CHAPTER 1 Accounting as a Form of Communication

OVERVIEW OF EXERCISES, PROBLE S, A!" CASES

1* Identify the primary users of accounting information and their needs. +* Explain the purpose of each of the financial statements and the relationships among them, and prepare a set of simple statements.

1 12* 14* 2 4 5 ! " # % 12* 1 *

5 10 15 5 15 10 10 15 10 20 15 10 10 10 10 5 15

Mod Mod Mod Easy Mod Mod Mod Easy Easy $iff Mod Mod Mod Mod Mod Easy Mod

,* Identify and explain the primary assumptions made in preparing 10 financial statements. 1 * -* $escri&e the 'arious roles of accountants in organi(ations. *Exercise, pro&lem, or case co'ers t)o or more learning o&*ecti'es +e'el , $ifficulty le'els- Easy. Moderate /Mod0. $ifficult /$iff0 11 14*

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L#arning O%&#cti'#

Pro%)#ms an$ A)t#rnat#s 1 2 10 4 5 ! " # 11* 11* %

Estimat#$ Tim# in inut#s 0 20 20 0 0 !0 45 !0 25 45 45 15

L#'#) Mod Mod Mod Easy Easy Mod Mod $iff Mod $iff $iff Easy

1* Identify the primary users of accounting information and their needs. +* Explain the purpose of each of the financial statements and the relationships among them, and prepare a set of simple statements.

,* Identify and explain the primary assumptions made in preparing financial statements. -* $escri&e the 'arious roles of accountants in organi(ations. *Exercise, pro&lem, or case co'ers t)o or more learning o&*ecti'es +e'el , $ifficulty le'els- Easy. Moderate /Mod0. $ifficult /$iff0

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1.,

L#arning O%&#cti'# 1* Identify the primary users of accounting information and their needs. +* Explain the purpose of each of the financial statements and the relationships among them, and prepare a set of simple statements.

Cas#s 1* 4 !* 1* 2 * 5 !*

Estimat#$ Tim# in inut#s 25 0 "5 25 20 0 !0 "5

L#'#) Mod Mod $iff Mod Mod Mod $iff $iff

,* Identify and explain the primary assumptions made in preparing financial statements. -* $escri&e the 'arious roles of accountants in organi(ations. *Exercise, pro&lem, or case co'ers t)o or more learning o&*ecti'es +e'el , $ifficulty le'els- Easy. Moderate /Mod0. $ifficult /$iff0 * 0 Mod

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/0ESTIO!S

1*

3ccounting is a communication process. Its purpose is to pro'ide economic information a&out an organi(ation that )ill &e useful to those )ho need to ma=e decisions regarding that entity. 1or example, information pro'ided &y an accountant a&out an entity is useful to a &an=er in reaching a decision a&out )hether to loan money to a &usiness. 1inancial accounting and management accounting differ )ith regard to the users of the information pro'ided &y the t)o &ranches of the discipline. Management accounting is the &ranch of accounting that pro'ides management )ith information to facilitate the planning and control functions. 7he information pro'ided &y a management accounting system can &e tailored to meet the needs of managers. 3lternati'ely, financial accounting is concerned )ith the preparation of general purpose financial statements for use &y &oth management and outsiders. >ecause the information pro'ided &y financial accounting must meet the needs of many different groups, it is necessary to rely on a set of generally accepted accounting principles in preparing the financial statements. Many different groups rely on accounting information in ma=ing decisions. 1or example, investors and potential investors rely on financial statements and related disclosures in deciding )hether to sell or &uy stoc= in a company. 7his group is particularly concerned )ith the recent profita&ility of the company as sho)n on the income statement. Bankers and other creditors need information to decide )hether to loan money to a company or )hether to extend an existing loan. Many different government agencies ha'e information needs that are specified &y la). 7he Internal <e'enue 9er'ice needs to =no) a&out a company?s profita&ility in le'ying taxes on it. 7he 9ecurities and Exchange 4ommission, the Interstate 4ommerce 4ommission, and the 1ederal 7rade 4ommission also depend on the information pro'ided &y accountants in ma=ing decisions. Labor unions need information a&out a company?s profita&ility and financial position in negotiating contracts )ith the company for the employees. Trade associations rely on the information pro'ided in financial statements in compiling information for use &y their mem&ers. 5)ners? e@uity is the difference &et)een the assets of an entity and its lia&ilities. 7hus, it represents the claims of the o)ners to the assets of the &usiness. 7he t)o distinct elements of o)ners? e@uity in a corporation are contri&uted capital and retained earnings. 4ontri&uted capital, as represented &y capital stoc=, is the original contri&ution to the company &y the o)ners. <etained earnings represents the claims of the o)ners to the assets of the

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&usiness. 7hese claims result from the earnings of the company that ha'e not &een paid out in di'idends. 2* 7he purpose of a &alance sheet is to sho) the financial position of an entity as of a particular point in time. It consists of three distinct elementsassets, lia&ilities, and o)ners? e@uity. 3 &alance sheet should &e dated as of a particular day. It is a statement of financial position and sho)s the assets, lia&ilities, and o)ners? e@uity of a &usiness at a particular point in time. 6nli=e an income statement, it is not a flo) statement and therefore is not dated for a particular period of time. >alance sheets are typically prepared to coincide )ith the end of an accounting period, such as the end of the month or the end of the year. 7he cost principle is an accounting re@uirement to record an asset at the cost to ac@uire it and report it on su&se@uent &alance sheets at this amount. 7he purpose of an income statement is to summari(e the re'enues and expenses of a company for a period of time. It is an indicator of the profita&ility of an entity. 3n income statement should &e dated for a particular period of time- for example, for the month of Aune or for the year ended $ecem&er 1, 2004. 7he income statement is a flow statement &ecause it summari(es re'enues and expenses for a period of time. 6nli=e a &alance sheet, it is not an indication of position at any one particular point in time. If a company has B55,000 in <etained Earnings to &egin the year and net income for the year of B2",000, the ending &alance in <etained Earnings )ould &e B#2,000 if no di'idends )ere paid during the year. >ecause the ending &alance in <etained Earnings is B"0,000, the company must ha'e paid B12,000 in di'idends. 3 controller is usually the chief accounting professional of a corporation and is responsi&le for the operation of the accounting system and the preparation of the financial statements. 7he treasurer is responsi&le for the safeguarding and efficient use of a company?s cash and other li@uid resources. 4hec= )riting and the deposit of cash into &an= accounts are usually the responsi&ility of the treasurer?s office. ;u&lic accounting firms pro'ide auditing, tax, and management consulting ser'ices. 7he auditors may &e in an excellent position to e'aluate a company, &ut not &ecause they ha'e prepared the financial statements. 7he preparation of the statements is the responsi&ility of management. 7he role of the auditor is to perform 'arious tests and procedures as a &asis for rendering an opinion on the fairness of the presentation of the statements.

