896 $591,287.5
= 6.0 times
**($42,676 + $29,084)
365 5.7
= 64.0 days
365 6.0
= 60.8 days
(b) Generally, companies that are able to keep their inventory at lower levels and higher turnovers and still satisfy customer needs are the most successful. Tootsie Roll’s and Hershey Company’s days in inventory are approximately the same at about 61-64 days. This means that both companies maintain more than two months of inventory on hand.
.
(For Instructor Use Only)
6-67
BYP 6-3
RESEARCH CASE
(a) Companies with slow moving inventory, such as industrial manufacturers, benefit most from the use of LIFO, because the extended time that they hold their inventory make them more susceptible to price changes. (b) A proposed 2011 budget estimated that eliminating the use of LIFO for tax purposes would increase federal tax receipts by $59 billion over 10 years. (c) If the U.S. decides to adopt IFRS for financial reporting purposes, LIFO usage would probably end. This is because IFRS does not allow LIFO for financial reporting. Current tax laws require that if LIFO is used for taxes it must also be used for financial reporting. Therefore, unless this so called “conformity rule” was eliminated, the use of LIFO would end. (d) Proponents of LIFO argue that without LIFO, there is mismatch between the price that was paid for the inventory many months earlier, and the price that would now have to be paid to replenish the inventory at the current, higher, price. They argue that this mismatch makes it appear that their profits are higher than they really are, because it is including an inflation component that is not really profit. (e) FIFO tends to be preferred by retailers and manufacturers of fastmoving inventory such as electronics or perishable goods. They say that it better reflects the current values of their inventories.
6-68
.
(For Instructor Use Only)
BYP 6-4
INTERPRETING FINANCIAL STATEMENTS
(a) Finished goods are manufactured inventory items that are ready for resale. Work in process is inventory that has been put into production but is not complete. Raw materials are the basic materials that will be used in production. (b) American Greetings may use LIFO for U.S. operations because of its tax advantages. Since many foreign countries do not allow the use of LIFO, American Greetings may use FIFO for non-domestic inventories. Using FIFO will result in higher reported profit and inventory values than LIFO. (c) Inventory turnover:
Days in inventory:
2014
2013
$809,956 ($216,671+ $203, 873)/ 2
$780,771 ($182,618 + $216, 671)/ 2
$809, 956 = 3.9 times $210, 272
$780, 771 = 3.9 times $199, 644.5
365/3.9 = 93.6 days
365/3.9 = 93.6 days
The inventory turnover remain unchanged from 2013 to 2014. (d) The LIFO reserve, $86,025, represents 42% of total inventory ($86,025/$203,873 = .42). Ending inventory using LIFO ..................... Ending LIFO reserve .................................. Ending inventory assuming FIFO ..............
$203,873 86,025 $289,898
This difference is probably considered “material” since it exceeds 10 percent. Since the reserve is disclosed, analysts can include both FIFO and LIFO amounts when analyzing performance. The FIFO value better represents the current value of American Greetings’ inventory.
.
(For Instructor Use Only)
6-69
BYP 6-4 (Continued) (e) Current ratio:
$561,395 = 1.63: 1 $343,405
Current assets using LIFO Ending LIFO reserve Current assets assuming FIFO Current ratio:
6-70
.
$647,420 = 1.89 :1 $343,405
(For Instructor Use Only)
$561,395 86,025 $647,420
BYP 6-5
REAL-WORLD FOCUS
Answers will vary depending on the company chosen.
.
(For Instructor Use Only)
6-71
BYP 6-6
DECISION MAKING ACROSS THE ORGANIZATION
(a)
2014 Current ratio
$1, 800
2013
= 3.00:1
$600 Gross profit rate
$9, 428 – $6, 328
$754
= 32.9%
Days in inventory
$8, 674 – $5, 474
= 36.9%
$8, 674 = 8.0%
$9, 428 Inventory turnover
$1, 183 = 2.41 : 1
$590
$9, 428 Profit margin
$1, 423
2012
$6, 328
$987
$7, 536 – $4, 445
$979
= 11.4%
$5,474
= 13.0%
$7, 536 $4, 445
= 8.1 times
($925 + $757)/ 2
($757 + $602)/ 2
($602 + $418)/ 2
365
365
365
= 48.7 days
7.5
8.1
= 41.0%
$7, 536
$8, 674 = 7.5 times
= 2.25: 1
$525
= 45.1 days
= 8.7 times
= 42.0 days
8.7
(b) The company’s current ratio has increased steadily over this period. While this might be interpreted as a positive, since it would normally represent improved liquidity, the company started this period with a current ratio in excess of 2, thus it already had good liquidity. With its current ratio now 3 it would appear that the company has too many funds tied up in current assets. In particular, it would appear that the company has a surplus of unsold inventory. This is supported by the fact that inventory as a percent of total assets has increased significantly. The gross profit rate has been steadily declining. From the CEO’s comments we learned that the company has frequently been forced to discount its products in order to move them off the shelves. This discounting will directly reduce the gross profit rate. The profit margin has also declined. Originally the company made a profit of 13 cents on each dollar of sales. Now it only makes 8 cents per sales dollar. A significant portion of this decline is most likely the result of the decline in the gross profit rate.
6-72
.
(For Instructor Use Only)
BYP 6-6 (Continued) Inventory turnover, as measured by the days in inventory has worsened considerably during this period. At the beginning of this period it took 42 days to sell the average inventory item, now it takes 49. (c) The evaluation above suggests that many of the company’s problems stem from poor inventory management. As the company has grown, its ability to manage its inventory has declined. This has caused a decline in its profitability. By implementing a just-in-time inventory system the company could reduce the amount of resources that it has tied up in inventory, thus reducing its storage and handling costs. Also, it should reduce the need for product discounting, since the company will be less likely to be stuck with surplus inventory. (d) The marketing and sales department may well be concerned that a justin-time inventory system will result in more stock-outs. The company already is having stock-out problems, even though it has a lot of inventory. The company’s current inventory system appears to lack good technological support, which would allow it to identify which products are selling well. As discussed in the case of both Caterpillar and Dell computers in the chapter, a well implemented just-in-time system, supported by technology and coordination with suppliers, would enable the company to reduce its inventory balance while actually increasing its ability to deliver products to customers in a timely fashion.
.
(For Instructor Use Only)
6-73
BYP 6-7
COMMUNICATION ACTIVITY
In a period of changing prices, the cost flow assumption can have a significant impact on income and on evaluations based on income. Under the FIFO method, the costs of the earliest goods purchased are the first to be recognized as cost of goods sold. Under the average-cost method, the calculation of cost of goods sold is made on the basis of the weightedaverage unit cost incurred. In a period of rising prices, FIFO will produce a lower cost of goods sold and a higher net income. Starbucks’ change from FIFO to average-cost will result in a higher cost of goods sold and a lower net income. Because of increasing competition, Starbucks probably is not able to pass the coffee bean price increase on to its customers. Using the average-cost method allows Starbucks to average its changing inventory prices and avoid a distortion of income. A possible disadvantage of the change is the related balance sheet effect. Since inventory is a current asset, Starbucks’ current ratio will be lower because of the change. In addition, the company’s inventory turnover and days in inventory could be adversely affected.
6-74
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(For Instructor Use Only)
*BYP 6-8
COMMUNICATION ACTIVITY
MEMO To:
K. L. Howard, President
From:
Student
Subject: 2013 ending inventory error As you know, 2013 ending inventory was overstated by $1 million. Of course, this error will cause 2013 net income to be incorrect because the ending inventory is used to compute 2013 cost of goods sold. Since the ending inventory is subtracted in the computation of cost of goods sold, an overstatement of ending inventory results in an understatement of cost of goods sold and therefore an overstatement of net income. Unfortunately, unless corrected, this error will also affect 2014 net income. The 2013 ending inventory is also the 2014 beginning inventory. Therefore, 2014 beginning inventory is also overstated, which causes an overstatement of cost of goods sold and an understatement of 2014 net income.
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(For Instructor Use Only)
6-75
BYP 6-9
ETHICS CASE
(a) The higher cost of the items ordered, received, and on hand at yearend will be charged to cost of goods sold, thereby lowering current year’s income and income taxes. Next year’s income will be increased because the inventory carried at lower costs from the earlier year will be charged to next year’s cost of goods sold. If the purchase at yearend had been made in the next year, the next year’s cost of goods sold would have absorbed the higher cost. (b) No. The president would not have given the same directive because the purchase under FIFO would have had no effect on net income of the current year. (c) The accountant has no grounds for not ordering the goods if the president insists. The purchase is legal and ethical, even though it allows the company to “manage” this year’s net income.
6-76
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(For Instructor Use Only)
BYP 6-10
ALL ABOUT YOU
Students responses to this question will vary depending on the inventory fraud they choose to investigate. Here are responses for the two examples given in the activity. The fraud at Leslie Fay involved a number of illegal actions, all of which increased net income. The company intentionally overstated ending inventory, which has the effect of understating cost of goods sold. It also understated or completely omitted discounts and allowances that it gave to retailers. In addition, it recorded inventory costs at amounts that differed from the invoice amount. It also reported sales in incorrect periods. McKesson Corporation increased its reported net income through manipulation of inventory and sales records. It back-dated many transactions to increase current period results. It also swapped inventory to increase reported revenue. Many of the transactions that it reported as sales, and which resulted in reductions in inventory, were actually not sales because they had negotiated side agreements which allowed the buyer to return the merchandise.
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(For Instructor Use Only)
6-77
BYP 6-11
FASB CODIFICATION ACTIVITY
(a) The primary basis of accounting for inventories is cost, which has been defined generally as the price paid or consideration given to acquire an asset. As applied to inventories, cost means in principle the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location. It is understood to mean acquisition and production cost, and its determination involves many considerations. (330-10-30-1) (b) The basis of stating inventories shall be consistently applied and shall be disclosed in the financial statements; whenever a significant change is made therein, there shall be disclosure of the nature of the change and, if material, the effect on income. A change of such basis may have an important effect upon the interpretation of the financial statements both before and after that change, and hence, in the event of a change, a full disclosure of its nature and of its effect, if material, upon income shall be made. Codification reference (330-10-50-1). (c) A departure from the cost basis of pricing the inventory is required when the utility of the goods is no longer as great as their cost. Where there is evidence that the utility of goods, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the difference shall be recognized as a loss of the current period. This is generally accomplished by stating such goods at a lower level commonly designated as market. Codification reference (330-10-35-1).
6-78
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(For Instructor Use Only)
BYP6-12
CONSIDERING PEOPLE, PLANT, AND PROFIT
(a) By the end of 2011, Caterpillar had turbines up and running that eliminate the equivalent of 540,000 metric tons of CO2 emissions per year. The application is sustainable in several ways. First, pollutants are reduced in the combustion process. Second, electricity is produced which allows reduction in the coal consumed (and the emissions generated) by the local power plant. Third, the exhaust heat from the turbine is used to make steam to quench the coke and is used in other chemical processes at the plant. Caterpillar’s success on this project has opened up new business opportunities for the growing number of natural gas fired CHP projects currently being developed in that market. (b) The company’s goals were separated into two groups as follows: 2020 Goals for Operations ● Reduce recordable workplace Injury rate to 0.6 and lost-time case rate due to Injury to 0.15 ● Increase energy efficiency by 25% ● Reduce absolute greenhouse gas emissions from existing facilities by 25% ● Use alternative/renewable sources to meet 20% of our energy needs ● Eliminate waste by reducing waste generation and reusing or recycling all that remains ● Hold water consumption flat ● Design all new construction to meet Leadership in Energy and Environmental Design (LEED) or comparable green building criteria 2020 Goals for Product, Services and Solutions ● Provide leadership in the safety of people in, on and around our products. ● Reduce customer greenhouse gas emissions by 20% ● Increase customer energy efficiency by 20% ● Increase customer materials efficiency by 20%
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(For Instructor Use Only)
6-79
BYP 6-12 (Continued) (c) The company improved its Recordable Injury Frequency rate by 83 percent from our 2003 baseline year and 13 percent from its last reporting period. It improved its Lost-Time Case Frequency rate by 91 percent from our 2003 baseline year and 20 percent from our last reporting period. Both of these would appear to be significant improvements in the area of worker conditions and safety. (d) The company measures its energy efficiency by dividing its total revenue in dollars by a measure of its total energy used. This then provides a measure of how much energy it uses to generate revenue. Based on this measure, the company showed significant improvement relative to the base year of 2006.
6-80
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(For Instructor Use Only)
IFRS CONCEPTS AND APPLICATION IFRS6-1 Key Similarities are (1) the definitions for inventory are essentially the same, (2) the guidelines on who owns the goods—goods in transit, consigned goods, and the costs to include in inventory are essentially accounted for the same under IFRS and U.S. GAAP; (3) use of specific identification cost flow assumption, where appropriate; (4) unlike property, plant, and equipment, IFRS does not permit the option of valuing inventories at fair value; (5) certain agricultural products and minerals and mineral products can be reported at net realizable value using IFRS. Key differences are related to (1) the LIFO cost flow assumption—U.S. GAAP permits the use of LIFO for inventory valuation, but IFRS prohibits its use. FIFO and average-cost are the only two acceptable cost flow assumptions permitted under IFRS; (2) lower-of-cost-or-market test for inventory valuation—IFRS defines market as net realizable value. U.S. GAAP on the other hand defines market as replacement cost; (3) inventory write-downs—under U.S. GAAP, if inventory is written down under the lower-of-cost-or-market valuation, the new basis is now considered its cost. As a result, the inventory may not be written back up to its original cost in a subsequent period. Under IFRS, the write-down may be reversed in a subsequent period up to the amount of the previous write-down. Both the write-down and any subsequent reversal should be reported on the income statement; (4) The requirements for accounting and reporting for inventories are more principles-based under IFRS. That is, U.S. GAAP provides more detailed guidelines for inventory accounting. IFRS6-2 Under IFRS, LaTour’s inventory turnover is computed as follows: Cost of Goods Sold/Average Inventory €578/€154 = 3.75 or approximately 97 days (365 ÷ 3.75). Difficulties in comparison to a company using U.S. GAAP could arise if the U.S. company uses the LIFO cost flow assumption, which is prohibited under IFRS. Generally in times of rising prices, LIFO results in a lower inventory balance reported on the balance sheet (assume more recently purchased items are sold first). Thus, the U.S. GAAP company will report higher inven-
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(For Instructor Use Only)
6-81
tory turnovers. The LIFO reserve can be used to adjust the reported LIFO numbers to FIFO and to permit an “apples to apples” comparison.
6-82
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(For Instructor Use Only)
IFRS6-3 Item No. AB TRX NWA SGH
.
(For Instructor Use Only)
Cost $ 1,700 2,200 7,800 3,000 $14,700
Net Realizable Value $ 1,400 2,300 7,100 3,700 $14,500
LCNRV $ 1,400 2,200 7,100 3,000 $13,700
6-83
IFRS6-4
INTERNATIONAL FINANCIAL REPORTING PROBLEM
(a) Inventories are stated at the lower-of-cost-or-net realizable value, using first-in-first out cost flow assumption. (b) During 2011, Zetar wrote off £437,000 of inventory. (c) As of April 30, 2011, Zetar reported raw materials of £9,805, work-inprogress of £1,236, and finished goods inventory of £5,412.
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(For Instructor Use Only)
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(For Instructor Use Only)
6-85
CHAPTER 7 Fraud, Internal Control, and Cash Learning Objectives 1. 2. 3. 4. 5. 6. 7. 8. 9.
Define fraud and internal control. Identify the principles of internal control activities. Explain the applications of internal control principles to cash receipts. Explain the applications of internal control principles to cash disbursements. Prepare a bank reconciliation. Explain the reporting of cash. Discuss the basic principles of cash management. Identify the primary elements of a cash budget. Explain the operation of a petty cash fund.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4. 5. 6.
1 1 1 1 1 2
BT C C C C K C
Item 7. 8. 9. 10. 11. 12.
LO 2 2 2 2 2 2
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
C C C C C C
Questions 13. 2 C 14. 6 AP 15. 3 C 16. 3 C 17. 3 C 18. 4 C
19. 20. 21. 22. 23.
4 4 5 5 5
C K K C C
24. 25. 26. 27. 28.
7 5 6 6 9*
C C C C C
5 5 6
AP AP C
13. 14.
8 9*
AP AP
8
AP
11. 12. 13.
5 6 7
AP AP C
14. 15. 16.
8 9* 9*
AP AP AP
8
AP
8.
2, 3, 4, 5
E
2, 3, 4, 5
E
1. 2. 3.
1 2 2
C C C
4. 5. 6.
3 3 4
1.
2
C
2.
3
Brief Exercises C 7 4 C 10. AP 8. 5 C 11. C 9. 5 C 12. Do It Review Exercises C 3. 5 K 4.
2, 4 5 5
E AP AP
Exercises 8. 5 AP 9. 5 AP 10. 5 AP
AP AP
Problems: Set A 5. 5 AP 6. 8 AP
7.
AP AP
Problems: Set B 5. 5 AP 6. 8 AP
7.
1. 2. 3. 4.
2 2 2, 3 2, 4
1. 2, 3 2. 2, 3, 4 1. 2, 3 2. 2, 3, 4
C C E E C C C C
5. 6. 7.
3. 4. 3. 4.
5 5 5 5
8
AP
8.
*Continuing Cookie Solutions for this chapter are available online.
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(For Instructor Use Only)
7-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
7-2
Description
Difficulty Level
Time Allotted (min.)
1A
Identify internal control weaknesses for cash receipts.
Simple
20–30
2A
Identify internal control weaknesses in cash receipts and cash disbursements.
Simple
20–30
3A
Prepare a bank reconciliation and adjusting entries.
Simple
20–30
4A
Prepare a bank reconciliation and adjusting entries from detailed data.
Moderate
40–50
5A
Prepare a bank reconciliation and adjusting entries.
Moderate
30–40
6A
Prepare a cash budget.
Moderate
30–40
7A
Prepare a cash budget.
Moderate
30–40
8A
Prepare a comprehensive bank reconciliation with theft and internal control deficiencies.
Complex
40–50
1B
Identify internal control principles for cash disbursements.
Simple
20–30
2B
Identify internal control weaknesses in cash disbursements.
Simple
20–30
3B
Prepare a bank reconciliation and adjusting entries.
Simple
20–30
4B
Prepare a bank reconciliation and adjusting entries from detailed data.
Moderate
40–50
5B
Prepare a bank reconciliation and adjusting entries.
Moderate
30–40
6B
Prepare a cash budget.
Moderate
30–40
7B
Prepare a cash budget.
Moderate
30–40
8B
Prepare a comprehensive bank reconciliation with theft and internal control deficiencies.
Complex
40–50
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(For Instructor Use Only)
ANSWERS TO QUESTIONS 1.
Fraud is a dishonest act by an employee that results in personal benefit to the employee at a cost to the employer. An example of fraud that might occur at a bank would be a computer operator embezzling funds by transferring a customer’s deposits into another account.
2.
The three main factors that contribute to employee fraud are opportunity, financial pressure, and rationalization. Opportunities that an employee can take advantage of occur when the workplace lacks sufficient controls to deter and detect fraud. Financial pressure occurs when employees want to lead a lifestyle that they cannot afford on their current salary. Rationalization involves employees justifying fraud because they believe they are underpaid while their employer is making lots of money.
3.
The five components of a good internal control system are: (1) A control environment, (2) Risk assessment, (3) Control activities, (4) Information and communication, and (5) Monitoring.
4.
Disagree. Internal control is also concerned with the safeguarding of company assets, increasing efficiency of operations, and ensuring compliance with laws and regulations.
5.
The Sarbanes-Oxley Act requires that a company develop sound principles of internal control over financial reporting and continually verify that these controls are working. The act specifically requires top management to attest that the company’s internal controls are reliable and effective.
6.
The principles of internal control that apply to most businesses are: (a) establishment of responsibility, (b) segregation of duties, (c) documentation procedures, (d) physical controls, (e) independent internal verification, and (f) human resource controls.
7.
Yes, this is a violation of the internal control principle of establishing responsibility. In this case, each sales clerk should have a separate cash register or cash register drawer.
8.
The two applications of segregation of duties are: (1) The responsibility for related activities should be assigned to different individuals. (2) The responsibility for record keeping for an asset should be separate from the physical custody of that asset.
9.
Documentation procedures contribute to good internal control by providing evidence of the occurrence of transactions and events and, when signatures (or initials) are added, the documents establish responsibility for the transactions. The prompt transmittal of documents to accounting contributes to recording transactions in the proper period, and the prenumbering of documents helps to ensure that a transaction is not recorded more than once or not at all.
10.
Safes, vaults, and locked warehouses contribute to the safeguarding of company assets. Cash registers and computerized accounting equipment contribute to the accuracy and reliability of the accounting records, and electronic burglary systems and sensors help to safeguard assets.
.
(For Instructor Use Only)
7-3
Questions Chapter 7 (Continued) 11.
(a) Independent internal verification involves the review, comparison, and reconciliation of data prepared by employees. (b) Maximum benefit is obtained from independent internal verification when: (1) The verification is made periodically or on a surprise basis. (2) The verification is done by an employee who is independent of the personnel responsible for the information. (3) Discrepancies and exceptions are reported to a management level that can take appropriate corrective action.
12.
(a) The concept of reasonable assurance means that the costs of establishing control procedures should not exceed their expected benefit. Ordinarily, a system of internal control provides reasonable but not absolute assurance, since absolute assurance would be too costly. (b) The human element is an important factor in a system of internal control. A good system may become ineffective as the result of employee fatigue, carelessness, or indifference. Moreover, internal control may become ineffective as a result of collusion.
13.
The human resources department plays an important role in internal control by (a) bonding employees who handle cash, (b) rotating employees’ duties and requiring employees to take vacations, (c) conducting thorough background checks.
14.
Cash should be reported at $21,100 ($8,000 + $1,100 + $12,000).
15.
Daily cash counts pertain primarily to the principles of segregation of duties, documentation procedures, and independent internal verification. Daily cash counts also involve the establishment of responsibility for performing the counts.
16.
Cash registers are readily visible to the customer. Thus, they prevent the sales clerk from ringing up a lower amount and pocketing the difference. In addition, the customer receives an itemized receipt, and the cash register tape is locked into the register for further verification, providing documentation and enabling independent internal verification.
17.
Two mail clerks contribute to a more accurate listing of mail receipts and to the endorsement of all checks “For Deposit Only.” In addition, two clerks reduce the likelihood of mail receipts being diverted to personal use.
18.
True. Payment by check contributes to effective internal control over cash disbursements. However, effective control is also possible when small payments are made from petty cash.
19.
The procedure and related principle are:
7-4
Procedure
Principle
(1) Treasurer signs checks. (2) Checks imprinted by a checkwriter. (3) Comparing check with approved invoice before signing.
• • •
.
(For Instructor Use Only)
Establishment of responsibility. Physical controls. Independent internal verification.
Questions Chapter 7 (Continued) 20. (a) Physical controls apply to cash disbursements when blank checks are stored in a safe, and access to the safe is restricted to authorized personnel, and a check-writing machine is used to print amounts on checks with indelible ink. (b) Human resource controls apply when the company bonds personnel who handle cash, requires employees to take vacations, and conducts background checks. 21. Electronic funds transfer is a cash disbursement system that uses wire, telephone, or computers to transfer cash balances from one location to another. 22. True. A bank contributes significantly to internal control over cash because it: (1) safeguards cash on deposit, (2) minimizes the amount of cash that must be kept on hand, and (3) provides a double record of all bank transactions. 23. The lack of agreement between the balances may be due to either: (1) Time lags—a check written in July does not clear the bank until August. (2) Errors—a check for $110 is recorded by the depositor as $101. 24. The basic principles of cash management are: (1) increase the speed of receivables collection, (2) keep inventory low, (3) monitor payment of liabilities, (4) plan timing of major expenditures, and (5) invest idle cash. 25. (a) An NSF check occurs when the checkwriter’s bank balance is less than the amount of the check. (b) In a bank reconciliation, a customer’s NSF check is deducted from the balance per books. (c) An NSF check results in an adjusting entry in the company’s books, as a debit to Accounts Receivable and a credit to Cash. 26. (a) Cash equivalents are short-term highly liquid investments that may be converted to a specific amount of cash. Cash equivalents may be reported with cash in the current assets section of the balance sheet. (b) Cash restricted for a special purpose should be reported separately as a current or noncurrent asset depending on when the cash is expected to be used. 27.
At December 31, 2011, Tootsie Roll reported cash and cash equivalents of $78,612,000. It reported no restricted cash. In Note 1 to its financial statements it defines cash equivalents as “temporary cash investments with an original maturity of three months or less.”
*28.
The activities in a petty cash system and the related principles are: • Establishment of responsibility for custody of the fund. (2) Making payments from the fund. • Documentation procedures because the custodian must use a prenumbered petty cash receipt. (3) Replenishing the fund. • Independent internal verification because the request for replenishment must be approved before the check is written.
(a) (1) Establishing the fund.
(b) Journal entries are required for a petty cash fund when it is established and replenished. Entries are also required when the size of the fund is increased or decreased.
.
(For Instructor Use Only)
7-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 7-1 (a) (b) (c) (d)
Financial Pressure Rationalization Financial Pressure Opportunity
BRIEF EXERCISE 7-2 The purposes of internal control are to: 1.
Safeguard a company’s assets from employee theft, robbery, and unauthorized use. An application for Brighan Co. is the use of a cash register to safeguard assets.
2.
Enhance the accuracy and reliability of a company’s accounting records by reducing the risk of errors (unintentional mistakes) and irregularities (intentional mistakes and misrepresentations) in the accounting process. An application for Brighan Co. is preparation of a bank reconciliation.
3.
Increase efficiency of operations. An application is assignment of responsibility to specific employees.
4.
Ensure compliance with laws and regulations. An application is use of cash register tapes to document sales and applicable sales taxes.
All of these purposes are important to the success of any business endeavor. BRIEF EXERCISE 7-3 (a) Segregation of duties. (b) Independent internal verification. (c) Documentation procedures.
7-6
.
(For Instructor Use Only)
BRIEF EXERCISE 7-4 (a) (b) (c) (d) (e)
Physical controls. Human resource controls. Independent internal verification. Segregation of duties. Establishment of responsibility.
BRIEF EXERCISE 7-5 Cash ($1,125.74 – $150.00) ..................................... Cash Over and Short............................................... Sales Revenue .................................................
975.74 12.88 988.62
BRIEF EXERCISE 7-6 (a) (b) (c) (d) (e)
Documentation procedures. Independent internal verification. Physical controls. Establishment of responsibility. Segregation of duties.
BRIEF EXERCISE 7-7 (a) The use of a checking account minimizes the amount of currency that must be kept on hand. Therefore, cash is safeguarded by using the bank as a depository and clearinghouse for checks written and received. (b) A bank statement provides a double record of a depositor’s bank transactions. It also is used in making periodic independent bank reconciliations. BRIEF EXERCISE 7-8 (a) (b) (c) (d)
.
Outstanding checks—deducted from cash balance per bank. Bank service charge—deducted from cash balance per books. Collection of note by bank—added to cash balance per books. Deposit in transit—added to cash balance per bank.
(For Instructor Use Only)
7-7
BRIEF EXERCISE 7-9 (a) The reconciling items per the books, items (b) and (c) above, will require adjustment on the books of the depositor. (b) The other reconciling items, deposits in transit and outstanding checks, do not require adjustment because they have already been recorded on the depositor’s books. BRIEF EXERCISE 7-10 Cash balance per bank statement ................................................ Add: Deposits in transit .............................................................. Less: Outstanding checks ........................................................... Adjusted cash balance per bank ..................................................
$7,291 1,350 8,641 762 $7,879
BRIEF EXERCISE 7-11 Checks written in November ........................................................ Less: Checks paid by bank in November .................................. Checks outstanding at the end of November .............................. Add: Checks written in December ............................................. Less: Checks paid by bank in December ................................... Checks outstanding at the end of December ..............................
$ 9,750 8,800 950 11,762 10,889 $ 1,823
BRIEF EXERCISE 7-12 Span Company should report cash in bank and payroll bank account as current assets. Plant expansion fund cash should be reported as restricted cash, a non-current asset, assuming the fund is not expected to be used during the next year.
7-8
.
(For Instructor Use Only)
BRIEF EXERCISE 7-13 CONGER COMPANY Cash Budget For the Month of January Beginning cash balance ............................................................... Add: Cash receipts ..................................................................... Total available cash ...................................................................... Less: Cash disbursements .......................................................... Excess of available cash over cash disbursements ................... Add: Borrowings .......................................................................... Ending cash balance.....................................................................
$12,000 59,000 71,000 67,000 4,000 5,000 $ 9,000
*BRIEF EXERCISE 7-14 Mar. 20
Postage Expense.......................................................... Supplies ........................................................................ Travel Expense ............................................................. Cash .......................................................................
40 26 15 81
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 7-1 1.
Violates the control activity of documentation procedures. Source documents should be promptly forwarded to the accounting department so accounting entries can be made. This control activity helps to ensure timely recording of sales transactions and contributes directly to the accuracy and reliability of the accounting records.
2.
Violates the control activity of segregation of duties. Different individuals should be responsible for related activities, such as these three related purchasing activities. Many abuses could occur: placing orders with friends and getting kickbacks; approving fictitious invoices for payment.
3.
Violates the control activity of establishment of responsibility. Guillen’s would be unable to determine who was responsible for a cash shortage; this lapse could even encourage employee theft.
.
(For Instructor Use Only)
7-9
DO IT! 7-2 All mail receipts should be opened in the presence of two mail clerks. Those mail clerks should immediately stamp each check “For Deposit Only.” The mail clerks should prepare, in triplicate, a list of the checks received each day. The checks and the original copy of the list should be sent on to the cashier’s department each day. A copy of the list is sent to the accounting department for recording in the accounting process. The clerks also keep a copy. DO IT! 7-3 Doug should treat the reconciling items as follows: 1.
Outstanding checks: Deduct from balance per bank.
2.
A deposit in transit: Add to balance per bank.
3.
The bank charged to our account a check written by another company: Add to balance per bank and notify the bank of its error.
4.
A debit memorandum for a bank service charge: Deduct from balance per books.
DO IT! 7-4 Beginning cash balance................................................ Add: Cash receipts for September .............................. Total available cash....................................................... Less: Cash disbursements for September ................. Excess (deficiency) of available cash over cash disbursements ............................................................ Add: Borrowings .......................................................... Ending cash balance .....................................................
$ 12,270 97,200 109,470 115,000 (5,530) 13,530 $ 8,000
To maintain the desired minimum cash balance of $8,000 Hull must borrow $13,530 of cash.
7-10
.
(For Instructor Use Only)
SOLUTIONS TO EXERCISES EXERCISE 7-1 The principles of internal control inherent in the “maker-checker” procedure are: 1.
Segregation of duties. The employee records the transactions. The supervisor verifies and approves the transactions.
2.
Physical controls. Access to the computer system is passwordprotected and task-specific.
EXERCISE 7-2 1.
Establishment of responsibility. The counter clerk is responsible for handling cash. Other employees are responsible for making the pizzas.
2.
Segregation of duties. Employees who make the pizzas do not handle cash.
3.
Documentation procedures. The counter clerk uses your order invoice (ticket) in registering the sale on the cash register. The cash register produces a tape of all sales.
4.
Physical controls. A cash register is used to record the sale.
5.
Independent internal verification. The counter clerk, in handling the pizza, compares the size of the pizza with the size indicated on the order.
6.
Human resource controls. No visible application possible.
.
(For Instructor Use Only)
7-11
EXERCISE 7-3 (a) Principle Violated
(b) Recommended Change
Procedure
Weakness
1.
Cashiers are not bonded and background checks are not conducted.
Human resource controls.
Cashiers should be bonded and background checks should be performed.
2.
Inability to establish responsibility for cash on a specific clerk.
Establishment of responsibility.
There should be separate cash drawers and register codes for each clerk.
3.
Cash is not adequately protected from theft.
Physical controls. Cash should be stored in a safe until it is deposited in bank.
4.
Cash is not independently counted.
Independent internal verification.
A cashier office supervisor should count cash, and reconcile the total to the cash register tape.
5.
The accountant should not handle cash.
Segregation of duties.
The cashier’s department should make the deposits.
7-12
.
(For Instructor Use Only)
EXERCISE 7-4 (a) Procedure
.
Weakness
(b) Principle Violated
Recommended Change
1.
Checks are not stored in a secure area.
Physical controls.
Checks should be stored in a safe or locked file drawer.
2.
The approval and payment of bills is done by the same individual.
Segregation of duties.
The store manager should approve bills for payment and the treasurer should sign and issue checks.
3.
Unauthorized employees making purchases.
Establishment of responsibility.
Only employees granted authority should make purchases for the store.
Use of cash instead of checks; no prenumbered invoices.
Documentation procedures.
Purchases should be paid with prenumbered checks and the purchases should be documented by a prenumbered invoice signed by the seller.
4.
Filing does not prevent a bill from being paid more than once.
Documentation procedures.
Bills should be stamped PAID after payment.
5.
The bank reconciliation is not independently prepared.
Independent internal verification.
Someone with no other responsibilities relating to cash should prepare the bank reconciliation.
(For Instructor Use Only)
7-13
EXERCISE 7-5 (a) Weaknesses
(b) Suggested Improvement
1.
Checks are not prenumbered. (Documentation procedures)
Use prenumbered checks.
2.
The purchasing agent signs checks. (Establishment of responsibility)
Only the treasurer’s department personnel should sign checks.
3.
Unissued checks are stored in unlocked file cabinet. (Physical controls)
Unissued checks should be stored in a locked file cabinet with access restricted to authorized personnel.
4.
Purchasing agent approves and pays for goods purchased. (Segregation of duties)
Purchasing should approve bills for payment by the treasurer.
5.
After payment, the invoice is filed. (Documentation procedures)
The invoice should be stamped PAID.
6.
The purchasing agent records payments in cash disbursements journal. (Segregation of duties)
Only accounting department personnel should record cash disbursements.
7.
The treasurer records the checks in cash disbursements journal. (Segregation of duties)
Same as answer to No. 6 above.
8.
The treasurer reconciles the bank statement. (Independent internal verification)
An internal auditor should reconcile the bank statement.
7-14
.
(For Instructor Use Only)
EXERCISE 7-6 (a) Cash balance per bank statement ................... Add: Deposits in transit .................................
$3,677.20 590.00 4,267.20 770.00 $3,497.20
Less: Outstanding checks .............................. Adjusted cash balance per bank ..................... (b) Cash balance per books................................... Less: NSF check .............................................. Bank service charge .............................. Adjusted cash balance per books ...................
$3,975.20 $450.00 28.00
(c) Accounts Receivable ........................................ Cash ...........................................................
450.00
Miscellaneous Expense.................................... Cash ...........................................................
28.00
478.00 $3,497.20 450.00 28.00
EXERCISE 7-7 The outstanding checks are as follows: No. 255 261 264
.
(For Instructor Use Only)
Amount $ 700 500 360 Total $1,560
7-15
EXERCISE 7-8 (a)
JOYCE COMPANY Bank Reconciliation July 31, 2014 Cash balance per bank statement ................................ Add: Deposits in transit ..............................................
$7,328 2,700 10,028 686 $9,342
Less: Outstanding checks .......................................... Adjusted cash balance per bank ................................. Cash balance per books ................................................ Add: Collection of note receivable ($2,000 plus accrued interest $36, less collection fee $20) ......................................
$7,364 2,016 9,380 38 $9,342
Less: Bank service charge ........................................... Adjusted cash balance per books ................................ (b) July 31
31
7-16
.
Cash ............................................................... Miscellaneous Expense ................................ Notes Receivable ................................... Interest Revenue ...................................
2,016 20
Miscellaneous Expense ................................ Cash .......................................................
38
(For Instructor Use Only)
2,000 36 38
EXERCISE 7-9 (a)
TREANOR COMPANY Bank Reconciliation September 30, 2014 Cash balance per bank statement ......................... Add: Deposits in transit .......................................
$16,500 4,738 21,238 2,383 $18,855
Less: Outstanding checks .................................... Adjusted cash balance per bank ........................... Cash balance per books......................................... Add: Collection of note receivable ($1,800 + $30) ............................................... Interest earned ............................................. Less: NSF check .................................................... Safety deposit box rent ............................... Adjusted cash balance per books ......................... (b) Sept. 30
30 30 30
.
$17,600 $1,830 45 560 60
Cash ...................................................... Notes Receivable .......................... Interest Revenue ..........................
1,830
Cash ...................................................... Interest Revenue ..........................
45
Accounts Receivable—H. Kane .......... Cash ..............................................
560
Miscellaneous Expense ....................... Cash ..............................................
60
(For Instructor Use Only)
1,875 19,475 620 $18,855
1,800 30 45 560 60
7-17
EXERCISE 7-10 (a) Deposits in transit: Deposits per books in July ........................... Less: Deposits per bank in July .................. Deposits in transit, June 30 ............... July receipts deposited in July .................... Deposits in transit, July 31 ........................... (b) Outstanding checks: Checks per books in July ............................. Less: Checks clearing bank in July ............ Outstanding checks, June 30............ July checks cleared in July .......................... Outstanding checks, July 31 ........................ (c) Deposits in transit: Deposits per bank statement in September.................................................. Add: Deposits in transit, September 30..... Total deposits to be accounted for .............. Less: Deposits per books ............................ Deposits in transit, August 31 ...................... (d) Outstanding checks: Checks clearing bank in September ............ Add: Outstanding checks, September 30 ..................................... Total checks to be accounted for ................. Less: Cash disbursements per books ........ Outstanding checks, August 31 ...................
7-18
.
(For Instructor Use Only)
$16,900 $15,600 (580) 15,020 $ 1,880
$17,500 $16,400 (940) 15,460 $ 2,040
$25,900 2,200 28,100 26,400 $ 1,700
$24,000 2,100 26,100 23,500 $ 2,600
EXERCISE 7-11 (a) Deposits in transit = $74,000 – ($71,000 – $4,800) = $7,800 (b) Outstanding checks = ($73,570 + $360) – ($68,678 – $4,500) = $9,752 (c)
WERTH INC. Bank Reconciliation August 31, 2014 Cash balance per bank statement ...................... Add: Deposits in transit .....................................
$20,692* 7,800 28,492 9,752 $18,740
Less: Outstanding checks .................................. Adjusted cash balance per bank ........................ Cash balance per books...................................... Add: Interest earned .......................................... Less: Error in recording check ($400 – $40) ..... Service charge .......................................... Safety deposit box rent ............................ Adjusted cash balance per books ......................
$19,130** 45 19,175 $360 50 25
435 $18,740
*Proof of cash balance per bank statement: $18,400 + $71,000 – $68,678 + $45 – $25 – $50 = $20,692 **Proof of cash balance per books: $18,700 + $74,000 – $73,570 = $19,130 (d) Aug. 31 Cash ........................................................... Interest Revenue ............................... 31 31
.
45 45
Accounts Payable ..................................... Cash ...................................................
360
Miscellaneous Expense ($50 + $25) ........ Cash ...................................................
75
(For Instructor Use Only)
360 75
7-19
EXERCISE 7-12 (a) Cash and Cash Equivalents 1. 2. 3. 5. 6.
Currency .......................................................................... U.S. Treasury bill............................................................. April checks .................................................................... Checking account ........................................................... Savings account ............................................................. Total ...........................................................................
$ 60 10,000 260 2,500 4,800 $17,620
(b) 4. Post-dated check—Accounts Receivable; Balance Sheet 7. Prepaid postage in postage meter—Prepaid Postage Expense; Balance Sheet, or Postage Expense; Income Statement 8. IOU from company receptionist—Accounts Receivable; Balance Sheet EXERCISE 7-13 Suggestions to improve cash management practices for Canzer, Morel and Wang: 1. 2. 3. 4.
7-20
Prepare a cash budget. Bill clients as work progresses. Establish a line of credit with bank. Arrange a long-term loan for renovations and equipment and plan the timing of major expenditures.
.
(For Instructor Use Only)
EXERCISE 7-14 ENRIGHT COMPANY Cash Budget For the Two Months Ending February 28, 2014
Beginning cash balance ........................................ Add: Cash receipts Collections from customers ....................... Sale of short-term investments.................. Total receipts .............................................. Total available cash ............................................... Less: Cash disbursements Payments to suppliers ................................ Wages .......................................................... Administrative expenses ............................ Selling expenses ......................................... Total disbursements ................................... Excess (deficiency) of available cash over disbursements ..................................................... Financing Add: Borrowings .................................................. Less: Repayments ................................................ Ending cash balance..............................................
.
(For Instructor Use Only)
January
February
$ 46,000
$ 24,000
71,000 12,000 83,000 129,000
146,000 0 146,000 170,000
40,000 30,000 20,000 15,000 105,000
75,000 40,000 23,000 20,000 158,000
24,000
12,000
0 0 $ 24,000
8,000 0 $ 20,000
7-21
*EXERCISE 7-15 Oct. 1 31
Petty Cash ........................................................ Cash ..........................................................
150.00
Petty Cash ........................................................ Postage Expense ............................................. Supplies ........................................................... Miscellaneous Expense .................................. Freight-Out ....................................................... Cash Over and Short ....................................... Cash ($200.00 – $59.70) ...........................
50.00 39.70 26.10 16.40 6.80 1.30
150.00
140.30
*EXERCISE 7-16 (a) Aug. 1 15
16 31
(b) 8/1 8/16 8/31 Bal.
7-22
.
Petty Cash ............................................... Cash..................................................
200.00
Freight-Out .............................................. Entertainment Expense .......................... Postage Expense .................................... Miscellaneous Expense .......................... Cash Over and Short............................... Cash..................................................
74.40 36.00 33.70 27.50 3.40
Petty Cash ............................................... Cash..................................................
200.00
Postage Expense .................................... Entertainment Expense .......................... Freight-Out .............................................. Cash Over and Short............................... Cash..................................................
145.00 90.60 46.40 1.00
Petty Cash 200 200 400
(For Instructor Use Only)
200.00
175.00 200.00
283.00
*EXERCISE 7-16 (Continued) (c) The internal control features of a petty cash fund include: (1) A custodian is responsible for the fund. (2) A pre-numbered petty cash receipt signed by the custodian and the individual receiving payment is required for each payment from the fund. (3) The treasurer’s office examines all payments and stamps supporting documents to indicate they were paid when the fund is replenished. (4) Surprise counts can be made at any time to determine whether the fund is intact.
.
(For Instructor Use Only)
7-23
SOLUTIONS TO PROBLEMS PROBLEM 7-1A (a) Principles
Application to Granada Theater
Establishment of responsibility.
Only cashiers are authorized to sell tickets. Only the manager and cashier can handle cash.
Segregation of duties.
The duties of receiving cash and admitting customers are assigned to the cashier and to the doorperson. The manager maintains custody of the cash, and the company accountant records the cash.
Documentation procedures.
Tickets are prenumbered. Cash count sheets are prepared. Deposit slips are prepared.
Physical controls.
A safe is used for the storage of cash and a machine is used to issue tickets.
Independent internal verification.
Cash counts are made by the manager at the end of each cashier’s shift. Daily comparisons are made by the company treasurer.
Human resource controls.
Cashiers are bonded.
(b) Actions by the doorperson and cashier to misappropriate cash include: (1) Instead of tearing the tickets, the doorperson could return the tickets to the cashier who could resell them, and the two could divide the cash. (2) The cashier could issue a lower price ticket than paid for and the doorperson would admit the customer. The difference between the price of the ticket issued and the cash received could be divided between the doorperson and cashier.
7-24
.
(For Instructor Use Only)
PROBLEM 7-2A
Trent has created a situation that leaves many opportunities for undetected theft. Here is a list of some of the weaknesses in internal control. You may find others. 1.
Documentation procedures. The tickets were unnumbered. By numbering the tickets, the students could have been held more accountable for the tickets. See number 3 below.
2.
Physical controls and establishment of responsibility. The tickets were left in an unlocked box on his desk. Instead, Trent should have assigned control of the tickets to one individual, in a locked box which that student alone had control over.
3.
Documentation procedures. No record was kept of which students took tickets to sell or how many they took. In combination with items 1 and 2 above, the student assigned control over the tickets should have kept a record of which tickets were issued to each student for resale. (Note: This problem could have been largely avoided if the tickets had only been sold at the door on the day of the dance.)
4.
Documentation procedures. There was no control over unsold tickets. This deficiency made it possible for students to sell tickets, keep the cash, and tell Trent that they had disposed of the unsold tickets. Instead, students should have been required to return the unsold tickets to the student maintaining control over tickets, and the cash to Trent. In each case, the students should have been issued a receipt for the cash they turned in and the tickets they returned.
5.
Establishment of responsibility. Inadequate control over the cash box. In effect, it was operated like a petty cash fund, but too many people had the key. Instead, Trent should have had the key and dispersed funds when necessary for purchases.
6.
Documentation procedures. Instead of receipts, students simply wrote notes saying how they used the funds. Instead, it should have been required that they provided a valid receipt.
.
(For Instructor Use Only)
7-25
PROBLEM 7-2A (Continued) 7.
Segregation of duties. Sandy Overbay counted the funds, made out the deposit slip, and took the funds to the bank. This made it possible for Sandy Overbay to take some of the money and deposit the rest since there was no external check on his work. Trent should have counted the funds, with someone observing him. Then he could have made out the deposit slip and had Sandy Overbay deposit the funds.
8.
Documentation procedures. Trent did not receive a receipt from Jay Dee. Without a receipt, there is no way to verify how much Jay Dee was actually paid. For example, it is possible that he was only paid $100 and that Trent took the rest.
9.
Segregation of duties. Deb Younger was collecting tickets and receiving cash for additional tickets sold. Instead, there should have been one person selling tickets at the door and a second person collecting tickets.
7-26
.
(For Instructor Use Only)
PROBLEM 7-3A
(a)
REDEKER COMPANY Bank Reconciliation July 31, 2014 Cash balance per bank statement .................... Add: Deposits in transit ..................................
$7,690.80 1,193.30 8,884.10 1,860.10 $7,024.00
Less: Outstanding checks ............................... Adjusted cash balance per bank ...................... Cash balance per books.................................... Add: Collection of note receivable ($1,500 plus accrued interest $30, less collection fee $10) .......................... Less: NSF check ............................................... Error in recording check No. 2480 ........ Bank service charge ............................... Adjusted cash balance per books ....................
(b) July 31
31 31 31
.
$6,140.00 1,520.00 7,660.00 $575.00 36.00 25.00
Cash ................................................... Miscellaneous Expense.................... Notes Receivable ...................... Interest Revenue .......................
1,520 10
Accounts Receivable—K. Wagner .... Cash ...........................................
575
Accounts Payable—T. Laird............. Cash ...........................................
36
Miscellaneous Expense.................... Cash ...........................................
25
(For Instructor Use Only)
636.00 $7,024.00
1,500 30 575 36 25
7-27
PROBLEM 7-4A
(a)
LAROCHE COMPANY Bank Reconciliation November 30, 2014 Cash Balance per bank statement ............... Add: Deposits in transit ............................. Less: Outstanding checks No. 2451 .......................................... No. 2472 .......................................... No. 2478 .......................................... No. 2482 .......................................... No. 2484 .......................................... No. 2485 .......................................... No. 2487 .......................................... No. 2488 .......................................... Adjusted cash balance per bank .................
$17,712.50 1,304.00 19,016.50 $1,260.40 426.80 538.20 612.00 829.50 974.80 398.00 800.00
Cash Balance per books .............................. Add: Collection of note receivable ($2,100 plus accrued interest $157 less collection fee $15) .................. Less: Check printing charge ....................... Error in recording check No. 2479 ($1,750 – $1,705) ............. Error in 11-21 deposit ($2,954 – $2,945) ............................ Adjusted cash balance per books ...............
7-28
.
(For Instructor Use Only)
5,839.70 $13,176.80 $11,073.80 2,242.00 13,315.80
$
85.00 45.00 9.00
139.00 $13,176.80
PROBLEM 7-4A (Continued) (b) Nov. 30
30 30 30
.
Cash ........................................................ Miscellaneous Expense ......................... Notes Receivable ............................ Interest Revenue .............................
2,242 15
Miscellaneous Expense ......................... Cash.................................................
85
Accounts Payable .................................. Cash.................................................
45
Accounts Receivable ............................. Cash.................................................
9
(For Instructor Use Only)
2,100 157 85 45 9
7-29
PROBLEM 7-5A
(a)
ZIMMERMAN COMPANY Bank Reconciliation May 31, 2014 Cash balance per bank statement .................... Add: Deposits in transit .................................. $1,880.15 Bank error—Zinderberg ......................... 360.00 Less: Outstanding checks ............................... Adjusted cash balance per bank ...................... Cash balance per books .................................... Add: Collection of note receivable ($2,600 plus accrued interest $110 less collection fee $20) .......................
Cash ................................................... Miscellaneous Expense .................... Notes Receivable ....................... Interest Revenue ........................
31
Accounts Receivable— B. Sullivan ....................................... Cash............................................
31 31 31
7-30
.
2,690.00 9,428.90
497.00 $8,931.90
2,690 20 2,600 110 380 380
Sales Revenue ................................... Cash............................................
50
Accounts Payable—M. Hartley ......... Cash............................................
27
Miscellaneous Expense .................... Cash............................................
40
(For Instructor Use Only)
2,240.15 9,208.15 276.25 $8,931.90 $6,738.90
Less: NSF check ............................................... $ 380.00 Error in May 12 deposit .......................... 50.00 Error in recording check No. 1181......... 27.00 Check printing charge ............................ 40.00 Adjusted cash balance per books .................... (b) May 31
$6,968.00
50 27 40
PROBLEM 7-6A
LANGERHAN INC. Cash Budget For the Month Ending April 30, 2014 Beginning cash balance ............................................. Add: Cash receipts Cash sales ........................................................ Collections from customers............................ Total receipts ................................................ Total available cash .................................................... Less: Cash disbursements Payment of March purchases ......................... April cash purchases....................................... Cash operating costs ...................................... Equipment purchase ....................................... Total disbursements .................................... Excess (deficiency) of available cash over disbursements ......................................................... Financing Add: Borrowings ....................................................... Less: Repayments ..................................................... Ending cash balance...................................................
.
(For Instructor Use Only)
$11,000 42,000 18,400 60,400 71,400 22,400 28,100 11,200 2,500 64,200 7,200 1,800 0 $ 9,000
7-31
PROBLEM 7-7A
CASTLE CORPORATION Cash Budget For the Two Months Ending February 28, 2014
Beginning cash balance........................................ Add: Cash receipts Collections from customers ...................... Notes receivable ......................................... Sale of securities ........................................ Total receipts ......................................................... Total available cash............................................... Less: Cash disbursements Purchases ................................................... Salaries ....................................................... Administrative expenses (Jan. $72,000 – $1,000; Feb. $75,000 – $1,000) ................ Selling expenses ........................................ Dividends .................................................... Total disbursements ............................................. Excess (deficiency) of available cash over disbursements.................................................... Financing Add: Borrowings ................................................. Less: Repayments ................................................ Ending cash balance .............................................
7-32
.
(For Instructor Use Only)
January
February
$ 46,000
$ 43,000
326,000 15,000 0 341,000 387,000
378,000
110,000 84,000
135,000 81,000
71,000 79,000 0 344,000
74,000 88,000 10,000 388,000
43,000
37,000
0 0 $ 43,000
3,000 0 $ 40,000
4,000 382,000 425,000
PROBLEM 7-8A
(a)
HEISEY COMPANY Bank Reconciliation October 31, 2014 Balance per bank statement .............................................. Plus: Undeposited receipts ..............................................
$18,380.00 3,795.51 22,175.51
Less: Outstanding checks No. 62 183 284
Amount $140.75 180.00 253.25
No. 862 863 864
Amount $190.71 226.80 165.28 ....................
1,156.79
Adjusted balance per bank ................................................
$21,018.72
Cash balance per books..................................................... Add: Bank credit (collection of note receivable) ............ Adjusted balance per books (before theft) ....................... Less: Theft ($22,062.72 – $21,018.72) ............................... Adjusted balance per books ..............................................
$21,877.72 185.00 22,062.72 1,044.00 $21,018.72
(b) The cashier attempted to cover the theft of $1,044.00 by: 1. Not listing as outstanding three checks totaling $574.00 (No. 62, $140.75; No. 183, $180.00; and No. 284, $253.25). 2. Underfooting the outstanding checks listed by $100. (The correct total is $582.79.) 3. Subtracting the $185 credit from the bank balance instead of adding it to the book balance, thereby concealing $370 of the theft. (c) 1. 2.
.
The principle of independent internal verification has been violated because the cashier prepared the bank reconciliation. The principle of segregation of duties has been violated because the cashier had access to the accounting records and also prepared the bank reconciliation.
(For Instructor Use Only)
7-33
PROBLEM 7-1B
(a)
(b)
7-34
Weaknesses include the following. 1.
There is no clear establishment of responsibility. All members appear to have the authority to take books and collect cash.
2.
There is little or no segregation of duties. The treasurer purchased the books, and will deposit cash as it is collected.
3.
There are no documentation procedures. Members are allowed to take books without completing a receipt. It does not appear that receipts are issued as books are sold.
4.
Physical controls are lacking. The books are kept on an open shelf in an office that is accessible to many people. Cash is kept in a desk drawer.
5.
Independent internal verification procedures are not used. The treasurer handles all cash transactions and no one tracks the supply of books.
Improvements include the following. 1.
A club member should be assigned as the director of this fundraising program. This member would track distribution, sales, and returns of books.
2.
Someone other than the treasurer should handle and track cash receipts from this activity. Receipts would then be forwarded to the treasurer for deposit.
3.
Members who take books should sign a pre-numbered receipt and be informed that they must return the book or payment within a designated amount of time.
.
(For Instructor Use Only)
PROBLEM 7-1B (Continued)
.
4.
The supply of books should be kept in a secure (locked) location, not on an open shelf. When students need more books, they must contact the member in charge of inventory and complete a receipt. Collections from sales must be kept in a secure (locked) location and deposited in the bank as collected.
5.
An independent club member with no responsibility for purchase, distribution, or sales of the books should perform an audit of cash receipts and disbursements as well as accounting for all books purchased, sold, and returned.
(For Instructor Use Only)
7-35
PROBLEM 7-2B
Violations: 1.
It is Sue’s responsibility to post payments to patient accounts. In allowing Tom to assist her, the establishment of responsibility principle is violated.
2.
Although this may be a small office, it is not appropriate that Tom opens the mail, prepares a bank deposit form, and receives and records cash receipts from patients. This violates the segregation of duties principle.
3.
The documentation principle is violated when patients are not given cash receipts.
4.
Independent internal verification is also violated. There is no independent counting of the cash and comparison to total receipts.
5.
Leaving the computer program on all the time and failing to comply with employee specific user ID and password violates physical controls.
6.
Human resource controls are being violated. Tom should be required to take a vacation and since he handles cash, he should be bonded.
7-36
.
(For Instructor Use Only)
PROBLEM 7-3B
(a)
TAGGERT COMPANY Bank Reconciliation March 31, 2014 Cash balance per bank statement .................... Add: Deposits in transit ..................................
$6,041.40 1,481.60 7,523.00 1,360.00 $6,163.00
Less: Outstanding checks ............................... Adjusted cash balance per bank ...................... Cash balance per books.................................... Add: Collection of note receivable ($2,000 plus accrued interest $115, less collection fee $20)...........................
$5,174.20 2,095.00 7,269.20
Less: NSF check ............................................... $1,033.20 Error in recording check No. 1245 ........ 45.00 Bank service charge ............................... 28.00 Adjusted cash balance per books ....................
(b) Mar. 31
31 31 31
.
Cash ................................................... Miscellaneous Expense.................... Notes Receivable ...................... Interest Revenue .......................
2,095 20
Accounts Receivable—R. Fross ....... Cash ...........................................
1,033.20
Accounts Payable—T. Gilroy ........... Cash ...........................................
45
Miscellaneous Expense.................... Cash ...........................................
28
(For Instructor Use Only)
1,106.20 $6,163.00
2,000 115 1,033.20 45 28
7-37
PROBLEM 7-4B (a)
TRIAD IMPORTS, INC. Bank Reconciliation August 31, 2014 Balance per bank statement ........................ Add: Deposits in transit ............................. Less: Outstanding checks No. 3151 .......................................... No. 3172 .......................................... No. 3178 .......................................... No. 3182 .......................................... No. 3184 .......................................... No. 3185 .......................................... No. 3186 .......................................... No. 3188 .......................................... Adjusted cash balance per bank ................. Balance per books ........................................ Add: Collection of note receivable ($1,600 plus accrued interest $80 less collection fee $10) .................. Error in Aug. 13 deposit ($1,104 – $1,014) ................................ Less: Check printing charge ....................... Error in recording check No. 3181 ($569 – $596) ....................... Adjusted cash balance per books ...............
(b) Aug. 31
Cash ............................................. Miscellaneous Expense .............. Notes Receivable ................. Interest Revenue .................. Cash ............................................. Accounts Receivable ........... Miscellaneous Expense .............. Cash ...................................... Accounts Payable........................ Cash ......................................
31 31 31 7-38
.
(For Instructor Use Only)
$13,563 500 14,063 $ 290 1,000 1,598 1,508 760 1,038 455 273
6,922 $ 7,141 $5,478
$1,670 90
1,760 7,238
70 27
97 $7,141
1,670 10 1,600 80 90 90 70 70 27 27
PROBLEM 7-5B (a)
BUG BUSTERS COMPANY Bank Reconciliation October 31, 2014 Cash balance per bank statement ........................ Add: Deposits in transit ...................................... Bank error—Fig Leaf ..................................
$4,070 $2,390 120
Less: Outstanding checks ................................... Adjusted cash balance per bank .......................... Cash balance per books........................................ Add: Collection of note receivable ($1,000 plus accrued interest $50 less collection fee $15) .......................... Less: NSF check ................................................... Error in deposit ........................................... Error in recording check No. 4263 ............ Check printing charge ................................ Adjusted cash balance per books ........................ (b) Oct. 31
31 31 31 31
.
$4,632 1,035 5,667 $230 30 27 50
Cash ....................................................... Miscellaneous Expense ........................ Notes Receivable ........................... Interest Revenue ...........................
1,035 15
Accounts Receivable—J. Simpson ....... Cash ...............................................
230
Sales Revenue....................................... Cash ...............................................
30
Accounts Payable—T. Grey ................. Cash ...............................................
27
Miscellaneous Expense ........................ Cash ...............................................
50
(For Instructor Use Only)
2,510 6,580 1,250 $5,330
337 $5,330
1,000 50 230 30 27 50 7-39
PROBLEM 7-6B
ITEMS INC. Cash Budget For the Month Ending June 30, 2014 Beginning cash balance ..................................... Add: Cash receipts Cash sales ................................................ Collections from customers .................... Total receipts ........................................ Total available cash ............................................ Less: Cash disbursements Payment of May purchases ..................... June cash purchases ............................... Cash operating costs ............................... Equipment purchase ................................ Total disbursements ............................ Excess (deficiency) of available cash over disbursements................................................... Financing Borrowings ..................................................... Repayments ................................................... Ending cash balance...........................................
7-40
.
(For Instructor Use Only)
$19,000 18,000 47,600 65,600 84,600 18,200 27,500 21,300 6,000 73,000 11,600 0 600 $11,000
PROBLEM 7-7B
NOBLE CORPORATION Cash Budget For the Two Months Ending February 28, 2014
Beginning cash balance ....................................... Add: Cash receipts Collections from customers.......................... Interest receivable ...................................... Sale of securities ........................................ Total receipts ......................................................... Total available cash .............................................. Less: Cash disbursements Purchases ................................................... Salaries ....................................................... Administrative expenses (Jan. $58,000 – $2,000; Feb. $60,000 – $2,000) ................... Selling expenses ........................................ Note payable ............................................... Dividends .................................................... Total disbursements ............................................. Excess (deficiency) of available cash over disbursements ..................................................... Financing Borrowings ................................................. Repayments ................................................ Ending cash balance.............................................
.
(For Instructor Use Only)
January
February
$ 52,000
$ 40,000
279,500 7,500
298,000
287,000 339,000
8,000 306,000 346,000
106,000 72,000
116,000 78,000
56,000 30,000 35,000
58,000 36,000
299,000
5,000 293,000
40,000
53,000
0 0 $ 40,000
13,000 $ 40,000
7-41
PROBLEM 7-8B
(a)
ELITE SERVICE COMPANY Bank Reconciliation March 31, 2014 Balance per bank statement .............................................. Plus: Undeposited receipts ...............................................
$5,931.51 1,591.63 7,523.14
Less: Outstanding checks No.
Amount
No.
Amount
206 441 590
$358.53 292.00 283.00
781 782 783
$286.00 319.47 303.14
1,842.14
Adjusted balance per bank ................................................
$5,681.00
Cash balance per books ..................................................... Add: Bank credit (collection of note receivable) ............ Adjusted balance per books (before theft) ....................... Theft ($7,064.53 – $5,681.00) .............................................. Adjusted balance per books ..............................................
$6,889.53 175.00 7,064.53 1,383.53 $5,681.00
(b) The cashier attempted to cover the theft of $1,383.53 by:
7-42
1.
Not listing as outstanding three checks totaling $933.53 (No. 206, $358.53; No. 441, $292.00; and No. 590, $283.00).
2.
Underfooting the outstanding checks listed by $100. (The correct total is $908.61.)
3.
Subtracting the $175 credit from the bank balance instead of adding it to the book balance, thereby concealing $350 of the theft. .
(For Instructor Use Only)
PROBLEM 7-8B (Continued) (c) 1.
The principle of independent internal verification has been violated because the cashier prepared the bank reconciliation.
2.
The principle of segregation of duties has been violated because the cashier had access to the accounting records and also prepared the bank reconciliation.
.
(For Instructor Use Only)
7-43
COMPREHENSIVE PROBLEM SOLUTION
(a)
Dec. 7
Cash ............................................................. Accounts Receivable...........................
12 17
19 22
26
31
7-44
.
3,600 3,600
Inventory ...................................................... 12,000 Accounts Payable ................................
12,000
Accounts Receivable .................................. 16,000 Sales Revenue .....................................
16,000
Cost of Goods Sold ..................................... 10,000 Inventory ..............................................
10,000
Salaries and Wages Expense ..................... Cash .....................................................
2,200
2,200
Accounts Payable ....................................... 12,000 Cash ($12,000 X .99) ............................ Inventory ..............................................
11,880 120
Cash ($16,000 X .98) .................................... 15,680 Sales Discounts .......................................... 320 Accounts Receivable...........................
16,000
Cash ............................................................ Accounts Receivable...........................
2,700
(For Instructor Use Only)
2,700
COMPREHENSIVE PROBLEM SOLUTION (Continued) (b) & (e) Cash 12/1 Bal. 18,200 12/19 12/7 3,600 12/22 12/26 15,680 12/31 12/31 2,700 12/31 2,000 12/31 Bal. 27,420
General Ledger
2,200 11,880 680
12/22
12/31 Bal. 425 Accounts Payable 12,000 12/1 Bal. 6,100 12/12 12,000 12/31 Bal. 6,100 Common Stock 12/1 Bal. 50,000
Notes Receivable 12/1 Bal. 2,000 12/31 12/31 Bal. – 0 –
2,000
Retained Earnings 12/1 Bal. 14,200
Accounts Receivable 12/1 Bal. 7,500 12/7 3,600 12/17 16,000 12/26 16,000 12/31 680 12/31 2,700 12/31 Bal. 1,880
Sales Revenue 12/17 16,000 12/31 Bal. 16,000
Inventory 12/1 Bal. 16,000 12/17 12/12 12,000 12/22 12/31 Bal. 17,880
10,000 120
Prepaid Insurance 12/1 Bal. 1,600 12/31 12/31 Bal. 1,200
400
Equipment 12/1 Bal. 28,000 Accumulated Depreciation—Equipment 12/1 Bal. 3,000 12/31 200 12/31 Bal. 3,200 Income Taxes Payable 12/31 .
(For Instructor Use Only)
425
Sales Discounts 12/26 320 12/31 Bal. 320 Cost of Goods Sold 12/17 10,000 12/31 Bal. 10,000 Depreciation Expense 12/31 200 12/31 Bal. 200 Salaries and Wages Expense 12/19 2,200 12/31 Bal. 2,200 Insurance Expense 12/31 400 12/31 Bal. 400 Income Tax Expense 12/31 425 7-45
12/31 Bal.
425
7-46
.
(For Instructor Use Only)
COMPREHENSIVE PROBLEM SOLUTION (Continued) (c)
HAVENHILL COMPANY Bank Reconciliation December 31, 2014 Cash balance per bank statement .......................... Add: Deposits in transit ..........................................
$25,930 2,700 28,630 1,210 $27,420
Less: Outstanding checks ...................................... Adjusted cash balance per bank ............................ Cash balance per books ......................................... Add: Collection of note receivable .........................
26,100 2,000 28,100 680 $27,420
Less: NSF check ...................................................... Adjusted cash balance per books .......................... (d) Dec. 31 Cash .......................................................... Notes Receivable ...............................
2,000
31 Accounts Receivable ............................... Cash....................................................
680
31 Depreciation Expense .............................. Accumulated Depreciation— Equipment .......................................
200
31 Insurance Expense ................................... Prepaid Insurance..............................
400
31 Income Tax Expense ................................ Income Taxes Payable.......................
425
.
(For Instructor Use Only)
2,000 680
200 400 425
7-47
COMPREHENSIVE PROBLEM SOLUTION (Continued) (f)
HAVENHILL COMPANY Adjusted Trial Balance December 31, 2014 Cash ............................................................. Accounts Receivable .................................. Inventory ...................................................... Prepaid Insurance ....................................... Equipment ................................................... Accumulated Depreciation—Equipment ... Accounts Payable ....................................... Income Taxes Payable ................................ Common Stock ............................................ Retained Earnings....................................... Sales Revenue............................................. Sales Discounts .......................................... Cost of Goods Sold..................................... Depreciation Expense ................................. Salaries and Wages Expense ..................... Insurance Expense ..................................... Income Tax Expense...................................
(g)
CR.
$ 3,200 6,100 425 50,000 14,200 16,000 320 10,000 200 2,200 400 425 $89,925
$89,925
HAVENHILL COMPANY Income Statement For the Month Ending December 31, 2014 Sales revenue .............................................. Less: Sales discounts ............................... Net sales ...................................................... Cost of goods sold...................................... Gross profit ................................................. Operating expenses Salaries and wages expense .............. Insurance expense .............................. Depreciation expense .......................... Income before income taxes ...................... Income tax expense .................................... Net income...................................................
7-48
DR. $27,420 1,880 17,880 1,200 28,000
.
(For Instructor Use Only)
$16,000 320 15,680 10,000 5,680 $2,200 400 200
2,800 2,880 425 $ 2,455
COMPREHENSIVE PROBLEM SOLUTION (Continued) (g)
HAVENHILL COMPANY Balance Sheet December 31, 2014 Assets Current assets Cash ....................................................... Accounts receivable.............................. Inventory ................................................ Prepaid insurance ................................. Total current assets .......................... Property, plant, and equipment Equipment .............................................. Less: Accumulated depreciation—Equipment .......... Total assets ...................................................
$27,420 1,880 17,880 1,200 $48,380 28,000 3,200
24,800 $73,180
Liabilities and Stockholders’ Equity Current liabilities Accounts payable .................................. Income taxes payable ........................... Stockholders’ equity Common stock ...................................... Retained earnings ($14,200 + $2,455) .. Total stockholders’ equity............... Total liabilities and stockholders’ equity ....
.
(For Instructor Use Only)
$6,100 425
$6,525
50,000 16,655 66,655 $73,180
7-49
BYP 7-1
FINANCIAL REPORTING PROBLEM
(a) The first paragraph of the independent registered public accounting firm’s report states that: In our opinion, the accompanying consolidated statements of financial position and the related consolidated statements of earnings, comprehensive earnings and retained earnings, and of cash flows present fairly, in all material respects, the financial position of Tootsie Roll Industries, Inc. and its subsidiaries at December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America. (b) The consolidated statement of financial position shows the combined cash and cash equivalent balances (in thousands) at December 31, 2011 and 2010: 2011—$78,612 and 2010—$115,976 (c) The consolidated statement of cash flows indicates that three activities are responsible for the change in cash in 2011: (1) operating, (2) investing, and (3) financing. (d) The notes say: The company considers temporary cash investments with an original maturity of three months or less to be cash equivalents. (e) The management of Tootsie Roll Industries, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. After performing an evaluation of company procedures, management concluded that its internal control over financial reporting was effective. Management’s assessment of Tootsie Roll’s internal control was audited by and addressed in the opinion of its public accounting firm, PricewaterhouseCoopers, LLP.
7-50
.
(For Instructor Use Only)
BYP 7-2
COMPARATIVE ANALYSIS PROBLEM
Tootsie Roll
Hershey Company
(a) Cash/cash equivalents balance
$78,612
$693,686
(b) Cash as a percentage of total assets 2011: 2010:
9.2%* 13.5%**
15.7%*** 20.7%****
(In thousands)
Cash as a percentage of total assets decreased 32% for Tootsie Roll and 24% for Hershey Company. (c) Cash provided by operating activities
$50,390
$580,867
(d) The objective in cash management is to ensure that a company has sufficient cash to meet payments as they come due, yet minimize the amount of non-revenue-generating cash on hand. The decrease in cash as a percentage of total assets experienced by both companies is a cause of concern only if they are missing opportunities to generate revenue. If not, both companies have probably done a better job managing cash in 2011 than 2010. Data from several years would be necessary to look for trends to draw more reliable conclusions. *$78,612/$857,856 **$115,976/$857,959 ***$693,686/$4,412,199 ****$884,642/$4,272,732
.
(For Instructor Use Only)
7-51
BYP 7-3
RESEARCH CASE
(a) The article lists 8 different forms of payment. They are: wire transfer, paper checks, automated clearing house (ACH) credits, ACH debits, purchasing cards (p-cards), paying from statements, petty cash, payment via travel and expense (T&E) reimbursement. (b) As more payment options become available, it is more likely that companies will pay the same bill twice. (c) The controls suggested in the article are: 1. 2. 3. 4. 5.
7-52
Limit payment type i.e. only p-card. Make sure purchase orders are extinguished whenever a payment is made. Make sure the invoice number is entered using the coding standard whenever payments are made. Make sure the same coding standards are used. Establish a payment timing policy adhered to by everyone.
.
(For Instructor Use Only)
BYP 7-4
INTERPRETING FINANCIAL STATEMENTS
(a) The global percentage of companies that experienced a significant instance of fraud during the period covered by the survey was 16% and Western Europe had the highest rate at 21%. (b) 44% of survey respondents performed a fraud risk assessment in the six months prior to the survey. 15% of survey respondents have never performed a fraud risk assessment. (c) 43% of respondents thought members of the board of directors were “very concerned” and 33% thought “fairly concerned” about board members’ personal legal liability resulting from fraud at their companies. (d) The top three issues of concern to compliance officers according to the survey were: data security; unethical business conduct; and competition law.
.
(For Instructor Use Only)
7-53
BYP 7-5
REAL-WORLD FOCUS
(a) The mission of the Financial Accounting Standards Board is to establish and improve standards of financial accounting and reporting that foster financial reporting by non-governmental entities that provides decision-useful information to investors and other users of financial reports. (b) The Chairman will consult with FASB members, staff directors, and others as appropriate before making a decision to add or remove a project from the FASB’s technical agenda or to change the priorities of existing projects. The FASB and its Chairman consult with FASAC concerning, among other things, major technical issues, the FASB’s agenda of projects and the priorities of the projects, and matters likely to require the attention of the FASB. The FASB also considers timely suggestions from other individuals and organizations. (c) The FASB is committed to following an open, orderly process for setting standards. The FASB designed its comprehensive due process procedures to permit timely, thorough, and open study of financial accounting and reporting issues and to encourage broad public participation in the standards-setting process by creating channels for the communication of all points of view and expressions of opinion at all stages of the process. The cooperation of all concerned with or affected by financial accounting and reporting is fundamental to the operation of the FASB. Of particular importance to the FASB is the receipt of thoughtful, reasoned, and timely input during the FASB’s research, discussion, and deliberative processes. The FASB recognizes that acceptance of its conclusions is enhanced by demonstrating that the comments received in due process are considered carefully.
7-54
.
(For Instructor Use Only)
BYP 7-6
REAL-WORLD FOCUS
(a) The PCAOB is a private-sector, non-profit corporation, created by the Sarbanes-Oxley Act of 2002 to oversee the auditors of public companies in order to protect investors and the public interest by promoting informative, fair, and independent audit reports. (b) The PCAOB is required to conduct inspections of public accounting firms to assess compliance with the Sarbanes-Oxley Act, the rules of the Board, the rules of the SEC, and professional standards in connection with the firm’s performance of audits, issuance of audit reports, and related matters involving U.S. public companies and other issuers. Inspections occur annually for larger firms and at least triennially for smaller firms. The PCAOB prepares written reports concerning each inspection for regulatory authorities and the public. (c) The PCAOB has authority to investigate and discipline registered public accounting firms and persons associated with those firms for noncompliance with the Sarbanes-Oxley Act of 2002, the rules of the PCAOB and the Securities and Exchange Commission, and other laws, rules, and professional standards governing the audits of public companies. When violations are found, the PCAOB can impose appropriate sanctions. As required by the Sarbanes-Oxley Act, the Board’s investigations are confidential and nonpublic. The SarbanesOxley Act also requires that disciplinary proceedings are confidential and nonpublic, unless and until there is a final decision imposing sanctions.
.
(For Instructor Use Only)
7-55
BYP 7-7
DECISION MAKING ACROSS THE ORGANIZATION
(a) The material weaknesses and the related principle(s) of internal control that was violated are as follows: Material Weakness
Internal Control Principle
•
Non-timely deposit of cash receipts
•
Physical controls—cash should be deposited in total daily
•
Excessive past due accounts receivable
•
Establishment of responsibility
•
Disregard of advantages offered by vendors for prompt payment of invoices
•
Establishment of responsibility
•
Absence of segregation of duties
•
Segregation of duties
•
Inadequate procedures for applying accounting principles
•
Documentation procedures
•
Lack of qualified management personnel
•
Establishment of responsibility
•
Lack of supervision by outside board of directors
•
Establishment of responsibility; independent internal verification
•
Overall poor record keeping
•
Documentation procedures
(b) Under the Sarbanes-Oxley Act, publicly traded companies are required to maintain adequate systems of internal control. Failure to comply with the Act can result in fines and imprisonment of officers. Managers should recognize that good internal control is necessary to stay in business. In addition, good internal control principles should benefit the company by safeguarding its assets and enhancing the accuracy and reliability of accounting records.
7-56
.
(For Instructor Use Only)
BYP 7-8
COMMUNICATION ACTIVITY
Mr. D. A. Flynn Lyman Company Main Street, USA Dear Mr. Flynn: During our audit of your financial statements, we reviewed the internal controls over cash receipts. The weaknesses we discovered and our suggested improvements are listed below. Weaknesses
Suggested Improvement
1.
A list of checks received is not prepared by the person who opens the mail.
This list should be prepared so that it can later be compared with the daily cash summary. While this procedure does not assure that all checks will be listed, it does allow the company to verify that all checks on the list did get deposited.
2.
Mail is opened by only one person.
When this occurs, there is no assurance that all incoming checks are forwarded to the cashier’s department.
3.
The cashier is allowed to open the mail.
Under this arrangement, it is possible for the cashier to open the mail, prepare the cash summary and make the bank deposit. This involves no segregation of duties as the cashier controls the cash from the time it is received until it is deposited in the bank.
4.
The accounts receivable clerk is allowed to open the mail.
Again, there is poor segregation of duties. In this case, the clerk could write off a customer’s account as uncollectible and then misappropriate the collection when it’s received.
.
(For Instructor Use Only)
7-57
BYP 7-8 (Continued)
5.
Weaknesses
Suggested Improvement
Mail receipts are deposited weekly.
This makes the receipts vulnerable to robbery and to misappropriation. The receipts should be deposited daily.
We would be pleased to discuss the weaknesses and our recommended improvements with you, at your convenience. Yours sincerely,
Good and Rich Certified Public Accountants
7-58
.
(For Instructor Use Only)
BYP 7-9
ETHICS CASE
(a) The amount of fee revenue depending on order of processing would be: (1) Largest to smallest: (2) Smallest to largest: (3) In order of check number:
5 bounced checks X $30 = $150 1 bounced check X $30 = $30 2 bounced checks X $30 = $60
(b) Whether this is ethical is subject to debate. On the one hand, it can be argued that customers have a responsibility to maintain an adequate balance in their accounts. Some customers are frequently overdrawn; thus only severe penalties will persuade them to maintain an adequate balance. However, it could be argued that charging $30 for something that has a cost to the bank of $1.50 is “gouging”—that is, taking unfair advantage of the customer. (c) In deciding what approach to take, the bank must consider its relationship with the customer. Clearly, by adopting a “largest to smallest” approach, it is going to anger some customers, who may well decide to leave the bank and go to a more customer-friendly bank. However, it could be argued that some of the customers the bank may lose are customers that are frequently overdrawn and therefore costly to the bank. Also, it can be time-consuming to change banks, and most people don’t have the spare time to change banks unless they really need to. (d) Answer will vary depending on student’s opinion.
.
(For Instructor Use Only)
7-59
BYP 7-10
ETHICS CASE
Answers will vary depending on article chosen.
7-60
.
(For Instructor Use Only)
BYP 7-11
ALL ABOUT YOU
Answers are provided to students on the government website as they complete the ID Theft Faceoff quiz.
.
(For Instructor Use Only)
7-61
BYP 7-12
FASB CODIFICATION ACTIVITY
(a) Consistent with common usage, cash includes not only currency on hand but demand deposits with banks or other financial institutions. Cash also includes other kinds of accounts that have the general characteristics of demand deposits in that the customer may deposit additional funds at any time without prior notice or penalty. All charges and credits to those accounts are cash receipts or payments to both the entity owning the account and the bank holding it. For example, a bank’s granting of a loan by crediting the proceeds to a customer’s demand deposit account is a cash payment by the bank and a cash receipt of the customer when the entry is made. Codification reference (305-10-20). (b) Cash equivalents are short-term, highly liquid investments that have both of the following characteristics: a.
Readily convertible to known amounts of cash
b.
So near their maturity that they present insignificant risk of changes in value because of changes in interest rates.
Generally, only investments with original maturities of three months or less qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a threemonth U.S. Treasury bill and a three-year Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining maturity is three months. Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations). Codification reference (305-10-20).
7-62
.
(For Instructor Use Only)
BYP 7-12 (Continued) (c) Cash and cash items. Separate disclosure shall be made of the cash and cash items which are restricted as to withdrawal or usage. The provisions of any restrictions shall be described in a note to the financial statements. Restrictions may include legally restricted deposits held as compensating balances against short-term borrowing arrangements, contracts entered into with others, or company statements of intention with regard to particular deposits; however, time deposits and short-term certificates of deposit are not generally included in legally restricted deposits. In cases where compensating balance arrangements exist but are not agreements which legally restrict the use of cash amounts shown on the balance sheet, describe in the notes to the financial statements these arrangements and the amount involved, if determinable, for the most recent audited balance sheet required and for any subsequent unaudited balance sheet required in the notes to the financial statements. Compensating balances that are maintained under an agreement to assure future credit availability shall be disclosed in the notes to the financial statements along with the amount and terms of such agreement.
.
(For Instructor Use Only)
7-63
IFRS CONCEPTS AND APPLICATION
IFRS7-1 Companies listed on U.S. stock exchanges must comply with the SarbanesOxley Act. This compliance gives investors greater assurance that these companies have adequate internal controls in place. In addition, the auditors for these publicly traded companies must attest to the effectiveness of such controls. This process can result in discovery of weaknesses that companies had previously overlooked. After correcting these weaknesses to satisfy auditors, investors may find such companies to be less risky and therefore better investments. In order to comply with SOX, a company must document its internal control procedures and have an auditor attest to their effectiveness. Doing so costs money. A recent study indicated that audit fees can double in the first year of a company’s compliance. Since this cost is incurred only if a company lists on U.S. exchanges, many investors see SOX compliance as a costly undertaking. IFRS7-2 (a) (b) (c) (d)
7-64
True. False. Different cultures have different perspectives on bribery and other questionable activities. False. Cash (not cash equivalents) is comprised of cash on hand and demand deposits. False. Sox was created by the U.S. Congress.
.
(For Instructor Use Only)
IFRS7-3
INTERNATIONAL FINANCIAL REPORTING PROBLEM
(a)
Zetar’s Audit Committee reviews management’s reports on internal control.
(b)
The key control procedures include 1.
2. 3. 4. 5. 6.
A comprehensive system of financial budgeting, forecasting and then reporting and reviewing actual monthly results for the current year against these expectations and against the results of prior years. A system of operational and financial Key Performance Indicators (“KPIs”), which are reviewed on a weekly and monthly basis. Procedures for appraisal, review and authorization of capital expenditures. Properly authorized treasury procedures and banking arrangements. Regular review of materials and services supply commitments. Regular review of tax, insurance, and health and safety matters.
(c)
No, Zetar’s Board does not consider it appropriate to establish an internal audit department.
(d)
Bank overdrafts are reported as the last item in the current liabilities section of its consolidated balance sheet.
.
(For Instructor Use Only)
7-65
CHAPTER 8 Reporting and Analyzing Receivables Learning Objectives 1. 2. 3. 4. 5. 6. 7. 8. 9.
Identify the different types of receivables. Explain how accounts receivable are recognized in the accounts. Describe the methods used to account for bad debts. Compute the interest on notes receivable. Describe the entries to record the disposition of notes receivable. Explain the statement presentation of receivables. Describe the principles of sound accounts receivable management. Identify ratios to analyze a company’s receivables. Describe methods to accelerate the receipt of cash from receivables.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item 1. 2. 3. 4. 5.
LO 1 1 3 3 3
BT
Item
C K C C AP
6. 7. 8. 9. 10.
LO 3 3 7 4 4
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
K C C C K
Questions 11. 4 AP 12. 5 C 13. 6 K 14. 7 K 15. 7 C
16. 17. 18. 19. 20.
7 8 7, 8 8 9
K C C AP K
21. 22. 23. 24.
9 9 9 9
C AP C AP
12.
9
AP
14. 15. 16. 17.
9 9 9 9
C AP AP AN
9.
7, 8
AN
9.
7, 8
AN
Brief Exercises 1. 2. 3. 4. 1. 1. 2. 3. 4. 1. 2.
1. 2.
1 2 3 3 3 2 2 2, 3 3 2, 3 2, 3, 8 2, 3 2, 3, 8
C AP AP AP AP AP AP AP AP AP AP AP AP
5. 6. 7.
2. 5. 6. 7.
3 4 4
AP AP AP
10. 11.
8 9
AP AP
4, 5
Do It! Review Exercises AP 3. 8 AP 4.
9
AP
3 3 4, 5
Exercises 8. 4, 5 AP 9. 6 AP 10. 7 K
7, 8 7, 8, 9 9
AN
AP AP AP
8. 9.
4 3, 6, 7, 8
AP AP
11. 12. 13.
3. 4. 5. 3. 4. 5.
2, 3 3 2, 3 2, 3 3 2, 3
AP AP AP AP AP AP
Problems: Set A 2, 6. 4, 5 AP 7.
8
8
4, 5, 6, 9
AP
4, 5, 6, 9
AP
C
Problems: Set B 2, 6. 4, 5 AP 7.
8.
AN AP
8.
C
*Continuing Cookie Solutions for this chapter are available online. .
(For Instructor Use Only)
8-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
8-2
Description
Difficulty Level
Time Allotted (min.)
1A
Journalize transactions related to bad debts.
Simple
15–20
2A
Prepare journal entries related to bad debt expense, and compute ratios.
Simple
15–20
3A
Journalize transactions related to bad debts.
Moderate
20–30
4A
Compute bad debts amounts.
Moderate
20–25
5A
Journalize entries to record transactions related to bad debts.
Moderate
20–30
6A
Journalize various receivables transactions.
Moderate
40–50
7A
Explain the impact of transactions on ratios.
Moderate
20–30
8A
Prepare entries for various credit card and notes receivable transactions.
Complex
50–60
9A
Calculate and interpret various ratios.
Moderate
10–15
1B
Journalize transactions related to bad debts.
Simple
15–20
2B
Prepare journal entries related to bad debt expense, and compute ratios.
Simple
15–20
3B
Journalize transactions related to bad debts.
Moderate
20–30
4B
Compute bad debts amounts.
Moderate
20–25
5B
Journalize entries to record transactions related to bad debts.
Moderate
20–30
6B
Journalize various receivables transactions.
Moderate
40–50
7B
Explain the impact of transactions on ratios.
Moderate
20–30
8B
Prepare entries for various credit card and notes receivable transactions.
Complex
50–60
9B
Calculate and interpret various ratios.
Moderate
10–15
.
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
ANSWERS TO QUESTIONS 1.
Accounts receivable are amounts customers owe on account. They result from the sale of goods and services (i.e., in trade). Notes receivable represent claims that are evidenced by formal instruments of credit.
2.
Other receivables include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable.
3.
The essential features of the allowance method of accounting for bad debts are: (1) Uncollectible accounts receivable are estimated and matched against revenues in the same accounting period in which the revenues are recorded. (2) Estimated uncollectibles are debited to Bad Debt Expense and credited to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. (3) Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off as uncollectible.
4.
Mitch should realize that the decrease in cash realizable value occurs when estimated uncollectibles are recognized in an adjusting entry. The write-off of an uncollectible account reduces both accounts receivable and the allowance for doubtful accounts by the same amount. Thus, cash realizable value does not change.
5.
The adjusting entry under the percentage of receivables basis is: Bad Debt Expense .................................................................................. Allowance for Doubtful Accounts ($5,100 – $2,200) ..........................
2,900 2,900
6.
Tootsie Roll reports two types of receivables on its balance sheet: Accounts receivable trade, and Other receivables. Since Tootsie Roll’s balance sheet reports allowance amounts for receivables, we know that Tootsie Roll uses the allowance method rather than the direct write-off method.
7.
Under the direct write-off method, bad debt losses are not estimated and no allowance account is used. When an account is determined to be uncollectible, the loss is debited to Bad Debt Expense and credited to Accounts Receivable. The direct write-off method makes no attempt to match bad debts expense to revenues or to show the cash realizable value of the receivables in the balance sheet.
8.
Offering credit usually results in an increase in sales because customers prefer to “buy now and pay later”. If a company decides to extend credit to customers, it should also establish credit standards to determine if a particular customer is credit worthy. Standards that are easily met can result in additional sales being made to customers that may not be able to meet the “tighter” credit policies of competitors. If such customers fail to pay, the additional sales revenue will be offset by higher collection costs and bad debts expense.
9.
A promissory note gives the holder a stronger legal claim than one on an account receivable. As a result, it is easier to sell to another party. Promissory notes are negotiable instruments, which means they can be transferred to another party by endorsement. The holder of a promissory note also can earn interest.
10.
The maturity date of a promissory note may be stated in one of three ways: (1) on demand, (2) on a stated date, and (3) at the end of a stated period of time.
.
(For Instructor Use Only)
8-3
Questions Chapter 8 (Continued) 11.
The missing amounts are: (a) $27,000, (b) 10%, (c) six months or 180 days, and (d) $7,200.
12.
When Carrera Company has dishonored a note, the lender can renegotiate new terms for the receivable which is equal to the full amount of the note plus the interest due. It will then try to collect the balance due, or as much as possible. If there is no hope of collection, it will write-off the note receivable.
13.
Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements. Both the gross amount of receivables and the allowance for doubtful accounts should be reported. If collectible within a year or the operating cycle, whichever is longer, these receivables are reported as current assets immediately below short-term investments. Notes receivables are usually listed before accounts receivable because notes are more easily converted to cash.
14.
The steps involved in receivables management are: (1) Determine to whom to extend credit. (2) Establish a payment period. (3) Monitor collections. (4) Evaluate the liquidity of receivables. (5) Accelerate cash receipts from receivables when necessary.
15.
A company can prepare an aging schedule to monitor collection success. An aging schedule provides information about the overall collection experience of a company and identifies problem accounts.
16.
A concentration of credit risk is a threat of nonpayment from either a single large customer or class of customers that could adversely affect the company’s financial health.
17.
An increase in the current ratio normally indicates an improvement in short-term liquidity. This may not always be the case because the composition of current assets may vary. In order to determine if the increase is an improvement in financial health, other ratios that should be considered include: accounts receivable turnover ratio and average collection period.
18.
An increase of more than 100% in the average collection period is probably caused by the adoption of looser credit standards. The new sales director may have increased sales by extending credit to customers that did not meet the company’s previous credit standards. Management should try to determine if the longer collection period jeopardizes the company’s overall financial position. It should compare its collection period to that of its competitors to determine if it is reasonable. It should also monitor collections to see if the additional sales are producing significant increases in costs associated with collection and bad debts. To reduce the average collection period, management might consider offering a sales discount to encourage customers to pay sooner.
19.
Net credit sales for the period are 9.05 X $3,424 million = $30,987.2 million. Average collection period in days = 365 days ÷ 9.05 = 40.3 days.
8-4
.
Kimmel, Accounting, 5/e, Solutions Manual
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Questions Chapter 8 (Continued) 20.
From its own credit cards, the JC Penney Company may realize financing charges from customers who do not pay the balance due within a specified grace period. National credit cards offer the following advantages: (1) The credit card issuer does the credit investigation of the customer. (2) The issuer maintains individual customer accounts. (3) The issuer undertakes the collection process and absorbs any losses from uncollectible accounts. (4) The retailer receives cash more quickly from the credit card issuer than it would from individual customers.
21.
The reasons companies sell their receivables are: (1) For competitive reasons, companies often must provide financing to purchasers of their goods. Such financing can result in receivables balances that are larger than the company wishes to hold. Selling the receivables reduces the excessive balance. (2) Receivables may be sold because they may be the only reasonable source of cash. (3) Billing and collection are often time-consuming and costly. As a result, it is often easier for a retailer to sell the receivables to another party that has expertise in billing and collecting receivables.
22.
Cash ............................................................................................................... 388,000 Service Charge Expense (3% X $400,000) ..................................................... 12,000 Accounts Receivable .............................................................................. 400,000
23.
Sales revenue is recorded when goods or services are provided, even if cash is yet to be received. As a consequence, if sales are growing rapidly, cash collections are sometimes significantly lower than sales.
24.
Cash collections can be determined by adjusting Sales Revenue for the net change in Accounts Receivable. An increase in the receivables balance is deducted from Sales Revenue, a decrease in the receivables balance is added to Sales Revenue.
.
(For Instructor Use Only)
8-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 8-1 (a) Other receivables. (b) Notes receivable. (c) Accounts receivable. BRIEF EXERCISE 8-2 (a) Accounts Receivable ............................................... Sales Revenue .................................................
23,000
(b) Sales Returns and Allowances ............................... Accounts Receivable ......................................
2,400
(c) Cash ($20,600 – $412) .............................................. Sales Discounts ($20,600 X 2%).............................. Accounts Receivable ($23,000 – $2,400)........
20,188 412
23,000 2,400
20,600
BRIEF EXERCISE 8-3 (a) Allowance for Doubtful Accounts........................... Accounts Receivable ...................................... (b) Accounts receivable Less: Allowance for doubtful accounts Cash realizable value
8-6
.
(1) Before Write-Off $700,000
Kimmel, Accounting, 5/e, Solutions Manual
25,000 $675,000
(For Instructor Use Only)
4,300 4,300 (2) After Write-Off $695,700 20,700 $675,000
BRIEF EXERCISE 8-4 Accounts Receivable ...................................................... Allowance for Doubtful Accounts ..........................
4,300
Cash ................................................................................. Accounts Receivable ..............................................
4,300
4,300 4,300
BRIEF EXERCISE 8-5 (a) Bad Debt Expense [($400,000 X 2%) – $2,800].................................... Allowance for Doubtful Accounts ..................
5,200
(b) Bad Debt Expense [($400,000 X 2%) + $900] ...................................... Allowance for Doubtful Accounts ..................
8,900
5,200
8,900
BRIEF EXERCISE 8-6 Interest (a) $800 (b) $875 (c) $200
Maturity Date August 9 October 12 July 11
BRIEF EXERCISE 8-7 Maturity Date (a) May 31 (b) August 1 (c) September 7
Annual Interest Rate 9% 8% 10%
Total Interest $9,000 $ 600 $6,000
BRIEF EXERCISE 8-8 Jan. 10 Accounts Receivable ...................................... Sales Revenue ........................................
8,000
Feb. 9 Notes Receivable............................................. Accounts Receivable .............................
8,000
.
(For Instructor Use Only)
8,000 8,000 8-7
BRIEF EXERCISE 8-9 (a) Bad Debt Expense ................................................. Allowance for Doubtful Accounts .................
18,000 18,000
(b) Current assets Cash ................................................................. $ 90,000 Accounts receivable ....................................... $400,000 Less: Allowance for doubtful accounts ........ 18,000 382,000 Inventory .......................................................... 180,000 Supplies ........................................................... 13,000 $665,000 (c) Accounts receivable turnover ratio =
Average collection period =
$3,000,000 = 10 times $300,000
365 days = 36.5 days 10
The accounts receivable turnover ratio is a liquidity measure. The average collection period indicates the effectiveness of a company’s credit and collection policies. To evaluate Gehrig’s liquidity and credit policies, these measures should be compared to the same measures for competitors. BRIEF EXERCISE 8-10 Accounts Receivable Turnover Ratio:
$23.1B $23.1B = = 7.2 times ($3.2B + 3.25B) ÷ 2 $3.225B Average Collection Period: 365 days = 50.7 days 7.2 times
8-8
.
Kimmel, Accounting, 5/e, Solutions Manual
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BRIEF EXERCISE 8-11 (a) Cash ($200 – $6)....................................................... Service Charge Expense ($200 X 3%) .................... Sales Revenue ..................................................
194 6
(b) Cash ($65,000 – $1,950) ........................................... Service Charge Expense ($65,000 X 3%) ............... Accounts Receivable .......................................
63,050 1,950
200
65,000
BRIEF EXERCISE 8-12 Accounts Receivable
Beg. Sales End
70,000 598,000 577,000 Collections 91,000 or
Sales $598,000
– Increase in Receivables = – ($91,000 – $70,000) =
Cash Collections $577,000
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 8-1 The following entry should be prepared to bring the balance in the Allowance for Doubtful Accounts up from $5,700 credit to $21,700 credit (7% X $310,000): Bad Debt Expense ................................................................. Allowance for Doubtful Accounts ............................... (To record estimate of uncollectible accounts)
.
(For Instructor Use Only)
16,000 16,000
8-9
DO IT! 8-2 The interest payable at maturity is $186: Face X Rate X Time = Income $6,200 X 9% X 4/12 = $186 The entry recorded by Berkman Wholesalers at the maturity date is: Cash ................................................................................. 6,386 Notes Receivable ...................................................... 6,200 Interest Revenue ....................................................... 186 (To record collection of Almonte note and interest) DO IT! 8-3 (a)
(b)
Net credit sales ÷
Average net accounts receivable
=
Accounts receivable turnover ratio
$1,600,000
÷
$108,000 + $120,000 2
=
14.0 times
Days in year
÷
Accounts receivable turnover ratio
=
365
÷
14.0 times
=
Average collection period in days 26.1 days
DO IT! 8-4 To speed up the collection of cash, Lounow sells $170,000 of its accounts receivable to a factor. Assuming the factor charges Lounow a 2% service charge, it would make the following entry: Cash ................................................................................. Service Charge Expense ($170,000 X 2%) ..................... Accounts Receivable ............................................. (To record sale of receivables to factor)
8-10
.
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
166,600 3,400 170,000
SOLUTIONS TO EXERCISES EXERCISE 8-1 Jan. 6 16
Accounts Receivable—Foley Inc ................... Sales Revenue ..........................................
9,200
Cash ($9,200 – $92) ......................................... Sales Discounts (1% X $9,200) ....................... Accounts Receivable—Foley Inc.............
9,108 92
9,200
9,200
EXERCISE 8-2 Jan. 10 Feb. 12 Mar. 10
Accounts Receivable—Milo............................ Sales Revenue ..........................................
1,700
Cash ................................................................. Accounts Receivable—Milo .....................
1,100
Accounts Receivable—Milo............................ Interest Revenue [1% X ($1,700 – $1,100)] ........................
6
1,700 1,100
6
EXERCISE 8-3 (a)
(b) (c)
.
Accounts Receivable ........................................... Sales Revenue .................................................
800,000
Cash ...................................................................... Accounts Receivable ......................................
763,000
Allowance for Doubtful Accounts ....................... Accounts Receivable ......................................
7,300
Accounts Receivable ........................................... Allowance for Doubtful Accounts ..................
3,100
Cash ...................................................................... Accounts Receivable ......................................
3,100
(For Instructor Use Only)
800,000 763,000 7,300 3,100 3,100 8-11
EXERCISE 8-3 (Continued) (d)
Bad Debt Expense ................................................ Allowance for Doubtful Accounts ..............
20,200 20,200
Allowance for Doubtful Accounts Beg. Bal. 9,000 Write-off 7,300 Recovery 3,100 Bad Debts 20,200 [$25,000 – ($9,000 + $3,100 – $7,300)] End Bal. 25,000
(e)
Accounts Receivable Beg. Bal. 200,000 Collections 763,000 Sales 800,000 Write-off 7,300 Recovery 3,100 Collections 3,100 End Bal. 229,700
(f)
Net realizable value of receivables is $204,700 ($229,700 – $25,000)
Allowance for Doubtful Accounts Beg. Bal. 9,000 Write-off 7,300 Recovery 3,100 Bad Debts 20,200 End Bal. 25,000
EXERCISE 8-4 (a) Dec. 31
Bad Debt Expense ........................................... Accounts Receivable—Hiller ...................
(b) Dec. 31
(c) Dec. 31
8-12
.
900 900
Bad Debt Expense ........................................... 6,700 Allowance for Doubtful Accounts [($78,000 X 10%) – $1,100].....................
6,700
Bad Debt Expense ........................................... 6,740 Allowance for Doubtful Accounts [($78,000 X 8%) + $500] .........................
6,740
Kimmel, Accounting, 5/e, Solutions Manual
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EXERCISE 8-5 (a)
Accounts Receivable Current 1–30 days past due 31–90 days past due Over 90 days past due
(b) Mar. 31
Amount $65,000 12,900 10,100 7,400
% 2 5 30 50
Estimated Uncollectible $1,300 645 3,030 3,700 $8,675
Bad Debt Expense ........................................... Allowance for Doubtful Accounts ($8,675 – $2,100) ....................................
6,575 6,575
(c) The total balance of receivables increased from 2013 to 2014. However, of concern is the fact that each of the three categories of older accounts increased substantially during 2014. That is, customers are taking longer to pay and bad debts are likely to increase. Management needs to investigate the causes of this change. EXERCISE 8-6 December 31, 2013 Bad Debt Expense .......................................................... Allowance for Doubtful Accounts [(9% X $90,000) + $1,400]......................................
9,500 9,500
May 11, 2014 Allowance for Doubtful Accounts .................................. Accounts Receivable—Byrd ...................................
1,200
June 12, 2014 Accounts Receivable—Byrd ........................................... Allowance for Doubtful Accounts ..........................
1,200
Cash ................................................................................. Accounts Receivable—Byrd ...................................
.
(For Instructor Use Only)
1,200
1,200 1,200 1,200
8-13
EXERCISE 8-7 Nov. 1 Notes Receivable ............................................. Cash...........................................................
60,000
Dec. 11 Notes Receivable ............................................. Sales Revenue ..........................................
3,600
16 Notes Receivable ............................................. Accounts Receivable—M. Adcock ..........
12,000
31 Interest Receivable .......................................... Interest Revenue* .....................................
761
60,000 3,600 12,000 761
*Calculation of interest revenue: Carr’s note: $60,000 X 7% X 2/12 = $700 Kiner’s note: 3,600 X 8% X 20/360 = 16 Adcock’s note: 12,000 X 9% X 15/360 = 45 Total accrued interest = $761 EXERCISE 8-8 May
2013 1 Notes Receivable ............................................. Accounts Receivable—S. Rooney ...........
Dec. 31 Interest Receivable .......................................... Interest Revenue ($5,000 X 6% X 8/12) .............................. May
8-14
2014 1 Cash ................................................................. Notes Receivable ...................................... Interest Receivable ................................... Interest Revenue ($5,000 X 6% X 4/12) ..............................
.
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
5,000 5,000 200 200 5,300 5,000 200 100
EXERCISE 8-9 SHANNON CORP. Balance Sheet (Partial) October 31, 2014 (in thousands) Receivables Notes receivable ........................................................ Accounts receivable .................................................. Other receivables ...................................................... Total receivables ....................................................... Less: Allowance for doubtful accounts ........................ Net receivables ................................................................
$1,353 2,910 189 $4,452 52 $4,400
EXERCISE 8-10 (a) 2. Reviewing company ratings in the Dun and Bradstreet Reference Book of American Business. (b) 3. Collecting information on competitors’ payment period policies. (c) 4. Preparing monthly accounts receivable aging schedule and investigating problem accounts. (d) 5. Calculating the accounts receivable turnover ratio and average collection period. (e) 1. Selling receivables to a factor. EXERCISE 8-11 (a) $35,497 Accounts receivable = = 9.2 times turnover ratio ($3,391+ $4,359)/2
Average collection 365 days = = 39.7 days period 9.2 (b) Accounts receivable comprise 48% ($3,391/$7,116) of the company’s total current assets. This is certainly a material component.
.
(For Instructor Use Only)
8-15
EXERCISE 8-11 (Continued) (c) The balance in the allowance account increased $38 million ($196 – $158) while its accounts receivable decreased $930 million ($3,587 – $4,517). As a result, the allowance for uncollectible accounts increased from 3.5% of accounts receivable in 2013 to 5.5% in 2014. EXERCISE 8-12 (a) At first glance it appears that Lin’s liquidity had deteriorated over the past year since the company’s current ratio has fallen from 1.5:1 to 1.3:1. However, it is taking the company less time to collect its accounts receivable as evidenced by the higher accounts receivable turnover. The company also appears to be moving its inventory more quickly as evidenced by the higher inventory turnover. It is possible that the lower current ratio is due to the fact that with improved collections and inventory turnover, the company is carrying fewer current assets and not because the company’s liquidity has deteriorated. (b) Changes in the turnover ratios do not directly affect profitability. However, improvements in turnover generally indicate that the company is better able to convert sales to cash. Improved liquidity could allow the company to better manage its cash flows and therefore, indirectly improve profitability. (c) There are several steps that Lin might have taken to improve its receivables and inventory turnover: Receivables
8-16
-
The company could limit credit to only the best customers, however, this could negatively affect sales.
-
The company could initiate the use of a cash discount to encourage early payment of receivables.
-
The company could more aggressively monitor collections to encourage customers to pay on time.
-
The company could sell its receivables to a factor to accelerate cash receipts. .
Kimmel, Accounting, 5/e, Solutions Manual
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EXERCISE 8-12 (Continued) Inventory -
The company could limit the amount of inventory by improving its purchasing relationships with suppliers. If inventory could be purchased more frequently, required inventory levels could be reduced.
-
Improvements in production processes could reduce the amount of work in process, thereby reducing inventory and improving the turnover ratio.
-
Moving to a system whereby inventory is only produced as needed, will reduce the amount of finished goods inventory and improve the turnover ratio. However, there is some risk to this option as sales could be lost if stock-outs occur.
EXERCISE 8-13 Mar. 3
Cash ($710,000 – $28,400) .............................. Service Charge Expense (4% X $710,000) ..... Accounts Receivable ...............................
681,600 28,400 710,000
EXERCISE 8-14 One possible reason Office Depot chose to sell its receivables may have been to improve its financial ratios. Other reasons include not wanting to deal with the administration of collecting accounts or the desire to accelerate cash receipts. EXERCISE 8-15 May 10
.
Cash ($4,000 – $152) ....................................... Service Charge Expense (3.8% X $4,000) ...... Sales Revenue ..........................................
(For Instructor Use Only)
3,848 152 4,000
8-17
EXERCISE 8-16 July 4
Cash ($250 – $10) ............................................ Service Charge Expense (4% X $250) ............ Sales Revenue ..........................................
240 10 250
EXERCISE 8-17 (a)
Accounts Receivable
Beg 38,000 Sales 380,000 227,000 End 191,000
Collections or
Sales – Increase in Receivables = Cash Collections $380,000 – ($191,000 – $38,000) = $227,000 (b) The quality of earnings ratio is net cash provided by operating activities divided by net income. If accrual sales exceed cash collections, then net income will exceed net cash provided by operating activities, all else being equal. Therefore, this would cause a drop in the quality of earnings ratio. (c) If the company relaxed its credit requirements it should increase its estimated bad debts expense. If it doesn’t do this, net income in the current period will likely be overstated.
8-18
.
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SOLUTIONS TO PROBLEMS PROBLEM 8-1A
(a)
Total estimated bad debts Number of Days Outstanding 31–60 61–90 91–120
Over 120
$377,000 $222,000 1%
$90,000 4%
$38,000 5%
$15,000 8%
$12,000 10%
$10,120
$3,600
$1,900
$1,200
$1,200
Total Accounts receivable % uncollectible Estimated bad debts
0–30
$2,220
(b) Bad Debt Expense .......................................... Allowance for Doubtful Accounts ($10,120 + $4,000) .................................
14,120
(c)
Allowance for Doubtful Accounts ................. Accounts Receivable ..............................
5,000
(d) Accounts Receivable ..................................... Allowance for Doubtful Accounts ..........
5,000
Cash ................................................................ Accounts Receivable ..............................
5,000
(e)
14,120 5,000 5,000 5,000
If Reynolds.com used 3% of total accounts receivable rather than aging the individual accounts, the bad debt expense adjustment would be $15,310 [($377,000 X 3%) + $4,000]. Aging the individual accounts rather than applying a percentage to the total accounts receivable should produce a more accurate allowance account and bad debts expense.
.
(For Instructor Use Only)
8-19
PROBLEM 8-2A
(a)
1.
Accounts Receivable ..................................... 2,500,000 Sales Revenue ......................................... 2,500,000
2.
Sales Returns and Allowances ...................... Accounts Receivable ...............................
Cash ................................................................ 2,200,000 Accounts Receivable ............................... 2,200,000
4.
Allowance for Doubtful Accounts ................. Accounts Receivable ...............................
41,000
Accounts Receivable ..................................... Allowance for Doubtful Accounts ..........
15,000
Cash ................................................................ Accounts Receivable ...............................
15,000
Accounts Receivable Bal. 600,000 (1) 2,500,000 (5) 15,000 Bal.
(c)
50,000
3.
5.
(b)
50,000
(2) 50,000 (3) 2,200,000 (4) 41,000 (5) 15,000
41,000 15,000 15,000
Allowance for Doubtful Accounts (4)
41,000
809,000
Bal. (5)
37,000 15,000
Bal.
11,000
Balance needed ...................................................... Balance before adjustment [See (b)]..................... Adjustment required ..............................................
$46,000 (11,000) $35,000
The journal entry would therefore be as follows: Bad Debt Expense .................................................. Allowance for Doubtful Accounts ...............
8-20
.
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35,000 35,000
PROBLEM 8-2A (Continued) (d)
$2,500,000 – $50,000 $2,450,000 = = 3.7 times ($563,000* + $763,000**) ÷ 2 $663,000
*$600,000 – $37,000 **$809,000 – $46,000 The average collection period is: 365 days = 98.6 days 3.7
.
(For Instructor Use Only)
8-21
PROBLEM 8-3A
(a) Dec. 31 Bad Debt Expense ..................................... Allowance for Doubtful Accounts ($42,400 – $8,000) ............................
34,400 34,400
(a) & (b) 12/31 12/31
Bad Debt Expense
Allowance for Doubtful Accounts
34,400 Bal. 34,400
2013
2014 3/1
(b) (1) (2)
Mar. 1 May 1
1 (c)
600 5/1
2014 Allowance for Doubtful Accounts ....... Accounts Receivable ....................
.
600
600 600
Accounts Receivable ............................ Allowance for Doubtful Accounts ....................................
600
Cash ....................................................... Accounts Receivable ....................
600
2014 Bad Debt Expense ...................................... Allowance for Doubtful Accounts ($36,700 + $1,400) ..............................
Dec. 31
8-22
12/31 Bal. 8,000 12/31 34,400 12/31 Bal. 42,400
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(For Instructor Use Only)
600 600 38,100 38,100
PROBLEM 8-4A
(a) $37,000. (b) $30,600 [($840,000 X 4%) – $3,000]. (c) $34,600 [(840,000 X 4%) + $1,000]. (d) The are two major weaknesses with the direct write-off method. First, it does not match expenses with revenues. Second, the accounts receivable are not stated at cash realizable value at the balance sheet date.
.
(For Instructor Use Only)
8-23
PROBLEM 8-5A
Bad Debt Expense ($10,200 – $1,500) ..... Allowance for Doubtful Accounts .....
8,700
Bad Debt Expense ($10,200 + $1,500) ..... Allowance for Doubtful Accounts .....
11,700
Allowance for Doubtful Accounts ........................... Accounts Receivable ........................................
2,100
Bad Debt Expense .................................................... Accounts Receivable ........................................
2,100
(a) Dec. 31
(b) Dec. 31
(c)
(d)
(e)
8-24
8,700
11,700
2,100
2,100
The advantages of the allowance method over the direct write-off method are: 1.
It attempts to match bad debts expense related to uncollectible accounts receivable with sales revenues on the income statement.
2.
It attempts to show the cash realizable value of the accounts receivable on the balance sheet.
.
Kimmel, Accounting, 5/e, Solutions Manual
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PROBLEM 8-6A
Jan. 5 Feb. 2 12 26 Apr. 5 12
June 2
June 15
.
Accounts Receivable—Ross Company ......... Sales Revenue ..........................................
4,000
Notes Receivable ............................................ Accounts Receivable—Ross Company ..
4,000
Notes Receivable ............................................ Sales Revenue ..........................................
12,000
Accounts Receivable—Meachum Co............. Sales Revenue ..........................................
5,200
Notes Receivable. ........................................... Accounts Receivable—Meachum Co ......
5,200
Cash ($12,000 + $200) ..................................... Notes Receivable...................................... Interest Revenue ($12,000 X 10% X 2/12) ..........................
12,200
Cash ($4,000 + $120) ....................................... Notes Receivable...................................... Interest Revenue ($4,000 X 9% X 4/12) ...
4,120
Notes Receivable ............................................ Sales Revenue ..........................................
2,000
(For Instructor Use Only)
4,000 4,000 12,000 5,200 5,200 12,000 200 4,000 120
2,000
8-25
PROBLEM 8-7A
Transaction 1. Recorded cash sale. 2. Recorded bad debts expense. Use allowance method 3. Wrote off an account receivable as uncollectible. Use allowance method 4. Recorded sales on account.
8-26
.
Current Ratio (2:1) I
Accounts Receivable Turnover (10X) NE
Average Collection Period (36.5 days) NE
D
I
D
NE
NE
NE
I
D
I
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
PROBLEM 8-8A
(a) July
5 14
20
24
31
Accounts Receivable ............................... Sales Revenue ....................................
4,500
Cash ($600 – $18) ..................................... Service Charge Expense ($600 X 3%) ..... Sales Revenue ....................................
582 18
Cash ......................................................... Notes Receivable ................................ Interest Revenue ($6,000 X 8% X 90/360) ....................
6,120
Cash ......................................................... Notes Receivable ................................ Interest Revenue ($7,800 X 10% X 60/360) ..................
7,930
Interest Receivable .................................. Interest Revenue ($10,000 X 6% X 1/12) ......................
50
4,500
600 6,000 120 7,800 130
50
(b) Notes Receivable 7/1 Bal. 23,800 7/20 7/24 7/31 Bal. 10,000
6,000 7,800
7/31
Interest Receivable 50
7/31 Bal.
50
Accounts Receivable 7/5 4,500 7/31 Bal. 4,500
.
(For Instructor Use Only)
8-27
PROBLEM 8-8A (Continued) KOLTON COMPANY Balance Sheet (Partial) July 31, 201X (c) Current assets Notes receivable ............................................... Accounts receivable......................................... Interest receivable ............................................ Total receivables.........................................
8-28
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Kimmel, Accounting, 5/e, Solutions Manual
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$10,000 4,500 50 $14,550
PROBLEM 8-9A
Nike Accounts receivable turnover
Adidas
$19,176.1 a
$10,381 b
($2,795.3 + $2,883.9 )/ 2 $19,176.1 $2,839.6
= 6.8 times
($1,624c + $1,429d )/ 2 $10,381 $1,526.5
= 6.8 times
a2,873.7 – 78.4 b2,994.7 – 110.8 c1,743 – 119 d1,553 – 124
Average collection period
365 6.8
= 53.7 days
365 6.8
= 53.7 days
Both companies have the same turnover ratios and average collection periods.
.
(For Instructor Use Only)
8-29
SOLUTIONS TO PROBLEMS—SET B PROBLEM 8-1B
(a) Total estimated bad debts Number of Days Outstanding 31–60 61–90 91–120
Over 120
$305,000 $107,000 2%
$60,000 5%
$50,000 7.5%
$38,000 10%
$50,000 25%
$25,190
$3,000
$3,750
$3,800
$12,500
Total Accounts receivable % uncollectible Estimated bad debts
0–30
$2,140
(b) Bad Debt Expense .............................................. Allowance for Doubtful Accounts [$25,190 – $7,000] .....................................
18,190
(c) Allowance for Doubtful Accounts ...................... Accounts Receivable...................................
2,600
(d) Accounts Receivable .......................................... Allowance for Doubtful Accounts ..............
1,200
Cash ..................................................................... Accounts Receivable...................................
1,200
18,190 2,600 1,200 1,200
(e) When an allowance account is used, an adjusting journal entry is made at the end of each accounting period. This entry satisfies the expense recognition principle by recording the bad debts expense in the period in which the sales occur.
8-30
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Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
PROBLEM 8-2B
(a)
1.
Accounts Receivable ................................. 3,600,000 Sales Revenue ..................................... 3,600,000
2.
Sales Returns and Allowances .................. Accounts Receivable ..........................
150,000 150,000
3.
Cash ............................................................. 3,100,000 Accounts Receivable .......................... 3,100,000
4.
Allowance for Doubtful Accounts .............. Accounts Receivable ..........................
92,000
Accounts Receivable .................................. Allowance for Doubtful Accounts ......
28,000
Cash ............................................................. Accounts Receivable ..........................
28,000
5.
(b)
Accounts Receivable Bal. 960,000 (2) 150,000 (1) 3,600,000 (3) 3,100,000 (5) 28,000 (4) 92,000 (5) 28,000 Bal. 1,218,000
(c)
Balance needed .................................................... Balance before adjustment [see (b)] ................... Adjustment required ............................................
92,000 28,000 28,000
Allowance for Doubtful Accounts (4) 92,000 Bal. 78,000 (5) 28,000 Bal. 14,000
$140,000 (14,000) $126,000
The journal entry would therefore be as follows: Bad Debt Expense ......................................... Allowance for Doubtful Accounts .........
.
(For Instructor Use Only)
126,000 126,000
8-31
PROBLEM 8-2B (Continued) (d)
$3,600,000 – $150,000 $3,450,000 = = 3.5 times ($882,000* + $1,078,000**) ÷ 2 $980,000 *$960,000 – $78,000 **$1,218,000 – $140,000 Its average collection period is:
8-32
.
365 days = 104.3 days 3.5
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
PROBLEM 8-3B
(a) Dec. 31
Bad Debt Expense .................................. Allowance for Doubtful Accounts ($33,480 – $9,000) ........................
24,480 24,480
(a) & (b) 12/31 12/31
Bad Debt Expense
Allowance for Doubtful Accounts
24,480 Bal. 24,480
2013
2014 2/1
(b) (1) (2)
Feb. 1 July 1
1 (c) Dec. 31
.
12/31 Bal. 9,000 12/31 24,480 12/31 Bal. 33,480 900 7/1
2014 Allowance for Doubtful Accounts ..... Accounts Receivable..................
900 900
Accounts Receivable.......................... Allowance for Doubtful Accounts ..............................
900
Cash .................................................... Accounts Receivable..................
900
2014 Bad Debt Expense .................................... Allowance for Doubtful Accounts ($30,600 + $2,800) .......................
(For Instructor Use Only)
900
900 900 33,400 33,400
8-33
PROBLEM 8-4B
(a)
$15,000.
(b)
$16,300 [($500,000 X 4%) – $3,700].
(c)
$22,000 [(500,000 X 4%) + $2,000].
(d)
The weakness of the direct write-off method is twofold. First, it does not match expenses with revenues. Second, the accounts receivable are not stated at cash realizable value at the balance sheet date.
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Kimmel, Accounting, 5/e, Solutions Manual
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PROBLEM 8-5B
(a)
(b)
(c)
(d)
(e)
.
Dec. 31 Bad Debt Expense ($7,600 – $2,800) ....... Allowance for Doubtful Accounts .....................................
4,800
Dec. 31 Bad Debt Expense ($7,600 + $2,500) ....... Allowance for Doubtful Accounts .....................................
10,100
Allowance for Doubtful Accounts ........................... Accounts Receivable ........................................
750
Bad Debt Expense .................................................... Accounts Receivable ........................................
750
4,800
10,100
750
750
The advantages of the allowance method over the direct write-off method are: (1)
It attempts to match bad debt expense related to uncollectible accounts receivable with sales revenue on the income statement.
(2)
It attempts to show the cash realizable value of the accounts receivable on the balance sheet.
(For Instructor Use Only)
8-35
PROBLEM 8-6B
Jan. 5 20
Feb. 18 Apr. 20
30
May 25 Aug. 18
Sept. 1
8-36
Accounts Receivable—Flynn Company ........ Sales Revenue ..........................................
10,000
Notes Receivable............................................. Accounts Receivable— Flynn Company......................................
10,000
Notes Receivable............................................. Sales Revenue ..........................................
4,000
Cash ($10,000 + $150) ..................................... Notes Receivable ...................................... Interest Revenue ($10,000 X 6% X 3/12) ............................
10,150
Cash ($12,000 + $360) ..................................... Notes Receivable ...................................... Interest Revenue ($12,000 X 9% X 4/12) ............................
12,360
Notes Receivable............................................. Accounts Receivable—Creech Inc ..........
9,000
Cash ($4,000 + $160) ....................................... Notes Receivable ...................................... Interest Revenue ($4,000 X 8% X 6/12) ..............................
4,160
Notes Receivable............................................. Sales Revenue ..........................................
5,000
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Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
10,000
10,000 4,000 10,000 150 12,000 360 9,000 4,000 160 5,000
PROBLEM 8-7B
Current Ratio (2:1)
Accounts Receivable Turnover (10X)
Average Collection Period (36.5 days)
1. Recorded sales on account.
I
D
I
2. Recorded bad debts expense. Use allowance method.
D
I
D
3. Wrote off an account receivable as uncollectible. Use allowance method.
NE
NE
NE
4. Collected an account receivable that had been written off.
NE
I
D
Transaction
.
(For Instructor Use Only)
8-37
PROBLEM 8-8B
(a) Oct.
7 12
15
25
31
Accounts Receivable ........................... Sales Revenue ................................
4,600
Cash ($600 – $18) ................................. Service Charge Expense ($600 X 3%) ........................................ Sales Revenue ................................
582
Cash ...................................................... Notes Receivable ............................ Interest Revenue ($10,000 X 6% X 60/360)...............
10,100
Cash ...................................................... Notes Receivable ............................ Interest Revenue ($3,000 X 7% X 2/12).....................
3,035
Interest Receivable ............................... Interest Revenue ($9,800 X 6% X 1/12).....................
49
4,600
18 600 10,000 100 3,000 35
49
(b) Notes Receivable 10/1 Bal. 22,800 10/15 10/25 10/31 Bal. 9,800
10,000 3,000
Interest Receivable 10/31 49 10/31 Bal.
Accounts Receivable 10/ 7 4,600 10/31 Bal. 4,600
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Kimmel, Accounting, 5/e, Solutions Manual
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49
PROBLEM 8-8B (Continued) DURHAN COMPANY Balance Sheet (Partial) October 31, 2014 (c) Current assets Notes receivable ..................................................... Accounts receivable .............................................. Interest receivable .................................................. Total receivables ..............................................
.
(For Instructor Use Only)
$ 9,800 4,600 49 $14,449
8-39
PROBLEM 8-9B
Redbird Sportswear
Carwright Company
$1,350
$1, 200
Accounts receivable turnover
a
b
($286.6 + $299.8 )/2 $1, 200 $293.2
= 4.1 times
c
($204.0 + $188.1d )/ 2 $1, 350 $196.1
= 6.9 times
$293.3 – $ 6.7 $307.2 – $ 7.4 c $216.5 – $12.5 d $202.9 – $14.8 a
b
Average collection period
365 4.1
= 89.0 days
365 6.9
= 52.9 days
Carwright’s accounts receivable turnover was over 68% higher [(6.9 – 4.1) ÷ 4.1] than Redbird’s, which means that Carwright was significantly more efficient than Redbird in turning accounts receivables into cash.
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Kimmel, Accounting, 5/e, Solutions Manual
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COMPREHENSIVE PROBLEM SOLUTION (a) Jan. 1
3 8 11
15
17 21 24
27 31
.
Notes Receivable ........................................... Accounts Receivable— Matheny Company ..............................
1,200
Allowance for Doubtful Accounts ................ Accounts Receivable .............................
730
Inventory ........................................................ Accounts Payable ..................................
17,200
Accounts Receivable .................................... Sales Revenue .......................................
25,000
Cost of Goods Sold ....................................... Inventory ................................................
17,500
Cash ............................................................... Service Charge Expense ............................... Sales Revenue .......................................
970 30
Cost of Goods Sold ....................................... Inventory ................................................
700
Cash ............................................................... Accounts Receivable .............................
22,900
Accounts Payable ......................................... Cash ........................................................
16,300
Accounts Receivable .................................... Allowance for Doubtful Accounts.........
280
Cash ............................................................... Accounts Receivable .............................
280
Supplies ......................................................... Cash ........................................................
1,400
Other Operating Expenses ........................... Cash ........................................................
3,218
(For Instructor Use Only)
1,200 730 17,200 25,000 17,500
1,000 700 22,900 16,300 280 280 1,400 3,218 8-41
COMPREHENSIVE PROBLEM SOLUTION (Continued) Adjusting Entries Jan. 31 31
31 31
Interest Receivable ........................................ Interest Revenue ($1,200 X 8% X 1/12) ....... Bad Debt Expense [($19,950 X 6%) – ($800 – $730 + $280)] .................................. Allowance for Doubtful Accounts..........
8 847 847
Supplies Expense .......................................... Supplies ($1,400 – $560) ........................
840
Income Tax Expense ...................................... Income Taxes Payable [$2,873 (See c) X 30%] .........................
862
(b)
840
862
MADSON CORPORATION Adjusted Trial Balance January 31, 2014 Cash ............................................................ Notes Receivable ....................................... Accounts Receivable ................................. Allowance for Doubtful Accounts ............. Interest Receivable .................................... Inventory ..................................................... Supplies ...................................................... Accounts Payable ...................................... Income Taxes Payable ............................... Common Stock ........................................... Retained Earnings...................................... Sales Revenue............................................ Cost of Goods Sold.................................... Supplies Expense ...................................... Bad Debt Expense...................................... Service Charge Expense ........................... Other Operating Expenses ........................ Interest Revenue ........................................ Income Tax Expense..................................
8-42
8
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Kimmel, Accounting, 5/e, Solutions Manual
Debit $16,332 1,200 19,950
Credit
$ 1,197 8 8,400 560 9,650 862 20,000 12,730 26,000 18,200 840 847 30 3,218 8 862 $70,447
(For Instructor Use Only)
$70,447
COMPREHENSIVE PROBLEM SOLUTION (Continued) (b)
Optional T accounts for accounts with multiple transactions
Cash 1/1 Bal. 13,100 1/21 1/15 970 1/27 1/17 22,900 1/31 1/24 280 1/31 Bal. 16,332
16,300 1,400 3,218
1/21
Accounts Receivable 1/1 Bal. 19,780 1/1 1,200 1/11 25,000 1/3 730 1/24 280 1/17 22,900 1/24 280 1/31 Bal. 19,950 Allowance for Doubtful Accounts 1/3 730 1/1 Bal. 800 1/24 280 1/31 847 1/31 Bal. 1,197 Inventory 1/1 Bal. 9,400 1/11 1/8 17,200 1/15 1/31 Bal. 8,400
.
(For Instructor Use Only)
1/27 1/31 Bal.
Supplies 1,400 1/31 560
840
Accounts Payable 16,300 1/1 Bal. 8,750 1/8 17,200 1/31 Bal. 9,650 Sales Revenue 1/11 25,000 1/15 1,000 1/31 Bal. 26,000
Cost of Goods Sold 1/11 17,500 1/15 700 1/31 Bal. 18,200
17,500 700
8-43
COMPREHENSIVE PROBLEM SOLUTION (Continued) (c)
MADSON CORPORATION Income Statement For the Month Ending January 31, 2014 Sales revenue .................................................. Cost of goods sold.......................................... Gross profit ..................................................... Operating expenses ........................................ Other operating expenses....................... Bad debt expense .................................... Supplies expense .................................... Service charge expense .......................... Total operating expenses ............................... Income from operations ................................. Other revenues and gains .............................. Interest revenue ....................................... Income before taxes ....................................... Income tax expense ($2,873 X 30%) ....... Net income.......................................................
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Kimmel, Accounting, 5/e, Solutions Manual
$26,000 18,200 7,800 $3,218 847 840 30
(For Instructor Use Only)
4,935 2,865 8 2,873 862 $ 2,011
COMPREHENSIVE PROBLEM SOLUTION (Continued) MADSON CORPORATION Retained Earnings Statement For the Month Ending January 31, 2014 Retained earnings, January 1 ........................................... Add: Net income ................................................................ Retained earnings, January 31 .........................................
$12,730 2,011 $14,741
MADSON CORPORATION Balance Sheet January 31, 2014 Assets Current assets Cash ........................................................... Notes receivable ........................................ Accounts receivable.................................. Less: Allowance for doubtful accounts ......................................... Interest receivable ..................................... Inventory .................................................... Supplies ..................................................... Total assets .......................................................
$16,332 1,200 $19,950 1,197
18,753 8 8,400 560 $45,253
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ...................................... Income taxes payable ............................... Total liabilities ................................................... Stockholders’ equity Common stock .......................................... Retained earnings ..................................... Total stockholders’ equity ........................ Total liabilities and stockholders’ equity ........
.
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
$ 9,650 862 $10,512 $20,000 14,741 34,741 $45,253
8-45
BYP 8-1
FINANCIAL REPORTING PROBLEM
2011 (a)
Accounts receivable turnover
$528,369 = ($41,895 + $37,394) ÷ 2 =
Average collection period =
$528,369 = 13.3 times $39,644.5 365 = 27.4 days 13.3
(b)
Note 1 states that revenue from a major customer exceeded 20% of net product sales in recent years. Note 9 reports significant foreign sales, primarily Mexico and Canada. Material sales to a single customer could create potential credit risk problems.
(c)
At 27.4 days, Tootsie Roll’s average collection period appears reasonable. It should be compared to its credit terms (normally 30 days) and to previous years to determine whether it is of concern.
8-46
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Kimmel, Accounting, 5/e, Solutions Manual
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BYP 8-2
(a) (1)
(2)
COMPARATIVE ANALYSIS PROBLEM
Accounts receivable turnover ratio Tootsie Roll
Hershey Company
$528,369 ($41,895 + $37,394) ÷ 2
$6,080,788 ($399,499 + $390,061) ÷ 2
$528,369 = 13.3 times $39,644.5
$6,080,788 = 15.4 times $394,780
Average collection period
365 = 27.4 days 13.3
365 = 23.7 days 15.4
(b) The general rule for the average collection period is that it should not greatly exceed the credit term period. Tootsie Roll’s average collection period (approximately 27 days) is shorter than the normal credit term period of 30 days but is worse than Hershey Company’s 24 day average collection period.
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Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
8-47
BYP 8-3
RESEARCH CASE
(a) InBev told its suppliers that it would take up to 120 days to pay. This is compared to 30 days previously. (b) To free up cash, General Electric shortened collection times, collected on past-due accounts, and stretched out its payments to suppliers. By doing this the company says that it freed up $3.8 billion. (c) Companies with sales of more than $5 billion took an average of 55.8 days to pay suppliers and they took an average of 41 days to collect from customers. Companies with sales of less than $500 million took an average of 40.1 days to pay suppliers and they took an average of 58.9 days to collect from customers. (d) If a company negotiates payment terms that are too severe for its suppliers, the suppliers may be forced out of business. This can then disrupt the company’s operations as it searches for substitute suppliers.
8-48
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Kimmel, Accounting, 5/e, Solutions Manual
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BYP 8-4
(a)
INTERPRETING FINANCIAL STATEMENTS
Accounts receivable turnover
=
$2,981.8 = 11.7 times ($259.8* + $248.3**)/2
*$270.4 – $10.6 **$259.7 – $11.4 Average collection period =
365 days = 31.2 days 11.7
(b)
Accounts receivable represent 24.9% [($270.4 – $10.6)/$1,044.9] of the company’s current assets. This is a material amount of the current assets.
(c)
The ratios would probably vary throughout the year as receivables increase during the busy season and decrease in the “off” season. To improve the accuracy of the ratio, average receivables should be calculated using monthly or quarterly data, rather than just the beginning and ending balance.
(d)
It is difficult to evaluate Scotts’ credit risk with only a single year’s data and no industry norms. An average collection period of 31.2 days may be reasonable for the type of customers that make up Scotts’ receivables. Scotts explained that a majority of its receivables were from its North American Consumer segment. Within this segment, there were several subgroups (i.e., home centers, mass merchandisers, hardware stores). The note explains that its top 3 customers accounted for 48% of its total receivables from the North American consumer business. In addition its two largest customers accounted for more than 34% of its net sales. These facts indicate a higher degree of credit risk than having numerous smaller customers.
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Kimmel, Accounting, 5/e, Solutions Manual
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8-49
BYP 8-4 (Continued) (e)
8-50
Note 19 addressed the issues that surround credit risk. It provided the reader with at least a moderate degree of “comfort” that Scotts’ accounts receivable and allowance policies were acceptable. The note also appears to comply with the full disclosure principle required under GAAP. It does not, however, disclose what the company’s credit exposure is to any individual customers. This would be of interest, since some of its customers are probably very large. As noted in part (d), having the receivables balance spread across multiple customers is usually less risky than having a few large customers.
.
Kimmel, Accounting, 5/e, Solutions Manual
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BYP 8-5 (a)
REAL-WORLD FOCUS
Factoring invoices enhances cash flow and allows a company to meet business expenses and take on new opportunities. The benefits of factoring include: • • • •
Predictable cash flow and elimination of slow payments Flexible financing, as factoring line is tied to sales. It’s the ideal tool for growth Factoring is easy to obtain. Works well with startups and established companies Factoring financing lines can be setup in a few days
(b)
Factoring rates range between 1.5% and 3.5% per month. The two major variables considered when determining the rate are: (1) the size of the transaction, and (2) the credit quality of the company’s clients .
(c)
The first installment is paid within a couple of days and is typically 90% of the invoice amount. After customers pay the invoice amount to the factor, the second installment (10%) is paid, less a fee for the transaction.
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8-51
BYP 8-6
DECISION MAKING ACROSS THE ORGANIZATION
(a) 2014 $500,000
2013 2012 $600,000 $400,000
$
2,900
$ 2,600
$ 1,600
4,400 8,000 2,500 1,000 $ 18,800
4,400 9,600 3,000 1,200 $ 20,800
4,400 6,400 2,000 800 $ 15,200
3.8%
3.5%
3.8%
Average accounts receivable (5%) ...
$ 25,000
$ 30,000
$ 20,000
Investment earnings (10%) ..............
$
2,500
$ 3,000
$ 2,000
Total credit and collection expense per above .................................. Add: Investment earnings* ............. Net credit and collection expense ....
$ 18,800 2,500 $ 21,300
$ 20,800 3,000 $ 23,800
$ 15,200 2,000 $ 17,200
Net expenses as a percentage of net sales ...............................
4.3%
4.0%
4.3%
Net credit sales................................. Credit and collection expenses Collection agency fees............. Salary of accounts receivable clerk .................................... Uncollectible accounts ............ Billing and mailing costs ......... Credit investigation fees .......... Total .................................... Total expenses as a percentage of net credit sales ..................... (b)
*The investment earnings on the cash tied up in accounts receivables is an additional expense of continuing the existing credit policies. (c)
8-52
The analysis shows that the credit card fee of 4% of net credit sales will be higher than the percentage cost of credit and collection expenses in each year before considering the effect of earnings from other investment opportunities. However, after considering investment earnings, the credit card fee of 4% will be less than or equal to the company’s percentage cost.
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Kimmel, Accounting, 5/e, Solutions Manual
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BYP 8-6 (Continued) Finally, the decision hinges on (1) the accuracy of investment earnings, (2) the expected trend in credit sales, and (3) the effect the new policy will have on sales. Nonfinancial factors include the effects on customer relationships of the alternative credit policies and whether the Falcons want to continue with the handling of their own accounts receivable.
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8-53
BYP 8-7
COMMUNICATION ACTIVITY
To:
John Doe, President
From:
Mary Jane, Student
Re:
Improving debt-paying ability
Date:
September 14, 2014
The first step that should be taken to improve your company’s debt-paying ability is to accelerate collections of your accounts receivable. The current credit policy (i.e., “pay when they can”) encourages slow payment from credit customers. Most companies have a 30-day credit period with finance charges applied on late payments. You may also want to consider adopting a discount period which allows customers a reduction in the amount owed if payment is made within a specified time period. Measuring success in improving collections can be done by monitoring collections and evaluating the receivables balance. Monitoring collections is done by preparing an accounts receivable aging schedule on a monthly basis. Evaluating receivables is accomplished by computing an accounts receivable turnover and an average collection period. Another step that can be taken with receivables to ease your company’s liquidity problems is to sell the receivables to another company for cash. Selling receivables to another company (called a factor) shortens the cashto-cash operating cycle. It should be pointed out that factors normally charge a commission of 1% to 3%. Hopefully this memo addresses the questions you have on improving your company’s debt-paying ability. Please contact me if you have any questions or need additional information.
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Kimmel, Accounting, 5/e, Solutions Manual
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BYP 8-8
(a)
ETHICS CASE
The stakeholders in this situation are: The president of Ortiz Corp. The controller of Ortiz Corp. The stockholders of Ortiz Corp.
(b)
Yes. The controller is posed with an ethical dilemma—should he/she follow the president’s “suggestion” and prepare misleading financial statements (understated net income) or should he/she attempt to stand up to and possibly anger the president by preparing a fair (realistic) income statement.
(c)
No. Ortiz Corp.’s growth rate should be a product of fair and accurate financial statements, not vice versa. That is, one should not prepare financial statements with the objective of achieving or sustaining a predetermined growth rate. The growth rate should be a product of management and operating results, not of creative accounting.
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8-55
BYP 8-9
ALL ABOUT YOU
(a) There are a number of sources that compare features of credit cards. Here are three: www.creditcards.com/, www.federalreserve.gov/pubs/shop/, and www.creditorweb.com/. (b) Here are some of the features you should consider: annual percentage rate, credit limit, annual fees, billing and due dates, minimum payment, penalties and fees, premiums received (airlines miles, hotel discounts etc.), and cash rebates. (c) Answer depends on present credit card and student’s personal situation.
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BYP 8-10
FASB CODIFICATION ACTIVITY
(a) Receivables represent contractual rights to receive money on fixed or determinable dates, whether or not there is any stated provision for interest. Receivables may arise from credit sales, loans, or other transactions. Receivables may be in the form of loans, notes, and other types of financial instruments and may be originated by an entity or purchased from another entity. (Codification reference 310-10-05-4). (b) The conditions under which receivables exist usually involve some degree of uncertainty about their collectibility, in which case a contingency exists. Subtopic 450-20 requires recognition of a loss when both of the following conditions are met: a. Information available prior to issuance of the financial statements indicates that it is probable that an asset has been impaired at the date of the financial statements. b. The amount of the loss can be reasonably estimated. Losses from uncollectible receivables shall be accrued when both the preceding conditions are met. Those conditions may be considered in relation to individual receivables or in relation to groups of similar types of receivables. If the conditions are met, accrual shall be made even though the particular receivables that are uncollectible may not be identifiable. (Codification reference 310-10-35-7, 35-8-35-9).
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Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
8-57
IFRS8-1
IFRS CONCEPTS AND APPLICATION
FASB and IASB have both worked toward reporting financial instruments at fair value. Both require disclosure of fair value information in notes to financial statements and both permit (but do not require) companies to record some types of financial instruments at fair value. IFRS requires that specific loans and receivables be reviewed for impairment and then all loans and receivables as a group be reviewed. This “twotiered” approach is not used by the FASB. IFRS and GAAP also differ in the criteria used to derecognize receivables. IFRS considers risks and rewards as well as loss of control over the receivables sold or factored. GAAP uses only the loss of control as it criteria. In addition, IFRS allows partial derecognition but GAAP does not.
8-58
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Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
IFRS8-2
INTERNATIONAL FINANCIAL REPORTING PROBLEM
(a)
Zetar indicated that a later Easter contributed to a £5.9m increase in receivables due from customers compared to the previous year.
(b)
Note 3.14 states that loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market.
(c)
Note 18 reports that £35 of trade receivables were written off (utilized) during 2011.
(d)
Note 18 indicates that the provision for impairment of receivables was £65 or 0.3% of trade receivables for 2011. In 2010, the provision was £95 or 0.6% of trade receivables. This decrease signals that Zetar is having less difficulty collecting its receivables. It is also interesting to note that trade receivables increased 32% from £16,790 in 2010 to £22,145 in 2011.
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Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
8-59
8-60
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Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
CHAPTER 9 Reporting and Analyzing Long-Lived Assets Learning Objectives 1. Describe how the historical cost principle applies to plant assets. 2. Explain the concept of depreciation. 3. Compute periodic depreciation using the straight-line method, and contrast its expense pattern with those of other methods. 4. Describe the procedure for revising periodic depreciation. 5. Explain how to account for the disposal of plant assets. 6. Describe methods for evaluating the use of plant assets. 7. Identify the basic issues related to reporting intangible assets. 8. Indicate how long-lived assets are reported in the financial statements. *9. Compute periodic depreciation using the declining-balance method and the unitsof-activity method.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4. 5. 6.
1 1 1 1 2 2
C K C C C K
Item 7. 8. 9. 10. 11. 12.
LO 3 3 4 4 5 5, 8
1. 2. 3.
1 1 3
AP AP AP
4. 5. 6.
3 4 4
1.
1
C
2.
3
BT C C C C K C
Item
LO
BT
Item
LO
BT
Item
LO
BT
Questions 13. 8 K 14. 7 C 15. 7 C 16. 7 C 17. 7 C
18. 19. 20. 21. 22.
7 7 7 6 6
C K C AP C
23. 24. 25. 26. 27.
6 6 6 6 8
C C C C C.
7 8 8
AP AP AP
13. 14.
9* 9*
AP AP
5
AP
5.
7
C
13.
7
AN
17.
8
AN
14. 15. 16.
7 7 2, 7
AN C C
18. 19.
9* 9*
AP AP
Brief Exercises AN 7. 5 AP 10. AP 8. 5 AP 11. AP 9. 6 AP 12. Do It! Review Exercises AP 3. 4 AP 4.
1.
1
C
5.
3
AP
2. 3. 4.
1 1 2
C AP C
6. 7. 8
3, 4 5 5
AN AP AP
Exercises 9. 1, 2, 6, 7 C 10. 6 AP 11. 6 AP 12. 6 AP
AP AP
Problems: Set A 5. 7 AP 6. 6 AN
7.
3, 9*
AP
8.
3, 9*
AP
AP AP
Problems: Set B 5. 7 AP 6. 6 AN
7.
3, 9*
AP
8.
3, 9*
AP
1. 1 2. 3, 5, 8 1. 1 2. 3, 5, 8 .
BT
C AP C AP
(For Instructor Use Only)
3. 4. 3. 4.
5 7, 8 5 7, 8
9-1
*Continuing Cookie Solutions for this chapter are available online.
9-2
.
(For Instructor Use Only)
ASSIGNMENT CLASSIFICATION TABLE Problem Number
.
Description
Difficulty Level
Time Allotted (min.)
1A
Determine acquisition costs of land and building.
Simple
20–30
2A
Journalize equipment transactions related to purchase, sale, retirement, and depreciation.
Moderate
40–50
3A
Journalize entries for disposal of plant assets.
Simple
20–30
4A
Prepare entries to record transactions related to acquisition and amortization of intangibles; prepare the intangible assets section and note.
Moderate
30–40
5A
Prepare entries to correct errors in recording and amortizing intangible assets.
Moderate
15–20
6A
Calculate and comment on return on assets, profit margin, and asset turnover ratio.
Moderate
15–20
*7A
Compute depreciation under different methods.
Simple
30–40
*8A
Compute depreciation under different methods.
Moderate
15–20
1B
Determine acquisition costs of land and building.
Simple
20–30
2B
Journalize equipment transactions related to purchase, sale, retirement, and depreciation.
Moderate
40–50
3B
Journalize entries for disposal of plant assets.
Simple
20–30
4B
Prepare entries to record transactions related to acquisition and amortization of intangibles; prepare the intangible assets section and note.
Moderate
30–40
5B
Prepare entries to correct errors in recording and amortizing intangible assets.
Moderate
15–20
6B
Calculate and comment on return on assets, profit margin, and asset turnover ratio.
Moderate
15–20
*7B
Compute depreciation under different methods.
Simple
30–40
*8B
Compute depreciation under different methods.
Moderate
30–40
(For Instructor Use Only)
9-3
ANSWERS TO QUESTIONS 1.
For plant assets, the historical cost principle states that plant assets are recorded at cost, which consists of all expenditures necessary to acquire the asset and make it ready for its intended use.
2.
In a cash transaction, cost is equal to the cash paid. In a noncash transaction, cost is equal to the cash equivalent price paid, which is the fair value of the asset given up or the fair value of the asset received, whichever is more clearly determinable.
3.
When only the land is to be used, all demolition and removal costs of the building less any proceeds from salvaged materials are necessary expenditures to make the land ready for its intended use. Any costs for clearing, draining, filling, and grading are also part of the cost of the land. And any back taxes are also included in the cost of the land. When both the land and building are to be used, necessary costs of the building include remodeling expenditures and the cost of replacing or repairing the roofs, floors, wiring, and plumbing.
4.
The potential benefits of leasing are (1) reduced risk of obsolescence (an obvious concern to Ronald), (2) little or no required down payment, (3) shared tax advantages, (4) assets and liabilities may not reported on the balance sheet.
5.
You should explain to the president that depreciation is a process of allocating the cost of a plant asset to expense over its service (useful) life in a rational and systematic manner. Recognition of depreciation is not intended to result in the accumulation of cash for replacement of the asset.
6.
(a) Salvage value is the expected cash value of the asset at the end of its useful life. (b) Salvage value is used in determining depreciable cost in the straight-line method by subtracting it from the plant asset’s cost.
7.
(a) Useful life is expressed in years under the straight-line method and in units of activity under the units-of-activity method. (b) The pattern of periodic depreciation expense over an asset’s useful life is constant under the straight-line method and variable under the units-of-activity method.
8.
The effects of the three depreciation methods on annual depreciation expense are: Straightline—constant amount; units-of-activity—varying amounts; declining-balance—decreasing amounts.
9.
A revision of depreciation is made in current and future years but not retroactively. The rationale is that continual restatement of prior periods would adversely affect the reader’s confidence in the financial statements.
10.
Ordinary repairs are made to maintain the operating efficiency and expected productive life of the asset. Capital expenditures are additions and improvements made to increase efficiency, productive capacity, or expected useful life of the asset. Ordinary repairs are recognized as expenses when incurred; capital expenditures are generally debited to the plant asset affected.
9-4
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(For Instructor Use Only)
Questions Chapter 9 (Continued) 11.
In a sale of plant assets, the book value of the asset is compared to the proceeds received from the sale. If the proceeds of the sale exceed the book value of the plant asset, a gain on disposal occurs. If the proceeds of the sale are less than the book value of the plant asset sold, a loss on disposal occurs.
12.
The plant asset and related accumulated depreciation should continue to be reported on the balance sheet without further depreciation or adjustment until the asset is retired. Reporting the asset and related accumulated depreciation on the balance sheet informs the reader of the financial statements that the asset is still being used by the company. However, once an asset is fully depreciated, even if it is still being used, no additional depreciation should be taken on this asset. In no situation can the depreciation on the plant asset exceed the cost of the plant asset.
13.
Tootsie Roll depreciates its buildings over 20 to 35 years and its machinery and equipment over 5 to 20 years.
14.
Depreciation and amortization are both concerned with writing off the cost of an asset to expense over the periods benefited. Depreciation refers to allocating the cost of a plant asset to expense and amortization to allocating the cost of an intangible asset to expense.
15.
It is true that successful marketing campaigns often benefit multiple accounting periods in the future, enhancing the company’s value, and potentially creating goodwill. However, from an accounting perspective David’s proposal is unacceptable. First of all, accounting standards only allow the recording of “purchased goodwill” that results from the purchase of another business. Internally created goodwill is not allowed to be recorded. Second, marketing expenditures are to be treated as expenses of the period in which they are incurred. They can not be capitalized. It is unethical to capitalize costs simply to boost reported income by spreading the cost over multiple periods.
16.
The intern is not correct. If an intangible asset has a limited life, the cost of the asset should be amortized over that asset’s useful life (the period of time when operations are benefited by use of the asset) or its legal life, whichever is shorter. The cost of intangible assets with indefinite lives should not be amortized.
17.
The favorable attributes which could result in goodwill include exceptional management, desirable location, good customer relations, skilled employees, high quality products, fair pricing policies, and harmonious relations with labor unions.
18.
Goodwill is the value of many favorable attributes that are intertwined in the business enterprise. Goodwill can be identified only with the business as a whole and, unlike other assets, cannot be sold separately. Goodwill can only be sold if the entire business is sold.
19.
Goodwill is recorded only when there is an exchange transaction that involves the purchase of an entire business. Goodwill is the excess of cost over the fair value of the net assets (assets less liabilities) acquired. The recognition of goodwill without an exchange transaction would lead to subjective valuations which would reduce the reliability of financial statements. Goodwill is not amortized because it has an indefinite life. It remains at its original value as an intangible asset unless it is considered to be impaired. If it is impaired, it is written down.
.
(For Instructor Use Only)
9-5
Questions Chapter 9 (Continued) 20.
Research and development costs present several accounting problems. It is sometimes difficult to assign the costs to specific projects, and there are uncertainties in identifying the extent and timing of future benefits. As a result, research and development costs are usually recorded as an expense when incurred.
21.
Campbell Soup Company’s return on assets is computed as follows:
Net Income Average Total Assets
=
$736
= 11.7%
$6, 265
22.
The return on assets is closely monitored by management. It is the product of the profit margin and the asset turnover. At first glance, if this new product line has a lower profit margin, then it will reduce the company’s asset turnover. However, it is likely that it will have a higher turnover than the company’s more expensive offerings. As a consequence, it is not possible to know what effect the new product line will have on the company’s return on assets without knowing the expected effect on the company’s asset turnover.
23.
(a) Grocery stores usually have a high asset turnover and a low profit margin. (b) Car dealerships normally have a low asset turnover and a high profit margin.
24.
Since Gooden uses the straight-line depreciation method, its depreciation expense will be lower in the early years of an asset’s useful life as compared to using an accelerated method. Perron’s depreciation expense in the early years of an asset’s useful life will be higher as compared to the straight-line method. Gooden’s net income will be higher than Perron’s in the first few years of the asset’s useful life.
25.
Yes, the tax regulations of the IRS allow a company to use a different depreciation method on the tax return than is used in preparing financial statements. Garcia Corporation uses an accelerated depreciation method for tax purposes to minimize its income taxes in the early years of the assets’ lives.
26.
By selecting a higher estimated useful life, Leslie Corp. is spreading the plant assets’ cost over a longer period of time. The depreciation expense reported in each period is lower and net income is higher. Camby’s choice of a shorter estimated useful life will result in higher depreciation expense reported in each period and lower net income.
27.
In the operating activities section of the statement of cash flows, depreciation expense (from plant assets) and amortization expense (from intangible assets) are added back to net income in the determination of net cash provided by operating activities. In the investing section, cash paid to purchase plant assets or intangible assets is shown as a use of cash. If the company sells any of its used plant assets, or if it sells intangibles, it would report the amount of cash received as a source of cash from investing activities.
9-6
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(For Instructor Use Only)
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 All of the expenditures should be included in the cost of the land. Therefore, the cost of the land is $73,900 ($60,000 + $5,000 + $2,100 + $3,300 + $3,500). BRIEF EXERCISE 9-2 The cost of the truck is $26,780 (cash price $24,000 + sales taxes $1,080 + painting and lettering $1,700). The expenditures for insurance and motor vehicle license should not be added to the cost of the truck. BRIEF EXERCISE 9-3 The depreciable cost is $27,000 ($31,000 – $4,000). With a 4-year useful life, annual depreciation is $6,750 ($27,000 ÷ 4). Under the straight-line method, depreciation is the same each year. Thus, depreciation is $6,750 for both the first and second years. BRIEF EXERCISE 9-4 It is likely that management requested this accounting treatment to boost reported net income. Land is not depreciated; thus, by reporting land at $130,000 above its actual value the company increased yearly income by $130,000 $6,500 or the reduction in depreciation expense. This practice is 20 years not ethical because management is knowingly misstating asset values. BRIEF EXERCISE 9-5 Book value, 1/1/14 ($36,000 – $13,600) ........................................... Less: Salvage value ........................................................................ Depreciable cost .............................................................................. Remaining useful life ....................................................................... Revised annual depreciation ($20,400 ÷ 2) .....................................
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(For Instructor Use Only)
$22,400 2,000 $20,400 2 years $10,200 9-7
BRIEF EXERCISE 9-6 (a) Maintenance and Repairs Expense ........................ Cash ....................................................................
38
(b) Equipment ................................................................ Cash ....................................................................
400
38 400
BRIEF EXERCISE 9-7 (a) Accumulated Depreciation—Equipment ................ Equipment ...........................................................
41,000
(b) Accumulated Depreciation—Equipment ................ Loss on Disposal of Plant Assets........................... Equipment...........................................................
37,200 3,800
Cost of delivery equipment Less accumulated depreciation Book value at date of disposal Proceeds from sale Loss on disposal
41,000
41,000
$41,000 37,200 3,800 0 $ 3,800
BRIEF EXERCISE 9-8 (a) 7/31/14 Depreciation Expense .............................. Accumulated Depreciation— Equipment ........................................
4,600
(b) 7/31/14 Accumulated Depreciation—Equipment .... Cash........................................................... Loss on Disposal of Plant Assets ........... Equipment ..........................................
46,600 21,000 4,400
Cost of office equipment Less accumulated depreciation Book value at date of disposal Proceeds from sale Loss on disposal *$42,000 + $4,600 9-8
.
(For Instructor Use Only)
$72,000 46,600* 25,400 21,000 $ 4,400
4,600
72,000
BRIEF EXERCISE 9-9 (a) Return on assets =
(b) Asset turnover =
$4.55 ($28.46 + $30.22)÷2
= 15.5%
$22.74 = .78 times ($28.46 + $30.22)÷ 2
BRIEF EXERCISE 9-10 (a) Amortization Expense ($156,000 ÷ 6) ..................... Patent ................................................................
26,000 26,000
(b) Intangible Assets Patent (Net of $26,000 of amortization) ..........
$130,000
BRIEF EXERCISE 9-11 NIKE, INC. Partial Balance Sheet As of May 31, 2014 (in millions) Property, plant, and equipment Land ....................................................... Buildings ............................................... Machinery and equipment.................... Other plant assets ................................ Less: Accumulated depreciation ........ Total property, plant, and equipment ................................... Intangible assets Goodwill ................................................ Patents and trademarks ....................... Less: Accumulated amortization ........ Total intangible assets..................
.
(For Instructor Use Only)
$ 221.6 $ 974.0 2,094.3 965.8 2,298.0
1,736.1 1,957.7
193.5 $515.1 47.7
467.4 660.9*
9-9
*Alternatively, many companies would simply show a single line for net intangibles.
9-10
.
(For Instructor Use Only)
BRIEF EXERCISE 9-12 In the determination of net cash provided by operating activities, add depreciation expense and amortization expense to net income: Net cash provided by = $157,000 + $12,000 + $8,000 = $177,000 operating activities
*BRIEF EXERCISE 9-13 The declining-balance rate is 50% (1/4 X 2) and this rate is applied to the book value at the beginning of the year. The computations are: Book Value Year 1 Year 2
$31,000 ($31,000 – $15,500)
X
Rate
=
Depreciation
50% 50%
$15,500 $ 7,750
*BRIEF EXERCISE 9-14 The depreciation cost per unit is 18 cents per mile computed as follows: Depreciable cost ($27,500 – $500) ÷ 150,000 = $.18 Depreciation expense for each year is as follows: 2013 32,000 miles X $.18 = $5,760 2014 33,000 miles X $.18 = $5,940
.
(For Instructor Use Only)
9-11
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 9-1 The following four items are expenditures necessary to acquire the truck and get it ready for use: Negotiated purchase price......................................... Installation of special shelving .................................. Painting and lettering ................................................. Sales tax...................................................................... Total paid .........................................................
$24,000 1,100 900 1,440 $27,440
Thus, the cost of the truck is $27,440. The cost of the motor vehicle license is an operating cost and is expensed. The annual insurance policy would be recorded as prepaid insurance and then expensed over the year. DO IT! 9-2 Depreciation expense = Cost – Salvage = $15,000 – $1,000 = $1,400 Useful life 10 years The entry to record the first year’s depreciation would be: Depreciation Expense .......................................................... Accumulated Depreciation—Equipment ....................
1,400 1,400
DO IT! 9-3 Original depreciation expense = ($50,000 – $2,000) ÷ 8 years = $6,000 Accumulated depreciation after three years = 3 X $6,000 = $18,000 Book value, $50,000 – $18,000 ............................................. Less: Salvage value ............................................................ Depreciable cost ................................................................... Remaining useful life ........................................................... Revised annual depreciation ($28,000 ÷ 7) .........................
9-12
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(For Instructor Use Only)
$32,000 4,000 $28,000 7 years $ 4,000
DO IT! 9-4 (a)
(b)
Sale of machine for cash at a gain: Accumulated Depreciation—Equipment.................... Cash ............................................................................. Equipment ............................................................. Gain on Disposal of Plant Assets ........................ Sale of machine for cash at a loss: Accumulated Depreciation—Equipment.................... Cash ............................................................................. Loss on Disposal of Plant Assets .............................. Equipment..............................................................
28,000 25,000 50,000 3,000 28,000 15,000 7,000 50,000
DO IT! 9-5 1. 2. 3. 4. 5.
.
Intangible assets Amortization Franchise Research and development costs Goodwill
(For Instructor Use Only)
9-13
SOLUTIONS TO EXERCISES EXERCISE 9-1 (a)
The following points explain the application of the historical cost principle to plant assets. 1. 2. 3.
(b)
1. 2. 3. 4.
Under the historical cost principle, the acquisition cost for a plant asset includes all expenditures necessary to acquire the asset and make it ready for its intended use. Cost is measured by the cash paid in a cash transaction, or by the cash equivalent price paid when noncash assets are used in payment. The cash equivalent price is equal to the fair value of the asset given up or the fair value of the asset received, whichever is more clearly determinable. Land Equipment Equipment Land Improvements
EXERCISE 9-2 1. 2. 3. 4. 5. 6. 7. 8. 9.
9-14
Equipment Equipment Equipment Land Prepaid Insurance Land Improvements Land Improvements Land Building
.
(For Instructor Use Only)
5. 6. 7. 8.
Equipment Equipment Prepaid Insurance License Expense
EXERCISE 9-3 (a)
(b)
Cost of land Cash paid ................................................................... Net cost of removing warehouse ($8,200 – $1,700) .... Attorney’s fee ............................................................ Real estate broker’s fee ............................................ Total ....................................................................
$80,000 6,500 1,900 5,200 $93,600
The architect’s fee ($9,100) should be debited to the building account. The cost of the driveways and parking lot ($14,000) should be debited to Land Improvements.
EXERCISE 9-4 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
False. Depreciation is a process of cost allocation, not asset valuation. True. False. The book value of a plant asset may be quite different from its market value. False. Depreciation applies to three classes of plant assets: land improvements, building, and equipment. False. Depreciation does not apply to land because its usefulness and revenue-producing ability generally remain intact over time. True. False. Recognizing depreciation on an asset does not result in an accumulation of cash for replacement of the asset. True. False. Depreciation expense is reported on the income statement, and accumulated depreciation is reported as a deduction from plant assets on the balance sheet. False. Three factors affect the computation of depreciation: cost, useful life, and salvage value (also called residual value).
EXERCISE 9-5
$90,000 – $8,000 Straight-line method: = $10,250 per year. 8 2014 depreciation = $10,250 X 3/12 = $2,562.50 2015 depreciation = $10,250. . Kimmel, Accounting, 5/e, Solutions Manual (For Instructor Use Only)
9-15
EXERCISE 9-6 (a)
Type of Asset Cost ........................................................ Less: Accumulated depreciation ......... Book value, 1/1/14 ................................. Less: Salvage value ............................. Depreciable cost (1) .............................. Revised remaining useful life in years (2) *(48 – 8)
Warehouse $120,000 23,000 97,000 3,600 $ 93,400
40*
15**
**(20 – 5)
Revised annual depreciation (1) ÷ (2) (b) Dec. 31
Building $700,000 130,000 570,000 35,000 $535,000
$13,375
$6,227
Depreciation Expense ............................ Accumulated Depreciation— Buildings .......................................
13,375
(a) Loss on Disposal of Plant Assets........................... Accumulated Depreciation—Equipment .................. Equipment.........................................................
26,000 24,000
(b) Cash .......................................................................... Accumulated Depreciation—Equipment ................ Equipment......................................................... Gain on Disposal of Plant Assets ...................
37,000 24,000
(c) Accumulated Depreciation—Equipment ................ Cash .......................................................................... Loss on Disposal of Plant Assets........................... Equipment.........................................................
24,000 20,000 6,000
13,375
EXERCISE 9-7
9-16
.
(For Instructor Use Only)
50,000
50,000 11,000
50,000
EXERCISE 9-8 Jan.
1 Accumulated Depreciation—Equipment ........... Equipment ......................................................
62,000
June 30 Depreciation Expense ......................................... Accum. Depreciation—Equipment ($36,000 X 1/3 X 6/12) ..................................
6,000
Accumulated Depreciation—Equipment ($36,000 X 2/3 = $24,000; $24,000 + $6,000) ...... Cash ..................................................................... Loss on Disposal of Plant Assets [$5,000 – ($36,000 – $30,000)] .......................... Equipment ...................................................... Dec. 31 Depreciation Expense ......................................... Accumulated Depreciation—Equipment [($25,000 – $4,000) X 1/5] ............................ 31 Accumulated Depreciation—Equipment [($25,000 – $4,000) X 4/5] ................................. Cash ..................................................................... Equipment ...................................................... Gain on Disposal of Plant Assets .................
62,000
6,000 30,000 5,000 1,000 36,000 4,200 4,200 16,800 9,000 25,000 800
EXERCISE 9-9 1.
Depreciation is the process of allocating the cost of a long-lived asset to expense over the asset’s useful life. Because the value of land generally does not decline with time and usage, its usefulness and revenue producing ability does not decline. In addition, the useful life of land is indefinite. Therefore, it would be incorrect for the student to depreciate the land.
2.
Goodwill is an intangible asset with an indefinite life. According to generally accepted accounting principles, goodwill is not amortized but reviewed annually for impairment. If a permanent decline in value has occurred the goodwill is written down and an impairment loss is recorded on the income statement. Therefore the amortization entry should
.
(For Instructor Use Only)
9-17
be reversed and no decline in value recorded until an impairment in value occurs.
9-18
.
(For Instructor Use Only)
EXERCISE 9-9 (Continued) 3.
This is a violation of the historical cost principle. Because current market values are subjective and not reliable, they are not used to increase the recorded value of an asset after acquisition. The appropriate accounting treatment is to leave the building on the books at its zero book value.
EXERCISE 9-10
$35,497 = 1.42 times ($25,633 + $24,244) ÷ 2
(a)
Asset turnover =
(b)
Return on assets =
$98 = .4% ($25,633 + $24,244) ÷ 2
EXERCISE 9-11 (a)
Without new products
With new products
Return on assets
$500,000 = 10% $5,000,000
$960,000 = 8% $12,000,000
Profit margin
$500,000 = 5% $10,000,000
$960,000 = 6% $16,000,000
Asset turnover
$10,000,000 = 2.0 $5,000,000
$16,000,000 = 1.3 $12,000,000
(b) The return on assets declined from 10% to 8%. This means that the company is not generating as much income from each dollar invested in assets. It is common for companies to try to maximize their return on assets, thus top management might not find this proposal very desirable. The new product line would increase the company’s profit margin (the amount of net income generated from each dollar of sales) from 5% to 6%. However, because of the huge investment in new assets that the proposal requires, the asset turnover plummets from 2.0 times down to 1.3 times.
.
(For Instructor Use Only)
9-19
EXERCISE 9-12 (a) ($ in millions) 1. Return on assets
$264.8 = 6.2% ($4,312.6 + $4,254.3) ÷ 2
2. Asset turnover
$11,408.5 = 2.7 times ($4,312.6 + $4,254.3) ÷ 2
3. Profit margin
$264.8 = 2.3% $11,408.5
(b) Profit Margin X Asset Turnover = Return on Assets = 2.3% X 2.7 times = 6.2% (c) Asset turnover and profit margin vary considerably across industries. Therefore, when you have a diverse group of businesses from several industry types combined into one company, such as in Bakely Company, the ability to compare these ratios to other businesses becomes very difficult. Bakely Company would almost need to calculate ratios for each of the separate industry segments to allow for a meaningful analysis. EXERCISE 9-13 Dec. 31 Amortization Expense ..................................... Copyright ($120,000 X 1/6) .......................
20,000
31 Amortization Expense ..................................... Patent ($54,000 X 1/4 X 10/12) ..................
11,250
20,000 11,250
The goodwill would not require an adjusting entry because it has an indefinite life.
9-20
.
(For Instructor Use Only)
EXERCISE 9-14 (a)
1/2/14
Patent ........................................................ Cash....................................................
280,000
Goodwill .................................................... Cash.................................................... (Part of the entry to record purchase of another company)
360,000
Franchise .................................................. Cash....................................................
540,000
Research and Development Expense ..... Cash....................................................
185,000
Amortization Expense............................................ Patent ($280,000 ÷ 5) ....................................... Franchise [($540,000 ÷ 9) X 6/12] ....................
86,000
4/1/14
7/1/14 9/1/14 (b)
(c)
280,000 360,000
540,000 185,000 56,000 30,000
Ending balances, 12/31/14: Patent = $224,000 ($280,000 – $56,000) Goodwill = $360,000 Franchise = $510,000 ($540,000 – $30,000)
EXERCISE 9-15 Alliance Atlantis Communications Inc.’s change of accounting policy to amortize broadcast rights will probably increase its reported income. Prior to the change, Alliance Atlantis had amortized broadcast rights over a maximum of two years. Their new policy calls for amortization over the contracted exhibition period. If this is greater than two years, annual amortization expense will decrease and income will increase. A change of this nature will make comparison of financial results with previous years’ difficult. To evaluate the company’s performance one will need to make an adjustment for such changes in estimated lives.
.
(For Instructor Use Only)
9-21
EXERCISE 9-16 (a)
A company should depreciate its buildings because depreciation is necessary in order to allocate the cost of the buildings to the periods in which they are in use. This allows the cost of the buildings to be matched against the revenues generated each year in accordance with the expense recognition principle.
(b)
A building can have a zero book value if it has no salvage value and it is fully depreciated—that is, if it has been used for a period at least as long as its expected life. Because depreciation is used to allocate cost rather than to reflect actual value, it is not at all unlikely that a building could have a low or zero book value, but a substantial fair value.
(c)
Examples of intangibles that might be found on a college campus are a franchise of a bookstore chain, the license to operate a radio station, a patent developed by professors, and a permit to operate a bus service.
(d)
Typical company or product trade names are: Clothes—Gap, Gitano, Dockers, Calvin Klein, Chaus, Guess. Perfume—Passion, Ruffles, Chanel No. 5, Diamonds. Cars—TransAm, Nova, Prelude, Coupe DeVille, Eclipse. Shoes—Nike, Florsheim, L.A. Gear, Adidas. Breakfast cereals—Cheerios, Wheaties, Frosted Mini-Wheats, Rice Krispies. Trade names and trademarks are reported on a balance sheet if there is a cost attached to them. If the trade name or trademark is purchased, the cost is the purchase price. If it is developed by the enterprise, the cost includes attorney’s fees, registration fees, design costs, successful legal defense costs, and other expenditures directly related to securing the trade name or trademark.
9-22
.
(For Instructor Use Only)
EXERCISE 9-17 10-year life $58,000
Net Income
15-year life $102,000*
*$58,000 + ($132,000 – $88,000) Calculation of net cash provided by operating activities: 10-year Net income $ 58,000 Plus: depreciation expense 132,000 Net cash provided by operating activities $190,000
15-year $102,000 88,000 $190,000
The CEO is correct regarding the impact on net income. By increasing the expected useful life depreciation, expense would be lowered and net income would increase. However, this move would be appropriate only if, in fact, a 15-year life was a better estimate of the expected period of use. The CEO is incorrect in stating that cash provided by operating activities would be increased. Depreciation expense does not use up cash. Therefore, net cash provided by operating activities would be the same no matter what expected life was used. *EXERCISE 9-18 (a)
Depreciation cost per unit is $.575 per mile [($100,000 – $8,000) ÷ 160,000].
(b)
.
Computation
End of Year
Years
Annual Units of Depreciation Depreciation Accumulated Activity X Cost/Unit = Expense Depreciation
Book Value
2014 2015 2016 2017
40,000 52,000 41,000 27,000
$77,000 47,100 23,525 8,000
(For Instructor Use Only)
$.575 .575 .575 .575
$23,000 29,900 23,575 15,525
$23,000 52,900 76,475 92,000
9-23
*EXERCISE 9-19 (a)
Declining-balance method: 2014 depreciation = $90,000 X 25%* X 3/12 = $5,625 Book value January 1, 2015 = $90,000 – $5,625 = $84,375 2015 depreciation = $84,375 X 25% = $21,093.75. *(1/8) X 2 = 25%
(b)
Units-of-activity method: $90,000–$8,000 =$1.17 per hour 70,000
2014 depreciation = 3,900 hours X $1.17 = $4,563.
9-24
.
(For Instructor Use Only)
SOLUTIONS TO PROBLEMS PROBLEM 9-1A
Item
Land
1 2 3 4 5 6 7 8 9 10
$280,000
.
Building
Other Accounts $ 6,800
Land Improvements
29,000
Land Improvements
6,400
Property Tax Expense
31,000 $ 23,000 3,170 33,000 640,000 (12,000) $302,170
(For Instructor Use Only)
$696,000
9-25
PROBLEM 9-2A (a) April
1
Land....................................................... 2,200,000 Cash................................................ 2,200,000
May
1
Depreciation Expense .......................... Accumulated Depreciation— Equipment ($600,000 X 1/10 X 4/12) ..............
1
Accumulated Depreciation— Equipment .......................................... Cash ...................................................... Equipment ...................................... Gain on Disposal of Plant Assets..........................................
20,000 20,000 440,000 170,000 600,000 10,000
Cost .......................................... $600,000 Accum. depr.—Equipment ...... (440,000) [($600,000 X 1/10) X 7 + $20,000)]
Book value ............................... 160,000 Cash proceeds ......................... 170,000 Gain on disposal ..................... $ 10,000 June
1
Cash ...................................................... 1,600,000 Land ................................................ 1,000,000 Gain on Disposal of Plant Assets.......................................... 600,000
July
1
Equipment ............................................. 1,100,000 Cash................................................ 1,100,000
Dec. 31
Depreciation Expense .......................... Accumulated Depreciation— Equipment ($700,000 X 1/10) ......
31
9-26
Accumulated Depreciation— Equipment .......................................... Equipment ......................................
.
(For Instructor Use Only)
70,000 70,000 700,000 700,000
PROBLEM 9-2A (Continued) Cost ........................................ Accum. depr.—Equipment ($700,000 X 1/10 X 10) ........ Book value ............................. (b) Dec. 31
31
$700,000 (700,000) $ 0
Depreciation Expense ............................ Accumulated Depreciation— Buildings ($26,500,000 X 1/40) .....
662,500 662,500
Depreciation Expense ............................ 3,925,000 Accumulated Depreciation— Equipment ..................................... 3,925,000 $38,700,000* X 1/10............... $ 1,100,000 X 1/10 X 6/12 .....
$3,870,000 55,000 $3,925,000
*($40,000,000 – $600,000 – $700,000) (c)
NAVARO CORPORATION Partial Balance Sheet December 31, 2015 Plant Assets* Land ......................................................... Buildings ................................................. Less: Accumulated depreciation— buildings ...................................... Equipment ............................................... Less: Accumulated depreciation— equipment .................................... Total plant assets..............................
$ 4,200,000 $26,500,000 12,587,500 39,800,000
13,912,500
7,875,000
31,925,000 $50,037,500
*See T-accounts which follow.
.
(For Instructor Use Only)
9-27
PROBLEM 9-2A (Continued) Land 12/31/14 04/01/15
3,000,000 2,200,000
12/31/15
Bal. 4,200,000
6/1/14
1,000,000
Buildings 12/31/14
26,500,000
12/31/15
Bal. 26,500,000
Equipment 12/31/14 07/01/15
40,000,000 1,100,000
12/31/15
Bal. 39,800,000
05/01/15 12/31/15
600,000 700,000
Accumulated Depreciation—Buildings 12/31/14 12/31/15
11,925,000 662,500
12/31/15
Bal. 12,587,500
Accumulated Depreciation—Equipment 05/01/15 12/31/15
9-28
440,000 700,000
.
(For Instructor Use Only)
12/31/14 5/1/15 12/31/15 12/31/15
5,000,000 20,000 70,000 3,925,000
12/31/15
Bal. 7,875,000
PROBLEM 9-3A Jan. 1 June 30
June 30
Dec. 31
31
.
Accumulated Depreciation—Equipment ...... Equipment ................................................
71,000
Depreciation Expense .................................... Accum. Depreciation—Equipment ($30,000 X 1/5 X 6/12) ...........................
3,000
Cash ................................................................ Accumulated Depreciation—Equipment ...... Equipment ................................................ Gain on Disposal of Plant Assets...........
12,000 21,000
Cost ................................................................. Accumulated Depreciation—Equipment [($30,000 X 1/5) X 3 + $3,000] ...................... Book Value ..................................................... Cash Proceeds ............................................... Gain on Disposal ............................................
$30,000
Depreciation Expense .................................... Accumulated Depreciation—Equipment [($33,400 – $3,000) X 1/8]......................
3,800
Loss on Disposal of Plant Assets ................. Accumulated Depreciation—Equipment ...... Equipment ................................................
10,600 22,800
Cost ................................................................. Accumulated Depreciation—Equipment [($33,400 – $3,000) X 1/8 X 6] ...................... Book Value ..................................................... Proceeds ......................................................... Loss on Disposal ...........................................
$33,400
(For Instructor Use Only)
71,000
3,000
30,000 3,000
(21,000) 9,000 12,000 $ 3,000
3,800
33,400
(22,800) 10,600 0 $10,600
9-29
PROBLEM 9-4A (a) Jan. 2
Patents ........................................................ Cash .......................................................
46,800 46,800
Jan.– June
Research and Development Expense ....... 230,000 Cash .......................................................
230,000
July 1
Patents ........................................................ Cash .......................................................
20,000 20,000
Advertising Expense .................................. Cash .......................................................
40,000
Sept. 1 Oct. 1
40,000
Copyright .................................................... 200,000 Cash .......................................................
(b) Dec. 31
31
Amortization Expense ................................ Patents................................................... [($60,000 X 1/10) + ($46,800 X 1/9) + ($20,000 X 1/20 X 6/12)]
11,700
Amortization Expense ................................ Copyrights............................................. [($36,000 X 1/10) + ($200,000 X 1/50 X 3/12)]
4,600
11,700
(c) Intangible Assets Patents ($126,800 cost less $17,700 amortization) (1) ......... Copyrights ($236,000 cost less $29,800 amortization) (2)..... Total intangible assets .................................................. (1) (2) (d)
9-30
200,000
4,600
$109,100 206,200 $315,300
Cost ($60,000 + $46,800 + $20,000); amortization ($6,000 + $11,700). Cost ($36,000 + $200,000); amortization ($25,200 + $4,600).
The intangible assets of Cedeno Corporation consist of two patents and two copyrights. One patent with a cost of $60,000 is being amortized over 10 years. In addition, legal costs of $46,800 incurred in the successful defense of this patent are being amortized over the remaining useful life, 9 years. The other patent with a cost of $20,000 is being amortized over 20 years. A copyright with a cost of $36,000 is being amortized
.
(For Instructor Use Only)
over 10 years; the other copyright with a cost of $200,000 is being amortized over 50 years.
.
(For Instructor Use Only)
9-31
PROBLEM 9-5A
1.
2.
9-32
Research and Development Expense ....................... 160,000 Patents ................................................................ Patents ........................................................................ Amortization Expense [$10,000 – ($40,000 X 1/20)] .............................
8,000
Goodwill ...................................................................... Amortization Expense ........................................
2,000
.
(For Instructor Use Only)
160,000
8,000 2,000
PROBLEM 9-6A
(a)
(b)
Danner
London
1.
Return on assets
$240,000 = 7.5% $3,200,000
$300,000 = 10.0% $3,000,000
2.
Profit margin
$240,000 = 20.9% $1,150,000
$300,000 = 25.0% $1,200,000
3.
Asset turnover
$1,150,000 = .36 times $3,200,000
$1,200,000 = .40 times $3,000,000
Based on the asset turnover, London Corp. is more effective in using assets to generate sales. Its asset turnover is 11% higher than Danner’s ratio. A factor that inhibits comparing the two companies is the differing composition of total assets for each company. Eighty-four percent [($2,400,000 + $300,000) ÷ $3,200,000] of Danner’s total assets are plant or intangible assets compared to only sixty percent ($1,800,000 ÷ $3,000,000) for London. Also, London reports no intangible assets.
.
(For Instructor Use Only)
9-33
PROBLEM 9-7A
(a) Year
Computation
Accumulated Depreciation 12/31
2012 2013 2014 2015
MACHINE 1 $84,000* X 1/8 = $10,500 $84,000 X 1/8 = $10,500 $84,000 X 1/8 = $10,500 $84,000 X 1/8 = $10,500
$10,500 21,000 31,500 42,000
*($96,000 – $12,000) MACHINE 2 $85,000 X 40%* X 6/12 = $17,000 $68,000 X 40% = $27,200 $40,800 X 40% = $16,320
2013 2014 2015
$17,000 44,200 60,520
*(1/5) X 2 MACHINE 3 800 X $2.00a = $ 1,600 4,500 X $2.00 = 9,000 6,000 X $2.00 = 12,000
2013 2014 2015 a
(b)
9-34
($66,000 – $6,000) ÷ 30,000 Year 2013
Depreciation Expense MACHINE 2 $85,000 X 40% X 9/12 = $25,500
2014
$59,500 X 40%
.
(For Instructor Use Only)
= $23,800
$ 1,600 10,600 22,600
*PROBLEM 9-8A (a)
STRAIGHT-LINE DEPRECIATION Computation Depreciable Years Cost X
End of Year
Annual Depreciation Depreciation Accumulated Rate = Expense Depreciation
2014 $220,000* 2015 220,000 2016 220,000 2017 220,000
25%** 25% 25% 25%
$ 55,000 55,000 55,000 55,000 $220,000
$ 55,000 110,000 165,000 220,000
Book Value $195,000 140,000 85,000 30,000
*($250,000 – $30,000) **1/4 = 25% DOUBLE-DECLINING-BALANCE DEPRECIATION Computation Book Value Beginning Years of Year X 2014 2015 2016 2017
$250,000 125,000 62,500 31,250
End of Year
Annual Depreciation Depreciation Accumulated Rate = Expense Depreciation 50%* 50% 50% 50%
$125,000 62,500 31,250 1,250** $220,000
$125,000 187,500 218,750 220,000
Book Value $125,000 62,500 31,250 30,000
*(1/4) X 2 = 50% **Adjusted so ending book value will equal salvage value.
(b)
Straight-line depreciation provides the lower amount for 2014 depreciation expense ($55,000) and, therefore, the higher 2014 income. Over the four-year period, both methods result in the same total depreciation expense ($220,000) and, therefore, the same total income.
(c)
Double-declining-balance depreciation provides the higher amount for 2014 depreciation expense ($125,000) and, therefore, the lower 2014 income. Both methods result in the same total income over the four-year period.
.
(For Instructor Use Only)
9-35
PROBLEM 9-1B
Item
Land
1 2 3 4 5 6 7 8 9 10
$270,000 6,000 31,000 7,700
9-36
Building
Other Accounts
$ 21,900 44,000 629,500 $36,000 7,300 (12,700) $302,000
.
$695,400
(For Instructor Use Only)
Land Improvements Property Tax Expense
PROBLEM 9-2B (a) April
1
Land ....................................................... 2,600,000 Cash ................................................ 2,600,000
May
1
Depreciation Expense ........................... Accumulated Depreciation— Equipment .................................... ($750,000 X 1/10 X 4/12)
1
Accumulated Depreciation— Equipment........................................... Cash ....................................................... Equipment ....................................... Gain on Disposal of Plant Assets ..........................................
25,000 25,000
400,000 367,000 750,000 17,000
Cost .............................................. $750,000 Accum. depr.—Equipment.......... 400,000 [($750,000 X 1/10) X 5 + $25,000)]
Book value ................................... 350,000 Cash proceeds ............................ 367,000 Gain on disposal ......................... $ 17,000 June
1
Cash ...................................................... 2,000,000 Gain on Disposal of Plant Assets ......................................... 1,200,000 Land................................................ 800,000
Sept.
1
Equipment............................................. Cash ...............................................
840,000
Depreciation Expense .......................... Accumulated Depreciation— Equipment ($470,000 X 1/10) .....
47,000
Dec. 31
31
.
Accumulated Depreciation— Equipment.......................................... Equipment ......................................
(For Instructor Use Only)
840,000
47,000 470,000 470,000
9-37
PROBLEM 9-2B (Continued) Cost ........................................ Accum. depr.—equipment ($470,000 X 1/10 X 10)..... Book value ............................. (b) Dec. 31
$470,000 470,000 $ 0
Depreciation Expense ........................... Accumulated Depreciation— Buildings ($28,800,000 X 1/40) ....
31
720,000 720,000
Depreciation Expense ........................... 4,706,000 Accumulated Depreciation— Equipment .................................... 4,706,000 ($46,780,000* X 1/10) ........... [($840,000 X 1/10) X 4/12] ....
$4,678,000 28,000 $4,706,000
*($48,000,000 – $750,000 – $470,000) (c)
TONG CORPORATION Partial Balance Sheet December 31, 2014 Plant Assets* Land ......................................................... Buildings ................................................. Less: Accumulated depreciation— buildings ...................................... Equipment ............................................... Less: Accumulated depreciation— equipment .................................... Total plant assets .............................. *See T-accounts which follow.
9-38
.
(For Instructor Use Only)
$ 5,800,000 $28,800,000 12,240,000 47,620,000
16,560,000
8,908,000
38,712,000 $61,072,000
PROBLEM 9-2B (Continued) Land 12/31/13 4/1/14
4,000,000 2,600,000
12/31/14
Bal. 5,800,000
6/1/14
800,000
Buildings 12/31/13
28,800,000
12/31/14
Bal. 28,800,000
Equipment 12/31/13 9/1/14
48,000,000 840,000
12/31/14
Bal. 47,620,000
5/1/14 12/31/14
750,000 470,000
Accumulated Depreciation—Buildings 12/31/13 12/31/14
11,520,000 720,000
12/31/14
Bal. 12,240,000
Accumulated Depreciation—Equipment 5/1/14 12/31/14
.
(For Instructor Use Only)
400,000 470,000
12/31/13 5/1/14 12/31/14 12/31/14
5,000,000 25,000 47,000 4,706,000
12/31/14
Bal. 8,908,000
9-39
PROBLEM 9-3B Jan. 1
Accumulated Depreciation— Equipment ($47,000 X 1/10 X 10 years) .................. Equipment .........................................
Mar. 31
Dec. 31
Dec. 31
1,550
Cash ......................................................... Accumulated Depreciation— Equipment ............................................. Equipment ......................................... Gain on Disposal of Plant Assets ....
25,000
Cost .......................................................... Accumulated Depreciation—Equipment [($43,400 X 1/7) X 3 + $1,550] ............... Book Value ............................................... Cash Proceeds ........................................ Gain on Disposal .....................................
$43,400
Depreciation Expense ............................. Accumulated Depreciation— Equipment [($30,000 – $3,000) X 1/6] ...............
4,500
Accumulated Depreciation— Equipment [($30,000 – $3,000) X 1/6 X 4] ............... Loss on Disposal of Plant Assets .......... Equipment .........................................
.
47,000
Depreciation Expense ............................. Accumulated Depreciation— Equipment ($43,400 X 1/7 X 3/12) .....................
Cost .......................................................... Accumulated Depreciation— Equipment [($30,000 – $3,000) X 1/6 X 4] ............... Book Value ............................................... Proceeds .................................................. Loss on Disposal ..................................... 9-40
47,000
(For Instructor Use Only)
1,550
20,150 43,400 1,750
20,150 23,250 25,000 $ 1,750
4,500
18,000 12,000 30,000 $30,000 18,000 12,000 0 $12,000
PROBLEM 9-4B (a) Jan. 2 Jan.June July
Patents ......................................................... Cash ........................................................
45,000 45,000
Research and Development Expense ........ 220,000 Cash ........................................................ 220,000 1
Patents ......................................................... Cash ........................................................
22,000 22,000
Sept. 1
Advertising Expense ................................... 110,000 Cash ........................................................ 110,000
Oct.
Copyrights ................................................... 120,000 Cash ........................................................ 120,000
1
(b) Dec. 31
31
Amortization Expense ................................. Patents .................................................... [($70,000 X 1/10) + ($45,000 X 1/9) + ($22,000 X 1/20 X 6/12)]
12,550
Amortization Expense ................................. Copyrights .............................................. [($48,000 X 1/8) + ($120,000 X 1/50 X 3/12)]
6,600
12,550
(c) Intangible Assets Patents ($137,000 cost less $19,550 amortization) (1) ......... Copyrights ($168,000 cost less $24,600 amortization) (2) ... Total intangible assets .................................................. (1) (2)
6,600
$117,450 143,400 $260,850
Cost ($70,000 + $45,000 + $22,000); amortization ($7,000 + $12,550). Cost ($48,000 + $120,000); amortization ($18,000 + $6,600).
(d) The intangible assets of Venable Company consist of two patents and two copyrights. One patent with a cost of $70,000 is being amortized over 10 years; an additional $45,000 incurred in successfully defending this patent is being amortized over 9 years. The other patent, obtained at cost of $22,000, is being amortized over 20 years. A copyright with a cost of $48,000 is being amortized over 8 years; the other copyright with a cost of $120,000 is being amortized over 50 years. .
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
9-41
PROBLEM 9-5B 1.
2.
9-42
Research and Development Expense ..................... Patents ..............................................................
225,000
Patents ...................................................................... Amortization Expense [$13,650 – ($48,000 X 1/20)] ...........................
11,250
Goodwill .................................................................... Amortization Expense ......................................
2,000
.
(For Instructor Use Only)
225,000
11,250 2,000
PROBLEM 9-6B (a)
(b)
Quiver 1.
Return on assets
2.
Profit margin
3.
Asset turnover
$800,000 $3,000,000 $800,000 $2,400,000 $2,400,000 $3,000,000
= 26.7%
= 33.3%
= .80 times
Swaze $920,000 $2,700,000 $920,000 $2,500,000 $2,500,000 $2,700,000
= 34.1%
= 36.8%
= .93 times
Based on the asset turnover, Swaze Corp. is more effective in using assets to generate sales. Its asset turnover is 16% higher than Quiver’s ratio. A factor that inhibits comparing the two companies is the differing composition of total assets for each company. Sixteen percent ($480,000 ÷ $3,000,000) of Quiver’s total assets are intangible assets. Swaze has no recorded intangible assets.
.
(For Instructor Use Only)
9-43
*PROBLEM 9-7B
(a) Year
Computation MACHINE 1 $63,000* X 1/7 X 6/12 = $4,500 $63,000 X 1/7 = $9,000 $63,000 X 1/7 = $9,000 $63,000 X 1/7 = $9,000 *($68,000 – $5,000)
2012 2013 2014 2015
MACHINE 2 $64,000 X 50%* X 9/12 = $24,000 $40,000 X 50% = $20,000 $20,000 X 50% = $10,000 *(1/4) X 2
2013 2014 2015
MACHINE 3 1,200 X $2.00a = $ 2,400 6,400 X $2.00 = $12,800 7,000 X $2.00 = $14,000
2013 2014 2015 a
(b)
9-44
($84,000 – $4,000) ÷ 40,000
2013
Depreciation Expense MACHINE 2 $64,000 X 50% X 2/12 = $5,333
2014
$58,667 X 50% = $29,333
Year
.
(For Instructor Use Only)
Accumulated Depreciation 12/31 $ 4,500 13,500 22,500 31,500
$24,000 44,000 54,000
$ 2,400 15,200 29,200
*PROBLEM 9-8B (a)
STRAIGHT-LINE DEPRECIATION Computation
End of Year
Annual Depreciable Depreciation Depreciation Accumulated Years Cost X Rate = Expense Depreciation 2014 2015 2016 2017 2018 a
$360,000a 360,000 360,000 360,000 360,000
20%b 20% 20% 20% 20%
$ 72,000 72,000 72,000 72,000 72,000 $360,000
$ 72,000 144,000 216,000 288,000 360,000
Book Value
$308,000 236,000 164,000 92,000 20,000
$380,000 – $20,000 1/5 = 20%
b
DOUBLE-DECLINING-BALANCE DEPRECIATION Computation Book Value Beginning Years of Year X 2014 2015 2016 2017 2018 c
$380,000 228,000 136,800 82,080 49,248
End of Year
Annual Depreciation Depreciation Accumulated Rate = Expense Depreciation 40%c 40% 40% 40% 40%
$152,000 91,200 54,720 32,832 29,248d $360,000
$152,000 243,200 297,920 330,752 360,000
Book Value
$228,000 136,800 82,080 49,248 20,000
(1/5) X 2 = 40% Adjusted so ending book value will equal salvage value.
d
(b)
Straight-line depreciation provides the lower amount for 2014 depreciation expense and, therefore, the higher 2014 income. Over the fiveyear period, both methods result in the same total depreciation expense ($360,000) and, therefore, the same total income.
(c)
Double-declining-balance depreciation provides the higher amount for 2014 depreciation expense and, therefore, the lower 2014 income. Both methods result in the same total income over the five-year period.
.
(For Instructor Use Only)
9-45
9-46
.
(For Instructor Use Only)
CHAPTER 9
(a)
Dec. 2 2
.
COMPREHENSIVE PROBLEM SOLUTION
Equipment ................................................... 16,800 Cash........................................................ Depreciation Expense ................................. Accumulated Depreciation— Equipment ...........................................
825
Cash ............................................................. Accumulated Depreciation—Equipment ... Equipment .............................................. Gain on Disposal of Plant Assets [$3,500 – ($5,000 – $2,250)] ................
3,500 2,625
15 Accounts Receivable .................................. Sales Revenue .......................................
5,000
Cost of Goods Sold ..................................... Inventory ................................................
3,500
23 Salaries and Wages Expense ..................... Cash........................................................
6,600
31 Bad Debt Expense ($4,000 – $500) ............. Allowance for Doubtful Accounts ........
3,500
Interest Receivable ($10,000 X .08 X 9/12) ............................... Interest Revenue ....................................
600
825
5,000 1,125 5,000 3,500 6,600 3,500
600
Insurance Expense ($3,600 X 4/6) .............. Prepaid Insurance..................................
2,400
Depreciation Expense ................................. Accumulated Depreciation—Building [($150,000 – $30,000) ÷ 30] .................
4,000
Depreciation Expense ................................. Accumulated Depreciation— Equipment [($55,000 – $5,500) ÷ 5] ....
9,900
(For Instructor Use Only)
16,800
2,400
4,000
9,900 9-47
COMPREHENSIVE PROBLEM (Continued)
9-48
.
Depreciation Expense .................................... Accumulated Depreciation—Equipment [($16,800 – $1,800) ÷ 5] X 1/12 ...............
250
Amortization Expense ($9,000 ÷ 9) ................ Patent.........................................................
1,000
Salaries and Wages Expense ........................ Salaries and Wages Payable ....................
2,200
Interest Expense............................................. Interest Payable [($11,000 + $35,000) X .10] .....................
4,600
Income Tax Expense ...................................... Income Taxes Payable ..............................
15,000
(For Instructor Use Only)
250 1,000 2,200
4,600 15,000
COMPREHENSIVE PROBLEM (Continued) (b)
KENSETH CORPORATION Adjusted Trial Balance December 31, 2014 Debits
.
(For Instructor Use Only)
Credits
9-49
Cash .................................................................. $ 2,100 Accounts Receivable ....................................... 41,800 Notes Receivable .............................................. 10,000 Interest Receivable ........................................... 600 Inventory ........................................................... 32,700 Prepaid Insurance ............................................ 1,200 Land .................................................................. 20,000 Buildings ........................................................... 150,000 Equipment ......................................................... 71,800 Patent ................................................................ 8,000 Allowance for Doubtful Accounts ................... Accumulated Depreciation—Buildings ........... Accumulated Depreciation—Equipment......... Accounts Payable ............................................ Salaries and Wages Payable ........................... Notes Payable (due April 30, 2015) ................. Interest Payable ................................................ Notes Payable (due in 2020) ............................ Income Taxes Payable ..................................... Common Stock ................................................. Retained Earnings ............................................ Dividends .......................................................... 12,000 Sales Revenue .................................................. Interest Revenue .............................................. Gain on Disposal of Plant Assets.................... Bad Debt Expense ............................................ 3,500 Cost of Goods Sold .......................................... 633,500 Depreciation Expense ...................................... 14,975 Insurance Expense ........................................... 2,400 Interest Expense ............................................... 4,600 Other Operating Expenses .............................. 61,800 Amortization Expense ...................................... 1,000 Salaries and Wages Expense .......................... 118,800 Income Tax Expense ........................................ 15,000 Total ........................................................... $1,205,775
9-50
.
(For Instructor Use Only)
$
4,000 54,000 32,350 27,300 2,200 11,000 4,600 35,000 15,000 50,000 63,600 905,000 600 1,125
$1,205,775
COMPREHENSIVE PROBLEM (Continued) (c)
KENSETH CORPORATION Income Statement For the Year Ended December 31, 2014 Sales revenue ................................................... Cost of goods sold ........................................... Gross profit ....................................................... Operating expenses Salaries and wages expense ..................... $118,800 Other operating expenses .........................61,800 Depreciation expense ......................................14,975 Bad debt expense ....................................... 3,500 Insurance expense ..................................... 2,400 Amortization expense ................................ 1,000 Total operating expenses ................................ Income from operations ................................... Other revenues and gains Gain on disposal of plant assets ............... 1,125 Interest revenue .......................................... 600 Other expenses and losses Interest expense ......................................... Income before income taxes ........................... Income tax expense ......................................... Net income ........................................................
$905,000 633,500 271,500
202,475 69,025 1,725 (4,600) 66,150 15,000 $ 51,150
KENSETH CORPORATION Retained Earnings Statement For the Year Ending December 31, 2014 Retained earnings, 1/1/14.......................................... Add: Net income ...................................................... Less: Dividends ........................................................ Retained earnings, 12/31/14......................................
.
(For Instructor Use Only)
$ 63,600 51,150 114,750 12,000 $102,750
9-51
COMPREHENSIVE PROBLEM (Continued) (d)
KENSETH CORPORATION Balance Sheet December 31, 2014
Current assets Cash ............................................................. $ 2,100 Accounts receivable.................................... $ 41,800 Less: Allowance for doubtful accounts ...... 4,000 37,800 Notes receivable .......................................... 10,000 Interest receivable ....................................... 600 Inventory ...................................................... 32,700 Prepaid insurance ....................................... 1,200 Total current assets ............................... 84,400 Property, plant, and equipment Land.............................................................. 20,000 Buildings ...................................................... $150,000 Less: Accum. depr.—buildings ................. 54,000 96,000 Equipment .................................................... 71,800 Less: Accum. depr.—equipment ............... 32,350 39,450 Total property, plant, and equipment ..... 155,450 Intangible assets Patent ........................................................... 8,000 Total assets ....................................................... $247,850 Current liabilities Notes payable (due April 30, 2015)............. Accounts payable ........................................ Income taxes payable ................................. Interest payable ........................................... Salaries and wages payable ....................... Total current liabilities ........................... Long-term liabilities Notes payable (due in 2020) ....................... Total liabilities ................................................... Stockholders’ equity Common stock ............................................ Retained earnings ....................................... Total liabilities and stockholders’ equity .........
9-52
.
(For Instructor Use Only)
$ 11,000 27,300 15,000 4,600 2,200 60,100 35,000 95,100 50,000 102,750
152,750 $247,850
BYP 9-1
FINANCIAL REPORTING PROBLEM
(a)
At December 31, 2011, total cost of property, plant and equipment was $455,097,000; book value was $212,162,000.
(b)
Depreciation is calculated by use of the straight-line method over the estimated useful lives of the assets.
(c)
Depreciation $17,862,000.
(d)
Tootsie Roll’s purchases of property, plant, and equipment were: 2011, $16,351,000; 2010, $12,813,000.
(e)
Goodwill and intangible assets with indefinite lives are not amortized, but rather tested for impairment at least annually. The company tested goodwill and trademarks during the fourth quarter of each year. It recorded an impairment in 2009 but none in 2010 or 2011.
.
(For Instructor Use Only)
was:
2011,
$19,229,000;
2010,
$18,279,000;
2009,
9-53
BYP 9-2
COMPARATIVE ANALYSIS PROBLEM
(a)
Tootsie Roll 1. Return on assets
$43,938 ($857,856 + $857,959)/2 $43,938
2. Profit margin
3. Asset turnover
$532,505
= 5.1%
($857,856 + $857 ,959) ÷ 2
$628,962 ($4,412,199 + $4,272,732)/2 $628,962
= 8.3%
$532,505
Hershey Company
$6,080,788 = .62 times
= 14.5%
= 10.3%
$6,080,788 ($4,412,199 + 4,272,732) ÷ 2
= 1.40 times
The asset turnover measures how efficiently a company uses its assets to generate sales. It shows the dollars of sales generated by each dollar invested in assets. Hershey Company’s asset turnover (1.40) was 126% higher than Tootsie Roll’s (.62) in 2011. Therefore, it can be concluded that Hershey Company was significantly more efficient than Tootsie Roll during 2011 in utilizing assets to generate sales. This efficiency was partially offset by a profit margin (10.3%) that was lower than Tootsie Roll’s (8.3%). Tootsie Roll is more effective in generating profit from its sales but its lower asset turnover resulted in only a 5.1% return on assets compared to Hershey’s 14.5% return. What this shows is that a company can generate a reasonable return on assets with a lower profit margin, if it has a high turnover.
9-54
.
(For Instructor Use Only)
BYP 9-3
RESEARCH CASE
(a)
All of the companies have market values (that is, the total market price of all of their shares) that is less than the shareholders’ equity on their balance sheet. This means that the reported value of the company’s assets exceeds the fair value of those assets.
(b)
In most instances, when a company’s market value is less than its book value, the company needs to consider writing down its goodwill. It is hard to argue that a company has goodwill (which represents the amount by which fair value of a purchased asset exceeds its recorded value) when its market value is below its book value.
(c)
In order for goodwill to be present on a company’s balance sheet, that company must have purchased another business. If the amount paid for that other business exceeds the fair value of the identifiable assets acquired, then the difference is debited to goodwill.
(d)
The write-down of goodwill as part of an impairment adjustment (or the write-down of any asset) does not affect cash.
.
(For Instructor Use Only)
9-55
BYP 9-4
INTERPRETING FINANCIAL STATEMENTS
(a)
Online retailers, such as Amazon, have large investments in sophisticated warehouses, but they have no money tied up in massive stores, such as those of Best Buy. This is would mean that, all else equal, an online retailer would have lower total assets, which would increase the asset turnover as well as the return on assets. We would also expect that the online retailer’s operating costs would be lower since it doesn’t incur salary and other costs of running a store. This should increase its net income, which would increase the profit margin ratio. 2011 2006
(b)
Profit Margin
$1,277 $50,272
Asset Turnover
Return on Assets
(c)
Profit Margin 2006 3.7% 2011 2.5%
$50,272 ($17,849 + $18,302)/2
$30,848
($17,849 + $18,302)/2
($11,864 + $10,294)/2
= 2.78 times
$1,140
= 7.1%
Asset Turnover 2.78 2.78
= 3.7%
$30,848
= 2.78 times
$1,277
× × ×
$1,140
= 2.5%
($11,864 + $10,294)/2
= = =
= 10.3
Return on Assets 10.3 7.1*
*Difference due to rounding. (d)
9-56
It is interesting to note that the asset turnover stayed the same, at 2.78 times between 2006 and 2011. This means that the company generates the same amount of sales per dollar invested in assets. However, the profit margin declined from 3.7% down to 2.5%. This means that the company previously generated 3.7 cents on each dollar of sales, but it now only generates only 2.5 cents. From the presentation in part (c) we can clearly see that the decline in the return on assets is due to the decline in the profit margin. This is consistent with the suggestion that the company is having a hard time competing with online retailers. The online retailers can offer lower prices because they have lower operating costs. Best Buy lowers its prices to meet the competitive, which then cuts into its profit margin.
.
(For Instructor Use Only)
BYP 9-5
REAL-WORLD FOCUS
Answers will vary depending on the company chosen by student.
.
(For Instructor Use Only)
9-57
BYP 9-6
DECISION MAKING ACROSS THE ORGANIZATION
(a) (in thousands)
Proposed results Proposed results Current results without cannibalization with cannibalization
Return on assets
$12,000 = .12 $100,000
$13,500 = .135 $100,000
$12,000 = .12 $100,000
Profit margin
$12,000 = .27 $45,000
$13,500 = .225 $60,000
$12,000 = .24 $50,000
Asset turnover
$45,000 = .45 $100,000
$60,000 = .60 $100,000
$50,000 = .50 $100,000
(b)
If there is no cannibalization, return on assets increases from 12% to 13.5%. This occurs even though the profit margin decreases from 27% to 22.5% because the asset turnover increases significantly, from .45 times to .60 times. However, if there is cannibalization, the return on assets remains unchanged at 12% because the increase in the asset turnover is offset by the decrease in the profit margin.
(c)
Yes, there are other alternatives. Here are some examples.
9-58
1.
Increase spending on marketing in an effort to increase sales of high end product, without offering the new, low-end product line. If this was successful it would increase the asset utilization, thus increasing the asset turnover and return on assets.
2.
Consider marketing the new line under a different name, so as to minimize the cannibalization. This might substantially increase the marketing costs, and therefore reduce the profit margin. But the benefit of reducing cannibalization might make up for the increased marketing costs.
3.
If neither of 1. or 2. seems feasible, they should consider closing a plant. This would increase the asset turnover and return on assets.
.
(For Instructor Use Only)
BYP 9-7
COMMUNICATION ACTIVITY
Answers will depend on the position selected by the student. Some points that should be considered include: 1.
Some relatively small companies may spend less on R&D because they must expense these costs. However, the vast majority of companies realize that for continued growth and stability, R&D expenditures are a high priority regardless of how they are recorded for accounting purposes. Requiring companies to expense R&D costs instead of allowing them to be capitalized could leave U.S. companies at a competitive disadvantage as compared to non-U.S. companies. U.S. companies may be more reluctant to invest millions of dollars on research and development since the costs would negatively impact their financial statements in the short-run.
2.
.
The tangible future benefits of R&D costs may not be realized for several years, if ever. Conversely, the purchase of a long-lived asset (i.e., equipment, building) will provide benefits immediately as well as in future years. Accountants often employ an approach called conservatism which dictates that when reasonable doubt exists, a company should choose the option that has the least favorable affect on income. Expensing R&D costs is an example of applying conservatism.
(For Instructor Use Only)
9-59
BYP 9-8
ETHICS CASE
(a)
The stakeholders in this situation are: Tyler Weber, president of Fresh Air Anti-Pollution Company. Robin Cain, controller. The stockholders of Fresh Air Anti-Pollution Company. Potential investors in Fresh Air Anti-Pollution Company.
(b)
The intentional misstatement of the life of an asset or the amount of the salvage value is unethical for whatever the reason. There is nothing unethical per se about changing the estimates used for the life of an asset or of an asset’s salvage value if the change is an attempt to better match cost and revenues and is a better allocation of the asset’s depreciable cost over the asset’s useful life. In this case, it appears from the controller’s reaction that the revision in the life is intended only to improve earnings which would be unethical. The fact that the competition uses a longer life for its equipment is not necessarily relevant. The competition’s maintenance and repair policies and activities may be different. The competition may use its equipment fewer hours a year (e.g., one shift rather than two shifts daily) than Fresh Air Anti-Pollution Company.
(c)
Income before income taxes in the year of change is increased $155,000 ($387,500 – $232,500) by implementing the president’s proposed changes. Old Estimates Asset cost ............................................................. Estimated salvage ................................................ Depreciable cost................................................... Depreciation per year (1/8) ..................................
$3,500,000 400,000 3,100,000 $ 387,500 Revised Estimates
Asset cost ............................................................. Estimated salvage ................................................ Depreciable cost................................................... Depreciation taken to date ($387,500 X 2) .......... Remaining life in years ........................................ Depreciation per year ($2,325,000 ÷ 10) .............. 9-60
$3,500,000 400,000 3,100,000 775,000 2,325,000 10 years $ 232,500 .
(For Instructor Use Only)
BYP 9-9
(a) 1 c
ALL ABOUT YOU
2b
3a
4d 5c
(b) For the most part, the value of a brand is not reported on a company’s balance sheet. Most companies are required to expense all costs related to the maintenance of a brand name. Also any research and development that went into the development of the related product is generally expensed. The only way significant costs related to the value of the brand are reported on the balance sheet is when a company purchases another company that has a significant tradename (brand). In that case, given an objective transaction, companies are able to assign value to the brand and report it on the balance sheet. A conservative approach is used in this area because the value of the brand can be extremely difficult to determine. It should be noted that international rules permit companies to report brand values on their balance sheets.
.
(For Instructor Use Only)
9-61
BYP 9-10
FASB CODIFICATION ACTIVITY
(a) Capitalize is a term used to indicate that the cost would be recorded as the cost of an asset. That procedure is often referred to as deferring a cost, and the resulting asset is sometimes described as a deferred cost. (b)
Intangible assets are assets that lack physical substance. (The term intangible asset is used to refer to intangible assets other than goodwill.)
(c)
Codification reference 360-10-35-2 addresses the concept of depreciation accounting and the various factors to consider in selecting the related periods and methods to be used in such accounting. Generally accepted accounting principles (GAAP) require that the cost of a productive facility be spread over the expected useful life of the facility in such a way as to allocate it as equitably as possible to the periods during which services are obtained from the use of the facility (Codification reference 360-10-35-4).
9-62
.
(For Instructor Use Only)
BYP 9-11
CONSIDERING PEOPLE, PLANET AND PROFIT
(a)
Airbus developed a wing attachment called a Sharklet that is designed to reduce fuel consumption. It is quite similar to a device that is sold by Aviation Partners walled a Winglet. Aviation Partners has a patent on the device. Airbus filed a lawsuit against Aviation Partners claiming that the patent should be declared invalid.
(b)
Aviation Partners says that its Winglets will reduce fuel consumption by 5 to 7 percent. It says that the total amount of jet fuel that its device has saved is approximately 3 billion gallons.
(c)
Airbus and Aviation Partners were involved in discussions for about 5 years before they reached a memorandum of understanding to form a joint venture to design a device for use on Airbus aircraft. However, Airbus then developed the Sharklet, which Aviation Partners says violates its patent.
(d)
If Aviation Partners loses the lawsuit it would have expense the cost of the lawsuit. It would also have to review the recorded value of its patent to determine whether the loss of the lawsuit has caused the value of the patent to be impaired.
.
(For Instructor Use Only)
9-63
IFRS CONCEPTS AND APPLICATION IFRS9-1 Component depreciation is a method of allocating the cost of a plant asset into separate parts based on the estimated useful lives of each component. IFRS requires an entity to use component depreciation whenever significant parts of a plant asset have significantly different useful lives. IFRS9-2 Revaluation is an accounting procedure that adjusts plant assets to fair value at the reporting date. Revaluation must be applied annually to assets that are experiencing rapid price changes. IFRS9-3 Both types of development expenditures relate to the creation of new products but one is expensed and the other is capitalized. Development costs incurred before a new product achieves technological feasibility are recorded as development expenses and appear as part of operating expenses on the income statement. Costs incurred after technological feasibility are recorded as development costs and appear as an intangible asset on the statement of financial position. IFRS9-4 Warehouse component: ($280,000 – $40,000)/20 = $12,000 HVAC component: $40,000/10 = $4,000 Total component depreciation in first year $16,000 IFRS9-5 (a)
Accumulated Depreciation—Plant Assets ................ Revaluation Surplus ......................................... Plant Assets....................................................... (To record revaluation of plant assets)
60,000
(b) Accumulated Depreciation—Plant Assets ................ Revaluation Surplus .................................................... Plant Assets....................................................... (To record revaluation of plant assets)
60,000 20,000
9-64
.
(For Instructor Use Only)
40,000 20,000
80,000
IFRS9-6 Development Expense......................................................... Research Expense ............................................................... Development Costs ............................................................. Cash .............................................................................. (To record research and development costs)
.
(For Instructor Use Only)
400,000 300,000 200,000 900,000
9-65
IFRS9-7
INTERNATIONAL FINANCIAL STATEMENT ANALYSIS
(a) Zetar uses straight line and reducing-balance depreciation methods. The depreciation rates range from 10–33%. (b) Goodwill is reviewed annually for impairment. (c) Accumulated Depreciation ...................... Cash.......................................................... Loss on Disposal ..................................... Property, Plant, and Equipment ........
9-66
.
(For Instructor Use Only)
50 45 9 104
CHAPTER 10 Reporting and Analyzing Liabilities Learning Objectives 1. Explain a current liability and identify the major types of current liabilities. 2. Describe the accounting for notes payable. 3. Explain the accounting for other current liabilities. 4. Identify the types of bonds. 5. Prepare the entries for the issuance of bonds and interest expense. 6. Describe the entries when bonds are redeemed. 7. Identify the requirements for the financial statement presentation and analysis of liabilities. *8. Apply the straight-line method of amortizing bond discount and bond premium. *9. Apply the effective-interest method of amortizing bond discount and bond premium. *10. Describe the accounting for long-term notes payable.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
19. 20. 21. 22. 23. 24.
7 7 7 7 7 7
K C C C C C
25. 26. 27. 28. 29. 30. 31.
7 8* 8* 9* 9* 10* 10*
C C AP C C C C
13. 14. 15. 16.
7 7 7 8*
AP AP AN AP
17. 18. 19.
8* 9* 10*
AP AP AP
C
4.
5
AP
5.
6
AP
AP AP AP AP AN AN
19. 20.
7 5, 6, 8* 5, 6, 8* 5, 9*
C
23. 24. 25.
5, 9* 10* 10*
AP AP AP
Questions 1. 2. 3. 4. 5. 6.
1 2 3 3 3 3
C C AP AP K C
7. 8. 9. 10. 11. 12.
1 4 4 4 4 4
K C AN C C K
13. 14. 15. 16. 17. 18.
4, 5 5 5 5 6 7
C C AP AP AP C
Brief Exercises 1. 2. 3. 4.
1 2 3 3
C AP AP AP
5. 6. 7. 8.
3 3 3 5
AP AP AP AP
1.
2, 3
C
2.
3
AP
9. 10. 11. 12.
5 5 6 7
AP AP AP AP
Do It! Review Exercises 3.
4 Exercises
1. 2. 3. 4. 5. 6.
2 2 2 3 3 3
AP AP AP AP AP AP
7. 8. 9. 10. 11. 12.
3 5 5 5 5 5
AP AP AP AP AP AN
13. 14. 15. 16. 17. 18.
5, 6, 6 7 7 7 7
21. 22.
AP AP AP
Problems: Set A 1, 2, 5, 6, 5, 7, 5. 8. 3, 7 AP 7 AP 8* AP 5, 7, 2. 2, 7 AP 6. 7 AN 9. 8* AP 5, 6, 3. 5, 6 AP 7. 8* AP 4. 5, 6, 7 AP 10. 5, 9* AP *Continuing Cookie Solutions for this chapter are available online. 1.
.
(For Instructor Use Only)
11. 12. 13.
5, 7, 9* 7, 10* 7, 10*
AP AP AP
10-1
Summary of Questions by Learning Objectives and Bloom’s Taxonomy (Continued) Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
11.
5, 7, 9*
AP
7, 10*
AP
7, 10*
AP
Problems: Set B 1, 2, 3, 7
AP
2.
2, 7
AP
3.
5, 6
AP
4.
5, 6, 7
1.
10-2
5, 6, 7
AP
6.
7
AN
7.
5, 6, 8*
5.
8.
AP
AP
.
(For Instructor Use Only)
9. 10.
5, 7, 8*
AP
5, 7, 8*
AP
5, 9*
AP
12. 13.
Item
LO
BT
ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description
.
Difficulty Level
Time Allotted (min.)
*1A
Prepare current liability entries, adjusting entries, and current liabilities section.
Moderate
30–40
*2A
Journalize and post note transactions; show balance sheet presentation.
Moderate
30–40
3A
Prepare journal entries to record interest payments and redemption of bonds.
Moderate
30–40
4A
Prepare journal entries to record issuance of bonds, interest, balance sheet presentation, and bond redemption.
Moderate
30–40
*5A
Prepare journal entries to record issuance of bonds, show balance sheet presentation, and record bond redemption.
Simple
30–40
6A
Calculate and comment on ratios.
Moderate
30–40
*7A
Prepare journal entries to record interest payments, straight-line discount amortization, and redemption of bonds.
Moderate
30–40
**8A
Prepare journal entries to record issuance of bonds, interest, straight-line amortization, and balance sheet presentation.
Simple
30–40
**9A
Prepare journal entries to record issuance of bonds, interest, straight-line amortization, and balance sheet presentation.
Moderate
30–40
**10A
Prepare journal entries to record issuance of bonds, payment of interest, and amortization of bond discount using effective-interest method.
Moderate
30–40
**11A
Prepare journal entries to record issuance of bonds, payment of interest, effective-interest amortization, and balance sheet presentation.
Moderate
30–40
**12A
Prepare installment payments schedule, journal entries, and balance sheet presentation for a mortgage note payable.
Moderate
30–40
*13A
Prepare journal entries to record payments for long-term note payable, and balance sheet presentation.
Moderate
30–40
(For Instructor Use Only)
10-3
ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number
Description
Difficulty Level
Time Allotted (min.)
*1B
Prepare current liability entries, adjusting entries, and current liabilities section.
Moderate
30–40
*2B
Journalize and post note transactions; show balance sheet presentation.
Moderate
30–40
3B
Prepare journal entries to record interest payments and redemption of bonds.
Moderate
30–40
4B
Prepare journal entries to record issuance of bonds, interest, balance sheet presentation, and bond redemption.
Moderate
30–40
5B
Prepare journal entries to record issuance of bonds, show balance sheet presentation, and record bond redemption.
Simple
30–40
6B
Calculate and comment on ratios.
Moderate
30–40
**7B
Prepare journal entries to record interest payments, straight-line premium amortization, and redemption of bonds.
Moderate
30–40
**8B
Prepare journal entries to record issuance of bonds, interest, straight-line amortization, and balance sheet presentation.
Simple
30–40
**9B
Prepare journal entries to record issuance of bonds, interest, straight-line amortization, and balance sheet presentation.
Moderate
30–40
*10B
Prepare journal entries to record issuance of bonds, payment of interest, and amortization of bond premium using effective-interest method.
Moderate
30–40
*11B
Prepare journal entries to record issuance of bonds, payment of interest, effective-interest amortization, and balance sheet presentation.
Moderate
30–40
*12B
Prepare installment payments schedule, journal entries, and balance sheet presentation for a mortgage note payable.
Moderate
30–40
*13B
Prepare journal entries to record payments for long-term note payable, and balance sheet presentation.
Moderate
30–40
10-4
.
(For Instructor Use Only)
ANSWERS TO QUESTIONS 1.
While this is generally true, more precisely a current liability is a debt that can reasonably be expected to be paid: (a) from existing current assets or through the creation of other current liabilities and (2) within one year or the operating cycle, whichever is longer.
2.
In the balance sheet, Notes Payable of $20,000 and Interest Payable of $450 ($20,000 X 9% X 3/12) should be reported as current liabilities. In the income statement, Interest Expense of $450 should be reported under other expenses and losses.
3.
(a) Disagree. The company only serves as a collection agent for the taxing authority. It does not report sales taxes as an expense; it merely forwards the amount paid by the customer to the government. (b) The entry to record the proceeds is: Cash ........................................................................................ Sales Revenue ................................................................. Sales Taxes Payable ........................................................
4.
8,550 8,000 550
(a) The entry when the tickets are sold is: Cash ........................................................................................ Unearned Ticket Revenue ................................................
900,000
(b) The entry after each game is: Unearned Ticket Revenue ........................................................ Ticket Revenue ................................................................
180,000
900,000
180,000
5.
Three taxes commonly withheld by employers from employees’ gross pay are (1) federal income taxes, (2) state income taxes, and (3) social security (FICA) taxes.
6.
(a) Three taxes commonly paid by employers on employees’ salaries and wages are (1) social security (FICA) taxes, (2) state unemployment taxes, and (3) federal unemployment taxes. (b) Taxes withheld from employees’ gross pay and not yet remitted to the appropriate government agency are reported in the balance sheet as current liabilities.
7.
The liabilities that Tootsie Roll identified as current are: Accounts payable, Dividends payable, and Accrued liabilities.
8.
(a) Long-term liabilities are obligations that are expected to be paid after one year. Examples include bonds and long-term notes. (b) Bonds are a form of interest-bearing notes payable used by corporations, universities, and governmental agencies.
9.
(a) Secured bonds have specific assets of the issuer pledged as collateral. In contrast, unsecured bonds are issued against the general credit of the borrower. (b) Convertible bonds permit bondholders to convert them into common stock at their option. In contrast, callable bonds are subject to call and redemption at a stated dollar amount prior to maturity at the option of the issuer.
.
(For Instructor Use Only)
10-5
Questions Chapter 10 (Continued) 10.
(a) Face value is the amount of principal due at the maturity date. (b) The contractual interest rate is the rate used to determine the amount of cash interest the borrower pays and the investor receives. This rate is also called the stated interest rate because it is the rate stated on the bonds. (c)
11.
A bond certificate is a legal document that indicates the name of the issuer, the face value of the bonds, and such other information as the contractual interest rate and maturity date of the bonds.
(a) A convertible bond permits bondholders to convert it into common stock at the option of the bondholders. (b) For bondholders, the conversion option gives an opportunity to benefit if the market price of the common stock increases substantially. For the issuer, convertible bonds usually have: (1) a lower rate of interest than other debt securities, (2) a higher selling price.
12.
The two major obligations incurred by a company when bonds are issued are the interest payments due on a periodic basis and the principal which must be paid at maturity.
13.
Less than. Investors were required to pay more than the face value; therefore, the market interest rate is less than the contractual rate.
14.
No, Jack is not right. The market price on any bond is a function of three factors: (1) the dollar amounts to be received by the investor (interest and principal), (2) the length of time until the amounts are received (interest payment dates and maturity date), and (3) the market interest rate.
15.
$48,000. $800,000 X 6% X 1 year = $48,000.
16.
$664,000. The balance of the Bonds Payable account minus the balance of the Discount on Bonds Payable account (or plus the balance of the Premium on Bonds Payable account) equals the carrying value of the bonds.
17.
Debits: Credits:
18.
10-6
Bonds Payable (for the face value) and Premium on Bonds Payable (for the unamortized balance). Cash (for 97% of the face value) and Gain on Bond Redemption (to balance entry).
Two issues need to be considered. First, by financing a major purchase such as this with shortterm financing the company will reduce its liquidity. In the case of Mullins Inc., its current ratio will decrease from 2.2:1 to a less acceptable level of 1.5:1. However, of equal concern is that by financing a long-term project with short-term financing the company is exposing itself to interest rate risk. The company has the choice of locking in a long-term rate of 8%, or continually refinancing at whatever the short-term rate is when its short-term debt matures. If short-term rates increase substantially the increase in interest expense could significantly reduce the company’s profitability.
.
(For Instructor Use Only)
Questions Chapter 10 (Continued) 19. (a) The nature and the amount of each long-term liability should be presented in the balance sheet or in schedules in the accompanying notes to the financial statements. The notes should also indicate the interest rates, maturity dates, conversion privileges, and assets pledged as collateral. (b) To evaluate liquidity a company may compute working capital and the current ratio. To evaluate long-run solvency a company may compute a debt to assets ratio, and a times interest earned ratio. 20. No, Samuel is not correct. Liquidity involves measuring the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. Solvency involves measuring the ability of a company to survive over a long period of time. 21. When companies are trying to overcome customer skepticism about the quality of their product they often consider providing a more generous warranty. While this may be effective in increasing sales, it is not without costs. Clearly a longer warranty will usually result in more warranty claims. Warranties are a contingent liability that must be accrued for each year. If the warranty period is extended, the size of this accrual could increase significantly. If the quality of the company’s product is not improved at the same time that the warranty is extended, it is quite possible that the increase in the estimated warranty accrual could exceed the increase in net income from expanded sales from the more generous warranty. 22. One alternative to purchasing the assets is to lease them through an operating lease agreement. In an operating lease, the lease payments are recorded as an expense. This allows the lessee to keep the leased assets and, more importantly, lease liabilities off the balance sheet (referred to as off-balance-sheet financing). Keeping lease liabilities off the balance sheet will have a favorable impact on the lessee’s liquidity and solvency ratios. Another option is to lease the assets through a capital lease agreement. However, in a capital lease the lessee must record the asset and a related liability for the lease payments. This treatment would impact liquidity and solvency ratios the same way the purchase of assets would. 23. Tim is not correct. In order to reduce costs, many companies today keep low amounts of inventory on hand. Consequently, liquidity ratios are generally lower than they used to be. Companies that keep fewer liquid assets on hand frequently rely on a bank line of credit. A line of credit allows a company to borrow money on a short-term basis to meet any cash shortfalls caused by a low amount of liquid assets. 24.
If a company has significant operating leases, most analysts would argue that its recorded assets and liabilities understate their true values. These analysts will increase the company’s liabilities and assets for the unrecorded operating leases.
25. Two criteria must be met: (1) the contingency must be probable and (2) the company must be able to arrive at a reasonable estimate. If these criteria are not met, the company should disclose the major facts concerning the contingency in the notes to its financial statements.
.
(For Instructor Use Only)
10-7
Questions Chapter 10 (Continued) *26.
The straight-line method of amortization results in the same amortized amount being assigned to Interest Expense each interest period. This amount is determined by dividing the total bond discount or premium by the number of interest periods the bonds will be outstanding.
*27.
The total amount of interest expense is $10,800. Interest expense is the interest to be paid in cash less the premium amortization for the year. Cash to be paid equals 6% X $200,000 or $12,000. Total premium equals 3% of $200,000 or $6,000. Since this is to be amortized over 5 years (the life of the bonds) in equal amounts, the amortization amount is $6,000 ÷ 5 = $1,200. Thus, $12,000 – $1,200 or $10,800 is the interest expense for 2014.
*28.
Glenda is probably indicating that since the borrower has the use of the bond proceeds over the term of the bonds, the borrowing rate in each period should be the same. The effective-interest method results in a varying amount of interest expense but a constant rate of interest on the balance outstanding. Accordingly, it results in a better matching of expenses with revenues than the straight-line method.
*29.
Decrease. Under the effective-interest method the interest expense per period is determined by multiplying the carrying value of the bonds by the effective-interest rate. When bonds are issued at a premium, the carrying value decreases over the life of the bonds. As a result, the interest expense will also decrease over the life of the bonds because it is determined by multiplying the decreasing carrying value of the bonds at the beginning of the period by the effective-interest rate.
*30.
The installment note requires equal payments. Each payment will pay any interest that has been incurred during the time that has past since the previous payment. The remaining amount of the payment will pay off part of the principal balance owed. Over time, as the principal is payed down, the amount of interest owed will decline, so that the principal payed off by each payment will increase.
*31.
No, Roy is not right. Each payment by Roy consists of: (1) interest on the unpaid balance of the loan and (2) a reduction of loan principal. The interest decreases each period while the portion applied to the loan principal increases each period.
10-8
.
(For Instructor Use Only)
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 10-1 (a) A note payable due in two years is a long-term liability, not a current liability. (b) $20,000 of the mortgage payable is a current maturity of long-term debt. This amount should be reported as a current liability. (c) Interest payable is a current liability because it will be paid out of current assets in the near future. (d) Accounts payable is a current liability because it will be paid out of current assets in the near future.
BRIEF EXERCISE 10-2 (a) July 1 (b) Dec. 31
Cash .......................................................... Notes Payable ...................................
90,000
Interest Expense ....................................... Interest Payable ($90,000 X 7% X 6/12) ....................
3,150
90,000
3,150
BRIEF EXERCISE 10-3 Sales tax payable (1) Sales = ($10,388 ÷ 1.06) = $9,800 (2) Sales taxes payable = ($9,800 X 6%) = $588 or $10,388 – $9,800 = $588 Mar. 16
.
Cash .................................................................. Sales Revenue .......................................... Sales Taxes Payable .................................
(For Instructor Use Only)
10,388 9,800 588
10-9
BRIEF EXERCISE 10-4 (a) Cash (3,500 X $80) ................................................. Unearned Ticket Revenue.............................. (To record sale of 3,500 season tickets)
280,000
(b) Unearned Ticket Revenue ..................................... Ticket Revenue ($280,000 ÷ 10) ...................... (To record basketball ticket revenue earned)
28,000
280,000
28,000
BRIEF EXERCISE 10-5 Gross earnings: Regular pay (40 X $16) ........................................... Overtime pay (7 X $24) .......................................... Gross earnings .............................................................. Less: FICA taxes payable ($808 X 7.65%) ................... Federal income taxes payable........................... Net pay ...........................................................................
$640.00 168.00
$808.00 $808.00
$ 61.81 95.00
156.81 $651.19
BRIEF EXERCISE 10-6 Jan.
Jan.
15
15
Salaries and Wages Expense .................... FICA Taxes Payable ($808 X 7.65%) Federal Income Taxes Payable ........ Salaries and Wages Payable ............
808.00
Salaries and Wages Payable ..................... Cash ...................................................
651.19
61.81 95.00 651.19 651.19
BRIEF EXERCISE 10-7 Jan.
15
Payroll Tax Expense .................................. FICA Taxes Payable ($808 X 7.65%)
61.81 61.81
BRIEF EXERCISE 10-8 Cash ($300,000 X .98)................................. Discount on Bonds Payable ...................... 10-10
.
(For Instructor Use Only)
294,000 6,000
Bonds Payable ..................................
300,000
BRIEF EXERCISE 10-9 Cash ($400,000 X 1.01) ................................................... Bonds Payable .................................................. Premium on Bonds Payable ............................
404,000 400,000 4,000
BRIEF EXERCISE 10-10 2014 (a) Jan. 1
(b) Dec. 31
2015 (c) Jan. 1
Cash................................................... 3,000,000 Bonds Payable (3,000 X $1,000) ........................ 3,000,000 Interest Expense ........................ Interest Payable ($3,000,000 X 7%) ...............
210,000
Interest Payable ......................... Cash .........................................
210,000
210,000
210,000
BRIEF EXERCISE 10-11 Bonds Payable ......................................................... Loss on Bond Redemption ($2,040,000 – $1,955,000) ..................................... Cash ($2,000,000 X 1.02) .................................. Discount on Bonds Payable ............................
2,000,000 85,000 2,040,000 45,000
BRIEF EXERCISE 10-12 Long-term liabilities Bonds payable .................................................. Less: Discount on bonds payable .................. Notes payable ................................................... Total long-term liabilities ..........................
.
(For Instructor Use Only)
$700,000 28,000
$672,000 80,000 $752,000
10-11
BRIEF EXERCISE 10-13 DESMOND INC. Balance Sheet (Partial) December 31, 2014 Current liabilities Note payable .............................................. Accounts payable ...................................... Unearned rent revenue .............................. Interest payable ......................................... FICA taxes payable .................................... Income taxes payable ................................ Sales taxes payable ................................... Total current liabilities .......................... Long-term liabilities Bonds payable ........................................... Less: Discount on bonds payable ........... Notes payable ............................................ Total long-term liabilities ..................... Total liabilities ...................................................
$ 20,000 157,000 240,000 40,000 7,800 3,500 1,700 $ 470,000 900,000 41,000
859,000 80,000 939,000 $1,409,000
BRIEF EXERCISE 10-14 (a) (b) (c) (d)
Working capital = $4,485 – $2,836 = $1,649 Current ratio = $4,485 ÷ $2,836 = 1.58:1 Debt to assets = $5,099 ÷ $8,875 = 57% Times interest earned = ($245 + $113 + $169) ÷ $169 = 3.12 times
Working capital and the current ratio measure a company’s ability to pay maturing obligations and meet cash needs. Adidas’s current assets are 58% larger than the amount of its current liabilities which indicates a relatively high degree of liquidity. Debt to assets and times interest earned measure a company’s ability to survive over a long period of time. Adidas’s debt to assets ratio indicates that approximately $.57 of every dollar invested in assets was provided by creditors. Adidas’s times interest earned ratio of 3.12 indicates that its earnings are adequate to make interest payments as they come due.
10-12
.
(For Instructor Use Only)
BRIEF EXERCISE 10-15 (a) Debt to assets: Without operating leases
$14,180 = 59% $24,004
With operating leases
$14,180 + $740 = 60% $24,004 + $740
(b) CN does not have significant operating leases, therefore its assets and liabilities reflect its true financial position. By increasing its assets and liabilities for these operating leases we see that its debt to assets ratio increases only slightly from 59% to 60%. *BRIEF EXERCISE 10-16 (a) Jan. 1
(b) Dec. 31
Cash (99% X $2,000,000) ................. Discount on Bonds Payable............ Bonds Payable .........................
1,980,000 20,000
Interest Expense .............................. Cash ($2,000,000 X 7%)............ Discount on Bonds Payable ($20,000 ÷ 10) .........
142,000
2,000,000 140,000 2,000
*BRIEF EXERCISE 10-17 (a) Jan. 1
(b) Dec. 31
.
Cash (102% X $4,000,000) ............... Bonds Payable.......................... Premium on Bonds Payable ....
4,080,000
Interest Expense ............................. Premium on Bonds Payable ($80,000 ÷ 5) ............................. Interest Payable ($4,000,000 X 8%)......................
304,000
(For Instructor Use Only)
4,000,000 80,000
16,000 320,000
10-13
*BRIEF EXERCISE 10-18 (a) Interest Expense .............................................. Discount on Bonds Payable .................... Cash ..........................................................
48,070 3,070 45,000
(b) Interest expense is greater than interest paid because the bonds sold at a discount. The bonds sold at a discount because investors demanded a market interest rate higher than the contractual interest rate. Interest expense is calculated using the effective interest rate which is higher than the stated rate used to compute the cash payment. (c) Interest expense increases each period because the bond carrying value increases each period. As the market interest rate is applied to this bond carrying value, interest expense will increase. BRIEF EXERCISE 10-19 (A) Semiannual Interest Period Issue Date 1 Dec. June
10-14
31 30
.
Cash Payment
(B) Interest Expense (D) X 5%
(C) Reduction of Principal (A) – (B)
$48,145
$30,000
$18,145
Cash ...................................................... Mortgage Payable .......................
600,000
Interest Expense .................................. Mortgage Payable ................................ Cash .............................................
30,000 18,145
(For Instructor Use Only)
(D) Principal Balance (D) – (C) $600,000 581,855
600,000
48,145
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 10-1 1. 2. 3.
$60,000 X 10% X 5/12 = $2,500 $42,000/1.05 = $40,000; $40,000 X 5% = $2,000 $42,000 X 2/6 = $14,000
DO IT! 10-2 (a) To determine wages payable, reduce wages expense by the withholdings for FICA, federal income tax, and state income tax. Feb. 28 Salaries and Wages Expense ....................... FICA Taxes Payable .................................. Federal Income Taxes Payable ................ State Income Taxes Payable .................... Salaries and Wages Payable ....................
74,000 5,661 7,100 1,900 59,339
(b) Payroll taxes would be for the company’s share of FICA, as well as for federal and state unemployment tax. Feb. 28 Payroll Tax Expense ..................................... FICA Taxes Payable .................................. Federal Unemployment Taxes Payable ... State Unemployment Taxes Payable .......
5,931 5,661 110 160
DO IT! 10-3 1. 2. 3. 4.
.
False. Convertible bonds can be converted into common stock at the bondholder’s option; callable bonds can be redeemed by the issuer at a set amount prior to maturity. True. True. True.
(For Instructor Use Only)
10-15
DO IT! 10-4 (a)
(b)
Cash ..................................................................... Bonds Payable ................................................ Premium on Bonds Payable........................... (To record sale of bonds at a premium)
315,000 300,000 15,000
Long-term liabilities Bonds payable ................................................ Plus: Premium on bonds payable.................
$300,000 15,000 $315,000
DO IT! 10-5 Bonds Payable..................................................... Loss on Bond Redemption ................................. Cash ($400,000 X 99%) ................................... Discount on Bonds Payable........................... (To record redemption of bonds at 99)
10-16
.
(For Instructor Use Only)
400,000 8,000 396,000 12,000
SOLUTIONS TO EXERCISES EXERCISE 10-1 2014 (a) June 1
Cash ........................................................... Notes Payable....................................
(b) June 30 Interest Expense ($15,000 X .08 X 1/12) ............................ Interest Payable................................. (c) Interest payable accrued each month ...................... Number of months from borrowing to year end ............................................................. Balance in interest payable account ........................ 2015 (d) Jan. 1
Notes Payable ........................................... Interest Payable ........................................ Cash ...................................................
15,000 15,000 100 100 $100 X 7 $700 15,000 700 15,700
EXERCISE 10-2 (a) Principal X .08 X 4/12 = $480 Principal = $480 ÷ (.08 X 4/12) Principal = $18,000 (b) $18,500 X Interest Rate X 4/12 = $555 Interest Rate = $555 ÷ ($18,500 X 4/12) Interest Rate = 9 percent (c) Initial Borrowing: May 15
Cash ......................................................... Notes Payable ..................................
18,000 18,000
Repayment: Sept. 15
.
Notes Payable.......................................... Interest Expense ..................................... Cash..................................................
(For Instructor Use Only)
18,000 480 18,480 10-17
EXERCISE 10-3 (a) June 1
Cash ............................................................ 60,000 Notes Payable .....................................
(b) June 30
(c) Dec.
Interest Expense ($60,000 X .08 X 1/12) .... Interest Payable ..................................
1
60,000
400
Notes Payable ............................................. 60,000 Interest Payable ($60,000 X .08 X 6/12) ..... 2,400 Cash .....................................................
400
62,400
(d) Interest expense accrued each month ........................ $ 400 Number of months of loan ........................................... X 6 Total interest expense .................................................. $2,400 EXERCISE 10-4 Apr. 10
15
10-18
FURCAL COMPANY Cash ..................................................................... 23,100 Sales Revenue.............................................. Sales Taxes Payable ....................................
22,000 1,100
CRYSTAL COMPANY Cash ..................................................................... 13,780 Sales Revenue ($13,780 ÷ 1.06)................... Sales Taxes Payable ($13,780 – $13,000) ...
13,000 780
.
(For Instructor Use Only)
EXERCISE 10-5 (a) Mar. 31
(b) Mar. 31
Salaries and Wages Expense ............... FICA Taxes Payable....................... Federal Income Taxes Payable ..... State Income Taxes Payable ......... Union Dues Payable ...................... Salaries and Wages Payable .........
64,000
Payroll Tax Expense ............................. FICA Taxes Payable....................... State Unemployment Taxes Payable .......................................
5,596
4,896 7,500 3,100 400 48,104 4,896 700
EXERCISE 10-6 (a) $1,728,000 ÷ $320 = 5,400 season tickets sold. (b) $1,728,000 ÷ 16 home games = $108,000 revenue recognized per home game. $1,188,000 ÷ $108,000 = 11 home games already played. (c) Cash......................................................................... 1,728,000 Unearned Ticket Revenue .............................. 1,728,000 (d) Unearned Ticket Revenue ...................................... Ticket Revenue ................................................
108,000 108,000
EXERCISE 10-7 (a) Nov. (b) Dec. 31
.
Cash (6,300 X $28) ................................. Unearned Subscription Revenue..
176,400
Unearned Subscription Revenue ......... Subscription Revenue ($176,400 X 1/12) .........................
14,700
(For Instructor Use Only)
176,400
14,700
10-19
EXERCISE 10-7 (Continued) (c) Mar. 31
Unearned Subscription Revenue ........ Subscription Revenue ($176,400 X 3/12) ........................
44,100 44,100
EXERCISE 10-8 2014 (a) Aug. 1 (b) Dec. 31
2015 (c) Aug. 1
Cash ...................................................... Bonds Payable ..............................
600,000
Interest Expense ................................... Interest Payable ($600,000 X 7% X 5/12) ...............
17,500
Interest Expense ($600,000 X 7% X 7/12) ...................... Interest Payable .................................... Cash ($600,000 X 7% X 12/12) ......
600,000
17,500
24,500 17,500 42,000
EXERCISE 10-9 (a) Jan. 1
(b) Dec. 31
(c) Jan. 1
10-20
.
Cash....................................................... Bonds Payable ..............................
300,000
Interest Expense ................................... Interest Payable ($300,000 X 8% X 12/12) .............
24,000
Interest Payable .................................... Cash ...............................................
24,000
(For Instructor Use Only)
300,000
24,000
24,000
EXERCISE 10-10 (a) Jan. 1
Cash ($600,000 1.03) ........................... Bonds Payable ................................ Premium on Bonds Payable .........
(b) Long-term Liabilities Bonds Payable, due 2024 ............................. Add: Premium on Bonds Payable ................
618,000 600,000 18,000
$600,000 10,800 $610,800
(c) The bonds sold for more than their face amount because the contract interest rate (6%) was higher than the market interest rate. When the contract rate is higher than the market rate, bonds will sell at a premium. EXERCISE 10-11 (a) Jan.
1
Cash ($500,000 .96) ........................... Discount on Bonds Payable) ................ Bonds Payable ...............................
(b) Long-term Liabilities Bonds Payable, due 2029 .............................. Less: Discount on Bonds Payable ................
480,000 26,000 500,000 $500,000 12,000 $488,000
(c) The bonds sold for less than their face value because the contract interest rate (7%) was lower than the market interest rate. When the contract rate is lower than the market rate, the bonds will sell at a discount.
.
(For Instructor Use Only)
10-21
EXERCISE 10-12 (a) The General Electric bonds were issued at a premium and the Boeing bonds were issued at a discount. (b) The prices of the two bonds differed because bond price is based on the market rate of interest not the stated rate of interest. Market interest rates must have been different when the two bonds were issued causing the selling prices to differ. (c) Cash (111.12% X $800,000) ................................... Bonds Payable ................................................. Premium on Bonds Payable............................
888,960
Cash (99.08% X $800,000) ..................................... Discount on Bonds Payable .................................. Bonds Payable .................................................
792,640 7,360
800,000 88,960
800,000
EXERCISE 10-13 2014 (a) Jan. 1 (b) Dec. 31
2015 (c) Jan. 1 2034 (d) Jan. 1
10-22
.
Cash....................................................... Bonds Payable ..............................
350,000
Interest Expense ................................... Interest Payable ($350,000 X 8% X 12/12) .............
28,000
Interest Payable .................................... Cash ...............................................
28,000
Bonds Payable ...................................... Cash ...............................................
350,000
(For Instructor Use Only)
350,000
28,000
28,000
350,000
EXERCISE 10-14 (a) April 30
(b) June 30
Bonds Payable ...................................... Loss on Bond Redemption .................. Cash ($140,000 X 101%) ............... Discount on Bonds Payable* ($140,000 – $126,500) ................
140,000 14,900*
Bonds Payable ..................................... Premium on Bonds Payable ............... Cash ($170,000 X 98%) ................ Gain on Bond Redemption ..........
170,000 14,000
141,400 13,500
166,600 17,400**
**$126,500 – (101% X $140,000) **$184,000 – (98% X $170,000) EXERCISE 10-15 (a)
Account Accounts payable Accrued pension liability Unearned rent revenue Bonds payable Current portion of mortgage payable Income taxes payable Mortgage payable Operating leases
Classification
Current liability Due within one year Long-term liability Relates to pensions. Not due within one year Current liability Due within one year Long-term liability Not due within one year Current liability Due within one year Current liability Due within one year Long-term liability Not due within one year N/A Not a balance sheet item—may be disclosed in notes Long-term liability Not due within one year
Notes payable (due in 2017) Salaries and wages payable Current liability Notes payable (due in 2015) Current liability Unused operating line of N/A credit Warranty liability—current
.
(For Instructor Use Only)
Reason
Current liability
Due within one year Due within one year Not a balance sheet item as unused—may be disclosed in notes Can be current and/or long-term depending on the length of the warranty. Given as current
10-23
EXERCISE 10-15 (Continued) (b)
SANTANA INC. Balance Sheet (Partial) January 31, 2014 (in thousands) Current liabilities Notes payable ............................................ Accounts payable ...................................... Current portion of mortgage payable ....... Warranty liability ........................................ Unearned rent revenue .............................. Salaries and wages payable ..................... Income taxes payable ................................ Total current liabilities .......................... Long-term liabilities Mortgage payable ...................................... Bonds payable ........................................... Accrued pension liability .......................... Notes payable ............................................ Total long-term liabilities ..................... Total liabilities ...................................................
$2,563.6 4,263.9 1,992.2 1,417.3 1,058.1 858.1 265.2 $12,418.4 $6,746.7 1,961.2 1,115.2 335.6 10,158.7 $22,577.1
EXERCISE 10-16 (a) 1. 2. 3. 4.
Working capital = $3,416.3 – $2,988.7 = $427.6 Current ratio = $3,416.3 ÷ $2,988.7 = 1.14:1 Debt to assets ratio = $16,191.0 ÷ $30,224.9 = 54% Times interest earned = ($4,551.0 + $1,936.0 + $473.2) ÷ $473.2 = 14.71 times
A current ratio that is less than 1.30 indicates lower liquidity. The debt to assets ratio indicates that $.54 of each dollar of asset have been financed by creditors. The times interest earned of over 14 times indicates that McDonald’s income is large enough to make required interest payments as they come due.
10-24
.
(For Instructor Use Only)
EXERCISE 10-16 (Continued) (b) Debt to assets ratio, adjusted for off-balance-sheet lease obligations. $16,191.0 + $8,800 = 64% $30,224.9 + $8,800 By including these off-balance-sheet obligations the debt to assets ratio increases from 54% to 64%, suggesting that McDonald’s is not as solvent as it first appears. EXERCISE 10-17 (a) Current ratio 2014 2013
$10,795 ÷ $4,897 = 2.20:1 $9,598 ÷ $5,839 = 1.64:1
(b) Current ratio $10,495 ÷ $4,597 = 2.28 It would make its current ratio increase from 2.20 to 2.28. EXERCISE 10-18 (a) Current ratio 2014 2013
$6,244 ÷ $4,503 = 1.39:1 $3,798 ÷ $2,619 = 1.45:1
(b) Current ratio ($6,244 – $1,500) ÷ ($4,503 – $1,500) = 1.58:1 It would make its current ratio increase (from 1.39:1 to 1.58:1). (c) The liquidity ratios would not change but having access to a line of credit means that cash is available on a short-term basis and therefore the assessment of the company’s short-term liquidity would improve.
.
(For Instructor Use Only)
10-25
EXERCISE 10-19 (a)
The company does not have to record these contingent liabilities because they have determined that they are not likely to occur and the impact would be immaterial in any event.
(b) For financial statement users it is important to understand the possible implications that the contingent liabilities could have on the financial results of the company. If the contingent liabilities result in material losses for the company it will negatively impact the company’s financial results and affect the decisions made by the users of the financial statements. *EXERCISE 10-20 2014 (a) Jan. 1
(b) Dec. 31
2015 (c) Jan. 1 2044 (d) Jan. 1
10-26
.
Cash ($500,000 X 103%) ...................... Bonds Payable ............................. Premium on Bonds Payable ........
515,000
Interest Expense .................................. Premium on Bonds Payable ($15,000 X 1/30) ................................. Interest Payable ($500,000 X 6%) .........................
29,500
Interest Payable ................................... Cash ..............................................
30,000
Bonds Payable ..................................... Cash ..............................................
500,000
(For Instructor Use Only)
500,000 15,000
500 30,000
30,000
500,000
*EXERCISE 10-21 2013 (a) Dec. 31
2014 (b) Dec. 31
2028 (c) Dec. 31
Cash ...................................................... Discount on Bonds Payable ................ Bonds Payable ..............................
288,000 12,000
Interest Expense ................................... Cash ($300,000 X 8%) ................... Discount on Bonds Payable ($12,000 X 1/15) ..........................
24,800
Bonds Payable ...................................... Cash ...............................................
300,000
300,000
24,000 800
300,000
*EXERCISE 10-22 2014 (a) Jan. 1
(b) Dec. 31
2015 (c) Jan. 1
Cash ........................................................ Discount on Bonds Payable.................. Bonds Payable ...............................
360,727 39,273
Interest Expense (360,727 X 8%) .......... Interest Payable ($400,000 X 7%) ........................... Discount on Bonds Payable ..........
28,858
Interest Payable ..................................... Cash ................................................
28,000
400,000
28,000 858
28,000
For explanation of calculations, see the following table.
.
(For Instructor Use Only)
10-27
10-28 .
(A)
(For Instructor Use Only)
Interest Periods Issue date 1 2
10-28
(B) Interest Expense to Be Recorded Interest to (8% X Preceding Be Paid Bond Carrying Value) (7% X $400,000) [(E) X .08] 28,000 28,000
28,858 28,927
(C)
(D)
(E)
Discount Amortization (B) – (A)
Unamortized Discount (D) – (C)
Bond Carrying Value [$400,000 – (D)]
858 927
39,273 38,415 37,488
360,727 361,585 362,512
*EXERCISE 10-22 (Continued)
Kimmel, Accounting, 5/e, Solutions Manual
(b), (c)
*EXERCISE 10-23 2014 (a) Jan. 1
(b) Dec. 31
2015 (c) Jan. 1
Cash ....................................................... Bonds Payable ............................... Premium on Bonds Payable ..........
407,968
Interest Expense ($407,968 X 6%) ........ Premium on Bonds Payable ................. Interest Payable ($380,000 X 7%) ...........................
24,478 2,122
Interest Payable ..................................... Cash ................................................
26,600
380,000 27,968
26,600
26,600
For explanation of calculations, see the following table.
.
(For Instructor Use Only)
10-29
10-30 . (For Instructor Use Only)
(A)
Interest Periods Issue date 1 2
(B) Interest Expense to Be Recorded Interest to (6% X Preceding Be Paid Bond Carrying Value) (7% X $380,000) [(E) X .06]
26,600 26,600
24,478 24,351
(C)
(D)
(E)
Premium Amortization (A) – (B)
Unamortized Premium (D) – (C)
Bond Carrying Value [$380,000 + (D)]
2,122 2,249
27,968 25,846 23,597
407,968 405,846 403,597
*EXERCISE 10-23 (Continued)
Kimmel, Accounting ,5/e, Solutions Manual
(b), (c)
*EXERCISE 10-24 2014
2015
Dec. 31
June 30
Dec. 31
Issuance of Note Cash ................................................. Mortgage Payable ....................
280,000
First Installment Payment Interest Expense ($280,000 X 6% X 6/12) ................ Mortgage Payable ........................... Cash..........................................
Mortgage Payable ........................... Cash.......................................... (A)
.
(For Instructor Use Only)
8,400 5,885 14,285
Second Installment Payment Interest Expense [($280,000 – $5,885) X 6% X 6/12] ...
Semiannual Interest Period Issue date 6/30/15 12/31/15
280,000
Cash Payment
(B) Interest Expense (D X 3%)
(C) Reduction of Principal (A) – (B)
$14,285 14,285
$8,400 8,223
$5,885 6,062
8,223 6,062 14,285 (D) Principal Balance (D) – (C) $280,000 274,115 268,053
10-31
*EXERCISE 10-25 (A) Annual Interest Period 1/1/2014 1/1/2015
Cash Payment
(B) Interest Expense (D) X 10%
(C) Reduction of Principal (A) – (B)
$8,137
$5,000
$3,137
(D) Principal Balance (D) – (C) $50,000 46,863
GOINS CORPORATION Balance Sheet (Partial) December 31, 2014 Current liabilities Notes payable .............................................................................. Interest payable ...........................................................................
$3,137 5,000
Long-term liabilities Notes payable ..............................................................................
46,863
10-32
.
(For Instructor Use Only)
SOLUTIONS TO PROBLEMS PROBLEM 10-1A
(a) Jan. 1 5
12 14 20
(b) Jan. 31
31
31
.
Cash ........................................................... Notes Payable....................................
18,000
Cash ........................................................... Sales Revenue ($6,254 ÷ 1.06) .......... Sales Taxes Payable ($6,254 – $5,900) ............................
6,254
Unearned Service Revenue ...................... Service Revenue ...............................
10,000
Sales Taxes Payable ................................. Cash ...................................................
6,600
Accounts Receivable ................................ Sales Revenue ................................... Sales Taxes Payable (500 X $48 X 6%) ............................
25,440
Interest Expense ....................................... Interest Payable ($18,000 X 5% X 1/12) ....................
75
Salaries and Wages Expense................... FICA Taxes Payable .......................... Federal Income Taxes Payable ........ State Income Taxes Payable ............ Salaries and Wages Payable ............
70,000
Payroll Tax Expense ................................. FICA Taxes Payable ..........................
5,355
(For Instructor Use Only)
18,000 5,900 354 10,000 6,600 24,000 1,440
75 5,355 5,000 1,500 58,145 5,355
10-33
PROBLEM 10-1A (Continued) (c) Current liabilities Notes payable ................................................................. Accounts payable........................................................... Salaries and wages payable .......................................... FICA taxes payable ($5,355 X 2) .................................... Unearned service revenue ($19,000 – $10,000) ............ Federal income taxes payable ....................................... Sales taxes payable ....................................................... State income taxes payable........................................... Interest payable .............................................................. Total current liabilities............................................ *($6,600 + $354 – $6,600 + $1,440)
10-34
.
(For Instructor Use Only)
$ 18,000* 42,500* 58,145* 10,710* 9,000* 5,000* 1,794* 1,500* 75 $146,724*
PROBLEM 10-2A
(a) Sept. 1 30
Oct.
1 31
Nov.
1
30
Dec.
1
31
Inventory .................................................... Notes Payable .................................... Interest Expense ($12,000 X .06 X 1/12) ............................ Interest Payable ................................. Equipment.................................................. Notes Payable .................................... Interest Expense [($16,500 X .08 X 1/12) + $60] ................ Interest Payable ................................. Equipment.................................................. Notes Payable .................................... Cash.................................................... Interest Expense [($26,000 X .06 X 1/12) + $110 + $60] .... Interest Payable .................................
12,000 12,000 60 60 16,500 16,500 170 170 34,000 26,000 8,000 300 300
Notes Payable............................................ Interest Payable ......................................... Cash....................................................
12,000 180
Interest Expense ($110 + $130) ................ Interest Payable .................................
240
12,180 240
(b) 12/1
Notes Payable 12,000 9/1 10/1 11/1
12,000 16,500 26,000
12/31 Bal. 42,500
.
(For Instructor Use Only)
12/1
Interest Payable 180 9/30 10/31 11/30 12/31 12/31 Bal.
60 170 300 240 590
10-35
PROBLEM 10-2A (Continued) Interest Expense 9/30 60 10/31 170 11/30 300 12/31 240 12/31 Bal. 770 (c) Current liabilities Notes payable ..................................................................... Interest payable .................................................................. (d) Total interest expense is $770. See (b) above.
10-36
.
(For Instructor Use Only)
42,500 590
PROBLEM 10-3A
(a) Jan. 1 (b) Jan. 1
(c) Dec. 31
.
Interest Payable ................................ Cash ...........................................
40,000
Bonds Payable .................................. Loss on Bond Redemption .............. Cash ($200,000 X 103%) ...........
200,000 6,000
Interest Expense ............................... Interest Payable ($300,000 X 8%) ......................
24,000
(For Instructor Use Only)
40,000**
206,000
24,000
10-37
PROBLEM 10-4A
2013 (a) Oct. 1 (b) Dec. 31
Cash................................................... Bonds Payable ..........................
700,000
Interest Expense ............................... Interest Payable ($700,000 X 5% X 3/12) ...........
8,750
(c) Current Liabilities Interest Payable ............................................ Long-term Liabilities Bonds Payable .............................................. 2014 (d) Oct. 1
Interest Expense ($700,000 X 5% X 9/12)................... Interest Payable ................................ Cash ($700,000 X 5%) ...............
(e) Dec. 31
(f)
10-38
2015 Jan. 1
.
700,000
8,750 8,750 700,000
26,250 8,750 35,000
Interest Expense ............................... Interest Payable.........................
8,750
Interest Payable ................................ Cash ...........................................
8,750
Bonds Payable .................................. Loss on Bond Redemption .............. Cash ($700,000 X 104%)............
700,000 28,000
(For Instructor Use Only)
8,750
8,750
728,000
PROBLEM 10-5A
2014 (a) Jan. 1
Cash ($6,000,000 X 98%) ............... Discount on Bonds Payable ......... Bonds Payable .......................
5,880,000 120,000 6,000,000*
(b) Long-term Liabilities Bonds Payable, due 2029 ....................... Less: Discount on bonds payable ........
$6,000,000 112,000 $5,888,000*
2016 (c) Jan. 1
6,000,000
Bonds Payable ............................... Loss on Bond Redemption ($6,120,000 – $5,896,000) .......... Cash ($6,000,000 X 102%) ..... Discount on Bonds Payable ...............................
224,000 6,120,000* 104,000*
*$6,000,000 – $5,896,000
.
(For Instructor Use Only)
10-39
PROBLEM 10-6A
(a) 1. Current ratio 2. Free cash flow 3. Debt to assets ratio 4. Times interest earned
2014 $2,893 ÷ $2,806 = 1.03:1 ($1,521) – $923 – $13 = ($2,457) $9,355 ÷ $14,308 = 65% $4081 ÷ $130 = 3.14 times
2013 $4,443 ÷ $4,836 = .92:1 $2,845 – $1,331 – $14 = $1,500 $9,831 ÷ $16,772 = 59% $1,1772 ÷ $119 = 9.89 times
1$178 + $100 + $130 = $408 2$645 + $413 + $119 = $1,177
(b) The company’s position as measured through all ratios except the current ratio has deteriorated. Southwest appears to be much less liquid and solvent when comparing 2014 to 2013. (c) Southwest’s use of operating leases (vs. capital leases) would reduce its solvency. If the leases were capital rather than operating, the balance sheet would include higher total assets and higher liabilities. Using the $1,600 as an estimate of the increase in liabilities and assets that would result if the operating leases were capital leases, the revised debt to assets ratio would be [($9,355 + $1,600) ÷ ($14,308 + $1,600)] = 69%.
10-40
.
(For Instructor Use Only)
*PROBLEM 10-7A
2014 (a) Jan. 1
(b) Dec. 31
Interest Payable ................................ Cash ...........................................
96,000
Interest Expense ............................... Interest Payable ($2,400,000 X 4%) .................. Discount on Bonds Payable ($24,000 ÷ 10).........................
98,400
Bonds Payable .................................. Loss on Bond Redemption .............. Cash ($400,000 X 102%) ........... Discount on Bonds Payable .....
400,000 11,600
96,000
96,000 2,400
2015 (c) Jan. 1
408,000** 3,600**
*($24,000 – $2,400) X $400,000/ * $2,400,000 = $3,600 (d) Dec. 31
Interest Expense ............................... Interest Payable ........................ Discount on Bonds Payable .....
82,000 80,000** 2,000**
**$24,000 – $2,400 – $3,600 = $18,000; **$18,000 ÷ 9 = $2,000 or **$2,400 X $2,000,000/$2,400,000 = $2,000 **($2,400,000 – $400,000 = $2,000,000; **($2,000,000 X 4% = $80,000)
.
(For Instructor Use Only)
10-41
*PROBLEM 10-8A
(a) Jan. 1
Dec. 31
(b) Jan. 1
Dec. 31
Cash ($2,000,000 X 102%) .............. Bonds Payable ........................ Premium on Bonds Payable ...
2,040,000
Interest Expense ............................. Premium on Bonds Payable ($40,000 ÷ 5) ............................... Interest Payable ($2,000,000 X 7%) ................
132,000
Cash ($2,000,000 X 97%) ................ Discount on Bonds Payable .......... Bonds Payable ........................
1,940,000 60,000
Interest Expense ............................. Interest Payable....................... Discount on Bonds Payable ($60,000 ÷ 5) ..........
152,000
2,000,000 40,000
8,000 140,000
2,000,000 140,000 12,000
(c) Premium Current Liabilities Interest payable ........................................ Long-term Liabilities Bonds payable, due 2019......................... Add: Premium on bonds payable ...........
$ 140,000 $2,000,000 32,000
2,032,000
Discount Current Liabilities Interest payable ........................................ Long-term Liabilities Bonds payable, due 2019......................... Less: Discount on bonds payable .........
10-42
.
(For Instructor Use Only)
$ 140,000 $2,000,000 48,000
1,952,000
*PROBLEM 10-9A
(a) 1.
2.
1/1/14
1/1/14
Cash ($3,000,000 X 103%) ....... Bonds Payable ................. Premium on Bonds Payable .........................
3,090,000
Cash ($3,000,000 X 98%) ......... Discount on Bonds Payable................................. Bonds Payable .................
2,940,000
3,000,000 90,000
60,000 3,000,000
(b) See amortization tables on following page. (c) 1.
2.
(d) 1.
2.
.
12/31/14
12/31/14
Interest Expense ...................... Premium on Bonds Payable................................. Interest Payable ...............
231,000
Interest Expense ...................... Interest Payable ............... Discount on Bonds Payable .........................
246,000
Long-term Liabilities: Bonds Payable .................................... Plus: Unamortized Bond Premium ................................... Long-term Liabilities: Bonds Payable .................................... Less: Unamortized Bond Discount ..................................
(For Instructor Use Only)
9,000 240,000 240,000 6,000 $3,000,000 81,000 $3,081,000 $3,000,000 54,000 $2,946,000
10-43
10-44 .
Annual Interest Periods
(For Instructor Use Only)
Issue date 1 2 3
(A) Interest to Be Paid (8% X $3,000,000)
(B) Interest Expense to Be Recorded (A) – (C)
(C) Premium Amortization ($90,000 ÷ 10)
$240,000 240,000 240,000
$231,000 231,000 231,000
$9,000 9,000 9,000
(A) Interest to Be Paid (8% X $3,000,000)
(B) Interest Expense to Be Recorded (A) + (C)
(C) Discount Amortization ($60,000 ÷ 10)
(D) (E) Unamortized Bond Premium Carrying Value (D) – (C) [$3,000,000 + (D)] $90,000 81,000 72,000 63,000
$3,090,000 3,081,000 3,072,000 3,063,000
(2) Annual Interest Periods Issue date 1 2 3
10-44
.
$240,000 240,000 240,000
(For Instructor Use Only)
$246,000 246,000 246,000
$6,000 6,000 6,000
(D) (E) Unamortized Bond Discount Carrying Value (D) – (C) [$3,000,000 – (D)] $60,000 54,000 48,000 42,000
$2,940,000 2,946,000 2,952,000 2,958,000
*PROBLEM 10-9A (Continued)
Kimmel, Accounting, 5 /e, Solutions Manual
(b), (1)
*PROBLEM 10-10A
2014 (a) Jan. 1
(b)
Cash ................................................. Discount on Bonds Payable ........... Bonds Payable .........................
1,667,518 132,482 1,800,000
LOCK CORP. Bond Discount Amortization Effective-Interest Method—Annual Interest Payments 5% Bonds Issued at 6% (A)
(B) (C) (D) (E) Interest Discount UnamorBond Interest Expense Amortized Carrying to Be to Be tization Discount Value Paid Recorded (B) – (A) (D) – (C) ($1,800,000 – D)
Annual Interest Periods
Issue date 1 $90,000 2 90,000 3 90,000 (c) Dec. 31
2015 (d) Jan. 1
(e) Dec. 31
.
$100,051 100,654 101,293
$10,051 10,654 11,293
$132,482 122,431 111,777 100,484
Interest Expense ($1,667,518 X 6%) .................................. Interest Payable ($1,800,000 X 5%) .......................... Discount on Bonds Payable ............. Interest Payable ........................................ Cash ................................................... Interest Expense [($1,667,518 + $10,051) X 6%] .............. Interest Payable ................................ Discount on Bonds Payable .............
(For Instructor Use Only)
$1,667,518 1,677,569 1,688,223 1,699,516
100,051 90,000 10,051 90,000 90,000
100,654 90,000 10,654
10-45
*PROBLEM 10-11A
(a) 1.
2.
3. 4.
Jan. 1
Dec. 31
Jan. 1 Dec. 31
2014 Cash ............................................ 2,147,202 Bonds Payable ................... Premium on Bonds Payable............................ Interest Expense ($2,147,202 X 6%) ................... Premium on Bonds Payable ................................... Interest Payable ($2,000,000 X 7%) ........... 2015 Interest Payable ......................... Cash .................................... Interest Expense ........................ [($2,147,202 – $11,168) X 6%] Premium on Bonds Payable ................................... Interest Payable ..................
2,000,000 147,202
128,832 11,168 140,000 140,000 140,000 128,162 11,838
(b) Bonds payable .................................................... 2,000,000 Add: Premium on bonds payable ..................... 124,196*
140,000
2,124,196
*($147,202 – $11,168 – $11,838) (c) 1. 2.
10-46
Total bond interest expense—2015, $128,162. The effective-interest method will result in more interest expense reported than the straight-line method in 2015 when the bonds are sold at a premium. Straight-line interest expense for 2015 is $125,280 [$140,000 – ($147,202 ÷ 10)].
.
(For Instructor Use Only)
*PROBLEM 10-12A
(a)
(A) Quarterly Interest Period Issue Date 1 2 3 4 5
(b) Dec. 31
Cash Payment $30,259 30,259 30,259 30,259 30,259
(B) Interest Expense (D) X 2% $6,400 5,923 5,436 4,940 4,433
(C) Reduction of Principal (A) – (B)
(D) Principal Balance (D) – (C)
$23,859 24,336 24,823 25,319 25,826
$320,000 296,141 271,805 246,982 221,663 195,837
Mortgage Payable ................................. Interest Expense ................................... Cash ...............................................
23,859 6,400 30,259
(c) Current liabilities Mortgage payable............................................
$100,304*
Long-term liabilities Mortgage payable............................................ Total liabilities ..................................
195,837** $296,141*
**($24,336 + $24,823 + $25,319 + $25,826) **($296,141 – $100,304)
.
(For Instructor Use Only)
10-47
*PROBLEM 10-13A
(a) Cash Payment (A)
Period July 1, 2013 June 30, 2014 June 30, 2015 June 30, 2016 June 30, 2017 June 30, 2018 Total
$ 36,584 36,584 36,584 36,584 36,584 $182,920
Interest Principal Expense Reduction Balance (B) = (D) X 7% (C) = (A) – (B) (D) = (D) – (C) $150,000 $10,500 $ 26,084 123,916 8,674 27,910 96,006 6,720 29,864 66,142 4,630 31,954 34,188 2,396* 34,188 0 $32,920 $150,000
*Rounded to make principal element equal to balance. (b) July
1/13 Cash .................................................. Notes Payable .............................
150,000
June 30/14 Notes Payable .................................. Interest Expense .............................. Cash .............................................
26,084 10,500
June 30/15 Notes Payable .................................. Interest Expense .............................. Cash .............................................
27,910 8,674
(c) 2015 Current liabilities Notes payable .................................................... Long-term liabilities Note payable ($96,006 – $29,864) ......................
10-48
.
(For Instructor Use Only)
150,000
36,584
36,584
$29,864 $66,142
PROBLEM 10-1B
(a) Jan. 1 5
12 14 20
(b) Jan. 31
31
31
Cash ........................................................... Notes Payable....................................
18,000
Cash ........................................................... Sales Revenue ($18,480 ÷ 106.25%) ....................... Sales Taxes Payable ($18,480 – $17,393) ........................
18,480
Unearned Service Revenue ...................... Service Revenue ...............................
8,000
Sales Taxes Payable ................................. Cash ...................................................
8,200
Accounts Receivable ................................ Sales Revenue ................................... Sales Taxes Payable (500 X $50 X 6.25%) .......................
26,563
Interest Expense ....................................... Interest Payable ($18,000 X 8% X 1/12 = $120) ........
120
Salaries and Wages Expense................... FICA Taxes Payable .......................... Federal Income Taxes Payable ........ State Income Taxes Payable ............ Salaries and Wages Payable ............
54,000
Payroll Tax Expense ................................. FICA Taxes Payable ..........................
4,131
18,000
17,393* 1,087 8,000 8,200 25,000 1,563*
120 4,131 3,900 1,200 44,769 4,131
*Rounded to nearest dollar
.
(For Instructor Use Only)
10-49
PROBLEM 10-1B (Continued) (c) Current liabilities Notes payable ................................................................. Accounts payable........................................................... Salaries and wages payable .......................................... FICA taxes payable ($4,131 X 2) .................................... Federal income taxes payable ....................................... Unearned service revenue ($11,000 – $8,000) .............. Sales taxes payable ....................................................... State income taxes payable........................................... Interest payable .............................................................. Total current liabilities *$8,200 + $1,087 – $8,200 + $1,563
10-50
.
(For Instructor Use Only)
$ 18,000 52,000 44,769 8,262 3,900 3,000 2,650* 1,200 120 $133,901
PROBLEM 10-2B
(a) Aug.
1 31
Sept. 1 30
Oct.
1
31
Nov.
1
30 Dec. 31
.
Inventory or Purchases .......................... Notes Payable .................................. Interest Expense ($6,000 X .09 X 1/12) ............................ Interest Payable ............................... Equipment................................................ Notes Payable .................................. Interest Expense [($15,000 X .08 X 1/12) + $45] .............. Interest Payable ............................... Buildings .................................................. Notes Payable .................................. Cash.................................................. Interest Expense [($40,000 X .08 X 1/12) + $100 + $45]... Interest Payable ...............................
6,000 6,000 45 45 15,000 15,000 145 145 50,000 40,000 10,000 412 412
Notes Payable.......................................... Interest Payable ....................................... Cash..................................................
6,000 135
Interest Expense ($100 + $267) .............. Interest Payable ...............................
367
Interest Expense ($100 + $267) .............. Interest Payable ...............................
367
(For Instructor Use Only)
6,135 367 367
10-51
PROBLEM 10-2B (Continued) (b) 11/1
Notes Payable 6,000 8/1 9/1 10/1 12/31 Bal.
6,000 15,000 40,000 55,000
11/1
Interest Payable 135 8/31 9/30 10/31 11/30 12/31 12/31 Bal.
45 145 412 367 367 1,201
Interest Expense 8/31 45 9/30 145 10/31 412 11/30 367 12/31 367 12/31 Bal. 1,336 (c)
Current liabilities Notes payable ................................................................ Interest payable .............................................................
(d) Total interest expense is $1,336. See (b) above.
10-52
.
(For Instructor Use Only)
55,000 1,201
PROBLEM 10-3B
(a) Jan. (b) Jan.
1 1
(c) Dec. 31
.
Interest Payable ....................................... Cash..................................................
96,000
Bonds Payable ........................................ Loss on Bond Redemption ..................... Cash ($300,000 X 108%) ..................
300,000 24,000
Interest Expense ..................................... Interest Payable ($900,000 X 8%) .............................
72,000
(For Instructor Use Only)
96,000
324,000
72,000
10-53
PROBLEM 10-4B
(a) 2013 April 1
Cash ........................................................ Bonds Payable ................................
600,000
(b) Dec. 31
Interest Expense ..................................... Interest Payable ($600,000 X 5% X 9/12) .................
22,500
(c) Current Liabilities Interest Payable ................................................... Long-term Liabilities Bonds Payable...................................................... (d) 2014 April 1
(e) Dec. 31 (f)
10-54
2015 Jan. 1
.
600,000
22,500 22,500 600,000
Interest Payable ...................................... Interest Expense ($600,000 X 5% X 3/12) ........................ Cash ($600,000 X 5%) .....................
22,500
Interest Expense ..................................... Interest Payable ..............................
22,500
Interest Payable ...................................... Cash .................................................
22,500
Bonds Payable ........................................ Loss on Bond Redemption .................... Cash ($600,000 X 102.5%) ..............
600,000 15,000
(For Instructor Use Only)
7,500 30,000 22,500 22,500
615,000
PROBLEM 10-5B
(a) Jan. 1
2014 Cash ($5,000,000 X 103%) ................ Bonds Payable .......................... Premium on Bonds Payable ..................................
(b) Long-term Liabilities Bonds payable, due 2024 ......................... Add: Premium on bonds payable .......... (c) Jan. 1
2015 Bonds Payable .................................. Premium on Bonds Payable ............ Loss on Bond Redemption ($5,120,000 – $5,200,000) ............. Cash ($5,000,000 X 104%) ........
5,150,000 5,000,000 150,000
$5,000,000 135,000 $5,135,000
5,000,000 120,000* 80,000 5,200,000
*$5,120,000 – $5,000,000
.
(For Instructor Use Only)
10-55
PROBLEM 10-6B
(a)
1. Current ratio 2. Free cash flow 3. Debt to assets ratio 4. Times interest earned 1 2
2014 $2,717 ÷ $4,044 = .67:1 $1,503 – $472 – $475 = $556 $8,871 ÷ $11,397 = 78% $1,8661 ÷ $319 = 5.85 times
2013 $2,427 ÷ $4,020 = .60:1 $1,410 – $453 – $450 = $507 $8,645 ÷ $10,714 = 81% $1,7782 ÷ $307 = 5.79 times
$1,103 + $444 + $319 = $1,866 $1,004 + $467 + $307 = $1,778
(b) The company’s liquidity position as measured through the current ratio and free cash flow has improved. The debt to assets ratio decreased, and the times interest earned increased in 2014. Kellogg appears to be more liquid and solvent when comparing 2014 to 2013. (c) Kellogg’s use of operating leases (vs. capital leases) would reduce its solvency. If the leases were capital rather than operating, the balance sheet would include higher total assets and higher liabilities. Using the $584 as an estimate of the increase in liabilities and assets that would result if the operating leases were capital leases, the revised debt to assets ratio would be [($8,871 + $584) ÷ ($11,397 + $584)] = 79%.
10-56
.
(For Instructor Use Only)
*PROBLEM 10-7B
(a) Jan. 1
(b) Dec. 31
2014 Interest Payable ............................. Cash ........................................ Interest Expense ............................ Premium on Bonds Payable ($280,000 ÷ 10) ........................... Interest Payable .....................
144,000 144,000 116,000 28,000 144,000
2015 (c) Jan. 1
Bonds Payable ............................... Premium on Bonds Payable ......... Cash ($1,800,000 X 102%) ..... Gain on Bond Redemption ($1,926,000 – $1,836,000) ...
1,800,000 126,000* 1,836,000 90,000
*($280,000 – $28,000) X 1/2 = $126,000
(d) Dec. 31
Interest Expense ............................ Premium on Bonds Payable ......... Interest Payable ($1,800,000 X 4%) ...............
**$280,000 – $28,000 – $126,000 = $126,000;
.
(For Instructor Use Only)
58,000 14,000** 72,000
$126,000 = $14,000 or $28,000 X 1/2. 9
10-57
*PROBLEM 10-8B
(a) Jan. 1
Dec. 31
(b) Jan. 1
Dec. 31
Cash ($2,200,000 X 102%) .............. Premium on Bonds Payable ... Bonds Payable ........................
2,244,000
Interest Expense ............................. Premium on Bonds Payable ($44,000 ÷ 5) ............................. Interest Payable ($2,200,000 X 8%) ................
167,200
Cash ($2,200,000 X 98%) ................ Discount on Bonds Payable .......... Bonds Payable ........................
2,156,000 44,000
Interest Expense ............................. Discount on Bonds Payable ($44,000 ÷ 5) .......... Interest Payable.......................
184,800
44,000 2,200,000
8,800 176,000
2,200,000
8,800 176,000
(c) Premium Current Liabilities Interest payable Long-term Liabilities Bonds payable, due 2019 Add: Premium on bonds payable
$ 176,000 $2,200,000 35,200
2,235,200
Discount Current Liabilities Interest payable Long-term Liabilities Bonds payable, due 2019 Less: Discount on bonds payable
10-58
.
(For Instructor Use Only)
$ 176,000 $2,200,000 35,200
2,164,800
*PROBLEM 10-9B
(a) (1)
(2)
1/1/14
1/1/14
Cash ($3,000,000 X 103%) ...... Bonds Payable ................ Premium on Bonds Payable ........................
3,090,000
Cash ($3,000,000 X 99%) ........ Discount on Bonds Payable................................ Bonds Payable ................
2,970,000
3,000,000 90,000
30,000 3,000,000
(b) See amortization tables on following page. (c) (1) 12/31/14
(2) 12/31/14
Interest Expense ..................... Premium on Bonds Payable................................ Interest Payable ..............
198,750
Interest Expense ..................... Discount on Bonds Payable ........................ Interest Payable ..............
213,750
11,250 210,000
3,750 210,000
(d) (1) Long-term Liabilities: Bonds Payable Plus: Bond Premium
$3,000,000 78,750
$3,078,750
(2) Long-term Liabilities: Bonds Payable Less: Bond Discount
$3,000,000 26,250
$2,973,750
.
(For Instructor Use Only)
10-59
10-60 Kimmel, Accounting, 5/e, Solutions Manual
Annual Interest Periods
(For Instructor Use Only)
Issue date 1 2 3
(A) Interest to Be Paid (7% X $3,000,000)
(B) Interest Expense to Be Recorded (A) – (C)
(C) Premium Amortization ($90,000 ÷ 8)
$210,000 210,000 210,000
$198,750 198,750 198,750
$11,250 11,250 11,250
(A) Interest to Be Paid (7% X $3,000,000)
(B) Interest Expense to Be Recorded (A) + (C)
(C) Discount Amortization ($60,000 ÷ 8)
(D) (E) Unamortized Bond Premium Carrying Value (D) – (C) [$3,000,000 + (D)] $90,000 78,750 67,500 56,250
$3,090,000 3,078,750 3,067,500 3,056,250
(2) Annual Interest Periods Issue date 1 2 3
10-60
.
$210,000 210,000 210,000
(For Instructor Use Only)
$213,750 213,750 213,750
$3,750 3,750 3,750
(D) (E) Unamortized Bond Discount Carrying Value (D) – (C) [$3,000,000 – (D)] $30,000 26,250 22,500 18,750
$2,970,000 2,973,750 2,977,500 2,981,250
*PROBLEM 10-9B (Continued)
.
(b), (1)
*PROBLEM 10-10B 2014 Cash ................................................. Bonds Payable ......................... Premium on Bonds Payable ....
(a) Jan. 1
(b)
2,000,000 154,434
IMELDA CORPORATION Bond Premium Amortization Effective-Interest Method—Annual Interest Payments 6% Bonds Issued at 5%
Annual Interest Periods
(A)
(B)
Interest to Be Paid
Interest Expense
Issue date 1 $120,000 $107,722 2 120,000 $107,108 3 120,000 $106,463 (c) Dec. 31
(d) Jan. 1
(e) Dec. 31
.
2,154,434
(C) (D) (E) Premium UnamorBond Amortized Carrying tization Premium Value (A) – (B) (D) – (C) ($2,000,000 + D) $12,278 $12,892 $13,537
$154,434 $142,156 $129,264 $115,727
Interest Expense ($2,154,434 X 5%) .................................. Premium on Bonds Payable .................... Interest Payable ($2,000,000 X 6%) ..........................
$2,154,434 $2,142,156 $2,129,264 $2,115,727
107,722 12,278 120,000
2015 Interest Payable ........................................ Cash ...................................................
120,000
Interest Expense [($2,154,434 – $12,278) X 5%]............... Premium on Bonds Payable .................... Interest Payable ................................
107,108 12,892
(For Instructor Use Only)
120,000
120,000
10-61
*PROBLEM 10-11B
(a) (1) Jan. 1
(2) Dec. 31
(3) Jan. 1 (4) Dec. 31
2014 Cash ......................................... Bonds Payable ................ Premium on Bonds Payable.........................
1,717,761 1,600,000 117,761
Interest Expense ($1,717,761 X 6%) ................ Premium on Bonds Payable ................................ Interest Payable ($1,600,000 X 7%) ........
103,066 8,934 112,000
2015 Interest Payable ...................... Cash .................................
112,000 112,000
Interest Expense ..................... [($1,717,761 – $8,934) X 6%] Premium on Bonds Payable ................................ Interest Payable ...............
102,530
(b) Bonds payable ................................................. Add: Premium on bonds payable ..................
1,600,000 99,357*
9,470 112,000
1,699,357
*($117,761 – $8,934 – $9,470) (c) (1) Total bond interest expense—2015, $102,530. (2) The effective-interest method will result in more interest expense reported than the straight-line method in 2015 when the bonds are sold at a premium. Straight-line interest expense for 2015 is $100,224 [$112,000 – ($117,761 ÷ 10)].
10-62
.
(For Instructor Use Only)
*PROBLEM 10-12B
(a)
(A) Quarterly Interest Period Issue Date 1 2 3 4 5
(b) Dec. 31
Cash Payment $20,792 20,792 20,792 20,792 20,792
(B) Interest Expense (D) X 2% $6,800 6,520 6,235 5,944 5,647
(C) Reduction of Principal (A) – (B)
(D) Principal Balance (D) – (C)
$13,992 14,272 14,557 14,848 15,145
$340,000 326,008 311,736 297,179 282,331 267,186
Interest Expense ................................... Mortgage Payable ................................. Cash ...............................................
6,800 13,992 20,792
(c) Current liabilities Mortgage payable ...................................................
$ 58,822*
Long-term liabilities Mortgage payable .................................................. Total liabilities.........................................
267,186** $326,008
**($14,272 + $14,557 + $14,848 + $15,145) **($326,008 – $58,822)
.
(For Instructor Use Only)
10-63
*PROBLEM 10-13B
(a) Cash Payment (A)
Period July 1, 2013 June 30, 2014 June 30, 2015 June 30, 2016 June 30, 2017 June 30, 2018 Total
$35,064 35,064 35,064 35,064 35,064 175,320
Interest Principal Balance Expense Reduction (D) = (D) – (C) (B) = (D) X 8% (C) = (A) – (B) $140,000 $11,200 $ 23,864 116,136 9,291 25,773 90,363 7,229 27,835 62,528 5,002 30,062 32,466 2,598* 32,466 0 35,320 140,000
*Rounded to make principal element equal to balance. (b) July
1/13 Cash .................................................. Notes Payable .............................
140,000
June 30/14 Notes Payable .................................. Interest Expense .............................. Cash .............................................
23,864 11,200
June 30/15 Notes Payable .................................. Interest Expense .............................. Cash .............................................
25,773 9,291
(c) 2015 Current liabilities Notes payable .................................................... Long-term liabilities Notes payable ($90,363 – $27,835) ....................
10-64
.
(For Instructor Use Only)
140,000
35,064
35,064
$27,835 $62,528
COMPREHENSIVE PROBLEM SOLUTION
(a)
.
1. Interest Payable .............................................. Cash .........................................................
2,500
2. Inventory ......................................................... Accounts Payable ...................................
241,100
3. Cash................................................................. Sales Revenue......................................... Sales Taxes Payable ...............................
508,800
Cost of Goods Sold ........................................ Inventory ..................................................
265,000
4. Account Payable ............................................. Cash .........................................................
230,000
5. Interest Expense ............................................. Cash .........................................................
2,500
6. Insurance Expense ......................................... Prepaid Insurance ...................................
5,600
7. Prepaid Insurance .......................................... Cash .........................................................
10,200
8. Sales Taxes Payable....................................... Cash .........................................................
17,000
9. Other Operating Expenses............................. Cash .........................................................
91,000
10. Interest Expense ............................................. Cash .........................................................
2,500
Bonds Payable ................................................ Cash ......................................................... Gain on Bond Redemption .....................
50,000
(For Instructor Use Only)
2,500 241,100 480,000 28,800 265,000 230,000 2,500 5,600 10,200 17,000 91,000 2,500 48,000 2,000
10-65
COMPREHENSIVE PROBLEM SOLUTION (Continued) 11. Cash (90,000 X 103%) ..................................... Bonds Payable ........................................ Premium on Bonds Payable ...................
92,700 90,000 2,700
Adjusting Entries 12. Insurance Expense ($10,200 X 5/12) .............. Prepaid Insurance ...................................
4,250
13. Depreciation Expense ($38,000 – $3,000) ÷ 5 .... Accumulated Depreciation— Equipment.............................................
7,000
14. Income Tax Expense ...................................... Income Taxes Payable ............................
31,245
(b)
7,000 31,245
TREVOR CORPORATION Trial Balance 12/31/2014 Account Cash ............................................................ Inventory ..................................................... Prepaid Insurance ...................................... Equipment .................................................. Accumulated Depreciation—Equipment .. Accounts Payable ...................................... Sales Taxes Payable .................................. Income Taxes Payable ............................... Bonds Payable ........................................... Premium on Bonds Payable ...................... Common Stock ........................................... Retained Earnings...................................... Sales Revenue............................................ Cost of Goods Sold.................................... Depreciation Expense ................................ Insurance Expense .................................... Other Operating Expenses ........................ Interest Expense ........................................ Gain on Bond Redemption ........................ Income Tax Expense..................................
10-66
4,250
.
(For Instructor Use Only)
Debit $227,800 6,850 5,950 38,000
Credit
$
7,000 24,850 11,800 31,245 90,000 2,700 25,000 13,100 480,000
265,000 7,000 9,850 91,000 5,000 2,000 31,245 $687,695
$687,695
COMPREHENSIVE PROBLEM SOLUTION (Continued) (a) and (b) Optional T accounts
Bal.
Bal.
Bal. Bal.
Cash 30,000 508,800 92,700
2,500 230,000 2,500 10,200 17,000 91,000 2,500 48,000
227,800 Inventory 30,750 241,100 6,850
265,000
Interest Payable 2,500 Bal. Bal.
Sales Taxes Payable 17,000 28,800 Bal. 11,800 Income Taxes Payable 31,245
Bonds Payable 50,000 Bal. Bal.
Bal.
Prepaid Insurance 5,600 10,200 5,950
Bal.
Equipment 38,000
Bal.
5,600 4,250
Accumulated Depreciation—Equipment 7,000
Accounts Payable 230,000 Bal. 13,750 241,100 Bal. 24,850 .
(For Instructor Use Only)
2,500 0
50,000 90,000 90,000
Premium on Bonds Payable 2,700
Common Stock Bal.
25,000
Retained Earnings Bal. 13,100
Sales Revenue 480,000
10-67
COMPREHENSIVE PROBLEM SOLUTION (Continued) (a) and (b) (Continued) Cost of Goods Sold 265,000 Bal. Depreciation Expense 7,000
Bal.
Insurance Expense 5,600 4,250 9,850
Interest Expense 2,500 2,500 5,000 Income Tax Expense 31,245
Gain on Bond Redemption 2,000
Other Operating Expenses 91,000
(c)
TREVOR CORPORATION Income Statement For the Year Ending 12/31/14 Sales revenue ............................................. Cost of goods sold..................................... Gross profit ................................................ Operating expenses Insurance expense ............................. Depreciation expense ........................ Other operating expenses ................. Total operating expenses .......................... Income from operations ............................ Other revenues and expenses Gain on bond redemption .................. Interest expense ................................. Income before taxes .................................. Income tax expense ........................... Net income..................................................
10-68
.
(For Instructor Use Only)
$480,000 265,000 215,000 $9,850 7,000 91,000 107,850 107,150 2,000 5,000 104,150 31,245 $ 72,905
COMPREHENSIVE PROBLEM SOLUTION (Continued) TREVOR CORPORATION Retained Earnings Statement For the Year Ending 12/31/14 Retained earnings, 1/1/14 ............................................................ $13,100 Add: Net income .......................................................................... 72,905 Retained earnings, 12/31/14 ........................................................ $86,005 TREVOR CORPORATION Balance Sheet 12/31/2014 Current Assets Cash .................................................... Inventory ............................................. Prepaid insurance .............................. Total current assets ...................... Property, Plant, and Equipment Equipment ........................................... Accumulated depreciation— equipment ........................................ Total plant assets ......................... Total assets
$240,600 38,000 7,000 31,000 $271,600
Current Liabilities Accounts payable ............................... Income taxes payable ........................ Sales taxes payable............................ Total current liabilities ..................
$24,850 31,245 11,800
Long-term liabilities Bonds payable .................................... Premium on bonds payable ............... Total long-term liabilities ............. Total liabilities ...............................
90,000 2,700
Stockholders’ Equity Common stock ................................... Retained earnings .............................. Total stockholders’ equity............ Total liabilities and stockholders’ equity .......................................................
.
$227,800 6,850 5,950
(For Instructor Use Only)
$ 67,895
92,700 160,595 25,000 86,005 111,005 $271,600
10-69
BYP 10-1
FINANCIAL REPORTING PROBLEM
(a) Total current liabilities at December 31, 2011, $58,355,000. Tootsie Roll’s total current liabilities decreased by $150,000 ($58,505,000 – $58,355,000) relative to the prior year. (b) Tootsie Roll’s accounts payable at December 31, 2011, $10,683,000. (c) The other components of current liabilities are: Dividends payable .............................................................. $ 4,603,000 Accrued liabilities ............................................................... 43,069,000
10-70
.
(For Instructor Use Only)
BYP 10-2
COMPARATIVE ANALYSIS PROBLEM
(a) (1) Current ratio
Hershey
Tootsie Roll
$2,046,558 = 1.74:1 $1,173,775
$212,201 = 3.64:1 $58,355
Based on the current ratio, Tootsie Roll is more liquid than Hershey. Tootsie Roll’s current ratio is 209% larger than Hershey’s. Tootsie Roll appears much more able to meet its current obligations. (b)
Hershey (1) Debt to assets
$3,539,551 $4,412,199
(2) Times interest earned
**$58,355 + $133,566
= 80.2%
Tootsie Roll $191,921 ** $857,856
= 22.4%
$628,962 + $333,883 + $94,780
$43,938 + $16,974 + $121 ***
$94,780 = 11.2 times
$121 = 504.4 times
***See note 6
The higher the percentage of debt to assets, the greater the risk that a company may be unable to meet its maturing obligations. Tootsie Roll’s 2011 debt to assets ratio was considerably less than Hershey’s; thus, Tootsie Roll would be considered significantly better able to meet its obligations. The times interest earned provides an indication of a company’s ability to meet interest payments. Since Tootsie Roll’s times interest earned is approximately 44 times as large as Hershey’s, Tootsie Roll had a much greater ability to meet its interest payments in 2011 than Hershey. Tootsie Roll appears to be significantly more solvent.
.
(For Instructor Use Only)
10-71
BYP 10-3
RESEARCH CASE
(a) If a company can determine a reasonable estimate of the expected loss and if it is probable it will lose the suit, then the company should accrue for the loss. It should debit a loss account and credit a liability account. If it cannot arrive at a reasonable estimate, or if the loss is only possible (not probable) then it should disclose the item in the notes to the financial statements. (b) The article suggests that many of these companies are paying out amounts each year, but that their liability account remains roughly the same. This would suggest that rather than accruing for the full amount of their expected costs in the year that these costs become evident, they are simply expensing costs as they pay for them. This is not consistent with the approach described in part (a) because they are not accruing for the estimated costs up front. (c) The articles suggests that if a company cannot come up with a reasonable estimate of costs, but instead can only estimate a range of possible costs, then financial reporting rules say that they should accrue for the low end of the range. For example, if you thought you would lose between $1,000 and $10,000, you would accrue for $1,000. However, for insurance purposes they often report the higher number. The problem for the perspective of investors is that if they rely on the numbers reported in the financial statements they may not be well informed about the potential loss that the company may well incur. (d) International accounting rules differ from U.S. rules with regard to dealing with estimated ranges. They require in a situation where a company estimates a range of possible losses, the company should accrue for the midpoint.
10-72
.
(For Instructor Use Only)
BYP 10-4
(a)
INTERPRETING FINANCIAL STATEMENTS
Hechinger
Home Depot
Working capital
$1,153 – $938 = $215
$4,933 – $2,857 = $2,076
Current ratio
$1,153 ÷ $938 = 1.23:1
$4,933 ÷ $2,857 = 1.73:1
On both dimensions Hechinger’s liquidity is low and Home Depot’s is strong. (b) Debt to assets ratio Times interest earned
$1, 339 $1, 577 –$93 + $67 + $3 $67
$4, 716
= 85%
$13, 465
= –.34 times
= 35%
$1,614 + $37 + $1,040 $37
= 72.7 times
Hechinger relied heavily on debt financing—85% of every dollar of assets was financed with debt versus only 35% by Home Depot. Hechinger’s times interest earned ratio was negative, suggesting it did not have the ability to service its debt. In contrast, Home Depot’s times interest earned ratio is exceptionally high, suggesting it could handle even more debt. (c) Return on
–$93
assets
($1, 577 + $1, 668) 2
Profit margin
–$93 $3, 444
= –5.7%
= –2.7%
$1, 614 ($13, 465 + $11, 229) 2
$1, 614 $30, 219
= 13.1%
= 5.3%
Hechinger reported negative profitability ratios because it reported a loss for the year. If you combine its low liquidity and low solvency with its inability to generate a profit, it was clearly headed for trouble.
.
(For Instructor Use Only)
10-73
BYP 10-4 (Continued) (d) Debt to assets
Original
Restated
$4,716 = 35% $13,465
$4,716 + $2,347 = 45% $13,465 + $2,347
After treating Home Depot’s operating leases as purchases, its debt to assets ratio increases from 35% to 45%. While this suggests that its reliance on debt is actually higher than the balance sheet indicates, its reliance on debt is still quite reasonable and not cause for concern.
10-74
.
(For Instructor Use Only)
BYP 10-5
INTERPRETING FINANCIAL STATEMENTS
Borders
Barnes and Noble
(a)
Current ratio
$978.7 ÷ $918.1 = 1.07 : 1
$1, 719.5 ÷ $1, 724.4 = 1.00 : 1
(b)
Debt to assets ratio
$1,257.3 ÷ $1,415.6 = 89%
$2802.3 ÷ $3,705.7 = 76%
Times interest earned
$(109.4) + $24.1 + $(31.3) $24.1
= (4.84) times
$36.7 + $28.2 + $8.4 $28.2
= 2.60times
(c) Neither Borders nor Barnes and Noble were very liquid since their respective current ratio were only 1.07:1 and 1.0:1. Both companies had very high debt to assets ratios and their times interest earned were negative or relatively low. The bankruptcy of Borders did seem likely considering they had a very high debt to assets ratio and a negative times interest earned. In addition, its current ratio was fairly low.
.
(For Instructor Use Only)
10-75
BYP 10-6
REAL-WORLD FOCUS
(a) An ‘A’ rating means that the company has a strong capacity to meet financial commitments, but is somewhat susceptible to adverse economic conditions and changes in circumstances. A ‘C’ rating means that a company is currently highly vulnerable due to obligations and other defined circumstances. (b) Some factors that can change a company’s credit rating are new competition, changes in technology, increases or decreases in debt burdens, changes in the economy or business environment, or in the case of states or munipalities, shifts in populations or changes in taxpayer incomes. (c) To determine whether an investment has merit really depends on particular issues of importance to an individual. For example, a risky investment might have merit to a wealthy investor that can afford to take a chance in order to have the chance of a large gain. That same investment might not have merit to somebody with limited wealth who cannot afford to take large risks. Therefore, credit ratings provide important inputs in determining whether an investment would be of interest to an investor. But a high (or low) credit rating does not necessary mean that a particular investment would be a good or bad investment.
10-76
.
(For Instructor Use Only)
BYP 10-7
(a) 1.
DECISION MAKING ACROSS THE ORGANIZATION
Bonds Payable ........................................... Cash .................................................... Discount on Bonds Payable .............. Gain on Bond Redemption ($2,946,000 – $2,500,000) ............... (To record redemption of 8% bonds)
3,000,000 2,500,000 54,000* 446,000
*($3,000,000 – $2,946,000) 2.
Cash ............................................................ Bonds Payable ................................... (To record sale of 10-year, 12% bonds at par)
2,500,000 2,500,000
(b) Dear President Garner: The early redemption of the 8%, 5-year bonds results in recognizing a gain of $446,000 that increases current year net income by the after-tax effect of the gain. The amount of the liabilities on the balance sheet will be lowered by the issuance of the new bonds and redemption of the 5-year bonds. 1.
The cash flow of the company as it relates to bonds payable will be adversely affected as follows: Annual interest payments on the new issue ($2,500,000 X .12) ....................................................... Annual interest payments on the 5-year bonds ($3,000,000 X .08) ....................................................... Additional cash outflows per year ................................
.
(For Instructor Use Only)
$300,000 240,000 $ 60,000
10-77
BYP 10-7 (Continued) 2.
The amount of interest expense shown on the income statement will be higher as a result of the decision to issue new bonds: Annual interest expense on new bonds .......... Annual interest expense on 8% bonds: Interest payment ......................................... Discount amortization ($54,000 ÷ 3 yrs.).... Additional interest expense per year ...............
$300,000 $240,000 18,000
258,000 $ 42,000
These comparisons hold for only the 3-year remaining life of the 8%, 5-year bonds. The company must acknowledge either redemption of the 8% bonds at maturity, January 1, 2017, or refinancing of that issue at that time and consider what interest rates will be in 2017 in evaluating a redemption and issuance in 2014. Sincerely,
10-78
.
(For Instructor Use Only)
BYP 10-8
COMMUNICATION ACTIVITY
To:
Harry Jackman
From:
I. M. Student
Subject:
Bond Financing
The advantages of bond financing over common stock financing include: 1.
Stockholder control is not affected.
2.
Tax savings result.
3.
Income to common stockholders may increase.
4.
Earnings per share of common stock may be higher.
The types of bonds that may be issued are: 1.
Secured or unsecured bonds. Secured bonds have specific assets of the issuer pledged as collateral while unsecured bonds do not.
2.
Convertible bonds, which can be converted by the bondholder into common stock.
3.
Callable bonds, which are subject to early redemption by the issuer at a stated amount.
State laws grant corporations the power to issue bonds after formal approval by the board of directors and stockholders. The terms of the bond issue are set forth in a legal document called a bond indenture. After the bond indenture is prepared, bond certificates are printed.
.
(For Instructor Use Only)
10-79
BYP 10-9
ETHICS CASE
(a) The stakeholders in this situation include: Stockholders Creditors Employees Government inspectors Customers flying in airplanes (b) The possible courses of action and their consequences include: 1.
The CEO could inform the auditors. The auditors would then require that this information be disclosed in the annual report. When the lenders learn about this potential problem, they may decide to call their loans, and the company’s suppliers may decide to quit sending it goods. This could result in the bankruptcy of the company, even if the company was not at fault for the engine failures. However, this would be in compliance with the accounting requirement to disclose all material facts. By not disclosing, the CEO is misinforming a large number of important stakeholders.
2.
The CEO could conceal the information from the auditors. If the company is not ultimately found at fault, then the company will not have sustained any financial hardship. However, if the company is found to be at fault for the engine failures, then not only is it likely the company will go bankrupt, but the CEO could face prosecution for failing to disclose the existence of this problem to auditors.
(c) Answer will vary according to student. (d) If the CEO conceals the information, and the company is subsequently found to be at fault, a number of stakeholders will suffer. First, the company’s creditors will lose money because it is likely the company won’t be able to repay its loans in full. The stockholders will lose because the value of their shares will plummet. The employees may well lose their jobs because the company is likely to go bankrupt. Also, it is possible that other engines might fail in the interim, possibly resulting in a crash. Answers as to whether the CEO should be punished for concealing this information will vary by student. 10-80
.
(For Instructor Use Only)
BYP 10-10
ETHICS CASE
(a) The stakeholders include: 1. Enron management 2. Citigroup management 3. Enron investors 4. Enron creditors (b) Yes. Although the primary responsibility for proper accounting rests with company management, other knowledgable parties have secondary responsibilities. Auditors are expected to attest to full disclosure. Lenders, with access to information that is generally unavailable to others, are expected to provide full and accurate disclosure of transactions with borrowers. (c) The auditor may have been unable to detect the inappropriate accounting treatment because “secret” agreements between Enron and Citigroup were not made available for review. (d) A company may wish to conceal financing arrangements in order to appear more solvent to investors and creditors. GAAP requires full disclosure of all information that would make a difference to financial statement users. Intentionally understating liabilities is a violation of GAAP and thus inappropriate. It is unethical for lenders to market deals that circumvent GAAP. (e) The Citigroup deal was more harmful than other off-balance-sheet transactions because it was not fully explained in the financial statement notes. (The auditors didn’t even know the details.) This lack of explanation made it impossible for users of Enron's financial statements to incorporate such off-balance-sheet information into their evaluation of Enron’s performance.
.
(For Instructor Use Only)
10-81
BYP 10-11
ALL ABOUT YOU ACTIVITY
The answer to these questions depends on the state in which the student resides. It also will be depend on the year chosen, although we expect that the results will be much the same whether they pick any rates between 2012 and 2014. We provide a solution for this problem using the state of Wisconsin as an example. It should be pointed out that certain taxes can be deducted for computing federal income tax but are ignored in our computation. (a) Wisconsin state income tax for a single person with a taxable income of $60,000 is $3,710.80. The tax rate between $17,680 and $132,580 is $950.30 plus 6.5 percent over $17,680. Therefore the computation is as follows: ($60,000 – $17,680) X 6.5% = $2,751 Base rate 950 Total state income tax $3,701 (b) The property tax on a $200,000 home at 2.1% is $4,200. (c) The state gasoline tax in Wisconsin is 32.9 cents per gallon and the federal gasoline tax is 18.4 cents per gallon. Your total taxes on gasoline are computed as follows: 400 gallons X ($0.329 + $0.184) = $205 (d) In Wisconsin the state sales tax rate is 5% and excludes food and prescription drug purchases. Therefore the sales tax is $200 ($4,000 X 5%). (e) The social security rate is 7.65% on income of $60,000 or $4,590. (f) Federal income tax for a single person with a taxable income of $60,000 is $11,538. The tax rate between $30,650 and $74,200 is $4,220 plus 25% over $30,650. Therefore the computation is as follows: ($60,000 – $30,650) X 25% = $ 7,338 Base amount 4,220 Total tax $11,558
10-82
.
(For Instructor Use Only)
BYP 10-11 (Continued) The total taxes paid therefore are computed as follows, based on a $60,000 income amount: State income tax .................................................................. Property tax on home ......................................................... Gasoline tax ......................................................................... Sales tax .............................................................................. Social security tax ............................................................... Federal income tax .............................................................. Total tax ...............................................................................
$ 3,701 4,200 205 200 4,590 11,558 $24,454
The percentage of total taxes to income is therefore 41% ($24,454/$60,000), given the information above.
.
(For Instructor Use Only)
10-83
BYP 10-12
ALL ABOUT YOU
A company’s insurance premiums would be substantially lower if its employees did not smoke and if they were in better shape. Some argue that employees with unhealthy habits increase the share of insurance premiums that all employees have to pay. Also unhealthy employees miss more days of work and thus burden healthy employees. On the other hand, some argue that this approach discriminates in favor of “healthy” people. Also, it is not illegal to smoke or to be overweight. Should an employer really be able to dictate against non-illegal behavior that employees do on their own time? The cost of health care is a huge problem in the U.S., with no easy answers.
10-84
.
(For Instructor Use Only)
BYP 10-13
FASB CODIFICATION ACTIVITY
(a) Current liabilities is used principally to designate obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets, or the creation of other current liabilities. See paragraphs 210-10-45-5 through 45-12. (b) Long-term obligations are those scheduled to mature beyond one year (or the operating cycle, if applicable) from the date of an entity’s balance sheet. (c) The Codification provides the following guidance for disclosure of longterm obligations: Bonds, mortgages and other long-term debt, including capitalized leases. (1)
State separately, in the balance sheet or in a note thereto, each issue or type of obligation and such information as will indicate (see §210.4–06): (i)
The general character of each type of debt including the rate of interest; (ii) the date of maturity, or, if maturing serially, a brief indication of the serial maturities, such as “maturing serially from 1980 to 1990”; (iii) if the payment of principal or interest is contingent, an appropriate indication of such contingency; (iv) a brief indication of priority; and (v) if convertible, the basis. (2)
.
The amount and terms (including commitment fees and the conditions under which commitments may be withdrawn) of unused commitments for long-term financing arrangements that would be disclosed under this rule if used shall be disclosed in the notes to the financial statements if significant.
(For Instructor Use Only)
10-85
BYP 10-14
CONSIDERING PEOPLE, PLANET AND PROFIT
(a) The monthly rates paid by borrowers on loans from these microfinance organizations is 5% to 10%. This would convert to roughly 60% (5% × 12) to 120% (10% × 12) per year. (b) These rates are incredibly high. Under most circumstances they would be considered usurious. However, the borrowers benefit because they also receive very high interest on their savings at the institution. The structure helps to smooth the ups and downs of a families cash inflows and outflows during the course of a year so that they can weather financial distruptions. (c) The organizations are structured as savings and loans. (Savings and loans used to be quite common in the U.S. until a financial crisis in the 1980s caused many of them to go bankrupt.) The organizations in the article typically only involve a small group of people (15 to 30) who pool their savings. Each buys a share in a fund from which they can borrow. All must also contribute a small sum to a social fund, which acts as micro-insurance for misfortunes suffered by members. The organizations have a limited life cycle – typically one year. At the end of the cycle all of the money accumulated by the fund is shared out to members based on their contributions. Then a new cycle begins.
10-86
.
(For Instructor Use Only)
IFRS CONCEPTS AND APPLICATION IFRS 10-1 Under IFRS a provision is defined as a liability of uncertain timing or amount. Examples include warranties, employee vacation pay, and anticipated losses. IFRS 10-2 Under IFRS a contingent liability is defined as a possible obligation that is not recognized in the financial statements but may be disclosed if certain criteria are met. Under IAS 37 contingent liabilities are defined as being: •
A possible obligation that arises from past events whose existence will be confirmed only by the occurrence or nonoccurrence of one or more uncertain future events not wholly within the control of the entity; or
•
A present obligation that arises from past events but is not recognized because: 1.
It is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
2.
The amount of the obligation cannot be measured with sufficient reliability.
IFRS 10-3 The similarities between GAAP and IFRS include: (1) the basic definition of a liability, (2) liabilities are normally reported in the order of their liquidity, and (3) preferred stock that is required to be redeemed at a specific point in time in the future must be reported as debt. Differences between GAAP and IFRS include: (1) GAAP allows straight line amortization of bond discounts and premiums, but IFRS requires the effective-interest method in all cases, (2) IFRS does not isolate unamortized bond discount or premium in a separate account, (3) IFRS splits the proceeds from convertible bonds into debt and equity components, and (4) GAAP uses a “rules-based” approach to account for leases while IFRS is more conceptual in its approach.
.
(For Instructor Use Only)
10-87
IFRS 10-4 (a) Jan.
1
Cash (€2,000,000 X .97) ........................ 1,940,000 Bonds Payable .............................. 1,940,000
(b) Jan.
1
Cash (€2,000,000 X 1.04) ...................... 2,080,000 Bonds Payable .............................. 2,080,000
IFRS 10-5 (a) In the 1870s, a securities system was introduced in Japan and public bond negotiation began. This resulted in the request for a public trading institution and the “Stock Exchange Ordinance” was enacted in May of 1878. Based on this ordinance, the “Tokyo Stock Exchange Co., Ltd.” was established on May 15, 1878 and trading began on June 1st. Japan now has five stock exchanges. (b) In March of 1943, the “Japan Securities Exchange Law” was enacted to reorganize the Stock Exchange as a wartime-controlled institution. With worsening war conditions and air raids on the main island of Japan, the securities market was forced to suspend trading sessions on all securities markets on August 10, 1945. Trading was restarted by unofficial group transactions in December of 1945. (c) The following are major items with respect to decisions by the company that need to be disclosed to the public: • • • • • • • •
10-88
Issuance of stocks, convertible bonds, and bonds with warrants Reduction of capital Stock split or stock consolidation Merger Dissolution Purchase or sale of stocks or equity interest in a subsidiary Change of representative Change of the trade name
.
(For Instructor Use Only)
IFRS 10-5 (Continued) (d) The following are major items with respect to “occurrence of material fact” that need to be disclosed to the public: • • • • •
Damage incurred by natural disaster or business operations Change in major shareholders Commencement of litigation or rendering of a court judgment Commencement of bankruptcy or reorganization proceedings Dishonor of notes
• Change of laws and the like in the home country that have a material effect on the company or its shareholders, such as restriction on transfer of stocks, nationalization of the company • Tender offer for the company’s stocks • Occurrence of facts causing the delisting from the foreign stock exchange or the like
.
(For Instructor Use Only)
10-89
IFRS10-6
INTERNATIONAL FINANCIAL REPORTING PROBLEM
(a) Trade payables represent amounts payable for goods and services received. It took Zetar an average of 48 days to pay its trade payables. (b) Provisions relate to amounts potentially payable to the vendors of companies and businesses acquired by Zetar. The estimates are based on management’s judgment and assessment of future budgets, revenues, margins, and cash flows. These estimates are subject to change as a result of changing economic and competitive conditions. (c) The weighted average interest rate on bank loans and overdrafts was 3.2% in 2011 and 4.0% in 2010.
10-90
.
(For Instructor Use Only)
CHAPTER 11 Reporting and Analyzing Stockholders’ Equity Learning Objectives 1. Identify and discuss the major characteristics of a corporation. 2. Record the issuance of common stock. 3. Explain the accounting for the purchase of treasury stock. 4. Differentiate preferred stock from common stock. 5. Prepare the entries for cash dividends and understand the effect of stock dividends and stock splits. 6. Identify the items that affect retained earnings. 7. Prepare a comprehensive stockholders’ equity section. 8. Evaluate a corporation’s dividend and earnings performance from a stockholder’s perspective. *9. Prepare entries for stock dividends.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item LO 1. 2. 3. 4. 5. 6.
1 1 1 1 1 2
C C C K K K
Item 7. 8. 9. 10. 11.
LO 2, 3 2 3 3 4
BT
Item
BT
Item
LO
BT
Item
LO
BT
AP C C C C
Questions 12. 6 C 13. 7 C 14. 5 K 15. 5 C 16. 5 C
17. 18. 19. 20. 21.
5 5 5 5, 6 6
C C C K C
22. 23. 24. 25. 26.
8 8 8 8 8
C C C C C
Brief Exercises 7. 5 K 8. 7 AP
9. 10.
8 8
C AP
11. 12.
8 9*
AP AP
Do It! Review Exercises 4. 4 AP 5.
5
AP
6.
7
AP
10. 11. 12. 13.
7 8 8 8
AP AP AP AN
14. 15. 16.
8 8 5, 9*
AN AN AP
AN
Exercises 6. 5 AP 7. 5 AP 8. 7 AP 9. 7 AP
5.
2, 3, 4, 7 7
8 5, 7, 8, 9*
AP
AP AP
7. 8.
AP
Problems: Set A 3. 7 AP 4. 5, 6, 7 AP
2, 3, 4, 7 7 8
AP AP AP
1. 2. 3.
1 2 2
K AP AP
4. 5. 6.
4 5 5
AP AP AP
1. 2.
1 2
C AP
3.
3
AP
1. 2 2. 2, 3, 4 3. 4, 7 1. 2, 4, 7
1.
AP
4.
AP AP
5.
2. AP
2, 4, 7
.
BT
2. AP
2, 3, 4, 7 2, 3, 4 2, 3, 5, 7, 8
C
6.
Problems: Set B 3. 7 AP
2, 3, 5, 7, 8
LO
4. AP
5, 6, 7
AP
Kimmel, Accounting, 5/e, Solutions Manual
5. 6. 7.
8.
(For Instructor Use Only)
AP
5, 7, 8, 9*
AP
11-1
*Continuing Cookie Solutions for this chapter are available online.
11-2
.
(For Instructor Use Only)
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
.
Description
Difficulty Level
Time Allotted (min.)
1A
Journalize stock transactions, post, and prepare paid-in capital section.
Simple
30–40
2A
Journalize transactions, post, and prepare a stockholders’ equity section; calculate ratios.
Moderate
40–50
3A
Prepare a stockholders’ equity section.
Moderate
20–30
4A
Reproduce retained earnings account, and prepare a stockholders’ equity section.
Moderate
30–40
5A
Prepare entries for stock transactions, and prepare a stockholders’ equity section.
Moderate
20–30
6A
Prepare a stockholders’ equity section.
Simple
20–30
7A
Evaluate a company’s profitability and solvency.
Moderate
20–30
*8A
Prepare dividend entries, prepare a stockholders’ equity section, and calculate ratios.
Moderate
40–50
1B
Journalize stock transactions, post, and prepare paid-in capital section.
Simple
30–40
2B
Journalize transactions, post, and prepare a stockholders’ equity section; calculate ratios.
Moderate
40–50
3B
Prepare a stockholders’ equity section.
Moderate
20–30
4B
Reproduce retained earnings account, and prepare a stockholders’ equity section.
Moderate
30–40
5B
Prepare entries for stock transactions, and prepare a stockholders’ equity section.
Moderate
20–30
6B
Prepare a stockholders’ equity section.
Simple
20–30
7B
Evaluate a company’s profitability and solvency.
Moderate
30–40
*8B
Prepare dividend entries, prepare a stockholders’ equity section, and calculate ratios.
Moderate
40–50
(For Instructor Use Only)
11-3
ANSWERS TO QUESTIONS 1.
2.
(a)
Separate legal existence. A corporation is separate and distinct from its owners and it acts in its own name rather than in the name of its stockholders. In contrast to a partnership, the acts of the owners (stockholders) do not bind the corporation unless the owners are agents of the corporation.
(b)
Limited liability of stockholders. Because of its separate legal existence, creditors of a corporation ordinarily have recourse only to corporate assets to satisfy their claims. Thus, the liability of stockholders is normally limited to their investment in the corporation.
(c)
Transferable ownership rights. Ownership of a corporation is shown in shares of capital stock. The shares are transferable units. Stockholders may dispose of part or all of their interest by simply selling their stock. The transfer of ownership to another party is entirely at the discretion of the stockholder.
(a)
Corporate management is an advantage to a corporation because it can hire professional managers to run the company. Corporate management is a disadvantage to a corporation because it prevents owners from having an active role in directly managing the company.
(b)
Two other disadvantages of a corporation are government regulations and additional taxes. A corporation is subject to numerous state and federal regulations. For example, state laws prescribe the requirements for issuing stock, and federal securities laws govern the sale of stock to the general public. Corporations must pay both federal and state income taxes. These taxes are substantial. In addition, stockholders must pay income taxes on cash dividends received.
3.
Janie is incorrect. A corporation must be incorporated in only one state. It is to the company’s advantage to incorporate in a state whose laws are favorable to the corporate form of business organization. A corporation may incorporate in a state in which it does not have a headquarters’ office or major operating facilities.
4.
In the absence of restrictive provisions, the basic ownership rights of common stockholders are the rights to: (1) (2) (3) (4)
vote in the election of the board of directors and in corporate actions that require stockholders’ approval. share in corporate earnings. maintain the same percentage ownership when additional shares of common stock are issued (the preemptive right). share in assets upon liquidation.
5.
Legally, a corporation is an entity, separate and distinct from its owners. As a legal entity, a corporation possesses most of the privileges and is subject to the same duties and responsibilities as a natural person. The corporation acts under its own name rather than under the names of its stockholders. A corporation may buy, own, and sell property, borrow money, enter into legally binding contracts, and sue or be sued.
6.
The principal components of stockholders’ equity for a corporation are paid-in capital and retained earnings.
11-4
.
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
Questions Chapter 11 (Continued) 7.
The maximum number of shares that a corporation is legally allowed to issue is the number authorized. Gagne Corporation is authorized to sell 100,000 shares. Of these shares, 70,000 shares have been issued. Outstanding shares are those issued shares which have not been reacquired by the corporation; in other words, issued shares less treasury shares. Gagne has 66,000 shares outstanding (70,000 issued less 4,000 treasury).
8.
The relative par values should have no effect on the investment decision. The par value of common stock has no effect on its market value. Par value used to be a legal amount per share which usually indicated the minimum amount at which a share of stock can be issued. Therefore, either stock mentioned in the question could be the better investment.
9.
A corporation may acquire treasury stock (1) to reissue the shares to officers and employees under bonus and stock compensation plans, (2) to increase trading of the company’s stock in the securities market in the hopes of enhancing its market value, (3) to have additional shares available for use in the acquisition of other companies, (4) to reduce the number of shares outstanding and, thereby, increase earnings per share, or (5) to avoid a takeover of the company by investors that are hostile to management.
10.
When treasury stock is purchased, Treasury Stock is debited and Cash is credited at cost ($11,000 in this example). Treasury stock is a contra stockholders’ equity account and cash is an asset. Thus, this transaction has (a) no effect on net income, (b) decreases total assets, (c) has no effect on total paid-in capital, and (d) decreases total stockholders’ equity.
11.
(a)
Common stock and preferred stock both represent ownership of the corporation. Common stock signifies the basic residual ownership; preferred stock is ownership with certain privileges or preferences. Preferred stockholders typically have a preference as to dividends and as to assets in the event of liquidation. However, preferred stockholders generally do not have voting rights.
(b)
Some preferred stocks possess the additional feature of being cumulative. Cumulative preferred stock means that preferred stockholders must be paid both current year dividends and unpaid prior year dividends before common stockholders receive any dividends.
(c)
Dividends in arrears are disclosed in the notes to the financial statements.
12.
The debits and credits to retained earnings are:
1. 2.
.
Debits Net loss Cash and stock dividends
(For Instructor Use Only)
1.
Credits Net income
11-5
Questions Chapter 11 (Continued) 13.
The answers are summarized in the table below:
(a) (b) (c) (d)
Account Common Stock Paid-in Capital in Excess of Par Value Retained Earnings Treasury Stock
(e) (f)
Paid-in Capital in Excess of Stated Value Preferred Stock
Classification Paid-in capital—capital stock Paid-in capital—additional paid-in capital Retained earnings Deducted from total paid-in capital and retained earnings Paid-in capital—additional paid-in capital Paid-in capital—capital stock
14.
For a cash dividend to be paid, a corporation must have retained earnings, adequate cash, and a dividend declared by the board of directors.
15.
May 1 is the date on which the board of directors formally declares (authorizes) and announces the cash dividend. May 15 is the record date which marks the time when ownership of outstanding shares is determined for dividend purposes from the stockholders’ records. May 31 is the date when the dividend checks are mailed to stockholders. Accounting entries are made on May 1 (debit Cash Dividends and credit Dividends Payable), and on May 31 (debit Dividends Payable and credit Cash).
16.
A cash dividend decreases assets, retained earnings, and total stockholders’ equity. A stock dividend decreases retained earnings, increases paid-in capital, and has no effect on total assets and total stockholders’ equity.
17.
Angie is incorrect. A corporation generally issues stock dividends for one of the following reasons: (1) (2)
(3)
To satisfy stockholders’ dividend expectations without spending cash. To increase the marketability of its stock by increasing the number of shares outstanding and thereby decreasing the market price per share. Decreasing the market price of the stock makes it easier for small investors to purchase shares. To emphasize that a portion of stockholders’ equity that had been reported as retained earnings has been permanently reinvested in the business and therefore is unavailable for cash dividends.
18.
In a stock split, the number of shares is increased in the same proportion that par value is decreased. Thus, in Deane Corporation the number of shares will increase to 30,000 (10,000 X 3) and the par value will decrease to $5 ($15 ÷ 3). The effect of a split on market value is generally inversely proportional to the size of the split. In this case, the market price would fall to approximately $40 per share ($120 ÷ 3).
19.
The different effects of a stock split versus a stock dividend are: Item Total paid-in capital Total retained earnings Total par value (common stock) Par value per share
11-6
.
(For Instructor Use Only)
Stock Split No change No change No change Decrease
Stock Dividend Increase Decrease Increase No change
Questions Chapter 11 (Continued) 20.
The cost of Tootsie Roll’s treasury stock at December 31, 2011 was $1,992,000. It declared cash dividends of $18,360,000. The stock dividend reduced retained earnings by $47,175,000.
21.
(a)
The purpose of a retained earnings restriction is to indicate that a portion of retained earnings is currently unavailable for dividends.
(b)
Restrictions may result from the following causes: legal, contractual, or voluntary.
22.
Par value is a legal amount per share, often set at an arbitrarily selected amount, which usually indicates the minimum amount at which a share of stock can be issued. Market value is generally unrelated to par value. A stock’s market value will reflect many factors, including the company’s anticipated future earnings, its expected dividend rate per share, its current financial position, the current state of the economy, and the current state of the securities markets.
23.
The payout ratio is computed by dividing cash dividends declared on common stock by net income. The payout ratio indicates the percentage of earnings distributed as cash dividends to common stockholders.
24.
Debt financing will increase the return on common stockholders’ equity when the return on assets exceeds the interest rate paid on debt.
25.
The return on assets will equal the return on common stockholders’ equity when a company has no preferred dividends or debt.
26.
The issuance of bonds combined with a reduction in outstanding shares increases the company’s reliance on debt financing which will be reflected in an increase of the debt to assets ratio. The return on common stockholders’ equity should increase because the company’s return on assets exceeds the interest rate on the new debt and because the amount of stockholders’ equity in the denominator of the ratio has been reduced.
.
(For Instructor Use Only)
11-7
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 11-1 The advantages and disadvantages of a corporation are as follows: Advantages Separate legal existence Limited liability of stockholders Transferable ownership rights Ability to acquire capital Continuous life Corporate management— professional managers
Disadvantages Corporate management— separation of ownership and management Government regulations Additional taxes
BRIEF EXERCISE 11-2 May 10 Cash (2,500 X $13) ........................................ Common Stock (2,500 X $5) ................. Paid-in Capital in Excess of Par Value—Common Stock (2,500 X $8) .........................................
32,500 12,500 20,000
BRIEF EXERCISE 11-3 June 1 Cash (3,000 X $7).......................................... Common Stock......................................
21,000 21,000
BRIEF EXERCISE 11-4 Cash (8,000 X $106) .................................................... Preferred Stock (8,000 X $100) ........................... Paid-in Capital in Excess of Par Value— Preferred Stock (8,000 X $6) ............................
11-8
.
(For Instructor Use Only)
848,000 800,000 48,000
BRIEF EXERCISE 11-5 Nov.
1
Dec. 31
Cash Dividends (7,000 X $1) .................... Dividends Payable ............................
7,000
Dividends Payable .................................... Cash ...................................................
7,000
7,000 7,000
BRIEF EXERCISE 11-6
(a) Stockholders’ equity Paid-in capital Common stock, $8 par Paid in capital in excess of par value—common stock Total paid-in capital Retained earnings Total stockholders’ equity (b) Outstanding shares
Before Dividend
After Dividend
$1,000,000
$1,100,000
– 1,000,000 300,000 $1,300,000
137,500 1,237,500 62,500 $1,300,000
125,000
137,500
BRIEF EXERCISE 11-7 Total Total Total Stockholders’ Transaction Assets Liabilities Equity (a) Declared cash dividend N/A + – (b) Paid cash dividend declared in (a) – – N/A (c) Declared stock dividend N/A N/A N/A (d) Distributed stock dividend declared in (c) N/A N/A N/A (e) Split stock three-for-one N/A N/A N/A
.
(For Instructor Use Only)
11-9
BRIEF EXERCISE 11-8 Stockholders’ equity Paid-in capital Capital stock Common stock, $10 par value, 5,000 shares issued and 4,500 shares outstanding ................... Additional paid-in capital Paid-in capital in excess of par value— common stock................................. ...................... Total paid-in capital ............................................ Retained earnings .................................................................... Total paid-in capital and retained earnings ...... Less: Treasury stock (500 shares) ......................................... Total stockholders’ equity..................................
$ 50,000 22,000 72,000 42,000 114,000 (11,000) $103,000
BRIEF EXERCISE 11-9 Payout ratio—last year =
$120,000 = 20% $600,000
Dividends paid this year = $1,600,000 X .20 = $320,000 (assuming the same payout ratio) Maintaining a constant payout ratio may be considered a sign of stability from the stockholders’ perspective. However, maintaining a constant payout ratio may have a negative impact on the company’s cash flow and its ability to grow. BRIEF EXERCISE 11-10 Return on stockholders’ equity =
Net income–Preferred dividends Average common stockholders’ equity $393 – $0 = 14.37% ($2,581+ $2,887) ÷ 2
Supervalu’s 14.37% return on stockholders’ equity indicates that about 14 cents of net income was earned for each dollar invested by common stockholders.
11-10
.
(For Instructor Use Only)
BRIEF EXERCISE 11-11 Income before interest and taxes Interest ($2,000,000 X 6%) Income before income taxes Income tax expense (30%) Net Income (a) Outstanding shares (b) Earnings per share (a) ÷ (b)
Issue Stock $1,500,000 0 1,500,000 450,000 $1,050,000
Issue Bond $1,500,000 120,000 1,380,000 414,000 $ 966,000
900,000 $1.17
700,000 $1.38
Net income is higher if stock is used. However, earnings per share is lower than earnings per share if bonds are used because of the additional shares of stock that are outstanding. Issuance of bonds is preferable since earnings per share is higher under this alternative. *BRIEF EXERCISE 11-12 Dec. 1
31
Stock Dividends (24,000 X $17) ..................... Common Stock Dividends Distributable (24,000 X $10) ......................................... Paid-in Capital in Excess of Par Value—Common Stock (24,000 X $7) ...........................................
408,000
Common Stock Dividends Distributable ...... Common Stock .........................................
240,000
240,000 168,000 240,000
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 11-1 1. 2. 3. 4. 5. .
True. True. False. Additional government regulation is a disadvantage of the corporate form of business. True. False. No-par value stock is quite common today. (For Instructor Use Only)
11-11
11-12
.
(For Instructor Use Only)
DO IT! 11-2 Apr. 1
Cash ................................................................ Common Stock ......................................... Paid-in Capital in Excess of Par Value—Common Stock ...................
715,000 275,000 440,000
DO IT! 11-3 Aug. 1
Treasury Stock .............................................. Cash...........................................................
76,000 76,000
DO IT! 11-4 (1) The company has not missed past dividends and the preferred stock is noncumulative; thus, the preferred stockholders are paid only this year’s dividend. The dividend paid to preferred stockholders would be $24,000 (3,000 X .08 X $100). The dividend paid to common stockholders would be $81,000 ($105,000 – $24,000). (2) The preferred stock is noncumulative; thus, past unpaid dividends do not have to be paid. The dividend paid to preferred stockholders would be $24,000 (3,000 X .08 X $100). The dividend paid to common stockholders would be $81,000 ($105,000 – $24,000). (3) The preferred stock is cumulative; thus, dividends that have been missed in the past (dividends in arrears) must be paid. The dividend paid to preferred stockholders would be $72,000 (3 X 3,000 X .08 X $100). The dividend paid to common stockholders would be $33,000 ($105,000 – $72,000). DO IT! 11-5 (a) 1.
The stock dividend amount is $3,000,000 [(400,000 X 15%) X $50]. The new balance in retained earnings is $9,000,000 ($12,000,000 – $3,000,000).
2.
The retained earnings after the stock split would be the same as it was before the split: $12,000,000.
.
(For Instructor Use Only)
11-13
DO IT! 11-5 (Continued) (b) (1) and (2) The effects on the stockholders’ equity accounts are as follows:
Paid-in capital Retained earnings Total stockholder’s equity Shares outstanding
Original Balance $ 2,400,000 12,000,000 $14,400,000 400,000
After Dividend $ 5,400,000 9,000,000 $14,400,000 460,000
After Split $ 2,400,000 12,000,000 $14,400,000 800,000
Total stockholders’ equity remains the same under both options. DO IT! 11-6 FOYLE CORPORATION Balance Sheet (Partial) Stockholders’ equity Paid-in capital Capital Stock 9% preferred stock, $100 par value, 10,000 shares authorized, 2,000 shares issued and outstanding ....... Common stock, $5 par value, 500,000 shares authorized, 100,000 shares issued, and 93,000 shares outstanding............... Total capital stock ....................... Additional paid-in capital Paid-in capital in excess of par value— preferred stock ................................. Paid-in capital in excess of par value— common stock .................................. Total additional paid-in capital ... Total paid-in capital ..................... Retained earnings.............................................. Total paid-in capital and retained earnings ...................... Less: Treasury stock (7,000 shares) (at cost)................................................... Total stockholders’ equity........... 11-14
.
(For Instructor Use Only)
$200,000
500,000 $ 700,000 23,000 263,000 286,000 986,000 372,000 1,358,000 46,000 $1,312,000
SOLUTIONS TO EXERCISES EXERCISE 11-1 (a) Jan. 10 July 1
(b) Jan. 10
July 1
Cash (30,000 X $5) ................................ Common Stock ..............................
150,000
Cash (60,000 X $7) ................................ Common Stock (60,000 X $5) ....... Paid-in Capital in Excess of Par Value—Common Stock (60,000 X $2) ...............................
420,000
Cash (30,000 X $5) ................................ Common Stock (30,000 X $1) ....... Paid-in Capital in Excess of Stated Value—Common Stock (30,000 X $4) ...............................
150,000
Cash (60,000 X $7) ................................ Common Stock (60,000 X $1) ....... Paid-in Capital in Excess of Stated Value—Common Stock (60,000 X $6) ...............................
420,000
150,000 300,000 120,000 30,000 120,000 60,000 360,000
EXERCISE 11-2 June
July
Nov.
.
12
11
28
Cash .......................................................... Common Stock (80,000 X $1) ........... Paid-in Capital in Excess of Par Value—Common Stock .................
300,000
Cash (3,000 X $106) ................................. Preferred Stock (3,000 X $100) ........ Paid-in Capital in Excess of Par Value—Preferred Stock (3,000 X $6) .....................................
318,000
Treasury Stock ........................................ Cash...................................................
9,000
(For Instructor Use Only)
80,000 220,000 300,000 18,000 9,000 11-15
EXERCISE 11-3 (a) Feb. 1
July 1
Cash (40,000 X $51) .............................. Preferred Stock (40,000 X $50) ...... Paid-in Capital in Excess of Par Value—Preferred Stock (40,000 X $1) ................................
2,040,000
Cash (60,000 X $56) .............................. Preferred Stock (60,000 X $50) ...... Paid-in Capital in Excess of Par Value—Preferred Stock (60,000 X $6) ................................
3,360,000
2,000,000 40,000 3,000,000 360,000
(b) Preferred Stock 2/1 2,000,000 7/1 3,000,000 5,000,000
Paid-in Capital in Excess of Par Value—Preferred Stock 2/1 40,000 7/1 360,000 400,000
(c) Preferred Stock—listed first in paid-in capital under capital stock. Paid in Capital in Excess of Par Value—Preferred Stock—listed first under additional paid-in capital. EXERCISE 11-4 (a) Common stock outstanding is 574,000 shares. (Issued shares 580,000 less treasury shares 6,000.) (b) The stated value of the common stock is $5 per share. (Common stock issued $2,900,000 ÷ 580,000 shares.) (c) The par value of the preferred stock is $100 per share. (Preferred stock $600,000 ÷ 6,000 shares.) (d) The dividend rate is 6% ($36,000 ÷ $600,000). (e) The Retained Earnings balance is still $1,158,000. Cumulative dividends in arrears are only disclosed in the notes to the financial statements. 11-16
.
(For Instructor Use Only)
EXERCISE 11-5 May
2
10
15
Cash (8,000 X $13) .................................... Common Stock (8,000 X $10) ........... Paid-in Capital in Excess of Par Value—Common Stock (8,000 X $3) .....................................
104,000
Cash (10,000 X $53) .................................. Preferred Stock (10,000 X $20) ......... Paid-in Capital in Excess of Par Value—Preferred Stock (10,000 X $33) .................................
530,000
Treasury Stock (600 X $12) ...................... Cash ...................................................
7,200
80,000 24,000 200,000 330,000 7,200
EXERCISE 11-6 (a) June 15
Cash Dividends (69,000* X $1.50)..... Dividends Payable .....................
103,500 103,500
*60,000 shares + 9,000 shares July 10 Dec. 15
Dividends Payable ............................ Cash ............................................
103,500
Cash Dividends (73,000** X $1.60) ... Dividends Payable .....................
116,800
103,500 116,800
**69,000 shares + 4,000 shares (b) In the retained earnings statement, dividends of $220,300 will be deducted. In the balance sheet, Dividends Payable of $116,800 will be reported as a current liability.
.
(For Instructor Use Only)
11-17
EXERCISE 11-7
Stockholders’ equity Paid-in capital Retained earnings Total stockholders’ equity Outstanding shares
Before Action
After Stock Dividend
After Stock Split
$ 648,000 400,000
$ 716,850 331,150
$ 648,000 400,000
$1,048,000 81,000
$1,048,000 85,050
$1,048,000 162,000
EXERCISE 11-8 WELLS FARGO & COMPANY Partial Balance Sheet December 31, 2014 (in millions) Stockholders’ equity Paid-in capital Capital stock Preferred stock ................................................. Common stock, $123 par value, 6 billion shares authorized, 5,245,971,422 shares issued, and 5,178,624,593 shares outstanding .............. Total capital stock ...................................... Additional paid-in capital Paid-in capital in excess of par value— common stock .............................................. Total paid-in capital .................................... Retained earnings .................................................. Total paid-in capital and retained earnings .................................................. Less: Treasury stock (67,346,829 shares) ............ Total stockholders’ equity..........................
11-18
.
(For Instructor Use Only)
$8,485
8,743 $ 17,228 52,878 70,106 41,563 111,669 2,450 $109,219
EXERCISE 11-9 RODER CORPORATION Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock 8% Preferred stock, $100 par value, noncumulative, 6,000 shares issued ........................... $ 600,000 Common stock, no par, $2 stated value, 800,000 shares issued, and 788,000 shares outstanding ........................................ 1,600,000 Total capital stock ......................... $2,200,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock ..................... 45,000 Paid-in capital in excess of stated value—common stock ...................... 1,050,000 Total additional paid-in capital ..... 1,095,000 Total paid-in capital ....................... 3,295,000 Retained earnings ............................................... 1,334,000 Total paid-in capital and retained earnings ........................ 4,629,000 Less: Treasury stock (12,000 common shares) ......................... 72,000 Total stockholders’ equity ............ $4,557,000
.
(For Instructor Use Only)
11-19
EXERCISE 11-10 POLZIN INC. Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock 8% Preferred stock, $50 par value, 40,000 shares authorized, 14,000 shares issued ....................... Common stock, no-par, $1 stated value, 400,000 shares authorized, 250,000 shares issued and 241,000 outstanding ...................................... Total capital stock ....................... Additional paid-in capital Paid-in capital in excess of par value—preferred stock .................... Paid-in capital in excess of stated value—common stock ..................... Total additional paid-in capital ... Total paid-in capital ..................... Retained earnings (See Note R) ....................... Total paid-in capital and retained earnings ...................... Less: Treasury stock (9,000 common shares) ........................ Total stockholders’ equity...........
$ 700,000
250,000 $ 950,000 24,000 1,200,000 1,224,000 2,174,000 920,000 3,094,000 (64,000) $3,030,000
Note R: Retained earnings restricted for plant expansion, $100,000.
11-20
.
(For Instructor Use Only)
EXERCISE 11-11 Payout ratio
Return on common stockholders’ equity
2014 $298 = 59.1% $504
2013
$611 = 110.1% $555
$504 – $40 =18.3% $2,532
$555 – $40 =19.9% $2,591
Whitlock Corporation’s dividends decreased over 51% even though its net income decreased only 9% and return on stockholders’ equity decreased 8%. The company’s dividend policies should be reviewed for an explanation of these inconsistencies. EXERCISE 11-12 Payout ratio Return on common stockholders’ equity
2014 $471 =23.5% $2,006
2013
394 =18.3% $2,157
$2,006 – $0 =14.7% $13,622.5
$2,157 – $0 =18% $11,986.5
Walgreen’s payout ratio increased 28% even though its return on common stockholders’ equity and net income decreased by 18% and 7% respectively. The company’s dividend policies should be reviewed for an explanation. EXERCISE 11-13 (a) 2014:
$182,000–$8,000 =17.4% $1,000,000
2013:
$150,000 – $8,000 = 20.3% $700,000
.
(For Instructor Use Only)
11-21
EXERCISE 11-13 (Continued) (b) Korsak Corporation’s net income increased in part because it retired bonds and eliminated the interest expense associated with the bonds. Such an increase in income would produce an increase in return on common equity if stockholders’ equity had remained constant. In this example, common stockholders’ equity increased by 43% [($1,000,000 – $700,000) ÷ $700,000] while income increased by only 21%.
$200,000 =16.7% $1,200,000
(c) 2014:
$500,000 = 41.7% $1,200,000
2013:
Korsak Corporation retired all of its long term debt on January 1, 2014. This decreased its debt to assets ratio from 41.7% to 16.7%. Korsak Corporation would be considered to be very solvent. EXERCISE 11-14
Income before interest and taxes ......... Interest ($2,000,000 X 12%) ................... Income before taxes .............................. Income tax expense (30%) ..................... Net income.............................................. Outstanding shares ............................... Earnings per share .................................
11-22
.
(For Instructor Use Only)
(a) Plan One Issue Stock $800,000 800,000 240,000 $560,000 140,000 $4.00
(b) Plan Two Issue Bonds $800,000 240,000 560,000 168,000 $392,000 90,000 $4.36
EXERCISE 11-15 (a) Pre-debt net income .............................. Adjustment for interest expense ($400,000 X .04) ................................... Net income ............................................. Outstanding shares ............................... Earnings per share ................................ (b) Net income Average common stockholders’ equity
2013 $100,000
2014 $100,000
0 $100,000 40,000 $ 2.50
16,000 $ 84,000 20,000 $ 4.20
2013 $ 100,000 = 10% $1,000,000
2014 $ 84,000 = 14% $600,000
0 =0 $1,000,000
$ 400,000 = 40% $1,000,000
(c) Total liabilities Total assets
(d) The issuance of debt reduced the company’s net income because of the interest cost that was incurred. However, the debt significantly increased the company’s earnings per share because it was used to acquire treasury stock. This reduced the number of outstanding shares, thus increasing earnings per share. The issuance of debt also increased the company’s leverage. Because the interest rate paid on the debt was only 4% but the company’s return on assets was 10%, the company was able to earn much more on each dollar invested in assets than it was paying on the debt. Thus, it was able to significantly increase its return on common stockholders’ equity. This was especially true because it used the debt to repurchase shares of stock. The issuance of the debt did, however, reduce the company’s solvency. Prior to the debt, the company had no liabilities. After issuing the debt, it had a debt to total assets ratio of 40%. Investors might be concerned that the increased reliance on debt has made the company too risky. The determination as to whether this was a good decision depends on one’s opinion regarding the tradeoff between the increased risk versus the increased return. .
(For Instructor Use Only)
11-23
*EXERCISE 11-16 (a) Stock Dividends (22,500* X $15)......................... Common Stock Dividends Distributable (22,500 X $10) ...................... Paid-in Capital in Excess of Par Value— Common Stock (22,500 X $5) ...................
337,500 225,000 112,500
*[($1,200,000 ÷ $10) + 30,000] X 15% (b) Stock Dividends (40,500* X $8)........................... Common Stock Dividends Distributable (40,500 X $5) ........................ Paid-in Capital in Excess of Par Value— Common Stock (40,500 X $3) ................... *[($1,200,000 ÷ $5) + 30,000] X 15%
11-24
.
(For Instructor Use Only)
324,000 202,500 121,500
SOLUTIONS TO PROBLEMS PROBLEM 11-1A (a) Jan. 10
Mar. 1
May
1
Sept. 1
Nov. 1
Cash (70,000 X $4) ............................. Common Stock (70,000 X $1) .... Paid-in Capital in Excess of Stated Value—Common Stock (70,000 X $3)..................
280,000
Cash (12,000 X $53) ........................... Preferred Stock (12,000 X $50) .... Paid-in Capital in Excess of Par Value—Preferred Stock (12,000 X $3) ............................
636,000
Cash (120,000 X $6) ........................... Common Stock (120,000 X $1) .. Paid-in Capital in Excess of Stated Value—Common Stock (120,000 X $5) ................
720,000
Cash (5,000 X $5) ............................... Common Stock (5,000 X $1) ...... Paid-in Capital in Excess of Stated Value—Common Stock (5,000 X $4)....................
25,000
Cash (3,000 X $56) ............................. Preferred Stock (3,000 X $50) .... Paid-in Capital in Excess of Par Value—Preferred Stock (3,000 X $6) ..............................
168,000
70,000 210,000 600,000 36,000 120,000 600,000 5,000 20,000 150,000 18,000
(b) Preferred Stock 3/1 600,000 11/1 150,000 12/31 Bal. 750,000 .
Paid-in Capital in Excess of Par Value—Preferred Stock 3/1 36,000 11/1 18,000 12/31 Bal. 54,000
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
11-25
PROBLEM 11-1A (Continued) Common Stock 1/10 70,000 5/1 120,000 9/1 5,000 12/31 Bal. 195,000 (c)
Paid-in Capital in Excess of Stated Value—Common Stock 1/10 210,000 5/1 600,000 9/1 20,000 12/31 Bal. 830,000
TIDWELL CORPORATION Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock 6% Preferred stock, $50 par value, 20,000 shares authorized and 15,000 shares issued .............................. Common stock, no-par, $1 stated value, 500,000 shares authorized, 195,000 shares issued .......................................... Total capital stock .................. Additional paid-in capital Paid-in capital in excess of par value—preferred stock ............... Paid-in capital in excess of stated value—common stock ................ Total additional paid-in capital ................................... Total paid-in capital ................
11-26
.
(For Instructor Use Only)
$750,000
195,000 $ 945,000 54,000 830,000 884,000 $1,829,000
PROBLEM 11-2A (a) Feb.
1
Mar. 20 Oct. Nov. Dec.
1 1 1
Cash .......................................................... Common Stock (5,000 X $4) ............. Paid-in Capital in Excess of Stated Value—Common Stock ......
30,000
Treasury Stock (1,000 X $7) ..................... Cash ...................................................
7,000
Cash Dividends ($300,000 X .07) ............. Dividends Payable ............................
21,000
Dividends Payable ................................... Cash ...................................................
21,000
Cash Dividends ........................................
124,500
20,000 10,000 7,000 21,000 21,000
[250,000* + 5,000 – (5,000 + 1,000)] X $.50
Dividends Payable ............................ Dec. 31 31
31
124,500
Income Summary ..................................... Retained Earnings.............................
280,000
Retained Earnings .................................... Cash Dividends ($21,000 + $124,500) ........................
145,500
Dividends Payable ................................... Cash ...................................................
124,500
280,000
145,500 124,500
*$1,000,000 ÷ $4 (b)
300,000 300,000
Paid-in Capital in Excess of Par Value—Preferred Stock 1/1 Bal. 15,000 12/31 Bal. 15,000
Common Stock 1/1 Bal. 1,000,000 2/1 20,000 12/31 Bal. 1,020,000
Paid-in Capital in Excess of Stated Value—Common Stock 1/1 Bal. 480,000 2/1 10,000 12/31 Bal. 490,000
Preferred Stock 1/1 Bal. 12/31 Bal.
.
(For Instructor Use Only)
11-27
PROBLEM 11-2A (Continued) 12/31
Retained Earnings 145,500 1/1 Bal. 688,000 12/31 280,000 12/31 Bal. 822,500
Cash Dividends 10/1 21,000 12/1 124,500 12/31 12/31 Bal. –0– (c)
Treasury Stock 1/1 Bal. 40,000 3/20 7,000 12/31 Bal. 47,000
145,500
MILEY CORPORATION Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock 7% Preferred stock, $100 par value, noncumulative, 5,000 shares authorized, 3,000 shares issued and outstanding ................................. Common stock, no-par, $4 stated value, 300,000 shares authorized, 255,000 shares issued and 249,000 shares outstanding ................................. Total capital stock .................. Additional paid-in capital Paid-in capital in excess of par value—preferred stock .............. Paid-in capital in excess of stated value—common stock ............... Total additional paid-in capital ................................... Total paid-in capital ................ Retained earnings ........................................ Total paid-in capital and retained earnings ................. Less: Treasury stock (6,000 common shares) ............................................... Total stockholders’ equity .....
11-28
.
(For Instructor Use Only)
$ 300,000
1,020,000 $1,320,000 15,000 490,000 505,000 1,825,000 822,500 2,647,500 47,000 $2,600,500
PROBLEM 11-2A (Continued) (d) Payout ratio =
$124,500 = 44.5% $280,000
Earnings per share =
$280,000 – $21,000 $259,000 = =$1.05 (245,000* + 249,000* *)÷ 2 247,000
*250,000 – 5,000
**255,000 – 6,000
Return on common stockholders’ equity =
$280,000 – $21,000 $259,000 = =11.7% a b ($2,128,000 + $2,285,500 )÷ 2 $2,206,750 a
Beginning common stockholders’ equity: $1,000,000 + $480,000 + $688,000 – $40,000
b
.
Ending common stockholders’ equity: $1,020,000 + $490,000 + $822,500 – $47,000
(For Instructor Use Only)
11-29
PROBLEM 11-3A PAXSON COMPANY Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock 9% Preferred stock, $100 par value, cumulative, 120,000 shares issued and outstanding ............................... $12,000,000 Common stock, $5 par value, 1,300,000 shares issued and 1,285,000 shares outstanding ......... 6,500,000 Total capital stock ....................... $18,500,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock .................... 840,000 Paid-in capital in excess of par value—common stock ..................... 1,800,000 Total additional paid-in capital ... 2,640,000 Total paid-in capital ..................... 21,140,000 Retained earnings ............................................. 2,178,000* Total paid-in capital and retained earnings ...................... 23,318,000 Less: Treasury stock (15,000 shares) ............ 165,000 Total stockholders’ equity........... $23,153,000 *$1,200,000 + $3,600,000 – $1,542,000a – $1,080,000 a
1,300,000 shares issued less 15,000 shares in treasury = 1,285,000 shares; outstanding; 1,285,000 X $1.20 = $1,542,000.
11-30
.
(For Instructor Use Only)
PROBLEM 11-4A (a)
Retained Earnings Dec. 31
(b)
400,000 Jan. 1 Balance Dec. 31 Dec. 31 Balance
2,380,000 880,000 2,860,000
WADE CORPORATION Partial Balance Sheet December 31, 2014
Stockholders’ equity Paid-in capital Capital stock 8% Preferred stock, $100 par value, noncumulative, 20,000 shares authorized, 10,000 shares issued and outstanding ........................................ $1,000,000 Common stock, no-par, $5 stated value, 600,000 shares authorized, 300,000 shares issued and outstanding ..................... 1,500,000 Total capital stock .................. $2,500,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock ..................... 200,000 Paid-in capital in excess of stated value—common stock ...................... 1,600,000 Total additional paid-in capital ..... 1,800,000 Total paid-in capital ....................... 4,300,000 Retained earnings (See Note A) ......................... 2,860,000 Total stockholders’ equity ............ $7,160,000 Note A: Retained earnings restricted for plant expansion, $160,000.
.
(For Instructor Use Only)
11-31
PROBLEM 11-5A
(a) 1.
2.
3.
11-32
Cash .............................................................. Preferred Stock (1,500 X $100) ............. Paid-in Capital in Excess of Par Value—Preferred Stock .....................
170,000
Cash .............................................................. Common Stock (400,000 X $5) ............. Paid-in Capital in Excess of Stated Value—Common Stock ......................
3,520,000
Treasury Stock (4,000 X $9) ......................... Cash .......................................................
36,000
.
(For Instructor Use Only)
150,000 20,000 2,000,000 1,520,000 36,000
PROBLEM 11-5A (Continued) (b)
PRINGLE CORPORATION Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock 7% Preferred stock, $100 par value, noncumulative, 20,000 shares authorized, 1,500 shares issued and outstanding ................................. $ 150,000 Common stock, no-par, $5 stated value, 1,000,000 shares authorized, 400,000 shares issued, and 396,000 shares outstanding..................... 2,000,000 Total capital stock .................. $2,150,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock ............... 20,000 Paid-in capital in excess of stated value—common stock ................ 1,520,000 Total additional paid-in capital ................................... 1,540,000 Total paid-in capital ................ 3,690,000 Retained earnings ................................. 82,000 Total paid-in capital and retained earnings................. 3,772,000 Less: Treasury stock (4,000 shares) ............................ 36,000 Total stockholders’ equity ..... $3,736,000
.
(For Instructor Use Only)
11-33
PROBLEM 11-6A
KESSLER INC. Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Common stock, $1 par value, 2,000,000 shares authorized, 710,000* shares issued, and 690,000 shares outstanding ................................... Additional paid-in capital Paid-in capital in excess of par value— common stock................................................. Total paid-in capital ..................................... Retained earnings ............................................................. Total paid-in capital and retained earnings ..................................................... Less: Treasury stock—common (20,000 shares) ........... Total stockholders’ equity...........................
***600,000 + 50,000 + 60,000 = 710,000 shares ***$1,500,000 + (50,000 X $2) + (60,000 X $3) = $1,780,000 ***$700,000 – $207,000 + $410,000 = $903,000
11-34
.
(For Instructor Use Only)
$ 710,000 1,780,000** 2,490,000 903,000*** 3,393,000 76,000 $3,317,000
PROBLEM 11-7A (a) (i)
2014 Return on assets
$2,240,000 $15,687,500
(ii)
(iii)
Return on common stockholders’ equity
Payout ratio
$9,400,000
$2,240,000
(iv)
Debt to assets ratio
= 14.3%
$2,240,0 00 – $300,000
$890,000
$6,000,000
2013
= 20.6%
= 39.7%
Times interest earned
$17,763,000
= 14.1%
$2,500,000 – $300,000 $14,100,000
$1,026,000 $2,500,000
$3,000,000 = 41.4%
$14,500,000
(v)
$2,500,000
$16,875,000
= 15.6%
= 41.0%
= 17.8%
($2,240,000 +$500,000+$670,000)
($2,500,000 +$140,000 + $750,000)
$500,000 = 6.8 times
$140,000 = 24.2 times
(b) Cepeda’s net income declined from $2,500,000 to $2,240,000. Its return on assets increased slightly, but its return on common stockholders’ equity increased 32%. Based on these two measures, profitability improved. The payout ratio declined about 3%. (c) Cepeda’s debt to assets ratio increased from 17.8% to 41.4% and its times interest earned decreased from 24.2 to 6.8 times. These changes indicate that Cepeda is less solvent in 2014 than 2013. (d) It appears that the decision to issue debt to purchase common stock was wise. Cepeda’s 10% interest rate was less than its return on assets of 14.3%. This resulted in the 32% increase in return on common stockholders’ equity. Although the solvency ratios declined, Cepeda does not appear to be in trouble covering the extra debt. Its times interest earned ratio of 6.8 times is probably good coverage. If Cepeda’s earnings start to drop, it could consider reissuing the treasury stock and paying off debt.
.
(For Instructor Use Only)
11-35
*PROBLEM 11-8A
(a) Jan. 15 Feb. 15 Apr. 15
May 15
Dec.
Cash Dividends (70,000 X $0.50) ...... Dividends Payable......................
35,000
Dividends Payable ............................. Cash ............................................
35,000
Stock Dividends (7,000 X $14) .......... Common Stock Dividends Distributable (7,000 X $10) ...... Paid-in Capital in Excess of Par Value—Common Stock (7,000 X $4) ..............................
98,000
Common Stock Dividends Distributable ................................... Common Stock (7,000 X $10) ....
1 31 31 31
35,000 35,000
70,000 28,000 70,000 70,000
Cash Dividends (77,000 X $0.60) ...... Dividends Payable......................
46,200
Income Summary .............................. Retained Earnings ......................
400,000
Retained Earnings ............................. Stock Dividends .........................
98,000
Retained Earnings ............................. Cash Dividends ..........................
81,200
46,200 400,000 98,000 81,200
(b) Common Stock 1/1 Bal. 700,000 5/15 70,000 12/31 Bal. 770,000
11-36
.
(For Instructor Use Only)
12/31 12/31
Retained Earnings 98,000 1/1 Bal. 620,000 81,200 12/31 400,000 12/31 Bal. 840,800
*PROBLEM 11-8A (Continued) Paid-in Capital in Excess of Par Value 1/1 Bal. 500,000 4/15 28,000 12/31 Bal. 528,000 Cash Dividends 1/15 35,000 12/1 46,200 12/31 12/31 Bal. –0–
(c)
81,200
Common Stock Dividends Distributable 5/15 70,000 4/15 70,000 12/31 Bal. –0–
Stock Dividends 4/15 98,000 12/31 12/31 Bal. –0–
EVERETT CORPORATION Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock Common stock, $10 par value, 77,000 shares issued and outstanding ........................................ Additional paid-in capital Paid-in capital in excess of par value . Total paid-in capital ....................... Retained earnings ............................................... Total stockholders’ equity ............
.
98,000
(For Instructor Use Only)
$ 770,000 528,000 1,298,000 840,800 $2,138,800
11-37
*PROBLEM 11-8A (Continued) (d) Payout ratio =
$81,200 =20.3% $400,000
Return on common stockholders’ equity =
$400,000 – 0 $400,000 = =20.2% ($1,820,000*+$2,138,800**) ÷ 2 $1,979,400 *$700,000 + $500,000 + $620,000
11-38
.
(For Instructor Use Only)
**from req. (c)
PROBLEM 11-1B
(a) Jan. 10
Mar. 1
May
1
Sept. 1
Nov. 1
Cash (40,000 X $3.60) ........................ Common Stock (40,000 X $1) .... Paid-in Capital in Excess of Stated Value-Common Stock (40,000 X $2.60) .............
