Chapter 1

Chapter 1

Using the Financial Statements

Questions

1. Accounting is a system for measuring, processing and communicating financial information. Bookkeeping is a procedural element of accounting.

2. a. Individuals use accounting information to manage bank accounts and make investment decisions, among other things.

b. Managers of businesses use accounting information to set goals for their businesses and to determine what equipment to buy, for example.

c. Investors and creditors use accounting information to evaluate investments and loan applications.

d. Government agencies (including taxation authorities) use accounting data in regulating business activity.

e. Nonprofit organizations such as churches and hospitals use accounting information in much the same way that managers of businesses do — to run their organizations.

3. The Financial Accounting Standards Board (FASB) formulates generally accepted accounting principles. The FASB is not a government agency, nor is it part of any other organization.

4. The owner of a proprietorship is called the proprietor, the owners of a partnership are called partners, and the owners of a corporation are called stockholders (or shareholders).

5. Ethical standards in accounting are designed to produce honest information for decision-making.

Chapter 1 Using the Financial Statements 1

6. The entity concept draws clear boundaries around each entity. It is important because it allows decision makers to evaluate each entity as a separate economic unit.

7. Four examples of accounting entities are a household, a business such as a drugstore or a manufacturer, a professional organization such as a law firm or a medical practice, and a nonprofit organization such as a church or a hospital.

8. The essence of the reliability principle is that accounting information should be based on the most objective and verifiable data possible.

9. The cost principle dictates that assets and services purchased be recorded at their actual cost and that cost remain their accounting value.

10. Liabilities = Assets Owners’ Equity.

11. An account receivable is an asset because it is a claim against the cash of another party. An account payable is a liability because it is another party’s claim against the business’s cash.

12. The business can choose to retain the earnings or to pay dividends to stockholders.

13. A more descriptive title for the balance sheet is the “statement of financial position.”

14. The balance between assets on the left side and liabilities and owners’ equity on the right side of the balance sheet gives this financial statement its name. The balance appears in the accounting equation, Assets = Liabilities + Owners’ Equity, which is essentially a summary of the balance sheet in equation form.

Financial Accounting 4/e Solutions Manual2

15. Another title of the income statement is the “statement of operations.”

16. The balance sheet is like a snapshot of the entity at a specific time.

17. The statement of retained earnings presents a summary of the changes that occurred in retained earnings during the period due to net income or net loss and from dividends.

18. Net income (or net loss) flows from the income statement to the statement of retained earnings. Ending retained earnings then flows to the balance sheet.

19. Order of occurrence Order of importancefor a new business to investors Financing activities Operating activitiesInvesting activities Investing activitiesOperating activities Financing activities


Check Points

(5 min.) CP 1-1

Store manager decisions:

a. What merchandise to sell and how to market the goods

b. What types of assets to acquire for use in the business

c. How to finance operations

Accounting helps managers measure the revenues, the expenses, and the

profit (or loss) of the business. Profits indicate success, and losses reveal

failure. Depending on the profitability of the business, the manager can

decide which merchandise to offer, which other assets to purchase, and

how to finance operations.

Items on The Gap’s income statement that help decide whether to invest

in the company:

The company had net earnings (rather than a net loss).

This year’s net earnings are larger than last year’s.

Net sales revenue is increasing from year to year.


(5 min.) CP 1-2

Accounting is the information system that measures business activities,

processes that information into reports, and communicates the results to

decision makers.

Bookkeeping is the procedural element of accounting that processes the

information. Thus, bookkeeping is the information-processing phase of

accounting.


(5 min.) CP 1-3

Standards of professional conduct are designed to produce accurate

information for decision making. People need accurate information in

order to make wise decisions.

If there were no ethical guidelines for accountants, companies could

report inaccurate information. This could cause people not to invest their

money, and the failure to put resources to work would hurt our standard

of living.

(5 min.) CP 1-4

1. DeFilippo can be misled into believing that the business has produced

more cash than it has actually generated.

2. The entity concept applies.

3. Application of the entity concept will separate DeFilippo’s personal

cash from the cash produced by the business. This information will

show how much cash has come from the business, and this knowledge

will help her evaluate the business realistically.


(5 min.) CP 1-5

1. Owners’ Equity = Assets Liabilities

2. Liabilities = Assets Owners’ Equity

3. Assets = Liabilities + Owners’ Equity

(5 min.) CP 1-6

1. Assets are the economic resources of a business that are expected to

be of benefit in the future.

Owners’ equity represents the insider claims of a business, the claims

to the assets held by the owners of the business.

Assets and owners’ equity differ in that owners’ equity is a claim to

assets.

Assets must be at least as large as owners’ equity, so equity can be

smaller than assets.

2. Both liabilities and owners’ equity are claims to assets.

Liabilities are the outsider claims to the assets of a business. Owners’

equity represents the insider claims to the assets of the business.


(5-10 min.) CP 1-7

a. Accounts payable L

b. Common stock E

c. Receivables A

d. Retained earnings E

e. Land A

f. Prepaid expenses A

g. Cash A

h. Long-term debt L

i. Merchandise inventory A

j. Notes payable L

k. Accrued expenses payable L

l. Equipment A


(5 min.) CP 1-8

1. Revenues and expenses

2. Net earnings, or net income (or net loss)

3. Total assets are not used to measure net earnings. Only revenues and

gains, expenses and losses enter into the measurement of net earnings.

