ANSWERS TO QUESTIONS - CHAPTER 1 1. Stakeholders are the parties that use accounting information. (p.

4) Stakeholders with a direct interest include owners, managers, creditors, suppliers, and employees. These individuals are directly affected by what happens to the business. (p.4) Stakeholders with an indirect interest include financial analysts, brokers, attorneys, government regulators, and news reporters. These individuals use information in the financial reports to advise and influence their clients. (p.4) Students may give many different answers under the above categories depending on their level of experience in business. All students are direct users of accounting information about tuition and fees, financial aid, and account balances. 2. Accounting provides information that is useful in making decisions by all participants in the market for resource goods and services, both profit-oriented and nonprofit. Because accounting’s role is so important, it is often called the language of business. (p. 4) The primary mechanism used to allocate resources in the U.S. is competition for resources in the open market. (p. 4)

3.

4. A market is a group of people or organizations that come together for the purpose of exchanging items of value. (p. 4) 5. 6. See Exhibit 1-1 (p. 5) Financial Resource: money (p. 5) 1-1

Physical Resource: natural resources (i.e. land, forests, mine ore, petroleum, etc.), buildings, machinery and equipment, furniture and fixtures (p. 6) Labor Resource: includes both intellectual and physical labor; i.e. employees (p. 6) Investors expect a distribution of the business’s profits as a return on their financial investment (capital allocation). Creditors lend financial resources to businesses and receive interest as a return or profit on the loan. (p. 5) Financial accounting provides information that is useful to external resource providers. (p. 6) Managerial accounting provides information that is useful to managers in operating an organization (i.e., internal users). (p. 6) 9. Not-for-profit or nonprofit entities provide goods or services to consumers for humanitarian or special reasons rather than to earn a profit for owners. For example, governments allocate resources to provide for national defense or social/environmental welfare; benevolent organizations allocate resources to meet humanitarian needs and to promote the arts and meet social needs. (p. 7)

7.

8.

10. The U.S. rules of accounting information measurement are called generally accepted accounting principles (GAAP). (p. 8) 11. In the U.S., GAAP are established by the accounting profession through the Financial Accounting Standards Board (FASB). In Japan and Germany, GAAP are established by governmental bodies. (p. 8, 24) 12. The Financial Accounting Standards Board (FASB) has the primary responsibility for establishing GAAP in the U.S.

1-2

FASB is a non-governmental rule-making body established by the accounting profession. (p. 9) 13. Items reported on the financial statements are organized into classes or categories called elements. The ten elements of financial statements are: (p. 9) 1. Assets 2. Liabilities 3. Equity (Stockholders’ Equity) 4. Common Stock (Contributed Capital) 5. Revenue 6. Expenses 7. Distributions (Dividends) 8. Net Income 9. Gains 10. Losses Accounts are specific items or subclassifications of the elements. Examples of accounts include cash, land and common stock. 14. “Assets = Claims” is the most basic form of the accounting equation. (p. 10) 15. Assets, the economic resources of a business, are used to produce earnings. (p. 10) 16. The assets of a business belong to individuals and/or institutions that have claims on the assets (i.e., resource providers). (p. 10) 17. Creditors are individuals and/or institutions that have loaned goods or services to the business. These parties have first claim to the assets of the business, and the owners have a residual interest in the assets. (p. 10) 18. “Residual interest” means that in the case of liquidation, assets are distributed first to creditors, in order to settle the creditors’ claims, and any remaining assets are then distributed to the owners of the business. Residual interests are often labeled with the terms “equity” or “net assets”. (p. 10) 1-3

19. The term “liabilities” is used to describe creditors' claims on the assets of a business. (p. 10) 20. The accounting equation is: ASSETS – LIABILITIES = STOCKHOLDERS’ EQUITY or ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY Assets are the economic resources used by a business for the production of revenue. Liabilities are obligations of a business to relinquish assets, provide services, or accept other obligations. Equity, also called “residual interest” or “net assets”, is the portion of the assets remaining after the creditors' claims have been satisfied (i.e., Assets – Liabilities). (p10) 21. The owners ultimately bear the risk and collect the rewards associated with operating a business. (p. 15) 22. A double-entry bookkeeping system is one in which every transaction is recorded twice. A transaction can affect both assets and claims (liabilities and equity) or only assets or only claims. In order to “balance” the accounting equation, every transaction requires a “double entry.” (p. 14) 23. An asset source transaction results in an increase in an asset account and an increase in one of the claims accounts; i.e., investments by owners (equity), borrowing funds from creditors (liabilities), or earnings activities (revenue). (p. 14) An asset use transaction results in a decrease in an asset account and a decrease in either liabilities or equity; i.e., the payment of a liability, the payment of an expense, or a dividend. (p. 15)

1-4

An asset exchange transaction is a transaction in which one asset is exchanged for another; i.e., purchase of land with cash. (p. 14) A claims exchange transaction will be covered in a later chapter. 24. Capital is acquired from owners by issuing stock to them. When stock is issued, the assets of the business increase and the stockholders’ equity increases. (p. 14) 25. Assets that are acquired by issuing common stock are the result of investments by owners. Assets that are acquired by using retained earnings are assets the business acquires through its earnings activities. (pp. 14, 15) 26. Revenue increases the asset side of the accounting equation and also increases the source of that asset, the retained earnings account in the stockholders’ equity section of the equation. (p. 15) 27. The nominal or temporary accounts are closed to Retained Earnings at the end of the accounting period. The temporary accounts are the revenue, expense and dividends accounts. (p. 19) 28. The three primary sources of assets are (1) investments by owners (issue of stock), (2) borrowing from creditors, and (3) earnings activities. (p. 14) 29. Retained earnings are a result of a business retaining its earned assets, rather than distributing those earnings to its owners. (p. 11) 30. Distributions to owners, called dividends, decrease the asset side of the accounting equation and also decrease the retained earnings account in the stockholders’ equity section of the equation. (p. 16)

1-5

31. Dividends and expenses are similar in that they both decrease assets and affect the accounting equation in the same way (i.e. reduction of retained earnings). However, dividends differ from expenses because of the nature of the decline in assets. Expenses reduce assets as the result of a firm's efforts to earn revenue. Dividends reduce assets because of a transfer of wealth to the owners. (pp. 15, 16) 32. (1) Balance Sheet - lists the assets and the corresponding claims on those assets as of a particular date. (p. 11) (2) Income Statement - measures the difference between the asset increases and the asset decreases that were associated with operating a business during a particular accounting period. (p.11) (3) Statement of Cash Flows - explains how a company obtained and used cash during the accounting period. (p.12) (4) Statement of Changes in Stockholders’ Equity explains the effects of transactions on stockholders’ equity during the accounting period. (p.18) 33. The balance sheet provides information about the enterprise at a particular point in time. (p. 18) 34. Revenue, expenses, and dividends are temporary accounts and are closed to Retained Earnings at the end of the accounting period. (p.19) 35. A net loss occurs when expenses exceed revenues. (p. 11) 36. (1) Operating activities - explain the cash generated from revenue and the cash paid for expenses.

1-6

(2) Investing activities - include cash received or spent by the business on productive assets used in the business and investments in debt or equity of other companies. (3) Financing activities - include cash inflows and outflows from the company's transactions with its owners and inflows and outflows from its borrowing activities. (p. 12) 37. Asset accounts are arranged on the balance sheet in accordance with their level of liquidity (those that can be most quickly converted to cash are listed first). (p. 18) 38. Balance Sheet accounts (i.e., Assets, Liabilities, Common Stock, and Retained Earnings) are permanent accounts. The information in these accounts is cumulative. In other words, Balance Sheet accounts show the accumulation of the results of the continuing activities of the entity. Income Statement accounts (Revenue, Expenses, Gains, and Losses) and Dividends are nominal accounts. Data in these accounts show the results of activities of only one period. At the end of each period, the nominal account balances are transferred to the permanent account, Retained Earnings, through a process called closing. (p. 19) 39. While the contents of annual reports vary from company to company, all annual reports contain: Financial statements Footnotes to the financial statements Auditor’s report Management’s discussion and analysis (MD&A) (p. 26) 40. The three stages of the accounting cycle that were discussed in this chapter were (1) recording accounting data in accounts, (2) preparing financial statements, and (3) closing the nominal accounts After these stages are complete, a new cycle will begin. (p. 21)

1-7

SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 1 EXERCISE 1-1A 1. Income Statement; Statement of Operations; Earnings Statement 2. Statement of Changes in Equity; Capital Statement; Statement of Stockholders’ Equity 3. Balance Sheet; Statement of Financial Position 4. Statement of Cash Flows EXERCISE 1-2A The three participants in the free business market are: 1. Resource owners 2. Conversion agents 3. Consumers Note to instructor: The memo should discuss the fact that the resource owners are those who own resources that are desired by others, either in the original form or in a converted form. The conversion agents are the parties that acquire the resource and supplies it to consumers either in the original form or in a converted form with value added by the conversion. The consumers are the ultimate users of the resources.

1-8

EXERCISE 1-3A a. Wilson Auto Parts Accounting Equation Assets $6,200 = = Liabilities $5,000 Claims + Stockholders’ Equity + $1,200

Liabilities $5,000 Claims $6,200 b. Clark Juices, Inc. Accounting Equation Assets 5,600 Assets $5,600 = = Liabilities 1,200 Claims + Stockholders’ Equity + 4,400

Net Assets = Assets − Liabilities; or Net Assets = Total Stockholders’ Equity $5,600 − $1,200= $4,400 c. Ted’s Tennis Shop Accounting Equation Assets 56,700 = = Liabilities 32,300 Claims + Stockholders’ Equity + 24,400

Stockholders’ Equity $24,400 Net Assets are equal to Stockholders’ Equity: $24,400

1-9

EXERCISE 1-4A a. A business liquidation occurs when a business ceases activity and divides the remaining assets between the resource providers (i.e. creditors and investors). b. McNeal Company Accounting Equation Event Assets = Liabilitie + Stockholders’ Equity s Commo Retained n Stock Earnings Acquired $1,000 $400 $600 assets Incurred loss (500) (500) Balance $ 500 = $400 + $600 $(500) The cash balance of $500 will be distributed first to the creditors. Since creditors are owed $400, the creditors will receive the $400 that they are owed. c. The stockholders will receive the $100 cash that remains after the creditors are paid.

