Financial Accounting: The Impact on Decision Makers, 9th Edition solutions manual and test bank by Gary A. Porter | Curtis L. Norton
1. What is the primary objective of financial reporting?
a. To help investors make credit decisions.
b. To help management assess cash flows.
c. To protect users from fraudulent financial information.
d. To provide useful information for decision making
ANSWER: d
2. “Claims to economic resources” are known as
a. Assets and liabilities
b. Liabilities and stockholders’ equity
c. Owners’ equity and stockholders’ equity
d. Retained earnings and revenues
ANSWER: b
3. Which of the following is not an objective of financial reporting?
a. To reflect prospective cash receipts to investors and creditors.
b. To reflect prospective cash flows to an enterprise.
c. To reflect resources and claim to resources.
d. To reflect current stock prices and information concerning stock markets.
ANSWER: d
4. Which of the following statements is true concerning external users of financial information?
a. External users need detailed records of the business to make informed decisions.
b. External users are primarily responsible for the preparation of financial statements.
c. External users rely on the financial statements to help make informed decisions.
d. External users rely on management to tell them whether the company is a good investment
ANSWER: c
5. Relevant information can be quantitative or qualitative. In deciding whether to go to college part-time or full-time, which of the following is a qualitative factor for a student?
a. The cost of tuition
b. The opportunity to make friends
c. The price of football tickets
d. “Good Student” discounts on auto insurance rates.
ANSWER: b
6. The preparation of financial statements requires that the information be understandable
a. Only to CPAs.
b. To those willing to spend the time to understand it.
c. Only to those who take an accounting course.
d. Only to financial analysts and brokers.
ANSWER: b
7. Cook, Inc., a manufacturer of tires, has given you its most recent annual report in an effort to obtain a sizable loan. The company is very profitable and appears to have a sound financial position. Based on a report presented on prime-time television last night, you are aware that Cook is a defendant in several lawsuits related to its defective tires that cause vehicles to overturn. The information presented on television is an example of financial information that is
a. Relevant
b. Consistent
c. Predictable
d. Comparable
ANSWER: a
8. If an investor can use accounting information for two different companies to evaluate the types and amounts of expenses, the information is said to have the quality of
a. Comparability
b. Consistency
c. Neutrality
d. Understandability
ANSWER: a
9. Button Transportation purchases many pieces of office furniture with an individual cost below $200 each. Button chooses to account for these expenditures as expenses when acquired rather than reporting them as property, plant, and equipment on its balance sheet. The company's accountant and independent CPA agree that no accounting principle has been violated. What accounting justification allows Button to expense the furniture?
a. Conservatism
b. Matching
c. Materiality
d. Verifiability
ANSWER: c
10. Madden Company applies the consistency convention. What does this mean?
a. Madden Co. uses the same names for all its expenses as its competitors.
b. Madden Co. has selected certain accounting principles that can never be changed.
c. Madden Co. applies the same accounting principles each accounting period.
d. Madden Co. applies the same accounting principles as it competitors.
ANSWER: c
11. Information that is material means that an error or alternative method of handling a transaction
a. Would possibly affect the judgment of someone relying on the financial statements
b. Would not affect the decisions of users
c. Might cause a company to understate its earnings for the accounting period
d. Could increase the profitability of a company
ANSWER: a
12. An accountant is uncertain about the best estimate of an amount for a business transaction. If two amounts are about equally likely, the amount least likely to overstate assets and income is selected. Which of the following qualities is characterized by this action?
a. Comparability
b. Conservatism
c. Materiality
d. Neutrality
ANSWER: b
13. The qualitative characteristics of accounting data include
a. Assets reported on the balance sheet
b. All accounting information
c. Cash flows
d. Reliability
ANSWER: d
14. Which of the following is a noncurrent asset?
a. Inventories
b. Office supplies
c. Land
d. Accounts receivable
ANSWER: c
15. Which of the following is a current asset?
a. Land
b. Buildings
c. Store fixtures
d. Prepaid insurance
ANSWER: d
16. Which of the following include only current assets?
a. Accounts receivable, cash, inventory, office supplies
b. Cash, accounts payable, inventory, office supplies
c. Cash, land, accounts receivable, inventory
d. Accounts receivable, cash, furniture, office supplies
ANSWER: a
17. To determine the source of a company's assets, on which financial statement will you look?
a. Balance sheet only
b. Income statement only
c. Both the balance sheet and the income statement
d. Both the income statement and the statement of retained earnings
ANSWER: a
Moss Company
Moss Company has provided the following information from its accounting records for the current year:
| Cash | $ 55,000 | Accounts receivable | $ 45,000 |
| Inventory | 65,000 | Land | 75,000 |
| Accounts payable | 50,000 | Notes payable (due 2020) | 150,000 |
| Retained earnings | ? | Capital stock | 20,000 |
18. Read the information for Moss Corporation. What are Moss’ current assets?
a. $ 100,000
b. $ 165,000
c. $ 210,000
d. $ 240,000
ANSWER: b
RATIONALE: ($55,000 Cash + $45,000 Accounts Receivable + $65,000 Inventory = $165,000)
19. Read the information for Moss Company. What are Moss’ current liabilities?
a. $ 50,000
b. $ 125,000
c. $ 200,000
d. $ 230,000
ANSWER: a
RATIONALE: ($50,000 Accounts Payable)
20. Which one of the following items is reported as a current asset on a classified balance sheet?
a. Inventory
b. Accounts payable
c. Land
d. Common stock
ANSWER: a
21. The following information is given for Sego Company:
| Cash | $ 50,000 | Inventory | $ 45,000 |
| Land | 75,000 | Accumulated Depreciation | 40,000 |
| Plant & Equipment | 150,000 | Accounts Payable | 60,000 |
What are the company’s current assets?
a. $220,000
b. $155,000
c. $130,000
d. $95,000
ANSWER: d
RATIONALE: ($50,000 Cash + $45,000 Inventory = $95,000)
22. Which of the following accounts are normally reported as current liabilities on a classified balance sheet?
a. Accounts payable and bonds payable
b. Interest payable and mortgage payable
c. Income taxes payable and salaries payable
d. Capital stock and accounts payable
ANSWER: c
23. Which one of the following is not a major category for long-term assets?
a. Intangibles
b. Property, plant, and equipment
c. Receivables
d. Goodwill
ANSWER: c
24. Which of the following would not be considered to be an intangible asset?
a. Franchises
b. Copyrights
c. Investments
d. Goodwill
ANSWER: c
25. Which of the following statements is true concerning intangible assets?
a. Intangible assets have no economic substance.
b. Intangible assets lack physical existence.
c. Intangible assets are listed in the stockholders’ equity section of the balance sheet.
d. Intangible assets appear in the current assets section of the balance sheet.
