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Chapter 1: ANSWERS TO QUESTIONS

 1.

The three basic forms of business organizations are (1) sole proprietorship, (2)
partnership, and (3) corporation.

 2.

Advantages of a corporation are limited liability (stockholders not being personally liable
for corporate debts), easy transferability of ownership, and ease of raising funds.
Disadvantages of a corporation are increased taxation and government regulations.

 3.

Proprietorships and partnerships receive favorable tax treatment compared to corporations
and are easier to form than corporations. They are also owner controlled. Disadvantages of
proprietorships and partnerships are unlimited liability (proprietors/partners are personally
liable for all debts) and difficulty in obtaining financing compared to corporations.

 4.

Yes. A person cannot earn a living, spend money, buy on credit, make an investment, or
pay taxes without receiving, using, or dispensing financial information. Accounting
provides financial information to interested users through the preparation and distribution
of financial statements.

 5.

Internal users are managers who plan, organize, and run a business. To assist
management,
accounting provides timely internal reports. Examples include financial comparisons of
operating alternatives, projections of income from new sales campaigns, forecasts of cash
needs for the next year, and financial statements.

 6.

External users are those outside the business who have either a present or potential
direct
financial interest (investors and creditors) or an indirect financial interest (taxing
authorities, regulatory agencies, labor unions, customers, and economic planners).

 7.

The three types of business activities are financing activities, investing activities, and
operating activities. Financing activities include borrowing money and selling shares of
stock. Investing activities include the purchase and sale of property, plant, and equipment.
Operating activities include selling goods, performing services, and purchasing inventory.

 8.

(a) Income statement.
(b) Balance sheet.
(c) Income statement.

 9.

When a company pays dividends, it reduces the amount of assets available to pay
creditors. Therefore, banks and other creditors monitor dividend payments to ensure they
do not put a company’s ability to make debt payments at risk.

10.

Yes. Net income does appear on the income statement—it is the result of subtracting
expenses from revenues. In addition, net income appears in the retained earnings
statement—it is shown as an addition to the beginning-of-period retained earnings.
Indirectly, the net income of a company is also included in the balance sheet. It is included

(d) Balance sheet.
(e) Balance sheet.
(f) Balance sheet.

in the retained earnings account which appears in the stockholders’ equity section of the
balance sheet.
11.

The primary purpose of the statement of cash flows is to provide financial information
about the cash receipts and cash payments of a business for a specific period of time.

The purpose of the management discussion and analysis section is to provide management’s views on its ability to pay short-term obligations. and its results of operations. (b) The items that affect stockholders’ equity are common stock.000 * + Stockholders’ Equity $665. The basic accounting equation is Assets = Liabilities + Stockholders’ Equity. the financial statements have been presented fairly. Retained earnings is increased by net income and is decreased by dividends and a net loss. (a) Net income from the income statement is reported as an increase to retained earnings on the retained earnings statement. 19. dividends. Tootsie Roll’s accounting equation is: Assets $857. investing activities. 14. revenues. 16.000 . (b) The ending amount on the retained earnings statement is reported as the retained earnings amount on the balance sheet. and expenses. Information included in the notes to the financial statements clarifies information presented in the financial statements and includes descriptions of accounting policies. The categories were chosen because they represent the three principal types of business activities. 15. Using dollar amounts. 20. Stockholders’ equity is the ownership claim on net assets. Retained earnings is the net income retained in a corporation. Put more simply. The MD&A section is a required part of the annual report. The three categories of the statement of cash flows are operating activities. and financing activities. (a) Assets are resources owned by a business. 13. 18.921. 17. The liabilities are (b) Accounts payable and (g) Salaries and wages payable.000 = Liabilities $191. its ability to fund operations and expansion. liabilities are existing debts and obligations. (c) The ending amount on the statement of cash flows is reported as the cash amount on the balance sheet. explanations of uncertainties and contingencies.Questions Chapter 1 (Continued) 12. This gives investors more confidence that they can rely on the figures reported in the financial statements. Liabilities are amounts owed to creditors. in conformity with generally accepted accounting principles. in the opinion of an independent auditor.856.935. 21. and statistics and details too voluminous to be reported in the financial statements. retained earnings. An unqualified opinion shows that.

355.566.*$58.000 + $133.000 .

