Financial Accounting: Tools for Business Decision Making, 7th Edition. Kimmel, Paul solutions manual and test bank

Financial Accounting: Tools for Business Decision Making, 7th Edition. Kimmel, Paul    solutions manual and test bank 

CHAPTER 2

A Further Look at Financial Statements

Learning Objectives

1.      Identify the sections of a classified balance sheet.

2.      Identify tools for analyzing financial statements and ratios for computing a company’s profitability.

3.      Explain the relationship between a retained earnings statement and a statement of
stockholders’ equity.

4.      Identify and compute ratios for analyzing a company’s liquidity and solvency using a
balance sheet.

5.      Use the statement of cash flows to evaluate solvency.

6.      Explain the meaning of generally accepted accounting principles.

7.      Discuss financial reporting concepts.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy

Item	LO	BT	Item	LO	BT	Item	LO	BT	Item	LO	BT	Item	LO	BT
Questions
1.	1	K	6.	2, 4, 5	C	10.	4, 5	K	14.	7	C	18.	7	C
2.	1	K	7.	2, 4, 5	K	11.	2, 4, 5	C	15.	7	C	19.	7	C
3.	1	C	8.	4	C	12.	6	K	16.	7	C	20.	1	C
4.	1	C	9.	4, 5	C	13.	6, 7	K	17.	6	C
5.	1	K
Brief Exercises
1.	1	K	4.	3	K	7.	6	K	9.	7	K	11.	7	K
2.	1	AP	5.	4	AP	8.	7	K	10.	7	K
3.	2	AP	6.	4, 5	AP
Do It! Review Exercises
1.	1	AP	2.	1	AP	3.	4, 5	K	4.	7	K
Exercises
1.	1	AP	4.	1	AP	7.	2	AP	10.	4	AP	12.	7	K
2.	1	AP	5.	1	AP	8.	1, 3, 4	AP	11.	4, 5	AP	13.	7	C
3.	1	AP	6.	1	AP	9.	4	AP
Problems: Set A
1.	1	AP	3.	1, 3	AP	5.	2, 4, 5	AP	7.	2, 4, 5	AP	8.	6, 7	E
2.	1, 3	AP	4.	2, 4, 5	AN	6.	2, 4, 5	AP
Problems: Set B
1.	1	AP	3.	1, 3	AP	5.	2, 4, 5	AP	7.	2, 4, 5	AP	8.	6, 7	E
2.	1, 3	AP	4.	2, 4, 5	AN	6.	2, 4, 5	AP

ASSIGNMENT CHARACTERISTICS TABLE

Problem Number		Description		Difficulty Level		Time Allotted (min.)
1A		Prepare a classified balance sheet.		Simple		10–20
2A		Prepare financial statements.		Moderate		20–30
3A		Prepare financial statements.		Moderate		20–30
4A		Compute ratios; comment on relative profitability, liquidity, and solvency.		Moderate		20–30
5A		Compute and interpret liquidity, solvency, and profitability ratios.		Simple		10–20
6A		Compute and interpret liquidity, solvency, and profit- ability ratios.		Moderate		15–25
7A		Compute ratios and compare liquidity, solvency, and profitability for two companies.		Moderate		15–25
8A		Comment on the objectives and qualitative characteristics of financial reporting.		Simple		10–20
1B		Prepare a classified balance sheet.		Simple		10–20
2B		Prepare financial statements.		Moderate		20–30
3B		Prepare financial statements.		Moderate		20–30
4B		Compute ratios; comment on relative profitability, liquidity, and solvency.		Moderate		20–30
5B		Compute and interpret liquidity, solvency, and profitability ratios.		Simple		10–20
6B		Compute and interpret liquidity, solvency, and profit- ability ratios.		Moderate		15–25
7B		Compute ratios and compare liquidity, solvency, and profitability for two companies.		Moderate		15–25
8B		Comment on the objectives and qualitative characteristics of accounting information.		Simple		10–20

ANSWERS TO QUESTIONS

 1.     A company’s operating cycle is the average time that is required to go from cash to cash in prod-ucing revenue.

 2.     Current assets are assets that a company expects to convert to cash or use up within one year of the balance sheet date or the company’s operating cycle, whichever is longer. Current assets are listed in the order in which they are expected to be converted into cash.

 3.     Long-term investments are investments in stocks and bonds of other companies where the conversion into cash is not expected within one year or the operating cycle, whichever is longer and plant assets not currently in operational use. Property, plant, and equipment are tangible resources of a relatively permanent nature that are being used in the business and not intended for sale.

 4.     Current liabilities are obligations that will be paid within the coming year or operating cycle, whichever is longer. Long-term liabilities are obligations that will be paid after one year.

 5.     The two parts of stockholders’ equity and the purpose of each are: (1) Common stock is used to record investments of assets in the business by the owners (stockholders). (2) Retained earnings is used to record net income retained in the business.

 6.     (a)    Lorie is not correct. There are three characteristics: liquidity, profitability, and solvency.

          (b)    The three parties are not primarily interested in the same characteristics of a company. Short-term creditors are primarily interested in the liquidity of the company. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company.

 7.     (a)    Liquidity ratios:  Working capital and current ratio.

          (b)    Solvency ratios:  Debt to assets and free cash flow.

          (c)    Profitability ratio:  Earnings per share.

