Chapter 1
Introducing Financial Accounting
Learning Objectives – coverage by question
MiniExercises
Exercises
LO1 – Identify the users of
accounting information and discuss
the costs and benefits of disclosure.
25
28, 34
LO2 – Describe a company’s
business activities and explain how
these activities are represented by
the accounting equation.
19, 20, 21
27, 29, 32, 33
36, 37, 38, 43
47
LO3 – Introduce the four key
financial statements including the
balance sheet, income statement,
statement of stockholders’ equity
and statement of cash flows.
22, 23, 24
30, 31
37, 38, 39,
40, 41, 42,
43, 44, 45
46, 47, 49
26
34
LO4 – Describe the institutions that
regulate financial accounting and
their role in establishing generally
accepted accounting principles.
LO5 – Compute two key ratios that
are commonly used to assess
profitability and risk – return on
equity and the debt-to-equity ratio.
32, 33
LO6 – Appendix 1A: Explain the
conceptual framework for financial
reporting.
35
Solutions Manual, Chapter 4
Problems
Cases
and Projects
49, 50
50
36, 43, 44, 45
46, 47, 48, 49
©Cambridge Business Publishers, 2020
4-1
QUESTIONS
Q1-1.
Organizations undertake planning activities that subsequently shape three
major activities: financing, investing, and operating. Financing is the means
used to pay for resources. Investing refers to the buying and selling of
resources necessary to carry out the organization’s plans. Operating activities
are the actual carrying out of these plans. (Planning is the glue that connects
these activities, including the organization’s ideas, goals and strategies.)
Q1-2.
An organization’s financing activities (liabilities and equity = sources of funds)
pay for investing activities (assets = uses of funds). An organization cannot
have more or less assets than its liabilities and equity combined and, similarly,
it cannot have more or less liabilities and equity than its total assets. This
means: assets = liabilities + equity. This relation is called the accounting
equation (sometimes called the balance sheet equation, or BSE), and it applies
to all organizations at all times.
Q1-3.
The four main financial statements are: income statement, balance sheet,
statement of stockholders’ equity, and statement of cash flows. The income
statement provides information relating to the company’s revenues, expenses
and profitability over a period of time. The balance sheet lists the company’s
assets (what it owns), liabilities (what it owes), and stockholders’ equity (the
residual claims of its owners) as of a point in time. The statement of
stockholders’ equity reports on the changes to each stockholders’ equity
account during the year. Some changes to stockholders’ equity, such as those
resulting from the payment of dividends and unrealized gains (losses) on
marketable securities, can only be found in this statement as they are not
included in the computation of net income. The statement of cash flows
identifies the sources (inflows) and uses (outflows) of cash, that is, from what
sources the company has derived its cash and how that cash has been used.
All four statements are necessary in order to provide a complete picture of the
financial condition of the company.
Q1-4.
The balance sheet provides information that helps users understand a
company’s resources (assets) and claims to those resources (liabilities and
stockholders’ equity) as of a given point in time.
An income statement reports whether the business has earned a net income
(also called profit or earnings) or a net loss. Importantly, the income statement
lists the types and amounts of revenues and expenses making up net income
or net loss. The income statement covers a period of time.
Q1-5.
Your authors would agree with Mr. Buffett. A recent study of top financial
officers suggests they find earnings and the year-to-year changes in earnings
as the most important items to report. We would add cash flows particularly
from operations, and the year-to-year changes.
©Cambridge Business Publishers, 2020
4-2
Financial Accounting, 6th Edition
Q1-6.
The statement of cash flows reports on the cash inflows and outflows relating to
a company’s operating, investing, and financing activities over a period of time.
The sum of these three activities yields the net change in cash for the period.
This statement is a useful complement to the income statement which reports
on revenues and expenses, but conveys relatively little information about cash
flows.
Q1-7.
Articulation refers to the updating of the balance sheet by information contained
in the income statement or the statement of cash flows. For example, retained
earnings is increased each period by any profit earned during the period (as
reported in the income statement) and decreased each period by the payment
of dividends (as reported in the statement of cash flows and the statement of
stockholders’ equity). It is by the process of articulation that the financial
statements are linked.
Q1-8.
Return refers to income, and risk is the uncertainty about the return we expect
to earn. The lower the risk, the lower the expected return. For example, savings
accounts pay a low return because of the low risk of a bank not returning the
principal with interest. Higher returns are to be expected for common stocks as
there is a greater uncertainty about the realized return compared with the
expected return. Higher expected return offsets this higher risk.
Q1-9.
Companies often report more information than is required by GAAP because
the benefits of doing so outweigh the costs. These benefits often include lower
interest rates and better terms from lenders, higher stock prices and greater
access to equity investors, improved relationships with suppliers and
customers, and increased ability to attract the best employees. All of these
benefits arise because the increased disclosure reduces uncertainty about the
company’s future prospects.
Q1-10. External users and their uses of accounting information include: (a) lenders for
measuring the risk and return of loans; (b) shareholders for assessing the
return and risk in acquiring shares; and (c) analysts for assessing investment
potential. Other users are auditors, consultants, officers, directors for
overseeing management, employees for judging employment opportunities,
regulators, unions, suppliers, and appraisers.
Q1-11. Managers deal with a variety of information about their employers and
customers that is not generally available to the public. Ethical issues arise
concerning the possibility that managers might personally benefit by using
confidential information. There is also the possibility that their employers and/or
customers might be harmed if certain information is not kept confidential.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-3
Q1-12. Return on equity (ROE) is computed as net income divided by average
stockholders’ equity (an average of stockholders’ equity for the current and
previous year is commonly used, but the ratio is sometimes computed only with
beginning or ending stockholders’ equity). The return on equity is a popular
measure for analysis because it compares the level of return earned with the
amount of equity invested to generate the return. Furthermore, it combines both
the income statement and the balance sheet and, thereby, highlights the fact
that companies must manage both well to achieve high performance.
Q1-13. While businesses acknowledge the increasing need for more complete
disclosure of financial and nonfinancial information, they have resisted these
demands to protect their competitive position. These companies must weigh
the benefits they receive from the market as a result of more transparent and
revealing financial reporting against the costs of divulging proprietary
information.
Q1-14. Generally Accepted Accounting Principles (GAAP) are the various methods,
rules, practices, and other procedures that have evolved over time in response
to the need to regulate the preparation of financial statements. They are
primarily set by the Financial Accounting Standards Board (FASB), an entity of
the private sector with representatives from companies that issue financial
statements, accounting firms that audit those statements, and users of financial
information.
Q1-15. International Financial Reporting Standards (IFRS) are the accounting
methods, rules and principles established by the International Accounting
Standards Board (IASB). The need for IFRS stems from the wide variety of
accounting principles adopted in various countries and the lack of comparability
that this variety creates. IFRS are intended to create a common set of
accounting guidelines that will make the financial statements of companies from
different countries more comparable.
The IASB has no enforcement authority. As a consequence, the strict
enforcement of IFRS is left to the accounting profession and/or securities
market regulators in each country. Many countries have reserved the right to
make exceptions to IFRS by applying their own (local) accounting rules in
selected areas. Some accountants and investors argue that a little diversity is
a good thing – variations in accounting practice reflect differences in cultures
and business practices of various countries. However, one concern is that
IFRS may create the false impression that everyone is following the same
rules, even though some variation will continue to permeate international
financial reporting.
©Cambridge Business Publishers, 2020
4-4
Financial Accounting, 6th Edition
Q1-16. The auditor’s primary function is to express an opinion on whether the financial
statements fairly present the financial condition of the company and are free
from material misstatements. Auditors do not prepare the financial statements;
they only audit them and issue their opinion on them.
Q1-17.A The objectives of financial accounting are to provide information:
• That is useful to investors, creditors, and other decision makers who possess
a reasonable knowledge of business activities and accounting
• To help investors and creditors assess the amount, timing and uncertainty of
cash flows. This includes the information presented in the cash flow
statement as well as other information that might help investors and creditors
assess future dividend and debt payments
• About economic resources and financial claims on those resources. This
includes the information in the balance sheet and any supporting information
that might help the user assess the value of the company’s assets and future
obligations
• About a company’s financial performance, including net income and its
components (i.e., revenues and expenses)
• That allows decision makers to monitor company management to evaluate
their effective, efficient, and ethical stewardship of company resources
Q1-18.A The four enhancing qualitative characteristics of accounting information are
comparability, verifiability, timeliness, and understandability.
Comparability refers to the use of similar accounting methods across
companies.
Comparability improves the users’ ability to interpret the
information by making comparisons to other companies. Verifiability means
that consensus among independent observers could be reached that reported
information is a faithful representation. Verifiable financial information improves
the quality of the information because auditing and interpretation of the reported
data will be easier and more trusted.
Timeliness means that the financial reporting information must be available to
decision makers in time for the financial statement users to make decisions.
Understandability means that the financial statements should be presented in
such a way that users who have reasonable knowledge of business activities
can understand the statements. This is difficult because organizations and
transactions have become more complex over time (more global, expanding
into new industries, etc.) and thus the reporting of such complexities is difficult.
The more understandable the statements can be the better for users of the
statements.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-5
MINI EXERCISES
M1-19. (10 minutes)
LO 2
($ millions)
Assets
=
Liabilities
$19,381
+
Equity
$13,720
$5,661
Macy’s receives more of its financing from creditors ($13,720 million) versus owners
($5,661 million). Its owner financing comprises 29.2%% of its total financing ($5,661 mil
/ $19,381 mil.).
M1-20. (10 minutes)
LO 2
($ millions)
Assets
=
Liabilities
$87,896
+
Equity
$68,919
$18,977
Coca-Cola receives more of its financing from creditors ($68,919 million) than from
owners ($18,977 million). Its owner financing comprises 21.6% of its total financing
($18,977 mil./ $87,896 mil.).
M1-21. (15 minutes)
LO 2
($ millions)
Assets
Hewlett-Packard
Enterprises Co
General Mills
Harley-Davidson
=
Liabilities
+
Equity
$ 55,493
$ 34,219
(a) $ 21,274
$30,624.0
(c) $ 9,972.7
(b) $24,482.9
$ 8,128.4
$6,141.1
$1,844.3
The percent of owner financing for each company follows:
Hewlett-Packard Ent. Co:
38.3% ($21,274 mil./ $55,493 mil.);
General Mills:
20.1% ($6,141.1 mil./ $30,624 mil.);
Harley-Davidson:
18.5% ($1,844.3 mil./ $9,972.7 mil.).
continued next page
©Cambridge Business Publishers, 2020
4-6
Financial Accounting, 6th Edition
The creditor percent of financing is computed as 100% minus the owner percent.
Therefore, Hewlett Packard Enterprises Co is more owner-financed (38.3%) than the
other two firms, while Harley-Davidson has the highest percentage of creditor (nonowner) financing (81.5% = 100% - 18.5%).
M1-22. (15 minutes)
LO 3
For its annual report dated September 29, 2018, Apple reports the following amounts (in
$ millions):
Assets
=
Liabilities
+
Equity
$365,725
=
$258,578
+
$107,147
As shown, the accounting equation holds for Apple. Also, we can see that Apple’s
creditor financing is 70.7% of its total financing ($258,578 mil./$365,725 mil).
M1-23. (20 minutes)
LO 3
Nike, Inc.
Statement of Shareholders' Equity
For Year Ended May 31, 2017
Balance, May 31, 2016
Stock Issuance
Net Income
Dividends
Other changes
Balance, May 31, 2017
Contributed
Capital
$
7,789
121
$
731
8,641
Retained
Earnings
$
4,151
Other
Stockholders'
Equity
$
318
4,240
(1,159)
(3,253)
3,979
(531)
(213)
$
$
Total
Stockholders'
Equity
$
12,258
121
4,240
(1,159)
(3,053)
$
12,407
Nike was more profitable in the fiscal year ending May 2017 versus in the fiscal year
ending May 2018. Net income was $4,240 million in the fiscal year ending May 2017
compared to $1,933 in the fiscal year ending May 2018. Note: As reported in the text,
ROE was 17.4% in the fiscal year ending May 2018 compared to 34.4% in the fiscal
year ending May 2017.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-7
M1-24. (20 minutes)
LO 3
a. BS
d. BS and SE
g. SCF and SE
b. IS
e. SCF
h. SCF and SE
c. BS
f. BS and SE
i.
IS and SE
M1-25. (10 minutes)
LO 1
There are many stakeholders affected by this business decision, including the following
(along with a description of how):
•
•
•
•
You/Manager—your reputation, self-esteem, and potentially your livelihood can
be affected.
Creditors/Bondholders─ credit decisions based on inaccurate information can
occur.
Shareholders—buying or selling shares based on inaccurate information can
occur.
Management/Employees of your company—repercussions of your decision
extend to them; also, your decision may suggest an environment condoning
dishonesty
Indeed, our decisions can affect many more parties than we might initially realize.
M1-26. (10 minutes)
LO 4
Internal controls are rules and procedures that involve monitoring an organization’s
activities, transactions, and interactions with customers, employees and other
stakeholders to promote efficiency and to prevent wrongful use of its resources. They
help prevent fraud, ensure the validity and credibility of accounting reports, and are
often crucial to effective and efficient operations.
The absence or failure of internal controls can adversely affect the effectiveness of both
domestic and global financial markets. Enron (along with other accounting scandals)
provided a case in point. Because the failure of internal controls can have significant
economic consequences, Congress is interested in making sure that publicly- traded
companies have adequate internal controls and that any concerns about internal
controls are properly reported.
©Cambridge Business Publishers, 2020
4-8
Financial Accounting, 6th Edition
EXERCISES
E1-27. (15 minutes)
LO 2
($ millions)
Assets
=
Liabilities
+
Equity
Motorola Solutions, Inc .....
$ 8,208
$ 9,950
$ (1,742)
Kraft Heinz Company........ $ 119,992
Merck & Co Inc. ................ $87,872
$53,958
$ 66,034
$53,303
$34,569
The percent of creditor financing for each company follows:
Motorola Solutions:
121.2% ($9,950 mil./ $8,208 mil.);
Kraft Heinz:
45.0% ($53,958 mil./ $119,992 mil.);
Merck & Co:
60.7% ($53,303 mil./ $87,872 mil.).
The owner percent of financing is computed as 100% minus the owner percent. Merck
is more creditor-financed than Kraft Heinz. Motorola has negative equity so their
liabilities are larger than their recorded assets.
E1-28. (15 minutes)
LO 1
External users and some questions they seek to answer with accounting information
from financial statements include:
1. Shareholders (investors), who seek answers to questions such as:
a. Are resources owned by a business adequate to carry out plans?
b. Are the debts owed excessive in amount?
c. What is the current level of income (and its components)?
2. Creditors, who seek answers for questions such as:
a. Does the business have the ability to repay its debts?
b. Can the business take on additional debt?
c. Are resources sufficient to cover current amounts owed?
3. Employees (and potential employees), who seek answers to questions such as:
a. Is the business financially stable?
b. Can the business afford to pay higher salaries?
c. What are growth prospects for the organization?
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-9
E1-29. (20 minutes)
LO 2, 3
($ millions)
a. Using the accounting equation:
($ millions)
Assets
Intel ...................................$123,249
=
Liabilities
$54,230
+
Equity
$69,019
b. Starting with the accounting equation at the beginning of the year:
($ millions)
Assets
=
Liabilities
+
JetBlue Airways ................. $9,323
$5,310
Using the accounting equation at the end of the year:
($ millions)
Assets
=
Liabilities
JetBlue Airways .................
$9,781
$4,947
($9,323+$458)
($5,310$363)
Equity
$4,013
+
Equity
$4,834
Alternative approach to solving part (b):
Assets($458) = Liabilities($-363) + Equity(?)
where “” refers to “change in.”
Thus:  Ending Equity = $458 + $363 = $821 and
Ending equity = $4,013 + $821 = $4,834
c. Starting with the accounting equation at the end of the year:
($ millions)
Assets
=
Liabilities
Walt Disney .......................
$98,598
$44,693
($49,637-$4,944)
Using the accounting equation at the beginning of the year:
($ millions)
Assets
=
Liabilities
Walt Disney .......................
$95,789
$49,637
($98,598-$2,809)
©Cambridge Business Publishers, 2020
4-10
+
Equity
$53,905
+
Equity
$46,152
Financial Accounting, 6th Edition
E1-30. (10 minutes)
LO 3
Computation of dividends
Retained earnings, 2016 ........................................................................ $19,922
+ Net income .............................................................................................
2,024
– Cash dividends.......................................................................................
(?)
= Retained earnings, 2017 ........................................................................ $20,531
Thus, dividends were $1,415 million for 2017. This dividends amount comprises 70%
($1,415/ $2,024) of its 2017 net income.
E1-31. (20 minutes)
LO 3
COLGATE-PALMOLIVE COMPANY
Income Statement
For the year ended December 31, 2017
($millions)
Revenues
Cost of goods sold
Gross profit
$15,454
6,099
9,355
Other expenses, including income taxes
Net income (or loss)
7,331
$ 2,024
E1-32. (15 minutes)
LO 2, 5
a. Return on equity (ROE)
=
=
=
Net income / Average stockholders’ equity
$12,662 / [($152,502 + $139,036)/2]
8.69%
b. Debt-to-equity
=
=
=
Total liabilities / Stockholders’ equity
$44,793* / $152,502
29.4
*$44,793 = $197,295 - $152,502
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-11
E1-33. (150 minutes)
LO 2, 5
a. Return on equity (ROE)
=
=
=
Net income / Average stockholders’ equity
€10,525 / [(€64,023 + €57,950)/2]
17.3%
b. Debt-to-equity
=
=
=
Total liabilities / Stockholders’ equity
€191,582* / €64,023
2.99
*€191,582 = €255,605 - €64,023
E1-34. (20 minutes)
LO 1, 4
a. Financial information provides users with information that is useful in assessing the
financial performance of companies and, therefore, in setting securities prices. To
the extent that securities prices are accurate, the costs of the funds that companies
raise will accurately reflect their relative efficiency and risk of operations. Those
companies that can effectively utilize capital better will be able to obtain that capital
at a reasonable cost, and society’s financial resources will be effectively allocated.
b. First, the preparation of financial statements involves and understanding of complex
accounting rules and a significant amount of assumptions and estimation. Second,
GAAP allows for differing accounting treatments for the same transaction. And third,
auditors are at a relative information disadvantage vis-à-vis company accountants.
As the capital markets place increasing pressures on companies to perform,
accountants are often placed in a difficult ethical position to use the flexibility given
to them under GAAP in order to bias the financial results.
E1-35.A (15 minutes)
LO 6
1.
e
6.
g
2.
f
7.
j
3.
i
8.
c
4.
a
9.
d
5.
h
10.
b
©Cambridge Business Publishers, 2020
4-12
Financial Accounting, 6th Edition
PROBLEMS
P1-36. (40 minutes)
LO 2, 5
a.
Year
Assets
Liabilities
Equity
Net Income
2016
$127,136
$69,153
$57,983
$10,508
2017
$118,806
$64,628
$54,178
$15,326
2018
$118,310
$66,984
$51,326
$9,750
b. 2017 ROE = $15,326 / [($57,983+$54,178)/2] = 27.3%
2018 ROE = $9,750 / [($51,326+$54,178)/2] = 18.5%
P&G’s ROE decreased in 2018, however, it was above the median for Fortune 500
companies in both years.
c. 2017 debt-to-equity = $64,628 / $54,178 = 1.19
2018 debt-to-equity = $66,984 / $51,326 = 1.31
P&G’s debt-to-equity ratio increased in 2018 and it is below the median for Fortune
500 companies in both years.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-13
P1-37. (30 minutes)
LO 2, 3
a.
GENERAL MILLS, INC.
Income Statement
For Year Ended May 27,2018
($ millions)
Sales .......................................................................
Cost of goods sold ..................................................
Gross profit .............................................................
Other expenses, including income taxes ................
Net income ..............................................................
$15,740.4
10,312.9
5,427.5
3,264.5
$ 2,163
GENERAL MILLS, INC.
Balance Sheet
May 27, 2018
($ millions)
Cash & cash equivalents
Noncash assets
Total assets
$
399
30,225
$30,624
Total liabilities
Stockholders’ equity
Total liabilities and equity
$24,131.6
6,492.4
$30,624
GENERAL MILLS, INC.
Statement of Cash Flows
For Year Ended May 27, 2018
($ millions)
Net cash flows from operations ...............................
Net cash flows from investing .................................
Net cash flows from financing .................................
Effect of exchange rates on cash ............................
Net change in cash .................................................
Cash, beginning year ..............................................
Cash, ending year ...................................................
$ 2,841
(8,685.4)
5,445.5
31.8
(367.1)
766.1
$ 399
b. $6,492.4 /$30,624 = 21.2% contributed by owners
©Cambridge Business Publishers, 2020
4-14
Financial Accounting, 6th Edition
P1-38. (30 minutes)
LO 2, 3
a.
ABERCROMBIE & FITCH
Income Statement
For Year Ended February 3, 2018
($ millions)
Sales .......................................................................
Cost of goods sold ..................................................
Gross profit .............................................................
Other expenses including income taxes ........... .….
Net income ..............................................................
$ 3,492.7
1,408.8
2,083.9
2,073.4
$ 10.5
ABERCROMBIE & FITCH
Balance Sheet
February 3, 2018
($ millions)
Cash asset
Noncash assets
Total assets
$
675.6
1,650.1
$ 2,325.7
Total liabilities
Stockholders’ equity
Total liabilities and equity
$ 1,073.2
1,252.5
$ 2,325.7
ABERCROMBIE & FITCH
Statement of Cash Flows
For Year Ended February 1, 2014
($ millions)
Net cash flows from operations ...............................
Net cash flows from investing .................................
Net cash flows from financing .................................
Effect of exchange rate changes on cash ...............
Net change in cash .................................................
Cash, beginning year ..............................................
Cash, ending year ...................................................
$ 285.7
(106.8)
(74.8)
24.3
128.4
547.2
$ 675.6
b. $1,252.5 / $2,325.7 = 53.9% contributed by owners
$1,073.2 / $2,325.7 = 46.1% contributed by creditors
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-15
P1-39. (30 minutes)
LO 3
TILLY’S, INC.
Income Statements
For years ended February 3, 2018 and January 28, 2017
($ thousands)
Fiscal year ending
Sales
Cost of goods sold
2018
$576,899
401,529
2017
$568,952
400,493
Gross profit
Other expenses, including income taxes
175,370
160,670
168,459
157,049
Net income
$ 14,700
$ 11,410
TILLY’S, INC.
Balance Sheets
February 3, 2018 and January 28, 2017
($ thousands)
Cash asset
Noncash assets
2018
$ 53,202
236,909
2017
$ 78,994
211,512
Total assets
$290,111
$290,506
Total liabilities
Stockholders’ equity
$ 129,686
160,425
$ 101,286
189,220
Total liabilities and stockholders’ equity
$290,111
$290,506
TILLY’S, INC.
Cash Flow Statements
For years ended February 3, 2018 and January 28, 2017
($ thousands)
Cash flow from operating activities
Cash flow from investing activities
Cash flow from financing activities
2018
$32,708
(40,878)
(17,622)
2017
$48,509
(21,658)
1,123
Change in cash
Cash balance, beginning of the year
(25,792)
78,994
27,974
51,020
Cash balance, end of the year
$53,202
©Cambridge Business Publishers, 2020
4-16
$78,994
Financial Accounting, 6th Edition
P1-40. (30 minutes)
LO 3
TESLA , INC.
Income Statements
For years ended December 31, 2017 and 2016
($ millions)
Sales
Cost of goods sold
2017
$11,758.8
9,536.3
2016
$ 7,000.1
5,400.9
2,222.5
4,183.9
1,599.2
2,274.2
Gross profit
Other expenses, including income taxes
Net income (loss)
$ (1,961.4)
$ (675.0)
TESLA, INC.
Balance Sheets
December 31, 2017 and 2016
($ millions)
Cash asset
Noncash assets
2018
$ 3,367.9
25,287.5
2017
$ 3,393.2
19,270.9
Total assets
$28,655.4
$22,664.1
Total liabilities
Stockholders’ equity
$23,420.8
5,234.6
$ 17,126
5,538.1
Total liabilities and stockholders’ equity
$28,655.4
$22,664.1
TESLA, INC.
Cash Flow Statements
For years ended December 31, 2017 and 2016
($ millions)
Cash flow from operating activities
Cash flow from investing activities
Cash flow from financing activities
Effect of exchange rate changes on cash
Change in cash
Cash balance, beginning of the year
Cash balance, end of the year
Solutions Manual, Chapter 4
2017
$(60.7)
(4,419)
4,414.9
39.5
(25.3)
3,393.2
$3,367.9
2016
$(123,8)
(1,416.4)
3,744.0
(7.4)
2,196.3
1,196.9
$3,393.2
©Cambridge Business Publishers, 2020
4-17
P1-41. (15 minutes)
LO 3
CROCKER CORPORATION
Statement of Stockholders’ Equity
For Year Ended December 31, 2019
Contributed
Capital
December 31, 2018 ...............................
$ 70,000
Issuance of common stock ....................
30,000
Retained
Earnings
$ 30,000
_______
December 31, 2019 ...............................
$100,000
$100,000
30,000
Net income ............................................
Cash dividends ......................................
Stockholders’
Equity
50,000
50,000
(25,000)
(25,000)
$ 55,000
$155,000
P1-42. (15 minutes)
LO 3
DP SYSTEMS, INC.
Statement of Stockholders’ Equity
For Year Ended December 31, 2019
Common
Stock
December 31, 2018 ................................
$ 550
Net income .............................................
Cash dividends .......................................
____
December 31, 2019 ................................
$ 550
©Cambridge Business Publishers, 2020
4-18
Retained
Earnings
Stockholders’
Equity
$2,437
$2,987
859
859
(281)
(281)
$3,015
$3,565
Financial Accounting, 6th Edition
P1-43. (15 minutes)
LO 2, 3, 5
a. Return on equity is net income divided by average stockholders’ equity.
Nokia’s ROE: €-1,458 / [(€16,218 + €20,975)/2] = -0.078 or -7.8%.
b. Debt-to-equity is total liabilities divided by stockholders’ equity.
Nokia’s debt-to-equity: (€41,024 − €16,218) / €16,218 = 1.53.
c. Revenues less expenses equal net income. Taking the revenues and net income
numbers for Nokia, yields:
€23,147 million − Expenses = €-1,458 million.
Therefore, expenses must equal €24,605 million.
P1-44. (20 minutes)
LO 3, 5
a.
BEST BUY CO., INC.
Income Statement
For the year ended February 3, 2018
($ millions)
Sales revenue …………………………………
Cost of goods sold …………………………..
Gross profit ……………………………………
Other expenses, including income taxes ……
Net income (or loss) ………………………….
$42,151
32,275
9,876
8,876
$ 1,000
b. Best Buy’s ROE = $1,000 mil. / [($4,709 mil. + $3,612 mil.)/2] = 24.0%.
c. Best Buy’s debt-to-equity = ($13,049 - $3,612) / $3,612 = 2.61
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-19
P1-45. (20 minutes)
LO 3, 5
a.
FACEBOOK, INC.
Income Statement
For the years ended December 31, 2017 and 2016
($ millions)
Revenue
Operating expenses
Gross profit from operations
Other expenses, including income taxes
Net income
b. Stockholders’ equity:
2017
$ 40,653
20,450
2016
$ 27,638
15,211
20,203
12,427
4,269
2,210
$ 15,934
$
10,217
2017 -- $84,524 mil. - $10,177 mil. = $74,347 mil.
2016 -- $64,961 mil. - $5,767 mil. = $59,194 mil.
2017 ROE = $15,934 mil. / [($74,347 mil. + $59,194 mil.)/2] = 23.9.0%.
2016 ROE = $10,217 mil. / [($59,194 mil. + $44,218 mil.)/2] = 19.8%.
c. 2017 debt-to-equity = $10,177 / $74,347 = 0.14.
2016 debt-to-equity = $5,767 / $59,194 = 0.10.
©Cambridge Business Publishers, 2020
4-20
Financial Accounting, 6th Edition
CASES and PROJECTS
C1-46. (40 minutes)
LO 3, 5
a.
STARBUCKS CORPORATION
Income Statement
For the years ended September 30,2018 and October 1, 2017
($ millions)
2018
$ 24,719.5
10,174.5
14,545.0
10,027
$4,518.0
Sales revenue
Cost of goods sold
Gross profit on sales
Other expenses, including income taxes
Net income
b.
2017
$ 22,386.8
9,034.3
13,352.5
10,467.6
$ 2,884.9
2018 stockholders’ equity: $24,256.4 mil. – $22,980.6 mil. = $1,275.8 mil.
2017 stockholders’ equity: $14,365.6 mil. -- $8,908.6 mil. = $5,457 mil.
2018 ROE: $4,518 / [($1,275.8 + $5,457)/2] = 134.2%
2017 ROE: $2,884.9 / [($5,457 + $5,890.7)/2] = 50.8%
c.
2018 debt-to-equity: $22,980.6 / $1,275.8 = 18.01
2017 debt-to-equity: $8,908.6 / 5,457 = 1.63
d.
2018 ROE restated: ($4,518.0 - $3,700) / [($1,275.8- $3,700 + 5,457)/2] = 53.9%
The unrecorded potential litigation cost of $3,700 is subtracted from the net income
number and from the 2018 stockholders’ equity amount to arrive at this number.
This does not take into account the effect of income taxes.
e.
The primary cost to Starbucks of disclosing information about the pending litigation
is that the disclosure may cause potential investors and creditors to hold a less
favorable view of the company. A concern about the disclosure is that such
disclosure may actually affect the outcome of the litigation.
The primary benefit to disclosure is that by disclosing information about the lawsuit
before its completion, the company cannot be accused of withholding relevant
information from stakeholders. This prevents potential lawsuits from investors or
creditors and contributes to the company’s reputation for reliable financial reporting.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-21
C1-47. (40 minutes)
LO 2, 3, 5
a. The Gap, Inc.:
Nordstrom, Inc.:
ROE = $848 / [($3,144 + $2,904)/2] = 28.00%
ROE = $437 / [($977 + $870)/2] = 47.3%
Nordstrom had the higher ROE.
b. The Gap, Inc.:
Nordstrom, Inc.:
Debt-to-equity = ($7,989 - $3,144) / $3,144 = 1.54
Debt-to-equity = ($8,115 - $977) / $977 = 7.31
Nordstrom relies more on debt than The Gap.
c.
THE GAP, INC.
2018 Income Statement
($millions)
Revenues
Cost of goods sold
Gross profit
Other expenses, including income taxes
Net income (or loss)
$15,855
9,789
6,066
5,218
$ 848
NORDSTROM, INC.
2013 Income Statement
($millions)
Revenues
Cost of goods sold
Gross profit
Other expenses, including income taxes
Net income (or loss)
The Gap:
$15,478
9,890
5,588
5,151
$ 437
$6,066 / $15,855 = 38.3%
Nordstrom: $5,588 / $15,478 = 36.1%
d. Nordstrom earned a higher ROE than The Gap (47.3% vs. 28%). Nordstrom’s debtto-equity ratio is 7.31 vs. about 1.54 for The Gap. The Gap reported a slightly higher
gross profit per dollar of sales revenue (38.3% vs. 36.1% for Nordstrom). These two
percentages are very close, reflecting the similarity of their retail operations. One
important difference (not provided or apparent in the information supplied) is that
Nordstrom has a larger consumer credit business than The Gap.
©Cambridge Business Publishers, 2020
4-22
Financial Accounting, 6th Edition
C1-48. (30 minutes)
LO 5
a. JetBlue:
Southwest:
b. JetBlue:
Southwest:
c. JetBlue:
Southwest:
ROE = $1,147 / {[($9,781-$1,108) + ($9,323 - $1,444)] /2} = 13.9%
ROE = $3,488 / {[($25,110-$13,973) + ($23,286-$14,845)] /2} = 35.6%
Debt-to-equity = $1,108 / ($9,781 - $1,108) = 0.13
Debt-to-equity = $13,973 / ($25,110 - $13,973) = 1.25
$1,147 / $7,015 = 16.4%
$3,488 / $21,171 = 16.5%
d. JetBlue’s ROE was 13.9% for the year. In comparison, Southwest earned an ROE of
35.6% in 2017. Both of these ROE numbers are at or above the average for Fortune
500 companies. Currently, Southwest uses more creditor financing. This has changed
over time, JetBlue carried more debt just 5 years ago. Southwest’s debt-to-equity ratio
is 1.25 compared to a debt-to-equity ratio of 0.13 for JetBlue. In terms of income per
dollar of sales, both companies look very similar. JetBlue’s reported net income
equaled 16.4% of revenues, while Southwest reported net income equal to 16.5% of
revenues. The numbers for both airlines have improved significantly in recent years.
C1-49. (20 minutes)
LO 1, 3, 5
a. $285,000 Assets - $45,000 Liabilities = $240,000 Net Assets. $72,000 Average Annual
Income / $240,000 Investment = 30% return. Seale's return would be 24% ($72,000
Average Annual Income / $300,000 Investment), assuming no adjustment is made for
Meg’s salary. (See part b.)
b. No. Withdrawals do not affect net income, because they are not part of the firm's
operating activities. However, in calculating Krey's return in part a, Seale might wish to
"impute" an amount for Krey's half-time work in computing Krey's return on investment.
Thus, if Seale believes that Krey's services are worth $18,000 (half of the $36,000
salary she expects to pay a full-time manager), annual income should be calculated at
$54,000 instead of $72,000. If Seale hires a full-time manager at $36,000, her return
will be only 12% [($72,000 - $36,000)/$300,000].
c. Yes, the difference between net income shown in the financial statements and net
income shown on the tax return can be legitimate, because income tax rules for
determining revenues and deductions from revenues differ from Generally Accepted
Accounting Principles. Seale may obtain additional assurance about the propriety of
the financial statements by engaging a licensed professional accountant to audit the
financial statements and render a report on them.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-23
C1-50. (15 minutes)
LO 1, 4
a. It is important for a CPA to be independent when performing audit services
because third parties will be relying on the audited financial statements in making
decisions. The financial statements are the representations of the corporation's
management. The audit by a CPA adds credibility to the financial statements. Only
if third parties believe that the CPA is independent will a CPA be able to add
credibility to financial statements.
b. Jackie is not independent for two reasons: (1) her brother is president and chair of
the board of directors of the company to be audited and (2) Jackie is on the board
of directors of the company to be audited. The auditing profession takes the
position that Jackie's other activities for the company—consulting and tax work—do
not impair a CPA's independence. This last point may generate some discussion,
particularly in this case when the potential auditor is the same person (Jackie) who
is doing the consulting work. Usually, when the same CPA firm does both auditing
and consulting work, those tasks are assigned to different persons to ensure
auditor independence.
©Cambridge Business Publishers, 2020
4-24
Financial Accounting, 6th Edition
Chapter 2
Constructing Financial Statements
Learning Objectives – coverage by question
MiniExercises
Exercises
Problems
Cases
and Projects
LO1 – Describe and construct the
balance sheet and understand how
it can be used for analysis.
14, 17, 19,
21 - 27,
29 - 31
34-44,
46, 47
49 - 57, 59,
60, 62, 66,
67, 69
71
LO2 – Use the financial statement
effects template (FSET) to analyze
transactions.
18, 29 - 31
44 - 47
57, 62,
67, 69
LO3 – Describe and construct the
income statement and discuss how
it can be used to evaluate
management performance.
19 - 23,
28, 31
35, 37,
39 - 44,
47
49 - 51, 54,
57, 61, 62,
64 - 67, 69
71, 72
LO4 – Explain revenue
recognition, accrual accounting,
and their effects on retained
earnings.
18 - 20, 22,
23, 25, 26,
28, 29, 31
39, 44, 47
57, 62, 67, 69
71
LO5 – Illustrate equity transactions
and the statement of stockholders’
equity.
18, 21 - 24,
27, 31
35 - 37
53, 66, 67, 69
71
32, 33
45, 48
58, 63, 68, 70
34, 36, 38,
41, 42, 46
52, 55, 56,
59, 60
LO6 – Use journal entries and Taccounts to analyze and record
transactions.
LO7 – Compute net working
capital, the current ratio, and the
quick ratio, and explain how they
reflect liquidity.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-25
QUESTIONS
Q2-1.
An asset is something that we own that is expected to provide future benefits. A liability is a
current obligation that will require a future sacrifice. Equity is the difference between assets and
liabilities. It represents the claims of the company’s owners to its income and assets. The
following are some examples of each:
Assets
• Cash
• Receivables
• Inventories
• Plant, property and equipment
Liabilities
• Accounts payable
• Accrued liabilities
• Notes payable
• Long-term debt
Equity
• Contributed capital (common and preferred stock)
• Additional paid-in capital
• Earned capital (retained earnings)
• Treasury stock
Q2-2.
The revenue recognition principle requires that revenues be recognized when earned.
Revenues are earned when the product has been delivered to the buyer and is usually signified
by a formal transfer of title. A good test of whether revenue has been earned is whether the
rights, risks and obligations of ownership have been transferred to the buyer. If a service is
involved, revenues are not earned until the service has been provided. The expense
recognition principle prescribes that expenses be recognized when assets are diminished (or
liabilities increased) as a result of earning revenue or carrying out the company’s operations.
When these two principles are followed, income can be properly measured in a given
accounting reporting period.
Q2-3.
Accrual accounting entails the recognition of revenue under the revenue recognition principle
(record revenues when goods or services are transferred to the customer), and the recognition
of expenses when net assets decrease from the process of earning revenue or supporting the
company’s operations. The recognition of revenues or the expenses does not require that cash
be received or disbursed. For example, the recognition of revenues on sale can lead to an
account receivable, and wage expense can be accrued using a wages payable (accrued)
liability account.
©Cambridge Business Publishers, 2020
4-26
Financial Accounting, 6th Edition
Q2-4.
The statement of stockholders’ equity provides information relating to all events that impact
stockholders’ equity during the period. It contains information relating to stock sales and
repurchases, net income, dividends, and the use of stock for other purposes including
occasional acquisition of assets. This statement, also referred to as the statement of owners’
equity, also includes the effects of some transactions that are not captured in the determination
of net income. These items are included in what is called “other comprehensive income.” One
example of such an item is the loss or gain on the translation of the assets and liabilities of
foreign owned subsidiaries into United States currency.
Q2-5.
An asset must be “owned” and it must provide “future benefits.” Owning means we have title to
the asset (some leased assets are also recorded on the balance sheet as we will discuss in
Chapter 10). Future benefits can mean the future inflows of cash. Or, it could relate to some
other benefit, such as the reduction of expenditures, an increase in another asset, or the
reduction of a liability.
Q2-6.
Liquidity generally refers to cash. That is, how much cash do we have, how much cash is being
generated, and how much cash can we raise quickly. Liquidity is essential to the survival of the
business. After all, we can only pay our loans with cash, and our employees will only accept
cash for their wages. Some assets are more liquid than others in the sense that they can be
converted more easily to cash. Money market accounts and accounts receivable, which can be
sold, provide examples. Inventories are considered more liquid than plant assets. We will
address liquidity issues more formally in Chapters 4 and 9.
Q2-7.
Current means that the asset will be liquidated (converted to cash) within the next year (or the
operating cycle if longer than 1 year).
Q2-8.
Historical costs are used by accountants because they are less subjective and, therefore, more
reliable than using market values. Market values can be biased for two reasons: first, we may
not be able to measure them accurately (consider our inability to accurately measure the
market value of a production facility, for example), and second, managers may intervene in the
reporting process to intentionally bias the results in order to achieve a particular objective (i.e.
enhancing the stock price). The use of historical costs in accounting records does not negate
the importance of market values. For example, a firm offering to pledge land as collateral for a
loan will be expected to use the market value of that land rather than its historic cost. The same
would be true if a corporation were considering the sale of the land. Finally, we shall see that
certain assets are reported at market value in the balance sheet; securities that are available to
be sold provide an example.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-27
Q2-9.
An intangible asset is an asset that we cannot touch. To be included on the balance sheet, it
has to meet the tests of an asset (e.g., we own it, and it will provide future benefits). In addition,
recognized intangible assets are always acquired in a transaction with an independent party.
Internally generated intangible assets, however, are not recorded on the balance sheet. Some
examples are goodwill, patents and trademarks, contractual agreements like royalties, leases,
and franchise agreements. All of the intangible assets, though not recorded if internally
generated, are recorded if purchased, as in an acquisition of another company, for example.
Q2-10.
Both the current ratio and quick ratio are measures of a firm’s ability to pay its obligations as
they come due; measures of a firm’s liquidity. The current ratio is computed by dividing the
firm’s current assets by its current liabilities. Current ratios that exceed 1.0 are deemed to
represent a strong current liquidity position. The quick ratio is an even more conservative
measure of a firm’s liquidity as it excludes inventory from the calculation. The quick ratio is
computed by dividing the firm’s sum of cash and cash equivalents, marketable securities and
accounts receivable by its current liabilities.
Q2-11.
The three conditions necessary to recognize a liability are:
1. The liability reflects a probable future sacrifice on the part of the organization.
2. The amount of the obligation is known or can be reasonably estimated.
3. The transaction that caused the obligation has occurred.
Q2-12.
Net working capital = Current assets – Current liabilities. Increasing the amount of trade credit
(e.g., accounts payable to suppliers) increases current liabilities and reduces net working
capital. As trade credit increases, we are using someone else’s cash rather than our own. As a
business grows, its net working capital grows, as the growth of inventories and receivables are
generally greater than that of accounts payable and accrued liabilities. Net working capital is an
asset category that must be financed just like fixed assets.
Q2-13.
$700,000 Assets - $220,000 Liabilities = $480,000 Stockholders' equity
$480,000 Stockholders’ equity – $300,000 Common stock
= $180,000 Retained earnings
©Cambridge Business Publishers, 2020
4-28
Financial Accounting, 6th Edition
MINI EXERCISES
M2-14. (10 minutes)
LO 1
Use the accounting equation.
a. Cash
Accounts receivable
Supplies
Equipment
Accounts payable
Common stock
Retained earnings
b. Retained Earnings:
December 31, 2018
January 1, 2018
Increase
Add: Dividends
Net Income
$ 8,000
23,000
9,000
138,000
178,000
$ 11,000
110,000
121,000
$ 57,000
$ 57,000
30,000
27,000
12,000
$ 39,000
M2-15. (5 minutes)
LO 1
a. $200,000 - $85,000 = $115,000 equity
b. $32,000 + $28,000 = $60,000 assets
c.
$93,000 - $52,000 = $41,000 liabilities
M2-16. (5 minutes)
LO 1
a. $375,000 - $105,000 = $270,000 equity
b. $43,000 + $11,000 = $54,000 assets
c.
$878,000 - $422,000 = $456,000 liabilities
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-29
M2-17. (5 minutes)
LO 1
a. $450,000 - $326,000 = $124,000 equity
b. $618,000 - $165,000 = $453,000 liabilities
c.
$400,000 + $200,000 + $185,000 = $785,000 assets
M2-18. (10 minutes)
LO 2, 4, 5
a. no effect
e. increase
b. decrease
f.
c.
g. increase
decrease
increase
d. no effect
M2-19. (15 minutes)
LO 1, 3, 4
a. Balance sheet
e. Balance sheet
i.
Income statement
b. Income statement
f.
Balance sheet
j.
Income statement
c.
Balance sheet
g. Balance sheet
k.
Balance sheet
d. Income statement
h. Balance sheet
l.
Balance sheet
M2-20. (20 minutes)
LO 3, 4
a. Net income computation
Service revenue (record when earned) ……………
Wage expense ………………………………………….
Net income ………………………………………………
$100,000
(60,000)
$ 40,000
b. Yes, recognizing the wage liability would cause wage expense to increase by $10,000 and net
income would decrease by the same amount (before taxes).
©Cambridge Business Publishers, 2020
4-30
Financial Accounting, 6th Edition
M2-21. (10 minutes)
LO 1, 3, 5
a. Balance sheet
b. Income statement, Statement of stockholders’ equity
c.
Balance sheet
d. Income statement
e. Statement of stockholders’ equity
f.
Statement of stockholders’ equity
g. Balance sheet
h. Income statement
i.
Statement of stockholders’ equity, Balance sheet
M2-22. (10 minutes)
LO 1, 3, 4, 5
a. Balance sheet
b. Balance sheet
c.
Income statement, Statement of stockholders’ equity
d. Statement of stockholders’ equity, Balance sheet
e. Balance sheet
f.
Income statement
g. Balance sheet
h. Balance sheet
M2-23. (10 minutes)
LO 1, 3, 4, 5
a. Balance sheet
b. Income statement
c.
Statement of stockholders’ equity, Balance sheet
d. Income statement
e. Statement of stockholders’ equity
f.
Balance sheet
g. Balance sheet
h. Balance sheet
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-31
M2-24. (15 minutes)
LO 1, 5
Ending retained earnings = Beginning retained earnings + Net income – Dividends + the effects of other
adjustments. And, the ending retained earnings for one period is the beginning retained earnings for the
following period.
Fiscal year ending:
Beginning retained earnings (deficit) …………
Jan. 28, 2017
$
Net income (loss) ……………
Dividends paid ……………
Other net changes in retained earnings ………
Ending retained earnings (deficit) ……………
$
(258)
Feb. 3, 2018
$
(727)
1,158
983
(1,268)
(686)
(359)
(321)
(727)
$
(751)
M2-25. (10 minutes)
LO 1, 4
a. Increase assets (Cash);
Increase equity (Service Revenues)
b. Increase assets (Office Supplies)
Increase liabilities (Accounts Payable)
c.
Increase assets (Cash)
Increase equity (Contributed Capital or Common Stock)
d. Decrease liabilities (Accounts Payable)
Decrease assets (Cash)
e. Increase assets (Cash)
Increase liabilities (Notes Payable)
f.
Increase assets (Accounts Receivable)
Increase equity (Service Revenues)
g. Increase assets (Office Equipment)
Decrease assets (Cash)
h. Decrease equity (Interest Expense)
Decrease assets (Cash)
i.
Decrease equity (Utilities Expense)
Increase liabilities (Accounts Payable)
©Cambridge Business Publishers, 2020
4-32
Financial Accounting, 6th Edition
M2-26. (10 minutes)
LO 1, 4
a. Increase assets (Office Equipment)
Decrease assets (Cash)
b. Increase assets (Accounts Receivable)
Increase equity (Service Revenue)
c.
Decrease equity (Rent Expense)
Decrease assets (Cash)
d. Increase assets (Cash)
Increase equity (Service Revenue)
e. Increase assets (Cash)
Decrease assets (Accounts Receivable)
f.
Increase assets (Office Equipment)
Increase liabilities (Accounts Payable)
g. Decrease equity (Salaries Expense)
Decrease assets (Cash)
h. Decrease liabilities (Accounts Payable)
Decrease assets (Cash)
i.
Decrease equity (Retained Earnings)
Decrease assets (Cash)
M2-27. (10 minutes)
LO 1, 5
JOHNSON & JOHNSON
Statement of Retained Earnings
For Year Ended December 31, 2017
Retained earnings, January 1, 2017 ........................................................................
$70,418
Add:
Net income .................................................................................................
1,300
Less:
Dividends ...................................................................................................
(8,943)
Other retained earnings changes ..............................................................
(2,615)
Retained earnings, December 28, 2014 ..................................................................
Solutions Manual, Chapter 4
$60,160
©Cambridge Business Publishers, 2020
4-33
M2-28. (10 minutes)
LO 3, 4
2018
$350,000
200,000
$150,000
Revenues ....................................................................
Expenses .....................................................................
Net income ..................................................................
2019
$ 0
0
$ 0
Explanation: All of the revenue is reported in 2018 when services are provided—per the revenue
recognition principle. Likewise, the expense is reported in 2018 when it is incurred—because a liability
was incurred to generate the revenue. The timing of receipts or payments of cash does not affect the
recording of revenues, expenses, and net income.
M2-29. (15 minutes)
LO 1, 2, 4
Balance Sheet
Transaction
a. Issue stock
for $20,000
cash.
Cash
Asset
+20,000
Cash
+
Noncash
Assets
=
b. Pay $2,000
rent in
advance.
-2,000
Cash
+2,000
Prepaid
rent
c. Purchase
computer
equipment
for $7,000
cash.
-7,000
Cash
+7,000
Computer
Equipment
d. Purchase
inventory
for $13,000
on account
e. Pay
supplier of
inventory in
part d.
Totals
+13,000
Inventory
-13,000
Cash
-2,000
= Liabil-ities +
22,000
Contrib.
Capital +
+20,000
Common
Stock
Earned
Capital
Revenues
-
Expenses
=
-
=
=
-
=
=
-
=
+13,000
Accts
= Payable
-
=
-
=
-
=
=
+
Income Statement
=
-13,000
Accts
Payable
0
©Cambridge Business Publishers, 2020
4-34
+
20,000
+
Net
Income
Financial Accounting, 6th Edition
M2-30 (15 minutes)
LO 1, 2
Balance Sheet
Transaction
Cash
Asset
a. Borrow
€19,000 from
local bank.
+19,000
Cash
b. Pay €3,000
insurance
premium for
covered for
following year.
-3,000
Cash
c. Purchase
vehicle for
€32,000 cash.
-32,000
Cash
+
= Liabilities
=
d. Purchase and
receive €2,500
of office
supplies on
account (pay
supplier later).
-16,000
+
+
Contrib.
+
Capital
Earned
Capital
+19,000
Note
Payable
Revenues -
Expenses
=
-
=
+3,000
Prepaid
insurance
=
-
=
+32,000
Vehicle
=
-
=
=
-
=
NO ENTRY =
-
=
-
=
+2,500
Supplies
Inventory
e. Place order for
€1,000 of
additional
supplies to be
delivered next
month.
Totals
Noncash
Assets
Income Statement
37,500
Solutions Manual, Chapter 4
Net
Income
+2,500
Accts
Payable
=
21,500
+
0
+
0
©Cambridge Business Publishers, 2020
4-35
M2-31. (15 minutes)
LO 1, 2, 3, 4, 5
Balance Sheet
Transaction
a. Receive
merchandise
inventory
costing $9,000,
purchased with
cash
Cash
Asset
+
-9,000
Cash
= Liabilities +
Contrib.
+
Capital
Earned
Capital
Revenues -
=
-
-4,500
Inventory
+7,500
Accounts
Receivable
c. Place order for
$5,000 of
additional
merchandise
inventory to be
delivered next
month.
-4,500
-4,000
Cash
e. Pay $7,000 rent
for use of
premises
during the
month.
-7,000
Cash
f. Receive full
payment from
customer in
part b.
+7,500
Cash
=
+7,500
+7,500
Revenue
Net
Income
=
=
-
=
-
+4,000
Wage
Expense
-
+7,000
Rent
Expense
=
-
15,500
=
-7,000
=
-4,500
-
-4,000
=
-12,500
=
+4,500
Cost of
Goods Sold
NO ENTRY =
d. Pay employee
$4,000 for
compensation
earned during
the month.
Expenses
+9,000
Inventory
b. Sell half of
inventory in (a)
for $7,500 on
credit.
Totals
Noncash
Assets
Income Statement
+7,500
-4,000
=
-7,000
-7,500
Accounts
Receivable
+
4,500
=
©Cambridge Business Publishers, 2020
4-36
+
+
-8,000
7,500
-8,000
Financial Accounting, 6th Edition
M2-32. (10 minutes)
LO 6
a. Inventory (+A) ...............................................................................................
Cash (-A) ..............................................................................................
9,000
b. Cost of goods sold expense (+E, -SE) .........................................................
Inventory (-A) .........................................................................................
Accounts receivable (+A) .............................................................................
Sales revenue (+R, +SE) .......................................................................
4,500
c.
9,000
4,500
7,500
7,500
NO ENTRY
d. Wage expense (+E, -SE) ..............................................................................
Cash (-A) ...............................................................................................
4,000
e. Rent expense (+E, -SE)................................................................................
Cash (-A) ...............................................................................................
7,000
f.
Cash (+A) ……………………………………………………..
Accounts receivable (-A) ………………………………..
4,000
7,000
7,500
7,500
M2-33. (10 minutes)
LO 6
+
(f)
Cash (A)
7,500 (a)
(d)
(e)
-
+
9,000
4,000
7,000
(b)
+
(a)
Inventory (A)
9,000 (b)
Sales (R)
(b)
-
4,500
+
Wage Expense (E)
4,000
-
+
Rent Expense (E)
7,000
-
+
7,500
(e)
Solutions Manual, Chapter 4
7,500
-
(d)
-
-
Cost of Goods Sold (E)
4,500
(b)
+
Accounts Receivable (A)
7,500 (f)
©Cambridge Business Publishers, 2020
4-37
EXERCISES
E2-34. (25 minutes)
LO 1, 7
Use the accounting equation to determine Retained Earnings as of May 31, 2019.
a. & b.
BEAVER, INC.
Balance Sheets
May 31, 2019
June 1, 2019
Assets
Cash
$ 12,200
$
3,200
Accounts receivable
18,300
18,300
Supplies
16,400
16,400
Equipment
55,000
70,000
$101,900
$107,900
Accounts payable
$ 5,200
$ 5,200
Notes payable
20,000
33,000
Total liabilities
25,200
38,200
Common stock
42,500
42,500
Retained earnings
34,200
27,200
76,700
69,700
$101,900
$107,900
Total assets
Liabilities
Stockholders' Equity
Total stockholders' equity
Total liabilities and stockholders' equity
c.
Net working capital = Current assets – Current liabilities
$32,700 = ($3,200 + $18,300 + $16,400) – $5,200
©Cambridge Business Publishers, 2020
4-38
Financial Accounting, 6th Edition
E2-35. (30 minutes)
LO 1, 3, 5
Use the accounting equation and the information on changes in contributed capital and retained earnings.
Beginning equity (= Beginning assets – Beginning liabilities)
+ Common Stock Issued
+ Net income (= Revenues – Expenses)
– Dividends
Ending equity (= Ending assets – Ending liabilities)
a. Equity, Beginning ($28,000 - $18,600)
Equity, Ending ($30,000 - $17,300)
Increase
Add: Net Capital Withdrawn ($5,000 - $2,000)
Net Income
Add: Expenses
Revenues
$ 9,400
12,700
3,300
3,000
6,300
8,500
$14,800
b. Equity, Beginning ($12,000 - $5,000)
Add: Net Capital Contributed ($4,500 - $1,500)
Add: Net Income ($28,000 - $21,000)
Equity, Ending
$ 7,000
3,000
10,000
7,000
$17,000
Assets, Ending
Equity, Ending
Liabilities, Ending,
$26,000
17,000
$ 9,000
Equity, Beginning ($28,000 - $19,000)
Add: Net Income ($18,000 - $11,000)
$ 9,000
7,000
16,000
1,000
15,000
19,000
$ 4,000
c.
Less: Dividends
Equity, Ending ($34,000 - $15,000)
Common Stock Issued
d. Common Stock Issued
Net Income ($24,000 - $17,000)
Cash Dividends
Increase in Equity
Equity, Ending ($40,000 - $19,000)
Equity, Beginning
Add: Liabilities, Beginning
Total Assets, Beginning
Solutions Manual, Chapter 4
$ 3,500
7,000
10,500
6,500
4,000
21,000
17,000
9,000
$26,000
©Cambridge Business Publishers, 2020
4-39
E2-36 (30 minutes)
LO 1, 5, 7
Use the accounting equation to determine stockholders’ equity balances.
a.
LANG SERVICES
Balance Sheets
December 31,
2018
2017
Assets
Cash
Accounts receivable
Supplies
Equipment
Total assets
$10,000
22,800
4,700
32,000
$69,500
$ 8,000
17,500
4,200
27,000
$56,700
Liabilities
Accounts payable
Notes payable
Total liabilities
$25,000
1,800
26,800
$25,000
1,600
26,600
Stockholders’ equity
Equity
Total liabilities and stockholders’ equity
42,700
$69,500
30,100
$56,700
b. Equity, December 31, 2018
Equity, December 31, 2017
Increase
Add: Dividends
Less: Common Stock issued
Net Income for 2018
c.
$42,700
30,100
12,600
17,000
29,600
5,000
$24,600
Current ratio = ($10,000 + $22,800 + $4,700)/$25,000 = 1.50
Quick ratio = ($10,000 + $22,800)/$25,000 = 1.31
d. Lang’s liquidity position is satisfactory as its current ratio meets the industry norm, and its quick ratio
is also above the industry average. The firm appears to have invested about the “right” amount in
liquid assets—neither too much, nor too little.
©Cambridge Business Publishers, 2020
4-40
Financial Accounting, 6th Edition
E2-37. (30 minutes)
LO 1, 3, 5
Use the accounting equation to determine Retained Earnings balances.
a.
LYNCH SERVICES
Balance Sheets
December 31,
Assets
Cash
Accounts receivable
Supplies
Land
Building
Equipment
Total assets
Liabilities
Accounts payable
Mortgage payable
Total liabilities
Stockholders’ equity
Common stock
Retained earnings
Total stockholders' equity
Total liabilities and stockholders’ equity
2018
2017
$ 23,000
42,000
20,000
40,000
250,000
43,000
$418,000
$ 20,000
33,000
18,000
40,000
260,000
45,000
$416,000
$
$
6,000
90,000
96,000
220,000
102,000
322,000
$418,000
9,000
100,000
109,000
220,000
87,000
307,000
$416,000
b.
Retained Earnings, December 31, 2018
Retained Earnings, December 31, 2017
Increase during 2018
Add:
Dividend for 2018
Net Income for 2018
Solutions Manual, Chapter 4
$102,000
87,000
15,000
10,000
$ 25,000
©Cambridge Business Publishers, 2020
4-41
E2-38. (30 minutes)
LO 1, 7
Use the accounting equation to determine Retained Earnings as of September 30, 2019. The two
transactions have the following effects:
•
Equipment purchase increases the equipment asset by $11,000, decreases the cash asset by
$3,000, and increases the notes payable liability by $8,000.
•
Dividend payment decreases the cash asset by $3,000 and decreases the retained earnings
equity by $3,000.
a. & b.
BROWNLEE CATERING SERVICE
Balance Sheets
September 30,
2019
October 1,
2019
Assets
Cash
Accounts receivable
Supplies inventory
Equipment
Total assets
$10,000
17,000
9,000
34,000
$70,000
$ 4,000
17,000
9,000
45,000
$75,000
Liabilities
Accounts payable
Notes payable
Total liabilities
$24,000
12,000
36,000
$24,000
20,000
44,000
Stockholders’ equity
Common stock
Retained earnings
Total stockholders' equity
Total liabilities and stockholders’ equity
27,500
6,500
34,000
$70,000
27,500
3,500
31,000
$75,000
c.
Current ratio
Quick ratio
September 30
(10,000 + 17,000 + 9,000) ÷ 24,000 = 1.50
October 1
(4,000 + 17,000 + 9,000) ÷ 24,000 = 1.25
(10,000 + 17,000) ÷ 24,000
= 1.13
(4,000 + 17,000) ÷ 24,000
= 0.88
d. Quite a few possibilities exist, from increasing long-term borrowing to issuing new stock to selling
unneeded equipment.
©Cambridge Business Publishers, 2020
4-42
Financial Accounting, 6th Edition
E2-39. (15 minutes)
LO 1, 3, 4
Income statement
Balance sheet
Sales .......................................... $30,000
Cash ....................................................................$ 8,000
Wages expense .........................
12,000
Accounts receivable ............................................ 30,000
Net income (loss) ....................... $18,000
Total assets .........................................................$38,000
Wages payable ....................................................$12,000
Common stock .................................................... 8,000
Retained earnings ............................................... 18,000
Total liabilities and equity ....................................$38,000
E2-40. (15 minutes)
LO 1, 3
a.
Procter & Gamble ($ millions)
Amount
Classification
Net sales ........................................................................................$ 65,058
I
Income tax expense.......................................................................
3,063
I
Retained earnings.......................................................................... 96,124
B
Net earnings .................................................................................. 15,411
I
Property, plant and equipment (net) .............................................. 19,893
B
Selling, general and administrative expense ................................. 18,568
I
Accounts receivable.......................................................................
4,594
B
Total liabilities ................................................................................ 64,268
B
Stockholders' equity ....................................................................... 56,138
B
Net earnings from continuing operations
I
10,194
b. Total assets = Total liabilities + Stockholders’ equity
Total assets = $64,268 + $56,138 = $120,406
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-43
E2-41. (15 minutes)
LO 1, 3, 7
a.
Shoprite Holdings Ltd (rand millions)
Sales of merchandise
Amount
Classification
R 141,000
I
Depreciation and amortization
2,176
I
Reserves (Retained earnings)
18,838
B
Property, plant and equipment
18,407
B
107,174
I
Trade and other payables
17,414
B
Total assets
55,723
B
Total equity
27,749
B
Employee benefits expense
10,498
I
Total non-current assets
24,572
B
1,492
B
Cost of goods and services
Total non-current liabilities
b. Total liabilities = Total assets minus total equity
Total liabilities = R 55,723 – R 27,749 = R 27,974 million.
c.
Current ratio = Current assets/Current liabilities
= [R 55,723 – R 24,572] / [R 27,974 – R 1,492]
= R 31,151 / R 26,482 = 1.18
©Cambridge Business Publishers, 2020
4-44
Financial Accounting, 6th Edition
E2-42. (15 minutes)
LO 1, 3, 7
a.
El Puerto de Liverpool
(Mexican peso thousands)
Amount
Classification
$122,168,279
I
Retained earnings
82,963,786
B
Inventory
18,486,423
B
Administration expenses
33,549,108
I
168,266,121
B
33,358,545
B
7,137,563
I
Total current assets
67,351,290
B
Total stockholders’ equity
90,082,378
B
1,913,794
B
38,849,994
B
Total revenue
Total assets
Long-term debt
Financing costs (expenses)
Prepaid expenses
Total non-current liabilities
b. Total liabilities = Total assets - Stockholders’ equity
Total liabilities = $168,266,121 - $90,082,378 = $78,183,743
Current liabilities = $78,183,743 - $38,849,994 = $39,333,749
c.
Quick ratio = [Cash + Marketable securities + Accts. receivable] / Current Liabilities
= [Current assets – Inventory – Prepaid expenses] / Current liabilities
= [$67,351,290 - $18,486,423 - $1,913,794] / $39,333,749
= 1.19
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-45
E2-43. (15 minutes)
LO 1, 3
a.
Kimberly-Clark ($ millions)
Amount
Classification
Net sales ........................................................................................ $18,259
I
Cost of goods sold ......................................................................... 11,706
I
Retained earnings..........................................................................
6,730
B
Net income .....................................................................................
2,319
I
Property, plant & equipment, net ...................................................
7,436
B
Marketing, research and general expenses ..................................
3,227
I
Accounts receivable, net ...............................................................
2,315
B
Total liabilities ................................................................................ 14,269
B
Total stockholders' equity ..............................................................
B
882
b. Total assets = Total liabilities + Stockholders’ equity
Total assets = $14,269 + $882 = $15,151
Total revenue – Total expenses = Net income
$18,259 – Total expenses = $2,319
Thus, Total expenses = $15,940
c.
Debt-to-equity ratio = Total liabilities / Stockholders’ equity
= $14,269 / $882 = 16.18
©Cambridge Business Publishers, 2020
4-46
Financial Accounting, 6th Edition
E2-44. (15 minutes)
LO 1, 2, 3. 4
Balance Sheet
Transaction
Cash
Asset
(1) Receive
€50,000 in
exchange for
common
stock.
+50,000
(2) Borrow
€10,000
from bank.
+10,000
+
Noncash
Assets
=
Liabilities
Income Statement
+
Contrib.
+
Capital
Earned
Capital
Revenues -
Expenses
Cash
Common
Stock
=
-
=
-
=
-
=
-
=
-
=
-
=
-
=
+10,000
Cash
=
Notes
Payable
+2,000
+2,000
Inventory
=
Accounts
Payable
(4) Receive
€15,000
cash from
customers
for services
provided.
+15,000
(5) Pay €2,000
cash to
supplier in
part (3).
- 2,000
(6) Receive order
for future
services with
€3,500
advance
payment.
+3,500
(7) Pay
€5,000 cash
dividend to
shareholders.
- 5,000
(8) Pay
employees
€6,000
cash for
compensation
earned.
- 6,000
- 6,000
+6,000
Cash
Retained
Earnings
Wages
Expense
Totals
Cash
=
+15,000
+15,000
Retained
Earnings
Revenue
+15,000
- 2,000
Cash
=
Accounts
Payable
+3,500
Cash
=
Unearned
Revenue
- 5,000
Cash
Retained
Earnings
=
=
- 500
-
- 500
Cash
65,000
Net
Income
+50,000
(3) Purchase
€2,000 of
supplies
inventory on
credit.
(9) Pay €500
cash for
interest on
loan in (2).
=
+
2,000
Solutions Manual, Chapter 4
=
13,500
+
50,000
+
3,500
- 6,000
+500
Retained
Earnings
=
=
-
15,000
-
Interest
Expense
6,500
=
=
- 500
8,500
©Cambridge Business Publishers, 2020
4-47
E2-45. (20 minutes)
LO 2, 6
a.
1.
2.
3.
4.
5.
6.
7.
8.
9.
Cash (+A) .................................................................................................... 50,000
Common stock (+SE) ............................................................................
Receive €50,000 in exchange for common stock.
50,000
Cash (+A) .................................................................................................... 10,000
Notes payable (+L) ................................................................................
Borrow €10,000 from bank.
10,000
Inventory (+A) ............................................................................................. 2,000
Accounts payable (+L) ...........................................................................
Purchase €2,000 supplies inventory on account.
2,000
Cash (+A) .................................................................................................... 15,000
Revenue (+R, +SE) ...............................................................................
Recognize €15,000 revenue for services provided.
15,000
Accounts payable (-L) ................................................................................. 2,000
Cash (-A) ...............................................................................................
Pay supplier €2,000 cash.
2,000
Cash (+A) .................................................................................................... 3,500
Unearned revenue (+L) .........................................................................
Receive €3,500 advance from customer.
3,500
Retained earnings (-SE) ............................................................................. 5,000
Cash (-A) ...............................................................................................
Pay €5,000 cash dividend to shareholders.
5,000
Wages expense (+E, -SE) .......................................................................... 6,000
Cash (-A) ...............................................................................................
Pay employees €6,000
6,000
Interest expense (+E, -SE) .........................................................................
Cash (-A) ...............................................................................................
Pay €500 interest on note.
©Cambridge Business Publishers, 2020
4-48
500
500
Financial Accounting, 6th Edition
b.
+
(1)
(2)
(4)
(6)
Bal.
+
(3)
Bal.
-
+
(8)
Bal.
+
(9)
Bal.
Cash (A)
50,000
2,000
10,000
5,000
15,000
6,000
3,500
500
65,000
-
Supplies Inventory (A)
2,000
2,000
-
Revenue (R)
15,000
15,000
(5)
(7)
(8)
(9)
-
Unearned Revenue (L)
+
(3)
Bal.
+
3,500
3,500
-
+
Notes Payable (L)
10,000
10,000
-
Interest Expense (E)
500
500
-
(7)
Bal.
(6)
Bal.
+
(2)
Bal.
-
Common Stock (SE)
50,000
50,000
+
(1)
Bal.
-
Retained Earnings (SE)
5,000
5,000
+
(4)
Bal.
Wages Expense (E)
6,000
6,000
Solutions Manual, Chapter 4
Accounts Payable (L)
2,000
2,000
0
(5)
©Cambridge Business Publishers, 2020
4-49
E2-46. (20 minutes)
LO 1, 7
a. & b.
BETTIS CONTRACTORS
Balance Sheets
June 30,
2019
Assets
Cash
$ 14,700
Accounts receivable
July 2,
2019
$
2,200
9,200
9,200
30,500
30,500
54,400
41,900
Land
25,000
25,000
Equipment
98,000
108,000
$177,400
$174,900
$
$
Supplies
Current assets
Total assets
Liabilities
Accounts payable
Current liabilities
Notes payable
Total liabilities
8,900
8,900
8,900
8,900
30,000
33,000
38,900
41,900
100,000
100,000
38,500
33,000
138,500
133,000
$177,400
$174,900
Stockholders’ equity
Common stock
Retained earnings
Total stockholders' equity
Total liabilities and stockholders’ equity
c.
CR = $54,400 / $8,900 = 6.11
QR = ($14,700 +$9,200) / $8,900 = 2.69
d. Bettis’ current ratio indicates a strong liquidity position. The firm might want to consider investing
some of its cash in assets that contribute to the firm’s earning power. The quick ratio is reasonable as
a company does not want to tie up too much of its assets in a nonearning asset (cash). A quick
glance at the data indicates that the firm's liquidity position has weakened since June.
©Cambridge Business Publishers, 2020
4-50
Financial Accounting, 6th Edition
E2-47. (15 minutes)
LO 1, 2, 3, 4
Balance Sheet
Transaction
1. Receive
$20,000 cash
in exchange
for common
stock.
Cash
Asset
+
= Liabilities +
+20,000
Contrib.
+
Capital
Cash
+2,000
3. Sell inventory
for $3,000 on
credit.
4. Record cost
of goods sold
in 3.
=
Accts
Payable
+3,000
+3,000
+3,000
Accounts
Receivable
Retained
Earnings
Sales
Inventory
+3,000
-3,000
Cash
Accounts
Receivable
6. Acquire
$5,000 of
equipment by
signing a
note.
=
-5,000
9. Pay $2,000
cash
dividend.
-2,000
TOTALS
15,000
=
-
=
-
=
-
=
-2,000
Net
Income
-
=
COGS
Expense
=
-
=
-
=
- 2,000
+5,000
Notes
= Payable
-1,000
Cash
+3,000
+ 2,000
Retained
Earnings
=
+5,000
Equipment
8. Pay $5,000
cash on a
note payable.
Expenses
+2,000
-2,000
-1,000
Revenues -
Common
Stock
=
Inventory
7. Pay wages of
$1,000 in
cash.
Earned
Capital
+20,000
2. Purchase
$2,000 of
inventory on
credit.
5. Collect
$3,000 cash
from
transaction 3.
Noncash
Assets
Income Statement
+ 1,000
Retained
Earnings
=
-
Wages
Expense
=
- 1,000
-5,000
Cash
=
Notes
Payable
-
=
-
=
-2,000
=
Cash
+
5,000
Solutions Manual, Chapter 4
=
Retained
Earnings
2,000
+
20,000
+
-2,000
3,000
-
3,000
=
0
©Cambridge Business Publishers, 2020
4-51
E2-48. (20 minutes)
LO 6
a.
1.
2.
3.
4.
5.
6.
7.
8.
9.
Cash (+A) ....................................................................................................
20,000
Common stock (+SE) .............................................................................
20,000
Inventory (+A) ..............................................................................................
2,000
Accounts payable (+L) ...........................................................................
2,000
Accounts receivable (+A) ............................................................................
3,000
Sales (+R, +SE) .....................................................................................
3,000
Cost of goods sold (+E, -SE) .......................................................................
2,000
Inventory (-A)..........................................................................................
2,000
Cash (+A) ....................................................................................................
3,000
Accounts receivable (-A) ........................................................................
3,000
Equipment (+A) ...........................................................................................
5,000
Notes payable (+L) .................................................................................
5,000
Wages expense (+E, -SE) ...........................................................................
1,000
Cash (-A) ................................................................................................
1,000
Notes payable (-L) .......................................................................................
5,000
Cash (-A) ................................................................................................
5,000
Retained earnings (-SE) ..............................................................................
2,000
Cash (-A) ................................................................................................
2,000
©Cambridge Business Publishers, 2020
4-52
Financial Accounting, 6th Edition
b.
+
Cash (A)
20,000 1,000
3,000 5,000
2,000
(1)
(5)
-
(7)
(8)
(9)
-
+
Inventory (A)
2,000 2,000
(2)
Accounts Receivable (A)
3,000 3,000
Equipment (A)
5,000
(6)
(8)
Accounts Payable (L)
2,000
Notes Payable (L)
5,000 5,000
Solutions Manual, Chapter 4
(3)
-
(5)
-
(7)
-
+
Cost of Goods Sold (E)
2,000
+
+
Sales Revenue (R)
3,000
(1)
(4)
+
+
+
-
(4)
(3)
Common Stock (SE)
20,000
+
(9)
Wages Expense (E)
1,000
Retained Earnings (SE)
2,000
-
+
(2)
+
(6)
©Cambridge Business Publishers, 2020
4-53
PROBLEMS
P2-49. (30 minutes)
LO 1, 3
a. Comcast, Apple, Target and Harley-Davidson are financed primarily by debt (between 63% and 82% of
total assets). Nike is financed more by equity (47% debt).
b. The highest ratios of income to assets were Nike (18.2%), Apple (12.9%) and Comcast (12.2%).
Possible reasons include the firms’ ability to command a premium price for their brands and, in the
case of Nike and Apple, the ability to outsource a significant amount of their production (and avoid
investments in productive capacity).
c.
Apple has the highest estimated ROE at 36%. (The ROE is estimated because we have only this
year’s equity.) Nike has the second highest ROE at 34%, and Comcast is at just under 33%. Both
Apple and Nike are able to reduce expenses through outsourcing production to Asia.
P2-50. (30 minutes)
LO 1, 3
a. While Apple is 64% debt financed, Hewlett-Packard’s liabilities exceed its total assets. (It has
negative stockholders’ equity.) Hewlett-Packard is the more heavily leveraged firm. Some of the
difference can be attributed to HPQ’s expensive acquisitions that resulted in subsequent write-offs.
b. Hewlett-Packard's net income to asset ratio is 7.7% while Apple’s is 12.9%. The ratios are not close,
which might not be expected given the similarities of their activities. More heavily leveraged firms are
open to greater risk and for this reason we might expect a greater return to be earned on HewlettPackard’s assets to compensate for the higher risk. But that turns out not to be the case. Apple’s
return exceeds Hewlett-Packard’s, suggesting that Apple has superior products or is more efficient in
its operations.
c. Hewlett-Packard’s gross profit as a percent of sales is 18.4% while Apple’s is 38.5%. The implication
is that Apple does have the more efficient production operation and/or product designs that allow it to
command a premium price from consumers.
©Cambridge Business Publishers, 2020
4-54
Financial Accounting, 6th Edition
P2-51. (30 minutes)
LO 1, 3
a. Comcast is 63% financed with debt, while Verizon is 83% financed with debt. High debt financing is
not uncommon in an industry with large investments in property, plant and equipment. Verizon’s debt
percentage is particularly high as it repurchased a significant portion of its common stock that had
been held by Vodafone Group, thereby reducing shareholders’ equity.
b. Comcast has the slightly higher net income to total asset ratio at 12.2% compared to 11.9% for
Verizon. This small difference can be explained by the larger amount of interest expense that
Verizon pays on its debt financing.
c.
Verizon has a slightly lower return on total assets while reporting much higher leverage (debt), so it is
likely that Comcast would have better access to additional capital.
P2-52. (30 minutes)
LO 1, 7
a. 3M at 69% is the more heavily debt-financed firm. Abercrombie and Fitch is the lowest debt financed
at 46%. Apple is 64% financed by debt.
b. Apple has the most working capital, but it is a much larger firm than 3M or Abercrombie & Fitch. A
better measure of the comparative differences in working capital is the current ratio, which is the ratio
of the firm’s current assets to its current liabilities. This ratio is greatest for Abercrombie & Fitch at 2.5.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-55
P2-53. (30 minutes)
LO 1, 5
a.
BARTH COMPANY
Balance Sheet
December 31, 2018
Assets
Cash
Accounts receivable
Equipment
Land
$ 8,800
18,400
9,000
50,000
Liabilities
Total assets
$86,200
Accounts payable
$ 7,500
Equity
Stockholders’ equity
Total liabilities & equity
78,700
$86,200
b. Increase in Equity
Add: Dividends
Net Income for 2018
($78,700-$67,500)
$11,200
12,000
$23,200
c.
($78,700-$67,500)
$11,200
21,000
32,200
13,500
$18,700
Increase in Equity
Add: Dividends
Less: Additional Investment
Net Income for 2018
P2-54. (20 minutes)
LO 1, 3
a.
Total assets (Total liabilities and equity)
Total expenses (Sales – Net income)
Total expenses as percent of sales
ANF
JWN
$2,326
$8,115
3,482
14,700
99.7%
($3,482/$3,493)
97.1%
($14,700/$15,137)
b.
Return on average
equity…
ANF
$11
[($2,326-$1,074)+$1,252]/2
©Cambridge Business Publishers, 2020
4-56
= 0.9%
JWN
$437
[($8,115-$7,138)+$870]/2
= 47.3%
Financial Accounting, 6th Edition
P2-55. (30 minutes)
LO 1, 7
a.
($ millions)
Current
Assets
Noncurrent
Assets
Total
Assets
Current
Liabilities
Noncurrent
Liabilities
Total
Liabilities
Equity
2014 ……
$5,559
$9,967
$15,526
$6,226
$8,301
$14,527
$999
2015 ……
5,426
9,416
14,842
6,349
8,453
14,802
40
2016 ……
5,115
9,487
14,602
5,846
8,639
14,485
117
2017 ……
5,211
9,940
15,151
5,858
8,411
14,269
882
b. Kimberly Clark’s current assets most likely include cash, accounts receivable, inventories, and
prepaid assets.
Its long-term assets most likely include property, plant and equipment (PPE), goodwill, and other
intangible assets that have arisen from acquisitions.
c.
2016: Working capital = $5,115 - $5,846 = $(731)
Current ratio = $5,115 / $5,846= 0.87
2017: Working capital= $5,211 - $5,858 = $(647)
Current ratio $5,211 / $5,858 = 0.89
d. Kimberly Clark’s liquidity ratios have remained stable over this four year period. In 2014, the current
ratio was 0.89, the same as 2017. The company has reduced investment in current assets and
current liabilities proportionately over the last four years.
P2-56. (30 minutes)
LO 1, 7
a.
($ millions)
2014 ……
2015 ……
2016 ……
2017 ……
Current
Assets
Noncurrent
Assets
$ 5,863
6,045
4,996
3,812
$ 7,322
5,292
4,366
3,450
Total
Assets
$13,185
11,337
9,362
7,262
Current
Liabilities
$ 5,595
5,438
4,681
4,915
Noncurrent
Liabilities
Total
Liabilities
$ 8,535
7,855
8,505
6,070
$14,130
13,293
13,186
10,985
Equity
$ (945)
(1,956)
(3,824)
(3,723)
b. We might reasonably predict inventories to comprise the bulk of its current assets. In fact, SHLD’s
inventory is more than 80% of its current assets.
c.
2014: $5,863 / $5,595= 1.05
2017: $3,812 / $4,915 = 0.78
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-57
d. SHLD’s deteriorating condition can been seen in the decline in current assets, non-current assets and
its shareholders’ equity. In fact, beginning in 2014, SHLD’s shareholders’ equity was negative,
indicating that the book value of its liabilities exceeded the book value of its assets. This situation has
only become worse over the past three years as the negative balance in equity in 2017 is nearly four
times as large as it was in 2014.
P2-57. (30 minutes)
LO 1, 2, 3, 4
a.
Balance Sheet
Transaction
1. Issued
common stock
$7,000.
2. Paid rent
$750.
Cash
Asset
+7,000
Cash
+
Noncash
Assets
=
=
5. $1,200 cash
received for
services.
+1,200
Cash
=
+6,800
Accounts
Receivable
-2,200
Cash
8. Paid $370
cash for
utilities.
Earned
Capital
+500
Accounts
Payable
=
+750
Rent
Expense
+500
Advertising
Expense
=
-750
=
-500
-
=
-
=
+1,200
+6,800
Retained
Earnings
+6,800
Counseling
Services
Revenue
-
=
+6,800
-900
Cash
10. Acquired land
for $13,000.
-13,000
Cash
11. Paid $100
interest in
cash.
-100
Cash
-
+2,200
Salary
Expense
=
-2,200
=
-370
Retained
Earnings
-
+370
Utilities
Expense
=
-370
=
-900
Retained
Earnings
-
=
-
=
=
-100
Retained
Earnings
=
$19,800
Net
Income
+1,200
Counseling
Services
Revenue
9. Paid $900
cash dividend.
+
=
+1,200
Retained
Earnings
-370
Cash
$5,880
-
+15,000
Notes
Payable
-2,200
Retained
Earnings
Totals
-
-500
Retained
Earnings
=
Expenses
-
=
+13,000
Land
Revenues -
-750
Retained
Earnings
=
6. Billed clients
$6,800 for
services.
7. Paid $2,200
cash for
salary.
Contrib.
+
Capital
+7,000
Common
Stock
=
3. Received
$500 invoice
for advertising
expense.
+15,000
Cash
+
=
-750
Cash
4. Borrowed
$15,000 cash
from bank.
Liabilities
Income Statement
=
©Cambridge Business Publishers, 2020
4-58
$15,500
+
$7,000
+
$3,180
$8,000
-
+100
Interest
Expense
=
-100
-
$3,920
=
$4,080
Financial Accounting, 6th Edition
b.
LAMBERT SERVICES
Income Statement
For the Month of December 2018
Counseling services revenue
$8,000
Expenses
Rent expense
$ 750
Advertising expense
Salary expense
500
2,200
Utilities expense
370
Interest expense
100
Total expenses
3,920
Net income
$4,080
P2-58. (30 minutes)
LO 6
a.
1.
2.
3.
4.
5.
6.
7.
8.
Cash (+A) ....................................................................................................
7,000
Common stock (+SE) .............................................................................
7,000
Rent expense (+E,-SE) ...............................................................................
750
Cash (-A) ................................................................................................
750
Advertising expense (+E, -SE) ....................................................................
500
Accounts payable (+L) ...........................................................................
500
Cash (+A) ....................................................................................................
15,000
Notes payable (+L) .................................................................................
15,000
Cash (+A) ....................................................................................................
1,200
Counseling services revenue (+R,+SE) .................................................
1,200
Accounts receivable (+A) ............................................................................
6,800
Counseling services revenue (+R,+SE) .................................................
6,800
Salary expense (+E,-SE) .............................................................................
2,200
Cash (-A) ................................................................................................
2,200
Utilities expense (+E,-SE) ...........................................................................
370
Cash (-A) ................................................................................................
370
continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-59
a. continued
9.
10.
11.
Retained earnings (dividend paid) (-SE) .....................................................
900
Cash (-A) ................................................................................................
900
Land (+A) .....................................................................................................
13,000
Cash (-A) ................................................................................................
13,000
Interest expense (+E,-SE)
100
Cash (-A) ................................................................................................
100
b.
+
(1)
(4)
(5)
Cash (A)
7,000
750
15,000
2,200
1,200
370
900
13,000
100
-
(2)
(7)
(8)
(9)
(10)
(11)
-
+
Accounts Receivable (A)
6,800
(6)
-
+
Land (A)
13,000
(10)
-
(9)
+
Rent Expense (E)
750
-
+
Salary Expense (E)
2,200
-
Interest Expense (E)
100
-
(2)
(7)
+
(11)
©Cambridge Business Publishers, 2020
4-60
+
(3)
+
(8)
Accounts Payable (L)
500
+
(3)
Notes Payable (L)
15,000
+
Common Stock (SE)
7,000
+
Retained Earnings (SE)
900
+
Counseling Services Rev. (R)
1,200
6,800
Advertising Expense (E)
500
Utilities Expense (E)
370
(4)
(1)
+
(5)
(6)
-
-
Financial Accounting, 6th Edition
P2-59. (30 minutes)
LO 1, 7
a.
($ millions)
Current
Assets
2014 ……
2015 ……
2016 ……
2017 ……
$68,531
89,378
106,869
128,645
Noncurrent
Assets
$ 163,308
201,101
214,817
246,674
Total
Assets
$231,839
290,479
321,686
375,319
Current
Liabilities
$63,448
80,610
79,006
100,814
Noncurrent
Liabilities
Total
Liabilities
Equity
$ 56,844
90,514
114,431
140,458
$120,292
171,124
193,437
241,272
$ 111,547
119,355
128,249
134,047
b.
For a computer company we might reasonably expect inventories and cash to be the predominant
items in current assets. The reality is that inventory is not a large dollar amount (less than 1% of total
assets) because the company’s business model depends on high inventory turnover—that is, it works
diligently to minimize the quantity of inventory to avoid product obsolescence. The surprise is that
37% of Apple’s current assets are cash and short-term marketable securities. Long-term assets are
primarily concentrated in financial securities, with property, plant and equipment a distant second.
c.
The percentage of Apple’s assets that is financed with liabilities has increased over this time period.
AAPL has started to pay shareholder dividends and to repurchase its common stock, but it has
borrowed money to do so.
d.
2017: $128,645/$100,814 = 1.28;
2014: $68,531/$63,448 = 1.08
e.
Apple’s current ratio is below the industry average. A probable cause of this decrease is the
increasing size of the company. Net working capital has increased since 2014. So, even though
these measures are low, Apple’s size and the monetary “cushion” of AAPL’s financial assets gives
them a relatively strong liquidity position.
P2-60. (30 minutes)
LO 1, 7
a.
(RMB
millions)
2016 …
2017 …
2018 …
Current
Assets
Noncurrent
Assets
20,792
26,516
40,949
Solutions Manual, Chapter 4
35,675
47,114
73,377
Total
Assets
56,467
73,630
114,326
Current
Liabilities
8,071
13,623
21,651
Noncurrent
Liabilities
Total
Liabilities
9,696
12,919
22,619
17,767
26,542
44,270
Equity
38,700
47,088
70,056
©Cambridge Business Publishers, 2020
4-61
b. Alibaba’s current assets are likely to be primarily comprised of cash, accounts
receivable, inventories and prepaid expenses.
Its long-term assets will likely be primarily comprised of property, plant and
equipment (PPE) for its operations, financial investments, and goodwill and
other intangible assets arising from acquisitions.
c. Current ratio:
2016: 20,792 / 8,071 = 2.58
2018: 40,949 / 21,651 = 1.89
d. Working capital:
2016: 20,792 - 8,071 = 12,721
2018: 40,949 - 21,651 = 19,298
P2-61. (30 minutes)
LO 3
a.
($ millions)
2014 ……
2015 ……
2016 ……
2017 ……
Revenues
Cost of
Goods Sold
$ 27,799
30,601
32,376
34,350
$ 15,353
16,534
17,405
19,038
Gross
Profit
$12,446
14,067
14,971
15,312
Operating
Expenses
Operating
Income
$ 8,766
9,892
10,469
10,563
$ 3,680
4,175
4,502
4,749
Other
Expense
Net
Income
$ 987
902
742
509
$ 2,693
3,273
3,760
4,240
b. The gross profit percentage (also called gross profit margin) for each year follows:
Nike, Inc.
2014 ..............................
2015 ..............................
2016 ..............................
2017 ..............................
Gross Profit Percentage
44.8%
46.0%
46.2%
44.6%
Nike’s sales, gross profit and net income have remained steady over this period, reflecting continued
strength. The company's operating expenses have increased at about the same pace as sales.
c.
Wages, advertising and promotion, and general and administration expenses are likely to be the
major cost categories for Nike.
©Cambridge Business Publishers, 2020
4-62
Financial Accounting, 6th Edition
P2-62. (30 minutes)
LO 1, 2, 3, 4
a.
Balance Sheet
Transaction
1. Issued
common
stock for
cash.
2. Rent paid in
cash $4,800.
Cash
Asset
+
Noncash
Assets
5. July
insurance
premium
prepaid in
cash: $1,800.
6. Flight
services
collected in
cash;
$22,700.
Cash
-4,800
=
Cash
Expenses
=
Net
Income
-
-1,600
-
Retained
Earnings
-900
-900
=
Cash
-1,800
+1,800
Cash
Prepaid
Insurance
=
=
+15,900
-1,500
= Accounts
Payable
-
=
=
-
=
+15,900
+15,900
=
Retained
Earnings
Flight
Services
Revenue
-16,000
-16,000
=
Cash
11. Invoice
received for
fuel; $3,500.
-900
-
+15,900
Accounts
Receivable
10. Paid wages in
cash:
$16,000.
=
+22,700
Flight
Services
Revenue
Accounts
Receivable
Advertising
Expense
=
Retained
Earnings
Cash
-1,600
-
=
-13,200
+1,600
Entertainment
=
Expense
-4,800
=
+22,700
Cash
=
-
+22,700
-1,500
Rent
Expense
+900
-
Retained
Earnings
+22,700
Cash
=
+4,800
Retained
Earnings
+1,600
Accounts
=
Payable
+16,000
-
Retained
Earnings
+3,500
-3,500
= Accounts
Payable
Wages
expense
=
-16,000
=
-3,500
+3,500
-
Retained
Earnings
-3,000
Fuel
Expense
-3,000
=
Cash
$57,900
-
-
-4,800
+13,200
TOTALS
Revenues
Common
Stock
=
9. Received
$13,200 on
account.
12. Cash
dividend paid;
$3,000.
+
Earned
Capital
+$50,000
7. Billed for flight
services ;
$15,900.
8. Paid $1,500
on accounts.
+
+$50,000
3. Invoice for
entertainment
expense:
$1,600.
4. Cash paid for
advertising:
$900.
= Liabilities
Income Statement
Contrib.
Capital
+
$4,500
Solutions Manual, Chapter 4
=
-
Retained
Earnings
$3,600
+
$50,000
+
$8,800
$38,600
-
=
$26,800
=
$11,800
©Cambridge Business Publishers, 2020
4-63
b.
OUTBACK FLIGHTS
Income Statement
For the Month of June 2019
Revenue
Services fees earned
Expenses
Rent expense
Entertainment expense
Advertising expense
Wages expense
Fuel expense
Total expenses
Net income
$38,600
$ 4,800
1,600
900
16,000
3,500
26,800
$11,800
Note: The insurance premium paid is for the next month (July) and is not an expense at the end of
June.
P2-63. (30 minutes)
LO 6
a.
1.
2.
3.
4.
5.
6.
7.
Cash (+A) ....................................................................................................
50,000
Common stock (+SE) .............................................................................
50,000
Rent expense (+E,-SE) ...............................................................................
4,800
Cash (-A) ................................................................................................
4,800
Entertainment expense (+E,-SE) ................................................................
1,600
Accounts payable (+L) ...........................................................................
1,600
Advertising expense (+E,-SE) .....................................................................
900
Cash (-A) ................................................................................................
900
Prepaid insurance (+A) ................................................................................
1,800
Cash (-A) ................................................................................................
1,800
Cash (+A) ...................................................................................................
22,700
Flight services revenue (+R,+SE) ..........................................................
22,700
Accounts receivable (+A) ............................................................................
15,900
Flight services revenue (+R,+SE) ..........................................................
15,900
continued next page
©Cambridge Business Publishers, 2020
4-64
Financial Accounting, 6th Edition
a. continued
8.
9.
10.
11.
12.
Accounts payable (-L) .................................................................................
1,500
Cash (-A) ................................................................................................
1,500
Cash (+A) ....................................................................................................
13,200
Accounts receivable (-A) ........................................................................
13,200
Wages expense (+E,-SE) ............................................................................
16,000
Cash (-A) ................................................................................................
16,000
Fuel expense (+E,-SE) ................................................................................
3,500
Accounts payable (+L) ...........................................................................