(10 min.) CP 1-9

MillionsNet sales revenue………………………………… $9,054Expenses:

Cost of goods sold ($9,054 .618)…………..

5,595

Advertising expense…………………………. 419Depreciation expense………………………... 326Other operating expenses……………………. 1,658Interest expense……………………………... 14

Earnings before income taxes……………………. 1,042Income tax expense ($1,042 .375)……………..

391

Net earnings……………………………………… $ 651


(5 min.) CP 1-10

McCullough Water SystemsStatement of Retained EarningsYear Ended December 31, 2000

Retained earnings:Balance, beginning of year………………... $ 60,000Net income ($600,000 $530,000)………. 70,000Less: Dividends…………………………… (30,000 )Balance, end of year………………………. $100,000


(10-15 min.) CP 1-11

McCullough Water SystemsBalance Sheet

December 31, 2000ASSETSCurrent assets:

Cash………………………………………………….. $ 13,000Receivables…………………………………………... 2,000Inventory……………………………………………... 25,000 Total current assets…………………………………... 40,000

Land, buildings, and equipment………………………… 110,000Other assets……………………………………………... 10,000 Total assets……………………………………………… $160,000

LIABILITIESCurrent liabilities:

Accounts payable…………………………………….. $ 8,000Short-term notes payable…………………………….. 12,000 Total current liabilities………………………………. 20,000

Long-term liabilities:Long-term debt………………………………………. 80,000

STOCKHOLDERS’ EQUITYCommon stock………………………………………….. 15,000Retained earnings…………………………………….…. 45,000 *

Total stockholders’ equity…………………………… 60,000 Total liabilities and stockholders’ equity……………….. $160,000

_____*Computation:

Total assets ($160,000) current liabilities ($20,000) long-term debt ($80,000) common stock ($15,000) = $45,000


(10-15 min.) CP 1-12

McCullough Water SystemsStatement of Cash Flows

Year Ended December 31, 2000Cash flows from operating activities:

Collections from customers…………………………. $580,000Payments to suppliers and employees………………. (520,000 )

Net cash inflow from operating activities………... 60,000

Cash flows from investing activities:Purchases of plant……………………. $(300,000)Sale of equipment……………………. 90,000

Net cash outflow from investing activities………. (210,000)

Cash flows from financing activities:Borrowing on long-term note payable.. $150,000Payment of dividends………………... (10,000 )

Net cash inflow from financing activities………... 140,000 Net increase (decrease) in cash………………………… (10,000)Cash balance, December 31, 1999……………………... 23,000 Cash balance, December 31, 2000……………………... $ 13,000


(10 min.) CP 1-13

1. Dividends SRE, SCF

2. Depreciation expense IS

3. Inventory BS

4. Sales revenue IS

5. Retained earnings SRE, BS

6. Operating cash flows SCF

7. Net income (or net loss) IS, SRE

8. Cash BS, SCF

9. Cash flows from financing activities SCF

10. Accounts payable BS

11. Common stock BS

12. Interest revenue IS

13. Long-term debt BS

14. Increase or decrease in cash SCF


Exercises

(10-15 min.) E 1-1

a. Proprietorship. There is a single owner of the business, so the owner is answerable to no other owner.

b. Partnership. If the partnership fails and cannot pay its liabilities, creditors can force the partners to pay the business’s debts from their personal assets. A partnership affords more protection for creditors than a proprietorship because there are two or more owners to share this personal liability for the business’s debts.

c. Corporation. If the corporation fails and cannot pay its liabilities, creditors cannot force stockholders to pay the business’s debts from their personal assets. Therefore, the most an investor can expect to lose on an investment in a corporation is the amount invested.

d. Corporation. The life of a corporation is indefinite because it is not limited by the life of any owner. The life of a proprietorship or a partnership is limited to the life (lives) of the owner(s).

e. Corporation. Most investors are willing to invest more in a corporation than in a proprietorship or a partnership because of their limited personal liability for a corporation’s debts.

What form of business organization would you choose?

The answer depends on your objective. If you want to maintain absolute control of the business, you may prefer to organize as a proprietorship. If your objective is to maintain a high degree of control but you need additional money or expertise, a partnership may work for you. If you want the business to grow large, or if you wish to avoid personal liability for business debts, you should organize as a corporation.


(10 min.) E 1-2

The income statement reports the revenues and expenses of a particular entity for a period such as a month or a year. Total revenues minus total expenses equals net income, or profit. A lender would require this information in order to predict whether the borrower can generate enough income to repay the loan.

The balance sheet reports the assets, liabilities, and owners’ equity of the entity at a particular point in time. The assets show the resources that the business has to work with. Because borrowers pay loans with assets, a lender wants to know the business’s assets (especially cash). Liabilities — debts — represent creditors’ claims to the business’s assets. Owners’ equity is the portion of the business assets owned outright by the owners.

Note: Student responses may vary.


