Chapter 1 Solution of fundamental of financial accouting by EDMONDS (4th edition)

ANSWERS TO QUESTIONS - CHAPTER 1

1. Stakeholders are the parties that use accounting information. (p.4)

Stakeholders with a direct interest include owners, managers, creditors, suppliers, and employees. These individuals are directly affected by what happens to the business. (p.4)

Stakeholders with an indirect interest include financial analysts, brokers, attorneys, government regulators, and news reporters. These individuals use information in the financial reports to advise and influence their clients. (p.4)

Students may give many different answers under the above categories depending on their level of experience in business.

All students are direct users of accounting information about tuition and fees, financial aid, and account balances.

2. Accounting provides information that is useful in making decisions by all participants in the market for resource goods and services, both profit-oriented and nonprofit. Because accounting’s role is so important, it is often called the language of business. (p. 4)

3. The primary mechanism used to allocate resources in the U.S. is competition for resources in the open market. (p. 4)

4. A market is a group of people or organizations that come together for the purpose of exchanging items of value. (p. 4)

5. See Exhibit 1-1 (p. 5)

6. Financial Resource: money (p. 5)

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Physical Resource: natural resources (i.e. land, forests, mine ore, petroleum, etc.), buildings, machinery and equipment, furniture and fixtures (p. 6)

Labor Resource: includes both intellectual and physical labor; i.e. employees (p. 6)

7. Investors expect a distribution of the business’s profits as a return on their financial investment (capital allocation).Creditors lend financial resources to businesses and receive interest as a return or profit on the loan. (p. 5)

8. Financial accounting provides information that is useful to external resource providers. (p. 6)

Managerial accounting provides information that is useful to managers in operating an organization (i.e., internal users). (p. 6)

9. Not-for-profit or nonprofit entities provide goods or services to consumers for humanitarian or special reasons rather than to earn a profit for owners. For example, governments allocate resources to provide for national defense or social/environmental welfare; benevolent organizations allocate resources to meet humanitarian needs and to promote the arts and meet social needs. (p. 7)

10. The U.S. rules of accounting information measurement are called generally accepted accounting principles (GAAP). (p. 8)

11. In the U.S., GAAP are established by the accounting profession through the Financial Accounting Standards Board (FASB). In Japan and Germany, GAAP are established by governmental bodies. (p. 8, 24)

12. The Financial Accounting Standards Board (FASB) has the primary responsibility for establishing GAAP in the U.S.

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FASB is a non-governmental rule-making body established by the accounting profession. (p. 9)

13. Items reported on the financial statements are organized into classes or categories called elements. The ten elements of financial statements are: (p. 9)1. Assets2. Liabilities3. Equity (Stockholders’ Equity)4. Common Stock (Contributed Capital)5. Revenue6. Expenses7. Distributions (Dividends)8. Net Income9. Gains10. LossesAccounts are specific items or subclassifications of the elements. Examples of accounts include cash, land and common stock.

14. “Assets = Claims” is the most basic form of the accounting equation. (p. 10)

15. Assets, the economic resources of a business, are used to produce earnings. (p. 10)

16. The assets of a business belong to individuals and/or institutions that have claims on the assets (i.e., resource providers). (p. 10)

17. Creditors are individuals and/or institutions that have loaned goods or services to the business. These parties have first claim to the assets of the business, and the owners have a residual interest in the assets. (p. 10)

18. “Residual interest” means that in the case of liquidation, assets are distributed first to creditors, in order to settle the creditors’ claims, and any remaining assets are then distributed to the owners of the business. Residual interests are often labeled with the terms “equity” or “net assets”. (p. 10)

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19. The term “liabilities” is used to describe creditors' claims on the assets of a business. (p. 10)

20. The accounting equation is: ASSETS – LIABILITIES = STOCKHOLDERS’

EQUITY or

ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY

Assets are the economic resources used by a business for the production of revenue. Liabilities are obligations of a business to relinquish assets, provide services, or accept other obligations. Equity, also called “residual interest” or “net assets”, is the portion of the assets remaining after the creditors' claims have been satisfied (i.e., Assets – Liabilities). (p10)

21. The owners ultimately bear the risk and collect the rewards associated with operating a business. (p. 15)

22. A double-entry bookkeeping system is one in which every transaction is recorded twice. A transaction can affect both assets and claims (liabilities and equity) or only assets or only claims. In order to “balance” the accounting equation, every transaction requires a “double entry.” (p. 14)

23. An asset source transaction results in an increase in an asset account and an increase in one of the claims accounts; i.e., investments by owners (equity), borrowing funds from creditors (liabilities), or earnings activities (revenue). (p. 14)

An asset use transaction results in a decrease in an asset account and a decrease in either liabilities or equity; i.e., the payment of a liability, the payment of an expense, or a dividend. (p. 15)

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An asset exchange transaction is a transaction in which one asset is exchanged for another; i.e., purchase of land with cash. (p. 14)

A claims exchange transaction will be covered in a later chapter.

24. Capital is acquired from owners by issuing stock to them. When stock is issued, the assets of the business increase and the stockholders’ equity increases. (p. 14)

25. Assets that are acquired by issuing common stock are the result of investments by owners. Assets that are acquired by using retained earnings are assets the business acquires through its earnings activities. (pp. 14, 15)

26. Revenue increases the asset side of the accounting equation and also increases the source of that asset, the retained earnings account in the stockholders’ equity section of the equation. (p. 15)

27. The nominal or temporary accounts are closed to Retained Earnings at the end of the accounting period. The temporary accounts are the revenue, expense and dividends accounts. (p. 19)

28. The three primary sources of assets are (1) investments by owners (issue of stock), (2) borrowing from creditors, and (3) earnings activities. (p. 14)

29. Retained earnings are a result of a business retaining its earned assets, rather than distributing those earnings to its owners. (p. 11)

30. Distributions to owners, called dividends, decrease the asset side of the accounting equation and also decrease the retained earnings account in the stockholders’ equity section of the equation. (p. 16)

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31. Dividends and expenses are similar in that they both decrease assets and affect the accounting equation in the same way (i.e. reduction of retained earnings). However, dividends differ from expenses because of the nature of the decline in assets. Expenses reduce assets as the result of a firm's efforts to earn revenue. Dividends reduce assets because of a transfer of wealth to the owners. (pp. 15, 16)

32. (1) Balance Sheet - lists the assets and the corresponding claims on

those assets as of a particular date. (p. 11)

(2) Income Statement - measures the difference between the asset increases and the asset decreases that were associated with operating a business during a particular accounting period. (p.11)

(3) Statement of Cash Flows - explains how a company obtained and used cash during the accounting period. (p.12)

(4) Statement of Changes in Stockholders’ Equity - explains the effects of transactions on stockholders’ equity during the accounting period. (p.18)

33. The balance sheet provides information about the enterprise at a particular point in time. (p. 18)

34. Revenue, expenses, and dividends are temporary accounts and are closed to Retained Earnings at the end of the accounting period. (p.19)

35. A net loss occurs when expenses exceed revenues. (p. 11)

36. (1) Operating activities - explain the cash generated from revenue and

the cash paid for expenses.

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(2) Investing activities - include cash received or spent by the business on productive assets used in the business and investments in debt or equity of other companies.

(3) Financing activities - include cash inflows and outflows from the company's transactions with its owners and inflows and outflows from its borrowing activities. (p. 12)

37. Asset accounts are arranged on the balance sheet in accordance with their level of liquidity (those that can be most quickly converted to cash are listed first). (p. 18)

38. Balance Sheet accounts (i.e., Assets, Liabilities, Common Stock, and Retained Earnings) are permanent accounts. The information in these accounts is cumulative. In other words, Balance Sheet accounts show the accumulation of the results of the continuing activities of the entity.

Income Statement accounts (Revenue, Expenses, Gains, and Losses) and Dividends are nominal accounts. Data in these accounts show the results of activities of only one period. At the end of each period, the nominal account balances are transferred to the permanent account, Retained Earnings, through a process called closing. (p. 19)

39. While the contents of annual reports vary from company to company, all annual reports contain:Financial statementsFootnotes to the financial statementsAuditor’s reportManagement’s discussion and analysis (MD&A)(p. 26)

40. The three stages of the accounting cycle that were discussed in this chapter were (1) recording accounting data in accounts, (2) preparing financial statements, and (3) closing the nominal accounts After these stages are complete, a new cycle will begin. (p. 21)

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SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 1

EXERCISE 1-1A

1. Income Statement; Statement of Operations; Earnings Statement

2. Statement of Changes in Equity; Capital Statement; Statement of Stockholders’ Equity

3. Balance Sheet; Statement of Financial Position4. Statement of Cash Flows

EXERCISE 1-2A

The three participants in the free business market are:1. Resource owners2. Conversion agents3. Consumers

Note to instructor:

The memo should discuss the fact that the resource owners are those who own resources that are desired by others, either in the original form or in a converted form. The conversion agents are the parties that acquire the resource and supplies it to consumers either in the original form or in a converted form with value added by the conversion. The consumers are the ultimate users of the resources.

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EXERCISE 1-3A

a.Wilson Auto Parts

Accounting Equation

ClaimsAssets = Liabilities + Stockholders’

Equity$6,200 = $5,000 + $1,200

Liabilities $5,000Claims $6,200

b.Clark Juices, Inc.

