The financial statements and notes of ZETA Corporation are reproduced over the next several pages.

Required:
Answer the following questions and provide supporting calculations. Explain the accounts and amounts
used in each analysis.
a. What transactions and events explain the $7,000 increase in stockholders’ equity for Year 6?
b. Note 6 discloses “capitalized lease obligations” of $1,000. What accounts are increased in Year 6, and
by what amounts, to reflect these leases? Explain. How are these leases reflected in the statement of cash
flows?
c. Use T-account analysis to determine how much long-term debt is paid in Year 6. Does your answer
agree with the amount reported by ZETA?
d. Note 1 describes a change in accounting principle.
1) What effect did this change in accounting have on the Year 6 balance sheet and income
statement?
2) Describe the necessary adjustments in the Year 5 balance sheet and income statement for an
effective comparison of Year 5 with Year 6.
3) How would the $1,000 “cumulative effect” for Year 6 be reported in a statement of cash flows
(direct method). (Hint: Reconstruct the accounts and amounts affected to record the $1,000
effect.)
e. Note 3 describes ZETA’s acquisition of TRO Company.
1) Is TRO a separate legal entity at December 31, Year 6, or is it dissolved into ZETA?
2) What effect did the acquisition of TRO Company have at December 31, Year 6 (date of
acquisition), on the:
i. ZETA balance sheet?
ii. Consolidated balance sheet?
3) What are TRO’s revenues for Year 6?

ZETA CORPORATION
Consolidated Balance Sheets
As of December 31, Year 6 and Year 5
($ thousands) Year 6 Year 5
Assets
Current assets
Cash..................................................................................$ 2,000 $ 2,000
Receivables....................................................................... 25,000 20,000
Inventories (notes 1 and 2) ............................................... 56,000 38,000
Prepaid expenses ............................................................... 1,000 1,000
Total current assets........................................................... 84,000 61,000
Investment in associated companies.............................................. 14,000 11,000
Property, plant, and equipment ..................................................... 61,000 52,000
Less: accumulated depreciation .................................................. (23,000) (19,000)
Net property, plant, and equipment .............................................. 38,000 33,000
Goodwill.......................................................................................... 2,000 —
Total assets ................................................................................ $138,000 $105,000

Liabilities and Stockholders’ Equity

Current liabilities Notes payable to banks ......................$ 16,000 $ 14,000
Accounts payable and accruals........................................... 29,000 23,000
Income taxes payable........................................................... 7,000 2,000
Current portion of long-term debt (note 6) .......................... 2,000 1,000
 Total current liabilities ...................................... 54,000 40,000
Long-term debt (note 6)......................................... 25,000 15,200
Deferred income taxes (note 5) .............................. 3,600 2,000
Minority interest..................................................... 1,400 800
Stockholders’ equity (note 7)
Common stock, $5 par value............................. 5,500 5,000
Paid-in capital .................................................. 24,500 15,000
Retained earnings............................................. 24,000 27,000
Total stockholders’ equity.................................. 54,000 47,000
Total liabilities and stockholders’ equity................ $138,000 $105,000

ZETA CORPORATION
Consolidated Income Statement
For Years Ended December 31, Year 6 and Year 5
($ thousands) Year 6 Year 5
Net sales ......................................................................................... $186,000 $155,000
Equity in income (loss) of associated companies............................ 2,000 (1,000)
Expenses Cost of sales............................................................................... 120,000 99,000
Selling and administrative expenses .......................................... 37,000 33,000
Interest expense.......................................................................... 10,000 6,000
Total costs and expenses ............................................................ 167,000 138,000
Income before taxes and minority interest....................................... 21,000 16,000
Income tax expense (note 5)............................................................ 10,000 7,800
Income before minority interest....................................................... 11,000 8,200
Minority interest .............................................................................. 200 —
Income from continuing operations................................................. 10,800 8,200
Discontinued operations (note 4)
Operations, net of tax ................................................................. (1,100) (1,200)
Loss on disposal, net of tax ........................................................ (700) —
Total gain (loss) from discontinued operations........................... (1,800) (1,200)
Income before cumulative effect of accounting change .................. 9,000 7,000
Cumulative effect of change in accounting, net of tax (note 1)....... 1,000 —
Net income ...................................................................................... $ 10,000 $ 7,000

