Test Bank for Financial & Managerial Accounting for Decision Makers, 4e by Hanlon, Magee, Pfeiffer, by digitaldownload87

Financial & Managerial Accounting for Decision Makers, 4e by Hanlon, Magee, Pfeiffer, Dyckman

TABLE OF CONTENTS CHAPTER 1: Introducing Financial Accounting CHAPTER 2: Constructing Financial Statements CHAPTER 3: Adjusting Accounts for Financial Statements CHAPTER 4: Reporting and Analyzing Cash Flows CHAPTER 5: Analyzing and Interpreting Financial Statements CHAPTER 6: Reporting and Analyzing Revenues and Receivables CHAPTER 7: Reporting and Analyzing Inventory CHAPTER 8: Reporting and Analyzing Long-Term Operating Assets CHAPTER 9: Reporting and Analyzing Liabilities CHAPTER 10: Reporting and Analyzing Leases, Pensions, Income Taxes, and Commitments and Contingencies CHAPTER 11: Reporting and Analyzing Stockholders’ Equity CHAPTER 12: Reporting and Analyzing Financial Investments CHAPTER 13: Managerial Accounting: Tools for Decision Making CHAPTER 14: Cost Behavior, Activity Analysis, and Cost Estimation CHAPTER 15: Cost-Volume-Profit Analysis and Planning

CHAPTER 16: Relevant Costs and Benefits for Decision Making CHAPTER 17: Product Costing: Job and Process Operations CHAPTER 18: Activity-Based Costing, Customer Profitability, and Activity-Based Management CHAPTER 19: Additional Topics in Product Costing CHAPTER 20: Pricing and Other Product Management Decisions CHAPTER 21: Operational Budgeting and Profit Planning CHAPTER 22: Standard Costs and Performance Measurement CHAPTER 23: Segment Reporting, Transfer Pricing, and Balanced Scorecard CHAPTER 24: Capital Budgeting Decisions

Appendix A Compound Interest and the Time-Value of Money True/False

Topic: Compound interest 1. When interest is earned on interest in a savings account in a bank, this is called compound interest. Answer: True Rationale: As interest accumulates on an investment, both the original investment and the accumulated interest will earn a return in subsequent periods. Topic: Time value of money 2. A dollar received today is worth more than a dollar received two years ago. Answer: False Rationale: It is much better to receive money as soon as possible as it can be invested and will earn additional interest. Topic: Financial calculator 3. The interest rate on a financial calculator to be inputted using the I/Yr key means to enter the rate per period. Answer: True Rationale: I/Yr is the interest rate per period. Topic: Compounding 4. If an investment is made that pays 5% annual interest for a 3-year period with semiannual compounding, the number of periods is 6. Answer: True Rationale: There are 6 semiannual periods in three years: 3 years × 2 times per year = 6 periods of compounding.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Installment loans 5. Installment loans require a series of equal payments that often vary in the time period between each payment. Answer: False Rationale: Installment notes have equal payments on a periodic basis, such that the time period between each payment must be the same. Topic: Bond valuation 6. There are two cash flows associated with bonds—a balloon payment and periodic interest payments. Answer: True Rationale: The balloon payment is the principal due when the bond matures. Interest payments are most often paid semiannually.

Test Bank, Appendix A

Multiple Choice

Topic: Bond pricing (using a financial calculator or Excel) 1. TJ Services issued bonds with a face value of $5,000,000 and a coupon rate of 4% paid semiannually for 5 years. The market rate of interest is 3%. How much is the market value of the bonds? A. B. C. D.

$4,308,336 $4,573,490 $5,228,985 $5,230,555

Answer: D Rationale: Interest payment = $5,000,000 × 4% × 1/2 = $100,000 N = 10 (5 *2)

I/Y = 1.5 (3% / 2)

PV = ?

PMT = 100,000

FV = 5,000,000

PV = $5,230,555 Topic: Time value of money 2. Why is one dollar now worth more than one dollar in the future? A. B. C. D.

The time value of money depreciates over long periods of time The amount to be received in the future is smaller than the amount to be paid off today The value of interest declines over time Funds can be invested in earning assets to yield a positive return

Answer: D Rationale: Investing money received today generates interest so that the investor will have more accumulated funds compared to waiting to receive funds in the future. Topic: Future value (using a financial calculator or Excel) 3. If an investor invests $2,500,000 today at 4% interest compounded semiannually, how much will be in the bank account two years from the date invested? (Select the closest amount) A. B. C. D.

$2,706,080 $2,924,646 $2,704,000 $2,601,000

Answer: A Rationale: N = 4 (2 * 2)

I/Y = 2.0 (4% / 2)

PV = 2,500,000

PMT = 0

FV = ?

FV = $2,706,080

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Bond pricing (using a financial calculator or Excel) 4. Seismic Industries issued bonds with a face value of $10,000,000 and a coupon rate of 4% paid semiannually for 5 years. The market rate of interest is 5%. How much is the market value of the bonds using a financial calculator? A. B. C. D.

$ 7,683,480 $10,449,129 $ 9,562,397 $ 8,701,157

Answer: C Rationale: Interest payment = $10,000,000 × 4% × 1/2 = $200,000 N = 10 (5*2)

I/Y = 2.5 (5%/2)

PV = ?

PMT = 200,000

FV = 10,000,000

PV = $9,562,397 Topic: Bond pricing (using a financial calculator or Excel) 5. Seismic Industries issued bonds with a face value of $10,000,000 and a coupon rate of 4% paid semiannually for 4 years. The market rate of interest is 5%. How much is the market value of the bonds? A. B. C. D.

$8,207,466 $9,641,493 $8,936,215 $9,645,405

Answer: B Rationale: Interest payment = $10,000,000 × 4% × 1/2 = $200,000 N =8 (4* 2)

I/Y = 2.5 (5% /2)

PV = ?

PMT = 200,000

FV = 10,000,000

PV = $9,641,493 Topic: Present value of a single amount 6. Which of the following determines the present value of a single cash payment? A. B. C. D.

Future value × (1 + discount rate) Future value ÷ (1 + discount rate) Future value × (1 ‒ discount rate) Future value ÷ (1 ‒ discount rate)

Answer: B Rationale: 1 plus the discount rate is divided into the future amount.

Test Bank, Appendix A

Topic: Present value of an investment (using a financial calculator or Excel) 7. Classy, Inc. wishes to accumulate $1,500,000 to be used to pay off a note at the end of 5 years. How much will Classy, Inc. invest today to accumulate the desired amount if the investment earns an annual rate of 6% compounded quarterly? (Select the closest amount) A. B. C. D.

$ 830,514 $1,113,706 $1,116,141 $1,293,913

Answer: B Rationale: N =20 (5*4)

I/Y = 1.5 (6%/4)

PV = ?

FV = 1,500,000

PV = $1,113,706 Topic: Future value of annuity (using a financial calculator or Excel) 8. Classy, Inc. wishes to accumulate $1,500,000 to be used to pay off a loan at the end of 3 years. How much will Classy, Inc. deposit each month for three years, beginning at the end of the first month, to accumulate the desired amount if the investment earns an annual rate of 6%, compounded monthly? (Select the closest amount) A. B. C. D.

$ 15,652 $ 34,821 $115,020 $ 38,133

Answer: D Rationale: N = 36 (3*12)

I/Y = 0.5 (6%/12)

PMT = ?

FV =1,500,000

PMT = $38,133

Financial & Managerial Accounting for Decision Makers, 4th Edition

Exercises Topic: Present value of a sum (using a financial calculator or Excel) 1. Crawford Motor Company wants to accumulate $2,000,000 to pay off an equipment loan due in 6 years. How much should Crawford Motor Company deposit today if the bank pays 5% interest compounded annually? Answer: N=6

I/ Y = 5

PV = ?

PMT = 0

FV = 2,000,000

PV = $1,492,431 Topic: Present value of a sum (using a financial calculator or Excel) 2. Crawford Motor Company wants to accumulate $2,000,000 to pay off an equipment loan due in 6 years. How much should Crawford Motor Company deposit today if the bank pays 5% interest compounded semiannually? Answer: N = 12(6*2)

I/Y = 2.5 (5%/2)

PV = ?

PMT = 0

FV = 2,000,000

PV = $1,487,112 Topic: Future value of an annuity (using a financial calculator or Excel) 3. Crawford Motor Company wants to accumulate $1,500,000 to pay off an equipment note due in 4 years. How much should Crawford Motor Company deposit each quarter beginning one quarter from today to accumulate the amount required if the bank pays 5% annual interest compounded quarterly? Answer: N = 16 (4 * 4)

I/Y = 1.25 (5% /4)

PV = 0

PMT = ?

FV = 1,500,000

PMT = $85,270 Topic: Future value of an annuity (using a financial calculator or Excel) 4. Crawford Motor Company wants to accumulate $1,500,000 to pay off an equipment loan due in 3 years. How much should Crawford Motor Company deposit each month beginning one month from today in order to accumulate $1,500,000 if the bank pays 6% annual interest with monthly compounding? Answer: N = 36 (3 * 12)

I/Y = 0.5 (6% / 12)

PV = 0

PMT = ?

FV = 1,500,000

PMT = $38,133

Test Bank, Appendix A

Topic: Present value of a sum (using a financial calculator or Excel) 5. Magnum Co. needs to have $250 million accumulated to fund health insurance payments for its retirees. Will Magnum Co. have enough accumulated at the end of 4 years if it deposits $200 million today if compounding occurs semiannually with an annual rate of 6%? Answer: N = 8 (4*2)

I/Y = 3 (6% /2)

PV = 200,000,000

PMT = 0

FV = ?

FV = $253,354,016 Yes, it will have over $253.3 million accumulated, which is enough to fund the health insurance. Topic: Installment note (using a financial calculator or Excel) 6. Magnum Co. borrowed $2,000,000 to buy equipment to be repaid as a installment note monthly over 4 years. How much will Magnum Co. pay each month if payments begin one month from now and the annual loan rate is 6% compounded monthly? Answer: N = 48(4 * 12)

I/Y = 0.5 (6% /12)

PV = 2,000,000

PMT = ?

FV = 0

PMT = $46,970 Topic: Balloon note (using a financial calculator or Excel) 7. Magnum Co. borrowed $500,000,000 to buy equipment with the total principal and interest to be repaid as a balloon note at the end of 4 years. How much will Magnum Co. pay to liquidate the note at the maturity date if interest is 6% compounded quarterly? Answer: N = 16 (4 *4)

I/Y =1.5 (6% /4)

PV = 500,000,000

PMT = 0

FV = ?

FV = $634,492,774 Topic: Present value of bonds (using a financial calculator or Excel) 8. Premier Investments recently issued bonds with a face value of $4,000,000 and a coupon rate of 4% for 5 years. The market rate of interest is 3% and the bonds pay interest semiannually. Compute the market value of the bond on the issue date. Answer: Interest payment = $4,000,000 × 4% × 1/2 = $80,000 N = 10 (5 *2) I/Y = 1.5 (3% /2) PV = ?

PMT =80,000

FV = 4,000,000

PV = $4,184,444

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Present value of notes (using a financial calculator or Excel) 9. Boyer Pharmaceuticals is a new drug company entering the market. It plans to issue notes with a face value of $10,000,000 and a coupon rate of 5% for 10 years. The market rate of interest is 4%. Compute the market value of the notes on the issue date if interest is paid semiannually. Answer: Interest payment = $10,000,000 × 5% × 1/2 = $250,000 N = 20 (10 * 2) I/Y = 2 (4% / 2) PV = ?

PMT = 250,000

FV = 10,000,000

PV = $10,817,572

Test Bank, Appendix A

Problems Topic: Bond pricing (using a financial calculator or Excel) 1. Mountaineer Services recently issued bonds with a face value of $15,000,000 and a coupon rate of 5% for 20 years. The market rate of interest is 4%. A. Compute the market value of the bonds if interest is paid annually. B. Computer the market value of the bonds if interest is paid semiannually. C. Explain the difference in the market value determined in parts A and B. Answer: A. Interest payment = $15,000,000 × 5% = $750,000 N = 20 I/Y = 4 PV = ?

PMT = 750,000

FV = 15,000,000

PV = $17,038,549 B. Interest payment = $15,000,000 × 5% × 1/2 = $375,000 N = 40 (20 * 2)

I/Y = 2 (4% / 2)

PV = ?

PMT = 375,000

FV = 15,000,000

PV = $17,051,661 C. The present value differs because interest is compounded more frequently with the semiannual payments providing a better return to the investor, so the investor is willing to pay $13,112 (= $17,051,661 - $17,038,549) more if the interest is compounded semiannually. Topic: Present value calculations (using a financial calculator or Excel) 2. An investment of $2,200,000 will return $500,000 per year for 5 years. Should the investment be undertaken if the market interest rate is 5% and interest is compounded annually? Answer: N=5

I/Y = 5

PV = ?

PMT = 500,000

FV = 0

PV = $2,164,738 No. Based on the financial aspects of the investment, it should not be undertaken as the present value of $2,164,738 is less than the required initial investment.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Bond pricing (using a financial calculator or Excel) 3. Noodles and More Restaurants, Inc. plans to issue 10-year notes with a face value of $20,000,000 and a coupon rate of 4.5%. The market rate of interest is 4%. Interest payments will be made semiannually. A. Compute the market value of the notes. B. Assume the market rate remains at 4% after 4 years. How much cash will Noodles and More Restaurants, Inc. need to pay off the notes at this time? Answer: A. Interest payment = $20,000,000 × 4.5% × 1/2 = $450,000 N = 20 (10 * 2) I/Y = 2 (4% / 2) PV = ? 20,000,000

PMT = 450,000

FV =

PMT = 450,000

FV =

PV = $20,817,572 B. Interest payment = $20,000,000 × 4.5% × 1/2 = $450,000 N = 12 (6 * 2) I/Y = 2 (4% / 2) PV = ? 20,000,000 PV = $20,528,767 Topic: Present value (using a financial calculator or Excel) 4. Compute the present value for each of the following amounts. A. $100,000 received in 5 years if annual interest rate is: (1) 8% compounded annually or (2) 8% compounded semiannually B. $15,000 received at the end of each year for the next 6 years if the market rate of interest is 5% per year compounded annually Answer: A. (1) N = 5 PV = $68,058 (2) N = 10 (5*2) PV = $67,556 B. N = 6 PV = $76,135

Test Bank, Appendix A

I/Y = 8

PV = ?

