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Chapter 2: Financial Statements and the Annual Report
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Matching
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
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-01 - LO: 03-01
KEYWORDS:
Bloom's: Understanding
162. How much has Apple invested in research and development projects?
ANSWER:
b
163. Based on the financial information, should I buy shares of Apple?
ANSWER:
a
164. If I buy 50 shares of Apple, how much cash will I receive in dividends each year?
ANSWER:
b
165. How much revenue will Apple generate during the time period in which I own the shares?
ANSWER:
b
166. Based on the financial information, should I sell my shares of Apple next quarter?
ANSWER:
a
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
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-02 - LO: 02-02
KEYWORDS:
Bloom's: Remembering
167. Those willing to spend the time should be provided with comprehensible accounting information.
ANSWER:
g
168. The accounting information must be information that could affect a decision.
ANSWER:
f
169. Accounting information should use the least optimistic estimate.
ANSWER:
c
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
170. This quality allows users to analyze two or more companies and look for similarities and differences.
ANSWER:
d
171. Users must be able to compare accounting information of a firm with its prior year information.
ANSWER:
a
172. Accounting information must be verifiable and faithfully represent actual transactions.
ANSWER:
e
173. This quality refers to an amount large enough to affect a decision.
ANSWER:
b
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
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-03 - LO: 02-03
KEYWORDS:
Bloom's: Remembering
174. Cash
ANSWER:
a
175. Accounts payable
ANSWER:
c
176. Retained earnings
ANSWER:
e
177. Land
ANSWER:
b
178. Capital stock
ANSWER:
e
179. Accounts receivable
ANSWER:
a
180. Equipment
ANSWER:
b
181. Notes payable—due within one year
ANSWER:
c
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
182. Interest payable
ANSWER:
c
183. Bonds payable
ANSWER:
d
184. Computer used within the business
ANSWER:
b
185. Computer available for resale
ANSWER:
a
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)
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-03 - LO: 02-03
FACC.PONO.13.02-05 - LO: 02-05
KEYWORDS:
Bloom's: Remembering
186. Accounts receivable
ANSWER:
a
187. Consulting revenues
ANSWER:
f
188. Buildings
ANSWER:
b
189. Interest expense
ANSWER:
h
190. Capital stock
ANSWER:
e
191. Land
ANSWER:
b
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
192. Bonds payable
ANSWER:
d
193. Income taxes payable
ANSWER:
c
194. Service revenues
ANSWER:
f
195. Wages payable
ANSWER:
c
196. Cost of goods sold
ANSWER:
g
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
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-04 - LO: 02-04
KEYWORDS:
Bloom's: Understanding
197. Paid cash for supplies
ANSWER:
c
198. Purchased inventory on account
ANSWER:
c
199. Purchased land for cash
ANSWER:
b
200. Borrowed cash using a long-term note
ANSWER:
a
201. Borrowed cash using a six-month note
ANSWER:
c
202. Collected an account receivable
ANSWER:
c
Chapter 2: Financial Statements and the Annual Report
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
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
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-08 - LO: 02-08
KEYWORDS:
Bloom's: Remembering
203. Purchased equipment for cash
ANSWER:
b
204. Received cash from the sale of a building
ANSWER:
b
205. Paid a cash dividend on capital stock
ANSWER:
c
206. Received cash from bond issuance
ANSWER:
c
207. Paid income taxes
ANSWER:
a
208. Received cash from selling goods to customers
ANSWER:
a
209. Sold equipment no longer used in the business
ANSWER:
b
210. Paid suppliers cash for inventory purchased
ANSWER:
a
213. Read the information about Smith Corporation.
Required:
Prepare the current assets section of the balance sheet for Smith Corp. at December 31, 2016. You may omit the heading.
How does the concept of liquidity apply?
ANSWER:
Cash
$11,000
Accounts receivable
35,000
Inventory
33,000
Prepaid rent
4,000
Office supplies
2,000
Total current assets
$85,000
Liquidity is an indicator of how close to cash the company’s assets are. Those assets that are
most liquid are listed first. Current assets are expected to be converted into cash or used up
within the next accounting period.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-03 - LO: 02-03
KEYWORDS:
Bloom's: Analyzing
214. Read the information about Smith Corporation.
Required:
Calculate Smith’s current ratio at December 31, 2016. What does this ratio tell you about the "composition" of the current
assets?
ANSWER:
Current Assets = $85,000
($11,000 Cash + $35,000 Accounts receivable + $33,000 Inventory + $4,000 Prepaid
Rent + $2,000 Office Supplies = $85,000)
Current Liabilities = $71,000
($46,000 Accounts Payable + $1,000 Interest Payable + $14,000 Income Taxes
Payable = $71,000)
Current ratio = 1.20 to 1
($85,000 / $71,000)
The current ratio does not provide information about the composition of the current assets.
Only totals are used to calculate the current ratio
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-04 - LO: 02-04
KEYWORDS:
Bloom's: Analyzing
215. Read the information below about Smith Corporation.
Required:
Calculate the amount of working capital at December 31, 2016 for Smith Corp. What can you learn from the current ratio
that you cannot learn from the amount of working capital?
ANSWER:
Current Assets = $85,000
($11,000 Cash + $35,000 Accounts receivable + $33,000 Inventory + $4,000 Prepaid
Rent + $2,000 Office Supplies = $85,000)
Current Liabilities = $71,000
($46,000 Accounts Payable + $1,000 Interest Payable + $24,000 Income Taxes
Payable = $71,000)
Working Capital = $14,000
($85,000 – $71,000)
The current ratio indicates the number of times current assets is greater than current
liabilities. It is based on a relative relationship, not total dollars, as the amount of working
capital is.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-04 - LO: 02-04
KEYWORDS:
Bloom's: Analyzing
216. Harrison Company calculated the following amounts concerning its financial information for the years ending
December 31, 2017 and 2016:
2017
2016
Current ratio
3.1 to 1
2.0 to 1
Profit margin
22 %
18%
Required:
Examine Harrison’s ratios. Is the change in the current ratio favorable or not? Explain.
ANSWER:
The current ratio increased from 2.0 to 1 to 3.1 to 1. This is an unusually large increase for
most companies. A larger current ratio means a company is more liquid. This increase is
favorable, although care must be taken that the current ratio does not become too large which
may indicate an inefficient cash management system.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-04 - LO: 02-04
KEYWORDS:
Bloom's: Analyzing
217. Read the information about Fasoli, Inc.
Required:
Prepare the Liabilities section of the classified balance sheet, including total liabilities balance.
ANSWER:
Liabilities
Current liabilities:
Accounts payable
$ 32,650
Income taxes payable
7,500
Interest payable
2,200
Notes payable, due April 15, 2017
6,500
Salaries payable
7,400
Total current liabilities
$ 56,250
Long-term debt:
Notes payable, due December 31, 2020
251,630
Total liabilities
$307,880
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-03 - LO: 02-03
KEYWORDS:
Bloom's: Analyzing
Fasoli, Inc.
The following balance sheet items from Fasoli, Inc. are listed for December 31, 2016:
Accounts payable
$ 32,650
Interest payable
2,200
Accounts receivable
26,500
Land
250,000
Accumulated depreciation—buildings
40,000
Marketable securities
15,000
Merchandise inventory
112,900
Accumulated depreciation—equipment
12,500
Notes payable, due April 15, 2017
6,500
Office supplies
200
Notes payable, due December 31, 2020
251,630
Paid-in capital in excess of par value
75,000
Buildings
150,000
Patents
45,000
Capital stock, $1 par value
200,000
Prepaid rent
3,800
Cash
60,990
218. Read the information about Fasoli, Inc.
Required:
Present the Current Assets section (including the total) of a classified balance sheet.
ANSWER:
Current Assets:
Cash
$ 60,990
Marketable securities
15,000
Accounts receivable
26,500
Merchandise inventory
112,900
Prepaid rent
3,800
Office supplies
200
Total current assets
$ 219,390
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-03 - LO: 02-03
KEYWORDS:
Bloom's: Analyzing
219. Read the information about Fasoli, Inc.
Required:
Prepare the Stockholders’ Equity section of the classified balance sheet, including the total stockholders’ equity amount.
