University of Puget Sound
School of Business and Leadership
Business 205 B & C
Principles of Financial and Managerial Accounting
Fall, 2003
Course Objectives: This course introduces students to accounting and the language of
business. The students are provided with the basic vocabulary needed for entry into upper
level business courses. Students are introduced to understanding the uses of information
by those outside the organization (financial accounting) and by those inside the
organization (managerial accounting). Prerequisites- sophomore standing or instructors
permission.
Time: 205B Tuesday and Thursday 12:30 to 1:50 p.m.
205C Tuesday and Thursday 2:00 to 3:20 p.m.
Room: McIntyre 107
Text: Survey of Accounting, Raiborn and Watson
Faculty: L. L. Price, Ph.D.
Office: McIntyre 111A
Office Hours: Tuesday and Thursday: noon* to 12:30; 3:20 until all students have left
the office. *arrival time may vary 5-10 minutes.
Wednesday: Selected times to be announced.
Contact Information: Office Phone: 253-879-3309; Residence phone: 253-858-3838
Home email: drllprice@harbornet.com Office: lprice@ups.edu
Reading assignments and class discussion:
You are expected to read the assigned material and to have analyzed and
completed assigned homework problems. You are also expected to be prepared to
participate in the class discussion. Note that the appendices are required only if they are
assigned. If for some reason you are not prepared to participate, please notify me before
class, so that I will not call on you.
1
Grades:
Your grade will be based on 8 quizzes, a short project, and a comprehensive final
exam. A breakdown of the quizzes, chapters covered, and points follows:
Quiz
1
2
3
4
5
6
7
8
Final
Chapters
1&2
3
4&5
6&7
8&9
10
11 & 12
13 & 14
Project
Comprehensive
Points
50
25
50
50
50
50
50
50
25
100
500
Attendance and class participation may be a factor in determining your grade,
particularly if you are in a borderline situation. As a general policy, makeup
quizzes or exams will not be given. Certain types of scheduling conflicts will be
resolved by your taking the quiz early. Sometimes it will be necessary to adjust
the grading scale to more appropriately reflect your performance. If I do change
the grading scale it would be in your favor. I will not make the grading scale more
difficult.
The grading scale will approximate the following:
A range
B range
C range
D range
F
450-500 points
400-449
350-399
300-349
0-299
90%+
80-89%
70-79%
60-69%
0-59%, or any academic dishonesty.
Assignments:
You will be provided with solutions to the homework assignments. If you wish to
be successful in this class, it is imperative that you attempt the homework before
checking the solution. If you read the problem and then look at the solution it
make sense to you, but you will not be actively engaged in the learning process.
The keys to success in this class are simple. Do the work. And, do it on time.
2
Chapter
1
2
3
4
5
6
7
8
9
10
11
12
13
14
Assignment:
Ex: 11, 13, 16, Problem 19, [optional] Case 21, 22
Ex: 13 to 17, 20, 22, Problems 24 to 27, [optional] Cases 32 & 33
Ex: 14, 15,17, 19, 22 to 25, Problems 28, 30 & 31
Ex: 11 to 15, Problems 18, 22, 24
Ex: 14 to 19, 21 & 22, Problems 24 & 25
Ex: 13 to 20, Problems 24 & 25
Ex: 13, 14, 15, 17 to 23, Problems 29, 31, 32
Ex: 13, 14, 16 to 22, Problems 25 to 28
Ex: 14, 15,18, 29,
Ex: 14, 15, 17, 19, 21, 23, 25, 26, 27
Ex: 10, 12 to 16, 18, Problems 22, 23, 24
Ex: 11 to 15, 17 to 19
Ex: 16, 17, 18, Problems 24, 25, 27, 31, 32, 33
Ex: 14, 16, 18, Problems 22, 25, 26.
Schedule and Important Dates:
Tuesday, September 2nd is the first day of class.
Wednesday, October 22nd mid term grades are due.
Thursday, November 27th is Thanksgiving.
Tuesday, December 9th is the last day of class.
Wednesday, December 17th noon to 2 p.m., Final Exam for 205B
Thursday, December 18th noon to 2 p.m., Final Exam for 205C
Because of the number of quizzes (eight) and the fact that they will occur every week, to
week and a half, we will not have a detailed schedule of the dates of the quizzes for the
entire semester. You will be given ample notice of the dates of the quizzes. It is your
responsibility to keep informed of class announcements, changes to assignments and
schedules.
3
Survey of Accounting
Raiborn & Watson
Errata sheet
This is a first edition textbook, and as such contains some errors. Listed below is a list of
the errors that I have located so far. Please do not hesitate to speak up if you have any
doubts concerning the reading material.
Chapter 4: page 103, March 31 Journal entry Accounts ReceivableB. Joyner
Chapter 5: page 134, Top illustration (FIFO Method)
Total cost of Goods sold
400
18,560
Page 135, bottom illustration (Moving average method)
Total cost of Goods sold
18,660
Page 137, Exhibit 5-6, The moving average column,
Cost of goods sold
18,660
Gross profit
8,340
Chapter 7: Page 205, Exercise 15. The wording is a bit confusing. There are two notes
payable. One for $78,000 due in 12 months and the other for $400,000.
Page 205, Exercise 17. Four notes payable are listed….
Chapter 8: Page 229. Visual Recap 8.1. Last illustration “Reissuing Treasury stock”,
middle column. The journal entry should appear as follows:
Cash (#S x SP)
APIC [(PP-SP) x #S]*
TS(#S x PP)
(Note: in the text, the APIC entry was listed as a credit)
Chapter 9: Page 252, Exhibit 9-1. Normally, when dealing with income tax expense, you
would not see the terms current and deferred on an income statement. Outback
Steakhouse, Inc. financials for the last 3 years list “income tax expense” on the income
statement, and it appears before minority interest income.
Page 254. Exhibit 9-2. December 31 entry.
Interest Revenue
2,689
4
Chapter 9 (cont.)
Page 266. Exhibit 9-9. Debt to total assets ratio (computation)
= $198,105,000 : 1,022,535,000
Chapter 12
Page 352. Visual Recap 12.1 (last line, should be multiplied, not divided)
…=pre-tax profits x (1 – tax rate)
Page 355. Exhibit 12-5 – far right hand two columns:
“Basket”
Total
Selling Price
Variable expenses
(109)
Contribution margin 151
%
41.9%
58.1%
Page 359. Exhibit 12-8. Last sentence.
At 24,700 units, pretax profits….
Chapter 13
Page 377. Near bottom of page. First line below the bold facedSchedule of Cash Payments for Purchases
The purchases information from Exhibit 13-4 can be…
Page 389: Problem 24, desired ending inventory should be 30%
Page 390. Problem 25.
Required:
(1)
Prepare a production budget for the first quarter for Product # 431.
(2)
Prepare a purchases budgets for the first quarter for Materials X
and Y.
5
Bus 205 Quiz/Test Preview
Below is listed some information to help you prepare for your quizzes and final exam.
Quiz 1 (Chapters 1 & 2)
Twenty true/false
4 short problems consisting of:
 5 transactions and you must indicate the effect on Assets, Liabilities, and equity
 Given 3 company’s date re Assets, liabilities, equity, revenues, expenses and
income (some data is missing), solve for the unknown amounts
 Given a list of account titles, identify if it belongs on an income statement or
balance sheet, and what kind of account it is (Asset, liability, etc.)
 Given a list of accounts and year-end dollar amounts, prepare an income
statement and a balance sheet.
Quiz 2 (Chapter 3)
Twenty true/false
Problems consisting of:
 Given a transaction, determine which accounts should be debited, and which
should be credited.
 Given transactions, prepare journal entries, including adjustments.
 Given transactions, post directly to “T” accounts and prepare a trial balance.
 From a trial balance, prepare a balance sheet, income statement, and statement of
owners equity.
Quiz 3 (Chapters 4 & 5)
Thirty true/false
Problems consisting of:
 Making a journal entry to record uncollectable accounts expense.
 Identifying balances after bad debt write off
 Prepare a bank reconciliation
 From a trial balance, prepare a balance sheet, income statement, and statement of
owners equity.
 Prepare the journal entries to record the purchase (on credit) and payment of
inventory.
 Prepare the journal entries to record the sale of inventory.
 Compute the ending inventory, Cost of Goods Sold, and Gross profit using Fifo,
Lifo, and Weighted average.
 Determine the effect of an inventory error on cost of Goods sold and net income.
6
Quiz 4 (Chapters 6 and 7)
Thirty-four true/false
Problems consisting of:
 Prepare journal entries recording the warranty expense, warranty payments, and
ending liabilities.
 Prepare journal entries related to unearned revenues.
 Prepare journal entries recording the issue of bonds at par, premium and discount.
 Determine the cash to be paid to bond holders as an interest payment.
 Determine the maturity value of a note payable, accrued interest, and interest
expense.
 Prepare the journal entry related to the sale of an asset
 Prepare the journal entry to amortize an intangible asset.
 Compute depletion and net book value of a natural resource.
 For a two year period, compute depreciation expense, accumulated depreciation,
and net book value, using: straight line, declining balance and units of production.
Quiz 5 (Chapters 8 & 9)
Forty-six true/false
Problems consisting of:
 Compute the dividends to be paid to common and preferred stockholders
assuming cumulative and non-cumulative preferred stock.
 Prepare journal entries to record events related to dividends from date of
declaration to closing entries.
 Prepare journal entries related to treasury stock transactions.
 Given a stockholders equity section with some missing information, solve for
unknowns.
 Determine the effect various dividend transaction would have on total assets,
liabilities, and owners equity.
 Given a balance sheet and income statement, compute: current ratio; quick ratio;
age of receivables; accounts receivable turnover; age of inventory; inventory
turnover; profit margin %; gross profit %; P/E ratio; EPS.
 Compute the EPS under different situations.
 Given a list of information, prepare an income statement (may include
discontinued operations; extraordinary loss; change in accounting principle).
7
Quiz 6 (Chapter 10)
Twenty true/false
Problems consisting of:
 Given a list of events, determine if they would be an operating activity; investing
activity; financing activity; or not appear on a statement of cash flows.
 Compute the amount of cash paid/received under a variety of circumstances.
 Given an income statement and selected balance sheet information, prepare the
operating section of a statement of cash flows using both the direct and indirect
methods.
 Given a list of information, prepare a statement of cash flows – indirect
 Given a list of information, prepare a statement of cash flows – direct
Quiz 7 (Chapters 11 and 12)
Twenty-eight true/false
Problems consisting of:
 Given information, prepare a schedule of cost of goods manufactured.
 Determine if overhead was over or under applied.
 Prepare an income statement for a manufacturing company.
 Calculate the predetermined overhead rate.
 Calculate the overhead charged to jobs during the year.
 Calculate the over/under applied overhead
 Calculate the unit product costs.
 For a series of cost items, determine if they would be a period cost, or if a product
cost, if they would be labor, material, or overhead.
 Compute break even in dollars and units.
 Compute the amount of fixed costs.
 Compute the degree of operating leverage and the margin of safety
 Given revenue and cost data (fixed and variable), solve for unknowns.
 Given Tax and profit information, solve for unknowns.
 Using the high/low method, compute fixed costs, variable costs, and total costs at
a projected level of operations.
 Compute break even with multiple products (sales mix)
8
Quiz 8 (Chapters 13 and 14)
Twenty true/false
Problems consisting of:
 Prepare a cash disbursements schedule
 Prepare a cash receipts schedule
 Prepare a production budget
 Compute the labor rate, labor efficiency, material price, and material quantity
variance.
 Compute profit margin, asset turnover ratio, and return on investment.
 Using activity based costing, compute cost per unit for different products.
 Compute unit costs for different products, first using one overhead rate, and then
using activity based costing.
 Compute margin, turnover, and ROI.
9
Bus 205 – Final Exam preview
All questions are multiple-choice. An asterisk (*) denotes a computation. A number
after the topic indicates that the topic occurs more than once.
Activity based costing – 2
*ABC-2
*turnover
budgeting
*labor budget
*material price variance
break even
*CM ratio
*Break even in units
relevant range
*Overhead rate
Operating/investing/financing
*cash paid
minority interest
*quick ratio
*inventory turnover
treasury stock
stock split
*interest expense
leases
*depreciation – 3
*FIFO/LIFO – 2
bank accounts
*bad debt expense
accounting systems
account types - 2
assets
stockholders equity
business organizations – 4
financial statements
*overhead application
*profit margin
*ROI
*production budget
*cash receipts budget
*material quantity variance
*CM per unit
*Break even in $
*product/period costs – 2
direct/indirect –2
over/under applied overhead
Stmt of cash flows – indirect
parent/subsidiary
quick assets
*current ratio
shares of stock – s
dividends
liabilities
*warranty expense
bonds
types of assets –2
inventory errors
*sales discounts
*note payable
debit/credit
*adjustments
stock values
accounting cycle
*A = L + OE
10
CHAPTER 1
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
1.
The three general types of businesses mentioned in the chapter are service
companies, manufacturing companies, and merchandising companies.
Service companies include accounting firms and airlines. Manufacturing
companies include General Foods and Gateway computers. Merchandising
companies include Dillard's, Wal-Mart and Office Depot.
2.
The three common legal forms of business organization in the United States are
sole proprietorships, partnerships, and corporations. The nature of ownership is
the primary difference between these forms of business: sole proprietorships have
one and only one owner; partnerships have at least two owners called partners;
and a corporation has one or more owners called shareholders who own shares of
stock that represent a portion of ownership. The sole proprietorship is the most
common form of business in the United States.
3.
The primary function of accounting is to provide quantitative information about
economic events (primarily financial) that impact the organization in making
decisions.
4.
The four major financial statements are the balance sheet, income statement,
statement of cash flows, and statement of stockholders’ (or owners') equity.
Businesses use financial statements to communicate financial information to
external decision-makers such as bankers and creditors.
5.
A calendar year is 365 consecutive days that begins on January 1 and ends on
December 31. A fiscal year is similar except that the start date may be any day of
the year. For example, a company’s fiscal year might begin on May 1, in which
case, it would end on April 30.
11
6.
The three primary activities that business are engaged in are investing, financing,
and operating. Operating activities mostly include the day-to-day operations of a
business including generating and collecting revenues and incurring and paying
expenses. When a business raises extra money (not generated by operating
activities) by borrowing or raising money from investors, it is engaging in
financing activities. Investing activities include use of excess funds to purchase
equipment, earn interest, and make loans to others. These three activities are the
section headings on the Statement of Cash Flows where all cash transactions are
summarized by activity.
7.
Generally accepted accounting principles (GAAP) are the rules and regulations that
accountants must follow in recording and reporting financial information. The primary
purpose of GAAP is to provide to accountants guidelines for preparing financial
statements and relating financial transactions. The Financial Accounting Standards Board
(FASB) is currently charged with establishing GAAP.
8.
Accountant who work in public accounting firms provide their services (audit,
tax, consulting) to many different companies. Accountants in public accounting
work for accounting firms or, possibly, own their own accounting practice.
Accountants in private accounting work for corporations, not-for-profit
organizations, governmental agencies, and other business entities.
Some of the types of work an accountant in the private arena might include work
as a controller or cost analyst of an organization. A controller is the top
accounting executive of an organization and whose primary function is to make
sure that the financial statements are accurate. A cost analyst might prepare
budgets and analyze variances between actual and expected costs.
9.
Public accounting firms usually provide tax preparation, auditing, and
management consulting services. Probably the most important function that public
accounting provides to the general public would be auditing financial statements.
The objective of an audit is to determine if the financial statements have been
prepared according to GAAP, which should give some degree of confidence to
third parties that the financial statements are accurate.
10.
The SEC was established after the 1929 stock market crash in the early 1930s.
The primary function of the SEC is to ensure that third parties have sufficient
information to make informed decisions regarding securities.
12
EXERCISES
11.
True/False
(1)
T
(2)
T
(3)
F .........The accounting profession creates its own standards (primarily
FASB), and the SEC reserves the right to overrule them.
(4)
F .........Sole proprietorships are the most common, but corporations
generate the most revenue.
(5)
T
(6)
F .........A balance sheet is a snapshot that represents account balances on
one day. The fiscal year cover the income statement, statement of
stockholders’ equity, and statement of cash flows.
(7)
T
(8)
T
(9)
F .........Though the accounting function does not independently generate
revenues such as sales, it is essential to the success of a business.
(10) F .........The country in which a company is based dictates the accounting
rules it must follow.
(11) F .........Owners of LLPs, LLCs, and Subchapter S corporations pay taxes
on the business’s income as if it was personal income, similar to a
partnership.
13.
(1) Some of the advantages of operating a business as a sole proprietorship versus a
corporation include the following: in a sole proprietorship, you are working for
yourself and you do not have to answer to anyone else. You can be as creative as
you want/need to be to get the job done, set your own hours and come and go as
you please; if you were working for a corporation, you would have a time clock to
punch. In a corporation, everyone has to answer to someone, which can be stifling
if you are a really creative person. Some disadvantages of the sole proprietorship
include the fact that all the work falls on your shoulders, from managing to
accounting functions (unless you outsource). A corporation usually has the
financial ability to hire experts to work and perform some of those same duties
that sole proprietors must do themselves. Also, a sole proprietorship may have a
more difficult time in obtaining capital to expand, while a corporation generally
doesn’t have this problem, unless the credit rating of the corporation is bad.
(2) Some of the advantages of operating a business as a partnership versus a corporation
include the following: in a partnership (which could include as few as one
additional person to as many as hundreds), the work would be spread out and
generally shared by all partners. Each partner would help finance the partnership
through his/her investments (cash or non- cash assets) when forming or joining a
partnership. Also, a partnership may have an easier time than a sole proprietorship
in raising additional capital for expansion, but a corporation still comes out ahead
in that department. In a corporation, stockholders own the corporation through
13
their stock purchases, and, for the most part, cannot influence the day to day
operations of the corporation. A disadvantage of a partnership is that each partner
is separately liable for the debts of the partnership; so, if the other partners are
insolvent (or crooks), one partner might end up owing all the debts while the
others owe nothing.
(3) LLPs (Limited Liability Partnerships), LLCs (Limited Liability Corporations), and
Subchapter S corporations are a hybrid of corporations and partnerships. The goal
is to combine all the benefits of a partnership (e.g., single tax) with the primary
benefit of a corporation—providing limited liability to its owners.
16.
Transactions
(1)
Purchased
equipment for $12,500
cash.
Owners invested
an additional $17,000 in
the firm.
(3)
Paid $1,500
owed to an office
supply store for a
purchase made the
previous month.
(4)
Purchased
inventory for $4,000 on
credit.
Assets
=
Liabilities
+
Owners’
Equity
+$12,500
– $12,500
=
$0
+
$0
+$17,000
=
$0
+
$17,000
–$1,500
=
–$1,500
+
$0
+$4,000
=
$4,000
+
$0
(2)
19.
(a) $192,000
(c) $750,000
(e) $583,000
Assets
$510,000
(c)
$950,000
=
=
=
=
Liabilities
(a)
$430,000
$367,000
+
+
+
+
Equity
$318,000
$320,000
(e)
(b) $190,000
(d) $660,000
(f) $1,009,000
Revenues
$510,000
$870,000
(f)
–
–
–
–
Expenses
$320,000
(d)
$678,000
=
=
=
=
Net Income
(b)
$210,000
$331,000
REAL WORLD CASES
21.
(1) Fiscal year begins on December 31 and ends on November 30.
(2) 2 years of Balance Sheet information
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(3)
(4)
(5)
(6)
3 years of Income Statement information
3 years of Cash Flow information
3 years of Shareholders’ Equity information
a. 2001 Balance Sheet and 2001 Statement of Cash Flows
b. 2000 Balance Sheet and 2001 Statement of Cash Flows
c. 2001 Balance Sheet and 2001 Statement of Stockholders’ Equity
d. 2001 Income Statement and 2001 Statement of Stockholders’ Equity
e. 2001 Balance Sheet and 2001 Statement of Stockholders’ Equity
(7) PricewaterhouseCoopers LLP
22.
(1) The SEC
(2) Since 1973
(3) “The mission of the Financial Accounting Standards Board (FASB) is to establish and
improve standards of financial accounting and reporting for the guidance and
education of the public, including issuers, auditors and users of financial
information” (Source: Facts About FASB, 2002, www.fasb.org).
(4) Edmund Jenkins (may change)
(5) Observation of published reports; Liason with interested organizations; Emerging
Issues Task Force; Letter; Telephone
(6) “The Exposure Draft sets forth the proposed standards of financial accounting and
reporting, the proposed effective date and method of transition, background
information and an explanation of the basis for the Board’s conclusions” (Source:
Facts About FASB, 2002, www.fasb.org). Practitioners and other interested
parties can send written comments to FASB about the content of an exposure
draft, possibly effecting a change before the actual new standard is released.
(7) Answers will vary depending on when the FASB page is accessed.
CHAPTER 2
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
1.
The principal focus of financial accounting is to serve the needs of external
decision-makers. External decision makers need financial data about a business to
make sound economic decisions. External parties, such as investors, lenders, and
other groups (e.g., IRS) benefit from standardized financial reporting because the
information in consistent from year to year and comparable from company to
company.
2.
The balance sheet equation is:
Assets = Liabilities + Owners’ Equity.
15
Assets represent all the items owned by a company. Assets have some future
economic value (e.g., can be converted to cash, can be used to generate revenues).
Many assets are tangible such as cash, a piece of equipment, or inventory. However,
some assets do not have a physical representation such as accounts receivable,
patents, and prepaid insurance.
Liabilities represent all debts owed by a company to other companies or individuals.
All that a company has (assets) minus all it owes (liabilities) is the worth of a
company, known as owners’ equity. Equity can come from two sources. Equity can
be contributed by owners; for example, an owner gives $10,000 of his personal
money to the company in exchange for $10,000 equity in the company. Equity can
also be generated by a profitable company.
3.
The operating cycle is determined by the time period that exists between the use of
cash for normal business operating activities and the receipt or collection of cash
from the entity’s customers. The operating cycle for a homebuilder could may be
three to six months, while the operating cycle for winery could be over a year or
more. The operating cycle for a service firm could be a matter of days or weeks.
The operating cycle effects how assets are classified on the Balance Sheet. Current
assets, which are typically listed first in a balance sheet, include cash or any other
asset that will be converted into cash, sold, or used up within the next year or the
normal business operating cycle, whichever is longer.
4.
The retained earnings account does not contain cash. It is a representation of how
the equity in a business has increased because of profitable operations. Each year,
the revenues earned by a company minus both the cost of doing business (expenses)
and distributions to owners (dividends) is added to retained earnings. Therefore,
retained earnings is the sum of yearly [revenues – expenses – dividends] since the
company began.
5.
The income statement is a “period-of-time” statement because the statement will
reveal what revenues were earned and expenses incurred during a defined period
(e.g., a month or a year).
6.
Revenues are defined as increases in assets or decreases in liabilities that result
from the profit-oriented activities of the business.
Gross profit is the difference between the net revenues generated and the cost of
goods sold during a particular period.
Net income, which is computed by subtracting operating expenses from gross
profit, is “bottom line” on the income statement.
16
7.
Answer will vary depending on company chosen.
8.
The common theme of the three financial reporting objectives of business entities is
the need for the financial statements to give external parties the necessary
information to make informed and rational decisions about economic events.
Without this information, users of financial statements would not be able to make
appropriate business and investment decisions.
9.
Accounting information that is deemed to be reliable has the following three
characteristics: verifiability, neutrality, and representational faithfulness. To be
verifiable, more than one person should be able to validate accounting information.
To be neutral, accounting information must be without bias, and to have
representational faithfulness, accounting information must represent the business’
true economic resources, obligations, and transactions.
10. The principal reason that historical cost is used as the basis for assets is that it can
be verified through documentation (bill of sale, etc.). Current values may differ
depending on whose opinion is obtained.
11. Revenues should be both realized (assets exchanged for cash or a claim to cash) and
earned (provided a product or service) before they are entered in the accounting
records of an entity.
12. A general journal contains a chronological listing of transactions and how that
transaction affected individual accounts. A general ledger contains individual
accounts and all the changes made to the accounts by transactions.
Two separate records are used because events occur that alter two or more accounts
simultaneously. A record of the event is found in the general journal. However
financial reporting is done on an account basis, so the general journal is used to
track changes to individual accounts.
17
EXERCISES
13. a. T
g. F
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
b. T
h. F
c. F
i. F
d. F
j. T
e. T
f. T
T
T
F .........Intangible assets are not current assets; they will not be used up or
converted to cash within one year.
F .........This statement describes the full-disclosure principle.
T
F .........This statement describes the accounting period concept.
F .........The statement that reconciles beginning to ending cash is the
Statement of Cash Flows.
F .........This statement describes “relevant” information.
T
14.
(1) A = L + SE;
2x = x + $1,000,000
x (liabilities) = $1,000,000
2x (assets) = $2,000,000
(2)
SE = $1,000,000
SE = CS + PIC + RE
CS + PIC = $750,000
$1,000,000 = $750,000 + RE
RE = $250,000
15. Accounts payable .......................................................................................... current liability
Inventory ........................................................................................................... current asset
Retained earnings .................................................................................. stockholders’ equity
Notes payable (due in 2 years) ..................................................................long term liability
Prepaid expenses ............................................................................................... current asset
Common stock ...................................................................................... stockholders’ equity
Intangible asset.............................................................................................. long term asset
Cash................................................................................................................... current asset
Accounts receivable .......................................................................................... current asset
Notes payable (due in six months) ............................................................... current liability
Additional paid-in capital ..................................................................... stockholders’ equity
PPE................................................................................................................ long term asset
18
16.
(1)
(2)
17.
(1)
(2)
22.
(1)
(2)
24.
