Fa-chapter-2-answerss-answer-key

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FA chapter 2 answerss – answer key

Financial Accounting (Iqra University)

Studocu is not sponsored or endorsed by any college or university

FA chapter 2 answerss – answer key

Financial Accounting (Iqra University)

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Brie

f

Learnin

g

Exercises To

p

ic Ob

j

ectives Skills

B. Ex. 2.1 Recordin

g

transactions 3 Anal

y

sis, communicatio

n

B. Ex. 2.2 Recording transactions 3 Analysis, communicatio

n

B. Ex. 2.3 Computing retained earnings 4 Analysis

B. Ex. 2.4 Computing total liabilities 4 Analysis

B. Ex. 2.5 Computing net income 5 Analysis

B. Ex. 2.6 Computing net income 5 Analysis

B. Ex. 2.7 Computing change in cas

h

6 Analysis

B. Ex. 2.8 Alternative forms of equity 8 Analysis

B. Ex. 2.9 Alternative forms of equity 8 Analysis

B. Ex. 2.10 Articulation of financial statements 7 Analysis

Learning

Exercises Topic Objectives Skills

2.1 Real World: American Airlines, 3 Communication

Boston Celtics

Nature of assets and liabilities

2.2 Preparing a balance sheet 4 Analysis

2.3 Preparing a balance sheet 4 Analysis

2.4 2 Communication, judgment

2.5 Using the accounting equation 3 Analysis

2.6 Accounting equation 3 Analysis

2.7 Effects of business transactions 3 Analysis

2.8 Forms of business organizations 8 Analysis

2.9 Factors contributing to solvency 9 Analysis, judgment

2.10 Professional judgment 2 Communication

2.11 Statement of cash flows 6 Analysis

2.12 Income statement 5 Analysis

2.13 Income statement 5 Analysis

2.14 Statement of cash flows 6 Analysis

2.15 Window dressing financial statement 9 Analysis

2.16 Real World: Home Depot 4–6 Analysis, communication

Home Depot financial statements

2.17 Real World: Intel 5 Analysis, communication

Assessing financial results

CHAPTER

2

BASIC FINANCIAL STATEMENT

S

Accounting principles and asset valuation

OVERVIEW OF BRIEF EXERCISES, EXERCISES, AND CRITICAL THINKING

CASES

Overview

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Problems Learning

Sets A, B Topic Objectives Skills

2.1 A,B 4 Analysis, communication

2.2 A,B Effects of transactions 3 Analysis

2.3 A,B Effects of transactions 3 Analysis

2.4 A,B Effects of transactions 3 Analysis

2.5 A,B Preparing a balance sheet, effects of 4 Communication, judgment

transactions

2.6 A,B Preparing a balance sheet, effects of 4 Analysis, communication

transactions

2.7 A,B Preparing a balance sheet and statement 3, 4, 6 Analysis, communication

of cash flows, effects of transactions

2.8 A,B Preparing financial statements, effects of 4–6 Analysis, communication

of transactions, evaluating solvency

2.9 A,B 4, 8

2.10 A,B 2, 4

Preparing and evaluating a balance sheet

Preparing a balance sheet, discussion of

GAAP

Preparing a balance sheet, discussion of

GAAP

Analysis, communication,

judgment

Analysis, communication,

judgment

Overview (p. 2)

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2.1 Prepare a realistic balance sheet for a 4

hypothetical entity

2.2 Real World: Company of student choice 4–6

2.3 Using a balance sheet 4

2.4 Using a statement of cash flows 6

2.5 Window dressing 4

2.6 4

(Ethics, fraud & corporate governance)

2.7 4-5

DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASE

S

Problems (Sets A and B)

2.1 A,B 15 Easy

2.2 A,B 15 Easy

2.3 A,B 15 Medium

2.4 A,B 15 Medium

Locate and evaluate the financial statements of

a publicly owned company

Critical Thinkin

g

Cases

Analysis, communication,

judgment

Communication, research,

technology

Analysis, communication,

research

Analysis, communication

judgment

Analysis, communication,

judgment

Ajax Moving Company/Brigal Company

Smokey Mountain Lodge/Deep River Lodge

Shown below are brief descriptions of each problem and case. These descriptions are accompanied by the

estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume

use of the partially filled-in working papers.

Real World: Public Company Accounting

Oversight Board

Technology

Real World: Cisco Systems

(Internet)

Introduction to EDGAR

Rankin Truck Rental/Smith Trucking

Show in tabular form the effects of various business transactions

upon the accounting equation. (Alternate to Problem 2–3.)