FV = 100,000

I/Y = 4 (8% / 2)

PV = ?

FV = 100,000

I/Y = 5

PV = ?

PMT = 15,000

Essay Topic: Present value 1. Why is one dollar now worth more than one dollar in the future? Answer: In periods of inflation, the purchasing power of a dollar declines over time. Consequently, a dollar in hand today is worth more than one to be received in the future. Even in the absence of inflation, funds can be invested in earning assets to yield a positive return.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 1 Introducing Financial Accounting Learning Objectives – Coverage by question True/False

Multiple Choice

Exercises

LO1 Identify the users of accounting information and discuss the costs and benefits of disclosure. (p. 4)

1, 2

1-3

1, 2

2, 5, 6

LO2 Describe a company's business activities and explain how these activities are represented by the accounting equation. (p. 7)

3-6

4, 5

1, 6

LO3 Introduce the four key financial statements including the balance sheet, income statement, statement of stockholders' equity, and statement of cash flows. (p. 11)

7-9

4, 6-11

4-11

LO4 Describe the institutions that regulate financial accounting and their role in establishing generally accepted accounting principles. (p. 17)

10-12

12, 19, 20

LO5 Compute two key ratios that are commonly used to assess profitability and risk - return on equity and the debt-to-equity ratio. (p. 21)

13, 14

13-18

13, 14

LO6 Appendix 1A: Explain the conceptual framework for financial reporting. (p. 26)

15, 16

21, 22

Problems

Essay Questions

1-5

3, 4

3, 5

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 1: Introducing Financial Accounting

True/False Topic: Cost and benefits of disclosure LO: 1 1. One reason companies are motivated to disclose financial information to external decision makers is that it may lower financing and operating costs. Answer: True Rationale: For example, when a company applies for a loan, the bank uses the company’s financial statements to help determine the appropriate interest rate. Without this financial information, a company may have a higher cost of borrowing or not obtain the loan at all. Topic: Demand for accounting information LO: 1 2. Financial accounting is designed primarily for decision makers within the company. Answer: False Rationale: Financial accounting is designed primarily to provide information to decision makers outside of the company, while managerial accounting is designed primarily for decision makers within the company. Topic: Investing activities LO: 2 3. Investing activities are the acquiring and disposing of liabilities that a company needs in order to finance its operating activities. Answer: False Rationale: Investing activities are the acquiring and disposing of assets that a company needs for the production and sale of a company’s products and services. Topic: Accounting equation LO: 2 4. Assets must always equal liabilities plus stockholders’ equity. Answer: True Rationale: The accounting equation is Assets = Liabilities + Stockholders’ Equity. This relation must always stay in balance.

1-2

Topic: Financing activities LO: 2 5. Other than operating profit, there are three main sources of external financing. Answer: False Rationale: There are two main sources of financing: owner (also called shareholder or equity) financing and nonowner (also called creditor or lender) financing. Topic: Financing and investing activities LO: 2 6. Financing activities are defined as the acquiring and disposing of resources for the purpose

of selling products and services. Answer: False Rationale: Financing activities are defined as methods a company uses to raise funds to pay for resources. Investing activities are defined as the acquiring and disposing of resources for the purpose of selling products and services. Topic: Statement of cash flows LO: 3 7. A statement of cash flows reports on cash flows for operating, investing and financing activities at a point in time. Answer: False Rationale: A statement of cash flows reports on cash flows for operating, investing, and financing activities over a period of time. Topic: Retained earnings LO: 3 8. Retained earnings are present on both the income statement and the statement of stockholders’ equity. Answer: False Rationale: Retained earnings are present in the statement of stockholders’ equity and the balance sheet. The income statement represents current period earnings. Topic: Balance sheet LO: 3 9. If a company reports retained earnings of $242.6 million on its balance sheet, it will also

report $242.6 million in cash. Answer: False Rationale: The accounting equation requires total assets to equal total liabilities plus stockholders’ equity. That does not imply, however, that liability and equity accounts relate directly to specific assets.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Regulation and Oversight LO: 4 10. The goal of the Sarbanes-Oxley Act of 2002 was to increase the level of confidence that external users have in the financial statements. Answer: True Rationale: In the wake of scandals, like those that took down Enron, the U.S. Congress passed the Sarbanes-Oxley Act to improve external user confidence in financial statement reporting. Topic: Global accounting perspective LO: 4 11. The International Accounting Standards Board (IASB) has legal authority to impose accounting standards on any country. Answer: False Rationale: The IASB works with standard setters within many countries, but does not have legal authority to impose IASB standards on any country. It was charged with creating International Financial Reporting Standards with the intention of unifying all public companies under one global set of reporting standards. Topic: IFRS LO: 4 12. Foreign companies using international accounting standards must reconcile their financial statements to American rules if they wish to sell securities in the U.S. Answer: False Rationale: The SEC adopted a rule in 2007 that allows foreign companies to stop reconciling to American rules. Topic: Financial statement analysis LO: 5 13. One key measure of profitability is the debt-to-equity ratio. Answer: False Rationale: Return on equity is a key profitability metric. The debt-to-equity ratio is a measure of longterm solvency when looking at credit risk. Topic: Credit risk analysis LO: 5 14. The greater the risk of any decision, the greater the expected return. Answer: True Rationale: The riskier an investment is, the greater the return demanded by investors.

1-4

Topic: Qualitative characteristics of accounting information LO: 6 15. The enhanced qualitative characteristic of accounting information known as comparability means that the financial statements of different companies should be presented in a way that allows users to make comparisons across companies concerning their activities, financial condition, and performance. Answer: True Rationale: Comparability means that information should enable users to identify similarities and differences between sets of economic phenomena. Topic: Conceptual framework for financial reporting LO: 6 16. The amended conceptual framework, issued by the FASB in 2018, includes a statement of the objective of financial reporting and a discussion about the two fundamental qualitative characteristics of accounting information. Answer: True Rationale: The conceptual framework states that the objective of financial reporting is “to provide information that is useful to present and potential equity investors, as well as lenders and other creditors, in making decisions about providing resources to the entity”. It also identifies relevance and faithful representation as the two fundamental qualitative characteristics of financial information necessary to fulfill the objective.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Multiple Choice Topic: Business organizations LO: 1 1. Which of the following forms of business organizations exists as a legal entity? A) A sole proprietorship B) A partnership C) A corporation D) A labor union Answer: C Rationale: A corporation is a form of business organization that exists as a legal entity that issues shares of stock to its owners or shareholders in exchange for cash or other resources. Topic: Financial accounting information users LO: 1 2. All of the following are proper uses of financial accounting information by a company’s board of directors except: A) To review the results of operations B) To evaluate future strategy C) To assess management performance D) To distribute buy/sell recommendations prior to company release of information Answer: D Rationale: Providing buy or sell recommendations prior to release by the company is a type of fraud known as insider trading and is not a way that directors should use financial accounting information. Topic: Financial accounting information users LO: 1 3. Which one of the following is not an external user of financial information? A) Stockholders B) Creditors C) Internal Revenue Service D) Top company management Answer: D Rationale: Decision makers outside the company include stockholders, creditors, and tax agencies such as the Internal Revenue Service. Topic: Accounting equation LO: 2, 3 4. On which statement are assets, liabilities and equity reported? A) Balance sheet B) Income statement C) Statement of stockholders’ equity D) Statement of cash flows Answer: A Rationale: A balance sheet reports on investing and financing activities. It lists amounts for assets, liabilities, and equity at a point in time.

1-6

Topic: Accounting equation LO: 2 5. Which of the following is a correct statement of the accounting equation in terms of activities? A) Investing = Operating assets + Financial assets B) Investing = Creditor financing + Owner financing C) Investing = Nonowner financing – Owner financing D) Nonowner financing = Investing + Operating Answer: B Rationale: The accounting equation is Assets = Liabilities + Stockholders’ equity. Another way of viewing this equation is Investing = Creditor financing + Owner financing Topic Financial statement format LO: 3 6. Which of the following is not part of the standard heading of each financial statement? A) The company name B) The statement title C) The date or time period of the statement D) The company’s industry Answer: D Rationale: Each financial statement identifies the company, the statement title, and the date or time period of the statement. Topic: Balance sheet and income statement LO: 3 7. Which of the following items are in the balance sheet? (Select all that apply.) A) Inventory B) Operating expenses C) Account receivable D) Equipment E) Cash payments Answer: A, C, and D Rationale: Statement B) is incorrect – operating expenses are found in the income statement, not the balance sheet. Statement E) is incorrect – cash payments are found on the statement of cash flows. Topic: Expenses LO: 3 8. Which of the four basic financial statements would contain a line item for expenses? A) Balance sheet B) Income statement C) Statement of equity D) Statement of cash flows Answer: B Rationale: The income statement reports on the revenues less the expenses over the reporting period. Expenses only appear on the income statement.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Account classification LO: 3 9. Which of the following would be reported on a statement of stockholders’ equity? A) Cash B) Total expenses C) Dividends D) Financing cash flows Answer: C Rationale: Dividends are a return of capital to stockholders and are found only on the statement of stockholders’ equity. Cash is found on the balance sheet. Total expenses is an income statement amount. Financing cash flows are found on the statement of cash flows. Topic: Articulation of financial statements LO: 3 10. How are the balance sheet and the statement of cash flows linked? A) By the cash balance B) By the amount of total retained earnings C) By the total shareholder equity D) By the amount of net income Answer: A Rationale: The balance sheet and the statement of cash flows are linked by the cash balance. The statement of cash flows shows the inflows and outflows of cash during the period. Then ending cash balance is on the balance sheet. Topic: Financial Statement Linkages LO: 3 11. Which one of the following is not a key linkage among the four primary financial statements? A) The expenses in the income statement link to the total liability balance. B) The statement of cash flows links to ending cash in the balance sheet. C) The income statement links to the ending retained earnings in the statement of stockholders’ equity. D) The statement of stockholders’ equity links to ending equity in the balance sheet. Answer: A Rationale: The expenses in the income statement are not linked to the total liability balance. An unpaid expense might at one point in time be listed as a liability; however, the total of liabilities and expenses is rarely the same. Topic: Regulation and oversight LO: 4 12. Which of the following organizations was established by the Sarbanes-Oxley Act to approve auditing standards and monitor the quality of financial statements and audits? A) The Securities and Exchange Commission B) The American Institute of Certified Public Accountants C) The Financial Accounting Standards Board D) The Public Company Accounting Oversight Board Answer: D Rationale: The Sarbanes-Oxley Act of 2002 established the Public Company Accounting Oversight Board to approve auditor standards and monitor the quality of financial statements and audits.

1-8

Use the following information to answer Questions 13, 14, 15, and 16. Data from the financial statements of Albi Foods and Unimart, Inc., two national grocery chains are presented below:

Total liabilities, 2021 Total liabilities 2020 Total assets, 2021 Total assets 2020 Revenue, 2021 Net income, 2021

Albi Foods

Unimart, Inc.

$43,610 48,239 64,743 67,582 200,693 2,312

$23,817 21,935 29,652 32,589 81,494 1,062

Topic: Profitability analysis LO: 5 13. To the nearest hundredth of a percent, what is the 2021 return on equity ratio for Albi Foods? A) 10.94% B) 11.42% C) 11.95% D) 5.30% Answer: B Rationale: ROE = Net income / Average stockholders’ equity = $ 2,312 / [($21,133 + $19,343)/2] = $2,312 / $20,238 = 11.42% Stockholders’ equity 2021 = $64,743 – $43,610 = $21,133 Stockholders’ equity 2020 = $67,582 – $48,239 = $19,343 Topic: Credit risk analysis LO: 5 14. To the nearest hundredth, what is the 2021 debt-to-equity ratio for Albi Foods? A) 2.06 B) 0.67 C) 2.27 D) 2.49 Answer: A Rationale: Debt-to-equity = Total liabilities / Total stockholders’ equity = $43,610/ $21,133 = 2.06 Stockholders’ equity 2021 = $64,743 – $43,610 = $21,133

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Profitability analysis LO: 5 15. To the nearest hundredth of a percent, what is the 2021 return on equity ratio for Unimart? A) 18.20% B) 9.97% C) 3.58% D) 12.88% Answer D Rationale: ROE = Net income / Average stockholders’ equity = $ 1,062 / [($5,835+ $10,654)/2] = $ 1,062 / $8,245 = 12.88% Stockholders’ equity 2021 = $29,652 – $23,817 = $ 5,835 Stockholders’ equity 2020 = $32,589 – $21,935 = $ 10,654 Topic: Credit risk analysis LO: 5 16. To the nearest hundredth, what is the 2021 debt-to-equity ratio for Unimart? A) 2.89 B) 2.06 C) 4.08 D) 2.77 Answer: C Rationale: Debt-to-equity = Total liabilities / Total stockholders’ equity = $23,817 / $5,835 = 4.08 Stockholders’ equity 2021 = $29,652 – $23,817 = $ 5,835 Topic: Financial statement analysis LO: 5 17. Anchor, Inc. has an ROE of 19.27% and Ballast Company has an ROE of 15.45%. Which of the following statements is true? A) Anchor reported more dollars of profit than Ballast B) Anchor is able to bring its product to market more efficiently than Ballast C) Anchor has more of the firm financed with debt than Ballast does D) Ballast would likely be able to borrow money at a lower interest rate than would Anchor Answer: B Rationale: ROE measures profitability and how efficiently a company markets its products to produce profit. The debt-to-equity ratio measures the extent to which a company relies on debt versus owner financing. Anchor shows a higher return on equity, which means that it is able to bring its product to market more efficiently than Ballast.

