Chapter 02: Review of Accounting
2-11
2-10. Solution:
Precision Systems
Sales…………………………………………………….. $800,000
11. Depreciation and earnings (LO1) Stein Books, Inc. sold 1,400 finance textbooks for $195
each to High Tuition University in 2010. These books cost $150 to produce. Stein Books
spent $12,000 (selling expense) to convince the university to buy its books.
Depreciation expense for the year was $15,000. In addition, Stein Books borrowed
$100,000 on January 1, 2010, on which the company paid 10 percent interest. Both the
interest and principal of the loan were paid on December 31, 2010. The publishing firm’s
tax rate is 30 percent.
Did Stein Books make a profit in 2010? Please verify with an income statement
presented in good form.
2-11. Solution:
Stein Books, Inc.
Income Statement
For the Year Ending December 31, 2010
Sales (1,400 books at $195 each) …………………………... $273,000
Chapter 02: Review of Accounting
2-12
12. Determination of profitability (LO1) Lemon Auto Wholesalers had sales of $700,000 in
2010 and cost of goods sold represented 70 percent of sales. Selling and administrative
expenses were 12 percent of sales. Depreciation expense was $10,000 and interest expense
for the year was $8,000. The firm’s tax rate is 30 percent.
a. Compute earnings after taxes.
b. Assume the firm hires Ms. Carr, an efficiency expert, as a consultant. She suggests
that by increasing selling and administrative expenses to 14 percent of sales, sales can
be increased to $750,000. The extra sales effort will also reduce cost of goods sold to
66 percent of sales (There will be a larger markup in prices as a result of more
aggressive selling). Depreciation expense will remain at $10,000. However, more
automobiles will have to be carried in inventory to satisfy customers, and interest
expense will go up to $15,000. The firm’s tax rate will remain at 30 percent. Compute
revised earnings after taxes based on Ms. Carr’s suggestions for Lemon Auto
Wholesalers. Will her ideas increase or decrease profitability?
2-12. Solution:
Lemon Auto Wholesalers
Income Statement
a. Sales ………………………………………………………… $700,000
Cost of goods sold (70% of sales) ………………… $490,000
Chapter 02: Review of Accounting
2-13
2-12. (Continued)
b. Sales ………………………………………………………… $750,000
Cost of goods sold (66% of sales) ……………….. $495,000
Gross profit …………………………………………… $255,000
13. Balance sheet (LO3) Classify the following balance sheet items as current or
noncurrent:
Retained earnings Bonds payable
Accounts payable Accrued wages payable
Prepaid expenses Accounts receivable
Plant and equipment Capital in excess of par
Inventory Preferred stock
Common stock Marketable securities
2-13. Solution:
Retained earnings – noncurrent
Accounts payable – current
Chapter 02: Review of Accounting
2-14
14. Balance sheet and income statement classification (LO1 & 3) Fill in the blank spaces
with categories 1 through 7:
1. Balance sheet (BS) 5. Current liabilities (CL)
2. Income statement (IS) 6. Long-term liabilities (LL)
3. Current assets (CA) 7. Stockholders’ equity (SE)
4. Fixed assets (FA)
Indicate Whether
Item Is on Balance
Sheet (BS) or
Income
Statement (IS)
If on Balance
Sheet, Designate
Which
Category
Item
_____
_____
Accounts receivable
_____
_____
Retained earnings
_____
_____
Income tax expense
_____
_____
Accrued expenses
_____
_____
Cash
_____
_____
Selling and administrative expenses
_____
_____
Plant and equipment
_____
_____
Operating expenses
_____
_____
Marketable securities
_____
_____
Interest expense
_____
_____
Sales
_____
_____
Notes payable (6 months)
_____
_____
Bonds payable, maturity 2019
_____
_____
Common stock
_____
_____
Depreciation expense
_____
_____
Inventories
_____
_____
Capital in excess of par value
_____
_____
Net income (earnings after taxes)
_____
_____
Income tax payable
2-14. Solution:
Chapter 02: Review of Accounting
2-15
2-14. (Continued)
Indicate
Whether the
item is on
Income
Statement or
Balance
Sheet
If the Item
is on
Balance
Sheet,
Designate
Which
Category
Item
BS
CA
Accounts Receivable
BS
SE
Retained Earnings
IS
Income Tax Expense
BS
CL
Accrued Expenses
BS