(1)
Cash, Short-term investment, Accounts receivable, Inventory, Prepaid expenses
Assets should be listed on the balance sheet in order of liquidity, or the ability to
turn the assets into cash. The more liquid the asset, the closer to the top of the
current asset list it should appear.
Farewell should report $75,000 as a long-term liability, and $25,000 in the current
liability section of the balance sheet.
It is important to accurately list the items on the balance sheet, so that current and
potential creditors and assess the ability of the firm to pay its debts as they come
due.
The operating cycle would be 135 days.
Normally, anything that is receivable/due/payable within the operating cycle is
usually classified as current; anything receivable/due/payable past the operating
cycle is usually classified as long term.
PROBLEMS
Gross Profit = Net sales–Cost of goods sold
Gross Profit = $115,000 - $65,750
Gross Profit = $49,250.
Operating Income = Gross profit–SG&A Exp. =
Operating Income = $49,250 - $45,050
Operating Income = $4,200.
Income before Taxes = Operating Income + Interest Revenue
Income before Taxes = $4,200 + $5,000
Income before Taxes = $9,200.
Net Income = Income before Taxes – Income Tax Expense
Net Income = $9,200–$1,500
Net Income = $7,700.
(2)
Malenski Corporation
Income Statement
For period Ended date
Net Sales
Cost of Goods Sold
Gross Profit
$115,000
(65,750)
$ 49,250
19
Selling, Gen. & Admin. Exp.
Operating Income
Interest Revenue
Income Before Income Taxes
Income Tax Expense
Net Income
25.
(1)
(45,050)
$ 4,200
5,000
$ 9,200
(1,500)
$ 7,700
$18,000 / 5 years = $3,600 per year.
(2)
Accumulated Depreciation at the end of three years
$10,800 = $3,600 per year × 3 years
(3)
The matching principle requires that revenues generated in a particular accounting
cycle be matched with the expenses incurred during that same accounting cycle.
This purchase reflects an item that should be capitalized and depreciated over the
life of the asset rather than expensed immediately on the income statement.
20
26.
(1)
Revenue per unit = 2×cost per unit
Revenue per unit = 2×$27.50
Revenue per unit = $55.00
Sales (2001) = units sold × revenue per unit
Sales (2001) = 10,000 units × $55
Sales (2001) = $550,000
(2)
Cost of Goods Sold (CGS) = units sold × cost per unit
CGS = 10,000 × $27.50
CGS = $275,000
Gross Profit = Sales (2001)–CGS
Gross Profit = $550,000 - $275,000
Gross Profit = $275,000.
(3)
Gross Profit = Net Sale – CGS
Net sales (2002) = CGS + Gross Profit
Net sales (2002) = $225,000 + $200,000
Net sales (2002) = $425,000.
(4)
Gross Profit Percentage = Gross Profit ÷ Net Sales
Gross Profit Percentage = $200,000 ÷ $425,000
Gross Profit Percentage = 47.1%
27.
(1)
(2)
32.
(1a)
The ending balance on the Statement of Stockholders’ Equity for Common Stock,
Additonal Paid-in Capital, and Retained Earnings are presented on the balance
sheet in the Stockholders’ Equity section.
Sale of common stock for $540,000 (Par value $240,000 + $300,000).
CASES
Charging interest is not the principle operation of Carnival. Thought interest
earned is a revenue, it is a nonoperating revenue, and is, therefore, not listed with
operating revenues.
(1b)
Carnival primarily proves a service, although they do provide (sell) products. For
this reason, Carnival’s cost of goods sold is a relatively small portion of its
expenses. In fact, they do not list cost of goods sold separately and do not
calculate Gross Profit.
(1c)
Ticket sales for cruises, sales of sightseeing packages, sales of items to
passengers, etc.
21
(2a)
Total Assets = $11,563,552,000
(2b)
Current Assets
Long term investments
Property, Plant, & Equipment
Intangible Assets
(2c)
Cost of PPE
Depreciation
(2d)
The historical cost principle dictates that most assets are shown on the financial
statements at their original cost. Use of historical cost as the valuation basis for
assets stems from the fact that historical cost is more verifiable and less subject to
estimation than current values.
(2e)
Customer deposits represent money a customer gave Carnival for a future cruise.
Until Carnival provides the cruise the customer, that money is not earned and is
not a revenue. Instead, it is called unearned revenues, which is a form of current
liability because Carnival owes either a cruise or a refund.
(2f)
Carnival did estimate an amount owed but not yet recorded at the end of its fiscal
year. That amount was recorded as Accrued liabilities in the amount of
$298,032,000.
(2g)
Profits generated but not distributed to owners is known as Retained Earnings. As
of November 31, 2001, Carnival’s Retained Earnings was $5,556,296,000.
$1,958,988,000
188,955,000
8,390,230,000
651,841,000
$10,098,675,000
1,708,445,000
22
33.
(1)
For accounting information to be useful, it must possess a high degree of
relevance by being timely and having feedback and/or predictive value. The
information contained in Note 8 can help predict amounts that Carnival may owe
in the future. Therefore, it is relevant.
(2)
Materiality refers to the relative importance of specific items of accounting
information. An item is deemed material if its size is significant enough to
influence a financial statement user's decision. The contingent obligations and
travel vouchers alone equal $912 million in possible expenditures or lost revenues
(over 45% of current assets and over 7% of total assets). Adding in possible
unfavorable outcomes of the lawsuits mentioned is a material amount.
(3)
Objective 1. Financial reports should provide information that is useful in making
investing, lending, and other economic decisions.
Objective 2. Financial reports should provide information that is useful to
decision-makers in predicting the future cash flows of businesses and future cash
dividends from those businesses.
Objective 3. Financial reports should provide information about the assets and
liabilities of businesses and the transactions and other events that have resulted in
changes in those assets and liabilities.
(4)
Objective 1 would be violated if Note 8 were deleted. Though the amounts
described in Note 8 are uncertain, they have the potential to increase expenses or
decrease earnings. An investor or lender would want to know that before making
a decision. Also, an investor may not be interested in a company with, for
example, a potential lawsuit related to The Americans with Disabilities Act.
Objective 2 would also be violated. Without the information in Note 8, future
cash flows might be predicted too high. Objective 3 addresses current and
historical numbers. Because the numbers in Note 8 are represent the future, and
really only the possible future, Objective 3 would not be violated if Note 8 were
deleted.
CHAPTER 3
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
1.
Assets include cash and accounts receivable. Liabilities include accounts payable
and wages payable. Owners’ equity includes owners’ capital and owners’ drawing
accounts.
Stockholders’ equity includes common stock and retained earnings.
2.
Investments and drawings by the owner affect owners’ equity. Sales of stock and
dividends affect stockholders’ equity accounts.
23
3.
Sales slips indicate a transaction where the company has earned a revenue by
providing a product or service to a customer, who, in exchange gave the company
a payment or promise to pay.
Checks indicate that a payment has taken place, which may be for an expense, to
reduce a liability, purchase an asset, or distribute dividends.
Legal contracts can be evidence that a company has either promised to pay
(liability) or has been promised a payment by someone else (receivable)
Purchase orders and invoices indicate that a company ordered an asset (e.g.,
inventory, equipment) and it has been received, so the company must pay for it
(liability).
4.
Posting to the general ledger serves the purpose of summarizing the accounting
information into specific accounts.
5.
A trial balance is a work paper that lists all the accounts in the general ledger with
their respective debit or credit balance. The purpose of a trial balance is to prove
the equality of debits and credits in the ledger; if the trial balance balances, it does
not mean that everything has been done correctly; it only means that there is
equality between debits and credits.
24
6.
A deferred expense is actually an asset that has been created by a prepayment of
an expense, such as prepaid insurance and prepaid property taxes. If a portion of
the prepayment has been “used up”, failure to adjust deferred expenses (prepaid
assets) at the end of an accounting cycle will cause the balance in the asset
account will be overstated and the balance in the expense account will be
understated.
7.
A deferred revenue is a liability because the organization has received cash in
advance of the earning process. Examples of deferred revenues include unearned
magazine subscriptions revenues and unearned rental income. If the company
earns a portion or all of the deferred revenue, failure to adjust the balance will
result in liabilities that are overstated and revenues that are understated.
8.
An accrued revenue is an asset because it represents a receivable that has resulted
from revenues earned, but not yet received. Examples of accrued revenues
include Interest Receivable and Accounts Receivable. If revenues are earned but
not accrued, revenues and assets are understated. The adjusting entry corrects this
understatement.
9.
Through the closing process, net income or net loss is transferred to Retained
Earnings (a balance sheet account).
10.
Retained earnings is presented in the stockholders’ equity section of the balance
sheet; it is also on the statement of stockholders’ equity. This account represents
the
earnings of the organization that have not been distributed in the form of
dividends to the stockholders.
11.
Dividends are distributions to stockholders for their investment in the
organization. Dividends are found on the Statement of Stockholders’ Equity as a
reduction of retained earnings. [Dividends will also be found on the balance sheet
in current liabilities as Dividends Payable if they (dividends) have been declared
but not paid.] Dividends are not considered expenses, because they are not actual
costs of operating the business. They are, instead, returns on investments to the
business’ investors.
12.
Permanent (or real) accounts are not closed at the end of the cycle and are found
on the balance sheet. Temporary accounts (or nominal) accounts contain
accounting information are closed at the end of the cycle and are generally found
on the income statement. An exception is the temporary account Dividends
which is shown on the Statement of Retained Earnings.
13.
Correcting entries are made when a previous entry contains an error. The
purpose of a correcting entry is both to eliminate the effect of the erroneous
entry.
Adjusting entries are made at the end of each accounting cycle to bring all
25
revenue and expense accounts up-to-date to reflect the appropriate amounts of
revenues earned and expenses incurred during that particular cycle.
Closing entries are made at the end of each accounting cycle to bring all
temporary accounts to zero balances, which enables the organization to start
the next accounting cycle with a “fresh slate.”
EXERCISES
14.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
F .........A journal entry may affect as many accounts as necessary as long
as the dollar amount of the debits equals the dollar amount of the
credits.
F .........As long as every journal entry is in balance, the accounting records
will be in balance. A balanced journal entry may still be wrong.
T
T
T
F .........A credit balance in retained earnings represents the excess of
revenues over expenses and dividends. A net loss occurs when
revenues are less than expenses.
F .........The closing process starts with preparing closing entries.
F .........Income summary is a temporary account used during the closing
process.
T
F .........This statement refers to public companies although privatelyowned companies may also follow a similar pattern.
T
F
15.
Alcoa and Subsidiaries
(1) A
L
Q
X
R
17.
(1a)
(1b)
(2) DR
CR
CR
DR
C
R
Wendy's International,
Inc.
(1) X
(2) DR
A
DR
L
CR
X
DR
A
D
R
Honeywell Inc.
(1) L
(2) CR
A
DR
A
DR
X
DR
A
C
R
Cash $24,000
Unearned Rent Revenue
Prepaid Advertising
Cash
$24,000
6,000
6,000
26
(2a)
(2b)
Prepaid Rent
Cash
24,000
24,000
Cash 6,000
Unearned Advertising Revenue
(3a)
The first transaction increased assets (cash) by $24,000.
(3b)
The second transaction decreased assets (cash) by $6,000
6,000
19.
(1–3)
Cash
$12,400
320
5,750
4,300
2,000
$11,530
Accounts Receivable
$9,300
5,750
$3,550
Inventory
$6,100
7,500
$13,600
Office Supplies
$840
320
$1,160
Accounts Payable
$14,200
7,500
4,300
$17,400
Utility Expense
$0
2,000
$2,000
27
(4)
22.
(1)
The purpose of posting journal entries to the ledger accounts is to help consolidate
the information by accounts to aid in financial statement preparation and to
provide specific information on balances in particular accounts.
Cash
5,000
Unearned Design Fees
(2)
23.
(1a)
(2a)
(2b)
Accounts Receivable
Unearned Design Fees
Design Fee Revenue
5,000
5,000
5,000
5,000
Cleaning Supplies
Cash
6,500
Supply Expense
Cleaning Supplies
3,100
A/R
6,500
3,100
4,100,000
Fees Earned
4,100,000
(3a)
Assets in the firm’s balance sheet would be overstated by $3,100 because the used
supplies would not deleted from assets. Expenses in the income statement would
be understated (and, thus, income would be overstated) because supply expense
would not have been recorded.
(3b)
The revenue recognition principle would have been violated if the year-end
adjusting entry had not been made. Net income/net loss for the current cycle
would have been understated/overstated, while net income/net loss for the
following would be overstated/understated. Revenue should be reported in the
period in which it is earned rather than in the period in which it is collected (i.e.,
the cash basis of accounting).
(4)
By not recording entries that involve revenues and expenses, companies can
manipulate their net income. The omission of Silverman & Sachs adjusting entry
would have understated assets and revenues, reducing net income. The omission
of Harsha’s adjusting entry would have overstated assets and understated
expenses, increasing net income. Companies might choose to omit entries to
mislead the users of the financial statements.
28
24.
(1)
Total Assets = Cash + Equipment + Supplies + Land
$18,000 = $2,500 + $5,200 + Supplies + $8,200
Supplies = $18,000 – ($2,500 + $5,200 + $8,200)
Supplies = $2,100
Total Assets = Total Liability + Equity
Total Liabilities + Equity = $18,000
Total Liabilities + Equity = A/P + N/P + Owners’ Equity
$18,000 = Accounts payable + $5,400 + $9,000
Accounts Payable = $18,000 – ($5,400 + $9,000)
Accounts Payable = $3,600
(2)
Total Liabilities + Equity = A/P + N/P + Owners’ Equity
$19,900 = Accounts payable + $5,400 + $9,000
Accounts Payable = $19,900 – ($5,400 + $9,000)
Accounts Payable = $5,500
Total Assets = Total Liability + Equity
Total Assets = Cash + Equipment + Supplies + Land
$19,900 = $2,500 + $5,200 + Supplies + $8,200
Supplies = $19,900 – ($2,500 + $5,200 + $8,200)
Supplies = $4,000
(3)
Cash
Supplies
Equipment
Land
Accounts Payable
Notes Payable
Owners’Equity
Total
Debits
$ 2,500
2,100
5,200
8,200
$18,000
Credits
$3,600
5,400
9,000
$18,000
29
25.
(1)
(2)
28.
(1)
Sales Revenue
Income Summary
25,000
Income Summary
Selling Expenses
Income Taxes Expense
Utilities Expense
13,000
Income Summary
Retained Earnings
(or Owner’s Capital)
12,000
6,000
4,000
3,000
12,000
The company earned $12,000.
12/1
3
9
16
22
26
30
31
(2)
25,000
Supplies
Cash
300
Utilities Payable
Cash
250
300
250
Salary Expense
Cash
1,200
1,200
Cash
Interest Receivable
Cash
Accounts Receivable
Prepaid Rent
Cash
600
600
1,700
1,700
400
400
Cash
Unearned Revenue
2,500
Equipment
Accounts Payable
3,000
2,500
3,000
The entries on December 1, 26, 30, and 31.
30.
(1)
BCCI
Trial Balance
30
9/30/02
Cash
Accounts Receivable
Inventory
Office Equipment
Accumulated Depreciation-O.E.
Accounts Payable
Income Taxes Payable
Common Stock
Retained Earnings
Sales Revenue
Operating Expenses
Totals
Debits
$ 25,000
150,000
150,000
425,000
Credits
$ 55,000
350,000
50,000
45,000
50,000
300,000
100,000
$850,000
$850,000
(2)
Three examples are: (a) recording the purchase of Supplies for cash as a debit to
Office Equipment; (b) the payment on account recorded as a debit to Notes
Payable, instead of Accounts Payable, and (c) the recording of Rent Expense as a
debit to Utility Expense.
(3)
BCCI could take the following steps to help ensure the accuracy of its accounting
records: (1) automate its accounting system, (2) make sure all transactions are
recorded in the records, (3) hire qualified accounting professionals.
31
31.
(1a)
(1b)
(1c)
(1d)
Salary Expense
Salary Payable
840
Utility Expense
Utility Payable
240
Income Tax Expense
Income Tax Payable
800
Unearned Fee Revenue
Fee Revenue
100
(1e)
no adjusting entry needed
(1f)
Accounts Receivable
Fee Revenue
840
240
800
100
1,400
1,400
(2)
Neither expenses nor payables for salaries, utilities, or income taxes would have
been recorded until the cash had been paid. The $300 and $680 would have been
recorded as revenue when received; the $1,400 left unbilled would not have
shown up on the books at all for December, but rather when received in the
future.
(3)
The accrual basis of accounting would provide a better and more appropriate
matching of revenues and expenses for your business. It would allow you to
properly compute net income or net loss for each accounting cycle. The cash basis
of accounting only allows you to record transactions when cash comes into the
business or goes out of the business; it really isn’t conducive to preparing
appropriate financial statements.
Chapter 4
Solutions to End of Chapter Material
QUESTIONS
1.
Cash equivalents include funds invested in certificates of deposit, money market
funds, treasury bills, and short-term securities. Usually, these investments mature
in 90 or fewer days.
To qualify as a cash equivalent, the invested funds must be convertible to a
specified amount of cash virtually on demand. Therefore, these funds are
essentially as liquid as cash itself, which is why they are combined with cash on
the balance sheet.
32
2.
An operating cycle is defined as the time between the spending of money for
merchandise by an organization and the collection of cash from that organization's
customers. The longer the operating cycle, the more likely that the company may
need to augment its cash in alternative ways, such as through short-term
borrowing or (if long-term needs cannot be satisfied) through long-term debt or
stock issuances.
3.
The purpose of a bank reconciliation is to ensure that your general ledger cash
account agrees with the bank's accounting of your money. The bank reconciliation
should be prepared soon after it is received for several reasons: (a) your errors or
the bank's errors can be corrected quickly; (b) you become aware of certain items
when the statement is received such as drafts, direct deposits, fees, and NSF
checks; and (c) differences between your records and the bank's records may
assist in locating fraudulent activities perpetrated with your cash account.
4.
The most common adjustments on an individuals bank reconciliation including
the following: (a) adjusting the bank’s balance down for outstanding checks; (b)
adjusting the bank’s balance up for outstanding deposits; (c) adjusting your
balance down for service fees, check printing fees, NSF checks and fees, and
drafts; and (d) adjusting your balance up for interested earned and direct deposits.
33
5.
A company extends credit so that customers that cannot or will not pay cash at the
moment will still make a purchase. Companies that extend credit have two credit
options: national credit cards and in-house credit.
Accepting national credit cards is the less risky option because the credit card
company will usually pay the company before (and whether or not) the customer
pays his/her credit card bill. However, there is a fee, a small percentage of the sale
amount, which is deducted by the credit card company, so the business that
accepts national credit cards will realize less cash on a credit sale than a cash sale.
Issuing in-house credit eliminates the fee associated with national credit cards.
The issuing company has the right to collect 100% of the sale and, often, interest
on unpaid balances. However, new issues face the issuing company. Customer
should be screened and credit issued to only to customers with a good credit
history. Even with the best customer screening, collection of accounts receivable
is complex and many debts are often not collected.
6.
The matching principle dictates that companies estimate bad debts each
accounting cycle. The direct write-off method of recording bad debts does not
appropriately match the revenues generated in a particular period with the
potential and actual bad debt expenses that may be incurred in a future period
related to those revenues. The allowance method of estimating bad debts, based
on either accounts receivable or sales, attempts to properly match the revenues
generated during an accounting cycle with the bad debt expense anticipated for
that period.
7.
Liquidity is the ability to pay liabilities as they come due and the organization’s
ability to finance day-to-day operations. Liquidity is important in preparing a
balance sheet because current assets must be used to pay off or extinguish current
liabilities.
8.
Bankers and other creditors are very interested in a firm’s liquidity because they
want to know if short-term outstanding debt can be repaid on a timely basis.
34
9.
The quick ratio is computed as (cash + cash equivalents + short-term investments
+ net amounts of current notes and accounts receivable) divided by total current
liabilities. Lending decisions are often made after assessing a firm’s liquidity
ratios by comparing these to industry norms for that particular industry.
10.
The receivables turnover ratio tells an organization how many times during a
cycle the organization collects its receivables. The age of receivables indicates
how "old" on average the group of receivable is and can be compared to the credit
terms of the organization to see whether collections are being made on a timely
basis.
35
EXERCISES
11.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
F .........The risk of issuing in-house credit is much greater than accepting
national credit cards because the responsibility of collection is on
the issuing company.
T
F .........Errors on the part of the bank are adjustments to the bank balance
on the bank reconciliation and do not affect the company’s cash
ledger.
T
F .........The direct write-off method expenses bad debt when they are
deemed uncollectible, which may or may not be in the same period
that the sale (revenue) was generated.
F .........Quick assets include cash, accounts receivable, and short-term
investments.
F .........Securities that have a chance of fluctuating in value cannot be
considered a cash equivalent.
T
T
F .........Notes receivable can be dated as a daily, monthly, or yearly note.
36
12.
6/1
6/5
6/15
6/17
6/25
6/29
6/30
Accounts Receivable
Sales
400
Allowance for Uncollectible Accounts
Accounts Receivable
350
Accounts Receivable
Sales
400
350
1,200
1,200
Sales Returns & Allowances
Accounts Receivable
60
Cash
Sales Discounts
Accounts Receivable
1,176
24
60
1,200
Accounts Receivable
Allowance for Uncollectible Accounts
Cash
Accounts Receivable
350
Cash
340
350
350
350
Accounts Receivable
340
37
13.
(1)
Credit Card Receivable-PlasticCard
Credit Card Receivable-A/R-BanCard
Credit Card Receivable-A/R-BigCard
Sales Revenue
10,500.00
22,000.00
37,250.00
Cash
Credit Card Expense
Credit Card Receivable-PlasticCard
(10,500×3%=315)
10,185.00
315.00
Cash
Credit Card Expense
Credit Card Receivable-PlasticCard
(22,000×3%=660)
21,340.00
660.00
Cash
Credit Card Expense
Credit Card Receivable-PlasticCard
(37,250×5%=1,862.50)
37,250.00
1,862.50
69,750.00
10,500.00
22,000.00
37,250.00
(2)
Retail stores accept bank credit cards because they offer the stores better
collectibility than in-house credit accounts. Banks always pay their bills, while
retail customers often do not. Accepting credit cards for retail sales will not
reduce profit; it may in fact increase profits because customers may buy more
using credit.
(3)
The Magic Shoppe may honor BigCard inspire of its higher service fee because
many customers in its retail area choose to use that particular card. Choosing not
to accept this particular card might reduce sales and, therefore, profits.
38
14.
(1)
(2)
Notes Receivable
Accounts Receivable
Interest Receivable
Interest Revenue
(3,000×10%=300×3/12=75)
$3,000.00
$3,000.00
75.00
75.00
The revenue recognition principle requires that revenues be recorded in the period
in which they were earned. Interest is a factor of time and this interest is earned in
the three months of the current year.
(3)
The collection of Chris’s note and interest can be journalized in two ways:
Alternative #1 (one entry)
Cash
Interest Receivable
Interest Revenue
Notes Receivable
Alternative #2 (two entries)
Interest Receivable
Interest Revenue
Cash
Interest Receivable
Notes Receivable
3,100.00
75.00
25.00
3,000.00
25.00
25.00
3,100.00
100.00
3,000.00
39
15.
2002 Uncollectible Estimate = Credit Sales × 2.5%
2002 Uncollectible Estimate = $1,000,000 × .025
2002 Uncollectible Estimate = $25,000
2002 Write-offs
(1)
Allowance for Uncollectible
Accounts
$16,300
$12,500
$3,800
25,000
$28,800
January 1, 2002
December 31, 2002
Adjustment
2002 Estimate
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
$25,000
$25,000
(2)
$28,800
(3)
$25,000
(4)
The Allowance account balance at year end should be equal to the estimate.
Because the prior year’s estimate is almost never right, a balance (either debit or
credit) remains in the Allowance account, so the adjustment may be more or less
than the estimate.
PROBLEMS
18.
(1)
(2)
(3)
4/1
5/1
Petty Cash
Cash
Meals Expense
Repairs Expense
Art Supplies
Delivery Expense
Postage Expense
Cash
400
400
18.21
27.54
87.54
41.25
38.23
212.77
Cash might have been lower that expected for different reasons. Someone might
have accidentally taken the wrong amount or made the wrong change.
Alternatively, someone might be taking petty cash for personal use, or someone
might have taken petty cash without placing the receipt in the envelope.
22.
(1)
40
Xenon, Inc.
Bank Reconciliation
August 31
$2,567
1,900
$4,467
2,250
$2,217
Balance Per Bank
Add:
Deposits in transit
Subtotal
Less:
Outstanding Deposits
Adjusted Bank Balance
$860
Balance Per Books
Add:
Direct Deposit from customer
Interest
Subtotal
Less:
Error recording check 345 for
insurance
NSF customer check
Service Fee
Adjusted Book Balance
(2)
Cash
$1,400
12
$15
32
8
55
$2,217
1,400
Accounts Receivable
Cash
1,400
12
Interest Revenue
12
Insurance Expense
Cash
15
Accounts Receivable-NSF
Cash
32
Bank Fee Expense
Cash
(3)
1,412
2,272
15
32
8
8
Drawbacks: Service fees, possibility of overdrawing the account, possibility of
fraudulent use of account.
Benefits: Security of money, security of transactions (no mailing cash), record of
transactions, availability of drafts and electronic funds transfers, interest earned
on outstanding balances, third-party verification of balance.
24.