144,000
Cash (5,000 X $102) ........................... Preferred Stock (5,000 X $100) .... Paid-in Capital in Excess of Par Value—Preferred Stock (5,000 X $2) ..............................
510,000
Cash (90,000 X $4) ............................. Common Stock (90,000 X $1) .... Paid-in Capital in Excess of Stated Value—Common Stock (90,000 X $3)..................
360,000
Cash (10,000 X $4.40) ........................ Common Stock (10,000 X $1) .... Paid-in Capital in Excess of Stated Value—Common Stock (10,000 X $3.40) .............
44,000
Cash (4,000 X $103) ........................... Preferred Stock (4,000 X $100) ... Paid-in Capital in Excess of Par Value—Preferred Stock (4,000 X $3) ..............................
412,000
40,000 104,000 500,000 10,000 90,000 270,000 10,000 34,000 400,000 12,000
(b) Preferred Stock 3/1 500,000 11/1 400,000 12/31 Bal. 900,000 .
(For Instructor Use Only)
Paid-in Capital in Excess of Par Value—Preferred Stock 3/1 10,000 11/1 12,000 12/31 Bal. 22,000 11-39
PROBLEM 11-1B (Continued)
Common Stock 1/10 40,000 5/1 90,000 9/1 10,000 12/31 Bal. 140,000
(c)
Paid-in Capital in Excess of Stated Value—Common Stock 1/10 104,000 5/1 270,000 9/1 34,000 12/31 Bal. 408,000
BENNIS CORPORATION Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock 8% Preferred stock, $100 par value, 10,000 shares authorized, 9,000 shares issued .......................................... Common stock, no-par, $1 stated value, 500,000 shares authorized, 140,000 shares issued .......................................... Total capital stock .................. Additional paid-in capital Paid-in capital in excess of par value—preferred stock ............... Paid-in capital in excess of stated value—common stock ................ Total additional paid-in capital ................................... Total paid-in capital ................
11-40
.
(For Instructor Use Only)
$900,000
140,000 $1,040,000 22,000 408,000 430,000 $1,470,000
PROBLEM 11-2B (a) Feb.
1
Nov. 10 Nov. 15 Dec.
1
Dec. 15 Dec. 31
31
(b)
.
Cash ................................................... Common Stock (20,000 X $1) .... Paid-in Capital in Excess of Stated Value—Common Stock ($160,000 – $20,000) .....
160,000
Treasury Stock .................................. Cash ............................................
16,000
Cash Dividends ($200,000 X .09) ...... Dividends Payable .....................
18,000
Cash Dividends ([1,000,000 – 8,000 + 20,000 – 4,000) X $0.30] ................................ Dividends Payable .....................
20,000 140,000 16,000 18,000
302,400 302,400
Dividends Payable ............................ Cash ............................................
18,000
Income Summary .............................. Retained Earnings......................
408,000
Retained Earnings ............................. Cash Dividends ..........................
320,400
Dividends Payable ............................ Cash ............................................
302,400
18,000 408,000 320,400 302,400
200,000 200,000
Paid-in Capital in Excess of Par Value—Preferred Stock 1/1 Bal. 16,000 12/31 Bal. 16,000
Common Stock 1/1 Bal. 1,000,000 2/1 20,000 12/31 Bal. 1,020,000
Paid-in Capital in Excess of Stated Value—Common Stock 1/1 Bal. 1,400,000 2/1 140,000 12/31 Bal. 1,540,000
Preferred Stock 1/1 Bal. 12/31 Bal.
(For Instructor Use Only)
11-41
PROBLEM 11-2B (Continued) 12/31
Retained Earnings 320,400 1/1 Bal. 1,716,000 12/31 408,000 12/31 Bal.1,803,600
Cash Dividends 11/15 18,000 12/1 302,400 12/31 12/31 Bal. –0– (c)
Treasury Stock—Common 1/1 Bal. 20,000 11/10 16,000 12/31 Bal. 36,000
320,400
WARDEN CORPORATION Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock 9% Preferred stock, $50 par value, cumulative, 10,000 shares authorized, 4,000 shares issued and outstanding ................................. Common stock, no-par, $1 stated value, 2,000,000 shares authorized, 1,020,000 shares issued and 1,008,000 shares outstanding ................................. Total capital stock .................. Additional paid-in capital Paid-in capital in excess of par value—preferred stock ............... Paid-in capital in excess of stated value—common stock ................ Total additional paid-in capital ................................... Total paid-in capital ................ Retained earnings ........................................ Total paid-in capital and retained earnings ................. Less: Treasury stock (12,000 common shares) .................. Total stockholders’ equity .....
11-42
.
(For Instructor Use Only)
$ 200,000
1,020,000 $1,220,000 16,000 1,540,000 1,556,000 2,776,000 1,803,600 4,579,600 36,000 $4,543,600
PROBLEM 11-2B (Continued) (d) Payout ratio=
$302,400 = 74.1% $408,000
Earnings per share = *1,000,000 – 8,000
$408,000 – $18,000 $390,000 = = $0.39 (992,000* +1,008,000** ) ÷ 2 1,000,000 **1,020,000 – 12,000
Return on common stockholders’ equity =
$408,000 – $18,000 $390,000 = = 9.3% a b ($4,096,000 + $4,327,600 ) ÷ 2 $4,211,800
a
Beginning common stockholders’ equity: $1,000,000 + $1,400,000 + $1,716,000 – $20,000
b
.
Ending common stockholders’ equity: $1,020,000 + $1,540,000 + $1,803,600 – $36,000
(For Instructor Use Only)
11-43
PROBLEM 11-3B PEABODY COMPANY Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock 7% Preferred stock, $100 par value, cumulative, 80,000 shares issued and outstanding ............................... Common stock, $10 par value, 820,000 shares issued and 800,000 shares outstanding ............ Total capital stock ............................... Additional paid-in capital Paid-in capital in excess of par value—preferred stock .................... Paid-in capital in excess of par value—common stock ..................... Total additional paid-in capital ... Total paid-in capital ..................... Retained earnings ............................................. Total paid-in capital and retained earnings ...................... Less: Treasury stock—common (20,000 shares) ....................................... Total stockholders’ equity...........
$8,000,000 8,200,000 $16,200,000 560,000 2,460,000 3,020,000 19,220,000 2,340,000* 21,560,000 300,000 $21,260,000
*$1,600,000 + $2,900,000 – $1,600,000a – $560,000 a
820,000 shares issued less 20,000 shares in treasury = 800,000 shares; outstanding; 800,000 X $2.00 = $1,600,000.
11-44
.
(For Instructor Use Only)
PROBLEM 11-4B
(a)
Retained Earnings Dec. 31
(b)
380,000 Jan. 1 Balance Dec. 31 Net Income Dec. 31 Balance
800,000 300,000 720,000
DONDEC CORPORATION Partial Balance Sheet December 31, 2014
Stockholders’ equity Paid-in capital Capital stock 10% Preferred stock, $50 par value, cumulative, 20,000 shares authorized, 6,000 shares issued and outstanding ..................... $ 300,000 Common stock, $10 par value, 500,000 shares authorized, 350,000 shares issued and outstanding ........................................ 3,500,000 Total capital stock .................. $3,800,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock ...................... 250,000 Paid-in capital in excess of par value—common stock ....................... 520,000 Total additional paid-in capital ..... 770,000 Total paid-in capital ....................... 4,570,000 Retained earnings (See Note X) ......................... 720,000 Total stockholders’ equity ............ $5,290,000 Note X: Retained earnings restricted for plant expansion, $150,000.
.
(For Instructor Use Only)
11-45
PROBLEM 11-5B
(a) (1) Cash .............................................................. Preferred Stock (4,000 X $100) ............. Paid-in Capital in Excess of Par Value—Preferred Stock .....................
452,000
(2) Cash .............................................................. Common Stock (600,000 X $4) ............. Paid-in Capital in Excess of Stated Value—Common Stock ......................
9,000,000
(3) Treasury Stock (40,000 X $17) ..................... Cash .......................................................
680,000
11-46
.
(For Instructor Use Only)
400,000 52,000 2,400,000 6,600,000 680,000
PROBLEM 11-5B (Continued) (b)
HARTWELL CORPORATION Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock 8% Preferred stock, $100 par value, noncumulative, 25,000 shares authorized, 4,000 shares issued and outstanding ................................. $ 400,000 Common stock, no-par, $4 stated value, 1,000,000 shares authorized, 600,000 shares issued, and 560,000 shares outstanding..................... 2,400,000 Total capital stock .................. $ 2,800,000 Additional paid-in capital Paid-in capital in excess of par value—preferred stock ............... 52,000 Paid-in capital in excess of stated value—common stock ................ 6,600,000 Total additional paid-in capital ................................... 6,652,000 Total paid-in capital ................ 9,452,000 Retained earnings ................................. 3,630,000 Total paid-in capital and retained earnings................. 13,082,000 Less: Treasury stock (40,000 shares) ........................... 680,000 Total stockholders’ equity ..... $12,402,000
.
(For Instructor Use Only)
11-47
PROBLEM 11-6B
FERRIS INC. Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Common stock, $5 par value, 2,000,000 shares authorized, 735,000* shares issued, and 710,000 shares outstanding .......................................... Additional paid-in capital Paid-in capital in excess of par value— common stock ......................................................... Total paid-in capital ............................................ Retained earnings ............................................................. Total paid-in capital and retained earnings....... Less: Treasury stock (25,000 shares) ............................. Total stockholders’ equity ..................................
***600,000 + 75,000 + 60,000 = 735,000 shares ***$1,800,000 + (75,000 X $4) + (60,000 X $4.50) = $2,370,000 ***$810,000 – $284,000 + $860,000 = $1,386,000
11-48
.
(For Instructor Use Only)
$3,675,000 2,370,000** 6,045,000 1,386,000*** 7,431,000 250,000 $7,181,000
PROBLEM 11-7B
2014 (a) (i)
Return on assets
$800,000 $5,312,500
(ii) Return on common stockholders’ equity
(iii) Payout ratio
(iv) Debt to assets ratio
$3,322,500
$800,000
$2,000,000 $5,000,000
(v) Times interest earned
= 15.1%
$800,000 − $40,000
$270,000
2013 $900,000 $6,230,000
= 14.4%
$900,000 − $40,000 = 22.9%
= 33.8%
= 40%
$5,250,000
$300,000 $900,000
$1,200,000 $5,610,000
= 16.4%
= 33.3%
= 21.4%
($800,000+$120,000+ $166,000)
($900,000+$50,000+ $190,000)
$120,000 = 9.1 times
$50,000 = 22.8 times
(b) Hercules Company’s net income decreased $100,000 in 2014 even though its sales remained constant. Its return on assets, 15.1% increased about 5% from 2013 to 2014. Its payout ratio increased 0.2%. Its return on common stockholders’ equity increased almost 40% from 2013 to 2014. An increase of this size indicates improved profitability. (c) Hercules Company acquired more debt in 2014 and became less solvent. Its debt to assets ratio increased from 21.4% to 40%. In 2013, Hercules times interest earned was 22.8 times compared to 9.1 times in 2014. It is clear that Hercules is less solvent in 2014 than 2013.
.
(For Instructor Use Only)
11-49
PROBLEM 11-7B (Continued) (d) It appears that the decision to issue bonds and purchase treasury stock was a wise choice. The bonds require payment of 8% interest which is less than Hercules 15.1% return on assets. This positive difference resulted in the significant improvement in return on common stockholders’ equity. Hercules is less solvent in 2014 than 2013 but does not appear to have trouble covering interest payments. If Hercules earnings drop, it could consider reissuing the treasury stock to pay off the bonds.
11-50
.
(For Instructor Use Only)
*PROBLEM 11-8B
(a) Feb. Mar. July
1 1 1
Cash Dividends (80,000 X $1.00) ...... Dividends Payable .....................
80,000
Dividends Payable ............................ Cash ............................................
80,000
Stock Dividends (12,000* X $25) ...... Common Stock Dividends Distributable (12,000 X $20) .... Paid-in Capital in Excess of Par Value (12,000 X $5) ...........
300,000
80,000 80,000
240,000 60,000
*80,000 shares X 0.15 31
Dec.
1 31
.
Common Stock Dividends Distributable ................................... Common Stock ...........................
240,000 240,000
Cash Dividends (92,000 X $1) ........... Dividends Payable .....................
92,000
Income Summary .............................. Retained Earnings......................
500,000
Retained Earnings ............................. Stock Dividends .........................
300,000
Retained Earnings ............................. Cash Dividends ..........................
172,000
(For Instructor Use Only)
92,000 500,000 300,000 172,000
11-51
*PROBLEM 11-8B (Continued) (b) Common Stock 1/1 Bal. 1,600,000 7/31 240,000 12/31 Bal. 1,840,000 Paid-in Capital in Excess of Par Value 1/1 Bal. 240,000 7/1 60,000 12/31 Bal. 300,000 Cash Dividends 2/1 80,000 12/1 92,000 12/31 12/31 Bal. –0–
11-52
.
(For Instructor Use Only)
172,000
12/31 12/31
Retained Earnings 300,000 1/1 Bal. 750,000 172,000 12/31 500,000 12/31 Bal. 778,000
Common Stock Dividends Distributable 7/31 240,000 7/1 240,000 12/31 Bal. –0–
Stock Dividends 7/1 300,000 12/31 300,000 12/31 Bal. –0–
*PROBLEM 11-8B (Continued) (c)
LAMAR CORPORATION Partial Balance Sheet December 31, 2014 Stockholders’ equity Paid-in capital Capital stock Common stock, $20 par value, 92,000 shares issued and outstanding ........................................ Additional paid-in capital Paid-in capital in excess of par value . Total paid-in capital ....................... Retained earnings ............................................... Total stockholders’ equity ............
$1,840,000 300,000 2,140,000 778,000 $2,918,000
$172,000a = 34.4% (d) Payout ratio = $500,000 a
($80,000 + $92,000)
Return on common stockholders’ equity =
$500,000 – 0 $500,000 = = 18.2% ($2,590,000 * + $2,918,000 ** ) ÷ 2 $2,754,000 *$1,600,000 + $240,000 + $750,000
.
(For Instructor Use Only)
**from req. (c)
11-53
COMPREHENSIVE PROBLEM SOLUTION
(a)
1. Cash ................................................................ Preferred Stock ....................................... Paid-in Capital in Excess of Par Value—Preferred Stock............
49,200
2. Cash ................................................................ Common Stock........................................ Paid-in Capital in Excess of Par Value—Common Stock ............
21,000
3. Accounts Receivable ..................................... Service Revenue .....................................
320,000
4. Cash ................................................................ Unearned Service Revenue ....................
36,000
5. Cash ................................................................ Accounts Receivable ..............................
276,000
6. Supplies .......................................................... Accounts Payable ...................................
35,100
7. Accounts Payable........................................... Cash .........................................................
32,200
8. Treasury Stock ............................................... Cash .........................................................
11,200
9. Other Operating Expenses ............................ Cash .........................................................
188,200
10. Cash Dividends ($3,360 + $10,200*) .............. Dividends Payable ..................................
13,560
11. Allowance for Doubtful Accounts ................. Accounts Receivable ..............................
1,700
*[($80,000 ÷ $10) + 900 – 400] X $1.20 11-54
.
(For Instructor Use Only)
48,000 1,200 9,000 12,000 320,000 36,000 276,000 35,100 32,200 11,200 188,200 13,560 1,700
COMPREHENSIVE PROBLEM SOLUTION (Continued) Adjusting Entries 1. Supplies Expense ($4,400 + $35,100 – $5,900) .. Supplies................................................... 2. Unearned Service Revenue ........................... Service Revenue ($36,000 X 9/12) .......... 3. Bad Debts Expense [$3,500 – ($1,500 – $1,700)] ... Allowance for Doubtful Accounts ......... 4. Depreciation Expense .................................... Accumulated Depreciation—Buildings ($142,000 – $10,000) ÷ 30 .................... 5. Income Tax Expense ...................................... Income Taxes Payable............................ (b)
33,600 33,600 27,000 27,000 3,700 3,700 4,400 4,400 35,130
KLINGER CORPORATION Adjusted Trial Balance 12/31/14 Account Debit Cash ...................................................................... $175,200 Accounts Receivable ........................................... 87,800 Allowance for Doubtful Accounts ....................... Supplies ................................................................ 5,900 Land ...................................................................... 40,000 Buildings .............................................................. 142,000 Accum. Depreciation—Buildings........................ Accounts Payable ................................................ Income Taxes Payable ......................................... Unearned Service Revenue ................................. Dividends Payable ............................................... Preferred Stock .................................................... Paid-in Capital in Excess of Par Value—P.S. ..... Common Stock .................................................... Paid-in Capital in Excess of Par Value—C.S. ..... Retained Earnings ............................................... Cash Dividends .................................................... 13,560 Treasury Stock .................................................... 11,200 Service Revenue .................................................. Bad Debt Expense ............................................... 3,700 Depreciation Expense ......................................... 4,400 Supplies Expense ................................................ 33,600 Other Operating Expenses .................................. 188,200 Income Tax Expense ........................................... 35,130 Total .................................................................. $740,690
.
35,130
(For Instructor Use Only)
Credit $
3,500
26,400 28,500 35,130 9,000 13,560 48,000 1,200 89,000 12,000 127,400 347,000
$740,690 11-55
COMPREHENSIVE PROBLEM SOLUTION (Continued) (c)
Bal.
Bal.
Bal. Bal.
Optional T Accounts Cash 24,600 49,200 21,000 36,000 276,000 175,200
32,200 11,200 188,200
Accounts Receivable 45,500 276,000 320,000 1,700 87,800
Allowance for Doubtful Accounts 1,700 Bal. 1,500 3,700 Bal. 3,500
Bal. Bal.
Supplies 4,400 35,100 5,900
Accum. Depreciation—Buildings Bal. 22,000 4,400 Bal. 26,400 Accounts Payable 32,200 Bal. 25,600 35,100 Bal. 28,500 Income Taxes Payable 35,130 Unearned Service Revenue 27,000 36,000 Bal. 9,000 Dividends Payable 13,560
33,600 Preferred Stock
48,000 Bal.
Land 40,000
Bal.
Buildings 142,000
11-56
.
(For Instructor Use Only)
Paid-in Capital in Excess of Par Value—P.S. 1,200
COMPREHENSIVE PROBLEM SOLUTION (Continued) (c) (Continued) Common Stock Bal. Bal.
80,000 9,000 89,000
Paid-in Capital in Excess of Par Value—C.S. 12,000 Retained Earnings Bal. 127,400
Bad Debt Expense 3,700 Depreciation Expense 4,400 Supplies Expense 33,600 Other Operating Expenses 188,200 Income Tax Expense 35,130
Cash Dividends 13,560 Treasury Stock 11,200 Service Revenue
Bal.
.
(For Instructor Use Only)
320,000 27,000 347,000
11-57
COMPREHENSIVE PROBLEM SOLUTION (Continued) (d)
KLINGER CORPORATION Income Statement For the Year ending December 31, 2014 Service revenue ............................................ Operating expenses Other operating expenses..................... Supplies expense .................................. Depreciation expense ............................ Bad debt expense .................................. Total operating expenses ............................. Income before taxes ..................................... Income tax expense............................... Net income.....................................................
$347,000 $188,200 33,600 4,400 3,700 229,900 117,100 35,130 $ 81,970
KLINGER CORPORATION Statement of Retained Earnings For the Year ending December 31, 2014 Retained earnings, 1/1/14 ........................................... Add: Net income ....................................................... Less: Dividends ......................................................... Retained earnings, 12/31/14 .......................................
11-58
.
(For Instructor Use Only)
$127,400 81,970 209,370 13,560 $195,810
COMPREHENSIVE PROBLEM SOLUTION (Continued) KLINGER CORPORATION Balance Sheet At December 31, 2014 Assets Current assets Cash .............................................................. Accounts receivable .................................... Allowance for doubtful accounts ............... Supplies ........................................................ Total current assets ............................... Property, plant, and equipment Land............................................................... Buildings ....................................................... $142,000 Accumulated depreciation .......................... (26,400) Total assets ..........................................................
.
$175,200 $ 87,800 (3,500)
84,300 5,900 265,400
40,000 115,600
155,600 $421,000
Liabilities and Stockholders’ Equity Current liabilities Accounts payable ........................................ $ 28,500 Income taxes payable .................................. 35,130 Dividends payable........................................ 13,560 Unearned service revenue .......................... 9,000 Total current liabilities .........................................
$ 86,190
Stockholders’ equity Paid-in capital Capital stock Preferred stock..................................$48,000 Common stock .................................. 89,000 Total capital stock ......................... Additional paid-in capital Paid-in capital in excess of par value—preferred stock ........... 1,200 Paid-in capital in excess of par value—common stock ............ 12,000 Total additional paid-in capital ........... Total paid-in capital .......................... Retained earnings ........................................ Total paid-in capital and retained earnings ........................... Less: Treasury stock (400 shares) ...................................... Total stockholders’ equity ...............
334,810
(For Instructor Use Only)
137,000
13,200 150,200 195,810 346,010 11,200
11-59
Total liabilities and stockholders’ equity................
11-60
.
(For Instructor Use Only)
$421,000
BYP 11-1
FINANCIAL REPORTING PROBLEM
(a) The common stock has a par value of $0.69 4/9 per share. (b) There are 160 million shares authorized (120 million class A and 40 million class B) of which 57,504,000 (36,479,000 + 21,025,000) are issued. The percentage is 36% (57,504,000 ÷ 160,000,000). (c) The shares outstanding were ............... *57,504,000 – 71,000
(d) Payout ratio =
2011
2010
57,433,000*
56,454,000**
**56,523,000 – 69,000
$18,360 = 41.8% $43,938
Earnings per share = $0.76 (given under financial highlights and statement of earnings)
Return on common stockholders’ equity =
$43,938 – 0 = 6.6% $666,671*
*($665,935 + $667,408) ÷ 2
.
(For Instructor Use Only)
11-61
BYP 11-2
COMPARATIVE ANALYSIS PROBLEM
(a) Return on common stockholders’ equity
Hershey Company
Tootsie Roll
$628,962 ÷ $905,124.5* = 69.5%
$43,938 ÷ $666,671.5** = 6.6%
*($937,601 + $872,648) ÷ 2
Debt to assets
**($665,935 + $667,408) ÷ 2
$3,539,551 ÷ $4,412,199 = 80.2%
$191,921** ÷ $857,856 = 22.4% **($58,355 + $133,566)
Return on assets
$628,962 ÷ $4,342,466* = 14.5%
*($4,412,199 + $4,272,732) ÷ 2
$43,938 ÷ $857,907.5** = 5.1%
**($857,856 + $857,959) ÷ 2
(b) Hershey Company’s return on assets, 14.5%, is larger than Tootsie Roll’s 5.1% indicating that it is more profitable. Comparing the return on common stockholders’ equity indicates that Hershey is significantly more profitable because its shareholders earned 69.5% on each dollar invested while Tootsie Roll’s investors earned only 6.6%. These differences in profitability can be better understood by looking at the debt to assets ratios. Hershey Company’s relies much more on debt to provide a return to its investors. Hershey’s return to stockholders is higher than Tootsie Roll’s because it uses leverage to boost its return to shareholders. Hershey’s interest rate on borrowing is less than the rate it earns on its assets, therefore by borrowing it can increase its return. However, its reliance on debt increases its risk of default and decreases its solvency.
11-62
.
(For Instructor Use Only)
BYP 11-2 (Continued)
(c) Payout ratio
Hershey Company
Tootsie Roll
$304,083 = 48.3% $628,962
$18,360 = 41.8% $43,938
Hershey Company pays out a higher portion of its earnings as dividends.
.
(For Instructor Use Only)
11-63
BYP 11-3
RESEARCH CASE
(a) Before it considered paying a dividend or doing a stock buyback the company paid off near-term debt maturities. (b) Time Warner pays out 40% of its free cash flow as dividends. (c) Investors prefer steady dividends. If a company pays a high dividend in one year, investors often expect a high dividend in subsequent years. Therefore, the company might instead choose to pay a lower dividend that it knows it can sustain in future years, and use the excess to do share buybacks. Using this approach gives the company more flexibility to increase the dividend over time. (d) In the past media companies often attracted investors that were interested in growth. Paying a large dividend will likely attract incomeoriented investors that are less concerned with growth. (e) In the past media companies have been criticized for wasting the company’s cash on bad acquisitions. By paying significant dividends the companies might be trying to send a signal that they will be more careful in the future with how they spend the company’s money. If they don’t see a good investment opportunity they will instead return cash to investors in the form of dividends or stock buybacks.
11-64
.
(For Instructor Use Only)
BYP 11-4
RESEARCH CASE
(a) McDonalds is shifting away from leasing properties toward buying them because the depressed real estate market has made the purchase of properties attractive. (b) McDonalds owns 45 percent of the land that its restaurants sit on, and 70 percent of its restaurant buildings. (c) William Ackerman proposed that the company should borrow money against its real estate properties, and then use this borrowed money to buy back shares of its own stock as treasury stock. (d) Assuming that the rate of return on the company’s assets exceeds the rate paid on the debt, the actions proposed by William Ackerman would increase the company’s return on stockholders’ equity ratio. This would occur because both the increased borrowing as well as the purchase of treasury shares would increase the companies use of leverage. (e) McDonalds probably decided not to do this because they were concerned that the increased leverage would increase the riskiness of the company by reducing its solvency.
.
(For Instructor Use Only)
11-65
BYP 11-5
INTERPRETING FINANCIAL STATEMENTS
(a) This is a dividend transaction—a property dividend. (b) Debt to assets ratio (c) Return on assets Return on common stockholders’ equity
Host Marriott $3,112 = 81.4% $3,822
Marriott International $2,440 = 76.1% $3,207
$(25) = (.7%) $3,822
$200 = 6.2% $3,207
$(25) = (3.5%) $710
$200 = 26.1% $767
(d) The debtholders were concerned that by splitting the company and leaving most of the debt with only one half of the original company the likelihood that the debtholders would be repaid was reduced—that is, the probability that Marriott would default on the debt increased. This reduces the value of the debt investment.
11-66
.
(For Instructor Use Only)
BYP 11-6
REAL-WORLD FOCUS
Answers will vary depending on the company chosen by the student.
.
(For Instructor Use Only)
11-67
BYP 11-7
DECISION MAKING ACROSS THE ORGANIZATION
Year ended After Purchase of Before Purchase of Treasury Stock Treasury Stock $193.6 – 0 $123.4 – 0 = $1.76 = $1.03 109.7 119.9
(a) Earnings per share
Return on common stockholders’ equity
$193.6 = 18% $1,078
$123.4 = 11% $1,126.2
Return on assets
$193.6 = 9.6% $2,016.9
$123.4 = 6.5% $1,889.8
All three measures indicate a significant increase in profitability. (b) Payout ratio
Average cash dividend paid per share
$26.8 = 13.8% $193.6
$31.0 = 25.1% $123.4
$26.8 = $.24 109.7
$31.0 = $.26 119.9
Wendy’s paid less of its earnings as dividends after the purchase of treasury shares than the year before. Wendy’s appeared to be retaining more of its earnings to invest in its operations.
$1,046.3 = 50.4% $2,076.0
(c) Debt to assets ratio
Times interest earned ratio
11-68
.
$769.9 = 41.9% $1,837.9
($193.6 + $30.2 + $113.7) ($123.4 + $19.8 + $84.3) $30.2 $19.8 = 11.2 times = 11.5 times
(For Instructor Use Only)
BYP 11-7 (Continued) Wendy’s debt to assets ratio increased from 41.9% to 50.4% indicating a decrease in its solvency. This increase may not be cause for concern since Wendy’s times interest earned decreased only slightly. (d) Since Wendy’s return on assets and its return on common stockholders’ equity both increased it can be concluded that the improvement was due partially to increased reliance on debt financing and partially to improved profitability in use of assets. (e) It appears that Wendy’s International acted wisely in purchasing treasury stock and taking on more debt. Its profitability improved significantly and it appears to be handling its debt payments comfortably. Wendy’s has been able to increase its earnings per share and return to its stockholders.
.
(For Instructor Use Only)
11-69
BYP 11-8
COMMUNICATION ACTIVITY
Dear Uncle Ken: Thanks for your recent letter and for asking me to explain four terms. Here are my explanations: (1) Authorized stock is the total amount of stock that a corporation is given permission to sell as indicated in its charter. If all authorized stock is sold, a corporation must obtain the consent of the state to amend its charter before it can issue additional shares. (2) Issued stock is the amount of stock that has been sold either directly to investors or indirectly through an investment banking firm. (3) Outstanding stock is capital stock that has been issued and is being held by stockholders. It represents the difference between the stock issued by the company and the stock repurchased by the company. (4) Preferred stock is capital stock that has contractual preferences over common stock in certain areas. I really enjoy my accounting classes and especially like the accounting instructors. I hope your corporation does well, and I wish you continued success with your inventions. Regards,
11-70
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(For Instructor Use Only)
BYP 11-9
ETHICS CASE
(a) The stakeholders in this situation are: The director of Jobe’s R&D division. The president of Jobe. The shareholders of Jobe. Those who live in the environment to be sprayed by the new (untested) chemical. (b) The president is risking the environment and everything and everybody in it that is exposed to this new chemical in order to enhance his company’s sales and to preserve his job. Presidents and entrepreneurs frequently take risks in performing their leadership functions, but this action appears to be irresponsible and unethical. (c) A parent company may protect itself against loss and most reasonable business risks by establishing separate subsidiary corporations, but whether it can insulate itself against this type of action is a matter of state corporate law and criminal law.
.
(For Instructor Use Only)
11-71
BYP 11-10
ETHICS CASE
(a) The stakeholders in this situation are: Mr. Sigle, president of Osborn Corporation. Mandy Drummond, financial vice-president. The stockholders of Osborn Corporation. (b) There is nothing unethical in issuing a stock dividend. But the president’s order to write a press release convincing the stockholders that the stock dividend is just as good as a cash dividend is unethical. A stock dividend is not a cash dividend and does not necessarily place the stockholder in the same position. A stock dividend is a “paper” dividend—the issuance of a certificate, not a check (cash). (c) The stock dividend results in a decrease in retained earnings and an increase of the same amount in paid-in capital with no change in total stockholders’ equity. There is no change in total assets and no change in total liabilities and stockholders’ equity. As a stockholder, preference for a cash dividend versus stock dividend is dependent upon one’s investment objective—income (cash flow) or growth (reinvestment).
11-72
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(For Instructor Use Only)
BYP 11-11
ALL ABOUT YOU
Student responses will vary depending on the organization chosen by the student.
.
(For Instructor Use Only)
11-73
BYP 11-12
FASB CODIFICATION ACTIVITY
(a)
Stock Dividend: An issuance by a corporation of its own common shares to its common shareholders without consideration and under conditions indicating that such action is prompted mainly by a desire to give the recipient shareholders some ostensibly separate evidence of a part of their respective interests in accumulated corporate earnings without distribution of cash or other property that the board of directors deems necessary or desirable to retain in the business.
(b)
Stock Split: An issuance by a corporation of its own common shares to its common shareholders without consideration and under conditions indicating that such action is prompted mainly by a desire to increase the number of outstanding shares for the purpose of effecting a reduction in their unit market price and, thereby, of obtaining wider distribution and improved marketability of the shares. It is sometimes called a stock split-up.
(c)
Except for a few instances, the issuance of additional shares of less than 20 or 25 percent of the number of previously outstanding shares would call for treatment as a stock dividend as described in paragraph 505-20-30-3.
11-74
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(For Instructor Use Only)
BYP 11-13
CONSIDERING PEOPLE, PLANET AND PROFIT
(a)
The new law allows a company to incorporate under a new charter which classifies a company as a “benefit company.” A benefit company’s governing board is allowed to consider social or environmental objectives ahead of profits. The purpose of the law is to shield the board from lawsuits from investors who feel that the purpose of the company should be to maximize profits and shareholder value.
(b)
The article says that some people say the biggest benefit of the law would occur when the company is being considered for either a sale or break-up. Currently, if shareholder value would be maximized by selling the company or breaking it into pieces, board members can be sued if they do not agree to sell or breakup the company. Under this law, the board would be allowed to consider other factors, such as the impact of a sale on the employees or the community. The article suggests that if Ben and Jerry’s had been structured as a benefit corporation the board would not have allowed the company to be sold to Unilever.
(c)
Critics of the new law say that it reduces the accountability of the company to its shareholders. They say that if management makes a bad decision which hurts the value of the company, management can say that it made the decision for reasons other than to maximize profits.
(d)
Previously companies could apply for “B Corp” certification. Under this program, companies are evaluated by a private entity that created and administers the certification. Companies choose to obtain this certification in order to demonstrate their commitment to social and environmental causes. The difference is that this certification does not shield a company from investor lawsuits which claim that the company’s social or environment programs are causing it to not maximizing profits.
(e)
The companies that the article cites as either having adopted benefit corporation standing, or are considering it are: Patagonia Ben and Jerry’s Homemade Emerge Workplace Solutions Greyston Bakery
.
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
11-75
Comet Skateboards
11-76
.
(For Instructor Use Only)
IFRS CONCEPTS AND APPLICATION IFRS 11-1 May 10
Cash (1,000 X $18) ...................................... Share Capital—Ordinary (1,000 X $10) ..................................... Share Premium—Ordinary (1,000 X $8) .......................................
18,000 10,000 8,000
IFRS 11-2 LUTHER CORPORATION Partial Statement of Financial Position December 31, 2014 Equity Share capital—ordinary, €10 par value, 5,000 shares issued and 4,500 shares outstanding ....................................................... Share premium—ordinary................................... Retained earnings ............................................... Less: Treasury shares (500 shares) ................... Total equity ...............................................
€50,000 10,000 45,000 11,000 €94,000
IFRS 11-3 June 12
July 11
Nov. 28
.
Cash .......................................................... Share Capital—Ordinary (60,000 X $1)................................... Share Premium—Ordinary ................
375,000
Cash (1,000 X $110).................................. Share Capital—Preference (1,000 X $100) .................................. Share Premium—Preference (1,000 X $10)....................................
110,000
Treasury Shares ....................................... Cash ...................................................
80,000
(For Instructor Use Only)
60,000 315,000
100,000 10,000 80,000
11-77
IFRS 11-4 (a)
Santander is issuing shares of its Mexican banking subsidiary to the public in order to raise capital. It needs the capital because it has had very high loan-losses on its loans in southern Europe.
(b)
The bank feels that the local listings raise awareness of the bank’s brand when local investors become shareholders. Also, the bank feels that the listing give a “market-based gauge on how each unit is performing.” This is useful for evaluating the performance of the managers in that country.
(c)
Santander has done local listings in Brazil, Chile, Poland, and Peru. Regulators in those countries like the local listings because the fact that the bank has locally traded shares gives the regulators the right to exercise some oversight over the banks.
(d)
Many of Santander’s rivals that needed cash infusions have had to issue shares at deeply discounted prices because their stock price had fallen sharply due to European problems. Santander has instead taken advantage of the fact that hit has large subsidiaries in emerging economies where stock prices were still strong. It has raised funds by issuing some shares in these markets, while still keeping the majority of the shares, and thus maintaining control.
11-78
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(For Instructor Use Only)
IFRS 11-5 INTERNATIONAL FINANCIAL REPORTING PROBLEM
(a)
Cash ................................................................... Share Capital—Ordinary .......................... Share Premium—Ordinary ......................
(b)
(£4,482 – 0) ÷ [(£41,755 + £46,287) ÷ 2] = 10.2%
(c)
Share capital Share premium Merger reserve Equity reserve Retained earnings
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(For Instructor Use Only)
14 0 14
Common stock Paid-in capital in excess of par value Accumulated other comprehensive income Accumulated other comprehensive income Retained earnings
11-79
11-80
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(For Instructor Use Only)
CHAPTER 12 Statement of Cash Flows Learning Objectives 1. 2. 3. 4. 5. *6.
Indicate the usefulness of the statement of cash flows. Distinguish among operating, investing, and financing activities. Explain the impact of the product life cycle on a company’s cash flows. Prepare a statement of cash flows using the indirect method. Use the statement of cash flows to evaluate a company. Prepare a statement of cash flows using the direct method.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Questions 1.
1
C
6.
2
K
11.
2
C
16.
4
C
21.
6*
K
2.
1
C
7.
4
C
12.
4
C
17.
1
K
22.
6*
AP
3.
2
C
8.
3
K
13.
4
C
18.
2
C
23.
6*
C
4.
2
K
9.
3
C
14.
4
C
19.
5
C
5.
2
C
10.
4, 6*
C
15.
4
K
20.
6*
C
Brief Exercises 1.
2
K
4.
3
C
7.
4
AP
10.
5
AP
13.
6*
AP
2.
2
C
5.
4
AP
8.
4
AN
11.
5
AP
14.
6*
AP
3.
2
AP
6.
4
AP
9.
5
AP
12.
5
AN
15.
6*
AP
Do It! Review Exercises 1.
2
C
2.
4
AP
3.
5
AP
Exercises 1.
2
C
4.
4
AP
7.
4
AN
10.
5
AN
13.
6*
AP
2.
2
C
5.
4
AP
8.
4, 5
AP
11.
6*
AP
14.
6*
AP
3.
3
C
6.
4
AP
9.
5
AN
12.
6*
AP
15.
6*
AN
Problems: Set A 1.
2
C
4.
6*
AP
7.
4, 5
AP
9.
4
AP
11.
4
AP
2.
4
AN
5.
4
AP
8.
5, 6*
AP
10.
6*
AP
12.
5
C
3.
4
AP
6.
6*
AP Problems: Set B
1.
2
C
4.
6*
AP
7.
4, 5
AP
9.
4
AP
11.
4
AP
2.
4
AN
5.
4
AP
8.
5, 6*
AP
10.
6*
AP
12.
5
C
3.
4
AP
6.
6*
AP
Continuing Cookie Solutions for this chapter are available online. .
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
12-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Distinguish among operating, investing, and financing activities.
Simple
10–15
2A
Determine cash flow effects of changes in equity accounts.
Simple
10–15
3A
Prepare the operating activities section—indirect method.
Simple
20–30
*4A
Prepare the operating activities section—direct method.
Simple
20–30
5A
Prepare the operating activities section—indirect method.
Simple
20–30
*6A
Prepare the operating activities section—direct method.
Simple
20–30
7A
Prepare a statement of cash flows—indirect method, and compute cash-based ratios.
Moderate
40–50
*8A
Prepare a statement of cash flows—direct method, and compute cash-based ratios.
Moderate
40–50
9A
Prepare a statement of cash flows—indirect method.
Moderate
40–50
*10A
Prepare a statement of cash flows—direct method.
Moderate
40–50
11A
Prepare a statement of cash flows—indirect method.
Moderate
40–50
12A
Identify the impact of transactions on ratios.
Moderate
25–35
1B
Distinguish among operating, investing, and financing activities.
Simple
10–15
2B
Determine cash flow effects of changes in plant asset accounts.
Simple
10–15
3B
Prepare the operating activities section—indirect method.
Simple
20–30
*4B
Prepare the operating activities section—direct method.
Simple
20–30
5B
Prepare the operating activities section—indirect method.
Simple
20–30
*6B
Prepare the operating activities section—direct method.
Simple
20–30
7B
Prepare a statement of cash flows—indirect method, and compute cash-based ratios.
Moderate
40–50
12-2
.
(For Instructor Use Only)
ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number
.
Description
Difficulty Level
Time Allotted (min.)
*8B
Prepare a statement of cash flows—direct method, and compute cash-based ratios.
Moderate
40–50
9B
Prepare a statement of cash flows—indirect method.
Moderate
40–50
*10B
Prepare a statement of cash flows—direct method.
Moderate
40–50
11B
Prepare a statement of cash flows—indirect method.
Moderate
40–50
12B
Identify the impact of transactions on ratios.
Moderate
25–35
(For Instructor Use Only)
12-3
ANSWERS TO QUESTIONS 1.
(a) The statement of cash flows reports the cash receipts and cash payments from operating, investing, and financing activities during a period in a format that reconciles the beginning and ending cash balances. (b) Disagree. The statement of cash flows is required. It is the fourth basic financial statement.
2.
The statement of cash flows answers the following questions about cash: (a) Where did the cash come from during the period? (b) What was the cash used for during the period? and (c) What was the change in the cash balance during the period?
3.
The three activities are: Operating activities include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income. Investing activities include: (a) purchasing and disposing of investments and productive longlived assets and (b) lending money and collecting loans. Financing activities include: (a) obtaining cash from issuing debt and repaying amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying them dividends.
4.
(a) The sources of cash (inflows) in the statement of cash flows come from: (1)
Operating activities i. Sale of goods or services ii. Interest and dividends received
(2)
Investing activities i. Sale of property, plant, and equipment ii. Sale of investments in other entities’ securities iii. Collection of principal on loans to other entities
(3)
Financing activities i. Sale of common stock ii. Issuance of debt (bonds and notes)
(b) The uses of cash (outflows) in the statement of cash flows come from:
12-4
(1)
Operating activities i. Payments to suppliers for inventory ii. Payments to employees for services iii. Payments to government for taxes iv. Payments to lenders for interest v. Payments to others for expenses
(2)
Investing activities i. Purchase of property, plant, and equipment ii. Purchase of investments in other entities’ securities iii. Making loans to other entities
.
(For Instructor Use Only)
Questions Chapter 12 (Continued) (3)
Financing activities i. Payment of cash dividends to stockholders ii. Redeeming principal of long-term debt iii. Payment to reacquire capital stock (treasury stock)
5.
The statement of cash flows presents investing and financing activities so that even noncash transactions of an investing and financing nature are disclosed in the financial statements. If they affect financial conditions significantly, the FASB requires that they be disclosed in either a separate schedule at the bottom of the statement of cash flows or in a separate note or supplementary schedule to the financial statements.
6.
Examples of significant noncash activities are: (1) issuance of stock for assets, (2) conversion of bonds into common stock, (3) issuance of bonds or notes for assets, and (4) noncash exchanges of property, plant, and equipment.
7.
Comparative balance sheets, a current income statement, and certain transaction data all provide information necessary for preparation of the statement of cash flows. Comparative balance sheets indicate how assets, liabilities, and equities have changed during the period. A current income statement provides information about the amount of cash provided or used by operations. Certain transactions provide additional detailed information needed to determine how cash was provided or used during the period.
8.
(a) The phases of the corporate life cycle are the introductory phase, growth phase, maturity phase, and decline phase. (b) During the introductory phase, net cash provided by operating and investing activities would be expected to be negative, and cash from financing would be positive. During the growth phase, a company would be expected to show some small amounts of cash from operations while continuing to show negative cash from investing and positive cash from financing. During the maturity phase, net cash provided by operating, investing, and financing activities would all be expected to be positive while in the decline phase, net cash provided by operating and investing activities would continue to be positive while cash from financing would be negative.
9.
Tootsie Roll has positive net cash provided by operating activities that exceeds its net income. Net cash provided by operating exceeded its investing needs and it retired shares of stock and paid dividends. Tootsie Roll appears to be in the middle to late maturity phase.
10.
The advantage of the direct method is that it presents the major categories of cash receipts and cash payments in a format that is similar to the income statement and familiar to statement users. Its principal disadvantage is that the necessary data can be expensive and time-consuming to accumulate. The advantage of the indirect method is it is often considered easier to prepare, and it provides a reconciliation of net income to net cash provided by operating activities. It also tends to reveal less company information to competitors. Its primary disadvantage is the difficulty in understanding the adjustments that comprise the reconciliation.
.
(For Instructor Use Only)
12-5
Both methods are acceptable but the FASB expressed a preference for the direct method. However, the indirect method is the overwhelming favorite of companies.
12-6
.
(For Instructor Use Only)
Questions Chapter 12 (Continued) 11.
When total cash inflows exceed total cash outflows, the excess is identified as a “net increase in cash” near the bottom of the statement of cash flows.
12.
The indirect method involves converting accrual net income to net cash provided (used) by operating activities. This is done by starting with accrual net income and adjusting for items that do not affect cash. Examples of adjustments include depreciation and other noncash expenses, gains and losses on the sale of noncurrent assets, and changes in the balances of current asset and current liability accounts from one period to the next.
13.
It is necessary to convert accrual basis net income to cash basis income because the unadjusted net income includes items that do not provide or use cash. An example would be an increase in accounts receivable. If accounts receivable increased during the period, revenues reported on the accrual basis would be higher than the actual cash revenues received. Thus, accrual basis net income must be adjusted to reflect the net cash provided by operating activities.
14.
A number of factors could have caused an increase in cash despite the net loss. These are (1) high cash revenues relative to low cash expenses; (2) sales of property, plant, and equipment; (3) sales of investments; (4) issuance of debt or capital stock, and (5) differences between cash and accrual accounting, e.g. depreciation.
15.
Student answers will vary, however the five items selected should come from the following list: Depreciation/amortization/depletion expense. Gain or loss on disposal of a noncurrent asset. Increase/decrease in specific current assets. Increase/decrease in specific current liabilities.
16.
Under the indirect method, depreciation is added back to net income to reconcile net income to net cash provided (used) by operating activities because depreciation is an expense but not a cash payment.
17. The statement of cash flows is useful because it provides information to the investors, creditors, and other users about: (1) the company’s ability to generate future cash flows, (2) the company’s ability to pay dividends and meet obligations, (3) the reasons for the difference between net income and net cash provided by operating activities, and (4) the cash and noncash financing and investing transactions during the period. 18. This transaction is reported in the note or schedule entitled “Noncash investing and financing activities” as follows: “Acquired land through issuance of common stock, $1,700,000.” 19. (a) The current ratio is an accrual-based ratio that measures liquidity while the current cash debt coverage is a cash-based ratio that measures liquidity. (b) Solvency can be measured by the debt to assets ratio (accrual-based) or the cash debt coverage (cash-based). *20. Net cash provided (used) by operating activities under the direct approach is the difference between cash revenues and cash expenses. The direct approach adjusts the revenues and expenses directly to reflect the cash basis. This results in cash net income, which is equal to “net cash provided by operating activities.”
.
(For Instructor Use Only)
12-7
Questions Chapter 12 (Continued) *21. (a) Cash receipts from customers = Revenues from sales
(b) Purchases = Cost of goods sold
+ Decrease in accounts receivable – Increase in accounts receivable
+ Increase in inventory – Decrease in inventory
Cash payments to suppliers = Purchases
+ Decrease in accounts payable – Increase in accounts payable
*22. Sales revenue........................................................................................................ Add: Decrease in accounts receivable .................................................................. Cash receipts from customers ...............................................................................
$2,000,000 150,000 $2,150,000
*23. Depreciation expense is not listed in the direct method operating activities section because it is not a cash flow item—it does not affect cash.
12-8
.
(For Instructor Use Only)
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 12-1 (a) (b) (c) (d)
Cash inflow from financing activity, $200,000. Cash outflow from investing activity, $180,000. Cash inflow from investing activity, $20,000. Cash outflow from financing activity, $50,000.
BRIEF EXERCISE 12-2 (a) Investing activity. (b) Investing activity. (c) Financing activity.
(d) Operating activity. (e) Financing activity. (f) Financing activity.
BRIEF EXERCISE 12-3 Cash flows from financing activities Proceeds from issuance of bonds payable ....................... Payment of dividends .......................................................... Net cash provided by financing activities ..................
$300,000) (40,000) $260,000)
BRIEF EXERCISE 12-4 (a) Net cash provided by operating activities would be lower than net income during the growth phase because inventory must be purchased for future projected sales. Since sales during the growth phase are projected to be increasing, inventory purchases must increase and inventory expensed on an accrual basis would be less than inventory purchased on a cash basis. Also, collections on accounts receivable would lag behind sales; thus, accrual sales would exceed cash collections during the period.
.
(For Instructor Use Only)
12-9
(b) Cash from investing is often positive during the late maturity phase and the decline phase because the firm may sell off excess long-term assets that are no longer needed for productive purposes.
12-10
.
(For Instructor Use Only)
BRIEF EXERCISE 12-5 Net cash provided by operating activities is $2,730,000. Using the indirect approach, the solution is: Net income ................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .......................... Decrease in accounts receivable ........ Decrease in accounts payable ............ Net cash provided by operating activities............................................
$2,500,000
$160,000) 350,000) (280,000)
230,000 $2,730,000
BRIEF EXERCISE 12-6 Cash flows from operating activities Net income ................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .......................... Loss on disposal of plant assets ........ Net cash provided by operating activities............................................
$280,000
$70,000 28,000
98,000 $378,000
BRIEF EXERCISE 12-7 Net income ........................................................... Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable................ Increase in prepaid expenses ..................... Increase in inventories ................................ Net cash provided by operating activities ...................................................
.
(For Instructor Use Only)
$186,000 $80,000) (28,000) (40,000)
12,000 $198,000
12-11
BRIEF EXERCISE 12-8 Original cost of equipment sold ................................................. Less: Accumulated depreciation............................................... Book value of equipment sold .................................................... Less: Loss on disposal of equipment ....................................... Cash flow from sale of equipment .............................................
$22,000 5,100 16,900 3,500 $13,400
BRIEF EXERCISE 12-9 (a) Free cash flow = $89,303,000 – $25,823,000 – $0 = $63,480,000 (b) Current cash debt coverage = $89,303,000 ÷ $251,522,000 = .36 times (c) Cash debt coverage = $89,303,000 ÷ $286,214,500 = .31 times BRIEF EXERCISE 12-10 (a) Free cash flow = $412,000 – $200,000 – $0 = $212,000 (b) Current cash debt coverage = $412,000 ÷ $150,000 = 2.7 times (c) Cash debt coverage = $412,000 ÷ $225,000 = 1.8 times BRIEF EXERCISE 12-11 Free cash flow = ($104,539,000) – $79,330,000 = ($183,869,000) BRIEF EXERCISE 12-12 Free cash flow is net cash provided by operating activities less capital expenditures and cash dividends paid. For Unruh Inc. this would be $332,000 ($734,000 – $310,000 – $92,000). Since it has positive free cash flow that far exceeds its dividend, an increase in the dividend might be possible. However, other factors should be considered. For example, it must have adequate retained earnings, and it should be convinced that a larger dividend can be sustained over future years. It should also use the free cash flow to expand its operations or pay down its debt. 12-12
.
(For Instructor Use Only)
*BRIEF EXERCISE 12-13 Receipts from Sales = customers revenue
+ Decrease in accounts receivable – Increase in accounts receivable
$1,317,060,000 = $1,244,023,000 + $73,037,000 (Decrease in accounts receivable)
*BRIEF EXERCISE 12-14 + Decrease in income taxes payable
Cash payment Income Tax = for income taxes Expense
– Increase in income taxes payable
$119,000,000 = $370,000,000 – $251,000,000* *$528,000,000 – $277,000,000 = $251,000,000 (Increase in income taxes payable) *BRIEF EXERCISE 12-15 Cash Operating payments for expenses, = operating excluding expenses depreciation
+ Increase in prepaid expenses – Decrease in prepaid expenses and + Decrease in accrued expenses payable – Increase in accrued expenses payable
$78,400 = $90,000 – $7,200 – $4,400 SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 12-1 (1) (2) (3) (4) (5) .
Financing activity Operating activity Financing activity Investing activity Investing activity
(For Instructor Use Only)
12-13
DO IT! 12-2 Cash flows from operating activities Net income ................................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .......................................... Patent amortization expense ............................... Gain on disposal of plant assets......................... Decrease in accounts receivable ........................ Increase in accounts payable .............................. Net cash provided by operating activities ....
$100,000 $6,300 4,000 (3,600) 6,000 3,200
15,900 $115,900
DO IT! 12-3 (a) Free cash flow = $73,700 – $24,200 – $13,000 = $36,500 (b) Net cash provided by operating activities fails to take into account that a company a must invest in new plant assets just to maintain the current level of operations. Companies must also maintain dividends at current levels to satisfy investors. The measurement of free cash flow provides additional insight regarding a company’s cash-generating ability.
12-14
.
(For Instructor Use Only)
SOLUTIONS TO EXERCISES EXERCISE 12-1 (a) (b) (c) (d) (e) (f) (g)
Noncash investing and financing activities. Financing activities. Noncash investing and financing activities. Financing activities. Investing activities. Operating activities. Operating activities.
EXERCISE 12-2 (a) Operating activity. (b) Noncash investing and financing activity. (c) Investing activity. (d) Financing activity. (e) Operating activity. (f) Noncash investing and financing activity. (g) Operating activity.
(h) Financing activity. (i) Operating activity. (j) Noncash investing and financing activity. (k) Investing activity. (l) Operating activity. (m) Operating activity (loss); investing activity (cash proceeds from sale). (n) Financing activity.
EXERCISE 12-3 Point in Time A B C D
Phase Introductory phase Decline phase Maturity phase Growth phase
During the introductory phase (point A), net cash provided by operating and investing activities are expected to be negative while cash from financing would be positive. In the growth phase (point D), a company would continue to show negative net cash provided by operating and investing and positive cash from financing.
.
(For Instructor Use Only)
12-15
EXERCISE 12-3 (Continued) During the maturity phase (point C), net cash provided by operating activities and net income would be approximately the same. Net cash provided by operating activities would exceed investing needs. In the decline phase (point B), net cash provided by operating activities would diminish while cash from financing would be negative. EXERCISE 12-4 COSI COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ....................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .............................. Loss on disposal of plant assets ............ Increase in accounts receivable.............. Increase in prepaid expenses ................. Increase in accounts payable .................. Net cash provided by operating activities ................................................
12-16
.
(For Instructor Use Only)
$190,000 $35,000 5,000 (15,000) (4,000) 17,000
38,000 $228,000
EXERCISE 12-5 SANFORD INC. Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ........................................................ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ............................... Decrease in accounts receivable ............. Decrease in inventory ............................... Increase in prepaid expenses .................. Increase in accrued expenses payable ... Decrease in accounts payable ................. Net cash provided by operating activities.................................................
.
(For Instructor Use Only)
$153,000 $27,000) 9,000 4,000 (5,000) 10,000) (7,000)
38,000 $191,000
12-17
EXERCISE 12-6 RAMOS CORPORATION Statement of Cash Flows—Indirect Method For the Year Ended December 31, 2014 Cash flows from operating activities Net income .................................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ......................................... Increase in accounts receivable ........................ Increase in inventory .......................................... Increase in income taxes payable ...................... Decrease in accounts payable ........................... Net cash provided by operating activities ...
$284,100 $162,000 (8,200) (11,000) 4,700 (3,700)
Cash flows from investing activities Sale of land .......................................................... Purchase of building ........................................... Net cash used by investing activities ..........
35,000 (289,000)
Cash flows from financing activities Issuance of bonds ............................................... Payment of dividend ........................................... Purchase of treasury stock ................................ Net cash provided by financing activities ...
200,000 (12,000) (26,000)
Net increase in cash ................................................... Cash at beginning of period ...................................... Cash at end of period .................................................
12-18
.
(For Instructor Use Only)
143,800 427,900
(254,000)
162,000 335,900 45,000 $380,900
EXERCISE 12-7 LAUBER CORP Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ........................................................ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ............................... Loss on disposal of plant assets ............. Net cash provided by operating activities................................................. Cash flows from investing activities Sale of equipment ............................................. Purchase of equipment .................................... Construction of equipment .............................. Net cash used by investing activities ......
$ 72,000)
$28,000) 8,000)
108,000) 25,000* (70,000) (53,000) (98,000)
Cash flows from financing activities Payment of cash dividends.............................. *Cost of equipment sold................................... *Accumulated depreciation .............................. *Book value ....................................................... *Loss on sale of equipment ............................. *Cash proceeds ................................................
.
(For Instructor Use Only)
36,000)
(14,000) $49,000) (16,000)) 33,000) (8,000) $25,000)
)
12-19
EXERCISE 12-8 (a)
SCHMITT COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ................................................ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ....................... Increase in accounts receivable ...... Decrease in inventory....................... Decrease in accounts payable ......... Net cash provided by operating activities ........................................ Cash flows from investing activities Sale of land ............................................... Purchase of equipment ............................ Net cash used by investing activities ........................................ Cash flows from financing activities Issuance of common stock ..................... Payment of cash dividends ..................... Redemption of bonds .............................. Net cash used by financing activities ........................................ Net increase in cash ........................................ Cash at beginning of period ............................ Cash at end of period ......................................
12-20
.
(For Instructor Use Only)
$ 93,000)
$34,000) (12,000) 22,000) (4,000)
40,000) 133,000)
20,000) (60,000) (40,000) 42,000) (39,000) (50,000) (47,000) 46,000) 22,000) $ 68,000)
EXERCISE 12-8 (Continued) (b) 1.
Current cash debt coverage: Net cash provided Average current ÷ by operating activities liabilities $133,000 [Per Part (a)] ÷
2.
$43,000 + $39,000 2
= 3.2 times
Cash debt coverage: Net cash provided Average total ÷ by operating activities liabilities $133,000 ÷
$243,000* + $189,000** = .62 times 2
*$43,000 + $200,000
**$39,000 + $150,000
EXERCISE 12-9 PepsiCo
Coca-Cola
(a) Liquidity Current cash debt coverage
$6,796 $8,772
= .77 times
$8,186 $13,355
= .61 times
(b) Solvency Cash debt coverage
Free cash flow
$6,796 $22,909
= .30 times
$6,796 – $2,128 – $2,732 = $1,936
$8,186 $21,491
= .38 times
$8,186 – $1,993 – $3,800 = $2,393
PepsiCo’s liquidity is higher (better) than Coca-Cola’s. PepsiCo’s current cash debt coverage is 26% higher than Coca-Cola’s. Coca-Cola’s solvency is better than PepsiCo’s since its cash debt coverage is higher and its free cash flow is greater. .
(For Instructor Use Only)
12-21
EXERCISE 12-10 Patton Corporation (a)
Liquidity Current cash debt coverage
(b)
Sager Corporation
$80,000 $50,000
= 1.6 times
$100,000 $100,000
= 1.0 times
Solvency Cash debt coverage
$80,000 $180,000
Free cash flow
= .44 times
$80,000 – $40,000 – $5,000 = $35,000
$100,000 $250,000
= 0.40 times
$100,000 – $70,000 – $10,000 = $20,000
Patton’s liquidity and solvency ratios are higher (better) than Sager’s comparable ratios. In particular, Patton’s current cash debt coverage ratio is 60% higher than Sager’s. This ratio indicates that Patton is substantially more liquid than Sager. Patton’s solvency, as measured by the cash debt coverage ratio and free cash flow, is also better than Sager’s. *EXERCISE 12-11 Revenues ................................................................ Deduct: Increase in accounts receivable ............. Cash receipts from customers* ..................... Operating expenses ............................................... Deduct: Increase in accounts payable ................. Cash payments for operating expenses** ..... Net cash provided by operating activities ............ **
$198,000) 60,000 $138,000 83,000) 23,000 60,000 $ 78,000
Accounts Receivable Balance, Beginning of year 0 Revenues for the year 198,000 Cash receipts for year Balance, End of year 60,000
** Payments for the year 12-22
.
(For Instructor Use Only)
Accounts Payable Balance, Beginning of year 60,000 Operating expenses for year
138,000
0 83,000
Balance, End of year
.
(For Instructor Use Only)
23,000
12-23
*EXERCISE 12-12 (a) Cash payments to suppliers Cost of goods sold ........................ Deduct: Decrease in inventory .... Cost of purchases ......................... Deduct: Increase in accounts payable ........................... Cash payments to suppliers ......... (b) Cash payments for operating expenses Operating expenses exclusive of depreciation ($10,725.7 – $1,216.2) ................ Add: Increase in prepaid expenses ........................ Deduct: Increase in accrued expenses payable ..................... Cash payments for operating expenses ....................................
$5,178.0 million 5.3 $5,172.7 million 15.6 $5,157.1 million
$9,509.5 million $42.2 199.8
(157.6) $9,351.9 million
*EXERCISE 12-13 Cash flows from operating activities Cash receipts from Customers ................................................ Dividend revenue ..................................... Less cash payments: To suppliers for merchandise ................. For salaries and wages ............................ For operating expenses ........................... For income taxes ...................................... For interest ............................................... Net cash provided by operating activities ................................................ *$48,000 + $195,000
12-24
.
(For Instructor Use Only)
$243,000* 18,000* 261,000* $97,000 53,000 28,000 12,000 10,000
200,000* $ 61,000*
*EXERCISE 12-14 TALIAFERRO CORP. Statement of Cash Flows—Direct Method For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers ........................... Less: Cash payments: For goods and services ............................... For income taxes .......................................... For operating expenses ............................... For interest .................................................... Net cash provided by operating activities .............................................. Cash flows from investing activities Sale of building ............................................. Purchase of equipment ................................ Net cash provided by investing activities .............................................. Cash flows from financing activities Issuance of common stock .......................... Payment of cash dividend............................ Purchase treasury stock .............................. Cash paid to redeem bonds at maturity ...... Net cash provided by financing activities .............................................. Net increase in cash.................................................. Cash at beginning of period ..................................... Cash at end of period ................................................
.
(For Instructor Use Only)
$566,100 $279,100 99,000 77,000 22,400
477,500 88,600
197,600 (113,200) 84,400 355,000 (21,800) (48,100) (200,000) 85,100 258,100 11,000 $269,100
12-25
*EXERCISE 12-15 Cash payments for rent Rent expense .............................................................. Add: Increase in prepaid rent ................................... Cash payments for rent ..............................................
$ 30,000* 1,500* $ 31,500*
Cash payments for salaries Salaries and wages expense...................................... Deduct: Increase in salaries and wages payable .... Cash payments for salaries .......................................
$ 54,000* 6,000* $ 48,000*
Cash receipts from customers Revenue from sales .................................................... Add: Decrease in accounts receivable ..................... Cash receipts from customers...................................
$160,000* 9,000* $169,000*
12-26
.
(For Instructor Use Only)
SOLUTIONS TO PROBLEMS PROBLEM 12-1A
(a) (b) (c) (d) (e) (f) (g) (h) (i) (j)
.
Transaction Recorded depreciation expense on the plant assets. Recorded and paid interest expense. Recorded cash proceeds from a sale of plant assets. Acquired land by issuing common stock. Paid a cash dividend to preferred stockholders. Paid a cash dividend to common stockholders. Recorded cash sales. Recorded sales on account. Purchased inventory for cash. Purchased inventory on account.
(For Instructor Use Only)
SCF Activity Affected
Cash Inflow, Outflow, or No Effect?
O
No cash flow effect
O
Cash outflow
I
Cash inflow
NC
No cash flow effect
F
Cash outflow
F
Cash outflow
O O O
Cash inflow No cash flow effect Cash outflow
O
No cash flow effect
12-27
PROBLEM 12-2A
(a) Net income can be determined by analyzing the retained earnings account. Retained earnings beginning of year .......................... $270,000 Add: Net income (plug) ................................................ 58,800* 328,800 Less: Cash dividends .................................................. 20,000 Stock dividends ................................................. 8,800 Retained earnings, end of year .................................... $300,000 *($300,000 + $8,800 + $20,000 – $270,000) (b) Cash inflow from the issue of stock was $12,000 ($160,800 – $140,000 – $8,800). Common Stock 140,000 8,800 12,000 160,800
Stock Dividend Shares Issued for Cash
Cash outflow for dividends was $20,000. The stock dividend does not use cash. (c) Both of the above activities (issue of common stock and payment of dividends) would be classified as financing activities on the statement of cash flows.
12-28
.
(For Instructor Use Only)
PROBLEM 12-3A
PAXSON COMPANY Partial Statement of Cash Flows For the Year Ended November 30, 2014 Cash flows from operating activities Net income ........................................................... $1,750,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ............................. $ 110,000 Decrease in accounts receivable ............... 380,000 Decrease in inventory ............................. 300,000 Increase in prepaid expenses ................ (150,000) Decrease in accounts payable ............... (350,000) Decrease in accrued expenses payable... (100,000) 190,000 Net cash provided by operating activities .......................................... $1,940,000
.
(For Instructor Use Only)
12-29
*PROBLEM 12-4A
PAXSON COMPANY Partial Statement of Cash Flows For the Year Ended November 30, 2014 Cash flows from operating activities Cash receipts from customers......... Less cash payments: To suppliers ............................... For operating expenses ............ Net cash provided by operating activities ........................................
$7,980,000 (1) $4,750,000 (2) 1,290,000 (3)
6,040,000 $1,940,000
Computations: (1) Cash receipts from customers Sales.................................................................. Add: Decrease in accounts receivable .......... Cash receipts from customers ........................
$7,600,000 380,000 $7,980,000
(2) Cash payments to suppliers Cost of goods sold ........................................... Deduct: Decrease in inventories .................... Cost of purchases ............................................ Add: Decrease in accounts payable .............. Cash payments to suppliers ............................
$4,700,000 300,000 4,400,000 350,000 $4,750,000
(3) Cash payments for operating expenses Operating expenses, exclusive of depreciation............................... Add: Increase in prepaid expenses.................................. Decrease in accrued expenses payable .................. Cash payments for operating expenses ........................................ *$450,000 + ($700,000 – $110,000) 12-30
.
(For Instructor Use Only)
$1,040,000* $150,000 100,000
250,000 $1,290,000
PROBLEM 12-5A
THORNTON COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ........................................................ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ............................... Loss on disposal of plant assets ............. Increase in accounts receivable .............. Increase in accounts payable................... Increase in income taxes payable ............ Net cash provided by operating activities.................................................
.
(For Instructor Use Only)
$229,000
$55,000 16,000 (10,000) 9,000 6,000
76,000 $305,000
12-31
*PROBLEM 12-6A
THORNTON COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers......... Less cash payments: For operating expenses ............ For income taxes ....................... Net cash provided by operating activities ........................................
$960,000 (1) $605,000 (2) 50,000 (3)
(1) Cash receipts from customers Revenues ........................................................................ Deduct: Increase in accounts receivable ($70,000 – $60,000) ......................................... Cash receipts from customers...................................... (2) Cash payments for operating expenses Operating expenses per income statement ................. Deduct: Increase in accounts payable ($41,000 – $32,000) ......................................... Cash payments for operating expenses ...................... (3) Cash payments for income taxes Income tax expense per income statement ................. Deduct: Increase in income taxes payable ($13,000 – $7,000) ........................................... Cash payments for income taxes .................................
12-32
.
(For Instructor Use Only)
655,000 $305,000 $970,000 10,000 $960,000 $614,000 9,000 $605,000 $ 56,000 6,000 $ 50,000
PROBLEM 12-7A
(a)
KURTZEL COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income .................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ........................... Increase in accounts receivable .......... Increase in inventory ............................ Increase in accounts payable .............. Decrease in income taxes payable ...... Net cash provided by operating activities ............................................
$32,000
$17,500 (6,000) (8,000) 4,000 (1,000)
38,500
Cash flows from investing activities Sale of equipment ....................................... Cash flows from financing activities Issuance of common stock ........................ Redemption of bonds ................................. Payment of dividends ................................. Net cash used by financing activities ............................................. Net increase in cash .......................................... Cash at beginning of period ............................. Cash at end of period ........................................
.
(For Instructor Use Only)
6,500
8,500 4,000 (16,000) (20,000) (32,000) 15,000 20,000 $35,000
12-33
PROBLEM 12-7A (Continued) (b) 1.
$38,500 $23,000* + $26,000** ÷ = 1.57 times [Per Part (a)] 2 *$15,000 + $8,000
2.
$38,500 ÷
**$19,000 + $7,000
$56,000*+$43,000** = .78 times 2
*$15,000 + $8,000 + $33,000 3.
12-34
**$19,000 + $7,000 + $17,000
$38,500 – $0 – $20,000 = $18,500
.
(For Instructor Use Only)
*PROBLEM 12-8A
(a)
KURTZEL COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers ...... Less cash payments: To suppliers ............................ For operating expenses ......... For interest.............................. For income taxes .................... Net cash provided by operating activities .............
$236,000 (1) $179,000 (2) 6,500 (3) 3,000 9,000 (4)
38,500
Cash flows from investing activities Sale of equipment .......................... Cash flows from financing activities Issuance of common stock ........... Redemption of bonds .................... Payment of dividends .................... Net cash used by financing activities ..............................
197,500
8,500 4,000 (16,000) (20,000)
Net increase in cash .............................. Cash at beginning of period ................. Cash at end of period ............................
(32,000) 15,000 20,000 $ 35,000
Computations: (1) Cash receipts from customers Sales ....................................................................... Deduct: Increase in accounts receivable ............ Cash receipts from customers .....................................
.
(For Instructor Use Only)
$242,000 6,000 $236,000
12-35
*PROBLEM 12-8A (Continued) (2) Cash payments to suppliers Cost of goods sold ....................................................... Add: Increase in inventory ......................................... Cost of purchases ........................................................ Deduct: Increase in accounts payable....................... Cash payments to suppliers ........................................
$175,000 8,000 183,000 4,000 $179,000
(3) Cash payments for operating expenses Operating expenses ..................................................... Deduct: Depreciation .................................................. Cash payments for operating expenses .....................
$ 24,000 17,500 $ 6,500
(4) Cash payments for income taxes Income tax expense ..................................................... Add: Decrease in income taxes payable ................... Cash payments for income taxes................................ (b) 1.
$38,500 $23,000**+ $26,000*** ÷ [Per Part (a)] 2 **$15,000 + $8,000
2.
$38,500 ÷
12-36
= 1.57 times
$56,000* + $43,000** = .78 times 2
**$19,000 + $7,000 + $17,000
$38,500 – $0 – $20,000 = $18,500
.
$
8,000 1,000 9,000
***$19,000 + $7,000
*$15,000 + $8,000 + $33,000 3.
$
(For Instructor Use Only)
PROBLEM 12-9A
ODGERS INC. Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ........................................................ Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ............................... Loss on disposal of plant assets ............. Increase in accounts receivable .............. Increase in inventory ................................ Increase in prepaid expenses .................. Increase in accounts payable................... Decrease in accrued expenses payable .... Net cash provided by operating activities................................................. Cash flows from investing activities Sale of plant assets .......................................... Purchase of investments ................................. Purchase of plant assets.................................. Net cash used by investing activities................................................. Cash flows from financing activities Sale of common stock ...................................... Payment of cash dividends.............................. Redemption of bonds ....................................... Net cash used by financing activities................................................. Net increase in cash................................................. Cash at beginning of period .................................... Cash at end of period ...............................................
.
(For Instructor Use Only)
$154,580
$46,500 7,500 (49,800) (9,650) (2,400) 34,700 (4,500)
22,350 176,930
1,500 (29,000) (100,000) (127,500) 45,000 (26,030) (36,000) (17,030) 32,400 48,400 $ 80,800
12-37
*PROBLEM 12-10A
ODGERS INC. Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers.............. Less cash payments: To suppliers .................................... For income taxes ............................ For operating expenses ................. For interest ..................................... Net cash provided by operating activities ...................................... Cash flows from investing activities Sale of plant assets ............................... Purchase of investments....................... Purchase of plant assets ....................... Net cash used by investing activities ...................................... Cash flows from financing activities Sale of common stock ........................... Payment of cash dividends ................... Redemption of bonds ............................ Net cash used by financing activities ......................................
$338,660 (1) $110,410 (2) 27,280 19,310 (3) 4,730
161,730 176,930
1,500 (29,000) (100,000) (127,500) 45,000 (26,030) (36,000)
Net increase in cash ...................................... Cash at beginning of period ......................... Cash at end of period ....................................
(17,030) 32,400 48,400 $ 80,800
Computations: (1) Cash receipts from customers Sales................................................................. Deduct: Increase in accounts receivable ..... Cash receipts from customers ....................... 12-38
.
(For Instructor Use Only)
$388,460 49,800 $338,660
*PROBLEM 12-10A (Continued) (2) Cash payments to suppliers Cost of goods sold ......................................................... Add: Increase in inventory ........................................... Cost of purchases .......................................................... Deduct: Increase in accounts payable ........................ Cash payments to suppliers ......................................... (3) Cash payments for operating expenses Operating expenses exclusive of depreciation .............................................. Add: Increase in prepaid expenses ............... $2,400 Decrease in accrued expenses payable ................................................. 4,500 Cash payment for operating expenses ...................................................
.
(For Instructor Use Only)
$135,460 9,650 145,110 34,700 $110,410
$12,410 6,900 $19,310
12-39
PROBLEM 12-11A
YANIK COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ........................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................................. Loss on disposal of plant assets ................ Decrease in accounts receivable ................ Increase in inventory ................................... Decrease in prepaid expenses .................... Increase in accounts payable ...................... Net cash provided by operating activities .................................................... Cash flows from investing activities Sale of land ($130,000 + $40,000 – $145,000) ..... Sale of equipment ................................................ Purchase of equipment ....................................... Net cash used by investing activities .........
$ 37,000
$42,000 2,000 8,000 (9,450) 5,720 8,730
57,000 94,000
25,000 8,000 (92,000) (59,000)
Cash flows from financing activities Payment of cash dividends .................................
(12,000)
Net increase in cash .................................................... Cash at beginning of period ....................................... Cash at end of period ..................................................
23,000 45,000 $68,000
Noncash investing and financing activities Acquired land by issuance of common stock..........................................
$40,000
12-40
.
(For Instructor Use Only)
PROBLEM 12-12A
(a) (b) (c) (d)
(e)
(f)
Transaction Recorded credit sales $2,500. Collected $1,900 owed by customers. Paid amount owed to suppliers, $2,750. Recorded sales returns of $500 and credited the customer’s account. Purchased new equipment $5,000; signed a long-term note payable for the cost of the equipment. Purchased a patent and paid $65,000 cash for the asset.
Free Cash Flow ($125,000)
Current Cash Debt Coverage Ratio (0.5 times)
Cash Debt Coverage Ratio (0.3 times)
NE
NE
NE
I
I
I
D
D
D
NE
NE
NE
D*
NE
D
D
NE
NE
*Note to Instructor: If only cash capital expenditures are deducted, this answer would be NE.
.
(For Instructor Use Only)
12-41
PROBLEM 12-1B
Transaction (a) Purchased shares of common treasury stock. (b) Paid a cash dividend to common stockholders. (c) Recorded cash sales. (d) Recorded sales on account. (e) Recorded prepayment of insurance expense. (f) Purchased supplies on account. (g) Recorded amortization expense on a patent. (h) Recorded and received interest revenue. (i) Recorded cash proceeds from a sale of plant assets. (j) Acquired land by issuing a note payable.
12-42
.
(For Instructor Use Only)
SCF Activity Affected
Cash Inflow, Outflow, or No Effect?
F
Cash outflow
F
Cash outflow
O O
Cash inflow No cash flow effect
O
Cash outflow
O
No cash flow effect
O
No cash flow effect
O
Cash inflow
I
Cash inflow
NC
No cash flow effect
PROBLEM 12-2B
(a) Cash inflows (outflows) related to plant assets 2014: Equipment purchase .......................... Land purchase .................................... Proceeds from equipment sales ........
($85,000) (50,000) 5,000*
*Cost of equipment sold $240,000 + $85,000 – $300,000 = $25,000 Accumulated depreciation removed from accounts for sale of equipment Accumulated Depreciation— Equipment 96,000 Plug 14,000 62,000 Depreciation Expense 144,000 Cash proceeds = Cost $25,000 – accumulated depreciation $14,000 – loss $6,000 = $5,000 Note to instructor—some students may find journal entries helpful in understanding this exercise. Equipment...................................................................... Cash........................................................................
85,000
Land ............................................................................... Cash........................................................................
50,000
Cash (plug) .................................................................... Accumulated Depreciation—Equipment ..................... Loss on Disposal of Equipment ................................... Equipment ..............................................................
5,000 14,000 6,000
(b) Equipment purchase Land purchase Proceeds from equipment sale
.
(For Instructor Use Only)
85,000 50,000
25,000
Investing activities (outflow) Investing activities (outflow) Investing activities (inflow)
12-43
PROBLEM 12-3B
HUBBLE COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ...................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ............................. Amortization expense ............................. Decrease in accounts receivable ........... Increase in inventory .............................. Increase in prepaid expenses ................ Increase in accounts payable ................. Increase in accrued expenses payable .... Net cash provided by operating activities ...............................................
12-44
.
(For Instructor Use Only)
$1,245,000
$105,000 15,000 290,000 (140,000) (175,000) 63,000 145,000
303,000 $1,548,000
*PROBLEM 12-4B
HUBBLE COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers ........ Less cash payments: To suppliers............................... For operating expenses ............ Net cash provided by operating activities ........................................
$5,890,000 (1) $3,367,000 (2) 975,000 (3)
4,342,000 $1,548,000
Computations: (1) Cash receipts from customers Sales ................................................................. Add: Decrease in accounts receivable .......... Cash receipts from customers ........................
$5,600,000 290,000 $5,890,000
(2) Cash payments to suppliers Cost of goods sold ........................................... Add: Increase in inventories .......................... Cost of purchases ............................................ Deduct: Increase in accounts payable .......... Cash payments to suppliers ...........................
$3,290,000 140,000 3,430,000 63,000 $3,367,000
(3) Cash payments for operating expenses Operating expenses ($420,000 + $525,000) ................... Add: Increase in prepaid expenses ................................ Deduct: Increase in accrued expenses payable ............. Cash payments for operating expenses.......................................
.
(For Instructor Use Only)
$ 945,000 $175,000 145,000
30,000 $ 975,000
12-45
PROBLEM 12-5B
MOSLEY COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ....................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense .............................. Loss on disposal of equipment ............... Increase in accounts receivable.............. Decrease in accounts payable ................ Increase in income taxes payable ........... Net cash provided by operating activities ................................................
12-46
.
(For Instructor Use Only)
$204,000
$56,000 4,000 (7,000) (8,000) 5,000
50,000 $254,000
*PROBLEM 12-6B
MOSLEY COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers ........ Less cash payments: For operating expenses ............ For income taxes....................... Net cash provided by operating activities ........................................
$843,000 (1) $514,000 (2) 75,000 (3)
(1) Computation of cash receipts from customers Revenues Deduct: Increase in accounts receivable ($72,000 – $65,000) Cash receipts from customers (2) Computation of cash payments for operating expenses Operating expenses per income statement Add: Decrease in accounts payable ($35,000 – $27,000) Cash payments for operating expenses (3) Computation of cash payments for income taxes Income tax expense per income statement Deduct: Increase in income taxes payable ($23,000 – $18,000) Cash payments for income taxes
.
(For Instructor Use Only)
589,000 $254,000 $850,000 7,000 $843,000 $506,000 8,000 $514,000 $80,000 5,000 $75,000
12-47
PROBLEM 12-7B
(a)
FILMORE COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income .................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense ........................... Increase in accounts receivable .......... Increase in inventory ............................ Decrease in accounts payable ............. Increase in income taxes payable ....... Net cash provided by operating activities ............................................ Cash flows from investing activities Sale of equipment ........................................ Purchase of equipment ................................ Net cash provided by investing activities ............................................ Cash flows from financing activities Issuance of bonds ........................................ Payment of cash dividends ......................... Net cash used by financing activities ............................................ Net decrease in cash ........................................... Cash at beginning of period ................................ Cash at end of period ..........................................
12-48
.
(For Instructor Use Only)
$47,000
$ 6,000 (9,000) (16,000) (23,000) 3,000
(39,000) 8,000
10,000 (8,000) 2,000 10,000 (28,000) (18,000) (8,000) 33,000 $25,000
PROBLEM 12-7B (Continued) (b) 1.
$8,000 ÷
$49,000* + $69,000** = .136 times 2
*$23,000 + $26,000
2.
$8,000 ÷
**$46,000 + $23,000
$69,000* + $79,000** = .108 times 2
*$23,000 + $26,000 + $20,000 3.
.
**$46,000 + $23,000 + $10,000
$8,000 – $8,000 – $28,000 = –$28,000
(For Instructor Use Only)
12-49
*PROBLEM 12-8B
(a)
FILMORE COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers ...... Less cash payments: To suppliers ............................ For operating expenses ($37,000 – $6,000) ............... For interest .............................. For income taxes .................... Net cash provided by operating activities ............. Cash flows from investing activities Sale of equipment .......................... Purchase of equipment .................. Net cash provided by investing activities .............. Cash flows from financing activities Issuance of bonds .......................... Payment of cash dividends ........... Net cash used by financing activities ..............................
$286,000 (1) $233,000 (2) 31,000 3,000 11,000 (3)
278,000 8,000
10,000 (8,000) 2,000 10,000 (28,000)
Net decrease in cash ............................. Cash at beginning of period .................. Cash at end of period ............................
(18,000) (8,000) 33,000 $ 25,000
Computations: (1) Cash receipts from customers Sales........................................................................ Deduct: Increase in accounts receivable ............ Cash receipts from customers .............................. 12-50
.
(For Instructor Use Only)
$295,000 9,000 $286,000
*PROBLEM 12-8B (Continued) (2) Cash payments to suppliers Cost of goods sold ....................................................... Add: Increase in inventory ......................................... Cost of purchases ........................................................ Add: Decrease in accounts payable .......................... Cash payments to suppliers .......................................
$194,000 16,000 210,000 23,000 $233,000
(3) Cash payments for income taxes Income tax expense ..................................................... Deduct: Increase in income taxes payable................ Cash payments for income taxes ...............................
$ 14,000 3,000 $ 11,000
(b) 1.
$8,000 ÷
$49,000* + $69,000** = .136 times 2
*$23,000 + $26,000
2.
$8,000 ÷
**$46,000 + $23,000
$69,000* + $79,000** = .108 times 2
*$23,000 + $26,000 + $20,000 3.
.
**$46,000 + $23,000 + $10,000
$8,000 – $8,000 – $28,000 = –$28,000
(For Instructor Use Only)
12-51
PROBLEM 12-9B TURNER INC. Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ....................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .............................. Loss on disposal of plant assets ............ Increase in accounts receivable.............. Decrease in inventory .............................. Increase in prepaid expenses ................. Decrease in accounts payable ................ Increase in accrued expenses payable .................................................. Net cash provided by operating activities ................................................ Cash flows from investing activities Sale of plant assets ......................................... Purchase of plant assets ................................. Purchase of investments................................. Net cash used by investing activities ................................................ Cash flows from financing activities Sale of common stock ..................................... Payment of cash dividends ............................. Redemption of bonds ...................................... Net cash used by financing activities ................................................ Net increase in cash ................................................ Cash at beginning of period ................................... Cash at end of period ..............................................
12-52
.
(For Instructor Use Only)
$137,000
$ 50,000 9,000 (16,000) 3,000 (3,000) (7,000) 6,000
42,000 179,000
2,000 (90,000) (32,000) (120,000) 25,000 (40,000) (40,000) (55,000) 4,000 33,000 $ 37,000
*PROBLEM 12-10B
TURNER INC. Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Cash receipts from customers ............. Less cash payments: To suppliers.................................... For operating expenses ................. For income taxes............................ For interest ..................................... Net cash provided by operating activities...................................... Cash flows from investing activities Sale of plant assets ............................... Purchase of plant assets....................... Purchase of investments ...................... Net cash used by investing activities...................................... Cash flows from financing activities Sale of common stock ........................... Payment of cash dividends................... Redemption of bonds ............................ Net cash used by financing activities...................................... Net increase in cash...................................... Cash at beginning of period ......................... Cash at end of period ....................................
$594,000 (1) $294,000 (2) 62,000 (3) 47,000 12,000
415,000 179,000
2,000 (90,000) (32,000) (120,000) 25,000 (40,000) (40,000) (55,000) 4,000 33,000 $ 37,000
Computations: (1) Cash receipts from customers Sales ............................................... Deduct: Increase in accounts receivable ........................ .
(For Instructor Use Only)
$610,000 16,000 12-53
Cash receipts from customers ......
12-54
.
(For Instructor Use Only)
$594,000
*PROBLEM 12-10B (Continued) (2) Cash payments to suppliers Cost of goods sold ......................................................... Deduct: Decrease in inventory ..................................... Cost of purchases .......................................................... Add: Decrease in accounts payable ............................ Cash payments to suppliers ......................................... (3) Cash payments for operating expenses Operating expenses exclusive of depreciation ............................................ Add: Increase in prepaid expenses ............. Deduct: Increase in accrued expenses payable ............................................ Cash payment for operating expenses .................................................
.
(For Instructor Use Only)
$290,000 3,000 287,000 7,000 $294,000
$65,000 $3,000 (6,000)
(3,000) $62,000
12-55
PROBLEM 12-11B
BERKLER COMPANY Statement of Cash Flows For the Year Ended December 31, 2014 Cash flows from operating activities Net income ........................................................... Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................................. Gain on disposal of equipment ................... Increase in accounts receivable.................. Decrease in inventory .................................. Increase in prepaid expenses ..................... Decrease in accounts payable .................... Net cash provided by operating activities .................................................... Cash flows from investing activities Sale of land........................................................... Sale of equipment ................................................ Purchase of equipment ....................................... Net cash used by investing activities .........
$46,000
$48,000 (3,000) (6,000) 3,000 (4,000) (9,000)
29,000 75,000
34,000 9,000 (88,000) (45,000)
Cash flows from financing activities Payment of cash dividends .................................
(12,000)
Net increase in cash .................................................... Cash at beginning of period ....................................... Cash at end of period ..................................................
18,000 78,000 $96,000
Noncash investing and financing activities Conversion of bonds by issuance of common stock..........................................
$50,000
12-56
.
(For Instructor Use Only)
PROBLEM 12-12B
Transaction
(a) Recorded cash sales $4,800. (b) Sold land for $20,000 cash. (c) Declared $6,000 cash dividends. (d) Paid $5,800 cash dividends declared last year. (e) Paid amount owed to suppliers, $9,400. (f) Retired $20,000 convertible bonds payable by issuing common stock.
.
(For Instructor Use Only)
Free Cash Flow ($80,000)
Current Cash Debt Coverage Ratio (0.7 times)
Cash Debt Coverage Ratio (0.4 times)
I
I
I
NE
NE
NE
NE
D
D
D
I
I
D
D
D
NE
NE
I
12-57
BYP 12-1
FINANCIAL REPORTING PROBLEM
(a) Net cash provided by operating activities: 2011 2010
$50,390,000 $82,805,000
(b) The decrease in cash and cash equivalents for the year ended December 31, 2011 was $37,364,000. (c) Tootsie Roll uses the indirect method of computing and presenting the net cash provided by operating activities. (d) According to the statement of cash flows, accounts receivable increased $5,448,000 in 2011. Inventories increased $15,631,000 in 2011. Accounts payable (and accrued liabilities) increased $84,000 in 2011. (e) The net cash used by investing activities in 2011 was $51,157,000. (f)
12-58
The supplemental disclosure of cash flow information disclosed interest paid of $38,000 and income taxes paid of $16,906,000 in 2011.
.
(For Instructor Use Only)
BYP 12-2
COMPARATIVE ANALYSIS PROBLEM
(a) 1. Current cash debt coverage
2. Cash debt coverage
Hershey
Tootsie Roll
$580,867
$50,390
($1,298,845 + $1,173,775) ÷ 2 = .47 times
($58,505 + $58,355) ÷ 2 = .86 times
$580,867
$50,390
($3,335,131+ $3,539,551) ÷ 2 = .17 times
($190,551* + $191,921**) ÷ 2 = .26 times
**$58,505 + $132,046 **$58,355 + $133,566
(b) Tootsie Roll’s current cash debt coverage provides a ratio of $0.86 of net cash provided by operating activities for every dollar of current debt. It is a better representation of liquidity on an average day than the current ratio. Tootsie Roll’s higher ratio (.86 vs. .47) indicates Tootsie Roll was more liquid in 2011 than Hershey but both measures are acceptable. The cash debt coverage shows a company’s ability to repay its liabilities from cash generated from operating activities without having to liquidate the assets employed in its operations. Since Tootsie Roll’s cash debt coverage was 53% larger than Hershey’s, Tootsie Roll’s ability to repay liabilities with cash from operations was significantly greater than Hershey’s in 2011.
.
(For Instructor Use Only)
12-59
BYP 12-3
RESEARCH CASE
(a) At the end of 2009 the nonfinancial companies in the Standard and Poor’s 500 had accumulated $932 billion. This represented a 31% increase over the prior year. (b) First, cash (and short term investments) do not generate a very good return. Thus, having too much cash on your balance sheet can drag down the return on assets. Second, managers worry that if they accumulate too much cash it will appear that they have run out of good ideas to invest in to grow the company. Another concern is that, if you have a lot of cash on your balance sheet, another company might decide to acquire your company. If you use debt to acquire a company that has a lot of cash, you can use the acquired company’s cash to pay down the debt. (c) In order to motivate its managers to accumulate cash, Alcoa pegged the compensation of its top executives to cash goals. In response, top management cut 28,000 jobs (32% of its workforce), and reduced capital expenditures by 53%. As a consequence, even though its revenue dropped by 31%, it nearly doubled its cash to $1.5 billion. (d) At the time the article was written the stock prices of the Standard and Poor’s 500 was 29% below its October 2007 peak. As a consequence, companies felt that their shares were still undervalued, so they didn’t want to use them to acquire other companies. They felt that they should instead use cash. (e) In addition to acquisitions, companies can increase their dividends or do stock buybacks (buy treasury shares).
12-60
.
(For Instructor Use Only)
BYP 12-4
RESEARCH CASE
(a) The stock was issued at a price of $70 per share. A few months previously it sold for more than $300 per share. (b) The company issued shares of stock, even though its stock price was depressed, because its cash flows were not meeting its immediate needs. The company’s cash flows declined because the company lost subscribers when it raised its prices. (c) Netflix had used up more than $1 billion of cash to buy back stock during the previous four years. (d) The article says that growth companies should be very cautious about using cash to buy back stock. Growth companies have many ups and downs. They need to make sure they have enough cash on hand to get them through downtrends.
.
(For Instructor Use Only)
12-61
BYP 12-5
INTERPRETING FINANCIAL STATEMENTS
(a) Current ratio—2001: $1,207.9 ÷ $ 921.4 = 1.31 —2004: $2,539.4 ÷ $1,620.4 = 1.57 Current cash debt coverage—2001: ($119.8) ÷ $ 948.2 = (.13) times —2004: $566.6 ÷ $1,436.6 = .39 times Both Amazon’s current ratio and its current cash debt coverage improved dramatically from 2001 to 2004. Amazon’s current ratio increased by 20% (from 1.31 to 1.57) during the 3-year period. In addition Amazon’s current cash debt coverage improved by $.52 per dollar of current liabilities (from a negative $.13 per dollar in 2001 to a positive $.39 per dollar in 2004). Amazon’s liquidity improved greatly from 2001 to 2004. (b) Cash debt coverage—2001: ($119.8) ÷ $3,090.0 = (.04) times —2004: $566.6 ÷ $4,773.4 = .12 times Debt to assets ratio —2001: $3,077.5 ÷ $1,637.5 = 1.88 —2004: $5,096.1 ÷ $3,248.5 = 1.57 Amazon’s solvency also improved significantly from 2001 to 2004. Its cash debt coverage increased by $.16 per dollar of total liabilities during the 3-year period. Amazon’s debt to assets ratio also improved (decreased) by 16% from 2001 to 2004. (c) Free cash flow —2001: ($119.8) – $50.3 – $0 = ($170.1) —2004: $566.6 – $89.1 – $0 = $477.5 Amazon’s free cash flow increased by almost $650 million from 2001 to 2004. The increase was caused by Amazon finally generating a profit in 2004. If Amazon is able to continue operating at a profit and producing
12-62
.
(For Instructor Use Only)
a large free cash flow, it should be able to finance an expansion of its operations.
.
(For Instructor Use Only)
12-63
BYP 12-5 (Continued) (d) While these measures tell us a lot about Amazon.com, they don’t tell us whether the stock price is reasonable. Amazon.com’s high stock price is a reflection of a belief by investors that Amazon.com will continue to grow incredibly fast. If this growth falters, its stock price will fall rather quickly. Also, Amazon.com’s heavy reliance on debt financing compounds the risk of investing in its stock because it may have a difficult time paying its debts if its growth does not continue.
12-64
.
(For Instructor Use Only)
BYP 12-6
REAL-WORLD FOCUS
Answers will vary depending on the company chosen by the student.
.
(For Instructor Use Only)
12-65
BYP 12-7
DECISION MAKING ACROSS THE ORGANIZATION
(a)
GILBERT COMPANY Statement of Cash Flows For the Year Ended January 31, 2014 Cash flows from operating activities Net loss .................................................. Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense .................... Gain from disposal of investment Net cash provided by operating activities ..................................... Cash flows from investing activities Sale of investment................................. Purchase of investment ........................ Purchase of fixtures and equipment .... Net cash used by investing activities ..................................... Cash flows from financing activities Sale of capital stock .............................. Purchase of treasury stock .................. Net cash provided by financing activities ..................................... Net increase in cash ..................................... Cash at beginning of period ......................... Cash at end of period ................................... Noncash investing and financing activities Issuance of note for truck .....................
12-66
.
(For Instructor Use Only)
$ (35,000)*
$ 55,000 (5,000)
50,000 15,000
80,000 (75,000) (320,000) (315,000)* 405,000 (10,000) 395,000 95,000 140,000 $235,000 $ 20,000
BYP 12-7 (Continued) *Computation of net income (loss) Sales of merchandise ............................... Interest revenue ........................................ Gain on sale of investment ($80,000 – $75,000) ................................ Total revenues and gains .................. Merchandise purchased ........................... Operating expenses ($170,000 – $55,000) .............................. Depreciation .............................................. Interest expense ........................................ Total expenses................................... Net loss ......................................................
$385,000 6,000 5,000 396,000 $258,000 115,000 55,000 3,000 431,000 $ (35,000)
(b) From the information given, it appears that from an operating standpoint, Gilbert Company did not have a superb first year, having suffered a $35,000 net loss. Robyn is correct; the statement of cash flows is not prepared in correct form. The correct format classifies cash flows from three activities—operating, investing, and financing; and it also presents significant noncash investing and financing activities in a separate schedule. Robyn is wrong, however, about the actual increase in cash not being $95,000; $95,000 is the correct increase in cash.
.
(For Instructor Use Only)
12-67
BYP 12-8
COMMUNICATION ACTIVITY
MEMO To:
Jack Werth
From:
Student
Re:
Statement of cash flows
The statement of cash flows provides information about the cash receipts and cash payments of a firm, classified as operating, investing, and financing activities. The operating activities section of the company’s statement of cash flows shows that cash increased by $172,000 as a result of transactions which affected net income. This amount is computed by adjusting net income for those items which affect net income, but do not affect cash, such as sales on account which remain uncollected at year-end. The investing activities section of the statement reports cash flows resulting from changes in investments and other long-term assets. The company had a cash outflow from investing activities due to purchases of buildings and equipment. The financing activities section of the statement reports cash flows resulting from changes in long-term liabilities and stockholders’ equity. The company had a cash inflow from financing activities due to the issuance of common stock and an outflow due to the payment of cash dividends. If you have any further questions, please do not hesitate to contact me.
12-68
.
(For Instructor Use Only)
BYP 12-9
ETHICS CASE
(a) The stakeholders in this situation are: Rick Hanigan, president of Templeton Automotive Corporation. Nick Korte, controller. The Board of Directors. The stockholders of Templeton Automotive Corporation. (b) The president’s statement, “We must get that amount above $1 million,” puts undue pressure on the controller. This statement along with his statement, “I know you won’t let me down Nick,” encourages Nick to do something unethical. Controller Nick Korte’s reclassification (intentional misclassification) of a cash inflow from a long-term note (financing activity) issuance to an “increase in payables” (operating activity) is inappropriate and unethical. (c) It is unlikely that any board members (other than board members who are also officers of the company) would discover the misclassification. Board members generally do not have detailed enough knowledge of their company’s transactions to detect this misstatement. It is possible that an officer of the bank that made the loan would detect the misclassification upon close reading of Templeton Automotive Corporation’s statement of cash flows. It is also possible that close scrutiny of the balance sheet showing an increase in notes payable (long-term debt) would reveal that there is no comparable financing activity item (proceeds from note payable) in the statement of cash flows.
.
(For Instructor Use Only)
12-69
BYP 12-10
ALL ABOUT YOU
(a) The article describes three factors that determine how much money you should set aside. (1) Your willingness to take risk. You need to evaluate how willing you are to experience wide swings in your financial position. (2) Your needs. You need to carefully evaluate your situation and evaluate the possibility of various events and what the financial implications would be. This is also impacted by the number of dependents you have. (3) Your upcoming expenses. Here you need to look further out into the horizon and consider the implications of larger events such as a big trip, a wedding, or education costs. (b) They recommend having at least three months of living expenses set aside, and up to six months. (c) Responses to this question will vary. What is most important is that students begin the process of considering their cash needs and developing a plan to set aside enough money to provide a cushion in the event of a financial “hiccup.”
12-70
.
(For Instructor Use Only)
BYP 12-11
FASB CODIFICATION ACTIVITY
(a) Cash equivalents are short-term, highly liquid investments that have both of the following characteristics: a. Readily convertible to known amounts of cash b. So near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Generally, only investments with original maturities of three months or less qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a three-month U.S. Treasury bill and a three-year U.S. Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining maturity is three months. Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations). (b) Financing activities include obtaining resources from owners and providing them with a return on, and a return of, their investment; receiving restricted resources that by donor stipulation must be used for long-term purposes; borrowing money and repaying amounts borrowed, or otherwise setting the obligation; and obtaining and paying for other resources obtained from creditors on long-term credit. (c) Investing activities include making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other productive assets, that is, assets held for or used in the production of goods or services by the entity (other than materials that are part of the entity’s inventory). Investing activities exclude acquiring and disposing of certain loans or other debt or equity instruments that are acquired specifically for resale, as discussed in paragraph 230-10-45-12 and 230-10-45-21.
.
(For Instructor Use Only)
12-71
BYP 12-11 (Continued) (d) Operating activities include all transactions and other events that are not defined as investing or financing activities (see paragraph 230-1045-12 through 45-15). Operating activities generally involve producing and delivering goods and providing services. Cash flow from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. (e) The primary objective of a statement of cash flows is to provide relevant information about the cash receipts and cash payments of an entity during a period. As indicated in the glossary at this same section, cash includes not only currency on hand but demand deposits with banks or other financial institutions. Cash also includes other kinds of accounts that have the general characteristics of demand deposits in that the customer may deposit additional funds at any time and also effectively may withdraw funds at any time without prior notice or penalty. All charges and credits to those accounts are cash receipts or payments to both the entity owning the account and the bank holding it. For example, a bank’s granting of a loan by crediting the proceeds to a customer’s demand deposit account is a cash payment by the bank and a cash receipt of the customer when the entry is made. Thus, the basis for the statement of cash flows is cash, not broader measures of liquidity, like working capital. (f)
12-72
Information about all investing and financing activities of an entity during a period that affect recognized assets or liabilities but that do not result in cash receipts or cash payments in the period shall be disclosed. Those disclosures may be either narrative or summarized in a schedule, and they shall clearly relate the cash and noncash aspects of transactions involving similar items.
.
(For Instructor Use Only)
IFRS CONCEPTS AND APPLICATION
IFRS 12-1 Under IFRS bank overdrafts are treated as part of cash and cash equivalents on the balance sheet. As a result, on the statement of cash flows they are part of the change in cash and cash equivalents. In contrast, under GAAP they are treated as a liability on the balance sheet, as a source of financing on the statement of cash flows. IFRS 12-2 The treatment of these items under IFRS and GAAP is as follows:
(a) (b) (c) (d)
Interest paid Interest received Dividends paid Dividends received
IFRS
GAAP
Operating or financing Operating or investing Operating or financing Operating or investing
Operating Operating Financing Operating
IFRS 12-3 In the future cash equivalents will probably not be combined with cash. Instead they will most likely be reported separately, as a type of short term investment.
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(For Instructor Use Only)
12-73
IFRS 12-4 INTERNATIONAL FINANCIAL REPORTING PROBLEM
(a)
The company reports interest paid as an operating activity.
(b)
Zetar’s balance in cash and cash equivalents is negative because the company has £4,282 thousand of cash, but it has £12,923 of bank overdrafts. Bank overdrafts are a form of negative cash, so the company reports negative cash and cash equivalents of £8,641.
(c)
Under GAAP bank overdrafts are not reported in cash and cash equivalents. Instead they are treated as a financing activity, and would be reported on the balance sheet as a liability.
(d)
The components of the “net movement in working capital” are reported on the face of the statement of cash flows as
Decrease in inventory Increase in receivables Decrease in payables
12-74
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(For Instructor Use Only)
£ 72 (5,295) (817) (£ 6,040)
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(For Instructor Use Only)
12-75
CHAPTER 13 Financial Analysis: The Big Picture Learning Objectives 1. 2. 3. 4. 5. 6. 7.
Understand the concept of sustainable income. Indicate how irregular items are presented. Explain the concept of comprehensive income. Describe and apply horizontal analysis. Describe and apply vertical analysis. Identify and compute ratios used in analyzing a company’s liquidity, solvency, and profitability. Understand the concept of quality of earnings.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Questions 1.
1
C
6.
6
C
11.
6
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16.
6
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20.
6
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2.
2
C
7.
4, 5
C
12.
6
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17.
6
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21.
6
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3.
1
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8.
4, 5
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13.
6
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18.
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22.
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4.
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9.
4, 5
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14.
6
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19.
6
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23.
7
AN
5.
3
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10.
6
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15.
6
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Brief Exercises 1.
2
AP
4.
4
AP
7.
4
AP
10.
6
AP
13.
6
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2.
2
AP
5.
5
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8.
5
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11.
6
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14.
6
AN
3.
2
C
6.
4
AP
9.
4
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12.
6
AN
15.
6
AN
Do It! Review Exercises 1.
2
AP
2.
4
AP
3.
6
C
4.
2–7
K
Exercises 1.
2
AP
2.
1, 2, 6
C
3.
4
AP
6.
4, 5
AP
9.
6
AP
12.
6
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4.
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10.
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13.
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5.
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8.
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11.
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5.
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Problems: Set A 1.
5, 6
AN
2.
6
AP
3.
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Problems: Set B 1.
5, 6
AN
2.
6
AP
3.
6
AN
*Continuing Cookie Solutions for this chapter are available online.
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(For Instructor Use Only)
13-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Prepare vertical analysis and comment on profitability.
Simple
20–30
2A
Compute ratios from balance sheet and income statements.
Simple
20–30
3A
Perform ratio analysis, and discuss change in financial position and operating results.
Simple
20–30
4A
Compute ratios; comment on overall liquidity and profitability.
Moderate
30–40
5A
Compute selected ratios, and compare liquidity, profitability, and solvency for two companies.
Moderate
50–60
1B
Prepare vertical analysis and comment on profitability.
Simple
20–30
2B
Compute ratios from balance sheet and income statements.
Simple
20–30
3B
Perform ratio analysis, and discuss change in financial position and operating results.
Simple
20–30
4B
Compute ratios; comment on overall liquidity and profitability.
Moderate
30–40
5B
Compute selected ratios, and compare liquidity, profitability, and solvency for two companies.
Moderate
50–60
13-2
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(For Instructor Use Only)
ANSWERS TO QUESTIONS 1.
Sustainable income is defined as the most likely level of income to be obtained in the future. It is the amount of regular income that a company can expect to earn from its normal operations. In order to distinguish a company’s net income from its sustainable income, irregular items, such as an extraordinary gain or discontinued operations, are reported separately on the income statement.
2.
Items (a) and (f) are extraordinary items; item (g) is debatable.
3.
This would not be considered a favorable trend for Garvey Inc. The relevant earnings per share figures are the $3.26 in 2013 and the $2.99 in 2014. These figures indicate that, unless there was a sale of common stock, the earnings from the continuing operations of the company decreased during 2014. This should give the company’s management some concern because they will not always be able to count on revenue or gains from irregular items.
4.
Companies report a change from FIFO to average cost pricing for inventory retroactively. That is, they report both the current period and any previous periods reported on the face of the statement using the new principle. As a result, the same principle applies in all periods. This treatment improves the ability to compare results across years.
5.
Tootsie Roll reported “Other comprehensive earnings” of ($8,740,000) in 2011. “Comprehensive earnings” was less than “Net earnings” by 19.9% [($35,198 – $43,938) ÷ $43,938]
6.
(a) Jennifer is not correct. There are three characteristics: liquidity, profitability, and solvency. (b) The three parties are not primarily interested in the same characteristics of a company. Shortterm creditors are primarily interested in the liquidity of the enterprise. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company.
7.
(a) Comparison of financial information can be made on an intracompany basis, an intercompany basis, and an industry average basis. 1. An intracompany basis compares the same item with prior periods, or with other financial items in the same period. 2. An intercompany basis compares the same item with other companies’ published reports. 3. The industry average compares the item with the industry average as compiled by Dun & Bradstreet or by trade associations. (b) The intracompany basis of comparison is useful in detecting changes in financial relationships and significant trends within a company. The intercompany basis of comparison provides insight into a company’s competitive position. The industry average basis provides information about a company’s relative position within the industry.
8.
.
Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or decrease of an item over a period of time. In this approach, the amount of the item on one statement is compared with the amount of that same item on one or more earlier statements. Vertical analysis, also called common-size analysis, expresses each item within a financial statement as a percent of a relevant base amount.
(For Instructor Use Only)
13-3
Questions Chapter 13 (Continued) 9.
(a) $300,000 X 1.245 = $373,500, 2014 net income. (b) $300,000 ÷ .06 = $5,000,000, 2013 revenue.
10.
(a) Liquidity ratios: Working capital, current ratio, current cash debt coverage, inventory turnover, days in inventory, accounts receivable turnover, and average collection period. (b) Solvency ratios: Debt to assets ratio, cash debt coverage, times interest earned, and free cash flow.
11.
Andrea is correct. A single ratio by itself may not be very meaningful and is best interpreted by comparison with (1) past ratios of the same company, (2) ratios of other companies, or (3) industry norms or predetermined standards. In addition, other ratios of the company are necessary to determine overall financial well-being.
12.
(a) Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. (b) Solvency ratios measure the company’s ability to survive over a long period of time. (c) Profitability ratios measure the income or operating success of a company for a given period of time.
13.
Working capital and the current ratio both relate current assets to current liabilities. Working capital produces a dollar amount that indicates the difference between current assets and current liabilities. The current ratio produces a ratio which indicates the proportional relationship between current assets and current liabilities.
14.
Quick Mart does not necessarily have a problem. The accounts receivable turnover can be misleading in that some companies encourage credit and revolving charge sales and slow collections in order to earn a healthy return on the outstanding receivables in the form of high rates of interest.
15.
(a) (b) (c) (d)
16.
The price earnings (P-E) ratio is a reflection of investors’ assessments of a company’s future earnings. The P-E ratio takes into account such factors as relative risk, stability of earnings, trends in earnings, and the market’s perception of the company’s growth potential. In this question, investors favor Microsoft because it has the higher P-E ratio. The investors feel that Microsoft will be able to generate even higher future earnings and thus investors are willing to pay more for the stock.
17.
The payout ratio is cash dividends declared on common stock divided by net income. In a growth company, the payout ratio is often low because the company is reinvesting earnings in the business.
18.
(a) The increase in the profit margin is good news because it means that a greater percentage of net sales is going towards income. (b) The decrease in inventory turnover signals bad news because it is taking the company longer to sell the inventory and consequently there is a greater chance of inventory obsolescence.
13-4
Asset turnover. Inventory turnover and days in inventory. Return on common stockholders’ equity. Times interest earned.
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(For Instructor Use Only)
Questions Chapter 13 (Continued) (c)
An increase in the current ratio signals good news because the company improved its ability to meet maturing short-term obligations.
(d) Earnings per share is a deceptive ratio. The decrease might be bad news to the company because it could mean a decrease in net income. Or the decrease might be good news to the company because of an increase in stockholders’ investment. (e) The increase in the price-earnings ratio is generally good news because it means that the market price per share of stock has increased and investors are willing to pay that higher price for the stock. (f)
The increase in the debt to assets ratio is bad news because it means that the company has increased its obligations to creditors and has lowered its equity “buffer.”
(g) The decrease in the times interest earned is bad news because it means that the company’s ability to meet interest payments as they come due has weakened. 19.
Net Income Return on assets = Average Total Assets (7.6%) Net Income − Preferred dividends
Return on common stockholders’ equity = Average common stockholders’ equity (12.8%) The difference between the two rates can be explained by looking at the denominator value and by remembering the basic accounting equation, A = L + SE. The asset value will clearly be the larger of the two denominator values; therefore, it will also give the smaller rate of return. 20.
(a) Times interest earned, which is an indication of the company’s ability to meet interest charges, and the debt to total assets ratio, which indicates the company’s ability to withstand losses without impairing the interests of creditors. (b) The current ratio and current cash debt coverage, which indicate a company’s liquidity and short-term debt-paying ability. (c)
21.
The earnings per share of common stock and the return on common stockholders’ equity, both of which indicate the earning power of the investment.
Net income – Preferred dividends Average common shares outstanding $200,000 – $20,000 40,000
= Earnings per share.
= $4.50
EPS of $4.50 is high relative to what? Is it high relative to last year’s EPS? The president may be comparing the EPS of $4.50 to the market price of the company’s stock, which is inappropriate.
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(For Instructor Use Only)
13-5
Questions Chapter 13 (Continued) 22.
(1) Use of alternative accounting methods. Variations among companies in the application of generally accepted accounting principles may hamper comparability. (2) Use of pro forma income measures that do not follow GAAP. Pro forma income is calculated by excluding items that the company believes are unusual or nonrecurring. It is often difficult to determine what was included and excluded. (3) Improper revenue and expense recognition. Many high-profile cases of inappropriate accounting involve recording items in the wrong period.
23.
(a) During a period of inflation, net income will be less under the LIFO inventory costing method than it will be using the FIFO method because LIFO results in the larger cost of goods sold amount. (b) Inflation does not affect the amount of depreciation taken (except through its effect on salvage) since the depreciable amount is based on the acquisition cost. A six-year life produces greater depreciation for the first six years (thus, less net income) and less depreciation in years 7, 8, 9 (thus, more net income in those years) than a nine-year life. (c)
13-6
Inflation does not affect the amount of depreciation taken. Use of the straight-line method results in less depreciation in the earlier years (thus, more net income) than the decliningbalance method but more depreciation in the later years.
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(For Instructor Use Only)
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13-1 REYES CORPORATION Partial Income Statement Discontinued operations: Loss on disposal of Mexico facility, net of $160,000 ($640,000 X 25%) tax savings..........................................
($480,000)
BRIEF EXERCISE 13-2 FIELDER CORPORATION Partial Income Statement Income before income taxes ...................................................... Income tax expense ($300,000 X 30%) ....................................... Income before extraordinary item .............................................. Extraordinary loss from flood, net of $24,000 ($80,000 X 30%) tax savings ................................................... Net income ...................................................................................
$300,000 90,000 210,000 (56,000) $154,000
BRIEF EXERCISE 13-3 The change in inventory pricing for Jenner should be reported retroactively. That is, it should report both the current period and previous periods included on the face of the statement using the new principle. As a result, the same principle applies in all periods. The treatment improves the ability to compare results across years.
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(For Instructor Use Only)
13-7
BRIEF EXERCISE 13-4 Horizontal analysis: Increase or (Decrease) Dec. 31, 2014 Dec. 31, 2013 Amount Percentage* Accounts receivable $ 460,000 $ 400,000 $ 60,000 15% Inventory $ 780,000 $ 650,000 $130,000 20% Total assets $3,164,000 $2,800,000 $364,000 13%
*$60,000 = .15 $400,000
$130,000 = .20 $650,000
$364,000 = .13 $2,800,000
BRIEF EXERCISE 13-5 Vertical analysis:
Accounts receivable Inventory Total assets
Dec. 31, 2014 Dec. 31, 2013 Amount Percentage* Amount Percentage** $ 460,000 14.5% $ 400,000 14.3% $ 780,000 24.7% $ 650,000 23.2% $3,164,000 100% $2,800,000 100%
*$460, 000 = .145 $3,164,000
**$400,000 = .143 $2,800,000
* $780,000 = .247 $3,164,000
**
13-8
.
$650,000 = .232 $2,800, 000
(For Instructor Use Only)
BRIEF EXERCISE 13-6
Net income
2014 $518,400
2013 $485,000
2012 $500,000
(a) 2012–2013 (b) 2013–2014
Increase or (Decrease) Amount Percentage* ($15,000) (3%) $33,400) 7%)
*($15,000) = (.03) $500, 000
$33,400 = .07 $485,000
BRIEF EXERCISE 13-7
Net income .16 =
2014 $382,800
2013 X
Increase 16%
$382,800 – X X
.16X = $382,800 – X 1.16X = $382,800 X = $330,000 2013 Net Income = $330,000 BRIEF EXERCISE 13-8
Sales revenue Cost of goods sold Expenses Net income
2014 100.0 60.5 26.0 13.5
2013 100.0 62.9 26.6 10.5
2012 100.0 64.8 27.5 7.7
Net income as a percent of sales for Capuano increased over the three-year period because cost of goods sold and expenses both decreased as a percent of sales every year.
.
(For Instructor Use Only)
13-9
BRIEF EXERCISE 13-9 Comparing the percentages presented results in the following conclusions: The net income for Roswell increased in 2013 because of the combination of an increase in sales and a decrease in both cost of goods sold and expenses. However, the reverse was true in 2014 as sales decreased, while both cost of goods sold and expenses increased. This resulted in a decrease in net income. BRIEF EXERCISE 13-10 Current ratio: 2014
2013
$80,260 Current assets = = .33:1 $245,805 Current liabilities
$70,874 = .22:1 $326,203
The current ratio increased by 50% indicating that Bob Evans Farms is more liquid in 2014. BRIEF EXERCISE 13-11 Accounts receivable turnover = 2014 (a) $4,300,000 = 7.9 times $545,000* *($540,000 + $550,000) ÷ 2
Net credit sales Average net accounts receivable
2013
$4,000,000 = 7.5 times $530,000** **($520,000 + $540,000) ÷ 2
(b) Average collection period 365 = 46.2 days 7.9
365 = 48.7 days 7.5
Filbert Company can be somewhat pleased with the effectiveness of its credit and collection policies. The company has decreased the average collection period by more than two days and the collection period of approximately 46 days almost equals the 45 days allowed in the credit terms.
13-10
.
(For Instructor Use Only)
BRIEF EXERCISE 13-12 (a) Inventory turnover =
Cost of goods sold Average inventory
2014
2013 $4,541,000**
$4,780,000*
$960,000 + $1,020,000 2
= 4.8 times
Beginning inventory Purchases Goods available for sale Ending inventory Cost of goods sold
$840,000+$960,000 2
2014 $ 960,000 4,840,000 5,800,000 1,020,000 $4,780,000*
= 5.0 times
2013 $ 840,000 4,661,000 5,501,000 960,000 $4,541,000**
(b) Days in inventory
365 = 73 days 5.0
365 = 76 days 4.8
Management should be concerned with the fact that inventory moved slower in 2014 than it did in 2013. The decrease in inventory turnover could be because of poor pricing decisions or because the company is stuck with obsolete inventory.
BRIEF EXERCISE 13-13 (a) Asset turnover =
=
Net sales Average total assets $24,275.5 $13,073.1+ $13,717.3 2
= 1.81 times Staples generated $1.81 of sales for each dollar it had invested in assets. .
Kimmel, Accounting, 5/e, Solutions Manual
(For Instructor Use Only)
13-11
BRIEF EXERCISE 13-13 (Continued) (b) Profit margin =
=
Net income Net sales
$738.7 $24,275.5
= 3.0% Each dollar of sales resulted in about 3 cents of net income.
BRIEF EXERCISE 13-14 Payout ratio =
.18 =
Cash dividends declared on common stock Net income X $72,000
X = $72,000 (.18) = $12,960 Cash dividends = $12,960
Return on assets
=
.20 =
Net income Average total assets $72,000 X
.20X = $72,000 X =
$72,000 .20
X = $360,000 Average total assets = $360,000 13-12
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(For Instructor Use Only)
BRIEF EXERCISE 13-15 (a) Current cash debt Net cash provided by operating activities = coverage Average currentliabilities
$10.4 = .20 times $41.1+ $62.4 2 Topps Company could cover (or pay) approximately 20% of its current liabilities with cash generated by operating activities. (b) Cash debt coverage
=
Net cash provided by operatingactivities Average total liabilities
$10.4 = .15 times $65.2 + $73.2 2 Topps Company could cover (or pay) about 15% of its total liabilities with cash generated by operating activities. (c) Free Cash Flow = Cash provided by operating activities – Capital expenditures – Cash dividends $10.4 – $3.7 – $6.2 = $.5 Topps Company generated enough cash from operating activities to maintain its current productive capacity and pay dividends. The free cash flow that remained could have been used to expand operations, pay additional dividends, or reduce debt.
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(For Instructor Use Only)
13-13
SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 13-1 SUNFLOWER CORPORATION Income Statement (partial) Income before income taxes ......................................... Income tax expense ....................................................... Income before irregular items ....................................... Discontinued operations: Loss from disposal of discontinued music divison, net of $9,600 income tax savings .......................... Extraordinary earthquake loss, net of $72,000 tax savings ..................................................... Net income ......................................................................
$500,000 200,000 300,000 (14,400) (108,000) $177,600
DO IT! 13-2 Increase in 2014 Amount Current assets Plant assets Total assets
$ (20,000) (9.1)% [($ 200,000 – $ 220,000) ÷ $ 220,000] 260,000 33.3% [($1,040,000 – $ 780,000) ÷ $ 780,000] $240,000 24% [($1,240,000 – $1,000,000) ÷ $1,000,000]
DO IT! 13-3 (a) (b) (c) (d) (e) (f)
13-14
Profitability ratio Liquidity ratio Solvency ratio Solvency ratio Profitability ratio Liquidity ratio
.
Percent
(For Instructor Use Only)
DO IT! 13-4 1.
Current ratio: A measure used to evaluate a company’s liquidity.
2.
Pro forma income: Usually excludes items that a company thinks are unusual or nonrecurring.
3.
Quality of earnings: Indicates the level of full and transparent information provided to users of the financial statements.
4.
Discontinued operations: The disposal of a significant component of a business.
5.
Horizontal analysis: Determines increases or decreases in a series of financial statement data.
6.
Comprehensive income: Includes all changes in stockholders’ equity during a period except those resulting from investments by stockholders and distributions to stockholders.
.
(For Instructor Use Only)
13-15
SOLUTIONS TO EXERCISES EXERCISE 13-1 UTECH COMPANY Partial Income Statement For the Year Ended December 31, 2014 Income before irregular items .................................................... Discontinued operations: Gain from disposal of division, net of $9,000 income taxes................................... Extraordinary item: Fire loss, net of $18,000 tax savings ........ Net income ...................................................................................
$310,000 21,000 (42,000) $289,000
EXERCISE 13-2 (a) The loss on the sale of electrical equipment was reported as a part of continuing operations. The loss was reported in the fourth quarter of 2013 because the cross-reference to the item appears next to the quarterly results for net income. (b) The extraordinary items are listed separately so that the reader can evaluate the company’s results on the basis of normal operations and also see the impact of irregular items. If only the net income figure was disclosed, the reader would not be able to evaluate what portion of the earnings came from operations and what portion came from irregular items. (c) The extraordinary gain is the expropriation (takeover) of company property in the Middle East. It was not included in income for the fourth quarter because it is only cross-referenced in the year-to-date totals and not in the quarterly report.
13-16
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(For Instructor Use Only)
EXERCISE 13-2 (Continued) (d) The company had net income of over $68 million during the fourth quarter of 2013 but the year-to-date total shows net income of only $33.25 million. Therefore, Energy Enterprises had an operating loss at the end of the first three quarters of 2013. A reader can thus conclude that at least one of the first three quarters were operated at a loss. However, 2014 is not quite as clear. Since the company earned such a high percentage of its total net income ($102.7 million) in the third quarter ($97 million), it appears likely that one of the first three quarters of 2014 was operating at a loss. (e) Energy Enterprises had 75,514,706 shares of stock outstanding (Net Income ÷ EPS = $102,700,000 ÷ $1.36) at July 31, 2014. The number of shares of stock outstanding increased from the July 31, 2013 total of 69,270,833 ($33,250,000 ÷ $.48). (f)
.
The profit margin should be based on the company’s net income from its normal and continuing operations. The net income figure should be a more conservative amount and should not include any irregular items. The profit margin for the twelve months ended July 31, 2013 is 0.7%; for the twelve months ended July 31, 2014 it is 1.8%. The 2013 percentage was based on the $33,250,000 net income while the 2014 percentage was based on operating income of $100,800,000 ($102,700,000 – $1,900,000). These two figures are comparable because they are the end result of the company’s operations and do not include any irregular items which only affect the year of their occurrence. Some analysts might adjust net income in 2013 for the $26 million loss on sale of electrical equipment. Much depends on whether this type of transaction is recurring or not.
(For Instructor Use Only)
13-17
EXERCISE 13-3 SPANGLES INC. Condensed Balance Sheet December 31 Increase or (Decrease) Amount Percentage
2014
2013
Assets Current assets Plant assets (net) Total assets
$106,000 400,000 $506,000
$ 90,000 350,000 $440,000
($16,000 50,000 ($66,000
(17.8%) (14.3%) (15.0%)
Liabilities Current liabilities Long-term liabilities Total liabilities
$ 99,000 122,000 $221,000
$ 65,000 90,000 $155,000
($34,000 32,000 $66,000
(52.3%) (35.6%) (42.6%)
130,000 155,000
115,000 170,000
15,000 (15,000)
(13.0%) (8.8%)
285,000
285,000
–0–
(–0–
$506,000
$440,000
($66,000
(15.0%)
Stockholders’ Equity Common stock, $1 par Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity
13-18
.
(For Instructor Use Only)
EXERCISE 13-4 JACOBS CORPORATION Condensed Income Statement For the Years Ended December 31
Sales revenue Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Income before income taxes Income tax expense Net income
2014 Amount Percent $800,000 100.0% 520,000 65.0% 280,000 35.0% 120,000 15.0% 60,000 7.5% 180,000 22.5% 100,000 12.5% 30,000 3.7% $ 70,000 8.8%
2013 Amount Percent $600,000 100.0% 408,000 68.0% 192,000 32.0% 72,000 12.0% 48,000 8.0% 120,000 20.0% 72,000 12.0% 24,000 4.0% $ 48,000 8.0%
EXERCISE 13-5 (a)
NIKE, INC. Condensed Balance Sheet May 31 ($ in millions)
Assets Current assets Property, plant, and equipment (net) Other assets Total assets
.
(For Instructor Use Only)
Percentage Increase Change (Decrease) from 2013
2014
2013
$ 9,734
$ 8,839
$895
10.1%
1,958 1,558 $13,250
1,891 1,713 $12,443
67 (155) $807
3.5% (9.0)% 6.5%
13-19
EXERCISE 13-5 (Continued) NIKE, INC. Condensed Balance Sheet (Continued) December 31
2014
2013
$ 3,277
$ 3,322
$ (45)
(1.4%)
1,280
1,296
(16)
(1.2%)
8,693
7,825
868
11.1%
$13,250
$12,443
$807
6.5%
$ (in millions)
Percent
Assets Current assets Property, plant, and equipment (net) Other assets Total assets
$ 9,734 1,958 1,558 $13,250
73.5% 14.8% 11.7% 100.0%
Liabilities and stockholders’ equity Current liabilities Long-term liabilities Stockholders’ equity Total liabilities and stockholders’ equity
$ 3,277 1,280 8,693 $13,250
24.7% 9.7% 65.6% 100.0%
Liabilities and stockholders’ equity Current liabilities Long-term liabilities Stockholders’ equity Total liabilities and stockholders’ equity
(b)
13-20
Percentage Increase Change (Decrease) from 2013
NIKE, INC. Condensed Balance Sheet May 31, 2014
.
(For Instructor Use Only)
EXERCISE 13-6 (a)
EUDALEY CORPORATION Condensed Income Statement For the Years Ended December 31
Net sales Cost of goods sold Gross profit Operating expenses Net income (b)
2014 $598,000 477,000 121,000 80,000 $ 41,000
2013 $500,000 420,000 80,000 44,000 $ 36,000
Increase or (Decrease) During 2014 Amount Percentage $98,000 19.6% 57,000 13.6% (41,000) (51.3% 36,000) 81.8% $ 5,000) (13.9%
EUDALEY CORPORATION Condensed Income Statements For the Years Ended December 31
Net sales Cost of goods sold Gross profit Operating expenses Net income
2014 $ Percent $598,000 100.0% 477,000 79.8% 121,000 20.2% 80,000 13.4% $ 41,000 6.8%
2013 $ Percent $500,000 100.0% 420,000 84.0% 80,000 16.0% 44,000 8.8% $ 36,000 7.2%
EXERCISE 13-7 Current ratio = 2.01:1 ($4,054 ÷ $2,014) Current cash debt coverage = .69 ($1,251 ÷ $1,807.5a) Accounts receivable turnover = 4.2 times ($8,258 ÷ $1,988.5b) Average collection period = 86.9 days (365 days ÷ 4.2) Inventory turnover = 5.9 times ($5,328 ÷ $899c) Days in inventory = 61.9 days (365 days ÷ 5.9) a
($2,014 + $1,601) ÷ 2 ($2,035 + $1,942) ÷ 2 c ($898 + $900) ÷ 2 b
.
(For Instructor Use Only)
13-21
EXERCISE 13-8 Current ratio as of February 1, 2014 = 3.00:1 ($120,000 ÷ $40,000). Feb. 3 7 11 14 18
3.00 No change in total current assets or liabilities. 2.43 ($97,000 ÷ $40,000). 2.43 No change in total current assets or liabilities. 3.04 ($85,000 ÷ $28,000). 2.66 ($85,000 ÷ $32,000).
EXERCISE 13-9 (a) Current ratio =
$145,000 = 2.90:1 $50,000
(b) Accounts receivable turnover = (1) (c)
$350,000 = 5.4 times $65,000 (1)
($70,000 + $60,000) 2
Average collection period = 365 days ÷ 5.4 = 67.6 days
(d) Inventory turnover = (2)
$198,000 = 3.6 times $55,000 (2)
$60, 000 + $50,000 2
(e)
Days in inventory = 365 days ÷ 3.6 = 101.4 days
(f)
Cash debt coverage =
$48,000 = .31 times $160,000 + $150,000 2
(g) Current cash debt coverage =
$48,000 = .87 times $60,000 + $50,000 2
(h) Free cash flow = $48,000 – $25,000 – $10,000 = $13,000 13-22
.
(For Instructor Use Only)
EXERCISE 13-10
$75.9 = 1.5% $5,121.8
(a) Profit margin
$5,121.8 = 1.64 times $2,993.9 + $3,249.8 2
(b) Asset turnover
$75.9 = 2.4% $2,993.9 + $3,249.8 2
(c) Return on assets
(d) Return on common stockholders’ equity
$75.9 = 7.6% $921.6+ $1,074.7 2 $5,121.8 – $3,540.6 = 30.9% $5,121.8
(e) Gross profit rate
EXERCISE 13-11 (a) Earnings per share
$67,000 $72,000 – $5,000 = = $1.86 36,000 32,000+ 40,000 2
(b) Price-earnings ratio
$14.00 = 7.5 times $1.86
(c) Payout ratio
$21,000 – $5,000 = 22.2% $72,000
(d) Times interest earned .
(For Instructor Use Only)
$72,000 + $16,000 + $24,000 $112,000 = = 7.0 times $16,000 $16,000 13-23
EXERCISE 13-12 (a) Inventory turnover = 3.8 =
Cost of goods sold $200,000 + $180,000 2
3.8 X $190,000 = Cost of goods sold Cost of goods sold = $722,000. (b) Accounts receivable turnover = 11.2 =
Net sales (credit) $126, 000 + $72,500 2
11.2 X $99,250 = Net sales (credit) = $1,111,600. (c) Return on common stockholders’ equity = 22% = Net income $400, 000 + $113, 500 + $400, 000 + $101, 000 2
.22 X $507,250 = Net income = $111,595. (d) Return on assets = 18% =
Average assets =
$111,595 [see (c) above] Net income = Average assets Average assets
$111,595 = $619,972 .18
Total assets (Dec. 31, 2014) + $605,000 = $619,972 2 Total assets (Dec. 31, 2014) = ($619,972 X 2) – $605,000 = $634,944.
13-24
.
(For Instructor Use Only)
EXERCISE 13-13 2014 (a) Current ratio: $1,390 ÷ $820 = $1,310 ÷ $790 =
1.70:1
(b) Inventory turnover: $970/[($460 + $390) ÷ 2)] = $890/[($390 + $340) ÷ 2)] =
2.28
(c) Profit margin: $252 ÷ $3,800 = $132 ÷ $3,460 =
6.6%
(d) Return on assets: $252/[($2,340 + $2,210) ÷ 2)] = $132/[($2,210 + $1,900) ÷ 2)] =
11.1%
(e) Return on common stockholders’ equity: $252/[($1,040 + $1,040) ÷ 2)] = $132/[($1,040 + $900) ÷ 2)] =
24.2%
(f) Debt to assets ratio: ($820 + $480) ÷ $2,340 = ($790 + $380) ÷ $2,210 =
55.6%
(g) Times interest earned: ($252 + $168 + $10) ÷ $10 = ($132 + $ 88 + $20) ÷ $20 =
43 times
.
(For Instructor Use Only)
2013 1.66:1
2.44
3.8%
6.4%
13.6%
52.9%
12 times
13-25
SOLUTIONS TO PROBLEMS PROBLEM 13-1A
(a)
Condensed Income Statement For the Year Ended December 31, 2014 Prince Company King Company Dollars Percent Dollars Percent $1,849,000 100.0% $546,000 100.0% 1,063,200 57.5% 289,000 52.9% 785,800 42.5% 257,000 47.1% 240,000 13.0% 82,000 15.0% 545,800 29.5% 175,000 32.1%
Net sales Cost of goods sold Gross profit Operating expenses Income from operations Other expenses and losses Interest expense 6,800 Income before income taxes 539,000 Income tax expense 62,000 Net income $ 477,000
.4% 3,600 29.1% 171,400 3.3% 28,000 25.8% $143,400
.7% 31.4% 5.1% 26.3%
(b) King Company appears to be more profitable. It has higher relative gross profit, income from operations, income before taxes, and net in-
$477,000 a come. Also, Silver’s return on assets of 57.3% is lower than $832,593 $143,400 b King’s return on assets of 67% , and Prince’s return on $214,172 $477,000 c common stockholders’ equity of 72.3% is lower than King’s $659,528
$143,400 d return on common stockholders’ equity of 93.1% . $154,047
13-26
.
(For Instructor Use Only)
PROBLEM 13-1A (Continued) $477,000 is Prince’s 2014 net income. $832,593 is Prince’s 2014 average assets: a
Current assets Plant assets Total assets
2014 2013 $325,975 $312,410 526,800 500,000 $852,775 + $812,410 =
$1, 665,185 2
$143,400 is King’s 2014 net income. $214,172 is King’s 2014 average assets:
b a
Current assets Plant assets Total assets
2014 2013 $ 83,336 $ 79,467 139,728 125,812 $223,064 + $205,279 =
$428, 343 2
$477,000 is Prince’s 2014 net income. $659,528 is Prince’s 2014 average stockholders’ equity: c
2014 2013 Common stock $500,000 $500,000 Retained earnings 172,460 146,595 Stockholders’ equity $672,460 + $646,595 =
$1, 319, 055 2
d d
$143,400 is King’s 2014 net income. $154,047 is King’s 2014 average stockholders’ equity: 2014 2013 Common stock $120,000 $120,000 Retained earnings 38,096 29,998 Stockholders’ equity $158,096 + $149,998 =
$308, 094 2
.
(For Instructor Use Only)
13-27
PROBLEM 13-2A
(a) Earnings per share =
(1)
$218,000 = $3.69 59,000 (1)
60,000* + 58,000** 2
*$300,000 $5
**$290,000 $5
(b) Return on common stockholders’ equity =
=
$218,000 $465,400 + $603,400 2 $218,000 $534,400
= 40.8%
(c) Return on assets =
$218,000 $218,000 = = 23.2% $939,850 $852,800 + $1,026,900 2
(d) Current ratio = $377,900 = 1.86:1 $203,500
(e) Accounts receivable turnover =
=
(f)
13-28
$1,890,540 ($102,800 + $117,800) 2
$1,890, 540 = 17.1 times $110,300
Average collection period = 365 days ÷ 17.1 = 21.3 days
.
(For Instructor Use Only)
PROBLEM 13-2A (Continued)
(g) Inventory turnover =
$1,058,540 $1,058,540 = = 8.8 times $120,750 $115,500 + $126,000 2
(h) Days in inventory = 365 days ÷ 8.8 = 41.5 days
(i)
Times interest earned = $310,000 + $22,000 = 15.1 times $22,000
(j)
Asset turnover =
$1,890,540 = 2.01 times $1,026,900+ $852,800 2
(k) Debt to assets ratio = $423,500 = 41% $1,026,900
(l)
Current cash debt coverage =
(m) Cash debt coverage =
$220,000 = 1.13 times $187,400+ $203,500 2
$220,000 = .54 times $387,400 + $423,500 2
(n) Free cash flow = $220,000 – $136,000 – $70,000 = $14,000
.
(For Instructor Use Only)
13-29
PROBLEM 13-3A
(a)
2014 (1)
2013
Profit margin.
$70,000 = 12.3% $570,000
$95,000 = 13.6% $700,000 (2)
Gross profit rate.
$220,000 = 38.6% $570,000
$275,000 = 39.3% $700,000 (3)
Asset turnover.
$700,000
$600,000 + $725,000 2 (4)
31,000 + 32,000 2
= $3.02
(7)
= 1.01 times
$70,000
30,000 + 31,000 2
= $2.30
$7.50 = 3.3 times $2.30
Payout ratio.
$45,000** = 47% $95,000
$58,000* = 83% $70,000
**($125,000 + $95,000 – $175,000)
*($113,000 + $70,000 – $125,000)
Debt to assets ratio.
($85,000 + $145,000) = 32% $725,000
13-30
$533,000 + $600,000 2
Price-earnings ratio.
$8.50 = 2.8 times $3.02 (6)
$570,000
Earnings per share. $95,000
(5)
= 1.06 times
.
(For Instructor Use Only)
($80,000 + $85,000) = 28% $600,000
PROBLEM 13-3A (Continued) (b) The underlying profitability of the corporation appears to have improved. For example, profit margin and earnings per share have both increased. The corporation’s debt to assets ratio has increased but the improvements in profitability indicate that taking on more debt was a wise move.
.
(For Instructor Use Only)
13-31
PROBLEM 13-4A
(a) LIQUIDITY 2013
2014
% Change
Current ratio
$383,000 = 1.81:1 $212,000
$484,000 = 1.76:1 $275,000
Accounts receivable turnover
$790,000 = 9.0 times $88,000
$882,000 = 9.1 times $97,000
1%
Inventory turnover
$575,000 = 4.1 times $140,000
$640,000 = 3.2 times $197,500
(22%)
(3%)
An overall decrease in short-term liquidity has occurred. PROFITABILITY
$48,000 = 6.1% $790,000
Asset turnover
$790,000 = 1.16 times $882,000 = 1.12 times $679,000 $786,000
Return on assets
$48,000 = 7.1% $679,000
$52,000 = 6.6% $786,000
(7%)
Earnings per share
$48,000 = $2.40 20,000
$52,000 = $2.60 20,000
8%
Profitability has decreased slightly.
13-32
$52,000 = 5.9% $882,000
Profit margin
.
(For Instructor Use Only)
(3%)
(3%)
PROBLEM 13-4A (Continued) (b)
2014 1.
2.
3.
2015
%Change
Return on $52,000 common = 15.6% stockhold- $332,500 (a) ers’ equity
$54,000 = 11.6% $466,000 (b)
(26%)
Debt to assets ratio
$525,000 = 60% $874,000
$355,000 = 39% $900,000
(35%)
Priceearnings ratio
$9.00 = 3.5 times $2.60
$12.00 = 4.4 times $2.70 (c)
26%
(a) ($200,000 + $149,000 + $200,000 + $116,000) ÷ 2. (b) ($380,000* + $203,000** + $200,000 + $149,000) ÷ 2. (c) $54,000 ÷ 20,000. **$200,000 + (18,000 X $10/share) **$149,000 + $54,000
.
(For Instructor Use Only)
13-33
PROBLEM 13-5A
(a)
Ratio
Target
Wal-Mart
(All Dollars Are in Millions) (1) Current ratio 1.63:1 ($18,424 ÷ $11,327) .87:1 ($48,331 ÷ $55,561) (2) Accounts receivable turnover 8.7 ($65,357 ÷ $7,525) 101.4 ($408,214 ÷ $4,025) (3) Average collection period (in days) 42.0 (365 ÷ 8.7) 3.6 (365 ÷ 101.4) (4) Inventory turnover 6.6 ($45,583 ÷ $6,942) 9.0 ($304,657 ÷ $33,836) (5) Days in inventory 55.3 (365 ÷ 6.6) 40.6 (365 ÷ 9.0) (6) Profit margin 3.8% ($2,488 ÷ $65,357) 3.5% ($14,335 ÷ $408,214) (7) Asset turnover 1.5 ($65,357 ÷ $44,319.5a) 2.4 ($408,214 ÷ $167,067.5f) (8) Return on assets 5.6% ($2,488 ÷ $44,319.5a) 8.6% ($14,335 ÷ $167,067.5f) (9) Return on common stockholders’ equity 17.1% ($2,488 ÷ $14,529.5b) 21.0% ($14,335 ÷ $68,369g) (10) Debt to assets ratio 66% ($29,186 ÷ $44,533) 58% ($99,650 ÷ $170,706) c (11) Times interest earned 6.5 ($4,579 ÷ $707) 11.4 ($23,539h ÷ $2,065) (12) Current cash debt coverage .54 ($5,881 ÷ $10,919.5d) .47 ($26,249 ÷ $55,475.5i) e (13) Cash debt coverage .20 ($5,881 ÷ $29,790 ) .27 ($26,249 ÷ $98,698.5j) (14) Free cash flow $3,656 ($5,881 – $1,729 – $496) $9,848 ($26,249 – $12,184 – $4,217) a
f
b
g
($44,533 + $44,106) ÷ 2 ($15,347 + $13,712) ÷ 2 c ($2,488 + $1,384 + $707) d ($11,327 + $10,512) ÷ 2 e (($11,327 + $17,859) + $30,394) ÷ 2
($170,706 + $163,429) ÷ 2 ($71,056 + $65,682) ÷ 2 h ($14,335 + $7,139 + $2,065) i ($55,561 + $55,390) ÷ 2 j (($55,561 + $44,089) + $97,747) ÷ 2
(b) The comparison of the two companies shows the following: Liquidity—Target’s current ratio of 1.63:1 is better than Wal-Mart’s .87:1. However, Wal-Mart has a better inventory turnover than Target and its accounts receivable turnover is significantly better than Target’s. Solvency—Wal-Mart betters Target in all of the solvency ratios. Thus, it is more solvent than Target. Profitability—With the exception of profit margin, Wal-Mart betters Target in all of the profitability ratios. Thus, it is more profitable than Target.
13-34
.
(For Instructor Use Only)
PROBLEM 13-1B
(a)
Condensed Income Statement For the Year Ended December 31, 2014 Dean Company Gerald Company Dollars Percent Dollars Percent $350,000 100.0% $1,200,000 100.0% 175,000 50.0% 648,000 54.0% 175,000 50.0% 552,000 46.0% 72,000 20.6% 266,000 22.2% 103,000 29.4% 286,000 23.8%
Net sales Cost of goods sold Gross profit Operating expenses Income from operations Other expenses and losses Interest expense 5,000 Income before income taxes 98,000 Income tax expense 22,000 Net income $ 76,000
1.4% 10,000 28.0% 276,000 6.3% 54,000 21.7% $ 222,000
.8% 23.0% 4.5% 18.5%
(b) Dean Company appears to be more profitable. It has higher relative income from operations, income before taxes, and net income. $222,000 a Gerald’s return on assets of 14.3% is lower than Dean $1,550,000
$76,000 b Company’s return on assets of 16.9% , and Gerald’s return on $450,000 $222,000 c common stockholders’ equity of 20.0% is lower than Dean’s $1,112,500 $76,000 d return on common stockholders’ equity of 23.0% . $330,000
.
(For Instructor Use Only)
13-35
PROBLEM 13-1B (Continued) $222,000 is Gerald’s 2014 net income. $1,550,000 is Dean’s 2014 average assets: Return on assets = ($222,000 ÷ $1,550,000) = 14.3% a
Current assets Plant assets Total assets
2014 2013 $ 700,000 $ 650,000 1,000,000 750,000 $1,700,000 + $1,400,000 =
$3,100, 000 2
$76,000 is Dean’s 2014 net income. $450,000 is Dean’s 2014 average assets: Return on assets = ($76,000 ÷ $450,000) = 16.9% b
Current assets Plant assets Total assets
2014 $130,000 400,000 $530,000
+
2013 $100,000 270,000 $370,000
=
$900, 000 2
$222,000 is Gerald’s 2014 net income. $1,112,500 is Gerald’s 2014 average stockholders’ equity: Return = $222,000 ÷ $1,112,500 = 20.0%
c
Common stock Retained earnings Stockholders’ equity
2014 $ 950,000 300,000
2013 $700,000 275,000
$1,250,000 +
$975,000
=
$2, 225, 000 2
$76,000 is Dean’s 2014 net income. $330,000 is Dean’s 2014 average stockholders’ equity: Return = $76,000 ÷ $330,000 = 23% d
Common stock Retained earnings Stockholders’ equity
13-36
.
(For Instructor Use Only)
2014 $340,000 80,000 $420,000
2013 $200,000 40,000 +
$240,000
=
$660, 000 2
PROBLEM 13-2B
(a) Earnings per share =
$119,200 = $8.51 14,000 (1)
(1) [13,000 + 15,000] ÷ 2
(b) Return on common stockholders’ equity =
=
$119,200 $376,000 + $480,300 2 $119,200 $428,150
= 27.8%
(c) Return on assets =
(d) Current ratio =
$119,200 $652,000 + $775,800 2
.
$119,200 = 16.7% $713,900
$290,500 = 1.78:1 $163,500
(e) Accounts receivable turnover =
(f)
=
$780,000 $780,000 = = 8.2 times ($83,800+ $106,200) $95,000 2
Average collection period = 365 days ÷ 8.2 = 44.5 days
(For Instructor Use Only)
13-37
PROBLEM 13-2B (Continued)
(g) Inventory turnover =
$440,000 $440,000 = = 4.6 times $95,200 $74,000+ $116,400 2
(h) Days in inventory = 365 days ÷ 4.6 = 79.3 days
(i)
Times interest earned =
(j)
Asset turnover =
$119,200 + $9,920 + $34,000 = 16.4 times $9,920
$780,000 $780,000 = = 1.09 times $775,800 + $652,000 $713,900 2
(k) Debt to assets = $295,500 = 38% $775,800
(l)
Current cash debt coverage =
(m) Cash debt coverage =
$108,000
$163,500 + $156,000 2
=
$108,000 = .68 times $159,750
$108,000 $108,000 = = .38 times $285,750 $295,500+ $276,000 2
(n) Free cash flow = $108,000 – $47,000 – $30,900 = $30,100.
13-38
.
(For Instructor Use Only)
PROBLEM 13-3B
(a)
2014 (1)
2013
Profit margin.
$85,000 = 12.1% $700,000
$110,000 = 14.5% $760,000 (2)
Gross profit rate.
$340, 000 = 45% $760, 000 (3)
$294,000 = 42% $700,000
Asset turnover. $760,000 $620,000 +$813,000 2
(4)
34,000 + 40,000 2
= $2.97
(7)
2
$85,000
30,000 + 34,000 2
= $2.66
$3.50 = 1.32 times $2.66
Payout ratio.
$55,000** = 50% $110,000
$60,000* = 70.6% $85,000
**($130,000 + $110,000 – $185,000)
*($105,000 + $85,000 – $130,000)
Debt to assets ratio.
$228,000 = 28% $813,000
.
Price-earnings ratio.
$2.80 = 0.94 times $2.97 (6)
$700,000 = 1.21 times $540,000 + $620,000
Earnings per share.
$110,000
(5)
= 1.06 times
(For Instructor Use Only)
$150, 000 = 24% $620, 000
13-39
PROBLEM 13-3B (Continued) (b) The underlying profitability of the corporation has improved. For example, the profit margin and gross profit rate have both improved. In addition, the corporation’s earnings per share has increased, which suggests that investors will be looking more favorably at the corporation. Also, its payout ratio has decreased, which should have a positive effect on its solvency. However, the debt to total assets ratio has increased, indicating a heavier reliance on debt. Also, the asset turnover ratio has declined, indicating management has not managed assets well in generating sales. And, finally, the price-earnings ratio has declined, perhaps suggesting that investors are not impressed with the company’s future prospects.
13-40
.
(For Instructor Use Only)
PROBLEM 13-4B
(a)
LIQUIDITY 2013
2014
Change
Current ratio
$520,000 = 3.15:1 $165,000
$670, 000 = 2.03:1 $330, 000
(36%)
Accounts receivable turnover
$940,000 = 12.0 times $78,500
$1,050,000 = 11.9 times $88,500
(1%)
Inventory turnover
$635,000 = 1.95 times $325,000
$680,000 = 1.86 times $365,000
(5%)
An overall decrease in short-term liquidity exists.
PROFITABILITY Profit margin
$90,000 = 9.6% $940,000
$130,000 = 12.4% $1,050,000
29%
Asset turnover
$940,000 = .87 times $1,085,000
$1,050,000 = .91 times $1,155,000
5%
Return on assets
$90,000 = 8.3% $1,085,000
$130,000 = 11.3% $1,155,000
36%
Earnings per share
$90,000 = $.90 100,000
$130,000 = $1.30 100,000
44%
Overall profitability has improved.
.
(For Instructor Use Only)
13-41
PROBLEM 13-4B (Continued)
(b)
2014
2015
% Change
Return on common stockholders’ equity
$130,000 = 16.9% 767,500 (a)
$135,000 = 15.0% 897,500 (b)
(11%)
2.
Debt to assets
$510,000 = 39% 1,315,000
$390,000 = 29% 1,350,000
(26%)
3.
Priceearnings ratio
$15.00 = 11.5 times 1.30
$18.00 = 13.3 times 1.35 (c)
16%
1.
(a) (b) (c)
($500,000 + $305,000 + $500,000 + $230,000) ÷ 2. ($550,000* + $440,000** + $500,000 + $305,000) ÷ 2. $135,000 ÷ 100,000.
**$500,000 + (10,000 X $5/share) **$305,000 + $135,000
13-42
.
(For Instructor Use Only)
PROBLEM 13-5B
(a)
Ratio
Edgewater
Ritter
(All Dollars Are in Millions) (1) Current 5.32:1 ($885.7 ÷ $166.5) 2.83:1 ($617.2 ÷ $218.0) (2) Accounts receivable turnover 4.6 ($1,356.0 ÷ $293.2) 7.3 ($1,436.5 ÷ $196.1) (3) Average collection period 79.3 (365 ÷ 4.6) 50.0 (365 ÷ 7.3) (4) Inventory turnover 3.2 ($776.3 ÷ $239.1) 4.0 ($771.7 ÷ $194.3) (5) Days in inventory 114.1 (365 ÷ 3.2) 91.3 (365 ÷ 4.0) (6) Profit margin 10.6%($144.4 ÷ $1,356.0) 2.8% ($40.0 ÷ $1,436.5) (7) Asset turnover 1.2 ($1,356.0 ÷ $1,096.9a) 1.7 ($1,436.5 ÷ $848.4f) (8) Return on assets 13.2%($144.4 ÷ $1,096.9a) 4.7% ($40.0 ÷ $848.4f) (9) Return on common stockholders’ equity 16.0%($144.4 ÷ $900.4b) 7.0% ($40.0 ÷ $569.5g) (10) Debt to assets 16.8%($196.4 ÷ $1,166.5) 31% ($259.1 ÷ $836.3) c (11) Times interest earned 2,081.0 ($208.1 ÷ $.1) 598.1 ($59.8h ÷ $.1) (12) Current cash debt coverage .70 ($124.5 ÷ $177.2d) .15 ($38.6 ÷ $251.8i) e (13) Cash debt coverage .63 ($124.5 ÷ $196.5 ) .14 ($38.6 ÷ $278.9j) (14) Free cash flow $69.3 ($124.5 – $34.3 – $20.9) $8.1 ($38.6 – $30.5 – $0) a
f
b
g
($1,166.5 + $1,027.3) ÷ 2 ($970.1 + $830.7) ÷ 2 c ($144.4 + $63.6 + $.1) d ($166.5 + $187.9) ÷ 2 e (($166.5 + $29.9) + $196.6) ÷ 2
($836.3 + $860.4) ÷ 2 ($577.2 + $561.7) ÷ 2 h ($40.0 + $19.7 + $.1) i ($218.0 + $285.6) ÷ 2 j (($218.0 + $41.1) + $298.7) ÷ 2
(b) The comparison of the two companies shows the following: Liquidity—Edgewater’s current ratio and current cash debt coverage are much better than Ritter’s. However, Ritter has better accounts receivable and inventory turnovers. Solvency—Edgewater’s debt to assets ratio, times interest earned and cash debt coverage and free cash flow are better than Ritter’s. Both companies appear to be very solvent. Profitability—With the exception of asset turnover, Edgewater betters Ritter in all of the profitability ratios. Thus, it is more profitable than Ritter. \ .
(For Instructor Use Only)
13-43
BYP 13-1
FINANCIAL REPORTING PROBLEM
(a)
TOOTSIE ROLL INDUSTRIES, INC. Trend Analysis of Net Sales and Net Earnings For the Five Years Ended 2011 Base Period 2007—($ in thousands) 2011
2010
2009
2008
2007
(1) Net sales Trend
$528,369 107%
$517,149 105%
$495,592 $492,051 $492,742 101% 100% 100%
(2) Net earnings Trend
$ 43,938 84%
$ 53,063 102%
$ 53,157 $ 38,880 $ 52,175 102% 75% 100%
Net sales changed very little from 2007 to 2009, but increased slightly in 2010 and 2011. The net earnings decreased significantly from 2007 to 2008 and in 2011. The reasons for such large decreases in profitability would require further investigation. (b) (000’s omitted) 1.
Debt to Assets Ratio 2011: 2010:
2.
($857,856 – $665,935) ÷ $857,856 = 22% ($857,959 – $667,408) ÷ $857,959 = 22%
Times Interest Earned 2011: 2010:
($60,912 + $121) ÷ $121 = 504.4 times ($73,068 + $142) ÷ $142 = 515.6 times
Tootsie Roll’s long-term solvency is not in jeopardy. The debt to assets ratio indicates that creditors are providing approximately 22% of Tootsie Roll’s total assets. Also, Tootsie Roll easily has the ability to pay interest payments when they come due as indicated by the times interest earned of over 500 times.
13-44
.
(For Instructor Use Only)
BYP 13-1 (Continued) (c) (000’s omitted) 1.
Profit Margin 2011: 2010:
2.
Asset Turnover 2011: 2010:
3.
$528,369 ÷ [($857,856 + $857,959) ÷ 2] = .62 times $517,149 ÷ [($857,959 + $836,844) ÷ 2] = .61 times
Return on Assets 2011: 2010:
4.
$43,938 ÷ $528,369 = 8.3% $53,063 ÷ $517,149 = 10.3%
$43,938 ÷ [($857,856 + $857,959) ÷ 2] = 5.1% $53,063 ÷ [($857,959 + $836,844) ÷ 2] = 6.3%
Return on Common Stockholders’ Equity 2011: 2010:
$43,938 ÷ [($665,935 + $667,408) ÷ 2] = 6.6% $53,063 ÷ [($667,408 + $654,244) ÷ 2] = 8.0%
All of the profitability ratios except asset turnover decreased in 2011. Stockholders are earning an acceptable 6.6% on their investment. Considering that Tootsie Roll is primarily in a high-volume business where the margin above costs is historically low, the profit margins for both 2011 and 2010 are good. (d) Substantial amounts of important information about a company are not in its financial statements. Events involving such things as industry changes, management changes, competitors’ actions, technological developments, governmental actions, and union activities are often critical to the successful operation of a company. Financial reports in the media and publications of financial service firms (Standard & Poors, Dun & Bradstreet) will provide additional relevant information not usually found in the annual report.
.
(For Instructor Use Only)
13-45
BYP 13-2
COMPARATIVE ANALYSIS PROBLEM
(a)
Hershey
Tootsie Roll
1. (i) Percentage increase $6,080,788 – $5,671,009 = 7.2% (decrease) in net $5,671,009 sales
$528,369 – $517,149
(ii) Percentage increase $628,962 – $509,799 = 23.4% (decrease) in net $509,799 income
$43,938 – $53,063
2. (i) Percentage increase $4,412,199 – $4,272,732 = 3.3% (decrease) in total $4,272,732 assets
$857,856 – $857,959
(ii) Percentage increase $872,648 – $937,601 = (6.9%) (decrease) in total $937,601 stockholders’ equity
$665,935 – $667,408
3. Earnings per share
2.85*
= 2.2%
$517,149
= (17.2%)
$53,063
= 0.0%
$857,959
= (0.2%)
$667,408
.76*
*Given on income statement
(b) Hershey’s increases in net sales, net income, and total assets were all significantly larger than Tootsie Roll’s. Both Companies had a decrease in total stockholders’ equity, but Hershey suffered a much larger decrease than Tootsie Roll. Hershey’s earnings per share are over 3.5 times as large as Tootsie Roll’s, indicating that Hershey was much more profitable than Tootsie Roll.
13-46
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(For Instructor Use Only)
BYP 13-3
RESEARCH CASE
(a)
The article explains that unrealized losses on certain types of investment securities, known as available-for-sale securities, do not have to reported in the income statement. Instead, they can be reported as direct reductions of stockholders’ equity.
(b)
Companies are required to report these losses in net income when the company determines that the loss is permanent. This would occur either because the company has sold the security, or because the company believes that the losses are irreversible, that is, the price of the investment will not recover.
(c)
At the time of the article companies in the Standard and Poor’s 500 had approximately $80 billion of unrealized losses from these types of securities in the equity section of their balance sheet.
(d)
The article emphasizes that these companies actually are following accepted accounting standards.
(e)
The implications for investors are that investors need to look for these items in stockholders’ equity so that they are not surprised by unexpected losses on investments. As noted by the investment professionals cited in the article, these items are difficult to interpret. Therefore, they complicate efforts to forecast a company’s future earnings.
.
(For Instructor Use Only)
13-47
BYP 13-4
RESEARCH CASE
(a) As discussed in Chapter 11, when a company does a stock split, its share price drops accordingly. If Amazon had not engaged in past stock splits its stock price at the time of the article would have been $1,166. (b) Amazon dramatically increased its capacity to handle customer orders through its spending on fulfillment centers. However, until its sales increase enough to absorb this additional capacity, the company’s return on assets will probably suffer. First, the increase in plant assets will increase the company’s depreciation expense and reduce net income. Second, increasing plant assets increases the denominator of the return on assets, which reduces the company’s return. (c) At the time of the article, Amazon’s P/E ratio was 76. Apple had a P/E ratio of 11.4, Netflix was 38 and the article says that Amazon’s was 3 1/2 times that of Wal-Mart, making it approximately 21.7. Amazon’s high value suggests that investors were expecting significant growth in Amazon’s earnings in future years. (d) The article notes that Amazon’s 2012 operating margin was about half what it had been in the typical previous year. In the past, many of Amazon’s customers did not pay sales taxes on their purchases, which effectively gave Amazon a price advantage over traditional “brick and mortar” stores that do collect sales taxes. It stated that, because Amazon’s customers might have to start paying sales taxes on their purchases, Amazon might have to reduce its prices in order to continue to compete on price. This would reduce its profitability.
13-48
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(For Instructor Use Only)
BYP 13-5 (a)
INTERPRETING FINANCIAL STATEMENTS
Liquidity Ratios
Coca-Cola
PepsiCo
(1) Current ratio
1.28:1 ($17,551 ÷ $13,721)
1.44:1 ($12,571 ÷ $8,756)
(2) Accounts receivable turnover
9.1 times ($30,990 ÷ $3,424)
9.3 times ($43,232 ÷ $4,654)
(3) Average collection period
40.1 days (365 ÷ 9.1)
39.2 days (365 ÷ 9.3)
(4) Inventory turnover
4.9 times ($11,088 ÷ $2,271)
7.8 times ($20,099 ÷ $2,570)
(5) Days in inventory
74.5 (365 ÷ 4.9)
46.8 (365 ÷ 7.8)
(6) Current cash debt coverage
.61 ($8,186 ÷ $13,355)
.77 ($6,796 ÷ $8,772)
PepsiCo is more liquid than Coca-Cola. PepsiCo betters Coca-Cola in all of the ratios. (b)
Solvency Ratios (1) Debt to assets ratio
Coca-Cola
$23,872 $48,671
(2) Times interest earned
(3) Cash debt coverage
$23,044 $39,848
= 58%
$6,824 + $2,040 + $355
$5,946 + $2,100 + $397
$355 = 26.0 times
$397 = 21.3 times
$8,186
$6,796
$21,960 (4) Free cash flow
= 49%
PepsiCo
= .37 times
$8,186 – $1,993 – $3,800 = $2,393
$23,466
= .29 times
$6,796 – $2,128 – $2,732 = $1,936
Coca-Cola is more solvent than PepsiCo.
.
(For Instructor Use Only)
13-49
BYP 13-5 (Continued) (c)
Profitability Ratios
Coca-Cola
PepsiCo
(1) Profit margin
22.0% ($6,824 ÷ $30,990)
13.8% ($5,946 ÷ $43,232)
(2) Asset turnover
.69 times ($30,990 ÷ $44,595)
1.14 times ($43,232 ÷ $37,921)
(3) Return on assets
15.3% ($6,824 ÷ $44,595)
15.7% ($5,946 ÷ $37,921)
(4) Return on common stockholders’ equity
30.1% ($6,824 ÷ $22,636)
40.8% ($5,946 ÷ $14,556)
PepsiCo, Inc. has a lower profit margin than the Coca-Cola Company. However, PepsiCo, Inc. has a higher asset turnover, return on assets, and return on common stockholders’ equity.
13-50
.
(For Instructor Use Only)
BYP 13-6
REAL-WORLD FOCUS
(a), (b), and (c) Answers will vary depending on the year chosen by the student.
.
(For Instructor Use Only)
13-51
BYP 13-7
DECISION MAKING ACROSS THE ORGANIZATION
(a) Lenders prefer that financial statements are audited because an audit gives independent assurance that the financial statements give a reasonable representation of the company’s financial position and results of operations. With this independent assurance they feel more comfortable making a decision. (b) The current ratio increase is a favorable indication as to liquidity, but alone tells little about the going-concern prospects of the client. From this ratio change alone, it is impossible to know the amount and direction of the changes in individual accounts, total current assets, and total current liabilities. Also unknown are the reasons for the changes. The change in asset turnover cannot alone tell anything about either solvency or going-concern prospects. There is no way to know the amount and the direction of the changes in the two items. An increase in sales would be favorable for going-concern prospects, while a decrease in assets could represent a number of possible scenarios and would need to be investigated further. The 50 percent [(.1 – .2) ÷ .2] decrease in cash debt coverage may indicate that the company is having difficulties generating enough cash from operations to meet debt obligations and even operating needs. The increase in net income may not have brought a corresponding increase in cash collections from accounts receivable. Since cash debt coverage was low in 2013 and even lower in 2014, it appears that the company may have a solvency problem. The increase in net income is a favorable indicator for both solvency and going-concern prospects although much depends on the quality of receivables generated from sales and how quickly they can be converted into cash. Indirectly, the improved income picture may have a favorable impact on solvency and going-concern potential by enabling the client to borrow currently to meet cash requirements.
13-52
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(For Instructor Use Only)
BYP 13-7 (Continued) The 32 percent [($3.30 – $2.50) ÷ $2.50] increase in earnings per share, which is identical to the percentage increase in net income, is an indication there has probably been no change in the number of shares of common stock outstanding. This in turn indicates that financing was not obtained through the issuance of common stock. It is not possible to reach conclusions about solvency and going-concern prospects without additional information about the nature and extent of financing. The collective implications of these data alone are that the client entity is about as solvent and viable as a going concern at the end of the current year as it was at the beginning although there may be a need for short-term operating cash. Although a quick evaluation of a reporting entity can be made using only a few ratios and comparing these with past ratios and industry statistics, the creditors should realize the limitations of such analysis even from the best prepared statements carrying a CPA’s unqualified opinion. A limitation on comparisons with industry statistics or other companies within the industry exists because material differences can be created through the use of alternative (but acceptable) accounting methods. Further, when evaluating changes in ratios or percentages, the evaluation should be directed to the nature of the item being evaluated because very small differences in ratios or percentages can represent significant changes in dollar amounts or trends. The creditors should evaluate conclusions drawn from ratio analysis in light of the current status of, and expected changes in, such things as general economic conditions, the client’s competitive position, the public’s demand (for the product itself, increased quality of the product, control of noise and pollution, etc.), and the client’s specific plans. (c) 1.
Current cash debt coverage—indicates liquidity.
2.
Debt to assets ratio—indicates solvency.
3.
Times interest earned—indicates ability to repay interest when due.
Other answers are possible.
.
(For Instructor Use Only)
13-53
BYP 13-8
COMMUNICATION ACTIVITY
To:
David Lemay
From:
Accounting Student
Re:
Financial Statement Analysis
There are two fundamental considerations in financial statement analysis: (1) the bases of comparison and (2) the limitations of financial statement analysis. Each of these considerations is explained below. 1.
2.
13-54
Bases of comparison. The bases of comparison are: a.
Intracompany—This basis compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years.
b.
Intercompany—This basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies.
c.
Industry averages—This basis compares an item or financial relationship of a company with industry averages (or norms).
Three factors that affect quality of earnings are: a.
Alternative accounting methods—Variations among companies in the application of generally accepted accounting principles (GAAP) can cause variation in earnings quality across companies.
b.
Pro forma income—Many companies now report non-GAAP income measures in addition to GAAP income. There is little guidance regarding these measures, thus the earnings quality of these measures is difficult to determine.
c.
Improper recognition—In order to meet earnings targets, some companies record revenues and expenses in the wrong period. This directly reduces earnings quality. .
(For Instructor Use Only)
BYP 13-9
ETHICS CASE
(a) The stakeholders in this case are: Kelli Rice, president of LR Industries. Laurie Ellis, public relations director. You, as controller of LR Industries. Stockholders of LR Industries. Potential investors in LR Industries. Any readers of the press release. (b) The president’s press release is deceptive and incomplete and to that extent her actions are unethical. (c) As controller you should at least inform Laurie, the public relations director, about the biased content of the release. She should be aware that the information she is about to release, while factually accurate, is deceptive and incomplete. Both the controller and the public relations director (if she agrees) have the responsibility to inform the president of the bias of the about-to-be-released information.
.
(For Instructor Use Only)
13-55
BYP 13-10
ALL ABOUT YOU
Student responses will vary. We suggest that in class you ask for a few students to share their responses in order to increase students understanding of the reasons why different people will choose different investment vehicles.
13-56
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(For Instructor Use Only)
BYP 13-11
FASB CODIFICATION ACTIVITY
(a) Discontinued Operations 205-20-45-1 The results of operations of a component of an entity that either has been disposed of or is classified as held for sale under the requirements of paragraph 360-10-45-9, shall be reported in discontinued operations in accordance with paragraph 205-20-45-3 if both of the following conditions are met: a. The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction. b. The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction. (b) Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Thus, both of the following criteria should be met to classify an event or transaction as an extraordinary item: a. Unusual nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates. b. Infrequency of occurrence. The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates. (c) Comprehensive Income The change in equity (net assets) of a business entity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. .
(For Instructor Use Only)
13-57
IFRS CONCEPTS AND APPLICATION
IFRS 13-1 LING COMPANY Statement of Comprehensive Income For the Year Ended December 31, 2014 Sales revenue ............................................................... Cost of goods sold ....................................................... Gross profit ................................................................... Operating expenses ..................................................... Net income .................................................................... Other comprehensive income Unrealized gain on non-trading securities ............ Comprehensive income ...............................................
$1,000,000 700,000 300,000 200,000 100,000 75,000 $ 175,000
IFRS 13-2 LING COMPANY Income Statement For the Year Ended December 31, 2014 Sales revenue ............................................................... Cost of goods sold ....................................................... Gross profit ................................................................... Operating expenses ..................................................... Net income ....................................................................
$1,000,000 700,000 300,000 200,000 $ 100,000
LING COMPANY Statement of Comprehensive Income For the Year Ended December 31, 2014 Net income .................................................................... Other comprehensive income Unrealized gain on non-trading securities ............................................................. Comprehensive income ...............................................
13-58
.
(For Instructor Use Only)
$100,000
75,000 $175,000
IFRS 13-3 INTERNATIONAL FINANCIAL REPORTING PROBLEM
(a) The company decided to sell its Baked Snacks business. It said it was doing this in order to enhance earnings and focus its resources on its core profitable divisions. (b) During the year ended April 30, 2009 the company reported losses on the operation of the discontinued division of £1,553,000 and a loss on disposal of £4,283,000. (c) The total recorded value of net assets at the date of disposal was £4,063,000. The company incurred costs of £220,000 to dispose of the business.
.
(For Instructor Use Only)
13-59
13-60
.
(For Instructor Use Only)
CHAPTER 14 Managerial Accounting ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Questions
Brief Exercises
Do It!
Exercises
*1.
Explain the distinguishing features of managerial accounting.
1, 2, 3
1
1
1
*2.
Identify the three broad functions of management.
4, 5, 6, 7, 8
2, 3
1
*3.
Define the three classes of manufacturing costs.
11, 12
4, 5, 7
2
*4.
Distinguish between product and period costs.
13
6
2
*5.
Explain the difference between a merchandising and a manufacturing income statement.
9, 14
*6.
Indicate how cost of goods manufactured is determined.
15, 16, 17, 18
8, 10, 11
*7.
Explain the difference between a merchandising and a manufacturing balance sheet.
10, 19, 20, 21
9
*8.
Identify trends in managerial accounting.
22, 23, 24 25, 26
3
4
A Problems
B Problems
2, 3, 4, 5, 6
1A, 2A
1B, 2B
3, 4, 5, 7, 13
1A, 2A
1B, 2B
8, 12, 13, 14, 15, 17
3A, 4A, 5A
3B, 4B, 5B
8, 9, 10, 11, 3A, 4A, 5A 12, 13, 14, 15, 16, 17
3B, 4B, 5B
14, 15, 16, 17
3B, 4B
3A, 4A
18
*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
14-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Classify manufacturing costs into different categories and compute the unit cost.
Simple
20–30
2A
Classify manufacturing costs into different categories and compute the unit cost.
Simple
20–30
3A
Indicate the missing amount of different cost items, and prepare a condensed cost of goods manufactured schedule, an income statement, and a partial balance sheet.
Moderate
30–40
4A
Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet.
Moderate
30–40
5A
Prepare a cost of goods manufactured schedule and a correct income statement.
Moderate
30–40
1B
Classify manufacturing costs into different categories and compute the unit cost.
Simple
20–30
2B
Classify manufacturing costs into different categories and compute the unit cost.
Simple
20–30
3B
Indicate the missing amount of different cost items, and prepare a condensed cost of goods manufactured schedule, an income statement, and a partial balance sheet.
Moderate
30–40
4B
Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet.
Moderate
30–40
5B
Prepare a cost of goods manufactured schedule and a correct income statement.
Moderate
30–40
14-2
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Kimmel, Accounting, 5e, Solutions Manual
Learning Objective * 1. Explain the distinguishing features of managerial accounting.
Knowledge
* 2. Identify the three broad functions of management.
* 3. Define the three classes of manufacturing costs.
Q14-11
(For Instructor Use Only)
* 4. Distinguish between product and period costs. * 5. Explain the difference between a merchandising and a manufacturing income statement. * 6. Indicate how cost of goods manufactured is determined.
* 7. Explain the difference between a merchandising and a manufacturing balance sheet. * 8. Identify trends in managerial accounting.
Broadening Your Perspective
Q14-19
Comprehension Application Analysis Q14-1 BE14-1 Q14-2 DI14-1 Q14-3 E14-1 Q14-4 Q14-8 Q14-5 BE14-2 Q14-6 BE14-3 Q14-7 DI14-1 Q14-12 DI14-2 E14-4 P14-1A P14-2B BE14-4 E14-2 E14-5 P14-2A BE14-5 E14-3 P14-1B BE14-7 E14-6 Q14-13 E14-3 E14-4 E14-13 P14-1B BE14-6 E14-5 P14-1A P14-2B DI14-2 E14-7 P14-2A Q14-9 E14-8 E14-14 P14-4B P14-3A P14-5B Q14-14 E14-12 E14-17 P14-5A E14-15 E14-13 P14-4A P14-3B E14-15 Q14-15 DI14-3 E14-14 E14-10 Q14-16 E14-8 E14-16 E14-11 Q14-17 E14-9 E14-17 P14-3A Q14-18 E14-10 P14-4A P14-5A BE14-8 E14-11 P14-4B P14-3B BE14-10 E14-12 P14-5B BE14-11 E14-13 Q14-10 E14-15 BE14-9 E14-17 P14-3A Q14-20 E14-14 P14-4A P14-3B Q14-21 E14-16 P14-4B Q14-22 Q14-26 Q14-23 DI14-4 Q14-24 E14-18 Q14-25 BYP14-4 BYP14-1 BYP14-2 BYP14-3 BYP14-5 BYP14-6
Synthesis
Evaluation
BYP14-7 BYP14-8 BYP14-9
BLOOM’ S TAXONOMY TABLE
.
Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
14-3
ANSWERS TO QUESTIONS 1.
(a) Disagree. Managerial accounting is a field of accounting that provides economic and financial information for managers and other internal users. (b) Joe is incorrect. Managerial accounting applies to all types of businesses—service, merchandising, and manufacturing.
2.
(a) Financial accounting is concerned primarily with external users such as stockholders, creditors, and regulators. In contrast, managerial accounting is concerned primarily with internal users such as officers and managers. (b) Financial statements are the end product of financial accounting. The statements are prepared quarterly and annually. In managerial accounting, internal reports may be prepared as frequently as needed. (c) The purpose of financial accounting is to provide general-purpose information for all users. The purpose of managerial accounting is to provide special-purpose information for specific decisions.
3.
Differences in the content of the reports are as follows: Financial
Managerial
• Pertains to business as a whole and is highly aggregated. • Limited to double-entry accounting and cost data. • Generally accepted accounting principles.
• Pertains to subunits of the business and may be very detailed. • Extends beyond double-entry accounting system to any relevant data. • Standard is relevance to decisions.
In financial accounting, financial statements are verified annually through an independent audit by certified public accountants. There are no independent audits of internal reports issued by managerial accountants. 4.
Budgets are prepared by companies to provide future direction. Because the budget is also used as an evaluation tool, some managers try to game the budgeting process by underestimating their division’s predicted performance so that it will be easier to meet their performance targets. On the other hand, if the budget is set at unattainable levels, managers sometimes take unethical actions to meet targets to receive higher compensation or in some cases to keep their jobs.
5.
Linda should know that the management of an organization performs three broad functions: (1) Planning requires management to look ahead and to establish objectives. (2) Directing involves coordinating the diverse activities and human resources of a company to produce a smooth-running operation. (3) Controlling is the process of keeping the company’s activities on track.
6.
Disagree. Decision making is not a separate management function. Rather, decision making involves the exercise of good judgment in performing the three management functions explained in the answer to question five above.
7.
Employees with line positions are directly involved in the company’s primary revenue generating operating activities. Examples would include plant managers and supervisors, and the vice president of operations. In contrast, employees with staff positions are not directly involved in revenuegenerating operating activities, but rather serve in a support capacity to line employees. Examples include employees in finance, legal, and human resources.
14-4
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Questions Chapter 14 (Continued) 8.
CEOs and CFOs must now certify that financial statements give a fair presentation of the company’s operating results and its financial condition and that the company maintains an adequate system of internal controls. In addition, the composition of the board of directors and audit committees receives more scrutiny, and penalties for misconduct have increased.
9.
The differences between income statements are in the computation of the cost of goods sold as follows: Manufacturing company:
Beginning finished goods inventory plus cost of goods manufactured minus ending finished goods inventory = cost of goods sold.
Merchandising company:
Beginning merchandise inventory plus cost of goods purchased minus ending merchandise inventory = cost of goods sold.
10.
The difference in balance sheets pertains to the presentation of inventories in the current asset section. In a merchandising company, only merchandise inventory is shown. In a manufacturing company, three inventory accounts are shown: finished goods, work in process, and raw materials.
11.
Manufacturing costs are classified as either direct materials, direct labor, or manufacturing overhead.
12.
No, Mel is not correct. The distinction between direct and indirect materials is based on two criteria: (1) physical association and (2) the convenience of making the physical association. Materials which cannot be easily associated with the finished product are considered indirect materials.
13.
Product costs, or inventoriable costs, are costs that are a necessary and integral part of producing the finished product. Period costs are costs that are identified with a specific time period rather than with a salable product. These costs relate to nonmanufacturing costs and therefore are not inventoriable costs.
14.
A merchandising company has beginning merchandise inventory, cost of goods purchased, and ending merchandise inventory. A manufacturing company has beginning finished goods inventory, cost of goods manufactured, and ending finished goods inventory.
15.
(a) (b)
16.
Raw materials inventory, beginning ....................................................................... Raw materials purchases ....................................................................................... Total raw materials available for use ...................................................................... Raw materials inventory, ending ............................................................................ Direct materials used ....................................................................................
$ 12,000 170,000 182,000 (15,000) $167,000
17.
Direct materials used ............................................................................................. Direct labor used.................................................................................................... Total manufacturing overhead ............................................................................... Total manufacturing costs .............................................................................