ANSWER:
Stockholders’ Equity
Contributed capital:
Capital stock, $1 par value, 200,000
shares issued and outstanding
$ 200,000
Paid-in capital in excess of par value
75,000
Total contributed capital
$ 275,000
Retained earnings
113,510
Total stockholders’ equity
$ 388,510
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-03 - LO: 02-03
KEYWORDS:
Bloom's: Analyzing
220. Read the information about Fasoli, Inc.
Required:
Present the current liabilities section (including the total) of a classified balance sheet.
ANSWER:
Current liabilities:
Accounts payable
$ 32,650
Income taxes payable
7,500
Interest payable
2,200
Notes payable, due April 15, 2017
6,500
Salaries payable
7,400
Total current liabilities
$ 56,250
221. Read the information about Fasoli, Inc.
Required:
Compute Fasoli’s current ratio. On the basis of your answer, does Fasoli appear to be liquid? What other information do
you need to fully answer that question?
ANSWER:
Current Ratio = Current Assets/Current Liabilities
$219,390/$56,250 = 3.9 to 1
From the current ratio alone, Fasoli appears to be relatively liquid. In fact, Fasoli may be too
liquid, because its cash balance is greater than its total current liabilities. This indicates that
Fasoli may be missing significant investment opportunities by maintaining such a large cash
balance. To fully assess its liquidity, you would need to look more specifically at the activity
in accounts receivable and merchandise inventory. In other words, how long does it take to
collect an account receivable or how long does it take to sell inventory? Also, you would
want to compare Fasoli’s current ratio at the end of this period with prior periods, and with
the current ratio for companies in the same industry.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-04 - LO: 02-04
KEYWORDS:
Bloom's: Analyzing
222. Read the information about Fasoli, Inc.
Required:
Prepare the Assets section of the classified balance sheet.
ANSWER:
Assets
Current assets:
Cash
$ 60,990
Marketable securities
15,000
Accounts receivable
26,500
Merchandise inventory
112,900
Prepaid rent
3,800
Office supplies
200
Total current assets
$219,390
Property, plant, and equipment:
Land
$250,000
223. Complete the December 31, 2016 (first year of operation) Balance sheet for Lincoln Company using the following
information:
(a) Retained earnings at December 31, 2016 was $51,000.
(b) Total stockholders’ equity at January 1, 2016 was $139,000.
(c) On December 30, 2016, additional capital stock was sold for cash, $55,000
(d) The land and building were purchased on December 30, 2016 for $150,000.
Lincoln Company
Balance Sheet
December 31, 2016
Assets
Liabilities & Stockholders’ Equity
Cash
$ 80,000
Liabilities:
Accounts receivable
?
Notes payable
?
Land
112,000
Accounts payable
45,000
Buildings
?
Total liabilities
?
Equipment
30,000
Stockholders’ equity:
Capital Stock
?
Retained earnings
?
Total liabilities and
Total assets
$
stockholders’ equity
$ 390,000
ANSWER:
Lincoln Company
Balance Sheet
December 31, 2016
Assets
Liabilities & Stockholders’ Equity
Cash
$ 80,000
Liabilities:
Accounts receivable
130,000
Notes payable
$100,000
Land
112,000
Accounts payable
45,000
Building
38,000
Total liabilities
$145,000
Equipment
30,000
Stockholders’ equity:
Capital Stock
$194,000
Retained earnings
51,000
245,000
_______
Total liabilities and
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
224. Harrison Company calculated the following amounts concerning its financial information for the years ending
December 31, 2017 and 2016:
2017
2016
Current ratio
3.1 to 1
2.0 to 1
Profit margin
22 %
18%
REQUIRED:
Suppose Harrison Company had a decrease in its cash account from 2016 to 2017. Would the other current asset amounts
have increased or decreased? Explain.
ANSWER:
Since the current ratio increased from 2016 to 2017, the current assets other than cash would
have had to increase substantially to offset the decline in cash. The decline in cash changes
the liquidity somewhat, in that the other current assets must be converted to cash prior to
paying the current period debt.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-04 - LO: 02-04
KEYWORDS:
Bloom's: Analyzing
Fellsmere Corporation
Presented below are the condensed balance sheets of Fellsmere Corporation at December 31, 2017 and 2016. Net income
for the years ending December 31, 2016 and 2015 is $346,000 and $109,000, respectively.
