Spiceland SM Ch03

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© The McGraw-Hill Companies, Inc., 2007

Solutions Manual, Vol.1, Chapter 3 3-1

Question 3-1The purpose of the balance sheet, also known as the statement of financial position, is to

present the financial position of the company on a particular date. Unlike the income statementwhich is a change statement that reports events occurring during a period of time, the balance sheetis a statement that presents an organized array of assets, liabilities, and shareholders’ equity at a point in time. It is a freeze frame or snapshot picture of financial position at the end of a particularday marking the end of an accounting period.

Question 3-2The balance sheet does not portray the market value of the entity for a number of reasons.Most assets are not reported at market value, but instead are measured according to historical costAlso, there are certain resources, such as trained employees, an experienced management team, anda good reputation, that are not recorded as assets at all. Therefore, the assets of a company minus itsliabilities, as shown in the balance sheet, will not be representative of the company’s market value.

Question 3-3Current assets include cash and other assets that are reasonably expected to be converted to

cash or consumed during one year, or within the normal operating cycle of the business if theoperating cycle is longer than one year. The typical asset categories classified as current assets

include:

— Cash and cash equivalents — Short-term investments — Accounts receivable — Inventories — Prepaid expenses

Question 3-4Current liabilities are those obligations that are expected to be satisfied through the use of

current assets or the creation of other current liabilities. So, this classification will include alliabilities that are scheduled to be liquidated within one year or the operating cycle, whichever islonger, except those that management intends to refinance on a long-term basis. The typical liabilitycategories classified as current liabilities include:

— Accounts payable — Short-term notes payable — Accrued liabilities — Current maturities of long-term debt

Chapter 3 The Balance Sheet and Financial Disclosures

QUESTIONS FOR REVIEW OF KEY TOPICS

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3-2 Intermediate Accounting, 4/e

Answers to Questions (continued)

Question 3-5The operating cycle for a typical manufacturing company refers to the period of time required

to convert cash to raw materials, raw materials to a finished product, finished product to receivables,

and then finally receivables back to cash.

Question 3-6Investments in equity securities are classified as current if the company’s management (1)

intends to liquidate the investment in the next year or operating cycle, whichever is longer, and (2)has the ability to do so, i.e., the investment is marketable. If either of these criteria does not hold, theinvestment is classified as noncurrent.

Question 3-7The common characteristics that these assets have in common are that they are tangible, long-

lived assets used in the operations of the business. They usually are the primary revenue-generating

assets of the business. These assets include land, buildings, equipment, machinery, furniture andother assets used in the operations of the business, as well as natural resources, such as mineralmines, timber tracts and oil wells.

Question 3-8Property, plant, and equipment and intangible assets each represent assets that are long-lived

and are used in the operations of the business. The difference is that property, plant, and equipmentrepresent physical assets, while intangibles lack physical substance. Generally, intangibles representthe ownership of an exclusive right, such as a patent, copyright or franchise.

Question 3-9

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

Question 3-10Paid-in-capital consists of amounts invested by shareholders in the corporation. Retained

earnings equals net income less dividends paid to shareholders from the inception of the corporation.

Question 3-11Disclosure notes provide additional detail concerning specific financial statement items.

Included are such data as the market values of financial instruments and off-balance-sheet risk

associated with financial instruments and details of pension plans, leases, debt, and assets. Commonto all companies’ disclosures are certain specific notes such as a summary of significant accounting policies, descriptions of subsequent events, and related third-party transactions. However, manynotes are designed to fit the disclosure needs of the particular reporting company. In fact, anyexplanation that helps investors and creditors make decisions should be included.






Answers to Questions (continued)

Question 3-12The disclosure of the company’s significant accounting policies is extremely important to

external users in terms of their ability to compare financial information across companies. It is

critical to a financial analyst involved in assessing future cash flows of two construction companiesto know that one company uses the percentage-of-completion method in recognizing gross profitwhile the other company uses the completed contract method.

Question 3-13A subsequent event is an event that occurs after the date of the financial statements but prior to

the date on which the statements are actually issued. It may help to clarify a previously existingsituation or it may represent a new event not directly affecting financial position at the end of thereporting period.

Question 3-14

The discussion provides management’s views on significant events, trends and uncertainties pertaining to the company’s (a) operations, (b) liquidity, and (c) capital resources. Certainly theManagement Discussion and Analysis section may be slanted to management’s biased perspectiveand therefore can lack objectivity. However, management can offer an informed insight that mighnot be available elsewhere, so if the reader maintains awareness of the information’s source, it canoffer a unique view of the situation.

Question 3-15Depending on the circumstances, the auditor will issue a (an):

1. Unqualified opinion – The auditors are satisfied that the financial statements “present fairly” thefinancial position, results of operations, and cash flows and are “prepared in accordance with

generally accepted accounting principles.”2. Qualified opinion – This contains an exception to the standard unqualified opinion, but not of

sufficient seriousness to invalidate the financial statements as a whole. Examples of exceptionsare (a) unconformity with generally accepted accounting principles, (b) inadequate disclosuresand (c) a limitation or restriction of the scope of the examination.

3. Adverse opinion – This is necessary when the exceptions are so serious that a qualified opinionis not justified. Adverse opinions are rare because auditors usually are able to persuademanagement to rectify problems to avoid this undesirable report.

4. Disclaimer – An auditor will disclaim an opinion if insufficient information has been gatheredto express an opinion.

Question 3-16A proxy statement must be sent each year to all shareholders. It usually is in the same mailing

with the annual report. The statement invites shareholders to the shareholders’ meeting to elec board members and to vote on issues before the shareholders. It also permits shareholders to voteusing an enclosed proxy card. Beginning with 1992 financial statements, the proxy statement also provides for more disclosures on compensation to directors and executives, and in particular, stockoptions granted to executives.






Answers to Questions (concluded)

Question 3-17Working capital is the difference between current assets and current liabilities. The current

ratio is computed by dividing current assets by current liabilities. The acid-test ratio (or quick ratio)is computed by dividing quick assets (cash and cash equivalents, marketable securities, and accountsreceivable) by current liabilities.

