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Chapter 3 The Balance Sheet and Financial Disclosures

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documentation of outcomes assessment. Although schools, departments, and faculty may approach
assessment and its documentation differently, one approach is to provide specific questions on
exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each
question, exercise and problem in Intermediate Accounting, 5e with the following AACSB learning
skills:

Questions AACSB Tags Exercises AACSB Tags


(cont.)
3-1 Reflective thinking 3-4 Analytic
3-2 Reflective thinking 3-5 Analytic
3-3 Reflective thinking 3-6 Analytic
3-4 Reflective thinking 3-7 Analytic
3-5 Reflective thinking 3-8 Analytic
3-6 Reflective thinking 3-9 Analytic
3-7 Reflective thinking 3-10 Reflective thinking
3-8 Reflective thinking 3-11 Reflective thinking
3-9 Reflective thinking 3-12 Reflective thinking
3-10 Reflective thinking 3-13 Analytic
3-11 Reflective thinking 3-14 Analytic
3-12 Reflective thinking 3-15 Analytic
3-13 Reflective thinking 3-16 Analytic
3-14 Reflective thinking 3-17 Analytic
3-15 Reflective thinking 3-18 Reflective thinking, Diversity
3-16 Reflective thinking CPA/CMA
3-17 Reflective thinking 3-1 Analytic
3-18 Reflective thinking 3-2 Analytic
3-19 Reflective thinking 3-3 Reflective thinking
3-20 Reflective thinking 3-4 Analytic
Brief 3-5 Reflective thinking
Exercises
3-1 Reflective thinking 3-6 Analytic
3-2 Analytic 3-1 Reflective thinking
3-3 Analytic 3-2 Analytic
3-4 Analytic 3-3 Reflective thinking
3-5 Analytic Problems
3-6 Analytic 3-1 Analytic
3-7 Analytic 3-2 Analytic
3-8 Reflective thinking 3-3 Analytic
3-9 Analytic 3-4 Analytic
3-10 Analytic 3-5 Analytic
3-11 Analytic 3-6 Analytic, Reflective thinking
Exercises 3-7 Analytic
3-1 Analytic 3-8 Analytic

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Solutions Manual, Vol.1, Chapter 3 3-1
3-2 Reflective thinking 3-9 Analytic
3-3 Reflective thinking 3-10 Analytic

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3-2 Intermediate Accounting, 5/e
QUESTIONS FOR REVIEW OF KEY TOPICS
Question 3-1
The purpose of the balance sheet, also known as the statement of financial position, is to
present the financial position of the company on a particular date. Unlike the income statement,
which is a change statement that reports events occurring during a period of time, the balance sheet
is a statement that presents an organized array of assets, liabilities, and shareholders’ equity at a
point in time. It is a freeze frame or snapshot picture of financial position at the end of a particular
day marking the end of an accounting period.

Question 3-2
The balance sheet does not portray the market value of the entity (number of common stock
shares outstanding multiplied by price per share) for a number of reasons. Most assets are not
reported at fair value, but instead are measured according to historical cost. Also, there are certain
resources, such as trained employees, an experienced management team, and a good reputation, that
are not recorded as assets at all. Therefore, the assets of a company minus its liabilities, as shown in
the balance sheet, will not be representative of the company’s market value.

Question 3-3
Current assets include cash and other assets that are reasonably expected to be converted to
cash or consumed during one year, or within the normal operating cycle of the business if the
operating cycle is longer than one year. The typical asset categories classified as current assets
include:
— Cash and cash equivalents
— Short-term investments
— Accounts receivable
— Inventories
— Prepaid expenses

Question 3-4
Current liabilities are those obligations that are expected to be satisfied through the use of
current assets or the creation of other current liabilities. So, this classification will include all
liabilities that are scheduled to be liquidated within one year or the operating cycle, whichever is
longer, except those that management intends to refinance on a long-term basis. The typical liability
categories classified as current liabilities include:
— Accounts payable
— Short-term notes payable
— Accrued liabilities
— Current maturities of long-term debt

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Solutions Manual, Vol.1, Chapter 3 3-3
Answers to Questions (continued)

Question 3-5
The operating cycle for a typical manufacturing company refers to the period of time required
to convert cash to raw materials, raw materials to a finished product, finished product to receivables,
and then finally receivables back to cash.

Question 3-6
Investments in equity securities are classified as current if the company’s management (1)
intends to liquidate the investment in the next year or operating cycle, whichever is longer, and (2)
has the ability to do so, i.e., the investment is marketable. If either of these criteria does not hold,
the investment is classified as noncurrent.

Question 3-7
The common characteristics that these assets have in common are that they are tangible, long-
lived assets used in the operations of the business. They usually are the primary revenue-generating
assets of the business. These assets include land, buildings, equipment, machinery, furniture and
other assets used in the operations of the business, as well as natural resources, such as mineral
mines, timber tracts and oil wells.

Question 3-8
Property, plant, and equipment and intangible assets each represent assets that are long-lived
and are used in the operations of the business. The difference is that property, plant, and equipment
represent physical assets, while intangibles lack physical substance. Generally, intangibles represent
the ownership of an exclusive right, such as a patent, copyright or franchise.

Question 3-9
A note payable of $100,000 due in five years would be classified as a long-term liability. A
$100,000 note due in five annual installments of $20,000 each would be classified as a $20,000
current liability — current maturities of long-term debt — and an $80,000 long-term liability.

Question 3-10
Paid-in-capital consists of amounts invested by shareholders in the corporation. Retained
earnings equals net income less dividends paid to shareholders from the inception of the corporation.

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3-4 Intermediate Accounting, 5/e
Answers to Questions (continued)
Question 3-11
Disclosure notes provide additional detail concerning specific financial statement items.
Included are such data as the fair values of financial instruments and off-balance-sheet risk
associated with financial instruments and details of pension plans, leases, debt, and assets. Common
to all companies’ disclosures are certain specific notes such as a summary of significant accounting
policies, descriptions of subsequent events, and related third-party transactions. However, many
notes are designed to fit the disclosure needs of the particular reporting company. In fact, any
explanation that helps investors and creditors make decisions should be included.

Question 3-12
The disclosure of the company’s significant accounting policies is extremely important to
external users in terms of their ability to compare financial information across companies. It is
critical to a financial analyst involved in assessing future cash flows of two construction companies
to know that one company uses the percentage-of-completion method in recognizing gross profit,
while the other company uses the completed contract method.

Question 3-13
A subsequent event is an event that occurs after the date of the financial statements but prior to
the date on which the statements are actually issued. It may help to clarify a previously existing
situation or it may represent a new event not directly affecting financial position at the end of the
reporting period.

Question 3-14
The discussion provides management’s views on significant events, trends and uncertainties
pertaining to the company’s (a) operations, (b) liquidity, and (c) capital resources. Certainly the
Management Discussion and Analysis section may be slanted to management’s biased perspective
and therefore can lack objectivity. However, management can offer an informed insight that might
not be available elsewhere, so if the reader maintains awareness of the information’s source, it can
offer a unique view of the situation.

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Solutions Manual, Vol.1, Chapter 3 3-5
Answers to Questions (continued)

Question 3-15
Depending on the circumstances, the auditor will issue a (an):
1. Unqualified opinion – The auditors are satisfied that the financial statements “present fairly”
the financial position, results of operations, and cash flows and are “prepared in accordance with
generally accepted accounting principles.”
2. Qualified opinion – This contains an exception to the standard unqualified opinion, but not of
sufficient seriousness to invalidate the financial statements as a whole. Examples of exceptions
are (a) unconformity with generally accepted accounting principles, (b) inadequate disclosures,
and (c) a limitation or restriction of the scope of the examination.
3. Adverse opinion – This is necessary when the exceptions (a) and (b) above are so serious that a
qualified opinion is not justified. Adverse opinions are rare because auditors usually are able to
persuade management to rectify problems to avoid this undesirable report.
4. Disclaimer – An auditor will disclaim an opinion if item (c) above applies and therefore
insufficient information has been gathered to express an opinion.

Question 3-16
A proxy statement must be sent each year to all shareholders. It usually is in the same mailing
with the annual report. The statement invites shareholders to the shareholders’ meeting to elect
board members and to vote on issues before the shareholders. It also permits shareholders to vote
using an enclosed proxy card. The proxy statement also provides for more disclosures on
compensation to directors and executives, and in particular, stock options granted to executives.

