Chapter2 Accounting income and assets

会计英语第四版参考答案Chapter 1: Introduction to Accounting1. What is accounting?- Accounting is the systematic recording, summarizing, and reporting of financial transactions and events of a business entity.2. What are the main functions of accounting?- The main functions of accounting are to providefinancial information for decision-making, ensure compliance with laws and regulations, and facilitate the management of a business.3. What are the two main branches of accounting?- The two main branches of accounting are financial accounting and management accounting.4. What is the purpose of financial accounting?- The purpose of financial accounting is to provide an accurate and fair representation of an entity's financial position and performance to external users.5. What is the double-entry bookkeeping system?- The double-entry bookkeeping system is a method of recording financial transactions in which every transactionis recorded twice, once as a debit and once as a credit, to maintain the equality of the accounting equation.Chapter 2: Accounting Concepts and Principles1. What are the fundamental accounting concepts?- The fundamental accounting concepts include the accrual basis of accounting, going concern, consistency, and materiality.2. What is the accrual basis of accounting?- The accrual basis of accounting records transactions when they occur, regardless of when cash is received or paid.3. What is the going concern assumption?- The going concern assumption is the premise that a business will continue to operate for the foreseeable future.4. What is the principle of consistency?- The principle of consistency requires that an entity should apply accounting policies consistently over time.5. What is the principle of materiality?- The principle of materiality states that only items that could potentially affect the decisions of users of financial statements are included in the financial statements.Chapter 3: The Accounting Equation and Financial Statements1. What is the accounting equation?- The accounting equation is Assets = Liabilities +Owner's Equity.2. What are the four main financial statements?- The four main financial statements are the balance sheet, income statement, statement of changes in equity, and cashflow statement.3. What is the purpose of the balance sheet?- The balance sheet provides a snapshot of an entity's financial position at a specific point in time.4. What is the purpose of the income statement?- The income statement reports the revenues, expenses, and net income of an entity over a period of time.5. What is the purpose of the cash flow statement?- The cash flow statement reports the cash inflows and outflows of an entity over a period of time.Chapter 4: Recording Transactions1. What is a journal entry?- A journal entry is the initial recording of atransaction in the general journal.2. What are the steps in the accounting cycle?- The steps in the accounting cycle are analyzing transactions, journalizing, posting, preparing a trial balance, adjusting entries, preparing financial statements, and closing entries.3. What is the difference between a debit and a credit?- A debit is an increase in assets or a decrease inliabilities or equity, while a credit is an increase in liabilities or equity or a decrease in assets.4. What are adjusting entries?- Adjusting entries are made at the end of an accounting period to ensure that revenues and expenses are recorded in the correct period.5. What is the purpose of closing entries?- Closing entries are made to transfer the balances of temporary accounts to the owner's equity account and to prepare the accounts for the next accounting period.Chapter 5: Accounting for Merchandising Businesses1. What is a merchandise inventory?- A merchandise inventory is the stock of goods held by a business for sale to customers.2. What is the cost of goods sold?- The cost of goods sold is the direct cost of producing the merchandise sold during an accounting period.3. What is the gross profit?- The gross profit is the difference between the sales revenue and the cost of goods sold.4. What is the difference between a perpetual and a periodic inventory system?- A perpetual inventory system updates inventory records in real-time with each sale or purchase, while a periodicinventory system updates inventory records at specific intervals, such as at the end of an accounting period.5. What is the retail method of inventory pricing?- The retail method of inventory pricing is a method of estimating the cost of ending inventory by applying a cost-to-retail ratio to the retail value of the inventory.Chapter 6: Accounting for Service Businesses1. What are the main differences in accounting for service businesses compared to merchandise businesses?- Service businesses do not have inventory and their primary expenses are typically labor and overhead costs.2. What is the main source of revenue for service businesses? - The main source of revenue for service businesses is the fees charged for the services provided.3. What are the typical expenses。

Chapter 1 A. An example of a business stakeholder is the federal government.B. A corporation is a business that is legally separate and distinct from its owners.C. Accounting is a service that provides many different users with financial information to make economic decisions.D. Small ethical lapses are harmless in and of themselves.E. Managerial accounting is primarily concerned with the recording and reporting of economic data and activities of an entity for use by owners, creditors, governmental agencies, and the public.F. The unit of measurement concept requires that economic data be recorded in a common unit of measurement.G. If a building is appraised for $90,000, offered for sale at $95,000, and the buyer pays $85,000 cash for it, the buyer would record the building at $90,000.H. The owner’s rights to the assets rank ahead of the creditors’ rights to the assets.I. Business transactions are economic events that directly or indirectly change an entity’s financial condition or results f rom operations.J. If net income for a proprietorship was $25,000, the owner withdrew $10,000 in cash and the owner invested $5,000 in cash, the capital of the owner increased by $20,000. K. The owner is only allowed to withdraw cash from the business.L. Receiving a bill or otherwise being notified that an amount is owed is amount is paid.M. The principal financial statements of a proprietorship are the income statement, statement of owner’s equity, and the balance sheet.N. An income statement is a summary of the revenues and expenses of a business as of a specific date.O. A low ratio of liabilities to owner’s equity indicates that a business is near bankruptcy. 1. Profit is the difference betweena. assets and liabilitiesb. the incoming cash and outgoing cashc. the assets purchased with cash contributed by the owner and the cash spent to operate the businessd. the assets received for goods and services and the amounts used to provide the goods and services2. Which of the items below is not a business organization form?a. entrepreneurshipb. proprietorshipc. partnershipd. corporation3. Which of the following is not a step in providing accounting information to stakeholders? a. design the accounting information systemb. prepare accounting surveysc. identify stakeholdersd. record economic data4. For accounting purposes, the business entity should be considered separate from its owners if the entity isa. a corporationb. a proprietorshipc. a partnershipd. all of the above5. Which of the following is not a business transaction?a. make a sales offerb. sell goods for cashc. receive cash for services to be rendered laterd. pay for supplies6. The Reynolds Company estimated that the value of its land had increased from $10,000 to $16,000 and therefore wrote up the land account to $16,000. Which accounting concept(s) was (were) violated?a. cost conceptb. objectivity conceptc. all of the aboved. none of the above7. Goods purchased on account for future use in the business, such as supplies, are called a. prepaid liabilities b. revenuesc. prepaid expensesd. liabilities8. All of the following are financial statement(s) of a proprietorship except thea. statement of retained ear ningsb. statement of owner’s equityc. income statementd. statement of cash flowsChapter 2 A. A chart of accounts is a listing of accounts that make up the journal.B. Drawings are an example of an expense.C. To determine the balance in an account, always subtract credits from debits.D. The double-entry accounting system records each transaction twice.E. The increase side of all accounts is the normal balance.F. The journal is the book of original entry.G. Journalizing transactions using the double-entry bookkeeping system will eliminate fraud. H. The process of transferring the data from the journal to the ledger accounts is posting. I. The post reference notation used in the journal is the page number.J. When a business receives a bill from the utility company, no entry should be made until the invoice is paid.K. A proof of the equality of debits and credits in the ledger at the end of an accounting period is called a balance sheet.L. Even when a trial balance is in balance, there may be errors in the individual accounts. M. Posting a part of a transaction to the wrong account will cause the trial balance totals to be unequal.N. Horizontal analysis is used to compare the financial statements of the same company for different periods. 