$240,000 220,000 180,000 $640,000
18.
(a) (b)
$666,000 $634,000
19.
The order of listing is finished goods inventory, work in process inventory, and raw materials inventory.
.
X = total cost of work in process. X = cost of goods manufactured.
Total cost of work in process ($26,000 + $640,000)...................................... Cost of goods manufactured ($666,000 – $32,000) ......................................
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14-5
Questions Chapter 14 (Continued) 20. The products differ in how each are consumed by the customer. Services are consumed immediately; the product is not put into inventory. Meals at a restaurant are the best example where they are consumed immediately by the customer. There could be a long lead time before the product is consumed in a manufacturing environment. 21. Yes, product costing techniques apply equally well to manufacturers and service companies. Each needs to keep track of the cost of production or services in order to know whether it is generating a profit. The techniques shown in this chapter, to accumulate manufacturing costs to determine manufacturing inventory, are equally useful for determining the cost of services. 22. The value chain refers to all activities associated with providing a product or service. For a manufacturer, these include research and development, product design, acquisition of raw materials, production, sales and marketing, delivery, customer relations, and subsequent service. 23. An enterprise resource planning (ERP) system is an integrated software system that provides a comprehensive, centralized resource for information. Its primary benefits are that it replaces the many individual systems typically used for receivables, payables, inventory, human resources, etc. Also, it can be used to get information from, and provide information to, the company’s customers and suppliers. 24. In a just-in-time inventory system, the company has no extra inventory stored. Consequently, if some units that are produced are defective, the company will not have enough units to deliver to customers. 25. The balanced scorecard is called “balanced” because it strives to not over emphasize any one performance measure, but rather uses both financial and non-financial measures to evaluate all aspects of a company’s operations in an integrated fashion. 26. Activity-based costing is an approach used to allocate overhead based on each product’s relative use of activities in making the product. Activity-based costing is beneficial because it results in more accurate product costing and in more careful scrutiny of all activities in the value chain.
14-6
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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14-1 Financial Accounting
Managerial Accounting
Primary users
External users
Internal users
Types of reports
Financial statements
Internal reports
Frequency of reports Quarterly and annually
As frequently as needed
Purpose of reports
General-purpose
Special-purpose information for specific decisions
Content of reports
Generally accepted accounting principles
Relevance to decisions
Verification process
Annual audit by certified public accountant
No independent audits
BRIEF EXERCISE 14-2 One implication of SOX was to clarify top management’s responsibility for the company’s financial statements. CEOs and CFOs must now certify that financial statements give a fair presentation of the company’s operating results and its financial condition. In addition, top managers must certify that the company maintains an adequate system of internal controls to safeguard the company’s assets and ensure accurate financial reports. Also, more attention is now paid to the composition of the company’s board of directors. In particular, the audit committee of the board of directors must be comprised entirely of independent members (that is, non-employees) and must contain at least one financial expert. Finally, to increase the likelihood of compliance with these and other new rules, the penalties for misconduct were substantially increased. BRIEF EXERCISE 14-3 (a) 1. Planning. (b) 2. Directing. (c) 3. Controlling. .
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14-7
BRIEF EXERCISE 14-4 (a) (b) (c) (d)
DM DL MO MO
Frames and tires used in manufacturing bicycles. Wages paid to production workers. Insurance on factory equipment and machinery. Depreciation on factory equipment.
BRIEF EXERCISE 14-5 (a) (b) (c) (d) (e) (f) (g) (h)
Direct materials. Direct materials. Direct labor. Manufacturing overhead. Manufacturing overhead. Direct materials. Direct materials. Manufacturing overhead.
BRIEF EXERCISE 14-6 (a) (b) (c) (d) (e) (f)
Product. Period. Period. Period. Product. Product.
BRIEF EXERCISE 14-7
Direct Materials (a) (b) (c) (d)
14-8
Product Costs Direct Factory Labor Overhead X
X X X
.
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BRIEF EXERCISE 14-8 (a) Direct materials used ........................................................... Direct labor............................................................................ Total manufacturing overhead............................................. Total manufacturing costs ...........................................
$180,000 209,000 208,000 $597,000
(b) Beginning work in process .................................................. Total manufacturing costs ................................................... Total cost of work in process .......................................
$ 25,000 597,000 $622,000
BRIEF EXERCISE 14-9 RUIZ COMPANY Balance Sheet December 31, 2014 Current assets Cash................................................................... Accounts receivable ......................................... Inventories Finished goods.......................................... Work in process ........................................ Raw materials ............................................ Prepaid expenses ............................................. Total current assets ..........................
$ 62,000 200,000 $91,000 87,000 73,000
251,000 38,000 $551,000
BRIEF EXERCISE 14-10 Direct Materials Used (1) (2) (3)
.
Direct Labor Used
Factory Overhead
Total Manufacturing Costs $151,000
$81,000
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$144,000
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14-9
BRIEF EXERCISE 14-11 Total Manufacturing Costs (1) $151,000* (2) (3)
Work in Process (January 1)
Work in Process (December 31)
Cost of Goods Manufactured $189,000
$123,000 $58,000
*$40,000 + $61,000 + $50,000 (data from BE 14-10) SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 14-1 1. 2. 3. 4. 5. 6.
False False False True True True
DO IT! 14-2 Period costs: Advertising Salaries of sales representatives Product costs: Blank CDs (DM) Depreciation of CD image burner (MO) Salary of factory manager (MO) Factory supplies used (MO) Paper inserts for CD cases (DM) CD plastic cases (DM) Salaries of factory maintenance employees (MO) Salaries of employees who burn music onto CDs (DL)
14-10
.
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DO IT! 14-3 FISHEL COMPANY Cost of Goods Manufactured Schedule For the Month Ended April 30 Work in process, April 1 ................................ Direct materials .............................................. Raw materials, April 1 ............................... $ 10,000 Raw materials purchases .......................... 98,000 Total raw materials available for use........ 108,000 Less: Raw materials, April 30 .................. 14,000 Direct materials used ................................ $ 94,000 Direct labor ..................................................... 80,000 Manufacturing overhead ................................ 180,000 Total manufacturing costs ............................ Total cost of work in process ........................ Less: Work in process, April 30 ................... Cost of goods manufactured ........................
$
5,000
354,000 359,000 3,500 $355,500
DO IT! 14-4 1. 2. 3. 4. 5. 6.
.
f a c d e b
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14-11
SOLUTIONS TO EXERCISES EXERCISE 14-1 1. False. Financial accounting focuses on providing information to external users. 2. True. 3. False. Preparation of budgets is part of managerial accounting. 4. False. Managerial accounting applies to service, merchandising and manufacturing companies. 5. True. 6. False. Managerial accounting reports are prepared as frequently as needed. 7. True. 8. True. 9. False. Financial accounting reports must comply with generally accepted accounting principles. 10. False. Managerial accountants are expected to behave ethically, and there is a code of ethical standards for managerial accountants. EXERCISE 14-2 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
(b) (c) (c) (c) (a) (b) (c) (c) (c) (a)
Direct labor.* Manufacturing overhead. Manufacturing overhead. Manufacturing overhead. Direct materials. Direct labor. Manufacturing overhead. Manufacturing overhead. Manufacturing overhead. Direct materials.
*or sometimes (c), depending on the circumstances
14-12
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EXERCISE 14-3 (a) Materials used in product ...... DM Depreciation on plant .......... MOH Property taxes on store.....Period Labor costs of assembly line workers ........................... DL Factory supplies used ......... MOH
Advertising expense .............. Period Property taxes on plant ............ MOH Delivery expense .................... Period Sales commissions ................ Period Salaries paid to sales clerks ... Period
(b) Product costs are recorded as a part of the cost of inventory because they are an integral part of the cost of producing the product. Product costs are not expensed until the goods are sold. Period costs are recognized as an expense when incurred.
EXERCISE 14-4 (a) Factory utilities ....................................................................... Depreciation on factory equipment ...................................... Indirect factory labor .............................................................. Indirect materials.................................................................... Factory manager’s salary ...................................................... Property taxes on factory building ....................................... Factory repairs ....................................................................... Manufacturing overhead ........................................................
$ 15,500 12,650 48,900 80,800 8,000 2,500 2,000 $170,350
(b) Direct materials ...................................................................... Direct labor ............................................................................. Manufacturing overhead ........................................................ Product costs .........................................................................
$137,600 69,100 170,350 $377,050
(c) Depreciation on delivery trucks............................................ Sales salaries ......................................................................... Repairs to office equipment .................................................. Advertising ............................................................................. Office supplies used .............................................................. Period costs ...........................................................................
$
.
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3,800 46,400 1,300 15,000 2,640 $ 69,140
14-13
EXERCISE 14-5 1. 2.
(c) (c)
3. 4.
(a) (c)
5. 6.
(b)* (d)
7. 8.
(a) (b)
9. 10.
*or sometimes (c), depending on the circumstances. EXERCISE 14-6 1. (b) 2. (c) 3. (a) 4. (c) 5. (c) 6. (c) 7. (c) 8. (c) 9. (c) 10. (c)
EXERCISE 14-7 (a)
(b)
14-14
Delivery service (product) costs: Indirect materials Depreciation on delivery equipment Dispatcher’s salary Gas and oil for delivery trucks Drivers’ salaries Delivery equipment repairs Total
$ 5,400 11,200 5,000 2,200 16,000 300 $40,100
Period costs: Property taxes on office building CEO’s salary Advertising Office supplies Office utilities Repairs on office equipment Total
$ 870 12,000 3,600 650 990 180 $18,290
.
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(c) (c)
EXERCISE 14-8 (a) Work-in-process, 1/1 ............................... Direct materials used .............................. Direct labor .............................................. Manufacturing overhead Depreciation on plant ....................... Factory supplies used ..................... Property taxes on plant ................... Total manufacturing overhead ............... Total manufacturing costs...................... Total cost of work-in-process ................ Less: ending work-in-process ................ Cost of goods manufactured ..................
$ 12,000 $120,000 110,000 $60,000 23,000 14,000 97,000
(b) Finished goods, 1/1 ................................. Cost of goods manufactured ................. Cost of goods available for sale............. Less: Finished goods, 12/31.................. Cost of goods sold ..................................
327,000 339,000 15,500 $323,500 $ 60,000 323,500 383,500 45,600 $337,900
EXERCISE 14-9 Total raw materials available for use: Direct materials used ....................................................... Add: Raw materials inventory (12/31) ........................... Total raw materials available for use ..............................
$190,000 22,500 $212,500
Raw materials inventory (1/1): Total raw materials available for use: Direct materials used ....................................................... Add: Raw materials inventory (12/31) ........................... Total raw materials available for use .............................. Less: Raw materials purchases ...................................... Raw materials inventory (1/1) ..........................................
$190,000 22,500 212,500 158,000 $ 54,500
Total cost of work in process: Cost of goods manufactured ........................................... Add: Work in process (12/31) .......................................... Total cost of work in process ..........................................
$530,000 81,000 $611,000
.
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14-15
EXERCISE 14-9 (Continued) Total manufacturing costs: Total cost of work in process ................................. Less: Work in process (1/1) .................................... Total manufacturing costs ...................................... Direct labor: Total manufacturing costs ...................................... Less: Total overhead ............................................... Direct materials used .................................... Direct labor ...............................................................
$611,000 210,000 $401,000
$401,000 $122,000 190,000
312,000 $ 89,000
EXERCISE 14-10 A + $57,000 + $46,500 = $195,650 A = $92,150
$252,500 – $11,000 = F F = $241,500
$195,650 + B = $221,500 B = $25,850
$130,000 + G + $102,000 = $253,700 G = $21,700
$221,500 – C = $185,275 C = $36,225
$253,700 + H = $337,000 H = $83,300
$68,400 + $86,000 + $81,600 = D D = $236,000
$337,000 – $70,000 = I I = $267,000
$236,000 + $16,500 = E E = $252,500 Additional explanation to EXERCISE 14-10 solution: Case A (a) Total manufacturing costs ...................................... Less: Manufacturing overhead ............................... Direct labor .................................................... Direct materials used ...............................................
14-16
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$195,650 $46,500 57,000
103,500 $ 92,150
EXERCISE 14-10 (Continued) (b) Total cost of work in process ................................. Less: Total manufacturing costs ............................ Work in process (1/1/14)..........................................
$221,500 195,650 $ 25,850
(c) Total cost of work in process ................................. Less: Cost of goods manufactured ........................ Work in process (12/31/14)......................................
$221,500 185,275 $ 36,225
Case B (d) Direct materials used .............................................. Direct labor............................................................... Manufacturing overhead ......................................... Total manufacturing costs ......................................
$ 68,400 86,000 81,600 $236,000
(e) Total manufacturing costs ...................................... Work in process (1/1/14).......................................... Total cost of work in process .................................
$236,000 16,500 $252,500
(f)
$252,500 11,000 $241,500
Total cost of work in process ................................. Less: Work in process (12/31/14) ........................... Cost of goods manufactured ..................................
Case C (g) Total manufacturing costs ...................................... Less: Manufacturing overhead .............................. Direct materials used ................................... Direct labor...............................................................
$253,700 $102,000 130,000
232,000 $ 21,700
(h) Total cost of work in process ................................. Less: Total manufacturing costs ............................ Work in process (1/1/14)..........................................
$337,000 253,700 $ 83,300
(i)
$337,000 70,000 $267,000
.
Total cost of work in process ................................. Less: Work in process (12/31/14) ........................... Cost of goods manufactured ..................................
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14-17
EXERCISE 14-11 (a) (a) $127,000 + $140,000 + $87,000 = $354,000 (b) $354,000 + $33,000 – $360,000 = $27,000 (c) $450,000 – ($200,000 + $132,000) = $118,000 (d) $40,000 + $470,000 – $450,000 = $60,000 (e) $255,000 – ($80,000 + $100,000) = $75,000 (f)
$255,000 + $60,000 – $80,000 = $235,000
(g) $288,000 – ($70,000 + $75,000) = $143,000 (h) $288,000 + $45,000 – $270,000 = $63,000 (b)
COLAW COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2014 Work in process, January 1 ............................... Direct materials ................................................... Direct labor .......................................................... Manufacturing overhead .................................... Total manufacturing costs.......................... Total cost of work in process ............................ Less: Work in process inventory, December 31 ............................................ Cost of goods manufactured .............................
14-18
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$ 33,000 $127,000 140,000 87,000 354,000 387,000 27,000 $360,000
EXERCISE 14-12 (a)
CEPEDA CORPORATION Cost of Goods Manufactured Schedule For the Month Ended June 30, 2014 Work in process, June 1............................. Direct materials used ................................. Direct labor.................................................. Manufacturing overhead Indirect labor ....................................... Factory manager’s salary ................... Indirect materials ................................ Maintenance, factory equipment ........ Depreciation, factory equipment ........ Factory utilities.................................... Total manufacturing overhead ..... Total manufacturing costs ......................... Total cost of work in process .................... Less: Work in process, June 30 ............... Cost of goods manufactured .....................
(b)
$ 3,000 $20,000 40,000 $4,500 3,000 2,200 1,800 1,400 400 73,300 76,300 3,800 $72,500
CEPEDA CORPORATION Income Statement (Partial) For the Month Ended June 30, 2014 Sales revenue ......................................................... Cost of goods sold Finished goods inventory, June 1 ................. Cost of goods manufactured [from (a)] ........... Cost of goods available for sale .................... Less: Finished goods inventory, June 30 .... Cost of goods sold ......................... Gross profit .............................................................
.
13,300
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$92,100 $ 5,000 72,500 77,500 7,500 70,000 $22,100
14-19
EXERCISE 14-13 (a) MARKS CONSULTING Schedule of Cost of Contract Services Provided For the Month Ended August 31, 2014 Supplies used (direct materials) ................................... $ 1,200 Salaries of professionals (direct labor) ........................ 15,600 Service overhead: Utilities for contract operations ............................... $1,400 Contract equipment depreciation ............................ 900 Insurance on contract operations ........................... 800 Janitorial services for professional offices............. 400 Total overhead .................................................... 3,500 Cost of contract services provided ......................... $20,300 (b) The costs not included in the cost of contract services provided would all be classified as period costs. As such, they would be reported on the income statement under administrative expenses. EXERCISE 14-14 (a) Work-in-process, 1/1 .............................. Direct materials Materials inventory, 1/1 ................... $ 21,000 Materials purchased ........................ 150,000 Materials available for use .............. 171,000 Less: Materials inventory, 12/31..... 30,000 Direct materials used ............................. $141,000 Direct labor ............................................. 220,000 Manufacturing overhead ........................ 180,000 Total manufacturing costs ..................... Total cost of work-in-process................ Less: Work-in-process, 12/31 ................ Cost of goods manufactured .................
14-20
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$ 13,500
541,000 554,500 17,200 $537,300
EXERCISE 14-14 (Continued) AIKMAN COMPANY Income Statement (Partial) For the Year Ended December 31, 2014 (b) Sales revenue ....................................... Cost of goods sold Finished goods, 1/1 ........................ Cost of goods manufactured ........ Cost of goods available for sale .... Less: Finished goods, 12/31 ......... Cost of goods sold .......... Gross profit ............................................
$910,000 $ 27,000 537,300 564,300 21,000 543,300 $366,700
AIKMAN COMPANY (Partial) Balance Sheet December 31, 2014 (c) Current assets Inventories Finished goods .............................................. Work in process ............................................ Raw materials .................................................
$21,000 17,200 30,000
$68,200
(d) In a merchandising company’s income statement, the only difference would be in the computation of cost of goods sold. Beginning and ending finished goods would be replaced by beginning and ending merchandise inventory, and cost of goods manufactured would be replaced by purchases. In a merchandising company’s balance sheet, there would be one inventory account (merchandise inventory) instead of three. EXERCISE 14-15 1. 2. 3. 4. 5. 6. 7. 8. .
(a) (a) (a), (c) (b) (a) (a) (a) (b), (c) Kimmel, Accounting, 5e, Solutions Manual
9. 10. 11. 12. 13. 14. 15. 16. (For Instructor Use Only)
(a) (a), (b) (b) (b) (a) (a) (a) (a) 14-21
EXERCISE 14-16 (a)
ROBERTS COMPANY Cost of Goods Manufactured Schedule For the Month Ended June 30, 2014 Work in process inventory, June 1 ................. $ 5,000 Direct materials Raw materials inventory, June 1 ............ $ 9,000 Raw materials purchases........................ 54,000 Total raw materials available for use ........ 63,000 Less: Raw materials inventory, June 30 .... 13,100 Direct materials used .............................. 49,900 Direct labor ..................................................... 47,000 Manufacturing overhead Indirect labor............................................ $5,500 Factory insurance.................................... 4,000 Machinery depreciation........................... 4,000 Factory utilities ........................................ 3,100 Machinery repairs .................................... 1,800 Miscellaneous factory costs ................... 1,500 Total manufacturing overhead ......... 19,900 Total manufacturing costs ............................ 116,800 Total cost of work in process ....................... 121,800 Less: Work in process inventory, June 30 ...... 7,000 Cost of goods manufactured ........................ $114,800
(b)
ROBERTS COMPANY (Partial) Balance Sheet June 30, 2014 Current assets Inventories Finished goods ........................................... Work in process .......................................... Raw materials .............................................
14-22
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$ 8,000 7,000 13,100
$28,100
EXERCISE 14-17 (a) Raw Materials account: (5,000 – 4,650) X $10 = $3,500 Work in Process account: (4,600 X 10%) X $10 = $4,600 Finished Goods account: (4,600 X 90% X 30%) X $10 = $12,420 Cost of Goods Sold account: (4,600 X 90% X 70%) X $10 = $28,980 Selling Expenses account: 50 X $10 = $500 Proof of cost of head lamps allocated (5,000 X $10 = $50,000) Raw materials Work in process Finished goods Cost of goods sold Selling expenses Total (b) To:
$ 3,500 4,600 12,420 28,980 500 $50,000
Chief Accountant
From:
Student
Subject:
Statement Presentation of Accounts
Two accounts will appear in the income statement. Cost of Goods Sold will be deducted from net sales in determining gross profit. Selling expenses will be shown under operating expenses and will be deducted from gross profit in determining net income. Sometimes, the calculation for Cost of Good Sold is shown on the income statement. In these cases, the balance in Finished Goods inventory would also be shown on the income statement. The other accounts associated with the head lamps are inventory accounts which contain end-of-period balances. Thus, they will be reported under inventories in the current assets section of the balance sheet in the following order: finished goods, work in process, and raw materials. EXERCISE 14-18 (a) (b) (c) (d)
.
3. 4. 2. 1.
Balanced scorecard Value chain Just-in-time inventory Activity-based costing
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14-23
14-24
(a) .
Cost Item
$ 9,000 1,500 $75,000 900 $
300
$53,000 800 1,100 5,700 400
000,000 $75,000
000,000 $53,000
$ 75,000 53,000 20,100 $148,100
Production cost per helmet = $148,100/10,000 = $14.81.
1,500 $20,100
14,000 10,000 000,000 $25,100
SOLUTIONS TO PROBLEMS
(For Instructor Use Only)
(b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost
Period Costs
PROBLEM 14-1A
Kimmel, Accounting, 5e, Solutions Manual
Rent on factory equipment Insurance on factory building Raw materials Utility costs for factory Supplies for general office Wages for assembly line workers Depreciation on office equipment Miscellaneous materials Factory manager’s salary Property taxes on factory building Advertising for helmets Sales commissions Depreciation on factory building
Direct Materials
Product Costs Direct Manufacturing Labor Overhead
. Kimmel, Accounting, 5e, Solutions Manual
(a)
(1) (2) (3) (4) (5)
$90,000 $ 4,900 7,500 3,000 1,300 $9,500 00_0,000 $111,000
000,000 $90,000
650 750 $18,100
$74 X 1,500 = $111,000. $12 X 5 X 1,500 = $90,000. $5 X 1,500 = $7,500. $7,800/12 = $650. $9,000/12 = $750.
(b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost
Period Costs
$111,000 90,000 18,100 $219,100
Production cost per system = $219,100/1,500 = $146.07. (rounded)
00,000 $9,500
PROBLEM 14-2A
(For Instructor Use Only)
Cost Item Raw materials (1) Wages for workers (2) Rent on equipment Indirect materials (3) Factory supervisor’s salary Janitorial costs Advertising Depreciation on factory building (4) Property taxes on factory building (5)
Direct Materials $111,000
Product Costs Direct Manufacturing Labor Overhead
14-25
PROBLEM 14-3A
(a) Case 1 A = $9,600 + $5,000 + $8,000 = $22,600 $22,600 + $1,000 – B = $17,000 B = $22,600 + $1,000 – $17,000 = $6,600 $17,000 + C = $20,000 C = $20,000 – $17,000 = $3,000 D = $20,000 – $3,400 = $16,600 E = ($24,500 – $2,500) – $16,600 = $5,400 F = $5,400 – $2,500 = $2,900 Case 2 G + $8,000 + $4,000 = $16,000 G = $16,000 – $8,000 – $4,000 = $4,000 $16,000 + H – $3,000 = $22,000 H = $22,000 + $3,000 – $16,000 = $9,000 (I – $1,400) – K = $7,000 (I – $1,400) – $22,800 = $7,000 I = $1,400 + $22,800 + $7,000 = $31,200 (Note: Item I can only be solved after item K is solved.) J = $22,000 + $3,300 = $25,300 K = $25,300 – $2,500 = $22,800 $7,000 – L = $5,000 L = $2,000
14-26
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PROBLEM 14-3A (Continued) (b)
CASE 1 Cost of Goods Manufactured Schedule Work in process, beginning ................................. Direct materials ..................................................... Direct labor............................................................ Manufacturing overhead ...................................... Total manufacturing costs ........................... Total cost of work in process .............................. Less: Work in process, ending ........................... Cost of goods manufactured ...............................
(c)
$ 1,000 $9,600 5,000 8,000 22,600 23,600 6,600 $17,000
CASE 1 Income Statement Sales revenue ....................................................... Less: Sales discounts ......................................... Net sales ................................................................ Cost of goods sold Finished goods inventory, beginning .......... Cost of goods manufactured........................ Cost of goods available for sale .................. Less: Finished goods inventory, ending .... Cost of goods sold ................................ Gross profit ........................................................... Operating expenses ............................................. Net income ............................................................
$24,500 2,500 $22,000 3,000 17,000 20,000 3,400 16,600 5,400 2,500 $ 2,900
CASE 1 (Partial) Balance Sheet Current assets Cash ............................................................... Receivables (net)........................................... Inventories Finished goods ...................................... Work in process..................................... Raw materials ........................................ Prepaid expenses.......................................... Total current assets ..............................
.
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$ 4,000 15,000 $3,400 6,600 600
10,600 400 $30,000
14-27
PROBLEM 14-4A
(a)
CLARKSON COMPANY Cost of Goods Manufactured Schedule For the Year Ended June 30, 2014 Work in process, July 1, 2013 ............ Direct materials Raw materials inventory, July 1, 2013 .............................. Raw materials purchases ........... Total raw materials available for use ...................................... Less: Raw materials inventory, June 30, 2014 ................... Direct materials used .................. Direct labor .......................................... Manufacturing overhead Plant manager’s salary ............... Factory utilities ............................ Indirect labor ............................... Factory machinery depreciation ... Factory property taxes ................ Factory insurance ....................... Factory repairs ............................ Total manufacturing overhead........................... Total manufacturing costs ................. Total cost of work in process ............ Less: Work in process, June 30........ Cost of goods manufactured .............
14-28
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Kimmel, Accounting, 5e, Solutions Manual
$ 19,800 $ 48,000 96,400 144,400 39,600 $104,800 139,250 58,000 27,600 24,460 16,000 9,600 4,600 1,400
(For Instructor Use Only)
141,660 385,710 405,510 18,600 $386,910
PROBLEM 14-4A (Continued) (b)
CLARKSON COMPANY (Partial) Income Statement For the Year Ended June 30, 2014 Sales revenues Sales revenue ............................................. Less: Sales discounts............................... Net sales ..................................................... Cost of goods sold Finished goods inventory, July 1, 2013 ............................................. Cost of goods manufactured..................... Cost of goods available for sale ............... Less: Finished goods inventory, June 30, 2014 ................................. Cost of goods sold ............................. Gross profit ................................................
(c)
$534,000 4,200 $529,800 96,000 386,910 482,910 75,900 407,010 $122,790
CLARKSON COMPANY (Partial) Balance Sheet June 30, 2014 Assets Current assets Cash ............................................................ Accounts receivable .................................. Inventories Finished goods ................................... Work in process.................................. Raw materials ..................................... Total current assets ....................
.
Kimmel, Accounting, 5e, Solutions Manual
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$ 32,000 27,000 $75,900 18,600 39,600
134,100 $193,100
14-29
PROBLEM 14-5A
(a)
PHILLIPS COMPANY Cost of Goods Manufactured Schedule For the Month Ended October 31, 2014 Work in process, October 1 .............. Direct materials Raw materials inventory, October 1 ................................ $ 18,000 Raw materials purchases ............................... 264,000 Total raw materials available for use ..................................... 282,000 Less: Raw materials inventory, October 31 ....................... 29,000 Direct materials used ................. Direct labor ......................................... Manufacturing overhead Factory facility rent .................... 60,000 Depreciation on factory equipment ............................... 31,000 Indirect labor .............................. 28,000 Factory utilities* ......................... 9,000 Factory insurance** .................... 4,800 Total manufacturing overhead.......................... Total manufacturing costs ................ Total cost of work in process ........... Less: Work in process, October 31..... Cost of goods manufactured ............ **$12,000 X 75% = $9,000 **$ 8,000 X 60% = $4,800
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$ 16,000
$253,000 190,000
132,800 575,800 591,800 14,000 $577,800
PROBLEM 14-5A (Continued) (b)
PHILLIPS COMPANY Income Statement For the Month Ended October 31, 2014 Sales revenue ................................................... Cost of goods sold Finished goods inventory, October 1 ...... Cost of goods manufactured.................... Cost of goods available for sale .............. Less: Finished goods inventory, October 31 ..................................... Cost of goods sold ............................ Gross profit ....................................................... Operating expenses Advertising expense ................................. Selling and administrative salaries .......... Depreciation expense—sales equipment .............................................. Insurance expense** ................................. Utilities expense* ...................................... Total operating expenses ................. Net income ........................................................
$780,000 $ 30,000 577,800 607,800 45,000 562,800 217,200 90,000 75,000 45,000 3,200 3,000 216,200 $ 1,000
**$12,000 X 25% **$ 8,000 X 40%
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14-31
14-32
(a) .
Cost Item
(For Instructor Use Only)
(b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost
Period Costs
$ 1,500 5,500 8,000 4,000 700 6,000 3,000 $25,000 800 200 $54,000 000,000 $25,000
000,000 $54,000
$25,000 54,000 19,500 $98,500
Production cost per motorcycle helmet = $98,500/1,000 = $98.50
2,000 $19,500
500 000,000 $12,700
PROBLEM 14-1B
Kimmel, Accounting, 5e, Solutions Manual
Maintenance costs on factory building Factory manager’s salary Advertising for helmets Sales commissions Depreciation on factory building Rent on factory equipment Insurance on factory building Raw materials Utility costs for factory Supplies for general office Wages for assembly line workers Depreciation on office equipment Miscellaneous materials
Direct Materials
Product Costs Direct Manufacturing Labor Overhead
. Kimmel, Accounting, 5e, Solutions Manual
(a)
(1) (2) (3) (4) (5)
$75,000 $ 1,300 7,500 3,500 1,400 $8,000 000,000 $57,500
000,000 $75,000
$23 X 2,500 = 57,500. $15 X 2 X 2,500 = $75,000. $3 X 2,500 = $7,500. $8,400/12 = $700. $9,600/12 = $800.
(b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost
Period Costs
$ 57,500 75,000 15,200 $147,700
14-33
Production cost per racket = $147,700/2,500 = $59.08
700 800 $15,200
00,000 $8,000
PROBLEM 14-2B
(For Instructor Use Only)
Cost Item Raw materials (1) Wages for workers (2) Rent on equipment Indirect materials (3) Factory supervisor’s salary Janitorial costs Advertising Depreciation on factory building (4) Property taxes on factory building (5)
Direct Materials $57,500
Product Costs Direct Manufacturing Labor Overhead
PROBLEM 14-3B
(a) Case A A = $6,300 + $3,000 + $6,000 = $15,300 $15,300 + $1,000 – B = $15,800 B = $15,300 + $1,000 – $15,800 = $500 $15,800 + C = $18,300 C = $18,300 – $15,800 = $2,500 D = $18,300 – $1,200 = $17,100 E = ($22,500 – $1,500) – $17,100 = $3,900 F = $3,900 – $2,700 = $1,200 Case B G + $4,000 + $5,000 = $16,000 G = $16,000 – $4,000 – $5,000 = $7,000 $16,000 + H – $2,000 = $20,000 H = $20,000 + $2,000 – $16,000 = $6,000 (I – $1,200) – K = $6,000 (I – $1,200) – $22,500 = $6,000 I = $1,200 + $22,500 + $6,000 = $29,700 (Note: Item I can only be solved after item K is solved.) J = $20,000 + $5,000 = $25,000 K = $25,000 – $2,500 = $22,500 $6,000 – L = $2,200 L = $3,800
14-34
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 14-3B (Continued) (b)
CASE A Cost of Goods Manufactured Schedule Work in process, beginning ................................ Direct materials .................................................... Direct labor........................................................... Manufacturing overhead ..................................... Total manufacturing costs .......................... Total cost of work in process ............................. Less: Work in process, ending .......................... Cost of goods manufactured ..............................
(c)
$ 1,000 $ 6,300 3,000 6,000 15,300 16,300 500 $15,800
CASE A Income Statement Sales revenue ...................................................... Less: Sales discounts ........................................ Net sales ............................................................... Cost of goods sold Finished goods inventory, beginning......... Cost of goods manufactured ...................... Cost of goods available for sale ................. Less: Finished goods inventory, ending ... Cost of goods sold ..................... Gross profit .......................................................... Operating expenses ............................................ Net income ...........................................................
$22,500 1,500 $21,000 2,500 15,800 18,300 1,200 17,100 3,900 2,700 $ 1,200
CASE A (Partial) Balance Sheet Current assets Cash ............................................................... Receivables (net)........................................... Inventories Finished goods ...................................... Work in process..................................... Raw materials ........................................ Prepaid expenses.......................................... Total current assets .............................. .
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$ 3,000 10,000 $ 1,200 500 700
2,400 200 $15,600 14-35
PROBLEM 14-4B
(a)
MOXIE COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2014 Work in process inventory, January 1 ................................. Direct materials Raw materials inventory, January 1 ......................... Raw materials purchases ........................ Total raw materials available for use .............. Less: Raw materials inventory, December 31 ............ Direct materials used .......... Direct labor .................................. Manufacturing overhead Plant manager’s salary ....... Indirect labor ....................... Factory utilities ................... Factory machinery depreciation ..................... Factory insurance ............... Factory property taxes ........ Factory repairs .................... Total manufacturing overhead .................. Total manufacturing costs ......... Total cost of work in process .... Less: Work in process, December 31 .................... Cost of goods manufactured .....
14-36
.
Kimmel, Accounting, 5e, Solutions Manual
$
9,500
$ 47,000 62,500 109,500 44,200 $ 65,300 145,100 60,000 18,100 12,900 7,700 7,400 6,100 800 113,000 323,400 332,900 8,000 $324,900
(For Instructor Use Only)
PROBLEM 14-4B (Continued) (b)
MOXIE COMPANY (Partial) Income Statement For the Year Ended December 31, 2014 Sales revenues Sales revenue ............................................ Less: Sales discounts.............................. Net sales .................................................... Cost of goods sold Finished goods inventory, January 1 ............................................... Cost of goods manufactured (see schedule) ............................................... Cost of goods available for sale .............. Less: Finished goods inventory, December 31 .................................. Cost of goods sold .................. Gross profit .......................................................
(c)
$465,000 2,500 $462,500 85,000 324,900 409,900 57,800 352,100 $110,400
MOXIE COMPANY (Partial) Balance Sheet December 31, 2014 Assets Current assets Cash ........................................................... Accounts receivable ................................. Inventories Finished goods .................................. Work in process................................. Raw materials .................................... Total current assets ...................
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Kimmel, Accounting, 5e, Solutions Manual
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$ 18,000 27,000 $ 57,800 8,000 44,200
110,000 $155,000
14-37
PROBLEM 14-5B
(a)
ORTIZ COMPANY Cost of Goods Manufactured Schedule For the Month Ended August 31, 2014 Work in process, August 1 .................. Direct materials Raw materials inventory, August 1 .................................... Raw materials purchases ............ Total raw materials available for use ....................... Less: Raw materials inventory, August 31 ........................... Direct materials used ................... Direct labor ........................................... Manufacturing overhead Factory facility rent ...................... Depreciation on factory equipment ................................. Indirect labor ................................ Factory utilities* ........................... Factory insurance** ...................... Total manufacturing overhead ........................... Total manufacturing costs .................. Total cost of work in process ............. Less: Work in process, August 31 ................................... Cost of goods manufactured ..............
$ 25,000 $ 19,500 220,000 239,500 35,000 $204,500 160,000 $ 60,000 35,000 20,000 6,000 3,500
*$10,000 X 60% **$ 5,000 X 70%
14-38
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
124,500 489,000 514,000 21,000 $493,000
PROBLEM 14-5B (Continued) (b)
ORTIZ COMPANY Income Statement For the Month Ended August 31, 2014 Sales revenue ..................................................... Cost of goods sold Finished goods inventory, August 1.......... Cost of goods manufactured...................... Cost of goods available for sale ................ Less: Finished goods inventory, August 31 ......................................... Cost of goods sold .............................. Gross profit ......................................................... Operating expenses Advertising expense ................................... Selling and administrative salaries ............ Depreciation expense—sales equipment ................................................ Utilities expense* ........................................ Insurance expense** ................................... Total operating expenses ................... Net loss ...............................................................
$675,000 $ 40,000 493,000 533,000 52,000 481,000 194,000 75,000 70,000 50,000 4,000 1,500 200,500 $ (6,500)
*$10,000 X 40% **$ 5,000 X 30%
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14-39
BYP 14-1
DECISION-MAKING AT CURRENT DESIGNS
The answers to parts (a) and (b) may vary from student to student. (a) What are the primary information needs of each manager? Mike Cichanowski, CEO, needs to know the overall financial picture of the company. He also needs to have a general picture of sales by territory and product line, and of cost per unit by product line. Diane Buswell, Controller, needs all accounting-related information. Deb Welch, Purchasing Manager, needs to know the costs of the components for each product. Bill Johnson, Sales Manager, needs to know sales by territory and product line. Dave Thill, Kayak Plant Manager, needs to know all the costs of producing each type of kayak. Rick Thrune, Production Manager for Composite Kayaks, needs to know the costs related to the composite kayak production.
14-40
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 14-1 (Continued)
(b) Name one special-purpose management accounting report that could be designed for each manager. Include the name of the report, the information it would contain, and how frequently it should be issued. Manager
Name of report
Information report would contain
Mike Cichanowski
Analysis of proposed new product line Companywide budget analysis
Projected revenues and expenses for a possible new product line Revenues, expenses, and net income compared to the budgeted amounts for each List of items purchased and most recent cost for each item Sales by product line and by customer Direct materials, direct labor, and manufacturing overhead costs assigned to each product line Detailed direct material and direct labor costs for the composite kayaks
Diane Buswell
.
Deb Welch
Purchasing History
Bill Johnson
Sales Summary
Dave Thill
Cost of Production Report
Rick Thrune
Cost of Production Report for Composite Kayaks
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
How frequently should it be issued? As needed and requested
Monthly
Monthly or available online Monthly or weekly Monthly or weekly
Weekly
14-41
BYP 14-1 (Continued) (c) When Diane Buswell, controller for Current Designs, reviewed the accounting records for a recent period, she noted the following items. Classify each item as a product cost or a period cost. If a cost is a product cost, note if it is a direct materials, direct labor, or manufacturing overhead item. Payee
Product Costs Period Direct Direct Manufacturing Costs Materials Labor Overhead
Purpose
Winona Agency Bill Johnson (sales manager) Xcel Energy Winona Printing Jim Kaiser (sales representative) Dave Thill (plant manager)
Property insurance for the manufacturing plant Payroll–payment to sales manager Electricity for manufacturing plant Price lists for salespeople Sales commissions
X X X X X
Payroll–payment to plant manager
X
Dana Schultz (kayak Payroll–payment to assembler) kayak assembler Composite One Bagging film used when kayaks are assembled. It is discarded after use. Fastenal Shop supplies–brooms, paper towels, etc. Ravago
Winona County North American Composites
Polyethylene powder which is the main ingredient for the rotational molded kayaks Property taxes on manufacturing plant Kevlar fabric for composite kayaks
X
X
X
X
X X
Waste Management Trash disposal for the company office building None
14-42
X
Journal entry to record depreciation of manufacturing equipment
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X
BYP 14-2
DECISION-MAKING ACROSS THE ORGANIZATION
Ending Raw Materials Inventory Beginning raw materials + Raw materials purchased = Raw materials available for use = $19,000 + $365,000 = $384,000 Raw materials available for use – Ending raw materials inventory = Direct materials used $384,000 – Ending raw materials inventory = $350,000 Ending raw materials inventory = $384,000 – $350,000 = $34,000 Ending Work in Process Inventory Direct materials + Direct labor + Manufacturing overhead = Total manufacturing costs = $350,000 + $250,000 + ($250,000 X 60%) = $750,000 Beginning work in process inventory + Total manufacturing costs = Total cost of work in process = $25,000 + $750,000 = $775,000 Cost of goods manufactured + Beginning finished goods inventory = Cost of goods available for sale Cost of goods manufactured + $38,000 = $770,000 Cost of goods manufactured = $770,000 – $38,000 = $732,000 Total cost of work in process – Ending work in process inventory = Cost of goods manufactured $775,000 – Ending work in process inventory = $732,000 Ending work in process inventory = $775,000 – $732,000 = $43,000 Ending Finished Goods Inventory Sales – Cost of goods sold = Gross profit $1,240,000 – Cost of goods sold = $1,240,000 X 40% Cost of goods sold = $1,240,000 – $496,000 = $744,000 Cost of goods available for sale – Ending finished goods inventory = Cost of goods sold $770,000 – Ending finished goods inventory = $744,000 Ending finished goods inventory = $770,000 – $744,000 = $26,000 .
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14-43
BYP 14-3
MANAGERIAL ANALYSIS
Since the questions were fairly open-ended, the following are only suggested results. The class may be able to think of others, or of more items for each one. (a) Jason Dennis
Needs information on sales, perhaps by salesperson and by territory.
Peggy Groneman
Needs cost information for her department.
Dave Marley
Needs all accounting information.
Kevin Carson
Needs product cost information.
Sally Renner
Needs information on component costs and costs for her department. Income statement.
(b) Jason Dennis Peggy Groneman
None.
Dave Marley
All.
Kevin Carson
Income statement and cost of goods manufactured schedule.
Sally Renner (c) Jason Dennis
None. Sales by Territory—Detailed information, possibly by product line, issued daily or weekly.
14-44
Peggy Groneman
Cost of Computer Programs—Accumulated cost incurred for each major program used including maintenance and updates of program, issued monthly.
Dave Marley
Cost of Preparing Reports—Detailed analysis of all reports provided, their frequency, time, and estimated cost to prepare, issued monthly.
Kevin Carson
Cost of Product—Detailed cost by product line, including a comparison with estimated costs for that product. Issued as each batch of production is completed.
Sally Renner
Cost of Product Design—Accumulated total costs of each new product, issued at end of each project.
.
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BYP 14-4
REAL-WORLD FOCUS
The factors that affect the cost of products are direct materials, direct labor, and manufacturing overhead. The percentage increase of total cost of products sold to net sales of 1.7% during the year appears to be entirely due to net increases in costs. The current year events and their possible impact on the three manufacturing cost elements are as follows: Operational problems at a major furnace. The principal effect is on manufacturing overhead due to higher maintenance costs. The problems may also have resulted in higher direct labor costs and higher direct materials because of the malfunctioning of the furnace. Higher downtime and costs and expenses associated with capital improvement projects. Higher downtime causes higher indirect labor. Costs associated with capital improvement projects impact product costs through depreciation which is part of manufacturing overhead. Increases in labor and other manufacturing costs. The increases in labor resulted in higher direct labor costs. The increases in indirect labor costs and in other manufacturing costs resulted in higher manufacturing overhead. Reduced fixed costs. Fixed costs such as insurance and rent are classified as manufacturing overhead. Thus, this factor reduced overhead costs during the year. Productivity and efficiency gains. This factor could have resulted in reductions of both direct material and direct labor costs.
.
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BYP 14-5
REAL-WORLD FOCUS
(a) The IMA has more than 60,000 members. These members include business leaders, managers, and decision makers in accounting and finance. (b) Student and Associate members receive most of the benefits of Regular membership at a significant savings. • Unique access to the professional designation, the Certified Management Accountant (CMA) • Specialized learning opportunities • Educational assistance, grants, educational competitions • Around-the-Clock Networking • Career management resources (c) The answer to this question will vary by school.
14-46
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BYP 14-6
COMMUNICATION ACTIVITY
Ms. Shelly Phillips President Phillips Company Dear Shelly: As you requested, I corrected the income statement for October from the information you gave me. The corrected statement is enclosed and it shows that you actually earned net income of $1,000 for October. I also noticed that you did not have a cost of goods manufactured schedule, so I prepared one for you. The income statement your assistant accountant prepared was not correct for two primary reasons. First, product costs were not separated from selling and administrative expenses. Second, and more importantly, the reported net loss did not reflect changes in inventories. This had the effect of treating these costs as expenses rather than assets. A reconciliation of the reported net loss of $23,000 to net income of $1,000 is as follows: Net loss as reported ..................................................... Increase (decrease) in inventories Raw materials ($29,000 – $18,000)....................... $11,000 Work in process ($14,000 – $16,000) ................... (2,000) Finished goods ($45,000 – $30,000) .................... 15,000 Total increase ................................................ Net income as corrected ..............................................
$(23,000)
(24,000 $ (1,000
The changes in raw materials and work in process inventories are reported in the cost of goods manufactured schedule. You will see, for example, that the cost of direct materials used was $253,000, not $264,000 as reported by your accountant in the income statement. The difference is the change in raw materials inventories. Similarly, you will see that the $2,000 decrease in work in process inventories increases total manufacturing costs of $575,800 to produce cost of goods manufactured of $577,800. The change in finished goods inventories is reported in the income statement. Notice that the change of $15,000 is subtracted from cost of goods manufactured of $577,800 to produce cost of goods sold of $562,800. .
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14-47
BYP 14-6 (Continued) I have also modified the form of the income statement to recognize the distinction between product costs (cost of goods sold) and period costs (operating expenses) as required by generally accepted accounting principles. Thanks for letting me help. If I can be of further assistance, don’t hesitate to call. I hope you find a replacement for your controller soon. Sincerely,
14-48
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 14-7
ETHICS CASE
(a) The stakeholders in this situation are: • • • •
The users of Newton Industries’ financial statements. Steve Morgan, controller. The vice-president of finance. The president of Newton Industries.
(b) The ethical issues in this situation pertain to the adherence to sound and acceptable accounting principles. Intentional violation of generally accepted accounting principles in order to satisfy a practical short-term personal or company need and thus create misleading financial statements would be unethical. Selecting one acceptable method of accounting and reporting among other acceptable methods is not necessarily unethical. (c) Ethically, the management of Newton Industries should be trying to report the financial condition and results of operations as fairly as possible; that is, in accordance with GAAP. Steve should inform management what is acceptable accounting and what is not. The basic concept to be supported in this advertising cost transaction is matching costs and revenues. Normally, advertising costs are expensed in the period in which they are incurred because it is very difficult to associate them with specific revenues.
.
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BYP 14-8
ALL ABOUT YOU
Student responses will vary. We have provided some basic examples that may represent common responses. (a) Individuals must often make purchase decisions which involve choosing between an item that has a more expensive initial purchase price, but is expected to either last longer, or provides some form of cost savings. The question that the individual faces is whether the cost savings or additional benefit justifies the additional initial cost. For example, more expensive dishwashers and refrigerators also tend to be more energy efficient. The labels on these appliances provide information regarding the energy savings which can be used to make a break-even evaluation. (b) In order to increase control over their financial situation and reduce the probability of financial hardship, all people should prepare personal budgets. Preparation of a personal budget requires the individual to plan for the future and to prioritize expenditures. (c) Companies employ the balanced scorecard as a mechanism to ensure that their financial goals are consistent with their efforts. Use of the balanced scorecard requires clear articulation of goals, priorities, and strategies. By employing these same techniques in their everyday life, individuals can be better assured that they will expend effort on those things that really matter to them, rather than wasting efforts on less important distractions. (d) Capital budgeting involves financial evaluation of long-term assets. Companies routinely make capital budgeting decisions, but so do individuals. The purchase of a home or car is a decision that has implications for your finances for many subsequent years. Buying a house or car is a very personal decision, influenced by many personal, nonfinancial, preferences. However, these decisions should also be subjected to a financial evaluation using capital budgeting techniques to ensure that the choice makes good economic sense.
14-50
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BYP 14-9
CONSIDERING YOUR COSTS AND BENEFITS
Discussion guide: This is a difficult decision. While the direct costs of outsourced tax return preparation may in fact be lower, you must also consider other issues: Will the accuracy of the returns be as high? Will your relationships with your customers suffer due to the loss of direct contact? Will customers resent having their personal information shipped overseas? While you may not want to lay off six employees, you also don’t want to put your firm at risk by not remaining competitive. Perhaps one solution would be to outsource the most basic tasks, and then provide training to the six employees so they can perform higher-skilled services such as tax planning. Many of the techniques that you learn in the remaining chapters of this text will help you evaluate the merits of your various options.
.
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14-51
CHAPTER 15 Job Order Costing ASSIGNMENT CLASSIFICATION TABLE Brief Exercises
Do It!
Exercises
A Problems
B Problems
5, 6, 7, 8
1, 2
1
1, 2, 3, 4, 6, 7, 8, 9, 11
1A, 2A, 3A, 5A
1B, 2B, 3B, 5B
Explain the nature and importance of a job cost sheet.
9, 10, 11, 12
3, 4, 5
2
1, 2, 3, 6, 7, 8, 10, 12
1A, 2A, 3A, 5A
1B, 2B, 3B, 5B
4.
Indicate how the predetermined overhead rate is determined and used.
13, 14, 15
6, 7
2
2, 3, 5, 6, 7, 8, 11, 12, 13
1A, 2A, 3A, 4A, 5A
1B, 2B, 3B, 4B, 5B
5.
Prepare entries for jobs completed and sold.
16
8, 9
3
2, 3, 6, 7, 8, 9, 10, 11
1A, 2A, 3A, 5A
1B, 2B, 3B, 5B
6.
Distinguish between under- and overapplied manufacturing overhead.
17, 18
10
4
4, 5, 12, 13
1A, 2A, 4A, 5A
1B, 2B, 4B, 5B
Learning Objectives
Questions
1.
Explain the characteristics and purposes of cost accounting.
1, 2, 3, 4
2.
Describe the flow of costs in a job order costing system.
3.
.
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15-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Prepare entries in a job order cost system and job cost sheets.
Simple
30−40
2A
Prepare entries in a job order cost system and partial income statement.
Moderate
30−40
3A
Prepare entries in a job order cost system and cost of goods manufactured schedule.
Simple
30−40
4A
Compute predetermined overhead rates, apply overhead, and calculate under- or overapplied overhead.
Simple
20−30
5A
Analyze manufacturing accounts and determine missing amounts.
Complex
30−40
1B
Prepare entries in a job order cost system and job cost sheets.
Simple
30−40
2B
Prepare entries in a job order cost system and partial income statement.
Moderate
30−40
3B
Prepare entries in a job order cost system and cost of goods manufactured schedule.
Simple
30−40
4B
Compute predetermined overhead rates, apply overhead, and calculate under- or overapplied overhead.
Simple
20−30
5B
Analyze manufacturing accounts and determine missing amounts.
Complex
30−40
15-2
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Kimmel, Accounting, 5e, Solutions Manual
Learning Objective
Knowledge
1. Explain the characteristics and purposes of cost accounting.
Comprehension Q15-1 Q15-2
Application
Analysis
Synthesis
Evaluation
Q15-3 Q15-4
(For Instructor Use Only)
2. Describe the flow of costs in a job order costing system.
Q15-5 Q15-7 Q15-8
Q15-6 BE15-1
BE15-2 DI15-1 E15-1 E15-2 E15-3
E15-6 E15 -7 E15-8 E15-9 E15-11
P15-1A P15-2A P15-3A P15-5A P15-1B P15-2B P15-3B P15-5B E15-4
3. Explain the nature and importance of a job cost sheet.
Q15-11 Q15-12
Q15-9 Q15-10
BE15-3 BE15-4 BE15-5 D15-2 E15-1 E15-2
E15-3 E15-6 E15-7 E15-8 E15-10 E15-12
P15-1A P15-2A P15-3A P15-5A P15-1B P15-2B P15-3B P15-5B
4. Indicate how the predetermined overhead rate is determined and used.
Q15-15
Q15-13 Q15-14
BE15-6 BE15-7 DI15-2 E15-2 E15-3 E15-6
E15-7 E15-8 E15-11 E15-12 E15-13 P15-1A
P15-3A E15-5 P15-4A P15-2A P15-1B P15-5A P15-3B P15-2B P15-4B P15-5B
5. Prepare entries for jobs completed and sold.
Q15-16 BE15-9
BE15-8 DI15-3 E15-2 E15-3 E15-6
E15 -7 E15 -8 E15-9 E15-10 E15-11
P15-1A P15-2A P15-3A P15-5A P15-1B P15-2B P15-3B
P15-5B
6. Distinguish between under- and overapplied manufacturing overhead.
Q15-17 Q15-18 BE15-10
E15-12 E15-13 P15-1A
P15-4A DI15-4 P15-1B E15-4 P15-4B E15-5 P15-2A
P15-5A P15-2B P15-5B
Broadening Your Perspective
BYP15-4 BYP15-5 BYP15-6
BYP15-1
BYP15-3
BYP15-2 BYP15-7 BYP15-8 BYP15-9
BLOOM’ S TAXONOMY TABLE
.
Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
15-3
ANSWERS TO QUESTIONS 1.
(a) Cost accounting involves the measuring, recording, and reporting of product costs. A cost accounting system consists of manufacturing cost accounts that are fully integrated into the general ledger of a company. (b) An important feature of a cost accounting system is the use of a perpetual inventory system that provides immediate, up-to-date information on the cost of a product.
2.
(a) The two principal types of cost accounting systems are: (1) job order cost system and (2) process cost system. Under a job order cost system, costs are assigned to each job or batch of goods; at all times each job or batch of goods can be separately identified. A job order cost system measures costs for each completed job, rather than for set time periods. Under a process cost system, product-related costs are accumulated by or assigned to departments or processes for a set period of time. Job order costing lends itself to specific, special-order manufacturing or servicing while process costing is better suited to similar, largevolume products and continuous process manufacturing. (b) A company can use both types of systems. For example, General Motors uses process costing for standard model cars and job order costing for custom-made vehicles.
3.
A job order cost system is most likely to be used by a company that receives special orders, or custom builds, or produces heterogeneous items or products; that is, the product manufactured or the service rendered is tailored to the customer or client’s requests, needs, or situation. Examples of industries that use job order systems are custom home builders, commercial printing companies, motion picture companies, construction contractors, repair shops, accounting and law firms, hospitals, shipbuilders, and architects.
4.
A process cost system is most likely to be used by manufacturing firms with continuous production flows usually found in mass production, assembly line, large-volume, uniform, or relatively similar product industries. Companies producing appliances, chemicals, pharmaceuticals, rubber and tires, plastics, cement, petroleum, and automobiles utilize process cost systems.
5.
The major steps in the flow of costs in a job order cost system are: (1) accumulating the manufacturing costs incurred and (2) assigning the accumulated costs to work done.
6.
The three inventory control accounts and their subsidiary ledgers are: Raw materials inventory—materials inventory records. Work in process inventory—job cost sheets. Finished goods inventory—finished goods records.
7.
The source documents used in accumulating direct labor costs are time tickets and time cards.
8.
Disagree. Entries to Manufacturing Overhead are also made at the end of an accounting period. For example, there will be adjusting entries for factory depreciation, property taxes, and insurance.
9.
The source document for materials is the materials requisition slip and the source document for labor is the time ticket. The entries are: Materials Work in Process Inventory Manufacturing Overhead Raw Materials Inventory
15-4
.
Labor XX XX XX
Kimmel, Accounting, 5e, Solutions Manual
Work in Process Inventory Manufacturing Overhead Factory Labor
(For Instructor Use Only)
XX XX XX
Questions Chapter 15 (Continued) 10.
The purpose of a job cost sheet is to record the costs chargeable to a specific job and to determine the total and unit costs of the completed job.
11.
The source documents for charging costs to specific jobs are materials requisition slips for direct materials, time tickets for direct labor, and the predetermined overhead rate for manufacturing overhead.
12.
The materials requisition slip is a business document used as an authorization to issue materials from inventory to production. It is approved and signed by authorized personnel so that materials may be removed from inventory and charged to production, to specific jobs, departments, or processes. The materials requisition slip is the basis for posting to the materials inventory records and to the job cost sheet.
13.
Disagree. Actual manufacturing overhead cannot be determined until the end of a period of time. Consequently, there could be a significant delay in assigning overhead and in determining the total cost of the completed job.
14.
The relationships for computing the predetermined overhead rate are the estimated annual overhead costs and an expected activity base such as direct labor hours. The rate is computed by dividing the estimated annual overhead costs by the expected annual operating activity.
15.
At any point in time, the balance in Work in Process Inventory should equal the sum of the costs shown on the job cost sheets of unfinished jobs. Alternatively, posting to Work in Process Inventory may be compared with the sum of the postings to the job cost sheets for each of the manufacturing cost elements.
16.
Jane is incorrect. There is a difference in computing total manufacturing costs. In job order costing, manufacturing overhead applied is used, whereas in Chapter 1, actual manufacturing overhead is used.
17.
Underapplied overhead means that the overhead assigned to work in process is less than the overhead incurred. Overapplied overhead means that the overhead assigned to work in process is greater than the overhead incurred. Manufacturing Overhead will have a debit balance when overhead is underapplied and a credit balance when overhead is overapplied.
18.
Under- or overapplied overhead is not closed to Income Summary. The balance in Manufacturing Overhead is eliminated through an adjusting entry. Under- or overapplied overhead generally is considered to be an adjustment of Cost of Goods Sold.
.
Kimmel, Accounting, 5e, Solutions Manual
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15-5
.
Work in Process Inventory (4) Direct (7) Cost of commaterials used pleted jobs (5) Direct labor used (6) Overhead applied
Cost of Goods Sold (8) Cost of goods sold
(For Instructor Use Only)
Key to Entries: Accumulation 1. Purchase raw materials 2. Incur factory labor 3. Incur manufacturing overhead Manufacturing Overhead (3) Depreciation (6) Overhead Insurance applied Repairs (4) Indirect materials used (5) Indirect labor used
Assignment 4. Raw materials are used 5. Factory labor is assigned 6. Overhead is applied 7. Completed goods are recognized 8. Cost of goods sold is recognized
SOLUTIONS TO BRIEF EXERCISES
Kimmel, Accounting, 5e, Solutions Manual
Factory Labor (2) Factory labor (5) Factory labor incurred used
Finished Goods Inventory (7) Cost of com(8) Cost of goods pleted jobs sold
BRIEF EXERCISE 15-1
15-6 Raw Materials Inventory (1) Purchases (4) Materials used
BRIEF EXERCISE 15-2 Jan. 31 31
31
Raw Materials Inventory ...................................... Accounts Payable.........................................
4,000
Factory Labor ....................................................... Factory Wages Payable................................ Employer Payroll Taxes Payable .................
6,000
Manufacturing Overhead ..................................... Utilities Payable ............................................
2,000
4,000 5,200 800 2,000
BRIEF EXERCISE 15-3 Jan. 31
Work in Process Inventory .................................. Manufacturing Overhead ..................................... Raw Materials Inventory...............................
3,000 600 3,600
BRIEF EXERCISE 15-4 Jan. 31
Work in Process Inventory .................................. Manufacturing Overhead ..................................... Factory Labor ...............................................
5,200 800 6,000
BRIEF EXERCISE 15-5
Date 1/31 1/31
Job 1 Direct Materials 900
Direct Labor 2,200
Date 1/31 1/31
.
Date 1/31 1/31
Kimmel, Accounting, 5e, Solutions Manual
Job 3 Direct Materials 700
(For Instructor Use Only)
Job 2 Direct Materials 1,400
Direct Labor 1,600
Direct Labor 1,400
15-7
BRIEF EXERCISE 15-6 Overhead rate per direct labor cost is 180%, or ($900,000 ÷ $500,000). Overhead rate per direct labor hour is $18, or ($900,000 ÷ 50,000). Overhead rate per machine hour is $9, or ($900,000 ÷ 100,000). BRIEF EXERCISE 15-7 Jan. 31
Feb. 28
Mar. 31
Work in Process Inventory ............................. Manufacturing Overhead ($40,000 X 80%) ....................................
32,000
Work in Process Inventory ............................. Manufacturing Overhead ($30,000 X 80%) ....................................
24,000
Work in Process Inventory ............................. Manufacturing Overhead ($50,000 X 80%) ....................................
40,000
32,000
24,000
40,000
BRIEF EXERCISE 15-8 Mar. 31 31 31
Finished Goods Inventory .............................. Work in Process Inventory......................
50,000
Cash ................................................................. Sales Revenue .........................................
35,000
Cost of Goods Sold ......................................... Finished Goods Inventory.......................
20,000
50,000 35,000 20,000
BRIEF EXERCISE 15-9
15-8
Service Contracts in Process ......................... Operating Overhead ........................................ Service Salaries and Wages ...................
24,000 8,000
Service Contracts in Process ......................... Operating Overhead ................................
6,000
.
Kimmel, Accounting, 5e, Solutions Manual
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32,000 6,000
BRIEF EXERCISE 15-10 Dec. 31
Dec. 31
Shimeca Company Cost of Goods Sold ......................................... Manufacturing Overhead ........................
1,200
Garcia Company Manufacturing Overhead ................................ Cost of Goods Sold .................................
900
1,200
900
SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 15-1 (a) Raw Materials Inventory ............................................ Accounts Payable ............................................... (Purchases of raw materials on account)
16,000
(b) Factory Labor ............................................................. Factory Wages Payable ...................................... Employer Payroll Taxes Payable........................ (To record factory labor costs)
40,000
(c) Manufacturing Overhead .......................................... Accumulated Depreciation—Buildings.............. Utilities Payable ................................................... Prepaid Property Taxes ...................................... (To record overhead costs)
15,000
.
Kimmel, Accounting, 5e, Solutions Manual
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16,000
31,000 9,000
9,500 3,100 2,400
15-9
DO IT! 15-2 The three summary entries are: Work in Process Inventory ($7,200 + $9,000) .................. Raw Materials Inventory ............................................ (To assign materials to jobs)
16,200
Work Process Inventory ($4,000 + $8,000) ...................... Factory Labor ............................................................. (To assign labor to jobs)
12,000
Work in Process Inventory ($5,200 + $9,800) .................. Manufacturing Overhead .......................................... (To assign overhead to jobs)
15,000
16,200
12,000
15,000
DO IT! 15-3 Finished Goods Inventory ................................................ Work in Process Inventory ........................................ (To record completion of Job 310, costing $60,000 and Job 312, costing $50,000)
110,000
Accounts Receivable ........................................................ Sales Revenue ......................................................... (To record sale of Job 312)
90,000
Cost of Goods Sold ........................................................... Finished Goods Inventory ......................................... (To record cost of goods sold for Job 312)
50,000
110,000
90,000
50,000
DO IT! 15-4 Manufacturing overhead applied = 130% X $85,000 = $110,500 Underapplied manufacturing overhead = $115,000 – $110,500 = $4,500
15-10
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Kimmel, Accounting, 5e, Solutions Manual
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SOLUTIONS TO EXERCISES EXERCISE 15-1 (a) Factory Labor .......................................................... Factory Wages Payable .................................. Employer Payroll Taxes Payable ................... Employer Fringe Benefits Payable ................
80,000
(b) Work in Process Inventory ($80,000 X 85%) ......... Manufacturing Overhead........................................ Factory Labor ..................................................
68,000 12,000
66,000 8,000 6,000
80,000
EXERCISE 15-2 (a) May 31
31
31
31
Work in Process Inventory .................... Manufacturing Overhead ....................... Raw Materials Inventory ................
10,400 800
Work in Process Inventory .................... Manufacturing Overhead ....................... Factory Labor .................................
12,500 1,200
Work in Process Inventory ($12,500 X 60%) .................................. Manufacturing Overhead ............... Finished Goods Inventory ..................... Work in Process Inventory ............
11,200
13,700 7,500 7,500 7,540 7,540
($2,000 + $2,500 + $1,900 + $1,140*)
*$1,900 X 60% (b) May 1 Balance 31 31 31 May 31 Balance
.
Kimmel, Accounting, 5e, Solutions Manual
Work in Process Inventory 3,500 May 31 10,400 12,500 7,500 26,360
(For Instructor Use Only)
7,540
15-11
EXERCISE 15-2 (Continued)
Job No. 430 431
Beginning Work in Process $1,500 0 $1,500
Job Cost Sheets Direct Direct Manufacturing* Material Labor Overhead $3,500 $ 3,000 $1,800 4,400 7,600 4,560 $7,900 $10,600 $6,360
Total $ 9,800 16,560 $26,360
*Direct labor X .60 EXERCISE 15-3 (a) 1.
$16,100, or ($5,000 + $6,000 + $5,100).
2. Last year 85%, or ($5,100 ÷ $6,000); this year 80% (either $6,400 ÷ $8,000 or $3,200 ÷ $4,000). (b) Jan. 31
31 31 31
Work in Process Inventory....................... Raw Materials Inventory ...................
8,000
Work in Process Inventory....................... Factory Labor ....................................
12,000
Work in Process Inventory....................... Manufacturing Overhead ..................
9,600
Finished Goods Inventory........................ Work in Process Inventory ...............
45,700
EXERCISE 15-4 (a) + $50,000 + $42,500 = $145,650 (a) = $53,150 $145,650 + (b) = $201,500 (b) = $55,850 $201,500 – (c) = $192,300 (c) = $9,200
15-12
.
Kimmel, Accounting, 5e, Solutions Manual
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8,000 12,000 9,600 45,700
EXERCISE 15-4 (Continued) [Note: The instructions indicate that manufacturing overhead is applied on the basis of direct labor cost, and the rate is the same in all cases. From Case A, a student should note the overhead rate to be 85%, or ($42,500 ÷ $50,000).] (d) = .85 X $140,000 (d) = $119,000 $83,000 + $140,000 + $119,000 = (e) (e) = $342,000 $342,000 + $15,500 = (f) (f) = $357,500 $357,500 – $11,800 = (g) (g) = $345,700 [Note: (h) and (i) are solved together.] (i) = .85(h) $63,150 + (h) + .85(h) = $213,000 1.85(h) = $149,850 (h) = $81,000 (i) = $68,850 (j) = $213,000 + $18,000 (j) = $231,000 $231,000 – (k) = $222,000 (k) = $9,000 EXERCISE 15-5 (a) $2.60 per machine hour ($325,000 ÷ 125,000). (b) ($342,000) – ($2.60 x 130,000 Machine Hours) $342,000 – $338,000 = $4,000 underapplied (c) Cost of Goods Sold ................................................... Manufacturing Overhead ...................................
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
4,000 4,000
15-13
EXERCISE 15-6 (a) (1) The source documents are: Direct materials—Materials requisition slips. Direct labor—Time tickets. Manufacturing overhead—Predetermined overhead rate. (2) The predetermined overhead rate is 125% of direct labor cost. For example, on July 15, the computation is $550 ÷ $440 = 125%. The same result is obtained on July 22 and 31. (3) The total cost is: Direct materials ............................................................ Direct labor ................................................................... Manufacturing overhead ..............................................
$4,700 1,360 1,700 $7,760
The unit cost is $3.10 ($7,760 ÷ 2,500). (b) July 31
Finished Goods Inventory ............................ Work in Process Inventory ...................
7,760 7,760
EXERCISE 15-7 1. 2.
3.
4.
15-14
Raw Materials Inventory ................................................ Accounts Payable ..................................................
46,300
Work in Process Inventory ............................................ Manufacturing Overhead ............................................... Raw Materials Inventory ........................................
29,200 6,800
Factory Labor ................................................................. Factory Wages Payable ......................................... Employer Payroll Taxes Payable...........................
55,900
Work in Process Inventory ............................................ Manufacturing Overhead ............................................... Factory Labor .........................................................
50,000 5,900
.
Kimmel, Accounting, 5e, Solutions Manual
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46,300
36,000 51,000 4,900
55,900
EXERCISE 15-7 (Continued) 5. 6. 7. 8. 9.
Manufacturing Overhead....................................... Accounts Payable ..........................................
80,500
Depreciation Expense ........................................... Accumulated Depreciation—Building ..........
8,100
Work in Process Inventory ($50,000 X 150%) ...... Manufacturing Overhead ...............................
75,000
Finished Goods Inventory..................................... Work in Process Inventory ............................
88,000
Accounts Receivable............................................. Sales Revenue ................................................
103,000
Cost of Goods Sold ............................................... Finished Goods Inventory .............................
75,000
80,500 8,100 75,000 88,000 103,000 75,000
EXERCISE 15-8 1.
2.
3.
.
Raw Materials Inventory ........................................ Accounts Payable ..........................................
192,000
Factory Labor ......................................................... Factory Wages Payable .................................
87,300
Work in Process Inventory.................................... Manufacturing Overhead....................................... Raw Materials Inventory ................................
153,530 4,470
Work in Process Inventory.................................... Manufacturing Overhead....................................... Factory Labor .................................................
80,000 7,300
Manufacturing Overhead....................................... Accounts Payable ..........................................
49,500
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
192,000 87,300
158,000
87,300 49,500
15-15
EXERCISE 15-8 (Continued) 4.
5.
6.
7.
Manufacturing Overhead ....................................... Accumulated Depreciation—Equipment ......
14,550
Depreciation Expense ........................................... Accumulated Depreciation—Building...........
14,300
Work in Process Inventory .................................... Manufacturing Overhead (90% X $80,000) ..........................................
72,000
Finished Goods Inventory ..................................... Work in Process Inventory ............................
240,930
14,550
14,300
72,000
240,930
Computation of cost of jobs finished: Direct Materials $35,240 42,920 39,270
Job A20 A21 A23
Direct Labor $18,000 22,000 25,000
Manufacturing Overhead $16,200 19,800 22,500
Total $ 69,440 84,720 86,770 $240,930
EXERCISE 15-9 (a)
MANTLE COMPANY Cost of Goods Manufactured Schedule For the Month Ended May 31, 2014 Work in process, May 1 ........................................ Direct materials used............................................ Direct labor ............................................................ Manufacturing overhead applied ......................... Total manufacturing costs............................ Total cost of work in process .............................. Less: Work in process, May 31 ........................... Cost of goods manufactured ...............................
15-16
.
Kimmel, Accounting, 5e, Solutions Manual
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$ 14,700 $62,400 50,000 40,000 152,400 167,100 17,900 $149,200
EXERCISE 15-9 (Continued) (b)
MANTLE COMPANY (Partial) Income Statement For the Month Ended May 31, 2014 Sales revenue .................................................... Cost of goods sold Finished goods, May 1 ............................... Cost of goods manufactured..................... Cost of goods available for sale ............... Less: Finished goods, May 31.................. Cost of goods sold ............................. Gross profit ........................................................
(c)
$210,000 $ 12,600 149,200 161,800 9,500 152,300 $ 57,700
MANTLE COMPANY (Partial) Balance sheet May 31, 2014 Current assets: Finished goods inventory .......................... Work in process inventory ........................ Raw materials inventory ............................
$ 9,500 17,900 7,100
$34,500
EXERCISE 15-10 (a) Work in Process Inventory April 30 $ 9,300 (#10, $5,200 + #11, $4,100) May 31 $18,600 (#11, $8,000 + #13, $4,700 + #14, $5,900) June 30 $ 9,500 (#14, $5,900 + $3,600) (b) Finished Goods Inventory April 30 $ 1,200 (#12) May 31 $ 9,600 (#10) June 30 $19,200 (#11, $10,000 + #13, $9,200) (c) Gross Profit Month May June July .
Job Number 12 10 11/13
Kimmel, Accounting, 5e, Solutions Manual
Sales $ 1,500 12,000 24,000 (For Instructor Use Only)
Cost of Goods Sold $ 1,200 9,600 19,200
Gross Profit $ 300 2,400 4,800 15-17
EXERCISE 15--11 (a) 1
2
3
4
5
6
Supplies ............................................ Accounts Payable......................
1,500
Service Contracts in Process .......... Operating Overhead ......................... Supplies .....................................
720 480
Service Contracts in Process .......... Operating Overhead ......................... Service Salaries and Wages .....
48,000 12,000
Operating Overhead ......................... Cash ...........................................
40,000
1,200
60,000
40,000
Service Contracts in Process ($48,000 X 90%).............................. Operating Overhead ..................
43,200
Cost of Completed Service Contracts........................................ Service Contracts in Process ...
75,000
(b)
43,200
Service Contracts in Process 720 75,000 48,000 43,200 16,920
2. 3. 5.
15-18
1,500
.
Kimmel, Accounting, 5e, Solutions Manual
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75,000
(6)
EXERCISE 15-12 (a) Direct materials Auditor labor costs Applied overhead Total cost
Lynn $ 600 5,400 3,600 $9,600
Brian $ 400 6,600 4,400 $11,400
Mike $ 200 3,375 2,250 $5,825
(b) The Lynn job is the only incomplete job, therefore, $9,600. (c) Actual overhead Applied overhead Balance
$11,000 (DR) 10,250 (CR) $ 750 (DR)
EXERCISE 15-13 (a) Predetermined overhead rate = Estimated overhead ÷ Estimated decorator hours = $920,000 ÷ 40,000 decorator hours = $23 per decorator hour (b) Service Contracts in Process (40,500 hrs X $23) ...... 931,500 Operating Overhead...................................... 931,500 (c)
.
Actual overhead Applied overhead Balance
Kimmel, Accounting, 5e, Solutions Manual
$942,800 931,500 $ 11,300 underapplied
(For Instructor Use Only)
15-19
SOLUTIONS TO PROBLEMS PROBLEM 15-1A
(a) $980,000 ÷ $700,000 direct labor costs = 140% of direct labor costs (b) See solution to part (e) for job cost sheets (c) Raw Materials Inventory ............................................ Accounts Payable ..............................................
90,000
Factory Labor ............................................................. Factory Wages Payable ..................................... Employer Payroll Taxes Payable.......................
70,000
Manufacturing Overhead ........................................... Accounts Payable .............................................. Accumulated Depreciation—Equipment .......... Raw Materials Inventory .................................... Factory Labor .....................................................
72,000
(d) Work in Process Inventory ........................................ Raw Materials Inventory ($10,000 + $39,000 + $30,000) .......................
79,000
Work in Process Inventory ........................................ Factory Labor ($5,000 + $25,000 + $20,000) ..........................
50,000
Work in Process Inventory ........................................ Manufacturing Overhead ................................... ($50,000 X 140% of direct labor costs)
70,000
90,000 54,000 16,000 16,000 19,000 17,000 20,000
79,000
50,000
See solution to part (e) for postings to job cost sheets.
15-20
.
Kimmel, Accounting, 5e, Solutions Manual
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70,000
PROBLEM 15-1A (Continued) (b)&(e) Job Cost Sheets Job No. 50 Date Direct Materials Direct Labor Manufacturing Overhead Beg. $20,000 $12,000 *$16,000* Jan. 10,000 5,000 * 7,000* $30,000 $17,000 *$23,000* Cost of completed job Direct materials .............................................................. Direct labor ..................................................................... Manufacturing overhead ............................................... Total cost ...............................................................................
$30,000 17,000 23,000 $70,000
*$5,000 X 140% Job No. 51 Date Direct Materials Jan. $39,000 $39,000
Direct Labor $25,000 $25,000
Manufacturing Overhead **$35,000** **$35,000**
Cost of completed job Direct materials .............................................................. Direct labor ..................................................................... Manufacturing overhead ............................................... Total cost ...............................................................................
$39,000 25,000 35,000 $99,000
**$25,000 X 140% Job No. 52 Date Direct Materials Jan. $30,000
Direct Labor $20,000
Manufacturing Overhead ***$28,000***
***$20,000 X 140%
.
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15-21
PROBLEM 15-1A (Continued)
(f)
Finished Goods Inventory ...................................... Work in Process Inventory ($70,000 + $99,000) ......................................
169,000
Cost of Goods Sold ................................................ Finished Goods Inventory ($90,000 + $70,000) ......................................
160,000
Accounts Receivable .............................................. Sales Revenue ($122,000 + $158,000) ............
280,000
(g) Beginning balance Cost of completed jobs 50 and 51 Ending balance
Finished Goods Inventory 90,000 160,000 169,000 99,000
169,000
160,000 280,000
Cost of jobs 49 and 50 sold
The balance in this account consists of the cost of completed Job No. 51 which has not yet been sold. (h) Manufacturing Overhead Actual Applied 72,000 70,000 2,000 The balance in the Manufacturing Overhead account is underapplied.
15-22
.
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PROBLEM 15-2A
(a) 1/1
12/31
Work in Process Inventory Balance (1) 128,400 Completed work (5) (c) Direct materials (2) 131,000 Direct labor (3) 139,000 Manufacturing overhead (4) 166,800 Balance 179,000
(1)
Job 7640 Job 7641
$ 77,800 50,600 $128,400
(3)
Job 7640 Job 7641 Job 7642
$ 36,000 48,000 55,000 $139,000
(2)
Job 7640 Job 7641 Job 7642
$ 30,000 43,000 58,000 $131,000
(4)
Job 7640 Job 7641 Job 7642
$ 43,200 57,600 66,000 $166,800
(5) (a) Job 7640 Beginning balance ................................................. Direct materials...................................................... Direct labor ............................................................ Manufacturing overhead .......................................
(b) Job 7641 Beginning balance ................................................. Direct materials...................................................... Direct labor ............................................................ Manufacturing overhead .......................................
(c) Total cost of completed work Job 7640 ................................................................ Job 7641 ................................................................
.
386,200
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$ 77,800 30,000 36,000 43,200 $187,000
$ 50,600 43,000 48,000 57,600 $199,200
$187,000 199,200 $386,200
15-23
PROBLEM 15-2A (Continued) Work in process balance .............................................
$179,000
Unfinished job No. 7642 ..............................................
$179,000 (a)
(a) Current year’s cost Direct materials ................................ Direct labor....................................... Manufacturing overhead .................
$ 58,000 55,000 66,000 $179,000
(b) Actual overhead costs Incurred on account .............................................. Indirect materials................................................... Indirect labor ......................................................... Depreciation .......................................................... Applied overhead costs Job 7640 ................................................................. Job 7641 ................................................................. Job 7642 .................................................................
Actual overhead ............................................................ Applied overhead .......................................................... Overapplied overhead .................................................. Manufacturing Overhead .............................................. 6,800 Cost of Goods Sold ............................................... (c) Sales revenue (given) ........................................ Cost of goods sold Add: Job 7638 ................................................... Job 7639 ................................................... Job 7641 ................................................... Less: Overapplied overhead ........................... Gross profit .......................................................
15-24
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$120,000 14,000 18,000 8,000 $160,000 $ 43,200 57,600 66,000 $166,800 $160,000 166,800 $ 6,800
6,800 $530,000
$ 87,000 92,000 199,200 378,200 6,800
371,400 $158,600
PROBLEM 15-3A
(a) (i) Raw Materials Inventory ............................................ Accounts Payable ..............................................
4,900 4,900
Factory Labor ............................................................. Cash ....................................................................
4,400
Manufacturing Overhead........................................... Accumulated Depreciation—Equipment .......... Accounts Payable ..............................................
1,100
(ii) Work in Process Inventory........................................ Manufacturing Overhead........................................... Raw Materials Inventory ....................................
4,900 1,500
Work in Process Inventory........................................ Manufacturing Overhead........................................... Factory Labor .....................................................
3,200 1,200
Work in Process Inventory ($3,200 X 1.25) .............. Manufacturing Overhead ...................................
4,000
(iii) Finished Goods Inventory......................................... Work in Process Inventory ................................
13,840
Job
Direct Materials
Direct Labor
Manufacturing Overhead*
Total Costs
Gannon Rosenthal Linton
$1,700 1,300 2,200
$1,160 900 1,780
$1,450 1,125 2,225
$ 4,310 3,325 6,205 $13,840
4,400 700 400
6,400
4,400 4,000 13,840
*125% X direct labor amount
.
Cash............................................................................ Sales revenue .....................................................
18,900
Cost of Goods Sold ................................................... Finished Goods Inventory .................................
13,840
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18,900 13,840
15-25
PROBLEM 15-3A (Continued) (b) 6/1
6/30
Work in Process Inventory Balance 5,540 June Completed work Direct materials 4,900 Direct labor 3,200 Overhead applied 4,000 Balance 3,800
13,840
(c) Work in Process Inventory ........................................................
$3,800
Job: Koss (Direct materials $2,000 + Direct labor $800 + Manufacturing overhead $1,000) .................................
$3,800
(d)
STELLAR INC. Cost of Goods Manufactured Schedule For the Month Ended June 30, 2014 Work in process, June 1 .......................................... Direct materials used ............................................... Direct labor ............................................................... Manufacturing overhead applied ............................ Total manufacturing costs............................... Total cost of work in process ................................. Less: Work in process, June 30............................. Cost of goods manufactured ..................................
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Kimmel, Accounting, 5e, Solutions Manual
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$ 5,540 $4,900 3,200 4,000 12,100 17,640 3,800 $13,840
PROBLEM 15-4A
(a) Department D: Department E: Department K:
$1,200,000 ÷ $1,500,000 = 80% of direct labor cost. $1,500,000 ÷ 125,000 = $12.00 per direct labor hour. $900,000 ÷ 120,000 = $7.50 per machine hour.
(b) Manufacturing Costs Direct materials Direct labor Overhead applied Total
D $140,000 120,000 96,000* $356,000
Department E $126,000 110,000 132,000** $368,000
K $ 78,000 37,500 78,000*** $193,500
D $99,000 96,000 $ 3,000
Department E $124,000 132,000 $ (8,000)
K $79,000 78,000 $ 1,000
*$120,000 X 80% **11,000 X $12.00 ***10,400 X $7.50 (c) Manufacturing Overhead Incurred Applied Under (over) applied
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15-27
PROBLEM 15-5A
(a) $5,600
($16,850 + $7,975 – $19,225).
(b) $36,000
[$9,750 + $15,000 + (75% X $15,000)]. (Given in other data).
(c) $14,950
($16,850 – $1,900).
(d) $6,600
($8,800 X 75%).
(e) $12,200
[Given in other data—$3,800 + $4,800 + (75% X $4,800)].
(f)
($36,000 + $14,950 + $8,800 + $6,600 – $12,200).
$54,150
(g) $5,000
(Given in other data).
(h) $54,150
(See (f) above).
(i)
$55,150
($5,000 + $54,150 – $4,000).
(j)
$4,000
(Given in other data).
(k) $12,025
(Equal to factory labor incurred).
(l)
($12,025 – $8,800).
$3,225
(m) $6,600
($6,370* + $230) or (Same as (d)).
*$1,900 + $3,225 + $1,245
15-28
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 15-1B
(a) $440,000 ÷ 20,000 direct labor hours = $22 per direct labor hour (b) See solution to part (e) for job cost sheets (c) Raw Materials Inventory ............................................ Accounts Payable ..............................................
45,000
Factory Labor ............................................................. Employer Payroll Taxes Payable ...................... Factory Wages Payable .....................................
33,500
Manufacturing Overhead........................................... Accumulated Depreciation—Equipment .......... Accounts Payable .............................................. Raw Materials Inventory .................................... Factory Labor .....................................................
42,500
(d) Work in Process Inventory........................................ Raw Materials Inventory ($5,000 + $17,000 + $13,000) ..........................
35,000
Work in Process Inventory........................................ Factory Labor ($3,000 + $12,000 + $9,000) .......
24,000
Work in Process Inventory........................................ Manufacturing Overhead (200 + 800 + 600) X $22 per hour ...................
35,200
45,000 7,500 26,000 12,000 11,000 10,000 9,500
35,000 24,000
35,200
See solution to part (e) for postings to job cost sheets.
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15-29
PROBLEM 15-1B (Continued) (e)
Job Cost Sheets Job No. 25 Date Direct Materials Beg. $10,000 Jan. 5,000 $15,000
Direct Labor $6,000 3,000 $9,000
Manufacturing Overhead *$ 9,000* * 4,400* *$13,400*
Cost of completed job Direct materials.............................................................. Direct labor .................................................................... Manufacturing overhead ............................................... Total cost ...............................................................................
$15,000 9,000 13,400 $37,400
*$22 X 200 direct labor hours Job No. 26 Date Direct Materials Jan. $17,000 $17,000
Direct Labor $12,000 $12,000
Manufacturing Overhead **$17,600** **$17,600**
Cost of completed job Direct materials.............................................................. Direct labor .................................................................... Manufacturing overhead ............................................... Total cost ...............................................................................
$17,000 12,000 17,600 $46,600
**$22 X 800 direct labor hours
Job No. 27 Date Direct Materials Jan.
Direct Labor
Manufacturing Overhead
$9,000
***$13,200***
$13,000
***$22 X 600 direct labor hours
15-30
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PROBLEM 15-1B (Continued)
(f)
Finished Goods Inventory..................................... Work in Process Inventory ($37,400 + $46,600) .....................................
84,000
Accounts Receivable ............................................ Sales Revenue ($63,000 + $74,000) ...............
137,000
Cost of Goods Sold ............................................... Finished Goods Inventory ($42,000 + $37,400) .....................................
79,400
(g) Beginning balance Direct materials Direct labor Manufacturing overhead Ending balance
Work in Process 25,000 84,000 35,000 24,000 35,200 35,200
84,000 137,000
79,400
Cost of completed jobs 25 and 26
The balance in this account consists of the current costs assigned to Job No. 27: Direct Materials ................................................................ Direct Labor ...................................................................... Manufacturing Overhead ................................................. Total costs assigned ................................................
$13,000 9,000 13,200 $35,200
(h) Manufacturing Overhead Actual Applied 42,500 35,200 7,300 The balance in the Manufacturing Overhead account is underapplied.
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15-31
PROBLEM 15-2B
(a) 1/1
12/31
Work in Process Inventory Balance (1) 111,000 Completed work (5) (c) Direct materials (2) 97,000 Direct labor (3) 144,000 Manufacturing overhead (4)180,000 Balance 188,000
(1)
Job 7650 Job 7651
$ 63,000 48,000 $111,000
(3)
Job 7650 Job 7651 Job 7652
$ 36,000 40,000 68,000 $144,000
(2)
Job 7650 Job 7651 Job 7652
$ 32,000 30,000 35,000 $ 97,000
(4)
Job 7650 Job 7651 Job 7652
$ 45,000 50,000 85,000 $180,000
(5) (a) Job 7650 Beginning balance ................................................. Direct materials ...................................................... Direct labor............................................................. Manufacturing overhead .......................................
(b) Job 7651 Beginning balance ................................................. Direct materials ...................................................... Direct labor............................................................. Manufacturing overhead .......................................
(c) Total cost of completed work Job 7650 ................................................................. Job 7651 .................................................................
15-32
344,000
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$ 63,000 32,000 36,000 45,000 $176,000
$ 48,000 30,000 40,000 50,000 $168,000
$176,000 168,000 $344,000
PROBLEM 15-2B (Continued) Work in process balance ...............................................
$188,000
Unfinished job No. 7652 .................................................
$188,000 (a)
(a) Current year’s cost Direct materials........................... Direct labor ................................. Manufacturing overhead ............
$ 35,000 68,000 85,000 $188,000
(b) Actual overhead costs Incurred on account .............................................. Indirect materials ................................................... Indirect labor .......................................................... Depreciation ........................................................... Applied overhead costs Job 7650.................................................................. Job 7651.................................................................. Job 7652..................................................................
Actual overhead ............................................................ Applied overhead .......................................................... Underapplied overhead ................................................. Cost of Goods Sold ....................................................... 2,500 Manufacturing Overhead ....................................... (c) Sales revenue (given) ....................................... Cost of goods sold Add: Job 7648 .................................................. Job 7649 .................................................. Job 7650 .................................................. Add: Underapplied overhead .......................... Gross profit .......................................................
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$135,000 12,000 16,000 19,500 $182,500 $ 45,000 50,000 85,000 $180,000 $182,500 180,000 $ 2,500 2,500 $490,000
$ 93,000 62,000 176,000 331,000 2,500
333,500 $156,500
15-33
PROBLEM 15-3B
(a) (i) Raw Materials Inventory ........................................... Accounts Payable .............................................
4,000 4,000
Factory Labor ............................................................ Cash ...................................................................
7,000
Manufacturing Overhead .......................................... Cash ...................................................................
1,400
(ii) Work in Process Inventory ....................................... Manufacturing Overhead .......................................... Raw Materials Inventory ...................................
5,300 1,500
Work in Process Inventory ....................................... Manufacturing Overhead .......................................... Factory Labor ....................................................
5,000 2,000
Work in Process Inventory ($5,000 X .70) ......................................................... Manufacturing Overhead .................................. (iii) Finished Goods Inventory ........................................ Work in Process Inventory ............................... Job
Direct Materials
Direct Labor
Manufacturing Overhead*
Total Costs
Stiner Alton Herman
$3,000 2,600 3,200
$2,400 2,200 2,100
$1,680 1,540 1,470
$ 7,080 6,340 6,770 $20,190
7,000 1,400
6,800
7,000 3,500 3,500 20,190 20,190
*70% of direct labor amount
15-34
Cash ........................................................................... Sales Revenue (3 X $12,000) ............................
36,000
Cost of Goods Sold .................................................. Finished Goods Inventory ................................
20,190
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36,000 20,190
PROBLEM 15-3B (Continued) (b) 5/1
5/31
Work in Process Inventory Balance 12,200 5/31 Completed work Direct materials 5,300 Direct labor 5,000 Overhead applied 3,500 Balance 5,810
20,190
(c) Work in Process Inventory........................................................
$5,810
Job: Smith (Direct materials $1,900 + Direct labor $2,300 + Manufacturing overhead $1,610) .....................................
$5,810
(d)
ROBERT PEREZ COMPANY Cost of Goods Manufactured Schedule For the Month Ended May 31, 2014 Work in process, May 1 ........................................... Direct materials used .............................................. Direct labor............................................................... Manufacturing overhead applied ............................ Total manufacturing costs .............................. Total cost of work in process ................................. Less: Work in process, May 31 .............................. Cost of goods manufactured ..................................
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$12,200 $5,300 5,000 3,500 13,800 26,000 5,810 $20,190
15-35
PROBLEM 15-4B
(a) Department A: Department B: Department C:
$720,000 ÷ $600,000 = 120% of direct labor cost. $640,000 ÷ 40,000 = $16.00 per direct labor hour. $900,000 ÷ 150,000 = $6.00 per machine hour.
(b) Manufacturing Costs Direct materials Direct labor Overhead applied Total
A $ 92,000 48,000 57,600 * $197,600
Department B $ 86,000 35,000 56,000 ** $177,000
C $ 64,000 50,400 75,600 *** $190,000
A $60,000 57,600 $ 2,400
Department B $60,000 56,000 $ 4,000
C $72,100 75,600 $ (3,500)
*$48,000 X 120% **3,500 X $16 ***12,600 X $6.00 (c) Manufacturing Overhead Incurred Applied Under (over) applied
15-36
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 15-5B
(a) $88,900
($80,000 + $8,900).
(b) $20,500
[($19,000 + $90,400) – $88,900 (See (a))].
(c) $27,200
(Given in Other data—$19,000 + $8,200).
(d) $90,000
($117,000 manufacturing overhead applied ÷ 130%).
(e) $117,000
(Manufacturing overhead applied).
(f)
[$27,200 + $80,000 + $90,000 + $117,000 – $5,450 (See (g))].
$308,750
(g) $5,450
[$2,000 + $1,500 + ($1,500 X 130%)].
(h) $145,000
(Given in Other data).
(i)
$308,750
(Same as (f)).
(j)
$315,750
[$145,000 + $308,750 – $138,000 (Given in Other data)].
(k) $138,000
(Given in Other data).
(l)
[$90,000 (See (d)) + $16,000].
$106,000
(m) $106,000
(Same as (l)).
(n) $95,100
[$117,000 + $3,000 (Given in Other data) – $8,900 – $16,000].
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15-37
BYP 15-1
DECISION-MAKING AT CURRENT DESIGNS
Cost for one kayak: Direct Materials Polyethylene powder Finishing kit
54 pounds @ $1.50 per pound 1 kit @ $170
Direct Labor More skilled Less skilled
2 hours @ $15 per hour 3 hours @ $12 per hour
$
81 170 30 36
Manufacturing overhead 150% of direct labor costs 150% * $66 Total cost for one kayak
99 $ 416
Cost for order of 20 kayaks $416 per kayak * 20 kayaks
$8,320
15-38
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BYP 15-2
DECISION-MAKING ACROSS THE ORGANIZATION
(a) The manufacturing cost element that is responsible for the fluctuating unit costs is manufacturing overhead. Manufacturing overhead is being included as incurred rather than being applied on a predetermined basis. Direct materials and direct labor are not the cause as they have the same unit cost per batch in each quarter. (b) The solution is to apply overhead using a predetermined overhead rate based on a relevant basis of production activity. Based on actual overhead incurred and using batches of product TC-1 as the activity base, the overhead rate is $16,000 per batch [($105,000 + $153,000 + $97,000 + $125,000) ÷ 30]. Another approach would be to use direct labor cost as the relevant basis to apply overhead on a predetermined basis. For example, a rate of 133 1/3% of direct labor cost ($480,000 ÷ $360,000) could be used. Either approach will provide the same result. (c) The quarterly results using a predetermined overhead rate based on batches produced are as follows: Quarter Costs Direct materials Direct labor Manufacturing overhead Applied ($16,000 X batches) Total (a)
1 $100,000 60,000
2 3 $220,000 $ 80,000 132,000 48,000
4 $200,000 120,000
80,000 $240,000
176,000 64,000 $528,000 $192,000
160,000 $480,000
Production in batches (b)
5
11
4
10
$ 48,000
$ 48,000
$ 48,000
$ 48,000
Unit cost (per batch) (a) ÷ (b)
(Note: The unit cost of a batch remains the same in each quarter. Both sales and production should be pleased with this solution to fluctuating unit costs.)
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15-39
BYP 15-3
1.
MANAGERIAL ANALYSIS
(a) Work in Process Inventory ............................. Raw Materials Inventory..........................
25,000 25,000
(b) If not corrected, the balance sheet is affected. Cash is understated and Raw Materials Inventory is overstated. 2.
(a) Sales Bonus Expense ..................................... Cash .........................................................
12,000 12,000
(b) Both the income statement and the balance sheet are affected. In the income statement, Sales Bonus Expense is understated, Income Tax Expense is overstated, and net income is overstated. The error causes the underapplied overhead to be overstated or the overapplied overhead to be understated. This affects Cost of Goods Sold, since the over- or underapplied balance is closed out to Cost of Goods Sold. The error in Cost of Goods Sold also has an effect on Retained Earnings. Also, Retained Earnings is overstated because of the overstatement of net income, and Income Taxes Payable is overstated. 3.
(a) Factory Labor .................................................. Factory Wages Payable........................... Employer Payroll Taxes Payable ............
120,000 102,000 18,000
(b) If not corrected, both the income statement and the balance sheet are affected. On the income statement, Cost of Goods Sold is understated and Wages Expense is overstated. On the balance sheet, Cash, Factory Wages Payable, and Employer Payroll Taxes Payable are understated.
15-40
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BYP 15-3 (Continued) 4.
(a) Manufacturing Overhead ................................. Raw Materials Inventory ..........................
3,000 3,000
(b) Both the income statement and balance sheet are affected. If units that were in process during the month have been sold, then in the income statement Cost of Goods Sold is overstated, Income Tax Expense is understated, and net income is understated. This causes the Retained Earnings and Income Taxes Payable in the balance sheet to be understated. Also the error causes underapplied overhead to be understated or overapplied overhead to be overstated. This affects Cost of Goods Sold, since the over- or underapplied balance is closed out to Cost of Goods Sold. The error in Cost of Good Sold also has an affect on Retained Earnings.
.
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15-41
BYP 15-4
REAL-WORLD FOCUS
(a) The advantages of job order costing include the following: 1.
Accurate costing results because actual costs of direct materials and direct labor are assigned to each job.
2.
A comparison of actual costs with costs estimated in the company’s bid provides a basis for controlling job costs and improving operating efficiency.
3.
Cost data on specific jobs may be useful to management in bidding on similar jobs in the future.
4.
Accurate costs are assigned to work in process and finished goods inventories.
5.
Job costing enables management to assess the relationship of the cost of goods sold for each job to the sales price of each job. The reciprocal of this relationship is the gross profit on each job. Improving these relationships is an important factor in increasing net income.
(b) Products in job order costing are usually custom-made to customer specifications so that a sale is assured prior to the start of the manufacturing process. Specific products include cruise ships, presidential limousines, buildings, homes, wedding invitations, and graduation and birth announcements. Products in process costing are relatively homogeneous such as boxes of cereal, bottles and cans of soda, jars of peanut butter, quarts of motor oil, and automobiles. The manufacture of the product is continuous to ensure that adequate inventories of finished products are available at all times.
15-42
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BYP 15-5
REAL-WORLD FOCUS
(a) Candidates for the CMA or CFM Certificate must complete two continuous years of professional experience in management accounting or financial management. This requirement may be completed prior to or within seven years of passing the examination. (b) CMAs, CFMs, and candidates who have completed the CMA and/or the CFM examination but have not yet met the experience requirement, are required to maintain their proficiency in the fields of management accounting and financial management. This includes knowledge of new concepts and techniques as well as their application in the management accounting and financial management professions. The objective is to maintain the professional competence of the individual and to enhance one’s ability to perform job-related requirements. Persons who have retired need not meet continuing education requirements. The continuing requirement is 30 hours per year and at least 2 of those hours must be ethics-related. A broad range of subjects may be included in the programs for which hours of credit will be given. The subjects should be related to the topics covered on the CMA/CFM examination and/or to an individual’s job responsibilities. Illustrative of the subjects that may qualify are: all aspects of accounting, financial management, business applications of mathematics and statistics, computer science, economics, management, production, marketing, business law, and organizational behavior.
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15-43
BYP 15-6
COMMUNICATION ACTIVITY
Date Nancy Kopay 123 Cedar Lane Altoona, Kansas 66651 Dear Ms. Kopay: Thank you for your prompt payment! I am very glad that you found the cost information helpful. Thank you also for your questions about our overhead costs. We do try to provide our customers with as much information as possible, but we cannot give detailed information on overhead costs. The cost of providing such information is prohibitive. You asked why we do not use actual overhead costs when we bill our customers. We estimate overhead costs, rather than use actual costs, for several reasons. One of the most important reasons for you is that we could not prepare bills in a timely manner if we had to use actual overhead. We would have to wait until we were billed for such things as electricity and telephone service. A second reason is that some costs we include in overhead are only payable once or twice a year, such as insurance and taxes. When we use an estimated rate, we are able to allow for those costs. A third reason is that some costs are fixed, which means that they stay the same in dollar amount from month to month. This category includes items such as rent. If we billed you based on our actual costs, you would be billed a higher amount if your work was done during a slow time (because we would have fewer jobs to spread the costs over). An estimated overhead rate allows us to level out these costs.
15-44
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BYP 15-6 (Continued) I hope this answers some of your questions. I’m glad you are interested in our company and that you took the time to write. I am sending a copy of our annual report under separate cover. It contains some details on the information you asked about. Thanks again for your letter and for having Williams make your new cabinets! Sincerely, Student Williams Company
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15-45
BYP 15-7
ETHICS CASE
(a) The stakeholders in this situation are: Alice Reiley, controller for LRF Printing. The president of LRF Printing. The customers of LRF Printing. The competitors of LRF Printing. (b) Padding cost-plus contracts is both unethical and illegal. Alice is faced with an ethical dilemma. She will be in trouble with the president if she doesn’t follow his directive, and she will be committing an unethical act if she does follow his instructions. (c) Alice should continue to accurately account for cost-plus contracts and, if challenged by the president, she should say that she is doing her very best to charge each and every legitimate cost to the cost-plus contracts. Let the president perform the unethical act if he continues to persist in padding costs.
15-46
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BYP 15-8
ALL ABOUT YOU
(a) Your chances of success in small business are increased if you have the following characteristics: You are a self-starter, you get along with many different kinds of people, you are good at making decisions, you have physical and emotional stamina, you are well organized, you have a strong desire to succeed and you will receive family support during the start up phase. (b) The top ten reasons why businesses fail as cited in the books Small Business Management by Michael Ames, and The Do it Yourself Business Book by Gustav Berle are: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
.
Lack of experience Insufficient capital (money) Poor location Poor inventory management Over-investment in fixed assets Poor credit arrangements Personal use of business funds Unexpected growth Competition Low sales
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15-47
BYP 15-9
CONSIDERING YOUR COSTS AND BENEFITS
Discussion guide: The situation presented is a difficult one because you are presently receiving some help for free. It would seem that the best strategy is to price your services based on what it would cost you to do the landscape business without any free help. In the long run, it is going to be impossible to continue unless you can cover these costs. In addition, if you underprice your services today, your customers may expect your prices will remain as low in the future. That probably cannot happen, given that your costs will increase substantially after the first two years. However, we should note that it is not unusual to start a small business with some assets available to you. Then, as your business grows, you acquire additional assets to meet your needs. After all, you may need a low price to get started, and as you gain experience you will be able to charge more or become more efficient. So what to do? Let’s address your old truck first. You should treat the truck as an asset owned by your business. Put it on your books at its fair value, and depreciate it over a reasonable life. This will result in an overhead charge. You need to cover the cost of that truck, as you will have to buy another one some day. The land, barn, and your mother’s services are a little more difficult. If you rented the land and barn and if you paid an assistant, all of these costs would be charged to overhead. (The assistant would be indirect labor.) You are currently getting all these services for free. This is a good situation now, and you may need this situation early in your business to help you get started. But you should recognize that even if you run your business profitably for the first two years, you may have problems beginning in the third year. Thus, it would seem prudent to establish a budget based on both scenarios for the first two years. If you can charge based on your expected costs in the future, do so. If that is not realistic, because you need to establish yourself and get more experience, then charge less. But be sure from the start to cover a reasonable amount of your costs, or the business does not make sense for you financially.
15-48
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
CHAPTER 16 Process Costing ASSIGNMENT CLASSIFICATION TABLE A Problems
B Problems
3
1A
1B
2
2, 4
1A
1B
4, 9
3
3, 5, 6, 7, 8, 9, 10, 11, 13, 14, 15
2A, 3A, 4A, 5A, 6A
2B, 3B, 4B, 5B, 6B
8, 9, 14, 15, 18
5, 6, 7, 8
4
3, 5, 6, 7, 8, 9, 2A, 3A, 10, 11, 13, 14, 4A, 5A 15, 16, 17, 18, 19
2B, 3B, 4B, 5B
16, 17, 19
11
4
7, 12, 13
2A, 3A, 4A, 5A, 6A
2B, 3B, 4B, 5B, 6B
16, 17, 18, 19, 20
7A
7B
Learning Objectives
Questions
* 1.
Understand who uses process cost systems.
* 2.
Brief Exercises
Do It!
Exercises
1, 2, 20
1
1
Explain the similarities and differences between job order cost and process cost systems.
2, 3, 4, 5
1
1
* 3.
Explain the flow of costs in a process cost system.
6
* 4.
Make the journal entries to assign manufacturing costs in a process cost system.
6, 7
1, 2, 3
* 5.
Compute equivalent units.
10, 11, 12, 13
* 6.
Explain the four steps necessary to prepare a production cost report.
* 7.
Prepare a production cost report.
**8.
Compute equivalent units 21, 22 using the FIFO method.
10, 11, 12
*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix*to the chapter.
Copyright © 2013 John Wiley & Sons, Inc .
Kimmel, Accounting, 5e, Solutions Manual
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16-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Journalize transactions.
Moderate
20–30
2A
Complete four steps necessary to prepare a production cost report.
Simple
30–40
3A
Complete four steps necessary to prepare a production cost report.
Simple
30–40
4A
Assign costs and prepare production cost report.
Moderate
20–30
5A
Determine equivalent units and unit costs and assign costs.
Moderate
20–30
6A
Compute equivalent units and complete production cost report.
Moderate
15–25
*7A*
Determine equivalent units and unit costs and assign costs for processes; prepare production cost report.
Moderate
30–40
1B
Journalize transactions.
Moderate
20–30
2B
Complete four steps necessary to prepare a production cost report.
Simple
30–40
3B
Complete four steps necessary to prepare a production cost report.
Simple
30–40
4B
Assign costs and prepare production cost report.
Moderate
20–30
5B
Determine equivalent units and unit costs and assign costs.
Moderate
20–30
6B
Compute equivalent units and complete production cost report.
Moderate
15–25
*7B
Determine equivalent units and unit costs and assign costs for processes; prepare production cost report.
Moderate
30–40
16-2
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(For Instructor Use Only)
Kimmel, Accounting, 5e, Solutions Manual
* 1. Understand who uses process cost Q16-1 systems. Q16-2 * 2. Explain the similarities and differences Q16-2 between job order cost and process Q16-3 cost systems. * 3. Explain the flow of costs in a process Q16-6 cost system. * 4. Make the journal entries to assign Q16-6 manufacturing costs in a process cost system. * 5. Compute equivalent units. Q16-10 Q16-11
E16-1 DI16-1 Q16-20 Q16-4 DI16-1 Q16-5 E16-1
(For Instructor Use Only)
* 6. Explain the four steps necessary to prepare a production cost report.
Q16-8
Q16-9
* 7. Prepare a production cost report.
Q16-16 Q16-17 Q16-19
Learning Objective
Knowledge Comprehension
*8. Compute equivalent units using the FIFO method.
Broadening Your Perspective
BYP16-4
Application
E16-3 P16-1A Q16-7 BE16-1 BE16-2 Q16-12 Q16-13 BE163-4 BE16-9 DI16-3 E16-3 E16-5 E16-6 E16-7 E16-8 Q16-14 Q16-15 Q16-18 BE16-5 BE16-6 BE16-7 BE16-8 DI16-4 E16-3 E16-5 E16-6 BE16-11 DI16-4 E16-7 E16-11 E16-13 Q16-21 Q16-22 BE163-10 BE16-11 BYP16-1
BE16-3 DI16-2 E16-2 E16-9 E16-10 E16-11 E16-13 E16-14 E16-15 P16-2A P16-3A P16-4A
Analysis
Synthesis
Evaluation
P16-1B P16-1A P16-1B E16-4 P16-1A P16-1A P16-1B P16-1B P16-5A P16-2A P16-6A P16-3A P16-2B P16-2B P16-3B P16-3B P16-4B P16-5B P16-6B
E16-7 E16-8 E163-9 E16-10 E16-11 E16-13 E16-14 E163-15 E163-16 E16-17
E16-18 P16-2A E16-19 P16-3A P16-2A P16-2B P16-3A P16-3B P16-4A P16-5A P16-2B P16-3B P16-4B P16-5B
P16-2A P16-3A P16-4A P16-5A P16-6A BE16-12 E16-16 E16-17 E16-18
P16-2B P16-3B P16-4B P16-5B P16-6B E16-19 E16-20 P16-7A P16-7B BYP16-2 BYP16-3 BYP16-7
BYP16-5
BYP16-6
BLOOM’ S TAXONOMY TABLE
.
Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
16-3
ANSWERS TO QUESTIONS 1.
(a) (b) (c) (d)
Process cost. Process cost. Job order. Job order.
2.
The primary focus of job order cost accounting is on the individual job. In process cost accounting, the primary focus is on the processes involved in producing homogeneous products.
3.
The similarities are: (1) all three manufacturing cost elements—direct materials, direct labor, and overhead—are the same; (2) the accumulation of the costs of materials, labor, and overhead is the same; and (3) the flow of costs is the same.
4.
The features of process cost accounting are: (1) separate work in process accounts for each process, (2) production cost reports, (3) product costs computed for each accounting period, and (4) unit costs computed based on total manufacturing costs.
5.
Sam is correct. The flow of costs is the same in process cost accounting as in job order cost accounting. The method of assigning costs, however, is significantly different.
6.
(a) (1) Materials are charged to production on the basis of materials requisition slips. (2) Labor is usually charged to production on the basis of the payroll register or departmental payroll summaries. (b) The criterion used in assigning overhead to processes is to identify the activity that “drives” or causes the cost. In many companies this activity is machine time, not direct labor.
7.
The entry to assign overhead to production is: July 31
Work in Process—Machining .................................................... Work in Process—Assembly ..................................................... Manufacturing Overhead ...................................................
15,000 12,000 27,000
8.
To prepare a production cost report, four steps are followed: (a) compute the physical unit flow, (b) compute equivalent units of production, (c) compute unit production costs, and (d) prepare a cost reconciliation schedule.
9.
Physical units to be accounted for consist of units in process at the beginning of the period plus units started (or transferred) into production during the period. Units accounted for consist of units completed and transferred out during the period plus units in process at the end of the period.
10.
Equivalent units of production measure the work done during the period, expressed in fully completed units.
11.
Equivalent units of production are the sum of: (1) units completed and transferred out and (2) equivalent units of ending work in process.
12.
Units started into production were 9,600, or (9,000 + 600).
16-4
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Questions Chapter 16 (Continued)
13.
Equivalent Units Materials Conversion Costs 12,000 12,000
Units transferred out Work in process 500 X 100% 500 X 20% Total equivalent units
500 12,500
14. Units transferred out were 3,200* Units to be accounted for Work in process (beginning) Started into production Total units Units accounted for Completed and transferred out Work in process (ending) Total units *3,500 – 300
100 12,100
500 3,000 3,500 3,200* 300 3,500
15. (a) (b)
The cost of the units transferred out is $112,000, or (14,000 X $8). The cost of the units in ending inventory is $8,500, or [(2,000 X $3) + (500 X $5)].
16. (a) (b)
Ann is incorrect. The report is an internal report for management. There are four sections in a production cost report: (1) number of physical units, (2) equivalent units determination, (3) unit costs, and (4) cost reconciliation schedule.
17. The production cost report provides the basis for evaluating: (1) the productivity of a department, (2) whether unit and total costs are reasonable, and (3) whether current performance is meeting planned objectives. 18. The per unit conversion cost is $11.25. [Conversion costs = $6,000 – $2,400 = $3,600. Equivalent units for conversion costs are 320 (800 X 40%); $3,600 ÷ 320 = $11.25.] 19. Operations costing is similar to process costing in that standardized methods are used to manufacture the product. At the same time, the product may have some customized individual features that require the use of a job order cost system. 20. In deciding which system to use, a cost-benefit tradeoff occurs. In a job order system, detailed information related to the cost of the product is involved. The cost of implementing this system is often expensive. In a process cost system, an average cost of the product will suffice and therefore the cost to implement is less. In summary, the cost of implementing the system must be balanced against the benefits provided from the additional information. *21. Units transferred out were 2,800 (2,000 + 800). *22. (a) (b)
.
The cost of the units transferred out is $120,000 (12,000 X $10). The cost of the units in ending inventory is $9,500 [(2,000 X $3) + (500 X $7)].
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
16-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 16-1 Mar. 31 31
Raw Materials Inventory ................................. Accounts Payable ....................................
45,000
Factory Labor .................................................. Wages Payable ........................................
60,000
45,000 60,000
BRIEF EXERCISE 16-2 Mar. 31
31
Work in Process—Assembly Department ..... Work in Process—Finishing Department ...... Raw Materials Inventory ..........................
24,000 21,000
Work in Process—Assembly Department ..... Work in Process—Finishing Department ...... Factory Labor ...........................................
35,000 25,000
45,000
60,000
BRIEF EXERCISE 16-3 Mar. 31
Work in Process—Assembly Department ($35,000 X 200%) ......................................... Work in Process—Finishing Department ($25,000 X 200%) ......................................... Manufacturing Overhead.........................
70,000 50,000 120,000
BRIEF EXERCISE 16-4 Materials 45,000 (35,000 + 10,000) 48,000 (40,000 + 8,000) 61,000 (45,000 + 16,000)
January March July
Conversion Costs 39,000 (35,000 + 4,000a) 46,000 (40,000 + 6,000b) 49,000 (45,000 + 4,000c)
a. 10,000 X 40% b. 8,000 X 75% c. 16,000 X 25%
16-6
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
BRIEF EXERCISE 16-5 Total materials costs $36,000 Total conversion costs $54,000 Unit materials cost $3.60
÷
Equivalent units of materials 10,000
÷
Equivalent units of conversion costs 12,000
+
Unit conversion cost $4.50
=
Unit materials cost $3.60
=
Unit conversion cost $4.50
=
Total manufacturing cost per unit $8.10
BRIEF EXERCISE 16-6 Assignment of Costs
Equivalent Units
Unit Cost
40,000
$11
5,000 2,000
$ 4 $ 7
Transferred out Transferred out Work in process, 4/30 Materials Conversion costs Total costs
$440,000
$20,000 14,000
34,000 $474,000
BRIEF EXERCISE 16-7 Total materials costs $16,000 Total conversion *costs* $47,500
÷
Equivalent units of materials 20,000
÷
Equivalent units of conversion costs 19,000
=
Unit materials cost $.80
=
Unit conversion cost $2.50
*$29,500 + $18,000
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
16-7
BRIEF EXERCISE 16-8 Costs accounted for Transferred out Work in process Materials Conversion costs Total costs
(18,000 X $3.30) (2,000 X $.80) (1,000* X $2.50)
$59,400 $1,600 2,500
4,100 $63,500
*2,000 X 50% BRIEF EXERCISE 16-9 (a) Materials 8,000
Units transferred out Work in process, November 30 Materials (7,000 X 100%) Conversion costs (7,000 X 40%) Total equivalent units
(b) Conversion Costs 8,000
7,000 2,800 10,800
15,000
*BRIEF EXERCISE 16-10 Costs to Be Assigned Assignment of Costs
Equivalent Units
Unit Cost
Total Costs Assigned
Transferred out Work in process, 3/1 Started and completed
0 30,000
$ 0 $18
$
Work in process, 3/31 Materials Conversion costs
5,000 2,000
$ 6 $12
0 540,000 540,000
$594,000
16-8
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$ 30,000 24,000
54,000 $594,000
*BRIEF EXERCISE 16-11 Equivalent Units Conversion Materials Costs Units accounted for Completed and transferred out Work in process, March 1 Started and completed Work in process, March 31 Total units
-030,000 5,000 35,000
-030,000 2,000 32,000
SANDERSON COMPANY (Partial) Production Cost Report For the Month Ended March 31 COSTS Materials Unit costs Total costs (a) Equivalent units (b) Unit costs (a) ÷ (b) Costs to be accounted for In process, March 1 Costs in March Total costs Costs accounted for Transferred out In process, March 1 Started and completed (30,000 units X $18) In process, March 31 Materials (5,000 X $6) Conversion costs (2,000 X $12) Total costs
$210,000* 35,000 $ 6
Conversion Costs
Total
$384,000** $594,000 32,000 $ 12 $ 18 $ 0 594,000 $594,000 $
0 540,000
$ 30,000 24,000
54,000 $594,000
*35,000 equivalent units X $6 per unit **32,000 equivalent units X $12 per unit
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
16-9
*BRIEF EXERCISE 16-12 Total materials costs 1 $75,0001 1
Equivalent units of materials 20,000
÷
=
Unit materials cost $3.75
=
Unit conversion cost $2.00
$8,000 + $67,000 = $75,000
Total conversion costs 2 $38,0002 2
÷
Equivalent units of conversion costs 19,000
$20,000 + $18,000 SOLUTIONS FOR DO IT! REVIEW EXERCISES
DO IT! 16-1 1. 2. 3. 4.
False False True False
DO IT! 16-2 Work in Process—Mixing................................................... Work in Process—Packaging ............................................ Raw Materials Inventory ............................................. (To record materials used)
10,000 28,000
Work in Process—Mixing................................................... Work in Process—Packaging ............................................ Factory Labor .............................................................. (To assign factory labor to production)
8,000 36,000
Work in Process—Mixing................................................... Work in Process—Packaging ............................................ Manufacturing Overhead ............................................ (To assign overhead to production)
12,000 54,000
16-10
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
38,000
44,000
66,000
DO IT! 16-2 (Continued) Work in Process—Packaging ............................................ Work in Process—Mixing ........................................... (To record transfer of units to the Packaging Department)
21,000
Finished Goods Inventory ................................................. 106,000 Work in Process—Packaging .................................... (To record transfer of units to finished goods)
21,000
106,000
DO IT! 16-3 (a) Since materials are entered at the beginning of the process, the equivalent units of ending work in process are 12,000. 20,000 units + 12,000 units = 32,000 equivalent units of production for materials. (b) Since ending work in process is only 70% complete as to conversion costs, the equivalent units of ending work in process for conversion costs are 8,400 (70% X 12,000 units). 20,000 units + 8,400 units = 28,400 equivalent units of production for conversion costs. DO IT! 16-4 (a) 0 (Work in process, March 1) + 26,000* (Started into production) = 26,000 *22,000 + 4,000 (b) Equivalent units of production: Units transferred out ................. Work in process, March 31 ....... Total ............................................
.
Kimmel, Accounting, 5e, Solutions Manual
Materials 22,000 4,000 26,000
(For Instructor Use Only)
Conversion 22,000 1,600 (4,000 X 40%) 23,600
16-11
DO IT! 16-4 (Continued) (c) Cost reconciliation schedule Costs accounted for Transferred out (22,000 X $18) ............ Work in process, March 31 Materials (4,000 X $10) ................. Conversion costs (1,600 X $8) ..... Total costs ..................................................
16-12
.
Kimmel, Accounting, 5e, Solutions Manual
$396,000 $40,000 12,800
(For Instructor Use Only)
52,800 $448,800
SOLUTIONS TO EXERCISES EXERCISE 16-1 1. True. 2. True. 3. False. Companies that produce soft drinks and computer chips would use process cost accounting. 4. False. In a job order cost system, costs are tracked by individual jobs. 5. False. Job order costing and process costing track the same three manufacturing cost elements. 6. True. 7. True. 8. False. In a process cost system, multiple work in process accounts are used. 9. False. In a process cost system, costs are summarized in a production cost report for each department. 10. True. EXERCISE 16-2 April 30
30
30
30
.
Work in Process—Cooking .............................. Work in Process—Canning .............................. Raw Materials Inventory ...........................
21,000 9,000
Work in Process—Cooking .............................. Work in Process—Canning .............................. Factory Labor ............................................
8,500 7,000
Work in Process—Cooking .............................. Work in Process—Canning .............................. Manufacturing Overhead ..........................
31,500 25,800
Work in Process—Canning .............................. Work in Process—Cooking ......................
53,000
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
30,000
15,500
57,300 53,000
16-13
EXERCISE 16-3 (a) Work in process, May 1 Started into production Total units to be accounted for Less: Transferred out Work in process, May 31 (b) and (c) Units transferred out Work in process, May 31 300 X 100% 300 X 40%
Work in process, May 1 Costs added Total costs Equivalent units Unit costs
400 1,400 1,800 1,500 300 Equivalent Units Materials Conversion Costs 1,500 1,500 300 1,800
120 1,620
Direct Materials $2,040 5,160 $7,200 1,800 $4.00
Conversion Costs $1,550 4,120* $5,670 1,620 $3.50
*$2,740 + $1,380 (d) Transferred out (1,500 X $7.50) (e) Work in process Materials (300 X $4.00) Conversion costs (120 X $3.50)
16-14
.
Kimmel, Accounting, 5e, Solutions Manual
$11,250 $ 1,200 420 $ 1,620
(For Instructor Use Only)
EXERCISE 16-4 1. 2. 3.
4.
5.
6.
7. 8. 9.
.
Raw Materials Inventory .......................................... Accounts Payable ............................................
62,500
Factory Labor ........................................................... Wages Payable .................................................
60,000
Manufacturing Overhead......................................... Cash .................................................................. Accounts Payable ............................................
70,000
Work in Process—Cutting....................................... Work in Process—Assembly .................................. Raw Materials Inventory ..................................
15,700 8,900
Work in Process—Cutting....................................... Work in Process—Assembly .................................. Factory Labor ...................................................
33,000 27,000
Work in Process—Cutting (1,680 X $18) ................ Work in Process—Assembly (1,720 X $18) ............ Manufacturing Overhead .................................
30,240 30,960
Work in Process—Assembly .................................. Work in Process—Cutting ...............................
67,600
Finished Goods Inventory....................................... Work in Process—Assembly ...........................
134,900
Cost of Goods Sold ................................................. Finished Goods Inventory ...............................
150,000
Accounts Receivable ............................................... Sales Revenue ..................................................
200,000
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
62,500 60,000 40,000 30,000
24,600
60,000
61,200 67,600 134,900 150,000 200,000
16-15
EXERCISE 16-5 (a)
January
May
Units to be accounted for Beginning work in process Started into production Total units
0 11,000 11,000
0 23,000 23,000
Units accounted for Transferred out Ending work in process Total units
9,000 2,000 11,000
16,000 7,000 23,000
(b)
(1) January March May July
Materials
(2)
11,000 ( 9,000 + 2,000) 15,000 (12,000 + 3,000) 23,000 (16,000 + 7,000) 11,500 (10,000 + 1,500)
Conversion Costs 10,200 ( 9,000 + 1,200) 12,900 (12,000 + 900) 21,600 (16,000 + 5,600) 10,600 (10,000 + 600)
EXERCISE 16-6 (a) Units transferred out Work in process, July 31 3,000 X 100% 3,000 X 60% Total equivalent units
(1) Materials
(2) Conversion Costs
12,000
12,000
3,000 15,000
1,800 13,800
(b) Materials: $45,000 ÷ 15,000 = $3.00 Conversion costs: ($16,200 + $18,300) ÷ 13,800 = $2.50 Costs accounted for Transferred out (12,000 X $5.50) Work in process, July 31 Materials (3,000 X $3.00) Conversion costs (1,800 X $2.50) Total costs
16-16
.
Kimmel, Accounting, 5e, Solutions Manual
$66,000 $9,000 4,500
(For Instructor Use Only)
13,500 $79,500
EXERCISE 16-7 RICHARDS FURNITURE COMPANY Sanding Department Production Cost Report For the Month Ended March 31, 2014
Quantities
Physical Units
Units to be accounted for Work in process, March 1 Started into production Total units
0 12,000 12,000
Units accounted for Transferred out Work in process, March 31 Total units
9,000 3,000 12,000
Equivalent Units Conversion Materials Costs
9,000 3,000 12,000
9,000 600 9,600
Costs
Materials
Conversion Costs
Unit costs Total cost Equivalent units Unit costs (a) ÷ (b)
$33,000 12,000 $2.75
$60,000* 9,600 $6.25
Costs to be accounted for Work in process, March 1 Started into production Total costs
(3,000 X 20%)
Total $93,000 $9.00
$
0 93,000 $93,000
Cost Reconciliation Schedule Costs accounted for Transferred out (9,000 X $9.00) Work in process, March 31 Materials (3,000 X $2.75) Conversion costs (600 X $6.25) Total costs
$81,000 $8,250 3,750
12,000 $93,000
*$24,000 + $36,000
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
16-17
EXERCISE 16-8 (a)
(1)
Units transferred out Work in process, April 30 1,000 X 100% 1,000 X 40%
(2) Conversion Costs 17,000
Materials 17,000 1,000 18,000
400 17,400
Materials $900,000(1) 18,000 $ 50
Conversion Costs $435,000(2) 17,400 $ 25
(b) Total cost Equivalent units Unit costs (1)
$100,000 + $800,000
(2)
$ 70,000 + $365,000
(c) Transferred out (17,000 X $75) Work in process Materials (1,000 X $50) Conversion costs (400 X $25) Total costs
$50,000 10,000
(a) Materials: 34,000* + 6,000 = 40,000 Conversion costs: 34,000* + (6,000 X 40%) = 36,400 *40,000 – 6,000 (b) Materials: $72,000/40,000 = $1.80 Conversion costs: ($81,000 + $101,000)/36,400 = $5.00 (c) Transferred out: 34,000 X $6.80 = $231,200 Ending work in process: Materials (6,000 X $1.80) Conversion costs (2,400 X $5.00) Total .
Kimmel, Accounting, 5e, Solutions Manual
$
75
$1,275,000
EXERCISE 16-9
16-18
Total $1,335,000
= =
(For Instructor Use Only)
$10,800 12,000 $22,800
60,000 $1,335,000
EXERCISE 16-10 (a) Beginning work in process Units started into production
Units transferred out Ending work in process
Physical Units 20,000 164,000 184,000
Equivalent Units
Conversion Materials Costs 160,000 160,000 24,000 14,400 (60% X 24,000) 184,000 174,400
160,000 24,000 184,000
(b) Costs incurred Equivalent units Unit costs
Materials $101,200 184,000 $0.55
Conversion Costs $348,800 174,400 $2.00
(c) Assignment of costs: Transferred out (160,000 X $2.55) Ending work in process Materials (24,000 X $.55) Conversion costs (14,400 X $2.00) Total costs
Total $450,000 $2.55 $408,000
$13,200 28,800
42,000 $450,000
EXERCISE 16-11 (a) Work in process, September 1 Units started into production Units transferred out Work in process, September 30
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Physical Units 1,600 38,400 40,000 35,000 5,000 40,000
16-19
EXERCISE 16-11 (Continued) Equivalent Units Materials Conversion Costs 35,000 35,000
Units transferred out Work in process 5,000 X 100% 5,000 X 10%
5,000 500 35,500
40,000 (b)
Materials Work in process, September 1 Direct materials
$ 20,000
Costs added to production during September Total materials cost
177,200 $197,200
$197,200 ÷ 40,000 = $4.93 (Materials cost per unit) Conversion Costs Work in process, September 1 Conversion costs
$ 43,180
Costs added to production during September Conversion costs ($125,680 + $257,140) Total conversion costs
382,820 $426,000
$426,000 ÷ 35,500 = $12.00 (Conversion cost per unit) (c) Costs accounted for Transferred out (35,000 X $16.93) Work in process, September 30 Materials (5,000 X $4.93) Conversion costs (500 X $12.00) Total costs
16-20
.
Kimmel, Accounting, 5e, Solutions Manual
$592,550 $24,650 6,000
(For Instructor Use Only)
30,650 $623,200
EXERCISE 16-12 To:
David Skaros
From:
Student
Re:
Ending inventory
The reason for any confusion related to your department’s ending inventory quantity stems from the fact that the quantity can be measured in two different ways, depending on what the information is used for. The ending inventory quantity can be measured in physical units or equivalent units. Physical units are actual units present without regard to the stage of completion. Your department’s ending inventory in physical units is at least double the amount reported as equivalent units. Equivalent units measure the work done on the physical units, expressed in terms of fully completed units. Therefore, if your ending inventory contains 4,000 units which are 50% complete, that is equivalent to having 2,000 completed units at month end. Therefore, the ending inventory could be expressed as containing 4,000 physical units or 2,000 equivalent units. I hope this clears up any misunderstandings. Please contact me if you have any further questions.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
16-21
EXERCISE 16-13 THORPE COMPANY Welding Department Production Cost Report For the Month Ended February 28, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, February 1 Started into production Total units
15,000 45,000 60,000
Units accounted for Transferred out Work in process, February 28 Total units
49,000 11,000 60,000
Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)
49,000 11,000 60,000
49,000 2,200 51,200
Materials
Conversion Costs
(a) $198,000(1) (b) 60,000 $3.30
$128,000(2) 51,200 $2.50
Costs to be accounted for Work in process, February 1 Started into production Total costs
(11,000 X 20%)
Total $326,000 $5.80
$ 32,175 293,825 $326,000
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (49,000 X $5.80) Work in process, February 28 Materials (11,000 X $3.30) Conversion costs (2,200 X $2.50) Total costs
$284,200 $36,300 5,500
(1)
$18,000 + $180,000 $14,175 + $52,380 + $61,445
(2)
16-22
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
41,800 $326,000
EXERCISE 16-14 (a)
Containers in transit, April 1 Containers loaded Total containers
0 1,200 1,200
Containers off-loaded Containers in transit, April 30 Total containers
850 350 1,200
(b) Containers off-loaded Containers in transit, April 30 Total equivalent units *350 x 40% = 140 **350 x 20% = 70
Equivalent Units Physical Direct Conversion Units Materials Costs 850 850 850 350 140* 70** 990 920
EXERCISE 16-15 (a) Applications transferred out Work in process, September 30 Equivalent units
Materials 800 200* 1,000
Conversion Costs 800 120** 920
*100 + 900 – 800 = 200 **200 X 60% = 120 (b) Materials: $5,500 ÷ 1,000 = $5.50 Conversion costs: $25,300* ÷ 920 = $27.50 Costs accounted for: Transferred out (800 X $33.00) Work in process, September 30 Materials (200 X $5.50) Conversion costs (120 X $27.50) Total costs *($3,960 + $12,000 + $9,340)
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$26,400 $1,100 3,300
4,400 $30,800
16-23
*EXERCISE 16-16
(a)
Physical Units
Applications completed: Work in process, September 1 Started and completed Work in process, September 30 Total units
Equivalent Units Conversion Materials Costs
100 700 200 1,000
0 700 200 900
60 700 120 880
(b) Materials: $4,500 ÷ 900 = $5.00 Conversion costs: $21,340* ÷ 880 = $24.25 *($12,000 + $9,340) Costs accounted for: Applications completed: Work in process, September 1 Conversion costs (60 x $24.25) Started and completed (700 x $29.25) Work in process, September 30: Materials (200 x $5.00) Conversion costs (120 x $24.25) Total costs
$4,960 1,455
$ 6,415 20,475 1,000 2,910
$26,890 3,910 $30,800*
*Total costs to be accounted for: $1,000 + $3,960 + $4,500 + $12,000 + $9,340 = $30,800
16-24
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
*EXERCISE 16-17 (a) (1) Materials: Production Data
Physical Units
Materials Added This Period
Equivalent Units
Work in process, August 1 Started and completed Work in process, August 31 Total
0 8,000 2,000 10,000
0 100% 100%
0 8,000 2,000 10,000
(2) Conversion Costs: Production Data
Physical Units
Work Added This Period
Equivalent Units
Work in process, August 1 Started and completed Work in process, August 31 Total
0 8,000 2,000 10,000
0 100% 40%
0 8,000 800 8,800
(b) Unit costs are: Materials Conversion costs Total
$45,000 ÷ 10,000 = $4.50 $30,800* ÷ 8,800 = 3.50 $8.00
*$14,700 + $16,100 Costs to Be Assigned
Assignment of Costs
Equivalent Unit Units Cost
Total Costs Assigned
Total mfg. costs Transferred out Work in process, August 1 $75,800 (1) Started and completed
0 8,000
$0 $8
Work in process, August 31 Materials Conversion costs
2,000 800
$4.50 $ 9,000 $3.50 2,800
$ 0 64,000
$64,000
11,800 $75,800
(1) $45,000 + $14,700 + $16,100.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
16-25
*EXERCISE 16-18 (a) (1) Materials Work in process, September 1 Started and completed Work in process, September 30 Total (2) Conversion Costs Work in process, September 1 Started and completed Work in process, September 30 Total (b) Materials Conversion costs
(c)
Costs to Be Assigned
Materials Added This Period Q 0% 100%
Equivalent Units
1,000 12,000
100%
1,000 10,000
Physical Units
Work Added This Period
Equivalent Units
2,000 9,000
80% 100%
1,600 9,000
1,000 12,000
40%
400 11,000
Unit Cost
Total Costs Assigned
2,000 9,000
0 9,000
$ 60,000 ÷ 10,000 = $ 6 $132,000 ÷ 11,000 = 12 $18
Assignment of Costs
Total mfg. costs
*$207,200*
Physical Units
Equivalent Units
Transferred out Work in process, 9/1 0 Conversion costs 1,600 Started and completed 9,000 Total costs transferred out Work in process, 9/30 Materials 1,000 Conversion costs 400 Total costs
$ 0 $12 $18
$15,200 19,200
$ 6 $12
$6,000 4,800
$ 34,400 162,000 196,400
10,800 $207,200
*Work in process, September 1, $15,200 + materials costs $60,000 + labor and overhead costs $132,000.
16-26
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
*EXERCISE 16-19 (a) Work in process, March 1 Started into production Total units to be accounted for Less: Transferred out Work in process, March 31
800 1,200 2,000 1,500 500
(b) Materials: Physical Materials Added Equivalent Production Data Units This Period Units Work in process, March 1 800 %100 0 Started and completed 700 100% 700 Work in process, March 31 500 100% 500 Total 2,000 1,200 Unit cost = $6,600 ÷ 1,200 = $5.50. (c) Conversion costs: Physical Production Data Units Work in process, March 1 800 Started and completed 700 Work in process, March 31 500 Total 2,000
Work Added This Period 70% 100% 40%
Equivalent Units 560 700 200 1,460
Unit cost = $2,500 + $1,150 = $3,650 ÷ 1,460 = $2.50. (d) In process, March 1 ......................................................... Conversion costs (560 X $2.50) ...................................... Total cost..........................................................................
$3,680 1,400 $5,080
(e) 700 X ($5.50 + $2.50) = $5,600. (f)
.
Materials (500 X $5.50) .................................................... Conversion costs (200 X $2.50) ...................................... Total cost of work in process, March 31 ........................
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$2,750 500 $3,250
16-27
*EXERCISE 16-20 MAJESTIC COMPANY Welding Department Production Cost Report For the Month Ended February 28, 2014
Physical Units (Step 1)
Quantities Units to be accounted for Work in process, February 1 Started into production Total units
15,000 64,000 79,000
Units accounted for Completed and transferred out Work in process, February 1 Started and completed Total Work in process, February 28 Total units
15,000 39,000* 54,000 25,000 79,000
Equivalent Units Conversion Materials Costs (Step 2)
0 39,000 39,000 25,000 64,000
13,500 (15,000 X 90%) 39,000 52,500 5,000 (25,000 X 20%) 57,500
*(64,000 – 25,000)
Costs Unit costs (Step 3) Costs in February Equivalent units Unit costs (a) ÷ (b)
Materials (a) $192,000 (1) (b) 64,000 $3.00
Costs to be accounted for Work in process, February 1 Started into production Total costs
16-28
.
Kimmel, Accounting, 5e, Solutions Manual
Conversion Costs
Total
$103,500 (2) $295,500 57,500 $1.80 $4.80
$ 32,175 295,500 $327,675
(For Instructor Use Only)
*EXERCISE 16-20 (Continued) Cost Reconciliation Schedule Costs accounted for (Step 4) Transferred out Work in process, February 1 Costs to complete beginning work in process Conversion costs (13,500 X $1.80) Total costs Units started and completed (39,000 X $4.80) Total costs transferred out Work in process, February 28 Materials (25,000 X $3.00) Conversion costs (5,000 X $1.80) Total costs
$32,175
24,300 $ 56,475 187,200 $243,675 75,000 9,000
84,000 $327,675
(1) Cost of materials added $57,000 plus costs transferred in $135,000. (2) Labor $35,100 plus overhead $68,400.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
16-29
SOLUTIONS TO PROBLEMS PROBLEM 16-1A
1. 2.
3. 4.
5. 6.
7. 8. 9.
16-30
Raw Materials Inventory .................................. Accounts Payable ....................................
300,000
Work in Process—Mixing ................................ Work in Process—Packaging ......................... Raw Materials Inventory ..........................
210,000 45,000
Factory Labor ................................................... Wages Payable .........................................
258,900
Work in Process—Mixing ................................ Work in Process—Packaging ......................... Factory Labor ...........................................
182,500 76,400
Manufacturing Overhead ................................. Accounts Payable ....................................
810,000
Work in Process—Mixing (28,000 X $24)........ Work in Process—Packaging (6,000 X $24) ................................................. Manufacturing Overhead .........................
672,000
300,000
255,000 258,900
258,900 810,000
144,000 816,000
Work in Process—Packaging ......................... Work in Process—Mixing ........................
979,000
Finished Goods Inventory ............................... Work in Process—Packaging ..................
1,315,000
Accounts Receivable ....................................... Sales Revenue ..........................................
2,500,000
Cost of Goods Sold ......................................... Finished Goods Inventory .......................
1,604,000
.
Kimmel, Accounting, 5e, Solutions Manual
979,000 1,315,000 2,500,000
(For Instructor Use Only)
1,604,000
PROBLEM 16-2A
(a) Physical units Units to be accounted for Work in process, June 1 Started into production Total units
0 22,000 22,000
Units accounted for Transferred out Work in process, June 30 Total units
20,000 2,000 22,000
(b) Equivalent units Materials 20,000
Units transferred out Work in process, June 30 2,000 X 100% 2,000 X 40% Total equivalent units (c) Materials Conversion costs Total unit cost
Conversion Costs 20,000
2,000 800 20,800
22,000 Unit Costs $9.00 ($198,000 ÷ 22,000) $8.00 ($166,400* ÷ 20,800) $17.00 ($9.00 + $8.00)
*$53,600 + $112,800 (d) Costs accounted for Transferred out (20,000 X $17.00) Work in process, June 30 Materials (2,000 X $9.00) Conversion costs (800 X $8.00) Total costs
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$340,000 $18,000 6,400
24,400 $364,400
16-31
PROBLEM 16-2A (Continued) (e)
ROSENTHAL COMPANY Molding Department Production Cost Report For the Month Ended June 30, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, June 1 Started into production Total units
0 22,000 22,000
Units accounted for Transferred out Work in process, June 30 Total units
20,000 2,000 22,000
Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)
20,000 2,000 22,000
20,000 800 (2,000 X 40%) 20,800
Materials
Conversion Costs
(a) $198,000 (b) 22,000 $9.00
$166,400 20,800 $8.00
Costs to be accounted for Work in process, June 1 Started into production Total costs
Total $364,400 $17.00
$ 0 364,400 $364,400
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (20,000 X $17.00) Work in process, June 30 Materials (2,000 X $9.00) Conversion costs (800 X $8.00) Total costs
16-32
.
Kimmel, Accounting, 5e, Solutions Manual
$340,000 $18,000 6,400
(For Instructor Use Only)
24,400 $364,400
PROBLEM 16-3A
(a) (1) Physical units T12 Tables
C10 Chairs
Units to be accounted for Work in process, July 1 Started into production Total units
0 19,000 19,000
0 16,000 16,000
Units accounted for Transferred out Work in process, July 31 Total units
16,000 3,000 19,000
15,500 500 16,000
(2) Equivalent units
Units transferred out Work in process, July 31 (3,000 X 100%) (3,000 X 60%) Total equivalent units
Units transferred out Work in process, July 31 (500 X 100%) (500 X 80%) Total equivalent units
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
T12 Tables Conversion Materials Costs 16,000 16,000 3,000 19,000
1,800 17,800
C10 Chairs Conversion Materials Costs 15,500 15,500 500 16,000
400 15,900
16-33
PROBLEM 16-3A (Continued) (3) Unit costs
Materials ($380,000 ÷ 19,000) ($288,000 ÷ 16,000) Conversion costs ($338,200(a) ÷ 17,800) ($206,700(b) ÷ 15,900) Total (a)
T12 Tables $20
C10 Chairs $18
19 $39
13 $31
$234,200 + $104,000
(b)
$110,000 + $96,700
(4)
T12 Tables Costs accounted for Transferred out (16,000 X $39) Work in process Materials (3,000 X $20) Conversion costs (1,800 X $19) Total costs
$624,000 $60,000 34,200
94,200 $718,200
C10 Chairs Costs accounted for Transferred out (15,500 X $31) Work in process Materials (500 X $18) Conversion costs (400 X $13) Total costs
16-34
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$480,500 $9,000 5,200
14,200 $494,700
PROBLEM 16-3A (Continued) (b)
SEAGREN INDUSTRIES INC. Cutting Department—Plant 1 Production Cost Report For the Month Ended July 31, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, July 1 Started into production Total units
0 19,000 19,000
Units accounted for Transferred out Work in process, July 31 Total units
16,000 3,000 19,000
16,000 3,000 19,000
Materials
Conversion Costs
(a) $380,000 (b) 19,000 $ 20
$338,200 17,800 $ 19
Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)
16,000 1,800 (3,000 X 60%) 17,800
Costs to be accounted for Work in process, July 1 Started into production Total costs
Total $718,200 $
39
$
0 718,200 $718,200
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (16,000 X $39) Work in process, July 31 Materials (3,000 X $20) Conversion costs (1,800 X $19) Total costs
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$624,400 $60,000 34,200
94,200 $718,200
16-35
PROBLEM 16-4A
(a) Physical Units Units to be accounted for Work in process, November 1 Started into production Total units
35,000 660,000 695,000
Units accounted for Transferred out Work in process, November 30 Total units
670,000 25,000 695,000
Equivalent Units Conversion Materials Costs
670,000 25,000 695,000
670,000 10,000* 680,000
*25,000 X 40% Materials cost Beginning work in process Added during month Total Equivalent units Cost per unit
$
Conversion costs
79,000 1,589,000 $1,668,000
$ 48,150 563,850 $612,000
695,000
680,000
$2.40
$.90
($225,920 + $337,930)
(b) Costs accounted for Transferred out (670,000 X $3.30) Work in process, November 30 Materials (25,000 X $2.40) Conversion costs (10,000 X $.90) Total costs
16-36
.
Kimmel, Accounting, 5e, Solutions Manual
$2,211,000 $60,000 9,000
(For Instructor Use Only)
69,000 $2,280,000
PROBLEM 16-4A (Continued) (c)
RIVERA COMPANY Assembly Department Production Cost Report For the Month Ended November 30, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, November 1 Started into production Total units
35,000 660,000 695,000
Units accounted for Transferred out Work in process, November 30 Total units
670,000 25,000 695,000
670,000 25,000 695,000
Materials
Conversion Costs
(a) $1,668,000 (b) 695,000 $2.40
$612,000 680,000 $.90
Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)
670,000 10,000 (25,000 X 40%) 680,000
Costs to be accounted for Work in process, November 1 Started into production Total costs
Total $2,280,000 $3.30
$ 127,150 2,152,850 $2,280,000
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (670,000 X $3.30) Work in process, November 30 Materials (25,000 X $2.40) Conversion costs (10,000 X $.90) Total costs
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$2,211,000 $60,000 9,000
69,000 $2,280,000
16-37
PROBLEM 16-5A
(a) (1) Physical Units Units to be accounted for Work in process, July 1 Started into production Total units
500 1,250 1,750
Units accounted for Transferred out Work in process, July 31 Total units
1,150 600 1,750
Equivalent Units Conversion Materials Costs
1,150 600 1,750
1,150 240* 1,390
*600 X 40% (2)
Materials cost
Conversion costs
Beginning work in process Added during month Total
$ 750 2,400 $3,150
$ 600 2,875 $3,475
Equivalent units
1,750
1,390
Cost per unit
$1.80
$2.50
($1,580 + $1,295)
(3) Costs accounted for Transferred out (1,150 X $4.30) Work in process, July 31 Materials (600 X $1.80) Conversion costs (240 X $2.50) Total costs
16-38
.
Kimmel, Accounting, 5e, Solutions Manual
$4,945 $1,080 600
(For Instructor Use Only)
1,680 $6,625
PROBLEM 16-5A (Continued) (b)
MORSE COMPANY Basketball Department Production Cost Report For the Month Ended July 31, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, July 1 Started into production Total units
500 1,250 1,750
Units accounted for Transferred out Work in process, July 31 Total units
1,150 600 1,750
Costs Unit costs (Step 3) Costs in July Equivalent units Unit costs (a) ÷ (b)
(a) (b)
1,150 600 1,750
1,150 240 1,390
Materials
Conversion Costs
$3,150 1,750 $1.80
$3,475 1,390 $2.50
Costs to be accounted for Work in process, July 1 Started into production Total costs
Total $6,625 $4.30
$1,350 5,275 $6,625
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (1,150 X $4.30) Work in process, July 31 Materials (600 X $1.80) Conversion costs (240 X $2.50) Total costs
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$4,945 $1,080 600
1,680 $6,625
16-39
PROBLEM 16-6A
(a) Computation of equivalent units:
Units accounted for Transferred out Work in process, October 31 (60% materials, (40% conversion costs) Total units
Physical Units
Equivalent Units Conversion Materials Costs
120,000
120,000
120,000
50,000 170,000
30,000 150,000
20,000 140,000
Computation of October unit costs Materials: $240,000 ÷ 150,000 equivalent units = $1.60 Conversion cost: $105,000 ÷ 140,000 equivalent units = .75 Total unit cost, October $2.35
(b) Cost Reconciliation Schedule Costs accounted for Transferred out (120,000 X $2.35) Work in process, October 31 Materials (30,000 X $1.60) Conversion costs (20,000 X $0.75) Total costs
16-40
.
Kimmel, Accounting, 5e, Solutions Manual
$282,000 $48,000 15,000
(For Instructor Use Only)
63,000 $345,000
*PROBLEM 16-7A
(a) Bicycles (1) Equivalent units—Materials Materials Added This Period
Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total
200 950 (1,250 – 300) 300 1,450
*
Equivalent Units
0%* 100% 100%
0 950 300 1,250
*All materials are added at the beginning of the production process
Equivalent units—Conversion Conversion Added This Period
Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total
200 950 (1,250 – 300) 300 1,450
Equivalent Units
20% (1 – .8) 100% 40%
40 950 120 1,110
(2) Unit costs Costs in March (a) Equivalent units (b) Unit costs (a) ÷ (b)
Materials $50,000 1,250 $ 40
Conversion **$55,500** 1,110 $ 50
**Direct Labor $25,500 + Manufacturing Overhead $30,000
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
16-41
*PROBLEM 16-7A (Continued) (3) Assignment of costs to units transferred out and in process Costs to Be Assigned Total mfg. costs ***$124,780***
Assignment of Costs Transferred out Work in process, March 1 Conversion Started and completed Total costs transferred out Work in process, March 31 Materials Conversion costs Total costs
Equivalent Unit Units Cost
40 950
$50 $90
Total Costs Assigned $19,280 2,000 85,500 $106,780
300 120
$40 $50
12,000 6,000
18,000 $124,780
***Work in process, March 1, $19,280 + Materials $50,000 + Labor $25,500 + Overhead $30,000
Tricycles (1) Equivalent units—Materials Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total
100 740 (800 – 60) 60 900
Materials Added This Period *
0%* 100% 100%
Equivalent Units 0 740 60 800
*All materials are added at the beginning of the production process
Equivalent units—Conversion Physical Units Work in process, March 1 Started and completed Work in process, March 31 Total
16-42
.
100 740 (800 – 60) 60 900
Kimmel, Accounting, 5e, Solutions Manual
Conversion Added This Period 25% (1 – .75) 100% 25%
(For Instructor Use Only)
Equivalent Units 25 740 15 780
*PROBLEM 16-7A (Continued) (2) Unit costs Costs in March (a) Equivalent units (b) Unit costs (a) ÷ (b)
Materials $30,400 800 $ 38
Conversion $35,100** 780 $ 45
**Direct Labor $15,100 + Manufacturing Overhead $20,000 (3) Assignment of costs to units transferred out and in process Costs to Be Assigned
Assignment of Costs
Total mfg. costs Transferred out Work in process, March 1 ***$71,625*** Conversion Started and completed Total costs transferred out Work in process, March 31 Materials Conversion costs Total costs
Equivalent Unit Units Cost
25 740
$45 $83
Total Costs Assigned $ 6,125 1,125 61,420 $68,670
60 15
$38 $45
2,280 675
2,955 $71,625
***Work in process, March 1, $6,125 + Materials $30,400 + Labor $15,100 + Overhead $20,000
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
16-43
*PROBLEM 16-7A (Continued) (b)
RONDELI COMPANY Production Cost Report—Bicycles For the Month Ended March 31
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, March 1 Started into production Total units
200 1,250 1,450
Units accounted for Completed and transferred out Work in process, March 1 Started and completed Work In process, March 31 Total units
200 950 300 1,450
0 950 300 1,250
Costs
Materials
Conversion Costs
Unit costs (Step 3) Costs in March (a) Equivalent units (b) Unit costs [(a) ÷ (b)]
$50,000 1,250 $ 40
$ 55,500 1,110 $ 50
Costs to be accounted for Work in process, March 1 Started into production Total costs Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out Work in process, March 1 Conversion costs to complete beginning inventory (40 X $50) Started and completed (950 X $90) Work in process, March 31 Materials (300 X $40) Conversion costs (120 X $50) Total costs
$ 19,280 105,500* $124,780
$19,280 2,000 85,500 12,000 6,000
$106,780
18,000 $124,780
*($50,000 + $25,500 + $30,000)
16-44
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
40 950 120 1,110 Total $105,500 $
90
PROBLEM 16-1B
1. 2.
3. 4.
5. 6.
7. 8. 9.
.
Raw Materials Inventory ............................................. Accounts Payable ...............................................
25,000
Work in Process—Blending ....................................... Work in Process—Packaging .................................... Raw Materials Inventory .....................................
18,930 9,140
Factory Labor .............................................................. Wages Payable ....................................................
25,770
Work in Process—Blending ....................................... Work in Process—Packaging .................................... Factory Labor ......................................................
15,320 10,450
Manufacturing Overhead............................................ Accounts Payable ...............................................
36,500
Work in Process—Blending (900 X $28) ................... Work in Process—Packaging (300 X $28) ................. Manufacturing Overhead ....................................
25,200 8,400
Work in Process—Packaging .................................... Work in Process—Blending ...............................
44,940
Finished Goods Inventory.......................................... Work in Process—Packaging .............................
67,490
Accounts Receivable .................................................. Sales Revenue .....................................................
90,000
Cost of Goods Sold .................................................... Finished Goods Inventory ..................................
62,000
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
25,000
28,070 25,770
25,770 36,500
33,600 44,940 67,490 90,000 62,000
16-45
PROBLEM 16-2B
(a) Physical units Units to be accounted for Work in process, January 1 Started into production Total units
0 50,000 50,000
Units accounted for Transferred out Work in process, January 31 Total units
47,500 2,500 50,000
(b) Equivalent units Units transferred out Work in process, January 31 2,500 X 100% 2,500 X 40% Total equivalent units (c) Materials Conversion costs Total manufacturing
Materials 47,500 2,500
.
1,000 48,500
50,000
Unit Costs $10.20 ($510,000 ÷ 50,000) $ 5.00 ($242,500 ÷ 48,500) $15.20 ($10.20 + $5.00)
(d) Costs accounted for Transferred out (47,500 X $15.20) .................. Work in process, January 31 Materials (2,500 X $10.20) ..................... Conversion costs (1,000 X $5.00) ........... Total costs .......................................
16-46
Conversion Costs 47,500
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$722,000 $25,500 5,000
30,500 $752,500
PROBLEM 16-2B (Continued) (e)
STEINER CORPORATION Molding Department Production Cost Report For the Month Ended January 31, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, January 1 Started into production Total units
0 50,000 50,000
Units accounted for Transferred out Work in process, January 31 Total units
47,500 2,500 50,000
Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)
47,500 2,500 50,000
47,500 1,000 (2,500 X 40%) 48,500
Materials
Conversion Costs
(a) $510,000 (b) 50,000 $10.20
$242,500 48,500 $5.00
Costs to be accounted for Work in process, January 1 Started into production Total costs
Total $752,500 $15.20
$
0 752,500 $752,500
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (47,500 X $15.20) Work in process, January 31 Materials (2,500 X $10.20) Conversion costs (1,000 X $5.00) Total costs
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$722,000 $25,500 5,000
30,500 $752,500
16-47
PROBLEM 16-3B
(a) (1) Physical units R12 Refrigerators
F24 Freezers
Units to be accounted for Work in process, June 1 Started into production Total units
0 20,000 20,000
0 20,000 20,000
Units accounted for Transferred out Work in process, June 30 Total units
16,000 4,000 20,000
17,500 2,500 20,000
(2) Equivalent units
Units transferred out Work in process, June 30 (4,000 X 100%) (4,000 X 75%) Total equivalent units
Units transferred out Work in process, June 30 (2,500 X 100%) (2,500 X 60%) Total equivalent units
16-48
.
Kimmel, Accounting, 5e, Solutions Manual
R12 Refrigerators Conversion Materials Costs 16,000 16,000 4,000 20,000
3,000 19,000
F24 Freezers Conversion Materials Costs 17,500 17,500 2,500 20,000
(For Instructor Use Only)
1,500 19,000
PROBLEM 16-3B (Continued) (3) Unit costs
Materials ($840,000 ÷ 20,000) ($720,000 ÷ 20,000) Conversion costs ($665,000(a) ÷ 19,000) ($551,000(b) ÷ 19,000) Total (a)
R12 Refrigerators $42
F24 Freezers $36
35 $77
29 $65
$245,000 + $420,000
(b)
$259,000 + $292,000
(4)
R12 Refrigerators Costs accounted for Transferred out (16,000 X $77) ............. Work in process Materials (4,000 X $42) ................... Conversion costs (3,000 X $35) ............................... Total costs ..............................
$1,232,000 $168,000 105,000
273,000 $1,505,000
F24 Freezers Costs accounted for Transferred out (17,500 X $65) .............. Work in process Materials (2,500 X $36) ................... Conversion costs (1,500 X $29) ............................... Total costs ..............................
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$1,137,500 $90,000 43,500
133,500 $1,271,000
16-49
PROBLEM 16-3B (Continued) (b)
BORMAN CORPORATION Stamping Department—Plant A Production Cost Report For the Month Ended June 30, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, June 1 Started into production Total units
0 20,000 20,000
Units accounted for Transferred out Work in process, June 30 Total units
16,000 4,000 20,000
Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)
16,000 4,000 20,000
16,000 3,000 19,000
Materials
Conversion Costs
(a) $840,000 (b) 20,000 $ 42
$665,000 19,000 $ 35
Costs to be accounted for Work in process, June 1 Started into production Total costs
(4,000 X 75%)
Total $1,505,000 $
77
$
0 1,505,000 $1,505,000
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (16,000 X $77) Work in process, June 30 Materials (4,000 X $42) Conversion costs (3,000 X $35) Total costs
16-50
.
Kimmel, Accounting, 5e, Solutions Manual
$1,232,000 $168,000 105,000
(For Instructor Use Only)
273,000 $1,505,000
PROBLEM 16-4B
(a) Physical Units Units to be accounted for Work in process, October 1 Started into production Total units
25,000 435,000 460,000
Units accounted for Transferred out Work in process, October 31 Total units
425,000 35,000 460,000
Equivalent Units Conversion Materials Costs
425,000 35,000 460,000
425,000 14,000* 439,000
*35,000 X 40% Materials cost Beginning work in process Added during month Total Equivalent units Cost per unit
Conversion costs
$
29,000 1,006,000 $1,035,000
$ 16,500 246,900 $263,400
460,000
439,000
$2.25
$.60
($138,900 + $108,000)
(b) Costs accounted for Transferred out (425,000 X $2.85) Work in process, October 31 Materials (35,000 X $2.25) Conversion costs (14,000 X $.60) Total costs
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$1,211,250 $78,750 8,400
87,150 $1,298,400
16-51
PROBLEM 16-4B (Continued) (c)
LUXMAN COMPANY Assembly Department Production Cost Report For the Month Ended October 31, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, October 1 Started into production Total units
25,000 435,000 460,000
Units accounted for Transferred out Work in process, October 31 Total units
425,000 35,000 460,000
Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)
425,000 35,000 460,000
425,000 14,000 (35,000 X 40%) 439,000
Materials
Conversion Costs
(a) $1,035,000 (b) 460,000 $2.25
$263,400 439,000 $.60
Costs to be accounted for Work in process, October 1 Started into production Total costs
Total $1,298,400 $2.85
$ 45,500 1,252,900 $1,298,400
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (425,000 X $2.85) Work in process, October 31 Materials (35,000 X $2.25) Conversion costs (14,000 X $.60) Total costs
16-52
.
Kimmel, Accounting, 5e, Solutions Manual
$1,211,250 $78,750 8,400
(For Instructor Use Only)
87,150 $1,298,400
PROBLEM 16-5B
(a) (1) Physical Units Units to be accounted for Work in process, May 1 Started into production Total units
500 2,000 2,500
Units accounted for Transferred out Work in process, May 31 Total units
1,700 800 2,500
Equivalent Units Conversion Materials Costs
1,700 800 2,500
1,700 320* 2,020
*800 X 40% (2) Beginning work in process Added during month Total Equivalent units Cost per unit
Materials cost
Conversion costs
$15,000 50,000 $65,000
$18,000 52,700 $70,700
2,500
2,020
$26
$35
($19,020 + $33,680)
(3) Costs accounted for Transferred out (1,700 X $61) Work in process, May 31 Materials (800 X $26) Conversion costs (320 X $35) Total costs
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$103,700 $20,800 11,200
32,000 $135,700
16-53
PROBLEM 16-5B (Continued) (b)
SWINN COMPANY Bicycle Department Production Cost Report For the Month Ended May 31, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, May 1 Started into production Total units
500 2,000 2,500
Units accounted for Transferred out Work in process, May 31 Total units
1,700 800 2,500
Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)
(a) (b)
1,700 800 2,500
1,700 320 2,020
Materials
Conversion Costs
$65,000 2,500 $26
$70,700 2,020 $35
Costs to be accounted for Work in process, May 1 Started into production Total costs
(800 X .40)
Total $135,700 $61
$ 33,000 102,700 $135,700
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (1,700 X $61) Work in process, May 31 Materials (800 X $26) Conversion costs (320 X $35) Total costs
16-54
.
Kimmel, Accounting, 5e, Solutions Manual
$103,700 $20,800 11,200
(For Instructor Use Only)
32,000 $135,700
PROBLEM 16-6B
(a) Computation of equivalent units:
Units accounted for Transferred out Work in process, March 31 (60% materials, (20% conversion costs) Total units
Physical Units
Equivalent Units Conversion Materials Costs
66,000
66,000
66,000
20,000 86,000
12,000 78,000
4,000 70,000
Computation of March unit costs Materials: $156,000 ÷ 78,000 equivalent units = Conversion cost: $98,000 ÷ 70,000 equivalent units = Total unit cost, March
$2.00 1.40 $3.40
(b) Cost Reconciliation Schedule Costs accounted for Transferred out (66,000 X $3.40).................... Work in process, March 31 Materials (12,000 X $2.00) ....................... Conversion costs (4,000 X $1.40) ........... Total costs ......................................................
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$224,400 $24,000 5,600
29,600 $254,000
16-55
*PROBLEM 16-7B
(a) Basketballs (1) Equivalent units—Materials Materials Added This Period
Physical Units Work in process, August 1 Started and completed Work in process, August 31 Total
500 1,400 (2,000 – 600) 600 2,500
*
Equivalent Units
0%* 100% 100%
0 1,400 600 2,000
*All materials are added at the beginning of the production process
Equivalent units—Conversion Conversion Added This Period
Physical Units Work in process, August 1 Started and completed Work in process, August 31 Total
500 1,400 (2,000 – 600) 600 2,500
Equivalent Units
40% (1 – .6) 100% 50%
200 1,400 300 1,900
(2) Unit costs Costs in August (a) Equivalent units (b) Unit costs [(a) ÷ (b)]
Materials $1,600 2,000 $.80
Conversion **$2,280** 1,900 $1.20
**Direct Labor $1,280 + Manufacturing Overhead $1,000
16-56
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Kimmel, Accounting, 5e, Solutions Manual
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*PROBLEM 16-7B (Continued) (3) Assignment of costs to units transferred out and in process Costs to Be Assigned
Assignment of Costs
Total mfg. costs Transferred out Work in process, August 1 ***$5,005*** Conversion Started and completed Total costs transferred out Work in process, August 31 Materials Conversion costs Total costs
Equivalent Unit Units Cost
200 1,400
Total Costs Assigned
$1,125 1.20 240 2.00 2,800 $4,165
600 300
.80 1.20
480 360
840 $5,005
***Work in process, August 1, $1,125 + Materials $1,600 + Labor $1,280 + Overhead $1,000
Soccer balls (1) Equivalent units—Materials Physical Units Work in process, August 1 Started and completed Work in process, August 31 Total
200 1,850 (2,000 – 150) 150 2,200
Materials Added This Period *
0%* 100% 100%
Equivalent Units 0 1,850 150 2,000
*All materials are added at the beginning of the production process
Equivalent units—Conversion Physical Units Work in process, August 1 Started and completed Work in process, August 31 Total
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Kimmel, Accounting, 5e, Solutions Manual
200 1,850 (2,000 – 150) 150 2,200
(For Instructor Use Only)
Conversion Added This Period
Equivalent Units
20% (1 – .8) 40 100% 1,850 70% 105 1,995
16-57
*PROBLEM 16-7B (Continued) (2) Unit costs Materials $2,800 2,000 $1.40
Costs in August (a) Equivalent units (b) Unit costs (a) ÷ (b)
Conversion $2,394** 1,995 $1.20
**Direct Labor $1,000 + Manufacturing Overhead $1,394 (3) Assignment of costs to units transferred out and in process Costs to Be Assigned
Assignment of Costs
Total mfg. costs Transferred out Work in process, August 1 ***$5,644*** Conversion Started and completed Total costs transferred out Work in process, August 31 Materials Conversion costs Total costs
Equivalent Unit Units Cost
40 1,850
$1.20 $2.60
Total Costs Assigned $ 450 48 4,810 $5,308
150 105
$1.40 $1.20
210 126
336 $5,644
***Work in process, August 1, $450 + Materials $2,800 + Labor $1,000 + Overhead $1,394
16-58
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Kimmel, Accounting, 5e, Solutions Manual
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*PROBLEM 16-7B (Continued) (b)
HOLIDAY COMPANY Production Cost Report—Basketballs For the Month Ended August 31
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, August 1 Started into production Total units
500 2,000 2,500
Units accounted for Completed and transferred out Work in process, August 1 Started and completed Work in process, August 31 Total units
500 1,400 600 2,500
0 1,400 600 2,000
200 1,400 300 1,900
Costs
Materials
Conversion Costs
Total
Unit costs (Step 3) Costs in August (a) Equivalent units (b) Unit costs [(a) ÷ (b)]
$1,600 2,000 $.80
$2,280 1,900 $1.20
Costs to be accounted for Work in process, August 1 Started into production Total costs
$3,880 $2.00
$1,125 3,880* $5,005
Cost Reconciliation Schedule Costs accounted for Transferred out Work in process, August 1 Conversion costs to complete beginning inventory (200 X $1.20) Started and completed (1,400 X $2.00) Work in process, August 31 Materials (600 X $.80) Conversion costs (300 X $1.20) Total costs
$1,125 240 2,800 480 360
$4,165
840 $5,005
*($1,600 + $1,280 + $1,000)
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Kimmel, Accounting, 5e, Solutions Manual
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16-59
BYP 16-1
DECISION-MAKING AT CURRENT DESIGNS
CURRENT DESIGNS Fabrication Department Production Cost Report For the Month Ended April 30, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, April 1 Started into production Total units
30 72 102
Units accounted for Transferred out Work in process, April 30 Total units
67 35 102
Costs Unit costs (Step 3) Total cost* Equivalent units Unit costs [(a) ÷ (b)]
67 7 (35 X 20%) 74
Materials
Conversion Costs
(a) $25,900 (b) 74 $ 350
$48,600 81 $ 600
Costs to be accounted for Work in process, April 1 Started into production Total costs
Kimmel, Accounting, 5e, Solutions Manual
$74,500 $
950
$63,650 $ 2,450 8,400
*Material costs = $8,400 + $17,500 Conversion costs = $9,000 + $39,600
.
Total
$17,400 57,100 $74,500
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (67 X $950) Work in process, April 30 Materials (7 X $350) Conversion costs (14 X $600) Total costs
16-60
67 14 (35 X 40%) 81
(For Instructor Use Only)
10,850 $74,500
BYP 16-2
DECISION-MAKING ACROSS THE ORGANIZATION
(a) The unit cost suggests that Joe took the highest total costs and divided these costs by the units started into production. The highest total costs would be the total costs charged to the Mixing Department ($88,000 + $573,000 + $765,000) divided by the units started during July (100,000 gallons), which results in a per unit cost of $14.26 ($1,426,000 ÷ 100,000). (b) The principal errors made by Joe were: (1) he did not compute equivalent units of production; (2) he did not use the weighted-average costing method; and (3) he did not assign costs to ending work-in-process.
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16-61
BYP 16-2 (Continued) (c)
FLORIDA BEACH COMPANY Mixing Department Production Cost Report For the Month Ended July 31, 2014
Quantities
Physical Units
Equivalent Units Conversion Materials Costs
(Step 1)
(Step 2)
Units to be accounted for Work in process, July 1 Started into production Total units
8,000 100,000 108,000
Units accounted for Transferred out Work in process, July 31 Total units
103,000 5,000 108,000
Costs Unit costs (Step 3) Total cost Equivalent units Unit costs (a) ÷ (b)
103,000 5,000 108,000
103,000 1,000 (5,000 X 20%) 104,000
Materials
Conversion Costs
(a) $594,000 (b) 108,000 $5.50
$832,000 104,000 $8.00
Costs to be accounted for Work in process, July 1 Started into production Total costs
Total $1,426,000 $13.50
$ 88,000 1,338,000 $1,426,000
Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (103,000 X $13.50) Work in process, July 31 Materials (5,000 X $5.50) Conversion costs (1,000 X $8.00) Total costs
16-62
.
Kimmel, Accounting, 5e, Solutions Manual
$1,390,500 $27,500 8,000
(For Instructor Use Only)
35,500 $1,426,000
BYP 16-3
MANAGERIAL ANALYSIS
(a) The unit cost of materials is $150 ($450,000 ÷ 3,000). (b) The materials cost of the goods transferred out is $375,000 (2,500 X $150). Conversion costs, therefore, are $225,000 ($600,000 – $375,000), and per unit conversion cost is $90 ($225,000 ÷ 2,500). (c) There are 500 units in ending work-in-process inventory (3,000 started – 2,500 transferred out). The materials cost is $75,000 (500 X $150). Thus, the conversion costs in the inventory are $36,000 ($261,000 – $225,000). $36,000 divided by $90 per unit conversion cost equals 400 equivalent units or 80% (400 ÷ 500) complete.
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16-63
BYP 16-4
REAL-WORLD FOCUS
(a) The outer shell of the paintballs is made from a mixture that includes water, sweeteners, food ingredients, and most importantly, gelatin. All of the ingredients used to make paintballs are food grade, biodegradable products. The “paint” filling inside a paintball is comprised of the same inert ingredient used in cough syrup, as well as crayon wax. After mixing the gelatin and other materials, the mixture is heated, and then spread on rolling drums which create thin gelatin ribbons. Each of the ribbons then passes over a rotating die. The dies are designed so that they can form round capsules. The dies press against each other as they rotate. As the dies meet, both shells are filled with paint, which is injected into the area between the sheets. The two halves then seal as they press against each other to form a filled capsule. Once the capsules are sealed they drop out of the machine to become paintballs. They pass along a conveyor belt to a tumble drier, then onto a drying rack. Once they are dry, they go into a counting machine, then into a packing machine which packs exactly the correct number of balls into each container. (b) Materials: water, sweeteners, food ingredients, gelatin, “cough syrup material”, crayon wax, and food coloring. Labor: People would be needed run the various machines. Overhead: Depreciation and maintenance of the various machines. It would appear that overhead would be by far the highest cost because the process is very automated. Machines are needed for mixing the gelatin, heating it, rolling it into ribbons, making the capsules, filling the capsules, sorting and drying the capsules, counting the capsules and packing them. (c) This would appear to be a perfect situation for the use of process costing. Paintballs are a high volume product, and the paintballs are very homogenous. While there may be some differences in various types of paintballs that would merit keeping track of specific costs to make the various types, the primary method of cost determination would be process costing.
16-64
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
BYP 16-5
COMMUNICATION ACTIVITY
To:
Diane Barone, Regional Sales Manager
From:
Student, Accounting Manager
Re:
Production Cost Reports
Diane, congratulations again on your promotion! It’s going to be great working with you. It kind of reminds me of our days at Dairy-Freeze after school (although this work is more fun, and it certainly pays better!). I’ll try to clear up some of the questions you raised in your email. Here in the Snack Foods Division we use process costing rather than the job order system that Special Projects uses. The reason for this is that we produce all our products in a more or less continuous process, even when we run occasional special orders. You see, all our workers are assigned a particular part of the process to control. One might be in charge of making sure the mixing machines work properly, while another verifies the weight of the finished products. Whichever job a worker is assigned, he or she stays with it to completion, or at least the completion of that particular process. That’s different from what you had in Special Projects, where workers moved from job to job. That’s why we don’t usually track the orders separately. Our special orders are for various quantities of the foods we produce, so only the Packing Department needs to be concerned with the particular set of products shipped to the particular customer—which is its ordinary concern anyway. Your next question was about what an equivalent unit is. Well, you know already that Special Projects bids on various jobs, and then costs are recorded when the jobs are complete. The costs accumulated on jobs that aren’t complete are reflected in Work in Process inventory. We in Snack Foods can’t use that method for a simple reason—we produce our products in huge batches that we keep going fairly continuously. Or, in other words, we don’t have a “job” that we can record as “complete.” A batch may contain enough of our product to fill thirty or more orders, so we may have thirty or more “jobs” in each batch. One job may happen to be filled from two batches. Since the cost of each batch is about the same, it isn’t worth keeping track of separately.
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16-65
BYP 16-5 (Continued) At the end of the month, we need to record what we finished and what still remains undone. Equivalent units are the way we measure the amount of work we have done on our work in process. It’s kind of like comparing the contents of 4-ounce cups with the contents of 12-ounce cups. It doesn’t make sense to compare by counting the number of cups you have. You need to find out how many ounces you have in one set; then you can get a meaningful comparison with the ounces you have in the other set. We compare by the number of “units” of materials or labor that are required to finish a product completely. If it requires 12 ounces of flour and 15 minutes of labor for a finished bag of pretzels, for example, then the 12 ounces and 15 minutes are “finished equivalents.” If we have enough pretzels to fill 30 bags, but we’ve only spent 5 minutes (or 1/3 of the total required) of labor on them at the end of the month, we could have used the same amount of time and completely finished 10 bags. Thus, we have the “equivalent” of 10 bags worth of labor. Your last question is the easiest to answer. You get four reports because we use four processes here in Snack Foods Division. Each process has to report its status at the end of every month. It’s kind of like we have four miniature factories, each reporting “completion” of a certain number of products. The products from one department are used as raw materials for other departments, so we have a chain of reports. Notice that the units and costs transferred out of Process 1 are the same as the units and costs transferred in to Process 2, and so on. I hope this helps. Call, write, or email me any time!
16-66
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 16-6
ETHICS CASE
(a) The stakeholders in this situation are:
Jan Wooten, molding department head. Tony Ferneti quality control inspector. Customers of R. B. Dillman Company. The department manager of the assembly department.
(b) Tony is placed in an ethical dilemma. He can offend his department head by disregarding Jan’s instructions and lose the support of his supervisor, and maybe lose his job. He can follow Jan’s instructions and be in violation of company policy. He can also report Jan’s instructions to supervisors (plant superintendent or vice-president of production). The company should make the position of quality control inspector responsible to someone other than the department head. Tony should not report to Jan.
.
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16-67
BYP 16-7
CONSIDERING PEOPLE, PLANET, AND PROFIT
(a) Some of the costs that the company now faces include: • Monetary damages: The company paid $21.4 million in fines as a result of an OSHA investigation; $1.6 billion to compensate those affected by the accident; and $1 billion to repair and update its refinery (plus an additional $250 million to install safety valves) • Bad publicity • Lost sales • Cost of cleaning up the affected area including transporting workers to the site; housing workers near the site; per diem for cleanup workers; safety equipment for the workers • Transportation and storage/disposal fees for any contaminants removed from the area • Legal fees associated with lawsuits/settlements • Reimburse the Coast Guard for any oil containment equipment provided • Possible air/water testing for an extensive time following the accident (b) Some steps that the company could have taken to reduce the environmental failure costs include: • • • •
Install up to date safety equipment Increase the frequency and efficacy of inspections Increase maintenance on older facilities Be responsive to and investigate thoroughly complaints by neighbors and regulators • Invest in research to discover safer means of boosting octane • Locate plants further away from population centers to the extent possible
16-68
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
CHAPTER 17 Activity-Based Costing ASSIGNMENT CLASSIFICATION TABLE Brief Exercises
Do It!
Exercises
A Problems
B Problems
1, 2
1
1, 2, 3, 4, 5, 6, 12, 13
1A, 3A, 4A, 5A
1B, 3B, 4B, 5B
1A, 2A, 3A, 4A, 5A
1B, 2B, 3B, 4B, 5B
1A, 5A
1B, 5B
5A
5B
Learning Objectives
Questions
*1.
Recognize the difference between traditional costing and activity-based costing.
1, 2, 3, 4, 5
*2.
Identify the steps in the development of an activitybased costing system.
7
*3.
Know how companies identify the activity cost pools used in activity-based costing.
9
*4.
Know how companies identify and use cost drivers in activity-based costing.
6, 10, 11, 12
*5.
Understand the benefits and limitations of activity-based costing.
13, 14, 15
*6.
Differentiate between value-added and nonvalue-added activities.
8, 16, 17
8, 9
3
12, 13, 14
*7.
Understand the value of using activity levels in activity-based costing.
19
10, 11, 12
4
15, 16
*8.
Apply activity-based costing to service industries.
18
9, 10
3
14
*9.
Explain just-in-time (JIT) processing.
20
1
7, 8
3, 4, 5, 6, 7, 12
2
1, 3, 4, 5, 6, 8, 9, 10, 11, 12, 13
11
*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter.
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Kimmel, Accounting, 5e, Solutions Manual
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17-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Assign overhead using traditional costing and ABC; compute unit costs; classify activities as value- or non-value-added.
Moderate
35–45
2A
Assign overhead to products using ABC and evaluate decision.
Moderate
25–35
3A
Assign overhead costs using traditional costing and ABC; compare results.
Moderate
35–45
4A
Assign overhead costs using traditional costing and ABC; compare results.
Moderate
40–50
5A
Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results.
Moderate
35–45
1B
Assign overhead using traditional costing and ABC; compute unit costs; classify activities as value- or non-value-added.
Moderate
35–45
2B
Assign overhead to products using ABC and evaluate decision.
Moderate
25–35
3B
Assign overhead costs using traditional costing and ABC; compare results.
Moderate
35–45
4B
Assign overhead costs using traditional costing and ABC; compare results.
Moderate
40–50
5B
Assign overhead costs to services using traditional costing and ABC; compute overhead rates and unit costs; compare results.
Moderate
35–45
17-2
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Kimmel, Accounting, 5e, Solutions Manual
Learning Objective
Knowledge Comprehension
*1. Recognize the difference Q17-1 between traditional costing and Q17-2 activity-based costing. Q17-3 Q17-4 Q17-5 DI17-1
Application BE17-1 BE17-2 E17-1 E17-2
E17-12 E17-13 P17-1A P17-4A
(For Instructor Use Only)
*2. Identify the steps in the development of an activitybased costing system.
Q17-7 DI17-1
*3. Know how companies identify the activity cost pools used in activity-based costing.
Q17-9
E17-7
*4. Know how companies identify and use cost drivers in activity-based costing.