3,500
Retained earnings (dividend paid) (-SE) .....................................................
3,000
Cash (-A) ................................................................................................
3,000
b.
+
(1)
(6)
(9)
+
Accounts Receivable (A)
15,900 (9)
+
Prepaid Insurance (A)
1,800
(7)
(5)
+
(2)
+
(4)
Cash (A)
50,000
4,800
22,700
900
13,200
1,800
1,500
16,000
3,000
Rent Expense (E)
4,800
Advertising Expense (E)
900
-
(2)
(4)
(5)
(8)
(10)
(12)
13,200
Accounts Payable (L)
1,500 1,600
3,500
(8)
-
Common Stock (SE)
50,000
(12)
-
-
(1)
+
Flight Services Revenue (R)
22,700
15,900
+
(6)
(7)
+
Entertainment Expense (E)
1,600
-
+
Wages Expense (E)
16,000
+
Solutions Manual, Chapter 4
+
-
(10)
(11)
(3)
(11)
Retained Earnings (SE)
3,000
(3)
-
+
Fuel Expense (E)
3,500
-
-
©Cambridge Business Publishers, 2020
4-65
P2-64. (30 minutes)
LO 3
a.
($ millions)
Revenues
Cost of
Revenues
Gross
Profit
Operating
Expenses
Operating
Income
Other
Expense
Net
Income
2014 ……
$ 16,447.8
$ 6,858.8
$9,589.0
$ 6,507.9
$ 3,081.1
$ 1,013.4
$2,067.7
2015 ……
19,162.7
7,787.5
11,375.2
7,774.2
3,601.0
841.7
2,759.3
2016 ……
21,315.9
8,511.1
12,804.8
8,632.9
4,171.9
1,353.0
2,818.9
2017 ……
22,386.8
9,038.2
13,348.6
9,213.9
4,134.7
1,249.8
2,884.9
b. The gross profit percentage (also called gross profit margin) for each year follows:
Starbucks, Inc.
2014
Gross Profit Percentage
58.3%
2015
59.4%
2016
60.1%
2017
59.6%
SBUX gross profit percentage edged up in 2015 and 2016, but decreased slightly in 2017. It is still
quite high.
c.
Selling, general and administrative expenses are the major operating expense categories for
Starbucks. Most store operating expenses (rent, utilities, coffee, etc.) are included in the Cost of
Revenues category.
©Cambridge Business Publishers, 2020
4-66
Financial Accounting, 6th Edition
P2-65. (30 minutes)
LO 3
a.
Revenues
Cost of
Goods Sold
2014 ……
€ 71,227
€ 50,869
€ 20,358
2015 ……
75,636
53,789
2016 ……
79,645
2017 ……
83,049
(€ millions)
Gross
Profit
Operating
Expenses
Operating
Income
Other
Expense
Net
Income
€ 13,751
€ 6,607
€ 1,100
€ 5,507
21,847
15,805
6,042
(1,338)
7,380
55,826
23,819
16,500
7,319
1,735
5,584
58,021
25,028
17,337
7,691
1,512
6,179
b. The gross profit percentage (also called gross profit margin) for each year follows:
Siemens AG
Gross Profit Percentage
2014
28.6%
2015
28.9%
2016
29.9%
2017
30.1%
Siemens’ gross profit percentage increased steadily between 2014 and 2017. The increase reflects
the improved economic conditions and Siemens’ increasing sales over the period.
c.
The principal items in Siemens’ operating expenses include selling and general administrative
expenses and research and development expenses.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-67
P2-66. (25 minutes)
LO 1, 3, 5
a.
GEYER, INC.
Income Statement
For Year Ended December 31, 2018
Service fees ....................................................................................................................
$67,600
Supplies expense ...........................................................................................................
$ 9,700
Insurance expense .........................................................................................................
1,500
Salaries expense ............................................................................................................
30,000
Advertising expense .......................................................................................................
1,700
Rent expense ..................................................................................................................
7,500
Miscellaneous expense ..................................................................................................
200
Total expenses .........................................................................................................
50,600
Net income ......................................................................................................................
$17,000
b.
GEYER, INC.
Statement of Stockholders’ Equity
For Year Ended December 31, 2018
Common
Stock
Retained
Earnings
Balance at December 31, 2017 ........................... $4,000
Total
Stockholders’ Equity
$6,200
$10,200
(13,500)
(13,500)
Net income ........................................................ _____
17,000
17,000
Balance at December 31, 2018 ........................... $5,400
$9,700
$15,100
Stock issuance .................................................. 1,400
Dividends ..........................................................
1,400
c.
GEYER, INC.
Balance Sheet
December 31, 2018
Cash ...............................................
$14,800
Accounts payable .............................................
$ 1,800
Supplies ..........................................
6,100
Notes payable .................................................. 4,000
Total assets ....................................
$20,900
Total liabilities ………………
5,800
Common stock ……………….
5,400
Retained earnings* ………….
9,700
Total liabilities and equities ..
$20,900
* $6,200 beginning balance + $17,000 net income - $13,500 dividend
©Cambridge Business Publishers, 2020
4-68
Financial Accounting, 6th Edition
P2-67. (45 minutes)
LO 1, 2, 3, 4, 5
a & b.
Balance Sheet
Transaction
Beg. Balances
1. Paid $600
cash toward
accounts
payable
2. Paid rent in
cash: $3,600
Cash
Asset
+
+5,000
Noncash
Assets
+5,200
+
+3,500
Contrib.
Capital +
Earned
Capital
+5,500
+1,200
Revenues
-
Expenses
=
Net
Income
-
-600
= Accounts
Payable
-
-3,600
-3,600
=
Cash
Accounts
Receivable
=
+500
5. Cash
collected on
account:
$10,000
+10,000
-10,000
Cash
Accounts
Receivable
6. Paid wages
expense in
cash: $2,400
-2,400
+11,500
+11,500
Retained
Earnings
Services
Revenue
-
=
-680
= Accounts
Payable
-
-20
=
Retained
Earnings
=
Retained
Earnings
-900
=
+11,500
=
-500
=
Wages
Expense
=
-2,400
=
-680
=
-20
+680
Retained
Earnings
-20
-3,600
+2,400
-
Retained
Earnings
+680
Cash
Advertising
Expense
-
-2,400
7. Invoiced for
utility
expense:
$680
=
+500
Retained
Earnings
=
Cash
Rent
Expense
-
-500
= Accounts
Payable
=
+3,600
-
Retained
Earnings
+11,500
4. $500 invoice
received for
advertising
9. Paid $900
cash
dividend
=
-600
Cash
3. Billed clients
$11,500
8. Paid $20
cash for
interest on
note
= Liabilities
Income Statement
Utilities
Expense
+20
-
Interest
Expense
-900
Cash
10. Paid $4,000
cash for
sound
equipment
-4,000
+4,000
Cash
Equipment
=
TOTALS
$3,480
$10,700
=
+
Solutions Manual, Chapter 4
$4,080
+
$5,500
+
$4,600
$11,500
-
=
-
=
-
$7,200
=
$4,300
©Cambridge Business Publishers, 2020
4-69
c.
SCHRAND AEROBICS, INC.
Income Statement
For Month Ended January 31, 2019
Services revenue .................................................................................................................. $11,500
Expenses ..............................................................................................................................
Rent expense...................................................................................................................
3,600
$3,600
Advertising expense ........................................................................................................
500
Wages expense ....................................................................................................................
2,400
Interest expense ..............................................................................................................
20
Utilities expense...............................................................................................................
680
Total expenses .....................................................................................................................
7,200
Net income .......................................................................................................................
$4,300
d.
SCHRAND AEROBICS, INC.
Statement of Stockholders’ Equity
For Month Ended January 31, 2019
Common
Stock
Balance at January 1, 2019 ................................. $5,500
Retained
Earnings
$1,200
Total
Stockholders’ Equity
$ 6,700
Stock issuance ..................................................
Dividends ..........................................................
(900)
(900)
Net income ........................................................ _____
4,300
4,300
Balance at January 31, 2019 ............................... $5,500
$4,600
$10,100
e.
SCHRAND AEROBICS, INC.
Balance Sheet
January 31, 2019
Cash ...............................................
Accounts receivable........................
Equipment .......................................
Total assets …………….
©Cambridge Business Publishers, 2020
4-70
$ 3,480
6,700
4,000
$14,180
Accounts payable .........................................
$ 1,580
Notes payable ...............................................
2,500
Total liabilities ................................................
4,080
Common stock ...............................................
5,500
Retained earnings ........................................
4,600
Total liabilities and equity ..............................
$14,180
Financial Accounting, 6th Edition
P2-68. (30 minutes)
LO 6
a.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Accounts payable (-L) .................................................................................
600
Cash (-A) ................................................................................................
600
Rent expense (+E,-SE) ...............................................................................
3,600
Cash (-A) ................................................................................................
3,600
Accounts receivable (+A) ............................................................................
11,500
Services revenue (+R,+SE) ...................................................................
11,500
Advertising expense (+E, -SE) ....................................................................
500
Accounts payable (+L) ...........................................................................
500
Cash (+A) ....................................................................................................
10,000
Accounts receivable (-A) ........................................................................
10,000
Wages expense (+E, -SE) ...........................................................................
2,400
Cash (-A) ................................................................................................
2,400
Utilities expense (+E, -SE) ..........................................................................
680
Accounts payable (+L) ...........................................................................
680
Interest expense (+E, -SE) ..........................................................................20
Cash (-A) ................................................................................................
20
Retained earnings (-SE) ..............................................................................
900
Cash (-A) ................................................................................................
900
Equipment (+A) ...........................................................................................
4,000
Cash (-A) ................................................................................................
4,000
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-71
b.
+
Beg. Bal.
(5)
End Bal.
Cash (A)
5,000
600
10,000
3,600
2,400
20
900
4,000
3,480
(1)
(2)
(6)
(8)
(9)
(10)
+
Beg. Bal.
(3)
End Bal.
Accounts Receivable (A)
5,200 10,000
11,500
6,700
+
Equipment (A)
(10)
4,000
End Bal.
4,000
+
(6)
End Bal.
Wages Expense (E)
2,400
2,400
+
(2)
End Bal.
+
(4)
End Bal.
Rent Expense (E)
3,600
3,600
Advertising Expense (E)
500
(1)
-
2,500
Common Stock (SE)
5,500
(5)
(9)
-
-
-
+
(7)
End Bal.
-
+
(8)
End Bal.
Accounts Payable (L)
+
600
1,000
Beg. Bal.
500
(4)
680
(7)
1,580 End Bal.
Notes Payable (L)
+
2,500
Beg. Bal.
End Bal.
+
Beg. Bal.
5,500 End Bal.
Retained Earnings (SE) +
900
1,200
Beg. Bal.
300
End Bal.
Services Revenue (R)
11,500
11,500
+
Utilities Expense (E)
680
680
-
Interest Expense (E)
20
20
(3)
End Bal.
-
500
©Cambridge Business Publishers, 2020
4-72
Financial Accounting, 6th Edition
P2-69. (45 minutes)
LO 1, 2, 3, 4, 5
a & b.
Balance Sheet
Transaction
Cash
Asset
Beg.Balances
+6,700
1. Paid $950
cash for
rent.
-950
2. Received
$8,800 cash
on account.
3. $500 paid
on accts.
payable.
+
= Liabilities +
Contrib.
Capital +
Earned
Capital
+14,800
=
+6,000
+12,400
Cash
Accounts
Receivable
+1,600
+1,600
Retained
Earnings
Services
Revenue
Notes
Payable
+8,100
Accounts
Receivable
=
-4,000
Rent
Expense
=
-$950
-
=
-
=
-
=
-
=
+8,100
+8,100
Retained
Earnings
Services
Revenue
-
=
+8,100
=
-4,000
=
-410
-4,000
=
Cash
8. Received
invoice for
utilities:
$410.
=
9. Paid $6,000
dividend.
-6,000
+1,600
10. Paid $9,800
cash for
vehicle.
-9,800
+9,800
Cash
Vehicles
+4,000
-
Retained
Earnings
+410
-410
Accts
Payable
Retained
Earnings
Salary
Expense
+410
-
Utilities
Expense
-6,000
=
Cash
$800
Net
Income
+5,000
=
6. Billed
$8,100 for
services.
TOTALS
-
Accts
Payable
=
Cash
Cash
=
-500
=
Cash
11. Paid $50
cash
interest on
note.
Expenses
+950
=
-500
Cash
+5,000
-
=
Retained
Earnings
=
-8,800
5. Borrowed
$5,000
signed note.
+3,100
Revenues
-950
+8,800
+1,600
7. Paid $4,000
for cash
salary.
Noncash
Assets
Cash
4. Received
$1,600 cash
for services.
Income Statement
Retained
Earnings
=
-50
-
=
-
=
-50
=
+
$23,900
Solutions Manual, Chapter 4
=
+50
Retained
Earnings
$8,010
+
$6,000
+
$10,690
$9,700
-
Interest
Expense
=
-50
-
$5,410
=
$4,290
©Cambridge Business Publishers, 2020
4-73
c.
KROSS, INC.
Income Statement
For Month Ended January 31, 2019
Services revenue .......................................................................................
Rent expense………………………………………………...
$9,700
$ 950
Utilities expense…………………………………………….
Salary expense………………………………………….…
Interest expense………………………………………….…
Total expenses ...........................................................................................
Net income .............................................................................................
410
4,000
50
5,410
$4,290
d.
KROSS, INC.
Statement of Stockholders’ Equity
For Month Ended January 31, 2019
Common
Retained
Stock
Earnings
Balance at January 1, 2019 ................................. $6,000
$12,400
Total
Stockholders’ Equity
$18,400
Stock issuance ..................................................
Dividends ..........................................................
(6,000)
(6,000)
Net income ........................................................ _____
4,290
4,290
Balance at January 31, 2019 ............................... $6,000
$10,690
$16,690
e.
KROSS, INC.
Balance Sheet
January 31, 2019
Cash ............................................... $
800
Accounts payable ...........................................
$ 510
Accounts receivable........................
14,100
Notes payable ................................................7,500
Equipment .......................................
9,800
Total liabilities .................................................8,010
Total assets .................................... $24,700
Common stock ...............................................6,000
Retained earnings ..........................................
10,690
Total liabilities and equity ...............................
$24,700
©Cambridge Business Publishers, 2020
4-74
Financial Accounting, 6th Edition
P2-70. (30 minutes)
LO 6
a.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Rent expense (+E,-SE) ...............................................................................950
Cash (-A) ................................................................................................
950
Cash (+A) ....................................................................................................
8,800
Accounts receivable (-A) ........................................................................
8,800
Accounts payable (-L) .................................................................................500
Cash (-A) ................................................................................................
500
Cash (+A) ....................................................................................................
1,600
Services revenue (+R,+SE) ...................................................................
1,600
Cash (+A) ....................................................................................................
5,000
Notes payable (+L) .................................................................................
5,000
Accounts receivable (+A) ............................................................................
8,100
Services revenue (+R, +SE) ..................................................................
8,100
Salary expense (+E,-SE) .............................................................................
4,000
Cash (-A) ................................................................................................
4,000
Utilities expense (+E,-SE) ...........................................................................410
Accounts payable (+L) ...........................................................................
410
Retained earnings (-SE) ..............................................................................
6,000
Cash (-A) ................................................................................................
6,000
Vehicles (+A) ...............................................................................................
9,800
Cash (-A) ................................................................................................
9,800
Interest expense (+E,-SE) ........................................................................... 50
Cash (-A) .................................................................................................
50
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-75
b.
+
Beg. Bal.
(2)
(4)
(5)
+
Beg. Bal.
(6)
+
+
+
(7)
(1)
(3)
(7)
(9)
(10)
(11)
Accounts Receivable (A)
14,800
8,800
8,100
(10)
(1)
Cash (A)
6,700
950
8,800
500
1,600
4,000
5,000
6,000
9,800
50
Vehicles (A)
9,800
Rent Expense (E)
950
Salary Expense (E)
4,000
©Cambridge Business Publishers, 2020
4-76
-
+
Interest Expense (E)
50
-
-
Accounts Payable (L)
+
500
600 Beg. Bal.
410
(8)
-
Notes Payable (L)
+
2,500 Beg. Bal.
5,000
(5)
-
Common Stock (SE)
+
6,000 Beg. Bal.
(3)
-
-
-
Retained Earnings (SE)
+
6,000
12,400 Beg. Bal.
-
Services Revenue (R)
+
1,600
8,100
(9)
-
Utilities Expense (E)
410
(11)
(2)
+
(8)
Financial Accounting, 6th Edition
(4)
(6)
CASES and PROJECTS
C2-71. (30 minutes)
LO 1, 3, 4, 5
WILDLIFE PICTURE GALLERY
Income Statement
For the month of March 2019
a.
Revenues
Commissions earned
$28,500
Expenses
Rent expense
$ 900
Wages expense
Utilities expense
4,900
350
Delivery expense
Total expenses
1,700
7,850
Net income
b.
$20,650
WILDLIFE PICTURE GALLERY
Statement of Stockholders’ Equity
For the month of March 2019
Common
Stock
Balance at March 1, 2019 ....................................$
0
Stock issuance .................................................. 6,500
Dividends ..........................................................
Net income ........................................................ _____
Balance at March 31, 2019 .................................. $6,500
c.
Assets
Cash
Advance receivable*
Total assets
Retained
Earnings
$
0
20,650
$20,650
WILDLIFE PICTURE GALLERY
Balance Sheet
March 2019
Liabilities
$51,200
Payable to artists**
500
Notes payable
Accounts payable
Total liabilities
Stockholders’ equity
Total liabilities and
$51,700
stockholders’ equity
Stockholders’ Equity
$
0
6,500
20,650
$27,150
$12,500
10,000
2,050
24,550
27,150
$51,700
* It is important to recognize that the Wildlife Picture Gallery is a separate entity from its shareholder/operator,
Sarah Penney. The $500 payment for airfare is not an expense of the business, but rather a payment on
behalf of an employee. Sarah will have to reimburse the company or have the amount deducted in future
compensation, as recognized in the advance receivable asset for Wildlife Picture Gallery.
** 70% x ($95,000) – $54,000 is owed to artists.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-77
C2-72. (30 minutes)
LO 3
Andrea faces a dilemma when she prepares her expense reimbursement request. She has, in essence, been
asked by her supervisor to join him in overcharging expenses to the company. Should Andrea not file a
reimbursement request for the Luxury Inn lodging costs, the company should question why she and her
supervisor stayed at different locations.
Discussion of this case should focus on the options available to Andrea. The options include the following:
1.
File an expense reimbursement request for the Luxury Inn and, therefore, minimize the likelihood of
jeopardizing her relationship with her supervisor.
2.
File an expense reimbursement request for the Spartan Inn and let future events take whatever course
they follow.
3.
Report the situation to her supervisor's boss.
4.
Discuss the situation with her supervisor and indicate that she (Andrea) is not comfortable with filing the
Luxury Inn receipt. Perhaps encourage the supervisor to seek a change in company policy to provide
daily allowances for lodging and meal costs rather than reimbursing actual costs.
5.
Leave the employ of the company.
There is no single correct answer to the problem. The first choice is not a good solution for the long run
as it starts a slippery slope for Andrea, which is likely to lead to further concessions to improper behavior
and more serious problems. Additional and more serious situations increase the chances her behavior is
likely to be discovered and she could be fired or even sent to jail. One would hope that sleepless nights
would intervene long before this time. It is better to draw the line here. Talking to her supervisor is a good
idea and perhaps instituting a policy that avoids any temptation. Leaving the company would be a fallback
choice if discussion of the situation does not lead to a resolution of the situation that preserves Andrea’s
ethical requirements.
©Cambridge Business Publishers, 2020
4-78
Financial Accounting, 6th Edition
Chapter 3
Adjusting Accounts
for Financial Statements
Learning Objectives – coverage by question
MiniExercises
Exercises
21 - 23, 25, 29,
33, 35,
30
36, 38
23, - 25,
32 - 36,
29, 30
38
Problems
Cases
and Projects
LO1 – Identify the major steps in the
accounting cycle.
LO2 – Review the process of
journalizing and posting transactions.
LO3 – Describe the adjusting process
and illustrate adjusting entries.
LO4 – Prepare financial statements from
adjusted accounts.
40 - 42, 46, 47,
49,
55 - 58
52 - 54
40 - 43,
46 - 49,
55 - 58
52 - 54
40 - 42,
26
39
44, 47, 49, 50,
55, 58
53, 54
LO5 – Describe the process of closing
temporary accounts.
LO6 – Analyzing changes in balance
sheet accounts.
Solutions Manual, Chapter 4
27, 28, 30
24, 25, 29
31, 33,
37, 39
34 - 36, 38
42, 44, 45,
49 - 51
55
53, 54
40, 42, 49
52 - 54
55, 56, 58
©Cambridge Business Publishers, 2020
4-79
QUESTIONS
Q3-1.
The five major steps in the accounting cycle are:
1.
2.
3.
4.
5.
Analyze business activity using transaction analysis based on the related source documents.
Record results of the transaction analysis chronologically in the general journal and create a trial
balance.
Adjust the recorded data to update all accounts for expense and revenue recognition not previously
recognized.
Report the adjusted financial data in the form of financial statements.
Close the books by posting the adjusting and closing entries, which “zero out” the temporary accounts.
Q3-2.
The fiscal year is the annual accounting period adopted by a firm. A firm using a fiscal year ending on
December 31 is on a calendar-year basis.
Q3-3.
Examples of source documents that underlie business transactions are invoices sent to customers, invoices
received from suppliers, bank checks, bank deposit slips, cash receipt forms, and written contracts.
Q3-4.
A general journal is a book of original entry that may be used for the initial recording of any type of
transaction. It contains space for dates and for accounts to be debited and credited, columns for the amounts
of the debits and credits, and a posting reference column for numbers of the accounts that are posted.
Q3-5.
When entries are posted, the page number and identifying initials of the appropriate journal are placed next to
the amounts in the appropriate accounts. The account number is entered beside the related amount posted in
the journal's posting reference column. This procedure enables interested users to trace amounts in the ledger
back to the originating journal entry and permits us to know which entries have been posted.
Q3-6.
An adjusting journal entry is a journal entry made at the end of an accounting period to reflect accural
accounting. It usually affects a balance sheet account and an income statement account and rarely involves
cash.
Q3-7.
A chart of accounts is a list of the accounts appearing in the general ledger, with the account numbering
system indicated. Normally the accounts are classified as asset, liability, owners' equity, revenue, and
expense accounts, and often the numbering system identifies the account classification. For example, a
coding system might assign the numbers 100–199 to assets, 200–299 to liabilities, and so on.
©Cambridge Business Publishers, 2020
4-80
Financial Accounting, 6th Edition
Q3-8.
Many of the transactions reflected in the accounting records through the first two steps of the accounting
cycle affect the net income of more than one period. Therefore, adjustments to the account balances are
ordinarily necessary at the end of each accounting period to record the proper amount of revenue and to
match expenses with revenue properly. This process is also intended to achieve a more accurate picture of
financial position by adjusting balance sheet amounts to show unexpired costs, up-to-date amounts of
obligations, and so on.
Q3-9.
1.
Allocating assets to expense to reflect expenses incurred during the period. Example: Recording supplies
used by debiting Supplies Expense and crediting Supplies.
2.
Allocating payments received in advance by crediting the revenue account to reflect revenues earned
during the period. Example: Recording service fees earned by debiting Unearned Service Fees and
crediting Service Fees Earned.
3.
Accruing expenses to reflect expenses incurred during the period that are not yet paid or recorded.
Example: Recording unpaid wages by debiting Wages Expense and crediting Wages Payable.
4.
Accruing revenues to reflect revenues earned during the period that are not yet received or recorded.
Example: Recording commissions earned by debiting Commissions Receivable and crediting
Commissions Earned.
Q3-10.
Jan. 31
Insurance expense (+E, -SE)
Prepaid insurance (-A)
To record insurance expense for January ($1,872/24 = $78).
78
78
Q3-11.
A contra account is an account that is related to, and deducted from, another account when financial
statements are prepared or when book values are computed. Accumulated depreciation is deducted from the
cost of a depreciable asset in computing and portraying the asset's book value.
Q3-12.
The building is five years old by the end of 2015, so the accumulated depreciation of $800,000 represents
five years of depreciation at an annual rate of $160,000 ($800,000/5). If the annual depreciation is $160,000,
then the expected life of the building must be 25 years.
At the end of 2022, the building will be twelve years old, and the accumulated depreciation will be
12×$160,000, or $1,920,000. The book value of the building (defined as original cost less accumulated
depreciation) will be $2,080,000.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-81
Q3-13.
(a)
(b)
Q3-14.
Q3-15.
Jan. 1
Cash (+A)
Subscriptions received in advance (+L)
To record receipt of two-year subscriptions.
Jan. 31
Subscriptions received in advance (-L)
Subscriptions revenue (+R,+SE)
To record subscription revenue earned during
January ($9,720/24 = $405).
Jan. 31
Jan. 31
9,720
9,720
405
405
Wages expense (+E, -SE)
Wages payable (+L)
To record unpaid wages for Jan. 30–31
[($475/5)  2 = $190].
190
Interest receivable (+A)
Interest income (+R,+SE)
To record interest earned during January.
360
190
360
Q3-16.
The temporary accounts—sometimes called nominal accounts—are closed at year-end. They consist
principally of the income statement accounts (expense and revenue accounts). (The Income Summary
account and the Dividend account are also closed if they are used.)
Q3-17.
Step 1)
Step 2)
Q3-18.
Close revenue accounts: Debit each revenue account for an amount equal to its balance, and
credit the Retained Earnings account for the total of revenues.
Close expense accounts: Credit each expense account for an amount equal to its balance, and
debit the Retained Earnings account for the total of expenses.
A post-closing trial balance ensures that an equality of debits and credits has been maintained throughout the
adjusting and closing procedures and that the general ledger is in balance to start the next period. Only
balance sheet accounts appear in a post-closing trial balance. Depreciation Expense and Supplies Expense are
temporary accounts that should have been closed and should not appear in the post-closing trial balance.
©Cambridge Business Publishers, 2020
4-82
Financial Accounting, 6th Edition
Q3-19.
The cost principle and the matching concept support Dehning's handling of its catalog costs. Prepaid Catalog
Costs is an asset account that is initially recorded at the amount that the catalogs cost Dehning. This is
consistent with the cost principle that states that assets are initially recorded at the amounts paid to acquire
the assets. The catalogs help Dehning generate sales revenues. The matching concept states that the catalog
costs should be matched as expenses with the revenues they help generate. Dehning does this by expensing
the catalog costs over their estimated useful lives.
Q3-20.
(a)
Supplies Expense ($825 + $260 − $630 = $455) for the period is omitted from the income statement,
overstating net income by $455 (ignoring taxes).
(b)
Both Supplies and Owners' Equity are overstated by $455 on the January 31 balance sheet (again,
before considering taxes).
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-83
MINI EXERCISES
M3-21. (45 minutes)
LO 2
a.
Balance Sheet
Cash
Asset
Transaction
June 1.
June 2.
June 3
June 6.
Invested
$12,000 cash.
Paid $950
cash for June
rent.
+
=
Cash
Contrib.
Capital
+ Earned Capital
+6,400
Office
Equipment
-1,800
+3,800
Cash
Supplies
Accounts
Receivable
-3,250
Cash
Accounts
Receivable
June 19. Paid $3,000
on office
equipment
account.
-3,000
+950
- Rent Expense =
-950
+6,400
-
=
-
=
Service Fees
Earned
=
-
=
-
=
-
=
+2,000
Accounts
= Payable
+4,700
Retained
Earnings
=
+4,700
=
-900
+4,700
-900
=
Retained
Earnings
=
Retained
Earnings
=
Retained
Earnings
-350
-350
Cash
5,750
Net
Income
=
-950
= Accounts
Payable
Cash
TOTALS
=
-3,000
Cash
-2,500
Expenses
Retained
Earnings
Accounts
= Payable
+4,700
June 30. Paid $2,500
salaries.
-
-
=
+3,250
of
Revenues
Common
Stock
-950
Cash
June 17. Collected
$3,250 on
accounts.
June 30. Paid $350
utilities.
+
+12,000
June 11. $4,700 billed
for services.
June 25. Paid cash
dividend
$900.
= Liabilities
+12,000
Purchased
$6,400 of
office
equipment on
account.
Purchased
$3,800 of
supplies;
$1,800 cash,
$2,000 on
account.
Noncash
Assets
Income Statement
+350
-
Utilities
Expense
-
Salaries
Expense
=
-
3,800
=
-2,500
Cash
+
11,650
=
5,400
©Cambridge Business Publishers, 2020
4-84
+
12,000
+
0
=
+2,500
4,700
-350
-2,500
900
Financial Accounting, 6th Edition
b.
June
1
2
3
6
11
17
19
25
30
30
Cash (+A)
Common stock (+SE)
Owner invested cash for stock.
Rent expense (+E, -SE)
Cash (-A)
Paid June rent.
12,000
12,000
950
950
Office equipment (+A)
Accounts payable (+L)
Purchased office equipment on account.
6,400
Supplies (+A)
Cash (-A)
Accounts payable (+L)
Purchased $3,800 of supplies; paid $1,800 down
with balance due in 30 days.
3,800
Accounts receivable (+A)
Service fees earned (+R,+SE)
Billed clients for services.
4,700
Cash (+A)
Accounts receivable (-A)
Collections from clients on account.
3,250
Accounts payable (-L)
Cash (-A)
Payment on account.
3,000
6,400
1,800
2,000
4,700
3,250
3,000
Retained earnings (-SE)
Cash (-A)
Issued dividends.
900
Utilities expense (+E, -SE)
Cash (-A)
Paid utilities bill for June.
350
Salaries expense (+E, -SE)
Cash (-A)
Paid salaries for June.
2,500
Solutions Manual, Chapter 4
900
350
2,500
©Cambridge Business Publishers, 2020
4-85
c.
+
June 1
17
+
June 11
Cash (A) 12,000
950
3,250
1,800
3,000
900
350
2,500
+
June 2
6
19
25
30
30
Accounts Receivable (A) 4,700
3,250
June 17
-
Common Stock (SE) +
12,000
June 1
June 6
+
June 3
June 19
Service Fees Earned (R)
4,700
+
June 11
June 30
+
June 30
©Cambridge Business Publishers, 2020
4-86
-
Office Equipment (A)
6,400
-
Accounts Payable (L) +
3,000
6,400
2,000
June 3
June 6
-
Retained Earnings (SE)
900
+
+
Rent Expense (E)
950
-
+
Utilities Expense (E)
350
-
June 25
June 2
-
Supplies (A)
3,800
Salaries Expense (E)
2,500
-
Financial Accounting, 6th Edition
M3-22. (45 minutes)
LO 2
a.
Balance Sheet
Transaction
April 1
April 2
April 3
April 3
April 4
April 7
Cash
Asset
Invested
$9,000 in
cash.
+9,000
Paid $2,850
cash for
lease.
-2,850
+
Noncash
Assets
Contrib.
Capital
+ Earned Capital
-
Expenses
=
Net
Income
Common
Stock
-
=
-
=
-
=
-
=
-
=
+2,850
Prepaid Van =
Lease
Cash
+10,000
Purchased
$5,500
equipment
for $2,500
cash with
rest on
account.
-2,500
+5,500
Cash
Equipment
Paid $4,300
cash for
supplies.
-4,300
+4,300
Cash
Supplies
Paid $350
cash for ad.
-350
= Note Payable
Cash
+3,000
=
Accounts
Payable
=
-350
=
Cash
April 21 Billed
$3,500 for
services
Accounts
Receivable
April 23 Paid $3,000
cash on
account.
-3,000
April 28 Collected
$2,300 on
account.
+2,300
-2,300
Cash
Accounts
Receivable
April 29 Paid $1,000
cash
dividend.
-1,000
April 30 Paid $1,750
cash for
wages.
-1,750
+350
- Ad.
Retained
Earnings
+3,500
+3,500
=
Retained
Earnings
Expense
-350
=
+3,500
Cleaning Fees Earned
=
-
=
-
=
-
=
+3,500
-3,000
=
Cash
Accounts
Payable
=
-1,000
Cash
=
Retained
Earnings
=
Retained
Earnings
=
Retained
Earnings
-1,750
Cash
-995
+1,750
-
Wages
Expense
-
Van Fuel
Expense
-
3,095
-995
Cash
4,555
Revenues
+9,000
+10,000
TOTALS
+
=
Cash
Borrowed
$10,000.
April 30 Paid $995
cash for gas.
= Liabilities
Income Statement
+
13,850
Solutions Manual, Chapter 4
=
10,000
+
9,000
+
-595
=
-1,750
+995
3,500
=
=
©Cambridge Business Publishers, 2020
4-87
-995
405
b.
April
1
2
Cash (+A)
Common stock (+SE)
Owner invested cash for stock.
9,000
Prepaid van lease (+A)
2,850
9,000
Cash (-A)
2,850
Paid six months' lease on van.
3
3
4
7
21
23
Cash (+A)
Notes payable (+L)
Borrowed money from bank for one year at
10% interest.
10,000
10,000
Equipment (+A)
Cash (-A)
Accounts payable (+L)
Purchased $5,500 of equipment; paid $2,500 down
with balance due in 30 days.
5,500
Supplies (+A)
Cash (-A)
Purchased supplies for cash.
4,300
Advertising expense (+E, -SE)
Cash (-A)
Paid for April advertising.
2,500
3,000
4,300
350
350
Accounts receivable (+A)
Cleaning fees earned (+R, +SE)
Billed customers for services.
3,500
Accounts payable (-L)
Cash (-A)
3,000
3,500
3,000
Payment on account.
28
29
30
30
Cash (+A)
Accounts receivable (-A)
Collections from customers on account.
2,300
Retained earnings (-SE)
Cash (-A)
Issued cash dividends.
1,000
Wages expense (+E, -SE)
Cash (-A)
Paid wages for April.
1,750
Van fuel expense (+E, -SE)
Cash (-A)
Paid for gasoline used in April.
©Cambridge Business Publishers, 2020
4-88
2,300
1,000
1,750
995
995
Financial Accounting, 6th Edition
c.
+
April 1
3
28
+
Cash (A)
9,000
2,850
10,000
2,500
2,300
4,300
350
3,000
1,000
1,750
995
April 4
Supplies (A)
4,300
April 23
Accounts Payable (L)
3,000
3,000
-
Common Stock (SE)
9,000
+
April 7
Van Fuel Expense (E)
995
Solutions Manual, Chapter 4
Accounts Receivable (A)
3,500
2,300
April 21
+
Prepaid Van Lease (A)
2,850
April 2
+
April 3
-
-
+
April 3
-
-
-
April 3
+
Cleaning Fees Earned (R) +
3,500 April 21
+
April 30
-
Retained Earnings (SE)
1,000
April 1
-
Equipment (A)
5,500
April 28
Notes Payable (L)
+
10,000
April 29
+
Advertising Expense (E)
350
+
April 30
+
April 2
3
4
7
23
29
30
30
Wages Expense (E)
1,750
-
-
©Cambridge Business Publishers, 2020
4-89
M3-23. (20 minutes)
LO 2, 3
a.
Balance Sheet
Cash
Asset
Transaction
1. Received
$20,100 in
advance for
contract
work.
Jan. 1
+
Noncash
Assets
= Liabilities
+20,100
Income Statement
+
Contrib.
Capital +
Earned
Capital
Revenues
-
Expenses
=
Net
Income
+20,100
Cash
Unearned
= Service Fees
-
Cash (+A)
Unearned service fees (+L)
To record fee received in advance.
=
20,100
20,100
b.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets
2. Adjusting
entry for
work
completed
by Jan. 31.
= Liabilities
Income Statement
+
Contrib.
Capital +
-3,350
Earned
Capital
+3,350
Unearned
= Service Fees
Retained
Earnings
Revenues
-
Expenses
=
Net
Income
+3,350
Service
Fees
Jan. 31 Unearned service fees (-L)
Service fees (+R, +SE)
To reflect January service fees earned on
contract ($20,100/6 = $3,350).
-
=
+3,350
3,350
3,350
c.
Balance Sheet
Transaction
3. Adjusting
entry for fees
earned but
not billed.
Jan. 31
Cash
Asset
+
Noncash
Assets
= Liabilities
Income Statement
+
Contrib.
Capital +
Earned
Capital
+570
+570
Fees
Receivable
Retained
Earnings
=
Fees receivable (+A)
Service fees (+R, +SE)
To record unbilled service fees earned
at January 31.
©Cambridge Business Publishers, 2020
4-90
Revenues
-
Expenses
=
Net
Income
=
+570
+570
Service
Fees
-
570
570
Financial Accounting, 6th Edition
M3-24. (15 minutes)
LO 3, 6
1.
Balance Sheet
Cash
Asset
Transaction
+
1. Adjusting
entry for
prepaid
insurance
Noncash
Assets
= Liabilities
Income Statement
+
Contrib.
Capital +
-185
Earned
Capital
Revenues
-
-185
Prepaid
Insurance
=
Net
Income
=
-185
+185
Retained
Earnings
=
Expenses
-
Jan. 31 Insurance expense (+E, -SE)
Prepaid insurance (-A)
To record January insurance expense
($6,660/36 = $185).
Insurance
Expense
185
185
2.
Balance Sheet
Cash
Asset
Transaction
+
2. Adjusting
entry for
supplies used
Jan.
31
Noncash
Assets
= Liabilities
Income Statement
+
Contrib.
Capital +
Earned
Capital
Revenues
-
Expenses
-
-1,080
-1,080
+1,080
Supplies
Inventory
Retained
Earnings
Supplies
Expense
=
Supplies expense (+E, -SE)
Supplies inventory (-A)
To record January supplies expense
($1,930 − $850 = $1,080).
=
Net
Income
=
-1,080
1,080
1,080
3.
Transaction
Cash
Asset
+
Noncash
Assets
3. Adjusting
entry for
deprecia-tion
of
equipment.
-
-
Balance Sheet
Contra
Liabil=
Assets
ities
Income Statement
+
Contrib.
Capital
+62
Accum.
Deprecn.
+
Earned
Capital
Revenues
-62
Retained
Earnings
Jan. 31 Depreciation expense—Equipment (+E, -SE)
62
Accumulated depreciation—Equipment (+XA, -A)
To record January depreciation on office equipment ($5,952/96 = $62).
-
Expenses
=
-
+62
Deprec.
Expense
=
62
Continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-91
Net
Income
-62
4.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets
4. Adjusting
entry for rent
= Liabilities
Income Statement
Contrib.
Capital +
+
Earned
Capital
-875
Unearned
= Rent Liability
Revenues
+875
+875
Retained
Earnings
Rent Revenue
Jan. 31 Unearned rent liability (-L)
Rent revenue (+R, +SE)
To record portion of advance rent earned in January.
-
Expenses
-
=
Net
Income
=
+875
875
875
5.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets
5. Adjusting
entry for
accrued
salaries
= Liabilities
=
Income Statement
Contrib.
Capital +
+
Earned
Capital
Revenues
-
Expenses
-
+490
-490
+490
Salaries
Payable
Retained
Earnings
Salaries
Expense
Jan. 31 Salaries expense (+E, -SE)
Salaries payable (+L)
To record accrued salaries at January 31.
=
Net
Income
=
-490
490
490
M3-25. (15 minutes)
LO 2, 3, 6
(All amounts in thousands of Mexican pesos.)
a.
Balance Sheet
Transaction
Inventory
purchases (total)
Cash
Asset
+
Noncash
Assets
=
+78,023,979
Inventory
Liabilities
Income Statement
+
Contrib.
Capital +
Revenues
-
Expenses
=
Net
Income
+78,023,979
=
Accounts
Payable
Inventories (+A)…………………………………….
Accounts payable (+L)………………………
To record total purchases made at various dates.
b.
Earned
Capital
-
=
78,023,979
78,023,979
Beginning AP balance + Purchases – Payments = Ending AP balance.
So, $15,210,743 + $78,023,979 - Payments = $22,535,802.
Thus, Payments = $70,698,920.
©Cambridge Business Publishers, 2020
4-92
Financial Accounting, 6th Edition
c.
Balance Sheet
Transaction
Cash
Asset
Adjusting entry
for cost of goods
sold for 2013.
+
Noncash
Assets
= Liabilities
Income Statement
+
Contrib.
Capital + Earned Capital Revenues
–73,387,487
Inventory
=
-
Expenses
Net
Income
=
–73,387,487
+73,387,487
Retained
Earnings
- Cost of Goods =
Sold
–73,387,487
* Beginning Inv balance + Purchases – Cost of goods sold = Ending Inv balance.
So, $13,849,931 + $78,023,979 – COGS = $18,486,423.
Thus, COGS = $73,387,487
Cost of goods sold (+E, -SE)…………………...................
Inventories (-A)…………………………………
To record cost of goods sold for the year ended 12/31/2017.
73,387,487
73,387,487
(Note: the COGS figure can be verified from the firm’s financial statements. Purchases cannot be so determined,
but could be established by working backwards. See M3-29.)
M3-26. (15 minutes)
LO 4
ARCHITECT SERVICES COMPANY
Statement of Stockholders’ Equity
For Year Ended December 31, 2018
Common Stock
Balance at December 31, 2017 .................................... $30,000
Stock issuance ..........................................................
Retained
Earnings
$18,000
6,000
Dividends..................................................................
Total
Stockholders’ Equity
$48,000
6,000
(9,700)
(9,700)
_____
29,900
29,900
Balance at December 31, 2018 .................................... $36,000
$38,200
$74,200
Net income................................................................
M3-27. (5 minutes)
LO 5
Ending balance = Beginning balance + Credit from closing revenue – Debit from closing expenses: $137,600 = $99,000
+ $347,400 - $308,800
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-93
M3-28. (15 minutes)
LO 5
a.
Date 2018
Desc
ription
Debit
Credi
t
Dec.
31
31
Commissions revenue (-R)
Retained earnings (+SE)
To close the revenue account.
Retained earnings (-SE)
Wages expense (-E)
Insurance expense (-E)
Utilities expense (-E)
Depreciation expense (-E)
To close the expense accounts.
84,900
84,900
55,900
36,000
1,900
8,200
9,800
Closing the revenue and expense accounts into retained earnings has the effect of increasing the retained earnings
balance by an amount equal to net income (revenue minus expenses). The balance of Smith’s Retained Earnings
after closing entries are posted is: $101,100 credit ($72,100 + $84,900 - $55,900).
b.
+
Bal.
Bal.
+
Bal.
Bal.
+
Bal.
Bal.
Wages Expense (E)
36,000
36,000
0
-
+
(2) Dec. 31
Bal.
Bal.
(2) Dec. 31
(1) Dec. 31
Depreciation Expense (E) 9,800
9,800
(2) Dec. 31
0
(2) Dec. 31
Insurance Expense (E)
1,900
1,900
0
©Cambridge Business Publishers, 2020
4-94
-
Utilities Expense (E)
8,200
8,200
0
(2) Dec. 31
- Commissions Revenue (R) +
84,900
84,900
0
- Retained Earnings (SE) +
55,900
72,100
84,900
101,100
Bal.
Bal.
Bal.
(1) Dec.31
Bal. Dec.31
Financial Accounting, 6th Edition
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-95
M3-29. (30 minutes)
LO 2, 3, 6
(All amounts in $ millions.)
a.
Balance Sheet
Transaction
Cash
Asset
Recognize cost
of goods sold
+ Noncash Assets = Liabilities
Income Statement
+
Contrib.
Capital + Earned Capital Revenues
-111,934
Merchandise
Inventory
-
-111,934
=
=
+111,934
- Cost of Goods =
Sold
Retained
Earnings
Cost of goods sold (+E,-SE) ....................................................................................
Expenses
Net
Income
-111,934
111,934
Merchandise Inventory(-A)................................................................................
111,934
To recognize the cost of goods sold.
b.
Beginning Inv balance + Purchases – Cost of goods sold = Ending Inv balance. So $11,461 + Purchases - $111,934
= $16,047. Thus purchases = $116,520
Balance Sheet
Transaction
Recording
inventory
purchases.
Cash
Asset
+ Noncash Assets = Liabilities
+116,520
Merchandise
Inventory
Income Statement
+
Contrib.
Capital + Earned Capital Revenues
-
Expenses
=
Net
Income
+116,520
=
-
Account
Payable
Merchandise inventory(+A).....................................................................................
Accounts payable (+L) ......................................................................................
=
116,520
116,520
To recognize the purchases on account.
c.
Beginning AP balance + Purchases – Payments = Ending AP balance
So, $25,309 + $116,520 - Payments = $34,616. Thus, Payments = $107,213
©Cambridge Business Publishers, 2020
4-96
Financial Accounting, 6th Edition
M3-30 (10 minutes)
LO 2, 3, 5
a.
Balance Sheet
Transaction
a.
Cash
Asset
+
Dec. 31
Interest
earned.
Noncash
Assets
= Liabilities
Income Statement
+
+600
Interest
Receivable
=
Contrib.
Capital + Earned Capital Revenues
+600
+600
Retained
Earnings
Interest
Income
-
Dec.31 Interest receivable (+A)
Interest income (+R, +SE)
To record accrued interest income.
b.
Dec. 31
Expenses
=
Net
Income
=
+600
600
600
Interest income (-R)
Retained earnings (+SE)
To close the Interest Income account.
2,400
2,400
c.
Balance Sheet
Transaction
Cash
Asset
c.
+900
-600
Cash
Interest
Receivable
Jan. 31
Receipt of
$900 interest
+
Noncash
Assets
= Liabilities
=
2019
Jan. 31 Cash (+A)
Interest income (+R, +SE)
Interest receivable (-A)
600
To record cash receipt of interest.
Solutions Manual, Chapter 4
Income Statement
+
Contrib.
Capital + Earned Capital Revenues
+300
+300
Retained
Earnings
Interest
Income
-
Expenses
-
=
Net
Income
=
+300
900
300
©Cambridge Business Publishers, 2020
4-97
EXERCISES
E3-31. (30 minutes)
LO 5
a.
Dec.
31
31
Service fees earned (-R)
Retained earnings (+SE)
To close the revenue account.
80,300
80,300
Retained earnings (-SE)
Rent expense (-E)
Salaries expense (-E)
Supplies expense (-E)
Depreciation expense (-E)
To close the expense accounts.
82,300
20,800
45,700
5,600
10,200
b.
+
Bal.
Bal.
Rent Expense (E)
20,800
20,800
0
+
(2)
Bal.
Bal.
+
Bal.
Bal.
+
Bal.
Bal.
(2)
Salaries Expense (E)
45,700
45,700
0
-
Retained Earnings (SE)
82,300
67,000
80,300
65,000
+
(2)
(1)
Supplies Expense (E)
5,600
5,600
0
Depreciation Expense (E)
10,200
10,200
0
Service Fees Earned (R)
+
80,300
80,300
0
(2)
(2)
Bal.
Bal.
Bal.
(1)
Bal.
Brooks Consulting earned a loss during the period (expenses exceeded revenues by
€2,000), so the ending retained earnings is lower than the beginning retained earnings
(even though no dividends were paid).
©Cambridge Business Publishers, 2020
4-98
Financial Accounting, 6th Edition
E3-32. (30 minutes)
LO 3
a.
Income Statement
Balance Sheet
Transaction
Cash
Asset
Noncash
+ Assets
-
1. Adjusting
entry for
depreciateion:
equipment.
-
2. Adjusting
entry for
utilities
expense.
-
-700
=
+
+
-
+300
-610
=
+390
-390
Utilities
Payable
Retained
Earnings
=
+
-400
-
Expenses
-
+610
=
=
-
-
-
+468
+468
Retained
Earnings
Premium
Revenue
-965
Retained
Earnings
=
-
610
=
887
+
0
Depreciation expense—Equipment (+E,-SE)
Accumulated depreciation—Equip (+XA, -A)
To record depreciation for the period.
+
=
-610
+390
=
-390
+700
=
-700
=
+468
=
-965
=
+300
=
-1,897
Rent
Expense
-468
+965
-
-
+965
Wages
Expense
+300
+300
Retained
Earnings
Interest
Income
-1,897
768
-
-
2,665
610
610
2. Utilities expense (+E, - SE)
Utilities payable (+L)
To record accrued utilities expense.
390
3. Rent expense (+E,-SE)
Prepaid rent (-A)
To record rent expense for the month ($2,800/4 = $700).
700
4. Contract liabilities (-L)
Premium revenue (+R,+SE)
To record premium revenue earned [($624/12)  9 = $468].
468
390
700
468
Continued next page
Solutions Manual, Chapter 4
Net
Income
Utilities
Expense
Contract
Liabilities
Wages
Payable
=
Depreciation
Expense
-700
Interest
Receiv-able
0
Revenues
Retained
Earnings
5. Adjusting
entry for
wage
expense.
6. Adjusting
entry for
interest
earned.
Earned
Capital
Retained
Earnings
Prepaid
Rent
-
1.
+610
-
4. Adjusting
entry for
premium
revenues.
b.
= Liabilities
Contrib.
Capital
Accum.
Depreciation
3. Adjusting
entry for rent
expense.
TOTALS
Contra
Assets
©Cambridge Business Publishers, 2020
4-99
b.
continued
5. Wages expense (+E,-SE)
Wages payable (+L)
To record accrued wages at the end of the period.
965
6. Interest receivable (+A)
Interest income (+R,+SE)
To accrue interest earned but not yet received.
300
965
300
E3-33. (15 minutes)
LO 2, 3, 5
a.
Balance Sheet
Cash
Asset
Transaction
a.
+
Noncash
Assets
Adjusting
entry for
salaries
expense.
= Liabilities
=
Income Statement
+
Contrib.
Capital + Earned Capital Revenues
Expenses
-
+4,700
-4,700
+4,700
Salaries
Payable
Retained
Earnings
Salaries
Expense
2018
Dec.31 Salaries expense (+E,-SE)
Salaries payable (+L)
To record accrued salaries payable.
b.
-
=
Net
Income
-4,700
=
4,700
4,700
31 Retained earnings (-RE)
250,000
Salarie
To close the Salaries Expense account.
c.
Balance Sheet
Cash
Asset
Transaction
c.
Paid salaries.
Noncash
Assets
= Liabilities
-12,000
Cash
2019
Jan.
+
=
+
Contrib.
Capital + Earned Capital Revenues
+4,700
-7,300
Salaries
Payable
Retained
Earnings
7 Salaries payable (-L)
Salaries expense (+E,-SE)
Cash (-A)
To record payment of salaries.
©Cambridge Business Publishers, 2020
4-100
Income Statement
-
Expenses
-
Salaries
Expense
=
+7,300
Net
Income
-7,300
=
4,700
7,300
12,000
Financial Accounting, 6th Edition
E3-34. (20 minutes)
LO 3, 6
Balance, January 1 = $960 + $800 − $620 = $1,140.
a.
b.
Amount of premium = $82  12 = $984.
Therefore, five months' premium ($984 − $574 = $410) has expired by January 31.
The policy term began on and has been in effect since September 1, 2018.
c.
Wages paid in January = $3,200 − $500 = $2,700.
d.
Monthly depreciation expense = $8,700/60 months = $145.
Fields has owned the truck for 18 months ($2,610/$145 = 18).
E3-35. (30 minutes)
LO 2, 3, 6
a.
Balance Sheet
Transaction
1.7/31
Cash
Asset
+ Noncash Assets =
Adjusting
entry for
rent
expense.
-475
Prepaid
2. 7/31 Adjusting
entry for
ad.
expense.
Liabilities
Income Statement
+
Contrib.
Capital + Earned Capital
=
-475
Rent
-210
Revenues
=
+475
=
-475
=
-210
=
-1,900
-
=
+800
-1,900
-
=
+300
=
-1,485
-
+800
+800
Fees
Receivable
Retained
Earnings
Refinish.
Revenue
-300
+300
+300
Performance
Obligation
Liability
Retained
Earnings
Refinish.
Revenue
-1,485
1,100
Retained
Earnings
5. 7/31 Adjusting
entry for
fees
revenue.
=
-300
+
0
+
+210
Advertising
Expense
+800
Solutions Manual, Chapter 4
-
Retained
Earnings
4. 7/31 Adjusting
entry for
fees
revenue.
-1,785
Net
Income
-
-1,900 Supplies
Inventory
+
=
Rent Expense
- 210
Prepaid
Advertising
0
Expenses
Retained
Earnings
3. 7/31 Adjusting
entry for
supplies
expense.
TOTALS
-
+1,900
Supplies
Expense
-
2,585
©Cambridge Business Publishers, 2020
4-101
b.
July
31
31
31
31
31
Rent expense (+E,-SE)
Prepaid rent (-A)
To record July rent expense ($5,700/12 = $475).
475
475
Advertising expense (+E,-SE)
Prepaid advertising (-A)
To record July advertising expense ($630/3 = $210).
210
Supplies expense (+E,-SE)
Supplies inventory (-A)
To record supplies expense for July
($3,000 − $1,100 = $1,900).
1,900
Fees receivable (+A)
Refinishing fees revenue (+R,+SE)
To record unbilled revenue earned during July.
800
Performance obligation liability (-L)
Refinishing fees revenue (+R,+SE)
To record portion of advance fees earned in July ($600/2 = $300).
300
210
1,900
800
300
c.
+ Prepaid Rent (A)
-
Bal.
5,700
475
Bal.
5,225
Bal.
Bal.
+ Prepaid Advertising (A) 630
210
420
+ Supplies (A) (1)
(2)
Bal.
3,000
Bal.
1,100
(5)
+ Fees Receivable (A) (4)
(3)
- Performance Obligation Liability (L) +
300
600
Bal.
300
Bal.
- Refinishing Fees Revenue (R) +
800
2,500
800
300
3,600
+
Supplies Expense (E)
(3)
-
Advertising Expense(E) -
(2)
210
+
(1)
Bal.
(4)
(5)
Bal.
1,900
+
©Cambridge Business Publishers, 2020
4-102
1,900
Rent Expense (E)
-
475
Financial Accounting, 6th Edition
E3-36. (30 minutes)
LO 2, 3, 6
(All amounts in $ thousands.)
a.
Balance Sheet
Cash
Asset
Transaction
Recognize
inventory
purchases
+
Noncash
Assets
= Liabilities
+1,433,446
Inventory
Income Statement
+
Contrib.
Capital + Earned Capital Revenues
-
Expenses
=
Net
Income
+1,433,446
=
Accounts
Payable
-
Inventory (+A) .........................................................................................................
=
1,433,446*
Accounts payable (+L) .......................................................................................
1,433,446
To recognize inventory purchases.
* Beginning Inv balance + Purchases – Cost of goods sold = Ending Inv. So, $399,795 + Purchases $1,408,848 = $424,393. Thus, purchases = $1,433,446
b.
Beginning compensation payable + Compensation expense – Compensation paid = Ending compensation payable,
so
$37,235 + $650,000 – Payments =
$65,045
Payments = $622,190
c.
The balances of accrued compensation on February 3, 2018 and January 28, 2017 are reported as a current liability.
E3-37. (30 minutes)
LO 5
a.
Dec.
31
31
Service fees revenue (-R)
Interest income (-R)
Retained earnings (+SE)
To close the revenue accounts.
92,500
2,200
Retained earnings (-SE)
Salaries expense (-E)
Advertising expense (-E)
Depreciation expense (-E)
Income tax expense (-E)
To close the expense accounts.
64,700
Solutions Manual, Chapter 4
94,700
41,800
4,300
8,700
9,900
©Cambridge Business Publishers, 2020
4-103
b.
- Retained Earnings (SE) +
64,700
42,700
94,700
72,700
(2)
Bal.
(1)
Bal.
- Service Fees Revenue (R) +
92,500
92,500
0
- Interest Income (R) +
2,200
2,200
0
(1)
(1)
+ Salaries Expense (E) 41,800
41,800
0
+ Depreciation Expense (E) 8,700
8,700
0
Bal.
Bal.
Bal.
Bal.
(2)
Bal.
Bal.
(2)
Bal.
Bal.
Bal.
Bal.
Bal.
Bal.
+ Advertising Expense (E) 4,300
4,300
0
+ Income Tax Expense (E) 9,900
9,900
0
(2)
(2)
E3-38. (15 minutes)
LO 2, 3, 6
a.
Balance Sheet
Transaction
(1) Collect
deposits
from
customers.
Cash Asset
+200,000
Cash
(2) Recognize
income on
completed
customer
orders.
+565,387
Cash
(1)
+
Noncash
Assets
=
=
Liabilities
+200,000
Customer
Deposits
=
-197,998
Customer
Deposits
Income Statement
+
Contrib.
Capital
Cash (+A) ………………………………………………
+ Earned Capital
+763,385
Retained
Earnings
Revenues
-
+763,385
Sales
Revenue
-
Expenses
=
=
=
200,000
Customer deposits* (+L) ………………………
200,000
To record unearned customer deposits.
(2)
Customer deposits* (-L) ..........................................................................................197,998 **
Cash (+A)…………………………………………………
565,387
Sales revenue (+R, +SE) ....................................................................................
763,385
To record sales revenue and recognized deposits earned.
* Also sometimes called Unearned Customer Deposits
** $60,958 + $200,000 – Deposits earned = $62,960; Deposits earned = $197,998.
©Cambridge Business Publishers, 2020
4-104
Financial Accounting, 6th Edition
Net
Income
+763,385
b.
Balance Sheet
Transaction
Cash
Asset
Record inventory
purchases
+
Noncash
Assets
= Liabilities
+330,822
Inventory
Income Statement
+
Contrib.
Capital + Earned Capital Revenues
-
Expenses
=
Net
Income
+330,822
=
Accounts
Payable
-
Inventory (+A) ......................................................................................................
=
330,822
Accounts Payable (+L) ...................................................................................
330,822
To recognize inventory purchases.
BI +Purchases – EI = COGS.
So $162,323 + Purchases - $149,483 = $343,662.
Thus: Cost of acquiring inventory =$330,822
c.
Customer Deposits are reported as a current liability.
E3-39. (40 minutes)
LO 4, 5
a.
SOLOMON CORPORATION
Income Statement
For Year Ended December 31, 2018
Service fees revenue ....................................................................................................................
$71,000
Rent expense ...............................................................................................................................
(18,000)
Salaries expense ..........................................................................................................................
(37,100)
Depreciation expense……………………………….……………..
(7,000)
Net income ..................................................................................................................................
SOLOMON CORPORATION
Statement of Stockholders’ Equity
For Year Ended December 31, 2018
Common
Retained
Stock
Earnings
Balance at December 31, 2017 ....................................
$43,000
$20,600*
$ 8,900
Total Stockholders’
Equity
$63,600
Stock issuance .............................................................
Dividends.....................................................................
(8,000)
(8,000)
Net income...................................................................
_______
8,900
8,900
Balance at December 31, 2018 ....................................
$43,000
$21,500
$64,500
*12,600 + 8,000 The dividend was paid and debited to retained earnings prior to the end of the period.
continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-105
a.
continued
SOLOMON CORPORATION
Balance Sheet
December 31, 2018
Assets
Liabilities
Cash
$ 4,000
Accounts receivable
Equipment
Less:Accumulated
depreciation
6,500
Notes payable
$10,000
Total Liabilities
10,000
$78,000
14,000
Total Assets
64,000
$74,500
Owners’ Equity
Common stock
43,000
Retained earnings
21,500
Total Liabilities and Owners’ Equity
$74,500
b.
1.
2.
3.
4.
Service fees revenue (-R) ....................................................................................... 71,000
Retained earnings (+SE) ...................................................................................
71,000
Retained earnings (-SE) ......................................................................................... 18,000
Rent expense (-E) .............................................................................................
18,000
Retained earnings (-SE) ......................................................................................... 37,100
Salaries expense (-E) ........................................................................................
37,100
Retained earnings (-SE) ......................................................................................... 7,000
Depreciation expense (-E) ...............................................................................
7,000
The cash dividend has already been paid and is already reflected in the adjusted trial balance.
c.
Only the T-accounts affected by closing process are shown here.
Bal.
Bal
+ Depreciation Expense (E) 7,000
7,000
0
Bal.
Bal.
+ Salaries Expense (E) 37,100
37,100
0
(4)
(1)
+
(3)
Bal.
Bal
(2-4)
©Cambridge Business Publishers, 2020
4-106
- Service Fees Revenue (R) +
71,000
71,000
0
Bal.
Bal.
Rent Expense (E) 18,000
18,000
0
- Retained Earnings (SE) +
62,100
12,600
71,000
21,500
(2)
Bal. (1)
Financial Accounting, 6th Edition
Bal.
PROBLEMS
P3-40. (90 minutes)
LO 2, 3, 6
a., b. &d.
+
Cash (A)
Apr. 1
5
18
11,500
1,800
4,900
Bal.
+
2,880
6,100
1,000
675
Apr. 1
2
2
29
100
2,500
30
30
4,945
+
Prepaid Insurance (A)
2,880
2,880
120
2,760
Apr. 1
Unadj. bal.
Adj bal.
+
Apr. 2
Bal.
-
+
Apr. 30
Adj. Bal.
+
Apr. 30
Bal.
-
Equipment (A)
3,100
3,100
5,500
4,000
4,600
Bal.
+
4,900
Apr. 18
Supplies (A)
1,200
1,200
800
400
Apr. 5
Unadj. bal.
Adj. bal.
+
(d) Apr. 30
Apr. 2
Bal.
-
-
Apr. 12
30
Unadj. bal.
(d)
30
9,950
Adj. Bal.
Advertising Expense (E)
100
100
Apr. 12
30
-
(d) Apr. 30
-
Roofing Fees Revenue (R)
5,500
4,000
9,500
450
Supplies Expense (E)
(d) 800
800
Accounts Receivable (A)
+
Accounts Payable (L)
2,100
1,200
3,300
-
Apr. 30
-
-
-
Contract Liability (L)
1,800
(d) 450
1,800
1,350
-
+
Apr. 2
5
Bal.
+
Apr. 5
Unadj. bal
Adj. Bal
Common Stock (SE)
11,500
11,500
+
Apr. 29
Bal.
Trucks (A)
6,100
6,100
Fuel Expense (E)
675
675
+
Apr. 1
Bal.
-
continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-107
a.
continued
+
Insurance Expense (E)
(d) 120
120
Apr. 30
Adj. Bal.
-
+
Apr. 30
Bal.
Wages Expense (E)
2,500
2,500
-
+ Depreciation Expense – Equip. (E) Apr. 30
(d)
35
Adj. Bal.
35
- Accumulated Deprec. – Equip. (XA) +
35
(d) Apr. 30
35
Adj. Bal.
+ Depreciation Expense - Trucks (E) (d) 125
125
- Accumulated Deprec. – Trucks (XA) +
125
(d) Apr. 30
125
Adj. Bal
Apr. 30
Adj. Bal.
b.
Balance Sheet
Transaction
Cash
Asset
4/1
Cash received +11,500
for stock.
Cash
4/1
Purchase
liability
insurance.
4/2
Purchase
truck for
cash.
-6,100
Cash
4/2
Purchase
equipment.
-1,000
Cash
4/5
Purchase
supplies on
account.
4/5
Cash in
advance for
roofing
repairs.
+
=
Liabilities
+
=
-2,880
Cash
Income Statement
Contrib.
Capital
+ Earned Capital
+11,500
Common
Stock
-
Expenses
=
=
=
-
=
+ 6,100 Truck =
-
=
+3,100
Equipment
= +2,100 Accts
Payable
-
=
+ 1,200
Supplies
= +1,200 Accts
Payable
-
=
=
-
=
+5,500 Roofing Fees Revenue
=
-
=
+1,800
Cash
+1,800
Contract
Liability
+5,500 Accts =
Receivable
+4,900
Cash
Revenues
-
+2,880
Prepaid
Insurance
4/12 Bill
customers for
services.
4/18 Collected
cash on
account.
Noncash
Assets
+5,500
Retained
Earnings
-4,900 Accts =
Receivable
Net
Income
+5,500
4/29 Paid cash for -675 Cash
fuel.
=
-675 Retained
Earnings
- +675
Fuel =
Expense
-675
4/30 Paid cash for -100 Cash
ads.
=
-100 Retained
Earnings
- +100
Ad. =
Expense
-100
4/30 Paid cash
wages.
=
-2,500
Retained
Earnings
- +2,500 Wages =
Expense
-2,500
+4,000
Accounts
Receivable
=
+4,000
Retained
Earnings
17,880
=
-2,500
Cash
4/30 Bill
customers for
services.
Totals
4,945
+
5,100
+
11,500
+
6,225
+4,000 Roofing Fees Revenue
9,500
-
3,275
=
+4,000
=
6,225
continued next page
©Cambridge Business Publishers, 2020
4-108
Financial Accounting, 6th Edition
b.
continued
Date 2019
Apr. 1
Description
Debit
Credit
Cash (+A)
Common stock (+SE)
Owner invested cash.
11,500
11,500
1
Prepaid insurance (+A)
Cash (-A)
Paid two-year premium on liability insurance policy.
2,880
2,880
2
Trucks (+A)
Cash (-A)
Purchased used truck for $6,100 cash.
6,100
Equipment (+A)
Cash (-A)
Accounts payable (+L)
Purchased ladders and other equipment, $1,000 down with
$2,100 balance due in 30 days.
3,100
Supplies (+A)
Accounts payable (+L)
Purchased supplies on account.
1,200
2
5
5
12
18
29
30
30
30
Cash (+A)
Contract liability (+L)
Received advance payment for services.
6,100
1,000
2,100
1,200
1,800
1,800
Accounts receivable (+A)
Roofing fees revenue (+R,+SE)
Billed customers for services.
Cash (+A)
Accounts receivable (-A)
Collection on account from customers.
Fuel expense (+E,-SE)
Cash (-A)
Paid truck fuel bill for April.
Advertising expense (+E,-SE)
Cash (-A)
Paid for April newspaper advertising.
5,500
5,500
4,900
4,900
675
675
100
100
Wages expense (+E, -SE)
Cash (-A)
Paid wages.
2,500
Accounts receivable (+A)
Roofing fees revenue (+R, +SE)
Billed customeers for services.
4,000
Solutions Manual, Chapter 4
2,500
4,000
©Cambridge Business Publishers, 2020
4-109
c.
LOUGEE ROOFING SERVICE
Unadjusted Trial Balance
April 30, 2019
Debit
$ 4,945
4,600
1,200
2,880
6,100
3,100
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Trucks
Equipment
Accounts Payable
Contract liability
Common Stock
Roofing Fees Revenue
Fuel Expense
Advertising Expense
Wages Expense
Credit
$ 3,300
1,800
11,500
9,500
675
100
2,500
$26,100
$26,100
d.
Balance Sheet
Transaction
Cash
Asset
+
1. Recognize
one month of
insurance
expense.
Noncash
Assets
-
-120
-
= Liabilities
Income Statement
+
Contrib.
Capital
+
=
-800
-
-
=
-
4. Recognize
depreciation
expense on
equipment.
-
5. Recognize
roofing fees
earned.
-
+125
=
-
+35
-125
=
-450
+450
160
=
-450
+800
+125
-
-120
=
-800
=
-125
+35
=
-35
=
+450
=
-630
Depreciation
Expense
+450
-
Retained Roofing Fees
Earnings
Revenue
+
0
+
-630
450
-
1,080
continued next page
©Cambridge Business Publishers, 2020
4-110
=
Depreciation
Expense
-35
Contract
liability
-
-
Retained
Earnings
=
+120
Net
= Income
Supplies
Expense
Retained
Earnings
Accum.
Depreciation
Expenses
Insurance
Expense
-800
Accum.
Depreciation
-920
-
Retained
Earnings
3. Recognize
depreciation
expense –
Trucks.
+
Revenues
Retained
Earnings
Supplies
0
Earned
Capital
-120
Prepaid
Insurance
2. Recognize
supplies
expense.
Totals
Contra
Assets
Financial Accounting, 6th Edition
d.
continued
Description
Debit
Date 2019
April 30 Insurance expense (+E,-SE)
Credit
120
Prepaid insurance (-A)
120
To record April insurance expense ($2,880/24 months = $120).
30
Supplies expense (+E,-SE)
Supplies (-A)
800
Depreciation expense—Trucks (+E,-SE)
Accumulated depreciation—Trucks (+XA,-A)
125
800
To record April supplies expense ($1,200 − $400 = $800).
30
125
To record April depreciation on trucks.
30
Depreciation expense—Equipment (+E,-SE)
Accumulated depreciation—Equipment (+XA,-A)
35
35
To record April depreciation on equipment.
30
Contract liability (-L)
Roofing fees revenue (+R,+SE)
450
450
To record portion of advance payment earned in April
($1,800/4 = $450).
P3-41. (40 minutes)
LO 2, 3
a.
Cash
Accounts Receivable
Prepaid Rent
Prepaid Insurance
Supplies
Equipment
Accounts Payable
Performance Obligations
Common Stock
Photography Fees Revenue
Wages Expense
Utilities Expense
Solutions Manual, Chapter 4
SNAPSHOT COMPANY
Unadjusted Trial Balance
December 31, 2018
Debit
$2,150
3,800
12,600
2,970
4,250
22,800
Credit
$1,910
2,600
24,000
34,480
11,000
3,420
$62,990
______
$62,990
©Cambridge Business Publishers, 2020
4-111
b.
Balance Sheet
Transaction
1.
2.
3.
4.
5.
6.
7.
8.
Cash
Asset
+
Fees earned
but not
received.
Noncash
Assets
-
+925
-
=
Liabilities
Income Statement
+
Contrib.
Capital
+
=
Fees Receivable
Recognize
depreciatio
n expense
for one
year.
-
Recognize
utilities
expense.
-
+2,280
=
Accum.
Depreciation
Recognize
rent
expense for
year.
-6,300
=
-
-990
-2,730
+
-9,095
+925
-
Retained
Earnings
Photo Fees
Revenue
+2,280
Depreciation
Expense
-
-
+2,600
Retained
Earnings
=
-
+2,600
-
2,280
©Cambridge Business Publishers, 2020
4-112
=
-375
Wages Payable
Retained
Earnings
-1,825
+
0
+
-9,550
+6,300
-
-
-400
= -6,300
= +2,600
+990
=
-990
Insurance
Expense
-2,730
+375
=
Photo
Fees
Revenue
-
Retained
Earnings
=
= -2,280
Rent Expense
-990
=
+400
+925
Utilities
Expense
Retained
Earnings
-
Net
= Income
=
-2,280
-6,300
= -2,600 Performance
Obligations
Expenses
Retained
Earnings
Retained
Earnings
-
0
+925
-400
Supplies
Recognize
wages
expense.
-
Retained
Earnings
Prepaid
Insurance
Recognize
supplies
expense.
Revenues
+400
=
-
Recognize
insurance
expense.
Earned
Capital
Utilities
Payable
Prepaid Rent
Recognize
photo
revenues.
Totals
Contra
Assets
+2,730
= -2,730
Supplies
Expense
-
+375
=
-375
Wages
Expense
3,525
-
13,075
= -9,550
Financial Accounting, 6th Edition
c.
Date 2018
Dec.31
Description
Debit Credit
Fees receivable (+A)
Photography fees revenue (+R, +SE)
925
`
925
To record revenue earned but not billed.
31
Depreciation expense (+E,-SE)
Accum. depreciation—Equipment (+XA, -A)
2,280
2,280
To record depreciation for the year
($22,800/10 years = $2,280).
31
Utilities expense (+E, -SE)
Utilities payable (+L)
400
400
To record estimated December utilities expense.
31
Rent expense (+E, -SE)
Prepaid rent (-A)
6,300
6,300
To record rent expense for the year
($12,600/2 years = $6,300).
31
Performance obligations (-L)
Photography fees revenue (+R, +SE)
2,600
2,600
To record advance payments earned during the year.
31
Insurance expense (+E, -SE)
Prepaid insurance (-A)
990
990
To record insurance expense for the year
($2,970/3 years = $990).
31
Supplies expense (+E,-SE)
Supplies (-A)
2,730
2,730
To record supplies expense for the year
($4,250 − $1,520 = $2,730).
31
Wages expense (+E, -SE)
Wages payable(+L)
375
375
To record unpaid wages at December 31.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-113
d.
+ Cash (A) Unadj. bal.
2,150
Adj. bal.
2,150
+ Accounts Receivable (A) Unadj. bal.
3,800
Adj. bal.
3,800
- Accounts Payable (L) +
1,910
Unadj. bal.
1,910
Adj. bal.
- Performance Obligations (L) +
Dec.31
2,600
Unadj. bal.
0
Adj. bal.
(1) 925
400
(3) Dec.31
925
400
Adj. bal.
+ Fees Receivable (A) Dec. 31
Adj. bal.
- Utilities Payable (L) +
+ Prepaid Rent (A) Unadj. bal.
Adj. bal.
12,600
- Wages Payable (L) +
6,300 (4) Dec.31
6,300
+ Prepaid Insurance (A) -
Unadj. bal.
2,970
Adj. bal.
1,980
Unadj. bal.
Adj. bal.
+ Supplies (A) 4,250
2,730
1,520
Unadj. bal.
Adj. bal.
990
(6) Dec.31
(7) Dec.31
+ Equipment (A) 22,800
22,800
+ Supplies Expense (E) Adj. bal.
(7) 2,730
2,730
Adj. bal.
(6) 990
990
©Cambridge Business Publishers, 2020
4-114
(8) Dec.31
375
Adj. bal.
24,000
Unadj. bal.
24,000
Adj. bal.
- Photo Fees Revenue (R) +
34,480
Unadj. bal
925
(1) Dec.31
2,600
(5) Dec.31
38,005
Adj. bal.
+ Wages Expense (E) Unadj. bal.
11,000
Dec.31
(8) 375
Adj. Bal.
11,375
+ Utilities Expense (E) Unadj. bal.
3,420
Dec.31
(3) 400
Adj. Bal.
3,820
+ Depreciation Expense – Equip. (E) Dec.31
Adj. Bal.
+ Insurance Expense (E) Dec. 31
375
- Common Stock (SE) +
- Accum. Depreciation – Equip. (XA) +
2,280 (2) Dec.31
2,280
Adj. Bal.
Dec. 31
(5) 2,600
(2) 2,280
2,280
+ Rent Expense (E) -
Dec.31
Adj. Bal.
(4) 6,300
6,300
Financial Accounting, 6th Edition
P3-42. (90 minutes)
LO 2, 3, 4, 5, 6
a.
Balance Sheet
Transaction
Cash
Asset
+
1. Recognize
rent expense.
Noncash
Assets
-775
2. To recognize
supplies
expense.
-
Contra
Assets
Prepaid Rent
-1,700
Supplies
-
= Liabilities
Earned
Capital
Revenues
-
Expenses
Net
= Income
=
-775
Retained
Earnings
- +775 Rent =
Expense
=
-1,700
Retained
Earnings
-
=
-74
Retained
Earnings
-
+74
=
Depreciation
Expense
-74
+1,700
Supplies
Expense
=
-775
-1,700
3. To recognize
depreciation
expense.
-
4. To recognize
wages
expense.
-
= +210 Wages
Payable
-210
Retained
Earnings
-
+210 Wages =
Expense
-210
5. To recognize
utilities
expense.
-
=
-300
Retained
Earnings
- +300 Utilities =
Expense
-300
+380
Accounts
Receivable
-
=
=
+380
-2,095
-
=
-2,679
6. To recognize
fees earned.
Totals
0
+
+74
Accum.
Deprec.
Income Statement
Contrib.
+ Capital +
74
+300
Utilities
Payable
=
510
+
0
+
+380
Retained
Earnings
+380
Service
Fees
Revenue
-
-2,679
380
-
3,059
b.
Date 2019
June 30
Description
Debit Credit
Rent expense (+E, -SE)
Prepaid rent (-A)
775
775
To record June rent expense ($3,100/4 months = $775).
30
Supplies expense (+E, -SE)
Supplies (-A)
1,700
1,700
To record June supplies expense (2,520 − $820 = $1,700).
30
Depreciation expense—Equip (+E, -SE)
Accum. depreciation—Equipment (+XA, -A)
74
74
To record June depreciation ($4,440/60 months = $74).
30
Wages expense (+E, -SE)
Wages payable (+L)
210
210
To record unpaid wages at June 30.
30
Utilities expense (+E, -SE)
Utilities payable (+L)
300
300
To record estimated June utilities expense.
30
Accounts receivable (+A)
Service fees revenue (+R, +SE)
380
380
To record fees earned but not billed in June.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-115
c.
+ Cash (A) Unadj. bal
1,180
Adj. bal.
1,180
+ Accounts Receivable (A) Unadj. bal
Jun. 30
Adj. bal.
- Accounts Payable (L) +
760
760
- Wages Payable (L) +
Unadj. bal
Adj. bal.
450
210
(4) Jun.30
(6) 380
210
Adj. bal.
830
- Utilities Payable (L) +
+ Prepaid Rent (A) Unadj. bal
3,100
Adj. bal.
2,325
Adj. bal.
Unadj. bal
Adj. bal.
Unadj. bal
Adj. bal.
775 (1) Jun.30
Adj. bal.
5,300
Unadj. bal.
- Common Stock (SE) +
2,000
Unadj. bal
775
2,000
Adj. bal.
+ Supplies (A) 2,520
1,700 (2) Jun.30
820
+ Equipment (A) 4,440
4,440
Unadj. bal
Jun.30
Adj. bal.
Jun.30
Adj. bal.
(2) 1,700
1,700
©Cambridge Business Publishers, 2020
4-116
- Service Fees Revenue (R) +
4,650
380
5,030
+ Wages Expense (E) 1,020
(4) 210
1,230
+ Utilities Expense (E) (5) 300
300
Unadj. bal
(6) Jun.30
Adj. bal.
+ Depreciation Expense – Equip.(E) -
+ Supplies Expense (E) Adj. bal.
300
(1) 775
- Accum. Depreciation – Equip.(XA) +
74
(3) Jun.30
74
Adj. Bal.
Jun. 30
(5) Jun.30
- Retained Earnings (SE) +
+ Rent Expense (E) Jun.30
300
Jun.30
(3) 74
Adj. bal.
74
Financial Accounting, 6th Edition
d.
MURDOCK CARPET CLEANERS
Income Statement
For Year Ended June 30, 2019
Revenues
Service fees…………………………………….…
$5,030
Expenses
Rent expense……………………………………
$ 775
Wages expense…………………………………
1,230
Supplies expense…………………………………
1,700
Utilities expense………………………………….
300
Depreciation expense……………………………
74
Total expenses……………………………………
4,079
Net income………………………………………… ..........................................................................
$ 951
MURDOCK CARPET CLEANERS
Balance Sheet
June 30, 2019
Assets
Liabilities
Cash
Accounts receivable
Supplies
Prepaid rent
Equipment
Less: Accumulated
depreciation
Total Assets
Solutions Manual, Chapter 4
$ 1,180
830
820
2,325
$ 4,440
74
4,366
$9,521
Accounts payable
Wages payable
$ 760
210
Utilities payable
Total Liabilities
300
1,270
Owners’ Equity
Common stock
Retained earnings
Total Liabilities and Owners’ Equity
2,000
6,251
$9,521
©Cambridge Business Publishers, 2020
4-117
e.
1.
2.
3.
4.
5.
6.
Retained earnings (-SE) ........................................................................................
Rent expense (-E) .............................................................................................
775
Retained earnings (-SE) .........................................................................................
Supplies expense (-E) .......................................................................................
1,700
Retained earnings (-SE) .........................................................................................
Wages expense (-E)..........................................................................................
1,230
Retained earnings (-SE) .........................................................................................
Utilities expense (-E ).......................................................................................
300
Retained earnings (-SE) .........................................................................................
Depreciation expense (-E) ................................................................................
74
Service fees revenue (-R) .......................................................................................
5,030
775
1,700
1,230
300
74
Retained earnings (+SE)...................................................................................
1.
2.
3.
4.
5.
- Retained Earnings (SE) +
5,300
775
1,700
1,230
300
74
5,030
6,251
Bal.
Bal.
+ Rent Expense (E) 775
775
0
1.
Bal.
+ Supplies Expense (E) 1,700
1,700
0
2.
6.
Bal.
+ Wages Expense(E) Bal.
Bal.
1,230
0
1,230
+ Depreciation Expense (E) 74
74
0
©Cambridge Business Publishers, 2020
4-118
5,030
+ Utilities Expense (E) 3.
Bal.
5.
6.
300
0
300
4.
- Service Fees Revenue (R) +
5,030
5,030 Bal.
0
Financial Accounting, 6th Edition
P 3-43. (30 minutes)
LO 3
a.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets
-
Contra
Assets
= Liabilities
Income Statement
+
Contrib.
Capital
+
Earned
Capital
Revenues
-
Expenses
= Net Income
1. Accrue
salary
expense.
-
=
+720
Salaries
Payable
-720
Retained
Earnings
-
+720
Salaries
Expense
=
-720
2. Accrue
interest
expense.
-
=
+200
Interest
Payable
-200
Retained
Earnings
-
+200
Interest
Expense
=
-200
-
=
+900
Retained
Earnings
=
+900
-
=
-400
Retained
Earnings
-
+400
Maint.
Expense
=
-400
-
=
-300
-
+300
Ad.
Expense
=
-300
-
+160
Rent
Expense
=
-160
=
+38
3. Accrue fees
receivable.
+900
Fees
Receivable
4. Accrue
maintenance
expense.
-400
Prepaid
Maintenance
5. Accrue ad.
Expense.
-300
Prepaid
Advertising
6. Accrue rent
expanse.
7. Accrue
interest
revenue.
+38
Totals
0
+
+238
Solutions Manual, Chapter 4
-
Retained
Earnings
-
= +160 Rent
Payable
-160
Retained
Earnings
-
=
+38
Retained
Earnings
-
+2,175 =
Accum.
Depreciation
-2,175
Retained
Earnings
Interest
Receivable
8. Accrued
depreciation
expense.
+900
Printing
Revenue
-
2,175
=
1,080
+
0
+
-3,017
+38
Interest
Revenue
938
-
-
+2,175
Depreciation
Expense
=
-2,175
-
3,955
=
-3,017
©Cambridge Business Publishers, 2020
4-119
b.
Date
Dec
31
31
31
31
31
31
31
31
Description
Debit
Credit
Salaries expense (+E, -SE)
Salaries payable (+L)
To accrue salaries at December 31 ($1,800  2/5 = $720).
720
Interest expense (+E, -SE)
Interest payable (+L)
To accrue interest expense at December 31.
200
Fees receivable (+A)
Printing revenue (+R, +SE)
To record revenue earned but not yet billed.
900
Maintenance expense (+E ,-SE)
Prepaid maintenance (-A)
To record December maintenance expense.
($2,400 / 6 = $400).
400
Advertising expense (+E, -SE)
Prepaid advertising (-A)
To record December advertising expense
($900  1/3 = $300).
300
Rent expense (+E, -SE)
Rent payable (+L)
To accrue one-half month's rent expense
[(400  $0.80)/2 = $160].
160
Interest receivable (+A)
Interest income (+R, +SE)
To accrue interest earned in December.
38
Depreciation expense—Equipment (+E, -SE)
Accum. depreciation—Equipment (+XA)
To record annual depreciation on equipment.
©Cambridge Business Publishers, 2020
4-120
720
200
900
400
300
160
38
2,175
2,175
Financial Accounting, 6th Edition
P3-44. (40 minutes)
LO 4, 5
a.
TRUEMAN CONSULTING INC.
Income Statement
For the Year Ended December 31, 2018
Revenue
Service fees
Expenses
Rent expense
Salaries expense
Supplies expense
Insurance expense
Depreciation expense—Equipment
Interest expense
Total Expenses
Net Income
$58,400
$12,000
33,400
4,700
3,250
720
630
54,700
$ 3,700
TRUEMAN CONSULTING INC.
Statement of Stockholders’ Equity
For the Year Ended December 31, 2018
Common
Stock
Balance at December 31, 2017 .................................... $1,000
Retained
Earnings
$3,305
Total Stockholders’
Equity
$4,305
Stock issuance .............................................................
Dividends ....................................................................
Net income ..................................................................
_____
3,700
3,700
Balance at December 31, 2018 ....................................
$1,000
$7,005
$8,005
TRUEMAN CONSULTING
Balance Sheet
December 31, 2018
Assets
Liabilities
Cash
Accounts receivable
Supplies
Prepaid insurance
Equipment
Less: Accumulated
depreciation
$ 2,700 Accounts payable
3,270 Long-term notes payable
3,060 Total Liabilities
1,500
$ 6,400
1,080
Total Assets
Solutions Manual, Chapter 4
$ 845
7,000
7,845
Owners’ Equity
5,320 Common stock
$15,850
Retained earnings
Total Liabilities and Owners’ Equity
1,000
7,005
$15,850
©Cambridge Business Publishers, 2020
4-121
b.
Date 2018
Dec.
31
31
Description
Debit
Credit
Service fees revenue (-R)
Retained earnings (+SE)
To close the revenue account.
58,400
58,400
Retained earnings (-SE)
Rent expense (-E)
Salaries expense(-E)
Supplies expense (-E)
Insurance expense (-E)
Depreciation expense—Equip (-E)
Interest expense (-E)
To close the expense accounts.
54,700
12,000
33,400
4,700
3,250
720
630
P3-45. (30 minutes)
LO 5
a.
Date 2018
Description
Dec.31 Service fees revenue (-R)
Miscellaneous income (-R)
Retained earnings (+SE)
To close the revenue accounts.
31
Retained earnings (-SE)
Salaries expense (-E)
Rent expense (-E)
Insurance expense (-E)
Depreciation expense (-E)
Income tax expense (-E)
To close the expense accounts.
Debit
Credit
97,200
4,200
101,400
74,800
42,800
13,400
1,800
8,000
8,800
b. After the closing entries are posted, Retained Earnings has a $45,700 credit balance
($19,100 + $26,600 net income).
©Cambridge Business Publishers, 2020
4-122
Financial Accounting, 6th Edition
c.
Wilson Company
Post-Closing Trial Balance
December 31, 2018
Debit
Cash
Accounts Receivable
Prepaid Insurance
Equipment
Accumulated Depreciation
Accounts Payable
Income Tax Payable
Common Stock
Retained Earnings
Credit
$8,500
8,000
3,600
72,000
$12,000
600
8,800
25,000
45,700
$92,100
______
$92,100
P3-46. (30 minutes)
LO 2, 3
a.
Balance Sheet
Transaction
Cash
Asset
+
1. Recognize
Advertising
expense.
Noncash
Assets
=
-400
=
+
Contrib.
Capital +
-1,140
+1,300
-1,300
Wages Payable*
Retained
Earnings
=
+1,000
+
-540
=
Net
Income
-
+400
=
-400
=
-1,300
=
-1,140
-
=
+2,400
-
=
+1,000
=
560
-
-
+1,140
Insurance Expense
-2,400
+2,400
+2,400
Retained
Earnings
Service Fee
Revenue
+1,000
+1,000
=
+1,300
Wages Expense
Performance
Obligations
Rent Receivable
0
Expenses
Retained
Earnings
=
5. Recognize
rent revenue.
-
Advertising
Expense
-1,140
Prepaid
Insurance
4. Recognize
service fees
earned.
Revenues
Retained
Earnings
=
3. Recognize
insurance
expense.
Earned
Capital
-400
Prepaid
Advertising
2. Accrue wage
expense.
Totals
Liabilities
Income Statement
Retained Rental Income
Earnings
=
-1,100
+
0
+
560
3,400
-
2,840
*Assumes wages earned had not been accrued or recognized yet as an expense.
continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-123
a.
continued
Date 2018
Dec. 31
Description
Debit Credit
Advertising expense (+E, -SE)
Prepaid advertising (-A)
400
400
To record advertising expense ($1,200 − $800 = $400).
31
Wages expense (+E, -SE)
Wages payable (+L)
1,300
1,300
To record accrued wages.
31
Insurance expense (+E, -SE)
Prepaid insurance (-A)
1,140
Performance obligations (-L)
Service fee revenue (+R, +SE)
2,400
1,140
To record insurance expense ($3,420 − $2,280 = $1,140).
31
2,400
To recognize unearned fees as earned
($5,400 − $3,000 = $2,400).
31
Rent receivable (+A)
Rental income (R, +SE)
1,000
1,000
To record rent earned but not yet recorded.
b.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets
1. Pay wages of
$2,400.
-2,400
2. Receipt of
$1,000 rent
revenue.
+1,000
-1,000
Cash
Rent
Receivable
Date 2019
Jan. 4
= Liabilities +
=
Cash
Income Statement
Contrib.
Capital +
Earned
Capital
-1,300
-1,100
Wages
Payable
Retained
Earnings
=
Revenues
-
Expenses
-
+1,100
= Net Income
=
-1,100
Wages
Expense
-
=
Description
Debit
Credit
Wages payable (-L)
Wages expense (+E, -SE)
Cash (-A)
1,300
1,100
2,400
To record payment of wages.
4
Cash (+A)
Rent receivable (-A)
1,000
1,000
To record collection of rent.
©Cambridge Business Publishers, 2020
4-124
Financial Accounting, 6th Edition
P3-47. (90 minutes)
LO 2, 3
For part d, the adjusting entries are indicated by the numbers 1-5. The unadjusted trial balance required in part c is
calculated before the adjusting entries are made.
a., b. & d.
6/1
6/2
6/30
6/10
6/28
6/2
6/1
6/1
+ Cash (A) 24,000
4,400
6,400
875
7,800
930
3,600
1,240
520
3,600
1,500
21,535
+ Accounts Receivable (A) 5,800
7,800
5,200
3,200
+ Prepaid Advertising (A) 930
310
620
+ Office Supplies (A) 2,840
1,310
1,530
+ Advertising Expense (E) 310
+ Salaries Expense (E) -
6/12
6/26
2.
6/18
- Accounts Payable (L) +
9,480
6/1
- Salaries Payable (L) +
725
2.
- Contract Liabilities (L) +
3,200
6,400
3,200
5.
6/30
- Common Stock (SE) +
24,000
4.
6/30
- Retained Earnings(SE) +
1,500
1.
1.
+ Supplies Expense (E) 1,310
+ Office Equipment (A) 11,040
- Acc. Depreciation – Off. Equip (XA) +
115
4.
6/1
6/2
6/2
6/12
6/15
6/18
6/26
6/30
6/15
3.
6/1
+ Travel Expense (E) 1,240
3.
+ Depreciation Expense(E) 115
6/2
+ Rent Expense (E) 875
- Service Fees Revenue (R) +
3,600
3,600
725
5,800
5,200
3,200
7,925
14,200
+ Postage Expense (E) 520
Solutions Manual, Chapter 4
6/2
©Cambridge Business Publishers, 2020
4-125
6/10
6/28
5.
b.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets
=
6/1. Investment
for common
stock.
+24,000
Cash
6/1. Purchase of
assets for
cash & on
account.
-4,400
Cash
6/2. Pay rent
$875.
-875
Cash
=
6/2. Purchase
$930 of
advertising in
advance.
-930
Cash
+930 Prepaid =
Advertising
6/2
Signed
research
contract.
=
+ 11,040
Office
Equipment
+2,840
Supplies
+6,400
Cash
6/10. Bill
customers for
services.
Liabilities
=
=
+5,800
Accounts
Receivable
Income Statement
+
Contrib.