Question 3-18

Debt to equity ratio = Total liabilitiesShareholders' equity

Times interest earned ratio = Net income + interest + taxes

Interest

Question 3-19An operating segment is a component of an enterprise:

1. That engages in business activities from which it may earn revenues and incur expenses(including revenues and expenses relating to transactions with other components of the sameenterprise).

2. Whose operating results are regularly reviewed by the enterprise's chief operating decision-maker to make decisions about resources to be allocated to the segment, and to assess its

performance.3. For which discrete financial information is available.

Question 3-20For areas determined to be reportable operating segments, the following disclosures are required:

1. General information about the operating segment,2. Information about reported segment profit or loss, including certain revenues and expenses

included in reported segment profit or loss, segments assets, and the basis of measurement.3. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other

significant items to corresponding enterprise amounts.4. Interim period information.






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

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

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

Brief Exercise 3-3Assets: $ 52,000 current assets

80,000 equipment$132,000 total assets

minus

Liabilities $ 24,000 current liabilities30,000 notes payable54,000 total liabilities

equalsShareholders’ equity $78,000

(50,000) common stock$28,000 retained earnings

BRIEF EXERCISES






Brief Exercise 3-4

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

K and J Nursery, Inc. Balance Sheet

At December 31, 2006

Assets Current assets:

Cash ................................................................. $ 16,000Accounts receivable ......................................... 11,000Inventories ....................................................... 25,000

Total current assets ...................................... 52,000

Property, plant, and equipment:

Equipment ........................................................ $140,000Less: Accumulated depreciation ....................... (60,000)

Net property, plant, and equipment ............. 80,000Total assets ............................................... $132,000

Liabilities and Shareholders' Equity

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

Total current liabilities ................................ 24,000

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

Shareholders’ equity:

Common stock ................................................. $50,000Retained earnings* ........................................... 28,000

Total shareholders’ equity ........................... 78,000Total liabilities and shareholders’ equity $132,000






Brief Exercise 3-5

Culver City Lighting, Inc. Balance Sheet



Cash ................................................................. $ 55,000Accounts receivable ......................................... 39,000Inventories ....................................................... 45,000Prepaid insurance ............................................. 15,000


Property, plant, and equipment: Equipment ........................................................ $100,000Less: Accumulated depreciation ....................... (34,000)

Net property, plant, and equipment ............. 66,000

Intangibles: Patent ............................................................. 40,000

Total assets ............................................... $260,000


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


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


Common stock ................................................. $70,000

Retained earnings ............................................. 76,000Total shareholders’ equity ........................... 146,000

Total liabilities and shareholders’ equity $260,000






Brief Exercise 3-61. The $30,000 should be classified as a noncurrent asset, under the

investments and funds classification.2. $10,000, next year’s installment, should be classified as a current liability,

current maturities of long-term debt. The remaining $90,000 is included inlong-term liabilities.

3. Two-thirds of the unearned revenue, $40,000, should be classified as acurrent liability, the remaining $20,000 as a long-term liability.

Brief Exercise 3-7Current assets – cash and cash equivalents – accounts receivable = Inventories

$235,000 – 40,000 – 120,000 = $75,000

Total assets – current assets = property, plant, and equipment$400,000 – 235,000 = $165,000

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

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

Brief Exercise 3-8(1) A

(2) B

(3) B

(4) A

(5) B

(6) A

Brief Exercise 3-9(a) Current assets ÷ current liabilities






($55,000 + 39,000 + 45,000 + 15,000) ÷ ($12,000 + 2,000 + 10,000)

$154,000 ÷ $24,000 = 6.42

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

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

(c) Total liabilities ÷ shareholders’ equity

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

Brief Exercise 3-10Paying accounts payable reduces both current assets and current liabilities. If

the ratio before the payment were above 1.0, the transaction would cause the ratioto increase. However, if the ratio before the transaction were less than 1.0, theratio would decrease.

Brief Exercise 3-11

Acid-test ratio = (cash + short-term investments + A/R) ÷ current liabilities1.5 = ($20,000 + 0 + 40,000) ÷ current liabilities

1.5 x current liabilities = $60,000current liabilities = $60,000 ÷ 1.5

current liabilities = $40,000

Current ratio = current assets ÷ current liabilities

2.0 = current assets ÷ $40,000

current assets = $40,000 x 2.0

current assets = $80,000$80,000 – 20,000(cash) – 40,000(A/R) = $20,000 inventories






Exercise 3-11. Total current assets

Current liabilities = $44,000 + 15,000 + 1,000 (accrued interest)= $60,000

Since the current ratio is 1.5:1, current assets = 1.5 x $60,000 = $90,000

2. Short-term investments

$90,000 - 5,000 - 20,000 - 60,000 = $5,000

3. Retained earnings

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

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

RE = $20,000

Exercise 3-2

1. c Equipment 10. a Inventories2. f Accounts payable 11. d Patent3. -a Allowance for uncollectible accounts 12. c Land, in use4. b _ Land, held for investment 13. f Accrued liabilities5. g _ Note payable, due in 5 years 14. a Prepaid rent6. f Unearned rent revenue 15. h Common stock7. f Note payable, due in 6 months 16. c Building, in use8. i Income less dividends, accumulated 17. a Cash9. b Investment in XYZ Corp., long-term 18. f Taxes payable

EXERCISES






Exercise 3-3

1. f Accrued interest payable 10. a Supplies2. d Franchise 11. c Machinery

3. -c Accumulated depreciation 12. c Land, in use4. e Prepaid insurance, for 2005 13. f Unearned revenue5. g Bonds payable, due in 10 years 14. d Copyrights6. f Current maturities of long-term debt 15. h Preferred stock7. f Note payable, due in 3 months 16. b Land, held for speculation8. b Long-term receivables 17. a Cash equivalents9. b Bond sinking fund, will be used to 18. f Wages payable

retire bonds in 10 years






Exercise 3-4

JACKSON CORPORATION Balance Sheet



Cash ................................................................. $ 40,000Marketable securities ........................................ 10,000Accounts receivable ......................................... 34,000

