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©Cambridge Business Publishers, 2011

Solutions Manual, Chapter 2

2-1

Chapter 2

Constructing Financial Statements

Learning Objectives – coverage by question

Mini-exercises Exercises Problems Cases

LO1 – Describe and construct the balance sheet and understand how it can be used for analysis.

14, 15, 16, 17,

19, 21, 22, 23,

25, 26, 27, 29,

30, 31

32, 33, 34, 35,

36, 37, 38, 39,

40, 41, 42, 43,

44, 45, 46

47, 48, 49, 50,

51, 52, 53, 54,

55, 57, 58, 59,

60, 62, 64, 65,

67

69

LO2 – Use the financial statement effects template (FSET) to analyze transactions.

20, 29 33, 42, 45 55, 60, 65, 67

LO3 – Describe and construct the income statement and discuss how it can be used to evaluate management performance.

19, 20, 21, 22,

23, 28, 29

33, 34, 35, 37,

38, 39, 40, 41

47, 48, 49, 50,

51, 52, 53, 54,

55, 57, 58, 59,

60, 62, 63, 64,

65, 67

69, 70

LO4 – Explain revenue recognition, accrual accounting, and their effects on retained earnings.

20, 22, 23, 24,

29 37, 38

53, 55, 57, 58,

60, 64, 65, 67 69

LO5 – Illustrate equity transactions and the statement of stockholders’ equity.

18, 19, 21, 22,

23, 27, 29 33, 39, 41 51, 64, 65, 67 69

LO6 – Use journal entries and T-accounts to analyze and record transactions.

25, 26, 29, 30,

31 43, 44, 46

53, 56, 57, 58,

61, 66, 68 69

LO7 – Compute net working capital, the current ratio, and the quick ratio, and explain how they reflect liquidity.

32, 34, 36, 38,

40, 44 50, 53, 54, 57,

58


Financial Accounting, 3rd Edition

2-2

QUESTIONS

Q2-1. An asset is something that we own that is expected to provide future benefits. A liability is a current obligation that will require a future sacrifice. Equity is the difference between assets and liabilities. It represents the claims of the company’s owners to its income and assets. The following are some examples of each:

Assets Cash

Receivables

Inventories

Plant, property and equipment Liabilities Accounts payable

Accrued liabilities

Notes payable

Long-term debt Equity Contributed capital (common and preferred stock)

Additional paid-in capital

Earned capital (retained earnings)

Treasury stock

Q2-2. The revenue recognition principle requires that revenues be recognized when earned. Revenues are earned when the product has been delivered to the buyer and is usually signified by a formal transfer of title. A good test of whether revenue has been earned is whether the rights, risks and obligations of ownership have been transferred to the buyer. If a service is involved, revenues are not earned until the service has been provided. The matching principle prescribes that the expenses incurred in providing the service or product be matched against the revenues recognized from the sale or the provision of the service. When these two principles are followed, income can be properly measured in a given accounting reporting period.

Q2-3. Accrual accounting entails the recognition of revenue under the revenue recognition principle (record revenues when earned), and the recognition of expenses using the matching principle (record expenses when incurred). The recognition of revenues or the expenses does not require that cash be received or disbursed. For example the recognition of revenues on sale can lead to an account receivable, and wage expense can be accrued using a wages payable (accrued) liability account.



2-3

Q2-4. The statement of stockholders’ equity provides information relating to all events that impact stockholders’ equity during the period. It contains information relating to stock sales and repurchases, net income, dividends, and the use of stock for other purposes including occasional acquisition of assets. This statement, also referred to as the statement of owners’ equity, also includes the effects of some transactions that are not captured in the determination of net income. These items are included in what is called “other comprehensive income.” One example of such an item is the loss or gain on the translation of the assets and liabilities of foreign owned subsidiaries into United States currency.

Q2-5. An asset must be “owned” and it must provide “future benefits.” Owning means we have title to the asset (some leased assets are also recorded on the balance sheet as we will discuss in Chapter 10). Future benefits can mean the future inflows of cash. Or, it could relate to some other benefit, such as the reduction of expenditures, an increase in another asset, or the reduction of a liability.

Q2-6. Liquidity generally refers to cash. That is, how much cash do we have, how much cash is being generated, and how much cash can we raise quickly. Liquidity is essential to the survival of the business. After all, we can only pay our loans with cash, and our employees will only accept cash for their wages. Some assets are more liquid than others in the sense that they can be converted more easily to cash. Money market accounts and accounts receivable, which can be sold, provide examples. Inventories are considered more liquid than plant assets. We will address liquidity issues more formally in Chapters 4 and 9.

Q2-7. Current means that the asset will be liquidated (converted to cash) within the next year (or the operating cycle if longer than 1 year).

Q2-8. Historical costs are used by accountants because they are less subjective and, therefore, more reliable than using market values. Market values can be biased for two reasons: first, we may not be able to measure them accurately (consider our inability to accurately measure the market value of a production facility, for example), and second, managers may intervene in the reporting process to intentionally bias the results in order to achieve a particular objective (i.e. enhancing the stock price). The use of historical costs in accounting records does not negate the importance of market values. For example, a firm offering to pledge land as collateral for a loan will be expected to use the market value of that land rather than its historic cost. The same would be true if a corporation were considering the sale of the land. Finally, we shall see that certain assets are reported at market value in the balance sheet; securities that are available to be sold provide an example.



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Q2-9. An intangible asset is an asset that we cannot touch. To be included on the balance sheet, it has to meet the tests of an asset (e.g., we own it, and it will provide future benefits). Intangible assets are always acquired. Internally generated intangible assets are not recorded on the balance sheet. Some examples are goodwill, patents and trademarks, contractual agreements like royalties, leases, and franchise agreements. All of the intangible assets, though not recorded if internally generated, are recorded if purchased, as in an acquisition of another company, for example.

Q2-10. Both the current ratio and quick ratio are measures of a firm’s ability to pay its obligations as they come due; measures of a firm’s liquidity. The current ratio is computed by dividing the firm’s current assets by its current liabilities. Current ratios that exceed 1.0 are deemed to represent a strong current liquidity position. The quick ratio is an even more conservative measure of a firm’s liquidity. The quick ratio is computed by dividing the firm’s cash and cash equivalents by its current liabilities.

Q2-11. The three conditions necessary to recognize a liability are:

1. The liability reflects a probable future sacrifice on the part of the organization.

2. The amount of the obligation is known or can be reasonably estimated.

3. The transaction that caused the obligation has occurred.

Q2-12. Net working capital = current assets – current liabilities. Increasing the amount of trade credit (e.g., accounts payable to suppliers) increases current liabilities and reduces net working capital. As trade credit increases, we are using someone else’s cash rather than our own. As a business grows, its net working capital grows, as the growth of inventories and receivables are generally greater than that of accounts payable and accrued liabilities. Net working capital is an asset category that must be financed just like fixed assets.

Q2-13. $700,000 Assets - $220,000 Liabilities = $480,000 Stockholders' equity

$480,000 – $300,000 Common stock = $180,000 Retained earnings



2-5

MINI EXERCISES M2-14 (10 minutes) Use the accounting equation. a. Cash $ 8,000 Accounts receivable 23,000 Supplies 9,000 Equipment 138,000 178,000 Accounts payable $ 11,000 Common stock 110,000 121,000 Retained earnings $ 57,000 b. Retained Earnings: December 31, 2010 $ 57,000 January 1, 2010 30,000 Increase 27,000 Add: Dividends 12,000 Net Income $ 39,000

M2-15 (5 minutes) a. $200,000 - $85,000 = $115,000 equity b. $32,000 + $28,000 = $60,000 assets c. $93,000 - $52,000 = $41,000 liabilities

M2-16 (5 minutes) a. $375,000 - $105,000 = $270,000 equity b. $43,000 + $11,000 = $54,000 assets c. $878,000 - $422,000 = $456,000 liabilities

M2-17 (5 minutes) a. $450,000 - $326,000 = $124,000 equity b. $618,000 - $165,000 = $453,000 liabilities. c. $400,000 + $200,000 + $185,000 = $785,000 assets.