1-10

Topic: Financial statement analysis LO: 5 18. Anchor, Inc. has a debt-to-equity ratio of 0.42 and Ballast Company has 0.28. Which of the following statements is true? A) Anchor reported more dollars of profit than Ballast B) Anchor has more total debt than does Ballast C) Ballast would likely be able to borrow money at a lower interest rate than would Anchor D) Anchor is able to bring its product to market more efficiently than Ballast Answer: C Rationale: Ballast Company is the lower risk borrower of these two companies with a lower debt-toequity ratio. Ballast would likely be able to borrow money at a lower interest rate than Anchor. Anchor’s higher debt-to-equity means that the firm relies more on creditor financing than Ballast. Topic: Generally Accepted Accounting Principles LO: 4 19. Which of the following statements is true regarding generally accepted accounting principles (GAAP)? A) GAAP is a set of laws B) GAAP is subject to change as conditions warrant C) Under GAAP, if two companies engage in the same transactions, they must choose the same accounting methods D) U.S. GAAP is the same as GAAP in other countries Answer: B Rationale: Specific rules under GAAP are altered or new practices are formulated to fit changes in underlying economic circumstances of business transactions. Topic: IFRS LO: 4 20. Which statement is true about IFRS? A) It has legal authority to impose accounting standards world-wide B) It is working to reduce diversity in financial reporting practices across the world C) It has replaced GAAP financial accounting standards D) It is under the control of the SEC Answer: B Rationale: U.S. GAAP reporting still exists and has no control over the IASB who creates IFRS’s accounting standards. Topic: Assumptions for the preparation of financial statements LO: 6 21. Which of the following assumptions that underlies the preparation of financial statements assumes that companies will continue their operations over time? A) Separate economic entity B) Going concern C) Accounting period D) Measuring unit Answer: B Rationale: Under the going concern assumption, companies are assumed to have continuity in that they can be expected to continue in operations over time.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Qualitative characteristics of accounting information LO: 6 22. Which one of the following is not a quality of relevant accounting information? A) Materiality B) Predictive value C) Confirmatory value D) Understandability Answer: D Rationale: Accounting information is relevant when it has the ability to make a difference in a decision. Such information may be useful in making predictions about future performance of a company or in providing confirmatory feedback to evaluate past events. Accounting information can still be relevant, even though it may not be understandable to all users.

1-12

Exercises Topic: Financial accounting information LO: 1 1. Match each of the following terms (1-8) on the left with related explanations (A – H) on the right. 1.

Partnership

Board of directors

Managerial accounting

Stock market regulators

Creditors

Shareholders

Designed primarily for decision makers outside of the company Elected by the shareholders to oversee management Owners of a corporation

Financial accounting

Securities and Exchange Commission

Publicly traded corporations

Designed primarily for decision makers within the company

Answer: 1. B 2. E

3. H

4. G

5. C

6. F

Corporations with stock traded on public exchanges The common form of business ownership used by lawyers and CPAs Lenders of resources

7. D

8. A

Topic: Financial accounting information LO: 1 2. Match the following decision makers with the most likely decisions they seek to answer from accounting information. Use each answer only once. 1.

Suppliers and customers

Launch a new product or not?

Productions and operations

Purchase/sell goods from/to the company?

Creditors

Develop a new company strategy?

Investors and analysts

Lend to the company or not?

Top management

Manage operations?

Marketing teams

Buy or sell stock of the company?

Answer: 1. B 2. E

3. D

4. F

5. C

6. A

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Applying the accounting equation LO: 2 3. Compute the missing financial amounts (a) and (b): ($ millions) Company A Company B

Assets $ 28,800 $ 95,000

Liabilities (a) $ 79,600

Equity $5,670 (b)

Answer: (a) Liabilities = Assets – Equity = $28,800 - $5,670 = $23,130 (b) Equity = Assets – Liabilities = $95,000 - $79,600 = $15,400 Topic: Links between financial statements LO: 3 4. To which financial statements are each of the following financial values linked, and how are they linked? A. Retained earnings B. Net income C. Cash Answer: A. Retained earnings is linked to the income statement, the statement of shareholder’s equity, and the balance sheet. Net income on the income statement appears as an amount added to beginning retained earnings on the statement of stockholders’ equity. Ending retained earnings on the statement of stockholders’ equity is an amount in the stockholders’ equity section of the balance sheet. B. Net income is linked to the income statement and the statement of stockholder’s equity. Net income on the income statement appears as an amount added to beginning retained earnings on the statement of stockholders’ equity. C. Cash is linked to the statement of cash flows and the balance sheet. The ending balance is on the balance sheet and the changes in cash are shown on the statement of cash flows.

1-14

Topic: Constructing a balance sheet LO: 3 5. Construct a balance sheet from the financial statements components listed below. Cash Revenues Other expenses Retained earnings Operating cash flows Contributed capital Liabilities Noncash assets Cost of goods sold

$22,100 38,900 10,600 25,600 19,500 52,600 31,800 87,900 26,400

Answer:

Assets Cash Noncash assets

Total assets

$22,100 87,900

$110,000

Balance Sheet Liabilities and Equity Liabilities Equity Contributed capital Retained earnings Stockholders’ equity Total liabilities and equity

$31,800

52,600 25,600 78,200 $ 110,000

Topic: Compute stockholders’ equity LO: 3 6. At April 30, 2020, the end of Wegley, Inc.’s financial period, Wegley’s retained earnings were $75,220 million. During the following year, Wegley reported net income of $10,465 million and paid a dividend of $6,532 million. Determine Wegley’s retained earnings as of April 30, 2021. Answer: $75,220+ $10,465 ‒ $6,532 = $79,153 million

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Identifying sources of key financial data LO: 3 7. Match each item with the financial statement in which each item would most likely appear: Use (I) for Income Statement, (B) for Balance Sheet and (CF) for Statement of Cash Flow. _______

a. Cost of goods sold

_______

b. Revenue

_______

d. Contributed capital

_______

e. Retained earnings

_______

g. Net change in cash

Answer: a. I b. I c. B d. B

Liabilities

Cash from investing activities

e. B f. CF g. CF

Topic: Statement of cash flows LO: 3 8. Prepare a statement of cash flows for Pebble Company for 2021 given its information below (amounts in millions): Net income $1,681 Operating cash flows ? Investing cash flows Net decrease in cash Financing cash flows

(8,538) (495) 3,096

Answer: Operating cash flows + Investing cash flows + Financing cash flows = Net change in cash Operating cash flows ‒ $8,538 + 3,096 = $ (495) Operating cash flows = $ 4,947 Operating cash flows Investing cash flows Financing cash flows Net decrease in cash

$4,947 (8,538) 3,096 $ (495)

1-16

Topic: Financial statement relationships LO: 3 9. At the beginning of 2021 Resorts International, Inc. had $14,672 million in assets and $2,326 million in equity. During 2021, Resorts International’s assets decreased by $549 million while its equity increased by $392 million. How much were Resorts International’s liabilities at the beginning and end of 2021? Answer: Beginning liabilities = $14,672 million – $2,326 million = $12,346 million. Ending liabilities = ($14,672 million – $549 million) – ($2,326 million + $ 392 million) = $11,405 million. Topic: Retained earnings LO: 3 10. In its 2021 annual report, Pizza City reported net income of $37,960 thousand, retained earnings at the beginning of 2021 of $76,480 thousand, and dividends of $25,900 thousand. What is the amount of Pizza City’s retained earnings at the end of 2021? Answer: Retained earnings beginning + Net income – Dividends = Retained earnings ending = $76,480 + $37,960 - $25,900 = $88,540 thousand Topic: Other financial information LO: 3 11. In addition to the financial statements, list 3 other sources of information reported to external stakeholders? Answer: • Management Discussion and Analysis (MD&A) • Management report • Auditor report • Explanatory notes to financial statements • Proxy statements • Various regulatory filings

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Conceptual framework for financial reporting LO: 6 12. Match each of the following statements to the best qualitative characteristic or underlying assumption of accounting information that should be considered. Each answer is used only once. 1. Comparability

Although several accounting methods are acceptable, the information supplied to the decision makers should exhibit conformity from one accounting period to the next. A change in accounting methods should be rare.

2. Relevance

The company’s accountant ignores a $1.60 error in recording an invoice, discovered after the final financial statements were prepared.

3. Benefits > Costs

The accountant estimates the value of accounts receivable, based on recent information about economic forecasts and prior collection trends applicable to the company.

4. Going concern

Before each board meeting, the company prepares a number of reports that are time-consuming and expensive that are never used.

5. Separate economic entity

In estimating the life of a new piece of equipment, the accounting department assumes that the business will last indefinitely.

6. Materiality

George Bush, a stockholder of Halliburton, owes a debt to Union Bank for $3,000. This $3,000 is not a debt of Halliburton.

Answer: 1. A 2. C

3. D 4. E

5. F 6. B

1-18

Topic: Return on equity and debt-to equity ratio LO: 5 13. Mix Media reported the following amounts in its December 31, 2021 and 2020 financial statements.

Sales revenue Cost of sales Net income Total assets Stockholders’ equity

2021 $250,000 172,000 4,300 62,000 23,500

2020 $265,000 180,000 4,500 65,800 27,200

Calculate to the nearest hundredth: A. Return on equity for 2021. B. Debt-to-equity ratio as of December 31, 2021 Answer: A. ROE = Net Income / Average stockholders’ equity = $4,300 / [($23,500+ $27,200)/2] = 16.96% B. Debt-to-equity = Total liabilities / Total stockholders’ equity = $ 38,500/ $23,500= 1.64 Total liabilities = $62,000– $23,500 = $ 38,500 Topic: Return on equity and debt-to equity ratio LO: 5 14. Brock, Inc. has a debt-to-equity ratio of 0.32 and a ROE of 12.5%. The median ROE for similar companies in the same industry as Brock is about 15.1%. The median debt-to-equity ratio for similar companies in the same industry is 0.49. Based on this industry information, how does Brock compare to similar companies and what are the causes of these differences? Answer: As the return on equity shows, Brock is underperforming similar companies in its industry as far as its ability to generate profit for its stockholders at 12.5%. On average, other companies in its industry are more efficient in bringing their product or service to the market and produce a product or service that the market values. Brock’s debt-to-equity ratio, as compared to similar companies in its industry, indicates that the company is less aggressive with debt financing. Brock’s ratio indicates that the company is using approximately one part debt and two parts equity financing, contributing to less credit risk and more solvency than the industry average which is well above 0.32.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Problems Topic: Preparation of financial statements LO: 3 1. The following is selected financial information of Gordon Publishers for the year ended December 31, 2021. Cash Net income Total liabilities Stockholders’ equity Cost of goods sold Investing cash flows Sales Noncash assets Financing cash flows Other expenses Operating cash flows Cash at beginning of the year

$ 35,000 6,300 80,000 185,000 165,000 (6,400) 210,500 230,000 (87,000) 39,200 92,100 36,300

Prepare an income statement, balance sheet and statement of cash flows for Gordon Publishers at December 31, 2021. Answer: Gordon Publishers Income Statement For Year Ended December 31, 2021 Sales Cost of goods sold Gross profit Other expenses Net income

Assets Cash Noncash assets Total assets

$210,500 165,000 45,500 39,200 $ 6,300 Gordon Publishers Balance Sheet December 31, 2021 Liabilities and Equity $ 35,000 Total liabilities 230,000 Equity ______ Stockholders’ equity $ 265,000 Total liabilities and equity

$ 80,000 185,000 $ 265,000

Gordon Publishers Statement of Cash Flows For Year Ended December 31, 2021 Operating cash flows Investing cash flows Financing cash flows Net change in cash Cash, January 1 Cash, December 31

$ 92,100 (6,400) (87,000) (1,300) 36,300 $ 35,000 © Cambridge Business Publishers, 2021

Test Bank, Chapter 1

1-20

Topic: Preparation of statement of stockholders' equity LO: 3 2. The following is selected financial information for Qualmart, Inc. for its year ending January 31, 2021: Retained earnings, January 31, 2020 ………….. Stock issuance …………………………………… Contributed capital, January 31, 2020 …………. Net income ………………………………………… Other stockholders’ equity changes…………….. Dividends ………………………………………….. Other stockholders’ equity, January 31, 2020....

$153,790 1,235 9,470 32,560 (592) 14,930 2,463

Prepare a statement of stockholders' equity for 2021 for Qualmart. Answer: Qualmart, Inc. Statement of Stockholders' Equity For Year Ended January 31, 2021

Balance, January 31, 2020 Stock issuance

Contributed Capital

Retained Earnings

Other

Total

$ 9,470

$ 153,790

$2,463

$165,723

1,235

Net income

32,560

Dividends

(14,930)

Other stockholders’ equity changes

_______

(592)

Balance, January 31, 2021

$10,705

$171,420

$1,871

$183,996

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Preparation of balance sheet and statement of cash flows LO: 3 3. The following is selected financial information from Hargrove, Inc. for the year ended December 31, 2021. Cash Stockholders’ equity Sales Operating cash flows Cost of goods sold Financing cash flows Other expenses Noncash assets Total liabilities Investing cash flows

$2,565 1,661 25,125 14,650 20,621 8,308 4,218 32,950 33,854 (22,865)

Construct a balance sheet and statement of cash flows for Hargrove for 2021. Answer: Hargrove, Inc. Balance Sheet December 31, 2021 Assets

Liabilities and Equity

Cash

Noncash assets Total assets

2,565

Total liabilities

32,950

Equity

$ 33,854

______

Stockholders’ equity

$ 35,515

Total liabilities and equity

1,661 $ 35,515

. Hargrove, Inc. Statement of Cash Flows For Year Ended December 31, 2021 Operating cash flows

$14,650

Investing cash flows

(22,865)

Financing cash flows

8,308

Net change in cash

Cash, January 1, 2021 Cash, December 31, 2021

2,472 $ 2,565

1-22

Topic: Preparation of the financial statements LO: 3 4. The following is selected financial information for CoreLife Foods from its Form 10-K filed with the SEC for the year ended July 31, 2021: Cash Other expenses Operating cash flows Sales Stockholders’ equity Investing cash flows Cost of goods sold Total liabilities Financing cash flows Noncash assets

$ 1,050 5,846 2,722 24,740 2,358 (3,439) 18,218 14,382 683 15,690

Prepare each of the following financial statements for CoreLife Foods in proper form: • Income statement • Balance sheet • Statement of cash flows Answer: CoreLife Foods Income Statement For Year Ended July 31, 2021 Sales Cost of goods sold Gross profit Other expenses Net income

Assets Cash Noncash assets Total assets

$24,740 18,218 6,522 5,846 $ 676 CoreLife Foods Balance Sheet July 31, 2021 Liabilities and Equity $ 1,050 Total liabilities 15,690 Equity Stockholders’ equity $16,740 Total liabilities and equity

$14,382 2,358 $16,740

CoreLife Foods Statement of Cash Flows For Year Ended July 31, 2021 Operating cash flows Investing cash flows Financing cash flows Net change in cash Cash, August 1, 2020 Cash, July 31, 2021 © Cambridge Business Publishers, 2021 1-23

$2,722 (3,439) 683 (34) 1,084 $1,050

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Preparing a statement of stockholders’ equity LO: 3 5. Exciting Foods reported the following selected information at July 31, 2021: Contributed capital, July 31, 2020 Stock issuance, August 1, 2020 to July 31, 2021 Retained Earnings, July 31, 2020 Net income Dividends Other stockholders’ equity, July 31, 2020 Other stockholders’ equity changes

$25,280 521 36,172 2,478 893 1,665 (120)

Use this information to prepare a statement of stockholders’ equity for Exciting Foods for the year ending July 31, 2021. Answer: Exciting Foods Statement of Stockholders' Equity For Year Ended July 31, 2021

Balance, August 1, 2020 Stock issuance Net income Dividends Other stockholders’ equity changes Balance July 31, 2021

Contributed Capital $25,280 521

Retained Earnings $36,172

Other 1,665

Total $63,117 521 2,478 (893)

(120) $1,545

(120) $65,103

2,478 (893) ______ $25,801

______ $37,757

1-24

Essays Topic: Business activities LO: 2 1. Describe the four basic business activities conducted by a company in the production and sale of its products and services. Answer: The four activities include planning, financing, operating and investing. The planning activities are part of the creation of the company’s business plan, which is used to articulate and describe the company’s strategy for operations and earning income. Financing activities include all activities to acquire the capital used to pay for resources such as property, equipment and buildings. This financing can be either owner financing (i.e., money invested by the owner of the company), or non-owner financing (i.e., money contributed by those other than the owner). Operating activities refer to the processes by which resources owned by the company will be used to develop products and services. These activities will result in revenue (i.e., money coming into the company), and expenses (i.e., money used by the company as part of the operating activities). Investing activities encompass the steps involved in deciding which assets the company should acquire or sell with the money that was made available as a result of the financing activities. These assets are ultimately used in the operating activities to generate sales and revenues. Topic: Demand of financial accounting information LO: 1 2. List three users of financial accounting information and explain the significance of this information for each user. Answer: Shareholders and potential shareholders – Shareholders demand financial accounting information to assess the profitability and risks of companies. Shareholders look for information useful in their investment decisions. They use accounting information to evaluate manager performance. Creditors and suppliers – Creditors and other lenders demand financial accounting information to help decide loan terms, dollar amounts, interest rates and collateral. Suppliers similarly demand financial information to establish credit sales terms and to determine their long-term commitment to supplychain relations. Both creditors and suppliers use financial information to continuously monitor and adjust their contracts and commitments with a debtor company. Managers and directors – Managers and directors demand financial information on the financial condition, profitability and prospects of their companies for their own well-being and future earnings potential. They also demand comparative financial information on competing companies and other business opportunities. This permits them to conduct comparative analyses to benchmark company performance and condition. Managers similarly use such information to request further compensation and managerial power from directors. Outside directors are crucial to determining who runs the company, and these directors use accounting information to evaluate manager performance. continued next page

Financial & Managerial Accounting for Decision Makers, 4th Edition

Financial analysts – Financial analysts publish financial statistics about companies and disseminate financial information about specific industries. Labor unions – These groups examine financial statements in order to assess the financial health of firms prior to negotiating labor contracts on behalf of the firms’ employees. Customers– Customers demand accounting information to assess the ability of the company to provide products or services as agreed and to assess the company’s staying power and reliability. Customers also wish to estimate the company’s profitability to assess fairness of returns on mutual transactions. Tax agencies –Tax agencies use information to help establish tax policies. Over government agencies. They use accounting information to develop and enforce regulations, including public protection, price setting, import-export and various other uses. Topic: Use of estimates in financial reporting LO: 4, 6 3. Financial statements rely on countless estimates by accountants, including the useful life of building and equipment, the dollar amounts that will be collected from customers who purchase on credit, the prediction of future costs related to warranty claims or future pension obligations. Prepare a short argument to explain why estimates are an acceptable and important ingredient in the preparation of financial statements. Answer: Certain financial figures or costs cannot be quantified in exact terms, but still must be disclosed to shareholders in order to provide them with timely financial reporting. A practical way of disclosing such items is to quantify them in terms of conservative estimates. A company can then revise such estimates, prospectively, as future events, or data affect the original estimate. Topic: The effect of the Sarbanes-Oxley Act LO: 4 4. Accounting debacles, such as in the case of Enron, brought to light the necessity of accuracy in financial reporting and accountability of management. Describe how the introduction of the Sarbanes-Oxley Act has changed the requirements of financial reporting. Answer: Congress introduced the Sarbanes-Oxley act as a way of restoring confidence in the integrity of financial statement reporting of publicly traded companies. The Act requires the chief executive officer and chief financial officer of the company to personally sign-off on the accuracy and completeness of financial statements and the integrity of the company’s system of internal controls. This requirement is designed to hold management personally accountable for negligence in financial reporting and encourage vigilance in monitoring the company’s financial accounting system.

1-26

Topic: Costs and benefits of disclosure LO: 1, 6 5. Explain the benefits and costs associated with a company's disclosure of information. Answer: Supplying information benefits a company by helping it to compete in capital, labor, input, and output markets. Performance of a company hinges on successful business activities and the markets’ awareness of that success. Economic incentives exist for those companies that disclose reliable accounting information, especially when good news about products, processes, management, etc. is disclosed. Costs associated with the disclosure of information are associated with its preparation and dissemination. Other costs include competitive disadvantage, litigation potential, and political costs. Topic: Owner vs. Nonowner financing LO: 1, 2 6. Businesses rely on financing activities to fund their operating and investments. Explain the difference between owner and non-owner financing, and explain the benefits and risks involved in relying more heavily on each type of financing. Answer: Owner financing, also called equity refers to money given to the business in exchange for partial control of the company. Stock is the most common form of owner financing. Companies are not obligated to guarantee a return on owner investments. However, if returns are unacceptable to owners, they may use their power to take the business in different directions. In sum, owner financing provides cash inflow to the company without any guarantee of repayment. Control over the company is vested in the shareholders. Non-owner financing refers to money given to the business in exchange for a guaranteed repayment, usually with interest. Loans and bonds are very common examples of non-owner investment. The risk to the company lies in potential default if operations decline. The benefit is that the company does not need to cede operational control to its creditors, unless it defaults on its repayment. In sum, non-owner financing allows the current owners to maintain full control of the company, but requires repayment with interest. Companies that rely more heavily on owner financing are said to be financed conservatively; Companies that rely more heavily on non-owner financing are said to be financed less conservatively.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 2 Constructing Financial Statements Learning Objectives – Coverage by question True/False

Multiple Choice

Exercises

Problems

Essay Questions

1-3

LO1 Describe and construct the balance sheet and understand how it can be used for analysis. (p. 44)

1-4

1, 3-5, 7, 21

1, 2, 5, 10, 13

1, 2, 4

LO2 Use the financial statement effects template (FSET) to analyze transactions. (p. 49)

6, 9, 14, 15, 17

6, 7

5, 6

LO3 Describe and construct the income statement and discuss how it can be used to evaluate management performance. (p. 53)

6, 7

8, 10-12

3, 8, 12

LO4 Explain revenue recognition, accrual accounting, and their effects on retained earnings. (p. 54)

8, 9

9, 12-14

7, 10

2, 5, 6

LO5 Illustrate equity transactions and the statement of stockholders' equity. (p. 60)

10, 11

4, 5, 9-11, 13

LO6 Use journal entries and T-accounts to analyze and record transactions. (p. 62)

12, 13

16, 17

LO7 Compute net working capital, the current ratio, and the quick ratio, and explain how they reflect liquidity. (p. 71)

14, 15

18-20

14, 15

5, 6

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 2: Constructing Financial Statements True/False

Topic: Assets LO: 1 1. Companies may not report internally created assets, such as the value of a successful marketing campaign, design innovations and a highly motivated work force on their balance sheets. Answer: True Rationale: Even though these “assets” probably provide future benefits to the company that will be reflected in the company’s market value and in future revenues, these amounts cannot be reliably measured. They are excluded from the balance sheet under GAAP. Topic: Historical cost LO: 1 2. Assets such as inventory and property, plant, and equipment are reported on the balance sheet at their current market value. Answer: False Rationale: These assets are generally reported at historical cost. Topic: Reporting of assets LO: 1 3. Assets are listed on the balance sheet in order of liquidity and liabilities are listed in order of amount. Answer: False Rationale: Assets are reported in the order of liquidity which reflects the ease of converting into cash. Receivables are reported before inventories, and inventories before PPE. Liabilities are reported in order of maturity, with current liabilities expected to be paid within one year or within the operating cycle, and long-term liabilities expected to be paid over a longer period of time. Topic: The double-entry accounting system LO: 1 4. Under the double-entry accounting system, no more than two accounts can be affected by each transaction. Answer: False Rationale: Each transaction recorded under the double-entry accounting system must affect at least two accounts. It can affect more than two.

Test Bank, Chapter 2

Topic: Transaction analysis LO: 2 5. If Howard, Inc. purchased inventory on credit from Roan Company, then the transaction recorded by Howard would include an increase in a liability and an increase in asset. Answer: True Rationale: The transaction recorded by Howard would include an increase to an asset (inventory) and an increase to a liability (accounts payable). Topic: Reporting financial performance LO: 3 6. Operating expenses include interest expense related to a company’s financing activities. Answer: False Rationale: Interest expense is considered to be a nonoperating expense. Topic: Reporting financial performance LO: 3 7. The income statement is also called the statement of earnings. Answer: True Rationale: Another name for the income statement is the statement of earnings. Topic: Accrual accounting LO: 4 8. Accrual accounting recognizes revenues only when cash is received and expenses only when cash is paid. Answer: False Rationale: Accrual accounting refers to the recognition of revenue when earned and the matching of expenses when incurred. The recognition of revenues and expenses does not always relate to the receipt or payment of cash. Topic: Matching principle LO: 4 9. Under the matching principle, the cost of inventory should be reported as an expense in the income statement when it is purchased, even if it is purchased on credit and will not be paid until the next reporting period. Answer: False Rationale: Under the matching principle, the cost of inventory should only be reported as expense in the period in which it is used up, typically at the point of sale. Purchased inventories that have not yet been sold are reported as assets. Unpaid amounts to suppliers are reported as liabilities.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Analyzing and recording equity transactions LO: 5 10. If Uben Company paid $15,000 cash dividends to its shareholders, contributed capital would be reduced by $15,000. Answer: False Rationale: A cash dividend results in a reduction of retained earnings, not contributed capital. Topic: Analyzing and recording equity transactions LO: 5 11. If stockholders’ equity is $100,000 on January 1, 2021, and decreases to $90,000 on December 31, 2021, this could only be due to a dividend payment of $10,000. Answer: False Rationale: A reduction in stockholders’ equity could also be due to a net loss for the year. Topic: Debit and credit system LO: 6 12. A compound entry does not necessarily have to maintain total debits equal to total credits. Answer: False Rationale: A compound entry must adhere to the rule: total debits equal total credits. Topic: T-account LO: 6 13. The typical form of a T-account shows debits on the right and credits on the left. Answer: False Rationale: A T-account tracks debits on the left and credits on the right. Topic: Net working capital LO: 7 14. Net working capital = Current assets + Current liabilities Answer: False Rationale: Net working capital = Current assets less current liabilities. Topic: Assessing Liquidity LO: 7 15. Quick ratio is another name for a current ratio. Answer: False Rationale: The quick ratio differs from the current ratio in that the numerator only contains cash, short-term securities, and accounts receivable.