1. A group of related accounts that comprise a complete unit is called aa. Journalb. liability2.3.4.5.6. c. ledger d. transaction Which statement(s) concerning cash is (are) true? a. cash will always have more debits than credits b. cash will never have a credit balance c.cash is increased by debiting d. all of the above Which of the following types of accounts have a normal credit balance? a. assets and liabilities b. liabilities and expenses c. revenues and liabilities d. capital and drawing Which of the following entries records the receipt of cash from patients on account? a. Accounts Payable, debit; Fees Earned, credit b. Accounts Receivable, debit; Fees Earned, credit c. Accounts Receivable, debit; Cash, credit d. Cash, debit; Accounts Receivable, credit If the two totals of a trial balance are not equal, it could be due to a. failure to record a transaction b. recording the same erroneous amount for both the debit and the credit parts of a transaction c. an error in determining the account balances, such as a balance being incorrectly computed d. recording the same transaction more than once Which of the following errors, each considered individually, would cause the trial balance totals to be unequal?a. a transaction was not postedb. a payment of $96 for insurance was posted as a debit of $46 to Prepaid Insurance and a credit of $46 to Cashc. a payment of $311 to a creditor was posted as a debit of $3,111 to Accounts Payable and a debit of $311 to Accounts Receivabled. cash received from customers on account was posted as a debit of $140 to Cash and a credit of $140 to Accounts PayableChapter 3 1. The accrual basis of accounting requires revenue be recorded when cash is received from customers.2. The matching concept requires expenses be recorded in the same period that the related revenue is recorded.3. Adjusting entries are made at the end of an accounting period to adjust accounts on the balance sheet.4. The difference between deferred revenue and accrued revenue is that accrued revenue has been recorded and needs adjusting and deferred revenue has never been recorded.5. The systematic allocation of land’s cost to expense is called depreciation.6. The difference between the balance of a fixed asset account and the balance of its related accumulated depreciation account is termed the book value of the asset.7. If the adjustment for accrued salaries at the end of the period is inadvertently omitted, both liabilities and owner’s equity will be overstated for the period.8. The financial statements are prepared from the unadjusted trial balance.9. Vertical analysis compares each item in a statement with another item in the same statement.The correct: 2,6,91. Which account would normally not require an adjusting entry?a. Wages Expenseb. Accounts Receivablec. Accumulated Depreciationd. Smith, Capital2. What is the proper adjusting entry at June 30, the end of the fiscal year, based on a prepaid insurance account balance before adjustment, $15,500, and unexpired amounts per analysis of policies, $4,500?a. debit Insurance Expense, $4,500; credit Prepaid Insurance, $4,500b. debit Insurance Expense, $15,500; credit Prepaid Insurance, $15,500c. debit Prepaid Insurance, $11,500; credit Insurance Expense, $11,500d. debit Insurance Expense, $11,000; credit Prepaid Insurance, $11,0003. Depreciation Expense and Accumulated Depreciation are classified, respectively, asa. expense, contra assetb. asset, contra liabilityc. revenue, assetd. contra asset, expense4. If there is a balance in the unearned subscriptions account after adjusting entries are made, it represents a(n)a. deferralb. accrualc. drawingd. revenue5. What is the proper adjusting entry at June 30, the end of the fiscal year, based on a prepaid insurance account balance before adjustment, $15,500, and unexpired amounts per analysis of policies, $4,500?a. debit Insurance Expense, $4,500; credit Prepaid Insurance, $4,500b. debit Insurance Expense, $15,500; credit Prepaid Insurance, $15,500c. debit Prepaid Insurance, $11,500; credit Insurance Expense, $11,500d. debit Insurance Expense, $11,000; credit Prepaid Insurance, $11,0006. Depreciation Expense and Accumulated Depreciation are classified, respectively, asa. expense, contra assetb. asset, contra liabilityc. revenue, assetd. contra asset, expense7. If there is a balance in the unearned subscriptions account after adjusting entries are made, it represents a(n)a. deferralb. accrualc. drawingd. revenueMultiple choice: d d a aChapter 41. The most important output of the accounting cycle is the financial statements.2. A net loss is shown on the work sheet in the credit columns of both the Income Statement columns and the Balance Sheet columns.3. The difference between a classified balance sheet and one that is not classified is that the classified one has subheadings.4. Since the adjustments are entered on the work sheet, it is not necessary to record them in the journal or post them to the ledger.5. The post-closing trial balance will generally have fewer accounts than the trial balance.6. Solvency is essentially the ability of an organization to pay its bills.7. Working capital is current assets plus current liabilities.ANS:T F T F T T F1. The worksheeta. is an integral part of the accounting cycleb. eliminates the need to rewrite the financial statementsc. is a working paper that is requiredd. is used to summarize account balances and adjustments for the financial statements2. Which one of the fixed asset accounts listed below will not have a related contra asset account? a. Office Equipment b. Land c. Delivery Equipment d. Building3. Which of the accounts below would be closed by making a debit to the account?a. Unearned Revenueb. Fees Earnedc. Jeff Ritter, Drawingd. Rent Expense4. Which of the following accounts ordinarily appears in the post-closing trial balance?a. Bill Smith, Drawingb. Supplies Expensec. Fees Earnedd. Unearned Rent5. A fiscal yeara. ordinarily begins on the first day of a month and ends on the last day of the following twelfth monthb. for a business is determined by the federal governmentc. always begins on January 1 and ends on December 31 of the same yeard. should end at the height of the business’s annual operating cycle6. A current ratio of 4.3 means thata. there are $4.30 in current assets available to pay each dollar of current liabilitiesb. the company cannot pay its debts as they come duec. there are $4.30 in current assets for every $4.30 in current liabilitiesd. there are $4 in current assets for every $3 in current liabilitiesANS: dbbdaaChapter 61. In a merchandise business, sales minus operating expenses equals net income.2. In a perpetual inventory system, the Merchandise Inventory account is only used to reflect the beginning inventory.3. The single-step income statement is easier to prepare, but a criticism of this format is that gross profit and income from operations are not readily available.4. Under the perpetual inventory system, when a sale is made, both the retail and cost values are recorded.5. Sales Discounts is a revenue account with a credit balance.6. Discounts taken by the buyer for early payment of an invoice are credited to Cash Discounts by the buyer.7. If the ownership of merchandise passes to the buyer when the seller delivers the merchandise for shipment, the terms are stated as FOB destination.8. If merchandise costing $2,500, terms FOB destination, 2/10, n/30, with prepaid transportation costs of $100, is paid within 10 days, the amount of the purchases discount is $50.9. The adjusting entry to record inventory shrinkage would generally include a debit to Cost of Merchandise Sold. 1. The primary difference between a periodic and perpetual inventory system is that aa. periodic system determines the inventory on hand only at the end of the accounting periodb. periodic system keeps a record showing the inventory on hand at all timesc. periodic system provides an easy means to determine inventory shrinkaged. periodic system records the cost of the sale on the date the sale is made2. A sales invoice included the following information: merchandise price, $4,000; transportation, $300; terms 1/10, n/eom, FOB shipping point. Assuming that a credit for merchandise returned of $600 is granted prior to payment, that the transportation is prepaid by the seller, and that the invoice is paid within the discount period, what is the amount of cash received by the seller? a.$3,366 b.$3,400c.$3,666d.$3,9503. The net sales to asset s ratio measures a company’sa. working capitalb. net worthc. effective use of sales to support the purchase of new assetsd. effective use of assets to generate salesThe correct: 3,4,8,9 Multiple choice: a c dChapter 74. A customer’s c heck received in settlement of an account receivable is considered cash.5. If the balance in Cash Short and Over at the end of a period is a credit, it indicates that cash shortages have exceeded cash overages for the period.6. A voucher system is an example of an internal control procedure over cash payments.7. A remittance advice is the notification accompanying the check issued to a creditor that states the specific invoice being paid.8. The amount of the "adjusted balance" appearing on the bank reconciliation as ofa given date is the amount that is shown on the balance sheet for that date.9. When the petty cash fund is replenished, the petty cash account is credited for the total of all expenditures made since the fund was last replenished.10. Cash equivalents are short -term investments that will be converted to cash within 120 days.11. The doomsday ratio is almost always less than one.ANS:T F T T T F F T1. Credit memorandums from the banka. decrease a bank custom er’s accountb. are used to show a bank service chargec. show that a company has deposited a customer’s NSF checkd. show the bank has collected a note receivable for the customer2. Journal entries based on the bank reconciliation are required in the depositor’s accounts for a. outstanding checks b. deposits in transitc. bank errorsd. book errorsANS: d dChapter 81. Receivables from company owners and officers should be disclosed separately on the balance sheet.2. Since those responsible for receivables record keeping and credit approval do not handle cash, these duties do not need to be separated to maintain good internal control.3. Of the two methods of accounting for uncollectible receivables, the allowance method provides inadvance for uncollectible receivables.4. Although Allowance for Doubtful Accounts normally has a credit balance, it may have either a debit or a credit balance before adjusting entries are recorded at the end of the accounting period.5. At the end of a period, before the accounts are adjusted, Allowance for Doubtful Accounts