ANSWER: b
26. How are assets which are expected to be realized in cash, sold, or consumed within the normal operating cycle of a business or within one year (if the operating cycle is shorter than one year) reported on a classified balance sheet?
a. Property, plant, and equipment
b. Current assets
c. Intangible assets
d. Current liabilities
ANSWER: b
27. Which of the following terms characterizes the time period between the investment of cash in merchandise and the collection of cash from the sale of that merchandise?
a. Operating cycle
b. Natural business year
c. Accounting period
d. Fiscal period
ANSWER: a
28. Which set of items below are current assets?
a. Accounts receivable, net income, inventory, and dividends
b. Cash, accounts receivable, capital stock, and sales
c. Net income, cash, office supplies, and inventory
d. Cash, accounts receivable, inventory, and office supplies
ANSWER: d
29. One significant difference between a classified and a non-classified balance sheet is the distinction between which of the following items?
a. Assets and liabilities
b. Current and noncurrent items
c. Liabilities and owners’ equity
d. Resources invested by the owners and amounts borrowed from creditors
ANSWER: b
30. For several years, Flame Corporation has had a current ratio that was consistent with other companies in its industry. For the most recent year, Flame’s current ratio was significantly higher than that for the industry. What is the best possible explanation for this situation?
a. The other companies in the industry were not as profitable.
b. Flame’s liquidity has improved or is not leveraging financial resources effectively.
c. Flame has less property, plant and equipment than other companies.
d. Flame has too much debt.
ANSWER: b
Guinther & Sons, Inc.
Guinther & Sons, Inc. a retailer of men’s clothing, earned a net profit of $77,000 for 2014. The balance sheet for Guinther & Sons includes the following items:
| Cash | $29,000 | Accounts receivable | $39,000 |
| Inventory | 79,000 | Prepaid insurance | 3,000 |
| Land | 90,000 | Accounts payable | 21,000 |
| Taxes payable | 29,000 | Capital stock | 50,000 |
| Retained earnings | 97,000 | Long-term notes payable | 43,000 |
31. Read the information for Guinther & Sons. Calculate the total amount of current assets for Guinther & Sons.
a. $ 100,000
b. $ 147,000
c. $ 150,000
d. $ 249,000
ANSWER: c
RATIONALE: ($29,000 Cash + $39,000 Accounts Receivable + $79,000 Inventory + $3,000 Prepaid Insurance = $150,000)
32. Read the information for Guinther & Sons, Inc. Calculate the current ratio for Guinther & Sons.
a. 2.58 to 1
b. 2.75 to 1
c. 3.00 to 1
d. 2.00 to 1
ANSWER: c
RATIONALE: ($29,000 Cash + $39,000 Accounts Receivable + $79,000 Inventory + $3,000 Prepaid Insurance) / ($21,000 Accounts Payable + $29,000 Taxes Payable) = 3.00 to 1
33. Read the information for Guinther & Sons, Inc. The average current ratio for stores such as Guinther & Sons is 2.4 to 1. What does this comparison tell you about its liquidity?
a. It is more liquid than its competitors.
b. It has more long-term assets than its competitors.
c. Since a rule of thumb for current ratios is 2 to 1, neither Guinther & Sons, Inc. nor its competitors is liquid.
d. Guinther & Sons, Inc. is more profitable than its competitors.
ANSWER: a
34. Lamar Company has total current assets of $122,000 and total current liabilities of $57,000. What is the amount of working capital for Lamar Company?
a. $ 57,000
b. $ 65,000
c. $ 122,000
d. $ 179,000
ANSWER: b
35. What is the correct method for calculating working capital?
a. Total Assets minus Total Liabilities
b. Current Assets minus Total Liabilities
c. Current Assets minus Current Liabilities
d. Current Assets plus Current Liabilities
ANSWER: c
36. Oreo Company has current assets of $20,000, current liabilities of $8,000, and long-term liabilities of $3,000. Oreo wants to buy new equipment. How much of its existing cash can Oreo use to acquire equipment without allowing its current ratio to decline below 2.0 to 1?
a. $ 4,000
b. $ 8,000
c. $ 10,000
d. $ 12,000
ANSWER: a
RATIONALE: ($16,000 / $8,000 = 2.0 to 1; $20,000 - $16,000 = $4,000)
37. Excursion Corp. increased its dollar amount of working capital over the past several years. To further evaluate the company's short-run liquidity, which one of the following measures should be used?
a. The current ratio
b. An analysis of the company’s longterm debt
c. An analysis of the return on stockholders’ equity
d. An analysis of retained earnings
ANSWER: a
38. Which financial statement reports information helpful in assessing working capital?
a. Income statement
b. Balance sheet
c. Statement of retained earnings
d. Statement of cash flows
ANSWER: b
39. Use Rizwi Corporation’s list of accounts at December 31, 2015 to answer the following question.
Rizwi Corporation
List of Accounts at December 31, 2015
| Cash | $30,000 | Accumulated depreciation | $ 12,000 |
| Merchandise inventory | 21,000 | Notes payable—Due 12/31/2022 | 120,000 |
| Land | 40,000 | Accounts payable | 14,000 |
| Buildings | 80,000 | Equipment | 33,000 |
| Accounts receivable | 25,000 | Notes Payable—Due 07/01/2016 | 24,000 |
What is Rizwi Corp.’s current ratio?
a. 0.48 to 1
b. 2.00 to 1
c. 2.55 to 1
d. 2.86 to 1
ANSWER: b
RATIONALE: ($30,000 Cash + $21,000 Merchandise Inventory + $25,000 Accounts Receivable) / ($14,000 Accounts Payable + $24,000 Notes Payable--Due 07/01/2015) = 2.00 to 1
40. If the current ratio is 2.5 to 1, net income is $6,000, and current liabilities are $18,000, how much is working capital? a. $ 6,000
b. $ 24,000
c. $ 27,000
d. $ 45,000
ANSWER: c
RATIONALE: ($18,000 Current Liabilities X 2.5 = $45,000 Current Assets; $45,000 - $18,000 = $27,000)
41. For which of the following is the current ratio most useful?
a. In evaluating a company’s liquidity
b. In evaluating a company’s solvency
c. In evaluating a company’s profitability
d. In evaluating a company’s probability
ANSWER: a
42. Which of the following events will cause a company’s current ratio to decrease?
a. The sale of inventory for cash
b. The sale of inventory for credit (accounts receivable)
c. Issuing stock for cash
d. Paying off long-term debt with cash
ANSWER: d
43. Which of the following events will cause a company’s current ratio to increase?
a. The collection of an account receivable
b. Selling land for cash at a loss
c. The discharge of an account payable by signing a short-term note payable
d. Paying off a long-term loan
ANSWER: b
44. Liquidity relates to a company's ability to do which of the following?
a. The ability to pay its financial obligations as they become due
b. The ability to stay in business over the long run
c. The ability to pay dividends to its stockholders
d. The ability to collect the amount their customers owe the company
ANSWER: a
Skyline, Inc.
The balance sheet of Skyline Inc. includes the following items:
| Cash | $ 22,400 |
| Accounts receivable | 11,700 |
| Inventory | 23,300 |
| Prepaid insurance | 1,040 |
| Land | 80,000 |
| Accounts payable | 47,500 |
| Salaries payable | 1,200 |
| Capital stock | 84,040 |
| Retained earnings | 5,700 |
45. Read the information about Skyline, Inc. What is Skyline’s current ratio?
a. 0.8 to 1
b. 1.6 to 1
c. 1.2 to 1
d. 2.5 to 1
ANSWER: c
RATIONALE: Current Ratio = Current Assets/Current Liabilities = ($22,400 + $11,700 + $23,300 + $1,040)/($47,500 + $1,200) = $58,440/48,700 = 1.2 to 1
46. Read the information about Skyline, Inc. What is Skyline’s working capital?
a. $58,440
b. $89,740
c. $84,040
d. $9,740
ANSWER: d
RATIONALE: Current Ratio = Current Assets/Current Liabilities = ($22,400 + $11,700 + $23,300 + $1,040)/($47,500 + $1,200) = $58,440/48,700 = 1.2 to 1 Working Capital = Current Assets – Current Liabilities = $58,440 – $48,700 = $9,740
47. Which of the following would appear on a multiple-step income statement but not on a single-step income statement?
a. Net income
b. Total expenses
c. Total revenues
d. Income before income taxes
ANSWER: d
48. Which of the following would not appear on an income statement?
a. Sales revenue
b. Cost of goods sold
c. Accounts receivable
d. Insurance expense
ANSWER: c
49. Which statement is true concerning an income statement?
a. The income statement shows how much profit the company has earned since it began operations.
b. Net income on the income statement should be equal to the amount of cash on the balance sheet.
c. The income statement summarizes the results of operations for a period of time.
d. The income statement indicates the liquidity of the company on an annual basis.
ANSWER: c
50. Which statement is true concerning gains and losses?
a. Gains and losses are reported on the balance sheet in the Assets and Liabilities sections, respectively.
b. Gains and losses are special types of revenues and expenses that are reported on the income statement.
c. The amounts of gains and losses are included in the calculation of the current ratio, in the numerator and denominator, respectively.
d. Gains and losses are reported only on a multi-step income statement.
ANSWER: b
51. Which one of the following subtotals or totals would appear in a multiple-step, but not a single-step income statement?
a. Income tax expense
b. Income from operations
c. Cost of goods sold
d. Net income
ANSWER: b
52. What are the two subtotals that distinguish the multi-step income statement from the single-step income statement?
a. Income before taxes and income taxes
b. Total operating revenues and total operating expenses
c. Income from operations and income before taxes
d. Total revenues and total expenses
ANSWER: c
53. A question asked by stockholders is, "How much profit did the company make?" What should the stockholder examine to get the most information that will help evaluate the answer to this question?
a. The balance sheet, because retained earnings represents current profits
b. The statement of cash flows, as cash inflows and outflows represents current profits
c. The income statement, since it shows the revenues and expenses for the period
d. The economic resources of the company
ANSWER: c
54. Under current accounting principles, how is net income on the income statement measured?
a. Net change in owners’ equity during the period
b. Excess of revenues over expenses during the period
c. Net change in the cash balance during the period
d. Excess of revenues over expenses less any dividends paid during the period
ANSWER: b
55. Which of the following statements is true regarding the multiple-step income statement?
a. The multiple-step income statement is used only by companies that sell products, not those that provide services.
b. The multiple-step income statement is helpful in determining a company's working capital.
c. The multiple-step income statement reports the same net income as the single-step income statement.
d. The multiple-step income statement is required under generally accepted accounting principles.