M2-18 (10 minutes) a. no effect b. decrease c. decrease d. no effect e. increase f. increase g. increase



2-6

M2-19 (15 minutes) a. Balance sheet

b. Income statement

c. Balance sheet

d. Income statement

e. Balance sheet

f. Balance sheet

g. Balance sheet

h. Balance sheet

i. Income statement

j. Income statement

k. Balance sheet

l. Balance sheet

M2-20 (20 minutes) a. Net income computation

Service revenue (record when earned) …………… $100,000 Wage expense …………………………………………. (60,000) Net income ……………………………………………… $ 40,000

b. Yes, recognizing the wage liability would cause wage expense to increase

by $10,000 and income would go down by the same amount (before taxes). M2-21 (10 minutes)

a. Balance sheet b. Income statement, Statement of stockholders’ equity c. Balance sheet d. Income statement e. Statement of stockholders’ equity f. Statement of stockholders’ equity g. Balance sheet h. Income statement i. Statement of stockholders’ equity, Balance sheet



2-7

M2-22 (10 minutes)

a. Balance sheet b. Balance sheet c. Income statement, Statement of stockholders’ equity d. Statement of stockholders’ equity, Balance sheet e. Balance sheet f. Income statement g. Balance sheet h. Balance sheet

M2-23 (10 minutes)

a. Balance sheet b. Income statement c. Statement of stockholders’ equity, Balance sheet d. Income statement e. Statement of stockholders’ equity* f. Balance sheet g. Balance sheet h. Balance sheet

M2-24 (15 minutes)

Ending retained earnings = Beginning retained earnings + Net income – Dividends + the effects of other adjustments. And, the ending retained earnings for one period is the beginning retained earnings for the following period.

For the year ended January 31, 2009: $4,758 + Net income – $201 = $4,777, so Net income = $220

Ending retained earnings for the year ended February 2, 2008 equals $4,758, the beginning retained earnings for the following year.

For the year ended February 2, 2008: $4,277 + $718 – Dividends – $10 = $4,758, so Dividends = $227

Fiscal year ending February 2, 2008 January 31, 2009

Beginning retained earnings (deficit) $ 4,277 $ 4,758

Net income (loss) 718 220

Dividends paid 227 201

Increases (decreases) from other retained earnings changes (10) –

Ending retained earnings (deficit) $ 4,758 $ 4,777



2-8

M2-25 (10 minutes) a. Increase assets (Cash) Increase equity (Service Revenues) b. Increase assets (Office Supplies) Increase liabilities (Accounts Payable) c. Increase assets (Cash) Increase equity (Contributed Capital or Common Stock) d. Decrease liabilities (Accounts Payable) Decrease assets (Cash) e. Increase assets (Cash) Increase liabilities (Notes Payable) f. Increase assets (Accounts Receivable) Increase equity (Service Revenues) g. Increase assets (Office Equipment) Decrease assets (Cash) h. Decrease equity (Interest Expense) Decrease assets (Cash) i. Decrease equity (Utilities Expense) Increase liabilities (Accounts Payable) M2-26 (10 minutes) a. Increase assets (Office Equipment) Decrease assets (Cash) b. Increase assets (Accounts Receivable) Increase equity (Service Revenue) c. Decrease assets (Cash) Decrease equity (Rent Expense) d. Increase assets (Cash) Increase equity (Service Revenue) e. Increase assets (Cash) Decrease assets (Accounts Receivable) f. Increase assets (Office Equipment) Increase liabilities (Accounts Payable) g. Decrease assets (Cash) Decrease equity (Salaries Expense) h. Decrease assets (Cash) Decrease liabilities (Accounts Payable) i. Decrease assets (Cash) Decrease equity (Retained Earnings)



2-9

M2-27 (10 minutes)

Johnson & Johnson Statement of Retained Earnings

For Year Ended December 28, 2008

Retained earnings, December 30, 2007 ........................................ $55,280

Add: Net income .......................................................................... 12,949

Less: Dividends ............................................................................. (5,024)

Other retained earnings changes ....................................... 174

Retained earnings, December 28, 2008 ........................................ $63,379

M2-28 (10 minutes)

2010 2011

Revenues .................................................................... $350,000 $ 0

Expenses .............................................................. 200,000 0

Net income ............................................................ $150,000 $ 0

Explanation: All of the revenue is reported in 2010 when it is earned—per the revenue recognition principle. Likewise, the expense is reported in 2010 when it is incurred—per application of the matching principle. The receipt or payment of cash does not affect the recording of revenues, expenses, and net income.

M2-29 (15 minutes)

Balance Sheet Income Statement

Transaction Cash Asset

+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital

Revenues - Expenses = Net

Income

a. Issue stock for $1,000 cash.

+1,000 Cash =

+1,000 Common

Stock - =

b. Purchase inventory for $500 cash.

-500 Cash

+500 Inventory =

-

=

c. Sell inventory for $2,000 on credit.

+2,000 Accts Rec

=

+2,000 Retained Earnings

+2,000 Sales -

= +2,000

d. Record $500 for cost of inventory sold in c.

-500 Inventory =

-500 Retained Earnings

-

+500 COGS

Expense =

-500

e. Receive $2,000 cash on receivable from c.

+2,000 Cash

-2,000 Accts Rec =

-

=

Totals 2,500 + 0 = = + 1,000 + 1,500 2,000 - 500 = 1,500



2-10

M2-30 (10 minutes) a. Cash (+A) ............................................................................... 1,000 Common stock (+SE) ...................................................... 1,000

b. Inventory (+A) ....................................................................... 500 Cash (-A) ........................................................................... 500 c. Accounts receivable (+A) ..................................................... 2,000 Sales (+R, +SE) ................................................................. 2,000 d. Cost of goods sold (+E, -SE) ............................................... 500 Inventory (-A) .................................................................... 500

e. Cash (+A) ............................................................................... 2,000 Accounts receivable (-A) ................................................. 2,000 M2-31 (10 minutes)

+ Cash (A) - + Accounts Receivable (A) -

(a) 1,000 (b) 500 (c) 2,000 (e) 2,000

(e) 2,000

- Sales (R) +

(c) 2,000

+ Inventory (A) - + Cost of Goods Sold (E) -

(b) 500 (d) 500 (d) 500

- Common Stock (SE) +

(a) 1,000



2-11

EXERCISES E2-32 (25 minutes) Use the accounting equation to determine Retained Earnings as of May 31, 2010.

Beaver, Inc. a. and b. BALANCE SHEETS May 31, June 1, 2010 2010 Assets Cash $ 12,200 $ 3,200 Accounts receivable 18,300 18,300 Supplies 16,400 16,400 Equipment 55,000 70,000 Total assets $101,900 $107,900 Liabilities Notes payable $ 20,000 $ 33,000 Accounts payable 5,200 5,200 Total liabilities 25,200 38,200 Stockholders' Equity Common stock 42,500 42,500 Retained earnings 34,200 27,200 Total stockholders' equity 76,700 69,700 Total liabilities and stockholders' equity $101,900 $107,900 c. Net working capital = current assets – current liabilities $32,700 = ($3,200 + $18,300 + $16,400) – $5,200



2-12

E2-33 (30 minutes) Use the accounting equation and the information on changes in contributed capital and retained earnings.

Beginning retained earnings (= Beginning assets – Beginning liabilities) + Net income (= Revenues – Expenses) – Dividends

Ending retained earnings (= Ending assets – Ending liabilities) a. Equity, Beginning ($28,000 - $18,600) $ 9,400 Equity, Ending ($30,000 - $17,300) 12,700 Increase 3,300 Add: Net Capital Withdrawn ($5,000 - $2,000) 3,000 Net Income 6,300 Add: Expenses 8,500 Revenues $14,800 b. Equity, Beginning ($12,000 - $5,000) $ 7,000 Add: Net Capital Contributed ($4,500 - $1,500) 3,000 10,000 Add: Net Income ($28,000 - $21,000) 7,000 Equity, Ending $17,000 Assets, Ending $26,000 Equity, Ending 17,000 Liabilities, Ending, $ 9,000 c. Equity, Beginning ($28,000 - $19,000) $ 9,000 Add: Net Income ($18,000 - $11,000) 7,000 16,000 Less: Dividends 1,000 15,000 Equity, Ending ($34,000 - $15,000) 19,000 Common Stock Issued $ 4,000 d. Common Stock Issued $ 3,500 Net Income ($24,000 - $17,000) 7,000 10,500 Cash Dividends 6,500 Increase in Equity 4,000 Equity, Ending ($40,000 - $19,000) 21,000 Equity, Beginning 17,000 Add: Liabilities, Beginning 9,000 Total Assets, Beginning $26,000



2-13

E2-34(30 minutes) Use the accounting equation to determine stockholders’ equity balances.