(1)
Allowance for Uncollectible Accounts
Accounts Receivable-Cantore
1,425
1,425
41
Allowance for Uncollectible Accounts
Accounts Receivable-Bono
(2)
Uncollectible Accounts Expense
Allowance for Uncollectible Accounts
Allowance
1,425
112,500
930
110,145
930
930
252,855
252,855
$363,000 (desired balance) - $110,145 (current balance)
= $252,855 adjustment
(3)
On the income statement, the conservative estimate would have made
Uncollectible Accounts Expense too high (and net income too lo)w. On the
balance sheet, the conservative estimate would have made the net realizable value
of Accounts Receivable too low. Estimating too high an uncollectible accounts
expense may cause investors and bankers to view the business unfavorably for
investment purposes or loan negotiations.
(4)
If the estimate is too conservative, then EHC will not write off as much as was
estimated, leaving a large credit balance in the Allowance account at the end of
2004. If the 2004 estimate is reasonable, the entry to adjust the Allowance
account in 2004 will be small because the existing Allowance balance is large.
The 2004 balance sheet will have a reasonable estimate of the net realizable value
of receivables, but the income statement will have a small Uncollectible Accounts
Expense, resulting in a higher net income. However, if 2004’s following year’s
estimate is reasonable, the problem will be not continue on to 2005.
(5)
It is not permissible to intentionally overstate expenses. As depicted in part (4),
expenses will be higher than they should be in 2003 and lower than they should
be in 2004, which violates the matching principle.
(6)
Accounts Receivable-Bono 930
Allowance for Uncollectible Accounts
Cash
Accounts Receivable-Bono
930
930
930
CHAPTER 5
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
1.
The primary differences between a perpetual and periodic system are (1) the
accounts used to record transactions and (2) the timing and manner in which cost
of goods sold is determined.
42
In a periodic inventory system, accounts such as purchases, purchases discounts,
purchases returns and allowances are used, as well as, freight in. Additionally,
when a periodic system is used, no cost of goods sold is recorded during the
period; that amount is determined as a "plug" figure at the end of the period by
subtracting the ending inventory from the cost of goods available for sale.
In a perpetual inventory system, all amounts affecting inventory are either debited
or credited directly to the inventory account. Each time a sale takes place, an entry
is made to record the increase (debit) in cost of goods sold and decrease (credit) to
inventory. An individual could, at any time, go to the inventory account and
determine the value of inventory on hand (assuming away items such as theft and
breakage). Perpetual inventory requires more work than periodic inventory, but
provides significantly better internal control for items of high value. Technology
such as bar coding has made the use of perpetual inventory much easier and much
less expensive to use.
2.
Inventory is a current asset because it will be converted into cash within a year or
an operating cycle whichever is longer.
3.
Inventory cost flow refers to the movement of inventory costs from the Inventory account
to the Cost of Goods Sold account. This flow may differ from the physical flow of
inventory which refers to the actual movement of goods from Inventory to customers.
4.
Cost of goods available for sale refers to the cost of all inventory in-house during
the reporting period; that is, all inventory that a customer could have purchased.
To calculate cost of goods available for sale, add the cost of beginning inventory
and net purchases during the period.
5.
Specific identification requires the business track the actual cost of all items sold
and items remaining in inventory at the end of the cycle. Specific ID generally
requires that inventory be "readily identifiable."
The moving average inventory method calculates an average cost of all inventory
available before each sale, and that cost is used to determine cost of goods sold
for that transaction.
The FIFO method costs the oldest inventory items out to cost of goods sold first,
while the most recent purchase costs are left in inventory.
The LIFO method costs the most recent purchases out to cost of goods sold first
oldest, leaving the costs of the oldest items in inventory.
6.
In periods of rising prices, FIFO will generate the highest ending inventory
balance. The older (lower) costs are sent to cost of goods sold, leaving the newer
(higher) costs in inventory. In LIFO, the effects are reversed.
43
7.
For balance sheet purposes, FIFO is generally considered more appropriate
because the newest costs are reflected in inventory.
8.
For income statement purposes, LIFO is generally considered more appropriate
because it provides the best matching of current revenues and current costs
because the most recent purchases are reflected in cost of goods sold.
9.
The choice between LIFO and FIFO affects the dollar amount of cost of goods
sold, and expense. Higher expenses will yield lower net income, which results in
lower taxes paid. In an period of rising prices, the LIFO assumption will cause
cost of goods sold to be higher than FIFO.
10.
Using the retail inventory method, when inventory is received, information on
both purchase cost and retail price is gathered. Sales are recorded at retail prices
and deducted from inventory at retail price; there is no entry for Cost of Goods
Sold. At the end of the period, a physical count of inventory on hand is made at
the retail price. The retail prices of the goods that should be on hand can be
compared with the retail prices of the goods that are actually on hand to determine
if theft or breakage occurred.
44
11.
The lower-of-cost-or-market rule requires businesses to calculate inventories at
the end of the cycle using the lower of cost or the current market (replacement)
value. This rule reflects the conservatism principle by not overstating inventory
(asset) values.
12.
An overstatement of ending inventory in 2003 would have the following effects:
(a) The inventory account on the 2003 balance sheet would be overstated;
(b) The cost of goods sold account on the 2003 income statement would be
understated, resulting in net income that is overstated;
(c) In 2004, beginning inventory will be overstated, and if not corrected, ending
inventory will also be overstated;
(d) In 2004, beginning inventory will be overstated, resulting in an overstated cost
of goods sold on the 2004 income statement and an understated net income.
13.
Decision makers would use the inventory turnover ratio to determine how
frequently a business sells its inventory. The higher the ratio, the more often the
inventory is sold and replaced. The age of inventory indicates how long an
inventory item sits in inventory; in this case, the lower the ratio, the better. If
inventory sits a long time in the warehouse or on the shelf, the business is not
generating much revenue and the inventory has the opportunity to become out-ofdate or "stale."
45
EXERCISES
14.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
15.
(a)
T
F .........A company may value inventory at the lower of cost or market.
T
T
F .........A lower inventory turnover ratio indicates that inventory stays in
the store longer before being sold.
F .........A company may choose any acceptable cost flow assumption.
T
F .........In FIFO, the goods purchased earlier (the less expensive ones in an
inflationary period) are sent to cost of goods sold, yielding a higher
net income.
T
F .........Information about theft can be obtained at the end of the period
when a physical inventory is counted.
When goods are shipped FOB shipping point, title to the goods transfers when the
goods are put on the delivery truck (at the shipping point). Because Dean was the
shipper, Dean should exclude the items from its inventory as soon as they have
been shipped.
(b)
When goods are shipped FOB destination, title to the goods transfers when the
goods arrive at their destination. Because Dean was the recipient, Dean should
exclude the items from its inventory until they reach their destination.
(c)
When goods are shipped FOB destination, title to the goods transfers when the
goods arrive at their destination. Because Dean was the shipper, Dean should
include the items in its inventory until they reach their destination.
(d)
When goods are shipped FOB shipping point, title to the goods transfers when the
goods are put on the delivery truck (at the shipping point). Because Dean was the
recipient, Dean should include the items in its inventory as soon as they have
been shipped.
46
16.
(1)
(2)
a. increase
b. increase
c. decrease
d. increase
e. decrease
f. no change
g. decrease
h. no change
i. increase
j. no change
In a periodic inventory system, the Inventory account is not used during regular
monthly transactions. Therefore, all of the above transactions would result in no
change to the inventory account.
47
17.
(1)
CGAS = BI + Purchases
CGAS = $150,000 + $625,000
CGAS = $775,000
CGS = CGAS – EI
CGS = $775,000 – $125,000
CGS = $650,000
(2)
An error could have been made in taking the physical count, employees or
customers could have stolen inventory, or an error could have been made in
recording purchases and/or sales during the cycle. Loss due to theft is typically
included as a part of the cost of goods sold.
(3)
Four examples for preventing inventory shrinkage are given below. There are a
variety of answers; yours may differ.
(a) Inventory could be tagged with a magnetic sensor so that an alarm rings if
taken from the store. Tagging would help prevent stealing by customers, but
because employees can remove the tags, it would not help with theft by
employees.
(b) Newly received inventory should be counted separately by two employees and
compared to the quantities shipped. Independent counts would help prevent
inventory thefts by employees before merchandise is taken to the sales floor.
(c) Employee bags and person could be subject to search when leaving to prevent
their removing merchandise from the premises without a receipt.
(d) Security cameras monitored by a security personnel would help detect and
prevent theft by both customers and employees.
48
18.
Specific ID
CGAS
- EI
= CGS
Rev
- CGS
= GP
$790
$588
$202
$400
$202
$198
CGAS
- EI
$790.00
$592.50
= CGS
Rev
- CGS
= GP
$197.50
$400.00
$197.50
$202.50
FIFO
$790
$600
$190
$400
$190
$210
(95+95+98+98+101+101)
(98+104)
(200×2)
(98+98+98+ 101+101+104)
(95+95)
(200×2)
Moving Average
19.
(1)
LIFO
$790
$585
(AC=$790÷8=$98.75)
(EI=$98.75×6)
$205
$400
$205
$195
($98.75×2)
(200×2)
(95+95+98+98+98+101)
(101+104)
(200×2)
CGAS=$17,894.75
Units
600
650
750
840
745
3,585
BI
Purch(2/1)
Purch(2/8)
Purch(2/15)
Purch(2/22)
(2)
(3)
(4)
(5
LIFO
MAC
FIFO
(a) MAC
(6)
Net Sales = Units Sold × Sales Price
Net Sales = (500+800+795+825) × $10.50
Net Sales = 2,920 × $10.50
Net Sales = $30,660.00
(b) FIFO
Cost/Unit
4.00
4.50
5.00
5.40
5.75
Extended Cost
$2,400.00
2,925.00
3,750.00
4,536.00
4,283.75
$17,894.75
(c) LIFO
CGS (FIFO) = $2,000 + 3,575 + 4,013 + 4,483 = $14,071.00
CGS (LIFO) = $2,250 + 3,975 + 4,293 + 4,684.25 = $15,202.25
CGS (MAC) = $2,130 + 3 704 + 4 014.75 + 4,455 = $14,303.75
Gross Profit = Net Sales – Cost of Goods Sold
GP (FIFO) = $30,660.00 – $14,071.00 = $16,589.00
GP (LIFO) = $30,660.00 – $15,202.25 = $15,457.75
GP (MAC) = $30,660.00 – $14,303.75 = $16,356.25
49
FIFO
BI
Purch(2/1)
600
650
1,250
Available for Sale
4.00
2,400.00
4.50
2,925.00
5,325.00
Sale
500
4.00
2,000.00
500
2,000.00
100
650
750
Still in Inventory
4.00
400.00
4.50
2,925.00
3,325.00
100
650
750
1,500
4.00
4.50
5.00
400.00
2,925.00
3,750.00
7,075.00
100
650
50
800
4.00
4.50
5.00
400.00
2,925.00
250.00
3,575.00
0
0
700
700
4.00
4.50
5.00
0.00
0.00
3,500.00
3,500.00
Purch(2/15)
700
840
1,540
5.00
5.40
3,500.00
4,536.00
8,036.00
700
95
795
5.00
5.40
3,500.00
513.00
4,013.00
0
745
745
5.00
5.40
0.00
4,023.00
4,023.00
Purch(2/28)
745
745
1,490
5.40
5.75
4,023.00
4,283.75
8,306.75
745
80
825
5.40
5.75
4,023.00
460.00
4,483.00
0
665
665
5.40
5.75
0.00
3,823.75
3,823.75
Purch(2/8)
LIFO
BI
Purch(2/1)
Purch(2/8)
Purch(2/15)
Purch(2/28)
MAC
BI
Purch(2/1)
Purch(2/8)
Purch(2/15)
Purch(2/28)
600
650
1,250
Available for Sale
4.00
2,400.00
4.50
2,925.00
5,325.00
Sale
500
500
4.50
2,250.00
2,250.00
50
750
800
4.50
5.00
225.00
3,750.00
3,975.00
600
100
0
700
4.00
4.50
5.00
2,400.00
450.00
0.00
2,850.00
4.00
4.50
5.40
2,400.00
450.00
243.00
3,093.00
4.00
4.50
5.40
5.75
2,400.00
292.50
0.00
0.00
2,692.50
600
150
750
1,500
4.00
4.50
5.00
2,400.00
675.00
3,750.00
6,825.00
600
100
840
1,540
4.00
4.50
5.40
2,400.00
450.00
4,536.00
7,386.00
795
795
5.40
4,293.00
4,293.00
600
100
45
745
600
100
45
745
1,490
4.00
4.50
5.40
5.75
2,400.00
450.00
243.00
4,283.75
7,376.75
35
45
745
825
4.50
5.40
5.75
157.50
243.00
4,283.75
4,684.25
600
65
0
0
665
Available for Sale
600
4.00
650
4.50
1,250
Average Cost =
750
0.00
750
5.00
1,500
Average Cost =
700
0.00
840
5.40
1,540
Average Cost =
745
0.00
745
5.75
1,490
Average Cost =
Sold
2,400.00
2,925.00
5,325.00
4.26
3,195.00
3,750.00
6,945.00
4.63
3,241.00
4,536.00
7,777.00
5.05
3,762.25
4,283.75
8,046.00
5.40
Still in Inventory
4.00
2,400.00
4.50
675.00
3,075.00
600
150
750
Still in Inventory
500
4.26
2,130.00
750
3,195.00
800
4.63
3,704.00
700
3,241.00
795
5.05
4,014.75
745
3,762.25
825
5.40
4,455.00
665
3,591.00
50
21.
(1)
Cost EI = (50×$20)+(30×$25)+(40×$28)+(45×$32)=$4,310
(2)
Replacement Cost EI
= (50×$18)+(30×$25)+(40×$26)+(45×$35)=$4,265
(3)
Lower of Cost or Market (LCM) EI
= (50×$18)+(30×$25)+(40×$26)+(45×$32)=$4,130
Adjustment = Cost EI – LCM EI
= $4,310 – $4,130 = $180 reduction in inventory value
Journal Entry:
Cost of Goods Sold
Inventory
(4)
22.
(1)
$180
$180
The inventory on the balance sheet will be $180 lower than it would have been if
the adjustment hadn’t been made. Cost of goods sold on the income statement will
be $180 higher (resulting in a net income $180 lower) than if the adjustment
hadn’t been made.
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
Operating Income
Income Taxes (30%)
Net Income
$89,000
(43,000)*
$46,000
(10,000)
$36,000
(10,800)
$25,200
* If EI is too high, $12,000 that was counted as EI should have been included in
CGS. Therefore CGS should be $43,000 (31,000 + 12,000).
(2)
This error is material (large compared to other numbers). By not correcting it,
Kincade can mislead investors and lenders into believing that gross profit is much
higher than it actually is. Those parties are relying on the fact that $89,000 in
revenues can generate gross profit of $58,000 when it really only generates gross
profit of $46,000. If the error was immaterial, Kincade’s argument could be valid,
but with this material an error, it should be corrected.
PROBLEMS
24.
(1)
4/6
Inventory
Accounts Payable
660.00
660.00
51
4/9
4/13
4/16
4/17
4/20
4/21
4/27
4/27
Accounts Payable
Inventory
220.00
220.00
Cash
70.00
Sales
Cost of Goods Sold
Inventory
42.00
70.00
42.00
Accounts Payable
Cash
Inventory
440.00
Inventory
Accounts Payable
216.00
431.20
8.80
216.00
Accounts Receivable
Sales
Cost of Goods Sold
Inventory
35.00
Inventory
Cost of Goods Sold
Sales Returns & Allowances
Accounts Receivable or Cash
20.00
Accounts Receivable
Sales
Cost of Goods Sold
Inventory
70.00
Accounts Payable
Cash
Inventory
35.00
24.00
24.00
20.00
35.00
35.00
70.00
34.00
34.00
216.00
211.68
4.32
52
25.
(1a)
Revenues = Units sold × Selling Price
Revenues = (300×$40)+(350×$45)+(150×$45)+(450×$50)
Revenues = $57,000
FIFO
BI
Purch(1/2)
Purch(1/9)
Purch(1/18)
Purch(1/25)
400
200
600
Available for Sale
20.00
22.00
8,000.00
4,400.00
12,400.00
300
Sold
20.00
300
6,000.00
6,000.00
100
200
300
Still in Inventory
20.00
22.00
2,000.00
4,400.00
6,400.00
100
200
200
500
20.00
22.00
24.00
2,000.00
4,400.00
4,800.00
11,200.00
100
200
50
350
20.00
22.00
24.00
2,000.00
4,400.00
1,200.00
7,600.00
0
0
150
150
20.00
22.00
24.00
0.00
0.00
3,600.00
3,600.00
150
200
350
24.00
25.00
3,600.00
5,000.00
8,600.00
150
24.00
3,600.00
24.00
25.00
3,600.00
0
200
200
0.00
5,000.00
5,000.00
200
500
700
25.00
26.00
5,000.00
13,000.00
18,000.00
200
250
450
5,000.00
6,500.00
11,500.00
250
250
26.00
6,500.00
6,500.00
150
25.00
26.00
CGS(FIFO) = $6,000+7,600+3,600+11,550 = $28,750
EI (FIFO) = $6,450
Gross Profit (FIFO) = Revenues – CGS
Gross Profit (FIFO) = $57,000 – $28,750
Gross Profit (FIFO) = $28,250
(1b)
LIFO
BI
Purch(1/2)
400
200
600
Available for Sale
20.00
8,000.00
22.00
4,400.00
12,400.00
100
200
300
Sold
20.00
22.00
2,000.00
4,400.00
6,400.00
300
0
300
Still in Inventory
20.00
6,000.00
22.00
0.00
6,000.00
Purch(1/9)
300
200
500
20.00
24.00
6,000.00
4,800.00
10,800.00
150
200
350
20.00
24.00
3,000.00
4,800.00
7,800.00
150
0
150
20.00
24.00
3,000.00
0.00
3,000.00
Purch(1/18)
150
200
350
20.00
25.00
3,000.00
5,000.00
8,000.00
150
150
25.00
3,750.00
3,750.00
150
50
200
20.00
25.00
3,000.00
1,250.00
4,250.00
150
50
500
700
20.00
25.00
26.00
3,000.00
1,250.00
13,000.00
17,250.00
11,700.00
11,700.00
150
50
50
250
20.00
25.00
26.00
3,000.00
1,250.00
1,300.00
5,550.00
Purch(1/25)
450
450
26.00
Note- rounding error in solution.
CGS(LIFO) = $6,400+7,800+3,750+11,700 = $29,650
EI (LIFO) = $5,550
53
Gross Profit (LIFO) = $57,000 – $29,650 = $27,350
(1c)
MAC
BI
Purch(2/1)
Purch(2/8)
Purch(2/15)
Purch(2/28)
Available for Sale
400
20.00
8,000.00
200
22.00
4,400.00
600
12,400.00
Average Cost =
20.67
300
6,199.00
200
24.00
4,800.00
500
10,999.00
Average Cost =
22.00
150
3,299.00
200
25.00
5,000.00
350
8,299.00
Average Cost =
23.71
200
4,742.50
500
26.00
13,000.00
700
17,742.50
Average Cost =
25.35
Sold
Still in Inventory
300
20.67
6,201.00
300
6,199.00
350
22.00
7,700.00
150
3,299.00
150
23.71
3,556.50
200
4,742.50
450
25.35
11,407.50
250
6,335.00
28,865.00
CGS(MAC) = $6,201+7,700+3,556.50+11,407.50= $28,865.00
EI (MAC) = $6,335.00
Gross Profit (MAC) = $57,000 – $28,865.50 = $28,134.50
(2)
FIFO yields the lowest cost of goods sold, and the highest gross profit. Therefore,
if FIFO is used the net income will be higher than with the other methods. The
reason is that costs are increasing. FIFO uses the earlier (smaller) prices for cost
of goods sold and the later (larger) prices for ending inventory.
(3)
A company should consider how actual costs flow in their business and how the
cost flow methods will affect the accounting records. GAAP doesn’t require the
actual cost flow method to match the method used for financial reporting;
however, if they do match, the numbers in the financial statements are more likely
to reflect the actual inventory and cost of goods sold that a company has. The
method used is disclosed in the notes to the financial statement so that decision
makers will also know the impact it has on the financial statements.
CHAPTER 6
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
1.
The major types of long-term assets and examples of each are below.
Long-term investments: Investment in bonds, Investment in stocks of subsidiary
Property, plant, and Equipment: Land, Building, Equipment, Leasehold improvements
54
Intangible Assets: Patent, Copyright, Goodwill
2.
Depreciation is a method of allocating the cost of an asset (expended when the
asset is acquired) over the useful life of the asset (when the asset is used).
Depreciation expense is the portion of the cost expensed in a given year.
55
3.
Using the straight-line method, depreciation expense for a full year is calculated
by dividing the depreciable amount (acquisition cost minus salvage value) by the
useful life in years. [Partial years are adjusted by multiplying by a fraction that
indicates the portion of a year the asset was in service.] The straight-line rate of
depreciation (not needed for calculations) is 100% ÷ useful life in years.
Using the units-of-production method, depreciation expense for a given year is
calculated by multiplying the units used in that year by the per-unit depreciation
amount. Per-unit depreciation is calculated by dividing the depreciable amount
(acquisition cost minus salvage value) by the useful life in units.
Using the double-declining balance method, depreciation expense for a full year is
calculated by multiplying the beginning book balance (acquisition cost minus
accumulated depreciation from prior years) by the depreciation rate. The
depreciation rate is calculated in one of two ways: (1) 2 ÷ useful life in years, or
(2) twice the straight-line rate of depreciation. [Partial years are adjusted by
multiplying by a fraction that indicates the portion of a year the asset was in
service.]
EXAMPLE [Numerical examples given by students will differ.]
An asset costing $106,000, has a salvage value of $6,000 and a useful life of 10
years. For the first year (a full year), depreciation expense is calculated using
straight-line and double-declining balance methods below.
Straight Line (SL) Method:
Depreciable Amount = $106,000 – $6,000 = $100,000
Depreciation Expense = $100,000 ÷ 10 years = $10,000
Double-Declining Balance (DDB) Method:
Book Value = $106,000 – 0 = $106,000
(no accumulated depreciation yet)
Depreciation Rate = 2 ÷ 10 = 20%
Depreciation Expense = $106,000 × 20% = $21,200
The SL Method would yield a higher net income on the income statement because
expenses would be lower than if the company used the DDB Method. However,
the higher expenses obtained using the DDB Method would be beneficial for tax
purposes because the net income would be lower, and so would taxes.
56
4.
Book value is calculated by subtracting accumulated depreciation from asset cost.
Each year of the useful life of an asset, depreciation expenses is recorded causing
accumulated depreciation to increase and book value to decrease. Other events
that might cause the book value of an asset to change include capitalizable
expenditures (such as putting a new motor on a machine) that increase the value
of the asset.
5.
The gain or loss on the sale of a long-term asset is calculated by the following
formula: Gain (Loss) = Cash received for asset minus book value of the asset. If
the asset is not sold, but “junked” or disposed of, the cash received would be zero.
Therefore, the loss would be equal to the book value.
6.
When an asset is sold, three events occur that must be reflected in the journal
entry: (1) cash is received, (2) the asset is removed from the accounting records,
and (3) a gain or loss is recognized if one exists. In this journal entry, the first and
third event is handled properly.
The asset has not been removed from the books correctly. The original cost of the
asset is in the account Equipment. Therefore, that account should be credited for
$89,000, not $29,000. The accumulated depreciation (the difference between cost
and book value) is in a contra-asset account entitled Accumulated Depreciation—
Equipment, which has a balance of $60,000 ($89,000–$29,000). To remove that
account it should be debited for its balance. The correct journal entry is shown
below.
Cash
Loss on Sale of Equipment
Accumulated Depreciation–Equipment
Equipment
$24,600
4,400
60,000
$89,000
57
7.
Depreciation is used to expense the cost of a PPE asset over its useful life.
Depreciation takes into account the salvage value of the asset at the end of its
useful life, and the amount of depreciation taken each year is accumulated in an
account that is contra to the asset account.
Depletion is used to expense the portion of the cost of an asset (usually land) that
has natural resources (e.g., trees, oil, coal). After the natural resources are
completely depleted, the value of the asset should be equal to the value of the land
without the resources (or equal to zero if only the right to the resources were
purchased).
Amortization, which is similar to straight-line depreciation, is used for intangible
assets. The cost of an intangible asset such as a patent are expensed over its useful
life, legal life, or 40 years, whichever is shorter. There is typically no salvage
value for intangible assets, and the cost of the asset is written down directly
without the use of a contra account.
8.
Identifiable intangible assets include patents, copyrights, trademarks, and other
rights to profit from an “idea”. These assets are called intangible because they
represent “ideas” as opposed to a physical asset (e.g, car). However, those listed
above are attributable to a specific “idea”; for example, the right to profit from the
use of the trademarked name Pepsi is different from the copyright to the jingle,
“Pepsi, for those who think young.”
Goodwill is another intangible asset that represents some “idea” that a company is
more valuable than the fair market value of its assets. This intangible asset is
usually unidentifiable. It is the culmination of years of business, customer loyalty,
etc.
9.
An advantage of using historical cost to value assets is objectivity because
historical cost can be verified through source documents. A disadvantage of
using historical cost is that, after some period of ownership and use, the balance
sheet amount for an asset will probably be totally unrelated to the actual market
values of the assets they purport to represent. Most people, accountants included,
do not have the expertise to estimate the value of an asset; therefore, historical
cost is used to eliminate subjectivity.
58
10.
Acquisition cost includes all costs that are reasonable and necessary to get the
asset into place and ready for its intended use (i.e., purchase price, sales tax,
freight, insurance during shipping, and installation costs). Excluded costs (which
are expensed rather than capitalized) include costs that are not reasonable or
necessary to get the asset into place (e.g., insurance after shipping, yearly
registration or license fees).
