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CHAPTER 2

Financial statements and accounting


concepts/principles
CHAPTER OUTLINE
I. Financial statements
A. From transactions to financial statements
B. Financial statements illustrated
C. Explanations and definitions
1. Balance sheet
2. Income statement
3. Statement of changes in owners' equity
4. Cash flow statement
D. Comparative statements in subsequent years
E. Illustration of financial statement relationships
II. Accounting concepts and principles
A. Schematic model of concepts and principles
B. Concepts or principles related to the entire model
C. Concepts or principles related to transactions
D. Concepts or principles related to the accounting process
E. Concepts or principles related to financial statements
F. Limitations of financial statements
III. The companys annual report
IV. The ROA and ROE ratios

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TEACHING AND LEARNING OBJECTIVES


Principal
Tohavethestudent:

illustratethefourprincipalfinancialstatementsandtheirbasicformanddemonstrate
theirrelationships

understandandusetheterminologyoffinancialstatements

understandandusetheaccountingequation

explaintheconceptsoffinancialaccountingandfinancialstatementpresentation.
Supporting
Tohavethestudent:

showthatfinancialstatementsaretheproductoffinancialaccountingandthatthe
statementsrepresentahistoricalsummaryofpasttransactions

explainsomeofthelimitationsoffinancialstatements

illustratethefinancialstatementsthatareincludedinthecompanyannualreport

explainseveralbusinessproceduresandtheirterminology.
TEACHING OBSERVATIONS AND ASSIGNMENT SUGGESTIONS
1.

2.

This is the keystone chapter of the text, and the material presented here becomes a
foundation for all subsequent financial accounting topics. The instructor must resist
tryingtoteachtheentirecoursefromthisonechapter!Instead,trytohelpstudentssort
outthekeyideasthatmustbelearnednowfromthosethattheyshouldbeacquaintedwith,
butthatwillreallybelearnedwhensubsequentmaterialiscovered.Thisisverymuchan
introductiontotheclassificationsystemaccountinguses.Itemstobelearnednowinclude:
a.
definitionofatransaction
b.
thenameofeachfinancialstatementandwhatitshows
c.
theaccountingequation
d.
financialstatementrelationships
e.
limitationsoffinancialstatements.
Asignificantamountoftimeshouldbespentillustratingandexplainingthepurposeand
contentbyclassificationcategory(asset,liability,ownersequity,revenue,expense)of
eachfinancialstatementandhowthefinancialstatementslinktogether.Someinstructors
maywishtodiscussgainsandlossesatthispoint,butrestraintisrecommended.Thekeyis
tokeepitassimpleaspossible.

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Itisrecommendedthatthefollowingmodelsbeemphasised:
a.
BalanceSheet:
Beginning of
Period
Changes During
Period
End of Period

b.

Assets
$

+/

Liabilities
$
+/

Owners' Equity
$
+/
$

IncomeStatement:
Income
Expenses
= Net profit

c.
+
+

4.

5.

6.

7.
8.

9.
10.

StatementofChangesinOwnersEquity:

Beginning Balance of Owners' Equity


Owners' Investment
Net profit
Dividends
Ending Balance of Owners' Equity

(Aswiththediscussionofgainsandlosses,someinstructorsmaywishtoacknowledge
other sources of changes in owners equity. It usually based on the extent to which
studentshavebeenpreviouslyexposedtorealworldfinancialstatements.Anearlydoseof
realitycanberefreshingforgraduatestudents,butmaybedistractingoroverwhelmingto
anundergraduatelessexperiencedaudience.)
Itishelpfultospendtimewiththeconceptsandprinciplesmodel,explainingwhateach
conceptorprinciplemeansandshowinghowitrelatestotheTransactionstoFinancial
Statementsprocess.
Itisappropriatetoemphasisethelimitationsoffinancialstatementsnowbecausestudents
cancreateamindsetthathelpsunderstandspecificaccountingprincipleswhentheyare
coveredlater. Reallife limitations oftherole ofestimates inaccounting canneverbe
emphasisedenough.
The Business In Practice sections are designed to enhance student understanding by
removingsomejargonandexplanationfromtheflowofthetextmaterialwhileprovidinga
contextforthatmaterial.Theseprovidegoodclassdiscussiontopics.Theinstructorspress
gallery is also a useful source of current topical news items in manageable bitesize
proportionsthatcanusefullybeincorporatedintolessons.
Whenintroducingthematerialinthischapter,keepinmindthebigpicture.
TheInsidersView isintendedtohelpstudentsappreciatetherelevanceofthestudyof
accountingandcanbeusedtoaddrelevancetothenumbers.Theseareespeciallyhelpful
tononaccountingmajors.Accountingmajorscanseetheextentoftheirserviceindustry.
So What Do You Think? is intended to personally engage the student and encourage
reflectionandassociationwiththeessentialtopicsofthechapter.
Thetakehomequizprovidedforeachchapterisausefulfeedbackresourcethatcanalso
beusedasaminiclassquiz.Manyofthequizzesareinskeletonformatsotheycanbe

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appliedtoavarietyofcompanies.Thistemplateapproachenablesyoutoclaimthatyour
courseiscurrentwithminimaladditionaleffort.Italsoenables multiplequizzes tobe
generatedformulticampusoperations.
11. Atthisstage,studentsshouldhavepurchasedtheirbooksandtimecanusefullybespent
lookingatthevariousfeaturesofthetextbookandtalkingabouthowtheycanaddvalueas
part of the study program. This is your opportunity to provide guidance as to the
examinationrelevanceofthevariousfeatures.

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ASSIGNMENT OVERVIEW
Thischapterprovidesawidevarietyofassignmentsrangingfromthebasicassociationtype
exercises tothemorechallenging analyticaltypeproblems. Becareful nottooverassignor
underassignhomeworkfromthischapter.Someadvancedtopicsareincluded(e.g.gains or
lossesonthesaleofnoncurrentassets)toexpandconceptsandintroduceterminology.Thereis
noneedtogetintotechnicalmeasurementissuesatthisstage.

No.

Level

E2.1
E2.2
E2.3
E2.4

Learning
objectives
2, 4
2, 4
2, 8
6

E2.5
E2.6

7
4, 5

Easy
Easy

E2.7

2, 3

Easy

Evaluate info
Computer
literacy
Identify info

E2.8
E2.9

2, 3
2, 3

Easy
Easy

Identify info
Organise info

E2.10
E2.11

2, 3
2, 3

Easy
Easy

Organise info
Organise,
manage info

E2.12

2, 3

Med

E2.13

2, 3

Hard

Organise,
manage info
Reason,
conceptualise

E2.14

2, 3

Med

P2.15

2, 3, 6

Easy

P2.16

2, 3, 6

Easy

P2.17

2, 3, 4

Med

P2.18

2, 3, 4

Med

P2.19

2, 3, 4

Med

Evaluate
Organise info
Organise,
manage info
Organise,
manage info
Analyse, reason

P2.20
P2.21

2, 3, 4
2, 3

Med
Easy

Analyse, reason
Interpret data

P2.22

2, 3

Easy

Analyse data

Easy
Easy
Easy
Easy

General
attributes
Identify info
Identify info
Terminology
Differentiate

Reason,
conceptualise
Evaluate,
Organise info

Other
Comments
Simple accounts identification exercise
See E2.1
Familiar terms in an annual report
Difference between cash and net profitfirst pass at a difficult
concept
Limitations of annual reports
Demonstrate the variety of sources of publicly available
accounting info
Simple exercise but may need concrete examples to help
explanation
See E2.7
Reinforces the balance sheet equation and stresses the
distinction between SC and RE
See E2.9
'Retained earnings are affected only by net profit (loss) and
dividends.' This is a bit of fiction but it works effectively in
Chapter 2. Other effects on retained earnings (i.e. dividends
and prior period adjustments) are not discussed until Chapter
8
See E2.11 Good homework assignment
The worksheet format is used to help students understand
financial statement relationships.
Explain that 'net assets' = A L = OE
See E2.7 Good in-class demonstration exercise
Can be used to illustrate the sale of assets as gains/losses
and to emphasise the difference between cash and owners
equity
See P2.15
Straightforward problem emphasising financial statement
relationships. Works well as an illustration of problem solving
See P2.17
Similar to P2.14 and P2.15 but requires the preparation of
financial statements. Good for in-class demonstration
See P2.19 Good homework assignment
Good intro to transaction analysis and can be used as
preparation for Chapter 4
Group learning problem. Good in-class demonstration
problem.

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P2.23
P2.24
P2.25

2, 3, 4
2, 3, 5, 6
2, 4

Med
Med
Hard

P2.26

2, 4

Hard

P2.27

2, 4, 6, 7

Hard

Interpret data
Interpret data
Interpret data
and reports
Interpret data
and reports

Stress the importance of the historical cost principle


See P2.23
Group learning problem. Emphasises the structure of the
income statement
Explain why 'other income' is excluded from gross profit
Excellent conceptual case with personal relevance but make
sure to relate student responses back to the terminology
introduced in the chapter

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SOLUTIONS
E2.1
Category

Financial Statement

Cash............................................................................
Accounts payable........................................................

A
L

BS
BS

Ordinary shares...........................................................
Depreciation expense..................................................
Net sales.....................................................................
Income tax expense....................................................
Short-term investments...............................................
Gain on sale of land....................................................
Retained earnings.......................................................
Dividends payable.......................................................
Accounts receivable....................................................
Short-term borrowings................................................

OE
E
I
E
A
G
OE
L
A
L

BS and SCOE
IS
IS
IS
BS
IS
BS and SCOE
BS
BS
BS

Category

Financial Statement

-A
L
A
LS
OE
A
L
OE
E
OE
I
E

BS
BS
BS
IS
IS and SCOE
BS
BS
SCOE
IS
SCOE
IS
IS

E2.2
Accumulated depreciation...........................................
Long-term borrowings.................................................
Equipment...................................................................
Loss on sale of short-term investments......................
Profit for the period.....................................................
Inventory......................................................................
Other accrued liabilities..............................................
Dividends paid.............................................................
Cost of goods sold......................................................
Additional share capital...............................................
Interest income............................................................
Selling expenses.........................................................

Trickquestion!DividendspaidappearsonlyontheStatementofChangesinOwners
Equity.Dividendspaidaredistributionsofearningsthatreduceretainedearningsonthe
balancesheet.Dividendspaidarenotexpensesanddonotappearontheincomestatement.
Accumulateddepreciationisanegativeasset.Itisasetoffamountknowntechnicallyasa
'contra'accountandshownasadeductionoftherelatednoncurrentasset.
E2.3TheCEOistheChiefExecutiveDirector,alsoknownastheManagingDirector.Thisisa
salaried position. The CFO is the Chief Financial Officer and is usually the main
accountant. Sometimes this person also acts as the public secretary who takes
responsibility forcomplianceissuesrelatingtothelistingonthestockexchange.

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E2.4 Profit is a function of income earned exceeding expenses incurred. Many of these
transactionsareoncreditwithpartiesbuyingnowandpayinglater.
Thecashbalanceisafunctionofmoneycominginandmoneygoingout.Manycash
transactionsdonotinvolveanincomeoranexpense,e.g.aloanreceivedorrepaid.
Whileitmaybethataprofitablebusinessalsohasmoneyinthebank,thisisafunctionof
efficientmanagement.
Apossiblereasonforacompanynothavingenoughcashtopaythebillscouldoccurinthe
early set up phase of a business where the company needs to fill their shelves with
inventoryandmaynothaveestablishedcrediblelinesofcreditwiththeirsuppliers.They
maybeenticingnewcustomerswithofferingextendedperiodsofcredit.Therewouldbe
cashoutlaysrequiredtoprovideinfrastructure(noncurrentassets)priortoopeningthe
business.Thesewouldbeexpensedovertheirusefullives,likelytoexceedayear.
E2.5 Financial statements report quantitative economic data; they do not reflect qualitative
economic variables, e.g. value of management team or morale of workforce. Such
qualitative attributes of the firm are frequently relevant to the decisions and informed
judgmentsthatthefinancialstatementuserismaking,buttheyarenotcommunicatedin
thefinancialstatementsbecausetheycannotbemeasuredobjectively.
Inaddition,themoneymeasurementappliedtotransactionsistheoriginalcost.Noholding
gainsarerecognised forchanges inthepurchasepowerofthedollar orforeconomic
appreciationuntiltheassetissold.
E2.6 Answers will differ between students. Intention of this question is to demonstrate the
wealthofaccountinginformationavailable.Linkthisintofinancialliteracy.
E2.7Manyofthesetransactionsneedqualificationsoastorybehindthewordsmayhelp.Show
howthedetailmakesallthedifferencetothequalification.
Asset
Equipment

Liability

Rentpayable*
Stamps

Loanpayable
Electricity
payable*

Equity
Sharecapital

Income

Dividends
received

Expense
Costofgoods
sold
Rent*
Electricity
expense*

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E2.8Manyofthesetransactionsneedqualificationsoastorybehindthewordsmayhelp.Show
howthedetailmakesallthedifferencetothequalification.
Asset
Equipment

Liability

Equity
Sharecapital

Inventory
Fixeddeposit

Income

Expense
Electricity
expense

Interestearned
Dividendspaid

E2.9 Usetheaccountingequationtodeterminethemissinginformation.
FirmA:
A
A
$420 000

=
L
= $215 000

+
+
+

OE
SC
$75 000

+
+

(Beg. RE
($78 000

+
+

NP
?

DIV
$50 000

=
=

End RE)
)

Inthiscase,theendingbalanceofretainedearningsmustbedeterminedfirst:
$420000=$215000+$75000+EndRE
Retainedearnings31/12/08=$130000
Oncetheendingbalanceofretainedearningsisknownnetprofitcanbedetermined:
$78000+NP$50000=$130000
Netprofitfor2008=$102000
FirmB:
A

A
$540 000

=
L
= $145 000

OE

+
+

SC
?

+
+

(Beg. RE
(
?

+
+

NP
$83 000

DIV
$19 000

=
=

End RE)
$310 000)

(Beg. RE
($42 000

+
NP
+ $113 000

DIV
$65 000

=
=

End RE)
?
)

$540000=$145000+CC+$310000
Contributedcapital31/12/08=$85000
Beg.RE+$83000$19000=$310000
Retainedearnings1/1/08=$246000
FirmC:
A
A
$325 000

=
=
=

L
L
?

+
OE
+
SC
+ $40 000

+
+

Inthiscase,theendingbalanceofretainedearningsmustbedeterminedfirst:
$42000+$113000$65000=EndRE
Retainedearnings31/12/08=$90000
Oncetheendingbalanceofretainedearningsisknownliabilitiescanbedetermined:
$325000=L+$40000+$90000
Totalliabilities31/12/08=$195000
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AnalternativeapproachcouldbetoconsidertheStatementofChangesinEquityand
use a Balance sheet schedule to solve for the missing numbers rather than an
equation:
FirmA
FirmB
FirmC
ShareCapital
75000
85000(ii)
40000
RetainedEarnings
BeginningBal

78000

246000(iii)

42000

PlusProfit

102000(iii)

83000

113000

LessDividends

(50000)

(19000)

(65000)

RetainedEarningsat
endofyear

130000(ii)

310000

90000(i)

Liabilities
TotalL+OE

215000
420000(i)

145000
540000(i)

195000(iii)
325000(ii)

TotalAssets

420000

540000

325000

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E2.10Usetheaccountingequationtosolveforthemissinginformation.
FirmA:
A
A
?

=
=
=

L
L
$80 000

+
OE
+
SC
+ $55 000

+
+

(Beg. RE
($50 000

+
+

NP
$68 000

DIV
$12 000

=
=

End RE )
?
)

Inthiscase,theendingbalanceofretainedearningsmustbedeterminedfirst:
$50000+$68000$12000=EndRE.
Retainedearnings31/12/08=$106000
Oncetheendingbalanceofretainedearningsisknown,totalassetscanbedetermined:
A=$80000+$55000+$106000
Totalassets31/12/08=$241000
FirmB:
A
A
$435 000

=
=
=

L
L
?

+
OE
+
SC
+ $59 000

+
+

(Beg. RE
($124 000

+
+

NP
$110 000

DIV
?

=
=

End RE)
$186 000)

+
+

NP
$81 000

DIV
$28 000

=
=

End RE)
?
)

$435000=L+$59000+$186000
Totalliabilities31/12/08=$190000
$124000+$110000DIV=$186000
Dividendsdeclaredandpaidduring2008=$48000
FirmC:
A
A
$520 000

=
L
=
L
= $205 000

+
+
+

OE
SC
+
(Beg. RE
$140 000
+ (?

Inthiscase,theendingbalanceofretainedearningsmustbedeterminedfirst:
$520000=$205000+$140000+End.RE
Retainedearnings31/12/08=$175000
Oncetheendingbalanceofretainedearningsisknown,thebeginningbalanceofretained
earningscanbedetermined:
Beg.RE+$81000$28000=$175000
Retainedearnings1/1/08=$122000

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AnalternativeapproachcouldbetoconsidertheStatementofChangesinEquityand
use a Balance sheet schedule to solve for the missing numbers rather than an
equation:
FirmA
FirmB
FirmC
ShareCapital
55000
59000
140000
RetainedEarnings
BeginningBal

50000

124000

122000(iii)

PlusProfit

68000

110000

81000

LessDividends

(12000)

(48000)(ii)

(28000)

RetainedEarningsat
endofyear

106000(i)

186000

175000(ii)

Liabilities
TotalL+OE

80000
241000(ii)

190000(iii)
435000(i)

205000
520000(i)

TotalAssets

241000(iii)

435000

520000

E2.11
UseEquationforRetEarnings:
(Beg. RE

NP

DIV

End RE)

$311800$4700$18500=$288600
Alternatively:
Preparetheretainedearningsportionofastatementofchangesinowners'equityfortheyear
ended31December2008:
Retained earnings 31 December 2007......................................................................................
Less: Net loss for the year ended 31 December 2008..............................................................
Less: Dividends declared and paid in 2008..............................................................................
Retained earnings 31 December 2008......................................................................................

$311 800
(4 700)
(18 500)
$288 600

E2.12
UseEquationforRetEarnings:
(Beg. RE

NP

DIV

End RE)

?+$22600$4500=$210300
BeginR.E.=$192200
OrUseScheduleofchangesinEquityformat
Retained earnings 31 December 2007......................................................................................
Net profit for the year ended 31 December 2008......................................................................
Dividends declared and paid in 2008........................................................................................
Retained earnings 31 December 2008......................................................................................

$?
22 600
(4 500)
$210 300

Solvingthemodelretainedearningsat31December2007was$192200.
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E2.13Thecluetothisistheunderlinedwordsnetassetsinthequestion
OE
Beginning:
Changes:
Ending:

SC

RE

$12 400
?
?

=
=
=

$7 000
1 200

+
+
+

$0
0
0

+
+
+

$5 400
3 000
$6 000

(net profit)
(dividends)

Begin$12,400=$7,000+$0+$5,400(i)
Changes(ii)600=1,200+3,000(NP)
2,400(div)(iv)
End(ii)11,800=5,800+6,000(iii)
A_L=6,000
A=11,800
AL=OE=6,000
Solutionapproach:
(Rememberthatnetassets=AssetsLiabilities=Ownersequity=SC+RE)
Sincesharecapitaldidnotchangeduringtheyear,letthebeginningandendingbalances
equal$0.Thus,beginningretainedearnings=$12400 $7000= $5400 andending
retainedearnings=netassetsattheendoftheyear=$6000.BylookingattheREcolumn
itcanbeseenthatdividendsmusthavebeen $2400.Alsobylookingattheliabilities
columnitcanbeseenthatendingliabilitiesare$5800andthereforeendingassetsmustbe
$11800.Thus,totalassetsdecreasedby$600duringtheyear($12400$11800),which
isequaltothenetdecreaseontherighthandsideofthebalancesheet($1200liabilities+
$3000netincome $2400dividends = $600net decrease inassets).Theaccounting
equationistrueatthebeginningoftheyear,theendoftheyearandforchangesduringthe
year.
E2.14
OE
Beginning:
Changes:
Ending:

A
?
65 000

=
=
=

L
$320 000
18 000

+
+
+

SC
$ 30 000
?

$192 000

+
+
+
+

RE
?
?
25 000
?

(net profit or loss)


(dividends)
($429 000 total
OE)

OE
Beginning:
Changes:

A
666 000(v)
65 000

=
=
=

L
$320 000
18 000

+
+
+

SC
$ 30 000
162 000 (ii)

+
+
+

RE
316 000(vi)
-54 000(vii)
25 000

Instructor Resource Manual T/a Accounting: What the numbers mean by Marshall, McCartney, Van Rhyn et al.

(net profit or loss)


(dividends)
2-13

Ending:

731 000(iv) =

302 000(i)

$192 000

237 000(iii)

($429 000 total


OE)

SC+RE=429000
Oncethebeginningandendingretainedearningsbalances,areknownthenetprofitorloss
fortheyearcanbedeterminedasfollows:
Retained earnings beginning..................................................................................................
Less: Net profit or loss for the year........................................................................................
Less: Dividends declared and paid during the year...............................................................
Retained earnings ending.......................................................................................................

$316 000
?
(25 000)
$237 000

Solvingthemodel,thenetlossoftheyear=$54000.
P2.15Setuptheaccountingequationandshowtheeffectsofthetransactionsdescribed.Since
totalassetsmustequaltotalliabilitiesandownersequity,theunadjustedownersequity
canbecalculatedbysubtractingliabilitiesfromthetotaloftheassetsgiven.
Cash +
Data given
Liquidation of
inventory *
Collection of acc.
rec. *
Sale of plant &
equipment *
Payment of liabilities
Balance

$ 22 800

+
+

+49 120
+108 490

Inventory

61 400

61 400

A
Accounts
Receivable
114 200

+
+

=
=

L
Liabilities

305 600

+
+

OE
Owners' Equity

157 800
12 280
5 710

114 200

+190 000
305 600
$ 64 810

Plant
&Equipment
265 000

265 000
+

75 000
=

305 600
0

$ 64 810

*Theeffectsofthesetransactionsonownersequityrepresentlossesfromthesale(orcollection)ofthe
noncashassets.

P2.16
(a) TheapproachtothissolutionissimilartothatshowninProblem2.15.Gainsorlossescan
becalculatedforthesale(orcollection)ofeachofthenoncashassetsforKimberLtdas
follows:

Cash received upon


sale or collection of asset
Inventory
Accounts
receivable
Buildings &
Equipment
Land

Gain (loss) recorded and


effect on Owners Equity

$114 700 85% =


$62 600 88% =

$97 495
55 088

$114 700 15% =


$62 600 12% =

BV# + $40 000 =

188 000

Amount above BV =

Appraised amount =

65 000

Total cash received

$405 583

$65 000 $51 000


=
Net gain

$(17 205)
(7 512)
40 000
14 000
$ 29 283

#$343000$195000accumulateddepreciation=$148000bookvalueofbuildings&equipment.

The$405583cashreceivedfromtheliquidationofnoncashassetswouldbeaddedtothe
beginningcashbalanceof$18400,making

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$423983theamountofcashavailabletopaytheclaimsofcreditorsandshareholders.
Liabilitieswouldbepaidfirst(includingtheamountsthatare not shownonthebalance
sheet)andthebalancewouldbepaidtotheshareholders:
Total cash available............................................................................................
Accounts payable................................................................................................
Loan payable......................................................................................................
Wages payable (not shown on balance sheet)...................................................
Interest payable (not shown on balance sheet)..................................................
Long-term borrowings.........................................................................................
Total cash available to shareholders..............................................................

$423 983
$46 700
58 500
2 400
5 250
64 800

(177 650)
$246 333

Thetotalcashavailabletoshareholdersuponliquidationcanbeverified,asfollows:
Total owners equity (unadjusted from balance sheet)..............................................................
Add: Net gain calculated first calculation above......................................................................
Less: Unrecorded wages expense.............................................................................................
Less: Unrecorded interest expense...........................................................................................
Total owners equity, as adjusted...........................................................................................

$224 700
29 283
(2 400)
(5 250)
$246 333

(b)

Asshowninthescheduleabove,totalownersequityonthebalancesheet(beforethe
effectsofliquidation)hadnotbeenadjustedforthegainsandlossesfromthesale(or
collection) of the noncash assets; nor had it been adjusted for the effects of the
expense/liabilityaccrualsforwagesandinterest.
P2.17
(a)
Accounts receivable....................................................................................................
Cash ...........................................................................................................................
Supplies.......................................................................................................................
Inventory......................................................................................................................
Total current assets.....................................................................................................

$ 33 000
9 000
6 000
31 000
$ 79 000

Accounts payable .......................................................................................................


Long-term borrowings.................................................................................................
Share capital...............................................................................................................
Retained earnings at year end....................................................................................
Total liabilities and owners equity ..............................................................................

$ 23 000
40 000
10 000
59 000
$132 000

Sales revenue..............................................................................................................
Cost of goods sold......................................................................................................
Gross profit..................................................................................................................
Service revenue...........................................................................................................
Depreciation expense..................................................................................................
Supplies expense........................................................................................................
Operating profit...........................................................................................................

$140 000
(90 000)
$ 50 000
20 000
(12 000)
(14 000)
$ 44 000

Operating profit...........................................................................................................
Interest expense..........................................................................................................
Profit before tax...........................................................................................................
Income tax expense....................................................................................................
Net profit......................................................................................................................

$ 44 000
(4 000)
$ 40 000
(12 000)
$ 28 000

(b)

(c)

(d)

(e)$12000incometaxexpense/$40000profitbeforetax100=30%averagetaxrate
(f)
Retained earnings, 1 January 2008 ...........................................................................
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?
2-15

Net profit for the year..................................................................................................


Dividends declared and paid during the year..............................................................
Retained earnings, 31 December 2008......................................................................