Prepare a balance sheet from a list of balance sheet items in random

order. Determine the amount of one item as a plug figure. Also

evaluate the company’s solvency.

Effects of transactions upon the accounting equation are illustrated

in tabular form. Students are asked to write a sentence or two

explaining the nature of each transaction.

Goldstar Communications/Delta Corporation

Show in tabular form the effects of various business transactions

upon the accounting equation. (Problem 2–4 is an alternate.)

Judgment

Note: Additional Internet assignments for this chapter are available both in Appendix B and on our home

page: www.magpie.org/cyberlab

Overview and Desc. of Cases

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Problems (cont’d)

Here Come the Clowns/Circus World

Wilson Farms

,

Inc./A

pp

le Valle

y

Farms

The Oven Baker

y

/The Cit

y

Butcher

The Sweet Soda Sho

p

/The Cand

y

Sho

p

Berkele

y

Pla

y

house/Old Town Pla

y

house

Bi

g

Screen Scri

p

ts/Hit Scri

p

ts

Critical Thinking Cases

Content of a Balance Sheet

Usin

g

Financial Statements

*Omits time re

q

uired to obtain an annual re

p

ort.

2.5 A,B 20 Medium

2.6 A,B 20 Medium

Preparation of a balance sheet for a circus—an entity with an unusual variety o

f

asset accounts. Also requires students to explain the effects upon this balance

sheet of a fire that destroys one of the assets. (Problem 2–6 is an alternate.)

Prepare a balance sheet for a farm—an entity with a wide variety of assets.

Also, explain the effects upon this balance sheet of the destruction of one of the

assets.

(

Alternate to Problem 2–5.

)

2.7 A,B 35 Medium

2.8 A,B 40 Strong

Prepare a balance sheet from an alphabetical listing of accounts, and prepare a

second balance sheet and a statement of cash flows after some additional

transactions. Evaluate the com

p

an

y

’s relative solvenc

y

at each date

.

The student is asked to prepare a balance sheet from an alphabetical list of

accounts and then to prepare a second balance sheet as well as an income

statement and a statement of cash flows, after several transactions. Evaluate the

com

p

an

y

’s relative solvenc

y

at each date

.

35 Strong

2.10 A,B 30 Strong

Given an improperly prepared balance sheet, student is asked to prepare a

corrected balance sheet and to explain the proper valuation of assets, liabilities,

and owners’ equity. Stresses generally accepted accounting principles.

Given a balance sheet and supplementary information concerning the assets

and liabilities, the student is asked to prepare a corrected balance sheet and to

explain the violations that exist as to asset valuation and the entity concept.

Stresses GAAP.

2.9 A,B

30 Medium

2.2 30 Strong*

Students are to obtain an annual report from the library and answer questions

about the company’s balance sheet, income statement, and statement of cash

flows. Suitable assignment for groups or individuals.

Students are to prepare a realistic balance sheet for a hypothetical

business—the nature of which is specified by the instructor. Challenges the

student to think about the types of assets and liabilities arising in an actual

business. Suitable assignment either for groups or individuals.

2.1

Desc. of Prob & Cases

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Usin

g

a Balance Sheet

Using Statements of Cash Flow

on hand.

Ethics and Window Dressing

2.6 Public Company Accounting Oversight Board 30 Easy

Ethics, Fraud & Corporate Governance

Gathering Financial Information

Internet

Students locate the PCAOB and state the mission, identify the members, and

describe the authority and responsibility of the PCAOB.

2.5

2.3

2.4

30 Medium

A tried-and-true case in which students are to evaluate the financial position of

two similar companies first from the viewpoint of a short-term creditor and then

from the viewpoint of a buyer of the business. We always use this one.

35 Medium

Students are presented with abbreviated cash flow information and asked to

decide which is in a stronger position. An excellent way to show that how a

company generates its cash is equally important to how much cash it has

Students are to distinguish between legitimate window dressing and fraudulent

misrepresentation. Allows introduction of ethics, securities laws, and the role of

independent audits.

30 Medium

2.7 25 Easy

Visit EDGAR, the SEC’s database, and gather financial information about

Cisco Systems. A user-friendly “meet EDGAR” type of problem.

Desc. of Prob. & Cases

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1.

2.

3.

4.

5.

6.

Revenues result from transactions in which goods or services are transferred (i.e., sold) to

customers. Expenses are costs associated with earning revenues. Revenues already have

resulted in or will result in positive cash flows, while expenses have resulted in, or will result

in, negative cash flows. An enterprise’s net income is determined as the excess of revenues

over expenses for a period of time. If expenses exceed revenues, however, the difference is

called a net loss.