CA
Cash
IS
Selling and Administrative expenses
BS
FA
Plant & Equipment
IS
Operating Expenses
BS
CA
Marketable Securities
IS
Interest Expense
IS
Sales
BS
CL
Notes Payable (6 months)
BS
LL
Bonds payable (Maturity 2019)
BS
SE
Common Stock
IS
Depreciation Expense
BS
CA
Inventories
Chapter 02: Review of Accounting
2-16
BS
SE
Capital in excess of par value
IS
Net Income (Earnings after Taxes)
BS
CL
Income tax payable
15. Development of balance sheet (LO3) Arrange the following items in proper balance sheet
presentation:
Accumulated depreciation………………………..………………….. $300,000
Retained earnings………………………….….. ……………………….. 96,000
Cash………………………………….……… ……………………………… 10,000
Bonds payable…………………………………. ………………………… 136,000
Accounts receivable……………………………. ……………………… 48,000
Plant and equipment—original cost……………….. …………….. 680,000
Accounts payable………………………………. ………………………. 35,000
Allowance for bad debts..……………..……….. …………………… 6,000
Common stock, $1 par, 100,000 shares outstanding….. ……. 100,000
Inventory…………………………………….. ……………………………. 66,000
Preferred stock, $50 par, 1,000 shares outstanding… ……….. 50,000
Marketable securities………………………….. ……………………… 20,000
Investments…………………………………… ………………………….. 20,000
Notes payable…………………………………. …………………………. 33,000
2-15. Solution:
Assets
Current Assets:
Cash ……………………………………. $ 10,000
Chapter 02: Review of Accounting
2-15. (Continued)
Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable ……………………………………………..
Notes payable ………………………………………………….
Total current liabilities ……………………………………
Long-term Liabilities ………………………………………….
Bonds payable …………………………………………………
Total Liabilities …………………………..………………..
Stockholders’ Equity:
Preferred stock, $50 par, 1,000 shares outstanding ..
Common stock, $1 par, 100,000 shares outstanding
Capital paid in excess of par (common stock)……….
Retained earnings …………………………………………….
Total Stockholders’ Equity ……………………………..
Total Liabilities and Stockholders’ Equity ……..
$ 35,000
33,000
$ 68,000
136,000
$204,000
50,000
100,000
88,000
96,000
$334,000
$538,000
16. Earnings per share and retained earnings (LO1 & 3) Okra Snack Delights, Inc., has an
operating profit of $210,000. Interest expense for the year was $30,000; preferred
dividends paid were $24,700; and common dividends paid were $36,000. The tax was
Chapter 02: Review of Accounting
2-18
Okra Snack Delights, Inc.
a. Operating profit (EBIT) ………………………………….. $210,000
Interest expense ………………………………………… 30,000
Earnings Available to
Common Stockholders
Earnings per Share = Number of Shares of
Com. Stock Outstanding
$96,000/16,000 shares
$6.00 per share
=
=
Dividends per Share = $36,000/16,000 shares
= $2.25 per share
b. Increase in retained earnings = $60,000
Chapter 02: Review of Accounting
17. Earnings per share and retained earnings (LO1 & 3) Quantum Technology had
$640,000 of retained earnings on December 31, 2010. The company paid common
dividends of $30,000 in 2010 and had retained earnings of $500,000 on December 31,
2009. How much did Quantum Technology earn during 2010, and what would earnings per
share be if 40,000 shares of common stock were outstanding?
2-17. Solution:
Quantum Technology
Retained earnings, December 31, 2010 …………………… $640,000
Chapter 02: Review of Accounting
2-20
$40.00
19. Price/earning ratio (LO2) Assume for Botox Facial Care discussed in Problem 18 that in
2011, earnings after taxes declined to $140,000 with the same 200,000 shares outstanding.
The stock price declined to $24.50.
a. Compute earnings per share and the P/E ratio for 2011.
b. Give a general explanation of why the P/E changed. You might want to consult the
textbook to explain this surprising result.
2-19. Solution:
Botox Facial Care (continued)
a. EPS (2011)
$140,000 $.70
200,000
==
P/E ratio (2011) = Price/EPS =
$24.50 35
$.70 x=
20. Cash flow (LO4) Identify whether each of the following items increases or decreases
cash flow:
Increase in accounts receivable Decrease in prepaid expenses
Increase in notes payable Increase in inventory
Depreciation expense Dividend payment
Increase in investments Increase in accrued expenses
Decrease in accounts payable
2-20. Solution: