7-18 Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital
SHORT PROBLEMS
1. Page Inc., a computer manufacturer located in Texas, lost an uninsured building due to
the infrequent and unusual occurrence of a hurricane. The building has a balance sheet
value of $30,000 and will cost $165,000 to rebuild. Page’s income tax rate is 40%.
Calculate the amount of any extraordinary loss that should be reported on Page’s
income statement. Prepare a partial income statement that shows how the item will be
presented.
2. Profiles Corp. had the following infrequent income statement items during 2009:
• $44,000 of dividends received from a stock investment
• $20,000 gain on the sale of a plant asset which became outdated because of new technology
• $19,000 loss due to the sale of treasury stock at a price less than its original cost
• $34,000 fair value adjustment increase to market for available–for-sale investments
• $50,000 interest expense for the year of which only $42,000 was actually paid
How much should Profiles report as a component of ‘income from continuing operations’?
Use the information that follows concerning Palomar Corp. to answer questions 3
through 6.
Nichol Corp. has 20,000 shares of common stock outstanding. For the year ending December
31, 2009, the company tentatively reported income from continuing operations before taxes of
$320,000. Nichol Corp. has a 30 percent tax rate. The additional information given below has
not been recorded in the accounts unless specifically stated.
a. The company is located in Cheyenne, Wyoming . During the year, an earthquake destroyed some
of Nichol’s assets amounting to a loss of $120,000. Earthquakes are considered infrequent in this
area and are very unusual.
b. The company’s employees went on strike for six weeks in March of 2009. Revenues would have
been about $23,000 more had the strike not occurred. No adjustment was recorded.
c. During 2009, the company changed its method of accounting for inventories from FIFO to
weighted average. Cost of goods sold related to prior years would have been $39,000 greater.
d. The company’s accounts include $47,000 as Unrealized Holding Gain from Trading Investments
at December 31, 2009.
Test Bank – Chapter 7 – operating Transactions – Revenues, Expenses, and Working Capital 7-19
3. How much should be reported on the income statement for the year ended December
31, 2009 as ‘Extraordinary Gains or Losses’?
4. Calculate how much should be reported on Nichol’s income statement as ‘Income from
Continuing Operations’ for the period ended December 31, 2009.
5. How much should be reported on the income statement for the year ended December
31, 2009, as ‘Cumulative Effect of a Change in Accounting Principle’?
6. Name the specific items for which Nichol Corp. must apply intraperiod tax allocation in its
financial statements.
7-20 Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital
7. The following are the revenue and expense accounts of the current year for ABCO
Corporation:
Sales revenue
$200,000
Interest revenue
3,000
Interest expense
6,000
Gain from sale of land
2,700
Cost of goods sold
120,000
Administrative expense
39,000
Gain due to hurricane loss – infrequent and unusual
45,000
All items are before income taxes. The income tax rate is 20%. Calculate any
extraordinary gain or loss that should be disclosed on the income statement.
8. Accrued wages payable on December 31, 2008 and 2009 are $9,000 and $4,000,
respectively. During 2009, wages expense is $36,000. Calculate the amount of cash
paid for wages during 2009.
9. Beginning and ending balances for relevant balance sheet accounts are as follows:
1/01/09
Merchandise inventory
$21,000
Accounts payable
8,000
During 2009, cost of goods sold was $102,000. Calculate the amount of cash paid to
suppliers of merchandise inventory.
10. The comparative balance sheets of Shad Inc. contain prepaid insurance of $48,000 on
January 1, 2009 and $37,000 on December 31, 2009. Shad’s 2009 income statement
contains insurance expense of $15,000. Calculate the amount of cash paid for insurance
premiums during 2009.
Test Bank – Chapter 7 – operating Transactions – Revenues, Expenses, and Working Capital 7-21
11. The accounts receivable balances on January 1 and December 31 are $22,000 and
$18,000, respectively. The income statement for the year included sales revenue of
$120,000. Determine the amount of cash collected from customers during the year.
12. Beginning and ending balances for selected accounts are as follows:
12/31/09
1/01/09
Accounts receivable
$14,000
$19,000
Revenue received in advance
6,000
3,000
During 2009, sales revenue is $110,000. Calculate the cash collected from customers.
13. The August 1 and August 31 balances in accounts receivable are $21,000 and $18,000,
respectively. During August, the company collected $56,000 from its customers and
incurred $37,000 of expenses, all paid in cash. Calculate the amount of cash flows from
operations for August.
14. Parton Inc.. reported accounting service revenue of $450,000 for 2009. On January 1,
2009, Parton Inc. had $38,000 of accounts receivable and $0 of cash deposits received
from customers. On December 31, 2009, accounts receivable and deposits received
were $49,000 and $6,000, respectively. Calculate the amount of cash collected from
clients during 2009.
7-22 Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital
15. At the beginning of 2010, Kacie Corp.’s allowance for doubtful accounts is $9,000.
During 2010, $7,000 was written off as uncollectible. At December 31, the company
used an aging schedule of accounts receivable and determined that $8,000 of the
accounts receivable would probably be uncollectible. Calculate bad debts expense to be
reported on Kacie’s 2010 income statement.