Easier to transfer ownership and raise funds. Cash paid to purchase a new office building. BRIEF EXERCISE 1-2 (a) (b) (c) (d) (e) 4 3 2 5 1 Investors in common stock Marketing managers Creditors Chief Financial Officer Internal Revenue Service BRIEF EXERCISE 1-3 O F F O I (a) (b) (c) (d) (e) Cash received from customers. Cash paid to stockholders (dividends). increased skills and resources. Simple to set up and maintains control with founder. Cash paid to suppliers. no personal liability.SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1-1 (a) P (b) SP (c) C Shared control. BRIEF EXERCISE 1-4 E R E E D R E NSE (a) (b) (c) (d) (e) (f) (g) (h) Advertising expense Service revenue Insurance expense Salaries and wages expense Dividends Rent revenue Utilities expense Cash purchase of equipment . Cash received from issuing new common stock. tax advantages.

.C (i) Issued common stock for cash.

........ $22.............................. 71..............000 BRIEF EXERCISE 1-6 IS BS BS BS BS IS IS BS BS IS (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) Income tax expense Inventory Accounts payable Retained earnings Equipment Sales revenue Cost of goods sold Common stock Accounts Receivable Interest expense $18....... 2014 Assets Cash......................................................000   Liabilities and Stockholders’ Equity Liabilities Accounts payable...000 Accounts receivable............................000 Total assets....................000 Total liabilities and stockholders’ equity...........................................................................000 Stockholders’ equity Common stock....................... Retained earnings....................... 28............ $93.......BRIEF EXERCISE 1-5 BURNETT COMPANY Balance Sheet December 31................000   .......000  10.................. $93.......................... $65........................

Cash received from issuing new bonds during the period. Total debts outstanding at the end of the period.BRIEF EXERCISE 1-7 IS BS SCF BS (a) (b) (c) (d) Revenue during the period. Supplies on hand at the end of the year. .

000) – ($500. .000 – 0.000 (Total assets) (b) $170.000) + ($800.BRIEF EXERCISE 1-8 (a) $90.000 – $70.000 – $80.000 – $80.000 – $80.000 – $500.000 = $90.000 + $230.000) – ($800.000) = $310.000 + $100.000 + $110.000 – $500.000) = $830.000   (Liabilities) BRIEF EXERCISE 1-10 A L A A SE L (a) (b) (c) (d) (e) (f) Accounts receivable Salaries and wages payable Equipment Supplies Common stock Notes payable BRIEF EXERCISE 1-11 (d) All of these are required.25($800.000   (Assets) (c) ($800.000 (Stockholders’ equity) BRIEF EXERCISE 1-9 (a) ($800.000 + $150.000 (Total liabilities) (c) $800.000 = $320.000) = $600.000) = $530.000   (Stockholders’ equity) (b) ($500.

.......... DO IT! 1-3 MARSH CORPORATION Income Statement For the Year Ended December 31...................................... Net income......... Amounts owed to suppliers are classified as liabilities.000 1...............700 $ 9................. Land purchased is classified as an asset.......... 2014 Revenues Service revenue.......SOLUTIONS TO DO IT! REVIEW EXERCISES DO IT! 1-1 (a) (b) (c) (d) (e) Easier to transfer ownership: corporation Easier to raise funds: corporation More owner control: sole proprietorship Tax advantages: sole proprietorship and partnership No personal legal liability: corporation DO IT! 1-2 (a) (b) (c) (d) (e) (f) Issuance of ownership shares is classified as common stock.......... Cost of advertising is classified as expense.. Total expenses.......................... Supplies expense.....000 $10................. Bonds payable are classified as liabilities................... $25... Advertising expense.........300 .... Amount earned from selling a product is classified as revenue................................. Expenses Rent expense.......................................000 4.700 15....

800 $33........................................ $ 3........ Retained earnings........................ 2014 Retained earnings......................... Accounts receivable........................000 6...................... December 31....................................................................... 2014 Assets Cash............. Total assets............. January 1...........000 5................................DO IT! 1-3 (Continued) MARSH CORPORATION Retained Earnings Statement For the Year Ended December 31..................................................................................... Total stockholders’ equity............... Equipment.. Stockholder’s equity Common stock........ $ –0– 9...................800 ......................................500 $6............................. Account payable........................ MARSH CORPORATION Balance Sheet December 31....... Supplies................... $ 7...........300 2............300 9..........800 Liabilities and Stockholders’ Equity Liabilities Notes payable... Total liabilities and stockholder’s equity....................100 2...........900 26............000 15....................... Retained earnings.... Add: Net income..800 Less: Dividends......................000 21......................................................000 1............... Total liabilities..........800 $12....................................................800 $33.......