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11*

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Ce assume in the a&sence of e'idence to the contrary that a &usiness )ill continue indefinitely. 7his assumption, =no)n as the going concern assumption, helps to *ustify the use of historical costs in the statements. 1or example, if )e =ne) that a company )as in the process of li@uidation, it )ould not &e appropriate to use historical costs in assigning an amount to such assets as land and &uildings. Instead, the current or mar=et 'alues of the assets )ould &e more meaningful to a user of the &alance sheet. >ecause the normal assumption is that a &usiness )ill continue indefinitely, the o&*ecti'ity of historical cost ma=es it more attracti'e as a &asis for 'aluation. Inflation, as e'idenced &y the changing 'alue of the dollar, poses a pro&lem for the accountant. 3ccountants ma=e the assumption in preparing a set of financial statements that the dollar is a sta&le measuring unit. 7his assumption, called the monetary unit assumption, may or may not &e accurate, depending on the le'el of inflation in the economy. 7he higher the rate of inflation, the less relia&le is the dollar as a measuring unit. 3ny profession must ha'e a set of standards that go'ern the practice of the profession. In accounting, generally accepted accounting principles, or 833;, are those methods, rules, practices, and other procedures that ha'e e'ol'ed o'er time and that go'ern the preparation of financial statements. 7)o important points are )orth noting a&out 833;. 1irst, these principles are not static &ut rather change in response to changes in the )ays companies conduct &usiness. 9econd, there is not a single, identifia&le source of 833;. >oth the pri'ate and pu&lic sectors ha'e contri&uted to the de'elopment of generally accepted accounting principles. 3lthough the 9ecurities and Exchange 4ommission has the ultimate authority to determine the rules in preparing financial statements, it has to a large extent allo)ed the accounting profession, through the 1inancial 3ccounting 9tandards >oard, to esta&lish its o)n rules. 7he 9E4 has at times ta=en an acti'e role in the setting of accounting standards. It has stepped in )hen it has &elie'ed that the profession has not acted @uic=ly enough or in the correct manner. 9ince its inception in 1% 4, the commission has &een more in'ol'ed in the enforcement of 833; as a means of protecting the rights of in'estors than it has &een in setting standards.

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EXERCISES

LO 1

EXERCISE 1.1 0SERS OF ACCO0!TI!7 I!FOR ATIO! A!" THEIR !EE"S

1* 4ompany management +* 9toc=holder ,* -* +a&or union 9ecurities and Exchange 4ommission

1* >an=er 2* 9upplier 3* Internal <e'enue 9er'ice LO + Cas# 1: EXERCISE 1.+ THE ACCO0!TI!7 E/0ATIO! A 125,000 5E A 400,000 + A 3 3 8 , , 8 , , 8 , , L "5,000 50,000 9 D OE 5E OE 100,000 OE %5,000

Cas# +:

L 9 + D 00,000 L 9 20,000 D 415,000

Cas# ,:

LO + 1*

EXERCISE 1., THE ACCO0!TI!7 E/0ATIO! A 500,000 5E 8 , , L 250,000 250,000 L /250,000 D "",0000 2" ,000 L /250,000 D ,0000 2# ,000 D 1%2,000 4"5,000 9 D 9 D 9 D OE 5E OE 5E OE /250,000*E 5#,0000

+*

A 8 /500,000 D 100,0000 , 5E , A 3 3 3 8 , , ,

,*

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A 1,000,000 + * 1rom 1* a&o'e LO + 1*

8 , ,

L + "50,000

9 D

OE 250,000*

EXERCISE 1.- THE ACCO0!TI!7 E/0ATIO! A 100,000 8 , L #0,000 9 D D E 9 D OE 20,000 25,000 0 45,000 OE 20,000

>eginning of year D 2et income E $i'idends 5)ners? e@uity at end of year +* End of year <educe &y half to &eginning of year3ssets, &eginning of year ,* >eginning of year 7riples during year +ia&ilities, end of year LO +

A !0,000 di'ided &y 2 0,000 A 0,000

8 ,

L 40,000

8 ,

L 20,000 x !0,000

9 D

OE 10,000

EXERCISE 1.1 CHA!7ES I! OW!ERS; E/0IT<

1* 1irst compute the amount of o)nersF e@uity at the end of each year. 7hen, compute the change. A 8 L 9 OE 25,000 , 12,000 D 5E 5E , 1 ,000 A 8 L 9 OE "%,000 , !",000 D 5E 5E , 12,000 A 8 L 9 OE 1#4,000 , 1 ",000 D 5E 5E , 4",000

+66+:

+66,:

+66-:

C=ang# in o>n#rs; #?uit@ $uring +66,: 12,000 E 1 ,000 , /1,0000 C=ang# in o>n#rs; #?uit@ $uring +66-: 4",000 E 12,000 , 5,000

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1.5

+* +66,/1,0000 , Income E 0 in di'idends 2et loss , 1,000 ,* +66-5,000 , Income E 10,000 in di'idends 2et Income , 45,000 LO + EXERCISE 1.2 THE ACCO0!TI!7 E/0ATIO!

/In thousands of dollars0 A 8 L 9 CS 10 9 D AB#g* RE /15 9 D Incom# # B E "i'C 20

Cas# 1: 40 , + D +ia&ilities , % Cas# +: 3 , 15 D 3ssets , 4 Cas# ,: "5 , 25 D Income , 2 Cas# -: 50 , 10 D $i'idends , 4 LO +

/#

"

10

20

/10

Income

15

/20

$i'0

EXERCISE 1.3 CLASSIFICATIO! OF FI!A!CIAL STATE E!T ITE S ADD#ars on t=# C)assifi#$ as E 3 + < 5E 3 3 E 5E

1* +* ,* -* 1* 2* 3* 4* 5*

I9 >9 >9 I9 >9 >9 >9 I9 >9

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LO +

EXERCISE 1.4 !ET I!CO E AOR LOSSC A!" RETAI!E" EAR!I!7S R#'#nu# 25,000 B E E(D#ns#s /!,500 D 12,0000 !#t Incom# !,500 8 , !#t Incom# !,500 R#tain#$ Earnings En$ of <#ar 12,000 B 1 ,000 4,000 500 ",500 B 25,000 B 5,000

1* +*

R#tain#$ Earnings B#ginning of <#ar #,500

9 D

B E

"i'i$#n$s ,000

8 ,

,*

Tota) Ass#ts: 4ash 3ccounts recei'a&le 9upplies 5ffice e@uipment 7otal assets

-* Tota) Lia%i)iti#s: 3ccounts paya&le

1* O>n#rs; E?uit@: 4apital stoc= D <etained earnings , 5)nersF e@uity #,000 D 12,000 , 20,000 /5r B25,000 in total assets less B5,000 in total lia&ilities.0 2* A 25,000 8 , L 5,000 9 D OE 20,000

LO +

EXERCISE 1.5 STATE E!T OF RETAI!E" EAR!I!7S ACE CORPORATIO! STATE E!T OF RETAI!E" EAR!I!7S FOR THE O!TH E!"E" FEBR0AR< +4, +66-

>eginning &alance, 1e&ruary 1, 2004 3dd- 2et income $educt- 4ash di'idends Ending &alance, 1e&ruary 2#, 2004 *B2 5,#00 D B# ,000 E B#%,000 **B%!,000 E B#2,000

B 22%,#00* 14,000** 5,000 B 2 #,#00

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LO ,

EXERCISE 1.16 ACCO0!TI!7 PRI!CIPLES A!" ASS0 PTIO!S

1* 8oing concern /also economic entity0 +* 4ost principle ,* Economic entity -* Monetary unit 1* 7ime period LO EXERCISE 1.11 OR7A!IEATIO!S A!" ACCO0!TI!7

1* 9ecurities and Exchange 4ommission +* 3merican 3ccounting 3ssociation ,* 1inancial 3ccounting 9tandards >oard -* 3merican Institute of 4ertified ;u&lic 3ccountants 1* International 3ccounting 9tandards >oard 0LTI.CO!CEPT EXERCISES LO 1,+ EXERCISE 1.1+ 0SERS OF ACCO0!TI!7 I!FOR ATIO! A!" THE FI!A!CIAL STATE E!TS FI!A!CIAL STATE E!T I9 >9 >9 <E I9 >9 I!"0STRIES;

0SER 9toc=holder >an=er 9upplier 9toc=holder 3d'ertising account manager >an=er LO +,, EXERCISE 1.1, I!VE!TORIES WI!!EBA7O

In'entories at 3ugust 1, 2002- B11 ,!54,000 7he amount reported for in'entories represents the cost paid rather than mar=et 'alue. 4ost, that is the amount paid to ac@uire in'entory, or to produce it, is 'erifia&le &y an independent o&ser'er and is much more o&*ecti'e than mar=et 'alue.