Lang Services a. Balance Sheet December 31, 2011 2010

Assets Cash $10,000 $ 8,000 Accounts receivable 22,800 17,500 Supplies 4,700 4,200 Equipment 32,000 27,000 Total assets $69,500 $56,700

Liabilities Accounts payable $25,000 $25,000 Notes payable 1,800 1,600 Total liabilities 26,800 26,600 Stockholders’ equity Equity 42,700 30,100 Total liabilities and stockholders’ equity $69,500 $56,700 b.

Equity, December 31, 2011 $42,700 Equity, December 31, 2010 30,100 Increase 12,600 Add: Dividends 17,000

29,600 Less: Common Stock issued 5,000 Net Income for 2011 $24,600

c. Current ratio = ($10,000 + $22,800 + $4,700)/$25,000 = 1.5 Quick ratio = ($10,000 + $22,800)/$25,000 = 1.31 d. Lang’s liquidity position is satisfactory as it meets the industry norm, and

its quick ratio is also above the industry average. The firm appears to have invested about the “right” amount in liquid assets—neither too much, nor too little.



2-14

E2-35 (30 minutes) Use the accounting equation to determine Retained Earnings balances.

LYNCH SERVICES a. BALANCE SHEETS December 31, 2011 2010 Assets Cash $ 23,000 $ 20,000 Accounts receivable 42,000 33,000 Supplies 20,000 18,000 Land 40,000 40,000 Building 250,000 260,000 Equipment 43,000 45,000 Total assets $418,000 $416,000 Liabilities Accounts payable $ 6,000 $ 9,000 Mortgage payable 90,000 100,000 Total liabilities 96,000 109,000 Stockholders' equity Common stock 220,000 220,000 Retained earnings 102,000 87,000 Total stockholders' equity 322,000 307,000 Total liabilities and stockholders' equity $418,000 $416,000 b. Retained Earnings, December 31, 2011 $102,000 Retained Earnings, December 31, 2010 87,000 Increase during 2011 15,000 Add: Dividend for 2011 10,000 Net Income for 2011 $ 25,000



2-15

E2-36 (30 minutes) Use the accounting equation to determine Retained Earnings as of September 30, 2011. The two transactions have the following effects:

Equipment purchase increases the equipment asset by $11,000, decreases the cash asset by $3,000, and increases the notes payable liability by $8,000. Dividend payment decreases the cash asset by $3,000 and decreases the retained earnings equity by $3,000.

a. & b. BROWNLEE CATERING SERVICE

BALANCE SHEETS

September 30, 2011 October 1, 2011 Assets

Cash $ 10,000 $ 4,000 Accounts receivable 17,000 17,000 Supplies Inventory 9,000 9,000 Equipment 34,000 45,000 Total assets $ 70,000 $ 75,000

Liabilities Accounts payable $ 24,000 $ 24,000 Notes payable 12,000 20,000 Total liabilities 36,000 44,000

Stockholders’ Equity Common stock 27,500 27,500 Retained earnings 6,500 3,500 Total stockholders’ equity 34,000 31,000 Total liabilities and stockholders’ equity $ 70,000 $ 75,000 c. Current ratio (10,000 + 17,000 + 9,000)

÷ 24,000 = 1.50 (4,000 + 17,000 + 9,000)

÷ 24,000 = 1.25 Quick ratio (10,000 + 17,000)

÷ 24,000 = 1.13 (4,000 + 17,000) ÷ 24,000 = 0.88

d. Quite a few possibilities exist, from increasing long-term borrowing to

issuing new stock to selling unneeded equipment.



2-16

E2-37 (15 minutes)

Income statement Balance sheet

Sales ................................ $30,000 Cash ....................................................... $ 8,000

Wages expense ............... 12,000 Accounts receivable ............................. 30,000

Net income (loss) ............ $18,000 Total assets ........................................... $38,000

Wages payable ...................................... $12,000

Common stock ..................................... 8,000

Retained earnings................................. 18,000

Total liabilities and equity .................... $38,000

E2-38 (15 minutes) a.

Procter & Gamble ($ millions) Amount Classification

Net sales ..................................................................... $ 79,029 I

Depreciation expense ................................................ 1,358 I

Retained earnings ...................................................... 57,309 B

Net earnings ............................................................... 13,436 I

Property, plant and equipment (net) ........................ 19,462 B

Selling, general and admin expense ........................ 24,008 I

Accounts receivable .................................................. 5,836 B

Total liabilities ............................................................ 71,734 B

Stockholders' equity .................................................. 63,099 B

b. Total assets = Total liabilities + stockholders’ equity Total assets = $71,734 + $63,099 = $134,833 Total Revenue – Total Expenses = Net Income $79,029 – Total Expenses = $13,436; Thus, Total Expenses = $65,593



2-17

c. Return on equity = Net income/Stockholders’ equity = $13,436/$63,099 = 21.3% ROE is an estimate because we have only this year’s equity for the

denominator. Debt-to-equity ratio = Total liabilities/Stockholders’ equity = $71,734/$63,099 = 1.14 E2-39 (15 minutes) a.

Target Corp ($ millions) Amount Classification

Sales ........................................................................... $ 62,884 I

Depreciation and amortization expense .................. 1,826 I


Net earnings ............................................................... 2,214 I

Property, plant & equipment, net .............................. 25,756 B

Selling, general & admin. expense ........................... 12,954 I

Accounts payable ...................................................... 6,337 B

Total liabilities and shareholders’ investment .................................................................. 44,106 B

Total shareholders’ investment ................................ 13,712 B

b. Total assets = Total liabilities and shareholders’ investment Total assets = $44,106 Total revenue – Total expenses = Net income $62,884 – Total expenses = $2,214

Thus, Total expenses = $60,670 c. Return on equity = Net income/Stockholders’ equity = $2,214 / $13,712 = 16.1% ROE is an estimate because we have only this year’s equity for the

denominator.



2-18

E2-40 (15 minutes) a.

Briggs & Stratton ($ millions) Amount Classification

Net sales ..................................................................... $ 2,092 I

Interest expense......................................................... 31 I


Net income ................................................................. 32 I

Property, plant & equipment, net .............................. 364 B

Eng. selling, general & admin. expense ................... 265 I

Accounts receivable, net ........................................... 263 B

Total liabilities ............................................................ 924 B

Shareholders’ investment ......................................... 695 B

b. Total assets = Total liabilities + Shareholders’ investment Total assets = $924 + $695 = $1,619 Total revenue – Total expenses = Net income $2,092 – Total expenses = $32 Thus, Total expenses = $2,060 c. Return on equity = Net income/Stockholders’ equity = $32 / $695 = 4.6% ROE is an estimate because we have only this year’s equity for the

denomintator. Debt-to-equity ratio = Total liabilities / Stockholders’ equity = $924 / $695 = 1.33



2-19

E2-41 (15 minutes)

a.

Kimberly-Clark ($ millions) Amount Classification

Net sales ..................................................................... 19,415 I

Cost of goods sold .................................................... 13,557 I


Net income ................................................................. 1,690 I

Property, plant & equipment, net .............................. 7,667 B

Mktg. res., selling, general expense ......................... 3,291 I

Accounts receivable, net ........................................... 2,492 B

Total liabilities ............................................................ 14,211 B

Total stockholders' equity ......................................... 3,878 B

b. Total assets = Total liabilities + Stockholders’ equity Total assets = $14,211 + $3,878 = $18,089 Total revenue – Total expenses = Net income $19,415 – Total expenses = $1,690 Thus, Total expenses = $17,725 c. Debt-to-equity ratio = Total liabilities / Stockholders’ equity = $14,211 / $3,878 = 3.66



2-20

E2-42 (15 minutes)

Transaction



+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income (1) Receive €50,000

in exchange for common stock.

+50,000 Cash

= +50,000 Common

Stock - =

(2) Borrow €10,000 from bank.

+10,000 Cash =

+10,000 Notes

Payable - =

(3) Purchase €2,000 of supplies inventory on credit.

+2,000

Inventory

= +2,000

Accounts Payable

- =

(4) Receive €15,000 cash from customers for services provided.

+15,000 Cash =


+15,000 Revenue - =

+15,000

(5) Pay €2,000 cash to supplier in part (c).

- 2,000 Cash =

- 2,000 Accounts Payable

- =

(6) Receive order for future services with €3,500 advance payment.

+3,500 Cash =

+3,500 Unearned Revenue

- =

(7) Pay €5,000 cash dividend to shareholders.