Pro forma income (change in accounting is applied retroactively):

Income from continuing operations ............................................ $ 10,800 $ 8,500
Discontinued operations ............................................................. (1,800) (1,200)
Total pro forma net income.............................................................. $ 9,000 $ 7,300

f. For the asset “Investment in associated companies”:

(1) Explain all changes during Year 6.
(2) Identify all effects in the statement of cash flows relating to this investment.
g. For the “Minority interest” reported in the balance sheet:
(1) Explain all changes during Year 6.
(2) Show how this account relates to the asset “Investment in associated companies.”
h. If the FIFO method of inventory valuation is used (instead of LIFO), how much would Year 6 net
income be increased or decreased? i. Note 4 describes “discontinued operations”:
(1) What accounts (and amounts) are effected on October 31, Year 6, to record the loss on disposal?
(2) What effect did the loss on disposal of $700 have on the statement of cash flows? (Identify specific
items and amounts.)
(3) How should the discontinued operation and $1,100 operating loss be reported in a statement of cash
flows using the direct format, assuming we desire to include these operations among cash inflows and
outflows?
j. How is goodwill reflected in the Year 7 (next year) statement of cash flows?
k. Explain all changes during Year 6 in the Net Property, Plant, and Equipment account.

ZETA CORPORATION
Consolidated Statement of Cash Flows
For Years Ended December 31, Year 6 and Year 5
($ thousands) Year 6 Year 5
Cash provided from (used for) operations
Net income.................................................................................................... $ 10,000 $ 7,000
Add (deduct) adjustments to cash basis:
Depreciation ............................................................................................. 6,000 4,000
Deferred income taxes .............................................................................. 1,600 1,000
Minority interest ....................................................................................... 200 —
Undistributed income of associated companies ....................................... (1,400) 1,300
Loss on discontinued operations .............................................................. 700 —
Increase in accounts receivable (5,000 2,000† )................................... (3,000) (2,400)
Increase in inventories (18,000 100* 2,200† )................................. (15,900) (6,000)
Increase in prepaid expenses ................................................................... — (200)
Increase in accounts payable and accruals
(6,000 300* 3,200† )................................................................... 2,500 2,000
Increase in income taxes payable (5,000 700)*................................... 5,700 1,000
Net cash provided from (used for) operations........................................... 6,400 7,700
Cash provided from (used for) investing activities
Additions to property, plant, and equipment ................................................. (6,500) (5,800)
Acquisition of TRO Company (excluding cash of $4,200):
Property, plant, and equipment........................................... $(6,000)
Goodwill.............................................................................. (2,000)
Long-term debt................................................................... 4,800
Minority interest.................................................................. 400
Current assets (receivables and inventories)...................... (4,200)
Current liabilities................................................................ 3,200 (3,800) —
Investment in associated companies ...................................... (1,600) —
Proceeds from disposal of equipment ..................................... 500 —
Net cash used for investing activities ..................................... (11,400) (5,800)
Cash provided from (used for) financing
Issuance of long-term debt ......................................................................... 7,500 5,000
Reduction in long-term debt ....................................................................... (1,500) (1,000)
Dividends paid ............................................................................................ (3,000) (2,000)
Increase (decrease) in notes payable to bank ............................................. 2,000 (3,500)
Net cash provided from (used for) financing activities ............................... 5,000 (1,500)
Net increase (decrease) in cash‡ ..................................................................... $ 0 $ 400 *

*Adjustments of noncash transactions arising from discontinued operations (see note 4).
† Adjustments relating to acquisition of TRO Co (note 3). ‡ Supplemental disclosures of cash flow
information: Year 6 Year 5
Cash paid for interest 10,000 6,000
Cash paid for income taxes 2,600 4,800
Schedule of noncash activities:
Capital lease of $1,000 incurred on the lease of equipmen