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EXERCISE 1.1- ROLES OF ACCO0!TA!TS

7he students? comments reflect se'eral common misconceptions a&out the )or= of an accountantG 3ccounting is much more than H&ean countingI or &oo==eeping. Chat separates &oo==eeping and accounting are the *udgments that must &e made &y the accountant. ;eople s=ills are extremely important in the accounting profession &ecause accountants must &e a&le to communicate )ith management, )ith clients, and )ith other users of the statements. In'estors, creditors, analysts, and many other groups rely on the statements prepared &y accountants. 2ot all accountants are experts in tax la). 7axes are one important part of the profession, &ut other accountants speciali(e in corporate reporting, in auditing, or in management consulting.

G G

3s stated earlier, many groups rely on the statements accountants prepare. 3mong the users are management, stoc=holders, creditors, go'ernment agencies, suppliers, trade associations, and la&or unions.

PROBLE

LO 1

PROBLE

1.1 <O0 WO! THE LOTTER<

5&'iously, there is no single, correct ans)er to this pro&lem. 9tudents should start &y considering their personal circumstances and preference for ris=. 7hey should also consider their li@uidity re@uirements. 1rom this point, it is appropriate to consider sources of information. 9tudents should pro'ide specific *ustification for their chosen in'estments. 7he H&ottom lineI is that students should *ustify their selections using financial information from as many sources as is cost effecti'e and relate their choices to their preference or a'ersion to ris=.

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1ollo)ing are guidelines to &e usedODtions Issu#s <is= Information needed Information sources StocF :igh Mar=et price $i'idends 3nnual reports In'estor ne)sJ letters 2e)spapers, &usiness periodicals Earnings forecasts >ro=erage fees Bon$s Medium Mar=et price Interest rate Maturity date 9ame as for the stoc= BanF $#Dosit +o) Interest rate >an= ad'ertising 2e)spaper articles ;enalties for )ithdra)al

3dditional information needed

3lternati'e rates >ro=erage fees

7his pro&lem pro'ides the instructor )ith an opportunity to introduce the concept of the time 'alue of money. 4ertainly it )ould &e prefera&le to recei'e B1 million today, rather than B200,000 o'er each of the next fi'e years. If a lump sum is recei'ed immediately, it could &e put into one of the in'estments chosen, as opposed to needing to spread the in'estment o'er a fi'eJyear period. LO 1 PROBLE 1.+ 0SERS OF ACCO0!TI!7 I!FOR ATIO! A!" THEIR !EE"S anag#m#nt a. a. a. a. a. StocF=o)$#rs &. c. c. &. &. BanF#r a. a. a. a. &.

Information 1* +* ,* -* 1*

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PROBLE

1., BALA!CE SHEET FREESCIA CORPORATIO! BALA!CE SHEET "ECE BER ,1, +66-

Ass#ts 4ash 3ccounts recei'a&le 5ffice e@uipment >uildings 7otal assets B 4,220 2 ,%20 12,000 #5,000

B 125,140

Lia%i)iti#s an$ StocF=o)$#rsG E?uit@ 3ccounts paya&le B 12,550 2otes paya&le 50,000 4apital stoc= 25,000 <etained earnings ",5%0 7otal lia&ilities and stoc=holders? e@uity B 125,140

Items not sho)n on a &alance sheet and )here they )ould appear3d'ertising expenseKincome statement 9alary and )age expenseKincome statement 9ales re'enueKincome statement LO + 1* PROBLE 1.- CORRECTE" BALA!CE SHEET AVO! CO!S0LTI!7 I!C* BALA!CE SHEET "ECE BER ,1, +66Ass#ts 4ash 3ccounts recei'a&le 9upplies 1urniture and e@uipJ ment 7otal assets *B"2,000 E B1!,000 B 21,000 1!,000 %,000 4 ,000 B #%,000 Lia%i)iti#s an$ StocF=o)$#rsG E?uit@ 3ccounts paya&le B 1 ,000 4apital stoc= 20,000 <etained earnings 5!,000* 7otal lia&ilities and stoc=holdersF e@uity B #%,000

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+*

Memorandum to the company president751<5M$37E4ompany president 9tudentFs name Aanuary 1, 2005

96>AE47- 4orrected &alance sheet 3ttached please find the original &alance sheet your assistant prepared, along )ith a corrected 'ersion of that same statement. 7he differences can &e explained as follo)s1* 7he &alance sheet is al)ays as of a certain date, in this case, $ecem&er 1, 2004, rather than a period of time, such as a year. +* 3ccounts paya&le should &e classified as a lia&ility. ,* 4ash di'idends paid do not &elong on the &alance sheet. this amount should appear instead on the statement of retained earnings for the year. -* 3ccounts recei'a&le should &e classified as an asset. 1* 2et income for 2004 does not &elong on the &alance sheet. this amount should appear instead on the statement of retained earnings for the year. 2* 9upplies should &e classified as an asset. 3* <etained earnings should appear )ith capital stoc= as a component of stoc=holdersF e@uity on the &alance sheet. 9ince this is the first year of operations, the retained earnings &alance comprises the net income for the year less the cash di'idends paid. 4* 7otals )ere added as necessary to pro'ide summary information.

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PROBLE 1.1 I!CO E STATE E!T, STATE E!T OF RETAI!E" EAR!I!7S, A!" BALA!CE SHEET APLE PARH THEATRES CORP* I!CO E STATE E!T FOR THE O!TH E!"E" SEPTE BER ,6, +66-

<e'enues7ic=et sales 4oncessions re'enue Expenses<ent expenseKmo'ies 4ost of concessions sold 3d'ertising 9alaries and )ages Cater, gas, and electricity 2et income +*

B %5,100 !0, 00 B 50,!00 2 ,450 14,500 4!,4%0 !,"00

B 155,400

141,"40 B 1 ,!!0

APLE PARH THEATRES CORP* STATE E!T OF RETAI!E" EAR!I!7S FOR THE O!TH E!"E" SEPTE BER ,6, +66>eginning &alance, 9eptem&er 1, 2004 3dd- 9eptem&er net income $educt- 9eptem&er di'idends Ending &alance, 9eptem&er 0, 2004 B" ,"#0 1 ,!!0 #,400 B "%,040

,*

APLE PARH THEATRES CORP* BALA!CE SHEET SEPTE BER ,6, +66Ass#ts 4ash 3ccounts recei'a&le >uildings 1urniture and fixtures +and ;ro*ection e@uipment 7otal assets B 15,2 0 !,410 !0,000 4,000 2!,000 25,000 B1!!,!40 Lia%i)iti#s an$ StocF=o)$#rsG E?uit@ 3ccounts paya&le B 1",!00 2otes paya&le 20,000 4apital stoc= 50,000 <etained earnings "%,040 7otal lia&ilities and stoc=holders? e@uity