1-10

EXERCISE 1-5A Solar Enterprises Accounting Equation Stockholders’ Equity Event Common Retained Number Assets = Liabilities + Stock Earnings 1. I NA I NA 2. I NA NA I 3. D NA NA D 4. I I NA NA 5. I/D(NA) NA NA NA 6. D NA NA D

1-11

EXERCISE 1-6A
Greer Consulting Service Horizontal Statements Model for 2006 Balance Sheet Assets Even t No. 1 2 3 4 5 6 = Liab. + Notes e I I D I D D
+ + + + + +

Income Statement Revenu e − Expens = e Net Inc.

Cash + Land = Payabl + NA NA NA NA I NA =
= = = = =

NA NA NA I NA NA

+ + + + + +

Stockholders’ Equity Commo Retaine n Stock + d Earning s + I NA + NA I + NA D + NA NA + NA NA + NA D

Statement of Cash Flows

NA I NA NA NA NA

− − − − − −

NA NA I NA NA NA

= = = = = =

NA I D NA NA NA

I I D I D D

FA OA OA FA IA FA

1-12

EXERCISE 1-7A Chia Company Accounting Equation for 2009 Assets = Liabiliti + Stockholders’ es Equity Notes Commo Retaine n d Cash = Payable + Stock + Earnings 12,000 NA 12,000 NA

Event Issued stock

EXERCISE 1-8A Northern Rockies Company Accounting Equation for 2007 Assets = Liabiliti + Stockholders’ es Equity Notes Commo Retaine n d Cash = Payable + Stock + Earnings 7,200 7,200 NA NA

Event Issued note

1-13

EXERCISE 1-9A a. Kwon Company Accounting Equation for 2005 Assets = Liabiliti es Event 1. Cash revenue 2. Paid expense 3. Paid dividend Ending Balance b. Kwon Company Income Statement For the Year Ended December 31, 2005 Revenue Expense Net Income $9,500 (5,800) $3,700 Kwon Company Balance Sheet As of December 31, 2005 Assets Cash Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity $ -03,000 3,000 $ 3,000 $ 3,000 $ -0Cash = 9,500 (5,800) (700) 3,000 = Stockholders’ Equity Commo Retaine n d + Stock + Earnings NA NA 9,500 NA NA (5,800) NA NA (700) -0- + -0 + 3,000

1-14

c. The closing process.

1-15

EXERCISE 1-10A a.
Maulder Mechanics Horizontal Statements Model for 2001 Balance Sheet Assets Even t No. 1 2 3 4 Cash 7,000 14,000 (6,800) (1,000) 13,200 = Liab. + Stockholders’ Equity Income Statement Revenue − Expens e = Net Inc. Statement of Cash Flows

Notes Commo Retaine = Payable + n Stock + d Earnings + 7,000 + = NA NA = + + 14,000 NA NA = + + (6,800) NA NA = + + (1,000) NA NA = + 7,000 + -06,200

NA 14,000 NA NA 14,000

NA − NA − − 6,800 NA − − 6,800

= NA = 14,000 = (6,800) = NA =

7,200

7,000 14,000 (6,800) (1,000) 13,200

FA OA OA FA NC

b.

Net income is $7,200 and caused assets to increase by $7,200.

1-16

EXERCISE 1-11A Event a. b. c. d. e. f. g. h. i. j. Statement of Cash Flow Classification OA FA FA IA OA OA IA FA NA FA

1-17

EXERCISE 1-12A a. Sani Service Company Accounting Equation for 2001 = Liabiliti + Stockholders’ Equity es Notes Commo Retaine Acct. Cash + Land = Payable + n + d Title/RE Stock Earning s 25,000 50,000 35,000 30,000 10,000 NA (10,000 10,000 NA NA NA ) NA 15,000 NA NA 15,000 NA 55,000 NA NA NA 55,000
Revenue

Assets

Event Bal. 1/1/01
1. Pur. Land 2. Issued stk. 3. Provide Svc 4. Paid Exp. 5. Paid Note 6. Paid Div.

Totals

(38,000 NA NA NA (38,000 Op. Exp. ) ) NA (20,000 NA (20,000 NA NA ) ) (3,000) NA NA NA (3,000) Dividend 24,000 +60,000 =15,000 +45,000 +24,000

b. Net Income for 2001: Revenue Operating Expense Net Income

$55,000 (38,000) $17,000

c. Total assets at the end of 2001: Cash $24,000 Land 60,000 Total Assets $84,000 Net assets at the end of 2001: Total Assets $84,000 o Common Stock $45,000 r Less: (15,000) Plus: Retained 24,000 1-18

Liabilities Net Assets $69,000

Earnings Total Stockholders’ Equity (Net Assets)

$69,000

1-19

EXERCISE 1-13A a. Kerry Company Accounting Equation for 2002 Assets Event
Bal. 1/1/02 1. Issued stk. 2.Pur. Land 3. Loan 4. Provide Svc. 5. Paid Rent 6. Pd. Op. Exp. 7. Paid Div. = Liabiliti +

Stockholders’ Equity

es Notes Com. Retain Acct. = Payabl + Stock + Cash + Land ed Title/RE e Earnin gs 2,000 16,00 -0- 10,000 8,000 0 NA 25,000 NA NA 25,000 NA (9,000) 5,000 12,000 (500) (7,000) 9,000 NA NA NA NA NA 5,000 NA NA NA NA NA NA NA NA
NA NA NA NA 12,00 Svc. 0 Rev. Rent (500)

Totals

(7,000 ) (2,000) NA NA NA (2,000 Dividen ds ) 25,500 + 25,00 = 5,000 + 35,000 + 10,50 0 0

Exp. Oper. Exp

b. Kerry Company Income Statement For the Year Ended December 31, 2002 Service Revenue Rent Expense Operating Expense Net Income $12,000 (500) (7,000) $ 4,500

1-20

EXERCISE 1-13A b. (cont.) Kerry Company Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2002 Beginning Common Stock Plus: Common Stock Issued Ending Common Stock Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings Total Equity Stockholders’ $10,000 25,000 $35,000 8,000 4,500 (2,000) 10,500 $45,500

Kerry Company Balance Sheet As of December 31, 2002 Assets Cash Land Total Assets Liabilities Notes Payable Total Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity 1-21 $25,500 25,000 $50,500 $5,000 $ 5,000 $35,000 10,500 45,500 $50,500

1-22

EXERCISE 1-13A b. (cont.) Kerry Company Statement of Cash Flows For the Year Ended December 31, 2002 Cash Flows From Operating Activities: Cash Receipts from Revenue $12,000 Cash Payment for Rent Expense (500) Cash Payments for Other (7,000) Operating Exp. Net Cash Flow from Operating $ 4,500 Activities Cash Flows From Investing Activities Cash Paid to Purchase Land Net Cash Flow from Investing Activities Cash Flows From Financing Activities: Cash Receipts from Stock Issue Cash Receipts from Loan Cash Payments for Dividends Net Cash Flow from Financing Activities Net Increase in Cash Plus: Beginning Cash Balance Ending Cash Balance

(9,000) (9,000)

25,000 5,000 (2,000) 28,000 23,500 2,000 $25,500

c. The revenue, expense and dividends accounts will have a zero balance because they will have been closed to retained earnings.

1-23

EXERCISE 1-14A a.
Tax Time, Inc. Horizontal Statements Model for 2004 Balance Sheet Stockholders’ Equity Notes Commo Retaine + Land = Payabl + n Stock + Cash d e Earning s + + 30,000 + 30,000 NA = NA NA + 9,000 = + + (9,000 NA NA NA ) 28,000 + NA = NA + NA + 28,000 (9,500 + NA = NA + NA + (9,500) ) 5,000 + NA = NA + 5,000 + NA 10,000 + NA = 10,000 + NA + NA (5,000 + 5,000 = NA + NA + NA ) (6,000 + NA = NA + NA + (6,000) ) (2,800 + NA = NA + NA + (2,800) ) 40,700 + 14,000 = 10,000 + 35,000 + 9,700 Assets = Liab. + Income Statement Revenu e − Expens e = Net Inc. Statement of Cash Flows

E vent No . 1 2 3 4 5. 6. 7. 8. 9. Tota l

NA NA 28,000 NA NA NA NA NA NA 28,000

− − − − − − − − −

NA NA NA 9,500 NA NA NA 6,000 NA

= =

NA NA

30,000 FA (9000) IA 28,000 OA (9,500) OA 5,000 FA 10,000 FA (5,000) IA (6,000) OA (2,800) FA 40,700 NC

= 28,000 = (9,500) = = =

NA NA NA

= (6,000) =

NA 12,500

− 15,500

b. Net Income for 2004: $12,500 c. Total Assets at the end of 2004: $54,700 ($40,700 + $14,000) 1-24

d. Net Cash Flow from Operating Activities for 2004: 6,000). e. Net Cash Flow from Investing Activities for 2004: f. Net Cash Flow from Financing Activities for 2004: 10,000 − 2,800). g. Cash balance at December 31, 2004: $40,700

$12,500

(28,000

9,500

$−14,000 (−9,000 + −5,000) $42,200 (30,000 + 5,000 +

1-25

EXERCISE 1-15A a. b. c. d. e. f. g. h. i. j. Title or Account Common Stock Financial Statement(s) Balance Sheet; Statement of Changes in Stockholders’ Equity Land Balance Sheet Ending Cash Balance Balance Sheet; Statement of Cash Flows Beginning Cash Statement of Cash Flows Balance Notes Payable Balance Sheet Retained Earnings Balance Sheet; Statement of Changes in Stockholders’ Equity Revenue Income Statement Dividends Statement of Changes in Stockholders’ Equity Financing Activities Statement of Cash Flows Salary Expense Income Statement

1-26

EXERCISE 1-16A a. Permanent Accounts Cash Notes Payable Land Common Stock Retained Earnings Nominal (Temporary) Accounts Revenue Expenses Dividends b. Beginning Retained Earnings Add: Revenue Less: Expenses Less: Dividends Ending Retained Earnings c. Computation of Net Income Revenue Less: Expenses Net Income $4,000 (2,500) $1,500 $3,500 4,000 (2,500) (500) $4,500

d. Net income is only the current year’s net income. Retained Earnings is an accumulation of net income over the life of the business less any dividends that have been paid over the years.