Q17-6 Q17-10 Q17-11 Q17-12
BE17-3 E17-1 BE17-4 E17-4 BE17-5 E17-5 BE17-6 E17-11 BE17-7 BE17-12 DI17-2
*5. Understand the benefits and limitations of activity-based costing.
Q17-13 Q17-14 Q17-15
E17-11
*6. Differentiate between valueadded and non-value-added activities.
Q17-8 Q17-16 Q17-17
BE17-8 BE17-9 DI17-3
*7. Understand the value of using activity levels in activity-based costing.
Q17-19
*8. Apply activity-based costing to Q17-18 service industries. *9. Explain just-in-time (JIT) processing. Broadening Your Perspective
DI17-4
P17-5A P17-1B P17-4B P17-5B
E17-1 E17-2 E17-3 E17-4 E17-5 E17-6
Synthesis
Evaluation
P17-3A P17-4A P17-5A P17-3B P17-4B P17-5B
E17-8
E17-12 E17-13
E17-12 E17-13 P17-1A P17-2A P17-4A P17-5A
P17-1B P17-2B P17-3B P17-4B P17-5B
DI17-2 E17-9 E17-1 E17-10 E17-3 P17-3A E17-4 P17-4A E17-5 P17-5A E17-6 P17-3B E17-8 P17-4B P17-5B
P17-1A P17-1B BE17-8 BE17-9 E17-14
BE17-10 BE17-11 BE17-12 BE17-9 BE17-10
Analysis
P17-4B
E17-15 E17-16 P17-5A P17-5B
BE17-10 E17-17 E17-18 DI17-3 P17-5B P17-5A
P17-5A
P17-5B
Q17-20 BYP17-1 BYP17-3
BYP17-4 BYP17-7
BYP17-2 BYP17-5 BYP17-8
BYP17-3 BYP17-6
BLOOM’ S TAXONOMY TABLE
.
Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
17-3
ANSWERS TO QUESTIONS 1.
Direct labor is a valid basis for allocating overhead when: (a) direct labor constitutes a significant part of total product cost, and (b) there is a high correlation between direct labor and changes in the amount of overhead costs.
2.
The amount of direct labor in many industries has greatly decreased, due to advances in computerized systems, technological innovation, global competition and automation. Total overhead costs resulting from depreciation on expensive equipment and machinery, utilities, repairs, and maintenance have significantly increased. Many companies now use machine hours as the basis on which to allocate overhead in an automated manufacturing environment.
3.
In many automated manufacturing environments, machine hours is a more relevant basis on which to allocate overhead.
4.
Under a traditional volume-based costing system where overhead cost is allocated on the basis of units of output, the high-volume product will undoubtedly absorb more overhead than the lowvolume product.
5.
The principal differences are: (1) Primary focus (2) Bases of allocation
6.
Activity-Based Costing Activities performed in making products Multiple cost drivers
Traditional Costing Units of production Single unit-level base
Activity-based overhead rates are computed using the following formula: Estimated Overhead per Activity Expected Use of Cost Drivers per Activity
7.
The four steps involved in developing an ABC system are: 1. Identify and classify the major activities involved in the manufacture of specific products, and allocate manufacturing overhead costs to appropriate cost pools. 2. Identify the cost driver that has a strong correlation to the costs accumulated in the cost pool. 3. Compute the overhead rate for each cost driver. 4. Assign manufacturing overhead costs for each cost pool to products, using the overhead rates (cost per driver).
8.
A value-added/non-value-added activity flowchart is based on a systematic analysis of all the activities (resource-consuming actions and transactions) performed to manufacture a product or render a service. The flowchart documents each activity and the time involved in each activity. The flow chart also documents management’s proposed reengineering of the manufacturing process.
9.
An activity cost pool is the overhead cost attributed to a distinct type of activity.
10.
A cost driver is any factor or activity that has a direct cause-effect relationship with the resources consumed.
17-4
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Questions Chapter 17 (Continued)
11.
A cost driver is accurate and appropriate if it measures the actual consumption of the activity in manufacturing a product or rendering a service and the data relating to the cost driver is available and easily obtained.
12.
The formula for assigning activity cost pools to products is: Activity-based overhead rate X Expected use of cost drivers per product
13.
The primary benefit of ABC is more accurate product costing. This results from using more cost pools and enhanced control over overhead costs, and leads to better management decisions.
14.
The limitations of ABC are: (a) increased costs that accompany multiple-activity cost pools and cost drivers and (b) the necessity still to allocate some costs arbitrarily.
15.
ABC is the superior costing system when: (1) product lines differ greatly in volume and manufacturing complexity; (2) product lines are numerous, diverse, and require differing degrees of support services; (3) overhead costs constitute a significant portion of total costs; (4) the manufacturing process or the number of products has changed significantly; and (5) data from the existing system is being ignored.
16.
Basic ABC has been enhanced by identifying activities as value-added and non-value-added.
17.
Identifying non-value-added activities highlights for managers the activities that should be reduced or eliminated because they are not essential and they add no value to the product.
18.
The overall objective of ABC in service firms is no different than for manufacturing companies; that is, improved costing of services rendered (by job, service, contract, or customer). The general approach to costing is the same—analyze operations, identify activities, assign overhead costs to activity cost pools, and identify and use cost drivers to assign the cost pools to the services.
19.
Greater accuracy in cost allocation is achieved by recognizing the four levels of activity. Some activities are affected (driven) by changes in the number of units produced, while other activities are affected only by changes in the number of batches or the number of products, and some, facility-level activities, are unaffected by changes in either units, batches, or products produced.
*20. (a) Just-in-time processing has a just-in-time philosophy and a pull approach to eliminate inventory. It is dedicated to having the right amount of materials, parts, or products just as they are needed. (b) There are three important elements in JIT processing: (1) A company must have dependable suppliers who are willing to deliver on short notice exact quantities of raw materials according to precise quality specifications. (2) A multiskilled workforce must be developed. (3) A total quality control system must be established.
.
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17-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 17-1
(a)
Estimated annual overhead costs = Predetermined overhead rate Expected annual operating activity $1,000,000 = $10 per direct labor hour 100,000
(b)
92,000 direct labor hours X $10 = $920,000 overhead applied
(c)
If the manufacturing process is complex, then multiple allocation bases can result in more accurate product-cost computations. In such situations, managers need to consider an overhead cost allocation method that uses multiple bases. That method is activitybased costing.
BRIEF EXERCISE 17-2 Under ABC, overhead costs are shifted from the high-volume products to the low-volume products. This shift results in more accurate costing for two reasons: 1. Low-volume products often require more special handling, such as more machine setups and inspections, than high-volume products. Thus, the low-volume product frequently is responsible for more overhead costs per unit than is a high-volume product. 2. Assigning overhead using ABC will usually increase the cost per unit for low-volume products. Therefore, a traditional overhead allocation such as direct labor hours is usually a poor cost driver for assigning overhead costs to low-volume products. As a result, for Finney, one of the products (Product RX3) may have been low volume and therefore may have more overhead costs assigned to it under an ABC system.
17-6
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Kimmel, Accounting, 5e, Solutions Manual
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BRIEF EXERCISE 17-3 An appropriate cost driver for each activity is: Activity Materials handling Machine setups Factory machine maintenance Factory supervision Quality control
Cost Driver Number of requisitions Number of setups Machine hours used Number of employees Number of inspections
BRIEF EXERCISE 17-4 (a) (b) (c) (d) (e) (f) (g)
Number of parts or assemblies Number of setups Number of employees Number of inspections Number of purchase orders Machine hours Square footage occupied
BRIEF EXERCISE 17-5 Machine setups Machining Inspections
$150,000 ÷ 2,500 = $60 per setup $325,000 ÷ 25,000 = $13 per machine hour $ 87,500 ÷ 1,750 = $50 per inspection
BRIEF EXERCISE 17-6 Activity Cost Pool Designing Sizing and cutting Stitching and trimming Wrapping and packing
.
Estimated Expected Use of Overhead ÷ Cost Drivers per Activity = $ 450,000 4,000,000 1,440,000 336,000
Kimmel, Accounting, 5e, Solutions Manual
10,000 designer hours 160,000 machine hours 80,000 labor hours 32,000 finished units
(For Instructor Use Only)
Activity-Based Overhead Rates $45.00 per designer hour $25.00 per machine hour $18.00 per labor hour $10.50 per finished unit
17-7
BRIEF EXERCISE 17-7 Estimated Expected Use of Overhead ÷ Cost Drivers per Activity =
Activity Cost Pool Ordering and receiving Etching Soldering
$
Cost Drivers 11,000 orders 50,000 machine hours 500,000 labor hours
90,000 480,000 1,760,000
X
12,000 orders 60,000 machine hours 440,000 labor hours
Activity-Based Overhead Rates $7.50 per order $8.00 per machine hour $4.00 per labor hour
Overhead Total Overhead Rates = Applied $7.50 $ 82,500 $8.00 400,000 $4.00 2,000,000 $2,482,500
BRIEF EXERCISE 17-8 (a) (b) (c) (d) (e) (f)
Non-value-added Value-added Non-value-added Non-value-added Non-value-added Value-added
BRIEF EXERCISE 17-9 Value-added Activities (1) Designing and drafting (3) On-site supervision (5) Consultation with client
Hours 2.5 2.0 1.5 6.0
Non-value-added Activities (2) Staff meetings (4) Lunch (6) Entertaining a prospective client
Hours 1 1 2 4
17-8
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Kimmel, Accounting, 5e, Solutions Manual
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BRIEF EXERCISE 17-10 (a) (b) (c) (d) (e) (f) (g) (h) (i) (j)
Batch- or unit-level Unit-level Unit-level Batch- or unit-level Facility-level Batch- or product-level Batch- or product-level Unit-level Facility-level Batch-level
BRIEF EXERCISE 17-11 (a) (b) (c) (d) (e) (f) (g) (h)
Facility-level Unit-level Product-level Unit-level Batch-level Batch-level Product-level Facility-level
BRIEF EXERCISE 17-12 (a) Product design
(b)
.
$40,000 = $4,000 per product change 10
Machining
$300,000 = $2 per machine hour 150,000
Material handling
$100,000 = $1,000 per set up 100
Product design—product-level Machining—unit-level Material handling—batch-level
Kimmel, Accounting, 5e, Solutions Manual
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17-9
SOLUTIONS TO DO IT! REVIEW EXERCISES
DO IT! 17-1 1. 2. 3. 4. 5.
True False False True True
DO IT! 17-2 (a) Computations of activity-based overhead rates per cost driver: Activity Cost Pools Machine setup Machining Packing
Estimated Overhead $ 16,000 110,000 30,000 $156,000
Expected Use of Cost Activity-Based Drivers per Activity Overhead Rates 40 setups $400 per setup 5,000 machine hours $ 22 per machine hr. 500 orders $ 60 per order
(b) Assignment of each activity’s overhead cost to products using ABC: BC113
AD908
Expected Use of Cost Activity Cost Drivers per Activity-Based Cost Pools Product Overhead Rates Assigned Machine setup 25 $400 $10,000 Machining 1,000 $ 22 22,000 Packing 150 $ 60 9,000 Total assigned costs $41,000
Expected Use of Activity-Based Cost Drivers per Overhead Cost Product Rates Assigned 15 $400 $ 6,000 4,000 $ 22 88,000 350 $ 60 21,000 $115,000
(c) Computation of overhead cost per unit: Total costs assigned (a) Total units produced (b) Overhead cost per unit (a) ÷ (b)
17-10
.
Kimmel, Accounting, 5e, Solutions Manual
BC113 $41,000 3,000 $13.67
AD908 $115,000 1,500 $76.67
(For Instructor Use Only)
DO IT! 17-2 (Continued) (d) These computations show that the total overhead assigned to Product AD908 is more than two and a half times that assigned to BC113. On a per unit basis, the overhead assigned to AD908 is close to six times that assigned to each BC113. DO IT! 17-3 1. 2. 3. 4. 5.
NVA VA NVA VA VA
DO IT! 17-4 (a) (b) (c) (d) (e) (f) (g) (h)
.
unit-level product-level facility-level batch-level unit-level batch-level facility-level unit-level
Kimmel, Accounting, 5e, Solutions Manual
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17-11
SOLUTIONS TO EXERCISES EXERCISE 17-1 (a)
Estimated overhead = Predetermined overhead rate Direct labor costs $270,000 = 180% of direct labor cost $50,000 + $100,000
(b) Activity cost pools Machining Machine setup
Cost drivers Machine hours Set up hours
Estimated overhead $170,000 100,000
Activity-based overhead rates Machining: Machine setup: $170,000 $100,000 = $85 per machine hour = $200 per setup hour 1,000 + 1,000 400 + 100 (c) Traditional costing $50,000 X 180% $100,000 X 180%
Standard $90,000 $90,000
Activity-based costing Machining: 1,000 X $85 1,000 X $85 Machine setup: 100 X $200 400 X $200
.
Kimmel, Accounting, 5e, Solutions Manual
$180,000 $180,000
$85,000 $85,000
20,000 $105,000
17-12
Custom
(For Instructor Use Only)
80,000 $165,000
EXERCISE 17-2 (a)
Traditional costing system Product 540X
Product 137Y
Product 249S
$180,000 55,000 $125,000
$160,000 50,000 $110,000
$70,000 15,000 $55,000
Product 540X
Product 137Y
Product 249S
$180,000 50,000 $130,000
$160,000 35,000 $125,000
$70,000 35,000 $35,000
Sales Costs Operating income (b)
Activity-based costing system
Sales Costs Operating income (c) Product 540X:
($130,000 – $125,000) ÷ $125,000 = 4.00%
Product 137Y
($125,000 – $110,000) ÷ $110,000 = 13.64%
Product 249S
($35,000 – $55,000) ÷ $55,000 = (36.36%)
(d) These costs are similar probably because the cost drivers are essentially the same; that is, they are based on a unit volume concept.
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Kimmel, Accounting, 5e, Solutions Manual
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17-13
EXERCISE 17-3 (a)
Activity cost pools
Cost drivers
Estimated overhead
Cutting
Machine hours
$360,000
Design
Number of setups
630,000
Activity-based overhead rates Cutting $360,000 = $1.80 per machine hour 200,000
Design $630,000 = $420 per setup 1,500 Wool
Activity-based costing Cutting 100,000 X $1.80 100,000 X $1.80
$180,000 $180,000
Design 1,000 X $420 500 X $420 Total cost allocated
420,000 210,000 $390,000
$600,000
(b) Estimated overhead = $990,000 Direct labors hours 450,000
= $2.20 per direct labor hour
Wool Traditional costing 225,000 X $2.20 225,000 X $2.20
Cotton
Cotton
$495,000 $495,000
The wool product line is allocated $105,000 ($600,000 – $495,000) more overhead cost when an activity-based costing system is used. As a result, the cotton product line is allocated $105,000 ($495,000 – $390,000) less.
17-14
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 17-4 (a) Direct labor hours for car wheels (40,000 X 1) = 40,000 Direct labor hours for truck wheels (10,000 X 3) = 30,000 Total direct labor hours 70,000 $770,000 (total estimated overhead) 70,000 (total direct labor hours)
= $11 per direct labor hour.
Overhead assigned Car wheels Truck wheels Total overhead
(40,000 X $11) (30,000 X $11)
(b)
Expected Use of Cost Drivers
ABC Overhead = Rate
Activity Cost Pool
Estimated Overhead
Setting up machines Assembling Inspection
$220,000 280,000 270,000
Activity Cost Pools
Car Wheels Expected Use Activity-Based of Cost Driver Overhead per Product X Rates =
(c)
Setting up machines Assembling Inspection Total cost assigned
.
= $440,000 = 330,000 $770,000
Kimmel, Accounting, 5e, Solutions Manual
÷
200 40,000 100
(For Instructor Use Only)
1,000 70,000 1,200
$220 $ 4 $225
$220 $ 4 $225
Cost Assigned $ 44,000 160,000 22,500 $226,500
17-15
EXERCISE 17-4 (Continued) (c)
Truck Wheels
Activity Cost Pools Setting up machines Assembling Inspection Total cost assigned (d)
17-16
Expected use of Cost Driver X per Product 800 30,000 1,100
ActivityBased Overhead Rates $220 $ 4 $225
=
Cost Assigned $176,000 120,000 247,500 $543,500
Assuming that the cost drivers are a reasonable representation of what is occurring in the two product lines, it seems appropriate to switch to activity-based costing. By using this system, more accurate cost information is developed which should lead to better allocation of resources and pricing decisions in the future.
.
Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 17-5 (a)
Expected use ÷ of Cost Drivers = ABC Overhead Rates 1,500 $ 70.00 700 $100.00 $400,000* $ .15
Activity Cost Pools Estimated Overhead Scheduling and travel $105,000 Setup time $ 70,000 Supervision $ 60,000 *$100,000 + $300,000
Commercial Activity Cost Pools Scheduling and travel Setup time Supervision Total assigned costs
Expected use of Cost Drivers per Product X ABC Overhead Rates = 1,000 $ 70.00 450 $100.00 $100,000 $ .15
Cost Assigned $ 70,000 45,000 15,000 $130,000
Residential Activity Cost Pools Scheduling and travel Setup time Supervision Total assigned costs
Expected use of Cost Drivers per Product X ABC Overhead Rates = 500 $ 70.00 250 $100.00 $300,000 $ .15
(b) Revenues Direct material costs Direct labor costs Overhead costs Operating income (loss)
(c)
.
Commercial $300,000 $ 30,000 100,000 130,000
260,000 $ 40,000
Cost Assigned $ 35,000 25,000 45,000 $105,000 Residential $480,000
$ 50,000 300,000 105,000
455,000 $ 25,000
Assuming that the cost drivers are a reasonable representation of what is occurring in the two product lines, it seems appropriate to switch to activity-based costing. By using this system, more accurate cost information is developed which should lead to better allocations of resources and more informative pricing decisions in the future.
Kimmel, Accounting, 5e, Solutions Manual
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17-17
EXERCISE 17-6 (a) Traditional costing: $260,000 ÷ 2,500 (800 + 1,700) hours = $104 per direct labor hour (1) One mobile safe: 800 hours X $104 = $83,200 $83,200 ÷ 200 = $416 each (2) One walk-in safe: 1,700 hours X $104 = $176,800 $176,800 ÷ 50 = $3,536 each (b) Activity-based costing: (1) Material handling costs $160,000 ÷ 500 (300 + 200) moves = $320 per move (a) One mobile safe: 300 moves X $320 = $96,000 $96,000 ÷ 200 = $480 each (b) One walk-in safe: 200 moves X $320 = $64,000 $64,000 ÷ 50 = $1,280 each (2) Purchasing activity costs $100,000 ÷ 800 (450 + 350) orders = $125 per order (a) One mobile safe: 450 orders X $125 = $56,250 $56,250 ÷ 200 = $281.25 each (b) One walk-in safe: 350 orders X $125 = $43,750 $43,750 ÷ 50 = $875 each
17-18
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 17-6 (Continued) (c) The total amount of overhead allocated to each unit of the two products under the two allocation approaches is:
Mobile safe Walk-in safe
Traditional Costing $ 416 $3,536
Activity-Based Costing ** $761.25** $ 2,155**
**$480 + $281.25 **$1,280 + $875 EXERCISE 17-7 The following activities might be identified at Quik Prints Company from your analysis of its operations and a discussion with the owner-manager, Terry Morton. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.
.
Hiring and training personnel Purchasing supplies and materials Selling, promoting, and marketing Billing and collecting Designing Offset printing Copying Faxing Collating Cutting and folding Maintenance and repairs Delivery Accounting
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17-19
EXERCISE 17-8 Budgeted Costs
Activity Cost Pool
Cost Driver
Engineering design Engineering prototypes
Engineering
Engineering hours
Depreciation, machinery Electricity, machinery
Machinery
Machine hours
Machine setup
Number of setups
Inspections Tests
Quality control
Number of tests or inspections
Depreciation, plant Insurance, plant Property taxes Oil, heating Electricity, plant lighting
Factory utilities
Square feet or Machine hours
Machine maintenance wages
Maintenance
Machine setup, indirect labor Machine setup, indirect materials
Number of machines or Machine hours
EXERCISE 17-9 The following cost drivers might be used to assign overhead: 1. 2. 3. 4. 5. 6. 7. 8.
17-20
Labor hours Labor hours Labor hours Gallons of chemicals Number of cartfuls or labor hours Number of cartfuls Gallons of juice Gallons of juice
.
9. 10. 11. 12. 13. 14. 15.
Gallons of wine or months of aging Number of bottles Number of bottles Number of boxes Number of shipments Number of gallons processed Number of gallons processed
Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 17-10 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12.
Number of engineering change orders; hours of designing Number of orders processed Number of parts in stock Weight of material; number of boxes or cartons Employee turnover; number of employees hired Machine hours; direct labor hours Number of employees; number of parts; direct labor hours Number of employees Book or market value of assets Cost of goods manufactured, direct labor hours; number of employees Machine hours; number of machines Gallons of paint; number of appliances
EXERCISE 17-11 (a) The overhead rates are: Activity Cost Pools
Expected Use Estimated of Cost Drivers Activity-Based Overhead ÷ per Activity = Overhead Rates
Materials handling Machine setups Quality inspections
$40,000 27,500 27,000
1,000 500 600
$40 55 45
(b) The assignment of the overhead costs to products is as follows: Instruments Gauges Cost Driver Number Cost Number Cost Requisitions ($40) 400 $16,000 600 $24,000 Machine setups ($55) 200 11,000 300 16,500 Inspections ($45) 200 9,000 400 18,000 Total costs assigned (a) $36,000 $58,500 Units produced (b) Overhead cost per Unit (a) ÷ (b)
.
Kimmel, Accounting, 5e, Solutions Manual
50 $
720
(For Instructor Use Only)
Cost Assigned $40,000 27,500 27,000 $94,500
300 $
195
17-21
EXERCISE 17-11 (Continued) (c)
MEMO To:
President, Major Instrument, Inc.
From:
Student
Re:
Benefits of activity-based costing (ABC)
ABC focuses on the activities performed in producing a product. Overhead costs are assigned to products based on cost drivers that measure the activities performed on the product. The primary benefit of ABC is more accurate and meaningful product costing. This improved cost data can lead to reduced costs as managers become more aware of the underlying causes of cost incurrence. Thus, control over costs is enhanced. The improved cost data should also lead to better management decisions. More accurate product costing should contribute to setting selling prices which will help achieve desired profitability levels. In addition, it should be helpful in deciding whether to make or buy a product part or component, and sometimes even whether to eliminate a product.
17-22
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 17-12 (a) (1) Traditional product costing system: $400,000 X .70 = $280,000 Selling costs assigned in March to the “high intensity” product line. (2) Activity-based costing system:
Activity Cost Pools Sales commissions Advertising—TV/Radio Advertising—Newspaper Catalogs Cost of catalog sales Credit and collection Total assigned cost for March
ActivityBased Cost Drivers Overhead Overhead Cost Used X Rates = Assigned $900,000 250 2,000 60,000 9,000 $900,000
$.05 $300 $10 $2.50 $1.00 $.03
$ 45,000 75,000 20,000 150,000 9,000 27,000 $326,000
(b) As compared to ABC, traditional costing grossly undercosts the selling costs assigned to the “high intensity” product line. The difference of $46,000 ($326,000 – $280,000) in the month of March is a 14.1% understatement. (c) All six activities, as selling activities, are non-value-added activities.
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17-23
EXERCISE 17-13 (a) 1.
Traditional product costing system: Quality-control overhead costs assigned in June to the low-calorie dessert line are $11,050 ($65,000 X .17).
2.
Activity-based costing system:
Activity Cost Pools
ActivityBased Cost Drivers Overhead Overhead Cost Used X Rate = Assigned
Inspections of material received In-process inspections FDA certification Total assigned cost for June
6,000 10,000 420
$ .80 $ .33 $12.00
$ 4,800 3,300 5,040 $13,140
(b) As compared to ABC, the traditional costing system undercosts the quality-control overhead cost assigned to the low-calorie dessert product line by $2,090 ($13,140 – $11,050) in the month of June. That is a 15.9% understatement. (c) All three activities, as quality-control related activities, are non-valueadded activities.
17-24
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 17-14 Value-Added Activities Writing contracts and letters Taking depositions Contemplating legal strategy Litigating a case in court
Hours 1.5 1.0 1.0 2.5 6.0
Non-Value-Added Activities Attending staff meetings Doing research Traveling to/from court Eating lunch Entertaining a prospective client
Hours 0.5 1.0 1.0 1.0 1.5 5.0
Questionable Classifications Writing contracts is value-added; writing letters may be value-added if related to a specific case or it may be non-value-added if it is billing a client or collecting receivables. Research may be value-added if it is unique, related to a specific case, and is billable. Research may be non-value-added if it is something the attorney should already have known and is not billable to the client.
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17-25
EXERCISE 17-15 Activity Cost Pools Engineering Machinery Machine setup Quality control Factory utilities Maintenance
Activity Level Product-level Unit-level Batch-level Depends on frequency. Could be unit, batch, or product-level Facility-level Facility-level
EXERCISE 17-16 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
17-26
Facility-level activity Product-level activity Batch-level activity Product-level activity Product-level activity Batch-level activity Facility-level activity Batch-level or unit-level activity Unit-level activity Unit-level activity
.
Kimmel, Accounting, 5e, Solutions Manual
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SOLUTIONS TO PROBLEMS PROBLEM 17-1A
(a) Computation of unit costs—traditional costing. Products Manufacturing Costs
Home Model
Commercial Model
$18.50 19.00 * 24.26* $61.76
$26.50 19.00 * 24.26* $69.76
Direct materials Direct labor Overhead Total unit cost *$16.17 X 1.5 = $24.26
(b) Estimated Overhead ÷
Activity Cost Pool Receiving Forming Assembling Testing Painting Packing and shipping
$
70,350 150,500 412,300 51,000 52,580 820,750 $1,557,480
Expected Use of Cost Drivers
Activity-Based Overhead Rate
=
335,000 Pounds 35,000 Machine hours 217,000 Parts 25,500 Tests 5,258 Gallons 335,000 Pounds
$ .21 per pound $ 4.30 per machine hour $ 1.90 per part $ 2.00 per test $10.00 per gallon $ 2.45 per pound
(c) Home Model ActivityExpected Based Use of Overhead Cost Drivers X Rates = Assigned
Activity Cost Pool
Receiving 215,000 Forming 27,000 Assembling 165,000 Testing 15,500 Painting 3,680 Packing and shipping 215,000 Total costs assigned (a) Units produced
$ .21 $ 4.30 $ 1.90 $ 2.00 $10.00 $ 2.45
$
45,150 116,100 313,500 31,000 36,800 526,750 $1,069,300
Kimmel, Accounting, 5e, Solutions Manual
120,000 8,000 52,000 10,000 1,578 120,000
$ .21 $ 4.30 $ 1.90 $ 2.00 $10.00 $ 2.45
$ 25,200 34,400 98,800 20,000 15,780 294,000 $488,180
54,000
(b)
Overhead cost per unit [(a) ÷ (b)]
.
Commercial Model ActivityExpected Based Use of Overhead Cost Drivers X Rates = Assigned
(For Instructor Use Only)
$
19.80
10,200 $
47.86
17-27
PROBLEM 17-1A (Continued) (d) ABC Manufacturing Costs Direct materials Direct labor Overhead Total cost per unit
Home Model $18.50 19.00 19.80 $57.30
Commercial Model $26.50 19.00 47.86 $93.36
(e)
Activity Receiving Forming Assembling Testing Painting Packing and shipping
Value- vs. Non-Value-Added Non-value-added Value-added Value-added Non-value-added Value-added Value-added
(f)
(1) Activity-based costing shows the commercial model absorbs nearly 21/2 ($47.86 ÷ $19.80) times as much overhead per unit as the home model. (2) The comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products is not equal at $24.26 but rather $19.80 for the home model and $47.86 for the commercial model. Under traditional costing, the margin of error on the commercial model was almost 100%, an understatement of $23.60 on an assignment of $24.26. These distorted overhead assignments have likely led to overpricing the home model and underpricing the commercial model.
17-28
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 17-2A
(a) The allocation of total manufacturing overhead using activity-based costing is as follows:
Overhead Rate Purchase orders @ $30 Machine setups @ $50 Machine hours @ $40 Inspections @ $25 Total assigned costs (a)
Royale Drivers Cost Used Assigned
Majestic Drivers Cost Used Assigned
17,000 5,000 75,000 11,000
23,000 13,000 45,000 17,000
$ 510,000 250,000 3,000,000 275,000 $4,035,000
Units produced (b)
$ 690,000 650,000 1,800,000 425,000 $3,565,000
25,000
Cost per unit (a) ÷ (b)
$
161.40
Total Overhead $1,200,000 900,000 4,800,000 700,000 $7,600,000
10,000 $
356.50
(b) The cost per unit and gross profit of each model under ABC costing were: Direct materials Direct labor Manufacturing overhead Total cost per unit
Royale $ 700.00 120.00 161.40 $ 981.40
Majestic $ 420.00 100.00 356.50 $ 876.50
Sales price per unit Cost per unit Gross profit
$1,600.00 981.40 $ 618.60
$1,300.00 876.50 $ 423.50
(c) Management’s future plans for the two television models are not sound. Under ABC costing, the Royale model is $195.10 ($618.60 – $423.50) per unit more profitable than the Majestic model. If any product should be phased out, it is the Majestic. But, by applying ABC and activity-based management analysis, Schultz may determine how to reduce the costs of producing the Majestic model.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
17-29
PROBLEM 17-3A
(a) Predetermined overhead rate using machine hours: $852,000 ÷ 100,000 hrs. = $8.52 per machine hour (b) Manufacturing cost per stairway under traditional costing: Direct materials ............................................................... Direct labor ...................................................................... Overhead (14,500 X $8.52) .............................................. Total cost of 250 stairs............................................
$ 103,600 112,000 123,540 $ 339,140
Cost per stairway ($339,140 ÷ 250) ................................
$1,356.56
(c) Manufacturing cost per stairway under activity-based costing: Computation of Activity-Based Overhead Rates Activity Cost Pools Purchasing Handling materials Production Setting up machines Inspecting Inventory control Utilities
Estimated Expected Use of Cost Overhead ÷ Drivers per Activity = $ 69,000 82,000 210,000 95,000 90,000 126,000 180,000 $852,000
600 Orders 8,000 Moves 100,000 D/L Hours 1,250 Setups 6,000 Inspections 168,000 Components 90,000 Sq. ft.
Activity-Based Overhead Rate $115 per order $10.25 per move $2.10 per D/L hour $76 per setup $15 per inspection $.75 per component $2.00 per sq. ft.
Assignment of Overhead to Order of 250 Stairs Activity Cost Pools
Expected Use of Cost Drivers
Activity-Based X Overhead Rates = Cost Assigned
Purchasing 60 Orders Handling materials 800 Moves Production 5,000 D/L Hours Setting up machines 100 Setups Inspecting 450 Inspections Inventory control 16,000 Components Utilities 8,000 Sq. ft. Total overhead assigned
17-30
.
Kimmel, Accounting, 5e, Solutions Manual
$115 $10.25 $2.10 $76 $15 $.75 $2.00
(For Instructor Use Only)
$ 6,900 8,200 10,500 7,600 6,750 12,000 16,000 $67,950
PROBLEM 17-3A (Continued) Total manufacturing cost per stairway under ABC: Direct materials ...................................................................... Direct labor............................................................................. Overhead ................................................................................ Total cost of 250 stairs ..................................................
$ 103,600 112,000 67,950 $ 283,550
Total cost per stairway ($283,550 ÷ 250) ..............................
$1,134.20
(d) The difference between the traditional cost and the activity-based cost per unit, $1,356.56 versus $1,134.20, is not great in amount but $222.36 ($1,356.56 – $1,134.20) is 19.6% of the more correct ABC cost per unit. Activity-based costing is the preferable costing system for setting prices because the real costs are more accurately reflected. The greater accuracy is a result of multiple, more relevant activity cost drivers under ABC than the single cost driver used with the traditional volumebased system.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
17-31
PROBLEM 17-4A
(a) Computation of unit costs—traditional costing Overhead cost per direct labor hour is $1,241,660 ÷ (150,000 + 27,000) = $7.015 Products CoolDay LiteMist $0.400 $1.200 0.500 0.900 0.351* 0.631** $1.251 $2.731
Manufacturing Costs Direct materials Direct labor Overhead *$7.015 X .05 **$7.015 X .09 (b) Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment
(c)
Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment Total costs assigned (a) Liters produced
17-32
Estimated Expected Use Overhead ÷ of Cost Drivers = $ 145,860 396,000 270,000 189,000
6,600 6,600,000 900,000 900,000
240,800 $1,241,660
800
CoolDay Expected ActivityUse of Based Cost Overhead Cost Drivers X Rates = Assigned 6,000 $22.10 $132,600 3,000,000 $ 0.06 180,000 600,000 $ 0.30 180,000 600,000 $ 0.21 126,000 350
$301
105,350 $723,950
Activity-Based Overhead Rates $22.10 per cart $ 0.06 per month $ 0.30 per bottle $ 0.21 per bottle $301 per inspection
LiteMist Expected ActivityUse of Based Cost Overhead Cost Drivers X Rates = Assigned 600 $22.10 $ 13,260 3,600,000 $ 0.06 216,000 300,000 $ 0.30 90,000 300,000 $ 0.21 63,000 450
$301
135,450 $517,710
(b)
3,000,000
300,000
Overhead cost per liter [(a) ÷ (b)]
$0.241
$1.726
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 17-4A (Continued) (d)
Products CoolDay LiteMist $0.400 $1.200 0.500 0.900 0.241 1.726 $1.141 $3.826
Manufacturing Costs Direct materials Direct labor Overhead
(e) To:
Mr. Jack Eller
From:
Student
Subject:
Product costs using traditional approach versus ABC
The memorandum covers the following points:
.
a.
ABC allocates overhead costs as a function of each product’s use of cost drivers. Thus, ABC results in overhead allocation that more closely approximates each product’s generation of overhead costs.
b.
Traditional approaches that allocate costs as a function of volume tend to be biased toward allocating too much overhead to high volume, simple products, and too little to low volume, complex products. This is because the actual incurrence of overhead costs is rarely correlated with labor costs.
c.
In the case of the Benton Corporation, the LiteMist product required the company to begin using more complex methods and equipment. Overhead costs increased substantially. When overhead costs were allocated using labor rates, too much overhead was allocated to the high volume CoolDay product. This reduced the apparent profitability of this product.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
17-33
PROBLEM 17-5A
(a) Computation of assigned overhead under traditional costing (“direct labor dollars” appears in the first line of the schedule of overhead data): Predetermined overhead rate X direct labor dollars Overhead assigned to audit: Overhead assigned to tax:
.40 X $1,050,000 = $420,000 .40 X $750,000 = $300,000
(b) (1) Computation of activity-based overhead rates:
Activity Cost Pools Employee training Typing and secretarial Computing Facility rental Travel
Estimated Overhead ÷
Expected Use of Cost Drivers per Activity
$216,000 76,200 204,000 142,500 81,300 $720,000
$1,800,000 Direct labor dollars 2,500 Reports/forms 60,000 Minutes 40 Employees Direct
Activity-Based Overhead Rates
=
$.12 per DL dollar $30.48 per report/form $3.40 per minute $3,562.50 per employee Direct
(2) Assignment of overhead to audit and tax services:
Activity Cost Pools Employee training Typing and secretarial Computing Facility rental Travel Overhead costs assigned
17-34
.
Audit Expected ActivityUse of Based Cost Overhead Cost Driver X Rate = Assigned
Tax Expected ActivityUse of Based Cost Overhead Cost Driver X Rate = Assigned
$1,050,000 800 25,000 22 56,000
$750,000 1,700 35,000 18 25,300
$.12 $30.48 $3.40 $3,562.50 Direct
Kimmel, Accounting, 5e, Solutions Manual
$126,000 24,384 85,000 78,375 56,000 $369,759
(For Instructor Use Only)
$.12 $30.48 $3.40 $3,562.50 Direct
$ 90,000 51,816 119,000 64,125 25,300 $350,241
PROBLEM 17-5A (Continued) (c) Overhead is assigned to the two service lines as follows: Audit $420,000 369,759 $ 50,241
Traditional costing ABC Difference
Tax $300,000 350,241 $ 50,241
The $50,241 difference for audits is 12% lower under ABC costing, while the $50,241 difference for tax is 16.7% higher under ABC costing. Clearly, ABC costing should be used to determine the relative profitability of each service.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
17-35
PROBLEM 17-1B
(a) Computation of unit costs—traditional costing. VideoPlus, Inc. Products Manufacturing Costs Direct materials Direct labor Overhead Total unit cost
Standard Model
Deluxe Model
$11 18 * 15* $44
$42 18 * 15* $75
*$7.50 X 2 = $15
(b)
VideoPlus, Inc. Activity Cost Pool Purchasing Receiving Assembling Testing Finishing Packing and shipping
Estimated Overhead ÷
Expected Use of Cost Drivers =
$ 126,000 30,000 444,000 115,000 140,000 195,000 $1,050,000
400 Orders 20,000 Pounds 74,000 Parts 23,000 Tests 70,000 Units 80,000 Pounds
(c)
$315.00 per order $ 1.50 per pound $ 6.00 per part $ 5.00 per test $ 2.00 per unit $ 2.4375 per pound
VideoPlus, Inc.
Activity Cost Pool Purchasing Receiving Assembling Testing Finishing Packing and shipping Total costs assigned
17-36
Activity-Based Overhead Rate
Standard Model Expected Use of Overhead Cost Drivers X Rates = Assigned 100 4,000 20,000 10,000 20,000 18,000
$315.00 $ 1.50 $ 6.00 $ 5.00 $ 2.00 $ 2.4375
$ 31,500 6,000 120,000 50,000 40,000 43,875 $291,375
Deluxe Model Expected Use of Overhead Cost Drivers X Rates = Assigned 300 16,000 54,000 13,000 50,000 62,000
$315.00 $ 1.50 $ 6.00 $ 5.00 $ 2.00 $ 2.4375
$ 94,500 24,000 324,000 65,000 100,000 151,125 $758,625
Units produced
20,000
50,000
Overhead cost per unit
$14.57
$15.17
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 17-1B (Continued) (d)
VideoPlus, Inc. ABC Manufacturing Costs Direct materials Direct labor Overhead Total cost per unit
Standard Model $11.00 18.00 14.57 $43.57
Deluxe Model $42.00 18.00 15.17 $75.17
(e)
Activity Purchasing Receiving Assembling Testing Finishing Packing and shipping
Value- vs. Non-value-added Non-value-added Non-value added Value-added Non-value-added Value-added Value-added
(f)
(1) Activity-based costing shows the standard model absorbs about the same overhead per unit as the deluxe model. (2) The comparison of ABC and traditional costing shows that the proper amount of overhead assigned to the two products in this case is close to the equal amounts assigned by traditional costing. In many cases, ABC costing will provide a significant difference as overhead is allocated in a manner that better reflects cause and effect. In some situations, however, traditional costing can be a good approximation.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
17-37
PROBLEM 17-2B
(a) The allocation of total manufacturing overhead using activity-based costing is as follows: Elite Overhead Rate Purchase orders @ $31 Machine setups @ $29 Machine hours @ $31 Inspections @ $89 Total assigned costs (a)
Drivers Used
Cost Assigned
11,250 11,000 40,000 2,750
$ 348,750 319,000 1,240,000 244,750 $2,152,500
Preferred Drivers Cost Used Assigned 13,750 9,000 60,000 2,250
$ 426,250 261,000 1,860,000 200,250 $2,747,500
Units produced (b)
20,000
10,000
Cost per unit (a) ÷ (b)
$107.63
$274.75
Total Overhead $ 775,000 580,000 3,100,000 445,000 $4,900,000
(b) The cost per unit and gross profit of each model under ABC costing were: Direct materials Direct labor Manufacturing overhead Total cost per unit
Elite $ 600.00 100.00 107.63 $ 807.63
Preferred $ 320.00 80.00 274.75 $ 674.75
Sales price per unit Cost per unit Gross profit
$1,400.00 807.63 $ 592.37
$1,100.00 674.75 $ 425.25
(c) Management’s future plans for the two home theater systems are not sound. Under ABC costing, the Elite system is $167.12 per unit more profitable than the Preferred system. If any product should be phased out, it is the Preferred. But, by applying ABC and activity-based management analysis, Kinnard may determine how to reduce the costs of producing the Preferred system.
17-38
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 17-3B
(a) Predetermined overhead rate using materials cost: $550,000 ÷ $500,000 = 110% of materials cost (b) Manufacturing cost per armoire under traditional costing: Direct materials ............................................................... Direct labor...................................................................... Overhead (5,200 X 110%) ............................................... Total cost of 12 armoires ........................................
$
5,200 3,500 5,720 $ 14,420
Cost per armoire ($14,420 ÷ 12) .....................................
$1,201.67
(c) Manufacturing cost per armoire under activity-based costing: Computation of Activity-Based Overhead Rate Activity Cost Pools Purchasing Handling materials Production Setting up machines Inspecting Inventory control Utilities
Estimated Overhead ÷
Total Estimated Drivers
$ 45,000 50,000 130,000 85,000 60,000 80,000 100,000 $550,000
500 Orders 5,000 Moves 65,000 D/L Hours 1,000 Setups 4,000 Inspections 40,000 Components 50,000 Sq. ft.
=
Activity-Based Overhead Rate $90 per order $10 per move $ 2 per D/L hour $85 per setup $15 per inspection $ 2 per component $ 2 per sq. ft.
Assignment of Overhead to Order of 12 armoires Activity Cost Pools
Expected Use of Drivers
Purchasing 3 Orders Handling materials 32 Moves Production 200 D/L Hours Setting up machines 4 Setups Inspecting 20 Inspections Inventory control 640 Components Utilities 320 Sq. ft. Total overhead assigned
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Activity-Based X Overhead Rate = Cost Assigned $90 $10 $ 2 $85 $15 $ 2 $ 2
$ 270 320 400 340 300 1,280 640 $3,550
17-39
PROBLEM 17-3B (Continued) Total manufacturing cost per armoire under ABC: Direct materials ...................................................................... Direct labor ............................................................................. Overhead ................................................................................ Total cost of 12 armoires ...............................................
$
5,200 3,500 3,550 $ 12,250
Total cost per armoire ($12,250 ÷ 12) ...................................
$1,020.83
(d) The difference between the traditional cost and the activity-based cost per unit, $1,201.67 versus $1,020.83, is not great in amount but $180.84 or ($1,201.67 – $1,020.83) is 17.7% of the more correct ABC cost per unit. Activity-based costing is the preferable costing system for setting prices because the real costs are more accurately reflected. The greater accuracy is a result of multiple, more relevant activity cost drivers under ABC than the single cost driver used with the traditional volume-based system.
17-40
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 17-4B
(a) Computation of unit costs—traditional costing Overhead cost per labor hour is $1,150,000 ÷ (30,000 + 20,000) =$23 Products Valley Fresh Merando Valley $1.35 $3.60 0.75 1.50 1.15* 2.30** $3.25 $7.40
Manufacturing Costs Direct materials Direct labor Overhead *$23 X .05 **$23 X .10 (b) Activity Cost Pools Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment
Estimated Overhead
Expected Use of Cost Drivers
$ 146,000 420,000 210,000 140,000
8,000 3,000,000 1,400,000 1,400,000
234,000 $1,150,000
1,040
(c) Activity Cost Pool Grape processing Aging Bottling and corking Labeling and boxing Maintain and inspect equipment Total costs assigned (a) Liters produced
.
Activity-Based Overhead Rates $ 18.25 per cart $ 0.14 per month $ 0.15 per bottle $ 0.10 per bottle $225.00 per inspection
Valley Fresh
Merando Valley
Expected Use of Overhead Cost Drivers X Rates = Assigned 6,000 $ 18.25 $109,500 600,000 $ 0.14 84,000 600,000 $ 0.15 90,000 600,000 $ 0.10 60,000
Expected Use of Overhead Cost Drivers X Rates = Assigned 2,000 $ 18.25 $ 36,500 2,400,000 $ 0.14 336,000 800,000 $ 0.15 120,000 800,000 $ 0.10 80,000
240
$225.00
54,000 $397,500
800
$225.00
180,000 $ 752,500
(b)
600,000
200,000
Overhead cost per gallon [(a) ÷ (b)]
$0.663
$3.763
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
17-41
PROBLEM 17-4B (Continued) (d) Manufacturing Costs Direct materials Direct labor Overhead
(e) To:
Products Valley Fresh Merando Valley $1.350 $3.600 0.750 1.500 0.663 3.763 $2.763 $8.863
Mr. Frankie Merando
From:
Student
Subject:
Product costs using traditional approach versus ABC
The memorandum covers the following points:
17-42
a.
ABC allocates overhead costs as a function of each product’s use of cost drivers. Thus, ABC results in overhead allocation that more closely approximates each product’s generation of overhead costs.
b.
Traditional approaches that allocate costs as a function of volume tend to be biased toward allocating too much overhead to high volume, simple products, and too little to low volume, complex products. This is because the actual incurrence of overhead costs is rarely correlated with labor costs.
c.
In the case of the Merando Corporation, the Merando Valley product required the company to begin using more complex methods and equipment. Overhead costs increased substantially. When overhead costs were allocated using labor rates, too much overhead was allocated to the high volume Valley Fresh product. This reduced the apparent profitability of this product.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 17-4B (Continued) d.
The total cost of the two products under the two approaches was as follows:
Traditional approach ABC
Valley Fresh $3.25
Merando Valley $7.40
$2.763
$8.863
Therefore, the relative profitability of the two products should be determined using ABC costing.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
17-43
PROBLEM 17-5B
(a) Computation of assigned overhead under traditional costing (“direct labor dollars” appears in the first line of the schedule of overhead data): Predetermined overhead rate X direct labor dollars Overhead assigned to corporate: .30 X $900,000 = $270,000 Overhead assigned to individual: .30 X $700,000 = $210,000 (b) 1.
Computation of activity-based overhead rates:
Activity Cost Pool Employee training Typing and secretarial Computing Facility rental Travel
2.
Estimated Overhead ÷
Total Expected Use of Cost Drivers
$120,000 60,000 130,000 100,000 70,000 $480,000
$1,600,000 Direct labor dollars 2,000 Reports/forms 40,000 Minutes 25 Employees Direct
=
$.075 per DL dollar $30 per report/form $3.25 per minute $4,000 per employee Direct
Assignment of overhead to corporate and individual services: Corporate
Activity Cost Pool Employee training Typing and secretarial Computing Facility rental Travel Overhead assigned
17-44
Activity-Based Overhead Rates
.
Individual
Expected Use of Driver
Overhead Rate
Cost Assigned
$900,000 500 17,000 14 48,000
$.075 $30 $3.25 $4,000 Direct
$ 67,500 15,000 55,250 56,000 48,000 $241,750
Kimmel, Accounting, 5e, Solutions Manual
Expected Use of Driver
Overhead Rate
Cost Assigned
$700,000 1,500 23,000 11 22,000
$.075 $30 $3.25 $4,000 Direct
$ 52,500 45,000 74,750 44,000 22,000 $238,250
(For Instructor Use Only)
PROBLEM 17-5B (Continued) (c) Overhead is assigned to the two service lines as follows: Corporate $270,000 241,750 $ 28,250
Traditional costing ABC Difference
Individual $210,000 238,250 ($ 28,250)
ABC allocates $28,250 of overhead that had been assigned to the Corporate department to the Individual department. Since ABC costing usually provides more accurate results, it should be used to determine the relative profitability of each service.
.
Kimmel, Accounting, 5e, Solutions Manual
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17-45
BYP 17-1
DECISION-MAKING AT CURRENT DESIGNS
(a) Directly assigned Remaining amount ($832,000) allocated 50% to each product line Total Number of units Cost assigned per unit
Composite $ 28,000
Rotomolded $ 40,000
$416,000 $444,000 1,000 $ 444.00
$416,000 $456,000 4,000 $ 114.00
Composite $ 28,000
Rotomolded $ 40,000
$374,400* $402,400 1,000 $ 402.40
$457,600** $497,600 4,000 $ 124.40
(b) Directly assigned Remaining amount ($832,000) allocated based on direct labor costs Total Number of units Cost assigned per unit
*Overhead rate = $832,000 ÷ ($234,000 + $286,000) = $160% of direct labor cost Composite: 160% X $234,000 = 374,400. **Using overhead rate calculated in* Rotomolded: 160% X $286,000 = $457,600
17-46
.
Kimmel, Accounting, 5e, Solutions Manual
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BYP 17-1 (Continued) (c) Activity Cost Pools Design Prototypes Molds Supervision Curing time
Estimated Overhead $121,100 152,000 188,500 180,000 190,400
Expected Use of Cost Drivers 4 8 13 24 17,000
Composite Activity Cost Pool Design Prototypes Molds Supervision Curing time Total amount allocated Directly assigned Total cost (a) Number of units (b) Cost assigned per unit (a) ÷ (b)
Activity-Based Overhead Rates $30,275 per model $19,000 per prototype $14,500 per mold $7,500 per employee $11.20 per day Rotomolded
Expected Expected Use of Overhead Cost Use of Overhead Cost Drivers Rates Assigned Drivers Rates Assigned 3 $30,275 $ 90,825 1 $30,275 $ 30,275 6 $19,000 114,000 2 $19,000 38,000 12 $14,500 174,000 1 $14,500 14,500 12 $ 7,500 90,000 12 $ 7,500 90,000 15,000 $ 11.20 168,000 2,000 $ 11.20 22,400 636.825
195,175
28,000 $664,825
40,000 $235,175
÷
1,000
÷
4,000
$ 664.83
$
58.79
(d) Activity based costing assigns significantly more costs to the composite kayaks. Since the cost is divided into pools and each pool is allocated using a cost driver that is related to those particular costs, it provides a more accurate way to allocate the costs. Current Designs would need to weigh the additional costs of implementing an ABC system against the benefits that it provides.
.
Kimmel, Accounting, 5e, Solutions Manual
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17-47
BYP 17-2
DECISION-MAKING ACROSS THE ORGANIZATION
The following activities and cost drivers might be submitted: (a) Activities Laundering Housekeeping Dietary Computing information technology Nursing care Surgery Clinical lab Imaging (X-ray, etc.) Pharmacy Emergency room Maintenance Billing and collecting
17-48
.
(b) Cost Drivers Pounds of linen Square footage; number of beds Number of meals Minutes of computer usage; or number of work stations Number of patients Number of procedures or operations Number of tests Number of images Number of prescriptions Number of cases or patients Square footage Number of invoices
Kimmel, Accounting, 5e, Solutions Manual
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BYP 17-3
MANAGERIAL ANALYSIS
(a) Computation of activity-based overhead rate:
Activity Cost Pools
Total Estimated Overhead ÷
Expected Use of Cost Drivers Per Activity
Market analysis Product design Product development Prototype testing
$1,050,000 2,350,000 3,600,000 1,400,000
15,000 Hours 2,500 Designs 90 Products 500 Tests
=
Activity-Based Overhead Rates $ 70 per hour $ 940 per design $40,000 per product $ 2,800 per test
(b) Charges to in-house manufacturing department: In-House Manufacturing Department
Activity Cost Pools
Activity-Based Cost Drivers Used X Overhead Rates = Cost Assigned
Market analysis 1,800 Hours Product design 280 Designs Product development 10 Products Prototype testing 92 Tests Total overhead assigned
$ 70 $ 940 $40,000 $ 2,800
$ 126,000 263,200 400,000 257,600 $1,046,800
(c) Charges to outside R & D contractor: Outside Contract Costs
Activity Cost Pools
Activity-Based Cost Drivers Used X Overhead Rates = Cost Assigned
Market analysis 800 Hours Product design 178 Designs Product development 3 Products Prototype testing 70 Tests Total overhead assigned
.
Kimmel, Accounting, 5e, Solutions Manual
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$ 70 $ 940 $40,000 $ 2,800
$ 56,000 167,320 120,000 196,000 $539,320
17-49
BYP 17-3 (Continued) (d) Activity-based costing permits the company to identify its R&D costs by the activities that cause the costs; that is, ABC allows closer scrutiny of the causes for cost incurrences; hence, greater control. By charging in-house manufacturing departments for their fair share of the company’s R&D costs, these departments may exert their own control over such costs. Activity-based costing allows Ideal to compile realistic costs for bidding and charging outside users of its R&D department’s services.
17-50
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
BYP 17-4
REAL-WORLD FOCUS
(a) Some of the benefits of ABC for the financial services industry include: Identification of the most profitable customers More accurate product and service pricing Increased product profitability Well-organized process costs (b) Three things that the company’s original costing method did not take into account were: (1) The same servicing and administrative expenses were applied equally to all accounts, including fixed and adjustable rate mortgages. (2) No consideration was given to “seasoning”, that is, the amount of time a loan had been on the books. (3) It did not take credit quality into account. (c) Some of the cost drivers used under the new approach were: Average number of accounts that were at least 60 days delinquent. Average number of accounts outstanding. Average number of bankrupt accounts plus the average number of real estate owned accounts.
.
Kimmel, Accounting, 5e, Solutions Manual
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17-51
BYP 17-5
REAL-WORLD FOCUS
(a) According to the authors, “ABC loses power in large-scale operations, and can be difficult to implement and maintain.” They suggest, though, that ABC should not be abandoned but, rather, improved because it provides many potential benefits. They cite as benefits that ABC “has helped many companies identify important cost- and profit-enhancement opportunities through repricing of unprofitable customer relationships, process improvement on the shop floor, lower-cost product designs, and rationalized product variety.” (b) One way to estimate practical capacity is to simply use a rule of thumb, such as practical capacity is 80 to 85% of theoretical capacity. The authors suggest that estimates for people be put at the lower end of the range and for machines at the upper end of the range. A more systematic approach would be to review past activity levels during a month where a high level of orders was processed with a high degree of success. The authors say that it is not important to be extremely precise, as long as you are within 5 to 10% of the actual number. (c) After practical capacity is determined in terms of total time available, the cost per unit of time is determined by dividing the total cost of that capacity by the total capacity in units of time. This results in a cost per unit of time. Next, managers determine the amount of time it takes to carry out each type of activity. Then the cost per time unit can be multiplied by the time it takes to perform each activity so that the cost of the activity is determined. This then enables the company to assign costs to the activities performed for specific customers or in making specific products.
17-52
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BYP 17-5 (Continued) (d) One of the primary benefits of the report provided by “ABC, the TimeDriven Way” is that it highlights the difference between capacity supplied and capacity used. This enables management to evaluate its effectiveness in its use of the company’s resources and to evaluate decisions regarding increasing or decreasing capacity. As an example, the authors discuss the experience of Lewis-Goetz, a hose and belt fabricator. It found that one of its plants was operating at only 27% of capacity. It was able to use this information in making decisions regarding how it planned to meet the production requirements of a very large order it was anticipating for later in the year.
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
17-53
BYP 17-6
ETHICS CASE
(a) The stakeholders (parties affected by Curtis’s and Ed’s actions) in this case are: • Curtis as cost accountant. • Ed and all personnel employed in the production of the Supercut Model of lawn tractor. • Hi-Power Mower management. • Hi-Power Mower owners (stockholders). • The stakeholder group may be expanded to include Hi-Power Mower’s suppliers and customers. (b) The objective of cost accounting is to provide useful, accurate information for decision making by managers. Ed is coercing Curtis to massage the data to save the product line and, thus, Ed’s job. Ed is advocating knowingly providing false data, deceiving management, and jeopardizing Curtis’s job. (c) Curtis is a management accountant employed by Hi-Power Mower Company. His first job responsibility is to his employer to: (1) communicate information fairly and objectively and (2) disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented. Curtis’s obligation is to provide management with timely, truthful information.
17-54
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BYP 17-7
ALL ABOUT YOU
(a) The three main tools for time management for students are: Term calendar—records quizzes, exams, project due dates and other major events. Weekly schedule—records your scheduled time for learning for each course. Daily to do list—lists the tasks that must be accomplished each day in order to identify priorities. (b) Studies show that students are most inclined to waste time during the morning and afternoon. Your brain is best prepared for learning during day-light hours. Therefore, it is important to schedule your time so that you tackle your most difficult topics during daylight hours. (c) Many students resent time management practices because they think they will be constraining. In fact, time management practices can be liberating because they help you to get control of your life so that you have more time to devote to those things that are really important to you. (d) Goal setting is important because if you have clearly defined goals you will be more likely to accomplish those things that are important to you. Good goals are clearly defined, with as much detail as possible. They also should be realistic. To help you develop your goals, you should discuss your goals and objectives with a mentor or advisor.
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17-55
BYP 17-8
CONSIDERING YOUR COSTS AND BENEFITS
Discussion guide: In part, the response to this question depends on how broadly you apply the term “value-added activity” when looking at one’s life. For example, some value-added activities relate to goals and objectives for school and work. It is important to try to manage your time effectively to maximize your chance of achieving these objectives. But it is also important to identify the other things in life that are important. These would include time with friends, family, your health, and hobbies and activities that you value. When identifying personal value-added activities, it is important to identify all the things, school-related and otherwise, that matter most to you. In applying the activity-based concepts that you learned in this chapter to your life, try to eliminate the non-value-added activities that reduce your ability to focus on those aspects of life that are really important to you.
17-56
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Kimmel, Accounting, 5e, Solutions Manual
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CHAPTER 18 Cost-Volume-Profit ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Questions
Brief Exercises
Do It!
Exercises
1.
Distinguish between variable and fixed costs.
1, 2, 3, 6
1
1
1, 2, 3, 4, 5, 6
2.
Explain the significance of the relevant range.
4, 5
2
3.
Explain the concept of mixed costs.
6, 7, 8
1, 3, 4, 5
4.
List the five components of cost-volume-profit analysis.
9
5.
Indicate what contribution margin is and how it can be expressed.
10, 11, 17
6, 7
6.
Identify the three ways to determine the break-even point.
12, 13, 14
8, 9
7.
Give the formulas for determining sales required to earn target net income.
16
8.
Define margin of safety, and give the formulas for computing it.
15
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Kimmel, Accounting, 5e, Solutions Manual
A Problems
B Problems
1A, 6A
1B, 6B
1A
1B
8, 9, 10, 11, 12, 13, 17
1A, 2A, 3A, 4A, 5A, 6A
1B, 2B, 3B, 4B, 5B, 6B
3, 4
8, 9, 10, 11, 12, 13, 14, 16, 17
1A, 2A, 3A, 4A, 5A
1B, 2B, 3B, 4B, 5B
10, 12
4
14, 15, 17
2A, 5A, 6A
2B, 5B, 6B
11
4
16, 17
2A, 4A, 5A, 6A
2B, 4B, 5B, 6B
2
1, 2
1, 3, 4, 5, 6 7
(For Instructor Use Only)
18-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Determine variable and fixed costs, compute break-even point, prepare a CVP graph, and determine net income.
Simple
20–30
2A
Prepare a CVP income statement, compute break-even point, contribution margin ratio, margin of safety ratio, and sales for target net income.
Moderate
30–40
3A
Compute break-even point under alternative courses of action.
Simple
20–30
4A
Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.
Moderate
20–30
5A
Compute contribution margin, fixed costs, break-even point, sales for target net income, and margin of safety ratio.
Moderate
20–30
6A
Determine contribution margin ratio, break-even point, and margin of safety.
Moderate
20–30
1B
Determine variable and fixed costs, compute break-even point, prepare a CVP graph, and determine net income.
Simple
20–30
2B
Prepare a CVP income statement, compute break-even point, contribution margin ratio, margin of safety ratio, and sales for target net income.
Moderate
30–40
3B
Compute break-even point under alternative courses of action.
Simple
20–30
4B
Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.
Moderate
20–30
5B
Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.
Moderate
20–30
6B
Determine contribution margin ratio, break-even point, and margin of safety.
Moderate
20–30
18-2
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Kimmel, Accounting, 5e, Solutions Manual
Learning Objective * 1. Distinguish between variable and fixed costs.
Knowledge Comprehension E18-4
Application
Analysis
(For Instructor Use Only)
Q18-1 Q18-2 Q18-3 Q18-6
BE18- E18-5 1 E18-1 E18-2 DI18-1
E18-3 E18-6 P18-1A P18-1B
* 2. Explain the significance of the relevant range.
Q18-4 Q18-5
E18-2
BE18-2
* 3. Explain the concept of mixed costs. E18-4 E18-5
Q18-6 Q18-7 BE18-1
* 4. List the five components of cost-volume-profit analysis.
Q18-9
E18-7
DI18-1 Q18-8 E18-1 BE18-4 BE18-5
DI18-2 E18-5 E18-6
BE18-3 E18-3 P18-1A
Synthesis
Evaluation P18-6A P18-6B
P18-1B
* 5. Indicate what contribution margin is and how it can be expressed.
Q18-10
Q18-11 Q18-17 BE18-6 BE18-7 E18-8 E18-9
E18-10 E18-11 E18-12 E18-13 E18-17
BE18-6 P18-1A P18-2A P18-1B P18-2B
P18-3A P18-3B P18-4A P18-5A P18-6A P18-4B
* 6. Identify the three ways to determine the break-even point.
Q18-12 Q18-14
Q18-13 BE18-8 BE18-9 DI18-3 DI18-4 E18-8 E18-9
E18-10 E18-11 E18-12 E18-13 E18-14 E18-17
E18-16 P18-1A P18-2A P18-1B P18-2B
P18-3A P18-4A P18-3B P18-4B P18-5A P18-5B
* 7. Give the formulas for determining sales required to earn target net income.
Q18-16 BE18-10 BE18-12 DI18-4
E18-12 P18-2A E18-14 P18-2B E18-15 E18-17
P18-5A P18-6A P18-5B P18-6B
* 8. Define margin of safety, and give the formulas for computing it.
Q18-15 BE18-11 DI18-4
E18-17 E18-16 P18-2A P18-2B
BYP18-4
BYP18-1 BYP18-2
Broadening Your Perspective
BYP18-6
P18-5A P18-5B
P18-4A P18-6A P18-4B
18-3
BYP18-5 BYP18-3 BYP18-7 BYP18-8
P18-5B P18-6B
P18-6B
BLOOM’ S TAXONOMY TABLE
.
Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
ANSWERS TO QUESTIONS 1.
(a) Cost behavior analysis is the study of how specific costs respond to changes in the level of activity within a company. (b) Cost behavior analysis is important to management in planning business operations and in deciding between alternative courses of action.
2.
(a) The activity index identifies the activity that causes changes in the behavior of costs. Once the index is determined, it is possible to classify the behavior of costs in response to changes in activity levels into three categories: variable, fixed, or mixed. (b) Variable costs may be defined in total or on a per-unit basis. Variable costs in total vary directly and proportionately with changes in the activity level. Variable costs per unit remain the same at every level of activity.
3.
Fixed costs remain the same in total regardless of changes in the activity level. In contrast, fixed costs per unit vary inversely with activity. As volume increases, fixed costs per unit decline and vice versa.
4.
(a) The relevant range is the range of activity over which a company expects to operate during the year. (b) Disagree. The behavior of both fixed and variable costs are linear only over a certain range of activity. CVP analysis is based on the assumption that both fixed and variable costs remain linear within the relevant range.
5.
This is true. Most companies operate within the relevant range. Within this range, it is possible to establish a linear (straight-line) relationship for both variable and fixed costs. If a relevant range cannot be established, segregation of costs into fixed and variable becomes extremely difficult.
6.
Apartment rent is fixed because the cost per month remains the same regardless of how much Adam uses the apartment. Rent on a Hertz rental truck is a mixed cost because the cost usually includes a per day charge (a fixed cost) plus an activity charge based on miles driven (a variable cost).
7.
For CVP analysis, mixed costs must be classified into their fixed and variable elements. One approach to the classification of mixed costs is the high-low method.
8.
Variable cost per unit is $1.30, or [($165,000 – $100,000) ÷ (90,000 – 40,000)]. At any level of activity, fixed costs are $48,000 per month [$165,000 – (90,000 X $1.30)].
9.
No. Only two of the basic components of cost-volume-profit (CVP) analysis, unit selling prices and variable cost per unit, relate to unit data. The other components, volume, total fixed costs, and sales mix, are not based on per-unit amounts.
10.
There is no truth in Faye’s statement. Contribution margin is sales less variable costs. It is the revenue that remains to cover fixed costs and to produce income (profit) for the company.
11.
Contribution margin is $14 ($40 – $26). The contribution margin ratio is 35% ($14 ÷ $40).
18-4
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Questions Chapter 18 (Continued) 12.
Disagree. Knowledge of the break-even point is useful to management in deciding whether to introduce new product lines, change sales prices on established products, and enter new market areas.
13.
$26,000 ÷ 25% = $104,000
14.
(a) The break-even point involves the plotting of three lines over the full range of activity: the total revenue line, the total fixed cost line, and the total cost line. The break-even point is determined at the intersection of the total revenue and total cost lines. (b) The break-even point in units is obtained by drawing a vertical line from the break-even point to the horizontal axis. The break-even point in sales dollars is obtained by drawing a horizontal line from the break-even point to the vertical axis.
15.
Margin of safety is the difference between actual or expected sales and sales at the break-even point. 1,250 X $12 = $15,000; $15,000 – $13,200 = $1,800; $1,800 ÷ $15,000 = 12%.
16.
At break-even sales, the contribution margin is equal to the fixed costs. The contribution margin ratio is: $180,000 $500,000
= 36%
The sales volume to achieve net income of $90,000 is as follows:
$180,000 + $90,000 .36
= $750,000
17.
PACE COMPANY CVP Income Statement Sales ................................................................................................. Variable expenses Cost of goods sold ($600,000 X .70) .......................................... Operating expenses ($200,000 X .70)........................................ Total variable expenses ..................................................... Contribution margin ...........................................................................
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Kimmel, Accounting, 5e, Solutions Manual
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$900,000 $420,000 140,000 560,000 $340,000
18-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 18-1 Indirect labor is a variable cost because it increases in total directly and proportionately with the change in the activity level. Supervisory salaries is a fixed cost because it remains the same in total regardless of changes in the activity level. Maintenance is a mixed cost because it increases in total but not proportionately with changes in the activity level.
BRIEF EXERCISE 18-2 VARIABLE COST Relevant Range $10,000
$10,000
8,000
8,000
6,000
6,000
4,000
4,000
2,000
2,000 0
20
40
60
80 100
Activity Level
18-6
FIXED COST Relevant Range
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Kimmel, Accounting, 5e, Solutions Manual
0
20
40
60
80 100
Activity Level
(For Instructor Use Only)
BRIEF EXERCISE 18-3
$60,000 Total Cost Line
COST
45,000
Variable Cost Element
30,000
15,000 Fixed Cost Element 0
500
1,000
1,500
2,000
2,500
Direct Labor Hours
BRIEF EXERCISE 18-4 High Low Difference $15,000 – $13,500 = $1,500 8,500 – 7,500 = 1,000 $1,500 ÷ 1,000 = $1.50—Variable cost per mile.
Total cost Less: Variable costs 8,500 X $1.50 7,500 X $1.50 Total fixed costs
High $15,000
Low $13,500
12,750 $ 2,250
11,250 $ 2,250
The mixed cost is $2,250 plus $1.50 per mile.
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18-7
BRIEF EXERCISE 18-5 High Low Difference $66,100 – $32,000 = $34,100 40,000 – 18,000 = 22,000 $34,100 ÷ 22,000
= $1.55 per unit.
Total cost Less: Variable costs 40,000 X $1.55 18,000 X $1.55 Total fixed costs
Activity Level High Low $66,100 $32,000 62,000 000,000 $ 4,100
27,900 $ 4,100
BRIEF EXERCISE 18-6 1.
(a) (b)
$288 = ($640 – $352) 45% ($288 ÷ $640)
2.
(c) (d)
$207 = ($300 – $93) 31% ($93 ÷ $300)
3.
(e) (f)
$1,300 = ($325 ÷ 25%) $975 ($1,300 – $325)
BRIEF EXERCISE 18-7 RADIAL INC. CVP Income Statement For the Quarter Ended March 31, 2014 Sales .................................................................................. Variable costs ($920,000 + $70,000 + $86,000) ............... Contribution margin ......................................................... Fixed costs ($440,000 + $45,000 + $98,000) .................... Net income ........................................................................
18-8
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$2,400,000 1,076,000 1,324,000 583,000 $ 741,000
BRIEF EXERCISE 18-8 (a) $520Q – $286Q – $163,800 = $0 $234Q = $163,800 Q = 700 units (b) Contribution margin per unit $234, or ($520 – $286) X = $163,800 ÷ $234 X = 700 units BRIEF EXERCISE 18-9 Contribution margin ratio = [($300,000 – $180,000) ÷ $300,000] = 40% Required sales in dollars = $170,000 ÷ 40% = $425,000
BRIEF EXERCISE 18-10 If variable costs are 70% of sales, the contribution margin ratio is ($1 – $0.70) ÷ $1 = .30. Required sales in dollars = ($195,000 + $75,000) ÷ .30 = $900,000 BRIEF EXERCISE 18-11 Margin of safety = $1,000,000 – $840,000 = $160,000 Margin of safety ratio = $160,000 ÷ $1,000,000 = 16% BRIEF EXERCISE 18-12 Contribution margin per unit $1.60 is ($6.00 – $4.40) Required sales in units = ($480,000 + $1,500,000) ÷ $1.60 = 1,237,500.
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Kimmel, Accounting, 5e, Solutions Manual
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18-9
SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 18-1 Variable costs: Indirect labor, direct labor, and direct materials. Fixed costs: Property taxes and depreciation. Mixed costs: Utilities and maintenance. DO IT! 18-2 ($18,580 – $16,200) ÷ (10,500 – 8,800) = $1.40 per unit $18,580 – ($1.40 X 10,500 units) = $3,880 or $16,200 – ($1.40 X 8,800) = $3,880
(a)
Variable cost: Fixed cost:
(b)
Total cost to produce 9,200 units: $3,880 + ($1.40 X 9,200) = $16,760
DO IT! 18-3 (a)
The formula is $250Q – $170Q – $140,000 = 0. Therefore, 80Q = $140,000, and the breakeven point in units is 1,750 ($140,000 ÷ $80).
(b)
The contribution margin per unit is $80 ($250 – $170). The formula therefore is $140,000 ÷ $80, and the breakeven point in units is 1,750.
DO IT! 18-4 (a)
18-10
CM per unit = Unit selling price – Unit variable costs $12 = $30 – $18 CM ratio = CM per unit/Unit selling price 40% = $12/$30 Break-even point in dollars = Fixed costs ÷ Contribution margin ratio = $220,000 ÷ 40% = $550,000
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DO IT! 18-4 (Continued) (b)
Margin of safety
Actual sales – Break-even sales Actual sales $800,000 – $550,000 = $800,000 =
= (c)
.
31.25%
Sales – Variable costs – Fixed costs = Net income $30Q – $18Q = $220,000 + $140,000 $12Q = $360,000 Q = 30,000 units 30,000 units X $30 = $900,000 required sales
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
18-11
SOLUTIONS TO EXERCISES EXERCISE 18-1 (a) The determination as to whether a cost is variable, fixed, or mixed can be made by comparing the cost in total and on a per-unit basis at two different levels of production. Variable Costs Fixed Costs Mixed Costs
Vary in total but remain constant on a per-unit basis. Remain constant in total but vary on a per-unit basis. Contain both a fixed element and a variable element. Vary both in total and on a per-unit basis.
(b) Using these criteria as a guideline, the classification is as follows: Direct materials Direct labor Utilities
Variable Variable Mixed
Rent Maintenance Supervisory salaries
EXERCISE 18-2 (a)
18-12
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Fixed Mixed Fixed
EXERCISE 18-2 (Continued) (b) The relevant range is 3,000 – 8,000 units of output since a straight-line relationship exists for both direct materials and rent within this range. (c)
Variable cost per unit Within the relevant range (3,000 – 8,000 units)
= =
Cost Units $15,000* 5,000*
=
$3 per unit
*Any costs and units within the relevant range could have been used to calculate the same unit cost of $3. (d) Fixed cost within the relevant range (3,000 – 8,000 units)
=
$8,000
EXERCISE 18-3 (a) Maintenance Costs:
$4,900 – $2,500 $2,400 = = $6 variable cost per machine hour 700 – 300 400
Total costs Less: Variable costs 700 X $6 300 X $6 Total fixed costs
700 Machine Hours $4,900
300 Machine Hours $2,500
4,200 $ 700
1,800 $ 700
Thus, maintenance costs are $700 per month plus $6 per machine hour.
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18-13
EXERCISE 18-3 (Continued) (b)
$5,000 Total Cost Line
$4,900
COSTS
$4,000
$3,000 Variable Cost Element $2,000
$1,000 $ 700 Fixed Cost Element 0 100 200 300 400 500 600 700 Machine Hours
EXERCISE 18-4 1. Wood used in the production of furniture. 2. Fuel used in delivery trucks. 3. Straight-line depreciation on factory building. 4. Screws used in the production of furniture. 5. Sales staff salaries. 6. Sales commissions. 7. Property taxes. 8. Insurance on buildings. 9. Hourly wages of furniture craftsmen. 10. Salaries of factory supervisors. 11. Utilities expense. 12. Telephone bill.
18-14
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Kimmel, Accounting, 5e, Solutions Manual
Variable. Variable. Fixed. Variable. Fixed. Variable. Fixed. Fixed. Variable. Fixed. Mixed. Mixed.
(For Instructor Use Only)
EXERCISE 18-5 (a) Maintenance Costs:
$5,000 – $2,750 $2,250 = $.50 variable cost per machine hour = 8,000 – 3,500 4,500 Activity Level Total cost Less: Variable costs 8,000 X $.50 3,500 X $.50 Total fixed costs
High $5,000
Low $2,750
4,000 00,000 $1,000
1,750 $1,000
Thus, maintenance costs are $1,000 per month plus $.50 per machine hour. (b)
$5,000 Total Cost Line
COSTS
$4,000
Variable Cost Element
$3,000
$2,000
$1,000 Fixed Cost Element 0
2,000
4,000
6,000
8,000
Machine Hours
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18-15
EXERCISE 18-6 (a)
(b)
Cost Direct materials Direct labor Utilities Property taxes Indirect labor Supervisory salaries Maintenance Depreciation
Fixed
Variable X X
Mixed X
X X X X X
Fixed costs
= $1,000 + $1,900 + $2,400 + $300 + $200 = $5,800
Variable costs to produce 3,000 units = $7,500 + $18,000 + $4,500 = $30,000 Variable cost per unit
= $30,000/3,000 units = $10 per unit
Variable cost portion of mixed cost
= Total cost – Fixed portion
Utilities: Variable cost to produce 3,000 units = $2,100 – $300 = $1,800 Variable cost per unit
= $1,800/3,000 units = $.60 per unit
Maintenance: Variable cost to produce 3,000 units = $1,100 – $200 = $900 Variable cost per unit
= $900/3,000 units = $.30 per unit
Cost to produce 5,000 units = (Variable costs per + Fixed cost unit X 5,000 units) = (($10 + $.60 + $.30) X 5,000) + $5,800 = $54,500 + $5,800 = $60,300 18-16
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 18-7 MEMO To:
Jim Taylor
From:
Student
Re:
Assumptions underlying CVP analysis
CVP analysis is a useful tool in analyzing the effects of changes in costs and volume on a company’s profits. However, there are some assumptions which underline CVP analysis. When these assumptions are not valid, the results of CVP analysis may be inaccurate. The five assumptions are: 1. The behavior of both costs and revenues is linear throughout the relevant range of the activity index. 2. All costs can be classified accurately as either fixed or variable. 3. Changes in activity are the only factors that affect costs. 4. All units produced are sold. 5. When more than one type of product is sold, the sales mix will remain constant. If you want further explanation of any of these assumptions, please contact me. EXERCISE 18-8 (a) Contribution margin per lawn
=
$60 – ($12 + $10 + $2)
Contribution margin per lawn
=
$36
Contribution margin ratio
=
$36 ÷ $60 = 60%
Fixed costs = $1,400 + $200 + $2,000 = $3,600 Break-even point in lawns = $3,600 ÷ $36 = 100 (b) Break-even point in dollars = 100 lawns X $60 per lawn = $6,000 per month OR Fixed costs ÷ Contribution margin ratio = $3,600 ÷ .60 = $6,000 per month
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Kimmel, Accounting, 5e, Solutions Manual
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18-17
EXERCISE 18-9 1.
Contribution margin per room
=
$60 – ($11 + $28)
Contribution margin per room
=
$21
Contribution margin ratio
=
$21 ÷ $60 = 35%
Fixed costs = $6,200 + $1,100 + $1,000 + $100 = $8,400 Break-even point in rooms = $8,400 ÷ $21 = 400 2.
Break-even point in dollars
= 400 rooms X $60 per room = $24,000 per month
OR Fixed costs ÷ Contribution margin ratio = $8,400 ÷ .35 = $24,000 per month EXERCISE 18-10 (a) Contribution margin in dollars: Sales = 560 X $120 =
$67,200 Variable costs = $67,200 X .60 = 40,320 Contribution margin $26,880
Contribution margin per unit: Contribution margin ratio:
(b) Break-even sales in dollars: Break-even sales in units:
18-18
.
$120 – $72 ($120 X 60%) = $48. $48 ÷ $120 = 40%.
$21,024 = $52,560. 40% $21,024 = 438. $48
Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 18-11 (a) 1. Contribution margin ratio is: $27,000 = 75% $36,000 Break-even point in dollars = 2. Round-trip fare =
$15,000 = $20,000 75%
$36,000 = $25 1,440 fares
Break-even point in fares = $20,000 = 800 fares $25 (b) At the break-even point fixed costs and contribution margin are equal. Therefore, the contribution margin at the break-even point would be $15,000. EXERCISE 18-12 (a) Unit contribution margin =
=
Fixed costs Break-even sales in units
$112,000 ($350,000 ÷ $5)
= $1.60 Variable cost per unit
= Unit selling price – Unit contribution margin = $5.00 – $1.60 = $3.40
OR = 70,000 X $5.00 = 70,000X + $112,000 = where X = Variable cost per unit = Variable cost per unit = $3.40 Contribution margin ratio = $1.60 ÷ $5.00 = 32%
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18-19
EXERCISE 18-12 (Continued) (b) Fixed costs ÷ Contribution margin ratio = Break-even sales in dollars Fixed costs ÷ .32 = $420,000 = $134,400 ($420,000 X.32) Since fixed costs were $112,000 in 2013, the increase in 2014 is $22,400 ($134,400 – $112,000). EXERCISE 18-13 (a)
CANNES COMPANY CVP Income Statement For the Month Ended September 30, 2014 Sales (600 video game consoles) .................. Variable costs ................................................. Contribution margin ....................................... Fixed costs ...................................................... Net income ......................................................
(b)
Per Unit $400 275 $125
Sales = Variable costs + Fixed costs $400X = $275X + $52,000 $125X = 52,000 X = 416 units
(c)
CANNES COMPANY CVP Income Statement For the Month Ended September 30, 2014
Sales (416 video game consoles)................... Variable costs .................................................. Contribution margin ........................................ Fixed costs ...................................................... Net income .......................................................
18-20
Total $240,000 165,000 75,000 52,000 $ 23,000
.
Kimmel, Accounting, 5e, Solutions Manual
Total $166,400 114,400 52,000 52,000 $ –0–
(For Instructor Use Only)
Per Unit $400 275 $125
EXERCISE 18-14 (a) Units sold in 2013 =
$570,000 + $210,000 = 13,000 units $150 – $90
(b) Units needed in 2014 =
$570,000 + $262,000 * = 13,867 units (rounded) $150 – $90
*$210,000 + $52,000 = $262,000
(c)
$570,000 + $262,000 = 13,000 units, where X = new selling price X – $90 $832,000 = 13,000X – $1,170,000 $2,002,000 = 13,000X X = $154
EXERCISE 18-15 1.
Unit sales price = $400,000 ÷ 5,000 units = $80 Increase selling price to $88, or ($80 X 110%). Net income = $440,000 – $210,000 – $90,000 = $140,000.
2.
Reduce variable costs to 45% of sales. Net income = $400,000 – $180,000 – $90,000 = $130,000.
Alternative 1, increasing selling price, will produce the highest net income.
.
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18-21
EXERCISE 18-16 (a)
$3,200
Sales Line
2,800
DOLLARS (000)
2,400
Total Cost Line
Break-even Point
2,000 1,600 1,200 800 Fixed Cost Line 400 100 200 300 400 500 600 700 800 Number of Units (in thousands)
(b) 1.
Break-even sales in units: $4X = $2.50X + $600,000 $1.50X = $600,000 X = 400,000 units
2.
Break-even sales in dollars: X = .625X + $600,000 .375X = $600,000 X = $1,600,000 or $600,000 ÷ 37.5%
(c) 1. 2.
18-22
Margin of safety in dollars: $2,000,000 – $1,600,000 = $400,000 Margin of safety ratio: $400,000 ÷ $2,000,000 = 20%
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EXERCISE 18-17 (a) Contribution ratio = Contribution margin ÷ Sales ($40 – $16) ÷ $40 = 60% (b) Break-even in dollars: $19,500 ÷ 60% = $32,500 (c) Margin of safety = (2,600 X $40) – $32,500 = $71,500 $71,500 ÷ $104,000 = 68.75% (d) Current contribution margin $40 – $16 = $24 Total contribution margin is $24 X 2,600 = $62,400 30% increase in contribution margin is $62,400 X 30% = $18,720 Total increase in sales required: $18,720 ÷ 60% = $31,200
.
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18-23
SOLUTIONS TO PROBLEMS PROBLEM 18-1A (a) Variable costs (per haircut) Barbers’ commission Barber supplies Utilities Total variable cost per haircut
$4.50 .30 .20 $5.00
(b) $10.00X = $5.00X + $6,000 $ 5.00X = $6,000 X = 1,200 haircuts
DOLLARS (000)
(c)
Fixed costs (per month) Barbers’ salaries Manager’s extra salary Advertising Rent Utilities Magazines Total fixed
1,200 haircuts X $10 = $12,000
18
Sales Line
15
Total Cost Line Break-even Point
12 9 6
Fixed Cost Line
3
300
600
900 1,200 1,500 1,800
Number of Haircuts
(d) Net income = $17,000 – [($5.00 X 1,700) + $6,000] = $2,500
18-24
$4,000 500 200 1,100 175 25 $6,000
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PROBLEM 18-2A (a)
JORGE COMPANY CVP Income Statement (Estimated) For the Year Ending December 31, 2014 Sales .............................................................. Variable expenses Cost of goods sold ................................ Selling expenses ................................... Administrative expenses ...................... Total variable expenses ................ Contribution margin ..................................... Fixed expenses Cost of goods sold ................................ Selling expenses ................................... Administrative expenses ...................... Total fixed expenses ..................... Net income ....................................................
$1,800,000 $1,170,000 * 70,000 20,000 1,260,000 540,000 280,000 65,000 60,000 405,000 $ 135,000
*Direct materials $430,000 + direct labor $360,000 + variable manufacturing overhead $380,000. (b) Variable costs = 70% of sales ($1,260,000 ÷ $1,800,000) or $.35 per bottle ($.50 X 70%). Total fixed costs = $405,000. 1.
$.50X = $.35X + $405,000 $.15X = $405,000 X = 2,700,000 units
2.
2,700,000 X $.50 = $1,350,000
(c) Contribution margin ratio = ($.50 – $.35) ÷ $.50 = 30% (or 1 – .70) Margin of safety ratio
= ($1,800,000 – $1,350,000) ÷ $1,800,000 = 25%
(d) Required sales X=
.
$405,000 + $180,000 = $1,950,000 .30
Kimmel, Accounting, 5e, Solutions Manual
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18-25
PROBLEM 18-3A
(a) Sales were $2,500,000, variable expenses were $1,700,000 (68% of sales), and fixed expenses were $900,000. Therefore, the break-even point in dollars is:
$900,000 = $2,812,500 .32 (b) 1.
The effect of this alternative is to increase the selling price per unit to $6 ($5 X 120%). Total sales become $3,000,000 (500,000 X $6). Thus, the contribution margin ratio changes to 43% [($3,000,000 – $1,700,000) ÷ $3,000,000]. The new break-even point is:
$900,000 = $2,093,023 (rounded) .43 2.
The effects of this alternative are to change total fixed costs to $810,000 ($900,000 – $90,000) and to change the contribution margin to 27% [($2,500,000 – $1,700,000 – $125,000) ÷ $2,500,000]. The new break-even point is:
$810,000 = $3,000,000 .27 Alternative 1 is the recommended course of action because it has a lower break-even point.
18-26
.
Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 18-4A
(a) Current break-even point: $40X = $24X + $270,000 (where X = pairs of shoes) $16X = $270,000 X = 16,875 pairs of shoes New break-even point:
$38X = $24X + ($270,000 + $24,000) $14X = $294,000 X = 21,000 pairs of shoes
(b) Current margin of safety ratio =
(20,000 X $40) – (16,875 X $40) (20,000 X $40)
= 16% (rounded)
New margin of safety ratio
=
(24,000 X $38) – (21,000 X $38) (24,000 X $38)
= 13% (rounded) (c)
BARGAIN SHOE STORE CVP Income Statement
Sales (20,000 X $40) Variable expenses (20,000 X $24) Contribution margin Fixed expenses Net income
Current
New
$800,000 480,000 320,000 270,000 $ 50,000
$912,000 576,000 336,000 294,000 $ 42,000
(24,000 X $38) (24,000 X $24)
The proposed changes will raise the break-even point 4,125 units. This is a significant increase. Margin of safety is 3% lower and net income is $8,000 lower. The recommendation is to not accept the proposed changes.
.
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18-27
PROBLEM 18-5A
(a) (1) Sales
Current Year $1,500,000
Variable costs Direct materials Direct labor Manufacturing overhead ($350,000 X .70) Selling expenses ($250,000 X .40) Administrative expenses ($270,000 X .20) Total variable costs Contribution margin
511,000 290,000 245,000 100,000 54,000 1,200,000 $ 300,000
Sales
Current Year $1,500,000 X 1.1
Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin
511,000 290,000 245,000 100,000 54,000 1,200,000 $ 300,000
Projected Year $1,650,000
X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1
562,100 319,000 269,500 110,000 59,400 1,320,000 $ 330,000
(2) Fixed Costs Current Year Manufacturing overhead ($350,000 X .30) $105,000 Selling expenses ($250,000 X .60) 150,000 Administrative expenses ($270,000 X .80) 216,000 Total fixed costs $471,000
18-28
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Projected year $105,000 150,000 216,000 $471,000
PROBLEM 18-5A (Continued) (b) Unit selling price = $1,500,000 ÷ 100,000 = $15 Unit variable cost = $1,200,000 ÷ 100,000 = $12 Unit contribution margin = $15 – $12 = $3 Contribution margin ratio = $3 ÷ $15 = .20 Break-even point in units = Fixed costs ÷ Unit contribution margin 157,000 units = $471,000 ÷ $3 Break-even point in dollars = Fixed costs ÷ Contribution margin ratio $2,355,000 = $471,000 ÷ .20
(c) Sales dollars required for = (Fixed costs + Target net income) ÷ Contribution margin ratio target net income $3,355,000
=
($471,000
+
$200,000)
÷
.20
(d) Margin of safety = (Expected sales – Break-even sales) ÷ Expected sales ratio 29.8%
.
=
($3,355,000
Kimmel, Accounting, 5e, Solutions Manual
–
$2,355,000)
(For Instructor Use Only)
÷
$3,355,000
18-29
PROBLEM 18-6A
(a) 1.
Let variable selling and administrative expenses = VSA Sales – Variable cost of goods sold – VSA = Contribution Margin $1,200,000 – ($400,000 + $500,000 + $50,000 + VSA) = $180,000 VSA = $70,000
2.
Let fixed manufacturing overhead = FMO Sales – Variable cost of goods sold – FMO = Gross profit $1,200,000 – ($400,000 + $500,000 + $50,000 + FMO) = $180,000 FMO = $70,000
3.
Let fixed selling and administrative expenses = FSA Contribution margin ratio = $180,000 ÷ $1,200,000 = 15% Contribution margin at break-even = $1,300,000 X 15% = $195,000 At break-even, Contribution margin = Fixed costs (FSA + FMO) $195,000 = FSA + $70,000 FSA = $125,000
(b) Incremental sales = $1,200,000 X 25% = $300,000 Incremental contribution margin = $300,000 X 15% = $45,000 The maximum increased advertising expenditure would be equal to the incremental contribution margin earned on the increased sales, which is $45,000. The other fixed costs are irrelevant to this decision, because they would be incurred whether or not the advertising expenditure is increased.
18-30
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PROBLEM 18-1B
(a) Variable costs (per haircut) Barbers’ commission $3.00 Rent .60 Barber supplies .40 Total variable $4.00
Fixed costs (per month) Barbers’ salaries $7,500* Rent 700 Depreciation 400 Utilities 300 Advertising 100 Total fixed $9,000 *($1,500 X 3) + $3,000
(b) $10X = $4X + $9,000 $6X = $9,000 X = 1,500 haircuts
(c)
1,500 haircuts X $10 = $15,000
Break-even Point
18
Total Cost Line
15
DOLLARS (000)
Sales Line
12 Fixed Cost Line
9 6 3
300
600
900
1,200 1,500 1,800
Number of Haircuts
(d) Net income = $18,000 – [($4.00 X 1,800) + $9,000] = $1,800
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18-31
PROBLEM 18-2B (a)
ALL FRUTE COMPANY CVP Income Statement (Estimated) For the Year Ending December 31, 2014 Sales ....................................................... Variable expenses Cost of goods sold ......................... Selling expenses ............................ Administrative expenses ............... Total variable expenses ......... Contribution margin .............................. Fixed expenses Cost of goods sold ......................... Selling expenses ............................ Administrative expenses ............... Total fixed expenses .............. Net income .............................................
$2,500,000 $1,080,000 (1) 80,000 40,000 1,200,000 1,300,000 380,000 250,000 150,000 780,000 $ 520,000
(1) Direct materials $360,000 + direct labor $450,000 + variable manufacturing overhead $270,000. (b) Variable costs = 48% of sales ($1,200,000 ÷ $2,500,000) or $.24 per bottle ($.50 X 48%). Total fixed costs = $780,000. 1.
$.50X = $.24X + $780,000 $.26X = $780,000 X = 3,000,000 units (breakeven)
2.
3,000,000 X $.50 = $1,500,000
(c) Contribution margin ratio = ($.50 – $.24) ÷ $.50 = 52% Margin of safety ratio
= ($2,500,000 – $1,500,000) ÷ $2,500,000 = 40%
(d) Required sales X= 18-32
$780,000 + $624,000 = $2,700,000 .52 .
Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 18-3B
(a) Sales were $1,800,000 and variable expenses were $1,170,000, which means contribution margin was $630,000 and CM ratio was 35%. Fixed expenses were $840,000. Therefore, the breakeven point in dollars is:
$840,000 = $2,400,000 .35 (b) 1.
The effect of this alternative is to increase the selling price per unit to $37.50 ($30 X 125%). Total sales become $2,250,000 (60,000 X $37.50). Thus, the contribution margin ratio changes to 48% [($2,250,000 – $1,170,000) ÷ $2,250,000]. The new breakeven point is:
$840,000 = $1,750,000 .48 2.
The effects of this alternative are to change total fixed costs to $660,000 ($840,000 – $180,000) and to change the contribution margin to .30 [($1,800,000 – $1,170,000 – $90,000) ÷ $1,800,000]. The new breakeven point is:
$660,000 = $2,200,000 .30 3.
The effects of this alternative are: (1) variable and fixed cost of goods sold become $675,000 each, (2) total variable costs become $915,000 ($675,000 + $125,000 + $115,000), and (3) total fixed costs are $1,095,000 ($675,000 + $355,000 + $65,000). The new breakeven point is: X = ($915,000 ÷ $1,800,000)X + $1,095,000 X = .51X + $1,095,000 .49X = $1,095,000 X = $2,234,694 (rounded)
Alternative 1 is the recommended course of action using breakeven analysis because it has the lowest breakeven point.
.
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18-33
PROBLEM 18-4B
(a) Current break-even point: $30X = $12X + $216,000 (where X = pairs of shoes) $18X = $216,000 X = 12,000 pairs of shoes New break-even point:
$27X = $12X + ($216,000 + $18,000) $15X = $234,000 X = 15,600 pairs of shoes
(b) Current margin of safety ratio =
(20,000 X $30) – (12,000 X $30) (20,000 X $30)
= 40% New margin of safety ratio
=
(24,000 X $27)* – (15,600 X $27) (24,000 X $27)
= 35% *$30 X $90 (c)
COSTLESS SHOE STORE CVP Income Statement
Sales (20,000 X $30) Variable expenses (20,000 X $12) Contribution margin Fixed expenses Net income
Current
New
$600,000 240,000 360,000 216,000 $144,000
$648,000 288,000 360,000 234,000 $126,000
(24,000 X $27) (24,000 X $12)
No, the changes should not be made because net income will be lower than the net income currently earned. In addition, the break-even point would be higher by 3,600 units and the margin of safety ratio would decrease from 40% to 35%. 18-34
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PROBLEM 18-5B
(a) (1) Sales
Current Year $1,800,000
Variable costs Direct materials Direct labor Manufacturing overhead ($480,000 X .40) Selling expenses ($400,000 X .30) Administrative expenses ($484,000 X .50) Total variable costs Contribution margin
456,000 250,000 192,000 120,000 242,000 1,260,000 $ 540,000
Sales
Current Year $1,800,000 X 1.2
Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin
456,000 250,000 192,000 120,000 242,000 1,260,000 $ 540,000
(2) Fixed Costs Manufacturing overhead ($480,000 X .60) Selling expenses ($400,000 X .70) Administrative expenses ($484,000 X .50) Total fixed costs
.
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X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2
Projected Year $2,160,000 547,200 300,000 230,400 144,000 290,400 1,512,000 $ 648,000
Current Year $288,000 280,000 242,000 $810,000
Projected Year $288,000 280,000 242,000 $810,000
18-35
PROBLEM 18-5B (Continued) (b) Unit selling price = $1,800,000 ÷ 100,000 = $18.00 Unit variable cost = $1,260,000 ÷ 100,000 = $12.60 Unit contribution margin = $18.00 – $12.60 = $5.40 Contribution margin ratio = $5.40 ÷ $18.00 = .30 Break-even point in units = Fixed costs ÷ Unit contribution margin 150,000 units = $810,000 ÷ $5.40 Break-even point in dollars = Fixed costs ÷ Contribution margin ratio $2,700,000 = $810,000 ÷ .30 (c)
Sales dollars required for = (Fixed costs + Target net income) ÷ Contribution margin ratio target net income $3,410,000 = ($810,000 + $213,000) ÷ .30
(d)
Margin of safety = (Expected sales – Break-even sales) ÷ Expected sales ratio 21*% = ($3,410,000 – $2,700,000) ÷ 3,410,000
*(Rounded) (e) (1)
18-36
Sales
$1,800,000
Variable costs Direct materials Direct labor ($250,000 – $100,000) Manufacturing overhead ($480,000 X .10) Selling expenses ($400,000 X .80) Administrative expenses ($484,000 X .50) Total variable costs Contribution margin
456,000 150,000 48,000 320,000 242,000 1,216,000 $ 584,000
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PROBLEM 18-5B (Continued) (2) Contribution margin ratio = $584,000 ÷ $1,800,000 = .32 (Rounded) (3) Break-even point in dollars = $754,000 ÷ .32 = $2,356,250 Fixed costs Manufacturing overhead ($480,000 X .90) Selling expenses ($400,000 X .20) Administrative expenses ($484,000 X .50) Total fixed costs
$432,000 80,000 242,000 $754,000
The break-even point in dollars declined from $2,700,000 to $2,356,250. This means that overall the company’s risk has declined because it doesn’t have to generate as much in sales. The two changes actually had opposing effects on the break-even point. By changing to a more commission based approach to compensate its sales staff, the company reduced its fixed costs, and therefore reduced its break-even point. In contrast, the purchase of the new equipment increased the company’s fixed costs (by increasing its equipment depreciation) and reduced its variable direct labor cost, both of which would increase the break-even point.
.
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18-37
PROBLEM 18-6B
(a) 1.
Let variable selling and administrative expenses = VSA Sales – Variable cost of goods sold – VSA = Contribution Margin $2,000,000 – ($600,000 + $700,000 + $200,000 + VSA) = $150,000 VSA = $350,000
2.
Let fixed manufacturing overhead = FMO Sales – Variable cost of goods sold – FMO = Gross profit $2,000,000 – ($600,000 + $700,000 + $200,000 + FMO) = $400,000 FMO = $100,000
3.
Let fixed selling and administrative expenses = FSA Contribution margin ratio = $150,000 ÷ $2,000,000 = 7.50% Contribution margin at break-even = $2,400,000 X 7.50% = $180,000 At break-even, Contribution margin = Fixed costs (FSA + FMO) $180,000 = FSA + $100,000 FSA = $80,000
(b) Incremental sales = $2,000,000 X 15% = $300,000 Incremental contribution margin = $300,000 X 7.50% = $22,500 The maximum increased advertising expenditure would be equal to the incremental contribution margin earned on the increased sales, which is $22,500. The other fixed costs are irrelevant to this decision, because they would be incurred whether or not the advertising expenditure is increased.
18-38
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BYP 18-1
DECISION-MAKING AT CURRENT DESIGNS
(a) $250 + $100 + $170 + $420 + $400 = $1,340 total variable costs (b) Contribution margin per unit = $2,000 – $1,340 = $660 (c) $359,700* ÷ $660 = 545 units *$119,700 ÷ $240,000 (d) ($359,700 + $270,600) ÷ $660 = 955 units (e) Actual (expected) sales = $2,000 X 1,000 = $2,000,000 Break-even sales = $2,000 X 545 = $1,090,000 Margin of safety in dollars = $2,000,000 – $1,090,000 = $910,000 Margin of safety ratio = $910,000 ÷ $2,000,000 = 45.5%
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18-39
BYP 18-2
DECISION-MAKING ACROSS THE ORGANIZATION
(a) (1)
Capital-Intensive
Fixed manufacturing costs Incremental selling expenses Total fixed costs Selling price Variable costs Direct materials Direct labor Variable overhead Selling expenses Contribution margin
(2) $2,524,000 502,000 $3,026,000 $32.00
$5.00 6.00 3.00 2.00
Total fixed costs (1)
16.00 $16.00 $3,026,000
Labor-Intensive
Fixed manufacturing costs Incremental selling expenses Total fixed costs Selling price Variable costs Direct materials Direct labor Variable overhead Selling expenses Contribution margin
$1,550,000 502,000 $2,052,000 $32.00
$5.50 8.00 4.50 2.00
Total fixed costs (1)
20.00 $12.00 $2,052,000
Contribution margin per unit (2)
$16.00
Contribution margin per unit (2)
$12.00
Break-even in units (1) ÷ (2)
189,125
Break-even in units (1) ÷ (2)
171,000
(b) Creative Ideas Company would be indifferent between the two manufacturing methods at the volume (X) where total costs are equal. $16X + $3,026,000 = $20X + $2,052,000 $4X = $974,000 X = 243,500 units (c) Creative Ideas should employ the capital-intensive manufacturing method if annual sales are expected to exceed 243,500 units and the labor-intensive manufacturing method if annual sales are not expected to exceed 243,500 units. The labor-intensive method is more profitable for sales up to 243,500 units because the fixed costs are lower. The capital-intensive method is more profitable for sales above 243,500 units because its contribution margin is higher.
18-40
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BYP 18-3
MANAGERIAL ANALYSIS
(a) The variable costs per unit are: Cost of goods sold ($600,000 ÷ 240,000) ..................... Selling expenses ($117,600 ÷ 240,000) ........................ Administrative expenses ($60,000 ÷ 240,000) ............. Total........................................................................ Fixed costs are: Cost of goods sold ($800,000 X .25) ............................ Selling expenses ($280,000 X .58) ................................ Administrative expenses ($150,000 X .60) ...................
$2.50 .49 .25 $3.24 $200,000 162,400 90,000 $452,400
The break-even points are: X = ($3.24 ÷ $5.00) X + $452,400 X = .65X + $452,400 .35X = $452,400 X = $1,292,571 (rounded) $5.00X = $3.24X + $452,400 $1.76X = $452,400 X = 257,045 units (rounded) (b) Variable unit cost of goods sold = $2.75 ($600,000 ÷ 240,000 = $2.50; $2.50 + $.25) Sales volume = 300,000 units (240,000 X 125%) Total sales = 300,000 X $5.25 = $1,575,000 Net income computation: Sales ....................................................... Variable expenses Cost of goods sold (300,000 X $2.75) ......................... Selling expenses (300,000 X $.49) ........................... Administrative expenses (300,000 X $.25) ........................... Total variable expenses.......... Contribution margin ...............................
.
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$1,575,000 $825,000 147,000 75,000 1,047,000 528,000
18-41
BYP 18-3 (Continued) Fixed expenses Cost of goods sold ........................ Selling expenses............................ Administrative expenses............... Total fixed expenses .............. Net income .............................................
$200,000 162,400 90,000 452,400 $ 75,600
X = ($1,047,000 ÷ $1,575,000)X + $452,400 X = .66X + $452,400 .34X = $452,400 X = $1,330,588 (rounded) Profits and the break-even point would both increase. (c) Sales [384,000 (1) X ($5.00 – $.25)] ............... Variable expenses Cost of goods sold (384,000 X $2.50)................................. Selling expenses (384,000 X $.59) ......... Administrative expenses (384,000 X $.25) .................................. Total variable expenses ................. Contribution margin ...................................... Fixed expenses Cost of goods sold ................................. Selling expenses ($162,400 + $40,000) ........................... Administrative expenses ....................... Total fixed expenses ...................... Net income .....................................................
$1,824,000 $960,000 226,560 96,000 1,282,560 541,440 $200,000 202,400 90,000 492,400 $ 49,040
(1) Sales volume = 240,000 X 160% = 384,000 X = ($1,282,560 ÷ $1,824,000)X + $492,400 X = .70X + $492,400 .30X = $492,400 X = $1,641,333 Profits and the break-even point would both increase. (d) Peri’s plan should be accepted. It produces a higher net income and a lower break-even point than Paul’s plan.
18-42
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
BYP 18-4
REAL-WORLD FOCUS
(a) Sweeteners and packaging are a variable cost to Coca-Cola because their use is directly proportional to the amount of product produced. If the unit cost of a variable cost item increases, the contribution margin will decline. This will lead to a decline in net income unless the company can increase its selling price, increase the number of units it sells, or reduce other costs. (b) This description makes the marketing expenditures sound like they are a variable cost, since it suggests that they vary with the amount of units sold. However, unlike variable costs, the relationship of marketing costs is not directly proportional to sales, since other factors also influence units sold. Thus, it is not a pure variable cost. However, it is also not a fixed cost, in that there usually is a relationship between marketing expenditures and sales. For CVP purposes, it might best be handled as a mixed cost, having both a fixed and variable component. (c) The first measure, gallon shipments of concentrates and syrups, is the activity index, since it best reflects the company’s production and sales activity at the wholesale level, its primary line of business. The second measure, unit cases of finished product, indicates the amount of activity by Coke’s primary customers, the bottlers. Coke also keeps track of this since it provides information about what is happening at the retail level.
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(For Instructor Use Only)
18-43
BYP 18-5
REAL-WORLD FOCUS
(a) Barnes and Noble has 1,362 stores with a total of 18.8 million square feet. That is a huge investment in fixed costs that have very little value in an e-book environment. (b) Barnes and Noble’s big advantage (which enabled it to put lots of small independent book sellers out of business), was that each of its superstores had 150,000 books in stock. However, that is no longer as impressive when you consider that booksellers’ websites now give you access to millions of e-book titles which can be downloaded directly to e-readers. (c) The authors say that the arrival of Apple’s iPad has huge implications for e-books. ITunes has more than 125 million customers. They represent a very wide potential audience for e-books. (d) Barnes and Nobel earns about $12.50 on a $25 hardcover book. The same book, as an e-book, would sell for $12.99 and Barnes and Noble would earn $3.90. Obviously they can’t afford this decline unless they can dramatically reduce their fixed costs. (e) Barnes and Noble was one of the first companies to have an e-reader, called the Rocket e-book. However, it abandoned its e-reader in 2003 because sales of e-books had been very low. Four years later Amazon introduced its Kindle e-reader, which has been hugely popular. A second mistake was that Barnes and Noble was very slow to upgrade its website to encourage the sale of e-books. Again, Amazon was more than happy to fill the void.
18-44
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 18-6
COMMUNICATION ACTIVITY
To:
My Roommate
From:
Your Roommate
Subject:
Cost-Volume-Profit Questions
In response to your request for help, I provide you the following: (a) The mathematical formula for break-even sales is: Break-even Sales = Variable Costs + Fixed Costs Break-even sales in dollars is found by expressing variable costs as a percentage of unit selling price. For example, if the percentage is 70%, the break-even formula becomes X = .70X + Fixed Costs. The answer will be in sales dollars. Break-even sales in units is found by using unit selling price and unit variable costs in the formula. For example, if the selling price is $300 and variable costs are $210, the break-even formula becomes $300X = $210X + Fixed Costs. The answer will be in sales units. (b) The formulas for contribution margin per unit and contribution margin ratio differ as shown below: Unit Selling Price – Unit Variable Costs = Contribution Margin per Unit Contribution Margin per Unit ÷ Unit Selling Price = Contribution Margin Ratio You can see that CM per Unit is used in computing the CM ratio. (c) When contribution margin is used to determine break-even sales, total fixed costs are divided by either the contribution margin ratio or contribution margin per unit. Using the CM ratio results in determining the break-even point in dollars. Using CM per unit results in determining the break-even point in units.
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18-45
BYP 18-6 (Continued) The formula for determining break-even sales in dollars is: Fixed Costs ÷ Contribution Margin Ratio = Break-even Sales in Dollars The formula for determining break-even sales in units is: Fixed Costs ÷ Contribution Margin per Unit = Break-even Sales in Units I hope this memo answers your questions.
18-46
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 18-7
ETHICS CASE
(a) The stakeholders in this situation are: Scott Bestor, accountant of Westfield Company. The dislocated personnel of Westfield. The senior management who made the decision. (b) Scott is hiding an error and is knowingly deceiving the company’s management with inaccurate data. (c) Scott’s alternatives are: Keep quiet. Confess his mistake to management. The students’ recommendations should recognize the practical aspects of the situation but they should be idealistic and ethical. If the students can’t be totally ethical when really nothing is at stake, how can they expect to be ethical under real-world pressures?
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18-47
BYP 18-8
ALL ABOUT YOU
(a)
The variable gasoline cost of going one mile in the hybrid car would be $0.09 ($3.60/40). The variable gasoline cost of going one mile in the traditional car would be $0.12 ($3.60/30).
(b)
The savings per mile of driving the hybrid vehicle would be $0.03 ($0.12 – $0.09).
(c)
In order to break even on your investment, you would need to drive 150,000 miles. This is determined by dividing the additional fixed cost of $4,500 by the cost savings per mile of $0.03.
(d)
There are many other factors that you would want to consider in your analysis. For example, do the vehicles differ in their expected repair bills, insurance costs, licensing fees, or ultimate resale value. Also, some states and some employers offer rebates for the purchase of hybrid vehicles. In addition, your decision might be influenced by non-financial factors, such as a desire to reduce emissions.
18-48
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Kimmel, Accounting, 5e, Solutions Manual
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CHAPTER 19 Cost-Volume-Profit Analysis: Additional Issues ASSIGNMENT CLASSIFICATION TABLE Brief Exercises
A Problems
B Problems
1A, 2A
1B, 2B
1, 2, 3, 4, 5
1A, 2A, 6A
1B, 2B, 6B
3
6, 7, 8, 9, 10
4A
4B
4
11, 12, 13
3A
3B
12, 13, 14
14, 15, 16
5A, 6A
5B, 6B
17
16, 17, 18
17, 18, 19
7A, 8A
7B, 8B
Discuss net income effects under absorption costing versus variable costing.
19, 20, 21, 22
19
18
7A, 8A
7B, 8B
Discuss the merits of absorption versus variable costing for management decision making.
18
8A
8B
Learning Objectives
Questions
1.
Describe the essential features of a cost-volume-profit income statement.
1, 2, 3, 4
1, 2, 3, 4, 5, 6
1
2.
Apply basic CVP concepts.
2, 4, 5, 6
1, 2, 3, 4, 5, 6
2
3.
Explain the term sales mix and its effects on break-even sales.
7, 8, 9
7, 8, 9, 10
4.
Determine sales mix when a company has limited resources.
10, 11
11, 15
5.
Understand how operating leverage affects profitability.
12, 13, 14, 15, 16
*6.
Explain the difference between absorption costing and variable costing.
*7.
*8.
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Do It!
Exercises
19-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Compute break-even point under alternative courses of action.
Moderate
20–30
2A
Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.
Moderate
20–30
3A
Determine sales mix with limited resources.
Simple
10–15
4A
Determine break-even sales under alternative sales strategies and evaluate results.
Moderate
20–30
5A
Compute degree of operating leverage and evaluate impact of operating leverage on financial results.
Moderate
20–30
6A
Determine contribution margin, break-even point, target sales, and degree of operating leverage.
Moderate
20–30
*7A
Prepare income statements under absorption costing and variable costing for a company with beginning inventory, and reconcile differences.
Moderate
20–30
*8A
Prepare absorption and variable costing income statements and reconcile differences between absorption and variable costing income statements when sales level and production level change. Discuss relative usefulness of absorption costing versus variable costing.
Moderate
20–30
1B
Compute break-even point under alternative courses of action.
Moderate
20–30
2B
Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment.
Moderate
20–30
3B
Determine sales mix with limited resources.
Simple
10–15
4B
Determine break-even sales under alternative sales strategies and evaluate results.
Moderate
20–30
5B
Compute degree of operating leverage and evaluate impact of operating leverage on financial results.
Moderate
20–30
6B
Determine contribution margin, break-even point, target sales, and degree of operating leverage.
Moderate
20–30
*7B
Prepare income statements under absorption costing and variable costing for a company with beginning inventory, and reconcile differences.
Moderate
20–30
*8B
Prepare absorption and variable costing income statements and reconcile differences between absorption and variable costing income statements when sales level and production level change. Discuss relative usefulness of absorption costing versus variable costing.
Moderate
20–30
19-2
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Kimmel, Accounting, 5e, Solutions Manual
Learning Objective
Knowledge Comprehension
Application
(For Instructor Use Only)
*1.
Describe the essential features Q19-1 of a cost-volume-profit income Q19-3 statement.
Q19-2 Q19-4
BE19-2 BE19-3 BE19-4 BE19-5 BE19-6
*2.
Apply basic CVP concepts.
Q19-2 Q19-4 Q19-5 Q19-6
BE19-2 E19-2 P19-6A BE19-3 E19-3 P19-1B BE19-4 E19-4 P19-2B BE19-5 E19-5 P19-4B BE19-6 P19-1A P19-6B DI19-2 P19-2A E19-1 P19-4A
BE19-1 P19-6B P19-1A P19-2A P19-6A P19-1B P19-2B
*3.
Explain the term sales mix and Q19-7 its effects on break-even sales. Q19-8
Q19-8 Q19-9
BE19-7 DI19-3 E19-9 BE19-8 E19-6 E19-10 BE19-9 E19-7 P19-4A BE19-10 E19-8 P19-4B
E19-6 P19-4B E19-7 E19-8 P19-4A
*4.
Determine sales mix when a Q19-11 company has limited resources.
Q19-10
BE19-11 E19-11 P19-3A BE19-15 E19-12 P19-3B DI19-4 E19-13
E19-11 P19-3A E19-12 P-3B E19-13
*5.
Understand how operating leverage affects profitability.
Q19-14
Q19-16 E19-14 P19-6A B196-12 E19-15 P19-5B BE19-13 E19-16 BE19-14 P19-5A
E19-14 P19-6A E19-15 P19-5B E19-16 P19-6B P19-5A
**6.
Explain the difference between absorption costing and variable costing.
Q19-17
BE19-16 E19-18 P19-7B BE19-17 E19-19 P19-8B BE19-18 P19-7A E19-17 P19-8A
E19-18 P19-7B E19-19 P19-8B P19-7A P19-8A
*7.
Discuss net income effects under absorption costing versus variable costing.
Q19-19 Q19-22 Q19-20 Q19-21
Q19-19 P19-7A P19-8B BE19-19 P19-8A E19-18 P19-7B
P19-7A P19-8B P19-8A P19-7B
**8.
Discuss the merits of absorption versus variable costing for management decision making.
Q19-18
Broadening Your Perspective
Q19-12 Q19-13 Q19-15
BYP19-7
DI19-1 P19-1A P19-2A P19-1B P19-2B
Analysis
Synthesis
Evaluation
BE19-1 P19-1A P19-2A P19-1B P19-2B
P19-8A P19-8B
BYP19-4 BYP19-5
BYP19-1 BYP19-2
BYP19-6 BYP19-9
19-3
BYP19-3 BYP19-8 BYP19-10
BLOOM’ S TAXONOMY TABLE
.
Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
ANSWERS TO QUESTIONS 1.
CVP or cost-volume-profit analysis is the study of the effects of changes in costs and volume on a company’s profit.
2.
Managers use CVP analysis to make decisions involving break-even point, sales required to reach a target net income, margin of safety, the most profitable sales mix, allocation of limited resources, and operating leverage.
3.
Both types of income statements report the same amount of net income. But the format used to reach net income differs. A traditional income statement’s format consists of: Sales revenue – cost of goods sold = gross profit; Gross profit – selling and administrative expenses = net income. A CVP income statement’s format consists of: Sales revenue – variable expenses = contribution margin; Contribution margin – fixed expenses = net income.
4.
The CVP income statement isolates variable costs from fixed costs while the traditional income statement does not. The CVP format indicates contribution margin in total and frequently on a per unit basis as well. This format facilitates calculation of break-even point and target net income. It also highlights how changes in sales volume or cost structure affect net income.
5.
WHEAT COMPANY CVP Income Statement Sales ........................................................................................................ Variable costs ($500,000 X .75) + ($200,000 X .75) ................................. Contribution margin ..................................................................................
$900,000 525,000 $375,000
6.
If the selling price is reduced but variable and fixed costs remain unchanged, the break-even point will increase.
7.
Sales mix is the relative percentage of each product sold when a company sells more than one product. Sales mix changes the calculation of the break-even point because the fixed costs must be divided by the weighted-average unit contribution margin.
8.
The 150,000-mile tire has a higher unit contribution margin, that is, each tire sold covers a larger amount of fixed costs. Therefore, if the sales mix shifts away from the 150,000-mile tire to the 50,000-mile tire, the company will have to sell more total tires in order to break-even.
9.
If a company has many products, the break-even point is calculated using sales information for divisions or product lines, rather than individual products. The weighted-average contribution margin ratio is computed by multiplying the sales mix percentage of each product line by the contribution margin ratio of each product line, and then summing the results. Total break-even sales in dollars is then calculated by dividing the company’s total fixed costs by the weightedaverage contribution margin ratio. Finally, to determine the amount of sales generated by each product line at the break-even point, multiply the total break-even sales by the sales mix percentage of each product line.
19-4
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Kimmel, Accounting, 5e, Solutions Manual
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Questions Chapter 19 (Continued) 10. Contribution margin per unit of limited resource is determined by dividing the contribution margin per unit of the product by the number of units of the limited resource required to produce the product. 11. The theory of constraints is a specific approach used to identify and manage constraints to achieve the company’s goals. According to this theory, a company must continually identify its constraints and find ways to reduce or eliminate them, where appropriate. Examples of constraints would be production bottlenecks or poorly trained workers. 12. Cost structure refers to the relative proportion of fixed costs versus variable costs that a company incurs. Companies that rely heavily on fixed costs will have higher break-even points. 13. Operating leverage refers to the extent to which a company’s net income reacts to a given change in sales. A company can increase its operating leverage by increasing its reliance on fixed costs. 14. Typically manual labor is considered a variable cost. Depreciation on factory equipment is a fixed cost. Therefore, if a company replaces manual labor with automated factory equipment it will increase its operating leverage, and increase its break-even point. 15. The degree of operating leverage is a measure of a company’s relative operating leverage. It is calculated by dividing the contribution margin by net income at a particular level of sales. 16. Pine’s degree of operating leverage of 8 versus Fir’s measure of 4 tells us that Pine will experience twice (8 ÷ 4) the increase (or decrease) in net income for a given increase (decrease) in sales as Fir. *17. Under absorption costing, both variable and fixed manufacturing costs are considered to be product costs. Under variable costing, only variable manufacturing costs are product costs and fixed manufacturing costs are expensed when incurred. *18. (a)
(b)
The rationale for variable costing centers on the purpose of fixed manufacturing costs, which is to have productive facilities available for use. Since these costs are incurred whether a company operates at zero or 100% capacity, it is argued that they should be expensed when they are incurred. Variable costing is useful in product costing internally by management and it is useful in controlling manufacturing costs. Variable costing cannot be used for financial reporting purposes because it does not follow generally accepted accounting principles.
*19. One way to compute the difference is as follows: Ending inventory 8,500
X Fixed manufacturing overhead cost per unit X $5
= $42,500
Absorption costing will report a $42,500 higher net income than variable costing because a portion of the fixed manufacturing overhead costs are deferred in inventory.
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19-5
Questions Chapter 19 (Continued) *20. If production equals sales in any given period, the net incomes under both methods will be equal. In this case, there is no increase in the ending inventory. So fixed manufacturing overhead costs in the current period are not deferred to future periods through the ending inventory. *21. If production is greater than sales, absorption costing net income will be greater than variable costing net income. Absorption costing net income is higher because some of the fixed manufacturing overhead costs will be deferred in the inventory account until the products are sold. *22. In the long run, neither method will produce a higher net income amount. Over a long period of time, sales can never exceed production, nor production exceed sales by significant amounts. For this reason, over the lifetime of a corporation, variable costing and absorption costing will tend to yield the same net income amounts.
19-6
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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 19-1 1.
(a) (b)
$70 = ($250 – $180) 28% ($70 ÷ $250)
2.
(c) (d)
$200 = ($500 – $300) 60% ($300 ÷ $500)
3.
(e) (f)
$1,100 = ($330 ÷ 30%) $770 ($1,100 – $330)
BRIEF EXERCISE 19-2 HAMBY INC. Income Statement For the Quarter Ended March 31, 2014 Sales........................................................................ Variable expenses Cost of goods sold ......................................... Selling expenses............................................. Administrative expenses................................ Total variable expenses .......................... Contribution margin ............................................... Fixed expenses Cost of goods sold ......................................... Selling expenses............................................. Administrative expenses................................ Total fixed expenses ............................... Net income ..............................................................
$2,000,000 $760,000 95,000 79,000 934,000 1,066,000 600,000 60,000 66,000 726,000 $ 340,000
BRIEF EXERCISE 19-3 Contribution margin ratio = [($250,000 – $175,000) ÷ $250,000] = 30% Required sales in dollars = $120,000 ÷ 30% = $400,000
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19-7
BRIEF EXERCISE 19-4 (a) $400Q = $250Q + $210,000 + $0 $150Q = $210,000 Q = 1,400 units (b) Contribution margin per unit $150, or ($400 – $250) X = $210,000 ÷ $150 X = 1,400 units BRIEF EXERCISE 19-5 X = .60X + $210,000 + $60,000 .40X = $270,000 X = $675,000 BRIEF EXERCISE 19-6 Margin of safety = $1,200,000 – $960,000 = $240,000 Margin of safety ratio = $240,000 ÷ $1,200,000 = 20% BRIEF EXERCISE 19-7 Model A12 B22 C124
19-8
Sales Mix Percentage 60% 15% 25%
.
Unit Contribution Margin $10 ($50 – $40) $30 ($100 – $70) $100 ($400 – $300)
Kimmel, Accounting, 5e, Solutions Manual
Weighted-Average Unit Contribution Margin $ 6.00 4.50 25.00 $35.50
(For Instructor Use Only)
BRIEF EXERCISE 19-8 Total break-even = ($213,000 ÷ $35.50*) = 6,000 units *Computed in BE 19-7 Sales Units Units of A12 = .60 X 6,000 = 3,600 Units of B22 = .15 X 6,000 = 900 Units of C124 = .25 X 6,000 = 1,500 6,000 BRIEF EXERCISE 19-9 (a)
(b)
Weighted-average contribution = margin ratio
(.30 X .20) + (.50 X .20) + ( .20 X .45) = .25
Total break-even point = in dollars
($440,000 ÷ .25) = $1,760,000
Birthday $1,760,000 X .30 = $ 528,000 Standard tapered $1,760,000 X .50 = 880,000 Large scented $1,760,000 X .20 = 352,000 $1,760,000 BRIEF EXERCISE 19-10 (a)
Sales Mix Bedroom Division $500,000 ÷ $1,250,000 = .40 Dining Room Division $750,000 ÷ $1,250,000 = .60
(b)
Weight-average contribution = $575,000 = .46 margin ratio $1,250,000 OR Contribution Margin Ratio Bedroom Division($275,000 ÷ $500,000) = .55 Dining Room Division($300,000 ÷ $750,000) = .40 Weighted-average contribution margin ratio = (.55 X .40) + (.40 X .60) = .46
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19-9
BRIEF EXERCISE 19-11
Contribution margin per unit (a) Machine hours required (b) Contribution margin per unit of limited resource [(a) ÷ (b)]
Product A $12.0 2 $ 6
Product B $15 3 $ 5
BRIEF EXERCISE 19-12 Degree of operating leverage (old) =
$200,000 ÷ $40,000 = 5
Degree of operating leverage (new) =
$240,000 ÷ $40,000 = 6
If Sam’s sales change, the resulting change in net income will be 1.2 times (6 ÷ 5) higher with the new machine than under the old system. BRIEF EXERCISE 19-13 Break-even point in dollars: Logan Co. $60,000 ÷ ($120,000 ÷ $200,000) = $100,000
Morgan Co. $90,000 ÷ ($150,000 ÷ $200,000) = $120,000
Morgan Company’s cost structure relies much more heavily on fixed costs than that of Logan Co. As result, Morgan has a higher contribution margin ratio of .75 ($150,000 ÷ $200,000) versus .60 ($120,000 ÷ $200,000), for Logan Co. Morgan also has much higher fixed costs to cover. Its break-even point is therefore higher than that of Logan Co. BRIEF EXERCISE 19-14 Degree of operating leverage = Contribution margin ÷ Net income Montana Corp. 1.6 = Contribution margin ÷ $50,000 Contribution margin = $50,000 X 1.6 = $80,000 APK Co. 5.4 = Contribution margin ÷ $50,000 Contribution margin = $50,000 X 5.4 = $270,000
19-10
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Kimmel, Accounting, 5e, Solutions Manual
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BRIEF EXERCISE 19-15
Contribution margin per unit (a) Machine hours required (b) Contribution margin per unit of limited resource [(a) ÷ (b)]
Product 1 $ 42 .15 $280
Product 2 $ 35 .10 $350
Product 2 has a higher contribution margin per limited resource, even though it has a lower contribution margin per unit. Given that machine hours are limited to 2,000 per month, Ger Corporation should produce Product 2. *BRIEF EXERCISE 19-16 Variable Costing Direct materials Direct labor Variable manufacturing overhead Total product costs
$14,400 25,600 32,400 $72,400
*BRIEF EXERCISE 19-17 Absorption Costing Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total product costs
$14,400 25,600 32,400 12,000 $84,400
*BRIEF EXERCISE 19-18 (a) Absorption Costing ....... Direct materials................................................................ Direct labor ...................................................................... Variable manufacturing overhead .................................. Fixed manufacturing overhead ($128,000 ÷ 8,000) ........ Total manufacturing cost per unit ..................................
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$20 14 15 16 $65
19-11
*BRIEF EXERCISE 19-18 (Continued) (b) Variable Costing Direct materials ............................................... Direct labor...................................................... Variable manufacturing overhead ................. Total manufacturing cost per unit .................
$20 14 15 $49
*BRIEF EXERCISE 19-19 MEMO To:
Chief financial officer
From:
Student
Re:
Absorption and variable costing
Under absorption costing, fixed manufacturing overhead is a product cost, while under variable costing, fixed manufacturing overhead is a period cost (expensed as incurred). Since units produced (50,000) exceeded units sold (48,000) last month, income under absorption costing will be higher than under variable costing. Some fixed overhead (2,000 units X $4 = $8,000) will be assigned to ending inventory and therefore not expensed under absorption costing, whereas all fixed overhead is expensed under variable costing. Therefore, absorption costing net income will be higher than variable costing net income by $8,000.
19-12
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Kimmel, Accounting, 5e, Solutions Manual
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SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 19-1 AMANDA INC. Income Statement For the Month Ended January 31, 2014 Sales (10,000 units).......................................... Variable expenses Cost of goods sold..................................... Selling expenses ........................................ Administrative expenses ........................... Total variable expenses ...................... Contribution margin Fixed expenses Cost of goods sold..................................... Selling expenses ........................................ Administrative expenses ........................... Total fixed expenses ........................... Net income .......................................................
$400,000 $184,000 40,000 16,000 240,000 160,000 $ 70,000 30,000 50,000 150,000 $ 10,000
Contribution margin per unit: $160,000 ÷ 10,000 units = $16 per unit. Contribution margin ratio: $160,000 ÷ $400,000 = 40% or $16 ÷ $40 = 40%. DO IT! 19-2 (a)
Break-even point in units is 7,500 units ($150,000 ÷ $20). Break-even point in sales dollars is $375,000 ($150,000 ÷ .40*). The margin of safety in dollars is $75,000 ($450,000 – $375,000). *$20 ÷ $50.
(b) Break-even point in units is 8,333 units (rounded) ($150,000 ÷ $18*). Break-even point in sales dollars is $400,000 ($150,000 ÷ .375**). The margin of safety in dollars is $118,400 ($518,400*** – $400,000). *$50 – (.04 X $50) – 30 = $18. **$18 ÷ $48 = .375 ***9,000 + (.20 X 9,000) = 10,800 units, 10,800 units X $48 = $518,400
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Kimmel, Accounting, 5e, Solutions Manual
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19-13
DO IT! 19-2 (Continued) The increase in the break-even point from $375,000 to $400,000 indicates that management should not implement the proposed change while the increase in the margin of safety from $75,000 to $118,400 indicates that management should implement the proposed change. Since the expected 20% increase in sales volume will result in a contribution margin of $194,400 (10,800 X $18) which is only $14,400 more than the current amount, management should be cautious before reducing unit prices. DO IT! 19-3 (a)
The sales mix percentages as a function of units sold is: Basic 750 ÷ 1,500 = 50%
Basic Plus 450 ÷ 1,500 = 30%
Premium 300 ÷ 1,500 = 20%
(b) The weighted-average unit contribution margin is: [.50 X ($250 – $195)] + [.3 X ($400 – $288)] + [.20 X ($800 – $416)] = $137.90.
(c)
The break-even point in units is: $165,480 ÷ $137.90 = 1,200 units.
(d) The break-even units to produce for each product are: Basic: 1,200 units X 50% = 600 units Basic Plus 1,200 units X 30% = 360 units Premium: 1,200 units X 20% = 240 units 1,200 units DO IT! 19-4 (a)
19-14
The Best binoculars have the highest contribution margin per unit. Thus, ignoring any manufacturing constraints, it would appear that the company should shift toward production of more Best units.
.
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DO IT! 19-4 (Continued) (b) The contribution margin per unit of limited resource is calculated as:
Contribution margin per unit Limited resource consumed per unit
(c)
.
Good $40 .5 = $80
Better Best $150 $420 1.5 = $100 6 = $70
The Better binoculars have the highest contribution margin per unit of limited resource, even though they do not have the highest contribution margin per unit. Given the resource constraint, any additional capacity should be used to make Better binoculars.
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19-15
SOLUTIONS TO EXERCISES EXERCISE 19-1 (a)
1.
Contribution margin per room = Contribution margin per room = Contribution margin ratio =
$60 – ($8 + $37) $15 $15 ÷ $60 = 25%
Fixed costs = $8,800 + $2,400 + $1,500 + $800 = $13,500 Break-even point in rooms = $13,500 ÷ $15 = 900 2.
Break-even point in dollars
= =
900 rooms X $60 per room $54,000 per month
OR Fixed costs ÷ Contribution margin ratio = $13,500 ÷ .25 = $54,000 per month (b)
1.
Margin of safety in dollars: Planned activity = 50 rooms per day X 30 days = 1,500 rooms per month Expected rental revenue = 1,500 rooms X $60 = $90,000 Margin of safety in dollars = $90,000 – $54,000 = $36,000
2.
Margin of safety ratio:
$36,000 = 40% $90,000
EXERCISE 19-2 (a)
Contribution margin in dollars: Sales = 4,000 X $30 =
$120,000 Variable costs = $120,000 X .75 = 90,000 Contribution margin $ 30,000
Contribution margin per unit: Contribution margin ratio:
19-16
.
$30 – $22.50 ($30 X 75%) = $7.50. $7.50 ÷ $30 = 25%.
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EXERCISE 19-2 (Continued) (b) Break-even sales in dollars:
$16,800 = $67,200. 25%
Break-even sales in units:
$16,800 = 2,240. $7.50
(c) Margin of safety in dollars: Margin of safety ratio:
$120,000 – $67,200 = $52,800. $52,800 ÷ $120,000 = 44%.
EXERCISE 19-3 Current selling price = $310,000 ÷ 5,000 units Current selling price = $62 1.
Increase selling price to $68.20 ($62 X 110%). Net income = $341,000* – $210,000 – $75,000 = $56,000. *($68.20 X 5,000)
2.
Reduce variable costs to 58% of sales. Net income = $310,000 – $179,800** – $75,000 = $55,200. **($310,000 X .58)
3.
Reduce fixed costs to $55,000 ($75,000 – $20,000). Net income = $310,000 – $210,000 – $55,000 = $45,000.
Alternative 1, increasing unit sales price, will produce the highest net income.
.
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19-17
EXERCISE 19-4 (a) 1. Contribution margin ratio is:
$30,000 = 62.5% $48,000
Break-even point in dollars =
$20,250 = $32,400 62.5%
2. Round-trip fare =
$48,000 = $120 400 fares
Break-even point in fares =
$32,400 = 270 fares $120
(b) At the break-even point fixed costs and contribution margin are equal. Therefore, the contribution margin at the break-even point would be $20,250. (c) Fare revenue ($108* X 500**) Variable costs ($18,000 X 1.20) Contribution margin Fixed costs Net income
$54,000 21,600 32,400 20,250 $12,150
Yes, the fare decrease should be implemented because net income increases to $12,150. *$120 – (.10 X $120) **400 + 100 EXERCISE 19-5 (a)
HALL COMPANY CVP Income Statement For the Year Ended December 31, 2014
Sales (60,000 X $26) ...................................... Variable costs (60,000 X $12) ........................ Contribution margin (60,000 X $14) .............. Fixed costs..................................................... Net income .....................................................
19-18
.
Kimmel, Accounting, 5e, Solutions Manual
Total $1,560,000 720,000 840,000 500,000 $ 340,000
(For Instructor Use Only)
Per Unit $26 12 $14
EXERCISE 19-5 (Continued) (b)
HALL COMPANY CVP Income Statement For the Year Ended December 31, 2014
Sales [(60,000 X 105%) X $24.50*] ................ Variable costs (63,000 X $9.00**) .................. Contribution margin (63,000 X $15.50)......... Fixed costs ($500,000 + $150,000) ............... Net income .....................................................
Total $1,543,500 567,000 976,500 650,000 $ 326,500
Per Unit $24.50 9.00 $15.50
*$26.00 – ($3 X 50%) = $24.50. **$12.00 – ($12 X 25%) = $9.00. EXERCISE 9-6
Lawnmowers Weed-trimmers Chainsaws
Sales Mix Percentage 20% 50% 30%
Contribution Margin Per Unit $30 $20 $40
Weighted-Average Contribution Margin $ 6 10 12 $28
Total break-even sales in units = $4,200,000 ÷ $28 = 150,000 units
Lawnmowers Weed-trimmers Chainsaws Total units
.
Total Sales Mix Break-even Sales Percentage in Units 20% X 150,000 = 50% X 150,000 = 30% X 150,000 =
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Sales Units Needed Per Product 30,000 units 75,000 units 45,000 units 150,000 units
19-19
EXERCISE 19-7 (a) Sales Mix Percentage 70% 30%
Oil changes Brake repair
Contribution Margin Ratio 20% 60%
Weighted-Average Contribution Margin Ratio .14 .18 .32
Total break-even sales in dollars = $16,000,000 ÷ .32 = $50,000,000 Sales Mix Percentage 70% X 30% X
Oil changes Brake repair Total sales
Total Break-even Sales in Dollars $50,000,000 $50,000,000
= =
Sales Dollars Needed Per Product $35,000,000 15,000,000 $50,000,000
(b) Sales to achieve target net income = ($80,000 + $60,000) ÷ .32 = $437,500 Sales Mix Total Percentage Sales Needed 70% X $437,500 = 30% X $437,500 =
Oil changes Brake repair Total sales
Sales Dollars Needed Per Product Per Store $306,250 131,250 $437,500
EXERCISE 19-8 (a)
Mail pouches and small boxes Non-standard boxes
Sales Mix Percentage
Contribution Margin Ratio
Weighted-Average Contribution Margin Ratio
80%
20%
.16
20%
70%
.14 .30
Total break-even sales in dollars = $12,000,000 ÷ .30 = $40,000,000 19-20
.
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EXERCISE 19-8 (Continued) Total Breakeven Sales in Dollars
Sales Mix Percentage Mail pouches and small boxes Non-standard boxes Total sales
Sales Dollars Needed Per Product
80%
X
$40,000,000
=
$32,000,000
20%
X
$40,000,000
=
8,000,000 $40,000,000
(b)
Mail pouches and small boxes Non-standard boxes
Sales Mix Percentage
Contribution Margin Ratio
Weighted-Average Contribution Margin Ratio
40%
20%
.08
60%
70%
.42 .50
Total break-even sales in dollars = $12,000,000 ÷ .50 = $24,000,000 Total Breakeven Sales in Dollars
Sales Mix Percentage Mail pouches and small boxes Non-standardized boxes Total sales
Sales Dollars Per Product
40%
X
$24,000,000
=
$ 9,600,000
60%
X
$24,000,000
=
14,400,000 $24,000,000
EXERCISE 19-9 (a) Weighted-average unit contribution margin = ($40 X .30) + ($20 X .60) + ($60 X .10) = $30 Break-even point in units = $630,000 ÷ $30 = 21,000 (b) Shoes (21,000 X .30) = 6,300 pairs of shoes Gloves (21,000 X .60) = 12,600 pairs of gloves Range-finders (21,000 X .10) = 2,100 range-finders
.
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19-21
EXERCISE 19-9 (Continued) (c) Shoes: 6,300 X $40 = $252,000 Gloves: 12,600 X $20 = 252,000 Range-finders: 2,100 X $60 = 126,000 Total contribution margin 630,000 Fixed costs 630,000 Net income $ 0 EXERCISE 19-10 (a) Sales mix percentage iPad division: $600,000 ÷ ($600,000 + $400,000) = .60 iPod division: $400,000 ÷ ($600,000 + $400,000) = .40 Contribution margin ratio: iPad division: $180,000 ÷ $600,000 = .30 iPod division: $140,000 ÷ $400,000 = .35 (b)
Weighted-average contribution = $320,000 = .32 OR margin ratio $1,000,000 Weighted-average contribution margin ratio = (.60 X .30) + (.40 X .35) = .32
(c) Break-even point in dollars = $120,000 ÷ .32 = $375,000 (d) Sales dollars needed at break-even point for each division iPad division: $375,000 X .60 = $225,000 iPod division: $375,000 X .40 = $150,000 EXERCISE 19-11 (a) A Contribution margin per unit (a) Machine hours required (b) Contribution margin per unit of limited resource (a) ÷ (b)
$
5 2 $2.50
Product B $ $
2 1 2
C $
3 2 $1.50
(b) Product A should be manufactured because it results in the highest contribution margin per machine hour. 19-22
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EXERCISE 19-11 (Continued) (c) 1. Machine hours (a) (1,500 ÷ 3) Contribution margin per unit of limited resource (b) Total contribution margin [(a) X (b)]
Product A B 500 500 $ 2.50 $1,250
$ 2 $1,000
C 500 $1.50 $ 750
The total contribution margin = ($1,250 + $1,000 + $750) = $3,000. 2. Machine hours (a) Contribution margin per unit of limited resource (b) Total contribution margin [(a) X (b)]
Product A 1,500 $ 2.50 $3,750
EXERCISE 19-12 (a) Product D: $30 ÷ $10 = 3.0 hours per unit Product E: $80 ÷ $10 = 8.0 hours per unit Product F: $35 ÷ $10 = 3.5 hours per unit (b) Selling price Variable costs Contribution margin Direct labor hours per unit Contribution margin per direct labor hour
D $200 125 75 ÷ 3.0
Product E $ 300 160 140 ÷ 8.0
F $250 180 70 ÷ 3.5
$ 25
$17.50
$ 20
(c) Product D should be produced because it generates the highest contribution margin per direct labor hour. Total direct labor hours available Contribution margin per direct labor hour Total contribution margin
.
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Product D 2,000 X $25 $50,000
19-23
EXERCISE 19-13 (a)
Product Basic Deluxe $40 $ 52 20 22 $20 $ 30 .5 .8
Selling price per unit Variable costs per unit Contribution margin per unit (a) Machine hours required (b) Contribution margin per machine hour (a) ÷ (b)
$40
$37.50
(b) The Basic product should be manufactured because it results in the higher contribution margin per machine hour. (c) 1. Machine hours allocated X Contribution margin per machine hour Contribution margin 2. Machine hours allocated X Contribution margin per machine hour Contribution margin
Basic 500
Deluxe 500
Total 1,000
$40 $20,000
$37.50 $18,750
$38,750
Basic 1,000
Deluxe –0–
Total 1,000
$40 $40,000
$37.50 –0–
$40,000
EXERCISE 19-14 (a) Contribution Margin $260,000 $450,000
Armstrong Contador
÷ ÷ ÷
Net Income $100,000 $100,000
Degree of Operating = Leverage = 2.60 = 4.50
Interpretation: Contador has a higher degree of operating leverage. Its earnings would increase (decrease) by a greater amount than Armstrong if each experienced an equal increase (decrease) in sales.
19-24
.
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EXERCISE 19-14 (Continued) (b) Sales Variable costs Contribution margin Fixed costs Net income
Armstrong Company $550,000** 264,000** 286,000** 160,000** $126,000**
Contador Company $550,000*** 55,000*** 495,000*** 350,000*** $145,000***
*$500,000 X 1.1 **$240,000 X 1.1 ***$ 50,000 X 1.1 (c) Each company experienced a $50,000 increase in sales. However, because of Contador’s higher operating leverage, it experienced a $45,000 ($145,000 – $100,000) increase in net income while Armstrong experienced only a $26,000 ($126,000 – $100,000) increase. This is what we would have expected, since Contador’s degree of operating leverage exceeds that of Armstrong. EXERCISE 19-15 (a)
Manual system Computerized system
Contribution Margin ÷ $300,000 ÷ $900,000
÷
Net Income $250,000
= =
Degree of Operating Leverage 1.20
$250,000
=
3.60
(b) The computerized system would produce profits that are 3.0 times (3.60 ÷ 1.20) as much as the manual system. With a $150,000 increase in sales, net income would increase $30,000 ($280,000 – $250,000) under the manual system and $90,000 ($340,000 – $250,000) under the computerized system.
.
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19-25
EXERCISE 19-15 (Continued) Manual System $1,650,000 1,320,000* 330,000 50,000 $ 280,000
Sales Variable costs Contribution margin Fixed costs Net income
Computerized System $1,650,000 660,000** 990,000 650,000 $ 340,000
*($1,200,000 ÷ $1,500,000) X $1,650,000 **($600,000 ÷ $1,500,000) X $1,650,000 (c) Manual system
(Actual Sales
–
Break-even Sales)
÷
Actual Sales
=
Margin of Safety Ratio
($1,500,000
–
$250,000*)
÷
$1,500,000
=
.83
($1,500,000
–
$1,083,333**)
÷
$1,500,000
=
.28
Computerized system
*$ 50,000 ÷ ($300,000 ÷ $1,500,000) **$650,000 ÷ ($900,000 ÷ $1,500,000) The manual system could weather the greater decline in sales before reaching the break-even point. Under the manual system sales could drop 83% before suffering a loss, while sales under the computerized system could only decline by 28% before suffering a loss. EXERCISE 19-16 (a) Contribution Margin ÷ Traditional Yams $ 80,000 ÷ Auto-Yams $240,000 ÷
Net Income $50,000 $50,000
= = =
Degree of Operating Leverage 1.60 4.80
Auto-Yams, which relies more heavily on fixed costs, has the higher degree of operating leverage, 4.8 versus 1.60. That means for every dollar of increase (decrease) in sales, Auto-Yams will generate 3 (4.80 ÷ 1.60) times more (less) in contribution margin and net income.
19-26
.
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EXERCISE 19-16 (Continued) (b) % Change in Sales X
Degree of Operating Leverage
=
% Change in Net Income
15% decrease: Traditional Yams Auto-Yams
(15%) (15%)
X X
1.60 4.80
= =
(24.0%) (72.0%)
10% increase: Traditional Yams Auto-Yams
10% 10%
X X
1.60 4.80
= =
16.0% 48.0%
(c) There are several possible answers that could be given. For example, if the candied Yams business is fairly stable, Auto-Yams might be the choice, because they will generate the higher contribution margin and net income. If, however, sales swing widely from year to year, Traditional Yams might be chosen because they will provide the more stable contribution margin and net income. Finally, if the investment banker is a risk taker, she might choose Auto-Yams in spite of year to year sales swings. *EXERCISE 19-17 (a) Unit Cost Direct materials Direct labor Variable manufacturing overhead Manufacturing cost per unit
.
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$ 7.50 2.45 5.80 $15.75
19-27
*EXERCISE 19-17 (Continued) (b) FELDE COMPANY Income Statement For the Year Ended December 31, 2014 Variable Costing Sales (80,000 lures X $25) Variable cost of goods sold (80,000 lures X $15.75) Variable selling and administrative expenses (80,000 lures X $3.90) Contribution margin Fixed manufacturing overhead Fixed selling and administrative expenses Net Income (loss)
$2,000,000 $1,260,000 312,000
1,572,000 428,000
225,000 240,100
465,100 $ (37,100)
(c) Unit Cost Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead ($225,000 ÷ 90,000) Manufacturing cost per unit
$ 7.50 2.45 5.80 2.50 $18.25
(d) FELDE COMPANY Income Statement For the Year Ended December 31, 2014 Absorption Costing Sales (80,000 lures X $25) $2,000,000 Cost of goods sold (80,000 lures X $18.25) 1,460,000 Gross profit 540,000 Variable selling and administrative expenses (80,000 lures X $3.90) $312,000 Fixed selling and administrative expenses 240,100 552,100 Net Income $ (12,100)
19-28
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*EXERCISE 19-18 (a) Direct materials used Direct labor incurred Variable manufacturing overhead Variable manufacturing costs
$ 79,000 30,000 21,500 $130,500
Variable manufacturing cost per unit = $130,500 ÷ 9,000 = $14.50 per unit Finished goods inventory cost = (9,000 – 8,200 units) X $14.50 = $11,600 (b) Absorption costing would show a higher net income because a portion of the fixed costs are deferred to future periods. The following computation indicates that finished goods inventory will be $4,000 higher under absorption costing which will cause its net income to be $4,000 higher. Direct materials used Direct labor incurred Variable manufacturing overhead Fixed manufacturing overhead Total manufacturing costs
$ 79,000 30,000 21,500 45,000 $175,500
Total manufacturing costs per unit = $175,500 ÷ 9,000 = $19.50 per unit Finished goods inventory cost = (9,000 – 8,200 units) X $19.50 = $15,600 Inventory (absorption costing) Inventory (variable costing)
$15,600 11,600 $ 4,000
*EXERCISE 19-19 (a)
.
Utility Expense Kilowatt Hourly Variable X = hours Charge Utilities
Months in a year
X
12
X
500
X
$0.40
Months in a year
X
Monthly Fee
=
Fixed Utilities
12
X
$1,500
= $18,000
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=
$2,400
19-29
*EXERCISE 19-19 (Continued) Variable Costing Labor: Crate builders Material: Wood Variable Overhead: Utilities Nails Total manufacturing costs
$38,000 54,000 2,400 350 $94,750
(b) Absorption Costing Labor: Crate builders Material: Wood Variable overhead: Utilities Nails Fixed overhead: Utilities Rent Total manufacturing costs
$ 38,000 54,000 2,400 350 18,000 21,400 $134,150
(c) The entire difference in costs between the two methods is due to the fact that fixed overhead is included as part of manufacturing costs only under the absorption costing method. This difference amounts to $39,400 ($18,000 + $21,400).
19-30
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SOLUTIONS TO PROBLEMS PROBLEM 19-1A (a) Sales were $2,000,000 and variable expenses were $1,100,000, which means contribution margin was $900,000 and CM ratio was .45. Fixed expenses were $1,035,000. Therefore, the break-even point in dollars is: $1,035,000 = $2,300,000 .45 (b) 1.
The effect of this alternative is to increase the selling price per unit to $31.25 ($25 X 125%). Total sales become $2,500,000 (80,000 X $31.25). Thus, contribution margin ratio changes to 56% [($2,500,000 – $1,100,000) ÷ $2,500,000]. The new break-even point is: $1,035,000 = $1,848,214 (rounded) .56
2.
The effects of this alternative are: (1) fixed costs decrease by $160,000, (2) variable costs increase by $100,000 ($2,000,000 X 5%), (3) total fixed costs become $875,000 ($1,035,000 – $160,000), and the contribution margin ratio becomes .40 [($2,000,000 – $1,100,000 – $100,000) ÷ $2,000,000]. The new break-even point is: $875,000 = $2,187,500 .40
3.
The effects of this alternative are: (1) variable and fixed cost of goods sold become $734,000 each, (2) total variable costs become $884,000 ($734,000 + $92,000 + $58,000), (3) total fixed costs are $1,251,000 ($734,000 + $425,000 + $92,000) and the contribution margin ratio becomes .558 [($2,000,000 – $884,000) ÷ $2,000,000]. The new break-even point is: $1,251,000 = $2,241,935 (rounded) .558
Alternative 1 is the recommended course of action using break-even analysis because it has the lowest break-even point. .
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19-31
PROBLEM 19-2A
(a) (1) Sales
Current Year $1,500,000
Variable costs Direct materials Direct labor Manufacturing overhead ($350,000 X .70) Selling expenses ($250,000 X .40) Administrative expenses ($270,000 X .20) Total variable costs Contribution margin
511,000 290,000 245,000 100,000 54,000 1,200,000 $ 300,000
Sales
Current Year $1,500,000 X 1.1
Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin
511,000 290,000 245,000 100,000 54,000 1,200,000 $ 300,000
Projected Year $1,650,000
X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1
562,100 319,000 269,500 110,000 59,400 1,320,000 $ 330,000
(2) Fixed Costs Current Year Manufacturing overhead ($350,000 X .30) $105,000 Selling expenses ($250,000 X .60) 150,000 Administrative expenses ($270,000 X .80) 216,000 Total fixed costs $471,000
19-32
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Projected year $105,000 150,000 216,000 $471,000
PROBLEM 19-2A (Continued) (b) Unit selling price = $1,500,000 ÷ 100,000 = $15 Unit variable cost = $1,200,000 ÷ 100,000 = $12 Unit contribution margin = $15 – $12 = $3 Contribution margin ratio = $3 ÷ $15 = .20 Break-even point in units 157,000 units
= Fixed costs = $471,000
÷ ÷
Unit contribution margin $3.00
Break-even point in dollars $2,355,000
= Fixed costs = $471,000
÷ ÷
Contribution margin ratio .20
(c) Sales dollars required for = (Fixed costs target net income
+ Target net income) ÷ Contribution margin ratio
$3,355,000 =
+
($471,000
$200,000)
(d) Margin of safety = (Expected sales ratio 29.8%
=
($3,355,000
÷
.20
– Break-even sales)
÷ Expected sales
–
÷
$2,355,000)
$3,355,000
(e) (1) Current Year $1,500,000
Sales Variable costs Direct materials Direct labor ($290,000 – $104,000) Manufacturing overhead ($350,000 X .30) Selling expenses ($250,000 X .90) Administrative expenses ($270,000 X .20) Total variable costs Contribution margin
.
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511,000 186,000 105,000 225,000 54,000 1,081,000 $ 419,000
19-33
PROBLEM 19-2A (Continued) Fixed cost Manufacturing overhead ($350,000 X .70) Selling expenses ($250,000 X .10) Administrative expenses ($270,000 X .80) Total fixed costs
$245,000 25,000 216,000 $486,000
(2) Contribution margin ratio = $419,000 ÷ $1,500,000 = .28 (rounded) (3) Break-even point in dollars = $486,000 ÷ .28 = $1,735,714 (rounded) The break-even point in dollars declined from $2,355,000 to $1,735,714. This means that overall the company’s risk has declined because it doesn’t have to generate as much in sales. The two changes actually had opposing effects on the break-even point. By changing to a more commission-based approach to compensate its sales staff the company reduced its fixed costs, and therefore reduced its break-even point. In contrast, the purchase of the new equipment increased the company’s fixed costs (by increasing its equipment depreciation) which would increase the break-even point.
19-34
.
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PROBLEM 19-3A
(a) Selling price Less: Variable costs Contribution margin per unit
Economy $30 14 $16
Product Standard $50 15 $35
Deluxe $100 46 $ 54
Ignoring the machine time constraint, the Deluxe product should be produced because it has the highest contribution margin per unit. (b) Contribution margin per unit (a) Machine hours required (b) Contribution margin per limited resource (a)/(b)
Economy $16 .5
Product Standard $ 35 .8
Deluxe $ 54 1.6
$32
$43.75
$33.75
(c) If additional machine hours become available, the additional time should be used to produce the Standard product since it has the highest contribution margin per machine hour.
.
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19-35
PROBLEM 19-4A (a) Sales Mix Percentage 15% 50% 10% 25%
Appetizers Main entrees Desserts Beverages
Total sales required to achieve target net income =
= = = = =
( $1,053,000 + $117,000 ) ÷ .45 = $2,600,000
Sales Mix Percentage 15% 50% 10% 25%
Appetizers Main entrees Desserts Beverages
X X X X X
Contribution Margin Ratio 50% 25% 50% 80%
Weighted-Average Contribution Margin Ratio .075 .125 .050 .200 .450
X X X X X
Total Sales Needed $2,600,000 $2,600,000 $2,600,000 $2,600,000
Sales from Each Product $ 390,000 1,300,000 260,000 650,000 $2,600,000
= = = = =
(b) Sales Mix Percentage 25% 25% 10% 40%
Appetizers Main entrees Desserts Beverages
Total sales required to achieve target net income =
X X X X X
Contribution Margin Ratio 50% 10% 50% 80%
= = = = =
Weighted-Average Contribution Margin Ratio .125 .025 .050 .320 .520
( $1,638,000* + $117,000) ÷ .52 = $ 3,375,000
*$1,053,000 + $585,000
19-36
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PROBLEM 19-4A (Continued) Thus, sales would have to increase by $775,000 ($3,375,000 – $2,600,000) to achieve the target net income. This increase in sales is driven by the increase in fixed costs. The sales of each product line would be:
Appetizers Main entrees Desserts Beverages
Sales Mix Percentage 25% 25% 10% 40%
X X X X X
Total Sales Needed $3,375,000 $3,375,000 $3,375,000 $3,375,000
= = = = =
Sales from Each Product $ 843,750 843,750 337,500 1,350,000 $3,375,000
(c)
Appetizers Main entrees Desserts Beverages
Sales Mix Percentage 15% 50% 10% 25%
X X X X X
Contribution Margin Ratio 50% 10% 50% 80%
= = = = =
Weighted-Average Contribution Margin Ratio .075 .050 .050 .200 .375
The weighted-average contribution margin ratio computed in part (a) was 45%. With the contribution margin ratio on entrees falling to 10%, that average will now be 37.5% as shown previously. Applying this to the new fixed costs of $1,638,000 and target net income of $117,000 we get: Total sales required to achieve target net income
Appetizers Main entrees Desserts Beverages
=
($1,638,000 + $117,000) ÷ .375 = $ 4,680,000
Sales Mix Percentage 15% 50% 10% 25%
X X X X X
Total Sales Needed $4,680,000 $4,680,000 $4,680,000 $4,680,000
= = = = =
Sales from Each Product $ 702,000 2,340,000 468,000 1,170,000 $4,680,000
Relative to parts (a) and (b), the total required sales for (c) would increase. It appears that the least risky approach would be for Phil to switch to the new sales mix, but not to incur the additional fixed costs of expanding operations. If the switch in sales mix appears to be successful, then it may be appropriate for him to incur the additional fixed costs necessary for expansion of operations. .
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
19-37
PROBLEM 19-5A (a) To determine the break-even point in dollars we must first calculate the contribution margin ratio for each company.
Viejo Company Nuevo Company
Contribution Margin ÷ $220,000 ÷ $320,000 ÷
Sales $500,000 $500,000
Viejo Company Nuevo Company
Fixed Costs $180,000 $280,000
Contribution Margin Ratio .44 .64
(Actual Sales ($500,000 ($500,000
Viejo Company Nuevo Company
– – –
÷ ÷ ÷
Break-even Sales) $409,091) $437,500)
÷ ÷ ÷
Contribution Margin = Ratio = .44 = .64 Break-even Point = in Dollars = $409,091 = $437,500
Actual Sales $500,000 $500,000
= = =
Margin of Safety Ratio .182 .125
(b)
Viejo Company Nuevo Company
Contribution Margin ÷ $220,000 ÷ $320,000 ÷
Net Income $40,000 $40,000
Degree of Operating = Leverage = 5.5 = 8.0
Because Nuevo Company relies more heavily on fixed costs, it has a higher degree of operating leverage. This means that its net income will be more sensitive to changes in sales. For a given change in sales, the change in net income will be 1.45 (8.0 ÷ 5.5) times higher for Nuevo Company than for Viejo Company. (c) Sales Variable costs Contribution margin Fixed costs Net income
Viejo Company $600,000* 336,000** 264,000 180,000 $ 84,000
Nuevo Company $600,000 216,000*** 384,000 280,000 $104,000
*$500,000 X 1.2 **$280,000 X 1.2 ***$180,000 X 1.2
19-38
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 19-5A (Continued) (d) Sales Variable costs Contribution margin Fixed costs Net income (Loss)
Viejo Company $400,000* 224,000** 176,000 180,000 ($ 4,000)
Nuevo Company $400,000 144,000*** 256,000 280,000 ($ 24,000)
*$500,000 X .80 **$280,000 X .80 ***$180,000 X .80 (e) In part (b) the degree of operating leverage of Nuevo Company was higher than that of Viejo Company, telling us that the net income of Nuevo Company was more sensitive to changes in sales than that of Viejo Company. In part (c) we see that a 20% increase in sales increased the net income of Nuevo Company by $64,000 ($104,000 – $40,000), while the net income of Viejo Company increased by only $44,000 ($84,000 – $40,000). However, in part (d) we see that a 20% decrease in sales resulted in a $64,000 ($40,000 + $24,000) decline in net income for Nuevo Company, while Viejo Company’s net income only declined by $44,000 ($40,000 + $4,000). The increased risk caused by higher operating leverage is also seen in part (a). Nuevo Company has a higher break-even point, and a lower margin of safety ratio than Viejo Company. Thus, while operating leverage can be very beneficial for a company that expects its sales to increase, it can also significantly increase a company’s risk.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
19-39
PROBLEM 19-6A
(a) Reformat the income statement to CVP format. All amount are in $000s. Sales ........................................................ Variable costs ($31,500 + $13,500) ......... Contribution margin ................................ Less: Fixed costs ($8,610 + $10,260) .... Operating income....................................
$75,000 45,000 30,000 18,870 $11,130
Contribution margin ratio = $30,000 ÷ $75,000 = 40% Break-even point = $18,870 ÷ 40% = $47,175 (b) If a hired workforce replaces sales agents, commissions will be reduced to 8% of sales, or $6,000; but fixed costs will increase by $7,500. Sales ........................................................ Variable costs ($31,500 + $6,000) ........... Contribution margin ................................ Less: Fixed costs ($18,870* + $7,500) ... Operating income....................................
$75,000 37,500 37,500 26,370 $11,130
*($8,610 + $10,260) Contribution margin ratio = $37,500 ÷ $75,000 = 50% Break-even point = $26,370 ÷ 50% = $52,740 (c) Operating leverage = contribution margin ÷ operating income (1) Current situation: from part (a) $30,000 ÷ $11,130 = 2.70 (2) Proposed situation: from part (b) $37,500 ÷ $11,130 = 3.37
19-40
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 19-6A (Continued) The calculations indicate that at a sales level of $75 million, a percentage change in sales and contribution margin will result in 2.70 times that percentage change in operating income if Bonita continues to use sales agents. If they choose to employ their own, the change in operating income will be 3.37 times the percentage change in sales. The higher contribution margin per dollar of sales and higher fixed costs from Bonita employing their own agents gives them more operating leverage. This will result in greater benefits (increases in operating income) if revenues increase, but greater risks (decreases in operating income) if revenues decline. (d) The sales level at which operating incomes will be identical is called the point of indifference. This would be when the cost of the network of agents (18% of sales) is exactly equal to the cost of paying employees 8% commission along with additional fixed costs of $7.5 million. None of the other costs is relevant, because they will not change between alternatives. Let the sales volume = S 18% X S = (8% X S) + $7,500,000 .18S = .08S + $7,500,000 .10S = $7,500,000 S = $75,000,000
.
Kimmel, Accounting, 5e, Solutions Manual
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19-41
*PROBLEM 19-7A
(a)
GARDNER COMPANY Income Statement For the Year Ended December 31, 2013 Variable Costing Sales (2,500 tons X $2,000) ......................... Variable cost of goods sold Inventory, January 1 ............................ Variable cost of goods manufactured [4,000 tons X ($2,000 X .15)] ............ Variable cost of goods available for sale .............................................. Inventory, December 31 [1,500 tons X ($2,000 X .15)] ............ Variable cost of goods sold ................. Variable selling expenses [2,500 tons X ($2,000 X .10)] ............ Contribution margin .................................... Fixed manufacturing overhead ................... Fixed administrative expenses ................... Net income ...................................................
19-42
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Kimmel, Accounting, 5e, Solutions Manual
$5,000,000 –0–
$
1,200,000 1,200,000 450,000 750,000 500,000 2,000,000 500,000
(For Instructor Use Only)
1,250,000 3,750,000 2,500,000 $1,250,000
*PROBLEM 19-7A (Continued) GARDNER COMPANY Income Statement For the Year Ended December 31, 2014 Variable Costing Sales (4,000 tons X $2,000) ........................... Variable cost of goods sold Inventory, January 1 .............................. Variable cost of goods manufactured [2,500 tons X ($2,000 X .15)] .............. Variable cost of goods available for sale ................................................ Inventory, December 31 ......................... Variable cost of goods sold .................. Variable selling expenses [4,000 tons X ($2,000 X .10)] .............. Contribution margin ...................................... Fixed manufacturing overhead ..................... Fixed administrative expenses ..................... Net income ..................................................... (b)
$8,000,000 $ 450,000 750,000 1,200,000 –0– 1,200,000 800,000 2,000,000 500,000
2,000,000 6,000,000 2,500,000 $3,500,000
GARDNER COMPANY Income Statement For the Year Ended December 31, 2013 Absorption Costing Sales (2,500 tons X $2,000) ...................... Cost of goods sold Inventory, January 1 ......................... Cost of goods manufactured............ Cost of goods available for sale ...... Inventory, December 31 .................... Cost of goods sold ............................ Gross profit ............................................... Variable selling expenses [2,500 tons X ($2,000 X .10)] ................. Fixed administrative expenses ................ Net income ................................................
$5,000,000 $ –0– 3,200,000 (1) 3,200,000 1,200,000 (2) 2,000,000 3,000,000 500,000 500,000
1,000,000 $2,000,000
(1) 4,000 X [($2,000 X .15) + ($2,000,000 ÷ 4,000)] (2) 1,500 X [($2,000 X .15) + ($2,000,000 ÷ 4,000)] .
Kimmel, Accounting, 5e, Solutions Manual
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19-43
*PROBLEM 19-7A (Continued) GARDNER COMPANY Income Statement For the Year Ended December 31, 2014 Absorption Costing Sales (4,000 tons X $2,000) .................. Cost of goods sold Inventory, January 1 ..................... Cost of goods manufactured ........ Cost of goods available for sale ... Inventory, December 31 ................ Cost of goods sold ........................ Gross profit ........................................... Variable selling expenses [4,000 tons X ($2,000 X .10)] ............. Fixed administrative expenses ............ Net income ............................................
$8,000,000 $1,200,000 2,750,000 (1) 3,950,000 –0– 3,950,000 4,050,000 800,000 500,000
1,300,000 $2,750,000
(1) 2,500 X [($2,000 X .15) + ($2,000,000 ÷ 2,500)] (c) The variable costing and the absorption costing net income can be reconciled as follows: 2013
2014
Variable costing net income $1,250,000 $3,500,000 Fixed manufacturing overhead expensed with variable costing $2,000,000 $2,000,000 Less: Fixed manufacturing overhead expensed with absorption costing (1,250,000)(1) (2,750,000)(2) Difference 750,000 (750,000) Absorption costing net income $2,000,000 $2,750,000
In 2013, with absorption costing $1,250,000 $2,000,000 X
(1)
of the 4,000 units produced 2,500 units sold
fixed manufacturing overhead is expensed as part of cost of goods sold, and $750,000
1,500 units in inventory $2,000,000 X 4,000 units produced is included in the ending inventory.
(2)
In 2014, with absorption costing $2,750,000 of fixed manufacturing overhead is expensed as part of cost of goods sold. This includes the fixed manufacturing overhead for 2014 of $2,000,000 plus $750,000 of fixed manufacturing overhead from 2013 that was included in the beginning inventory for 2014.
19-44
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Kimmel, Accounting, 5e, Solutions Manual
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*PROBLEM 19-7A (Continued) (d) Income parallels sales under variable costing as seen in the increase in net income in 2014 when 1,500 additional units were sold. In contrast, under absorption costing, income parallels production as seen in the higher net income in 2013 when production exceeded sales by 1,500 tons.
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Kimmel, Accounting, 5e, Solutions Manual
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19-45
*PROBLEM 19-8A (a) DILITHIUM BATTERIES DIVISION Income Statement For the Year Ended December 31, 2014 Absorption Costing _______________________________________________________________
Sales (60,000 units X $30) Cost of goods sold (60,000 units X $21) Gross profit Variable selling and administrative expenses (60,000 units x $2) Fixed selling and administrative expenses Net income
60,000 Produced $1,800,000 1,260,000 540,000
90,000 Produced $1,800,000 (60,000 X $18)
1,080,000 720,000
120,000
120,000
50,000 $ 370,000
50,000 $ 550,000
(b) DILITHIUM BATTERIES DIVISION Income Statement For the Year Ended December 31, 2014 Variable Costing _______________________________________________________________
Sales (60,000 units X $30) Variable cost of goods sold (60,000 units X $12) Variable selling and administrative expenses (60,000 units X $2) Contribution margin Fixed manufacturing overhead Fixed selling and administrative expenses Net income
19-46
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Kimmel, Accounting, 5e, Solutions Manual
60,000 Produced $1,800,000
90,000 Produced $1,800,000
720,000
720,000
120,000 960,000 540,000
120,000 960,000 540,000
50,000 $ 370,000
50,000 $ 370,000
(For Instructor Use Only)
*PROBLEM 19-8A (Continued) (c) If the company produces 90,000 units, but only sells 60,000 units, then 30,000 units will remain in ending inventory. Under absorption costing these 30,000 units will each include $6 of fixed manufacturing overhead—a total of $180,000. However, under variable costing, fixed manufacturing overhead is expensed when incurred. This accounts for the $180,000 difference ($550,000 – $370,000) in net income. This is summarized as: Net income under absorption costing Less: Fixed manufacturing overhead included in ending inventory (30,000 units X $6) Net income under variable costing
$550,000 180,000 $370,000
(d) Variable costing has a number of advantages over absorption costing for decision making and evaluation purposes. (1) The use of variable costing is consistent with cost-volume-profit and incremental analysis. (2) Net income computed under variable costing is unaffected by changes in production levels. Note that, under variable costing the company’s net income is $370,000 no matter what the level of production is. (3) Net income computed under variable costing is closely tied to changes in sales levels (not production levels), and therefore provides a more realistic assessment of the company’s success or failure during a period. (4) The presentation of fixed and variable cost components on the face of the variable costing income statement makes it easier to identify these costs and understand their effect on the business. Under absorption costing, the allocation of fixed costs to inventory makes it difficult to evaluate the impact of fixed costs on the company’s results.
.
Kimmel, Accounting, 5e, Solutions Manual
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19-47
PROBLEM 19-1B
(a) Sales were $2,400,000 and variable expenses were $1,536,000, which means contribution margin was $864,000 and CM ratio was .36. Fixed expenses were $936,000. Therefore, the break-even point in dollars is: $936,000 = $2,600,000 .36 (b) 1.
The effect of this alternative is to increase the selling price per unit to $15 ($12 X 125%). Total sales become $3,000,000 (200,000 X $15). Thus, contribution margin changes to 48.8% [($3,000,000 – $1,536,000) ÷ $3,000,000]. The new break-even point is: $936,000 = $1,918,033 (rounded) .488
2.
The effects of this alternative are: (1) fixed costs decrease by $120,000, (2) variable costs increase by $144,000 ($2,400,000 X 6%), (3) total fixed costs become $816,000 ($936,000 – $120,000), and the contribution margin becomes .30 [($2,400,000 – $1,536,000 – $144,000) ÷ $2,400,000]. The new break-even point is: $816,000 = $2,720,000 .30
3.
The effects of this alternative are: (1) variable and fixed cost of goods sold become $594,400 and $891,600, (2) total variable costs become $1,060,400 ($594,400 + $356,000 + $110,000), (3) total fixed costs are $1,411,600 ($891,600 + $325,000 + $195,000) and the contribution margin becomes .5582 [($2,400,000 – $1,060,400) ÷ $2,400,000]. The new break-even point is: $1,411,600 = $2,529,749 (rounded) .558
Alternative 1 is the recommended course of action using break-even analysis because it has the lowest break-even point.
19-48
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 19-2B
(a) (1) Sales
Current Year $1,000,000
Variable costs Direct materials Direct labor Manufacturing overhead ($240,000 X .20) Selling expenses ($200,000 X .30) Administrative expenses ($250,000 X .30) Total variable costs Contribution margin
327,000 190,000 48,000 60,000 75,000 700,000 $ 300,000
Sales
Current Year $1,000,000 X 1.2
Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin
327,000 190,000 48,000 60,000 75,000 700,000 $ 300,000
X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2
Projected Year $1,200,000 392,400 228,000 57,600 72,000 90,000 840,000 $ 360,000
(2) Fixed Costs Current Year Manufacturing overhead ($240,000 X .80) $192,000 Selling expenses ($200,000 X .70) 140,000 Administrative expenses ($250,000 X .70) 175,000 Total fixed costs $507,000
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Kimmel, Accounting, 5e, Solutions Manual
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Projected year $192,000 140,000 175,000 $507,000
19-49
PROBLEM 19-2B (Continued) (b) Unit selling price = $1,000,000 ÷ 40,000 = $25.00 Unit variable cost = $700,000 ÷ 40,000 = $17.50 Unit contribution margin = $25.00 – $17.50 = $7.50 Contribution margin ratio = $7.50 ÷ $25 = .30 Break-even point in units 67,600 units
= Fixed costs = $507,000
÷ ÷
Unit contribution margin $7.50
Break-even point in dollars $1,690,000
= Fixed costs = $507,000
÷ ÷
Contribution margin ratio .30
(c) Sales dollars required for = (Fixed costs target net income
+ Target net income) ÷ Contribution margin ratio
$2,090,000 =
+
($507,000
$120,000)
(d) Margin of safety = (Expected sales ratio 19.1%
=
($2,090,000
÷
.30
– Break-even sales)
÷ Expected sales
–
÷
$1,690,000)
(e) (1) Current Year $1,000,000
Sales Variable costs Direct materials Direct labor ($190,000 – $90,000) Manufacturing overhead ($240,000 X .10) Selling expenses ($200,000 X .80) Administrative expenses ($250,000 X .30) Total variable costs Contribution margin Fixed cost Manufacturing overhead ($240,000 X .90) Selling expenses ($200,000 X .20) Administrative expenses ($250,000 X .70) Total fixed costs
19-50
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Kimmel, Accounting, 5e, Solutions Manual
327,000 100,000 24,000 160,000 75,000 686,000 $ 314,000 $ 216,000 40,000 175,000 $ 431,000
(For Instructor Use Only)
$2,090,000
PROBLEM 19-2B (Continued) (2) Contribution margin ratio = $314,000 ÷ $1,000,000 = .314 (3) Break-even point in dollars = $431,000 ÷ .314 = $1,372,611 (rounded) The break-even point in dollars declined from $1,690,000 to $1,372,611. This means that overall the company’s risk has declined because it doesn’t have to generate so much in sales. The two changes actually had opposing effects on the break-even point. By changing to a more commission-based approach to compensate its sales staff the company reduced its fixed costs, and therefore reduced its break-even point. In contrast, the purchase of the new equipment increased the company’s fixed costs (by increasing its equipment depreciation) and reduced its variable direct labor cost, both of which would increase the break-even point.
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Kimmel, Accounting, 5e, Solutions Manual
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19-51
PROBLEM 19-3B
(a) Selling price Less: Variable costs Contribution margin per unit
Economy $270 144 $126
Product Standard $450 260 $190
Deluxe $650 430 $220
Ignoring the machine time constraint, the Deluxe product should be produced because it has the highest contribution margin per unit. (b) Contribution margin per unit (a) Machine hours required (b) Contribution margin per limited resource (a)/(b)
Economy $126 .6
Product Standard $ 190 .8
Deluxe $ 220 1.1
$210
$237.50
$
200
(c) If additional machine hours become available, the additional time should be used to produce the Standard product since it has the highest contribution margin per machine hour.
19-52
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 19-4B (a)
Appetizers Main entrees Desserts Beverages
Sales Mix Percentage 15% 60% 10% 15%
Total sales required to achieve target net income =
Appetizers Main entrees Desserts Beverages
X X X X X
Contribution Margin Ratio 60% 25% 40% 80%
= = = = =
Weighted-Average Contribution Margin Ratio .09 .15 .04 .12 .40
( $352,000 + $176,000 ) ÷ .40 = $1,320,000
Sales Mix Percentage 15% 60% 10% 15%
X X X X X
Total Sales $1,320,000 $1,320,000 $1,320,000 $1,320,000
X X X X X
Contribution Margin Ratio 60% 10% 50% 80%
= = = = =
Sales from Each Product $ 198,000 792,000 132,000 198,000 $1,320,000
(b)
Appetizers Main entrees Desserts Beverages
Sales Mix Percentage 25% 40% 10% 25%
Total sales required to achieve target net income =
= = = = =
Weighted-Average Contribution Margin Ratio .15 .04 .05 .20 .44
( $528,000* + $176,000) ÷ .44 = $1,600,000
*$352,000 X 1.5
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Kimmel, Accounting, 5e, Solutions Manual
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19-53
PROBLEM 19-4B (Continued) Thus, sales would have to increase by $280,000 ($1,600,000 – $1,320,000) to achieve the target net income. This increase in sales is driven by the increase in fixed costs. The sales of each product line would be: Sales Mix Percentage 25% 40% 10% 25%
Appetizers Main entrees Desserts Beverages
X X X X X
Total Sales Needed $1,600,000 $1,600,000 $1,600,000 $1,600,000
Sales Dollars Per Product $ 400,000 640,000 160,000 400,000 $1,600,000
= = = = =
(c) Sales Mix Percentage 15% 60% 10% 15%
Appetizers Main entrees Desserts Beverages
Contribution X Margin Ratio X 60% X 10% X 50% X 80%
= = = = =
Weighted-Average Contribution Margin Ratio .09 .06 .05 .12 .32
The weighted-average contribution margin ratio computed in part (a) was 40%. With the contribution margin ratio on entrees falling to 10%, that average will now be 32% as shown above. Applying this to the new fixed costs of $528,000 and target net income of $176,000 we get: Total sales required to achieve target net income
($528,000 + $176,000) ÷ .32 = $2,200,000
Sales Mix Percentage 15% 60% 10% 15%
Appetizers Main entrees Desserts Beverages
19-54
=
.
X X X X X
Total Sales Needed $2,200,000 $2,200,000 $2,200,000 $2,200,000
Kimmel, Accounting, 5e, Solutions Manual
= = = = =
(For Instructor Use Only)
Sales from Each Product $ 330,000 1,320,000 220,000 330,000 $2,200,000
PROBLEM 19-4B (Continued) Relative to parts (a) and (b), the total required sales for (c) would increase. It appears that the least risky approach would be for Michael to switch to the new sales mix, but not to incur the additional fixed costs of expanding operations. If the switch in sales mix appears to be successful, then it may be appropriate for him to incur the additional fixed costs necessary for expansion of operations.
.
Kimmel, Accounting, 5e, Solutions Manual
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19-55
PROBLEM 19-5B
(a) To determine the break-even point in dollars we must first calculate the contribution margin ratio for each company.