B1!!,!40

-* 5n the &asis of these statements alone, Maple ;ar= )ould appear to &e a good candidate for an in'estment. It is operating at a profit and is paying di'idends. >efore one ma=es an in'estment in Maple ;ar= stoc=, it )ould &e useful to see the statement of cash flo)s. Information a&out the current mar=et price of the stoc=, the competitors, the general outloo= for the industry, the age of the 'arious longJterm assets, and the due date of the

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1.13

note paya&le )ould also &e useful &efore one ma=es an in'estment. 7he financial statements of earlier periods )ould &e helpful for purposes of ma=ing comparisons. LO + PROBLE 1.2 I!CO E STATE E!T A!" BALA!CE SHEET 7REE! BA< CORPORATIO! I!CO E STATE E!T FOR THE O!TH E!"E" I0L< ,1, +66<e'enues1ishing re'enue ;assenger ser'ice re'enue Expenses<ent 9alaries and )ages 2et income +* 7REE! BA< CORPORATIO! BALA!CE SHEET I0L< ,1, +66Ass#ts 4ash 3ccounts recei'a&le >oats 7otal assets B "," 0 1#,500 #0,000 Lia%i)iti#s an$ StocF=o)$#rsG E?uit@ 2otes paya&le B !0,000 4apital stoc= 40,000 <etained earnings !,2 0* 7otal lia&ilities and o)ners? e@uity B 10!,2 0 B 21, 00 12,5!0 B 4,000 1#,2 0

1*

,#!0

22,2 0 B 11,! 0

B10!,2 0

*>eginning retained earnings D net income E di'idendsB0 D B11,! 0 E B5,400 ,* 7o fully assess 8reen >ay?s longJterm 'ia&ility, you )ould need the follo)ing information a&out the B!0,000 note paya&leG G G G Chen is it dueL Chat is the interest rateL Is interest paid periodically or only at maturityL :a'e any assets &een offered as collateral for the loanL

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PROBLE 1.3 CORRECTE" FI!A!CIAL STATE E!TS HO ETOW! CLEA!ERS I!C* I!CO E STATE E!T FOR THE <EAR E!"E" "ECE BER ,1, +66-

1*

<e'enues4leaning ser'icesKcredit sales 4leaning ser'icesKcash sales Expenses6tilities 9alaries and )ages 2et income +*

B 2!,200 2,500 B 12,200 1",100

B5#,"00 2%, 00 B 2%,400

HO ETOW! CLEA!ERS I!C* STATE E!T OF RETAI!E" EAR!I!7S FOR THE <EAR E!"E" "ECE BER ,1, +66>eginning &alance, Aanuary 1, 2004 3dd- 2et income $educt- 4ash di'idends Ending &alance, $ecem&er 1, 2004 B42,"00 2%,400 4,000 B !#,100

,*

HO ETOW! CLEA!ERS, I!C* BALA!CE SHEET "ECE BER ,1, +66Ass#ts 4ash 3ccounts recei'a&le >uilding and e@uipment +and 7otal assets B ",400 15,200 #0,000 40,000 Lia%i)iti#s an$ StocF=o)$#rsG E?uit@ 3ccounts paya&le B 4,500 2otes paya&le 50,000 4apital stoc= 20,000 <etained earnings !#,100 7otal lia&ilities and stoc=holdersF e@uity B 142,!00

B 142,!00

-* Memorandum to the company president751<5M$37E4ompany president 9tudentFs name Aanuary 1, 2005

96>AE47- 4orrected income statement 3ttached please find the original income statement you prepared, along )ith a corrected 'ersion of that same statement. 1ortunately, your

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1.15

disappointment )ith the 2004 net income is not )arranted, as you )ill see from my re'ised statement. 7he difference &et)een the net income on the original income statement of B%,%00 and the re'ised amount of B2%,400, or B1%,500, can &e explained as follo)s1* 3ccounts recei'a&le of B15,200 does not &elong on the income statement. instead, ser'ices pro'ided on account of B2!,200 should &e sho)n on the statement. the difference is B11,000. +* $i'idends are not an expense, and thus they do not &elong on the income statement- B4,000. ,* 3ccounts paya&le is a lia&ility and appears on a &alance sheet- B4,500. 7hese corrections result in increased income of B1%,500. 3lso note that notes paya&le should &e reported on the &alance sheet as a lia&ility, not as an offset to &uilding and e@uipment. ;lease let me =no) if I can &e of any further assistance in interpreting the results of our operations for 2004. LO + PROBLE 1.4 STATE E!T OF RETAI!E" EAR!I!7S FOR THE WALT "IS!E< CO PA!< WALT "IS!E< CO PA!< STATE E!T OF RETAI!E" EAR!I!7S FOR THE <EAR E!"E" SEPTE BER ,6, +66+ >eginning &alance, 9eptem&er 0, 2001 $educt- 2002 net income $educt- 2002 di'idends Ending &alance, 9eptem&er 0, 2002 B12,1"1,000,000 1,2 !,000,000 /42#,000,0000 B12,%"%,000,000

1*

+* 7he statement of stoc=holdersF e@uity )ould include all changes in stoc=holdersF e@uity such as issuances and retirements of stoc= in addition to the information normally pro'ided in a retained earnings statement. LO PROBLE 1.5 ROLE OF THE ACCO0!TA!T I! VARIO0S OR7A!IEATIO!S

> , >usiness 2> , 2on&usiness 1 , 1inancial M , Managerial 7 , 7ax 1* +* ,* -* > E 1, M > E 1, 7 >EM > E 1, M, 7

2; , 2otJforJprofit

1. +6 1* 2* 3* 4* 5* 16* LO 1

1I2324I3+ 3445627I28 95+67I529 M3263+

> E 1, M, 7 >EM > or 2> E M 2> E 1, M, 2; > E 1, M > E M, 2; PROBLE 1.16 I!FOR ATIO! !EE"S A!" SETTI!7 ACCO0!TI!7 STA!"AR"S

7he 1inancial 3ccounting 9tandards >oard )ould ha'e &een targeting external users )ith this standard. >ecause these users )ould not other)ise ha'e access to information a&out the separate operating areas of a di'ersified company, this standard re@uired such disclosure. Most groups of external users )ould &e interested in ho) much of the &usiness is concentrated in one segment, and thus su&*ect to mar=et fluctuations. 0LTI.CO!CEPT PROBLE LO +,, PROBLE 1.11 PRI AR< ASS0 PTIO!S I! PREPARI!7 FI!A!CIAL STATE E!TS A"E

3ssumptions 'iolated1* Economic #ntit@K9hould ha'e separated his personal affairs from those of the &usiness. +* Cost DrinciD)#K9hould ha'e recorded the ne) e@uipment at the amount paid to ac@uire it, not its list price. ,* atc=ing DrinciD)#KE'en though this principle has not yet &een introduced in the first chapter, it can &e pointed out that not all of the cost of the tools should &e expensed in the first year. Instead, the cost of the tools and the e@uipment should &e depreciated o'er their useful li'es. >ecause no useful li'es are gi'en in the pro&lem, depreciation is ignored in the solution that follo)s. IOEGS ACHI!E REPAIR SHOP I!CO E STATE E!T FOR THE O!TH E!"E" I0L< ,1, +66<epair re'enue <ent expense 2et income B 2,%00 00 B 2,!00

4:3;7E< 1 3445627I28 39 3 15<M 51 45MM62I437I52

1.+1

IOEGS

ACHI!E REPAIR SHOP BALA!CE SHEET I0L< ,1, +66Lia%i)iti#s an$ O>n#rsG E?uit@

Ass#ts 4ash <ent deposit 3ccounts recei'a&le 7ools E@uipment 7otal assets B 400 1,000 2,500 ",500 4,200 B15,!00