ANSWER: c
56. How is income from operations determined?
a. By subtracting the cost of goods sold from sales
b. By subtracting the total operating expenses from sales
c. By subtracting the total operating expenses from gross profit
d. By subtracting selling expenses from operating revenues
ANSWER: c
57. The following list contains several items that appear on an income statement.
| 1. | Other revenue and expenses | 5. | Net Income |
| 2. | Income before taxes | 6. | Operating revenues |
| 3. | Income taxes | 7. | Income from operations |
| 4. | Operating expenses |
Select the choice that lists the items in the order they would appear on a multi-step income statement.
a. 6, 1, 7, 4, 2, 3, 5
b. 7, 6, 1, 4, 2, 3, 5
c. 6, 4, 7, 1, 2, 3, 5
d. 6, 7, 4, 1, 2, 3, 5
ANSWER: c
Webb Company
Selected data from the accounting records of Webb Company are listed below:
| General & administrative expenses | $2,200 | Operating revenues | $6,000 |
| Selling expenses | 1,800 | Income taxes | 600 |
| Other revenues (expenses) | 800 | Dividends paid | 1,200 |
58. Read the information about Webb Company. What is Webb’s income from operations?
a. $ 1,600
b. $ 2,000
c. $ 2,200
d. $ 2,800
ANSWER: b
RATIONALE: ($6,000 Operating Revenues - $2,200 General & Administrative Expenses - $1,800 Selling Expenses = $2,000)
59. Read the information about Webb Company. What is Webb’s net income?
a. $ 1,600
b. $ 2,000
c. $ 2,200
d. $ 2,800
ANSWER: c
RATIONALE: ($6,000 Operating Revenues - $2,200 General & Administrative Expenses - $1,800 Selling Expenses = $2,000 + $800 Other Revenues (Expenses) - $600 Income Taxes = $2,200)
60. Read the information about Webb Company. By what amount will net income on a single-step income statement differ from net income on a multi-step income statement if Webb Company prepares both formats?
a. $ 800
b. $ 600
c. $ 200
d. $ -0-
ANSWER: d
Deal Mart
The 2014 income statement of Deal Mart shows operating revenues of $130,800, selling expenses of $37,100, general and administrative expenses of $34,900, interest expense of $900, and income tax expense of $11,430. Deal Mart’s stockholders’ equity was $280,000 at the beginning of the year and $320,000 at the end of the year. The company has 20,000 shares of stock outstanding at December 31, 2014.
61. Read the information about Deal Mart. What is Deal Mart’s net income?
a. $80,000
b. $92,190
c. $130,800
d. $46,470
ANSWER: d
RATIONALE: Net Income = $130,800 – $37,100 – $34,900 – $900 – $11,430 = $46,470
62. Read the information about Deal Mart. What is Deal Mart’s profit margin (to the closest tenth of a percent)?
a. 2.8
b. 35.5
c. 61.2
d. 14.5
ANSWER: b
RATIONALE: Profit margin: Net Income/Revenues = $46,470*/$130,800 = 35.5%
*$130,800 – $37,100 – $34,900 – $900 – $11,430 = $46,470
63. Forman, Inc. earned $600,000 profit during 2015. On which financial statement(s) will you find the dollar amount of the profit earned by the company?
a. Balance sheet and income statement
b. Income statement only
c. Statement of retained earnings only
d. Income statement and statement of retained earnings
ANSWER: d
64. Grand Stores, Inc. is concerned about its profitability for the current year, since its profit margin has dropped 10% since last year. Which of the following is the least useful comparison in evaluating the drop in Grand Stores’ profit margin?
a. Comparison with the industry average for the current year
b. Comparison with its current ratio for the current year
c. Comparison with the profit margins for its major competitors for the current year
d. Comparison with its profit margins for the past five years
ANSWER: b
65. Assume that you want to determine the profit margin for a company. Which one of the following financial statements is the best source of this information?
a. Statement of retained earnings
b. Statement of cash flows
c. Statement of stockholders’ equity
d. Income statement
ANSWER: d
Hopper, Inc.
Use the information from Hopper Inc. to answer the following question(s).
| 2014 | 2013 | |
| Operating revenues | $1,900,000 | $1,600,000 |
| Operating expenses | 1,400,000 | 1,100,000 |
| Income taxes | 200,000 | 200,000 |
66. Read the information about Hopper. Inc. Which statement best represents Hopper’s performance?
a. Hopper’s profit margin ratio decreased.
b. Hopper has become more profitable.
c. Hopper’s increase in operating revenues increased the company’s net income.
d. Hopper’s operating expenses as a percentage of operating revenues remained the same.
ANSWER: a
67. Read the information about Hopper, Inc. Which of the following statements is the best answer regarding the company’s profit margin?
a. The profit margin was 15.8% in 2014.
b. The profit margin was 15.8% in 2013.
c. The profit margin was 31.5% in 2014.
d. The profit margin was 31.5% in 2013.
ANSWER: a
RATIONALE: ($300,000 (or $1,900,000 Operating revenues - $1,400,000 Operating expenses - $200,000 Income taxes)/$1,900,000 = 15.8%)
68. Read the information about Hopper, Inc. Which ratio are you able to calculate given only the information provided by Hopper?
a. Profit margin
b. Current ratio
c. Working capital
d. Gross profit percentage
ANSWER: a
69. Which one of the following equations represents retained earnings activity?
a. Beginning balance + net income + dividends = profits for the year
b. Beginning balance + cash inflows – cash outflows = ending balance
c. Beginning balance + dividends – net income = ending balance
d. Beginning balance + net income – dividends = ending balance
ANSWER: d
Bartlett Industries
Bartlett Industries began operations on January 2, 2015, with an investment of $50,000 by each of its two stockholders. Net income for its first year of business was $240,000. Bartlett Industries paid a total of $100,000 in dividends to its stockholders during the year.
70. Read the information about Bartlett Industries. What is the company’s retained earnings balance at December 31, 2015?
a. $140,000
b. $190,000
c. $240,000
d. $340,000
ANSWER: a
RATIONALE: ($ -0- Beginning Balance + $240,000 Net Income - $100,000 Dividends = $140,000)
71. Read the information about Bartlett Industries. If the company’s revenues were $500,000 for the year ended December 31, 2015, how much were total expenses?
a. $160,000
b. $260,000
c. $640,000
d. $740,000
ANSWER: b
RATIONALE: ($500,000 Revenues - $240,000 Net Income = $260,000)
72. Read the information about Bartlett Industries. The company’s dividends for the year
a. Reduce the amount of capital stock reported by the company.
b. Are part of Bartlett Industries' operating costs.
c. Are reported on the statement of retained earnings.
d. Are an expense of Bartlett Industries.
