Chapter 3
Operating Decisions and
the Income Statement
ANSWERS TO QUESTIONS
1.
A typical business operating cycle for a manufacturer would be as follows:
inventory is purchased, cash is paid to suppliers, the product is manufactured
and sold on credit, and the cash is collected from the customer.
2.
The time period assumption means that the financial condition and performance
of a business can be reported periodically, usually every month, quarter, or year,
even though the life of the business is much longer.
3.
Net Income = Revenues + Gains - Expenses - Losses.
Each element is defined as follows:
Revenues -- increases in assets or settlements of liabilities from ongoing
operations.
Gains -increases in assets or settlements of liabilities from peripheral
transactions.
Expenses -- decreases in assets or increases in liabilities from ongoing
operations.
Losses -decreases in assets or increases in liabilities from peripheral
transactions.
4.
Both revenues and gains are inflows of net assets. However, revenues occur in
the normal course of operations, whereas gains occur from transactions
peripheral to the central activities of the company. An example is selling land at
a price above cost (at a gain) for companies not in the business of selling land.
Both expenses and losses are outflows of net assets. However, expenses occur
in the normal course of operations, whereas losses occur from transactions
peripheral to the central activities of the company. An example is a loss suffered
from fire damage.
5.
Accrual accounting requires recording revenues when earned and recording
expenses when incurred, regardless of the timing of cash receipts or payments.
Cash basis accounting is recording revenues when cash is received and
expenses when cash is paid.
McGraw-Hill/Irwin
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3-1
6.
The four criteria that must be met for revenue to be recognized under the accrual
basis of accounting are (1) delivery has occurred or services have been
rendered, (2) there is persuasive evidence of an arrangement for customer
payment, (3) the price is fixed or determinable, and (4) collection is reasonably
assured.
7.
The matching principle requires that expenses be recorded when incurred in
earning revenue. For example, the cost of inventory sold during a period is
recorded in the same period of the sale, not when the goods are produced and
held for sale.
8.
Net income equals revenues minus expenses. Thus revenues increase net
income and expenses decrease net income. Because net income increases
stockholders’ equity, revenues increase stockholders’ equity and expenses
decrease it.
9.
Revenues increase stockholders’ equity and expenses decrease stockholders’
equity. To increase stockholders’ equity, an account must be credited; to
decrease stockholders’ equity, an account must be debited. Thus revenues are
recorded as credits and expenses as debits.
10.
Item
Increase
Credit
Debit
Credit
Debit
Decrease
Debit
Credit
Debit
Credit
Item
Debit
Decrease
Increase
Decrease
Increase
Credit
Increase
Decrease
Increase
Decrease
Transaction
Operating,
Investing, or
Financing
Operating
None
Operating
Investing
Operating
Financing
Direction
of the Effect
on Cash
–
None
+
–
–
+
Revenues
Losses
Gains
Expenses
11.
Revenues
Losses
Gains
Expenses
12.
Cash paid to suppliers
Sale of goods on account
Cash received from customers
Purchase of investments
Cash paid for interest
Issuance of stock for cash
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
13.
Asset turnover is calculated as Sales  Average total assets. The asset turnover
ratio measures the sales generated per dollar of assets. A high ratio suggests
that the company is managing its assets (resources used to generate revenues)
efficiently.
ANSWERS TO MULTIPLE CHOICE
1. b)
6. d)
2. c)
7. c)
3. d)
8. a)
McGraw-Hill/Irwin
Financial Accounting, 5/e
4. a)
9. c)
5. b)
10. c)
© The McGraw-Hill Companies, Inc., 2007
3-3
Authors' Recommended Solution Time
(Time in minutes)
Mini-exercises
No.
Time
1
5
2
6
3
6
4
5
5
5
6
5
7
5
8
6
9
6
10
6
11
6
Exercises
No.
Time
1
10
2
15
3
20
4
20
5
20
6
20
7
18
8
20
9
20
10
20
11
20
12
15
13
20
14
20
15
20
16
20
17
20
18
10
19
10
Problems
No.
Time
1
20
2
20
3
25
4
40
5
20
6
40
7
30
Alternate
Problems
No.
Time
1
30
2
30
3
35
4
40
5
20
6
40
Cases and
Projects
No.
Time
1
20
2
30
3
30
4
20
5
30
6
30
7
60
8
30
9
*
* Due to the nature of this project, it is very difficult to estimate the amount of time
students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While
students often benefit from the extra effort, we find that some become frustrated by the
perceived difficulty of the task. You can reduce student frustration and anxiety by
making your expectations clear. For example, when our goal is to sharpen research
skills, we devote class time discussing research strategies. When we want the students
to focus on a real accounting issue, we offer suggestions about possible companies or
industries.
McGraw-Hill/Irwin
3-4
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
MINI-EXERCISES
M3–1.
TERM
F
D
G
C
E
(1) Losses
(2) Matching principle
(3) Revenues
(4) Time period assumption
(5) Operating cycle
M3–2.
Cash Basis
Income Statement
Revenues:
Cash sales
Customer deposits
Expenses:
Inventory purchases
Wages paid
Net Income
$6,000
1,000
1,000
600
$5,400
Accrual Basis
Income Statement
Revenues:
Sales to customers
$10,000
Expenses:
Cost of sales
Wages expense
Utilities expense
Net Income
7,000
600
200
$2,200
M3–3.
Revenue Account Affected
a. Game fees revenue
b. Sales revenue
Amount of Revenue Earned in July
$10,000
$5,000
c. None
No revenue earned in July; cash collections
in July related to earnings in June.
d. None
No revenue earned in July; earnings
process is not yet complete.
McGraw-Hill/Irwin
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3-5
M3–4.
Expense Account Affected
e. Cost of goods sold
f. None
g. Wages expense
h. Insurance expense
i. Repairs and maintenance
expense
j. Utilities expense
Amount of Expense Incurred in July
$2,000
No expense is incurred in July; payment
related to June electricity usage.
$4,000
$400 incurred and expensed in July;
$800 not incurred until future months
$1,000
$2,200 incurred in July
M3–5.
a.
b.
c.
d.
Cash (+A) ............................................................................
Game fees revenue (+R, +SE) .......................................
10,000
Cash (+A) ............................................................................
Accounts receivable (+A).....................................................
Sales revenue (+R, +SE) ...............................................
3,000
2,000
Cash (+A) ............................................................................
Accounts receivable (A) ...............................................
1,000
Cash (+A) ............................................................................
Unearned revenue (+L) ..................................................
1,500
McGraw-Hill/Irwin
3-6
10,000
5,000
1,000
1,500
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
M3–6.
e.
f.
g.
h.
i.
j.
Cost of goods sold (+E, SE) ..............................................
Inventory (A).................................................................
2,000
Accounts payable (–L) .........................................................
Cash (A) .......................................................................
2,000
Wages expense (+E, SE) ..................................................
Cash (A) .......................................................................
4,000
Insurance expense (+E, SE)..............................................
Prepaid expenses (+A) ........................................................
Cash (A) .......................................................................
400
800
Repairs and maintenance expense (+E, SE) .....................
Cash (A) .......................................................................
1,000
Utilities expense (+E, SE) ..................................................
Accounts payable (+L) ...................................................
2,200
2,000
2,000
4,000
1,200
1,000
2,200
M3–7.
Assets
Balance Sheet
Income Statement
Stockholders’
Net
Liabilities
Equity
Revenues Expenses
Income
a.
+10,000
NE
+10,000
+10,000
NE
+10,000
b.
+5,000
NE
+5,000
+5,000
NE
+5,000
c.
+1,000
–1,000
NE
NE
NE
NE
NE
d.
+1,500
+1,500
NE
NE
NE
NE
Transaction (c) results in an increase in an asset (cash) and a decrease in an asset
(accounts receivable). Therefore, there is no net effect on assets.
McGraw-Hill/Irwin
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3-7
M3–8.
Balance Sheet
Income Statement
Stockholders’
Net
Liabilities
Equity
Revenues Expenses
Income
Assets
e.
–2,000
NE
–2,000
NE
+2,000
–2,000
f.
–2,000
–2,000
NE
NE
NE
NE
g.
–4,000
NE
–4,000
NE
+4,000
–4,000
NE
–400
NE
+400
–400
h. –1,200/+800
i.
–1,000
NE
–1,000
NE
+1,000
–1,000
j.
NE
+2,200
–2,200
NE
+2,200
–2,200
Transaction (h) results in an increase in an asset (prepaid expenses) and a decrease in
an asset (cash). Therefore, the net effect on assets is  400.
M3–9.
Bob’s Bowling, Inc.
Income Statement
For the Month of July 2008
Revenues:
Game fees
Sales
Total revenues
Expenses:
Cost of goods sold
Utilities expense
Wages expense
Insurance expense
Repairs and maintenance expense
Total expenses
Net income
McGraw-Hill/Irwin
3-8
$10,000
5,000
15,000
2,000
2,200
4,000
400
1,000
9,600
$ 5,400
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
M3–10.
Bob’s Bowling, Inc.
Partial Statement of Cash Flows
For the Month of July 2008
Operating Activities:
Cash received from customers
(=10,000+3,000+1,000+1,500)
$15,500
Cash paid to suppliers
(=2,000+1,200+1,000)
(4,200)
Cash paid to employees
(4,000)
Total cash from operating activities
$ 7,300
M3–11.
2008
Total Asset =
Sales
Turnover
Average Total Assets
$144,000
$45,000*
2009
= 3.2
$154,000
$55,000**
= 2.8
* ($40,000 + $50,000) ÷ 2
** ($50,000 + $60,000) ÷ 2
The decrease in the asset turnover ratio suggests that the company is managing its
assets less efficiently, generating fewer sales per dollar of assets in 2009 than in 2008.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-9
EXERCISES
E3–1.