Test Bank, Chapter 2

Multiple Choice

Topic: Current assets LO: 1 1. Which one of the following is included in current assets? A) B) C) D)

Accounts receivable Taxes payable Automobiles Common stock

Answer: A Rationale: Accounts receivable is included in current assets as it represents amount owed by customers that are expected to be paid within one year or the operating cycle. Topic: Stockholders’ equity LO: 5 2. Which of the following is not shown in the statement of stockholder’s equity? A) B) C) D)

Unearned revenue Dividends Retained earnings Common stock

Answer: A Rationale: Unearned revenue is a liability that represents amounts collected in advance from customers. It is an obligation that must be satisfied with a future cash payment or delivery of goods or services. Topic: Reporting of assets LO: 1 3. Assets are recorded in the balance sheet in order of: A) B) C) D)

Market value Historic value Liquidity Maturity

Answer: C Rationale: Liquidity refers to the ease of conversation to cash. Current assets are to be used during the current operating cycle (starting with cash, short-term investments, accounts receivables, inventories and other assets). Market value and historic value refer to the measurement of assets. Maturity refers to the order in which liabilities are recorded in the balance sheet.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Liabilities LO: 1 4. Which one of the following is not a current liability? A) B) C) D)

Taxes payable Accounts payable Wages payable Wage expense

Answer: D Rationale: Wages expense is an income statement account, not a balance sheet account. Current liabilities are amounts owed and due to be repaid within one year or within one operating cycle. Topic: Reporting of assets LO: 1 5. What are probable future sacrifices called and how are they reported? A) B) C) D)

Assets on the balance sheet Stockholders’ equity on the balance sheet Dividends on the statement of stockholders’ equity Liabilities on the balance sheet

Answer: D Rationale: Liabilities are probably future economic sacrifices resulting from a current or past event. They are obligations that must be satisfied with a future cash payment or delivery of goods or services. Topic: Chart of accounts LO: 2 6. Account titles are commonly grouped into what five categories in the chart of accounts? A) Current assets, Current liabilities, Noncurrent assets, Noncurrent liabilities, Stockholders’ equity B) Assets, Liabilities, Equity, Revenue, Expenses C) Common stock, Additional paid-in capital, Treasury stock, Retained earnings, Accumulated other comprehensive income or loss D) Cash, Marketable securities, Accounts payable, Long-term debt, Common stock Answer: B Rationale: In the chart of accounts, account titles are commonly grouped into the five categories of: Assets, Liabilities, Equity, Revenues, and Expenses. Topic: Stockholders’ equity LO: 1 7. Which one of the following does not impact retained earnings directly? A) B) C) D)

Net income Net loss Dividends Stock issuances

Answer: D Rationale: Stock issuances impact stockholders’ equity through the common stock account.

Test Bank, Chapter 2

Topic: Income statement LO: 3 8. An income statement does not include which of the following? A) B) C) D)

Operating expenses Cost of goods sold Retained earnings Sales

Answer: C Rationale: Retained earnings represent accumulated earnings from previous accounting periods that has not been distributed to stockholders as dividends. Topic: Effects of accrued wages LO: 2, 4 9. An accrual of wages expense would produce what effect on the balance sheet? A) B) C) D)

Increase liabilities and decrease equity Decrease liabilities and increase equity Increase assets and increase liabilities Decrease assets and decrease liabilities

Answer: A Rationale: An accrual of wages expense produces an increase in wages payable (liability) and a decrease in retained earnings (stockholders’ equity), resulting in a decrease of profit. Topic: Gross profit LO: 3 10. Sales less cost of goods sold equals: A) B) C) D)

Net income Net profit margin Gross profit Gross profit margin

Answer: C Rationale: Sales – Cost of goods sold = Gross profit. The gross profit margin is gross profit divided by sales. Topic: Reporting financial performance LO: 3 11. Hariwell Industries recorded and paid $2,000 in wages. Which occurred? A) B) C) D)

Current assets increase. Gross profit decreases. Retained earnings increases. Operating income decreases.

Answer: D Rationale: Assets (cash) decrease and Wages Expense (an operating expense) increases, causing operating income to decrease.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Recognition of costs as expense LO: 3, 4 12. As inventory and PPE assets on the balance sheet are consumed, they are reflected: A) B) C) D)

As a revenue on the income statement As an expense on the income statement As common stock on the balance sheet Assets are never consumed

Answer: B Rationale: As assets are consumed (used up), their cost is transferred into the income statement as an expense. Topic: Analyzing and recording income statement transactions LO: 4 13. Which of the following will properly record the payment of a one-year insurance policy? A) B) C) D)

Increase assets and increase retained earnings Increase liabilities and decrease retained earnings Increase and decrease assets Decrease assets and decrease liabilities

Answer: C Rationale: Prepaid insurance in increased and cash is decreased, both of which are assets. Topic: Collection of a receivable LO: 2, 4 14. Cash collected on accounts receivable would produce what effect on the balance sheet? A) B) C) D)

Increase liabilities and decrease equity Decrease liabilities and increase equity Increase assets and decrease assets Decrease assets and decrease liabilities

Answer: C Rationale: Cash collected on accounts receivable produces an increase in cash and a decrease in accounts receivable, both asset accounts. There is no impact on profit and on equity. Topic: Transaction analysis LO: 2 15. Which of the following is one effect of a purchase of $2,500 of equipment on credit? A) B) C) D)

It would decrease retained earnings by $2,500 It would increase assets by $2,500 It would decrease liabilities by $2,500 It would decrease cash by $2,500

Answer: B Rationale: The purchase on credit creates an account payable. It would increase liabilities by $2,500. In addition, the equipment account in the asset section of the balance sheet would also increase.

Test Bank, Chapter 2

Topic: Journalizing and posting transactions LO: 6 16. The Cash T-account has a beginning balance of $52,000. During the year, $365,000 was debited and $360,000 was credited to the account. What is the ending balance of cash? A) B) C) D)

$ 5,000 $57,000 $47,000 $(5,000)

Answer: B Rationale: $52,000 + $365,000 - $360,000 = $57,000 Topic: Journalizing and posting transactions LO: 2, 6 17. On January 1, 2021, George Company paid $45,000 in cash for insurance covering the year 2021. Which of the following would be the correct journal entry to record this transaction? A) Insurance expense Cash

45,000

B) Cash

45,000

Insurance expense

45,000

C) Prepaid insurance Cash

45,000

D) Cash

45,000

Prepaid insurance

45,000

Answer: C Rationale: Prepaid insurance is debited and Cash is credited for $45,000. Topic: Net working capital LO: 7 18. Net working capital is defined as: A) B) C) D)

Assets – liabilities Current assets Current assets – Current liabilities Market value – Book value

Answer: C Rationale: Net working capital = Current assets – Current liabilities

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Assessing liquidity LO: 7 19. Which of the following statements is true regarding the current ratio? A) A company with a high current ratio cannot have liquidity problems B) A low current ratio suggests inefficient use of resources C) The current ratio can be improved by paying creditors immediately prior to the preparation of financial statements D) The current ratio presents a more conservative liquidity measure than does the quick ratio Answer: C Rationale: A current ratio can be manipulated by management and improved if creditors are paid immediately prior to the close of a financial statement period. Topic: Assessing Liquidity LO: 7 20. If Finscher Toys has working capital of $2,000,000, which of the following will cause its working capital to decrease? A) B) C) D)

Recorded interest payable in the amount of $150,000 Paid wages payable in the amount of $150,000 Borrowed $150,000 from a bank to be repaid in 90 days Purchased $150,000 of inventory on credit

Answer: A Rationale: Working capital will remain the same in B, C, and D, because current assets and current liabilities are equally affected. Only option A will show a decrease in working capital, because current assets are not affected but current liabilities increase. Topic: Measuring assets LO: 1 21. Which of the following is the justification of reporting certain assets at historical cost? A) B) C) D)

Executory Reliability Relevance Accrual

Answer: B Rationale: Historical cost is used because it is objective and reliable. It can easily be verified as it represents the cost originally paid.

Test Bank, Chapter 2

Exercises Topic: Balance sheet accounts LO: 1 1. Identify the following as an asset (A), liability (L), or equity (E) by writing the letter of the correct classification in the space provided. Account A. B. C. D. E. F. G. H. Answer: A. Liability B. Asset

Classification

Accounts payable Office equipment Accounts receivable Common stock Cash Contributed capital Wages payable Unearned revenue C. Asset D. Equity

E. Asset F. Equity

G. Liability H. Liability

Topic: Balance sheet relations LO: 1 2. Compute the missing amounts in the table below: Year 1 $190,000 A $ 24,000 $145,000 $190,000

Total assets Contributed capital Retained earnings Total liabilities Liabilities and equity

Year 2 B $ 10,000 C $165,000 $206,000

Answer: A. Liabilities and equity ‒ equity = Liabilities $190,000 ‒ equity = $145,000 Equity = $45,000 Contributed capital + retained earnings = Equity Contributed capital + $24,000 = $45,000 Contributed capital = $21,000 B. Total assets = Liabilities and equity Total assets = $206,000 C. Liabilities and equity ‒ liabilities = Equity $206,000 ‒ $165,000 = $41,000 Contributed capital + retained earnings = Equity $10,000 + $? = $41,000 Retained earnings = $31,000 © Cambridge Business Publishers, 2021 2-11

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Prepare an income statement LO: 3 3. Prepare an income statement for the month ended July 31, 2021 for Thrifty Books. Thrifty’s account balances for the month ending July 31, 2021 are: Cash Utilities expense Supplies Equipment Land Miscellaneous expenses Common stock

$ 3,000 2,200 8,000 85,000 100,000 1,300 150,000

Rent expense Accounts receivable Salaries expense Sales Retained earnings, July 1 Dividends Accounts payable

$ 41,000 40,000 192,000 250,000 27,800 4,500 49,200

Answer: Thrifty Books Income Statement For the Month Ended July 31, 2021 Revenues Sales Expenses Salaries expense Rent expense Utilities expense Miscellaneous expenses Total expenses Net income

Test Bank, Chapter 2

$250,000 $192,000 41,000 2,200 1,300 236,500 $13,500

Topic: Prepare a statement of stockholders’ equity LO: 5 4. Prepare a statement of stockholders’ equity for the month ended July 31, 2021 for Thrifty Books. Assume no changes in contributed capital during the month. Thrifty’s account balances for the month ending July 31, 2021 are: Cash Utilities expense Supplies Equipment Land Miscellaneous expenses Common stock

$ 3,000 2,200 8,000 85,000 100,000 1,300 150,000

Rent expense Accounts receivable Salaries expense Sales Retained earnings, July 1 Dividends Accounts payable

$ 41,000 40,000 192,000 250,000 27,800 4,500 49,200

Answer: Thrifty Books Statement of Stockholders’ Equity For the Month Ended July 31, 2021

Balance, July 1, 2021 Common stock issued Add: Net income Less: Dividends Balance, July 31, 2021

Contributed Capital $150,000 0 0 $150,000

Retained Earnings $27,800 13,500 (4,500) $36,800

Total Equity $177,800 0 13,500 (4,500) $186,800

Net Income: $250,000 ‒ $192,000 ‒ $41,000 ‒ 2,200 ‒ $1,300 = $13,500

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Prepare a balance sheet LO: 1, 5 5. Prepare a balance sheet for Thrifty Books as of July 31, 2021. Thrifty’s account balances for the month ending July 31, 2021 are: Cash Utilities expense Supplies Equipment Land Miscellaneous expenses Common stock

$ 3,000 2,200 8,000 85,000 100,000 1,300 150,000

Rent expense Accounts receivable Salaries expense Sales Retained earnings, July 1 Dividends Accounts payable

$ 41,000 40,000 192,000 250,000 27,800 4,500 49,200

Answer:

Assets Cash Accounts receivable Supplies Total current assets Equipment Land Total noncurrent assets Total assets

Thrifty Books Balance Sheet July 31, 2021 Liabilities $ 3,000 Accounts payable 40,000 8,000 Equity 51,000 Common stock 85,000 Retained earnings 100,000 Total equity 185,000 $236,000 Total liabilities and equity

$ 49,200

150,000 36,800 186,800 _______ $236,000

Topic: Identifying transactions that yield statement effects LO: 2, 6 6. Provide an example of a transaction that creates each of following effects: A. B. C. D.

Increase assets and increase equity Decrease asset and decrease liability Decrease asset and decrease equity Increase asset and increase liability

Answer: A. Owner invests cash into business B. Pay cash to settle a liability in accounts payable C. Business incurs an expense and it is paid with cash D. Business buys a new machine on credit

Test Bank, Chapter 2

Topic: Transaction analysis LO: 2, 4 7. Record the effects of each transaction or event in the table below: Balance Sheet Transaction

Cash

Noncash Assets

Income Statement Contrib. + Capital

= Liabilities +

Earned Capital

Revenues

Expenses

Net Income

(1) Purchase $20,000 of supplies for cash

(2) Paid $4,000 cash for rent expense

(3) Collected $120,000 cash from accounts receivable

(4) Employees earn $15,000 in wages that are not paid in cash

(5) Paid $35,000 cash toward accounts payable

(6) Made $150,000 in credit sales

Answer: Balance Sheet Transaction

Cash

(1) Purchase $20,000 of supplies for cash

-20,000 Cash

(2) Paid $4,000 cash for rent expense

-4,000 Cash

(3) Collected $120,000 cash from accounts receivable

+120,000 Cash

Noncash Assets +20,000 Supplies

(6) Made $150,000 in credit sales

Earned Capital

Revenues

Expenses

= -4,000 Retained Earnings

+4,000 Rent Expense

-120,000 Accounts Receivable =

= -35,000 Cash

= +150,000 Accounts = Receivable

Net Income

(4) Employees earn $15,000 in wages that are not paid in cash (5) Paid $35,000 cash toward accounts payable

= Liabilities

Income Statement Contrib. + Capital

-4,000 =

= +15,000 Wages Payable

-15,000 Retained Earnings

+15,000 Wages Expense

-35,000 Accounts Payable

-15,000 =

= +150,000 Retained Earnings

+150,000 Sales Revenue

Financial & Managerial Accounting for Decision Makers, 4th Edition

+150,000 =

Topic: Preparing income statement LO: 3 8. The following items and amounts are taken from the 2021 financial records of Labrador Co.: Supplies expense…………. Equipment………………….. Salaries expense……………. Utilities expense……………. Dividends………………….… Accounts payable…………… Accounts receivable……….