ANSWER: c
73. A company is not required to prepare both a(n)
a. Income statement and statement of stockholders’ equity.
b. Income statement and statement of retained earnings.
c. Statement of stockholders’ equity and statement of retained earnings.
d. Statement of cash flows and statement of retained earnings.
ANSWER: c
74. In preparing the financial statements for December 31, 2015, an accountant improperly classified the payment of prepaid rent as rent expense. Which of the following amounts would not be affected by this improper classification?
a. Retained earnings, January 1, 2015
b. Retained earnings, December 31, 2015
c. Net income
d. Total assets
ANSWER: a
75. Carnival Bakery borrowed $500,000 from Front Street Bank. Carnival then hired a contractor to build a new cookie distribution outlet. In which section of Carnival’s statement of cash flows would you find information that indicated that Carnival acquired the new cookie distribution outlet?
a. Operating Activities
b. Investing Activities
c. Financing Activities
d. Profit Activities
ANSWER: b
76. A bank loaned $62 million to Apex Corporation to finance the construction of a new distribution warehouse. In which section of Apex’s statement of cash flows would you be able to determine whether the company repaid any portion of the debt during the year?
a. Operating Activities
b. Investing Activities
c. Financing Activities
d. Profit Activities
ANSWER: c
77. Which of the following categories on a statement of cash flows is used to report the cash flow effects of transactions involving a company's stock?
a. Operating Activities
b. Investing Activities
c. Financing Activities
d. Profit Activities
ANSWER: c
78. Which one of the following categories on a statement of cash flows is used to report the cash flow effects of buying and selling property, plant, and equipment?
a. Operating Activities
b. Investing Activities
c. Financing Activities
d. Profit Activities
ANSWER: b
79. Which one of the following is considered a financing activity?
a. The payment of interest on a note payable to the bank
b. Selling products to customers
c. Paying wages to employees
d. The payment of a cash dividend
ANSWER: d
80. Which one of the following statements is true?
a. The two primary sources of financing available to corporations are borrowed funds and funds invested by owners.
b. Financing activities involve the acquisition of property, plant and equipment.
c. Borrowed funds are a more permanent source of financing than funds invested by owners.
d. Investing activities involve the selling of products or services and the incurring of expenses related to selling these products and services.
ANSWER: a
Marvel Shoes
Marvel Shoes reported the following items on its statement of cash flows for the current year:
Net cash inflows from operating activities $70,000
Net cash outflows from investing activities (20,000)
Net cash outflows from financing activities (40,000)
Cash balance at the beginning of the year 30,000
81. Read the information about Marvel Shoes. What was the amount of net increase or decrease in the cash balance for Marvel Shoes for the current year?
a. $ 10,000 increase
b. $ 30,000 increase
c. $ 40,000 increase
d. $ 70,000 increase
ANSWER: a
RATIONALE: ($70,000 Operating Activities - $20,000 Investing Activities - $40,000 Financing Activities = $10,000)
82. Read the information about Marvel Shoes. What was the cash balance for Marvel Shoes at the end of the current year?
a. $ 10,000
b. $ 30,000
c. $ 40,000
d. $ 70,000
ANSWER: c
RATIONALE: ($30,000 Beginning Balance + $10,000 Increase in Cash = $40,000)
83. Which financial statement reports the sources and uses of an entity's cash resources?
a. Income statement
b. Statement of retained earnings
c. Balance sheet
d. Statement of cash flows
ANSWER: d
84. During its fifth year of operations, Bright Creations Company reports a beginning cash balance of $132,000, cash inflows from investing activities of $210,000, cash outflows for financing activities of $79,000, and cash outflows for operating activities of $13,000. What was Bright Creations’ cash balance at the end of the fifth year?
a. $ 250,000
b. $ 434,000
c. $ 276,000
d. $ 132,000
ANSWER: a
RATIONALE: ($132,000 Beginning Balance - $13,000 Cash Flow from Operating Activities + $210,000 Cash Flows from Investing Activities - $79,000 Cash Flows from Financing Activities = $250,000)
85. Which of the following best describes a company’s financing activities?
a. Financing activities focus on the sale of products and services.
b. Financing activities include selling products.
c. Financing activities enable a company to acquire assets needed to run a business.
d. Financing activities are represented by the revenues and expenses on the income statement.
ANSWER: c
86. Which of the following best describes a company’s operating activities?
a. Operating activities focus on the sale of products and services.
b. Operating activities are necessary to provide the money to start a business.
c. Operating activities are needed to provide the valuable assets required to run a business.
d. Operating activities represent the right to receive a benefit in the future.
ANSWER: a
CHAPTER 2
Financial Statements
and the Annual Report
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Estimated
Time in
Learning Outcomes Exercises Minutes Level
1. Describe the objectives of financial reporting.
2. Describe the qualitative characteristics of accounting information. 1 10 Easy
3. Explain the concept and purpose of a classified balance sheet 2 10 Mod
and prepare the statement. 3 10 Easy
5 10 Easy
12* 10 Mod
4. Use a classified balance sheet to analyze a company’s 4 10 Easy
financial position.
5. Explain the difference between a single-step and a 6 10 Easy
multiple-step income statement and prepare each type 7 10 Mod
of income statement. 12* 10 Mod
13* 15 Mod
14* 5 Easy
6. Use a multiple-step income statement to analyze a 8 10 Easy
company’s operations. 13* 15 Mod
14* 5 Easy
7. Identify the components of the statement of retained earnings 9 10 Mod
and prepare the statement. 12* 10 Mod
8. Identify the components of the statement of cash flows and 10 10 Easy
prepare the statement.
9. Read and use the financial statements and other elements 11 20 Diff
in the annual report of a publicly held company.