- 5,000 Cash =

- 5,000 Retained Earnings

- =

(8) Pay employees €6,000 cash for compensation earned.

- 6,000 Cash =

- 6,000 Retained Earnings

- +6,000 Wages

Expense =

- 6,000

(9) Pay €500 cash for interest on loan in (2).

- 500 Cash =

- 500 Retained Earnings

- +500

Interest Expense

= - 500

Totals +65,000 + 2,000 = 13,500 + 50,000 + 3,500 15,000 - 6,500 = 8,500



2-21

E2-43 (20 minutes) a. 1. Cash (+A) ............................................................................... 50,000 Common stock (+SE) ....................................................... 50,000 Receive €50,000 in exchange for common stock. 2. Cash (+A) ............................................................................... 10,000 Notes payable (+L) ........................................................... 10,000 Borrow €10,000 from bank. 3. Inventory (+A) ....................................................................... 2,000 Accounts payable (+L) ..................................................... 2,000 Purchase €2,000 supplies inventory on account. 4. Cash (+A) ............................................................................... 15,000 Revenue (+R, +SE) ........................................................... 15,000 Recognize €15,000 revenue for services provided.

5. Accounts payable (-L) .......................................................... 2,000 Cash (-A) ........................................................................... 2,000 Pay supplier €2,000 cash. 6. Cash (+A) ............................................................................... 3,500 Unearned revenue (+L) .................................................... 3,500 Receive €3,500 advance from customer.

7. Retained earnings (-SE) ....................................................... 5,000 Cash (-A) ........................................................................... 5,000 Pay €5,000 cash dividend to shareholders. 8. Wages expense (+E, -SE) ..................................................... 6,000 Cash (-A) ........................................................................... 6,000 Pay employees €6,000 9. Interest expense (+E, -SE) ................................................... 500 Cash (-A) ........................................................................... 500 Pay €500 interest on note.



2-22

b.

+ Cash (A) - - Accounts Payable (L) +

(1) 50,000 2,000 (5) (5) 2,000 2,000 (3)

(2) 10,000 5,000 (7) 0 Bal.

(4) 15,000 6,000 (8)

(6) 3,500 500 (9) - Unearned Revenue (L) +

Bal. 65,000 3,500 (6)

3,500 Bal.

+ Supplies Inventory (A) - - Notes Payable (L) +

(3) 2,000 10,000 (2)

Bal. 2,000 10,000 Bal.


50,000 (1)

50,000 Bal.

- Retained Earnings (SE) +

(7) 5,000

Bal. 5,000

- Revenue (R) +

15,000 (4)

15,000 Bal.

+ Wages Expense (E) -

(8) 6,000

Bal. 6,000

+ Interest Expense (E) -

(9) 500

Bal. 500



2-23

E2-44 (20 minutes)

Bettis Contractors a. and b. Balance Sheets June 30, July 2, 2010 2010 Assets Cash ……………………………………………………… $ 14,700 $ 2,200 Accounts receivable 9,200 9,200 Supplies 30,500 30,500 Current assets 54,400 41,900 Land 25,000 25,000 Equipment 98,000 108,000 Total assets $177,400 $174,900 Liabilities Accounts payable 8,900 8,900 Current liabilities 8,900 8,900 Notes payable $ 30,000 $ 33,000 Total liabilities 38,900 41,900 Stockholders' Equity Common stock 100,000 100,000 Retained earnings 38,500 33,000 Total stockholders' equity 138,500 133,000 Total liabilities and stockholders' equity $177,400 $174,900 c. CR = $54,400/$8,900 = 6.1 QR = ($14,700 +$9,200)/$8,900 = 2.69 d. Bettis’ current ratio indicates a strong liquidity position. The firm might

want to consider investing some of its cash in assets that contribute to the firm’s earning power. The quick ratio is reasonable as a company does not want to tie up to much of it’s assets in a nonearning asset (cash). A quick glance at the data indicates that the firm's liquidity position has weakened since June.



2-24

Exercise 2-45 (15 minutes)



+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income

1. Receive $20,000 cash in exchange for common stock.

+20,000 Cash

= +20,000

Common Stock

- =

2. Purchase $2,000 of inventory on credit.

+2,000

Inventory =

+2,000 Accounts Payable

- =

3. Sell inventory for $3,000 on credit.

+3,000 Accounts

Receivable

=

+3,000

Retained Earnings

+3,000 Sales

-

=

+3,000

4. Record cost of goods sold in 3.

-2,000

Inventory =

-2,000 Retained Earnings

- + 2,000 COGS

Expense =

- 2,000

5. Collect $3,000 cash from transaction 3.

+3,000 Cash

-3,000

Accounts Receivable

= - =

6. Acquire $5,000 of equipment by signing a note.

+5,000

Equipment =

+5,000 Notes

Payable - =

7. Pay wages of $1,000 in cash.

-1,000 Cash

=


- + 1,000 Wages

Expense =

- 1,000

8. Pay $5,000 cash on a note payable.

-5,000 Cash

= -5,000 Notes

Payable - =

9. Pay $2,000 cash dividend. -2,000

Cash =


- =

TOTALS 15,000 + 5,000 = 2,000 + 20,000 + -2,000 3,000 - 3,000 = 0



2-25

E2-46 (20 minutes) a. 1. Cash (+A) ............................................................................... 20,000 Common stock (+SE) ....................................................... 20,000 2. Inventory (+A) ....................................................................... 2,000 Accounts payable (+L) ..................................................... 2,000 3. Accounts receivable (+A) ..................................................... 3,000 Sales (+R, +SE) ................................................................. 3,000 4. Cost of goods sold (+E, -SE) ............................................... 2,000 Inventory (-A) .................................................................... 2,000

5. Cash (+A) ............................................................................... 3,000 Accounts receivable (-A) ................................................. 3,000 6. Equipment (+A) ..................................................................... 5,000 Notes payable (+L) ........................................................... 5,000

7. Wages expense (+E, -SE) ..................................................... 1,000 Cash (-A) ........................................................................... 1,000 8. Notes payable (-L) ................................................................ 5,000 Cash (-A) ........................................................................... 5,000 9. Retained earnings (-SE) ....................................................... 2,000 Cash (-A) ........................................................................... 2,000



2-26

b.

+ Cash (A) - - Common Stock (SE) +

(1) 20,000 1,000 (7) 20,000 (1)

(5) 3,000 5,000 (8) 2,000 (9)

- Sales Revenue (R) +

3,000 (3)

+ Inventory (A) - + Cost of Goods Sold (E) -

(2) 2,000 2,000 (4) (4) 2,000


(7) 1,000

+ Accounts Receivable (A) - - Accounts Payable (L) +

(3) 3,000 3,000 (5) 2,000 (2)

- Retained Earnings (SE) +

(9) 2,000

+ Equipment (A) -

(6) 5,000

- Notes Payable (L) +

(8) 5,000 5,000 (6)



2-27

PROBLEMS P2-47 (30 minutes)

a. Comcast, Target and Harley-Davidson are financed primarily by debt (between 65% and 75% of total assets). Apple is about equally financed by debt and equity, while Nike is 2/3 financed by equity and only 1/3 by debt.

b. Apple and Nike both earned over 10% on assets. Possible reasons include

the firms’ ability to command a premium price for their brands and the ability to outsource a significant amount of their production (and avoid investments in productive capacity).

c. Harley-Davidson has the highest estimated ROE at 31%. (The ROE is

estimated because we have only this year’s equity.) Harley-Davidson’s ROE is higher than those of Apple and Nike due to the difference in their debt-equity relationship. We explore this topic more in Chapter 5.

P2-48 (30 minutes) a. Dell is over 80% debt financed while Apple is just over 50% equity financed.

We describe Dell as the more heavily leveraged firm. b. Dell's net income to asset ratio is 9.4% while Apple’s is 10.6%. The ratios

are quite close, which might be expected given the similarities of their activities. On the other hand, more heavily leveraged firms are open to greater risk and for this reason, we might expect a greater return to be earned on Dell’s assets to compensate for the higher risk. Dell’s return does not exceed Apple’s suggesting that Apple has superior product or is more efficient in its operations.

c. Dell’s gross profit as a percent of sales is 18% while Apple’s is 36%. The

implication is that Apple does have the more efficient production operation and/or product designs that allow it to command a premium price from consumers.



2-28

P2-49 (30 minutes) a. Verizon is 79% financed by debt while Comcast is 64% financed with debt.