1-27

e. All revenue, expense and dividends accounts will have a zero balance because they have been closed to retained earnings.

1-28

EXERCISE 1-17A a. Account 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Cash Salaries Expense Notes Payable Utilities Expense Service Revenue Dividends Common Stock Land Interest Revenue Retained Earnings

Classificatio n P T P T T T P P T P

b. The three stages of the accounting cycle are: recording transactions preparing financial statements closing temporary accounts. The first stage of the cycle must be recording accounting data in accounts to put it into usable form. Once the accounting data is summarized in the accounts, it is used to prepare the financial statements. After the financial statements are prepared, the temporary accounts (revenue, expenses, and dividends) must be closed to prepare these accounts for the next accounting period.

1-29

EXERCISE 1-18A Event 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Classification Asset Source Asset Source Asset Exchange Asset Source Asset Source Asset Exchange Asset Use NA Asset Use Asset Use

1-30

EXERCISE 1-19A a. Event 1. Asset 2. Asset 3. Asset 4. Asset 5. Asset 6. Asset b.

Source Source Source Use Exchange Use
Better Sports Horizontal Statements Model for 2008 Balance Sheet Income Statement Revenu − Expens = e e Net Inc. Statement of Cash Flows

Assets Even t No. 1 2 3 4 5 6 Cash I I I D D D

Stockholders’ Equity Notes Commo Retaine + Land = Payabl + n + d e Stock Earning s + + + NA = NA I NA
+ + + + +

=

Liab.

+

NA I NA NA NA NA

NA NA NA I NA

= = = = =

NA I NA NA NA

+ + + + +

NA NA NA NA NA

+ + + + +

I NA D NA D

− − − − − −

NA NA NA I NA NA

= = = = = =

NA I NA D NA NA

I I I D D D

FA OA FA OA IA FA

1-31

1-32

EXERCISE 1-20A a. b. c. d. Dundee Company: Asset Source Don Sinclair: Asset Exchange Dundee Company: Financing Activity Don Sinclair: Investing Activity

EXERCISE 1-21A Accounting Equation Stockholders’ Equity Common Retained = Liabilities + Stock + Earnings = = = = 48,000 25,000 15,000 29,000 + + + + 52,000 25,000 35,000 42,000 + + + + 36,000 40,000 37,000 31,000

Compan Assets y A 136,000 B 90,000 C 87,000 D 102,000

1-33

EXERCISE 1-22A a. 2002 Assets = Liabilities + Retained Earnings $156,000 = $85,600 $22,000 Common Stock + + $48,400 +

Or: $156,000 − $85,600 − $48,400 = $22,000.

b.

2003 Revenue − $22,000 −

Expenses $12,500

= =

Net Income $9,500

c.

Retained Earnings, Jan 1, 2003 $22,000 Plus: 2003 Net Income 9,500 Less: 2003 Dividends (500) Retained Earnings, December 31, 2003 $31,000

1-34

EXERCISE 1-23A Steps: 1. Common Stock Issued = Change in Common Stock $11,000 (given) = $11,000 2. Change in Stk. Equity= Change in Ret. Earn. $53,400 (given) = $11,000 (1) Change in Com. Stock + + $42,400

3. Increase in Ret. Earn. = Net Income − Dividends $42,400 (2) = $50,400 − $8,000 (given) Alternate Solution: From the Statement of Changes in Stockholders’ Equity we know (with minor modifications): Beginning Total Stk. Equity, 1/1/2007 (Common Stock + Retained Earnings) Plus: Common Stock Issued Plus: Net Income Less: Dividends Change in Stockholders’ Equity Ending Total 12/31/2007 Stk. Equity, $11,000 ? (8,000) 53,400 $115,900 $ 62,500

Working backwards from the change in equity we can solve for net income: Change 2007 in Stockholders’ Equity, $53,400

1-35

Plus: Dividends Less: Common Stock Issued Net Income, 2007

8,000 (11,000) $50,400

1-36

EXERCISE 1-24A a. Price-Earnings Ratio Henry Company Pager Company 38.5 ÷1.05 = 36.67 108 ÷ 4.5 = 24 b. Stockholders’ expectations of future growth will cause the price to increase at a faster rate than earnings.

1-37

SOLUTIONS TO PROBLEMS -SERIES A - CHAPTER 1

PROBLEM 1-25A
Lighthouse Services Horizontal Statements Model for 2006 Balance Sheet Assets Even t No. 1 2 3 4 5 6 7 = Liab. + Notes e I I I D D D D
+ + + + + +

Income Statement Revenu e − Expens = e Net Inc.

Cash + Land = Payabl + NA NA NA NA I NA NA =
= = = = =

NA I NA NA NA D NA

+ + + + + +

Stockholders’ Equity Commo Retaine n Stock + d Earning s + I NA + NA NA + NA I + NA D + NA NA NA NA + NA D

Statement of Cash Flows

NA NA I NA NA NA NA

− − − − − −

NA NA NA I NA NA NA

= = = = = =

NA NA I D NA NA NA

I I I D D D D

FA FA OA OA IA FA FA

1-38

PROBLEM 1-26A a.
Marx Company Horizontal Statements Model for 2003 Balance Sheet Assets Even t No . 1 2 3 4 5. 6. 7. 8. Total = Liab. + Notes e 24,000 16,000 36,000 (25,000 ) (4,000) 20,000 (5,000) (53,000 ) 9,000
+ + + +

Income Statement Revenu − Expens e e = Net Inc.

Cash + Land = Payabl + NA NA NA NA = NA = 16,000 = NA = NA
+ + + +

Stockholders’ Equity Commo Retaine n Stock + d Earning s + 24,000 NA + NA NA + 36,000 NA NA + (25,000)
+ (4,000) + NA + NA + NA + 7,000

Statement of Cash Flows

NA NA 36,000 NA NA NA NA NA 36,000

NA − NA − NA − − 25,000 − − − − NA NA NA NA

= NA = NA = 36,000 = (25,00 = = = =

+ NA + NA + NA + 53,000

= NA + NA = NA + 20,000 = (5,000) + NA = NA + NA

0) NA NA NA NA 11,000

+ 53,000 = 11,000 + 44,000

− 25,000

24,000 FA 16,000 FA 36,000 OA (25,000) OA (4,000) FA 20,000 FA (5,000) FA (53,000) IA 9,000 NC

b. Total Assets = $9,000 + $53,000 = $62,000 c. Sources of Assets Event 1. Issue of stock $ 24,000 1-39

2. Cash from loan 3. Cash from revenue 6. Issue of stock Total Sources of Assets

16,000 36,000 20,000 $96,000

1-40

PROBLEM 1-26A (cont.) d. Net income is $11,000 (see part a.) Dividends are not expenses and do not appear on the income statement. e. Operating Activities: Cash from revenue Cash paid for expenses Net Cash Flow from Operating Activities Financing Activities: Cash from stock issues ($24,000 + $20,000) Cash from loan Paid cash dividend Cash paid on loan principal Net Cash Flow from Financing Activities Investing Activities: Cash paid to purchase land Net Cash Flow from Investing Activities $36,000 (25,000) $11,000

$44,000 16,000 (4,000) (5,000) $51,000

$(53,000) $(53,000)

PROBLEM 1-27A a. Reynolds Consulting Accounting Equation for 2006 = Liabiliti + Stockholders’ Equity es Notes Commo Retaine Acct. Cash + Land = Payable + n + d Title/RE 1-41 Assets

Event

Stock
1. Issued stk 2. Revenue 3. Loan 4. Paid Exp. 5. Pur. Land

25,000 72,000

NA NA

NA NA

25,000 NA

Earning s NA

NA

72,000 Revenue

Totals

NA 16,000 NA 16,000 NA NA (50,000 NA NA NA (50,00 Oper. ) 0) Exp. NA (44,000 44,00 NA NA NA ) 0 19,000 + 44,00 = 16,000 + 25,000 + 22,000 0

Reynolds Consulting Accounting Equation for 2007 = Liabiliti + Stockholders’ Equity es Notes Commo Retaine Acct. Cash + Land = Payabl + n +d Title/RE e Stock Earning s 19,000 44,00 16,000 25,000 22,000 0 NA 24,000 NA NA 24,000 NA 94,000 (10,000 ) (71,500 ) (6,000) NA NA NA NA NA (10,00 0) NA NA NA NA NA NA 94,000 NA
Revenue NA

Assets

Event
Beg. Bal. 1. Issued stk 2. Revenue 3. Paid Loan 4. Paid Exp. 5. Paid Div.

(71,500 Oper. ) Exp. (6,000) Dividend
s

Totals

49,500 + 44,00 = 6,000 + 49,000 + 38,500 0

1-42

PROBLEM 1-27A (cont.) b. Reynolds Consulting Income Statements 2006 Service Revenue Expenses Net Income $ 72,000 (50,000) $ 22,000 2007 $ 94,000 (71,500) $ 22,500

Statements of Changes in Stockholders’ Equity Beginning Common Stock Plus: Common Stock Issued Ending Common Stock Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings Total Stockholders’ Equity Balance Sheets Assets Cash Land Total Assets Liabilities Notes Payable Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity $ 19,000 44,000 $ 63,000 $ 16,000 25,000 22,000 47,000 $ 63,000 $ 49,500 44,000 $ 93,500 $ 6,000 49,000 38,500 87,500 $ 93,500 $ -025,000 25,000 $ 25,000 24,000 49,000 22,000 22,500 (6,000) 38,500 $ 87,500

-022,000 -022,000 $ 47,000

1-33

PROBLEM 1-27A b. (cont.) Reynolds Consulting Statements of Cash Flows 2006 Cash Flows From Operating Activities: Cash Receipts from Revenue Cash Payments for Expenses Net Cash Flow from Operating Activities Cash Flows From Investing Activities: Cash Payment for Land Net Cash Flow from Investing Activities Cash Flows From Financing Activities: Cash Receipts from Borrowed Funds Cash Payment of Debt Cash Receipts from Stock Issue Cash Payment for Dividends Net Cash Flow from Financing Activities Net Change in Cash Plus: Beginning Cash Balance Ending Cash Balance $ 72,000 (50,000) 22,000 2007 $ 94,000 (71,500) 22,500

(44,000) (44,000)

-0-0-

16,000 -025,000 -041,000 19,000 -0$ 19,000

-0(10,000) 24,000 (6,000) 8,000 30,500 19,000 $ 49,500

c. Assets increased from $63,000 at December 31, 2006 to $93,500 at December 31, 2007. This increase of $30,500 is solely due to the increase in cash. d. ($22,500 − $22,000) ÷ $22,000 = 2.27%; This is a low growth company.