5)ners? e@uity B 1 ,000 2,!00 B 15,!00 S

B 15,!00*

*5)nersF contri&utionsB 00 D B1,000 D B",500 D B4,200 3dd- 2et income 5)ners? e@uity, end of first month

ALTER!ATE PROBLE

LO 1

PROBLE

1.1A WHAT TO "O WITH A

ILLIO! "OLLARS

5&'iously, there is no single, correct ans)er to this pro&lem. 9tudents should start &y considering their personal circumstances and preference for ris=. 7hey should also consider their li@uidity re@uirements. 1rom this point, it is appropriate to consider sources of information. 9tudents should pro'ide specific *ustification for their chosen in'estments. 7he H&ottom lineI is that students should *ustify their selections using financial information from as many sources as is cost effecti'e and relate their choices to their preference or a'ersion to ris=. 1ollo)ing are guidelines to &e usedODtions Issu#s <is= Information needed Information sources StocF :igh Mar=et price $i'idends 3nnual reports In'estor ne)sJ letters 2e)spapers, &usiness periodicals Earnings forecasts >ro=erage fees Bon$s Medium Mar=et price Interest rate Maturity date 9ame as for the stoc= BanF $#Dosit +o) Interest rate >an= ad'ertising 2e)spaper articles ;enalties for )ithdra)al

3dditional information needed

3lternati'e rates >ro=erage fees

1. ++

1I2324I3+ 3445627I28 95+67I529 M3263+

LO 1

PROBLE 1.+A 0SERS OF ACCO0!TI!7 I!FOR ATIO! A!" THEIR !EE"S anag#r StocF=o)$#rs a. &. a. &. a. &. a. c. a. &. 1.,A BALA!CE SHEET VICTOR CORPORATIO! BALA!CE SHEET I0L< ,1, +66Franc=isor a. a. &. &. &.

Information 1* +* ,* -* 1* PROBLE LO +

Ass#ts 4ash 3ccounts recei'a&le >utter and cheese in'entory 4omputeri(ed mixers 5ffice e@uipment >uildings 7ools 7otal assets

B 21,#00 5,"00 12,100 25,#00 12,000 5,000 5,#00 B 11#,200

Lia%i)iti#s an$ StocF=o)$#rsG E?uit@ 3ccounts paya&le B 1!,%00 2otes paya&le 50,000 4apital stoc= 25,000 <etained earnings 2!, 00

7otal lia&ilities and stoc=holdersF e@uity

B 11#,200

Items not sho)n on a &alance sheet and )here they )ould appear$eli'ery expenseKincome statement 9alary and )age expenseKincome statement 9ales re'enueKincome statement LO + 1* PROBLE 1.-A CORRECTE" BALA!CE SHEET ISLA!" E!TERPRISES BALA!CE SHEET "ECE BER ,1, +66Ass#ts 4ash 3ccounts recei'a&le 9upplies >uilding and e@uipJ ment 7otal assets *B11 ,#50 E B1!,000 B 14,"50 2 ,200 12,200 1"", 00 B 22",450 Lia%i)iti#s an$ StocF=o)$#rsG E?uit@ 3ccounts paya&le B 2%,!00 4apital stoc= 100,000 <etained earnings %",#50* 7otal lia&ilities and stoc=holdersF e@uity B 22",450

4:3;7E< 1 3445627I28 39 3 15<M 51 45MM62I437I52

1.+,

+* Memorandum to the company president751<5M$37E4ompany president 9tudentFs name Aanuary 1, 2005

96>AE47- 4orrected &alance sheet 3ttached please find the original &alance sheet your assistant prepared, along )ith a corrected 'ersion of that same statement. 7he differences can &e explained as follo)s1* 7he &alance sheet is al)ays as of a certain date, in this case, $ecem&er 1, 2004, rather than a period of time, such as a year. +* 3ccounts paya&le should &e classified as a lia&ility. ,* 4ash di'idends paid do not &elong on the &alance sheet. this amount should appear instead on the statement of retained earnings for the year. -* 3ccounts recei'a&le should &e classified as an asset. 1* 2et income for 2004 does not &elong on the &alance sheet. this amount should appear instead on the statement of retained earnings for the year. 2* 9upplies should &e classified as an asset. 3* <etained earnings should appear )ith capital stoc= as a component of stoc=holdersF e@uity on the &alance sheet. 9ince this is the first year of operations, the retained earnings &alance comprises the net income for the year less the cash di'idends paid. 4* 7otals )ere added as necessary to pro'ide summary information. LO + PROBLE 1.1A I!CO E STATE E!T, STATE E!T OF RETAI!E" EAR!I!7S, A!" BALA!CE SHEET STER!S A0"IO BOOH RE!TAL CORP* I!CO E STATE E!T FOR THE <EAR E!"E" "ECE BER ,1, +66<ental re'enue Expenses3d'ertising expense <entK&uildings 9alaries and )ages Cater, gas and electricity 2et income B 125,%00 B 14,500 !0,000 1",%00 ,!00

1*

%!,000 B 2%,%00

1. ++*

1I2324I3+ 3445627I28 95+67I529 M3263+

STER!S A0"IO BOOH RE!TAL CORP* STATE E!T OF RETAI!E" EAR!I!7S FOR THE <EAR E!"E" "ECE BER ,1, +66>eginning &alance, Aanuary 1, 2004 3dd- 2et income $educt- $i'idends Ending &alance, $ecem&er 1, 2004 B 5, %0 2%,%00 12,000 B 5 ,2%0

,*

STER!S A0"IO BOOH RE!TAL CORP* BALA!CE SHEET "ECE BER ,1, +66Ass#ts 4ash 3ccounts recei'a&le 3udio tape in'entory $isplay fixtures 7otal assets B 2,4%0 00 "0,000 45,000 Lia%i)iti#s an$ StocF=o)$#rsG E?uit@ 3ccounts paya&le B 4,500 2otes paya&le 10,000 4apital stoc= 50,000 <etained earnings 5 ,2%0 7otal lia&ilities and stoc=holders? e@uity B 11","%0

B 11","%0

-* 5n the &asis of these statements alone, 9terns )ould appear to &e a good candidate for an in'estment. It is operating at a profit and is paying di'idends. It is controlling its costs and has a profit margin /net income di'ided &y rental re'enue0 of nearly 24M. >efore one ma=es an in'estment in 9terns stoc=, it )ould &e useful to see the statement of cash flo)s. Information a&out the current mar=et price of the stoc=, the competitors, the general outloo= for the industry, the age of the 'arious longJterm assets, and the due date of the note paya&le )ould also &e useful &efore one ma=es an in'estment. 7he financial statements of earlier periods )ould &e helpful for purposes of ma=ing comparisons. LO + 1* PROBLE 1.2A I!CO E STATE E!T A!" BALA!CE SHEET

FORT WORTH CORPORATIO! I!CO E STATE E!T FOR THE O!TH E!"E" IA!0AR< ,1, +664leaning re'enue Expenses<ent 9alaries and )ages 2et income B45,%00 B ,!00 #,400 B 12,000 ,%00

4:3;7E< 1 3445627I28 39 3 15<M 51 45MM62I437I52

1.+1

+*

FORT WORTH CORPORATIO! BALA!CE SHEET IA!0AR< ,1, +66Ass#ts 4ash 3ccounts recei'a&le E@uipment 7otal assets B 51,!50 24,"50 !2,000 B 1 #,400 Lia%i)iti#s an$ StocF=o)$#rsG E?uit@ 2otes paya&le B 0,000 4apital stoc= #0,000 <etained earnings 2#,400* 7otal lia&ilities and stoc=holders? e@uity B 1 #,400