Accounting Equation


Equity5,600 = 1,200 + 4,400

Assets $5,600

Net Assets = Assets Liabilities; or Net Assets = Total Stockholders’ Equity$5,600 $1,200= $4,400

c. Ted’s Tennis Shop

Accounting Equation


Equity56,700 = 32,300 + 24,400

Stockholders’ Equity $24,400Net Assets are equal to Stockholders’ Equity: $24,400

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EXERCISE 1-4A

a. A business liquidation occurs when a business ceases activity and divides the remaining assets between the resource providers (i.e. creditors and investors).

b. McNeal Company

Accounting EquationEvent Assets = Liabilitie

s + Stockholders’ Equity

Common Stock

Retained Earnings

Acquired assets

$1,000 $400 $600

Incurred loss (500) (500)Balance $ 500 = $400 + $600 $(500)

The cash balance of $500 will be distributed first to the creditors. Since creditors are owed $400, the creditors will receive the $400 that they are owed.

c. The stockholders will receive the $100 cash that remains after the creditors are paid.

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EXERCISE 1-5A

Solar EnterprisesAccounting Equation

Stockholders’Equity

Event Number Assets = Liabilities +

Common Stock

Retained

Earnings1. I NA I NA2. I NA NA I3. D NA NA D4. I I NA NA5. I/D(NA) NA NA NA6. D NA NA D

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EXERCISE 1-6A

Greer Consulting ServiceHorizontal Statements Model for 2006

Balance Sheet Income Statement Statement of

Assets = Liab. + Stockholders’ Equity

Revenue

Expense

= Net Inc.

Cash Flows

Event No.

Cash + Land =NotesPayabl

e+

Common Stock +

Retained

Earnings

1 I + NA = NA + I + NA NA NA = NA I FA2 I + NA = NA + NA + I I NA = I I OA3 D + NA = NA + NA + D NA I = D D OA4 I + NA = I + NA + NA NA NA = NA I FA5 D + I = NA + NA + NA NA NA = NA D IA6 D + NA = NA + NA + D NA NA = NA D FA

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EXERCISE 1-7A

Chia CompanyAccounting Equation for 2009

Assets = Liabilities

+ Stockholders’ Equity

Notes Common

Retained

Event Cash = Payable + Stock + Earnings

Issued stock 12,000 NA 12,000 NA

EXERCISE 1-8A

Northern Rockies CompanyAccounting Equation for 2007



Notes Common

Retained

Event Cash = Payable + Stock + Earnings

Issued note 7,200 7,200 NA NA

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EXERCISE 1-9Aa.

Kwon CompanyAccounting Equation for 2005


Stockholders’ Equity

Common

Retained

Event Cash = + Stock + Earnings

1. Cash revenue 9,500 NA NA 9,5002. Paid expense (5,800) NA NA (5,800)3. Paid dividend (700) NA NA (700)Ending Balance 3,000 = -0- + -0 + 3,000

b.Kwon Company

Income StatementFor the Year Ended December 31, 2005

Revenue $9,500Expense (5,800)Net Income $3,700

Kwon CompanyBalance Sheet

As of December 31, 2005

AssetsCash $ 3,000

Liabilities $ -0-

Stockholders’ EquityCommon Stock $ -0-Retained Earnings 3,000

Total Stockholders’ Equity 3,000

Total Liabilities and Stockholders’ Equity

$ 3,000

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c. The closing process.

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EXERCISE 1-10A

a.Maulder Mechanics

Horizontal Statements Model for 2001


Assets = Liab. + Stockholders’ Equity Revenue Expense

= Net Inc.

Cash Flows

Event No.

Cash =Notes

Payable +Common Stock +

Retained

Earnings1 7,000 = NA + 7,000 + NA NA NA = NA 7,000 FA2 14,000 = NA + NA + 14,000 14,000 NA = 14,000 14,000 OA3 (6,800) = NA + NA + (6,800) NA 6,800 = (6,800) (6,800) OA4 (1,000) = NA + NA + (1,000) NA NA = NA (1,000) FA

13,200 = -0- + 7,000 + 6,200 14,000 6,800 = 7,200 13,200 NC

b. Net income is $7,200 and caused assets to increase by $7,200.

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EXERCISE 1-11A

Event Statement of Cash Flow Classification

a. OAb. FAc. FAd. IAe. OAf. OAg. IAh. FAi. NAj. FA

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EXERCISE 1-12Aa.

Sani Service CompanyAccounting Equation for 2001



Event Cash + Land =Notes

Payable+Commo

nStock

+Retaine

d Earning

s

Acct. Title/RE

Bal. 1/1/01 25,000 50,000 35,000 30,000 10,0001. Pur. Land (10,000

)10,000 NA NA NA NA

2. Issued stk.

15,000 NA NA 15,000 NA NA

3. Provide Svc

55,000 NA NA NA 55,000 Revenue

4. Paid Exp. (38,000)

NA NA NA (38,000)

Op. Exp.

5. Paid Note (20,000)

NA (20,000)

NA NA NA

6. Paid Div. (3,000) NA NA NA (3,000) Dividend

Totals 24,000 +60,000=15,000 +45,000 +24,000

b. Net Income for 2001:Revenue $55,000Operating Expense (38,000)Net Income $17,000

c. Total assets at the end of 2001:Cash $24,000Land 60,000Total Assets $84,000

Net assets at the end of 2001:Total Assets $84,000 o

rCommon Stock $45,000

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Less: Liabilities

(15,000) Plus: Retained Earnings

24,000

Net Assets $69,000Total Stockholders’ Equity (Net Assets) $69,000

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EXERCISE 1-13Aa.

Kerry CompanyAccounting Equation for 2002



Event Cash + Land =NotesPayabl

e+

Com.Stock +

Retained

Earnings

Acct. Title/RE

Bal. 1/1/02 2,000 16,000

-0- 10,000 8,000

1. Issued stk.

25,000 NA NA 25,000 NA NA

2.Pur. Land (9,000) 9,000 NA NA NA NA3. Loan 5,000 NA 5,000 NA NA NA4. Provide Svc.

12,000 NA NA NA 12,000

Svc. Rev.

5. Paid Rent (500) NA NA NA (500) Rent Exp.

6. Pd. Op. Exp.

(7,000) NA NA NA (7,000)

Oper. Exp

7. Paid Div. (2,000) NA NA NA (2,000)

Dividends

Totals 25,500+ 25,000

= 5,000 + 35,000 + 10,500

b.

Kerry CompanyIncome Statement

For the Year Ended December 31, 2002

Service Revenue $12,000Rent Expense (500)Operating Expense (7,000)Net Income $ 4,500

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EXERCISE 1-13A b. (cont.)

Kerry CompanyStatement of Changes in Stockholders’ Equity


Beginning Common Stock $10,000Plus: Common Stock Issued

25,000

Ending Common Stock $35,000

Beginning Retained Earnings

8,000

Plus: Net Income 4,500Less: Dividends (2,000)Ending Retained Earnings 10,500

Total Stockholders’ Equity

$45,500

Kerry CompanyBalance Sheet


AssetsCash $25,500Land 25,000

Total Assets $50,500

LiabilitiesNotes Payable $5,000

Total Liabilities $ 5,000

Stockholders’ EquityCommon Stock $35,000Retained Earnings 10,500


Total Liabilities and Stockholders’ $50,500

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Equity

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EXERCISE 1-13A b. (cont.)

Kerry CompanyStatement of Cash Flows


Cash Flows From Operating Activities:

Cash Receipts from Revenue $12,000Cash Payment for Rent Expense (500)Cash Payments for Other

Operating Exp.(7,000)

Net Cash Flow from Operating Activities

$ 4,500

Cash Flows From Investing Activities

Cash Paid to Purchase Land (9,000)Net Cash Flow from Investing Activities

(9,000)

Cash Flows From Financing Activities:

Cash Receipts from Stock Issue 25,000Cash Receipts from Loan 5,000Cash Payments for Dividends (2,000)

Net Cash Flow from Financing Activities

28,000

Net Increase in Cash 23,500Plus: Beginning Cash Balance 2,000Ending Cash Balance $25,500

c. The revenue, expense and dividends accounts will have a zero balance because they will have been closed to retained earnings.

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EXERCISE 1-14Aa.

Tax Time, Inc.Horizontal Statements Model for 2004



Revenue

Expense

= Net Inc.

Cash Flows

Event No.


e+

Common Stock +

Retained

Earnings

1 30,000 + NA = NA + 30,000 + NA NA NA = NA 30,000 FA2 (9,000

)+ 9,000 = NA + NA + NA NA NA = NA (9000) IA

3 28,000 + NA = NA + NA + 28,000 28,000 NA =28,000 28,000 OA4 (9,500

)+ NA = NA + NA + (9,500) NA 9,500 = (9,500) (9,500) OA

5. 5,000 + NA = NA + 5,000 + NA NA NA = NA 5,000 FA6. 10,000 + NA = 10,000 + NA + NA NA NA = NA 10,000 FA7. (5,000

)+ 5,000 = NA + NA + NA NA NA = NA (5,000) IA

8. (6,000)

+ NA = NA + NA + (6,000) NA 6,000 = (6,000) (6,000) OA

9. (2,800)

+ NA = NA + NA + (2,800) NA NA = NA (2,800) FA

Total

40,700 + 14,000 = 10,000 + 35,000 + 9,700 28,000 15,500 12,500 40,700 NC

b. Net Income for 2004: $12,500c. Total Assets at the end of 2004: $54,700 ($40,700 + $14,000)

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d. Net Cash Flow from Operating Activities for 2004:$12,500 (28,000 9,500 6,000).

e. Net Cash Flow from Investing Activities for 2004: $14,000 (9,000 + 5,000)f. Net Cash Flow from Financing Activities for 2004: $42,200 (30,000 + 5,000 +

10,000 2,800).g. Cash balance at December 31, 2004: $40,700

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EXERCISE 1-15A

Title or Account Financial Statement(s)a. Common Stock Balance Sheet; Statement of

Changes in Stockholders’ Equityb. Land Balance Sheetc. Ending Cash Balance Balance Sheet; Statement of Cash

Flowsd. Beginning Cash

BalanceStatement of Cash Flows

e. Notes Payable Balance Sheetf. Retained Earnings Balance Sheet; Statement of

Changes in Stockholders’ Equityg. Revenue Income Statementh. Dividends Statement of Changes in

Stockholders’ Equityi. Financing Activities Statement of Cash Flowsj. Salary Expense Income Statement

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EXERCISE 1-16Aa.