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
Problems Estimated
and Time in
Learning Outcomes Alternates Minutes Level
1. Describe the objectives of financial reporting. 12* 45 Diff
2. Describe the qualitative characteristics of accounting information. 1 15 Diff
2 15 Mod
10* 35 Mod
11* 20 Mod
3. Explain the concept and purpose of a classified balance sheet 3 50 Mod
and prepare the statement.
4. Use a classified balance sheet to analyze a company’s 4 20 Easy
financial position. 5 15 Mod
10* 35 Mod
12* 45 Diff
5. Explain the difference between a single-step and a 6 30 Mod
multiple-step income statement and prepare each type 7 45 Mod
of income statement. 11* 20 Mod
6. Use a multiple-step income statement to analyze a
company’s operations.
7. Identify the components of the statement of retained earnings
and prepare the statement.
8. Identify the components of the statement of cash flows and 8 30 Mod
prepare the statement. 12* 45 Diff
9. Read and use the financial statements and other elements 9 30 Diff
in the annual report of a publicly held company.
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
Estimated
Time in
Learning Outcomes Cases Minutes Level
1. Describe the objectives of financial reporting.
2. Describe the qualitative characteristics of accounting information. 5 30 Mod
3. Explain the concept and purpose of a classified balance sheet
and prepare the statement.
4. Use a classified balance sheet to analyze a company’s 1 30 Mod
financial position. 2 20 Mod
6* 30 Mod
5. Explain the difference between a single-step and a
multiple-step income statement and prepare each type
of income statement.
6. Use a multiple-step income statement to analyze a 6* 30 Mod
company’s operations.
7. Identify the components of the statement of retained earnings
and prepare the statement.
8. Identify the components of the statement of cash flows and 3 25 Mod
prepare the statement.
9. Read and use the financial statements and other elements 4 20 Mod
in the annual report of a publicly held company.
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
questions
1. The primary concern to an investor is the future cash to be received from the investment. However, this does not mean that the cash flows of the company that has been invested in are not relevant. A relationship exists between the cash flows to the investor and those to the company. For example, a company that does not consistently generate sufficient cash flows from its operations will not be able to pay cash dividends to the investors over a sustained time.
2. The understandability characteristic does not imply that someone must have an extensive accounting background to be able to use financial statements. However, accounting information should be understandable to those who are willing to learn to use it properly. In other words, the information should make sense to someone who spends the time required to have a basic understanding of accounting.
3. Relevance is the capacity of accounting information to make a difference in a financial decision. For example, an income statement is relevant when the use of it has at least the potential to make a difference in an investment decision.
4. Comparability is the quality of accounting information that allows comparisons to be made between or among companies. Without it, financial statements would be very limited in their value. Financial decisions require choices to be made about the investment of limited resources. Investors need assurance that the financial statements of companies that they are considering as investments are comparable.
5. Comparability is the quality of information that allows for comparisons to be made between two or more companies, whereas consistency is the quality that allows for comparisons to be made within a single entity from one accounting period to the next.
6. The concept of materiality is closely related to the size of a company. For example, assume that a company must decide whether a $500 expenditure that will benefit future periods should be expensed immediately or capitalized (i.e., recorded as an asset). The decision cannot be made without considering the amount in relation to the size of the company. An amount that is immaterial for a large multinational corporation may be material for a smaller business.
7. The IASB recognizes the same qualitative characteristics for useful information as does the FASB. The two groups are working together on a joint conceptual framework project, of which the chapter on qualitative characteristics is completed.
8. A current asset is an asset that a company expects to realize in cash, sell, or consume during its normal operating cycle. Therefore, accounts receivable, inventory, and supplies all meet this definition and are classified as current assets. By their nature, the benefits from each of these assets will be realized during the normal operating cycle of the business.
9. The note payable will be classified on the balance sheet as long term until one year from its maturity date. At that time, it should be reclassified from long term to current because it will be paid within the next year. Any liability that will mature within one year of the date of the balance sheet should be classified as current, regardless of the original term of the loan (five years in this case).
10. Both capital stock and retained earnings represent claims of the stockholders on the assets of the business. They differ, however, in the source of those claims. Capital stock represents the claims of the stockholders that arise from their contributions of cash and other assets to the business. Retained earnings represent the accumulated earnings, or net income, of the business since its inception less all dividends declared during that time.
11. Working capital is an absolute measure of liquidity. That is, it is the total dollar amount of current assets minus current liabilities. One of the problems with working capital as a measure of liquidity is that it does not allow someone to compare the relative liquidity of two companies of different sizes. Even within a single company, it may be difficult to compare the relative liquidity of the company over time if the company has grown. The current ratio (current assets divided by current liabilities) overcomes these deficiencies by focusing attention on the relative size of the current
assets and current liabilities.
12. Capital structure refers to the right side of a balance sheet. All items on the right side of the balance sheet represent claims against the assets of the business: liabilities are the claims of outsiders, and stockholders’ equity is the claim of the owners on the assets of the business. The capital structures of all companies differ in that some companies rely more on outsiders to provide assets, whereas others rely more on the owners to provide the necessary assets to run the business.
13. The single-step income statement shows a subtotal for all expenses and deducts this amount from total revenues. The weakness of the single-step form for the income statement is that relationships between key items on the statement are not highlighted. For example, the relationship between sales revenue and the cost of the products sold is very important for a product-oriented company. The difference between the two amounts is called gross profit and would appear on a multiple-step statement but not in the single-step form.
14. A statement of retained earnings links the income statement and the balance sheet in the following way. A statement of retained earnings shows the beginning balance in the account, the addition (deduction) to the account for the net income (loss) of the period, and any deduction from the account for dividends. The beginning balance in Retained Earnings is taken from the balance sheet at the end of the prior
period. The income statement indicates the net income for the period. The ending balance in Retained Earnings appears on the balance sheet at the end of the period.