Question 3-17
Working capital is the difference between current assets and current liabilities. The current
ratio is computed by dividing current assets by current liabilities. The acid-test ratio (or quick ratio)
is computed by dividing quick assets (cash and cash equivalents, marketable securities, and accounts
receivable) by current liabilities.

Question 3-18

Debt to equity ratio = Total liabilities


Shareholders' equity

Times interest earned ratio = Net income + interest + taxes


Interest

Answers to Questions (concluded)


Question 3-19
An operating segment is a component of an enterprise:
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3-6 Intermediate Accounting, 5/e
1. That engages in business activities from which it may earn revenues and incur expenses
(including revenues and expenses relating to transactions with other components of the same
enterprise).
2. Whose operating results are regularly reviewed by the enterprise's chief operating decision-
maker to make decisions about resources to be allocated to the segment, and to assess its
performance.
3. For which discrete financial information is available.

Question 3-20
For areas determined to be reportable operating segments, the following disclosures are required:
1. General information about the operating segment,
2. Information about reported segment profit or loss, including certain revenues and expenses
included in reported segment profit or loss, segments assets, and the basis of measurement.
3. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other
significant items to corresponding enterprise amounts.
4. Interim period information.

BRIEF EXERCISES
Brief Exercise 3-1
(a) Current
(b) Current
(c) Noncurrent
(d) Current
(e) Noncurrent
(f) Noncurrent

Current Assets:
Brief Exercise 3-2 $16,000 + 11,000 + 25,000 = $52,000

Current liabilities:
$14,000 + 9,000 + 1,000 = $24,000

Assets: $ 52,000 current assets


Brief Exercise 3-3 80,000 equipment
$132,000 total assets
minus
Liabilities $ 24,000 current liabilities
30,000 notes payable
54,000 total liabilities
equals
Shareholders’ equity $78,000
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Solutions Manual, Vol.1, Chapter 3 3-7
(50,000) common stock
$28,000 retained earnings

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3-8 Intermediate Accounting, 5/e
Brief Exercise 3-4K and J Nursery, Inc.
Balance Sheet
At December 31, 2009

Assets
Current assets:
Cash .................................................................... $ 16,000
Accounts receivable ........................................... 11,000
Inventories .......................................................... 25,000
Total current assets ....................................... 52,000

Property, plant, and equipment:


Equipment .......................................................... $140,000
Less: Accumulated depreciation ........................ (60,000)
Net property, plant, and equipment ............... 80,000
Total assets ................................................. $132,000

Liabilities and Shareholders' Equity


Current liabilities:
Accounts payable ............................................... $ 14,000
Wages payable ................................................... 9,000
Interest payable .................................................. 1,000
Total current liabilities .................................. 24,000

Long-term liabilities:
Note payable ...................................................... 30,000

Shareholders’ equity:
Common stock ................................................... $50,000
Retained earnings* ............................................. 28,000
Total shareholders’ equity ............................. 78,000
Total liabilities and shareholders’ equity $132,000

$28,000 is the amount needed to cause total assets to equal total liabilities and
shareholders’ equity. This is calculated in BE 3-3.

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Solutions Manual, Vol.1, Chapter 3 3-9
Brief Exercise 3-5 Brief
Culver City Lighting,
Exercise 3-6 Inc.
Balance Sheet
At December 31, 2009
Assets
Current assets:
Cash .................................................................... $ 55,000
Accounts receivable ........................................... 39,000
Inventories .......................................................... 45,000
Prepaid insurance ............................................... 15,000
Total current assets ....................................... 154,000

Property, plant, and equipment:


Equipment .......................................................... $100,000
Less: Accumulated depreciation ........................ (34,000)
Net property, plant, and equipment ............... 66,000
Intangibles:
Patent ............................................................... 40,000
Total assets ................................................. $260,000

Liabilities and Shareholders' Equity


Current liabilities:
Accounts payable ............................................... $ 12,000
Interest payable................................................... 2,000
Current maturities of long-term debt .................. 10,000
Total current liabilities .................................. 24,000

Long-term liabilities:
Note payable ...................................................... 90,000

Shareholders’ equity:
Common stock ................................................... $70,000
Retained earnings ............................................... 76,000
Total shareholders’ equity ............................. 146,000
Total liabilities and shareholders’ equity $260,000

1. The $30,000 should be classified as a noncurrent asset, under the


investments classification.

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3-10 Intermediate Accounting, 5/e
2. $10,000, next year’s installment, should be classified as a current liability,
current maturities of long-term debt. The remaining $90,000 is included in
long-term liabilities.
3. Two-thirds of the unearned revenue, $40,000, should be classified as a
current liability, the remaining $20,000 as a long-term liability.

Current assets – cash and cash equivalents – accounts


Brief Exercise 3-7 receivable = Inventories
$235,000 – 40,000 –
120,000 = $75,000

Total assets – current assets = property, plant, and equipment


$400,000 – 235,000 = $165,000

Total assets – accounts payable – note payable – common stock = retained


earnings
$400,000 – 32,000 – 50,000 – 100,000 = $218,000

(1) A
Brief Exercise 3-8 (2) B
(3) B
(4) A
(5) B
(6) A

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Solutions Manual, Vol.1, Chapter 3 3-11
(a) Current assets ÷
Brief Exercise 3-9 current liabilities
($55,000 + 39,000 + 45,000 + 15,000) ÷ ($12,000
+ 2,000 + 10,000)
$154,000 ÷ $24,000 = 6.42

(b) (Cash + short-term investments + accounts receivable) ÷ current liabilities


($55,000 + 0 + 39,000) ÷ $24,000 =
3.92

(c) Total liabilities ÷ shareholders’ equity


$24,000 current liabilities + 90,000 long-term liabilities = $114,000
$70,000 common stock + 76,000 retained earnings = $146,000
$114,000 ÷ $146,000 = .78

Paying accounts payable reduces both current


Brief Exercise 3-10 assets and current liabilities. If the ratio before the
payment were above 1.0, the transaction would cause
the ratio to increase. However, if the ratio before the transaction were less than
1.0, the ratio would decrease.

Acid-test ratio = (cash + short-term investments +


Brief Exercise 3-11 A/R) ÷ current liabilities
1.5 = ($20,000 + 0 + 40,000) ÷ current liabilities
1.5 x current liabilities = $60,000
current liabilities = $60,000 ÷ 1.5
current liabilities = $40,000

Current ratio = current assets ÷ current liabilities


2.0 = current assets ÷ $40,000
current assets = $40,000 x 2.0
current assets = $80,000
$80,000 – 20,000(cash) – 40,000(A/R) = $20,000 inventories
EXERCISES
Exercise 3-1
1. Total current assets
Current liabilities = $44,000 + 15,000 + 1,000 (accrued interest)
= $60,000
Since the current ratio is 1.5:1, current assets = 1.5 x $60,000 = $90,000
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3-12 Intermediate Accounting, 5/e
2. Short-term investments
$90,000 - 5,000 - 20,000 - 60,000 = $5,000

3. Retained earnings
Current assets + Noncurrent assets = Current liabilities + Long-term liabilities
+ Paid-in capital + Retained earnings (RE)

$90,000 + 120,000 = $60,000 + 30,000 (Note payable) + 100,000 + RE

RE = $20,000
1. c Equipment 10. a
Exercise 3-2 Inventories
2. f Accounts payable 11. d _ Patent
3. -a _ Allowance for uncollectible accounts 12. c Land, in use
4. b_ Land, held for investment 13. f _ Accrued liabilities
5. g_ Note payable, due in 5 years 14. a Prepaid rent
6. f Unearned rent revenue 15. h _ Common stock
7. f Note payable, due in 6 months 16. c Building, in use
8. i Income less dividends, accumulated 17. a Cash
9. b Investment in XYZ Corp., long-term 18. f Taxes payable
1. f Accrued interest payable 10. a
Exercise 3-3 Supplies
2. d Franchise 11. c Machinery
3. -c Accumulated depreciation 12. c Land, in use
4. e Prepaid insurance, for 2011 13.___ f Unearned
revenue
5. g Bonds payable, due in 10 years 14. d _ Copyrights
6. f Current maturities of long-term debt 15. h _ Preferred stock
7. f Note payable, due in 3 months 16. b _ Land, held for speculation
8. b Long-term receivables 17. a Cash equivalents
9. b Bond sinking fund, will be used to 18. f Wages payable
retire bonds in 10 years

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Solutions Manual, Vol.1, Chapter 3 3-13
Exercise 3-4Exercise 3-5JACKSON
VALLEY PUMPCORPORATION
CORPORATION
Balance
BalanceSheet
Sheet
At December
At December 31, 2009
Exercise 3-6 31, 2009
Assets
Current assets:
Assets
Current assets:
Cash ................................................................................. $ 25,000
Cash ....................................................................
Marketable securities ...................................................... $22,000
40,000
Marketable
Accounts securities
receivable, net of .........................................
allowance for 10,000
uncollectible accounts of $5,000 ..............................
Accounts receivable ........................................... 51,000
34,000
Inventories ......................................................................
Inventories .......................................................... 81,000
75,000
Prepaid expenses ............................................................. 32,000
Prepaid rent ........................................................ 16,000
Total current assets ................................................... 211,000
Total current assets ....................................... 175,000
Investments:
Marketable plant,
Property, securities and ......................................................
equipment: $22,000
Land ................................................................................ 20,000
Machinery ..........................................................
Total investments ......................................................
$145,000 42,000
Less: Accumulated depreciation ........................ (11,000)
Property,
Netplant, and equipment:
property, plant, and equipment ............... 134,000
Land ................................................................................ 100,000
Buildings ......................................................................... 300,000
Intangibles:
Equipment ....................................................................... 75,000
Patent ............................................................... 475,000 83,000
Total assetsdepreciation
Less: Accumulated .................................................
..................................... (125,000) $392,000
Net property, plant, and equipment .......................... 350,000
Liabilities and Shareholders' Equity
Intangibles:
Current liabilities:
Copyright
Accounts ........................................................................
payable ............................................... $12,000
8,000
Total assets ............................................................. $615,000
Wages payable ...................................................
Liabilities and Shareholders' Equity
4,000
Taxes
Current payable .....................................................
liabilities: 32,000
Total
Accounts current
payable liabilities ..................................
............................................................ 44,000
$ 65,000
Interest payable ............................................................... 10,000
Long-term liabilities:
Unearned revenues .......................................................... 20,000
Note payable
Bonds ...................................................................
payable .................................................... 100,000
200,000
Current maturities of long-term debt .............................. 50,000
Total current equity:
Shareholders’ liabilities .............................................. 245,000
Common
Long-term stock ...................................................
liabilities: $100,000
Retained
Note payableearnings ...............................................
................................................................... 48,000 100,000
Total shareholders’
Shareholders’ equity: equity ............................. 148,000
CommonTotal
stockliabilities and shareholders’ equity
................................................................ $200,000 $392,000
Retained earnings ............................................................ 70,000
Total shareholders’ equity ........................................ 270,000
Total liabilities and shareholders’ equity ............... $615,000

Current assets:
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3-14 Intermediate Accounting, 5/e
Cash $20,000
Accounts receivable 130,000
Less: allowance for uncollectible accounts (13,000)
Note receivable 100,000
Interest receivable 3,000
Marketable securities 32,000
Raw materials 24,000
Work in process 42,000
Finished goods 89,000
Prepaid rent (one-half of $60,000) 30,000
Total current assets $457,000

Current liabilities:
Unearned revenue (one half of $36,000) 18,000
Accounts payable 180,000
Interest payable 5,000
Total current liabilities (203,000)

Working capital $254,000

Exercise 3-7

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Solutions Manual, Vol.1, Chapter 3 3-15
LOS GATOS CORPORATION
Exercise
See 3-8 below the balance sheet.
calculations Balance Sheet
At December 31, 2009 Exercise 3-9
Assets
Current assets:
Cash ........................................................................ $ 20,000
Accounts receivable, net of allowance for
uncollectible accounts of $5,000 ......................... 55,000
Inventories ............................................................... 55,000
Total current assets ............................................ 130,000

Investments:
Bond sinking fund ................................................... $ 20,000
Note receivable ........................................................ 20,000
Total investments ............................................... 40,000

Property, plant, and equipment:


Machinery ............................................................... 190,000
Less: Accumulated depreciation .............................. (70,000)
Net property, plant, and equipment .................... 120,000

Intangibles: CONE CORPORATION


Balance Sheet (Partial)
Franchise ................................................................. 30,000
At December 31, 2009
Total assets ...................................................... $320,000
Liabilities and Shareholders' Equity
Current liabilities: Assets
Accounts payable
Current assets: .................................................... $ 50,000
Interest payable securities
Marketable .......................................................
......................................... $5,000
40,000
Note payable ...........................................................
Prepaid rent ........................................................ 50,000
12,000
Total current liabilities ....................................... 105,000
Investments:
Long-term liabilities:
Bond
Bonds sinking
payable fund ..............................................
......................................................... 50,000
110,000
Marketable securities ......................................... 40,000
Shareholders’ equity:
Common stock, no par value; 100,000 shares
Other assets:
authorized; 50,000 shares issued and outstanding $ 70,000
Prepaid
Retained rent (1)....................................................
earnings ................................................... 35,000 12,000
Total shareholders’ equity .................................. 105,000
Total liabilities andLiabilities
shareholders’and Shareholders'
equity ........ Equity $320,000
Current liabilities:
Interest payable .................................................. $ 12,000
Current maturities of long-term debt .................. 20,000

Long-term liabilities:
NoteCompanies,
© The McGraw-Hill payable ......................................................
Inc., 2009 180,000
3-16 Intermediate Accounting, 5/e
(1) Note: In practice, companies often report all prepaid expenses as
current assets.
Korver Supply Company
Balance Sheet
At December 31, 2009
Assets
Current assets:
Cash .................................................................... $168,000
Accounts receivable ........................................... 320,000
Inventories .......................................................... 250,000
Total current assets ....................................... 738,000
Property, plant, and equipment:
Furniture and fixtures ......................................... $300,000
Less: Accumulated depreciation ........................ (170,000)
Net property, plant, and equipment ............... 130,000
Total assets ................................................. $868,000
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable ............................................... $180,000
Interest payable .................................................. 6,000
Note payable ...................................................... 200,000
Total current liabilities .................................. 386,000
Shareholders’ equity:
Common stock ................................................... $100,000
Retained earnings ............................................... 382,000
Total shareholders’ equity ............................. 482,000
Total liabilities and shareholders’ equity $868,000

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Solutions Manual, Vol.1, Chapter 3 3-17
Exercise 3-9 (concluded)

Beginning balance in cash $120,000


+ Cash collected from customers 780,000
- Cash paid to suppliers (560,000)
- Cash paid for operating expenses (160,000)
- Cash paid for interest (12,000)
Ending cash balance $168,000

Beginning balance in accounts receivable $300,000


+ Credit sales 800,000
- Cash collected from customers (780,000)
Ending balance in accounts receivable $320,000

Beginning balance in inventories $200,000


+ Purchases 550,000
- Cost of merchandise sold (500,000)
Ending balance in inventories $250,000

Beginning balance in furniture and fixtures, net $150,000


- Depreciation for the year (20,000)
Ending balance in furniture and fixtures, net $130,000

Beginning balance in accounts payable $190,000


+ Purchases on account 550,000
- Cash paid to suppliers (560,000)
Ending balance in accounts payable $180,000

Beginning balance in retained earnings $274,000


+ Sales revenue 800,000
- Cost of goods sold (500,000)
- Operating expenses (160,000)
- Depreciation expense (20,000)
- Interest expense (12,000)
Ending balance in retained earnings $382,000

Accrued interest on note ($200,000 x 6% x 6/12) $6,000


1. Inventory costing
Exercise 3-10method A

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3-18 Intermediate Accounting, 5/e
2. Information on related party transactions B
3. Composition of property, plant, and equipment B
4. Depreciation method A
5. Subsequent event information B
6. Basis of revenue recognition on long-term contracts A
7. Important merger occurring after year-end B
8. Composition of receivables B
1. When related-party transactions occur, companies must
Exercise 3-11 disclose the nature of the relationship, provide a description of
the transaction, and report the dollar amounts of the
transactions and any amounts due from or to related parties.
2. When an event that has a material effect on the company’s financial position
occurs after the fiscal year-end, but before the financial statements actually are
issued, the event is disclosed in a subsequent event disclosure note.
3. The choice of the straight-line method to determine depreciation typically is
disclosed in the company’s summary of significant accounting policies disclosure
note.
4. This information would be included in a disclosure note describing the
company’s debt.
5. The choice of the FIFO method to determine value inventory typically is
disclosed in the company’s summary of significant accounting policies disclosure
note.

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Solutions Manual, Vol.1, Chapter 3 3-19
List AList B
d 1. Balance sheet a. Will be satisfied
Exercise 3-12through the use of current assets.
h 2. Liquidity b. Items expected to be converted to cash or consumed
within one year or the operating cycle.
b 3. Current assets c. The statements are presented fairly in conformity
with GAAP.
j 4. Operating cycle d. An organized array of assets, liabilities and equity.
a 5. Current liabilities e. Important to a user in comparing financial
information across companies.
k 6. Cash equivalent f. Scope limitation or a departure from GAAP.
m 7. Intangible asset g. Recorded when an expense is incurred but not yet
paid.
l 8. Working capital h. Relates to the amount of time before an asset is
converted to cash or a liability is paid.
g 9. Accrued liabilities i. Occurs after the fiscal year-end but before the
statements are issued.
e 10. Summary of significant j. Cash to cash.
accounting policies
i 11. Subsequent events k. One-month U.S. treasury bill.
c 12. Unqualified opinion l. Current assets minus current liabilities.
f 13. Qualified opinion m. Lacks physical existence.
1. Current ratio [$200 + 150 + 200 + 350] ÷ $400 = 2.25
Exercise 3-13 2. Acid-test ratio[$200 + 150 + 200] ÷ $400 = 1.375
3. Debt to equity ratio [$400 + 350] ÷ [$750 + 400] = .65
4. Times interest earned ratio [$160 + 40 + 100] ÷ $40 = 7.5 times

© The McGraw-Hill Companies, Inc., 2009


3-20 Intermediate Accounting, 5/e
Exercise 3-14Requirement 1
a. Current ratio $1,401,233 ÷ $341,169 = 4.11
b. Acid-test ratio [$384,409 + 570,440 + 148,694] ÷ $341,169 = 3.23
c. Debt to equity ratio [$341,169 + 41,246] ÷ $1,411,532 = .27
d. Times interest earned ratio [$85,787 + 97 + 24,038] ÷ $97 = 1,133 times

Requirement 2
Activision’s current and acid-test ratios are both considerably higher than the
industry averages indicating relatively high liquidity. While the debt to equity ratio is
slightly higher than the industry average, it indicates that the company’s assets are
primarily financed with equity rather than liabilities. Also, the company’s extremely
high times interest earned ratio is a result of very little interest-bearing debt in the
company’s capital structure. Activision is more liquid than the average company in its
industry and appears to be in no danger of becoming insolvent.
Exercise 3-151. Acid-test ratio = Quick assets ÷ Current liabilities = 1.20
Quick assets = Current assets - Inventories
Quick assets = Current assets - $840,000
Current assets ÷ Current liabilities = 2.25
Current assets - $840,000 ÷ Current liabilities = 1.20
$840,000 ÷ Current liabilities = 1.05
Current liabilities = $800,000
Current assets ÷ $800,000 = 2.25
Current assets = $1,800,000
2. Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1.8
Total liabilities + Shareholders' equity = Total assets
Total liabilities + Shareholders' equity = $2,800,000
Let x equal shareholders' equity
1.8 x + x = $2,800,000
x = $1,000,000 = Shareholders' equity
3. Noncurrent assets = Total assets - Current assets
Noncurrent assets = $2,800,000 – 1,800,000 = $1,000,000
4. Long-term liabilities = Total assets - Current liabilities - Shareholders'
equity
Long-term liabilities = $2,800,000 - 800,000 - 1,000,000 = $1,000,000

© The McGraw-Hill Companies, Inc., 2009


Solutions Manual, Vol.1, Chapter 3 3-21
Current Acid-test
Exercise 3-16 Debt to
Action Ratio Ratio
Equity Ratio
1. Issuance of long-term bonds I I I
2. Issuance of short-term notes I I I
3. Payment of accounts payable D D D
4. Purchase of inventory on account I D I
5. Purchase of inventory for cash N D N
6. Purchase of equipment with a 4-year note N N I
7. Retirement of bonds D D D
8. Sale of common stock I I D
9. Write-off of obsolete inventory D N I
10. Purchase of short-term investment for cash N N N
11. Decision to refinance on a long-term basis
some currently maturing debt I I N

© The McGraw-Hill Companies, Inc., 2009


3-22 Intermediate Accounting, 5/e
Exercise 3-17Requirement 1
The pharmaceuticals, plastics and farm equipment segments
are reportable. Only segments representing 10% or more of total company revenues,
assets or net income must be reported. The electronics segment does not meet this
criterion.
Requirement 2
For segments determined to be reportable, the following disclosures are required:
a. General information about the operating segment.
b. Information about reported segment profit or loss, including certain revenues and
expenses included in reported segment profit or loss, segments assets, and the basis
of measurement.
c. Reconciliations of the totals of segment revenues, reported profit or loss, assets,
and other significant items to corresponding enterprise amounts.
d. Interim period information.
In addition to revenues, profit or loss, and assets, international
Exercise 3-18standards also require the disclosure of total liabilities for each of
the reportable segments.

© The McGraw-Hill Companies, Inc., 2009


Solutions Manual, Vol.1, Chapter 3 3-23
CPA / CMA REVIEW QUESTIONS
CPA Exam Questions
1. b. The principal would have to be due in 2010 to be considered as a noncurrent
asset at April 30, 2009. The accrued interest for eight months (since August
31, 2008) is a current asset at April 30, 2009. Since the principal is due
August 31, 2010, additional interest would have to be recorded for the period
September 1, 2009 to August 31, 2010.

2. a. Current liabilities are obligations that are expected to be paid within one year
or the operating cycle whichever is longer.

Accounts payable $15,000


Bonds payable 22,000
Dividends payable 8,000
Total current liabilities $45,000

The notes payable are not classified as current liabilities because they are not
due until 2011.

3. a. Inventory pricing is a significant accounting policy which should be


disclosed according to APB Opinion No. 22 but the composition of plant assets
is not a policy disclosure.

© The McGraw-Hill Companies, Inc., 2009


3-24 Intermediate Accounting, 5/e
CPA Exam Questions (concluded)
4. b. Current ratio -- increased; Quick ratio -- decreased.
Current ratio = Current assets ÷ Current liabilities.
When the current ratio is greater than 1 to 1, an equal decrease in current
assets and current liabilities will result in an increase in the current ratio. The
decrease in current liabilities (the smaller number) is proportionately greater
than the decrease in current assets, resulting in an increase in the ratio.
Quick ratio = (Cash + Marketable Securities + Accounts receivable) ÷ Current liabilities
When the quick ratio is less than 1:1, an equal decrease in quick assets
and current liabilities will result in a decrease in the ratio. The decrease
in current liabilities (the larger number) is proportionately smaller than
the decrease in quick assets, resulting in a decrease in the ratio.

5. c. The auditors’ standard report includes a statement that the financial


statements are the responsibility of the Company's management and that the
auditors’ responsibility is to express an opinion on the financial statements.

6. a. Since inventory is not included in the quick ratio, the write-off of obsolete
inventory would have no effect on the quick ratio; however, it would
decrease the current ratio as the write-off would reduce current assets.

© The McGraw-Hill Companies, Inc., 2009


Solutions Manual, Vol.1, Chapter 3 3-25
CMA Exam Questions

1. d. SFAS 57 requires disclosure of related-party transactions except for


compensation agreements, expense allowances, and transactions eliminated
in consolidated working papers. Required disclosures include the
relationship(s) of the related parties; a description and dollar amounts of
transactions for each period presented and the effects of any change in the
method of establishing their terms; and amounts due to or from the related
parties and, if not apparent, the terms and manner of settlement. The effect
on the cash flow statement need not be disclosed.
2. b. The MD&A section is included in SEC filings. It addresses in a
nonquantified manner the prospects of a company. The SEC examines it
with care to determine that management has disclosed material information
affecting the company’s future results. Disclosures about commitments and
events that may affect operations or liquidity are mandatory. Thus, the
MD&A section pertains to liquidity, capital resources, and results of
operations.
3. a. The current ratio equals current assets divided by current liabilities. An
equal increase in both the numerator and denominator of a current ratio less
than 1.0 causes the ratio to increase. Windham Company’s current ratio is .8
($400,000/ $500,000). The purchase of $100,000 of inventory on account
would increase the current assets to $500,000 and the current liabilities to
$600,000, resulting in a new current ratio of .833.

ProblemPROBLEMS
3-1

© The McGraw-Hill Companies, Inc., 2009


3-26 Intermediate Accounting, 5/e
Balance Sheet
Assets Problem 3-2
Current assets: Requirement 1
Cash Inventories:
Short-term investments
Accounts receivable, net of allowance for uncollectible accounts
Current assets -
Interest receivable Cash and cash
Inventories equivalents - Short-
Prepaid expenses term investments -
Total current assets Accounts
receivable - Prepaid
Investments:
Bond sinking fund
expenses =
Long-term investments Inventories
Notes receivable $1,594,927 -
Total investments 239,186 - 353,700 -
504,944 - 83,259 =
Property, plant, and equipment: $413,838
Land
Buildings
Equipment Total assets:
Less: Accumulated depreciation Total liabilities +
Net property, plant, and equipment Shareholders’
equity = Total
Intangibles: assets
Patent
$956,140 +
Copyright
Total intangibles 1,370,627 =
Total assets $2,326,767

Liabilities and Shareholders' Equity Property and


Current liabilities: equipment (net):
Accounts payable
Rent payable Total assets -
Taxes payable Current assets -
Wages payable Long-term
Notes payable receivables =
Total current liabilities
Property and
Long-term liabilities:
Bonds payable
equipment
$2,326,767 -
Shareholders’ equity: 1,594,927 - 110,800
Common stock
= $621,040
Preferred stock
Retained earnings
Total shareholders’ equity Accounts
Total liabilities and shareholders’ equity payable:
© The McGraw-Hill Companies, Inc., 2009
Solutions Manual, Vol.1, Chapter 3 3-27
Total current liabilities - Notes payable and short-term debt - Accrued liabilities -
Other current liabilities = Accounts payable
$693,564 - 31,116 - 421,772 - 181,604 = $59,072

Long-term debt and deferred taxes:


Total liabilities - Current liabilities = Long-term debt and deferred taxes
$956,140 - 693,564 = $262,576

© The McGraw-Hill Companies, Inc., 2009


3-28 Intermediate Accounting, 5/e
Problem 3-2 (concluded)
Requirement 2

© The McGraw-Hill Companies, Inc., 2009


Solutions Manual, Vol.1, Chapter 3 3-29
Problem 3-3 ALMWAY CORPORATION
AMDAHL CORPORATION
Problem 3-4 Balance Sheet
AtBalance
DecemberSheet
31, 2009
Assets
Current assets: Assets
Cash and cash equivalents ..................................................... ($ in thousands)
$ 30,000
Short-term
Current investments ..........................................................
assets: 80,000
Accounts receivable, net of allowance for
Cash and cashaccounts
uncollectible equivalents of $8,000 ............................
....................................... $ 239,186
60,000
Short-term investments .................................
Inventories ............................................................................. 353,700
200,000
Accounts receivable,
Prepaid insurance net of allowance for
................................................................... 9,000
Total current assets ..........................................................
uncollectible accounts ............................. 379,000
504,944
Investments:
Inventories ..................................................... 413,838
Marketable securities ............................................................. $ 30,000
Prepaid expenses ...........................................
Land held for sale .................................................................. 25,000
83,259
BondTotal
sinking current assets ..................................
fund ................................................................. 15,000 1,594,927
Total investments ............................................................ 70,000
Investments:
Property, plant, and equipment: WEISMULLER PUBLISHING COMPANY
Long-term Balance Sheet
receivables ...................................
Land ....................................................................................... 65,000 110,800
At December 31, 2009
Buildings ............................................................................... 420,000
Equipment ..............................................................................
Assets 110,000
Property and equipment (net)........................... 595,000 621,040
Current assets:
Cash Total
Less: and cashassets
Accumulated ............................................
depreciation
equivalents ............................................
(1) ................................................ (160,000) $2,326,767
$ 95,000
Net property,
Short-term investmentsplant, ..........................................................
and equipment ................................. 435,000
110,000
Accounts
Intangibles: receivable, Liabilities
net of allowance and for Shareholders'
uncollectible Equity
accounts
Current
Patents of $16,000
liabilities: ............................................................
.................................................................................... 144,000
10,000
Inventories .............................................................................
Total assets ...................................................................... 285,000
$894,000
Notes
Prepaid payable and short-term debt .................
expenses (2)............................................................... $ 31,116
88,000
Accounts
Total currentpayable Liabilities and Shareholders' Equity
assets...........................................
.......................................................... 59,072
722,000
Current liabilities:
Accrued
Property,
Accounts plant,liabilities
payable ..........................................
and...................................................................
equipment: 421,772
$ 75,000
Other
Machinerycurrent
and liabilities
equipment ..................................
......................................................
Interest payable ...................................................................... $320,000 181,604
20,000
Less: Accumulated
NoteTotal
payable current depreciation ............................................
liabilities ..............................
.......................................................................... (110,000) 693,564
30,000
Net property, plant, and equipment .................................
Current maturities of long-term debt ..................................... 210,000
10,000
OtherTotal
assets:current liabilities .................................................... 135,000
Long-term debt and deferred taxes ..................
Prepaid expenses
262,576
60,000
Long-term liabilities:
Notes Total
payable assets ...................................................................
......................................................................... $ 90,000 $992,000
Shareholders’ equity .........................................
Bonds payable ........................................................................ 1,370,627
Liabilities and Shareholders' Equity 240,000
Total
Total liabilities
long-term and................................................
liabilities shareholders’ equity $2,326,767
330,000
Current liabilities:
Shareholders’ equity:
Accounts payable ................................................................... $ 60,000
Common stock, no par value; 500,000 shares
Interest payable ...................................................................... 20,000
authorized; 100,000 shares issued and outstanding ............ 300,000
Unearned revenues ................................................................. 80,000
Retained earnings ................................................................... 129,000
Taxes payable ........................................................................ 30,000
Total shareholders’ equity ............................................... 429,000
Note payable .......................................................................... 40,000
Total liabilities and shareholders’ equity ..................... $894,000
Current maturities of long-term debt ..................................... 20,000
Total current liabilities .................................................... 250,000
Long-term liabilities:
Notes payable ......................................................................... 140,000
Shareholders’ equity:
© The McGraw-Hill Companies, Inc., 2009
Common stock, no par value; 800,000 shares
3-30 Intermediate Accounting, 5/e
authorized; 400,000 shares issued and outstanding ............ 400,000
Retained earnings ................................................................... 202,000
Total shareholders’ equity ............................................... 602,000
Total liabilities and shareholders’ equity ..................... $992,000
(1) Includes $30,000 in U.S. treasury bills.
(2) Excludes $60,000 in prepaid rent for the second year on the building lease.

Problem 3-5 EXCELL COMPANY


Balance Sheet
At June 30, 2009
Assets
Current assets:
Cash and cash equivalents (1) ................................................ $101,000
Short-term investments .......................................................... 47,000
Accounts receivable, net of allowance for uncollectible
accounts of $15,000 ............................................................ 210,000
Interest receivable .................................................................. 5,000
Prepaid expenses .................................................................... 32,000
Total current assets .......................................................... 395,000
Investments:
Note receivable
(1) Includes ......................................................................
$18,000 in U.S. treasury $65,000
Land bills
held for sale .................................................................. 25,000 90,000
Property, plant, and equipment:
Problem 3-6
Land ....................................................................................... 50,000
Buildings ............................................................................... 320,000
Equipment .............................................................................. 265,000
635,000
Less: Accumulated depreciation ............................................ (280,000)
Net property, plant, and equipment ................................. 355,000
Total assets ................................................................... $840,000
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable ................................................................... $173,000
Accrued expenses ................................................................... 45,000
Note payable .......................................................................... 50,000
Current maturities of long-term debt ..................................... 10,000
Total current liabilities .................................................... 278,000
Long-term liabilities:
Note payable .......................................................................... 50,000
Mortgage payable .................................................................. 240,000
Total long-term liabilities ................................................ 290,000
Shareholders’ equity:
Common stock, no par value; 500,000 shares
authorized; 200,000 shares issued and outstanding ............ 100,000
Retained earnings ................................................................... 172,000
Total shareholders’ equity ............................................... 272,000
Total liabilities and shareholders’ equity ..................... $840,000
Requirement 1

© The McGraw-Hill Companies, Inc., 2009


Solutions Manual, Vol.1, Chapter 3 3-31
VOSBURGH ELECTRONICS CORPORATION
Balance Sheet
At December 31, 2009

Assets
Current assets:
Cash and cash equivalents (1).......................................... $ 117,000
Marketable securities (2).................................................. 132,000
Accounts receivable (net) ............................................... 115,000
Loans to employees ........................................................ 40,000
Interest receivable ........................................................... 12,000
Note receivable – current portion ................................... 50,000
Inventories ...................................................................... 215,000
Prepaid expenses ............................................................. 16,000
Total current assets ................................................... 697,000

Investments:
Marketable securities....................................................... $ 35,000
Note receivable ............................................................... 200,000
Total investments ...................................................... 235,000

Property, plant, and equipment:


Land ................................................................................ 280,000
Buildings ......................................................................... 1,550,000
Machinery and equipment .............................................. 637,000
2,467,000
Less: Accumulated depreciation ..................................... (830,000)
Net property, plant, and equipment .......................... 1,637,00
0

Intangibles:
Patent .............................................................................. 152,000
Franchise ......................................................................... 40,000
Total intangibles .................................................... 192,000
Total assets ............................................................. $2,761,000

© The McGraw-Hill Companies, Inc., 2009


3-32 Intermediate Accounting, 5/e
Problem 3-6 (continued)

Liabilities and Shareholders' Equity


Current liabilities:
Accounts payable ............................................................ $ 189,000
Dividends payable ........................................................... 10,000
Interest payable ............................................................... 16,000
Taxes payable .................................................................. 40,000
Unearned revenue (3)....................................................... 48,000
Total current liabilities .............................................. 303,000

Long-term liabilities:
Notes payable .................................................................. 300,000
Unearned revenue (3)....................................................... 12,000
Total long-term liabilities ....................................... 312,000

Shareholders’ equity:
Common stock, no par value; 1,000,000 shares
authorized; 500,000 shares issued and outstanding ..... $2,000,000
Retained earnings ............................................................ 146,000
Total shareholders’ equity ........................................ 2,146,000
Total liabilities and shareholders’ equity ............... $2,761,000

© The McGraw-Hill Companies, Inc., 2009


Solutions Manual, Vol.1, Chapter 3 3-33
Problem 3-6 (concluded)

(1) $67,000 + $50,000 in treasury bills considered a cash equivalent.


(2) $182,000 - $50,000 in treasury bills considered a cash equivalent.
(3) $60,000 in unearned revenue, 80%, $48,000, current and 20%, $12,000,
long-term.

Requirement 2
Cash equivalents - the policy used to determine what items are considered to be
cash equivalents.
Accounts receivable, net - disclosure on the face of the statement of the
allowance for uncollectible accounts, if material.
Investments - information about the types of investments and the accounting
method used to value the investments.
Inventories - disclosure in Accounting Policies note of the cost method used.
Also, for a manufacturer, note disclosure of the breakout of inventory into raw
materials, work in process and finished goods.
Property, plant and equipment - original cost by major category should be
disclosed along with the accumulated depreciation either on the face of the statement
or in a note. Also, the method used to compute depreciation should be disclosed in
the Accounting Policies disclosure note.
Long-term liabilities - disclosure in a note of the various debt instruments
comprising long-term liabilities to include information such as payment terms, interest
rates, and collateral pledged as security for the debt.

Problem 3-7

© The McGraw-Hill Companies, Inc., 2009


3-34 Intermediate Accounting, 5/e
HUBBARD CORPORATION
Balance Sheet
At December 31, 2009
Assets
Current assets:
Cash ....................................................................................... $ 60,000
Marketable securities ............................................................. 20,000
Accounts receivable (net) ....................................................... 120,000
Inventories ............................................................................. 160,000
Total current assets .......................................................... 360,000
Investments:
Marketable securities.............................................................. $ 40,000
Land held for sale .................................................................. 50,000
Total investments ............................................................ 90,000
Property, plant, and equipment:
Land (1) ................................................................................. 130,000
Buildings ............................................................................... 750,000
Machinery .............................................................................. 280,000
1,160,000
Less: Accumulated depreciation ............................................ (255,000)
Net property, plant, and equipment ................................. 905,000
Intangibles:
Patent ..................................................................................... 100,000
Total assets ................................................................... $1,455,000

Liabilities and Shareholders' Equity


Current liabilities:
Accounts payable ................................................................... $ 215,000
Current maturities of long-term debt ..................................... 25,000
Total current liabilities .................................................... 240,000
Long-term liabilities:
Notes payable ......................................................................... 475,000
Shareholders’ equity:
Common stock, no par value; 100,000 shares
authorized; 100,000 shares issued and outstanding ............ $ 430,000
Retained earnings (2) ............................................................. 310,000
Total shareholders’ equity ............................................... 740,000
Total liabilities and shareholders’ equity ..................... $1,455,000

(1) $250,000 - $50,000 in land held for sale - $70,000 increase in land
(2) $380,000 - $70,000 increase in land

Problem 3-8 Solve for missing amounts:

Liabilities ÷ Equity = 1.2


$18,000 ÷ Equity = 1.2
© The McGraw-Hill Companies, Inc., 2009
Solutions Manual, Vol.1, Chapter 3 3-35
Equity = $18,000 ÷ 1.2 = $15,000

Beginning retained earnings + net income – dividends = Ending retained earnings


$4,000 + 1,560 – 560 = $5,000

Total equity – retained earnings = Common stock


$15,000 – 5,000 = $10,000

Assets = Liabilities + equity


Assets = $18,000 + 15,000 = $33,000

$33,000 – all other assets = Patent


$33,000 – 27,600 = $5,400

© The McGraw-Hill Companies, Inc., 2009


3-36 Intermediate Accounting, 5/e
Problem 3-8 (concluded)
Sanderson Manufacturing Company
Balance Sheet
At December 31, 2009
($ in 000s, except share data)

Assets
Current assets:
Cash ................................................................................. $ 1,250
Short-term investments ................................................... 3,000
Accounts receivable, net of $400 allowance for
uncollectible accounts .................................................. 3,100
Inventories:
Raw materials and work in process ............................. $ 2,250
Finished goods ............................................................. 6,000 8,250
Prepaid expenses ............................................................. 1,200
Total current assets ................................................... 16,800
Property, plant, and equipment:
Equipment ....................................................................... 15,000
Less: Accumulated depreciation ..................................... (4,200)
Net property, plant, and equipment .......................... 10,800
Intangibles:
Patent ........................................................................... 5,400
Total assets ............................................................. $33,000
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable ............................................................ $ 5,200
Interest payable................................................................ 300
Unearned revenue ........................................................... 1,500
Current maturities of long-term debt .............................. 1,000
Total current liabilities .............................................. 8,000
Long-term liabilities:
Unearned revenue ........................................................... 1,500
Note payable ................................................................... 3,000
Bonds payable ................................................................. 5,500 10,000
Shareholders’ equity:
Common stock, no par, 400,000 shares authorized,........
250,000 shares issued and outstanding 10,000
Retained earnings ............................................................ 5,000
Total shareholders’ equity ........................................ 15,000
Total liabilities and shareholders’ equity $33,000

Problem 3-9
© The McGraw-Hill Companies, Inc., 2009
Solutions Manual, Vol.1, Chapter 3 3-37
HHD, Inc.
Balance Sheet
At December 31, 2009
Assets
Current assets:
Cash $ 150,000
Problem 3-10
...............................................................................................
Investment in stocks 90,000
MELODY LANE MUSIC COMPANY
...............................................................................................
Accounts receivable Balance Sheet 200,000
At December 31, 2009
...............................................................................................
Inventories 225,000
...............................................................................................
Prepaid insurance Assets 25,000
Current assets:
...............................................................................................
Cash
Total (1) ...............................................................
current assets $167,000
690,000
.........................................................................................
Inventories .......................................................... 100,000
Prepaid rent ........................................................
Investments: 3,000
InvestmentTotal current assets .......................................
in stocks $ 160,000 270,000
...............................................................................................
Bond sinking fund 250,000
Property, plant, and equipment:
...............................................................................................
Equipment
Total investmentsand furniture ..................................... $ 40,000 410,000
Less: Accumulated depreciation ........................
......................................................................................... (4,000)
Net property, plant, and equipment ............... 36,000
Property, plant, and equipment:
Land Total assets ................................................. 800,000 $306,000
...............................................................................................
Buildings Liabilities and Shareholders'1,500,000 Equity
...............................................................................................
Current liabilities:
Equipment 500,000
Accounts payable (2) ..........................................
............................................................................................... $ 21,000
Interest payable .................................................. 2,800,000 9,000
Loan payable
Less: Accumulated ......................................................(800,000)
depreciation 100,000
...............................................................................................
Total current liabilities .................................. 130,000
Net property, plant, and equipment 2,000,000
.........................................................................................
Shareholders’ equity:
Intangibles:Common stock, no par, 100,000 shares
Patent authorized, 20,000 shares issued and outstanding ...... 110,000 $100,000
...............................................................................................
Copyright Retained earnings (3) .......................................... 90,000 76,000
Total shareholders’ equity .............................
............................................................................................... 176,000
Total intangibles
Total liabilities and shareholders’ equity . . . 200,000
$306,000
.........................................................................................
Total assets $3,300,000
......................................................................................

Liabilities and Shareholders' Equity


Current liabilities:
Accounts payable ................................................................. $ 100,000
Notes payable ....................................................................... 150,000
Taxes payable ....................................................................... 60,000
Total current liabilities ................................................... 310,000
Long-term liabilities:
Notes payable ....................................................................... $ 90,000
Bonds payable ...................................................................... 1,100,000
TotalCompanies,
© The McGraw-Hill long-termInc.,
liabilities
2009 .............................................. 1,190,000
3-38 Shareholders’ equity: Intermediate Accounting, 5/e
Common stock, no par, 500,000 shares authorized,
200,000 shares issued and outstanding .............................. 1,000,000
Retained earnings ................................................................. 800,000
(1) Cash receipts of $560,000 less cash disbursements of $393,000
(2) $20,000 owed to suppliers + $1,000 owed to utility company
(3) Net income for the year
CASES
Communication Case 3-1
IBM manufactures and sells personal and main frame computers. The computers
included as current assets in the balance sheet for the company represent the cost of
inventory available for sale. In addition, IBM uses computers in its operations. The
cost of these computers is included in the property, plant, and equipment category in
the balance sheet.
Marketable securities could be classified as either current or noncurrent assets
depending on the intent of management. If management intends to sell the securities
in the next year or operating cycle, they are classified as current assets. If
management intends to hold the securities beyond the coming year or operating cycle,
they are classified as noncurrent assets.
Analysis Case 3-2Requirement 1
Current assets include cash and other assets that are
reasonably expected to be converted to cash or consumed during one year, or within
the normal operating cycle of the business if the operating cycle is longer than one
year. Current liabilities include all liabilities that are scheduled to be liquidated within
one year or the operating cycle, whichever is longer, except those that management
intends to refinance on a long-term basis.
Therefore, key factors determining classification are the nature of the asset or
liability, management’s intent, and the length of the operating cycle.
Requirement 2
Assets:
Cash Normally classified as current, however, if restriction
prohibits use of the cash, could be classified as noncurrent.
Receivables Depends on the expected date of collection.
Marketable Depends on when management intends to sell the securities.
securities
Prepaid expenses Depends on the period of time prepaid.
Liabilities:
Notes payable Depends on scheduled payment date and management’s
intent to pay or refinance.
Unearned revenue Depends on the period the revenue will be earned.

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Solutions Manual, Vol.1, Chapter 3 3-39
Communication Case 3-3 The critical question that student groups should
address is whether the cost of the egg-producing
flock should be classified as inventory or as property, plant, and equipment. There is
no right or wrong answer. The process of developing the proposed solutions will
likely be more beneficial than the solutions themselves. Students should benefit from
participating in the process, interacting first with other group members, then with the
class as a whole.
Solutions should address the following issues:
1. The definitions of inventory and property, plant, and equipment.
The definition of inventory according to ARB No. 43 is “goods awaiting sale,
goods in the course of production, and goods to be consumed directly in production.”
The chickens certainly represent goods awaiting sale, since they will eventually be
sold to soup companies. However, they also represent property, plant, and equipment,
since they are used in the production of product — the eggs.
2. The definition of a current asset.
ARB No. 43 also provides the following definition of a current asset:
“..., the term current assets is used to designate cash and
other assets or resources commonly identified as those
which are reasonably expected to be realized in cash or sold
or consumed during the normal operating cycle of the
business.”

ARB No. 43 also states that a one-year time period is to be used where there are
several operating cycles occurring within a year. In this case, it could be argued that
the operating cycle is two years, since the chickens are not sold until after the laying
life and, therefore, the cost of the flock should be classified as a current asset.
However, if the chickens are considered productive assets, then the concept of an
operating cycle is not relevant. According to this argument, the chickens should be
classified as a noncurrent asset, i.e., a producing asset, and not a saleable asset. It
appears that the primary benefits of the chickens come from the sale of eggs, not the
sale of the chickens themselves.

3. Regardless of the classification of the cost of the chickens, the cost capitalized
when the chickens begin to lay must be depreciated down to an estimated salvage
value at the end of the laying life. This is necessary to properly match expenses with
revenues.

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3-40 Intermediate Accounting, 5/e
Case 3-3 (concluded)

(Industry practice is to classify the costs of the egg-producing flock as inventory


in the current asset section of the balance sheet, but to depreciate the inventory down
to estimated salvage value.)

It is important that each student actively participate in the process. Domination


by one or two individuals should be discouraged. Students should be encouraged to
contribute to the group discussion by (a) offering information on relevant issues, and
(b) clarifying or modifying ideas already expressed, or (c) suggesting alternative
direction.
DEFICIENCIES:
Judgment Case 3-4 1. Accounts receivable - if material, the allowance for
uncollectible accounts should be disclosed.
2. Note receivable - only the interest receivable of $3,000 should be classified as
a current asset. The $50,000 note receivable should be classified in the
noncurrent Investments category.
3. Inventories - the method used to cost inventory should be disclosed in a note.
4. Investments - should be classified in the noncurrent Investments category.
5. Prepaid expenses - in the absence of information to the contrary, should be
classified as a current asset.
6. Land - should be classified in the noncurrent Investments category.
7. Equipment, net - should be classified in the Property, plant and equipment
category. Original cost should be disclosed along with the accumulated
depreciation to arrive at the net amount. Also, the method used to compute
depreciation should be disclosed in a note.
8. Patent - should be classified in the Intangibles category of noncurrent assets.
9. Note payable - $20,000, the next installment, should be classified as a current
liability as current maturities of long-term debt. Also, note disclosure is
required for the note and bonds payable that provides information such as
payment terms, interest rates, and collateral pledged as security for the debt.
10. Interest payable - should be classified as a current liability.
11. Common stock - the par value, if any, and the number of shares authorized,
issued and outstanding should be disclosed.

Accounts receivable, net - disclosure on the face of the


Judgment Case 3-5statement of the allowance for uncollectible accounts, if
material.

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Solutions Manual, Vol.1, Chapter 3 3-41
Inventories - disclosure in Accounting Policies note of the cost method used.
Also, for a manufacturer, note disclosure of the breakout of inventory into raw
materials, work in process and finished goods.
Investments - information about the types of investments and the accounting
method used to value the investments.
Property, plant and equipment - original cost by major category should be
disclosed along with the accumulated depreciation either on the face of the statement
or in a note. Also, the method used to compute depreciation should be disclosed in
the Accounting Policies disclosure note.
Long-term liabilities - disclosure in a note of the various debt instruments
comprising long-term liabilities to include information such as payment terms, interest
rates, and collateral pledged as security for the debt.
Common stock - disclosure on the face of the statement of par value, if any, and
the number of shares authorized, issued and outstanding.

Real World Case 3-6Requirement 1


The asset classifications are 1) Current assets, 2)
Plant, rental machines and other property, 3) Long-term financing receivables, 4)
Prepaid pension assets, (5) Goodwill, (6) Intangible assets – net, and (7) Investments
and sundry assets
Requirement 2
a. Total assets = $103,234 million
b. Current assets = $44,660 million
c. Current liabilities = $40,091 million
d. Total shareholders' equity = $28,506 million
e. Retained earnings = $52,432 million
f. Inventories = $2,810 million
Requirement 3
The par value is $.20 per share. 4,687,500,000 shares are authorized and
2,008,470,383 shares are issued.
Requirement 4
Current ratio = Current assets divided by Current liabilities.
Current ratio = $44,660 ÷ $40,091 = 1.11
Requirement 5

a. The lower of average cost or net realizable value.


b. The straight-line method.