TERM
F
E
G
I
D
C
M
K
J
L
(1) Expenses
(2) Gains
(3) Revenue principle
(4) Cash basis accounting
(5) Unearned revenue
(6) Operating cycle
(7) Accrual basis accounting
(8) Prepaid expenses
(9) Revenues  Expenses = Net Income
(10) Ending Retained Earnings =
Beginning Retained Earnings + Net Income  Dividends
E3–2.
Req. 1
Cash Basis
Income Statement
Revenues:
Cash sales
Customer deposits
Expenses:
Inventory purchases
Wages paid
Utilities paid
Net Income
$340,000
21,000
90,000
54,200
7,200
$209,600
Accrual Basis
Income Statement
Revenues:
Sales to customers $410,000
Expenses:
Cost of sales
Wages expense
Utilities expense
287,000
59,000
7,880
Net Income
$56,120
Req. 2
Accrual basis financial statements provide more useful information to external users.
Financial statements created under cash basis accounting normally postpone (e.g.,
$70,000 cash sales) or accelerate (e.g., $21,000 customer deposits) recognition of
revenues and expenses long before or after goods and services are produced and
delivered (until cash is received or paid). They also do not necessarily reflect all assets
or liabilities of a company on a particular date.
McGraw-Hill/Irwin
3-10
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E3–3.
Activity
Amount of Revenue Earned in
September
Revenue Account Affected
a.
Sales revenue
$25,000
b.
Sales revenue
$21,000
c.
None
No transaction has occurred; exchange of
promises only.
d.
Sales revenue
$18,000 (= 1,000 shirts x $18 per shirt);
revenue earned when goods are delivered.
e.
None
Payment related to revenue recorded
previously in (d) above.
f.
None
No revenue earned in September;
earnings process is not yet complete.
g.
None
No revenue is earned; the issuance of
stock is a financing activity.
h.
None
No revenue earned in September;
earnings process is not yet complete.
i.
Ticket sales revenue
$4,000,000 (= $20,000,000 ÷ 5 games)
j.
None
No revenue earned in September;
earnings process is not yet complete.
k.
Interest revenue
$1,000 (= $100,000 x 12%  12 months)
l.
None
No revenue earned in September;
earnings process is not yet complete.
m.
Sales revenue
$100
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3-11
E3–4.
Activity
Amount of Expense Incurred in
January
Expense Account Affected
a.
Salary expense
$45,000 incurred in January.
The remaining half was incurred in
December.
b.
Insurance expense
$1,500 incurred in January.
The remainder is not incurred until February
and March.
c.
Utilities expense
$6,000
d.
Cost of goods sold
$4,500 (= 500 shirts x $9 per shirt)
e.
None
Expense will be recorded in the future when
the related revenue has been earned.
f.
Cost of goods sold
$45,000 (= 450 books x $100 per book)
g.
None
December expense paid in January.
h.
Commission expense
$14,200
i.
None
Expense will be recorded as depreciation
over the equipment’s useful life.
j.
None
Expense will be recorded when the related
revenue has been earned.
k.
Supplies expense
$4,800 (= $4,000 + $2,600 - $1,800)
l.
Wages expense
$120 (= 8 hours x $15 per hour)
m.
Insurance expense
$300 (= $3,600 ÷ 12 months)
n.
Repairs expense
$280
o.
Utilities Expense
$230
p.
Consulting Expense
$11,500
q.
None
December expense paid in January.
McGraw-Hill/Irwin
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Solutions Manual
E3–5.
Assets
Balance Sheet
Income Statement
Stockholders’
Net
Liabilities
Equity
Revenues Expenses
Income
a.
+
NE
+
NE
NE
NE
b.
+
+
NE
NE
NE
NE
c.
+
+
NE
NE
NE
NE
d.
+
NE
+
+
NE
+
e.
NE
+
–
NE
+
–
f.
+
NE
+
+
NE
+
g.
–
–
NE
NE
NE
NE
h.
–
NE
–
NE
+
–
i.
+
NE
+
+
NE
+
j.
–
NE
–
NE
NE
NE
k.
+/–
NE
NE
NE
NE
NE
l.
–
NE
–
NE
+
–
m.
–
+
–
NE
+
–
n.
–
NE
–
NE
+
–
Transaction (k) results in an increase in an asset (cash) and a decrease in an asset
(accounts receivable). Therefore, there is no net effect on assets.
McGraw-Hill/Irwin
Financial Accounting, 5/e
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3-13
E3–6.
Assets
Balance Sheet
Income Statement
Stockholders’
Net
Liabilities
Equity
Revenues Expenses
Income
a.
+7,570
NE
+7,570
NE
NE
NE
b.
+561,346
+561,346
NE
NE
NE
NE
c.
+66,194
+66,194
NE
NE
NE
NE
NE
+326,588
+888,926
+562,338
+326,588
NE
–8,588
NE
NE
NE
NE
NE
NE
NE
NE
d. +888,926/
–562,338
–8,588
e.
f. +/–16,015
g.
–184,989
+61,663
–246,652
NE
+246,652
–246,652
h.
+422
NE
+422
+422
NE
+422
i.
NE
+5,896
–5,896
NE
+5,896
–5,896
Transaction (f) results in an increase in an asset (property, plant, and equipment) and a
decrease in an asset (cash). Therefore, there is no net effect on assets.
E3–7.
(in millions)
a.
Cash (+A) ...........................................................................
185
Short-term notes payable (+L) .......................................
Debits equal credits. Assets and liabilities increase by the same amount.
185
b.
Cash (+A) ...........................................................................
8,035
Accounts receivable (+A) ....................................................
21,300
Service revenue (+R, +SE) .............................................
29,335
Debits equal credits. Revenue increases retained earnings (part of
stockholders' equity). Stockholders' equity and assets increase by the same
amount.
c.
Plant and equipment (+A) ...................................................
530
Cash (A) .......................................................................
Debits equal credits. Assets increase and decrease by the same amount.
McGraw-Hill/Irwin
3-14
530
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E3–7. (continued)
d.
Inventory (+A) .....................................................................
23,836
Accounts payable (+L) ....................................................
23,836
Debits equal credits. Assets and liabilities increase by the same amount.
e.
3,102
Payroll expense (+E, SE) .................................................
3,102
Cash (A) .......................................................................
Debits equal credits. Expenses decrease retained earnings (part of
stockholders' equity). Stockholders' equity and assets decrease by the same
amount.
f.
Cash (+A) ...........................................................................
21,120
21,120
Accounts receivable (A) ...............................................
Debits equal credits. Assets increase and decrease by the same amount.
g.
730
Fuel expense (+E, SE) .....................................................
730
Cash (A) .......................................................................
Debits equal credits. Expenses decrease retained earnings (part of
stockholders' equity). Stockholders' equity and assets decrease by the same
amount.
h.
310
Retained earnings (SE) ....................................................
310
Cash (A) .......................................................................
Debits equal credits. Assets and shareholders’ equity decrease by the same
amount.
i.
4,035
Accounts payable (L) ........................................................
4,035
Cash (A) .......................................................................
Debits equal credits. Assets and liabilities decrease by the same amount.
j.
61
Utilities expense (+E, SE) .................................................
53
Cash (A) .......................................................................
8
Accounts payable (+L) ....................................................
Debits equal credits. Expenses decrease retained earnings (part of
stockholders' equity). Together, stockholders' equity and liabilities decrease by
the same amount as assets.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-15
E3–8.
Req. 1
a.
Cash (+A) ................................................................... 2,500,000
Short-term note payable (+L) ...........................
2,500,000
Debits equal credits. Assets and liabilities increase by the same amount.
b.
Equipment (+A) .......................................................... 90,000
Cash (A).........................................................
90,000
Debits equal credits. Assets increase and decrease by the same amount.
c.
Merchandise inventory (+A) ........................................
40,000
Accounts payable (+L) .....................................
40,000
Debits equal credits. Assets and liabilities increase by the same amount.
d.
Repair and maintenance expense (+E, SE) ............. 62,000
Cash (A).........................................................
62,000
Debits equal credits. Expenses decrease retained earnings (part of stockholders'
equity). Stockholders' equity and assets decrease by the same amount.
e.
Cash (+A) ................................................................... 372,000
Unearned pass revenue (+L) ...........................
372,000
Debits equal credits. Since the season passes are sold before Vail Resorts
provides service, revenue is deferred until it is earned. Assets and liabilities
increase by the same amount.
f.
Cash (+A) ................................................................... 270,000
Lift revenue (+R, +SE) .....................................
270,000
Debits equal credits. Revenue increases retained earnings (a part of
stockholders' equity). Stockholders' equity and assets increase by the same
amount.
g.
Two transactions occur:
(1) Accounts receivable (+A) ......................................
750
Ski shop sales revenue (+R, +SE) ...................
750
Debits equal credits. Revenue increases retained earnings (a part of
stockholders' equity). Stockholders' equity and assets increase by the same
amount.
(2) Cost of goods sold (+E, SE) ................................
450
Merchandise inventory (A) .............................
450
Debits equal credits. Expenses decrease retained earnings (a part of
stockholders' equity). Stockholders' equity and assets decrease by the same
amount.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E3–8. (continued)
h.
Cash (+A) ................................................................... 3,200
Unearned rent revenue (+L) ............................
3,200
Debits equal credits. Since the rent is received before the townhouse is used,
revenue is deferred until it is earned. Assets and liabilities increase by the same
amount.
i.
Accounts payable (L) ................................................ 20,000
Cash (A).........................................................
20,000
Debits equal credits. Assets and liabilities decrease by the same amount.
j.
Cash (+A) ...................................................................
200
Accounts receivable (A) .................................
200
Debits equal credits. Assets increase and decrease by the same amount.
k.
Wages expense (+E, SE) ......................................... 258,000
Cash (A).........................................................
258,000
Debits equal credits. Expenses decrease retained earnings (a part of
stockholders' equity). Stockholders' equity and assets decrease by the same
amount.