ZETA CORPORATION
Notes to Consolidated Financial Statements ($ thousands)
Note 1: Change in accounting principle
During Year 6, the company broadened its definition of overhead costs to be included in the
determination of inventories to more properly match costs with revenues. The effect of the change in Year
6 is to increase income from continuing operations by $400. The adjustment of $1,000 (after reduction for
income taxes of $1,000) for the cumulative effect for prior years is shown in the net income for Year 6.
The pro forma amounts show the effect of retroactive application of the revised inventory costing
assuming that the new method had been in effect for all prior years.
Note 2: Inventories
Inventories are priced at cost (principally last-in, first-out [LIFO] method of determination) not in excess
of replacement market. If the first-in, first-out (FIFO) method of inventory accounting had been used,
inventories would have been $6,000 and $4,500 higher than reported at December 31, Year 6, and
December 31, Year 5, respectively.
Note 3: Acquisition of TRO Company
Effective December 31, Year 6, the company purchased most of the outstanding common stock of TRO
Company for $8,000 in cash. The excess of the acquisition cost over fair value of the net assets acquired,
$2,000, will be recorded as goodwill and not amortized. The following unaudited supplemental pro forma
information shows the condensed results of operations as though TRO Company had been acquired as of
January 1, Year 5.

Year 6 Year 5
Revenues .......... $205,000 $172,000
Net income........ 10,700 7,400
Details of acquisition (resources and obligations assumed):
Cash ............................................ $4,200
Accounts Receivable.................... 2,000
Inventories................................... 2,200
Property, Plant & Equipment........ 6,000
Long-Term Debt ........................... 4,800
Accounts Payable & Accruals....... 3,200

Note 4: Discontinued operations

As of October 31, Year 6, the board of directors adopted a plan authorizing the disposition of the assets
and business of its wholly owned subsidiary, Zachary Corporation. The “Loss on Disposal” is $700 (net
of income tax credits of $700) and is based upon the estimated realizable value of the assets to be sold
plus a provision for costs of $300 for operating the business until its expected disposition in early Year 7.
Property, plant, and equipment is reduced by $1,000 and inventories are reduced by $100 to net realizable
value. The provision for costs of $300 is included in “Accounts payable and accruals” and is reduced to
$200 at year-end. Net sales of the operations to be discontinued are $18,000 in Year 6 and $23,000 in
Year 5.

Note 5: Income taxes

The income tax expense consists of the following:
Year 6 Year 5
Current ......... $ 8,400 $6,800
Deferred........ 1,600 1,000
Total ............. $10,000 $7,800
The effective tax rates of 47.6% and 48.8% for Year 6 and Year 5, respectively, differ from the statutory
federal income tax rate of 50% due to research and development tax credits of $500 in Year 6 and $200 in
Year 5. Deferred taxes result from the use of accelerated depreciation methods for income tax reporting
and the straight-line method for financial reporting.

Note 6: Long-term debt

Year 6 Year 5 10%
promissory notes to institutional investors payable
in annual installments of $900 through Year 10................... $13,000 $13,900
Unsecured notes to banks—interest 1% over prime ................. 4,000 —
Capitalized lease obligations—payable to Year 9 with
an average interest rate of 8% .................................................. 1,000 —
11% subordinated note payable in annual installments of
$500 from Year 7 through Year 16......................................... 5,000 —
Other mortgages and notes ....................................................... 4,000 2,300
27,000 16,200
Less current maturities.............................................................. 2,000 1,000
Total long-term debt .................................................................. $25,000 $15,200

The various loan agreements place certain restrictions on the corporation including the payment of cash
dividends on common stock and require the maintenance of working capital, as defined, of not less than
$18,000. Approximately $10,000 of retained earnings is available for payment of cash dividends on
common stock at December 31, Year 6. The corporation entered into several long-term noncancelable
leases of equipment during Year 6 which have been capitalized for financial reporting. There are no other
significant lease arrangements.
Note 7: Stockholders’ equity
The corporation has 5 million shares of authorized common stock, par value $5. There are 1 million
shares outstanding at December 31, Year 5, and this is increased by a 10% dividend payable in common
stock during Year 6. The changes in retained earnings are as follows:
Year 6 Year 5
Beginning balance ................. $ 27,000 $22,000
Add net income....................... 10,000 7,000
Less cash dividends ............... (3,000) (2,000)
Less 10% stock dividend........ (10,000) —
Ending balance ...................... $ 24,000 $27,000