(5-10 min.) E 1-3

a. Entity conceptb. Reliability (Objectivity) principlec. Entity conceptd. Going-concern concepte. Cost principle

(5-15 min.) E 1-4

(Amounts in billions)Assets = Liabilities + Owners’ Equity

IBM $86 $67 $19Hershey Foods 3.3 2.4 0.9SONY 49 35 14

(10-15 min.) E 1-5

(Amounts in millions)

Assets = Liabilities +Stockholders’

Equity$402 $122 216 115 35 24

Total $653 = $261 + $392

Resourcesto work with

Amountowed

Actually owned by the stockholders


(10-20 min.) E 1-6

Situation1 2 3

MillionsTotal stockholders’ equity

August 31, 1999 ($101 $61)……………... $40 $40 $40Add: Issuances of stock……………………….. 1 -0- 10

Net income……………………………… 3 7Less: Dividends……………………………….. -0- (3) (2)

Net loss………………………………….. (4)Total stockholders’ equity,

August 31, 2000 ($132 $88)……………... $44 $44 $44


(10-15 min.) E 1-7

1. The Gap, Inc.(Amounts in billions)

Assets = Liabilities +Stockholders’

EquityBeginning $ 3.4 = $1.8 + $1.6Multiplier for increase

1.166 Ending $ 3 .964

2. Johnson & Johnson(Amounts in billions)

Assets - Liabilities =Stockholders’

EquityBeginning amount $12.2 - $6.7 = $5.5Net income 2.0Dividends and other decreases (.4)Ending amount $7.1


(10-15 min.) E 1-8

a. Statement of cash flows

b. Income statement

c. Statement of cash flows

d. Balance sheet, Statement of cash flows

e. Balance sheet

f. Income statement, Statement of retained earnings

g. Balance sheet

h. Balance sheet

i. Income statement

j. Balance sheet

k. Statement of cash flows

l. Statement of retained earnings, Statement of cash flows

m. Income statement

n. Balance sheet, Statement of retained earnings

o. Income statement


(10-20 min.) E 1-9

Req. 1

The Home Depot is a corporation, as shown by the common stock and retained earnings.

Req. 2

The Home Depot, Inc.Balance Sheet (Amounts in millions)

January 31, 1999ASSETS LIABILITIES

Cash $ 62 Accounts payable $ 1,586Accounts receivable 469 Other liabilities 3,139Merchandise inventory 4,402 Total liabilities 4,725Property and equipment 8,532 STOCKHOLDERS’

EQUITYCommon stock $ 2,864Retained earnings 5,876*Total stockholders’ equity 8,740

Total liabilities and Total assets $13,465 stockholders’ equity $13,465

_____*Computation:

Total assets ($13,465) Total liabilities ($4,725) Common stock ($2,864) = $5,876


(15-25 min.) E 1-10

Req. 1

The Home Depot, Inc.Income Statement

Year Ended January 31, 1999 Millions

Sales revenue………………………… $30,219Expenses:

Cost of goods sold………………… $21,614Selling and store operating expense. 5,341Other expenses (summarized)…….. 1,650Total expenses…………………….. 28,605

Net income…………………………… $ 1,614

Req. 2

The statement of retained earnings reports dividends, as follows

Statement of Retained Earnings(millions)

Retained earnings, beginning of year…………… $4,430Add: Net income for the year (Req. 1)………….. 1,614

6,044Less: Dividends…………………………………. (168)Retained earnings, end of year (from Exercise 1-9).. $5,876


(15-20 min.) E 1-11

Sprint CorporationStatement of Cash Flows

Year Ended December 31, 20X1Millions

Cash flows from operating activities:Receipts:

Collections from customers……………………….. $12,629Payments:

To suppliers and employees………………………. (9,900)Net cash inflow from operating activities……… 2,729

Cash flows from investing activities (summarized):Net cash outflow from investing activities…….. (3,141)

Cash flows from financing activities (summarized):Net cash inflow from financing activities……… 422

Net increase in cash……………………………………... 10Beginning cash balance…………………………………. 113Ending cash balance…………………………………….. $ 123

Items given that do not appear on the statement of cash flows:Net income - Income statement and statement of retained

earningsTotal assets - Balance sheetTotal liabilities - Balance sheet


(15-20 min.) E 1-12

KINK’S COPY SERVICE, INC.INCOME STATEMENT

MONTH ENDED JULY 31, 20X1Revenue:

Service revenue……………………………… $2,400Expenses:

Rent expense………………………………… $700Utilities expense……………………………... 200Total expenses……………………………….. 900

Net income………………………………………. $1,500

KINK’S COPY SERVICE, INC.STATEMENT OF RETAINED EARNINGS

MONTH ENDED JULY 31, 20X1Retained earnings, July 1, 20X1…………………………. $ 100Add: Net income for the month………………………….. 1,500

1,600Less: Dividends………………………………………….. (1,200)Retained earnings, July 31, 20X1………………………... $ 400

(15-20 min.) E 1-13

KINK’S COPY SERVICE, INC.BALANCE SHEET

JULY 31, 20X1Assets Liabilities

Cash……………... $ 6,200 Accounts payable………... $ 2,000Office supplies….. 1,200Copy equipment… 30,000 Stockholders’ Equity

Common stock…………… 35,000Retained earnings………... 400Total stockholders’ equity.. 35,400

______ Total liabilities and ______Total assets $37,400 stockholders’ equity…. $37,400


(15-20 min.) E 1-14

KINK’S COPY SERVICE, INC.STATEMENT OF CASH FLOWSMONTH ENDED JULY 31, 20X1

Cash flows from operating activities:Collections from customers………………….. $ 1,900Payments to suppliers and employees……….. (450)

Net cash inflow from operating activities… 1,450

Cash flows from investing activities:Acquisition of land…………………………... $(30,000)

Net cash outflow from investing activities.. (30,000)

Cash flows from financing activities:Issuance (sale) of stock to owners…………… $ 35,000Dividends…………………………………….. (1,200)

Net cash inflow from financing activities… 33,800Net increase in cash…………………………….. $ 5,250Cash balance, July 1, 20X1……………………... 950Cash balance, July 31, 20X1……………………. $ 6,200


(10-15 min.) E 1-15

TO: Owners of Kink’s Copy Service, Inc.