$ 28 000
(16 000)
$ 59 000

Solving the model, the beginning retained earnings balance must have been $47 000
becausetheaccountbalanceincreasedby$12000duringtheyeartoanendingbalanceof
$59000.
(g) PopesGaragePtyLtd
StatementofChangesinOwnersEquityfortheyearended31December2008
Ownersequityat1January2008
Sharecapital$10000
Retainedearnings47000$57000
Netprofit28000
Dividendsdeclaredandpaid(16000)
Ownersequityatendoftheyear$69000
P2.18
(a)
Inventory.........................................................................................................................
Accounts receivable.......................................................................................................
Cash...............................................................................................................................
Total current assets........................................................................................................
Less: Accounts payable *...............................................................................................
Current assets less current liabilities.............................................................................

$210 000
48 000
36 000
$294 000
(23 000)
$271 000

*Noothercurrentliabilitiesareincludedintheproblem.

(b)
Total current assets (from(a))........................................................................................
Land................................................................................................................................
Equipment......................................................................................................................
Accumulated depreciation..............................................................................................
Total assets....................................................................................................................

$294 000
320 000
18 000
(6 000)
$626 000

Sales revenue.................................................................................................................
Cost of goods sold.........................................................................................................
Gross profit....................................................................................................................
Rent expense..................................................................................................................
Depreciation expense.....................................................................................................
Operating profit..............................................................................................................

$778 000
(440 000)
$338 000
(18 000)
(3 000)
$317 000

Operating profit..............................................................................................................
Interest expense.............................................................................................................
Profit before tax..............................................................................................................
Income tax expense.......................................................................................................
Net profit.........................................................................................................................

$317 000
(30 000)
$287 000
(86 100)
$ 200 900

(c)

(d)

(e)
(f)

$86100incometaxexpense/$287000earningsbeforetax=30%averagetaxrate
Retained earnings, 1 January 2008 ..............................................................................
Net profit for the year.....................................................................................................
Dividends declared and paid during the year................................................................
Retained earnings, 31 December 2008.........................................................................

Instructor Resource Manual T/a Accounting: What the numbers mean by Marshall, McCartney, Van Rhyn et al.

?
$ 200 900
(64 000)
$383 000
2-16

Solving the model, the beginning retained earnings balance must have been $246100
becausetheaccountbalanceincreasedby$136100duringtheyeartoanendingbalanceof
$383000.

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2-17

P2.19
(a)
BREANNA LTD
Income Statement
For the Year Ended 31 December 2008
Sales...............................................................................................................................
Cost of goods sold.........................................................................................................
Gross profit....................................................................................................................
Selling general and administrative expenses ...............................................................
Net profit from operations (operating profit)..................................................................
Interest expense.............................................................................................................
Net profit before tax........................................................................................................
Income tax expense.......................................................................................................
Net profit.........................................................................................................................

$200 000
(128 000)
$ 72 000
(34 000)
$ 38 000
(6 000)
$ 32 000
(8 000)
$ 24 000

BREANNA LTD
Statement of Changes in Owners Equity
For the Year Ended 31 December 2008
Contributed capital:
Ordinary shares ............................................................................................
Retained earnings:
Beginning balance.........................................................................................
Net profit for the year ...................................................................................
Less: Dividends declared and paid during the year......................................
Ending balance ............................................................................................
Total owners equity.......................................................................................

$ 90 000
$ 23 000
24 000
(12 000)
35 000
$125 000

BREANNA LTD
Balance Sheet
31 December 2008
Assets:
Cash .......................................................................................................
Accounts receivable................................................................................
Inventory..................................................................................................
Total current assets.................................................................................
Equipment...............................................................................................
Less: Accumulated depreciation.............................................................
Total assets..............................................................................................
Liabilities:
Accounts payable....................................................................................
Long-term borrowings.............................................................................
Total liabilities..........................................................................................

$ 65 000
10 000
37 000
$112 000
120 000
(52 000)

$ 15 000

Owners Equity:
Ordinary shares ......................................................................................
Retained earnings ..................................................................................
Total owners equity.................................................................................
Total liabilities and owners equity...........................................................

(b)
(c)

68 000
180 000

40 000
$ 55 000
$ 90 000
35 000
$125 000
$180 000

$8000incometaxexpense/$32000earningsbeforetax=25%averagetaxrate.
$6 000 interest expense / $40 000 longterm borrowings = 15% interest rate. This
assumesthattheyearendbalanceoflongtermborrowingsisrepresentativeoftheaverage
longtermborrowingsaccountbalancethroughouttheyear.

Instructor Resource Manual T/a Accounting: What the numbers mean by Marshall, McCartney, Van Rhyn et al.

2-18

(d)

$12000dividendsdeclaredandpaid/$24000netprofit= 50%.Thisassumesthatthe
boardofdirectorshasapolicytopaydividendsinproportiontonetprofit.Beforethiscan
beestablished,thetrendofdividenddistributionswouldneedtobestudied.

P2.20
(a)
SHAH LTD
Income Statement
For the Year Ended 31 December 2008
Sales........................................................................................................
Cost of goods sold...................................................................................
Gross profit..............................................................................................
Selling general and administrative expenses .........................................
Net profit from operations (operating profit)...........................................
Interest expense......................................................................................
Profit before tax.......................................................................................
Income tax expense.................................................................................
Net profit..................................................................................................

$150 000
(90 000)
$ 60 000
(12 000)
$ 48 000
(8 000)
$ 40 000
(14 000)
$ 26 000

SHAH LTD
Statement of Changes in Owners Equity
For the Year Ended 31 December 2008
Contributed capital:
Ordinary shares.......................................................................................
Retained earnings:
Beginning balance...................................................................................
Net profit for the year .............................................................................
Less: Dividends declared and paid during the year................................
Ending balance .......................................................................................
Total owners equity.................................................................................

$ 35 000
$ 21 500
26 000
(6 500)
41 000
$ 76 000

SHAH LTD
Balance Sheet
At 31 December 2008
Assets:
Cash .......................................................................................................
Accounts receivable................................................................................
Inventory..................................................................................................
Total current assets.................................................................................
Buildings and equipment.........................................................................
Less: Accumulated depreciation.............................................................
Total assets..............................................................................................
Liabilities:
Accounts payable....................................................................................
Accrued liabilities.....................................................................................
Loan payable (long term)........................................................................
Total liabilities..........................................................................................
Owners Equity:
Ordinary shares ......................................................................................
Retained earnings ..................................................................................
Total owners equity.................................................................................
Total liabilities and owners equity...........................................................

$ 32 000
20 000
44 000
$ 96 000
84 000
(36 000)

8 000
$144 000

$ 15 000
3 000
50 000
$ 68 000
$ 35 000
41 000

Instructor Resource Manual T/a Accounting: What the numbers mean by Marshall, McCartney, Van Rhyn et al.