Such similar financing is not unusual for companies in the same industry. b. Verizon has the slightly higher net income to total asses ratio at 3%, but

neither company is doing very well. The cost of raising operating funds is probably larger than either firm’s current return. Certainly one reason is the highly competitive market in which these two firms operate.

c. Verizon has a slightly higher return on total assets but also more leverage

(debt), so it is hard to conclude which firm would have more difficulty raising additional capital. The decision would likely turn on other factors including trends in these numbers and others like cash flows. Based on the limited data supplied, it appears that Comcast might find it easier to borrow additional capital. If lenders are willing to fund 79% of Verizon’s assets, they might be willing to increase Comcast’s debt funding from 64%.

P2-50 (30 minutes) a. 3M at 61% is the more heavily debt-financed firm. Apple is about equally

financed with owner (stockholder) funds and debt (nonowner) funds. Abercrombie and Fitch is 35% financed by debt.

b. Apple has more working capital, but it is also the larger firm. A better

measure of the comparative differences in working capital is the ratio of the firm’s current assets to its current liabilities. This ratio is greatest for Abercrombie & Fitch at 2.4



2-29

P2-51 (30 minutes)

Barth Company Balance Sheet

a. December 31, 2010 Assets Liabilities Cash ................................ $ 8,800 Accounts payable ........... $ 7,500 Accounts receivable ....... 18,400 Equipment .......................... 9,000 Land .................................. 50,000 Equity Stockholders’ equity ....... 78,700 Total assets $86,200 Total liabilities & equity .. $86,200 b. Increase in Equity ($78,700-$67,500) $11,200 Add: Dividends 12,000 Net Income for 2010 23,200 c. Increase in Equity ($78,700-$67,500) $11,200 Add: Dividends 21,000 32,200 Less: Additional Investment 13,500 Net Income for 2010 $18,700 P2-52 (20 minutes) a.

ANF JWN

Total assets (Total liabilities and equity) ......................................................

$2,848 $5,661

Total expenses (Sales – Net income) ..... 3,268 7,871

Total expenses as percent of sales ........ 92%

($3,268/$3,540) 95%

($7,871/$8,272) b.

ANF JWN

Return on average equity…

$272 =15.7%

$401 =34.5% [($2,848-$1,003)+$1,618]/2 [($5,661-$4,451)+$1,115]/2



2-30

P2-53 (30 minutes) a.

3M Current Assets

Long-term Assets

Total Assets

Current Liabilities

Long-term Liabilities

Total Liabilities

Stockholders' Equity

2003 7,720 9,880 17,600 5,082 4,633 9,715 7,885

2004 8,720 11,988 20,708 6,071 4,259 10,330 10,378

2005 7,115 13,398 20,513 5,238 5,175 10,413 10,100

2006 8,946 12,348 21,294 7,323 4,012 11,335 9,959

2007 9,838 14,856 24,694 5,362 7,585 12,947 11,747

2008 9,598 15,949 25,547 5,839 9,829 15,668 9,879

b. 3M’s current assets most likely include cash, accounts receivable,

inventories, and prepaid assets.

Its long-term assets most likely include property, plant and equipment (PPE), goodwill, and other intangible assets that have arisen from acquisitions.

c. 2003: $7,720/$5,082 = 1.52. 2008: $9,598/$5,839 = 1.64. d. 3M’s current ratio is reasonable and has not changed appreciably in the six

years covered by the data. Apparently the company is comfortable with its current liquidity position even though it is below the industry average.



2-31


Abercrombie & Fitch

Current Assets

Long-term Assets

Total Assets

Current Liabilities


Total Liabilities


2002 405 366 771 164 12 176 595

2003 601 394 995 211 34 245 750

2004 753 446 1,199 280 48 328 871

2005 671 718 1,389 429 71 500 889

2006 947 843 1,790 492 303 795 995

2007 1,092 1,156 2,248 511 332 843 1,405

2008 1,140 1,428 2,568 543 406 949 1,619

b. We might reasonably predict inventories to comprise the bulk of its current

assets. In reality, ANF’s largest current asset is cash and short-term investments—suggesting that the company is very liquid.

c. In fiscal year 2002, current assets comprised 53% ($405/$771) of total

assets. In fiscal year 2008, current assets comprised 44% ($1,140/$2,568). Thus, the company has fewer current assets as a percentage of total assets in 2008 than it did 7 years ago.

d. Yes, but the company is less conservatively financed in 2008 [63%:

$1,619/$2,568]. In 2002, stockholders’ equity comprises 77% ($595/$771) of its total capitalization. The average publicly traded firm is about 50% equity financed.

e. In fiscal 2002, ANF’s current ratio is 2.47 ($405/$164). In fiscal 2008 the

ratio is 2.10 ($1,140/$543). f. While less than 2.25, the ratio is reasonable for ANF. The firm’s current

ratio has decreased relative to what it was in 2002. Despite the less liquid position of the firm, this change is likely to be to the firm’s advantage as more of its assets are deployed in productive activities. The change also suggests a less conservative financing of the company.



2-32




+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income 1. Issued common

stock $7,000. +7,000

Cash

=

+7,000 Common

Stock

-

=

2. Paid rent $750. -750 Cash

=

-750

Retained Earnings

-

+750 Rent

Expense

= -750

3. Received $500 invoice for advertising expense.

=

+500 Accounts Payable


-

+500 Advertising

Expense =

-500

4. Borrowed $15,000 cash from bank.

+15,000 Cash

= +15,000

Notes Payable

-

=

5. $1,200 Cash received for services.

+1,200 Cash

=


+1,200 Counseling

Services Revenue

-

=

+1,200

6. Billed clients $6,800 for services.

+6,800 Accounts

Receivable =


+6,800 Services Revenue

-

= +6,800

7. Paid $2,200 cash for salary.

-2,200 Cash

=

-2,200

Retained Earnings

-

+2,200 Salary

Expense =

-2,200

8. Paid $370 cash for utilities.

-370 Cash

=

-370

Retained Earnings

-

+370 Utilities Expense

= -370

9. Paid $900 cash dividend.

-900 Cash

=

-900

Retained Earnings

-

=

10. Acquired land for $13,000.

-13,000 Cash

+13,000 Land = - =

11. Paid $100 interest in cash.

-100 Cash

=


-

+100 Interest Expense

= -100

Totals $5,880 + $19,800 = $15,500 + $7,000 + $3,180 $8,000 - $3,920 = $4,080

b. Lambert Services Income Statement

For the Month of December 2010 Counseling services revenue $8,000 Expenses Rent expense $ 750 Advertising expense 500 Salary expense 2,200 Utilities expense 370

Interest expense 100 Total expenses 3,920 Net income $4,080



2-33

P2-56 (30 minutes) a. 1. Cash (+A) ............................................................................... 7,000 Common stock (+SE) ....................................................... 7,000

2. Rent expense (+E,-SE) ......................................................... 750 Cash (-A) ........................................................................... 750 3. Advertising expense (+E, -SE) ............................................. 500 Accounts payable (+L) ..................................................... 500 4. Cash (+A) ............................................................................... 15,000 Notes payable (+L) ........................................................... 15,000

5. Cash (+A) ............................................................................... 1,200 Counseling services revenue (+R,+SE) .......................... 1,200 6. Accounts receivable (+A) ..................................................... 6,800 Counseling services revenue (+R,+SE) .......................... 6,800

7. Salary expense (+E,-SE) ....................................................... 2,200 Cash (-A) ........................................................................... 2,200 8. Utilities expense (+E,-SE) .................................................... 370 Cash (-A) ........................................................................... 370 9. Retained earnings (dividend paid) (-SE) ............................. 900 Cash (-A) ........................................................................... 900 10. Land (+A) ............................................................................... 13,000 Cash (-A) ........................................................................... 13,000 11. Interest expense (+E,-SE) 100 Cash (-A) ........................................................................... 100



2-34

b.