Lyte Company Darke Company
Contribution Margin ÷ $400,000 ÷ $800,000 ÷
Lyte Company Darke Company
Fixed Costs ÷ $200,000 ÷ $600,000 ÷
Contribution Margin Ratio .40 .80
Sales = $1,000,000 = $1,000,000 =
Contribution Margin Ratio = .40 = .80 =
Break-even Point in Dollars $500,000 $750,000 Margin of Safety
(Actual Sales
–
Break-even Sales)
÷
Actual Sales
=
Ratio
Lyte Company
($1,000,000
–
$500,000)
÷
$1,000,000
=
.50
Darke Company
($1,000,000
–
$750,000)
÷
$1,000,000
=
.25
(b)
Lyte Company Darke Company
Contribution Net Margin ÷ Income = $400,000 ÷ $200,000 = $800,000 ÷ $200,000 =
Degree of Operating Leverage 2.00 4.00
Because Darke Company relies more heavily on fixed costs, it has a higher degree of operating leverage. This means that its net income will be more sensitive to changes in sales. For a given change in sales, the change in net income will be 2.0 (4.00 ÷ 2.00) times higher for Darke Company than for Lyte Company.
19-56
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PROBLEM 19-5B (Continued) (c) Sales Variable costs Contribution margin Fixed costs Net income
Lyte Company $1,300,000* 780,000** 520,000 200,000 $ 320,000
Darke Company $1,300,000 260,000*** 1,040,000 600,000 $ 440,000
Lyte Company $700,000* 420,000** 280,000 200,000 $ 80,000
Darke Company $700,000 140,000*** 560,000 600,000 ($ 40,000)
*$1,000,000 X 1.3 **$600,000 X 1.3 ***$200,000 X 1.3 (d) Sales Variable costs Contribution margin Fixed costs Net income *$1,000,000 X .70 **$600,000 X .70 ***$200,000 X .70 (e) In part (b) the degree of operating leverage of Darke Company was higher than that of Lyte Company, telling us that the net income of Darke Company was more sensitive to changes in sales than that of Lyte Company. In part (c) we see that a 30% increase in sales increased the net income of Darke Company by $240,000 ($440,000 – $200,000), while the net income of Lyte Company increased by only $120,000 ($320,000 – $200,000). However, in part (d) we see that a 30% decrease in sales resulted in a $240,000 ($40,000 + $200,000) decline in net income for Darke Company, while Lyte Company’s net income only declined by $120,000 ($200,000 – $80,000). The increased risk caused by higher operating leverage is also seen in part (a). Darke Company has a higher break-even point, and a lower margin of safety ratio than Lyte Company. Thus, while operating leverage can be very beneficial for a company that expects its sales to increase, it can also significantly increase a company’s risk.
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Kimmel, Accounting, 5e, Solutions Manual
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19-57
PROBLEM 19-6B
(a) Reformat the income statement to CVP format. All amount are in $000s. Sales .................................................................. Variable costs ($58,500 + $19,500) ................... Contribution margin .......................................... Less: Fixed costs ($11,000 + $10,000) ............ Operating income..............................................
$120,000 78,000 42,000 21,000 $ 21,000
Contribution margin ratio = $42,000 ÷ $120,000 = 35% Break-even point = $21,000 ÷ 35% = $60,000 (b) If a hired workforce replaces sales agents, commissions will be reduced to 10% of sales, or $12,000; but fixed costs will increase by $12,000. Sales .................................................................. $120,000 Variable costs ($58,500 + $12,000) ................... 70,500 Contribution margin .......................................... 49,500 Less: Fixed costs ($21,000* + $12,000) ........... 33,000 Operating income.............................................. $ 16,500 *($11,000 + $10,000) Contribution margin ratio = $49,500 ÷ $120,000 = 41.25% Break-even point = $33,000 ÷ 41.25% = $80,000 (c) Operating leverage = contribution margin ÷ operating income (1) Current situation: from part (a) $42,000 ÷ $21,000 = 2.00 (2) Proposed situation: from part (b) $49,500 ÷ $16,500 = 3.00
19-58
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PROBLEM 19-6B (Continued) The calculations indicate that at a sales level of $120 million, a percentage change in sales and contribution margin will result in 2.00 times that percentage change in operating income if Peaches continues to use sales agents. If they choose to employ their own, the change in operating income will be 3.00 times the percentage change in sales. The higher contribution margin per dollar of sales and higher fixed costs from Peaches employing their own agents gives them more operating leverage. This will result in greater benefits (increases in operating income) if revenues increase, but greater risks (decreases in operating income) if revenues decline. (d) The sales level at which operating incomes will be identical is called the point of indifference. This would be when the cost of the network of agents (16.25% of sales) is exactly equal to the cost of paying employees 10% commission along with additional fixed costs of $12.0 million. None of the other costs is relevant, because they will not change between alternatives. Let the sales volume = S 16.25% X S = (10% X S) + $12,000 .1625S = .10S + $12,000 .0625S = $12,000 S = $192,000
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*PROBLEM 19-7B
(a)
FAB COMPANY Income Statement For the Year Ended December 31, 2013 Variable Costing Sales (400,000 yards X $2.50) ...................... Variable cost of goods sold Inventory, January 1 ............................. Variable cost of goods manufactured [500,000 yards X $2.50 X 30%] .......... Variable cost of goods available for sale ............................................... Inventory, December 31 [100,000 yards X $2.50 X 30%] .......... Variable cost of goods sold .................. Variable selling expenses [400,000 yards X $2.50 X 10%] .......... Contribution margin ..................................... Fixed manufacturing overhead .................... Fixed administrative expenses .................... Net income ....................................................
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$1,000,000 $ –0– 375,000 375,000 75,000 300,000 100,000 400,000 100,000
(For Instructor Use Only)
400,000 600,000 500,000 $ 100,000
*PROBLEM 19-7B (Continued) FAB COMPANY Income Statement For the Year Ended December 31, 2014 Variable Costing Sales (500,000 yards X $2.50) .................... Variable cost of goods sold Inventory, January 1 ........................... Variable cost of goods manufactured [400,000 yards X $2.50 X 30%]........ Variable cost of goods available for sale ............................................. Inventory, December 31 ...................... Variable cost of goods sold ............... Variable selling expenses [500,000 yards X ($2.50 X 10%)] ..... Contribution margin ................................... Fixed manufacturing overhead .................. Fixed administrative expenses .................. Net income .................................................. (b)
$1,250,000 $ 75,000 300,000 375,000 –0– 375,000 125,000 400,000 100,000
500,000 750,000 500,000 $ 250,000
FAB COMPANY Income Statement For the Year Ended December 31, 2013 Absorption Costing Sales (400,000 yards X $2.50) .................. Cost of goods sold Inventory, January 1 ......................... Cost of goods manufactured............ Cost of goods available for sale Inventory, December 31 .................... Cost of goods sold ............................ Gross profit ............................................... Variable selling expenses [400,000 yards X ($2.50 X .10)] ............. Fixed administrative expenses ................ Net income ................................................
$1,000,000 $ –0– 775,000 (1) 775,000 155,000 (2) 620,000 380,000 100,000 100,000
200,000 $ 180,000
(1) 500,000 X [($2.50 X 30%) + ($400,000 ÷ 500,000)] (2) 100,000 X [($2.50 X 30%) + ($400,000 ÷ 500,000)] .
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*PROBLEM 19-7B (Continued) FAB COMPANY Income Statement For the Year Ended December 31, 2014 Absorption Costing Sales (500,000 yards X $2.50) .............. Cost of goods sold Inventory, January 1 ..................... Cost of goods manufactured ........ Cost of goods available for sale... Inventory, December 31 ................ Cost of goods sold ........................ Gross profit ........................................... Variable selling expenses [500,000 yards X ($2.50 X .10)] ......... Fixed administrative expenses ............ Net income ............................................
$1,250,000 $ 155,000 700,000 (1) 855,000 –0– 855,000 395,000 125,000 100,000
225,000 $ 170,000
(1) 400,000 X [($2.50 X 30%) + ($400,000 ÷ 400,000)] (c) The variable costing and the absorption costing income from operations can be reconciled as follows: 2013 Variable costing net income Fixed manufacturing overhead expensed with variable costing Less: Fixed manufacturing overhead expensed with absorption costing Difference Absorption costing income
2014
$100,000
$250,000
$400,000
$400,000
(320,000)(1)
(480,000)(2) 80,000 $180,000
In 2013, with absorption costing $320,000 $400,000 X
(1)
(80,000) $170,000
of 500,000 units manufactured 400,000 units sold
the fixed manufacturing overhead is expensed as part of cost of goods sold, and $80,000
100,000 units in inventory $400,000 X is included in the ending inventory. 500,000 units produced
(2)
In 2014, with absorption costing $480,000 of fixed manufacturing overhead is expensed as part of cost of goods sold. This includes the fixed manufacturing overhead for 2014 of $400,000 plus $80,000 of fixed manufacturing overhead from 2013 that was included in the beginning inventory for 2014.
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*PROBLEM 19-7B (Continued) (d) Income parallels sales under variable costing as seen in the increase in net income in 2014 when 100,000 additional units were sold. In contrast, under absorption costing, income parallels production as seen in the higher net income in 2013 when production exceeded sales by 100,000.
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*PROBLEM 19-8B (a) ELECTRICOIL DIVISION Income Statement For the Year Ended December 31, 2014 Absorption Costing
Sales (200,000 units X $9) Cost of goods sold (200,000 units X $5.50) Gross profit Variable selling and administrative expenses (200,000 units X $0.40) Fixed selling and administrative expenses Net income
200,000 Produced $1,800,000
250,000 Produced $1,800,000
1,100,000 (200,000 X $5.00) 1,000,000 700,000 800,000 80,000
80,000
15,000 $ 605,000
15,000 $ 705,000
(b) ELECTRICOIL DIVISION Income Statement For the Year Ended December 31, 2014 Variable Costing _______________________________________________________________ 200,000 250,000 Produced Produced Sales (200,000 units X $9) $1,800,000 $1,800,000 Variable cost of goods sold (200,000 units X $3) 600,000 600,000 Variable selling and administrative expenses (200,000 units X $0.40) 80,000 80,000 Contribution margin 1,120,000 1,120,000 Fixed manufacturing overhead 500,000 500,000 Fixed selling and administrative expenses 15,000 15,000 Net income $ 605,000 $ 605,000 19-64
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*PROBLEM 19-8B (Continued) (c) If the company produces 250,000 units, but only sells 200,000 units, then 50,000 units will remain in ending inventory. Under absorption costing these 50,000 units will each include $2.00 of fixed manufacturing cost—a total of $100,000. However, under variable costing, fixed manufacturing cost is expensed when incurred. This accounts for the $100,000 difference ($705,000 – $605,000) in net income. This is summarized as: Net income under absorption costing Less: Fixed manufacturing cost included in ending inventory Net income under variable costing
$705,000 100,000 $605,000
(d) Variable costing has a number of advantages over absorption costing for decision making and evaluation purposes. (1) The use of variable costing is consistent with cost-volume-profit and incremental analysis: (2) Net income computed under variable costing is unaffected by changes in production levels. Note that, under variable costing the company’s net income is $605,000 no matter what the level of production is. (3) Net income computed under variable costing is closely tied to changes in sales levels (not production levels), and therefore provides a more realistic assessment of the company’s success or failure during a period. (4) The presentation of fixed and variable cost components on the face of the variable costing income statement makes it easier to identify these costs and understand their effect on the business. Under absorption costing, the allocation of fixed costs makes it difficult to evaluate the impact of fixed costs on the company’s results.
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BYP 19-1
DECISION-MAKING AT CURRENT DESIGNS
(a) Rotomolded Kayaks (($950 – $570) X .80)
+
Composite Kayaks = (($2,000 – $1,340) X .20)
Weighted Average Unit Contribution Margin $436
(b) Break-even Sales = $820,000 ÷ $436 = 1,881 units Break-even Sales Distribution:
Rotomolded Kayaks = 1,881 X 80% = 1,505 units Composite Kayaks = 1,881 X 20% = 376 units
(c) Target Net Income in Units: Rotomolded Kayaks + ($380 X .70)
Composite Kayaks ($660 X .30)
=
Weighted-Average CM/Unit $464
Required Sales in Units = ($820,000 + $2,000,000) ÷ $464 = 6,078 units Break-even Sales Distribution:
Rotomolded Kayaks = 6,078 X 70% = 4,255 units Composite Kayaks = 6,078 X 30% = 1,823 units
(d) CVP Income Statement
Sales Variable Costs Contribution Margin Fixed Costs Net Income
Rotomolded $2,000,000 1,200,000* 800,000 660,000 $ 140,000
*($570 ÷ $950) X $2,000,000
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Composite $1,000,000 670,000** 330,000 160,000 $ 170,000
**($1,340 ÷ $2,000) X $1,000,000
(For Instructor Use Only)
BYP 19-1 (Continued) (e) Degree of Operating Leverage Rotomolded Kayaks = $800,000 ÷ $140,000 = 5.71 Composite Kayaks = $330,000 ÷ $170,000 = 1.94 At a sales mix of 2/3 to 1/3, the degree of operating leverage is nearly three times as high for the rotomolded kayaks as it is for the composite kayaks. This means that the company’s net income will respond more quickly to a change in the sales of rotomolded kayaks than to composite kayaks. For example, an increase in sales of the rotomolded kayaks will increase the company’s net income at a faster rate than an increase in the sales of the composite kayaks. This result will differ depending on what sales mix assumption is made.
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BYP 19-2
DECISION-MAKING ACROSS THE ORGANIZATION
(a) Sales (10,000 seats X $500) Variable costs (10,000 seats X $200) Contribution margin Fixed costs Net income
$5,000,000 2,000,000 3,000,000 2,000,000 $1,000,000
(b) Contribution margin ratio = $3,000,000 ÷ $5,000,000 = .60 Break-even point in dollars = $2,000,000 ÷ .60 = $3,333,333 Margin of safety ratio = ($5,000,000 – $3,333,333) ÷ $5,000,000 = .333 Degree of operating leverage = $3,000,000 ÷ $1,000,000 = 3.0 (c) Sales (10,000 seats X $500) Variable costs (10,000 seats X $ 100) Contribution margin Fixed costs Net income
$5,000,000 1,000,000 4,000,000 3,000,000 $1,000,000
(d) Contribution margin ratio = $4,000,000 ÷ $5,000,000 = .80 Break-even point in dollars = $3,000,000 ÷ .80 = $3,750,000 Margin of safety ratio = ($5,000,000 – $3,750,000) ÷ $5,000,000 = .25 Degree of operating leverage = $4,000,000 ÷ $1,000,000 = 4.00 (e) By automating its manufacturing process the company will replace some of its variable costs with fixed costs. This shift toward more fixed costs will increase its break-even point from $3,333,333 to $3,750,000 and reduce its margin of safety from 33.3% to 25%. This means that under the old system sales could fall by 33.3% percent before the company would operate at a loss, whereas under the automated system they could only fall by 25%. Both of these findings suggest that the company would be riskier with the automated system. However, the company’s degree of operating leverage would increase from 3.0 to 4.00. This means that with a change in sales, the change in net income would be 1.33 (4 ÷ 3) times higher under the automated system. This would be good if the company expects sales to increase, but would be bad if the company’s sales fall.
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BYP 19-3
(a)
MANAGERIAL ANALYSIS
The contribution margin ratios under each approach are: Current approach Automated approach
$500,000/$2,000,000 = .25 $1,000,000/$2,000,000 = .50
This means that for every dollar of sales, net income goes up by 25 cents under the current approach, but by $.50 under the automated approach. (b)
The break-even points in sales dollars under each approach are: Current approach Automated approach
$380,000/.25 $800,000/.50
= =
$1,520,000 $1,600,000
This shows that, under the automated approach, the company’s sales would have to be 5.26% higher just to break-even. (c)
At the current level of sales, the margin of safety ratio under each approach is: Current approach Automated approach
($2,000,000 – $1,520,000)/$2,000,000 ($2,000,000 – $1,600,000)/$2,000,000
= .24 = .20
The company has a low margin of safety under either approach. Under the current approach sales could drop 24% before the company would be operating at a loss. Under the automated approach the company’s sales could drop by 20% before it would be operating at a loss. (d)
The degree of operating leverage under each approach at the current level of sales is: Current approach Automated approach
$500,000/$120,000 $1,000,000/$200,000
= =
4.17 5.00
This means that for a 10% drop in sales net income would drop by 41.7 percent for the current approach, but 50% for the automated approach. Recall, however, that at the current level of sales the company makes considerably more money using the automated approach.
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BYP 19-3 (Continued) (e)
In order to solve for the sales level where net income would be equal under either approach, set the two CVP equations equal to each other and solve for sales: Sales – ((1 – .75) X Sales) – $380,000 = Sales – ((1 – .5) X Sales) – $800,000 (.25 X Sales) – $380,000 = (.5 X Sales) – $800,000 (.25 X Sales) = $420,000 Sales = $1,680,000
When sales are equal to $1,680,000 the company would make the same amount of income under either approach. Current approach Automated approach
(f)
19-70
$1,680,000 – [(1 – .25) X $1,680,000] – $380,000 = $40,000 $1,680,000 – [(1 – .5) X $1,680,000] – $800,000 = $40,000
Based upon this numeric analysis it would appear that the decision to purchase the automated system would be a good decision. The current level of sales far exceeds the break-even point, and, unless sales were to fall all the way to $1,680,000, the company would be better off under the automated system. However, there are many difficult issues that should also be considered. Not-the-least of these is the decision to lay-off 15 employees, many of whom have likely been with the company for a long time. Also, the company should carefully evaluate whether the automated system will be able to attain the same level of quality as the skilled employees. Perhaps the automated system would be more appropriate for some of the painting work, while skilled labor would be more appropriate for other painting work.
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BYP 19-4
REAL-WORLD FOCUS
(a) ($ in millions)
Sales Variable costs Contribution margin
Consumer Products $1,031.8 610.0 $ 421.8
Pet Products $ 837.3 350.0 $ 487.3
Soup and Infant-Feeding Products $ 302.0 100.0 $ 202.0
Contribution margin ÷ Sales Contribution margin ratio
$ 421.8 1,031.8 40.9%
$ 487.3 837.3 58.2%
$ 202.0 302.0 66.9%
Division sales ÷ Total sales Sales mix percentage
$1,031.8 2,171.1 47.5%
$ 837.3 2,171.1 38.6%
$ 302.0 2,171.1 13.9%
(b)
Consumer products Pet products Soup and infant-feeding products Break-even point in dollars
Consumer products Pet products Soup and infantfeeding products Total sales
=
Weighted-Average Sales Mix Contribution Contribution Percentage X Margin Ratio = Margin Ratio 47.5% 40.9% .194 38.6% 58.2% .225 13.9%
66.9%
.093 .512
$860,300,000 ÷ .512 = $1,680,273,438 Sales Mix Sales from Percentage X Total Sales = Each Product* 47.5% X $1,680,273,438 = $ 798,129,883 38.6% X $1,680,273,438 = 648,585,547 13.9%
X $1,680,273,438 =
233,558,008 $1,680,273,438
*Sales are rounded
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BYP 19-5
REAL-WORLD FOCUS
(a) The four primary product lines are FedEx Express (provides express transportation); FedEx Ground (small package ground delivery); FedEx Freight (regional, less-than-truckload freight service); and FedEx Services (Kinkos). The key factors affecting operating results are the volumes of shipments transported through networks; the mix of services purchased by customers; the prices obtained for services; ability to manage cost structure for capital expenditures and operating expenses; and ability to match operating costs to shifting volumes. (b) FEDEX GROUND Income Statement For the Year Ended May 31, 2008 Variable Costing (In Millions) ____________________________________________________________ Revenues ...................................................... $ 6,751 Variable costs: Salaries and employee benefits ............. $1,073 Purchased transportation ...................... 2,691 Fuel .......................................................... 201 Maintenance and repairs ........................ 145 Intercompany charges ............................ 658 4,768 Contribution margin................................ 1,983 Fixed costs: Rentals ..................................................... 189 Depreciation and amortization ............... 305 Other ........................................................ 753 1,247 Net income ................................................... $ 736
19-72
Contribution Margin $1,983
÷ ÷
Revenues $6,751
= =
Contribution Margin Ratio 29.4%
Fixed Costs $1,247
÷ ÷
Contribution Margin Ratio .294
= =
Break-even Point in Dollars $4,241.5 million
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BYP 19-5 (Continued) (c) (i) 2008
2006
FedEx Express FedEx Ground FedEx Freight FedEx Services Total
$24,421 ÷ $38,244 = 63.9% 6,751 ÷ $38,244 = 17.6% 4,934 ÷ $38,244 = 12.9% 2,138 ÷ $38,244 = 5.6% $38,244
$21,446 ÷ $32,485 = 66.0% 5,306 ÷ $32,485 = 16.3% 3,645 ÷ $32,485 = 11.2% 2,088 ÷ $32,485 = 6.4% $32,485
FedEx Express FedEx Ground FedEx Freight FedEx Services
2008 7.8% 10.9% 6.7% (41.7%)*
2006 8.2% 13.3% 13.3% ____
(ii)
*$(891) ÷ $2,138 (iii) In part (ii) we see that in all divisions the company’s operating margins declined. We also see in part (ii) that in 2006 FedEx Express had the lowest operating margin (8.2%), and FedEx Services had the lowest in 2008 (–41.7%) while FedEx Ground had the highest (13.3% and 10.9%). In part (i) we see that the company shifted its sales mix percentage down in FedEx Express (66.0% to 63.9%) and FedEx Services (6.4% and 5.6%) but increased its sales mix percentage for FedEx Ground (16.3% to 17.6%) and FedEx Freight (11.2% to 12.9%). Thus, during this period two of the company’s divisions became more profitable, and the company successfully shifted its sales mix so that more of its revenue came from its more profitable divisions.
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BYP 19-6
REAL-WORLD FOCUS
(a) Smart Balance relies very heavily on outsourcing. It keeps it employees and investments in fixed assets to a minimum. As a consequence it has very low fixed costs. (b) The company keeps new-product development and marketing in house. (c) The potential advantage of having very low fixed costs is that the company has a lower break-even point. It can be profitable at relatively low volumes of sales and therefore it has less potential for financial failure. (d) The potential disadvantage of this approach is that its low fixed costs means that the company has low operating leverage. If the company’s sales increase significantly, it would not enjoy the same increase in profitability as a company that was producing its own goods.
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BYP 19-7
COMMUNICATION ACTIVITY
MEMO To:
Bjorn Borg—CEO
From:
Student
Re:
Best use of limited resources
I share your concern, that, since we are operating at full capacity, we need to ensure that our product mix maximizes our profitability. The decision of how to best utilize our limited productive resources is one of the most important decisions we face. We currently make two different anchors, a traditional fishing anchor, and a high-end yacht anchor. The contribution margin per unit produced of the yacht anchor is three times that of the fishing anchor, thus one might logically assume that we should shift our production toward producing the yacht anchor. However, this assumption ignores an element that is critical to the decision. In order to make a proper decision, we would need to know the contribution margin per unit of limited resource that each product produces. While the yacht anchor has a very high contribution margin, it also consumes considerably more productive resources. I propose that a study be done to determine exactly how much of the limited productive resource is consumed by one unit of each of the two anchor types. In addition, at the same time that this study is being undertaken, I propose that the marketing department undertake a study of the demand for each anchor type. This is important so that we don’t produce anchors that we can’t sell. Finally, a shift in our product mix would maximize our profitability at our current level of productive capacity. However, we should also consider a more long-term solution to our production constraints. Since we have been operating at, or near full capacity for two years, it would seem appropriate to undertake a study of whether an acquisition of additional plant equipment would be appropriate.
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*BYP 19-8
ETHICS CASE
(a) The division’s net income increased by $225,000 ($525,000 – $300,000). This represents a 75% increase over the previous year ($225,000 ÷ $300,000). Thus Brett’s bonus would be 75 X $5,000 = $375,000. (b) In 2013 the number of units produced and sold were equal. When this occurs variable costing and absorption costing provide the same results. Thus, in 2013, net income under variable costing would have been $300,000. In 2014, units produced exceeded units sold by 5,000 units. However, net income under variable costing is not impacted by the number of units produced. Since the number of units sold did not change from 2013 to 2014, and the selling price, variable cost per unit, and total fixed costs didn’t change, the division’s net income in 2014 would equal its 2013 income of $300,000. (c) In part (b) it was determined that the division’s net income would have been $300,000 in 2014 under variable costing. Since this is the same as 2013 net income, Brett would not receive a bonus. (d) If Brett intentionally overproduced inventory in order to increase his bonus, then his actions were unethical. Overproduction of inventory increases the company’s costs related to inventory, such as storage, handling, waste and theft. Based on the information provided we can’t actually determine Brett’s motives. He may have believed that just-in-time inventory was causing the company to lose sales due to “stock-outs.” If that was the case, there would be options available to the company other than totally giving up on just-in-time practices. In order to eliminate any potential conflicts of interest between Brett and the company, and to ensure that his actions are in the best interest of the company, the company could begin preparing variable costing income statements to supplement its absorption costing statements for the purpose of calculating bonuses. This would eliminate any incentive Brett might have to over-produce, as well as providing useful information for other internal management decision making.
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BYP 19-9
(a)
ALL ABOUT YOU
Using a common equation for CVP analysis, Sales = Variable Costs + Fixed Costs + Net Income, and substituting the information provided, and knowing that at break-even, net income = $0, ($26 X 300) = Variable Costs + ($4,000 + $1,460) + $0 $7,800 = Variable Costs + $5,460 + $0 $2,340 = Variable Costs (in total) or $7.80 (variable costs/member/month) = $2,340 ÷ 300
(b)
To find the sales required to reach a target net income, contribution margin must be calculated. Contribution Margin = Sales – Variable Costs Contribution Margin = $7,800 – $2,340 Contribution Margin = $5,460 Contribution Margin per Unit = $5,460/300 memberships = $18.20 Contribution Margin Ratio = $5,460/$7,800 = 70% To compute the sales required to reach a target net income of $3,640. Required Sales in Units = (Fixed Costs + /Contribution Margin Target Net Income) per Unit Required Sales in Units = ($5,460 + $3,640)/$18.20 Required Sales in Units = 500 memberships Required Sales in Dollars = 500 memberships X $26 = $13,000 Using the contribution margin ratio, Required Sales in Dollars = (Fixed Costs + Target Net Income)
/Contribution Margin Ratio
Required Sales in Dollars = ($5,460 + $3,640)/70% Required Sales in Dollars = $13,000 (c)
Answers will vary. Suggested examples include franchise fees, employee wages, utilities, supplies, and maintenance.
(d)
Answers will vary.
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BYP 19-10
CONSIDERING PEOPLE, PLANET, AND PROFIT
Discussion Guide: If reduction of greenhouse gas emissions is a goal, then one step toward attainment of that goal is to assign a cost to greenhousegas emissions. One approach that is currently being used is the buying and selling of carbon-emission rights. As companies buy and sell emission rights, the price of polluting becomes a tangible factor in the formulations that will be used to make future energy-source decisions. This approach has been effective in addressing similar issues, such as the reduction of sulfur emissions. However, as suggested in the “No” response, many believe that, to be effective and fair, an enforceable international agreement on such an approach would be necessary. In the United States, companies currently participate on a voluntary basis; in some other countries, participation is required. Another factor to consider in these decisions is the timing of conversion to new technology. A gradual conversion to new technologies as existing power plants reach the end of their productive lives would be far less costly than a rapid conversion to new technologies that required scrapping existing plants before they are fully depreciated. Decisions about which plants to replace and when to replace them will require careful cost-benefit analyses.
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CHAPTER 20 Incremental Analysis ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Questions
Brief Exercises
1.
Identify the steps in management’s decisionmaking process.
1, 2
1
1
2.
Describe the concept of incremental analysis.
3, 4
2
1, 17
3.
Identify the relevant costs in accepting an order at a special price.
5
3
1
4.
Identify the relevant costs in a make-or-buy decision.
6, 7
4
5.
Identify the relevant costs in determining whether to sell or process materials further.
8, 9, 10
5, 6
6.
Identify the relevant costs to be considered in repairing, retaining or replacing equipment.
11
7
7.
Identify the relevant costs in deciding whether to eliminate an unprofitable segment.
12
8
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A Problems
B Problems
2, 3, 4, 18
1A
1B
2
5, 6, 7, 8, 18
2A
2B
3
9, 10, 11, 12, 18
3A
3B
13, 14, 18
4A
4B
15, 16, 17, 18
5A
5B
Do It!
4
Exercises
20-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Use incremental analysis for special order and identify nonfinancial factors in the decision.
Simple
20–30
2A
Use incremental analysis related to make or buy, consider opportunity cost, and identify nonfinancial factors.
Moderate
30–40
3A
Determine if product should be sold or processed further.
Moderate
30–40
4A
Compute gain or loss, and determine if equipment should be replaced.
Moderate
30–40
5A
Prepare incremental analysis concerning elimination of divisions.
Moderate
30–40
1B
Use incremental analysis for special order and identify nonfinancial factors in the decision.
Simple
20–30
2B
Use incremental analysis related to make or buy, consider opportunity cost, and identify nonfinancial factors.
Moderate
30–40
3B
Determine if product should be sold or processed further.
Moderate
30–40
4B
Compute gain or loss, and determine if equipment should be replaced.
Moderate
30–40
5B
Prepare incremental analysis concerning elimination of divisions.
Moderate
20–30
20-2
.
Kimmel, Accounting, 5e, Solutions Manual
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Kimmel, Accounting, 5e, Solutions Manual
Learning Objective
Knowledge Comprehension
(For Instructor Use Only)
*1.
Identify the steps in management’s BE20-1 decision-making process.
Q20-1 Q20-2
E20-1
*2.
Describe the concept of incremental analysis.
Q20-3 Q20-4
E20-1
*3.
Identify the relevant costs in accepting an order at a special price.
*4.
Identify the relevant costs in a make-or-buy decision.
*5.
Identify the relevant costs in determining whether to sell or process materials further.
*6.
Identify the relevant costs to be considered in repairing, retaining or replacing equipment.
*7.
Identify the relevant costs in deciding whether to eliminate an unprofitable segment.
Broadening Your Perspective
Application
Analysis
Synthesis
Evaluation
BE20-2
E20-17
Q20-5
BE20-3 DI20-1
E20-2 E20-3 E20-4
E20-18 P20-1A P20-1B
Q20-6 Q20-7
BE20-4 DI20-2
E20-5 E20-6 E20-7 E20-8
E20-18 P20-2A P20-2B
BE20-5 BE20-6 DI20-3
E20-9 E20-10 E20-11 E20-12
E20-18 P20-3A P20-3B
Q20-11
BE20-7
E20-13 E20-14 E20-18
P20-4A P20-4B
Q20-12
BE20-8 DI20-4
E20-15 E20-16 E20-17
E20-18 P20-5A P20-5B
Q20-8 Q20-9 Q20-10
BYP20-1 BYP20-4 BYP20-5
BYP20-2
BYP20-8 BYP20-9
BYP20-3 BYP20-6 BYP20-7
BLOOM’ S TAXONOMY TABLE
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Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
20-3
ANSWERS TO QUESTIONS 1.
The following steps are frequently involved in management’s decision-making process: (1) Identify the problem and assign responsibility. (2) Determine and evaluate possible courses of action. (3) Make a decision. (4) Review results of the decision.
2.
My roommate is incorrect. Accounting contributes to the decision-making process at Steps 2 and 4. Prior to the decision, accounting provides relevant revenue and cost data for each course of action. Following the decision, internal reports are prepared to show the actual impact of the decision.
3.
Disagree. Incremental analysis involves the identification of financial data that change under alternative courses of action.
4.
In incremental analysis, the important point to consider is whether costs will differ (change) between the two alternatives. As a result, sometimes (1) variable costs do not change under the alternative courses of action and (2) fixed costs do change.
5.
The relevant data in deciding whether to accept an order at a special price are the incremental revenues to be obtained compared to the incremental costs of filling the special order.
6.
The manufacturing costs that are relevant in the make-or-buy decision are those that will change if the parts are purchased.
7.
Opportunity cost may be defined as the potential benefit that may be obtained by following an alternative course of action. Opportunity cost is relevant in a make-or-buy decision when the facilities used to make the part can be used to generate additional income.
8.
The decision rule in a decision to sell a product or to process it further is: Process further as long as the incremental revenue from the additional processing exceeds the incremental processing costs.
9.
Joint products are products that are produced from a single raw material and a common production process. An accounting issue related to joint products is how to allocate the joint costs incurred during the production process that creates the joint products.
10.
Joint costs are irrelevant to a sell-or-process-further decision because they are sunk costs and will not change whether the decision is to sell the existing product or process it further. Therefore, joint costs are ignored in this decision.
11.
A sunk cost is a cost that cannot be changed by any present or future decision. Sunk costs, such as the book value of an old piece of equipment, therefore, are not relevant in a decision to retain or replace equipment.
12.
Net income will be lower if an unprofitable product line is eliminated when the product line is producing a positive contribution margin and its fixed costs cannot be avoided or reduced.
20-4
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Kimmel, Accounting, 5e, Solutions Manual
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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 20-1 The correct order is: 1. 2. 3. 4.
Identify the problem and assign responsibility. Determine and evaluate possible courses of action. Make a decision. Review results of the decision.
BRIEF EXERCISE 20-2
Revenues Costs Net income
Alternative A $160,000 100,000 $ 60,000
Alternative B $180,000 125,000 $ 55,000
Net Income Increase (Decrease) ($ 20,000) (25,000) ($ 5,000)
Alternative A is better than Alternative B.
BRIEF EXERCISE 20-3
Revenues Costs—Variable manufacturing Shipping Net income
Reject Order $0 0 0 $0
Accept Order $75,000* 60,000** 6,000*** $ 9,000
Net Income Increase (Decrease) ($ 75,000) ( (60,000) ( (6,000) ($ 9,000)
The special order should be accepted. *3,000 X $25 **3,000 X $20 ***3,000 X $ 2
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20-5
BRIEF EXERCISE 20-4
Variable manufacturing costs Fixed manufacturing costs Purchase price Total annual cost
Make $50,000 30,000 –0– $80,000
Buy $ –0– 30,000 60,000 $90,000
Net Income Increase (Decrease) $ 50,000 0 (60,000) ($(10,000)
The decision should be to make the part. BRIEF EXERCISE 20-5
Sales price per unit Cost per unit Variable Fixed Total Net income per unit
Sell $62.00
Process Further $70.00
Net Income Increase (Decrease) $8.00
36.00 10.00 46.00 $16.00
43.00 10.00 53.00 $17.00
( (7.00) 0 ( (7.00) $1.00
The bookcases should be processed further because the incremental revenues exceed incremental costs by $1.00 per unit. BRIEF EXERCISE 20-6 The allocated joint costs are irrelevant to the sell or process further decisions. If AB1 is processed further, the company will earn incremental revenue of $50,000 ($150,000 – $100,000) and only incur incremental costs of $45,000. Therefore, the company should process AB1 further and sell AB2. If XY1 is processed further, the company will earn incremental revenue of $35,000 ($130,000 – $95,000) but will incur incremental costs of $50,000. Therefore, the company should sell XY1 rather than process it further.
20-6
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Kimmel, Accounting, 5e, Solutions Manual
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BRIEF EXERCISE 20-7
Variable manufacturing costs for 4 years New machine cost Sell old machine Total
Retain Equipment
Replace Equipment
Net 4-Year Income Increase (Decrease)
$3,000,000 (30,000)
$2,500,000 300,000 (30,000) $2,770,000
($ 500,000 ((300,000) 30,000 $ 230,000
$3,000,000
The old factory machine should be replaced. BRIEF EXERCISE 20-8
Sales Variable costs Contribution margin Fixed costs Net income
Continue $200,000 180,000 20,000 30,000 ($ (10,000)
Eliminate $ –0– –0– ( –0– 20,000) $(20,000)
Net Income Increase (Decrease) $(200,000) (180,000) (20,000) ( 10,000) $ (10,000)
The Big Bart product line should be continued because $20,000 of contribution margin will not be realized if the line is eliminated. This amount is greater than the $10,000 savings of fixed costs. SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 20-1
Revenues Costs Net income
Reject $ –0– $ –0– $ –0–
Accept $180,000 138,000* $ 42,000
Net Income Increase (Decrease) $180,000 (138,000) $ 42,000
*(6,000 X $20) + (6,000 X $3) Given the results of the above analysis, Maize Company should accept the special order. .
Kimmel, Accounting, 5e, Solutions Manual
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20-7
DO IT! 20-2 (a)
Direct materials Direct labor Variable manufacturing costs Fixed manufacturing costs Purchase price Total cost
Net Income Increase (Decrease) $ 30,000 42,000
Make $ 30,000 42,000
Buy $ –0– –0–
45,000
–0–
45,000
60,000 –0– $177,000
45,000 162,000 $207,000
15,000 (162,000) $ (30,000)
Given the results of the above analysis, Rubble Company will incur $30,000 of additional costs if it buys the switches. (b)
Total cost Opportunity cost Total cost
Make $177,000 34,000 $211,000
Buy $207,000 –0– $207,000
Net Income Increase (Decrease) $(30,000) 34,000 $ 4,000
Yes, the answer is different: The analysis shows that net income will be increased by $4,000 if Rubble Company purchases the switches. DO IT! 20-3
Sales per unit Cost per unit Variable Fixed Total Net income per unit
Sell $75
Process Further $100
Net Income Increase (Decrease) $25
$40 10 $50
$ 57 13 $ 70
($17) (3) ($20)
$25
$ 30
$ 5
The tables should be processed further and Mesa Verde should finish the tables because the incremental revenues exceed incremental costs by $5 per unit. 20-8
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Kimmel, Accounting, 5e, Solutions Manual
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DO IT! 20-4
Sales Variable costs Contribution margin Fixed costs Net income
Continue $500,000 370,000 130,000 150,000 $ (20,000)
Eliminate $ 0 0 0 38,000 $(38,000)
Net Income Increase (Decrease) $(500,000) 370,000 (130,000) 112,000 $ (18,000)
The analysis indicates that Gator should not eliminate the gloves and mittens line because net income would decrease $18,000.
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Kimmel, Accounting, 5e, Solutions Manual
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20-9
SOLUTIONS TO EXERCISES EXERCISE 20-1 1. 2. 3. 4. 5. 6. 7. 8. 9.
False. The first step in management’s decision-making process is “identify the problem and assign responsibility”. False. The final step in management’s decision-making process is to review the results of the decision. True. False. In making business decisions, management ordinarily considers both financial and nonfinancial information. True. True. False. Costs that are the same under all alternative courses of action do not affect the decision. False. When using incremental analysis, either costs or revenues or both will change under alternative courses of action. False. Sometimes variable costs will not change under alternative courses of action, but fixed costs will.
EXERCISE 20-2 (a)
Revenues ($4.80) Materials ($0.50) Labor ($1.50) Variable overhead ($1.00) Fixed overhead Sales commissions Net income
Reject Order $ –0– –0– –0– –0– –0– –0– $ –0–
Accept Order $24,000 (2,500) (7,500) (5,000) (6,000) –0– $ 3,000
Net Income Increase (Decrease) $24,000 (2,500) (7,500) (5,000) (6,000) –0– $ 3,000
(b) As shown in the incremental analysis, Gruden should accept the special order because incremental revenue exceeds incremental expenses by $3,000. (c) It is assumed that sales of the golf discs in other markets would not be affected by this special order. If other sales were affected, Gruden would have to consider the lost sales in making the decision. Second, if Gruden is operating at full capacity, it is likely that the special order would be rejected.
20-10
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 20-3 (a)
Revenues (15,000 X $7.60) Cost of goods sold Operating expenses Net income
Reject Order $0 0 0 $0
Accept Order $114,000 78,000 (1) 30,000 (2) $ 6,000
Net Income Increase (Decrease) ($114,000) ( (78,000) ( (30,000) ($ 6,000)
(1) Variable cost of goods sold = $2,600,000 X 70% = $1,820,000. Variable cost of goods sold per unit = $1,820,000 ÷ 350,000 = $5.20 Variable cost of goods sold for the special order = $5.20 X 15,000 = $78,000.
(2) Variable operating expenses = $840,000 X 75% = $630,000 $630,000 ÷ 350,000 = $1.80 per unit 15,000 X $1.80 = $27,000 $27,000 + $3,000 = $30,000 (b) As shown in the incremental analysis, Leno Company should accept the special order because incremental revenues exceed incremental expenses by $6,000. EXERCISE 20-4
Revenues Variable costs: Direct materials Direct labor Variable overhead Total variable costs Net income
Reject Order $0
Accept Order $1,187,500 (1)
Net Income Increase (Decrease) $1,187,500
0 0 0 0 $0
500,000 187,500 250,000 937,500 $ 250,000
(500,000) (187,500) (250,000) (937,500) $ 250,000
(1) [($2.00 + $0.75 + $1.00 + $1.00) X 250,000] Klean Fiber should accept the Army’s offer since it would increase net income by $250,000.
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Kimmel, Accounting, 5e, Solutions Manual
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20-11
EXERCISE 20-5 (a)
Direct materials (30,000 X $4.00) Direct labor (30,000 X $5.00) Variable overhead costs ($150,000 X 70%) Fixed manufacturing costs Purchase price (30,000 X $12.75) Total annual cost
Make $120,000 150,000
$
0 0
Net Income Increase (Decrease) $ 120,000 150,000
105,000 45,000 0 $420,000
0 45,000 382,500 $427,500
105,000 0 ( (382,500) ($ (7,500)
Buy
(b) No, Schopp Inc. should not purchase the shades. As indicated by the incremental analysis, it would cost the company $7,500 more to purchase the lamp shades. (c) Yes, by purchasing the lamp shades, a total cost saving of $17,500 will result as shown below.
Total annual cost (above) Opportunity cost Total cost
Make $420,000 25,000 $445,000
Buy $427,500 0 $427,500
Net Income Increase (Decrease) $ (7,500) (25,000) $(17,500)
EXERCISE 20-6 (a) 1.
Direct materials Direct labor Variable overhead Fixed overhead Purchase price Total annual cost
Make Buy $1,000,000 $ –0– 800,000 –0– 120,000 –0– 600,000 195,000 0 2,300,000 $2,520,000 $2,495,000
Net Income Increase (Decrease) $ 1,000,000 800,000 120,000 405,000 (2,300,000) $ 25,000
Yes. The offer should be accepted as net income will increase by $25,000.
20-12
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 20-6 (Continued) 2.
Direct materials Direct labor Variable overhead Fixed overhead Opportunity cost Purchase price Totals
Make $1,000,000 800,000 120,000 600,000 405,000 0 $2,925,000
Buy $
0 0 0 600,000 0 2,300,000 $2,900,000
Net Income Increase (Decrease) $ 1,000,000 800,000 120,000 0 405,000 (2,300,000) $ 25,000
Yes. The offer should be accepted as net income would be $25,000 more. (b) Qualitative factors include the possibility of laying off those employees that produced the robot and the resulting poor morale of the remaining employees, maintaining quality standards, and controlling the purchase price in the future. EXERCISE 20-7 (a) Direct materials Direct labor Variable overhead Purchase price Total unit cost
Make Sails $100 80 35 0 $215
Buy Sails $ 0 0 0 250 $250
Net Income Increase (Decrease) $ 100 80 35 (250) $ (35)
Gibbs should be making the sails, because they could save $35 per unit or $42,000. The president was including the fixed overhead cost in the calculation. Variable overhead = Total overhead ($100) – Fixed overhead ($78,000 ÷ 1,200) = $35. This amount has been allocated, so Gibbs will incur the cost whether or not they make the sails. This is an example of an irrelevant cost, because it does not differ between the two alternatives.
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20-13
EXERCISE 20-7 (Continued) (b)
The best decision would be to rent out the space as shown below. The differential savings would be $77,000 – $42,000 = $35,000.
(Based on 1,200 units) Manufacturing cost Purchase price Opportunity cost Total annual cost (c)
Per Unit $215 $250
Make Sails $258,000 0 77,000 $335,000
Buy Sails $ 0 300,000 0 $300,000
Net Income Increase (Decrease) $ 258,000 (300,000) 77,000 $ 35,000
Qualitative factors to consider would be (1) whether Gibbs will be able to exercise control over the future price of the product (2) whether Gibbs will be able to exercise control over the quality of the product and (3) the potential for interruptions in the supply of the product.
EXERCISE 20-8 (a) Direct materials Direct labor Material handling Variable overhead Purchase price Total unit cost
Make IMC2 $ 65.00 45.00 6.50 72.00* 0 $188.50
Buy IMC2 $ 0 0 0 0 200.00 $200.00
Net Income Increase (Decrease) $ 65.00 45.00 6.50 72.00 (200.00) $ (11.50)
*Variable overhead = 60% X ($126.50 – 6.50) The unit should not be purchased from the outside vendor, as the per unit cost would be $11.50 greater than if they made it.
20-14
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 20-8 (Continued) (b)
In order for Innova to make an accurate decision, they would have to know the opportunity cost of manufacturing the other product. As determined in (a), purchasing the product from outside would cost $11,500 more (1,000 X $11.50). Innova would have to increase their contribution margin by more than $11,500 through the manufacture of the other product, before it would be economical for them to purchase the IMC2 from the outside vendor.
(c)
Qualitative factors to consider would be (1) quality of the component (2) on-time delivery, and (3) reliability of the vendor.
EXERCISE 20-9
Sales per unit Costs per unit Direct materials Direct labor Total Net income per unit
Sell (Basic Kit) $30
Process Further (Stage 2 Kit) ( )$35( )
Net Income Increase (Decrease) $(5)
$14 0 $14
( ) $ 7 (1) ( ) 9 (2) ( ) $16 ( )
$(7) (9) $(2)
$16
( ) $19 ( )
$(3)
(1) The cost of materials decreases because Rachel can make two Stage 2 Kits from the materials for a basic kit. (2) The total time to make the two kits is one hour at $18 per hour or $9 per unit.
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20-15
EXERCISE 20-9 (Continued) Rachel should carry the Stage 2 Kits. The incremental revenue, $5, exceeds the incremental processing costs, $2. Thus, net income will increase by processing the kits further. EXERCISE 20-10 (a)
Sales ($60,000 + $15,000 + $55,000) Joint costs Net income
$ 130,000 (100,000) $ 30,000
(b) Sales ($190,000 + $35,000 + $215,000) Joint costs Additional costs ($100,000 + $30,000 + $150,000) Net income
$ 440,000 (100,000) (280,000) $ 60,000
(c) (1)
Incremental revenue Incremental costs Incremental profit (loss) (1)
Product 10 Product 12 Product 14 $ 130,000 $ 20,000 $ 160,000 (100,000) (30,000) (150,000) $ 30,000 $(10,000) $ 10,000
Sales value after further processing – Sales value @ split-off point
Products 10 and 14 should be processed further and product 12 should be sold at the split-off point. (d) Sales ($190,000 + $15,000 + $215,000) Joint costs Additional costs ($100,000 + $150,000) Net income
$ 420,000 (100,000) (250,000) $ 70,000
Net income is $10,000 ($70,000 – $60,000) higher in (d) than in (b) because product 12 is not processed further, thereby increasing overall profit $10,000.
20-16
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 20-11 To determine whether each of the three joint products should be sold as is, or processed further, we must determine the incremental profit or loss that would be earned by each. The allocated joint costs are irrelevant to the decision since these costs will not change whether or not the products are sold as is or processed further. Larco $100,000* (110,000) $ (10,000)
Incremental revenue Incremental cost Incremental profit (loss)
Marco $100,000** (85,000) $( 15,000
Narco $395,000*** (250,000) $145,000
From this analysis we see that Marco and Narco should be processed further because the incremental revenue exceeds the incremental costs, but Larco should be sold as is. *$300,000 – $200,000
**$400,000 – $300,000
***$800,000 – $405,000
EXERCISE 20-12 (a)
The costs that are relevant in this decision are the incremental revenues and the incremental costs associated with processing the material past the split-off point. Any costs incurred up to the split-off point are sunk costs, and therefore, irrelevant to this decision.
(b)
Revenue after further processing: Product D—$60,000 (4,000 units X $15.00 per unit) Product E—$97,200 (6,000 units X $16.20 per unit) Product F—$45,200 (2,000 units X $22.60 per unit) Revenue at split-off: Product D—$40,000 (4,000 units X $10.00 per unit) Product E—$69,600 (6,000 units X $11.60 per unit) Product F—$38,800 (2,000 units X $19.40 per unit) Incremental revenue Incremental cost Increase (decrease) in profit
D $20,000 (14,000) $ 6,000
E $27,600 (20,000) $ 7,600
F $ 6,400 (9,000) $(2,600)
Products D and E should be processed further. (c)
.
The decision would remain the same. It does not matter how the joint costs are allocated because joint costs are irrelevant to this decision.
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20-17
EXERCISE 20-13 (a)
Cost Accumulated depreciation Book value Sales proceeds Loss on sale
$100,000 (25,000*) 75,000 40,000 $ 35,000
*One year’s depreciation: ($100,000 – $0) ÷ 4 years (b)
Annual operating costs New scanner cost Old scanner salvage Total
Retain Scanner $315,000* $315,000
Replace Scanner $225,000** 110,000 (40,000) $295,000
Net Income Increase (Decrease) $ 90,000 (110,000) 40,000 $ 20,000
*(3 years X $105,000) **[3 years X ($105,000 – $30,000)] Yes. Benson Hospital should replace the old scanner because it will result in a savings of $20,000 over the next four years. (c)
20-18
As shown in (a) above, replacing the old scanner will result in reporting a loss of $35,000. Reluctance to report losses of this nature is the usual reason for not recognizing that a poor decision was made in the past. The remaining book value of the old scanner ($75,000) is a sunk cost. It will be deducted in the future, if the scanner is retained, or written off now if it is replaced. However, if it is replaced now, that cost will be partially offset by the salvage value that Dyno is willing to pay ($40,000).
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 20-14
Operating costs New machine cost Salvage value (old) Total
Retain Machine $125,000 (1) 0 0 $125,000
Replace Machine ($100,000) (2) ( 25,000) ( (6,000) ($119,000)
Net Income Increase (Decrease) ($ 25,000 ( (25,000) ( 6,000 ($ 6,000
(1) $25,000 X 5. (2) $20,000 X 5. The current machine should be replaced. The incremental analysis shows that net income for the five-year period will be $6,000 higher by replacing the current machine. EXERCISE 20-15
Sales Variable costs Cost of goods sold Operating expenses Total variable Contribution margin Fixed costs Cost of goods sold Operating expenses Total fixed Net income (loss)
Net Income Increase (Decrease) $(100,000)
Continue $100,000)
Eliminate $( 0)
( 61,000) (26,000) (87,000) (13,000)
( ( ( (
0) 0) 0) 0)
(61,000) (26,000) (87,000) (13,000)
(15,000) (24,000) (39,000) $(26,000)
(15,000) (24,000) (39,000) $(39,000)
( 0) ( 0) ( 0) $ (13,000)
Judy is incorrect. The incremental analysis shows that net income will be $13,000 less if the Huron Division is eliminated. This amount equals the contribution margin that would be lost through discontinuing the division. (Note: None of the fixed costs can be avoided.)
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20-19
EXERCISE 20-16 (a)
$30,000 + $70,000 – $40,000 = $60,000
(b)
Tingler $300,000 150,000 150,000 142,500* $ 7,500
Sales Variable expenses Contribution margin Fixed expenses Net income
Shocker $500,000 200,000 300,000 267,500** $ 32,500
Total $800,000 350,000 450,000 410,000 $ 40,000
*$30,000 + [($300,000 ÷ $800,000) X $300,000] **$80,000 + [($500,000 ÷ $800,000) X $300,000] (c)
As shown in the analysis above, Cawley should not eliminate the Stunner product line. Elimination of the line would cause net income to drop from $60,000 to $40,000. The reason for this decrease in net income is that elimination of the product line would result in the loss of $55,000 of contribution margin while saving only $35,000 of fixed expenses.
EXERCISE 20-17 Calculation of contribution margin per unit: Selling price per unit Less: variable costs/unit Contribution margin/unit
C $95 50 $45
D $75 40 $35
E $115 40 $ 75
Fixed costs = $22 X (9,000 + 20,000) = $638,000 Company profit with Products C and D: Units sold Sales revenue Less: Variable costs Contribution margin Less: Fixed costs Net income 20-20
.
C 9,000
D 20,000
Total
$855,000 450,000 $405,000
$1,500,000 800,000 $ 700,000
$2,355,000 $1,250,000 1,105,000 638,000 $ 467,000
Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 20-17 (Continued) Company profit with Products C and E: Units sold Sales revenue Less: Variable costs Contribution margin Less: Fixed costs Net income
C 9,900*
E 10,000
Total
$940,500 495,000 $445,500
$1,150,000 400,000 $ 750,000
$2,090,500 895,000 1,195,500 638,000 $ 557,500
*Product C sales increase by 10%, (9,000 X 110%) Yes they should introduce Product E since net profit would increase by $90,500 ($557,500 – $467,000). EXERCISE 20-18 1. Irrelevant. Unavoidable costs will be incurred regardless of the decision made. 2. Relevant. 3. Irrelevant. This is a sunk cost and all sunk costs are irrelevant. 4. Irrelevant. These are sunk costs. 5. Relevant. 6. Relevant. 7. Relevant. 8. Relevant. 9. Irrelevant. If there is no change in the direct materials charge regardless of the decision made, the cost is irrelevant. 10. Relevant.
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20-21
SOLUTIONS TO PROBLEMS PROBLEM 20-1A
(a)
Revenues (10,000 X $27) Cost of goods sold Selling and administrative expenses Net income
Reject Order $0 0
Accept Order $270,000 220,000 (1)
Net Income Increase (Decrease) $ 270,000 ( (220,000)
0 $0
20,000 (2) $ 30,000
( (20,000) $ 30,000
(1) Variable costs = $3,600,000 – $960,000 = $2,640,000; $2,640,000 ÷ 120,000 units = $22.00 per unit; 10,000 X $22.00 = $220,000. (2) Variable costs = $405,000 – $225,000 = $180,000; $180,000 ÷ 120,000 units = $1.50 per unit; 10,000 X ($1.50 + $0.50) = $20,000. (b) Yes, the special order should be accepted because net income will increase by $30,000. (c) Unit selling price = $22.00 (variable manufacturing costs) + $2.00 variable selling and administrative expenses + $4.00 net income = $28. (d) Nonfinancial factors to be considered are: (1) possible effect on domestic sales, (2) possible alternative uses of the unused plant capacity, and (3) ability to meet customer’s schedule for delivery without increasing costs.
20-22
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(For Instructor Use Only)
PROBLEM 20-2A
(a) Make CISCO Direct materials (8,000 X $4.80) Direct labor (8,000 X $4.30) Indirect labor (8,000 X $.43) Utilities (8,000 X $.40) Depreciation Property taxes Insurance Purchase price Freight and inspection (8,000 X $.35) Receiving costs Total annual cost
$38,400
Buy CISCO $
Net Income Increase (Decrease)
0
($38,400)
34,400
0
( 34,400)
3,440 3,200 3,000 700 1,500 0
0 0 900 200 600 80,000
( 3,440) ( 3,200) ( 2,100) ( 500) ( 900) ( (80,000)
0 0 $84,640
2,800 1,300 $85,800
( (2,800) ( (1,300) ($ (1,160)
(b) The company should continue to make CISCO because net income would be $1,160 less if CISCO were purchased from the supplier. (c) The decision would be different. Because of the opportunity cost of $3,000, net income will be $1,840 higher if CISCO is purchased as shown below: Net Income Increase Make CISCO Buy CISCO (Decrease) Total annual cost $84,640 $85,800 $(1,160) Opportunity cost 3,000 0 (3,000) Total cost $87,640 $85,800 $(1,840) (d) Nonfinancial factors include: (1) the adverse effect on employees if CISCO is purchased, (2) how long the supplier will be able to satisfy the Shatner Manufacturing Company’s quality control standards at the quoted price per unit, and (3) whether the supplier will deliver the units when they are needed by Shatner.
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Kimmel, Accounting, 5e, Solutions Manual
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20-23
PROBLEM 20-3A
(a) (1)
Table Cleaner Not Processed Further Sales: FloorShine (600,000 ÷ 30) X $20 Table Cleaner (300,000 ÷ 25) X $18 Total revenue Costs: CDG Additional costs of FloorShine Total costs Gross profit
(2)
$400,000 216,000 $616,000 210,000 240,000 450,000 $166,000
Table Cleaner Processed Further Sales: FloorShine Table Stain Remover (300,000 ÷ 25) X $14 Table Polish (300,000 ÷ 25) X $14 Total revenue Costs: CDG Additional costs of FloorShine TCP Total costs Gross profit
$400,000 168,000 168,000 $736,000 210,000 240,000 100,000 550,000 $186,000
(3) If the table cleaner is processed further overall company profits will be $20,000 higher. Therefore, management made the wrong decision by choosing to not process table cleaner further.
20-24
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 20-3A (Continued) (b) Incremental revenue Incremental costs Totals
Don’t Process Table Cleaner Further $216,000 0 $216,000
Process Table Cleaner Further $336,000 100,000 $236,000
Net Income Increase (Decrease) $120,000 (100,000) $ 20,000
When trying to decide if the table cleaner should be processed further into TSR and TP, only the relevant data need be considered. All of the costs that occurred prior to the creation of the table cleaner are sunk costs and can be ignored. The decision should be made by comparing the incremental revenue from further processing to the incremental costs.
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Kimmel, Accounting, 5e, Solutions Manual
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20-25
PROBLEM 20-4A (a)
Cost Accumulated depreciation Book value Sales proceeds Loss on sale
$120,000 (24,000*) 96,000 (25,000) $ 71,000
*$120,000 ÷ 5 years = $24,000 (b) (1) Revenues ($240,000 X 4 yrs.) Less costs: Variable costs ($35,000 X 4) Fixed costs ($23,000 X 4) Selling & administrative Depreciation Net income
Retain Old Elevator $960,000 $140,000 92,000 116,000* 96,000
444,000 $516,000
*($29,000 X 4) (2) Revenues Less costs: Variable costs ($10,000 X 4) Fixed costs ($8,500 X 4) Selling and administrative Depreciation Operating income Less: Loss on old elevator Net income
Replace Old Elevator $960,000 $ 40,000 34,000 116,000 160,000
350,000 610,000 71,000 $539,000
(c) Variable operating costs Fixed operating costs New elevator cost Salvage on old elevator Totals
20-26
.
Retain Replace Old Elevator Old Elevator $140,000 $ 40,000 92,000 34,000 160,000 (25,000) $232,000 $209,000
Kimmel, Accounting, 5e, Solutions Manual
.
(For Instructor Use Only)
Net Income Increase (Decrease) $ 100,000 58,000 (160,000) 25,000 $ 23,000
PROBLEM 20-4A (Continued) (d)
MEMO
TO: Ron Richter FROM: Student SUBJECT: Relevant Data for Decision to Replace Old Elevator When deciding whether or not to replace any old equipment, the analysis should only include cost data relevant to the replacement decision. The $71,000 loss that would be experienced if we replace the old elevator with the newer model is related to a sunk cost, namely the cost of the old elevator. Sunk costs are irrelevant in decision making. The loss occurs when comparing the book value of the old elevator to the cash proceeds that would be received. The book value of $96,000 would be deducted as depreciation expense over the next four years if the elevator were retained. If the elevator is replaced with the newer model, the book value will be expensed in the current year, less the cash proceeds received on disposal. Therefore, the $96,000 book value will be expensed under either alternative, making it irrelevant.
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Kimmel, Accounting, 5e, Solutions Manual
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20-27
PROBLEM 20-5A
(a) Sales Variable costs Cost of goods sold Selling and administrative Total variable expenses Contribution margin
Division I $250,000
Division II $200,000
150,000 30,000 180,000 ($ 70,000)
172,800 42,000 214,800 $ (14,800)
(b) (1) Division I
Continue
Eliminate
Net Income Increase (Decrease)
Contribution margin (above) Fixed costs Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations
$(70,000)
$(
0)
$(70,000)
(50,000) (45,000) (95,000) $(25,000)
(25,000) (22,500) (47,500) $(47,500)
25,000 22,500 47,500 $(22,500)
(2) Division II
Continue
Eliminate
Net Income Increase (Decrease)
Contribution margin (above) Fixed costs Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations
$(14,800)
$(
0)
$14,800
(19,200 ( 18,000 ( 37,200 $(52,000)
( 9,600) ( 9,000) (18,600) $(18,600)
( 9,600 9,000 18,600 $33,400
Division II should be eliminated as its negative contribution margin is $14,800. Income from operations would increase $33,400 if Division II is eliminated. Division I should be continued because it is producing positive contribution margin of $70,000. Income from operations will decrease $22,500 by discontinuing this division.
20-28
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 20-5A (Continued) (c)
GUTIERREZ COMPANY CVP Income Statement For the Quarter Ended March 31, 2014 Divisions Sales Variable costs Cost of goods sold Selling and administrative Total variable costs Contribution margin Fixed costs Cost of goods sold (1) Selling and administrative (2) Total fixed costs Income (loss) from operations
I
III
IV
Total
$250,000
$500,000
$450,000
$1,200,000
150,000
240,000
187,500
577,500
30,000
30,000
30,000
90,000
180,000 70,000
270,000 230,000
217,500 232,500
667,500 532,500
53,200
63,200
65,700
182,100
48,000
33,000
23,000
104,000
101,200
96,200
88,700
286,100
$(31,200) $133,800
$143,800
$ 246,400
(1) Division’s fixed cost of goods sold plus 1/3 of Division II’s unavoidable fixed cost of goods sold [$192,000 X (100% – 90%) X 50% = $9,600]. Each division’s share is $3,200. (2) Division’s fixed selling and administrative expense plus 1/3 of Division II’s unavoidable fixed selling and administrative expenses [$60,000 X (100% – 70%) X 50% = $9,000]. Each division’s share is $3,000. (d) Income from operations with Division II of $213,000 (given) plus incremental income of $33,400 from eliminating Division II = $246,400 income from operations without Division II.
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Kimmel, Accounting, 5e, Solutions Manual
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20-29
PROBLEM 20-1B
(a)
Revenues (10,000 X $30) Cost of goods sold Selling and administrative expenses Net income
Reject Order $0 0
Net Income Accept Increase Order (Decrease) $300,000 $ 300,000 240,000 (1) ( (240,000)
0 $0
25,000 (2) ( (25,000) $ 35,000 $ 35,000
(1) Variable costs = $3,060,000 – $900,000 = $2,160,000; $2,160,000 ÷ 90,000 units = $24 per unit; 10,000 X $24 = $240,000. (2) Variable costs = $360,000 – $180,000 = $180,000; $180,000 ÷ 90,000 units = $2.00 per unit; 10,000 X ($2.00 + $0.50) = $25,000. (b) Yes, the special order should be accepted because net income will be increased by $35,000. (c) Unit selling price = $24 (variable manufacturing costs) + $2.50 (variable selling and administrative expenses) + $5.50 (net income) = $32.00. (d) Nonquantitative factors to be considered are: (1) possible effect on domestic sales, (2) possible alternative uses of the unused plant capacity, and (3) ability to meet customer’s schedule for delivery without increasing costs.
20-30
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 20-2B
(a) Make FIZBE Direct materials (5,000 X $4.75) Direct labor (5,000 X $4.60) Indirect labor (5,000 X $.45) Utilities (5,000 X $.35) Depreciation Property taxes Insurance Purchase price Freight and inspection (5,000 X $.30) Receiving costs Total annual cost
Buy FIZBE
$23,750 23,000 2,250 1,750 2,000 700 1,500 0
$
0 0 0 0 900 200 600 56,000
0 0 $54,950
1,500 500 $59,700
Net Income Increase (Decrease) ($ 23,750 ( 23,000 ( 2,250 ( 1,750 ( 1,100 ( 500 ( 900 ( (56,000) ( (1,500) (500) ($ (4,750)
(b) The company should continue to make FIZBE because net income would be $4,750 less if FIZBE were purchased from the supplier. (c) The decision would be different. Because of the opportunity cost of $6,000, net income will be $1,250 higher if FIZBE is purchased as shown below:
Total annual cost Opportunity cost Total cost
Make FIZBE $54,950 6,000 $60,950
Buy FIZBE $59,700 0 $59,700
Net Income Increase (Decrease) $(4,750) 6,000 $ 1,250
(d) Nonfinancial factors include: (1) the adverse effect on employees if FIZBE is purchased, (2) how long the supplier will be able to satisfy the Gill Corporation’s quality control standards at the quoted price per unit, and (3) will the supplier deliver the units when they are needed by Gill?
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Kimmel, Accounting, 5e, Solutions Manual
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20-31
PROBLEM 20-3B (a) (1)
General-Purpose Cleaner Not Processed Further Sales ShineBrite (750,000 ÷ 25) X $15 $450,000 General-Purpose Cleaner (250,000 ÷ 20) X $20 250,000 Total revenue $700,000 Costs NPR 200,000 Additional costs for ShineBrite 300,000 Total costs 500,000 Gross profit $200,000
(2)
General-Purpose is Processed Further Sales ShineBrite (750,000 ÷ 25) X $15 Premium Cleaner (250,000 ÷ 20) X $16 Premium Stain Remover (250,000 ÷ 20) X $16 Total revenue Costs NPR Additional costs for ShineBrite PST Total costs Gross profit
$450,000 200,000 200,000 $850,000 200,000 300,000 140,000 640,000 $210,000
(3) If the general-purpose cleaner is processed further overall company profits will be $10,000 higher. Therefore, management made the wrong decision by choosing to not process the general-purpose cleaner further.
20-32
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 20-3B (Continued) (b) Incremental revenue Incremental costs Totals
Don’t Process G-P Cleaner Further $250,000 0 $250,000
Process G-P Cleaner Further $400,000 140,000 $260,000
Net Income Increase (Decrease) $150,000 (140,000) $ 10,000
When trying to decide if the general-purpose cleaner should be processed further into PC and PSR, only the relevant data need be considered. All of the costs that occurred prior to the creation of the general-purpose cleaner are sunk costs and can be ignored. The decision should be made by comparing the incremental revenue from further processing to the incremental costs.
.
Kimmel, Accounting, 5e, Solutions Manual
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20-33
PROBLEM 20-4B
(a)
Cost Accumulated depreciation Book value Sales proceeds Loss on sale
$210,000 (42,000*) 168,000 (58,000) $110,000
*$210,000 ÷ 5 years = $42,000 (b) (1)
Retain Old Equipment $1,440,000
Revenues ($360,000 X 4 yrs.) Less costs: Variable costs Fixed costs Selling & administrative Depreciation Net income
$200,000 120,000 180,000 168,000
(2)
668,000 $ 772,000 Replace Old Equipment $1,440,000
Revenues Less costs: Variable costs Fixed costs Selling and administrative Depreciation Operating income Less: Loss on old equipment Net income
$ 48,000 20,000 180,000 250,000
498,000 942,000 110,000 $ 832,000
(c)
Variable costs Fixed costs New equipment cost Salvage on old 20-34
.
Retain Old Equipment $200,000 120,000
Kimmel, Accounting, 5e, Solutions Manual
.
Replace Old Equipment $ 48,000 20,000 250,000
Net Income Increase (Decrease) $152,000 100,000 (250,000)
(58,000)
58,000
(For Instructor Use Only)
equipment Totals
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Kimmel, Accounting, 5e, Solutions Manual
$320,000
(For Instructor Use Only)
$260,000
$ 60,000
20-35
PROBLEM 20-4B (Continued) (d)
MEMO
TO: Gene Simmons FROM: Student SUBJECT: Relevant Data for Decision to Replace Old Equipment When deciding whether or not to replace any old equipment, the analysis should only include cost data relevant to the replacement decision. The $110,000 loss that would be experienced if we replace the old equipment with the newer equipment is related to a sunk cost, namely the cost of the old equipment. Sunk costs are irrelevant in decision making. The loss occurs when comparing the book value of the old equipment to the cash proceeds that would be received. The book value of $168,000 would be deducted as depreciation expense over the next four years if the equipment were retained. If the equipment is replaced with the newer model the book value will be expensed in the current year, less the cash proceeds received on disposal. Therefore, the $168,000 book value will be expensed under either alternative, making it irrelevant.
20-36
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 20-5B
(a) Sales Variable expenses Cost of goods sold Selling and administrative Total variable expenses Contribution margin
Division III $310,000
Division IV $170,000
189,000 45,000 234,000 $ 76,000
140,400 49,000 189,400 ($ (19,400)
(b) (1) Division III
Continue
Eliminate
Net Income Increase (Decrease)
Contribution margin (above) Fixed expenses Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations
$ 76,000
$
0
$(76,000)
81,000 30,000 111,000 ($(35,000)
(40,500 15,000 55,500 $(55,500)
40,500 15,000 55,500 $(20,500) Net Income Increase (Decrease)
(2) Division IV
Continue
Eliminate
Contribution margin (above) Fixed expenses Cost of goods sold Selling and administrative Total fixed expenses Income (loss) from operations
$(19,400)
$
0
$19,400
(15,600) 21,000) 36,600) $(56,000)
7,800 10,500 18,300 $(18,300)
7,800 10,500 18,300 $37,700
Division III should be continued as contribution margin ($76,000) is greater than the savings in fixed costs ($55,500) that would result from elimination. Therefore, income from operations would decrease $20,500 if Division III is eliminated. Division IV should be eliminated because it is producing negative contribution margin ($19,400). Income from operations will increase $37,700 by discontinuing this division. .
Kimmel, Accounting, 5e, Solutions Manual
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20-37
PROBLEM 20-5B (Continued) (c)
PANDA COMPANY CVP Income Statement For the Quarter Ended March 31, 2014 Divisions Sales Variable expenses Cost of goods sold Selling and administrative Total variable expenses Contribution margin Fixed expenses Cost of goods sold (1) Selling and administrative (2) Total fixed expenses Income (loss) from operations
I
II
III
Total
$510,000
$400,000
$310,000
$1,220,000
210,000
200,000
189,000
599,000
24,000
40,000
45,000
109,000
234,000 276,000
240,000 160,000
234,000 76,000
708,000 512,000
92,600
52,600
83,600
228,800
39,500
43,500
33,500
116,500
132,100 $143,900
96,100 $ 63,900
117,100 345,300 $ (41,100 ) $ 166,700
(1) Division’s fixed cost of goods sold plus 1/3 of Division IV’s unavoidable fixed cost of goods sold [$156,000 X (100% – 90%) X 50% = $7,800]. Each division’s share is $2,600. (2) Division’s fixed selling and administrative expenses plus 1/3 of Division IV’s unavoidable fixed selling and administrative expenses [$70,000 X (100% – 70%) X 50% = $10,500]. Each division’s share is $3,500. (d) Income from operations with Division IV of $129,000 (given) plus incremental income of $37,700 from eliminating Division IV = $166,700 income from operations without Division IV.
20-38
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 20-1
DECISION-MAKING AT CURRENT DESIGNS
Situation #1 (a) Current Designs should accept the special order based on the following calculations:
Revenues Costs Net Income
Reject Order $0 0 $0
Accept Order $25,000* (19,000)** $ 6,000
Net Income Increase (Decrease) $25,000 (19,000) $ 6,000
*(100 X $250) **(($80 + $60 + $20) X 100) + ($1,000 + $2,000) (b) Assuming that Current Designs is currently operating with excess capacity, it should accept the order based on the calculations shown in part (a). If Current Designs is currently operating at full capacity, it would have to weigh its options. If it displaced production of regular kayaks in order to fill this order, it would have to consider the opportunity costs associated with this decision. The opportunity cost, when operating at full capacity, would be the lost contribution margin from regular sales given up in order to fulfill the special order. Alternatively, rather than reject the special order, it might consider temporarily expanding the plant’s capacity by adding an additional production shift to handle the special order. If this option were considered, it would have to identify all additional incremental costs (for example, overtime pay) that would be incurred.
.
Kimmel, Accounting, 5e, Solutions Manual
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20-39
BYP 20-1 (Continued) Situation #2 (a) Current designs should not replace the Rotomold oven based on the following calculations:
Variable manufacturing costs New oven cost Proceeds from scrapping old oven Total
Retain Oven $110,500* 0 0 $110,500
Replace Oven $ 97,500** 250,000 (10,000) $337,500
Net Income Increase (Decrease) $ 13,000 (250,000) 10,000 ($ 227,000)
*(17,000 therms/year X $0.65/therm X 10 years) **(15,000 therms/year X $0.65/therm X 10 years)
(b) Even with the cost of natural gas increasing at a faster than expected rate, Current Designs still should not replace the Rotomold oven as the rate increase does not cover the cost of the new oven based on the following calculations:
Variable manufacturing costs New oven cost Proceeds from scrapping old oven Total
Retain Oven $144,500* 0 0 $144,500
Replace Oven $127,500** 250,000 (10,000) $367,500
*(17,000 therms/year X $0.85/therm X 10 years) **(15,000 therms/year X $0.85/therm X 10 years)
20-40
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Kimmel, Accounting, 5e, Solutions Manual
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Net Income Increase (Decrease) $ 17,000 (250,000) 10,000 ($ 223,000)
BYP 20-1 (Continued) Situation #3 (a) Current Designs should make the seats based on the following calculations:
Direct materials Direct labor Variable manufacturing costs Fixed manufacturing costs Purchase price ($50 X 3,000) Total annual cost
Make $ 60,000 45,000 36,000 20,000 0 $161,000
Buy $
0 0 0 15,000 150,000 $165,000
Net Income Increase (Decrease) $ 60,000 45,000 36,000 5,000 (150,000) ($ 4,000)
(b) When the opportunity cost of $20,000 is considered, Current Designs should buy the seats based on the following calculations:
Total annual cost Opportunity cost Total cost
.
Kimmel, Accounting, 5e, Solutions Manual
Make $161,000 20,000 $181,000
(For Instructor Use Only)
Buy $165,000 0 $165,000
Net Income Increase (Decrease) ($ 4,000) 20,000 $16,000
20-41
BYP 20-2
DECISION-MAKING ACROSS THE ORGANIZATION
Sales Costs and expenses Cost of goods sold Selling expenses Administrative expenses Purchase price Total costs and expenses Net income (1) (2) (3) (4) (5)
Retain Purchase Old Machine New Machine $6,000,000 (1) $6,600,000 (2)
Net Income Increase (Decrease) ($ 600,000
4,500,000 (3) 900,000 500,000 — 5,900,000 $ 100,000
( (120,000) ( (90,000) ( (65,000) ( (150,000) ( (425,000) ($ 175,000
4,620,000 (4) 990,000 565,000 150,000 (5) 6,325,000 $ 275,000
12,000 X $100 X 5 years = $6,000,000. $6,000,000 X 110% = $6,600,000. $6,000,000 X (100% – 25%) = $4,500,000. $6,600,000 X (100% – 30%) = $4,620,000. $140,000 + $4,000 + $6,000 = $150,000.
The new machine should be purchased. The incremental analysis shows that net income will increase from $100,000 to $275,000 over the five years with the new machine.
20-42
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 20-3
MANAGERIAL ANALYSIS
(a)
$ 14.50
Buy— TransTech $ 14.50
$ 14.50
2.00 0.80 0.60 3.00 0.50 0 — 6.90 $ 7.60 $38,000
0 0 0 0 0 10.00 1.00* 11.00 $ 3.50 $17,500
0 0 0 0 0 5.00 1.00 6.00 $ 8.50 $42,500
Make Sales Revenue Variable Manufacturing Cost: Circuit Board Plastic Case Alarms (4 @ $.15 each) Labor Overhead Purchase Cost Fixed Manufacturing Cost: Total Manufacturing Cost Profit per Unit Total Profit
Buy— Omega
*The $5,000 cost that will continue to be incurred, even if the product is not manufactured, divided by the 5,000 units. The company will make the most profit if the clocks are purchased from Omega Company. The company will make $4,500 less if the clocks are manufactured by MiniTek. The company will make $25,000 less if the clocks are purchased from Trans-Tech. (b) There are several important nonfinancial factors described in the case. Other factors might be identified as well. The factors described are: The company is having serious difficulty manufacturing the clocks. Therefore, it would probably be willing to have someone else manufacture the clocks, even if it cost more to do so. The most promising company appears to be Omega; however, there is a serious question about Omega’s ability to remain in business. However, the company could purchase just this one order from Omega, and then continue to search for another manufacturer, or stop manufacturing the clocks. Trans-Tech’s stringent requirements for preferred customer status, in the form of large sales requirements, appear to limit the possibilities for MiniTek to use it as a supplier. However, if MiniTek does desire to continue to offer the clocks because of their popularity, then perhaps Trans-Tech could be used in the future.
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20-43
BYP 20-3 (Continued) (c) Many answers are possible, depending upon each student’s assessment of the seriousness of the issues mentioned in (b). One answer would be: The company should use Omega to manufacture the Kmart order. After that, the company should not offer the clocks any longer. Especially since the clocks are no longer very profitable, it does not seem like a good idea to keep spending money to modify the process.
20-44
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 20-4
REAL-WORLD FOCUS
(a) Before building the special-order new ceiling fans, company management must consider the effect of the new lines on current production capacity, existing and available channels of distribution, the effect on manufacturing efficiency, the effect on sales of current lines of product, and the supply of materials and labor. (b) Incremental analysis would provide a financial comparison of income with the special-order ceiling fans to income without the special orders.
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20-45
BYP 20-5
REAL-WORLD FOCUS
(a) The types of outsourcing services that the company provides assistance on are: Information technology outsourcing, finance and accounting, human resource outsourcing, business process outsourcing, procurement, and call centers. (b) Insourcing means to take work that is currently being performed by an outside service provider back in-house. For example, collections of accounts receivable might currently be performed by a collection agency, and you might decide to establish a collection group within your company. (c) Some of the benefits of insourcing include: • Greater control over resources • Greater ability to control intellectual property • Increased visibility of accountability within the organization
20-46
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 20-6
COMMUNICATION ACTIVITY
To:
Preston Thiese—Plant Manager
From:
Hank Jewel—Production Manager
I have spent considerable time thinking about the dilemma created by the new PDD1130 machine. Clearly, it is far superior to our existing machine. There is no question that it would save us tremendous amounts of money. I hope I am not overstepping my bounds here, but I just reviewed a chapter in my managerial accounting text on incremental analysis which has made me think we need to reconsider this decision. The key to incremental analysis is identifying relevant costs. Relevant costs are those costs that vary depending on the course of action taken. In our situation, a relevant cost would be the savings that we would experience were we to purchase the new machine. The book value of the existing machine is not a relevant cost since it would not be changed by purchasing or not purchasing the new machine. Costs incurred in the past that do not change are referred to as sunk costs. Sunk costs are irrelevant to incremental analysis. I would really like to lay out an analysis of our options to decide the proper course of action. I am concerned that by using the old machine for a couple of years the profitability of the plant could be impacted negatively.
.
Kimmel, Accounting, 5e, Solutions Manual
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20-47
BYP 20-7
ETHICS CASE
(a) Many factors need to be considered when determining whether to close a division. The loss of jobs can have a devastating impact on a community and on the morale of remaining employees. From a financial perspective, closing a division that is reporting losses will not necessarily increase the reported net income of the company. The reason: if fixed costs that have been allocated to a division that is closed are reallocated to the remaining divisions, the company’s net income might actually decrease. This sounds like it would most likely be the case at Peters. (b) It is not unusual to reevaluate fixed cost allocations periodically. However, the allocation should be based on the underlying economics of the situation rather than the motives of individuals. (c) Blake should explain to the board of directors that the change in income is due to a reallocation and that closing the plumbing division is not advisable. In this case, being honest is not only the ethical thing to do, but it will also maximize the company’s net income.
20-48
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 20-8
ALL ABOUT YOU
(a) Chronic homelessness is defined as being on the streets for a year or more. (b) Homelessness costs cities money because the chronic homeless have frequent jail time, shelter costs, emergency room visits and hospital stays. Some costs per city per homeless person are: New York $40,000; Dallas $50,000; San Diego $150,000. (c) The first step is to try to identify the size of the problem by doing street counts. From this count, benchmarks can be set, enabling a reward system for meeting goals. Next is to identify what the homeless people want. What do they think they need to help them address their problem? They typically want adequate housing with some privacy. (d) It has been estimated that in New York this approach costs about $22,000 per year. New York has documented an 88% success rate (defined as not returning to the streets for five years). (e) In terms of incremental analysis, two alternatives are to either continue with the current situation, with the costs presented in part (b) or to implement the approach outlined in part (d). From a purely financial perspective the approach in (d) appears to have significant merit. Also (d) does not even take into account the intangible benefits of improving the quality of life for this segment of the population.
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20-49
BYP 20-9
CONSIDERING YOUR COSTS AND BENEFITS
Discussion guide: This is a very difficult decision. All of the evidence suggests that your short-term and long-term prospects will be far greater with some form of post–high-school degree. Because of this, we feel strongly that you should make every effort to continue your education. Many of the discussions provided in this text present ideas on how to get control of your individual financial situation. We would encourage you to use these tools to identify ways to reduce your financial burden in order to continue your education. We also want to repeat that even taking only one course a semester is better than dropping out. Your instructors and advisors frequently provide advice to students who are faced with the decision about whether to continue with their education. If you are in this situation, we would encourage you to seek their advice since the implications of this decision can be long-lasting.
20-50
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CHAPTER 21 Budgetary Planning ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Questions
1.
Indicate the benefits of budgeting.
1, 2, 4
2.
State the essentials of effective budgeting.
3, 5, 6, 7, 8
3.
Identify the budgets that comprise the master budget.
9, 10, 11, 12, 13, 14, 15, 16
4.
Describe the sources for preparing the budgeted income statement.
5.
Brief Exercises
Do It!
Exercises
A Problems
B Problems
1
1
1
1, 2, 3, 4, 5, 6, 7
1, 2, 3
1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12
1A, 2A, 3A
1B, 2B, 3B
17, 18
8
4
13
1A, 2A, 3A, 6A
1B, 2B, 3B
Explain the principal sections of a cash budget.
19, 20
9
5
14, 15, 16, 17, 18, 19
4A, 6A
4B
6.
Indicate the applicability of budgeting in nonmanufacturing companies.
21, 22
10
3, 18, 19, 20
5A
5B
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21-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Prepare budgeted income statement and supporting budgets.
Simple
30–40
2A
Prepare sales, production, direct materials, direct labor, and income statement budgets.
Simple
40–50
3A
Prepare sales and production budgets and compute cost per unit under two plans.
Moderate
30–40
4A
Prepare cash budget for two months.
Moderate
30–40
5A
Prepare purchases and income statement budgets for a merchandiser.
Simple
30–40
6A
Prepare budgeted income statement and balance sheet.
Complex
40–50
1B
Prepare budgeted income statement and supporting budgets.
Simple
30–40
2B
Prepare sales, production, direct materials, direct labor, and income statement budgets.
Simple
40–50
3B
Prepare sales and production budgets and compute cost per unit under two plans.
Moderate
30–40
4B
Prepare cash budget for two months.
Moderate
30–40
5B
Prepare purchases and income statement budgets for a merchandiser.
Simple
30–40
21-2
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Learning Objective
Knowledge Comprehension
1.
Indicate the benefits of budgeting.
Q21-1 Q21-2
Q21-4 E21-1
2.
State the essentials of effective budgeting.
DI21-1
Q21-3 Q21-5 Q21-6
Q21-7 Q21-8 E21-1
3.
Identify the budgets that comprise the master budget.
DI21-1
Q21-9 Q21-10 Q21-11 E21-1
Q21-12 Q21-13 Q21-14 Q21-15 Q21-16 BE21-2 BE21-3 BE21-4 BE21-5 BE21-6
4.
Describe the sources for preparing the budgeted income statement.
Q21-18
Q21-17 E21-13 P21-6A BE21-8 P21-1A P21-1B DI21-4 P21-2A P21-2B
5.
Explain the principal Q21-19 sections of a cash budget.
Q21-20 BE21-9 DI21-5 E21-14
E21-15 P21-4A E21-17 P21-6A E21-18 P21-4B E21-19
6.
Indicate the applicability of budgeting in nonmanufacturing companies.
BE21-10 E21-3 E21-18 E21-19
E21-20 P21-5A P21-5B
Broadening Your Perspective
Q21-21 Q21-22
Application
BYP21-1
BE21-7 E21-9 DI21-2 E21-10 DI21-3 E21-11 E21-2 E21-12 E21-3 P21-1A E21-4 P21-2A E21-5 P21-1B E21-6 P21-2B E21-7 E21-8
Analysis
Synthesis
BE21-1
Evaluation
P21-3A P21-3B
P21-3A P21-3B E21-16
BYP21-3 BYP21-4 BYP21-5 BYP21-6
BYP21-2
BYP21-7 BYP21-8 BYP21-9
BLOOM’ S TAXONOMY TABLE
.
Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
21-3
ANSWERS TO QUESTIONS 1.
(a) A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms. (b) A budget aids management in planning because it represents the primary method of communicating agreed-upon objectives throughout the organization. Once adopted, a budget becomes an important basis for evaluating performance.
2.
The primary benefits of budgeting are: (1) It requires all levels of management to plan ahead and to formalize goals on a recurring basis. (2) It provides definite objectives for evaluating performance at each level of responsibility. (3) It creates an early warning system for potential problems, so that management can make changes before things get out of hand. (4) It facilitates the coordination of activities within the business by correlating the goals of each segment with overall company objectives. (5) It results in greater management awareness of the entity’s overall operations and the impact of external factors such as economic trends. (6) It motivates personnel throughout the organization to meet planned objectives.
3.
The essentials of effective budgeting are: (1) a sound organizational structure, (2) research and analysis, and (3) acceptance by all levels of management.
4.
(a) Disagree. Accounting information makes major contributions to the budgeting process. Accounting provides the starting point of budgeting by providing historical data on revenues, costs, and expenses. An accountant becomes the translator of the budget and communicates the budget to all areas of responsibility. Accountants also prepare periodic budget reports that compare actual results with planned objectives and provide a basis for evaluating performance. (b) The budget itself, and the administration of the budget, are the responsibility of management.
5.
The budget period should be long enough to provide an attainable goal under normal business conditions. The budget period should minimize the impact of seasonal and cyclical business fluctuations, but it should not be so long that reliable estimates are impossible. The most common budget period is one year.
6.
Disagree. Long-range planning usually encompasses a period of at least five years. It involves the selection of strategies to achieve long-term goals and the development of policies and plans to implement the strategies. In addition, long-range planning reports contain considerably less detail than budget reports.
7.
Participative budgeting involves the use of a “bottom-to-top” approach, which requires input from lower level management during the budgeting process so as to involve employees from various levels and areas within the company. The potential benefits of this approach are lower-level managers have more detailed knowledge of the specifics of their job, and thus should be able to provide better budgetary estimates. In addition, by involving lower-level managers in the process, it is more likely that they will perceive the budget as being fair and reasonable. One disadvantage of participative budgeting is that it takes more time, and thus costs more. Another disadvantage of participative budgeting is that it may enable managers to game the system through such practices as budgetary slack.
21-4
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Questions Chapter 21 (Continued) 8.
Budgetary slack is the amount by which a manager intentionally underestimates budgeted revenues or overestimates budgeted expenses in order to make it easier to achieve budgetary goals. Managers may have an incentive to create budgetary slack in order to increase the likelihood of receiving a bonus, or decrease the likelihood of losing their job.
9.
A master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period. The master budget is developed within the framework of a sales forecast.
10.
The sales budget is the starting point in preparing the master budget. An inaccurate sales budget may adversely affect net income. An overly optimistic sales budget may result in excessive inventories and a very conservative sales budget may lead to inventory shortages.
11.
The statement is false. The production budget only shows the units that must be produced to meet anticipated sales and ending inventory requirements.
12.
The required units of production are 155,000 (160,000 + 15,000 = 175,000 – 20,000 = 155,000).
13.
The desired ending direct materials units are 21,000 (64,000 + 9,000 = 73,000 – 52,000 = 21,000).
14.
Total budgeted direct labor costs are $960,000 (80,000 X .75 X $16 = $960,000).
15.
(a) Manufacturing overhead rate based on direct labor cost is 48% [$198,000 + $162,000 = $360,000; $360,000 ÷ (150,000 X 1/3 X $15/hr.) = 48%]. (b) Manufacturing overhead rate per direct labor hour is $7.20 ($360,000 ÷ 50,000).
16.
The first quarter budgeted selling and administrative expenses are $74,000 [(12% X $200,000) + $50,000]. The second quarter total is $78,800 [(12% X $240,000) + $50,000].
17.
The budgeted cost per unit of product is $46 ($10 + $20 + $16). Gross profit per unit is $19 ($65 – $46). Total budgeted gross profit is $475,000 (25,000 X $19).
18.
The supporting schedules are the budgets for sales, direct materials, direct labor, and manufacturing overhead.
19.
The three sections of a cash budget are: (1) cash receipts, (2) cash disbursements, and (3) financing. The cash budget also shows the beginning and ending cash balances.
20.
Cash collections are: January—$600,000 X 40% = $240,000. February—$600,000 X 50% = $300,000. March—$600,000 X 10% = $60,000.
21.
The formula is: Budgeted cost of goods sold plus desired ending merchandise inventory minus beginning merchandise inventory equals required merchandise purchases.
22.
In a service company, expected revenues can be obtained from expected output or expected input. The former is based on anticipated billings of clients for services provided. The latter is based on expected billable time of the professional staff.
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21-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 21-1 Sales Budget
Production Budget
Direct Materials Budget
Direct Labor Budget
Manufacturing Overhead Budget
Operating Budgets
Budgeted Balance Sheet
Financial Budgets
Selling and Administrative Expense Budget
Budgeted Income Statement
Capital Expenditure Budget
21-6
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Cash Budget
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BRIEF EXERCISE 21-2 PALERMO COMPANY Sales Budget For the Year Ending December 31, 2014 Quarter Expected unit sales Unit selling price Total sales
1
2
3
4
Year
10,000
12,000
15,000
18,000
55,000
X $70 X $70 $700,000 $840,000
X $70 $1,050,000
X $70 $1,260,000
X $70 $3,850,000
BRIEF EXERCISE 21-3 PALERMO COMPANY Production Budget For the Six Months Ending June 30, 2014 Quarter Expected unit sales Add: Desired ending finished goods Total required units Less: Beginning finished goods inventory Required production units a
.
12,000 X .25
b
10,000 X .25
Kimmel, Accounting, 5e, Solutions Manual
c
1 2 10,000 12,000 3,000 a 3,750 c 13,000 15,750 2,500 b 3,000 10,500 12,750
Six Months
23,250
15,000 X .25
(For Instructor Use Only)
21-7
BRIEF EXERCISE 21-4 PERINE COMPANY Direct Materials Budget For the Month Ending January 31, 2014 Units to be produced....................................................... Direct materials per unit ................................................. Total pounds required for production............................ Add: Desired ending inventory (25% X 5,000 X 2) ...... Total materials required .................................................. Less: Beginning materials inventory (4,000 X 2 X 25%).................................................. Direct materials purchases ............................................. Cost per pound ................................................................ Total cost of direct materials purchases .......................
4,000 X 2 8,000 2,500 10,500 2,000 8,500 X $6 $51,000
BRIEF EXERCISE 21-5 MIZE COMPANY Direct Labor Budget For the Six Months Ending June 30, 2014 Quarter Units to be produced Direct labor time (hours) per unit Total required direct labor hours Direct labor cost per hour Total direct labor cost
1 5,000 X 1.6 8,000 X $15 $120,000
21-8
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2 6,000 X 1.6 9,600 X $15 $144,000
Six Months
$264,000
BRIEF EXERCISE 21-6 ROCHE INC. Manufacturing Overhead Budget For the Year Ending December 31, 2014 Quarter 1 Variable costs Fixed costs Total manufacturing overhead
2
3
4
Year
$20,000 $25,000 $30,000 $35,000 $110,000 40,000 40,000 40,000 40,000 160,000 $60,000 $65,000 $70,000 $75,000 $270,000
BRIEF EXERCISE 21-7 NOBLE COMPANY Selling and Administrative Expense Budget For the Year Ending December 31, 2014 Quarter 1
2
3
4
Year
Variable expenses $22,000 $26,000 $30,000 $34,000 $112,000 Fixed expenses 40,000 40,000 40,000 40,000 160,000 Total selling and administrative expenses $62,000 $66,000 $70,000 $74,000 $272,000
BRIEF EXERCISE 21-8 NORTH COMPANY Budgeted Income Statement For the Year Ending December 31, 2014 Sales.................................................................................. Cost of goods sold (50,000 X $25) .................................. Gross profit....................................................................... Selling and administrative expenses .............................. Income before income taxes ........................................... Income tax expense ......................................................... Net income ........................................................................
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$2,250,000 1,250,000 1,000,000 300,000 700,000 210,000 $ 490,000
21-9
BRIEF EXERCISE 21-9 Credit Sales January, $200,000 February, $260,000 March, $300,000
Collections from Customers January February March $150,000 $ 50,000 195,000 $ 65,000 225,000 $150,000 $245,000 $290,000
BRIEF EXERCISE 21-10 Budgeted cost of goods sold ($400,000 X 65%) ........................ Add: Desired ending inventory ($480,000 X 65% X 20%) ....... Total inventory required ............................................................. Less: Beginning inventory ($400,000 X 65% X 20%) ................ Required merchandise purchases for April ..............................
$260,000 62,400 322,400 52,000 $270,400
SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 21-1 1. 2. 3. 4. 5. 6.
Operating budgets Master budget Participative budgeting Financial budgets Sales forecast Long-range plans
DO IT! 21-2 ZELLER COMPANY Production Budget For the Six Months Ending June 30, 2014
Expected unit sales Add: Desired ending finished goods inventory Total required units Less: Beginning finished goods inventory Required production units
Quarter Six 1 2 Months 20,000 24,000 2,400 2,900* 22,400 26,900 2,000 2,400 20,400 24,500 44,900
*(29,000 X .10) 21-10
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DO IT! 21-3 ASH CREEK COMPANY Sales Budget For the Year Ending December 31, 2014 Quarter 1
2
3
4
Year
Expected unit sales 200,000 200,000 300,000 300,000 1,000,000 Unit selling price X $40 X $40 X $40 X $45 — Total sales $8,000,000 $8,000,000 $12,000,000 $13,500,000 $41,500,000
ASH CREEK COMPANY Production Budget For the Year Ending December 31, 2014 Quarter 1
2
Expected unit sales 200,000 200,000 Add: Desired ending finished goods units 50,000 75,000 Total required units 250,000 275,000 Less: Beginning finished goods units 50,000** 50,000 Required production units 200,000 225,000
3
4
300,000
300,000
75,000 375,000
60,000* 360,000
75,000 300,000
75,000 285,000
Year
1,010,000
*Estimated first-quarter 2015 sales volume 200,000 + (200,000 X 20%) = 240,000: 240,000 X 25%. **25% of estimated first-quarter 2014 sales units (200,000 X 25%).
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21-11
DO IT! 21-3 (Continued) ASH CREEK COMPANY Direct Materials Budget For the Year Ending December 31, 2014 Quarter 1
2
3
4
Year
Units to be produced 200,000 225,000 300,000 285,000 Direct materials per unit X 2 X 2 X 2 X 2 Total pounds needed for production 400,000 450,000 600,000 570,000 Add: Desired ending direct materials (pounds) 45,000 60,000 57,000 *45,000 Total materials required 445,000 510,000 657,000 615,000 Less: Beginning direct materials (pounds) **40,000 45,000 60,000 57,000 Direct materials purchases 405,000 465,000 597,000 558,000 Cost per pound X $12 X $12 X $12 X $12 Total cost of direct materials purchases $4,860,000 $5,580,000 $7,164,000 $6,696,000 $24,300,000 *Estimated first-quarter 2015 production requirements 450,000 X 10% = 45,000 **10% of estimated first-quarter pounds needed for production.
DO IT! 21-4 (a)
21-12
Total unit cost: Cost Element Direct materials .............................. Direct labor ..................................... Manufacturing overhead ................ Total unit cost ........................
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Quantity 2 pounds 0.3 hours 0.3 hours
(For Instructor Use Only)
Unit Cost $12.00 $15.00 $20.00
Total $24.00 4.50 6.00 $34.50
DO IT! 21-4 (Continued) (b)
ASH CREEK COMPANY Budgeted Income Statement For the Year Ending December 31, 2014 Sales (1,000,000) units from sales budget, page 9-11....... Cost of goods sold (1,000,000 X $34.50/unit) .................. Gross profit ....................................................................... Selling and administrative expenses............................... Net income ........................................................................
$41,500,000 34,500,000 7,000,000 6,000,000 $ 1,000,000
DO IT! 21-5 BATISTA COMPANY Cash Budget April Beginning cash balance ............................................................. Add: Cash receipts for April ...................................................... Total available cash .................................................................... Less: Cash disbursements in April ........................................... Excess of available cash over cash disbursements ................. Add: Financing ($20,000 – $15,000) .......................................... Ending cash balance...................................................................
$ 25,000 245,000 270,000 255,000 15,000 5,000 $ 20,000
To maintain the desired minimum cash balance of $20,000, Batista Company must borrow $5,000.
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21-13
SOLUTIONS TO EXERCISES EXERCISE 21-1 MEMO To
Jim Dixon
From: Student Re:
Budgeting
I am glad Adler Company is considering preparing a formal budget. There are many benefits derived from budgeting, as I will discuss later in this memo. A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms. The master budget generally consists of operating budgets such as the sales budget, production budget, direct materials budget, direct labor budget, manufacturing overhead budget, selling and administrative expense budget, and budgeted income statement; and financial budgets such as the capital expenditure budget, cash budget, and budgeted balance sheet. The primary benefits of budgeting are: 1. It requires all levels of management to plan ahead and to formalize goals on a recurring basis. 2. It provides definite objectives for evaluating performance at each level of responsibility. 3. It creates an early warning system for potential problems, so that management can make changes before things get out of hand. 4. It facilitates the coordination of activities within the business by correlating the goals of each segment with overall company objectives. 5. It results in greater management awareness of the entity’s overall operations and the impact of external factors such as economic trends. 6. It motivates personnel throughout the organization to meet planned objectives. In order to maximize these benefits, it is essential that budgeting take place within a sound organizational structure, so authority and responsibility for all phases of operations are clearly defined. Also, the budget should be based on research and analysis that results in realistic goals. Finally, the effectiveness of a budget program is directly related to its acceptance by all levels of management. If you want further explanation of any of these topics, please contact me. 21-14
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EXERCISE 21-2
. (For Instructor Use Only)
EDINGTON ELECTRONICS INC. Sales Budget For the Six Months Ending June 30, 2014
Product
Units
XQ-103 XQ-104 Totals
20,000 12,000 32,000
Quarter 1 Selling Total Price Sales $15 25
Units
$300,000 22,000 300,000 15,000 $600,000 37,000
Quarter 2 Selling Total Price Sales $15 25
$330,000 375,000 $705,000
Units 42,000 27,000 69,000
Six Months Selling Total Price Sales $15 25
$ 630,000 675,000 $1,305,000
21-15
EXERCISE 21-3
21-16 . Kimmel, Accounting, 5e, Solutions Manual
GARZA AND NEELY, CPAs Sales Revenue Budget For the Year Ending December 31, 2014
Dept. Auditing Tax Consulting Totals
(For Instructor Use Only)
Dept. Auditing Tax Consulting Totals
Billable Hours 2,300 3,000 1,500
Billable Hours 8,300a 9,700b 6,000c
Quarter 1 Billable Total Rate Rev. $ 80 $184,000 90 270,000 100 150,000 $604,000
Year Billable Rate $ 80 90 100
a2,300 + 1,600 + 2,000 + 2,400 b3,000 + 2,200 + 2,000 + 2,500 c1,500 X 4
Billable Hours 1,600 2,200 1,500
Total Rev. $ 664,000 873,000 600,000 $2,137,000
Quarter 2 Billable Rate $ 80 90 100
Total Rev. 128,000 198,000 150,000 $476,000
Billable Hours 2,000 2,000 1,500
Quarter 3 Billable Total Rate Rev. $ 80 $160,000 90 180,000 100 150,000 $490,000
Billable Hours 2,400 2,500 1,500
Quarter 4 Billable Total Rate Rev. $ 80 $192,000 90 225,000 100 150,000 $567,000
EXERCISE 21-4 TURNEY COMPANY Production Budget For the Year Ending December 31, 2014 Product HD-240 Quarter Expected unit sales Add: Desired ending finished goods units(1) Total required units Less: Beginning finished goods units Required production units (1) (2)
.
1
2
3
4
5,000
7,000
8,000
10,000
2,800 7,800
3,200 10,200
4,000 12,000
2,500 (2) 12,500
2,000 5,800
2,800 7,400
3,200 8,800
4,000 8,500
Year
30,500
40% of next quarter’s sales. 40% X (5,000 X 125%).
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21-17
EXERCISE 21-5 DALLAS INDUSTRIES Direct Materials Purchases Budget For the Quarter Ending March 31, 2014
Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials (pounds)* Total materials required Less: Beginning direct materials (pounds) Direct materials purchases Cost per pound Total cost of direct materials purchases
January 10,000 X 2 20,000
February 8,000 X 2 16,000
March 5,000 X 2 10,000
3,200 23,200
2,000 18,000
1,600 11,600
4,000 19,200 X $2
3,200 14,800 X $2
2,000 9,600 X $2
$38,400
$29,600
$19,200
*20% of next month’s production needs. EXERCISE 21-6 (a)
HARDIN COMPANY Production Budget For the Six Months Ending June 30, 2014 Quarter Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units
1 5,000
2 6,000
1,500 (1) 6,500 1,250 (3) 5,250
1,750 (2) 7,750 1,500 6,250 11,500
(1)
25% X 6,000. 25% X 7,000. (3) 25% X 5,000. (2)
21-18
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Six Months
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EXERCISE 21-6 (Continued) (b)
HARDIN COMPANY Direct Materials Budget For the Six Months Ending June 30, 2014 Quarter Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials (pounds) Total materials required Less: Beginning direct materials (pounds) Direct materials purchases Cost per pound Total cost of direct materials Purchases (1) 40% X 18,750. (2) 7,200 X (3 X 40%). (3) 40% X 15,750.
1 5,250 X 3 15,750
2 6,250 X 3 18,750
7,500 (1) 23,250
8,640 (2) 27,390
Six Months
6,300 (3) 7,500 16,950 19,890 X $4 X $4
0000,000
$67,800
$79,560
$147,360
Finished goods: Sales ........................................................................ Plus: Ending inventory ........................................... Total required .............................................................. Less: beginning inventory .................................... Production required ....................................................
2,475 2,200 4,675 2,230 2,445
EXERCISE 21-7
Direct materials per unit ............................................. Units of direct material required for production ....... Plus: ending inventory ................................................ Total required .............................................................. Less: beginning inventory .................................... Purchases of direct material required ....................... Cost per unit ................................................................ Total cost of materials ................................................
X
2 4,890 2,500(a) 7,390 2,445(b) 4,945 X $4 $19,780
The May raw material purchases would be $19,780. (a)
2,390 + 2,310 – 2,200 = 2,500; 2,500 X 2 X .50 = 2,500 2,475 + 2,200 – 2,230 = 2,445; 2,445 X 2 X .50 = 2,445
(b)
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21-19
EXERCISE 21-8 RODRIQUEZ, INC. Direct Labor Budget For the Year Ending December 31, 2014 Quarter Units to be produced Direct labor time (hours) per unit Total required direct labor hours Direct labor cost per hour Total direct labor cost
X
1
2
3
4
Year
20,000
25,000
35,000
30,000
110,000
1.5
X
1.5
X
1.5
X
1.5
30,000
37,500
52,500
45,000
X $16 $480,000
X $16 $600,000
X $18 $945,000
X $18 $810,000
.2
$2,835,000
EXERCISE 21-9 DONNEGAL COMPANY Production Budget For the Quarter Ending March 31, 2014 Sales in units Plus: desired ending inventory Total needs Less: beginning inventory Required production units
Jan 12,000 18,000(1) 30,000 17,600 12,400
Feb 14,000 14,400(2) 28,400 18,000 10,400
(1)
(14,000 X 100%) + (10,000 X 40%) (10,000 X 100%) + (11,000 X 40%) (3) (11,000 X 100%) + (11,000 X 40%) (2)
21-20
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Mar 10,000 15,400(3) 25,400 14,400 11,000
Total 36,000 15,400 51,400 17,600 33,800
EXERCISE 21-9 (Continued) DONNEGAL COMPANY Direct Labor Budget For the Quarter Ending March 31, 2014 Production in units Direct labor hours per unit Total hours needed Rate per hour Total direct labor
Jan 12,400 X 2.00 24,800 X $8.00 $198,400
Feb Mar 10,400 11,000 X 2.00 X 1.50 20,800 16,500 X $8.00 X $8.00 $166,400 $132,000
Total
$496,800
EXERCISE 21-10 ATLANTA COMPANY Manufacturing Overhead Budget For the Year Ending December 31, 2014 Quarter 1 Variable costs Indirect materials ($.80/hour) $12,000 Indirect labor ($1.20/hour) 18,000 Maintenance ($.50/hour) 7,500 Total variable 37,500 Fixed costs Supervisory salaries 35,000 Depreciation 15,000 Maintenance 12,000 Total fixed 62,000 Total manufacturing overhead $99,500 Direct labor hours Manufacturing overhead rate per direct labor hour ($443,000 ÷ 78,000)
15,000*
2
3
4
Year
$ 14,400 21,600 9,000 45,000
$ 16,800 25,200 10,500 52,500
$ 19,200 28,800 12,000 60,000
$ 62,400 93,600 39,000 195,000
35,000 15,000 12,000 62,000 $107,000
35,000 15,000 12,000 62,000 $114,500
35,000 15,000 12,000 62,000 $122,000
140,000 60,000 48,000 248,000 $443,000
18,000
21,000
24,000
78,000 $5.68
*(10,000 X 1.5)
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Kimmel, Accounting, 5e, Solutions Manual
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21-21
EXERCISE 21-11 DUNCAN COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2014 Quarter
Six Months
Budgeted sales in units
1 20,000
2 22,000
Variable expenses (1) Sales commissions Delivery expense Advertising Total variable
$20,000* 8,000 16,000 44,000
$22,000 8,800 17,600 48,400
$ 42,000 16,800 33,600 92,400
10,000 8,000 4,200 1,500 800 500 25,000
10,000 8,000 4,200 1,500 800 500 25,000
20,000 16,000 8,400 3,000 1,600 1,000 50,000
$69,000
$73,400
$142,400
Fixed expenses Sales salaries Office salaries Depreciation Insurance Utilities Repairs expense Total fixed Total selling and administrative expenses
(1) Variable costs per dollar of sales are: Sales commissions (5%), Delivery expense (2%), and Advertising (4%). *(20,000 X $20 X 5%)
21-22
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 21-12 (a)
FUQUA COMPANY Production Budget For the Two Months Ending February 28, 2014 _____________________________________________________________ January February Expected unit sales ............................................ 10,000 12,000 Add: desired ending finished goods inventory .................................................. 2,400* 2,600*** Total required units ............................................ 12,400 14,600 Less: beginning finished goods inventory ...... 2,000** 2,400 Required production units ................................. 10,400 12,200 *20% X next month’s expected sales or 12,000 X 20% **20% X 10,000 ***20% X 13,000
(b)
FUQUA COMPANY Direct Materials Budget For the Month Ending January 31, 2014 _____________________________________________________________ January Units to be produced ............................................................ 10,400 Direct material pounds per unit ........................................... X 4 Total pounds needed for production................................... 41,600 Add: desired pounds in ending materials inventory ......... 19,520* Total materials required ....................................................... 61,120 Less: beginning direct materials (pounds) ......................... 16,640** Direct materials purchases .................................................. 44,480 Cost per pound ..................................................................... X $2 Total cost of direct materials purchases ............................ $88,960 *(12,200 X 4) X 40%
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**(10,400 X 4) X 40%
(For Instructor Use Only)
21-23
EXERCISE 21-13 (a) DALBY COMPANY Computation of Cost of Goods Sold For the Year Ending December 31, 2014 Cost of one unit of finished goods: Direct materials (2 X $5) ............................................................... Direct labor (3 X $15) .................................................................... Manufacturing overhead (3 X $5) ................................................ Total ......................................................................................
$10 45 15 $70
30,000 units X $70 = $2,100,000. (b) DALBY COMPANY Budgeted Income Statement For the Year Ending December 31, 2014 Sales (30,000 X $85) ............................................................ Cost of goods sold (see part (a)) ....................................... Gross profit ......................................................................... Selling and administrative expenses ................................ Income before income taxes .............................................. Income tax expense ($250,000 X 30%) .............................. Net income ..........................................................................
21-24
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Kimmel, Accounting, 5e, Solutions Manual
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$2,550,000 2,100,000 450,000 200,000 250,000 75,000 $ 175,000
EXERCISE 21-14 DANNER COMPANY Cash Budget For the Two Months Ending February 28, 2014
Beginning cash balance .......................................... Add: Receipts Collections from customers ....................... Sale of marketable securities ..................... Total receipts ............................................... Total available cash ................................................. Less: Disbursements Direct materials............................................ Direct labor .................................................. Manufacturing overhead ............................. Selling and administrative expenses ......... Total disbursements.................................... Excess (deficiency) of available cash over cash disbursements ..................................................... Financing Add: Borrowings ..................................................... Less: Repayments ................................................... Ending cash balance ...............................................
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Kimmel, Accounting, 5e, Solutions Manual
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January $ 45,000
February $ 27,500
85,000 12,000 97,000 142,000
150,000 0 150,000 177,500
50,000 30,000 19,500 15,000 114,500
75,000 45,000 23,500 20,000 163,500
27,500
14,000
0 0 $ 27,500
6,000 0 $ 20,000
21-25
EXERCISE 21-15 AARON CORPORATION Cash Budget For the Quarter Ended March 31, 2014 Beginning cash balance ........................................................... Add: Receipts Collections from customers......................................... Sale of equipment ......................................................... Total receipts .......................................................... Total available cash .................................................................. Less: Disbursements Direct materials ............................................................. Direct labor .................................................................... Manufacturing overhead .............................................. Selling and administrative expenses .......................... Purchase of securities.................................................. Total disbursements .............................................. Excess of available cash over disbursements ........................ Financing Add: Borrowings ..................................................................... Less: Repayments .................................................................... Ending cash balance ................................................................
21-26
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Kimmel, Accounting, 5e, Solutions Manual
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$ 30,000 180,000 3,000 183,000 213,000 41,000 70,000 35,000 45,000 14,000 205,000 8,000 17,000 –0– $ 25,000
EXERCISE 21-16 (a)
TRENSHAW COMPANY Cash Budget For the Month Ended July 31, 2014 Beginning cash balance ............................ Add: Cash collections .............................. Total cash available ................................... Less: Cash disbursements Merchandise purchases ......... Operating expenses................ Equipment purchase .............. Total cash disbursements ......................... Excess of available cash over disbursements ................................ Add: Borrowings ....................................... Ending cash balance .................................
$45,000 90,000 $135,000 $56,200 40,800 20,000 117,000 18,000 7,000 $ 25,000
Cash disbursements of $117,000 plus the desired ending cash balance of $25,000 exceeds the $135,000 total cash available by $7,000. Therefore, Trenshaw Company will have to borrow $7,000. (b)
.
An advantage of cash budgeting is that it allows cash shortfalls to be predicted. If the timing of future cash shortfalls is known, arrangements to borrow funds can be made well in advance, which often means that interest rates may be more favorable than if the funds are needed on short notice.
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21-27
EXERCISE 21-17 (a)
LRF COMPANY Expected Collections from Customers
March cash sales (30% X $270,000) ..................................... Collection of March credit sales [(70% X $270,000) X 10%] .................................................. Collection of February credit sales [(70% X $220,000) X 50%] .................................................. Collection of January credit sales [(70% X $200,000) X 36%] .................................................. Total collections ........................................................ (b)
March $ 81,000 18,900 77,000 50,400 $227,300
LRF COMPANY Expected Payments for Direct Materials
March cash purchases (50% X $40,000) .............................. Payment of March credit purchases [(50% X $40,000) X 40%] .................................................... Payment of February credit purchases [(50% X $36,000) X 60%] .................................................... Total payments ..........................................................
21-28
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Kimmel, Accounting, 5e, Solutions Manual
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March $20,000 8,000 10,800 $38,800
EXERCISE 21-18 (a)
(1) GREEN LANDSCAPING INC. Schedule of Expected Collections From Clients For the Quarter Ending March 31, 2014 January
February
November ($80,000) .............................................. $ 8,000 December ($90,000) .............................................. 27,000 $ 9,000 January ($100,000) ............................................... 60,000 30,000 February ($120,000) .............................................. 72,000 March ($140,000)................................................... ______ _______ Total collections ............................................. $95,000 $111,000
March
Quarter $
$ 10,000 36,000 84,000 $130,000
8,000 36,000 100,000 108,000 84,000 $336,000
(2) GREEN LANDSCAPING INC. Schedule of Expected Payments for Landscaping Supplies For the Quarter Ending March 31, 2014 ________________________________________________________ January
February
December ($14,000) .............................................. $ 5,600 January ($12,000) ................................................. 7,200 $ 4,800 February ($15,000) ................................................ 9,000 March ($18,000)..................................................... Total payments ............................................... $12,800 $13,800
March
Quarter
$ 6,000 10,800 $16,800
$ 5,600 12,000 15,000 10,800 $43,400
(b) (1) Accounts receivable at March 31, 2014: ($120,000 X 10%) + ($140,000 X 40%) = $68,000 (2) Accounts payable at March 31, 2014: ($18,000 X 40%) = $7,200
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EXERCISE 21-19 LAGER DENTAL CLINIC Cash Budget For the Two Quarters Ending June 30, 2014 1st Quarter Beginning cash balance ......................................... $ 30,000 Add: Receipts Collections from clients........................... 230,000 Sale of equipment .................................... 12,000 Investment interest .................................. 0 Total receipts ...................................... 242,000 Total cash available ................................................ 272,000 Less: Disbursements Professional salaries ............................... 140,000 Overhead costs ........................................ 75,000 Selling and administrative costs............. 48,000* Equipment purchase ................................ 0 Payment of income taxes ........................ 0 Total disbursements .......................... 263,000 Excess (deficiency) of cash available over cash disbursements ................................... 9,000 Financing Add: Borrowings ................................................... 16,000 Less: Repayments ................................................. 0 Ending cash balance .............................................. $ 25,000 *$50,000 – $2,000 **$70,000 – $2,000
21-30
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2nd Quarter $ 25,000 380,000 0 7,000 387,000 412,000 140,000 100,000 68,000** 50,000 4,000 362,000 50,000 0 16,400 $ 33,600
EXERCISE 21-20 (a)
GRAND STORES Merchandise Purchases Budget For the Month Ending June 30, 2014 Budgeted cost of goods sold ($500,000 X 75%) .................. Add: Desired ending merchandise inventory ($600,000 X 75% X 30%) .................................................... Total ........................................................................................ Less: Beginning merchandise inventory ($375,000 X 30%)......................................................... Required merchandise purchases .......................................
(b)
135,000 510,000 112,500 $397,500
GRAND STORES Budgeted Income Statement For the Month Ending June 30, 2014 Sales ...................................................................................... Cost of goods sold (75% X $500,000) .................................. Gross profit ...........................................................................
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$375,000
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$500,000 375,000 $125,000
21-31
SOLUTIONS TO PROBLEMS PROBLEM 21-1A
GLENDO FARM SUPPLY COMPANY Sales Budget For the Six Months Ending June 30, 2014 Quarter Expected unit sales ..................... Unit selling price ......................... Total sales ...................................
1 30,000 X $60 $1,800,000
2 42,000 X $60 $2,520,000
Six Months 72,000 X $60 $4,320,000
GLENDO FARM SUPPLY COMPANY Production Budget For the Six Months Ending June 30, 2014 Quarter 1 Expected unit sales ............................................ 30,000 Add: Desired ending finished goods units ......................................................... 15,000 Total required units ............................................ 45,000 Less: Beginning finished goods units ............. 8,000 Required production units ................................. 37,000
21-32
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2 42,000 18,000 60,000 15,000 45,000
Six Months
82,000
PROBLEM 21-1A (Continued) GLENDO FARM SUPPLY COMPANY Direct Materials Budget—Gumm For the Six Months Ending June 30, 2014 Quarter Units to be produced .................................... Direct materials per unit ............................... Total pounds needed for production .......... Add: Desired ending direct materials (pounds) ............................................. Total materials required ............................... Less: Beginning direct materials (pounds) ............................................ Direct materials purchases .......................... Cost per pound .............................................. Total cost of direct materials purchases ..................................................
1
2
37,000 X4 148,000
45,000 X 4 180,000
10,000 158,000
13,000 193,000
9,000 149,000 X $3.80
10,000 183,000 X $3.80
$566,200
$695,400
Six Months
$1,261,600
GLENDO FARM SUPPLY COMPANY Direct Labor Budget For the Six Months Ending June 30, 2014 Quarter Units to be produced ........................... Direct labor time (hours) per unit ........ Total required direct labor hours ........ Direct labor cost per hour.................... Total direct labor cost ..........................
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1 37,000 X 1/4 9,250 X $16 $148,000
2 45,000 X 1/4 11,250 X $16 $180,000
Six Months
$328,000
21-33
PROBLEM 21-1A (Continued) GLENDO FARM SUPPLY COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2014 Quarter Budgeted sales in units Variable (.15 X sales) .......................... Fixed .................................................... Total.....................................................
1 30,000
2 42,000
Six Months 72,000
$270,000 175,000 $445,000
$378,000 175,000 $553,000
$ 648,000 350,000 $998,000
GLENDO FARM SUPPLY COMPANY Budgeted Income Statement For the Six Months Ending June 30, 2014 Sales ............................................................................................. Cost of goods sold (72,000 X $34.20)* ....................................... Gross profit .................................................................................. Selling and administrative expenses ......................................... Income from operations .............................................................. Income tax expense (30%) .......................................................... Net income ...................................................................................
$4,320,000 2,462,400 1,857,600 998,000 859,600 257,880 $ 601,720
*Cost Per Bag Cost Element Direct materials Gumm .......................................... Tarr ............................................... Direct labor ...................................... Manufacturing overhead (150% of direct labor cost) ......... Total ........................................
21-34
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Kimmel, Accounting, 5e, Solutions Manual
Quantity
Unit Cost
Total
4 pounds 6 pounds 1/4 hour
$ 3.80 1.50 16.00
$15.20 9.00 4.00 6.00 $34.20
(For Instructor Use Only)
PROBLEM 21-2A
(a)
DELEON INC. Sales Budget For the Year Ending December 31, 2014 JB 50 Expected unit sales .............. 400,000 Unit selling price .................. X $20 Total sales............................. $8,000,000
(b)
JB 60 200,000 X $25 $5,000,000
000,000,0 $13,000,000
DELEON INC. Production Budget For the Year Ending December 31, 2014 JB 50 400,000
Expected unit sales .............................. Add: Desired ending finished goods units ................................ 30,000 Total required units .............................. 430,000 Less: Beginning finished goods units ........................................... 25,000 Required production units ................... 405,000
.
Total
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JB 60 200,000 15,000 215,000 10,000 205,000
21-35
PROBLEM 21-2A (Continued) (c)
DELEON INC. Direct Materials Budget For the Year Ending December 31, 2014 JB 50 Units to be produced ...................... 405,000 Direct materials per unit ................. X 2 Total pounds needed for production.................................... 810,000 Add: Desired ending direct materials (pounds) ............... 30,000 Total materials required ................. 840,000 Less: Beginning direct materials (pounds) ............... 40,000 Direct materials purchases ............ 800,000 Cost per pound ................................ X $3 Total cost of direct materials purchases ................................... $2,400,000
(d)
JB 60 205,000 X 3 615,000 10,000 625,000 15,000 610,000 X $4 $2,440,000
$4,840,000
DELEON INC. Direct Labor Budget For the Year Ending December 31, 2014 JB 50 Units to be produced ...................... 405,000 Direct labor time (hours) per unit ................................................ X .4 Total required direct labor hours ............................................ 162,000 Direct labor cost per hour .............. X $12 Total direct labor cost ..................... $1,944,000
21-36
Total
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Kimmel, Accounting, 5e, Solutions Manual
JB 60
Total
205,000
650,000
X .6
—
123,000 X $12 $1,476,000
301,000 X $10 $3,420,000
(For Instructor Use Only)
PROBLEM 21-2A (Continued) (e)
DELEON INC. Budgeted Income Statement For the Year Ending December 31, 2014
Sales ...................................... Cost of goods sold ............... Gross profit ........................... Operating expenses Selling expenses ............... Administrative expenses ....................... Total operating expenses................ Income before income taxes .................................. Income tax expense (30%) .................................. Net income ............................ (1) (2)
.
JB 50 JB 60 Total $8,000,000 $5,000,000 $13,000,000 (1) 5,200,000 4,000,000 (2) 9,200,000 2,800,000 1,000,000 3,800,000 560,000
360,000
920,000
540,000
340,000
880,000
1,100,000
700,000
1,800,000
$1,700,000
$ 300,000
2,000,000 600,000 $ 1,400,000
400,000 X $13. 200,000 X $20.
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21-37
PROBLEM 21-3A
(a)
MARSH INDUSTRIES Sales Budget For the Year Ending December 31, 2014
Expected unit sales ................................... Unit selling price ........................................ Total sales ..................................................
Plan A Plan B 720,000 (1) 900,000 (2) X $8.40 X $7.50 (3) $6,048,000 $6,750,000
(1)
$6,400,000 ÷ $8 = 800,000 X 90% = 720,000. 800,000 + 100,000 = 900,000. (3) $8.00 – $0.50 (2)
(b)
MARSH INDUSTRIES Production Budget For the Year Ending December 31, 2014 Plan A 720,000 36,000 (1) 756,000 38,000 718,000
Expected unit sales.............................................. Add: Desired ending finished goods units ...... Total required units.............................................. Less: Beginning finished goods units............... Required production units .................................. (1)
Plan B 900,000 60,000 960,000 38,000 922,000
720,000 X 5%
(c) Variable costs = $4.30 per unit ($1.80 + $1.30 + $1.20) for both plans. Plan A Total variable costs Total fixed costs Total costs (a) Total units (b) Unit cost (a) ÷ (b)
Plan B
$3,087,400 (718,000 X $4.30) 1,895,000 $4,982,400
$3,964,600 (922,000 X $4.30) 1,895,000 $5,859,600
718,000
922,000
$6.94
$6.36
The difference is due to the fact that fixed costs are spread over a larger number of units (204,000) in Plan B. 21-38
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PROBLEM 21-3A (Continued) (d)
Gross Profit Plan A Sales Cost of goods sold Gross profit
$6,048,000 4,996,800 (720,000 X $6.94) $1,051,200
Plan B $6,750,000 5,724,000 (900,000 X $6.36) $1,026,000
Plan A should be accepted because it produces a higher gross profit than Plan B.
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21-39
PROBLEM 21-4A
(a) (1)
Expected Collections from Customers
November ($250,000) ................................ December ($320,000) ................................ January ($360,000).................................... February ($400,000) .................................. Total collections .............................. (2)
.
$326,000
February $ 0 64,000 108,000 200,000 $372,000
Expected Payments for Direct Materials
December ($100,000) ................................ January ($120,000).................................... February ($125,000) .................................. Total payments ................................
21-40
January $ 50,000 96,000 180,000
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January $ 40,000 72,000 .
$112,000
(For Instructor Use Only)
February $ 0 48,000 75,000 $123,000
PROBLEM 21-4A (Continued) (b)
COLTER COMPANY Cash Budget For the Two Months Ending February 28, 2014
Beginning cash balance .................................. Add: Receipts Collections from customers ............ [See Schedule (1)] Notes receivable ............................... Sale of securities .............................. Total receipts ............................ Total available cash ......................................... Less: Disbursements Direct materials ............................... [See Schedule 2] Direct labor ...................................... Manufacturing overhead ................. Selling and administrative expenses* .................................... Cash dividend .................................. Total disbursements ............... Excess (deficiency) of available cash over cash disbursements ............................ Financing Add: Borrowings ............................................ Less: Repayments .......................................... Ending cash balance .......................................
January $ 60,000
February $ 51,000
326,000
372,000
15,000 341,000 401,000
6,000 378,000 429,000
112,000
123,000
90,000 70,000
100,000 75,000
78,000 350,000
84,000 6,000 388,000
51,000
41,000
0 0 $ 51,000
9,000 0 $ 50,000
*Selling and administrative expenses less $1,000 depreciation.
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21-41
PROBLEM 21-5A
(a)
LITWIN COMPANY San Miguel Store Merchandise Purchases Budget For the Months of May and June, 2014
Budgeted cost of goods sold ........................... Add: Desired ending merchandise inventory..... Total ................................................................... Less: Beginning merchandise inventory ........ Required merchandise purchases ...................
May June $600,000 $630,000 (1) 94,500(2) 99,225 (3) 694,500 729,225 (4) 90,000 94,500 $604,500 $634,725
(1)
$800,000 X 105% = $840,000; $840,000 X 75% = $630,000. $630,000 X 15% = $94,500. (3) $840,000 X 105% = $882,000; $882,000 X 75% = $661,500; $661,500 X 15% = $99,225. (4) $600,000 X 15% = $90,000. (2)
21-42
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PROBLEM 21-5A (Continued) (b)
LITWIN COMPANY San Miguel Store Budgeted Income Statement For the Months of May and June, 2014
Sales .................................................................. Cost of goods sold Beginning inventory.................................. Purchases .................................................. Cost of goods available for sale .............. Less: Ending inventory............................ Cost of goods sold ............................ Gross profit ....................................................... Operating expenses Sales salaries ............................................ Advertising* ............................................... Delivery** ................................................... Sales commissions*** ............................... Rent ............................................................ Depreciation .............................................. Utilities ....................................................... Insurance ................................................... Total .................................................... Income from operations ................................... Income tax expense (30%) ............................... Net income ........................................................
May $800,000
June $840,000
90,000 604,500 694,500 94,500 600,000 200,000
94,500 634,725 729,225 99,225 630,000 210,000
30,000 48,000 24,000 40,000 5,000 800 600 500 148,900 51,100 15,330 $ 35,770
30,000 50,400 25,200 42,000 5,000 800 600 500 154,500 55,500 16,650 $ 38,850
*6% of sales. **3% of sales. ***5% of sales.
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21-43
PROBLEM 21-6A
KRAUSE INDUSTRIES Budgeted Income Statement For the Year Ending December 31, 2014 Sales (8,000 X $32) .................................................. Cost of goods sold Finished goods inventory, January 1 ............. Cost of goods manufactured ($62,500 + $50,900 + $48,600) ...................... Cost of goods available for sale ..................... Finished goods inventory, December 31 (3,000 X $18) ................................................. Cost of goods sold ................................... Gross profit .............................................................. Selling and administrative expenses ..................... Income from operations .......................................... Interest expense ...................................................... Income before income taxes .................................. Income tax expense (40%) ...................................... Net income ...............................................................
21-44
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$256,000 $ 15,000
(For Instructor Use Only)
162,000 177,000 54,000 123,000 133,000 75,000 58,000 3,500 54,500 21,800 $ 32,700
PROBLEM 21-6A (Continued) KRAUSE INDUSTRIES Budgeted Balance Sheet December 31, 2014 Assets Current assets Cash...................................................................... Accounts receivable ($76,800 X 40%) ................ Finished goods inventory (3,000 units X $18) ........................................... Total current assets ..................................... Property, plant, and equipment Equipment ($40,000 + $9,000) ............................. Less: Accumulated depreciation ($10,000 + $4,000) ..................................... Total assets ..................................................
$ 6,980 30,720 54,000 $91,700 $49,000 14,000
35,000 $126,700
Liabilities and Stockholders’ Equity Liabilities Notes payable ($25,000 – $8,000) ....................... Accounts payable ($8,500* + $6,500).................. Income taxes payable .......................................... Total liabilities .............................................. Stockholders’ equity Common stock ..................................................... Retained earnings ($25,000 + $32,700 – $8,000)............................ Total stockholders’ equity ........................... Total liabilities and stockholders’ equity ........................................................
$17,000 15,000 5,000 $ 37,000 $40,000 49,700 89,700 $126,700
*$17,000 X 50%
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PROBLEM 21-1B
MERCER FARM SUPPLY COMPANY Sales Budget For the Six Months Ending June 30, 2014 Quarter Expected unit sales ................... Unit selling price ....................... Total sales .................................
1 40,000 X $63 $2,520,000
2 50,000 X $63 $3,150,000
Six Months 90,000 X $63 $5,670,000
MERCER FARM SUPPLY COMPANY Production Budget For the Six Months Ending June 30, 2014 Quarter 1 Expected unit sales ............................................40,000 Add: Desired ending finished goods units .........................................................15,000 Total required units ............................................55,000 Less: Beginning finished goods units .............10,000 Required production units ................................45,000
21-46
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2 50,000 20,000 70,000 15,000 55,000
Six Months
100,000
PROBLEM 21-1B (Continued) MERCER FARM SUPPLY COMPANY Direct Materials Budget—Crup For the Six Months Ending June 30, 2014 Quarter 1
2
Units to be produced ................................. 45,000 Direct materials per unit ............................ X 5 Total pounds needed for production ....... 225,000 Add: Desired ending direct materials (pounds) .......................................... 12,000 Total materials required ............................ 237,000 Less: Beginning direct materials (pounds) ......................................... 9,000 Direct materials purchases ....................... 228,000 Cost per pound ........................................... X $3.80 Total cost of direct materials purchases ............................................... $866,400
Six Months
55,000 X 5 275,000 15,000 290,000 12,000 278,000 X $3.80 $1,056,400
$1,922,800
MERCER FARM SUPPLY COMPANY Direct Labor Budget For the Six Months Ending June 30, 2014 Quarter Units to be produced ......................... Direct labor time (hours) per unit ...... Total required direct labor hours ...... Direct labor cost per hour ................. Total direct labor cost ........................
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Kimmel, Accounting, 5e, Solutions Manual
1 45,000 X .25 11,250 X $12 $135,000
(For Instructor Use Only)
2 55,000 X .25 13,750 X $12 $165,000
Six Months
$300,000
21-47
PROBLEM 21-1B (Continued) MERCER FARM SUPPLY COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2014 Quarter Budgeted sales in units .....................
1 40,000
2 50,000
Six Months 90,000
Variable (.10 X sales) .......................... Fixed.................................................... Total ....................................................
$252,000 150,000 $402,000
$315,000 150,000 $465,000
$567,000 300,000 $867,000
MERCER FARM SUPPLY COMPANY Budgeted Income Statement For the Six Months Ending June 30, 2014 Sales ............................................................................................ Cost of goods sold (90,000 X $40)............................................. Gross profit ................................................................................. Selling and administrative expenses ........................................ Income from operations ............................................................. Income tax expense (30%) ......................................................... Net income ..................................................................................
$5,670,000 3,600,000 2,070,000 867,000 1,203,000 360,900 $ 842,100
Cost Per Bag Cost Element Direct materials Crup ............................................ Dert ............................................. Direct labor .................................... Manufacturing overhead (100% of direct labor cost) ........ Total .......................................
21-48
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Kimmel, Accounting, 5e, Solutions Manual
Quantity
Unit Cost
Total
5 pounds 10 pounds .25 hour
$ 3.80 1.50 12.00
$19.00 15.00 3.00 3.00 $40.00
(For Instructor Use Only)
PROBLEM 21-2B
(a)
URBINA INC. Sales Budget For the Year Ending December 31, 2014 LN 35 Expected unit sales .............. 400,000 Unit selling price ................... X $25 Total sales ............................. $10,000,000
(b)
Total 000,000,0 $18,400,000
URBINA INC. Production Budget For the Year Ending December 31, 2014
Expected unit sales .............................. Add: Desired ending finished goods units ................................ Total required units .............................. Less: Beginning finished goods units ........................................... Required production units ...................
.
LN 40 240,000 X $35 $8,400,000
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LN 35 400,000
LN 40 240,000
20,000 420,000
25,000 265,000
30,000 390,000
15,000 250,000
21-49
PROBLEM 21-2B (Continued) (c)
URBINA INC. Direct Materials Budget For the Year Ending December 31, 2014 LN 35 Units to be produced ...................... 390,000 Direct materials per unit ................. X 2 Total pounds needed for production.................................... 780,000 Add: Desired ending direct materials (pounds) ............... 50,000 Total materials required ................. 830,000 Less: Beginning direct materials (pounds) ............... 40,000 Direct materials purchases ............ 790,000 Cost per pound ................................ X $2 Total cost of direct materials purchases .................................... $1,580,000
(d)
LN 40 250,000 X 3 750,000 10,000 760,000 20,000 740,000 X $3 $2,220,000
$3,800,000
URBINA INC. Direct Labor Budget For the Year Ending December 31, 2014 LN 35 Units to be produced ...................... 390,000 Direct labor time (hours) per unit ................................................ X .5 Total required direct labor hours ............................................ 195,000 Direct labor cost per hour .............. X $12 Total direct labor cost ..................... $2,340,000
21-50
Total
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Kimmel, Accounting, 5e, Solutions Manual
X
LN 40
Total
250,000
550,000
.75
187,500 X $12 $2,250,000
(For Instructor Use Only)
322,500 X $10 $4,590,000
PROBLEM 21-2B (Continued) (e)
URBINA INC. Budgeted Income Statement For the Year Ending December 31, 2014 LN 35 LN 40 Total Sales ...................................... $10,000,000 $8,400,000 $18,400,000 Cost of goods sold................ 4,800,000 (1) 5,280,000 (2) 10,080,000 Gross profit ........................... 5,200,000 3,120,000 8,320,000 Operating expenses Selling expenses ............... 750,000 580,000 1,330,000 Administrative expenses........................ 420,000 380,000 800,000 Total operating expenses ................ 1,170,000 960,000 2,130,000 Income before income taxes................................... $ 4,030,000 $2,160,000 6,190,000 Income tax expense (30%) .................................. 1,857,000 Net income ............................ $ 4,333,000 (1) (2)
.
400,000 X $12. 240,000 X $22.
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21-51
PROBLEM 21-3B
(a)
OGLEBY INDUSTRIES Sales Budget For the Year Ending December 31, 2014
Expected unit sales .................................. Unit selling price ....................................... Total sales .................................................
Plan A Plan B 760,000 (1) 950,000 (2) X $7.60 X $6.65 (3) $5,776,000 $6,317,500
(1)
800,000 X 95% = 760,000. 800,000 + 150,000 = 950,000. (3) $7.00 X 95% = $6.65. (2)
(b)
OGLEBY INDUSTRIES Production Budget For the Year Ending December 31, 2014 Plan A 760,000 90,000 850,000 70,000 780,000
Expected unit sales.............................................. Add: Desired ending finished goods units ...... Total required units.............................................. Less: Beginning finished goods units............... Required production units ..................................
Plan B 950,000 100,000 1,050,000 70,000 980,000
(c) Variable costs = $4.00 per unit ($2.00 + $1.50 + $.50) for both plans. Plan A Total variable costs Total fixed costs Total costs (a) Total units (b) Unit cost (a) ÷ (b)
Plan B
$3,120,000 (780,000 X $4.00) 980,000 $4,100,000
$3,920,000 (980,000 X $4.00) 980,000 $4,900,000
780,000
980,000
$5.26
$5.00
The difference is due to the fact that fixed costs are spread over a larger number of units (200,000) in Plan B.
21-52
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PROBLEM 21-3B (Continued) (d)
Gross Profit Plan A Sales Cost of goods sold Gross profit
$5,776,000 3,997,600 (760,000 X $5.26) $1,778,400
Plan B $6,317,500 4,750,000 (950,000 X $5.00) $1,567,500
Plan A should be accepted because it produces a higher gross profit than Plan B.
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21-53
PROBLEM 21-4B
(a) 1.
Expected Collections from Customers
November ($200,000) .................................. December ($290,000) .................................. January ($350,000)...................................... February ($400,000) .................................... Total collections ................................ 2.
$312,500
February $ 0 43,500 87,500 240,000 $371,000
Expected Payments for Direct Materials
December ($90,000) .................................... January ($110,000)...................................... February ($120,000) .................................... Total payments ..................................
21-54
January $ 30,000 72,500 210,000
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January $63,000 33,000
(For Instructor Use Only)
$96,000
February $ 0 77,000 36,000 $113,000
PROBLEM 21-4B (Continued) (b)
DERBY COMPANY Cash Budget For the Two Months Ending February 28, 2014
Beginning cash balance ................................... Add: Receipts Collections from customers .................. [See Schedule (1)] Interest receivable .................................. Sale of securities .................................... Total receipts .................................. Total available cash .......................................... Less: Disbursements Direct materials ..................................... [See Schedule 2] Direct labor ....................................... Manufacturing overhead .................. Selling and administrative expenses ....................................... Purchase of land .............................. Total disbursements ................ Excess (deficiency) of available cash over cash disbursements............................. Financing Add: Borrowings ............................................. Less: Repayments ............................................ Ending cash balance ........................................
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January $ 50,000
February $ 49,500
312,500
371,000
3,000 315,500 365,500
5,000 376,000 425,500
96,000
113,000
85,000 60,000
115,000 75,000
75,000 316,000
80,000 20,000 403,000
49,500
22,500
0 0 $ 49,500
17,500 0 $ 40,000
21-55
PROBLEM 21-5B
(a)
WIDNER COMPANY Westwood Store Merchandise Purchases Budget For the Months of July and August, 2014 July August Budgeted cost of goods sold ............................. $260,000(1) $292,500 Add: Desired ending merchandise inventory ... 43,875(2) 48,750 (3) Total ..................................................................... 303,875 341,250 Less: Beginning merchandise inventory .................................................. 39,000(4) 43,875 Required merchandise purchases ..................... $264,875 $297,375 (1)
$400,000 X 65% = $260,000 $292,500 X 15% = $ 43,875. (3) $500,000 X 65% = $325,000; $325,000 X 15% = $48,750. (4) $260,000 X 15% = $ 39,000. (2)
21-56
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PROBLEM 21-5B (Continued) (b)
WIDNER COMPANY Westwood Store Budgeted Income Statement For the Months of July and August, 2014
Sales ................................................................... Cost of goods sold Beginning inventory................................... Purchases ................................................... Cost of goods available for sale ............... Less: Ending inventory ............................. Cost of goods sold ..................................... Gross profit ........................................................ Operating expenses Sales salaries ............................................. Advertising* ................................................ Delivery expense** ..................................... Sales commissions*** ................................ Rent ............................................................. Depreciation ............................................... Utilities ........................................................ Insurance .................................................... Total ..................................................... Income from operations .................................... Income tax expense (30%) ................................ Net income .........................................................
July $400,000
August $450,000
39,000 264,875 303,875 43,875 260,000 140,000
43,875 297,375 341,250 48,750 292,500 157,500
50,000 20,000 8,000 16,000 3,000 700 500 300 98,500 41,500 12,450 $ 29,050
50,000 22,500 9,000 18,000 3,000 700 500 300 104,000 53,500 16,050 $ 37,450
*5% of sales **2% of sales ***4% of sales
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BYP 21-1
DECISION-MAKING AT CURRENT DESIGNS CREATIVE DESIGNS Production Budget For the Year Ending December 31, 2013
Expected unit sales Add: desired ending finished goods units Total required units Less: Beginning finished goods units Required production units
Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total 1,000 1,500 750 750 4,000 300* 1,300
150* 1,650
150* 900
220** 220 970 4,220
200*** 1,100
300 1,350
150 750
150 820
*(20% of next quarter’s sales) **20% X 1,100 ***given in problem
21-58
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200 4,020
BYP 21-1 (Continued) CREATIVE DESIGNS Direct materials Budget For the Year Ending December 31, 2013 Units to be produced Pounds of polyethylene powder per unit Total pounds needed for production Add: desired ending inventory of powder Total pounds of powder required Less: Beginning inventory of powder Pounds of Polyethylene powder to be purchased Cost per pound Cost of polyethylene powder to be purchased Cost of required finishing kits (one kit per kayak manufactured) @$170 each Total costs for direct materials
X
X
Quarter 1
Quarter 2
Quarter 3
Quarter 4
1,100
1,350
750
820
54
X
54
X
54
X
54
Total 4,020 X
54
59,400
72,900
40,500
44,280
217,080
18,225*
10,125*
11,070*
15,930**
15,930
77,625
83,025
51,570
60,210
233,010
19,400***
18,225
10,125
11,070
19,400
58,225 $1.50
64,800 $1.50
41,445 $1.50
49,140 $1.50
213,610 $1.50
X
X
X
X
$ 87,337.50
$ 97,200.00
$ 62,167.50 $ 73,710.00
$ 320,415.00
187,000.00 $274,337.50
229,500.00 $326,700.00
127,500.00 139,400.00 $189,667.50 $213,110.00
683,400.00 $1,003,815.00
*25% of needs for next quarter **Desired ending inventory for Quarter 4 = 25% of amount needed for first quarter of 2014 production. Production for first quarter of 2014 = 1,100 + 300 – 220 = 1,180 units Desired ending inventory for Quarter 4 of 2013 = 25% *(1,180 units * 54 pounds per unit) = 15,930 pounds ***given in problem
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21-59
BYP 21-1 (Continued) CREATIVE DESIGNS Direct labor Budget For the Year Ending December 31, 2013 Units to be produced Number of hours of more skilled labor/unit Total number of hours of more skilled labor Hourly rate for more skilled labor Total cost of more skilled labor Units to be produced Number of hours of less skilled labor/unit Total number of hours of less skilled labor Hourly rate for less skilled labor Total cost of less skilled labor Total cost for direct labor
Quarter 1
Quarter 2
Quarter 3
Quarter 4
1,100
1,350
750
820
X
2
X
2
X
2
X
2
Total 4,020 X
2
2,200 X $15 $33,000 1,100
2,700 X $15 $40,500 1,350
1,500 X $15 $22,500 750
1,640 X $15 $24,600 820
8,040 X $15 $120,600 4,020
X
X
X
X
X
3
3,300 X $12 39,600 $72,600
3
4,050 X $12 48,600 $89,100
3
2,250 X $12 27,000 $49,500
3
2,460 X $12 29,520 $54,120
3
12,060 X $12 144,720 $265,320
CREATIVE DESIGNS Manufacturing Overhead Budget For the Year Ending December 31, 2013 Quarter 1 Quarter 2 Quarter 3 Quarter 4
Total
Total costs for direct labor $72,600 $89,100 $49,500 $54,120 $265,320 Manufacturing overhead rate per direct labor dollar X 150% X 150% X 150% X 150% X 150% Manufacturing overhead costs $108,900 $133,650 $74,250 $81,180 $397,980
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BYP 21-1 (Continued) CREATIVE DESIGNS Selling and Administrative Expense Budget For the Year Ending December 31, 2013 Expected unit sales Variable selling and administrative costs at $45 per unit sold Fixed selling and administrative costs Total selling and administrative costs
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Kimmel, Accounting, 5e, Solutions Manual
Quarter 1 Quarter 2 Quarter 3 Quarter 4 1,000 1,500 750 750
Total 4,000
$45,000
$67,500
$33,750
$33,750
$180,000
7,500
7,500
7,500
7,500
30,000
$52,500
$75,000
$41,250
$41,250
$210,000
(For Instructor Use Only)
21-61
BYP 21-2
DECISION-MAKING ACROSS THE ORGANIZATION
(a) The budget at Palmer Corporation is an imposed “top-down” budget which fails to consider both the need for realistic data and the human interaction essential to an effective budgeting/control process. The president has not given any basis for his goals, so one cannot know whether they are realistic for the company. True participation of company employees in preparation of the budget is minimal and limited to mechanical gathering and manipulation of data. This suggests there will be little enthusiasm for implementing the budget. The budget process is the merging of the requirements of all facets of the company on a basis of sound judgment and equity. Specific instances of poor procedures other than the approach and goals include the following: 1.
The sales by product line should be based upon an accurate sales forecast of potential market. Therefore, the sales by product line should have been developed first to derive the sales target rather than the reverse.
2.
Production costs probably would be the easiest and most certain costs to estimate. Given variable and fixed production costs, one could estimate the sales volume needed to cover manufacturing costs plus the costs of other aspects of the operation. This would be helpful before budgets for marketing costs and corporate office expenses are set.
3.
The initial meeting between the vice president of finance, executive vice president, marketing manager, and production manager should be held earlier. This meeting is held too late in the budgeting process.
(b) Palmer Corporation should consider the adoption of a “bottom to top” (participative) budget process. This means that the people responsible for performance under the budget would participate in the decisions by which the budget is established. In addition, this approach requires initial and continuing involvement of sales, financial, and production personnel to define sales and profit goals which are realistic within the constraints under which management operates. Although time-consuming, the approach should produce a more acceptable, honest, and workable goal-control mechanism. It also provides for goal congruence possibilities for both individuals and departments within the firm. 21-62
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BYP 21-2 (Continued) The sales forecast should be developed considering internal sales forecasts as well as external factors. Costs within departments should be divided into fixed and variable, discretionary and nondiscretionary. (c) The functional areas should not necessarily be expected to cut costs when sales volume falls below budget. The time frame of the budget (one year) is short enough so that many costs are relatively fixed in amount. For those costs which are fixed, there is little hope for a reduction as a consequence of short-run changes in volume. However, the functional areas should be expected to cut costs should sales volume fall below target when:
.
1.
Control is exercised over the costs within their function.
2.
Budgeted costs were more than adequate for the originally targeted sales; i.e., slack was present.
3.
Budgeted costs vary to some extent with changes in sales.
4.
There are discretionary costs which can be delayed or omitted with no serious effect on the department. (CMA adapted)
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21-63
BYP 21-3
MANAGERIAL ANALYSIS
(a) Direct materials
Either lower quality materials resulting in an inferior product and possible lost sales, or fewer units produced resulting in lost sales.
Direct labor
Reduced production resulting in lost sales, or reduction in quality of product resulting in lost sales.
Insurance
Less coverage; may increase risk beyond acceptable levels.
Depreciation
To reduce depreciation, fixed assets would have to be disposed of. Could result in less production and lost sales.
Machine repairs
Less efficient operations, or lost production and sales.
Sales salaries
Lost sales.
Office salaries
Less effective administrative functions.
Factory salaries
Lost production due to inefficiency, and therefore lost sales.
(b) Given the nature of their product, a decline in quality should be avoided, since this could result in lower future sales. Direct materials represent the largest single cost, and thus perhaps the greatest potential savings. Perhaps substitute materials of similar quality can be found, or less expensive materials can be used for aspects of the product where quality is not as critical. Additionally, it may be possible to renegotiate prices with the supplier. Elliot & Hesse should be very reluctant to reduce repair costs, since in the long run this can be very expensive. Perhaps salaried and hourly employees can be encouraged to take pay cuts if a profit-sharing mechanism is introduced.
21-64
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BYP 21-4
REAL-WORLD FOCUS
(a) The factors that affect the budgeting process at Network Computing Devices, Inc. are general economic conditions affecting industry demand for computer products, the timing and market acceptance of new products of the Company and its competitors, the timing of significant orders from large customers, periodic changes in product pricing and discounting due to competitive factors, and the availability of key product components (raw materials). In addition, the budgeting process will be affected by the Company’s success with its products, its product and customer mix, and the level of competition it experiences. (b) Internationally, third quarter sales are adversely affected because European customers reduce their business activity in August. In addition, international sales are denominated in U.S. dollars and any change in the value of the dollar relative to foreign currencies could make the Company’s products more or less competitive in foreign markets.
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BYP 21-5
REAL-WORLD FOCUS
(a) According to Mr. LaFaive, zero-based budgeting requires that the existence of a government program or programs be justified in each fiscal year, as opposed to simply basing budgeting decisions on a previous year’s funding level. Zero-based budgeting is often encouraged by fiscal watchdog groups as a way to ensure against unnecessary spending. (b) In addition to saving money and improving services, zero-based budgeting may: • • •
Increase restraint in developing budgets; Reduce the entitlement mentality with respect to cost increases; and Make budget discussions more meaningful during review sessions.
(c) On the cost side of the equation, zero-based budgeting: • • •
May increase the time and expense of preparing a budget; May be too radical a solution for the task at hand. You don’t need a sledgehammer to pound in a nail; Can make matters worse if not done in the right way. A substantial commitment must be made by all involved to ensure that this doesn’t happen.
(d) In Oklahoma, which has recently adopted zero-based budgeting, officials are applying the method to two departments and several agencies each year. Once those reviews are complete, the same departments and agencies will not see another zero-based review for eight years.
21-66
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BYP 21-6
COMMUNICATION ACTIVITY
Date 2014 Mrs. Megan Parcells, CEO Life Protection Products Dear Mrs. Parcells: Allow me to congratulate you on the success of your new venture! The growth in sales you have experienced is phenomenal. You have managed the business side of the venture very well also. At the same time, I understand your concern about cash flow. You are selling these kits as fast as you can make them, and yet you are running out of cash. There is a solution to your problem. Before describing that, it may be helpful for you to understand why this situation occurred. The primary reason is that you are purchasing kit supplies at least two months in advance of sales. As your business expands, these materials costs continue to increase. Sales do not “catch up” until the Drs. Parcells have a seminar. You did not describe in detail how often these seminars are, but I would guess that they tend to run in cycles rather than being regularly spaced. Eventually, as sales stabilize, you will find that cash inflows exceed cash outflows, and your need for additional cash will subside. Presently, I think it would be a good idea to try to borrow additional funds. I have not seen all your financial data, but judging only from the cash budget you showed me, it appears that you have the basis of a very successful company. If so, your banker will be able to see the potential in your business and should be happy to provide the cash you need. You will need to prepare a full set of financial statements. I will be happy to assist you, if you desire. There is also a possibility that you have underpriced your product. You are providing a valuable service in assembling this information and these materials. The fact that every seminar results in a sellout of the materials may mean that you have priced your product too low. I know that your husband wishes to have these materials available to every family, but increasing the price a little may not make the price too high, and would better compensate you for your efforts.
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BYP 21-6 (Continued) However, even if you raised prices, you will find that you need additional cash as long as the business continues to expand. It certainly does not mean that you and Sue are doing anything wrong. It just means that you will be investing additional funds as long as you continue to grow. In my opinion, the best way to make sure these kits are available to as many families as possible is for you and Sue to have a consultant evaluate and determine the size of the market for you. Then you can decide whether to expand to meet the need, or whether to keep your own business small and allow competitors to imitate your product. Congratulations again on a very successful product. Call or email this office if we may be of further assistance preparing financial statements or providing additional advice. Sincerely, Ima Student Best and Superior, Certified Public Accountants
21-68
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BYP 21-7
ETHICS CASE
(a) At best, if you disclose the errors in your calculations, you will be embarrassed. At worst, you will be dismissed without a recommendation for another job. (b) The president will continue making presentations using data that are grossly overstated. In time, your error may be detected when the events you projected do not materialize. (c) The most ethical scenario would be to admit your error, let the president know about the error, provide the president with corrected projections, and allow the president to decide how to alter his presentations during the second week of his speech-making.
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BYP 21-8
ALL ABOUT YOU
Personal Budget Typical Month Income: Wages earned .................................................. Interest income ................................................ Income subtotal .......................................................... Income tax withheld ................................................... Spendable income........................................... Expenses: Rent ............................................................................. Utilities Electricity ......................................................... Telephone and Internet ................................... Food: Groceries ......................................................... Eating out......................................................... Insurance .................................................................... Transportation ............................................................ Student loan payments .............................................. Entertainment ............................................................. Savings ....................................................................... Miscellaneous ............................................................. Total investments and expenses .............. Surplus/Shortage........................................................
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$2,500 50 2,550 300 $2,250 500 85 125 100 150 100 150 375 250 50 210 2,095 $ 155
BYP 21-9
CONSIDERING YOUR COSTS AND BENEFITS
We are concerned that the personal budgets presented on websites and in financial planning textbooks often list student loans among the sources of income. This type of thinking can lead to an overreliance on debt during college, and will result in accumulation of large amounts of debt that must be repaid. We would prefer a format that lists nondebt sources of income, then subtracts expenses, then shows debt borrowed. This format emphasizes an important point: Just like a business, in the short run you can borrow money when your cash inflows are not sufficient to meet your outflows, but in the long run you need to learn to live within your income, and your budget.
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CHAPTER 22 Budgetary Control and Responsibility Accounting ASSIGNMENT CLASSIFICATION TABLE Brief Exercises
Learning Objectives
Questions
Do It!
1.
Describe the concept of budgetary control.
1, 2
2.
Evaluate the usefulness of static budget reports.
3, 4, 5
1, 2
3.
Explain the development of flexible budgets and the usefulness of flexible budget reports.
6, 7, 8, 9, 10, 11, 12
3, 4, 5
4.
Describe the concept of responsibility accounting.
13, 14, 15, 16, 17, 18, 24
5.
Indicate the features of responsibility reports for cost centers.
19
6
6.
Identify the content of responsibility reports for profit centers.
20, 21
7
3
7.
Explain the basis and formula used in evaluating performance in investment centers.
22, 23, 24
8, 9, 10
4
*8.
Explain the difference between ROI and residual income.
25, 26
11, 12
A Problems
B Problems
1, 2, 8, 10
3A
3B
1, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12
1A, 2A, 3A
1B, 2B, 3B
13
6A
6B
15, 16
4A
4B
16, 17, 18, 19
5A
5B
20, 21
7A
7B
Exercises 1
1, 2
9, 11, 14
*Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter.
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22-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Prepare flexible budget and budget report for manufacturing overhead.
Simple
20–30
2A
Prepare flexible budget, budget report, and graph for manufacturing overhead.
Moderate
30–40
3A
State total budgeted cost formula, and prepare flexible budget reports for two time periods.
Simple
20–30
4A
Prepare responsibility report for a profit center.
Moderate
20–30
5A
Prepare responsibility report for an investment center, and compute ROI.
Moderate
40–50
6A
Prepare reports for cost centers under responsibility accounting, and comment on performance of managers.
Moderate
40–50
*7A
Compare ROI and residual income.
Moderate
25–35
1B
Prepare flexible budget and budget report for manufacturing overhead.
Simple
20–30
2B
Prepare flexible budget, budget report, and graph for manufacturing overhead.
Moderate
30–40
3B
State total budgeted cost formula, and prepare flexible budget reports for two time periods.
Simple
20–30
4B
Prepare responsibility report for a profit center.
Moderate
20–30
5B
Prepare responsibility report for an investment center, and compute ROI.
Moderate
40–50
6B
Prepare reports for cost centers under responsibility accounting, and comment on performance of managers.
Moderate
40–50
*7B
Compare ROI and residual income.
Moderate
25–35
22-2
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Kimmel, Accounting, 5e, Solutions Manual
Learning Objective
Knowledge Comprehension
Application
Analysis
(For Instructor Use Only)
1. Describe the concept of budgetary control.
E22-1
Q22-1 Q22-2
2. Evaluate the usefulness of static budget reports.
E22-1
Q22-3 Q22-4
Q22-5 BE22-1 BE22-2
E22-2 P22-3A E22-10 P22-3B
3. Explain the development of flexible budgets and the usefulness of flexible budget reports.
Q22-9 Q22-12 E22-1
Q22-6 Q22-7 Q22-8 Q22-10
Q22-11 BE22-4 DI22-1 DI22-2 E22-3 E22-5
E22-7 BE22-5 E22-9 E22-4 E22-10 E22-6 E22-11 P22-1A E22-12 P22-3A P22-1B
Q22-13 Q22-14 Q22-15 Q22-16
Q22-17 E22-13 Q22-18 Q22-24
P22-6A P22-6B
BE22-6 E22-9 E22-11
E22-14
4. Describe the concept of responsibility accounting.
5. Indicate the features of responsibility reports for cost centers.
Q22-19
6. Identify the content of responsibility reports for profit centers.
Q22-20 Q22-21
BE22-7 DI22-3 E22-16
E22-15 P22-4A P22-4B
7. Explain the basis and formula used in evaluating performance in investment centers.
Q22-22 Q22-23 Q22-24
BE22-8 BE22-9 BE22-10 DI22-4
E22-16 E22-19 E22-17 E22-18
BE22-11 BE22-12
E22-20 E22-21 P22-7A
BYP22-5
BYP22-4 BYP22-6 BYP22-7
*8. Explain the difference between ROI and residual income. Broadening Your Perspective
Q22-25 Q22-26
Synthesis
Evaluation
E22-8 P22-3B
BE22-3 E22-8 P22-2A P22-2B
P22-5A P22-5B
P22-7B
BYP22-2 BYP22-3
BYP22-8 BYP22-9
BLOOM’ S TAXONOMY TABLE
.
Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
23-3
ANSWERS TO QUESTIONS 1.
(a) Budgetary control is the use of budgets in controlling operations. (b) The steps in budgetary control are: (1) Develop the planned objectives (budget). (2) Analyze differences between actual and budgeted results. (3) Take corrective action. (4) Modify future plans, if necessary.
2.
Purpose
Name of Report
Frequency
(a) (b) (c)
Scrap Departmental overhead costs Income statement
Daily Monthly Monthly and Quarterly
Primary Recipient(s) Production manager Department manager Top management
3.
The budget report for the second quarter can include year-to-date information as well as data for the second quarter.
4.
There is no justification for Ken’s concern. The sales budget is derived from the sales forecast and it represents management’s best estimate of sales. Thus, it is a useful basis for evaluating sales performance.
5.
A static budget is an appropriate basis for evaluating a manager’s effectiveness in controlling costs when: (1) The actual level of activity closely approximates the master budget activity level and/or (2) The behavior of the costs in response to changes in activity is fixed.
6.
Yes, this is true. A flexible budget is a series of static budgets at different levels of activity.
7.
The performance is unfavorable. The budgeted indirect labor cost in the static budget is $1.35 per direct labor hour ($54,000 ÷ 40,000). At 45,000 direct labor hours, budgeted costs are $60,750 (45,000 X $1.35). Thus, indirect labor is $3,250 over budget ($64,000 – $60,750).
8.
The performance is favorable. Factory insurance is a fixed cost. At 50,000 direct labor hours, the budgeted cost is still $6,500. Thus, factory insurance is $200 under budget ($6,500 – $6,300).
9.
The steps in preparing a flexible budget are: (1) Identify the activity index and the relevant range of activity. (2) Identify the variable costs, and determine the budgeted variable cost per unit of activity for each cost. (3) Identify the fixed costs, and determine the budgeted amount for each cost. (4) Prepare the budget for selected increments of activity within the relevant range.
10.
Cali Company can say that total budgeted costs are $20,000 fixed plus $6.50 per direct labor hour [($85,000 – $20,000) ÷ 10,000].
11.
(a) At 9,000 hours, total budgeted costs are $86,000, or [$50,000 + ($4 X 9,000)]. (b) At 12,345 hours, total budgeted costs are $99,380, or [$50,000 + ($4 X 12,345)].
22-4
.
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Questions Chapter 22 (Continued) 12.
Management by exception means that top management’s review of a budget report is focused either entirely or primarily on differences between actual results and planned objectives. The criteria for identifying exceptions are materiality and controllability of the item.
13.
Responsibility accounting is a method of controlling operations that involves accumulating and reporting costs (and revenues, where relevant) on the basis of the manager who has the authority to make the day-to-day decisions about the items. The purpose of responsibility accounting is to evaluate a manager’s performance on the basis of matters directly under that manager’s control.
14.
Eve should know that the following conditions contribute to the effective use of responsibility accounting: (1) Costs and revenues can be directly associated with the specific level of management responsibility. (2) The costs and revenues are controllable at the level of responsibility with which they are associated. (3) Budget data can be developed for evaluating the manager’s effectiveness in controlling the costs and revenues.
15.
A cost is controllable at a given level of managerial responsibility if the manager has the power to incur the cost within a given period of time. Most costs incurred directly are controllable, whereas costs incurred indirectly and allocated to a responsibility level are noncontrollable at that level.
16.
Responsibility reports differ from budget reports in two respects: (1) a distinction is made between controllable and noncontrollable items and (2) performance reports either emphasize, or only include, items controllable by the individual manager.
17.
Usually there is a relationship between a responsibility reporting system and a company’s organization chart. In a responsibility reporting system, reports are prepared for each level of responsibility in the organization chart.
18.
There are three types of responsibility centers: (a) A cost center incurs costs (and expenses) but does not generate revenues. (b) A profit center incurs costs (and expenses) and also generates revenues. (c) An investment center incurs costs (and expenses), generates revenues, and controls the investment funds available for use.
19.
(a) Only controllable costs are included in a performance report for a cost center. (b) Variable and fixed costs are not identified in the report.
20.
Direct fixed costs relate specifically to one center and are incurred for the sole benefit of that center. An indirect fixed cost relates to the company’s overall activities and is incurred for the benefit of more than one profit center. Both types of fixed costs are controllable. A direct fixed cost is controllable by a specific center manager and an indirect fixed cost is controllable by an officer higher up in the organization.
21.
Controllable margin is contribution margin less controllable fixed costs in a profit center. The purpose of controllable margin is to provide a basis for evaluating the manager’s effectiveness in controlling revenues and costs.
.
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22-5
Questions Chapter 22 (Continued) 22. The primary basis for evaluating the performance of the manager of an investment center is return on investment (ROI). The formula is: Controllable Margin divided by Average Operating Assets. 23. ROI can be improved by: (1) increasing controllable margin and (2) reducing average operating assets. Controllable margin can be increased by increasing sales or by reducing variable and controllable fixed costs. 24. (a) The manager being evaluated should have direct input into the process of establishing budget goals and have the opportunity to respond to the evaluation. (b) Top management should make the evaluation entirely on matters controllable by the manager, and should fully support the evaluation process. *25. ROI fails to indicate the dollar amount of change in residual income. That is, a positive increase in residual income may result from a project that is rejected because of its negative effect on ROI. *26. Residual income is the income that remains after subtracting from the controllable margin the minimum rate of return on a company’s average operating assets. Residual income as a performance measure ignores the amount of difference in investments (average operating assets) by concentrating only on the amount of additional residual income.
22-6
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Kimmel, Accounting, 5e, Solutions Manual
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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 22-1 MARIS COMPANY Sales Budget Report For the Quarter Ended March 31, 2014 Product Line Garden-Tools
Budget $310,000
Actual $305,000
Difference $5,000 U
BRIEF EXERCISE 22-2 MARIS COMPANY Sales Budget Report For the Quarter Ended June 30, 2014 Product Line
Second Quarter Budget Actual Difference
Garden-Tools $380,000 $384,000
$4,000 F
Year to Date Budget Actual Difference $690,000 $689,000
$1,000 U
BRIEF EXERCISE 22-3 (a)
Direct Labor (b)
Direct Labor .
PAIGE COMPANY Static Direct Labor Budget Report For the Month Ended January 31, 2014 Budget $200,000
(10,000 X $20)
Actual $204,000
Difference $4,000 U
PAIGE COMPANY Flexible Direct Labor Budget Report For the Month Ended January 31, 2014 Budget $208,000
Kimmel, Accounting, 5e, Solutions Manual
(10,400 X $20)
(For Instructor Use Only)
Actual $204,000
Difference $4,000 F 22-7
BRIEF EXERCISE 22-3 (Continued) The static budget does not provide a proper basis for evaluating performance because the budget is not based on the hours actually worked. In contrast, the flexible budget provides the proper basis for evaluating performance because the budget is based on the hours actually worked.
BRIEF EXERCISE 22-4 GUNDY COMPANY Monthly Flexible Manufacturing Budget For the Year 2014 Activity level Finished units Variable costs Direct materials ($5) Direct labor ($6) Overhead ($8) Total variable costs ($19) Fixed costs Depreciation (1) Supervision (2) Total fixed costs Total costs (1) (2)
22-8
80,000
100,000
120,000
$ 400,000 480,000 640,000 $1,520,000
$ 500,000 600,000 800,000 $1,900,000
$ 600,000 720,000 960,000 $2,280,000
200,000 100,000 300,000 $1,820,000
200,000 100,000 300,000 $2,200,000
200,000 100,000 300,000 $2,580,000
($2 X 1,200,000) ÷ 12 ($1 X 1,200,000) ÷ 12
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BRIEF EXERCISE 22-5 GUNDY COMPANY Manufacturing Flexible Budget Report For the Month Ended March 31, 2014
Units produced Variable costs Direct materials Direct labor Overhead Total variable costs Fixed costs Depreciation Supervision Total fixed costs Total costs
Budget
Actual
100,000
100,000
Difference Favorable F Unfavorable U
$ 500,000 600,000 800,000 $1,900,000
$ 525,000 596,000 805,000 $1,926,000
$25,000 U 4,000 F 5,000 U $26,000 U
200,000 100,000 300,000 $2,200,000
200,000 100,000 300,000 $2,226,000
–0– –0– –0– $26,000 U
Costs were not entirely controlled as evidenced by the difference between budgeted and actual for the variable costs.
BRIEF EXERCISE 22-6 HANNON COMPANY Assembly Department Manufacturing Overhead Cost Responsibility Report For the Month Ended April 30, 2014 Controllable Cost
Budget
Actual
Indirect materials Indirect labor Utilities Supervision
$16,000 20,000 10,000 5,000 $51,000
$14,300 20,600 10,850 5,000 $50,750
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Difference Favorable F Unfavorable U $1,700 F 600 U 850 U 0U $ 250 F
22-9
BRIEF EXERCISE 22-7 ELBERT COMPANY Water Division Responsibility Report For the Year Ended December 31, 2014
Sales Variable costs Contribution margin Controllable fixed costs Controllable margin
Budget
Actual
$2,000,000 1,000,000 1,000,000 300,000 $ 700,000
$2,080,000 1,060,000 1,020,000 305,000 $ 715,000
Difference Favorable F Unfavorable U $80,000 F 60,000 U 20,000 F 5,000 U $15,000 F
BRIEF EXERCISE 22-8 COBB COMPANY Plastics Division Responsibility Report For the Year Ended December 31, 2014 Budget
Actual
Contribution margin Controllable fixed costs Controllable margin
$700,000 300,000 $400,000
$710,000 302,000 $408,000
Return on investment
20%
20.4%
.4% F
($400,000 ÷ $2,000,000)
($408,000 ÷ $2,000,000)
($8,000 ÷ $2,000,000)
BRIEF EXERCISE 22-9 III III III
22-10
26% ($1,300,000 ÷ $5,000,000) 25% ($2,000,000 ÷ $8,000,000) 30% ($3,600,000 ÷ $12,000,000)
.
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Difference Favorable F Unfavorable U $10,000 F 2,000 U $ 8,000 F
BRIEF EXERCISE 22-10 III
A $300,000 ($2,000,000 X .15) increase in sales will increase contribution margin and controllable margin $210,000 ($300,000 X 70%). The new ROI is 30.2% ($1,510,000 ÷ $5,000,000).
III
A decrease in costs results in a corresponding increase in controllable margin. The new ROI is 30% ($2,400,000 ÷ $8,000,000).
III
A decrease in average operating assets reduces the denominator. The new ROI is 31.3% ($3,600,000 ÷ $11,500,000).
*BRIEF EXERCISE 22-11 Controllable Margin $660,000
÷ ÷
Average Operating Assets $3,000,000
= ROI = 22%
Controllable Margin $660,000 $660,000
– – –
(Minimum Rate of Return X Average Operating Assets) (10% X $3,000,000) $300,000
= = =
Residual Income Residual Income $360,000
= = =
Residual Income Residual Income $200,000
*BRIEF EXERCISE 22-12 Controllable Margin $800,000
÷ ÷
Average Operating Assets $4,000,000
Controllable Margin $800,000 $800,000
– – –
(Minimum Rate of Return X Average Operating Assets) (15% X $4,000,000) $600,000
.
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= ROI = 20%
(For Instructor Use Only)
22-11
SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 22-1 Using the graph data, fixed costs are $90,000, and variable costs are $4.80 per direct labor hour [($330,000 – $90,000) ÷ 50,000]. Thus, at 65,000 direct labor hours, total budgeted costs are $402,000 [$90,000 + (65,000 X $4.80)]. DO IT! 22-2
Units produced
Budget 6,000 units
Actual 6,000 units
Difference Favorable F Unfavorable U
Variable costs Direct materials ($7) Direct labor ($13) Overhead ($18) Total variable costs
$ 42,000 78,000 108,000 228,000
$ 38,850 76,440 116,640 231,930
$3,150 F 1,560 F 8,640 U 3,930 U
Fixed costs Depreciation* Supervision** Total fixed costs Total costs
8,000 3,800 11,800 $239,800
8,000 4,000 12,000 $243,930
0 200 U 200 U $4,130 U
*$96,000/12 **$45,600/12 The flexible budget report indicates that actual overhead was 8.0% over budget. This cost was not well-controlled and should be examined further. The other variable costs came in under budget. The direct materials cost was 7.5% under budget; Mussatto should also investigate the cause of this difference, even though it is favorable. Finally, Mussatto also should investigate the unfavorable difference in supervision (5.3%) to determine if the budget amount is out-of-date.
22-12
.
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DO IT! 22-3 WELLSTONE DIVISION Responsibility Report For the Year Ended December 31, 2014
Sales Variable costs Contribution margin Controllable fixed costs Controllable margin
Budget $2,000,000 800,000 1,200,000 550,000 $ 650,000
Actual $1,860,000 760,000 1,100,000 550,000 $ 550,000
Difference Favorable F Unfavorable U $140,000 U 40,000 F 100,000 U –0– $100,000 U
DO IT! 22-4 (a)
Controllable margin for 2013: Sales ..................................................... Variable costs ...................................... Contribution margin ............................ Controllable fixed costs ...................... Controllable margin ............................. Return on investment for 2013:
(b)
$500,000 300,000 200,000 75,000 $125,000 $125,000 $625,000
=
20%
Expected return on investment for alternative 1: $125,000* = 25% $500,000 *Controllable margin remains unchanged from (a)
.
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22-13
DO IT! 22-4 (Continued) Controllable margin for alternative 2: Sales ($500,000 + 100,000) ............................ Variable costs ($300,000/$500,000 X $600,000) ................. Contribution margin ...................................... Controllable fixed costs ................................ Controllable margin ....................................... Expected return on investment for alternative 2:
22-14
.
Kimmel, Accounting, 5e, Solutions Manual
$600,000 360,000 240,000 75,000 $165,000 $165,000 $625,000
(For Instructor Use Only)
=
26.4%
SOLUTIONS TO EXERCISES EXERCISE 22-1 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
True. False. Budget reports are prepared as frequently as needed. True. True. False. Budgetary control works best when a company has a formalized reporting system. False. The primary recipients of the sales report are the sales manager and top management. True. True. False. Top management’s reaction to unfavorable differences is often influenced by the materiality of the difference. True.
EXERCISE 22-2 (a)
CREDE COMPANY Selling Expense Report For the Quarter Ending March 31
Month
Budget
By Month Actual Difference
January February March
$30,000 $35,000 $40,000
$31,200 $34,525 $46,000
$1,200 U $ 475 F $6,000 U
Budget
Year-to-Date Actual Difference
$ 30,000 $ 65,000 $105,000
$ 31,200 $ 65,725 $111,725
$1,200 U $ 725 U $6,725 U
(b)
The purpose of the Selling Expense Report is to help management control selling expenses. The primary recipient is the sales manager.
(c)
Most likely, when management scrutinized the results for January and February, they would determine that the difference was insignificant (4% in January and 1.4% in February), and require no action. When the March results are examined, however, the fact that the difference is 15% of budget would probably cause management to investigate further. As a result of their investigation, management would either take corrective action or modify the amounts of budgeted selling expense for future months to reflect changing conditions.
.
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22-15
EXERCISE 22-3 THOME COMPANY Monthly Manufacturing Overhead Flexible Budget For the Year 2014 Activity level Direct labor hours Variable costs Indirect labor ($1) Indirect materials ($.60) Utilities ($.40) Total variable costs ($2.00) Fixed costs Supervision Depreciation Property taxes Total fixed costs Total costs
7,000
8,000
9,000
10,000
$ 7,000 4,200 2,800 14,000
$ 8,000 4,800 3,200 16,000
$ 9,000 5,400 3,600 18,000
$10,000 6,000 4,000 20,000
4,000 1,200 800 6,000 $20,000
4,000 1,200 800 6,000 $22,000
4,000 1,200 800 6,000 $24,000
4,000 1,200 800 6,000 $26,000
EXERCISE 22-4 (a)
THOME COMPANY Manufacturing Overhead Flexible Budget Report For the Month Ended July 31, 2014
Direct labor hours (DLH) Variable costs Indirect labor Indirect materials Utilities Total variable costs Fixed costs Supervision Depreciation Property taxes Total fixed costs Total costs
22-16
.
Budget at 9,000 DLH
Actual Costs 9,000 DLH
Difference Favorable F Unfavorable U
$ 9,000 5,400 3,600 18,000
$ 8,800 5,300 3,200 17,300
$200 F 100 F 400 F 700 F
4,000 1,200 800 6,000 $24,000
4,000 1,200 800 6,000 $23,300
— — — — $700 F
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EXERCISE 22-4 (Continued) (b)
THOME COMPANY Manufacturing Overhead Flexible Budget Report For the Month Ended July 31, 2014
Direct labor hours (DLH) Variable costs Indirect labor ($1.00) Indirect materials ($0.60) Utilities ($0.40) Total variable costs ($2.00) Fixed costs Supervision Depreciation Property taxes Total fixed costs Total costs
Budget at 8,500 DLH
Actual Costs 8,500 DLH
Difference Favorable F Unfavorable U
$ 8,500 5,100 3,400
$ 8,800 5,300 3,200
$300 U 200 U 200 F
17,000
17,300
300 U
4,000 1,200 800 6,000 $23,000
4,000 1,200 800 6,000 $23,300
— — — — $300 U
(c) In case (a) the performance for the month was satisfactory. In case (b) management may need to determine the causes of the unfavorable differences for indirect labor and indirect materials, or since the differences are small, 3.5% of budgeted cost for indirect labor and 3.9% for indirect materials, they might be considered immaterial.
.