$ 76 000
$144 000
2-19

(b)
(c)

(d)

$14000incometaxexpense/$40000netprofitbeforetax=35%averagetaxrate
$8000interestexpense/$50000notespayable(longterm)= 16%interestrate.This
assumesthattheyearendbalanceoflongtermborrowingsisrepresentativeoftheaverage
longtermborrowingsaccountbalancethroughouttheyear.Iflargeamountsofcashhad
been borrowed near the end of the year then the interest rate charged on longterm
borrowingswouldbegreaterthan16%becausetheaverageborrowingsoutstandingwould
havebeenlessthan$50000.Likewiseiflargerepaymentsoflongtermborrowingshad
occurrednearyearendthentheinterestratewouldbelessthan16%becausetheaverage
outstandinglongtermborrowingswouldhavebeengreaterthan$50000.
$6500dividendsdeclaredandpaid/$26000netprofit= 25%.Thisassumesthatthe
boardofdirectorshasapolicytopaydividendsinproportiontonetprofit.

P2.21Tutorsshouldidentifythetheaccountsaffectedandhowtheyaffecttheaccounmting
equation.Ausefulanalysischartisprovidedbelowtheanswer.Incomeandexpensescouldbe
combinedintoOEifthisiswheretheastudentsareat.Amountscaneasilybeassumedto
demonstratethechangeintheaccountingequation

a.
b.
c.
d.
e.
f.
g.
h.
i.

Assets

= Liabilities +

Owners
Equity

+
+

NE
+

NE
+
NE
NE
NE
NE

NE
NE
+
NE

NE
+

Borrowed cash on a bank loan


Paid an account payable
Issued ordinary shares in the company
Purchased inventory on account
Declared and paid dividends
Collected an account receivable
Sold inventory on account at a profit
Paid operating expenses in cash
Repaid principal and interest on a bank loan

Trans Accounts

Classification

Inc/Dec

Proof of effect
onaccequation
+=+

A,L,OE,Inc,Ex
a

Cash

Inc

LoanPay

Inc

Cash

Dec

AccPay

Dec

Cash

Inc

ShareCapital

OE

Inc

Inventory

Inc

Instructor Resource Manual T/a Accounting: What the numbers mean by Marshall, McCartney, Van Rhyn et al.

+=+

+=+
2-20

f.

g.

AccPay

Inc

Cash

Dec

RetEarn

OE

Dec

Cash

Inc

AccRec

Dec

AccRec

Inc

Sales

Inc

Inc

Inventory

Dec

CostofGoodssold

Ex

Inc

Cash

Dec

Operatingexp

Exp

Inc

Cash

Dec

LoanPay

Dec

Interestexpense

Ex

Inc

+=

+=+

=+

P2.22
(a)

1 August 2008 totals........................................................................


3 August borrowed $15 000 in cash from the bank ........................
New totals.........................................................................................
7 August bought inventory valued at $32 000 on account...............

Assets
$420 000
+ 15 000
$435 000
+32 000

= Liabilities
$345 000
+ 15 000
$360 000
+32 000

New totals.........................................................................................
10 August paid $3 000 cash operating expenses.............................
New totals..........................................................................................
14 August received $30 000 in cash from sales..............................
of merchandise that had cost $21 000 ............................................
New totals..........................................................................................
17 August paid $8 000 owed on accounts payable..........................
New totals..........................................................................................
21 August collected $11 000 of accounts receivable.......................

$467 000
3 000
$464 000
+30 000
21 000
$473 000
8 000
$465 000
0

$392 000

Instructor Resource Manual T/a Accounting: What the numbers mean by Marshall, McCartney, Van Rhyn et al.

$392 000
$392 000
8 000
$384 000
2-21

Owners
+ Equity
$75 000
$75 000
$75 000
3 000
$72 000
+30 000
21 000
$81 000
$81 000

New totals..........................................................................................
24 August repaid $10 000 to the bank plus $200 interest................
New totals..........................................................................................
29 August paid Cynthia Merkin a $2 000 cash dividend .................
31 August 2008 totals......................................................................

(b)

$465 000
10 200
$454 800
2 000
$452 800

$384 000
10 000
$374 000
= $374 000

$81 000
200
$80 800
2 000
+ $78 800

Total revenues were $30 000 (from sales) and total expenses were $24 200 (which
included$3000ofoperatingexpenses,$21000ofcostofgoodssoldand$200ofinterest
expense).Thus,netprofitwas$5800($30000$24200).
Alternativecalculation:Ownersequityincreasedby$3800duringthemonthofAugust
(seeanswertopart(c))eventhougha$2000cashdividendwasdeclaredandpaidto
CynthiaMerkin.Sincetherewerenosharetransactionsduringthemonth,netprofitwas
$5800.($75000beginningownersequity,plus$5800netprofit,minus$2000dividends
equals$78800endingownersequity.)

(c)
Total assets.......................................................................
Total liabilities...................................................................
Total owners equity..........................................................

1 August
$420 000
345 000
75 000

31 August
$452 800
374 000
78 800

Net Change
$32 800
29 000
3 800

(d)

CynthiaMerkinsownersequity increased by$9000asaresultofthesaleonAugust


14th($30000revenue$21000costofgoodssold).Herownersequitydecreasedby$3
000fortheoperatingexpensesrecordedonAugust10th,by$200fortheinterestexpense
recordedonAugust24thandby$2000forthecashdividendrecordedonAugust29th.In
other words, her owners equity was increased by revenues and it was decreased by
expensesanddividends.
(e) Interestisanexpensebecauseitrepresentsanecessarypaymentto others(i.e.creditors)
for the use of their moneythus it is a cost of doing business. Dividends are a
distributionofprofitstotheownersofthefirmandrepresentapartialliquidationofthe
firm. A dividend is not an expense because it represents a profit distribution; it is a
transactionwiththeownerinhercapacityasowner.
(f) Whenmoneyisborrowedfromthebank,anasset(cash)isincreasedandaliability(loan
payable)isalsoincreasedbyanequalamount.Netprofitisincreasedonlywhenrevenue
hasbeenearnedandmoneyborrowedfromthebankrepresentsaliabilitythatmustbe
repaidnotrevenuethathasbeenearned.
(g) Payingoffaccountspayabledecreasesanasset(cash)anddecreasesaliability(accounts
payable)byanequalamount.Collectinganaccountreceivableincreasesanasset(cash)
anddecreasesanotherasset(accountsreceivable)byequalamounts. Inbothcases, only
balancesheetaccountsareinvolved.Netprofitisincreasedbyrevenuesanddecreasedby
expenses.Theexpenseassociatedwithacashpaymentofanaccountpayablewouldhave
beenrecordedinanearliertransaction(whentheexpensewas incurred andtheaccount
payablewasestablished).Bythesamelogictherevenueassociatedwiththecollectionof
an account receivable would have been recorded in an earlier transaction (when the
revenuewasearnedandtheaccountreceivablewasestablished).
P2.23Amountsshowninthebalancesheetbelowreflectthefollowinguseofthedatagiven:
(a) An asset should have a probable future economic benefit; therefore, the accounts
receivablearestatedattheamountexpectedtobecollectedfromcustomers.
(b) Assetsarereportedatoriginalcostnotcurrentworth.Depreciationinaccountingreflects
theallocationofthecostofanassetoveritsestimatedusefullife.
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2-22

(c)
(d)

Assetsarereportedatoriginalcostnotatanassessedorappraisedvalue.
TheamountoftheloanpayableiscalculatedusingtheaccountingequationA=L+OE.
Totalassetscanbedeterminedbasedonitems(a)(b)and(c);totalowners'equityisknown
afterconsideringitem(e);andtheloanpayableisthedifferencebetweentotalliabilities
andtheaccountspayable.