DO IT! 1-4 (1) Description of ability to pay near-term obligations: MD&A (2) Unqualified opinion: auditor’s report (3) Details concerning liabilities. too voluminous to be included in the statements: notes (4) Description of favorable and unfavorable trends: MD&A (5) Certified Public Accountant (CPA): auditor’s report (6) Descriptions of significant accounting policies: notes .

5. 7. 4. 1. Abitibi Consolidated Inc. Auditor’s opinion Corporation Common stock Accounts payable Accounts receivable Creditor Stockholder Partnership EXERCISE 1-2 (a) Answers will vary. 6. Cal State—Northridge Stdt Union Financing Sale of stock Borrow money from a bank Investing Purchase long-term investments Purchase office equipment Oracle Corporation Sale of bonds Purchase other companies Sportsco Investments Payment of dividends to stockholders Distribute earnings to partners Sale of stock Purchase hockey equipment Grant Thornton LLP Southwest Airlines Purchase computers Purchase airplanes Operating Sale of newsprint Payment of wages and benefits Payment of research expenses Payment for rink rentals Bill clients for professional services Payment for jet fuel . 2. 3.SOLUTIONS TO EXERCISES EXERCISE 1-1 (a) (b) (c) (d) (e) (f) (g) (h) 8.

Operating The general activities identified would be common to most businesses. A new business or expanding business would be more apt to acquire property.EXERCISE 1-2 (Continued) (b) Financing Sale of stock is common to all corporations. and equipment would be common to all businesses—the types of assets would vary according to the type of business and some types of businesses require a larger investment in long-lived assets. plant. Sale of bonds is common to large corporations. EXERCISE 1-3 Accounts payable Accounts receivable Equipment Sales revenue Service revenue Inventory Mortgage payable Supplies expense Rent expense Salaries and wages expense (a) L A A R R A L E E E (b) O O I O O O F O O O . Payment of dividends is common to all corporations. plant. Investing Purchase and sale of property. Borrowing from a bank is common to all businesses. and equipment while a mature or declining business would be more apt to sell it. although the service or product would differ.

..................... $67...... Advertising expense..............................400 Less: Dividends..........................000 Retained earnings.............. $74.....000 Expenses Salaries and wages expense..................EXERCISE 1-4 MOLINA CO........... 13......... $13................. December 31................................... Rent expense.......... $58...........800 MOLINA CO.................600 Net income................................................ 2014 Retained earnings................................................... Retained Earnings Statement For the Year Ended December 31.................400 $30.............................................................................. 44........................ Total expenses..................400   2............. 2014 Revenues Service revenue...... Income Statement For the Year Ended December 31.............000 Add: Net income.400 ... Utilities expense.......................................400  80............................. 6...................................... January 1..........................000  10......400   1...................

............ $38....4 ....6  Total expenses.........543.......002................... 2014 (in millions) Revenues Sales revenue................. $ 9....901....................................7 Net income............................901....1 Less: Dividends........... 2.....7 Retained earnings......................0 Income tax expense.....576.600........................ $53...........3 56.............................. 12...0 Expenses Cost of goods sold..........674.... December 31...................... $43............EXERCISE 1-5 (a) MERCK AND CO.............. 5......2 Research and development expense...... 25.................. Income Statement For the Year Ended December 31.267......3 MERCK AND CO...... 2014 (in millions) Retained earnings.... Retained Earnings Statement For the Year Ended December 31........... $12...... January 1............8 Add: Net income. 8.............845....018.............9 Selling and administrative expenses........................... 3...698..........597....

3).(b) The short-term implication would be a decrease in expenses of $2.5 ÷ $12.5 ($5. . If all other revenues and expenses remain unchanged. decreasing research and development expenses would produce 22.845 X 50%) resulting in a corresponding increase in income (ignoring income taxes).922.7% more net income ($2.901.922.

..000 *Service revenue........... *Total expenses...................000  175................... Decreasing research and development activities will probably mean fewer new products... December 31............ EXERCISE 1-6 DEVITO INC...............................................000 Retained earnings... *Net income........................................................................... ..... 2014 Retained earnings..$130.........................000 Add: Net income.......... Such a reaction would probably be very short-lived as more knowledgeable investors reviewed Merck’s financial statements and discovered the cause of the increase............EXERCISE 1-5 (Continued) The long-term implications would be more difficult to quantify but it is safe to predict that a reduction in research and development expenses would probably result in lower sales revenues in the future................. $400............ 225. Pharmaceutical companies are usually able to charge higher prices for newly developed products while lower cost generic versions usually replace older products.000*  355.......................................000 Less: Dividends...... ............ 65......000 $225..000 ............................... The stock market’s initial reaction might be positive since Merck’s net income would increase significantly........... Retained Earnings Statement For the Year Ended December 31. January 1.$290.......................................................................................................................