has a debit balance of $2,000. If the estimate of uncollectible accounts determined by aging the receivables is $30,000, the current provision to be made for uncollectible accounts expense is $30,000.6. The due date of a 60-day note dated July 10 is September 10.7. If the maker of a note fails to pay the debt on the due date, the note is said to be dishonored.8. The discounting of a note receivable creates a contingent liability that continues in effect until the due date of the note. ANS: T F T T F F T T 1. Allowance for Doubtful Accounts has a debit balance of $500 at the end of the year (before adjustment), and uncollectible accounts expense is estimated at 3% of net sales. If net sales are $600,000, the amount of the adjusting entry to record the provision for doubtful accounts is a. $18,500 b. $17,500 c. $18,000 d. none of the above 2. On the balance sheet, the amount shown for the Allowance for Doubtful Accounts is equal to the a. Uncollectible accounts expense for the year b. total of the accounts receivables written-off during the year c. total estimated uncollectible accounts as of the end of the year d. sum of all accounts that are past due. 3. What is the type of account and normal balance of Allowance for Doubtful Accounts? a. Contra asset, credit b. Asset, debit c. Asset, credit d. Contra asset, debit 4. If the direct write-off method of accounting for uncollectible receivables is used, what general ledger account is credited to write off a customer’s account as uncollectible? a. Uncollectible Accounts Expense b. Accounts Receivable c. Allowance for Doubtful Accounts d. Interest Expense 5. A 90-day, 12% note for $10,000, dated May 1, is received from a customer on account. Thematurity value of the note isa. $10,000b. $10,300c. $450d. $9,550ANS: c c a b bChapter 91. 2. 3. 4. A business using the perpetual inventory system, with its detailed subsidiary records, does not need to take a physical inventory. Purchased goods in transit, shipped FOB destination, should be excluded from ending inventory. Unsold consigned merchandise should be included in the consignee’s inventory. Of the three widely used inventory costing methods (FIFO, LIFO, and average), the LIFO method of costing inventory is based on the assumption that costs are charged against revenues in the reverse order in which they were incurred.During inflationary periods, the use of the FIFO method of costing inventory will yield an inventory amount for the balance sheet approximating the current replacement cost.When using the FIFO inventory costing method, the most recent costs are assigned to the cost of goods sold.The use of the lower-of-cost-or-market method of inventory valuation increases net income for the period in which the inventory replacement price declined. Generally, the lower the number of days’ sales in inventory, the better.ANS: F F F T T F F TTaking a physical count of inventorya. is not necessary when a periodic inventory system is usedb. is a detective controlc. has no internal control relevanced. is not necessary when a perpetual inventory system is usedMerchandise inventory at the end of the year was inadvertently overstated. Which of the following statements correctly states the effect of the error on net income, assets, and owner’s equity?a. net income is overstated, assets are overstated, owner’s equity is understatedb. net income is overstated, assets are overstated, ow ner’s equity is overstatedc. net income is understated, assets are understated, owner’s equity is understatedd. net income is understated, assets are understated, owner’s equity is overstated Inventory costing methods place primary emphasis on assumptions abouta. flow of goodsb. flow of costsc. flow of goods or costs depending on the methodd. flow of valuesIf merchandise inventory is being valued at cost and the purchase price is steadily falling, which method of costing will yield the largest net income?a. average costb. LIFO 5. 6. 7. 8. 1. 2. 3. 4.c. FIFOd. weighted average 5. On the basis of the following data, what is the estimated cost of the merchandise inventory on October 31 by the retail method? Oct. 1 Merchandise Inventory $225,000 $324,500 Oct. 1-31 Purchases (net) 335,000 475,500 Oct. 1-31 Sales (net) 700,000 a. $372,000 b. $140,000 c. $100,000 d. $ 70,000 6. If the estimated rate of gross profit is 40%, what is the estimated cost of the merchandise inventory on June 30, based on the following data? June 1 Merchandise inventory $ 75,000 June 1-30 Purchases (net) 150,000 June 1-30 Sales (net) 135,000 a. $144,000 b. $140,000 c. $ 81,000 d. $ 54,500 7. Too much inventory on handa. reduces solvencyb. increases the cost to safeguard the assetsc. increases the losses due to price declinesd. all of the aboveANS: b b b b d a dChapter 10 1. The acquisition costs of property, plant, and equipment should include all normal, reasonable and necessary costs to get the asset in place and ready for use.2. Land acquired as a speculation is reported under Investments on the balance sheet.3. Standby equipment held for use in the event of a breakdown of regular equipment is reported as property, plant, and equipment on the balance sheet.4. As a company depreciates a piece of equipment, it cash flow goes up.5. All property, plant, and equipment assets are depreciated over time.6. The declining-balance method is an accelerated depreciation method.7. The cost of replacing an engine in a truck is an example of ordinary maintenance.8. The cost of new equipment is called a revenue expenditure because it will help generate revenues in the future.9. A gain can be realized when a fixed asset is discarded.10. When exchanging equipment, if the trade-in allowance is greater than the book value a loss results.11. The cost of a patent with a remaining legal life of 10 years and an estimated useful life of 7 years is amortized over 10 years.12. The method used to calculate the depletion of a natural resource is the straight line method.13. The higher the ratio of fixed assets to long-term liabilities the greater the margin of safety.ANS: T T T F F T F F F F F F T1. Factors contributing to a decline in the usefulness of a fixed asset may be divided into the following two categoriesa. salvage and functionalb. physical and functionalc. residual and salvaged. functional and residual2. Accumulated Depreciationa. is used to show the amount of cost expiration of intangiblesb. is the same as Depreciation Expensec. is a contra asset accountd. is used to show the amount of cost expiration of natural resources3. Equipment with a cost of $80,000, an estimated residual value of $5,000, and an estimated life of 15 years was depreciated by the straight-line method for 5 years. Due to obsolescence, it was determined that the useful life should be shortened by 5 years and the residual value changed to zero. The depreciation expense for the current and future years isa. $5,500b. $11,000c. $10,000d. $5,0004. A fixed asset with a cost of $42,000 and accumulated depreciation of $38,500 is traded for a similar asset priced at $60,000. Assuming a trade-in allowance of $5,000, the cost basis of the new asset isa. $58,000b. $58,500c. $60,000d. $61,5005. A machine with a cost of $65,000 has an estimated residual value of $5,000 and an estimated life of 4 years or 18,000 hours. What is the amount of depreciation for the second full year, using the declining-balance method at double the straight-line rate?a. $15,000b. $30,000c. $16,250d. $32,500ANS: b c b b cChapter 11 1. For a current liability to exist, the following two tests must be met. The liability must be due usually within a year and must be paid out of current assets.2. For an interest bearing note payable, the amount borrowed is equal to the face value of the note.3. The proceeds of a discounted note are equal to the face value of the note.4. Obligations that depend on past events and that are based on future transactions are contingent liabilities.5. The journal entry to record the cost of warranty repairs that were incurred during the current period, but related to sales made in prior years, includes a debit to Warranty Expense.6. Generally, all deductions made from an employee’s gross pay are required by law.7. FICA tax is a payroll tax that is paid only by employers.8. The higher the quick ratio, the more liquid a company is.ANS: T T F F F F F T1. On June 8, Acme Co. issued an $80,000, 6%, 120-day note payable to Still Co. Assume that the fiscal year of Acme Co. ends June 30. What is the amount of interest expense recognized by Acme in the current fiscal year?a. $293.33b. $400.00c. $391.11d. $1,600.002. Proceeds of $48,750 were received from discounting a $50,000, 90-day note at a bank. The discount rate used by the bank in computing the proceeds wasa. 6.25%b. 10.00%c. 10.26%d. 9.75%3. Pilgrim Company sells merchandise with a one year warranty. In 2005, sales consisted of 1,500 units. It is estimated that warranty repairs will average $10 per unit sold, and 30% of the repairs will be made in 2005 and 70% in 2006. In the 2005 income statement, Pilgrim should show warranty expense ofa. $4,500b. $10,500c. $15,000d. $0ANS: a b cChapter 12 1. A corporation is a separate entity for accounting purposes but not for legal purposes.2. Double taxation is a disadvantage of a corporation because the same party has to pay taxes twice on the income.3. The two main sources of stockholders’ equity are investments contributed by stockholders and net income retained in the business.4. The balance in retained earnings should be interpreted as representing surplus cash left over for dividends.5. Preferred stock with a preferential right to dividends in arrears is referred to asparticipating preferred.6. If 50,000 shares are authorized, 37,000 shares are issued, and 2,000 shares are reacquired, the number of outstanding shares is 39,000.7. When a corporation issues stock at a premium, it reports the premium as an other income item on the income statement.8. If 100 shares of treasury stock were purchased for $50 per share and then sold at $60 per share, $1,000 of income is reported in the income statement.9. Since a stock split changes