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2-23

(e)

Retainedearningsrepresents,thedifferencebetweencumulativenetprofitandcumulative
dividends.
Assets:
Cash ....................................................
Accounts receivable.............................
Land......................................................
Motor vehicle........................................
Less: Accumulated depreciation..........

$ 700
3 400
11 000
$18 000
(6 000)

Total assets...........................................

12 000
$27100

Liabilities and Owners Equity:


Loan payable....................
$ 2 200
Accounts payable...........
3 400
Total liabilities................
$ 5 600
Contributed capital.........
8 000
Retained earnings.........
13 500
Total owners equity.......
21 500
Total liabilities and owners
equity..............................
$27100

P2.24

Assets
Current assets:
Cash...............................
Accounts receivable.......
Inventory........................
Total current assets........
Land...............................
Equipment......................
Less: Accumulated
depreciation...................
Total land & equipment. .
Total assets....................

1.

EPSI LTD
Balance Sheets
31 December 2008 and 2007
2008
2007
Liabilities
: Current liabilities
$ 38
$ 30 Loan payable.................
126
120 Accounts payable...........
241
230 Total current liabilities...
$ 405
$ 380 Long-term borrowings...
$ 25
$ 25
Owners Equity..............
390
375 Ordinary shares.............
(180)
$ 235
$ 640

(160)
$ 240
$ 620

Retained earnings..........
Total owners equity.......
Total liabilities & owners
equity..............................

2008

2007

$ 49
123
$ 172
$ 60

$ 40
110
$ 150
$ 80

$ 200

$ 200

208
$ 408

190
$ 390

$ 640

$ 620

Solutionapproach:
Retained earnings 31/12/07...............................................................................................................
Net profit for 2008 (given)..................................................................................................................
Dividends for 2008 (given).................................................................................................................
Retained earnings 31/12/08 ..............................................................................................................

$190
26
(8)
$208

2.
3.
4.
5.
6.
7.

Cashat31/12/08is$8morethanat31/12/07.
Costofequipmentat31/12/08is$15morethanthebalanceat31/12/07
Landbalanceat31/12/08isthesameasat31/12/07.Fairmarketvalueisirrelevant.
Calculatetotalcurrentassets,totallandandequipment,andtotalassets.
Totalassetscanthenbeusedfortotalliabilitiesandownersequity.
Totalownersequityiscalculatedandaddedtototalcurrentliabilities.Thisamountis
subtractedfromtotalliabilitiesandownersequitytodeterminelongtermborrowings.
P2.25
(a)
2008

For the years ended 31 December 2007 and 2008, respectively:


Net sales...........................................................................................
Cost of goods sold............................................................................
Gross profit.......................................................................................
Marketing, general, administrative and other operating expenses
Operating profit.................................................................................
Interest expense ...............................................................................
Profit before taxes.............................................................................
Income tax expense..........................................................................
Profit for the period...........................................................................

$ 4 258 674
2 461 198
1 797 476
. 1 318 179
. 479 297
239 608
239 689
88 685
$ 151 004

Instructor Resource Manual T/a Accounting: What the numbers mean by Marshall, McCartney, Van Rhyn et al.

2007

$ 4 645 126
2 690 170
1 954 956
1 416 194
538 762
195 082
343 680
120 288
$ 223 392
2-24

Dividends declared and paid.............................................................


As at 31 December 2007 and 2008, respectively:
Total assets.......................................................................................
Total liabilities...................................................................................
Total shareholders' deficit.................................................................
Accumulated deficit *........................................................................
* Accumulated deficit 31 December 2007.........................................
Add: Net profit for the year...............................................................
Less: Cash dividends declared.........................................................
Accumulated deficit 31 December 2008...........................................

$0

$0

$ 2 983 486
3 919 429
(935 943)
(1 020 860)
$(1 171 864)
151 004
. (0)
$(1 020 860)

$ 3 205 728
4 304 301
(1 098 573)
(1 171 864)

NotethatitmakeseconomicsensethatLeviStrauss&Co.wouldfollowazerodividends
policydespitethenetprofitfiguresreportedin2007and2008becausetheiraccumulated
deficitissolarge(i.e.netprofitisusedeachyeartoreducethedeficit).Recallthatthere
mustbeasufficientpositivebalanceinretainedearnings(toabsorbthedividendwithout
creating a deficit) for the board of directors to declare legally a dividend to its
shareholders.Thus,whenadeficitexists,dividendsareinappropriateindeedcontraryto
theCorporationsAct.
(b) Thedifferencebetweentotalshareownersequityandaccumulateddeficitrelatesprimarily
tocontributedcapitalamounts.
P2.26
(a)
Net sales and other income..........................................................................
Less: Other income.......................................................................................
Net sales........................................................................................................
Less: Cost of sales........................................................................................
Gross profit...................................................................................................
Gross profit/net sales....................................................................................

2008
$219 812
(2 013)
$217 799
(171 562)
$ 46 237

2007
$193 295
(1 966)
$191 329
(150 255)
$ 41 074

21.2%

21.5%

Thechangeinthegrossprofit/netsalesratioduringtheyearended31January2008was
insignificant,relativetotheprioryear,suggestingthatthecompanyssalesmixandpricing
strategieshavebeenconsistent.
(b)
Gross profit (from part (a) above)..................................................................
Operating selling and general and administrative expenses..........................
Operating profit...............................................................................................

2008
$ 46 237
(36 173)
$ 10 064

Operating profit/net sales.................................................................................

2007
$ 41 074
(31 150)
$ 9 924

4.6%

5.2%

Thechangeinoperatingprofitasapercentageofnetsalesduringthefinancialyearended
on31January2008wasslightlyunfavourabledueto1)thedecreaseingrossprofitmargin
(ascalculatedinpart(a)and2)theincreaseinotheroperatingexpenses(asapercentof
sales).
(c)
Operating profit (from part (b) above) ...........................................................
Other income..................................................................................................
Interest costs...................................................................................................
Other non-operating expenses.......................................................................
Profit before tax...............................................................................................
Income tax expense.........................................................................................
Net profit.........................................................................................................