 8.     Debt financing is riskier than equity financing because debt must be repaid at specific points in time, whether the company is performing well or not. Thus, the higher the percentage of assets financed by debt, the riskier the company.

 9.     (a)    Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.

          (b)    Profitability ratios measure the income or operating success of a company for a given period of time.

          (c)    Solvency ratios measure the company’s ability to survive over a long period of time.

Questions Chapter 2 (Continued)

10.     (a)    The increase in earnings per share is good news because it means that profitability has improved.

          (b)    An increase in the current ratio signals good news because the company improved its ability to meet maturing short-term obligations.

          (c)    The increase in the debt to assets ratio is bad news because it means that the com­pany has increased its obligations to creditors and has lowered its equity “buffer.”

          (d)    A decrease in free cash flow is bad news because it means that the company has become less solvent. The higher the free cash flow, the more solvent the company.

11.     (a)    The debt to assets ratio and free cash flow indicate the company’s ability to repay the face value of the debt at maturity and make periodic interest payments.

          (b)    The current ratio and working capital indicate a company’s liquidity and short-term debt-paying ability.

          (c)    Earnings per share indicates the earning power (profitability) of an investment.

12.     (a)    Generally accepted accounting principles (GAAP) are a set of rules and practices, having substantial support, that are recognized as a general guide for financial reporting purposes.

          (b)    The body that provides authoritative support for GAAP is the Financial Accounting Standards Board (FASB).

13.     (a)    The primary objective of financial reporting is to provide information useful for decision making.

          (b)    The fundamental qualitative characteristics are relevance and faithful representation. The enhancing qualities are comparability, consistency, verifiability, timeliness, and understandability.

14.     Jantz is correct. Consistency means using the same accounting principles and accounting methods from period to period within a company. Without consistency in the application of accounting principles, it is difficult to determine whether a company is better off, worse off, or the same from period to period.

15.     Comparability results when different companies use the same accounting principles. Consistency means using the same accounting principles and methods from year to year within the same company.

16.     The cost constraint allows accounting standard-setters to weigh the cost that companies will incur to provide information against the benefit that financial statement users will gain from having the information available.

17.     Accounting standards are not uniform because individual countries have separate standard-setting bodies. Currently many non-U.S. countries are choosing to adopt International Financial Reporting Standards (IFRS). It appears that accounting standards in the United States will move toward compliance with IFRS.

Questions Chapter 2 (Continued)

18.     Accounting relies primarily on two measurement principles. Fair value is sometimes used when market price information is readily available. However, in many situations reliable market price information is not available. In these instances, accounting relies on historical cost as its basis.

19.     The economic entity assumption states that every economic entity can be separately identified and accounted for. This assumption requires that the activities of the entity be kept separate and distinct from (1) the activities of its owners (the shareholders) and (2) all other economic entities. A shareholder of a company charging personal living costs as expenses of the company is an example of a violation of the economic entity assumption.

20.     At December 31, 2011 Tootsie Roll’s largest current asset was Cash and Cash Equivalents of $78,612, its largest current liability is accrued liabilities of $43,069 and its largest item under other assets was trademarks of $175,024. (Note: amounts are in thousands)

CHAPTER 2

CHAPTER LEARNING OBJECTIVES

1.   Identify the sections of a classified balance sheet. In a classified balance sheet, companies classify assets as current assets; long-term investments; property, plant, and equipment; and intangibles. They classify liabilities as either current or long-term. A stockholders’ equity section shows common stock and retained earnings.

2.   Identify tools for analyzing financial statements and ratios for computing a company’s profitability. Ratio analysis expresses the relationship among selected items of financial statements data. Profitability ratios, such as earnings per share (EPS), measure aspects of the operating success of a company for a given period of time.

3.   Explain the relationship between a retained earnings statement and a statement of stockholders’ equity. The retained earnings statement presents the factors that changed the retained earnings balance during the period. A statement of stockholders’ equity presents the factors that changed stockholders’ equity during the period, including those that changed retained earnings. Thus, a statement of stockholders’ equity is more inclusive.

4.     Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet. Liquidity ratios, such as the current ratio, measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. Solvency ratios, such as the debt to assets ratio, measure the ability of a company to survive over a long period.

5.     Use the statement of cash flows to evaluate solvency. Free cash flow indicates a company’s ability to generate cash from operations that is sufficient to pay debts, acquire assets, and distribute dividends.

6.   Explain the meaning of generally accepted accounting principles. Generally accepted accounting principles are a set of rules and practices recognized as a general guide for financial reporting purposes. The basic objective of financial reporting is to provide information that is useful for decision making.

7.   Discuss financial reporting concepts. To be judged useful, information should have the primary characteristics of relevance and faithful representation. In addition, useful information is comparable, consistency, verifiable, timely, and understandable.

The monetary unit assumption requires that companies include in the accounting records only transaction data that can be expressed in terms of money. The economic entity assumption states that economic events can be identified with a particular unit of accountability. The periodicity assumption states that the economic life of a business can be divided into artificial time periods and that meaningful accounting reports can be prepared for each period. The going concern assumption states that the company will continue in operation long enough to carry out its existing objectives and commitments.

The historical cost principle states that the companies should record assets at their cost. The fair value principle indicates that assets and liabilities should be reported at fair value. The full disclosure principle requires that companies disclose circumstances and events that matter to financial statement users.

The cost constraint weighs the cost that companies incur to provide a type of information against its benefit to financial statement users.