11.
A company can depart using historical cost when long-term assets become
impaired and must be written down to lower values.
12.
The information needs concerning PPE include the following:
(a) disclosure of major types of depreciable assets;
(b) historical cost of assets;
(c) depreciation methods used;
(d) any restrictions on the use of long-term assets;
(e) impairments to the fair market value of the asset;
(f) average age of assets; and
(g) average useful or legal life of assets.
59
EXERCISES
13.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
14.
(1)
(2)
F .........Intangible assets should amortized over the SHORTER of legal
life, useful life, or forty years.
T
F .........Acquisition cost is the total amount capitalized to acquire the asset.
Depreciable cost is acquisition cost minus salvage value.
F .........Even though the salvage value is not used in calculations, it is
needed to decide how much to depreciate the asset.
F .........Intangible assets are presented at the unamortized portion of cost.
F .........Depreciation is the method of expensing cost over useful life and is
not influenced by value.
F .........Land does not depreciate.
F .........Depreciation is an operating expense.
Acquisition Cost
Invoice Cost ($400,000 × .85)
Delivery Cost
Installation and Testing
Installation and Testing Supplies
Total Acquisition Cost
Computer
344,000
Cash (or Accounts Payable)
(3)
$340,000
2,300
1,500
200
$344,000
344,000
Because of the accounting principle of verifiability, historical cost is still the best
value to use for depreciable assets in spite of rapid changes in technology. For
assets that decline in value so quickly, it is appropriate to choose a decliningbalance depreciation method. Therefore, even though the historical cost is shown
on the balance sheet, the book value would reflect the big reduction due to
depreciation. However, if the assets have had substantial declines in value,
conservatism would require writing those items down to their impaired values.
60
15.
(1)
(2)
(3)
(4)
(5)
(6)
see calculations below
$6,600
Units of Production
Double-Declining Balance
Ending book value will be equal to salvage value ($3,000)
Accumulated Depreciation will be equal to depreciable amount ($33,000)
$1,665.60
$5,910.00
Cost
Salvage Value
$36,000.00
$3,000.00
2003
2004
2005
2006
2007
2003
2004
2005
2006
2007
UOP
Units/Year
2003 110,000
2004 140,000
2005 150,000
2006 141,800
2007 118,200
Useful Life
(units)
5 660,000
BBV
$36,000.00
29,400.00
22,800.00
16,200.00
9,600.00
$6,600.00
AD
$6,600.00
13,200.00
19,800.00
26,400.00
33,000.00
0.4
BBV
$36,000.00
21,600.00
12,960.00
7,776.00
4,665.60
Annual Depreciation Rate:
Depr
EBV
$14,400.00
$21,600.00
8,640.00
12,960.00
5,184.00
7,776.00
3,110.40
4,665.60
1,665.60
3,000.00
BBV
$36,000.00
30,500.00
23,500.00
16,000.00
8,910.00
Per-unit depreciation rate:
Depr
EBV
$5,500.00
$30,500.00
7,000.00
23,500.00
7,500.00
16,000.00
7,090.00
8,910.00
5,910.00
3,000.00
DDB
Year
Useful Life
(years)
Annual Depreciation:
Depr
EBV
$6,600.00
$29,400.00
6,600.00
22,800.00
6,600.00
16,200.00
6,600.00
9,600.00
6,600.00
3,000.00
SL
Year
Depreciable
Amount
$33,000.00
AD
$14,400.00
23,040.00
28,224.00
31,334.40
33,000.00
$0.05
AD
$5,500.00
12,500.00
20,000.00
27,090.00
33,000.00
61
16.
Calculations:
Cost
Salvage Value
$6,500.00
$500.00
2003
2004
2003
2004
UOP
Units/Year
2500
1900
(1a)
(1b)
(2)
6
Useful Life
(units)
12,000
BBV
$6,500.00
5,500.00
$1,000.00
AD
$1,000.00
2,000.00
0.33
BBV
$6,500.00
4,333.33
Annual Depreciation Rate:
Depr
EBV
$2,166.67
$4,333.33
$1,444.44
2,888.89
BBV
$6,500.00
5,250.00
Per-unit depreciation rate:
Depr
EBV
$1,250.00
$5,250.00
950.00
4,300.00
DDB
Year
Useful Life
(years)
Annual Depreciation:
Depr
EBV
$1,000.00
$5,500.00
1,000.00
4,500.00
SL
Year
Depreciable
Amount
$6,000.00
Depreciation Expense - equipment
Accumulated Depreciation - equipment
(same entry for both years)
1,000.00
Depreciation Expense - equipment
Accumulated Depreciation - equipment
2,166.67
Depreciation Expense - equipment
Accumulated Depreciation - equipment
1,444.44
Depreciation Expense - equipment
Accumulated Depreciation - equipment
1,250.00
Depreciation Expense - equipment
Accumulated Depreciation - equipment
950.00
AD
$2,166.67
3,611.11
$0.50
AD
$1,250.00
2,200.00
1,000.00
2,166.67
1,444.44
1,250.00
950.00
62
17.
Calculations:
Cost
Salvage Value
$2,500.00
$500.00
SL
Year
2000
2001
(½ year) 2002
BBV
$2,500.00
2,100.00
1,700.00
Depreciable
Amount
$2,000.00
Useful Life
(years)
5
Annual Depreciation:
Depr
EBV
$400.00
$2,100.00
400.00
1,700.00
200.00
1,500.00
(1)
Book Value on December 31, 2001 = $1,700
(2)
Depreciation Expense
Accumulated Depreciation—Computer
Cash
Accumulated Depreciation—Computer
Loss on Sale
Computer
$400.00
AD
$400.00
800.00
1,000.00
$200.00
200.00
1,250.00
1,000.00
250.00
2,500.00
18.
Cost
Salvage Value
$4,000.00
$400.00
SL
Year
1999
2000
2001
9
( /12 year)2002
(1)
BBV
$4,000.00
3,550.00
3,100.00
2,650.00
Depreciable
Amount
$3,600.00
Useful Life
(years)
8
Annual Depreciation:
Depr
EBV
$450.00
$3,550.00
$450.00
3,100.00
$450.00
2,650.00
$337.50
2,312.50
Depreciation Expense - machines
Accumulated Depreciation - machines
$450.00
AD
$450.00
900.00
1,350.00
1,687.50
337.50
337.50
Book value = $2,312.50
(2)
Gain (Loss) = Cash received – Book Value
Gain (Loss) = $2,200 – $2,312.50
Loss = $112.50
Cash
Accumulated Depreciation - machines
Loss on Sale of Machines
2,200.00
1,687.50
112.50
63
Machines
(3)
4,000.00
Gain (Loss) = Cash received – Book Value
Gain (Loss) = $0 – $2,312.50
Loss = $2,312.50
Accumulated Depreciation - machines
Loss on Disposal of Machines
Machines
1,687.50
2,312.50
4,000.00
64
19.
(1)
Land
$5,000,000.00
Cash
$5,000,000.00
(2)
Depletion will be used to write down the cost of the asset from 5 million to
$500,000. As the trees (a natural resource) are cleared and eventually sold, the
value of the land will decrease.
(3)
Depletable Amount = Cost – Residual Value
Depletable Amount = $5,000,000 – $500,000
Depletable Amount = $4,500,000
Depletion per acre = Depletable Amount ÷ Number of Acres
Depletion per acre = $4,500,000 ÷ 1,500
Depletion per acre = $3,000 per acre
Using a per acre depletion would be inappropriate if the trees were not spread
evenly across the 1,500 acres or if the size of trees varied throughout. In that case
another method should be used.
(4)
Cost of Goods Sold
Accumulated Depletion
Cost
$5,000,000.00
Depletion
Units
100 acres
$300,000.00
$300,000.00
Value after
Depletion
$500,000.00
Depletable
Amount
$4,500,000.00
Per-acre depletion rate:
Beginning
Balance
$5,000,000.00
Acres
1,500
$3,000.00
Depletion
Ending Balance
$300,000.00
$4,700,000.00
65
20.
(1)
Patent $1,855,000.00
Cash
$1,855,000
(2)
The salvage value will be zero after 7 years. As with most intangible assets, after
the right to use the patent expires, the patent has no value.
(3)
Amortization
(4)
Cost
$1,855,000.00
Amortization
Year
2003
2004
2005
2006
2007
2008
2009
(5)
Salvage Value
$0.00
Amortizable
Amount
$1,855,000.00
Beginning Balance
$1,855,000.00
1,590,000.00
1,325,000.00
1,060,000.00
795,000.00
530,000.00
265,000.00
Annual Amortization:
Depr
$265,000.00
$265,000.00
$265,000.00
$265,000.00
$265,000.00
$265,000.00
$265,000.00
Amortization Expense
Patent
Legal Life
7
$265,000.00
Ending Balance
$1,590,000.00
1,325,000.00
1,060,000.00
795,000.00
530,000.00
265,000.00
0.00
$265,000.00
$265,000
24.
(1)
Cost
$1,600,000.00
Salvage Value
$100,000.00
Depreciable
Amount
Useful Life (years) Useful Life (units)
$1,500,000.00
5
500,000
2002
2003
2004
2005
2006
BBV
$1,600,000.00
1,300,000.00
1,000,000.00
700,000.00
400,000.00
Depr
$300,000.00
300,000.00
300,000.00
300,000.00
300,000.00
Annual Depreciation:
EBV
$1,300,000.00
1,000,000.00
700,000.00
400,000.00
100,000.00
$300,000.00
AD
$300,000.00
600,000.00
900,000.00
1,200,000.00
1,500,000.00
2002
2003
2004
2005
2006
BBV
$1,600,000.00
960,000.00
576,000.00
345,600.00
207,360.00
Annual Depreciation Rate:
Depr
EBV
$640,000.00
$960,000.00
$384,000.00
576,000.00
$230,400.00
345,600.00
$138,240.00
207,360.00
$82,944.00
124,416.00
0.4
AD
$640,000.00
1,024,000.00
1,254,400.00
1,392,640.00
1,475,584.00
SL
Year
DDB
Year
66
2007
124,416.00
UOP
Units/Year
100,000
120,000
130,000
90,000
60,000
BBV
$1,600,000.00
1,300,000.00
940,000.00
550,000.00
280,000.00
$24,416.00
100,000.00
1,500,000.00
Per-unit depreciation rate:
Depr
EBV
$300,000.00
$1,300,000.00
$360,000.00
940,000.00
$390,000.00
550,000.00
$270,000.00
280,000.00
$180,000.00
100,000.00
$3.00
AD
$300,000.00
660,000.00
1,050,000.00
1,320,000.00
1,500,000.00
(2)
Units of production is probably the best because it depreciates the asset only to
the extent that it is used.
(3)
The bank would probably prefer Midori to use the straight-line method because
the effect on net income is consistent. Also, other methods may cause a smaller
net income in early years while the bank loan is still outstanding.
(4)
The depreciation method should have no effect on Midori’s ability to repay the
bank because depreciation is not a cash expense. Regardless of the method
chosen, no cash will be spent on depreciation.
The only way that a depreciation method could affect cash flows (ability to repay
the loan) is if large depreciation amounts (i.e., DDB Method) caused lower net
income, which then led to a loss of confidence in the company and lower future
revenues. This is not likely because investors are usually more savvy that that.
67
25.
Calculations
Cost
$15,500.00
Salvage Value
$2,000.00
Depreciable
Amount
Useful Life (years)
$13,500.00
6
SL
Year
2002
2003
2004
(3/12 year)2005
(1)
BBV
$15,500.00
13,250.00
11,000.00
8,750.00
Depr
$2,250.00
2,250.00
2,250.00
562.50
Annual Depreciation:
EBV
$13,250.00
11,000.00
8,750.00
8,187.50
Depreciation Expense - Machines
Accumulated Depreciation - Machines
562.50
562.50
(2)
8,187.50
(3)
Cash
Accumulated Depreciation - Machines
Machines
Gain on Sale of Machines
8,200.00
7,312.50
Cash
Accumulated Depreciation - Machines
Machines
Gain on Sale of Machines
11,300.00
7,312.50
(4)
$2,250.00
AD
$2,250.00
4,500.00
6,750.00
7,312.50
15,500.00
12.50
15,500.00
3,112.50
CHAPTER 7
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
1.
(1a)
Liabilities are amounts owed to other entities or individuals.
(1b) Current liabilities are amounts owed that must be paid or converted into other
current liabilities within one year or an operating cycle, whichever is longer. Examples
of current liabilities include accounts payable, wages payable, interest payable, and
dividends payable.
(1c) Long-term liabilities are those liabilities other than those classified as current
liabilities; long-term liabilities are normally due in more than a year or an operating cycle
(whichever is longer). Examples of long-term liabilities include long-term notes payable,
mortgages payable, and bonds payable.
68
2.
An account payable is an amount owed to suppliers, while a note payable usually
is supported by a legally binding document. Accounts payable typically do not bear
interest and notes payable do bear interest. Accounts payable are generally short-term,
while notes payable can be either short- or long-term in nature.
3.
Accrued liabilities are liabilities that originate from an expense that has been
incurred but not yet paid. Accrued liabilities include accrued wages, accrued interest,
accrued income taxes, and accrued warranties.
4.
Answers will vary depending on companies chosen.
5.
Common deductions from an employee’s paycheck include federal and state
income taxes, state income taxes, FICA taxes, health insurance premiums, charitable
contributions, and union dues. The first three are considered involuntary deductions, and
they are remitted to the government appropriate government agency. The remaining
deductions are voluntary, and the funds remitted to a variety of agencies. For example,
health insurance premiums are sent to the company that provides health insurance.
6.
Contingent liabilities are potential liabilities that may arise in the future because
of a particular circumstance or occurrence.
The fast food restaurants should include the lawsuit in the notes to the financial
statements. In addition, there may be a journal entry that increases expenses on the
income statement and liabilities on the balance sheet. The latter would occur if the
restaurant believed it was likely that they would lose the case and have to pay some
award and they are able to estimate the amount of the award.
7.
A bond issue is a long-term loan made between numerous parties that is
documented by a legal document known as a bond certificate.
An advantage of having a callable bond feature is that the issuing company has
the option of calling in or retiring the bonds early. The advantage of this is that the
company, in the future, is able to eliminate debt without market restrictions.
8.
Leasing assets usually results in a company using less cash to initially acquire
assets. Asset purchases normally must be paid for in full at the time of purchase or over a
short period of time, thus depleting cash reserves. Leasing allows a company to pay for
the asset over a more extended time. Leasing, however, may cost more in the long run
(because of interest payments or other restrictions) and, in many lease situations, the
lessee does not retain the asset at the end of the lease payment period.
9.
A defined benefit plan is one in which employees are promised or guaranteed a
monthly pension benefit or payment. A defined contribution plan is one in which
employers are obligated to make specified contributions to the plan while the employees
are working; the employees' benefits are retirement depend on how well the pension fund
was managed.
69
Student answers may vary depending; however, a defined benefit plan is usually
preferable because no matter how well the fund is managed, the benefit is guaranteed. In
a long-term employment situation, a defined contribution plan can often be better if the
fund is managed well.
10.
Information needs of decision makers concerning current and long-term liabilities
include completeness, unusual circumstances, and valuation methods of current
liabilities. In addition, decision makers need to assess the company’s liquidity to
determine if current obligations will be met and solvency to assess whether long-term
obligations can be met.
11.
The current ratio is current assets divided by current liabilities. This ratio
indicates how many dollars of current assets there are for every dollar of current
liabilities, or how many times current liabilities can be paid out of current assets. Users
want this ratio to be greater than 1. If it is less, it is an indication that the company does
not liquid or cannot pay its near-term debts.
Working capital is calculated as current assets minus current liabilities. If
positive, working capital indicates the amount of current assets that will be left when all
current liabilities are paid, which is an indication of how difficult it will be to meet nearterm debts as well as what funds will be available for unforeseen needs. If negative,
working capital indicates a liquidity problem, that is, how short the company will be from
meeting its near-term debts.
70
12.
When a bond is sold at more than face value, it is said to be sold at a premium.
The journal entry to sell a $1,000, 10% bond at a premium is shown below; fictional
numbers are used for illustration purposes:
Cash
1,100
Bonds Payable
Premium on Bond
1,000
100
During the life of the bond, interest, equal to the face value times the stated rate,
is paid annually. When a premium is paid, it is amortized (written down to zero) as
interest is paid. The journal entry to accrue annual interest is shown below:
Interest Expense
Premium on Bond
90
10
Interest Payable
100
The portion of the premium that is written off reduces the amount of interest
expense accrued though it does not affect the amount of interest paid.
The accounting for a bond discount is similar.
Cash
Discount on Bond
Interest Expense
950
50
Bonds Payable
105
Discount on Bond
Interest Payable
1,000
5
100
As the discount is amortized, interest expense accrued is increased though the
amount of interest payable is not affected.
71
EXERCISES
13.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
T
F .........“whichever is LONGER”
F .........A deferred liability is created when a customer pays for a service
in advance and the product or service will not be provided until
sometime in the future.
T
F .........If the possibility is remote, a company may ignore the contingency.
T .........Presentation on the balance sheet may be altered, but no journal
entry is necessary.
T
T
T
T
F .........Long-term debt to total assets and to total equity are measure of
financial leverage.
F .........Defined contribution plans define the amount to be paid in.
72
14.
Payment Schedule
01/01/99
12/31/99
12/31/00
12/31/01
12/31/02
12/31/03
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
Balance
$50,000
$45,000
$40,000
$35,000
$30,000
$25,000
$20,000
$15,000
$10,000
$5,000
$0
Notes Payable
Current
Lng-term
$5,000
$45,000
$5,000
$40,000
$5,000
$35,000
$5,000
$30,000
$5,000
$25,000
$5,000
$20,000
$5,000
$15,000
$5,000
$10,000
$5,000
$5,000
$5,000
$0
$0
$0
Interest
Expense
Payable
$0
$0
$5,000
$5,000
$4,500
$4,500
$4,000
$4,000
$3,500
$3,500
$3,000
$3,000
$2,500
$2,500
$2,000
$2,000
$1,500
$1,500
$1,000
$1,000
$500
$500
(1)
On December 31st, the first $5,000 payment will be made, so the balance due will
be $45,000, $5,000 of which should be classified as a current liability and the rest as a
long-term liability. Interest expense and interest payable of $5,000 will also be reported
on the income statement and balance sheet respectively.
(2)
On December 31st in 2004, $20,000 remains unpaid, $5,000 of which is current
and $15,000 is long-term.
(3)
When assessing the liquidity of Hamilton’s Bakery, the amount of current assets
will be too low and liquidity will seem higher.
73
15.
Weist Co.
Partial Balance Sheet
December 31
Current Liabilities
Current portion of long-term debt
Accounts Payable
Accrued Expenses
Income Taxes Payable
Notes Payable, short-term
Salaries Payable
Vacation Payable*
Total Current Liabilities
Long-term Liabilities
Notes Payable, long-term
Bonds Payable
Total Long-term Liabilities
Total Liabilities
17.
(1)
(a)
(b)
$100,000
298,000
510,000
272,000
78,000
145,000
208,000
$1,611,000
$300,000
700,000
1,000,000
$2,611,000
Alpha Company
Maturity date: July 1, 2004
Interest = principle × rate × time
Interest = $3,600 × 10% × 6/12
Interest = $180
Maturity value = Principle + interest
Maturity value = $3,600 + $180
Maturity value = $3,780
(c)
No interest will be accrued on December 31, 2004, because this note will be paid
in full before December 31, 2004.
(d)
No interest will be accrued on December 31, 2005, because this note will be paid
in full before December 31, 2005.
(a)
(b)
Beta Co.
Maturity date: March 31, 2005
Interest = principle × rate × time
Interest = $12,000 × 12% × 12/12
Interest = $1,440
Maturity value = Principle + interest
74
Maturity value = $12,000 + $1,440
Maturity value = $13,440
(c)
On December 31, 2004, nine months of interest should be accrued:
Interest = principle × rate × time
Interest = $12,000 × 12% × 9/12
Interest = $1,080
(d)
No interest will be accrued on December 31, 2005, because this note will be paid
in full before December 31, 2005.
75
(a)
(b)
Gamma Industries
Maturity date: August 1, 2006
Interest = principle × rate × time
Interest = $3,000 × 9% × 24/12
Interest = $540
Maturity value = Principle + interest
Maturity value = $3,000 + $540
Maturity value = $3,540
(c)
On December 31, 2004, five months of interest should be accrued:
Interest = principle × rate × time
Interest = $3,000 × 9% × 5/12
Interest = $112.50
(d)
On December 31, 2005, seventeen months has past, and five months of interest
have already been accrued. Therefore, an additional 12 months of interest should be
accrued:
Interest = principle × rate × time
Interest = $3,000 × 9% × 12/12
Interest = $270
(a)
(b)
Sigma, Inc.
Maturity date: May 30, 2005
Interest = principle × rate × time
Interest = $2,000 × 9% × 6/12
Interest = $90
Maturity value = Principle + interest
Maturity value = $2,000 + $90
Maturity value = $2,090
(c)
On December 31, 2004, one month of interest should be accrued:
Interest = principle × rate × time
Interest = $2,000 × 9% × 1/12
Interest = $15
(d)
No interest will be accrued on December 31, 2005, because this note will be paid
in full before December 31, 2005.
(2)
2004 Balance Sheets
76
Alpha, Inc.: This note will not appear on the 2004 balance sheet because it will be
paid off before the balance sheet is prepared.
Beta Co.: This note will be a current liability on the 2004 balance sheet because it
will be due in 2005.
Gamma Industries: This note will be listed as a long-term liability on the 2004
balance sheet because it will be due in 2006
Sigma Inc.: This note will be listed as a current liability on the 2004 balance sheet
because it will be due in 2005.
18.
(1)
Purchase Amount
Down-payment
Amount to Borrow
Years of finance
Interest rate:
(a) 6.5%
(b) 5.8%
(c) 5.0%
19.
(1)
(2)
Salary Expense
(2)
$29,000
$4,000
$25,000
5 yrs
(60 months)
$489
481
472
(3)
$29,000
$1,500
$27,500
$29,000
$4,000
$25,000
5 yrs
4 yrs
(60 months)
(48 months)
Monthly payments:
$538
$593
529
585
519
576
$8,200
FICA Payable
Federal Income Tax Payable
State Income Tax Payable
Health Insurance Payable
Salaries Payable
$ 627
2,010
311
225
5,027
Federal and state unemployment tax and a FICA match.
Student’s answers will vary, but should include the following information.
Regardless of whether an employer withholds taxes or not, the taxes must be paid.
If the employer withholds the amount, the employer must remit the taxes. If no taxes are
withheld, the employee must remit the taxes him/herself. Typically, independent
contractors are not disciplined enough to put aside the tax amount, and when it becomes
due, the funds are not available. Employees who pay as they go usually do not have that
problem.
(3)
77
20.
(1)
If product warranties are not recorded, expenses and liabilities will be
understated. This situation will lead to inaccurate balance sheets and income statements
for the cycle(s).
The bike shop would be violating the matching principle because the expenses for
repairing bikes may be recorded in the fiscal year following the year of sale when the
revenue was recorded.
(2)
If Cross Country Bikes were experiencing an immaterial rate or amount of
warranty, it may be proper for the bike shop not to accrue the warranty liability and
expense. However, without knowing the selling price of the bikes, the $500 amount
cannot be determined to be material or immaterial.
(3)
Ford Motor Company has material warranty expenditures each year so the
assumption for Cross Country Bikes from part (2) is not valid.
21.
(1)
Saddleback should consider ask themselves two questions. First, is it probable
that Saddleback will lose the lawsuit and have to pay some amount? Second, can
Saddleback estimate that amount? Because there is a specific claim of $2.4 million, it is
estimable. Saddleback should consider whether they have lost similar lawsuits in the past
to determine if they will lose this suit.
(2a) Saddleback would record and expense and a liability in its accounting records if
the payment related to this lawsuit is both probable and estimable.
(2b) Saddleback would disclose the lawsuit in the footnotes to its financial statements
in three situations: (1) if it records an entry [see part (2a)], (2) if the chances of a loss are
probable but an amount is not estimable, and (3) if the chances of a loss are reasonable
probable, whether or not the amount can be estimated.
(2c) Saddleback would ignore the lawsuit for accounting and financial reporting
purposes if the chance of a loss is remote.
78
22.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
23.
(1)
(2)
b
d
f
h
j
i
c
g
a
e
Interest = face value × rate × time
Interest = $1,000 × 8% × 6/12
Interest = $40
$1,000 × 98% = $980
Interest payable is not affected by the amount of a bond discount or premium.
Annual interest is always the face value times the stated rate. Amortizing bond premium
or discount will have a decreasing or increasing effect on interest expense.
(3)
The market rate of interest is higher than 8%; therefore, investors are not willing
to buy these bonds without an incentive. The incentive is a discount on the selling price.
The investor will pay $980, but will receive 8% interest as if they had invested $1,000,
and will receive $1,000 when the bond matures.
(4)
29.
(1)
$1,000
Air Conditioners (2,400 × 8% = 192; 192 × $120)
Air Compressors (1,650 × 6% = 99; 99 × $50)
Fans (1,500 × 3% = 45; 45 × $18)
Total estimated cost
Estimated Warranty Expense
(2)
Estimated Warranty Liability
$23,040
4,950
810
$28,800
28,800
Estimated Warranty Liability
28,800
7,100
Cash
7,100
79
31.
(1)
Cash
$1,080.00
Unearned Subscription Revenue
(2)
(3)
32.