$ 32,000 72,000 150,000 8,200 1,000 6,000 26,800

Salaries payable…………………….. Common stock………………………. Cash………………………………….. Retained earnings, Jan. 1, 2021…… Insurance expense………………….. Repair expense……………….…….. Service revenue……………………..

$ 5,000 50,000 12,000 47,000 12,000 14,000 220,000

Prepare an income statement for the year ending December 31, 2021: Answer: Labrador Co. Income Statement For the Year Ended December 31, 2021 Revenues Service revenue $220,000 Expenses Salaries expense $150,000 Utilities expense 8,200 Supplies expense 32,000 Repair expense 14,000 Insurance expense 12,000 Total expense 216,200 Net Income $ 3,800

Test Bank, Chapter 2

Topic: Preparing a statement of stockholders’ equity LO: 5 9. The following items and amounts are taken from the 2021 financial records of Labrador Co.: Supplies expense…………. Equipment………………….. Salaries expense……………. Utilities expense……………. Dividends………………….… Accounts payable…………… Accounts receivable……….

$ 32,000 72,000 150,000 8,200 1,000 6,000 26,800

$ 5,000 50,000 12,000 47,000 12,000 14,000 220,000

Prepare a statement of stockholders’ equity for Labrador Co. for the year ending December 31, 2021. Assume no changes in common stock during the year. Answer: Labrador Co. Statement of Stockholders’ Equity For the Year Ended December 31, 2021

Balance, January 1, 2021 Add: Net income Less: Dividends Balance, December 31, 2021

Contributed Capital $50,000 0 $50,000

Retained Earnings $47,000 3,800 (1,000) $ 49,800

Total Equity $97,000 3,800 (1,000) $ 99,800

Net Income: $220,000 ‒ $150,000 ‒ $8,200 ‒ $32,000 ‒ $14,000 ‒$12,000 = $3,800

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Preparing a balance sheet LO: 1, 4, 5 10. The following items and amounts are taken from the 2021 financial records of Labrador Co.: Supplies expense…………. Equipment………………….. Salaries expense……………. Utilities expense……………. Dividends………………….… Accounts payable…………… Accounts receivable……….

$ 32,000 72,000 150,000 8,200 1,000 6,000 26,800

$ 5,000 50,000 12,000 47,000 12,000 14,000 220,000

Prepare a balance sheet for Labrador Co. for the year ending December 31, 2021. Answer: Net Income: $220,000 ‒ $150,000 ‒ $8,200 ‒ $32,000 ‒ $14,000 ‒$12,000 = $3,800 Retained earnings, December 31, 2021: $47,000 + $3,800 ‒ $1,000 = $49,800 Labrador Co. Balance Sheet December 31, 2021 Assets

Liabilities

Cash Accounts receivable Total current assets Equipment Total noncurrent assets

$ 12,000 26,800 38,800 72,000 72,000

Total assets

_______ $ 110,800

Test Bank, Chapter 2

Accounts payable Salaries payable Total liabilities Equity Common stock Retained earnings Total equity Total liabilities and equity

$ 6,000 5,000 11,000 50,000 49,800 99,800 $ 110,800

Topic: Statement of stockholders’ equity LO: 5 11. The records of Prairie Corp. show the following information after all transactions are recorded for the year ended December 31, 2021. Notes payable Service fees earned Supplies expense Insurance expense Miscellaneous expense Common stock, January 1 Accounts payable Dividends

28,000 200,000 42,000 12,000 1,000 35,000 11,800 3,000

Supplies Cash Advertising expense Salaries expense Rent expense Retained earnings, January 1 Accounts receivable Equipment

$ 30,600 7,300 9,200 68,000 59,000 17,000 8,700 61,000

Prairie raised $10,000 cash through the issuance of additional common stock during the year. Based on this information, prepare Prairie’s statement of stockholders’ equity for the year ending December 31, 2021. Answer: Prairie Corp Statement of Stockholders’ Equity For Year Ended December 31, 2021 Balance at January 1, 2021 Stock issuance Dividends Net income* Balance at December 31, 2021

Common Stock

Retained Earnings

$35,000 10,000

$17,000

_______ $45,000

(3,000) 8,800 $22,800

Total Equity

$52,000 10,000 (3,000) 8,800 $67,800

*$8,800 = $200,000 – $42,000 – $12,000 – $1,000 – $9,200 – $68,000 ‒ $59,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Preparing income statement from account balances LO: 3 12. On December 31, 2021, Shaw Corporation’s records show the following selected amounts. Cash Accounts receivable Rent expense Equipment Utilities expense Common stock Retained earnings, Dec. 31, 2021

$ 12,800 14,000 21,000 38,000 5,000 2,500 52,300

Dividends Sales Supplies Salaries expense Accounts payable Miscellaneous expense

$ 4,000 75,000 5,000 40,000 15,000 4,000

Prepare an income statement for Shaw for its year ending December 31, 2021. Answer: Shaw Corporation Income Statement For the Year Ended December 31, 2021 Revenues Sales $75,000 Expenses Salaries expense $40,000 Rent expense 21,000 Utilities expense 5,000 Miscellaneous expense 4,000 Total expense 70,000 Net Income $ 5,000 Topic: Equity changes LO: 1, 5 13. At the end of 2021, Lunar Company reported the following amounts on its balance sheet: Cash Accounts receivable Equipment Land Accounts payable Common stock Retained earnings

$ 27,600 129,100 78,300 250,000 105,000 200,000 180,000

Answer each of the following independent questions: A. Assume that Lunar’s stockholders’ equity on January 1, 2021 was $310,000. Lunar did not issue common stock during the year, but it paid $15,000 cash in dividends. How much is Lunar’s net income or loss for 2021? B. Assume that Lunar’s stockholders’ equity on January 1, 2021 was $357,000, and that Lunar issued additional common stock of $50,000 and paid $24,000 in cash dividends before the end of 2021. What was Lunar’s net income or loss for 2021?

Test Bank, Chapter 2

Answer: A. Increase in equity ($200,000 + $ 180,000 ‒ $310,000) Add: Dividends Net Income for 2021

$ 70,000 15,000 $ 85,000

B. Increase in equity ($200,000 + $180,000 ‒ $357,000) Add: Dividends Less: Additional Investment Net Loss for 2021

$ 23,000 24,000 (50,000) $ (3,000)

Topic: Net working capital and current ratio LO: 7 14. Lovepop, Inc. has $6,720 net working capital and $12,320 of current assets. What is the amount of the firm’s current liabilities? What is its current ratio? Answer: Net working capital = Current assets – Current liabilities. $6,720 = $12,320 ‒ Current liabilities Current liabilities = $5,600 Current ratio = Current assets / Current liabilities $12,320/$5,600 = 2.2 Topic: Operating cycle LO: 7 15. Companies strive to reduce operating cycles (time between paying cash for goods and receiving cash from customers). List 2 ways by which companies can achieve this. Answer: 1. Increase trade credit to minimize the cash invested in inventories, 2. Reduce inventory levels from improved production systems and management, 3. Better underwriting and collection of receivables to reduce past due accounts, 4. Offer incentives to customers for early payment of receivables.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Problems Topic: Balance sheet accounts LO: 1 1. In the blank space beside each numbered balance sheet item, enter the letter of its balance sheet classification. If the item should not appear on the balance sheet, enter a Z in the blank. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. Answer: 1. A 2. A 3. C 4. C 5. C 6. E 7. E 8. A

Test Bank, Chapter 2

Cash Inventory Land Machine Building Income taxes payable in 30 days Utilities payable Note receivable due in 30 days Common Stock Goodwill Value of company logo Wages expense Value of land in excess of cost Mortgage payable Accounts receivable

9. 10. 11. 12. 13. 14. 15.

A. B. C. D. E. F. G.

Current assets Long-term investments Long-term assets Intangible assets Current liabilities Noncurrent liabilities Equity

G D Z Z Z F A

Topic: Transaction analysis LO: 2, 4 2. Based on the following list of transactions, indicate their effect on Frankland’s assets, liabilities and equity for one month of operations. A. Frank buys a cooler and a George Foreman grill for $800 cash. B. Frank takes out a loan for $2,500. C. Frank pays cash for 600 hot dogs at $0.75 each, 500 buns at $0.25 each, 800 cans of soft drinks at $0.65 each and a huge bottle of ketchup for $40. D. Frank sells 160 hot dog / drink combos for $7.50 each. E. Frank records the product cost for the sales in (D) above, including ketchup, at $1.90 each. F. Frank pays his hot dog salesmen $650 for the month. G. Frank pays $100 of his loan. Cash

Inventory

Equipment

Accounts Payable

Loans Payable

Equity

Cash

Inventory

Equipment

Accounts Payable

Loans Payable

Equity

A B C D E F G

Answer:

(800)

+2,500

(1,135)

+1,200

+800 +2,500 +1,135 +1,200 (304)

(650)

(100)

(304) (650) (100)

C: (600 × $0.75) + (500 × $0.25) + (800 × $0.65) + $40 = $1,135 D: 160 × $7.50 = $1,200 E: $1.90 × 160 = $304

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Income statement relations LO: 3 3. Information concerning Ezekiel’s earnings for three years appears below. Ezekiel’s Income Statement Information ($ millions) Year Sales

2021 $26,250

Cost of goods sold Gross profit

2020 $14,980

2019

10,200

9,650

7,625

(2,340)

Operating expenses

2,900

Other income (loss)

3,160

220

Net income

(200)

1,870

1,700

Calculate the missing amounts. Answer: Ezekiel’s Income Statement Information ($ millions) Year

2021

2020

2019

Sales

$26,250

$14,980

$11,990

Cost of goods sold

18,625

10,200

9,650

Gross profit

7,625

4,780

2,340

Operating expenses

5,975

2,900

3,160

Other income (loss)

220

(180)

(200)

1,870

1,700

(1,020)

Net income

Test Bank, Chapter 2

Topic: Constructing a balance sheet LO: 1 4. Compute the missing amounts for each of the last 3 years for East City Inc. (millions) Current assets

2021 $14,650

2020

Noncurrent assets

121,090

118,740

Total assets Current liabilities

25,793

Noncurrent liabilities

77,182

Total liabilities

102,975

Stockholders’ equity

2019 $10,194

131,285

122,460

21,973

18,544 68,846

92,714 38,571

35,060

Liabilities and equity Answer:

Current assets Noncurrent assets Total assets

2021 $ 14,650 121,090 $135,740

2020 $ 12,545 118,740 $131,285

2019 $10,194 112,266 $122,460

Current liabilities Noncurrent liabilities Total liabilities Stockholders’ equity Liabilities and equity

$25,793 77,182 102,975 32,765 $135,740

$21,973 70,741 92,714 38,571 $131,285

$18,554 68,846 87,400 35,060 $122,460

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Transaction analysis LO: 2, 4, 6 5. Identify the effects of the following transactions in the table below: Balance Sheet Transaction

Cash

Noncash Assets

(1) Paid $1,400 cash interest on borrowings (2) $1,000 of employee wages payable are paid in cash

= Liabilities

Income Statement Contrib. + Capital

Earned Capital

Revenues

Expenses

(3) $2,500 of inventory is purchased for cash

(4) Sold goods for $2,800 on account

(5) Record $1,500 for the cost of inventory sold in (4) above

(6) Collected $2,000 cash from transaction (4) above

(7) $4,500 of equipment is financed by a loan

(8) Paid $20,000 on a note payable that came due

Net Income

Answer: Balance Sheet Transaction

Cash

(1) Paid $1,400 cash interest on borrowings

-1,400 Cash

(2) $1,000 of employee wages payable are paid in cash

-1,000 Cash

(3) $2,500 of inventory is purchased for cash

-2,500 Cash

(4) Sold goods for $2,800 on account

+2,000 Cash

(7) $4,500 of equipment is financed by a loan (8) Paid $20,000 on a note payable that came due

Test Bank, Chapter 2

+2,500 Inventory

Liabilities

Earned Capital -1,400 Retained Earnings

Revenues

Expenses

+1,400 Interest Expense

= +2,800 Retained Earnings -1,500 Retained Earnings

-2,000 Accounts = Receivable

Net Income -1,400

+4,500 Equipment = -20,000 Cash

Income Statement Contrib. + Capital

-1,000 Wages Payable

+2,800 Accounts = Receivable -1,500 Inventory =

(5) Record $1,500 for the cost of inventory in (4) above (6) Collected $2,000 cash from transaction (4) above

Noncash Assets

+2,800 Sales Revenue

+2,800 = +1,500 Cost of Goods Sold

-1,500 =

= +4,500 Loan Payable

-20,000 Note Payable

Topic: Transaction analysis LO: 2, 4, 6 6. Identify the effects of the following transactions in the table below: Balance Sheet Transaction

Cash

Noncash Assets

Liabilities +

Income Statement Contrib. + Capital

Earned Capital

Revenues

Expenses

(1) Sold gift cards for $500 cash

(2) Signed a loan agreement and received $6,000 cash

(3) Purchased inventory for $4,200 on credit

(4) Sold goods for $5,800 on account

(5) Recorded $2,200 for the cost of merchandise sold in (4) above

(6) Collected $3,100 cash from transaction (4) above

(7) Paid $2,700 on the account payable in transaction (3) above

(8) Employees earn $1,600 in wages to be paid the following month

Net Income

Answer: Balance Sheet Transaction

Cash

(1) Sold gift cards for $500 cash

+500 Cash

(2) Signed a loan agreement and received $6,000 cash

+6,000 Cash

Noncash Assets

+4,200 Inventory

(4) Sold goods for $5,800 on account

+5,800 Accounts = Receivable -2,200 Inventory =

(7) Paid $2,700 on the account payable in transaction (3) above (8) Employees earn $1,600 in wages to be paid the following month