December 31, 2017
December 31, 2016
Current assets
$2,228,186
$2,544,683
Property, plant, & equipment (net)
530,589
376,647
Intangibles and other assets
131,206
118,121
Total assets
$2,889,981
$3,039,451
Current liabilities
$1,429,674
$1,003,906
Long-term obligations
3,360
7,240
Warranty and other liabilities
112,971
98,081
Total liabilities
$1,546,605
$1,109,227
Stockholders’ equity:
Common stock
$ 1,566
$ 501,631
Additional paid-in capital
365,986
799,483
Retained earnings
980,509
634,509
Accumulated other
comprehensive loss
(4,085)
(5,489)
Total stockholders’ equity
$1,343,976
$1,930,224
Total liabilities and stockholders’
equity
$2,889,981
$3,039,451
© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
225. Read the information about Fellsmere Corporation.
Required:
(A) Did Fellsmere’s current ratio increase or decrease from 2016 to 2017? Make any necessary calculations and explain
your answer. Which financial statement users are most concerned with this ratio?
(B) The balance sheets show a large increase in retained earnings during 2017. Identify the possible reason(s) for this
increase.
ANSWER:
(A) Current ratio for 2017 = 1.56 to 1
($2,228,186 Current Assets / $1,429,674 Current Liabilities)
Current Ratio for 2016 = 2.53 to 1
($2,544,683 Current Assets / $1,003,906 Current Liabilities)
This ratio is an indicator of the company's ability to pay its current debt when it is due.
Fellsmere’s current ratio has declined significantly. A company with decreasing liquidity
ratios is not appealing to bankers and creditors, and it may have trouble trying to borrow
money, since the decrease indicates the company is less likely able to repay its debts.
(B) The amount of retained earnings increases primarily because of net income for a period.
A company that has a positive balance in retained earnings over time has cumulative profits
in excess of cumulative dividends paid.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-04 - LO: 02-04
FACC.PONO.13.02-07 - LO: 02-07
KEYWORDS:
Bloom's: Analyzing
226. Read the information about Fellsmere Corporation.
Required:
(A) Explain the change in Fellsmere’s working capital from 2016 to 2017. Why do users believe the current ratio provides
more information than the dollar amount of working capital? Explain.
(B) Fellsmere Corporation's creditors need to know whether its working capital position improved during the year. How
would you evaluate this?
ANSWER:
(A) Working Capital, 2016 = $1,540,777
($2,544,683 Current Assets – $1,003,906 Current Liabilities = $1,540,777)
Working Capital, 2017 = $798,512
($2,228,186 Current Assets – $1,429,674 Current Liabilities = $798,512)
Decrease in Working Capital = $742,265
($1,540,777 Working Capital, 2016 – $798,512 Working Capital, 2017 = $742,265)
Working capital represents the excess of current assets over current liabilities in total dollars.
The current ratio indicates the number of times that current assets exceed the current
liabilities. It is possible that $742,265 could pay the current debts of one company easily, but
pay for only a small portion of a larger company's debts.
(B) The amount of working capital and the current ratio are the best indicators of a company's
working capital position. While the amount of working capital provides the dollar amount of
current assets that exceed the company's current debt, the current ratio provides a relative
indicator of how many times the dollar amount of current assets exceeds currently due debt.
In 2016, Fellsmere Corporation’s working capital was $1,540,777. However, this figure
declined in 2017 to $798,512. Less current assets are available to cover current liabilities.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-04 - LO: 02-04
KEYWORDS:
Bloom's: Analyzing
Crystal, Inc.