(1)
(2a)
Unearned Subscription Revenue
Unearned Subscription Revenue
$1,080.00
1,590.00
Subscription Revenue
1,590.00
6,402.00
Cash
6,402.00
Interest = Face Value × Interest Rate
Interest = $1,000 × 10%
Interest = $100
Cash
$1,000.00
Bonds Payable
(2b)
(2c)
Cash
Discount on Bonds
$1,000.00
980.00
20.00
Bonds Payable
Cash
1,000.00
10,10.00
Bonds Payable
Premium on Bonds
1,000.00
10.00
(3a) The bond was sold at face value. The market rate of interest was equal to the
stated rate of interest.
(3b) The bond was sold at a discount. The market rate of interest was greater than the
stated rate of interest.
(3c) The bond was sold at premium. The market rate of interest was less than the
stated rate of interest.
(4)
In each situation, the investor will receive $1,000 o the maturity date.
CHAPTER 8
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
1.
A corporation is an organization that has an existence apart from its owners and has
inherent and distinct powers and drawbacks. A “closely-held” corporation is usually
owned by a few people, oftentimes family members, and is not traded on a stock
exchange.
80
Generally, people choose the corporate form of business because of it’s most valuable
attribute: limited liability of shareholders. Closely-held corporations offer 100% of
control by a small number of people (family members). However, publicly traded
corporations can raise more capital by selling stock to a variety of investors.
2.
Articles of incorporation identify the purpose of the organization, type(s) and
quantity of stock the organization plans to issue, and principal operating units.
A corporate charter is a contract between the organization and the state in which
the organization was created. The charter identifies the rights and obligations of
the corporation.
Shareholders will think the corporate charter is more important because it is the
document that authorizes the issuance of a maximum number of shares of one or
more classes of stock
3.
Advantages of the corporate form of business include limited liability of
stockholders, ease of raising capital, ease of transferability of ownership, ability to
hire/retain professionals, and unlimited life. Disadvantages of the corporate form
of business include double taxation and regulatory requirements.
4.
A corporation pays income taxes on its net income; in addition, when the
corporation declares and pays cash dividends, the stockholders must pay taxes on
the dividends received as income.
81
5.
There are similarities between common and preferred stock. Both forms of stock
pay dividends, both represented ownership in the corporation, and both entitle the
owner to a portion of the company that goes out of business (after creditors are
paid).
There are some important differences. Common stock has voting rights whereas
preferred stock usually does not. Common stock usually has lower par and market
values than preferred stock. Preferred stockholders get their dividends and their
share of liquidations before common stockholders. In addition, preferred stock
may have cumulative dividends, whereas common stock will not.
6.
Rights of a common stockholder
• One vote per share.
• Preemptive right (right to maintain ownership percentage)
• Share proportionately in dividends
• Share proportionately in remaining assets of a liquidated corporation after
creditors and preferred stockholders get their share.
Rights of a preferred stockholder
• Receive dividend before common stockholders
• Often entitled to a fixed annual rate
• Sometimes dividends are cumulative
• Fixed share of remaining assets of a liquidated corporation after debts to
creditors have been settled.
Student preferences will be different as to which type of shareholder they prefer.
However, if the shareholder wishes to receive dividends and not bother with
voting, the preferred stock is better; this is often the case with older shareholders.
7.
A corporation may decide to buy back its own shares from the market if it feels
that the stock is selling for less than its actual value. The corporation may also
want to buy back stock to use in providing employees with stock as part of an
incentive package; the corporation may have issued all of its authorized stock.
Buying back its own stock also has the impact of reducing the amount of
dividends that a corporation must pay in the future.
Examples given by students will vary.
82
8.
When a cash dividend is declared and paid, cash is sent to stockholders (a credit
to cash). Because dividends are a distribution of earnings, retained earnings is also
decreased (a debit).
In a stock dividend, stockholders receive additional shares of stock instead of
cash. A stock dividend does not alter total stockholders’ equity; it just moves the
dollars around between stockholders’ equity accounts. A portion of retained
earnings (equal to the market value of the stock on the declaration date) is moved
to common stock and APIC (a debit to retained earnings and credits to common
stock and APIC).
9.
A stock split increases the number of shares in the hands of stockholders and
proportionately reduces the par value of the stock. A stock split does not affect
total stockholders’ equity except to reduce the par value of the stock and increase
the number of shares. Split shares typically trade for a proportionately smaller
amount of the stock exchange. This often stimulates trading of shares that were
too expensive to trade before the split, which may increase the value of a
shareholders investment.
10.
Retained earnings and cash are not the same account; therefore, the balances
would be different. Retained earnings represents the cumulative income earned
during the life of the corporation less any dividends declared; this amount does
not have any relationship to the balance in the cash account.
11.
A prior period adjustment is made to correct an error that occurred in one fiscal
year, but it is made in a subsequent year. Because the year in which the error
occurred has already been closed, the adjustment is made considering how the
accounts were closed. For example if the error resulted in understating an expense
(which is closed as a reduction to retained earnings), the correction would reduce
retained earnings. These adjustments are made on the statement of stockholders’
equity.
12.
Return on equity is computed as (Net income – preferred stock dividends) 
average common stockholders’ equity. This ratio is a measure of the firm’s
profitability for the cycle.
83
EXERCISES
13.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
14.
16.
(1a)
(1b)
(1c)
(2)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
F .........BVPS is computed by dividing common stockholders’ equity by
the number of common shares outstanding.
T
T
F .........“automatically considered common stock”
T
F .........Authorized stock is the number of shares that CAN be sold.
T
T
T
F .........If common shares outstanding are less than common shares
ISSUED, the company must have treasury stock.
c
k,f
a
d
g
i
j
not used
e
h
b
Cash (367,000 shares × $18 MV)
Common Stock (367,000 shares × $1.50 PV)
APIC-CS (367,000 shares × $16.50 MV–PV)
$6,606,000
Cash (367,000 shares × $18 MV)
Common Stock (367,000 shares × $10 PV)
APIC-CS (367,000 shares × $8 MV–PV)
$6,606,000
Cash (367,000 shares × $18 MV)
Common Stock (367,000 shares × $18 MV)
$6,606,000
$ 550,500
6,055,500
$3,670,000
2,936,000
$6,606,000
A company does not “profit” from the sale of its stock. When a company receives
money from its investors that money is contributed equity, not a revenue. If it
isn’t a revenue, it cannot appear on the income statement, and therefore, cannot
affect profit.
17.
84
(1)
Issued refers to the number of shares that have ever been sold. To have be an
issued share, it must have been sold to a shareholder at some time since it was
authorized, but there is no requirement that it is still owned by a shareholder. If
that share IS still issued by a shareholder, it is issued and outstanding. Therefore,
a share of stock that was sold to a shareholder and then repurchased later by the
issuing company is still issued, but not outstanding; instead it is in treasury.
(2a)
(2b)
(2c)
40,000
60,000
250,000
(3)
Authorized = 100,000
Issued = 50,000
Outstanding = 50,000
Treasury = 0
85
18.
(1)
Dividend per share = $30,000 ÷ 50,000 shares outstanding
Dividend per share = $0.60
My dividend = $0.60 per share × 500 shares
My dividend = $300
Alternate calculation:
My share of stock = 500 ÷ 50,000 = 1%
My share of dividends = $30,000 × 1% = $300
(2)
The preemptive right gives me the right to purchase a proportionate share of all
new issues so that I can maintain my ownership percentage. Therefore, I will have
the right to purchase 1% of 14,000 shares or 140 shares.
Proof:
Before new issue = 500 ÷ 50,000 = 1%
After new issue = (500+140)÷(50,000+14,000)=640÷64,000=1%
(3)
Assume facts in introduction
Book Value per Share = $3,200,000 ÷ 50,000 = $64
Book Value of my investment = $64 × 500 shares = $32,000
Market Value of my investment = $71 × 500 shares = $35,500
Assume new shares issued
Book Value per Share = $3,200,000 ÷ 64,000 = $50
Book Value of my investment = $50 × 640 shares = $32,000
Market Value of my investment = $71 × 640 shares = $45,440
86
19.
(1)
(2)
Common Stock = 550,000 shares issued × $6 par value
Common Stock = $3,300,000
Outstanding Shares = 550,000 issued – 40,000 in treasury
Outstanding Shares = 510,000 shares
(3)
Authorized
Original
Option (a)
Option (b)
1,000,000
×2÷1
2,000,000
Issued
550,000
×2÷1
1,100,000
Outstanding
Treasury
510,000
×2÷1
1,020,000
40,000
×2÷1
80,000
Dividend shares = 510,000 × 15% = 76,500
+ 0
+ 76,500
+ 76,500
1,000,000
626,500
586,500
+ 0
40,000
(4a)
Reduction in Retained Earnings of Split = 0
(4b)
Reduction in Retained Earnings of Stock Dividend
= 76,500 shares × $6 (assumes shares trading at PV)
= $459,000
(5a)
Par value per share after 2:1 split = $6 ÷ 2 × 1 = $3
(5b)
Par value per share after stock dividend = $6
(6a)
Market value per share would decrease because there would be more shares
outstanding representing the same amount of equity in the company.
(6b)
Same as (6a) for a dividend.
87
20.
(1)
Treasury shares = Issued shares – outstanding shares
Treasury shares = 40,000 – 38,000 = 2,000 shares
(2)
Dividend shares = 38,000 shares outstanding × 10% = 3,800
(3a)
Dividends (3,800 shares × $40 MV)
Common Stock Dividends Distributable
$152,000
$ 38,000
(3,800 shares × $10 PV)
APIC-CS (3,800 shares × $30 MV–PV)
(3b)
no entry
(3c)
Common Stock Dividends Distributable
Common Stock
(4)
114,000
$38,000
$38,000
No liability for the undistributed stock will be shown on the balance sheet.
Technically, liabilities are debts to others that will be settled using assets or
issuing new liabilities. In this case, the company owes stock. The account
Common Stock Dividends Distributable is a stockholders’ equity account.
88
21.
(1)
Annual preferred dividends = $5 per share × 10,000 shares
Annual preferred dividends = $50,000
(2)
Year
2001
2002
2003
2004
2005
Dividends
$150,000
0
150,000
30,000
200,000
(3a)
Year
2001
2002
2003
2004
2005
Dividends
$150,000
0
150,000
30,000
200,000
Due to Preferred
Shareholders
$50,000
50,000
50,000
50,000
50,000
Due to Preferred
Shareholders
$50,000
50,000
100,000
50,000
70,000
Paid to Preferred
Shareholders
$50,000
0
50,000
30,000
50,000
Paid to Preferred
Shareholders
$50,000
0
100,000
30,000
70,000
Paid to Common
Stockholders
$100,000
0
100,000
0
150,000
Paid to Common
Stockholders
$100,000
0
50,000
0
130,000
(3b)
Regardless of whether the shares of EAM are cumulative, the shareholders are
entitled to $50,000 each year before common shareholders get anything. In the
case of cumulative dividends, dividends that aren’t paid in one year to preferred
shareholders are carried forward to the next year. The amount of unpaid dividends
at the end of any one year is called dividends in arrears, which is listed in the
notes to the financial statements.
(3c)
Dividends in arrears are not listed as a liability on the balance sheet, because there
is no obligation to pay these dividends; the only obligation is that they be paid
before common shareholders receive any dividends. As long as the dividends in
arrears is included in the notes, generally accepted accounting principles has been
followed and EAM is not misleading investors.
89
22.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
25.
(1)
(2)
(1) Effect on
Retained Earnings
(2) Timing
of Effect
(3) Effect on Total
Stockholders’ Equity
Decrease
Decrease
No effect
Increase
Increase
Decrease
Decrease
Increase
Closing
Closing
n/a
Immediate
Closing
Closing
Immediate
Immediate
Decrease
No change
No change
Increase
Increase
Decrease
Decrease
Decrease
A company will buy back its own stock to reduce the number of shares
outstanding and, thus, amount of dividends that it is required to pay. Also, a
company may purchase its own shares if it believes the stock is selling for less
than its actual value or if it needs shares to issue as part of employee
compensation.
Treasury Stock
Cash
$1,943,200
$1,943,200
($1943,200 ÷ 69,400 shares = $28 per share)
(3)
(4)
(5)
Cash (2,000 × $35 SP)
Treasury Stock (2,000 × $28 PP)
APIC-TS (2,000 x $7 SP-PP)
70,000
Cash (3,000 × $27 SP)
81,000
APIC-TS (3,000 x $1 PP-SP)
3,000
Treasury Stock (3,000 × $28 PP)
A company cannot own itself; therefore treasury stock is just a reduction in
equity, not an asset.
56,000
14,000
84,000
90
26.
(1)
The dividend became a liability on January 11, the date of declaration.
(2)
1/11
Dividends
Dividends Payable
200,000
200,000
(1,000,000 x $0.20 = $200,000)
2/12
no entry
3/9
Dividends Payable
Cash
200,000
Retained Earnings
Dividends
200,000
12/31
200,000
200,000
(3)
The board of directors authorized the dividend.
(4)
Organizations must disclose the amount of cash dividends declared and paid out for the
last five years. Any significant restrictions on the amount of dividends that can be
declared must also be disclosed. Investors would want to know how frequently dividends
had been declared and how if dividends in arrears exist.
91
27.
(1)
Biloxi should disclose the fact that dividends in arrears exist in the amount of
$240,000 (10,000 shares x $8 per share dividend x 3 years).
(2)
This disclosure should be made in the footnotes to the financial statements.
(3)
Dividends in arrears provides information the amount of dividends that preferred
shareholder must receive before common shareholders can be paid anything.
Potential investors in preferred stock may see this as positive (lots of money to
come) or negative (company is not meeting its obligations). Potential common
stock holders can only view this as negative; that is, not only is the company not
meeting its obligations, but it must pay $150,000 before common shareholders
can receive anything.
(4)
Preferred Shareholders Dividends
= Dividends in arrears + Current year’s dividends
= $150,000 + $50,000
= $200,000
Common Shareholders Dividends
= Total dividends – Preferred Shareholder Dividends
= $500,000 – $200,000
= $300,000
Dividend per common share
= CS Dividends ÷ CS Shares Outstanding
= $300,000 ÷ 250,000
= $1.20
(5)
Dividend yield per common share
= Annual dividend ÷ Market price
= $1.20 ÷ $22
= 5.45%
92
28.
(1a)
(2)
(a) No effect, (b) Decrease, (c) No effect
Treasury shares = Issued shares – outstanding shares
Treasury shares = 2,300,000 – 2,100,000 = 200,000
Dividends are not distributed to treasury shares because a company does not pay
dividends to itself.
(3)
Dividend shares = Outstanding shares × dividend percent
Dividend shares = 2,100,000 × 5% = 105,000 shares
(4a)
Dividends (105,000 shares × $30 MV)
CS Dividend Distributable
$3,150,000
$ 525,000
(105,000 shares × $5 PV)
APIC-CS (105,000 shares × $25 MV–PV)
(4b)
no entry
(4c)
CS Dividend Distributable
Common Stock
2,625,000
$525,000
$525,000
CHAPTER 9
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
1.
(1a)
<20%

Income Statement
Dividends received from Sanri
are recorded as revenues


(1b)
20%
–50%

Paolo’s portion of Sanri’s income
or loss appears on the income
statement as an income or loss
from unconsolidated affiliates.



(1c)
>50%

The income statement of both
companies are consolidated
omitting the effects of
intercompany transactions and
deducting minority interest in Sanri

Balance Sheet
Investment in Sanri is recorded as an asset at
original cost.
At year end the investment account is adjusted
to fair market value with an off-setting
adjustment to equity.
The investment in Sanri is recorded as an
asset at cost.
Dividends received from Sanri reduce the
investment account.
Paolo’s portion of Sanri’s income or loss used
to adjust the investment account.
The balance sheet of both companies are
consolidated omitting the effects of
intercompany transactions.
93
2.
Income from continuing operations is used by decision makers in developing financial
forecasts for the organization. This line item is considered to be the one that might be
best used to forecast because there should be no nonrecurring items included in it.
3.
Basic earnings per share is computed by dividing net income minus preferred stock
dividends by the weighted average shares of common stock outstanding during the cycle.
4.
Taxable income is the amount of income that is reported to the Internal Revenue Service
and on which corporations pay taxes. Income before income taxes is also know as pretax
accounting income and is calculated using generally accepted accounting principles.
Because there are differences between the accounting for some items for tax and GAAP
purposes, taxable income is not always equal to income before income taxes.
94
5.
A temporary difference is one that will eventually reverse itself. With respect to income
taxes, a temporary difference arises because there are different rules for Generally
Accepted Accounting Principles and tax law. For example, an asset can be depreciated in
different way on the income statement and the tax return. Therefore, in any one year that
asset is being depreciated, taxable income and income before income taxes will be
different. However, the difference is temporary because, regardless of how the
depreciation expense is spread over the life of the asset, total depreciation expense and
deductions over the asset’s life will be the same.
These differences create deferred income taxes, which are shown on the balance sheet. It
will be shown as a deferred tax asset if the company taxable income (on which tax is
calculated) is more than income before income taxes. If the reverse is true, the difference
is a deferred tax liability.
6.
A corporation uses a Deferred Income Taxes account when there is a difference between
the amount of Taxes Payable that has been determined on the tax return and the amount
of Tax Expense determined on the income statement. Regardless of whether the deferred
taxes are an asset or liability, it is usually long-term because there may be several years
before the differences are reversed. However, the Deferred Income Tax account is usually
a liability account, because companies try to pay less taxes and have an amount due.
7.
Discontinued operations are shown separately on a corporate income statement as an
indication that these items are not part of the firm's continuing operations and should not
be considered in financial projections. Typically, two items are included: (1) any net
income or net loss from that operation for the portion of the year it was in operation, and
(2) any realized gain or loss from the sale of the assets of the discontinued operation.
8.
Investors rely on corporate income statements to determine if they should make initial
investments or invest additional funds in a firm. Creditors rely on corporate income
statements to determine an organization's profitability to make decisions concerning
whether the organization would be able to pay interest and maturity values on a timely
basis.
95
9.
Trend analysis tracks proportional changes in financial statement items over a
number of accounting cycles. Trend analysis is used to predict future dollar
amounts for certain financial statement items. Financial statement items in trend
analysis are presented as a percentage of a base year.
Common-sized financial statements are used to gain a better understanding of
relationships among items in a financial statement for a number of years. These
statements are also used as a comparison against industry norms for a company.
Items in common-sized financial statements are presented as a percentage of total
assets on the balance sheet and net revenue on the income statement.
Ratio analysis studies the relationships between two financial statement items.
Cross-sectional ratio analysis compares a company’s financial ratios with those of
competitors. Longitudinal ratio analysis focuses on changes in a company’s
financial ratios over a period of time.
10.
Earnings per share is the portion of net income associated with one share of stock
outstanding for the fiscal year. This ratio is one of the most influential as evidenced by
the stock market reaction to unexpected negative or positive EPS.
96
11.
(a)
Liquidity is defined as the ability to pay debts as they come due. The current and quick
ratios are examples of liquidity ratios. They are the ratio between current assets, from
which liabilities are paid, and current liabilities.
(b)
Leverage addresses sources of capital; that is, whether the company is raising
capital through debt or equity, and the relationship between them. Debt to total
asset and debt to equity ratios are ratio measures of leverage
(c)
Activity ratios measure how well a company is utilizing its assets. Common
activity ratios examine turnover or accounts receivable, inventory, and total
assets.
(d)
Profitability ratios measure the company’s ability to use its assets and equity to generate
profits. Return on equity and return on assets are common measure of profitability. Also,
the gross profit percentage and the profit margin percentage measure how revenues relate
to profit.
(e)
Market strength ratios measure how capital markets perceive the company’s common
stock. The price-earnings ratio and market to book value ratio will help investors decide
if the purchase of a particular company’s stock is a good investment.
12.
Earnings quality relates to the degree to which reported earnings reflect the firm’s
economic income. Several factors that impact earnings quality include different methods
of accounting for depreciation, different methods of accounting for cost of goods sold,
different methods of accounting for bad debts, and management's delaying the
recognition of expenses or advancing the recognition of revenues.
13.
Earnings management refers to using bending or manipulating GAAP (or outright
violating it) in an effort to achieve a desired net income amount. If earnings management
presents a more favorable (or less favorable, which is unusual) earnings number, then it
ceases to accurately reflect economic income and is, therefore, of lower quality.
97
EXERCISES
14.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
T
T
T
F .........“much lower”
T
F .........Liquidity ratios evaluate liquidity.
T
F .........Stockholders benefit when interest paid is less than the rate of
return.
T
T
T
15.
(1)
Gross Profit
Operating Income
Income from Continuing Operations
Discontinued Operations
Extraordinary Loss
Cumulative Effect of a Change in Accounting Principle
Net Income
(2)
Extraordinary items, by definition, are material items that are unusual in nature
and infrequent in occurrence in the environment that the business operates. These
items should be shown separately on the income statement to alert readers that
something out of the ordinary happened during the accounting cycle and is not
likely to ever reoccur.
(3)
Income from continuing operations usually refers to the profit oriented operations
of the firm. The items that are presented after continuing operations typically are
not expected to have an effect on future years. Therefore, income from continuing
operations is the best indicator of future earnings.
18.
(1)
1/1-3/31
100,000 x 3/12
3/31-8/31
120,000 x 5/12
9/1–12/31
150,000 x 4/12
Total weighted-average shares
= 25,000
= 50,000
= 50,000
125,000
(2)
$371,250  125,000 = $2.97 per share
(3)
The weighted-average number of shares is used as the denominator in the
calculation because that number better represents the actual capital availability
98
from common stock. Using the number of shares outstanding at the end of the
year would distort the calculation, because earnings were generated throughout
the year using the equity provided by stocks that weren’t outstanding throughout
the year.
29.
(1)
Year 1
$144,267
100%
Year 2
$173,164
120%
Year 3
$205,348
142%
Year 4
$322,308
223%
Year 5
$401,685
278%
Operating
Income
3,546
100%
5,023
142%
5,842
165%
8,343
235%
14,666
414%
Earnings per
share
.26
100%
.31
119%
.37
142%
.29
112%
.61
235%
Book value
per share
.99
100%
1.16
117%
4.02
406%
5.77
583%
6.87
694%
Sales
(2)
The percentages are not consistent across items because each item measures
something different on the financial statements.
(3)
Trend analysis is used by decision-makers to track changes in financial statement
items over a period of years to predict future dollar amounts for financial
statement items. Trend analysis helps identify trends from year to year, but does
not examine relationships within a year, which could help explain trends.
CHAPTER 10
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
1.
The principal use of a statement of cash flows by decision makers is to predict an
organization's ability to generate positive cash flows in the future.
2.
The primary objective is to account for the change in the cash balance during the
cycle.
3.
Operating activities are those activities related to the production and delivery of
goods and services by a business. Examples include paying of suppliers for
merchandise and selling inventory to customers for cash or on account.
Investing activities are those activities related to the purchase and sale of long-term assets
(use of money not needed for day-to-day operating activities). Investing activity include
the purchase of equipment or lending/investing money to earn interest/return.
99
Financing activities are those activities related to obtaining cash from lenders and
investors, and repaying these sums (acquiring money needed but not provided by
operating activities). Financing activities include borrowing money from lenders
(notes payable, bonds payable) or raising capital from investors (sell stock);
repayment of principle or payment of dividends are also financing activities.
4.
The principal inflows from operating activities include cash received from
customers, receipt of interest or dividends (as a result of investing activities), and
other receipts resulting from converting current assets to cash (e.g., sale of shortterm securities).
The principles outflows from operating activities include payments to suppliers
for merchandise, to employees for wages, to governing agencies for taxes,
payment of interest on debt (as a result of financing activities), and payments for
purchasing short-term securities.
100
5.
The FASB prefers the direct method because it discloses the specific types of
operating cash flows. The indirect method is more commonly used for three
reasons: (1) because it begins with an already existing financial statement figure,
net income, so that articulation among the financial statements is depicted; (2) it
adjusts accrual to cash basis income; and (3) if the direct method were used, the
indirect method would have to be shown in the footnotes to the financial
statement.
6.
The starting point in a cash flow statement prepared using the indirect method is
net income. Net income is used because net income is calculated on an accrual
basis and must then be converted to cash basis to determine cash from operating
activities.
7.
Using the indirect method to prepare the statement of cash flows requires a
conversion of net income to a “cash only” number. Many items on the income
statement are non-cash items. Any non cash increases (decreases) to net income
must be subtracted from (added to) net income to arrive at a “cash only” number.
The most common non-cash item found on an income statement is the deduction
for depreciation. While a company pays cash for its PPE assets at the time of
purchase, depreciation is only a method is spreading the cost throughout the assets
life, no cash is actually used for depreciation. Therefore, depreciation expense is
added back to net income as the first step to determining cash flows from
operating activities. (Note: the cash spent to acquire the PPE assets does appear
on the statement of cash flows in the investing section.)
8.
Significant noncash investing and financing activities are generally reported as a
supplemental schedule to the financial statement.
9.
Investors can gain an understanding of how a company gets and uses its cash. In
the long-run, an investor is looking to see that a company is generating the
majority of its money from operating activities as opposed to financing activities.
101
10.
The current ratio is calculated by dividing current assets by current liabilities. The
result, hopefully a number greater than one, depicts the number of times a
company can pay its current liabilities using its current assets. However, many
current assets are not cash (e.g., inventory, prepaid insurance, accounts
receivable) and some will never be cash (e.g., prepaid insurance). These noncash
items cannot be used to pay a liability until they are converted into cash. When a
company will convert its accounts receivable and inventory into cash is another
set of ratios.
Therefore, some investors think it is better to look at the relationship of cash
flows to current liabilities as an indication of whether a company will be able to
meet its short-term (liquidity) and long-term obligations (solvency).
11.