Permanent AccountsCashNotes PayableLandCommon StockRetained Earnings

Nominal (Temporary) AccountsRevenueExpensesDividends

b.Beginning Retained Earnings

$3,500

Add: Revenue 4,000Less: Expenses (2,500)Less: Dividends (500)Ending Retained Earnings

$4,500

c.Computation of Net IncomeRevenue $4,000Less: Expenses (2,500)Net Income $1,500

d. Net income is only the current year’s net income. Retained Earnings is an accumulation of net income over the life of the business less any dividends that have been paid over the years.

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e. All revenue, expense and dividends accounts will have a zero balance because they have been closed to retained earnings.

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EXERCISE 1-17Aa.

Account Classification

1. Cash P2. Salaries Expense T3. Notes Payable P4. Utilities Expense T5. Service Revenue T6. Dividends T7. Common Stock P8. Land P9. Interest Revenue T10. Retained Earnings P

b. The three stages of the accounting cycle are:recording transactionspreparing financial statementsclosing temporary accounts.

The first stage of the cycle must be recording accounting data in accounts to put it into usable form. Once the accounting data is summarized in the accounts, it is used to prepare the financial statements. After the financial statements are prepared, the temporary accounts (revenue, expenses, and dividends) must be closed to prepare these accounts for the next accounting period.

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EXERCISE 1-18A

Event Classification1. Asset Source2. Asset Source3. Asset Exchange4. Asset Source5. Asset Source6. Asset Exchange7. Asset Use8. NA9. Asset Use10. Asset Use

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EXERCISE 1-19Aa.

Event1. Asset Source2. Asset Source3. Asset Source4. Asset Use5. Asset Exchange6. Asset Use

b.Better Sports




Revenue

Expense

= Net Inc.

Cash Flows

Event No.

Cash + Land =Notes

Payable

+Commo

n Stock

+RetainedEarnings

1 I + NA = NA + I + NA NA NA = NA I FA2 I + NA = NA + NA + I I NA = I I OA3 I + NA = I + NA + NA NA NA = NA I FA4 D + NA = NA + NA + D NA I = D D OA5 D + I = NA + NA + NA NA NA = NA D IA6 D + NA = NA + NA + D NA NA = NA D FA

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EXERCISE 1-20A

a. Dundee Company: Asset Source

b. Don Sinclair: Asset Exchangec. Dundee Company: Financing

Activityd. Don Sinclair: Investing

Activity

EXERCISE 1-21A

Accounting Equation

Stockholders’ EquityCommon Retained

Company

Assets = Liabilities + Stock + Earnings

A 136,000 = 48,000 + 52,000 + 36,000B 90,000 = 25,000 + 25,000 + 40,000C 87,000 = 15,000 + 35,000 + 37,000D 102,000 = 29,000 + 42,000 + 31,000

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EXERCISE 1-22A

a. 2002Assets = Liabilities + Common Stock +Retained Earnings

$156,000 = $85,600 + $48,400 + $22,000

Or: $156,000 $85,600 $48,400 = $22,000.

b. 2003Revenue Expenses = Net Income$22,000 $12,500 = $9,500

c. Retained Earnings, Jan 1, 2003 $22,000Plus: 2003 Net Income 9,500Less: 2003 Dividends (500)Retained Earnings, December 31, 2003 $31,000

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EXERCISE 1-23A

Steps:1.Common Stock Issued = Change in Common Stock $11,000 (given) = $11,000

2.Change in Stk. Equity= Change in Com. Stock + Change in Ret. Earn.$53,400 (given) = $11,000 (1) + $42,400

3.Increase in Ret. Earn. = Net Income Dividends$42,400 (2) = $50,400 $8,000 (given)

Alternate Solution:

From the Statement of Changes in Stockholders’ Equity we know (with minor modifications):

Beginning Total Stk. Equity, 1/1/2007

$ 62,500

(Common Stock + Retained Earnings)

Plus: Common Stock Issued $11,000Plus: Net Income ?Less: Dividends (8,000)Change in Stockholders’ Equity 53,400

Ending Total Stk. Equity, 12/31/2007

$115,900

Working backwards from the change in equity we can solve for net income:

Change in Stockholders’ Equity, $53,400

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2007Plus: Dividends 8,000Less: Common Stock Issued (11,000)Net Income, 2007 $50,400

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EXERCISE 1-24Aa.

Price-Earnings RatioHenry Company Pager Company

38.5 1.05 = 36.67 108 4.5 = 24

b. Stockholders’ expectations of future growth will cause the price to increase at a faster rate than earnings.

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SOLUTIONS TO PROBLEMS -SERIES A - CHAPTER 1

PROBLEM 1-25A

Lighthouse ServicesHorizontal Statements Model for 2006



Revenue

Expense

= Net Inc.

Cash Flows

Event No.


e+

Common Stock +

Retained

Earnings

1 I + NA = NA + I + NA NA NA = NA I FA2 I + NA = I + NA + NA NA NA = NA I FA3 I + NA = NA + NA + I I NA = I I OA4 D + NA = NA + NA + D NA I = D D OA5 D + I = NA + NA + NA NA NA = NA D IA6 D NA D NA NA NA NA NA D FA7 D + NA = NA + NA + D NA NA = NA D FA

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PROBLEM 1-26Aa.

Marx CompanyHorizontal Statements Model for 2003



Revenue

Expense

= Net Inc.

Cash Flows

Event No.


e+

Common Stock +

Retained

Earnings

1 24,000 + NA = NA + 24,000 + NA NA NA = NA 24,000 FA2 16,000 + NA = 16,000 + NA + NA NA NA = NA 16,000 FA3 36,000 + NA = NA + NA + 36,000 36,000 NA =36,000 36,000 OA4 (25,000

)+ NA = NA + NA + (25,000) NA 25,000 = (25,00

0)(25,000)

OA5. (4,000) + NA = NA + NA + (4,000) NA NA = NA (4,000) FA6. 20,000 + NA = NA + 20,000 + NA NA NA = NA 20,000 FA7. (5,000) + NA = (5,000) + NA + NA NA NA = NA (5,000) FA8. (53,000

)+ 53,000 = NA + NA + NA NA NA = NA (53,000)

IATota

l9,000 + 53,000 = 11,000 + 44,000 + 7,000 36,000 25,000 11,000 9,000 NC

b. Total Assets = $9,000 + $53,000 = $62,000

c.Sources of Assets

Event

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1. Issue of stock $ 24,0002. Cash from loan 16,0003. Cash from revenue 36,0006. Issue of stock 20,000Total Sources of Assets $96,000

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PROBLEM 1-26A (cont.)

d. Net income is $11,000 (see part a.) Dividends are not expenses and do not appear on the income statement.

e.Operating Activities:Cash from revenue $36,000Cash paid for expenses (25,000)Net Cash Flow from Operating Activities

$11,000

Financing Activities:Cash from stock issues ($24,000 + $20,000)

$44,000

Cash from loan 16,000Paid cash dividend (4,000)Cash paid on loan principal (5,000)Net Cash Flow from Financing Activities

$51,000

Investing Activities:Cash paid to purchase land $(53,000)Net Cash Flow from Investing Activities

$(53,000)

PROBLEM 1-27Aa.

Reynolds ConsultingAccounting Equation for 2006



Notes Commo Retaine Acct.

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Event Cash + Land = Payable + nStock

+ d Earning

s

Title/RE

1. Issued stk

25,000 NA NA 25,000 NA NA

2. Revenue


3. Loan 16,000 NA 16,000 NA NA NA4. Paid Exp.

(50,000)

NA NA NA (50,000)

Oper. Exp.

5. Pur. Land

(44,000)

44,000

NA NA NA NA

Totals 19,000 +44,000

= 16,000 +25,000 + 22,000

Reynolds ConsultingAccounting Equation for 2007

Assets =Liabilities



e+

Common

Stock+

Retained Earnings

Acct. Title/RE

Beg. Bal. 19,000 44,000

16,000 25,000 22,000

1. Issued stk

24,000 NA NA 24,000 NA NA

2. Revenue


3. Paid Loan

(10,000)

NA (10,000)

NA NA NA

4. Paid Exp.

(71,500)

NA NA NA (71,500)

Oper. Exp.

5. Paid Div.

(6,000) NA NA NA (6,000) Dividends

Totals 49,500 +44,000

= 6,000 +49,000 + 38,500

1-44

PROBLEM 1-27A (cont.)b.

Reynolds Consulting

Income Statements

2006 2007

Service Revenue $ 72,000 $ 94,000Expenses (50,000) (71,500)Net Income $ 22,000 $ 22,500

Statements of Changes in Stockholders’ Equity

Beginning Common Stock $ -0- $ 25,000Plus: Common Stock Issued 25,000 24,000Ending Common Stock 25,000 49,000

Beginning Retained Earnings -0- 22,000Plus: Net Income 22,000 22,500Less: Dividends -0- (6,000)Ending Retained Earnings 22,000 38,500Total Stockholders’ Equity $ 47,000 $ 87,500

Balance Sheets

Assets Cash $ 19,000 $ 49,500 Land 44,000 44,000Total Assets $ 63,000 $ 93,500

Liabilities Notes Payable $ 16,000 $ 6,000

Stockholders’ Equity Common Stock 25,000 49,000 Retained Earnings 22,000 38,500Total Stockholders’ Equity 47,000 87,500Total Liabilities and Stockholders’ Equity

$ 63,000 $ 93,500

1-33

PROBLEM 1-27A b. (cont.)