*>eginning retained earnings D net income E di'idends B0 D B ,%00 E B5,500 ,* 7o fully assess 1ort Corth?s longJterm 'ia&ility, you )ould need the follo)ing information a&out the B 0,000 note paya&leG G G G LO + 1* Chen is it dueL Chat is the interest rateL Is interest paid periodically or only at maturityL :a'e any assets &een offered as collateral for the loanL PROBLE 1.3A CORRECTE" FI!A!CIAL STATE E!TS

HEI"I;S BAHER< I!C* I!CO E STATE E!T FOR THE <EAR E!"E" "ECE BER ,1, +66<e'enues;astry cash sales ;astry credit sales Expenses6tilities 9alaries and )ages 2et income B 2 ,"00 22,100 B %,500 1#,200

B45,#00 2","00 B 1#,100

+*

HEI"I;S BAHER< I!C* STATE E!T OF RETAI!E" EAR!I!7S FOR THE <EAR E!"E" "ECE BER ,1, +66>eginning &alance, Aanuary 1, 2004 3dd- 2et income $educt- 4ash di'idends Ending &alance, $ecem&er 1, 2004 B %,%00 1#,100 5,!00 B 52,400

1. +2 ,*

1I2324I3+ 3445627I28 95+67I529 M3263+

HEI"I;S BAHER< I!C* BALA!CE SHEET "ECE BER ,1, +66Ass#ts 4ash 3ccounts recei'a&le >uilding and e@uipment +and 7otal assets B ,"00 15,500 !0,000 50,000 Lia%i)iti#s an$ StocF=o)$#rsG E?uit@ 3ccounts paya&le B !,#00 2otes paya&le 40,000 4apital stoc= 0,000 <etained earnings 52,400 7otal lia&ilities and stoc=holdersF e@uity B 12%,200

B 12%,200

-* Memorandum to the company president751<5M$37E4ompany president 9tudentFs name Aanuary 1, 2005

96>AE47- 4orrected income statement 3ttached please find the original income statement you prepared, along )ith a corrected 'ersion of that same statement. 1ortunately, your disappointment )ith the 2004 net income is not )arranted, as you )ill see from my re'ised statement. 7he difference &et)een the net loss on the original income statement of B%00 and the re'ised net income of B1#,100, or B1%,000, can &e explained as follo)s1* 3ccounts recei'a&le of B15,500 does not &elong on the income statement. instead, ser'ices pro'ided on account of B22,100 should &e sho)n on the statement. the difference is B!,!00. +* $i'idends are not an expense and thus they do not &elong on the income statement- B5,!00. ,* 3ccounts paya&le is a lia&ility and appears on a &alance sheet- B!,#00. 7hese corrections result in increased income of B1%,000. 3lso note that notes paya&le should &e reported on the &alance sheet as a lia&ility, not as an offset to &uilding and e@uipment. ;lease let me =no) if I can &e of any further assistance in interpreting the results of our operations for 2004.

4:3;7E< 1 3445627I28 39 3 15<M 51 45MM62I437I52

1.+3

LO +

PROBLE 1.4A STATE E!T OF RETAI!E" EAR!I!7S FOR BR0!SWICH CORPORATIO! BR0!SWICH CORPORATIO! STATE E!T OF RETAI!E" EAR!I!7S FOR THE <EAR E!"E" "ECE BER ,1, +66+

1*

>eginning &alance, $ecem&er 1, 2001 3dd- 2002 net income $educt- 2002 di'idends Ending &alance, $ecem&er 1, 2002

B 1,0"%,400,000 "#,400,000 /45,100,0000 B 1,112,"00,000

+* 7he statement of stoc=holdersF e@uity )ould include all changes in stoc=holdersF e@uity such as issuances and retirements of stoc= in addition to the information normally pro'ided in a retained earnings statement. LO 1* +* ,* -* 1* 2* 3* 4* 5* 16* 11* 1+* LO 1 PROBLE 1.5A ROLE OF THE ACCO0!TA!T I! VARIO0S OR7A!IEATIO!S 1inancial accountant 7ax accountant 1inancial accountant 2ot an accounting position Managerial accountant Managerial accountant 2ot an accounting position 3uditor 2ot an accounting position 2ot an accounting position 1inancial accountant, accountant for notJforJprofit organi(ation 3uditor PROBLE 1.16A I!FOR ATIO! !EE"S A!" SETTI!7 ACCO0!TI!7 STA!"AR"S

7he 1inancial 3ccounting 9tandards >oard )ould ha'e &een targeting external users )ith this standard. >ecause these users )ould not other)ise ha'e access to information a&out the separate operating areas of a di'ersified company, this standard re@uired such disclosure. Most groups of external users )ould &e

1. +4

1I2324I3+ 3445627I28 95+67I529 M3263+

interested in ho) much of the &usiness is concentrated in one segment, and thus su&*ect to mar=et fluctuations. ALTER!ATE 0LTI.CO!CEPT PROBLE

LO +,,

PROBLE 1.11A PRI AR< ASS0 PTIO!S PREPARI!7 FI!A!CIAL STATE E!TS

A"E

I!

AssumDtions 'io)at#$: 1* Economic #ntit@K9hould ha'e separated her personal affairs from those for the &usiness. +* Cost DrinciD)#K9hould ha'e recorded the molds and paint at their mar=et 'alue /B",5000. ,* atc=ing DrinciD)#KE'en though this principle has not yet &een introduced in the first chapter, it can &e pointed out that a portion of the cost of the longJ term assets should &e recogni(ed as depreciation expense. >ecause no useful li'es are gi'en in the pro&lem, depreciation is ignored in the solution that follo)s. It can also &e pointed out that the o)ner 'iolated the re'enue recognition principle &y recogni(ing the entire B1,400 of re'enue )hen only oneJhalf of the total recei'ed had &een earned at the end of the first month. ILLIEGS CERA IC ST0"IO I!CO E STATE E!T FOR THE O!TH E!"E" I0L< ,1, +66<e'enues4lasses 8reen)are sales Expenses<ent 9upplies 4ost of green)are 2et income B B "00 ,000 00 !00* 1,000

,"00

1,%00 B 1,#00

*3ssumes the o)ner &rought B!00 of supplies from home and used all of them during the month of Auly.

4:3;7E< 1 3445627I28 39 3 15<M 51 45MM62I437I52

1.+5

ILLIEGS CERA IC ST0"IO BALA!CE SHEET I0L< ,1, +66Ass#ts 4ash $eposit Molds and paint Niln 7otal assets B 4,400 1,000 !,%00* 5,000 B 1", 00 Lia%i)iti#s an$ O>n#rsG E?uit@ 6nearned re'enue B "00 5)ners? e@uity 1!,!00**

7otal lia&ilities and o)nersF e@uity

B 1", 00

*3ssumes that the B!00 of supplies used during the month )ere part of the B",500 of molds and paint &rought from home. **5)nersF contri&utionsB 00 D B1,000 D B",500 D B5,000 D B1,000 B 14,#00 3dd- 2et income 1,#00 5)ners? e@uity, end of first month B 1!,!00