+3,100 Cash

Earned Capital

Revenues

Expenses

+500 = Unearned Revenue +6,000 = Loan Payable +4,200 = Accounts Payable

(3) Purchased inventory for $4,200 on credit

(5) Recorded $2,200 for the cost of merchandise sold in (4) above (6) Collected $3,100 cash from transaction (4) above

Liabilities +

Income Statement Contrib. + Capital

Net Income

= +5,800 Retained Earnings -2,200 Retained Earnings

+5,800 Sales Revenue

+5,800 = +2,200 Cost of Goods Sold

-3,100 Accounts = Receivable

-2,700 Cash

-2,200 =

= -2,700 Accounts Payable +1,600 Wages Payable

= -1,600 Retained Earnings

+1,600 Wage Expense

Financial & Managerial Accounting for Decision Makers, 4th Edition

-1,600 =

Essays Topic: Historical cost vs. Market value LO: 1 1. With few exceptions, why do we report most assets at their original acquisition price (historical cost) and not at current market value? Answer: When company valuation is the goal, accurate and current market values of assets are preferred. For some assets like marketable securities, values are readily obtained from online quotes. For other assets like property, plant and equipment, we can only estimate their market values until they are ultimately sold. Allowing companies to report estimates of market values for assets would introduce potential bias into financial reporting, thus lessening financial statement reliability and usefulness. Topic: Intangible assets vs. Tangible assets LO: 1 2. Compare and contrast intangible and tangible assets. Answer: Intangible assets are similar to property, plant and equipment (PP&E) in that they are owned and controlled by the company and the company expects to realize future benefits from the use of the asset. For example, an internally created intangible asset, such as Mickey Mouse in the case of Walt Disney, is owned and controlled by Walt Disney and the company certainly anticipates that it will generate future sales from Mickey Mouse. Despite these similarities, Mickey Mouse cannot be capitalized because its historical cost is not reliably measurable. In contrast, the historical cost of PP&E is reliably measurable, and, therefore, can be capitalized on the balance sheet. Topic: Undervalued assets LO: 1 3. Prepare a list of two possible undervalued assets on the balance sheet of a company. Indicate how these items can be undervalued. Answer: Land is an asset that can often be undervalued on a balance sheet because it is typically an appreciating asset. Inventories are often carried at cost, below their current market price if prices rise since the items were acquired.

Test Bank, Chapter 2

Chapter 3 Adjusting Accounts for Financial Statements Learning Objectives – Coverage by question True/False

Multiple Choice

Exercises

LO1 Identify the major steps in the accounting cycle. (p. 102)

1, 2

LO2 Review the process of journalizing and posting transactions. (p. 103)

3-5

3, 4

2, 5, 10-18

1, 6

LO3 Describe the adjusting process and illustrate adjusting entries. (p. 109)

6-11, 14, 15

5-12, 15-17, 20

1-3, 5, 14-18

2, 3, 6, 7

LO4 Prepare financial statements from adjusted accounts. (p. 118)

6-10, 13, 15-17

4, 6-8, 10-13, 15, 18

1, 4, 6

LO5 Describe the process of closing temporary accounts. (p. 122)

14, 18

9, 13

LO6 Analyze changes in balance sheet accounts. (p. 125)

Problems

Essay Questions

1, 2

Financial & Managerial Accounting for Decision Makers, 4th Edition

Chapter 3: Adjusting Accounts for Financial Statements

True/False

Topic: Fiscal year LO: 1 1. A company’s fiscal year cannot coincide with the calendar year. Answer: False Rationale: A company’s fiscal year often coincides with the calendar year, but it need not. Topic: Fiscal year LO: 1 2. All companies have a fiscal year ending on December 31. Answer: False Rationale: Only about 60% of companies have fiscal year ends that correspond to their calendar year end. Topic: Chart of accounts LO: 2 3. The chart of accounts is a tabular record in which business activities are analyzed in terms of debits and credits and recorded in chronological order. Answer: False Rationale: The chart of accounts lists the titles and numbers of all accounts found in the general ledger. Topic: Chart of accounts LO: 2 4. The chart of accounts is also known as the book of original entry. Answer: False Rationale: The general journal is also known as the book of original entry. Topic: Posting LO: 2 5. The process of transferring debit and credit entries from the journal to their related general ledger accounts is called “posting.” Answer: True Rationale: Posting results when debits and credits are entered into the general ledger from the journal.

Test Bank, Chapter 3

Topic: Accrued expense LO: 3 6. An accrued expense is one that has been incurred but not yet paid. Answer: True Rationale: An expense is accrued when it becomes owed if it has not yet been paid. Topic: Adjusted trial balance LO: 3, 4 7. An adjusted trial balance is a listing of all the year-end balance sheet accounts, since all the income statement accounts have been closed to zero. Answer: False Rationale: The adjusted trial balance lists all general ledger accounts after adjustments have been posted. It contains much of the data needed to construct the financial statements, including the income statement. Topic: Deferred revenue LO: 3 8. Deferred revenue and unearned revenue both refer to cash that has been received but not yet earned. Answer: True Rationale: Both unearned revenue and deferred revenue refer to fees received before services are performed to earn those fees. Topic: Prepaid asset LO: 3 9. Prepaid rent is an example of a contra account, and is used to record a reduction to its related account, rent expense. Answer: False Rationale: Prepaid rent is an asset account reflecting the benefit owed the company from paying cash in advance for rent. Rent expense is used to accumulate costs associated with using property rented from others. Topic: Unadjusted trial balance LO: 3 10. The purpose of an unadjusted trial balance is to be sure the general ledger is in balance. Answer: True Rationale: The primary purpose of the unadjusted trial balance is to ensure the general ledger is in balance before management posts adjusting entries.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Adjusting entries LO: 3 11. Adjusting entries always impact the income statement and the cash account. Answer: False Rationale: Adjusting entries affect a balance sheet account and an income statement account, but never the cash account. Topic: Preparing financial statements LO: 6 12. The income statement, statement of stockholders’ equity, and statement of cash flows report on time periods that depict flows. Answer: True Rationale: Specific periods of time are reported on all financial statements, except the balance sheet. They depict changes or flows in levels over a period of time. Topic: Temporary accounts LO: 5 13. All accounts in the general ledger are closed at a company’s fiscal year end in order to facilitate preparation of the financial statements and to ready the accounts for the activities of the next year. Answer: False Rationale: Only temporary accounts (revenue, expense and dividends) are closed at the end of the period. Balance sheet accounts, also known as permanent accounts, are not closed as the balances are carried over to the next accounting period. Topic: Asset book value LO: 3 14. The book value of a building is equivalent to its historical cost. Answer: False Rationale: A building’s book value is its historical cost minus the accumulated depreciation associated with the building. Topic: Adjusting unearned revenues LO: 3 15. Adjusting unearned revenues causes a liability to decline. Answer: True Rationale: The adjustment of unearned revenues reduces Unearned Revenue, a liability, and increases Service Revenue or Sales.

Test Bank, Chapter 3

Multiple Choice

Topic: Accounting cycle LO: 1 1. Which of the following is the correct order of the steps in the accounting cycle? A) B) C) D)

Adjust, report, analyze, record, and close Record, report, analyze, adjust, and close Report, analyze, close, record, and adjust Analyze, record, adjust, report, and close

Answer: D Rationale: The steps in the cycle are to first analyze the transaction, the record it, then make any necessary adjustments, report the results, and finally to close the temporary accounts to ready them for the next period’s activity. Topic: Fiscal year LO: 1 2. A company’s fiscal year may: A) B) C) D)

Be any portion of a year including a month or quarter Be for a period either greater or less than 12 months Be the same as the calendar year All of the above are true of a company’s fiscal year

Answer: C Rationale: A company’s fiscal year must be a complete year, may not be for a period greater or less than 12 months, and may be the same as the calendar year. Topic: Recording transactions LO: 2 3. Which of the following journal entries will record the payment of a $1,500 salaries payable originally incurred for Salaries Expense? A) B) C) D)

Debit Salaries Payable; credit Cash Debit Salaries Expense; credit Cash Debit Salaries Expense; credit Salaries Payable Debit Cash; credit Salaries Payable

Answer: A Rationale: The original entry was: Salaries Expense Salaries payable

1,500 1,500

The entry to record the payment of cash reduces the liability and reduces cash. Salaries payable Cash

1,500 1,500

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Recording Transactions LO: 2 4. A company bills customers for services rendered on account. Which of the following is one part of recording this transaction? A) B) C) D)

Debit Service Revenue Credit Cash Debit Accounts Receivable Credit Unearned Revenue

Answer: C Rationale: The journal entry includes a debit to Accounts Receivable and a credit to Service Revenue. Topic: Adjusting entries LO: 3 5. Which one of the following is not a reason for which adjusting entries are made? A) B) C) D)

To close the income statement accounts and ready them for the following year’s activity To allocate used or expired assets to reflect expenses incurred in the period To allocate the earned portion of unearned revenue to reflect revenues earned during the period To accrue expenses to reflect expenses incurred in the period that are not yet paid or recorded

Answer: A Rationale: Adjusting entries are made for all the reasons above except to close out the accounts. Answer A describes closing entries.

Use the following information to answer questions 6, 7, and 8: On the last day of December 2021, Coaster Trucks entered into a transaction that resulted in a receipt of $300,000 cash in advance related to services that will be provided during January 2022. During December of 2021, the company also performed $165,000 of services which were neither billed nor paid. Prior to December adjustments and before these two transactions were recorded, the company’s trial balance showed service revenue of $1,425,790 at December 31, 2021. There are no other prepaid services yet to be delivered, and during the month all outstanding accounts receivable from prior months were collected. Topic: Adjusting entries LO: 3, 4 6. If Coaster Trucks makes the appropriate adjusting entry, how much service revenue will be reflected on the December 31, 2021 income statement? A) B) C) D)

$1,590,790 $1,425,790 $1,725,790 $1,890,790

Answer: A Rationale: Service revenue = $1,425,790 + $165,000 = $1,590,790

Test Bank, Chapter 3

Topic: Adjusting entries LO: 3, 4 7. If Coaster Trucks makes the appropriate adjusting entry, how much will be reported on the December 31, 2021 balance sheet as unearned revenue? A) B) C) D)

$465,000 $135,000 $300,000 $165,000

Answer: C Rationale: Unearned revenue represents the amount collected in advance that the company has not yet earned. Topic: Adjusting entries LO: 3, 4 8. If Coaster Trucks makes the appropriate adjusting entry, how much will be reported on the December 31, 2021 balance sheet as accounts receivable? A) B) C) D)

$165,000 $465,000 $300,000 $135,000

Answer: A Rationale: Outstanding receivables are the amount earned but not yet received from customers.

Use the following information to answer questions 9 and 10: On May 1, 2021, Cedar Corp. paid $432,000 for rent on warehouse space one year in advance. On November 1, 2021, Cedar Corp. entered into a lease agreement to rent out its old warehouse space it was no longer using. This agreement calls for Cedar to receive $10,000 per month from the lessee, due and payable at the end of the 5-month lease term. At December 31, 2021, none of the rental payments from the lessee had yet been received. Topic: Adjusting entries LO: 3, 4 9. If Cedar makes the appropriate adjusting entry, how much will be reported on the December 31, 2021 income statement for rent expense? A) B) C) D)

$288,000 $268,000 $144,000 $432,000

Answer: A Rationale: Rent expense = $432,000 × 8/12 = $288,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Adjusting entries LO: 3, 4 10. If Cedar makes the appropriate adjusting entry, how much will be reported on the December 31, 2021 balance sheet as prepaid rent and rent receivable, respectively? A) B) C) D)

$288,000 and $20,000 $144,000 and $20,000 $432,000 and $50,000 $144,000 and $30,000

Answer: B Rationale: Prepaid rent remaining = $432,000 × 4/12 = $144,000 Rent receivable = $10,000 × 2 = $20,000 Topic: Deferral LO: 3 11. Which of the following is a distinguishing characteristic of a deferral? A) B) C) D)

It affects at least one liability account. It always impacts the cash account. It includes the adjustment of an amount previously recorded in a balance sheet account. It increases a balance sheet account and decreases an income statement account.

Answer: C Rationale: A deferral adjusts an amount previously recorded in a balance sheet account. Topic: Accruals LO: 3 12. A company provides services to clients during the period that are neither paid for, nor billed to the clients. What must the company do? A) B) C) D)

Bill the client prior to year-end in order to recognize the revenue. Record the revenues as a liability at the end of the year. Accrue revenue by making an adjusting entry at the end of the period. All of the above are true.

Answer: C Rationale: Services earned but not yet billed or collected require an accrual to recognize the revenue and the account receivable at the end of the period. The bill does not have to be sent prior to yearend and there is no liability at year end since money is owed to the company.

Test Bank, Chapter 3

Topic: Statement of stockholders’ equity LO: 4 13. Which statement is true of the statement of stockholders’ equity? A) B) C) D)

It reports a company’s assets, liabilities, and equities. It reports a company’s revenue and expenses for a period. It is prepared using the unadjusted trial balance in order to facilitate the closing process. It shows a company’s stock issuances and dividends paid to shareholders.