Inventories ....................................................... 75,000Prepaid rent ...................................................... 16,000


Property, plant, and equipment: Machinery ........................................................ $145,000Less: Accumulated depreciation ....................... (11,000)

Net property, plant, and equipment ............. 134,000

Intangibles: Patent ............................................................. 83,000

Total assets ............................................... $392,000

Liabilities and Shareholders' EquityCurrent liabilities:

Accounts payable ............................................. $ 8,000Wages payable ................................................. 4,000Taxes payable ................................................... 32,000


Long-term liabilities:

Bonds payable .................................................. 200,000

Shareholders’ equity:Common stock ................................................. $100,000Retained earnings ............................................. 48,000







Exercise 3-5

VALLEY PUMP CORPORATION Balance Sheet



Cash ............................................................................. $ 25,000Marketable securities .................................................... 22,000Accounts receivable, net of allowance for

uncollectible accounts of $5,000 ............................. 51,000Inventories .................................................................... 81,000Prepaid expenses .......................................................... 32,000

Total current assets ................................................. 211,000

Investments: Marketable securities .................................................... $22,000

Land ............................................................................. 20,000Total investments .................................................... 42,000

Property, plant, and equipment: Land ............................................................................. 100,000Buildings ...................................................................... 300,000Equipment .................................................................... 75,000

475,000Less: Accumulated depreciation ................................... (125,000)

Net property, plant, and equipment ......................... 350,000

Intangibles:

Copyright ..................................................................... 12,000Total assets .......................................................... $615,000


Current liabilities: Accounts payable .......................................................... $ 65,000Interest payable ............................................................. 10,000Unearned revenues ....................................................... 20,000 Note payable ................................................................. 100,000Current maturities of long-term debt ............................. 50,000

Total current liabilities ............................................ 245,000


Note payable ................................................................. 100,000

Shareholders’ equity: Common stock .............................................................. $200,000Retained earnings ......................................................... 70,000

Total shareholders’ equity ....................................... 270,000Total liabilities and shareholders’ equity .............. $615,000






Exercise 3-6

LOS GATOS CORPORATION Balance Sheet



Cash ....................................................................... $ 20,000Accounts receivable, net of allowance for

uncollectible accounts of $5,000 ......................... 55,000Inventories ............................................................. 55,000

Total current assets ........................................... 130,000

Investments: Bond sinking fund .................................................. $ 20,000

Note receivable ...................................................... 20,000Total investments .............................................. 40,000

Property, plant, and equipment: Machinery .............................................................. 190,000Less: Accumulated depreciation ............................. (70,000)

Net property, plant, and equipment ................... 120,000

Intangibles: Franchise ................................................................ 30,000

Total assets ..................................................... $320,000

Liabilities and Shareholders' EquityCurrent liabilities:

Accounts payable ................................................... $ 50,000Interest payable ...................................................... 5,000 Note payable .......................................................... 50,000

Total current liabilities ...................................... 105,000

Long-term liabilities: Bonds payable ........................................................ 110,000


Common stock, no par value; 100,000 sharesauthorized; 50,000 shares issued and outstanding $ 70,000Retained earnings ................................................... 35,000

Total shareholders’ equity ................................. 105,000Total liabilities and shareholders’ equity ........ $320,000






Exercise 3-7

CONE CORPORATION

Balance Sheet (Partial)At December 31, 2006


Marketable securities ........................................ $ 40,000Prepaid rent ...................................................... 12,000

Investments: Bond sinking fund ............................................ 50,000Marketable securities ........................................ 40,000

Other assets: Prepaid rent (1) .................................................. 12,000


Current liabilities: Interest payable ................................................. $ 12,000Current maturities of long-term debt ................. 20,000


Note payable ..................................................... 180,000

(1) Note: In practice, companies often report all prepaid expenses ascurrent assets.






Exercise 3-8See calculations below the balance sheet.

Exercise 3-8 (concluded)

Korver Supply Company Balance Sheet



Cash ................................................................. $168,000Accounts receivable ......................................... 320,000Inventories ....................................................... 250,000



Furniture and fixtures ....................................... $300,000Less: Accumulated depreciation ....................... (170,000)

Net property, plant, and equipment ............. 130,000Total assets ............................................... $868,000


Current liabilities: Accounts payable ............................................. $180,000

Interest payable ................................................ 6,000 Note payable .................................................... 200,000



Common stock ................................................. $100,000Retained earnings ............................................. 382,000







Beginning balance in cash $120,000+ Cash collected from customers 780,000

- Cash paid to suppliers (560,000)- Cash paid for operating expenses (160,000)

- Cash paid for interest (12,000)Ending cash balance $168,000

Beginning balance in accounts receivable $300,000+ Credit sales 800,000- Cash collected from customers (780,000)Ending balance in accounts receivable $320,000

Beginning balance in inventories $200,000+ Purchases 550,000

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

Beginning balance in furniture and fixtures, net $150,000- Depreciation for the year (20,000)Ending balance in furniture and fixtures, net $130,000

Beginning balance in accounts payable $190,000+ Purchases on account 550,000

- Cash paid to suppliers (560,000)Ending balance in accounts payable $180,000

Beginning balance in retained earnings $274,000

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

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






Exercise 3-91. Inventory costing method A2. Information on related party transactions B

3. Composition of property, plant, and equipment B4. Depreciation method A5. Subsequent event information B6. Basis of revenue recognition on long-term contracts A7. Important merger occurring after year-end B8. Composition of receivables B

Exercise 3-101. When related-party transactions occur, companies must disclose the nature of the

relationship, provide a description of the transaction, and report the dollaramounts of the transactions and any amounts due from or to related parties.

2. When an event that has a material effect on the company’s financial positionoccurs after the fiscal year-end, but before the financial statements actually areissued, the event is disclosed in a subsequent event disclosure note.

3. The choice of the straight-line method to determine depreciation typically is

disclosed in the company’s summary of significant accounting policies disclosurenote.

4.

This information would be included in a disclosure note describing thecompany’s debt.

5.

The choice of the FIFO method to determine value inventory typically isdisclosed in the company’s summary of significant accounting policies disclosurenote.