information of a business, this transaction needs to be recorded.10. If 20,000 shares are authorized, 14,000 shares are issued, and 500 shares are held as treasury stock, a cash dividend of $1 per share would amount to $14,000.11. The declaration and issuance of a stock dividend does not affect the total amount of a corporation’s assets, liabilities, or stockholders’ equity.12. The dividend yield indicates the rate of return to stockholders in terms of cash dividend distributions.ANS: F F T F F F F F F F T T1. The outstanding stock is composed of 10,000 shares of $100 par, cumulative preferred $8 stock, and 50,000 shares of no-par common stock. Preferred dividends have been paid every year except for the preceding year and the current year. If $380,000 is to be distributed as a dividend for the current year, what total amount will be distributed to the common stockholders? a. $380,000b. $220,000c. $80,000d. $160,0002. A corporation issues 2,000 shares of common stock for $ 32,000. The stock has a stated value of $10 per share. The journal entry to record the stock issuance would include a credit to Common Stock fora. $20,000b. $32,000c. $12,000d. $2,0003. When common stock is issued in exchange for a noncash asset, the transaction should be recorded ata. the par value of the stock issuedb. the fair market value of the stockc. the fair market value of the asset acquiredd. the fair market value of the asset acquired or the fair market value of the stock, whichever canbe determined more objectively.4. Treasury stock that had been purchased for $5,400 last month was reissued this month for $7,500. The journal entry to record the reissuance would include a credit。

CHAPTER 2FINANCIAL STATEMENTS AND CASH FLOWAnswe rs to Concepts Review and Critical Thinking Questions1. True. Every asset can be converted to cash at some price. However, when we are referring to a liquidasset, the added assumption that the asset can be quickly converted to cash at or near market value is important.2. The recognition and matching principles in financial accounting call for revenues, and the costsassociated with producing those revenues, to be ―booked‖when the revenue process isessentiallycomplete, not necessarily when the cash is collected or bills are paid. Note that this way is notnecessarily correct; it‘s the way accountants have chosen to do it.3. The bottom line number shows the change in the ca sh balanc e on the balance sheet. As such, it is nota use ful number for analyzing a company.4. The major difference is the treatment of interest expense. The accounting statement of cash flowstreats interest as an operating ca sh flow, while the financial ca sh flows treat interest as a financing cash flow. The logic of the accounting statement of cash flows is that since interest appears on the income statement, which shows the operations for the period, it is an operating cash flow. In reality, interest is a financing expense, which results from the company‘s choice of debt and equity. We will have more to say about this in a later chapter. When compa ring the two c ash flow statements, thefinancial statement of cash flows is a more appropriate measure of the company‘s performa ncebecause of its treatment of interest.5. Market values can never be negative. Imagine a share of stock selling for –$20. This would meanthat if you placed an order for 100 shares, you would get the stock along with a check for $2,000.How ma ny shares do you want to buy? More generally, because of corpora te andindividualbankruptcy laws, net worth for a person or a corporation cannot be negative, implying that liabilities cannot exceed assets in market value.6. For a successful c ompany that is rapidly expanding, for example, capital outlays will be large,possibly leading to negative c ash flow from assets. In general, what matters is whether the money is spent wisely, not whe ther cash flow from assets is positive or negative.7. It‘s probably not a good sign for an e stablished company to have negative cash flow from operations,but it would be fairly ordinary for a start-up, so it depends.would have this effect. Negative net c apital spending would mea n more long-lived assets wereliquidated than purchased.49.10. If a company raises more money from selling stock than it pays in dividends in a particular period,its cash flow to stockholders will be negative. If a company borrows more than it pays in interest and principal, its cash flow to creditors will be negative.The adjustments discussed were purely accounting changes; they had no cash flow or market value consequences unless the new accounting information caused stockholders to revalue the derivatives.Solutions to Questions and Proble msNOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiplesteps. Due to space and readability constraints, when these intermediate steps are included in thissolutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem.Basic1. To find owners‘ equity, we must construct a balance sheet as follows:Balance SheetCA $ 5,300 CL $ 3,900NFA 26,000 LTD 14,200OE ??TA $31,300 TL & OE $31,300We know that total liabilities and owners‘ equity (TL & OE) must equal total assets of $31,300. We also know that TL & OE is equal to current liabilities plus long-term debt plus owner‘s equity, soowner‘s equity is:OE = $31,300 –14,200 – 3,900 = $13,200NWC = CA – CL = $5,300 – 3,900 = $1,4002. The income statement for the company is:Income StatementSales $493,000Costs 210,000Depreciation 35,000EBIT $248,000Interest 19,000EBT $229,000Taxes 80,150Net income $148,8503.4.5.6. One equation for net income is:Net income = Dividends + Addition to retained earningsRearranging, we get:Addition to retained earnings = Net income – Divide ndsAddition to retained earnings = $148,850 – 50,000Addition to retained earnings = $98,850To find the book value of current assets, we use: NWC = CA – CL. Rearranging to solve for current assets, we get:CA = NWC + CL = $800,000 + 2,100,000 = $2,900,000The market value of current assets and net fixed assets is given, so:Book value CA= $2,900,000 Market value CA= $2,800,000Book value NFA = $5,000,000 Market value NFA= $6,300,000Book value assets = $7,900,000 Market value assets= $9,100,000Taxes = 0.15($50K) + 0.25($25K) + 0.34($25K) + 0.39($246K – 100K)Taxes = $79,190The average tax ra te is the total tax paid divided by net income, so:Average tax rate = $79,190 / $246,000Average tax rate = 32.19%The marginal tax rate is the tax rate on the next $1 of earnings, so the marginal tax ra te = 39%.To calculate OCF, we first need the income state ment:Income StatementSales $14,900Costs 5,800Depreciation 1,300EBIT $7,800Interest 780Taxable income $7,020Taxes 2,808Net income $4,212OCF = EBIT + Depreciation – TaxesOCF = $7,800 + 1,300 – 2,808OCF = $6,292Net capital spending = $1,730,000 – 1,650,000 + 284,000Net capital spending = $364,0007. The long-term debt account will increase by $10 million, the amount of the new long-term debt issue.Since the company sold 10 million new shares of stock with a $1 par value, the common stockaccount will increase by $10 million. The capital surplus account will increase by $33 million, thevalue of the new stoc k sold above its par value. Since the company had a net income of $9million,and pa id $2 million in dividends, the addition to retained earnings was $7 million, which willinc rease the accumulated retained earnings account. So, the new long-term debt a nd stockholders‘ equity portion of the balance sheet will be:Long-term debt $82,000,000Total long-term debt $82,000,000Shareholders equityPreferred stock $9,000,000Common stock ($1 par value) 30,000,000Ac cumulated retained earnings 104,000,000Capital surplus 76,000,000Total equity $ 219,000,000Total Liabilities & Equity $ 301,000,0008.9. Cash flow to creditors = Interest paid – Net new borrowingCash flow to creditors = $118,000 – ($1,390,000 – 1,340,000)Cash flow to creditors = $118,000 – 50,000Cash flow to creditors = $68,000Cash flow to stockholders = Dividends paid – Net new equityCash flow to stockholders = $385,000 – [(Common+ APIS) – (Common+ APIS)]end end beg beg10. Cash flow to stockholders = $385,000 – [($450,000 + 3,050,000) – ($430,000 + 2,600,000)] Cash flow to stockholders = $385,000 – ($3,500,000 – 3,030,000)Cash flow to stockholders = –$85,000Note, APIS is the additional paid-in surplus.Cash flow from assets= Cash flow to creditors + Cash flow to stockholders= $68,000 – 85,000= –$17,000Cash flow from assets= –$17,000 = OCF – Change in NWC – Net capital spending–$17,000 = OCF – (–$69,000) – 875,000Operating cash flowOperating cash flow= –$17,000 – 69,000 + 875,000= $789,000Cash flow to creditors = $118,000 – (LTD– LTD)11. a. IntermediateThe accounting statement of cash flows explains the change in cash during the year. Theaccounting statement of cash flows will be:Statement of cash flowsOperationsNet income $105Depreciation 90Changes in other current assets (55)Accounts payable (10)Total cash flow from operations $170Investing activitiesAcquisition of fixed assets $(140)Total cash flow from investing activities $(140)Financing activitiesProc eeds of long-term debt $30Dividends (45)Total cash flow from financing activities ($15)Change in cash (on balance sheet) $15b.Change in NWC= NWC e nd– NWC beg= (CA end–CL en d ) – (CA beg–CL be g)c.