Crystal, Inc. reported $52,000 of net income for 2016. Crystal’s balance sheet at December 31, 2016 includes the
following amounts:
Wages payable
$ 1,000
Inventory
$26,000
Prepaid rent
3,000
Land
40,000
Cash
15,000
Accounts receivable
22,000
Accounts payable
25,000
Capital stock
40,000
Retained earnings
29,000
Income taxes payable
11,000
228. Read the information about Crystal, Inc. Has Crystal been profitable since it began operations? How do you know?
ANSWER:
Retained earnings represents the company's cumulative profits since it began operations less
the dividends it paid out. Since Crystal, Inc. has a positive balance in its retained earnings
account, it has been profitable over the time it has been in business. Cumulative net income
exceeds aggregate net loss and aggregate dividends paid.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-05 - LO: 02-05
FACC.PONO.13.02-07 - LO: 02-07
KEYWORDS:
Bloom's: Analyzing
229. The balance sheet of Delray Inc. includes the following items:
Cash
$ 21,500
Accounts receivable
12,400
Inventory
45,300
Prepaid insurance
1,800
Land
80,000
Accounts payable
49,000
Salaries payable
1,625
Capital stock
105,100
Retained earnings
5,700
Required:
(1) Determine the current ratio and working capital.
(2) What does the composition of the current assets tell you about Delray’s liquidity?
(3) What other information do you need to fully assess Delray’s liquidity?
ANSWER:
1. Current Ratio = Current Assets/Current Liabilities
= ($21,500 + $12,400 + $45,300 + $1,800)/($49,000 + $1,625)
= $81,000/$50,625 = 1.6 to 1
Working Capital = Current Assets – Current Liabilities
= $81,000 – $50,625 = $30,375
2. One concern is the relatively large percentage of the current assets tied up in inventory.
This asset accounts for $45,300/$81,000, or approximately 56% of the total current assets.
What is the normal period of time it takes to sell inventory? Is any part of the inventory slow
moving or obsolete?
3. On the basis of the current ratio alone, Delray appears to be relatively liquid, although it
would be important to compare the ratio with those of prior years and with those of other
companies in the same industry.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-04 - LO: 02-04
Chapter 2: Financial Statements and the Annual Report
Huntington Corporation
Presented below are all of the items from Huntington Corporation’s income statement for the years ending December 31,
2017 and 2016.
December 31, 2017
December 31, 2016
Service fees
$2,300,000
$2,100,000
General and administrative expenses
1,900,000
1,500,000
Other income, net
40,000
20,000
Income taxes
150,000
180,000
230. Read the information about Huntington Corporation.
Required:
How much is net income for the year ended December 31, 2017? If Huntington Corporation had used a single-step
statement, by how much would net income be different? Explain.
ANSWER:
Net Income = $290,000
($2,300,000 Service Fees + $40,000 Other Income, net – $1,900,000 General and
Administrative Expenses – $150,000 Income Taxes = $290,000)
Net income is the same under a single-step or a multiple-step income statement. Only
subtotals and the order the amounts are listed differ.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-05 - LO: 02-05
KEYWORDS:
Bloom's: Analyzing
231. Read the information about Huntington Corporation.
Required:
Compare the profit margins for 2017 and 2016. Is the company becoming more or less profitable or staying the same?
What could be contributing to this?
ANSWER:
Profit Margin for 2017 = 12.61%
($290,000 Net Income / $2,300,000 Service Fees = 12.61%)
Profit Margin for 2016 = 20.95%
($440,000 Net Income / $2,100,000 Service Fees = 20.95%)
The decrease in profit margin is unfavorable and indicates that the company is becoming less
profitable. A significant increase in general and administrative expenses seems to be the
cause of the decline.
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FACC.PONO.13.02-06 - LO: 02-06
KEYWORDS:
Bloom's: Analyzing
Chapter 2: Financial Statements and the Annual Report
Burke Company
The following income statement items are taken from the records of Burke Company for the year ended December 31,
2016:
Advertising expense
$2,600
Commission expense
3,515
Cost of goods sold
29,200
Depreciation expense - Office Building
4,000
Income tax expense
190
Insurance expense - sales person’s auto
3,350
Interest expense
1,400
Interest revenue
2,340
Rent revenue
7,700
Salaries and wages expense - Office
13,660
Sales Revenue
50,300
Supplies expense - Office
1,990
232. Read the information about Burke Company.
Required:
Prepare a multiple-step income statement for the year ended December 31, 2016.
ANSWER:
BURKE COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2016
Sales
$50,300
Cost of goods sold
29,200
Gross profit
$21,100
Operating expenses:
Selling expenses:
Advertising
$ 2,600