Reynolds Consulting

Statements of Cash Flows

2006 2007Cash Flows From Operating Activities: Cash Receipts from Revenue $ 72,000 $ 94,000 Cash Payments for Expenses (50,000) (71,500)Net Cash Flow from Operating Activities

22,000 22,500

Cash Flows From Investing Activities: Cash Payment for Land (44,000) -0-Net Cash Flow from Investing Activities

(44,000) -0-

Cash Flows From Financing Activities: Cash Receipts from Borrowed Funds

16,000 -0-

Cash Payment of Debt -0- (10,000) Cash Receipts from Stock Issue 25,000 24,000 Cash Payment for Dividends -0- (6,000)Net Cash Flow from Financing Activities

41,000 8,000

Net Change in Cash 19,000 30,500Plus: Beginning Cash Balance -0- 19,000Ending Cash Balance $ 19,000 $ 49,500

c. Assets increased from $63,000 at December 31, 2006 to $93,500 at December 31, 2007. This increase of $30,500 is solely due to the increase in cash.

d. ($22,500 $22,000) $22,000 = 2.27%; This is a low growth company.

1-34

1-35

PROBLEM 1-28A

Not required:Chase Enterprises

Accounting Equation



+Common Stock +

Retained Earnings

Beg. Balances 30,000 18,000 4,000 8,000Earned Revenue

36,000 36,000

Paid Expenses (23,000) (23,000)Paid Dividends

(2,000) (2,000)

Issued Stock 10,000 10,000Paid Liability (6,000) (6,000)

45,000 = 12,000 + 14,000 + 19,000

Chase EnterprisesIncome Statement

For the Period Ended December 31, 2002

Revenue $36,000Expenses (23,000)Net Income $13,000

1-36


Chase EnterprisesStatement of Changes in Stockholders’ Equity

For the Period Ended December 31, 2002

Beginning Common Stock $ 4,000Plus: Common Stock Issued

10,000



8,000



$33,000

Chase EnterprisesBalance Sheet


Assets $45,000

Liabilities $12,000




$45,000

1-37


Chase EnterprisesStatement of Cash Flows



Cash Receipt from Revenue $36,000Cash Payment for Expenses (23,000)


$13,000


-0-


Cash Receipts from Stock Issue 10,000Cash Payment to Creditors (6,000)Cash Dividend to Stockholders (2,000)


2,000

Net Increase in Cash 15,000Plus: Beginning Cash Balance* 30,000Ending Cash Balance $45,000

*Assumes that all assets are cash.

1-38

PROBLEM 1-29A

ItemIncome

Statement

Statement of Changes

in Stk. Equity

Balance Sheet

Statement of Cash Flows

Ending Cash Balance Salary Expense Consulting Revenue Dividends Financing Activities Ending Common Stock

Interest Expense As of (Date) Land Beginning Cash Balance

Notes Payable Beginning Common Stock

Service Revenue Utility Expense Cash Received from Stock Issue

Operating Activities For the Period Ended (Date)

Net Income Investing Activities Net Loss

1-39

PROBLEM 1-30A

a.Green View Company


Revenue $7,400

ExpensesSalary Expense $2,900Utility Expense 600Rent Expense 1,400

Total Expense (4,900)

Net Income $2,500

b.Accounts to be Closed:1. Revenue2. Salary Expense3. Utility Expense4. Dividends5. Rent Expense

c.Computation of Retained Earnings:


$14,700

Add: Net Income 2,500Less: Dividends (1,200)Ending Retained Earnings

$16,000

Net income only includes revenue and expense for the current year. Retained earnings not only includes current year net income, but also the balance from previous years and reductions for dividends.

1-40

d. The balances are zero; they have been closed to Retained Earnings.

PROBLEM 1-31A

1-41

FOR THE YEARS 2001 2002 2003

Income StatementsRevenue (cash) $ 700 $1,300 $ 2,000Expense (cash) (a) (500) (700) (1,300)Net Income (Loss) $200 (m) $

600$ 700

Statements of Changes in Stockholders’ EquityBeginning Common Stock $ -0- (n)

$5,000$6,000

Plus: Stock Issued 5,000 1,000 2,000Ending Common Stock 5,000 6,000 (t)8,000


-0- 100 200

Plus: Net Income (Loss) (b) 200 (o) 600 700Less: Dividends (c) (100) (500) (300)

Ending Retained Earnings 100 (p) 200 600Total Stockholders’ Equity (d)

$5,100$6,200 $8,600

Balance SheetsAssetsCash (e)

$8,100(q) $ 3,200

(u)$2,600

Land -0- (r) 8,000 8,000Total Assets (f)$8,100 $11,200 $10,600

Liabilities (g)$3,000

$ 5,000 $ 2,000

Stockholders’ EquityCommon Stock (h) 5,000 (s)6,000 8,000Retained Earnings (i) 100 200 600

Total Stockholders’ Equity (j) 5,100 6,200 8,600Total Liab. and Stk. Equity $8,100 $11,200 $10,600

1-42


FOR THE YEARS 2001 2002 2003


Cash Flows From Oper. Activities: Cash Receipts from Revenue

(k)$ 700

$ 1,300 (v) $ 2,000

Cash Payments for Expenses

(l) (500) (700) (w)(1,300)

Net Cash Flow from Oper. Act.

200 600 700

Cash Flows From Invest. Activities: Cash Payments for Land -0- (8,000) -0-Net Cash Flow from Invest. Act.

-0- (8,000) -0-

Cash Flows From Fin. Activities: Cash Receipts from Loan 3,000 3,000 -0- Cash Payments to Reduce Debt

-0- (1,000) (x)(3,000)

Cash Receipts from Stock Issue

5,000 1,000 (y)2,000

Cash Payments for Dividends

(100) (500) (z) (300)

Net Cash Flow from Fin. Activities

7,900 2,500 (1,300)

Net Change in Cash 8,100 (4,900) 600Plus: Beginning Cash Balance -0- 8,100 3,200Ending Cash Balance $8,100 $3,200 $2,600

1-43


Computations of amounts:a. $500 Expense = $700 Revenue $200 Net Income.b. $200 Net Income = $200 Net Income from Income Statement.c. $100 Dividends = $200 Net Income $100 Ending Ret. Earnings.d. $5,100 Total Stk. Equity = $5,000 Ending Common Stock + Ending

Retained Earn.e. $8,100 Cash = $8,100 Total Assets $-0- Land.f. $8,100 Total Assets = $8,100 Liabilities and Stockholders’ Equity.g. $3,000 Liabilities = $3,000 Cash Receipts from Loan.h. $5,000 Common Stock = $5,000 Com. Stock from Statement of

Changes in Stockholders’ Equity.i. $100 Retained Earnings = $100 Ret. Earnings from Statement of

Changes in Stockholders’ Equity.j. $5,100 Total Stockholders’ Equity = $5,000 Common Stock + $100

Retained Earnings or $5,100 Total Stk. Equity from Statement of Changes in Stk. Equity.

k. $700 Cash Receipts from Revenue = $700 Revenue from Income Statement.

l. $500 Cash Payment for Expense = $500 Expense from Income Statement.

m. $600 Net Income = $1,300 Revenue $700 Expense.n. $5,000 Beginning Common Stock = $5,000 Ending Common Stock

2001.o. $600 Net Income = $600 Net Income from Income Statement.p. $200 Ending Retained Earnings = $100 Beginning Ret. Earnings +

$600 Net Income $500 Dividends.q. $3,200 Cash = Ending Cash Balance from Statement of Cash Flows.r. $8,000 Land = $8,000 Cash Payment for Land from Statement of Cash

Flows.s. $6,000 Common Stock = $6,000 Ending Common Stock from

Statement of Changes in Equity.t. $8,000 Ending Common Stock = $6,000 Beginning Common Stock +

$2,000 Common Stock Issued.u. $2,600 Cash = $2,600 Ending Cash Balance from Statement of Cash

Flows.v. $2,000 Cash Receipts from Revenue = $2,000 Revenue from

Income Statement.w. $1,300 Cash Payment for Expenses = $1,300 Expense from Income

Statement.x. $3,000 Cash Payment to Reduce Debt = $5,000 Balance of

Liabilities, 2002 Balance of Liabilities, 2003.

1-44

y. $2,000 Cash Receipts from Stock Issue = $2,000 Stock Issued from Statement of Changes in Stockholders’ Equity.

z. $300 Cash Payment for Dividends = $300 Dividends from Statement of Changes in Stockholders’ Equity.

1-45

PROBLEM 1-32A

Event No. Type of Event Effect on Total Assets

1. Asset Source Increase2. Asset Use Decrease3. Asset Exchange No Effect4. Asset Source Increase5. Asset Exchange No Effect6. NA NA7. Asset Source Increase8. Asset Source Increase9. Asset Use Decrease10. Asset Use Decrease11. Asset Use Decrease12. Asset Source Increase13. NA NA14. Asset Use Decrease15. Asset Exchange No Effect

1-46

PROBLEM 1-33A

The growth in earnings between two years is measured as follows:

Alternative year earnings Base year earnings Base year earnings

a. 2000 to 2001 2001 to 2002Advantage, Inc.: ($4.13 $4.22) = 2.13% ($4.18 $4.13) = 1.21%

4.22 4.13

Hi-Lite, Inc. ($4.19 $3.27) = 28.13% ($5.81 $4.19) = 38.66% 3.27 4.19

b. PE Ratio: Market price per share Earnings per share

Advantage, Inc. 2000: $50.64 $4.22 = 122001: $45.43 $4.13 = 112002: $45.98 $4.18 = 11

Hi-Lite, Inc. 2000: $98.10 $3.27 = 302001: $129.89 $4.19 = 312002: $220.78 $5.81 = 38

c. The price-earnings ratio is the most commonly reported

measure of a company’s value. It indicates how many years it will take for an investor to recover his investment through a company’s earnings, assuming EPS and market price remain constant.

d. A different price-earnings ratio is caused by different growth expectations of two different companies.