Answer: D Rationale: The balance sheet is described in “A,” the income statement in “B,” and “C” applies primarily to the income statement. Answer “D” is the best choice as it shows changes in all equity accounts. Topic: Closing entries LO: 5 14. Manoa Corporation has the following account balances in its general ledger at the end of a period: Service revenue Utilities expense

$ 1,650,000 200,000

Which of the following gives the correct entry required to close the accounts above? A) Utilities Expense Retained Earnings Service Revenue

200,000 1,450,000

B) Service Revenue Utilities Expense Retained Earnings

1,650,000 200,000

C) Retained Earnings Utilities Expense Service Revenue

1,850,000

D) Service Revenue Utilities Expense Retained Earnings

1,650,000

1,850,000

200,000 1,650,000 200,000 1,450,000

Answer: D Rationale: The closing process requires that revenue accounts are debited and retained earnings are credited for the amount equal to the revenue balance. The closing process also requires that expense accounts are credited and retained earnings debited for an amount equal to the expense balance. The net amount of retained earnings credited in this problem is equal to $1,450,000 (or $1,650,000 – $200,000), since revenues are greater than expenses.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Use the following information to answer questions 15, 16, and 17: Tim’s Donuts has 10 employees who are paid $20 per hour. The company purchases its inventory, on account, daily. At December 31, 2021, each of Tim’s Donuts’ employees had worked 15 hours which had not been paid or recorded. Also on this date, the company had taken receipt of $80,400 of inventory from its suppliers which had not been recorded in the accounts. As of the beginning of 2021, the company had equipment totaling $2,650,000 which was depreciated at $265,000 per year. Prior to adjustments, the company’s trial balance showed $310,550 in the wage expense account and $110,375 of inventory. Topic: Adjusting entries LO: 3, 4 15. If Tim’s Donuts makes the appropriate adjusting entry, how much will be reported on the December 31, 2021 income statement as wage expense? A) B) C) D)

$310,550 $575,550 $313,550 $578,550

Answer: C Rationale: Wage expense = 15 hours x 10 employees x $20 = $3,000 + $310,550= $313,550 Topic: Adjusting entries LO: 3, 4 16. If Tim’s Donuts makes the appropriate adjusting entry, how much will be reported on the December 31, 2021 balance sheet as inventory? A) B) C) D)

$190,775 $110,375 $345,400 $ 80,400

Answer: A Rationale: $110,375 + $80,400 = $190,775 Topic: Adjusting entries LO: 3, 4 17. If Tim’s Donuts makes the appropriate adjusting entry, which of the following is one part of the journal entry that will be made when the payment of wages is made in January? A) B) C) D)

Credit Wages Expense for $2,000 Debit Wages Payable for $3,000 Credit Wages Payable for $310,550 Debit Cash for $3,000

Answer: B Rationale: The entry will debit Wages Payable for $3,000 and credit cash for the same amount.

Test Bank, Chapter 3

Topic: Post-closing trial balance LO: 5 18. Which one of the following will never appear on a post-closing trial balance? A) B) C) D)

Unearned revenue Retained earnings Rent expense Common stock

Answer: C Rationale: All temporary accounts (revenues and expenses) have zero balance after closing, so only balance sheet accounts appear on the post-closing trial balance. Topic: Financial statement flows LO: 6 19. What is a ‘flow’ as it relates to financial statements? A) B) C) D)

An amount that varies over time A change in a level over a period of time An amount depicted on the balance sheet A balance at the end of the period that appears on the income statement

Answer: B Rationale: The income statement portrays changes in balance sheet levels over time. Topic: Adjusting for depreciation LO: 3 20. When adjusting for depreciation, which of the following is one effect of the adjustment? A) B) C) D)

Accumulated depreciation is debited. The asset’s book value declines. The cost of the equipment declines. The market value of the equipment declines.

Answer: B Rationale: The adjusting entry creates a credit to accumulated depreciation and a debit to depreciation expense. The credit causes the book value to decline because it increases the contra account that is shown as a deduction from the cost of the equipment on the balance sheet.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Exercises Topic: Adjusting unearned revenue LO: 3 1. Parker Company received an advance payment of $160,000 for a consulting contract during the year. The balance in the Unearned Consulting Fees account at the beginning of the year was $15,000. At the end of the year, $18,000 was still unearned. Required: a. Create T-accounts for the accounts involved in the adjusting entry needed at year end, and post all amounts to them, including the adjusting entry necessary, and calculate the account balances. b. How much will Parker report as Consulting Revenue on its income statement for the year? Answer: a. Unearned Consulting Revenue 15,000 157,000 160,000 18,000

Consulting Revenue 157,000 157,000

b. Parker will report $157,000 consulting revenue for the year.

Test Bank, Chapter 3

Topic: Journal and adjusting entries LO: 2, 3 2. Below are several accounts from Donald Company’s accounting records. Columns representing the accounting equation appear to the right of each transaction listed below. Next to each transaction in the column of the respective account classification, write the 1) name of each account, 2) the dollar amount by which each account increases or decreases, and 3) either debit or credit to indicate the effect on the account, for each of the adjustments necessary at the end of April 2021. The company records adjustments monthly. Assets

Liabilities

Equity

Revenues

Expenses

a. Provided services to customers in the amount of $25,000. Customers will pay next month b. Recognized equipment depreciation of $3,500 for the current month c. Provided services totaling $10,000 to customers that had paid for services in advance. d. Recognized April’s insurance cost. On February 1, the company had paid $32,000 for 5 months coverage from February 1 to June 30. e. Recognized interest owed on a loan payable for $250. f. Recognized supplies used during the month. At the beginning of the month, the total of supplies on hand was $4,000, while $4,200 of supplies were left at the end of the month. During the month, $30,000 of additional supplies were purchased. g. Accrued wages earned by employees for the last 4 days of the month. Employees work 5 days per week and the weekly wages total $40,000.

Financial & Managerial Accounting for Decision Makers, 4th Edition

Answer: Assets a. Provided services to customers in the amount of $25,000. Customers will pay next month

Accounts Receivable Debit $25,000

b. Recognized equipment depreciation of $3,500 for the current month

Accumulated Depreciation Credit 3,500

f. Recognized supplies used during the month. At the beginning of the month, the total of supplies on hand was $4,000, while $4,200 of supplies were left at the end of the month. During the month, $30,000 of additional supplies were purchased. g. Accrued wages earned by employees for the last 4 days of the month. Employees work 5 days per week and the weekly wages total $40,000.

Test Bank, Chapter 3

Revenues

Expenses

Depreciation Expense Debit $3,500

Prepaid Insurance Credit $6,400

Service Revenue Credit $10,000

Insurance Expense Debit $6,400

Interest Payable Credit $250

e. Recognized interest owed on a loan payable for $250.

Equity

Service Revenue Credit $25,000

Unearned Service Revenue Debit $10,000

c. Provided services totaling $10,000 to customers that had paid for services in advance. d. Recognized April’s insurance cost. On February 1, the company had paid $32,000 for 5 months coverage from February 1 to June 30.

Liabilities

Supplies Credit $29,800

Interest Expense Debit $250

Supplies Expense Debit $29,800

$4,000 + $30,000 $4,200 = $29,800

Wages Payable Credit $32,000 $40,000 × 4/5 = $32,000

Wages Expense Debit $32,000

Topic: Asset prepayments LO: 3 3. Colton Corporation took out a 3-year insurance policy and paid a $334,800 premium for coverage beginning on June 1, 2021. Fill the missing parts of the statements below: Prepaid Insurance on the Balance Sheet Accrual Basis

Cash Basis

Insurance Expense Accrual Basis

Cash Basis

Dec. 31, 2021 .............................

2021 ..........................................

Dec. 31, 2022 .............................

2022 ..........................................

Dec. 31, 2023 .............................

2023 ..........................................

Dec. 31, 2024 .............................

2024 .......................................... Total ..........................................

Answer: Monthly cost = $334,800 / 36 = $9,300 Balance Sheet Accrual Basis

Insurance Expense

Cash Basis

Accrual Basis

Cash Basis

Dec. 31, 2021 ............................. $269,700

$ 0

2021........................................... $ 65,100

$334,800

Dec. 31, 2022 ............................. 158,100

2022........................................... 111,600

Dec. 31, 2023 ............................. 46,500

2023........................................... 111,600

Dec. 31, 2024 ............................. 0

2024........................................... 46,500 Total........................................... $334,800

0 $334,800

Topic: Preparing a statement of stockholders’ equity after closing LO: 4 4. Arnold’s Cleaning provides janitorial services for commercial customers. On December 31, 2020, the credit balance of the Common Stock and Retained Earnings accounts were $56,000 and $27,000, respectively. During 2021, the company issued $5,200 of stock, and paid $3,000 in dividends. The income statement reported a profit of $10,800. Prepare a 2021 statement of stockholders’ equity for Arnold’s Cleaning. Answer: Arnold’s Cleaning Statement of Stockholders’ Equity For Year Ended December 31, 2021 Common Retained Stock Earnings Balance at December 31, 2020 ........................... $56,000 $27,000 Stock issuance .................................................. 5,200 Dividends .......................................................... (3,000) Net income ........................................................ ______ 10,800 Balance at December 31, 2021 ........................... $61,200 $34,800

Total Stockholders’ Equity $83,000 5,200 (3,000) 10,800 $96,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Journalizing transactions and adjusting accounts LO: 2, 3 5. Splashbright offers pool and spa cleaning services to hotels and residential customers. Commercial (hotels) customers pay on a monthly contract basis, while residential customers pay an hourly rate based on services provided. In July 2021, Splashbright signed a 6-month contract with Resorts Unlimited to provide pool and spa cleaning services for its hotel sites. The contract price of $210,000 was collected on July 1, 2021. The services will be provided evenly over the 6 months. During July 2021, Splashbright also provided 100 hours of residential pool services at $65 per hour. Payment is expected in August. a.

Prepare the entry on July 1, 2021 to record the receipt of $210,000 cash related to the contract with Resorts Unlimited (1) using the financial statements effect template and (2) in journal entry form. Prepare the adjusting entry to be made on July 31, 2021 for the contract work performed for Resorts Unlimited during the month (1) using the financial statements effect template and (2) in journal entry form. Prepare the adjusting entry needed on July 31, 2021 to reflect the residential pool services performed during the month (1) using the financial statements effect template and (2) in journal entry form.

Answer: a. Balance Sheet Transaction Received $ 210,000 in advance for contract work

July 1

Cash Noncash + Asset Assets + 210,000 Cash

= Liabilities

Income Statement Contrib. + + Capital

Earned Capital

Revenues

+ 210,000 Unearned = Service Fees

Cash

Expenses

Net Income

210,000

Unearned Service Fees To record cash received in advance

210,000

b. Balance Sheet Transaction

Cash Asset

Noncash + Assets

Adjusting entry for services provided in July

July 31

= Liabilities

Income Statement Contrib. + + Capital

- 35,000 Unearned Service Fees

Earned Capital +35,000 Retained Earnings

Revenues

+ 35,000 Service Fees Revenue

Expenses

Net Income + 35,000

Unearned Service Fees 35,000 Service Fees Revenue 35,000 To reflect July service fees earned on contract ($210,000/6 = $35,000)

c. Transaction Adjusting entry for fees earned but not paid

July 31

Cash Asset

Noncash Assets +6,500 Accounts Receivable

Balance Sheet Liabil= + ities =

Income Statement Contrib. + Capital

Earned Capital +6,500 Retained Earnings

Revenues

+6,500 Service Fees Revenue

Expenses

Net Income + 6,500

Accounts Receivable 6,500 Service Fees Revenue 6,500 To record unbilled service fees earned at July 31, 2021: 100 hours x $ 65/hr.

Test Bank, Chapter 3

Use the following adjusted trial balance for Waterhouse Corporation to answer Exercises 6, 7, 8, and 9. Waterhouse Corporation Adjusted Trial Balance For the Year Ending December 31, 2021 Debit $ 57,000 72,000 490,000

Cash Accounts receivable Equipment Accumulated depreciation Loan payable Common stock Retained earnings Sales revenue Utilities expense Salaries expense Depreciation expense Totals

Credit

15,000 405,500 20,000 $1,059,500

85,000 145,000 250,000 119,500 460,000

0 $1,059,500

Topic: Preparing an income statement LO: 4 6. Use Waterhouse’s adjusted trial balance to prepare the company’s income statement. Answer: Waterhouse Corporation Income Statement For Year Ended December 31, 2021 Sales revenue Utilities expense Salaries expense Depreciation expense Net income

$460,000 15,000 405,500 20,000 $19,500

Topic: Preparing the statement of stockholders’ equity LO: 4 7. Use Waterhouse’s adjusted trial balance to prepare Waterhouse’s statement of stockholders’ equity for 2021. There were no stock issuances or repurchases during 2021. Answer: Waterhouse Corporation Statement of Stockholders’ Equity For Year Ended December 31, 2021

Balance at December 31, 2020 Net income Balance at December 31, 2021

Common Stock $250,000 _______ $250,000

Retained Earnings $ 119,500 19,500 $139,000

Total Stockholders Equity $369,500 19,500 $389,000

Financial & Managerial Accounting for Decision Makers, 4th Edition

Topic: Preparing a balance sheet LO: 4 8. Use Waterhouse’s adjusted trial balance above to prepare Waterhouse’s balance sheet for the current year-end. Answer: Waterhouse Corporation Balance Sheet December 31, 2021 $ 57,000 Loan payable 72,000 Total liabilities 490,000 (85,000) Common stock Retained earnings $ 534,000 Total liabilities and equity

Cash Accounts receivable Equipment Accumulated depreciation Total assets

$ 145,000 145,000 250,000 139,000 $ 534,000

Topic: Closing temporary accounts LO: 5 9. Use Waterhouse’s adjusted trial balance to prepare entries to close Waterhouse’s temporary accounts in journal entry form. Answer: 1. Sales revenue Retained earnings

460,000

440,500

460,000

Retained earnings Utilities expense Salaries expense Depreciation expense

15,000 405,500 20,000

Topic: Analyzing transactions with T-accounts LO: 2, 4 10. Use the T-account below, to answer the following questions. 1/1

Accounts Receivable (A) 160,000

5/1

1,420,000

12/31

1,480,000

7/1

A. What journal entry is most likely represented by $ 1,420,000 in the T-account? What business event caused this? B. What journal entry is most likely represented by the $1,480,000 in the T-account? What business event caused this? C. What is the balance of Accounts Receivable on December 31?

Test Bank, Chapter 3