Cash flow per share is computed as (net cash flow from operating activities preferred stock dividends) divided by the weighted average shares of common
stock outstanding.
12.
The larger amount would depend on the company, the company's industry, and
the types of transactions in which the company engaged during the year.
13.
In general, free cash flow from operating activities is equal to cash flow from
operating activities with adjustments for mandatory payments of principle,
payments for capital spending (purchasing new assets), and sometimes dividends.
Investors are interested in this amount because it is believed to be a better
indicator of funds available for paying current liabilities.
102
EXERCISES
14.
(1)
(10)
F .........Increases in noncash current assets indicate that assets increased
without the use of cash (e.g., increase in accounts receivable);
therefore the increase is deducted from net income.
T
F .........Definition refers to Operating Activities.
F .........To avoid confusion of EPS and CFPS, FASB only permit reporting
EPS.
F .........FCF indicates a company’s ability to maintain its current level of
productive capacity, but not to grow or increase that level.
F .........A majority of cash flow must be generated from operating
activities for a company to be in operation long-term.
F .........Acquisition and sale of PPE is an investing activity; companies are
not in business to purchase and sell PPE.
T
F .........The statement of cash flows (and in the income statement) depict
activities over a period of time (e.g., fiscal year, quarter).
T
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
b
d
b
a
c
b
d
a
f
b
f
e
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
15.
17.
(1)
(2)
Indirect method
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense
Gain on sale of land
Changes in current assets and liabilities:
Increase in accounts receivable
Decrease in inventories
Decrease in prepaid expenses
$ 1,433
(e)
1,088
(115)
(863)
350
667
103
Decrease in short-term notes payable
Decrease in accrued liabilities
Net cash provided by operating activities
Cash flows from investing activities:
Sale of land
Purchase of property, plant & equipment
Net cash used by investing activities
Cash flows from financing activities:
Sale of common stock
Dividend payments
Net cash provided by financing activities
Net increase in Cash
Cash balance, December 31, 2001
Cash balance, December 31, 2002
(400)
(1,004)
(b)
$1,156
(d)
$6,526
(7,639)
$ (1,113)
$ 6,329
(2,257)
(c)
$ 4,072
$ 4,115
(a)
7,217
$11,332
(a)
Ending Cash = Beginning Cash ± Net change in cash
$11,332 = Beginning Cash + $4,115
Beginning Cash = $7,217
(b)
Net change in Cash = ± Operating ± Investing ± Financing
$4,115 = Operating – $1,113 + $4,072
Operating = $1,156
(c)
Financing = Inflows (stock sale)–Outflows (Dividends paid)
$4,072 = $6,329 – Dividends paid
Dividends Paid = $2,257
(d)
Investing = Inflows (land sale)–Outflows (purchase PPE)
–$1,113 = Land Sale – $7,639
Land Sale =
(e)
Operating = Net income – Depreciation ± Adjustments
$1,156 =$1,433–Depreciation-$115–$863+$350+$667–$400–$1,004
$1,156 = Depreciation + $68
Depreciation = $1,088
(3)
The largest source of cash during the year was the sale of land.
(4)
Too much of the net cash inflow came from financing activities and not enough
from operating activities. In on year, that is not necessarily an issue, but long-term
the reverse should be true.
19.
Pd. During Yr
Salaries Payable
$ 3,560
$80,464
76,904
2,986
$2,986
BB
BB
<-Accrued during yr->
<-End of Yr Accrual->
EB
EB
Salaries Expense
$ 0
76,904
2,986
$79,890
104
(1)
Salaries payable at the end of the year represents an accrual of year-end salary
expenses that won’t be paid until early in the next fiscal year.
(2)
Salaries paid (see t-accounts above)
Salaries earned (the expense taken).
Difference
(3)
Salaries paid in cash were actually more than $514 more than salaries expensed
(earned). This number can be calculated by comparing debits to salary expense
with debits to salaries payable, or by taking the difference between beginning and
ending salaries payable. The cash amount is more than the accrual amount
(salaries payable went down), the amount expensed (subtracted from net income)
was not large enough. An additional $514 must be subtracted to adjust net income
to a cash number.
(4)
Using the direct method, there would be one line item for Salaries paid which
would be an outflow of $80,464.
21.
(1)
=
=
$80,464
$79,890
$574
Current Ratio
= Current Assets ÷ Current Liabilities
= $179,600 ÷$92,100 = 1.95 times
Operating Cash Flow Ratio
= Cash inflow from Operating Activities ÷ Current Liabilities
= $350,000 ÷ $92,000 = 3.8 times
The operating cash flow ratio is much higher, indicating that last year the
company was able to generate 3.8 times more cash than the year-end balance of
their current liabilities. Many believe that this is a better measure of liquidity than
the current ratio; however, users should be careful to remember the following: (1)
cash inflows is a historical number and current liabilities is a number that must be
paid in the future, and (2) cash inflows is a number that represents a year’s worth
of cash, while current liabilities are only the liabilities due in the next year that
have been accrued so far (more are sure to come).
(2)
Times Interest Earned
= (Net Income + Interest Exp + Income Tax Exp) ÷ Interest Exp
= ($234,000 + $57,000 + $128,000) ÷ $57,000 = 7.35 times
Interest Coverage Ratio
= (Inflow Op + Interest Exp + Income Tax Exp) ÷ Interest Exp
= ($350,000 + $57,000 + $128,000) ÷ $57,000 = 9.39 times
The interest coverage ratio is larger, indicating that the company had enough cash
inflows from operating activities to pay interest expense 9.39 times. The times
105
interest earned ratio isn’t as large indicating the company “earned” enough to pay
interest 7.35 times.
(3)
Free Cash Flow
= Inflow Op – Equipment purchases
= $350,000 – $290,000 = $60,000
FCF is much less than net income, indicating that cash available after operating
activities and purchasing equipment was far less than the amount that the
company “earned”.
PROBLEMS
23.
Indirect method of preparing the Statement of Cash Flows
Operating
Activities
(1) Inflows
(2) Outflows
Investing
Activities
(3) Inflows
(w) Proceeds from the sale of
property, plant & equipment
(4) Outflows
(g)
Purchase of property and
equipment
(u)
Loans to officers
Financing
Activities
(5) Inflows
(p)
Proceeds from common stock
offering
(t)
Issuance of treasury stock for
cash
(6) Outflows
(a)
Repurchase of common stock
(d)
Principal payments on
long-term notes payable
(j)
Principal payments under cap.
lease obligations
(l)
Payment of dividends on
preferred stock
(m) Principal payments on
mortgages
Noncash Adj
to Net Income
(7) Positive
(f)
Increase in accounts payable
(k)
Depreciation expense
(y)
Decrease in prepaid insurance
(8) Negative
(n)
Increase in accounts receivable
(q)
Decreases in wages payable
(o)
Gain on sale of equipment
(9) Does not appear on the INDIRECT Statement of Cash Flows
(b)
Interest received(a)
(c)
Refund of Income taxes(a)
(e) Cash paid to suppliers and employees(a)
(h)
Proceeds from issuing long-term note payable
(there are no proceeds on liabilities)
(i)
Cash paid for taxes(a)
(r)
Declaration of a stock dividend
(there is no cash involved in a declaration or a stock dividend)
(s)
Cash paid to suppliers for inventory(a)
(v)
Issuance of common stock for land
(There is no cash involved; this is known as off-balance sheet financing
and is disclosed in the footnotes.)
(x)
Cash received from customers(a)
106
(a)
25.
These items are operating activities, but using the indirect method to prepare the SFC, they are
not listed individually because the operating section is an adjustment of net income.
Goody’s Family Clothing, Inc.
Statement of Cash Flows
For the year ended, December 31, 2003
Operating Activities:
Net Income
Depreciation expense
Gains on disposal of long-term assets
Increase in miscellaneous current assets
Increase in accounts payable
Increase in accrued salaries
Increase in inventories
Increase in income taxes payable
Net cash inflow from operating activities
Investing Activities:
Purchase of PPE
Purchase of long-term investments
Proceeds from sale of PPE
Proceeds from sale of long-term investment
Net cash outflow from investing activities
Financing Activities:
Issue common stock
Reductions of long-term debt
Issue long-term notes
Net cash flow from financing activities
Net Cash flow
Cash & cash equivalents, 1/1
Cash & cash equivalents, 12/31
$16,214
5,285
(135)
(1,396)
12,590
4,072
(11,320)
2,108
$27,418
$(11,043)
(34,959)
192
8,077
($37,733)
$ 126
(172)
500
$ 454
$(9,861)
31,350
$21,489
107
26.
(1)
End A/R = Beg A/R + Sales on Account – Cash collected
End A/R – Beg A/R = Sales on Account – Cash collected
Change in A/R = Sales on Account – Cash collected
$1,396* = $1,756,000 – Cash Collected
Cash Collected = $1,754,604
* assumes that increase in miscellaneous current assets is A/R
(2)
End Inventory = Beg Inventory + Cost of Purchases – Cost of Sales
End Inventory – Beg Inventory = Cost of Purchases – Cost of Sales
Change in inventory = Cost of Purchases – Cost of Sales
$11,320 = Cost of Purchases – $810,000
Cost of Purchases = $821,320
End A/P = Beg A/P + Purchases on Acct – Payments on Acct
End A/P – Beg A/P = Purchases on Acct – Payments on Acct
$12,590 = $821,320 – Payments on Account
Payments on Account = $808,730
(3)
End Taxes Payable = Beg Taxes Payable + Tax Expense – Tax Paid
End Taxes Payable – Beg Taxes Payable = Tax Expense – Tax Paid
Change in Taxes Payable = Tax Expense – Tax Paid
$2,108 = $134,000 – Tax Paid
Tax Paid = $131,892
(4)
End Sal. Pay. = Beg Sal. Pay. + Salary Expense – Salary paid
End Sal. Pay. – Beg Sal. Pay. = Salary Expense – Salary paid
Change in Sal. Pay. = Salary Expense – Salary paid
$4,072 = $235,000 – Salary paid
Salary paid = $230,928
27.
(1)
Claims Corporation
Partial Indirect Statement of Cash Flows
For the year ended December 31, 2002
Operating Activities:
Net Income
Depreciation expense
Gain on sale of land
Increase in accounts receivable
Increase in inventory
Decrease in prepaid expenses
Increase in accounts payable
Increase in accrued liabilities
Net cash flow from operating activities
$16,800
1,900
(5,500)
(5,300)
(4,600)
2,700
2,700
1,200
$ 9,900
108
(2)
Claims Corporation
Partial Direct Statement of Cash Flows
For the year ended December 31, 2002
Operating Activities:
Receipts from customersa
Payment to suppliersb
Payments for expensec
Payment of income taxes
Net cash flow from operating activities
$72,300
(46,300)
(4,900)
(11,200)
$ 9,900
(a) End A/R = Beg A/R + Sales – Cash collected
$9,800 = $4,500 + $77,600 – Cash Collected
Cash Collected = $72,300
(b) End Inventory = Beg Inventory + Cost of Purchases – Cost of Sales
$11,300 = $6,700 + Cost of Purchases – $44,400
Cost of Purchases = $49,000
End A/P = Beg A/P + Cost of Purchases – Payments on Acct
$5,600 = $2,900 + $49,000 – Payments on Account
Payments on Account = $46,300
(c) Because the selling and general administrative expenses amount on the income statement is not
separated into the part that was paid in cash and the part that had been prepaid, we must examine these
two accounts together.
Accrued Liabilities
$2,800 BB
Exp Accrued
Prepaid Expenses
BB $3,500
Prepay used
Exp paid
$1,600
End Liab. Due
Sell & Gen Expenses
$0
Exp Accrued
Prepay used
New Prepay
$800
= Beg Liab. Due
$8,800
+ Liab. accrued
– Liab.
+ Liab. accrued
– Liab.
+ $8,800
– Liab.
paid
(End A/Liab – End PP Exp) = (BB A/Liab – BB PP Exp)
paid
($2,800 – $800) = ($1,600 – 3,500)
paid
$2,000 = $6,900 – Liab. Paid
Liabilities paid = $4,900
(3)
Liab. are increasing while collections of Accounts Receivable seem to be lagging.
Inventory increases could be caused by a downturn in sales. Also, the company
may be slow in paying its Accounts Payable. The financial health of Claims
Corporation does not appear to be good.
CHAPTER 11
Solutions to End of Chapter Material
Questions
1.
109
(1a)
Financial accounting refers to the accounting information (such as the balance
sheet, income statement, and statement of cash flows) that is developed primarily
for external users (such as investors and creditors). This information is generally
historical, monetary, required, aggregated, verifiable, and presented in conformity
with generally accepted accounting principles. Managerial accounting refers to
the accounting information that is developed primarily for internal users. This
information is not required and is commonly based on current or expected future
amounts, related to individual parts of the organization, presented in a manner that
is most informative to its users, and likely to be more timely and less verifiable
(than financial accounting).
(1b)
Product costs are those costs that are directly related to inventory items that
generate organizational revenues. In a retail company, product costs include
purchase prices of inventory plus any other normal and reasonable charges to get
that inventory into place, position, and ready for sale. In a manufacturing
company, product costs include the material, labor, and overhead costs of making
the products that are to be sold to others. Period costs are those costs that are
related to the selling and administrative activities of an organization. These costs
are more closely associated with a specific time period or the passage of time than
they are with the generation of revenues.
(1c)
Direct costs are those costs that are clearly and conveniently traceable to and are
a monetarily important part of a designated cost object. Indirect costs are those
costs that either cannot be directly traceable to a designated cost object or are not
directly traced to a designated cost object because it is not convenient (generally
in terms of monetary significance) to do so. Indirect costs must be allocated
(assigned) to products using a reasonable measure of activity.
110
(1d)
Variable costs are those costs that, within the relevant range of activity, change
in total in direct proportion to changes in some designated measure of activity.
These costs are constant per unit of activity. Fixed costs are those costs that,
within the relevant range of activity, do not change in total in response to changes
in some designated measure of activity. On a per-unit basis, these costs vary
inversely with changes in activity. Mixed costs have variable and fixed
components. One portion of the cost, the dollar amount of which may or may not
be known, is constant (fixed) regardless of the number of units produced. The
remaining portion represents the total variable cost, which will increase in direct
proportion to increases in production.
(1e)
Job order costing is a costing system that is used by most service companies and
by manufacturers that are producing goods in relatively small quantities and in
response to specific customer demands. Direct material and direct labor costs can
be easily traced to the resulting products in a job order system. Process costing is
a costing system that is used by manufacturers that are producing mass quantities
of homogeneous goods. Costs cannot be easily traced to individual products in a
process costing system and, thus, equivalent units of production are employed to
do so.
(1f)
Actual costing refers to an inventory valuation method in which the actual costs
of material, labor and overhead are used to compute product or service cost.
Normal costing refers to an inventory valuation method in which product or
service cost is calculated using the actual costs of material, the actual cost of
labor, and overhead applied at an estimated standard rate. Standard costing uses
a standard cost for material, a standard cost for labor, and a standard rate for
applied overhead to calculate cost.
111
2.
Job order costing is accomplished by assigning a job ticket to each job and
accumulating costs specific to each job by writing it on the job ticket. This is
convenient when there is a relatively small number of jobs, when jobs are
distinguishable, and when jobs are made to customer satisfaction.
Process costing is accumulates costs for batches of identical products. Companies
that produce large quantities of homogenous products like breakfast cereal, could
not assign costs to each individual box of cereal. The products are made in huge
batches and then separated into sellable units. Therefore, these products are
assigned a cost using process costing.
3.
Process costing is accomplished by accumulating costs for “batches” of product.
Often, the production process is ongoing; that is, there is product at every stage of
product at all times. In that case, it would be difficult attach a specific cost to a
specific batch. Therefore, costs are often accumulated for one big batch. To
identify how much one batch of a defined size costs, production would have to be
taken to completion without starting a new batch, which wastes valuable time.
For that reason, process costing often involves equivalent units of production
(EUP), a calculation that converts the costs of several partially completed units to
fewer fully completed units. EUP equals the sum of (1) the number of products
that were started and finished during the period, (2) the number of units started
times the progress toward completion expressed as a percentage, and (3) the
number of units started in a previous period that were completed times the
remaining progress toward completion expressed as a percentage. [Note: The
percentage from (2) + the percentage from (3) = 1.]
112
4.
A predetermined overhead rate is an estimated per-unit charge for overhead that is
used in both normal and standard costing. It is calculated by computing expected
overhead at an expected level of activity and then dividing that expected overhead
amount by that level of activity. Predetermined overhead rates are used so that
timely determinations of product/service cost can be made without having to wait
for all actual overhead costs of a period to be determined. Additionally,
predetermined overhead rates allow overhead costs that vary on a monthly basis
to be "smoothed" over an annual period, providing the same "average" overhead
cost per unit of product in each period.
5.
Under- and overapplied overhead refer to a difference between the actual
overhead incurred during a period and the overhead that has been assigned
(applied) to products or services during a period using a predetermined overhead
application rate. Overhead is underapplied (overapplied) if the amount of actual
overhead is greater than (less than) the amount of applied overhead.
Under- or overapplied overhead exists at the end of a period for two reasons: (1)
the expected level of activity chosen to calculate the predetermined overhead rate
does not match the actual level of activity incurred during the period, and (2)
expected overhead costs used to calculate the predetermined overhead rate do not
match the actual overhead costs incurred during the period.
At the end of the period, if the amount is insignificant, the under- or overapplied
amount is closed to Cost of Goods Sold on the income statement. Underapplied
overhead will cause CGS to increase; overapplied overhead will cause CGS to
decrease. (Note: If the amount is significant, it is proportionately allocated among
the Work in Process Inventory, Finished Goods Inventory, and Cost of Goods
Sold accounts using the ending balances of these accounts. This situation is not
discussed in the chapter.)
113
6.
Financial statements, prepared by financial accountants for use by creditors and
investors, are sometimes intentionally misstated to enhance confidence in the
viability or economic position of the company. At first thought, it seems that
misstating managerial accounting, which is an internal process, would not benefit
anyone because the primary purpose is to provide information. However,
managers are often evaluated on the data provided by managerial accounting.
Therefore, costs that reflect badly on a manager may be covered up. For example,
a completed product is check for a certain characteristic (quality control), and
“bad” products must be reworked or disposed of. If a manager is evaluated by the
percentage of reworks, s/he may try to conceal how high that percentage is.
7.
To be accounted for as a direct material, the cost must be significant and easily
traceable to the job. A shirt, for example, is made of fabric, thread, and buttons;
there is a fixed number of buttons that could represent a significant portion of the
cost of the shirt. If the button were an insignificant portion of the cost, it would be
inconvenient to account for each button used. It would be more likely that a large
container of buttons would be available to production and the entire container
would be added to overhead. For example, a cashmere coat, tie-front coat with a
zip-out lining may cost $100 to produce. If there is one button inside the coat as
part of the lining, the cost of the button compared to the cost of the coat would be
insignificant.
8.
Student answers will vary.
(a)
General Motors
Product/
Service
Direct
Material
Direct
Labor
Variable
Overhead
Fixed
Overhead
(c)
(d) Applebee’s
Restaurant
Buick LeSabre
(b)
Gateway
Computers
Desktop computer
Windshield
Processor Chip
H&R Block
Personal income
tax return
(probably none)
Windshield
installer
Electricity
Chip installer
Tax preparer
(probably none)
Solder
Tax forms
Production Line
Manager’s salary
Insurance on
production
facilities
Rent on storefront
Grease for deep
frying
Salary of kitchen
staff
Chicken fingers
Chicken
114
9.
The term cost of goods manufactured refers to the total cost of the products that
were completed in a specific period of time. The CGM includes the costs of
beginning work in process inventory (those items started in a previous period but
not completed until the current period), direct material used, direct labor incurred,
and actual or applied overhead; the cost of ending work in process inventory
(those items started in the current period but not complete) is then subtracted to
get CGM.
There is a figure that is called cost of services rendered that is similar to CGM.
The primary difference is that there may not be direct materials included in the
CSR; that part of the computation may be related to supplies instead.
115
Exercises
10.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
F .........A cost may be controllable to one person in an organization and
not another. Therefore, a cost is defined as controllable or
uncontrollable with respect to a person or department.
F .........Some costs have both variable and fixed portions, called mixed
costs.
T
T
T
F .........In standard costing, no actual costs are used. Material, labor, and
overhead are all applied at standard rates.
F .........Application of overhead is based on estimates of (a) overhead
costs, (b) which driver to use, and (c) units of the driver. Because
there are so many estimates, there will almost always be over- or
under-applied overhead. If it is reasonably close, the errors are
probably due to estimation errors.
T
T
T
12.
(1) Product/
Period
(a) Wood
(b) Brass ornament
(c) Engraving material
(d) Engraving machine
(e) Salary of sales staff
(f) Rent & ins on building
(g) Depr on equipment
(h) Salary of trophy mfgr
(i) Salary of mach operators
(j) Maint on engraving mach
(k) Electricity
(l) Adhesive for production
(1)
(2)
(3)
(4)
13.
(1)
Product
Product
Product
Product
Period
Both(1)
Product
Product
Product
Product
Both(1)
Product
(2)
Direct/
Indirect
Direct
Direct
Indirect
n/a(2)
n/a(3)
Indirect
Indirect
Direct
Indirect
Indirect
Indirect
Indirect
(3)
Variable/
Fixed/Mix
Variable
Variable
Mixed
n/a(2)
Fixed(4)
Fixed
Fixed
Fixed(4)
Fixed(4)
Variable
Mixed
Variable
(4)
Control/
Uncontrol
Control
Control
Control
n/a(2)
Uncontrol
Uncontrol
Uncontrol
Control
Control
Control
Uncontrol
Control
These costs should be divided between production and sales facilities.
The cost of machinery is not added to the cost of a product, but the maintenance and
depreciation on that machinery is.
Period costs are typically not classified as direct or indirect because they are not part of
production.
Typically salaries are fixed, however these people may be paid per unit of production
making their wage variable.
Variable:
clocks, resin bases, direct labor
Fixed: machine depreciation, supervisor salaries
116
Mixed: utilities
(2)
$23,200 for 5,000 clocks
1 clock cost $23,200÷5,000 = $4.64
(3)
Clocks
Resin base
Direct labor
Depreciation
Supervisor salary
Utilities
Total
Cost of 5,000
units
$5,000.00
8,750.00
3,250.00
1,200.00
3,400.00
1,600.00
$23,200.00
Cost of
1 unit
$1.00
1.75
0.65
1,200.00
3,400.00
?
Cost of
6,000 units
$ 6,000.00
10,500.00
3,900.00
1,200.00
3,400.00
_____?____
$25,000.00
plus utilities
The utilities cannot be determined because there is no basis for dividing it into it’s
fixed and variable portions.
117
14.
(1)
(a) Auto mfr
(b) Custom furniture Mfr
(c) Interior decorator
(d) Restaurant
(e) Mfr of cleaning products
(f) Producer of TV drama
Costing:
Process or Job Order
Job Order
Job Order
Job Order
Process
Process
Process
(Job Order for whole season)
(2)
Companies that use process costing have work in process at every stage of
completion. All costs are accumulated for a batch, often defined by a period of
time or a large quantity of finished product. The batch costs are divided by the
number of whole units completed to get a cost per unit. If there units in partial
stages of completion, EUP is used to determine the equivalent number of whole
units produced.
(3)
Cost plus a reasonable markup is probably the primary determinant of
automobiles, custom furniture, interior decoration, and cleaning products.
Demand and reputation for the product will play a role in the markup amount.
Ambiance and reputation drive the cost of restaurant food at least as much as cost
if not more.
Popularity, time slot, appeal of stars, and other factors drive the selling price of a
television show.
118
15.
(1)
Predetermined Overhead Rate
= Estimated Overhead ÷ Estimated units of driver
= $455,000 ÷ 175,000
= $2.60 per MH
(2)
Overhead Applied
= Actual units of driver × Predetermined overhead rate
= 180,000 × $2.60
= $468,000
(3)
Actual overhead
Applied overhead
Underapplied overhead
(4)
The underapplied overhead will be closed to Cost of Goods Sold, causing that
account to increase and net income to decrease.
16.
(1)
No
overtime
Overtime
Total
$471,300
468,000
$ 3,300
Day shift
Hours:
8,000
Wage:
$10
Pay:
$80,000
Evening Shift
Hours:
6,000
Wage:
$12
Pay:
$72,000
Hours:
Wage:
Pay:
1,000
$15
$15,000
Hours:
Wage:
Pay:
$0
Hours:
9,000
Hours:
6,000
Pay:
$95,000
Pay:
0
$72,000
(2)
Direct Labor = Total Hours × Base Rate
Direct Labor = 15,000 × $10 = $150,000
(3)
Shift Premium = Evening Hours × (Shift Pay – Base Rate)
Shift Premium = 6,000 × ($12 – $10) = $12,000
Total
Hours:
Pay:
Hours:
Pay:
Hours:
Pay:
14,000
$152,000
1,000
$15,000
15,000
$167,000
Overtime Premium = Overtime Hours × (OT Pay – Base Rate)
Overtime Premium = 1,000 × ($15 – $10) = $5,000
119
18.