1-47

SOLUTIONS TO EXERCISES - SERIES B -CHAPTER 1

EXERCISE 1-1Ba. Elements of Financial Statements:

1. assets2. liabilities3. equity4. common stock (contributed capital, owners’ capital,

partners’ equity)5. revenue6. expenses7. distributions (withdrawals, dividends)8. net income (net profit; net earnings)

b.Element Financial Statement(s)

assets Balance Sheetliabilities Balance Sheetequity Balance Sheet; Statement of

Changes in Stockholders’ Equitycommon stock Balance Sheet; Statement of

Changes in Stockholders’ Equityrevenue Income Statementexpenses Income Statementdistributions Statement of Changes in

Stockholders’ Equitynet income Income Statement; Statement of

Changes in Stockholders’ Equity

EXERCISE 1-2B

The three types of resources available to conversion agents are:

1. Financial resources2. Physical resources3. Labor resources

1-48

A memo is required and should include a discussion of the role resource owners play in the market and the profit expected from providing resources.

1-49

EXERCISE 1-3B

a.Jackson Camping Supplies

Accounting Equation

Claims

Assets=

Liabilities +Stockholders

’ Equity$8,500 = $5,300 + $3,200

Liabilities $5,300 ($8,500 $3,200)Claims $5,300 + $3,200 = $8,500

b.Betty’s Snow ConesAccounting Equation

Claims

Assets = Liabilities +Stockholders

’ Equity6,800 = 2,400 + 4,400

Assets $6,800 ($2,400 + $4,400)Net Assets = Assets Liabilities $6,800 $2,400=

$4,400or Net Assets = Total Stockholders’ Equity $4,400

c. Petrello Company

Accounting Equation

Claims

Assets = Liabilities +Stockholders

’ Equity98,300 = 56,200 + 42,100

Stockholders’ Equity $42,100 ($98,300 $56,200)

1-50

Residual interest is equal to stockholders’ equity $42,100

1-51

EXERCISE 1-4B

a. Investors put assets into the company with the expectation of sharing profits. Creditors lend assets to the company with the expectation of repayment of the principal plus interest on the loan.

b. Clark Company

Accounting EquationEvent Assets = Liabilitie

s + Stockholders’

Equity

CashNotes

PayableCommon Stock

Retained Earnings

Acquired assets

$1,700 $800 $900

Incurred loss (600) (600)Balance $1,100 = $800 + $900 $(600)

The cash balance of $1,100 will be distributed first to the creditors. Since creditors are owed $800 and there are sufficient funds to pay them, the creditors will receive the $800 that they are owed.

c. The stockholders will receive the remaining $300 cash that remains after the creditors are paid. ($1,100 $800 = $300)

1-52

EXERCISE 1-5B

Olive EnterprisesAccounting Equation

Stockholders’Equity

Event Number Assets = Liabilities +

Common Stock

Retained

Earnings1. I NA I NA2. D D NA NA3. I/D(NA) NA NA NA4. I NA NA I5. D NA NA D6. D NA NA D

1-53

EXERCISE 1-6B

Lourens Auto RepairHorizontal Statements Model for 2007



Revenue

Expense

= Net Inc.

Cash Flows

Event No.


e+

Common Stock +

Retained

Earnings

1 D + I = NA + NA + NA NA NA = NA D IA2 I + NA = NA + I + NA NA NA = NA I FA3 I + NA = NA + NA + I I NA = I I OA4 D + NA = NA + NA + D NA NA = NA D FA5 D + NA = NA + NA + D NA I = D D OA6 D + NA = D + NA + NA NA NA = NA D FA

1-54

EXERCISE 1-7B

1. Balance Sheet2. Statement of Changes in Stockholders’ Equity3. Statement of Cash Flows

EXERCISE 1-8B

1. Balance Sheet2. Statement of Cash Flows

1-55

EXERCISE 1-9Ba.

Kim CompanyAccounting Equation for 2004



Common

Retained

Event Cash = + Stock + Earnings

Cash revenue 12,500 NA NA 12,500Paid expense (8,600) NA NA (8,600)Paid dividend (1,000) NA NA (1,000)Ending Balance 2,900 = -0- + -0 + 2,900

b.Kim Company



Kim CompanyBalance Sheet


AssetsCash $2,900

Liabilities $ -0-

Stockholders’ EquityCommon Stock $ -0-Retained Earnings 2,900



$2,900

1-56

c. The balances will be zero; they have been closed to retained earnings.

1-57

EXERCISE 1-10B

a.Eaton Boat Repairs



Assets = Liab. + Stockholders’ Equity Revenue Expense

= Net Inc.

Cash Flows

Event No.

Cash =Notes

Payable +Common Stock +

Retained

Earnings1 9,000 = NA + 9,000 + NA NA NA = NA 9,000 FA2 22,000 = NA + NA + 22,000 22,000 NA = 22,000 22,000 OA3 (12,800) = NA + NA + (12,800) NA 12,800 = (12,800

)(12,800) OA

4 (800) = NA + NA + (800) NA NA = NA (800) FA17,400 = -0- + 9,000 + 8,400 22,000 12,800 = 9,200 17,400 NC

b. Cash is increased by the issue of common stock, $9,000, and decreased by dividends, $800. Neither of these amounts is used in the computation of net income.

1-58

EXERCISE 1-11B

Event Statement of Cash Flows Classification

a. FAb. OAc. NAd. OAe. IAf. OAg. IAh. FAi. FAj. FA

1-59

EXERCISE 1-12Ba.

Pete’s Pest ControlAccounting Equation for 2001




e+

Com.Stock +

Retained Earnings

Acct. Title/RE

Bal. 1/1/01 15,000 20,000

15,000 7,000 13,000

1. Pur. Land (5,000) 5,000 NA NA NA NA2. Issued stk.

25,000 NA NA 25,000 NA NA

3. Provide Svc.


4. Paid Exp. (42,000)

NA NA NA (42,000)

Oper. Exp.

5. Loan 10,000 NA 10,000 NA NA NA6. Paid Div. (2,500) NA NA NA (2,500) Dividend

Totals 65,500 + 25,000

=25,000 + 32,000 + 33,500

b. Net Cash Flow from Financing Activities:Issue of Stock $25,000Borrowed Cash 10,000Paid Dividend (2,500)Net Cash Flow from Financing Activities

$32,500

c. The balance in the Retained Earnings account will be $33,500. The revenue, expense and dividends accounts will have a zero balance; they are temporary accounts and have been closed to Retained Earnings.

1-60

EXERCISE 1-13Ba.

J & A, Inc.Accounting Equation for 2004




e+

Com.Stock +

Retained

Earnings

Acct. Title/

RE

Bal. 1/1/2004

12,000 20,000

-0- 15,000 17,000

1. Issued stk.

55,000 NA NA 55,000 NA NA

2.Pur. Land (15,000)

15,000

NA NA NA NA

3. Loan 5,000 NA 5,000 NA NA NA4. Provide Svc.

21,000 NA NA NA 21,000 Svc. Rev.

5. Paid Utilities

(1,500) NA NA NA (1,500) Util. Exp.

6. Pd. Op. Exp.

(11,000)

NA NA NA (11,000)

Oper. Exp.

7. Paid Div. (2,000) NA NA NA (2,000) Dividends

Totals 63,500 + 35,000

= 5,000 +70,000 + 23,500

b.

J & A, Inc.Income Statement


Service Revenue $21,000Utilities Expense (1,500)Other Operating Expenses (11,000)Net Income $ 8,500

1-61

EXERCISE 1-13B b. (cont.)

J & A, Inc.Statement of Changes in Stockholders’ Equity



55,000



17,000



$93,500

J & A, Inc.Balance Sheet


AssetsCash $63,500Land 35,000

Total Assets $98,500

LiabilitiesNotes Payable $5,000

Total Liabilities $ 5,000



Total Liabilities and Stockholders’ $98,500

1-62

Equity

1-63

EXERCISE 1-13B b. (cont.)

J & A, Inc.Statement of Cash Flows



Cash Receipts from Revenue $21,000Cash Payment for Utilities

Expense(1,500)

Cash Payments for Other Operating Exp.

(11,000)


$ 8,500


Cash Paid to Purchase Land (15,000)Net Cash Flow from Investing Activities

(15,000)


Cash Receipts from Stock Issue 55,000Cash Receipts from Loan 5,000Cash Payments for Dividends (2,000)


58,000

Net Increase in Cash 51,500Plus: Beginning Cash Balance 12,000Ending Cash Balance $63,500

c. Balances in revenue, expense and distributions accounts will be zero because they will have been closed to retained earnings.

1-64

EXERCISE 1-14Ba.

Computer Software ServicesHorizontal Statements Model for 2006



Revenue

Expense

= Net Inc.