Capital
+
Earned
Capital
Revenues -
+24,000
Common
Stock
+9,480
Accounts
Payable
-875
Retained
Earnings
=
+5,800
Retained
Earnings
+5,800
Service
Fees
Revenue
=
-
=
-
=
-
+6,400
Contract
Liabilities
Expenses
+875
Rent
Expense
Net
Income
=
-875
-
=
-
=
-
=
+5,800
6/12. Paid salaries.
-3,600
Cash
=
-3,600
Retained
Earnings
-
+3,600
Salaries
Expense
=
-3,600
6/15. Paid travel
expenses.
-1,240
Cash
=
-1,240
Retained
Earnings
-
+1,240
Travel
Expense
=
-1,240
6/18. Paid postage.
-520
Cash
=
-520
Retained
Earnings
-
+520
Postage
Expense
=
-520
6/26. Paid salaries.
-3,600
Cash
=
-3,600
Retained
Earnings
-
+3,600
Salaries
Expense
=
-3,600
+5,200
Accounts
Receivable
=
+5,200
Retained
Earnings
-
=
+5,200
-7,800
Accounts
Receivable
=
-
=
6/28. Bill
customers
for services.
6/30. Collect
service fees.
+7,800
Cash
6/30. Cash
dividend
paid.
-1,500
Cash
-1,500
Retained
Earnings
+5,200
Service
Fees
Revenue
-
continued next page
©Cambridge Business Publishers, 2020
4-126
Financial Accounting, 6th Edition
P3-47.
b. continued
Date 2019
June
1
Description
Debit
Credit
Cash (+A)
Common stock (+SE)
24,000
24,000
Owner invested cash for common stock.
1
Office equipment (+A)
Office supplies (+A)
Cash (-A)
Accounts payable (+L)
11,040
2,840
4,400
9,480
Purchased equipment and supplies;
$4,400 cash paid with the remainder due in 60 days.
2
Rent expense (+E, -SE)
Cash (-A)
875
875
Paid June rent.
2
Prepaid advertising (+A)
Cash (-A)
930
930
Paid three months' advertising in advance.
2
Cash (+A)
Contract liabilities (+L)
6,400
6,400
Received two months' fees in advance on six-month contract.
10
Accounts receivable (+A)
Service fee revenue (+R, +SE)
5,800
5,800
Billed customers for services.
12
Salaries expense (+E, -SE)
Cash (-A)
3,600
3,600
Paid two weeks' salaries to employees.
15
Travel expense (+E, -SE)
Cash (-A)
1,240
1,240
Paid business travel expenses.
18
Postage expense (+E, -SE)
Cash (-A)
520
520
Paid postage for questionnaire mailing.
26
Salaries expense (+E, -SE)
Cash (-A)
3,600
3,600
Paid two weeks' salaries to employees.
continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-127
P3-47.
b. continued
Date 2019
June
28
Description
Debit
Credit
Accounts receivable (+A)
Service fees revenue (+R, +SE)
5,200
5,200
Billed customers for services.
30
Cash (+A)
Accounts receivable (-A)
7,800
7,800
Collections from customers on account.
30
Retained earnings (-SE)
Cash (-A)
1,500
1,500
Declared and paid dividends.
c.
MARKET-PROBE
Unadjusted Trial Balance
June 30, 2019
Debit
Cash
Accounts Receivable
Office Supplies
Prepaid Advertising
Office Equipment
Accounts Payable
Contract Liabilities
Common Stock
Retained Earnings*
Service Fees Revenue
Salaries Expense
Rent Expense
Travel Expense
Postage Expense
Credit
$21,535
3,200
2,840
930
11,040
$9,480
6,400
24,000
1,500
11,000
7,200
875
1,240
520
$50,880
______
$50,880
* The negative (debit) balance in Retained Earnings reflects the dividend paid.
©Cambridge Business Publishers, 2020
4-128
Financial Accounting, 6th Edition
P3-47.
d.
Balance Sheet
Cash
Asset
Transaction
a.
Recognize
supplies
expense.
+
Noncash
Assets
-
-1,310
-
c.
-
Accrue
depreciation
expense.
-310
30
30
=
+115
-
+725
-725
Salaries
Payable
Retained
Earnings
=
Expenses
-
+1,310
-
=
=
-1,310
=
-725
+115
=
Depreciation
Expense
-115
+725
Salaries
Expense
-115
=
Net
= Income
Supplies
Expense
-
Retained
Earnings
-310
-
+310
=
-3,200
+3,200
+3,200
Retained
Earnings
Service
Fees
Revenue
-
= +3,200
Debit Credit
Supplies expense (+E, -SE)
Office supplies (-A)
To record supplies used during June ($2,840 − $1,530 = $1,310).
Salaries expense (+E, -SE)
Salaries payable (+L)
To record unpaid salaries at June 30.
1,310
1,310
725
725
Depreciation expense—Office equipment (+E, -SE)
Accum. deprec. Off. equipment (+XA, -A)
To record June depreciation ($11,040/96 mo. = $115).
Advertising expense (+E, -SE)
Prepaid advertising (-A)
To record one month's advertising expense.
115
115
310
310
Contract liabilities (-L)
Service fee revenue (+R, +SE)
To record one month's fees earned, received in advance.
-310
Advertising
Expense
Contract
Liabilities
Description
Solutions Manual, Chapter 4
-
Retained
Earnings
-
Date 2019
Revenues
-1,310
Prepaid
Advertising
Recognize
earned
service fees.
30
=
Accum.
Depreciation
d. Recognize
advertising
expense.
30
= Liabilities
Earned
Capital
Retained
Earnings
-
June 30
Income Statement
Contrib.
+ Capital +
Office Supplies
b. Recognize
salaries
expense.
e.
Contra
Assets
3,200
3,200
©Cambridge Business Publishers, 2020
4-129
P3-48. (40 minutes)
LO 3
a.
DELIVERALL
Unadjusted Trial Balance
December 31, 2018
Debit
$ 2,300
5,120
1,680
6,270
42,240
Cash
Accounts Receivable
Prepaid Advertising
Supplies
Equipment
Notes Payable
Accounts Payable
Common Stock
Mailing Fee Revenue
Wages Expense
Rent Expense
Utilities Expense
Credit
$7,500
2,700
9,530
86,000
38,800
6,300
3,020
$105,730
________
$105,730
b
Balance Sheet
Transaction
1. Recognize
advertising
expense.
Cash
Asset
+
Noncash
Assets
-
Contra
Assets
-1,540
Prepaid
Advertis- ing
+
+
Earned
Capital
Revenues
-
Expenses
Net
= Income
=
-1,540
Retained
Earnings
-
+1,540
Advertising
Expense
=
-1,540
=
-5,280
Retained
Earnings
-
+5,280
=
Depreciation
Expense
-5,280
2. Recognize
depreciation
expense.
-
3. Recognize
utilities
expense.
-
= +325 Accts
Payable
-325
Retained
Earnings
- +325 Utilities =
Expense
4. Accrue
wages
expense.
-
=
-1,200
Retained
Earnings
-
+1,200
Wages
Expense
=
-1,200
-
=
-4,750
Retained
Earnings
-
+4,750
Supplies
Expense
=
-4,750
6. Accrue
interest
expense.
-
=
-450
Retained
Earnings
- +450 Interest =
Expense
-450
7. Recognize
rent
expense*.
-
= +430 Accts
Payable
-430
Retained
Earnings
- +430 Rent =
Expense
-430
5. Recognize
supplies
expense.
-4,750
Supplies
+5,280
Accum.
Deprec.
= Liabilities
Income Statement
Contrib.
Capital
+1,200
Wages
Payable
+450
Interest
Payable
*(1/2%  $86,000 = $430). The rent for the year ($6,300 = $525 x 12) has already been recognized in the accounts. See the beginning balances given
in the problem statement.
continued next page
©Cambridge Business Publishers, 2020
4-130
Financial Accounting, 6th Edition
-325
P3-48.
b.
continued
Date 2018
Dec. 31
Description
Debit
Credit
Advertising expense (+E, -SE)
Prepaid advertising (-A)
1,540
1,540
To record 11 months' advertising expense
($1,680  11/12 = $1,540).
31
Depreciation expense (+E, -SE)
Accumulated depreciation (+XA, -A)
5,280
5,280
To record depreciation for the year
($42,240/8 years = $5,280).
.
31
Utilities expense (+E, -SE)
Accounts payable (+L)
325
325
To record estimated December utilities expense.
31
Wages expense (+E, -SE)
Wages payable (+L)
1,200
1,200
To record unpaid wages at December 31.
31
Supplies expense (+E, -SE)
Supplies (-A)
4,750
4,750
To record supplies expense for the year
($6,270 − $1,520 = $4,750).
31
Interest expense (+E, -SE)
Interest payable (+L)
450
450
To record accrual of interest expense at Dec. 31.
31
Rent expense (+E, -SE)
Accounts payable (+L)
430
430
To record additional rent owed under lease
(1/2%  $86,000 = $430).
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-131
P3-48.
c.
Only the T-accounts needed to enter the adjustments are provided.
- Accounts Payable (L) +
2,700
325
430
2.
Bal.
3.
7.
Bal.
+ Prepaid Advertising (A) 1,680
1,540
1.
Bal.
+ Supplies (A) 6,270
4,750
5.
- Accumulated Depreciation–Equip (XA) +
5,280
2.
1.
- Interest Payable (L) +
450
6.
Bal.
7.
+ Rent Expense (E) 6,300
430
- Wages Payable (L) +
1,200
4.
Bal.
4.
+ Wages Expense (E) 38,800
1,200
Bal.
3.
+ Utilities Expense (E) 3,020
325
+ Depreciation Expense (E) 5,280
+ Interest Expense (E) 6.
450
©Cambridge Business Publishers, 2020
4-132
+Advertising Expense (E) 1,540
+ Supplies Expense (E) 5.
4,750
Financial Accounting, 6th Edition
P3-49 (60 minutes)
LO 2, 3, 4, 5, 6
a.
Balance Sheet
Transaction
1. Recognize
rent expense.
2. Recognize
supplies
expense.
Cash
Asset
+
Noncash
Assets
-
-795
-
Contra
Assets
=
Liabilities
+
Contrib.
Capital
+
=
-1,980
Earned
Capital
Revenues
-795
Prepaid
Rent
-
Expenses
=
Net
Income
-
+795
=
-795
=
-1,980
=
-335
=
-560
=
-390
=
+500
Retained
Earnings
-
=
Rent
Expense
-1,980
Supplies
-
+1,980
Retained
Earnings
3. Accrue
depreciation
expense.
-
4. Accrue
wages
payable.
-
5. Recognize
utilities
expense.
-
6. Recognize
service
revenue.
-
+335
=
Supplies
Expense
-335
Accum.
Depreciation
-
Retained
Earnings
=
=
=
+335
Depreciatio
n Expense
+560
-560
Wages
Payable
Retained
Earnings
+390
-390
Accounts
Payable
Retained
Earnings
-500
+500
+500
Service
Contract
Liability
Retained
Earnings
Service
Revenue
Date 2019 Description
Mar. 31
Income Statement
-
+560
Wages
Expense
-
+390
Utilities
Expense
-
Debit Credit
Rent expense (+E, -SE)
Prepaid rent (-A)
795
795
To record March rent expense ($4,770/6 months = $795).
31
Supplies expense (+E, -SE)
Supplies (-A)
1,980
1,980
To record March supplies expense ($3,700−$1,720 = $1,980).
31
Depreciation expense—Equipment (+E, -SE)
Accumulated depreciation—Equipment (+XA, -A)
335
335
To record March depreciation ($36,180/108 months = $335).
31
Wages expense (+E, -SE)
Wages payable (+L)
560
560
To record unpaid wages at March 31.
31
Utilities expense (+E, -SE)
Accounts payable (+L)
390
390
To record estimated March utilities expense.
31
Service contract liability (-L)
Service revenue (+R, +SE)
500
500
To record revenue received in advance that was earned in March.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-133
P3-49.
b.
Not all the T-accounts given are needed to enter the adjustments required. Also, the closing entries required in part
d are referenced by 1c, 2c etc.
- Accounts Payable (L) +
2,510
390
2,900
Bal.
5.
Bal.
Bal.
Bal.
Bal.
Bal.
- Acc Depreciation - Equipment (XA) +
335
3.
6.
-Service Revenue(R) +
6c.
12,860
12,360
500
+ Prepaid Rent (A) 4,770
795
3,975
+ Supplies (A) 3,700
1,980
1,720
- Service Contract Liability (L) +
500
1,000
1.
2.
Bal.
500
Bal.
795
1c.
+ Rent Expense (E) Bal.
6.
1.
795
+ Supplies Expense (E) 2.
3.
5.
1c.
2c.
3c.
4c.
5c.
+Depreciation Expense (E) 335
335
+ Utilities Expense (E) 390
390
- Retained Earnings (SE) +
795
1,980
335
4,460
390
12,860
4,900
©Cambridge Business Publishers, 2020
4-134
3c.
5c.
Bal.
4.
1,980
1,980
2c.
+Wages Expense (E) 3,900
560
4,460
4c.
- Wages Payable (L) +
560
4.
6c.
Financial Accounting, 6th Edition
P3-49.
c.
WHEEL PLACE COMPANY
Income Statement
For Month Ended March 31, 2019
Service revenue…………………………………….……...
$12,860
Expenses:
Utilities expense…………….…………………..…………
$390
Supplies expense…………..………………………………
1,980
Wages expense……………..…………………………..…
4,460
Depreciation expense………………………………….…
335
Rent expense……………………………………………...
795
Net income ………………………………………………...
7,960
$4,900
WHEEL PLACE COMPANY
Balance Sheet
March 31, 2019
Assets
Liabilities
Cash
$ 1,900 Accounts payable
$ 2,900
Accounts receivable
3,820 Wages payable
560
Supplies
1,720 Service contract liability
500
Prepaid rent
3,975
Equipment
Less:Accumulated
depreciation
Total Liabilities
$ 36,180
335
35,845 Owners’ Equity
Common stock
Retained earnings
Total Assets
Solutions Manual, Chapter 4
3,960
$47,260 Total Liabilities and Owners’ Equity
38,400
4,900
$47,260
©Cambridge Business Publishers, 2020
4-135
P3-49.
d.
1c.
2c.
3c.
4c.
5c.
6c.
Retained earnings (-SE).................................................................
Rent expense (-E)......................................................................
795
Retained earnings (-SE).................................................................
Supplies expense (-E) ...............................................................
1,980
Retained earnings (-SE).................................................................
Depreciation expense (-E) ........................................................
335
Retained earnings (-SE).................................................................
Wages expense (-E) ..................................................................
4,460
Retained earnings (-SE).................................................................
Utilities expense (-E) ................................................................
390
795
1,980
335
4,460
390
Service revenue (-R) ..................................................................... 12,860
Retained earnings (+SE) ...........................................................
12,860
The closing journal entries are shown in the T-accounts in part b.
P3-50. (30 minutes)
LO 4, 5
a.
TRAILS, INC.
Income Statement
For the Year Ended December 31, 2018
Revenues
Subscription revenue
Advertising revenue
Total revenues
Expenses
Salaries expense
Printing and mailing expense
Rent expense
Supplies expense
Insurance expense
Depreciation expense
Income tax expense
Total expenses
Net income
$ 168,300
49,700
$218,000
100,230
85,600
8,800
6,100
1,860
5,500
1,600
209,690
$8,310
Continued next page
©Cambridge Business Publishers, 2020
4-136
Financial Accounting, 6th Edition
P3-50.
a.
continued
TRAILS, INC.
Statement of Stockholders’ Equity
For Year Ended December 31, 2018
$25,000
$23,220
Total
Stockholders’
Equity
$48,220
Net income ...............................................................
_____
8,310
8,310
Balance at December 31, 2018 ....................................
$25,000
$31,530
$56,530
Common Stock
Balance at December 31, 2017 ....................................
Retained
Earnings
Stock issuance ..........................................................
Dividends .................................................................
TRAILS, INC.
Balance Sheet
December 31, 2018
Assets
Liabilities
Cash
$3,400
Accounts payable
Accounts receivable
8,600
Subscription liabilities
Supplies
4,200
Salaries payable
Prepaid insurance
Office equipment
Less:
Accum. depreciation
930
3,500
15,600
$66,000
Stockholders' equity
11,000
55,000
Retained earnings
Total stockholders' equity
_______
Solutions Manual, Chapter 4
10,000
Total liabilities
Common stock
Total assets
$ 2, 100
$72,130
$25,000
31,530
56,530
Total liabilities and
stockholders' equity
$72,130
©Cambridge Business Publishers, 2020
4-137
b.
Date 2018
Dec.
31
Description
Debit
Credit
Subscription revenue (-R)
Advertising revenue (-R)
Retained earnings (+SE)
168,300
49,700
218,000
To close the revenue accounts.
31
Retained earnings (-SE)
Salaries expense (-E)
Printing and mailing expense (-E)
Rent expense (-E)
Supplies expense (-E)
Insurance expense (-E)
Depreciation expense (-E)
Income tax expense (-E)
209,690
100,230
85,600
8,800
6,100
1,860
5,500
1,600
To close the expense accounts.
P3-51. (30 minutes)
LO 5
a.
Date 2018
Dec.
31
Description
Debit
Service fee revenue (-R)
Retained earnings (+SE)
Credit
72,500
72,500
To close the revenue account.
31
Retained earnings (-SE)
Wages expense (-E)
Rent expense (-E)
Insurance expense (-E)
Supplies expense (-E)
Advertising expense(-E)
Depreciation expense—Trucks(-E)
Depreciation expense—Equipment (-E)
58,800
29,800
10,200
2,900
5,100
6,000
4,000
800
To close the expense accounts.
b. The balance in Retained Earnings after closing entries are posted is $29,250 credit
($15,550 + $13,700).
©Cambridge Business Publishers, 2020
4-138
Financial Accounting, 6th Edition
c.
MAYFLOWER MOVING SERVICE
Post-Closing Trial Balance
December 31, 2018
Debit
$ 3,800
5,250
2,300
3,000
28,300
Cash
Accounts Receivable
Supplies
Prepaid Advertising
Trucks
Accumulated Depreciation—Trucks
Equipment
Accumulated Depreciation—Equipment
Accounts Payable
Service contract liabilities
Common Stock
Retained Earnings
Credit
$10,000
7,600
2,100
1,200
2,700
5,000
29,250
$50,250
______
$50,250
P3-52. (20 minutes)
LO 2, 3, 6
a.
Balance Sheet
Transaction
1. Recognize
maintenance
expense.
2. Recognize
supplies
expense.
Cash
Asset
+ Noncash Assets =
-1,800
=
-5,200
=
Revenues
Expenses
=
Net
Income
+1,800
=
-1,800
=
-5,200
-
=
+4,500
-
=
+2,800
=
-913
-
Maintenance
Expense
-
Retained
Earnings
-4,500
+4,500
+4,500
Retained
Earnings
Commission
Revenue
+2,800
+2,800
Retained
Earnings
Commission
Revenue
=
=
+913
Rent
Payable
-913
Retained
Earnings
+5,200
Supplies
Expense
Performance
Obligations
Commis- sions
Receivable
Solutions Manual, Chapter 4
Earned
Capital
-5,200
=
5. Rent expense.
Contrib.
Capital +
Retained
Earnings
Supplies
+2,800
+
-1,800
Prepaid
Maintenance
3. Accrue earned
commissions.
4. Earned but
unbilled
commission
fees.
Liabilities
Income Statement
-
+913
Rent
Expense
©Cambridge Business Publishers, 2020
4-139
b.
Balance Sheet
Cash
Asset
Transaction
1. Recognize
maintenance
expense.
+
Noncash
Assets
=
Liabilities
Income Statement
+
Contrib.
Capital +
-2,800
=
Commis-sions
Receivable
Earned
Capital
Revenues
-
=
Net
Income
+1,800
Retained
Earnings
+1,800
Commission
Revenue
-
=
+1,800
-
=
Expenses
+4,600
Accounts
Receivable
2. Recognize rent -913 Cash
expense.
= -913
Rent
Payable
c.
Date 2018
Dec. 31
Description
Debit Credit
Maintenance expense (+E, -SE)
Prepaid maintenance (-A)
1,800
1,800
To record four months' maintenance expense
[($2,700/6)  4 = $1,800].
31
Supplies expense (+E, -SE)
Supplies (-A)
5,200
Performance obligations (-L)
Commission revenue (+R, +SE)
4,500
5,200
To record supplies expense ($8,400 − $3,200 = $5,200).
31
4,500
To transfer fees earned from unearned fees
($8,500 − $4,000 = $4,500).
31
Commissions receivable (+A)
Commission revenue (+R, +SE)
2,800
2,800
To record fees earned but not yet billed.
31
Rent expense (+E, -SE)
Rent payable (+L)
913
913
To record additional 2018 rent
[1%  ($84,000 + $4,500 + $2,800) = $913].
2019
Jan. 10
Accounts receivable (+A)
Commisions receivable (-A)
Commision revenue (+R, +SE)
4,600
2,800
1,800
To record billings on Jan. 10, 2016.
10
Rent payable (-L)
Cash (-A)
913
913
To record payment of contingent rent from 2018.
©Cambridge Business Publishers, 2020
4-140
Financial Accounting, 6th Edition
P3-53. (60 minutes)
LO 3, 4, 5, 6
a.
Balance Sheet
Transaction
1. Cash sales.
Cash
Asset
Noncash
Assets
+145,850
Cash
-
Contra
Assets
= Liabilities
+
Contrib.
Capital +
Earned
Capital
Revenues
-
Expenses
Net
Income
=
-
=
+76,200
Accounts
Payable
3. Recognize
-77,300 Cash
recent
payments on
A/P.
-
=
-77,300
Accounts
Payable
4. Recognize
-24,000 Cash
rent paid and
rent expense.
+200 Prepaid Rent
=
-23,800
Retained
Earnings
-
+23,800
Rent
Expense
=
-23,800
5. Recognize
-12,500 Cash
wage expense
and wages
paid.
-
= +250 Wages
Payable
-12,750
Retained
Earnings
-
+12,750
Wages
Expense
=
-12,750
6. Recognize
depreciation
expense.
-
=
-1,700
Retained
Earnings
-
+1,700
Deprec.
Expense
b.
1.
+2,500
Inventories
+1,700
Accum.
Deprec.
+145,850
+145,850
Retained Sales Revenue
Earnings
=
-
2. Record
inventory
purchased and
used.
2.
+
Income Statement
-73,700
Retained
Earnings
= +145,850
-
+73,700
=
Cost of
Goods Sold
-
=
Cash (+A) ...................................................................................................................................
145,850
Sales revenue (+R,+SE) ............................................................................................................
145,850
Inventories (+A) ........................................................................................................................
2,500
Cost of goods sold (+E, -SE) ....................................................................................................
73,700*
Accounts payable (+L) ..............................................................................................................
76,200
Or, make two separate entries with the same net effect:
Inventory (+A) ...........................................................................................................................
76,200
Accounts payable (+L) ..............................................................................................................
76,200
Cost of goods sold (+E, -SE) ....................................................................................................
73,700*
Inventory (-A) ............................................................................................................................
73,700
*73,700 = 12,000 +76,200 – 14,500.
continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-141
=
-73,700
-1,700
P3-53.
b.
continued
3.
Accounts payable (-L) ...............................................................................................................
77,300*
Cash (-A) ....................................................................................................................................
77,300
*77,300 = 5,200 +76,200 – 4,100.
4. Prepaid rent (+A) .......................................................................................................................
200*
Rent expense (+E, -SE) .............................................................................................................
23,800*
Cash (-A) ...................................................................................................................................
24,000
* $23,800 = $3,800 + ($24,000 ÷12) x (10) and 200 = $24,000 – $3,800 – ($24,000 ÷12) x (10). The rent
expense for the first two months of the year is $3,800. But the rate for March 1, 2019 through February
29, 2020 is $2,000 per month. So, for the last ten months of 2019, the rent expense is $20,000, making
the total rent expense $23,800 for 2019.
5.
6.
Wages expense (+E,-SE) ..........................................................................................................
12,750*
Cash (-A) ....................................................................................................................................12,500
Wages payable (+L) .................................................................................................................. 250
* 12,750 = 12,500 + (350 – 100).
Depreciation expense (+E,-SE) ................................................................................................
1,700
Acc. depreciation – Equipment (+XA, -A) .............................................................................. 1,700
c. & e.
The closing entries required in part e are also included here and indicated by the letter e before the relevent
entry.
Bal.
1.
Bal.
Bal.
Bal.
+ Cash (A) 8,500
145,850
77,300
24,000
12,500
40,550
+ Equipment (A) 7,500
7,500
- Accumulated Depreciation Equip.(XA) +
3,000
1,700
4,700
3.
3.
4.
5.
-Accounts Payable (L)+
5,200
77,300
76,200
4,100
Bal.
2.
Bal.
+ Inventories (A) 12,000
2,500
14,500
Bal.
4.
Bal.
+ Prepaid Rent (A) 3,800
200
4,000
Bal.
6.
Bal.
- Wages Payable (L) +
100
250
350
Bal.
2.
Bal.
-Owners’ Equity (SE)+
23,500
33,900
57,400
Bal.
5.
Bal.
continued next page
©Cambridge Business Publishers, 2020
4-142
Financial Accounting, 6th Edition
Bal.
e.
Bal.
P3-53.
c. & e. continued
-Sales Revenue (R)+
145,850
145,850
0
e.
4.
Bal.
5.
Bal.
+Rent Expense (E)23,800
23,800
0
+Wages Expense (E)12,750
12,750
0
1.
Bal.
2.
Bal.
6.
e.
Bal.
+Cost of Goods Sold (E)73,700
73,700
0
+Depreciation Expense(E)1,700
1,700
0
e.
d. & e.
Part d is easier to complete if the closing entries required in part e are journalized and entered in the T-accounts. The
appropriate T-account entries for part e have been made earlier and indicated by the letter e.
Sales revenue (-R) .....................................................................................................................
145,850
Cost of goods sold (-E) .............................................................................................................
Rent expense (-E) ......................................................................................................................
Wages expense (-E) ..................................................................................................................
Depreciation expense (-E) ........................................................................................................
Owners’ equity ...........................................................................................................................
To close temporary revenue and expense accounts.
73,700
23,800
12,750
1,700
33,900
FISCHER CARD SHOP
Income Statement
For the Year ended December 31, 2019
Sales revenue
Cost of goods sold
Gross profit
Other expenses:
Rent expense
Wages expense
Depreciation expense
Total other expenses
Net income
$145,850
73,700
72,150
$23,800
12,750
1,700
38,250
$33,900
continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-143
e.
e.
P3-53.
d. & e. continued
FISCHER CARD SHOP
Balance Sheets
As of December 31,
2018
2019
$ 8,500
$ 40,550
Inventories
12,000
14,500
Prepaid rent
3,800
4,000
24,300
59,050
Equipment
7,500
7,500
Accumulated depreciation
(3,000)
(4,700)
Equipment, net
4,500
2,800
$ 28,800
$ 61,850
$ 5,200
$ 4,100
Wages payable
100
350
Total liabilities
5,300
4,450
Owners’ equity
23,500
57,400
$ 28,800
$ 61,850
Assets:
Cash
Total current assets
Total assets
Liabilities and owners’ equity:
Accounts payable
Total liabilities and owners’ equity
©Cambridge Business Publishers, 2020
4-144
Financial Accounting, 6th Edition
P3-54. (120 minutes)
LO 2, 3, 4, 5, 6
a. & b. The T-accounts follow the journal entries and the FSET.
Balance Sheet
Transaction
12/1 Investment for
common stock.
12/2. Rent paid in
cash.
12/2
Purchase
supplies on
account.
12/3
Office
equipment
bought for
4,700 cash and
rest on account.
12/8. Paid for supplies.
Cash
Asset
+20,000
Cash
+
Noncash
Assets
=
=
-1,200
Cash
Liabilities
Income Statement
+
Contrib.
Capital
+20,000
Common
Stock
=
+1,080
Supplies
+
Earned
Capital
-1,200
Retained
Earnings
=
=
- +1,200 Rent =
Expense
-
=
-4,700
Cash
+9,500 Office =
Equipment
+4,800
Accounts
Payable
-
=
-1,080
Cash
=
-1,080
Accounts
Payable
-
=
-900
Retained
Earnings
12/20 Received cash
for consulting
services.
+3,000
Cash
=
+3,000
Retained
Earnings
12/28 Paid wages in
cash.
-900 Cash
=
-900
Retained
Earnings
=
+7,200
Retained
Earnings
=
-1,800
Retained
Earnings
12/30 Bill clients for
consulting.
1. Record supplies
expense.
Expenses
+1,080
Accounts
Payable
=
Adjusting Entries
-
=
12/14 Paid wages in -900 Cash
cash.
12/30 Paid cash
dividends.
Revenues
+7,200
Fees
Receivable
-1,800
Cash
Cash
Asset
+
Noncash
Assets
-
Balance Sheet
Contra
LiabiAssets = lities
-370 Supplies -
=
2. Accrue wages
expense.
-
=
3. Record
depreciation
expense.
4. Recognize
accrued
consulting fees.
-
+120
=
Accum.
Deprec.
=
+2,250 Fees Receivable
Solutions Manual, Chapter 4
+270
Wages
Payable
Net
Income
-1,200
- +900 Wages =
Expense
+3,000
Consulting
Revenue
-
=
-900
+3,000
- +900 Wages =
Expense
+7,200
Consulting
Revenue
-
=
-
=
-900
+7,200
Income Statement
Contrib.
+ Capital +
Earned
Capital
Revenues
Net
= Income
-
Expenses
-370
Retained
Earnings
-
+370
Supplies
Expense
=
-370
-270
Retained
Earnings
- +270 Wages =
Expense
-270
-120
Retained
Earnings
+2,250
Retained
Earnings
-
+2,250
Consulting
Revenue
+120
= -120
Depreciation
Expense
= +2,250
©Cambridge Business Publishers, 2020
4-145
P3-54.
c.
Transactions:
Dec.
1
Cash (+A)
Common stock (+SE)
20,000
20,000
Invested $20,000 cash in the business.
2
Rent expense (+E, -SE)
Cash (-A)
1,200
1,200
Paid rent for December.
2
Supplies (+A)
Accounts payable (+L)
1,080
1,080
Purchased various supplies on account.
Dec.
3
Office equipment (+A)
Cash (-A)
Accounts payable (+L)
9,500
4,700
4,800
Purchased $9,500 of office equipment, $4,700 cash
down payment and balance due in 30 days.
8
Accounts payable (-L)
Cash (-A)
1,080
1,080
Payment on account.
14
Wages expense (+E, -SE)
Cash (-A)
900
900
Paid assistant's wages.
20
Cash (+A)
Consulting revenue (+R, +SE)
3,000
3,000
Cash received for services.
28 Wages expense (+E, -SE)
Cash (-A)
900
900
Paid assistant's wages.
30
31
Fees receivable (+A)
Consulting revenue (+R, +SE)
Billed customers for services.
7,200
Retained earnings (-SE)
Cash (-A)
1,800
7,200
1,800
Issued and paid $1,800 in dividends.
©Cambridge Business Publishers, 2020
4-146
Financial Accounting, 6th Edition
P3-54.
b, c, and g.
The adjusting entries requested are included and are denoted by the letter a followed by a number 1 through 5. The
closing entries requested in part g are indicated by the letter g.
+
12/1
12/20
Cash (A)
20,000
3,000
Bal.
12,420
1,200
4,700
1,080
900
900
1,800
12/2
12/3
12/8
12/14
12/28
12/31
12/2
Bal.
+Supplies(A)1,080 370
710
12/3
+Office Equipment (A) 9,500
1a
-Wages Payable(L) +
2a.
270
-Accumulated Depreciation+
Office Equipment (XA)
120
12/8
12/31
g.
- Accounts Payable (L) +
1,080 1,080
4,800
4,800
3a.
Bal.
3a.
-Consulting Revenue(R)+
3,000
7,200
12,450 2,250
Bal.
+Depreciation Expense(E)120 120
0
Solutions Manual, Chapter 4
20,000
12/2
Bal.
+Rent Expense (E) 1,200
1,200
0
g.
12/14
12/28
2a.
Bal.
+ Wages Expense (E) 900 2,070
900
270
0
12/20
12/30
4a.
0
12/30
4a.
Bal.
+Fees Receivable (A)7,200
2,250
9,450
12/2
12/3
Bal.
- Retained Earnings (SE)+
1,800 12,450
3,760
6,890
g.
-Common Stock(SE)+
Bal.
g.
1a.
Bal.
12/1
+ Supplies Expense (E) 370
370
0
©Cambridge Business Publishers, 2020
4-147
g.
g.
g.
P3-54.
d.
Cash
Fees Receivable
Supplies
Office Equipment
Accounts Payable
Common Stock
Retained Earnings (Dividend)
Consulting Revenue
Wages Expense
Rent Expense
e.
RHOADES TAX SERVICES
Unadjusted Trial Balance
December 31, 2018
Debit
$12,420
7,200
1,080
9,500
Credit
$4,800
20,000
1,800
10,200
1,800
1,200
$35,000
______
$35,000
Adjusting Entries:
Date 2018
Dec.
31
Description
Debit
Supplies expense (+E, -SE)
Supplies (-A)
370
Wages expense (+E, -SE)
Wages payable (+L)
270
370
To record December supplies expense ($1,080 − $710).
31
Credit
270
To reflect unpaid wages at December 31.
31
Depreciation expense (+E, -SE)
Accumulated depreciation (+XA, -A)
120
120
To record December depreciation.
31
Fees receivable (+A)
Consulting revenue (+R, +SE)
To record unbilled service revenue (30  $75).
2,250
2,250
Continued next page
©Cambridge Business Publishers, 2020
4-148
Financial Accounting, 6th Edition
P3-54.
e.
continued
Cash
Fees Receivable
Supplies
Office Equipment
Accumulated Depreciation
Accounts Payable
Wages Payable
Common Stock
Retained Earnings
Consulting Revenue
Supplies Expense
Wages Expense
Rent Expense
Depreciation Expense
RHOADES TAX SERVICES
Adjusted Trial Balance
December 31, 2018
Debit
$12,420
9,450
710
9,500
Credit
$120
4,800
270
20,000
1,800
12,450
370
2,070
1,200
120
$37,640
______
$37,640
f.
RHOADES TAX SERVICES
Income Statement
For the Month of December 2018
Revenue
Consulting revenue
Expenses
Wages expense
Rent expense
Supplies expense
Depreciation expense
Total expenses
Net income
$12,450
$ 2,070
1,200
370
120
3,760
$ 8,690
Continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-149
P3-54.
f.
continued
RHOADES TAX SERVICES
Statement of Stockholders’ Equity
For the Month of December 2018
Common
Stock
Balance at December 1, 2018 ......................................
$0
Stock issuance ..........................................................
20,000
Retained Earnings
$0
Total
Stockholders’ Equity
$0
20,000
Dividends .................................................................
(1,800)
(1,800)
Net income ...............................................................
______
8,690
8,690
Balance at December 31, 2018 ....................................
$20,000
$6,890
$26,890
RHOADES TAX SERVICES
Balance Sheet
December 31, 2018
Assets
Cash
Fees receivable
Supplies
Total current assets
Office equipment
Less:
Accum. depreciation
$ 9,500
120
Total assets
©Cambridge Business Publishers, 2020
4-150
Liabilities and Equity
$12,420 Accounts payable
9,450 Wages payable
710 Total liabilities
22,580
Stockholders’ equity
9,380 Common stock
Retained earnings
Total liabilities and stockholders’
$31,960
equity
$ 4,800
270
5,070
20,000
6,890
$31,960
Financial Accounting, 6th Edition
P3-54.
g.
Date 2018
Dec.31
Description
Debit
Consulting revenue (-R)
Retained earnings (+SE)
Credit
12,450
12,450
To close the revenue account.
31
Retained earnings (-SE)
Wages expense (-E)
Rent expense (-E)
Supplies expense (-E)
Depreciation expense (-E)
3,760
2,070
1,200
370
120
To close the expense accounts.
h.
Cash
Fees Receivable
Supplies
Office Equipment
Accumulated Depreciation
Accounts Payable
Wages Payable
Retained Earnings
Common Stock
RHOADES TAX SERVICES
Post-Closing Trial Balance
December 31,2018
Debit
Credit
$12,420
9,450
710
9,500
$32,080
Solutions Manual, Chapter 4
$ 120
4,800
270
6,890
20,000
$32,080
©Cambridge Business Publishers, 2020
4-151
CASES and PROJECTS
C3-55. (90 minutes)
LO 2, 3, 4, 5, 6
a.
1.
Entries in the FSET are first shown for the initial deposits and checks. These are entries 1- 8. Entries a - f are the
adjusting entries that would be made at the end of the three months. The expenditures for rent and salaries are
assumed to have been initially debited to expense accounts.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets
-
Contra
Assets
=
Liabilities
Income Statement
+
Contrib.
Capital
+ Earned Capital
-
Expenses
+50,000
Cash
-
=
2. Collections from
customers.
+81,000
Cash
-
=
3. Bank borrowing.
+10,000
Cash
-
= +10,000
Loans
Payable
4. Rent expense.
-24,000
Cash
-
=
5. Purchased
equipment.
-25,000
Cash
+25,000
Equipment
-
=
-
=
6. Purchased
inventory.
-62,000
Cash
+62,000
Inventory
-
=
-
=
-6,000 Cash
-
=
-6,000 Retained
Earnings
-
+6,000
Salaries
Expense
=
-6,000
-13,000
Cash
-
=
-13,000
Retained
Earnings
-
+13,000
Misc.
Expenses
=
-13,000
-
=
+9,000
Retained
Earnings
+9,000 Sales Revenue
=
+9,000
+12,000
Prepaid Rent
=
+12,000
Retained
Earnings
- -12,000 Rent =
Expense
+12,000
8. Paid other
expenses.
a. Recognize credit
sales.
b. Adjust rent
expense.
+9,000
d. Recognize cost of
goods sold.
+81,000
Retained
Earnings
-41,000
Inventory
-
= +3,000
Salaries
Payable
-
=
-41,000
Retained
Earnings
=
e. Accrue
depreciation
expense.
-
f. Accrue interest
expense*.
-
+1,250
Accumulated
Depreciation
=
+81,000 Sales Revenue
= +81,000
-
-24,000
Retained
Earnings
A/R
c. Accrue salaries
expense.
-
Net
= Income
1. Investment for
common stock.
7. Paid salaries.
+50,000
Investment
Revenues
-3,000 Retained
Earnings
=
- +24,000 Rent = -24,000
Expense
-
+3,000
Salaries
Expense
=
-3,000
- +41,000 Cost =
of Goods
Sold
-41,000
-1,250 Retained
Earnings
-
-1,250
-300 Retained
Earnings
- +300 Interest =
Expense
+1,250
Deprec.
Expense
=
+300
Interest
Payable
*($10,000 x 1% x 3 mos.)
continued next page
©Cambridge Business Publishers, 2020
4-152
=
Financial Accounting, 6th Edition
-300
a.
2.
Journal entries are shown only for the adjustments a-f.
a.
Accounts receivable (+A)
Sales revenue (+R, +SE)
To recognize sales on account.
b.
c.
d.
e.
f.
Prepaid rent (+A)
Rent expense (-E, +SE)
To recognize remaining prepaid rent and correct rent expense.
Salaries expense (+E, -SE)
Salaries payable (+L)
To recognize unpaid salaries earned during September.
Cost of goods sold (+E, -SE)
Merchandise inventory (-A)
To recognize cost of sales; ($62,000 - $21,000).
Depreciation expense (+E, -SE)
Accumulated depreciation (+XA, -A)
To accrue depreciation on the fixtures and equipment
($25,000/60) x (3).
Interest expense (+E, -SE)
Interest payable (+L)
To accrue interest on bank loan assumed taken out 7/1/2019.
($10,000) x (0.12) x (1/4).
Solutions Manual, Chapter 4
9,000
9,000
12,000
12,000
3,000
3,000
41,000
41,000
1,250
1,250
300
300
©Cambridge Business Publishers, 2020
4-153
C3-55.
b.
T-accounts: The opening balances shown are the amounts in the accounts prior to the entry of the adjustments
described in items a through f. The cash balance represents the deposits made, $141,000, less the checks drawn,
$130,000.
+ Cash (A) 11,000
Bal.
Bal.
+ Merchandise Inventory (A) 62,000
41,000
+ Prepaid Rent (A) 12,000
b.
+ Equipment (A) 25,000
Bal.
- Accumulated Deprec.-Equip. (XA) +
1,250
a.
Bal.
+ Rent Expense (E) 24,000
12,000
Bal.
+ Other Expense (E) 13,000
+
Bal.
c.
+
c.
- Owners’ Equity (SE) +
50,000
Bal.
Bal.
a.
b.
d.
+ Cost of Goods Sold (E) 41,000
e.
+ Depreciation Expense (E) 1,250
- Bank Loan Payable (L) +
10,000
Salaries Expense (E)
6,000
3,000
-
Interest Expense (E)
300
-
©Cambridge Business Publishers, 2020
4-154
- Salaries Payable (L) +
3,000
e.
+ Accounts Receivable (A) 9,000
- Sales Revenue (R) +
81,000
9,000
f.
d.
-
Interest Payable (L) +
300
Financial Accounting, 6th Edition
Bal.
f.
C3-55.
c.
SEASIDE SURF SHOP
Income Statement
July 1, 2019 to September 30 ,2019
Sales revenue
Cost of goods sold
Gross margin
Expenses:
Rent expense
Salaries expense
Depreciation expense
Interest expense
Misc. expenses
Net income
$90,000
41,000
49,000
$12,000
9,000
1,250
300
13,000
35,550
$13,450
SEASIDE SURF SHOP
Balance Sheet
September 30, 2019
Assets
Current assets
Cash
Accounts receivable
$11,000
9,000
Inventory
21,000
Prepaid rent
12,000
Total current assets
53,000
Fixtures and equipment, net
Total assets
23,750
$76,750
Liabilities and owners’ equity
Current liabilities
Salaries payable
$3,000
Bank loan payable
10,000
Interest payable
Total current liabilities
Owners’ equity*
Total liabilities and owners’ equity
300
13,300
63,450
$76,750
*$50,000 + $13,450
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-155
C3-55.
d.
Chapter 1 introduced the return on equity ratio as a simple performance measure that can be used to evaluate
how well this new business is doing. The return on equity is calculated as the ratio of net income to average
total equity. In this case, the return on equity for the three-month period was 23.7% = $13,450 / [($50,000+
$63,450)/2]. This is a very good return for a three-month period and equates to 95% annualized. However, the
favorable performance evaluation should be tempered by a few caveats:
(1) Because this business appears to be a sole proprietorship, any “salary” paid to the owner is not deducted
from net income. Instead, cash payments to the owner are treated as dividends (or withdrawals). As a
consequence, any services provided by the owner to the business would not be reflected among the
expenses reported in the income statement, and net income would be overstated.
(2) No expense is reported in the income statement for income taxes. This is consistent with the business being
a sole proprietorship, in which income taxes are levied against the owner as an individual taxpayer. Again,
this makes “net” income appear to be larger than it otherwise might be.
(3) Retail businesses are notoriously seasonal. That is, sales (and profits) fluctuate from season to season. A
business such as this one would likely have its highest sales in the second and third quarters. This
seasonality must be considered when we try to annualize quarterly results like these. Once the business has
operated for a year or two, the owner would likely have a better idea about how seasonal fluctuations affect
sales and returns and would be better able to interpret quarterly performance measures.
(4) Finally, Seaside’s cash position is precarious. The firm has burned through most of the $60 thousand cash raised
to begin the business and is likely to have trouble replacing its inventory as well as paying its bills. Perhaps they
can convince lenders to come to its rescue. If not, the firm will not last another three months.
©Cambridge Business Publishers, 2020
4-156
Financial Accounting, 6th Edition
C3-56. (15 minutes)
LO 2, 3, 6
a.
The following analysis shows how the relevant information affects total assets, liabilities, and owners’ equity of the
firm:
Assets
$88,500
Per original balance sheet
Percentage of debt equity
1. Recognition of insurance expense ($4,500 
1/2 = $2,250)
2. Depreciation correction
$68,500 = $3,425)
3. (No adjustment required)
4. Unbilled services performed
Liabilities
$45,900
51.9%
Owners Equity
$42,600
48.1%
(2,250)
(2,250)
3,425
3,425
6,000
6,000
(5% 
5. Advance consulting fee earned ($11,300  1/2
= $5,650)
6. Recognition of supplies expense ($13,200 −
$4,800 = $8,400)
Revised totals
Percentage of debt and equity
(5,650)
(8,400)
$87,275
______
$40,250
46.1%
5,650
(8,400)
$47,025
53.9%
Revised debt-to-equity ratio: $40,250/$47,025 = 0.86
Original debt-to-equity ratio: $45,900/$42,600 = 1.08
b.
Apparently, the loan agreement has not been violated.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-157
C3-57. (30 minutes)
LO 2, 3
a.
b.
Discussion of this case may consider the following ethical considerations facing Javetz:
1.
Balancing the long-run interests of the firm (securing the international contract) against the short-run
requirement to present accurately the financial data of the company for the current year (recording $150,000
adjusting entry).
2.
Compromising the confidentiality of the contract negotiations (by disclosing the contract negotiations to
additional persons) versus compromising her professional responsibilities (by omitting a significant year-end
adjusting entry).
3.
Jeopardizing her position with the firm (by revealing information the president wants kept secret) versus risking
possible future legal action by parties relying on the firm's financial statements (by not revealing a significant
accrued expense and accrued liability in the financial statements).
Discussion of this case should also note that outside auditors frequently access confidential data and disclosing the
contract negotiations to the auditor should not represent a significant breach of confidentiality. Perhaps Javetz can
achieve a reasonable solution to her dilemma by suggesting that an adjusting entry be recorded and described in
very general terms (for example, labeling the liability Payable to Consultants and indicating it is for marketing
research and development). Such an adjustment would permit the disclosure of the significant liability without
revealing important details to anyone else within or outside the company.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
C3-58. (30 minutes)
LO 2, 3, 4, 6
a. - d.
FSET:
Balance Sheet
Transaction
a1. Recognize
prepaid
catalog costs.
Cash
Asset
Noncash
Assets
=
-62,550
+62,550
=
Cash
Prepaid
Catalog Costs
a2. Advertising
credits
received.
+ 849
-62,138
+
=
-336
+849
=
+849
-
Expenses
= Net Income
-
=
-
=
+849
=
-62,138
=
-336
-
Retained
Earnings
=
=
+62,138
Catalog
Expenses
-336
-
Retained
Earnings
Cash
d2. Recognize
sales using
gift
certificates.
Revenues
-62,138
Advertising
Credits
Receivable
+19,175
+
Earned
Capital
Retained
Advertising
Earnings Credits Revenue
Prepaid
Catalog Costs
Recognize
expiration of
advertising
credits.
d1. Sales of gift
certificates.
Liabilities
Advertising
Credits
Receivable
b. Recognize
advertising
expense.
c.
+
Income Statement
Contrib.
Capital
+336
Expense:
Expiration of
Advertising
Credits
+19,175
-
=
-
=
Gift
Certificate
Liability
=
- 18,230
Gift
Certificate
Liability
+18,230
+18,230
Retained Gift Certificate
Earnings
Revenues
Continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-159
+18,230
a. – d.
continued
Journal Entries:
a1.
a2.
b.
c.
Prepaid catalog costs (+A)
Cash (-A)
To record catalog printing costs.
62,550
62,550
Advertising credits receivable (+A)
Advertising credits revenue (+R, +SE)
To recognize advertising credits earned.
849
849
Catalog expense (+E, -SE)
Prepaid catalog costs (-A)
To regognize catalog expense ($3,894 + $62,550 - $4,306).
62,138
62,138
Advertising credit expiration expense (+E, -SE)
Advertising credits receivable (-A)
To record the expiration of advertising credits ($21 + $849 - $534).
336
336
Advertising credits expire either because they were used to advertise or, if there was a time limitation to their
use, the time limit expired.
d1.
d2.
Cash (+A)
Customer deposits (+L)
To recognize gift certificates sold but not yet redeemed.
19,175
Gift certificate liability (-L)
Gift certificate revenues (+R, +SE)
To recognize revenues based on redeemed gift certificates
($6,108 +$19,175 - $7,053).
18,230
©Cambridge Business Publishers, 2020
4-160
19,175
18,230
Financial Accounting, 6th Edition
2
Chapter 4
Reporting and Analyzing Cash Flows
Learning Objectives – coverage by question
MiniExercises
Exercises
Problems
Cases
and Projects
LO1 – Explain the purpose of the
statement of cash flows and classify cash
transactions by type of business activity:
operating, investing and financing
21 - 24, 29
LO2 – Construct the operating activities
section of the statement of cash flows
using the direct method.
25, 27, 30, 31
34, 38, 41, 43,
44
47, 49, 51, 53
59
LO3 – Reconcile cash flows from
operations to net income and use the
indirect method to compute operating
cash flows.
21, 23,
25 - 29
35, 42, 44
45, 46, 48,
50 - 56
57, 58, 59
LO4 – Construct the investing and
financing activities sections of the
statement of cash flows.
21, 24
36 - 40, 42
46, 48,
50 - 56
57, 58, 59
32, 33, 35, 43
46, 48, 50, 52,
55, 56
59
LO5 – Compute and interpret ratios that
reflect a company’s liquidity and
solvency using information reported in
the statement of cash flows.
LO6 – Appendix 4A: Use a spreadsheet
to construct the statement of cash flows.
Solutions Manual, Chapter 4
58, 59
55
©Cambridge Business Publishers, 2020
4-161
QUESTIONS
Q4-1.
Cash equivalents are short-term, highly liquid investments that firms acquire with temporarily idle cash
to earn interest on these excess funds. To qualify as a cash equivalent, an investment must (1) be easily
convertible into a known cash amount and (2) be close enough to maturity so that its market value is not
sensitive to interest rate changes (generally, investments with initial maturities of three months or less).
Three examples of cash equivalents are treasury bills, commercial paper, and money market funds.
Q4-2.
Cash equivalents are included with cash in a statement of cash flows because the purchase and sale of
such investments are considered to be part of a firm's overall management of cash rather than a source or
use of cash. Similarly, as statement users evaluate cash flows, it may matter very little to them whether
the cash is on hand, deposited in a bank account, or invested in cash equivalents.
Q4-3.
Operating activities
Inflow: Cash received from customers
Outflow: Cash paid to suppliers
Investing activities
Inflow: Sale of equipment
Outflow: Purchase of stocks and bonds
Financing activities
Inflow: Issuance of common stock
Outflow: Payment of dividends
Q4-4.
a.
b.
c.
d.
e.
f.
g.
h.
Investing; outflow.
Investing; inflow.
Financing; outflow.
Operating (direct method, not shown separately under indirect method); inflow.
Financing; inflow.
Operating (direct method, not shown separately under indirect method); inflow.
Operating (direct method, not shown separately under indirect method); outflow.
Operating (direct method, not shown separately under indirect method); inflow.
©Cambridge Business Publishers, 2020
4-162
Financial Accounting, 6th Edition
Q4-5.
This is a noncash investing and financing event. It must be reported in a supplementary schedule to the
statement of cash flows.
Q4-6.
Noncash investing and financing transactions are disclosed as supplemental information to a statement of
cash flows because a secondary objective of cash flow reporting is to present information about investing
and financing activities. Noncash investing and financing transactions, generally, affect future cash
flows. Issuing bonds payable to acquire equipment, for example, requires future cash payments for
interest and principal on the bonds. On the other hand, converting bonds payable into common stock
eliminates future cash payments related to the bonds. Knowledge of these types of events, therefore,
should be helpful to users of cash flow data who wish to assess a firm's future cash flows.
Q4-7.
A statement of cash flows helps external users assess the amount, timing, and uncertainty of future cash
flows to the enterprise. These assessments help users evaluate their own future cash receipts from their
investments in, or loans to, the firm. A statement of cash flows shows the periodic cash effects of a firm's
operating, investing, and financing activities. Distinguishing among these different categories of cash
flows helps users compare, evaluate, and predict cash flows. With cash flow information, creditors and
investors are better able to assess a firm's ability to settle its liabilities and pay its dividends. Over time,
the statement of cash flows permits users to observe and analyze management's investing and financing
policies. A statement of cash flows also provides information useful in evaluating a firm's financial
flexibility (which is its ability to generate cash to respond to unanticipated needs and opportunities).
Q4-8.
The direct method presents the net cash flow from operating activities by showing the major categories
of operating cash receipts and cash payments (such as cash received from customers, cash paid to
employees and suppliers, cash paid for interest, and cash paid for income taxes). The indirect (or
reconciliation) method, in contrast, presents the net cash flow from operating activities by applying a
series of adjustments to the accrual net income to convert it to a cash basis.
Q4-9.
Under the indirect method, depreciation is added to net income because, as a noncash expense, it was
deducted in computing net income. Adding depreciation to net income, therefore, eliminates it from the
cash-basis income amount. Amortization and depletion expenses are handled the same way.
Q4-10.
Under the indirect method, the $98,000 cash received from the sale of the land will appear in the cash
flows from investing activities section of the statement of cash flows. In addition, the $28,000 gain from
the sale will be deducted from net income as one of the adjustments made to determine the net cash flow
from operating activities.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-163
Q4-11.
Net income
Add (deduct) items to convert net income to cash basis
Depreciation expense
Subtract change in accounts receivable
Subtract change in inventory
Add change in accounts payable
Add change in income tax payable
Net cash provided by operating activities
$ 88,000
6,000
13,000
(9,000)
(3,500)
1,500
$ 96,000
Q4-12.
The separate disclosures required for a company using the indirect method in the statement of cash flows
are (1) cash paid during the year for interest (net of amount capitalized) and for income taxes, (2) all
noncash investing and financing transactions, and (3) the policy for determining which highly liquid,
short-term investments are treated as cash equivalents.
Q4-13.
The statement of cash flows will show a positive net cash flow from operating activities if operating cash
receipts exceed operating cash payments. This could happen, for example, if noncash expenses (such as
depreciation and amortization) exceed the net loss. It would also happen if operating cash receipts exceed
sales by more than the loss or if operating cash payments are less than accrual expenses by more than the
loss (or some combination of these events).
Q4-14.
Sales
+ Accounts receivable decrease
= Cash received from customers
$925,000
14,000
$939,000
Q4-15.
Wages expense
+ Wages payable decrease
= Cash paid to employees
$ 86,000
1,100
$ 87,100
Q4-16.
+
=
Advertising expense
Prepaid advertising increase
Cash paid for advertising
$ 43,000
1,600
$ 44,600
Q4-17.
Under the direct method, the $5,100 cash received from the sale of equipment will appear in the cash
flows from investing activities section of the statement of cash flows.
Q4-18.
The separate disclosures required for a company using the direct method in the statement of cash flows
are (1) a reconciliation of net income to net cash flow from operating activities, (2) all noncash investing
and financing transactions, and (3) the policy for determining which highly liquid, short-term
investments are treated as cash equivalents.
©Cambridge Business Publishers, 2020
4-164
Financial Accounting, 6th Edition
Q4-19.
The operating cash flow to current liabilities ratio is calculated by dividing net cash flow from operating
activities by average current liabilities. This ratio is a measure of a firm's ability to liquidate its current
liabilities.
Q4-20.
The operating cash flow to capital expenditures ratio is calculated by dividing a firm's cash flow from
operating activities by its annual capital expenditures. A ratio below 1.00 means that the firm's current
operating activities are not providing enough cash to cover the capital expenditures. A ratio above 1.0 is
normally considered a sign of financial strength.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-165
MINI EXERCISES
M4-21. (5 minutes)
LO 1, 3, 4
a.
b.
c.
d.
e.
Positive adjustment
Negative adjustment
Positive adjustment
Positive adjustment
Negative adjustment
M4-22. (10 minutes)
LO 1
a.
b.
c.
d.
e.
f.
g.
Cash flow from an operating activity.
Cash flow from an investing activity.
Cash flow from an investing activity.
Cash flow from an operating activity.
Cash flow from a financing activity.
Cash flow from a financing activity.
Cash flow from an investing activity.
M4-23. (15 minutes)
LO 1, 3
1
2
3
4
5
6
7
8
9
10
11
GENERAL MILLS, INC.
Selected Items from the Cash Flow Statement
Long-term debt repayments
Change in receivables
Depreciation and amortization
Change in prepaid expenses
Dividends paid
Stock-based compensation
Cash received from sales of assets and businesses
Net earnings
Change in accounts payable
Proceeds from common stock issued
Purchases of land, buildings and equipment
©Cambridge Business Publishers, 2020
4-166
Financing
Operating
Operating
Operating
Financing
Operating
Investing
Operating
Operating
Financing
Investing
Financial Accounting, 6th Edition
M4-24. (10 minutes)
LO 1, 4
a.
(3) Cash flow from a financing activity.
b.
(1) Cash flow from an operating activity.
c.
(4) Noncash investing and financing activity.
d.
(1) Cash flow from an operating activity.
e.
(1) Cash flow from an operating activity.
f.
(5) None of the above (a change in the composition of cash and cash equivalents).
M4-25. (30 minutes)
LO 2, 3
a.
Income Statement
Balance Sheet
+
Accts.
Receivable
(1)
+
+507,400 +
(2)
+91,500 +
+
(3)
Transaction
+
Contrib.
Capital +
=
+
+
+507,400
+507,400 -
=
+507,400
=
+
+
+91,500
+91,500 -
=
+91,500
+
+ –320,100 =
+
+
–320,100
-
+320,100 =
–320,100
(4)
+
+ –63,400 =
+
+
–63,400
-
+63,400 =
–63,400
(5)
+
+ +351,600 =
+351,600 +
+
-
=
(6)
-47,700 +
+ +47,700 =
+
+
-
=
(7)
+483,400 +
–483,400 +
=
+
+
-
=
(8)
–340,200 +
+
=
–340,200 +
+
-
=
(9)
-172,300 +
+
=
+
+
-172,300
-
+172,300 =
-172,300
Total
+14,700 +
+24,000 + +15,800 =
+11,400 +
+
+43,100
-
+555,800 =
+43,100
+
Inventories
=
Accts.
Payable
Earned
Capital
Revenue
+598,900
-
Expenses
= Net Income
Net income was €43,100 (from the net income column), and cash flow from operating activities was €14,700
(from the cash column).
b.
c.
Cash
Asset
1.
2.
3.
Accounts receivable increased by €24,000,
Inventories increased by €15,800, and
Accounts payable increased by €11,400.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-167
d.
The accounting equation is kept with every entry, so it is kept for the totals over the period.
Cash flow + change in accounts receivable + change in inventory
= Change in accounts payable + net income.
This relationship can be presented in the following indirect method cash flow from operating activities.
Net income
€ 43,100
- Change in accounts receivable
–24,000
- Change in inventories
–15,800
+ Change in accounts payable
+11,400
Cash flow from operating activities
€ 14,700
M4-26. (15 minutes –INDIRECT METHOD)
LO 3
Net income
Add (deduct) items to convert net income to cash basis
Add back depreciation
Subtract gain on sale of investments
Subtract change in operating assets:
Accounts receivable
Inventory
Prepaid rent
Add change in operating liabilities:
Accounts payable
Income tax payable
Net cash provided by operating activities
©Cambridge Business Publishers, 2020
4-168
$ 45,000
8,000
(9,000)
(9,000)
(6,000)
2,000
4,000
(2,000)
$ 33,000
Financial Accounting, 6th Edition
M4-27. (30 minutes)
LO 2, 3
a.
Balance Sheet
Transaction
Cash
Asset
(1)
(2)
+46,200
(3)
+
Accts.
Receivable
+
+
+769,200
+
-
+
+
+
+
+
Contr.
+
Capital
=
+
+
+769,200
+769,200 -
=
+769,200
-
=
+
+
+46,200
+46,200 -
=
+46,200
-
=
+
+
–526,700
-
+526,700 =
–526,700
-
=
+
+
-
=
-
=
+
+
-
=
-
=
+
+
-
+117,900 =
+
-
=
+
+
-
=
=
+
+
–122,800
-
+122,800 =
–122,800
+
+
-23,000
-
+23,000 =
-23,000
+
+
+25,000
+815,400 -
+790,400 =
+25,000
(4)
–149,100
+
+
(5)
–521,600
+
+
+
+
(6)
–724,100
Prepaid
Rent
+149,100
–117,900
-
Accum.
Deprec.
=
(7)
+724,100
+
(8)
–122,800
+
+
-
+
+
-
+23,000
=
-
+23,000
=
(9)
Total
–23,200
+
+45,100
Income Statement
+
+31,200
Wages
Payable
+526,700
–521,600
+5,100
Earned
Capital
Revenue
–117,900
-
Expenses
= Net Income
b.
Net income was $25,000 (from the net income column), and cash flow from operating activities was –$23,200
(from the cash column).
c.
1.
2.
3.
4.
d.
The accounting equation is kept with every entry, so it is kept for the totals over the period.
Accounts receivable increased by $45,100,
Prepaid rent increased by $31,200,
Accumulated depreciation (a contra-asset) increased by $23,000 due to depreciation expense and
Wages payable increased by $5,100.
Cash flow + change in accounts receivable + change in prepaid rent
– change in accumulated depreciation
= Change in wages payable + net income.
This relationship can be presented in the following indirect method cash flow from operating activities.
Net income
$ 25,000
+ Depreciation expense
23,000
– Change in accounts receivable
–45,100
– Change in prepaid rent
–31,200
+ Change in wages payable
+5,100
Cash flow from (used in) operating activities
($ 23,200)
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-169
–117,900
M4-28. (15 minutes—INDIRECT METHOD)
LO 3
Net loss
Add (deduct) items to convert net loss to cash basis
Add back depreciation
Subtract change in operating assets:
Accounts receivable
Inventory
Prepaid expenses
Add change in operating liabilities:
Accounts payable
Accrued liabilities
Net cash provided by operating activities
$(21,000)
8,600
(9,000)
(3,000)
(3,000)
4,000
(2,600)
$ 4,000
Weber Company's 2018 operating activities provided $4,000 cash. The dividend paid to shareholders affects cash flows
from financing activities.
M4-29. (20 minutes)
LO 1, 3
A “+” indicates that the amount is added and a “-“ indicates that it is subtracted when preparing the cash flow statement
using the indirect method.
NORDSTROM, INC.
Consolidated Statement of Cash Flows – Selected Items
1
Decrease in accounts receivable
Operating
+-
2
Capital expenditures
Investing
-
3
Proceeds from long-term borrowings
Financing
+
4
Increase in deferred income tax net liability
Operating
+
5
Principal payments on long-term borrowings
Financing
-
6
Increase in merchandise inventories
Operating
-
7
Increase in prepaid expenses and other assets
Operating
-
8
Proceeds from issuances under stock compensation plans
Financing
+
9
Increase in accounts payable
Operating
+
10
Net earnings
Operating
+
11
Payments for repurchase of common stock
Financing
-
12
Increase in accrued salaries, wages and related benefits
Operating
+
13
Cash dividends paid
Financing
-
14
Depreciation and amortization expenses
Operating
+
©Cambridge Business Publishers, 2020
4-170
Financial Accounting, 6th Edition
M4-30. (15 minutes—DIRECT METHOD)
LO 2
a.
–
=
Rent expense
Prepaid rent decrease
Cash paid for rent
$ 60,000
(2,000)
$ 58,000
Balance Sheet
Transaction
Cash
Begin
Balance
Make rent
payment
+
+
-X
+
Record
rent
expense
+
End
Balance
+
Noncash
Assets
10,000
Prepaid
Rent
+X
Prepaid
Rent
-60,000
Prepaid
Rent
8,000
Income Statement
= Liabilities
+
Contr.
+
Capital
Earned
Surplus
=
+
+
-
=
=
+
+
-
=
=
+
+
=
+
+
Revenue
-
-60,000
Retained
Earnings
-
Expenses
+60,000
Rent
Expense
-
=
=
Net
Income
-60,000
=
X must equal $58,000 to make the FSET balance.
b.
–
=
Interest income
Interest receivable increase
Cash received as interest
$ 16,000
(700)
$ 15,300
Balance Sheet
Transaction
Cash
Begin
Balance
Record
interest
income
Receive
interest
payment
End
Balance
+
+
+
+X
Noncash
Assets
3,000
Interest
Receivable
+16,000
Interest
Receivable
Income Statement
= Liabilities
+
Contr.
+
Capital
=
+
+
=
+
+
Earned
Surplus
+16,000
Retained
Earnings
Revenue
-
Expenses
=
-
=
+16,000
Interest income
=
+
-X
=
+
+
-
=
+
3,700
=
+
+
-
=
Net
Income
+16,000
X must equal $15,300 to make the FSET balance.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-171
c.
Cost of goods sold
+ Inventory increase
+ Accounts payable decrease
= Cash paid for merchandise purchased
$ 98,000
3,000
4,000
$105,000
Balance Sheet
Income Statement
+
Noncash
Assets
=
Liabilities
+
Contr.
+
Capital
Begin
Balance
+
19,000
Inventory
=
11,000
Accounts
Payable
+
+
-
=
Purchase
inventory
+
+X
=
+X
+
+
-
=
=
-Y
Accounts
Payable
+
+
-
=
Transaction
Pay
supplier
Recognize
Cost of
Goods
Sold
End
Balance
Cash
-Y
+
+
-98,000
Inventory
=
+
22,000
=
7,000
+
+
+
+
Earned
Surplus
-98,000
Retained
Earnings
Revenue
-
-
Expenses
98,000
Cost of
Goods
Sold
-
=
=
Net
Income
-98,000
=
To make the inventory account work properly, X (purchases) must equal $101,000. If purchases were $101,000,
then Y (payments to suppliers) must equal $105,000.
M4-31. (15 minutes—DIRECT METHOD)
LO 2
Operating cash flow + change in operating assets
= net income + change in operating liabilities
or
Net income - change in operating assets + change in operating liabilities
= operating cash flow
–
=
Effect of sales on net income
Change in accounts receivable
Effect of customers on cash
+
=
Effect of cost of goods sold on net income
Change in inventory
Change in accounts payable
Effect of merchandise purchases on cash
$825,000
(11,000)
$814,000
($550,000)
(13,000)
(6,000)
($569,000)
Chakravarthy Company received $814,000 in cash from its customers and paid $569,000 in cash to its suppliers.
©Cambridge Business Publishers, 2020
4-172
Financial Accounting, 6th Edition
EXERCISES
E4-32. (20 minutes)
LO 5
(All dollar amounts in millions)
a. Merck: $6,447/$17,909 = 0.360
Pfizer: $16,470/$30,771 = 0.535
Abbott Labs: $5,570/$7,786 = 0.715
Johnson & Johnson: $21,056/$28,412 = 0.741
b.
Merck: $6,447 – $1,888 = $4,559
Pfizer: $16,470 – $1,956 = $14,514
Abbott Labs: $5,570 – $1,135 = $4,435
Johnson & Johnson: $21,056 – $3,279 = $17,777
c.
None of the firms has sufficient cash flow to cover their current liabilities although none of the ratios is
alarmingly low. The industry ratios shown in Chapter 5, show that only Merck is below median. Pfizer and
Johnson & Johnson are the larger of these companies and have relatively more cash left over after capital
expenditures to consider using on other activities that could strengthen the firm’s operating or financial position.
But all four have significant free cash flow that could be invested or returned to shareholders in the form of
dividends or stock repurchases. Given that these firms are of different sizes and have different research
program success, it is difficult to generalize further.
E4-33. (20 minutes)
LO 5
(All dollar amounts in millions)
a. Wal-Mart: $28,337/$72,725 = 0.390
Coca-Cola: $6,995/$26,863 = 0.260
ExxonMobil: $30,066/$52,705 = 0.570
b.
Wal-Mart: $28,337 – ($10,051 – $378) = $18,664
Coca-Cola: $6,995 – ($1,675 – $104) = $5,424
ExxonMobil: $30,066 – ($15,402 – $3,103) = $17,767
c.
All three companies are producing much more cash than needed for capital expenditures. All of them are
returning substantial amounts of cash to shareholders through dividends and share repurchases. ExxonMobil
appears to be in the best position with respect to OCFCL, but it is lower than the industry average reported in
Chapter 5. Wal-Mart and Coca-Cola have lower ratios, and are also below the average ratio for their industries.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-173
E4-34. (30 minutes—INDIRECT METHOD)
LO 2
MASON CORPORATION
Statement of Cash Flows
For Year Ended December 31, 2018
Cash flows from operating activities
Cash received from customers
Cash received as interest
Cash paid to employees and suppliers
Cash paid as income taxes
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 bonds payable
Acquisition of treasury stock
Payment of dividends
Net cash provided by financing activities
Net decrease in cash
Cash at beginning of year
Cash at end of year
$194,000
6,000
(148,000)
(11,000)
$ 41,000
40,000
(89,000)
(49,000)
30,000
(10,000)
(16,000)
4,000
(4,000)
16,000
$ 12,000
E4-35. (15 minutes—INDIRECT METHOD)
LO 3, 5
a.
Net income
$113,000
Add (deduct) items to convert net income to cash basis
Accounts receivable increase
Inventory decrease
Prepaid insurance increase
Accounts payable increase
Wages payable decrease
Net cash provided by operating activities
b.
(5,000)
6,000
(1,000)
4,000
(2,000)
$115,000
$115,000/[($31,000 + $29,000)/2] =3.83
©Cambridge Business Publishers, 2020
4-174
Financial Accounting, 6th Edition
E4-36. (15 minutes–INVESTING ACTIVITIES)
LO 4
The basic approach here is to use the beginning and ending balances and the additional information to reconstruct
what must have happened during 2018. Begin by setting up the T-accounts for property, plant and equipment with
the beginning and ending balances.
+
Beg. balance
Ending balance
Property, plant and
equipment at cost (A)
1,000
-
-
Accumulated
depreciation (XA)
1,200
+
350
Beg. balance
390
Ending balance
At this point in the book, we know four entries that can affect these two accounts – (1) acquisitions using cash, (2)
acquisitions without cash (other financing), (3) disposals, and (4) depreciation expense. The journal entries for these
entries are given below, with amounts given in the problem filled in.
(1)
(2)
(3)
(4)
Property, plant and equipment at cost (+A)
Cash (-A)
To record purchase of property, plant and equipment with cash.
300
Property, plant and equipment at cost (+A)
Mortgage payable (+L)
To record purchase of property, plant and equipment with financing.
100
Cash (+A)
Accumulated depreciation (-XA, +A)
Property, plant and equipment at cost (-A)
Gain on equipment disposal (+R, +SE)
To record sale of used equipment.
100
Y
Depreciation expense (+E, -SE)
Accumulated depreciation (+XA, -A)
To record depreciation expense.
300
100
X
20
Z
Z
continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-175
The three unknowns in the journal entries correspond to the three questions in the problem. We begin by putting the
journal entry amounts into the T-accounts.
+
Beg. balance
(1)
(2)
(3)
Ending balance
Property, plant and
equipment at cost (A)
1,000
300
100
-
X
1,200
-
Accumulated
depreciation (XA)
+
350
Beg. balance
Z
390
(3)
(4)
Ending balance
Y
a.
The PPE at cost account will only balance if the value X equals 200. So, the original cost of the used equipment
that was sold is €200. We can put that amount in the T-account (so it balances) and also in Journal entry (3).
b.
Now, looking at journal entry (3), we see that there is only one unknown left – the depreciation that had
accumulated on the used equipment. In order for the entry to balance (with debits equal to credits), the
accumulated depreciation must have been 120 (= Y). Cost of 200 and accumulated depreciation of 120 would
produce a net book value of 80, so when Meubles Fischer sold it for 100, they recorded a gain of 20 on the
disposal.
c.
Back at the Accumulated depreciation T-account, we can fill in the entry for (3), leaving only the depreciation
expense to determine for entry (4). Knowing that the disposal reduced the contra-asset by 120, and that the
contra-asset increased by 40 over the year, we can infer than the depreciation expense must have been €160 (= Z).
©Cambridge Business Publishers, 2020
4-176
Financial Accounting, 6th Edition
E4-37. (15 minutes—INVESTING ACTIVITIES)
LO 4
The basic approach here is to use the beginning and ending balances and the additional information to reconstruct
what must have happened during 2018. Begin by setting up the T-accounts for property, plant and equipment with
the beginning and ending balances.
+
Beg. balance
Ending balance
Property, plant and
equipment at cost (A)
175
-
-
Accumulated depreciation
(XA)
78
Beg. balance
83
Ending balance
183
+
At this point in the course, we know four entries that can affect these two accounts – (1) acquisitions using cash, (2)
acquisitions without cash (other financing), (3) disposals, and (4) depreciation expense. The journal entries for these
entries are given below, with amounts given in the problem filled in.
(1)
(2)
(3)
(4)
Property, plant and equipment at cost (+A)
Cash (-A)
To record purchase of property, plant and equipment with cash.
28
28
Property, plant and equipment at cost (+A)
Mortgage payable (+L)
To record purchase of property, plant and equipment with financing.
0
Cash (+A)
Accumulated depreciation (-XA, +A)
Loss on equipment disposal (+E, -SE)
Property, plant and equipment at cost (-A)
To record sale of used equipment.
Z
Y
5
Depreciation expense (+E, -SE)
Accumulated depreciation (+XA, -A)
To record depreciation expense.
17
0
X
17
continued next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-177
The three unknowns in the journal entries correspond to the three questions in the problem. We begin by putting the
journal entry amounts into the T-accounts.
+
Beg. balance
(1)
(2)
(3)
Ending balance
Property, plant and
equipment at cost (A)
175
28
0
-
X
183
-
Accumulated depreciation
(XA)
78
Y
17
83
+
Beg. balance
(3)
(4)
Ending balance
a.
The PPE at cost account will only balance if the value X equals 20. So, the original cost of the used equipment
that was sold is £20. We can put that amount in the T-account (so it balances) and also in Journal entry (3).
b.
The accumulated depreciation account will only balance if the value Y equals 12. So, the accumulated
depreciation on the used equipment sold must be £12, and that amount can be entered into transaction (3) above.
c.
Now, looking at journal entry (3), we see that there is only one unknown left – the amount of cash received
from disposal of the used equipment. In order for the entry to balance (with debits equal to credits), the cash
amount must have been £3 million (= Z). Cost of 20 and accumulated depreciation of 12 would produce a net
book value of 8, so when Kasznik Ltd. sold it for 3, they recorded a loss of 5 on the disposal.
©Cambridge Business Publishers, 2020
4-178
Financial Accounting, 6th Edition
E4-38. (30 minutes)
LO 2, 4
a.
The analysis from the chapter shows that
Cash flow
(payments)
+
Change in inventory
=
Change in
accounts payable
+
Net income (COGS
expense)
X
+
-57
(=8,899-8,956)
=
+1,484
(=12,484-11,000)
+
-89,052
The solution to this is that X = -$89,052 + 57 + 1,484 = -$87,511. So, the payments to suppliers reduced cash by
$87,511 million in fiscal year 2017.
b.
The net property and equipment account decreased by $693 million (=$13,642 – $14,335). Depreciation expense
would have decreased this balance by $1,545 million in fiscal year 2017, so the net investment must have been $852
million (=-$693 + $1,545) to result in the ending balance of $13,642 million.
c.
With the beginning balance of $27,684 million in retained earnings, net earnings of $4,078 would have increased
retained earnings to $31,762 million. But the ending balance in retained earnings is $30,137 million, so Walgreens
Boots must have paid $1,625 million in dividends (=$31,762 - $30,137).
E4-39. (15 minutes)
LO 4
a.
Cash flows from investing activities will show:
Purchase of stock investments
Sale of stock investments
b.
Cash flows from financing activities will show:
Issuance of bonds
Retirement of bonds
Solutions Manual, Chapter 4
$ (80,000)
59,000
$130,000
(131,000)
©Cambridge Business Publishers, 2020
4-179
E4-40. (20 minutes)
LO 4
a.
The net increase in property and equipment, cost was $821,989 (= $98,190,992 - $97,369,003). Expenditures should
have increased this by $1,182,854, and the non-cash transaction another $239,382. Therefore, the original cost of
the property and equipment sold must have been $600,247 (= $1,182,854 + $239,382 - $821,989).
Depreciation expense should have increased the accumulated depreciation account by $3,876,111, but the account
increased by only $3,275,864. The accumulated depreciation on the property and equipment sold must account for
the difference, making it $600,247 (=$3,876,111 - $3,275,864).
b.
The book value of the property and equipment sold was zero (=$600,247 – $600,247), and the reported gain on sale
of the property and equipment was $56,446. Therefore, the cash proceeds on the sale of these fully-depreciated
assets must have been $56,446!
c.
Cash (+A)
Accumulated depreciation (-XA, +A)
Property and equipment, cost (-A)
Gain on sale of property and equipment (+R, +SE)
d.
$ 56,446
600,247
$ 600,247
56,446
Retained earnings increased by $1,688,643 (= $20,738,143 – 19,049,500), and net income was $3,184,803, which
would increase retained earnings. The difference would be accounted for by cash dividends paid to shareholders,
and the amount is $1,496,160 ($3,184,803 - $1,688,643). The dividends paid are approximately equal to previous
years even though earnings are considerably higher, demonstrating that companies are reluctant to change dividends
as earnings fluctuate up and down..
E4-41. (20 minutes—DIRECT METHOD)
LO 2
a.
+
=
Advertising expense
Prepaid advertising increase
Cash paid for advertising
$ 62,000
4,000
$ 66,000
+
=
Income tax expense
Income tax payable decrease
Cash paid for income taxes
$ 29,000
2,200
$ 31,200
–
–
=
Cost of goods sold
Inventory decrease
Accounts payable increase
Cash paid for merchandise purchased
$180,000
(5,000)
(2,000)
$173,000
b.
c.
©Cambridge Business Publishers, 2020
4-180
Financial Accounting, 6th Edition
E4-42.
LO 3, 4
HOSKINS CORPORATION
Statement of Cash Flows
Year ended December 31, 2018
Cash Flows from Operations:
Net income
Adjustments:
Add back Depreciation
– Change in Accounts Receivable
– Change in Inventory
– Change in Prepaid Expenses
+ Change in Accounts Payable
+ Change in Income Taxes Payable
Cash Flows from Operating Activities
Cash Flows from Investing:
Purchases of Equipment
Proceeds from Disposal of Equipment
$ 700
350
(900)
(100)
250
400
(100)
$ 600
(1,200)
600
Cash Flows from Investing Activities
Cash Flows from Financing:
Dividends Paid
Increase in Short-term Debt
Decrease in Long-term Debt
Cash Flows from Financing Activities
Net Change in Cash
Beginning Cash Balance
Ending Cash Balance
Solutions Manual, Chapter 4
(600)
(250)
1,500
(1,000)
250
250
300
$ 550
©Cambridge Business Publishers, 2020
4-181
E4-43. (30 minutes—DIRECT METHOD)
LO 2, 5
a.
–
=
Sales
Accounts Receivable Increase
Cash Received from Customers
$750,000
(5,000)
$745,000
–
–
=
Inventory Decrease
Accounts Payable Increase
Cash Paid for Merchandise Purchased
(6,000)
(4,000)
$460,000
+
=
Wages Expense
Wages Payable Decrease
Cash Paid to Employees
$110,000
2,000
$112,000
+
=
Insurance Expense
Prepaid Insurance Increase
Cash Paid for Insurance
$ 15,000
1,000
$ 16,000
Cost of Goods Sold
Cash Flows from Operating Activities
Cash Received from Customers
Cash Paid for Merchandise Purchased
Cash Paid to Employees
Cash Paid for Rent
Cash Paid for Insurance
Net Cash Provided by Operating Activities
b.
$470,000
$745,000
$460,000
112,000
42,000
16,000
630,000
$115,000
$115,000/[($31,000 + $29,000)/2] =3.83
E4-44. (15 minutes)
LO 2, 3
1.
True
---
2.
False
$25
3.
False
$10
4.
False
$0
©Cambridge Business Publishers, 2020
4-182
Changing financial reporting depreciation will change net income, but
not cash flows. Changing tax depreciation will change cash flows, but
not net income. This issue is examined later in Chapter 10.
Financial Accounting, 6th Edition
PROBLEMS
P4-45. (20 minutes)
LO 3
Cash flows from operating activities
Net income ...............................................................................................................................
$135,000
Adjustments to reconcile net income to operating cash flows
Add back depreciation expense .........................................................................................
$25,000
Gain on sale of assets
(5,000)
Subtract changes in:
Accounts receivable ..........................................................................................................(10,000)
Prepaid expenses ............................................................................................................... 3,000
Add changes in:
Accounts payable .............................................................................................................. 6,000
Wages payable................................................................................................................... (4,000)
Net cash provided from operating activities .............................................................................
Solutions Manual, Chapter 4
15,000
$150,000
©Cambridge Business Publishers, 2020
4-183
P4-46. (45 minutes—INDIRECT METHOD)
LO 3, 4, 5
a.
Cash, December 31, 2018 .......................................................................................... $11,000
Cash, December 31, 2017 ..........................................................................................
5,000
Cash increase during 2018 ......................................................................................... $ 6,000
b.
STATEMENT OF CASH FLOWS (INDIRECT METHOD)
WOLFF COMPANY
Statement of Cash Flows
For Year Ended December 31, 2018
Net Cash Flow from Operating Activities
Net Income
Add (Deduct) Items to Convert Net Income to Cash Basis
Depreciation
Accounts Receivable Increase
Inventory Increase
Prepaid Insurance Decrease
Accounts Payable Decrease
Wages Payable Increase
Income Tax Payable Decrease
Net Cash Provided by Operating Activities
Cash Flows from Investing Activities
Purchase of Plant Assets
Cash Flows from Financing Activities
Issuance of Bonds Payable
Payment of Dividends
Net Cash Provided by Financing Activities
Net Increase in Cash
Cash at Beginning of Year
Cash at End of Year
c.
$56,000
17,000
(9,000)
(30,000)
2,000
(3,000)
3,000
(1,000)
$35,000
(55,000)
55,000
(29,000)
26,000
6,000
5,000
$11,000
(1) $35,000/(($23,000 + $24,000)/2) = 1.49
(2) $35,000/$55,000 = 0.64
Wolff’s cash flow ratios indicate that, while the company has sufficient cash flow to cover its current
obligations, it must rely on external financing to pay for capital expenditures.
©Cambridge Business Publishers, 2020
4-184
Financial Accounting, 6th Edition
P4-47. (30 minutes)
LO 2
a.
Adjustments to Convert Income Statement Items to Operating Activity Cash Flows
Net income
=
$ 56,000
Sales
revenue
–Cost of
goods sold
–Wage
expenses
–Insurance
expense
–Depreciation
expense
–Interest
expense
+Gains
–Losses
–Income tax
expense
$635,000
–430,000
–86,000
–8,000
–17,000
–9,000
+0
–0
–29,000
Adjustments:
+Depreciation
expense
Add back
depreciation
expense
+17,000
–Gains
0
Subtract (add)
non-operating
gains (losses)
+Losses
0
Subtract the
change in
operating assets
(operating
investments)
–Change in
accounts
receivable
–
Change in
inventory
–Change in
prepaid
insurance
-9,000
-30,000
-(-2,000)
Add the change
in operating
liabilities
(operating
financing)
Cash
from
operations
$ 35,000
=
Receipts
from
customers
$626,000
b.
+Change in
accounts
payable
+Change in
wages
payable
+Change in
income tax
payable
+(-3,000)
+3,000
+(-1,000)
–Payments
for merchandise
–Payments
for
Wages
–Payments
for
insurance
(zero)
–Payments
for
interest
(zero)
(zero)
–Payments
for
income tax
-83,000
-6,000
0
-9,000
+0
–0
–30,000
-463,000
Computing cash flows from operating activities using the direct method provides additional detail about the specific
cash flows that occurred during the period. For example, the indirect method does not reveal that Wolff paid
$463,000 for merchandise during 2018, or $83,000 for wages. Because this detail is missing, the FASB requires
supplemental disclosure of two specific (and important) cash payments – interest and taxes – if the indirect method
is used.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-185
P4-48. (45 minutes—INDIRECT METHOD)
LO 3, 4, 5
a.
Cash, December 31, 2018
Cash, December 31, 2017
Cash increase during 2018
$49,000
28,000
$21,000
b.
Statement of Cash Flows (Indirect Method)
ARCTIC COMPANY
Statement of Cash Flows
For Year Ended December 31, 2018
Net Cash Flow from Operating Activities
Net Loss
$ (42,000)
Add (Deduct) Items to Convert Net Loss
to Cash Basis
Depreciation
Gain on Sale of Land
Accounts Receivable Decrease
Inventory Decrease
Prepaid Advertising Decrease
Accounts Payable Decrease
Interest Payable Increase
Net Cash Used 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 Bonds Payable
Purchase of Treasury Stock
Net Cash Provided by Financing Activities
Net Increase in Cash
Cash at Beginning of Year
Cash at End of Year
22,000
(25,000)
8,000
6,000
3,000
(14,000)
6,000
$ (36,000)
70,000
(183,000)*
(113,000)
200,000
(30,000)
170,000
21,000
28,000
$ 49,000
* The sum of the increase in PPE assets account ($138,000) and the book value of the land sold ($45,000).
c.
- $36,000/(($23,000 + $31,000)/2) = -1.33
- $36,000/$183,000 = -0.20
Arctic’s operating cash flows are negative, primarily because the firm reported a net loss for the year. As a
consequence, its cash flow ratios indicate insufficient cash flows to fund operations and capital expenditures.
©Cambridge Business Publishers, 2020
4-186
Financial Accounting, 6th Edition
P4-49. (30 minutes)
LO 2
a.
Adjustments to Convert Income Statement Items to Operating Activity Cash Flows
Net income
(loss)
–$ 42,000
=
Sales
revenue
$728,000
–Cost of
goods sold
–534,000
–Wage
expenses
–190,000
–Advertising
expense
–31,000
–Depreciation
expense
–22,000
–Interest
expense
–18,000
+Gains
–Losses
+25,000
–0
Income tax
expense
–0
Adjustments:
Add back
depreciation
expense
+Depreciation
expense
+22,000
–Gains
–25,000
Subtract (add)
non-operating
gains (losses)
+Losses
0
Subtract the
change in
operating
assets
(operating
investments)
–Change in
accounts
receivable
-(-8,000)
Add the change
in operating
liabilities
(operating
financing)
Cash
from
operations
–$ 36,000
=
b.
Receipts
from
customers
$736,000
–Change in
prepaid
advertising
-(-3,000)
–Change in
inventory
-(-6,000)
+Change in
accounts
payable
+(-14,000)
+change in
wages
payable
+0
–Payments for
merchandise
–542,000
–Payments
for Wages
–190,000
+Change in
interest
payable
+6,000
–Payments
for
advertising
–28,000
(zero)
0
–Payments
for
interest
–12,000
+Change in
income tax
payable
+0
(zero)
(zero)
+0
–0
–Payments
for income
tax
–0
Computing cash flows from operating activities using the direct method provides additional detail about the specific
cash flows that occurred during the period. For example, the indirect method does not reveal that Arctic paid
$542,000 for merchandise during 2018, or $28,000 for advertising. Because this detail is missing, the FASB
requires supplemental disclosure of two specific (and important) cash payments – interest and taxes – if the indirect
method is used.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-187
P4-50. (50 minutes—INDIRECT METHOD)
LO 3, 4, 5
a.
Cash, December 31, 2018 ...............................................................................
Cash, December 31, 2017 ...............................................................................
Cash increase during 2018 ..............................................................................
b.
STATEMENT OF CASH FLOWS (INDIRECT METHOD)
$27,000
18,000
$ 9,000
DAIR COMPANY
Statement of Cash Flows
For Year Ended December 31, 2017
Net Cash Flow from Operating Activities
Net Income
Add (deduct) items to convert net income
to cash basis
Depreciation
Amortization of intangible assets
Loss on bond retirement
Accounts receivable increase
Inventory decrease
Prepaid expenses increase
Accounts payable increase
Interest payable decrease
Income tax payable decrease
Net cash provided by operating activities
Cash flows from investing activities
Sale of equipment
Cash flows from financing activities
Retirement of bonds payable
Issuance of common stock
Payment of dividends
Net cash used by financing activities
Net increase in cash
Cash at beginning of year
Cash at end of year
©Cambridge Business Publishers, 2020
4-188
$ 85,000
22,000
7,000
5,000
(5,000)
6,000
(2,000)
6,000
(3,000)
(2,000)
$119,000
17,000
(125,000)
24,000
(26,000)
(127,000)
9,000
18,000
$ 27,000
Financial Accounting, 6th Edition
c.
(1) Supplemental cash flow disclosures
Cash paid for interest ...................................................................................................................
Cash paid for income taxes ..........................................................................................................
*
Interest expense
+ Interest payable decrease
Cash paid for interest
$10,000
3,000
$13,000
†
Income tax expense
+ Income tax payable decrease
Cash paid for income taxes
$36,000
2,000
$38,000
(2) Schedule of noncash investing and financing activities
Issuance of bonds payable to acquire equipment ........................................................................
d.
(1)
(2)
(3)
$ 13,000*
$ 38,000†
$ 60,000
$119,000/[($42,000 + $41,000)/2] = 2.87.
The firm did not spend any cash on capital investments. The firm did issue debt for equipment, but this is not
a capital expenditure.
$119,000 + $17,000 = $136,000
P4-51. (45 minutes)
LO 2, 3, 4
a.
Cash received from customers was $176,594. They report an increase in accounts receivable, net of $941. So, based
on the information in the statement of cash flows, total revenues would be $176,594 + $941 = $177,535
b.
Add net income and subtract dividends as follows: $38,983 + $6,623 - $2,049 = $43,557.
c.
Stock-based compensation is deducted as an expense when computing net income. However, it is compensation paid
in the form of common stock, not cash. Since it doesn’t decrease cash, it is added back to net income when
reconciling net income to cash flow from operations.
d.
Some of CVS’ operations occur in Canada and some of its cash transactions are transacted in Canadian dollars. When
the financial statements are prepared, the Canadian dollars must be translated into U.S. dollars so that the statements
are presented in a common unit of currency. The amount listed in the cash flow statement reflects the small effect that
this conversion had on the cash flows and cash balances of CVS.
e.
CVS used its cash flow from operating activities as follows:
• It invested over $2.9 billion, mostly in new property, plant and equipment and acquisitions;
• It spent over 6.7 billion on financing transactions, mostly to repurchase stock and pay dividends, net of amounts
borrowed;
• It decreased its cash balance by almost 1.7 billion.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-189
P4-52. (50 minutes—INDIRECT METHOD)
LO 3, 4, 5
a.
Cash and cash equivalents, December 31, 2018 ..................................................................
Cash and cash equivalents, December 31, 2017 ..................................................................
Cash and cash equivalents decrease during 2018 ................................................................
$19,000
25,000
$ 6,000
b.