.

. $584...951 4............................ Expenses Cost of goods sold.......... (b) Remington Corporation is not generating sufficient cash provided by operating activities to fund its investing activities.................. This suggests that Grant is not pursuing rapid growth.....131 $589.....757 .....806 438......... Income Statement For the Year Ended December 31.. EXERCISE 1-8 (a) (b) A SE E E A A A R L L R E Cash Retained earnings Cost of goods sold Salaries and wages expense Prepaid insurance Inventory Accounts receivable Sales revenue Notes payable Accounts payable Service revenue Interest expense MOTTE INC.458 115.................. Instead it generates additional cash through financing activities...... Salaries and wages expense.......... Service revenue...EXERCISE 1-7 (a) Grant Corporation is distributing nearly all of this year’s net income as dividends... 2014 Revenues Sales revenue....... Companies that have a lot of opportunities for growth pay low dividends...........  Total revenues............... This is common for companies in their early years of existence..........

......... 555................... 1..............................................................286 ..............Interest expense........  Total expenses......882 $ 34..471 Net income.....

000 ..............000....000 = $27........000 a = $30.... 2014  126...... Sales revenue... Revenue – Cost of goods sold – Salaries and wages expense = Net income $85......000 $75.000 + a + $27...000 FLINT HILLS PARK Retained Earnings Statement For the Year Ended December 31.000 EXERCISE 1-10 (a) Service revenue...............000 c = $55.. Accounts payable + Common stock + Retained earnings = Total liabilities and stockholders’ equity $5...............000 + e – $5..000 = $20...000........000 = $62.... $157....000     25.000 = $62..000 Beginning retained earnings + Net income – Dividends = Ending retained earnings $12........000 e = $20.. (b) $132...000 – c – $10.........000 Expenses.........................................000 $ 31...... we know that net income (d) equals $20..000 a + $32...........000 + e = $27............... Total revenue.......000 From above........................EXERCISE 1-9 First note that the retained earnings statement shows that (b) equals $27................000 $7.....000 – c = $20................ Net income....

.................................................000  36.000 Less: Dividends.................. December 31....... 31.................................... 9....000 Add: Net income...................... January 1......................000 Retained earnings............................Retained earnings....... $27................ 5................000 ................

......................................................... In order to decide if the store is “more trouble than it is worth............................. Supplies................................................000) of total revenue which tends to support Joe’s opinion.. I might recommend retaining it if campers indicated that the convenience of having a ..... A break down into two categories would help me decide if the general store is generating a profit or loss.. Retained earnings.........................EXERCISE 1-10 (Continued) FLINT HILLS PARK Balance Sheet December 31.000  40.................... The income statement reports all expenses in a single category rather than separating them into camping and general store expenses to correspond with revenues............................... Equipment... 67...........” I would need to know the amount of expenses attributable to the general store.000  27..............000  11.................... 2014 Assets Cash. Total liabilities.....................................000 Stockholders’ equity Common stock........ Accounts payable...... 61...... Total assets......................000 (c) The income statement indicates that revenues from the general store were only about 16% ($25.500  114.000 $50...........................500    5... Even if the general store is operating at a loss..000 Liabilities and Stockholders’ Equity Liabilities Notes payable........000 $128....000 Total liabilities and stockholders’ equity............. $  8............................................000 ÷ $157............................ $128.......

.general store on site was an important amenity in selecting a camp ground.

. Selling and administrative expenses.......367 $ 1....................................390    498    295 11..................... 2014 (in millions) Revenues Sales revenue.....................184  3.............................208 ........................... Total expenses............................ $12........575 $7.................. Interest expense..EXERCISE 1-11 (a) (b) SE E E A L E L A R L SE E Retained earnings Cost of goods sold Selling and administrative expenses Cash Notes payable Interest expense Bonds payable Inventory Sales revenue Accounts payable Common stock Income tax expense KELLOGG COMPANY Income Statement For the Year Ended December 31..... Income tax expense................ Net income...................... Expenses Cost of goods sold.....................