Cash Flows

Event No.


e+

Common Stock +

Retained

Earnings

1 20,000 + NA = NA + 20,000 + NA NA NA = NA 20,000 FA2 (5,000) + 5,000 = NA + NA + NA NA NA = NA (5,000) IA3 32,000 + NA = NA + NA + 32,000 32,000 NA =32,000 32,000 OA4 (12,500

)+ NA = NA + NA + (12,500

)NA 12,500 = (12,50

0)(12,500)OA

5. 4,000 + NA = NA + 4,000 + NA NA NA = NA 4,000 FA6. 15,000 + NA = 15,000 + NA + NA NA NA = NA 15,000 FA7. (15,000

)+ 15,000 = NA + NA + NA NA NA = NA (15,000)IA

8. (14,000)

+ NA = NA + NA + (14,000)

NA 14,000 = (14,000)

(14,000)OA

9. (2,500) + NA = NA + NA + (2,500) NA NA = NA (2,500) FATota

l22,000 + 20,000 = 15,000 + 24,000 + 3,000 32,000 26,500 5,500 22,000 NC

b. Net Income for 2006: $5,500c. Total Assets at the end of 2006: $42,000 ($22,000 + $20,000)d. Net Cash Flow from Operating Activities for 2006:$5,500 (32,000 12,500

14,000).

1-65

e. Net Cash Flow from Investing Activities for 2006: $20,000 (5,000 + 15,000)f. Net Cash Flow from Financing Activities for 2006: $36,500 (20,000 + 4,000 +

15,000 2,500).g. Cash balance at December 31, 2006: $22,000

1-66

EXERCISE 1-15B

Title or Account Financial Statement(s)a. Retained Earnings Balance Sheet; Statement of

Changes in Stockholders’ Equityb. Revenue Income Statementc. Common Stock Balance Sheet; Statement of

Changes in Stockholders’ Equityd. Financing Activities Statement of Cash Flowse. Salaries Expense Income Statementf. Land Balance Sheetg. Ending Cash Balance Balance Sheet; Statement of Cash

Flowsh. Beginning Cash

BalanceStatement of Cash Flows

i. Notes Payable Balance Sheetj. Dividends Statement of Changes in


1-67

EXERCISE 1-16Ba.

Accounts to be Closed to Retained EarningsRevenue $5,500Expenses 2,000Dividends 900

b.Beginning Retained Earnings

$1,900

Add: Revenue 5,500Less: Expenses (2,000)Less: Dividends (900)Ending Retained Earnings

$4,500

c.Computation of Net IncomeRevenue $5,500Less: Expenses (2,000)Net Income $3,500

d. Net income is only the current year’s net income. Retained Earnings is an accumulation of net income over the life of the business less any dividends that have been paid over the years.

e. All will have a zero balance because they are temporary accounts and have been closed to retained earnings.

1-68

EXERCISE 1-17Ba.

Account Classification

1. Common Stock P2. Notes Payable P3. Cash P4. Service Revenue T5. Dividends T6. Land P7. Salaries Expense T8. Retained Earnings P9. Utilities Expense T10. Interest Revenue T

b. The accounting cycle is divided into one year accounting periods. Using the accounting cycle rationale, experience is gained one year at a time. But experience is like the balance sheet, it accumulates and one year adds to another. You do not start over at the beginning of each year when working at the same job.

1-69

EXERCISE 1-18B

Event Classification1. Asset Source2. Asset Use3. Asset Source4. Asset Exchange5. Asset Source6. Asset Source7. Asset Use8. Asset Use9. Asset Source10. Asset Exchange

1-70

EXERCISE 1-19Ba.

Event1. Asset Source2. Asset Exchange3. Asset Source4. NA5. Asset Use6. Asset Use

b.Computer Parts




Revenue

Expense

= Net Inc.

Cash Flows

Event No.

Cash + Land =Notes

Payable

+Com.Stock +

RetainedEarnings

1 I + NA = NA + I + NA NA NA = NA I FA2 D + I = NA + NA + NA NA NA = NA D IA3 I + NA = I + NA + NA NA NA = NA I FA4 NA + NA = NA + NA + NA NA NA = NA NA5 D + NA = NA + NA + D NA NA = NA D FA6 D + NA = NA + NA + D NA I = D D OA

1-71

1-72

EXERCISE 1-20B

a. Jackling Company: Asset Exchange

b. Power Company: Asset Exchangec. Jackling Company: Investing

Activityd. Power Company: Investing

Activity

EXERCISE 1-21B

Accounting Equation

Stockholders’ EquityCommon Retained

Company

Assets = Liabilities + Stock + Earnings

A 98,000 = 25,000 + 48,000 + 25,000B 50,000 = 5,000 + 15,000 + 30,000C 75,000 = 20,000 + 13,000 + 42,000D 125,000 = 45,000 + 75,000 + 5,000

1-73

EXERCISE 1-22B

a. December 31, 2004Assets = Liabilities + Common Stock +Retained Earnings

$132,000 = $12,700 + $45,000 + $74,300

Or: $132,000 $45,000 $74,300 = $12,700.

b. December 31, 2005Revenue Expenses = Net Income$42,000 $21,500 = $20,500

c. Assets, January 1, 2004 $132,000Less: Debt Reduction, 2005 (5,000)Plus: 2005 Net Income 20,500Less: 2005 Dividends (600)Assets, December 31, 2005 $146,900

d. Liabilities, January 1, 2004$12,700Paid on debt (5,000 ) Liabilities, December 31, 2004 $ 7,700

1-74

EXERCISE 1-23BSteps:

1.Change in Stk. Equity = Change in Com. Stk. + Change in Retained Earn.$46,500 (given) = $15,000 (given) + $31,500

2.Increase in Ret. Earn. = Net Income Dividends$31,500 (1) = $36,500 $5,000 (given)

3.Net Income = Revenue Expenses$36,500 (2) = $58,500 $22,000 (given)

Alternate Solution:Working backwards from the change in equity we can solve for total revenue:

Computation of Total Revenues:Increase in Retained Earnings $31,500Plus: Dividends (given) 5,000Plus: Expenses (given) 22,000Total Revenues $58,500

or : Net Income + Expenses = Total Revenues$36,500 $22,000 = $58,500

1-75

EXERCISE 1-24Ba.

Price Earnings RatioARC Company Pager Company

46.5 .85 = 54.71 75.4 2.25 = 33.51

b. You would expect that ARC Company would have the greatest earnings potential because it has the highest PE ratio.

1-76

SOLUTIONS TO PROBLEMS - SERIES B - CHAPTER 1

PROBLEM 1-25Ba.

Belzio CompanyHorizontal Statements Model for 2006



Revenue

Expense

= Net Inc.

Cash Flows

Event No.


e+

Common Stock +

Retained

Earnings

1 D + NA = NA + NA + D NA NA = NA D FA2 I + NA = NA + I + NA NA NA = NA I FA3 NA + NA = NA + NA + NA NA NA = NA NA4 I + NA = NA + NA + I I NA = I I OA5 D + NA = NA + NA + D NA I = D D OA6 I D NA NA NA NA NA NA I IA7 I + NA = I + NA + NA NA NA = NA I FA

1-77

PROBLEM 1-26Ba.

Foreman CompanyHorizontal Statements Model for 2003



Revenue

Expense

= Net Inc.

Cash Flows

Event No.


e+

Common Stock +

Retained

Earnings

1 32,000 + NA = NA + 32,000 + NA NA NA = NA 32,000 FA2 20,000 + NA = 20,000 + NA + NA NA NA = NA 20,000 FA3 42,000 + NA = NA + NA + 42,000 42,000 NA =42,000 42,000 OA4 (28,000

)+ NA = NA + NA + (28,000

)NA 28,000 = (28,00

0)(28,000)

OA5. (6,000) + NA = NA + NA + (6,000) NA NA = NA (6,000) FA6. 10,000 + NA = NA + 10,000 + NA NA NA = NA 10,000 FA7. (15,000

)+ NA = (15,00

0)+ NA + NA NA NA = NA (15,000)

FA8. (45,000

)+ 45,000 = NA + NA + NA NA NA = NA (45,000)

IATota

l10,000 + 45,000 = 5,000 + 42,000 + 8,000 42,000 28,000 14,000 10,000 NC

b. Total Assets = $10,000 + $45,000 = $55,000

c.Sources of Assets

1. Issue of stock $ 32,000

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2. Cash from loan 20,0003. Cash from revenue 42,0006. Issue of stock 10,000Total Sources of Assets $104,000

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PROBLEM 1-26B (cont.)

d. Net income amounts to $14,000 (see part a.) Dividends are not expenses and do not appear on the income statement.

e.Operating Activities:Cash from revenue $42,000Cash paid for expenses (28,000)Net Cash Flow from Operating Activities

$14,000

Financing Activities:Cash from stock issue ($32,000 + $10,000)

$42,000

Cash from loan 20,000Paid cash dividend (6,000)Cash paid on loan principal (15,000)Net Cash Flow from Financing Activities

$41,000

Investing Activities:Cash paid to purchase land $(45,000

)Net Cash Flow from Investing Activities

$(45,000)

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EXERCISE 1-27Ba.

Jim’s Janitorial ServicesAccounting Equation for 2001




e+

Com. Stock +

Retained Earnings

Acct. Title/RE

1. Issued stk

60,000 NA NA 60,000 NA NA

2. Revenue

100,000 NA NA NA 100,000

Revenue

3. Loan 25,000 NA 25,000 NA NA NA4. Paid Exp.

(70,000) NA NA NA (70,000)

Oper. Exp.

5. Pur. Land

(40,000) 40,000

NA NA NA NA

Totals 75,000 + 40,000

= 25,000 +60,000 + 30,000

Jim’s Janitorial ServicesAccounting Equation for 2002




e+

Com.Stock +

Retained Earnings

Acct. Title/RE

Beg. Bal. 75,000 40,000

25,000 60,000 30,000

1. Issued stk

20,000 NA NA 20,000 NA NA

2. Revenue

120,000 NA NA NA 120,000

Revenue

3. Paid Loan

(10,000) NA (10,000)

NA NA NA

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4. Paid Exp.