RAINBOW COMPANY
Statement of Cash Flows
For Year Ended December 31, 2018
Cash flow from operating activities
Net income
Add (deduct) items to convert net income to cash basis
Depreciation
Patent amortization
Loss on sale of equipment
Gain on sale of investments
Accounts receivable increase
Inventory increase
Prepaid expenses increase
Accounts payable increase
Interest payable increase
Income tax payable decrease
Net cash provided by operating activities ………
Cash flows from investing activities
Sale of investments
Purchase of land
Improvements to building
Sale of equipment
Net cash used by investing activities
Cash flows from financing activities
Issuance of bonds payable
Issuance of common stock
Payment of dividends
Net cash provided by financing activities ………
Net decrease in cash and cash equivalents
Cash and cash equivalents at beginning of year ….
Cash and cash equivalents at end of year
©Cambridge Business Publishers, 2020
4-190
$ 90,000
39,000
7,000
5,000
(3,000)
(10,000)
(26,000)
(4,000)
4,000
1,000
(2,000)
$101,000
60,000
(90,000)
(95,000)
14,000
(111,000)
30,000
24,000
(50,000)
4,000
(6,000)
25,000
$ 19,000
Financial Accounting, 6th Edition
c.
(1)
(2)
d.
(1)
(2)
(3):
Supplemental Cash Flow Disclosures
Cash paid for interest
Cash paid for income taxes
$ 12,000*
$ 46,000†
* Interest expense
- Interest payable increase
Cash paid for interest
$13,000
(1,000)
$12,000
† Income tax expense
+ Income tax payable decrease
Cash paid for income taxes
$44,000
2,000
$46,000
Schedule of noncash investing and financing activities
Issuance of preferred stock to acquire patent
$ 25,000
$101,000/[($34,000 + $31,000)/2] = 3.11.
$101,000/$185,000 = 0.55.
$101,000 – ($90,000 + $95,000 - $14,000) = -$70,000
P4-53. (35 minutes)
LO 2, 3, 4
a.
Cash and cash equivalents, December 31, 2018 ………..
Cash and cash equivalents, December 31, 2017 ………..
Cash and cash equivalents decrease during 2018 ……..
$19,000
25,000
$ 6,000
b.
RAINBOW COMPANY
Statement of Cash Flows (Direct Method)
For Year Ended December 31, 2018
Cash flows from operating activities
Cash received from customers …………………………
Cash received as dividends ……………………………..
Cash paid for merchandise purchased ………………..
Cash paid for wages and other operating expenses …
Cash paid for interest ……………………………………..
Cash paid for income taxes ………………………………
Net cash provided by operating activities ……………..
$740,000
15,000
462,000
134,000
12,000
46,000
Cash flows from investing activities
Sale of investments ………………………………………..
Purchase of land ……………………………………………
Improvements to building …………………………………
Sale of equipment …………………………………………..
Net cash used by investing activities …………………...
$755,000
(654,000)
101,000
60,000
(90,000)
(95,000)
14,000
(111,000)
Table continued on next page
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-191
b. Table continued
RAINBOW COMPANY
Statement of Cash Flows (Direct Method)
For Year Ended December 31, 2018
Cash flows from financing activities
Issuance of bonds payable ……………………………….
Issuance of common stock ……………………………….
Payment of dividends ………………………………………
Net cash provided by financing activities ………………
30,000
24,000
(50,000)
4,000
Net decrease in cash and cash equivalents ………………..
Cash and cash equivalents at beginning of year ………….
Cash and cash equivalents at end of year ………………….
c.
(1)
(2)
(6,000)
25,000
$ 19,000
Reconciliation of net income to net cash flow from operating activities
Net income
Add (deduct) items to convert net income to cash basis
Depreciation
Patent amortization
Loss on sale of equipment
Gain on sale of investments
Accounts receivable increase
Inventory increase
Prepaid expenses increase
Accounts payable increase
Interest payable increase
Income tax payable decrease
Net cash provided by operating activities
39,000
7,000
5,000
(3,000)
(10,000)
(26,000)
(4,000)
4,000
1,000
(2,000)
$101,000
Schedule of noncash investing and financing activities
Issuance of preferred stock to acquire patent
$ 25,000
©Cambridge Business Publishers, 2020
4-192
$ 90,000
Financial Accounting, 6th Edition
P4-54. (30 minutes)
LO 3, 4
Operating cash flow + change in operating assets
= net income + change in operating liabilities,
or
Net income - change in operating assets + change in operating liabilities
= operating cash flow
a.
Apple’s adjustment for accounts receivable is ($2,093) million. This adjustment represents minus the change in
receivables, so Apple’s operations would have caused accounts receivable to go up by $2,093 million.
($ millions)
Net sales …………………………………………………………………
- Change in accounts receivable ……………………………………
-2,093
+ Change in deferred revenue
-626
Cash collected from customers ……………………………………..
b.
c.
$226,515
($ millions)
- Cost of goods sold …………………………………………………….
- Change in inventories ……………………………………………..
+ Change in accounts payable ………………………………………
($141,048)
-2,723
+9,618
- Cash paid for purchases of inventories ……………………………
($134,153)
($ billions)
Property, plant and equipment, ending balance …………………
$33.8
- Purchases of property, plant and equipment …………………
(12.5)
+ Book value of PPE assets sold …………………………………...
none
+ Depreciation of property, plant and equipment ………………
8.2
Property, plant and equipment, beginning balance ……………
d.
$229,234
$29.5
Stock-based compensation expense is deducted when calculating net income similar to cash compensation. The
only difference is that the compensation is paid in shares of stock (or stock options) instead of cash. Because stockbased compensation does not require the payment of cash, it is treated as a noncash expense, much like depreciation,
and added back to net income when the indirect method is used in the cash flow statement. Generally speaking,
compensation cost is classified as part of operating activities whether or not the compensation is paid in cash.
Solutions Manual, Chapter 4
©Cambridge Business Publishers, 2020
4-193
P4-55.A (75 minutes)
LO 3, 4, 5, 6
a.
A
B
C
D
E
F
G
1
Effect of change on cash flow
2
3
H
2016
2015
Change
Operating
Investing
Financing
I
J
No effect
Total
on cash
(F+G+H+I)
Assets
4
Cash and cash equivalents
1,993,854
1,159,449
834,405
5
Receivables, net
O
10,666,986
11,085,689
(418,703)
418,703
418,703
6
Inventories
O
5,735,110
5,242,197
492,913
(492,913)
(492,913)
7
Prepaid expenses
O
1,275,918
1,350,201
(74,283)
74,283
74,283
8
Income tax receivable
O
22,473
476,154
(453,681)
453,681
453,681
O,I
22,034,603
24,488,478
(2,453,875)
9
Property, plant and equipment, net
10
Depreciation expense
11
PPE purchased
12
PPE sold
13
3,876,111
(1,182,854)
(56,446)
2,453,875
56,446
PPE acuired w/o cash
(239,382)
14
Cash surrender value of life
insurance
O
15
Other
O
438,429
630,259
(191,830)
191,830
191,830
917,533
973,195
(55,662)
55,662
55,662
1,068,745
(1,068,745)
16
17
LIABILITIES
18
Checks outstanding in excess of
bank balances
O
19
Accounts payable
O
4,235,488
20
Current portion of long-term debt
F
837,225
21
Line of credit outstanding
F
22
Other accrued expenses
O
5,158,236
5,021,286
136,950
136,950
136,950
23
Salary continuation plan
O
114,958
106,148
8,810
8,810
8,810
-
-
4,049,333
799,204
2,823,477
186,155
(1,068,745)
(1,068,745)
186,155
38,021
186,155
38,021
(2,823,477)
(2,823,477)
38,021
(2,823,477)
Table continued next page
©Cambridge Business Publishers, 2020
4-194
Financial Accounting, 6th Edition
a.
Table continued
A
B
C
D
E
24
Note payable to bank, non-current
F
5,351,057
25
Capital lease obligation
F
208,412
-
26
6,213,513
F
G
H
(862,456)
I
J
(862,456)
208,412
(862,456)
239,382
Repayment of lease principal
208,412
(30,970)
27
Salary continuation plan
O
920,440
921,882
(1,442)
(1,442)
(1,442)
28
Deferred income taxes, net
O
2,632,762
2,717,360
(84,598)
(84,598)
(84,598)
29
30
STOCKHOLDERS’ EQUITY
31
Common stock at par value
F
9,219,195
9,219,195
32
Additional paid-in capital
F
6,805,984
6,552,973
33
34
35
253,011
Stock-based compensation
Retained earnings
O, F
20,738,143
19,049,500
253,011
253,011
3,184,803
3,184,803
1,688,643
Net income
-
Dividends
Treasury shares – at cost
(2,537,036 shares in 2016 and 2015)
(1,496,160)
F
(13,136,994)
(13,136,994)
7,135,855
Solutions Manual, Chapter 4
(1,496,160)
(1,126,408)
(5,175,042)
-
834,405
©Cambridge Business Publishers, 2020
4-195
b.
The following statement of cash flows from operations combines the effects of the income tax asset and liability and
combines the effects of the deferred tax asset and liability. In addition, the effects of changes in current and
noncurrent salary continuation plan liabilities have been combined in the operating cash flow.
GOLDEN ENTERPRISES, INC.
Consolidated Statement of Cash Flows
Year ended June 3, 2016
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
Deferred income taxes
Stock based compensation
Gain on sale of property and equipment
- Change in receivables, net
- Change in inventories
- Change in prepaid expenses
- Change in cash surrender value of insurance
- Change in other assets
+ Change in accounts payable
+ Change in checks outstanding in excess of bank balances
+ Change in accrued expenses
+ Change in salary continuation plan(both current and noncurrent)
+ Change in accrued income taxes
Net cash provided by operating activities
3,876,111
(84,598)
253,011
(56,446)
418,703
(492,913)
74,283
191,830
55,662
186,155
(1,068,745)
136,950
7,368
453,681
7,135,855
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment
Proceeds from sale of property, plant and equipment
Net cash used in investing activities
(1,182,854)
56,446
(1,126,408)
CASH FLOWS FROM FINANCING ACTIVITIES:
Debt repayments (line of credit and long-term debt)
Principal payments under capital lease obligations
Cash dividends paid
Net cash used by financing activities
(3,647,912)
(30,970)
(1,496,160)
(5,175,042)
NET INCREASE IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR
CASH AND CASH EQUIVALENTS AT END OF YEAR
c.
$ 3,184,803
834,405
1,159,449
$ 1,993,854
OCFCL = $7,135,855 ÷ [(10,345,907 + 13,868,193) ÷ 2] = 0.589
OCFCX = $7,135,855 ÷ 1,182,854 = 6.03
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-1
P4-56. (30 minutes)
LO 3, 4, 5
The problem demonstrates the effect of payment terms on cash flows. A young, growing organization is
particularly susceptible to cash shortages, even when reporting profits. Many of the decisions that might foster
growth also use cash. In this simple case, Amazin, Inc. could eliminate the dividend for the present time.
Sometimes a company’s business model will facilitate the generation of cash flows. For example, at the time it
went public, Groupon was collecting cash as customers bought coupons, but then they didn’t pay the vendors
until a few weeks went by. With that arrangement, faster growth meant that Groupon generated more cash, not
less.
a.
Base case
Beginning
Quarter 1
Amazin, Inc
Balance sheets
Cash
Accts receivable
PPE, net
Accts payable
Shareholders’ equity
Income statement
Statement of cash
flows
Revenue
COGS
Depreciation
SG&A
Net income
Net income
+ Depreciation
- Δ Accts receivable
+ Δ Accts payable
Cash from opns
Capital expenditures
Dividends
Change in cash
400.0
600.0
-95.0
1000.0
675
1,000.0
400.0
1,180
1,000.0
400.0
75.0
300.0
225.0
225.0
75.0
-1,000.0
+400.0
-300.0
-150.0
-45.0
-495.0
©Cambridge Business Publishers, 2020
1-2
Financial Accounting, 6th Edition
b.
Aggressive growth
Beginning
Quarter 1
Amazin, Inc
Balance sheets
Cash
Accts receivable
PPE, net
Accts payable
Shareholders’ equity
Income statement
Statement of cash
flows
Revenue
COGS
Depreciation
SG&A
Net income
Net income
+ Depreciation
- Δ Accts receivable
+ Δ Accts payable
Cash from opns
400.0
600.0
-195.8
1,200
675
1,000.0
480
1,199.2
1,200.0
480.0
75.0
396.0
249.0
249.0
75.0
-1,200.0
480.0
-396.0
Capital expenditures
-150
Dividends
-49.8
Change in cash
-595.8
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-3
c.
Happy suppliers
Amazin, Inc
Balance sheets
Beginning
Cash
Accts receivable
PPE, net
Accts payable
Shareholders’ equity
Income statement
Statement of cash
flows
Quarter 1
400.0
600.0
-463.0
1,000.0
675.0
1,000.0
̶
1,212.0
Revenue
COGS
Depreciation
SG&A
Net income
1000.0
360.0
75.0
300.0
265.0
Net income
+ Depreciation
- Δ Accts receivable
+ Δ Accts payable
Cash from opns
265.0
75.0
-1000
̶
-660.0
Capital expenditures
-150.0
Dividends
Change in cash
-53.0
-863.0
©Cambridge Business Publishers, 2020
1-4
Financial Accounting, 6th Edition
CASES AND PROJECTS
C4-57. (30 minutes)
LO 3, 4
The required debt to equity ratio allows for total liabilities to be up to $477 million. That is $477 / ($125+$148) =1.747
< 1.75. This implies total short-term borrowing of $107 million and an ending cash balance of $70 million.
LAMBERT CO.
Statement of Cash Flows (projected)
Cash from operations
Net income ……………………………………………………
Depreciation expense ………………………………………
Increase in accounts receivable ………………………….
Decrease in inventory ………………………………………
Increase accounts payable ………………………………..
Decrease in income taxes payable ……………………….
Cash provided by (used in) operations ………………..
Cash from investing
Acquisitions of property, plant and equipment …………
Disposal proceeds …………………………………………..
Cash provided by (used in) investing ………………….
Cash from financing
Issue long-term debt ………………………………………..
Repay long-term debt ………………………………………..
Common stock issue ………………………………………..
Shareholder dividends ………………………………………
Increase (decrease) in short-term borrowing ……………
Cash provided by (used in) financing …………………..
Net change in cash ……………………………………………..
Beginning cash balance ……………………………………….
Ending cash balance …………………………………………..
$
18
120
(40)
20
30
(10)
$ 138
(225)
75
(150)
80
(100)
25
(30)
57
$
32
20
50
70
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-5
C4-58. (45 minutes)
LO 1, 3, 4
a.
see following page
b.
1
2
3
4
5
6
7
8
9
10
11
12
13
Accounts receivable (+A) ……………………………
Sales revenue (+R,+SE)…………………………
3,800
Cash (+A) ………………………………………………
Accounts receivable (-A) ………………………
3,500
Cost of goods sold (+E,-SE) …………………………
Inventory (-A) …………………………………….
1,800
Inventory (+A) …………………………………………
Accounts payable (+L) …………..……………..
1,200
Accounts payable (-L) …..……………………………
Cash (-A) …….…………………………………..
1,100
3,800
3,500
1,800
1,200
1,100
Salaries and wages expense (+E,-SE) …………….
Salaries and wages payable (+L) …………….
700
Salaries and wages payable (-L) ……………………
Cash (-A) ……..…………………………………..
730
Rent expense (+E,-SE)……………………….………
Prepaid rent (-A) ………………………………..
200
Prepaid rent (+A) ……………………..………………
Cash (-A) …….…………………………………..
600
Depreciation expense (+E,-SE) …………………….
Accumulated depreciation (+XA,-A) ………….
150
Cash (+A) ……………………………………………….
Accumulated depreciation (-XA,+A) …………………
Fixtures and equipment (-A) ……………………
700
730
200
600
150
10
70
80
Fixtures and equipment (+A) ………………………..
Cash (-A) …………………………………………..
800
Interest expense (+E,-SE) …..………………………..
Cash (-A) …………………………………………..
16
800
16
continued next page
©Cambridge Business Publishers, 2020
1-6
Financial Accounting, 6th Edition
b.
continued
14
15
16
Bank loan payable (-L) ……….………………………..
Cash (-A) …………………………………………..
1,600
Cash (+A) ………………………………………………..
Long-term loan payable (+L) ……………………
2,000
Income tax expense (+E,-SE) ………………………….
Taxes payable (+L) ………………………………..
374
1,600
2,000
374
Retained earnings (-SE) ……………………………….
Cash (-A) ……………………………………………
17
80
80
Revenue (-R) …………………………………………….
Cost of goods sold (-E) ………………………….
Salaries and wages expense (-E) ………………
Rent expense (-E) …………………………………
Depreciation expense (-E) ………………………
Interest expense (-E) ……………………………..
Income tax expense (-E) …………………………
Retained earnings (+SE) …………………………
18
3,800
1,800
700
200
150
16
374
560
Entry 18 closes revenue and expense accounts to retained earnings.
a. & c.
+
2
11
15
Bal
Cash (A)
600
3,500
1,100
730
600
10
800
16
1,600
2,000
80
1,184
5
7
9
12
13
14
- Accounts Payable (L) +
3,000
5
1,100
1,200
4
3,100 Bal
- Salaries and Wages +
Payable (L)
100
7
730
700
6
70 Bal
- Retained Earnings (SE)+
1,300
17
80
560
18
1,780 Bal
17
-
+ Accounts Rec. (A) 6,500
1
3,800
3,500
Bal
6,800
- Common Stock (SE) +
4,600
4,600 Bal
2
Taxes Payable (L) +
0
374
16
374 Bal
- Bank Loan Payable (L) +
1,600
14
1,600
0 Bal
18
Revenue (R) +
3,800
3,800
0
1
Bal
+ Cost of Goods Sold (E) 3
1,800
1,800
18
Bal
0
continued next page
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-7
a. & c.
continued
+
4
Bal
Inventory (A) 2,400
1,200
1,800
1,800
+ Prepaid Rent (A) 0
9
600
200
Bal
400
+
12
Bal
Fixtures and
Equipment (A)
1,900
800
80
2,620
3
- Long-term Loan (L) +
0
2,000
15
2,000 Bal
+ Salaries & Wages (E) 6
700
700
18
Bal
0
+ Rent Expense (E) 200
200
18
Bal
0
8
8
+ Depreciation Exp. (E) 10
150
150
18
Bal
0
11
- Accum. Deprec. (XA) +
800
11
70
150
10
880 Bal
+ Interest Expense (E) 13
16
16
18
Bal
0
+ Income Tax Exp (E) 16
374
374
18
Bal
0
©Cambridge Business Publishers, 2020
1-8
Financial Accounting, 6th Edition
C4-59. (30 minutes)
LO 1, 2, 3, 4, 5
a.
Depreciation and amortization are noncash expenses that are deducted in the computation of net income. The
depreciation and amortization add-back effectively zeros these expenses out of the income statement to focus on
operating cash flow. The positive amount for depreciation and amortization does not mean that the company is
generating cash from depreciation and amortization, a common misconception. It is merely an adjustment to remove
these expenses from net income to convert profit to cash flow.
b.
Gains and losses on disposals of asset are the result of investing activity, not operating activity, but they are
recognized in net income. When we start with net income in an indirect method cash from operations, subtracting
the gain removes this investing item from the determination of cash from operations.
Daimler reports cash proceeds from disposals of PPE and intangible assets of €812 million. If the recognized gain is
€453 million, then the book value of the assets disposed would be €359 million (= €812 million - €453 million).
c.
It does not. The adjustments can only be interpreted relative to the amounts that are included in net income. The
negative €1,455 million inventory adjustment means that Daimler’s cost to acquire inventory for the year exceeded
its cost of goods sold for the year by €1,455 million.
d.
Free cash flow (€ millions): ̶€1,652 – €(6,744 + 3,414 - 812) = -€10,998.
Daimler’s operating cash flow is slightly negative, but its free cash flow is significantly negative due to the large
investment in PPE and intangible assets. Daimler financed its investing activities and dividends by €16 billion in
net additions to long-term financing.
e.
The primary sources of difference between net income and cash from operating activities are a net increase in
operating assets, income taxes, and large increases in financial receivables and vehicles on operating leases. These
last two items are related to their customer finance operation. In its financial statements, Daimler reports that
“Customized financing and leasing products accelerate our automotive business.” One of the most
important factors behind our success is our attractive and innovative range of services around vehicle financing
and insurance. Daimler Financial Services has posted record figures for many years. We aim to systematically
pursue our strategy of profitable growth at high speed in the future. Daimler Financial Services finances or
leases half of all the new vehicles sold worldwide by the Daimler Group.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-9
f.
Daimler is a global corporation and transacts business in many different currencies. When the financial
statements are prepared, these various currencies must be translated into one common currency (Euros in this
case) for reporting purposes. Because exchange rates fluctuate, this translation process results in some changes
in the cash value of some transactions and cash balances. The -€868 million listed in the cash flow statement
reflects the net impact on Euros of the translation of foreign currencies.
©Cambridge Business Publishers, 2020
1-10
Financial Accounting, 6th Edition
Chapter 5
Analyzing and Interpreting
Financial Statements
Learning Objectives – coverage by question
MiniExercises
Exercises
LO1 – Prepare and analyze
common-size financial statements.
15, 16,
19, 20
35
LO2 – Compute and interpret
measures of return on investment,
including return on equity (ROE),
return on assets (ROA), and return
on financial leverage (ROFL).
14, 17,
21, 22
LO3 – Disaggregate ROA into
profitability (profit margin) and
efficiency (asset turnover)
components.
LO4 – Compute and interpret
measures of liquidity and solvency.
Problems
Cases
and Projects
25 - 31, 34
36, 38, 41
49
14, 17, 21,
22, 24
25, 27 - 31,
34
36, 38,
41, 45, 46
47 - 49
18, 23
32, 33
37, 39, 42
49
LO5 – Appendix 5A: Measure and
analyze the effect of operating
activities on ROE.
LO6 – Appendix 5B: Prepare
financial statement forecasts.
40, 43
35
44
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-11
QUESTIONS
Q5-1.
Return on investment measures profitability in relation to the amount of investment that has
been made in the business. A company can always increase dollar profit by increasing the
amount of investment (assuming it is a profitable investment). So, dollar profits are not
necessarily a meaningful way to look at financial performance. Using return on investment in
our analysis, whether as investors or business managers, requires us to focus not only on the
income statement, but also on the balance sheet.
Q5-2.
ROE is the sum of return on assets (ROA) and the return that results from the effective use of
financial leverage (ROFL). Increasing leverage increases ROE as long as ROA exceeds the
after-tax interest rate. Financial leverage is also related to risk: the risk of potential bankruptcy
and the risk of increased variability of profits. Companies must, therefore, balance the positive
effects of financial leverage against their potential negative consequences. It is for this reason
that we do not witness companies entirely financed with debt.
Q5-3.
Gross profit margins can decline because 1) the industry has become more competitive, and/or
the firm’s products have lost their competitive advantage so that the company has had to
reduce prices or is selling fewer units or 2) product costs have increased, or 3) the sales mix
has changed from higher-margin/slowly-turning products to lower-margin/higher-turning
products. Declining gross profit margins are usually viewed negatively. On the other hand, cost
increases that reflect broader economic events or certain strategic product mix changes might
not be viewed negatively.
Q5-4.
Reducing advertising or R&D expenditures can increase current operating profit at the expense
of the long-term competitive position of the firm. Expenditures on advertising or R&D are more
asset-like and create long-term economic benefits even though they are not reported as assets
on the balance sheet.
Q5-5.
Asset turnover measures the amount of revenue volume compared with the investment in an
asset. Generally speaking, we want turnover to be higher rather than lower. Turnover measures
productivity, and an important company objective is to make assets as productive as possible.
Since turnover is one of the components of ROE (via ROA), increasing turnover increases
shareholder value. Turnover is, therefore, viewed as a value driver.
Q5-6.
ROE>ROA implies a positive return on financial leverage. This results from borrowed funds
being invested in operating assets whose return (ROA) exceeds the cost of borrowing. In this
case, borrowing money increases ROE.
©Cambridge Business Publishers, 2020
1-12
Financial Accounting, 6th Edition
Q5-7.
Common-size financial statements express balance sheet and income statement items in ratio
form. Common-size balance sheets express each asset, liability and equity item as a
percentage of total assets and common-size income statements express each line item as a
percentage of sales. The ratio form facilitates comparison among firms of different sizes as well
as across time for the same firm.
Q5-8.
The asset turnover ratio (AT) is the ratio of sales revenue to average total assets. The ratio is
increased by increasing sales while holding assets constant, or by reducing assets without
reducing sales. The most effective means of improving the ratio is to increase the efficient
utilization of operating assets. This is done by improving inventory management practices,
improving accounts receivable collection, and improving the efficient use of PP&E.
Q5-9.
The “net” in net operating assets, means operating assets “net” of operating liabilities. This
netting recognizes that a portion of the costs of operating assets is financed by parties other
than the company. For example, payables and accrued expenses help fund inventories, wages,
utilities, and other operating costs. Similarly, long-term operating liabilities also help finance the
cost of long-term operating assets. Thus, these long-term operating liabilities are deducted from
long-term operating assets.
Q5-10.
Companies must manage both the income statement and the balance sheet in order to
maximize ROA. This is important, as many managers look only to the income statement and do
not fully appreciate the value added by effective balance sheet management. The
disaggregation of ROA into its profit margin and turnover components facilitates analysis of
these two areas of focus.
Q5-11.
There are an infinite number of possible combinations of margin and turnover that will yield a
given level of ROA. The relative weighting of profit margin and asset turnover is driven in large
part by the company’s business model. As a result, since companies in an industry tend to
adopt similar business models, industries will generally trend toward points along the
margin/turnover continuum.
Q5-12.
Liquidity refers to how much cash a company has, how much cash is coming in, and how much
cash can be raised quickly. Companies must generate cash in order to pay their debts, pay
their employees and provide their shareholders a return on investment. Cash is, therefore,
critical to a company’s survival.
Q5-13.
Ratio analysis relies on the data presented in the financial statements and is, therefore,
dependent on the quality of those statements. Differences in the application of GAAP across
companies or within the same company across time can affect the reliability of the analysis.
Limitations of GAAP itself and differences in the make-up of the company (e.g., types of
products or industries in which the company competes) can also affect the usefulness of ratio
analysis.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-13
MINI EXERCISES
M5-14. (15 minutes)
LO 2, 3
a. ROE = $5,000/$500,000 = 1%
ROA = $20,000/$1,000,000 = 2%
ROFL = 1% - 2% = -1%
b. Net profit margin = $5,000/$1,000,000 = 0.5%
Asset turnover = $1,000,000/$1,000,000 = 1.0
Financial leverage = $1,000,000/$500,000 = 2.0
c.
ROFL is negative for Sunder Company, indicating that financial leverage is hurting this company.
The return on assets is insufficient to cover the interest cost of the debt. DuPont analysis masks this
problem. The financial leverage ratio of 2.0 suggests (incorrectly) that leverage doubled the return.
M5-15. (20 minutes)
LO 1
TARGET CORPORATION
Common-size Balance Sheets
Cash and cash equivalents…………………………………….
Inventory………………………………………………………….
Other current assets…………………………………………….
Total current assets……………………………………………..
Property and equipment, net…………………………………..
Other noncurrent assets………………………………………..
Total assets………………………………………………………
2018
6.8%
22.2%
3.2%
32.2%
64.2%
3.6%
100.0%
2017
6.7%
22.2%
3.1%
32.0%
65.9%
2.1%
100.0%
Accounts payable……………………………………………….
Accrued and other current liabilities…………………………..
Current portion of long-term debt and other borrowings.......
Total current liabilities………………………………………….
Long-term debt and other borrowings………………………..
Deferred income taxes………………………………………….
Other noncurrent liabilities…………………………………….
Total shareholders' investment……………………………….
Total liabilities and shareholders' investment………………..
22.2%
10.9%
0.7%
33.8%
29.0%
1.8%
5.3%
30.0%
100.0%
19.4%
10.0%
4.6%
33.9%
29.5%
2.3%
5.0%
29.3%
100.0%
©Cambridge Business Publishers, 2020
1-14
Financial Accounting, 6th Edition
M5-16 (20 minutes)
LO 1
TARGET CORPORATION
Common-size Income Statement
Year ended:
Sales revenue………………..……………………………………………….
Cost of sales………………………………………………………………….
Selling, general and administrative expenses…………………………….
Depreciation and amortization………………………………………………
Earnings from continuing operations before interest and income taxes
Net interest expense…………………………………………………………
Earnings from continuing operations before income taxes………………
Provision for income taxes………………………………………………….
Net earnings from continuing operations …………………………………
Discontinued operations, net of tax ………………………………………..
Net earnings (loss) …………………………………………………………..
February 3, 2018
100.0%
71.1%
19.8%
3.1%
6.0%
0.9%
5.1%
1.0%
4.1%
0.0%
4.1%
M5-17. (15 minutes)
LO 2, 3
($ millions)
a. EWI = $2,928 + $666 x (1 - 0.25) = $3,427.5
(using net earnings from continuing operations)
Average total assets = ($38,999 + $37,431)/2 = $38,215
ROA = $3,427.5/$38,215 = 8.97%
(using net earnings from continuing operations)
Using net earnings, ROA = ($2,934 + (1 - 0.25) × 666)/(($38,999 + $37,431)/2)
= 8.98%
b. Using earnings from continuing operations:
PM = $3,427.5/$71,879 = 4.77%
AT = $71,879 /$38,215= 1.88
4.77% X 1.88 = 8.97%
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-15
M5-18. (20 minutes)
LO 4
a. 2018 Current ratio = $12,564 / $13,201 = 0.95
2017 Current ratio = $11,990 / $12,707 = 0.94
2018 Quick ratio = $2,643 / $13,201 = 0.20
2017 Quick ratio = $2,512 / $12,707 = 0.20
Both of these ratios held steady over the year. Target’s current assets increased modestly, as did its
current liabilities. The make-up of the current liabilities changes somewhat over the year, with
operating liabilities increasing and current debt repayments decreasing. Both of these ratios are
lower than the retail industry medians, though Target’s scale of operation seems to reassure its
creditors.
b. 2018 Times interest earned = $4,312 / $666 = 6.47
2018 Debt-to-equity = ($38,999 - $11,709) / $11,709= 2.33
2017 Debt-to-equity = ($37,431 - $10,953) / $10,953 = 2.42
Target’s debt-to-equity decreased slightly and is lower than the retail industry median. The timesinterest-earned ratio is calculated without including the income from discontinued operations.
c.
Target is liquid and not excessively financially leveraged. Its times interest earned ratio indicates that
earnings before interest and taxes is just about 6.5 times interest expense. Because the company
generates significant operating profits and operating cash flow ($6.8 billion), we have no solvency
concerns about Target.
©Cambridge Business Publishers, 2020
1-16
Financial Accounting, 6th Edition
M5-19. (20 minutes)
LO 1
3M COMPANY
Common-size Balance Sheets
Assets
Current assets
Cash, cash equivalents and marketable securities
Accounts receivable - net of allowances of $103 and $88
Total inventories
Prepaids
Other current assets
Total current assets
Property, plant and equipment - net
Goodwill
Intangible assets - net
Other assets
Total assets
Liabilities and Shareholders’ Equity
Current liabilities
Short-term borrowings and current portion of long-term debt
Accounts payable
Accrued payroll
Accrued income taxes
Other current liabilities
Total current liabilities
Long-term debt
Pension and postretirement benefits
Other liabilities
Total liabilities
Total equity
Total liabilities and equity
2017
2016
10.9%
12.9%
10.6%
2.5%
0.7%
37.6%
8.1%
13.3%
10.3%
2.5%
1.4%
35.6%
23.3%
27.7%
7.7%
3.7%
100.0%
25.9%
27.9%
7.1%
3.6%
100.0%
4.9%
5.1%
2.3%
0.8%
7.1%
20.2%
3.0%
5.5%
2.1%
0.9%
7.5%
18.9%
31.8%
9.5%
7.8%
69.4%
30.6%
100.0%
32.5%
12.2%
5.0%
68.6%
31.4%
100.0%
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-17
M5-20. (15 minutes)
LO 1
3M COMPANY
Common-size Income Statements
Net sales
Operating expenses
Cost of sales
Selling, general and administrative expenses
Research, development and related expenses
Gain on sale of businesses
Total operating expenses
Operating income
Interest expense
Interest income
Income before income taxes
Provision for income taxes
Net income including noncontrolling interest
2017
2016
100.0%
100.0%
50.5%
20.8%
5.8%
-1.9%
75.3%
24.7%
1.0%
-0.2%
50.0%
20.7%
5.8%
-0.4%
76.0%
24.0%
0.7%
-0.1%
23.8%
8.5%
15.4%
23.4%
6.6%
16.8%
M5-21. (20 minutes)
LO 2, 3
($ millions)
a. 2017 EWI = $4,869 + $322 x (1 - 0.35) = $5,078.3
2017 Average total assets = ($37,987 + $32,906)/2 = $35,446.5
ROA = $5,078.3/$35,446.5 = 14.33%
b. PM = $5,078.3/$31,657 = 16.04%
AT = $31,657/$35,446.5 = 0.893
16.04% X 0.893 = 14.32% (0.01 difference due to rounding)
©Cambridge Business Publishers, 2020
1-18
Financial Accounting, 6th Edition
M5-22. (15 minutes)
LO 2, 3
($ millions)
a. URBN:
TJX:
b. URBN:
TJX:
c.
Average total assets = ($1,953 + $1,903)/2 = $1,928
ROA = $108 / $1,928 = 5.60%
Average total assets = ($14,058 + $12,884)/2 = $13,471
ROA = $2,653 / $13,471 = 19.69%
PM = $108 / $3.616 = 2.99%
AT = $3,616 / $1,928 = 1.88
2.99% X 1.88 = 5.62% (0.02 difference due to rounding)
PM = $2,653 / $35,865 = 7.40%
AT = $35,865 / $13,471 = 2.66
7.40% X 2.66 = 19.68% (0.01 difference due to rounding)
URBN’s ROA is quite a bit lower than TJX’s. TJX has a higher PM and AT. As is typical of valuepriced retailers, TJX’s asset turnover is high – its AT is 41% higher than that of URBN. On balance,
TJX’s business model appears to be more successful in 2017 as it is able to maintain both a high AT
and a high PM, resulting in higher ROA.
M5-23. (20 minutes)
LO 4
($ millions)
a. Verizon’s current ratio for the two years presented is as follows:
2017 current ratio: $29,913 / $33,037 = 0.91
2016 current ratio: $26,395 / $30,340 = 0.87
In 2017, Verizon’s current ratio was below 1.0 which is below the industry median current ratio of
1.19. We might want to know, however, whether Verizon’s current assets are concentrated in cash or
relatively illiquid inventories, as well as the maturity schedule of its current liabilities.
Its CR in 2016 is in the same range as 2017. From 2016 to 2017, Verizon reports a significant
increase in accounts receivable and a significant increase in debt due within the next year.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-19
b. Verizon’s times interest earned ratio for the two years is as follows:
2017 times interest earned = $25,327 / $4,733 = 5.35
2016 times interest earned = $25,362 / $4,376 = 5.80
Verizon’s times interest earned ratio has decreased, but remains higher than the industry median
(2.57).
2017 debt-to-equity = $212,456 / $43,096 = 4.93
2016 debt-to-equity = $220,148 / $22,524 = 9.77
Verizon’s 2016 debt-to-equity ratio is significantly above the 1.83 median for companies in the
telecommunications industry. The ratio decreased dramatically to 4.93 in 2017 due to increased
shareholders’ equity.
Verizon’s operating cash flow to current liabilities ratio is as follows:
2017 OCFCL = $25,305 / [($33,037 + $30,340)/2] = 0.80
2016 OCFCL = $22,810 / [($30,340 + $35,052)/2] = 0.70
c.
Verizon is carrying a significant amount of debt. Although its profitability and operating cash flow are
fairly strong, neither is particularly high in relation to the company’s liabilities and interest costs.
Verizon’s liquidity appears below that of others in its industry, and its debt-to-equity is now very high.
Given its significant capital expenditure requirements and its current debt load, Verizon may have to
fund future capital expenditures with higher-cost equity. And, to the extent that its competitors are not
as highly leveraged, this may negatively impact Verizon’s competitive position.
©Cambridge Business Publishers, 2020
1-20
Financial Accounting, 6th Edition
M5-24. (30 minutes)
LO 3
a.
$ millions
Procter & Gamble ...........................................
CVS.................................................................
Valero Energy .................................................
Asset Turnover
$66,832/$66,119 = 1.01
$184,765/$94,797 = 1.95
$88,407/ $48,166 = 1.84
b.
$ millions
ART
Procter & Gamble ........................................... $66,832/$4,640 = 14.40
CVS................................................................. $184,765/$12,673 = 14.58
Valero Energy ................................................. $88,407/ $6,296 = 14.04
$ millions
INVT
Procter & Gamble ...........................................
$33,449/$4,681 = 7.15
CVS................................................................. $156,208/$15,028 = 10.39
Valero Energy ................................................. $81,926/ $6,047 = 13.55
$ millions
PPET
Procter & Gamble ........................................... $66,832/$20,247 = 3.30
CVS................................................................. $184,765/$10,234 = 18.05
Valero Energy ................................................. $88,407/ $26,976 = 3.28
c.
For all three companies, these ratios reflect differences in their businesses, and the overall AT ratio is
related to the three individual ratios as seen in Exhibit 5.8 in the chapter. The three companies
collect from their customers relative quickly, as seen in the similar values of ART. Valero carries the
smallest amount of inventory relative to its cost of goods sold. Procter & Gamble’s ratios are
influenced by the relative strength of its largest customer (Walmart), resulting in higher inventory
levels and slower collections. In addition, P&G has a large level of intangible assets, as we will see in
Chapter 8, so its PPET is relatively high, but its AT is the lowest of the three. CVS’s inventory
turnover is higher than P&G. CVS leases most of its store space, so PP&E is low relative to sales
(though that practice will change in the near future as we will see in Chapter 10).
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-21
EXERCISES
E5-25. (30 minutes)
LO 2, 3
a.
($ millions)
McDonald’s
[$5,192 + $921 x (1 - 0.35)] / $32,414 = 17.9%
Yum! Brands
[($1,340 + $440 x (1 - 0.35)] / $5,382 = 30.2%
($ millions)
PM = EWI / Sales
AT = Sales / Avg. Assets
McDonald’s
[$5,192 + $921 x (1 - 0.35)] / $22,820 = 25.4%
$22,820 / $32,414
= 0.70
Yum! Brands
[($1,340 + $440 x (1 - 0.35)] / $5,878
= 27.7%
$5,878 / $5,382
= 1.09
b.
c.
McDonald’s ROA is lower than Yum! Brands’ in fiscal 2017. The companies’ profit margins (PM) are
similar, but Yum! Brands has a significantly higher asset turnover (AT). For both firms, asset turnover
is influenced by franchising and leasing of retail stores.
E5-26. (20 minutes)
LO 2
a.
Case
Assets
Non-interest-bearing liabilities
Interest-bearing liabilities
Shareholders’ equity
Earnings before interest and taxes
Interest expense
Earnings before taxes
Tax expense (40%)
Net income
ROE
ROA
ROFL
A
1,000
0
0
1,000
B
1,000
0
250
750
C
1,000
0
500
500
D
1,000
0
500
500
E
1,000
200
0
800
F
1,000
200
300
500
120
0
120
48
72
120
25
95
38
57
120
50
70
28
42
80
50
30
12
18
100
0
100
40
60
80
30
50
20
30
7.2%
7.2%
0.0%
7.6%
7.2%
0.4%
8.4%
7.2%
1.2%
3.6%
4.8%
-1.2%
7.5%
6.0%
1.5%
6.0%
4.8%
1.2%
©Cambridge Business Publishers, 2020
1-22
Financial Accounting, 6th Edition
b. These three cases differ only in the amount of interest-bearing liabilities used to finance the firm. As
leverage increases, the return to shareholders’ equity (ROE) increases. However, the return on
assets (ROA) does not change, because the ROA is independent of the way that the business was
financed.
c.
However, financial leverage (the use of liabilities to finance the firm) does not always work in favor of
shareholders. The liability holders require a fixed return (6% after-tax = 10% x (1 – 40%)), and in
order for leverage to work in favor of shareholders, the overall return on assets must exceed this fixed
return. In case C, the return on assets is 7.2% > 6%, so ROFL is positive. In case D, the return on
assets is 4.8% < 6%, so ROFL is negative.
In case E, the return on assets equals the after-tax return required on interest-bearing liabilities, but
the company has only non-interest-bearing liabilities. The ROA is greater than zero, so ROFL is
positive. In essence, the rate required on liabilities is the “break-even” ROA in order for ROFL to be
positive.
d. In case F, there is a mixture of liability types. Even though ROA is less than the amount needed for
interest-bearing liabilities, ROFL is positive because some of Company F’s liabilities require no
interest.
The general relationship among these variables is the following:
ROE = ROA + ROA*(NL/SE) + [ROA – (1 – t)*i]*(IL/SE)
where
A = Assets,
NL = non-interest-bearing liabilities,
IL = interest-bearing liabilities,
SE = shareholders’ equity,
t = tax rate,
i = pre-tax interest rate on interest-bearing liabilities,
ROE = return on shareholders’ equity, and
ROA = return on assets.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-23
E5-27. (20 minutes)
LO 2, 3
($ millions)
CVS
Walgreens
a.
EWI
Avg. Assets
ROA
$6,623 + $1,062 x (1 - 0.35) = $7,313.3
($95,131 + $94,462)/2 = $94,796.5
$7,313.3/ $94,796.5 = 7.71%
$4,101 + $728 x (1 - 0.35) = $4,574.2
($66,009 + $72,688) /2 = $69,348.5
$4,574.2/ $69,348.5 = 6.60%
b.
PM
AT
$7,3313.3/$184,765 = 3.96%
$184,765 /$94,796.5 = 1.95
$4,574.2/$118,214 = 3.87%
$118,214/$69,348.5 = 1.70
c.
Avg. Equity
ROE
ROFL
($37,695 + $36,834)/2 = $37,264.5
$6,623 / $37,264.5 = 17.77%
17.77% - 7.71% = 10.06%
($28,274 + $30,281)/2 = $29,277.5
$4,101 / $29,277.5 = 14.01%
14.01% - 6.60% = 7.41%
d. Walgreen’s ROE and ROA are lower than CVS’s. CVS’s PM is slightly higher than Walgreen’s, but its
AT is considerably higher than Walgreen’s. The low PMs for both companies reflect the highly
competitive retail pharmaceutical industry. Both companies are using financial leverage, but to a
larger degree for CVS. Asset turnover and ROA differences would have to be examined further,
because both companies use operating leases that do not show up on the balance sheet. (Though,
that is scheduled to change in the near future. Chapter 10 looks at this important topic.)
E5-28. (30 minutes)
LO 2, 3
($ millions)
a. ROE
2017: $9,601 / [($69,019 + $66,226) / 2] = 14.20%
2016: $10,316 / [($66,226 + $61,085) / 2] = 16.21%
b. ROA
2017: [$9,601 + $637x(1 - 0.35)] / [($123,249 + $113,327) / 2] = 8.47%
2016: [$10,316 + $725x(1 - 0.35)] / [($113,327 + $101,459) / 2] = 10.04%
ROFL
2017: 14.20% - 8.47% = 5.73%
2016: 16.21% - 10.04% = 6.17%
ROFL is positive, so leverage is working in favor of Intel’s shareholders.
©Cambridge Business Publishers, 2020
1-24
Financial Accounting, 6th Edition
c.
Net Profit Margin
2017: $9,601 / $62,761 = 15.30%
2016: $10,316 / $59,387 = 17.37%
Asset Turnover
2017: $62,791 / [($123,249 + $113,327) / 2] = 0.531
2016: $59,387 / [($113,327 + $101,459) / 2] = 0.553
Financial Leverage
2017: [($123,249 + $113,327) / 2] / [($69,019 + $66,226) / 2] = 1.749
2016: [($113,327 + $101,459) / 2] / [($66,226 + $61,085) / 2] = 1.687
Intel’s financial leverage increased slightly from 2016 to 2017. Both ROA and ROE decreased.
Based on ROFL, leverage increased ROE by about 70% over ROA each year. These increases
correspond to the DuPont financial leverage measure in this case because Intel’s borrowing costs are
so low.
In general, there is a bias in DuPont analysis in that it tends to overstate the benefits of financial
leverage. Offsetting this bias, DuPont analysis calculates the net profit margin, which is lower than
PM because the numerator is net of interest costs. For comparison purposes, Intel’s PM ratios are
presented below.
PM ratio
2017: [$9,601 + $637 x (1 - 0.35)] / $62,761 = 15.96%
2016: [$10,316 + $725 x (1 - 0.35)] / $59,387 = 18.16%
E5-29. (30 minutes)
LO 2, 3
($ millions)
a.
ROE
2019:
2018:
2017:
€850 / [(€138+€1,477) / 2] = 105.26%
€805 / [(€1,477+€2,184) / 2] = 43.98%
€448 / [(€2,184+$€1,875) / 2] = 22.07%
b.
ROA
2019:
2018:
2017:
[€850+€246x(1 - 0.25)] / [(€6,108+€6,451) / 2] = 16.47%
[€805+€208x(1 - 0.25)] / [(€6,451+€7,173) / 2] = 14.11%
[€448+€237x(1 - 0.25)] / [(€7,173+€6,972) / 2] = 8.85%
ROFL
2019:
2018:
2017:
105.26% - 16.47% = 88.79%
43.98% - 14.11% = 29.87%
22.07% - 8.85% = 13.22%
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-25
c.
Net Profit Margin
2019:
2018:
2017:
€850 / €10,364 = 8.20%
€805 / €9,613 = 8.37%
€448 / €8,632 = 5.19%
Asset Turnover
2019:
2018:
2017:
€10,364 / [(€6,108+€6,451) / 2] = 1.650
€9,613 / [(€6,451+€7,173) / 2] = 1.411
€8,632 / [(€7,173+€6,972) / 2] = 1.221
Financial Leverage
2019:
2018:
2017:
[(€6,108+€6,451) / 2] / [(€138+€1,477) / 2] = 7.776
[(€6,451+€7,173) / 2] / [(€1,477+€2,184) / 2] = 3.721
[(€7,173+€6,972) / 2] / [(€2,184+€1,875) / 2] = 3.485
HD Rinker’s ROA increased slightly from 2018 to 2019 (mostly due to better asset turnover), but its
ROE skyrocketed! During both 2018 and 2019, Rinker increased its liabilities, and significantly
reduced its equity. Its debt-to-equity ratio is 43.3 at the end of fiscal year 2019, so the ROE is greater
than 100%. This level of returns is exceptional for shareholders, but the company’s condition could
be precarious if its performance were to deteriorate.
The DuPont analysis shows that the net profit margin decreased from 2018 to 2019, but the asset
turnover improved significantly. Based on ROFL, leverage increased ROA by 2.5 times in 2017
(22.07%/8.85%) while in 2019, leverage increased ROA by a factor of 6.4 (105.26%/16.47%).
DuPont analysis suggests that leverage had a slightly larger impact (3.485 in 2017 and 7.776 in
2019) but the trend is the same. This is consistent with the bias in DuPont analysis in that it tends to
overstate the effects of financial leverage. Offsetting this bias, DuPont analysis calculates the net
profit margin, which is lower than PM because the numerator is net of interest costs. For comparison
purposes, HD Rinker’s PM ratios are presented below:
PM ratio
2019:
2018:
2017:
[€850+€246x (1-.25)] / €10,364 = 9.98%
[€805+€208x (1-.25)] / €9,613 = 10.00%
[€448+€237x(1-.25)] / €8,632 = 7.25%
©Cambridge Business Publishers, 2020
1-26
Financial Accounting, 6th Edition
E5-30. (20 minutes)
LO 2, 3
($ millions)
a. EWI
$181 + $62 x (1 - 0.35) = $221.3
Avg. Equity
($2,120 + $1,852)/2 = $1,986.0
Avg. Assets
($6,323 + $5,540)/2 = $5,931.5
ROE
$181 / $1,986.0 = 9.11%
ROA
$221.3 / $5,931.5 = 3.73%
ROFL
9.11% - 3.73% = 5.38%
b. PM
$221.3 / $10,240 = 2.16%
AT
$10,240 / $5,931.5 = 1.73
c.
Office Depot has a very low profit margin and an asset turnover that is a little less than 2.0. This ratio
combination is consistent with a low-price, high-volume business model. However, compared to the
retail industry, Office Depot is doing poorly. Both its AT and its PM are below the median. As a
result, its ROA and ROE are well below the industry medians.
E5-31. (20 minutes)
LO 2, 3
($ millions)
a.
b.
c.
EWI
$1,211 + $20 x (1-.35) = $1,224.0
Avg. Equity
($2,354 + $1,354) / 2 = $1,854.0
Avg. Assets
($5,178 + $4,068) / 2 = $4,623.0
ROE
$1,211 / $1,854.0 = 65.32%
ROA
$1,224.0 / $4,623.0 = 26.48%
ROFL
65.32% - 26.48% = 38.84%
PM
$1,224.0 / $5,964 = 20.52%
AT
$5,964 / $4,623.0 = 1.29
Intuit has a relatively high PM ratio and a low AT ratio. These numbers are consistent with the
business model employed in the software industry. Contrast these numbers with those of Office
Depot (E5-30). Intuit uses financial leverage effectively; leverage increased its ROA by a factor of
almost 2.5 (65.32%/26.48%).
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-27
E5-32. (30 minutes)
LO 4
a.
2017
2016
$6,570,520/$7,674,670 = 0.86
$6,259,796/$5,827,005 = 1.07
($3,367,914+$155,323+$515,381)
/$7,674,670 = 0.53
($3,393,216+$105,519+$499,142)/$5,827,005
= 0.69
2017
2016
Debt-toequity ratio
$23,022,980/$5,632,392 = 4.09
$16,750,167/$5,913,909 = 2.83
Timesinterestearned ratio
(-2,209,032 + $471,259)/$471,259
= -3.69
Current ratio
Quick ratio
b.
c.
Cash burn rate = (-60,654 - $3,414,814)/365 days = -$9,522 thousand per day.
Tesla’s financial condition has been a topic of considerable discussion in the recent past. Its current
and quick ratios have dropped from 2016 to 2017, and they are among the lowest in Exhibit 5.13.
(The restricted cash should not be considered an available resource for paying obligations, but the
amount is not very significant.) The same is true of its debt-to-equity ratio. The times-interest-earned
ratio doesn’t tell us much because it’s negative. Tesla is not earning income from which interest cash
be paid; rather it is earning losses that are increased by interest expense. As of 2017, Tesla is using
up cash for operations and capital expenditures at the rate of about $10 million per day. With $3.3
billion in cash as of the end of 2017, that means that if Tesla continues to spend at the same rate, it
will run out of cash in late 2018.
But that’s a very big “if,” and it is the source of disagreement among investors. Almost every new
company starts its life with negative free cash flow. But every successful new company must reach a
point where it stops consuming cash and begins to generate cash. The 2018 quarterly reports for
Tesla appear to show that point may have been reached.
©Cambridge Business Publishers, 2020
1-28
Financial Accounting, 6th Edition
E5-33. (30 minutes)
LO 4
a.
($ millions)
Current Ratio
OCFCL
2015
€51,442 / €39,562 = 1.30
€6,612 / [(€36,598 + €39,562) / 2] = 0.174
2016
€55,329 / €42,916 = 1.29
€7,611 / [(€39,562 + €42,916) / 2] = 0.185
2017
€58,429 / €43,394 = 1.35
€7,176 / [(€42,916 + €43,394) / 2] = 0.166
Siemens has a current ratio that is above 1.0 and has been steady around 1.3 over these years.
Moreover, its OCFCL ratio stayed in the same range around 0.175. While the current ratio provides a
useful point estimate of liquidity, the OCFCL ratio suggests that operations are not generating
sufficient net cash flow to cover short-term obligations, but it would be useful to also get a sense of
the volume of resource flows relative to the current liabilities. Siemens’ revenues for 2017 exceeded
€83 billion.
b.
($ millions)
Times interest earned
Debt-to-equity
2015
€(7,218 + 818) / €818 = 9.82
€85,293 / €34,474 = 2.47
2016
€(7,404 + 989) / €989 = 8.49
€90,901 / €34,211 = 2.66
2017
€(8,306 + 1,051) / €1,051 = 8.90
€89,277 / €43,089 = 2.07
The times interest earned ratio decreased in 2016 but rebounded in 2017. Siemens’ debt-to-equity
ratio has been quite high around 2.50, but decreased in 2017.
c.
It’s always a good idea to look into the numbers that make up the ratios before coming to
conclusions. For instance, Siemens’ current liabilities include about €10.3 billion in unearned
revenue, representing more than a quarter of its current liabilities. In the normal course of business,
deferred performance liabilities like these aren’t paid off with cash – rather Siemens must provide the
agreed-upon services and products to the customers.
It’s not easy to place Siemens into one of the industry groups in Exhibit 5.13, but its DE ratio appears
to be higher than any industry median except utilities. However, its TIE appears to be in a
satisfactory range. And, the company’s size and diversified businesses give it a stability that can
reassure lenders.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-29
E5-34. (30 minutes)
LO 2, 3
($ millions)
a.
b.
c.
EWI
$848 + $74 x (1 - 0.35) = $896.1
Avg. Equity
($3,144 + $2,904) / 2 = $3,024.0
Avg. Assets
($7,989 + $7,610) / 2 = $7,799.5
ROE
$848 / $3,024.0 = 28.04%
ROA
$896.10 / $7,799.5 = 11.49%
ROFL
28.04% - 11.49% = 16.55%
PM
$896.10 / $15,855 = 5.65%
AT
$15,855 / $7,799.5 = 2.033
GPM
$6,066 / $15,855 = 38.26%
INVT
$9,789 / [($1,997 + $1,830) / 2] = 5.116
d. The Gap showed strong performance in the year ended February 3, 2018 (hereafter, 2017), with
modest improvements over 2016. Its ROA was 11.5%, which is high for the retail industry. ROE was
almost 30% indicating the effective use of financial leverage. Interest costs were low, suggesting that
most of The Gap’s debt is from operating liabilities (accounts payable and accrued expenses). Its
profit margin and asset turnover ratios place The Gap in a strong position for this industry.
The GPM and INVT ratios are two important performance measures for retail companies such as The
Gap. GPM measures the ability of the firm to sell its merchandise at reasonable margins while INVT
provides evidence on inventory management and the popularity of its product line. Both measures
are near the median for retailers in 2017.
©Cambridge Business Publishers, 2020
1-30
Financial Accounting, 6th Edition
E5-35.B (20 minutes)
LO 1, 6
a. & b.
THE GAP, INC.
Common-size and Income Statement Forecasts
Net sales
Cost of goods sold and occupancy
expenses
Gross profit
Operating expenses
Operating income
Interest expense
Interest income
Income before income taxes
Income taxes
Net income
c.
100.0%
100.0%
$15,800
$16,300
$16,800
63.7%
36.3%
28.7%
7.7%
0.5%
-0.1%
7.2%
2.9%
4.4%
61.7%
38.3%
28.9%
9.3%
0.5%
-0.1%
9.0%
3.6%
5.3%
9,796
6,004
4,582
1,422
74
(19)
1,367
342
$ 1,025
10,106
6,194
4,727
1,467
74
(19)
1,412
353
$ 1,059
10,416
6,384
4,872
1,512
74
(19)
1,457
364
$ 1,093
Note: 2016 and 2017 common size statements are reversed (2016 on the left). Forecasted
statements are presented for three different sales levels. The Gap’s statement forecasts are based
on (1) projected sales and (2) a set of assumptions that determine the relationship between various
expense items and sales revenue. The accuracy of the projection depends on the reliability of these
estimates, which depends on management’s ability to maintain a stable GPM ratio, maintain INVT
ratio, and control operating expense ETS ratios. It also depends on which costs are variable and
which are fixed. If SG&A expenses were fixed at the 2017 level regardless of 2018 sales, then the
forecasted statements would show a greater variation in profits as sales change.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-31
PROBLEMS
P5-36. (45 minutes)
LO 2, 3
($ millions)
Nike
a.
Adidas
EWI
$1,933 + $54 x (1 - 0.25) = $1,973.5
€1,100 + €93 x (1 - 0.30) = €1,165.10
Avg. Equity
($9,812 + $12,407) / 2 = $11,109.5
(€6,435 + €6,455) / 2 = €6,445
Avg. Assets
($22,536 + $23,259) / 2 = $22,897.5
(€14,522 + €15,176) / 2 = €14,849
ROE
$1,933 / $11,109.5 = 17.40%
€1,100 / €6,445 = 17.07%
ROA
$1,973.5 / $22,897.5 = 8.62%
€1,165.1 / €14,849 = 7.85%
ROFL
17.40% - 8.62% = 8.78%
17.07% - 7.85% = 9.22%
Nike’s performance on both measures of profitability exceeded that of Adidas, though not by a wide
margin. We can examine possible reasons for that difference by looking at the ratios below.
b.
PM
AT
$1,973.5 / $36,397 = 5.42%
$36,397 / $22,897.5 = 1.59
€1,165.1 / €21,218 = 5.49%
€21,218 / €14,849 = 1.43
Nike’s PM ratio is very slightly lower than Adidas’s, but its AT ratio is 11% higher. So, Nike’s higher ROA
appears to be driven by more efficient use of assets.
c.
GPM
Operating ETS
$15,956 / $36,397 = 43.8%
$11,511 / $36,397 = 31.6%
€10,703 / €21,218 = 50.4%
€8,634 / €21,218 = 40.7%
Adidas reports a higher GPM ratio than Nike by about 7%. However, that is more than offset by much
higher operating expenses as a percentage of sales.
d.
ART
INVT
PPET
$36,397 / $[(3,498 + 3,677) / 2] = 10.15
$20,441 / $[(5,261 + 5,055) / 2] = 3.96
$36,397 / $[(4,454 + 3,989) / 2] = 8.62
€21,218 / €[(2,315 + 2,200) / 2] = 9.40
€10,514 / €[(3,693 + 3,764) / 2] = 2.82
€21,218 / €[(2,000 + 1,915) / 2] = 10.84
Nike’s INVT is significantly higher than Adidas’s, suggesting that Nike may be managing inventory more
efficiently. Both companies’ PPET ratios are high. These are consistent with a business model that
outsources most of the production.
©Cambridge Business Publishers, 2020
1-32
Financial Accounting, 6th Edition
e. The two companies’ fiscal years overlap by seven months. Nike’s income statement includes
January through May 2018 while Adidas’ statements cover January through May 2017. (Both cover
June through December 2017.) Economic conditions were not materially different in 2018 than 2017,
so the comparisons involving income statement accounts shouldn’t be affected too much.
However, companies that experience seasonality will have balance sheets that look different at
different points in time. For instance, a company might have lower inventory levels just after a busy
season, and choosing that point for the end of its fiscal year would produce a higher value for ROA or
INVT than a fiscal year just prior to its busy season.
f.
Normally, we would want to identify any major differences in the valuation of assets and the
measurement of income between these two companies. For example, some assets are more likely to
be valued at current value (rather than historical cost) under IFRS reporting. Such a difference would
affect ratios such as ROA, AT, INVT and PPET.
P5-37. (20 minutes)
LO 4
($ millions)
a.
Current Ratio
Quick Ratio
Nike
Adidas
2017: $15,134 / $6,040 = 2.51
€8,645 / €6,291 = 1.37
2016: $16,061 / $5,474 = 2.93
€8,886 / €6,765 = 1.31
2017: $(4,249+996+3,498) / $6,040 = 1.45
€(1,598+398+2,315) / €6,291 = 0.69
2016: $(3,808+2,371+3,677) / $5,474 =
1.80
€(1,510+734+2,200) / €6,765 = 0.66
Nike is more liquid than Adidas. Its current ratio is around 2.5 and its quick ratio is near 1.5 – both values
close to the medians for the apparel industry. In fact, Nike’s quick ratio is higher than Adidas’s current ratio.
b.
TIE
Debt-to-Equity
2017: ($4,325 + $54) / $54 = 81.09
(€2,022 + €93) / €93 = 22.74
2016: ($4,886 + $59) / $59 = 83.81
(€1,536 + €74) / €74 = 21.76
2017: $12,724 / $9,812 = 1.30
€8,087 / €6,435 = 1.26
2016: $10,852 / $12,407 = 0.87
€8,721 / €6,455 = 1.35
Nike’s debt-to-equity ratio is very low with values close to the apparel industry average. But the ratio
increased significantly in 2017 when liabilities increased by $1.9 billion and equity decreased by about $2.6
billion. Adidas’s debt-to-equity ratio is higher, and also went up in 2017. Nike’s TIE ratio decreased while
Adidas’ ratio increased slightly.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-33
c.
Historically, Adidas relies on greater amounts of debt financing than does Nike, but their DE ratios
are essentially equivalent in this latest year. The TIE ratio for Nike is much higher than for Adidas.
Although Adidas’s TIE ratio is not too low, Nike’s small amount of interest expense produces a very
high TIE. Neither company should have difficulty meeting its debt obligations, but Adidas may not
be able to borrow as much in the future (if needed).
P5-38. (45 minutes)
LO 2, 3
($ millions)
a.
Home Depot
Lowe’s
EWI
$8,630 + $1,057 x (1 - 0.35) = $9,317.05
$3,447 + $649 x (1 - 0.35) = $3,868.85
Avg. Equity
($1,454 + $4,333) / 2 = $2,893.5
($5,873 + $6,434) / 2 = $6,153.5
Avg. Assets
($44,529 + $42,966) / 2 = $43,747.5
($35,291 + $34,408) / 2 = $34,849.5
ROE
$8,630 / $2,893.50 = 298.3%
$3,447 / $6,153.5 = 56.0%
ROA
$9,317.05 / $43,747.5 = 21.3%
$3,868.85 / $34,849.5 = 11.1%
ROFL
298.3% - 21.3% = 277.0%
56.0% - 11.1% = 44.9%
In 2017, Home Depot’s profitability exceeded that of Lowe’s, both in return to shareholders and in
return on assets. Home Depot also had a much larger proportional effect from the use of leverage. It
has shareholders’ equity that is only 17% of its current earnings – the result of large dividends and
share buybacks.
b.
PM
$9,317.05 / $100,904 = 9.2%
$3,868.85 / $68,619 = 5.6%
AT
$100,904 / $43,747.5 = 2.31
$68,619 / $34,849.5 = 1.97
Home Depot has a higher PM ratio, so it makes more money for every dollar of sales, and it also
generates more sales for every dollar of resources, suggesting that it is managing assets more
efficiently.
c.
GPM
$34,356 / $100,904 = 34.0%
$23,409 / $68,619 = 34.1%
Operating ETS
($17,864 + $1,811) / $100,904 = 19.5%
($15,376 + $1,447) / $68,619 = 24.5%
These two companies have identical gross profit margins, but The Home Depot’s operating ETS ratio
is lower by a significant amount (5% of sales, or $5 billion). Overall, Home Depot performed slightly
better with respect to these two profitability measures.
©Cambridge Business Publishers, 2020
1-34
Financial Accounting, 6th Edition
d.
($ millions)
Lowe’s
Home Depot
ART
$100,904 / $[(1,952 + 2,029)/2] = 50.69
$68,619 / 0 = N/A
INVT
$66,548 / $[(12,748 + 12,549)/2] = 5.26
$45,210 / $[(11,393 + 10,458)/2] = 4.14
PPET
$100,904 / $[(22,075 + 21,914)/2] = 4.59
$68,619 / $[(19,721 + 19,949)/2] = 3.46
Lowe’s reports no accounts receivable and Home Depot reports very small amounts of receivables.
Neither company relies on customer credit to generate sales, so the ART ratio is not very informative.
More important is the INVT ratio. Home Depot’s INVT is higher than Lowe’s ratio. The same is true
for the PPET ratio. These differences are consistent with the difference in the AT ratios noted earlier.
Overall, the numbers suggest that Home Depot is managing inventories and PPE assets more
efficiently.
e. Overall, It appears that Home Depot performed better than Lowe’s in 2017. Its ratio values are either
equal to or better than Lowe’s in almost every category.
P5-39. (30 minutes)
LO 4
($ millions)
a.
Home Depot
Lowe’s
Current Ratio
2017:
2016:
$18,933 / $16,194 = 1.17
$17,724 / $14,133 = 1.25
$12,772 / $12,096 = 1.06
$12,000 / $11,974 = 1.00
Quick Ratio
2017:
2016:
($3,595 + $1,952) / $16,194 = 0.343
($2,538 + $2,029) / $14,133 = 0.323
($588 + $102) / $12,096 = 0.057
($558 + $100) / $11,974 = 0.055
Both companies’ current ratios are above one, though Home Depot’s is a bit higher. Quick ratios are
very low due to the lack of receivables and low cash balances. Both companies rely on operating
cash flow to cover liquidity needs. Given the lack of receivables, the INVT ratio becomes doubly
important (see P5-38). Failure to turn inventories quickly would result in lower operating cash flow
and liquidity problems. Hence, both companies emphasize inventory management.
b.
TIE
Debt-to-Equity
2017:
2016:
($13,698 + $1,057)/$1,057 = 13.96
($12,491 + $972)/$972 = 13.85
($5,489 + $649)/$649 = 9.46
($5,201 + $657)/$657 = 8.92
2017:
2016:
$43,075 / $1,454 = 29.63
$38,633 / $4,333 = 8.92
$29,418 / $5,873 = 5.01
$27,974 / $6,434 = 4.35
For both companies, the debt-to-equity ratio increased from 2016 to 2017 indicating more reliance on
debt financing. In fact, The Home Depot had free cash flow over $10 billion in 2017, and it returned
$12.2 billion to shareholders in dividends and repurchases of common stock. Both companies’ DEs
are higher than the median for the retail industry. Despite this trend, both companies’ TIE ratios
increased.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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c.
The Home Depot utilizes more debt financing than does Lowe’s though both are higher than the
median retail firm. This results in a higher ROFL (see P5-38), as well as higher debt-to-equity. Both
firms have TIE ratios that are above the median for the retail industry.
P5-40.A (30 minutes)
LO 5
($millions)
Home Depot
Lowe’s
NOPAT
$8,630 – [($74 - $1,057) x (1 - 0.35)]
= $9,268.95
$3,447 – [($16 - $649) x (1 - 0.35)]
= $3,858.45
NOA 2017:
$44,529 - $(43,075 – 2,761 – 24,267)
= $28,482
$(35,291 - 102 - 408) - $(29,418 – 1,431 –
15,564) = $22,358
NOA 2016:
$42,966 - $(38,633 - 1,252– 22,349)
= $27,934
$(34,408 - 100 - 366) - $(27,974 – 1,305 –
14,394) = $21,667
Avg. NOA
($28,482 + $27,934) / 2 = $28,208
($22,358 + $21,667) / 2 = $22,012.5
b.
RNOA
$9,268.95 / $28,208 = 32.9%
$3,858.45 / $22,012.5 = 17.5%
c.
NOPM
$9,268.95 / $100,904 = 9.19%
$3,858.45 / $68,619 = 5.62%
NOAT
$100,904 / $28,208 = 3.58
$68,619 / $22,012.5 = 3.12
a.
d. The Home Depot reports a higher RNOA than does Lowe’s, and the pattern in the operating results
parallels that in the total-firm results in P5-38. This is consistent with the ROA numbers computed in
P5-38 (ROA=21.3% for Home Depot and 11.1% for Lowe’s). Overall, we would expect operating
companies to have higher RNOA than ROA, because their core business is the operations of the
company, not investing in financial assets. And, if management seeks to earn a favorable return for
shareholders, they must expect a higher return on their operations than they have to pay for borrowed
funds.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
P5-41. (30 minutes)
LO 2, 3
($ millions)
a.
2017
2016
EWI
$4,910 + $453 x (1 - 0.35) = $5,204.45
$3,431 + $381 x (1 - 0.35) = $3,678.65
Avg. Assets
($45,403 + $40,377) / 2 = $42,890.0
($40,377 + $38,311) / 2 = $39,344.0
ROA
$5,204.45/ $42,890.0= 12.1%
$3,678.65/ $39,344.0= 9.3%
PM
$5,204.45/ $65,872 = 7.9%
$3,678.65/ $60,906 = 6.0%
AT
$65,872 / $42,890.0 = 1.54
$60,906 / $39,344.0= 1.55
UPS’ ROA appears healthy in both years. Although AT decreased slightly in 2017, PM increased,
which caused a corresponding increase in ROA.
b.
Compensation ETS
$34,588 / $65,872 = 52.5%
$34,770 / $60,906 = 57.1%
The largest single expense on UPS’s income statement is compensation.
ratio from 57.1% to 52.5% of sales explains the rise in PM in 2017.
c.
d.
The decrease in this ETS
Avg. Equity
($1,030 + $429) / 2 = $729.5
($429 + $2,491) / 2 = $1,460.0
ROE
$4,910 / $729.5 = 673.1%
$3,431 / $1,460 = 235.0%
ROFL
673.1% - 12.1% = 661.0%
235.0% - 9.3% = 225.7%
UPS relies very heavily on debt financing. In 2017 and 2016, when ROA was at an acceptable level,
ROFL produced an ROE 25 to 55 times as large as ROA.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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P5-42. (30 minutes)
LO 4
($ millions)
a.
2017
2016
Current Ratio
$15,548 / $12,708 = 1.22
$13,849 / $11,730 = 1.18
Quick Ratio
$(3,320 + 749 + 8,773) / $12,708 = 1.01
$(3,476 + 1,091 + 7,695) / $11,730 = 1.05
UPS current and quick ratios changed little in 2017. The quick ratio is only slightly lower than the
current ratio because UPS does not carry inventory balances.
b.
TIE
($7,148 + $453) / $453 = 16.78
($5,136 + $381) / $381 = 14.48
Debt-to-Equity
$44,373 / $1,030 = 43.08
$39,948 / $429 = 93.12
The debt-to-equity ratio decreased dramatically in 2017 due to percentage change in shareholders’
equity exceeding that of liabilities. Nevertheless, a debt-to-equity ratio in the 40s is extremely high. At
the same time, the TIE ratio increased due to an increase in pre-tax earnings.
c.
UPS relies heavily on liability financing. The company’s current ratio and quick ratio are quite a bit
lower than the medians of the Business Services industry. Being a capital-intensive business, their
debt-to-equity ratio is significantly higher than the median. Although the company appears liquid, its
ability to meet its obligations depends heavily on operating cash flow. The high debt-to-equity ratio
suggests that UPS may have difficulty borrowing additional funds if needed.
P5-43.A (30 minutes)
LO 5
($ millions)
a. NOPAT
United Parcel Service (UPS)
$4,910 – [($72 – $453) x (1 – 0.35)] = $5,157.65
NOA
2017: $(45,403 – 749 - 483) - $(44,373 – 4,011 – 20,278) = $24,087
2016: $(40,377 – 1,091 - 476) - $(39,948 – 3,681 – 12,394) = $14,937
Avg. NOA
($24,087 + $14,937) / 2 = $19,512
b. RNOA
$5,157.65 / $19,512 = 26.4%
©Cambridge Business Publishers, 2020
1-38
Financial Accounting, 6th Edition
c.
NOPM
$5,157.65 / $65,872 = 7.8%
NOAT
$65,872 / $19,512.0 = 3.38
d. UPS invests only small amounts in non-operating assets (less than 3% of total assets). So, when
UPS invests borrowed funds in its operations, it earns a return above 20%, at least in 2017. Because
its borrowing costs are significantly less than 20%, the financial leverage works in favor of the
shareholders.
P5-44.B (45 minutes)
LO 6
a.
UNITED PARCEL SERVICE, INC.
Income Statements
($ millions)
2017
Actual
2018
Forecast
Revenue………………………………………………
$65,872
$70,000
Compensation and benefits………………………..
34,588
36,756
Other…………………………………………………..
23,755
25,244
Operating profit………………………………………
7,529
8,000
Investment income…………………………………..
72
72
Interest expense………………………………………
453
453
Income before income taxes………………………..
7,148
7,619
Income taxes…………………………………………..
2,238
1,905
Net income……………………………………………..
$ 4,910
$ 5,714
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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b.
UNITED PARCEL SERVICE, INC.
Balance Sheets
2017
Actual
($ millions)
2018
Forecast
Cash and equivalents………………………………….
$ 3,320
$ 3,844
Marketable securities…………………………………..
749
749
Accounts receivable, net………………………………
8,773
9,323
Other current assets…………………………………..
2,706
2,876
Total current assets……………………………………
15,548
16,792
Property, plant and equipment……………………….
22,118
23,504
Goodwill ………………………………………………
3,872
4,115
Intangible assets, net ………………………………
1,964
2,087
Non-current investments and restricted cash ………
483
483
Deferred income tax assets…………………………
265
282
Other assets…………………………….………………
1,153
1,225
Total assets……………………….…………………….
$45,403
$48,488
Current maturities of long-term debt…………………
$
4,011
$
4,011
Accounts payable……………………………………….
3,872
4,115
Accrued wages and withholdings…………………….
2,521
2,679
17
18
Self-insurance reserves, current portion……………..
Accrued group welfare and retirement plan contributions
……………………………………….
705
749
677
719
Other current liabilities…………………………………
905
962
Total current liabilities…………………………………
12,708
13,253
Long-term debt………………………….………………
20,278
20,278
Pension and postretirement obligation………………
7,061
7,503
Deferred taxes liabilities………………………………..
757
804
Self-insurance reserves ……………………………….
1,765
1,876
Other noncurrent liabilities……………………………..
1,804
1,917
Total liabilities…………………………………………...
44,373
45,631
Shareowners' equity……………………………………
1,030
2,857
Total liabilities and shareowners' equity……………..
$45,403
$48,488
Hedge margin liabilities
Students’ forecast calculations may vary. An unrounded forecast factor was used in the calculations
presented in the solution.
©Cambridge Business Publishers, 2020
1-40
Financial Accounting, 6th Edition
P5-45. (45 minutes)
LO 3
a. A summary of the ratios for these five companies appears in the following table. Calculations are
provided below for each company.
ABT
PM
GPM
BMY
JNJ
GSK
PFE
3.89%
5.72%
2.49%
9.15%
42.21%
54.96%
68.50%
66.84%
65.74%
78.61%
b. A summary of the ratios for these five companies appears in the following table. Calculations are
provided below for each company.
ABT
R&D ETS
SG&A ETS
c.
BMY
JNJ
GSK
PFE
8.16%
33.29%
13.81%
14.83%
14.57%
33.29%
24.34%
28.02%
32.04%
28.14%
What is perhaps most remarkable is how similar these five companies are. For example, the SG&A
ETS ratio ranges between 24% and 34%, with three of the five between 28% and just over 32%.
GPM ranges from a low of 55% (ABT) to 79% (PFE), but the other three firms are between 65% and
69%. This suggests that the business models employed by these companies are very similar. The
PM ratio shows a fairly wide variation, ranging from a low of 2.5% (JNJ) to 42.2% (PFE).
Interestingly, ABT appears to be one of the least profitable, with a 3.9% PM and a 55.0% GPM, yet it
spends the least on R&D. That pattern could be caused by the fact that ABT spun off its researchoriented pharmaceuticals into a separate company (AbbVie).
As an example, calculations of ratios for Abbott Laboratories follow:
($ millions)
Abbott Laboratories (ABT)
PM
$477 + $904 x (1 - 0.35) / $27,390 = 3.89%
GPM
($27,390 - $12,337) / $27,390 = 54.96%
R&D ETS
$2,235 / $27,390 = 8.16%
SG&A ETS
$9,117 / $27,390 = 33.29%
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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P5-46. (45 minutes)
LO 3
a.
Best Buy
Kroger
Nordstrom
Office
Depot
Walgreens
Boots
Return on assets (ROA)
7.85%
6.35%
3.52%
3.84%
8.20%
Profit margin (PM)
2.51%
1.91%
3.64%
2.22%
4.18%
Asset turnover (AT)
3.13
3.33
0.97
1.73
1.96
b.
AR turnover (ART)
Inventory turnover (INVT)
PP&E turnover (PPET)
Best Buy
Kroger
Nordstrom
Office
Depot
Walgreens
Boots
35.18
74.66
89.99
12.66
20.08
6.41
14.61
5.04
6.56
10.91
17.88
5.83
3.95
15.44
9.55
c.
Gross profit margin (GPM)
Best Buy
Kroger
Nordstrom
Office
Depot
Walgreens
Boots
23.4%
22.0%
36.1%
24.0%
23.4%
Nordstrom has the highest GPM (36.1%), but WBA has the highest ROA (8.20%) and PM (4.18%).
Nordstrom has the lowest AT (0.97), reflecting its “higher margin, lower volume” position. On the
other end of the spectrum, Kroger has the lowest PM (1.91%) and the highest AT and INVT,
Inventory management is critical for a grocery chain. All of these companies have high ART,
reflecting the fact that most of their customers pay at the time of purchase.
Retail companies have the choice to report inventory and cost of sales using last-in, first-out (LIFO) or
first-in, first-out (FIFO), which can affect margins and turnover ratios. We will look into this more
closely in Chapter 7. In addition, retail companies lease much of their store space. As a result, the
PPET ratio depends on how these store leases are reported in the balance sheet. Lease accounting
is discussed in Chapter 10.
continued next page
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
c.
continued
Calculations follow for Best Buy as an example ($ millions):
Best Buy (BBY)
EWI
$1,000 + $75 x (1-.25) = $1,056.25
ROA
$1,056.25 / $13,452.5 = 7.85%
PM
$1,056.25 / $42,151 = 2.51%
AT
$42,151 / $13,452.5 = 3.13
ART
$42,151 / $1,198 = 35.18
INVT
$32,275 / $5,036.5 = 6.41
PPET
$42,151 / $2,357 = 17.88
GPM
($42,151 - $32,275) / $42,151 = 23.4%
©Cambridge Business Publishers, 2020
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CASES and PROJECTS
C5-47. (30 minutes)
LO 3
a. Raising prices and/or reducing manufacturing costs are not necessarily independent solutions and
are likely related to other factors. The effect of a price increase on gross profit is a function of the
demand curve for the company’s product. If the demand curve is relatively elastic, a price increase
will likely significantly reduce demand, thereby decreasing, rather than increasing, gross profit (an
example is a 10% increase in price and a 20% decrease in demand). A price increase will have a
more desired effect if the demand curve is relatively inelastic (a 10% price increase with a 3%
decrease in demand).
Cutting manufacturing costs will positively affect gross profit (via reduction of COGS) if the more
inexpensively made product is not perceived to be of lesser quality, thereby reducing demand.
b. Raising prices is difficult in competitive markets. As the number of product substitutes increases,
companies are less able to raise prices. Rather, they must be able to effectively differentiate their
products in some manner in order to reduce consumers’ substitution. This can be accomplished, for
example, by product design and/or advertising. These efforts, however, likely entail additional cost,
and, while gross profit might be increased as a result, SG&A expense may also increase with little
effect on the bottom line.
Manufacturing costs consist of raw materials, labor and overhead. Each can be targeted for cost
reduction. A reduction of raw materials costs generally implies some reduction in product quality, but
not necessarily. It might be the case that the product contains features that are not in demand by
consumers. Eliminating those features will reduce product costs with little effect on selling price.
Similarly, companies can utilize less expensive sources of labor (off-shore production, for example),
that can significantly reduce product costs and increase gross profit provided that product quality is
maintained.
Finally, manufacturing overhead can be reduced by more efficient production. Wages and
depreciation expense are two significant components of manufacturing overhead. These are largely
fixed costs, and the per-unit product cost can often be reduced by increasing capacity utilization of
manufacturing facilities (provided, of course, that the increased inventory produced can be sold).
The bottom line is that increasing gross profit is a difficult process than can only be accomplished by
effective management and innovation.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
C5-48. (30 minutes)
LO 3
a. Working capital management is an important component of the management of a company. By
reducing the level of working capital, companies reduce the costs of carrying excess assets. This can
have a significantly positive effect on financial performance. Some common approaches to reducing
working capital via reductions in receivables and inventories, and increases in payables, include the
following:
•
Reduce receivables
o Constricting the payment terms on product sales
o Better credit policies that limit credit to high-risk customers
o Better reporting to identify delinquencies
o Automated notices to delinquent accounts
o Increased collection efforts
o Prepayment of orders or billing as milestones are reached
o Use of electronic (ACH) payment
o Use of third-party guarantors, including bank letters of credit
•
Reduce inventories
o Reduce inventory costs via less costly components (of equal quality), produce with lower
wage rates, eliminate product features (costs) not valued by customers
o Outsource production to reduce product cost and/or inventories the company must carry on
its balance sheet
o Reduce raw materials inventories via just-in-time deliveries
o Eliminate bottlenecks in manufacturing to reduce work-in-process inventories
o Reduce finished goods inventories by producing to order rather than producing to
estimated demand
•
Increase payables
o Extend the time for payment of low or no-cost payables—so long as the relationship with
suppliers is not harmed.
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b. The terms of payment that a company offers to its customers is a marketing tool, similar to product
price and advertising programs. Many companies promote payment terms separately from other
promotions (no payment for six months or interest-free financing, for example). As companies restrict
credit terms, the level of receivables will likely decrease, thereby reducing working capital. The
restriction of credit terms may also have the undesirable effect of reducing demand for the company’s
products. The cost of credit terms must be weighed against the benefits, and credit terms must be
managed with care so as to optimize costs rather than minimize them. Credit policy is as much art as
it is science.
Likewise, the depth and breadth of the inventories that companies carry impact customer perception.
At the extreme, inventory stock-outs result in not only the loss of current sales, but also the potential
loss of future sales as customers are introduced to competitors and may develop an impression of the
company as “thinly stocked.” Inventories are costly to maintain, as they must be financed, insured,
stocked, moved, and so forth. Reduction in inventory levels can reduce these costs. On the other
hand, the amount and type of inventories carried is a marketing decision and must be managed with
care so as to optimize the level inventories, not necessarily to minimize them.
One company’s account payable is another’s account receivable. So, just as one company seeks to
extend the time of payment, so as to reduce its working capital, so does the other company seek to
reduce the average collection period so as to accomplish the same objective. Capable, dependable
suppliers are a valuable resource for the company, and the supplier relation must be handled with
care. All companies take as long to pay their accounts payable as the supplier allows in its credit
terms. Extending the payment terms beyond that point begins to negatively impact the supplier
relation, ultimately resulting in the loss of the supplier. The supplier relation must be managed with
care so as to optimize the terms of payment, rather than necessarily to minimize them.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
C5-49. (30 minutes)
LO 2, 3
a. The list of parties that are affected by schemes to manage earnings is often much broader than first
thought. It includes the following affected parties:
1. employees above and below the level at which the scheme is implemented
2. stockholders and elected members of the board of directors
3. creditors of the company (suppliers and lenders) and their employees, stockholders, and boards
of directors
4. competitors of the company
5. the company’s independent auditors
6. regulators and taxing authorities
b. Managers often believe that earnings management activities will be short-lived, and will be curtailed
once its operations “turn around.” Often, this does not prove to be the case. Interviews with managers
and employees who have engaged in these activities often reveal that they started rather innocuously
(just managing earnings to “make the numbers” in one quarter), but, quickly, earnings management
became a slippery slope. Ultimately, the parties the company was trying to protect (shareholders, for
example) are hurt more than they would have been had the company reported its results correctly,
exposing problems early so that corrective action could be taken (possibly by removing managers) to
protect the broader stakeholders in the company.
c.
Company managers are just ordinary people. They desire to improve their compensation, which is
often linked to financial performance. Managers may act to maximize their current compensation at
the expense of long-term growth in shareholder value. The reduction in the average employment
period at all levels of the company has exacerbated the problem.
d. Unfortunately, the separation of ownership and control often leads to less informed shareholders who
are unable to effectively monitor the actions of the managers they have hired. To the extent that
compensation programs are linked to financial measures, managers can use the flexibility given to
them under GAAP to their benefit, even without violating GAAP per se. These actions can only be
uncovered by effective auditing and enforced by an effective audit committee of the board. Corporate
governance has grown considerably in importance following the accounting scandals of the early
2000s. The Sarbanes-Oxley Act mandates new levels of corporate governance. The stock market
and the courts are helping to enforce this mandate.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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Chapter 6
Reporting and Analyzing Revenues,
Receivables, and Operating Income
Learning Objectives – coverage by question
MiniExercises
Exercises
LO1 – Describe and apply the criteria
for determining when revenue is
recognized.
14, 15, 17
27, 28,
33, 40
LO2 – Illustrate revenue and expense
recognition when the transaction
involves future deliverables and/or
multiple elements.
17, 24, 25
27, 28, 31,
40, 41
47
LO3 – Illustrate revenue and expense
recognition for long-term projects.
13, 16
27 - 30
43
18 - 21, 23
34 - 38
45, 46
50
LO5 – Calculate return on net
operating assets, net operating profit
after taxes, net operating profit
margin, accounts receivable turnover,
and average collection period.
20, 22
32, 35, 39
42, 45
50
LO6 –Discuss earnings management
and explain how it affects analysis
and interpretation of financial
statements.
26
33
44
48, 49
39
42
51
LO4 – Estimate and account for
uncollectible accounts receivable.
LO7 Appendix 6A – Describe and
illustrate the reporting for nonrecurring
items.
Problems
Cases
and Projects
48, 49
48 - 50
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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QUESTIONS
Q6-1.
Revenue should be the amount of consideration that a firm expects to receive
for the performance obligations to the customer that it fulfilled during the period.
The revenue rules describe a five-step process. First, the contract (i.e.,
agreement) with the customer myst be identified. Then the firm’s distinct
performance obligations under the contract must be determined. Next, the
amount of consideration the the firm expects to receive must be estimated. If
there are multiple performance obligations, then the consideration must be
allocated to them based on their stand-alone selling prices. These steps are
completed at the commencement of the contract with the customer. Then, as
the firm fulfills a performance obligation, it should recognize as revenue the
amount that was allocated to the performance obligation..
For retailers, like Abercrombie & Fitch, revenue is generally earned when title
to the merchandise passes to the buyer (e.g., when the buyer takes possession
of the merchandise), because returns can be estimated. For companies
operating under long-term contracts, the performance obligation (e.g., to
construct an office building) is usually fulfilled over the period of construction.
Many such companies use the amount of cost incurred as a measure of the
fulfillment of the performance obligation. See the examples of The Gap and
Fluor in the chapter.
Q6-2.
Financial statement analysis is usually conducted for purposes of forecasting
future financial performance of the company. Discontinued operations are, by
definition, not expected to continue to affect the profits and cash flows of the
company. Accordingly, the financial statements separately report discontinued
operations from continuing operations to provide more useful measures of
financial performance and financial income. For example, yielding an income
measure that is more likely to persist into the future, and a net assets measure
absent discontinued items.
Q6-3.
Restructuring costs typically consist of two general categories: asset writedowns and accruals of liabilities. Asset write-downs reduce assets and are
recognized in the income statement as an expense that reduces income and,
thus, equity. Liability accruals create a liability, such as for anticipated
severance costs and exit costs, and yield a corresponding expense that
reduces income and equity.
Q6-4.
Big bath refers to an event in which a company records a nonrecurring loss in a
period of already depressed income. By deliberately reducing current period
earnings, the company removes future costs from the balance sheet or creates
‘reserves’ that can be used to increase future period earnings.
©Cambridge Business Publishers, 2020
1-50
Financial Accounting, 6th Edition
Q6-5.
Earnings management may be motivated by a desire to reach or exceed
previously stated earnings targets, to meet analysts’ expectations, or to
maintain steady growth in earnings from year to year. This desire to achieve
income goals may be motivated by the need to avoid violating covenants in
loan indentures or to maximize incentive-based compensation.
The tactics used to manage income involve transaction timing (recognizing a
gain or loss) and estimations that increase (or decrease) income to achieve a
target.
Q6-6.
Non-GAAP or Pro forma income adjusts GAAP income to eliminate (and
sometimes add) various items that the company believes do not (or do) reflect
its core operations. The SEC requires that GAAP income be reported together
with pro forma income. Yet, companies often report their GAAP income at the
very end of the earnings or press release, thus obfuscating their comparison
and focusing attention on the pro forma income.
It is because of this potential to confuse the reader about the true financial
performance of the company that the SEC has become concerned. Also, pro
forma numbers are not subject to accepted standards (and, thus, we observe
differing definitions over time and across companies), are not subject to usual
audit tests, and are subject to management latitude in what is and is not
included and how items are measured.
Q6-7.
Estimates are necessary in order to accurately measure and report income on
a timely basis. For example, in order to record periodic depreciation of longlived assets, one must estimate the useful life of the asset. Estimates allow
accountants to match revenues and expenses incurred in different periods. For
example, accountants estimate warranty costs so that the warranty expense is
matched against the corresponding sales revenue. If the accounting process
waited until no estimates were necessary, there would be a significant delay in
the reporting of financial results.
Q6-8.
When analysts publish earnings forecasts, these forecasts become a
benchmark against which some investors evaluate the company’s
performance. A company that fails to meet analysts’ forecasts may suffer a
stock price decline, even though earnings are higher than previous years’
earnings and overall performance is good. Consequently, management may
feel pressure to meet or slightly exceed analysts’ forecasts of earnings.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-51
Q6-9.
Bad debts expense is recorded in the income statement when the allowance for
uncollectible accounts is increased. If a company overestimates the allowance
account, net income will be understated on the income statement and accounts
receivable (net of the allowance account) will be underestimated on the
balance sheet. In future periods, such a company will not need to add as much
to its allowance account since it is already overestimated from that prior period
(or, it can reverse the existing excess allowance balance). As a result, future
net income will be higher.
On the other hand, if a company underestimates its allowance account, then
current net income will be overstated. In future periods, however, net income
will be understated as the company must add to the allowance account and
report higher bad debts expense.
Q6-10. There are several possible explanations for a decrease in the allowance
account. First, after an aging of accounts receivable, Wallace Company may
have determined that a smaller percentage of its receivables are past due.
Wallace Company may have changed its credit policy such that it is attracting
lower-risk customers than in the past. Second, experience may have indicated
that the percentages used to estimate uncollectibles was too high in previous
years. By correcting the estimated percentage of defaults, the estimated
uncollectibles would end up lower than in past years. Third, Wallace Company
may be managing earnings.
By lowering estimated uncollectibles, the
company can increase current earnings, but may end up reporting a loss in a
future year when write-offs exceed the balance in the allowance account.
Q6-11. Minimizing uncollectible accounts is not necessarily the best objective for
managing accounts receivable. That objective could be accomplished by not
offering to sell to customers on credit. The purpose of offering credit to
customers is to increase sales and profits. Losses from uncollectible accounts
are a cost of doing business. As long as the benefit (greater contribution to
profits due to increased sales) exceeds the cost (increased losses due to
uncollectibles) then a higher-risk credit policy which increases the amount of
uncollectible accounts would be a more profitable policy.
Q6-12. The number of defaults tends to rise and fall with the economy. For example,
in a recession, customers are more likely to default and companies take longer,
on average, to pay their bills than during a healthy economy. This would result
in higher estimated uncollectibles if the estimates are based on an aging of
accounts receivable.
For many companies, sales revenue also tends to decline during a recession.