= [($50 + 155) – 85] – [($35 + 140) – 95)= $120 – 80= $40To find the cash flow generated by the firm‘s assets, we need the operating cash flow, and thecapital spending. So, calculating each of these, we find:Operating cash flowNet income $105Depreciation 90Operating cash flow $195Note that we can calculate OCF in this manner since there a re no taxes.Capital spendingEnding fixed assets Beginning fixed assets DepreciationCapital spending $340 (290)90 $140Now we c an calculate the cash flow gene rated by the firm‘s assets, which is: Cash flow from assetsOperating cash flow Capital spending Change in NWC Cash flow from assets $195 (140) (40) $1512. With the information provided, the cash flows from the firm are the capital spending and the changein net working capital, so:Cash flows from the firmCapital spending $(15,000)Additions to NWC (1,500)Cash flows from the firm $(16,500)And the cash flows to the investors of the firm are:Cash flows to investors of the firmSale of long-term debt (19,000)Sale of common stock (3,000)Dividends paid 19,500Cash flows to investors of the firm $(2,500)13. a.b. The interest expense for the company is the amount of debt times the interest rate on the debt. So, the income statement for the company is:Income StatementSales $1,200,000Cost of goods sold 450,000Selling costs 225,000Depreciation 110,000EBIT $415,000Interest 81,000Taxable income $334,000Taxes 116,900Net income $217,100And the opera ting cash flow is:OCF = EBIT + Depreciation – TaxesOCF = $415,000 + 110,000 – 116,900OCF = $408,10014. To find the OCF, we first calculate net income.Income StatementSales $167,000Costs 91,000Depreciation 8,000Other expe nses 5,400EBIT $62,600Interest 11,000Taxable income $51,600Taxes18,060Net income $33,540Dividends $9,500Additions to RE $24,040a.OCF = EBIT + Depreciation – TaxesOCF = $62,600 + 8,000 – 18,060OCF = $52,540b.CFC = Interest – Net new LTDCFC = $11,000 – (–$7,100)CFC = $18,100Note that the net new long-term debt is negative because the compa ny repaid part of its long-term debt.c.CFS = Dividends – Net new equityCFS = $9,500 – 7,250CFS = $2,250d.We know that CFA = CFC + CFS, so:CFA = $18,100 + 2,250 = $20,350CFA is also equal to OCF – Net capital spending – Change in NWC. We already know OCF.Net capital spending is equal to:Net capital spending = Increase in NFA + De preciationNet capital spending = $22,400 + 8,000Net capital spending = $30,400Now we c an use:CFA = OCF – Net capital spending – Change in NWC$20,350 = $52,540 – 30,400 – Change in NWC.Solving for the change in NWC gives $1,790, me aning the company increased its NWC by$1,790.15. The solution to this question works the income statement backwards. Starting at the bottom:Net income = Dividends + Addition to ret. earningsNet income = $1,530 + 5,300Net income = $6,830Now, looking at the income statement:EBT – (EBT × Tax rate) = Net incomeRecognize that EBT × tax rate is simply the calculation for ta xes. Solving this for EBT yields: EBT = NI / (1– Tax rate)EBT = $6,830 / (1 – 0.65)EBT = $10,507.69Now we can calculate:EBIT = EBT + InterestEBIT = $10,507.69 + 1,900EBIT = $12,407.69The last step is to use:EBIT = Sales – Costs – Depreciation$12,407.69 = $43,000 – 27,500 – DepreciationDepreciation = $3,092.31Solving for depreciation, we find that depreciation = $3,092.3116. The balance sheet for the company looks like this:Balance SheetCash $183,000 Accounts payableAc counts receivable 138,000 Notes payableInventory 297,000 Current liabilitiesCurrent assets $618,000 Long-term debtTotal liabilities Tangible net fixed assets 3,200,000Intangible net fixed assets 695,000 Common stockAccumulated ret. earnings Total assets $4,513,000 Total liab. & owners‘ equity Total liabilities and owners‘ equity is:TL & OE = Total debt + Common stock + Accumulated retained earnings Solving for this equation for equity gives us:Common stock = $4,513,000 – 1,960,000 – 2,160,000Common stock = $393,000$465,000145,000 $610,000 1,550,000 $2,160,000?? 1,960,000 $4,513,00017.18.19. The market value of shareholders‘ equity cannot be negative. A negative market value in this casewould imply that the company would pay you to own the stock. The market value of sha reholders‘ equity can be stated as: Shareholders‘ equity = Max [(TA –TL), 0]. So, if TA is $9,700, equity isequal to $800, and if TA is $6,800, e quity is equal to $0. We should note here that while the market value of equity cannot be negative, the book value of shareholders‘ equity can be negative.a.Taxes Growth= 0.15($50K) + 0.25($25K) + 0.34($3K) = $14,770Taxes Income= 0.15($50K) + 0.25($25K) + 0.34($25K) + 0.39($235K) + 0.34($7.465M)= $2,652,000b. Each firm has a marginal tax rate of 34% on the next $10,000 of taxa ble income, despite theirdifferent average ta x rates, so both firms will pay an additional $3,400 in taxes.Income State mentSales $740,000COGS 610,000A&S expenses 100,000Depreciation 140,000EBIT ($115,000)Interest 70,000Taxable income ($185,000)Taxes (35%) 0 income ($185,000)b.OCF = EBIT + Depreciation – TaxesOCF = ($115,000) + 140,000 – 0OCF = $25,00020.21. c. Net income was negative because of the tax deductibility of depreciation and interest expense.However, the actual cash flow from operations wa s positive because de preciation is a non-cashexpense and interest is a financing expense, not an operating expense.A firm can still pay out dividends if net income is negative; it just has to be sure there is sufficientcash flow to make the dividend payments.Change in NWC = Net ca pital spending = Net new equity = 0. (Given)Cash flow from assets = OCF – Change in NWC – Net capital spendingCash flow from assets = $25,000 – 0 – 0 = $25,000Cash flow to stockholders = Divide nds – Net new equityCash flow to stockholders = $30,000 – 0 = $30,000Cash flow to creditors = Cash flow from assets – Cash flow to stockholdersCash flow to creditors = $25,000 – 30,000Cash flow to creditors = –$5,000Cash flow to creditors is also:Cash flow to creditors = Interest – Net new LTDSo:Net new LTD = Interest – Cash flow to creditorsNet new LTD = $70,000 – (–5,000)Net new LTD = $75,000a. The income statement is:Income StatementSales $15,300Cost of good sold 10,900Depreciation 2,100EBIT $ 2,300Interest 520Taxable income $ 1,780Taxes712Net income $1,068b.OCF= EBIT + Depreciation – TaxesOCF = $2,300 + 2,100 – 712OCF = $3,68813c. Change in NWC=NWC end– NWC beg= (CA end–CL en d ) – (CA beg–CL be g)22.= ($3,950 – 1,950) – ($3,400 – 1,900)= $2,000 – 1,500 = $500Ne t capital spending= NFA end– NFA beg+ Depreciation= $12,900 – 11,800 + 2,100= $3,200CFA= OCF – Change in NWC – Net capital spending= $3,688 – 500 – 3,200= –$12The cash flow from assets can be positive or ne gative, since it represents whether the firm raisedfunds or distributed funds on a net basis. In this problem, even though net income and OCF arepositive, the firm invested heavily in both fixed assets and net working capital; it had to raise a net $12 in funds from its stockholders and creditors to make these investments.d. Ca sh flow to creditors= Interest – Net new LTD= $520 – 0= $520Ca sh flow to stoc kholders = Cash flow from assets – Cash flow to creditors= –$12 – 520= –$532We can also calculate the cash flow to stockholders as:Ca sh flow to stoc kholders = Dividends – Ne t new equitySolving for net new equity, we get:Net new equity= $500 – (–532)= $1,032The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow fromoperations. The firm invested $500 in new net working capital and $3,200 in new fixed assets. The firm had to raise $12 from its stakeholders to support this new inve stment. It accomplished this by raising $1,032 in the form of new equity. After paying out $500 of this in the form of dividends to shareholders and $520 in the form of interest to creditors, $12 was left to meet the firm‘s ca sh flow needs for investment.a. Total assets 2009= $780 + 3,480 = $4,260Total liabilities 2009= $318 + 1,800 = $2,118Owners‘ equity 2009 = $4,260 – 2,118 = $2,142Total assets 2010= $846 + 4,080 = $4,926Total liabilities 2010= $348 + 2,064 = $2,412Owners‘ equity 2010= $4,926 – 2,412 = $2,51414b. NWC 2009NWC 2010Change in NWC = CA09 – CL09 = $780 – 318 = $462= CA10 – CL10 = $846 – 348 = $498= NWC10 – NWC09 = $498 – 462 = $36c.d. We can calculate net capital spe nding as:Net capital spending = Net fixed assets 2010 – Net fixed assets 2009 + Deprec iationNet capital spending = $4,080 – 3,480 + 960Net capital spending = $1,560So, the company had a net capital spending cash flow of $1,560. We also know that net capital spending is:Net capital spending = Fixed assets bought – Fixed assets sold$1,560= $1,800 – Fixed assets soldFixed assets sold= $1,800 – 1,560 = $240To c alculate the cash flow from assets, we must first calculate the operating cash flow. Theoperating cash flow is calculated as follows (you can also prepare a traditional incomestatement):EBIT = Sales – Costs – DepreciationEBIT = $10,320 – 4,980 – 960EBIT = $4,380EBT = EBIT – InterestEBT = $4,380 – 259EBT = $4,121Taxes = EBT ⨯ .35Taxes = $4,121 ⨯ .35Taxes = $1,442OCF = EBIT + Depreciation – TaxesOCF = $4,380 + 960 – 1,442OCF = $3,898Ca sh flow from a ssets = OCF – Change in NWC – Net capital spending.Ca sh flow from a ssets = $3,898 – 36 – 1,560Ca sh flow from a ssets = $2,302Net new borrowing = LTD10 – LTD09Net new borrowing = $2,064 – 1,800Net new borrowing = $264Ca sh flow to creditors = Interest – Net ne w LTDCa sh flow to creditors = $259 – 264Ca sh flow to creditors = –$5Net new borrowing = $264 = Debt issue d – Debt retiredDebt retired = $360 – 264 = $961523.CashAccounts receivable InventoryCurrent assetsNet fixed assets Total assetsCashAccounts receivable InventoryCurrent assetsNet fixed assets Total assets Balance sheet as of Dec. 31, 2009$2,739 Accounts payable3,626 Notes payable6,447 Current liabilities$12,812Long-term debt$22,970 Owners' equity$35,782 Total liab. & equityBalance sheet as of Dec. 31, 2010$2,802Accounts payable4,085 Notes payable6,625Current liabilities$13,512Long-term debt$23,518Owners' equity$37,030Total liab. & equity$2,877529$3,406$9,173$23,203$35,782$2,790497$3,287$10,702$23,041$37,03024.2009 Income StatementSales $5,223.00COGS 1,797.00Othe r expenses 426.00Depreciation 750.00EBIT $2,250.00Interest 350.00EBT $1,900.00Taxes646.00Net income $1,254.00Dividends $637.00Additions to RE 617.00OCF = EBIT + Depreciation – TaxesOCF = $2,459 + 751 – 699.38OCF = $2,510.62Change in NWC = NWC end– NWC beg= (CA – CL)end2010 Income StatementSales $5,606.00COGS 2,040.00Other expense s 356.00Depreciation 751.00EBIT $2,459.00Interest 402.00EBT $2,057.00Taxes699.38Net income $1,357.62Dividends $701.00Additions to RE 656.62– (CA – CL)begChange in NWC = ($13,512 – 3,287) – ($12,812 – 3,406)Change in NWC = $819Net capital spending = $23,518 – 22,970 + 751Net capital spending = $1,29916Net capital spending = NFA– NFA+ Depreciation25. Cash flow from assets = OCF – Change in NWC – Net capital spendingCash flow from assets = $2,510.62 – 819 – 1,299Cash flow from assets = $396.62Cash flow to creditors = Interest – Net new LTDNet new LTD = LTD end– LTD begCash flow to creditors = $402 – ($10,702 – 9,173)Cash flow to creditors = –$1,127Common stock + Retained earnings = Total owners‘ equityNet new equity = (OE – RE)end– (OE – RE)begRE end= RE beg+ Additions to RENet new equity = $23,041 – 23,203 – 656.62 = –$818.62Cash flow to stockholders = Dividends – Net new equityCash flow to stockholders = $701 – (–$818.62)Cash flow to stockholders = $1,519.62As a check, ca sh flow from assets is $396.62.Cash flow from assets = Cash flow from creditors + Cash flow to stockholdersCash flow from assets = –$1,127 + 1,519.62Cash flow from assets = $392.62ChallengeWe will begin by calculating the operating cash flow. First, we need the EBIT, which c an becalculated as:EBIT = Net income + Current taxes + Deferred taxes + Inte restEBIT = $144 + 82 + 16 + 43EBIT = $380Now we can calculate the operating cash flow as:Operating cash flowEarnings before interest and taxes $285Depreciation 78Current taxes (82)Operating cash flow $28117Net new equity = Common stock– Common stockNet new equity = OE– OE+ RE– RE∴ Net new equity= OE– OE+ RE– (RE+ Additions to RE)= OE– OE– Additions to REThe cash flow from assets is found in the investing activities portion of the accounting statement of cash flows, so:Cash flow from assetsAcquisition of fixed a ssets $148Sale of fixed assets (19)Capital spending $129The net working capital cash flows are all found in the operations cash flow section of theaccounting statement of cash flows. However, instead of c alculating the net working capital cashflows as the change in net working capital, we must calculate each item individually. Doing so, wefind:Net working capital cash flowCash $42Accounts receivable 15Inventories (18)Accounts payable (14)Accrued expenses 7Notes payable (5)Other (2)NWC cash flow $25Except for the interest expense and note s payable, the ca sh flow to creditors is found in the financing activities of the accounting statement of cash flows. The inte rest expense from the income statementis given, so:Cash flow to creditorsInterest $43Retirement of debt 135Debt service $178Proceeds from sale of long-term debt (97)Total $81And we can find the cash flow to stockholders in the financing se ction of the accounting stateme nt of cash flows. The cash flow to stockholders was:Cash flow to stockholdersDividends $ 72Repurchase of stock 11Cash to stockholders $ 83Proceeds from new stock issue(37)Total $ 461826. Net capital spending= (NFA– NFA + Depreciation) + (Depreciation + AD) – AD= (NFA+ AD) – (NFA+ ADbeg) =FAbeg– FAend end beg beg end beg27. a.b.c. The tax bubble causes average tax rates to catch up to marginal tax rates, thus eliminating the tax advantage of low marginal rates for high inc ome corporations.Assuming a taxable income of $335,000, the taxes will be:Taxes = 0.15($50K) + 0.25($25K) + 0.34($25K) + 0.39($235K) = $113.9KAverage tax rate = $113.9K / $335K = 34%The marginal tax rate on the next dollar of income is 34 percent.For corporate taxable income levels of $335K to $10M, average tax rates are equal to marginal tax rates.Taxes = 0.34($10M) + 0.35($5M) + 0.38($3.333M) = $6,416,667Average tax rate = $6,416,667 / $18,333,334 = 35%The marginal tax rate on the ne xt dollar of income is 35 percent. For corporate taxable income levels over $18,333,334, ave rage tax rates are again e qual to marginal tax rates.Taxes= 0.34($200K) = $68K = 0.15($50K) + 0.25($25K) + 0.34($25K) + X($100K);X($100K)= $68K – 22.25K = $45.75KX= $45.75K / $100KX= 45.75%19=NFA– NFAend= (NFAbeg– NFA)+ AD– AD。

CHAPTER 2COVERAGE OF LEARNING OBJECTIVESChapter 2 Measuring Income to Assess Performance 25CHAPTER 22-1 The operating cycle depends on the nature of the company. It is the time it takes the company to use cash to acquire goods and services, to sell those goods and services to customers, and to collect cash from the sales.2-2 A fiscal year is the year used for financial reporting. It may be the same as a calendar year, but often it is not. Many companies elect to begin and end a fiscal year at the low point in their annual business activity.2-3 Expenses are reductions in stockholders’ equity; thus they may be accurately described as negative stockholders’ equity accounts.2-4 The cash basis fails to match accomplishments with efforts. In particular, the cash basis fails to match revenues and expenses properly. Inventory may be bought and paid for in one period, and sold in the second with the collection from customers in a third period.Accrual accounting matches revenue and cost of goods sold in the second period, although the cash outlay was in the first and the collection was in the third.2-5 The two tests of revenue recognition are earning and realization (realized or realizable).2-6 Revenue recognition is delayed when a company sells a magazine subscription because the company does not recognize revenue until it is earned by delivery of the magazines.Revenue recognition is also delayed if collection of the account receivable is not reasonably certain, which means that it is not realized or realizable. This may happen with speculative land sales.2-7 Product costs are naturally linked to revenues, while period costs support a company’s operations for a given period. Product costs become expenses when the company recognizes the related revenue. Period costs become expenses in the period in which they are incurred.2-8 In theory, all expenses are goods and services that were first purchased as assets and that have now been utilized (used up) in the conduct of operations.2-9 Managers acquire assets (goods and services) that are then either used instantaneously or at a later time. When the assets are used, they become expenses.2-10 The balance sheet is a financial picture of a company at one point in time, like a snapshot.In contrast, an income statement shows activity over a period of time. It shows the series of events that take a company from one “snapshot” (balance sheet) to another, just as a moving picture shows movement from one position to the next.262-11 Synonyms for the income statement are statement of earnings, statement of operations, profit and loss (P&L) statement, and operating statement. A major reason to learn accounting is to be able to read real financial statements. Such statements contain a variety of terms that may differ from the one first leaned in an introductory accounting course. To be able to read and interpret the financial statements, users need to understand the terminology used, including synonyms used for the major accounting terms.2-12 Managers are often optimistic and feel that things are bound to get better, so they do not like to report bad news. In addition, they may have bonuses or possible future promotions that depend on the financial reports, so they want the reports to be as good as possible. Finally, financial reports are often the “scorecard” for business success, and competitive managers want to report a high score.2-13 Cash dividends are not necessary in the conduct of revenue-producing operations.Therefore, they are not expenses but are distributions of assets to owners. These distributions are made possible because of profitable operations, but are not part of the profitable operations.2-14 Retained earnings is a stockholders’ equity account (a residual claim against assets) not an asset account.2-15 The statement of stockholders’ equity provides information on why the stockholders’ equity accounts changed during a given period. The three main items that affect stockholders’ equity are net income, transactions with s tockholders, and other comprehensive income—a catch-all category of all equity changes that are neither part of net income nor arise from transactions with owners.2-16 No. An accounting entity can be a part of an organization, such as a division or department. It can also be an entire economy, such as national income accounting for the United States or another country.2-17 Reliable data require convincing evidence that can be verified by independent auditors.Accountants must make sure that data reported in the financial statements can be measured with enough accuracy to be useful to users of the statements.2-18 Materiality means that items that are not large enough to influence users’ decisions can be omitted from the financial statements. Thus, you do not find pencils or paper clips listed among a company’s assets. Cost-benefit means, for example, that if the cost of measuring an item is greater than the value from knowing it, it can be omitted. Thus, the financial statements of a division of a company may not include an expense for any portion of the company president’s salary, even though the president spends time overseeing the division’s activities. It would simply be too costly for the president to account for each minute spent on each different activity he undertakes and there is no benefit to attempting to allocate the president’s salary to individual divisions. However, in the corporate financial statements, the president’s salary would be treated as an operating cost assigned to the corporation as a whole.Chapter 2 Measuring Income to Assess Performance 272-19 No. One financial ratio, earnings per share (EPS), is presented on the income statement.2-20 A high P-E ratio means that investors expect future earnings to significantly exceed current earnings. This is likely to be true for fast growing companies.2-21 Two dividend ratios are as follows:∙Dividend-yield ratio—The amount of dividends paid per dollar invested in a stock at the current market price. The dividend-yield ratio is computed as Dividends pershare ÷ Market price per share.