Business transactions affect a company’s financial position, and as a result, they change the

statement of financial position or balance sheet. The other financial statements—the income

statement and the statement of cash flows—are detailed expansions of certain aspects of the

statement of financial position and help explain in greater detail how the company’s financial

position changed over time.

The basic accounting equation indicates that assets = liabilities + owners’ equity. Assets are

resources owned by the company that are used in carrying out its business activities.

Liabilities are debts owed by the enterprise, and owners’ equity is the interest of the owners

in the enterprise’s assets.

The going concern assumption states that in the absence of evidence to the contrary (i.e.,

bankruptcy proceedings), an enterprise is expected to continue to operate in the foreseeable

future. This means, for example, that it will continue to use the assets it has in its financial

statements for the purpose for which they were acquired.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

Many of these questions are well suited to classroom discussions. These discussions can stimulate

students’ interest, help develop verbal skills, and provide instructors with an opportunity to introduce

ideas and situations not discussed in the text. If class size permits, we also encourage instructors to

review and evaluate selected written assignments throughout the course.

The basic purpose of accounting is to provide decision makers with information useful in

making economic decisions.

A knowledge of accounting terms and concepts is useful to persons other than professional

accountants because nearly everyone working in business, government, or the professions

will encounter these terms and concepts. Supervisors and managers at every level will use

financial statements, budgets, or other forms of accounting reports. Investment in securities

or real estate also calls for the use of accounting information. In every election, propositions

on the ballot and in the platforms of candidates can be much better understood by voters who

are familiar with accounting. Accounting information is also useful to individuals in

handling their personal financial affairs. In short, all economic activity is supported by

accounting information.

Q1-6

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7.

8. a.

b.

9.

10.

11.

12. Adequate disclosure refers to the requirement that financial statements, including

accompanying notes, must include information necessary for reasonably informed users of

financial statements to understand the company’s financial activities. This requirement is met,

in part, by the addition of notes to the financial statements. Financial statement notes include

both quantitative and qualitative information that is not included in the body of the financial

statements.

Operating activities—Cash provided by and used in revenue and expense transactions.

Investing activities—Cash provided by and used as a result of investments in assets, such as

machinery, equipment, land, and buildings.

Financial statements—the balance sheet, income statement, statement of cash flows—are all

based on the same underlying transactions. They reflect different aspects of the enterprise’s

activities. Their relationship is referred to as “articulation.” For example, the revenues and

expenses in the income statement result from changes in the assets and liabilities in the balance

sheet and their cash effects are presented in the operating activities section of the statement of

cash flows.

Financing activities—Cash provided by and used in debt and equity financing, such as

borrowing and repaying loans, and new capital received from and dividends paid to the

enterprise’s owners.

Positive cash flows means that cash increases. Negative cash flows means that cash decreases.

Generally, revenues result in positive cash flows—either at the time of the revenue transaction,

earlier, or later. Expenses result in negative cash flows—either at the time the expense is

incurred, earlier, or later.

The three categories and the information included in each are:

No, a business transaction could not affect only a single asset. There must be an offsetting

change elsewhere in the accounting equation. If the transaction increases an asset, for

example, it must reduce another asset, increase a liability, or increase owners’ equity (or some

combination of these). On the other hand, if the transaction decreases an asset, it must increase

another asset, decrease a liability, or decrease owners’ equity (or some combination of

these).

An example of a transaction that would cause one asset to increase and another asset to

decrease without any effect on the liabilities or owners’ equity is the receipt of cash in

collection of an account receivable. Another common example is the payment of cash to bu

y

land, a building, office equipment, or other assets.

An example of a transaction that would cause both total assets and total liabilities to

increase without any effect on the owners’ equity is the purchase of an asset on credit. The

acquisition of the asset could be entirely on credit or could involve a partial cash payment

with the balance on credit. Another example is an increase in cash by borrowing from a

bank.

Q7-12

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12.

13.

14.

15.

A strong income statement is one that has significantly more dollars of revenue than expenses,

resulting in net income that is a relatively high percentage of the revenue figure. A trend of

relatively high income numbers over several accounting periods signals a particularly strong

income situation.

A strong statement of cash flows is one that shows significant amounts of cash generated from

operating activities. This means that the enterprise is generating cash from its ongoing activities

and is not required to rely heavily on debt and equity financing, or the sale of its major assets, t

o

finance its daily operations. A trend of relatively high cash flows provided by operations

numbers over several accounting periods signals a particularly strong cash flow situation.