FROM: Student Name

SUBJECT: Opinion of operating results, financial position, and cash flows

Your first month of operations appears to have been successful.

Revenues totaled $2,400 and net income was $1,500. These operating

results look very strong.

The company was able to pay a $1,200 dividend, and this should make

you happy with so quick a return on your investment.

Your financial position looks secure, with assets of $37,400 and

liabilities of only $2,000. Your stockholders’ equity is $35,400.

Operating activities generated cash of $1,450, which is respectable.

You ended the month with cash of $6,200. Based on the above facts, I

believe you should stay in business.



(15-20 min.) E 1-16

a. The single best source of cash for a business is collections from

customers. This source of cash is best because it results from the core

operating activity of the business. Collections from customers do not

create liabilities that must be paid back to anyone.

b. Heavy investing activity and paying off debts can result in a cash

shortage even if net income has been high.

c. Borrowing money, issuing (selling) stock to stockholders, and selling

long-term assets such as land, buildings, and equipment can bring in

cash even during a period when the company has experienced net

losses.

d. Paying large dividends will cause retained earnings to be low.

e. You can finance the payment of current liabilities in several ways:

Borrow money, issue (sell) stock to stockholders, or sell long-term

assets such as land, buildings, and equipment.


Problems

Group A

(15-30 min.) P 1-1A

TO: Investment committee

SUBJECT: Helix Corporation request for us to buy its stock

I recommend purchasing Helix Corporation stock because:

1. Operations are the main source of Helix’s cash flows, and the company is increasing its cash without a lot of borrowing. Moreover, Helix has been investing lots of money in long-term assets, as shown by its investing cash flows.

2. Net income has increased dramatically during the past two years.

3. Total assets have grown from $720,000 to $990,000 during the past two years, and liabilities have risen more slowly.

I believe Helix has a bright future and that its stock is likely to increase in value.



(15-20 min.) P 1-2A

Req. 1

Ford Motor CompanyIncome Statement

Year Ended December 31, 20X1Billions

Sales revenue…………………………. $119.1Other revenue………………………… 46.6Total revenue…………………………. $165.7

Cost of goods sold……………………. 101.2Selling and administrative expenses….. 6.0Other expenses………………………... 23.4Total operating expenses……………... 130.6Income before income tax……………. 35.1Income tax expense ($35.1 .36)……..

12.6

Net income……………………………. $ 22.5


(continued) P 1-2A

Req. 2

a. Reliability (objectivity) principle. Report revenues at their actual sale value because that amount is more reliable than what management believes the goods are worth.

b. Cost principle. Account for expenses at their actual cost, not a hypothetical amount that the company might have incurred if the products were purchased outside.

c. Cost principle. Account for expenses at their actual cost.

d. Entity concept. Each division of the company is a separate entity, and the company as a whole constitutes an entity for accounting purposes.

e. Stable-monetary-unit concept. Accounting in the United States ignores the effect of inflation.

f. Going-concern concept. There is no evidence that Ford is going out of business, so it seems safe to assume that the company is a going concern.


(30-40 min.) P 1-3A

Computed amounts are shown in boxes. Amounts are in billions.

Coca-Cola Company

Ford Corp.

Sara Lee Corp.

Beginning:Assets $17 $279 $13

Liabilities (10) (228) (9)= Owners’ equity $ 7 $ 51 $ 4

Ending:Assets $19 $2692 $11

Liabilities (11) (204) (9)= Owners’ Equity $ 8 $ 65 $ 2

Owners’ Equity:Issuances of stock $ 0 $ 1 $03

Dividends (3) (9) (1)

Income Statement:Revenues $19 $119 $20

Expenses (15)1 (97) (21)= Net income (net loss) $ 4 $ 22 $ (1)

Statement of owners’ equityBeginning owners’ equity $ 7 $ 51 $ 4

+ Issuances of stock 0 1 03

+ Net income (Net loss) 41 22 (1) Dividends (3) (9) (1)= Ending owners’ equity $ 8 $ 65 $ 2_____ _____ _____1Net income (x) = $4 2Assets liabilities = OE 3$4 + Issuances of stock (y) Revenue expenses = net income Assets = $204 + $65 $1 $1 = $2 $19 expenses = $4 Assets = $269 Issuances of stock = $-0- Expenses = $15


(20-25 min.) P 1-4A

Req. 1

Nocona, Inc.Balance SheetJuly 31, 20X1

ASSETS LIABILITIESCash $15,000 Accounts payable $ 9,000Accounts receivable 12,000 Note payable 16,000Office supplies 1,000 Total liabilities 25,000Office furniture 10,000 STOCKHOLDERS’Land 44,000 EQUITY

Stockholders’ equity 57,000* Total liabilities and

Total assets $82,000 stockholders’ equity $82,000

_____*Total assets ($82,000) Total liabilities ($25,000) = Stockholders’ equity ($57,000).

Req. 2

The accounts that are not presented on the balance sheet because they are revenues or expenses, but which are presented on the income statement, are:

Rent expenseAdvertising expenseService revenueProperty tax expense


(20-25 min. P 1-5A

Req. 1

Kristina Pea, Realtor, Inc.Balance Sheet

November 30, 2000ASSETS LIABILITIES

Cash $ 12,000 Accounts payable $ 6,000Office supplies 1,000 Note payable 40,000Franchise 20,000 Total liabilities 46,000Furniture 17,000 STOCKHOLDERS’Land 120,000 EQUITY