15. An audit of a set of financial statements does not ensure that the statements contain no errors. Because of the sheer number of transactions entered into during a period of time, it would be impossible for an auditor to check every single transaction to determine that it was correctly recorded. Instead, through various types of tests, the auditor renders an opinion as to whether the statements are free of material mis-statement.
16. The first note is the summary of significant accounting policies. As the name implies, the purpose of this note is to summarize all of the company’s important accounting policies, such as those relating to the method of depreciating assets and the method for valuing inventories.
BRIEF exercises
| LO 1 | BRIEF EXERCISE 2-1 OBJECTIVES OF FINANCIAL REPORTING |
The overriding objective of financial reporting is to provide financial information to permit users of the information to make informed decisions. Financial statements do not report the value of the reporting entity, but should provide useful information to allow users to make estimates of the value of the entity.
| LO 2 | BRIEF EXERCISE 2-2 QUALITATIVE CHARACTERISTICS OF ACCOUNTING |
The two fundamental qualities that make accounting information useful are relevance and faithful representation. Financial information is enhanced when it is understandable, comparable, and consistent.
| LO 3 | BRIEF EXERCISE 2-3 CLASSIFICATION OF ASSETS |
Accounts receivable—CA Furniture and fixtures—NCA
Land—NCA Office supplies—CA
Inventories—CA Buildings—NCA
Cash—CA
| LO 4 | BRIEF EXERCISE 2-4 WORKING CAPITAL AND CURRENT RATIO |
Working Capital = Current Assets – Current Liabilities
Working Capital: $80,000 – $60,000 = $20,000
Current Ratio = Current Assets/Current Liabilities
Current Ratio: $80,000/$60,000 = 1.33 to 1
| LO 5 | BRIEF EXERCISE 2-5 MULTIPLE- VERSUS SINGLE-STEP INCOME STATEMENT |
Lines that will appear on a multiple-step income statement, but not on a single-step income statement, are Gross profit, Total operating expenses, Income from operations, Excess of other revenues over other expenses, and Income before income taxes.
| LO 6 | BRIEF EXERCISE 2-6 PROFIT MARGIN |
Profit Margin = Net Income/Sales =
($100,000 – $60,000 – $15,000 – $10,000)/$100,000 = $15,000**/$100,000* = 15%
Sales $100,000*
– Cost of goods sold 60,000
= Gross profit $ 40,000
– Total operating expenses 15,000
= Income before income taxes $ 25,000
– Income tax expense 10,000
= Net income $ 15,000**
| LO 7 | BRIEF EXERCISE 2-7 RETAINED EARNINGS |
Ending retained earnings = $200,000 + $80,000 – $50,000 = $230,000*
Retained earnings, beginning balance $200,000
Add: Net income for the year 80,000
$280,000
Less: Dividends paid (50,000)
Retained earnings, ending balance $230,000*
| LO 8 | BRIEF EXERCISE 2-8 INVESTING AND FINANCING ACTIVITIES |
The amount borrowed from the bank, $100,000, would be reported on the statement of cash flows as an inflow from financing activities. The amount used to buy a new piece of equipment, $80,000, would be shown on the statement of cash flows as an outflow from investing activities.
| LO 9 | BRIEF EXERCISE 2-9 ELEMENTS OF AN ANNUAL REPORT |
In addition to the financial statements, an annual report usually includes the following items: a letter to the stockholders from either the president or the chair of the board of directors, a section describing the company’s products/services and markets, the auditors’ report, management discussion and analysis, and notes to the financial statements.
exercises
| LO 2 | EXERCISE 2-1 CHARACTERISTICS OF USEFUL ACCOUNTING INFORMATION |
1. materiality 4. consistency
2. relevance 5. understandability
3. faithful representation 6. comparability
| LO 3 | EXERCISE 2-2 THE OPERATING CYCLE |
1. For a company that sells a product, the operating cycle begins when the cash is invested in inventory and ends when cash is collected by the company from its customers. Two Wheeler’s operating cycle would be a minimum of 45 days (for cash sales) and a maximum of 75 days (for sales on credit: 45 days to sell the bike and 30 days to collect).
2. The operating cycle for Baxter, the manufacturer of the bikes, would normally be longer than Two Wheeler’s. This is because a manufacturer incurs various costs to produce the bikes before it sells them to retailers such as Two Wheeler and eventually collects cash from the sales. On the other hand, the retailer only buys a
finished good from the manufacturer and then sells it to the customer.
| LO 3 | EXERCISE 2-3 CLASSIFICATION OF FINANCIAL STATEMENT ITEMS |
1. CA 6. CA
2. SE 7. CL
3. CL 8. NCA
4. CA 9. SE
5. NCA 10. LTL
| LO 4 | EXERCISE 2-4 CURRENT RATIO |
1. Current Ratio = Current Assets/Current Liabilities
December 31, 2013:
Current Ratio = ($6,000 + $10,000 + $8,000)/($7,000 + $1,000 + $4,000)
= $24,000/$12,000
= 2.0 to 1
December 31, 2014:
Current Ratio = ($3,000 + $15,000 + $12,000)/($12,000 + $2,000 + $6,000)
= $30,000/$20,000
= 1.5 to 1
EXERCISE 2-4 (Concluded)
2. Baldwin’s current ratio decreased from 2.0 at the end of 2013 to 1.5 at the end of 2014. In general, the higher the current ratio, the more liquid the company.