∙Dividend-payout ratio—The percentage of a company’s earnings that is paid out in dividends The dividend-payout ratio is computed as Dividends per share ÷ EPS.2-22 No. A high dividend-payout ratio may be a bad sign. Companies with a high dividend-payout ratio tend to be slow-growing companies. They return a larger percentage of their income to shareholders because they do not have profitable investments for which to use the money.2-23 Yes, accountants make many trade-offs between relevance and faithful representation.Although both are desirable, sometimes it is necessary to sacrifice some of one to gain much of the other. A major trade-off is between market values, which are often more relevant but may raise questions about faithful representation, and historical costs, which faithfully represent an event but may be less relevant.2-24 The two main characteristics that make accounting information relevant are predictive value—meaning that it helps users form their expectations about the future—and confirmatory value—meaning that it can confirm or contradict existing expectations.2-25 These criteria support faithful representation. They help ensure that information truly captures the economic substance of the transactions, events, or circumstances it describes. 2-26 A year is a long time to wait for new information about a company’s performance.Preparing full financial statements is time consuming and costly. Quarterly financial disclosures are less complete than annual ones, but they represent a balanced answer to how often and how complete information should be. Within companies, managers get financial reports daily, weekly, or monthly depending on their needs. In different countries the tradition and the identity of investors have led to different customs. The United States relies on public ownership of companies and needs a system to keep large numbers of investors adequately informed. In countries where more of the ownership is closely held and more of the liabilities are bank financed, there is less need for frequent public disclosure.2-27 The real choice is not between the cash basis and the accrual basis. We can have either one, but they provide very different information. The accrual-basis income statement is a better measure of overall performance over an accounting period. The cash-basis income statement provides better information about the risks of running out of cash. In the end, our choice between the two would depend on the question we are trying to answer.282-28 The stock price should drop by the amount of the dividend per share. Just before the dividend, the stock is worth whatever it will be worth after the dividend plus the amount of the dividend. The chapter does not address details of exactly when rights to a dividend are created, when they accompany the sale of a share, or when they are retained by the seller. These issues are covered in the owners’ equity chapter (Chapter 10).2-29 Many investors would say that it does not matter because the security markets are efficient and the P-E ratios reflect the expected growth rates of future earnings for each firm. High-growth firms have high P-E ratios and low-growth firms have lower ones.Other investors would sort into two groups. Each group of investors believes the market tends to systematically misvalue firms, but they disagree on the nature of the market’s “error.” Value investors believe that the market undervalues good low-growth, low P-E firms and therefore buy them. Growth investors believe that the market undervalues good high-growth, high P-E firms and therefore buy them. Empirically, we can find periods of time when value investors have had better results from their investments than growth investors and vice versa. The bottom line is that investing based on P-E ratios alone is never a good idea, although they are an important descriptor of what the market perceptions of a company are at a moment in time.2-30 (10 min.)Balance Sheet Income Statement3. Accumulated deficit 1. Sales4. Unexpired costs—asset 2. Net earnings5. Prepaid expenses—asset 7. Statement of earnings6. Accounts receivable—asset 8. Used up costs—expense12. Retained earnings 9. Net profits14. Statement of financial condition 10. Net income16. Statement of financial position 11. Revenues13. Expenses—expense15. Statement of income17. Operating statement18. Cost of goods sold—expense2-31 (5-10 min.)The dealer is confused. As used by accountants, revenue is a gross amount earned from sales to customers. For example, sales and revenues are synonyms. Revenue is not “the bottom line” in accountants’ minds. “The bottom line” is net income, that is, revenue minus all expenses. The dealer has $280,000 revenue per month, not income.Of course, many people use “bottom line” in a nontechnical sense to mean the important or significant result—the result that really matters. For example, “the bottom line is not how much you earn but how much you keep.”Chapter 2 Measuring Income to Assess Performance 292-32 (10 min.)1. On the cash basi s, Yankton’s net income would be as follows:Revenue (cash received) $190,000*Expenses 175,000Net income $15,000* Beginning receivables + Credit sales – Cash collections = Ending receivables$60,000 + 240,000 – Cash collections = $110,000$60,000 + 240,000 – 110,000 = Cash collections = $190,0002. On an accrual basis, Yankton’s net income would be as follows:Revenue (sales) $240,000Expenses 175,000Net income $ 65,0003. The $65,000 net income on the accrual basis is generally the most relevant for assessingYankton’s performance. It gives credit for all $240,000 of sales because, provided theaccounts receivable are likely to be received (which is one criterion for the accrualrecognition of revenue), Yankton has created value from all the sales, not just those forwhich cash has been received.2-33 (15-20 min.)The theme of this solution is that retained earnings is not a pot of cash awaiting distribution to stockholders.1. Cash $1,000 Paid-in capital $1,0002. Cash $ 400 Paid-in capital $1,000Inventory 600Total $1,000Note in both Requirements 1 and 2 that the ownership equity is fundamentally a claim against the total assets (in the aggregate). For example, none of the shareholders have a specific claim on cash, and none have a specific claim on inventory. Instead, they all have an undivided claim against (or interest in) all of the assets.303. Cash $1,150 Paid-in capital $1,000Retained earnings 150Total $1,150 Retained Earnings is part of stockholders’equity. Even though Cash and Retained Earnings have increased by identical amounts compared to number 1, the retained earnings is fundamentally a general claim against total assets (just as paid-in capital is a general claim). Retained earnings is the net rise in ownership claim attributable to profitable operations. However, the assets themselves should not be confused with the claims against the assets.4. Cash $ 50 Paid-in capital $1,000($1,150 – $300 – $800) Retained earnings 150 Inventory 300Equipment 800Total $1,150 Total $1,150The same explanation applies here as in Requirement 3. However, Transaction 4 should clarify the lack of a specific link between retained earnings (and paid-in capital) and any particular assets. The ownership claims are general, not specific.5. Cash $ 50 Account payable $ 500Inventory Paid-in capital 1,000 ($300 + $500) 800 Retained earnings 150 Equipment 800Total $1,650 Total $1,650The meaning of retained earnings was explained above. Purchases on “open account”usually create a general liability; that is, the trade creditors usually hold only general claims against the total assets, not specific claims against particular assets (such as mortgages on buildings). In sum, both the creditors and the owners hold general claims against the assets. Of course, if the corporation is liquidated (all assets converted to cash to be distributed to claimants), the creditors’ general claims must be satisfied before the owners get one dollar. Thus, the stockholders are said to have a residual claim or residual interest.2-34 (15-25 min.)See Exhibit 2-34 on the following page.Chapter 2 Measuring Income to Assess Performance 312-35 (15-20 min.)1. First calculate stockholders’ equity from the asset and liability amounts given.Assets –Liabilities = Stockholders’ equity Dec. 31: £126,000 –£55,000 = £71,000Jan. 1: 110,000 – 50,000 = 60,000Change: £ 16,000 –$ 5,000 = £11,000Note that the £16,000 asset increase less the £5,000 liability increase yields the increase in stockholders’ equity of £11,000.2. We can use knowledge of what changes stoc kholders’ equity to “deduce” the amount ofnet income. Net income increases stockholders’equity and dividends decrease stockholders’ equity.Beginning stockholders’ equity + net income – dividends = ending stockholders’ equity £60,000 + net income – £5,000 = £71,000net income = £71,000 + £5,000 – £60,000= £16,0003. Sales – Cost of goods sold – Operating expense = Net income£354,000 –Cost of goods sold – £200,000 = £16,000–Cost of goods sold = £16,000 + £200,000 –£354,000Cost of goods sold = £138,0002-36 (15 min.)The cash balance on June 30 was $55,000, as shown in the balance sheet equationtransactions in Exhibit 2-36 on the next page. The cash balance is the only beginning or ending balance that is available from the data.2-37 (10-15 min.)1. The name of the statement is antiquated. It should be titled income statement (orstatement of earnings, statement of operations, or operating statement).2. The line with the date should not be for an instant of time but for an indicated span oftime: a year, a quarter, or a month ending on December 31, 20X0.3. Increases in market values of land and buildings are not recognized under U. S. GAAP.4. Dividends are not expenses and are not deducted before net profit is computed.5. The appropriate deduction is the cost of goods sold, not the cost of the cars purchased.6. The bottom line should be titled net income or net earnings.7. The cost of the products sold is usually listed right after revenue, not near the bottom ofthe statement.8. Although it is not the major point of the problem, the income statement has apparentlyomitted some expenses; for example, neither rent nor depreciation is shown. As a minimum, one or the other would ordinarily be included.Chapter 2 Measuring Income to Assess Performance 332-38 (5-10 min.) Amounts are in millions.1.Revenues $3,275.4Expenses 3,462.1Net income (loss) $ (186.7)Beginning retained earnings $250.5+ Net income (loss) (186.7)– Dividends ?Ending retained earnings $ 63.82. Dividends = $63.8 – $250.5 + $186.7 = $02-39 (20-30 min.) Amounts are in thousands of dollars.The basic