If estimated uncollectibles are estimated as a percentage of sales, then the
estimate would tend to fall in a recession. This is contrary to the increase in the
number of defaults that occurs during a recession. Therefore, the percentage
of sales approach is not as sensitive to changing economic conditions as is
accounts receivable aging.
©Cambridge Business Publishers, 2020
1-52
Financial Accounting, 6th Edition
MINI EXERCISES
M6-13. (15 minutes)
LO 3
Year
2019
2020
2021
Total
a
b
c
Costs
Incurred
$ 400,000
1,000,000
500,000
$1,900,000
Performance Obligation Fulfilled Over Time
Revenue
Recognized
Percent of Total
(percentage of costs
Income
Expected costs
incurred  total
(revenue –
(rounded)
21%a
53%b
26%c
contract amount)
$ 525,000
1,325,000
650,000
$2,500,000
costs incurred)
$125,000
325,000
150,000
$600,000
$400,000 / $1,900,000
$1,000,000/ $1,900,000
$500,000 / $1,900,000
M6-14. (20 minutes)
LO 1
Company
GAP
Revenue recognition
When merchandise is given to the customer and returns can be
estimated (or the right of return period has expired).
Merck
When merchandise is transferred to the customer and returns
can be estimated (or the right of return period has expired). The
company will also establish a reserve and recognize expense
relating to uncollectible accounts receivable at the time the sale
is recorded.
When merchandise is transferred to the customer and the right
of return period, if any, has expired. The company will also
establish a reserve and recognize expense for uncollectible
accounts receivable and anticipated warranty costs at the time
the sale is recorded.
Interest is earned by the passage of time. Each period, Bank of
America accrues income on each of its loans and establishes a
receivable on its balance sheet.
Deere
Bank of America
Johnson Controls
Revenue is recognized under long-term contracts under the
cost-to-cost method as a measure of the fulfillment of
performance obligation over time.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M6-15. (15 minutes)
LO 1
The Unlimited can only recognize revenues once they have transferred the products to
the customer and the amount of returns can be estimated with sufficient accuracy.
Assuming that happens at the time of sale, it must estimate the proportion of product
that is likely to be returned and deduct that amount from gross sales for the period. In
this case, it would report $4.9 million in net revenue (98% of $5 million) for the period. If
The Unlimited does not have sufficient experience to estimate returns, then one would
question whether there is a substantive contract with the customer, and it should wait to
recognize revenue until the right of return period has elapsed.
M6-16. (20 minutes)
LO 3
a. Performance Obligation Fulfilled Over Time:
Year
Percent completed
Revenue
Expense:
Construction costs
Gross profit
2019
2020
2021
Total
30%
$12,000,000
50%
$20,000,000
20%
$8,000,000
$40,000,000
9,000,000
$3,000,000
15,000,000
$5,000,000
6,000,000
$2,000,000
30,000,000
$10,000,000
2021
$40,000,000
Total
$40,000,000
30,000,000
$10,000,000
30,000,000
$10,000,000
b. Performance Obligation Fulfilled At Delivery:
Year
Revenue
Expense:
Construction costs
Gross profit
2019
2020
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-55
M6-17. (20 minutes)
LO 1, 2
a. A.J. Smith should recognize the warranty revenue as it is earned. Since the
warranties provide coverage for three years beginning in 2020, one-third of the
revenue should be recognized in 2020, one-third in 2021, and the remaining third in
2022.
b.
Year
Revenue
Warranty expenses
Gross profit
2020
$566,666
166,666
$400,000
2021
$566,667
166,667
$400,000
2022
$566,667
166,667
$400,000
Total
$1,700,000
500,000
$1,200,000
c. Total revenue from sales of the camera packages is $79,800 ($399 x 200). The
revenue is allocated among the three elements of the sale (camera, printer and
warranty) as follows:
Element
Camera
Printer
Warranty
Total
Retail Price
$300
125
75
$500
Proportion of Total
60% ($300/$500)
25% ($125/$500)
15% ($75/$500)
100%
Using these proportions, the revenue is allocated among the three elements and
recognized for each element as it is earned. In this case, the portion of the revenue
allocated to the camera and printer are recognized immediately, while the revenue
allocated to the warranty is deferred and recognized over the three-year warranty
coverage period.
Year
2020
2021
2022
2023
Total
Revenue
$67,830
3,990
3,990
3,990
$79,800
($79,800 x 0.6) + ($79,800 x 0.25)
($79,800 x 0.15) / 3
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M6-18. (15 minutes)
LO 4
a. To bring the allowance to the desired balance of $2,100, the company will need to
increase the allowance account by $1,600, resulting in bad debts expense of that
same amount.
b. The net amount of Accounts Receivable is calculated as follows: $98,000 − $2,100
= $95,900.
c.
- Allowance for Doubtful Accounts (XA) +
500
Balance
1,600
(a)
2,100
Balance
(a)
+ Bad Debts Expense (E) 1,600
Balance
1,600
M6-19. (15 minutes)
LO 4
a. Credit losses are incurred in the process of generating sales revenue. Specific
losses may not be known until many months after the sale. A company sets up an
allowance for uncollectible accounts to place the expense of uncollectible accounts
in the same accounting period as the sale and to report accounts receivable at its
estimated realizable value at the end of the accounting period.
b. The balance sheet presentation shows the gross amount of accounts receivable, the
allowance amount, and the difference between the two, the estimated net realizable
value. The balance sheet, thus, reports the net amount that we expect to collect.
That is the amount that is the most relevant to financial statement users.
c. The rule for expense recognition is that expenses are recognized when assets are
diminished (or liabilities increased) as a result of earning revenue or supporting
operations, even if there is no immediate decrease in cash. This dictates the use of
the allowance method. Recognition of expense only upon the write-off of the account
would delay the reporting of our knowledge that losses are likely and, thereby,
reduce the informativeness of the income statement. Accountants believe that
providing more timely information justifies the use of estimates that may not be as
precise as we would like.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-57
M6-20. (20 minutes)
LO 4, 5
a.
($ millions)
2018
2017
Accounts receivable (net) .............................................$421.4
$450.2
Allowance for returns and uncollectible
222.2
accounts ....................................................................
214.4
Gross accounts receivable ...........................................$643.6
$664.6
Percentage of uncollectible accounts to gross
accounts receivable ................................................... 3.1%
($19.7/$643.6 )
1.7%
($11.6/$664.6)
b. In general, an increase in the allowance for uncollectible accounts as a percentage
of gross accounts receivable may indicate that the quality of the accounts receivable
has declined, perhaps because the economy has declined, the company is selling to
a less creditworthy class of customers, or the company’s management of accounts
receivable is less effective. Ralph Lauren’s three biggest wholesale customers
accounted for 19% of sales in 2018 and 29% of receivables at the end of March
2018. The declining fortunes of traditional retailers may account for the increase in
the allowance for uncollectibles. It may also indicate, however, that the receivables
were under-reserved (e.g., allowance account was too low in 2017). This would
result in lower reported profits in 2018 because past profits were too high. It is also
possible that credit quality has not changed and that the amount recorded in prior
years is correct, but that management has incentives to record less income in 2018.
c. $6,182.3/[($421.4+$450.2)/2] = 14.19 times
365/14.19 = 25.73 days
M6-21. (10 minutes)
LO 4
Bad debts expense of $2,400 ($120,000 × 0.02) would cause the allowance for
uncollectibles to increase by the same amount. If the allowance increased by only
$2,100 for the period, Sloan Company must have written off accounts totaling $300. In
computing accounts receivable, sales revenue increased the account by $120,000, and
the write-offs would decrease it by $300. If there was a net increase of $15,000 for the
period, Sloan Company must have collected $104,700 in cash. ($104,700 = $120,000 $300 - $15,000.)
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M6-22. (20 minutes)
LO 5
a.
Accounts Receivable Turnover
Average Collection Period
Procter &
Gamble
$66,832/ [($4,686 +$4,594)/2]
365 / 14.4 = 25.3 days
ColgatePalmolive
$15,454 / [($1,480+$1,411)/2]
= 14.4 times
365 / 10.7 = 34.1 days
= 10.7 times
b. P&G turns its accounts receivable faster than Colgate-Palmolive. Receivable turns
typically evolve to an equilibrium level for each industry that arises from the general
business models used by industry competitors. Differences can arise due to
variations in the product mix of competitors, the types of customers they sell to, their
willingness to offer discounts for early payment, and their relative strength vis-à-vis
the companies or individuals owing them money.
Also, the size of the firm may affect the ability of a company to exert bargaining
power over major suppliers or customers. For instance, both of these companies sell
a significant amount of their product to Walmart. P&G is a sizable company, and
may have greater bargaining power over Walmart than does the smaller ColgatePalmolive.
One other possibility is that the difference is due to the companies’ differing fiscal
year-ends. If the receivable balance is not constant during the year due to some
seasonality, then the receivable turnover ratio will depend on the choice of fiscal
year.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-59
M6-23. (20 minutes)
LO 4
a.
i.
ii.
Accounts receivable (+A) ………………………………………
Sales revenue (+R, +SE) …………………………..……
Bad debts expense (+E, -SE)
3,200,000
3,200,000
42,000
…………………………………
Allowance for uncollectible accounts (+XA, -A)…….
iii.
iv.
v.
42,000
Allowance for uncollectible accounts (-XA, +A) ……….
Accounts receivable (-A) …………………………………..
39,000
Accounts receivable (+A) ………………………………………
Allowance for uncollectible accounts (+XA, -A)
12,000
Cash (+A) …..………………………………………………………
Accounts receivable (-A) …………………………………
12,000
39,000
12,000
12,000
The recovered receivable is reinstated, so that its payment may be properly
recorded.
b. Besides the $12,000 in recovery, the collections from customers can be summarized
in the following entry:
vi.
Cash (+A)
Accounts receivable (-A)
2,926,000
2,926,000
(This amount includes payment of the recovered receivable for $12,000. The
allowance increases by $15,000 over the period, so the fact that net receivables
increased by $220,000 means that gross receivables must have increased by
$235,000. That fact allows us to “back out” the cash received.)
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
c.
+
(v)
(vi)
(i)
(iv)
(iii)
Cash (A) 12,000
2,926,000
2,938,000
+ Accounts Receivable (A) 3,200,000
12,000
39,000
12,000
2,926,000
235,000
Allowance for Uncollectibles (XA)
42,000
39,000
12,000
15,000
-
+
(ii)
Sales Revenue (R) +
3,200,000
Bad Debts Expense (E)
42,000
(i)
-
(iii)
(v)
(vi)
+
(ii)
(iv)
d.
Balance Sheet
Transaction
Cash
Asset
i. Sales on
account.
+
Noncash
Assets
+3,200,000 Accounts
Receivable
ii. Bad debts
expense.
-
-39,000
-
Accounts
Receivable
iv. Reinstate
account
previously
written off.
vi. Collect
cash on
sales.
+42,000
=
=
=
Allowance for
Uncollectible
Accounts
iii. Write-off of
uncollectibl
e accounts.
v. Collect
reinstated
account.
Contra
Assets
+12,000
+2,926,000
Cash
-12,000
+
Contrib.
Capital
+
Earned
Capital
+3,200,000
Retained
Earnings
-42,000
Revenues
- Expenses =
+3,200,000
-
-
Retained
Earnings
=
-
+12,000
= +3,200,000
+42,000
=
Bad Debts
Expense
-
=
-
=
-
=
-
=
Allowance for
Uncollectible
Accounts
-
Accounts
Receivable
-2,926,000 -
=
Accounts
Receivable
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
Net
Income
Sales
Revenue
Allowance for
Uncollectible
Accounts
Accounts
Receivable
+12,000
Cash
-39,000
Liabilities
Income Statement
1-61
-42,000
M6-24. (20 minutes)
LO 2
a.
Fiscal Year
2018
2019
2020
2021
Revenue
$48,000
55,000
62,000
62,000
Revenue Growth
14.6%
12.7%
0.0%
b.
Fiscal
Year Revenue
2018
$48,000
2019
55,000
2020
62,000
2021
62,000
(end of year)
Customer Purchases =
Revenue + Change in
Unearned Revenue Liability
Growth in
Customer
Purchases
$20,000
24,000
26,000
25,000
55,000 + 4,000 = 59,000
62,000 + 2,000 = 64,000
62,000 - 1,000 = 61,000
8.5%
-4.7%
Unearned
Revenue Liability
c. In both fiscal year 2020 and 2021, the growth in customer purchases is lower than
the growth in reported revenues. The practice of deferring revenue recognition
implies that reported revenues in a given period are the result of customer
purchases over many periods, resulting in a smoothing of revenues. In the case of
Finn Publishing, revenues in any given year are the result of newsstand and
bookstore purchases during that year, plus part of the subscriptions from that year,
plus part of the subscriptions from the previous year. That means that growth in
annual revenues is a composite of growth in customer purchases over an even
longer period of time.
For 2020 and 2021, Finn’s growth in revenues exceeds the growth in customer
purchases because the revenues are still reflecting growth from prior periods.
Purchases are a “leading indicator” of revenues, and thus, calculating customer
purchase behavior can be useful in forecasting future revenue and identifying
changes in customers’ attitudes about a company’s current offerings.
©Cambridge Business Publishers, 2020
1-62
Financial Accounting, 6th Edition
M6-25. (15 minutes)
LO 2
This question is based on an actual situation, in which the accounting rules were
influencing the product decisions. The rules for revenue deferral when there are
multiple deliverables (i.e., multiple performance obligations) deterred the company from
providing enhancements and upgrades that were available. If Commtech’s customers
(the wireless companies) had been willing to pay for the upgrades to their customers’
phones, that would have been allowed. (It’s not clear what the wireless companies’
incentives would be, because they may want to encourage users to purchase new
phones – with a new service contract – rather than improving their existing phones.)
The question can generate a discussion about whether accounting should drive
decisions. Whether it should or not, it does, so the question should evolve into what top
management should do about this type of situation. Does the situation described in the
problem require some managerial action, or not. Is the company foregoing sales
because of its accounting? Within Commtech, the finance staff was skeptical of
marketing’s predictions that the upgrades and enhancements would increase the sales
of existing phone models. If the upgrades and enhancements are delivered, Commtech
will have to change its accounting for revenue, with a resulting decrease in near-term
profitability. How might the company communicate that change in a way that the
investing public will understand as a net benefit to the company?
M6-26 (20 minutes)
LO 6
a. Verdi Co. would report stable sales because extending sales to lower credit quality
customers broadens the customer pool and thus Verdi Co. can sell the same
number of computers year over year.
b. Verdi Co. should have disclosed that is was selling to higher credit risk customers.
At a minimum, Verdi Co. should have estimated a larger expected bad debts
expense related to these customers. (If the credit quality was so poor, Verdi Co. may
even consider not reporting the revenue on the grounds that the agreement with the
customer lacked commercial substance).
c. In future periods when it is revealed that customers cannot pay for the computers,
Verdi Co. will have to write off the related accounts receivable. If these bad debts
were not reserved for early via the bad debts expense and allowance for doubtful
accounts, then Verdi Co. will have to record bad debts expense when the debt goes
bad. This will result in an expense in a year different than the reported revenue and
will supress future earnings, potentially significantly.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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EXERCISES
E6-27. (20 minutes)
LO 1, 2, 3
Company
Revenue Recognition
a. L Brands
When merchandise is given to the customer and returns can be
estimated (or the right of return period has expired).
b. Boeing
Corporation
Revenue is recognized under long-term government contracts
under the cost-to-cost (percentage-of-completion) method.
c. SUPERVALU
When merchandise is given to the customer and cash is
received.
d. Real estate
developer
When title to a house is transferred to the buyers.
e. Wells Fargo
Interest is earned by the passage of time. Each period, Wells
Fargo accrues income on each of its loans and establishes an
account receivable on its balance sheet.
f. Harley-Davidson When title to the motorcycles is transferred to the buyer. Harley
will also set up a reserve for anticipated warranty costs and
recognize the expected warranty cost expense when it
recognizes the sales revenue.
g. Gannett Co.
When the publications are sent to subscribers.
©Cambridge Business Publishers, 2020
1-64
Financial Accounting, 6th Edition
E6-28. (15 minutes)
LO 1, 2, 3
April 6
May 31
June 15
July 15
July 31
DR Cash (+A)
CR Contract liability (+L)
$40,000
DR Contract liability (-L)
DR Accounts receivable (+A)
DR Contract asset (+A)
CR Revenue (+R, +SE)
$40,000
$50,000
$30,000
DR Cash (+A)
CR Accounts receivable (-A)
$50,000
$40,000
$120,000
$50,000
DR Accounts receivable (+A)
CR Contract asset (-A)
CR Revenue (+R, +SE)
$110,000
DR Cash (+A)
CR Accounts receivable (-A)
$110,000
$30,000
$80,000
$110,000
On May 31, Haskins is entitled to payment of $50,000, but it has earned revenue of
$120,000. That is, it expects to receive consideration of $120,000 for the 120 units that
it has delivered to Skaife. The contract asset represents consideration that Haskins has
earned, but which is contingent on future events (i.e., delivery of the remaining 80
units).
E6-29. (20 minutes)
LO 3
($ millions)
a. Performance obligation fulfilled over time
b. Performance obligation
with cost-to-cost method
Revenue recognized
(percentage of costs
incurred  total
contract amount)
fulfilled at a point in time.
Year
Costs
incurred
Percent
of total
expected
costs
Income
(revenue
– costs
incurred)
2019
$100
25%
$125
$ 25
2020
300
75%
375
75
500
100
$400
100%
$500
$100
$500
$100
Revenue
recognized
$
0
Income
$
c. Any ratios involving revenues (Profit margin or Accounts receivable turnover would
be affected. Ratios based on any measure of profit would show more variation in
the method in part (b), The cumulative effect on net income would cause retained
earnings to be higher (or at least never lower) under the method in part (a), affecting
the debt-to-equity ratio and the return on shareholders’ equity.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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0
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E6-30. (30 minutes)
LO 3
a. Design/Engineering
Year Cost incurred % Completed Revenue Margin
1
7.00
70.0%
10.50
3.50
2
2.00
20.0%
3.00
1.00
3
1.00
10.0%
1.50
0.50
10.00
100.0%
15.00
5.00
Margin %
33.3%
33.3%
33.3%
Construction
Year Cost incurred % Completed Revenue Margin
1
0.00
0.0%
0.00
0.00
2
15.00
60.0%
18.00
3.00
3
10.00
40.0%
12.00
2.00
25.00
100.0%
30.00
5.00
Margin %
NA
16.7%
16.7%
Sum
Year
1
2
3
b. Combined
Year
1
2
3
Total
7.00
17.00
11.00
35.00
7.00
17.00
11.00
35.00
20.0%
48.6%
31.4%
100.0%
10.50
21.00
13.50
45.00
3.50
4.00
2.50
10.00
33.3%
19.0%
18.5%
9.00
21.87
14.13
45.00
2.00
4.87
3.13
10.00
22.2%
22.3%
22.2%
c. Treating the two activities as distinct performance obligations causes the
design/engineering activities to report a margin of 33.3%, while the construction
activities have a margin of 16.7%. When the design/engineering activities are
greater than the construction activities, the margin will be higher. When the activities
are viewed as a single performance obligation, the margins are “homogenized” into
a combined rate of 22.2%.
Treating the two activities as separate performance obligations results in more
variation in the margin reported. In addition, it would lower the debt-to-equity ratio.
Earlier recognition of revenue and profit would cause shareholders’ equity to be
higher earlier in the contract, with no impact on the liabilities, resulting in lower debtto-equity.
©Cambridge Business Publishers, 2020
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E6-31. (15 minutes)
LO 2
a. Multiple element arrangements are sales transactions in which two or more
performance obligations (deliverables) are “bundled” together and sold for one price.
The revenue should be recognized on each performance obligation as it is fulfilled.
This involves first assigning a portion of the sales revenue to each performance
obligation and then recognizing each portion of the revenue only when that
obligation has been fulfilled. i.e., delivered to the customer.
b. The total revenue for the “bundle” is $200. However the Fire, if sold alone sells for
$110 and the Amazon Prime membership sells for $120, which brings the total
“value” to $230. Thus, the Fire tablet represents 47.83% of the total value of the
bundle ($110/$230). Amazon should recognize $95.65 at the time of the sale
(47.83% of the $200 sale price) and defer the remaining $104.35. Over the
remainder of the quarter, Amazon would recognize one-fourth of this amount as
revenue from the Amazon Prime membership.
c.
Cash
Asset
Transaction
To record bundled sale
transaction on July 1
+200
Balance Sheet
Noncash
Contrib.
+
= Liabilities +
+
Assets
Capital
+
To recognize Prime
revenue at end of
quarter
=
+104.35
Unearned
revenue
+95.62
Retained
earnings
Sales
revenue
-$26.09
+$26.09
+$26.09
Unearned
revenue
Retained
earnings
Sales
revenue
Unearned revenue (-L)
Sales revenue (+R, +SE)
+
Revenues - Expenses =
+95.65
Cash (+A)
Sales revenue (+R, +SE)
Unearned revenue (+L)
+
Income Statement
Earned
Capital
-
Net
Income
=
+95.65
+$26.09
200.00
95.65
104.35
26.09
26.09
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E6-32. (15 minutes)
LO 5
a. 2016: €4,363 – [€0 – €432 x (1- 0.30)] = $4,665.40
2017: €5,616 – [€0 – €179 x (1- 0.30)] = $5,741.30
b. 2016: €4,665.40/€37,600 = .1241 or 12.41%
2017: €5,741.30/€42,636 = .1347 or 13.47%
c. €5,741.30/ [(€67,246 - €26,714 + €58,504 - €24,340) / 2] = .1537 or 15.37%
E6-33. (15 minutes)
LO 1, 6
a. There is not yet a contract with the customer that meets the company’s normal
business practice,” so revenue would not be recognized.
b. The performance obligation – to deliver customized units to the customer – has not
yet been fulfilled. The product has been shipped, but not to the customer and not
with the specified customizations that are required by the customer.
c. The company could recognize revenue using the expected amount of
“consideration” that it will receive from the customer. (Prior to ASC 606, the revenue
could not be recognized because the price is not yet fixed or determinable.)
d. The distributor does not have the means to pay for the items delivered, so
collectability cannot be reasonably assured (until the distributor sells the product to
an end customer). Again, there would be a question as to whether a contract exists
with the distributor.
©Cambridge Business Publishers, 2020
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E6-34. (20 minutes)
LO 4
a. Prior to the aging of accounts, the balance in the Allowance for Uncollectible
Accounts would be a credit of $520 (the opening balance of $4,350 less the amounts
written off of $3,830).
2019 bad debts expense computation
$250,000  0.5%
$ 90,000  1%
20,000  2%
11,000  5%
6,000  10%
4,000  25%
Less: Unused balance before adjustment
Bad debts expense for 2019
=
=
=
=
=
=
$1,250
900
400
550
600
1,000
4,700
520
$4,180
b. Accounts receivable, net = $381,000 - $4,700 = $376,300
Reported in the balance sheet as follows:
Accounts receivable, net of $4,700 in allowances ...................................
$376,300
c.
+
(a)
Bad Debts Expense (E)
4,180
-
- Allowance for Uncollectible Accounts (XA) +
4,350
Balance
Write-offs
3,830
4,180
(a)
4,700
Balance
d. If the write-offs had been $1000 higher, so too would be the bad debt expense. And,
if the write-offs had been $1000 lower, the bad debt expense would have been
$1000 lower. The aging of accounts determines the end-of-period balance sheet
value, which is combined with the beginning-of-period value and the write-offs during
the period to determine the bad debt expense. Any difference between the bad debt
expectations and the actual bad debt experience is corrected in this process.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E6-35. (25 minutes)
LO 4, 5
a. Allowance for doubtful accounts (-XA)
Accounts receivable (-A)
2.6
2.6
Provision for doubtful accounts (+E,-SE)
Allowance for doubtful accounts (+XA)
2.5
2.5
The provision for doubtful accounts (bad debts expense) has the effect of
decreasing Steelcase’s reported income by $2.5 million for the year. The write-off of
$2.6 million of uncollectible accounts has no direct effect on income.
b.
Accounts receivable, net
Allowance for doubtful accounts
2018
300.3
11.1
2017
307.6
11.2
Gross receivables (net plus allowance)
$311.4
$318.8
Allowance as a % of gross receivables
3.56%
3.51%
c. $3,055.5 / [($300.3 + $307.6) / 2] = 10.1 times.
d. $3,055.5 + ($28.2 - $15.9) – ($300.3 - $307.6) – $2.5 = $3,072.6.
E6-36. (15 minutes)
LO 4
Accounts receivable
Less Allowance for uncollectible accounts
$138,100
10,384
$127,716
Computations
Accounts
Receivable
Beginning balance
Sales
Collections
Write-offs ($3,600 + $2,400 +$900)
Provision for uncollectibles ($1,173,000  0.8%)
$
122,000
1,173,000
(1,150,000)
(6,900)
_________
$ 138,100
Allowance for
Uncollectible Accounts
$ 7,900
(6,900)
9,384
$ 10,384
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-71
E6-37. (20 minutes)
LO 4
a. Aging schedule at December 31, 2016
Current
$304,000  1% = $ 3,040
0–60 days past due
44,000  5% =
2,200
61–180 days past due
18,000  15% =
2,700
Over 180 days past due
9,000  40% =
3,600
Amount required
11,540
Balance of allowance
4,200
Provision
$ 7,340 = 2019 bad debts expense
b. Current Assets
Accounts receivable
Less: Allowance for uncollectible accounts
$375,000
11,540
$363,460
c.
+
(a)
Bad Debts Expense (E)
7,340
-
- Allowance for Uncollectible Accounts (XA) +
4,200
Balance
7,340
(a)
11,540
Balance
E6-38. (30 minutes)
LO 4
a.
Year
2018
2019
2020
Total
Sales
$ 751,000
876,000
972,000
$2,599,000
Collections
$ 733,000
864,000
938,000
$2,535,000
Accounts Written Off
$ 5,300
5,800
6,500
$17,600
Accounts Receivable at the end of 2020 is $46,400, computed as:
($2,599,000 - $2,535,000 - $17,600).
Bad Debts Expense is:
2018
2019
2020
208-2020
$ 7,510
8,760
9,720
$25,990
computed as 1%  $751,000
computed as 1%  $876,000
computed as 1%  $972,000
computed as 1%  $2,599,000
Allowance for Uncollectible Accounts is $8,390 computed as:
$25,990 total bad debts expense less $17,600 in total write-offs.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-73
b.
Beg Bal
Sales
2018 Bal
Sales
2019 Bal
Sales
2020 Bal
Accounts Receivable (A)
0
751,000
5,300
Write offs
733,000
Collections
12,700
876,000
5,800
Write offs
864,000
Collections
18,900
972,000
6,500
Write offs
938,000
Collections
46,400
Allowance for Uncollectibles (XA)
0
Beg Bal
Write offs
5,300
7,510 Bad debts exp.
Write offs
5,800
2,210
8,760
2018 Bal
Bad debts exp.
Write offs
6,500
5,170
9,720
2019 Bal
Bad debts exp.
8,390
2020 Bal
There isn’t any indication that the 1% rate is incorrect. If the rate is too high, we would
expect the allowance to grow at a faster rate than receivables. If the rate is too low, the
opposite would occur. In this case, the allowance percentage of receivables is 17%,
27% and 18% at the end of 2018, 2019 and 2020, respectively. So, there is no clear
direction that would indicate an inappropriate estimate.
E6-39. (20 minutes)
LO 5, 7
a.
Personal Systems
Printing
Earnings
from
Operations
$1,213
3,161
Corporate Investments
(87)
End.
Assets
$12,156
10,548
3
Beg.
Avg.
Assets
Assets
$ 10,686 $11,421.0
9,959 10,253.5
1
2
Return on
Capital
Employed
10.6%
30.8%
(4,350.0)%
b. The most profitable group is Printing, which represents HP’s traditional strength.
However, it is not growing (based on a small sales percentage increase in 2017). The
Personal Systems (commercial and personal PCs, workstations, calculators, etc.) also
has a good return on capital employed. Corporate Investments is described by the
company as including HP Labs and cloud-related business incubation projects. The
negative return makes sense as this sounds like new businesses and R&D within HP.
c. The activities in Corporate Investments are reducing profits in the present, but they are
vital to the long-run competitive health of the company. An operating manager might
have a short-term horizon and be tempted to reduce the resources devoted to these
activities. Keeping it separate allows top management (which should have the longestrun horizon) to keep a close eye on it.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E6-40. (20 minutes)
LO 1, 2
a. Just like for-profit organizations, not-for-profit organizations cannot recognize
revenue until it has been earned. In the case of The Metropolitan Opera, it cannot
recognize the ticket revenue until the performances occur. (The Metropolitan Opera
does not issue quarterly reports, so we cannot observe how much of the revenue
has been earned part way through its fiscal year.)
b. This entry is simplified by the fact the fiscal year-end is after the end of the current
season and by assuming that all of The Metropolitan Opera’s deferred revenue
relates to the following season (and none to any years after the following season).
To record revenue for the fiscal year 2017 season:
Deferred revenue (-L)
Cash or Accounts receivable (+A)
Revenues (+R, +NA)
46,609
41,905
88,514
(As a not-for-profit, The Metropolitan Opera does not have shareholders’ equity, but
rather “net assets.” Therefore, the recognition of revenue increases net assets (NA)
on the balance sheet.)
To record advance purchases for the fiscal year 2018 season:
Cash or Accounts receivable (+A)
42,649
Deferred revenue (+L)
42,649
c. The Metropolitan Opera usually operates close to seating capacity. And, in a typical
year, more than one-half of its seats are sold before the season. The quantity of
unsold seats will affect The Metropolitan Opera’s marketing efforts for subscribers
who have not yet renewed, outreach to new potential subscribers and promotions for
individual tickets which go on sale shortly before the season. Those efforts can be
scaled up or down depending on the experience with advance sales.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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E6-41. (20 minutes)
LO 2
a. Membership fees are initially recorded as a liability (deferred revenue) and
recognized on a straight-line basis over the membership term (12 months). BJ’s
obligation is to provide access to its clubs, its website, and its gas stations over the
membership period, so the value transferred to the member is provided on a
straight-line basis.
b.
Cash (+A)
Deferred membership fees (+L)
142.1
Deferred membership fees (-L)
Membership fee revenue (+R, +SE)
138.4
142.1
138.4
The latter entry can be inferred from the information on membership fee revenue in
the income statement. The former entry can be inferred by noting that the Deferred
membership fee liability increased by $3.7 million over the period. Therefore, the
sales of memberships exceeded the revenue from memberships by $3.7 million.
c. When a customer spends $100 in the rewards program, they are entitled to $2 in
cash back. This reduces the value of the consideration that BJ’s receives from the
customer’s purchase from $100 to $98. The $2 would be provided to the member in
electronic awards in $20 increments. So, the entry would be the following:
Cash
100
Revenue
Payable to member
98
2
Once the member reaches the $20 mark, the payable would be debited and cash
would be credited.
©Cambridge Business Publishers, 2020
1-76
Financial Accounting, 6th Edition
PROBLEMS
P6-42.A (20 minutes)
LO 5, 7
a. The following items might be considered to be operating:
1. Net Sales, cost of sales, R&D expenses, and SG&A expenses are typically
designated as operating.
2. Amortization of intangible assets, integration and separation costs, and
restructuring charges would usually be considered to be operating under the
assumptions that the acquisition that gave rise to the intangible assets is included
as part of operations, and that the restructuring did not involve discontinuation of
distinct parts of the business.
3. The asbestos-related charge, restructuring charges and goodwill impairment
losses would be considered to be operating since they are related to DowDuPont’s
operating activities. (These items are both operating and nonrecurring – see b.)
4. Equity in earnings of nonconsolidated affiliates would be considered operating
under the assumption that the affiliates are related to DowDuPont’s core
operations, which is typically the case.
5. Sundry income would generally be considered nonoperating in the absence of a
footnote clearly indicating its connection to the operating activities of the company.
6. Interest expense and amortization of debt discount is nonoperating.
b. The following items might be identified as nonrecurring items:
1. Asbestos-related charges – this is an accrual of an expense due to increased
asbestos-related liability related to Union Carbide Corporation, a wholly-owned
subsidiary of the company. More specifically, it is primarily due to higher
mesothelioma claim activity relative to forecasts of such activity. GAAP requires
such an accrual if the loss is probable and can be reasonably estimated. Since it is
a one-time occurrence, it can be considered to be a transitory item.
2. Goodwill and other asset impairment losses – this loss results from changes in
expectations of the performance of past acquisitions. It would be considered
operating, but transitory.
3. Restructuring charges (credits) – The $3,280 million resturcturing charge for 2017
reflects the actions following the Dow/DuPont merger, a goodwill impairment
charge of $1,491 million and $939 million impairment relating to a facility in Brazil.
Restructuring costs are considered “special items,” meaning that individually they
are transitory, but as a category, they happen frequently.
©Cambridge Business Publishers, 2020
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c. 2017 NOPAT: $1,592 – [($966 - $1,082) x (1-0.25)] = $1,679.00
NOPM: $1,679.00 / $62,484 = 2.69%
2016 NOPAT: $4,404 – [($1,452 - $858) x (1-0.25)] = $3,958.50
NOPM: $3,958.50 / $48,158 = 8.22%
P6-43. (20 minutes)
LO 3
a. 1. Performance obligation fulfilled based on number of employees trained
Year
Number of employees trained
Revenues (# trained x $1,200)
Expenses (# trained x $437.50)*
Gross Profit
2019
125
$150,000.00
54,687.50
$95,312.50
2020
200
$240,000.00
87,500.00
$152,500.00
2021
75
$90,000.00
32,812.50
$57,187.50
Total
400
$480,000.00
175,000.00
$305,000.00
2021
$30,000.00
17.14%
$82,285.71
30,000.00
$52,285.71
Total
$175,000.00
100.00%*
$480,000.00*
175,000.00
$305,000.00
* $437.50 = $175,000 / 400
2. Performance obligation fulfilled based on costs incurred
Year
Cost incurred
Percentage completed
Revenues (% x $480,000)
Expenses
Gross profit
2019
$65,000.00
37.14%
$178,285.71
65,000.00
$113,285.71
2020
$80,000.00
45.71%
$219,428.57
80,000.00
$139,428.57
* Answers may vary due to rounding of percentage completed.
b. The question depends on what measure best reflects the value delivered to the
customer as the contract progresses. Using the number of employees trained would
reflect Elliot Company’s value from a more effective salesforce. The cost of
developing the materials is spread across the 400 employees as they are trained.
But the cost incurred to develop the materials also creates value for the customer.
The accounting standard says “An output method would not provide a faithful
depiction of the entity’s performance if the output selected would fail to measure
some of the goods or services for which control has transferred to the customer. For
example, output methods based on units produced or units delivered would not
faithfully depict an entity’s performance in satisfying a performance obligation if, at
the end of the reporting period, the entity’s performance has produced work in
process or finished goods controlled by the customer that are not included in the
measurement of the output.” (ASC 606-10-55-17)
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
P6-44. (15 minutes)
LO 6
a. Management would have an incentive to shift $1 million of income from the current
period into next. This might be accomplished by delaying revenue recognition or
accelerating expenses. This would increase their bonus by $100,000 next year
without decreasing the current bonus.
b. Management would have an incentive to shift $3 million of income from next year
into income reported this year. This would increase the current year bonus by
$300,000 without reducing next year’s bonus.
c. Management would have an incentive to shift income from the current year into next
year. Even though this would reduce earnings this year, earnings are already so low
that management does not expect to receive a bonus. Shifting earnings into a future
period increases the bonus in that period.
d. These incentives for earnings management would be mitigated if the “kinks” in the
bonus formula were removed. Alternatively, some companies pay bonuses based
on a three-year moving average of earnings to minimize the impact of earnings
management.
This problem can provide an opportunity to discuss the “slippery slope” of earnings
management. For example, management’s optimism about next year in part b may not
turn out to be warranted. Suppose next year’s “natural” earnings turns out to be $20
million instead of $24 million. Management’s action in the first year will have reduced
next year’s $20 million to $17 million, and earnings management would again be
required to meet the target. And, if meeting the target in one year causes the next
year’s target to increase, things can get out of control very quickly.
©Cambridge Business Publishers, 2020
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P6-45. (40 minutes)
LO 4, 5
($ millions)
a. Net receivables as of January 31, 2017 were $1,128,610 thousand.
b.
($ thousands)
Bad debts expense (+E, -SE)
Allowance for doubtful accounts (+XA)
Allowance for doubtful accounts (-XA)
Accounts receivable (-A)
+
Bad Debts Expense (E)
17,568
17,568
17,568
13,566
13,566
-
- Allowance for Doubtful Accounts (XA) +
21,376
Balance
13,566 17,568
25,378
Balance
Balance
+ Accounts Receivable (A) 1,136,593
13,566
The $350 thousand recovery of a written-off account would be accounted for in the
following way:
Accounts receivable (+A)
Allowance for doubtful accounts
(+XA)
350
Cash (+A)
Accounts receivable (-A)
350
350
350
The first entry reestablishes the customer’s account, and the second entry
recognizes the cash payment that discharges that account.
c. Allowance for doubtful accounts to gross accounts receivables are:
2.2% ($25,378/$1,153,988) in fiscal 2017
1.9% ($21,376/$1,136,593) in fiscal 2016
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
d. The 2017 receivables turnover rate is $4,881,951 / [($1,128,610 + $1,115,217)/2]
= 4.35.
In 2016, the ART was $5,456,650/[($1,115,217 + $1,145,099)/2] = 4.83.
The Average Collection Period (ACP) is 365/4.35 = 83.9 days in 2017
and 365/4.83 = 75.6 days in 2016.
e. The increase in the allowance as a percentage of receivables and the slowdown in
collections both indicate that Mattel is having a little more trouble in collecting from
its customers. It’s possible that this change is due to the retail sector’s financial
difficulties (e.g., the bankruptcy of Toys R Us). Or, Mattel’s decline in sales may
mean that its products are less important to its distribution channel, and therefore
less of a priority for payment. More generally, it’s also possible that the changes
reflect a general decline in economic conditions or a relaxing of Mattel’s credit
policies, including collection practices.
P6-46. (25 minutes)
LO 4
a. The gross margin for the first quarter is 37.7% = $1,427/$3,783. The items sold in
the first quarter, but expected to be returned in the second quarter, had a gross
margin of 59.1% = $93 - $38)/$93. The Gap expects that the returns will be those
items that have a higher-than-average margin.
b. Sale and expected returns:
(1) Record revenue.
Cash (+A)
Revenue (+R,+SE)
(2) Record COGS.
Cost of goods sold (+E,-SE)
Inventory (-A)
(3) Recognize
Revenue contra, returns (+XR, -SE)
expected returns.
Sales returns allowance liability
(+L)
Right-of-return asset (+A)
Cost of goods sold (-E, +SE)
5,000
5,000
3,000
3,000
500
500
300
300
continued next page
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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b. continued
Returns:
(4) Process return
transactions.
Inventory (+A)
300
Right-of-return asset (-A)
Sales return allowance liability (-L)
Cash (-A)
300
500
500
At the conclusion of this transaction, the customers have their cash, the inventory
costs have been adjusted to include the returned items, and the sales returns
allowance liability has a balance of zero because the actual returns coincided with
the expected returns
P6-47. (25 minutes)
LO 2
a. The deferred net revenue liability goes up when customers purchase game software
from TTWO, and it goes down when TTWO recognized revenue for the post-sale
service. So, TTWO must have recognized more in revenue than it sold during the
quarter. This phenomenon could be due to a seasonality effect. For example,
TTWO’s revenues are greatest in the last calendar quarter.
b. Purchases equal revenues plus the change in the deferred net revenue liability.
Therefore, the first quarter purchases were $387,982 thousand + ($466,429
thousand - $566,141 = $288,270 thousand. Purchases were less than revenue
recognized in the income statement. Changes in the deferred net revenue liability
provide a leading indicator of the company’s revenues. One must be careful,
though, to account for seasonality in purchases.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
CASES and PROJECTS
C6-48. (40 minutes)
LO 1, 2, 6
a.
Cash or Accounts receivable (+A)
Sales revenue (+R, +SE)
80
Cost of sales (+E, -SE)
Inventory (-A)
40
Cash or Accounts receivable (+A)
Sales revenue (+R, +SE)
Payable to restaurant merchant (+L)
80
80
40
b.
40
40
The revenue recognized differs between parts a and b because in part a, Groupon is
acting as a principal in the transaction. In part b, Groupon is acting as an agent for
the restaurant, and its revenue is limited to its commission.
c. In this case, Groupon must account for “variable consideration.” There is a 90%
chance that Groupon will earn $40 in revenue and a 10% chance that it will earn $80
in revenue. Therefore, its expected revenue is $44 = 0.9*40 + 0.1*80. The payable
to the merchant is $36 = 0.9*40 + 0.1*0.
Cash or Accounts receivable (+A)
Sales revenue (+R, +SE)
Payable to restaurant merchant (+L)
80
44
36
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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C6-49. (30 minutes)
LO 1, 2, 6
a. When Dell sells other companies’ software products, it is often as part of a multipleelement sales agreement. For example, the customer may purchase hardware,
software, and customer support for one price. This is an example of a bundled sale.
Dell must allocate the sales price based on the relative fair market value of each
element. Revenue is recognized for each specific element when it is clear that the
element has been delivered and the revenue is earned.
There are at least two possibilities for earnings management here. First, Dell could
misallocate the sales price. By allocating more of the price to hardware and less to
software, Dell may be able to manage when earnings are reported. Second, Dell
may be aggressive in applying the “earned and realizable” criteria to each element,
thereby prematurely recognizing revenue.
From the information provided, it appears that Dell was recognizing revenue on
software “resales” at the time of sale. However, most software is not truly sold.
Instead, the customer purchases a license to use the software. As a result, Dell
should have deferred part of the revenue and recognized it ratably over the license
period.
b. Extended warranties are typically sold separately from other products. Therefore,
the revenue should be deferred and recognized ratably over the warranty contract
period. Dell employees were apparently recording revenue at the time of sale, or
were recognizing the revenue over a shorter time period than the contract period.
As a result, revenues and income were overstated.
c. It is common for managers to have performance targets based on revenues and
earnings. This provides an incentive for these employees to take actions to
accelerate revenue recognition when it appears that targets may not be met. On the
other hand, in periods when revenues and earnings exceed the targets, managers
may delay revenue recognition until a future period. In this way, they can “store up”
revenues and earnings to meet future targets.
The key to preventing this type of abuse is the periodic audit of divisional revenues
and earnings. In addition, businesses spend a large amount of resources trying to
design incentive compensation plans that do not encourage this type of abuse.
Note: Dell Inc. was publicly traded under the ticker symbol DELL until it was taken
private in October of 2013 by Michael Dell, the company’s founder, and Silver Lake
Partners.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
C6-50. (45 minutes)
LO 2, 4, 5
a. 2017:
i. Bad debts expense (+E, -SE)
Allowance for doubtful accounts (+XA, -A)
ii.
2,913
2,913
Allowance for doubtful accounts (-XA, +A)
Accounts receivable (-A)
2,981
2,981
2018:
iii. Bad debts expense (+E, -SE)
Allowance for doubtful accounts (+XA, -A)
5,439
iv.
2,518
5,439
Allowance for doubtful accounts (-XA, +A)
Accounts receivable (-A)
2,518
- Allowance for Doubtful Accounts (XA) ($000) +
Balance
7,254
2016 Balance
2,913
(i)
(ii)
2,981
Balance
7,186
2017 Balance
5,439
(iii)
(iv)
2,518
10,107
2018 Balance
b. 2017: $7,186 / ($188,679 + $7,186 + $24,300) = 3.3%
2018: $10,107 / ($212,377 + $10,107 + $18,628) = 4.2%
The increase in allowance relative to receivables could be due to the difficult
environment that many retail companies (Wiley’s customers) are experiencing.
c. If sales returns are material in amount and can be estimated with a reasonable
degree of accuracy, they should be estimated just as bad debts are estimated.
Sales revenue is debited for the estimated returns in the amount of the revenue
while an allowance for returns is credited an equal amount. In addition, the Cost of
goods sold is credited for the cost of the expected returns, and a right-of-return asset
is debited. One important difference is that with sales returns (unlike bad debts) the
customer returns the product to the company and it is often returned to inventory.
Hence, the amount of allowance for returns is a net amount equal to the estimated
gross profit on expected returns.
d. Accounts receivable turnover: $1,796,103 / [($212,377 + $188,679)/2] = 8.96 times.
Average collection period: 365 / 8.96 = 40.74 days.
©Cambridge Business Publishers, 2020
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C6-51 (20 minutes)
LO 7
a. Restructuring charges are reported as part of operating income though 3M has
allocated the restructuring costs to various operating categories in the income
statement rather than reporting a single line item for restructuring. A liability is
recorded on the balance sheet for the restructuring costs (e.g., severance) that
have not been paid. Reporting the gain on sale of businesses as part of
operating income implies that these were peripheral transactions and did not
qualify as discontinued operations.
b. A financial analyst generally should treat these costs as nonrecurring in nature.
Thus, when forecasting future earnings the analyst would generally not expect
another restructuring.
c. Management may have incentives to overstate restructuring charges in some
cases. If the charges are overstated, the manager will expense more as
restructuring costs (and record a larger liability) than they really expect. If the
company does not actually have cash outlays in future periods equivalent to the
accrued liability related to the restructuring charge, the liability that was recorded
will need to be reversed. In the period in which that occurs, recorded income will
be higher than it otherwise would be, perhaps helping managers meet an
earnings target.
On the other hand, management may have incentives to understate restructuring
charges in some cases. If they do not want the current period earnings to be too
low (relative to some target, or if the managers are nearing the end of their
working horizon) then they may record too low a cost for restructuring. However,
this will make it harder to reach future targets because if the actual cash outlays
turn out to be higher than the costs they accrue, additional expenses will need to
be recorded in future years.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
Chapter 7
Reporting and Analyzing Inventory
Learning Objectives – coverage by question
MiniExercises
Exercises
Problems
Cases
and Projects
33, 34, 36
37, 38
LO1 – Interpret disclosures of
information concerning operating
expenses, including manufacturing
and retail inventory costs.
13 - 15, 17
LO2 – Account for inventory and cost
of goods sold using different costing
methods.
18 - 21, 23
26, 27,
29 - 31
LO3 – Apply the lower of cost or net
realizable value rule to value
inventory.
24
28
LO4 – Evaluate how inventory costing
affects management decisions and
outsiders’ interpretations of financial
statements.
18
26, 29 - 31
33, 34, 36
37, 38
16, 22
25, 31, 32
33 - 35
37
26, 29, 30
36
37
LO5 – Define and interpret gross
profit margin and inventory turnover
ratios. Use inventory footnote
information to make appropriate
adjustments to ratios.
LO6 – Appendix 7A: Analyze LIFO
liquidations and the impact they have
on the financial statements.
©Cambridge Business Publishers, 2020
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QUESTIONS
Q7-1.
When company A purchases inventory from company B, the buyer and seller
must agree on which firm is responsible for the transportation costs. The
terminology “freight on board shipping point” or FOB is used to indicate the
buyer assumes responsibility for the transportation cost once notice of delivery
to the shipper is received. In addition, the buyer assumes responsibility for any
delay or damage during transit.
When goods are shipped FOB, the seller normally can recognize revenue
unless the seller has not fulfilled all requirements of the purchase agreement.
An example is when an equipment installation and/or up-and-running properly
is part of that agreement.
Q7-2.
If stable purchase prices prevail, the dollar amount of inventories (beginning or
ending) tends to be approximately the same under different inventory costing
methods and the choice of method does not materially affect net income. To see
this, remember that FIFO profits include holding gains on inventories. If the
inflation rate is low (or inventories turn quickly), there will be less holding
(inflationary) profit in inventory.
Q7-3.
FIFO holding gains occur when the costs of earlier inventory acquisitions are
matched against current selling prices. Holding gains on inventories increase with
an increase in the inflation rate and a decrease in the inventory turnover rate.
Conversely, if the inflation rate is low or inventories turn quickly, there will be less
holding (inflationary) profit in inventory.
Q7-4.
(a) Last-in, first-out, (b) Last-in, first-out, (c) First-in, first-out, (d) First-in, first-out,
(e) Last-in, first-out.
Q7-5.
A significant tax benefit results from using LIFO when costs are consistently
rising. LIFO results in lower pretax income and, therefore, lower taxes payable,
than other inventory costing methods.
Q7-6.
Kaiser Aluminum Corporation is using the lower of cost or market (LCM) rule.
When the replacement cost for inventory falls below its (FIFO or LIFO)
historical cost, the inventory must be written down to the lower replacement
costs (market value).
Q7-7.
The various inventory costing methods would produce the same results (inventory
values and cost of goods sold) if prices were stable. The inventory costing
methods produce differing results when prices are changing.
Q7-8.
Inventory “shrink” refers to the loss of inventory due to theft, spoilage, damage,
etc. Shrink costs are part of cost of goods sold but do not represent goods that
were actually sold.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
Q7-9.
The “LIFO reserve” is the difference between the cost of inventory determined
using the last-in, first-out (LIFO) method and the cost determined using another
method (either FIFO or average cost). Companies that report inventory cost
using the LIFO method must also report the LIFO reserve. This allows the
financial statement reader to convert from LIFO to another method for comparison
purposes.
The LIFO reserve represents the difference between the historical, LIFO cost of
inventory and its current cost. This disparity between the book value and the
current value represents a gain from holding the inventory that has not yet been
recognized in income or in equity ̶ an unrealized holding gain.
Q7-10. Because LIFO assigns the last units purchased during the year to cost of goods
sold (COGS), changing prices can make it difficult to forecast earnings.
Companies have discretion as to when and how much inventory they purchase
during an accounting period. LIFO is always applied on a periodic, annual basis,
so a purchase made during the final days of the year will end up in COGS and
affect current earnings. However, if that purchase is delayed until the first week of
the next year, it could be several years before those units are transferred to
COGS. Unlike other inventory methods, LIFO requires that the quantity and price
of inventory purchases be predicted to make accurate earnings forecasts.
Q7-11A. LIFO liquidation is involuntary when it is caused by events that are beyond
management’s control. Examples of such events include labor strikes, natural
disasters, or wars which could interrupt the delivery of inventory by suppliers or
shut down production facilities.
Q7-12A. In periods of rising prices, LIFO liquidation results in older, lower-cost goods being
expensed as cost of goods sold, yielding higher profits. This may be the result of
a management decision to reduce inventory levels for efficiency purposes.
However, it may also be an earnings management tactic. Management may be
trying to avoid violating bond covenants, or it may be trying to manipulate
management compensation. In any case, this practice is costly, in that the
additional profits lead to higher income taxes.
©Cambridge Business Publishers, 2020
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MINI EXERCISES
M7-13. (15 minutes)
LO 1
The cost to be assigned to the inventory is $535 ($500 + $30 + $5).
+
(a)
(b)
(d)
-
Inventory (A)
500
30
5
-
Notes Payable (L)
500
-
+
(a)
(c)
Accounts Payable (L)
30
10
5
+
+ Interest Expense, Discounts Lost (E)
10
(b)
(c)
(d)
-
M7-14. (15 minutes)
LO 1
The only cost that should be included in inventory is the cost of merchandise to be sold.
M7-15. (20 minutes)
LO 1
RAW MATERIALS INVENTORY
Beginning inventory
Purchases
Materials used
Ending inventory
WORK IN PROCESS INVENTORY
Beginning inventory
Materials used
Labor costs
Overhead costs
Cost of goods produced
Ending inventory
FINISHED GOODS INVENTORY
Beginning inventory
Cost of goods produced
Cost of goods sold
Ending inventory
$
+
-
0
84,000
63,000
$ 21,000
+
+
+
-
$
0
63,000
58,000
28,000
130,000
$ 19,000
+
-
$
0
130,000
95,000
$ 35,000
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M7-16. (10 minutes)
LO 5
2017:
$76,450 - 25,354
$76,450
= 0.668
2016:
$71,890 - 21,685
$71,890
= 0.698
2015:
$70,074 - 21,536
$70,074
= 0.693
M7-17. (15 minutes)
LO 1
a. Purchases are understated. If ending inventory is correctly valued, cost of goods
sold will also be understated and current income will be overstated. There would be
no effect in the following year.
If, however, ending inventory is understated (due to the mistakenly recorded
purchase) then there is no effect on income in either period.
b. Purchases are overstated. The effect on income, assuming normal inventory levels,
depends on the inventory costing system being used by the company. Assuming
rising prices, income would be reduced in the current year under LIFO or average
costing but unaffected under FIFO costing. Income in the following year would not
be affected. (The solution assumes the error is not discovered and corrected in the
current year.)
c. Shrink (part of cost of goods sold) is overstated and ending inventory is understated.
Consequently, current period income is understated. If the inventory is counted
correctly the following year, the error will reverse itself and income will be
overstated. This is an example of a “self-correcting” inventory error.
©Cambridge Business Publishers, 2020
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M7-18. (20 minutes)
LO 2, 4
a. Balance Sheet, December 2019
Assets
Cash
Inventory
$12,000
50,000
Shareholders’ equity
Contributed capital
$62,000
b. All monetary amounts in $ thousands.
Year
Income statement:
Revenue
COGS-FIFO
Earnings before tax
Tax expense
Net income
Cash flows:
Receipts
Inventory purchases
Tax payments
Cash from
operations
2020
2021
2022
75
50
25
10
15
85
60
25
10
15
95
70
25
10
15
75
-60
-10
5
85
-70
-10
5
95
-80
-10
5
Dividends
Cash from financing
Net change in cash
-9
-9
-4
-9
-9
-4
-9
-9
-4
Balance sheet:
Assets
Cash
Inventory
Total
8
60
68
4
70
74
0
80
80
Shareholders’ equity
Contributed capital
Retained earnings
Total
62
6
68
62
12
74
62
18
80
Clearly there is a problem with this business model. The company is showing
profits, and assets and retained earnings are increasing. However, there is a cash
flow problem. The net change in cash every year is -$4 thousand and, by the end of
2022, the company would have a cash balance of zero. In 2023, it would not be
possible to replenish the inventory and to pay the dividend.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
c. All monetary amounts in $ thousands.
Year
Income statement:
Revenue
COGS-LIFO
Earnings before tax
Tax expense
Net income
2020
2021
2022
75
60
15
6
9
85
70
15
6
9
95
80
15
6
9
75
-60
-6
9
85
-70
-6
9
95
-80
-6
9
-9
-9
0
-9
-9
0
-9
-9
0
Balance sheet:
Assets
Cash
Inventory
Total
12
50
62
12
50
62
12
50
62
Shareholders’ equity
Contributed capital
Retained earnings
Total
62
0
62
62
0
62
62
0
62
Cash flows:
Receipts
Inventory purchases
Tax payments
Cash from operations
Dividends
Cash from financing
Net change in cash
Interestingly, the use of LIFO reduces profits, and the company’s reported assets
(and net assets) are not growing like the FIFO case above. However, the cash flow
situation is improved. The company can pay the desired dividends and continue to
replace its inventory at the end of every year. The difference between LIFO and
FIFO is that FIFO profits include a gain from holding inventory while prices are
rising. When the company is taxed on that gain, it has less cash available to
maintain its physical assets (inventory). In essence, paying taxes based on FIFO
(when inventory costs are increasing) can cause a firm’s ability to stay in business to
be taxed away. LIFO profits exclude holding gains, so the company could continue
to stay in business. (The tax authorities will “catch up” when the business decides to
stop investing in inventory, and the LIFO liquidation profits get taxed.)
©Cambridge Business Publishers, 2020
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M7-19. (20 minutes)
LO 2
a. FIFO cost of goods sold = 1,000 @ $100 + 700 @ $150 = $205,000
FIFO ending inventories = $400,000 - $205,000 = $195,000
b. LIFO cost of goods sold = 1,700 @ $150 = $255,000
LIFO ending inventories = $400,000 - $255,000 = $145,000
c. AC cost of goods sold = 1,700 @ $400,000/3,000 = $226,667
AC ending inventories = $400,000 – $226,667 = $173,333
M7-20. (15 minutes)
LO 2
a. $1,320,000 + purchases - $6,980,000 = $1,460,000; purchases = $7,120,000.
b.
1.
2.
Inventory (+A)
Cash or Accounts payable (-A or +L)
7,120,000
Cost of goods sold (+E, -SE)
Inventory (-A)
6,980,000
7,120,000
6,980,000
c.
+
+
Balance
(1)
Balance
Cash (A) 7,120,000
Inventory (A) 1,320,000
7,120,000
6,980,000
1,460,000
+
(1)
(2)
Cost of Goods Sold (E)
6,980,000
-
(2)
d.
Transaction
a. Purchase
inventory.
c. Cost of
inventory
sold.
Cash
Asset
-7,120,000
Cash
Balance Sheet
Noncash
LiabiContrib.
+
=
+
+
Assets
lities
Capital
+7,120,000
Inventory
=
-6,980,000
Inventory
=
Income Statement
Earned
Capital
Revenues - Expenses =
-
-6,980,000
Retained
Earnings
-
Net
Income
=
+6,980,000
Cost of
Goods Sold
-6,980,000
=
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M7-21. (10 minutes)
LO 2
a. FIFO cost of goods sold = 400 @ $10 + 200 @ $12 = $6,400
FIFO ending inventories = $12,400 - $6,400 = $6,000
b. LIFO cost of goods sold = 600 @ $12 = $7,200
LIFO ending inventories = $12,400 - $7,200 = $5,200
c. AC cost of goods sold = 600 @ $12,400/1,100 = $6,764
AC ending inventories = $12,400 – $6,764 = $5,636
M7-22. (20 minutes)
LO 5
a.
Wal-Mart
Target
Inventory Turnover-2017
373/[(43.8+43.0)/2] = 8.59
51.1/[(8.66+8.31)/2] = 6.07
Inventory Turnover-2016
361/[(43.0+44.5)/2] = 8.25
49.1/[(8.31+8.60)/2] = 5.81
b. Wal-Mart’s inventory turnover rate is higher than Target’s. There can be several
reasons for this. Wal-Mart’s product lines may be oriented toward lowermargin/higher-turnover goods (Wal-Mart does report a lower gross profit margin than
Target). Both companies had slight increases in turnover rates from 2016 to 2017.
At the end of 2017, both companies hold roughly the same, or slightly more,
inventory than in the prior year, possibly in anticipation of increased sales in 2018 (or
the addition of new products).
c. Inventory turns improve as the dollar volume of goods sold increases relative to the
dollar volume of goods on hand. Inventory reductions can be realized by reducing
the depth and breadth of product lines carried (e.g., not every style, size and color),
eliminating slow-moving product lines, working with suppliers to arrange for delivery
when needed rather than inventorying for a longer holding period, and marking down
goods for sale at the end of product seasons.
Retailers must balance the cost savings from inventory reductions against the
marketing implications of lower inventory levels on hand. It would be possible to
stock only those items that turn over very quickly, but those items may have low
margins. Or, there may be items that turn over slowly, but have sufficient margins to
make offering them attractive, even though it reduces inventory turnover. Whenever
ratios are used as incentive measures, it is important to recognize that they may
cause “cherry-picking” of only those activities that provide the highest ratio outcome.
©Cambridge Business Publishers, 2020
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M7-23. (15 minutes)
LO 2
a. Cost of goods sold (+E, -SE)
Inventory (-A)
142,790,000
142,790,000
b.
Balance
(c)
Balance
c.
+
Inventory
25,790,000
142,790,000
140,560,000
23,560,000
+
(a)
Cost of Goods Sold
142,790,000
-
(a)
Inventory (+A)
Cash or Accounts payable (-A or +L)
140,560,000
140,560,000
d. ($000)
Transaction
Cash
Asset
c. Purchase
inventory
-140,560
Cash
a. Cost of
inventory sold
Balance Sheet
Noncash
LiabilContrib.
+
=
+
+
Assets
ities
Capital
+140,560
Inventory
-142,790
Inventory
Income Statement
Earned
Capital
Revenues - Expenses =
=
=
-142,790
Retained
Earnings
-
Net
Income
=
+142,790
Cost of
Goods Sold
-142,790
=
M7-24. (10 minutes)
LO 3
a. (60 x $45) + (210 x $34) + (300 x $20) + (100 x $27) = $18,540
b. Cost: (60 x $45) + (210 x $38) + (300 x $22) + (100 x $27) = $19,980
Market: (60 x $48) + (210 x $34) + (300 x $20) + (100 x $32) = $19,220
Therefore, the ending inventory balance should be $19,220.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
EXERCISES
E7-25. (45 minutes)
LO 5
a. Fiscal year 2015:
Gross profit margin = ($705 – $503) ÷ $705 = 28.7%
Inventory turnover ratio = $503 ÷ [($214 + $223) ÷ 2] = 2.30 times
Fiscal year 2016:
Gross profit margin = ($703 – $497) ÷ $703 = 29.3%
Inventory turnover ratio = $497 ÷ [($223 + $212) ÷ 2] = 2.29 times
b.
Fiscal Year
2015
2016
Quarter
1
2
3
4
1
2
3
4
Gross Profit
$ 27
91
56
28
32
90
55
29
Gross
Profit Margin
21.3%
36.0%
28.9%
21.5%
24.6%
35.7%
28.7%
22.3%
The gross profit and gross profit margin numbers show that West Marine is
significantly more profitable in the second and third quarters. The revenues from
these quarters are 50% - 100% higher than the other quarters and the gross profit
from quarters two and three is sometimes more than three times that of quarters one
and four. Unlike many retailers, who make most of their sales and profits in the
fourth calendar quarter, West Marine must discount its prices and run promotions in
order to generate sales in the first and fourth quarters.
©Cambridge Business Publishers, 2020
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c. Inventory is lowest at the end of the fiscal year. At the end of the first quarter (end of
March), inventory has increased in anticipation of the busy second quarter, and
inventory stays high through the second quarter (end of June). By the end of
September (third quarter), inventory has declined, and it continues to decline
through the fourth quarter.
It is common for seasonal businesses to choose fiscal year-ends when inventories
(and other balances like receivables) are lower. But it can mean that annual ratios
(like those calculated in part a) do not reflect the inventory investment that was
necessary to generate the sales reported for the year. Understanding these
seasonal effects can be important for cash management over the year.
d. One approach to calculating an inventory turnover ratio is to use an “average of
averages” approach. For the first quarter of 2015, the average inventory was
($214 + $257) / 2 = $235.5. Follow the same process to determine the average
inventory for quarters two, three and four. Then average the averages. The effect
of this process is the following:
2015: Weighted average inventory = [214 + 2x(257 + 258 + 237) + 223)] / 8 = $242.6
2016: Weighted average inventory = [223 + 2x(269 + 254 + 232) + 212)] / 8 = $243.1
The weighted average inventory levels are greater than the simple annual averages
for both years because the fiscal year-end is set when inventory is predictably low.
When these inventory values are divided into annual cost of goods sold, the
inventory turnover ratios are lower than those calculated in part a.
Weighted average inventory turnover ratio:
2015: $503 / $242.6 = 2.07 times
2016: $497 / $243.1 = 2.04 times
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E7-26.A (30 minutes)
LO 2, 4 6
Units
1,000
1,800
800
1,200
4,800
Beginning Inventory
Purchases: #1
#2
#3
Goods available for sale
Cost
$ 20,000
39,600
20,800
34,800
$115,200
Units in ending inventory = 4,800 – 2,800 = 2,000
a. First-in, first-out
Ending Inventory
Units
1,200
800
2,000
@
@
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
Cost
$29 =
$26 =
Total
$34,800
20,800
$55,600
$115,200
55,600
$ 59,600
b. Last-in, first-out
Ending inventory
Units
1,000 @
1,000 @
2,000
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
Cost
$20
$22
Total
= $20,000
= 22,000
$42,000
$115,200
42,000
$ 73,200
c. Average cost
$115,200/4,800 = $24 average unit cost
2,000 x $24 = $48,000 ending inventory
$115,200 - $48,000 = $67,200 cost of goods sold (or 2,800x$24)
©Cambridge Business Publishers, 2020
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d. 1. The first-in, first-out method in most circumstances represents physical flow. This
inventory system applies to perishables or to situations in which the earliest items
acquired are moved out first because of risk of deterioration or obsolescence.
2. Last-in, first-out results in the lowest inventory amount during periods of rising unit
costs, which in turn results in the lowest net income and the lowest income tax.
3. The first-in, first-out results in the lowest cost of goods sold in periods of rising
prices. This is the inventory method Chen should use to report the largest amount
of income. Of course, this assumes that prices will continue to rise. Companies
cannot change inventory costing methods without justification, and the change may
be prohibited by tax laws as well.
E7-27. (25 minutes)
LO 2
Beginning inventory
Purchases:
Purchase #1
Purchase #2
Purchase #3
Cost of goods available for sale
Units
100
650
550
200
1,500
@
@
@
@
Cost
$46
42
38
36
@
@
Cost
$36
38
=
=
=
=
Total
$ 4,600
27,300
20,900
7,200
$60,000
=
=
Total
$ 7,200
5,700
$12,900
a. First-in, first-out
Ending inventory .................................
Units
200
150
350
Cost of goods available for sale..........
Less: Ending inventory .......................
Cost of goods sold ..............................
$60,000
12,900
$47,100
b. Average cost
Cost of Goods Available for Sale/Total Units Available for Sale
= $60,000/1,500 = $40 Average Unit Cost
Ending Inventory = 350 units x $40 =
$14,000
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
$60,000
14,000
$46,000
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©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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c. Last-in, first-out
Ending inventory
Units
100
@
250
@
350
Cost
$46
42
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
=
=
Total
$ 4,600
10,500
$15,100
$60,000
15,100
$44,900
E7-28. (20 minutes)
LO 3
a. 1. (70 x $190) + (45 x $268) + (20 x $350) + (120 x $60) + (80 x $88) + (50 x $126)
= $52,900.
2. Desks: (70 x $190) + (45 x $280) + (20 x $350) = $32,900
(70 x $210) + (45 x $268) + (20 x $360) = $33,960
Chairs: (120 x $60) + (80 x $95) + (50 x $130) = $21,300
(120 x $64) + (80 x $88) + (50 x $126) = $21,020
Therefore, inventory would be reported at $32,900 + $21,020 = $53,920.
3. (70 x $190) + (45 x $280) + (20 x $350) + (120 x $60) + (80 x $95) + (50 x $130)
= $54,200
(70 x $210) + (45 x $268) + (20 x $360) + (120 x $64) + (80 x $88) + (50 x $126)
= $54,980
Therefore, inventory would be reported at $54,200.
b. Applying the lower of cost or net realizable value (NRV) rule to individual items in
inventory results in the lowest inventory amount, the highest cost of goods sold and
the lowest net income. Under either of the other two methods, the inventory may be
valued at the higher of cost or NRV for some items in inventory.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E7-29.A (20 minutes)
LO 2, 4, 6
a. $13,042 million
b. $14,275 million
c. Pretax income has been reduced by $1,233 million cumulatively since GM adopted
LIFO inventory costing. This is because it has matched current inventory costs
against current selling prices, thus avoiding the recognition of holding gains that
would have resulted had FIFO inventory costing been used. If LIFO has put $1,233
million less into ending inventory than FIFO, it must have put $1,233 more into cost
of goods sold than FIFO.
d. Pretax income has been reduced by $1,233 million (see part c). Assuming a 35% tax
rate, taxes have been reduced by $1,233 x 0.35 = $431.6 million.
Cumulative taxes were decreased by the use of LIFO inventory costing.
e. During this period GM was experiencing declining earnings while inventory costs
were not keeping pace. Under these conditions, FIFO reporting mitigates the effect
on income.
E7-30.A (25 minutes)
LO 2, 4, 6
a. $6,149 million
b. $7,786 million. The FIFO inventory carrying amount is greater than the LIFO carrying
amount, which is common. It implies Deere’s current inventory costs are rising. We
cannot blindly assume that inventory costs always rise, however. When costs
decline as is true in the computer chip industry (generally not on LIFO) or in the past
year in the oil and gas industry (generally on LIFO), a lower FIFO carrying amount
can occur. However, if prices fall for so long and to such an extent that the FIFO
carrying amount is lower than the LIFO carrying amount the company would have to
consider switching off of LIFO onto FIFO.
c. Pretax income has been decreased by $1,637 million cumulatively since Deere
adopted LIFO inventory costing. This result occurs because higher current inventory
costs are matched against current selling prices, thus avoiding the recognition of
holding gains that would have resulted had FIFO inventory costing been used.
d. Pretax income has been decreased by $1,637 million (see part c). Assuming a 25%
tax rate, taxes have been decreased by $1,637 x 0.25 = $409.25 million.
Cumulative taxes have been decreased by use of LIFO inventory costing.
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e. For 2018, the change in the LIFO reserve is an increase of $176 million. Pretax
income has been decreased by this amount, thus decreasing taxes by $176 million x
0.25 = $44 million.
Observation: If Deere’s inventory were at some future date to be more highly valued
under LIFO than under FIFO, the company could reduce its tax expense by
switching to FIFO costing. This is, however, unlikely for Deere or other industries
facing continued price increases or even essentially constant prices.
f. In 2016 and 2015, Deere liquidated some LIFO layers, meaning that it sold more
inventory than it bought (of a certain type) and thus older costs assigned previously
assigned to inventory are now assigned to cost of goods sold as that inventory is
sold. In periods of rising costs that means old, lower costs are assigned to cost of
goods sold and matched with revenues from the current period. As a result, higher
profits are recorded than would have been recorded if new inventory (purchased at
higher prices) would have been bought and assumed to have been sold. Companies
are required to disclose this when it happens because it shows a higher profit merely
for depleting inventory layers. Deere states that they recorded $4 million in pretax
profit attributable to such LIFO liquidations in 2016 ($22 million in 2015).
E7-31. (20 minutes)
LO 2, 4, 5
a. ($ millions)
$517 + Purchases - $10,633 = $471. Purchases = $10,587.
b.
($ millions)
Sales revenue
Cost of goods sold
Gross profit
As reported (LIFO)
$16,030
10,633
$ 5,397
Pro forma (FIFO)
$16,030
10,628
$ 5,402
$10,633 - ($47 - $42) = $10,628
c. As reported (LIFO): $5,397 / $16,030 = 33.67%
Pro forma (FIFO): $5,402 / $16,030 = 33.70%
The small differences between LIFO and FIFO reflect both the rate of price change
for Whole Foods’ inventories and the fact that its inventory moves through very
quickly (about 21 times per year).
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E7-32. (30 minutes)
LO 5
a.
Revenue
COGS
Gross profit
Gross profit margin (GPM)
Tiffany
2017
2016
$4,170 $4,002
1,565
1,512
2,605
2,490
62.5%
62.2%
Best Buy
RH
2017
2016
2017
2016
$42,151 $39,403 $2,440 $2,135
32,275 29,963 1,591 1,455
9,876
9,440
849
680
23.4%
24.0% 34.8% 31.9%
b.
COGS
Average inventory
Inventory turnover
Average inventory
Average daily COGS
AIDO
Tiffany
2017
1,565
2,206
0.71
2,206
4.29
514.2
Best Buy
2017
32,275
5,036.5
6.41
5,036.5
88.42
57.0
RH
2017
1,591
639.5
2.49
639.5
4.36
146.7
c. These three retailers offer very different products (jewelry, consumer electronics,
and furniture) and thus have different gross profit margins and inventory turnover
ratios.
All three have seen their gross profit margins improve slightly from 2016 to 2017.
Comparing the three retailers, each has ratios that are consistent with the type of
product they sell. Tiffany’s GPM is quite high, but its inventory turnover is very low.
This is representative of jewelry retailers. Best Buy, a “big box” store chain,
illustrates a more typical retail GPM and turnover. RH, which sells furniture, has
ratios between the jewelry retailer, Tiffany, and Best Buy. The comparison illustrates
that retailers of “big ticket” items tend to have inventory that turns slower but has
higher gross profit per dollar of sales.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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PROBLEMS
P7-33. (25 Minutes)
LO 2, 4, 5
a. Caterpillar: INVT: $31,049 / [($8,614 + $10,018) / 2] = 3.33
AIDO: [($8,614 + $10,018) / 2] / ($31,049 / 365) =109.52
Komatsu: INVT: ¥1,765,832 / [(¥533,897 + ¥730,288) / 2] = 2.79
AIDO: [(¥533,897 + ¥730,288) / 2] / ¥1,765,832 / 365) =130.65
As calculated, Caterpillar’s turnover is about 0.54 times faster than Komatsu’s, and
there is a 21-day difference in the companies’ average inventory days outstanding.
This difference could be attributed to differential production efficiencies or to
differential component sourcing strategies. Perhaps, Caterpillar purchased more
components from outside suppliers.
b. When there are no LIFO liquidation effects, decreases in the LIFO reserve can be
attributed to changes in the company’s costs. Caterpillar’s LIFO reserve decreased
in 2017, implying that its costs probably decreased.
c. Pretax income has been reduced by $1,934 million cumulatively since CAT adopted
LIFO inventory costing. This is because it has matched current inventory costs
against current selling prices, thus avoiding the recognition of holding gains that
would have resulted had FIFO inventory costing been used. Each year, the
difference between FIFO cost of goods sold and LIFO cost of goods sold is added to
the LIFO reserve.
Assuming a 25% tax rate, cumulative taxes have been reduced by $1,934 x 0.25
= $483.5 million by the use of LIFO inventory costing.
d. For 2017, the change in the LIFO reserve is a decrease of $205 million ($1,934
million - $2,139 million). Pretax income has been increased by this amount (relative
to FIFO), thus increasing taxes by $205 million x 0.25 = $51.25 million.
e. Komatsu’s use of specific identification probably approximates a FIFO inventory
costing method. As a result, the comparison in part a above is not valid because
Caterpillar’s use of LIFO produces distortions. We should use the LIFO reserve
information to construct Caterpillar’s inventory turnover based on FIFO.
FIFO 2017 cost of goods sold = $31,049 – ($1,934 – $2,139) = $31,254
FIFO 2017 average inventory = [($8,614 + $2,139) + ($10,018+$1,934)]÷2 = $11,352.5
FIFO 2017 inventory turnover = $31,254 ÷ $11,352.5 = 2.75 times
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
So, Caterpillar’s inventory turnover is 0.04 slower than Komatsu’s once we take into
account the differences in their inventory cost flow assumptions.
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P7-34. (20 minutes)
LO 2, 4, 5
a. $7,781 million - $1,248 million = $6,533 million
b. $1,248 million
c. $1,248 million x 0.25 = $ 312 million
d. $1,907 million + [($1,248 million - $1,291 million) x (1 - 0.25)] = $1,874.75 million
e. $95,662 / [($6,533 + $6,561) / 2] = 14.61
f. [$95,662 - ($1,248 - $1,291)] / [($7,781 + $7,852) / 2] = 12.24
P7-35. (30 minutes)
LO 5
a. ($ millions)
Samsung
2017
2016
Hewlett-Packard
2015
Apple
2017
2016
2015
2017
2016
2015
Revenue
239,575,376 201,866,745 200,653,482
58,472
52,056
48,238
265,395
229,234
215,639
COGS
129,290,661 120,277,715 123,482,118
47,803
42,478
39,240
163,756
141,048
131,376
Gross
profit
110,284,715
81,859,030
77,171,364
10,669
9,578
8,998
101,639
88,186
84,263
40.4%
38.8%
38.5%
18.2%
18.4%
18.7%
38.3%
38.5%
39.1%
Gross
profit
margin
(GPM)
b.
COGS
Average ending inventory
Inventory turnover
Samsung
2017
2016
129,290,661 120,277,715
21,668,429 18,582,648.5
5.97
6.47
Hewlett-Packard
2017
2016
47,803
42,478
5,924
5,135
8.07
8.27
Apple
2017
2016
163,756
141,048
4,405.5
3,493.5
37.17
40.37
Average ending inventory
Average daily COGS
AIDO
Samsung
2017
2016
21,668,429 18,582,648.5
354,221
329,528
61
56
Hewlett-Packard
2017
2016
5,924
5,135
131
116
45
44
Apple
2017
2016
4,405.5
3,493.5
449
386
10
9
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
c. Gross profit margins reflect the companies’ cost control, their product mix, and their
relative ability to create differentiated products.
Inventory turnover is much higher at Apple. This may be tied to Apple’s practice of
outsourcing a great deal of its production to third party manufacturers in Asia. In
fact, Apple reports “The Company’s inventories consist primarily of finished goods
for all periods presented.” In addition, Apple seems willing to be out of stock
following new product releases meaning they do not hold as much inventory at any
particular time.
P7-36.A (45 minutes)
LO 2, 4, 6
($ thousands)
a. Inventories as a percent of current assets follow:
87.5% ($680,828/$778,012) of current assets in 2017
As long as Seneca has sufficient product to meet demand, a reduction of inventories
represents efficient manufacturing processes, while an increase in inventories might
reflect slowing demand, rising input prices, or production inefficiencies.
b. The inventory turnover rate follows:
2018: $1,240,178/[($680,828+$628,935)/2]=1.89
2017: $1,150,194/[($628,935+$609,481)/2]=1.86
The inventory turnover rate has increased very slightly from 2017 to 2018. This
increase, though very small, is positive because it represents increased
manufacturing/retailing efficiency.
c. Seneca uses the LIFO inventory costing method. The effect of LIFO was to reduce
net earnings by $11.2 million relative to if the firm had used FIFO in 2018 and
increased earnings by $6.6 million in 2017. This is because LIFO records newer
(higher in 2018 and lower in 2017) costs in cost of goods sold which makes income
lower in 2018 and higher in 2017.
d. Seneca’s use of LIFO has led to a reduction of its taxes as indicated by the $158.8
million amount in the LIFO reserve. Seneca’s cash savings due to the use of
assuming a constant tax rate of 25% amount to $39.7 million = $158.8M X (0.25).
©Cambridge Business Publishers, 2020
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CASES and PROJECTS
C7-37.A (30 minutes)
LO 2, 4, 5, 6
a. In the year 2017, Exxon’s pretax earnings would be higher by the change in the
LIFO reserve because the reserve increased. In 2017, the LIFO reserve increased
from $8.1 billion to $10.8 billion, for an increase of $2.7 billion. The 2017 pretax
income that would have been reported if FIFO had been used would thus be $18.7
billion + $2.7 billion = $21.4 billion. Note: The increase in the LIFO reserve is likely
due to rising oil (and oil product) prices in the last year.
b. The inventory turnover would be as follows:
$128,217
[($12,871+$4,121) + ($10,877+$4,203)] / 2
= 8.0
c. BP’s inventory turnover is calculated as follows:
$179,716
= 9.8
($19,011+$17,655) /2
d. Based on calculations from their financial statements, it appears that BP’s inventory
turns over more quickly than Exxon Mobil’s. However, Exxon Mobil’s use of LIFO
makes such a comparison invalid, because BP is not allowed to use LIFO under
IFRS. To make a better comparison, we adjust Exxon Mobil’s inventory turnover
ratio to FIFO. In 2017 there was an increase in the LIFO reserve, so we need to
decrease the cost of goods sold by the increase in the LIFO reserve and increase
the value of the inventories by the balance in the LIFO reserve each year:
$128,217 + $10,800
[($12,871 + $4,121 + $10,800)+($10,817 + $4,203 + $8,100)]/2
= 5.5
This ratio shows that Exxon Mobil’s inventory is turning over more slowly than the
original calculation implied.
e. The statement refers to the impact of LIFO liquidation on Exxon-Mobil’s profits.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
C7-38. (40 minutes)
LO 2, 4
a. GAAP requires that LIFO abandonment decisions be presented using the
retrospective method. That is, all of the financial statements that are presented must
be restated using the new accounting method (FIFO). As a result, all of Virco’s
statements – income statement and balance sheets - that are presented in the
January 31, 2011 10-K are restated to reflect the switch to FIFO.
Virco’s 10-K reveals that inventories increased by $7.6 million for the year ended
January 31, 2011. This represents the LIFO reserve that is added to LIFO inventory
value to get to the inventory valued at FIFO. The company states that $4.7 is added
to equity. This adjustment reflects that LIFO reduces reported earnings by allocating
higher cost goods (most recently purchased) in cost of goods sold and lower cost
goods (earlier purchases). These lower earnings over time cause retained earnings
to be lower. Thus, to adjust to FIFO retained earnings needs to be increased to get
to what retained earnings would have been had the company been on the FIFO
method of accounting for inventory all along. Finally, the increase to inventory and
the increase to equity are not the same because of taxes. If the company would
have been on FIFO they would have paid extra taxes over time. Upon the switch to
FIFO the company has to pay tax on the LIFO reserve amount (but can spread the
payments over time). Thus, the effect on equity will be net of tax on the earnings but
the effect on inventory is not net of tax.
b. Virco argues (correctly) that the FIFO method is better because all inventory will be
on the same method of accounting for inventory, it results in a balance sheet that
reflects current acquisition costs, and it increases comparability with companies on
IFRS because IFRS does not allow LIFO.
c. Note that Virco justified the use of LIFO in prior annual reports by saying it provided
a better matching of current costs to current revenues in the income statement. This
is a correct statement but in some contrast to the statements made in the year the
company decided to switch to FIFO? Do they not care about matching anymore?
One explanation is that the arguments in favor of FIFO outweighed the matching
benefit of LIFO. The IFRS is potentially an explanation (although financial statement
users should be able to adjust the inferences from the statements to use “as if FIFO”
numbers). The company’s statement about the line of credit is interesting. It
potentially suggests that the covenants in their debt agreement are affected
adversely if the company uses LIFO (e.g., income is lower so the covenant more
easily violated). Other potential explanations are that 1) the company may not
expect prices to rise in the future which would negate the tax savings of LIFO, or 2)
perhaps corporate performance is declining and management is switching off LIFO
so stated results look better.
©Cambridge Business Publishers, 2020
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Chapter 8
Reporting and Analyzing
Long-Term Operating Assets
Learning Objectives – coverage by question
MiniExercises
Exercises
17
31
11,17
22
LO3 – Apply different depreciation
methods to allocate the cost of assets
over time.
12, 13,
16, 18, 19
22 - 28, 32
LO4 – Determine the effects of asset
sales and impairments on financial
statements.
14, 15
LO5 – Describe the accounting and
reporting for intangible assets.
LO6 – Analyze the effects of tangible
and intangible assets on key
performance measures.
LO1 – Describe and distinguish
between tangible and intangible
assets.
LO2 – Determine which costs to
capitalize and report as assets and
which costs to expense.
Problems
Cases
and Projects
22, 24,
26, 35
36, 38, 39
40, 42, 43
17, 21
31, 34
37
42
20, 21
29, 30, 33
40 – 42
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Financial Accounting, 6th Edition
QUESTIONS
Q8-1.
Routine maintenance costs that are necessary to realize the full benefits of
ownership of the asset should be expensed.
However, betterment or
improvement costs should be capitalized if the outlay enhances the usefulness
of the asset or extends the asset’s useful life beyond original expectations. As
would be the case with any cost, an immaterial amount should be expensed as
incurred.
Q8-2.
Capitalizing interest costs as part of the cost of constructing an asset reduces
interest expense, and increases net income during the construction period. In
subsequent periods, the interest costs that were capitalized as part of the cost
of the asset will increase the periodic depreciation expense and reduce net
income.
Q8-3.
As any asset is used up, its cost is removed from the balance sheet and
transferred into the income statement as an expense. Capitalization of costs
onto the balance sheet and subsequent removal as expense is the essence of
accrual accounting. If the cost of a depreciable asset is recognized in full upon
purchase, profit would be inaccurately measured: it would be too low in the year
of purchase when the asset is expensed and too high in later years as
revenues earned by the asset are not matched with a corresponding cost. In
other words, expenses would not be recognized as assets are used up or as a
result of earning revenue.
Q8-4.
The primary benefit of accelerated depreciation for tax reporting is that the
higher depreciation deductions in early periods reduce taxable income and
income taxes. Cash flow is, therefore, increased, and this additional cash can
be invested to yield additional cash inflows (e.g., an "interest-free loan" that can
be used to generate additional income). We would generally prefer to receive
cash inflows sooner rather than later in order to maximize this investment
potential.
Q8-5.
When a change occurs in the estimate of an asset's useful life or its salvage
value, the revision of depreciation expense is handled by depreciating the
current undepreciated cost of the asset (original cost – accumulated
depreciation) using the revised assumptions of remaining useful life and
salvage value.
Present and future periods are affected by such revisions. Depreciation
expense calculated and reported in past periods is not revised.
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Q8-6.
The gain or loss on the sale of a PPE asset is determined by the difference
between the asset's book value and the sale proceeds. Sales proceeds in
excess of book values create gains; sales proceeds less than book values
cause losses. The relevant factors, then, are the depreciation rate and salvage
values used to compute depreciation expense, accumulated depreciation and
the net book value of the asset, as well as the selling price of the asset.
Q8-7.
A PPE asset is considered to be impaired when the sum of the undiscounted
expected cash flows to be derived from the asset is less than its current book
value.
An impairment loss is calculated as the difference between the asset's book
value and its current fair market value.
Q8-8.
Research and development costs must be expensed under GAAP unless they
have alternative future uses. Equipment relating to a specific research project
with no alternative use would, therefore, be expensed rather than capitalized
and subsequently depreciated.
Accounting standard-setters have justified this ‘expense as incurred’ treatment
for R&D costs since the outputs from research and development activities are
uncertain and thus there is not a way to know when the asset is used up or
whether revenue will be earned from the R&D spending.
Q8-9.
The difficulty with amortizing intangible assets is estimating the useful life. For
some intangibles, the useful life is limited and can be easily estimated.
However, some intangibles have an indefinite life. This means that the useful
life of the intangible is long and cannot be determined with any reasonable
degree of accuracy. Under these circumstances, it is not appropriate to
amortize the asset until the useful life can be determined.
Q8-10. Goodwill arises whenever a company acquires another company and the
purchase price is greater than the fair value of the identifiable assets acquired.
The amount of goodwill is the difference between the purchase price and the
value assigned to the net assets of the acquired company. It is recorded as a
long-term asset in the balance sheet.
Since goodwill is assumed to have an indefinite life, it is not amortized. The
only time that goodwill will affect the income statement is if it is determined that
its value is impaired. In that case, an impairment loss is recorded in the income
statement and the value of the goodwill asset on the balance sheet is reduced.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
MINI EXERCISES
M8-11. (10 minutes)
LO 2
a. Expense
b. Capitalize
c. Capitalize (the new equipment enhances the assembly line)
d. Expense – this is routine maintenance of the building, unless it extends the
building’s useful life
e. Capitalize – the useful life is extended
f. Capitalize – this is a purchased intangible asset
M8-12. (15 minutes)
LO 3
a. Straight-line: ($18,000 - $1,500)/ 5 years = $3,300 for both 2019 and 2020.
b. Double-declining-balance: Twice straight-line rate = 2 x 1/5 = 40%
2018: $18,000 x 0.40 = $7,200
2019: ($18,000 - $7,200) x 0.40 = $4,320
Notice that, over the first two years, the company reports $6,600 of depreciation
expense under the straight-line method and $11,520 of depreciation expense under
the double-declining-balance method.
M8-13. (15 minutes)
LO 3
a. Straight-line: ($130,000 - $10,000)/ 6 years = $20,000 for both 2019 and 2020.
b. Double-declining-balance: Twice straight-line rate = 2 x 1/6 = 1/3
2018: $130,000 x 1/3 = $43,333
2019: ($130,000 - $43,333) x 1/3 = $28,889
c. Units of production: ($130,000 - $10,000) / 1,000,000 = $0.12 per unit
2018: 180,000 units x $0.12 = $21,600
2019: 140,000 units x $0.12 = $16,800
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M8-14. (15 minutes)
LO 4
Straight-line depreciation: $40,000/10 = $4,000; 8 years x $4,000 = $32,000.
a. Cash (+A) ..........................................................................................
3,500
Accumulated depreciation (-XA, +A) .................................................
32,000
Loss on sale of furniture and fixtures (+E, -SE) .................................
4,500
Furniture and fixtures (-A) ................................................................40,000
b.
Balance Sheet
Transaction
Sold furniture
and fixtures
for cash.
Cash
Asset
Noncash
+ Assets
Contra
Assets
+3,500
Cash
-40,000
Furniture
and
Fixtures
-32,000
Accum.
Deprec.
-
Liabi=
lities
Income Statement
Contrib.
+
+
Capital
Earned
Capital
Net
Income
Revenues - Expenses =
-4,500
Retained
Earnings
+4,500
-4,500
Loss
on Sale =
of Furniture
and
Fixtures
M8-15. (15 minutes)
LO 4
Twice the straight-line rate = 1/5 x 2 = 40%
Year 1: $75,000 x .4 =
Year 2: ($75,000 - $30,000) x .4 =
Year 3: ($75,000 - $30,000 - $18,000) x .4 =
Total accumulated depreciation
$30,000
18,000
10,800
$58,800
a. Cash (+A) ...........................................................................................
25,000
Accumulated depreciation (-XA, +A) ..................................................
58,800
Machinery (-A) ..................................................................................
Gain on sale of machinery (+R, +SE) ...............................................
75,000
8,800
b.
Balance Sheet
Transaction
Sold
machinery
for cash.
Cash
Asset
+25,000
Cash
Noncash
+ Assets
-75,000
Machinery
-
Contra
Assets
-
-58,800
Accum.
Deprec.
Liabi=
lities
Income Statement
Contrib.
+
+
Capital
Earned
Capital
+8,800
Retained
Earnings
Revenues
+8,800
Gain on
Sale of
Machinery
- Expenses =
Net
Income
+8,800
-
=
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M8-16. (15 minutes)
LO 3
a. Straight-line depreciation
2018: ($145,800 - $5,400)/3 = $46,800; (8/12) x $46,800 = $31,200
(Note: 8/12 is the fraction of the year, May through December)
2019: $46,800
b. Double-declining-balance depreciation
Preliminary computation: Twice straight-line rate = 2 x 1/3 = 66⅔%
($145,800 x 66⅔%) = $97,200
2018: (8/12) x $97,200 = $64,800
2019: ($145,800 - $64,800) x 66⅔% = $54,000
M8-17. (20 minutes)
LO 1, 2, 5
a. Under U.S. GAAP, capitalization of development costs is not allowed and all R&D
costs must be expensed. Under IFRS, development costs are capitalized if there is the
intention, feasibility and resources to bring the asset to completion, there exists the
ability to use or sell the asset to generate an economic benefit. Otherwise the costs
must be expensed.
b. Yes, impairment should be tested for annually (or sooner if there is an indication that
goodwill is impaired).
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-117
M8-18. (20 minutes)
LO 3
a.
Year
1
2
3
4
Book Value
$50,000
25,000
12,500
8,000
Depreciation Rate
2 x ¼ = 0.5
2 x ¼ = 0.5
Depreciation Expense
$25,000
12,500
4,500
0*
*No depreciation is recorded in Year 4 because the asset is depreciated to its residual value of $8,000.
b.
Year
1
2
3
4
5
Book Value
$50,000
30,000
18,000
10,800
6,480
Depreciation Rate
2 x 1/5 = 0.4
2 x 1/5 = 0.4
2 x 1/5 = 0.4
2 x 1/5 = 0.4
Depreciation Expense
$20,000
12,000
7,200
4,320
3,480*
*$3,480 of depreciation is required in Year 5 to depreciate the asset to its residual value of $3,000.