Exercise 3-111. a2. c

3. c






Exercise 3-12

List A List B

d 1. Balance sheet a. Will be satisfied through the use of current assets.

h 2. Liquidity b. Items expected to be converted to cash or consumedwithin one year or the operating cycle.

b 3. Current assets c. The statements are presented fairly in conformitywith GAAP.

j 4. Operating cycle d. An organized array of assets, liabilities and equity.a 5. Current liabilities e. Important to a user in comparing financial

information across companies.k 6. Cash equivalent f. Scope limitation or a departure from GAAP.m 7. Intangible asset g. Recorded when an expense is incurred but not yet

paid.l 8. Working capital h. Relates to the amount of time before an asset is

converted to cash or a liability is paid.g 9. Accrued liabilities i. Occurs after the fiscal year-end but before the

statements are issued.e 10. Summary of significant j. Cash to cash.

accounting policiesi 11. Subsequent events k. One-month U.S. treasury bill.c 12. Unqualified opinion l. Current assets minus current liabilities.f 13. Qualified opinion m. Lacks physical existence.

Exercise 3-131. Current ratio [$200 + 150 + 200 + 350] ÷ $400 = 2.252. Acid-test ratio [$200 + 150 + 200] ÷ $400 = 1.3753. Debt to equity ratio [$400 + 350] ÷ [$750 + 400] = .654. Times interest earned ratio [$160 + 40 + 100] ÷ $40 = 7.5 times






Exercise 3-141. Acid-test ratio = Quick assets ÷ Current liabilities = 1.20

Quick assets = Current assets - InventoriesQuick assets = Current assets - $840,000

Current assets ÷ Current liabilities = 2.25Current assets - $840,000 ÷ Current liabilities = 1.20

$840,000 ÷ Current liabilities = 1.05Current liabilities = $800,000Current assets ÷ $800,000 = 2.25Current assets = $1,800,000

2. Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1.8Total liabilities + Shareholders' equity = Total assetsTotal liabilities + Shareholders' equity = $2,800,000Let x equal shareholders' equity1.8 x + x = $2,800,000x = $1,000,000 = Shareholders' equity

3. Noncurrent assets = Total assets - Current assets Noncurrent assets = $2,800,000 – 1,800,000 = $1,000,000

4. Long-term liabilities = Total assets - Current liabilities - Shareholders' equityLong-term liabilities = $2,800,000 - 800,000 - 1,000,000 = $1,000,000






Exercise 3-15Current Acid-test Debt to

Action Ratio Ratio Equity Ratio

1. Issuance of long-term bonds I I I

2. Issuance of short-term notes I I I3. Payment of accounts payable D D D4. Purchase of inventory on account I D I5. Purchase of inventory for cash N D N6. Purchase of equipment with a 4-year note N N I7. Retirement of bonds D D D8. Sale of common stock I I D9. Write-off of obsolete inventory D N I

10. Purchase of short-term investment for cash N N N11. Decision to refinance on a long-term basis

some currently maturing debt I I N

Exercise 3-161. a2. a






Exercise 3-17

1. d. SFAS 57 requires disclosure of related-party transactions except forcompensation agreements, expense allowances, and transactions eliminated inconsolidated working papers. Required disclosures include the relationship(s)of the related parties; a description and dollar amounts of transactions for each

period presented and the effects of any change in the method of establishingtheir terms; and amounts due to or from the related parties and, if not apparent,the terms and manner of settlement. The effect on the cash flow statement neednot be disclosed.

2.

b. The MD&A section is included in SEC filings. It addresses in a nonquantified

manner the prospects of a company. The SEC examines it with care todetermine that management has disclosed material information affecting thecompany’s future results. Disclosures about commitments and events that mayaffect operations or liquidity are mandatory. Thus, the MD&A section pertainsto liquidity, capital resources, and results of operations.

3. c. The current ratio equals current assets divided by current liabilities. An equalincrease in both the numerator and denominator of a current ratio less than 1.0causes the ratio to increase. Windham Company’s current ratio is .8 ($400,000/$500,000). The purchase of $100,000 of inventory on account would increase

the current assets to $500,000 and the current liabilities to $600,000, resultingin a new current ratio of .833.






Exercise 3-18

Requirement 1

The pharmaceuticals, plastics and farm equipment segments are reportable. Onlysegments representing 10% or more of total company revenues, assets or net incomemust be reported. The electronics segment does not meet this criterion.

Requirement 2

For segments determined to be reportable, the following disclosures are required:a. General information about the operating segment.

b. Information about reported segment profit or loss, including certain revenues andexpenses included in reported segment profit or loss, segments assets, and the basis

of measurement.c. Reconciliations of the totals of segment revenues, reported profit or loss, assetsand other significant items to corresponding enterprise amounts.

d. Interim period information.






Problem 3-1

PROBLEMS

Balance Sheet


CashShort-term investments

Accounts receivable, net of allowance for uncollectible accountsInterest receivable

Inventories

Prepaid expensesTotal current assets

Investments:

Bond sinking fundLong-term investments

Notes receivableTotal investments

Property, plant, and equipment: LandBuildings

Equipment

Less: Accumulated depreciation Net property, plant, and equipment

Intangibles: Patent

Copyright

Total intangiblesTotal assets


Current liabilities: Accounts payable

Rent payableTaxes payable

Wages payable Notes payable

Total current liabilities

Long-term liabilities: Bonds payable


Common stock

Preferred stockRetained earnings

Total shareholders’ equity

Total liabilities and shareholders’ equity






Problem 3-2

Requirement 1

Inventories: Current assets - Cash and cash equivalents - Short-term investments -Accounts receivable - Prepaid expenses = Inventories$1,594,927 - 239,186 - 353,700 - 504,944 - 83,259 = $413,838

Total assets:

Total liabilities + Shareholders’ equity = Total assets$956,140 + 1,370,627 = $2,326,767

Property and equipment (net):

Total assets - Current assets - Long-term receivables = Property and equipment$2,326,767 - 1,594,927 - 110,800 = $621,040