Req. 2
Accounts Receivable
(j)
Beg. bal. 1,200
(g)
750
End. bal. 1,750
McGraw-Hill/Irwin
Financial Accounting, 5/e
200
© The McGraw-Hill Companies, Inc., 2007
3-17
E3–9.
2/1 Rent expense (+E, SE) .....................................................
Cash (A) .................................................................
200
2/2 Fuel expense (+E, SE) .....................................................
Accounts payable (+L) ..............................................
450
2/4 Cash (+A) ...........................................................................
Unearned revenue (+L) ............................................
800
2/7 Cash (+A) ...........................................................................
Transport revenue (+R, +SE) ...................................
900
2/10 Wages payable (L) ...........................................................
Cash (A) .................................................................
1,200
2/14 Advertising expense (+E, SE) ...........................................
Cash (A) .................................................................
60
2/18 Cash (+A) ...........................................................................
Accounts receivable (+A) ....................................................
Transport revenue (+R, +SE) ...................................
500
1,200
2/25 Parts inventory (+A) ............................................................
Accounts payable (+L) ..............................................
1,350
2/27 Retained earnings (SE) ....................................................
Dividends payable (+L) .............................................
200
McGraw-Hill/Irwin
3-18
200
450
800
900
1,200
60
1,700
1,350
200
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E3–10.
Req. 1 and 2
Cash
6,000 1,700
(a)
500 10,000
(b)
300 3,000
(c) 14,500
800
(d) 6,000
11,800
(g)
(i)
(j)
(k)
(e)
Contributed Capital
8,000
600 (h)
8,600
Rent Revenue
300
(b)
300
(k)
19,000
Equipment
8,000
(h) 600
8,600
Accounts
Payable
(g) 1,700 8,000
350
6,650
Accounts Receivable
25,000 6,000 (d)
Supplies
1,200
800
2,000
Land
6,000
Building
22,000
6,000
22,000
Unearned Fee
Revenue
3,200
500 (a)
3,700
Note
Payable
40,000
40,000
Rebuilding Fees
Revenue
14,500 (c)
Retained Earnings
(j) 3,000 9,000
6,000
14,500
Wages Expense
(i) 10,000
Utilities Expense
(e) 350
10,000
350
Item (f) is not a transaction; there has been no exchange.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-19
E3–10. (continued)
Req. 3
Net income using the accrual basis of accounting:
Revenues
$14,800 ($14,500 + 300)
– Expenses
10,350 ($10,000 + 350)
Net Income
$ 4,450
(accrual basis)
Assets
$11,800
19,000
2,000
8,600
6,000
22,000
$69,400
=
Liabilities
$ 6,650
3,700
40,000
$50,350
+
Stockholders’ Equity
$ 8,600
6,000
4,450 net income
$19,050
Req. 4
Net income using the cash basis of accounting:
Cash receipts
$21,300 (transactions a through d)
– Cash disbursements
12,500 (transactions g, i, and k)
Net Income
$ 8,800
(cash basis)
Cash basis net income ($8,800) is higher than accrual basis net income ($4,450)
because of the differences in the timing of recording revenues versus receipts and
expenses versus disbursements between the two methods. The $6,500 higher amount
in cash receipts over revenues includes cash received prior to being earned (from (a),
$500) and cash received after being earned (in (d), $6,000). The $2,150 higher amount
in cash disbursements over expenses includes cash paid after being incurred in the
prior period (in (g), $1,700), plus cash paid for supplies to be used and expensed in the
future (in (k), $800), less an expense incurred in January to be paid in February (in (e),
$350).
McGraw-Hill/Irwin
3-20
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E3–11.
Req. 1
EDDY’S PIANO REBUILDING COMPANY
Income Statement (unadjusted)
For the Month Ended January 31, 2008
Revenues:
Rebuilding fees revenue
Rent revenue
Total revenues
Costs and expenses:
Wages expense
Utilities expense
Total costs and expenses
Net Income
$ 14,500
300
14,800
10,000
350
10,350
$ 4,450
Req. 2
EDDY’S PIANO REBUILDING COMPANY
Statement of Retained Earnings (unadjusted)
For the Month Ended January 31, 2008
Retained Earnings, December 31, 2007
Net income
Dividends
Retained Earnings, January 31, 2008
McGraw-Hill/Irwin
Financial Accounting, 5/e
$
9,000
4,450
(3,000)
$ 10,450
© The McGraw-Hill Companies, Inc., 2007
3-21
E3–11. (continued)
Req. 3
EDDY’S PIANO REBUILDING COMPANY
Balance Sheet (unadjusted)
At January 31, 2008
Assets
Current assets:
Cash
Accounts receivable
Supplies
Total current assets
Equipment
Land
Building
Total Assets
Liabilities
Current liabilities:
Accounts payable
Unearned fee revenue
Total current liabilities
Note payable
Total Liabilities
Stockholders’ Equity
Contributed Capital
Retained Earnings
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
McGraw-Hill/Irwin
3-22
$ 11,800
19,000
2,000
32,800
8,600
6,000
22,000
$ 69,400
$
6,650
3,700
10,350
40,000
50,350
8,600
10,450
19,050
$ 69,400
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E3–12.
EDDY’S PIANO REBUILDING COMPANY
Statement of Cash Flows
For the Month Ended January 31, 2008
Operating Activities
Cash received from customers
(=$500+$300+$14,500+$6,000)
Cash paid to employees
Cash paid to suppliers (=$1,700+$800)
Total cash from operating activities
Financing Activities
Dividends paid
Total cash used in financing activities
Increase in cash
Beginning cash balance
Ending cash balance
$21,300
(10,000)
(2,500)
8,800
(3,000)
(3,000)
5,800
6,000
$11,800
Transaction (h) is omitted from the statement of cash flows because the transaction did
not involve a cash payment. However, as discussed in future chapters, this type of
transaction is a noncash investing and financing activity that requires supplemental
disclosure.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-23
E3–13.
Req. 1 and 2
Cash
(a) 40,000 20,000
(c) 75,000
8,830
(e) 10,900
63
(f) 1,700
5,080
600
55,000
38,027
(b)
(d)
(h)
(i)
(j)
(k)
Equipment
(a) 18,300
(k) 35,000
53,300
Note Payable
75,000 (c)
Accounts Receivable
(a) 2,000
(f) 1,500
3,500
(j)
Retained
Earnings
600
Mortgage Payable
140,000(b)
8,830
Accounts Payable
320
(g)
320
Contributed Capital
61,500 (a)
140,000
Food Sales Revenue
10,900 (e)
600
Cost of Food and
Paper Products
(d) 8,830
Supplies
1,200
1,200
Building
(b)160,000
(k) 20,000
180,000
75,000
(a)
61,500
Catering Sales
Revenue
3,200 (f)
10,900
Utilities Expense
(g)
320
320
3,200
Wages Expense
(i) 5,080
5,080
Fuel Expense
(h)
63
63
McGraw-Hill/Irwin
3-24
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E3–14.
Req. 1
THE TRAVELING GOURMET, INC.
Income Statement (unadjusted)
For the Month Ended March 31, 2008
Revenues:
Food sales revenue
Catering sales revenue
Total revenues
Costs and expenses:
Cost of food and paper products
Utilities expense
Wages expense
Fuel expense
Total costs and expenses
Net Loss
$ 10,900
3,200
14,100
8,830
320
5,080
63
14,293
$ (193)
Req. 2
THE TRAVELING GOURMET, INC.
Statement of Retained Earnings (unadjusted)
For the Month Ended March 31, 2008
Retained Earnings, March 1, 2008
Net loss
Dividends
Retained Earnings, March 31, 2008
McGraw-Hill/Irwin
Financial Accounting, 5/e
$
0
(193)
(600)
$ (793)
© The McGraw-Hill Companies, Inc., 2007
3-25
E3–14. (continued)
Req. 3
THE TRAVELING GOURMET, INC.
Balance Sheet (unadjusted)
At March 31, 2008
Assets
Current assets:
Cash
Accounts receivable
Supplies
Total current assets
Equipment
Building
Total Assets
Liabilities
Current liabilities:
Accounts payable
Note payable
Total current liabilities
Mortgage payable
Total Liabilities
Stockholders’ Equity
Contributed Capital
Retained Earnings
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
$ 38,027
3,500
1,200
42,727
53,300
180,000
$276,027
$
320
75,000
75,320
140,000
215,320
61,500
(793)
60,707
$276,027
Note: In many states, dividends could not have been declared legally due to the
insufficient amount in retained earnings.
Req. 4
The company generated a small loss during its first month of operation, before making
any adjusting entries. The adjusting entries for depreciation and interest expense will
increase the loss. So far the company does not appear to be successful, but it is only in
its first month of operating a retail store. If sales can be increased without inflating fixed
costs (particularly salaries expense), the company may soon turn a profit. It is not
unusual for small businesses to lose money as they start up operations.
McGraw-Hill/Irwin
3-26
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E3–15.
THE TRAVELING GOURMET, INC.
Statement of Cash Flows
For the Month Ended March 31, 2008
Operating Activities
Cash received from customers
(=$10,900+$1,700)
Cash paid to employees
Cash paid to suppliers (=$8,830+$63)
Total cash used in operating activities
$ 12,600
(5,080)
(8,893)
(1,373)
Investing Activities
Purchased building (=$20,000+$20,000)
Purchased equipment
Total cash used in investing activities
(40,000)
(35,000)
(75,000)
Financing Activities
Borrowed on a note payable
Issued stock
Paid dividends
Total cash from financing activities
75,000
40,000
(600)
114,400
Increase in cash
Beginning cash balance
Ending cash balance
38,027
0
$ 38,027
Note that portions of transactions (a) and (b) are omitted from the statement of cash
flows. However, as discussed in future chapters, these types of transactions are
noncash investing and financing activities that require supplemental disclosure.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-27
E3–16.