(1) 7,000 750 (2) 500 (3)

(4) 15,000 2,200 (7) (5) 1,200 370 (8) 900 (9) 13,000 (10) 100 (11)

- Notes Payable (L) +

15,000 (4)

+ Accounts Receivable (A) - - Common Stock (SE) +

(6) 6,800 7,000 (1)

+ Land (A) - - Retained Earnings (SE) +

(10) 13,000 (9) 900

- Counseling Services Rev. (R) +

1,200 (5) 6,800 (6)

+ Rent Expense (E) - + Advertising Expense (E) -

(2) 750 (3) 500

+ Salary Expense (E) - + Utilities Expense (E) -

(7) 2,200 (8) 370

+ Interest Expense (E) -

(11) 100



2-35


CA NCA TA CL NCL TL SE

2004 $ 7,055 $ 995 $ 8,050 $ 2,651 $ 323 $ 2,974 $5,076

2005 10,300 1,251 11,551 3,484 601 4,085 7,466

2006 14,509 2,696 17,205 6,471 750 7,221 9,984

2007 21,956 3,391 25,347 9,280 1,535 10,815 14,532

2008 32,311 7,261 39,572 14,092 4,450 18,542 21,030

2009 36,265 17,586 53,851 19,282 6,737 26,019 27,832

b. For a computer company we might reasonably expect inventories and cash

to be the predominant items in current assets. The reality is that inventory is not a large dollar amount because the company’s business model depends on high inventory turnover—that is, it works diligently to minimize the quantity of inventory to avoid product obsolescence. The surprise is that two-thirds of Apple’s current assets are about equally divided between cash and short-term marketable securities. Long-term assets are primarily concentrated in property, plant and equipment (PPE) and financial securities. The latter grew to over 50% in 2009.

c. The percentage of Apple’s assets that is financed with liabilities has

increased steadily over this period (from 37% in 2004 to 48% in 2009). This increase in the proportion of debt financing coincides with an increase in the proportion of noncurrent assets to total assets (from 12% in 2004 to 33% in 2009).

d. 2004: $7,055/$2,651 = 2.66; 2009: $36,265/$19,282 = 1.88 e. Apple’s current ratio has fallen from above the industry average to below

the industry average. A probable cause of this decrease is the increasing size of the company. Net working capital increased from $4,404 in 2004 to $16,983 in 2009. So, even though the ratio has declined, the monetary “cushion” of current assets over current liabilities has increased substantially.



2-36

P2-58 (30 minutes) a. Harley-Davidson

Current Assets

Long-term Assets

Total Assets

Current Liabilities


Total Liabilities


2003 2,729 2,194 4,923* 956 1,010 1,966 2,958*

2004 3,683 1,800 5,483 1,173 1,092 2,265 3,218

2005 3,145 3,022 6,167 873 2,211 3,084 3,083

2006 3,551 1,981 5,532 1,596 1,179 2,775 2,757

2007 3,467 2,190 5,657 1,905 1,377 3,282 2,375

2008 5,378 2,451 7,829 2,603 3,110 5,713 2,116

* Due to rounding, total assets of $4,923 has a $1 difference from total liabilities and equity of $4,924.

b. Harley’s current assets are likely to be comprised of cash, accounts receivable, inventories and prepaid expenses.

Its long-term assets will likely be comprised of property, plant and equipment (PPE) for its manufacturing operations and goodwill and other intangible assets arising from acquisitions.

c. No, stockholders’ equity represents only 27% ($2,116/$7,829) of total

capitalization. However, this ratio was 60% in 2003. Harley Davidson became significantly more leveraged in 2008. The capitalization of the average publicly traded company is financed through about 50% of equity and about 50% nonowner financing.

d. 2003: $2,729 - $956 = $1,773. 2008: $5,378 - $2,603 = $2,775.



2-37


($ millions) Revenues Cost of

Goods Sold Gross Profit

Operating Expenses

Operating Income

Other Expenses

Net Income

2002 9,893 6,005 3,888 2,820 1,068 405 663

2003 10,697 6,313 4,384 3,138 1,246 772 474

2004 12,253 7,001 5,252 3,702 1,550 604 946

2005 13,740 7,625 6,115 4,222 1,893 682 1,211

2006 14,955 8,368 6,587 4,478 2,109 717 1,392

2007 16,326 9,165 7,161 5,029 2,132 640 1,492

2008 18,627 10,240 8,387 5,954 2,433 550 1,883

b. The gross profit percentage (also called gross profit margin) for each year

follows:

Nike, Inc. Gross Profit Percentage

2002 ....................... 39.3%

2003 ....................... 41.0%

2004 ....................... 42.9%

2005 ....................... 44.5%

2006 ....................... 44.0%

2007 ....................... 43.9%

2008 ....................... 45.0%

Nike’s gross profit has fluctuated over this period, and it is somewhat higher recently than it has been in earlier years reflecting continued strength and a possible upward trend. The company's operating expenses have grown substantially over this period, from 28.5% of revenue to 32.0% of revenue, but net income has increased steadily from 2002 to 2008 both in absolute terms and as a percentage of revenue.

c. Cost of goods sold, wages, and selling and administration expenses are

likely to be the major cost categories for Nike.



2-38




+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income 1. Issued common

stock for cash. +$50,000

Cash

=

+$50,000 Common

Stock

-

=

2. Rent paid in cash $4,800.

-4,800 Cash

=


-

+4,800 Rent Expense =

-4,800

3. Invoice for entertainment expense: $1,600.

=


-1,600

Retained Earnings

-

+1,600 Entertainment

Expense =

-1,600

4. Cash paid for advertising: $900.

-900 Cash

=


-

+900 Advertising

Expense =

-900

5. July insurance premium prepaid in cash: $1,800.

-1,800 Cash

+1,800 Prepaid

Insurance =

-

=

6. Flight services collected in cash $22,700.

+22,700 Cash

=


+22,700 Flight

Services Revenue

-

=

+22,700

7. Billed for flight services $15,900.

+15,900 Accounts

Receivable =


+15,900 Flight

Services Revenue

-

=

+15,900

8. Paid $1,500 on accounts.

-1,500 Cash

=

-1,500 Accounts Payable

-

=

9. Received $13,200 on account.

+13,200 Cash

-13,200 Accounts

Receivable =

-

=

10. Paid wages in cash: $16,000.

-16,000 Cash

=


-

+16,000 Wages

expense =

-16,000

11. Invoice received for fuel; $3,500.

=


-3,500

Retained Earnings

-

+3,500 Fuel Expense =

-3,500

12. Cash dividend paid: $3,000.

-3,000 Cash

=


-

=

TOTALS $57,900 + $4,500 = $3,600 + $50,000 + $8,800 $38,600 - $26,800 = $11,800



2-39

b. Outback Flights

INCOME STATEMENT FOR THE MONTH OF JUNE 2010

Revenue Services fees earned $38,600 Expenses Rent expense $4,800 Entertainment expense 1,600 Advertising expense 900 Wages expense 16,000 Fuel expense 3,500 Total expenses 26,800 Net income $11,800

Note that the insurance premium paid is for the next month (July) and is not an expense at the end of June. P2-61 (30 minutes) a. 1. Cash (+A) ............................................................................... 50,000 Common stock (+SE) ....................................................... 50,000

2. Rent expense (+E,-SE) ......................................................... 4,800 Cash (-A) ........................................................................... 4,800 3. Entertainment expense (+E,-SE) ......................................... 1,600 Accounts payable (+L) ..................................................... 1,600 4. Advertising expense (+E,-SE) .............................................. 900 Cash (-A) ........................................................................... 900

5. Prepaid insurance (+A) ........................................................ 1,800 Cash (-A) ........................................................................... 1,800 6. Cash (+A) .............................................................................. 22,700 Flight services revenue (+R,+SE) .................................... 22,700

7. Accounts receivable (+A) ..................................................... 15,900 Flight services revenue (+R,+SE) .................................... 15,900 8. Accounts payable (-L) .......................................................... 1,500 Cash (-A) ........................................................................... 1,500



2-40

9. Cash (+A) ............................................................................... 13,200 Accounts receivable (-A) ................................................. 13,200 10. Wages expense (+E,-SE) ...................................................... 16,000 Cash (-A) ........................................................................... 16,000 11. Fuel expense (+E,-SE) .......................................................... 3,500 Accounts payable (+L) ..................................................... 3,500 12. Retained earnings (dividend paid) (-SE) ............................. 3,000 Cash (-A) ........................................................................... 3,000 b.