Accounts payable: Total current liabilities - Notes payable and short-term debt - Accrued liabilities -Other current liabilities = Accounts payable$693,564 - 31,116 - 421,772 - 181,604 = $59,072

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






Problem 3-2 (concluded)

Requirement 2

AMDAHL CORPORATION Balance Sheet

Assets ($ in thousands)

Current assets:

Cash and cash equivalents ........................... $ 239,186Short-term investments ................................ 353,700Accounts receivable, net of allowance for

uncollectible accounts ............................ 504,944Inventories ................................................... 413,838Prepaid expenses ......................................... 83,259

Total current assets ................................. 1,594,927

Investments: Long-term receivables ................................. 110,800

Property and equipment (net).......................... 621,040Total assets ........................................... $2,326,767


Current liabilities:

Notes payable and short-term debt ................ $ 31,116Accounts payable .......................................... 59,072Accrued liabilities ......................................... 421,772Other current liabilities ................................. 181,604

Total current liabilities ............................. 693,564

Long-term debt and deferred taxes ................. 262,576

Shareholders’ equity ....................................... 1,370,627

Total liabilities and shareholders’ equity $2,326,767






Problem 3-3

ALMWAY CORPORATION Balance Sheet



Cash and cash equivalents ........................................................ $ 30,000

Short-term investments ............................................................. 80,000

Accounts receivable, net of allowance foruncollectible accounts of $8,000 ......................................... 60,000

Inventories ................................................................................. 200,000

Prepaid insurance ....................................................................... 9,000Total current assets ............................................................. 379,000

Investments: Marketable securities ................................................................ $ 30,000

Land held for sale ...................................................................... 25,000

Bond sinking fund ..................................................................... 15,000Total investments ................................................................ 70,000


Land ............................................................................................ 65,000Buildings .................................................................................... 420,000Equipment .................................................................................. 110,000

595,000Less: Accumulated depreciation ............................................... (160,000)

Net property, plant, and equipment ................................... 435,000

Intangibles:

Patents ........................................................................................ 10,000

Total assets .......................................................................... $894,000Liabilities and Shareholders' Equity


Accounts payable ....................................................................... $ 75,000Interest payable .......................................................................... 20,000

Note payable .............................................................................. 30,000Current maturities of long-term debt ........................................ 10,000

Total current liabilities ....................................................... 135,000

Long-term liabilities: Notes payable ............................................................................. $ 90,000

Bonds payable ............................................................................ 240,000

Total long-term liabilities ................................................... 330,000


Common stock, no par value; 500,000 shares

authorized; 100,000 shares issued and outstanding ............. 300,000Retained earnings ...................................................................... 129,000

Total shareholders’ equity .................................................. 429,000Total liabilities and shareholders’ equity ....................... $894,000






Problem 3-4

(1)

Includes $30,000 in U.S. treasury bills.(2) Excludes $60,000 in prepaid rent for the second year on the building lease.

WEISMULLER PUBLISHING COMPANY

Balance Sheet



Cash and cash equivalents (1) .................................................. $ 95,000Short-term investments ............................................................. 110,000

Accounts receivable, net of allowance for uncollectibleaccounts of $16,000 ............................................................... 144,000

Inventories ................................................................................. 285,000Prepaid expenses (2)................................................................... 88,000

Total current assets ............................................................. 722,000

Property, plant, and equipment :

Machinery and equipment ......................................................... $320,000Less: Accumulated depreciation ............................................... (110,000)


Other assets:

Prepaid expenses 60,000Total assets ...................................................................... $992,000



Accounts payable ....................................................................... $ 60,000Interest payable .......................................................................... 20,000Unearned revenues .................................................................... 80,000

Taxes payable ............................................................................ 30,000

Note payable .............................................................................. 40,000Current maturities of long-term debt ........................................ 20,000



Notes payable ............................................................................. 140,000

Shareholders’ equity: Common stock, no par value; 800,000 shares

authorized; 400,000 shares issued and outstanding ............. 400,000Retained earnings ...................................................................... 202,000

Total shareholders’ equity .................................................. 602,000

Total liabilities and shareholders’ equity ....................... $992,000






Problem 3-5

EXCELL COMPANY

Balance Sheet

At June 30, 2006


Cash and cash equivalents (1) .................................................. $101,000Short-term investments ............................................................. 47,000

Accounts receivable, net of allowance for uncollectibleaccounts of $15,000 ............................................................... 210,000

Interest receivable ...................................................................... 5,000Prepaid expenses ....................................................................... 32,000


Investments:

Note receivable .......................................................................... $65,000Land held for sale ...................................................................... 25,000 90,000

Property, plant, and equipment :

Land ............................................................................................ 50,000

Buildings .................................................................................... 320,000Equipment .................................................................................. 265,000

635,000

Less: Accumulated depreciation ............................................... (280,000) Net property, plant, and equipment ................................... 355,000

Total assets ...................................................................... $840,000



Accounts payable ....................................................................... $173,000

Accrued expenses ...................................................................... 45,000 Note payable .............................................................................. 50,000

Current maturities of long-term debt ........................................ 10,000


Long-term liabilities: Note payable .............................................................................. 50,000

Mortgage payable ...................................................................... 240,000

Total long-term liabilities ................................................... 290,000


authorized; 200,000 shares issued and outstanding ............. 100,000

Retained earnings ...................................................................... 172,000Total shareholders’ equity .................................................. 272,000

Total liabilities and shareholders’ equity ....................... $840,000

(1) Includes $18,000 in U.S. treasury bills






Problem 3-6

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

(2) $380,000 - $70,000 increase in land

HUBBARD CORPORATION Balance Sheet



Cash ............................................................................................ $ 60,000

Marketable securities ................................................................ 20,000

Accounts receivable (net) ......................................................... 120,000

Inventories ................................................................................. 160,000Total current assets ............................................................. 360,000

Investments: Marketable securities.................................................................. $ 40,000

Land held for sale ...................................................................... 50,000Total investments ................................................................ 90,000


Land (1) ...................................................................................... 130,000Buildings .................................................................................... 750,000

Machinery .................................................................................. 280,0001,160,000

Less: Accumulated depreciation ............................................... (255,000)