Common stock 50,000Retained earnings 74,000 *Total stockholders’ equity 124,000

________ Total liabilities and ________Total assets $170,000 stockholders’ equity $170,000

_____*Total assets ($170,000) Total liabilities ($46,000) Common stock ($50,000) = $74,000.

Req. 2

Personal items not reported on the balance sheet of the business:

a. Personal cash ($10,000)b. Personal accounts payable ($1,800)g. Personal residence ($190,000) and mortgage payable ($100,000)


(30-45 min.) P 1-6A

Req. 1

Liberty CorporationIncome Statement

Year Ended December 31, 20XXRevenue

Service revenue……………………. $180,000Expenses

Salary expense……………………... $63,000Rent expense………………………. 23,000Advertising expense……………….. 13,000Interest expense……………………. 9,000Property tax expense………………. 4,000Total expenses……………………... 112,000

Net income……………………………. $ 68,000

Req. 2

Liberty CorporationStatement of Retained Earnings

Year Ended December 31, 20XXRetained earnings, beginning of year……... $ 50,000Add: Net income for the year……………... 68,000

118,000Less: Dividends…………………………… (70,000)Retained earnings, end of year……………. $ 48,000


(continued) P 1-6A

Req. 3

Liberty CorporationBalance Sheet

December 31, 20XXASSETS LIABILITIES

Cash $ 10,000 Accounts payable $ 19,000Accounts receivable 12.000 Salary payable 1,000Supplies 3,000 Note payable 85,000 Furniture 20,000 Total liabilities 105,000Building 110,000 STOCKHOLDERS’Land 98,000 EQUITY


_______ Total liabilities and _______Total assets $253,000 stockholders’ equity $253,000

_____*Total assets ($253,000) Total liabilities ($105,000) Common stock ($100,000) = Retained earnings ($48,000).


(20 min.) P 1-7A

Nike, Inc.Statement of Cash Flows

Year Ended May 31, 20X0Cash flows from operating activities:

Collections from customers……………………… $8,779Payments to suppliers and employees…………… (8,456)

Net cash inflow from operating activities…….. 323

Cash flows from investing activities:Purchases of property, plant, and equipment…….. $(510)Sales of property, plant, and equipment…………. 24Other investing cash receipts…………………….. 33

Net cash outflow for investing activities……… (453)

Cash flows from financing activities:Borrowing on long-term debt……………………. $ 388Issuance of common stock……………………….. 26Payment of dividends……………………………. (101)

Net cash inflow from financing activities…….. 313

Net increase in cash…………………………………. $ 183Cash, beginning……………………………………... 262Cash, ending………………………………………… $ 445


(40-50 min.) P 1-8A

Req. 120X1 20X0

(Thousands)Statement of operationsRevenues $94,749 = $ k $88,412Cost of sales 74,564 a = 65,586Other expenses 15,839 13,564Income before income taxes 4,346 9,262Income taxes (36.95% in 20X1) 1,606 = l 1,581Net income 2,740 = $ m $ b = 7,681

Statement of retained earningsBeginning balance 17,213 = $ n $ 9,987Net income 2,740 = o c = 7,681Dividends (559) (455)Ending balance 19,394 = $ p $ d = 17,213

Balance sheetAssets:

Cash 83 = $ q $ e = 45Property, plant and equipment 23,894 20,874Other assets 18,564 = r 16,900

Total assets 42,541 = $ s $37,819

Liabilities:Current liabilities 11,454 = $ t $ 9,973Long-term debt and other liabilities 11,331 10,120

Total liabilities 22,785 f = 20,093

Shareholders’ Equity:Common stock $ 229 $ 230Retained earnings 19,394 = u g = 17,213Other shareholders’ equity 133 283

Total shareholders’ equity 19,756 = v 17,726Total liabilities and shareholders’ equity 42,541 = $ w $ h = 37,819

Statement of cash flowsNet cash provided by operating activities 2,383 = $ x $ 2,906Net cash used in investing activities (3,332) (3,792)Net cash provided by financing activities 987 911

Increase (decrease) in cash 38 i = 25Cash at beginning of year 45 = y 20Cash at end of year 83 = $ z $ j = 45


(continued) P 1-8A

Req. 2

a. Operations deteriorated during 20X1. Revenues increased, but net

income fell from $7,681 thousand to $2,740 thousand.

b. The company retained most of its net earnings for use in the business.

Dividends were $455 thousand in 20X0 and $559 thousand in 20X1,

which are much less than net income.

c. Total assets at the end of 20X1 were $42,541 thousand. This is the

amount of total resources that the company had to work with as it

moves into the year 20X2. At the end of 20X0 the company had total

assets of $37,819 thousand.

d. At the end of 20X0 the company owed total liabilities of $20,093

thousand. At the end of 20X1 the company owed $22,785 thousand.

e. The company’s major source of cash is operating activities, and cash is

increasing. Based on these two facts, it appears that the company’s

ability to generate cash is strong despite the dip in 20X1 net income.

The company is using most of its cash to expand. This is clear from the

large amounts of cash used for investing activities, which indicate that

the company is growing.