1-34

PROBLEM 1-28A Not required: Chase Enterprises Accounting Equation Stockholders’ Equity Commo Retained Assets = Liabilitie + n Stock + Earnings s 30,000 18,000 4,000 8,000 36,000 36,000 (23,000) (2,000) (23,000) (2,000)

Beg. Balances Earned Revenue Paid Expenses Paid Dividends Issued Stock Paid Liability

10,000 10,000 (6,000) (6,000) 45,000 = 12,000 + 14,000 + 19,000

Chase Enterprises Income Statement For the Period Ended December 31, 2002 Revenue Expenses Net Income $36,000 (23,000) $13,000

1-35

PROBLEM 1-28A (cont.) Chase Enterprises Statement of Changes in Stockholders’ Equity For the Period Ended December 31, 2002 Beginning Common Stock Plus: Common Stock Issued Ending Common Stock Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings Total Equity Stockholders’ $ 4,000 10,000 $14,000 8,000 13,000 (2,000) 19,000 $33,000

Chase Enterprises Balance Sheet As of December 31, 2002 Assets Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities Stockholders’ Equity and $14,000 19,000 33,000 $45,000 $45,000 $12,000

1-36

PROBLEM 1-28A (cont.) Chase Enterprises Statement of Cash Flows For the Year Ended December 31, 2002 Cash Flows From Operating Activities: Cash Receipt from Revenue $36,000 Cash Payment for Expenses (23,000) Net Cash Flow from Operating Activities Cash Flows Activities From Investing

$13,000 -0-

Cash Flows From Financing Activities: Cash Receipts from Stock Issue Cash Payment to Creditors Cash Dividend to Stockholders Net Cash Flow from Financing Activities Net Increase in Cash Plus: Beginning Cash Balance* Ending Cash Balance *Assumes that all assets are cash.

10,000 (6,000) (2,000) 2,000 15,000 30,000 $45,000

1-37

PROBLEM 1-29A
Income Statement Statement of Changes in Stk. Equity Statement of Cash Flows

Item Ending Cash Balance Salary Expense Consulting Revenue Dividends Financing Activities Ending Common Stock Interest Expense As of (Date) Land Beginning Cash Balance Notes Payable Beginning Common Stock Service Revenue Utility Expense Cash Received from Stock Issue Operating Activities For the Period Ended (Date) Net Income Investing Activities Net Loss

Balance Sheet

1-38

PROBLEM 1-30A a. Green View Company Income Statement For the Year Ended December 31, 2004 Revenue Expenses Salary Expense Utility Expense Rent Expense Total Expense Net Income b. Accounts to be Closed: 1. Revenue 2. Salary Expense 3. Utility Expense 4. Dividends 5. Rent Expense c. Computation of Retained Earnings: Beginning Retained Earnings Add: Net Income Less: Dividends Ending Retained Earnings $14,700 2,500 (1,200) $16,000 $2,900 600 1,400 (4,900) $2,500 $7,400

Net income only includes revenue and expense for the current year. Retained earnings not only includes current year net income, but also the balance from previous years and reductions for dividends.

1-39

d. The balances are zero; they have been closed to Retained Earnings. PROBLEM 1-31A

1-40

FOR THE YEARS Income Statements Revenue (cash) Expense (cash) Net Income (Loss)

2001 $ 700 (a) (500) $200

2002 $1,300 (700) (m) $ 600

2003 $ 2,000 (1,300) $ 700

Statements of Changes in Stockholders’ Equity Beginning Common Stock $ -0- (n) $5,000 Plus: Stock Issued 5,000 1,000 Ending Common Stock 5,000 6,000 Beginning Retained -0Earnings Plus: Net Income (Loss) (b) 200 Less: Dividends (c) (100) Ending Retained Earnings 100 Total Stockholders’ Equity (d) $5,100 Balance Sheets Assets Cash Land Total Assets Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liab. and Stk. Equity 100 (o) 600 (500) (p) 200 $6,200

$6,000 2,000 (t)8,000 200 700 (300) 600 $8,600

(e) (q) $ (u)$ $8,100 3,200 2,600 -0- (r) 8,000 8,000 (f)$8,100 $11,200 $10,600 (g) $3,000 (h) 5,000 (i) 100 (j) 5,100 $8,100 $ 5,000 $ 2,000

(s) 6,000 200 6,200 $11,200

8,000 600 8,600 $10,600

1-41

PROBLEM 1-31A (cont.)

FOR THE YEARS Statements of Cash Flows

2001

2002

2003

Cash Flows From Oper. Activities: Cash Receipts from (k)$ Revenue 700 Cash Payments for (l) (500) Expenses Net Cash Flow from Oper. 200 Act. Cash Flows From Invest. Activities: Cash Payments for Land Net Cash Flow from Invest. Act. Cash Flows From Fin. Activities: Cash Receipts from Loan Cash Payments to Reduce Debt Cash Receipts from Stock Issue Cash Payments for Dividends Net Cash Flow from Fin. Activities Net Change in Cash Plus: Beginning Cash Balance Ending Cash Balance

$

1,300 (v) $ 2,000 (700) (w) (1,300) 600 700

-0-0-

(8,000) (8,000)

-0-0-

3,000 -05,000 (100) 7,900 8,100 -0$8,100

3,000 (1,000) 1,000 (500) 2,500 (4,900) 8,100 $3,200

-0(x) (3,000) (y)2,000 (z) (300) (1,300) 600 3,200 $2,600

1-42

PROBLEM 1-31A (cont.)
Computations of amounts: a. $500 Expense = $700 Revenue − $200 Net Income. b. $200 Net Income = $200 Net Income from Income Statement. c. $100 Dividends = $200 Net Income − $100 Ending Ret. Earnings. d. $5,100 Total Stk. Equity = $5,000 Ending Common Stock + Ending Retained Earn. e. $8,100 Cash = $8,100 Total Assets − $-0- Land. f. $8,100 Total Assets = $8,100 Liabilities and Stockholders’ Equity. g. $3,000 Liabilities = $3,000 Cash Receipts from Loan. h. $5,000 Common Stock = $5,000 Com. Stock from Statement of Changes in Stockholders’ Equity. i. $100 Retained Earnings = $100 Ret. Earnings from Statement of Changes in Stockholders’ Equity. j. $5,100 Total Stockholders’ Equity = $5,000 Common Stock + $100 Retained Earnings or $5,100 Total Stk. Equity from Statement of Changes in Stk. Equity. k. $700 Cash Receipts from Revenue = $700 Revenue from Income Statement. l. $500 Cash Payment for Expense = $500 Expense from Income Statement. m. $600 Net Income = $1,300 Revenue − $700 Expense. n. $5,000 Beginning Common Stock = $5,000 Ending Common Stock 2001. o. $600 Net Income = $600 Net Income from Income Statement. p. $200 Ending Retained Earnings = $100 Beginning Ret. Earnings + $600 Net Income − $500 Dividends. q. $3,200 Cash = Ending Cash Balance from Statement of Cash Flows. r. $8,000 Land = $8,000 Cash Payment for Land from Statement of Cash Flows. s. $6,000 Common Stock = $6,000 Ending Common Stock from Statement of Changes in Equity. t. $8,000 Ending Common Stock = $6,000 Beginning Common Stock + $2,000 Common Stock Issued. u. $2,600 Cash = $2,600 Ending Cash Balance from Statement of Cash Flows. v. $2,000 Cash Receipts from Revenue = $2,000 Revenue from Income Statement. w. $1,300 Cash Payment for Expenses = $1,300 Expense from Income Statement. x. $3,000 Cash Payment to Reduce Debt = $5,000 Balance of Liabilities, 2002 − Balance of Liabilities, 2003.

1-43

y. $2,000 Cash Receipts from Stock Issue = $2,000 Stock Issued from
Statement of Changes in Stockholders’ Equity. z. $300 Cash Payment for Dividends = $300 Dividends from Statement of Changes in Stockholders’ Equity.

1-44

PROBLEM 1-32A Event No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. Type of Event Asset Asset Asset Asset Asset NA Asset Asset Asset Asset Asset Asset NA Asset Asset Source Use Exchange Source Exchange Source Source Use Use Use Source Use Exchange Effect on Total Assets Increase Decrease No Effect Increase No Effect NA Increase Increase Decrease Decrease Decrease Increase NA Decrease No Effect

1-45

PROBLEM 1-33A The growth in earnings between two years is measured as follows: Alternative year earnings − Base year earnings Base year earnings a. 2000 to 2001 2001 to 2002 Advantage, Inc.: ($4.13 − $4.22) = − 2.13% ($4.18 − $4.13) = 1.21% 4.22 4.13 Hi-Lite, Inc. 38.66% ($4.19 − $3.27) = 28.13% ($5.81 − $4.19) = 3.27 4.19

b. PE Ratio: Market price per share ÷ Earnings per share Advantage, Inc. 2000: $50.64 ÷ $4.22 = 12 2001: $45.43 ÷ $4.13 = 11 2002: $45.98 ÷ $4.18 = 11 2000: 2001: 2002: $98.10 ÷ $3.27 = 30 $129.89 ÷ $4.19 = 31 $220.78 ÷ $5.81 = 38

Hi-Lite, Inc.

c. The price-earnings ratio is the most commonly reported measure of a company’s value. It indicates how many years it will take for an investor to recover his investment through a company’s earnings, assuming EPS and market price remain constant. d. A different price-earnings ratio is caused by different growth expectations of two different companies.