Intangibles: Patent .......................................................................................... 100,000

Total assets ...................................................................... $1,455,000


Current liabilities: Accounts payable ....................................................................... $ 215,000

Current maturities of long-term debt ........................................ 25,000Total current liabilities ....................................................... 240,000


Notes payable ............................................................................. 475,000


authorized; 100,000 shares issued and outstanding ............. $ 430,000Retained earnings (2) ................................................................ 310,000

Total shareholders’ equity .................................................. 740,000

Total liabilities and shareholders’ equity ....................... $1,455,000






Problem 3-7

HHD, Inc. Balance Sheet



Cash ............................................................................................ $ 150,000

Investment in stocks .................................................................. 90,000

Accounts receivable ................................................................... 200,000

Inventories .................................................................................. 225,000Prepaid insurance ....................................................................... 25,000


Investments: Investment in stocks .................................................................. $ 160,000Bond sinking fund ..................................................................... 250,000

Total investments ................................................................ 410,000


Land ............................................................................................ 800,000

Buildings .................................................................................... 1,500,000Equipment .................................................................................. 500,000

2,800,000Less: Accumulated depreciation ............................................... (800,000)

Net property, plant, and equipment ................................... 2,000,000

Intangibles:

Patent .......................................................................................... 110,000

Copyright .................................................................................... 90,000Total intangibles ................................................................. 200,000

Total assets ....................................................................... $3,300,000



Accounts payable ..................................................................... $ 100,000 Notes payable ........................................................................... 150,000

Taxes payable .......................................................................... 60,000Total current liabilities ..................................................... 310,000


Notes payable ........................................................................... $ 90,000Bonds payable .......................................................................... 1,100,000

Total long-term liabilities ................................................. 1,190,000

Shareholders’ equity: Common stock ......................................................................... 1,000,000

Preferred stock ......................................................................... 450,000Retained earnings .................................................................... 350,000

Total shareholders’ equity ................................................ 1,800,000

Total liabilities and shareholders’ equity ..................... $3,300,000






Problem 3-8

(1) Cash receipts of $560,000 less cash disbursements of $393,000

(2) $20,000 owed to suppliers + $1,000 owed to utility company

(3) Net income for the year

MELODY LANE MUSIC COMPANY Balance Sheet



Cash (1) ............................................................. $167,000Inventories ........................................................ 100,000Prepaid rent ...................................................... 3,000



Equipment and furniture ................................... $ 40,000Less: Accumulated depreciation ....................... (4,000)

Net property, plant, and equipment .............. 36,000Total assets ................................................ $306,000


Current liabilities: Accounts payable (2) ......................................... $ 21,000Interest payable ................................................. 9,000

Loan payable .................................................... 100,000Total current liabilities ................................. 130,000

Shareholders’ equity: Common stock .................................................. $100,000Retained earnings (3) ......................................... 76,000

Total shareholders’ equity ............................ 176,000Total liabilities and shareholders’ equity ... $306,000






Communication Case 3-1IBM manufactures and sells personal and main frame computers. The computers

included as current assets in the balance sheet for the company represent the cost ofinventory available for sale. In addition, IBM uses computers in its operations. Thecost of these computers is included in the property, plant, and equipment category inthe balance sheet.

Marketable securities could be classified as either current or noncurrent assetsdepending on the intent of management. If management intends to sell the securitiesin the next year or operating cycle, they are classified as current assets. Ifmanagement intends to hold the securities beyond the coming year or operating cyclethey are classified as noncurrent assets.

Analysis Case 3-2Requirement 1

Current assets include cash and other assets that are reasonably expected to beconverted to cash or consumed during one year, or within the normal operating cycleof the business if the operating cycle is longer than one year. Current liabilitiesinclude all liabilities that are scheduled to be liquidated within one year or theoperating cycle, whichever is longer, except those that management intends torefinance on a long-term basis.

Therefore, key factors determining classification are the nature of the asset or

liability, management’s intent , and the length of the operating cycle.

Requirement 2

Assets:

Cash Normally classified as current, however, if restriction prohibits use of the cash, could be classified as noncurrent.

Receivables Depends on the expected date of collection.

Marketable Depends on when management intends to sell the securities.securities

Prepaid expenses Depends on the period of time prepaid.

Liabilities: Notes payable Depends on scheduled payment date and management’s

intent to pay or refinance.

Unearned revenue Depends on the period the revenue will be earned.

CASES






Communication Case 3-3The critical question that student groups should address is whether the cost of the

egg-producing flock should be classified as inventory or as property, plant, andequipment. There is no right or wrong answer. The process of developing the

proposed solutions will likely be more beneficial than the solutions themselves.Students should benefit from participating in the process, interacting first with othergroup members, then with the class as a whole.

Solutions should address the following issues:

1. The definitions of inventory and property, plant, and equipment.The definition of inventory according to ARB No. 43 is “goods awaiting sale,

goods in the course of production, and goods to be consumed directly in production.”The chickens certainly represent goods awaiting sale, since they will eventually besold to soup companies. However, they also represent property, plant, and equipment,

since they are used in the production of product — the eggs.

2. The definition of a current asset.

ARB No. 43 also provides the following definition of a current asset:

“..., the term current assets is used to designate cash andother assets or resources commonly identified as thosewhich are reasonably expected to be realized in cash or soldor consumed during the normal operating cycle of the

business.”

ARB No. 43 also states that a one-year time period is to be used where there are

several operating cycles occurring within a year. In this case, it could be argued thatthe operating cycle is two years, since the chickens are not sold until after the layinglife and, therefore, the cost of the flock should be classified as a current asset.However, if the chickens are considered productive assets, then the concept of anoperating cycle is not relevant. According to this argument, the chickens should beclassified as a noncurrent asset, i.e., a producing asset, and not a saleable asset. Itappears that the primary benefits of the chickens come from the sale of eggs, not the

sale of the chickens themselves.

3. Regardless of the classification of the cost of the chickens, the cost capitalizedwhen the chickens begin to lay must be depreciated down to an estimated salvagevalue at the end of the laying life. This is necessary to properly match expenses withrevenues.