(1) 50,000 4,800 (2) (8) 1,500 1,600 (3) (6) 22,700 900 (4) 3,500 (11)

(9) 13,200 1,800 (5) 1,500 (8)

16,000 (10) - Common Stock (SE) +

3,000 (12) 50,000 (1)

+ Accounts Receivable (A) - - Retained Earnings (SE) +

(7) 15,900 (9) 13,200 (12) 3,000

+ Prepaid Insurance (A) - - Flight Services Revenue (R) +

(5) 1,800 22,700 (6)

15,900 (7)

+ Rent Expense (E) - + Entertainment Expense (E) -

(2) 4,800 (3) 1,600

+ Advertising Expense (E) - + Wages Expense (E) -

(4) 900 (10) 16,000

+ Fuel Expense (E) -

(11) 3,500



2-41


Starbucks Sales Cost of


Operating Expenses

Operating Income

Other Expenses

Net Income

2003 4,076 1,686 2,390 1,965 425 157 268

2004 5,294 2,191 3,103 2,497 606 217 389

2005 6,369 2,605 3,764 2,983 781 287 494

2006 7,787 3,179 4,608 3,715 893 329 564

2007 9,412 3,999 5,413 4,359 1,054 381 673

2008 10,383 4,645 5,738 5,234 504 188 316

2009 9,775 4,325 5,450 4,888 562 171 391

b. The gross profit percentage (also called gross profit margin) for each year

follows:

Starbucks, Inc. Gross Profit Percentage

2003 58.6%

2004 58.6%

2005 59.1%

2006 59.2%

2007 57.5%

2008 55.3%

2009 55.8% SBUX gross profit percentage has declined since 2007 reflecting the

decline of in-store sales over the last several years. c. Cost of goods sold, wages, and advertising expenses are likely to be major

cost categories for Starbucks.



2-42


($ millions) Revenues Cost of


Operating Expenses

Operating Income

Other Expenses

Net Income

2002 42,722 29,260 13,462 10,198 3,264 1,610 1,654

2003 46,781 31,790 14,991 11,472 3,519 1,678 1,841

2004 45,682 31,445 14,237 10,636 3,601 403 3,198

2005 51,271 34,927 16,344 12,021 4,323 1,915 2,408

2006 57,878 39,399 18,479 13,410 5,069 2,282 2,787

2007 61,471 41,895 19,576 14,304 5,272 2,423 2,849

2008 62,884 44,157 18,727 14,325 4,402 2,188 2,214

Table notes: 1. Sales and Cost of Goods Sold relate only to product sales. Target’s

credit card revenue and costs are netted and included in operating expenses.

2. Target’s Other Expenses is small in 2004 because it includes a large

gain on discontinued operations (the sale of Marshall Field’s and Mervyn’s stores). Those transactions also account for the drop in revenues from 2003 to 2004. All numbers are as reported in that fiscal year – not as subsequently restated for discontinued operations.



2-43

b. The gross profit percentage (also called gross profit margin) for each year follows:

Target Corporation Gross Profit Percentage

2002 31.5%

2003 32.0%

2004 31.2%

2005 31.9%

2006 31.9%

2007 31.8%

2008 29.8%

Target’s gross profit percentage has decreased over the past two years.

The decline reflects the difficult economic conditions and declining consumer spending that occurred during that period.

c. Cost of goods sold, wages, and advertising expenses are likely to be the

major cost categories for Target Corporation. P2-64 (25 minutes) a.

Geyer, Inc. Income Statement

For Year Ended December 31, 2011

Service fees........................................................................................... $67,600

Supplies expense ................................................................................. $ 9,700

Insurance expense ............................................................................... 1,500

Salaries expense .................................................................................. 30,000

Advertising expense ............................................................................ 1,700

Rent expense ........................................................................................ 7,500

Miscellaneous expense ........................................................................ 200

Total expenses ................................................................................ 50,600

Net income ............................................................................................ $17,000



2-44

b.

Geyer, Inc. Statement of Stockholders’ Equity For Year Ended December 31, 2011

Common Stock

Retained Earnings

Total Stockholders’ Equity

Balance at December 31, 2010 ............ $4,000 $6,200 $10,200

Stock issuance ..................................... 1,400 1,400

Dividends ............................................. (13,500) (13,500)

Net income ........................................... _____ 17,000 17,000

Balance at December 31, 2011 ............ $5,400 $9,700 $15,100

c.

Geyer, Inc. Balance Sheet

December 31, 2011

Cash ..................................... $14,800 Accounts payable .............................. $ 1,800

Supplies ............................... 6,100 Notes payable .................................... 4,000

Total assets ......................... $20,900 Total liabilities ……………… 5,800

Common stock ………………. 5,400

Retained earnings* …………. 9,700

Total liabilities and equities .. $20,900 * $6,200 beginning balance + $17,000 net income - $13,500 dividend



2-45

P2-65 (45 minutes) a & b.



+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income Beginning Balances +5,000 +5,200 = +3,500 +5,500 +1,200 -

1. Paid $600 cash toward accounts payable

-600 Cash

=

-600 Accounts Payable

-

=

2. Paid rent in cash: $3,600

-3,600 Cash

=


-

+3,600 Rent

Expense =

-3,600

3. Billed clients $11,500

+11,500 Accounts

Receivable

=



-

= +11,500

4. $500 invoice received for advertising

=



-

+500 Advertising

Expense

=

-500

5. Cash collected on account: $10,000

+10,000 Cash

-10,000 Accounts

Receivable =

-

=

6. Paid wages expense in cash: $2,400

-2,400 Cash

=


-

+2,400 Wages

Expense =

-2,400

7. Invoiced for utility expense: $680

=


-680

Retained Earnings

-


= -680

8. Paid $20 cash for interest on note

-20 Cash

=


-


= -20

9. Paid $900 cash dividend

-900 Cash

=


-

=

10. Paid $4,000 cash for sound equipment

-4,000 Cash

+4,000 Equipment =

-

=

TOTALS $3,480 + $10,700 = $4,080 + $5,500 + $4,600 $11,500 - $7,200 = $4,300



2-46

c.

Schrand Aerobics, Inc. Income Statement

For Month Ended January 31, 2011

Sales revenue ....................................................................................... $11,500

Expenses ...............................................................................................

Rent expense ................................................................................... $3,600

Advertising expense ....................................................................... 500

Wages expense ............................................................................... 2,400

Interest expense .............................................................................. 20

Utilities expense .............................................................................. 680

Total expenses ...................................................................................... 7,200

Net income ....................................................................................... $4,300

d.

Schrand Aerobics, Inc. Statement of Stockholders’ Equity For Month Ended January 31, 2011

Common Stock

Retained Earnings

Total Stockholders’

Equity

Balance at January 1, 2011 .................. $5,500 $1,200 $6,700

Stock issuance .....................................

Dividends ............................................. (900) (900)

Net income ........................................... _____ 4,300 4,300

Balance at January 31, 2011 ................ $5,500 $4,600 $10,100

e.

Schrand Aerobics, Inc. Balance Sheet

January 31, 2011

Cash ..................................... $3,480 Accounts payable .......................... $ 1,580

Accounts receivable ........... 6,700 Notes payable ................................. 2,500

Equipment ............................ 4,000 Total liabilities ................................. 4,080

Total assets ……………. $14,180 Common stock ................................ 5,500

Retained earnings …………….. 4,600

Total liabilities and equity .............. $14,180



2-47

P2-66 (30 minutes) a. 1. Accounts payable (-L) .......................................................... 600 Cash (+A) .......................................................................... 600

2. Rent expense (+E,-SE) ......................................................... 3,600 Cash (-A) ........................................................................... 3,600 3. Accounts receivable (+A) ..................................................... 11,500 Services revenue (+R,+SE) .............................................. 11,500 4. Advertising expense (+E, -SE) ............................................. 500 Accounts payable (+L) ..................................................... 500

5. Cash (+A) ............................................................................... 10,000 Accounts receivable (-A) ................................................. 10,000 6. Wages expense (+E, -SE) ..................................................... 2,400 Cash (-A) ........................................................................... 2,400

7. Utilities expense (+E, -SE) ................................................... 680 Accounts payable (+L) ..................................................... 680 8. Interest expense (+E, -SE) ................................................... 20 Cash (-A) ........................................................................... 20 9. Retained earnings (-SE) ....................................................... 900 Cash (-A) ........................................................................... 900 10. Equipment (+A) ..................................................................... 4,000 Cash (-A) ........................................................................... 4,000



2-48

b.


Beg. Bal. 5,000 600 (1) (1) 600 1,000 Beg. Bal. (5) 10,000 3,600 (2) 500 (4) 2,400 (6) 680 (7)

20 (8) 1,580 End Bal.

900 (9) - Notes Payable (L) +

4,000 (10) 2,500 Beg. Bal.

End Bal. 3,480

2,500 End Bal.

+ Accounts Receivable (A) - - Common Stock (SE) +

Beg. Bal. 5,200 10,000 (5) 5,500 Beg. Bal. (3) 11,500

End Bal. 6,700 5,500 End Bal.