1-46

SOLUTIONS TO EXERCISES - SERIES B -CHAPTER 1 EXERCISE 1-1B a. Elements of Financial Statements: 1. assets 2. liabilities 3. equity 4. common stock (contributed capital, partners’ equity) 5. revenue 6. expenses 7. distributions (withdrawals, dividends) 8. net income (net profit; net earnings) b. Element assets liabilities equity common stock revenue expenses distributions net income Financial Statement(s) Balance Sheet Balance Sheet Balance Sheet; Statement of Changes in Stockholders’ Equity Balance Sheet; Statement of Changes in Stockholders’ Equity Income Statement Income Statement Statement of Changes in Stockholders’ Equity Income Statement; Statement of Changes in Stockholders’ Equity

owners’

capital,

EXERCISE 1-2B The three types of resources available to conversion agents are: 1. Financial resources 2. Physical resources 3. Labor resources

1-47

A memo is required and should include a discussion of the role resource owners play in the market and the profit expected from providing resources.

1-48

EXERCISE 1-3B a. Jackson Camping Supplies Accounting Equation = Assets $8,500 = Claims Stockholders’ Liabilities + Equity $5,300 + $3,200

Liabilities $5,300 ($8,500 − $3,200) Claims $5,300 + $3,200 = $8,500 b. Betty’s Snow Cones Accounting Equation Claims Stockholders’ Liabilities + Equity 2,400 + 4,400 −

Assets 6,800

= =

Assets $6,800 ($2,400 + $4,400) Net Assets = Assets − Liabilities $6,800 $2,400= $4,400 or Net Assets = Total Stockholders’ Equity $4,400 c. Petrello Company Accounting Equation Claims Stockholders’ Liabilities + Equity 56,200 + 42,100

Assets 98,300

= =

Stockholders’ Equity $42,100 ($98,300 − $56,200) Residual interest is equal to stockholders’ equity $42,100 1-49

EXERCISE 1-4B a. Investors put assets into the company with the expectation of sharing profits. Creditors lend assets to the company with the expectation of repayment of the principal plus interest on the loan. b. Event Clark Company Accounting Equation Assets = Liabilitie + Stockholders’ Equity s Notes Commo Retained Cash Payable n Stock Earnings $1,700 $800 $900 (600) $1,100 = $800 + $900 (600) $(600)

Acquired assets Incurred loss Balance

The cash balance of $1,100 will be distributed first to the creditors. Since creditors are owed $800 and there are sufficient funds to pay them, the creditors will receive the $800 that they are owed. c. The stockholders will receive the remaining $300 cash that remains after the creditors are paid. ($1,100 − $800 = $300)

1-50

EXERCISE 1-5B Olive Enterprises Accounting Equation Stockholders’ Equity Event Common Retained Number Assets = Liabilities + Stock Earnings 1. I NA I NA 2. D D NA NA 3. I/D(NA) NA NA NA 4. I NA NA I 5. D NA NA D 6. D NA NA D

1-51

EXERCISE 1-6B
Lourens Auto Repair Horizontal Statements Model for 2007 Balance Sheet Assets Even t No. 1 2 3 4 5 6 = Liab. + Stockholders’ Equity Commo Retaine n Stock + d Earning s + NA NA + I NA + NA I + NA D + NA D + NA NA Income Statement Revenu e − Expens = e Net Inc. Statement of Cash Flows

Notes Cash + Land = Payabl + e D I I D D D
+ + + + + +

I NA NA NA NA NA

=
= = = = =

NA NA NA NA NA D

+ + + + + +

NA NA I NA NA NA

− − − − − −

NA NA NA NA I NA

= = = = = =

NA NA I NA D NA

D I I D D D

IA FA OA FA OA FA

1-52

EXERCISE 1-7B 1. Balance Sheet 2. Statement of Changes in Stockholders’ Equity 3. Statement of Cash Flows

EXERCISE 1-8B 1. Balance Sheet 2. Statement of Cash Flows

1-53

EXERCISE 1-9B a. Kim Company Accounting Equation for 2004 Assets = Liabiliti es Event Cash revenue Paid expense Paid dividend Ending Balance b. Kim Company Income Statement For the Year Ended December 31, 2004 Revenue Expense Net Income $12,500 (8,600) $3,900 Kim Company Balance Sheet As of December 31, 2004 Assets Cash Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity $ -02,900 2,900 $2,900 $2,900 $ -0Cash = 12,500 (8,600) (1,000) 2,900 = Stockholders’ Equity Commo Retaine n d + Stock + Earnings NA NA 12,500 NA NA (8,600) NA NA (1,000) -0- + -0 + 2,900

1-54

c. The balances will be zero; they have been closed to retained earnings.

1-55

EXERCISE 1-10B a.
Eaton Boat Repairs Horizontal Statements Model for 2002 Balance Sheet Assets Even t No. 1 2 3 4 = Liab. + Stockholders’ Equity Income Statement Revenue − Expens = e Net Inc. Statement of Cash Flows

Notes Commo Retaine Cash = Payable + n Stock + d Earnings + 9,000 + 9,000 = NA NA + + 22,000 22,000 = NA NA + + (12,800) (12,800) = NA NA (800) = 17,400 = NA -0+ +

NA 22,000 NA NA 22,000

NA − NA − − 12,800 NA − − 12,800

= NA = 22,000 = (12,800 = =

9,000 FA 22,000 OA (12,800) OA (800) FA 17,400 NC

NA 9,000

+ +

(800) 8,400

) NA 9,200

b. Cash is increased by the issue of common stock, $9,000, and decreased by dividends, $800. Neither of these amounts is used in the computation of net income.

1-56

EXERCISE 1-11B Event a. b. c. d. e. f. g. h. i. j. Statement of Cash Flows Classification FA OA NA OA IA OA IA FA FA FA

1-57

EXERCISE 1-12B a. Pete’s Pest Control Accounting Equation for 2001 = Liabiliti + Stockholders’ Equity es Notes Com. Retaine Acct. Cash + Land = Payabl + Stock + d Title/RE e Earning s 15,000 20,00 15,000 7,000 13,000 0 NA (5,000) 5,000 NA NA NA NA 25,000 NA NA 25,000 NA 65,000 NA NA NA 65,000 Revenue Assets

Event
Bal. 1/1/01 1. Pur. Land 2. Issued stk. 3. Provide Svc. 4. Paid Exp. 5. Loan 6. Paid Div.

Totals

(42,00 NA NA NA (42,000 Oper. 0) ) Exp. NA 10,000 NA 10,000 NA NA (2,500) NA NA NA (2,500) Dividend 65,500 + 25,00 =25,000 + 32,000 + 33,500 0

b. Net Cash Flow from Financing Activities: Issue of Stock $25,000 Borrowed Cash 10,000 Paid Dividend (2,500) Net Cash Flow from Financing $32,500 Activities

c. The balance in the Retained Earnings account will be $33,500. The revenue, expense and dividends accounts will have a zero balance; they are temporary accounts and have been closed to Retained Earnings.

1-58

EXERCISE 1-13B a. J & A, Inc. Accounting Equation for 2004 Assets Event
Bal. 1/1/2004 1. Issued stk. 2.Pur. Land 3. Loan 4. Provide Svc. 5. Paid Utilities 6. Pd. Op. Exp. 7. Paid Div. = Liabiliti +

Stockholders’ Equity Acct. Title/ RE

es Notes Com. Retaine = Payabl + Stock + Cash + Land d e Earning s 12,000 20,00 -0- 15,000 17,000 0 55,000 NA NA 55,000 NA (15,000 ) 5,000 21,000 (1,500) (11,000 ) (2,000) 15,00 0 NA NA NA NA NA NA 5,000 NA NA NA NA NA NA NA NA NA NA NA

NA NA

NA NA 21,000 Svc. Rev.

(1,500) Util. Exp. (11,00 Oper. 0) Exp. (2,000) Dividend
s

Totals

63,500 + 35,00 = 5,000 +70,000 + 23,500 0

b. J & A, Inc. Income Statement For the Year Ended December 31, 2004 Service Revenue Utilities Expense Other Operating Expenses Net Income $21,000 (1,500) (11,000) $ 8,500

1-59

EXERCISE 1-13B b. (cont.) J & A, Inc. Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2004 Beginning Common Stock Plus: Common Stock Issued Ending Common Stock Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings Total Equity Stockholders’ $15,000 55,000 $70,000 17,000 8,500 (2,000) 23,500 $93,500

J & A, Inc. Balance Sheet As of December 31, 2004 Assets Cash Land Total Assets Liabilities Notes Payable Total Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity 1-60 $63,500 35,000 $98,500 $5,000 $ 5,000 $70,000 23,500 93,500 $98,500

1-61

EXERCISE 1-13B b. (cont.) J & A, Inc. Statement of Cash Flows For the Year Ended December 31, 2004 Cash Flows From Operating Activities: Cash Receipts from Revenue $21,000 Cash Payment for Utilities (1,500) Expense Cash Payments for Other (11,000) Operating Exp. Net Cash Flow from Operating $ 8,500 Activities Cash Flows From Investing Activities Cash Paid to Purchase Land (15,000) Net Cash Flow from Investing (15,000) Activities Cash Flows From Financing Activities: Cash Receipts from Stock Issue Cash Receipts from Loan Cash Payments for Dividends Net Cash Flow from Financing Activities Net Increase in Cash Plus: Beginning Cash Balance Ending Cash Balance

55,000 5,000 (2,000) 58,000 51,500 12,000 $63,500

c. Balances in revenue, expense and distributions accounts will be zero because they will have been closed to retained earnings.

1-62

EXERCISE 1-14B a.
Computer Software Services Horizontal Statements Model for 2006 Balance Sheet Assets E vent No . 1 2 3 4 5. 6. 7. 8. 9. Tota l Cash 20,000 (5,000) 32,000 (12,500 ) 4,000 15,000 (15,000 ) (14,000 ) (2,500) 22,000 = Liab. + Notes e
+ NA = + 5,000 = + NA = + NA =

Income Statement Revenu − Expens e e = Net Inc.