Problems Group B

(15-30 min.) P 1-1B

TO: Merrill Lynch loan committee

SUBJECT: Alcoa Tire Company loan request

I recommend not lending $300,000 to Alcoa because:

1. Operations are generating less and less of the company’s cash, and the cash balance has decreased by $120,000 during the past three years.

2. Net income has decreased for the past two years.

3. Dividends have exceeded net income for the past two years. As a result, stockholders’ equity has decreased from $400,000 to $340,000.

4. Liabilities have increased from $260,000 to $390,000, which exceeds stockholders’ equity. A $300,000 loan to Alcoa would make this situation worse.

I doubt Alcoa could repay this loan.



(15-20 min.) P 1-2B

Req. 1

The Chrysler DivisionIncome Statement

Year Ended December 31, 20X1Billions

Sales revenue…………………………. $69.4Other revenue………………………… 5.8Total revenue…………………………. $75.2

Cost of goods sold……………………. $59.0Selling and administrative expenses….. 3.9Other expenses………………………... 4.5Total operating expenses……………... 67.4Income before income tax……………. 7.8Income tax expense ($7.8 .36)………

2.8

Net income……………………………. $ 5.0


(continued) P 1-2B

Req. 2

a. Reliability (objectivity) principle. Report revenues at their actual sale value because that amount is more reliable than what management believes the good are worth.

b. Cost principle. Account for expenses at their actual cost, not a hypothetical amount that the company might have incurred if the products were purchased outside.

c. Cost principle. Account for expenses at their actual cost.

d. Entity concept. Each division of the company is a separate entity, and the company as a whole constitutes an entity for accounting purposes.

e. Stable-monetary-unit concept. Accounting in the United States ignores the effect of inflation.

f. Going-concern concept. There is no evidence that Chrysler is going out of business, so it seems safe to assume that the division is a going concern.


(30-40 min.) P 1-3B

Computed amounts are shown in boxes.

Granite Co. Shale Corp. Marble, Inc..Beginning:

Assets $150,000 $ 60,000 $ 80,000 Liabilities (70,000) (30,000) (60,000)= Owners’ equity $ 80,000 $ 30,000 $ 20,000

Ending:Assets $180,000 $ 90,000 $180,0003

Liabilities (70,000) (55,000) (80,000)= Owners’ Equity $110,000 $ 35,000 $100,000

Owners’ Equity:Issuances of stock $ 20,0001 $ 0 $ 10,000

Dividends (70,000) (40,000) (30,000)

Income Statement:Revenues $400,000 $240,000 $400,000

Expenses (320,000) (195,000)2 (300,000)= Net income $ 80,000 $ 45,000 $100,000

Statement of owners’ equity:Beginning owners’ equity $ 80,000 $ 30,000 $ 20,000

+ Issuances of stock 20,0001 0 10,000+ Net income (Net loss) 80,000 45,0002 100,000 Dividends (70,000) (40,000) (30,000)= Ending owners’ equity $110,000 $ 35,000 $100,000

_____ _____ _____1$80,000 + Issuances of stock 2Net income (x) = $45,000 3Assets liabilities = OE (y) + $80,000 $70,000 = $110,000 Revenue expenses = net income Assets $80,000 = $100,000Issuances of stock = $20,000 $240,000 expenses = $45,000 Assets = $180,000

Expenses = $195,000


(20-25 min.) P 1-4B

Req. 1

Shipp Belting, Inc.Balance Sheet

October 31, 20X1ASSETS LIABILITIES

Cash $ 15,400 Accounts payable $ 3,000Accounts receivable 2,600 Note payable 50,000Noted receivable 14,000 Total liabilities 53,000Office supplies 800 STOCKHOLDERS’Office furniture 6,700 EQUITYLand 80,500 Stockholders’ equity 67,000*

_______ Total liabilities and ________Total assets $120,000 stockholders’ equity $120,000

_____*Total assets ($120,000) Total liabilities ($53,000) = Stockholders’ equity ($67,000).

Req. 2

The amounts that are not presented on the balance sheet because they are expenses, but which are presented on the income statement, are:

Utilities ExpenseAdvertising ExpenseSalary ExpenseInterest Expense


(20-25 min.) P 1-5B

Req. 1

Bob Hearn, Realtor, Inc.Balance Sheet

March 31, 2000ASSETS LIABILITIES

Cash $ 16,000 Accounts payable $ 6,000Office supplies 1,000 Note payable 33,000 Franchise 15,000 Total liabilities 39,000Furniture 12,000 STOCKHOLDERS’Land 100,000 EQUITY


_______ Total liabilities and _______Total assets $144,000 stockholders’ equity $144,000

_____*Total assets ($144,000) Total liabilities ($39,000) Common stock ($60,000) = Retained earnings ($45,000).

Req. 2

Personal items not reported on the balance sheet of the business:

a. Personal cash ($9,000)e. Personal residence ($90,000) and mortgage payable ($65,000)f. Personal account payable ($300)


(30-45 min.) P 1-6B

Req. 1

Jaworsky Legal AssociatesIncome Statement

Year Ended December 31, 20XXRevenue

Service revenue…………………... $115,000Expenses

Salary expense…………………… $38,000Rent expense……………………... 14,000Interest expense…………………... 4,000Utilities expense………………….. 3,000Property tax expense……………... 2,000Total expenses……………………. 61,000

Net income………………………….. $ 54,000

Req. 2

Jaworsky Legal AssociatesStatement of Retained Earnings

Year Ended December 31, 20XX

Retained earnings, beginning of year……... $11,000Add: Net income for the year……………... 54,000