(1)
BritSpan Industries
Cost of Good Manufactured Schedule
For the month ended June 30, 2003
Beginning Inventory—Work in process
Manufacturing Costs for the period:
Raw Materials (direct & indirect)
Beginning Balance
Purchases
Raw Materials available
Ending Balance
Total Raw Materials used
Indirect Materials
Direct Materials Used
Direct Labor Used
Variable Overhead Applied
Fixed Overhead Applied
Total Manufacturing Costs
Total Costs in Work In Process
Less: Ending Balance—Work In Process
Cost of Goods Manufactured
(2)
(b)
$ 400,000
$120,000
350,000
(d)
$470,000
140,000
$330,000
40,000
(e)
(c)
(a)
CGM = Total Costs in WIP – End WIP
$735,000 = $1,240,000 – End WIP
End WIP = $505,000
(b)
Total Costs in WIP = Beg WIP + Total Mfg Costs
$1,240,000 = Beg WIP + $840,000
Beg WIP = $400,000
(c)
Tot Mfg Costs = DM Used + DL Used + Var & Fixed OH Applied
$840,000 = DM Used + $310,000 + $95,000 + $145,000
DM Used = $290,000
(d)
Raw Mat Used = Raw Mat Available – Ending Raw Mat
$330,000 = Raw Mat Available – $140,000
Raw Mat Available = $190,000
(e)
Raw Mat Available = Beg Raw Mat + Purchases
$190,000 = $120,000 + Purchases
Purchases = $70,000
$290,000
310,000
95,000
145,000
840,000
$1,240,000
(a)
505,000
$ 735,000
Cost per unit = CGM ÷ Units produced
Cost per unit = $735,000 ÷ 100,000 = $7.35
120
(3)
Finished Goods
Cost
Units
Cost per unit
Units Sold
Cost of Goods
Sold
(4)
22.
(1)
5/31/03
$485,750
67,000
$7.25
×
67,000
$485,750
Added in June
$735,000
100,000
$7.35
×
31,000
$227,850
6/30/03
$1,220,750
167,000
98,000
$713,600
Ending FG = FG Available for Sale – Cost of Goods Sold
Ending FG = $1,220,750 – $713,600 = $507,150
Predetermined Overhead Rate—DLHs
= Estimated Total Overhead ÷ Estimated total DLHs
= ($201,000 + $22,200) ÷ (1,500 + 10,000)DLHs
= $223,200 ÷ 11,500 DLHs = $19.41 per DLH
Applied to one unit of Product N—DLHs
= Predetermined Overhead Rate × DLHs per unit of N
= $19.41 per DLH × (.15 + 1.20)DLHs
= $26.20 total OH applied per unit of N
(2)
Predetermined Overhead Rate—MHs
= Estimated Total Overhead ÷ Estimated total MHs
= ($201,000 + $22,200) ÷ (15,000 + 3,000)MHs
= $223,200 ÷ 18,000 MHs = $12.40 per MH
Applied to one unit of Product N—MHs
= Predetermined Overhead Rate × MHs per unit of N
= $12.40 per MH × (8.0 + 0.3)MHs
= $102.92 total OH applied per unit of N
(3)
Predetermined Overhead Rate—Assembly/DLHs
= Estimated Overhead ÷ Estimated DLHs
= $22,200 ÷ 10,000 DLHs = $2.22 per DLH
Predetermined Overhead Rate—Production/MHs
= Estimated Overhead ÷ Estimated MHs
= $201,000 ÷ 15,000 MHs = $13.40 per MH
Applied to one unit of Product N—MHs & DLHs
= Predetermined Overhead Rate × MHs per unit of N
= ($13.40 per MH × 8 MH) + ($2.22 per DLH × 1.2 DLHs)
= $107.20 + $2.66
121
= $109.86 total OH applied per unit of N
(4)
Because Product N uses so few direct labor hours, using that base to apply
overhead will result in an extremely low amount of overhead applied. Using MHs
in part b gives a better overhead application amount because the majority of the
work performed on Product N is done in the form of machine hours. Part c allows
the use of the best base in each department, thus resulting in the most appropriate
allocation of overhead to Product N, given the quantity of each type of work
performed in each department.
122
23.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
Raw Materials Inventory
Accounts Payable
$43,000
$43,000
Work in Process Inventory
Raw Materials Inventory
22,000
Work in Process Inventory
Overhead Control
Wages Payable
20,000
6,000
22,000
26,000
Overhead Control
Accumulated Depreciation
2,200
Overhead Control
Prepaid Insurance
1,000
2,200
1,000
Overhead Control
Utilities Payable
850
Overhead Control
Cash
250
Work in Process Inventory
Overhead Control
850
250
6,800
6,800
(1,700 DLHs × $4)
(i)
(j)
Finished Goods Inventory
Work in Process Inventory
53,600
Accounts Receivable
Sales
89,000
Cost of Goods Sold
Finished Goods Inventory
50,000
53,600
89,000
50,000
123
24.
(1)
Work in Process - beginning
Raw Materials Inventory
Beginning Balance
Purchases
Available to use
Ending Balance
Raw materials used
Direct labor
Overhead applied
Total cost used in production
Total costs to account for
Work in Process - ending
Cost of Goods Manufactured
$ 21,300
$ 4,500
65,000
$69,500
(5,200)
$64,300
54,000
(a)
49,500
167,800
$189,100
(12,700)
$176,400
(a) Direct Labor Costs = Direct Labor Hours × Labor Rate
$54,000 = Direct Labor Hours × $6
Direct Labor Hours = $54,000 × $6 = 9,000 DLHs
Overhead Applied = Predetermined Overhead Rate × DLHs
Overhead Applied = $5.5 × 9,000 DLHs
Overhead Applied = $49,500
(2)
Finished Goods - beginning
Cost of Goods Manufactured
Total cost of goods available for sale
Finished Goods - ending
Cost of Goods Sold
$ 10,800
176,400
$187,200
(4,900)
$182,300
CHAPTER 12
Solutions to End of Chapter Material
Questions
1.
The break-even point is that level of sales at which no profits are generated and
no losses are incurred. Total sales (dollars collected from customers) are equal to
total costs (dollars associated with production of the product sold to customers) at
the break-even point. The BEP is the starting point for cost-volume-profit analysis
because a company must break even before it can begin to earn profits.
Calculating the BEP also provides a picture of how costs will (variable) or will
not (fixed) react in response to changes in sales volume.
2.
A relevant range is a quantity of units that can be produced while keeping fixed
costs fixed and variable costs constant. The assumption is necessary for CPV and
BEP analysis because beyond the relevant range costs begin to change in ways
that aren’t easy to use in a single equation.
124
For example, restaurant has a certain amount of floor space devoted to the dining
room. Because of that, a certain number of tables and chair are available and a
certain number cooks are needed to prepare meals for those tables in a timely
manner. These “certains” define the restaurant’s relevant range. If the restaurant
wants to expand its dining area to add more tables, costs such as linen service,
electricity, salary of the cooks if more must be hired are likely to change.
125
3.
The assumptions underlying break-even analysis are not very realistic for the
following reasons:
 Most companies do not sell a single product or cannot predict with great
accuracy the sales mix of the group of products being sold.
 Most companies have varying selling prices depending on the type of
customer doing the purchasing and the volume of goods being purchased
(either at a single point in time or for a period of time).
 Most companies cannot accurately separate mixed costs into their fixed and
variable elements.
 Most companies' variable and fixed costs are not constant, respectively, per
unit and in total for an annual period of time.
 Most companies do not have equal production and sales levels.
 Most companies face frequently changing business conditions throughout an
annual period.
4.
The assumption that all units produced are sold ignores the fact that a company
may incur costs for producing items that it might not sell until later or that it
might not sell at all due obsolescence, defects, or lack of demand. CVP and BEP
analysis are calculated on a per-unit basis and does not have the capability of
adding in additional costs of products that aren’t sold.
5.
The contribution margin is the difference between selling price (on either a per
unit or total basis) and variable costs (on either a per unit or total basis). CM
fluctuates in direct proportion to sales volume because both the selling price and
the variable cost per unit are assumed to be constant for each unit sold; thus, the
CM is also constant per unit.
6.
The contribution margin ratio is calculated as the difference between revenues
and variable costs, divided by revenues. The ratio can be calculated using either
per-unit numbers or in-total numbers; the answer will be the same either way. The
ratio provide information about the portion (percentage) of each sales dollars that
is used to cover fixed costs and then “contributes to” (accumulates as) profit after
fixed costs are covered. The remaining percentage (100–CMR) is the portion
(percentage) of each sales dollar that is used to cover variable costs.
126
7.
The constant sales mix assumption is necessary in a multiproduct firm because it
allows a weighted average contribution margin to be computed for the "basket" of
goods sold by the company. Without such a weighted average, it would be
impossible to estimate the impact of each product's contribution margin on the
coverage of fixed costs and the generation of profits.
8.
The break-even graph provides three lines for revenues, total costs and fixed
costs. At any level of production (x-axis), a comparison can be made between the
total revenues and total costs. The point at which the lines cross is the break-even
point and before and after that point the losses and profits are depicted.
The profit-volume graph has one line depicting revenues. At any level of
production (x-axis), the total revenues are determined by the line. The line crosses
the x-axis at the break-even point in units. Before and after that point, the
company incurs a loss or profit.
Student answers will vary about which provides better information. However,
using the break-even point graph allows one to determine fixed costs, total costs,
variable costs, and revenues in addition to the point at which the company breaks
even. The profit-volume graph only gives profit (or loss), but not the numbers the
underlying components.
9.
The margin of safety allows managers to assess how closely the company is
operating to the break-even point. This information is important because the
closer operations are to BE, the more important it is not to lose any sales so that
losses will not be incurred. The degree of operating leverage shows the impact a
percentage increase in sales will have on company profitability. The closer the
company is to the BEP, the more dramatic (percentage-wise) a profitability
impact a sales percentage increase is; the further a company is from BEP, the less
dramatic (percentage-wise) profitability impact will occur but the dollar impact
can be substantially greater.
10.
Benefits

Drawbacks

Margin of Safety
Gives management as
sense of how much they
can decline in sales before
profits are in danger
Assumes operation
within a relevant range
which may not be the case
as sales are declining



Degree of
Operating Leverage
Measure the effect on
profit with a change in sales
Assumes operation
within a relevant range
Measures change as a
percentage which can be
misleading
127
128
Exercises
11.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
F .........At the break-even point, total revenue dollars equal total cost.
T
T .........CVP provides better information if the profit assumption is after
tax because the company cannot keep 100% of its pretax profits.
However, the pretax number (derived from the after-tax number) is
the one used in the CVP calculation
T
T
F .........Degree of operating leverage is a percentage of change in profit for
a change in sales. Margin of safety can be expressed in dollars or
units.
F
T
T
T
12.
R(X) – VC(X) – FC = $0
(1)
R(10,000) – $8(10,000) – $120,000 = 0
R(10,000) = $200,000
R = $20
(2)
$40(20,000) – VC(20,000) – $360,000 = 0
VC(20,000) = $440,000
VC = $22
(3)
$8(X) – $3.50(X) – $59,994 = 0
$4.50(X) = $59,994
X = 13,332
(4)
$59(42,700) – $40(42,700) – FC = 0
$19(42,700) = FC
FC = $811,300
129
13.
Pretax Profit × (1 – Tax Rate) = After-tax profit
(1)
Pretax Profit × (1 – .35) = $650,000
Pretax Profit × .65 = $650,000
Pretax Profit = $1,000,000
(2)
$2,500,000 × (1 – TR) = $1,600,000
1 – TR = .64
TR = .36
(3)
$950,000 × (1 – .29) = After-tax profit
$950,000 × .71 = After-tax profit
After-tax profit = $674,500
14.
(1)
(2)
BEP$ = FC ÷ CMRatio
BEP$ = $2,385,000 ÷ .45 = $5,300,000
VCRatio = 1 – CMRatio
VCRatio = 1 – .45 = .55
VC ÷ R = VCRatio
VC ÷ 130 = .55
VC = $71.50
(3)
BEPu = BEP$ ÷ R
BEPu = $5,300,000 ÷ $130
BEPu = 40,770 (rounded)
R(X) – VC(X) – FC = 0
$130(X) – $71.50(X) – $2,385,000 = 0
$58.50(X) = $2,385,000
X = 40,770 (rounded)
130
15.
(1)
$30(150,000) – $16(150,000) – $1,115,000 = Profit
Profit = $985,000
(2)
R(70,000) – $65(70,000) – $2,020,000 = $1,130,000
R(70,000) = $7,700,000
R = $110
(3)
$44(85,400) – $1,907,600 = profit
Profit = $1,850,000
(4)
$45(X) – $35(X) – $12,000,000 = $9,000,000
$10(X) = $21,000,000
X = 2,100,000
(5)
Pretax profit × (1 – .35) = $6,650,000
Pretax profit = $10,230,769
$37(X) – $18,000,000 = $10,230,769
$37(X) = $28,230,769
X = 762,994 (rounded)
17.
Number in Basket
Contribution Margin
(1)
Kitchen Towels
Unit
Basket
3
$0.75
$2.25
Potholders
Unit
Basket
2
$0.25
$0.50
Basket
Total
%
5
$2.75
BEPu = Fixed Costs ÷ CM
BEPu = $4,400 ÷ $2.75
BEPu = 1,600 baskets
Towels = 1.600 baskets × 3 = 4,800 towels
Potholders = 1,600 baskets × 2 = 3,200 potholders
Not enough information to calculate revenue requirements.
(2)
Pretax profit × (1 – .25) = After tax
Pretax profit × .75 = $20,250
Pretax profit = $27,000
Annual FC = $4,400 × 12 = $52,800
R(X) – VC(X) – FC = Pretax profit
CM(X) – $52,800 = $27,000
$2.75(X) = $79,800
X = 29,019 baskets (rounded up)
131
Not enough information to calculate revenue requirements.
(3)
Number in Basket
Contribution Margin
Kitchen Towels
Unit
Basket
4
$0.75
$3.00
Potholders
Unit
Basket
2
$0.25
$0.50
Basket
Total
%
6
$3.50
CM(X) – FC = Pretax Profit (Loss)
$3.50(29,019 baskets) – $52,800 = Pretax Profit (Loss)
$101,566.50 – $52,800 = Pretax Profit (Loss)
Pretax Profit = $48,766.50
The amount is not the same as desired because the "basket" sales mix changed
and added one additional unit. Thus, sales of the same number of "baskets"
generated additional profits.
132
(4)
Number in Basket
Contribution Margin
Kitchen Towels
Unit
Basket
2
$0.75
$1.50
Potholders
Unit
Basket
3
$0.25
$.75
Basket
Total
%
5
$2.25
CM(X) – FC = Pretax Profit (Loss)
$2.25(29,019 baskets) – $52,800 = Pretax Profit (Loss)
$65,292.75 – $52,800 = Pretax Profit (Loss)
Pretax Profit = $12,492.75
The amount is not the same as desired because the "basket" sales mix changed
and the new mix resulted in a smaller contribution margin per "basket". Thus,
sales of the same number of "baskets" generated fewer dollars of profits.
133
18.
(1)
The numbers are dollars. If you follow a revenue line to the y-axis, it is dollars of
revenues; for a cost line it is dollars of cost.
(2a)
(2b)
(2c)
Total revenues
Total cost
Fixed cost
(3)
Point (d) is created by the intersection of total revenues (a) and total cost (b); that
is, total revenues equal total cost. Therefore, (d) is the break-even point in dollars.
(4)
Student answers will vary slightly from those given as both these answers and
student answer are estimates.
(4a)
$5,250,000
(4b)
Variable cost per unit is the slope of line (b)
Slope = (y1 – y2)÷(x1 – x2) <- Select any two points
For example: When x=0, y=$5,250,000 and When x=106,000, y=$10,000,000
VC = ($10,000,000–$5,250,000)÷(106,000–0)units
VC = $4,750,000 ÷ 106,000 units
VC = $44.81 per unit
(4c)
Revenue per unit is the slope of line (a)
Slope = (y1 – y2)÷(x1 – x2) <- Select any two points
For example: When x=0, y=0 and When x=106,000, y=$10,000,000
VC = ($10,000,000–$0)÷(106,000–0)units
VC = $94.34 per unit
(4d)
106,000
(4e)
$10,000,000
(4f)
Profit = Revenues – total costs
Profit when x=150,000 = $14,000,000 – $11,750,000
Profit when x=150,000 = $2,250,000
(4g)
$4,000,000
(4h)
Total cost = VC + FC
VC = Total Cost – FC
VC when x=100,000 = $9,250,000 – $5,250,000
VC when x=100,000 = $4,000,000
134
19.
Actual (210,000 units)
CMu = Ru – VCu = $6.50 - $2.75 = $3.75
Total CM = Salesu × CMu = 210,000 × $3.75 = $787,500
Total Revenue = Salesu × Ru = 210,000 × $6.50 = $1,365,000
Total VC = Salesu × VCu = 210,000 × $2.75 = $577,500
Pretax Profit = TCM – TFC = $787,500 – $750,000 = $37,500
Breakeven
BEPu = FC ÷ CMu = 750,000 ÷ $3.75 = 200,000
BEP$ = BEPu × Ru = 200,000 × $6.50 = $1,300,000
(1)
MSu = Actual units – BEu = 210,000 - 200,000 = 10,000 units
MS$ = Revenue – BEP$ = $1,365,000 - $1,300,000 = $65,000
(2)
DOL = TCM ÷ Pretax Profit = $787,500 ÷ $37,500 = 21
(3)
% increase in profit = DOL × % increase in sales
% increase in profit = 21 × .30 = 6.3 times or 630%
Revenues
Variable Cost
Fixed Cost
Pretax Profit
Per unit
$6.50
2.75
$750,000
Current
210,000 units
$1,365,000
(577,500)
(750,000)
$37,500
Increase 30%
273,000 units
$1,774,500
(750,750)
(750,000)
$273,750
Increase in profit = $273,750 – $37,500 = $236,250
% increase in profit = $236,250 ÷ $37,500 = 6.3 times
(4)
Revenues
Variable Cost
Contribution Margin
Fixed Cost
Pretax Profit
Per unit
$6.50
2.75
Increase 15%
241,500 units
$1,569,750
(664,125)
$ 905,625
(772,500)
$133,125
DOL = TCM ÷ Pretax Profit = $905,625 ÷ $133,125 = 6.8
CHAPTER 13
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
135
1.
A budget is a financial plan for the future of a business. Two primary reasons
make the budget a necessary tool for businesses. First, the budget helps determine
whether the plans for the future are working toward the overall company goal;
once a budget is prepared, it may be reveled that adjustments need to be made to
reach the goals they have in mind. Second, a budget is a target to work toward or
exceed during the coming period.
2.
A budget is prepared by upper management typically. Occasionally, lower-level
employees are involved in the budget process, but upper management always has
the final say. Lower-level employees are usually involved when upper
management wants them to feel like part of the process (as opposed to having the
budget forded on them). Lower-level participation encourages employees to have
in interest in and adhere to the budget.
3.
The budgeting information begins with sales information. All budgets are based
on the sales assumptions made on the sales budget; for example, production is
based on sales, which then affects the need for materials, labor, and factory
overhead items. Sales will also have a tremendous effect on the cash budget
because of the collection process.
4.
The production and purchases budgets are similar in that they both start with a
specified number to which desired ending inventory is added and beginning
inventory is subtracted. The difference between the two budgets is that the
production budget begins with sales information and the purchases budget begins
with production information. Additionally, the purchases budget will be computed
on the basis of input quantities for the particular direct material and will be
converted into dollars at the end of the budget.
Production budgets are only used in manufacturing organizations. Purchases
budgets are used by manufacturing, retail, and service organizations.
136
5.
Related to production, if we have to sell an item of inventory on the first of the
month, there would not be any finished goods in the warehouse if we only made
enough to sell in the previous month. Therefore, we produce enough in one month
to cover sales early in the following month.
Related to purchasing raw materials, if we use all the raw materials on hand
during the month, we will not be able to start new productions in the coming
month until we get more raw materials.
6.
We add desired ending inventory to the production budget to cover sales early in
the next month (before additional production is finished). The total units to sell in
a month plus a percentage of next months sales equals all units we need.
However, we started with some units (beginning inventory), so we can deduction
them from our needs to arrive at the number we need to actually produce.
The beginning and ending inventory on the production budget affect the number
of items we will produce. The beginning and ending inventory on the purchases
budget affect the raw materials that we will purchase. We add a desired ending
inventory to the purchases budget so that our raw material warehouse is not empty
at the beginning of the month. We deduct what we start with because we already
have it and don't have to buy it.
7.
Production overhead and selling/administrative expenses need to be separated into
their variable and fixed components because as the level of sales or production
increases, the variable overhead and selling/administrative expenses will also
increase. Fixed costs, however, will not change with sales or production levels.
(This latter situation may change if the organization moves out of its relevant
range of activity.)
Overhead costs are separated from selling and administrative expenses because
overhead is applied to work-in-process as part of the production costs. Selling and
administrative costs are period costs and are not used in the computation of
product cost. Only product costs are transferred to finished goods and eventually
cost of goods sold. Therefore, gross profit is revenues on sales minus the cost of
the items sold, but does not include selling and administrative costs.
137
8.
A cash budget begins with a beginning balance for the month. Collections of cash
are added and cash disbursements are subtracted to arrive at an ending balance.
The only difference between the cash budget and a checking account is that with a
checking account, the receipts and disbursements are actually happening, and a
budget is just a plan for what will happen. These two are similar in that only cash
received or spent is included. Money that is due to us or from us is not a part of a
cash budget or a checking account.
If a company expects a cash shortage to develop, the company has two choices:
spend less or borrow. If the shortage is expected to be short-term (a cash flow
issue), the company will typically borrow money from the bank for a short period
of time. If the shortage is going to persist, the company must revamp its budget to
plan for less spending.
Similarly, in a checking account, if a cash shortage is anticipated, the account
holder should try to spend less, rebudget his/her money. The account holder may
try borrow to cover the shortfall in cash, but borrowing is only a reasonable
option if the shortage is going to turn around. Otherwise, more money is due that
was due before with no hope of more available cash.
9.
The master budget concludes with pro forma financial statements so that
management will be able to see the total impact of the budgeting process. If
management does not "feel comfortable" with the projected outcomes, changes to
the forecasted information can be made prior to the start of the budget period. The
amounts shown on pro forma financial statements are not likely to be the same as
the financial statement prepared when the time actually arrives. Budgets are all
based on estimates, so the resulting pro forma financial statements are also just
estimates. How close or far they are away from reality depends on how good the
budget preparer is at estimating and how well the underlying assumptions hold
up.
138
10.
The primary benefit to preparing a budget on a rolling basis is that a rolling
budget ensures that 12 months of budget is always prepared. As one month ends,
another month (one year out) is added to the budget. To start a rolling budget, a
company must first create a master budget. As the first period, January 2004 for
example) elapses, the budget is prepared for January 2005. (Rolling budgets may
be prepared on a monthly or quarterly basis).
11.
Standard costs are used for two reasons. First, if a standard cost is a goal of the
company, comparison of actual costs to standard costs lets the company determine
how far away from the goal they are in reality. Then the company can determine
if changes can be made so that the goal is reached in the future or to determine
that the goals are unrealistic.
Second, standard costs are used because actual costs take time to accumulate and
use. Using a standard cost, allows for quick evaluation of actual productivity. For
example, if 5,000 units are produced and sold, you could quickly calculate
revenues, cost of sales, and gross profit if you just used a standard cost. If you
wanted actual gross profit, you would have to wait until the electric bill arrives,
until all employees' pay has been calculated, etc. Then you could determine actual
cost. Eventually, standard and actual costs are compared and differences
reconciled by calculating variances.
Standard costs are typically based on historical costs and goals for improvement
of historical costs.
139
12.
Material quantity variance (MQV) occurs when more or less raw materials are
used than prescribed by the standards. MQVs are caused by waste due to low
quality materials, waste due to mistakes or inexperience, or savings due to
experience.
Material price variance (MPV) occurs when the materials used cost more than
prescribed by the standards. MPVs are a result of changing prices, savings or
losses related to the quantity of material purchased, and losses when a premium is
paid for last-minute shipping of materials.
These two variances often occur together, mostly because standards are just goals
or estimates, which are rarely 100% accurate. However, it is possible for one to
happen without the other; for example, the quantity of material may vary because
of mistakes made in production, but the cost of the material used was exactly
what was expected because the company had a contract with its supplier.
13.
Large variances are an indication that something is wrong. It could be that the
budget estimates are bad, or it could be that the variances are due to actions (or
lack of action) by employees. Assuming the latter is true in the restaurant, the
large variances could be explained by the following scenario. The individual who
purchases the food may have purchased substandard food (e.g., lower quality,
closer to spoiling) at greatly reduced prices explaining the large favorable price
variance. As a result, the chef is forced to throw out a lot of food that is unusable
resulting in a large unfavorable quantity variance. In this situation, the person
responsible for the favorable variance, the food purchaser, is to blame for the
large quantity variance, not the chef who threw out all the food.
140
14.
Labor rate variances may be caused by (1) changes in enforceable wages (e.g.,
federal minimum wage changes, union negotiates a new wage), (2) changes in the
experience level of the labor pool (i.e., more or less inexperience, lower-paid
employees as compared to experienced, higher-paid employees), or (3) payments
of overtime or shift premiums. The first and third typically result in unfavorable
variances. The second may result in favorable or unfavorable variances depending
on whether there are more higher-paid or lower-paid employees than expected.
Labor efficiency variances may be caused by (1) changes in the experience level
of the labor pool (i.e., the more experienced a laborer is, the more efficient), (2)
the mood of the labor pool (i.e., happy employees outperform unhappy
employees), or (3) production problems (e.g., substandard materials, waste)
require more time to produce the same amount of products. The third typically
results in unfavorable variances. The first and second may result in either
favorable or unfavorable variances depending on the experience level or mood of
the employees.
15.
Management by exception involves setting a range of acceptable variances and
only examining the cause of variances that fall outside the range. There will
always be variances because standards are based on estimates and historical data.
To investigate every variance would be very time consuming. If the standards are
good, investigating only large variances is an efficient use of management's time.