16. Before adjusting entries, Kelvin’s accounts receivable and allowance for doubtful
accounts are $65,000 and $1,500, respectively. Using an aging schedule of accounts
receivable, it is determined that $3,000 of the accounts receivable would probably be
uncollectible. Calculate bad debts expense to be reported on Kelvin’s current year’s
income statement?
17. Paxton’s aging schedule of its accounts receivable on December 31 follows:
Account Age
Balance
Non-collection Likelihood
1-30 days
$100,000
3%
31-90 days
70,000
7%
Over 90 days
40,000
10%
The balance in Paxton’s allowance for doubtful accounts immediately prior to December
31 adjusting entries is $700 credit. Determine bad debts expense and the net realizable
value of the December 31 accounts receivable.
Test Bank – Chapter 7 – operating Transactions – Revenues, Expenses, and Working Capital 7-23
Use the information that follows concerning the current assets and current liabilities of
Kandace Company at December 31, 2010, to answer problems 18 through 23. Each
problem is independent of the others.
Current Assets
Cash
$1,700
Accounts Receivable
$2,900
Less Allowance
(70)
2,830
Inventory
2,270
Prepaid expenses
300
Total
$7,100
Current Liabilities
Accounts payable
$4,000
Wages payable
300
Taxes payable
200
Rent payable
800
Notes payable
1,000
Total
$6,300
18. How would the current ratio be affected if Kandace collects the accounts receivable and
then uses some of the cash to pay off the accounts payable?
19. Calculate Kandace’s working capital, current ratio, and quick ratio at December 31,
2010.
20. How would the quick ratio be affected if Kandace purchased $500 of inventory on
account?
7-24 Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital
21. How would the current ratio be affected if Kandace collects $600 from customers for
amounts owed?
22. What would the quick ratio be if Kandace sold all of its inventory for $5,000 cash?
23. How would the current ratio be affected if Kandace paid off its wages and taxes?
Use the information that follows concerning Walker Corporation to answer problems 24- 27.
Walker Corporation began business on January 1. During January, Walker reported the
following:
January 1 purchase:
100 units @ $10 =
$1,000
January 10 purchase:
150 units @ $15 =
$2,250
January sales:
200 units
24. Determine the amount of inventory to report on Walker’s balance sheet at January 31
under the FIFO cost flow assumption.
Test Bank – Chapter 7 – operating Transactions – Revenues, Expenses, and Working Capital 7-25
25. Determine the amount of inventory to report on Walker’s balance sheet at January 31
under the LIFO cost flow assumption.
26. Determine the amount of the inventory valuation on January 31 under the averaging cost
flow assumption.
27. Determine the amount of cost of goods sold under the FIFO cost flow assumption for the
month of January.
28. Warren Trading pays for its inventory purchases with cash. Beginning inventory is
$2,000, purchases were $19,000, and cost of goods sold is $18,000. Determine the cost
of Warren’s ending inventory.
7-26 Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital
29. Yakir Company began business on August 1, 2004. During August, Yakir made the
following purchases:
August 3
100 units @ $10
$1,000
August 21
300 units @ $20
$6,000
Other information provided:
August sales
350 units at $50 each
August expenses excluding cost of goods sold
$7,200
August 31 current assets excluding inventory
$34,000
August 31 current liabilities
$26,000
Calculate Yakir’s August 31 ending inventory under the FIFO and LIFO cost flow assumptions.
30. Nakita Inc. reported beginning inventory of $90,000, ending inventory of $23,000,
purchases of $128,000, purchase returns of $2,000, and transportation-in of $3,000.
Calculate cost of goods sold.
31. On October 1, Accurate Company borrowed $2,000 in return for a nine-month note
payable with a maturity value of $2,600. Calculate the amount of interest expense and
the balance sheet value for the year ending December 31.
Test Bank – Chapter 7 – operating Transactions – Revenues, Expenses, and Working Capital 7-27
32. Bradley Incorporated owns a chain of retail stores. During December of 2009, a
customer slipped in a doorway of its Missouri store and broke his ribs. He is suing
Bradley for $200,000 for negligence. Bradley’s legal counsel believes that it is only
reasonably probable that Bradley will lose its defense of the lawsuit because, although
the doorway was icy due to an ice storm that was occurring at the time of the fall, a sign
on the door warned customers that the doorway was slippery when icy. On December
30, 2009, before considering the effects of this lawsuit, Bradley’s current assets, total
assets, current liabilities, and total liabilities were $420,000, $840,000, $100,000, and
$300,000, respectively. After this event is properly accounted for, calculate Bradley’s
debt/equity ratio on December 31, 2009.
33. Patrick Incorporated owns a chain of retail stores. During December of 2009, a customer
slipped in a doorway of its Nebraska store and broke his ribs. He is suing Patrick for
$200,000 for negligence. Patrick’s legal counsel believes that it is remote that Patrick will
lose its defense of the lawsuit because the doorway recently was rebuilt with all weather
traction stripping and a sign on the door warned customers that the doorway was
slippery when icy. On December 30, 2009, before considering the effects of this lawsuit,
Patrick’s current assets, total assets, current liabilities, and total liabilities were $420,000,
$840,000, $100,000, and $300,000, respectively. After this event is properly accounted
for, calculate Patrick’s debt/equity ratio on December 31, 2009.