Adequate disclosure refers to the requirement that financial statements, including

accompanying notes, must include information necessary for reasonably informed users of

financial statements to understand the company’s financial activities. This requirement is met,

in part, by the addition of notes to the financial statements. Financial statement notes include

both quantitative and qualitative information that is not included in the body of the financial

statements.

The term “window dressing” refers to enhancing the appearance of the enterprise’s financial

statements by taking certain steps near the end of the financial reporting period. While some

steps that may be taken, or delayed, are appropriate, care must be taken that steps taken are not

unethical or illegal.

Q13-15

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B. Ex. 2.1

B. Ex. 2.2

B. Ex. 2.3

B. Ex. 2.4

B. Ex. 2.5

B. Ex. 2.6

B. Ex. 2.7

Increases in cash:

Revenues $100,000

Sale of land 10,000

Borrowing from bank 15,000 $125,000

Decreases in cash:

Expenses 56,000

Purchase of truck 20,000 (76,000)

Net increase in cash $49,000

B. Ex. 2.8

Joe Solway, Capital $25,000

Tom Solway, Capital 25,000 $50,000

B. Ex. 2.9

Capital stock $40,000

Retained earnings 10,000 $50,000

$65,000 (total equity) – $50,000 (capital stock) = $15,000 (retained earnings)

SOLUTIONS TO BRIEF EXERCISES

Green Company’s assets (machinery) will increase by $10,000. The company’s liabilities will

also increase by $10,000 to include the new obligation the company has assumed.

Foster Inc.’s assets will increase by a net amount of $25,000. Cash will decrease by $5,000 and

the truck account will increase by $30,000, a net increase of $25,000. The company’s liabilities

will also increase by $25,000 to reflect the new obligation that has been assumed.

$150,000 (assets) – $85,000 (liabilities) = $65,000 (total equity)

$125,000 (revenues) – $50,000 (expenses) = $75,000 net income

Note: The year-end cash balance of $35,000 does not affect the amount of net income.

Yes, the company has liabilities because its assets exceed its capital stock and its retained

earnings. $780,000 (assets – [$500,000 + 150,000](equity) = $130,000 (liabilities)

$300,000 (revenues) – $205,000 (expenses) = $95,000 (net income)

Note: The purchase of land for $45,000 does not affect net income.

BE2.1,9

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B. Ex. 2.10

50,000$

Add: 10,000

25,000

85,000$

Net income for 2011…………………………

…

Balance, December 31, 2011………………………………

…

The end-of-year balance of owner’s equity in the balance sheet is $85,000.

This amount articulates with the amount of net income in the income

statement because net income is added to the amount of beginning owner’s

equity, plus additional investment, to determine the ending balance that

appears in the December 31, balance sheet. The accounting equation stays

in balance because the amount of net income is reflected in changes in the

balances of various assets and liabilities that are also presented in the

ba

l

a

n

ce

s

h

eet.

John Franklin, owner’s equity:

Balance, January 1, 2011…………………………………

…

Investment during 2011………………………

…

BE2.10

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Ex. 2.1 a.

1.

2.

b.

1.

SOLUTIONS TO EXERCISES

Assets are economic resources owned by the business entity.

Among the assets of American Airlines we might expect to find

investments, accounts receivable (say, from travel agents), fuel (in

storage), maintenance supplies, aircraft, and various types of equipment.

The company also owns land and buildings—as, for example, its corporate

head

q

uarters.

Among the assets of a professional sports team are investments (in stocks and

bonds), notes receivable (often from players), training equipment, supplies, and

office furniture. (The balance sheet of a professional sports team may not

include land or buildings, as they generally do not own the stadiums in which

the

y

p

la

y

.

)

Note to instructor: You may wish to expand this solution to include intangible assets, such as the

team’s league franchise, and player contracts, the right to receive the future services of a given

player. (Player contracts only appear as an asset if they have a cost—that is, if they were

purchased from other teams. Advance payments to players usually are shown as prepaid

expenses.) We address intangible assets in Chapter 9, but the concept is consistent with the

discussion of assets in Cha

p

ter 2.

Liabilities are existing debts and other obligations of the entity.

Among the liabilities of American Airlines, we might expect to find accounts

payable, notes payable (or mortgages or bonds payable) stemming from

purchases of aircraft, salaries payable, interest payable, rent payable (for space

in air

p

orts

),

and income taxes

p

a

y

able.

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