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3-42 Intermediate Accounting, 5/e
c.
All highly liquid investments with a maturity of three months or less
at date of purchase are carried at fair value and considered to be cash
equivalents.
1. This is a significant event occurring after the end of the
Judgment Case 3-7 fiscal year but prior to the issuance of the financial
statements. Details of the merger should be disclosed
in a note to the financial statements.
2. This is a significant event occurring after the end of the fiscal year but prior to the
issuance of the financial statements. Details of the issuance of the new debt
should be described in a note to the financial statements.
3. This is a significant event occurring after the end of the fiscal year but prior to the
issuance of the financial statements. The event should be described in a note to
the financial statements along with the amount of uninsured damage.

Research Case 3-8Requirement 1


Statement of Financial Accounting Standards No. 57,
“Related Party Disclosures,” requires the disclosure of related party transactions. This
statement was issued in March of 1982 and became effective for fiscal years ending
after June 15,1982.
Requirement 2
When related-party transactions occur, companies must disclose the nature of the
relationship(s) involved, provide a description of the transactions, and report the dollar
amounts of the transactions and any amounts due from or to related parties.
Requirement 3
The related party transactions disclosure note describes transactions with limited
partnerships whose general partner’s managing member is a senior officer of Enron.
The transactions include various hedging and derivative transactions with the related
party, as well as the sale of inventory and other assets to the related party.
Requirement 4
The potential problem with related party transactions is that their economic
substance may differ from their legal form. One of Enron’s disclosed transactions
involved the sale of dark fiber inventory to the related party in exchange for $30
million in cash and a $70 million note receivable. Enron recognized gross margin on
the sale of $67 million. Is the $100 million sales price a proper representation of the
sales price of the inventory in a normal transaction to an unrelated party? Is the
interest rate charged by Enron on the note a fair interest rate? If the answer to these
questions is no, then income (wealth) has been transferred from one party to the other,
to the detriment of the shareholders of one of the entities and the benefit of the other.

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Solutions Manual, Vol.1, Chapter 3 3-43
Real World Case 3-9Requirement 3
a. The disclosure note describes two subsequent
events, (1) the acquisition of Demonware, a company headquartered in Dublin,
Ireland, and (2) the commencement of an offer to amend the exercise prices of
certain employee stock options.
b. The company's auditor was PricewaterhouseCoopers LLP. The firm rendered an
unqualified opinion on the company's financial statements. There is an
explanatory paragraph concerning the change in the manner the company
accounts for share-based compensation.
Requirement 4
a. Robert A. Kotick is listed as Chairman, Chief Executive Officer, and Director.
b. The annual salary for Mr. Kotick in 2007 was $797,200.
Comparative income for the first year of operations
Judgment Case 3-10resulting from the two alternative financing choices is
illustrated below.

DEBT Versus EQUITY


Comparative Income for Two Financing Alternatives

Alternative 1 Alternative 2
Income before interest and taxes $5,000,000 $5,000,000
Less: Interest -0- (1,600,000)*
Income before taxes 5,000,000 3,400,000
Less: Income taxes (2,500,000)** (1,700,000)**
Net Income $2,500,000 $1,700,000

* 8% x $20,000,000.
** 50% x Income before taxes.

Return on investment $2,500,000 $1,700,000


= 5% =5.67%
(Net income ÷ investment) $50,000,000 $30,000,000

We can see that Alternative 1 generated a higher net income. However, the
return on shareholders’ investment is actually higher for Alternative 2.
Alternative 2 generated a higher return for each dollar invested by shareholders.
This was made possible because the corporation was able to generate income on
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3-44 Intermediate Accounting, 5/e
borrowed funds at a higher rate than the cost of the debt. This represents financial
leverage. However, alternative 2 also results in a riskier capital structure. The debt in
Alternative 2 requires fixed payments of interest and principal to be made. The
company's income before interest and income taxes could drop to zero under
Alternative 1 and the company would still be solvent (i.e., able to pay its debts).
Under Alternative 2, however, if income before interest and taxes drops below the
required interest payments of $1,600,000, the company could become insolvent and
eventually go bankrupt.

The objective of this case is to motivate students to


Analysis Case 3-11obtain hands-on familiarity with an actual annual report.
You may wish to provide students with multiple copies of
the same annual report and compare responses. Another approach is to divide the
class into teams who evaluate reports from a group perspective.
The objectives of this case are to motivate students to
Analysis Case 3-12obtain hands-on familiarity with an actual annual report and
to apply the techniques learned in the chapter. You may
wish to provide students with multiple copies of the same annual reports and compare
responses. Another approach is to divide the class into teams who evaluate reports
from a group perspective.

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Solutions Manual, Vol.1, Chapter 3 3-45
Analysis Case 3-13Requirement 1
The balance sheet includes seven asset classifications:
Current assets; Prepaid revenue shares, expenses and other assets – non-current;
Deferred income taxes, net, non-current; Non-marketable equity securities; Property
and equipment, net; Intangible assets, net; and Goodwill, and five liability
classifications: Current liabilities; Deferred revenue, long-term; Deferred income
taxes, net; Income taxes payable, long-term; and Other long-term liabilities.
Requirement 2
These assets are shown as current because the company intends to convert them
to cash in the next year or operating cycle.
Requirement 3
Deferred revenue, sometimes called unearned revenue, represents cash received
from customers in advance of providing goods or services.
Requirement 4
Disclosure notes explain or elaborate upon the data presented in the financial
statements themselves. They must include certain specific notes such as a summary
of significant accounting policies, descriptions of subsequent events, and related third-
party transactions, but many notes are company specific. Actually, any explanation
that contributes to investors’ and creditors’ understanding of the results of operations,
financial position, or cash flows of the company should be included.
Requirement 5
Straight-line.
Requirement 6
There are no subsequent events noted. The only related party transaction
indicated in the notes is a 2005 contribution to the Google Foundation.

Analysis Case 3-14Requirement 1


Segment disclosures assist in analyzing and
understanding financial statements by permitting better assessment of past
performance and future prospects. Disaggregated information provides more precise
details of the uncertainties surrounding the timing and the amount of expected cash
flows, because the various segments may have different rates of profitability, degrees
and types of risk, opportunities for growth, and future capital demands.
Requirement 2
An operating segment is a component of an enterprise:

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3-46 Intermediate Accounting, 5/e
1. That engages in business activities from which it may earn revenues and incur
expenses (including revenues and expenses relating to transactions with other
components of the same enterprise).
2. Whose operating results are regularly reviewed by the enterprise's chief
operating decision-maker to make decisions about resources to be allocated to
the segment and assess its performance.
3. For which discrete financial information is available.
Requirement 3
For areas determined to be reportable operating segments, the following
disclosures are required:
1. General information about the operating segment.
2. Information about segment profit or loss, including certain revenues and
expenses included in reported segment profit or loss, segment assets, and the
basis of measurement.
3. Reconciliations of the totals of segment revenues, reported profit or loss,
assets, and other significant items to corresponding enterprise amounts.
4. Interim period information.

Discussion should include these elements.


Ethics Case 3-15Facts:
The impact of following the controller's suggestions would be to obscure
financial information by aggregating the financial data of segment operations and
investments. Aggregation of data makes projections of future performance for African
or European segments difficult and does not reveal relative investments for each
segment. SFAS 131 "Disclosures about Segments of an Enterprise and Related
Information," suggests that reportable segments are those for whom financial data is
available and whose results are regularly reviewed by company management in
assessing performance. The data for South Africa, Egypt, France and Denmark are
available and most likely reviewed for performance purposes by the controller and
higher management levels.

Ethical Dilemma:
Should you as staff accountant challenge the controller's combination of segments
or follow the controller's suggestion to obscure financial information by aggregating
the financial data of segment operations and investments?

Who is affected?
You as a staff accountant

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Solutions Manual, Vol.1, Chapter 3 3-47
Controller and other managers
Other employees
Shareholders
Potential shareholders
Creditors
Financial analysts
Auditors
Who benefits and who is injured:
Company management may benefit from aggregating the African and European
data by attracting more investors to their company and obtaining more loans from
creditors than would be the case with more complete disclosure regarding the South
African segment. Injured parties include current and future investors and creditors
with economic, social and political concerns regarding Africa and Europe. If
investors and creditors later learn about undisclosed segment operations that prove
unprofitable or violate their value systems, they may take action against McCarver-
Lynn.

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