1. ,6

1I2324I3+ 3445627I28 95+67I529 M3263+

CASES

REA"I!7 A!" I!TERPRETI!7 FI!A!CIAL STATE E!TS LO 1,+ "ECISIO! CASE REFERE!CE 1.1 A! A!!0AL REPORT AS REA"<

1* Earnings per share is reported at the &ottom of the consolidated statement of income. Information a&out di'idends paid to stoc=holders )ould appear on the consolidated statement of cash flo)s. +* 7he historical financial statements can pro'ide some information that )ould &e useful in predicting future earnings. :o)e'er, a potential in'estor )ould )ant to loo= at other sections of the annual report to find out ho) the management of the company feels a&out future prospects for the company. 1or example, the chairman of the &oard?s letter )ould &e helpful in this regard. ,* Information a&out the company?s current li@uid assets, such as cash and accounts recei'a&le, can &e found on the consolidated &alance sheet. 7he &alance sheet )ill also pro'ide &an=ers and other creditors )ith information a&out existing de&ts of the company. 7he statement of cash flo)s is also useful in learning a&out a company?s operating, financing, and in'esting acti'ities o'er the past year. -* 7he amount o)ed &y Cinne&ago Industries for taxes at the end of the year is reported on its consolidated &alance sheet as HIncome 7axes ;aya&le.I 1* Information a&out executi'e compensation is not standardi(ed for all companies. 3lthough some annual reports specifically disclose the salaries paid to =ey officers of the company, Cinne&ago Industries does not. 3nother source of information regarding executi'e compensation is the companyFs 10N filed )ith the 9E4. LO + "ECISIO! CASE 1.+ REA"I!7 A!" I!TERPRETI!7 WI!!EBA7O I!"0STRIES; FI!A!CIAL STATE E!TS

1* 2002 2et income- B54,!"1,000 +* B B Ass#ts ",0"",000 ",0"",000 8 , , Lia%i)iti#s 9 B15",2!2,000* D B ",0"",000 O>n#rsG E?uit@ B1"%,#15,000

*B##,!01,000 D B!#,!!1,000 , B15",2!2,000

4:3;7E< 1 3445627I28 39 3 15<M 51 45MM62I437I52

1.,1

,* <eason for change in retained earnings &alance>alance on 3ugust 25, 2001 3dd- 2et income for 2002 $educt- $i'idends for 2002 >alance on 3ugust 25, 2001 B 2 4,1 %,000 54,!"1,000 / ,%54,0000* B 2#4,#5!,000

* B2 4,1 %,000 D B54,!"1,000 J B2#4,#5!,000 , B ,%54,000. LO +,- "ECISIO! CASE 1., CO PARI!7 TWO CO PA!IES I! THE SA E I!"0STR<: WI!!EBA7O I!"0STRIES; A!" O!ACO COACH CORPORATIO! 1* Cinne&ago Industries reported total net re'enues for 2002 of B#2#,40 ,000. 7his amount represented an increase from the re'enues reported in the prior year. Monaco 4oach reported net sales in 2002 of B1,222,!#%,000, )hich also represented an increase from the amount reported in 2001. +* In 2002, Cinne&ago Industries reported net income of B54,!"1,000, an increase from the net income in 2001. Monaco 4oachFs net income in 2002 )as B44,515,000, )hich )as also an increase from the prior yearFs amount. Cinne&ago Industries total assets at the end of 2002 amounted to B ",0"",000. In'entories )ere the largest asset category on the companyFs &alance sheet. Monaco 4oach reported total assets at the end of 2002 of B54",41",000 and the largest of its assets )as its in'entories.

,*

-* Cinne&agoFs statement of changes in stoc=holdersF e@uity includes a column for retained earnings /Cinne&ago calls this Hrein'ested income.I0 7his column sho)s a deduction in 2002 for Hcash di'idends on common stoc=I of B ,%54,000. 9imilarly, Monaco 4oach presents a statement of stoc=holdersF e@uity. :o)e'er, no di'idends appear in the retained earnings column, an indication that the company did not declare and pay any di'idends during the year. 1* E'en though the format of the t)o companiesF auditorsF reports are different, they contain the same &asic information. 7he report from Cinne&ago Industries auditors is arranged in three paragraphs )hile the report from Monaco 4oachFs auditors is in t)o paragraphs. <egardless of the format, the t)o reports contain the same information a&out ho) the audits )ere conducted and the findings from the audits.

1. ,+

1I2324I3+ 3445627I28 95+67I529 M3263+

AHI!7 FI!A!CIAL "ECISIO!S LO 1 "ECISIO! CASE 1.- A! I!VEST E!T OPPORT0!IT<

3ll in'estments re@uire a tradeJoff &et)een ris= and return. 3 college education may ha'e intrinsic 'alue, &ut it is ris=y in that it does not assure anyone of a *o& upon graduation. :o)e'er, the return may &e )orth the ris= in'ol'ed in committing one?s life sa'ings to a college education if the degree allo)s one the opportunity to ma=e a start on a career. 4ertainly, the offer to commit your sa'ings to your high school friend?s art gallery in'ol'es a significant amount of ris=. 7he friend?s prediction that you )ill &e a&le to sell the art)or= for 10 times the cost of your in'estment is su&*ect to considera&le uncertainty. >oth in'estments, in a college education and in an art gallery, re@uire an assessment of the ris=s and returns. 7he profit split &et)een you and your friend if you decide to open the art gallery is a matter of negotiation. Oou )ill certainly )ant a significant share of the profits for the ris= you are ta=ing in in'esting your sa'ings. :o)e'er, other factors must &e considered as )ell, such as the amount of time each of you )ill spend in running the &usiness. LO + "ECISIO! CASE 1.1 PREPARATIO! OF PROIECTE" STATE E!TS FOR A !EW B0SI!ESS RE OTE "V" WORL" I!C* PROIECTE" I!CO E STATE E!T FOR THE FIRST O!TH <e'enues$aily rentals /B P #000 Monthly mem&erships /B25 P 2000 ExpensesCages /B5 per hour P 15 hours P 4 )ee=s P 4 employees0 <ent 2et income B2,400 5,000 B1,200 1,000

1*

B ",400

2,200 B 5,200

4:3;7E< 1 3445627I28 39 3 15<M 51 45MM62I437I52

1.,,

+*

RE OTE "V" WORL" I!C* PROIECTE" BALA!CE SHEET E!" OF FIRST O!TH Ass#ts 4ash 3ccounts recei'a&le $Q$s 7otal assets B 200* 5,000 20,000 Lia%i)iti#s an$ StocF=o)$#rs; E?uit@ 2otes paya&le B 10,000 4apital stoc= 10,000 <etained earnings 5,200 7otal lia&ilities and stoc=holders? e@uity B 25,200

B 25,200

*B10,000 D B10,000 E B20,000 D #00/B 0 E B1,200 E B1,000 ,* 5n the surface, the decision to in'est in the &usiness appears to &e an easy one. Cith net income of B5,200 per month, it seems as if the B10,000 loan from the &an= could &e repaid in t)o months /of course, interest )ould ha'e to &e paid also0. :o)e'er, net income is not al)ays the same as cash flo) from operations. In this case, the a&ility to generate B5,200 in cash flo) each month depends on )hether the B5,000 in monthly mem&erships can &e collected each month /the assumption is that the first month?s mem&erships )ill not &e collected until the second month0. 3 second concern is )hether the company )ill &e a&le to attain and then sustain the pro*ected sales forecasts of #00 rentals per month and 200 monthly mem&erships. Cill the demand for rentals and mem&erships increase, decrease, or stay relati'ely sta&le in the futureL 3 third issue concerns the useful life of the $Q$s. 3 si(a&le in'estment of B20,000 has &een made in the initial in'entory of $Q$s. :o) long )ill it &e &efore more $Q$s )ill need to &e purchased to =eep customers returning to the storeL 3lso, )ill the company &e a&le to rent space in the area for B1,000 per month in the futureL Chat is the possi&ility that the rent )ill &e increasedL 1inally, is it li=ely that someone else )ill open a rental store in the areaL Chat effect )ould this ha'e on salesL ACCO0!TI!7 A!" ETHICS: WHAT WO0L" <O0 "OJ LO 1,+ "ECISIO! CASE 1.2 I"E!TIFICATIO! OF ERRORS I! FI!A!CIAL STATE E!TS A!" PREPARATIO! OF REVISE" STATE E!TS

1* Errors made in preparing the financial statementsa* 7he recognition of the 2005 season tic=et sales as re'enue in 2004. >ecause +a=eside has not pro'ided these fans )ith any ser'ice yet /the games0, the sale of the 2005 season tic=ets does not result in re'enue in 2004.