Req. 1
Transaction
Brief Explanation
a
Issued capital stock to shareholders for $50,000 cash.
b
Purchased store fixtures for $10,000 cash.
c
Purchased $20,000 of inventory, paying $5,000 cash and the balance
on account.
d
Sold $10,000 of goods or services to customers, receiving $7,000 cash
and the balance on account. The cost of the goods sold was $3,000.
e
Paid $2,000 in cash for rent, $500 related to the current month and
$1,500 related to future months.
f
Paid $1,000 in wages to employees.
g
Used $1,200 of utilities during the month, not yet paid.
h
Received $3,000 cash from customers, $1,000 related to current sales
and $2,000 related to goods or services to be provided in the future.
Req. 2
Katie’s Kite Company
Income Statement
For the Month Ended April 30, 2007
Sales Revenue
Expenses:
Cost of sales
Wages expense
Rent expense
Utilities expense
Total expenses
Net Income
McGraw-Hill/Irwin
3-28
$ 11,000
$
3,000
1,000
500
1,200
5,700
5,300
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E3–16. (continued)
Katie’s Kite Company
Balance Sheet
At April 30, 2007
Assets
Current Assets
Cash
Accounts receivable
Inventory
Prepaid expenses
Total current assets
Store fixtures
$42,000
3,000
17,000
1,500
63,500
10,000
Total Assets
$73,500
Liabilities
Current Liabilities
Accounts Payable
Unearned Revenue
Total current liabilities
Shareholders’ Equity
Contributed Capital
Retained Earnings
Total shareholders’ equity
Total Liabilities &
Shareholders’ Equity
$16,200
2,000
18,200
50,000
5,300
55,300
$73,500
E3–17.
Req. 1
Assets
$ 4,000
10,000
8,000
$22,000
=
Liabilities
$ 3,000
7,000
2,000
$12,000
+
Stockholders’ Equity
$ 6,000
4,000
$10,000
Req. 2
(a)
(b)
(c)
(g)
Cash
4,000 54,000 (d)
7,000
600 (f)
60,000
500
2,000
18,900
Accounts
Payable
(d) 2,000 3,000
1,000
2,000
McGraw-Hill/Irwin
Financial Accounting, 5/e
(e)
Accounts
Receivable
10,000 7,000
(b) 10,000
(a)
13,000
Unearned
Revenue
7,000
2,000
9,000
Long-Term
Investments
8,000
8,000
Long-Term
Notes Payable
2,000
(g)
2,000
© The McGraw-Hill Companies, Inc., 2007
3-29
E3–17. (continued)
Contributed Capital
6,000
6,000
Retained Earnings
(f)
600 4,000
3,400
Consulting Fee
Revenue
70,000 (b)
70,000
Investment
Income
500 (c)
500
Wages Expense
(d) 20,000
Travel Expense
(d) 20,000
20,000
(e)
20,000
Utilities Expense
1,000
1,000
Rent Expense
(d) 12,000
12,000
Req. 3
Revenues
– Expenses
Net Income
Assets
$18,900
13,000
8,000
$39,900
$70,500 ($70,000 + 500)
53,000 ($20,000 + 20,000 + 1,000 + 12,000)
$ 17,500
=
Liabilities
$ 2,000
9,000
2,000
$13,000
Stockholders’ Equity
$ 6,000
3,400
17,500 net income
$26,900
+
Req. 4
Total Asset Turnover =
Sales
=
Average Total Assets
$70,500
$30,950*
= 2.28
* ($22,000 + $39,900) ÷ 2
The increasing trend in the asset turnover ratio from 1.80 in 2007 and 2.00 in 2008 to
2.28 in 2009 suggests that the company is managing its assets more efficiently over
time.
McGraw-Hill/Irwin
3-30
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E3–18.
Req. 1
Accounts receivable increases with customer sales on account and decreases with
cash payments received from customers.
Prepaid expenses increase with cash payments of expenses related to future periods
and decrease as these expenses are incurred over time.
Unearned revenue increases with cash payments received from customers for goods or
services to be provided in the future and decreases when those goods and services are
provided.
Req. 2
Accounts Receivable
1/1
313
2,573
Prepaid Expenses
1/1
25
240 1/1
43
2,591
12/31 295
Unearned Revenue
12/31
315 328
42
26
253 12/31
Computations:
Beginning
+
“+”

“”
=
Ending
Accounts
receivable
313
+
2,573

?
?
=
=
295
2,591
Prepaid
expenses
25
+
43

?
?
=
=
26
42
Unearned
revenues
240
+
328

?
?
=
=
253
315
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-31
E3–19.
ITEM
LOCATION
1. Description of a company’s
primary business(es).
Letter to shareholders;
Management’s Discussion and Analysis;
Summary of significant accounting policies
note
2. Income taxes paid.
Notes; Statement of cash flows
3. Accounts receivable.
Balance sheet
4. Cash flow from operating
activities.
Statement of cash flows
5. Description of a company’s
revenue recognition policy.
Summary of significant accounting policies
note
6. The inventory sold during the
year.
Income statement (Cost of Goods Sold)
7. The data needed to compute the
total asset turnover ratio.
Balance sheet and income statement
McGraw-Hill/Irwin
3-32
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
PROBLEMS
P3–1.
Transaction
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
Debit
5
1
14
1
1
2
14
7
14
3
14
6
8, 14
15
4
Credit
1, 8
11
1
13
2
13
1
1
7
1
3
1
1
1, 10
1
P3–2.
a.
b.
c.
d.
e.
f.
g.
Cash (+A) ............................................................................
Contributed capital (+SE) ...............................................
30,000
Cash (+A) ............................................................................
Long-term note payable (+L) ..........................................
50,000
Rent expense (+E, SE)......................................................
Prepaid rent (+A) .................................................................
Cash (A) .......................................................................
2,200
2,200
Prepaid insurance (+A) ........................................................
Cash (A) ......................................................................
2,400
Furniture and fixtures (+A) ...................................................
Accounts payable (+L) ..................................................
25,000
Inventory (+A) ......................................................................
Cash (A) ......................................................................
2,800
Advertising expense (+E, SE)............................................
Cash (A) ......................................................................
450
McGraw-Hill/Irwin
Financial Accounting, 5/e
30,000
50,000
4,400
2,400
25,000
2,800
450
© The McGraw-Hill Companies, Inc., 2007
3-33
P3–2. (continued)
h.
i.
j.
Cash (+A) ............................................................................
Accounts receivable (+A) ....................................................
Sales revenue (+R, +SE) ..............................................
700
700
Cost of goods sold (+E, SE) ..............................................
Inventory (A) ...............................................................
400
Accounts payable (L) .........................................................
Cash (A) ......................................................................
25,000
Cash (+A) ............................................................................
Accounts receivable (A) ..............................................
250
1,400
400
25,000
250
P3–3.
Req. 1
Req. 2
Assets
Balance Sheet
Income Statement
Stockholders’
Net
Liabilities
Equity
Revenues Expenses Income
Stmt of
Cash
Flows
a.
+/–
NE
NE
NE
NE
NE
I
b.
+
NE
+
+
NE
+
O
c.
–
NE
–
NE
+
–
NE*
d.
–
NE
–
NE
NE
NE
F
e.
–
+
–
NE
+
–
O
f.
+
NE
+
+
NE
+
O
g.
–
NE
–
NE
+
–
O
h.
+/–
+
NE
NE
NE
NE
O
* Cash is not affected in this transaction.
McGraw-Hill/Irwin
3-34
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P3–4.
Req. 1 and 2
Cash
(a) 16,000 5,400
(e) 20,000
900
(h) 4,925 20,000
(k)
250
625
(m) 3,000
500
1,420
315
15,015
(b)
(c)
(f)
(g)
(i)
(j)
(l)
Accounts Receivable
(h) 875
250 (k)
(c)
625
900
Merchandise Inventory
(d) 5,000 3,000 (h)
1,700 (m)
300
Prepaid Expenses
(b) 5,400
Furniture and Fixtures
(f) 16,500
Accounts Payable
(i)
500 5,000 (d)
5,400
16,500
Supplies
900
(f)
Equipment
3,500
3,500
Notes Payable
20,000 (e)
4,500
Contributed Capital
16,000 (a)
16,000
Advertising Expense
(g) 625
625
McGraw-Hill/Irwin
Financial Accounting, 5/e
Sales Revenue
5,800 (h)
3,000 (m)
8,800
Wage Expense
(j) 1,420
1,420
20,000
Cost of Goods Sold
(h) 3,000
(m) 1,700
4,700
Repair Expense
(l) 315
315
© The McGraw-Hill Companies, Inc., 2007
3-35
P3–4. (continued)
Req. 3
SYRENA’S SWEETS
Income Statement (unadjusted)
For the Month Ended February 29, 2008
Revenues:
Sales revenue
$ 8,800
Costs and expenses:
Cost of goods sold
Advertising expense
Wage expense
Repair expense
Total costs and expenses
Net Income
4,700
625
1,420
315
7,060
$ 1,740
SYRENA’S SWEETS
Statement of Retained Earnings (unadjusted)
For the Month Ended February 29, 2008
Retained earnings, February 1, 2008
Net income
Dividends
Retained earnings, February 29, 2008
McGraw-Hill/Irwin
3-36
$
0
1,740
0
$ 1,740
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P3–4. (continued)
SYRENA’S SWEETS
Balance Sheet (unadjusted)
At February 29, 2008
Assets
Current assets:
Cash
Accounts receivable
Supplies
Merchandise inventory
Prepaid rent
Total current assets
Furniture and fixtures
Equipment
Total Assets
Liabilities
Current liabilities:
Accounts payable
Total current liabilities
Note payable
Total Liabilities
Stockholders’ Equity
Contributed capital
Retained earnings
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
$ 15,015
625
900
300
5,400
22,240
16,500
3,500
$ 42,240
$ 4,500
4,500
20,000
24,500
16,000
1,740
17,740
$ 42,240
Req. 4
Date: (today’s date)
To:
Syrena Shirley
From: (your name)
After analyzing the effects of transactions for Syrena’s Sweets for February, the
company has realized a profit of $1,740. This is 19.8% of sales revenue. However, this
is based on unadjusted amounts. There are several additional expenses that will
decrease the net income amount. These include rent, supplies, depreciation, interest,
and wages. Therefore, the company does not appear to be profitable, which is common
for small businesses at the beginning of operations. A focus on maintaining expenses
while increasing revenues should result in profit in future periods. It would also be
useful to prepare a budget of cash flows each month for the upcoming year to decide
how potential cash shortages will be handled.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-37
P3–4. (continued)
Req. 5
Total Asset =
Turnover
Sales
Average
Total Assets
2009
2010
$75,000 =1.88
$40,000*
$85,000 = 1.36
$62,500**
* ($35,000 + $45,000) ÷ 2
** ($45,000 + $80,000) ÷ 2
The ratio for 2010 is lower than it otherwise would have been given Syrena’s decision to
open a second store. The loans and inventory purchases required have increased the
average total assets used and therefore decreased the turnover ratio. With future sales
expected to grow, the ratio should increase in coming years. Based on this rationale,
the manager should be promoted.