+ Land = Payabl +

NA NA NA NA

+ + + +

+ NA = NA + + NA = 15,000 + + 15,000 = NA + +

Stockholders’ Equity Commo Retaine n Stock + d Earning s + 20,000 NA + NA NA + 32,000 NA NA + (12,500 ) 4,000 + NA NA + NA NA + NA

Statement of Cash Flows

NA NA 32,000 NA NA NA NA NA NA 32,000

NA − NA − NA − − 12,500 − − − NA NA NA

= NA = NA = 32,000 = (12,50 = = =

20,000 FA (5,000) IA 32,000 OA (12,500) OA 4,000 FA 15,000 FA (15,000) IA (14,000) OA (2,500) FA 22,000 NC

0) NA NA NA

NA + (14,000 ) + NA = NA + NA + (2,500) + 20,000 = 15,000 + 24,000 + 3,000
+

NA =

NA

− 14,000 NA − − 26,500

= (14,00

0) = NA 5,500

b. Net Income for 2006: $5,500 c. Total Assets at the end of 2006: $42,000 ($22,000 + $20,000) d. Net Cash Flow from Operating Activities for 2006: $5,500 (32,000 14,000). 1-63

12,500

e. Net Cash Flow from Investing Activities for 2006: f. Net Cash Flow from Financing Activities for 2006: 15,000 − 2,500). g. Cash balance at December 31, 2006: $22,000

$−20,000 (−5,000 + −15,000) $36,500 (20,000 + 4,000 +

1-64

EXERCISE 1-15B a. b. c. d. e. f. g. h. i. j. Title or Account Retained Earnings Financial Statement(s) Balance Sheet; Statement of Changes in Stockholders’ Equity Revenue Income Statement Common Stock Balance Sheet; Statement of Changes in Stockholders’ Equity Financing Activities Statement of Cash Flows Salaries Expense Income Statement Land Balance Sheet Ending Cash Balance Balance Sheet; Statement of Cash Flows Beginning Cash Statement of Cash Flows Balance Notes Payable Balance Sheet Dividends Statement of Changes in Stockholders’ Equity

1-65

EXERCISE 1-16B a. Accounts to be Closed to Retained Earnings Revenue $5,500 Expenses 2,000 Dividends 900 b. Beginning Retained Earnings Add: Revenue Less: Expenses Less: Dividends Ending Retained Earnings c. Computation of Net Income Revenue Less: Expenses Net Income $5,500 (2,000) $3,500 $1,900 5,500 (2,000) (900) $4,500

d. Net income is only the current year’s net income. Retained Earnings is an accumulation of net income over the life of the business less any dividends that have been paid over the years. e. All will have a zero balance because they are temporary accounts and have been closed to retained earnings.

1-66

EXERCISE 1-17B a. Account 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Common Stock Notes Payable Cash Service Revenue Dividends Land Salaries Expense Retained Earnings Utilities Expense Interest Revenue

Classificatio n P P P T T P T P T T

b. The accounting cycle is divided into one year accounting periods. Using the accounting cycle rationale, experience is gained one year at a time. But experience is like the balance sheet, it accumulates and one year adds to another. You do not start over at the beginning of each year when working at the same job.

1-67

EXERCISE 1-18B Event 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Classification Asset Source Asset Use Asset Source Asset Exchange Asset Source Asset Source Asset Use Asset Use Asset Source Asset Exchange

1-68

EXERCISE 1-19B a. Event 1. Asset 2. Asset 3. Asset 4. NA 5. Asset 6. Asset b.

Source Exchange Source Use Use
Computer Parts Horizontal Statements Model for 2007 Balance Sheet Income Statement Revenu − Expens = e e Net Inc. Statement of Cash Flows

Assets Even t No. 1 2 3 4 5 6 Cash I D I NA D D

Stockholders’ Equity Notes Com. Retaine + Land = Payabl + Stock + d e Earning s + + + NA = NA I NA
+ + + + +

=

Liab.

+

NA NA NA NA NA NA

I NA NA NA NA

= = = = =

NA I NA NA NA

+ + + + +

NA NA NA NA NA

+ + + + +

NA NA NA D D

− − − − − −

NA NA NA NA NA I

= = = = = =

NA NA NA NA NA D

I D I NA D D

FA IA FA FA OA

1-69

1-70

EXERCISE 1-20B a. b. c. d. Jackling Company: Asset Exchange Power Company: Asset Exchange Jackling Company: Investing Activity Power Company: Investing Activity

EXERCISE 1-21B Accounting Equation Stockholders’ Equity Common Retained = Liabilities + Stock + Earnings = = = = 25,000 5,000 20,000 45,000 + + + + 48,000 15,000 13,000 75,000 + + + + 25,000 30,000 42,000 5,000

Compan Assets y A 98,000 B 50,000 C 75,000 D 125,000

1-71

EXERCISE 1-22B a. December 31, 2004 Assets = Liabilities + Retained Earnings $132,000 = $12,700 $74,300 Common Stock + + $45,000 +

Or: $132,000 − $45,000 − $74,300 = $12,700.

b. December 31, 2005 Revenue − Expenses $42,000 − $21,500 c. Assets, January 1, 2004 Less: Debt Reduction, 2005 Plus: 2005 Net Income Less: 2005 Dividends Assets, December 31, 2005 Liabilities, January 1, 2004 Paid on debt Liabilities, December 31, 2004

= =

Net Income $20,500 $132,000 (5,000) 20,500 (600) $146,900 $12,700 (5,000) $ 7,700

d.

1-72

EXERCISE 1-23B Steps: 1. Change in Stk. Equity = Change in Com. Stk. + Change in Retained Earn. $46,500 (given) = $15,000 (given) + $31,500 2. Increase in Ret. Earn. = Net Income − Dividends $31,500 (1) = $36,500 − $5,000 (given) 3. Net Income $36,500 (2) = = Revenue $58,500 − − Expenses $22,000 (given)

Alternate Solution: Working backwards from the change in equity we can solve for total revenue: Computation of Total Revenues: Increase in Retained Earnings Plus: Dividends (given) Plus: Expenses (given) Total Revenues

$31,500 5,000 22,000 $58,500

or : Net Income + Expenses = Total Revenues $36,500 $22,000 = $58,500

1-73

EXERCISE 1-24B a. Price Earnings Ratio ARC Company Pager Company 46.5 ÷.85 = 54.71 75.4 ÷ 2.25 = 33.51 b. You would expect that ARC Company would have the greatest earnings potential because it has the highest PE ratio.

1-74

SOLUTIONS TO PROBLEMS - SERIES B - CHAPTER 1 PROBLEM 1-25B a.
Belzio Company Horizontal Statements Model for 2006 Balance Sheet Assets Even t No. 1 2 3 4 5 6 7 = Liab. + Notes e D I NA I D I I
+ + + + + +

Income Statement Revenu e − Expens = e Net Inc.

Cash + Land = Payabl + NA NA NA NA NA D NA =
= = = = =

NA NA NA NA NA NA I

+ + + + + +

Stockholders’ Equity Commo Retaine n Stock + d Earning s + NA D + I NA + NA NA + NA I + NA D NA NA + NA NA

Statement of Cash Flows

NA NA NA I NA NA NA

− − − − − −

NA NA NA NA I NA NA

= = = = = =

NA NA NA I D NA NA

D I I D I I

FA FA NA OA OA IA FA

1-75

PROBLEM 1-26B a.
Foreman Company Horizontal Statements Model for 2003 Balance Sheet Assets E vent No . 1 2 3 4 5. 6. 7. 8. Tota l Cash 32,000 20,000 42,000 (28,000 ) (6,000) 10,000 (15,000 ) (45,000 ) 10,000 = Liab. + Notes e
+ + + + + + +

Income Statement Revenu − Expens e e = Net Inc.

+ Land = Payabl +

NA NA NA NA

=

NA = 20,000 = NA = NA

+ + + + + + + +

NA = NA NA = NA NA = (15,00 0) + 45,000 = NA
+ 45,000 = 5,000

Stockholders’ Equity Commo Retaine n Stock + d Earning s + 32,000 NA + NA NA + 42,000 NA NA + (28,000 ) NA + (6,000) 10,000 + NA NA + NA NA + NA

Statement of Cash Flows

NA NA 42,000 NA NA NA NA NA 42,000

NA − NA − NA − − 28,000 − − − − NA NA NA NA

= NA = NA = 42,000 = (28,00 = = = =

0) NA NA NA NA 14,000

+ 42,000

+ 8,000

− 28,000

32,000 FA 20,000 FA 42,000 OA (28,000) OA (6,000) FA 10,000 FA (15,000) FA (45,000) IA 10,000 NC

b. Total Assets = $10,000 + $45,000 = $55,000 c. 1. Sources of Assets Issue of stock $ 32,000 1-76

2. Cash from loan 3. Cash from revenue 6. Issue of stock Total Sources of Assets

20,000 42,000 10,000 $104,000

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PROBLEM 1-26B (cont.) d. Net income amounts to $14,000 (see part a.) Dividends are not expenses and do not appear on the income statement. e. Operating Activities: Cash from revenue Cash paid for expenses Net Cash Flow from Operating Activities Financing Activities: Cash from stock issue ($32,000 + $10,000) Cash from loan Paid cash dividend Cash paid on loan principal Net Cash Flow from Financing Activities Investing Activities: Cash paid to purchase land Net Cash Flow from Investing Activities $42,000 (28,000) $14,000

$42,000 20,000 (6,000) (15,000) $41,000

$(45,000 ) $(45,000 )

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EXERCISE 1-27B a. Jim’s Janitorial Services Accounting Equation for 2001 Assets Event
1. Issued stk 2. Revenue 3. Loan 4. Paid Exp. 5. Pur. Land = Liabiliti +

Stockholders’ Equity Acct. Title/RE
NA Revenue NA Oper. Exp. NA

es Notes Com. Retaine Cash + Land = Payabl + Stock + d e Earning s 60,000 NA NA 60,000 NA 100,000 25,000 (70,000) (40,000) NA NA NA NA 25,000 NA NA NA NA 100,00 0 NA (70,00 0) NA

Totals

40,00 NA NA 0 75,000 + 40,00 = 25,000 +60,000 + 30,000 0 Jim’s Janitorial Services Accounting Equation for 2002 Assets
= Liabiliti +

Stockholders’ Equity

Event
Beg. Bal. 1. Issued stk 2. Revenue 3. Paid Loan

es Notes Com. Retaine Acct. Cash + Land = Payabl + Stock + d Title/RE e Earning s 75,000 40,00 25,000 60,000 30,000 0 20,000 NA NA 20,000 NA NA 120,000 (10,000) NA NA NA (10,00 0) NA NA 120,00 Revenue 0 NA NA

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4. Paid Exp. 5. Paid Div.

