Chapter 2: Financial Statements and the Annual Report
186. Mill Valley Corporation was organized on January 1, 2014, with the investment of $225,000 in cash by its
stockholders. The company immediately purchased an office building for $300,000, paying $201,000 in cash
and signing a three-year promissory note for the balance. Mill Valley signed a five-year, $50,000
promissory note at a local bank during 2014 and received cash in the same amount. During its first year, Mill
Valley collected $93,000 from its customers. It paid $60,600 for inventory, $22,400 in salaries and wages,
and another $5,100 in taxes. Mill Valley paid $5,300 in cash dividends.
Required:
1. Prepare a statement of cash flows for the year ended December 31, 2014.
2. What does this statement tell you that an income statement does not?
Chapter 2: Financial Statements and the Annual Report
187. Identify each of the following items as operating (O), investing (I), or financing (F) activities on the statement
of cash flows(assuming the indirect method). If an item is not on the statement, please mark it as none of
these (N). If the item is an inflow, please indicate by a (+), (e.g. O+, I+ or F+). If the item is an outflow, please
indicate by brackets, (e.g., <O> for operating outflow, <I> for investing outflow, and <F> for financing
outflow:
(a) Paid an account payable for inventory purchased in the previous accounting period.
(b) Amortization of debt issuance costs
(c) Paid a dividend to stockholders.
(d) Paid the interest on a note payable to National Street Bank.
(e) Paid the principal amount due on the note payable to National Street Bank.
(f) Transferred cash from a checking account into a money market fund.
(g) Purchased equipment for cash.
188. Most financial reports contain the following list of basic elements. For each element identify the person(s)
who prepared the element and describe the information a user would expect to find in each element.
Elements
Prepared By
Information Provided
Management
Discussion &
Analysis
Financial Statements
Notes to Financial
Statements
Report of
Independent
Accountants
Chapter 2: Financial Statements and the Annual Report
189. Comparative income statements for Gregson Inc. are as follows:
2014
2013
Sales
$2,000,000
$600,000
Cost of sales
800,000
400,000
Gross profit
$1,200,000
$200,000
Operating expenses
520,000
120,000
Operating income
$ 680,000
$ 80,000
Loss on sale of subsidiary
(800,000)
0
Net income (loss)
$ (120,000)
$ 80,000
Required:
The president and management believe that the company performed better in 2014 than it did in 2013. Write
the president’s letter to be included in the 2014 annual report. Explain why the company is financially sound
and why shareholders should not be alarmed by the $120,000 loss in a year when gross profit increased
significantly.
190. What financial statement items are investors and creditors most interested in and why?
Chapter 2: Financial Statements and the Annual Report
191. Cory Harper, a newly hired accountant, wanted to impress his boss, so he stayed late one night to analyze the
office supplies expense account. He determined the cost by month, for the past 12 months, of each of the
following: computer paper, copy paper, fax paper, pencils and pens, note pads, postage, corrections supplies,
stationery, and miscellaneous items. Why do companies not include information of this nature in published
financial statements?
192. Service-oriented companies have different needs than product-oriented companies when analyzing
financial statements.
Required:
Why is this true? Give an example of a financial ratio that is meaningless to a service business.
193. Ginger Company claims its financial information is useful. What two qualities must be present in order to
have “useful” accounting information? Explain these two qualities.
194. What is the difference between comparability and consistency?
195. What is conservatism and why is it important in accounting?
Chapter 2: Financial Statements and the Annual Report
196. How is a classified balance sheet useful to decision makers?
197. What is the operating cycle of a business? How does this impact the classification of assets into current
and noncurrent categories?
198. How does the definition of a current liability relate to that of a current asset?
199. Potential stockholders and lenders are interested in a company’s financial statements. Several financial
statement items appear below. Answer the questions that follow.
Accounts receivable
Accounts payable
Advertising expense
Cash
Depreciation expense
Income taxes
Common stock
Land held for future expansion
Dividends
Retained earnings
Loss on the sale of equipment
Service revenue
Office supplies
Patent amortization expense
Sales
Unearned revenue
Utilities expense
A) Which two items would stockholders be most interested in that can either be computed
from the above data or are included in the items listed above? Explain why the two you
selected are important to stockholders.
B) In which one item would lenders be most interested? Explain why this item is important.
200. What is the purpose of a statement of stockholders’ equity? How does it differ from the statement of
retained earnings? Which statement is required?