P3–5.
SYRENA’S SWEETS
Statement of Cash Flows
For the Month Ended February 29, 2008
Operating Activities
Cash received from customers
(=$4,925+250+3,000)
Cash paid to employees
Cash paid to suppliers
(=$5,400+900+625+500+315)
Total cash used in operating activities
Investing Activities
Purchased fixed assets
Total cash used in investing activities
$ 8,175
(1,420)
(7,740)
(985)
(20,000)
(20,000)
Financing Activities
Issued stock
Borrowed from bank
Total cash from financing activities
16,000
20,000
36,000
Increase in cash
Beginning cash balance
15,015
0
Ending cash balance
McGraw-Hill/Irwin
3-38
$15,015
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P3–6.
Req. 1 and 2
ASSETS:
(a)
(e)
(f)
(g)
Cash
744
155
600
396
6,524 3,804
900
492
240
384
2,599
(c)
(d)
(h)
(i)
(j)
(a)
Receivables
923 6,524
7,200
(e)
Spare Parts, Supplies,
and Fuel
164
1,599
164
Prepaid Expenses
64
(c)
96
160
Other Assets
1,011
LIABILITIES:
Accounts Payable
(j)
384 554
Accrued Expenses
Payable
761
Flight and Ground
Equipment
3,476
(b)
816
4,292
1,011
170
Long-term
Notes Payable
2,016
816 (b)
900 (f)
3,732
761
STOCKHOLDERS' EQUITY:
Other Noncurrent
Liabilities
790
790
Contributed Capital
702
240
(g)
942
REVENUES AND EXPENSES:
Delivery Service
Revenue
7,800 (a)
(c)
7,800
Wage Expense
(h) 3,804
3,804
(i)
Rental
Expense
648
648
Retained Earnings
970
970
(d)
Repair
Expense
396
396
Fuel Expense
492
492
Item k does not constitute a transaction.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-39
P3–6. (continued)
Req. 3
FEDERAL EXPRESS CORPORATION
Income Statement (unadjusted)
For the Year Ended June 30, 2007
(in millions)
Revenues:
Delivery service revenue
Expenses:
Rental expense
Wage expense
Fuel expense
Repair expense
Total expenses
Net Income
$ 7,800
648
3,804
492
396
5,340
$ 2,460
FEDERAL EXPRESS CORPORATION
Statement of Retained Earnings (unadjusted)
For the Year Ended June 30, 2007
(in millions)
Retained earnings, June 30, 2006
Net income
Dividends
Retained earnings, June 30, 2007
McGraw-Hill/Irwin
3-40
$
970
2,460
0
$ 3,430
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P3–6. (continued)
FEDERAL EXPRESS CORPORATION
Balance Sheet (unadjusted)
At June 30, 2007
(in millions)
Assets
Current assets:
Cash
Receivables
Prepaid expenses
Spare parts, supplies, and fuel
Total current assets:
Flight and ground equipment
Other assets
Total assets
$ 2,599
1,599
160
164
4,522
4,292
1,011
$ 9,825
Liabilities
Current liabilities:
Accounts payable
Accrued expenses payable
Total current liabilities
Long-term notes payable
Other noncurrent liabilities
Total liabilities
$
Stockholders' Equity
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
McGraw-Hill/Irwin
Financial Accounting, 5/e
170
761
931
3,732
790
5,453
942
3,430
4,372
$ 9,825
© The McGraw-Hill Companies, Inc., 2007
3-41
P3–6. (continued)
FEDERAL EXPRESS CORPORATION
Statement of Cash Flows
For the Year Ended June 30, 2007
(in millions)
Operating Activities
Cash received from customers
(=$600+6,524)
Cash paid to employees
Cash paid to suppliers
(=$744+396+492+384)
Total cash from operating activities
$ 7,124
(3,804)
(2,016)
1,304
Financing Activities
Proceeds from share issuance
Proceeds from notes payable
Total cash from financing activities
240
900
1,140
Increase in cash
Beginning cash balance
2,444
155
Ending cash balance
$2,599
Note that transaction (b) is omitted from the statement of cash flows. However, as
discussed in future chapters, this type of transaction is a noncash investing and
financing activity that requires supplemental disclosure.
McGraw-Hill/Irwin
3-42
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P3–6. (continued)
Req. 4
Total Asset Turnover
=
Sales
=
Average Total Assets
$7,800 = 1.00
$7,809*
* ($5,793 + $9,825) ÷ 2
The asset turnover ratio suggests that the company obtained $1 in sales for the month
for every $1 in assets. To analyze this result, we would need to calculate the ratio for
the company over time to observe the trend in how efficiently assets are being utilized.
We would also need the industry ratio for the current period to determine how the
company is doing in comparison to others in the industry.
P3–7.
Req. 1
a.
b.
c.
d.
e.
f.
g.
Cash (+A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Admissions revenue (+R, +SE). . . . . . . . . . . . . . . .
89,664,000
Operating expenses (+E, SE). . . . . . . . . . . . . . . . . . .
Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts payable (+L). . . . . . . . . . . . . . . . . . . . . . . .
66,347,000
Interest expense (+E, SE). . . . . . . . . . . . . . . . . . . . . .
Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6,601,000
Cash (+A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Food, merchandise, and games revenue (+R, + SE)
77,934,000
Cost of products sold (+E, SE). . . . . . . . . . . . . . . . . .
Food and merchandise inventory (A). . . . . . . . . . . .
19,525,000
Property and equipment (+A). . . . . . . . . . . . . . . . . . . . .
Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
23,813,000
Depreciation expense (+E, SE). . . . . . . . . . . . . . . . . .
Accumulated depreciation (A). . . . . . . . . . . . . . . . . .
14,473,000
Cash (+A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts receivable (+A). . . . . . . . . . . . . . . . . . . . . . . .
Accommodations revenue (+R, +SE). . . . . . . . . . . . .
11,010,000
335,000
McGraw-Hill/Irwin
Financial Accounting, 5/e
89,664,000
60,200,000
6,147,000
6,601,000
77,934,000
19,525,000
23,813,000
14,473,000
11,345,000
© The McGraw-Hill Companies, Inc., 2007
3-43
P3–7. (continued)
h.
i.
j.
k.
Notes payable (L). . . . . . . . . . . . . . . . . . . . . . . . . .
Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,900,000
Food and merchandise inventory (+A). . . . . . . . . . .
Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts payable (+L). . . . . . . . . . . . . . . . . . . . .
19,100,000
Selling, general and admin. expenses (+E, SE)
Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts payable (+L). . . . . . . . . . . . . . . . . . . . .
21,118,000
Accounts payable (L). . . . . . . . . . . . . . . . . . . . . . .
Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8,600,000
2,900,000
18,000,000
1,100,000
19,500,000
1,618,000
8,600,000
Req. 2
Transaction
Operating, Investing, or
Financing Effect
Direction and Amount
of the Effect
(a)
O
+89,664,000
(b)
O
–60,200,000
(c)
O
–6,601,000
(d)
O
+77,934,000
(e)
I
–23,813,000
(f)
None
(g)
O
+11,010,000
(h)
F
–2,900,000
(i)
O
–18,000,000
(j)
O
–19,500,000
(k)
O
–8,600,000
McGraw-Hill/Irwin
3-44
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
ALTERNATE PROBLEMS
AP3–1.
Transaction
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
k.
l.
m.
n.
o.
p.
Debit
1
2
3
4
5
1
9
7
14
14
1
14
15
12
8, 14
None
Credit
11
13
7
1
1, 8
2
1
1
1
7
13
3
10
1
1
None
AP3–2.
a.
b.
c.
d.
e.
f.
Office supplies (+A) .............................................................
Accounts payable (+L) ...............................................
1,500
Accounts receivable (+A) ....................................................
Service revenue (+R, +SE) ........................................
13,950
Accounts payable (L) .........................................................
Cash (A) ..................................................................
1,250
Advertising expense (+E, SE) ............................................
Cash (A) ..................................................................
600
Equipment (+A) ...................................................................
Cash (A) ..................................................................
4,300
Wages expense (+E, SE) ..................................................
Wages payable (L) ............................................................
Cash (A) ..................................................................
7,000
1,200
McGraw-Hill/Irwin
Financial Accounting, 5/e
1,500
13,950
1,250
600
4,300
8,200
© The McGraw-Hill Companies, Inc., 2007
3-45
AP3–2. (continued)
g.
h.
i.
j.
k.
Cash (+A) ............................................................................
Accounts receivable (A) ...........................................
10,000
Land (+A) ............................................................................
Cash (A) ..................................................................
Note payable (+L) ......................................................
10,000
Cash (+A) ............................................................................
Contributed capital (+SE) ..........................................
80,000
Accounts receivable (+A) ....................................................
Service revenue (+R, +SE) ........................................
12,000
Utilities expense (+E, SE) ..................................................
Accounts payable (+L) ...............................................
1,245
10,000
2,000
8,000
80,000
12,000
1,245
AP3–3.