2008
$10 064
2 013
(1 326)
(183)
$10 568
(3 897)
$ 6 671

Instructor Resource Manual T/a Accounting: What the numbers mean by Marshall, McCartney, Van Rhyn et al.

2007
$ 9 924
1 966
(1 374)
(129)
$10 387
(4 092)
$ 6 295
2-25

Solution approach: Thekeytoansweringpart (c)correctly istoreformat theincome


statementdataasshownabove,rememberingtoincludeOtherincomeasasourceofnon
operatingrevenue.TheProfitbeforetaxlinehasbeenaddedtoemphasisetheimportance
ofunderstandingthedifferencebetweenoperatingandnonoperatingitemsontheincome
statement.Theproblemcouldbesolvedwithoutcalculatingthisnumber.
P2.27 Inparts (a),(b)and (d)ifstudents are willing tosharethe different kinds ofassets,
liabilities,revenues,expensesandcashflowstheyhaveidentified,thiscasecanbeusedto
review the basic characteristics of the balance sheet income statement and cash flow
statement.
Inpart(c),thepointisthat projected incomeactivityforthecurrentperiodhasadirect
impactontheprojectedbalancesheet.
Inpart(e),thepointisthatincomeandcashflowaretwodifferentthingsentirely.Possible
explanationsmightinclude:

Receipt of student loan proceeds (orscholarships grants) towards the end of the
semester.

Certaincostsofattendingcollege(i.e.tuitionroomandboardmealplans)mightbe
incurredbythestudentbutnotpaidyet.

Many students work on a parttime (or fulltime) basis throughout the semester,
whichmaygeneratemorecashflowthantheywereabletoaccumulatebeforethe
semester.

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2-26

TAKE-HOME QUIZ:CHAPTER 2
NAME______________________________________________ ID_________________
PresentedbelowistheCashflowstatementforMystoreLtdfortheyearended31December
2008.Alsoshownisapartiallycompletedcomparativebalancesheetasat31December2008
and2007.
MYSTORE LTD
Cash flow statement
For the Year Ended 31 December 2008
Cash flows from operating activities:
Net profit ................................................................................................................................
Add (deduct) items not affecting cash:
Depreciation expense.............................................................................................................
Decrease in accounts receivable............................................................................................
Decrease in accounts payable................................................................................................
Net cash provided by operating activities...............................................................................

$ 23 000
6 000
8 000
(6 000)
$ 31 000

Cash flows from investing activities:


Purchase of store fixtures.......................................................................................................

$ (4 000)

Cash flows from financing activities:


Repayment of long-term borrowings......................................................................................
Payment of cash dividends on ordinary shares.....................................................................
Net cash used by financing activities.....................................................................................
Increase in cash for the year..................................................................................................

$ (2 000)
(5 000)
$ (7 000)
$ 20 000

Current assets:
Cash..............................
Accounts receivable......
Total current assets......
Store fixtures.................
Less: Accumulated
depreciation..................
Net store fixtures...........
Total assets...................

1.

MYSTORE LTD
Balance Sheets
AT 31 December 2008 and 2007
2008
2007
Liabilities:
$ 37 000
$______ Accounts payable...........
______
39 000
Long-term borrowings...
$
$ Total liabilities................
$______
$ 24 000 Share capital..................
Retained earnings..........
(13 000)
______
Total owners equity......
. $______
$______
Total liabilities and
$______
$______ owners equity................

2008

2007

$ _____
18 000
$ _____
$ _____
______
$ _____

$ 18 000
______
$______
$ 20 000
______
$______

. $ _____

$______

CompletethebalancesheetsforMystoreLtdat31December2008and2007.Identifyyour
strategy by listing, in general, the sequence of steps you used to find the unknown
amounts.
Notetoinstructors
Theindirectformofcashflowstatementisgivenheresinceitprovidesinformationmoredirectlyforusein
completingthequiz.Assuch,studentscomprehensionoftermsisthefocusofthisexercise.

2.
3.

DoestheamountshownonthebalancesheetforNetStoreFixturesrepresentthecurrent
fairmarketvalueofthestorefixtures?Explainyouranswer.
PrepareaStatementofChangesinRetainedEarningsfortheyearended31December
2008.

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TAKE-HOME QUIZ KEY: CHAPTER 2


1.

Useinformationinthecashflowstatementtodetermineeitherthebeginningor
endingamountsforassetsandliabilities.Forexample,accountsreceivabledecreased
$8000soattheendof2008thebalancewas$31000.
Based on total assets and total liabilities at the beginning and end of the year,
determinetotalowners'equityateachdate.
Usingtotalowners'equityattheendof2007,solveforretainedearningsatthatdate.
Thecashflowsfromfinancingactivitiesonthecashflowstatementdoesnotshow
anycashfromthesaleofadditionalstocksotheendingbalanceisthesameasthe
beginningbalance.Knowingthis,retainedearningsattheendoftheyearcanbe
determined.
Alternatively,useinformationaboutnetprofitanddividendsfromthecashflow
statementandthebeginningbalanceofretainedearnings(asdeterminedabove)to
calculateendingretainedearnings.Then,capitalcontributedattheendoftheyear
canbedetermined.
MYSTORE LTD
Balance Sheets
AT 31 December 2008 and 2007
2008
2007

Current assets:
Cash.................................
Accounts receivable.........
Total current assets.........
Store fixtures....................
Less: Accumulated
depreciation.....................
Net store fixtures..............
Total assets......................

2.
3.

$37 000
31 000
. $68 000
$28 000

$17 000
39 000
$56 000
$24 000

(13 000)
$15 000
. $83 000

(7 000)
$17 000
$73 000

Accounts payable.............
Long-term borrowings.....
Total liabilities...................
Contributed capital............
Retained earnings............
Total owners equity..........
Total liabilities and
owners equity..................

2008

2007

. $12 000
18 000
. $30 000
$20 000
. 33 000
. $53 000

$18 000
20 000
$38 000
$20 000
15 000
$35 000

. $83 000

$73 000

No, the balance sheet shows the original cost of assets less accumulated depreciation,
whichforaccountingpurposesisthatportionofthecostoftheassetthathasbeen'used
up.'
MYSTORELTD
Statementofchangesinownersequityfortheyearended31December2008
Owners equity at 31/12/07.......................................................................................................
Add: Net profit for the year.......................................................................................................
Less: Dividends declared and paid..........................................................................................
Owners equity at 31/12/08......................................................................................................

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$35 000
23 000
(5 000)
$53 000

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