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22-17
EXERCISE 22-5 DEWITT COMPANY Monthly Selling Expense Flexible Budget For the Year 2014 Activity level Sales Variable expenses Sales commissions (6%) Advertising (4%) Traveling (3%) Delivery (2%) Total variable expenses (15%) Fixed expenses Sales salaries Depreciation Insurance Total fixed expenses Total expenses
$170,000
$180,000
$190,000
$200,000
$ 10,200 6,800 5,100 3,400
$ 10,800 7,200 5,400 3,600
$ 11,400 7,600 5,700 3,800
$ 12,000 8,000 6,000 4,000
25,500
27,000
28,500
30,000
35,000 7,000 1,000 43,000 $ 68,500
35,000 7,000 1,000 43,000 $ 70,000
35,000 7,000 1,000 43,000 $ 71,500
35,000 7,000 1,000 43,000 $ 73,000
EXERCISE 22-6 (a)
DEWITT COMPANY Selling Expense Flexible Budget Report For the Month Ended March 31, 2014
Sales Variable expenses Sales commissions Advertising Travel Delivery Total variable expenses Fixed expenses Sales salaries Depreciation Insurance Total fixed expenses Total expenses
22-18
.
Budget $170,000
Actual $170,000
Difference Favorable F Unfavorable U
$ 10,200 6,800 5,100 3,400 25,500
$ 11,000 6,900 5,100 3,450 26,450
$800 U 100 U 0U 50 U 950 U
35,000 7,000 1,000 43,000 $ 68,500
35,000 7,000 1,000 43,000 $ 69,450
0U 0U 0U 0U $950 U
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EXERCISE 22-6 (Continued) (b)
DEWITT COMPANY Selling Expense Flexible Budget Report For the Month Ended March 31, 2014
Sales Variable expenses Sales commissions Advertising Travel Delivery Total variable expenses Fixed costs Sales salaries Depreciation Insurance Total fixed expenses Total expenses
Budget $180,000
Actual $180,000
Difference Favorable F Unfavorable U
$ 10,800 7,200 5,400 3,600
$ 11,000 6,900 5,100 3,450
$200 U 300 F 300 F 150 F
27,000
26,450
550 F
35,000 7,000 1,000 43,000 $ 70,000
35,000 7,000 1,000 43,000 $ 69,450
0U 0U 0U 0U $550 F
(c) Flexible budgets are essential in evaluating a manager’s performance in controlling variable expenses because the budget allowance varies directly with changes in the activity index. At $170,000 of sales, the manager was over budget (unfavorable) by $950 but at $180,000 of sales, the manager was under budget (favorable) by $550.
.
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22-19
EXERCISE 22-7 (a)
KITCHEN HELP INC. Flexible Production Cost Budget Activity level Production levels Variable costs: Manufacturing ($6) Administrative ($4) Selling ($2) Total variable costs ($12) Fixed costs: Manufacturing Administrative Total fixed costs Total costs
90,000
100,000
110,000
$ 540,000 360,000 180,000 1,080,000
$ 600,000 400,000 200,000 1,200,000
$ 660,000 440,000 220,000 1,320,000
160,000 80,000 240,000 $1,320,000
160,000 80,000 240,000 $1,440,000
160,000 80,000 240,000 $1,560,000
(b) Let (X) represent number of units Sales price(X) = Variable costs(X) + Fixed costs + Profit Sales price(X) = Variable costs(X) + $240,000 + $200,000 (Sales price – Variable costs)(X) = $440,000 ($16 – $12)(X) = $440,000 $4(X) = $440,000 X = 110,000 units to be sold
22-20
.
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EXERCISE 22-8 (a)
RENSING GROOMERS Flexible Budget Activity level Direct labor hours Variable costs: Grooming supplies ($5) Direct labor ($14) Overhead ($1) Total variable costs ($20) Fixed costs: Overhead Total fixed costs Total costs
550
600
700
$ 2,750 7,700 550 11,000
$ 3,000 8,400 600 12,000
$ 3,500 9,800 700 14,000
10,000 10,000 $21,000
10,000 10,000 $22,000
10,000 10,000 $24,000
(b) A flexible budget presents expected costs at various levels of production volume, not just one, so that comparisons can be made between actual costs and budgeted costs at the same volume. This allows the person to determine whether a difference between the actual results and budget is due to better or worse cost control than expected or due to achieving a different volume than that upon which the fixed budget was predicated. (c) $21,000 ÷ 550 = $38.18 $22,000 ÷ 600 = $36.67 $24,000 ÷ 700 = $34.29 (d) Cost formula is $10,000 + $20(X), where (X) = direct labor hours Total cost = $10,000 + ($20 X 650) = $23,000. Number of clients = 650 hrs ÷ 1.30 hrs/client = 500 Cost per client = $23,000 ÷ 500 = $46.00 Charge per client = $46.00 X 1.40 = $64.40
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22-21
EXERCISE 22-9 (a)
LOWELL COMPANY Manufacturing Overhead Flexible Budget Report For the Quarter Ended March 31, 2014
Variable costs Indirect materials Indirect labor Utilities Maintenance Total variable costs Fixed costs Supervisory salaries Depreciation Property taxes and insurance Maintenance Total fixed costs Total costs
(b)
Budget
Actual
Difference Favorable F Unfavorable U
$12,000 10,000 8,000 6,000 36,000
$13,900 9,500 8,700 5,000 37,100
$1,900 U 500 F 700 U 1,000 F 1,100 U
36,000 7,000
36,000 7,000
0U 0U
8,000 5,000 56,000 $92,000
8,400 5,000 56,400 $93,500
400 U 0U 400 U $1,500 U
LOWELL COMPANY Manufacturing Overhead Responsibility Report For the Quarter Ended March 31, 2014
Controllable Costs Indirect materials Indirect labor Utilities Maintenance* Supervisory salaries
Budget $12,000 10,000 8,000 11,000 36,000 $77,000
Actual $13,900 9,500 8,700 10,000 36,000 $78,100
*Includes variable and fixed costs
22-22
.
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Difference Favorable F Unfavorable U $1,900 U 500 F 700 U 1,000 F 0U $1,100 U
EXERCISE 22-10 (a)
SORIA COMPANY Selling Expense Flexible Budget Report Clothing Department For the Month Ended October 31, 2014
Sales in units Variable expenses Sales commissions ($.30) Advertising expense ($.09) Travel expense ($.45) Free samples ($.20) Total variable expenses ($1.04) Fixed expenses Rent Sales salaries Office salaries Depreciation—sale staff autos Total fixed expenses Total expenses
Budget 10,000
Actual 10,000
Difference Favorable F Unfavorable U
$ 3,000 900 4,500 2,000
$ 2,600 850 4,100 1,400
$ 400 F 50 F 400 F 600 F
10,400
8,950
1,450 F
1,500 1,200 800 500 4,000 $14,400
1,500 1,200 800 500 4,000 $12,950
0U 0U 0U 0 0U $1,450 F
(b) No, Joe should not have been reprimanded. As shown in the flexible budget report, variable costs were $1,450 below budget.
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22-23
EXERCISE 22-11 (a) KIRKLAND PLUMBING COMPANY Home Plumbing Services Segment Responsibility Report For the Quarter Ended March 31, 2014
Service revenue Variable costs: Material and supplies Wages Gas and oil Total variable costs Contribution margin Controllable fixed costs: Supervisory salaries Insurance Equipment depreciation Total controllable fixed costs Controllable margin
Budget
Actual
Difference Favorable F Unfavorable U
$25,000
$26,000
$1,000 F
1,600 3,000 2,800 7,400 17,600
1,200 3,250 3,400 7,850 18,150
400 F 250 U 600 U 450 U 550 F
9,000 4,000 1,500 14,500 $ 3,100
9,500 3,600 1,300 14,400 $ 3,750
500 U 400 F 200 F 100 F $ 650 F
(b) MEMO TO:
Lenny Kirkland
FROM:
Student
SUBJECT:
The Reporting Principles of Performance Reports
When evaluating the performance of a company’s segments, the performance reports should: 1. Contain only data that are controllable by the segment’s manager. 2. Provide accurate and reliable budget data to measure performance. 3. Highlight significant differences between actual results and budget goals. 4. Be tailor-made for the intended evaluation. 5. Be prepared at reasonable intervals. I hope these suggested guidelines will be helpful in establishing the performance reporting system to be used by Kirkland Plumbing Company. 22-24
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EXERCISE 22-12 (a) Fabricating Department = $50,000 fixed costs plus total variable costs of $2.00 per direct labor hour [($150,000 – $50,000) ÷ 50,000]. Assembling Department = $40,000 fixed costs plus total variable costs of $1.60 per direct labor hour [($120,000 – $40,000) ÷ 50,000]. (b) Fabricating Department = $50,000 + ($2.00 X 53,000) = $156,000. Assembling Department = $40,000 + ($1.60 X 47,000) = $115,200. (c)
$300
Total Budgeted Cost Line
250
Costs in (000)
200 Budgeted Variable Costs
150
100 Budgeted Fixed Costs
50
0
10
20
30
40
50
60
70
80
90 100
Direct Labor Hours in (000)
.
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22-25
EXERCISE 22-13 (a) To Dallas Department Manager—Finishing Controllable Costs: Direct Materials Direct Labor Manufacturing Overhead Total
Budget $ 44,000 82,000 49,200 $175,200
Month: July Actual $ 41,500 83,400 51,000 $175,900
(b) To Assembly Plant Manager—Dallas Controllable Costs: Dallas Office Departments: Machining Finishing Total
Month: July
Budget $ 92,000
Actual $ 95,000
Fav/Unfav $3,000 U
219,000 175,200 $486,200
220,000 175,900 $490,900
1,000 U 700 U $4,700 U
(c) To Vice President—Production Controllable Costs: V P Production Assembly plants: Atlanta Dallas Tucson Total
22-26
.
Fav/Unfav $2,500 F 1,400 U 1,800 U $ 700 U
Month: July
Budget $ 130,000
Actual $ 132,000
Fav/Unfav $2,000 U
421,000 486,200 496,500 $1,533,700
424,000 490,900 494,200 $1,541,100
3,000 U 4,700 U 2,300 F $7,400 U
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EXERCISE 22-14 (a)
MALONE COMPANY Mixing Department Responsibility Report For the Month Ended January 31, 2014 Controllable Cost Indirect labor Indirect materials Lubricants Maintenance Utilities
(b)
Budget $12,000 7,700 1,675 3,500 5,000 $29,875
Actual $12,250 10,200 1,650 3,500 6,400 $34,000
Difference $ 250 UU 2,500 U 25 F -01,400 U $4,125 U
Most likely, when management examined the responsibility report for January, they would determine that the differences were insignificant for indirect labor (2.1% of budget), lubricants (1.5%), and maintenance (0%) and require no action. However, the differences for indirect materials (32.5%) and utilities (28%) would cause management to investigate further. As a result of their investigation, management would either take corrective action or modify the budgeted amounts for future months to reflect changing conditions.
EXERCISE 22-15 (a) 1. 2. 3. 4. 5. 6.
.
Controllable margin ($250,000 – $100,000) Variable costs ($600,000 – $250,000) Contribution margin ($450,000 – $320,000) Controllable fixed costs ($130,000 – $90,000) Controllable fixed costs ($180,000 – $95,000) Sales ($250,000 + $180,000)
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$150,000 350,000 130,000 40,000 85,000 430,000
22-27
EXERCISE 22-15 (Continued) (b)
DEITZ INC. Women’s Shoe Division Responsibility Report For the Month Ended June 30, 2014
Sales Variable costs Contribution margin Controllable fixed costs Controllable margin
Budget $600,000 340,000 260,000 100,000 $160,000
Actual $600,000 350,000 250,000 100,000 $150,000
Difference Favorable F Unfavorable U $ 0U 10,000 U 10,000 U 0U $10,000 U
EXERCISE 22-16 (a)
HARRINGTON COMPANY Sports Equipment Division Responsibility Report 2014
Sales Variable costs Cost of goods sold Selling and administrative Total Contribution margin Controllable fixed costs Cost of goods sold Selling and administrative Total Controllable margin
Budget
Actual
Difference
$900,000
$880,000
$20,000 U
440,000 60,000 500,000 400,000
408,000 61,000 469,000 411,000
32,000 F 1,000 U 31,000 F 11,000 F
100,000 90,000 190,000 $210,000
105,000 66,000 171,000 $240,000
5,000 U 24,000 F 19,000 F $30,000 F
(b) ($240,000 – $90,000)/$1,000,000 = 15%
22-28
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EXERCISE 22-17 (a) Controllable margin = ($3,000,000 – $1,980,000 – $600,000) = $420,000 ROI = $420,000 ÷ $5,000,000 = 8.4% (b) 1.
Contribution margin percentage is 34%, or ($1,020,000 ÷ $3,000,000) Increase in controllable margin = $320,000 X 34% = $108,800 ROI = ($420,000 + $108,800) ÷ $5,000,000 = 10.6%
2.
($420,000 + $150,000) ÷ $5,000,000 = 11.4%
3.
$420,000 ÷ ($5,000,000 – $200,000) = 8.75%
EXERCISE 22-18 (a) DINKLE AND FRIZELL DENTAL CLINIC Preventive Services Responsibility Report For the Month Ended May 31, 2014
Service revenue Variable costs Filling materials Novocain Dental assistant wages Supplies Utilities Total variable costs Contribution margin Controllable fixed costs Dentist salary Equipment depreciation Total controllable fixed costs Controllable margin Return on investment*
Budget $39,000
Actual $40,000
Difference Favorable F Unfavorable U $1,000 F
4,900 3,800 2,500 2,250 390 13,840 25,160
5,000 3,900 2,500 1,900 500 13,800 26,200
100 U 100 U 0 350 F 110 U 40 F 1,040 F
9,400 6,000 15,400 $ 9,760
9,800 6,000 15,800 $10,400
400 U 0 400 U $ 640 F
12.2%
13.0%
0.8% F
*Average investment = ($82,400 + $77,600) ÷ 2 = $80,000 Budget ROI = $9,760 ÷ $80,000 Actual ROI = $10,400 ÷ $80,000 ROI Difference = $640 ÷ $80,000 .
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22-29
EXERCISE 22-18 (Continued) (b) MEMO TO: Drs. Reese Dinkle and Anita Frizell FROM: Student SUBJECT: Deficiencies in the Current Responsibility Reporting System The current reporting system has the following deficiencies: 1. 2. 3. 4.
It does not clearly show both budgeted goals and actual performance. It does not indicate the contribution margin generated by the center, showing the amount available to go towards covering controllable fixed costs. It does not report only those costs controllable by the manager of the center. Instead, it includes both controllable and common fixed costs. This results in the center appearing to be unprofitable. It does not indicate the return on investment earned by the center.
All of these deficiencies have been addressed in the recommended responsibility report attached. As can be seen from that report, the Preventive Services center is profitable. The service revenues generated in this center are adequate to cover all of its costs, both variable and controllable fixed costs, and contribute toward the covering of the clinic’s common fixed costs. In addition, the report indicates the return on investment earned by the center and that it exceeds the budget goal.
22-30
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EXERCISE 22-19 Planes: ROI = Controllable margin ÷ Average operating assets 13% = Controllable margin ÷ $25,000,000 Controllable margin = $25,000,000 X 13% = $3,250,000 Contribution margin = Controllable margin + Controllable fixed costs = $3,250,000 + $1,500,000 = $4,750,000 Service revenue = Contribution margin + Variable costs = $4,750,000 + $5,500,000 = $10,250,000 Taxis: ROI = Controllable margin ÷ Average operating assets 10% = $80,000 ÷ Average operating assets Average operating assets = $80,000 ÷ 10% = $800,000 Controllable margin = Contribution margin – Controllable fixed costs $80,000 = $250,000 – Controllable fixed costs Controllable fixed costs = $250,000 – $80,000 = $170,000 Contribution margin = Service revenue – Variable costs $250,000 = $500,000 – Variable costs Variable costs = $500,000 – $250,000 = $250,000
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22-31
EXERCISE 22-19 (Continued) Limos: ROI = Controllable margin ÷ Average operating assets = $240,000 ÷ $1,500,000 = 16% Controllable margin = Contribution margin – Controllable fixed costs $240,000 = $480,000 – Controllable fixed costs Controllable fixed costs = $480,000 – $240,000 = $240,000 Contribution margin = Service revenue – Variable costs $480,000 = Service revenue – $300,000 Sales = $480,000 + $300,000 = $780,000
*EXERCISE 22-20 (a)
North Division: ROI = $140,000 ÷ $1,000,000 = 14% West Division: ROI = $360,000 ÷ $2,000,000 = 18% South Division: ROI = $210,000 ÷ $1,500,000 = 14%
(b)
North Division: Residual Income = $140,000 – (.13 X $1,000,000) = $10,000 West Division: Residual Income = $360,000 – (.16 X $2,000,000) = $40,000 South Division: Residual Income = $210,000 – (.10 X $1,500,000) = $60,000
22-32
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*EXERCISE 22-20 (Continued) (c)
1.
2.
If ROI is used to measure performance, only the North Division (with a 14% ROI) and the South Division (with a 14% ROI) would make the additional investment that provides a 16% ROI. The West Division presently earns an 18% return ($360,000 ÷ $2,000,000), and therefore would decline the investment. If residual income is used to measure performance, all three divisions would probably make the additional investment because each would realize an increase in residual income.
*EXERCISE 22-21 (a)
ROI
(b)
Controllable margin – (Minimum rate of return X Average operating assets) = Residual income $200,000 – (Minimum rate of return X $1,000,000) = $100,000 $100,000 = Minimum rate of return X $1,000,000 Minimum rate of return = 10%
(c)
Controllable margin Controllable margin Controllable margin
(d)
ROI =
= Controllable margin 20% = $200,000 Average operating assets =
30% =
.
÷ ÷
Average operating assets Average operating assets $1,000,000
– (Minimum rate of return X Average operating assets) = Residual income – (13% X $1,200,000) = $204,000 = $360,000
Controllable margin $360,000
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÷ ÷
Average operating assets $1,200,000
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22-33
SOLUTIONS TO PROBLEMS PROBLEM 22-1A
(a)
COOK COMPANY Packaging Department Monthly Manufacturing Overhead Flexible Budget For the Year 2014
Activity level Direct labor hours 27,000 Variable costs Indirect labor ($.42)* $11,340 Indirect materials ($.30) 8,100 Repairs ($.18) 4,860 Utilities ($.24) 6,480 Lubricants ($.06) 1,620 Total variable costs ($1.20) 32,400
30,000
33,000
36,000
$12,600 9,000 5,400 7,200 1,800 36,000
$13,860 9,900 5,940 7,920 1,980 39,600
$15,120 10,800 6,480 8,640 2,160 43,200
Fixed costs Supervision** Depreciation Insurance Rent Property taxes Total fixed costs Total costs
8,000 6,000 2,500 2,000 1,500 20,000 $56,000
8,000 6,000 2,500 2,000 1,500 20,000 $59,600
8,000 6,000 2,500 2,000 1,500 20,000 $63,200
8,000 6,000 2,500 2,000 1,500 20,000 $52,400
*$126,000/300,000 **$96,000/12
22-34
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PROBLEM 22-1A (Continued) (b)
COOK COMPANY Packaging Department Manufacturing Overhead Flexible Budget Report For the Month Ended October 31, 2014
Direct labor hours (DLH) Variable costs Indirect labor Indirect materials Repairs Utilities Lubricants Total variable costs Fixed costs Supervision Depreciation Insurance Rent Property taxes Total fixed costs Total costs
Budget at 27,000 DLH
Actual Costs 27,000 DLH
Difference Favorable F Unfavorable U
$11,340 8,100 4,860 6,480 1,620 32,400
$12,432 7,680 4,800 6,840 1,920 33,672
$1,092 U 420 F 60 F 360 U 300 U 1,272 U
8,000 6,000 2,500 2,000 1,500 20,000 $52,400
8,000 6,000 2,460 2,000 1,500 19,960 $53,632
0U 0U 40 F 0U 0U 40 F $1,232 U
(c) The overall performance of management was slightly unfavorable. However, none of the unfavorable differences exceeded 10% of budget except for lubricants (19%).
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22-35
PROBLEM 22-2A
(a)
ZELMER COMPANY Monthly Manufacturing Overhead Flexible Budget Ironing Department For the Year 2014
Activity level Direct labor hours 35,000 Variable costs Indirect labor ($.40) $14,000 Indirect materials ($.50) 17,500 Factory utilities ($.30) 10,500 Factory repairs ($.20) 7,000 Total variable costs ($1.40) 49,000 Fixed costs Supervision 4,000 Depreciation 1,500 Insurance 1,000 Rent 2,500 Total fixed costs 9,000 Total costs $58,000
22-36
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40,000
45,000
50,000
$16,000 20,000 12,000 8,000 56,000
$18,000 22,500 13,500 9,000 63,000
$20,000 25,000 15,000 10,000 70,000
4,000 1,500 1,000 2,500 9,000 $65,000
4,000 1,500 1,000 2,500 9,000 $72,000
4,000 1,500 1,000 2,500 9,000 $79,000
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PROBLEM 22-2A (Continued) (b)
ZELMER COMPANY Ironing Department Manufacturing Overhead Flexible Budget Report For the Month Ended June 30, 2014
Direct labor hours (DLH) Variable costs Indirect labor Indirect materials Factory utilities Factory repairs Total variable costs Fixed costs Supervision* Depreciation Insurance Rent Total fixed costs Total costs (1) 41,000 X $0.40 (5) 41,000 X $0.44
Budget at 41,000 DLH
Actual Costs 41,000 DLH
Difference Favorable F Unfavorable U
$16,400 (1) 20,500 (2) 12,300 (3) 8,200 (4) 57,400
$18,040 (5) 19,680 (6) 13,120 (7) 10,250 (8) 61,090
$1,640 U 820 F 820 U 2,050 U 3,690 U
4,000 1,500 1,000 2,500 9,000 $66,400
4,000 1,500 1,000 2,500 9,000 $70,090
0U 0U 0U 0U 0U $3,690 U
(3) 41,000 X $0.30 (7) 41,000 X $0.32
(4) 41,000 X $0.20 (8) 41,000 X $0.25
(2) 41,000 X $0.50 (6) 41,000 X $0.48
*$48,000/12 (c) The manager was ineffective in controlling variable costs ($3,690 U). Fixed costs were effectively controlled. (d) The formula is fixed costs of $9,000 plus total variable costs of $1.40 per direct labor hour.
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22-37
PROBLEM 22-2A (Continued) (e)
Total Budgeted Cost Line
$80 70
Costs in (000)
60 50 Budgeted Variable Costs
40 30 20 10
Budgeted Fixed Costs
5
10
15
20
25
30
35
40
45
Direct Labor Hours in (000)
22-38
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50
PROBLEM 22-3A
(a) The formula is fixed costs $35,000 plus variable costs of $2.75 per unit ($165,000 ÷ 60,000 units). (b)
HILL COMPANY Assembling Department Flexible Budget Report For the Month Ended August 31, 2014 Difference
Units Variable costs* Direct materials ($.80 X 58,000) Direct labor ($.90 X 58,000) Indirect materials ($.40 X 58,000) Indirect labor ($.30 X 58,000) Utilities ($.25 X 58,000) Maintenance ($.10 X 58,000) Total variable ($2.75 X 58,000) Fixed costs Rent Supervision Depreciation Total fixed Total costs
Budget at 58,000 Units
Actual Costs 58,000 Units
Favorable F Unfavorable U
$ 46,400 52,200 23,200 17,400 14,500 5,800 159,500
$ 47,000 51,200 24,200 17,500 14,900 6,200 161,000
$ 600 U 1,000 F 1,000 U 100 U 400 U 400 U 1,500 U
12,000 17,000 6,000 35,000 $194,500
12,000 17,000 6,000 35,000 $196,000
0U 0U 0U 0U $1,500 U
*Note that the per unit variable costs are computed by taking the budget amount at 60,000 units and dividing it by 60,000. For example, $48, 000 direct materials per unit is therefore $0.80 or . 60, 000 This report provides a better basis for evaluating performance because the budget is based on the level of activity actually achieved. The manager should be criticized because every variable cost was over budget except for direct labor.
.
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22-39
PROBLEM 22-3A (Continued) (c)
HILL COMPANY Assembling Department Flexible Budget Report For the Month Ended September 30, 2014 Difference Units Variable costs Direct materials (.80 X 64,000) Direct labor ($.90 X 64,000) Indirect materials ($.40 X 64,000) Indirect labor ($.30 X 64,000) Utilities ($.25 X 64,000) Maintenance ($.10 X 64,000) Total variable costs Fixed costs Rent Supervision Depreciation Total fixed costs Total costs
Budget at 64,000 Units
Actual Costs 64,000 Units
Favorable F Unfavorable U
$ 51,200 57,600 25,600 19,200 16,000 6,400 176,000
$ 51,700 56,320 26,620 19,250 16,390 6,820 177,100
$ 500 U 1,280 F 1,020 U 50 U 390 U 420 U 1,100 U
12,000 17,000 6,000 35,000 $211,000
12,000 17,000 6,000 35,000 $212,100
0U 0U 0U 0U $1,100 U
The manager’s performance was slightly better in September than it was in August. However, each variable cost was slightly over budget again except for direct labor. Note that actual variable costs in September were 10% higher than the actual variable costs in August. Therefore to find the actual variable costs in September, the actual variable costs in August must be increased 10% as follows:
Direct materials Direct labor Indirect materials Indirect labor Utilities Maintenance
22-40
.
August (actual) $ 47,000 X 110% 51,200 X 110% 24,200 X 110% 17,500 X 110% 14,900 X 110% 6,200 X 110% $161,000 X 80%
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September (actual) = $ 51,700 56,320 26,620 19,250 16,390 6,820 $177,100
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PROBLEM 22-4A
(a)
CLARKE INC. Patio Furniture Division Responsibility Report For the Year Ended December 31, 2014 Difference Budget
Actual
Favorable F Unfavorable U
Sales
$2,500,000
$2,550,000
$50,000 F
Variable costs Cost of goods sold Selling and administrative Total
1,300,000 220,000 1,520,000
1,259,000 226,000 1,485,000
41,000 F 6,000 U 35,000 F
Contribution margin
980,000
1,065,000
85,000 F
Controllable fixed costs Cost of goods sold Selling and administrative Total
200,000 50,000 250,000
203,000 52,000 255,000
3,000 U 2,000 U 5,000 U
$ 730,000
$ 810,000
$80,000 F
Controllable margin
(b) The manager effectively controlled revenues and costs. Contribution margin was $85,000 favorable and controllable margin was $80,000 favorable. Contribution margin was favorable primarily because sales were $50,000 over budget and variable cost of goods sold was $41,000 under budget. Apparently, the manager was able to control variable cost of goods sold when sales exceeded budget expectations. The manager was ineffective in controlling fixed costs. However, the unfavorable difference of $5,000 was only 6% of the favorable difference in controllable margin. (c) Two costs are excluded from the report: (1) noncontrollable fixed costs and (2) indirect fixed costs. The reason is that neither cost is controllable by the Patio Furniture Division Manager.
.
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22-41
PROBLEM 22-5A
(a)
SUPPAN COMPANY Home Division Responsibility Report For the Year Ended December 31, 2014 (in thousands of dollars)
Sales Variable costs Cost of goods sold Selling and administrative Total Contribution margin Controllable direct fixed costs Cost of goods sold Selling and administrative Total Controllable margin ROI $330 (1) $2,000
$350 (2) $2,000
Budget $1,300
Actual $1,400
Difference Favorable F Unfavorable U $100 F
620 100 720 580
675 125 800 600
55 U 25 U 80 U 20 F
170 80 250 $ 330
170 80 250 $ 350
0U 0U 0U $ 20 F
16.5% (1)
17.5% (2)
1% F (3)
$20 (3) $2,000
(b) The performance of the manager of the Home Division was slightly above budget expectations for the year. The item that top management would likely investigate is the reason why variable cost of goods sold is $55,000 unfavorable. In making the inquiry, it should be recognized that the budget amount should be adjusted for the $620 increased sales as follows: $1,400,000 X = $667,692. Thus, $1,300 there should be an explanation of a $7,308 unfavorable difference.
22-42
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PROBLEM 22-5A (Continued) (c) 1.
.
$350,000 + ($675,000 X 5%) = 19.2%. $2,000,000
2.
$350,000 = 19.4%. $2,000,000 – ($2,000,000 X 10%)
3.
$350,000 + $85,000 = 21.8%. $2,000,000
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22-43
PROBLEM 22-6A
(a) To Cutting Department Manager—Seattle Division Controllable Costs: Budget Actual Indirect labor $ 70,000 $ 73,000 Indirect materials 46,000 47,900 Maintenance 18,000 20,500 Utilities 17,000 20,100 Supervision 20,000 22,000 Total $171,000 $183,500
To Division Production Manager—Seattle Controllable Costs: Budget Seattle Division $ 51,000 Departments: Cutting 171,000 Shaping 148,000 Finishing 205,000 Total $575,000
To Vice President—Production Controllable Costs: Budget V-P Production $ 64,000 Divisions: Seattle 575,000 Denver 673,000 San Diego 715,000 Total $2,027,000
22-44
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No. 1 Month: January Fav/Unfav $ 3,000 U 1,900 U 2,500 U 3,100 U 2,000 U $12,500 U
No. 2 Month: January Actual Fav/Unfav $ 52,500 $ 1,500 U 183,500 158,000 210,000 $604,000
12,500 U 10,000 U 5,000 U $29,000 U
No. 3 Month: January Actual Fav/Unfav $ 65,000 $ 1,000 U 604,000 678,000 722,000 $2,069,000
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29,000 U 5,000 U 7,000 U $42,000 U
PROBLEM 22-6A (Continued)
To President Controllable Costs: President Vice-Presidents: Production Marketing Finance Total
Budget $ 74,200
No. 4 Month: January Actual Fav/Unfav $ 76,400 $ 2,200 U
2,027,000 130,000 104,000 $2,335,200
2,069,000 133,600 109,000 $2,388,000
42,000 U 3,600 U 5,000 U $52,800 U
(b) 1.
Within the Seattle division the rankings of the department managers were: (1) Finishing, (2) Shaping, and (3) Cutting. If the rankings were done on a percentage basis, they would rank as follows: (1) Finishing – 2.4% U (2) Shaping – 6.8% U and (3) Cutting – 7.3% U.
2.
At the division manager level, the rankings were: (1) Denver, (2) San Diego, and (3) Seattle.
3.
Rankings in terms of dollars may be somewhat misleading in this case because of the substantial difference between the production budget and the other budgets. On a percentage basis the differences and rankings are: (1) production, 2.1%; (2) marketing, 2.8%; and (3) finance, 4.8%.
.
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22-45
*PROBLEM 22-7A
(a)
(b)
1.
ROI = Controllable Margin ÷ Average Operating Assets ROI = $2,583,000 ÷ $12,300,000 ROI = 21%
2.
Residual Income = Controllable Margin – (Minimum Rate of Return X Average Operating Assets) Residual Income = $2,583,000 – (.18 X $12,300,000) Residual Income = $2,583,000 – $2,214,000 = $369,000
The management of Jensen Division would clearly have accepted the investment opportunity it had in 2014 if residual income had been used as the performance measure because an increase in residual income results from a project whose ROI is greater than the minimum rate of return. If management of the Jensen Division had used ROI as the performance measure, the decision would be to reject the project because the ROI of 19% is less than Jensen’s ROI experience range of 20.1% to 23.5%. With bonuses based in part on ROI, the 19% project would have a negative effect on bonuses.
22-46
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PROBLEM 22-1B
(a)
SPEIER COMPANY Flexible Monthly Manufacturing Overhead Budget Assembly Department For the Year 2014
Activity level Direct labor hours Variable costs Indirect labor ($.30) Indirect materials ($.20) Repairs ($.15) Utilities ($.10) Lubricants ($.05) Total variable costs ($.80) Fixed costs Supervision Depreciation Insurance Rent Property taxes Total fixed costs Total costs
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18,000
20,000
22,000
24,000
$ 5,400 3,600 2,700 1,800 900
$ 6,000 4,000 3,000 2,000 1,000
$ 6,600 4,400 3,300 2,200 1,100
$ 7,200 4,800 3,600 2,400 1,200
14,400
16,000
17,600
19,200
6,300 2,500 1,000 800 500 11,100 $25,500
6,300 2,500 1,000 800 500 11,100 $27,100
6,300 2,500 1,000 800 500 11,100 $28,700
6,300 2,500 1,000 800 500 11,100 $30,300
(For Instructor Use Only)
22-47
PROBLEM 22-1B (Continued) (b)
SPEIER COMPANY Manufacturing Overhead Budget Report (Flexible) Assembly Department For the Month Ended January 31, 2014
Direct labor hours (DLH) Variable costs Indirect labor ($0.30) Indirect materials ($0.20) Repairs ($0.15) Utilities ($0.10) Lubricants ($0.05) Total variable costs ($0.80) Fixed costs Supervision* Depreciation Insurance Rent Property taxes Total fixed costs Total costs
Budget at 20,000 DLH
Actual Costs 20,000 DLH
Difference Favorable F Unfavorable U
$ 6,000 4,000 3,000 2,000 1,000
$ 6,200 3,600 2,300 1,700 1,050
$200 U 400 F 700 F 300 F 50 U
16,000
14,850
1,150 F
6,300 2,500 1,000 800 500 11,100 $27,100
6,300 2,500 1,000 850 500 11,150 $26,000
0U 0U 0U 50 U 0U 50 U $1,100 F
*$75,600/12
(c) Control over both variable and fixed costs was good.
22-48
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PROBLEM 22-2B
(a)
GONZALEZ COMPANY Flexible Monthly Manufacturing Overhead Budget Assembly Department For the Year 2014
Activity level Direct labor hours Variable costs Indirect labor ($1.00) Indirect materials ($.50) Utilities ($.30) Maintenance ($.20) Total variable costs ($2.00) Fixed costs Supervision Depreciation Insurance and taxes Total fixed costs Total costs
.
Kimmel, Accounting, 5e, Solutions Manual
22,500
25,000
27,500
30,000
$22,500 11,250 6,750 4,500
$25,000 12,500 7,500 5,000
$27,500 13,750 8,250 5,500
$30,000 15,000 9,000 6,000
45,000
50,000
55,000
60,000
12,000 8,000 5,000 25,000 $70,000
12,000 8,000 5,000 25,000 $75,000
12,000 8,000 5,000 25,000 $80,000
12,000 8,000 5,000 25,000 $85,000
(For Instructor Use Only)
22-49
PROBLEM 22-2B (Continued) (b)
GONZALEZ COMPANY Assembly Department Manufacturing Overhead Budget Report (Flexible) For the Month Ended July 31, 2014
Direct labor hours (DLH) Variable costs Indirect labor ($1.00) Indirect materials ($0.50) Utilities ($0.30) Maintenance ($0.20) Total variable costs ($2.00) Fixed costs Supervision Depreciation Insurance and taxes Total fixed costs Total costs
Budget at 27,500 DLH
Actual Costs 27,500 DLH
Difference Favorable F Unfavorable U
$27,500 13,750 8,250 5,500
$26,000 11,350 8,050 5,400
$1,500 F 2,400 F 200 F 100 F
55,000
50,800
4,200 F
12,000 8,000 5,000 25,000 $80,000
12,000 8,000 5,000 25,000 $75,800
0F 0F 0F 0F $4,200 F
(c) Based on the above budget report, control over costs was effective. For variable costs, all differences were favorable. For fixed costs, there were no differences between budgeted and actual costs. (d) The formula is fixed costs of $25,000 plus total variable costs of $2.00 per direct labor hour.
22-50
.
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PROBLEM 22-2B (Continued) (e)
Total Budgeted Cost Line
$100 90
Overhead Costs in (000)
80 70 Budgeted Variable Costs
60 50 40 30 20
Budgeted Fixed Costs
10 0
5
10
15
20
25
30
Direct Labor Hours in (000)
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22-51
PROBLEM 22-3B
(a) The formula is fixed costs $21,000 plus total variable costs of $2.60 per unit ($130,000 ÷ 50,000 units). (b)
HARDESTY COMPANY Packaging Department Budget Report (Flexible) For the Month Ended May 31, 2014 Difference Units Variable costs* Direct materials ($.80 X 55,000) Direct labor ($.90 X 55,000) Indirect materials ($.30 X 55,000) Indirect labor ($.25 X 55,000) Utilities ($.20 X 55,000) Maintenance ($.15 X 55,000) Total variable costs ($2.60 X 55,000) Fixed costs Rent Supervision Depreciation Total fixed costs Total costs
Budget at 55,000 Units
Actual Costs 55,000 Units
Favorable F Unfavorable U
$ 44,000 49,500 16,500 13,750 11,000 8,250
$ 41,000 47,300 15,200 13,000 9,600 8,000
$3,000 F 2,200 F 1,300 F 750 F 1,400 F 250 F
143,000
134,100
8,900 F
10,000 7,000 4,000 21,000 $164,000
10,000 7,000 4,000 21,000 $155,100
0F 0F 0F 0F $8,900 F
*Note that the per unit variable costs are computed by taking the budget amount at 50,000 units and dividing it by 50,000. For example, direct $40,000 materials per unit is $0.80 or . 50,000 This report provides a better basis for evaluating performance because the budget is based on the level of activity actually achieved.
22-52
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PROBLEM 22-3B (Continued) (c)
HARDESTY COMPANY Packaging Department Budget Report (Flexible) For the Month Ended June 30, 2014 Difference
Units Variable costs Direct materials ($.80 X 40,000) Direct labor ($.90 X 40,000) Indirect materials ($.30 X 40,000) Indirect labor ($.25 X 40,000) Utilities ($.20 X 40,000) Maintenance ($.15 X 40,000) Total variable costs ($2.60 X 40,000) Fixed costs Rent Supervision Depreciation Total fixed costs Total costs
Budget at 40,000 Units
Actual Costs 40,000 Units
Favorable F Unfavorable U
$ 32,000 36,000 12,000 10,000 8,000 6,000
$ 32,800* 37,840 12,160 10,400 7,680 6,400
$ 800 U 1,840 U 160 U 400 U 320 F 400 U
104,000
107,280
3,280 U
10,000 7,000 4,000 21,000 $125,000
10,000 7,000 4,000 21,000 $128,280
0U 0U 0U 0U $3,280 U
*Note that the actual variable costs in June was 20% less than the actual costs in May. Therefore to find the actual costs in June, the actual variable costs in May are multiplied by 80% as follows.
Direct materials Direct labor Indirect materials Indirect labor Utilities Maintenance
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May (actual) $ 41,000 X 80% 47,300 X 80% 15,200 X 80% 13,000 X 80% 9,600 X 80% 8,000 X 80% $134,100 X 80%
(For Instructor Use Only)
=
June (actual) $ 32,800 37,840 12,160 10,400 7,680 6,400 $107,280
22-53
PROBLEM 22-4B
(a)
GUZMAN INC. Home Appliance Division Responsibility Report For the Year Ended December 31, 2014
Budget
Actual
Difference Favorable F Unfavorable U
Sales
$2,400,000
$2,310,000
$90,000 U
Variable costs Cost of goods sold Selling and administrative Total
1,200,000 240,000 1,440,000
1,258,000 232,000 1,490,000
58,000 U 8,000 F 50,000 U
Contribution margin
960,000
820,000
140,000 U
Controllable fixed costs Cost of goods sold Selling and administrative Total
200,000 60,000 260,000
192,000 63,000 255,000
8,000 F 3,000 U 5,000 F
$ 700,000
$ 565,000
$135,000 U
Controllable margin
(b) The manager did not effectively control revenues and costs. Contribution margin was $140,000 unfavorable and controllable margin was $135,000 unfavorable. Contribution margin was unfavorable primarily because sales were $90,000 under budget and variable cost of goods sold was $58,000 over budget. Apparently, the manager was unable to control variable cost of goods sold when sales failed to meet budget expectations. The manager was effective in controlling fixed costs. However, the favorable difference of $5,000 was only 3.7% of the unfavorable difference in controllable margin. (c) Two costs are excluded from the report: (1) noncontrollable fixed costs and (2) indirect fixed costs. The reason is that neither cost is controllable by the Home Appliance Division Manager. 22-54
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PROBLEM 22-5B
(a)
STRAUSS COMPANY Lawnmower Division Responsibility Performance Report For the Year Ended December 31, 2014 (in thousands of dollars)
Sales Variable costs Cost of goods sold Selling and administrative Total Contribution margin Controllable fixed costs Cost of goods sold Selling and administrative Total Controllable margin
Budget $3,050
Actual $2,900
Difference Favorable F Unfavorable U $150 U
1,300 340 1,640 1,410
1,400 300 1,700 1,200
100 U 40 F 60 U 210 U
270 140 410 $1,000
270 140 410 $ 790
0U 0U 0U $210 U
20% (1)
15.8% (2)
4.2% U (3)
ROI $1,000 (1) $5,000
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$790 (2) $5,000
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$210 (3) $5,000
22-55
PROBLEM 22-5B (Continued) (b) The performance of the manager of the Lawnmower Division was below budget expectations for the year. The item that top management would likely investigate first is the reason why sales were $150,000 below budget. Next, inquiry would be made as to the reason variable cost of goods sold is $100,000 unfavorable. Finally, the reasons for the favorable variable selling and administrative expenses would be discussed. It is conceivable that an inadequate selling effort contributed to the lower sales. (c) 1.
[$790,000 + ($1,400,000 X 20%)] ÷ $5,000,000 = 21.4%.
2.
$790,000 ÷ [$5,000,000 – ($5,000,000 X 24%)] = 20.8%.
3.
($790,000 + $260,000) ÷ $5,000,000 = 21.0%.
22-56
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PROBLEM 22-6B
(a) To Cutting Department Manager—Phoenix Division Controllable Costs: Budget Actual Indirect labor $ 90,000 $ 95,000 Indirect materials 61,000 62,700 Maintenance 25,000 27,400 Utilities 20,000 25,200 Supervision 28,000 31,000 Total $224,000 $241,300
No. 1 Month: January Fav/Unfav $ 5,000 U 1,700 U 2,400 U 5,200 U 3,000 U $17,300 U
No. 2 To Division Production Manager—Phoenix Month: January Controllable Costs: Budget Actual Fav/Unfav Phoenix Division $ 70,000 $ 73,100 $ 3,100 U Departments: Cutting 224,000 241,300 17,300 U Shaping 177,000 190,000 13,000 U Finishing 245,000 250,000 5,000 U Total $716,000 $754,400 $38,400 U
To Vice-President—Production Controllable Costs: Budget V-P Production $ 70,000 Divisions: Phoenix 716,000 San Francisco 715,000 Tulsa 750,000 Total $2,251,000
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No. 3 Month: January Actual Fav/Unfav $ 72,000 $ 2,000 U 754,400 724,000 760,000 $2,310,400
38,400 U 9,000 U 10,000 U $59,400 U
22-57
PROBLEM 22-6B (Continued)
To President Controllable Costs: President Vice-Presidents: Production Marketing Finance Total
Budget $ 91,300
No. 4 Month: January Actual Fav/Unfav $ 94,200 $ 2,900 U
2,251,000 160,000 120,000 $2,622,300
2,310,400 167,200 125,000 $2,696,800
59,400 U 7,200 U 5,000 U $74,500 U
(b) 1.
Within the Phoenix division the rankings of the department managers were: (1) Finishing, (2) Shaping, and (3) Cutting. If the rankings were done on a percentage basis, they would rank as follows: (1) Finishing – 2.0% U (2) Shaping – 7.3% U and (3) Cutting – 7.7% U.
2.
At the division manager level, the rankings were: (1) San Francisco, (2) Tulsa, and (3) Phoenix.
3.
Rankings in terms of dollars may be somewhat misleading in this case because of the substantial difference between the production budget and the other budgets. On a percentage basis the differences and rankings are: (1) production, 2.6% U; (2); finance, 4.2% U and (3) marketing, 4.5% U.
22-58
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*PROBLEM 22-7B
(a)
(b)
1.
ROI = Controllable Margin ÷ Average Operating Assets ROI = $1,500,000 ÷ $7,500,000 ROI = 20%
2.
Residual Income = Controllable Margin – (Minimum Rate of Return X Average Operating Assets) Residual Income = $1,500,000 – (.15 X $7,500,000) Residual Income = $1,500,000 – $1,125,000 = $375,000
The management of Washington Enterprises would clearly have accepted the investment opportunity it had in 2014 if residual income had been used as the performance measure because an increase in residual income results from a project whose ROI is greater than the minimum rate of return. If management of the division had used ROI as the performance measure, the decision would be to reject the project because the ROI of 18% is less than Washington Enterprise’s ROI experience range of 19.9% to 23.3%. With bonuses based in part on ROI, the 18% project would have a negative effect on bonuses.
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22-59
BYP 22-1
DECISION-MAKING AT CURRENT DESIGNS
(a)
Current Designs Rotomolded Line Manufacturing Budget For the Year Ended December 31, 2013 Units to be produced Costs: Variable costs Polyethylene powder Finishing kits Labor—type I Labor—type II Indirect materials Manufacturing supplies Maintenance and utilities Total variable costs Fixed costs Supervision Insurance Depreciation Total fixed costs Total costs
22-60
.
Calculation
4,000 X 54 X $1.50 4,000 X $170 4,000 X 2 X $15 4,000 X 3 X $12
Kimmel, Accounting, 5e, Solutions Manual
4,000 kayaks Amount budgeted
$ 324,000 680,000 120,000 144,000 40,000 53,800 88,000 1,449,800 90,000 14,400 109,800 214,200 $1,664,000
(For Instructor Use Only)
BYP 22-1 (Continued) (b)
Current Designs Rotomolded Line Manufacturing Flexible Budget Report For the Quarter Ended March 31, 2013 Units to be produced 900 kayaks 1,000 kayaks Costs: Variable costs Polyethylene powder (54 X 1.50 per unit) $ 72,900 $ 81,000 Finishing kits ($170 per unit) 153,000 170,000 Labor—type I (2 hours per unit X $15 per hour) 27,000 30,000 Labor—type II (3 hours per unit X $12 per hour) 32,400 36,000 Indirect materials ($10* per unit) 9,000 10,000 Manufacturing supplies ($13.45** per unit) 12,105 13,450 Maintenance and utilities ($22*** per unit) 19,800 22,000 Total variable costs ($362.45 per unit) 326,205 362,450 Fixed costs Supervision a 22,500 22,500 Insurance b 3,600 3,600 Depreciation c 27,450 27,450 Total fixed costs 53,550 53,550 Total costs $379,755 $416,000 *$40,000 ÷ 4,000 **$53,800 ÷ 4,000 ***$88,000 ÷ 4,000
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1,050 kayaks
$ 85,050.00 178,500.00 31,500.00 37,800.00 10,500.00 14,122.50 23,100.00 380,572.50 22,500.00 3,600.00 27,450.00 53,550.00 $434,122.50
a. $ 90,000 ÷ 4 b. $ 14,400 ÷ 4 c. $109,800 ÷ 4
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22-61
BYP 22-1 (Continued) (c)
Current Designs Rotomolded Line Manufacturing Flexible Budget Report For the Quarter Ended March 31, 2013
Difference Budget for Actual costs for F = favorable Units to be produced 1,050 kayaks 1,050 kayaks U = unfavorable Costs: Variable costs Polyethylene powder $ 85,050.00 $ 87,000.00 $1,950.00 Finishing kits 178,500.00 178,840.00 340.00 Labor—type I 31,500.00 31,500.00 0 Labor—type II 37,800.00 39,060.00 1,260.00 Indirect materials 10,500.00 10,500.00 0 Manufacturing supplies 14,122.50 14,150.00 27.50 Maintenance and utilities 23,100.00 26,000.00 2,900.00 Total variable costs 380,572.50 387,050.00 6,477.50 Fixed costs Supervision 22,500.00 20,000.00 2,500.00 Insurance 3,600.00 3,600.00 0 Depreciation 27,450.00 27,450.00 0 Total fixed costs 53,550.00 51,050.00 2,500.00 Total costs $434,122.50 $438,100.00 $3,977.50
22-62
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U U U U U U F F U
BYP 22-2
(a) 1.
DECISION-MAKING ACROSS THE ORGANIZATION
The primary causes of the loss in net income were the decrease in the number of boarding days and the decrease in the boarding fee. The number of boarding days decreased by 2,900 or approximately 13% (2,900 days ÷ 21,900 days), and the boarding fee decreased from $25(a) per day to $20(b) per day, a decrease of 20% ($5 ÷ $25). Together these resulted in a $167,500 decrease in sales revenue, a decrease of approximately 31% ($167,500 ÷ $547,500). (a)
$547,500 ÷ 21,900 days = $25 per day $380,000 ÷ 19,000 days = $20 per day
(b)
.
2.
Management did a poor job in controlling variable expenses. Given that boarding days declined by about 13%, variable expenses should decline by about 13%, or more precisely, variable expenses 2,900 should decline by $25,520 $192,720 X . However, variable 21,900 expenses only declined by $14,330 or about 7.4% ($14,330 ÷ $192,720). Thus, management did a poor job in controlling variable expenses. Management did a better job in controlling fixed expenses. Fixed expenses were under budget by $4,000 and this includes the additional expenses incurred in advertising and entertainment.
3.
Management’s decisions to stay competitive probably were sound. Given the decline in boarding days, the decision not to replace the worker was sound. The decision to reduce rates was probably forced by the competition. Without the additional advertising and entertainment expenses, the loss in net income might have been even greater.
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22-63
BYP 22-2 (Continued) (b)
GREEN PASTURES Income Statement Flexible Budget Report For the Year Ended December 31, 2014 Difference Boarding days (BD) Sales ($25) Less variable expenses Feed ($5) Veterinary fees ($3) Blacksmith fees ($.25) Supplies ($.55) Total variable expenses ($8.80) Contribution margin Less fixed expenses Depreciation Insurance Utilities Repairs and maintenance Labor Advertising Entertainment Total fixed expenses Net income
(c) 1.
Budget at 19,000 BD $475,000
Actual at 19,000 BD $380,000
Favorable F Unfavorable U $ 95,000 U
95,000 57,000 4,750 10,450
104,390 58,838 4,984 10,178
9,390 U 1,838 U 234 U 272 F
167,200 307,800
178,390 201,610
11,190 U 106,190 U
40,000 11,000 14,000 11,000 95,000 8,000 5,000 184,000 $123,800
40,000 11,000 12,000 10,000 88,000 12,000 7,000 180,000 $ 21,610
$
0U 0U 2,000 F 1,000 F 7,000 F 4,000 U 2,000 U 4,000 F $102,190 U
The primary causes of the decrease in net income are the decreases in boarding rates and volume. The average daily rate charged was $20 = ($380,000 ÷ 19,000). This rate resulted in a decrease in sales revenue of $95,000 or 20% = ($95,000 ÷ $475,000). Given that it is “an extremely competitive business,” if Green Pastures had not reduced rates, boarding days almost certainly would have declined even more.
22-64
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BYP 22-2 (Continued) 2.
Management did a poor job of controlling variable expenses. These expenses in total were $11,190 over budget or 6.7%, or ($11,190 ÷ $167,200). Moreover, each individual variable expense was over budget, except for supplies. Management did a good job of controlling fixed expenses as noted in part (a).
3.
As noted in part (a), management’s decisions to stay competitive probably were sound.
(d) Given that the industry is “extremely competitive,” management should consider two options. One, become the lowest cost operator. If Green Pastures is the company with the lowest operating costs, it can underprice its competitors and take customers away from them (increasing its sales). Eventually, some of its competitors (those with the highest operating costs) will go out of business, and Green Pastures will get their customers, or at least some of them. (Wal-Mart is an example of this strategy.) Option two is to offer its customers a superior product or service. If customers perceive that Green Pastures is the “best” boarding stable in Kentucky, the company will take customers away from its competitors. Also, if Green Pastures is perceived as the “best,” many customers will be willing to pay a premium for its boarding service, and Green Pastures will be able to raise its rates. (Gillette is an example of this strategy.)
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22-65
BYP 22-3
MANAGERIAL ANALYSIS
(a) Mary Gammel—Profit Center: Responsible for sales, inventory cost, advertising, sales personnel, printing, and travel. She is not responsible for the assets invested in her division and probably does not control the rent or depreciation costs either. As a profit center manager she might have control of the insurance, but she probably does not. Stephen Flott—Cost Center: Responsible for inventory cost, advertising, sales personnel, printing, and travel. As a cost center manager, he might or might not have control of rent and insurance costs, but he probably does not. He does not have control of the assets invested in his department; thus, he does not have control of the depreciation. Jose Gomez—Investment Center: Responsible for all items shown. (b) Mary Gammel Budget differences: The cost of goods sold is 28% ($42,000 ÷ $150,000) above budget and so should definitely be brought to her attention. Travel is 30% ($6,000 ÷ $20,000) below budget. Students may differ as to whether they believe that this should be brought to her attention. The differences in rent and depreciation should not be brought to her attention because she does not control those costs. Stephen Flott Budget differences: The cost of goods sold, which is 22% ($22,000 ÷ $100,000) above budget, should definitely be brought to his attention. Travel costs are 30% ($9,000 ÷ $30,000) below budget. This should probably be brought to his attention, so that he can verify that the goal of travel is being adequately accomplished by other means. The 67% ($20,000 ÷ $30,000) increase in rent and 10% ($10,000 ÷ $100,000) decrease in depreciation are not under his control and so should not be brought to his attention. It should probably be pointed out to students that all budget differences are monitored by someone within the company. These differences that are not the responsibility of the various managers are still within the scope of top management’s responsibility.
22-66
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BYP 22-3 (Continued) Jose Gomez Budget differences: As manager of an investment center, Mr. Gomez is responsible for all categories of the budget. The selection in this case would be which differences merit his attention. Any decrease in a company’s gross profit rate (gross profit ÷ sales) is a cause for concern. (Remember the gross profit is sales minus cost of goods sold.) Thus, the 6% [($26,500 – $25,000) ÷ $25,000] increase in cost of goods sold should be brought to his attention. Travel is below budget 25% ($500 ÷ $2,000), which is $500. This is not a large percentage of total costs, nor is it a large dollar amount, so there could be an argument that this should be left out. The 23% ($2,300 ÷ $10,000) increase in rent is only a $2,300 increase, so it could be included, though it might be left out as immaterial. The 40% ($16,000 ÷ $40,000) increase in depreciation should definitely be included.
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22-67
BYP 22-4
REAL-WORLD FOCUS
(a) The company’s costs do not increase proportionately with the revenues increase in the third and fourth quarter because the behavior of the costs is primarily fixed. (b) Static budgeting seems to be most appropriate for Computer Associates because costs do not respond proportionately with changes in the activity level (revenues).
22-68
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BYP 22-5
REAL-WORLD FOCUS
(a) The two most common pain points are (1) dealing with other managers and (2) technology issues, mainly frustration of budgeting in Excel spreadsheets. (b) Of those companies that participated in the survey, 97 percent said that they prepare annual budgets. Of those that prepare annual budgets, 60 percent say that they begin the process by determining sales forecasts. (c) The most common amount of time for the budgeting process is 4 to 8 weeks. (d) The most commonly defined range of acceptable tolerance levels was that variances were tolerated up to 5 to 10 percent. Beyond that level there were consequences. (e) Severe consequences were defined as: Compensation is affected or other sanctions applied, the manager receives a formal reprimand, or job losses result (the manager responsible for the variance, or the variance drives company layoffs due to missed numbers).
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22-69
BYP 22-6
COMMUNICATION ACTIVITY
(a) Fred Bedner should be able to control all the variable costs and the fixed costs of supervision (but not his portion) and inspection. Insurance and depreciation ordinarily are not the responsibility of the department manager. (b) The total variable cost per unit is $25 ($50,000 ÷ 2,000). The total cost during the month to manufacture 1,500 units is variable costs $37,500 (1,500 X $25) plus fixed costs ($35,000) or $72,500 ($37,500 + $35,000). (c)
FLEMING COMPANY Production Department Manufacturing Overhead Flexible Budget Report For the Month Ended Difference Budget at 1,500 units
Actual at 1,500 units
Favorable F Unfavorable U
$16,500 9,000 7,500
$22,500 13,500 8,200
$ 6,000 U 4,500 U 700 U
4,500 37,500
5,000 49,200
500 U 11,700 U
Fixed costs Supervision Inspection costs Insurance expense Depreciation Total fixed
17,000 1,000 2,000 15,000 35,000
18,400 1,200 2,200 14,700 36,500
1,400 U 200 U 200 U 300 F 1,500 U
Total costs
$72,500
$85,700
$13,200 U
Variable costs Indirect materials ($11) Indirect labor ($6) Maintenance expense ($5) Manufacturing supplies ($3) Total variable ($25)
(d) A production department is a cost center. Thus, the report should include only the costs that are controllable by the production manager. This report is shown in Illustration 10–21. In this type of report, no distinction is made between variable and fixed costs. 22-70
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BYP 22-6 (Continued) FLEMING COMPANY Production Department Manufacturing Overhead Responsibility Report For the Month Ended
Controllable Cost Indirect materials Indirect labor Maintenance expense Manufacturing supplies Supervision* Inspection costs Total
Budget $16,500 9,000 7,500 4,500 7,000 1,000
Actual $22,500 13,500 8,200 5,000 8,400 1,200
Difference Favorable F Unfavorable U $ 6,000 U 4,500 U 700 U 500 U 1,400 U 200 U
$45,500
$58,800
$13,300 U
*$10,000 is deducted from both budget and actual for Mr. Bedner’s cost.
To:
Mr. Fred Bedner, Production Manager
From: Subject:
, Vice President of Production Performance Evaluation for the Month of XXXXX
Your performance in controlling costs that are your responsibility was very disappointing in the month of XXXXX. As indicated in the accompanying responsibility report, total costs were $13,300 over budget. On a percentage basis, costs were 29% over budget. As you can see, actual costs were over budget for every cost item. In two instances, costs were more significantly over budget (Indirect materials 36% and Indirect labor 50%).
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22-71
BYP 22-6 (Continued) Fred, it is imperative that you get costs under control in your department as soon as possible. I think we need to talk about ways to implement more effective cost control measures. I would like to meet with you in my office at 9 a.m. on Wednesday to discuss possible alternatives.
22-72
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BYP 22-7
ETHICS CASE
(a) The stakeholders in this ethical situation are: The employees and managers of each investment center. The central management and chief executive officer. The customers who buy the product. The owners or stockholders. (b) Pressure to perform is a frequently identified cause for unethical conduct. Employees are more prone to engage in unethical conduct when unreasonable demands are made upon them. Rather than lose their jobs or be demoted, if given no alternatives, employees may seek to cut corners, reduce quality control, use questionable sales tactics, and bend the rules. (c) The company might maintain open lines of communication with its employees to better know the pressures of its managers. By “keeping in touch,” the company may avoid making unreasonable demands on its managers and employees. The company might also develop a company code of ethical conduct and enforce it. However, if dismissal or demotion continues to be the probable consequence of failure to meet objectives, some managers are likely to engage in unethical behavior in an attempt to meet the objectives.
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BYP 22-8
ALL ABOUT YOU
(a)
The basic idea is to set up individual envelopes for different expense categories. Once you have used up the money in a particular envelope, you can’t use more. Begin by preparing a monthly budget. Identify those items that you will pay in cash. These would include things like groceries, eating out at restaurants, clothing, gasoline, car repairs, gifts, and entertainment. These are the categories for which you will have envelopes. Next, decide how often to fill the envelopes and determine the amount to put in each envelope. If you continually run out of money in a particular envelope you many need to re-evaluate your allocation. If you don’t use up all the money in an envelope in one month, you can carry it over to the next month.
(b)
Answers will vary by student.
22-74
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BYP 22-9
CONSIDERING YOUR COSTS AND BENEFITS
In general, in past years it has usually been considered prudent to purchase a home rather than to rent. As noted, over time, home prices have usually appreciated in most parts of the country. Mortgage interest provides some tax relief, and by purchasing a home you get some control over your housing costs. However, recent turbulence in the housing market has made the decision more complicated. In some parts of the country home prices have fallen considerably, and there is no indication how soon they will recover. In some areas renting appears to be an attractive alternative to purchasing. In the scenario described, there is considerable uncertainty surrounding this individual’s life. Purchasing a home is a huge decision, with very high transactions costs. It is often suggested that, because of the high transactions costs, you should not purchase a home unless you intend on living in it for a number of years. The person in the case is starting a new job in a new community. Until they are more certain that they will like their job, that the job is stable, and that they like the community, they should delay the purchase of a home.
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CHAPTER 23 Standard Costs and Balanced Scorecard ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Questions
Brief Exercises 1
Do It!
Exercises
A Problems
B Problems
1.
Distinguish between a standard and a budget.
1, 2
2.
Identify the advantages of standard costs.
3
3.
Describe how companies set standards.
4, 5, 6, 7, 8, 9
2, 3
1
1, 2, 3, 4, 17
4.
State the formulas for determining direct materials and direct labor variances.
10, 11
4, 5
2, 3
4, 5, 6, 7, 8, 9, 10, 13, 14, 19
1A, 2A, 3A, 4A, 5A, 6A
1B, 2B, 3B, 4B, 5B, 6B
5.
State the formula for determining the total manufacturing overhead variance.
12
6
3
11, 12, 19
1A, 2A, 3A, 4A, 5A, 6A
1B, 2B, 3B, 4B, 5B, 6B
6.
Discuss the reporting of variances.
13, 14
10, 14, 15
3A
3B
7.
Prepare an income statement for management under a standard costing system.
18
16
2A, 5A, 6A
2B, 5B, 6B
8.
Describe the balanced scorecard approach to performance evaluation.
15, 16, 17
7
*9.
Identify the features of a standard cost accounting system.
19
8, 9
18, 19, 20
6A
6B
*10.
Compute overhead controllable and volume variances.
20, 21, 22, 23
10, 11
21, 22, 23
7A, 8A, 9A, 10A
7B, 8B, 9B, 10B
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1
1
(For Instructor Use Only)
4
17
23-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Compute variances.
Simple
20–30
2A
Compute variances, and prepare income statement.
Simple
30–40
3A
Compute and identify significant variances.
Moderate
20–30
4A
Answer questions about variances.
Complex
30– 0
5A
Compute variances, prepare an income statement, and explain unfavorable variances.
Moderate
30–40
*6A
Journalize and post standard cost entries, and prepare income statement.
Moderate
40–50
*7A
Compute overhead controllable and volume variances.
Simple
10–15
*8A
Compute overhead controllable and volume variances.
Simple
10–15
*9A
Compute overhead controllable and volume variances.
Moderate
10–15
*10A
Compute overhead controllable and volume variances.
Moderate
10–15
1B
Compute variances.
Simple
20–30
2B
Compute variances, and prepare income statement.
Simple
30–40
3B
Compute and identify significant variances.
Moderate
30–40
4B
Answer questions about variances.
Complex
30–40
5B
Compute variances, prepare an income statement, and explain unfavorable variances.
Moderate
30–40
*6B
Journalize and post standard cost entries, and prepare income statement.
Moderate
40–50
*7B
Compute overhead controllable and volume variances.
Simple
10–15
*8B
Compute overhead controllable and volume variances.
Simple
10–15
*9B
Compute overhead controllable and volume variances.
Moderate
10–15
*10B
Compute overhead controllable and volume variances.
Moderate
10–15
23-2
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Kimmel, Accounting, 5e, Solutions Manual (For Instructor Use Only)
Learning Objective Distinguish between a standard and a budget. Identify the advantages of standard costs. Describe how companies set standards.
Knowledge Comprehension Application Q23-1 BE23-1 Q23-2 E23-1 Q23-3 E23-1
4.
State the formulas for determining direct materials and direct labor variances.
Q23-10 Q23-11
5.
State the formula for determining the total manufacturing overhead variance.
Q23-12
6.
Discuss the reporting of variances. Prepare an income statement for management under a standard costing system. Describe the balanced scorecard approach to performance evaluation. Identify the features of a standard cost accounting system. Compute overhead controllable and volume variances.
Q23-13 Q23-14 Q23-18
1. 2. 3.
7.
8.
*9.
*10.
Broadening Your Perspective
Q23-8
Q23-4 Q23-5 Q23-6
Q23-7 Q23-9
Q23-15 DI23-4 Q23-16 Q23-17 Q23-19
Q23-20 Q23-21 Q23-22 Q23-23 BYP23-5 BYP23-7
BE23-2 E23-1 BE23-3 E23-2 DI23-1 E23-3 BE23-4 E23-7 BE23-5 E23-9 DI23-2 E23-10 DI23-3 E23-13 E23-4 E23-14 E23-5 P23-1A E23-6 P23-2A BE23-6 P23-1A DI23-3 P23-2A E23-11 P23-5A E23-12 P23-6A E23-19 P23-1B E23-10 E23-14 E23-16 P23-6A P23-2A P23-2B P23-5A P23-5B BE23-7 E23-17
Analysis
Synthesis
Evaluation
E23-4 E23-17 P23-5A E23-8 P23-6A E23-19 P23-1B P23-3A P23-2B P23-4A P23-5B P23-3B P23-6B P23-4B P23-2B E23-11 P23-3B P23-5B E23-12 P23-4B P23-6B E23-19 P23-3A P23-4A E23-15 P23-3A P23-3B P23-6B
BE23-8 E23-20 E23-19 BE23-9 P23-6A E23-18 P23-6B BE23-10 P23-7A P23-8B E23-20 BE23-11 P23-8A P23-9B E23-21 E23-21 P23-9A P23-10BE23-22 E23-22 P23-10A E23-23 P23-7B BYP23-3 BYP23-1
23-3
BYP23-2 BYP23-4 BYP23-6 BYP23-8 BYP23-9 BYP23-10
BLOOM’ S TAXONOMY TABLE
.
Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
ANSWERS TO QUESTIONS 1.
(a) This is incorrect. Standard costs are predetermined unit costs. (b) Agree. Examples of governmental regulations that establish standards for a business are the Fair Labor Standards Act, the Equal Employment Opportunity Act, and a multitude of environmental laws.
2.
(a) Standards and budgets are similar in that both are predetermined costs and both contribute significantly to management planning and control. The two terms differ in that a standard is a unit amount and a budget is a total amount. (b) There are important accounting differences between budgets and standards. Except in the application of manufacturing overhead to jobs and processes, budget data are not journalized in cost accounting systems. In contrast, standard costs may be incorporated into cost accounting systems. It is possible for a company to report inventories at standard costs in its financial statements, but it is not possible to report inventories at budgeted costs.
3.
In addition to facilitating management planning, standard costs offer the following advantages to an organization: (1) They promote greater economy by making employees more “cost-conscious.” (2) They may be useful in setting selling prices. (3) They contribute to management control by providing a basis for evaluating cost control. (4) They are useful in highlighting variances in “management by exception.” (5) They simplify the costing of inventories and reduce clerical costs.
4.
The management accountant provides input to the setting of standards through the accumulation of historical cost data and knowledge of the behavior of costs in response to changes in activity levels. Management has the responsibility for setting the standards.
5.
Ideal standards represent optimum levels of performance under perfect operating conditions. Normal standards represent efficient levels of performance that are attainable under expected operating conditions.
6.
(a) The direct materials price standard should be based on the purchasing department’s best estimate of the cost of raw materials and an amount for related costs such as receiving, storing, and handling. (b) The direct materials quantity standard should be based on both quality and quantity requirements plus allowances for unavoidable waste and normal spoilage.
7.
Agree. The direct labor quantity standard should include allowances for rest periods, cleanup, machine setup, and machine downtime.
8.
With standard costs, the predetermined overhead rate is determined by dividing budgeted overhead costs by an expected standard activity index.
9.
A favorable cost variance has a positive connotation. It suggests efficiencies in incurring manufacturing costs and in using direct materials, direct labor, and manufacturing overhead. An unfavorable cost variance has a negative connotation. It suggests that too much was paid for one or more of the manufacturing cost elements or that the elements were used inefficiently.
23-4
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Questions Chapter 23 (Continued) 10.
(a) (1) actual price. (b) (3) actual quantity. (c) (5) standard price.
11.
(1) – (3) = total labor variance; (1) – (2) = labor price variance; and (2) – (3) = labor quantity variance.
12.
Overhead applied = $9 X 27,000 = $243,000.
13.
Variances should be reported to appropriate levels of management as soon as possible. The principle of “management by exception” may be used with variance reports.
14.
The purchasing department would be responsible for an unfavorable materials price variance when it paid more than the standard price for the materials. The purchasing department would also be responsible for an unfavorable materials quantity variance if it purchased materials of inferior quality which caused an excess use of materials.
15.
The four perspectives of the balanced scorecard are: financial, customer, internal process, and learning and growth. The financial perspective employs financial measures of performance used by most firms. The customer perspective evaluates the company from the viewpoint of those people who buy its product in terms of price, quality, product innovation, customer service, and other dimensions. The internal process perspective evaluates the value chain—product development, production, delivery and after-sale service—to ensure that the company is operating effectively and efficiently. The learning and growth perspective evaluates how well the company develops and retains its employees. The four perspectives are linked in that the results in one perspective influence the results in the next.
16.
Kerry James is not correct. The balanced scorecard does not replace financial measures, it instead integrates both financial and nonfinancial measures. In fact, financial measures are very critical to the balanced scorecard, since they represent the final “destination” of all the company’s efforts.
17.
The possibilities for nonfinancial measures are limitless. Some that were mentioned in the chapter were: capacity utilization of plants, average age of key assets, impact of strikes, brand-loyalty statistics, market profile of customer-end products, number of new products, employee stock ownership percentages, number of scientists and technicians used in R&D, customer satisfaction data, factors affecting customer product selection, number of patents and trademarks held, customer brand awareness, number of ATMs by state, number of products used by average customer, percentage of customer service calls handled by interactive voice response units, personnel cost per employee, credit card retention rates.
18.
(a) Variances are reported in income statements for management below gross profit which is reported at standard costs. Each variance is identified and the total variance is shown. (b) Standard costs may be used in costing inventories when there is no significant difference between actual costs and standard costs. When there are significant differences, actual costs must be reported.
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Kimmel, Accounting, 5e, Solutions Manual
(2) standard price. (4) standard price. (6) standard quantity.
(For Instructor Use Only)
23-5
Questions Chapter 23 (Continued) *19. (a) A standard cost accounting system is a double-entry system of accounting in which standard costs are used in making entries and standard cost variances are formally recognized in the accounts. (b) The variance account will have: (1) a debit balance when the materials price variance is unfavorable and (2) a credit balance when the labor quantity variance is favorable. *20. Overhead controllable variance = actual overhead costs ($248,000) – overhead budgeted. Overhead budgeted is based on standard hours allowed as follows: variable costs (27,000 X $5 = $135,000) + fixed costs (28,000 X $4 = $112,000) = total overhead budgeted ($247,000). Thus, the controllable variance is $1,000 unfavorable. *21. The purpose of computing the overhead volume variance is to determine whether plant facilities were efficiently used during the period. The basic formula is fixed overhead rate X (normal capacity – standard hours allowed). *22. Fixed costs remain the same at every level of activity within the relevant range. Since the predetermined overhead rate is based on normal capacity, it follows that if standard hours allowed are less than standard hours at normal capacity, fixed overhead costs will be underapplied. The reverse is true when production exceeds normal capacity. *23. John should include the following points about overhead variances: (1) Standard hours allowed are used in each of the variances. (2) Budgeted costs for the controllable variance are derived from the flexible budget. (3) The controllable variance generally pertains to variable costs. (4) The volume variance pertains solely to fixed costs.
23-6
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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 23-1 (a) Standards are stated as a per unit amount. Thus, the standards are materials $2.60 ($1,300,000 ÷ 500,000) and labor $3.40 ($1,700,000 ÷ 500,000). (b) Budgets are stated as a total amount. Thus, the budgeted costs for the year are materials $1,300,000 and labor $1,700,000.
BRIEF EXERCISE 23-2 (a) Standard direct materials price per gallon = $2.60 ($2.30 + $.20 + $.10). (b) Standard direct materials quantity per gallon = 4 pounds (3.6 + .4). (c) Standard materials cost per gallon = $10.40 ($2.60 X 4).
BRIEF EXERCISE 23-3 (a) Standard direct labor rate per hour = $15.00 ($13.00 + $.80 + $1.20). (b) Standard direct labor hours per gallon = 1.5 hours (1.1 + .25 + .15). (c) Standard labor cost per gallon = $22.50 ($15.00 X 1.5). BRIEF EXERCISE 23-4 Total materials variance = $1,192 U (3,200 X $5.06*) – (3,000** X $5.00). Materials price variance = $192 U (3,200 X $5.06) – (3,200 X $5.00). Materials quantity variance = $1,000 U (3,200 X $5.00) – (3,000 X $5.00). *$16,192 ÷ 3,200
**1,500 X 2
BRIEF EXERCISE 23-5 Total labor variance = $680 U (2,100 X $10.80) – (2,000 X $11.00). Labor price variance = $420 F (2,100 X $10.80) – (2,100 X $11.00). Labor quantity variance = $1,100 U (2,100 X $11.00) – (2,000 X $11.00).
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23-7
BRIEF EXERCISE 23-6 The formula is:
Actual Overhead Overhead – Applied = Total Overhead Variance $118,000 – *$122,400* $4,400 F
*20,400 X $6 = $122,400
BRIEF EXERCISE 23-7 1. 2. 3. 4.
financial ...................................... (c) return on assets customer ..................................... (d) brand recognition internal process ......................... (a) plant capacity utilization learning and growth ................... (b) employee work days missed due to injury
*BRIEF EXERCISE 23-8 (a) Raw Materials Inventory ............................................. Materials Price Variance ..................................... Accounts Payable ...............................................
12,000
(b) Work in Process Inventory (5,800 X $2*) ................... Materials Quantity Variance ............................... Raw Materials Inventory (5,600 X $2) .................
11,600
500 11,500 400 11,200
*$12,000 ÷ 6,000
*BRIEF EXERCISE 23-9 (a) Factory Labor .............................................................. Labor Price Variance ........................................... Factory Wages Payable ......................................
25,500
(b) Work in Process Inventory (3,150 X $8.50*) .............. Labor Quantity Variance ..................................... Factory Labor ......................................................
26,775
*$25,500 ÷ 3,000
23-8
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1,500 24,000 1,275 25,500
*BRIEF EXERCISE 23-10 The formula is:
Overhead Overhead Actual Overhead – Budgeted = Controllable Variance $118,000 – *$131,600* $13,600 F
*(20,400 X $4) + $50,000 = $131,600 *BRIEF EXERCISE 23-11 The formula is: Fixed Overhead Overhead X (Normal Capacity Hours – Standard Hours Allowed) = Volume Rate Variance (25,000 – 20,400)
$2.00*/hr. X
= $9,200 U
*($50,000 ÷ 25,000 hrs.) SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 23-1 Manufacturing Cost Standard Quantity Standard X Element Direct materials 2 pounds Direct labor 0.2 hours Manufacturing overhead 0.2 hours Total
Price
=
Standard
$ 5.00 15.00 18.75*
$
$
*125% of direct labor cost DO IT! 23-2 The variances are: Total materials variance = (29,000 X $6.30) – (32,000* X $6.00) = $9,300 favorable Materials price variance = (29,000 X $6.30) – (29,000 X $6.00) = $8,700 unfavorable Materials quantity variance = (29,000 X $6.00) – (32,000* X $6.00) = $18,000 favorable
*(16,000 X 2)
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23-9
DO IT! 23-3 The variances are: Total labor variance = (4,100 X $14.30) – (3,800* X $14.00) = $5,430 unfavorable Labor price variance = (4,100 X $14.30) – (4,100 X $14.00) = $1,230 unfavorable Labor quantity variance = (4,100 X $14.00) – (3,800* X $14.00) = $4,200 unfavorable Total overhead variance = $81,300 – $83,600** = $2,300 favorable *2,000 X 1.9 **3,800 hours X $22.00
DO IT! 23-4 1. 2. 3. 4. 5. 6.
23-10
Learning and growth perspective. Financial perspective. Customer perspective. Internal process perspective. Learning and growth perspective. Customer perspective.
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SOLUTIONS TO EXERCISES EXERCISE 23-1 (a) Direct materials: (2,000 X 3) X $5 = $30,000 Direct labor: (2,000 X 1/2) X $15 = $15,000 Overhead: $15,000 X 70% = $10,500 (b) Direct materials: 3 X $5 = $15.00 Direct labor: 1/2 X $15 = 7.50 Overhead: $7.50 X 70% = 5.25 Standard cost: $27.75 (c) The advantages of standard costs which are carefully established and prudently used are: 1. Management planning is facilitated. 2. Greater economy is promoted by making employees more costconscious. 3. Setting selling prices is facilitated. 4. Management control is enhanced by having a basis for evaluation of cost control. 5. Variances are highlighted in management by exception. 6. Costing of inventories is simplified and clerical costs are reduced. EXERCISE 23-2
Ingredient
Amount Per Gallon
Standard Waste
Grape concentrate Sugar (54 ÷ 50) Lemons (60 ÷ 50) Yeast Nutrient Water (2,600 ÷ 50)
60* oz. 1.08 lb. 1.2 1 tablet 1 tablet 52 oz.
4% 10% 25% 0% 0% 0%
Standard Usage (a) 62.5 oz. (b) 1.20 lb. (c) 1.6 1 tablet 1 tablet 52 oz.
Standard Price $.06 .30 .60 .25 .20 .005
Standard Cost Per Gallon $3.75 .36 .96 .25 .20 .26 $5.78
*3,000 ÷ 50 (a) (b) (c)
.
.96X = 60 ounces; or X = (60 ounces)/.96. .90X = 1.08 pounds; or X = (1.08 pounds)/.90. .75X = 1.2 lemons; or X = (1.2 lemons)/.75.
Kimmel, Accounting, 5e, Solutions Manual
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23-11
EXERCISE 23-3 Direct materials Cost per pound [$5 – (2% X $5) + $0.25] Pounds per unit (4.5 + 0.5)
$5.15 X 5
$25.75
Direct labor Cost per hour ($12 + $3) Hours per unit (2 + .3)
$ 15 X 2.3
34.50
Manufacturing overhead 2.3 hours X $7 Total standard cost per unit
16.10 $76.35
EXERCISE 23-4 (a) Actual service time Setup and downtime Cleanup and rest periods Standard direct labor hours per oil change
1.0 hours 0.2 hours 0.3 hours 1.5 hours
(b) Hourly wage rate Payroll taxes ($12 X 10%) Fringe benefits ($12 X 25%) Standard direct labor hourly rate
$12.00 1.20 3.00 $16.20
(c) Standard direct labor cost per oil change = 1.50 hours X $16.20 per hour = $24.30 (d) Direct labor quantity variance = (1.60 hours X $16.20) – (1.50 hours X $16.20) = $25.92 – $24.30 = $1.62 U
23-12
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EXERCISE 23-5 (a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (29,000 X $4.70) (28,500* X $5.00) $136,300 – $142,500 = $6,200 F *9,500 X 3 Materials price variance: ( AQ X AP ) – ( AQ X SP ) (29,000 X $4.70) (29,000 X $5.00) $136,300 – $145,000 = $8,700 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (29,000 X $5.00) (28,500 X $5.00) $145,000 – $142,500 = $2,500 U (b) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (28,000 X $5.15) (28,500 X $5.00) $144,200 – $142,500 = $1,700 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (28,000 X $5.15) (28,000 X $5.00) $144,200 – $140,000 = $4,200 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (28,000 X $5.00) (28,500 X $5.00) $140,000 – $142,500 = $2,500 F
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23-13
EXERCISE 23-6 (a) Total labor variance: ( AH X AR ) – ( SH X SR ) (40,600 X $12.15) (40,000* X $12.00) $493,290 – $480,000 = $13,290 U *10,000 X 4 (b) Labor price variance: ( AH X AR ) – ( AH X SR ) (40,600 X $12.15) (40,600 X $12.00) $493,290 – $487,200 = $6,090 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (40,600 X $12.00) (40,000 X $12.00) $487,200 – $480,000 = $7,200 U (c) Labor price variance: ( AH X AR ) – ( AH X SR ) (40,600 X $12.15) (40,600 X $12.25) $493,290 – $497,350 = $4,060 F Labor quantity variance: ( AH X SR ) – ( SH X SR ) (40,600 X $12.25) (41,000* X $12.25) $497,350 – $502,250 = $4,900 F *4.1 X 10,000 EXERCISE 23-7 Total materials variance: ( AQ X AP ) – ( SQ X SP ) (1,900 X $2.65*) (1,880** X $2.50) $5,035 – $4,700 = $335 U Materials price variance: ( AQ X AP ) – (1,900 X $2.65) $5,035 – *$5,035 ÷ 1,900 23-14
.
( AQ X SP ) (1,900 X $2.50) $4,750 = $285 U **235 X 8
Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 23-7 (Continued) Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (1,900 X $2.50) (1,880 X $2.50) $4,750 – $4,700 = $50 U Total labor variance: ( AH X AR ) – ( SH X SR ) (700 X $11.80*) (705** X $12.00) $8,260 – $8,460 = $200 F *$8,260 ÷ 700
**235 X 3
Labor price variance: ( AH X AR ) – ( AH X SR ) (700 X $11.80) (700 X $12.00) $8,260 – $8,400 = $140 F Labor quantity variance: ( AH X SR ) – ( SH X SR ) (700 X $12.00) (705 X $12.00) $8,400 – $8,460 = $60 F
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Kimmel, Accounting, 5e, Solutions Manual
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23-15
EXERCISE 23-7 (Continued) (Not Required) Materials Variance Matrix (1)
(2)
(3)
Actual Quantity X Actual Price 1,900 X $2.65 = $5,035
Actual Quantity X Standard Price 1,900 X $2.50 = $4,750
Standard Quantity X Standard Price 1,880 X $2.50 = $4,700
Price Variance (1) – (2) $5,035 – $4,750 = $285 U
Quantity Variance (2) – (3) $4,750 – $4,700 = $50 U
Total Variance (1) – (3) $5,035 – $4,700 = $335 U
Labor Variance Matrix (1)
(2)
(3)
Actual Hours X Actual Rate 700 X $11.80 = $8,260
Actual Hours X Standard Rate 700 X $12.00 = $8,400
Standard Hours X Standard Rate 705 X $12.00 = $8,460
Price Variance (1) – (2) $8,260 – $8,400 = $140 F
Quantity Variance (2) – (3) $8,400 – $8,460 = $60 F
Total Variance (1) – (3) $8,260 – $8,460 = $200 F
23-16
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
EXERCISE 23-8 (a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (1,220 X $128) (1,200 X $130) $156,160 – $156,000 = $160 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (1,220 X $128) (1,220 X $130) $156,160 – $158,600 = $2,440 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (1,220 X $130) (1,200 X $130) $158,600 – $156,000 = $2,600 U Total labor variance: ( AH X AR ) – ( SH X SR ) (4,150 X $13) (4,300 X $12.50) $53,950 – $53,750 = $200 U Labor price variance: ( AH X AR ) – ( AH X SR ) (4,150 X $13) (4,150 X $12.50) $53,950 – $51,875 = $2,075 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (4,150 X $12.50) (4,300 X $12.50) $51,875 – $53,750 = $1,875 F (b) The unfavorable materials quantity variance may be caused by the carelessness or inefficiency of production workers. Alternatively, the excess quantities may be caused by inferior quality materials acquired by the purchasing department. The unfavorable labor price variance may be caused by misallocation of the work force by the production department. In this case, more experienced workers may have been assigned to tasks normally done by inexperienced workers. An unfavorable labor variance may also occur when workers are paid higher wages than expected. The manager who authorized the wage increase is responsible for this variance.
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Kimmel, Accounting, 5e, Solutions Manual
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23-17
EXERCISE 23-9 (a)
Number of units = Total standard cost ÷ Standard cost per unit Number of units = $405,000 ÷ $20.00 (5 lb X $4 per lb) = 20,250
(b) AQ = [(SQ X SP) ± Quantity variance] ÷ SP AQ = ($405,000 + $9,000) ÷ $4.00 per lb = 103,500 pounds (c)
AP = [(AQ X SP) ± Price variance] ÷ AQ AP = [(103,500 X $4) – $5,175] = $408,825 ÷ 103,500 lb = $3.95/lb
(d) AH = [(SH X SR) ± Quantity variance] ÷ SR AH = ($180,000 + $6,000) ÷ $10.00/hr = 18,600 hours (e)
AR = [(AH X SR) ± Price variance] ÷ AH AP = [(18,600 X $10) + $3,840] = $189,840 ÷ 18,600 hr = $10.21/hr
EXERCISE 23-10 TOBY TOOL & DIE COMPANY Direct Labor Variance Report For the Month Ended March 31, 2014 Job No.
Actual Hours
Standard Hours
Quantity Variance (a)
Actual Standard Rate (1) Rate (2)
Price Variance (b) Explanation
A257 A258 A259
221 450 300
225 430 300
$ 80.00 F 400.00 U ( 0
$20.00 $21.00 $20.60
$20.00 $20.00 $20.00
A260
116 110 Totals
120.00 U $ 440.00 U
$18.00
$20.00
$ 0 Repeat job 450.00 U Rush job 180.00 U Replacement worker 232.00 F New trainee $398.00 U
LQV = SR X (AH – SH) (b) LPV = AH X (AR – SR) (a)
23-18
.
(1)
Actual costs ÷ actual hours Standard costs ÷ standard hours
(2)
Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 23-11 Total overhead variance: Actual Overhead – Overhead Applied $263,000 – $255,000 (51,000 X $5)
= $8,000 U
EXERCISE 23-12 (a)
Overhead Budget ÷ (at normal capacity) Variable $250,000 Fixed 600,000 (b)
Standard Hours Allowed 95,000
X
Direct Labor Hours (at normal capacity) 100,000 100,000 Predetermined Overhead Rate $8.50
(c) Actual Overhead – $856,000 – ($256,000 + $600,000)
Overhead Applied $807,500 (95,000 X $8.50)
=
Predetermined Overhead Rate $2.50 $6.00
=
Overhead Applied $807,500
Total Overhead = Variance = $48,500 U
EXERCISE 23-13 (a)
(AQ X AP) – ( SQ X SP) = Total Materials Variance ( $10,800) – (2,140* X $5) = $100 U (AQ X AP) – ( AQ X SP) = Materials Price Variance ( $10,800) – (2,400 X $5) = $1,200 F ( AQ X SP) – ( SQ X SP) = Materials Quantity Variance (2,400 X $5) – (2,140* X $5) = $1,300 U *1,070 X 2
(b) One possible cause of an unfavorable materials quantity variance is the purchase of substandard materials. Such materials would normally be purchased at a lower price than normal, which means there would also be favorable materials price variance. Substandard materials could also cause work slowdowns and delays, causing an unfavorable labor quantity variance. Therefore, the purchase of substandard materials could cause all three variances mentioned.
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Kimmel, Accounting, 5e, Solutions Manual
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23-19
EXERCISE 23-14 (a) PICARD LANDSCAPING Variance Report – Purchasing Department For the Current Month
Project Remington Chang Wyco
Actual (1) Pounds Actual Purchased Price 500 400 550
$2.40 2.30 2.60
(2) Standard Price Price Variance (a) $2.50 2.50 2.50
Total price variance
$50 F 80 F 55 U
Explanation Purchased poor-quality seeds Seeds on sale Price increased
$75 F
(a)
MPV = AQ X (AP – SP) (1)Actual costs ÷ actual quantity (2)Standard costs ÷ standard quantity.
(b) PICARD LANDSCAPING Variance Report – Production Department For the Current Month Project Remington Chang Wyco
Actual Pounds 500 400 550
Standard Standard Pounds Price 460 410 480
$2.50 2.50 2.50
Total quantity variance
Quantity Variance (b)
Explanation
$100 U 25 F 175 U
Purchased poor-quality seeds Purchased higher-quality seeds New employee
$250 U
MQV = SP X (AQ – SQ)
(b)
23-20
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE 23-15 BURTE CORPORATION Variance Report – Purchasing Department For Week Ended January 9, 2014 Type of Materials
Quantity Purchased
Actual Price
Standard Price
Price Variance
Explanation
Rogue 11 Storm 17 Beast 29
25,000 lbs.
$5.20
7,000 oz. 22,000 units.
$3.45
$5.00 $3.30
$0.40
$0.42
$5,000 U $1,050 U $ 440 F
Price increase Rush order Bought larger quantity
25,000 = $5,000/($5.20 – $5.00). $5,000 U because the actual price ($5.20) exceeds the standard price ($5.00). $1,050/7,000 = $0.15; $3.30 + $0.15 = $3.45 $440/22,000 = $0.02; $0.40 + $0.02 = $0.42 EXERCISE 23-16 FISK COMPANY Income Statement For the Month Ended January 31, 2014 Sales revenue (8,000 X $8)............................................. Cost of goods sold (8,000 X $5) .................................... Gross profit (at standard) .............................................. Variances Materials price ........................................................ $1,200 U Materials quantity ................................................... 800 F Labor price .............................................................. 550 U Labor quantity ......................................................... 750 U Overhead ................................................................. 800 U Total variance—unfavorable .......................... Gross profit (actual) ....................................................... Selling and administrative expenses ............................ Net income ......................................................................
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$64,000 40,000 24,000
2,500 21,500 8,000 $13,500
23-21
EXERCISE 23-17 1.
Balanced scorecard—(c) An approach that incorporates financial and nonfinancial measures in an integrated system that links performance measurement and a company’s strategic goals.
2.
Variance—(a) The difference between total actual costs and total standard costs.
3.
Learning and growth perspective—(d) A viewpoint employed in the balanced scorecard to evaluate how well a company develops and retains its employees.
4.
Nonfinancial measures —(e) An evaluation tool that is not based on dollars.
5.
Customer perspective—(f) A viewpoint employed in the balanced scorecard to evaluate the company from the perspective of those people who buy its products or services.
6.
Internal process perspective—(h) A viewpoint employed in the balanced scorecard to evaluate the efficiency and effectiveness of the company’s value chain.
7.
Ideal standards—(g) An optimum level of performance under perfect operating conditions.
8.
Normal standards—(b) An efficient level of performance that is attainable under expected operating conditions.
*EXERCISE 23-18 1.
2.
3.
23-22
Raw Materials Inventory (18,000 X $4.40) ................ Materials Price Variance (18,000 X $.10) ................. Accounts Payable (18,000 X $4.50) ..................
79,200 1,800
Work in Process Inventory (17,500 X $4.40) ........... Materials Quantity Variance (500 X $4.40) ............... Raw Materials Inventory (18,000 X $4.40) ........
77,000 2,200
Factory Labor (15,300 X $5.50)................................. Labor Price Variance (15,300 X $.50) ............... Factory Wages Payable (15,300 X $5.00) .........
84,150
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81,000
79,200 7,650 76,500
*EXERCISE 23-18 (Continued) 4.
5.
Work in Process Inventory (15,400 X $5.50) ............ Labor Quantity Variance (100 X $5.50) ............. Factory Labor (15,300 X $5.50) ..........................
84,700
Work in Process Inventory ($84,700 X 100%) .......... Manufacturing Overhead ...................................
84,700
550 84,150 84,700
*EXERCISE 23-19 (a) $126,000 ($128,000 – $2,000). (b) $129,000 ($126,000 + $3,000). (c) $138,500 ($140,000 – $1,500). (d) $140,900 ($140,000 + $900). (e) $163,800 ($165,000 – $1,200). *EXERCISE 23-20 Raw Materials Inventory (1,900 X $2.50) ............................ Materials Price Variance (1,900 X $0.15) ............................ Accounts Payable (1,900 X $2.65) ..............................
4,750 285
Work in Process Inventory (1,880* X $2.50) ...................... Materials Quantity Variance (20 X $2.50) ........................... Raw Materials Inventory (1,900 X $2.50) ....................
4,700 50
5,035
4,750
*235 X 8 Factory Labor (700 X $12) ................................................... Labor Price Variance (700 X $0.20) ............................. Factory Wages Payable (700 X $11.80) ......................
8,400
Work in Process Inventory (705* X $12) ............................ Labor Quantity Variance (5 X $12) .............................. Factory Labor (700 X $12) ...........................................
8,460
140 8,260 60 8,400
*235 X 3
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23-23
*EXERCISE 23-21 (a) Item Variable overhead ................................... Fixed overhead ....................................... Total overhead ........................................ (b) Total overhead variance: Actual Overhead – Overhead Applied $55,000 – $52,800 (16,000* X $3.30)
Amount $34,650 19,800 $54,450
Hours 16,500 16,500 16,500
Rate $2.10 1.20 $3.30
= $2,200 U
*4,000 X 4 hrs. = 16,000 hrs. Overhead controllable variance: Actual Overhead – Overhead Budgeted $55,000 – $53,400 = $1,600 U [(16,000 X $2.10) + $19,800] Overhead volume variance: Fixed Overhead Normal Capacity Standard Hours Rate X Hours – Allowed $1.20 X [(16,500 – (4,000 X 4)] = $600 U (c) The overhead controllable variance is generally associated with variable overhead costs. Thus, this variance indicates the production manager’s inefficiency in controlling variable overhead costs. The overhead volume variance relates to fixed overhead costs. This variance indicates whether plant facilities were efficiently used. In this case 500 (16,500 – 16,000) hours of plant capacity were not utilized.
23-24
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Kimmel, Accounting, 5e, Solutions Manual
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*EXERCISE 23-22 (a) 1. Total actual overhead cost
Overhead Budgeted
=
+
= ($18,000 + $12,600) +
Overhead Controllable Variance $1,200
= $31,800 2.
Actual variable overhead cost = Actual Overhead – Fixed Overhead –
= $31,800
$12,600
= $19,200 3.
Variable overhead cost applied = 2,000 hours X $9 = $18,000
4.
Fixed overhead cost applied
= 2,000 hours X $6 = $12,000
5.
Overhead volume variance
=
Normal Standard Overhead X Capacity – Hours Hours Rate Allowed Fixed
=
$6
X
(2,100* –
2,000)
= $600 U *$12,600 ÷ $6 per hour = 2,100 hours (b)
Number of loans processed
= Standard hours allowed ÷ Standard hours per application = 2,000 ÷ 2 = 1,000 loans processed
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23-25
EXERCISE 23-23 (a) (Actual) – (Applied) = Total Overhead Variance ($19,000) – (1,800 X $10*) = $1,000 U (Actual) – ($19,000) – Fixed OH Rate $3**
(Budgeted) ($17,600)
X
*$200,000/20,000
Normal Capacity (1,667***
= Overhead Controllable Variance = $1,400 U
– –
Standard Hours Overhead Volume Allowed = Variance 1,800) = $400 F
**($5,000 X 12)/20,000
***20,000/12
(b) The cause of an unfavorable controllable variance could be higher than expected use of indirect materials, indirect labor, and factory supplies, or increases in indirect manufacturing costs, such as fuel and maintenance costs. A favorable volume variance would be caused by production of more units than what is considered normal capacity.
23-26
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Kimmel, Accounting, 5e, Solutions Manual
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SOLUTIONS TO PROBLEMS PROBLEM 23-1A
(a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (5,100 X $7.20) (4,900 X $7.00) $36,720 – $34,300 = $2,420 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (5,100 X $7.20) (5,100 X $7.00) $36,720 – $35,700 = $1,020 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (5,100 X $7.00) (4,900 X $7.00) $35,700 – $34,300 = $1,400 U Total labor variance: ( AH X AR ) – ( SH X SR ) (7,500 X $12.50) (7,840* X $12.00) $93,750 – $94,080 = $330 F *4,900 X 1.6 Labor price variance: ( AH X AR ) – ( AH X SR ) (7,500 X $12.50) (7,500 X $12.00) $93,750 – $90,000 = $3,750 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (7,500 X $12.00) (7,840 X $12.00) $90,000 – $94,080 = $4,080 F (b) Total overhead variance: Actual Overhead Overhead – Applied ($59,700 + $21,000) – (7,840 X $10.00) $80,700 $78,400 = $2,300 U
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23-27
PROBLEM 23-2A
(a) 1. Total materials variance: ( AQ X AP ) – ( SQ X SP ) (10,600 X $2.25) (10,000 X $2.10) $23,850 – $21,000 = $2,850 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (10,600 X $2.25) (10,600 X $2.10) $23,850 – $22,260 = $1,590 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (10,600 X $2.10) (10,000 X $2.10) $22,260 – $21,000 = $1,260 U 2. Total labor variance: ( AH X AR ) – ( SH X SR ) (14,400 X $8.40*) (15,000 X $8.00**) $120,960 – $120,000 = $960 U *$120,960 ÷ 14,400
**$120,000 ÷ 15,000
Labor price variance: ( AH X AR ) – ( AH X SR ) (14,400 X $8.40) (14,400 X $8.00) $120,960 – $115,200 = $5,760 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (14,400 X $8.00) (15,000 X $8.00) $115,200 – $120,000 = $4,800 F (b)
Total overhead variance: Actual Overhead Overhead – Applied $189,500 – $193,500 = $4,000 F (45,000* X $4.30) *15,000 X 3
23-28
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PROBLEM 23-2A (Continued) (c)
AYALA CORPORATION Income Statement For the Month Ended June 30, 2014 Sales revenue .................................................... Cost of goods sold (at standard) ...................... Gross profit (at standard).................................. Variances Materials price ............................................ Materials quantity....................................... Labor price ................................................. Labor quantity ............................................ Overhead .................................................... Total variance—favorable .................. Gross profit (actual) .......................................... Selling and administrative expenses ............... Net income .........................................................
$400,000 334,500* 65,500 $ 1,590 U 1,260 U 5,760 U 4,800 F 4,000 F 190 65,690 40,000 $ 25,690
*Materials $21,000 + labor $120,000 + overhead applied $193,500.
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23-29
PROBLEM 23-3A
(a) 1.
Total materials variance: ( AQ X AP ) – ( SQ X SP ) (90,500 X $4.15) (89,600* X $4.40) $375,575 – $394,240 = $18,665 F *11,200 X 8 Materials price variance: ( AQ X AP ) – ( AQ X SP ) (90,500 X $4.15) (90,500 X $4.40) $375,575 – $398,200 = $22,625 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (90,500 X $4.40) (89,600 X $4.40) $398,200 – $394,240 = $3,960 U
2.
Total labor variance: ( AH X AR ) – ( SH X SR ) (14,200 X $14.10) (13,440* X $13.40) $200,220 – $180,096 = $20,124 U *11,200 X 1.2 Labor price variance: ( AH X AR ) – ( AH X SR ) (14,200 X $14.10) (14,200 X $13.40) $200,220 – $190,280 = $9,940 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (14,200 X $13.40) (13,440 X $13.40) $190,280 – $180,096 = $10,184 U
(b)
Total overhead variance: Actual Overhead Overhead – Applied $86,000 – $81,984 ($49,000 + $37,000) (13,440* X $6.10**) = $4,016 U *11,200 X 1.2
23-30
.
**$3.50 + $2.60
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PROBLEM 23-3A (Continued) (c) The materials price variance is more than 4% from standard. The actual price for materials of $4.15 is $.25 below the standard price of $4.40 or 5.7% ($.25 ÷ $4.40). The same result can be obtained by dividing the total price variance by the total standard price for the quantities purchased ($22,625 ÷ $398,200). The labor price variance is 5.2% from standard ($.70 ÷ $13.40). The same result can be obtained by dividing the total price variance by the total standard price for the direct labor hours used ($9,940 ÷ $190,280). The labor quantity variance is 5.7% (760 ÷ 13,440) from standard. The same result can be obtained by dividing the total quantity variance by the total standard price for the standard hours allowed ($10,184 ÷ $180,096).
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23-31
PROBLEM 23-4A
(a) $3,510 ÷ 117,000 = $.03; $.92 + $.03 = $.95 standard materials price per pound. OR 117,000 X $.92 = $107,640; $107,640 + $3,510 = $111,150; $111,150 ÷ 117,000 = $.95 per pound. (b) $4,750 ÷ $.95 = 5,000 pounds; 117,000 – 5,000 = 112,000 standard quantity for 28,000 units or 4.0 pounds (112,000 ÷ 28,000) per unit. OR $111,150 – $4,750 = $106,400; $106,400 ÷ $.95 = 112,000; 112,000 ÷ 28,000 = 4.0 pounds per unit. (c) Standard hours allowed are 44,800 (28,000 X 1.6). (d) $7,200 ÷ $12.00 = 600 hours over standard; 44,800 standard hours + 600 hours = 45,400 actual hours worked. OR 44,800 X $12 = $537,600; $537,600 + $7,200 = $544,800; $544,800 ÷ $12 = 45,400 actual hours worked. (e) $9,080 ÷ 45,400 = $.20; $12.00 – $.20 = $11.80 actual rate per hour. OR $544,800 – $9,080 = $535,720; $535,720 ÷ 45,400 = $11.80 actual rate per hour. (f)
$360,000 ÷ 50,000 = $7.20 predetermined overhead rate per direct labor hour.
(g) Direct materials 4.0 pounds X $.95 = $3.80; direct labor 1.6 X $12.00 = $19.20; manufacturing overhead 1.6 X $7.20 = $11.52. $3.80 + $19.20 + $11.52 = $34.52 standard cost per unit. (h) 44,800 X $7.20 = $322,560 overhead applied. (i)
23-32
$34.52 [see (g) above] X 28,000 = $966,560 or direct materials $106,400 + direct labor $537,600 + overhead applied $322,560 = $966,560.
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 23-5A
(a) Materials price variance: ( AQ X AP ) – ( AQ X SP ) (3,050 X $1.38*) (3,050 X $1.46) $4,209 – $4,453
= $244 F
*$4,209 ÷ 3,050 Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (3,050 X $1.46) (3,000* X $1.46) $4,453 – $4,380 *1,500 X 2 Labor price variance: ( AH X AR) – ( AH X SR) (1,600 X $23*) (1,600 X $24) $36,800 – $38,400 *$36,800 ÷ 1,600 Labor quantity variance: ( AH X SR) – (SH X SR ) (1,600 X $24) (1,500* X $24) $38,400 – $36,000
= $73 U
= $1,600 F
= $2,400 U
*1,500 X 1 hr. (b) Total Overhead variance: Actual Overhead Overhead – Applied $22,400 – $24,000 ($7,400 + $15,000) (1,500 X $16*)
= $1,600 F
*$10 + $6
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23-33
PROBLEM 23-5A (Continued) (c) PACE LABS, INC. Income Statement For the Month Ended November 30, 2014 Service revenue ..................................................... Cost of service provided (at standard) (1,500 X $42.92) .................................................. Gross profit (at standard) ...................................... Variances Materials price ................................................ Materials quantity ........................................... Labor price...................................................... Labor quantity ................................................ Overhead......................................................... Total variance—favorable ...................... Gross profit (actual)............................................... Selling and administrative expenses ................... Net income .............................................................
$75,000 64,380 10,620 $ 244 F 73 U 1,600 F 2,400 U 1,600 F 971 11,591 5,000 $ 6,591
(d) The unfavorable materials quantity variance could be caused by poor quality materials or inexperienced workers or faulty test procedures. The unfavorable labor quantity variance could be caused by inexperienced workers, poor quality materials, or faulty test procedures.
23-34
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Kimmel, Accounting, 5e, Solutions Manual
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*PROBLEM 23-6A
(a) 1.
2.
Raw Materials Inventory (6,200 X $1.00)............ Materials Price Variance [6,200 X ($1.05 – $1.00)] .................................. Accounts Payable (6,200 X $1.05) ..............
6,200
Work in Process Inventory (5,700* X $1) ........... Materials Quantity Variance [(6,200 – 5,700) X $1.00] .................................. Raw Materials Inventory .............................
5,700
310 6,510
500 6,200
*1,900 X 3 3.
4.
5. 6.
Factory Labor (2,000 X $8) ................................. Labor Price Variance [2,000 X ($8.00 – $7.80)] .......................... Factory Wages Payable (2,000 X $7.80) ..... Work in Process Inventory (1,900 X $8.00) ................................................. Labor Quantity Variance [(2,000 – 1,900) X $8.00] .................................. Factory Labor .............................................. Manufacturing Overhead .................................... Accounts Payable ....................................... Work in Process Inventory (3,800* X $6.25**) ............................................. Manufacturing Overhead ............................ *1,900 X 2
7.
8.
.
16,000 400 15,600 15,200 800 16,000 25,000 25,000 23,750 23,750
**$4.00 + $2.25
Finished Goods Inventory (1,900 X $23.50) ............................................... Work in Process Inventory .........................
44,650 44,650
Accounts Receivable .......................................... Sales Revenue .............................................
65,000
Cost of Goods Sold ............................................ Finished Goods Inventory ..........................
44,650
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65,000 44,650
23-35
*PROBLEM 23-6A (Continued) (b)
Raw Materials Inventory (1) 6,200 (2) 6,200
Materials Price Variance (1) 310
Work in Process Inventory (2) 5,700 (7) 44,650 (4) 15,200 (6) 23,750
Factory Labor 16,000 (4) 16,000
Materials Quantity Variance (2) 500
Finished Goods Inventory (7) 44,650 (8) 44,650
Manufacturing Overhead (5) 25,000 (6) 23,750
Labor Price Variance (3) 400
(3)
(8)
Cost of Goods Sold 44,650
Labor Quantity Variance (4) 800
(c) Overhead Variance ($25,000 – $23,750)................ Manufacturing Overhead ............................... (d)
1,250
JORGENSEN CORPORATION Income Statement For the Month Ended January 31, 2014 Sales revenue......................................................... Cost of goods sold (at standard) (1,900 X $23.50) .................................................. Gross profit (at standard) ...................................... Variances Materials price ................................................ Materials quantity ........................................... Labor price...................................................... Labor quantity ................................................ Overhead......................................................... Total variance—unfavorable .................. Gross profit (actual)............................................... Selling and administrative expenses ................... Net income .............................................................
23-36
1,250
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$65,000 44,650 20,350 $ 310 U 500 U 400 F 800 U 1,250 U 2,460 17,890 2,000 $15,890
*PROBLEM 23-7A
Overhead controllable variance: Actual Overhead Overhead – Budgeted $80,700 – $78,800 = $1,900 U [(7,840* X $7.50) + $20,000] *(4,900 X 1.6 hours) Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $2.50/hr. X (8,000 – 7,840)
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= $400 U
23-37
*PROBLEM 23-8A
Overhead controllable variance: Actual Overhead Overhead – Budgeted $189,500 – $190,250 [(45,000* X $3.00) + (42,500 X $1.30)]
= $750 F
*(15,000 X 3 hours) Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $1.30/hr. X (42,500 – 45,000) = $3,250 F
23-38
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
*PROBLEM 23-9A
Overhead controllable variance: Actual Overhead Overhead – Budgeted $86,000 – $83,944 = $2,056 U ($49,000 + $37,000) [(13,440* X $2.60) + $49,000] *(11,200 X 1.2 hours) Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $3.50/hr. X (14,000 – 13,440)
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
= $1,960 U
23-39
*PROBLEM 23-10A
Overhead controllable variance: Actual Overhead Overhead – Budgeted $22,400 – $23,000 = $600 F ($7,400 + $15,000) [(1,500 X $6) + $14,000] Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $10 X (1,400* – 1,500) = $1,000 F *$14,000 ÷ $10
23-40
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 23-1B
(a) Total materials variance: ( AQ X AP ) – ( SQ X SP ) (20,000 X $5.95) (19,400* X $6.00) $119,000 – $116,400 = $2,600 U *9,700 X 2 Materials price variance: ( AQ X AP ) – ( AQ X SP ) (20,000 X $5.95) (20,000 X $6.00) $119,000 – $120,000 = $1,000 F Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (20,000 X $6.00) (19,400 X $6.00) $120,000 – $116,400 = $3,600 U Total labor variance: ( AH X AR ) – ( SH X SR ) (19,600 X $13.10) (19,400* X $13.00) $256,760 – $252,200 = $4,560 U *9,700 X 2 Labor price variance: ( AH X AR ) – ( AH X SR ) (19,600 X $13.10) (19,600 X $13.00) $256,760 – $254,800 = $1,960 U Labor quantity variance: ( AH X SR ) – ( SH X SR ) (19,600 X $13.00) (19,400 X $13.00) $254,800 – $252,200 = $2,600 U (b) Total overhead variance: Actual Overhead Overhead – Applied ($68,800 + $50,000) – (19,400 X $6.00*) $118,800 $116,400 = $2,400 U *Standard per labor hour overhead cost ($3.50 variable + $2.50 fixed).
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
23-41
PROBLEM 23-2B
(a) 1.
Total materials variance: ( AQ X AP ) – ( SQ X SP ) (21,000 X $3.70) (22,000 X $3.50) $77,700 – $77,000 = $700 U Materials price variance: ( AQ X AP ) – ( AQ X SP ) (21,000 X $3.70) (21,000 X $3.50) $77,700 – $73,500 = $4,200 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (21,000 X $3.50) (22,000 X $3.50) $73,500 – $77,000 = $3,500 F
2.
Total labor variance: ( AH X AR ) – ( SH X SR ) (3,450 X $11.50) (3,600 X $12.00) $39,675 – $43,200 = $3,525 F Labor price variance: ( AH X AR ) – ( AH X SR ) (3,450 X $11.50) (3,450 X $12.00) $39,675 – $41,400 = $1,725 F Labor quantity variance: ( AH X SR ) – ( SH X SR ) (3,450 X $12.00) (3,600 X $12.00) $41,400 – $43,200 = $1,800 F
(b) Total overhead variance: Actual Overhead Overhead – Applied $94,800 – $100,800 = $6,000 F (3,600 X $28*) *($16 + $12)
23-42
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 23-2B (Continued) (c)
HUANG COMPANY Income Statement For the Month Ended July 31, 2014 Sales revenue .................................................... Cost of goods sold (at standard) ...................... Gross profit (at standard).................................. Variances Materials price ............................................ Materials quantity....................................... Labor price ................................................. Labor quantity ............................................ Total overhead ........................................... Total variance—favorable .................. Gross profit (actual) .......................................... Selling and administrative expenses ............... Net income .........................................................
$270,000 221,0001 49,000 $ 4,200 U 3,500 F 1,725 F 1,800 F 6,000 F 8,825 57,825 20,000 $ 37,825
1
Materials $77,000 (22,000 X $3.50) + Direct labor $43,200 (3,600 X $12.00) + Overhead applied $100,800.
1
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 23-3B (a) 1.
Total materials variance: ( AQ X AP ) – ( SQ X SP ) (76,000 X $7.20) (78,500* X $6.75) $547,200 – $529,875 = $17,325 U *15,700 X 5 Materials price variance: ( AQ X AP ) – ( AQ X SP ) (76,000 X $7.20) (76,000 X $6.75) $547,200 – $513,000 = $34,200 U Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (76,000 X $6.75) (78,500 X $6.75) $513,000 – $529,875 = $16,875 F
2.
Total labor variance ( AH X AR ) – ( SH X SR ) (14,800 X $11.20) (15,700 X $11.45) $165,760 – $179,765 = $14,005 F Labor price variance: ( AH X AR ) – ( AH X SR ) (14,800 X $11.20) (14,800 X $11.45) $165,760 – $169,460 = $3,700 F Labor quantity variance: ( AH X SR ) – ( SH X SR ) (14,800 X $11.45) (15,700 X $11.45) $169,460 – $179,765 = $10,305 F
(b) Total overhead variance: Actual Overhead – $169,000 – ($120,000 + $49,000)
Overhead Applied $147,580 = $21,420 U (15,700 X $9.40*)
*$6.25 + $3.15 23-44
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 23-3B (Continued) (c) The following variances are more than 5% from standard: Materials price variance. The actual price of $7.20 is 6.7% higher than the standard price of $6.75. The same result can be obtained by dividing the total variance by the total standard. For the materials price variance, the computation would be $34,200 ÷ $513,000 = 6.7%. Labor quantity variance. The actual hours of 14,800 is 5.7% under the standard hours of 15,700. The same result can be obtained by dividing the total variance by the total standard. For example, for the labor quantity variance, the computation would be $10,305 ÷ $179,765 = 5.7%. The unfavorable materials price variance was caused by paying more than the standard cost for the materials purchased. This unfavorable variance may have been caused by price increases or the purchase of better quality materials. Since the labor quantity variance is favorable, the latter explanation is reasonable. Better quality materials may have required fewer hours of labor to construct the suits.
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
23-45
PROBLEM 23-4B
(a) $10,000 ÷ 200,000 = $.05; $1.00 – $.05 = $.95 standard materials price per pound. OR 200,000 X $1.00 = $200,000; $200,000 – $10,000 = $190,000; $190,000 ÷ 200,000 = $.95. (b) $23,750 ÷ $.95 = 25,000 pounds; 200,000 + 25,000 = 225,000 standard quantity for 45,000 units or 5.0 pounds (225,000 ÷ 45,000) per unit. OR $190,000 + $23,750 = $213,750; $213,750 ÷ $.95 = 225,000; 225,000 ÷ 45,000 = 5.0 pounds per unit. (c) Standard hours allowed are 90,000 (45,000 X 2). (d) $10,080 ÷ $12 = 840 hours over standard; 90,000 standard hours + 840 hours = 90,840 actual hours worked. OR 90,000 X $12 = $1,080,000; $1,080,000 + $10,080 = $1,090,080; $1,090,080 ÷ $12 = 90,840 actual hours worked. (e) $18,168 ÷ 90,840 = $.20; $12.00 – $.20 = $11.80 actual rate per hour. (f)
$713,800 ÷ 86,000 = $8.30 predetermined overhead rate per direct labor hour.
(g) Direct materials 5.0 pounds X $.95 = $4.75; direct labor 2 X $12.00 = $24.00; manufacturing overhead 2 X $8.30 = $16.60. $4.75 + $24.00 + $16.60 = $45.35 standard cost per unit. (h) 90,000 X $8.30 = $747,000 overhead applied. (i)
23-46
$45.35 [see (g) above] X 45,000 = $2,040,750 or direct materials $213,750 + direct labor $1,080,000 + overhead applied $747,000 = $2,040,750.
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 23-5B
(a) Materials price variance: ( AQ X AP ) – ( AQ X SP ) (2,530 X $2.00*) (2,530 X $1.80) $5,060 – $4,554
= $506 U
*$5,060 ÷ 2,530 Materials quantity variance: ( AQ X SP ) – ( SQ X SP ) (2,530 X $1.80) (2,500 X $1.80) $4,554 – $4,500
= $54 U
Labor price variance: (AH X AR) – (AH X SR) (1,240 X $21*) (1,240 X $20.50) $26,040 – $25,420
= $620 U
*$26,040 ÷ 1,240 Labor quantity variance: (AH X SR) – ( SH X SR ) (1,240 X $20.50) (1,250* X $20.50) $25,420 – $25,625 *2,500 X .5 (b) Total overhead variance: Actual Overhead – Overhead Applied $15,800 – $16,250 [($10,100 + $5,700) – (1,250 X $13*)
= $205 F
= $450 F
*($8 + $5)
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PROBLEM 23-5B (Continued) (c) BONITA LABS Income Statement For the Month Ended May 31, 2014 Service revenue ..................................................... Cost of service provided (at standard) ($18.55 X 2,500) .................................................. Gross profit (at standard) ...................................... Variances Materials price ................................................ Materials quantity ........................................... Labor price...................................................... Labor quantity ................................................ Overhead......................................................... Total variance—unfavorable.................. Gross profit (at actual) .......................................... Selling and administrative expenses ................... Net income .............................................................
$55,000 46,375 8,625 $ 506 U 54 U 620 U 205 F 450 F 525 8,100 2,000 $ 6,100
(d) The unfavorable materials price variance could be caused by using the wrong shipping method or rising prices. The unfavorable materials quantity variance could be caused by inexperienced workers, carelessness, poor quality material, or faulty test procedures. The unfavorable labor price variance could be caused by rising labor costs, or assigning the wrong workers to perform the tests.
23-48
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
*PROBLEM 23-6B (a) 1.
2.
3.
4.
5. 6.
7.
8.
.
Raw Materials Inventory (8,100 X $4.00)......... Materials Price Variance [8,100 X ($3.70 – $4.00)] ....................... Accounts Payable (8,100 X $3.70) ........... Work in Process Inventory (8,250* X $4.00) ............................................. Materials Quantity Variance [(8,100 – 8,250) X $4.00] ....................... Raw Materials Inventory .......................... *5,500 X 1.5 Factory Labor (5,200 X $9.00) ......................... Labor Price Variance [5,200 X ($9.20 – $9.00)] ............................... Factory Wages Payable (5,200 X $9.20) ....................................... Work in Process Inventory (5,500 X $9.00) .............................................. Labor Quantity Variance [(5,500 – 5,200) X $9.00] ....................... Factory Labor ........................................... Manufacturing Overhead ................................. Accounts Payable ....................................
32,400 2,430 29,970 33,000 600 32,400 46,800 1,040 47,840 49,500 2,700 46,800 87,500 87,500
Work in Process Inventory (5,500 X $15.40) ............................................ Manufacturing Overhead .........................
84,700
Finished Goods Inventory (5,500 X $30.40) ............................................ Work in Process Inventory ......................
167,200
84,700
167,200
Accounts Receivable ....................................... Sales Revenue ..........................................
270,000
Cost of Goods Sold ......................................... Finished Goods Inventory .......................
167,200
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
270,000 167,200
23-49
*PROBLEM 23-6B (Continued) (b)
Raw Materials Inventory (1) 32,400 (2) 32,400
Materials Price Variance (1) 2,430
Work in Process Inventory (2) 33,000 (7) 167,200 (4) 49,500 (6) 84,700
Factory Labor 46,800 (4) 46,800
Materials Quantity Variance (2) 600
Finished Goods Inventory (7) 167,200 (8) 167,200
(3)
Manufacturing Overhead (5) 87,500 (6) 84,700
(3)
Labor Price Variance 1,040
(8)
Cost of Goods Sold 167,200
Labor Quantity Variance (4) 2,700
(c) Overhead Variance (1) ................................................... Manufacturing Overhead .......................................
2,800 2,800
(1) [$87,500 – (5,500 X $15.40)]
(d)
FRIO MANUFACTURING COMPANY Income Statement For the Month Ended January 31, 2014 Sales revenue......................................................... Cost of goods sold (at standard) (5,500 X $30.40) .................................................. Gross profit (at standard) ...................................... Variances Materials price ................................................ Materials quantity ........................................... Labor price...................................................... Labor quantity ................................................ Overhead......................................................... Total variance—favorable ...................... Gross profit (actual)............................................... Selling and administrative expenses ................... Net income .............................................................
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Kimmel, Accounting, 5e, Solutions Manual
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$270,000 167,200 102,800 $2,430 F (600 F (1,040 U 2,700 F 2,800 U 1,890 104,690 60,000 $ 44,690
*PROBLEM 23-7B
Overhead controllable variance: Actual Overhead Overhead – Budgeted ($68,800 + $50,000) – [($50,000 + (19,400* X $3.50)] $118,800 $117,900 = $900 U Overhead volume variance: Normal Standard Fixed Overhead X Capacity – Hours Rate Hours Allowed 2.50/hr. X (20,000 – 19,400*)
= $1,500 U
*9,700 X 2
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23-51
*PROBLEM 23-8B
Overhead controllable variance: Actual Overhead Overhead – Budgeted $94,800 – $98,400 = $3,600 F [(3,600 X $16) + $40,800*] *3,400 X $12 Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $12/hr. X (3,400 – 3,600)
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Kimmel, Accounting, 5e, Solutions Manual
= $2,400 F
(For Instructor Use Only)
*PROBLEM 23-9B
Overhead controllable variance: Actual Overhead Overhead – Budgeted $169,000 – $174,455 = $5,455 F ($120,000 + $49,000) [(15,700 X $3.15) + $125,000] Overhead volume variance: Normal Standard Fixed Overhead X Capacity – Hours Rate Hours Allowed $6.25/hr. X (20,000 – 15,700) = $26,875 U
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
23-53
*PROBLEM 23-10B
Overhead controllable variance: Actual Overhead – Overhead Budgeted $15,800 – $16,000 [($10,100 + $5,700) – [(1,250* X $8) + $6,000] = $200 F Overhead volume variance: Fixed Normal Standard Overhead X Capacity – Hours Rate Hours Allowed $5.00 X (1,200** – 1,250*) = $250 F *2,500 X .5
23-54
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**$6,000 ÷ $5.00/hour
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
BYP 23-1
DECISION-MAKING AT CURRENT DESIGNS
(a) Quantity variance for polyethylene powder Price variance for polyethylene powder Quantity variance for finishing kits Price variance for finishing kits Quantity variance for type I workers Price variance for type I workers Quantity variance for type II workers Price variance for type II workers
Unfavorable Unfavorable NEI = Not enough information Favorable Favorable NEI = Not enough information Unfavorable NEI = Not enough information
(b) Quantity variance for polyethylene powder ( AQ X SP ) – ( SQ X SP ) (1,200 X $1.50) (1,080* X $1.50) $1,800 – $1,620 = $180 U *54 X 20 Price variance for polyethylene powder ( AQ X AP ) – ( AQ X SP ) (1,200 X $1.70*) (1,200 X $1.50) $2,040 – $1,800
= $240 U
*$2,040 ÷ 1,200 Quantity variance for finishing kits ( AQ X SP ) – ( SQ X SP ) (20 X $170) (20 X $170) $3,400 – $3,400
=$ 0
Price variance for finishing kits ( AQ X AP ) – ( AQ X SP ) (20 X $162*) (20 X $170) $3,240 – $3,400
= $160 F
*$3,240 ÷ 20
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 23-1 (Continued) Quantity variance for type I workers ( AH X SR ) – ( SH X SR ) (38 X $15) (40* X $15) $570 – $600
= $30 F
*20 X 2 Price variance for type I workers ( AH X AR ) – ( AH X SR ) (38 X $15*) (38 X $15) $570 – $570
=$ 0
*$570 ÷ 38 Quantity variance for type II workers ( AH X SR ) – ( SH X SR ) (65 X $12) (60* X $12) $780 – $720
= $60 U
*20 X 3 Price variance for type II workers ( AH X AR ) – ( AH X SR ) (65 X $12.25*) (65 X $12.00) $796.25 – $780
= $16.25 U
*$796.25 ÷ 65
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
BYP 23-2
DECISION-MAKING ACROSS THE ORGANIZATION
(a) When setting a standard for computer/labor hours usage, Milton Professionals should consider the following factors: 1.
A standard set conservatively high may discourage clients from purchasing the model.
2.
A standard set too low may encourage sales of the model, but if customers use more hours than the standard suggests, they may be upset at having been misled.
3.
Clients are likely to use the standard as an evaluation tool for their own employees operating the model. Standards set inappropriately may adversely affect productivity and/or morale of client employees.
(b) Logical alternatives for the standard include: 1.
34 hours:
The average number of hours used for one application by all five financial institutions.
2.
45 hours:
The conservatively high number experienced by one financial institution.
3.
25 hours:
The optimistic low number experienced by one financial institution.
4.
30 hours:
The number of hours required most frequently in the sample of five institutions.
(c) In light of earlier factors listed, the second and third choices for the standard should be eliminated (i.e., 45 and 25 hours). The average 34 hours is probably the most representative. However, Milton Professionals may select 30 hours, given that the company has a high incentive to sell the new model. Consequently, it may make the most sense to pick the lower of the two remaining choices (30 hours).
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23-57
BYP 23-2 (Continued) (d) Standard material cost for one model application:
23-58
User Manuals:
$320 ÷ 20 manuals = $16/application.
Computer Forms:
$60 ÷ 250 forms = $.24/form $.24/form X 50 forms = $12/application.
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
BYP 23-3
MANAGERIAL ANALYSIS
(a) The overhead application rate is $144,000 divided by 5,000 hours, or $28.80 per direct labor hour. (b) The standard direct labor hours are used to apply overhead to production, so the calculation is $28.80 X 4,500, or $129,600. (c)
Actual Overhead – Overhead Applied = Total Overhead Variance $150,000 $129,600 = $20,400 U The overhead budgeted for 4,500 direct labor hours is computed below. Fixed:
$22,500 + $13,000 + $27,000 + $8,000 + $3,000 + $1,500 + $500 + $300 = $75,800
Variable: ($12,000 + $43,000 + $10,000 + $2,500 + $700) ÷ 5,000 = $13.64 Fixed Variable (4,500 X $13.64)
$ 75,800 61,380 $137,180
The variances are: Controllable: Actual ($150,000) – Budgeted ($137,180) = $12,820 U Volume: $15.16*/hr. X (5,000 – 4,500) = $7,580 U *$75,800 ÷ 5,000 hrs. (d) Both variances appear significant. The controllable variance is 9.3% of budgeted overhead ($12,820 ÷ $137,180), and the volume variance is 5.8% of applied overhead ($7,580 ÷ $129,600). (e) The controllable variance is caused by either spending more than expected on overhead items, or using more than expected of overhead items (for example, more indirect labor hours). The volume variance is caused by underutilizing factory time. To improve performance, management must spend less on overhead items, use them more efficiently, and increase production to 1,000 units.
.
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23-59
BYP 23-4
REAL-WORLD FOCUS
(a) Glassmaster is using standard costs because management states that a factor that contributed to improved margins (profit) was a favorable materials price variance. (b) The materials price variance experienced should not lead to changes in the standard for the next fiscal year. Management indicates that the favorable variance is temporary and will begin to reverse itself as stronger worldwide demand for commodity products improves in tandem with the economy.
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 23-5
REAL-WORLD FOCUS
(a) The objectives for each perspective are: Financial: Increase profitability, lower costs, increase revenue Customer: Flight is on-time, lowest prices, more customers Internal: Improve turnaround time. Learning: Ground crew alignment. (b) To measure achievement of the customer perspective objectives of ontime flights, lowest prices and more customers, the company will use FAA on time arrival ratings, customer ranking, and number of customers. (c) To achieve the learning perspective objective of ground crew alignment, the company plans to implement an employee stock ownership plan and ground crew training.
.
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23-61
BYP 23-6
REAL-WORLD FOCUS
(a) The normal industry standard for plants to be considered operating at 100% capacity is two shifts working about 250 days a year. (b) A government task force urged the company to try to operate at 120% capacity by traditional standards. (c) It is argued that assembly lines need too much scheduled maintenance and restocking. This is normally done during the period that the company is proposing to run a third shift. For example, the paint shop typically requires 4 hours of cleaning per day. To address these issues, the company is considering “overspeeding” some parts of the line so it can be slowed down later. (d) Potential drawbacks of the midnight shift are that midnight-shift workers are prone to above-average rates of on-the-job errors, absenteeism and illness. All of these issues could cause the night shift to deviate materially from standards for materials, labor and overhead. (e) Another potential problem with this approach is that each plant can only make a limited number of car models. Adding a third shift at the Kansas City plant assumes that the market demand for these cars will be sufficient to absorb the additional cars produced. If not, the company will have to discount the selling price and lay off employees.
23-62
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 23-7
COMMUNICATION ACTIVITY
To:
Professor Standard
From:
I. M. Smart
Subject:
Setting Standard Costs
This memorandum covers two points as follows: (a) The comparative advantages and disadvantages of ideal versus normal standards. Ideal standards represent optimum levels of performance under perfect operating conditions. In contrast, normal standards represent efficient levels of performance that are attainable under expected operating conditions. An advantage of ideal standards is that they stimulate the conscientious worker to ever-increasing improvement. The disadvantage of ideal standards is that because they are so difficult to meet, they lower the morale of the entire work force. Normal standards are rigorous but attainable. Such standards should stimulate the worker to self-improvement without discouraging him or her or lowering the morale of the work force. (b) Factors to be considered in setting standards for direct materials, direct labor, and manufacturing overhead. 1.
.
Direct materials. The direct materials price standard is the cost per unit of direct materials that should be incurred. This standard should be based on the purchasing department’s best estimate of the cost of raw materials. The price standard should include allowances for related costs such as receiving, storing and handling.
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BYP 23-7 (Continued) The direct materials quantity standard is the quantity of direct materials that should be used per unit of finished goods. This standard is a physical measure and it should include allowances for unavoidable waste and normal spoilage. 2.
Direct labor. The direct labor price standard is the rate per hour that should be incurred for direct labor. This standard should be based on current wage rates adjusted for expected cost of living adjustments and employer payroll taxes and fringe benefits. The direct labor quantity standard is the time that should be required to make one unit of product. In setting this standard, allowances should be made for rest periods, cleanup, and machine setup and downtime.
3.
23-64
Manufacturing overhead. For this standard, a standard predetermined overhead rate is used. This rate is determined by dividing budgeted overhead costs by an expected standard activity index. The budgeted overhead costs should be based on a realistic estimate of overhead costs at normal capacity.
.
Kimmel, Accounting, 5e, Solutions Manual
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BYP 23-8
ETHICS CASE
(a) Bill and his fellow painters in the painting department will benefit from Bill’s slow action. The company and its customers are harmed. The company will incur higher costs on the product and therefore will have to set a higher selling price or suffer a smaller gross profit. Customers will have to pay a greater price for the product or stockholders will obtain less benefit from their investment. (b) Deliberately falsifying and distorting the time study was unethical. If every employee in every phase of producing this new product distorted the time study, the company would not be competitive. If the company is not competitive and profitable, it will eventually go out of business and Bill will be out of a job. It is in Bill’s best interest to support the development of reasonable standards and improved efficiency. (c) The company might conduct several time study tests using different employees. Or the company might conduct unannounced time studies. And the standard might be changed more often than every six months by conducting monthly time studies to effect continuous improvements in efficiency. Incentives might be offered to employees who produce the most efficient effort in the time studies, thereby discouraging distorted, inefficient performance.
.
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BYP 23-9
ALL ABOUT YOU
(a) The panel made recommendations regarding a number of areas of concern in higher education. For example, it suggested that new approaches should be used to control costs, and it stated that the cost of tuition should grow no faster than median family income. It made recommendations to strengthen the Pell Grant program, which is the core of the federal financial aid program. It also recommended that public universities should use standardized tests to measure student learning. (b) As discussed in the chapter, standards provide a mechanism for evaluating performance and, if used properly, can be used as a motivational tool. The results of standardized tests might help to evaluate the effectiveness of various approaches to education. They might also be used to “weed out” schools that are not meeting minimum expectations. (c) Potential disadvantages of standards are that they might reduce the willingness of instructors or institutions to experiment with new teaching approaches. In addition, in order to obtain high scores, instructors might feel compelled to “teach to the exam,” thus narrowing the breadth of exposure obtained by the student. Also, by their very nature, standardized tests have a difficult time addressing differences across various instructional settings that can cause differences in results. (d) Answers will vary depending on student response.
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 23-10
CONSIDERING YOUR COSTS AND BENEFITS
Discussion Guide: The practice of medicine holds an unusual place in society. On the one hand, it provides a critical, life-sustaining service. We expect and demand the highest-quality service. We measure its success in terms of health improvement and lives saved. On the other hand, it is a business, and like other businesses, it must operate profitably. Some healthcare providers characterize this delicate balance as “The Business of Caring.” How should we balance providing quality health-care and reducing costs? In recent years, managerial accounting has played an important, although not always successful, role in this issue. In the 1990s, health-care providers made extensive use of managerial accounting techniques to reduce costs. By the end of that decade, a number of important studies suggested that the quality of health care had suffered as a result of concentrating too much on cost-controlling efforts and not enough on maintaining quality. Today, many health-care organizations are implementing balanced scorecards in an effort to balance the dual (and in some ways competing) goals of quality health-care and reduced costs. For example, by providing incentives for preventive medicine, health-care providers can reduce costs and at the same time improve patient health. It is likely that, in order to provide health-care to more Americans, we will have to reduce costs. It is hoped that successful implementation of balanced scorecard programs will result in reduced costs through increased efficiency, while increasing the quality of health-care.
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23-67
CHAPTER 24 Planning for Capital Investments ASSIGNMENT CLASSIFICATION TABLE Brief Exercises
Do It!
Exercises
2, 3
1
1
Explain the net present value method.
4, 5, 6, 7
2, 3, 4, 5
2
4.
Identify the challenges presented by intangible benefits in capital budgeting.
8, 9
4
5.
Describe the profitability index.
10
5
6.
Indicate the benefits of performing a post-audit.
11
6
7.
Explain the internal rate of return method.
12, 13, 16
7, 8
8.
Describe the annual rate of return method.
3, 14, 15
9
Learning Objectives
Questions
1.
Discuss capital budgeting evaluation, and explain inputs used in capital budgeting.
1
2.
Describe the cash payback technique.
3.
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A Problems
B Problems
1, 2, 6, 9, 10, 11
1A, 2A
1B, 2B
1, 2, 3, 4 10, 11
1A, 2A, 3A, 4A, 5A
1B, 2B, 3B, 4B, 5B
4A
4B
4
3A
3B
3
5, 6, 7
3A, 5A
3B, 5B
4
8, 9, 10, 11
1A, 2A
1B, 2B
24-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
1A
Compute annual rate of return, cash payback, and net present value.
Moderate
30–40
2A
Compute annual rate of return, cash payback, and net present value.
Complex
30–40
3A
Compute net present value, profitability index, and internal rate of return.
Moderate
20–30
4A
Compute net present value considering intangible benefits.
Moderate
20–30
5A
Compute net present value and internal rate of return with sensitivity analysis.
Moderate
30–40
1B
Compute annual rate of return, cash payback, and net present value.
Moderate
30–40
2B
Compute annual rate of return, cash payback, and net present value.
Complex
30–40
3B
Compute net present value, profitability index, and internal rate of return.
Moderate
20–30
4B
Compute net present value considering intangible benefits.
Moderate
30–40
5B
Compute net present value and internal rate of return with sensitivity analysis.
Moderate
30–40
24-2
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Kimmel, Accounting, 5e, Solutions Manual
Learning Objective
Knowledge Comprehension
Application
(For Instructor Use Only)
1.
Discuss capital budgeting evaluation, and explain inputs used in capital budgeting.
Q24-1
2.
Describe the cash payback technique.
Q24-2 Q24-3
BE24-1 DI24-1 E24-9 E24-10
3.
Explain the net present value method. Q24-5 Q24-6
Q24-4 Q24-7
BE24-3 E24-8 E24-10 E24-11
4.
Identify the challenges presented by intangible benefits in capital budgeting.
Q24-8
5.
Describe the profitability index.
6.
Indicate the benefits of performing a post-audit.
Q24-11
7.
Explain the internal rate of return method.
Q24-24 Q24-13
Q24-16
BE24-7 E24-7
8.
Describe the annual rate of return method.
Q24-14 Q24-15
Q24-3
BE24-9 E24-8 E24-9
BYP24-4
BYP24-5 BYP24-2
Broadening Your Perspective
Q24-9
Analysis Synthesis
E24-11
Evaluation
E24-1 E24-2 E24-6 P24-1A
P24-2A P24-1B P24-2B
BE24-4 P24-5A P24-5B
BE24-2 BE24-5 DI24-2 E24-1 E24-2 E24-3 E24-4 P24-1A
P24-2A P24-3A P24-4A P24-1B P24-2B P24-3B P24-4B
BE24-4
P24-4A P24-4B
Q24-10
BE24-5 E24-4
P24-3A P24-3B
BE24-6 P24-5A P24-5B E24-10 E24-11 BYP24-1 BYP24-8 BYP24-9
BE24-8 DI24-3 E24-6
E24-5 P24-3A P24-3B
DI24-4 P24-1A P24-2A
P24-1B P24-2B
BYP24-3 BYP24-6 BYP24-7
BLOOM’ S TAXONOMY TABLE
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Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems
24-3
ANSWERS TO QUESTIONS 1.
The screening of proposed capital expenditures may be done by a capital budgeting committee which submits its findings to the officers of the company. The officers, in turn, select the projects they believe to be the most worthy of funding and submit them to the board of directors. The directors ultimately approve the capital expenditure budget for the year.
2.
The cash payback technique is relatively easy to compute and understand. However, it should not ordinarily be the only basis for the capital budgeting decision because it ignores the expected profitability of the investment and the time value of money.
3.
Tom is not correct. The formula for the cash payback technique is: Cost of the capital investment ÷ Net annual cash flow. The formula for the annual rate of return is: Expected annual net income ÷ average investment.
4.
The two tables are: (1) The present value of a single future amount (Table 3 in Appendix A). This table is used when a project has uneven cash payments over its useful life and to compute the present value of the salvage value of the project. (2) The present value of an annuity (Table 4 in Appendix A). This table is used when a project has equal cash payments occurring at equal intervals of time over its useful life.
5.
The decision rule is: Accept the project when net present value is zero or positive; reject the project when net present value is negative.
6.
The discount rate has two elements, a cost of capital element and a risk element. Many times companies set the risk element equal to zero; thus, they are setting the discount rate equal to the cost of capital. However, if a project is considered to be riskier than the firm’s other projects, the discount rate should include a risk element.
7.
The following simplifying assumptions were made: • All cash flows come at the end of the year. • All cash flows are immediately reinvested in another project that has a similar return. • All cash flows can be predicted with certainty.
8.
Examples of intangible benefits of investment projects would be increased product quality, improved safety, and enhanced employee loyalty. Intangible benefits often complicate the capital budgeting process because their value can be difficult to quantify. Ignoring intangible benefits may result in rejecting projects that would be financially beneficial to the company.
9.
Two approaches can be taken. Under the first approach, management should ask whether the value of the intangible benefits exceeds the amount by which the net present value of the project is negative. If so, the project should be accepted. Under the second approach, management should make conservative dollar estimates of the value of the intangible benefits and the net present value should be recalculated.
24-4
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Questions Chapter 24 (Continued) 10.
When trying to choose between competing proposals, simply comparing the net present value of the competing proposals ignores the fact that one proposal may require a considerably larger investment. The profitability index is useful because it incorporates the required initial investment into the evaluation.
11.
A post-audit is a thorough evaluation of how well a project’s actual performance matches the original projections. Performing post-audits can be valuable because: (1) managers are more likely to submit reasonable and accurate data if they know that their estimates will be evaluated subsequently, (2) they provide a process for determining whether projects should be continued, and (3) they improve the development of future investment proposals because, by evaluating their past successes and failures, managers improve their estimation techniques.
12.
When the net annual cash flows are equal each year, the steps are: (1) Compute the internal rate of return factor by dividing Capital Investment by Net Annual Cash Flows. (2) Use the factor and the present value of an annuity of 1 table to find the internal rate of return.
13.
Under the internal rate of return method, the objective is to find the rate that will make the present value of the expected net annual cash flows equal the present value of the proposed capital expenditure. The decision rule under the internal rate of return method is: Accept the project when the internal rate of return is equal to or greater than the required rate of return, and reject the project when the internal rate of return is less than the required rate.
14.
The advantages of this method are the simplicity of its calculation and management’s familiarity with the accounting terms used in the computation. A limitation is that it does not consider the time value of money. Also, by employing accrual accounting numbers rather than cash flows, it ignores the fact that the value of an investment proposal is based on the cash flows that it generates.
15.
The formula for the annual rate of return technique is: Expected annual net income ÷ Average investment.
16.
Cost of capital is the average rate of return that the company must pay to obtain borrowed and equity funds. The decision rule is: Accept the project when the internal rate of return is equal to or greater than the required rate of return (which often is its cost of capital). Reject the project when the internal rate of return is less than the required rate of return.
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24-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 24-1 $450,000 ÷ $50,000 = 9 years BRIEF EXERCISE 24-2 Present Value $226,000 215,000 $ 11,000
Net annual cash flows – $40,000 X 5.65 Capital investment Net present value
The investment should be made because the net present value is positive. BRIEF EXERCISE 24-3
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 10% Discount Present Flows X Factor = Value $25,000 X 3.79079 = $ 94,770 65,000 X .62092 = 40,360 135,130 136,000 $ (870)
Since the net present value is negative, the project is unacceptable. BRIEF EXERCISE 24-4
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 9% Discount Present Flows X Factor = Value $34,000 X 5.53482 = ($188,184) 0X .50187 =( 0) ( 188,184) ( 200,000) ($ (11,816)
The reduction in downtime would have to have a present value of at least $11,816 in order for the project to be acceptable.
24-6
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BRIEF EXERCISE 24-5 Project A
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 9% Discount Present Flows X Factor = Value $70,000 X 6.41766 = $449,236 0 X .42241 = 0 449,236 400,000 $ 49,236
Profitability index = $449,236/$400,000 = 1.12 Project B
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 9% Discount Present Flows X Factor = Value $50,000 X 6.41766 = $320,883 0 X .42241 = 0 320,883 280,000 $ 40,883
Profitability index = $320,883/$280,000 = 1.15 Project B has a lower net present value than Project A, but because of its lower capital investment, it has a higher profitability index. Based on its profitability index, Project B should be accepted. BRIEF EXERCISE 24-6 Original estimate
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
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Cash 10% Discount Present Flows X Factor = Value $46,000 X 5.75902 = $264,915 0 X .42410 = 0 264,915 250,000 $ 14,915
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24-7
BRIEF EXERCISE 24-6 (Continued) Revised estimate
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 10% Discount Present Flows X Factor = Value $39,000 X 6.49506 = ($253,307) 0X .35049 =( 0) ( 253,307) ( 260,000) ($ (6,693)
The original net present value was projected to be a positive $14,915; however, the revised estimate is a negative $6,693. The project is not a success.
BRIEF EXERCISE 24-7 When net annual cash flows are expected to be equal, the internal rate of return can be approximated by dividing the capital investment by the net annual cash flows to determine the discount factor, and then locating this discount factor on the present value of an annuity table. $176,000/$33,740 = 5.21636 By tracing across on the 7-year row we see that the discount factor for 8% is 5.20637. Thus, the internal rate of return on this project is approximately 8%. BRIEF EXERCISE 24-8 When net annual cash flows are expected to be equal, the internal rate of return can be approximated by dividing the capital investment by the net annual cash flows to determine the discount factor, and then locating this discount factor on the present value of an annuity table. Since this exercise has a salvage value, not all cash flows are equal. In this case, the internal rate of return can be approximated by identifying the discount rate that will result in a net present value of zero. By experimenting with various rates, we determined that the net present value is approximately zero when a discount rate of approximately 9% is used.
24-8
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BRIEF EXERCISE 24-8 (Continued) Net annual cash flows = $400,000 – $150,000 = $250,000 Cash 9% Discount Present Flows X Factor = Value Present value of net annual cash flows $250,000 X 7.16073 = $1,790,183 Present value of salvage value 716,000 X .35554 = 254,567 2,044,750 Capital investment 2,045,000 Net present value $ (250) The 9% internal rate of return exceeds the company’s 7% required rate of return; thus, the project should be accepted.
BRIEF EXERCISE 24-9 The annual rate of return is calculated by dividing expected annual income by the average investment. The company’s expected annual income is: $130,000 – $70,000 = $60,000 Its average investment is: $470,000 + $10,000 = $240,000 2 Therefore, its annual rate of return is: $60,000/$240,000 = 25%
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24-9
SOLUTIONS FOR DO IT! REVIEW EXERCISES DO IT! 24-1 Estimated annual cash inflows................................. Estimated annual cash outflows .............................. Net annual cash flow .................................................
$80,000 40,000 $40,000
Cash payback period = $120,000/$40,000 = 3 years. DO IT! 24-2 Estimated annual cash inflows................................. Estimated annual cash outflows .............................. Net annual cash flow .................................................
Present value of net annual cash flows Capital investment Net present value a Table 4, Appendix A.
$80,000 40,000 $40,000
Cash Flow
12% Discount Factor
Present Value
$40,000
3.03735 a
$121,494 120,000 $ 1,494
Since the net present value is positive, the project should be accepted DO IT! 24-3 Estimated annual cash inflows................................. Estimated annual cash outflows .............................. Net annual cash flow .................................................
$80,000 40,000 $40,000
$120,000/$40,000 = 3.00. Using Table 4 of Appendix A and the factors that correspond with the four-period row, 3.00 is between the factors for 12% and 15%. Since the project has an internal rate that is more than 12%, the company’s required rate of return, the project should be accepted.
24-10
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DO IT! 24-4 Revenues .................................................................... Less: Expenses (excluding depreciation) .................... Depreciation ($120,000/4 years) .......................... Annual net income .....................................................
$80,000 $40,000 30,000
70,000 $ 10,000
Average investment = ($120,000 + 0)/2 = $60,000. Annual rate of return = $10,000/$60,000 = 16.7%. Since the annual rate of return, 16.7%, is greater than Wallowa’s required rate of return, 12%, the proposed project is acceptable.
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24-11
SOLUTIONS TO EXERCISES EXERCISE 24-1 (a) The cash payback period is: $56,000 ÷ $7,500 = 7.5 years The net present value is:
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
8% Cash Discount Present Flows X Factor = Value $ 7,500 X 5.74664 = $43,100 27,000 X .54027 = 14,587 57,687 56,000 $ 1,687
(b) In order to meet the cash payback criteria, the project would have to have a cash payback period of less than 4 years (8 ÷ 2). It does not meet this criteria. The net present value is positive, however, suggesting the project should be accepted. The reason for the difference is that the project’s high estimated salvage value increases the present value of the project. The net present value is a better indicator of the project’s worth. EXERCISE 24-2 (a) AA Net Annual Cash Flow $ 7,000 9,000 12,000
Year 1 2 3
Cumulative Net Cash Flow $ 7,000 16,000 28,000
Cash payback period 2.50 years $22,000 – $16,000 = $6,000 $6,000 ÷ $12,000 = .50
24-12
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EXERCISE 24-2 (Continued) BB 22,000 ÷ 10,000 = 2.2 years
Year 1 2 3
CC Net Annual Cash Flow $13,000 12,000 11,000
Cumulative Net Cash Flow $13,000 25,000 36,000
Cash payback period 1.75 years $22,000 – 13,000 = $9,000 $9,000 ÷ $12,000 = .75 The most desirable project is CC because it has the shortest payback period. The least desirable project is AA because it has the longest payback period. As indicated, only CC is acceptable because its cash payback is 1.75 years. (b)
AA Year
Discount Factor
Cash Flow
1 .89286 $ 7,000 2 .79719 9,000 3 .71178 12,000 Total present value Investment Net present value
Present Value
BB Cash Present Flow Value
$ 6,250 $10,000 7,175 10,000 8,541 10,000 21,966 (22,000) $ (34)
CC Cash Flow
Present Value
$ 8,929 $13,000 7,972 12,000 7,118 11,000 24,019(1) (22,000) $ 2,019
$11,607 9,566 7,830 29,003 (22,000) $ 7,003
(1) This total may also be obtained from Table 4: $10,000 X 2.40183 = $24,018. (The difference of $1 is due to rounding)
Project CC is still the most desirable project. Also, on the basis of net present values, project BB is also acceptable. Project AA is not desirable.
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24-13
EXERCISE 24-3 Investment in new equipment ............. Disposal of old equipment ................... Additional training required ................. Net initial investment required ............
$2,450,000 (260,000) 85,000 $2,275,000
Calculation of net present value:
Cash flows
Maintenance Net cash flows from operations: Terminal salvage Present value of cash inflows Initial investment Net present value
Year 1 2 3 4 5 6 7
Discount Factor, 9% 0.91743 0.84168 0.77218 0.70843 0.64993 0.59627 0.54703
Amount $ 390,000 400,000 411,000 426,000 434,000 435,000 436,000
Present Value $ 357,798 336,672 317,366 301,791 282,070 259,377 238,505
5
0.64993
(100,000)
(64,993)
350,000
2,028,586 191,461
7
0.54703
2,220,047 (2,275,000) $ (54,953)
Based on the net present calculation alone, the sewing machine should not be purchased. However, the internal rate of return would be only slightly lower than the 9% minimum required, so the company may want to look at some of the non-quantitative factors involved.
24-14
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EXERCISE 24-4 Machine A
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 9% Discount Present Flows X Factor = Value $15,000 X 5.53482 = $83,022 0 X .50187 = 0 83,022 75,500 $ 7,522
Profitability index = $83,022/$75,500 = 1.10 Machine B Cash 9% Discount Present Flows X Factor = Value Present value of net annual cash flows $30,000 X 5.53482 = ($166,045) Present value of salvage value 0X .50187 = ( 0) ( 166,045) Capital investment ( 180,000) Net present value ($ (13,955) Profitability index = $166,045/$180,000 = .92 Machine B has a negative net present value, and also a lower profitability index. Machine B should be rejected and Machine A should be purchased. EXERCISE 24-5 When net annual cash flows are expected to be equal, the internal rate of return can be approximated by dividing the capital investment by the net annual cash flows to determine the discount factor, and then locating this discount factor on the present value of an annuity table. $430,000/$101,000 = 4.25743 By tracing across on the 6-year row, we see that the discount factor for 11% is 4.23054. Thus, the internal rate of return on this project is approximately 11%. Since this is above the company’s required rate of return, the project should be accepted. .
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24-15
EXERCISE 24-6 (a)
Total net investment = $29,300 + $1,500 – $2,000 = $28,800 Annual net cash flow = $7,000 Payback period = $28,800 ÷ $7,000 = 4.1 years
(b)
Net present value approximates zero when discount rate is 12%. Item Net annual cash flows Capital investment Net present value
(c)
Amount $7,000
Years 1–6
PV Factor 4.11141
Present Value $28,780 (28,800) $ (20)
Because the approximate internal rate of return of 12% exceeds the required rate of return of 10%, the investment should be accepted.
EXERCISE 24-7 (a)
Project
Capital Investment ÷
Net Annual Cash Flows*
Internal Rate of Return = Factor
22A 23A 24A
$240,000 $270,000 $280,000
($16,700 + $40,000) ($20,600 + $30,000) ($17,500 + $40,000)
= = =
÷ ÷ ÷
4.233 5.336 4.870
Closest Discount Factor
Internal Rate of Return
4.23054 5.32825 4.86842
11% 12% 10%
*(Annual income + Depreciation expense) (b) The acceptable projects are 22A and 23A because their rates of return are equal to or greater than the 11% required rate of return.
24-16
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EXERCISE 24-8 The annual rate of return is calculated by dividing expected annual income by the average investment. The company’s expected annual income is: $70,000 – $41,500 = $28,500 Its average investment is: $300,000 + $80,000 = $190,000 2 Therefore, its annual rate of return is: $28,500 ÷ $190,000 = 15% EXERCISE 24-9 (a) Cost of hoist: $35,000 + $3,300 + $700 = $39,000. Net annual cash flows: Number of extra mufflers 5 X 52 weeks Contribution margin per muffler ($72 – $36 – $12) Total net annual cash flows (a) X (b) Cash payback period = $39,000 ÷ $6,240 = 6.25 years.
(a) 260 (b) X $24 $6,240
(b) Average investment: ($39,000 + $3,000) ÷ 2 = $21,000. Annual depreciation: ($39,000 – $3,000) ÷ 8 = $4,500. Annual net income: $6,240 – $4,500 = $1,740. Annual rate of return = $1,740 ÷ $21,000 = 8.3% (rounded).
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24-17
EXERCISE 24-10 (a) 1. 2.
Cash payback period: $190,000 ÷ $50,000 = 3.8 years. Annual rate of return: $12,000 ÷ [($190,000 + $0) ÷ 2] = 12.63%.
(b)
Item
Amount
Years
PV Factor
Present Value
Net annual cash flows Capital investment Net present value
$ 50,000
1–5
3.60478
$180,239)) (190,000) $ (9,761)))
EXERCISE 24-11 (a) Year 1 2 3
Net Annual Cash Flow $45,000 40,000 35,000
Cumulative Net Cash Flow $ 45,000 85,000 120,000
Cash payback period 2.57 years (2 + [($105,000 – $85,000) ÷ $35,000]) (b) Average annual net income = ($10,000 + $12,000 + $14,000 + $16,000 + $18,000) ÷ 5 = $14,000 Average investment = ($105,000 + $0) ÷ 2 = $52,500 Annual rate of return = $14,000 ÷ $52,500 = 26.67% (c) Net cash flows
24-18
Year 1 2 3 4 5
Discount Factor, 12% 0.89286 0.79719 0.71178 0.63552 0.56743
Amount $45,000 40,000 35,000 30,000 25,000
Present Value $ 40,179 31,888 24,912 19,066 14,186
Present value of cash in flows Initial investment
130,231 (105,000)
Net present value
$ 25,231
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SOLUTIONS TO PROBLEMS PROBLEM 24-1A
(a) Project Kilo $150,000 ÷ ($14,000 + $30,000) = 3.41 years
Year 1 2 3 4 5
Project Lima Cash Flow $51,000 ($18,000 + $33,000) $50,000 ($17,000 + $33,000) $49,000 ($16,000 + $33,000) $45,000 ($12,000 + $33,000) $42,000 ($ 9,000 + $33,000)
Cumulative Cash Flow $ 51,000 $101,000 $150,000 $195,000 $237,000
Cash payback period 3.33 years $165,000 – $150,000 = $15,000 $15,000 ÷ $45,000 = .33
Year 1 2 3 4 5
Project Oscar Cash Flow $67,000 ($27,000 + $40,000) $63,000 ($23,000 + $40,000) $61,000 ($21,000 + $40,000) $53,000 ($13,000 + $40,000) $52,000 ($12,000 + $40,000)
Cumulative Cash Flow $ 67,000 $130,000 $191,000 $244,000 $296,000
Cash payback period 3.17 years $200,000 – $191,000 = $9,000 $9,000 ÷ $53,000 = .17
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24-19
PROBLEM 24-1A (Continued) (b)
Project Kilo Item Net annual cash flows Capital investment Negative net present value Discount Factor .86957 .75614 .65752 .57175 .49718
Year 1 2 3 4 5 Total Capital investment Positive (negative) net present value
Amount $44,000
Years 1–5
Discount Factor 3.35216
Present Value $147,495 (150,000) $ (2,505)
Project Lima Cash Flow PV $ 51,000 $ 44,348 50,000 37,807 49,000 32,218 45,000 25,729 42,000 20,882 $237,000 160,984 (165,000)
Project Oscar Cash Flow PV $ 67,000 $ 58,261 63,000 47,637 40,109 61,000 30,303 53,000 25,853 52,000 202,163 $296,000 (200,000)
$ (4,016)
$
2,163
(c) Project Kilo = $14,000 ÷ [($150,000 + $0) ÷ 2] = 18.67%. Project Lima = $14,400 ÷ [($165,000 + $0) ÷ 2] = 17.5%. Project Oscar = $19,200 ÷ [($200,000 + $0) ÷ 2] = 19.2%. (d) Project Kilo Lima Oscar
Cash Payback 3 2 1
Net Present Value 2 3 1
The best project is Oscar.
24-20
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Annual Rate of Return 2 3 1
PROBLEM 24-2A
(a)
Sales Expenses Drivers’ salaries Out-of-pocket expenses Depreciation Total expenses Net income Cash inflow
(1) Annual Net Income *$108,000*
(2) Annual Cash Inflow $108,000
* 48,000* * 30,000* * 25,000* * 103,000* *$ 5,000*
48,000 30,000 0 78,000 $ 30,000
*5 vans X 10 trips X 6 students X 30 weeks X $12.00 = $108,000. (b) 1.
Cash payback period = $75,000 ÷ $30,000* = 2.50 years. *$5,000 + $25,000
2.
Annual rate of return = $5,000 ÷
($75,000 + 0) = 13.33%. 2
(c) Present value of annual cash inflows ($30,000 X 2.28323*) = $68,497 Capital investment = (75,000) Net present value = $ (6,503) *3 years at 15%, PV of annuity of 1. (d) The computations show that the commuter service is not a wise investment for these reasons: (1) annual net income will only be $5,000, (2) the annual rate of return (13.33%) is less than the cost of capital (15%), (3) the cash payback period is 83% (2.5 ÷ 3) of the useful life of the vans, and (4) net present value is negative.
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
24-21
PROBLEM 24-3A (a) (1) Option A Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value Capital investment Net present value
Cash 8% Discount Present Flows X Factor = Value a$40,000a X 5.20637 = ($208,255) ( (50,000) X .73503 = ( (36,752) ( 0) X .58349 =( 0) ($171,503) ( (160,000) ($ 11,503)
aNet annual cash flows = $70,000 – $30,000 = $40,000
(2) Profitability index = $171,503/$160,000 = 1.07 (3) The internal rate of return can be approximated by finding the discount rate that results in a net present value of approximately zero. This is accomplished with a 10% discount rate.
Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value Capital investment Net present value
Cash 10% Discount Present Flows X Factor = Value a$40,000a X 4.86842 = ($194,737) ( (50,000) X .68301 = ( (34,151) ( 0) X .51316 = ( 0) ($160,586) (160,000) ($ 586
aNet annual cash flows = $70,000 – $30,000 = $40,000
(1) Option B Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value
Cash 8% Discount Flows X Factor b$54,000b X 5.20637 0 X .73503 8,000 X .58349
Capital investment Net present value bNet annual cash flows = $80,000 – $26,000 = $54,000
(2) Profitability index = $285,812/$227,000 = 1.26
24-22
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
Present = Value = $281,144 = 0 = 4,668 $285,812 (227,000) $ 58,812
PROBLEM 24-3A (Continued) (3) Internal rate of return on Option B is 15%, as calculated below:
Present value of net annual cash flows Present value of cost to rebuild Present value of salvage value Capital investment Net present value
Cash 15% Discount Present Flows X Factor = Value b$54,000b X 4.16042 = $224,663 0 X .57175 = 0 8,000 X .37594 = 3,008 $227,671 (227,000) $ 671
bNet annual cash flows = $80,000 – $26,000 = $54,000
(b) Option A has a lower net present value than Option B, and also a lower profitability index and internal rate of return. Therefore, Option B is the preferred project.
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
24-23
PROBLEM 24-4A
(a) The net present value based on the original estimates is as follows:
Present value of net annual cash flows Present value of cost of overhaul Present value of salvage value Capital investment Net present value
Cash 9% Discount Present Flows X Factor = Value $ 8,000 X 5.53482 = ($ 44,279 ( (6,000) X .70843 = ( (4,251) ( 12,000) X .50187 = ( 6,022 ($ 46,050 (60,000) ($(13,950)
Based on its negative net present value, the tow truck should not be purchased. (b) The net present value based on the revised estimates is as follows:
Present value of net annual cash flows Present value of cost of overhaul Present value of salvage value Capital investment Net present value
Cash 9% Discount Present Flows X Factor = Value $13,500* X 5.53482 = ($74,720) ( (6,000)* X .70843 = ( (4,251) ( 12,000 * X .50187 = ( 6,022) ($76,491) (60,000) ($16,491)
*$8,000 + ($3,000 + $750 + $1,000 + $750) Based on the revised figures, the tow truck has a positive net present value and therefore should be purchased. (c) The present value of the intangible benefits was $30,441 (the increase in the net present value from a negative $13,950 to a positive $16,491). Rick’s estimates of the value of these intangible benefits may be overly optimistic. In order for the project to be acceptable, the present value of the intangible benefits would only have to be $13,950. That is the amount by which the original estimate fell short of having a positive net present value.
24-24
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 24-5A
(a) Using the original estimates, the net present value is calculated as follows: Cash 8% Discount Present Flows X Factor = Value a a Present value of net annual cash flows $ 100,000 X 9.81815 = $ 981,815 Present value of salvage value 1,500,000 X .21455 = 321,825 1,303,640 Capital investment ($300,000 + $600,000) (900,000) Net present value $ 403,640 aNet annual cash flows = $940,000 – $840,000
The positive net present value of the project suggests that it should be accepted. (b) Using the revised estimates, the net present value is calculated as follows:
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 8% Discount Present Flows X Factor = Value b$ b 50,000 X 9.81815 = $(490,908) 1,500,000 X .21455 = (321,825) $(812,733) (900,000) $ (87,267)
bNet annual cash flows = $800,000 – $750,000
Under these revised estimates, the project should be rejected. It appears that many of the camp’s costs are fixed; thus, when the number of players declines, cash inflows decline, but cash outflows don’t decline proportionately.
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
24-25
PROBLEM 24-5A (Continued) (c) Using the original estimates, but an 11% discount rate, the net present value is calculated as follows:
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 11% Discount Present Flows X Factor = Value c$ X 7.96333 = $ 796,333 c 100,000 X .12403 = 186,045 1,500,000 $ 982,378 (900,000) $ 82,378
cNet annual cash flows = $940,000 – $840,000
The positive net present value of the project suggests that it should be accepted; however, it is not nearly as profitable using an 11% discount rate. (d) The internal rate of return can be determined by calculating the discount rate that results in a net present value of approximately zero. In this case the internal rate of return was approximately 12%.
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 12% Discount Present Flows X Factor = Value $ 40,000 X 3.60478 = $144,191 1,332,000 X .56743 = 755,817 $900,008 (900,000) $ 8
The project had a high internal rate of return, even though the business itself was not generating much cash flows, because the property increased significantly in value during the 5-year period.
24-26
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 24-1B
(a) Project Mary $140,000 ÷ [($10,000 + $28,000)] = 3.68 years Project Winnie Cash Flow Cumulative Cash Flow $47,500 ($12,500 + $35,000) $ 47,500 $47,000 ($12,000 + $35,000) $ 94,500 $46,000 ($11,000 + $35,000) $140,500 $43,000 ($ 8,000 + $35,000) $183,500 $41,000 ($ 6,000 + $35,000) $224,500
Cash payback period 3.80 years $175,000 – $140,500 = $34,500 $34,500 ÷ $43,000 = .80
Year 1 2 3 4 5
Project Sarah Cash Flow $57,000 ($19,000 + $38,000) $54,000 ($16,000 + $38,000) $52,000 ($14,000 + $38,000) $47,000 ($ 9,000 + $38,000) $46,000 ($ 8,000 + $38,000)
Cumulative Cash Flow $ 57,000 $111,000 $163,000 $210,000 $256,000
Cash payback period 3.57 years $190,000 – $163,000 = $27,000 $27,000 ÷ $47,000 = .57
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Kimmel, Accounting, 5e, Solutions Manual
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24-27
PROBLEM 24-1B (Continued) (b)
Project Mary Item Net annual cash flows Capital investment Negative net present value Discount Factor .89286 .79719 .71178 .63552 .56743
Year 1 2 3 4 5 Total Capital investment Positive (negative) net present value (c) Project Mary Project Winnie Project Sarah
Amount $38,000
Present Value $136,982 (140,000) $ (3,018)
Project Winnie Cash Flow PV $ 47,500 $ 42,411 47,000 37,468 46,000 32,742 43,000 27,327 41,000 23,265 $224,500 163,213 (175,000)
Project Sarah Cash Flow PV $ 57,000 $ 50,893 54,000 43,048 52,000 37,013 47,000 29,869 46,000 26,102 $256,000 186,925 (190,000)
$ (11,787)
$ (3,075)
= $10,000 ÷ [($140,000 + $0) ÷ 2] = 14.29%. = $ 9,900 ÷ [($175,000 + $0) ÷ 2] = 11.31%. = $13,200 ÷ [($190,000 + $0) ÷ 2] = 13.89%.
(d) Project Mary Winnie Sarah
Years 1–5
Discount Factor 3.60478
Cash Payback 2 3 1
Net Present Value 1 3 2
Annual Rate of Return 1 3 2
The best project is Mary, but even Mary should not be recommended, because the net present value is negative.
24-28
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM 24-2B
(a)
Sales Expenses Drivers’ salaries Out-of-pocket expenses Depreciation Total expenses Net income Cash inflow
(1) Annual Net Income *$144,000*
(2) Annual Cash Inflow $144,000
43,000 * 42,000*** * 30,000 * 115,000 $ 29,000
43,000 42,000 0 85,000 $ 59,000
*5 vans X 10 trips X 6 students X 32 weeks X $15.00 = $144,000. **$26,000 + $4,000 + $5,300 + $4,500 + $2,200 = $42,000 (b) 1. 2.
Cash payback period = $90,000 ÷ $59,000 = 1.53 years. Annual rate of return = $29,000 ÷
($90,000 + 0) 2
= 64.44%.
(c) Present value of annual cash inflows ($59,000 X 2.28323*) = $134,711 Capital investment = (90,000) Net present value = $ 44,711 *3 years at 15%, PV of ordinary annuity. (d) The computations show that the commuter service is a good investment for these reasons: (1) annual net income will be $29,000, (2) the annual rate of return is 64.44%, (3) the cash payback period is 51% (1.53 ÷ 3) of the useful life of the vans, and (4) net present value is positive.
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Kimmel, Accounting, 5e, Solutions Manual
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24-29
PROBLEM 24-3B
(a) (1) Option A Present value of net annual cash inflows Present value of cost to rebuild Present value of salvage value
Cash Flows a $32,000a ( (53,000) ( 0)
X X X X
Capital investment Net present value
11% Discount Present Factor = Value 4.23054 = ($135,377) .73119 = ( (38,753) .53464 = ( 0) ( 96,624) (100,000) ($ (3,376)
aNet annual cash inflows = $56,000 – $24,000 = $32,000
(2) Profitability index = $96,624/$100,000 = .97 (3) The internal rate of return can be approximated by finding the discount rate that results in a net present value of approximately zero. This is accomplished with a 10% discount rate.
Present value of net annual cash inflows Present value of cost to rebuild Present value of salvage value
Cash Flows a $32,000a ( (53,000) ( 0)
X X X X
Capital investment Net present value
10% Discount Present Factor = Value 4.35526 = ($139,368) .75132 = ( (39,820) .56447 = ( 0) ( 99,548) (100,000) $ (452)
aNet annual cash inflows = $56,000 – $24,000 = $32,000
(1) Option B Present value of net annual cash inflows Present value of cost to rebuild Present value of salvage value
Cash Flows b $36,000b 0 24,000
X X X X
11% Discount Factor 4.23054 .73119 .53464
Capital investment Net present value bNet annual cash inflows = $60,000 – $24,000 = $36,000
(2) Profitability index = $165,130/$160,000 = 1.03
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Kimmel, Accounting, 5e, Solutions Manual
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= = = =
Present Value $152,299 0 12,831 165,130 (160,000) $ 5,130
PROBLEM 24-3B (Continued) (3) Internal rate of return on Option B is 12%, as calculated below:
Present value of net annual cash inflows Present value of cost to rebuild Present value of salvage value Capital investment Net present value
Cash 12% Discount Present Flows X Factor = Value b b $36,000 X 4.11141 = $148,011 0 X .71178 = 0 24,000 X .50663 = 12,159 160,170 (160,000) $ 170
bNet annual cash inflows = $60,000 – $24,000 = $36,000
(b) Option A has a lower net present value than Option B, and also a lower profitability index and internal rate of return. Therefore, Option B is the preferred project. Option A is unacceptable due to its negative NPV.
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Kimmel, Accounting, 5e, Solutions Manual
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24-31
PROBLEM 24-4B
(a) The net present value based on the original estimates is as follows:
Present value of net annual cash inflows Present value of cost of overhaul Present value of salvage value
Cash 10% Discount Flows X Factor $ 9,600 X 5.33493 ( (7,000) X .68301 16,000 X .46651
Capital investment Net present value
Present = Value = ($ 51,215 = ( (4,781) = ( 7,464 (53,898 (65,000) ($(11,102)
Based on its negative net present value, the tow truck should not be purchased. (b) The net present value based on the revised estimates is as follows:
Present value of net annual cash inflows Present value of cost of overhaul Present value of salvage value Capital investment Net present value
Cash 10% Discount Present Flows X Factor = Value $14,500* X 5.33493 = ($77,356) (7,000)* X .68301 = ( (4,781) 16,000 * X .46651 = ( 7,464) (80,039) (65,000) ($15,039)
*$9,600 + ($2,600 + $600 + $1,200 + $500) Based on the revised figures, the tow truck has a positive net present value and therefore should be purchased. (c) The present value of the intangible benefits was $26,141 (the increase in the net present value from a negative $11,102 to a positive $15,039). Brad’s estimates of the value of these intangible benefits may be overly optimistic. In order for the project to be acceptable, the present value of the intangible benefits would only have to be $11,102. That is the amount by which the original estimate fell short of having a positive net present value.
24-32
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM 24-5B
(a) Using the original estimates, the net present value is calculated as follows:
Present value of net annual cash inflows Present value of salvage value Capital investment ($200,000 + $350,000) Net present value
Cash 12% Discount Present Flows X Factor = Value a a $130,000 X 7.46944 = $ 971,027 700,000 X .10367 = 72,569 1,043,596 (550,000) $ 493,596
aNet annual cash inflows = $700,000 – $570,000
The positive net present value of the project suggests that it should be accepted. (b) Using the revised estimates, the net present value is calculated as follows:
Present value of net annual cash inflows Present value of salvage value Capital investment Net present value
Cash 12% Discount Present Flows X Factor = Value b b $ 62,000 X 7.46944 = $463,105 700,000 X .10367 = 72,569 535,674 (550,000) $ (14,326)
bNet annual cash inflows = $570,000 – $508,000
Under these revised estimates, the project should be rejected. It appears that many of the camp’s costs are fixed; thus, when the number of campers declines, cash inflows decline, but cash outflows don’t decline proportionately.
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Kimmel, Accounting, 5e, Solutions Manual
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24-33
PROBLEM 24-5B (Continued) (c) Using the original estimates, but a 15% discount rate, the net present value is calculated as follows:
Present value of net annual cash inflows Present value of salvage value
Cash 15% Discount Flows X Factor = c c $130,000 X 6.25933 = 700,000 X .06110 =
Capital investment Net present value
Present Value $813,713 42,770 856,483 (550,000) $306,483
cNet annual cash inflows = $700,000 – $570,000
The positive net present value of the project suggests that it should be accepted; however, it is not nearly as profitable using a 15% discount rate. (d) The internal rate of return can be determined by calculating the discount rate that results in a net present value of approximately zero. In this case the internal rate of return was approximately 15%.
Present value of net annual cash inflows Present value of salvage value Capital investment Net present value
Cash Flows $ 65,000 668,000
X X X
15% Discount Present Factor = Value 3.35216 = $217,890 .49718 = 332,116 550,006 (550,000) $ 6
The project had a high internal rate of return, even though the business itself was not generating much cash flows, because the property increased significantly in value during the 5-year period.
24-34
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Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
BYP 24-1
DECISION-MAKING AT CURRENT DESIGNS
(a) Average investment = ($256,000 + 0) ÷ 2 = $128,000 Annual rate of return = $15,200 ÷ $128,000 = 11.88% (b) Net annual cash flow = $15,200 + $32,000 = $47,200 Payback period = $256,000 ÷ $47,200 = 5.42 years (c) Event Net annual cash flow Oven purchase Net present value
Time Period 1-8 0
Cash 9% Discount Present Flows Factor Value $ 47,200 5.53482 $ 261,244 (256,000) 1.00000 (256,000) $ 5,244
Time Period 1-8 0
Cash 15% Discount Present Flows Factor Value $ 47,200 4.48732 $ 211,802 (256,000) 1.00000 (256,000) $ (44,198)
Accept the proposal (d) Event Net annual cash flow Oven purchase Net present value
Do not accept the proposal
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Kimmel, Accounting, 5e, Solutions Manual
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24-35
BYP 24-2
DECISION-MAKING ACROSS THE ORGANIZATION
Purchase New Machine $5,000,000 (1)
Sales Costs and expenses Cost of goods sold Selling expenses Administrative expenses Depreciation Loss on disposal of machine Total costs and expenses Net income (1) (2) (3) (4) (5) (6)
$3,500,000 704,000 448,000 130,000 40,000
(2) (3) (4) (5) (6) 4,822,000 $ 178,000
10,000 X $100 X 4 years = $4,000,000 X 125% = $5,000,000 $5,000,000 X (100% – 30%) = $3,500,000 $160,000 X 110% X 4 years = $704,000 $112,000 X 4 years = $448,000 $122,000 + $3,000 + $5,000 = $130,000 Assuming old machine has zero scrap value
(a) Annual rate of return = 68.5%; ($178,000 ÷ 4) ÷ [($130,000 + $0) ÷ 2] (b) Cash payback period = 1.49 yrs.; $130,000 ÷ [($178,000 + $130,000 + $40,000) ÷ 4] (c) Net present value = Net annual cash flows Capital investment Net present value
Amount $ 87,000 * $130,000
Discount Factor 2.85498 1.00000
Present Value $248,383 (130,000) $118,383
*($178,000 + $130,000 + $40,000) ÷ 4 (d) The new machine should be purchased. The analysis shows that net income will be $178,000 over the four years with the new machine, which results in a 68.5% annual rate of return. The cash payback period of 1.49 years meets management’s minimum requirement of three years. In addition, net present value is $118,383 positive, which indicates that the investment meets the required minimum rate of return of 15%.
24-36
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 24-3
MANAGERIAL ANALYSIS
(a) Using the original estimates, the present value is calculated as follows:
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 11% Discount Present Flows X Factor = Value a $ 460,000 X 7.19087 = ($3,307,800) 2,000,000 X .20900 = ( 418,000) (3,725,800 (4,000,000) ($ (274,200)
aNet annual cash flows = $4,000,000 – $3,540,000
The negative net present value of the project suggests that it should be rejected. (b) Using the revised estimates, the net present value is calculated as follows: Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 11% Discount Present Flows X Factor = Value b$ 720,000b X 7.19087 = $5,177,426 2,000,000 X .20900 = 418,000 5,595,426 (4,000,000) $1,595,426
bNet annual cash flows = $4,200,000 – $3,480,000
Under these revised estimates, the project should be accepted.
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Kimmel, Accounting, 5e, Solutions Manual
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24-37
BYP 24-3 (Continued) (c) Using the original estimates, but a 9% discount rate, the net present value is calculated as follows:
Present value of net annual cash flows Present value of salvage value Capital investment Net present value
Cash 9% Discount Present Flows X Factor = Value c c $ 460,000 X 8.06069 = $3,707,917 2,000,000 X .27454 = 549,080 $4,256,997 (4,000,000) $ 256,997
Net annual cash flows = $4,000,000 – $3,540,000
c
Using the original estimates, but the lower discount rate, the net present value is positive, suggesting the project should be accepted. (d) If Bob is correct in either his belief that the estimated net annual cash flows are too conservative, or that the discount rate being used is too high, then the project is acceptable. At a minimum, this analysis suggests that further investigation is warranted.