Case 3-3 (concluded)

(Industry practice is to classify the costs of the egg-producing flock as inventoryin the current asset section of the balance sheet, but to depreciate the inventory downto estimated salvage value.)

It is important that each student actively participate in the process. Domination by one or two individuals should be discouraged. Students should be encouraged tocontribute to the group discussion by (a) offering information on relevant issues, and(b) clarifying or modifying ideas already expressed, or (c) suggesting alternativedirection.

Judgment Case 3-4

DEFICIENCIES: 1. Accounts receivable - if material, the allowance for uncollectible accounts

should be disclosed.2. Note receivable - only the interest receivable of $3,000 should be classified as

a current asset. The $50,000 note receivable should be classified in thenoncurrent Investments category.

3. Inventories - the method used to cost inventory should be disclosed in a note.4. Investments - should be classified in the noncurrent Investments category.5. Prepaid expenses - in the absence of information to the contrary, should be

classified as a current asset.6. Land - should be classified in the noncurrent Investments category.7. Equipment, net - should be classified in the Property, plant and equipment

category. Original cost should be disclosed along with the accumulated

depreciation to arrive at the net amount. Also, the method used to computedepreciation should be disclosed in a note.

8. Patent - should be classified in the Intangibles category of noncurrent assets.9. Note payable - $20,000, the next installment, should be classified as a current

liability as current maturities of long-term debt. Also, note disclosure isrequired for the note and bonds payable that provides information such as

payment terms, interest rates, and collateral pledged as security for the debt.10. Interest payable - should be classified as a current liability.11. Common stock - the par value, if any, and the number of shares authorized

issued and outstanding should be disclosed.






Judgment Case 3-5Accounts receivable, net - disclosure on the face of the statement of the

allowance for uncollectible accounts, if material.

Inventories - disclosure in Accounting Policies note of the cost method used.Also, for a manufacturer, note disclosure of the breakout of inventory into rawmaterials, work in process and finished goods.

Property, plant and equipment - original cost by major category should bedisclosed along with the accumulated depreciation either on the face of the statementor in a note. Also, the method used to compute depreciation should be disclosed inthe Accounting Policies disclosure note.

Long-term liabilities - disclosure in a note of the various debt instrumentscomprising long-term liabilities to include information such as payment terms, interest

rates, and collateral pledged as security for the debt.

Common stock - disclosure on the face of the statement of par value, if any, andthe number of shares authorized, issued and outstanding.






Real World Case 3-6

Requirement 1

The asset classifications are 1) Current assets, 2) Plant, rental machines and other property, 3) Long-term financing receivables, 4) Prepaid pension assets, (5)Investments and sundry assets, (6) Goodwill, and (7) Intangible assets – net.

Requirement 2

a. Total assets = $109,183 million

b. Current assets = $46,970 million

c. Current liabilities = $39,798 million

d. Total shareholders' equity = $29,747 million

e. Retained earnings = $44,525 million

f. Inventories = $3,316 million

Requirement 3

The par value is $.20 per share. 4,687,500,000 shares are authorized and1,962,687,087 shares are issued.

Requirement 4

Current ratio = Current assets divided by Current liabilities.Current ratio = $46,970 ÷ $39,798 = 1.18

Requirement 5

a. The lower of average cost or net realizable value. b. The straight-line method.c. All highly liquid investments with a maturity of three months or less

at date of purchase are carried at fair value and considered to be cashequivalents.






Judgment Case 3-71. This is a significant event occurring after the end of the fiscal year but prior to the

issuance of the financial statements. Details of the merger should be disclosed in

a note to the financial statements.2. This is a significant event occurring after the end of the fiscal year but prior to theissuance of the financial statements. Details of the issuance of the new debtshould be described in a note to the financial statements.

3. This is a significant event occurring after the end of the fiscal year but prior to theissuance of the financial statements. The event should be described in a note tothe financial statements along with the amount of uninsured damage.






Research Case 3-8

Requirement 1

Statement of Financial Accounting Standards No. 57, “Related PartyDisclosures,” requires the disclosure of related party transactions. This statement wasissued in March of 1982 and became effective for fiscal years ending after June15,1982.

Requirement 2

When related-party transactions occur, companies must disclose the nature of therelationship(s) involved, provide a description of the transactions, and report the dollaramounts of the transactions and any amounts due from or to related parties.

Requirement 3

The related party transactions disclosure note describes transactions with limited

partnerships whose general partner’s managing member is a senior officer of EnronThe transactions include various hedging and derivative transactions with the related

party, as well as the sale of inventory and other assets to the related party.

Requirement 4

The potential problem with related party transactions is that their economicsubstance may differ from their legal form. One of Enron’s disclosed transactionsinvolved the sale of dark fiber inventory to the related party in exchange for $30

million in cash and a $70 million note receivable. Enron recognized gross margin onthe sale of $67 million. Is the $100 million sales price a proper representation of thesales price of the inventory in a normal transaction to an unrelated party? Is theinterest rate charged by Enron on the note a fair interest rate? If the answer to thesequestions is no, then income (wealth) has been transferred from one party to the other,to the detriment of the shareholders of one of the entities and the benefit of the other.






Research Case 3-9(Note: This case requires the student to reference a journal article.]

Requirement 2

Affirmative covenants contain pledges by the borrower to take actions such asinsuring and maintaining assets and paying taxes, as well as agreements to keepcertain financial amounts and ratios within specified limits. Negative covenants can

prohibit activities and specify limits for accounting ratios. Accounting-based

covenants are typically used to limit leverage levels (amount of debt compared toequity) and dividend payouts as well as to establish minimum levels of net worth,working capital, and interest coverage.

Requirement 3

The authors conclude that annual report disclosures of debt covenants is presently

inadequate. They state that a user relying on annual report covenant disclosures isoften not on an equal footing with someone having access to other costly resources.Only after a covenant violation has occurred or is imminent does GAAP requirefinancial statement presentation.