65,000Less: Dividends…………………………… (42,000)Retained earnings, end of year……………. $23,000


(continued) P 1-6B

Req. 3

Jaworsky Legal Associates.Balance Sheet

December 31, 20XXASSETS LIABILITIES

Cash $ 4,000 Accounts payable $12,000Accounts receivable 6,000 Interest payable 1,000Supplies 2,000 Note payable 31,000 Equipment 31,000 Total liabilities 44,000Building 26,000 STOCKHOLDERS’Land 8,000 EQUITY


______ Total liabilities and Total assets $77,000 stockholders’ equity $77,000

_____ *Total assets ($77,000) Total liabilities ($44,000) Common stock ($10,000) = Retained earnings ($23,000).


(20 min.) P 1-7B

The Home Depot, Inc.Statement of Cash Flows

Year Ended January 31, 20X0Millions

Cash flows from operating activities:Collections from customers……………………... $30,306Payments to suppliers and employees…………... (28,389)

Net cash inflow from operating activities…… 1,917

Cash flows from investing activities:Putchases of property, plant, and equipment……. $(2,320)Sales of property, plant, and equipment………… 45Other investing cash payments………………….. (1)

Net cash outflow for investing activities……... (2,276)

Cash flows from financing activities:Borrowing on short-term debt…………………... $ 238Issuance of common stock………………………. 168Payment of dividends…………………………… (157)

Net cash inflow from financing activities……. 249

Net increase (decrease) in cash…………………….. (110)Cash, beginning…………………………………….. 172Cash, ending………………………………………... $ 62


(40-50 min.) P 1-8B

Req. 120X1 20X0

(Thousands)Statement of operationsRevenues 13,176 = $ k $15,487Cost of goods sold 11,026 a = 12,822Other expenses 1,230 1,169Earnings before income taxes 920 1,496Income taxes (35% in 20X1) 322 = l 100Net earnings 598 = $ m $ b = 1,396

Statement of retained earningsBeginning balance 4,043 = $ n $ 2,702Net earnings 598 = o c = 1,396Dividends (65) (55)Ending balance 4,576 = $ p $ d = 4,043

Balance sheetAssets:

Cash 1,421 = $ q $ e = 1,086Property, plant and equipment 1,597 1,750Other assets 10,198 = r 10,190

Total assets 13,216 = $ s $13,026

Liabilities:Current liabilities 5,706 = $ t $ 5,403Notes payable and long-term debt 2,569 3,138Other liabilities 69 72

Total liabilities 8,344 f = 8,613

Shareholders’ Equity:Common stock $ 117 $ 118Retained earnings 4,576 = u g = 4,043Other shareholders’ equity 179 252

Total shareholders’ equity 4,872 = v 4,413Total liabilities and shareholders’ equity 13,216 = $ w $ h = 13,026

Statement of cash flowsNet cash provided by operating activities 986 = $ x $ 475Net cash provided by investing activities 58 574Net cash used by financing activities (709) (1,045)

Increase (decrease) in cash 335 i = 4Cash at beginning of year 1,086 = y 1,082Cash at end of year 1,421 = $ z $ j = 1,086


(continued) P 1-8B

Req. 2

a. Operations deteriorated during 20X1. Revenues decreased, and net

earnings fell from $1,396 thousand to $598 thousand.

b. The company retained most of its net earnings for use in the business.

Dividends were only $55 thousand in 20X0 and $65 thousand in 20X1,

which are much less than net earnings.

c. Total assets at the end of 20X1 were $13,216 thousand. This is the

amount of total resources that the company had to work with as it

moves into the year 20X2.

d. At the end of 20X0 the company owed total liabilities of $8,613

thousand. At the end of 20X1 the company owed $8,344 thousand. A

decrease in total liabilities is usually a good trend in relation to an

increase in total assets because this means that total stockholders’

equity is increasing.

e. The company’s major source of cash is operating activities, and cash is

increasing. Based on these two facts, it appears that the company’s

ability to generate cash is strong despite the drop in 20X1 net earnings.


Decision Cases

(30-40 min.) Decision Case 1

Req. 1

Based solely on these balance sheets, Zalenski appears to be the better credit risk because:

1. Swinger has more assets ($431,000) that Zalenski ($213,500), but Swinger owes much more in liabilities than Zalenski ($30,000 versus $391,000). Zalenski’s stockholders’ equity is far greater than that of Swinger’s ($183,500 compared to $40,000). Zalenski is not heavily in debt, but Swinger is.

2. You would be better off granting the loan to Zalenski. You should consider what would happen if the borrower could not pay you back as planned. Swinger has far more liabilities to pay, and very little owners’ equity. It may be hard for Swinger to come up with the money to pay you. And Zalenski has little debt to pay to others before paying you.

Req. 2

a. Most lenders require the borrower to present the entity’s income statement for a recent period, such as the most recent month, the most recent three months, and the last year. The income statement reports the revenues earned by the entity, the expenses it incurred, and the net income or net loss for the period. Income statement data (especially the amount of net income or net loss) provide an important measure of business success or failure.

b. You would require the borrower to present the entity’s statement of cash flows for a recent period. In particular you would want to know how the borrower generates cash — from operating, investing, or financing activities.

c. You would want to know what the borrower plans to do with your money.