1. ,-

1I2324I3+ 3445627I28 95+67I529 M3263+

%* 7he recognition of B100,000 in ad'ertising re'enue. 7he contract )ith the ad'ertisers re@uired +a=eside to a'erage 2,000 fans per game. >ecause it a'eraged only 1,500, the re'enue should not &e recorded. c* 7he treatment of the player contracts. 7he B5,000 paid to the parent clu& for each of the 25 players on the roster is an expense, not an asset. 3lso, the amount o)ed to the parent clu& is not an element of stoc=holders? e@uity &ut instead is a lia&ility, since this amount is due &y 1e&ruary 1, 2005. $* 7he recognition of the 'alue of the controller?s personal residence as an asset. 6nder the economic entity assumption, the personal affairs of the o)ner of a &usiness should not &e intermingled )ith those of the company. 7he controller?s personal residence is not an asset of the &usiness. +* LAHESI"E SLA ERS I!C* I!CO E STATE E!T FOR THE <EAR E!"E" "ECE BER ,1, +66<e'enues9ingle game tic=et re'enue 4oncessions re'enue Expenses4ost of concessions sold ;layer contracts 9alariesKplayers 9alaries and )agesKstaff <ent 2et loss B 420,000 2#0,000 B 110,000 125,000 225,000 150,000 210,000 B

"00,000

#20,000 120,0000

LAHESI"E SLA ERS I!C* STATE E!T OF RETAI!E" EAR!I!7S FOR THE <EAR E!"E" "ECE BER ,1, +66>eginning &alance, Aanuary 1, 2004 $educt- 2et loss $educt- 4ash di'idends Ending &alance, $ecem&er 1, 2004 B 0 /120,0000 /40,0000 B /1!0,0000

4:3;7E< 1 3445627I28 39 3 15<M 51 45MM62I437I52

1.,1

LAHESI"E SLA ERS I!C* BALA!CE SHEET "ECE BER ,1, +66Ass#ts 4ash E@uipment B 5,000 50,000 Lia%i)iti#s an$ StocF=o)$#rs; E?uit@ 2otes paya&le B 50,000 $ue to parent clu& 125,000 4apital stoc= 40,000 <etained earnings /deficit0 /1!0,0000 7otal lia&ilities and stoc=holdersF e@uity B 55,000

7otal assets ,*

B 55,000

7he original financial statements grossly o'erstate the income of the company and its assets. 7he information regarding season tic=et re'enue does not pro'ide relia&le information to the outsider. <elia&le information represents )hat it claims to represent. 7he B140,000 recogni(ed &y the initial preparer of the financial statements is actually re'enue for the follo)ing year. It should not &e recogni(ed as re'enue in the current year. 7he B100,000 of ad'ertising re'enue that )as recogni(ed on the initial income statement does not represent the economic reality of the transaction. <e'enue must &e collecti&le to &e recogni(ed. 9ince the company =no)s that the re'enue is not li=ely to &e collected, it should not &e recogni(ed. /7he economic reality of this transaction must reflect the future cash flo)s.0 >ecause you are a)are of these errors, it is your responsi&ility to share the re'isions )ith the other o)ners as )ell as the &an=. It appears that the controller has made a deli&erate attempt to o'erstate the assets and income of the &usiness for the express purpose of o&taining an extension of the loan. >oth the other o)ners and the &an=er rely on the statements in ma=ing decisions, and it is your responsi&ility to inform them of any ma*or deficiencies in the statements. a* 7he o)ners of the company may &enefit in the shortJterm, &ecause the &an= may &e more li=ely to gi'e them a loan &ased on the original financial statements. 3ll outsiders are harmed, &ecause the financial information they recei'e does not represent the economic acti'ity of the firm. %* 7he o)ners of the company )ill &enefit &ecause the outsiders )ill e'aluate the company more fa'ora&ly &ased on the original financial statements /e.g. &an=ers )ill gi'e loans at lo)er interest rates, the stoc= 'aluations )ill &e higher0. 7he &an=ers )ill &e harmed if they are not a)are of the correct financial statement num&ers, &ecause they )ill assess the ris= of the firm &ased on the incorrect num&ers and )ill

1. ,2

1I2324I3+ 3445627I28 95+67I529 M3263+

c*

$*

#*

f*

use and lo)er interest rate on the de&t than they )ould if the ris= more accurately reflected the future cash flo). 9toc=holders )ho currently o)n shares of stoc= may not ma=e the correct decisions a&out holding the stoc=. 9toc=holders )ho currently o)n shares of stoc= may not ma=e the correct decisions a&out holding the stoc=. ;otential stoc=holders may ma=e the )rong decisions a&out purchasing the stoc=. 7he company may lac= the resources to pay the claims to the creditors /the notes paya&le and the lia&ility to the parent clu&0. 7he di'idend payment pro&a&ly 'iolated the corporate charter for the company /most companies )ould not &e permitted to pay di'idends )ithout positi'e stoc=holders e@uity.0 7he interests of the shareholders are in conflict )ith the interests of the creditors of the company. 7he shareholders appear to )ant to )ithdra) cash from the company. 7he creditors )ould prefer that the company =eep its cash to pay de&ts. 3s one of the o)nersR managers of the company, it is your responsi&ility to ma=e sure that the company follo)s the accounting rules. 4ompany management is responsi&le for the accuracy of the financial statements. 7he information in the original set of financial statements is not rele'ant /the re'enue num&ers are not useful for predicting future re'enue num&ers, since they include &oth earned and unearned re'enue0, relia&le /the seasonJtic=et and ad'ertising re'enue are not relia&le, they do not represent re'enue as claimed0, does not accurately represent )hat it claims to represent, and it is not un&iased /re'enue is too high, expenses are too lo), assets are o'erstated and o)ners e@uity is o'erstated0. 7he original financial statements are clearly presented in a )ay that is &iased to)ard the o)ners.

FRO

CO!CEPT TO PRACTICE 1*1

Oes, it is logical that H4ost of manufactured productsI )ould increase if re'enues increased &ecause the former represents all of the costs necessary to manufacture the products that )ere sold during the same period. 4ost of sales for a manufacturer, such as Cinne&ago Industries includes materials, la&or, and o'erhead. Materials include steel, plastic, glass, ru&&er and all of the 'arious items added to the product. +a&or consists of the )ages and salaries paid to )or=ers on the production line. 5'erhead includes such costs as utilities and supplies used in production. FRO CO!CEPT TO PRACTICE 1*+

4ompanies differ in terms of the length of time they ta=e to release their annual reports. 5ne month is actually a 'ery short time. 7he time re@uired to perform the yearJend audit is primarily responsi&le for the gap &et)een a companyFs year end and the release of its financial statements.