Totals

(80,00 Oper. 0) Exp. (15,000) NA NA NA (15,00 Dividend s 0) 110,000 + 40,00 = 15,000 +80,000 + 55,000 0 (80,000) NA NA NA

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PROBLEM 1-27B (cont.) b. Jim’s Janitorial Services Income Statements 2001 Revenue Expense Net Income $100,000 (70,000) $ 30,000 2002 $ 120,000 (80,000) $ 40,000

Statements of Changes in Stockholders’ Equity Beginning Common Stock Plus: Common Stock Issued Ending Common Stock Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings Total Stockholders’ Equity Balance Sheets Assets Cash Land Total Assets Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity 1-81 $ 75,000 40,000 $115,000 $ 25,000 60,000 30,000 90,000 $115,000 $ 110,000 40,000 $ 150,000 $ 15,000 80,000 55,000 135,000 $ -060,000 60,000 $ 60,000 20,000 80,000 30,000 40,000 (15,000) 55,000 $ 135,000

-030,000 -030,000 $ 90,000

$150,000

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PROBLEM 1-27B b. (cont.) Jim’s Janitorial Services Statements of Cash Flows 2001 Cash Flows From Operating Activities: Cash Receipts from Revenue Cash Payments for Expenses Net Cash Flow from Operating Activities Cash Flows From Investing Activities: Cash Payment for Land Net Cash Flow from Investing Activities Cash Flows From Financing Activities: Cash Receipts from Borrowed Funds Cash Payment of Debt Cash Receipts from Stock Issue Cash Payment for Dividends Net Cash Flow from Financing Activities Net Change in Cash Plus: Beginning Cash Balance Ending Cash Balance $100,000 (70,000) 30,000 2002 $120,000 (80,000) 40,000

(40,000) (40,000)

-0-0-

25,000 -060,000 -085,000 75,000 -0$ 75,000

-0(10,000) 20,000 (15,000) (5,000) 35,000 75,000 $110,000

c. In 2001 and 2002 net income and cash flows from operating activities are the same because all revenues and expenses are cash. Ordinarily, net income will be different from cash flows from operating activities due to non-cash revenue and expense transactions (discussed in Chapter 2). The net change in cash is different from net income because

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investing and financing activities do not directly affect revenues or expenses. d. $40,000 (2002) − $30,000 (2001) ÷ (2001) $30,000 = 33% growth. This is a high growth company.

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PROBLEM 1-28B Best Electronics Accounting Equation Stockholders’ Equity Commo Retained n Event Assets = Liabiliti + Stock + Earnings es Beginning Balances 10,000 = 2,200 + 3,2501 + 4,550 1. Paid Expense (5,010) (5,010) 3. Paid Dividend (625) (625) 4. Paid Liability (1,000) (1,000) 5. Issued Stock 2,000 2,000 6. Revenue* 9,200 9,2002 Ending Balance 14,565 = 1,200 + 5,250 + 8,115
1

Assets Stock: $10,000
2

Liabilities − $2,200

Retained Earnings = Common − $4,550 = $3,250

Increase in Retained Earnings:$3,565 Add: Expenses 5,010 Add: Dividends 625 Revenue $9,200 Best Electronics Income Statement For the Year Ended December 31, 20-Revenue Expense Net Income $9,200 (5,010) $4,190

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PROBLEM 1-28B (cont.) Best Electronics Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 20-Beginning Common Stock Plus: Common Stock Issued Ending Common Stock Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings Total Equity Stockholders’ $3,250 2,000 $ 5,250 4,550 4,190 (625) 8,115 $13,365

Best Electronics Balance Sheet As of December 31, 20-Assets Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity $ 5,250 8,115 13,365 $14,565 $14,565 $ 1,200

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PROBLEM 1-28B (cont.) Best Electronics Statement of Cash Flows For the Year Ended December 31, 20-Cash Flows From Operating Activities: Cash Receipt from Revenue Cash Payment for Expense Net Cash Flow from Operating Activities Cash Flows Activities From Investing

$9,200 (5,010) $ 4,190 -0-

Cash Flows From Financing Activities: Cash Receipts from Stock Issue Cash Payment to Creditors Cash Dividend Paid to Stockholders Net Cash Flow from Financing Activities Net Increase in Cash Plus: Beginning Cash Balance* Ending Cash Balance *Assumes all assets are cash.

2,000 (1,000) (625) 375 4,565 10,000 $14,565

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PROBLEM 1-29B
Income Statement Statement of Changes in Stockholde rs’ Equity Statement of Cash Flows

Components of Financial Statements 1. Retained Earnings Ending Balance 2. Revenues 3. Common Stock Beginning Balance 4. Common Stock Ending Balance 5. Assets 6. Expenses 7. Operating Activities 8. Dividends 9. Retained Earnings Beginning Balance 10. Investing Activities 11. Common stock issued this period 12. Liabilities 13. Financing Activities

Balance Sheet

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PROBLEM 1-30B a. Accounts to be Closed: Consulting Revenue Travel Expense Dividends Rent Expense Salary Expense Other Operating Expenses b. Peaks View Company Income Statement For the Year Ended December 31, 2005 Consulting Revenue Expenses Travel Expense Rent Expense Salary Expense Other Operating Expenses Total Expenses Net Income c. Computation of Retained Earnings: Beginning Retained Earnings Add: Net Income Less: Dividends Ending Retained Earnings $19,000 2,500 (3,000) $18,500 $1,100 1,800 6,900 2,200 (12,000) $2,500 $14,500

Since this is not the first year of operations for the company, Peaks View can pay dividends out of both this year’s profits and previous years’ profits.

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d. Accounting Cycle: Record transactions, prepare financial statements, and close the temporary accounts. PROBLEM 1-31B

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FOR THE YEARS Income Statements Revenue (cash) Expense (cash) Net Income (Loss)

2001 400 (250) (a) $150 $

2002 $ 500 (l) (400) $ 100

2003 $ 800 (425) $ 375 $9,100 310 (s) 9,410 75

Statements of Changes in Stockholders’ Equity Beginning Common Stock $ -0- (m) $8,000 Plus: Stock Issued (b) 8,000 1,100 Ending Common Stock 8,000 9,100 Beginning Retained -0Earnings Plus: Net Income (Loss) (c) 150 Less: Dividends (d) (125) Ending Retained Earnings 25 Total Stockholders’ Equity (e) $8,025 Balance Sheets Assets Cash Land Total Assets Liabilities 25

100 375 (50) (150) (n) 75 300 $9,175 (t) $9,710

(f) (o) $ (u)$ $11,000 6,650 8,050 -0- (p) 5,000 2,500 $11,000 $11,650 $10,550 (g) 2,975 $ (q) $ 2,475 (r) 9,100 75 9,175 $11,650 $ 840

Stockholders’ Equity Common Stock (h) 8,000 Retained Earnings (i) 25 Total Stockholders’ Equity 8,025 Total Liabilities and Stk. $11,000 Equity

9,410 300 9,710 $10,550

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PROBLEM 1-31B (cont.)

FOR THE YEARS Statements of Cash Flows

2001

2002

2003

Cash Flows From Oper. Activities: Cash Receipts from (j)$ Revenue 400 Cash Payments for (k)(250) Expenses Net Cash Flow from Oper. 150 Act. Cash Flows From Invest. Activities: Cash Payments for Land Cash Receipt from Sale of Land Net Cash Flow from Invest. Act. Cash Flows From Fin. Activities: Cash Receipts from Creditors Cash Payments to Reduce Debt Cash Receipts from Stock Issue Cash Payments for Dividends Net Cash Flow from Fin. Activities

$

500 (400) 100

(v) $ 800 (w) (425) 375

-0-0-0-

(5,000) -0(5,000)

-02,500 2,500

2,975 -08,000 (125) 10,850

-0(500) 1,100 (50) 550 (4,350) 11,000 $ 6,650

-0(x) (1,635) (y) 310 (z) (150) (1,475) 1,400 6,650 $ 8,050

Net Change in Cash 11,000 Plus: Beginning Cash Balance -0Ending Cash Balance $11,000

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PROBLEM 1-31B (cont.) Computations of amounts: a. $150 Net Income = $400 − $250 Expenses. b. $8,000 Common Stock Issued = $8,000 Ending Common Stock − $-0- Beginning

Common Stock. c. $150 Net Income = $150 Net Income from Income Statement. d. $125 Dividends = $-0- Beginning Retained Earnings + $150 Net Income − $25 Ending Retained Earnings. e. $8,025 Total Stockholders’ Equity = $8,000 Ending Common Stock + $25 Ending Retained Earnings. f. $11,000 Cash = $11,000 Total Assets − $-0- Land. g. $2,975 Liabilities = $11,000 Total Liabilities and Stockholders’ Equity − $8,025 Total Stockholders’ Equity. h. $8,000 Common Stock = $8,000 Ending Common Stock from Statement of Changes in Stockholders’ Equity. i. $25 Retained Earnings = $25 Ending Retained Earnings from Statement of Changes in Stockholders’ Equity. j. $400 Cash Receipts from Revenue = $400 Revenue from Income Statement. k. $250 Cash Payments for Expense = $250 Expenses from Income Statement. l. $400 Expenses = $500 Revenue − $100 Net Income. m. $8,000 Beginning Common Stock = $8,000 Ending Common Stock for 2001. n. $75 Ending Retained Earnings = $25 Beginning Retained Earnings + $100 Net Income − $50 Dividends. o. $6,650 Cash = $6,650 Ending Cash Balance from the Statement of Cash Flows. p. $5,000 Land = $11,650 Total Assets − $6,650 Cash. q. $2,475 Liabilities = $11,650 Total Liabilities and Stockholders’ − $9,175 Total Stockholders’ Equity. r. $9,100 Common Stock = $9,100 Ending Common Stock from Statement of Changes in Stockholders’ Equity. s. $9,140 Ending Common Stock = $9,100 Beginning Common Stock + $310 Stock Issued. t. $9,710 Total Stockholders’ Equity = $9,410 Ending Common Stock + $300 Ending Retained Earnings. u. $8,050 Cash = $10,550 Total Assets − $2,500 Land. v. $800 Cash Receipts from Revenue = $800 Revenue from Income Statement. w. $425 Cash Payments for Expenses = $425 Expenses from Income Statement.