(15 min.) Decision Case 2

Accounting information is used:

a. By a private individual — to balance a checkbook and account for personal transactions, to prepare financial statements in order to obtain a loan, to lend and borrow intelligently, to understand stock and bond investments, and to compute one’s income tax and prepare the tax return, among other uses.

b. By a friend who plans to be a farmer — same as the answer to a, plus to account for the cost of seed, fertilizer, livestock, employee wages, and crops, to determine whether the business has earned a profit or had a loss, to prepare government forms for assistance plans, to compute depreciation on farm equipment, and to budget operations.

c. By a friend who plans a career in sales — same as the answer to a, plus to determine whether the business has earned a profit or had a loss, to budget sales and expenses, to set the prices of products, and to compute sales commissions to be received.



Ethical Issue

Req. 1

The fundamental ethical issue in this situation is telling the truth about the company’s performance for the past year. Performance was bad, and the financial statements should present a bad picture of the company.

Req. 2

The proposal to transfer personal assets temporarily to the company violates the spirit, if not the letter, of the entity concept. The president implies that these assets can be transferred back to her at will, and the “investment” appears designed to make the company’s financial position appear better than it is. This is dishonest and unethical.

The request to “shave expenses” violates the reliability principle. The president wants the accountant to understate expenses in order to convert a loss into a reported income. This is dishonest and unethical.

The AICPA Code of Professional Conduct requires honorable behavior and accurate information for people’s decision-making. “Cooking the company’s books” to paint an unduly positive picture of a business violates these requirements of the Code.


Financial Statement Cases

(30 min.) Financial Statement Case 1

1. Net earnings, because it expresses the net result of all the revenues minus all the expenses for a period. In effect, net earnings give the results of operations in a single figure.

During fiscal year 1999, net earnings increased from $534 million to $825 million. This is good news because the company earned a profit for the year, and the year’s net earnings increased handsomely over last year’s.

Net sales revenue and cost of goods sold are chiefly responsible for making net earnings increase during 1999. During fiscal year 1999 net sales increased and cost of goods sold decreased as a percentage of sales.

2. Gap is retaining most of its net earnings for use in the business, as shown by the fact that dividends are low in comparison to net earnings.

3. Total resources (total assets) at the end of fiscalyear 1999…………………………………………. $3,964 million

Amount owed (total liabilities) at the end of the year($1,553 million + $837 million)………………….. $2,390 million

Portion of the company’s assets owned by the companystockholders (this is stockholders’ equity)……….. $1,574 million

The Gap’s accounting equation is (in millions):

Assets = Liabilities + Stockholders’ equity$3,964 = $2,390 + $1,574


(continued) Financial Statement Case 1

4. The Gap gets most of its cash from customers.

The company spends its cash mainly for inventory and other items that it purchases from suppliers, and for payments to employees, payments for income taxes, the purchase of property and equipment, and purchases of treasury stock.

At the beginning of fiscal year 1999, Gap had $913 million of cash.At the end of the fiscal year, Gap had $565 million of cash.

(30 min.) Financial Statement Case 2

Because the students will be using the annual reports of real companies, the answers to this problem will vary widely.


Solutions to Internet Exercise

HARLEY-DAVIDSON

The numerical computations printed here are based on information from fiscal years 1996 through 1998. Exact figures for subsequent years will of course vary. Go to the http://www.prenhall.com/harrison/ Web site for updated solutions.

2. Harley-Davidson reported Net sales of $2,063,956,000 for 1998, $1,762,569,000 for 1997, and $1,531,227,000 for 1996. Net sales increased each year which indicates Harley-Davidson is staying competitive within their industry. This is considered a favorable trend.

Harley-Davisdon reported net income of $213,500,000 for 1998, $174,070,000 for 1997, and $166,028,000 for 1996. Net income increased each year, which indicates Harley-Davidson is more profitable each year. This is considered a favorable trend. This company is profitable since a positive amount was reported for net income each year.

3. On December 31, 1998, Harley-Davidson reported $165,170,000 of cash and cash equivalents, $1,920,209,000 of total assets $890,298,000 of total liabilities, and $1,029,911,000 of total stockholders’ equity. The accounting equation holds true since $1,920,209,000 = $890,298,000 + $1,029,911,000. Assets are primarily financed by stockholders’ equity since stockholders’ equity is greater in amount than liabilities.

On December 31, 1997, Harley-Davidson reported $147,462,000 of cash and cash equivalents, $1,598,901,000 of total assets, $772,233,000 of total liabilities, and $826,668,000 of total stockholders’ equity. The accounting equation holds true since $1,598,901,000 = $772,233,000 + $826,668,000. Assets are primarily financed by stockholders’ equity since stockholders’ equity is greater in amount than liabilities.


http://www.prenhall.com/harrison/

4. Eleven (11) asset accounts are listed. For both years, the greatest amount is reported in the property, plant, and equipment, net asset account. ($627,759,000 on 12/31/1998 and $528,869,000 on 12/31/1997.)

Seven (7) liability accounts are listed. For both years, the greatest amount is reported in the finance debt liability account. ($280,000,000 on 12/31/1998 and $280,000,000 on 12/31/1997.) Commitments and contingencies are reported in the notes of the financial statements. If counted as another liability account, there would be a total of 8 liability accounts.

Seven (7) stockholders’ equity accounts are listed. For both years, the greatest amount is reported in the retained earnings stockholders’ equity account. ($873,171,000 on 12/31/1998 and $683,824,000 on 12/31/1997.)


Chapter 1

Business

accounting information

operations accounting

accounting data

information system

inaccurate information

accepted accounting

net income

balance sheet