24-38
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 24-4
REAL-WORLD FOCUS
This disclosure, provided by the company’s management in its annual report, suggests that the scroll compressor project has not achieved the goals originally hoped for. In deciding whether to continue with this project, management should undertake a post-audit. This would involve collecting data on results obtained thus far and comparing those results with original projections. Those people responsible for the original projections should then be asked to provide explanations for differences between the results and projections. Careful consideration of the nature of these differences and their implications for future performance should provide valuable information regarding the decision to continue or terminate the project.
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Kimmel, Accounting, 5e, Solutions Manual
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24-39
BYP 24-5
REAL-WORLD FOCUS
Answers to this problem will vary depending on the year chosen by the student. The following solution is provided for the year ended August 1, 2010. (a) The statement of cash flows indicates that capital expenditures (purchase of plant assets) were $315 million in 2010, a decrease of $36 million from the prior year. (b) The statement of cash flows indicates $400 million of long-term borrowings were made in 2010. Note 13 indicates that interest rates on existing long-term borrowing ranged from 3.05% to 8.88% during the year. (c) The internal rate of return on these capital expenditures is approximately 7%, computed as follows: $315 million ÷ $42 million = 7.5 Note that the factor for n = 10, i = 6% is 7.36009. (Table A-4, n = 10, i = 6%) and the factor for 5% is 7.72173. 7.5 is approximately halfway between 7.36009 and 7.72173, so the IRR is estimated to be 5.5%.
24-40
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 24-6
To:
COMMUNICATION ACTIVITY
Maria Fierro, Supervisor
From: Subject:
, Assistant Chief Accountant Recommendation for New Hoist
The quantitative analysis pertaining to this management decision is as follows: Cost of hoist: $35,000 + $3,300 + $700 = $39,000. Net annual cash flows: Number of extra mufflers 5 X 52 weeks Contribution margin per muffler ($72 – $36 – $12) Total net annual cash flows (a) X (b) Cash payback period = $39,000 ÷ $6,240 = 6.25 years.
(a) 260 (b) X $24 $6,240
Average investment: ($39,000 + $3,000) ÷ 2 = $21,000. Annual depreciation: ($39,000 – $3,000) ÷ 8 = $4,500. Annual net income: $6,240 – $4,500 = $1,740. Annual rate of return = $1,740 ÷ $21,000 = 8.3% (rounded). These data indicate that the cash payback period is 78% of the new asset’s useful life. This would generally be considered fairly high, indicating a less desirable project. The data also show a 8.3% annual rate of return. This is a low return and it is below what management would consider an acceptable return. The quantitative data do not include any technique that considers the time value of money. However, I believe there is a strong probability that the discounted cash flow technique would show a negative net present value for the new hoist. I believe that the information I have presented would indicate that, based on the current data, the investment should not be made.
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Kimmel, Accounting, 5e, Solutions Manual
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24-41
BYP 24-7
ETHICS CASE
(a) The stakeholders are: • • • • •
Yourself. Your spouse and children. Employees of NuComp Company. Citizens of the town where the company is presently located. The stockholders of NuComp Company.
(b) The ethical issue is: • An employee’s personal interests and those of his co-workers and the town versus the best interests of the company and its stockholders. (c) The student should recognize a conflict of interest. The company should hire an outside consultant to study and evaluate such a move rather than place one of its employees in this dilemma. You should rise above the conflict of interest and perform an objective economic evaluation, but also be prepared to remind management, should they be so oblivious, of the consequences to the employees and the town. Knowingly preparing a biased or false report is unethical.
24-42
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Kimmel, Accounting, 5e, Solutions Manual
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BYP 24-8
ALL ABOUT YOU
Results will vary depending on article selected by the student. Some common signals identified in articles are: bills more than two months in arrears; must make decisions about who to pay; you have a debt judgment filed against you; spending exceeds income; all credit cards are at their maximum.
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Kimmel, Accounting, 5e, Solutions Manual
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24-43
BYP 24-9
YOUR COSTS AND BENEFITS
(a) The total cost of the installed solar panels was $80,000. The “out-ofpocket” cost to the couple was $27,000. (b) Using the total annual electricity bill of $5,000 mentioned in the story, the cash payback of the project using the total costs of $80,000 is 16 years ($80,000 ÷ $5,000). The cash payback based on the “out-of-pocket” cost of $27,000 is 5.4 years ($27,000 ÷ $5,000). (c) The net present value of the project using the total cost is: Cash X 6% Discount = Flows Factor Present value of net annual cash flows Capital investment Net present value
$5,000 X
11.46992
Present Value
= $ 57,350 (80,000) $(22,650)
The net present value of the project using the out-of-pocket cost is:
Present value of net annual cash flows Capital investment Net present value
Cash X 6% Discount = Flows Factor
Present Value
$5,000 X
$57,350 (27,000) $30,350
11.46992
=
(d) The wholesale price of panels per watt at the time the article was written was $1.70 per watt. The price per watt the article says that subsidies no longer would be needed is $1.00. One solar panel provider said that it would be providing panels that cost $1.00 per watt within three years of the time the article was written.
24-44
.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
APPENDIX D Time Value of Money Learning Objectives 1. 2. 3. 4. 5. 6. 7. 8.
Distinguish between simple and compound interest. Solve for future value of a single amount. Solve for future value of an annuity. Identify the variables fundamental to solving present value problems. Solve for present value of a single amount. Solve for present value of an annuity. Compute the present value of notes and bonds. Use a financial calculator to solve time value of money problems.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
18.
6
AP
25.
8
AP
19.
6, 7
AP
26.
8
AP
20.
5
AN
27.
8
AP
21.
5
AN
28.
8
AP
Brief Exercises 1.
AP
8.
5, 6
AP
2.
2, 3
C
9.
5
AP
3.
2
AP
10.
5
AP
4.
3
AP
11.
6
AP
5.
2, 3
AP
12.
6
AP
6. 7.
.
2
2 5, 6
AP
13.
C
(For Instructor Use Only)
5, 6, 7
AP
14. 15. 16. 17.
5, 6, 7
AP
5, 6, 7
AP
5, 6, 7
22.
6
AN
AP
23.
6
AN
6, 7
AP
24.
8
AP
D-1
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE D-1 (a) Interest = p X i X n I = $8,000 X .05 X 12 years I = $4,800 Accumulated amount = $8,000 + $4,800 = $12,800 (b) Future value factor for 12 periods at 5% is 1.79586 (from Table 1) Accumulated amount = $8,000 X 1.79586 = $14,366.88
BRIEF EXERCISE D-2
(1) A B
(a)
(b)
6% 4%
3 periods 8 periods
(2) A B
(a)
(b)
5% 3%
8 periods 12 periods
BRIEF EXERCISE D-3 FV = p X FV of 1 factor = $9,200 X 1.60103 = $14,729.48
BRIEF EXERCISE D-4 FV of an annuity of 1 = p X FV of an annuity factor = $78,000 X 12.57789 = $981,075.42
D-2
.
(For Instructor Use Only)
BRIEF EXERCISE D-5 FV = p X FV of 1 factor + (p X FV of an annuity factor) = ($6,000 X 2.02582) + ($1,000 X 25.64541) = $12,154.92 + $25,645.41 = $37,800.33
BRIEF EXERCISE D-6 FV = p X FV of 1 factor = $34,000 X 1.53862 = $52,313.08
BRIEF EXERCISE D-7 (a) (1) A B C
12% 10% 3%
(b) 6 periods 11 periods 18 periods
(2) A B C
12% 10% 4%
20 periods 5 periods 8 periods
BRIEF EXERCISE D-8 (a)
i = 10% ?
0
$28,000
1
2
3
4
5
6
7
8
9
Discount rate from Table 3 is .42410 (9 periods at 10%). Present value of $28,000 to be received in 9 years discounted at 10% is therefore $11,874.80 ($28,000 X .42410).
.
(For Instructor Use Only)
D-3
BRIEF EXERCISE D-8 (Continued) (b)
i = 9% ?
$28,000 $28,000 $28,000 $28,000 $28,000 $28,000
0
1
2
3
4
5
6
Discount rate from Table 4 is 4.48592 (6 periods at 9%). Present value of 6 payments of $28,000 each discounted at 9% is therefore $125,605.76 ($28,000 X 4.48592).
BRIEF EXERCISE D-9 i = 9% ?
$750,000
0
1
2
3
4
5
Discount rate from Table 3 is .64993 (5 periods at 9%). Present value of $750,000 to be received in 5 years discounted at 9% is therefore $487,447.50 ($750,000 X .64993). Elmdale Company should therefore invest $487,447.50 to have $750,000 in five years.
BRIEF EXERCISE D-10 i = 10% ?
$480,000
0
1
2
3
4
5
6
7
8
Discount rate from Table 3 is .46651 (8 periods at 10%). Present value of $480,000 to be received in 8 years discounted at 10% is therefore $223,924.80 ($480,000 X .46651). Orear Company should invest $223,924.80 to have $480,000 in eight years.
D-4
.
(For Instructor Use Only)
BRIEF EXERCISE D-11 i = 5% ?
$45,000 $45,000 $45,000 $45,000
0
1
2
3
$45,000 $45,000
4
14
15
Discount rate from Table 4 is 10.37966. Present value of 15 payments of $45,000 each discounted at 5% is therefore $467,084.70 ($45,000 X 10.37966). Dayton Company should pay $467,084.70 for this annuity contract.
BRIEF EXERCISE D-12 i = 8% ?
$90,000
$90,000
$90,000
$90,000
$90,000
$90,000
0
1
2
3
4
5
6
Discount rate from Table 4 is 4.62288. Present value of 6 payments of $90,000 each discounted at 8% is therefore $416,059.20 ($90,000 X 4.62288). Nolasko Enterprises invested $416,059.20 to earn $90,000 per year for six years.
.
(For Instructor Use Only)
D-5
BRIEF EXERCISE D-13 i = 4% ?
$300,000
Diagram for Principal
0
1
2
3
4
19
20
i = 4% ?
$13,500 $13,500 $13,500 $13,500
$13,500 $13,500
Diagram for Interest
0
1
2
3
4
19
20
Present value of principal to be received at maturity: $300,000 X 0.45639 (PV of $1 due in 20 periods at 4% from Table 3) .............................................................. $136,917.00 Present value of interest to be received periodically over the term of the bonds: $13,500 X 13.59033 (PV of $1 due each period for 20 periods at 4% from Table 4) ........................................................................ 183,469.45 Present value of bonds ............................................................... $320,386.45 BRIEF EXERCISE D-14 The bonds will sell at a discount (for less than $300,000). This may be proven as follows: Present value of principal to be received at maturity: $300,000 X .37689 (PV of $1 due in 20 periods at 5% from Table 3) .............................................................. $113,067.00 Present value of interest to be received periodically over the term of the bonds: $13,500 X 12.46221 (PV of $1 due each period for 20 periods at 5% from Table 4) ........................................................................ 168,239.83 Present value of bonds ............................................................... $281,306.83
D-6
.
(For Instructor Use Only)
BRIEF EXERCISE D-15 i = 8% ?
$64,000
Diagram for Principal
0
1
2
3
4
5
6
i = 8% ?
$3,840
$3,840
$3,840
$3,840
$3,840
$3,840
0
1
2
3
4
5
6
Diagram for Interest
Present value of principal to be received at maturity: $64,000 X .63017 (PV of $1 due in 6 periods at 8% from Table 3) ............................................................. Present value of interest to be received annually over the term of the note: $3,840 X 4.62288 (PV of $1 due each period for 6 periods at 8% from Table 4) ................................................................. Present value of note received ..................................................
.
(For Instructor Use Only)
$40,330.88
17,751.86 $58,082.74
D-7
BRIEF EXERCISE D-16 i = 5% ?
$2,600,000
Diagram for Principal
0
1
2
3
4
14
15
16
i = 5% ?
$117,000 $117,000 $117,000 $117,000
$117,000 $117,000 $117,000
Diagram for Interest
0
1
2
3
4
14
15
Present value of principal to be received at maturity: $2,600,000 X 0.45811 (PV of $1 due in 16 periods at 5% from Table 3) ............................................................. Present value of interest to be received periodically over the term of the bonds: $117,000 X 10.83777 (PV of $1 due each period for 16 periods at 5% from Table 4) ....................................................................... Present value of bonds and cash proceeds .............................
16
$1,191,086*
1,268,019 $2,459,105
BRIEF EXERCISE D-17 i = 10% ?
$3,300 $3,300 $3,300 $3,300 $3,300 $3,300 $3,300 $3,300
0
1
2
3
4
5
6
7
8
Discount rate from Table 4 is 5.33493. Present value of 8 payments of $3,300 each discounted at 10% is therefore $17,605.27 ($3,300 X 5.33493). Phil Emley should not purchase the tire retreading machine because the present value of the future cash flows is less than the $18,000 purchase price of the retreading machine.
D-8
.
(For Instructor Use Only)
BRIEF EXERCISE D-18 i = 4% ?
$46,850
$46,850
$46,850
$46,850
$46,850
$46,850
0
1
2
3
4
9
10
Discount rate from Table 4 is 8.11090. Present value of 10 payments of $46,850 each discounted at 4% is therefore $379,995.66 ($46,850 X 8.11090). Jamison Company should receive $379,995.66 from the issuance of the note.
BRIEF EXERCISE D-19 i = 10% ?
$38,000
$40,000
$50,000
0
1
2
3
To determine the present value of the future cash flows, discount the future cash flows at 10%, using Table 3. Year 1 ($38,000 X .90909) = Year 2 ($40,000 X .82645) = Year 3 ($50,000 X .75132) = Present value of future cash flows
$ 34,545.42 33,058.00 37,566.00 $105,169.42
To achieve a minimum rate of return of 10%, Pendley Company should pay no more than $105,169.42. If Pendley pays less than $105,169.42, its rate of return will be greater than 10%.
.
(For Instructor Use Only)
D-9
BRIEF EXERCISE D-20 i=? $4,172.65
$10,000
0
1
2
3
4
14
15
Present value = Future value X Present value of 1 factor $4,172.65 = $10,000 X Present value of 1 factor Present value of 1 factor = $4,172.65 ÷ $10,000 = .41727 The .41727 for 15 periods is found in the 6% column. Barbara Oxford will receive a 6% return.
BRIEF EXERCISE D-21 i = 10% $25,490
$80,000
n=? Present value = Future value X Present value of 1 factor $25,490 = $80,000 X Present value of 1 factor Present value of 1 factor = $25,490 ÷ $80,000 = .31863 The .31863 at 10% is found in the 12 years row. Blake Mohr therefore must wait 12 years to receive $80,000.
D-10
.
(For Instructor Use Only)
BRIEF EXERCISE D-22 i=? ?
$1,000 $1,000 $1,000 $1,000 $1,000 $1,000
0
1
2
3
4
5
6
$1,000 $1,000
19
20
$9,128.55
Present value = Annuity amount X Present value of an annuity factor $9,128.55 = $1,000 X Present value of an annuity factor Present value of an annuity factor = $9,128.55 ÷ $1,000 = 9.12855
The 9.12855 for 20 periods is found in the 9% column. Amanda Tevis will therefore earn a rate of return of 9%.
BRIEF EXERCISE D-23 i = 11% $1,000 $1,000 $1,000 $1,000 $1,000 $1,000
$5,146.12 n=? Present value = Annuity amount X Present value of an annuity factor $5,146.12 = $1,000 X Present value of an annuity factor Present value of an annuity factor = $5,146.12 ÷ $1,000 = 5.14612
The 5.14612 at an interest rate of 11% is shown in the 8-year row. Therefore, Kelly will receive 8 payments.
.
(For Instructor Use Only)
D-11
BRIEF EXERCISE D-24 10
?
–18,000
0
50,000
N
I/YR.
PV
PMT
FV
10.76%
BRIEF EXERCISE D-25 10
?
60,000
–8,860
0
N
I/YR.
PV
PMT
FV
7.80%
BRIEF EXERCISE D-26 40
?
178,000
–8,400
0
N
I/YR.
PV
PMT
FV
3.55% (semiannual)
D-12
.
(For Instructor Use Only)
BRIEF EXERCISE D-27 (a) Inputs:
7
6.9
?
–16,000
0
N
I
PV
PMT
FV
Answer:
86,530.07
(b) Inputs:
10
8.65
?
14,000
200,000
N
I
PV
PMT
FV
Answer:
.
(For Instructor Use Only)
–178,491.52
D-13
BRIEF EXERCISE D-28 (a) Note—set payments at 12 per year. Inputs: 96 7.8
N
I
42,000
?
0
PV
PMT
FV
–589.48
Answer: (b) Note—set payments to 1 per year. Inputs: 5 7.25
8,000
?
0
N
PV
PMT
FV
I
–1,964.20
Answer:
D-14
.
(For Instructor Use Only)
APPENDIX E Reporting and Analyzing Investments Learning Objectives 1. 2. 3. 4. 5. 6.
Identify the reasons corporations invest in stocks and debt securities. Explain the accounting for debt investments. Explain the accounting for stock investments. Describe the purpose and usefulness of consolidated financial statements. Indicate how debt and stock investments are reported in the financial statements. Distinguish between short-term and long-term investments.
Summary of Questions by Learning Objectives and Bloom’s Taxonomy Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Item
LO
BT
Questions 1.
1
K
5.
3
K
9.
3
C
13.
5
C
17.
5
K
2.
2
K
6.
3
AP
10.
3
C
14.
5
C
18.
5
C
3.
2
C
7.
3
K
11.
4
K
15.
5
AP
19.
6
C
4.
2
C
8.
3
C
12.
5
K
16.
5
AP
7.
6
AN
8.
6
AP
7.
5, 6
AN
8.
5, 6
AN
4.
3
AN
6.
6
AP
5.
3, 5, 6
AN
Brief Exercises 1.
2
AP
3.
3
AP
5.
6
AN
2.
3
AP
4.
5
AP
6.
5
AP
Exercises 1.
2
AP
3.
3
AP
5.
3
AP
2.
3
AN
4.
3
AP
6.
5, 6
AP
Problems: Set A 1.
.
2, 5, 6
2. AN
(For Instructor Use Only)
2, 3, 5, 6
3. AN
3, 5, 6
AN
E-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
PE-1
Journalize debt investment transactions.
Moderate
30–40
PE-2
Journalize investment transactions, prepare adjusting entry, and show financial statement presentation.
Moderate
30–40
PE-3
Journalize transactions, prepare adjusting entry for stock investments, and show balance sheet presentation.
Moderate
30–40
PE-4
Prepare entries under cost and equity methods, and prepare memorandum.
Simple
20–30
PE-5
Journalize stock transactions, and show balance sheet presentation.
Moderate
40–50
PE-6
Prepare a balance sheet.
Moderate
30–40
E-2
.
(For Instructor Use Only)
ANSWERS TO QUESTIONS 1.
Companies invest because (1) they have excess cash for a short period of time, or (2) they want to generate investment income or (3) they have strategic reasons such as controlling a competitor or supplier or entering a new industry.
2.
(a)
The cost of an investment in bonds consists of the market price of the bonds plus any brokerage fees.
(b)
Interest is recorded as it is earned; that is, over the life of the investment in bonds.
(a)
Losses and gains on the sale of debt investments are computed by comparing the cost of the securities to the net proceeds from the sale.
(b)
Losses are reported in the income statement under other expenses and losses whereas gains are reported under other revenues and gains.
3.
4.
Townsend Company is incorrect. The gain is the difference between the net proceeds, exclusive of interest, and the cost of the bonds. The correct gain is $4,000 [($45,000 – $1,000) – $40,000].
5.
The cost of an investment in stock includes all expenditures necessary to acquire the investment. These expenditures include the actual purchase price plus any commissions or brokerage fees.
6.
Brokerage fees are part of the cost of the investment. Therefore, the entry is: Stock Investments ........................................................................... Cash ......................................................................................
7.
.
61,500 61,500
(a)
Whenever the investor’s influence on the operating and financial affairs of the investee is significant, the equity method should be used. The major factor in determining significant influence is the percentage of ownership interest held by the investor in the investee. The general guideline for use of the equity method is 20% or more ownership interest. Companies are required to use judgement, however, rather than blindly follow the 20% guideline. For example, 25% ownership in a company that is 75% controlled by another organization would not indicate significant influence.
(b)
Revenue is recognized as it is earned by the investee.
8.
Since Upson Corporation uses the equity method, the income reported by Holland Packing ($80,000) should be multiplied by Upson’s ownership interest (30%) and the result ($24,000) should be debited to Stock Investments and credited to Revenue from Stock Investments. Also, of the total dividend declared and paid by Holland ($10,000) Upson will receive 30% or $3,000. This amount should be debited to Cash and credited to Stock Investments.
9.
Significant influence over an investee may result from representation on the board of directors, participation in policy-making processes, or material intercompany transactions. An investment (direct or indirect) of 20% or more of the voting stock of an investee constitutes significant influence unless there exists evidence to the contrary.
(For Instructor Use Only)
E-3
Questions Appendix E (Continued) 10.
Under the cost method, an investment is originally recorded and reported at cost. Dividends are recorded as revenue. In subsequent periods, it is adjusted to fair value and an unrealized holding gain or loss is recognized and included in income (trading security) or as separate component of stockholders’ equity (available-for-sale security). Under the equity method, the investment is originally recorded and reported at cost; subsequently, the investment account is adjusted during each period for the investor’s share of the earnings or losses of the investee. The investor’s share of the investee's earnings is recognized in the earnings of the investor. Dividends received from the investee are reductions in the carrying amount of the investment.
11.
Consolidated financial statements present the assets and liabilities controlled by the parent company and the total revenues and expenses of the affiliated companies. Consolidated financial statements are useful to the stockholders, board of directors, and management of the parent company.
12.
The valuation and reporting of investments is as follows: Category Trading Available-for-sale
13.
Diana should report the data as follows: (1) (2)
14.
Under current assets in the balance sheet: Short-term investments, at fair value ....................................................... Under other expenses and losses in the income statement: Unrealized Loss—Income .......................................................................
(2)
Under investments in the balance sheet: Investments in stock of less than 20% owned companies, at fair value ... Under stockholders’ equity in the balance sheet: Less: Unrealized loss on available-for-sale securities ............................
E-4
$70,000 $(4,000)
8,000 8,000
The entry is: Fair Value Adjustment—Trading ..................................................... Unrealized Gain—Income ......................................................
17.
$(4,000)
The entry is: Fair Value Adjustment—Available-for-Sale ..................................... Unrealized Gain or Loss—Equity ...........................................
16.
$70,000
Diana should report as follows: (1)
15.
Valuation and Reporting At fair value with changes reported in net income At fair value with changes adjusted through equity
8,000 8,000
Unrealized Gain or Loss—Equity is reported in stockholders’ equity. It is not included in the computation of net income.
.
(For Instructor Use Only)
Questions Appendix E (Continued) 18.
Reporting Unrealized Gains (Losses)—Equity in the stockholders’ equity section serves two important purposes: (1) it reduces the volatility of net income due to fluctuations in fair value, and (2) it still informs the financial statement user of the gain or loss that would occur if the securities were sold at fair value.
19.
The investment in Kriley Corporation stock is not a short-term investment because there is no intent to convert the stock into cash within a year or the operating cycle, whichever is longer.
.
(For Instructor Use Only)
E-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE E-1 Jan. July
1 1
Debt Investments.......................................... Cash .......................................................
40,800
Cash .............................................................. Interest Revenue ...................................
1,660
40,800 1,660
BRIEF EXERCISE E-2 Aug. Dec.
1 1
Stock Investments ........................................ Cash .......................................................
35,600
Cash .............................................................. Stock Investments ................................. Gain on Sale of Stock Investments ........................................
38,000
35,600 35,600 2,400
BRIEF EXERCISE E-3 Dec. 31
31
Stock Investments ........................................ Revenue from Stock Investments (25% X $150,000) ................................
37,500
Cash (25% X $60,000) ................................... Stock Investments .................................
15,000
37,500 15,000
BRIEF EXERCISE E-4 Dec. 31
E-6
Unrealized Loss—Income ............................ Fair Value Adjustment—Trading ($62,000 – $59,600) .............................
.
(For Instructor Use Only)
2,400 2,400
BRIEF EXERCISE E-5 Balance Sheet Current assets Short-term investments, at fair value ..............................
$59,600
Income Statement Other expenses and losses Unrealized Loss—Income.................................................
2,400
BRIEF EXERCISE E-6 Dec. 31
Unrealized Gain or Loss—Equity .................. Fair Value Adjustment— Available-for-Sale .................................
3,000 3,000
BRIEF EXERCISE E-7 Balance Sheet Investments Investments in stock of less than 20% owned companies, at fair value....................................................
$69,000
Stockholders’ Equity Less: Unrealized loss on available-for-sale securities.....
$ 3,000
BRIEF EXERCISE E-8 Investments Bond sinking fund............................................................... Investments in stock of less than 20% owned companies, at fair value................................................... Investment in stock of 20–50% owned company, at equity ............................................................................ Total investments ........................................................
.
(For Instructor Use Only)
$150,000 112,000 230,000 $492,000
E-7
SOLUTIONS TO EXERCISES EXERCISE E-1 (a) Jan. 1 July 1 1
(b) Dec. 31
Debt Investments ................................... Cash .................................................
90,000
Cash ($90,000 X 10% X 1/2).................... Interest Revenue .............................
4,500
Cash ....................................................... Debt Investments ($90,000 X 30/90)........................... Gain on Sale of Debt Investments ($32,000 – $30,000) .......................
32,000
Interest Receivable ................................. Interest Revenue ($60,000 X 10% X 1/2) ...................
3,000
Stock Investments .................................. Cash .................................................
8,400
Cash (1,200 X $2) .................................... Dividend Revenue ...........................
2,400
Cash ........................................................ Stock Investments ($8,400 X 500/1,200)...................... Gain on Sale of Stock Investments ($5,400 – $3,500) ...........................
5,400
Cash (700 X $1) ....................................... Dividend Revenue ...........................
700
90,000 4,500
30,000 2,000
3,000
EXERCISE E-2 (a) Feb. 1 July 1 Sept. 1
Dec. 1
8,400 2,400
3,500 1,900 700
(b) Dividend revenue and the gain on sale of stock investments are reported under other revenues and gains in the income statement.
E-8
.
(For Instructor Use Only)
EXERCISE E-3 Jan.
1
July
1
Dec.
1
Dec. 31
Stock Investments ....................................... Cash .....................................................
59,200
Cash (1,200 X $7) ......................................... Dividend Revenue ................................
8,400
Cash ........................................................... Stock Investments ($59,200 X 900/1,200) ........................ Gain on Sale of Stock Investments .....
47,200
Cash (300 X $7) ............................................ Dividend Revenue ................................
2,100
59,200 8,400
44,400 2,800 2,100
EXERCISE E-4 (a) Jan. 1 Dec. 31 Dec. 31
Stock Investments ............................... Cash ...............................................
150,000
Cash ($80,000 X 25%)........................... Stock Investments ........................
20,000
Stock Investments ............................... Revenue from Stock Investments ($380,000 X 25%)...
95,000
(b) Investment in Dougherty, January 1 ..................... Less: Dividend received ....................................... Plus: Share of reported income .......................... Investment in Dougherty, December 31 ...............
.
(For Instructor Use Only)
150,000 20,000
95,000 $150,000 20,000 95,000 $225,000
E-9
EXERCISE E-5 2014 Mar. 18
1.
June 30
Dec. 31
2.
Stock Investments ................................. Cash (300,000 X 12% X $14) ..........
504,000
Cash ....................................................... Dividend Revenue ($75,000 X 12%) ...........................
9,000
Fair Value Adjustment— Available-for-Sale ............................... Unrealized Gain or Loss—Equity ($576,000 – $504,000) ..................
Jan. 1 June 15
Dec. 31
504,000
9,000 72,000 72,000
Stock Investments ................................. Cash (30,000 X 25% X $11) ............
82,500
Cash ....................................................... Stock Investments ($35,000 X 25%) ...........................
8,750
Stock Investments ................................. Revenue from Stock Investments ($120,000 X 25%)...........................
30,000
Unrealized Loss—Income ..................... Fair Value Adjustment—Trading ...
4,800
82,500
8,750
30,000
EXERCISE E-6 (a) Dec. 31 (b)
E-10
4,800
Balance Sheet Current assets Short-term investments, at fair value .............
$48,800
Income Statement Other expenses and losses Unrealized Loss—Income ................................
$ 4,800
.
(For Instructor Use Only)
EXERCISE E-7 (a) Dec. 31
Unrealized Gain or Loss—Equity .............. Fair Value Adjustment— Available-for-Sale .............................
(b)
4,800 4,800
Balance Sheet Investments Investments in stock of less than 20% owned companies, at fair value ....................................
$48,800
Stockholders’ equity Less: Unrealized loss on available-for-sale securities ...................................................
$ 4,800
(c) Dear Ms. Parks: Investments which are classified as trading (held for sale in the near term) are reported at fair value in the current asset section of the balance sheet, with unrealized gains or losses reported in net income. Investments which are classified as available-for-sale (held longer than trading but not to maturity) are also reported at fair value in either the current assets section or the investment section of the balance sheet, but unrealized gains or losses are reported in the stockholders’ equity section of the balance sheet. Fair value is used as a reporting basis because it represents the cash realizable value of the securities. Unrealized gains or losses on trading investments are reported in the income statement because of the likelihood that the securities will be sold at fair value in the near term. Unrealized gains or losses on available-for-sale securities are reported in stockholders’ equity rather than in income because there is a significant chance that future changes in fair value will reverse unrealized gains or losses. To avoid distorting income with these fluctuations, they are reported directly in stockholders’ equity. I hope the preceding discussion clears up any misunderstandings. Please contact me if you have any questions. Sincerely, Student .
(For Instructor Use Only)
E-11
EXERCISE E-8 (a) Fair Value Adjustment—Trading ($122,000 – $110,000) ....................................... Unrealized Gain—Income ............................ Unrealized Gain or Loss—Equity ....................... Fair Value Adjustment— Available-for-Sale ...................................... (b)
12,000 12,000 4,000
Balance Sheet Current assets Short-term investments, at fair value ....................... Investments Investments in stock of less than 20% owned companies, at fair value.......................................... Stockholders’ equity Less: Unrealized loss on available-for-sale securities......................................................... Income Statement Other revenues and gains Unrealized gain—income...........................................
E-12
4,000
.
(For Instructor Use Only)
$122,000 96,000 $ 4,000
$ 12,000
SOLUTIONS TO PROBLEMS PROBLEM E-1
2014 Jan. 1 July 1 Dec. 31 2017 Jan. 1 1
July 1 Dec. 31
.
Debt Investments .............................. Cash ............................................
600,000
Cash ($600,000 X .07 X 1/2)............... Interest Revenue ........................
21,000
Interest Receivable ........................... Interest Revenue ........................
21,000
Cash ................................................... Interest Receivable ....................
21,000
Cash ($300,000 X 1.10) ..................... Debt Investments ....................... Gain on Sale of Debt Investments .............................
330,000
Cash ($300,000 X .07 X 1/2)............... Interest Revenue ........................
10,500
Interest Receivable ........................... Interest Revenue ........................
10,500
(For Instructor Use Only)
600,000 21,000 21,000
21,000 300,000 30,000 10,500 10,500
E-13
PROBLEM E-2
(a) Feb. 1 Mar. 1 Apr. 1 July 1 Aug. 1
Sept. 1 Oct. 1 1
Stock Investments ..................................... Cash ....................................................
51,600
Stock Investments ..................................... Cash ....................................................
18,500
Debt Investments ....................................... Cash ....................................................
70,000
Cash ($0.80 X 1,200) .................................. Dividend Revenue ...............................
960
Cash ($200 X $42) ...................................... Loss on Sale of Stock Investments .......... Stock Investments [($51,600 ÷ 1,200) X 200] ..................
8,400 200
Cash ($2 X 500) .......................................... Dividend Revenue ...............................
1,000
Cash ($70,000 X 08% X 1/2) ....................... Interest Revenue .................................
2,800
Cash .......................................................... Debt Investments ................................ Gain on Sale of Debt Investments ($75,700 – $70,000)...........................
75,700
Stock Investments Feb. 1 51,600 Aug. 1 Mar. 1 18,500 Dec. 31 Bal. 61,500
E-14
.
(For Instructor Use Only)
8,600
51,600 18,500 70,000 960
8,600 1,000 2,800
Debt Investments Apr. 1 70,000 Oct. 1 Dec. 31 Bal. 0
70,000 5,700
70,000
PROBLEM E-2 (Continued) (b) Dec. 31
Unrealized Loss—Income ................. Fair Value Adjustment—Trading
Security ALF common LNC common
Cost $43,000* 18,500 $61,500
7,500 7,500
Fair Value $39,000 (1,000 X $39) 15,000 (500 X $30) $54,000
*$51,600 – $8,600 (c) Current assets Short-term investments, at fair value .......................
$54,000
(d) Other revenues and gains: Dividend Revenue, Interest Revenue, and Gain on Sale of Debt Investments. Other expenses and losses: Loss on Sale of Stock Investments, and Unrealized Loss—Income.
.
(For Instructor Use Only)
E-15
PROBLEM E-3
(a) 2014 July 1 Aug. 1 Sept. 1
Oct.
1
Nov. 1 Dec. 15 31
Cash (5,000 X $2.00) ............................... Dividend Revenue ..............................
10,000
Cash (1,000 X $0.50) ............................... Dividend Revenue ..............................
500
Cash (1,000 X $9) .................................... Stock Investments (1,000 X $7.20) .... Gain on Sale of Stock Investments ...................................
9,000
Cash (300 X $53) ..................................... Stock Investments (300 X $48) .......... Gain on Sale of Stock Investments [$15,900 – (300 X $48)] ..................
15,900
Cash (1,200 X $1) .................................... Dividend Revenue ..............................
1,200
Cash (700 X $0.50) .................................. Dividend Revenue ..............................
350
Cash (4,000 X $2.20) ............................... Dividend Revenue ..............................
8,800
2014 Jan. 1 Balance 2014 Dec. 31 Balance
E-16
.
(For Instructor Use Only)
Stock Investments 2014 108,000 Sept. 1 Oct. 1 86,400
10,000 500 7,200 1,800 14,400 1,500 1,200 350 8,800
7,200 14,400
PROBLEM E-3 (Continued) (b) Dec. 31
Fair Value Adjustment—Availablefor-Sale ($89,700 – $86,400)............. Unrealized Gain or Loss—Equity ....
Security A Co. common B Co. common C Co. common
Cost $33,600* 28,800** 24,000 $86,400
3,300 3,300
Fair Value $32,900 ( 700 X $47) 28,000 (4,000 X $ 7) 28,800 (1,200 X $24) $89,700
*$48,000 – $14,400 **$36,000 – $7,200 (c) Investments Investments in stock of less than 20% owned companies, at fair value .............. Stockholders’ equity Common stock ............................................ Retained earnings ....................................... Total paid-in capital and retained earnings............................................. Plus: Unrealized gain on availablefor-sale securities ............................ Total stockholders’ equity...................
.
(For Instructor Use Only)
$
89,700
$2,000,000 1,200,000 3,200,000 3,300 $3,203,300
E-17
PROBLEM E-4
(a) 2014 Jan.
1
June 30
Dec. 31
(b) 2014 Jan.
1
June 30 Dec. 31 31
E-18
.
Stock Investments ............................. Cash ............................................
1,800,000
Cash ................................................... Dividend Revenue (60,000 X $0.50) .......................
30,000
Cash ................................................... Dividend Revenue (60,000 X $0.50) .......................
30,000
Stock Investments ............................. Cash ............................................
1,800,000
Cash ................................................... Stock Investments......................
30,000
Cash ................................................... Stock Investments......................
30,000
Stock Investments ............................. Revenue from Stock Investments ($800,000 X 30%) .......................
240,000
(For Instructor Use Only)
1,800,000
30,000
30,000
1,800,000 30,000 30,000
240,000
PROBLEM E-4 (Continued) (c)
MEMO To:
Board of Directors
From:
Student
Re:
Cost and equity methods
Under the cost method of accounting for investments, the investment is recorded at cost and revenue is recognized only when cash dividends are received. Under the equity method, the investment is initially recorded at cost, and the investment account is adjusted annually to show the investor’s equity in the investee. The investment account is increased for the investor’s share of the investee’s net income. Dividends received are recorded as a reduction of the investment account instead of as dividend revenue. The table below illustrates the differences in account balances for Farwell Company’s investment in Ingold Inc. at December 31, 2014.
Stock investments Dividend revenue Revenue from stock investments
Cost Method $1,800,000 60,000 0
Equity Method $1,980,000* 0 240,000
*$1,800,000 – $60,000 + $240,000
.
(For Instructor Use Only)
E-19
PROBLEM E-5
(a) Jan. 20
Cash (1,400 X $55) .................................. Investment in Tabares Inc. Common Stock ............................. Gain on Sale of Stock Investments ..................................
28
Investment in M. Powell Corporation Common Stock .................................... Cash (400 X $78) ..............................
30
Feb.
8 18
July 30
Sept.
Dec.
E-20
6
3,500 31,200 31,200 1,500
Cash ........................................................ Dividend Revenue ($0.40 X 800) .....
320
Cash ($35 X 800) ..................................... Loss on Sale of Stock Investments....... Investment in H. Hogan Corporation Preferred Stock ............................
28,000 5,600
Cash ........................................................ Dividend Revenue ($1.10 X 1,200) ..............................
1,320
Cash ........................................................ Dividend Revenue ($1.50 X 1,000) ...............................
.
73,500
Cash ........................................................ Dividend Revenue ($1.25 X 1,200) ...............................
Investment in M. Powell Corporation Common Stock .................................... Cash ($82 X 600) ..............................
1
77,000
(For Instructor Use Only)
1,500 320
33,600
1,320 49,200 49,200 1,500 1,500
PROBLEM E-5 (Continued) (b) Investment in Tabares Inc. Common Stock 1/1 Bal. 73,500 1/20 73,500 12/31 Bal. 0
Investment in Munoz Corporation Common Stock 1/1 Bal. 84,000 12/31 Bal. 84,000
Investment in H. Hogan Corporation Preferred Stock 1/1 Bal. 33,600 2/18 33,600 12/31 Bal. 0
Investment in M. Powell Corporation Common Stock 1/28 31,200 9/6 49,200 12/31 Bal. 80,400
(c) Dec. 31
Unrealized Gain or Loss—Equity ............ Fair Value Adjustment—Availablefor-Sale ($164,400 – $155,000) .......
Security Munoz Corporation common M. Powell Corporation common
Cost $ 84,000 80,400 $164,400
9,400
Fair Value $ 78,000 (1,200 X $65) 77,000 (1,000 X $77) $155,000
(d) Investments Investments in stock of less than 20% owned companies, at fair value ......................................... Stockholders’ equity Total paid-in capital and retained earnings Less: Unrealized loss on availablefor-sale securities........................................... Total stockholders’ equity..................................
.
(For Instructor Use Only)
9,400
$155,000 XXXXX 9,400 $ XXXXX
E-21
PROBLEM E-6
WELLMAN CORPORATION Balance Sheet December 31, 2014 Current assets Cash ......................................................................... $ 63,000 (Short-term investments, at fair value) .................. 128,000 Accounts receivable ............................................... $ 90,000 Less: Allowance for doubtful accounts ................ 6,000 84,000 Inventory .................................................................. 170,000 Prepaid insurance ................................................... 16,000 Total current assets ......................................... 461,000 Investments Debt investments ...................................................... Stock Investments (Lawton Inc. stock, 30% ownership, at equity) .... Total investments............................................. Property, plant, and equipment Land .......................................................... Buildings .................................................. $900,000 Less: Accumulated depreciation— buildings ....................................... 180,000 Equipment ................................................ 275,000 Less: Accumulated depreciation— equipment ..................................... 52,000 Total property, plant, and equipment ..................................... Intangibles Goodwill ..................................................................... Total assets.....................................................................
E-22
.
(For Instructor Use Only)
400,000 240,000 640,000 410,000 720,000 223,000 1,353,000 190,000 $2,644,000
PROBLEM E-6 (Continued) WELLMAN CORPORATION Balance Sheet (Continued) December 31, 2014 Liabilities and Stockholders’ Equity Current liabilities Notes payable ....................................................... $ 70,000 Accounts payable ................................................ 150,000 Dividends payable................................................ 50,000 Income taxes payable .......................................... 70,000 Total current liabilities .................................. $ 340,000 Long-term liabilities Bonds payable, 10% due 2025 ............................ Less: Discount on bonds payable ..................... Total long-term liabilities .............................. Total liabilities .............................................................
350,000 20,000 330,000 670,000
Stockholders’ equity Paid-in capital Common stock, $5 par value, 500,000 shares authorized, 240,000 shares issued and outstanding ............................. $1,200,000 Paid-in capital in excess of par value .......... 464,000 Total paid-in capital ............................... 1,664,000 Retained earnings ................................................ 310,000 Total stockholders’ equity..................... 1,974,000 Total liabilities and stockholders’ equity ........... $2,644,000
.
(For Instructor Use Only)
E-23
E-24
.
(For Instructor Use Only)
APPENDIX F Payroll Accounting ASSIGNMENT CLASSIFICATION TABLE Learning Objectives
Questions
Brief Exercises
Exercises Problems
1.
Compute and record the payroll for a pay period.
1, 2, 3, 5, 6, 7,
1, 2
1, 2, 3, 4
1, 2, 3
2.
Describe and record employer payroll taxes.
2, 3, 4, 8
3
3, 5
1, 2, 3
3.
Discuss the objectives of internal control for payroll.
9, 10
4
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
4
(For Instructor Use Only)
F-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
Description
Difficulty Level
Time Allotted (min.)
F-1
Prepare payroll register and payroll entries.
Simple
30–40
F-2
Journalize payroll transactions and adjusting entries.
Moderate
30–40
F-3
Prepare entries for payroll and payroll taxes, and prepare W-2 data.
Moderate
30–40
F-4
Identify internal control weaknesses and make recommendations for improvement.
Simple
20–30
F-2
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
ANSWERS TO QUESTIONS 1.
Gross pay is the amount an employee actually earns. Net pay, the amount an employee is paid, is gross pay reduced by both mandatory and voluntary deductions, such as FICA taxes, union dues, federal income taxes, etc. Gross pay should be recorded as wages or salaries expense.
2.
Both employees and employers are required to pay FICA taxes.
3.
No. When an employer withholds federal or state income taxes from employee paychecks, the employer is merely acting as a collection agent for the taxing body. Since the employer holds employees’ funds, these withholdings are a liability for the employer until they are remitted to the government.
4.
FICA stands for Federal Insurance Contribution Act; FUTA stands for Federal Unemployment Tax Act; and SUTA stands for State Unemployment Tax Act.
5.
A W-4 statement shows the employee’s name, address, social security number, marital status, and the number of allowances claimed for income tax withholding purposes. A W-2 statement contains the employee’s name, address, social security number, wages, tips, other compensation, social security taxes withheld, wages subject to social security taxes, and federal, state and local income taxes withheld.
6.
Payroll deductions can be classified as either mandatory (required by the government) or voluntary (not required by the government). Mandatory deductions include FICA taxes and income taxes. Examples of voluntary deductions are health and life insurance premiums, pension contributions, union dues, and charitable contributions.
7.
The employee earnings record is used in: (1) determining when an employee has earned the maximum earnings subject to FICA taxes, (2) filing state and federal payroll tax returns, and (3) providing each employee with a statement of gross earnings and tax withholdings for the year.
8.
(a) The three types of taxes are: (1) FICA, (2) federal unemployment, and (3) state unemployment. (b) The tax liability accounts are classified as current liabilities in the balance sheet. Payroll Tax Expense is classified under operating expenses in the income statement.
9.
The main internal control objectives associated with payrolls are: (1) to safeguard company assets from unauthorized payments of payrolls and (2) to ensure the accuracy and reliability of the accounting records pertaining to payrolls.
10.
The four functions associated with payroll are: (1) hiring employees, (2) timekeeping, (3) preparing the payroll, and (4) paying the payroll.
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
F-3
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE F-1 Gross earnings: Regular pay (40 X $14) ........................................... Overtime pay (5 X $21) .......................................... Gross earnings .............................................................. Less: FICA taxes payable ($665 X 7.65%) ................... Federal income taxes payable ........................... Net pay ...........................................................................
$560.00 105.00
$665.00 $665.00
$ 50.87 95.00
145.87 $519.13
BRIEF EXERCISE F-2 Jan. 15
15
(a) Salaries and Wages Expense ............... FICA Taxes Payable ($665 X 7.65%) ........................... Federal Income Taxes Payable..... Salaries and Wages Payable ........
665.00
(b) Salaries and Wages Payable ................ Cash ...............................................
519.13
50.87 95.00 519.13 519.13
BRIEF EXERCISE F-3 Jan. 31
Payroll Tax Expense ..................................... FICA Taxes Payable ($70,000 X 7.65%) ............................. Federal Unemployment Taxes Payable ($70,000 X .8%) .................... State Unemployment Taxes Payable ($70,000 X 5.4%) ..................
9,695 5,355 560 3,780
BRIEF EXERCISE F-4 (a) Timekeeping (b) Hiring
(c) Preparing the payroll (d) Paying the payroll
F-4
Kimmel, Accounting, 5e, Solutions Manual
Copyright © 2012 John Wiley & Sons, Inc.
(For Instructor Use Only)
SOLUTIONS TO EXERCISES EXERCISE F-1 (a) 1.
Regular 40 X $16.00 = $640.00 Overtime 2 X $24.00 = 48.00 Gross earnings $688.00
2.
FICA taxes—$52.63 = ($688 X 7.65%).
3.
Federal income taxes $61.
4.
State income taxes $13.76 = ($688 X 2%).
5.
Net pay $545.61 = ($688.00 – $52.63 – $61.00 – $13.76 – $15.00).
(b) Salaries and Wages Expense ................................... FICA Taxes Payable ............................................ Federal Income Taxes Payable .......................... State Income Taxes Payable .............................. Health Insurance Payable................................... Salaries and Wages Payable ..............................
688.00 52.63 61.00 13.76 15.00 545.61
EXERCISE F-2 C. Sotelo
$4,500 X 7.65% = $344.25. Sotelo’s total gross earnings for the year are $98,000 = ($93,500 + $4,500), which is below the $110,100 maximum for FICA taxes.
D. Marshall
$ 2,000 X 7.65% = $ 153.00. Marshall’s total gross earnings for the year are $ 112,600. Thus, only $ 2,000 of the gross earnings ($4,500 – $ 2,500) for this pay period are subject to FICA taxes.
L. Griner
$ 3,500 X 7.65% = $ 267.75Griner’s total gross earnings for the year are $ 111,100. Thus, only $ 3,500 of the gross earnings ($4,500 – $ 1,000) for this pay period are subject to FICA taxes.
T. Ziegler
$0. Ziegler’s gross earnings prior to this pay exceeds the maximum amount subject to FICA taxes. Thus, none of the gross earnings in the December 31 pay period is subject to FICA taxes.
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
F-5
EXERCISE F-3 (a) See next page. (b) Jan. 31
31
Salaries and Wages Expense ............. FICA Taxes Payable .................... Federal Income Taxes Payable..................................... Health Insurance Payable ........... Salaries and Wages Payable ......
1,604.00
Payroll Tax Expense ........................... FICA Taxes Payable .................... Federal Unemployment Taxes Payable ($1,604 X .8%) ............ State Unemployment Taxes Payable ($1,604 X 5.4%) ..........
222.16
122.71 129.00 40.00 1,312.29 122.71 12.83 86.62
EXERCISE F-4 (a) (1) (2) (3) (4) (5)
$1,100 [$10,000 see (2) below – $8,900]. $10,000 (FICA taxes $765 ÷ 7.65%). $300 ($10,000 X 3%). $2,305 ($10,000 – $7,695). $10,000
(b) Feb. 28
Salaries and Wages Expense ............ FICA Taxes Payable .................... Federal Income Taxes Payable .................................... State Income Taxes Payable .................................... Union Dues Payable .................... Salaries and Wages Payable ...................................... 28
F-6
Salaries and Wages Payable .............. Cash .............................................
Copyright © 2012 John Wiley & Sons, Inc.
10,000 765 1,140 300 100 7,695 7,695
Kimmel, Accounting, 5e, Solutions Manual
7,695
(For Instructor Use Only)
EXERCISE F-3 (Continued)
Copyright © 2012 John Wiley & Sons, Inc. Kimmel, Accounting, 5e, Solutions Manual
(a)
PALMAIRO COMPANY Payroll Register For the Week Ending January 31 Earnings
Employee M. Pinson E. Tavaras K. Helton Totals
Total Hours 46 42 44
Deductions
Regular
Overtime
Gross Pay
FICA Taxes
Federal Income Taxes
Health Insurance
Total
Net Pay
$ 400.00 480.00 520.00 $1,400.00
$ 90.00 36.00 78.00 $204.00
$ 490.00 516.00 598.00 $1,604.00
$ 37.49 39.47 45.75 $122.71
$ 34.00 37.00 58.00 $129.00
$10.00 15.00 15.00 $40.00
$ 81.49 91.47 118.75 $291.71
$ 408.51 424.53 479.25 $1,312.29
(For Instructor Use Only)
F-7
EXERCISE F-5 (a) FICA tax ($730,000 X 7.65%)..................................... SUTA tax ($40,000 X 5.4%) ....................................... FUTA tax ($40,000 X 0.8%) ....................................... Total payroll tax ................................................. (b) Payroll Tax Expense ................................................. FICA Taxes Payable .......................................... State Unemployment Taxes Payable ............... Federal Unemployment Taxes Payable ...........
F-8
Copyright © 2012 John Wiley & Sons, Inc.
$55,845 2,160 320 $58,325 58,325
Kimmel, Accounting, 5e, Solutions Manual
55,845 2,160 320
(For Instructor Use Only)
Earnings
Employee
Hours
Regular
Overtime
Ben Agler Rita Hager JackNeuer Sue Perez Totals
40 42 44 46
560.00 520.00 520.00 520.00 2,120.00
0 39.00 78.00 117.00 234.00
Deductions Gross Pay
FICA
Fed.
State
U.F.
Total
Net Pay
560.00 559.00 598.00 637.00 2,354.00
42.84 42.76 45.75 48.73 180.08
66.00 33.00 60.00 51.00 210.00
16.80 16.77 17.94 19.11 70.62
5.00 5.00 8.00 5.00 23.00
130.64 97.53 131.69 123.84 483.70
429.36 461.47 466.31 513.16 1,870.30
Salaries and Wages Expense 560.00 559.00 598.00 0,637.00 2,354.00.
PROBLEM F-1
Kimmel, Accounting, 4/e, Solutions Manual
MARIS HARDWARE Payroll Register For the Week Ending March 15, 2014
(For Instructor Use Only)
SOLUTIONS TO PROBLEMS
Copyright © 2012 John Wiley & Sons, Inc.
(a)
F-9
PROBLEM F-1 (Continued) (b) Mar. 15
15
(c) Mar. 16
(d) Mar. 31
F-10
Salaries and Wages Expense ............. FICA Taxes Payable .................... Federal Income Taxes Payable..................................... State Income Taxes Payable....... United Fund Contributions Payable..................................... Salaries and Wages Payable ......
2,354.00
Payroll Tax Expense ........................... FICA Taxes Payable ($2,354 X 7.65%) ...................... Federal Unemployment Taxes Payable ($2,354 X .8%) ............ State Unemployment Taxes Payable ($2,354 X 5.4%) ..........
326.03
Salaries and Wages Payable .............. Cash .............................................
1,870.30
FICA Taxes Payable ($180.08 + $180.08).......................... Federal Income Taxes Payable .......... Cash .............................................
Copyright © 2012 John Wiley & Sons, Inc.
180.08 210.00 70.62 23.00 1,870.30
180.08 18.83 127.12
1,870.30
360.16 210.00
Kimmel, Accounting, 5e, Solutions Manual
570.16
(For Instructor Use Only)
PROBLEM F-2
(a) Jan. 10 12
15 17 20
Union Dues Payable ...................... Cash ........................................
870.00
FICA Taxes Payable ....................... Federal Income Taxes Payable ..... Cash ........................................
760.00 1,004.60
U.S. Savings Bonds Payable......... Cash ........................................
360.00
State Income Taxes Payable ......... Cash ........................................
108.95
Federal Unemployment Taxes Payable ....................................... State Unemployment Taxes Payable ....................................... Cash ........................................
31
Salaries and wages Expense ........ FICA Taxes Payable ............... Federal Income Taxes Payable ............................... State Income Taxes Payable ............................... United Fund Contributions Payable ............................... Union Dues Payable ............... Salaries and Wages Payable . 31
Salaries and Wages Payable ......... Cash ........................................
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
870.00
1,764.60 360.00 108.95 288.95 1,954.40 2,243.35 43,000 3,289.50 1,684 360 1,888 400 35,378.50 35,378.50 35,378.50
(For Instructor Use Only)
F-11
PROBLEM F-2 (Continued) (b) Jan. 31
31
F-12
Payroll Tax Expense ........................... FICA Taxes Payable ($43,000 X 7.65%) .................... Federal Unemployment Taxes Payable ($43,000 X .8%) .......... State Unemployment Taxes Payable ($43,000 X 5.4%) ........ Vacation Benefits Expense ($43,000 X 6%) ................................. Vacation Benefits Payable ..........
Copyright © 2012 John Wiley & Sons, Inc.
5,955.50 3,289.50 344 2,322 2,580
Kimmel, Accounting, 5e, Solutions Manual
2,580
(For Instructor Use Only)
PROBLEM F-3
(a) Salaries and Wages Expense ................................ 650,000Delete this blank line ........................................................................ FICA Taxes Payable 43,299 Federal Income Taxes Payable ...................... 188,000 State Income Taxes Payable .......................... 16,900 United Fund Contributions Payable .............. 32,500 Hospital Insurance Premiums Payable.......... 20,300 Salaries and Wages Payable .......................... 349,001 (b) Payroll Tax Expense ............................................... FICA Taxes Payable ($566,000 X 7.65%)........ Federal Unemployment Taxes Payable ($145,000 X .8%) .......................................... State Unemployment Taxes Payable ($145,000 X 2.5%) ........................................ (c) Employee Maria Sandoval Andrea Mingenback
Wages, Tips, Other Compensati on $58,000 28,000
Federal Income Tax Withheld 8 $28,500 10,800
State Income Tax Withheld
48,084 43,299 1,160 3,625
FICA Wages
FICA Tax Withheld
$1,508 (1) $58,000 728 (2) 28,000
$4,437 2,142
(1) $58,000 X 2.6%. (2) $28,000 X 2.6%.
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
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F-13
PROBLEM F-4
1.
2.
F-14
(a) Weaknesses
(b) Recommended Procedures
•
Department managers have too much authority in hiring.
•
The human resources department should do the hiring.
•
An interview should not be the sole basis for hiring or rejecting an applicant.
•
The qualifications of each applicant should be determined and letters of recommendation should be obtained.
•
The pay rate should not be manually written on the W-4 form.
•
The human resources department should notify the payroll department of new hires through a hiring authorization form.
•
The chief accountant manually signs the payroll checks.
•
The treasurer should sign the payroll checks. A checkwriter should be used.
•
The department managers distribute the payroll checks.
•
A representative of the treasurer’s department should distribute the payroll checks.
•
The department managers retain custody of unclaimed checks.
•
A representative of the treasurer’s department should have custody of unclaimed checks.
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PROBLEM F-4 (Continued)
3.
(a) Weaknesses
(b) Recommended Procedures
•
•
The assignment of duties among the payroll clerks does not result in any independent internal verification.
Copyright © 2012 John Wiley & Sons, Inc.
The duties of the payroll clerks should be assigned so that one clerk computes gross earnings for all employees. Then the computations made should be verified by the clerk that did not make the initial determination of the data. Each month the duties of the clerks should be reversed.
Kimmel, Accounting, 5e, Solutions Manual
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F-15
APPENDIX G Subsidiary Ledgers and Special Journals ASSIGNMENT CLASSIFICATION TABLE Learning Objectives
Questions
1.
Describe the nature and purpose of a subsidiary ledger.
1, 2, 5, 7, 12
2.
Explain how special journals are used in journalizing.
3.
Indicate how a multi-column journal is posted.
Copyright © 2012 John Wiley & Sons, Inc.
Brief Exercises
Exercises
Problems
1, 2
1, 2, 3, 4, 5, 7, 9, 10
1, 2, 3, 4, 5, 6
3, 4, 6, 7, 9, 10, 11, 13
3, 4, 6, 7
1, 3, 4, 5, 6, 7, 8, 10
1, 2, 3, 4, 5, 6
8, 12
5
3, 9, 11
1, 2, 3, 4, 5, 6
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G-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
G-2
Description
Difficulty Level
Time Allotted (min.)
1
Journalize transactions in cash receipts journal; post to control account and subsidiary ledger.
Simple
30–40
2
Journalize transactions in cash payments journal; post to control account and subsidiary ledger.
Simple
30–40
3
Journalize transactions in multi-column purchases journal; post to the general and subsidiary ledgers.
Moderate
40–50
4
Journalize transactions in special journals.
Moderate
50–60
5
Journalize in sales and cash receipts journals; post; prepare a trial balance; prove control to subsidiary; prepare adjusting entries; prepare an adjusted trial balance.
Moderate
60–70
6
Journalize in special journals; post; prepare a trial balance.
Complex
60–70
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
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ANSWERS TO QUESTIONS 1.
A subsidiary ledger is a group of accounts with a common characteristic. The subsidiary ledger frees the general ledger from details concerning individual balances. The advantages of using subsidiary ledgers are that they: • • • •
2.
Show transactions affecting a single customer or single creditor in a single account, thus providing necessary up-to-date information on specific account balances. Free the general ledger of excessive details. As a result, a trial balance of the general ledger does not contain potentially thousands and thousands of individual account balances. Assist in locating errors in individual accounts by reducing the number of accounts combined in one ledger and by using controlling accounts. Permit a division of labor in posting by having one employee post to the general ledger while someone else posts to the subsidiary ledgers.
(a) (1) Individual transactions are generally posted daily to the subsidiary accounts. (2) In contrast, postings to the control accounts are usually made in total at the end of the month. (b) A control account is a general ledger account that summarizes subsidiary ledger data. Subsidiary ledger accounts keep track of specific account activity (i.e., specific debtors or creditors). A subsidiary ledger is an addition to, and an expansion of, the general ledger.
3.
Sales journal. Records entries for all sales of merchandise on account. Cash receipts journal. Records entries for all cash received by the business. Purchases journal. Records entries for all purchases of merchandise on account. Cash payments journal. Records entries for all cash paid. Some advantages of each journal are given below: •
•
• •
Sales journal. (1) Since the sales journal employs one column to record an Accounts Receivable debit and a Sales credit and another column to record Cost of Goods Sold debit and Merchandise Inventory credit, its use reduces recording time; (2) the credit to Sales is only posted once an accounting period; and (3) the journal’s use separates responsibilities between employees. Cash receipts journal. (1) Its use aids in the posting process since the totals for Cash, Sales Discounts, Accounts Receivable, Sales, Cost of Goods Sold, and Merchandise Inventory are all recorded in the general ledger only at the end of the month; and (2) it allows all accounts receivable credits to be posted to the appropriate subsidiary ledger accounts daily. Purchases journal. The advantages are similar to those of the sales journal except that items involved are Merchandise Inventory debits and Accounts Payable credits. Cash payments journal. Similar advantages to cash receipts journal except the columns involved are different.
In general, special journals: (1) allow greater division of labor because various individuals can record entries in different journals at the same time; and (2) reduce posting time of journals. 4.
The entry for the sales return should be recorded in the general journal. Since V. Diaz Company has a sales journal, only credit sales can be recorded there. A purchase by V. Diaz Company has not taken place, so the use of the purchases journal is inappropriate. Finally, no cash is received or paid, so neither the cash receipts or cash payments journal should be used.
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G-3
Questions Appendix G (Continued) 5.
At the end of the month, after all postings to both the general ledger and the subsidiary accounts have been made, a total of a subsidiary account balances should equal the balance of the control account in the general ledger. In this case, the control account balance will be $450 larger than the total of the subsidiary accounts.
6.
The purpose of special journals is to facilitate the recording process of the business entity. Therefore, the columns included in any special journal should correspond to the unique needs of the entity. In particular, one type of business which might not require an Accounts Receivable column would be grocery stores. These businesses rarely sell on credit to their customers. The minimum frequency of the transaction implies no need for an accounts receivable column in the cash receipts journal.
7.
(a) No, the customers’ ledger will not agree with the Accounts Receivable control account. The customers’ ledger will be posted correctly, but the Accounts Receivable control account will be incorrect. (b) The trial balance will balance, although Cash will be $4,000 too high and Accounts Receivable $4,000 too low.
8.
This special journal is the sales journal. The other account is Sales. (The cash receipts journal is an incorrect answer because there would be more than two month-end postings to general ledger accounts.)
9.
(a) General journal. (b) General journal. (c) Cash receipts journal.
(d) Sales journal. (e) Cash receipts journal. (f) General journal.
10.
(a) Cash receipts journal. (b) Cash receipts journal. (c) General journal.
(d) Purchases journal. (e) General journal. (f) Cash payments journal.
11.
Typically included would be credit purchases of equipment, office supplies, and store supplies. However, any other item purchased on credit could also be included in a special column or the “other” column.
12.
One such example is a purchase return. Here the accounts payable control and subsidiary account must be debited for the same amount. The debit/credit equality is unaffected since the balance sheet equation is computed using general ledger (control) accounts only. The subsidiary accounts should prove to the control account balance.
13.
The general journal may be used to record such transactions as the granting of credit to a customer for a sales return or allowance, the receipt of credit from a supplier for purchases returned, acceptance of a note receivable from a customer, or the purchase of a plant asset by issuing a note payable. In addition, all correcting, adjusting, and closing entries should be made in the general journal.
G-4
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
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SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE G-1 Accounts Receivable Subsidiary Ledger Date Jan. 7 17
Ref.
Green Co. Debit Credit 8,000 7,000
Balance 8,000 1,000
General Ledger Date Jan. 31 31
Accounts Receivable Ref. Debit Credit 23,000 21,000
Balance 23,000 2,000
Kline Co. Date Jan. 15 24
Date Jan. 23 29
Ref.
Ref.
Debit 6,000
Credit 5,000
Balance 6,000 1,000
Rossi Co. Debit Credit 9,000 9,000
Balance 9,000 0
BRIEF EXERCISE G-2 (a). General ledger (b). Subsidiary ledger
(c). General ledger (d). Subsidiary ledger
BRIEF EXERCISE G-3 (a). Cash Receipts Journal (b). Cash Payments Journal (c). Cash Payments Journal
(d). Sales Journal (e). Purchases Journal (f). Cash Receipts Journal
BRIEF EXERCISE G-4 (a). No (b). Yes
Copyright © 2012 John Wiley & Sons, Inc.
(c). Yes (d). No
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G-5
BRIEF EXERCISE G-5 (a). Both in total and daily (b). In total
(c). In total (d). Only daily
BRIEF EXERCISE G-6 (a). General Journal (if a one-column Purchases Journal) Purchases Journal (if a columnar Purchases Journal) (b). Purchases Journal (c). Cash Payments Journal (d). Sales Journal
BRIEF EXERCISE G-7 (a). Cash Receipts Journal (b). Cash Receipts Journal (c). Cash Receipts Journal (d). Sales Journal and/or Cash Receipts Journal (e). Purchases Journal and/or Cash Payments Journal
G-6
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Kimmel, Accounting, 5e, Solutions Manual
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SOLUTIONS TO EXERCISES EXERCISE G-1 (a) $370,400. Beginning balance of $350,000 plus $161,400 debit from sales journal less $141,000 credit from cash receipts journal. (b) $93,860. Beginning balance of $87,000 plus $54,360 credit from purchases journal less $47,500 debit from cash payments journal. (c) The column total of $161,400 in the sales journal would be posted to the credit side of the Sales account and the debit side of the Accounts Receivable account in the general ledger. (d) The accounts receivable column total of $141,000 in the cash receipts journal would be posted to the credit side of the Accounts Receivable account in the general ledger.
EXERCISE G-2 To:
Marie Fleming, President
From:
Joe Fernetti, Controller
Subject:
Peter Jones account
The explanation of the three entries in the subsidiary ledger for Quincy Smith is as follows: Sept. 2
This was a credit sale of merchandise to Jones. The entry was recorded on page 31 of the Sales Journal.
Sept. 9
This was a sales return or allowance granted to Jones. The entry was recorded on page 4 of the General Journal.
Sept. 27
This was a payment by Jones of the balance due. The entry was recorded on page 8 of the Cash Receipts Journal.
If I can be of further help, please let me know. Copyright © 2012 John Wiley & Sons, Inc.
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G-7
EXERCISE G-3 (a) & (b)
General Ledger
Accounts Receivable Date Explanation Sept. 1 Balance
Ref. ✓ S CR G
Debit
Credit
4,280* 7,060** 220
Balance 11,960 16,240 9,180 8,960
*800 + 1,350 + 1,030 + 1,100 **1,310 + 2,300 + 410 + 1,800 + 1,240 Accounts Receivable Subsidiary Ledger Dingler Date Sept. 1
Explanation Balance
Ref. ✓ S CR
Debit
Ref. ✓ CR
Debit
Ref. S CR
Debit 1,030
Ref. ✓ S CR
Debit
Credit
1,350 1,240
Balance 2,440 3,790 2,550
Mock Date Sept. 1
Jamar Date Sept.
Rathke Date Sept. 1
G-8
Explanation Balance
Explanation
Explanation Balance
Copyright © 2012 John Wiley & Sons, Inc.
Credit 1,800
Credit 410
Credit
1,100 1,310
Kimmel, Accounting, 5e, Solutions Manual
Balance 2,640 840
Balance 1,030 620
Balance 2,060 3,160 1,850 (For Instructor Use Only)
EXERCISE G-3 (Continued) Worley Date Sept. 1
Explanation Balance
(c)
Ref. ✓ S CR G
Debit
Credit
Balance 4,820 5,620 3,320 3,100
800 2,300 220
GRAHAM COMPANY Schedule of Customers As of September 30, 2014 Dingler ....................................................................................... Mock .......................................................................................... Jamar ......................................................................................... Rathke ....................................................................................... Worley ....................................................................................... Total ...................................................................................
$2,550 840 620 1,850 3,100 $8,960
Accounts Receivable ................................................................
$8,960
EXERCISE G-4 (a) & (b)
VIKING COMPANY Sales Journal S1
Date
Account Invoice Accounts Receivable Dr. Debited No. Ref. Sales Revenue Cr.
2014 Sept. 2 S. Bower 21 L. Salas
101 102
Copyright © 2012 John Wiley & Sons, Inc.
480 800 1,280
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Cost of Goods Sold Dr. Inventory Cr. 300 480 780
(For Instructor Use Only)
G-9
EXERCISE G-4 (Continued) VIKING COMPANY Purchases Journal Date
Account Credited
2014 Sept. 10 25
L. Freeze F. Willis
Terms
P1 Inventory Dr. Accounts Payable Cr.
Ref.
2/10, n/30 n/30
600 900 1,500
EXERCISE G-5 (a) & (b)
EMIG CO. Cash Receipts Journal
Date
Account Credited
2014 May 1 2 22
Common Stock J. Pauls R. Yevak
Date 2014 May 3 14
G-10
Ref.
Cash Dr.
CR1
Sales Accounts Other Discounts Receivable Sales. Account Dr. Cr. Revenue s Cr. Cr.
60,000 6,000 9,000 75,000
Cost of Goods Sold Dr. Inventory Cr.
60,000 9,000 9,000
6,000 0,000 6,000
00,000 60,000
4,200 0,000 4,200
EMIG CO. Cash Payments Journal CP1 Other Accounts Ck. Accounts Payable Cash No. Account Debited Ref. Dr. Dr. Cr. 101 Inventory 102 Salaries and wages Expense
Copyright © 2012 John Wiley & Sons, Inc.
9,000 700 9,700
Kimmel, Accounting, 5e, Solutions Manual
9,000 700 9,700
(For Instructor Use Only)
EXERCISE G-6 (a) Journal
(b) Columns in the journal
1. 2.
Cash Payments Cash Receipts
3. 4.
Cash Payments Cash Payments
5. 6. 7. 8. 9. 10.
Cash Receipts Cash Payments Cash Payments Cash Receipts Cash Payments Cash Receipts
Cash (Cr.), Other Accounts (Dr.). Cash (Dr.), Sales Discount (Dr.), and Accounts Receivable (Cr.). Cash (Cr.), Other Accounts (Dr.). Cash (Cr.), Inventory (Cr.), and Accounts Payable (Dr.). Cash (Dr.), Accounts Receivable (Cr.). Cash (Cr.), Other Accounts (Dr.). Cash (Cr.), Other Accounts (Dr.). Cash (Dr.), Other Accounts (Cr.). Cash (Cr.), Other Accounts (Dr.). Cash (Dr.), Sales (Cr.), Cost of Goods Sold (Dr.), and Inventory (Cr.).
EXERCISE G-7 (a) Mar. 2
5
7
Equipment ..................................................... Accounts Payable—Dinkel Company ........................................... Accounts Payable—Lowther Company ................................................... Inventory................................................
6,000 6,000 300 300
Sales Returns and Allowances .................... Accounts Receivable—Veazey Company ...........................................
400
Inventory ....................................................... Cost of Goods Sold ..............................
260
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Kimmel, Accounting, 5e, Solutions Manual
400
(For Instructor Use Only)
260
G-11
EXERCISE G-7 (Continued) (b) To:
President Miguel Navanno
From:
Chief Accountant
Subject:
Posting to Control and Subsidiary Accounts
The posting to these accounts varies with the journals used in recording the transactions. Sales and purchases journals—the total for the month is posted to the control accounts. The individual entries are posted daily to the subsidiary accounts. Columnar cash receipts and cash payments journals—the total of the control account column for the month is posted to the control account. The individual amounts in the column are posted daily to the subsidiary accounts. General journal—the individual entries are posted daily. Each entry that pertains to a control and a subsidiary account is dual-posted. That is, it is posted to both the control account and the subsidiary account. I hope this memo answers your questions about posting.
EXERCISE G-8 1. 2. 3. 4. 5. 6. 7.
G-12
Cash Payments Journal General Journal Cash Receipts Journal Cash Receipts Journal Sales Journal Cash Receipts Journal General Journal
Copyright © 2012 John Wiley & Sons, Inc.
8. 9. 10. 11. 12. 13.
Cash Receipts Journal Cash Payments Journal Cash Payments Journal General Journal Cash Payments Journal Purchases Journal
Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE G-9 (a) The debit posting reference on February 28 should be from the cash payments journal to record the payments made during the month. The general ledger debit amount should be $29,500 to balance. Grieder’s ending balance must be $3,240. (Accounts Payable control balance of $9,840 less Norris, $4,600, and Koger, $2,000.) (b) Only the general journal amounts were dual posted. Thus, the amounts were $1,400 (Dr.), $265 (Cr.), and $550 (Cr.).
EXERCISE G-10 (a) Purchases Journal Date
Account Credited
Ref.
July 3 12 14 17 20 21 29
Eklund Co. Pinkston Co. Knobler Co. Glaser Materials Eklund Co. Pinkston Co. Glaser Materials
✓ ✓ ✓ ✓ ✓ ✓ ✓
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
P1 Merchandise Inventory Dr. Accounts Payable Cr. 2,000 500 1,100 1,400 700 600 2,100 8,400 120/201
(For Instructor Use Only)
G-13
EXERCISE G-10 (Continued) (b) General Journal Accounts and Explanations
Date July 1
15
18
25
Equipment ....................................... Accounts Payable—Bakken Equipment Co. .....................
Ref.
Debit
153/
3,600
201/✓ 120/
Credit
3,600
Inventory ......................................... Accounts Payable—Terrell Transit ..................................
400
201/✓
Accounts Payable—Glaser Materials ...................................... Inventory ..................................
201/✓ 120/
100
Accounts Payable—Knobler Co. ... Inventory ..................................
201/✓ 120/
200
400
100 200
EXERCISE G-11 $995 ($200 + $290 + $145 + $190 + $170). All of the debit postings to the subsidiary ledger accounts should be from sales invoices. The total of all these debits should therefore be the total credit sales for the month, which would be the same amount as the end-of-month debit to Accounts Receivable.
G-14
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SOLUTIONS TO PROBLEMS PROBLEM G-1
(a) Cash Receipts Journal Account Credited
Ref.
Common Stock Utley Pietroski Co.
311 ✓ ✓
Date Apr. 1 4 5 8 10 11 23 29
Ellison Inventory Pietroski Co. Judson
Cash Dr.
CR1
Sales Accounts Other Discounts Receivable Sales. Accounts Dr. Cr. Revenue Cr. Cr.
6,000 1,666* 620 7,245 ✓ 800 120 550 ✓ 1,500 ✓ 1,200 19,581 (101)
Cost of Goods Sold Dr. Merchandise Inventory Cr.
6,000 34**
1,700 620 7,245
4,347
800 550 00 34 (414)
1,500 1,200 5,820 (112)
0,000 7,245 (401)
0,000 6,550 (X)
0,000 4,347 (505)(120)
*1,700 X .98 **1,700 X .02 (b)
General Ledger
Accounts Receivable Date Explanation Apr. 1 Balance 30
Ref. ✓ CR1
Debit
Credit 5,820
No. 112 Balance 7,350* 1,530
*1,550 + 1,200 + 2,900 + 1,700 Accounts Receivable Subsidiary Ledger Ellison Date Explanation Apr. 1 Balance 10 PROBLEM G-1 (Continued) Copyright © 2012 John Wiley & Sons, Inc.
Ref. ✓ CR1
Debit
Kimmel, Accounting, 5e, Solutions Manual
Credit 800
(For Instructor Use Only)
Balance 1,550 750
G-15
Judson Date Apr. 1 29
Explanation Balance
Pietroski Co. Date Explanation Apr. 1 Balance 5 23
Ref. ✓ CR1
Debit
Ref. ✓ CR1 CR1
Debit
Ref. ✓ CR1
Debit
Credit 1,200
Credit 620 1,500
Balance 1,200 0
Balance 2,900 2,280 780
Utley Date Apr. 1 4
Explanation Balance
1,700
(c) Accounts receivable balance:
$1,530
Subsidiary account balances: Ellison Pietroski Co. Total
$ 750 780 $1,530
G-16
Copyright © 2012 John Wiley & Sons, Inc.
Credit
Kimmel, Accounting, 5e, Solutions Manual
Balance 1,700 0
(For Instructor Use Only)
PROBLEM G-2
(a) Cash Payments Journal
CP1
Other Accounts Accounts Payable Ref. Dr. Dr.
Date
Ck. No.
Account Debited
Oct. 1 3 5 10 15 16 19 29
63 64 65 66 67 68 69 70
Inventory Equipment Eckert Co. Inventory Mallins Co. Dividends Kord Co. Nobel Co.
(b)
120 157 ✓ 120 ✓ 332 ✓ ✓
Inventory Cr.
700 800 1,700
34
2,250 1,400 400 1,400 2,600 7,100 (201)
0,000 4,150 (X)
28 00 62 (120)
Cash Cr. 700 800 1,666 2,250 1,400 400 1,372 2,600 11,188 (101)
General Ledger
Accounts Payable Date Explanation Oct. 1 Balance 31
Ref. ✓ CP1
Debit
Credit
7,100
No. 201 Balance 9,300* 2,200
*1,700 + 2,500 + 1,400 + 3,700
Accounts Payable Subsidiary Ledger Eckert Co. Date Explanation Oct. 1 Balance 5
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Ref. ✓ CP1
Debit
Credit
1,700
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Balance 1,700 0
G-17
PROBLEM G-2 (Continued) Kord Co. Date Explanation Oct. 1 Balance 19
Ref. ✓ CP1
Debit
Mallins Co. Date Explanation Oct. 1 Balance 15
Ref. ✓ CP1
Debit
Ref. ✓ CP1
Debit
Credit
Balance 2,500 1,100
Credit
Balance 1,400 0
Credit
Balance 3,700 1,100
1,400
1,400
Noble Co. Date Oct. 1 29
Explanation Balance
(c) Accounts payable balance: Subsidiary account balances: Kord Co. Noble Co.
G-18
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2,600
$2,200
$1,100 1,100 $2,200
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PROBLEM G-3
(a) Purchases Journal
Date
Account Credited (Debited)
Ref.
July 1 2 5 13
Elkins Company Mossman Shipping Ikerd Company Aspen Supply (Supplies) Elkins Company Wang Company Quayle Advertisements (Advertising Expense) Ikerd Company Aspen Supply (Equipment) Mossman Shipping
✓ ✓ ✓ 126/✓
15 15 18 24 26 28
Other Accounts Dr.
Inventory Dr.
Accounts Payable Cr.
7,000 400 3,200
7,000 400 3,200 720
3,600 2,900
3,600 2,900 600
3,000
3,000 600
380 20,480 (120)
380 22,400 (201)
720
✓ ✓ 610/✓
600
✓ 157/✓ ✓
P1
600 0,000 1,920 (X)
Sales Journal Date
Account Debited
Ref.
July 3 3 16 16 21 21 30
Hosey Company Cogswell Bros. Prater Company Cogswell Bros. Hosey Company Valdez Company Quayle Company
✓ ✓ ✓ ✓ ✓ ✓ ✓
Copyright © 2012 John Wiley & Sons, Inc.
S1
Accounts Receivable Dr. Sales Revenue Cr.
Cost of Goods Sold Dr. Inventory Cr.
1,300 1,900 3,450 1,570 310 2,300 4,900 15,730 (112)(401)
910 1,330 2,415 1,099 217 1,610 3,430 11,011 (505)(120)
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G-19
PROBLEM G-3 (Continued)
Date July 8
22
General Journal Accounts and Explanations
Ref.
Debit
Accounts Payable—Ikerd Company ..................................... Inventory ..................................
201/✓ 120/
300
412/
40
Sales Returns and Allowances ...... Accounts Receivable— Hosey Company ..................
(b)
300
112/✓
40
General Ledger
Accounts Receivable Date Explanation July 31 22
Ref. S1 G1
Debit 15,730
Credit 40
Inventory Date July 31 8 31
No. 112 Balance 15,730 15,690
No. 120 Explanation
Supplies Date Explanation July 13
G-20
G1 Credit
Copyright © 2012 John Wiley & Sons, Inc.
Ref. P1 G1 S1
Ref. P1
Debit 20,480
Credit 300 11,011
Debit 720
Credit
Kimmel, Accounting, 5e, Solutions Manual
Balance 20,480 20,180 9,169
No. 126 Balance 720
(For Instructor Use Only)
PROBLEM G-3 (Continued) Equipment Date Explanation July 26
Ref. P1
Accounts Payable Date Explanation July 31 8
Ref. P1 G1
Sales Revenue Date Explanation July 31
Ref. S1
Sales Returns and Allowances Date Explanation July 22
Cost of Goods Sold Date Explanation July 31
Advertising Expense Date Explanation July 18
Copyright © 2012 John Wiley & Sons, Inc.
Ref. G1
Ref. S1
Ref. P1
Debit 600
Debit
Credit
No. 157 Balance 600
Credit 22,400
No. 201 Balance 22,400 22,100
300
Debit
Credit
No. 412 Balance 40
Credit
No. 505 Balance 11,011
Credit
No. 610 Balance 600
(For Instructor Use Only)
G-21
Debit 40
Debit 11,011
Debit 600
Kimmel, Accounting, 5e, Solutions Manual
Credit 15,730
No. 401 Balance 15,730
PROBLEM G-3 (Continued) Accounts Receivable Subsidiary Ledger Cogswell Bros. Date Explanation July 3 16
Ref. S1 S1
Debit 1,900 1,570
Credit
Balance 1,900 3,470
Hosey Company Date Explanation July 3 21 22
Ref. S1 S1 G1
Debit 1,300 310
Credit
Balance 1,300 1,610 1,570
Prater Company Date Explanation July 16 30
Ref. S1 S1
Debit 3,450 4,900
Credit
Balance 3,450 8,350
Valdez Company Date Explanation July 21
Ref. S1
Debit 2,300
Credit
Balance 2,300
40
Accounts Payable Subsidiary Ledger Aspen Supply Date Explanation July 13 26
G-22
Copyright © 2012 John Wiley & Sons, Inc.
Ref. P1 P1
Debit
Credit 720 600
Kimmel, Accounting, 5e, Solutions Manual
Balance 720 1,320
(For Instructor Use Only)
PROBLEM G-3 (Continued) Elkins Company Date Explanation July 1 15
Ref. P1 P1
Debit
Credit 7,000 3,600
Balance 7,000 10,600
Ikerd Company Date Explanation July 5 24 8
Ref. P1 P1 G1
Debit
Credit 3,200 3,000
Balance 3,200 6,200 5,900
Mossman Shipping Date Explanation July 2 28
Ref. P1 P1
Debit
Credit 400 380
Balance 400 780
Quayle Advertisements Date Explanation July 18
Ref. P1
Debit
Credit 600
Balance 600
Wang Company Date Explanation July 15
Ref. P1
Debit
Credit 2,900
Balance 2,900
Copyright © 2012 John Wiley & Sons, Inc.
300
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
G-23
PROBLEM G-3 (Continued) (c) Accounts receivable balance ................................ Subsidiary account balances Cogswell Bros. ............................................... Hosey Company ............................................. Prater Company.............................................. Valdez Company............................................. Total .........................................................
$15,690 $ 3,470 1,570 8,350 2,300 $15,690
Accounts payable balance .................................... Subsidiary account balances Aspen Supply ................................................. Elkins Company ............................................. Ikerd Company ............................................... Mossman Shipping ........................................ Quayle Advertisements.................................. Wang Company .............................................. Total .........................................................
G-24
Copyright © 2012 John Wiley & Sons, Inc.
$22,100 $ 1,320 10,600 5,900 780 600 2,900
Kimmel, Accounting, 5e, Solutions Manual
$22,100
(For Instructor Use Only)
PROBLEM G-4
(a), (b) & (c) Sales Journal Date
Account Debited
Jan. 4 9 17 31
Flowers Kent Corp. Nieto Co. Flowers
S1
Invoice Accounts Receivable Dr. No. Ref. Sales Revenue Cr. 371 372 373 374
✓ ✓ ✓ ✓
Cost of Goods Sold Dr. Inventory Cr.
7,250 5,800 1,200 9,330 23,580 (112)(401)
4,350 3,480 720 5,598 14,148 (505)(120)
Purchases Journal
P1 Inventory Dr. Accounts Payable Cr.
Date
Account Credited
Ref.
Jan. 3 8 11 23 24
Aber Co. Jay Co. Flint Co. Aber Co. Hickox Corp.
✓ ✓ ✓ ✓ ✓
Date
General Journal Accounts and Explanations
Ref.
Debit
Accounts Payable—Aber Co. ......... Inventory ..................................
201/✓ 120/
300
Equipment ........................................ Accounts Payable—Guthrie Corp. .....................................
157/
5,500
Jan. 5 19
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
10,000 4,500 3,700 7,800 4,690 30,690 (120)(201)
G1 Credit 300
201/✓
(For Instructor Use Only)
5,500
G-25
PROBLEM G-4 (Continued) Cash Receipts Journal
Date Jan. 6 13 15 17 20 27 30
Account Credited
Kent Corp. Flowers
Ref.
✓ ✓
Nieto Co. ✓
CR1
Sales Accounts Other Discounts Receivable Sales. Account Dr. Cr. Revenue s Cr. Cr.
Cash Dr. 3,150 5,340 5,742 7,250 3,200 3,730 1,200 29,612 (101)
58
00 58 (414)
Cost of Goods Sold Dr. Merchandise Inventory Cr.
3,150 5,340
1,890 3,204
3,200 3,730 00,000 15,420 (401)
1,920 2,238 0,000 9,252 (505)(120)
5,800 7,250
1,200 14,250 (112)
0 0 (X)
Cash Payments Journal
Other Accounts Accounts Payable Inventory Cash Ref. Dr. Dr. Cr. Cr.
Date
Account Debited
Jan. 4 13 15 20 31
Supplies 126 Aber Co. ✓ Salaries and wages Expense 726 Jay Co. ✓ Salaries and wage Expense 726
G-26
Copyright © 2012 John Wiley & Sons, Inc.
CP1
80 9,700
194
4,500 00,000 14,200 (201)
90 000 284 (120)
14,300 13,200 27,580 (X)
Kimmel, Accounting, 5e, Solutions Manual
80 9,506 14,300 4,410 13,200 41,496 (101)
(For Instructor Use Only)
PROBLEM G-5
(a), (d) & (g)
General Ledger
Cash Date July 31 31
No. 101 Explanation
Ref. CR1 CP1
Accounts Receivable Date Explanation July 31 31
Ref. S1 CR1
Inventory Date Explanation July 31 29 31 31 31
Ref. P1 CR1 CP1 S1 CR1
Debit 98,265
Credit 38,472
Debit 17,900
Credit 13,900
Debit 42,320
Credit 450 228 11,635 2,600
Supplies Date July 4 31
Balance 98,265 59,793 No. 112 Balance 17,900 4,000 No. 120 Balance 42,320 41,870 41,642 30,007 27,407 No. 127
Explanation Adjusting entry
Prepaid Rent Date Explanation July 11 31 Adjusting entry
Copyright © 2012 John Wiley & Sons, Inc.
Ref. CP1 G1
Ref. CP1 G1
Debit 600
Credit 460
500
No. 131 Balance 6,000 5,500
(For Instructor Use Only)
G-27
Debit 6,000
Kimmel, Accounting, 5e, Solutions Manual
Balance 600 140
Credit
PROBLEM G-5 (Continued) Accounts Payable Date Explanation July 31 31
Common Stock Date Explanation July 1
Dividends Date Explanation July 19
Sales Revenue Date Explanation July 31 31
Ref. P1 CP1
Ref. CR1
Ref. CP1
Ref. S1 CR1
Debit
Credit 42,320
29,600
Debit
Debit 2,500
Debit
Credit 80,000
Credit
Credit 17,900 4,000
Sales Discounts Date July 31
Explanation
G-28
Explanation
Copyright © 2012 John Wiley & Sons, Inc.
No. 311 Balance 80,000
No. 332 Balance 2,500
No. 401 Balance 17,900 21,900
No. 414 Ref. CR1
Debit 85
Credit
Cost of Goods Sold Date July 31 31
No. 201 Balance 42,320 12,720
Balance 85
No. 505 Ref. S1 CR1
Debit 11,635 2,600
Credit
Kimmel, Accounting, 5e, Solutions Manual
Balance 11,635 14,235
(For Instructor Use Only)
PROBLEM G-5 (Continued) Supplies Expense Date Explanation July 31 Adjusting entry
Ref. G1
Rent Expense Date Explanation July 31 Adjusting entry
Ref. G1
Debit 460
Debit 500
Credit
No. 631 Balance 460
Credit
No. 729 Balance 500
(b) Sales Journal
S1
Date
Account Debited
Accounts Receivable Dr. Ref. Sales Revenue Cr.
July 6 8 10 21
Ewing Co. D. Storrer L. Ortega S. Howe
✓ ✓ ✓ ✓
Cost of Goods Sold Dr. Inventory Cr.
5,400 3,600 4,900 4,000 17,900 (112)(401)
3,510 2,340 3,185 2,600 11,635 (505)(120)
Cash Receipts Journal Account Credited
Date July 1 7 13 16 20 29
Common Stock D. Storrer L. Ortega Ewing Co. Inventory
Ref.
Cash Dr.
311 80,000 4,000 ✓ 3,564 ✓ 4,851 ✓ 5,400 120 450 98,265 (101)
Copyright © 2012 John Wiley & Sons, Inc.
CR1
Sales Accounts Other Discounts Receivable Sales. Accounts Dr. Cr. Revenue Cr. Cr.
Cost of Goods Sold Dr. Inventory Cr.
80,000 4,000 36 49 00 85 (414)
3,600 4,900 5,400 00,000 13,900 (112)
0,000 4,000 (401)
Kimmel, Accounting, 5e, Solutions Manual
2,600
450 80,450 (X)
(For Instructor Use Only)
0,000 2,600 (505)(120)
G-29
PROBLEM G-5 (Continued) (c)
Accounts Receivable Subsidiary Ledger
Ewing Co. Date Explanation July 6 20
Ref. S1 CR1
Debit 5,400
S. Howe Date July 21
Ref. S1
Debit 4,000
Credit
Balance 4,000
L. Ortega Date Explanation July 10 16
Ref. S1 CR1
Debit 4,900
Credit
Balance 4,900 0
D. Storrer Date Explanation July 8 13
Ref. S1 CR1
Debit 3,600
(d) J. Dolan Date July 4 15
Explanation
5,400
4,900
Credit 3,600
Balance 5,400 0
Balance 3,600 0
Accounts Payable Subsidiary Ledger
Explanation
W. Hanna Date Explanation July 5 10
G-30
Credit
Copyright © 2012 John Wiley & Sons, Inc.
Ref. P1 CP1
Debit
Ref. P1 CP1
Debit
Credit 6,800
Balance 6,800 0
Credit 7,500
Balance 7,500 0
6,800
7,500
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM G-5 (Continued) R. Keysen Date Explanation July 11
Ref. P1
Debit
Credit 3,920
Balance 3,920
M. Metz Date July 13 21
Ref. P1 CP1
Debit
Credit 15,300
Balance 15,300 0
Credit 8,800
Balance 8,800
Debit
Credit
Explanation
D. Roblez Date Explanation July 20
(e)
Ref. P1
15,300
Debit
CALVARY CO. Trial Balance July 31, 2014
Cash................................................................. Accounts Receivable ...................................... Inventory ......................................................... Supplies .......................................................... Prepaid Rent ................................................... Accounts Payable ........................................... Common Stock ............................................... Dividends ........................................................ Sales Revenue ................................................ Sales Discounts .............................................. Cost of Goods Sold ........................................
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
$ 59,793 4,000 27,407 600 6,000 $ 12,720 80,000 2,500 21,900 85 14,235 $114,620
(For Instructor Use Only)
0000,000 $114,620
G-31
PROBLEM G-5 (Continued) (f)
Accounts payable balance ..................................................... Subsidiary accounts balance R. Keysen ......................................................................... D. Roblez ..........................................................................
$12,720 $ 3,920 8,800 $12,720
Accounts receivable balance .................................................
$ 4,000
Subsidiary accounts balance S. Howe ............................................................................
$ 4,000
(b) & (g) General Journal
G1
Date
Accounts and Explanations
Ref.
Debit
July 31
Supplies Expense ........................... Supplies ...................................
631 127
460*
729 131
500
Credit 460
*600 – 140 31
G-32
Rent Expense .................................. Prepaid Rent ............................
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Kimmel, Accounting, 5e, Solutions Manual
500
(For Instructor Use Only)
PROBLEM G-5 (Continued) (h)
CALVARY CO. Adjusted Trial Balance July 31, 2014 Debit Cash ................................................................ Accounts Receivable ..................................... Inventory ......................................................... Supplies .......................................................... Prepaid Rent ................................................... Accounts Payable .......................................... Common Stock ............................................... Dividends ........................................................ Sales Revenue ................................................ Sales Discounts.............................................. Cost of Goods Sold ........................................ Supplies Expense........................................... Rent Expense..................................................
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
Credit
$ 59,793 4,000 27,407 140 5,500 $ 12,720 80,000 2,500 21,900 85 14,235 460 500 $114,620
(For Instructor Use Only)
0000,000 $114,620
G-33
PROBLEM G-6
(b) & (c) Cash Receipts Journal
Date
Account Credited
Ref.
Jan. 7 13 23 29
S. Haskin B. Polzin
✓ ✓
Notes Receivable
115
Cash Dr. 3,500 3,920 8,600 40,000 56,020 (101)
Sales Discounts Dr.
Accounts Receivable Cr.
80
3,500 4,000
00 80 (414)
0,000 7,500 (112)
CR1
Other Sales. Revenue Accounts Cr. Cr.
8,600 0,000 8,600 (401)
Cost of Goods Sold Dr. Inventory Cr.
40,000 40,000 (X)
Cash Payments Journal
Account Debited
Jan. 11 12 15 18
Inventory Rent Expense D. Moyer Salaries and Wages Expense S. Ulrich
27
CP1
Other Accounts Accounts Payable Ref. Dr. Dr.
Date
120 729 ✓
300 1,000
726 ✓
4,300 0,000 5,600 (X)
Inventory Cr.
150
000 150 (120)
4,300 950 21,400 (101)
15,000
950 15,950 (201)
Account Debited
Ref.
Jan. 3 24
B. Polzin B. Fair
✓ ✓
G-34
Cash Cr. 300 1,000 14,850
Sales Journal Date
5,590 0,000 5,590 (505)(120)
S1
Accounts Receivable Dr. Sales Revenue Cr.
Cost of Goods Sold Dr. Inventory Cr.
4,000 7,700 11,700 (112)(401)
2,600 5,005 7,605 (505)(120)
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
PROBLEM G-6 (Continued) Purchases Journal
Inventory Dr. Accounts Payable Cr.
Date
Account Credited
Ref.
Jan. 5 17
S. Ulrich D. Alpers
✓ ✓
Date
General Journal Accounts and Explanations
Jan. 14
20 30
P1
2,500 1,600 4,100 (120)(201)
Ref.
Debit
Sales Returns and Allowances ....... Accounts Receivable— N. Botken .............................. Inventory ($700 X .65)................................... Cost of Goods Sold .................
412
700
120 505
455
Accounts Payable—A. Iverson ....... Notes Payable ..........................
201 200
18,000
Accounts Payable—D. Alpers ........ Inventory ..................................
201 120
500
112
G1 Credit
700 455 18,000 500
(a) & (c) General Ledger Cash Date Jan. 1 31 31
Explanation Balance
Copyright © 2012 John Wiley & Sons, Inc.
Ref. ✓ CR1 CP1
21,400
No. 101 Balance 41,500 97,520 76,120
(For Instructor Use Only)
G-35
Debit
Credit
56,020
Kimmel, Accounting, 5e, Solutions Manual
PROBLEM G-6 (Continued) Accounts Receivable Date Explanation Jan. 1 Balance 14 31 31
Notes Receivable Date Explanation Jan. 1 Balance 29
Inventory Date Explanation Jan. 1 Balance 14 30 31 11 31 31 31
Ref. ✓ G1 CR1 S1
Ref. ✓ CR1
Ref. ✓ G1 G1 P1 CP1 CP1 CR1 S1
Debit
Credit 700 7,500
11,700
Debit
Credit 40,000
Debit
Credit
455 500 4,100 300 150 5,590 7,605
Equipment Date Jan. 1
G-36
No. 115 Balance 45,000 5,000
No. 120 Balance 23,000 23,455 22,955 27,055 27,355 27,205 21,615 14,010
No. 157
Explanation Balance
Ref. ✓
Debit
Credit
Accumulated Depreciation—Equipment Date Jan. 1
No. 112 Balance 15,000 14,300 6,800 18,500
Explanation Balance
Copyright © 2012 John Wiley & Sons, Inc.
Ref. ✓
Balance 6,450
No. 158 Debit
Credit
Kimmel, Accounting, 5e, Solutions Manual
Balance 1,500
(For Instructor Use Only)
PROBLEM G-6 (Continued) Notes Payable Date Explanation Jan. 20
Ref. G1
Accounts Payable Date Explanation Jan. 1 Balance 20 30 31 31
Ref. ✓ G1 G1 P1 CP1
Common Stock Date Explanation Jan. 1 Balance
Ref. ✓
Retained Earnings Date Explanation Jan. 1 Balance
Ref. ✓
Sales Revenue Date Explanation Jan. 31 31
Ref. CR1 S1
Debit
Debit
Credit 18,000
Credit
18,000 500 4,100 15,950
Debit
Debit
Debit
Explanation
Copyright © 2012 John Wiley & Sons, Inc.
No. 201 Balance 43,000 25,000 24,500 28,600 12,650
Credit
No. 311 Balance 80,000
Credit
No. 320 Balance 6,450
Credit 8,600 11,700
Sales Returns and Allowances Date Jan. 14
No. 200 Balance 18,000
No. 401 Balance 8,600 20,300
No. 412 Ref. G1
Debit 700
Kimmel, Accounting, 5e, Solutions Manual
Credit
(For Instructor Use Only)
Balance 700
G-37
PROBLEM G-6 (Continued) Sales Discounts Date Explanation Jan. 31 Cost of Goods Sold Date Explanation Jan. 31 31 14
Ref. CR1
Ref. CR1 S1 G1
Debit 80
Debit 5,590 7,605
Credit
Credit
455
Salaries and Wages Expense Date Jan. 18
Explanation
No. 505 Balance 5,590 13,195 12,740 No. 726
Ref. CP1
Debit 4,300
Credit
Rent Expense Date Jan. 12
No. 414 Balance 80
Balance 4,300 No. 729
Explanation
Ref. CP1
Debit 1,000
Credit
Balance 1,000
Accounts Receivable Subsidiary Ledger N. Botken Date Jan. 1 14 B. Fair Date Jan. 1 24
G-38
Explanation Balance
Explanation Balance
Copyright © 2012 John Wiley & Sons, Inc.
Ref. ✓ G1
Debit
Ref. ✓ S1
Debit
Credit 700
Credit
7,700
Kimmel, Accounting, 5e, Solutions Manual
Balance 2,500 1,800
Balance 7,500 15,200
(For Instructor Use Only)
PROBLEM G-6 (Continued) S. Haskin Date Explanation Jan. 1 Balance 7
Ref. ✓ CR1
Debit
B. Polzin Date Explanation Jan. 3 13
Ref. S1 CR1
Debit 4,000
Credit 3,500
Credit 4,000
Balance 5,000 1,500
Balance 4,000 0
Accounts Payable Subsidiary Ledger D. Alpers Date Explanation Jan. 17 30
Ref. P1 G1
Debit
S. Dakin Date Jan. 1
Explanation Balance
Ref. ✓
A. Iverson Date Explanation Jan. 1 Balance 20
Ref. ✓ G1
Credit 1,600
Balance 1,600 1,100
Debit
Credit
Balance 10,000
Debit
Credit
Balance 18,000 0
Credit
Balance 15,000 0
500
18,000
D. Moyers Date Jan. 1 15
Explanation Balance
Copyright © 2012 John Wiley & Sons, Inc.
Ref. ✓ CP1
Debit 15,000
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
G-39
PROBLEM G-6 (Continued) S. Ulrich Date Explanation Jan. 5 27
(d)
Ref. P1 CP1
Debit
Credit 2,500
Balance 2,500 1,550
Debit
Credit
950
MELINA CO. Trial Balance January 31, 2015
Cash ................................................................ Accounts Receivable ..................................... Notes Receivable ........................................... Inventory ........................................................ Equipment ...................................................... Accumulated Depreciation—Equipment ...... Notes Payable ................................................ Accounts Payable .......................................... Common Stock .............................................. Sales Revenue ............................................... Sales Returns and Allowances ..................... Sales Discounts ............................................. Cost of Goods Sold ....................................... Salaries and Wages Expense ........................ Rent Expense .................................................
$ 76,120 18,500 5,000 14,010 6,450 $
700 80 12,740 4,300 1,000 $138,900
0000,000 $138,900
(e) Accounts Receivable Subsidiary Ledger N. Botken ......................................................................... B. Fair ............................................................................... S. Haskin .......................................................................... Accounts Receivable Control ................................................
G-40
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
1,500 18,000 12,650 86,450 20,300
$ 1,800 15,200 1,500 $18,500 $18,500
(For Instructor Use Only)
PROBLEM G-6 (Continued) Accounts Payable Subsidiary Ledger D. Alpers .......................................................................... S. Dakin ............................................................................ S. Ulrich ........................................................................... Accounts Payable Control .....................................................
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
$ 1,100 10,000 1,550 $12,650 $12,650
G-41
APPENDIX H Accounting for Partnerships ASSIGNMENT CLASSIFICATION TABLE Brief Exercises
Exercises
Problems
4
1, 2
1
1
Identify the bases for dividing net income or net loss.
5, 6, 7, 8, 9
3, 4, 5
2
2
4.
Describe the form and content of partnership financial statements.
10
3
1, 2
5.
Explain the effects of the entries to record the liquidation of a partnership.
11, 12, 13, 14
4, 5, 6
3
Learning Objectives
Questions
1.
Identify the characteristics of the partnership form of business organization.
1, 2, 3
2.
Explain the accounting entries for the formation of a partnership.
3.
Copyright © 2012 John Wiley & Sons, Inc.
6
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
H-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
H-2
Description
Difficulty Level
Time Allotted (min.)
1
Prepare entries for formation of a partnership and a balance sheet.
Simple
20–30
2
Journalize divisions of net income and prepare a partners’ capital statement.
Moderate
30–40
3
Prepare entries with a capital deficiency in liquidation of a partnership.
Moderate
30–40
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
ANSWERS TO QUESTIONS 1.
(a) Association of individuals. A partnership is a voluntary association of two or more individuals based on as simple an act as a handshake. Preferably, however, the agreement should be in writing. A partnership is both a legal entity and an accounting entity, but it is not a taxable entity. (b) Limited life. A partnership does not have unlimited life. A partnership may be ended voluntarily or involuntarily. Thus, the life of a partnership is indefinite. Any change in the members of a partnership results in the dissolution of the partnership. (c)
2.
Co-ownership of property. Partnership assets are co-owned by all the partners. If the partnership is terminated, the assets do not legally revert to the original contributor. Each partner has a claim on total assets equal to his or her capital balance. This claim does not attach to specific assets the individual partner contributed to the firm.
(a) Mutual agency. This characteristic means that the act of any partner is binding on all other partners when engaging in partnership business. This is true even when the partners act beyond the scope of their authority, so long as the act appears to be appropriate for the partnership. (b) Unlimited liability. Each partner is personally and individually liable for all partnership liabilities. Creditors’ claims attach first to partnership assets and then to personal resources of any partner, irrespective of that partner’s equity in the partnership.
3.
The advantages of a partnership are: (1) combining skills and resources of two or more individuals, (2) ease of formation, (3) freedom from governmental regulations and restrictions, and (4) ease of decision making. Disadvantages are: (1) mutual agency, (2) limited life, and (3) unlimited liability.
4.
The capital balance should be $112,000, comprised of land $75,000, and equipment $57,000, less debt $20,000.
5.
When the partnership agreement does not specify the division of net income or net loss, net income and net loss should be divided equally.
6.
Factors to be considered in discussing how income and loss should be divided are: (1) a fixed ratio is easy to apply and it may be an equitable basis in some circumstances; (2) capital balance ratios when the funds invested in the partnership are considered the most critical factor; and (3) salary allowance and/or interest allowance coupled with a fixed ratio. This last approach gives specific recognition to differences that may exist among partners by providing salary allowances for time worked and interest allowances for capital invested.
7.
The net income of $24,000 should be divided equally—$12,000 to Mandy Elston and $12,000 to Jeff Baker.
8.
(a) Account debited: Income Summary; accounts credited: Debbie Hunt, Capital and Kyle Keegar, Capital. (b) Account debited: Debbie Hunt, Drawing; account credited: Cash.
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
H-3
Questions Appendix H (Continued)
9.
Division of Net Income
Salary Allowance Deficiency: ($5,000) ($50,000 – $55,000) G. Jocketty (60% X $5,000) B. Madson (40% X $5,000) Total division
G. Jocketty
B. Madson
Total
($30,000)
($25,000)
($55,000)
( (2,000) ($23,000)
( (3,000) ( (2,000) ($50,000)
( (3,000) ($27,000)
10.
The financial statements of a partnership are similar to those of a corporation. The income statement for a partnership is identical to the income statement for a corporation except for the division of net income and there is no income tax expense. The equity statement is called the partners’ capital statement. This statement shows the changes in each partner’s capital account and in total partnership capital during the year. On the balance sheet each partner’s capital balance is reported in the equity section.
11.
No, Dean is not correct. All gains and losses on liquidation should be allocated to the partners on the basis of their income-sharing ratio. However, final cash distributions should be based on their capital balances.
12.
Yes, Bill is correct. Capital balances are used because they represent the individual partner’s equity in the partnership. The objective of the distribution is to eliminate the balance in each partner’s capital account.
13.
Total cash after paying liabilities .............................................................................. Total capital balances ($34,000 + $31,000 + $28,000) ............................................ Excess (gain on sale of noncash assets) .................................................................
$119,000 93,000 $ 26,000
Allocated to Matt ($26,000 X 3/10)...........................................................................
$
Cash to Matt ($31,000 + $7,800) .............................................................................
$ 38,800
Capital deficiency, T. Luthi .......................................................................................
$
6,000
Loss allocated to: L. Seastrom, capital ($6,000 X 3/8) ............................................
$
2,250
Cash to L. Seastrom ($12,000 – $2,250) .................................................................
$
9,750
14.
H-4
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
7,800
(For Instructor Use Only)
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE H-1 Cash ................................................................................ Equipment....................................................................... Fred Bowden Nasser, Capital ................................
10,000 7,000 17,000
BRIEF EXERCISE H-2 Accounts Receivable ..................................................... Less: Allowance for doubtful accounts ....................... Equipment.......................................................................
$16,000 3,500
$12,500 10,000
Accumulated depreciation should not be shown because a new company cannot have any accumulated depreciation. BRIEF EXERCISE H-3 The division is: Newland $42,000 ($70,000 X 60%) and Green $28,000 ($70,000 X 40%). The entry is: Income Summary .................................................... 70,000 Newland, Capital ............................................. 42,000 Green, Capital .................................................. 28,000 BRIEF EXERCISE H-4 Division of Net Income
Salary allowance Remaining income, $35,000: ($65,000 – $30,000) G ($35,000 X 50%) E ($35,000 X 30%) R ($35,000 X 20%) Total remainder Total division Copyright © 2012 John Wiley & Sons, Inc.
Grand $20,000
Easley $ 5,000
Rod $ 5,000
Total $30,000
7,000 000,000 $12,000
35,000 $65,000
(For Instructor Use Only)
H-5
17,500 10,500 000,000 $37,500
000,000 $15,500
Kimmel, Accounting, 5e, Solutions Manual
BRIEF EXERCISE H-5 Division of Net Income
Salary allowance Interest allowance Remaining deficiency, ($12,000): [($25,000 + $11,000) – $24,000] Jabb ($12,000 X 50%) Nabb ($12,000 X 50%) Total remainder Total division
Jabb $15,000 6,000
Nabb $10,000 5,000
Total $25,000 11,000
(6,000) 000,000 $ 9,000
(12,000) $24,000
(6,000) 000,000 $15,000
BRIEF EXERCISE H-6 C, Capital ........................................................................... A, Capital ........................................................................... B, Capital ........................................................................... Cash ...........................................................................
H-6
Copyright © 2012 John Wiley & Sons, Inc.
Kimmel, Accounting, 5e, Solutions Manual
9,000 7,000 5,000 21,000
(For Instructor Use Only)
SOLUTIONS TO EXERCISES EXERCISE H-1 Jan. 1
Cash .................................................................... Accounts Receivable ......................................... Equipment........................................................... Allowance for Doubtful Accounts.............. Garg Ellis, Capital .......................................
15,000 14,000 17,500 3,000 43,500
EXERCISE H-2 (a) 1.
DIVISION OF NET INCOME
Salary allowance ............................... Interest allowance B. Pedigo ($50,000 X 10%)......... W. Vernon ($40,000 X 10%) ....... Total interest ........................ Total salaries and interest ............... Remaining income, $14,000 ($55,000 – $41,000) B. Pedigo ($14,000 X 70%)......... W. Vernon ($14,000 X 30%) ....... Total remainder.................... Total division .....................................
2.
B. Pedigo
W. Vernon
Total
$20,000
$12,000
$32,000
4,000 000,000 16,000
9,000 41,000
4,200 000,000 $20,200
14,000 $55,000
B. Pedigo
W. Vernon
Total
($20,000) ( 5,000) ( 25,000)
($12,000) ( 4,000) ( 16,000)
$32,000 9,000 41,000
( (3,300) (000,000) ($12,700)
(11,000) $30,000
5,000 000,000 25,000
9,800 000,000 $34,800
DIVISION OF NET INCOME
Salary allowance ............................... Interest allowance ............................. Total salaries and interest ............... Remaining deficiency, ($11,000) ($41,000 – $30,000) B. Pedigo ($11,000 X 70%)......... W. Vernon ($11,000 X 30%) ....... Total remainder.................... Total division .....................................
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( (7,700) (000,000) ($17,300)
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H-7
EXERCISE H-2 (Continued) (b) 1.
2.
Income Summary .............................................. B. Pedigo, Capital ...................................... W. Vernon, Capital .....................................
55,000
Income Summary .............................................. B. Pedigo, Capital ...................................... W. Vernon, Capital .....................................
30,000
34,800 20,200 17,300 12,700
EXERCISE H-3 (a)
ROYWEB CO. Partners’ Capital Statement For the Year Ended December 31, 2014 K. Rory $20,000 16,000 36,000 8,000 $28,000
Capital, January 1 Add: Net income Less: Drawings Capital, December 31 (b)
Total $38,000 32,000 70,000 11,000 $59,000
ROYWEB CO. Partial Balance Sheet December 31, 2014 Owners’ equity K. Rory, Capital ............................................. D. Webb, Capital ............................................ Total owners’ equity ..............................
H-8
D. Webb $18,000 16,000 34,000 3,000 $31,000
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$28,000 31,000
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$59,000
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EXERCISE H-4 DAYNEN COMPANY Schedule of Cash Payments Item Balances before liquidation Sale of noncash assets and allocation of gain New balances Pay liabilities New balances Cash distribution to partners Final balances
Cash
Noncash Assets
Liabilities
Day Capital
Nen Capital
$ 20,000
($100,000)
($55,000)
$45,000
$20,000
120,000 140,000 (55,000) 85,000
( (100,000) ( 0) (0000,000) ( 0)
(0000,00) ( 55,000) ( (55,000) ( 0)
11,000* 9,000 56,000 29,000 0000,00 0000,00 56,000 29,000
(85,000) (0000,000) $ 0 ($ 0)
(0000,00) ($ 0)
(56,000) (29,000) $ 0 $ 0
*(120,000 – 100,000) X .55 EXERCISE H-5 (a) Cash......................................................................... Noncash Assets .............................................. Gain on Realization .........................................
120,000
(b) Gain on Realization ................................................ Day, Capital ($20,000 X 55%) .......................... Nen, Capital ($20,000 X 45%) ..........................
20,000
(c) Liabilities ................................................................. Cash .................................................................
55,000
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100,000 20,000
11,000 9,000
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55,000
H-9
EXERCISE H-5 (Continued) (d) Day, Capital ............................................................... Nen, Capital ............................................................... Cash ...................................................................
56,000 29,000 85,000
EXERCISE H-6 (a) (1) Cash ................................................................... Dody, Capital ..............................................
2,000
(2) Kolmer, Capital .................................................. Noble, Capital .................................................... Cash............................................................
18,000 14,000
(b) (1) Kolmer, Capital ($2,000 X 5/8) .......................... Noble, Capital ($2,000 X 3/8) ............................. Dody, Capital ..............................................
1,250 750
(2) Kolmer, Capital ($18,000 – $1,250) ................... Noble, Capital ($14,000 – $750) ........................ Cash............................................................
16,750 13,250
H-10
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32,000
2,000
30,000
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SOLUTIONS TO PROBLEMS PROBLEM H-1
(a) Jan. 1
1
(b) Jan. 1
1
Cash ............................................................ Accounts Receivable ................................. Inventory ..................................................... Equipment ................................................... Allowance for Doubtful Accounts ......................................... Notes Payable ..................................... Accounts Payable ............................... Yung, Capital .......................................
14,000 17,500 30,000 25,000
Cash ............................................................ Accounts Receivable ................................. Inventory ..................................................... Equipment ................................................... Allowance for Doubtful Accounts ......................................... Notes Payable ..................................... Accounts Payable ............................... Olde, Capital ........................................
13,000 26,000 20,000 18,000
Cash ............................................................ Yung, Capital .......................................
3,000
Cash ............................................................ Olde, Capital ........................................
18,000
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4,500 20,000 20,000 42,000
4,000 15,000 31,000 27,000
3,000
(For Instructor Use Only)
18,000
H-11
PROBLEM H-1 (Continued) (c)
OLDE YUNG COMPANY Balance Sheet January 1, 2014 Assets Current assets Cash ............................................................ ($14,000 + $13,000 + $3,000 + $18,000) Accounts receivable ($17,500 + $26,000) ................................. Less: Allowance for doubtful accounts ($4,500 + $4,000) ............................. Inventory ($30,000 + $20,000) ................................. Total current assets ............................ Property, plant, and equipment Equipment ($25,000 + $18,000) .................. Total assets .........................................
$ 48,000 $43,500 8,500
35,000 50,000 133,000 43,000 $176,000
Liabilities and Owners’ Equity Current liabilities Notes payable ($20,000 + $15,000) ............ Accounts payable ($20,000 + $31,000) ...... Total current liabilities........................ Owners’ equity Yung, Capital ($42,000 + $3,000) ............... Olde, Capital ($27,000 + $18,000) .............. Total owners’ equity ........................... Total liabilities and owners’ equity ....
H-12
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$ 35,000 51,000 86,000 $45,000 45,000
Kimmel, Accounting, 5e, Solutions Manual
90,000 $176,000
(For Instructor Use Only)
PROBLEM H-2
(a) 1.
2.
Income Summary ................................................ Jodi Ames, Capital ($28,000 X 60%) ........... Jill Bolen, Capital ($28,000 X 30%) ............. Ann Saylo, Capital ($28,000 X 10%) ...........
28,000
Income Summary ................................................ Jodi Ames, Capital ($18,000 + $2,000) ....... Jill Bolen, Capital ($10,000 + $2,000) ......... Ann Saylor, Capital ($0 + $2,000) ...............
34,000
Net income ............................ Salary allowance Ames ................................. Bolen ................................. Remainder ......................... To each partner ($6,000 X 1/3)..................... 3.
To each partner ($3,300 X 1/3).....................
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20,000 12,000 2,000
$34,000 (18,000) (10,000) $ 6,000 $ 2,000
Income Summary ................................................ Jodi Ames, Capital ($4,800 + $15,000 – $1,100) ..................... Jill Bolen, Capital ($3,000 – $1,100) ........... Ann Saylor, Capital ($2,500 – $1,100)......... Net income ............................ Interest allowance Ames ($48,000 X 10%) ...... Bolen ($30,000 X 10%)...... Saylor ($25,000 X 10%)..... Balance ................................. Salary allowance Ames ................................. Remainder .........................
16,800 8,400 2,800
22,000 18,700 1,900 1,400
$22,000 (4,800) (3,000) (2,500) 11,700 (15,000) $ (3,300) $ (1,100)
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H-13
PROBLEM H-2 (Continued) (b)
DIVISION OF NET INCOME Jodi Ames Salary allowance ........................ Interest allowance Jodi Ames ............................ ($48,000 X 10%) Jill Bolen ............................... ($30,000 X 10%) Ann Saylor ............................ ($25,000 X 10%) Total interest ................. Total salaries and interest ......... Remaining deficiency, ($3,300) Jodi Ames ............................ ($3,300 X 1/3) Jill Bolen ............................... ($3,300 X 1/3) Ann Saylor ............................ ($3,300 X 1/3) Total remainder ............. Total division ..............................
(c)
Ann Saylor
Total
(
$15,000
$15,000 4,800 (
( $3,000 ($2,500)
000,000 19,800
00,000 3,000
(00,000) ( 2,500)
10,300 25,300
(1,100) (1,100) ( (1,100) 000,000 $18,700
00,000 $1,900
(00,000) ($1,400)
(3,300) $22,000
ABS COMPANY Partners’ Capital Statement For the Year Ended December 31, 2014
Capital, January 1 .......... Add: Net income .......... Less: Drawings ............. Capital, December 31.....
H-14
Jill Bolen
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Jodi Ames $48,000 18,700 66,700 23,000 $43,700
Jill Bolen $30,000 1,900 31,900 14,000 $17,900
Ann Saylor $25,000 1,400 26,400 10,000 $16,400
Kimmel, Accounting, 5e, Solutions Manual
Total $103,000 22,000 125,000 47,000 $ 78,000
(For Instructor Use Only)
PROBLEM H-3
(a)
(1) Cash............................................................................ Allowance for Doubtful Accounts ............................ Accumulated Depreciation ........................................ Loss on Realization ................................................... Accounts Receivable ......................................... Inventory ............................................................. Equipment .......................................................... Noncash assets (net) ................. Sale proceeds ............................. Loss on sale of non cash assets ......................................
53,000 1,000 5,500 21,000 25,000 34,500 21,000
$74,000* 53,000 $21,000
*25,000 + 34,500 + 21,000 – 1,000 – 5,500 (2) S. Roscoe, Capital ($21,000 X 5/10) .......................... J. Sorenson, Capital ($21,000 X 3/10) ....................... M. Posada, Capital ($21,000 X 2/10) .......................... Loss on Realization ...........................................
10,500 6,300 4,200
(3) Notes Payable ............................................................ Accounts Payable ...................................................... Salaries and Wages Payable ..................................... Cash ....................................................................
13,500 27,000 3,800
(4) Cash............................................................................ M Posada, Capital ..............................................
3,000
(5) S. Roscoe, Capital (36,000 – 10,500) ........................ J. Sorenson, Capital (20,000 – 6,300) ....................... Cash ....................................................................
25,500 13,700
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21,000
44,300
3,000
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39,200
H-15
PROBLEM H-3 (Continued) (b) Bal. (1) (4)
(2) (4)
(c) 1.
2.
H-16
Cash 27,500 (3) 53,000 (5) 3,000 83,500
44,300 39,200
(2) (4)
83,500
J. Sorenson, Capital 6,300 Bal. 20,000 13,700 20,000 20,000
S. Roscoe, Capital 10,500 Bal. 36,000 25,500 36,000
(2)
36,000
M. Posada, Capital 4,200 Bal. 1,200 (4) 3,000 4,200 4,200
S. Roscoe, Capital ($3,000 X 5/8)...................... J. Sorenson, Capital ($3,000 X 3/8) .................. M. Posada, Capital .....................................
1,875 1,125
S. Roscoe, Capital ($25,500 – $1,875) .............. J. Sorenson, Capital ($13,700 – $1,125) ........... Cash ($39,200 – $3,000) .............................
23,625 12,575
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3,000
36,200
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APPENDIX I Accounting for Sole Proprietorships ASSIGNMENT CLASSIFICATION TABLE Learning Objectives
Questions
1.
Identify the differences in equity accounts between a corporation and a sole proprietorship.
1, 2
2.
Understand what account transactions increase and decrease owner’s equity.
3, 4
3.
Describe the differences between a retained earnings statement and an owner’s equity statement.
4.
Explain the process of closing the books for a sole proprietorship.
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Brief Exercises
Exercises
Problems
3
1, 2, 3
1, 3
1, 2, 3
5
2, 3
1, 2, 3
6
3
1, 2, 3
1, 2, 3
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I-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
I-2
Description
Difficulty Level
Time Allotted (min.)
1
Prepare income statement, owner’s equity statement, and balance sheet.
Moderate
15–20
2
Prepare financial statements, closing entries, and post-closing trial balance.
Moderate
15–20
3
Prepare financial statements, closing entries, and post-closing trial balance.
Moderate
15–20
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ANSWERS TO QUESTIONS 1.
The accounting equation for a sole proprietorship is Assets = Liabilities + Owner’s Equity (rather than Stockholders’ Equity).
2.
A corporation has two separate equity accounts – Common Stock and Retained Earnings. A sole proprietorship has a single equity account – Owner’s Capital.
3.
Owner’s equity is increased by revenues and investments by the owner and it is decreased by expenses and withdrawals (drawings) by the owner.
4.
It is correct that the company’s cash increased. However, investments of cash into the company by the owner are not revenue. Instead, they increase the Owner’s Capital account directly.
5.
An owner’s equity statement begins with the beginning balance in the owner’s capital account. Then it adds any investments made by the owner during that period as well as net income for the period. It then subtracts any withdrawals (drawings) by the owner during that period, as well as a net loss.
6.
Assuming that the company had net income, the entries to close the accounts would be: i. Debit each revenue account for its balance, and credit Income Summary for total revenues. ii. Debit Income Summary for total expenses, and credit each expense account for its balance. iii. Debit Income Summary and credit Owner’s Capital for the amount of net income. (The reverse is true for a loss). iv. Debit Owner’s Capital for the balance in the Owner’s Drawing account, and credit Owner’s Drawing for the same amount.
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I-3
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE I-1 Assets + – NE
(a) (b) (c)
Liabilities NE NE NE
Owner’s Equity + – NE
BRIEF EXERCISE I-2 R NOE E
Received cash for services performed. Paid cash to purchase equipment. Paid employee salaries.
BRIEF EXERCISE I-3
1. 2. 3. 4. 5. 6.
I-4
Accounts Payable Advertising Expense Service Revenue Accounts Receivable A. L. Brislin, Capital A. L. Brislin, Drawing
(a) Debit Effect Decrease Increase Decrease Increase Decrease Increase
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(b) Credit Effect Increase Decrease Increase Decrease Increase Decrease
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(c) Normal Balance Credit Debit Credit Debit Credit Debit
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SOLUTIONS TO EXERCISES EXERCISE I-1 (a) 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
Owner invested $12,000 cash in the business. Purchased equipment for $5,000, paying $2,000 in cash and the balance of $3,000 on account. Paid $750 cash for supplies. Earned $6,300 in service revenue, receiving $2,600 cash and $3,700 on account. Paid $1,500 cash on accounts payable. Owner withdrew $2,000 cash for personal use. Paid $650 cash for rent. Collected $450 cash from customers on account. Paid salaries and wages of $2,900. Incurred $500 of utilities expense on account.
(b) Investment............................................................................... Service revenue ...................................................................... Drawings ................................................................................. Rent expense .......................................................................... Salaries and wages expense ................................................. Utilities expense ..................................................................... Increase in owner’s equity .....................................................
$12,000 6,300 (2,000) (650) (2,900) (500) $12,250
(c) Service revenue ...................................................................... Rent expense .......................................................................... Salaries and wages expense ................................................. Utilities expense ..................................................................... Net income ..............................................................................
$ 6,300 (650) (2,900) (500) $ 2,250
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I-5
EXERCISE I-2 KURT COOPER, ATTORNEY Owner’s Equity Statement For the Year Ended December 31, 2014 Kurt Cooper, Capital, January 1 ............................................ Add: Net income ................................................................... Less: Drawings ...................................................................... Kurt Cooper, Capital, December 31 .......................................
$ 23,000 (a) 149,000 (b) 172,000 74,000 $ 98,000 (c)
Supporting Computations (a) Assets, January 1, 2014 Liabilities, January 1, 2014 .................................................... Capital, January 1, 2014 ........................................................
$ 85,000 (62,000) $ 23,000
(b) Legal service revenue ........................................................... Total expenses ....................................................................... Net income .............................................................................
$360,000 (211,000) $149,000
(c) Assets, December 31, 2014 ................................................... Liabilities, December 31, 2014 .............................................. Capital, December 31, 2014 ...................................................
$168,000 (70,000) $ 98,000
EXERCISE I-3 (a)
LORENZ COMPANY Income Statement For the Year Ended July 31, 2014 Revenues Service revenue .......................................... Rent revenue .............................................. Total revenues .................................... Expenses Salaries and wages expense ..................... Utilities expense ......................................... Depreciation expense ................................ Total expenses .................................... Net loss...............................................................
I-6
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$65,100 6,500 $71,600 55,700 14,900 4,000
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74,600 ($ 3,000) (For Instructor Use Only)
EXERCISE I-3 (Continued) LORENZ COMPANY Owner’s Equity Statement For the Year Ended July 31, 2014 J. D. Lorenz, Capital, August 1, 2013 ................ Less: Net loss .................................................... Drawings .................................................. J. D. Lorenz, Capital, July 31, 2014.................... (b)
$45,200 $ 3,000 14,000
17,000 $28,200
LORENZ COMPANY Balance Sheet July 31, 2014 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Total current assets .............................. Property, plant, and equipment Equipment ..................................................... Less: Accumulated depreciation ................ Total assets ............................................
$14,940 8,780 $23,720 15,900 5,400
10,500 $34,220
Liabilities and Owner’s Equity Current liabilities Accounts payable ......................................... Unearned rent revenue ................................. Total current liabilities .......................... Owner’s equity J. D. Lorenz, Capital ...................................... Total liabilities and owner’s equity ......
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$ 4,220 1,800
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$ 6,020 28,200 $34,220
I-7
SOLUTIONS TO PROBLEMS PROBLEM I-1
(a)
SKYLINE FLYING SCHOOL Income Statement For the Month Ended May 31, 2014 Revenues Service revenue ........................................... Expenses Gasoline expense ........................................ Rent expense ............................................... Advertising expense ................................... Insurance expense ...................................... Maintenance and repairs expense ............. Total expenses ..................................... Net income ..........................................................
$8,600 $2,500 1,200 500 400 400 5,000 $3,600
SKYLINE FLYING SCHOOL Owner’s Equity Statement For the Month Ended May 31, 2014 Steven Ramfond Capital, May 1 ......................... Add: Investments.............................................. Net income ...............................................
$ $45,000 3,600
Less: Drawings .................................................. Steven Ramfond Capital, May 31 .......................
0
48,600 48,600 1,700 $46,900
SKYLINE FLYING SCHOOL Balance Sheet May 31, 2014 Assets Cash ......................................................................................... Accounts receivable ............................................................... Equipment ............................................................................... Total assets ..................................................................... I-8
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$ 6,500 7,200 64,000 $77,700
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PROBLEM I-1 (Continued) SKYLINE FLYING SCHOOL Balance Sheet (Continued) May 31, 2014 Liabilities and Owner’s Equity Liabilities Notes payable .................................................................. Accounts payable ........................................................... Total liabilities.......................................................... Owner’s equity Steven Ramfond, Capital ................................................ Total liabilities and owner’s equity ........................
(b)
$30,000 800 30,800 46,900 $77,700
SKYLINE FLYING SCHOOL Income Statement For the Month Ended May 31, 2014 Revenues Service revenue ($8,600 + $900) ................. Expenses Gasoline expense ($2,500 + $3,300)............ Rent expense ................................................ Advertising expense .................................... Insurance expense ....................................... Maintenance and repairs expense .............. Total expenses...................................... Net income ...........................................................
$9,500 $5,800 1,200 500 400 400 8,300 $1,200
SKYLINE FLYING SCHOOL Owner’s Equity Statement For the Month Ended May 31, 2014 Steven Ramfond, Capital, May 1 ......................... Add: Investments .............................................. Net income ................................................
$ $45,000 1,200
Less: Drawings ................................................... Steven Ramfond, Capital, May 31 .......................
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0
46,200 46,200 1,700 $44,500
I-9
PROBLEM I-2
(a)
WHITMORE COMPANY Income Statement For the Year Ended December 31, 2014 Revenues Service revenue ............................................. Expenses Salaries and wages expense ........................ Advertising expense ..................................... Depreciation expense ................................... Insurance expense ........................................ Supplies expense .......................................... Interest expense ............................................ Total expenses ....................................... Net income ............................................................
$79,000 $39,000 12,000 6,000 4,000 3,700 1,000 65,700 $13,300
WHITMORE COMPANY Owner’s Equity Statement For the Year Ended December 31, 2014 B. Whitmore Capital, January 1 ............................................. Add: Net income ................................................................... Less: Drawing ........................................................................ B. Whitmore Capital, December 31 ........................................
I-10
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$36,000 13,300 49,300 12,000 $37,300
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PROBLEM I-2 (Continued) WHITMORE COMPANY Balance Sheet December 31, 2014 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Supplies ......................................................... Prepaid insurance ......................................... Total current assets .............................. Property, plant, and equipment Equipment ..................................................... Less: Accumulated depreciation ................ Total assets............................................
$20,800 15,400 2,300 4,800 $43,300 44,000 18,000
26,000 $69,300
Liabilities and Owner’s Equity Current liabilities Notes payable ................................................ Accounts payable ......................................... Salaries and wages payable ......................... Interest payable ............................................. Total current liabilities .......................... Long-term liabilities Notes payable ................................................ Total liabilities........................................ Owner’s equity B. Whitmore, Capital ..................................... Total liabilities and owner’s equity ......
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$10,000 8,000 3,000 1,000
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$22,000 10,000 32,000 37,300 $69,300
I-11
PROBLEM I-2 (Continued) (b) Date Dec. 31 31
31 31
General Journal Account Titles and Explanation
Ref.
Debit
Service Revenue Income Summary
400 350
79,000
Income Summary Advertising Expense Supplies Expense Depreciation Expense Insurance Expense Salaries and Wages Expense Interest Expense
350 610 631 711 722 726 905
65,700
Income Summary B. Whitmore, Capital
350 301
13,300
B. Whitmore, Capital B. Whitmore, Drawing
301 306
12,000
J14 Credit 79,000 12,000 3,700 6,000 4,000 39,000 1,000 13,300 12,000
(c)
Date Jan. 1 Dec. 31 31
Date Dec. 31 31
I-12
Explanation Balance Closing entry Closing entry
Whitmore Capital Ref. Debit ✓ J14 J14 12,000
Explanation Balance Closing entry
Whitmore Drawing Ref. Debit ✓ 12,000 J14
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Credit 13,300
Credit 12,000
Kimmel, Accounting, 5e, Solutions Manual
No. 301 Balance 36,000 49,300 37,300 No. 306 Balance 12,000 0
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PROBLEM I-2 (Continued)
Date Dec. 31 31 31
Explanation Closing entry Closing entry Closing entry
Income Summary Ref. Debit J14 J14 65,700 J14 13,300
Credit 79,000
Service Revenue Date Dec. 31 31
Date Dec. 31 31
Date Dec. 31 31
No. 400
Explanation Balance Closing entry
Ref. ✓ J14
Debit
Credit 79,000
79,000
Balance 79,000 0
Explanation Balance Closing entry
Advertising Expense Ref. Debit ✓ 12,000 J14
No. 610 Balance 12,000 0
Explanation Balance Closing entry
Supplies Expense Ref. Debit ✓ 3,700 J14
Credit 12,000
Credit 3,700
Depreciation Expense Date Dec. 31 31
Date Dec. 31 31
No. 350 Balance 79,000 13,300 0
No. 711
Explanation Balance Closing entry
Ref. ✓ J14
Explanation Balance Closing entry
Insurance Expense Ref. Debit ✓ 4,000 J14
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Debit 6,000
Kimmel, Accounting, 5e, Solutions Manual
No. 631 Balance 3,700 0
Credit 6,000
Balance 6,000 0
4,000
No. 722 Balance 4,000 0
(For Instructor Use Only)
I-13
Credit
PROBLEM I-2 (Continued)
Date Dec. 31 31
Salaries and Wages Expense Explanation Ref. Debit Balance ✓ 39,000 Closing entry J14
Date Dec. 31 31
Interest Expense Ref. Debit ✓ 1,000 J14
(d)
Explanation Balance Closing entry
Credit 39,000
1,000
No. 905 Balance 1,000 0
Debit
Credit
Credit
WHITMORE COMPANY Post-Closing Trial Balance December 31, 2014
Cash .................................................................... Accounts Receivable ......................................... Supplies .............................................................. Prepaid Insurance .............................................. Equipment .......................................................... Accumulated Depreciation—Equipment .......... Notes Payable .................................................... Accounts Payable .............................................. Salaries and Wages Payable ............................. Interest Payable ................................................. B. Whitmore, Capital ..........................................
I-14
No. 726 Balance 39,000 0
Copyright © 2012 John Wiley & Sons, Inc.
$20,800 15,400 2,300 4,800 44,000
000,000 $87,300
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$18,000 20,000 8,000 3,000 1,000 37,300 $87,300
(For Instructor Use Only)
PROBLEM I-3
(a)
RICK POOL COMPANY Income Statement For the Year Ended December 31, 2014 Revenues Service revenue............................................. Expenses Salaries and wages expense ........................ Advertising expense ..................................... Supplies expense .......................................... Insurance expense ........................................ Depreciation expense ................................... Interest expense ............................................ Total expenses....................................... Net income ............................................................
$88,000 $42,000 12,000 5,700 5,000 4,000 500 69,200 $18,800
RICK POOL COMPANY Owner’s Equity Statement For the Year Ended December 31, 2014 Rick Pool Capital, January 1 .................................................. Add: Net income ................................................................... Less: Drawings ...................................................................... Rick Pool Capital, December 31 ............................................
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$25,000 18,800 43,800 10,000 $33,800
I-15
PROBLEM I-3 (Continued) RICK POOL COMPANY Balance Sheet December 31, 2014 Assets Current assets Cash ............................................................... Accounts receivable ..................................... Supplies ......................................................... Prepaid insurance ......................................... Total current assets ............................... Property, plant, and equipment Equipment...................................................... Less: Accumulated depreciation ................ Total assets ............................................
$13,600 15,400 1,500 2,800 $33,300 34,000 8,000
26,000 $59,300
Liabilities and Owner’s Equity Current liabilities Notes payable – (Current portion) ................ Accounts payable.......................................... Salaries and wages payable ......................... Interest payable ............................................. Total current liabilities........................... Long-term liabilities Notes payable ................................................ Total liabilities ........................................ Owner’s equity Rick Pool, Capital .......................................... Total liabilities and owner’s equity .......
I-16
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$10,000 6,000 3,000 500
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$19,500 6,000 25,500 33,800 $59,300
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PROBLEM I-3 (Continued) (b) Date Dec. 31 31
31 31
General Journal Account Titles and Explanation
Ref.
Debit
Service Revenue Income Summary
400 350
88,000
Income Summary Advertising Expense Supplies Expense Depreciation Expense Insurance Expense Salaries and Wages Expense Interest Expense
350 610 631 711 722 726 905
69,200
Income Summary Rick Pool, Capital
350 301
18,800
Rick pool, Capital Rick pool, Drawing
301 306
10,000
J14 Credit 88,000 12,000 5,700 4,000 5,000 42,000 500 18,800 10,000
(c)
Date Jan. 1 Dec. 31 31
Explanation Balance Closing entry Closing entry
Rick Pool, Capital Ref. Debit ✓ J14 J14 10,000
Credit 18,800
Rick Pool, Drawing Date Dec. 31 31
Explanation Balance Closing entry
Copyright © 2012 John Wiley & Sons, Inc.
Ref. ✓ J14
No. 306
Debit 10,000
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No. 301 Balance 25,000 43,800 33,800
Credit 10,000
(For Instructor Use Only)
Balance 10,000 0
I-17
PROBLEM I-3 (Continued)
Date Dec. 31 31 31
Explanation Closing entry Closing entry Closing entry
Income Summary Ref. Debit J14 J14 69,200 J14 18,800
Credit 88,000
Service Revenue Date Dec. 31 31
Date Dec. 31 31
Date Dec. 31 31
Debit
No. 400
Explanation Balance Closing entry
Ref. ✓ J14
Credit 88,000
88,000
Balance 88,000 0
Explanation Balance Closing entry
Advertising Expense Ref. Debit ✓ 12,000 J14
No. 610 Balance 12,000 0
Explanation Balance Closing entry
Supplies Expense Ref. Debit ✓ 5,700 J14
Credit 12,000
Credit 5,700
Depreciation Expense Date Dec. 31 31
Date Dec. 31 31
I-18
No. 350 Balance 88,000 18,800 0
Explanation Balance Closing entry
Ref. ✓ J14
Explanation Balance Closing entry
Insurance Expense Ref. Debit ✓ 5,000 J14
Copyright © 2012 John Wiley & Sons, Inc.
Debit 4,000
No. 631 Balance 5,700 0 No. 711
Credit 4,000
Credit 5,000
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Balance 4,000 0 No. 722 Balance 5,000 0
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PROBLEM I-3 (Continued)
Date Dec. 31 31
Salaries and Wages Expense Explanation Ref. Debit Balance ✓ 42,000 Closing entry J14
Date Dec. 31 31
Interest Expense Ref. Debit ✓ 500 J14
Explanation Balance Closing entry
(d)
Credit 42,000
No. 726 Balance 42,000 0
500
No. 905 Balance 500 0
Debit
Credit
Credit
RICK POOL COMPANY Post-Closing Trial Balance December 31, 2014
Cash..................................................................... Accounts Receivable .......................................... Supplies .............................................................. Prepaid Insurance............................................... Equipment ........................................................... Accumulated Depreciation—Equipment ........... Notes Payable ..................................................... Accounts Payable ............................................... Salaries and Wages Payable .............................. Interest Payable .................................................. Rick Pool, Capital ............................................... Totals
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$13,600 15,400 1,500 2,800 34,000
000,000 $67,300
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$ 8,000 16,000 6,000 3,000 500 33,800 $67,300
I-19
APPENDIX J Pricing ASSIGNMENT CLASSIFICATION TABLE
Learning Objectives
Questions
Brief Exercises
Exercises
1. Compute a target cost when the market determines a product price.
1, 2
1
1, 2, 3
2. Compute a target selling price using cost-plus pricing.
3, 4, 5, 6, 7, 8
2, 3, 4, 5
3, 4, 5, 6, 7
1, 2
3. Use time-and-material pricing to determine the cost of services provided.
9, 10
6
8, 9, 10
3
4. Determine a transfer price using the negotiated, costbased, and market-based approaches.
11, 12, 13, 14, 15, 16, 17
7, 8, 9
11, 12, 13, 14, 15, 16, 17
4, 5, 6
5. Explain issues involved in transferring goods between divisions in different countries.
18
6.
Determine prices using absorption-cost pricing and variable-cost pricing.
19, 20
10, 11
18, 19, 20
7, 8
.
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Problems
J-1
ASSIGNMENT CHARACTERISTICS TABLE Problem Number
J-2
Description
Difficulty Level
Time Allotted (min.)
1
Use cost-plus pricing to determine various amounts.
Simple
20–30
2
Use cost-plus pricing to determine various amounts.
Simple
20–30
3
Use time-and-material pricing to determine bill.
Simple
20–30
4
Determine minimum transfer price with no excess capacity and with excess capacity.
Moderate
20–30
5
Determine minimum transfer price with no excess capacity.
Moderate
20–30
6
Determine minimum transfer price under different situations.
Moderate
20–30
7*
Compute the target price using absorption-cost pricing and variable-cost pricing.
Moderate
30–40
8*
Compute various amounts using absorption-cost pricing and variable-cost pricing.
Complex
40–50
.
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Correlation Chart between Bloom’s Taxonomy, Learning Objectives and End-of-Chapter Exercises and Problems Knowledge
Comprehension
Kimmel, Accounting, 5e, Solutions Manual
Q J-2 BE J-1
*2. Compute a target selling price using cost-plus pricing.
Q J-6
Q J-3 Q J-5
Application
Analysis
E J-3 E J-1 E J-2 Q J-4 Q J-7 Q J-8 BE J-2 BE J-3 BE J-4 BE J-5
E J-4 E J-5 E J-6 E J-7 P J-1 P J-2
E J-3
(For Instructor Use Only)
*3. Use time-and-material pricing to determine the cost of services provided.
Q J-10
Q J-9
BE J-6
E J-10 P J-3
E J-8 E J-9
*4. Determine a transfer price using Q J-13 the negotiated, cost-based, and Q J-15 market-based approaches. Q J-16
Q J-11 Q J-12 Q J-14 Q J-17
BE J-7 BE J-8 BE J-9 E J-11 E J-12 E J-13 E J-14 E J-15
*5. Explain issues involved in transferring goods between divisions in different countries. 6.
Determine prices using absorption-cost pricing and variable-cost pricing.
Q J-18
Q J-19
Q J-20 E J-20 BE J-10 P J-7 BE J-11 P J-8 E J-18 E J-19
E J-16 E J-17 P J-4 P J-5 P J-6
Synthesis
Evaluation
BLOOM’ S TAXONOMY TABLE
.
Learning Objective
*1. Compute a target cost when the Q J-1 market determines a product price.
J-3
ANSWERS TO QUESTIONS 1.
The first type of pricing environment is where the company is a price taker; that is, the company does not set the price, but instead the price is set by a competitive market. In the second type of situation, the company sets the price. This happens most often when the product is specially made for a customer or there are few or no other producers capable of manufacturing a similar item.
2.
A company focuses on target cost when it cannot influence the market price. The target cost is determined by subtracting the desired profit per unit from the market-determined selling price.
3.
The basic formula to determine the target selling price in cost-plus pricing is: Target selling price = Cost + (Markup percentage X Cost)
4.
The basic formula to determine the target selling price in cost-plus pricing is: Target selling price = Cost + (Markup percentage X Cost) $23.40 = $18 + (30% X $18)
5.
The basic formula to compute the markup percentage is: Markup percentage =
Desired ROI per unit Total unit cost
6.
Some of the factors that affect a company’s desired ROI are competitive and market conditions, political and legal issues, and other relevant risk factors.
7.
Total cost base per unit, excluding selling and administrative expenses ......................... Selling and administrative expenses per unit .................................................................. Total unit cost .................................................................................................................
$60 15 $75
The markup percentage is computed as follows: $6 = 8% $75 8.
Variable cost per unit ...................................................................................................... Fixed cost per unit .......................................................................................................... Desired ROI per unit ....................................................................................................... Target selling price .........................................................................................................
$16 9 6 $31
The markup percentage is: $6 = 24% $25 9.
Time-and-material pricing is most often used in service industries. It involves two pricing rates, one for the labor used on a job, while the other involves the materials used. Each typically has a profit rate factored into it.
10.
The material loading charge is a fee added to each bill to cover the costs of purchasing, receiving, handling, and storing materials, plus any desired profit margin on the materials themselves. The material loading charge is expressed as a percentage of the total estimated costs of parts and materials for the year.
J-4
.
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Questions Chapter J (Continued) *11.
A transfer price is the price used to record the transfer of goods or services between two divisions in the same company. Setting a fair transfer price is important because an improper price will benefit one division while hurting the other.
*12.
The objective of an appropriate transfer price is to maximize the return to the whole company and not cause divisional performance to decline.
*13.
The three approaches for determining transfer prices are: (1) Negotiated transfer prices (2) Cost-based transfer prices (3) Market-based transfer prices
*14.
When a cost-based transfer price is used, the exchange of goods between divisions is recorded by using the costs incurred by the selling division. This may either be the variable costs or the variable costs with an additional markup to cover fixed costs. The primary advantage of this approach is that it is relatively simple to use. The disadvantage is that it understates the selling division’s contribution to the company’s total contribution margin. Finally, it reduces the selling division’s incentive to control cost.
*15.
The general formula for determining the minimum transfer price that the selling division should be willing to accept is: Minimum transfer price = Variable cost + Opportunity cost
*16.
When determining the minimum transfer price, the opportunity cost is the contribution margin that would be received if the goods were sold externally.
*17.
A company is likely to use a negotiated transfer price rather than a market-based price when the selling division has excess capacity, and is therefore eager to expand production, or when a market price does not exist (e.g., for a special order).
*18.
A company with divisions in different countries will set the transfer price so that more profit is allocated to the division located in the country with the lower tax rate. This is improper. The proper (and legal) treatment is to base the transfer price on the market value of the goods transferred.
19.
The absorption-cost approach defines the cost base as manufacturing cost. Therefore, it excludes variable and fixed selling and administrative costs.
20.
The markup percentage using variable-cost pricing would be: $3 + $9 = 75% $16
.
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J-5
SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE J-1 In order to obtain a profit of $15 per drive, Voorhees must set its target cost at $30 per drive ($45 – $15). It will then need to form a design team that will design a product that will meet quality specifications without exceeding the target cost.
BRIEF EXERCISE J-2 Direct materials ....................................................................................... Direct labor .............................................................................................. Variable manufacturing overhead .......................................................... Fixed manufacturing overhead .............................................................. Variable selling and administrative expenses ....................................... Fixed selling and administrative expenses ........................................... Total unit cost ..................................................................................
$12 8 6 14 4 12 $56
Total unit cost + (Markup percentage X Total unit cost) = Target selling price $56 + (30% X $56) = $72.80
BRIEF EXERCISE J-3 ROI per unit = =
(Total investment X Desired ROI percentage) Number of units ($10,000,000 X 16%) = $32 50,000
BRIEF EXERCISE J-4 The markup percentage would be: $30 = 18.75% $36 + $24 + $18 + $40 + $14 + $28
J-6
.
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BRIEF EXERCISE J-5 The markup percentage is equal to Desired ROI per unit divided by total unit cost. The desired ROI per unit is computed as follows: Desired ROI per unit =
$1,500,000 X 24% =$36 10,000 units
The total unit cost is computed as follows: Total unit cost =
$1,100,000 + $100,000 =$120 10,000 units
The markup percentage is computed as follows: Desired ROI per unit $36 = = 30% Total unit cost $120 BRIEF EXERCISE J-6 Rooney’s total bill would equal: (10.5 hours X $42) + $700 + ($700 X 40%) = $1,421 BRIEF EXERCISE J-7 The minimum transfer price is equal to the division’s variable cost plus its opportunity cost. The opportunity cost is equal to its contribution margin on goods sold to external parties. Thus, the minimum transfer price in this case is: Minimum transfer price = $20 + ($45 – $20) = $45. BRIEF EXERCISE J-8 If the division has excess capacity, then its opportunity cost is zero. In this case, the minimum transfer price is: Minimum transfer price = $20 + $0 = $20.
.
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J-7
BRIEF EXERCISE J-9 The minimum transfer price is equal to the division’s variable cost plus its opportunity cost. In this case the minimum transfer price is: Minimum transfer price = $24 + ($45 – $20) = $49.
BRIEF EXERCISE J-10 The markup percentage using the absorption-cost approach is calculated by including only manufacturing costs in the cost base. Therefore, all costs related to selling and administration are excluded from the cost base and added back in the numerator. Markup percentage =
$30 + ($14 + $28) = 61.02% $36 + $24 + $18 + $40
BRIEF EXERCISE J-11 The markup percentage using variable-cost pricing is calculated by including only variable costs in the cost base. Therefore, all fixed costs are excluded from the cost base and added back in the numerator. Markup percentage =
J-8
.
$30 + ($40 + $28) = 106.52% $36 + $24 + $18 + $14
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SOLUTIONS TO EXERCISES EXERCISE J-1 The target cost formula is: Target cost = Market price – Desired profit.
(a)
In this case, the market price is $20 and the desired profit is $6 (30% X $20). Therefore the target cost is $14 ($20 – $6). (b)
Target costing is particularly helpful when a company faces a competitive market. In this case, the price is affected by supply and demand, so no company in the industry can affect price. Therefore to earn a profit, companies must focus on controlling costs.
EXERCISE J-2 The following formula may be used to determine return on investment Investment $8,000,000
X X
ROI percentage = Return on investment 20% = $1,600,000
Return on investment per unit is then $16 ($1,600,000 ÷ 100,000) The target cost is therefore $74 computed as follows: Target cost = Market price – Desired profit $74 = $90 – $16 EXERCISE J-3 (a)
(1) In this case the selling price would be $120 ($100 + [$100 X 20%]). The problem with the $120 is that it is unlikely that Hannon will be able to sell any All-Body suits at that price. Market research seems to indicate that it will sell for only $100. (2) One way that Hannon might consider manufacturing the All-Body swimsuit is if it has excess capacity and therefore manufacturing the All-Body will not affect fixed costs. Thus if the company can cover its variable costs, it might want to sell at the $100 level.
(b)
In this case, the amount would be the selling price of $100.
.
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J-9
EXERCISE J-3 (Continued) (c)
The highest acceptable cost would be the target cost. The target cost is $80 as shown below: Target cost = Market price – Desired profit $80 = $100 – $20
EXERCISE J-4 (a) Total cost per unit: Per Unit Direct materials .......................................................................... $17 Direct labor ................................................................................. 8 Variable manufacturing overhead ............................................ 11 Fixed manufacturing overhead ($300,000/30,000).................................................................... 10 Variable selling and administrative expenses ......................... 4 Fixed selling and administrative expenses ($150,000/30,000).................................................................... 5 $55 (b) Target selling price = $55 + (40% X $55) = $77 EXERCISE J-5 (a) Total cost per unit: Per Unit Direct materials .......................................................................... $ 7 Direct labor ................................................................................. 9 Variable manufacturing overhead ............................................ 15 Fixed manufacturing overhead ($3,000,000/500,000) ............................................................... 6 Variable selling and administrative expenses ......................... 14 Fixed selling and administrative expenses ($1,500,000/500,000) ............................................................... 3 $54 (b) Desired ROI per unit = (25% X $26,000,000)/500,000 = $13
J-10
.
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EXERCISE J-5 (Continued) (c) Markup percentage using total cost per unit: $13 $54
= 24.07%
(d) Target selling price = $54 + ($54 X 24.07%) = $67 EXERCISE J-6 (a)
Total cost per session: Direct materials ................................................. Direct labor ........................................................ Variable overhead ............................................. Fixed overhead ($950,000 ÷ 1,000) ................... Variable selling & administrative expenses .... Fixed selling & administrative expenses ($500,000 ÷ 1,000) .......................................... Total cost per session ..............................
Per Session $ 20 400 50 950 40 500 $1,960
(b)
Desired ROI per session = (20% X $2,352,000) ÷ 1,000 = $470.40
(c)
Mark-up percentage on total cost per session = $470.40 ÷ $1,960 = 24%
(d)
Target price per session = $1,960 + ($1,960 X 24%) = $2,430.40
EXERCISE J-7 (a) Fixed manufacturing overhead per unit =
$1,800,000 = $600 per unit 3,000
Fixed selling and administrative = $324,000 = $108 per unit expenses per unit 3,000 (b) Desired ROI per unit =
20% X $51,000,000 = $3,400 per unit 3,000
.
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J-11
EXERCISE J-7 (Continued) (c) Direct materials .......................................................................... Direct labor ................................................................................. Variable manufacturing overhead ............................................ Fixed manufacturing overhead ................................................. Variable selling and administrative expenses ......................... Fixed selling and administrative expenses .............................. Total cost per unit ...................................................................... Desired ROI per unit .................................................................. Target selling price ....................................................................
Per Unit $ 380 290 72 600 55 108 1,505 3,400 $4,905
EXERCISE J-8 (a)
Total Cost Hourly labor rate for repairs Technician’s wages and benefits Overhead costs Office employee’s salary and benefits Other overhead
Total Per Hour ÷ Hours = Charge
$228,000 ÷
7,600
=
$30
38,000 ÷ 15,200 ÷ $281,200 ÷
7,600 7,600 7,600
= = =
5 2 37 30 $67
Profit margin Rate charged per hour of labor
(b)
Total Material Invoice Cost, Material Loading Parts and Loading Charges ÷ Materials = Percentage Overhead costs Parts manager’s salary and benefits Office employee’s salary and benefits Other overhead
$42,500 9,000 51,500 24,000 $75,500
÷ ÷ ÷
$400,000 $400,000 $400,000
Profit margin Material loading percentage
J-12
.
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= = =
12.875% 6.000% 18.875% 20.000% 38.875%
EXERCISE J-8 (Continued) (c) Job: Pace Corporation—Rebuild spot welder Labor charges 40 hours @ $67 ............................................ Material charges Cost of parts and materials......................... Material loading charge (38.875% X $2,000) ....................................
$2,680.00 $2,000.00 777.50
2,777.50
Total price of labor and material ..........
$5,457.50
EXERCISE J-9 (a)
Total Cost Hourly labor rate for repairs Technician’s wages and benefits Overhead costs Office employee’s salary and benefits Other overhead
Total Per Hour ÷ Hours = Charge
$150,000 ÷
6,250
=
$24.00
28,000 ÷ 15,000 ÷ $193,000 ÷
6,250 6,250 6,250
= = =
4.48 2.40 30.88 38.00 $68.88
Profit margin Rate charged per hour of labor
(b)
Total Material Invoice Cost, Material Loading Parts and Loading Charges ÷ Materials = Percentage Overhead costs Parts manager’s salary and benefits Office employee’s salary and benefits Other overhead
$34,000 15,000 49,000
÷
$700,000
=
7.00%
42,000 $91,000
÷ ÷
$700,000 $700,000
=
6.00% 13.00% 100.00% 113.00%
Profit margin Material loading percentage .
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J-13
EXERCISE J-9 (Continued) (c) Job: Buil Builders Labor charges 80 hours @ $68.88 ...............................
$ 5,510.40
Material charges Cost of parts and materials ................. Material loading charge (113% X $40,000) ..............................
$40,000.00 45,200.00
85,200.00
Total price of labor and material ...
$90,710.40
EXERCISE J-10 (a)
Total Cost Hourly labor rate: Restorers’ wages and fringes Overhead costs: Administrative salaries & fringes Other overhead costs Total hourly cost
Total Hours ÷
$270,000 ÷
12,000 =
$22.50
54,000 ÷
12,000 =
4.50
24,000 ÷ $348,000 ÷
12,000 = 12,000 =
2.00 $29.00
Profit margin = Hourly rate – total hourly cost = $70.00 – $29.00 = $41.00
J-14
.
Hourly = Charge
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EXERCISE J-10 (Continued) (b) Material Loading Charges Overhead costs: Purchasing agent’s salary and fringes Administrative salaries and fringes Other overhead costs Total
Total Invoice Cost, Parts & ÷ Materials
Material Loading = Percentage
$ 67,500 21,960 89,460 ÷
$1,260,000
=
7.10%
77,490 ÷ $166,950 ÷
$1,260,000 $1,260,000
= =
6.15% 13.25%
Material loading charge (with profit) Material loading charge (without profit) Profit margin on materials (c) Labor charges: 150 hours @ $70 Material charges: Cost of parts & materials Material loading charge ($60,000 X 83.25%) Total price of labor and materials
83.25% 13.25% 70.00% $ 10,500 $60,000 49,950
109,950 $120,450
EXERCISE J-11 (a)
The minimum transfer price is: Minimum transfer price = Variable cost + opportunity cost Given that the Small Motor Division has excess capacity, the minimum transfer price is the variable cost of $9.00 per unit.
(b)
.
Given no excess capacity, the minimum transfer price is $30, which is its variable cost plus the lost contribution margin.
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J-15
EXERCISE J-11 (Continued) (c)
The level of capacity plays a significant role in determining the appropriate transfer price. If a division has no excess capacity, why should it sell its product below a selling price it can obtain in an outside market? Conversely, if it has excess capacity, as long as it receives more than its variable cost, it has a net gain.
EXERCISE J-12 (a) As indicated, FrameBody has excess capacity and therefore should be willing to accept any price that equals or exceeds its variable cost. 1.
The effect on Cycle Division is as follows:
Selling price Variable cost of goods sold Body frame Other variable costs Contribution margin
Purchase from FrameBody $2,200
Present Situation $2,200 $300 900
1,200 $1,000
$280 900
1,180 $1,020
In this case, Cycle Division makes $20 ($1,020 – $1,000) more per cycle sold and therefore if it sells 1,000 cycles, it makes an additional $20,000. 2.
The effect on FrameBody is that it makes $10 on each frame sold as shown below: Selling price to Cycle Division Variable cost
$280 270 $ 10
Thus the FrameBody Division gains $10,000 ($10 X 1,000). 3.
J-16
As a result, the overall income for Ayala increases $30,000 ($20,000 from Cycle Division and $10,000 from FrameBody).
.
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EXERCISE J-12 (Continued) (b) 1.
The answer would not change from (a)(1). Cycle Division would gain $20,000 if it purchased the frames from FrameBody.
2.
However, FrameBody would incur a loss of $70,000 as computed below: Selling price to outside buyer Selling price to Cycle Division Lost contribution margin per cycle Number of cycles Lost contribution margin
3.
$
350 280 $ 70 X 1,000 $70,000
The effect on the overall income to Ayala is a net loss of $50,000 as shown below: Cycle Division gain Frame Body loss Overall loss
$20,000 70,000 ($50,000)
EXERCISE J-13 (a) The minimum transfer price that Venetian should accept is: Minimum transfer price = ($35 – $4) + ($86 – $35) = $82 (b) The lost contribution margin per unit to the company is: Contribution margin lost by Venetian [($86 – $35) – $4] ....... Increased contribution margin to vehicle division ($80 – $35) ................................................. Net loss in contribution margin ..............................................
$47 45 $ 2
Total lost contribution margin is $2 X 200,000 units = $400,000 (c) If management insists that it wants Venetian to provide the stereo units, and Venetian is operating at full capacity, then it must be willing to pay the minimum transfer price for those units. Otherwise it will be penalizing the managers of Venetian by not giving them adequate credit for their contribution to the corporation’s contribution margin.
.
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J-17
EXERCISE J-14 The minimum transfer price on this special order would be: Minimum transfer price = ($140 – $6) + ($50 – $29) = $155. Since the $160 price offered by the Bathtub Division exceeds this minimum price, the offer should probably be accepted. However, given that the division is operating at full capacity, it should give some consideration to the chance that it may anger existing customers if it has to turn away business. EXERCISE J-15 (a) Minimum transfer price = ($130 – $6) + $0 = $124 (b) Minimum transfer price = ($130 – $6) + ($162 – $130) = $156 (c) No. By forcing the Appraisal Department to accept the $150 per appraisal price, management is penalizing the Appraisal department. If the department was allowed to sell its services to outside customers, it could earn $32 ($162 – $130) in contribution margin per appraisal. Forcing them to sell their services internally would allow them to earn only $26 ($150 – $124) in contribution margin. A loss of $6 per appraisal or a total of $7,200 (1,200 X $6) would result. EXERCISE J-16 (a) The minimum transfer price for Division B would be variable costs, which are $6 per unit ($7, variable cost – $1, variable selling expense). The maximum price would be the external price paid by Division A, which is $10 per unit. (b) Minimum transfer price = variable costs + opportunity cost Variable costs = $6 (as in (a)) Opportunity cost = (($7 – $5) X 15,000) ÷ 10,000 = $3 Therefore the minimum transfer price should be $9 ($6 + $3) The maximum price would still be the external price paid by Division A, which is $10 per unit.
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Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE J-16 (Continued) (c) Minimum transfer price = variable costs + opportunity cost Variable costs = $6.00 (as in (a)) Opportunity cost = (($12 – $7) X 5,000) ÷ 15,000 = $1.67 Therefore the minimum transfer price should be $7.67 ($6 + $1.67) The maximum price would still be the external price paid by Division A, which is $10 per unit. EXERCISE J-17 (a) Sales Less: Costs Variable costs Transfer costs Total costs Contribution to income
Division A $1,500
Division B $2,400
Total Company $3,900
$1,050 0 $1,050 $ 450
$1,200 1,500 $2,700 $ (300)
$2,250 1,500 $3,750 $ 150
(b) The opportunity cost is the market price. Transfers should be made at market prices less any avoidable costs. In the current situation, it would appear that no transfers would be made. (c) (i) (ii)
Maintain price, no transfers (500 X $1,500) – ($500 X $1,050) = $225,000 Cut price, no transfers (1,000 X $1,200) – ($1,000 X $1,050) = $150,000
(iii) Maintain price and transfers (500 X $2,400) + (500 X $1,500) – $1,650,000* = $300,000 *(500 X $2,250) + (500 X $1,050) The firm is better off by maintaining the current market price for Division A’s product and transferring 500 units to Division B. A transfer price within the range of $1,050 to $1,200 would be needed to motivate both divisional managers to engage in the transfers. An optimal transfer price cannot be determined from the information given (even with full information, the best transfer price in the range may not be determinable). .
Kimmel, Accounting, 5e, Solutions Manual
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EXERCISE J-18 (a) Cost per unit: Direct materials .......................................................................... Direct labor ................................................................................. Variable manufacturing overhead ............................................ Fixed manufacturing overhead ($3,000,000/500,000) .............. Variable selling and administrative expenses ......................... Fixed selling and administrative expenses ($1,500,000/500,000) ...............................................................
Per Unit $ 7 9 15 6 14 3 $54
(b) Desired ROI per unit = (25% X $26,000,000)/500,000 = $13 (c) Absorption-cost pricing markup percentage
=
(d) Variable-cost pricing markup percentage
$13 + ($6 + $3) = 48.89% ($7 + $9 + $15 + $14)
=
$13 + ($14 + $3) = 81.08% ($7 + $9 + $15 + $6)
EXERCISE J-19 (a) The cost base of absorption-cost pricing includes only manufacturing costs. All selling and administrative costs are excluded from the cost base and are added back in the numerator of the markup percentage. Absorption-cost pricing markup percentage
=
$20 + ($9 + $11) = 50% ($20 + $25 + $14 + $21)
(b) The cost base of variable-cost pricing includes only variable costs. All fixed costs are excluded from the cost base and are added back in the numerator of the markup percentage. Variable-cost pricing markup percentage
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.
=
$20 + ($21 + $11) = 76.47% ($20 + $25 + $14 + $9)
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
EXERCISE J-20 (a) Fixed manufacturing $1,800,000 = = $600 per unit overhead per unit 3,000 Fixed selling and administrative $324,000 = = $108 per unit expenses per unit 3,000
(b) Desired ROI per unit =
20% X $51,000,000 = $3,400 per unit 3,000
(c) Absorption-cost pricing $3,400 + ($55 + $108) = = 265.499% markup percentage $380 + $290 + $72 + $600 Target selling price = $1,342 + ($1,342 X 265.499%) = $4,905 (d) Variable-cost pricing markup percentage
=
$3,400 + ($600 + $108) = 515.433% $380 + $290 + $72 + $55
Target selling price = $797 + ($797 X 515.433%) = $4,905
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SOLUTIONS TO PROBLEMS PROBLEM J-1
(a) Direct materials ......................................................................... Direct labor ................................................................................ Variable manufacturing overhead ........................................... Variable selling and administrative expenses ........................ Variable cost per unit ...............................................................
Fixed manufacturing overhead Fixed selling and administrative expenses Fixed cost per unit
$20 40 10 5 $75
Total Budgeted Cost Costs ÷ Volume = Per Unit $1,440,000 ÷ 80,000 = $18 960,000 ÷ $2,400,000 ÷
80,000 80,000
Variable cost per unit ............................................................... Fixed cost per unit .................................................................... Total cost per unit .....................................................................
= =
12 $30 $ $
75 30 105
(b) Total cost per unit ..................................................................... Markup ....................................................................................... Desired ROI per unit .................................................................
$ 105 X 30% $ 31.50
(c) Total cost per unit ..................................................................... Desired ROI per unit ................................................................. Target selling price ...................................................................
$105.00 31.50 $136.50
(d) Variable cost per unit ......... Fixed cost per unit .............. Total cost per unit ...............
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$ 75 40 $115
Kimmel, Accounting, 5e, Solutions Manual
(same as above) ($1,440,000 + $960,000) ÷ 60,000
(For Instructor Use Only)
PROBLEM J-2
(a) Direct materials .......................................................................... Direct labor................................................................................. Variable manufacturing overhead ............................................ Variable selling and administrative expenses ......................... Variable cost per unit ................................................................
Fixed manufacturing overhead Fixed selling and administrative expenses Fixed cost per unit
$ 50 26 20 19 $115
Total Budgeted Cost Costs ÷ Volume = Per Unit $ 600,000 ÷ 50,000 = $12 400,000 ÷ $1,000,000 ÷
50,000 50,000
= =
Variable cost per unit ................................................................ Fixed cost per unit ..................................................................... Total cost per unit...................................................................... Desired ROI per unit =
25% X $1,000,000 = $5 50,000
Markup percentage =
$5 $135
8 $20 $115 20 $135
= 3.70%
Total cost per unit...................................................................... Desired ROI per unit .................................................................. Target selling price .................................................................... (b) Variable cost per unit .............................................
$135 5 $140
$115 (same as (a))
Total Budgeted Cost Costs ÷ Volume = Per Unit $ 600,000 ÷ 40,000 = $15
Fixed manufacturing overhead Fixed selling and administrative expenses 400,000 ÷ Fixed cost per unit $1,000,000 ÷
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Kimmel, Accounting, 5e, Solutions Manual
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40,000 40,000
=
10 $25
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PROBLEM J-2 (Continued) Variable cost per unit ............................................................... Fixed cost per unit .................................................................... Total cost per unit ..................................................................... Desired ROI per unit = Markup percentage =
25% X $1,000,000 = $6.25 40,000
$6.25 = 4.46% $140
Total cost per unit ..................................................................... Desired ROI per unit ................................................................. Target selling price ...................................................................
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.
$115 25 $140
Kimmel, Accounting, 5e, Solutions Manual
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$140.00 6.25 $146.25
PROBLEM J-3
(a) Computation of time charge rate Total Cost Hourly labor rate for repairs Shop employees’ wages and benefits Overhead costs Office employee’s salary and benefits Other overhead Total Profit margin Rate charged per hour of labor
Total Per Hour ÷ Hours = Charge
$108,000 ÷ 5,000 =
$21.60
23,500 ÷ 5,000 = 26,000 ÷ 5,000 = $157,500 ÷ 5,000 =
4.70 5.20 31.50 5.00 $36.50
(b) Computation of material loading charge Material Material Loading Total Invoice Cost, Loading Charges ÷ Parts and Materials = Percentage Overhead costs Parts manager’s salary and benefits Office employee’s salary and benefits Other overhead Total Profit margin Material loading percentage
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Kimmel, Accounting, 5e, Solutions Manual
$25,400 13,600 39,000 ÷ 16,000 ÷ $55,000 ÷
(For Instructor Use Only)
$100,000 100,000 100,000
= = =
39% 16% 55% 30% 85%
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PROBLEM J-3 (Continued) (c) Price quotation for time and material JOSE’S ELECTRONIC REPAIR SHOP Time and Material Price Quotation January 5, 2014 Job: Fix big screen TV set Labor charges: 5 hours @ $36.50 .................... Material charges Cost of parts and materials ......................... Material loading charge (85% X $200) ........ Total price of labor and material .......................
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$182.50 $200 170
370.00 $552.50
PROBLEM J-4
(a) Assuming no available capacity, the printing operation’s variable cost is $0.004 per page and its opportunity cost is $0.006 ($0.01 – $0.004) per page. The minimum transfer price would be $0.01 ($0.004 + $0.006). Therefore, the printing operation would not accept the internal transfer price of $0.007. (b) Assuming that the printing operation has available capacity, the printing operation’s variable cost is $0.004 and its opportunity cost is $0. The minimum transfer price would be $0.004 ($0.004 + $0). Therefore, in this case, the printing operation should accept the offer to print internally. The $0.007 transfer price would provide a contribution margin of $0.003 ($0.007 – $0.004) per page. Depending on its bargaining strength, the printing operation might want to ask for a transfer price higher than $0.007, since the company is saving money at any price below the $0.009 price that the line pays to outside printers. (c) The advantages of having all of the company’s printing done internally include: (1) ensuring that the company’s quality expectations are met, (2) ensuring that all projects are completed on a timely basis, and (3) ensuring that jobs are scheduled in a manner consistent with the company’s priorities. The primary disadvantages of forcing the printing operation to print internal work when it doesn’t feel it is in its best interest are: (1) the division manager loses control over the division’s performance, resulting in a loss of morale, and (2) the profitability of the division, as well as the company as a whole, will decline. (d) The printing operation would lose: ($0.01 – $0.007) X 500 pages X 1,500 copies
= ($2,250)
Business Books would save: ($0.009 – $0.007) X 500 pages X 1,500 copies = Overall loss to the company as a whole
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Kimmel, Accounting, 5e, Solutions Manual
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1,500
= ($ 750)
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PROBLEM J-5
(a) The minimum transfer price is based on the variable cost of units transferred internally, plus the opportunity cost of units sold externally. The variable cost of internal sales would be $10 ($14.50 – $4.50). The opportunity cost would be $8 ($22.50 – $14.50). Therefore, the minimum transfer price would be $18 ($10 + $8). Since the $20 transfer price offered by the Board Division exceeds this minimum transfer price, the Chip Division should sell the chip internally. Since it is already at capacity, it probably needs to consider the implications to its existing customers. (b) If the Chip Division rejects the offer, each division will suffer a loss of contribution margin, as well as the company as a whole. The amount of this loss is calculated as: Lost contribution margin by Board Division: Cost of buying externally, per chip Cost of buying internally, per chip Increased cost, resulting in lower unit contribution margin Number of units purchased Total lost contribution margin
$22 20 2 X 30,000
Lost contribution margin by Chip Division: Unit contribution margin on internal sales ($20 – $10) $10 Unit contribution margin on external sales ($22.50 – $14.50) 8 Lost unit contribution margin 2 Number of units sold X 30,000 Total lost contribution margin Overall lost contribution margin for the company
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Kimmel, Accounting, 5e, Solutions Manual
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$ 60,000
60,000 $120,000
PROBLEM J-6
(a) Assuming no available capacity, and that the number of new units produced would be equal to the number of standard units forgone, variable cost of the special pager would be $80 ($50 + $30) and the opportunity cost would be $45 ($95 – $50). Therefore, the minimum transfer price would be $125 ($80 + $45). Since this is higher than the $105 transfer price, the CD Division should reject the offer. (b) Assuming no available capacity, and that in order to produce the 12,000 special pagers, 16,000 standard pagers would be forgone, the minimum variable cost would be ($50 + $30) or $80 and the opportunity cost would be: Total contribution margin on standard pagers ($95 – $50) X 16,000 = = $60 Number of special pagers 12,000
Therefore, the minimum transfer price would be $140 [($50 + $30) + $60]. Since the $150 transfer price being offered exceeds the minimum transfer price of $140, the CD Division should accept the offer. (c) Assuming that the CD Division has available capacity, variable cost would be $80 ($50 + $30) and the opportunity cost would be zero. Therefore, the minimum transfer price would be $80 ($80 + $0). Since the $100 transfer price being offered exceeds the $80 minimum transfer price, the offer should be accepted.
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PROBLEM J-7
(a) Absorption-cost pricing: Computation of unit manufacturing cost and target selling price Direct materials ......................................................................... Direct labor ................................................................................ Variable manufacturing overhead ........................................... Fixed manufacturing overhead ($1,200,000 ÷ 80,000) ............ Unit manufacturing cost ................................................... Markup: 50% X $85.00 ............................................................. Target selling price ...................................................................
$ 20.00 40.00 10.00 15.00 85.00 42.50 $127.50
The markup of $42.50 per unit must cover selling and administrative expenses (variable and fixed) plus provide a desired return on investment. (b) Variable-cost pricing: Computation of total variable cost and target selling price Direct materials ......................................................................... Direct labor ................................................................................ Variable manufacturing overhead ........................................... Variable selling and administrative expenses ........................ Unit total variable cost ...................................................... Markup: 70% X $75 .................................................................. Target selling price ...................................................................
$ 20.00 40.00 10.00 5.00 75.00 52.50 $127.50
The markup of $52.50 per unit must cover fixed manufacturing and fixed selling and administrative costs plus provide a desired return on investment.
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Kimmel, Accounting, 5e, Solutions Manual
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PROBLEM J-8
Absorption-cost pricing (a) Step one—Computation of unit manufacturing cost: Direct materials ........................................................................ Direct labor............................................................................... Variable manufacturing overhead .......................................... Fixed manufacturing overhead ($120,000 ÷ 4,000) ................ Total manufacturing cost ................................................
Per Unit $100 70 20 30 $220
Step two—Computation of markup percentage to provide a 25% ROI: Markup [(25% X $1,016,000) ÷ 4,000] + [$10 + ($102,000 ÷ 4,000)] $99 = = = 45% Percentage $220 $220
(b) Step three—Computation of target price: Target price: $220 + [45% X $220) = $319 Proof of 25% ROI under absorption-cost pricing: ANDERSON WINDOWS INC. Budgeted Absorption-Cost Income Statement (Tinted Window) Revenues (4,000 units X $319) ........................................ Cost of goods sold (4,000 units X $220) ........................ Gross profit ...................................................................... Selling and administrative expenses [(4,000 units X $10) + $102,000] .................................. Net income ....................................................................... Desired ROI =
$1,276,000 880,000 396,000 142,000 $ 254,000
$254,000 = 25% $1,016,000
Markup percentage =
$254,000 + $142,000 = 45% *$880,000*
*$220 X 4,000
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PROBLEM J-8 (Continued) Variable-cost pricing (c) Step one—Computation of unit variable cost: Direct materials ...................................................................... Direct labor ............................................................................. Variable manufacturing overhead ........................................ Variable selling and administrative expenses ............................................................................ Total variable cost ..........................................................
Per Unit $100 70 20 10 $200
Step two—Computation of markup percentage to provide a 25% ROI: Markup [(25% X $1,016,000) ÷ 4,000] + [($120,000 + $102,000) ÷ 4,000] $119 = = = 59.50% Percentage $200 $200
(d) Step three—Computation of target price: Target price: $200 + (59.5% X $200) = $319 Proof of 25% ROI under variable-cost pricing: ANDERSON WINDOWS INC. Budgeted Variable-Cost Income Statement (Tinted Window) Revenue (4,000 units X $319) ............................ Variable costs (4,000 units X $200)................... Contribution margin .......................................... Fixed costs Fixed manufacturing overhead costs ........... Fixed selling and administrative expenses .... Net income ......................................................... Desired ROI =
.
$120,000 102,000
$254,000 = 25% $1,016,000
Markup percentage =
J-32
$1,276,000 800,000 476,000
$222,000 + $254,000 = 59.5% $800,000
Kimmel, Accounting, 5e, Solutions Manual
(For Instructor Use Only)
222,000 $ 254,000
PROBLEM J-8 (Continued) (e) Both absorption-cost pricing and variable-cost pricing are used because they have differing merits. Absorption-cost pricing, especially when it includes full or all costs, is preferred by some because in the long-run all costs plus a normal profit margin must be covered. Using only variable costs, as the variable-cost pricing does, is thought to encourage decision makers to set too low a price in order to boost sales. Also, absorption-cost pricing is preferred because of its convenience. Absorption-cost data is more readily provided by most companies’ financial and cost accounting systems. The accounts and numbers used to prepare financial reports can be used for absorption-cost pricing. Variable-cost pricing is preferred by some, even though the basic accounting data is less accessible, because it is more consistent with cost-volume-profit analysis. In addition, it can be used in pricing special orders since it shows the incremental cost of one more unit or one more order. Variable-cost pricing also avoids arbitrary allocation of common fixed costs to individual product lines.
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$7,000,000
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