Req. 1
Req. 2
Assets
Balance Sheet
Income Statement
Stmt of
Cash
Flows
Stockholders’
Net
Liabilities
Equity
Revenues Expenses Income
a.
–
+
–
NE
+
–
O
b.
Net +
NE
Net +
+
+
Net +
NE
c.
Net +
NE
+
+
NE
+
I
d.
+/–
NE
NE
NE
NE
NE
O
e.
–
NE
–
NE
+
–
NE
f.
–
–
NE
NE
NE
NE
F
g.
–
NE
–
NE
+
–
O
h.
Net +
+
NE
NE
NE
NE
I
i.
–
–
NE
NE
NE
NE
O
j.
+
NE
+
NE
NE
NE
F
k.
–
NE
–
NE
+
–
O
l.
+
NE
+
+
NE
+
O
McGraw-Hill/Irwin
3-46
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP3–4.
Req. 1 and 2
Cash
(a) 50,000 21,000 (b)
(d) 13,200
840 (g)
(e) 1,500 1,700 (h)
(i) 1,000 4,000 (j)
3,600 (k)
500 (m)
34,060
Accounts Receivable
(c) 15,260 1,000 (i)
14,260
5,210
Prepaid Insurance
(k) 3,600
Land
(a) 60,000
Barns
(a)100,000
(b) 42,000
142,000
3,600
Accounts Payable
(h) 1,700 3,210 (f)
1,200 (l)
2,710
Contributed Capital
212,000(a)
212,000
60,000
Unearned Revenue
1,500 (e)
1,500
Utilities Expense
840
1,200
2,040
McGraw-Hill/Irwin
Financial Accounting, 5/e
Supplies
2,000
3,210
Long-term
Note Payable
21,000 (b)
21,000
Retained Earnings
(m) 500
500
Animal Care
Service Revenue
15,260 (c)
15,260
(g)
(l)
(a)
(f)
Rental
Revenue
13,200 (d)
13,200
(j)
Wages Expense
4,000
4,000
© The McGraw-Hill Companies, Inc., 2007
3-47
AP3–4. (continued)
Req. 3
SPICEWOOD STABLES, INC.
Income Statement (unadjusted)
For the Month Ended April 30, 2007
Revenues:
Animal care service revenue
Rental revenue
Total revenues
$ 15,260
13,200
28,460
Expenses:
Wages expense
Utilities expense
Total costs and expenses
Net Income
4,000
2,040
6,040
$ 22,420
SPICEWOOD STABLES, INC.
Statement of Retained Earnings (unadjusted)
For the Month Ended April 30, 2007
Retained earnings, April 1, 2007
Net income
Dividends
Retained earnings, April 30, 2007
McGraw-Hill/Irwin
3-48
$
0
22,420
(500)
$ 21,920
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP3–4. (continued)
SPICEWOOD STABLES, INC.
Balance Sheet (unadjusted)
At April 30, 2007
Assets
Current assets:
Cash
Accounts receivable
Supplies
Prepaid insurance
Total current assets
Barns
Land
Total Assets
Liabilities
Current liabilities:
Accounts payable
Unearned revenue
Total current liabilities
Note payable
Total Liabilities
Stockholders’ Equity
Contributed Capital
Retained Earnings
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
$ 34,060
14,260
5,210
3,600
57,130
142,000
60,000
$259,130
$
2,710
1,500
4,210
21,000
25,210
212,000
21,920
233,920
$259,130
Req. 4
Date: (today’s date)
To:
Shareholders of Spicewood Stables, Inc.
From: (your name)
After analyzing the effects of transactions for Spicewood Stables, Inc., for April,
the company has realized a profit of $22,420. This is 79% of sales revenue. However,
this is based on unadjusted amounts. There are several additional expenses that will
decrease the net income amount. These include depreciation of the barns, supplies,
insurance, interest, and wages. Therefore, the company appears to have earned a
small profit in its first month. It would be useful to prepare a budget of income and of
cash flows each month for the upcoming year to decide whether the positive income
and cash flows are likely to continue in the future.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-49
AP3–4. (continued)
Req. 5
2008:
Total =
Asset
Turnover
Sales
Average
Total Assets
=
2009:
Total =
Asset
Turnover
Sales
Average
Total Assets
=
$400,000
= $400,000 = 1.29
($300,000+$320,000)÷2
$310,000
$450,000
($320,000+$480,000)÷2
= $450,000 = 1.13
$400,000
Under your management, the asset turnover ratio appears to be decreasing over time.
The ratio for 2009 is lower than it otherwise would have been given the shareholders’
decision to build a riding arena. The loans and building have increased the average
total assets used and therefore decreased the turnover ratio. In addition, with the new
facilities, revenues should increase in the future. Based on this rationale, you should be
promoted.
AP3–5.
SPICEWOOD STABLES, INC.
Statement of Cash Flows
For the Month Ended April 30, 2007
Operating Activities
Cash received from customers ($13,200 +1,500 +1,000)
Cash paid to employees
Cash paid to suppliers ($840+1,700+3,600)
Total cash provided by operating activities
$15,700
(4,000)
(6,140)
5,560
Investing Activities
Purchase of barns
Total cash used in investing activities
(21,000)
(21,000)
Financing Activities
Proceeds from share issuance
Dividends paid
Total cash provided by financing activities
50,000
(500)
49,500
Increase in cash
Beginning cash balance
34,060
0
Ending cash balance
McGraw-Hill/Irwin
3-50
$34,060
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP3–6.
Req. 1 and 2 (in millions)
ASSETS:
Cash
1 (c)
1,157
(b) 500
1 (e)
1,122 (f)
12 (h)
11 (i)
8 (j)
502
(g)
Inventories
1 (d)
5,541
23
5,563
Property &
Equipment (net)
63,425
(a)
150
63,575
LIABILITIES:
Accounts Payable
13,391
150 (a)
23 (g)
13,564
(i)
Marketable Securities
618
618
7,578
Prepaid Expenses
1,071
(h)
12
1,083
Utilities Expense
(c)
1
1
McGraw-Hill/Irwin
Financial Accounting, 5/e
Investments
5,394
5,394
Intangibles (net)
2,583
(j)
8
2,591
Income Tax Payable
(f)
1,122
2,244
1,122
Notes Payable
3,858
3,858
SHAREHOLDERS' EQUITY:
Shareholders' Equity
37,415
37,415
Other Debt
10 30,954
30,944
REVENUES AND EXPENSES:
Sales Revenue
5 (d)
5
Accounts Receivable
500 (b)
8,073
(d)
5
Cost of Sales
(d)
1
1
Wages Expense
(e)
1
1
Interest Expense
(i)
1
1
© The McGraw-Hill Companies, Inc., 2007
3-51
AP3–6. (continued)
Req. 3
Exxon Mobil Corporation
Income Statement (unadjusted)
For the Month Ended January 31, 2008
(in millions)
Revenues:
Sales revenue
$
Costs and expenses:
Cost of sales
Wage expense
Utilities expense
Operating income
5
1
1
1
2
Other revenues (expenses):
Interest expense
Net Income (pretax)
$
1
1
Exxon Mobil Corporation
Statement of Stockholders’ Equity (unadjusted)
For the Month Ended January 31, 2008
(in millions)
Stockholders’ equity, December 31, 2007
Stock issuance
Net income
Dividends
Stockholders’ equity, January 31, 2008
McGraw-Hill/Irwin
3-52
$ 37,415
0
1
0
$ 37,416
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP3–6. (continued)
Exxon Mobil Corporation
Balance Sheet (unadjusted)
At January 31, 2008
(in millions)
Assets
Current assets:
Cash
Marketable securities
Accounts receivable
Inventories
Prepaid expenses
Total current assets
Investments
Property & equipment (net)
Intangibles (net)
$
502
618
7,578
5,563
1,083
15,344
5,394
63,575
2,591
Total assets
$86,904
Liabilities
Current liabilities:
Accounts payable
Income tax payable
Total current liabilities
Notes payable
Other debt
Total liabilities
$13,564
1,122
14,686
3,858
30,944
49,488
Shareholders' Equity
Shareholders' equity
37,416
Total liabilities and shareholders' equity
McGraw-Hill/Irwin
Financial Accounting, 5/e
$86,904
© The McGraw-Hill Companies, Inc., 2007
3-53
AP3–6. (continued)
Exxon Mobil Corporation
Statement of Cash Flows
For the Month Ended January 31, 2008
(in millions)
Operating Activities
Cash received from customers
Cash paid to employees
Cash paid to suppliers (=$1+12)
Cash paid to government for taxes
Interest paid
Total cash used in operating activities
$
500
(1)
(13)
(1,122)
(1)
(637)
Investing Activities
Purchase of intangible assets
Total cash used in investing activities
(8)
(8)
Financing Activities
Repayment of debt
Total cash used in financing activities
(10)
(10)
Decrease in cash
Beginning cash balance
(655)
1,157
Ending cash balance
$
502
Req. 4
Total Asset
Turnover
=
Sales
=
Average Total Assets
$5
$87,383
= 0.00006
* ($87,862 + $86,904) ÷ 2
The asset turnover ratio suggests that the company obtained $0.00006 in sales for the
month for every $1 in assets. Assuming that sales are spread equally throughout the
year, the annual asset turnover would be 0.00072 (.00006 x 12 months). Compared to
other examples in the text, this suggests either that Exxon Mobil is in a higher capital
intensive industry (requiring extremely high levels of assets) or that Exxon Mobil is very
inefficient in its use of resources. Indeed, the ratio appears low due to the low amounts
used for revenues in this hypothetical month. Exxon Mobil’s actual asset turnover for a
recent year was 1.07.
McGraw-Hill/Irwin
3-54
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CASES AND PROJECTS
FINANCIAL REPORTING AND ANALYSIS CASES
CP3–1.