(80,000) NA NA NA (80,000)

Oper. Exp.

5. Paid Div.

(15,000) NA NA NA (15,000)

Dividends

Totals 110,000 + 40,000

= 15,000 +80,000 + 55,000

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PROBLEM 1-27B (cont.)b.

Jim’s Janitorial Services

Income Statements

2001 2002

Revenue $100,000 $120,000

Expense (70,000) (80,000)Net Income $ 30,000 $ 40,000

Statements of Changes in Stockholders’ Equity

Beginning Common Stock $ -0- $ 60,000Plus: Common Stock Issued 60,000 20,000Ending Common Stock 60,000 80,000

Beginning Retained Earnings -0- 30,000Plus: Net Income 30,000 40,000Less: Dividends -0- (15,000)Ending Retained Earnings 30,000 55,000Total Stockholders’ Equity $ 90,000 $

135,000

Balance Sheets

Assets Cash $ 75,000 $

110,000 Land 40,000 40,000Total Assets $115,000 $

150,000

Liabilities $ 25,000 $ 15,000

Stockholders’ Equity Common Stock 60,000 80,000 Retained Earnings 30,000 55,000Total Stockholders’ Equity 90,000 135,000Total Liabilities and Stockholders’ $115,000

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Equity$150,000

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PROBLEM 1-27B b. (cont.)

Jim’s Janitorial Services


2001 2002Cash Flows From Operating Activities: Cash Receipts from Revenue $100,000 $120,000 Cash Payments for Expenses (70,000) (80,000)Net Cash Flow from Operating Activities

30,000 40,000

Cash Flows From Investing Activities: Cash Payment for Land (40,000) -0-Net Cash Flow from Investing Activities

(40,000) -0-

Cash Flows From Financing Activities: Cash Receipts from Borrowed Funds

25,000 -0-

Cash Payment of Debt -0- (10,000) Cash Receipts from Stock Issue 60,000 20,000 Cash Payment for Dividends -0- (15,000)Net Cash Flow from Financing Activities

85,000 (5,000)

Net Change in Cash 75,000 35,000Plus: Beginning Cash Balance -0- 75,000Ending Cash Balance $ 75,000 $110,000

c. In 2001 and 2002 net income and cash flows from operating activities are the same because all revenues and expenses are cash. Ordinarily, net income will be different from cash flows from operating activities due to non-cash revenue and expense transactions (discussed in Chapter 2). The net change in cash is different from net income because

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investing and financing activities do not directly affect revenues or expenses.

d. $40,000 (2002) $30,000 (2001) (2001) $30,000 = 33% growth. This is a high growth company.

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PROBLEM 1-28B

Best Electronics Accounting Equation


Common

Retained

Event Assets = Liabilities

+ Stock + Earnings

Beginning Balances 10,000 = 2,200 + 3,2501 + 4,5501. Paid Expense (5,010) (5,010)3. Paid Dividend (625) (625)4. Paid Liability (1,000) (1,000)5. Issued Stock 2,000 2,0006. Revenue* 9,200 9,2002

Ending Balance 14,565 = 1,200 + 5,250 + 8,115

1Assets Liabilities Retained Earnings = Common Stock:$10,000 $2,200 $4,550 = $3,250

2Increase in Retained Earnings:$3,565 Add: Expenses 5,010 Add: Dividends 625 Revenue $9,200

Best ElectronicsIncome Statement

For the Year Ended December 31, 20--


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Best ElectronicsStatement of Changes in Stockholders’ Equity



2,000

Ending Common Stock $ 5,250


4,550

Plus: Net Income 4,190Less: Dividends (625)Ending Retained Earnings 8,115


$13,365

Best ElectronicsBalance Sheet

As of December 31, 20--

Assets $14,565

Liabilities $ 1,200

Stockholders’ EquityCommon Stock $ 5,250Retained Earnings 8,115



$14,565

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Best ElectronicsStatement of Cash Flows



Cash Receipt from Revenue $9,200Cash Payment for Expense (5,010)


$ 4,190


-0-


Cash Receipts from Stock Issue 2,000Cash Payment to Creditors (1,000)Cash Dividend Paid to

Stockholders(625)


375

Net Increase in Cash 4,565Plus: Beginning Cash Balance* 10,000Ending Cash Balance $14,565

*Assumes all assets are cash.

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PROBLEM 1-29B

Components of Financial Statements

Income Statement

Statement of Changes

in Stockholders’ Equity

Balance Sheet

Statement of Cash Flows

1. Retained EarningsEnding Balance

2. Revenues 3. Common Stock

Beginning Balance

4. Common StockEnding Balance

5. Assets 6. Expenses 7. Operating Activities

8. Dividends 9. Retained Earnings

Beginning Balance

10.Investing Activities

11. Common stockissued this period

12.Liabilities 13.Financing Activities

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PROBLEM 1-30Ba.

Accounts to be Closed:Consulting RevenueTravel ExpenseDividends Rent ExpenseSalary ExpenseOther Operating

Expensesb.

Peaks View CompanyIncome Statement


Consulting Revenue $14,500

ExpensesTravel Expense $1,100Rent Expense 1,800Salary Expense 6,900Other Operating

Expenses2,200

Total Expenses (12,000)

Net Income $2,500

c.Computation of Retained Earnings:


$19,000

Add: Net Income 2,500Less: Dividends (3,000)Ending Retained Earnings

$18,500

Since this is not the first year of operations for the company, Peaks View can pay dividends out of both this year’s profits and previous years’ profits.

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d. Accounting Cycle: Record transactions, prepare financial statements, and close the temporary accounts.

PROBLEM 1-31B

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FOR THE YEARS 2001 2002 2003

Income StatementsRevenue (cash) $ 400 $ 500 $ 800Expense (cash) (250) (l) (400) (425)Net Income (Loss) (a) $150 $ 100 $ 375

Statements of Changes in Stockholders’ EquityBeginning Common Stock $ -0- (m)

$8,000$9,100

Plus: Stock Issued (b) 8,000 1,100 310Ending Common Stock 8,000 9,100 (s)

9,410


-0- 25 75

Plus: Net Income (Loss) (c) 150 100 375Less: Dividends (d) (125) (50) (150)

Ending Retained Earnings 25 (n) 75 300Total Stockholders’ Equity (e)

$8,025$9,175 (t)

$9,710

Balance SheetsAssetsCash (f)

$11,000(o) $ 6,650

(u)$8,050

Land -0- (p) 5,000 2,500Total Assets $11,000 $11,650 $10,550

Liabilities (g) $ 2,975

(q) $ 2,475

$ 840

Stockholders’ EquityCommon Stock (h) 8,000 (r) 9,100 9,410Retained Earnings (i) 25 75 300

Total Stockholders’ Equity 8,025 9,175 9,710Total Liabilities and Stk. Equity

$11,000 $11,650 $10,550

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FOR THE YEARS 2001 2002 2003


Cash Flows From Oper. Activities: Cash Receipts from Revenue

(j)$ 400

$ 500 (v) $ 800

Cash Payments for Expenses

(k)(250) (400) (w) (425)

Net Cash Flow from Oper. Act.

150 100 375

Cash Flows From Invest. Activities: Cash Payments for Land -0- (5,000) -0-

Cash Receipt from Sale of Land

-0- -0- 2,500

Net Cash Flow from Invest. Act.

-0- (5,000) 2,500

Cash Flows From Fin. Activities: Cash Receipts from Creditors

2,975 -0- -0-

Cash Payments to Reduce Debt

-0- (500) (x)(1,635)

Cash Receipts from Stock Issue

8,000 1,100 (y) 310

Cash Payments for Dividends

(125) (50) (z) (150)

Net Cash Flow from Fin. Activities

10,850 550 (1,475)

Net Change in Cash 11,000 (4,350) 1,400Plus: Beginning Cash Balance -0- 11,000 6,650Ending Cash Balance $11,000 $ 6,650 $ 8,050

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PROBLEM 1-31B (cont.)Computations of amounts:a. $150 Net Income = $400 $250 Expenses.b. $8,000 Common Stock Issued = $8,000 Ending Common Stock $-0- Beginning

Common Stock.c. $150 Net Income = $150 Net Income from Income Statement.d. $125 Dividends = $-0- Beginning Retained Earnings + $150 Net

Income $25 Ending Retained Earnings.e. $8,025 Total Stockholders’ Equity = $8,000 Ending Common Stock +

$25 Ending Retained Earnings.f. $11,000 Cash = $11,000 Total Assets $-0- Land.g. $2,975 Liabilities = $11,000 Total Liabilities and Stockholders’ Equity

$8,025 Total Stockholders’ Equity.h. $8,000 Common Stock = $8,000 Ending Common Stock from

Statement of Changes in Stockholders’ Equity.i. $25 Retained Earnings = $25 Ending Retained Earnings from

Statement of Changes in Stockholders’ Equity.j. $400 Cash Receipts from Revenue = $400 Revenue from Income

Statement.k. $250 Cash Payments for Expense = $250 Expenses from Income

Statement.l. $400 Expenses = $500 Revenue $100 Net Income.m. $8,000 Beginning Common Stock = $8,000 Ending Common Stock

for 2001.n. $75 Ending Retained Earnings = $25 Beginning Retained Earnings +

$100 Net Income $50 Dividends.o. $6,650 Cash = $6,650 Ending Cash Balance from the Statement of

Cash Flows.p. $5,000 Land = $11,650 Total Assets $6,650 Cash.q. $2,475 Liabilities = $11,650 Total Liabilities and Stockholders’

$9,175 Total Stockholders’ Equity.r. $9,100 Common Stock = $9,100 Ending Common Stock from

Statement of Changes in Stockholders’ Equity.s. $9,140 Ending Common Stock = $9,100 Beginning Common Stock +

$310 Stock Issued.t. $9,710 Total Stockholders’ Equity = $9,410 Ending Common Stock +

$300 Ending Retained Earnings.u. $8,050 Cash = $10,550 Total Assets $2,500 Land.v. $800 Cash Receipts from Revenue = $800 Revenue from Income

Statement.w. $425 Cash Payments for Expenses = $425 Expenses from Income

Statement.x. $1,635 Cash Payments to Reduce Debt = $2,475 Liabilities Balance,

2002 $840 Liabilities Balance, 2003.