relations used in these problems are as follows:Revenues – Expenses = Net incomeAssets = Liabilities + Stockholders’ equityBeginning retained earnings + Net income – Dividends = Ending retained earningsBeginning paid-in-capital + additional investment = Ending paid-in-capital.1. E = 165 – 125 = 40D = 30 + 40 = 70C = 15 because there were no additional investments by stockholdersA = 80 – 15 – 30 = 35; or 80 – (15 + 30) = 35B = 95 – 15 – 70 = 10; or 95 – (15 + 70) = 102. K = 20 + 200 = 220J = 60 + 20 – 7 = 73H = 10 + 40 = 50F = 60 + 10 + 90 = 160G = 280 – 73 – 50 = 1573. P = 280 – 250 = 30Q = 120 + 30 – 130 = 20N = 85 – 35 = 50L = 105 + 50 + 120 = 275M = 95 + 85 + 130 = 3102-40 (10-15 min.)This is straightforward. Computations are in millions of dollars:A = 23,185 – 6,406 = 16,779B = 11,203 – 646 = 10,557C = 962 + 646 – 420 = 1,188D = 17,890+ 7,069 = 24,959Chapter 2 Measuring Income to Assess Performance 352-41 (10 min.)1. Companies choose what details to report based partly on materiality. A $250,000investment is definitely material to Dayton Service Stations. It is 27% of its total assetsbefore the investment. However, it is not necessarily material to ExxonMobil—it is avery small fraction of 1% of its total assets and even a smaller fraction of its net income.2. A key question a company must ask is whether a potential investor would find theinformation relevant for assessing the position and prospects of the company. Theinvestment would certainly be an important factor in assessing Dayton Service Stations,but it would be so small as to be insignificant for assessing ExxonMobil.2-42 (10-15 min.)1. Income statement or operating statement is used instead of statement of income andexpenses.2. The end of the fiscal year is typically identified.3. The terms income or profit are used rather than surplus (and net income rather than netsurplus).4.The term loss is used instead of deficit.5. A profit-seeking organization would not receive a subsidy.2-43 (10-15 min.)This problem demonstrates how financial statements provide information for investor decisions. These ratios are compared with other companies in the industry and with the company’s ratios through the years.1. EPS = £364,000,000 ÷ 1,611,000,000 = £0.2262. P-E = £6.000 ÷ £0.226 = 26.53. Dividend Yield = (£295 ÷ 1,611) ÷ £6.000 = 3.1%4. Dividend Payout = (£295 ÷ 1,611) ÷ £0.226 = 81%362-44 (10-15 min.)1. $23,931,000,000 ÷ $11.74 = 2,038,415,673 average shares2. $11.74 × .2155 = $2.53; this is much less than the $11.74 EPS.3. (a) $2.53 ÷ $76.50 = 3.3% dividend yield(b) $76.50 ÷ $11.74 = 6.5 P-E ratio2-45 (20-30 min.)1 and 2. See Exhibit 2-45 on the following page.3. R. J. SEN CORPORATIONIncome StatementFor the Month Ended June 30, 20X0Accrual Basis Cash BasisSales $115,000 Revenue (cash collectedfrom customers*) $ 45,000 Deduct: Cost of Expenses (cash disbursedgoods sold 60,000 for merchandise) 85,000Net cash used byNet income $ 55,000 operating activities $(40,000)*The entire revenue is cash sales. If any cash had been collected from credit customers during June, it would be added here.The accrual basis provides a better measure of the economic accomplishments and efforts of the entity. The cash basis is inferior because it fails to recognize revenue as earned (the sales on credit), and it often recognizes expenses before they help generate revenues (for example, inventory acquired but not sold). Note that the June 28 acquisition of inventory on open account is irrelevant under both the accrual and cash basis.Chapter 2 Measuring Income to Assess Performance 371. The first two items in the first sentence of the footnote (i.e., reference to persuasiveevidence of an arrangement and delivery) relate to the earning of the revenue, and the last two (i.e., fee fixed and determinable and collectability probable) relate to its realization.Microsoft used to recognize revenue on products licensed to OEMs when the OEMsshipped product to customers, based on the assumption that Microsoft does not earn the revenue until the product actually is sent to a final customer. However, a change inlicensing earlier this decade made it possible to regard revenue as earned when Microsoft ships product to the OEMs. The licensing agreement may have been changed to make the OEMs more responsible for the products after Microsoft ships them. Microsoft decided not to wait until the OEM delivers product to customers to regard the revenue as earned;instead, it is deemed earned at the time Microsoft ships it. This accelerates Microsoft’s recognition of revenues.2. Multi-year licensing agreements are treated as a magazine publisher would treat asubscription. The revenue is not earned until the customer uses the software for which it has a licensing agreement. Therefore, revenue recognition is spread over the life of thelicense.3. Revenue related to games published by third parties is recognized when the games aremanufactured, not when they are shipped to customers. Microsoft must believe that itsells the right to manufacture the games, and as soon as the manufacturing process iscomplete its revenue-earning process is complete.Chapter 2 Measuring Income to Assess Performance 391. See Exhibit 2-47 on the following page.Transactions 8 to 11 illustrate the culmination of the asset acquisition-asset expiration sequence: that is, most assets are “stored” as “unexpired” or “prepaid” costs that are expected to benefit future operations (inventory, prepaid rent, prepaid insurance and equipment). As these assets are “used up” or “expire,” they become expenses or “expired costs.”2. MONTERO COMPANYIncome StatementFor the Month Ended July 31, 20X2Sales $205,000Deduct expenses:Cost of goods sold $160,000Rent 5,000Depreciation 2,000Insurance 1,000Total expenses 168,000Net income $ 37,0003. MONTERO COMPANYBalance SheetJuly 31, 20X2Liabilities andAssets Stockholders’ EquityLiabilities:Cash $ 126,000 Note payable $ 60,000 Accounts receivable 140,000 Accounts payable 110,000 Merchandise inventory 65,000 Total liabilities 170,000 Prepaid rent 55,000 Stockholders’ equity:Prepaid insurance 23,000 Paid-in capital 300,000 Equipment 98,000 Retained earnings 37,000Total stockholders’ equity 337,000 Total assets $507,000 Total liab. and stk. equity $507,000 402-48 (35-40 min.)1. See Exhibit 2-48 on the following page.2. BEKELE COMPANYBalance SheetApril 30, 20X2Liabilities andAssets Stockholders’ EquityLiabilities:Cash $106,000 Note payable $ 24,000 Accounts receivable 57,000 Accounts payable 5,000 Merchandise inventory 43,000 Total liabilities 29,000 Prepaid rent 4,000 Stockholders’ equity:Equipment and fixtures 35,000 Paid-in capital $200,000Retained earnings 16,000Total stk. equity $216,000 Total $245,000 Total $245,000BEKELE COMPANYIncome StatementFor the Month Ended April 30, 20X0Sales revenue $100,000Deduct expenses:Cost of goods sold $37,000Wages and sales commissions 34,000Rent ($2,000 + $10,000) 12,000Depreciation 1,000Total expenses 84,000 Net Income $16,000 3. Most businesses tend to have net losses during their infant mont hs, so Bekele’s abilityto show a net income for April is impressive. Indeed, the rate of return on beginninginvestment is ($16,000 ÷ $200,000) = 8% per month, or 96% per year. Bekele also hashigh stockholders’ equity compared to its liabilities, quite a high cash balance, andflexibility because most assets are either in cash or will be turned into cash relativelyquickly. Many other points can be raised, including the problem of maintaining an“optimum” cash balance so that creditors can be paid neither too quickly nor too slowly.See the next solution also.422-49 (5-10 min.)Cash Inflows:Cash sales $ 25,000Cash collected from credit customers 18,000Cash disbursements:* 43,000 Disbursements for merchandise $(75,000)**Disbursements for rent, wages,and sales commissions (50,000)***Total cash disbursements 125,000Net cash outflow for operations $(82,000) *Some students will also include the $12,000 cash paid to purchase equipment as a cash outflow. This is consistent with a strict cash-basis of accounting.**$45,000 + $30,000*** $6,000 + $10,000 + $34,000The accrual basis provides a more accurate measure of economic performance. If the two revenue recognition criteria are met (earning and realization), the $100,000 measure of revenue on the accrual basis is preferred to the $43,000 measure of cash receipts for measuring economic performance, and the $84,000 measure of costs is preferred to the $125,000 measure of cash disbursements. The $16,000 net income is a more accurate measure of total accomplishments for April than is the $82,000 net cash outflow for operations.442-50 (20-35 min.)1. See Exhibit 2-50 on the following page.2. H. J. HEINZ COMPANYStatement of EarningsFor the Month Ended August 31, 2009(In Millions)Sales $11Deduct expenses:Cost of goods sold $4Selling and administrative expenses 1Rent and insurance 1Depreciation 1 7Net earnings $ 4H. J. HEINZ COMPANYBalance SheetAugust 31, 2009(In Millions)Liabilities andAssets Stockholders’ EquityCash $ 542 Liabilities:Receivables 1,055 Accounts payable $ 1,086 Inventories 1,336 Other liabilities 7,363 $ 8,449 Other assets 5,154 Stockholders’ equity 1,706 Property, plant and equip. 2,068 Total $10,155 Total $10,155Chapter 2 Measuring Income to Assess Performance 452-51 (5-10 min.) Amounts are in millions.Cash Inflows:Cash sales $ 3Collections from credit customers 58 Cash disbursements:Payments on account payable $ (4)Disbursements to prepay rent and insurance (12)Disbursements for selling andadministrative expenses (1)Total cash disbursements (17)Net cash outflow $ ( 9)The accrual basis provides a more accurate measure of economic performance. If the two revenue recognition criteria are met (earning and realization), the $11 million measure of revenue on the accrual basis is preferred to the $8 million measure of cash receipts for measuring economic performance, and the $7 million measure of costs is preferred to the $17 million measure of cash disbursements. The $4 million net income is a more accurate measure of total accomplishments for August than is the $9 million net cash outflow.Chapter 2 Measuring Income to Assess Performance 47。