International Case 3-10The standard audit report used in the U.S.A. consists of three paragraphs. The

first two paragraphs of the report deal with the scope of the audit (the work that wasdone by the auditor) and the third paragraph states the auditor's opinion on whether ornot the statements covered in the scope paragraphs have been presented fairly in

conformity with GAAP.The U.K. report is quite similar to the report used in the U.S.A. The introduction

and first two sections deal with the scope of the audit. Both reports describe theresponsibility of the company's management (directors) as well as the responsibility ofthe auditors, and they both briefly discuss auditing standards.

The last section of the U.K. report is similar to the opinion paragraph of theU.S.A. report.






Real World Case 3-11

Requirement 3

a. The disclosure note describes the acquisition of Simplicity Manufacturing, Incfor $227 million in cash plus certain transaction related expenses.

b. The company's auditor was Deloitte & Touche LLP. The firm rendered anunqualified opinion on the company's financial statements.

Requirement 4

a. J. S. Shiely is listed as the Chairman, President, and Chief Executive Officer.b. The annual compensation for Mr. Shiely in 2004 included $737,768 in salary

and a bonus of $1,000,000.






Judgment Case 3-12Comparative income for the first year of operations resulting from the two

alternative financing choices is illustrated below.

DEBT VS. EQUITY

Comparative Income For Two Financing Alternatives

Alternative 1 Alternative 2

Income before interest and taxes $5,000,000 $5,000,000Less: Interest -0- (1,600,000)*

Income before taxes 5,000,000 3,400,000Less: Income taxes (2,500,000)** (1,700,000)**

Net Income $2,500,000 $1,700,000

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

Return on investment $2,500,000 $1,700,000= 5% =5.67%

(Net income ÷ investment) $50,000,000 $30,000,000

We can see that Alternative 1 generated a higher net income. However, thereturn on shareholders’ investment is actually higher for Alternative 2.Alternative 2 generated a higher return for each dollar invested by shareholders.

This was made possible because the corporation was able to generate income on borrowed funds at a higher rate than the cost of the debt. This represents financialleverage. However, alternative 2 also results in a riskier capital structure. The debt inAlternative 2 requires fixed payments of interest and principal to be made. Thecompany's income before interest and income taxes could drop to zero underAlternative 1 and the company would still be solvent (i.e., able to pay its debts).Under Alternative 2, however, if income before interest and taxes drops below the

required interest payments of $1,600,000, the company could become insolvent andeventually go bankrupt.

Analysis Case 3-13The objective of this case is to motivate students to obtain hands-on familiarity

with an actual annual report. You may wish to provide students with multiple copies






of the same annual report and compare responses. Another approach is to divide theclass into teams who evaluate reports from a group perspective.

Analysis Case 3-14

The objectives of this case are to motivate students to obtain hands-on familiaritywith an actual annual report and to apply the techniques learned in the chapter. Youmay wish to provide students with multiple copies of the same annual reports andcompare responses. Another approach is to divide the class into teams who evaluatereports from a group perspective.

Analysis Case 3-15

Requirement 1

The balance sheet includes three asset classifications: Current assets, Property

and equipment, and Other long-term assets; and three liability classifications: Currentliabilities, Long-term debt and Other long-term liabilities.

Requirement 2

These assets are shown as current because the company intends to use them in thenext year or operating cycle.

Requirement 3

Current portion of long-term debt represents the principal amounts due in thenext year on long-term debt.

Requirement 4

Disclosure notes explain or elaborate upon the data presented in the financialstatements themselves. They must include certain specific notes such as a summary ofsignificant accounting policies, descriptions of subsequent events, and related third-

party transactions, but many notes are company specific. Actually, any explanationthat contributes to investors’ and creditors’ understanding of the results of operationsfinancial position, or cash flows of the company should be included.

Requirement 5

Straight-line.

Requirement 6 No.






Analysis Case 3-16

Requirement 1

Segment disclosures assist in analyzing and understanding financial statements by permitting better assessment of past performance and future prospects.Disaggregated information provides more precise details of the uncertaintiessurrounding the timing and the amount of expected cash flows, because the varioussegments may have different rates of profitability, degrees and types of risk,opportunities for growth, and future capital demands.

Requirement 2

An operating segment is a component of an enterprise:1. That engages in business activities from which it may earn revenues and incur

expenses (including revenues and expenses relating to transactions with othercomponents of the same enterprise).2. Whose operating results are regularly reviewed by the enterprise's chief

operating decision-maker to make decisions about resources to be allocated tothe segment and assess its performance.

3. For which discrete financial information is available.

Requirement 3

For areas determined to be reportable operating segments, the followingdisclosures are required:

1. General information about the operating segment.2. Information about segment profit or loss, including certain revenues and

expenses included in reported segment profit or loss, segment assets, and the basis of measurement.

3. Reconciliations of the totals of segment revenues, reported profit or loss,

assets, and other significant items to corresponding enterprise amounts.4. Interim period information.




Ethics Case 3-17Discussion should include these elements.

Facts:

The impact of following the controller's suggestions would be to obscurefinancial information by aggregating the financial data of segment operations andinvestments. Aggregation of data makes projections of future performance for

African or European segments difficult and does not reveal relative investments foreach segment. SFAS 131 "Disclosures about Segments of an Enterprise and RelatedInformation," suggests that reportable segments are those for whom financial data isavailable and whose results are regularly reviewed by company management inassessing performance. The data for South Africa, Egypt, France and Denmark areavailable and most likely reviewed for performance purposes by the controller andhigher management levels.

Ethical Dilemma:

Should you as staff accountant challenge the controller's combination ofsegments or follow the controller's suggestion to obscure financial information byaggregating the financial data of segment operations and investments?

Who is affected?

You as a staff accountantController and other managersOther employeesShareholdersPotential shareholdersCreditorsFinancial analystsAuditors

Who benefits and who is injured:Company management may benefit from aggregating the African and European data by

attracting more investors to their company and obtaining more loans from creditors thanwould be the case with more complete disclosure regarding the South African segment.Injured parties include current and future investors and creditors with economic, social and political concerns regarding Africa and Europe. If investors and creditors later learn aboutundisclosed segment operations that prove unprofitable or violate their value systems, theymay take action against McCarver Lynn


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Spiceland SM Ch03