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y. $310 Cash Receipts from Stock Issued = $310 Stock Issued from Statement of Changes in Stockholders’ Equity.

z. $150 Cash Payments for Dividends = $150 Dividends from Statement of Changes in Stockholders’ Equity.

PROBLEM 1-32B

Event No. Type of Event Effect on Total Assets

1. Asset Source Increase2. Asset Source Increase3. Asset Use Decrease4. NA NA5. Asset Exchange No Effect6. Asset Use Decrease7. NA NA8. Asset Source Increase9. Asset Use Decrease10. Asset Use Decrease11. Asset Use Decrease12. Asset Exchange No Effect13. Asset Exchange No Effect14. Asset Use Decrease15. NA NA

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PROBLEM 1-33B

The growth of earnings between two years is measured as follows:

Alternative year earnings Base year earnings Base year earnings

a. Beta One, Inc:2004 to 2005 ($1.20 $1.19) $1.19 = .84% 2003 to 2004 ($1.19 $1.22) $1.22 = 2.46%

b. Beta One, Inc. is a low growth company.

c. PE Ratio: Market price per share Earnings per share

Beta One, Inc. 2003: $85.40 $1.22 = 702004: $84.49 $1.19 = 712005: $87.60 $1.20 = 73

d. Beta One, Inc. is high growth company.

e. The price per share reflects future profits of the company. The market expects the profitable results in the future.

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ATC 1-1

a. $2,177,000,000.

b. 2001's net income is approximately 31% higher than that of 2000.

STOCKHOLDERS’c. ASSETS = LIABILITIES + EQUITY

$13,435,000,000 = $7,813,000,000 + $5,622,000,000

d. Net revenue increased by 26.2%Cost of revenue increased by 26.9%Total operating expenses increased by 27.9%

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ATC 1-2a.Income Statements (amounts given are in millions)

1999 1998 1997 1996

Revenue $ 661 (a)$1,307

(a)$1,930

$ 894

Cost and Expenses (a) (654) (1,133) (1,859) (769)Income from Cont. Op. (b) 7 174 71 (a) 125Unusual Items -0- 218 (b) 24 (b) 52Net Income $ 7 (b) $

392$ 47 $ 177

Balance SheetsCash and Marketable Sec.

$ 249 $1,247 (c) $ 419

$ 419

Other Assets 1,661 (c)1,657 1,226 (c) 999Total Assets $1,910 $2,904 (d)

$1,906$1,418

Liabilities (c)$ 848 (d)$1,562

$ 907 (d) $ 378

Stockholders’ EquityCommon Stock 422 356 (e) 315 313Retained Earnings (d) 986 (e) 986 684 (e) 727


1,062 1,342 (f) 999 1,040

Total Liab. and Stk. Equity

(f)$1,910

(f)2,904 $1,906 $1,418

c. Some examples of events that may have caused the unusual items are discontinued items, change in accounting principle, or extraordinary item.

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ATC 1-3

REAL WORLD CASE Deciding Which Company is the Best Investment

_______________Annual Growth Rates_______________

Company 2000 1999 1998

Average of

Averages

Total Growth Over 3 Years

Autozone

$267,590 $244,783 $244,783 =9.3%

$244,783 $227,903 $227,903 =7.4%

$227,903 $195,00 8 $195,008 =16.9%

11.2% 37.2% (1)

H&R Block

$251,895 $215,366 $215,366 =17.0%

$215,366 $392,130 $392,130 =45.1%

$392,130 $47,755 $ 47,755 =721.1%

231% 427.5%(2)

Intuit $305,661 $386,564 $386,564 =20.9%

$386,564 $6,182 $ 6,182 =6,153%

$ 6,182 $68,308 $68,308 =90.9% 2,013.7

%347.5%(3)

Kohl’s $258,142 $192,266 $192,266 =34.3%

$192,266 $141,273 $141,273 =36.1%

$141,273 $102,47 8 $102,478 =37.9%

36.1% 151.9%(4)

(1) ($267,590 $195,008) 195,008 = 37.2% (2) ($251,895 $47,755) $47,755 = 427.5%

(3) ($305.661 $68,308) $68,308 = 347.5%

(4) ($258,142 $102,478) $102,478 = 151.9%

This case can be used to discuss the problems with averages. Based on the “average of the averages,” Intuit seems the best, but this is distorted by the high growth rate in 1999 that was mostly the result of a bad year in 1998. By comparison, based on the “total growth rate over 3 years,” H&R Block looks best.

Of course no one can be sure which company will be the best or worst investment opportunity, but the data suggest an argument can be made that Kohl’s will be the best. Even though Intuit and H&R Block had the highest growth rates over the past 3 years, their annual performance was erratic. Kohl’s annual growth rate has been very consistent. Many students will instinctively appreciate the desirability of consistency over volatility.

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The authors would argue that Intuit is the worst investment opportunity. Even though its total growth rate seems rather high, it had negative growth rate in two of the past 3 years.

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ACT 1-3 (cont.)

The requirement asking students to predict earnings for 2008, which is eight years in the future, is primarily intended to force them to consider how difficult such a task is. Given the rather consistent growth rates of Autozone and Kohl’s, their average growth rates might be used to make a prediction, However, students may forget to compound the growth rate over the eight years, so this is another financial analysis issue that can be discussed.

Starting with the net earnings of 2000, and using the average growth rates of 11.2% for Autozone and 36.1 % for Kohl’s, and compounding annually, the predictions for 2008 would be $625,616 and $3,038,598, respectively.

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ATC 1-4

a. The percentage growth from 2001 to 2002 was 67% ($80,000 $120,000). However, this rate of growth will probably not continue from 2002 to 2003 because 77.5% ($62,000 $80,000) of the growth was from the lottery win. If the company continues to grow at the current rate, shareholders should expect an increase in net income of approximately 15%. This is the increase in net income from continuing operations ($18,000 $120,000 = 15%).

b. One could assume that the $200,000 was used to pay off liabilities since the total liabilities were reduced by $200,000. Also, assets and common stock did not change.

c. The percentage increase in net income from continuing operations was 15% (see a. above). Therefore, owners could expect net income to be $158,700 ($138,000 x 115%) in 2003.

d.Machine Imports Company

Income StatementFor Year Ended December 31, 2003

Revenue ($690,000 x 115%) $793,500

Operating Expenses ($552,000 x 115%)

(634,800)

Net Income from Continuing Operations

158,700

Extraordinary Loss (40,000)

Net Income $118,700

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ATC1-4 d. (cont.)

Machine Imports CompanyBalance Sheet


Assets $998,700

Liabilities $ -0-

Stockholders’ EquityCommon Stock $380,000Retained Earnings ($500,000 +

$118,700)618,700



$998,700

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ATC 1-5

This problem is designed to test written communication skills. The memo should describe the balance sheet and the income statement. It should explain that the balance sheet is a statement of assets, liabilities, and stockholders’ equity at the date of the financial statement. The income statement gives the amount of revenues and expense for the designated period. The memo should also define each of the following terms:AssetsLiabilitiesStockholders’ EquityRevenueExpense Net Income

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ATC 1-6 a.Financial Statements

Income StatementRevenue $57,000Expense (40,000)Net Income $17,000

Statement of Changes in Stockholders’ EquityBeginning Common Stock $20,000Plus: Common Stock Issued 5,000Ending Common Stock 25,000

Beginning Retained Earnings 50,000Plus: Net Income 17,000Less: Dividends (2,000)Ending Retained Earnings 65,000

Total Stockholders’ Equity $90,000

Balance SheetAssets

Cash $90,000Total Assets $90,000


Total Stockholders’ Equity $90,000

Statement of Cash FlowsNet Cash Flow From Operating Activities:

Inflow from Customers $57,000Outflow for Expenses (40,000)

Net Cash Flow from Operating Activities 17,000

Net Cash Flow From Investing Activities -0-

Net Cash Flow From Financing Activities:Inflow from Stock Issue 5,000Outflow for Dividends (2,000)

Net Cash Flow from Financing Activities 3,000

Net Change in Cash $20,000Plus: Beginning Cash Balance 70,000Ending Cash Balance $90,000

ATC 1-6 (cont.)

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b. In the short-run replacing Jones would save $5,000 in cash expenses. Accordingly, net income, assets, stockholders’ equity, and cash flow from operating activities would increase. These effects can be confirmed by comparing the statements above (i.e., after effect of replacement) with those shown in the textbook (i.e., before effect of replacement). However, the long-run impact may be different depending on how other employees react to Jones’ replacement. If the replacement creates resentment and low morale among the remaining employees, then productivity and profitability may decline. In this case, the company may experience a negative impact rather than the expected positive effect. The best solution to this dilemma is avoidance. Jones’ salary should never have been permitted to rise above his value to the company. As future business managers, students should take heed of the perils of excessive generosity. Employees should be paid on a basis that is consistent with their contribution to the company’s profitability. The pain of corporate downsizing can be avoided if businesses do not oversize in the first place.

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Documents

Chapter 1 Solution of fundamental of financial accouting by EDMONDS (4th edition)