+ Equipment (A) - - Retained Earnings (SE) +

(10) 4,000 (9) 900 1,200 Beg. Bal.

End Bal. 4,000 300 End Bal.

- Services Revenue (R) +

11,500 (3)

11,500 End Bal.

+ Rent Expense (E) - + Utilities Expense (E) -

(2) 3,600 (7) 680

End Bal. 3,600 End Bal. 680

+ Advertising Expense (E) - + Interest Expense (E) -

(4) 500 (8) 20

End Bal. 20

End Bal. 500


(6) 2,400

End Bal. 2,400



2-49

P2-67 (45 minutes) a & b.



+ Noncash Assets

= Liabil-ities

+ Contrib. Capital

+ Earned Capital


Income Beginning Balances +6,700 +14,800 +3,100 +6,000 +12,400

1. Paid $950 cash for rent.

-950 Cash

=


-

+950 Rent

Expense

= -$950

2. Received $8,800 cash on account.

+8,800 Cash

-8,800 Accounts

Receivable

=

-

=

3. $500 paid on accts. payable.

-500 Cash

=

-500 Accounts Payable

-

=

4. Received $1,600 cash for services.

+1,600 Cash

=



-

= +1,600

5. Borrowed $5,000 signed note.

+5,000 Cash

=

+5,000 Notes

Payable

-

=

6. Billed $8,100 for services.

+8,100 Accounts

Receivable =



-

= +8,100

7. Paid $4,000 for cash salary.

-4,000 Cash

=


-

+4,000 Salary

Expense =

-4,000

8. Received invoice for utilities: $410.

=


-410

Retained Earnings

-


= -410

9. Paid $6,000 dividend.

-6,000 Cash

=


-

=

10. Paid $9,800 cash for vehicle.

-9,800 Cash

+9,800 Vehicles =

-

=

11. Paid $50 cash interest on note.

-50 Cash

=


-


= -50

TOTALS $800 + $23,900 = $8,010 + $6,000 + $10,690 $9,700 - $5,410 = $4,290

c.

Kross, Inc. Income Statement

For Month Ended January 31, 2011

Services revenue .................................................................................. $9,700

Rent expense……………………………………………………... $ 950

Utilities expense…………………………………………….…… 410

Salary expense………………………………………….……….. 4,000

Interest expense………………………………………….……... 50

Total expenses ...................................................................................... 5,410

Net income ....................................................................................... $4,290



2-50

d.

Kross, Inc. Statement of Stockholders’ Equity For Month Ended January 31, 2011

Common Stock

Retained Earnings

Total Stockholders’

Equity

Balance at January 1, 2011 .................. $6,000 $12,400 $18,400

Stock issuance .....................................

Dividends ............................................. (6,000) (6,000)

Net income ........................................... _____ 4,290 4,290

Balance at January 31, 2011 ................ $6,000 $10,690 $16,690

e.

Kross, Inc. Balance Sheet

January 31, 2011

Cash ..................................... $ 800 Accounts payable ........................... $ 510

Accounts receivable ........... 14,100 Notes payable .................................. 7,500

Equipment ............................ 9,800 Total liabilities ................................. 8,010

Total assets ......................... $24,700

Common stock ................................ 6,000

Retained earnings ........................... 10,690

Total liabilities and equity .............. $24,700



2-51

P2-68 (30 minutes) a. 1. Rent expense (+E,-SE) ......................................................... 950 Cash (-A) ........................................................................... 950

2. Cash (+A) ............................................................................... 8,800 Accounts receivable (-A) ................................................. 8,800 3. Accounts payable (-L) .......................................................... 500 Cash (-A) ........................................................................... 500 4. Cash (+A) ............................................................................... 1,600 Services revenue (+R,+SE) .............................................. 1,600

5. Cash (+A) ............................................................................... 5,000 Notes payable (+L) ........................................................... 5,000 6. Accounts receivable (+A) ..................................................... 8,100 Services revenue (+R, +SE) ............................................. 8,100

7. Salary expense (+E,-SE) ....................................................... 4,000 Cash (-A) ........................................................................... 4,000 8. Utilities expense (+E,-SE) .................................................... 410 Accounts payable (+L) ..................................................... 410 9. Retained earnings (-SE) ....................................................... 6,000 Cash (-A) ........................................................................... 6,000 10. Vehicles (+A) ......................................................................... 9,800 Cash (-A) ........................................................................... 9,800 11. Interest expense (+E,-SE) .................................................... 50 Cash (-A) ............................................................................ 50



2-52

b.

+ Cash (A) - + Utilities Expense (E) -

Beg. Bal. 6,700 950 (1) (8) 410

(2) 8,800 500 (3) (4) 1,600 4,000 (7) (5) 5,000 6,000 (9)

9,800 (10) + Interest Expense (E) -

50 (11) (11) 50

+ Accounts Receivable (A) - - Accounts Payable (L) +

Beg. Bal. 14,800 8,800 (2) (3) 500 600 Beg. Bal.

(6) 8,100 410 (8)

+ Vehicles (A) - - Notes Payable (L) +

(10) 9,800 2,500 Beg. Bal.

5,000 (5)


6,000 Beg. Bal.

+ Rent Expense (E) - - Retained Earnings (SE) +

(1) 950 (9) 6,000 12,400 Beg. Bal.

+ Salary Expense (E) - - Services Revenue (R) +

(7) 4,000 1,600 (4)

8,100 (6)



2-53

CASES and PROJECTS C2-69 (30 minutes)

WILDLIFE PICTURE GALLERY

INCOME STATEMENT FOR THE MONTH OF MARCH 2011

a. Revenues Commissions earned ………………………….. $28,500 Expenses Rent expense $ 900 Wages expense 4,900 Utilities expense 350 Delivery expense 1,700 Total expenses 7,850 Net income $20,650 b.

WILDLIFE PICTURE GALLERY Statement of Stockholders’ Equity

For the Month of MARCH 2011

Common Stock

Retained Earnings

Stockholders’ Equity

Balance at March 1, 2011 ..................... $0 $0 $0

Stock issuance ..................................... 6,500 6,500

Dividends .............................................

Net income ........................................... _____ 20,650 20,650

Balance at March 31, 2011 ................... $6,500 $20,650 $27,150



2-54

c. WILDLIFE PICTURE GALLERY BALANCE SHEET MARCH 31, 2011

Assets Liabilities Cash $51,200 Payable to artists** $12,500 Advance recvbl.* 500 Notes payable 10,000 Accounts payable 2,050 Total liabilities 24,550 Stockholders’ equity 27,150 Total liabilities and Total assets $51,700 stockholders’ equity $51,700 * It is important to recognize that the Wildlife Picture Gallery is a separate entity from its shareholder/operator, Sarah Penney. The $500 payment for airfare is not an expense of the business, but rather a payment on behalf of an employee. Sarah will have to reimburse the company or have the amount deducted in future compensation, as recognized in the advance receivable asset for Wildlife Picture Gallery. **70%($95,000) – $54,000 is owed to artists.



2-55

C2-70 (30 minutes) Andrea faces a dilemma when she prepares her expense reimbursement request. She has, in essence, been asked by her supervisor to join him in overcharging expenses to the company. Should Andrea not file a reimbursement request for the Luxury Inn lodging costs, the company may question why she and her supervisor stayed at different locations. Discussion of this case should focus on the options available to Andrea. The options include the following: 1. File an expense reimbursement request for the Luxury Inn and, therefore,

minimize the likelihood of jeopardizing her relationship with her supervisor. 2. File an expense reimbursement request for the Spartan Inn and let future events

take whatever course they follow. 3. Report the situation to her supervisor's boss. 4. Discuss the situation with her supervisor and indicate that she (Andrea) is not

comfortable with filing the Luxury Inn receipt. Perhaps encourage the supervisor to seek a change in company policy to provide daily allowances for lodging and meal costs rather than reimbursing actual costs.

5. Leave the employ of the company. There is no single correct answer to the problem. The first choice is not a good solution for the long run as it starts a slippery slope for Andrea, which is likely to lead to further concessions to proper behavior and more serious problems. Additional and more serious situations increase the chances her behavior is likely to be discovered and she could be fired or even sent to jail. One would hope that sleepless nights would intervene long before this time. It is better to draw the line here. Talking to her supervisor is a good idea and perhaps instituting a policy that avoids any temptation. Leaving the company would be a fallback choice if discussion of the situation does not lead to a resolution of the situation that preserves Andrea’s ethical requirements.

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