34. Atlantic Company estimates warranty expense as 5% of sales. On January 1, warranties
payable was $10,000. During the year, Atlantic paid $8,000 to meet its warranty
obligations and recorded sales of $300,000. Calculate warranties payable on December
31.
7-28 Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital
35. On July 1, Garden Company borrowed $10,000 in return for an eight-month note
payable with a maturity value of $10,600. Calculate the amount of interest expense for
the current year.
36. On January 1 and December 31, warranties payable were $6,000 and $4,000,
respectively. During the current year, sales were $100,000, upon which 3% was
estimated to be the amount required for future warranty payments. Calculate the amount
paid for warranties during the current year.
37. On December 31, 2009, Roper Company had current assets of $15,000 in cash and
current liabilities of $8,000 in accounts payable, resulting in a current ratio of 1.88. The
company needs to increase its current ratio to 2.75 by December 31, 2010. Calculate the
amount of accounts payable that needs to be paid in order to boost the current ratio to
2.75.
Test Bank – Chapter 7 – operating Transactions – Revenues, Expenses, and Working Capital 7-29
SHORT ESSAY QUESTIONS
1. How are operating transactions that are not based primarily on the normal operations of
a company reported on the financial statements?
2. One of the three objectives of financial reporting directly relates to the income statement
and measure of income. Indicate the context of this objective, and explain how it relates
to the earnings process.
3. Is consistency violated when a company changes accounting principles?
Solution:
7-30 Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital
4. How does the direct method of preparing the statement of cash flows differ from the
indirect method?
Solution:
5. In the operating activities section of a statement of cash flows prepared using the
indirect method certain items are added to net income. Why is depreciation added?
6. Why is cash generated from operating activities more important than cash generated
from other sources?
Test Bank – Chapter 7 – operating Transactions – Revenues, Expenses, and Working Capital 7-31
7. Preston Bank has $50 million of loans outstanding on December 31 of the current year,
in which it recorded net income of $770,000. Preston did not provide for any
uncollectible loans because all of its loans are collateralized by real estate. That is, if the
loans were to default, Preston would obtain the title to the real estate for which the loans
were made. However, during the audit of Preston’s financial statements, the auditing
company determined that $5 million of the outstanding loans would probably be
dishonored (uncollectible). Because during the last three years real estate values have
deteriorated, they also investigated the real estate that backed these collateralized
loans. The market value of that real estate is negligible.
Recalculate Preston’s loans receivable on December 31 and current net income to an
amount that would be acceptable to the auditors.
Solution:
8. Why is the timing of recording a receivable important?
Solution:
7-32 Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital
9. The following is a partial balance sheet for Que Company dated December 31, 2010:
Current assets
Cash
$20,000
Accounts receivable
$45,000
Allowance for doubtful accounts
(3,000)
Net realizable value
42,000
Inventory
33,000
Total current assets
$95,000
Current liabilities
$65,000
During 2010, $4,000 of accounts receivable were written off and bad debts expense
recognized on Que’s 2010 net income statement was $8,000. However, the president of
the company believes that $2,500 of these receivables were written off too soon. She
correctly believes that there is a good chance that they will be collected next year.
The reason for her position is that Que has a debt covenant requiring it to maintain a
current ratio of 1.5. The president believes that by reversing the write-off of $2,500 of
accounts receivable, the current assets will be $97,500 and the current ratio will be 1.5.
However, the chief financial officer states that a better approach is to pay off some
accounts payable. If the company paid $5,000 of accounts payable, the current ratio
would become the minimum 1.5 required by the debt covenant.
Comment, with numerical illustration, on the president’s and chief financial officer’s
positions.
Test Bank – Chapter 7 – operating Transactions – Revenues, Expenses, and Working Capital 7-33
10. Please explain the statement that “a LIFO liquidation creates ‘phantom’ income”.
Solution:
11. Identify the options a manager has in measuring the cost of inventory as it flows through
the accounting system.
12. If an entity overstates its ending inventory for the current year, what are the effects on
assets, cost of goods sold, retained earnings, and total stockholders’ equity for the
current year?
7-34 Test Bank – Chapter 7 – Operating Transactions – Revenues, Expenses, and Working Capital
13. A major airline issues frequent flyer credits that allow the passenger to receive credit
toward future flights. For every ticket sold the customer receives a credit which, when 40
are collected, can be exchanged for a free ticket. During the year, the airline company
recorded revenues of $60 million, which represented 100,000 tickets. The airline did not
recognize the flyer credits on its income statement or its balance sheet. In the context of
contingent liabilities, comment on the airline’s accounting procedures.
14. What three characteristics should all liabilities that appear on the balance sheet have in
common?
15. How do ‘determinable’ current liabilities differ from ‘contingent’ liabilities?