Chapter 2: Financial Statements and the Annual Report
201. What is the purpose of a statement of cash flows? Give an example of one of each of the three activities.
202. What information is provided in an annual report in addition to the financial statements?
Identify whether the following investor questions are associated with (a) primary or (b) secondary
financial reporting objectives.
a. primary financial reporting objective
b. secondary financial reporting objective
203. How much has Apple invested in research and development projects?
204. Based on the financial information, should I buy shares of Apple?
205. If I buy 50 shares of Apple, how much cash will I receive in dividends each year?
206. How much revenue will Apple generate during the time period in which I own the shares?
207. Based on the financial information, should I sell my shares of Apple next quarter?
Match the following characteristics with the statements about each qualitative characteristic’s
importance.
a. Consistency
b. Materiality
c. Conservatism
d. Comparability
e. Reliability
f. Relevance
g. Understandability
208. Those willing to spend the time should be provided with comprehensible accounting information.
209. The accounting information must be information that could affect a decision.
Chapter 2: Financial Statements and the Annual Report
210. Accounting information should use the least optimistic estimate.
211. This quality allows users to analyze two or more companies and look for similarities and differences.
212. Users must be able to compare accounting information of a firm with its prior year information.
213. Accounting information must be verifiable and faithfully represent actual transactions.
214. This quality refers to an amount large enough to affect a decision.
For each item listed, select the section of the balance sheet in which the item would be reported.
a. Current Assets
b. Property. Plant, and Equipment
c. Current Liabilities
d. Long-term Liabilities
e. Stockholders’ Equity
215. Cash
216. Accounts payable
217. Retained earnings
218. Land
219. Capital stock
220. Accounts receivable
221. Equipment
222. Notes payable—due within one year
223. Interest payable
Chapter 2: Financial Statements and the Annual Report
224. Bonds payable
225. Computer used within the business
226. Computer available for resale
Match the selected items from a classified balance sheet and multiple-step income statement to the section
in which they would appear on the classified balance sheet or the income statement.
a. Current Assets (balance sheet)
b. Property, Plant, & Equipment (balance sheet)
c. Current Liabilities (balance sheet)
d. Long-term Liabilities (balance sheet)
e. Stockholders’ Equity (balance sheet)
f. Operating Revenue (income statement)
g. Operating Expenses (income statement)
h. Other Revenue & Expenses (income statement)
i. Income Taxes (income statement)
227. Accounts receivable
228. Consulting revenues
229. Buildings
230. Interest expense
231. Capital stock
232. Land
233. Bonds payable
234. Income taxes payable
235. Service revenues
Chapter 2: Financial Statements and the Annual Report
236. Wages payable
237. Cost of goods sold
From the following choices, select the answer that describes the effect on working capital as a result of
the transaction.
a. Working capital will increase
b. Working capital will decrease
c. Working capital will not change
238. Paid cash for supplies
239. Purchased inventory on account
240. Purchased land for cash
241. Borrowed cash using a long-term note
242. Borrowed cash using a six-month note
243. Collected an account receivable
From the following list, select the proper section from the statement of cash flows in which it would be
classified.
a. Operating Activities
b. Investing Activities
c. Financing Activities
244. Purchased equipment for cash
245. Received cash from the sale of a building
246. Paid a cash dividend on capital stock
247. Received cash from bond issuance
248. Paid income taxes
Chapter 2: Financial Statements and the Annual Report
249. Received cash from selling goods to customers
250. Sold equipment no longer used in the business
251. Paid suppliers cash for inventory purchased
252. In preparing financial statements, accountants should consider all of the following except:
a. The objectives of financial reporting.
b. The characteristics that make accounting information useful.
c. The most useful way to display the information found on the financial statements.
d. The presentation of the value of a company.
253. Which of the following is the best description of the purpose of financial reporting?
a. To allow users to access to the daily detailed records of a business.
b. To help the users reach their decisions in an informed manner.
c. To provide users with an assessment of how long the company will continue as a going concern.
d. To allow users access to a list of all the individuals who owe the company money.
254. The quality of accounting information that allows a user to analyze two or more companies and look for
similarities and differences is known as understandability.
a. True
b. False
255. The quality of accounting information that makes it comprehensible to those willing to spend the necessary
time is consistency.
a. True
b. False
256. The quality of accounting information that allows a user to compare two or more accounting periods for a
single company is known as consistency.
a. True
b. False
257. You are comparing three companies that use different depreciation methods. Which of the following would
help you the most in making a comparison of the companies?
a. The average earnings per share for the quarter.
b. Prospective cash receipts.
c. Claims to resources.
d. Disclosure of accounting policies.
258. There is a standard threshold for materiality set by the Financial Accounting Standards Board for all companies.
a. True
b. False
259. The lack of a common depreciation method makes it impossible to compare the performance companies
using different methods.
a. True
b. False
260. The amount of a transaction may be immaterial by company standards but still be considered significant
by financial statement users.
a. True
b. False
261. Which of the following are generally supplementary information required by GAAP concerning the accounting
treatments used by a company?
a. A Year-End Worksheet
b. Management’s Discussion and Analysis
c. The Report of Independent Accountants
d. Notes to the Consolidated Financial Statements