3. Cash decreased by 50%, from $6,000 to $3,000, and accounts receivable increased by 50%, from $10,000 to $15,000. Inventory also increased by 50%, from $8,000 to $12,000. Not only did Baldwin’s current ratio decrease, but its current assets are also less liquid at the end of the year, with more invested in receivables and inventory and less in cash.
| LO 3 | EXERCISE 2-5 CLASSIFICATION OF ASSETS AND LIABILITIES |
1. CA 4. NCA 7. CA
2. CL 5. CL 8. LTL
3. CA 6. CL 9. NCA
| LO 5 | EXERCISE 2-6 SELLING EXPENSES AND GENERAL AND ADMINISTRATIVE EXPENSES |
1. Advertising expense—S
2. Depreciation expense—store furniture and fixtures—S
3. Office rent expense—G&A
4. Office salaries expense—G&A
5. Store rent expense—S
6. Store salaries expense—S
7. Insurance expense—G&A*
8. Supplies expense—G&A*
9. Utilities expense—G&A*
*Each of these could be classified as a selling expense if the cost is related in some way to the sales function; e.g., insurance on cars driven by salespeople could be
classified as a selling expense.
| LO 5 | EXERCISE 2-7 MISSING INCOME STATEMENT AMOUNTS |
Sara’s Amy’s Jane’s
Coffee Shop Deli Bagels
Net sales $35,000 (3) $63,000 $78,000
Cost of goods sold (1) 28,000 45,000 (7) 39,000
Gross profit 7,000 18,000 (6) 39,000
Selling expenses 3,000 (4) 6,000 9,000
General and administrative expenses 1,500 2,800 (5) 4,600
Total operating expenses (2) 4,500 8,800 13,600
Net income $ 2,500 $ 9,200 $25,400
Solved as follows (in the order listed):
(1) $35,000 – $7,000 = $28,000
(2) $3,000 + $1,500 = $4,500
(3) $45,000 + $18,000 = $63,000
(4) $8,800 – $2,800 = $6,000
(5) $13,600 – $9,000 = $4,600
(6) $25,400 + $13,600 = $39,000
(7) $78,000 – $39,000 = $39,000
| LO 6 | EXERCISE 2-8 INCOME STATEMENT RATIO |
Profit margin:
Net Income/Revenues = $45,000*/$134,800 = 33.4%
*$134,800 – $38,310 – $36,990 – $580 – $13,920 = $45,000
A profit margin of 33% indicates that for every dollar of sales, Holly Enterprises has $0.33 in net income. It would be beneficial to compare the company’s profit margin with some of its competitors and with previous years.
| LO 7 | EXERCISE 2-9 STATEMENT OF RETAINED EARNINGS |
LANDON CORPORATION
STATEMENT OF RETAINED EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 2014
Retained earnings, January 1, 2014............................... $130,520*
Add: Net income for 2014............................................ 145,480
Less: Dividends declared and paid................................ (40,000)
Retained earnings, December 31, 2014.......................... $236,000
*Retained earnings, January 2, 2012.............................. $ 0
Add: Net income:
2012.............................................................. $ 85,200
2013.............................................................. 125,320 210,520
Deduct: Dividends:
2012.............................................................. $ 40,000
2013.............................................................. 40,000 80,000
Retained earnings, December 31, 2013......................... $130,520
| LO 8 | EXERCISE 2-10 COMPONENTS OF THE STATEMENT OF CASH FLOWS |
1. Paid for supplies—O
2. Collected cash from customers—O
3. Purchased land (held for resale)—O
4. Purchased land (for construction of new building)—I
5. Paid dividend—F
6. Issued stock—F
7. Purchased computers (for use in the business)—I
8. Sold old equipment—I
| LO 9 | EXERCISE 2-11 BASIC ELEMENTS OF FINANCIAL REPORTS |
1. Management discussion and analysis—The information in this section of the annual report is prepared by management and is management’s opportunity to explain various items that appear in the financial statements. Increases and decreases in various items are highlighted and reasons for these changes are given. The information in this section is not subject to any outside review or support. Users must rely on the integrity of management that the information contained in the report is reliable.
2. Product/markets of company—Management provides information in the annual report about the company’s products and markets. The detail provided by management differs widely among companies, but most companies describe their various products and often show pictures of them. The distribution system for the products, i.e., whom the company sells to, is also described. Because the company’s products and markets are a matter of public knowledge, they are subject to verification.
3. Financial statements—These are the responsibility of management and are normally prepared by the controller. They include the income statement, balance sheet, statement of changes in stockholders’ equity, and statement of cash flows. The information provided in the financial statements is subject to verification as part of the external audit.
4. Notes to financial statements—These are also the responsibility of management, and they include detailed explanations about the various items appearing in the
financial statements. The first note in most annual reports is a summary of the significant accounting policies, such as the company’s inventory valuation methods and depreciation methods. The information included in the notes is subject to review by the independent auditors and is therefore highly verifiable.
5. Independent accountants’ report—As the name implies, this report is prepared by the independent auditors. It includes information about the scope of the audit (the statements included in the audit), the auditing standards followed in conducting the audit, and an opinion as to the fairness of presentation of the financial statements. Because the public relies on the auditors to render an impartial opinion, the auditing profession is subject to a set of high ethical standards in performing audits.
MULTI-CONCEPT EXERCISES
| LO 3,5,7 | EXERCISE 2-12 FINANCIAL STATEMENT CLASSIFICATION |
BS = Balance sheet; IS = Income statement; RE = Retained earnings statement
1. Accounts payable—BS 11. Land held for future expansion—BS
2. Accounts receivable—BS 12. Loan payable—BS
3. Advertising expense—IS 13. Office supplies—BS
4. Bad debt expense—IS 14. Patent—BS
5. Bonds payable—BS 15. Patent amortization expense—IS
6. Buildings—BS 16. Prepaid insurance—BS
7. Cash—BS 17. Retained earnings—BS and RE
8. Common stock—BS 18. Sales—IS
9. Depreciation expense—IS 19. Utilities expense—IS
10. Dividends—RE 20. Wages payable—BS
| LO 5,6 | EXERCISE 2-13 SINGLE- AND MULTIPLE-STEP INCOME STATEMENT |
1. Sales—B 7. Net income—B
2. Cost of goods sold—B 8. Supplies on hand—N
3. Selling expenses—M* 9. Accumulated depreciation—N
4. Total revenues—S 10. Income before income taxes—M
5. Utilities expense—B 11. Gross profit—M
6. Administrative expense—M*
*This assumes that selling and administrative expenses are each headings for a group of expenses. If this is the case, they would appear only on a multiple-step income statement.
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