However, management by exception may not serve to better the standard
estimates because the smaller variances are essentially ignored or uninvestigated.
141
EXERCISES
16.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
17.
T
T
F .........The production budget is used to determine how much to produce.
The purchases budget is used to determine how much raw material
is needed to meet production budgets.
F .........Favorable variances don't always indicate something favorable has
happened. In addition, the total variance, which includes quantity
variance and price variance, cannot indicate anything about
efficiency; the material quantity variance must be examined.
F .........The labor efficiency variance is the difference between standard
cost (standard rate × standard quantity of time) and actual quantity
of time × standard rate.
F
F .........The direct labor budget should only include the wages of those
who actually produce the product.
T
T .........Sales, the final step, is budgeted first.
F .........Multiple purchase budgets are prepared if a product contains
multiple raw materials.
Clubs, Inc.
2004 Sales Budget
Sales in Units
Unit Selling Price
Sales in Dollars
January
70,000
× $8
$560,000
February
70,000
× $8
$560,000
March
First Quarter
110,000
250,000
× $8
× $8
$880,000
$2,000,000
Sales in Units
Unit Selling Price
Sales in Dollars
April
120,000
× $8
$960,000
May
70,000
× $8
$560,000
June
Second Quarter
110,000
300,000
× $8
× $8
$880,000
$2,400,000
Sales in Units
Unit Selling Price
Sales in Dollars
July
120,000
× $8
$960,000
August
80,000
× $8
$640,000
September
Third Quarter
50,000
250,000
× $8
× $8
$400,000
$2,000,000
Sales in Units
Unit Selling Price
Sales in Dollars
October
70,000
× $8
$560,000
November
50,000
× $8
$400,000
December
Fourth Quarter
80,000
200,000
× $8
× $8
$640,000
$1,600,000
Year
1,000,000
× $8
$8,000,000
142
18.
(1)
April
12,000
1,950
13,950
1,875
12,075
Sales in Units
Desired EI
Units Needed
Beginning Inv.
Units to Produce
May
13,000
2,250
15,250
1,950
13,300
June
15,000
2,100
17,100
2,250
14,850
Second
Quarter
40,000
2,100
42,100
1,875
40,225
Desired Ending Inventory = Next Month's Sales × Percentage
1,950 = 13,000 × Percentage
Percentage = 15%
(2)
Desired EI March = April Sales × 15%
Desired EI March = 12,000 × 15%
Desired EI March = 1,800
There is not enough information to determine March's budgeted beginning
inventory.
(3)
Desired Ending Inventory = Next Month's Sales × Percentage
1,959 = 13,000 × Percentage
Percentage = 15%
July Sales × 15% = June Desired Ending Inventory
July Sales × 15% = 2,100
July Sales = 14,000
PROBLEMS
24.
Astor Corporation
2004 Production Budget (3Q)
Sales in Units
Desired EI (25%)
Units Needed
Beginning Inv.
Units to Produce
25.
July
15,000
7,500
22,500
3,700
18,800
August
30,000
6,000
36,000
7,500
28,500
September
24,000
4,500
28,500
6,000
22,500
Third Quarter
69,000
4,500
73,500
3,700
69,800
March
5,600
580
6,180
1,120
5,060
First Quarter
13,400
580
13,980
840
13,140
Marconi Company
2004 (1Q) Production Budget—Product #431
Sales in Units
Desired EI (20%)
Units Needed
Beginning Inv.
Units to Produce
January
4,000
760
4,760
840
3,920
February
3,800
1,120
4,920
760
4,160
143
Marconi Company
2004 (1Q) Purcases Budget—Material X
Units
Production
Desired EI (30%)
Total Needed
Beginning Inv.
Purchaes
Raw Materials
Gallons per unit
Gallons to purchase
Cost per Gallon
Cost of Purchases
January
3,920
1,248
5,168
1,160
4,008
February
4,160
1,518
5,678
1,248
4,430
March
5,060
870
5,930
1,518
4,412
First Quarter
13,140
870
14,010
1,160
12,850
× 2.5 gal
10,020
× $5.90/gal
$59,118.00
× 2.5 gal
11,075
× $5.90/gal
$65,342.50
× 2.5 gal
11,030
× $5.90/gal
$65,077.00
× 2.5 gal
32,125
× $5.90/gal
$189,537.50
Marconi Company
2004 (1Q) Purcases Budget—Material Y
Units
Production
Desired EI (25%)
Total Needed
Beginning Inv.
Purchaes
January
3,920
1,248
5,168
1,200
3,968
February
4,160
1,518
5,678
1,248
4,430
March
5,060
870
5,930
1,518
4,412
First Quarter
13,140
870
14,010
1,160
12,850
Raw Materials
Pounds per unit
Pounds to purchase
Cost per pound
Cost of Purchases
× 3 lbs
11,904
× $3.75/lb
$44,640.00
× 3 lbs
13,290
× $3.75/lb
$49,837.50
× 3 lbs
13,236
× $3.75/lb
$49,635.00
× 3 lbs
38,550
× $3.75/lb
$144,562.50
27.
(1&2)
Cash
30%
Sales
100%
Credit
70%
Month of Sale 100%
(30%×100%)
= 30%
1 Month After 50%
(70%×50%)
= 35%
2 Month After 40%
(70%×40%)
= 28%
3 Months After 10%
(70%×10%)
= 7%
Calista Gardens
2004 Cash Collections Budget
Soldin
October
$36,000
November
$24,000
$24,000
January
× 7%
$2,520
× 28%
× 7%
6,720
Collected In
February
March
First Quarter
Accounts
Receivable
$2,520
$1,680
6,720
1,680
144
December
$52,000
$52,000
$52,000
January
$18,900
$18,900
$18,900
$18,900
February
$27,000
$27,000
$27,000
$27,000
March
$22,000
$22,000
$22,000
$22,000
Total
(3)
× 35%
× 28%
× 7%
×
×
×
×
30%
35%
28%
7%
×
×
×
×
30%
35%
28%
7%
×
×
×
×
30%
35%
28%
7%
18,200
$3,640
18,200
14,560
3,640
5,292
5,670
6,615
5,292
14,560
5,670
6,615
$1,323
8,100
9,450
8,100
9,450
7,560
1,890
6,600
$33,110
$30,955
$24,982
6,600
$89,047
7,700
6,160
1,540
$26,173
An fairly simplistic explanation is that people overspent during the holiday period
and now are lacking the funds to pay as promptly as they normally would.
Because the company was not open at this time in the previous year, such
information on distortions in cash flow collections would not have been available.
Another possible explanation is a significant downturn in the local economic
conditions (which would not have been budgeted for).
31.
AQ
×AP
AC
3,780 yds
$7.50/yd
$28,350
MPV
AQ 3,780 yds
×SP $7.30/yd
SAC $27,594
$756 U
MQV
AUnits
×SQ/U
SQ
×SP
SC
$219 U
2,500
1.5 yds
3,750
$7.30/yd
$27,375
(1)
Standard Quantity of material allowed for actual production
= Actual production × std quantity of material per unit
= 2,500 units × 1.5 yards per unit
= 3,750
(2)
MPV = $756 U
MQV = $219 U
(3)
The actual price of a raw material might be greater than the standard price for a
variety of reasons. The company might be purchasing in smaller quantities than
usual, thereby not obtaining as large a volume discount. The cost of an underlying
base product (such as oil for many petroleum products) could have increased due
to a reduction in supply. The supply of the raw material (such as a fruit or
145
vegetable) may have diminished due to weather conditions. The cost may increase
because the company's source supplier may have changed or the quantity of
suppliers has decreased. To contain the cost, Dragon Corp. should obtain
competitive pricing or negotiate contract prices.
146
32.
AQ
×AP
AC
320 hours
$7.50/hr
$2,400
LRV
AQ 320 hours
×SP $7.00/hr
SAC $2,240
$160 U
LEV
AUnits
×SQ/U
SQ
×SP
SC
$280 F
2,160 pac.
10 min/pac
360 hours
$7.00/hr
$2,520
(1)
Standard Quantity of material allowed for actual production
= Actual production × std quantity of material per unit
= 2,160 units × 10 minutes per unit
= 21,600 minutes = 360 hours
(2)
LRV = $160 U
LEV = $280 F
(3).
The labor rate variance could have occurred because (1) the employees
performing the work were more highly trained than the usual; (2) the company
wanted to be certain to retain these employees during the Christmas rush season;
or (3) the minimum wage increased and the company decided to increase these
employees' wage rate.
The labor efficiency variance could have occurred because the employees (1)
performing the work were more highly trained than the usual; (2) felt that they
needed to work more efficiently to show appreciation for the wage increase; (3)
felt pressured because of the increased number of customers to serve; or (4)
wrapped packages less well than usual because of the "need for speed" at the rush
season.
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33.
AQ
×AP
AC
AQ
×AP
AC
4,750 lbs*
$8.30/lb
$39,425
MPV
1,280 hrs
$9.25/hr
$11,840
LRV
AQ 4,750 lbs
×SP $8.00/lb
SAC $38,000
$1,425 U
MQV
AUnits
×SQ/U
SQ
×SP
SC
$1,000 U
15,600
5 oz/unit
4,875 lbs
$8.00/oz
$39,000
AQ 1,280 hrs
×SP $9.00/hr
SAC $11,520
$320 U
LEV
AUnits
×SQ/U
SQ
×SP
SC
$180 F
15,600
5 minutes
1,300 hrs
$9.00/hr
$11,700
(1)
Standard Quantity of material allowed for actual production
= Actual production × std quantity of material per unit
= 15,600 units × 5 ounces per unit
= 78,000 ounces = 4,875 lbs
(2)
MPV = $1,425 U
MQV = $1,000 U
(3)
Standard Quantity of material allowed for actual production
= Actual production × std quantity of material per unit
= 15,600 units × 5 minutes per unit
= 78,000 minutes = 1,300 hours
(4)
LRV = $320 U
LEV = $180 F
(5)
The material could have been of higher quality than normally used resulting in
less spoilage and easier processing.
(6)
Paying the labor a higher wage rate could have been necessitated by using more
proficient laborers who could perform tasks more quickly and efficiently.
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CHAPTER 14
SOLUTIONS TO END OF CHAPTER MATERIAL
QUESTIONS
1.
Each student will provide different examples for value-added, non-value-added,
and business-value-added activities. In the strictest possible definition, a customer
would not (given a choice) want to pay for business-value-added activities (e.g.,
invoice preparation); thus, they are non-value-added. These activities, however,
may be necessary at a particular point in time given the management, employees,
and/or technology used by an organization to make a product or perform a service
for a customer. Over time, some of these activities should be eliminated.
2.
Each student will have a different answer to this question depending on the
activity they choose.
3.
A cost driver is a factor that causes a cost to be incurred; thus, there is a direct
cause-effect relationship between the driver and the cost. If the driver is
eliminated, the cost will also be eliminated.
Batch cost: the cost of printing one set of payroll checks for employees or of
moving a dolly full of products between locations
Product/process cost: the cost of research and development activities on a new
product
Organizational level cost: the cost of the CEO's salary or of the annual company
audit
It is important to classify costs as to level of incurrence so that the costs may be
traced to the appropriate products/services that are affected by the cost incurrence
or, in the case of organizational level costs, not traced at all to products/services.
4.
Activity-based costing differs from traditional costing in that it collects costs on
the basis of the underlying nature and extent of the activities that cause the costs
to be incurred. ABC focuses on overhead costs (rather than direct material or
direct labor).
5.
The use of ABC does not change the amount of overhead incurred by an
organization. ABC merely changes the allocation of that overhead; therefore, total
costs are same. This change usually means that the costs of standard, high-volume
products/services will decline and the costs of specialized, low-volume
products/services will increase.
6.
The three most common types of responsibility centers are the cost, profit, and
investment centers. A cost center has the control of costs as its primary area of
149
responsibility. A profit center needs to generate revenues and control costs so as
to produce a "reasonable" profit. An investment center must be able to generate a
"reasonable" rate of return (as specified by the organization's top management)
through the use of assets, generation of revenues, and control of costs. [Students
will provide different examples.]
7.
The items over which a center is responsible determines how narrowly or broadly
that center's performance can be measured. For example, because a cost center is
responsible only for controlling costs, the management of that center should not
be evaluate on “profit” associated with that center. For example, the legal
department of a company is typically a cost center because it does not bring in
revenue, and therefore, does not generate profit. The management of the legal
department is responsible for controlling the costs necessary to perform the
department’s function. To evaluate the legal department’s management on firm
profit would be unreasonable because the legal department cannot influence the
department.
8.
The two formulas for return on investment are: (1) income ÷ assets and (2) the Du
Pont model of (income ÷ sales) × (sales ÷ assets). The breakdown of the Du Pont
model in computations for profit margin and asset turnover allow more
information to be gained on what factors created the ROI: what rate of profit was
generated on each sales dollar and how many dollars of revenues were generated
by each dollar of assets.
150
9.
A balanced scorecard is a set of interrelated categories for which performance
measurements need to be generated. The scorecard is based on the organization's
vision and mission. The scorecard normally contains the following four
categories: financial, internal process, learning and growth, and customer. The
number of or titles of these categories may vary depending on the organization or
the level within the organization at which the scorecard is implemented. Each
category is included in the BSC because these are the categories at which an
organization must excel to succeed over the long-run.
10.
Benchmarking is the process of comparing a product, process, or service to a
similar product, process, or service in another company, specifically a company
that is known to be “the best” in that area. For example, for years, Federal Express
was the best at tracking parcels while in shipment. Other companies that make
shipments (e.g., US Postal Service, UPS) might want to compare their tracking to
Federal Express. Also, other industries that track items might want to compare
(e.g., a nationwide department store, airline luggage departments).
Benchmarking is not always appropriate. For companies that are highly
specialized, adopting the goals set forth by another might be detrimental to the
way the company operates. Benchmarking is a lengthy and sometimes costly
process; therefore, it is not appropriate to benchmark processes that are of low
cost to a company or are unimportant. For example, assume that a national chain
of gas stations is known for the cleanliness of its bathrooms. Other gas stations
and places with high-traffic bathrooms might want to benchmark that process.
However, even a large company like H&R Block would not need to benchmark
the process of cleaning bathrooms because theirs are not as high-traffic, used by
customers, or considered a part of their business.
151
11.
For a company to succeed in the long-run, it must generate profits and cash flow.
However, to generate those profits, companies need to have good customer
relations and loyalty, reliable and standard internal procedures, and competent
employees. The balanced scorecard uses all of these elements, even though most
are non-financial, to evaluate employees.
On the surface, it seems that if a company generates profits in the short-run every
year, in the long-run it will be profitable. However, short-run goals often lead to
short-sighted decisions. For example, if a manager is evaluated and given a bonus
based only on the bottom line (profit) in any given year, that manager has an
incentive to inflate profits in each individual year. S/he might choose to eliminate
a $10 million dollar advertising campaign, which will decrease expenses and
increase profit by $10 million dollars this year. But if the company’s market share
begins to slip because the competition is still advertising, in the long-run, profits
will be down. Therefore, it is critical to emphasize and evaluate based on both
short-term and long-term financial goals to counteract effects of shortsightedness.
12.
An organization does not necessarily need to focus on industry competitors when
determining a benchmark if that organization is attempting to compare a process
rather than a product. Process benchmarking allows organizations to assess their
abilities at performing certain tasks with the "best of class" regardless of the
industry in which those organizations happen to be. For example, many
companies have billing; any company with billing could benefit from
understanding the best practices of billing from another company, even if it was in
a different industry.
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13.
An organization's performance measurement and performance reward systems
must be aligned so that people understand that the behaviors that will cause the
organization to succeed will allow cause them to succeed relative to the reward
system. A lack of integration between these two systems may cause frustration to
the employee or behaviors that are not in the organization's best long-term
interests.
All rewards should not be monetary because, like financial measures of
performance for the organization, such rewards are short-term in nature. To help
the employee focus on the company's short- and long-term goals, the reward
system should provide a reasonable current standard of living and provide
incentives for the long-term (such as stock ownership).
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EXERCISES
14.
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
16.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
T
T
T
F .........The lower someone is in an organization, the more specific his or
her responsibilities are. For example, compare the duties of a
receptionist and the chief financial officer.
F .........If business-value-added activities can be eliminated, they should.
From the customer’s perspective, they are non-value-added.
F .........Dividends are a distribution of retained earnings, which is a longterm accumulation of yearly profits.
F .........If overhead is low compared to direct material and labor, the
distribution (application) of overhead to products or jobs will be
insignificant.
T
F .........Cost drivers should be chosen so that more overhead is distributed
to divisions that generate the most overhead.
F .........Long-run performance measure may be financial in nature, but
include many nonfinancial measures.
Level
Organizational
Batch
Batch
Product/process
Unit
Organizational
Batch
or Unit
Unit
Product/process
Unit
Batch
time (paid per period)
number of batches transferred
number of set-ups
engineering change orders made
number of tables manufactured
time (per year)
number of carts of meals
number of rooms delivered
number of envelopes stamped
number of special meals developed
number of holes drilled
18.
(1)
ROI = Income ÷ Assets = $1,110,000 ÷ $5,120,000 = 21.7%
(2)
PM = Income ÷ Sales = $1,110,000 ÷ $3,500,000 = 31.7%
(3)
AT = Sales ÷ Assets = ÷$3,500,000 ÷ $5,120,000 = 68.36%
(4)
ROI = PM × AT = 31.7% × 68.36% = 21.7%
22.
(1)
Overhead per DLH = Total Overhead ÷ DLHs
154
Overhead per DLH = $1,229,000 ÷ 80,000 = $15.36 per DLH
Overhead Cost (calc A) = Department DLHs × Overhead per DLH
X = 40,000 DLHs × $15.36 =
$614,400
Y = 30,000 DLHs × $15.36 =
$460,800
Z = 10,000 DLHs × $15.36 =
$153,600
Total applied overhead* $1,228,800
*Different because of rounding
Overhead Cost (alt B) = (Dept DLHs ÷ Total DLHs) × Overhead
X = (40,000÷80,000) × $1,229,000 =
$614,500
Y = (30,000÷80,000) × $1,229,000 =
$460,875
Z = (10,000÷80,000) × $1,229,000 =
$153,625
Total applied overhead $1,229,000
(2)
Costs
DM & DL
OH
Total cost
# of units
Cost per unit
Selling price
Profit (loss)
Profit %
X
$180,000.00
614,500.00
$794,500.00
÷ 80,000.00
$9.93
$11.00
$1.07
9.73%
Y
$140,000.00
460,875.00
$600,875.00
÷ 40,000.00
$15.02
$15.00
$(.02)
n/a
Z
$200,000.00
153,625.00
$353,625.00
÷ 8,000.00
$44.20
$45.00
$.80
.018%
Given this information, it appears that the order of product profitability is Z and
X; Y generates a loss on each sale (albeit a small one). Thus, Y should be
discontinued and emphasis should be placed on selling Z.
155
(3)
Overhead
& Rates
Material Handling
(MH)
Overhead
Amount: $700,000.00
Cost Driver:
Pounds of
Mat Used
Drivers Used:
Product X:
Product Y:
Product Z:
Total Cost Driver
Used:
Overhead Rates:
Overhead Type
Scheduling and
Utilities &
Setup
Depreciation
(SS)
(UD)
Indirect
Materials
(IM)
$132,000.00
$345,000.00
$52,000.00
Number
of Setups
Machine Hours
Incurred
DL Hours Used
600,000
300,000
100,000
20
25
10
15,000
20,000
40,000
40,000
30,000
10,000
1,000,000
55
75,000
80,000
$0.70
Per Pound
$2,400.00
Per Setup
$4.60
Per MH
$0.65
Per DL Hour
Total Overhead
$1,229,000.00
(4)
Applied Overhead
Product X:
Product Y:
Product Z:
All Products:
Material
Handling
(MH)
$420,000.00
$210,000.00
$70,000.00
$700,000.00
Overhead Type
Scheduling and
Utilities and
Setup
Depreciation
(SS)
(UD)
$48,000.00
$69,000.00
$60,000.00
$92,000.00
$24,000.00
$184,000.00
$132,000.00
$345,000.00
Indirect
Materials
(IM)
$26,000.00
$19,500.00
$6,500.00
$52,000.00
Total Overhead
Per Product
$563,000.00
$381,500.00
$284,500.00
$1,229,000.00
(5)
Costs
DM & DL
OH
Total cost
# of units
Cost per unit
Selling price
Profit (loss)
Profit %
X
$180,000.00
563,000.00
$743,000.00
÷ 80,000.00
$9.29
$11.00
$1.71
15.55%
Y
$140,000.00
381,500.00
$521,000.00
÷ 40,000.00
$13.04
$15.00
$1.96
13.07%
Z
$200,000.00
284,500.00
$484,500.00
÷ 8,000.00
$60.56
$45.00
$(15.56)
n/a
The new information shows that X is the most profitable product, followed by Y.
Z now is shown to be unprofitable to sell and, thus, should be discontinued. The
decision difference reflects the more appropriate tracing of costs to products.
156
(6)
Alternative Drivers
Materials Handling:
• Size of material – some material might be more dense than others; that is, size
makes delivery costs increase
• Number of deliveries
Scheduling and Setup:
• Time of setup – some setups might be more complicated that others
Utilities and Depreciation:
• Square footage occupied – depreciation on facility should be allotted by the
size of the department and utilities would be higher for larger departments
Indirect materials used:
• Direct material used – more complicated products may require more indirect
material
25.
(1)
50,000 gates
Total Standard Cost
$2,000,000
Total Actual Cost
$1,813,000
D
M
DL
=$40×50,000
=$.70×2,590,000
=$18×50,000
900,000
OH
=$8×50,000
400,000
$345,000
$3,300,000
$3,244,000
=$9.05×120,000
$1,086,000
Based on this information, the manager did a good job of controlling costs during
the month.
(2)
Pipe
Direct labor
Overhead:
Indirect materials
Indirect labor
Depreciation
Utilities
Maintenance
Other
Total
Standard Cost
$2,000,000
900,000
Actual Cost
$1,813,000
1,086,000
Variance
$187,000 F
186,000 U
60,000
30,000
175,000
45,000
25,000
,000
$3,300,000
40,000
25,000
155,000
52,500
17,500
55,000
$3,244,000
20,000 F
5,000 F
20,000 F
7,500 U
7,500 F
10,000 F
$ 56,000 F
The manager may have purchased inferior quality pipe at a less-than-standard
cost, which caused a favorable material price variance ($.10 per foot) and an
unfavorable material usage variance (90,000 feet). If this situation is true, it could
explain the unfavorable labor efficiency variance (20,000 DLHs) and, possibly,
the need to use additional utilities to rework problems. The manager may have
also disregarded the need for certain indirect labor (supervisory) and maintenance
157
activities, so that the $20,000 and $7,500 favorable variances were created for
those line items.
(3)
Actual Q
×Actual P
Act. Rev
50,000
$80.00 each
$4,000,000
RPV
Actual Q 50,000
×Budget P $85.00 each
$4,250,000
$250,000 U
RQV
RV
$675,000 U
Budget Q
×Budget P
Bud. Rev
$425,000 U
55,000
$85.00 each
$4,675,000
158
(4)
A transfer price is like revenue to the division that builds a part and a cost to the
division that uses the part. For example, automobile manufacturers have a
division that builds engines. The engine (and other internally built parts) is
transferred to the assembly line, a separate division, that puts the whole car
together. The assembly line division is the only division capable of generating
actual profit because consumers don’t typically buy an engine without a car
(except for parts). So, a fair price is determined for the engine division to
“charge” to assembly line division.
Therefore, the division that builds the part, has revenues and can be classified as a
profit center. The responsibility of a cost center is just to control costs, when the
responsibility of generating revenues and profit is added, other benefits are also
received. For example, a division that has to “sell” its product is more likely to be
conscious of quality, something that might have been downplayed to minimize
costs.
159
26.
(1)
Return on Investment = Net income ÷ Assets
Div 1 = $450,000 ÷ $14,350,000 = 3.14%
Div 2 = $980,000 ÷ $29,438,000 = 3.33%
Div 3 = $1,340,000 ÷ $37,259,000 = 3.60%
As investment centers, the rank would be 3–2–1.
As profit centers, the rank would be 3–2–1.
As cost centers*, the rank would be 1–2–3.
*Costs = Sales – Net Income
Div 1 = $1,569,000 – $450,000 = $1,119,000
Div 2 = $3,986,000 – $980,000 = $3,006,000
Div 3 = $8,231,000 – $1,340,000 = $6,891,000
(71.3% of Sales)
(75.4% of Sales)
(83.7% of Sales)
Division 3 is clearly the most profitable and earning the best return on its assets,
but its costs are a much hither percentage of sales than the other divisions.
(2)
Profit Margin = Net Income ÷ Revenues
Div 1 = $450,000 ÷ $1,569,000 = 28.68%
Div 2 = $980,000 ÷ $3,986,000 = 24.59%
Div 3 = $1,340,000 ÷ $8,231,000 = 16.28%
Asset Turnover = Revenues ÷ Assets
Div 1 = $1,569,000 ÷ $14,350,000 = 10.93%
Div 2 = $3,986,000 ÷ $29,438,000 = 13.54%
Div 3 = $8,231,000 ÷ $37,259,000 = 22.09%
With respect to profit margin, the rank would be 1–2–3. This is another indication
that costs are higher for division 2 than for other divisions.
3.
Division 1 Assets = $14,350,000 – $2,400,000 = $11,950,000
Asset Turnover $1,569,000 ÷ $11,950,000 = 13.12%
Return on Investment = $450,000 ÷ $11,950,000 = 3.77%
Given the new information, as investment centers, the rank would be 1–3–2.
Division 1’s ROI is the highest.
160