1. The largest expense on the income statement for the year ended January 29, 2005,
is the “cost of sales” for $781,828 (in thousands). As goods were sold throughout
the year, cost of goods sold would be recorded and inventory would be reduced.
2. Interest receivable (+A) ........................................... 1,889,000
Interest income (+R, +SE) ................................................. 1,889,000
3. This question is intended to focus students on accounts receivable and the typical
activities that increase and decrease the account.
Assuming all net sales are on credit, Pacific Sunwear of California collected
$1,226,827,000 from customers. T-account numbers are in thousands.
Accounts Receivable
Beginning
Sales
Ending
5,194
1,229,762
1,226,827 Collections
8,129
As noted in the assignment, most retailers settle sales in cash at the register and
would not have accounts receivable related to sales unless they had layaway or
private credit. For PacSun, the accounts receivable on the balance sheet primarily
relates to amounts owed from landlords for their construction allowances for building
new PacSun stores in malls.
4. Over the life of the business, total earnings will equal total net cash flow. However,
for any given year, the assumption that net earnings is equal to cash inflows is not
valid. Accrual accounting requires recording revenues when earned and expenses
when incurred, not necessarily when cash is received or paid. There may be
revenues recorded as earnings that are not yet received in cash. In the same way,
there may be cash outflows as prepayments of expenses that are not recorded as
expenses until incurred, such as inventories, insurance, and rent. Or, there may be
expenses that have been incurred for which payment will occur in the future.
5. An income statement reports the financial performance of a company over a period
of time in terms of revenues, gains, expenses, and losses. A balance sheet or
statement of financial position lists the economic resources owned by an entity and
the claims to those resources from creditors and investors at a point in time. They
are linked through retained earnings.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-55
CP3–1. (continued)
6.
Total Asset =
Turnover
Sales
Average
Total Assets
(In thousands)
=
$1,229,762
= $1,229,762 =
($677,778 + $644,487)÷2 $661,132.5
1.86
The total asset turnover ratio measures the sales generated per dollar of assets. Pacific
Sunwear of California generated $1.86 of sales per $1 of assets.
CP3-2.
1. American Eagle Outfitter’s revenue recognition policy is to record revenues when
customers purchase merchandise. Internet sales are recognized when the goods
are shipped. Revenue is recognized for stored value cards and gift certificates when
they are redeemed for merchandise. (See page 42 of the notes to the financial
statements).
2. Assuming that $50 million of cost of sales is due to occupancy and warehousing
expenses, American Eagle purchased $970,838 thousand worth of inventory.
Inventory
Beginning
120,586
Purchases
970,646
Ending
137,799
953,433
Cost of
Sales*
* Total cost of sales reported was $1,003,433. Take away an estimated $50,000 for
non-inventory purchase costs to get $953,433.
3.
2004
2003
Percentage
Genl., Admin. &
Selling Expenses
Net Sales
446,829
1,881,241
23.8%
356,261
1,435,436
Percentage
Percentage
Change
24.8%
(0.4%)
4.
Total Asset =
Turnover
Sales
=
$1,881,241
= $1,881,241 =
Average
($1,293,659+932,414)÷2 $1,113,036.5
Total Assets
1,69
The total asset turnover ratio measures the sales generated per dollar of assets.
American Eagle Outfitters generated $1,69 of sales per $1 of assets.
McGraw-Hill/Irwin
3-56
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP3–3.
1. American Eagle Outfitters calls its income statement the “Consolidated Statements
of Operations.” Pacific Sunwear of California calls its income statement the
“Consolidated Statements of Income and Comprehensive Income.” “Consolidated”
implies that the statements of two or more companies (usually the company and its
majority-owned subsidiaries) have been combined into a single statement for
presentation.
2. American Eagle Outfitters had the higher net income of $213,343,000 for the year
ended January 29, 2005, compared to Pacific Sunwear of California’s net income of
$106,904,000 for the same year (all dollars in thousands).
3.
(in thousands)
Total Asset =
Sales
Turnover
Average Total Assets
American Eagle
Outfitters
Pacific Sunwear of
California
$1,881,241 =1.69
$*1,113,036.5
$1,229,762 = 1.86
$661,132.5**
* ($1,293,659 + $932,414) ÷ 2
** ($677,778 + $644,487) ÷ 2
Pacific Sunwear of California is utilizing its assets more effectively to generate sales
than is American Eagle Outfitters. Pacific Sunwear of California has the higher asset
turnover ratio, 1.86 compared to American Eagle Outfitters’ of 1.69. However, the
difference is not very large.
4.
Asset Turnover =
Industry
Average
2.03
American Eagle
Outfitters
1.69
Pacific Sunwear of
California
1.86
Both Pacific Sunwear of California and American Eagle Outfitters are utilizing their
assets less effectively to generate sales than the average company in their industry.
However, the difference is probably too small to focus on when discussing operating
efficiency. Both Pacific Sunwear of California and American Eagle Outfitters will have
higher asset turnover ratios because they rely heavily on operating leases.
5.
Cash flow
from
operations
American Eagle Outfitters
FYE
FYE
Percentage
1/29/05 1/31/04
Change
Pacific Sunwear of California
FYE
FYE
Percentage
1/29/05 1/31/04
Change
368,683
143,012
McGraw-Hill/Irwin
Financial Accounting, 5/e
215,201
71.32%
161,004
(11.17%)
© The McGraw-Hill Companies, Inc., 2007
3-57
CP3–4.
Req. 1
2001:
Total =
Asset
Turnover
Sales
Average
Total Assets
=
$1,271,248
= $1,271,248 = 1.94
($723,480+$583,748)÷2
$653,614
2002:
Total =
Asset
Turnover
Sales
Average
Total Assets
=
$1,382,923
($802,854+$723,480)÷2
2003:
Total =
Asset
Turnover
Sales
Average
Total Assets
=
2004:
Total =
Asset
Turnover
Sales
=
$1,881,241
= $1,881,241 =1.69
Average
($1,293,659+932,414)÷2
$1,113,036.5
Total Assets
= $1,382,923 =1.81
$763,167
$1,435,436
= $1,435,436 = 1.65
($932,414+$802,854)÷2
$867,634
Req. 2
2001: Financial =
Leverage
Average
Total Assets
= $(723,480+583,748)÷2 = $653,614 = 1.52
Average
$(496,792+363,360)÷2
$430,076
Stockholders’ Equity
Average
2002: Financial =
Total Assets
=$(802,854+723,480)÷2 = $763,167 = 1.43
Leverage
Average
$(571,590+496,792)÷2
$534,191
Stockholders’ Equity
2003: Financial =
Leverage
Average
Total Assets
= $(932,414+802,854)÷2 = $867,634 = 1.44
Average
$(637,377+571,590)÷2
$604,483.5
Stockholders’ Equity
Average
2004: Financial =
Total Assets
= $(1,293,659+932,414)÷2 = $1,113,036.5 = 1.39
Leverage
Average
$(963,486+637,377)÷2
$800,431.5
Stockholders’ Equity
McGraw-Hill/Irwin
3-58
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP3–4. (continued)
Req. 3
Although American Eagle Outfitters’ asset turnover ratio increased from 2003 to 2004, it
has an overall trend that decreased from 2001 to 2004. This indicates a lower sales
per dollar of assets over time. Its financial leverage ratio decreased between 2001 and
2004, indicating that American Eagle is financing its assets with lower levels of debt
than in prior years. Together, the two ratios indicate that American Eagle is growing
while relying slightly less on debt over time, but has not yet generated higher sales per
dollar of assets.
CP3–5.
Req. 1
Accrual accounting is defined in the article as follows:
“By accruing, or allotting, revenues to specific periods, they (accountants) aim to
allocate income to the quarter or year in which it was effectively earned, though
not necessarily received. Likewise, expenses are allocated to the period when
sales were made, not necessarily when the money was spent.” (from Business
Week, October 4, 2004, p. 78)
Req. 2
The author of the article suggests that “fuzzy numbers” result from the judgments
companies make to come up with revenues and expenses on an accrual basis.
Companies are given wide discretion in determining estimates to use to compute net
income under current accounting rules, and users of the financial statements need to
read statements carefully to understand the impact of management judgments and
accounting rules. Even then, the author suggests that financial statements are often
unclear, incomplete, or too complex.
Req. 3
Congress and the SEC have adopted reforms to attempt to address the rising concerns
about financial reporting. The article suggests that many of the reforms will not help to
make financial statements clearer and more consistent. Instead, many of the reforms
are aimed at policing managers and auditors and not at clarifying estimates managers
make.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-59
CP3–6.
Req. 1
a. and b. given as examples in the textbook.
c. Cash increased $15,000, Accounts Receivable increased $12,000, and Paint
Revenue increased $27,000. Therefore, transaction (c) was delivery of painting
services for $27,000; $15,000 was received in cash and the rest was on account.
d. Cash decreased $14,000, Land increased $18,000, and Note Payable increased
$4,000. Therefore, transaction (d) was a purchase of land for $18,000; $14,000 was
paid in cash and an interest-bearing note was signed for the remainder.
e. Cash decreased $10,000, Accounts Payable increased $3,000, Supplies Expense
increased $5,000, and Wages Expense increased $8,000. Therefore, transaction (e)
was purchase and use of $5,000 of supplies and $8,000 of employee labor. $10,000
was paid in cash and $3,000 is owed.
f. Accounts Receivable increased $14,000, and Paint Revenue increased $14,000.
Therefore, transaction (f) was a sale of painting services made on account.
g. Cash decreased $4,000, and Retained Earnings decreased $4,000. Therefore,
transaction (g) was declaration and payment of a dividend of $4,000.
h. Cash decreased $11,000, Accounts Payable increased $7,000, Supplies Expense
increased $3,000, and Wages Expense increased $15,000. Therefore, transaction
(h) was purchase and use of supplies of $3,000 and employee labor of $15,000.