Year
1
2
3
4
5
6
7
8
9
10
Book Value
$50,000
40,000
32,000
25,600
20,480
16,384
13,107
10,486
8,389
6,711
Depreciation Rate
2 x 1/10 = 0.2
2 x 1/10 = 0.2
2 x 1/10 = 0.2
2 x 1/10 = 0.2
2 x 1/10 = 0.2
2 x 1/10 = 0.2
2 x 1/10 = 0.2
2 x 1/10 = 0.2
2 x 1/10 = 0.2
Depreciation Expense
$10,000
8,000
6,400
5,120
4,096
3,277
2,621
2,097
1,678
5,711*
* $5,711 of depreciation is required in Year 10 to depreciate the remaining value of the asset.
Alternatively, DeFond could switch to straight-line depreciation in Year 7, recording $3,027 of
depreciation in Years 7 through 10.
©Cambridge Business Publishers, 2020
1-118
Financial Accounting, 6th Edition
M8-19. (15 minutes)
LO 3
a.
Year
2019
2020
2021
Barrels Extracted
300,000
500,000
600,000
Depletion per Barrel
$32,000,000 / 4,000,000 = $8
$32,000,000 / 4,000,000 = $8
$32,000,000 / 4,000,000 = $8
Depletion
$2,400,000
$4,000,000
$4,800,000
b.
i.
Oil reserve (+A) ......................................................... 32,000,000
Cash (-A) ..............................................................
ii. Oil inventory (+A) ......................................................
Oil reserve (-A) ......................................................
32,000,000
2,400,000
2,400,000
c.
+
i.
Balance
+
Oil Reserve (A) 32,000,000
2,400,000
29,600,000
Cash (A)
32,000,000
Balance
+
ii.
Oil Inventory (A)
2,400,000
Balance
2,400,000
-
ii.
i.
32,000,000
M8-20. (15 minutes)
LO 6
a.
Texas Instruments
Intel Corp.
PPE Turnover Rates for 2018
$15,784 / [($3,183 + $2,664) / 2] = 5.40
$70,848 / [($48,976 + $41,109) / 2] = 1.57
Texas Instruments turns its PPE more quickly than does Intel.
b. PPE turnover rates increase with increases in sales volume relative to the dollar
amount of PPE on the balance sheet. The PPE turnover rate is often a very difficult
turnover rate to change, and typically requires creative thinking. Many companies are
outsourcing the manufacturing process in whole or in part to others in the supply chain.
This is beneficial so long as the savings realized by the reduction of manufacturing
assets more than offset the higher cost of the goods as these are now purchased
rather than manufactured. Another approach is to utilize long-term operating assets in
partnership with another firm, say in a joint venture.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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M8-21. (15 minutes)
LO 5, 6
a. $2,300 / $30,578 = 7.52%.
Abbott’s R&D expenditure level could be compared to the R&D expenditure level for its
competitors to gain a sense of the appropriateness of its R&D expenditures. Roche
Holding AG has historically spent 20% of its revenues on R&D while Teva
Pharmaceutical Industries Limited has a research and development intensity ratio of
about 7% (note both of these companies are listed as primary competitors on Yahoo
Finance).
b. R&D costs must be expensed when incurred unless they are expenditures for
depreciable assets that have alternative future uses (in which case the depreciation is
expensed as recognized). As a result, the balance sheet does not reflect the costs
incurred for long-term R&D assets. In addition, operating expenses are increased, thus
reducing retained earnings.
($ millions)
Balance Sheet
Transaction
Cash
Asset
R&D
expenditures
-2,300
Cash
Noncash
Liabi+ Assets = lities
=
Contrib.
+ Capital +
Income Statement
Earned
Capital
-2,300
Retained
Earnings
Revenues
Net
- Expenses = Income
-
+2,300
R&D
Expense
=
-2,300
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
EXERCISES
E8-22. (15 minutes)
LO 2, 3, 4
a. Machine (+A) .....................................................................................
89,500
Cash (-A) ($85,000 + $2,000 + $2,500) ............................................ 89,500
b. ($89,500 - $7,000) / 5 = $16,500 per year.
Depreciation expense (+E, -SE) ........................................................
16,500
Accumulated depreciation (+XA, -A) ................................................. 16,500
c. Cash (+A) ...........................................................................................
12,000
Accumulated depreciation (-XA, +A) ($16,500 x 4) ............................
66,000
Loss on sale of machine (+E, -SE) ....................................................
11,500
Machine (-A) ..................................................................................
89,500
E8-23. (20 minutes)
LO 3
a. Straight line:
($80,000 - $5,000)/5 years = $15,000 per year
b. Double declining balance: Twice straight-line rate = 2 x 1/5 = 40%
Year
Book Value x Rate
1
2
3
4
5
Total
$80,000 x 0.40 =
($80,000 - $32,000) x 0.40 =
($80,000 - $51,200) x 0.40 =
($80,000 - $62,720) x 0.40 =
Depreciation Expense
$32,000
19,200
11,520
6,912
5,368 (plug)
$75,000
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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E8-24. (25 minutes)
LO 3, 4
a. 1. Accumulated depreciation on the date of sale:
[($800,000-$80,000)/10 years] x 6 years = $432,000
2. Net book value of the plane at date of sale:
$800,000 - $432,000 = $368,000
b. 1.
Cash (+A) ........................................................................................
368,000
Accumulated depreciation (-XA, +A) ...............................................
432,000
Plane (-A) .....................................................................................
800,000
2. Loss on sale of: $195,000 - $368,000 = $173,000
Cash (+A) .......................................................................................
195,000
Accumulated depreciation (-XA, +A) ...............................................
432,000
Loss on sale of plane (+E, -SE) ......................................................
173,000
Plane (-A) ....................................................................................
800,000
3. Gain on sale of: $600,000 - $368,000 = $232,000
Cash (+A) .......................................................................................
600,000
Accumulated depreciation (-XA, +A) ...............................................
432,000
Gain on sale of plane (+R, +SE) ..................................................
Plane (-A) ....................................................................................
232,000
800,000
E8-25. (15 minutes)
LO 3
a. Straight-line: 2019 and 2020 ($218,700 - $23,400)/6 years = $32,550
b. Double-declining-balance: twice straight-line rate = 2 x 1/6 = 33⅓%
2019
$218,700 x 33⅓% =
$72,900
2020
($218,700 - $ 72,900) x 33⅓% =
$48,600
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E8-26. (15 minutes)
LO 3, 4
a. Depreciation expense to date of sale is [($27,200 - $2,000)/6] x 3 = $12,600.
The net book value of the van is, therefore, $27,200 - $12,600 = $14,600.
b. 1. $0
2. $400 gain ($15,000 - $14,600)
3. $2,600 loss ($12,000 - $14,600)
E8-27. (20 minutes)
LO 3
a. Straight line: ($110,000 - $15,000) / 6 = $15,833 each year.
b. Double-declining-balance: rate = 2 x 1/6 = 1/3
2019: $110,000 x 1/3 = $36,667
2020: ($110,000 – $36,667) x 1/3 = $24,444
2021: ($110,000 – $36,667 – $24,444) x 1/3 = $16,296
c. Straight line: [$110,000 – ($15,833 x 2) – $10,000] / 5 = $13,667 in 2021 and each
subsequent year.
Double-declining balance: rate = 2 x 1/5 = 40%.
($110,000 – $36,667 – $24,444) x 40% = $19,556 in 2021
E8-28. (20 minutes)
LO 3
a. Straight-line: $6,000,000 / 30 = $200,000 per year each year.
b. Double-declining balance: rate = 2 x 1/30 = 1/15.
2019: $6,000,000 x 1/15 = $400,000
2020: ($6,000,000 – $400,000) x 1/15 = $373,333
c. The revised depreciation rate = 2 x 1/23 = 8.7%
2021: ($6,000,000 – $400,000 – $373,333) x 8.7% = $454,720*
*$454,493 (using unrounded depreciation rate)
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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E8-29. (10 minutes)
LO 6
Percent depreciated = Accumulated depreciation / Asset cost
= $7,095 million / ($12,916 - $283 - $619) million = 59%
Note: We eliminate land and construction in progress from the computation because
these assets are not depreciated.
Assuming that assets are replaced evenly as they are used up, we would expect assets
to be 50% depreciated, on average. Deere’s 59% is slightly higher than this level. If the
percentage depreciation were high, one possible concern is that it often requires higher
capital expenditures in the near future to replace aging assets.
E8-30. (25 minute)
LO 6
a.
2017
2018
Receivable Turnover Rate
$31,657
= 6.81
$4,911+$4,392
2
$32,765
$5,020+$4,911
2
=6.60
Inventory Turnover Rate
$16,055
= 4.33
$4,034+$3,385
2
$16,682
$4,366+$4,034
2
= 3.97
PPE Turnover Rate
$31,657
= 3.64
$8,866+$8,516
2
$32,765
$8,738+$8,866
2
= 3.72
b. 3M’s Receivable and Inventory turnover ratios have declined from 2017 to 2018,
while its PPET improved. 3M’s revenues increased in 2018, and that increase is
likely to account for the increase in the PPET. PPE turns can also be improved by
off-loading manufacturing to other companies in the supply chain and acquiring longterm operating assets in partnership with other companies, for example, in a joint
venture. Receivable turnover decline indicates that receivables have increased
faster than sales. This could indicate a need to monitor more closely the quality of
customers to which credit is granted, implement better collection procedures, or
offering discounts as an incentive for early payment. Inventory turnover rates can be
improved by weeding out slowly moving product lines, by reducing the depth and
breadth of products carried, and by implementing just-in-time deliveries.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E8-31. (10 minutes)
LO 1, 5
a.
Fair Value
(Capitalized)
Useful
Life
b.
Amortization
Expense for 2019
Patent
$200,000
3 years
$66,667
Trademark
Noncompetition agreement
$500,000
$300,000
Indefinite
5 years
$60,000
$126,667
E8-32. (15 minutes)
LO 3
a. Cost of resource property: $7,200,000 + $420,000 + $50,000 + $800,000
= $8,470,000
Residual value: $1,200,000
Depletion base: $8,470,000 – $1,200,000 = $7,270,000
Depletion rate: $7,270,000 / 500,000 tons = $14.54 per ton
2019: 60,000 x $14.54 = $872,400
2020: 85,000 x $14.54 = $1,235,900
b. 2019: Inventory (+A) ...................................................................................
872,400
Resource property (-A) .....................................................................
872,400
2020: Inventory (+A) ...................................................................................
1,235,900
Resource property (-A) .....................................................................
1,235,900
©Cambridge Business Publishers, 2020
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E8-33. (15 minutes)
LO 6
a. PPET: $21,461,268 / [($11,330,077 + $10,027,522)/2] = 2.0 times
b. Percent depreciated: $2,699,098 / ($14,029,175 - $807,297) = 20.4%
The cost of construction in progress is subtracted in the denominator because this
amount represents PPE assets that are not currently in the base of depreciable
assets. The cost of land should also be subtracted, but because Tesla lumps land
and buildings together, this is not possible. Therefore, the actual percent
depreciated ratio should be a little higher than the 20.4% we calculated.
c. Tesla’s assets are about one fifth depreciated at the end of 2018. This results in an
extremely low percent depreciated ratio and PPE turnover ratio (PPET).
Tesla’s useful life assumptions could affect these ratios. For example, Tesla uses a
units-of-production approach to depreciate tooling. In the auto industry, companies
retool each time they make major design changes to a model. Years ago, this would
happen annually, but in more recent years, automakers may retool only every three
to five years. Tesla’s depreciation for tooling costs depend on its assumptions about
sales of each model. So, it assumes 325,000 units for the expensive Models S and
X while the (relatively) less expensive Model 3 has a projected demand of 1,000,000
units. Ultimately, the accuracy of these sales estimates will have an effect on
depreciation expenses and, in turn, Tesla’s ratios.
E8-34. (15 minutes)
LO 5
a. The list illustrates the wide range in expenditures for R&D (as a percent of sales)
across firms. Note the large amount spent by Intel (19.11%) and pharmaceutical
companies Pfizer (14.92%) and Merck (23.06%), compared to the amount spent by
Apple (5.36%), Deere (4.97%) or Callaway Golf (3.28%). The companies in the list
are to some extent paired by industry. It is interesting to see how similar some firms
in the same industry are. For example, Apple and Samsung spend almost the same
percentage of sales on R&D.
b. Beside industry affiliation, the differences in R&D expenditures as a percent of sales
is due to differences in markets, product mix, and other strategic considerations. As
suppliers of technology (hardware and software), Intel and Microsoft depend very
heavily on their intellectual property. As a result, their expenditures on research and
development are among the highest of established firms. Apple has established
itself as an innovator in technology and design and has spent billions of dollars
developing unique products such as the iPad®. Apple’s research intensity looks
relatively low but the company has tremendous sales revenue (the denominator in
the R&D intensity ratio). In addition, the company has increased their spending on
R&D.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-127
E8-35. (20 minutes)
LO 4
a. Yes, the equipment is impaired at July 1, 2020 because its book value is not
recoverable through future cash flows. Specifically, on July 1, 2020, its book value is
$145,000 ($225,000 initial cost less $80,000 accumulated depreciation*) and the
estimated future (undiscounted) cash flows are only $125,000.
*4 years of [($225,000-$25,000)/10 years].
b. The impairment loss in a is computed as the equipment's book value minus its current
fair value: $145,000 − $90,000 = $55,000
Impairment loss (+E, -SE) ..................................................................
55,000
Equipment* (-A) ................................................................................
55,000
*Accumulated depreciation is sometimes credited for the loss.
c. Assuming that the salvage value remains the same after the impairment (this is not
likely given the decline in market value of the asset), the annual depreciation expense
would be ($90,000 - $25,000) / 6 = $10,833 per year.
Depreciation expense (+E, -SE) .......................................................
10,833
Accumulated depreciation (+XA, -A) ................................................
10,833
d.
($000)
Transaction
b. Impairment
charge.
Income Statement
Balance Sheet
Cash
Asset
+
Noncash
Assets
-55,000
Equipment
c. Depreciation
expense.
-
Contra
Assets
-
-
+10,833
Accum.
Deprec.
=
Liabilities
+
Contrib.
Capital +
Earned
Capital
Revenues
Net
- Expenses = Income
-55,000
Retained
Earnings
+55,000
-55,000
- Impairment =
Loss
-10,833
Retained
Earnings
-
+10,833
Deprec.
Expense
=
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
-10,833
PROBLEMS
P8-36. (20 minutes)
LO 4
In order to determine the entries for the sale of property, plant and equipment, we need
to “fill in the blanks” for the PPE and accumulated depreciation accounts. Once we
record the purchases and the depreciation expense, we can determine the cost and
accumulated depreciation for the assets sold.
(i)
Property, plant and equipment (+A) ................................................. 72
Cash (-A) ......................................................................................
72
Depreciation expense (+E, -SE) ....................................................... 54
Accumulated depreciation (+XA, -A) ............................................
54
(iii) Cash (+A) ......................................................................................... 4
Accumulated depreciation (-XA, +A) ................................................ 23
Property, plant and equipment (-A) .............................................
27
(ii)
+ Property, Plant and Equipment (A)
Balance
803
(i)
72
27
Balance
848
-
(iii)
-
(iii)
Accumulated Depreciation (XA) +
450
Balance
54
(ii)
23
481
Balance
The net book value of the assets that were sold was $4 million. If Hilton sold the assets
for more (less) than $4 million a gain (loss) would have resulted equal to the difference
between the sale price and the net book value. A gain would be recorded as a credit
entry in the journal entry (iii) and a loss would be recorded as a debit entry.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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P8-37. (20 minutes)
LO 5
a. $385 million / $4,914 million = 7.8%
b. R&D costs are expensed in the income statement except for the portion relating to
depreciable assets that have alternate uses. Expensing (rather than capitalizing and
depreciating) reduces assets, and the additional expense reduces profit and equity
(via the reduction in retained earnings). In addition, expensing R&D as incurred
means that potentially valuable intangible assets are omitted from the balance sheet.
c. Agilent has reduced its R&D spending as a percent of revenues in recent years and,
as a result, increased its earnings. This has turned operating losses into an
operating profit for the company. However, Agilent is dependent upon technology in
order to maintain its market position, and R&D is critical to its very existence. Agilent
divested itself of some high-intensity R&D businesses between 2003 and 2011.
Changes in R&D spending, as a percent of revenues, is affected by R&D spending
and also by revenues. Agilent’s revenues have decreased from 2014 to 2018 but its
R&D expenditures have decreased at a faster rate. A company can maintain its
investment in intellectual capital and reduce expenses by outsourcing the activity to
other countries where the intellectual resources are less expensive.
P8-38. (20 minutes)
LO 4
($ millions)
a.
i. Depreciation expense (+E, -SE) ...................................................... 2,460
Accumulated depreciation (+XA, -A) ................................................
ii.
2,460
Property and equipment (+A) ........................................................... 3,516
Cash (-A) ..........................................................................................
3,516
iii. Cash (+A) ......................................................................................... 85
Accumulated depreciation (-XA, +A) (see T-account) ...................... 2,171
Property and equipment (-A) (see T-account) ..................................
2,256
iv. Impairment and writedown charges (+E, -SE)
Property and equipment (-A)
+ Property and Equipment (A)
Balance
42,934
(ii)
3,516
2,256
92
(b)
118
Balance
44,220
-
-
(iii)
(iv)
(iii)
92
92
Accumulated Depreciation (XA) +
18,398
Balance
2,460
(i)
2,171
18,687
Balance
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-131
b.
The problem provides information directly to make entries (i), (ii), (iii) and (iv) in part
a. For part (iii), we can infer the accumulated depreciation on disposed property
and equipment as being the amount ($2,171) that makes that account balance.
Since no gain or loss was reported on these disposals, the credit to property and
equipment in part (iii) is the amount that balances the disposal transaction ($2,256).
However, this leaves the property and equipment T-account unbalanced. A likely
reason is that Target acquires some property and equipment without an expenditure
of cash. (Chapter 10 will cover capital lease transactions, which play a role in
Target’s operations.) Based on the information in the problem, we would estimate
that $118 million of property and equipment was acquired through such transactions,
because that amount balances the property and equipment T-account.
P8-39. (20 minutes)
LO 4
The process used in this question is to fill in the entries for property and equipment and
for accumulated depreciation in parts a, b and c, and then to use the “plug” figures in
the T-accounts to determine the values in part d.
($ thousands)
a. Depreciation expense (+E, -SE) .......................................................
182,533
Accumulated depreciation (+XA, -A) ................................................
182,533
b. Property and equipment (+A) ............................................................
190,102
Cash (-A) ..........................................................................................
190,102
c. Loss on impairment of property and equipment (+E) ........................9,639
Property and equipment (-A) ............................................................
9,639
d. Cash (+A) .........................................................................................
8
Loss on disposal of property and equipment
570
Accumulated depreciation (-XA, +A) (see T-account) .......................
56,595
Property and equipment (-A) (see T-account) ..................................
57,173
+
Property and Equipment (A)
Balance
2,619,112
(b)
190,102
9,639
57,173
Balance
2,742,402
-
-
(c)
(d)
(d)
Accumulated Depreciation (XA) +
1,686,829
Balance
182,533
(a)
56,595
1,812,767
Balance
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
CASES and PROJECTS
C8-40. (90 min)
LO 4, 6
a. PPE Turnover: $15,740.4/[($4,047.2 + $3,687.7)/2] = 4.07
The firm appears to be as capital intensive as others in the industry based on a
similar PPE turnover ratio to its closest competitors. However, if the assets are older
(more depreciation) the denominator will be smaller and could cause the PPE
turnover to be higher. Thus, the age of the assets can affect the ratio as well.
b. Accumulated depreciation / Depreciable asset cost
$5,596.0/ ($10,003.2 - $77.7*- $692.9*) = 0.606 or 61%
*Note: We eliminate land from the computation because land is never depreciated. We eliminate
construction in progress because these represent assets that the company is building. These assets
are not yet in service and are consequently not yet depreciable. This elimination is also used in part c.
If plant assets are replaced at a constant rate, we would expect those assets to be
about 50% “used up,” on average. A substantially higher percentage “used up”
indicates that the assets are closer to the end of their useful lives and will require
replacement (and usually higher maintenance costs near the end of their useful
lives). Such a situation would negatively affect future cash flows.
c. Average depreciable assets = [($10,003.2 – 77.7 – 692.9) + ($9,526.6 – 79.8 –
553.0)] / 2 = $9,063.2
Average depreciable assets/ Depreciation expense = $9,063.2 / $589.0 per year
= 15.4 years.
d. Depreciation expense (+E, -SE) .......................................................
589.0
PPE accumulated depreciation (+XA, -A) .........................................
589.0
PPE (+A) ...........................................................................................
622.7
Cash (-A) ..........................................................................................
622.7
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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C8-41. (40 minutes)
LO 6
Reducing operating assets is an important means of increasing performance measures
including the return on net operating assets. Most companies focus first on reducing
receivables and inventories. This is the so-called low-hanging fruit that can lead to quick
results. Some possible actions include those listed. Students will think of additional
possibilities.
a. Reducing receivables through:
1. Better underwriting of credit quality
2. Better controls to identify delinquencies, automated over-due notices, and better
collection procedures
3. Increased attention to accuracy in invoicing
4. Offering early payment incentives
b. Reducing inventories and inventory costs through essentially eliminating
nonproductive activities including inspection, moving activities, waiting setup time:
1. Use of less costly components (of equal quality) and production with lower wage
rates
2. Elimination of product features not valued by customers
3. Outsourcing to reduce product cost
4. Just-in-time deliveries of raw materials
5. Elimination of manufacturing bottlenecks to reduce work-in-process inventories
6. Producing to order rather than to estimated demand to reduce finished goods
inventories
7. Eliminating defects
c. Reducing PPE assets is much more difficult. The benefits, however, can be
substantial. Some suggestions are the following:
1. Sale of unused and unnecessary assets
2. Acquisition of production and administrative assets in partnership with other
companies for greater throughput
3. Acquisition of finished or semi-finished goods (sub-components) from suppliers
to reduce manufacturing assets
d. Reducing unnecessary intangible assets that are reported on the balance sheet is
the most difficult.
1. Sale of assets no longer relevant to company plans
2. License intangibles to other companies
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
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C8-42. (30 minutes)
LO 4, 5, 6
a. Take-Two (TTWO) spent $326,909 in 2018 on software development. TTWO’s
amortization and write-downs were $77,887 in 2018. Using EA’s method, the money
spent on additions would be expensed, and the amortization and write-downs would
disappear. The result is that if TTWO used EA’s approach, 2018 expenses would
increase by $249,022 ($326,909 – 77,887). Net income would decrease by
$186,766.5 [$249,022 X (1-0.25)] in 2018.
C8-43. (20 minutes)
LO 4
a. DreamWorks would have recorded a pretax profit of $10.6 million for 2014.
[($86.26 million) + $66.5 million + $30.3 million] = $10.6 million.
b. DreamWorks capitalizes film production costs and amortizes them over the life of the
film, meaning over the time period of the expected revenue stream. The unamortized
asset (that is, the unamortized capitalized costs) have to be tested for impairment
each reporting period.
c. Loss due to impairment (+E, -RE)
Mr. Peabody and Sherman (-A)
The Penguins of Madagascar (-A)
96.8 million
66.5 million
30.3 million
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Financial Accounting, 6th Edition
Chapter 9
Reporting and Analyzing Liabilities
Learning Objectives – coverage by question
MiniExercises
Exercises
Problems
18, 19,
21, 25, 33
38 - 40, 43
51, 59
LO2 – Describe and account for
current nonoperating (financial)
liabilities.
20, 21
49
LO3 – Explain and illustrate the
pricing of long-term nonoperating
liabilities.
22, 31, 32,
34 - 37
41, 42,
44 - 48, 50
52 - 58
60, 61
LO4 – Analyze and account for
financial statement effects of longterm nonoperating liabilities.
20, 23, 24,
26 - 29,
34 - 36
41, 44 - 50
51 - 58
60, 61
LO1 – Identify and account for
current operating liabilities.
LO5 – Explain how solvency ratios
and debt ratings are determined and
how they impact the cost of debt.
22, 30
Cases
and Projects
60, 61
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QUESTIONS
Q9-1.
Current liabilities are obligations that require payment within the coming year or
operating cycle, whichever is longer.
Generally, current liabilities are normally settled with use of existing current
assets or operating cash flows.
Q9-2.
If a company fails to take a cash discount that is offered by a supplier, it is
effectively paying a penalty for taking additional time to pay the account
payable. Depending on the size of the discount, this penalty (an implicit
interest rate) can be quite high.
The net-of-discount method records the inventory at the purchase cost less the
discount. If the discount is lost, the extra cost is treated as part of interest
expense for the period. This has two benefits: (1) the lost discount is not
capitalized as part of the cost of inventory, and (2) the lost discount is
highlighted, which is useful information that may be helpful in managing
accounts payable.
Q9-3.
An accrual is the recognition of an event in the financial statements even
though no actual transaction has occurred. Accruals can involve both liabilities
(and expenses) and assets (and revenues).
Accruals are vital to the fair presentation of the financial condition of a company
as they impact both the recognition of revenue and the matching of expense.
Q9-4.
The coupon rate is the rate specified on the face of the bond. It is used to
compute the amount of cash interest paid to the bond holder. The market rate
is the rate of return expected by investors that purchase the bonds. The market
rate determines the market price of the bond. It incorporates expectations about
the relative riskiness of the borrower and the rate of inflation. In general, there
is an inverse relation between the bond’s market rate and the bond’s market
price.
Q9-5.
Bonds sold at face (par) value earn an effective interest rate equal to the bonds’
coupon rate. Bonds are sold at a discount when the effective interest rate is
higher than the coupon rate. Bonds are sold at a premium when the effective
interest rate is lower than the coupon rate.
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Financial Accounting, 6th Edition
Q9-6.
Bonds are reported at historical cost, that is, the face amount plus (minus)
unamortized premium (discount). The market price of the bonds varies
inversely with the level of interest rates and fluctuates continuously. Differences
between the market price of a bond and its carrying amount represent
unrealized gains and losses. These unrealized gains (losses) are not reflected
in the financial statements (although they are disclosed in the footnotes). They
must be recognized upon repurchase of the bonds, the point at which they
become “realized.”
If the bonds are refunded (that is, replaced with new bonds reflecting current
market values and interest rates), the gain (or loss) that is recognized in the
current period will be offset by correspondingly higher (lower) interest payments
in the future. The present value of the future interest payments, along with the
present value of the difference between the face amount of the new bond and
the former face amount, exactly offset the reported gain (loss).
Q9-7.
Debt ratings reflect the relative riskiness of the borrowing company. This
riskiness relates to the probability of default (e.g., not repaying the principal and
interest when due). Higher (greater quality) debt ratings result in higher market
prices for the bonds and a correspondingly lower effective interest rate for the
issuer. Lower (lesser quality) debt ratings result in lower market prices for the
bonds and a correspondingly higher effective interest rate for the issuer.
Q9-8.
Reported gains or losses on bond redemption result from changes in the
market price of the bonds and the use of historical cost accounting. Because
bonds are typically reported at historical cost, fluctuations in bond prices are not
recognized until they are realized when the bonds are redeemed or refunded.
If the bonds are refunded (new bonds are issued), the gain or loss is offset by
the present value of lower (higher) future interest payments on the new bond
issue. (If the liabilities are reported at fair value, the gain or loss is the
difference between the last reported fair value and the sales price (assuming all
the fair value changes were recorded in income – meaning were not due to
instrument-specific credit risk changes.)
Q9-9.
(a) Bonds payable – the liability account used to record the face value of
bonds issued by a company
(b) Call provision – the right for the bond issuer to repurchase the debt, before
it matures, at a predetermined price.
(c) Face value – the predetermined amount (typically $1,000) that must be
repaid when a bond matures
(d) Coupon rate – the rate specified on the face of the bond that determines
the periodic interest (coupon) payment
(e) Bond discount – the difference between the face value of the bond and the
market price when the price is lower than the face value; recorded as a
contra-liability
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(f) Bond premium – the difference between the market price of a bond and the
face value when the market price is higher than the face value; recorded as
an adjunct-liability
(g) Amortization of premium or discount – the periodic reduction of the balance
in the premium or discount account recorded each time interest expense is
accrued; equal to the difference between the accrued interest and the
coupon payment (or payable)
Q9-10. The advantages of issuing bonds are (1) the interest payments are limited to
the predetermined amount specified on the bond; (2) the interest is tax
deductible; (3) bondholders do not have a vote when it comes to electing
directors and managing the company; (4) the additional financial leverage
created when bonds are issued increases profits in good years. The
disadvantages of bonds include (1) bonds must be repaid while common stock
is issued with an indefinite life; (2) bondholders can impose restrictive
covenants in the loan indenture; (3) the additional financial leverage created
when bonds are issued decreases profits in lean years.
Q9-11. $3,000,000 x [.98 + (.09 x 3/12)] = $3,007,500
Q9-12. The contract rate (or stated rate or coupon rate) determines the periodic
coupon payment. If this rate is not equal to the rate required by the market, the
bond price is adjusted to the present value of the cash payments from the bond
discounted at the applicable market rate of interest. If the market rate is higher
than the coupon rate, then the periodic coupon payments are insufficient and
the bond will be priced lower than the face value (a discount). If the market rate
is lower than the coupon rate, then the periodic coupon payments will be higher
than required by the market, and the bond will sell for a premium.
Q9-13. When the bonds mature, the book value of the bonds will be equal to the face
value. Over the life of the bonds, the change in the book value of the bonds will
be equal to face value less the market value at the time that the bonds are
issued.
Q9-14. When the effective interest method is used to amortize a bond discount or
premium, the effective rate is multiplied by the net balance in bonds payable
(bonds payable plus/minus the premium or discount). If the bond is issued at a
discount, the balance increases over the life of the bond; the interest expense
will increase as the balance increases. If the bond is issued at a premium, the
balance decreases over the life of the bond; the interest expense will decrease
as the balance decreases.
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Financial Accounting, 6th Edition
Q9-15. Bonds payable is presented in the balance sheet net of any discount or plus
any premium.
Q9-16. The loss is the difference between the retirement value and the book value of
the bond: (101% x $200,000) – $197,600 = $4,400.
Q9-17. Each payment includes both interest on the outstanding balance and
repayment of the principal. As each payment is made, the principal balance is
reduced. As a consequence, the interest component of the payment is smaller
each period.
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MINI EXERCISES
M9-18. (15 minutes)
LO 1
a.
11/15
11/23
Inventory (+A)
Accounts payable (+L)
6,076
Accounts payable (-L)
Cash (-A)
6,076
6,076
6,076
$6,076 = $6,200 x 0.98
b.
+
11/15
Inventory (A)
6,076
-
11/23
+
Cash (A)
Accounts Payable (L)
6,076
6,076
+
11/15
6,076
11/23
c. [($6,200 - $6,076)/$6,076] x [365/(30-10)] = 37.25%. (With interest compounding,
the annual rate of interest r can be solved from (1+r)(20/365)=1.02. The value that
solves this relationship is r = 43.5%.)
M9-19. (15 minutes)
LO 1
a.
1/20
2/15
Inventory (+A)
Accounts payable (+L)
12,250
Accounts payable (-L)
Interest expense, discounts lost (+E, -SE)
Cash (-A)
12,250
250
12,250
12,500
$12,250 = $12,500 x 0.98
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Financial Accounting, 6th Edition
b.
+
Inventory (A)
12,250
1/20
-
2/15
+
Cash (A)
12,500
Accounts Payable (L)
12,250
12,250
+
1/20
+ Interest Expense, Discounts Lost (E)
2/15
250
2/15
-
c. [($12,500- $12,250)/$12,250] x [365/(60-15)] = 16.55%. (With interest
compounding, the annual rate of interest r can be solved from (1+r)(45/365)=1.02.
The value that solves this relationship is r = 17.4%.)
M9-20. (10 minutes)
LO 2
a. Interest expense (+E,-SE)……………………
Interest payable (+L)…………………….
24
24
$7,200 × 8% × (15/365) = $24
b.
-
Interest Payable (L)
+
24
+
a.
a.
Interest Expense (E)
-
24
c.
Balance Sheet
Transaction
Accrued $24
interest on
note payable
Cash
Asset
+
Noncash
Assets
Liabilities
+24
= Interest
Payable
=
+
Income Statement
Contrib.
Capital +
Earned
capital
-24
Retained
Earnings
Revenues
- Expenses
+24
Interest
Expense
Net
= Income
-24
=
M9-21. (15 minutes)
LO 1, 2
a. Accounts Payable, $110,000 (current liability).
b. Not recorded as a liability; an accountable transaction has not yet occurred.
c. Estimated liability for product warranty, $2,200 (current liability).
d. Bonuses Payable, $30,000 (current liability)—computed as $600,000  5%. This
liability must be reported since its payment is “probable” and can be “estimated.”
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M9-22. (10 minutes)
LO 3, 5
a. Microsoft is offering bonds with a coupon (stated) rate of 3.3%% when the market
rate (yield) is higher (3.383%). In order to obtain this expected rate of return, the
bonds sell at a discount price of 99.31 (99.31% of par).
b. The first bond matures in 2027 while the second matures in 2057. There is,
generally, a higher rate (yield) expected for a longer maturity.
M9-23. (10 minutes)
LO 4
Amount paid to retire bonds ($400,000 x 102%)..............................................
Book value of retired bonds, net of $3,000 unamortized discount ...................
Loss on bond retirement ..................................................................................
$408,000
397,000
$ 11,000
M9-24. (10 minutes)
LO 4
a. The $3,546 million of debt that is due in 2018 is already listed as the current portion
of long-term debt in Pfizer’s current liabilities.
b. Pfizer will need to pay off the bonds when they mature. This will result in a cash
outflow that must come from operating activities if the bonds cannot be refinanced
prior to maturity. However, most of Pfizer’s long-term debt matures more than 5
years after the financial statement date (December 31, 2017). Thus, Pfizer’s nearterm cash needs for covering long-term debt should not place a significant burden
on the company’s operations.
M9-25 (10 minutes)
LO 1
a. Gain on Bond Retirement: In the other (nonoperating) income and expenses section of
the income statement.
b. Discount on Bonds Payable: Deduction from Bonds Payable; thus, a (contra) long-term
liability in the balance sheet (e.g., it is netted in the presentation of long-term liabilities).
c. Mortgage Notes Payable: Long-term liability in the balance sheet.
d. Bonds Payable: Long-term liability in the balance sheet.
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Financial Accounting, 6th Edition
e. Bond Interest Expense: In other (nonoperating) income and expenses section of the
income statement.
f. Bond Interest Payable: Current liability in the balance sheet.
g. Premium on Bonds Payable: Addition to Bonds Payable; thus, part of a long-term
liability in the balance sheet (e.g., it is included in the presentation of long-term
liabilities).
h. Loss on Bond Retirement: In the other (nonoperating) income and expenses section of
the income statement.
M9-26. (10 minutes)
LO 4
a. Restrictive loan covenants are typically designed to protect the bond holders against
actions by management that they feel would be detrimental to their interests. These
covenants might include restrictions against the impairment of liquidity, restrictions
on the amount of financial leverage the company can employ, and restrictions on the
payment of dividends. In addition, bond holders usually impose various covenants
prohibiting the acquisition of other companies or the divestiture of business
segments without their consent. All of these covenants, by design, restrict
management in its actions.
b. Management, facing imminent violation of one or more of its bond covenants, may
be pressured into taking actions in order to avoid default. These may include, for
example, foregoing profitable investments, reduction of discretionary spending such
as R&D or advertising in order to improve profitability, missing opportunities to take
cash discounts and other methods of “leaning on the trade,” or reduction of
receivables (via early payment incentives) and inventories (by marketing promotions
or delaying restocking) in order to boost cash balances. Actions may also include
questionable accounting measures, such as improper recognition of revenues or
delayed recognition of expenses.
c. When evaluating solvency, analysts should compare a company’s position relative to
its restrictive covenants. A company may appear solvent, but in fact may be in close
proximity to a restrictive covenant. Also, analysts should be aware of the potential
effect that restrictive covenants can have on management decisions (see the answer
to requirement b). Restricted assets, such as cash or securities, should not be
considered as general assets in an analysis of the firm’s liquidity or solvency
because they are not available to management for general corporate uses.
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M9-27. (15 minutes)
LO 4
a.
1/1/2013
1/1/2019
Cash (+A) …………………………………….....
Bonds payable (+L) ………………..……
Bond premium (+L) ………………..……
432,000
Bonds payable (-L) ………………………..…..
Bond premium (-L) ……………………..……..
Cash (-A) ……………………………….....
Gain on retirement of bonds (+R, +SE)
400,000
27,809
400,000
32,000
412,000
15,809
b.
+
1/1/13
-
Cash (A)
432,000
412,000
-
-
1/1/19
1/1/19
Gain on Retirement of Bonds (R) +
15,809
1/1/19
1/1/19
Bonds Payable (L)
400,000
400,000
+
Bond Premium (L)
32,000
27,809
+
1/1/13
1/1/13
c.
Balance Sheet
Transaction
1/1/13
Issue bonds
at a
premium.
Cash
Asset
Noncash
+ Assets
432,000
=
Liabilities
=
+400,000
Cash
Income Statement
Contrib.
+ Capital +
Earned
Capital
Revenues
-
Expenses
Net
= Income
-
=
-
= +15,809
Bonds
Payable
+32,000
Bond
Premium
1/1/19
-412,000
Retired
Cash
bonds issued
on 1/1/13.
=
-400,000
+15,809
+15,809
Bonds
Payable
Retained
Earnings
Gain on
Retirement
of Bonds
-27,809
Bond
Premium
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Financial Accounting, 6th Edition
M9-28. (15 minutes)
LO 4
a.
7/1/2012
7/1/2019
Cash (+A) …………………………………….
Bond discount (+XL, -L) …………….….….
Bonds payable (+L) …………………..
240,000
10,000
250,000
Bonds payable (-L) …………………………
Loss on retirement of bonds (+E, -SE) …
Bond discount (-XL, +L) ……….……
Cash (-A) ……………………………….
250,000
9,314
6,814
252,500
b.
+
7/1/12
Cash (A)
240,000
252,500
7/1/19
Bonds Payable (L)
250,000
250,000
7/1/19
+ Loss on Retirement of Bonds (E) 7/1/19
9,314
+
7/1/12
Bond Discount (XL)
10,000
6,814
+
7/1/12
7/1/19
c.
Balance Sheet
Transaction
7/1/12
Issue bonds
at a discount
Cash
Asset
+
Noncash
Assets
+240,000
= Liabilities
=
Cash
7/1/19 Retired -252,500
bonds issued
Cash
on 7/1/12
=
-
Income Statement
Contra
Liability +
Contrib.
Earned
Capital + Capital
+250,000
+10,000
Bonds
Payable
Bond
Discount
-250,000
-6,814
-9,314
Bonds
Payable
Bond
Discount
Retained
Earnings
Revenues
- Expenses =
-
-
=
+9,314
=
Loss on
retirement
of Bonds
M9-29. (10 minutes)
LO 4
Nissim:
$18,000  0.10  40/365
=
$197.26
Klein:
$14,000  0.09  18/365
=
62.14
Bildersee:
$16,000  0.12  12/365
=
63.12
$322.52
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Income
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-9,314
M9-30. (10 minutes)
LO 5
a. Unless there has been a decline in the General Mills’ operating liabilities, the Debtto-Equity ratio (D/E) will increase. The net effects of financing cash flows are to
increase financial liabilities and decrease shareholders’ equity. (although net income
would then increase equity, but still by an amount less than the increase in debt).
Times interest earned will likely decrease as additional interest cost on new
borrowing is added to the denominator. How much of an effect this will have
depends on the size of the change in net income.
b. Generally, the higher (lower) the firm's solvency measures, the higher (lower) the
firm's debt rating. In financial leverage terms, the higher (lower) the firm's leverage
the lower (higher) the firm's debt rating. Increasing the amount of debt while
decreasing equity may harm General Mills’ debt ratings, though increases in
operating results , could support additional financial liabilities.
M9-31. (15 minutes)
LO 3
a. Selling price of 9% bonds discounted at 8%
Present value of principal repayment ($500,000  0.45639)
Present value of interest payments ($22,500  13.59033)
Selling price of bonds
$228,195
305,782
$533,977
b. Selling price of 9% bonds discounted at 10%
Present value of principal repayment ($500,000  0.37689)
Present value of interest payments ($22,500  12.46221)
Selling price of bonds
$188,445
280,400
$468,845
M9-32. (15 minutes)
LO 3
a. Selling price of zero-coupon bonds discounted at 8%:
Present value of principal repayment ($500,000  0.45639)
$228,195
b. Selling price of zero coupon bonds discounted at 10%:
Present value of principal repayment ($500,000  0.37689)
$188,445
c. Based on the debt-to-equity ratio, financial leverage would increase from 2.0 [=($3 $1)/$1] to 2.19 [=($3 - $1 + $0.188)/$1)
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M9-33. (15 minutes)
LO 1
a.
Month
Income statement:
Revenue
Cost of goods sold
Operating expenses
Income
Operating cash flows
Receipts
Payments to suppliers
Payments for operating expenses
Net cash flow from operations
1
2
3
4
$420
300
110
$10
$420
300
110
$10
$420
300
110
$10
$420
300
110
$10
$420
300
110
$10
$420
300
110
$10
$420
300
110
$10
$420
300
110
$10
1
2
3
4
$420
300
110
$10
$420
300
110
$10
$420
300
110
$10
$420
300
110
$10
$420
0
110
$310
$420
300
110
$10
$420
300
110
$10
$420
300
110
$10
b.
Month
Income statement:
Revenue
Cost of goods sold
Operating expenses
Income
Operating cash flows
Receipts
Payments to suppliers
Payments for operating expenses
Net cash flow from operations
The CFO’s proposal would increase the cash generated by operations, but only for
one month. Then the cash flows would revert to their original pattern. Therefore,
“leaning on the trade,” (deferring payables) is not likely to produce a steady source
of cash for expansion of the business.
©Cambridge Business Publishers, 2020
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M9-34. (30 minutes)
LO 3, 4
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M9-35. (15 minutes)
LO 3, 4
a. Gain on bond retirement
Reported in the income statement under other
(nonoperating) income
b. Discount on bonds payable
Contra-liability netted against bonds payable
under long-term liabilities in the balance sheet
c. Mortgage notes payable
Long-term liability in the balance sheet; the
amount due within one year would be reported as
a current liability
d. Bonds payable
Long-term liability in the balance sheet; the
amount due within one year would be reported as
a current liability
e. Bond interest expense
Nonoperating expense reported in the income
statement
f. Bond interest payable
A current liability in the balance sheet
g. Premium on bonds payable
Adjunct-liability added to bonds payable under
long-term liabilities in the balance sheet
M9-36. (15 minutes)
LO 3, 4
a.
12/31/18
6/30/19
12/31/19
Cash (+A) ……………………………………..
Mortgage note payable (+L) …………..
700,000
Interest expense (+E, -SE) …………………….
Mortgage note payable (-L) ……………………
Cash (-A) …………………………………..
42,000
8,854
Interest expense (+E, -SE) ……………………
Mortgage note payable (-L) …………………..
Cash (-A) ………………………………….
41,469*
9,385
700,000
50,854
50,854
* $41,469 = ($700,000 – $8,854) x 12%/2.
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b.
+
12/31/18
Cash (A)
700,000
50,854
50,854
+
6/30/19
12/31/19
Interest Expense (E)
42,000
41,469
-
6/30/19
12/31/19
Mortgage Note Payable (L)
+
700,000 12/31/18
6/30/19
8,854
12/31/19
9,385
-
c.
Balance Sheet
Transaction
12/31/18
Borrow
$700,000 on
a 15-year
mortgage
note payable.
Cash
Asset
+
Noncash
Assets
+700,000
= Liabilities +
-50,854
12/31/19
Interest
payment
on note.
-50,854
Earned
Capital
Revenues
-
Expenses
-
Net
= Income
=
Mortgage
Note
Payable
=
Cash
Cash
Contrib.
Capital +
= +700,000
Cash
6/30/19
Interest
payment
on note.
Income Statement
=
-8,854
-42,000
Mortgage
Note
Payable
Retained
Earnings
-9,385
-41,469
Mortgage
Note
Payable
Retained
Earnings
-
+42,000
= -42,000
Interest
Expense
-
+41,469
= -41,469
Interest
Expense
M9-37. (5 minutes)
LO 3
$900,000 x 0.55839 + [(900,000 x 10%/2) x 7.36009] = $833,755.
$833,755 / $900,000 = 92.6% of par value.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
EXERCISES
E9-38. (15 minutes)
LO 1
a.
Total expected failures from units sold in the current period .............
1,380*
Average cost per failure ......................................................................
Total expected warranty costs for current period sales ......................

$50
$ 69,000
Plus beginning warranty liability..........................................................
$ 30,000
Minus warranty services provided ......................................................
Ending warranty liability ......................................................................
$ 27,000
$ 72,000
*(69,000 x 0.02)
The product warranty liability must be increased by $69,000 to cover the expected
repair costs of products sold during the period, and that amount would be recognized
as expense. With the opening liability balance of $30,000 and warranty services
provided of $27,000, the ending liability balance would be $72,000.
b. The warranty liability should be equal, at all times, to the expected dollar cost of
future repairs. Waymire Company should conduct an analysis similar to an aging of
accounts to determine which products are still under warranty and what the
expected cost will be. That estimate will provide the correct value for the warranty
liability and determines any required adjustments in the period’s warranty expense.
Analysis issues relate to whether the warranty liability exists and, if so, whether it is
at the correct amount. Understating (overstating) the accrual overstates
(understates) current period income at the expense (benefit) of future income.
c. The debt-to-equity ratio will increase and the operating cash flow to liabilities will
decrease. The times-interest earned ratio will decrease, because the increase in
liability causes an increase in warranty expense, which decreases earnings before
interest and taxes.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-153
E9-39. (10 minutes)
LO 1
Item
Accounting Treatment
a.
Neither record nor disclose (neither probable nor reasonably possible)
b.
Record a current liability for the note, no liability for interest until incurred as time
passes.
c.
Disclose in a footnote (at least reasonably possible) (Also, if Shevlin is an SEC
registrant and the amount is material, the line item “Commitment and
contingencies” may need to be shown on the face of the balance sheet, with no
associated amounts for that line item.)
d.
Record warranty liability on balance sheet and recognize expense in income
statement (costs are probable and reasonably estimable).
E9-40. (15 minutes)
LO 1
The company must accrue the $25,000 of wages that have been earned by employees
even though these wages will not be paid until the first of next month. The required
accounting accrual will:
• Increase wages payable by $25,000 on the balance sheet
• Increase wages expense by $25,000 in the income statement
Failure to make this accounting accrual (called an adjusting entry) would understate
liabilities, understate expenses, overstate income, and overstate stockholders’ equity.
E9-41. (15 minutes)
LO 3, 4
a. Selling price of bonds:
Present value of principal repayment ($300,000  0.30832)
Present value of interest payments ($16,500  17.29203)
Selling price of bonds
$ 92,496
285,318
$377,814
b.
1/1/19
6/30/19
Cash (+A) ……………………………………..
Bond premium (+L) ……………………
Bonds payable (+L) ……………...……
Interest expense (+E, -SE) …………………
Bond premium (-L) ……………...…………..
Cash (-A) ………………………………..
377,814
77,814
300,000
15,113
1,387
16,500
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
Continued next page
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-155
b. continued
12/31/19 Interest expense (+E, -SE) …………………
Bond premium (-L) ………………………….
Cash (-A) ………………………………..
15,057
1,443
16,500
$15,057 = ($377,814 – $1,387) x 8%/2.
c.
+
1/1/19
Cash (A)
377,814
16,500
16,500
+
6/30/19
12/31/19
Interest Expense (E)
-
Bonds Payable (L)
300,000
+
Bond Premium (L)
77,814
1,387
1,443
+
1/1/19
6/30/19
12/31/19
-
-
15,113
15,057
6/30/19
12/31/19
1/1/19
d.
Balance Sheet
Transaction
1/1/19
Issue bonds
at a premium.
Cash
Asset
+
Noncash
Assets =
Liabilities
=
+300,000
+377,814
Cash
Income Statement
+
Contrib.
Capital +
Earned
Capital
Revenues
Net
- Expenses = Income
-
=
Bonds
Payable
+77,814
Bond
Premium
6/30/19
Interest
payment
on bonds.
-16,500
12/31/19
Interest
payment
on bonds.
-16,500
=
Cash
Cash
=
-1,387
-15,113
Bond
Premium
Retained
Earnings
-1,443
-15,057
Bond
Premium
Retained
Earnings
-
+15,113
= -15,113
Interest
Expense
-
+15,057
= -15,057
Interest
Expense
©Cambridge Business Publishers, 2020
1-156
Financial Accounting, 6th Edition
E9-42. (10 minutes)
LO 3
Selling price of bonds
Present value of principal repayment ($900,000  0.44230)
Present value of interest payments ($49,500  9.29498)
Selling price of bonds
$398,070
460,102
$858,172
E9-43. (15minutes)
LO 1
a. Additions to the Warranty provision would be reflected in Warranty expense.
Warranty expense (+E, -SE) ……………………….
Warranty provision (+L)……………………
1,786
1,786
b. Usage of the warranty provision would reflect Siemens providing warranty services
to its customers. The provision liability would be reduced, as would balances in
cash and perhaps inventory reflecting the resources needed for the warranty work.
Warranty provision (-L) ……………………………..
Cash or inventory (-A)…………………….
993
993
c. It can be useful to report the additions and reversals separately for a couple of
reasons. First, the reversals would reflect past periods’ errors in estimates, while the
additions could reflect the expected cost of providing warranty service for sales
made in the current period. In addition, it may provide insights into whether Siemens
tends to be systematically optimistic or pessimistic in its estimates. The numbers
reported indicate that Siemens tends to overestimate its warranty expenses.
d. 2018: €1,786/€83,044 = 2.15%
2017: €1,820/€82,863 = 2.20%
Warranty expense appears to have increased in 2014 as a percentage of sales
revenue.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-157
E9-44. (15 minutes)
LO 3, 4
a.
Cash (+A) ………………………………………...
Bonds payable (+L) ……………………….
500,000
10/31/18 Interest expense (+E, -SE) …………………….
Cash (-A) …………………………………...
22,5001
Bonds payable (-L) ……………………………...
Loss on retirement of bonds (+E, -SE) ……….
Cash (-A) ……………………………………
300,000
3,000
5/1/18
11/1/19
500,000
22,500
303,0002
1
$500,000 x 0.09 x 1/2 = $22,500 interest expense. Because the bonds were sold at par, there is no
discount or premium amortization.
2
Cash required to retire $300,000 of bonds at 101 = $300,000 x 1.01 = $303,000. The difference
between the cash paid and the carrying amount of the bonds is the gain or loss on the redemption. In
this case, the loss is $3,000. This calculation assumes that the interest was paid on 10/31/19, so
accrued interest is not recorded.
b.
+
5/1/18
Cash (A)
500,000
-
22,500
303,000
+
10/31/18
Interest Expense (E)
22,500
10/31/18
11/1/19
-
11/1/18
Bonds Payable (L)
500,000
+
5/1/18
300,000
+ Loss on Retirement of Bonds (E) 11/1/18
3,000
c.
Balance Sheet
Transaction
5/1/18
Issue bonds.
Cash
Asset
+
Noncash
Assets = Liabilities +
+500,000
-22,500
11/1/19
Early
retirement
of bonds.
-303,000
Earned
Capital
Revenues
- Expenses
=
-
=
Net
Income
Bonds
Payable
=
-22,500
Cash
Cash
Contrib.
Capital +
= +500,000
Cash
10/31/18
Interest
payment
on bonds.
Income Statement
-
Retained
Earnings
= -300,000
Bonds
Payable
-3,000
Retained
Earnings
+22,500
=
-22,500
=
-3,000
Interest
Expense
-
+3,000
Loss on
Retirement
of Bonds
©Cambridge Business Publishers, 2020
1-158
Financial Accounting, 6th Edition
E9-45. (25 minutes)
LO 3, 4
a. Selling price of bonds
Present value of principal repayment ($250,000  0.41552)
Present value of interest payments ($10,000  11.68959)
Selling price of bonds
$103,880
116,896
$220,776
b.
1/1/19
6/30/16
Cash (+A) ……………………………………….
Bond discount (+XL, -L) ………………………
Bonds payable (+L) ……………………..
220,776
29,224
Interest expense (+E, -SE) ……………………
Bond Discount (-XL, +L) ………….…….
Cash (-A) …………………………………..
11,039
250,000
1,039
10,000
$11,039 = $220,776  0.05
12/31/19 Interest expense (+E, -SE) ………………….
Bond Discount (-XL, +L) …………….….
Cash (-A) …………………………………..
11,091
1,091
10,000
$11,091 = [$220,776 + $1,039]  0.05
c.
+
Cash (A)
220,776
10,000
10,000
1/1/19
+
-
-
+
1/1/19
6/30/19
12/31/19
Interest Expense (E)
6/30/19
12/31/19
Bonds Payable (L)
250,000
-
+
1/1/19
Bond Discount (XL)
29,224
1,039
1,091
11,039
11,091
6/30/19
12/31/19
d.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets
= Liabilities
=
-
Income Statement
Contra
Contrib.
Liability + Capital +
+220,776
6/30/19
Interest
payment
on bonds.
-10,000
-1,039
-11,039
+11,039
Cash
Bond
Discount
Retained
Earnings
Interest
Expense
12/31/19
Interest
payment
on bonds.
-10,000
-1,091
-11,091
Bond
Discount
Retained
Earnings
Cash
=
+29,224
Bonds
Payable
Bond
Discount
Revenues - Expenses
1/1/19
Issue
bonds at a
discount.
Cash
+250,000
Earned
Capital
-
-
Net
= Income
=
-11,039
+11,091
= -11,091
Interest
Expense
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-159
©Cambridge Business Publishers, 2020
1-160
Financial Accounting, 6th Edition
E9-46. (25 minutes)
LO 3, 4
a. Selling price of bonds:
Present value of principal repayment ($800,000  0.20829)
Present value of interest payments ($36,000  19.79277)
Selling price of bonds
$166,632
712,540
$879,172
b.
Cash (+A) ………………………………………...
Bond premium (+L) ………………………
Bonds payable (+L) ………………………
879,172
6/30/19 Interest expense (+E,-SE) …………………….
Bond premium (-L) …………….………………
Cash (-A) …………………………………..
35,167
833
1/1/19
79,172
800,000
36,000
$35,167 = $879,172 x 0.04
12/31/19 Interest expense (+E,-SE) …………………….
Bond premium (-L) …………….………………
Cash (-A) …………………………………..
35,134
866
36,000
$35,134 = ($879,172 - $833) x 0.04
c.
+
1/1/19
Cash (A)
879,172
36,000
36,000
+
6/30/19
12/31/19
Interest Expense (E)
35,167
35,134
-
Bonds Payable (L)
800,000
+
1/1/19
Bond Premium (L)
79,172
6/30/19
833
12/31/19
866
+
1/1/19
6/30/19
12/31/19
-
-
d.
Balance Sheet
Cash
Noncash
Transaction
Asset
+ Assets =
1/1/19
+879,172
=
Issue
Cash
bonds at a
premium.
6/30/19
Interest
payment
on bonds.
12/31/19
Interest
payment
on bonds.
Liabilities
+800,000
Bonds
Payable
+79,172
Bond
Premium
Income Statement
+
Contrib.
Capital +
Earned
Capital
Revenues
-
Expenses
=
=
Net
Income
-36,000
Cash
=
-833
Bond
Premium
-35,167
Retained
Earnings
-
+35,167
Interest
Expense
=
-35,167
-36,000
Cash
=
-866
Bond
Premium
-35,134
Retained
Earnings
-
+35,134
Interest
Expense
=
-35,134
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-161
©Cambridge Business Publishers, 2020
1-162
Financial Accounting, 6th Edition
E9-47. (20 minutes)
LO 3, 4
a. There is an inverse relation between interest rates and bond prices (examine the
increasing discount rates as the yield increases in present value tables). Since the
bonds now trade at a premium and assuming that Deere’s credit ratings have not
changed, we can conclude that interest rates have fallen since the bonds were
issued.
b. No, once the bond is initially recorded, neither the coupon rate nor the yield used to
compute interest expense is changed. Bonds are recorded at historical cost (like
most other balance sheet assets and liabilities). As a result, changes in the general
level of interest rates have no effect on interest expense (or the interest payment)
that is reflected in the financial statements.
c. Because the bonds trade at a premium in the market, Deere would be paying more
to retire the bonds than the amount at which they are carried on its balance sheet.
This would result in a loss on the repurchase that would lower current profitability.
d. The face amount of the bonds will be paid at maturity. As a result, the market price
of the bonds must also equal their face amount ($200 million) at that time.
E9-48. (25 minutes)
LO 3 4
a. Selling price of bonds
Present value of principal repayment ($600,000  0.09722)
Present value of interest payments ($33,000  15.04630)
Selling price of bonds
$ 58,332
496,528
$554,860
b.
1/1/19
Cash (+A) ……………………………………..
Bond discount (+XL, -L) ………………..……
Bonds payable (+L) ……………………
554,860
45,140
600,000
6/30/19 Interest expense (+E, -SE) ………………….
Bond discount (-XL, +L) ……………….
Cash (-A) …………………………………
33,292
292
33,000
$33,292 = $554,860  .06.
12/31/19 Interest expense (+E, -SE) …………………
Bond discount (-XL, +L) …………….….
Cash (-A) ………….…………………….
33,309
309
33,000
$33,309 = ($554,860 + $292)  0.06.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-163
c.
+
1/1/19
+
6/30/19
12/31/19
Cash (A)
554,860
33,000
33,000
Interest Expense (E)
-
-
Bonds Payable (L)
600,000
+
1/1/19
Bond Discount (XL)
45,140
292
309
+
1/1/19
6/30/19
12/31/19
-
33,292
33,309
6/30/19
12/31/19
d. At December 31, 2019 (after the coupon payment recorded in b), the book value of
the bonds would be $554,860 + $292 + $309 = $555,461. The market value would
be $600,000 X 1.01 = $606,000. Thus, a fair value adjustment of $50,539
(=$606,000-$555,461) would be recorded as follows:
12/31/19 Loss due to adjustment of bonds to fair value +E, -SE)
Fair value adjustment (+L)
50,539
50,539
The loss would be reported in net income for the period.
e. Coupon payments ($33,000 X 2)
Discount amortization ($292 + $309)
Total interest expense
Fair value adjustment (loss)
Total effect on income (deduction)
$ 66,000
601
66,601
50,539
$117,140
E9-49. (10 minutes)
LO 2, 4
Current liabilities:
Bond interest payable
Current maturities of long-term debt:
10% bonds payable due 2019
Total current liabilities
Long-term debt:
9% bonds payable due 2020, net of $19,000 discount
Zero coupon bonds payable due 2021
8% bonds payable due 2023, including $2,000 premium
Total long-term debt
$ 25,000
500,000
$525,000
$581,000
170,500
102,000
$853,500
©Cambridge Business Publishers, 2020
1-164
Financial Accounting, 6th Edition
E9-50. (20 minutes)
LO 3, 4
a.
12/31/18 Cash (+A) ……………………………………………
Mortgage note payable (+L) ……………….
500,000
Interest expense (+E, -SE) ……………………….
Mortgage note payable (-L) ……………………...
Cash (-A) ………………………………………
10,000
8,278
Interest expense (+E, -SE) ……………………….
Mortgage note payable (-L) ……………………...
Cash (-A) ………………………………………
9,834
8,444
3/31/19
6/30/19
500,000
18,278
18,278
$9,834 = ($500,000 – $8,278) x 8%/4.
b.
+
12/31/18
Cash (A)
500,000
18,278
18,278
+
3/31/19
6/30/19
Interest Expense (E)
10,000
9,834
-
3/31/19
6/30/19
Mortgage Note Payable (L)
+
500,000 12/31/18
3/31/19
8,278
6/30/19
8,444
-
c.
Balance Sheet
Transaction
12/31/18
Borrow
$500,000
on a 10-year
mortgage note
payable.
Cash
Asset
+500,000
+
Noncash
Assets
= Liabilities
-18,278
6/30/19
Payment
on note.
-18,278
Contrib.
Capital +
Earned
Capital
Revenues
-
Expenses
-
Net
= Income
=
Mortgage
Note
Payable
=
Cash
Cash
+
= +500,000
Cash
3/31/19
Payment
on note.
Income Statement
=
-8,278
-10,000
Mortgage
Note
Payable
Retained
Earnings
-8,444
-9,834
Mortgage
Note
Payable
Retained
Earnings
-
+10,000
=
-10,000
=
-9,834
Interest
Expense
-
+9,834
Interest
Expense
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-165
PROBLEMS
P9-51. (20 minutes)
LO 1
a.
-
Hewlett-Packard Enterprise Company
Accrued Warranty Liability (L)
+
475
17 bal.
265
18 exp.
310
430
18 bal.
-
Cisco Systems
Accrued Warranty Liability (L)
+
407
17bal.
582
18 exp.
630
359
18 bal.
Hewlett-Packard incurred $310 million in warranty repair costs and settlements in
2018 while Cisco Systems, Inc. incurred costs of $630 million.
b. HPE’s ratio of warranty expense to sales was 1.40% in 2018 ($265/$19,504) down
slightly from 1.7% in 2017 ($292/$17,597). Cisco’s ratio was 1.59% in 2018
($582/$36,709) and 1.94% ($691/$35,705) in 2017. Cisco’s warranty expense is
slightly higher relative to sales revenue than that of HPE. In general, reasons for the
higher warranty expense-to-sales ratio include: (1) perhaps Cisco products require
more repairs than HPE products or (2) HPE may have a less generous warranty
policy than Cisco, resulting in fewer warranty repairs, even if the quality is the same.
The slight decrease in HPE’s warranty expense as a percent of sales indicates that
either (1) warranty costs have gone down, (2) the company overestimated warranty
costs in the past and needed to record smaller than normal accruals in 2018 to
correct the overestimation; or (3) HPE was building up a “cookie-jar reserve” by
increasing its warranty liability in past years.
P9-52. (20 minutes)
LO 3, 4
a. Cash (+A) …………………………………………..
Accrued interest payable (+L) ……………
Bonds payable (+L) ………………………..
518,750
18,750
500,000
$18,750 = $500,000 x .09 x 5/12
b. Interest expense (+E, -SE)……………………….
Accrued interest payable (-L) …………………..
Cash (-A) ……………………………………..
3,750
18,750
22,500
$22,500 = $500,000 x 9% x 6/12
c. Interest expense (+E, -SE) ………………………
Accrued interest payable (+L) ……………
7,500
7,500
$7,500 = $500,000 x 9% x 2/12
©Cambridge Business Publishers, 2020
1-166
Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-167
d. Fair value adjustment (+XL, -L) ………………..
Gain from adjustment of bonds to fair value
(+R, +SE) ……………………………..
5,000
e. Interest expense (+E, -SE) ………………………
Accrued interest payable (-L) …………………..
Cash (-A) ……………………………………..
15,000
7,500
Bonds payable (-L) ……………………………….
Loss on retirement of bonds (+E, -SE) ……….
Cash (-A) ……………………………………..
Fair value adjustment (-XL, +L) …
*($15,000 x 60%) = $9,000
300,000
12,000
f.
5,000
22,500
303,000
9,000*
g. If gains/losses on bond revaluations were reported in other comprehensive income
rather than net income, Eskew, Inc.’s December 31, 2018 income statement would
be lower because it would not include the $5,000 gain from part d above. The
$5,000 gain (after accounting for expected taxes) would increase the balance in an
account entitled accumulated other comprehensive income in Eskew, Inc.’s
shareholders’ equity, so shareholders’ equity would be unchanged. (Such
gains/losses would go through the income statement when Eskew, Inc. redeems the
bonds.)
P9-53. (15 minutes)
LO 3, 4
a. CVS reports interest expense of $1.04 billion, plus $8 million in capitalized interest,
giving a total interest cost of $1.048 billion on average debt of $27,266.5 million
([$27,002million + $27,531million]/2) for an average rate of 3.8%. Using interest
paid ($1.07 billion) instead of interest expense yields 3.92%. See the answer to c
below.
b. CVS reports coupon rates of 1.9% to 6.25%. In addition, no rates are reported for
capital leases, mortgage notes, commercial paper, or the floating rate notes. So, the
average rate seems reasonable given the information disclosed in the long-term
debt footnote.
c. Interest paid can differ from interest expense if bonds are sold at a premium or a
discount. It can also differ because of capitalized interest. CVS reported capitalized
interest of $8 million in 2017. Thus, CVS apparently amortized $22 million in net
bond discounts ($1,070 million - $1,040 million - $8 million).
©Cambridge Business Publishers, 2020
1-168
Financial Accounting, 6th Edition
P9-54. (25 minutes)
LO 3, 4
Cash (+A) …………………………………….
Accrued interest payable (+L) …….
Bonds payable (+L) …………………
a. 7/1/19
824,000
24,000
800,000
$24,000 = $800,000 x .09 x 4/12
Interest expense (+E, -SE) ……………..…
Accrued interest payable (-L) …………….
Cash (-A) ………………………………
b. 9/1/19
12,000
24,000
36,000
$36,000 = $800,000 x 9%/2
Interest expense (+E, -SE) …………………
Accrued interest payable (+L) …….
c. 12/31/19
24,000
24,000
$24,000 = $800,000 x .09 x 4/12
d. 3/1/20
e. 3/1/20
+
a.
+
b.
c.
d.
Interest expense (+E) ………………………
Accrued interest payable (-L) …………….
Cash (-A) ………………………………
12,000
24,000
Bonds payable (-L) …………………………
Loss on retirement of bonds (+E, -SE) …
Cash (-A) ……………………………..
200,000
2,000
Cash (A)
824,000
36,000
36,000
202,000
Interest Expense (E)
12,000
24,000
12,000
b.
d.
e.
-
e.
-
36,000
202,000
Bonds Payable (L)
+
800,000
a.
200,000
Accrued Interest Payable (L)
b.
24,000
24,000
d.
24,000
24,000
+
a.
c.
+ Loss on Retirement of Bonds (E) e.
2,000
continued next page
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-169
e. continued
Balance Sheet
Transaction
a. 7/1/19
Issue
bonds.
Cash
Noncash
Asset
+ Assets
+824,000
Cash
= Liabilities
= +800,000
Bonds
Payable
+
Income Statement
Contrib.
Capital +
Earned
Capital
Revenues
- Expenses =
=
Net
Income
+24,000
Interest
Payable
b. 9/1/19
Interest
payment
on bonds.
-36,000
Cash
c. 12/31/9
Accrued
interest
on bonds.
=
-24,000
Interest
Payable
-12,000
Retained
Earnings
-
+12,000
Interest
Expense
=
-12,000
=
+24,000
Interest
Payable
-24,000
Retained
Earnings
-
+24,000
Interest
Expense
=
-24,000
+12,000
Interest
Expense
=
-12,000
+2,000
=
Loss on
Retirement
of bonds
-2,000
d. 3/1/20
Interest
payment
on bonds.
-36,000
Cash
=
-24,000
Interest
Payable
-12,000
Retained
Earnings
-
e. 3/1/120
Early
retirement
of bonds.
-202,000
Cash
=
-200,000
Bonds
Payable
-2,000
Retained
Earnings
-
P9-55. (20 minutes)
LO 3, 4
a.
Period
0
1
2
Interest
Expense
Cash Interest
Paid
$40,722
$40,790
$39,600
$39,600
Discount
Amortization
$1,122
$1,190
Discount
Balance
$41,292
$40,170
$38,980
Bond Payable
Net
$678,708
$679,830
$681,020
$40,722 = $678,708 x 12%/2
$40,790 = $679,830 x 12%/2
b.
12/31/18 Cash (+A) …………………………………..
Bond discount (+XL) …………………….
Bonds payable (+L) ………………..
678,708
41,292
Interest expense (+E,-SE) ……………….
Bond discount (-XL) ………………..
Cash (-A) ……………………………..
40,722
12/31/19 Interest expense (+E,-SE) ……………….
Bond discount (-XL) ………………..
Cash (-A) ……………………………..
40,790
6/30/19
720,000
1,122
39,600
1,190
39,600
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-171
c.
+
12/31/18
Cash (A)
678,708
39,600
39,600
+
-
Bonds Payable (L)
720,000
+
12/31/18
6/30/19
12/31/19
Interest Expense (E)
6/30/19
12/31/19
-
-
+
Bond Discount (XL)
12/31/18
41,292
1,122
1,190
40,722
40,790
6/30/19
12/31/19
d.
Balance Sheet
Cash
Asset
Transaction
+
Noncash
Assets
= Liabilities
-
Contra
Contrib.
Retained
Liability + Capital + Earnings Revenues
12/31/18
+678,708
Issue bonds
Cash
at a discount.
= +720,000
+41,292
Bonds
Payable
Bond
Discount
6/30/19
Interest
payment
on bonds.
-39,600
=
12/31/19
Interest
payment
on bonds.
-39,600
Cash
=
Cash
Income Statement
- Expenses =
-
-1,122
-40,722
Bond
Discount
Retained
Earnings
-1,190
-40,790
Bonds
Discount
Retained
Earnings
-
Net
Income
=
+40,722
=
-40,722
=
-40,790
Interest
Expense
-
+40,790
Interest
Expense
P9-56. (20 minutes)
LO 3, 4
a.
Period
0
1
2
Interest
Expense
$8,271
$8,302
Cash
Interest Paid
Discount
Amortization
$7,500
$7,500
Discount
Balance
$43,230
$42,459
$41,657
$771
$802
Bond Payable
Net
$206,770
$207,541
$208,343
$8,271= $206,770 x 8%/2
$8,302 = $207,541 x 8%/2
b.
Cash (+A) …………………….……….………..……
Bond discount (+XL, -L) ………………………….
Bonds payable (+L) …….……………………
206,770
43,230
10/31/19 Interest expense (+E, -SE) ………………..….…..
Bond discount (-XL, +L) …………………….
Cash(-A) ………………………………………..
8,271
4/30/19
250,000
771
7,500
continued next page
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-173
b. continued
12/31/19 Interest expense (+E, -SE) ………………..….…..
Bond discount (-XL, +L) …………………….
Accrued interest payable (+L) ……………..
2,767*
267
2,500
Interest expense (+E, -SE) …………………...…..
Accrued interest payable (-L) ………..….……….
Bond discount (-XL, +L) …………………….
Cash(-A) ………………………………………..
4/30/20
5,535**
2,500
535
7,500
Within each six-month period, interest is apportioned to individual months on a straight-line basis:
*$2,767 = ($8,302 x 2/6)
**$5,535 = ($8,302 x 4/6)
c.
+
4/30/19
Cash (A)
206,770
7,500
7,500
+
Bonds Payable (L)
250,000
+
4/30/19
10/31/19
4/30/20
Interest Expense (E)
10/31/19
12/31/19
4/30/20
-
-
+
Bond Discount (XL)
4/30/19
43,230
771
267
535
8,271
2,767
5,535
10/31/18
12/31/18
4/30/20
-
Accrued Interest Payable (L) +
2,500
12/31/19
4/30/20
2,500
d.
Balance Sheet
Transaction
4/30/19
Issue bonds
at a discount.
10/31/19
Interest
payment
on bonds.
Cash
Asset
Noncash
+ Assets = Liabilities
+206,770
=
Cash
-7,500
4/30/20
Interest
payment
on bonds.
+43,230
Bonds
Payable
Bond
Discount
=
=
-7,500
=
Cash
Contra
Liability
+250,000
+
Contrib.
Capital +
Earned
Capital
Revenues
Net
- Expenses = Income
-
-771
-8,271
Bond
Discount
Retained
Earnings
+2,500
-267
-2,767
Accrued
Interest
Payable
Bond
Discount
Retained
Earnings
-2,500
-535
-5,535
Accrued
Interest
Payable
Bond
Discount
Retained
Earnings
Cash
12/31/19
Accrued
interest
on bonds.
-
Income Statement
-
=
+8,271
=
-8,271
=
-2,767
=
-5,535
Interest
Expense
-
+2,767
Interest
Expense
-
+5,535
Interest
Expense
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-175
P9-57. (20 minutes)
LO 3, 4
a. Payment x 12.46221 = $500,000; Payment = $500,000/12.46221 = $40,121.
b.
12/31/18
6/30/19
Cash (+A) ………………………………………..……
Mortgage note payable (+L) …………………
500,000
Interest expense (+E, -SE) …………………………
Mortgage note payable (-L) ……………………….
Cash (-A) …………………………………..……
25,000
15,121
500,000
40,121
$25,000 = $500,000 x 10%/2
12/31/19
Interest expense (+E, -SE) ……………………….…
Mortgage note payable (-L) ………………………..
Cash (-A) …………………………………..……
24,244
15,877
40,121
$24,244 = ($500,000 – $15,121) x 10%/2
c.
+
12/31/18
+
6/30/18
12/31/18
Cash (A)
500,000
40,121
40,121
6/30/19
12/31/19
Interest Expense (E)
-
Mortgage Note Payable (L) +
500,000 12/31/18
6/30/19
15,121
12/31/19
15,877
-
25,000
24,244
d.
Balance Sheet
Transaction
Cash
Asset
Noncash
+ Assets
Contrib.
= Liabilities + Capital +
12/31/18
+500,000
Borrow
Cash
$500,000
on a 10-year
mortgage note
payable.
= +500,000
6/30/19
Interest
payment
on note.
-40,121
=
12/31/19
Interest
payment
on note.
-40,121
Revenues
- Expenses
Net
= Income
-
=
Mortgage
Note
Payable
Cash
Cash
Income Statement
Earned
Capital
=
-15,121
-25,000
Mortgage
Note
Payable
Retained
Earnings
-15,877
-24,244
Mortgage
Note
Payable
Retained
Earnings
-
+25,000
=
-25,000
=
-24,244
Interest
Expense
-
+24,244
Interest
Expense
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-177
P9-58. (20 minutes)
LO 3, 4
a. Payment x 16.35143 = $950,000; Payment = $950,000/16.35143 = $58,099.
b.
12/31/18 Cash (+A) ………………………………………..……
Mortgage note payable (+L) …………………
3/31/19
Interest expense (+E, -SE) …………………………
Mortgage note payable (-L) ……………………….
Cash (-A) …………………………………..……
950,000
950,000
19,000*
39,099
58,099
* $19,000 = $950,000 x 8%/4
6/30/19
Interest expense (+E, -SE) …………………………
Mortgage note payable (-L) ……………………….
Cash (-A) …………………………………..……
18,218*
39,881
58,099
* $18,218 = ($950,000 – $39,099) x 8%/4.
c.
+
12/31/18
+
3/31/19
6/30/19
Cash (A)
950,000
58,099
58,099
Interest Expense (E)
-
-
3/31/19
6/30/19
Mortgage Note Payable (L) +
950,000
12/31/18
3/31/19 39,099
6/30/19 39,881
-
19,000
18,218
d.
Balance Sheet
Transaction
Cash
Asset
Noncash
+ Assets
= Liabilities
12/31/18
+950,000
Borrow
Cash
$950,000
on a 5-year
mortgage note
payable.
= +950,000
3/31/19
Payment
on note.
-58,099
=
6/30/19
Payment
on note.
-58,099
+
Earned
Capital
Revenues - Expenses =
-
Net
Income
=
Mortgage
Note
Payable
Cash
Cash
Income Statement
Contrib.
Capital +
=
-39,099
-19,000
Mortgage
Note
Payable
Retained
Earnings
-39,881
-18,218
Mortgage
Note
Payable
Retained
Earnings
-
+19,000
=
-19,000
=
-18,218
Interest
Expense
-
+18,218
Interest
Expense
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
P9-59. (10 minutes)
LO 1
a. BP recorded the $9.2 billion estimate as an expense on its 2010 income
statement. This increased the company’s liabilities.
b. If BP had prepared its financial statements in accordance with U.S. GAAP, the
accrual would most likely have been at the low end of the range -- $6 million,
instead of the expected amount (best reliable estimate), or mid-point in the
range.
©Cambridge Business Publishers, 2020
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CASES and PROJECTS
C9-60. (30 minutes)
LO 3, 4, 5
a. The difference between interest expense and interest paid can be caused by three
factors: (1) interest capitalized as part of self-constructed assets is paid but not part
of interest expense (a detailed discussion is beyond the scope of this text); (2)
coupon payments differ from interest expense charged on bonds due to amortization
of discounts or premiums; (3) interest payments may not coincide with the fiscal
period, thus requiring the company to record accrued interest payable.
b. In 2017, Comcast’s debt had a fair value of $71.7 billion while its historical cost was
$64.6 billion. Thus, Comcast would report a fair value adjustment as a credit in its
balance sheet of $7.1 billion ($71.7 - $64.6). In 2016, the fair value was $66.3 billion
and the historical cost was $61.0 billion yielding a credit balance in the fair value
adjustment account of $5.3 billion ($66.3 - $61.0). The change in the fair value
adjustment from 2016 to 2017 ($1.8 = $7.1 – $5.3) would be recorded as follows:
12/31/17 Loss due to adjustment of bonds to fair value (+E, -SE)
Fair value adjustment (+L)
1.8
1.8
c. Debt-to-equity: $117,500 million/$69,449 million = 1.69
Times interest earned: ($15,322 million + $3,086 million)/$3,086 million = 5.97
Creditors are naturally concerned about the risk of default. The debt-to-equity ratio
measures the extent to which a company is relying on debt financing and the higher
the ratio, the greater chance of default. In addition, the times interest earned ratio
measures the company’s ability to pay the interest on the debt.
d. Management may bypass profitable investment projects or cut discretionary
expenditures such as R&D or advertising. It may also engage in questionable
accounting practices in an attempt to manage the ratios.
e. Note16 for Comcast discusses various contractual commitments – payment
schedules for future cash outflows as a result of their contractual agreements. These
are not recorded liabilities on the balance sheet, however. (We discuss these more
in Chapter 10). Comcast also discusses various contingent liabilities that it may
have, often as a result of litigation.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
C9-61. (20 minutes)
LO 3, 4, 5
a. The gain results from the difference between the book value of the debt
($3,000,000) and the current redemption (market) value ($2,200,000). The gain
would be reported in the income statement under other (nonoperating) income. The
source of the gain should be adequately disclosed in the notes.
b. Currently, Foster is paying 4% interest on the $3,000,000 of long-term debt, or
$120,000 per year. Under the proposed refinancing, Foster would pay 8%, or
$240,000. The refinancing would generate an additional $800,000 in cash.
However, because interest costs are increasing by $120,000 per year ($240,000 $120,000), Foster is effectively borrowing the additional $800,000 at a rate of almost
15% ($120,000 / $800,000). As such, Foster would be paying in the future (in the
form of higher interest costs) for a one-time boost in current earnings.
c. The potential ethical conflict exists because Foster’s president is concerned that his
job might be dependent on producing short-term earnings. Because of this, he
might be tempted to accept this proposal and boost current earnings at the cost of
lower earnings in future years. This thinking is misguided because, given adequate
disclosure, analysts and investors would be able to identify and discount the source
of the earnings boost. The most serious unethical act would be to try to hide (or
obfuscate) the bond refinancing with inadequate disclosure.
©Cambridge Business Publishers, 2020
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Chapter 10
Reporting and Analyzing
Leases, Pensions, Income Taxes, and
Commitments and Contingencies
Learning Objectives – coverage by question
MiniExercises
Exercises
LO1 – Define off-balance-sheet
financing and explain its effects on
financial analysis.
22
27
LO2 – Account for leases using the
finance lease method and the
operating lease method. Compare
and analyze the two methods.
13 – 17
24, 26, 27
36 – 37
46
LO3 – Explain and interpret the
reporting for pension plans.
18 -21
25, 30, 31
39, 40
45
LO4 – Analyze and interpret pension
footnote disclosures.
19 – 21
25, 30, 31
39, 40
45
23
32 – 35
41 – 44
47, 48
28, 29
38
LO5 – Describe and interpret
accounting for income taxes.
LO6 – Describe disclosures regarding
future commitments and
contingencies. Analyze financial
statements after converting offbalance sheet items to be considered
on the balance sheet.
Problems
Cases
and Projects
46
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
QUESTIONS
Q10-1. Under the old lease accounting standard for an operating lease, the lessee did
not record either the leased asset or the lease liability on the balance sheet,
and normally charged each lease payment to rent expense. Under the new
lease accounting standard, the lessee in an operating lease contract records a
right-of-use asset on the balance sheet as well as a lease liability on the
balance sheet. The expense is a straight-line lease expense (total cost of the
lease divided by the number of lease payments). Under the old standard, the
other type of lease was a capital lease and under the new standard the other
type is a finance lease. The lessee accounted for a capital lease by recording
the leased property as an asset and establishing a liability for the lease
obligation. The leased asset was subsequently depreciated, and interest
expense accrued on the lease liability. Under the new standard, the other type
of a lease is a finance-type lease. The lessee records a lease asset and a lease
liability on the balance sheet -- the lease asset is amortized and amortization
expense is recorded, and in addition, interest expense is recorded, and the
lease liability is reduced as payments are made.
Q10-2. As adoption occurs, the year of adoption (and years after adoption)_ will be
presented using the new standard, while prior years will likely be presented
using the old standard. Thus, financial statement users will need to compute
ratios for analysis after adjusting the year(s) prior to adoption to have “as-if”
capitalized operating leases. For the years presented before the new leasing
standard is adopted, the leasing footnote is reasonably complete to allow for
capitalization of operating leases for analysis purposes.
Q10-3. In general, yes. Over the term of the lease the straight-line lease expense for
an operating lease will be equal to the sum of the interest and amortization on a
finance lease. Only the timing of the expense recognition changes.
Q10-4. Under defined contribution plans, companies and employees make
contributions to the plans which, together with earnings on the amounts
invested, provide the sole source of funding for payments to retirees. Under
defined benefit plans, the obligations are defined with payment to be made in
the future from general corporate funds. These plans may or may not be fully
funded. Since the company’s obligation is extinguished upon contribution for a
defined contribution plan, the accounting is relatively simple: record an expense
when paid or accrued. Defined benefit plans present a number of complications
in that the liability is very difficult to estimate and involves a number of critical
assumptions. In addition, companies lobbied for (and the FASB agreed to)
various mechanisms to smooth the impact of pension costs on reported
earnings. These smoothing mechanisms further complicate the accounting for
defined benefit plans vis-à-vis defined contribution plans.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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Q10-5. Although the accounting can get complicated, a net pension asset will be
reported if the fair market value of the plan assets exceeds the plan obligation.
Otherwise, a net liability will be reported on the balance sheet to represent the
underfunding of the pension obligation.
Q10-6. Service cost, interest cost and the expected return on plan investments (a
reduction of the pension cost) are the basic components of pension expense.
Companies might also report amortization of deferred gains and losses.
Q10-7. The use of expected returns and the deferral of unexpected gains and losses
act to smooth corporate earnings by removing the effects of swings in the
market values of investments and variation in pension liabilities resulting from
changes in actuarial assumptions or plan amendments.
Q10-8. For a finance or operating lease, the initial value of the lease liability is
determined by calculating the present value of the remaining lease payments.
The remaining lease payments include those payments that are not subject to
options or contingencies, including any guaranteed residual value. The initial
right-of-use asset value for both types is the lease liability computed as just
described, adjusted for some items occurring at or before the lease
commencement date (e.g., add lease prepayments, subtract lease incentives,
and add initial direct costs).
Q10-9. Retirement benefits are normally expensed in the period in which they are
earned by the employee, not when they are paid. Some benefits are calculated
for periods of employment prior to the inception of a pension plan or prior to a
plan amendment. The cost of these benefits (called prior service costs) is
expensed by amortizing the cost over the average expected future period of
employee service.
Q10-10. Income tax expense is a financial accounting expense measured using accrual
accounting. Thus, the expense includes the cash taxes paid but also includes
accruals for future tax payments and future tax benefits that result from
transactions in the current period.
Q10-11. A tax payment would be recorded as a deferred tax asset or liability under two
situations. First, if the company is required to make a tax payment based on a
temporary difference that makes taxable income reported on the tax return
higher than the income reported for financial accounting. In this case, the tax on
the temporary difference would not be recorded as tax expense. Recall that tax
expense is the expense related to the accounting income. For example,
consider a company that receives a cash payment in advance of delivering a
service. For financial accounting this is recorded as unearned revenue and not
recognized as revenue until earned and thus is not in accounting earnings.
However, generally for tax purposes such a payment would be included in
taxable income. Thus, a cash tax payment would be required to be made on
this amount. For financial accounting, this would increase current tax expense
continued
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
but a deferred tax asset and corresponding deferred tax benefit (negative tax
expense) would need to be recorded yielding a zero effect on total income tax
for the year. The second situation arises when a deferred tax liability reverses.
In this situation, tax expense has been recognized in excess of tax payments in
prior years. When the tax return “catches up with” the income statement, the
tax deferral reverses and the deferred tax liability is reduced (debited).
Consider the example of depreciation discussed in the text. In the later years of
the asset’s life, taxable income will be higher than book income. The cash tax
payments related to that temporary difference will be recorded as current tax
expense. In addition, the deferred tax liability will also be reversed along with a
reduction to deferred tax expense, thus, again, the net effect on the total tax
expense will be zero.
Q10-12. An unrecognized tax benefit is recorded as a liability on a firm’s balance sheet
(and on the income statement increases to the unrecognized tax benefit
account are recorded as additional tax expense). The unrecognized tax benefit
(UTB) is essentially a contingent liability. It represents management’s estimate
of the amount that is more likely than not going to be owed to tax authorities in
the future (e.g., upon audit) for tax positions taken to date.
©Cambridge Business Publishers, 2020
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MINI EXERCISES
M10-13. (35 minutes)
LO 2
a. i.
1/3
Right-of-use asset – operating lease (+A) ...................
Operating lease liability (+L) ...................................
57,198
57,198
$57,198 = $12,000 x 4.76654
12/31 Operating lease liability (L) ..........................................
Cash (-A) ................................................................
12,000
12/31 Operating lease expense (+E) .....................................
Operating lease liability (+L) ...................................
Right-of-use asset – operating lease (-A) ...............
12,000
Right-of-use lease asset – finance lease (+A) .............
Finance lease liability (+L) ......................................
57,198
12,000
4,004
7,996
ii.
1/3
57,198
$57,198 = $12,000 x 4.76654
12/31 Amortization expense – finance lease (+E, -SE)..........
Accumulated amortization – finance lease (+XA) ...
9,533
9,533
$9,533 = $57,198 / 6
(note that the company could choose to credit the right-of-use
asset for the finance lease directly)
12/31 Finance lease liability (-L) ............................................
Interest expense (+E, -SE) ..........................................
Cash (-A) ................................................................
7,996
4,004
12,000
$4,004 = $57,198 x 0.07; $7,996 = $12,000 - $4,004
©Cambridge Business Publishers, 2020
1-186
Financial Accounting, 6th Edition
b. Operating Lease (i):
+
Cash (A)
12,000
Operating Lease Liability – (L) +
57,198
1/3
12/31
12,000
4,004
12/31
-
-
12/31
+ Right-of-use Asset (A)—Operating Lease 1/3
57,198
7,996
12/31
+ Lease Expense – Operating Lease (E) 12/31
12,000
Finance Lease (ii):
+
Cash (A)
12,000
-
-
Finance Lease Liability (L)
57,198
12/31
7,996
12/31
+ Right-of-use Asset (A) – Finance Lease
1/3
57,198
-
+
12/31
- Accumulated Amortization – Finance +
Lease (XA)
9,533
12/31
Interest Expense (E)
4,004
+
1/3
-
Amortization Expense – Finance Lease (E)
12/31
9,533
+
c. Operating Lease (i):
Balance Sheet
Transaction
Cash
Asset
Operating
lease
commences.
Lease
payment.
Noncash
+
Assets
+57,198
Right-of- use
asset –
Operating
lease
-12,000
Cash
Record lease
expense and
changes to
asset and
liability.
-
Contra
Assets
Income Statement
= Liabilities +
= +57,198
Operating
Lease
Liability
-
=
-12,000
Operating
Lease
Liability
-7,996
Right-of-use
asset –
Operating
lease
=
4,004
Operating
Lease
Liability
Contrib.
Capital
+
Earned
Capital
Revenues
-
- Expenses =
=
-
-12,000
Retained
Earnings
-
=
+12,000
Lease
Expense
=
continued
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
Net
Income
1-187
-12,000
c. continued
Finance Lease (ii):
Balance Sheet
Transaction
Finance lease
commences
Cash
Asset
+
Noncash
Assets
+57,198
Right-ofuse asset –
Finance
lease
Amortization of
leased asset.
-
Made annual
-12,000
lease payment. Cash
-
Contra
Assets
+9,533
Accum.
Amortization.
= Liabilities +
= +57,198
Finance
Lease
Liability
=
=
-7,996
Finance
Lease
Liability
Income Statement
Contrib.
Capital
+
Earned
Capital
Revenues
Net
- Expenses = Income
=
-9,533
Retained
Earnings
-
+9,533
Amort.
Expense
=
-9,533
-4,004
Retained
Earnings
-
+4,004
Interest
Expense
=
-4,004
d. The amount of interest plus amortization expense in the finance-type lease is greater
early in the asset’s life than the straight-line lease expense amount under the
operating lease. This is driven by the amortization portion meaning that the net rightof-use asset value on the balance sheet for an operating lease will be higher than for
the finance-type lease early in the asset’s life.
M10-14. (20 minutes)
LO 2
Right-of-use asset – finance lease (+A)
123,100
Finance lease liability (+L) .................................
a. 7/1
123,100
$123,100 = $4,500 x 27.35548
b. 9/30
Amortization expense (+E, -SE)
Accumulated amortization (+XA, -A) .................
$3,078 = $123,100 / (10 x 4)
3,078
3,078
(note the company could directly reduce the right-of-use asset value)
9/30
Finance lease liability (-L) .......................................
Interest expense (+E, -SE) .....................................
Cash (-A) ...........................................................
2,038
2,462
4,500
$2,462 = $123,100 x (0.08/4); $2,038 = $4,500 - $2,462
12/31 Amortization expense (+E, -SE)..............................
Accumulated amortization (+XA, -A) .................
3,078
12/31 Finance lease liability (-L) .......................................
Interest expense (+E, -SE) .....................................
Cash (-A) ...........................................................
2,079
2,421
3,078
4,500
$2,421 = ($123,100 - $2,038) x (0.08/4); $2,079 = $4,500 - $2,421
©Cambridge Business Publishers, 2020
1-188
Financial Accounting, 6th Edition
c.
+
+
Cash (A)
4,500
4,500
-
9/30
12/31
Right-of-use Asset – Finance Lease (A) 7/1
123,100
Finance Lease Liability (L)
123,100
2,038
2,079
9/30
12/31
+
- Accumulated Amort. – Finance lease (XA) +
3,078
9/30
3,078
12/31
9/30
12/31
Interest Expense (E)
2,462
2,421
+
9/30
12/31
Amortization Expense (E)
3,078
3,078
+
7/1
-
-
d.