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x. $1,635 Cash Payments to Reduce Debt = $2,475 Liabilities Balance,
2002 − $840 Liabilities Balance, 2003. y. $310 Cash Receipts from Stock Issued = $310 Stock Issued from Statement of Changes in Stockholders’ Equity. z. $150 Cash Payments for Dividends = $150 Dividends from Statement of Changes in Stockholders’ Equity.

PROBLEM 1-32B Event No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15.

Type of Event Asset Asset Asset NA Asset Asset NA Asset Asset Asset Asset Asset Asset Asset NA Source Source Use Exchange Use Source Use Use Use Exchange Exchange Use

Effect on Total Assets Increase Increase Decrease NA No Effect Decrease NA Increase Decrease Decrease Decrease No Effect No Effect Decrease NA

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PROBLEM 1-33B The growth of earnings between two years is measured as follows: Alternative year earnings − Base year earnings Base year earnings a. Beta One, Inc: 2004 to 2005 ($1.20 − $1.19) ÷ $1.19 = .84% 2003 to 2004 ($1.19 − $1.22) ÷ $1.22 = −2.46% b. Beta One, Inc. is a low growth company. c. PE Ratio: Market price per share ÷ Earnings per share Beta One, Inc. 2003: $85.40÷ $1.22 = 70 2004: $84.49 ÷ $1.19 = 71 2005: $87.60 ÷ $1.20 = 73

d. Beta One, Inc. is high growth company. e. The price per share reflects future profits of the company. The market expects the profitable results in the future.

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ATC 1-1 a. $2,177,000,000.

b. 2001's net income is approximately 31% higher than that of 2000. c. ASSETS = LIABILITIES $13,435,000,000 = $5,622,000,000 STOCKHOLDERS’ + EQUITY $7,813,000,000 +

d. Net revenue increased by 26.2% Cost of revenue increased by 26.9% Total operating expenses increased by 27.9%

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ATC 1-2 a. Income Statements (amounts given are in millions) 1999 Revenue 1998 1997 1996

$ 661 (a) (a) $ 894 $1,307 $1,930 Cost and Expenses (a) (654) (1,133) (1,859) (769) Income from Cont. Op. (b) 7 174 71 (a) 125 Unusual Items -0218 (b) 24 (b) 52 Net Income $ 7 (b) $ $ 47 $ 177 392 Balance Sheets Cash and Marketable Sec. Other Assets Total Assets

$1,247 (c) $ $ 419 419 1,661 (c) 1,657 1,226 (c) 999 $1,910 $2,904 (d) $1,418 $1,906 (c)$ 848 (d) $1,562 $ 907 (d)$ 378

$ 249

Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Total Liab. and Stk. Equity

422 356 (e) (d) 986 (e) 986 1,062 1,342 (f) (f) $1,910 (f)2,904

315 313 684 (e) 727 999 1,040 $1,418

$1,906

c. Some examples of events that may have caused the unusual items are discontinued items, change in accounting principle, or extraordinary item.

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ATC 1-3
REAL WORLD CASE Deciding Which Company is the Best Investment

_______________Annual Growth Rates_______________ Average of Average s Total Growth Over 3 Years 37.2%

Company Autozon e H&R Block Intuit

2000 $267,590− $244,783 ÷ $244,783 =9.3% $251,895− $215,366 ÷ $215,366 =17.0% $305,661− $386,564 ÷ $386,564 =−20.9% ÷ $258,142− $192,266 ÷ $192,266 =34.3%

1999 $244,783− $227,903÷ $227,903 =7.4% $215,366− $392,130÷ $392,130 =−45.1% $386,564− $6,182÷ $ 6,182 =6,153%

1998

$227,903− 11.2% $195,008÷ $195,008 =16.9% $392,130− $47,755 231% ÷ $ 47,755 =721.1% $ 6,182− $68,308÷ $68,308 =−90.9% 2,013.7 % $141,273− $102,478÷ $102,478 =37.9%

(1)

427.5%(2)

347.5%(3)

Kohl’s

$192,266− $141,273÷ $141,273 =36.1%

36.1%

151.9%(4)

(1) (2) (3) (4)

($267,590 − $195,008) ÷ 195,008 = 37.2% ($251,895 −$47,755) ÷ $47,755 = ($305.661 − $68,308) ÷ $68,308 = 427.5% 347.5%

($258,142 − $102,478) ÷ $102,478 = 151.9%

This case can be used to discuss the problems with averages. Based on the “average of the averages,” Intuit seems the best, but this is distorted by the high growth rate in 1999 that was mostly the result of a bad year in 1998. By comparison, based on the “total growth rate over 3 years,” H&R Block looks best. Of course no one can be sure which company will be the best or worst investment opportunity, but the data suggest an argument can be made that Kohl’s will be the best. Even though Intuit and H&R Block had the highest growth rates over the past 3 years, their annual performance was erratic. Kohl’s annual growth rate has been very consistent. Many students will instinctively appreciate the desirability of consistency over volatility.

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The authors would argue that Intuit is the worst investment opportunity. Even though its total growth rate seems rather high, it had negative growth rate in two of the past 3 years.

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ACT 1-3 (cont.) The requirement asking students to predict earnings for 2008, which is eight years in the future, is primarily intended to force them to consider how difficult such a task is. Given the rather consistent growth rates of Autozone and Kohl’s, their average growth rates might be used to make a prediction, However, students may forget to compound the growth rate over the eight years, so this is another financial analysis issue that can be discussed. Starting with the net earnings of 2000, and using the average growth rates of 11.2% for Autozone and 36.1 % for Kohl’s, and compounding annually, the predictions for 2008 would be $625,616 and $3,038,598, respectively.

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ATC 1-4 a. The percentage growth from 2001 to 2002 was 67% ($80,000 ÷ $120,000). However, this rate of growth will probably not continue from 2002 to 2003 because 77.5% ($62,000 ÷ $80,000) of the growth was from the lottery win. If the company continues to grow at the current rate, shareholders should expect an increase in net income of approximately 15%. This is the increase in net income from continuing operations ($18,000 ÷ $120,000 = 15%). b. One could assume that the $200,000 was used to pay off liabilities since the total liabilities were reduced by $200,000. Also, assets and common stock did not change. c. The percentage increase in net income from continuing operations was 15% (see a. above). Therefore, owners could expect net income to be $158,700 ($138,000 x 115%) in 2003. d. Machine Imports Company Income Statement For Year Ended December 31, 2003 Revenue Operating 115%) ($690,000 x 115%) Expenses from ($552,000 x $793,50 0 (634,800 ) 158,700 (40,000) $118,70 0

Net Income Operations

Continuing

Extraordinary Loss Net Income

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ATC1-4 d. (cont.) Machine Imports Company Balance Sheet As of December 31, 2003 Assets Liabilities Stockholders’ Equity Common Stock Retained Earnings ($500,000 + $118,700) Total Stockholders’ Equity Total Liabilities Equity and Stockholders’ $998,700 $ -0$380,000 618,700 998,700 $998,700

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ATC 1-5 This problem is designed to test written communication skills. The memo should describe the balance sheet and the income statement. It should explain that the balance sheet is a statement of assets, liabilities, and stockholders’ equity at the date of the financial statement. The income statement gives the amount of revenues and expense for the designated period. The memo should also define each of the following terms: Assets Liabilities Stockholders’ Equity Revenue Expense Net Income

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ATC 1-6 a.
Financial Statements Income Statement Revenue Expense Net Income Statement of Changes in Stockholders’ Equity Beginning Common Stock Plus: Common Stock Issued Ending Common Stock Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings Total Stockholders’ Equity Balance Sheet Assets Cash Total Assets Stockholders’ Equity Common Stock Retained Earnings Total Stockholders’ Equity Statement of Cash Flows Net Cash Flow From Operating Activities: Inflow from Customers Outflow for Expenses Net Cash Flow from Operating Activities Net Cash Flow From Investing Activities Net Cash Flow From Financing Activities: Inflow from Stock Issue Outflow for Dividends Net Cash Flow from Financing Activities Net Change in Cash Plus: Beginning Cash Balance Ending Cash Balance $57,000 (40,000) $17,000 $20,000 5,000 25,000 50,000 17,000 (2,000) 65,000 $90,000

$90,000 $90,000 $25,000 65,000 $90,000

$57,000 (40,000) 17,000 -05,000 (2,000) 3,000 $20,000 70,000 $90,000

ATC 1-6 (cont.)

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b.

In the short-run replacing Jones would save $5,000 in cash expenses. Accordingly, net income, assets, stockholders’ equity, and cash flow from operating activities would increase. These effects can be confirmed by comparing the statements above (i.e., after effect of replacement) with those shown in the textbook (i.e., before effect of replacement). However, the long-run impact may be different depending on how other employees react to Jones’ replacement. If the replacement creates resentment and low morale among the remaining employees, then productivity and profitability may decline. In this case, the company may experience a negative impact rather than the expected positive effect. The best solution to this dilemma is avoidance. Jones’ salary should never have been permitted to rise above his value to the company. As future business managers, students should take heed of the perils of excessive generosity. Employees should be paid on a basis that is consistent with their contribution to the company’s profitability. The pain of corporate downsizing can be avoided if businesses do not oversize in the first place.

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