$11,000 was paid in cash, and $7,000 is owed.
i. Cash decreased by $5,000, and Accounts Payable decreased by $5,000. Therefore,
transaction (i) is a payment made on account.
j. Cash increased $16,000, Accounts Receivable decreased $16,000. Therefore,
transaction (j) was the receipt of payments from customers.
McGraw-Hill/Irwin
3-60
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP3–6. (continued)
Req. 2
LIPPITT PAINTING SERVICE COMPANY
Income Statement
For the Month Ended January 31, 2008
Revenues:
Paint revenue
$41,000
Expenses:
Supplies expense
Wage expense
Total costs and expenses
Net Income
8,000
23,000
31,000
$10,000
LIPPITT PAINTING SERVICE COMPANY
Statement of Retained Earnings
For the Month Ended January 31, 2008
Retained earnings, January 20, 2008
Net income
Dividends
Retained earnings, January 31, 2008
McGraw-Hill/Irwin
Financial Accounting, 5/e
$
0
10,000
(4,000)
$ 6,000
© The McGraw-Hill Companies, Inc., 2007
3-61
CP3–6. (continued)
LIPPITT PAINTING SERVICE COMPANY
Balance Sheet
At January 31, 2008
Assets
Current assets:
Cash
Accounts receivable
Total current assets
Office fixtures
Land
Total assets
$ 57,000
10,000
67,000
20,000
18,000
$105,000
Liabilities
Current liabilities:
Accounts payable
Total current liabilities
Notes payable
Total liabilities
$ 5,000
5,000
19,000
24,000
Shareholders' Equity
Contributed capital
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders' equity
75,000
6,000
81,000
$105,000
Req. 3
Transaction
Operating, Investing, or
Financing Effect
(a)
F
+75,000
(b)
I
–5,000
(c)
O
+15,000
(d)
I
–14,000
(e)
O
–10,000
(f)
None
(g)
F
–4,000
(h)
O
–11,000
(i)
O
–5,000
(j)
O
+16,000
McGraw-Hill/Irwin
3-62
Direction and Amount
of the Effect
Noncash transaction
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CRITICAL THINKING CASES
CP3–7.
Req. 1
Estela used the cash basis of accounting. We can infer this from his references to
income collected rather than earned, expenses paid rather than incurred, and supplies
purchased rather than used. Accrual accounting should be used because it correctly
assigns revenues and expenses to the accounting period in which they are earned or
incurred.
Req. 2
(a)
(b)
Building (+A) ........................................................................
Tools and equipment (+A) ...................................................
Land (+A) ............................................................................
Cash (+A) ............................................................................
Contributed capital (+SE) .........................................
21,000
17,000
20,000
1,000
Cash (+A) .............................................................................
Accounts receivable (+A) .....................................................
Unearned revenue (+L) .............................................
Service fee revenue (+R, +SE) ..................................
55,000
52,000
59,000
20,000
87,000
(c)
No entry
(d)
Operating expenses (+E, SE) ............................................
Accounts payable (+L) ...............................................
Cash (A) ..................................................................
61,000
Supplies expense (+E, SE)* ..............................................
Supplies (A) .......................................................................
Cash (A) ..................................................................
2,500
700
(e)
Other
(1) Loss from theft (+E, SE) ....................................................
Cash (A) ..................................................................
(2)
Tools and equipment (+A) ...................................................
Cash (A) ..................................................................
39,000
22,000
3,200
500
500
1,000
1,000
* Supplies purchased, $3,200  Supplies on hand at end of 2009, $700 = $2,500
supplies used
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-63
CP3–7. (continued)
ASSETS:
Cash
(a) 1,000 22,000
(b) 55,000
3,200
500
1,000
(d)
(e)
(1)
(2)
29,300
(a)
Building
21,000
21,000
LIABILITIES:
Accounts Payable
39,000 (d)
39,000
SHAREHOLDER’S EQUITY:
Contributed Capital
59,000 (a)
59,000
Accounts Receivable
(b) 52,000
52,000
700
Land
(a) 20,000
Tools and Equipment
(a) 17,000
(2) 1,000
20,000
18,000
Unearned Revenue
20,000 (b)
20,000
Retained Earnings
REVENUES AND EXPENSES:
Service Fees Revenue
Operating Expenses
87,000 (b)
(d) 61,000
87,000
61,000
(1)
(e)
Supplies
700
Supplies Expense
(e)
2,500
2,500
Loss from Theft
500
500
McGraw-Hill/Irwin
3-64
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP3–7. (continued)
Req. 3
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
ESTELA COMPANY
Income Statement
For the Year Ended December 31, 2009
Revenues:
Service fees revenue
[see note]
Costs and expenses:
Operating expenses
Supplies expense
Loss from theft
Total costs and expenses
Net Income
$ 87,000
61,000
2,500
500
64,000
$ 23,000
Use the standard title.
Date to indicate time period covered.
Use appropriate title.
Use accrual figure -- revenue earned, rather than cash collected.
Exclude the dividends because the stock is owned by Julio and not the company
-- apply the separate entity assumption.
Use appropriate title.
Use accrual figure -- expenses incurred, not cash paid.
Expense is supplies used, $2,500; the $700 is still an asset until used.
Stolen property should be recorded as a loss for the amount not covered by
insurance.
Use appropriate caption.
Use standard terminology.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-65
CP3–7. (continued)
ESTELA COMPANY
Balance Sheet
At December 31, 2009
McGraw-Hill/Irwin
3-66
Assets
Current assets:
Cash
Accounts receivable
Supplies
Total current assets
Building
Land
Tools and equipment
Total assets
$ 29,300
52,000
700
82,000
21,000
20,000
18,000
$141,000
Liabilities
Current liabilities:
Accounts payable
Unearned revenue
Total current liabilities
$ 39,000
20,000
59,000
Shareholders' Equity
Contributed capital
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders' equity
59,000
23,000
82,000
$141,000
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP3–7. (continued)
ESTELA COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2009
Operating Activities
Cash received from customers
Cash paid to suppliers ($22,000 + 3,200)
Cash stolen
Total cash provided by operating activities
Investing Activities
Purchase of tools and equipment
Total cash used in investing activities
Financing Activities
Proceeds from share issuance
Total cash provided by financing activities
Increase in cash
Beginning cash balance
Ending cash balance
$55,000
(25,200)
(500)
29,300
(1,000)
(1,000)
1,000
1,000
29,300
0
$29,300
Req. 4
The above statements do not yet take into account most year-end adjustments,
including depreciation and income taxes. The adjusting entry for income taxes is
especially important because of the implication for future cash flows.
The statements also record the building, land, and tools and equipment originally
contributed in exchange for shares in the new company at their market value at that
time. Their current market value at year-end is more relevant to a loan decision.
Current market values for the building and land are provided ($32,000 and $30,000,
respectively), but the current value of the tools and equipment is also needed.
The stock in ABC Industrial is owned by Julio and not the company. However, it may be
used as collateral if Julio is willing to sign an agreement pledging personal assets as
collateral for the loan. This is a common requirement for small start-up businesses.
Other of Julio’s personal assets could also be considered for collateral.
Lastly, pro forma financial statements (or budgets) outlining the expected revenues,
expenses, and cash flows from the expanded business would be helpful to gauge its
viability.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-67
CP3–7. (continued)
Req. 5
(today’s date)
Dear Mr. Estela:
We regret to inform you that your request for a $100,000 loan has been denied.
Your current business appears profitable and appears to generate sufficient cash to
maintain operations, even once additional expenses, such as income taxes, are
considered. However, pro forma financial statements (or budgets) outlining the
expected revenues, expenses, and cash flows from the expanded business would be
needed to gauge its future viability.
We also require that there be sufficient collateral pledged against the loan before we
can consider it. A loan of this size would increase your company’s size by over 70% of
its current asset base. The current market value of the building and land held by the
company are insufficient as collateral. The current value of the tools and equipment
may provide additional collateral, if you provide us with this information. Your personal
investments may also be considered viable collateral if you are willing to sign an
agreement pledging these assets as collateral for the loan. This is a common
requirement for small start-up businesses.
If you would like us to reconsider your application, please provide us with the pro forma
financial statements and with the current market values of any assets you would pledge
as collateral.
Regards,
(your name)
Loan Application Department,
Your Bank
McGraw-Hill/Irwin
3-68
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP3–8.
Req. 1
This type of ethical dilemma occurs quite frequently. The situation is difficult personally
because of the possible repercussions to you by your boss, Mr. Lynch, if you do not
meet his request. At the same time, the ethical and professional response is to follow
the revenue recognition rule and account for the cash collection as deferred revenue (as
was done). To record the collection as revenue overstates income in the current period.
Req. 2
In the short run, Mr. Lynch would benefit by receiving a larger bonus. You also
benefit in the short run because you would not experience any negative repercussions
from your boss. However, there is the risk that sometime in the future, perhaps through
an audit, the error will be found. At that point, both you and Mr. Lynch could be
implicated in a fraud. In addition, this may be the first instance where you are being
asked to account for a transaction in violation of accepted principles or company
policies. There is a very strong possibility Mr. Lynch may ask you for additional favors
in the future if you demonstrate your willingness at this point.
Req. 3
In the larger picture, shareholders are harmed by the misleading income figures
by relying on them to purchase stock at inflated prices. In addition, creditors may lend
funds to the insurance company based on the misleading information. The negative
impact of the discovery of misleading financial information will cause stock prices to fall,
causing shareholders to lose on their investment. Creditors will be concerned about
future debt repayment. You will also experience diminished self-respect because of the
violation of your integrity.
Req. 4
Managers are agents for shareholders. To act in ways to the benefit of the
manager at the detriment of the shareholders is inappropriate. Therefore, the ethically
correct response is to fail to comply with Mr. Lynch's request. Explaining your position
to Mr. Lynch will not be easy. You may want to express that you understand the reason
for his request, but cannot ethically or professionally comply.
FINANCIAL REPORTING AND ANALYSIS TEAM PROJECT
CP3–9.
The solution to this project will depend on the companies and/or accounting periods
selected for analysis.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
3-69