Balance Sheet
Transaction
Cash
Asset
7/1/20
Finance lease
commences.
+
Noncash
Assets
-
+123,100
-
Liabilities
=
+123,100
+3,078
=
Net
- Expenses = Income
-
-3,078
-
=
-2,038
-2,462
Finance
Retained
Earnings
Lease
Liability
-
+3,078
=
-3,078
Accum.
Amort.
Cash
Revenues
-
-
Retained
Earnings
Cash
-4,500
Earned
Capital
=
Lease
Liability
Accum.
Amort.
-4,500
Income Statement
Contrib.
+ Capital +
Finance
-
12/31/20
Amortization
on leased
asset.
12/31/20
Made quarterly
lease
payment.
=
Right-of-use
asset –
finance lease
9/30/20
Amortization
on leased
asset.
9/30/20
Made quarterly
lease
payment.
Contra
Assets
-2,079
-2,421
Finance
Retained
Earnings
Lease
Liability
= -3,078
Amort.
Expense
-
+2,462
= -2,462
Interest
Expense
-
Retained
Earnings
=
+3,078
+3,078
= -3,078
Amort.
Expense
-
+2,421
= -2,421
Interest
Expense
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-189
M10-15 (10 minutes)
LO 2
a. Right-of-use asset – finance lease (+A).............................
Finance lease liability (+L) ......................................
74,520
b. Right-of-use asset – operating lease .................................
Operating lease liability (+L) ...................................
5,853
Operating lease liability (-L) ...............................................
Cash (-A) ................................................................
1,000
74,520
5,853
1,000
M10-16. (25 minutes)
LO 2
Determine the PV of the lease payments → $130,000 X 4.10020 ((or use excel or a
financial calculator) = $533,026.
Note: Table amounts may not compute precisely and all totals may not foot, due to
rounding.
a. Operating Lease Liability Amortization Schedule
Date
Lease
Payment
January 1, 2020
December 31, 2020 $
December 31, 2021
December 31, 2022
December 31, 2023
December 31, 2024
$
Interest
on Liability
Reduction of
Lease Liability
$
130,000
130,000
130,000
130,000
130,000
$
$
$
$
$
650,000 $
37,312
30,824
23,881
16,453
8,505
$
$
$
$
$
92,688
99,176
106,119
113,547
121,495
116,974 $
533,026
Lease Liability
533,026
440,337
341,161
235,042
121,495
0
b. Right-of-Use Asset Amortization Schedule
Date
Straight-line
Expense
Interest
on Liability
Amortization of
Right-of-Use Asset
January 1, 2020
December 31, 2020 $
December 31, 2021
December 31, 2022
December 31, 2023
December 31, 2024
130,000 $
130,000
130,000
130,000
130,000
37,312 $
30,824
23,881
16,453
8,505
92,688
99,176
106,119
113,547
121,495
$
$
650,000 $
116,974 $
533,026
Right-of-Use
Asset
533,026
440,338
341,161
235,043
121,496
0
©Cambridge Business Publishers, 2020
1-190
Financial Accounting, 6th Edition
c. Journal Entries
January 1, 2020
Right-of-use asset – operating lease (A) ...........................
Operating lease liability (L) .....................................
533,026
December 31, 2020
Operating lease Liability ....................................................
Cash .......................................................................
130,000
December 31, 2020
Operating lease expense ...................................................
Operating lease liability ...........................................
Right-of-use asset – operating lease ......................
December 31, 2021
Operating lease liability .....................................................
Cash .......................................................................
December 31, 2021
Operating lease expense ...................................................
Operating lease liability ...........................................
Right-of-use asset – operating lease ......................
533,026
130,000
130,000
37,312
92,688
130,000
130,000
130,000
30,824
99,176
M10-17. (20 minutes)
LO 2
Determine the PV of the payments – annuity due → $130,000 X 4.3872 (or use excel or
a financial calculator) =$570,377.
a. Operating Lease Liability Amortization Schedule
Date
Lease
Payment
Interest
on Liability
Reduction of
Lease Liability
January 1, 2020
January 1, 2020 $
January 1, 2021
January 1, 2022
January 1, 2023
January 1, 2024
$
130,000 $
130,000
130,000
130,000
130,000
$
30,824
23,881
16,453
8,505
130,000
99,176
106,119
113,547
121,495
$
650,000 $
79,663 $
570,337
Lease Liability
570,337
440,337
341,161
235,042
121,495
0
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-191
b. Right-of-Use Asset Amortization Schedule
Date
Straight-line
Expense
Interest
on Liability
Amortization of
Right-of-Use Asset
January 1, 2020
Year 2020 $
Year 2021
Year 2022
Year 2023
Year 2024
130,000 $
130,000
130,000
130,000
130,000
30,824 $
23,881
16,453
8,505
-
99,176
106,119
113,547
121,495
130,000
$
650,000 $
79,663 $
570,337
$
Right-of-Use
Asset
570,337
471,161
365,042
251,495
130,000
0
c. Journal entries
January 1, 2020
Right-of-use asset ................................................................
Operating lease liability .............................................
570,337
January 1, 2020
Operating lease liability ........................................................
Cash..........................................................................
130,000
December 31, 2020
Operating lease expense .....................................................
Operating lease liability .............................................
Right-of-use-asset – operating lease ........................
January 1, 2021
Operating lease liability ........................................................
Cash..........................................................................
December 31, 2021
Operating lease expense .....................................................
Operating lease liability .............................................
Right-of-use asset – operating lease ........................
570,337
130,000
130,000
30,824
99,176
130,000
130,000
130,000
23,881
106,119
M10-18 (10 minutes)
LO 3
a. Pension expense (+E, -SE) .......................................................
Cash (-A) ..............................................................................
$16,000 = $400,000 x 0.04
16,000
16,000
b. Bartov would report a net liability of $450,000 ($625,000 - $175,000) in its 2019
balance sheet. Because Bartov is effectively self-insured, it must report the estimated
death benefit obligation net of any assets set aside to meet that obligation.
©Cambridge Business Publishers, 2020
1-192
Financial Accounting, 6th Edition
M10-19. (10 minutes)
LO 3, 4
a. Exxon Mobil is reporting $2,769 million in pension expense for 2017.
b. Expected returns are an offset to service and interest costs and serve to reduce
reported pension expense.
c. “Expected” refers to the use of long-term average returns for the investment portfolio.
Expected returns are used in the computation of pension expense, rather than actual
returns, in order to smooth reported income.
M10-20. (10 minutes)
LO 3, 4
a. Yum! Brands is reporting $17 million of pension expense for 2017.
b. Expected returns are an offset to service and interest costs and serve to reduce
reported pension expense.
c. “Expected” refers to the use of long-term average returns for the investment portfolio.
Expected returns are used in the computation of pension expense, rather than actual
returns, in order to smooth reported income.
M10-21. (10 minutes)
LO 3, 4
a. A&F maintains a defined contribution plan for the benefit of its employees.
b. Contributions are expensed when made. The entry to record expenses for 2014 was
($ millions):
Pension expense (+E, -SE).....................................................
Cash (-A) ...........................................................................
14.4
14.4
c. Only the unpaid contribution, if any, appears on the A&F balance sheet.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-193
M10-22. (15 minutes)
LO 1
a. The use of contract manufacturers removes the manufacturing assets and related
liabilities from Nike’s balance sheet.
Because sales are unaffected, PPE turnover is increased by the removal of assets.
The effect on net operating profit after taxes (NOPAT) is uncertain; depreciation is
removed (interest on the liabilities incurred to purchase the manufacturing assets is
also removed, but this is a nonoperating expense and, therefore, does not affect
NOPAT), but Nike will pay a higher price for its manufactured goods in order to
provide the manufacturer with a return on its investment. If the contract manufacturer
is more efficient than Nike, however, the price increase is mitigated. Profitability will
increase if the turnover effect more than offsets the negative effect on NOPAT and
profit margin, which is likely.
b. Executory contracts are not recognized under GAAP. As a result, the use of contract
manufacturers achieves off-balance-sheet financing. This is one motivating factor for
their use.
M10-23. (20 minutes)
LO 5
a, b, and c.
Year
Book
Value
Temporary
Difference
Tax
Rate
Deferred
Tax Liability
2021
$300,000
$173,000
$127,000
25%
$31,750
2022
$200,000
$173,000 - ($100,000 - $31,000) = $104,000
$96,000
25%
$24,000
2023
$100,000
$104,000 - ($100,000 - $31,000) = $35,000
$65,000
25%
$16,250
Tax Basis (after depreciation deduction)
d. Deferred tax assets and liabilities are all recorded as non-current assets and liabilities.
©Cambridge Business Publishers, 2020
1-194
Financial Accounting, 6th Edition
EXERCISES
E10-24. (45 minutes)
LO 2
a. Present value of operating leases = $4,897, 005 , computed using the PV function in
Excel: =PV(0.04,5,1100000,0) or using the PV of annuity table in Appendix A:
4.45182 X $1,100,000 (or using a financial calculator or the formula for PV of an
annuity) [Note there will be small rounding differences between the methods.] This
amount is both the value of the asset and the liability (because there are no
payments already made or other complicating terms of this lease).
b. Lease liability amortization schedule
Date
Lease Payment
01-Jan-20
31-Dec-20 $
1,100,000 $
31-Dec-21
1,100,000
31-Dec-22
1,100,000
31-Dec-23
1,100,000
31-Dec-24
1,100,000
Total
$
5,500,000 $
Interest on
Liability
Reduction of Lease
Liability
195,880 $
159,715
122,104
82,988
42,308
602,996 $
904,120
940,285
977,896
1,017,012
1,057,693
4,897,005
Lease Liability
$4,897,005
$
3,992,885
3,052,601
2,074,705
1,057,693
0
Right-of-use Asset Amortization Schedule – operating lease
Date
01-Jan-20
31-Dec-20 $
31-Dec-21
31-Dec-22
31-Dec-23
31-Dec-24
$
Straight-line
Expense
1,100,000
1,100,000
1,100,000
1,100,000
1,100,000
5,500,000
Interest
on Liability
$
$
195,880
159,715
122,104
82,988
42,308
602,996
Amortization of
Right-of-Use Asset
$
$
904,120
940,285
977,896
1,017,012
1,057,693
4,897,005
Right-of-Use
Asset
$4,897,005
$
3,992,885
3,052,601
2,074,705
1,057,693
0
*Note: there are some small differences due to rounding in the tables above.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-195
c. Entries if a finance lease:
January 1, 2020
Right-of-use asset – finance lease ..........................
Finance lease liability ....................................
4,897,005
December 31, 2020
Amortization expense ..............................................
Accumulated amortization – finance lease....
979,401
4,897,005
979,401
$4,897,005 / 5
(note that company could choose to reduce the asset value directly)
Finance lease liability ..............................................
Interest expense ......................................................
Cash .............................................................
904,120
195,880
1,100,00
December 31, 2021
Amortization expense ..............................................
Accumulated amortization – finance lease....
979,401
979,401
$4,897,005 / 5
(Note that company could choose to reduce the asset value directly)
Finance lease liability ..............................................
Interest expense ......................................................
Cash .............................................................
940,285
159,715
1,100,00
Balance Sheet Equation:
January 1, 2020
Balance Sheet
Transaction
Cash
Asset
+
Lease
equipment
using financetype lease
Noncash
Assets
=
Liabilities
+4,897,005
=
+4,897,005
Right-of-use
asset
Income Statement
Contrib.
+ Capital +
Earned
Capital
Revenues
Net
Income
- Expenses =
-
=
Lease
liability
December 31, 2020
Balance Sheet
Transaction
Cash
Asset
+
Record
amortization
of asset
Noncash
Assets
=
–979,401
=
Liabilities
Income Statement
Contrib.
+ Capital +
Earned
Capital
–979,401
- Expenses =
-
Accum.
Amort. –
finance lease
Cash
Asset
+
Noncash
Assets
Record
–1,100,000
interest and
cash payment
+979,401
= –979,401
=
Liabilities
=
–904,120
Income Statement
+
Contrib.
Capital +
Earned
Capital
–195,880
Revenues
- Expenses =
-
+195,880
Interest
expense
©Cambridge Business Publishers, 2020
1-196
Net
Income
Amort.
expense
Balance Sheet
Transaction
Revenues
Financial Accounting, 6th Edition
Net
Income
= –195,880
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-197
d. Entries if an operating lease
January 1, 2020
Right-of-use asset – operating lease ................................. 4,897,005
Operating lease liability ...........................................
4,897,005
December 31, 2020
Operating lease liability ..................................................... 1,100,000
Cash .......................................................................
1,100,000
Lease expense .................................................................. 1,100,000
Operating lease liability .....................................................
Right-of-use asset – operating lease ......................
195,880
904,120
(note company could choose to maintain an accumulated amortization account)
December 31, 2021
Operating lease liability ..................................................... 1,100,000
Cash .......................................................................
1,100,000
Lease expense .................................................................. 1,100,000
Operating lease liability ...........................................
Right-of-use asset – operating lease ......................
159,715
940,285
Balance Sheet Equation
January 1, 2020
Balance Sheet
Transaction
Cash
Asset
+
Lease
equipment
operating-type
lease
Noncash
Assets
=
Liabilities
+4,897,005
=
+4,897,005
Right-of-use
asset
Income Statement
Contrib.
+ Capital +
Earned
Capital
Revenues
- Expenses =
-
Net
Income
=
Lease
liability
December 31, 2020
Balance Sheet
Transaction
Record
payment
Cash
Asset
+
Noncash
Assets
–1,100,000
=
Liabilities
=
–1,100,000
Income Statement
Contrib.
Capital +
Earned
Capital
Contrib.
+ Capital +
Earned
Capital
+
Balance Sheet
Transaction
Record lease
expense,
reduction in
asset value &
adjust liability
for interest
Cash
Asset
+
Noncash
Assets
=
Liabilities
–904,120
=
+195,880
Right-of-use
asset –
operating
lease
Lease
liability
Revenues
- Expenses =
Income Statement
–1,100,000
Revenues
- Expenses =
Net
Income
- +1,100,000 = –1,100,000
Lease
expense
©Cambridge Business Publishers, 2020
1-198
Net
Income
Financial Accounting, 6th Edition
continued
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-199
d. continued
Alternative Entry for Dec. 31, 2020
Because this lease has no prepayments and no incentives and payments are at the
end of the year, the entries could be recorded as follows (they are equivalent):
Operating lease liability ...............................................
Lease expense ............................................................
Cash .................................................................
Right-of-use asset – operating lease ................
904,120
1,100,000
1,100,000
904,120
e. Operating lease treatment and finance lease treatment both require the recording of
a lease liability at the present value of the remaining lease payments. Both types of
leases require the recording a right-of-use asset for the total cost of the lease. Thus,
both types of leases are now ‘on-balance sheet’. However, the income statement
treatment differs between the two types of leases and the asset amortization differs.
Finance leases record amortization expense for the straight-line amortization of the
right-of-use lease asset. Finance leases also record interest expense on the lease
liability. In contrast, operating lease treatment involves one straight-line lease
expense amount each period. There is no separate amortization expense and no
separate interest expense. As a result, whereas a finance lease records interest
expense in non-operating expenses, an operating lease will record one lease
expense in operating expenses. Overall, expenses are greater in the early part of
the asset’s life for finance leases relative to operating leases. As a result, the asset
value on the balance sheet will remain higher over the term of the lease for
operating leases relative to finance leases as can be seen in the table below:
Right-of-Use Asset Balance
Finance Lease
Operating Lease
January 1, 2020
4,897,005
4,897,005
December 31, 2020
3,917,604
3,992,885
December 31, 2021
2,938,203
3,052,600
December 31, 2022
1,958,802
2,074,704
December 31, 2023
979,401
1,057,692
December 31, 2024
0
0
Amounts may differ slightly due to rounding.
©Cambridge Business Publishers, 2020
1-200
Financial Accounting, 6th Edition
E10-25. (15 minutes)
LO 3, 4
a. Target maintains only a defined contribution plan for the benefit of its employees.
b. Contributions are expensed when made.
c. Only the unpaid contribution, if any, appears on Target’s balance sheet.
d. First, employees who do not meet the unspecified eligibility requirements will not be
covered. Second, matching contributions can be reduced or eliminated in bad times.
Third, employees covered by defined contribution plans must choose how those
funds are invested and, consequently, they bear all of the risks of price volatility.
E10-26. (20 minutes)
LO 2
a. JetBlue will record $1.2 billion more in assets, thus total assets would be $1.2 billion
+ $10.426 billion for a total of $11.626 billion. JetBlue will also have $1.2 billion
more in liabilities, thus total liabilities would be $1.2 billion + $5.815 billion for a total
of $7.015 billion (again, assuming nothing else changed for JetBlue).
•
Total debt-to-equity based on recorded numbers is 1.26 or 126% computed
as $5.815 B/ $4.611 B.
•
Using the numbers after operating lease assets and liabilities are added to
the balance sheet, the debt-to-equity ratio would be 1.52 or 152% computed
as $7.015/$4.611B.
The increase is quite significant – nearly a 21%increase of the debt-to-equity ratio!
b. Delta already adopted the lease standard. Thus, to make a correct comparison
between Delta and JetBlue – one that adopted the standard and one that did not –
the analyst will need to adjust JetBlue’s financial statements to be comparable to
Delta’s. One step, and likely the most important as JetBlue states, is the step in part
a above, putting the assets and liabilities on the balance sheet. Some companies do
not provide such clear disclosures of what the amounts will be. In that case, the
analyst needs to find the present value of the future minimum lease payments as
disclosed in the notes to estimate the liability (and asset) to add to the balance
sheet. Any difference would likely affect equity.
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E10-27. (25 minutes)
LO 1, 2
a. According to Verizon’s lease footnote, it has both capital and operating leases. As of
the end of 2018, the company states that only the capital leases are reported onbalance sheet: a liability in the amount of $905 million ($316 million in current liabilities
and $589 million as long-term liabilities). However, this is not the total obligation to its
lessors. Verizon also has a significant amount of leases that it has classified as
operating, which before the recent changes to the accounting for leases were “offbalance sheet”. Looking at the 2018 data, we can see that in fact, the minimum lease
payments under operating leases are more than 26 times that for capital leases!
b. Verizon states in their disclosures that do not know for certain what the amounts will
be, but that their estimates are that the new standard will require the addition of
somewhere in the range of $21.0 billion and $23.0 billion in additional assets and
liabilities.
c. Debt-to-equity as reported = $210,119 M/$54,710 M = 3.84 or 384%.
Debt-to-equity after adjusting for estimating operating leases
= $232,119/$54,710
= 4.24 or 424%
d. Return-on-assets will likely decline because assets will be much larger but the income
statement effect will not be very large. Rent was already being expensed and FASB
settled on straight-line-expensing for the operating leases under the new standard.
Thus, essentially the same income will be compared to a larger asset base and ROA
will likely decline (based on reported numbers).
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E10-28. (25 minutes)
LO 6
a. The payments promised to sponsored athletes are economically similar to a liability in
many ways. The payments do not rise to the level of a recognizable liability for GAAP
because the athlete is yet to wear the product and be sponsored (and Under Armour
has not taken control of an asset at the point when the sponsorship contract begins).
Yet, an analyst may want to consider these payments as economically equivalent to
liabilities for at least some analysis purposes. Arguably, there is an “asset” related to
these expenditures – but advertising is expensed as incurred for financial accounting
so an asset would not be considered for analysis purposes most likely.
b. The estimated amount would be the present value of the future payments.
•
First we need to specify the future payments (in thousands)
o
o
o
o
o
o
o
o
•
2019 $126,221
2020 $106,782
2021 $101,543
2022 $98,353
2023 $91,337
Then for 2024 and after, we can estimate by dividing the total by the payment in
2023
▪ $210,634/$91,337 = 2.3 years.
▪ Round to 2 years for simplicity and find the payment for the next two years:
$210,634/2 = $105,317
2024 $105,317
2025 $105,317
Using Excel’s NPV function to estimate the amount, using the 3% interest rate
stated in the problem:
[NPV(0.03, 126221,106782,101543,98353,91337,105317,105317)
= $656,130 thousand.
}
c. Under Armour does not record a liability for the lawsuit. The accrual of an
expense and recording of a liability would occur if the loss was estimable and
probable, and if the amount is material. The company says the amount is likely
not material and that the company has insurance that will cover the costs.
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E10-29. (30 minutes)
LO 6
a. The present value of the future payments at 2.5% using Excel’s NPV function and
assuming the “thereafter” amount on the table is all paid in 2024 is: NPV(0.025,
2447,3202,1749,1596,268,66) = $8,799 million.
b. An analyst might consider this to be essentially equivalent to a liability. The company
has promised future payments. We do not have additional information to estimate
any associated assets, however.
c. Apple has recorded a liability with respect to the Qualcomm royalty payments (and
an associated accrued expense). Apple does not disclose the amount of the liability
it has recorded, just that it has accrued its “best estimate” of the amount it will have
to pay for the resolution of the dispute.
E10-30. (15 minutes)
LO 3, 4
a. Service cost is the increase in the pension obligation resulting from employees working
another year for the company. Interest cost is the accrual of interest on the
(discounted) pension obligation.
b. Payments to retirees are made from the pension investment account. There is a
corresponding reduction in the pension obligation.
c. The funded status is the pension obligation less the fair value of the plan assets. In this
case $1,007 million (pension obligation) – $864 million (plan assets) = $(143) million
funded status (when pension obligations are greater than the plan assets it is an
underfunded amount).
d. A $143 million net pension liability is reported in the balance sheet.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E10-31. (20 minutes)
LO 3, 4
a. Service cost is the increase in the pension obligation resulting from employees
working another year for the company. Interest cost is the accrual of interest on the
(discounted) pension obligation.
b. Payments to retirees are made from the pension investment account. There is a
corresponding reduction in the pension obligation.
c. The funded status is the pension benefit obligation less the fair value of the plan
assets. In this case $21,531 million – $19,175 million = $(2,356) million funded
status (underfunded amount).
d. A $2,356 million net pension liability is reported on the balance sheet.
E10-32. (20 minutes)
LO 5
a. In 2019, the temporary difference is $8,000. $8,000 x 25% = $2,000.
In 2020, the temporary difference reverses and no liability would be reported as of the
end of the year.
b. 2019
Income tax expense (+E, -SE) ................................................
Income taxes payable* (+L) ...............................................
Deferred income tax liability (+L) .......................................
57,000
55,000
2,000
*($236,000 - $16,000) x 25% = $55,000
2020
Income tax expense (+E, -SE) ................................................
Deferred income tax liability (-L) .............................................
Income taxes payable* (+L) ...............................................
59,250
2,000
61,250
*($245,000 - $0) x 25% = $61,250
c. 2019
Income tax expense (+E, -SE) ................................................
Income taxes payable* (+L) ...............................................
Deferred income tax liability** (+L) ....................................
57,800
55,000
2,800
*($236,000 – $16,000) x 25% = $55,000 **($8,000 x 35% = $2,800)
2020
Income tax expense (+E, -SE) ................................................
Deferred income tax liability (-L) .............................................
Income taxes payable* (+L) ...............................................
82,950
2,800
85,750
*($245,000 - $0) x 35% = $85,750
©Cambridge Business Publishers, 2020
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©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
10-33. (15 minutes)
LO 5
a. $12,000 x 25% = $3,000. (None would be depreciable for book purposes
b. The entire amount will be a non-current liability.
c. $8,000 x 25% = $2,000.
E10-34. (15 minutes)
LO 5
a.
Balance Sheet
Transaction
To record
income tax
expense
Cash
Asset
Noncash
+ Assets
Contrib.
= Liabilities + Capital +
= +1,745
Taxes
Payable
Income Statement
Earned
Capital
-2,392
Retained
Earnings
Revenues
-
Expenses
+2,392
Income
Tax
Expense
=
=
Net
Income
-2,392
+647
Deferred
Tax
Liability
b. Income tax expense (+E, -SE) ..........................................
Income taxes payable (+L) ..........................................
Deferred income tax liability (+L) .................................
2,392
1,745
647
(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes
payable used above would be replaced with Cash—Cash would be reduced. Either is correct.)
c. An expense of $2,392 million is recorded in the income statement, thereby reducing
both net income and retained earnings. Liabilities are increased by $2,392 million,
$1,745 million in income taxes payable (assuming the amount due this year has not
been paid yet) and the increase of of $647million in deferred income tax liability.
d. 2016: 18.67% ($863/$4,623)
2017: 13.22% ($646/$4,886)
2018: 55.31% ($2,392/$4,325)
Nike’s tax rate is much higher in the year ended May 31, 2018 because the TCJA
was passed during this fiscal year for Nike. Examining their disclosures, they state
that they accrued an additional tax expense of $1.8 billion because of the one-time
Transition Tax (aka mandatory deemed repatriation tax) on unremitted foreign
earnings prior to the TCJA. In addition, they had an additional expense of $158
million because all their deferred tax assets and liabilities had to be re-measured at
the new tax rate.
©Cambridge Business Publishers, 2020
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E10-35. (15 minutes)
LO 5
a.
Balance Sheet
Transaction
a. To record
income tax
expense.
Cash
Asset
+
Noncash
Assets
= Liabilities +
= +2,139
Taxes
Payable
Income Statement
Contrib.
Capital +
Earned
Capital
-1,144
Retained
Earnings
Revenues
-
Expenses
+1,144
Income
Tax
Expense
=
=
Net
Income
-1,144
-995
Deferred
Tax
Liability
b. Deferred tax liability (-L).............................................................
Income tax expense (+E ) .........................................................
Income tax payable (+L ) .....................................................
995
1,144
2,139
(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes
payable used above would be replaced with Cash—Cash would be reduced. Either is correct. Also, in
this problem if you increased a Deferred Income Tax Asset for $995 million rather than decrease the
Deferred Tax Liability that is acceptable as well because the disclosures are not presented that show
whether the company has a net deferred tax asset or liability. )
c. An expense of $1,144 million is recorded in the income statement, thereby reducing
both net income and retained earnings. This total tax expense is composed of two
parts – current tax expense and deferred tax expense. The current portion ($2,139
million) approximates income taxes on the tax return for the current year (ignoring
some more complicated factors like unrecognized tax benefits, a detailed discussion
of which is beyond the scope of this text). Boeing also records an decrease in
deferred tax liabilities (or an increase in deferred tax assets) of $995 million and a
deferred tax benefit of $955.
©Cambridge Business Publishers, 2020
1-208
Financial Accounting, 6th Edition
PROBLEMS
P10-36. (25 minutes)
LO 2
a. $5,262 million ($2,380 + $2,882).
b. $5,995 million ($719 +$5,276)
c. Net book value of $346 ($992 - $646) for the asset. The liability is $347 ($123 + $224)
d. Operating leases were previously ‘off-balance’ sheet. Thus, companies often
structured their lease contracts to obtain this ‘off-balance’ sheet outcome. These
numbers tell us that operating lease liabilities are roughly 17 times the liability for
finance-type leases. How United and other companies adjust their use of operating
leases following the implementation of the new standard remains to be seen.
e. Reported ROA = 0.0475 or 4.75% ( $2,129/$44,792)
Reported Debt-to-equity = 3.48 or 348% ($34,797/$9,995)
Adjusted ROA = 0.0425 or 4.25% ($2,129/($44,792 + $5,262))
Adjusted Debt-to-Equity = 4.40 or 440% (($34,797 + $5,995)/($9,995 + (-$733*)))
*($2,380 + $2,882 -$719 - $5,276 = -$733)
P10-37. (60 minutes)
LO 2
a. $9,151 million
b. $545 million
d. $9,556 million. The amount is the present value of the remaining lease payments.
e. Amortization expense for finance leases is $78 million. Amortization expense for
operating leases is zero. There is no separate amortization expense recorded for
operating leases, only a straight-line ‘lease expense’ that expenses to the total cost
of the leased asset over the lease term.
©Cambridge Business Publishers, 2020
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f. Interest expense for the finance lease is $48 million. Interest expense on the
operating leases is zero. There is no separate interest expense recorded for
operating leases, only a straight-line ‘lease expense’ that expenses the total cost of
the leased asset over the lease term.
g. Right-of-use asset – operating lease ......................................
Operating lease liability ...........................................
$10 B
$10 B
P10-38. (40 minutes)
LO 6
a. The use of contract manufacturers removes the manufacturing assets and related
liabilities from Cisco’s balance sheet.
Because sales are unaffected, PPE turnover is increased by the removal of assets.
The effect on net operating profit after taxes (NOPAT) is uncertain; depreciation is
removed (interest on the liabilities incurred to purchase the manufacturing assets is
also removed, but this is a nonoperating expense and, therefore, does not affect
NOPAT), but Cisco will likely pay a higher price for its manufactured goods in order
to provide the manufacturer with a return on its investment. If the contract
manufacturer is more efficient than Cisco, however, the price increase is mitigated.
Profitability will increase if the turnover effect more than offsets the negative effect
on NOPAT and profit margin, which is likely.
b. The estimate of the present value given the assumptions in the problem is
$6,163 million.
c. Cisco states that it has accrued $159 million – meaning it has reported that amount
as a (current) liability on its balance sheet.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
P10-39. (30 minutes)
LO 3, 4
a. Hoopes Corporation recognized $543 million as pension expense in 2019.
b. The expected return is computed as the beginning fair market value of the pension
plan assets multiplied by the long-term expected return on these investments. For
2019, this is computed as $13,295  8% = $1063.6, slightly more than the reported
amount of $1,062 million. The plan assets reported an actual return of $2,425 million.
U.S. GAAP permits the use of the expected long-term rate of return in order to
smooth earnings. If actual returns were to be used, corporate profits would fluctuate
greatly with swings in investment returns. The logic behind using the long-term rate
is that investment returns are expected to fluctuate around this average and its use
more accurately captures the average cost of the pension plan. (It is similar to the
logic of reporting held-to-maturity bond investments at historical cost rather than
current market value.)
c. The pension liability is increased by the service and interest costs and decreased by
any payments made to plan participants. The actuarial loss (gain) relates to the effects
on the pension obligation of changes in assumptions used to compute it, such as the
discount rate or the rate of expected wage inflation. The pension plan assets are
increased (decreased) by investment gains (losses), are increased by company
contributions and are decreased by benefits paid to plan participants.
d. The “funded status” is the excess (deficiency) of the pension obligation over plan
assets. If plan assets exceed pension obligation, the funded status is positive or
overfunded. If pension obligations exceed the fair value of plan assets, the funded
status is negative or underfunded. The funded status of the Hoopes Corporation
pension plan is $(1,531) million at the end of 2019. Pension obligations are $17,372
million and plan assets are $15,841 million. Hoopes should report its net funded status
as a net pension liability of $1,531 million on its balance sheet.
e. Because the pension obligation is the present value of expected pension payments, a
decrease in the discount rate increases the present value reported on the balance
sheet. The effect on the income statement is more difficult to predict (when the same
discount rate is used to compute interest expense and the PBO). The interest cost
component of pension expense is the product of the beginning of the year pension
obligation and the discount rate. In 2019, the effect of a decrease in the discount rate is
to apply a lower discount rate to a higher pension obligation. These two effects are
offsetting, but usually result in lower interest cost.
f. The estimated wage inflation rate is used to project future benefit payments.
Decreasing the estimated inflation rate decreases the pension obligation because a
lower amount of payments to plan participants is projected. Decreasing the expected
wage inflation rate reduces service cost and decreases the pension obligation reported
on the balance sheet and, consequently, the interest component of pension expense.
It is an income-increasing action.
©Cambridge Business Publishers, 2020
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P10-40. (20 minutes)
LO 3, 4
a. Service cost is the increase in the pension obligation resulting from employees working
another year for the company. Interest cost is the accrual of interest on the
(discounted) pension obligation.
b. The “actual” return on plan assets is $4,274 million in 2017.
c. Actuarial losses (gains) generally arise as a result of decreases (increases) in the
discount rate used to compute the pension obligation (PBO). Because the PBO is the
present value of expected future payouts to retirees, a decrease in the discount rate
results in an increase in the PBO. This decrease is recorded as an actuarial loss.
d. Payments to retirees are made from the plan assets account. There is a corresponding
reduction in the pension obligation.
e. Johnson and Johnson contributed $664 million to its pension plans in 2017.
f. Johnson and Johnson paid $1,050 million in benefits to its retirees in 2017.
g. The funded status is the pension obligation less the fair value of the plan assets. In this
case $33,221 million – $28,404 million = $(4,817) million underfunded amount.
h. A $4,817 million net pension liability is reported on the balance sheet.
P10-41. (20 minutes)
LO 5
a.
Tax expense – 2018: $1,727 million; 2017: $971 million; 2016: $700 million.
Current tax expense – 2018: $247 mil.; 2017: $871 mil.; 2016: $417 mil.
Deferred tax expense – 2018: $1,480 mil.; 2017: $100 mil.; 2016: $283 mil.
b.
2018: $1,727 / $4,070.7 = 42.43%
2017: $971 / $3,153.8 = 30.79%
2016: $700 / $2,224.0 = 31.47%
c. Deferred tax liabilities are created when a company reports greater revenues and/or
lower expenses in the income statement than are reported on the tax return. The
most common cause is the use of accelerated depreciation for taxes and straightline depreciation for financial reporting. When these deferred taxes reverse (late in
the asset’s life) the deferred tax liability is reduced.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
P10-42. (15 minutes)
LO 5
a. Temporary differences
2019: $32,000 - $24,000 = $8,000;
2020: ($32,000 + $37,000) – ($24,000 + $26,000) = $19,000.
b. Deferred tax liability
2019: $8,000 x 25% = $2,000; 2020: $19,000 x 25% = $4,750
c. $12,000 + ($4,750 – $2,000) = $14,750
d. Income tax expense (+E, -SE)...................................................
Income taxes payable (+L)...................................................
Deferred tax liability (+L) ......................................................
+ Income Tax Expense (E) (d)
14,750
14,750
12,000
2,750
- Income Taxes Payable (L) +
12,000
(d)
- Deferred Tax Liability (L) +
2,750
(d)
(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes
payable used above would be replaced with Cash—Cash would be reduced. Either is correct.)
P10-43. (15 minutes)
LO 5
a. Temporary differences
2019: $140,000 - $130,000 = $10,000;
2020: ($140,000 + $122,000) – ($130,000 + $128,000) = $4,000.
b. Deferred tax liability
2019: $10,000 x 25% = $2,500; 2020: $4,000 x 25% = $1,000
c. $45,150 + ($1,000 – $2,500) = $43,650
d. Income tax expense (+E, -SE)...................................................
Deferred tax liability (-L).............................................................
Income taxes payable (+L)...................................................
+ Income Tax Expense (E) (d)
43,650
- Income Taxes Payable (L) +
45,150
(d)
43,650
1,500
45,150
- Deferred Tax Liability (L) +
(d)
1,500
(Note that if you assume the taxes due are paid in cash in the reporting period, the account Income taxes
payable used above would be replaced with Cash (Cash would be reduced). Either is correct.)
©Cambridge Business Publishers, 2020
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P10-44. (20 minutes)
LO 5
a. Macy’s reported an income tax benefit of $571 million.
b. Macy’s reported a benefit because its deferred income tax liabilities are greater than its
deferred income tax assets. When the value of the liabilities is reduced to the new
lower rate, this reduces deferred tax expense (creates a benefit). Recall that when the
liability was originally recorded it was recorded as follows (in general form):
Deferred tax expense (+E) ………………….
Deferred tax liability (+L) …………….
XX
XX
Now upon the TCJA enactment, the net liability is devalued to a new lower rate; the
entry is as follows (in general form):
Deferred tax liability (+L) …………………..
Deferred tax expense (-E)……………..
YY
YY
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
CASES and PROJECTS
C10-45. (30 minutes)
LO 3, 4
a. DowDuPont reported net pension expense of $58 million for 2018.
b. The expected rate of return is computed as the beginning fair value of the pension plan
assets multiplied by the long-term expected return on these investments. For 2018,
expected return was $2,846 on assets of $43,685 million. This implies an expected
rate of return of 6.51% ($2,846 / $43,685).
c. The pension liability is increased by the service and interest costs and decreased by
any payments made to plan participants. The actuarial loss (gain) relates to the effects
of changes in assumptions used to compute the pension obligation, such as the
discount rate or the rate of expected wage inflation. The pension plan assets are
increased (decreased) by investment gains (losses), are increased by company
contributions, and are decreased by benefits paid to plan participants.
d. The “funded status” is the excess (deficiency) of the pension obligation over plan
assets. If plan assets exceed pension obligation, the funded status is positive. If
pension obligations exceed the fair value of plan assets, the funded status is negative.
The funded status of DowDuPont’s pension plan is $(11,552) million at the end of
2018. Thus, the pension is underfunded and the balance sheet should show a net
pension liability of $11,552 million.
e. Since the pension obligation is the present value of expected pension payments, an
increase in the discount rate decreases the present value reported on the balance
sheet (and a decrease in the discount rate increases the present value reported on the
balance sheet). The effect on the income statement is more difficult to predict. The
interest cost component of pension expense is the product of the beginning-of-the-year
pension obligation and the discount rate. The effect of an increase (decrease) in the
discount rate is to apply a higher (lower) interest rate to a smaller (larger) pension
obligation. Interest expense on the pension liability will usually increase (decrease) in
this circumstance. However, the actuarial “gain” or “loss” resulting from the change in
the liability amount may offset the differential interest cost
f. An increase in expected return unambiguously increases profitability as pension cost is
reduced. This result occurs because the long-term expected rate of return is used to
compute the expected return that is subtracted in the computation of pension expense.
©Cambridge Business Publishers, 2020
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g. Inflation rates differ from country to country. For 2018, those rates are generally higher
outside the U.S. where Dow operates. Inflation is expected to increase in the U.S. and
could exceed the rates in other countries implying relatively higher compensation
levels. Discount rates vary across countries as well, due in part to differences in
inflation.
C10-46. (40 minutes)
LO 1, 2
a. $1,965 million
b. $872 million (net of amortization)
c. $2,170 million. The amount is the present value of the remaining lease payments.
d. $65 million
e. $42 million
f. Lease expense of $251 million.
g. Amortization expense (+E) ........................................................
Accumulated Amortization – finance lease (+XA) ..........
65
Finance Lease liability (-L ) ........................................................
Interest expense (+E) ................................................................
Cash (A) .........................................................................
83
42
65
125
h. The lease expense for operating leases is all recorded in SG&A, which is included in
operating income. For finance leases, the amortization expense may be included in
Cost of Goods sold (thus reducing gross profit) or in SG&A, or partially in both (as it
looks like the expense for Target is). For finance leases, interest expense is reported
as non-operating on income statement. Thus, finance leases have 1) a greater annual
expense amount early in the asset’s life, 2) lower net book values early in the asset’s
life, and 3) expenses allocated to various parts of the income statement in each
reporting period (whereas operating lease expense is in one place, SG&A).
i.
Target has reported debt-to-equity of 2.65 or 265% ($29,993/$11,297). Without
operating leases being “on balance sheet” Target would have had a reported debt-toequity of 2.51 or 251% (($29,993 - $2,170)/($11,297 + (- $205*))). Debt-to-equity is
higher when the operating leases are capitalized because there are significant liabilities
added to the balance sheet. More specifically these are debt-financed assets
essentially, thus adding substantial amounts to assets but also often very similar
amounts to liabilities. Thus, the debt-to-equity ratio rises when operating leases are
recorded on the balance sheet.
*($1,965 - $166 - $2,004 = -$205)
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
C10-47. (45 minutes)
LO 5
a. $192,894 thousand
b. 2018: $192,894 / $452,439 = 42.63%.
2017: $166,524 / $471,911 = 35.29%.
2016: $177,839/488,007 = 36.44%
Current US: $97,202 / $379,000 = 25.65%
Deferred US: $62,893 / $379,000 = 16.59%;
Total US rate: $160,095/$379,000 = 42.24%.
c. $23,245 - $56,783 + $129,513 = $95,975 thousand
d. Income tax expense (+E, -SE)...................................................
Deferred tax liability (+L).................................................
Income taxes payable (+L) .............................................
192,894
63,381
129,513
e. $932,283 – ($17,361/0.21) = $849,612 thousand.
f. Prepaid catalog expenses are capitalized and amortized for financial reporting purposes.
However, for tax reporting purposes, the costs are expensed when paid. Consequently,
the tax deduction is recognized before the expense is recognized in the income
statement. The prepaid catalog expense of $58,693 thousand represents a temporary
difference between financial and tax reporting. The resulting deferred tax liability shown
of $5,386 thousand offsets the current deferred tax assets in the balance sheet.
g. $13,200 thousand. This amount increased income tax expense in the year ended
January 2018 (likely by the full amount because the company says they did not have
any U.S. tax accrued prior to the TCJA.)
h. A valuation allowance is a contra-asset account related to deferred tax assets.
Management establishes a valuation allowance if it thinks the deferred tax assets will
not be realized in the future. That is, management does not think the company will
generate enough future taxable income to be able to offset the future deductions
represented by the deferred tax assets. Recognizing a valuation allowance lowers the
amount of deferred tax assets recognized and reduces income (increases tax
expense).
i. Williams Sonoma recorded $28.3 million in additional tax expense related to the
devaluation of its net deferred tax assets from the U.S. statutory tax rate of 33.9% to
the new, lower rate of 21%. Deferred tax assets and liabilities are to be valued at the
enacted rate expected to be in effect with the deferred tax item reverses. In a big
picture sense, an asset the company has is now worth less.
©Cambridge Business Publishers, 2020
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C10-48. (30 minutes)
LO 5
a. Domestic:
2018: ($2,153 + $907) / $15,800 = 19.4%
2017: ($12,608 + $220 ) / $10,700 = 119.9 %
2016: ($3,826 - $70 ) / $12,000 = 31.3%
Foreign:
2018: ($1,251 - $134) / $19,100 = 5.85%
2017: ($1,746 - $43) / $16,500 = 10.32%
2016: ($966 - $50) / $12,100 = 7.57%
Total:
2018: $4,177 / ($34,900) = 12.0%
2017: $14,531 / ($27,200) = 53.4%
2016: $4,672 / ($24,100) = 19.4%
b. Alphabet states that they have $10.2 billion due for the one-time transition tax. This
amount increased tax expense on the income statement, and reduced net income. The
amount was not paid in cash (they have eight years to pay the tax) and thus, the
company would have recorded a liability for this amount.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
Chapter 11
Reporting and Analyzing
Stockholders’ Equity
Learning Objectives – coverage by question
MiniExercises
Exercises
Problems
Cases
and Projects
LO1 – Describe business financing
through stock issuances.
19, 37
41, 45
59
62, 63
LO2 – Explain and account for the
issuance and repurchase of stock.
20 - 22, 24,
25, 36, 37
39 - 41,
45, 52, 54
55 - 59
62 - 65
LO3 – Describe how operations
increase the equity of a business.
30, 37
48, 49, 51
55 - 57
63, 64
23, 26 - 31,
36
42, 44,
46 - 51, 54
56, 58
LO4 – Explain and account for
dividends and stock splits.
LO5 – Define and illustrate
comprehensive income.
LO6 – Describe and illustrate basic
and diluted earnings per share
computations.
LO7 – Appendix 11A: Analyze the
accounting for convertible securities,
stock rights, and stock options.
56, 59, 60
24, 25,
32 - 34,
36 - 38
41, 43, 44, 50
55 - 57, 59
64
35
53
59, 60
61, 65
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QUESTIONS
Q11-1. Par value stock is stock that has a face value printed (identified) on the stock
certificate.
From an accounting standpoint, the par value of the common stock is the
amount added to the common stock portion of paid-in-capital upon the issuance
of stock. The remainder of the issue price is added to the additional paid-incapital portion of paid-in-capital. There are no analysis implications of the par
value of stock.
Q11-2. Preferred stock usually takes priority over common stock in the receipt of a
specified amount of dividends and in the distribution of assets if the corporation
is ever liquidated. Also, preferred stock does not usually have voting rights.
Typically, preferred stock has the following features: 1) Preferential claim to
dividends and to assets in liquidation, 2) Cumulative dividend rights, and 3) No
voting rights.
Q11-3. Preferred stock is similar to debt when
1. Dividends are cumulative.
2. Dividends are nonparticipating.
3. It has a preference to assets in liquidation.
Preferred stock is similar to common stock when
1. Dividends are not cumulative.
2. Dividends are fully participating.
3. It is convertible into common stock.
4. It does not have a preference to assets in liquidation.
Q11-4. Dividend arrearage on preferred stock is the aggregate amount of dividends on
cumulative preferred stock that has not been declared to date. The amount of
dividends in arrears and a current dividend must be paid to preferred
stockholders before common stockholders can receive any dividends. In the
example, preferred stockholders must receive $90,000 in dividends
($500,000  0.06  3 years = $90,000) before common stockholders receive
any dividends.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
Q11-5. A corporation's authorized stock is the maximum number of shares of stock it
may issue. The authorized amounts and classes of stock are enumerated in the
company's charter when the corporation is formed. A corporation can later
amend its charter to change the amount of authorized capital, but such action
must have the approval of the company’s shareholders. Shares that have been
sold and issued to stockholders are the company's issued stock. Shares that
have been sold and issued can be subsequently reacquired by the
corporation—called treasury stock. When treasury stock is held, the issued
shares exceed the outstanding shares.
Q11-6. Contributed capital represents the total investment that has been paid in to the
company by its shareholders as a result of the purchase of stock. Earned
capital represents the cumulative net income that has been earned, less the
portion of that income that has been paid out to shareholders in the form of
dividends.
When profit is earned, shareholders have the option of paying out that profit as
a dividend or reinvesting the earnings in order to grow the company. In fact,
many companies title the Retained Earnings account as Reinvested Earnings.
Earned capital, thus, represents an implicit investment by the shareholders in
the form of forgone dividends.
Q11-7. Paid-in capital is divided into two accounts: the common or preferred stock
account and additional paid-in capital. The common stock or preferred stock
accounts are increased by the par value of the shares issued and the additional
paid-in capital account is increased for the balance of the proceeds received
from the sale of the shares. The balance of the paid-in capital account is
affected by the par value of the stock; the higher (lower) the par value, the
lower (higher) the additional paid-in capital. Although paid-in capital will, in
general, be higher if the stock price is higher, the breakdown of paid-in capital
between the common or preferred stock accounts and additional paid-in capital
does not yield any inferences regarding the financial condition of the company.
Q11-8. A stock split refers to the issuance of additional shares of a class of stock to the
current stockholders in proportion to their ownership interests, normally
accompanied by a proportionate reduction in the par or stated value of the
stock. For example, a 2-for-1 stock split doubles the number of shares
outstanding and halves the par or stated value of the shares. Consequently,
there is no change in the amount of contributed capital associated with that
class of stock. The major reason for a stock split is to reduce the per-share
market price of the stock. Another possible reason is to influence shareholders’
in believing there has been some distribution of value.
©Cambridge Business Publishers, 2020
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Q11-9. Treasury stock is a corporation's issued stock that has been reacquired by the
issuing corporation through purchases of its stock from its shareholders. A
corporation often purchases treasury stock for distribution to employees under
stock option plans or to offset dilution resulting from such sales. It is also used
by management to prop up stock price when management believes its stock is
inappropriately underpriced.
On the balance sheet, treasury stock should be carried at its cost and is shown
as a deduction in deriving the total stockholders' equity—known as a contra
equity account.
Q11-10. The $2,400 increase should not be shown on the income statement as any
form of income or gain. The $2,400 is properly treated as additional paid-in
capital and is shown as such in the stockholders' equity section of the balance
sheet. The latter treatment is justified because treasury stock transactions are
considered capital rather than operating transactions.
Q11-11. The book value per share of common stock is the total stockholders' equity
divided by the number of shares outstanding, or $4,628,000/260,000 = $17.80.
Q11-12. A stock dividend is the distribution of additional shares of a corporation's stock
to its stockholders. A stock dividend does not change a stockholder's relative
ownership interest, because each stockholder owns the same fractional share
of the corporation before and after the stock dividend. There is empirical
evidence, however, suggesting that the stock price does not decline fully for the
additional shares issued—various hypotheses, such as signaling theory, have
been asserted as explanations of this phenomenon.
Q11-13. The stock dividend transfers capital from retained earnings to contributed
capital. For a small stock dividend, this transfer is recorded at the market price
of the shares at the time of the dividend. For a large stock dividend, the transfer
is made at the par value of the stock.
Q11-14. Many companies repurchase shares (as Treasury Stock) in order to offset the
dilutive effects of exercised stock options which increase the number of
outstanding shares. This repurchase results in a cash outflow, and has been
used by those arguing for the expensing of employee stock options as evidence
of the cash effect of these options and linkage to the payment of wages.
Q11-15. The statement of stockholders' equity analyzes and reconciles changes in all
major components of stockholders' equity for an accounting period. The
statement begins with the beginning balances of those key stockholders' equity
components, reports the items causing changes in these components, and
ends with the period-end balances.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
Q11-16. Other Comprehensive Income (OCI) represents changes in stockholders’ equity
that are caused by factors other than profit (loss) and the sale (repurchase) of
equity securities. Some examples include unrealized gains (losses) on
available-for-sale debt securities, foreign currency translation adjustments,
unrealized gains (losses) on some derivatives, and pension liability
adjustments.
Q11-17. A stock option vesting period is a period of time after the grant date that an
employee must wait before exercising stock options. For example, a company
may grant five-year options that vest in three years. An employee would then
be able to exercise the options in Years 4 or 5, but not before. Typically, the
vesting period requires that the employee remains employed at the company
until the options vest; otherwise he/she forfeits the options. GAAP requires that
the fair value of the option be recorded as a compensation expense ratably
over the vesting period.
Q11-18. When a convertible bond is converted, both the face amount and any
associated unamortized premium or discount are removed from the balance
sheet. The stock is, then, issued considering the “purchase price” to be the
book value (face amount ± an unamortized premium or discount) of the bond.
This purchase price is, then, allocated to common stock and additional paid-in
capital. No gain or loss is reported upon the conversion.
©Cambridge Business Publishers, 2020
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MINI EXERCISES
M11-19. (10 minutes)
LO 1
a. These transactions increase Beatty Corp.’s contributed capital. Earned capital is
affected by net income, other comprehensive income and dividends.
b. Transactions between a company and its shareholders do not affect the income
statement.
c. Preferred stock has priority over common stock in the payment of dividends and in
liquidation. That is, a company cannot pay common dividends until after it has fulfilled
its preferred dividend obligation. And, if a company liquidates, the claims of the
preferred shareholders are met before those of the common shareholders.
M11-20. (15 minutes)
LO 2
a.
Balance Sheet
Transaction
Issue 18,000
shares of $10
par value
preferred
stock at $48
per share.
Issue 120,000
shares of $2
par value
common at
$37 per
share.
Cash
Asset
+864,000
Cash
Noncash
+ Assets
= Liabilities
=
Income Statement
Contrib.
+ Capital +
+180,000
Preferred
Stock
Earned
Capital
Revenues
-
Expenses
Net
= Income
=
+684,000
Additional
Paid-in Capital
+4,440,000
Cash
=
+240,000
Common
Stock
-
=
+4,200,000
Additional
Paid-in Capital
b.
9/1
Cash (+A) .........................................................................................
864,000
Preferred stock (+SE) ...................................................................... 180,000
Additional paid-in capital (+SE) ........................................................ 684,000
9/1
Cash (+A) .........................................................................................
4,440,000
Common stock (+SE) ....................................................................... 240,000
Additional paid-in capital (+SE) ........................................................ 4,200,000
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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c.
+
Cash (A)
864,000
4,440,000
- Common Stock (SE) +
240,000
9/1
9/1
- Preferred Stock (SE) +
180,000
9/1
- Additional Paid-in Capital (SE) +
684,000
9/1
4,200,000
9/1
9/1
M11-21. (10 minutes)
LO 2
(in millions)
Common stock ....................................... $
4.614a
Additional paid in capital.........................
42,815.39
Total .......................................................
$42,820
a 4,614
million shares issued  $0.001 par value.
M11-22. (15 minutes)
LO 2
a.
Income Statement
Balance Sheet
Cash
Transaction
Asset
Issue 5,000
+1,250,000
shares of $100
Cash
par value
preferred stock
at $250 per
share.
Repurchase
5,000 shares
of $1 par value
common stock
at $83 per
share.
Noncash
+ Assets =
=
-415,000
Cash
Liabilities
+
Contrib.
Capital
+500,000
Preferred
Stock
Earned
+ Capital -
Contra
Equity
Net
Revenues - Expenses = Income
=
+750,000
Add’l
Paid-in
Capital
=
- +415,000
Treasury
Stock
-
=
b.
1/1
Cash (+A) ...................................................................................
1,250,000
Preferred stock (+SE) .................................................................. 500,000
Additional paid-in capital (+SE) .................................................... 750,000
3/1
Treasury stock (+XSE, -SE) .........................................................
415,000
Cash (-A) ....................................................................................
415,000
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
c.
1/1
+
Cash (A)
1,250,000
415,000
3/1
- Preferred Stock (SE) +
500,000
1/1
3/1
+ Treasury Stock (XSE) 415,000
- Additional Paid-in Capital (SE) +
750,000
1/1
M11-23. (10 minutes)
LO 4
A stock split that is affected as a large stock dividend requires an entry into the
accounting records. The number of outstanding shares must be changed in the
parenthetical note to the common and preferred stock accounts in the stockholders’
equity section of the balance sheet. The par value of the new shares must be taken out
of retained earnings and put into the common stock at par account. In the two-for-one
stock split effected by Aflac, each shareholder receives one additional share for each
share owned, thus doubling the outstanding shares, and – because the split was
effected as a large stock dividend – the par value of the shares is unchanged. The
dollar amount of total paid-in capital increases, but the total dollar amount of
stockholders’ equity is unchanged. Earnings per share is recomputed for all years
presented in the income statement to reflect the additional shares outstanding.
M11-24. (15 minutes)
LO 2, 6
a. Basic EPS: [$501,000 – (16,000 x $2)] / 134,000 = $3.50
Calculation of weighted average shares outstanding:
120,000
130,000
146,000
140,000
x
x
x
x
2/12
5/12
3/12
2/12
=
=
=
=
20,000
54,167
36,500
23,333
134,000
b. Diluted EPS: $501,000 / (134,000 + 16,000) = $3.34
c. Given a simple capital structure, only basic EPS need be reported.
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M11-25. (10 minutes)
LO 2, 6
a. Treasury shares are deducted from issued shares to yield outstanding shares. The
outstanding shares are, therefore:
Shares outstanding = 3,262,997,492 – 353,073,500 = 2,909,923,992
b. If the stock repurchase took place on July 1, 2017, three months after the end of the
previous fiscal year, the denominator of the basic EPS calculation would decrease
by 353,073,500 x 9/12. That is, the weighted average shares outstanding would be
3,262,997,492 – [353,073,500 x (9/12)] = 2,998,192,367 shares.
M11-26. (15 minutes)
LO 4
a.
Balance Sheet
Cash
Asset
Transaction
Noncash
+ Assets
Declared and
paid cash
dividend on
preferred
stock.
-18,000
Declared and
paid cash
dividend on
common stock.
-88,000
= Liabilities +
=
Income Statement
Contrib.
Capital +
Earned
Capital
-18,000
Cash
Revenues
-
Expenses
Net
= Income
-
=
-
=
Retained
Earnings
=
-88,000
Cash
Retained
Earnings
b. Preferred dividend:
12/31 Retained earnings (-SE) ........................................................
18,000
Cash (-A) ......................................................................................... 18,000
Common dividend:
12/31 Retained earnings (-SE) ...................................................................
88,000
Cash (-A) ..........................................................................................88,000
c.
+
Cash (A)
18,000
88,000
12/31
12/31
- Retained Earnings (SE) +
12/31
18,000
12/31
88,000
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M11-27. (15 minutes)
LO 4
Because this is a small stock dividend (4%), retained earnings is debited for the market
value of the 2,800 additional shares of stock (70,000 x 4% x $21).
a.
Balance Sheet
Transaction
Cash
Asset
+
Declaration
and
distribution of
stock
dividend.
Noncash
Assets
= Liabilities +
=
Income Statement
Contrib.
Capital +
Earned
Capital
+14,000
-58,800
Common
Stock
Retained
Earnings
Revenues
- Expenses
=
-
=
Net
Income
+44,800
Additional
Paid-in Capital
b.
12/31 Retained earnings (-SE) ..............................................................
58,800
Common stock (+SE) ..................................................................
14,000
Additional paid-in capital (+SE) ....................................................
44,800
c.
12/31
Retained Earnings (SE)
58,800
+
- Common Stock (SE) +
14,000
12/31
- Additional Paid-in Capital (SE) +
44,800
12/31
M11-28. (10 minutes)
LO 4
a. Immediately after the 3-for-2 stock split, the company has 375,000 shares of $10 par
value common stock [250,000 shares  (3/2) = 375,000 shares] issued and
outstanding.
b. The dollar balance in the Common Stock account is unchanged by the stock split; the
balance remains at $3,750,000 (375,000 shares at the new $10 par value per share).
c. The usual reason for a corporation to split its stock is to reduce the per share market
price of the stock and, therefore, improve the stock's marketability. The market price
of the common stock prior to the split is $165 per share, which is somewhat high.
Splitting the stock would reduce the per-share price (though not the total market
value).
©Cambridge Business Publishers, 2020
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©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M11-29. (15 minutes)
LO 4
Distribution to
Preferred
Common
a. $1,000,000  6% ...........................................................
$60,000
Balance to common .......................................................
$100,000
Per share
$60,000/20,000 shares .......................................
$3.00
$100,000/80,000 shares .....................................
$1.25
b. $1,000,000  6%  2 years............................................
Balance to common .......................................................
Per share
$120,000/20,000 shares .....................................
$40,000/80,000 shares .......................................
$120,000
$40,000
$6.00
$0.50
M11-30. (10 minutes)
LO 3, 4
MAFFETT COMPANY
Statement of Retained Earnings
For the Year Ended December 31, 2019
Retained earnings, December 31, 2018 ..................................................
Add: Net income ......................................................................................
Less: Cash dividends declared ................................................. $35,000
Stock dividends declared ................................................ 28,000
Retained earnings, December 31, 2019 ..................................................
$347,000
94,000
441,000
63,000
$378,000
M11-31. (10 minutes)
LO 4
a. No entry is made when the dividend is declared; an entry is required only when the
additional stock is issued. Because this is a large stock dividend, the dividend is
recorded at par value:
Retained earnings (-SE) ..............................................................
400,000
Common stock (+SE) ...................................................................400,000
b. The stock split would reduce the par value, but no journal entry would be recorded.
As a consequence, neither the common stock nor the retained earnings accounts
are affected. Neither method changes total shareholders’ equity.
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M11-32. (10 minutes)
LO 6
a. Basic EPS: [$440,000 – (10,000 x $50 x 8%)] / 50,000 = $8.00 per share
b. Diluted EPS: $440,000 / [50,000 + (10,000 x 3)] = $5.50 per share
M11-33. (15 minutes)
LO 6
a. Basic EPS: $234,000 / 45,000 = $5.20
Calculation of weighted average shares outstanding:
38,000
48,000
49,000
x
x
x
4/12
4/12
4/12
=
=
=
12,667
16,000
16,333
45,000
b. Basic EPS: [$234,000 – (6,000 x $50 x 6%)] / 45,000 = $4.80
M11-34. (15 minutes)
LO 6
a. Basic earnings per share is computed as net income less any preferred dividends
divided by the weighted average number of common shares outstanding for the
period. Diluted earnings per share adjusts for dilutive securities (such as convertible
securities or employee stock options) by including the securities in the denominator
and also adjusting for any effect on the numerator. Consequently, diluted earnings
per share is always less than or equal to basic earnings per share.
b. In the case of Siemens, it has 815,063 thousand weighted average common shares
outstanding, and an additional 13,253 thousand weighted average common shares
that could potentially be issued (dilutive). These dilutive shares relate to employee
stock options warrants, that potentially could be converted into common shares.
(Note: with 815,063 thousand shares and a basic EPS of €6.97, the implied earnings
number is €5,680,989 thousand, computed as 815,063 thousand  €6.97. For
diluted EPS, 828,316 thousand times €6.86 implies earnings of €5,682,248
thousand, a difference of €1,259 thousand. This difference is likely due to the
interest/dividends on convertible securities and rounding of EPS.)
c. While diluted EPS is favored over basic EPS by analysts, the data reflect events that
have not and may never occur. In addition, the dilution is assumed to be made at
the year’s start.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M11-35. (15 minutes)
LO 7
a. No entry is required when the options are granted. The compensation expense is
recognized ratably over the vesting period. As the options vest, the following entry is
required (assume one-third vested in 2017):
Compensation expense (+E, -SE) ................................................
9,931,093
Additional paid in capital (+SE) ...............................................
[(($7.04 X 4,232,000)/3) = $9,931,093]
9,931,093
b. Granted stock options (whether vested or not) are included in the denominator of
diluted EPS whenever the stock price is greater than the exercise price. These
options would reduce diluted EPS but have no effect on basic EPS.
c.
Cash (+A) ...................................................................................
499,000,000
Contributed capital (+SE) ........................................................
499,000,000
The details of the credit to contributed capital would depend on where the shares
came from. If they had been held as treasury shares, the credit would have been to
the treasury shares contra asset, with either a debit or credit in additional paid-in
capital. If the shares were newly issued, the credit would have been to the par value
and additional paid-in capital for Merck’s common stock.
d. When options are exercised, the number of outstanding shares increases. This
would reduce basic EPS. It might also lower diluted EPS, though most likely to a
lesser degree. This is because the dilutive effect may already be reflected in diluted
EPS prior to exercise.
M11-36. (10 minutes)
LO 2, 4, 6
Year
1 …..
2 …..
3 …..
Total
Assets
Total
Liabilities
Total
Stockholders’ Equity
EPS
Operating
Income
Increase
Decrease
No effect
No effect
No effect
Increase
Increase
Decrease
Decrease
Decrease
Increase
No effect
No effect
No effect
No effect
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M11-37. (15 minutes)
LO 1, 2, 3, 6
a. $30 = $18,000,000 / 600,000 shares
b. $10 = $6,000,000 / 600,000 shares
c. $12,000,000 = $18,000,000 - $6,000,000
d. $4,000,000 = $5,000,000 – $1,000,000
e. 50,000 shares = 600,000 – 550,000
f. $8.70 = $5,000,000 ÷ (600,000 + 550,000)/2. 600,000 shares were outstanding for
the first half year but only 550,000 during the second half of the year.
M11-38. (10 minutes)
LO 6
a. The diluted EPS calculation is made to reflect a worst-case scenario (conservative)
EPS figure.
b. $759/326.5 = $2.32 per share
c. $761/342.2 = $2.22 per share
d. When the options are not in-the-money. Options that are “under water” (the stock
price is below the exercise price) are not included in the calculation of diluted EPS.
This is because diluted EPS is supposed to be a conservative possible outcome, but
not so conservative that it assumes “under water” options would be exercised.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
EXERCISES
E11-39. (15 minutes)
LO 2
a.
Balance Sheet
Transaction
Issue 10,000
shares of $1
par value
common
stock at $25
per share.
Cash
Asset
+250,000
Cash
Noncash
+ Assets =
=
Liabilities
+
Contrib.
Capital
+10,000
Common
Stock
Income Statement
Earned
+ Capital -
Contra
Net
Equity Revenues - Expenses = Income
=
+240,000
Add’l
Paid-in
Capital
Issued 15,000 +4,125,000
shares of
Cash
$100 par
preferred
stock at $275
per share.
=
Purchased
2,000 shares
of treasury
stock at $15
per share.
-30,000
Cash
=
Sold 1,000
shares of
treasury stock
at $21 per
share.
+21,000
Cash
=
+1,500,000
Preferred
Stock
-
-
=
- +30,000
Treasury
Stock
-
=
-
-
=
+2,625,000
Add’l
Paid-in
Capital
+6,000
Add’l
Paid-in
Capital
-15,000
Treasury
Stock
b.
2/20
Cash (+A) .........................................................................................
250,000
Common stock (+SE) .......................................................................10,000
Additional paid-in capital (+SE) ........................................................
240,000
2/21 Cash (+A) .........................................................................................
4,125,000
Preferred stock (+SE) .......................................................................
1,500,000
Additional paid-in capital (+SE) ........................................................
2,625,000
6/30
Treasury stock (+XSE, -SE) .............................................................
30,000
Cash (-A) ........................................................................................... 30,000
9/25
Cash (+A) .........................................................................................
21,000
Treasury stock (-XSE, +SE) .............................................................
15,000
Additional paid-in capital (+SE) ........................................................6,000
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c.
+
Cash (A)
250,000
4,125,000
2/20
2/21
-
30,000
9/25
6/30
6/30
21,000
+ Treasury Stock (XSE) 30,000
15,000
9/25
- Preferred Stock (SE) +
1,500,000
2/21
- Common Stock (SE) +
10,000
2/20
- Additional Paid-in Capital (SE)
240,000
2,625,000
6,000
+
2/20
2/21
9/25
E11-40. (20 minutes)
LO 2
a.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
LiabilAssets = ities
Issue 25,000
shares of $5
par common
stock at $17
per share.
+425,000
Cash
=
Issued 6,000
shares of $50
par preferred
stock at $78
per share.
+468,000
Cash
Repurchased
3,000 shares
of treasury
stock at $20
per share.
-60,000
Cash
=
Sold 2,000
shares of
treasury stock
at $26 per
share.
+52,000
Cash
=
Sold 1,000
shares of
treasury stock
at $19 per
share.
+19,000
Cash
=
+
Income Statement
Contrib.
Capital
Earned
+ Capital -
Contra
Equity
+125,000
Common
Stock
-
-
=
-
-
=
Revenues
Net
- Expenses = Income
+300,000
Add’l
Paid-in
Capital
=
+300,000
Preferred
Stock
+168,000
Add’l
Paid-in
Capital
-
+60,000
Treasury
Stock
-
=
+12,000
Add’l
Paid-in
Capital
-
-40,000
Treasury
Stock
-
=
-1,000
Add’l
Paid-in
Capital
-
-20,000
Treasury
Stock
-
=
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
b.
1/15
Cash (+A) .........................................................................................
425,000
Common stock (+SE) .......................................................................
125,000
Additional paid-in capital (+SE) ........................................................
300,000
1/20
Cash (+A) .........................................................................................
468,000
Preferred stock (+SE) ......................................................................
300,000
Additional paid-in capital (+SE) ........................................................
168,000
3/31
Treasury stock (+XSE, -SE) .............................................................
60,000
Cash (-A) ..........................................................................................60,000
6/25
Cash (+A) .........................................................................................
52,000
Treasury stock (-XSE, +SE) .............................................................
40,000
Additional paid-in capital (+SE) ........................................................
12,000
7/15
Cash (+A) .........................................................................................
19,000
Additional paid-in capital (-SE) .........................................................
1,000
Treasury stock (-XSE, +SE) .............................................................
20,000
c.
+
1/15
1/20
Cash (A)
425,000
468,000
-
60,000
6/25
7/15
3/31
3/31
52,000
19,000
+ Treasury Stock (XSE) 60,000
40,000
20,000
6/25
7/15
- Preferred Stock (SE) +
300,000
1/20
- Common Stock (SE) +
125,000
1/15
- Additional Paid-in Capital (SE) +
300,000
1/15
168,000
1/20
12,000
6/25
7/15
1,000
E11-41. (20 minutes)
LO 1, 2, 6
a. 7,040 million - 2,781 million = 4,259 million shares outstanding.
b. ($1,760 million + $15,864 million) / 7,040 million shares = $2.50 per share.
c. $50,677 million / 2,781 million shares = $18.22 per share.
d. EPS is computed based on the number of shares outstanding. The number of
shares in treasury stock is subtracted from shares issued to get the number of
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-237
shares outstanding. Thus, the number of treasury shares is subtracted from the
denominator in computing EPS.
©Cambridge Business Publishers, 2020
1-238
Financial Accounting, 6th Edition
E11-42. (20 minutes)
LO 4
Dividend Distribution
a.
2018
2019
2020
Preferred
Common
Arrearage on preferred
[7%  (20,000  $60)]
Current year on preferred
[7%  (20,000  $60)]
Remainder to common
Total distribution
Per share
Preferred ($168,000/20,000)
Common ($15,000/100,000)
Current year on preferred
[7%  (20,000  $60)]
Remainder to common
Per share
Preferred ($84,000/ 20,000)
Common ($116,000/100,000)
Preferred
$0
Common
Preferred
per Share
$0.00
$0
Common
per Share
$0.00
$84,000
84,000
$168,000
$15,000
$15,000
$8.40
$0.15
$84,000
$116,000
$4.20
$1.16
b.
2018
2019
2020
Preferred
Common
Arrearage on preferred
[7%  (20,000  $60)]
Per share
Preferred ($84,000/20,000)
Common
Arrearage on preferred
[7%  (20,000  $60)]
Partial current year on preferred
Total distribution
Per share
Preferred ($150,000/20,000)
Common
$0
$0.00
$0
$0.00
$84,000
$4.20
$0.00
$ 84,000
66,000
$150,000
$7.50
$0.00
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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E11-43. (15 minutes)
LO 6
a. Basic EPS: [$230,000 – (5,000 x $4)] / 30,000 = $7.00
Calculation of weighted average shares outstanding:
25,000 x
4/12
=
8,333
34,000 x
2/12
=
5,667
28,000 x
2/12
=
4,667
34,000 x
4/12
=
11,333
30,000
b. Diluted EPS: $230,000 / [(30,000 + (5,000 x 2)] = $5.75
c. If Soliman Corporation had a simple capital structure, only basic EPS ($7.00) would
be reported.
E11-44. (25 minutes)
LO 4, 6
a. Year 1
Distribution to
Preferred
Common
$
0
$
0
Year 2: Arrearage from Year 1
($750,000  8%)
Current year dividend
($750,000  8%)
Balance to common
Total for Year 2
60,000
_______
$120,000
$160,000
$160,000
Year 3: Current year dividend
($750,000  8%)
$ 60,000
$
0
$
$
0
b. Year 1
Year 2: Current year dividend
($750,000  8%)
Balance to common
Year 3: Current year dividend
($750,000  8%)
$ 60,000
0
$ 60,000
$220,000
$ 60,000
$
0
c. Because the preferred stock is not convertible, Potter Company has a simple capital
structure and would only report basic EPS. Basic EPS would be reduced in Years 2
and 3 when the preferred dividends are subtracted from net income in the
numerator.
©Cambridge Business Publishers, 2020
1-240
Financial Accounting, 6th Edition
E11-45. (20 minutes)
LO 1, 2
a. 35,852 thousand  $0.01 = $358.52 thousand rounded to $359 thousand.
b. ($359 thousand + $1,305,090 thousand) / 35,852 thousand shares = $36.41 per
share
c. 35,852 thousand shares issued – 7,826 thousand shares in treasury = 28,026
thousand shares outstanding
d. $2,334,409 thousand / 7,826 thousand shares = $298.29 per share
e. Companies repurchase stock for a variety of reasons:
1. To offset the dilutive effects of shares issued to employees as part of equitybased compensation plans.
2. To mitigate a takeover threat by concentrating the remaining shares in “friendly
hands.”
3. To send a signal to the market that the company feels its shares are
undervalued.
E11-46. (30 minutes)
LO 4
a.
Preferred
2018
Current year on preferred
[6%  (18,000  $50)]
Remainder to common
Per share
Preferred ($54,000/18,000)
Common ($9,000/90,000)
2019
Preferred
Common
2020
Arrearage on preferred
[6%  (18,000  $50)]
Current year on preferred
[6%  (18,000  $50)]
Remainder to common
Total distribution
Per share
Preferred ($108,000/18,000)
Common ($270,000/90,000)
Dividend Distribution
Preferred
Common
per Share
Common
per Share
$54,000
$9,000
$3.00
$0.10
$0
$0.00
$0
$0.00
$54,000
54,000
$108,000
$270,000
$270,000
$6.00
$3.00
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-241
b.
Preferred
2018
Preferred
Common
2019
Arrearage on preferred
[6%  (18,000  $50)]
Current year on preferred
[6%  (18,000  $50)]
Common
Total distribution
Per share
Preferred ($108,000/18,000)
Common
2020
Current year on preferred
[6%  (18,000  $50)]
Remainder to common
Per share
Preferred ($54,000/18,000)
Common ($135,000/90,000)
Dividend Distribution
Preferred
Common
per Share
$0
Common
per Share
$0.00
$0
$0.00
$ 54,000
54,000
$0
$0
$108,000
$6.00
$0.00
$54,000
$135,000
$3.00
$1.50
E11-47. (15 minutes)
LO 4
a.
Balance Sheet
Transaction
Declared and
paid cash
dividend.
Cash
Asset
Noncash
+ Assets
-47,500
Cash
Declared and
issued stock
dividend.
Income Statement
Contrib.
= Liabilities + Capital +
Earned
Capital
=
-47,5001
Retained
Earnings
-
=
-35,0002
Retained
Earnings
-
=
=
+10,000
Common
Stock
Revenues
-
Expenses
=
Net
Income
+25,000
Additional
Paid-in Capital
1
$1.90  25,000 = $47,500.
2
Retained Earnings is reduced by the market price of the shares distributed (25,000 shares  4%  $35 market value = $35,000). Common
Stock is increased by the par value with the balance of the market price reflected in an increase in Additional Paid-in Capital.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
b.
1)
Retained earnings (-SE) ...................................................................
47,500
Cash (-A) ..........................................................................................
47,500
2)
Retained earnings (-SE) ...................................................................
35,000
Common stock (+SE) .......................................................................
10,000
Additional paid-in capital (+SE) ........................................................
25,000
c.
+
Cash (A)
47,500
1)
2)
Retained Earnings (SE)
47,500
35,000
- Common Stock (SE) +
10,000
1)
+
2)
- Additional Paid-in Capital (SE) +
25,000
2)
E11-48. (20 minutes)
LO 3, 4
a.
Balance Sheet
Transaction
Cash
Asset
Declared and
paid stock
dividend.
+
Noncash
Assets
=
=
Liabilities
+
Income Statement
Contrib.
Capital +
+56,000
Common
Stock
Earned
Capital
Revenues
-
Expenses
=
-100,8001
Retained
Earnings
-
=
-64,2002
Retained
Earnings
-
=
Net
Income
+44,800
Add’l
Paid-in
Capital
Declared and
issued cash
dividend.
-64,200
Cash
=
1
The 7% dividend is a small stock dividend and, accordingly, Retained Earnings is reduced by the market value of the shares distributed
(7%  80,000 shares  $18 = $100,800). Common Stock is increased by the par value of the shares ($56,000) and Additional Paid-in
Capital in increased by the remainder ($44,800).
2
Retained Earnings is reduced by $0.75 per share on 85,600 shares outstanding and Cash is decreased by the payment.
b.
5/12
Retained earnings (-SE) ...............................................................
100,800
Common stock (+SE) ..................................................................
56,000
Additional paid-in capital (+SE) ....................................................
44,800
12/31 Retained earnings (-SE) ..............................................................
64,200
Cash (-A) .............................................................................
64,200
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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c.
+
5/12
12/31
Cash (A)
64,200
Retained Earnings (SE)
100,800
64,200
- Common Stock (SE) +
56,000
12/31
+
5/12
- Additional Paid-in Capital (SE) +
44,800
5/12
d.
PALEPU COMPANY
Statement of Retained Earnings
For the Year Ended December 31, 2019
Retained earnings, December 31, 2018
Add:
Net income
$305,000
283,000
588,000
Less:
Cash dividends declared
Stock dividends declared
Retained earnings, December 31, 2019
$ 64,200
100,800
165,000
$423,000
E11-49. (20 minutes)
LO 3, 4
a.
Balance Sheet
Transaction
Cash
Asset
Noncash
+ Assets
Declared and
paid 100%
stock dividend.
Income Statement
Contrib.
= Liabilities + Capital +
=
Declared and
paid 3% stock
dividend.
Earned
Capital
+250,000
Common
Stock
-250,0001
Retained
Earnings
+15,000
Common
Stock
-42,0002
Retained
Earnings
Revenues
-
Expenses
=
-
=
-
=
Net
Income
+27,000
Additional
Paid-in
Captal
Declared and
issued cash
dividend.
1
2
3
-102,400
Cash
=
-102,4003
Retained
Earnings
The large stock dividend is reflected as a reduction of Retained Earnings at the par value of the shares distributed (50,000 shares 
100%  $5 par value per share = $250,000). Common Stock is increased by the same amount.
This is a small stock dividend. As a result, Retained Earnings is decreased by the market value of the shares to be distributed (3% 
100,000 shares  $14 per share = $42,000). Common Stock is increased by the par value of the shares distributed (3%  100,000 
$5 = $15,000) and Additional Paid-in Capital is increased by the balance ($27,000).
Total dividends are 4,000  $5 = $20,000 for the preferred shares and 103,000  $0.80 = $82,400 for the common shares. Retained
Earnings and Cash are reduced to reflect the payment.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-245
b.
4/1
Retained earnings (-SE) ...............................................................
250,000
Common stock (+SE) ...................................................................
250,000
12/7
Retained earnings (-SE) ..............................................................
42,000
Common stock (+SE) ..................................................................
15,000
Additional paid-in capital (+SE) ....................................................
27,000
12/20 Retained earnings (-SE) ..............................................................
102,400
Cash (-A) ....................................................................................
102,400
c.
+
4/1
12/7
12/20
Cash (A)
102,400
Retained Earnings (SE)
250,000
42,000
102,400
12/20
+
- Common Stock (SE) +
250,000
15,000
4/1
12/7
- Additional Paid-in Capital (SE) +
27,000 12/7
d.
KINNEY COMPANY
Statement of Retained Earnings
For the Year Ended December 31, 2019
Retained earnings, December 31, 2018
Add:
Net income
Less:
Cash dividends declared
Stock dividends declared
Retained earnings, December 31, 2019
$656,000
253,000
909,000
$102,400
292,000
394,400
$514,600
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E11-50. (15 minutes)
LO 4, 6
a. Immediately after the stock split, 800,000 shares (2 x 400,000 shares) of $10 par value
common stock are issued and outstanding.
b. The stock split does not change the Common Stock account balance. The account
balance is $8,000,000 just before and immediately after the stock split.
c. The stock split does not change the Paid-in Capital in Excess of Par Value account.
The account balance is $3,400,000 just before and immediately after the stock split.
d. The 2-for-1 split will reduce EPS by half. The EPS numbers currently reported in
previous years’ income statements would also be reduced by half for comparison
purposes.
E11-51. (20 minutes)
LO 3, 4
a. Beginning retained earnings + Net income – Dividends = Ending retained earnings,
so $7,297 million + $1,211 million – Dividends = $8,101 million. Dividends = $407
million.
b. The change in shares outstanding was 258,616 thousand – 255,668 thousand = an
increase of 2,948 thousand shares. Therefore, Intuit must have issued 1,078
thousand shares for the exercise of stock options.
c. When a company reissues treasury shares, the difference between the value
received and the treasury share cost is either put in or taken from Additional paid-in
capital (APIC). In this case, the option exercises increased APIC, implying that the
average exercise price exceeded the average cost of the treasury shares.
©Cambridge Business Publishers, 2020
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E11-52. (20 minutes)
LO 2
a. Shares issued  Par value = Common Stock amount
3,577 million shares  $0.50
= $1,788.5 million
b. (Common Stock + Other Paid-In Capital)/Shares issued = Average Issue price
($1,788 million + $39,902 million) / 3,577 million = $11.66 per share
c. Treasury Stock / Treasury shares = Treasury cost per share
$43,794 million / 880.5 million = $49.74 per treasury share
d. Shares issued – Treasury shares = Shares outstanding
3,577,103,522 – 880,491,914 = 2,696,611,608 shares outstanding
E11-53. (15 minutes)
LO 7
a. Using diluted EPS and average shares outstanding, ($1.27) per share × 235 million
shares = a loss of $ 298.45 million. This amount is after tax. Stock options and
restricted stock units are not outstanding shares of stock and are thus, not included
in the basic EPS computation. They are, however, potentially dilutive securities
because when the holder of the security can exercise the option or when the
restricted stock unit becomes a share, then more shares will be outstanding. Thus,
both of these need to be considered when computing diluted EPS.
b. In 2018, the assumed conversion of Class B stock into Class A stock results in a
reallocation of income, meaning more income allocated to Class A stockholders, of
$3,701 million. This amount increases the numerator for the diluted EPS calculation.
The number of Class A shares assumed to be outstanding is also increased (the ‘asif converted amount’), and in 2018 the increase in the number of shares due to the
assumed conversion of Class B shares is 484 million shares.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E11-54. (20 minutes)
LO 2, 4
a. Yes, the number of shares outstanding increased by 6 million from “equity
compensation activity”.
b. Net income + other comprehensive income = total comprehensive income.
$12,598 million + $ 431 million = $13,029 million.
c.
Balance Sheet
Cash
Asset
Transaction
+
Noncash
LiabilAssets = ities
-3,577
=
Cash
+
Contrib.
Capital
Income Statement
Earned
+ Capital -
Contra
Equity
-
+3,577
Revenues
Net
Expenses = Income
-
=
Treasury
Stock
Treasury stock (+XSE, -SE) ..........................................................
3,577
Cash (-A) .....................................................................................
+
-
Cash (A)
3,577
3,577
+ Treasury Stock (XSE) 3,577
d. The $14 million difference between $2,529 million and $2,515 million went into the
Common Stock account. Perhaps Disney paid some portion of its dividends into a
dividend reinvestment account that effectively provides a stock dividend.
©Cambridge Business Publishers, 2020
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PROBLEMS
P11-55. (45 minutes)
LO 2, 3, 6
a.
Transaction
Cash
Asset
+
Noncash
Assets
=
1/10:
Issued
common
stock.1
+476,000
Cash
=
1/23:
Purchased
treasury
stock.2
-152,000
Cash
=
3/14:
Sold
treasury
stock.3
+84,000
Cash
=
7/15:
Issued
preferred
stock.4
+128,000
Cash
=
11/15:
Sold
treasury
stock.5
+24,000
Balance Sheet
LiabilContrib.
+
ities
Capital
+280,000
Common
Stock
Income Statement
Earned
+
Capital
Contra
Equity
Revenues
-
Expen
-ses
=
-
-
=
- +152,000
Treasury
Stock
-
=
+8,000
Additional
Paid-in
Capital
-
-
=
+80,000
Preferred
Stock
-
-
=
-
=
Net
Income
+196,000
Additonal
Paid-in
Capital
-76,000
Treasury
Stock
+48,000
Additional
Paid-in
Capital
=
+5,000
Additonal
Paid-in
Capital
-
-19,000
Treasury
Stock
1
Total proceeds of 28,000  $17 = $476,000 are reflected as an increase in Cash. Common Stock is increased by the par value of the shares
issued (28,000  $10 = $280,000) and Additional Paid-in Capital is increased for the balance ($196,000).
2
Cash is decreased and Treasury Stock is increased by the purchase price of 8,000 shares  $19 = $152,000. The increase in Treasury
Stock reduces contributed capital.
3
Cash received is 4,000 shares  $21 = $84,000. Treasury Stock is reduced by the original cost of $19 per share and the remainder of $8,000
is reflected as an increase in Additional Paid-in Capital.
4
Cash received is $128,000. The Preferred Stock account is increased by the par value of the preferred shares issued (3,200  $25 =
$80,000) and Additional Paid-in Capital is increased for the balance.
5
Cash received is 1,000 shares  $24 = $24,000. Treasury Stock is reduced by its original cost of 1,000 shares  $19 = $19,000, thus
increasing contributed capital, and Additional Paid-in Capital is increased for the balance ($5,000).
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
b.
1/10
Cash (+A) ...................................................................................
476,000
Common stock (+SE) .................................................................. 280,000
Additional paid-in capital (+SE) .................................................... 196,000
1/23 Treasury stock (+XSE, -SE) .........................................................
152,000
Cash (-A) .................................................................................... 152,000
3/14
Cash (+A) ...................................................................................
84,000
Treasury stock (-XSE, +SE) ......................................................... 76,000
Additional paid-in capital (+SE) .................................................... 8,000
7/15
Cash (+A) ...................................................................................
128,000
Preferred stock (+SE) .................................................................. 80,000
Additional paid-in capital (+SE) ..................................................... 48,000
11/15 Cash (+A) ...................................................................................
24,000
Treasury stock (-XSE, +SE) ......................................................... 19,000
Additional paid-in capital (+SE) .................................................... 5,000
c.
1/10
3/14
7/15
11/15
+
1/23
+ Cash (A)
476,000
84,000
128,000
24,000
152,000
1/23
Treasury Stock (XSE)
152,000
76,000
3/14
19,000 11/15
-
Common Stock (SE) +
280,000
1/10
Preferred Stock (SE) +
80,000
7/15
- Additional Paid-in Capital (SE) +
196,000
1/10
8,000
3/14
48,000
7/15
5,000
11/15
©Cambridge Business Publishers, 2020
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d. 1/10:
Decrease basic EPS
1/23:
Increase basic EPS
3/14:
Decrease basic EPS
7/15:
Decrease basic EPS
11/15:
Decrease basic EPS
Note: These answers ignore the effect of cash balances on earnings. Each transaction
changed the cash balance. If cash is invested in operations or in securities to earn a
return, net earnings would be affected by each transaction.
e.
Stockholders’ Equity
Paid-in capital
8% Preferred stock, $25 par value,50,000 shares authorized; 10,000
shares issued and outstanding
Common stock, $10 par value, 200,000shares authorized; 78,000
shares issued, of which 3,000 shares are in treasury
$ 250,000
780,000
$1,030,000
Additional paid-in capital
Paid-in capital in excess of par value—Preferred stock
116,000
Paid-in capital in excess of par value—Common stock
396,000
Paid-in capital from Treasury stock
Total paid-in capital
Retained earnings
13,000
525,000
1,555,000
329,000
1,884,000
Less: Treasury stock (3,000 common shares) at cost
Total stockholders’ equity
57,000
$1,827,000
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
P11-56. (30 minutes)
LO 2, 3, 4, 5, 6
a.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets =
Purchased
-100,000
10,000 shares
Cash
of treasury
stock for cash.
=
Sold 1,500
+18,000
shares of
Cash
treasury stock.
=
Issued 5,000
shares of
common
stock.
=
+55,000
Cash
Sold 1,200
+10,800
shares of
Cash
treasury stock.
Liabilities
+
Contrib.
Capital
Income Statement
Earned
+ Capital -
Contra
Equity
Revenues
Net
- Expenses = Income
-
+100,0001
Treasury
Stock
-
=
+3,000
Add’l
Paid-in
Capital
-
-15,0002
Treasury
Stock
-
=
+25,0003
Common
Stock
-
-
=
-
=
+30,000
Add’l
Paid-in
Capital
=
-1,200
Add’l
Paid-in
Capital
-
-12,0004
Treasury
Stock
Notes:
1
The stock is acquired for 10,000 shares  $10 = $100,000. This is reflected as a reduction in Cash and a corresponding increase in the
Treasury Stock account, a contra-equity account which reduces contributed capital.
2
Cash received is 1,500 shares  $12 per shares = $18,000. Treasury Stock is reduced by its original cost of $10 per share and the balance
($3,000) is reflected as an increase in Additional Paid-in Capital.
3
Cash received is 5,000 shares  $11 per share. Common Stock is increased by the par value of the shares issued (5,000  $5 = $25,000) and
Additional Paid-in Capital is increased by the balance ($30,000).
4
Cash received is 1,200 shares  $9 = $10,800. Treasury Stock is reduced by the original cost of the shares (1,200 shares  $10 =
$12,000) and Additional Paid-in Capital is reduced by the balance ($10,800 - $12,000 = -$1,200).
b.
1/12 No entry is required for the 3-for-1 stock split.
9/1
Treasury stock (+XSE, -SE) .........................................................
100,000
Cash (-A) ....................................................................................
100,000
10/12 Cash (+A) ...................................................................................
18,000
Treasury stock (-XSE, +SE) ......................................................... 15,000
Additional paid-in capital (+SE) .................................................... 3,000
11/21 Cash (+A) ...................................................................................
55,000
Common stock (+SE) ................................................................... 25,000
Additional paid-in capital (+SE) ..................................................... 30,000
12/28 Cash (+A) ...................................................................................
10,800
Additional paid-in capital (-SE) .....................................................
1,200
Treasury stock (-XSE, +SE) ......................................................... 12,000
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©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
c.
10/12
11/21
12/28
+
9/1
d. 1/12:
9/1:
10/12:
11/21:
12/28:
+ Cash (A) 18,000
100,000
55,000
10,800
Treasury Stock (XSE)
100,000
15,000
12,000
9/1
10/12
12/28
- Common Stock (SE) +
25,000
11/21
- Additional Paid-in Capital (SE) +
12/28
1,200
3,000
10/12
30,000
11/21
stock split – decrease basic EPS
purchase treasury stock – increase basic EPS
sold treasury stock – decrease basic EPS
issued common stock – decrease basic EPS
sold treasury stock – decrease basic EPS
e.
Stockholders’ Equity
Paid-in capital
7% Preferred stock, $100 par value, 20,000 shares authorized;
5,000 shares issued and outstanding
Common stock, $5 par value, 300,000 shares authorized;
125,000 shares issued, of which 7,300 shares are in
the treasury
Additional paid-in capital
Paid-in capital in excess of par value—Preferred stock
Paid-in capital in excess of par value—Common stock
Paid-in capital from treasury stock
Total paid-in capital
Retained earnings
$500,000
625,000
24,000
390,000
1,800
Less: Treasury stock (7,300 common Shares) at cost
Total stockholders' equity
$1,125,000
415,800
1,540,800
408,000
1,948,800
73,000
$1,875,800
f. Because Sougiannis did not pay the 7% dividend on its preferred stock, ROCE is
computed as follows:
$83,000 / [($1,875,800+$1,809,000)/2 -$500,000] = 0.062 or 6.2%
©Cambridge Business Publishers, 2020
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P11-57. (45 minutes)
LO 2, 3, 6
a.
Balance Sheet
Transaction
Cash
Asset
Noncash
Liabil+ Assets = ities
Issued
+120,000
10,000 shares
Cash
of common
stock.1
=
Purchased
4,000 shares
of treasury
stock.2
-56,000
Cash
=
Sold
1,000 shares
of treasury
stock.3
+17,000
Cash
=
Sold 500
shares of
treasury
stock.4
+6,500
Cash
+175,000
Cash
Issued
5,000 shares
of preferred
stock.5
1
2
3
4
5
Income Statement
Contrib.
+ Capital
Earned
+ Capital -
+50,000
Common
Stock
-
Contra
Equity Revenues
Net
- Expenses = Income
-
=
+70,000
Add’l
Paid-in
Capital
-
+56,000
Treasury
Stock
-
=
+3,000
Add’l
Paid-in
Capital
-
-14,000
Treasury
Stock
-
=
=
-500
Add’l
Paid-in
Capital
-
-7,000
Treasury
Stock
-
=
=
+125,000
Preferred
Stock
-
-
=
+50,000
Add’l
Paid-in
Capital
Cash is increased by the proceeds from the stock sale (10,000 shares  $12 = $120,000). Common Stock is increased by the par
value (10,000 shares  $5) and Additional Paid-in Capital for the balance ($70,000).
Cash is reduced by the cost of the Treasury Stock (4,000 shares  $14 = $56,000). The Treasury Stock account is increased
accordingly. Since this account has a negative balance in stockholders’ equity, contributed capital is reduced.
Cash is increased by the proceeds from the sale of the Treasury Stock (1,000 shares  $17 = $17,000). The Treasury Stock account
is reduced by the original cost of the shares (1,000  $14 = $14,000) and Additional Paid-in Capital is increased for the balance.
Cash is increased by the proceeds from the sale of the Treasury Stock (500 shares  $13 = $6,500). Treasury Stock is reduced by its
original cost (500 shares  $14 = $7,000) and Additional Paid-in Capital is reduced for the balance.
Cash is increased by the proceeds from the sale of the Preferred Stock (5,000 shares  $35 per share = $175,000). Preferred Stock
is increased by its par value (5,000 shares  $25 = $125,000) and Additional Paid-in Capital is increased for the balance ($50,000).
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
b.
1/5
Cash (+A) ...................................................................................
120,000
Common stock (+SE) ................................................................... 50,000
Additional paid-in capital (+SE) ..................................................... 70,000
1/18
Treasury stock (+XSE, -SE) .........................................................
56,000
Cash (-A) ....................................................................................
56,000
3/12
Cash (+A) ...................................................................................
17,000
Treasury stock (-XSE, +SE) ......................................................... 14,000
Additional paid-in capital (+SE) .................................................... 3,000
7/17
Cash (+A) ...................................................................................
6,500
Additional paid-in capital (-SE) .....................................................
500
Treasury stock (-XSE, +SE) .........................................................
10/1
7,000
Cash (+A) ...................................................................................
175,000
Preferred stock (+SE) .................................................................. 125,000
Additional paid-in capital (+SE) .................................................... 50,000
c.
1/5
3/12
7/17
10/1
+
1/18
+ Cash (A)
120,000
17,000
6,500
175,000
-
56,000
1/18
-
Treasury Stock (XSE)
56,000
14,000 3/12
7,000 7/17
Common Stock (SE) +
50,000
1/5
Preferred Stock (SE) +
125,000
10/1
- Additional Paid-in Capital (SE) +
70,000
1/5
7/17
500
3,000
3/12
50,000
10/1
d.
Stockholders’ Equity
Paid-in capital
8% Preferred stock, $25 par value, 50,000 shares authorized,
5,000 Shares issued and outstanding
Common stock, $5 par value, 350,000 shares authorized;
160,000 shares issued; 2,500 shares in treasury
Additional paid-in capital
Paid-in capital in excess of par value—Preferred stock
Paid-in capital in excess of par value—Common stock
Paid-in capital from Treasury stock
Total paid-in capital
Retained earnings
Less: Treasury stock (2,500 shares) at cost
Total stockholders' equity
$125,000
800,000
50,000
670,000
2,500
$ 925,000
722,500
1,647,500
418,500
2,066,000
35,000
$2,031,000
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e. The transactions on January 5 (stock issue), March 12 and July 17 (both treasury
stock sales), and the transaction on October 1 (issued preferred stock) would
decrease basic EPS. The transaction on January 18 (treasury stock purchase)
would increase basic EPS.
P11-58. (30 minutes)
LO 2, 4
a. See explanations in part b below.
Balance Sheet
Transaction
Cash
Asset
Noncash
Liabil+ Assets = ities
Issued
1,000 shares
of preferred
stock.
+62,000
=
Issued
4,000 shares
of common
stock.
+144,000
Issued
2,000 shares
of common
stock.
+60,000
Purchased
2,500 shares
of treasury
stock.
-45,000
Cash
=
Sold 900
shares of
treasury
stock.
+18,900
Cash
=
Issued 500
shares of
preferred
stock.
+29,500
Cash
=
+
Contrib.
Capital
+50,000
Preferred
Stock
Income Statement
Earned
+ Capital -
Contra
Net
Equity Revenues - Expenses = Income
-
-
=
-
-
=
-
-
=
+12,000
Additional
Paid-in
Capital
=
Cash
+80,000
Common
Stock
+64,000
Additional
Paid-in
Capital
=
Cash
+20,000
Common
Stock
+40,000
Additional
Paid-in
Capital
-
+45,000
Treasury
Stock
-
=
+2,700
Additional
Paid-in
Capital
-
-16,200
Treasury
Stock
-
=
+25,000
Preferred
Stock
-
-
=
+4,500
Additional
Paid-in
Capital
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
b.
1/15
Cash (+A) ...................................................................................
62,000
Preferred stock (+SE) .................................................................. 50,000
Additional paid-in capital (+SE) ..................................................... 12,000
Cash is increased by the proceeds from the sale of the Preferred Stock (1,000 shares  $62 per
share = $62,000). The Preferred Stock account is increased for its par value (1,000 shares  $50 par
= $50,000) and Additional Paid-in Capital is increased for the balance ($12,000).
1/20
Cash (+A) ...................................................................................
144,000
Common stock (+SE) ................................................................... 80,000
Additional paid-in capital (+SE) ..................................................... 64,000
Cash is increased by the proceeds from the sale of the Common Stock (4,000 shares  $36 =
$144,000). Common Stock is increased by its par value (4,000  $20 = $80,000) and Additional Paidin Capital is increased for the remainder ($64,000).
5/18
6/1
No entry is required for the 2-for-1 stock split
Cash (+A) ...................................................................................
60,000
Common stock (+SE) .................................................................. 20,000
Additional paid-in capital (+SE) ..................................................... 40,000
Common Stock is increased by its par value (2,000  $10 = $20,000) and Additional Paid-in Capital is
increased for the balance ($40,000).
9/1
Treasury stock (+XSE, -SE) .........................................................
45,000
Cash (-A) ...................................................................................
45,000
Cash is reduced by the cost of the Treasury Stock (2,500 shares  $18 per share = $45,000). The
Treasury Stock account is increased by its cost, thereby reducing contributed capital.
10/12 Cash (+A) ...................................................................................
18,900
Treasury stock (-XSE, +SE) ......................................................... 16,200
Additional paid-in capital (+SE) .................................................... 2,700
Cash is increased by the proceeds from the sale of the Treasury Stock (900  $21 = $18,900). The
Treasury Stock account is reduced by its cost (900  $18 = $16,200), thereby increasing contributed
capital, and Additional Paid-in Capital is increased by the balance ($2,700).
12/22 Cash (+A) ...................................................................................
29,500
Preferred stock (+SE) .................................................................. 25,000
Additional paid-in capital (+SE) ..................................................... 4,500
Cash is increased by the proceeds from the sale of the preferred shares (500  $59 = $29,500). The
Preferred Stock account is increased for its par value (500 shares  $50 = $25,000) and Additional
Paid-in Capital is increased for the balance ($4,500).
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c.
+ Cash (A)
62,000
144,000
60,000
1/15
1/20
6/1
-
45,000
10/12
12/22
9/1
18,900
29,500
+
9/1
-
Treasury Stock (XSE)
45,000
16,200
10/12
-
Common Stock (SE) +
80,000
20,000
1/20
6/1
Preferred Stock (SE) +
50,000
1/15
25,000 12/22
- Additional Paid-in Capital (SE) +
12,000
1/15
64,000
1/20
40,000
6/1
2,700 10/12
4,500 12/22
P11-59. (50 minutes)
LO 1, 2, 5, 6, 7
a. 2018: 4,009.2 – 1,511.2 = 2,498 million 2017: 4,009.2 – 1,455.9 = 2,553.3 million
Estimated average shares outstanding: ($9,750 - $265)/$3.75 = 2,529.33 million.
Average shares outstanding is slightly greater than the number of shares
outstanding at year-end because P&G has more shares in treasury stock at the end
of 2018 than at the end of 2017. Meaning, P&G repurchases shares during the year.
b. 2018: $99,217/1,511.2 = $65.65
2017: $93,715/1,455.9 = $64.37
c.
Preferred stock (-SE) ………………………………………
39
Additional paid-in capital (+SE) .............................................
Treasury stock (-XSE, +SE) .........................................................
6
33
The reported value for preferred stock includes additional paid-in capital. This fact
can be discerned by noting that 600 million of class A preferred shares are
authorized and if all 600 million shares were issued, the stated value of $1 per share
would yield $600 million of preferred stock. But if the $967 million is assumed to be
the stated value, the number of issued shares exceeds the number authorized.
Therefore, the $967million figure must include additional paid-in capital and the
additional paid-in capital account refers only to common stock.
d. P&G’s diluted EPS reflects the effects of convertible preferred stock and, most likely,
outstanding stock options and other equity-based pay.
e. 2018 ($millions): ($9,750 - $265) / [($52,293-$967+$55,184-$1,006)/2] = 0.18 or
18%
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
P11-60. (50 minutes)
LO 5, 7
a. Class A and B common shares are identical except for voting rights. Class A shares
have 1 vote per share while class B shares have 10 votes per share. This means
that class B shareholders have greater control in the governance of the corporation.
Presumably, class B shares were retained by the original management team of the
firm when the class A shares were offered.
Class C capital shares have no voting rights at all, though they participate in any
dividends declared for common shares. Class C shares allow Alphabet executives
to continue using shares to make acquisitions and motivate employees, while
ensuring that the Class B shares retain more than 50% of the voting power.
b. Retained Earnings
Capital Stock
Cash
8,499
576
9,075 (millions)
c. RSUs vest over 4 years.
The fair value of the RSUs at grant date = 12,669,251 shares x $1,095.89 average FV
per share = $13,884,105,478.
Assume pro-rate vesting: $13,884,105,478/4 = $3,471,026,370
Compensation expense (+E, -SE)
Paid-in Capital – Restricted Stock (+SE)
3,471,026,370
3,471,026,370
This entry would reduce Alphabets’ income before tax by $3,471,026,370.
d. This cost is related to RSUs that are granted but not vested and not yet recorded as
compensation cost yet (the cost related to the latter part of the vesting period that
has not occurred yet). The unrecognized compensation cost related to unvested
employee RSUs is not a liability because Alphabet has not incurred the cost yet —
the employees have not worked yet. In addition, the amount is recorded as an
increase to equity (not an increase in liabilities) when the compensation expense is
recorded because the company is issuing equity shares to the employees.
e. $30,736 million / $44.22 = 695 million shares.
Alphabet had 694.8 million shares outstanding at the end of 2017 and 695.6 million
shares outstanding at the end of 2018.
©Cambridge Business Publishers, 2020
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f. If all outstanding stock options were exercised, basic EPS would decrease. Assume
Alphabet had 15.0 million options outstanding at the end of 2018. If all of these
options had been exercised and added to shares outstanding, basic EPS would
have been $30,736 / (695 + 15.0) = $43.29 per share (compared to $44.22).
g. The diluted EPS figure includes an adjustment only for outstanding options that are
not “under water,” i.e., are anti-dilutive. But this would cause the diluted EPS to be
higher than the amount calculated in part f. The difference is due to the fact that
Google has stock-based compensation besides stock options, like restricted stock
units.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
CASES and PROJECTS
C11-61. (30 minutes)
LO 7
a. Mandatorily redeemable means that the issuing company can decide to repurchase
all of the remaining shares that have not been converted before the redemption date
specified in the preferred issue contract. Prior to that date, holders of the preferred
shares can convert their shares to common stock. Northrop Grumman preferred
holders converted most of their shares and the rest were redeemed by the company.
“Convertible” means that the preferred stock can be exchanged for common stock.
Usually this option rests with the holder of the preferred stock. Sometimes,
companies retain an option to force the conversion. Northrop Grumman did so. This
option is spelled out in the preferred stock contract. The issue may also include a
“liquidation preference”, which would indicate the amount that will be paid to the
preferred shareholders in the event that the company fails. This amount must be
paid in full before the common shareholders can be paid anything in the event of the
liquidation of the company.
b. $350 million/$3.5 million = $100
c. The conversion option has increased substantially in value since issue. This
increase is likely due to an expected new government contract most likely for an
aircraft.
d. The answer depends on whether the remaining preferred shares are redeemed for
cash or converted into common shares. If Northrop Grumman pays for the
conversion in cash, cash is reduced, as is preferred stock. If converted into common,
the preferred stock is removed from the balance sheet and the common stock is
“sold” for the book value of the preferred; that is, the par value and additional paid-in
capital accounts increase as if the common were sold for the book value of the
preferred.
e. Outstanding convertible preferred shares need to be considered in our analysis of
the company, as the potential shares to be issued represent a contingent claim to
the future cash flows of the company. Convertible preferred shares are considered in
the computation of diluted EPS, which assumes conversion at the earliest possible
opportunity. The forgone preferred dividends are removed from (added back to) the
numerator, and the additional shares issued are added to the denominator. The net
effect is a reduction in the diluted EPS over basic EPS.
©Cambridge Business Publishers, 2020
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C11-62. (15 minutes)
LO 1, 2
King’s responsibility is to the shareholders of Image, Inc. Hatcher’s offer is beneficial to
the shareholders, so, in theory, King should support Hatcher’s efforts. However, since it
is likely that King and other managers will lose their jobs if Hatcher’s takeover attempt is
successful, King’s inclination may be to resist Hatcher’s move.
It would be unethical to pay Hatcher 50% above current market price to repurchase his
stock. This would harm the remaining shareholders in two ways. First, blocking the
takeover would deprive shareholders of the opportunity to sell their shares at a price
that is substantially higher than current market price. Second, King would be using
company funds to purchase Hatcher’s stock, so the other shareholders are essentially
paying for King’s job security.
A tactic that would be ethical and beneficial to shareholders is for King, along with other
managers and directors, to make a competing offer to shareholders for the outstanding
stock. In that way, shareholders benefit by receiving the higher stock price (whether
from King or Hatcher) and if King acquires the company, he keeps his job.
C11-63. (30 minutes)
LO 1, 3
a. There are no cash proceeds from the stock dividend.
b. 2018: $9,450,000 / 250,000 = $37.80 per share
2019: $10,285,000 / 275,000 = $37.40 per share
c. Because of the stock dividend, the number of shares you own increased by 10% to
8,250 in 2019. Your percentage ownership in Pillar has remained the same. The
market value of your shares at the end of 2019 is $214,500 (8,250 x $26). At December
14, just prior to the stock dividend, your shares were worth $210,000 (7,500 x $28).
d. Stock dividends, like stock splits, do not increase the book value of stockholders’
equity. Stock dividends are paid to indicate a continued expectation of earnings and
earnings growth in periods when cash must be maintained for investment needs.
Stock dividends also serve to keep the per share price of the stock at manageable
levels during growth periods.
e. Retained earnings are restricted as to the amount of cash dividends that Pillar can
pay. Except for this restriction, paying a cash dividend then allowing shareholders to
purchase additional shares would have accomplished the same thing as a stock
dividend. However, some of the shareholders may have chosen not to purchase the
additional shares. If this had happened, the company would have to make a public
offering in order to raise the required cash. A public offer that is this small is not
economical.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
f. The dividend cut is due to the restrictions on retained earnings and the amount of
cash needed to fund the plant addition.
g. Retained earnings are not the same as cash. The company is borrowing $500,000
cash because that is how much additional cash will be needed to build the plant
addition. The restriction on retained earnings simply prevents the company from
using available cash to pay cash dividends.
C11-64. (20 minutes)
LO 2, 3, 6
The projected 5% decline in net income will reduce net income from $7,800,000 last
year to $7,410,000 this year. The proposed stock buyback of 600,000 shares at
midyear would reduce the weighted average shares outstanding from 4,000,000 to
3,700,000 (4,000,000 x 6/12 + 3,400,000 x 6/12). The resulting earnings per share
would be $7,410,000 / 3,700,000 = $2.00 per share.
Plummer is likely concerned about the proposal because the stock repurchase appears
to manipulate EPS in order to achieve the goal of increasing EPS each year, earning
management a nice bonus. This raises ethical concerns, since the cash might be better
used to make profitable investments or pay a cash dividend to shareholders.
A less obvious question is why Sunlight has so much “excess cash?” If the cash that
would be used to repurchase stock (600,000 shares x market price per share) were
invested in a profitable investment, management may be able to make up for the
expected decline in earnings. It would be hard to believe that no profitable investment
opportunities exist. Even a short-term investment in marketable securities might make
up for the $390,000 decrease in earnings.
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C11-65. (20 minutes)
LO 2, 7
a. The shares were listed in the mezzanine section of the balance sheet – between
liabilities and equity. The preferred stock was contingently convertible – the shares
were potentially redeemable upon the occurrence of events outside the control of the
issuer.
b. $3,000 million. ($43.775848 x $68,530,939 shares)
c. $547 million ($3,297 - ($3,000 - $250)). This amount was recorded as a reduction in
income.
d. Answers may vary here. FASB requires that these shares be in the mezzanine
section of the balance sheet, meaning that they have characteristics of both debt
and equity. Some idicia that one might consider them more debt-like are that 1) they
are not convertible into common shares, and 2) the company increased the carrying
value to the redemption value in 2014. Another indicator – though only known after
the redemption - is that the company funded the redemption by issuing debt.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
Chapter 12
Reporting and Analyzing
Financial Investments
Learning Objectives – coverage by question
MiniExercises
Exercises
Problems
Cases
and Projects
LO1 – Explain and interpret the three
levels of investor influence over an
investee – passive, significant, and
controlling.
11
24, 25, 27,
32, 33
35 - 38
45, 47, 48
49 - 52
LO2 – Describe the term “fair value”
and the fair value hierarchy.
14
37
45, 47
51, 52
LO3 – Describe and analyze
accounting for passive investments.
12, 13,
20, 21, 22
24, 25, 27,
29, 32, 33,
35 - 37
45, 47
49 - 52
LO4 – Explain and analyze
accounting for investments with
significant influence.
15, 16, 19
30 - 32,
37, 38
47, 48
50 - 52
LO5 – Describe and analyze
accounting for investments with
control.
17,18,19, 23
26, 28, 34,
41, 42
46, 48
51
LO6 – Appendix 12A – Illustrate and
analyze accounting mechanics for
equity method investments.
43
48
LO7 – Appendix 12B – Apply
consolidation accounting mechanics.
39, 40, 42
46, 48
LO8 – Appendix 12C – Discuss the
reporting of derivative securities.
44
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QUESTIONS
Q12-1. (a) Trading securities are reported at their fair value in the balance sheet. (b)
Available-for-sale securities are reported at their fair value in the balance sheet.
(c) Held-to-maturity securities are reported at their amortized cost in the
balance sheet.
Q12-2. An unrealized holding gain (loss) is an increase (decrease) in the fair value of
an asset (in this case, an investment security) that is still owned. Investments
in equity securities should be reported at their fair value on the balance sheet,
with unrealized holding gains and losses reported in income in the period that
they occur. There is a provision for non-marketable securities to use when the
cost of estimating fair value is prohibitively expensive.
Q12-3. Unrealized holding gains and losses related to trading securities are reported in
the current-year income statement (and also retained earnings). Unrealized
holding gains and losses related to available-for-sale securities are reported as
a separate component of stockholders' equity called Other Comprehensive
Income (OCI).
Q12-4. Significant influence gives the owner of the stock the ability to significantly
influence the operating and financing activities of the company whose stock is
owned. Normally, this is accomplished with a 20% through 50% ownership of
the company's voting stock.
The equity method is used to account for investments with significant influence.
Such an investment is initially recorded at cost; the investment is increased by
the proportionate share of the investee company's net income, and equity
income is reported in the income statement; the investment account is
decreased by dividends received on the investment; and the investment
account is reported in the balance sheet at its book value. Unrealized
appreciation in the market value of the investment is not recognized.
Q12-5. Yetman Company's investment in Livnat Company is an investment with
significant influence, and should, therefore, be accounted for using the equity
method. At year-end, the investment should be reported in the balance sheet at
$258,000 [$250,000 + (40%  $80,000) - (40% x $60,000)].
Q12-6. A stock investment representing more than 50% of the investee company's
voting stock is generally viewed as conferring “control” over the investee
company. The investor and investee companies must be consolidated for
financial reporting purposes.
Q12-7. Consolidated financial statements attempt to portray the financial position,
operating results, and cash flows of affiliated companies as a single economic
unit so that the scope of the entire (whole) entity is more realistically conveyed.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
Q12-8. The $750,000 investment in Murray Company appearing in Finn Company's
balance sheet and the $300,000 common stock and $450,000 retained
earnings appearing on Murray Company's balance sheet are eliminated. The
two balance sheets (less the accounts eliminated) are then summed to yield the
consolidated balance sheet.
Q12-9.B The $75,000 accounts payable on Dee's balance sheet and the $75,000
accounts receivable on Bradshaw's balance sheet are eliminated. In a
consolidation, all intercompany items are eliminated so that the consolidated
statements show only the interests of outsiders.
Q12-10. Limitations of consolidated statements include the possibility that the
performances of poor companies in a group are "masked" in consolidation.
Likewise, rates of return, other ratios, and percentages calculated from
consolidated statements might prove deceptive because they are composites.
Consolidated statements also eliminate detail about product lines, divisional
operations, and the relative profitability of various business segments. (Some of
this information is likely to be available in the footnote disclosures relating to the
business segments of certain public firms.) Finally, shareholders and creditors
of subsidiary companies find it difficult to isolate amounts related to their legal
rights by inspecting only consolidated statements.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-269
MINI EXERCISES
M12-11. (10 minutes)
LO 1
a. SI
Griffin owns > 20% of Wright.
b. P
Bond investments are always classified as passive.
c. P
2,000 shares of Google is well below the number necessary to exert
influence
d. C
Watts owns more than half of Zimmerman stock
e. SI
Even though Shevlin owns less than 20% of Bowen, the fact that it buys
60% of Bowen’s output means it is capable of exercising significant
influence.
M12-12. (10 minutes)
LO 3
a. Available-for-sale securities are reported at fair value on the balance sheet. For
2018, this is equal to the original cost ($37,512 million) plus unrecognized gains ($44
million) and less unrealized losses ($547 million), or $37,009 million.
b. Unrealized gains (and losses) on available-for-sale securities are reported as a
component of Accumulated Other Comprehensive Income (AOCI) in the
shareholders’ equity section of the balance sheet.
M12-13. (15 minutes)
LO 3
Investments in equity securities must be reported at fair value, with all gains and losses
(realized and unrealized) recognized in income. Wasley will report $6,600 of dividend
income plus income relating to the increase in the market price of the stock of $6,000
($13 - $12 price increase for 6,000 shares). Total investment income is $12,600.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
M12-14. (10 minutes)
LO 2
a. All of these investments are marked to fair value, but the determination differs. Level
1 fair values are determined by reference to an active market where identical assets
are traded. Level 2 fair values are determined by using a model (discounted cash
flow, prices of similar assets, etc.) for which the inputs and assumptions can be found
from observable value. Level 3 fair values are also determined by using a model, but
the inputs and assumptions are not observable except to the reporting company.
b. All are marked-to-fair-value, but only Level 1 investments are marked-to-market, the
others are marked-to-model. Level 1 values would be the most objective since they
come from an active market. Level 3 would be most subjective because they depend
significantly on management’s judgments.
c. Level 1 assets are most liquid, because they are traded in active markets. Level 3
assets are likely to be least liquid because their value depends significantly on
information that is not publicly available.
M12-15. (20 minutes)
LO 4
a. Given the 30% ownership, “significant influence” is presumed and the investment
must be accounted for using the equity method. The year-end balance of the
investment account is computed as follows:
Beginning balance .......................
% Lang income earned ................
% Dividends received ..................
Ending balance ............................
$1,000,000
30,000
(12,000)
$1,018,000
($100,000  0.3)
($40,000  0.3)
b. $30,000 ($100,000  0.3) - Equity earnings are computed as the reported net income
of the investee (Lang Company) multiplied by the percentage of the outstanding
common stock owned.
c. (1) In contrast to the market method, the equity method of accounting does not report
investments at market value. The unrealized gain of $200,000 is not reflected in
either the balance sheet or the income statement.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-271
d.
1.
Investment in Lang Company (+A) ...................................................
1,000,000
Cash (-A) .......................................................................................... 1,000,000
2.
Investment in Lang Company (+A) ...................................................
30,000
Investment income (+R, +SE) ..........................................................
30,000
Cash (+A) .........................................................................................
12,000
Investment in Lang Company (-A) ....................................................
12,000
3.
e.
+
3.
+
1.
2.
Cash (A)
1,000,000
12,000
1.
Investment in Lang Company (A)
1,000,000
30,000
12,000
Investment Income (R)
30,000
+
2.
-
3.
f.
Transaction
Purchase
stock in Lang
Company.
Cash
Asset
-1,000,000
Cash
Recognize
share of Lang
income.
Receive
dividend from
Lang.
+12,000
Cash
+
Noncash
Assets
Balance Sheet
LiabilContrib.
=
ities
+ Capital +
+1,000,000
Investment
=
+30,000
Investment
=
-12,000
Investment
=
Income Statement
Earned
Capital
+30,000
Retained
Earnings
Revenues
+30,000
Investment
Income
-
Expenses
Net
= Income
-
=
-
= +30,000
-
=
©Cambridge Business Publishers, 2020
1-272
Financial Accounting, 6th Edition
M12-16. (10 minutes)
LO 4
Equity income on this investment is computed as the investee company (Penno)
earnings multiplied by the percentage of the company owned. In this case, equity
earnings equal:
$600,000  40% = $240,000
Note that dividends are treated as a return of investment (reduce the investment
balance by $80,000, computed as $200,000  40%), and not as income. Also, the
investment is recorded at adjusted cost, not at market value, and unrealized gains
(losses) are neither recognized on the balance sheet nor in the income statement.
M12-17. (10 minutes)
LO 5
The $600,000 investment in Hirst Company appearing on Philipich Company's balance
sheet and the $300,000 common stock and $450,000 retained earnings of Hirst
Company would be eliminated.
In addition, a $150,000 noncontrolling interest [20% of ($300,000 + $450,000)] would
appear on the consolidated balance sheet as part of shareholders equity.
M12-18. (10 minutes)
LO 5
Benartzi Company consolidated net income ..............................
less net income attributable to noncontrolling interests..............
Net income attributable to Benartzi Company shareholders ......
$750,000
15,000
$735,000
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
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M12-19. (20 minutes)
LO 4, 5
a. If DeFond purchases 100% of Verduzco’s common stock, then it must produce
consolidated reports.
Current assets
DeFond
Company
DeFond
Company
(before investment)
(after investment)
Verduzco
Company
Eliminating
Entries
DeFond
Company
(Consolidated)
$ 800
$ 500
$ 100
–
300
–
Noncurrent assets
2,000
2,000
900
2,900
Liabilities
2,200
2,200
700
2,900
600
600
300
Investment
Shareholders’ Equity
$ 600
–
(300)
(300)
600
b. If DeFond purchases 50% of the common stock of Lin Company, it uses the equity
method.
DeFond Company
DeFond Company
(before investment)
(after investment)
Lin
Company
$ 800
$ 500
$ 200
–
300
–
Noncurrent assets
2,000
2,000
1,800
Liabilities
2,200
2,200
1,400
600
600
600
Current assets
Investment
Shareholders’ Equity
c. If we compare DeFond’s consolidated balance sheet to the equity method balance
sheet, we can see that the total assets are higher and the liabilities are higher.
DeFond’s stockholders’ equity accounts are the same. So, the Debt-to-Equity ratio
will be higher if DeFond purchases the subsidiary rather than investing in the joint
venture. If reported profits are the same under either scenario, then purchasing the
subsidiary would produce a lower Return on Assets than the joint venture. Other
ratios would change as well (like the Current Ratio), but not in a predictable
direction.
©Cambridge Business Publishers, 2020
1-274
Financial Accounting, 6th Edition
M12-20. (40 minutes)
LO 3
a. 2018
10/1
Investment in Skyline, Inc. (+A) ........................................................
486,000
Cash (-A) ....................................................................................486,000
12/31 Interest receivable (+A) .....................................................................
8,750
Interest revenue (+R, +SE) .........................................................
8,750
12/31 Investment in Skyline, Inc. (+A) ........................................................
4,000
Unrealized gain (+R, +SE) ..........................................................
4,000
2019
3/31
4/1
Cash (+A) ........................................................................................
17,500
Interest receivable (-A) ...............................................................
Interest revenue (+R, +SE) ........................................................
8,750
8,750
Cash (+A) ........................................................................................
492,300
Realized gain (+R, +SE) .............................................................
2,300
Investment in Skyline, Inc. (-A) ................................................... 490,000
b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of $4,000 in Skyline
Inc. bonds is closed to retained earnings in 2018 increasing net income and retained
earnings.
+
-
Interest Revenue (R)
8,750
8,750
+
12/31/18
3/31/19
+
Investment in Skyline Bonds (A)
10/1/18
486,000
12/31/18
4,000
490,000
4/1/19
-
Unrealized Gain (R)
4,000
+
12/31/18
+
12/31/19
-
Realized Gain (R)
2,300
3/31/19
4/1/19
Cash (A)
486,000
10/1/18
17,500
492,300
Interest Receivable (A)
8,750
8,750
3/31/19
+
4/1/19
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-275
c.
Transaction
10/1/18
Purchase
$500,000 of
Skyline bonds
at 97.
Cash
Asset
-486,000
Cash
+
Noncash
Assets
Balance Sheet
Liabil= ities
+
+ 486,000
Investment
=
12/31/18
Recognize
interest
revenue.
+8,750
Interest
Receivable
=
12/31/18
Record
unrealized
gain.
+4,000
Investment
=
3/31/19
Recognize
interest
income.
+17,500
Cash
4/1/19
Sold Skyline
investment.
+492,300
Cash
-8,750
=
Interest
Receivable
-490,000
Investment
=
Income Statement
Contrib.
Capital +
Earned
Capital
Revenues
-
Expenses
=
Net
Income
-
=
-
=
+8,750
+4,000
Unrealized
Gain
=
+4,000
+8,750
Retained
Earnings
+8,750
Interest
Revenue
-
=
+8,750
+2,300
Retained
Earnings
+2,300
Realized
Gain
-
=
+2,300
+8,750
Retained
Earnings
+4,000
Retained
Earnings
+8,750
Interest
Revenue
M12-21. (40 minutes)
LO 3
a. 2018
11/15 Investment in Lane, Inc. (+A) ..................................................
171,200
Cash (-A) ................................................................................
171,200
12/22 Cash (+A) ...............................................................................10,000
Dividend income (+R, +SE) ....................................................
10,000
12/31 Unrealized loss (+E, -SE) .......................................................16,200
Investment in Lane, Inc. (-A) ..................................................
16,200
2019
1/20
Cash (+A) .........................................................................................
150,000
Loss on sale of investment in Lane, Inc. (+E, -SE) ...........................
5,000
Investment in Lane, Inc. (-A) .............................................................
155,000
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
b. Assuming the firm’s fiscal year ends 12/31, the unrealized loss of $16,200 is closed to
the income summary in 2018, reducing net income and retained earnings.
+ Cash (A) 10,000 171,200
150,000
12/22
1/20
11/15
11/15
+ Investment in Lane Inc (A) 171,200
16,200
155,000
+
1/20
+
12/31
Unrealized Loss (E)
16,200
-
Loss (E)
5,000
12/31
1/20
-
- Dividend Income (R) +
10,000
12/22
c.
Balance Sheet
Transaction
Cash
Asset
11/15
Purchase
10,000 shares
of Lane Inc
common.
-171,200
Cash
12/22
Dividend
income.
+10,000
Cash
12/31
Decrease in
Investment.
1/20
Sale of Lane
common.
+
Noncash
Assets
+171,200
Investment
Contrib.
+ Capital +
Income Statement
Earned
Capital
Revenues
-
Expenses
=
=
-16,200
Investment
+150,000
Cash
Liabil
= -ities
=
-155,000 =
Investment
Net
= Income
=
+10,000
Retained
Earnings
-16,200
Retained
Earnings
-5,000
Retained
Earnings
+10,000
Dividend
Income
= +10,000
+16,200
Unrealized
Loss
+5,000
Realized
Loss
= -16,200
=
-5,000
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-277
M12-22. (30 minutes)
LO 3
The main effect is to defer the gain in value experienced in 2018 to the year 2019.
a. 2018
10/1 Investment in Skyline, Inc. (+A) ........................................................
486,000
Cash (-A) ....................................................................................486,000
12/31 Interest receivable (+A) .....................................................................
8,750
Interest revenue (+R, +SE) .........................................................
8,750
12/31 Investment in Skyline, Inc. (+A) ........................................................
4,000
Unrealized gain AOCI (+SE) .......................................................
4,000
2019
3/31
4/1
Cash (+A) ........................................................................................
17,500
Interest receivable (-A) ...............................................................
Interest revenue (+R, +SE) ........................................................
8,750
8,750
Cash (+A) ........................................................................................
492,300
Unrealized gain – AOCI (-SE)
4,000
Realized gain (+R, +SE) .............................................................
6,300
Investment in Skyline, Inc. (-A) ................................................... 490,000
b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of $4,000 in Skyline
Inc. bonds is closed to retained earnings in 2018 increasing net income and retained
earnings.
+
3/31/19
4/1/19
Cash (A)
486,000
10/1/18
17,500
492,300
+
Investment in Skyline Bonds (A)
10/1/18
486,000
12/31/18
4,000
490,000
4/1/19
+
12/31/19
Interest Receivable (A)
8,750
8,750
3/31/19
-
Interest Revenue (R)
8,750
8,750
+
12/31/18
3/31/19
Unrealized Gain (AOCI)
+
4,000 12/31/18
4,000
4/1/19
-
Realized Gain (R)
6,300
+
4/1/19
Note that most of the gain occurred in 2018, but was not recognized on the income
statement until management decided to sell the securities in 2019.
©Cambridge Business Publishers, 2020
1-278
Financial Accounting, 6th Edition
c.
Transaction
10/1/18
Purchase
$500,000 of
Skyline bonds
at 97.
Cash
Asset
-486,000
Cash
+
Noncash
Assets
Balance Sheet
Liabil= ities
+
Income Statement
Contrib.
Capital +
Earned
Capital
+ 486,000
Investment
=
12/31/18
Recognize
interest
revenue.
+8,750
Interest
Receivable
=
+8,750
Retained
Earnings
12/31/18
Record
unrealized
gain.
+4,000
Investment
=
+4,000
Unrealized
Gain-AOCI
3/31/19
Recognize
interest
income.
+17,500
Cash
4/1/19
Sold Skyline
investment.
+492,300
Cash
-8,750
=
Interest
Receivable
-490,000
Investment
=
Revenues
+8,750
Interest
Revenue
-
Expenses
=
-
=
-
=
-
=
Net
Income
+8,750
Retained
Earnings
+8,750
Interest
Revenue
-
=
+8,750
+6,300
Retained
Earnings
+6,300
Realized
Gain
-
=
+6,300
-4,000
Unrealized
Gain-AOCI
M12-23. (10 minutes)
LO 5
Halen Inc. now owns all of Jolson. The company reports will be consolidated. The total
in the consolidated stockholder’s equity section on 1/1 is the stockholders’ equity
section of the parent company, determined as follows:
Common stock
Retained earnings
Total Equity
$600,000
310,000
$910,000
Jolson’s equity accounts are eliminated in the consolidation process.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
+8,750
1-279
EXERCISES
E12-24. (30 minutes)
LO 1, 3
a. Trading securities
1.
Investment in US Treasury bonds (+A) ........................................
407,000
Cash (-A) ...................................................................................... 407,000
2.
Cash (+A) .....................................................................................
8,000
Interest income (+R, +SE) ............................................................
8,000
Investment in US Treasury bonds .................................................
4,000
Unrealized holding gain (+R, +SE) ...............................................
4,000
3.
4a. Cash (+A) .....................................................................................
8,000
Interest income (+R, +SE) .............................................................
8,000
4b. Cash (+A) .....................................................................................
408,000
Realized loss on sale of investment (+E, -SE) ..............................
3,000
Investment in US Treasury bonds (-A) ..........................................411,000
b.
+ Cash (A) 8,000 407,000
8,000
408,000
2.
4a.
4b
+
3.
Unrealized Gain (R) 4,000
1.
1.
3.
4b.
+ Investment in Liu (A) 407,000
4,000
411,000
4b.
- Interest Income (R) +
8,000
8,000
2.
4a.
+ Realized Loss on Sale (E) 3,000
©Cambridge Business Publishers, 2020
1-280
Financial Accounting, 6th Edition
c.
Balance Sheet
Transaction
Cash
Asset
1. Purchase bonds for
$407,000
-407,000
Cash
2. Receive interest
payment of $8,000
+8,000
Cash
3. Year-end market
price of bonds is
$411,000
4a. Receive interest
payment of $8,000
4b. Sell bonds for
$408,000
+
Noncash
Assets
Contrib.
+ Capital +
Income Statement
Earned
Capital
Revenues
- Expenses =
+407,000 =
Investment
Net
Income
=
=
+8,000
Retained
Earnings
+8,000
Interest
Income
=
+8,000
+4,000 =
Investment
+4,000
Retained
Earnings
+4,000
Unrealized
Holding
Gain
=
+4,000
=
+8,000
Retained
Earnings
+8,000
Interest
Income
=
+8,000
-411,000 =
Investment
-3,000
Retained
Earnings
=
-3,000
+8,000
Cash
+408,000
Cash
Liabil= ities
+3,000
Realized
Holding
Loss
d. Available-for-Sale Securities
1.
2.
Investment in US Treasury bonds (+A)
Cash (-A)
407,000
407,000
Cash (+A)
8,000
Interest income (+R, +SE)
3.
8,000
Investment in US Treasury bonds
Unrealized holding gain - AOCI (+SE)
4a. Cash (+A)
4,000
4,000
8,000
Interest income (+R, +SE)
8,000
4b. Cash (+A)
Unrealized holding gain – AOCI (-SE)
Investment in US Treasury bonds (-A)
Realized holding gain (+R, +SE)
408,000
4,000
411,000
1,000
continued next page
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-281
d. continued
+ Cash (A) 8,000 407,000
8,000
408,000
2.
4a.
4b.
4b.
1.
- Unrealized Gain AOCI (SE) +
4,000
4,000
Transaction
Cash
Asset
1. Purchase bonds -407,000
for $407,000
Cash
2. Receive interest
payment of
$8,000
4b. Sell bonds for
$408,000
Balance Sheet
LiabilContrib.
=
ities
+ Capital +
=
+4,000
=
Investment
+8,000
Cash
+408,000
Cash
3.
+ Investment in Liu (A) 407,000
4,000
411,000
4b.
- Interest Income (R) +
8,000
8,000
2.
4a.
- Realized Gain (R) +
1,000
=
-411,000 =
Investment
4b.
Income Statement
Earned
Capital
Revenues
+407,000 =
Investment
+8,000
Cash
3. Year-end market
price of bonds is
$411,000
4a. Receive
interest
payment of
$8,000
+
Noncash
Assets
1.
3.
-
Expenses =
Net
Income
=
+8,000
Retained
Earnings
+8,000
Interest
Income
+4,000
AOCI
+8,000
Retained
Earnings
+1,000
Retained
Earnings
-4,000
AOCI
=
+8,000
=
+8,000
Interest
Income
=
+8,000
+1,000
Realized
Holding
Gain
=
+1,000
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E12-25. (30 minutes)
LO 1, 3
a. Equity investments measured at fair value, with all gains/losses recognized in
income.
1.
2.
3.
4.
2.
4.
Investment in Freeman, Co. (+A) ............................................80,000
Cash (-A) ................................................................................
80,000
Cash (+A) ............................................................................... 6,250
Dividend income (+R, +SE) ....................................................
6,250
Investment in Freeman, Co. (+A) ............................................ 7,500
Unrealized gain (+R, +SE) ......................................................
7,500
Cash (+A) ...............................................................................86,400
Loss on sale of investment (+E, -SE) ...................................... 1,100
Investment in Freeman, Co. (-A) ...................................
87,500
+ Cash (A) 6,250
80,000
86,400
1.
- Unrealized Gain (R) +
7,500
3.
1.
3.
+ Investment in Freeman (A) 80,000
7,500
87,500
4.
- Dividend Income (R) +
6,250
2.
+ Loss on Sale (E) 1,100
4.
Balance Sheet
Transaction
1. Ohlson Co.
purchases 5,000
common shares
of Freeman Co.
at $16 cash per
share.
2. Ohlson Co.
receives a cash
dividend of
$1.25 per
common share
from Freeman.
3. Year-end market
price of Freeman
common stock is
$17.50 per share.
Cash
Asset
-80,000
Cash
Noncash
+
Assets
+80,000
Investment
+6,250
Cash
4. Ohlson Co. sells
+86,400
all 5,000 common
Cash
shares of Freeman
for $86,400 cash.
Liabil= ities
=
Income Statement
Contrib.
+ Capital +
=
+6,250
Retained
Earnings
+7,500 =
Investment
-87,500
Investment
=
Earned
Capital
+7,500
Retained
Earnings
+
-1,100
Retained
Earnings
Expenses
Net
= Income
=
Revenues
-
+6,250
Dividend
Income
-
= +6,250
+7,500
Unrealized
Gain
-
= +7,500
-
+1,100
Loss
= -1,100
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-283
©Cambridge Business Publishers, 2020
1-284
Financial Accounting, 6th Edition
E12-26. (15 minutes)
LO 5
a. The annual growth rates in revenues are (110,360/96,571)-1 = 14.3% for 2018 and
(96,571/91,154)-1 = 5.9% for 2017. The cumulative average growth rate (CAGR) is
(110,360/91,154)^0.5 - 1 = 10.0%.
b. Microsoft’s acquisition of LinkedIn was completed in December 2016, and it was at
that point that Microsoft began to include LinkedIn’s revenues in its income
statement. Let’s say December 31, 2016 just to be concrete. As a result, 2016’s
revenue included a full year of Microsoft’s revenues, 2017’s revenues included a full
year of Microsoft’s revenues plus a half year of LinkedIn’s revenues, and 2018’s
revenues included a full year of each of Microsoft’s and LinkedIn’ revenues.
As a result, the growth trends over this period intermix the “organic growth” of these
companies with the “acquisition growth.” The former is likely to continue, while the
latter is dependent on acquisitions of other companies.
c. The footnote information provides revenues for 2016 and 2017 as if Microsoft and
LinkedIn had been one organization over this period. That is, the “acquisition
growth” can be set aside to focus on the “organic growth.” In this case, the revised
growth rates would be the following:
The annual growth rates in revenues are (110,360/98,291)-1 = 12.3% for 2018 and
(98,291/94,490)-1 = 4.0% for 2017. The cumulative average growth rate (CAGR) is
((110,360/94,490)^0.5) - 1 = 8.1%. So “acquisition growth” added about 2% to the
growth pattern in reported revenue.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-285
E12-27. (30 minutes)
LO 1, 3
a. 2018
11/1
Investment in Joos, Inc. (+A) .............................................. 306,900
Cash (-A) ............................................................................
306,900
12/31 Interest receivable (+A) ...................................................... 4,500
Interest revenue (+R, +SE) .................................................
4,500
12/31 Unrealized loss (+E, -SE) ................................................... 5,400
Investment in Joos, Inc. (-A) ...............................................
5,400
2019
4/30
5/1
Cash (+A) ........................................................................... 13,500
Interest receivable (-A) .......................................................
Interest revenue (+R, +SE) .................................................
4,500
9,000
Cash (+A) ........................................................................... 300,900
Loss on sale of investments (+E, -SE) ...............................
600
Investment in Joos, Inc. (-A) ................................................
301,500
b.
4/30
5/1
12/31
+ Cash (A) 13,500 306,900
300,900
+ Unrealized Loss (E)
5,400
11/1
11/1
-
- Interest Revenue (R) +
4,500
9,000
12/31
+
12/31
4/30
5/1
+ Investment in Joos Inc. (A) 306,900
5,400
301,500
12/31
5/1
+ Interest Receivable (A) 4,500
4,500
4/30
Loss on Sale of Investments (E) 600
©Cambridge Business Publishers, 2020
1-286
Financial Accounting, 6th Edition
c.
Balance Sheet
Transaction
11/1
Buy $300,000
Joos bonds
@102.
Cash
Asset
-306,900
Cash
+
Noncash
Assets
=
+306,900
Investment
=
12/31
Accrue
interest.
+4,500
Interest
Receivable
=
12/31
Recognize
decline in
value of
bonds.
-5,400
Investment
=
4/30
Receive
interest.
+13,500
Cash
5/1 Sold
Joos bonds.
+300,900
Cash
-4,500
Interest
Receivable
-301,500
Investment
Liabilities
Income Statement
Contrib.
+ Capital +
Earned
Capital
+4,500
Retained
Earnings
Revenues
+4,500
Interest
Revenue
-5,400
Retained
Earnings
=
+9,000
Retained
Earnings
=
-600
Retained
Earnings
+9,000
Interest
Revenue
- Expenses
Net
= Income
-
=
-
=
+4,500
-
+5,400
=
Unrealized
Loss
-5,400
-
=
+9,000
=
-600
-
+600
Loss
E12-28. (10 minutes)
LO 5
Baylor Company now owns 75% of Reed. The company reports will be consolidated. The
total in the consolidated stockholders’ equity section on 1/1 is determined as follows:
Common stock…………………………………………
Retained earnings………………………………….….
Baylor Company shareholders’ equity
Noncontrolling interests
Total equity
900,000
440,000
$1,340,000
200,000
$1,540,000
E12-29. (15 minutes)
LO 3
a. The fixed-maturity (debt) investment portfolio is reported in the balance sheet at its
current fair value of $39,546 million. The cost of the portfolio is $38,085 million, there
are $1,982 million in unrealized gains and $521 million of unrealized losses.
b. Because the fixed-maturity (debt) investments are accounted for as available-for-sale,
unrealized gains (losses) on investments are reported in Accumulated Other
Comprehensive Income (AOCI), rather than current income. The investments are
reported on the balance sheet at current market value on the statement date.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-287
c. Impairment losses are recognized in current income when the securities decline in
market value and the decline is deemed to be other than temporary. Gains and losses
realized from the sale of securities are recognized in current income. A reclassification
adjustment is required in Other Comprehensive Income. Because the gains and
losses from the sale of securities will be recognized in current income (and retained
earnings), they need to be removed from AOCI to avoid double-counting the gains and
losses in stockholders’ equity.
E12-30. (30 minutes)
LO 4
a. 1. Investment in Barth Co. (+A) ............................................................
108,000
Cash (-A) .........................................................................................108,000
2. Cash (+A) .........................................................................................
15,000
Investment in Barth Co. (-A) ............................................................ 15,000
3. Investment in Barth Co. (+A) ............................................................
24,000
Investment income (+R, +SE) .......................................................... 24,000
4. Cash (+A) .........................................................................................
120,500
Gain on sale of investment (+R, +SE) .............................................. 3,500
Investment in Barth Co. (-A) ............................................................117,000
b.
2.
4.
+ Cash (A) 15,000 108,000
120,500
1.
- Gain (R) +
3,500
1.
3.
4.
+ Investment in Barth (A) 108,000
15,000
24,000
117,000
2.
4.
- Investment Income (R) +
24,000
3.
c.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets
=
Liabilities
Income Statement
Contrib.
+ Capital +
Earned
Capital
Revenues
-
Expenses
Net
= Income
1. Buy 30% of
Barth stock.
-108,000
Cash
+108,000
Investment
=
-
=
2. Receive
dividend.
+15,000
Cash
-15,000
Investment
=
-
=
+24,000
Investment
=
+24,000
Retained
Earnings
=
+3,500
Retained
Earnings
3. Recognize
share of net
income of
Barth.
4. Sold Barth
investment.
+120,500
Cash
-117,000
Investment
+24,000 Investment
Income
+3,500
Gain
-
= +24,000
=
+3,500
©Cambridge Business Publishers, 2020
1-288
Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-289
E12-31. (30 minutes)
LO 4
a.
1. Investment in Palepu Co. (+A) ..................................................
120,000
Cash (-A) ..................................................................................
120,000
2. Cash (+A) .................................................................................12,000
Investment in Palepu Co. (-A) ...................................................
12,000
3. Investment in Palepu Co. (+A) ..................................................30,000
Investment income (+R, +SE) ...................................................
30,000
4. Cash (+A) .................................................................................
140,000
Gain on sale of investment (+R, +SE) ......................................
Investment in Palepu Co. (-A) ...................................................
2,000
138,000
b.
2.
4.
+ Cash (A) 12,000 120,000
140,000
1.
- Gain (R) +
2,000
1.
3.
4.
+ Investment in Palepu (A) 120,000
12,000
30,000
138,000
2.
4.
- Investment Income (R) +
30,000
3.
c.
Balance Sheet
Transaction
Cash
Asset
+
Noncash
Assets
=
Liabilities
Income Statement
Contrib.
+ Capital +
Earned
Capital
Revenues
-
Expenses
Net
= Income
1. Buy 25%
of Palepu
stock.
-120,000
Cash
+120,000
Investment
=
-
=
2. Receive
dividend.
+12,000
Cash
-12,000
Investment
=
-
=
+30,000
Investment
=
3. Recognize
share of
net income
of Palepu.
4. Sold
+140,000
Palepu
Cash
investment.
-138,000
Investment
=
+30,000
Retained
Earnings
+2,000
Retained
Earnings
+30,000 Investment
Income
+2,000
Gain
-
= +30,000
=
©Cambridge Business Publishers, 2020
1-290
Financial Accounting, 6th Edition
+2,000
E12-32. (40 minutes)
LO 1, 3, 4
a. 1. Fair Value Method
1.
Investment in Leftwich Co. (+A) ..................................... 150,000
Cash (-A) .......................................................................
150,000
2.
No entry
3.
Cash (+A) .......................................................................
11,000
Dividend income (+R, +SE) ...........................................
11,000
Investment in Leftwich Co. (+A) .....................................
40,000
Unrealized gain (+R, +SE) .............................................
40,000
4.
2.
+ Cash (A) 11,000 150,000
3.
1.
- Unrealized Gain (R) +
40,000
1.
4.
+ Investment in Leftwich (A) 150,000
40,000
-
4.
Dividend Income (R) +
11,000
3.
3.
Balance Sheet
Transaction
1. Purchase
Common
shares.
Cash
Asset
-150,000
Cash
2. No entry.
3. Received
a cash
dividend of
$1.10 per
common
share.
+11,000
Cash
4. Recognize
increase in
investment
value at
year end .
+
Noncash
Assets
=
Liabilities
Contrib.
+ Capital +
Income Statement
Earned
Capital
Revenues
-
Expenses
=
Net
Income
+150,000 =
Investment
-
=
=
-
=
+11,000
Dividend
Income
-
=
+40,000
Unrealized
Gain
-
= +40,000
=
+40,000 =
Investment
+11,000
Retained
Earnings
+40,000
Retained
Earnings
+11,000
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-291
b. 1. Equity Value Method
1. Investment in Leftwich Co. (+A) ................................................................
150,000
Cash (-A) ..................................................................................................
150,000
2. Investment in Leftwich Co. (+A) ................................................................
24,000
Investment income (+R, +SE) ...................................................................
24,000
3. Cash (+A) .................................................................................................
11,000
Investment in Leftwich Co. (-A) .................................................................
11,000
4. No entry
2.
3.
+ Cash (A) 11,000 150,000
1.
1.
2.
+ Investment in Leftwich (A) 150,000
11,000
24,000
3.
- Investment Income (R) +
24,000
2.
3.
Balance Sheet
Transaction
1. Purchase
Common
shares.
Cash
Asset
-150,000
Cash
2. Recognize
30%
portion of
Leftwich
net
income.
3. Received
a cash
dividend of
$1.10 per
common
share.
+11,000
Cash
+
Noncash
Assets
=
+150,000
Investment
=
+24,000
Investment
=
-11,000
Investment
4. No entry.
Liabilities
Contrib.
+ Capital +
Income Statement
Earned
Capital
Revenues
Net
- Expenses = Income
-
=
-
= +24,000
=
-
=
=
-
=
+24,000
Retained
Earnings
+24,000
Investment
Income
©Cambridge Business Publishers, 2020
1-292
Financial Accounting, 6th Edition
E12-33. (15 minutes)
LO 1, 3
a. The amounts reported for all these separately-identifiable assets and liabilities must
be fair values at the date of the acquisition. So, any property, plant and equipment
would be reported at what we would expect to get for it, rather than historical cost.
Any financial liabilities would be estimated at the value required to discharge them at
the date of the acquisition. In the fair value hierarchy, most of these amounts will be
determined using Level 2 or Level 3 approaches.
b. Goodwill is equal to the amount of consideration given for the transaction minus the
fair value of the net assets acquired. Other than goodwill, the asset fair value is
$8,432 million and the fair value of liabilities is $3,970 million. So, the fair value of
separately-identifiable net assets is $4,462 million (= $8,432 million - $3,970 million).
As a result, the goodwill is $9,501 million (= $13,963 million - $4,462 million). This
amount would not be amortized in the future, but Amazon would have to assess its
value annually for impairment. If the goodwill value is impaired, the goodwill asset is
reduced and a charge is recognized in income.
c. Investors are likely to prefer acquisitions of identifiable net assets (even if
intangible), rather than vaguely-defined “synergy effects.” When the acquired
company goes to the highest bidder, there is a real risk that the highest bidder was
the one that most overestimated the potential for future synergies. When purchase
price allocations are disclosed subsequent to the acquisition, stock prices respond
favorably (unfavorably) to the disclosure that less (more) goodwill was acquired
E12-34. (25 minutes)
LO 5
a. The amounts reported for all these separately-identifiable assets and liabilities must
be fair values at the date of the acquisition. So, any inventory would be reported at
what we would expect to get for it, rather than historical cost. Any financial liabilities
would be estimated at the value required to discharge them at the date of the
acquisition. In the fair value hierarchy, most of these amounts will be determined
using Level 2 or Level 3 approaches.
b. Goodwill is equal to the amount of consideration given for the transaction minus the
fair value of the net assets acquired. Other than goodwill, the asset fair value is
$5,079 million and the fair value of liabilities is $487 million. So, the fair value of
separately-identifiable net assets is $4,592 million (= $5,079 million - $487 million).
As a result, the goodwill is $10,283 million (= $14,875 million - $4,592 million). This
amount would not be amortized in the future, but Intel would have to assess its value
annually for impairment. If the goodwill value is impaired, the goodwill asset is
reduced and a charge is recognized in income.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-293
c. Investors are likely to prefer acquisitions of identifiable net assets (even if
intangible), rather than vaguely-defined “synergy effects.” When the acquired
company goes to the highest bidder, there is a real risk that the highest bidder was
the one that most overestimated the potential for future synergies. When purchase
price allocations are disclosed subsequent to the acquisition, stock prices respond
favorably (unfavorably) to the disclosure that less (more) goodwill was acquired.
E12-35. (30 minutes)
LO 1, 3
a. 2019:
11/15 Investment in Core, Inc. (+A) ...............................................
80,900
Cash (-A) ..............................................................................
80,900
12/22 Cash (+A) ............................................................................6,250
Dividend income (+R, +SE) ..................................................
6,250
12/31 Investment in Core, Inc. (+A) ...............................................6,600
Unrealized gain (+R, +SE) ...................................................
6,600
2020:
1/20 Cash (+A) ............................................................................
86,400
Loss on sale of investment (+E, -SE) ..................................1,100
Investment in Core, Inc. (-A) ................................................
87,500
b. Assuming the firm’s fiscal year ends 12/31, the unrealized gain of 6,600 increases
net income and retained earnings in 2019.
12/22/19
1/20/20
+ Cash (A) 6,250
80,900
86,400
11/15/19
11/15/19
12/31/19
+ Investment in Core Inc (A) 80,900
6,600
87,500
1/20/20
+ Loss on Sale of Investment (E)
1/20/20
1,100
-
Unrealized Gain (R)
6,600
+
12/31/19
- Dividend Income (R) +
6,250
-
12/22/19
©Cambridge Business Publishers, 2020
1-294
Financial Accounting, 6th Edition
c.
Balance Sheet
Transaction
Cash
Asset
11/15
Purchase
5,000 shares
of Core Inc
common.
-80,900
Cash
12/22
Dividend
income.
+6,250
Cash
+
12/31
Increase in
Investment.
1/20
Sale of Core
common.
Noncash
Assets
+80,900
Investment
Liabilities
+
Contrib.
Capital +
Earned
Capital
Revenues
Net
- Expenses = Income
=
=
=
+6,600
Investment
+86,400
Cash
=
Income Statement
+6,250
Retained
Earnings
=
+6,600
Retained
Earnings
-87,500
=
Investment
+6,250
Dividend
Income
=
+6,250
+6,600
Unrealized
Gain
=
+6,600
=
-1,100
-1,100
Retained
Earnings
+1,100
Loss
on Sale
E12-36 (30 minutes)
LO 1, 3
a. 2018:
11/15 Investment in Core, Inc. (+A) ...............................................
80,900
Cash (-A) .............................................................................
80,900
12/22 Cash (+A) ............................................................................6,250
Dividend income (+R, +SE) .................................................
6,250
12/31 Investment in Core, Inc. (+A) ...............................................6,600
AOCI (+SE) .........................................................................
6,600
2019:
1/20 Cash (+A) ............................................................................
86,400
AOCI (-SE) ………………………………………………..
1,100
Investment in Core, Inc. (-A) ................................................
87,500
+ Cash (A) 12/22/18
1/20/19
6,250
86,400
1/20/19
AOCI
1,100
80,900
+
6,600
+ Investment in Core Inc (A) 11/15/18
12/31/18
11/15/18
12/31/18
80,900
6,600
87,500
1/20/19
- Dividend Income (R) +
6,250
12/22/18
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-295
Continued next page
©Cambridge Business Publishers, 2020
1-296
Financial Accounting, 6th Edition
a. continued
Transaction
Cash
Asset
11/15
Purchase
5,000 shares
of Core Inc
common.
-80,900
Cash
12/20
Dividend
income.
+6,250
Cash
12/31
Increase in
Investment.
1/20
Sale of Core
common.
+
Noncash
Assets
+80,900
Investment
+6,600
Investment
+86,400
Cash
Balance Sheet
LiabilContrib.
=
ities
+ Capital +
Income Statement
Earned
Capital
Revenues
=
=
+6,250
Retained
Earnings
=
+6,600
AOCI
-87,500
=
Investment
-1,100
AOCI
+6,250
Dividend
Income
Net
- Expenses = Income
-
=
-
=
-
=
-
=
+6,250
b. Some companies complained that marking equity investments to fair value and
reporting fair value changes in the income statement did not fit their business model.
They wanted to make smaller investments in companies with whom they had a
strategic relationship or a continuing interest, but falling short of the significant
influence needed for the equity method. These companies said that they were not
interested in the possible holding gains that they might achieve. So, the IASB
allowed IFRS companies to make an irrevocable choice at the time of investment. If
they chose FVOCI, all holding gains and losses will end up in AOCI and never go
through the income statement.
E12-37. (30 minutes)
LO 1, 2, 3, 4
a. The trading stock investments will be reported at $225,300. This amount is computed
using their market values at year-end; specifically, $65,300 + $160,000, or $225,300.
b. The available-for-sale debt investments will be reported at $346,700. This amount is
computed using their market values at year-end; specifically, $192,000 + 154,700, or
$346,700.
c. The equity method stock investments will be reported at $236,000. This amount is
computed using their equity method value at year-end; specifically, $100,000 +
$136,000, or $236,000.
©Cambridge Business Publishers, 2020
Solutions Manual, Chapter 1
1-297
d. Unrealized holding losses of $5,200 will appear in the 2019 income statement. These
losses relate to the trading securities; specifically— Barth: $68,000 - $65,300 = $2,700;
Foster: $162,500 - $160,000 = $2,500; total of $2,700 + $2,500 = $5,200.
e. Unrealized holding losses of $7,300 will appear in the stockholders' equity section of
the December 31, 2019, balance sheet under other comprehensive income. These
losses relate to the available-for-sale debt securities; specifically— 30-Year Treasury
Bond: $197,000 - $192,000 = $5,000; 10-Year Treasury Note: $157,000 - $154,700 =
$2,300; total of $5,000 + $2,300 = $7,300.
f. A fair value adjustment to investments of $7,300 will appear in the December 31, 2019,
balance sheet. This adjustment relates to the available-for-sale securities. See part (e)
for the supporting computations. The fair value adjustment decreases the book value
of the available-for-sale securities to their year-end market value.
E12-38. (30 minutes)
LO 1, 4
(Entries in $ millions)
a. Record share of income:
Investment in affiliates (+A)…………………………….
Income from affiliates (+R, +SE)…………...
42
42
b. Record receipt of cash dividends:
Cash (+A)…………………………………………………
Investment in affiliates (-A)……………………
2
2
c. The ending balance should be $715 million + $42 million - $2 million = $755 million.
The actual balance, $767 million, was $12 million higher. The difference could be
due to advances (loans) made to the affiliates, foreign currency changes or AOCI
adjustments at the affiliates or some other transactions (or adjustments) besides the
ones described above.
©Cambridge Business Publishers, 2020
1-298
Financial Accounting, 6th Edition
E12-39.B (40 minutes)
LO 7
1. & 2.
Consolidating
Adjustments
Healy
$1,700,000
500,000
Miller
$120,000
Plant assets .................................
3,000,000
410,000
15,000
3,425,000
Goodwill .......................................
_________
________
45,000
45,000
Total assets .................................
$5,200,000
$530,000
$5,290,000
Liabilities ......................................
$ 700,000
$ 90,000
$790,000
Contributed capital ......................
3,500,000
400,000
(400,000)
3,500,000
Retained earnings .......................
1,000,000
40,000
(40,000)
1,000,000
Total liabilities & stockholders’
equity ........................................
$5,200,000
$530,000
Current assets
Investment in Miller
Consolidated
$ 1,820,000
0
$(500,000)
$5,290,000
3. Miller contributed capital (-SE) ...........................................................
400,000
Miller retained earnings (-SE) .............................................................
40,000
Plant assets (+A) ...............................................................................
15,000
Goodwill (+A) .....................................................................................
45,000
Investment in Miller Co. (-A) .............................................................
500,000
4.
+ Investment in Miller Co. (A) 500,000
1/1
+ Goodwill (A) 45,000
1/1
-
Miller Contributed Capital (SE) +
400,000
-
Miller Retained Earnings (SE) +
40,000
1/1
1/1
+ Plant Assets (A) 15,000
1/1
5.
Balance Sheet
Transaction
Cash
Asset
1/1
To consolidate
Healy & Miller.
+
Noncash
Assets
-500,000
Investment
in Miller
+45,000
Goodwill
+15,000
Plant
Assets
=
=
Liabilities
+
Income Statement
Contrib.
Capital +
Earned
Capital
-400,000
Miller
Contributed
Capital
Revenues
- Expenses
Net
= Income
-
=
-40,000
Miller
Retained
Earnings
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E12-40.B (30 minutes)
LO 7
1. & 2.
Rayburn Company purchased all of Kanodia Company's common stock for cash on
January 1, after which the separate balance sheets of the two corporations appeared
as follows:
Investment in Kanodia ................
Other assets ................................
Goodwill .......................................
Total assets .................................
Liabilities ......................................
Contributed capital ......................
Retained earnings .......................
Total liabilities & stockholders’
equity ........................................
Rayburn
$ 600,000
2,300,000
.
$2,900,000
$ 900,000
1,400,000
600,000
Kanodia
$700,000
.
$700,000
$160,000
300,000
240,000
$2,900,000
Consolidating
Adjustments
(600,000)
20,000
40,000
Consolidated
$
0
3,020,000
40,000
$3,060,000
$1,060,000
1,400,000
600,000
(300,000)
(240,000)
$700,000
$3,060,000
3. Kanodia contributed capital (-SE) ......................................................
300,000
Kanodia retained earnings (-SE) ........................................................
240,000
Other assets (+A) ...............................................................................
20,000
Goodwill (+A) .....................................................................................
40,000
Investment in Kanodia Co. (-A) .........................................................600,000
4.
+ Investment in Kanodia Inc. (A) 600,000
1/1
+ Goodwill (A) 40,000
1/1
-
Kanodia Contributed Capital (SE) +
300,000
1/1
1/1
+ Other Assets (A) 20,000
1/1
Kanodia Retained Earnings (SE) +
240,000
5.
Balance Sheet
Transaction
1/1
To
consolidate
Rayburn &
Kanodia.
Cash
Asset
+
Noncash
Assets
-600,000
Investment in
Kanodia
+40,000
Goodwill
+20,000
Other Assets
Liabil= ities
=
Contrib.
+ Capital +
Income Statement
Earned
Capital
-300,000
Kanodia
Contributed
Capital
Revenues
-
Net
Expenses = Income
=
-240,000
Kanodia
Retained
Earnings
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
E12-41. (20 minutes)
LO 5
a. The investment is initially recorded on Engel’s balance sheet at the purchase price of
$16.8 million, including $6.6 million of goodwill. Because the fair value of Ball is less
than the carrying amount of the investment on Engel’s balance sheet, the goodwill is
deemed to be impaired. To determine impairment, the imputed value of the goodwill is
determined to be 12.5 million - $10.2 million = $2.3 million.
b. Goodwill must be written down by $4.3 million. The write-down will reduce the carrying
amount of goodwill by this amount, and the write-down will be recorded as a loss in
Engel’s income statement, thereby reducing retained earnings by that amount.
E12-42.B (60 minutes)
LO 5, 7
a.
Cash paid ..........................................................................
Fair market value of shares issued ...................................
Purchase price ..................................................................
Less: Book value of Harris ................................................
Excess payment................................................................
$210,000
180,000
390,000
280,000
110,000
Excess payment assigned to specific accounts based on fair market value:
Buildings ...........................................................................
40,000
Patent ...............................................................................
30,000
Goodwill ............................................................................
$ 40,000
$110,000
b.
Accounts
Cash
Receivables
Inventory
Investment in Harris
Land
Buildings, net
Equipment, net
Patent
Goodwill
Totals
Easton Company
$ 84,000
160,000
220,000
390,000
100,000
400,000
120,000
0
$1,474,000
Harris Co.
$ 40,000
90,000
130,000
Consolidation
Entries
[S]
[A]
60,000
110,000
50,000
---$480,000
$(280,000)
(110,000)
[A]
40,000
[A]
[A]
30,000
40,000
Consolidated
Totals
$ 124,000
250,000
350,000
160,000
550,000
170,000
30,000
40,000
$1,674,000
Table continued next page
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Financial Accounting, 6th Edition
b. continued
Table continued from previous page
Accounts
Accounts payable
Long-term liabilities
Common stock
Additional paid-in capital
Retained earnings
Totals
Easton Company
$ 160,000
380,000
500,000
74,000
360,000
$1,474,000
Harris Co.
$ 30,000
170,000
40,000
240,000
$ 480,000
Consolidation
Entries
[S]
(40,000)
[S]
(240,000)
Consolidated
Totals
$ 190,000
550,000
500,000
74,000
360,000
$1,674,000
c. The tangible assets are accounted for just like any other acquired asset. The
receivables are removed when collected, inventories affect future cost of goods sold,
and depreciable assets are depreciated over their estimated useful lives. Intangible
assets with a determinable life are amortized (depreciated) over that useful life. Finally,
intangible assets with an indeterminate useful life (such as goodwill) are not amortized,
but are either tested annually for impairment, or more often if circumstances require.
E12-43.A (20 minutes)
LO 6
a. Investment in Harris Company (+A) ...................................................
28,800
Equity in earnings of Harris Company (-SE) ......................................
28,800
The equity in earnings of Harris Company is calculated as follows:
40% x [$80,000 – ($40,000  20) – ($30,000  5)] = $28,800
b. $156,000 + $28,800 – 40% x $40,000 = $168,800.
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E12-44.C (20 minutes)
LO 8
a. Companies use derivative securities in order to mitigate risks, such as commodity price
risks, risks relating to foreign exchange fluctuations, or risks relating to fluctuations in
interest rates.
b. Derivatives are reported on the balance sheet as are the assets or liabilities to which
they relate. Generally, derivatives and the related assets/liabilities are reported on the
balance sheet at their fair market value.
c. The unrealized gains (losses) on HPE’s derivatives are reported in the Accumulated
Other Comprehensive Income section of its stockholders’ equity. This reporting
indicates that the underlying item being hedged has not yet affected HPE’s profits.
Once the underlying item appears in income, these unrealized gains (losses) will be
removed from AOCI and transferred into current income, thus affecting HPE’s
profitability.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
PROBLEMS
P12-45. (50 minutes)
LO 1, 2, 3
a. Available-for-sale investments are reported at market value on the balance sheet.
Thus, Met Life’s bond investments are reported at:
$308,931 million as of 2017
$289,563 million as of 2016
b. Net unrealized gains (losses) at the end of 2017 are:
$22,820 million ($24,765 million - $1,945 million)
Net unrealized gains (losses) at the end of 2016 are:
$17,880 million ($21,826 million - $3,946 million)
Because the investments are accounted for as available-for-sale, these unrealized
gains (losses) did not affect reported income for 2017 and 2016. (Note: Had these
investments been accounted for as trading securities, those unrealized gains
(losses) would have affected reported income.)
c. Realized gains (losses) are gains (losses) that occur as a result of sales of
securities. These are reported in the income statement and affect reported income.
Unrealized gains (losses) reflect the difference between the current market price of
the security and its acquisition cost. Only unrealized gains (losses) from trading
securities are reported in income. If MetLife had sold all of the AFS securities on
which it had gains, its pre-tax income would have increased by $24,765 million.
d. The evaluation of investment performance is difficult as companies have discretion
over the timing of realized investment gains (losses) and can, thereby, affect
reported income. By including unrealized gains (losses) in the analysis, we are able
to get a clearer picture of overall investment performance—albeit, with an
understanding that these gains and losses are not yet realized. These returns could
then be compared with those of competitors and market rates in general for
investments of comparable risk. We believe this reporting metric provides useful
insights as noted.
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P12-46.B (30 minutes)
Current assets .............................
Investment in Alpine ...................
Plant assets (net) .......................
Total assets .................................
Liabilities ......................................
Common stock ............................
Retained earnings.......................
Noncontrolling interest ................
Total liabilities & stockholders’
equity ........................................
Gem
$258,000
392,000
265,000
$915,000
Alpine
$160,000
$ 50,000
700,000
165,000
$ 60,000
420,000
140,000
$915,000
$620,000
Consolidating
Adjustments
$(392,000)
460,000
$620,000
(420,000)
(140,000)
168,000
Consolidated
$ 418,000
0
725,000
$1,143,000
$ 110,000
700,000
165,000
168,000
$1,143,000
P12-47. (40 minutes)
LO 1, 2, 3, 4
a. The trading security investments will be reported at $375,300. This value is computed
using their market values at year-end; specifically, $105,300 + $270,000.
b. The available-for-sale investments will be reported at $359,000. This value is
computed using their market values at year-end; specifically, $199,000 + 160,000.
c. The held-to-maturity bond investments will be reported at $237,200. This value is
computed using their amortized cost value at year-end; specifically, $101,200 +
$136,000.
d. Unrealized holding gains of $10,400 will appear in the 2019 income statement. These
gains relate to the trading securities; specifically— Ling: $105,300 - $102,400 = $2,900
gain; Wren: $270,000 - $262,500 = $7,500; total of $2,900 + $7,500 = $10,400. The
calculation is only possible because this is the first year the bonds have been held.
Therefore, the entire price difference occurred this year.
e.
Unrealized holding gains of $8,000 will appear in the stockholders' equity section of
the December 31, 2019, balance sheet under accumulated other comprehensive
income (AOCI). These losses relate to the available-for-sale securities; specifically
— Olanamic: $199,000 - $197,000 = $2,000; Fossil: $160,000 - $154,000 = $6,000;
total of $2,000 + $6,000 = $8,000.
f.
A fair market value adjustment to investments of $8,000 will appear in the
December 31, 2019, balance sheet. This adjustment relates to the
available-for-sale securities. See part (e) for the supporting computations. The fair
value adjustment increases the book value of the available-for-sale securities to
their year-end market value.
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Financial Accounting, 6th Edition
©Cambridge Business Publishers, 2020
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P12-48.A,B (60 minutes)
LO 1, 4, 5, 6, 7
a. Yes, each individual company (e.g., parent and subsidiary) maintains its own
financial statements. This approach is necessary to report on the activities of the
individual units and to report to the respective stakeholders of each unit.
The purpose of consolidation is to combine these separate statements to more
clearly reflect the operations and financial condition of the combined (whole) entity.
b. The Investment in Financial Products Subsidiaries is reported on the parent’s
(Machinery and Power Systems’) balance sheet at $3,672 million.
This amount is the same balance as reported for stockholders’ equity of the
Financial Products subsidiary.
This relation will always exist so long as the investment is originally purchased at
book value (e.g., the parent created and funded the subsidiary).
c. The consolidated balance sheet more clearly reflects the actual assets and liabilities
of the combined company vis-à-vis that revealed in the equity method of accounting.
That is, it better reflects operations as one entity as far as investors and creditors are
concerned.
The equity method of accounting that is used by the parent company to account for
its investment in the subsidiary reflects only its proportionate share (100% in this
case) of the investee company stockholders’ equity and does not report the
individual assets and liabilities comprising that equity.
d. The consolidating adjustments generally accomplish three objectives:
(i) They eliminate the equity method investment on the parent’s balance sheet and
replace it with the actual assets and liabilities of the investee company to which it
relates.
(ii) They record any additional assets that are included in the investment balance
that may not be reflected on the subsidiary’s balance sheet, like goodwill, for
example.
(iii) They eliminate any intercompany sales and receivables/payables.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
e. The consolidated stockholders’ equity and the stockholders’ equity of the parent
company are equal. This equality will always be the case. The consolidation process
replaces the investment account with the assets and liabilities to which it relates.
Thus, stockholders’ equity remains unaffected.
f. Consolidated net income will equal the net income of the parent company. The
reason for this result is that the parent reflects the income of the subsidiary via the
equity method of accounting for its investment. The consolidation process merely
replaces the equity income account with the actual and individual sales and
expenses to which it relates. Net income is unaffected.
g. The equity method of accounting reports investments at adjusted cost (beginning
balance plus equity earnings and less dividends received)—this contrasts with the
market method. Unrealized gains for a subsidiary are, therefore, not reflected on the
consolidated balance sheet and income statement. Instead, the subsidiary is
reflected on the balance sheet at its purchase price net of depreciation and
amortization, just like any other asset. The consolidation process merely replaces
the investment account with the actual assets and liabilities to which it relates. Thus,
there can exist substantial unrealized gains subsequent to the acquisition that are
not reflected in the consolidated financial statements.
©Cambridge Business Publishers, 2020
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CASES
C12-49. (60 minutes)
LO 1, 3
a. Return on assets:
ROA =
$59,531 + (1 – 0.25)*$3,420
($365,725 + $375,319)/2
=
0.168 or 16.8%
=
9.196 or 919.6%
b. Return on net operating assets
RNOA =
(1 – 0.25)*$70,896
($10,443 + $1,121)/2
RNOA above 900% is a very high number. One factor contributing to this return is
Apple’s well-known use of contract manufacturers. Apple concentrates on the product
design, but they let other companies do much of the manufacturing. Another factor is
that Apple develops much of its intellectual property in-house, which means that it
doesn’t show up on the balance sheet. Apple reports no goodwill asset in its balance
sheet and no intangible assets, meaning that it does not buy other companies to
acquire intellectual property. This reduces the company’s reported assets and
increases its RNOA.
c. Apple is using the available-for-sale method to account for its fixed-income
investments. The value that will be used on the balance sheet is the fair value at the
end of the fiscal year. The unrealized gains and losses are reported in the
accumulated other comprehensive income section of the shareholders’ equity.
d. Return on financial assets: The return on financial assets is measured as the income
from interest and dividends divided by the average balance of financial assets (which
Apple refers to as marketable securities).
Return on Financial Assets =
(1 – 0.25)*$5,686
($211,187 + $248,606)/2
=
0.019 or 1.9%
Apple’s return on its financial assets is much lower than its return on its operating
assets. And, the dividend and interest income doesn’t tell the whole story. The
unrealized holding gains (losses) have decreased (increased) over 2018, meaning that
the value of the portfolio has dropped, but the decrease is not being reported in income
(as it would be if the investments were accounted for using the trading method. The
other comprehensive income (OCI) disclosure that there was a $3,407 million loss
(after a provision for taxes) means that the total income from this portfolio (average
value almost $230 billion) was less than a billion dollars after provision for taxes.
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C12-50. (50 minutes)
LO 1, 3, 4
a. 2019:
1/2
Investment in Dye, Inc. (+A) .............................................................
420,000
Cash (-A) ..........................................................................................
420,000
12/31 Dividend receivable (+A) ..................................................................
16,000
Dividend income (+R, +SE) ..............................................................
16,000
12/31 Unrealized loss (+E, -SE) .................................................................
60,000
Investment in Dye, Inc. (-A) ..............................................................
60,000
2020:
1/18 Cash (+A) .........................................................................................
16,000
Dividend receivable (-A) ...................................................................
16,000
b.
+ Cash (A) 16,000 420,000
1/18/20
1/2/19
+ Investment in Dye Inc. (A) 420,000
60,000
12/31/19
1/2/19
12/31/19
12/31/19
+ Unrealized Loss (E) 60,000
+ Dividend Receivable (A) 16,000
16,000
- Dividend Income (R) +
16,000
1/18/20
12/31/19
c.
Balance Sheet
Transaction
1/2/19
Buy 20,000
shares of
Dye.
Cash
Asset
Noncash
Assets
=
+420,000
Investment
=
12/31/19
Declare
dividend
$.8/share.
+16,000
Dividend
Receivable
=
12/31/19
Recognize
decline in
investment.
-60,000
Investment
=
1/18/20
Receipt of
dividend.
-420,000
Cash
+
+16,000
Cash
-16,000 =
Dividend
Receivable
Liabilities
Contrib.
+ Capital +
Income Statement
Earned
Capital
+16,000
Retained
Earnings
-60,000
Retained
Earnings
Revenues
+16,000
Dividend
Income
-
Expenses
=
Net
Income
-
=
-
=
+16,000
=
-60,000
-
-
+60,000
Unrealized
Loss
=
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
d. 2019:
½
Investment in Dye, Inc. (+A) .............................................................
420,000
Cash (-A) ..........................................................................................
420,000
12/31 Dividend receivable (+A) ..................................................................
16,000
Investment in Dye, Inc. (-A) ..............................................................16,000
12/31 Investment in Dye, Inc. (+A) .............................................................
112,000
Investment income (+R, +SE) ...........................................................
112,000
2020:
1/18 Cash (+A) .........................................................................................
16,000
Dividend receivable (-A) ...................................................................16,000
e.
+ Cash (A) 16,000 420,000
1/18/20
1/2/19
1/2/19
12/31/19
- Investment Income (R) +
112,000
12/31/19
+ Investment in Dye Inc. (A) 420,000
112,000
16,000
12/31/19
+ Dividend Receivable (A) 12/31/19
16,000
16,000
1/18/20
f.
Balance Sheet
Transaction
1/2/19
Buy 20,000
shares of
Dye.
Cash
Asset
Noncash
Assets
=
Liabilities
Contrib.
+ Capital +
Earned
Capital
Net
Revenues
- Expenses
= Income
+420,000
Investment
=
-
=
12/31/19
Declare
dividend
$.8/share.
+16,000
Dividend
Receivable
=
-
=
12/31/19
Recognize
income from
investment.
+112,000
Investment
1/18/20
Receipt of
dividend.
-420,000
Cash
+
Income Statement
-16,000
Investment
+16,000
Cash
=
-16,000 =
Dividend
Receivable
+112,000
Retained
Earnings
+112,000 Investment
Income
-
= +112,000
=
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C12-51. (15 minutes)
LO 1, 2, 3, 4, 5
a. Consolidated statements present the total assets and liabilities of all firms in which
the reporting firm has more than a fifty percent ownership with intercompany
accounts and transactions eliminated.
b. Demski has a controlling interest in Asare and Demski Finance. Therefore, their
assets and liabilities are all added to those of Demski Inc. Demski does not have a
controlling interest in Knechel. Therefore, it must show its investment in Knechel Inc.
as a financial asset.
c. This excess is the amount paid to Asare in excess of the net book value of Asare’s
assets (assets less liabilities assumed) when Asare was acquired by Demski. The
amount is known more commonly as Goodwill and reflects the fact that Demski
believed the company was worth more than the net book value of its assets.
d. The amount represents the outside ownership claim on Asare’s net assets, which
are aggregated in the balances of Demski’s accounts.
C12-52. (30 minutes)
LO 1, 2, 3, 4
a. While the approach recommended by Gayle is not disallowed by a specific
accounting standard, it is not consistent with the intent of GAAP. Certainly from a
position of representational faithfulness, it specifically does not represent how
management regards the investment or intends to treat it in the future. The approach
recommended is a flagrant attempt to violate the spirit of GAAP in order to manage
earnings.
Such practice may get by the firm’s auditors once or twice, but failure to be
consistent in the accounting treatment over time is unlikely to be tolerated under
SOX and the increased scrutiny applied by the SEC in the wake of the numerous
accounting scandals of the recent past.
Further, such practice can lead to lawsuits by investors who can argue that
management was not accounting truthfully.
b. We believe the suggested approach to be highly unethical.
©Cambridge Business Publishers, 2020
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Financial Accounting, 6th Edition
Appendix A
Compound Interest
and the Time-Value of Money
EXERCISES
EA-1.
a. Future value, 4%, 6 years: $4,000 x 1.26532 = $5,061.28
b. Future value, 6%, 6 years: $4,000 x 1.41852 = $5,674.08
c. Future value, 8%, 6 years: $4,000 x 1.58687 = $6,347.48
EA-2.
a. Future value, 12%, 4 years: $7,500 x 1.57352 = $11,801.40
b. Future value, 3%, 16 quarters: $7,500 x 1.60471 = $12,035.33
c. Future value, 1%, 48 months: $7,500 x 1.61223 = $12,091.70
The last calculation relies on a future value factor that is not in the table at the end of
Appendix A. The solution can be determined using a financial calculator or using Excel.
The Excel calculation is as follows:
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Financial Accounting, 6th Edition
EA-3.
Present value, 1% per quarter, 8 quarters: $14,000 x 0.92348 = $12,929.
EA-4.
Present value, 6%, 4 years: $24,000 x 0.79209 = $19,010.
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EA-5.
PV annuity, 1%, 36 months: $12,500/30.10751 = $415.18
EA-6.
The interest for the first month would be $12,500 x .01 = $125. The remaining
$290.18 would go to reduce the loan balance.
EA-7.
a. PV annuity, 2%, 24 quarters: $40,000 / 18.91393 = $2,114.84.
b. Approximate number of payments it would take paying $1,500 per month is 39.0
quarterly payments.
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Financial Accounting, 6th Edition
EA-8.
This problem requires computation as the future value of an annuity. This can be
calculated from Table 1 as follows:
Future value, 6%, 5 years ……….
Future value, 6%, 4 years ……….
Future value, 6%, 3 years ……….
Future value, 6%, 2 years ……….
Future value, 6%, 1 years ……….
Total ………………………………...
1.33823
1.26248
1.19102
1.12360
1.06000
5.97533
Annual deposit x Future value factor = Future value
Deposit x 5.97533 = $20 million; $20 million / 5.97533 = $3,347,095.47 per year.
EA-9.
PV of an Annuity, 9%, 7 years: $60,000 x 5.03295 = $301,977.
2019 Revenue: In 2019 Ott, Inc. would recognize the present value of $301,977 as
sales revenue, plus interest income for eight months (May 1 through December 31.
Interest income would be equal to $18,119 ($301,977 x 9% x 8/12).
2020 Revenue: in 2020, Ott would recognize interest income of:
($301,977 x 9% x 4/12) + {[$301,977-($60,000 - $301,977x9%)] x 9%x8/12} = $25,209.
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EA-10.
First, we must compute the payment due on December 1, 2021:
Future value, 5%, 3 years: $10,000 x 1.15763 = $11,576.30.
Next, we compute the present value of that payment at the market interest rate of 8%:
Present value, 8%, 3 years: $11,576.30 x 0.79383 = $9,189.61.
Finally, we compute the interest from December 1 through December 31, 2018:
$9,189.61 x 0.08/12 = $61.26
Thus, in 2018, Rex Corporation would recognize sales revenue of $9,189.61 and
interest income of $61.26.
EA-11.
Present value, 12%, 10 years: $50,000 x 0.32197 = $16,099.
PV annuity, 12%, 10 years: $200,000 x 5.65022 = $1,130,044.
Maximum price Rye Company should be willing to pay is $1,130,044 + $16,099 = $1,146,143.
Using Excel:
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EA-12.
If Debra Wilcox chooses 26 payments, she will receive $7 million/26 = $269,230.77 per
year for 26 years, with the first payment due today. This is an annuity due. Equivalently,
this can be structured as an annuity in arrears by recognizing that the present value
factor for the first payment is 1.0. Thus, the annuity factor is 1.0 plus the present value
of an annuity for 25 payments.
a. PV annuity due, 8%, 25+1 payments: $269,230.77 x (1 + 10.67478) = $3,143,210.01
b. PV annuity due, 4%, 25+1 payments: $269,230.77 x (1 + 15.62208) = $4,475,175.40
c. If her opportunity cost of capital is 8%, Debra Wilcox should choose the lump sum of
$3,500,000 rather than take the annuity. On the other hand, if her discount rate is
4%, the annuity gives a higher present value. One way to examine this problem is to
ask what opportunity cost of capital (or discount rate) would make her indifferent
between the two options. This is answered by solving for the rate at which the
present value of the annuity is equal to $3,500,000. Using the rate function in Excel:
So, the rate at which Debra Wilcox would be indifferent between $3,500,000 as a
lump sum payment and an annuity due of $269,230.77 for 26 payments is
approximately 6.68% per year.
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EA-13.
The answer depends on Ms. Reed’s opportunity cost of capital (discount rate). To
determine the rate at which she would be indifferent between these two options, we
divide the present value by the future value and consult Table 2: $60,000/$100,000 =
0.60000. From Table 2, the present value of $1 received five years in the future
discounted at 10% is 0.62092. At 11%, the present value is 0.59345. Thus the
discount rate at which she would be indifferent is between 10% and 11%.
Alternatively, we can use the rate function in Excel:
The rate at which she would be indifferent is 10.76%. So, if her discount rate is higher
than that, she should accept the $60,000 today. If her rate is less than 10.76%, she
should choose the deferred payment of $100,000.
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EA-14.
This calculation (and the calculation in A13) can be done with either the present value
or future value tables, depending on which value is placed in the numerator and which
is in the denominator. Using the present value tables:
$400,000/$955,000 = 0.41885
The present value factor for 11%, 8 years is 0.43393.
The present value factor for 12%, 8 years is 0.40388.
Hence, the required rate of return on the investment is between 11% and 12%.
Using Excel, we can determine the exact rate:
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EA-15.
This question can be answered by adding the future values at 12%:
Amount
Deposited
Date:
July 1, 2019 ……………..
June 30, 2020 …………..
June 30, 2021 …………..
June 30, 2022 …………..
June 30, 2023 …………..
Value on June 30, 2023
Future
Value
Factor
$360,000
60,000
60,000
60,000
60,000
Future
Value
1.57352
1.40493
1.25440
1.12000
1.00000
$566,467
84,296
75,264
67,200
60,000
$853,227
EA-16.
a. Present value of an annuity, 5% per half-year, 20 half-years:
Payment = $10,000,000/12.46221 = $802,425.89
b. $10,000,000 x 5% = $500,000.
c. Present value of an annuity, 5% per half-year, 10 half-years:
$802,425.89 x 7.72173 = $6,196,116.07
EA-17.
a. (i) Present value 2%, 10 periods: $200,000 x 0.82035 = $164,070
PV annuity, 2%, 10 periods: ($200,000x.05/2) x 8.98259 = $44,913
$164,070 + $44,913 = $208,983.
continued next page
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(ii) Present value 3%, 10 periods: $200,000 x 0.74409 = $148,818
PV annuity, 3%, 10 periods: ($200,000x.05/2) x 8.53020 = $42,651
$148,818 + $42,651 = $191,469.
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b. Present value 4%, 6 periods: $200,000 x 0.79031 = $158,062
PV annuity, 4%, 6 periods: ($200,000x.05/2) x 5.24214 = $26,211
$158,062 + $26,211 = $184,273.
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EA-18.
a. PV annuity, 9%, 20 years: $450,000 x 9.12855 = $4,107,847.50
b. PV annuity due, 9%, 19+1 years: $450,000 x (1+ 8.95011) = $4,477,549.50
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EA-19.
a. A: 1 + PV annuity, 5%, 5 years: $8,000 x (1 + 4.32948) = $42,635.84
B: PV annuity, 5%, 5 years: $9,000 x 4.32948 = $38,965.32
PV annuity, 5%, 2 years: $2,000 x 1.85941 = $3,718.82
$38,965.32 + $3,718.82 = $42,684.14 at 5% interest.
Alternative A appears to be the cheaper alternative.
b. A: 1 + PV annuity, 7%, 5 years: $8,000 x (1 + 4.10020) = $40,801.60
B: PV annuity, 7%, 5 years: $9,000 x 4.10020 = $36,901.80
PV annuity, 7%, 2 years: $2,000 x 1.80802 = $3,616.04
$36,901.80 + $3,616.04 = $40,517.84.
Alternative B appears to be the cheaper alternative at 7% interest.
EA-20.
A: PV annuity 2%, 24 quarters: $3,000 x 18.91393 = $56,741.79
B: PV annuity 8%, 5 years: $14,300 x 3.99271 = $57,095.75
Payment alternative A appears to be cheaper at an 8% discount rate. However, this is
misleading because the effective discount rate is higher in alternative A. If the same
discount rate (2% compounded quarterly) is used for both calculations, the annuity
factor for alternative B would be lower. To compute the appropriate discount rate, add
the present value of a single payment for each of the five payments as follows:
2%, 4 quarters
2%, 8 quarters
2%, 12 quarters
2%, 16 quarters
2%, 20 quarters
Total
0.92385
0.85349
0.78849
0.72845
0.67297
3.96725
$14,300 x 3.96725 = $56,731.68, hence, alternative B is slightly cheaper.
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EA-21
a. The future value factor from Table 4 for 40 periods and 4% interest is 98.8265, so
the future value of Samuel’s $2,400 annual contributions would be $237,183.60.
b. If Samuel waits 10 years, then the accumulation will only be over 30 years, which
has a future value factor of 58.3283 in Table 4. Therefore, the accumulation will be
$139,987.92, almost $100,000 less.
c. If Samuel can earn 5% per year on his investments, then Table 4 shows a future
value factor of 126.8398, which would turn the $2,400 investments into $304,415.52.
EA-22
The Table 4 future value factor for 36 periods at 1% interest per period is 43.5076, so
Janice Utley’s $1,000 monthly investments would accumulate to $43,507.60 after 36
months.
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