Chapter 05 – Communicating and Interpreting Accounting Information
5-1
CHAPTER 5
COMMUNICATING AND INTERPRETING
ACCOUNTING INFORMATION
Learning Objectives and Related Assignment Materials
Learning Objectives
Mini-
Exercises
Exercises
Problems
Alternate
Problems
Cases and
Projects
1. Recognize the people involved in the
accounting communication process
(regulators, managers, directors,
auditors, information intermediaries,
and users), their roles in the process,
and the guidance they receive from
legal and professional standards.
1
1
1
6, 7, 8
2. Identify the steps in the accounting
communication process, including the
issuance of press releases, annual
reports, quarterly reports, and SEC
filings as well as the role of electronic
information services in this process.
2
2, 3
1
1, 2, 8
3. Recognize and apply the different
financial statement and disclosure
formats used by companies in practice
and analyze the gross profit
percentage.
3, 4, 5, 6
4, 5, 6, 7,
8, 9, 10,
11, 12,
13, 14,
15, 16
2, 3, 4, 5,
6, 7, 9
1, 2, 3, 4
1, 2, 4, 6,
7, 8
4. Analyze a company’s performance
based on return on assets and its
components and the effect of
transactions on financial ratios.
7
17, 18,
19
7, 8
4
1, 3, 5, 8
Synopsis of Chapter Revisions
Focus Company: Apple Inc.
▪ New focus company Apple Inc., with integration of the financial statements and corporate governance
and disclosure processes of students’ favorite technology company.
▪ New simplified exhibit explaining the role of management, auditors, boards of directors, and
regulators in ensuring the integrity of financial reporting.
▪ Focus narrowed to three topics: details of the corporate governance and disclosure process; financial
statement formats and important subtotals, totals, and additional disclosures; and the analysis of
financial statements through gross profit, net profit, total asset turnover, and return on assets analyses.
▪ Fraud triangle added to corporate governance discussion.
▪ Issuance of par value stock moved to the discussion of financing activities in Chapter 2.
▪ New section on the effects of transactions on key ratios added to tie the material in this chapter to
coverage in Chapters 2, 3, and 4.
Chapter 05 – Communicating and Interpreting Accounting Information
5-2
Synopsis of Chapter Revisions
▪ New GUIDED HELP feature provides free access to step-by-step video instruction on preparing a
detailed classified income statement and balance sheet from a trial balance for amazon. com , the
world’s largest online retailer.
▪ Two New CONTINUING CASES added to the end-of-chapter problems. The first asks students to
evaluate the effects of key transactions on important statement subtotals and financial ratios for
Penny’s Pool Service & Supply. The second introduces Penny’s supplier, Pool Corporation, a public
company, and asks students to prepare a detailed classified income statement and balance sheet and
compute the gross profit percentage and return on assets ratios.
▪ New and updated real companies, as well as modified accounts, names, and amounts for fictional
companies in end-of-chapter exercises, problems, and cases.
PowerPoint Slides
Learning Objectives
PowerPoint® Slides
1. Recognize the people involved in the accounting communication process
(regulators, managers, directors, auditors, information intermediaries, and
users), their roles in the process, and the guidance they receive from legal
and professional standards.
5-1 through 5-8
2. Identify the steps in the accounting communication process, including the
issuance of press releases, annual reports, quarterly reports, and SEC filings
as well as the role of electronic information services in this process.
5-9 through 5-13
3. Recognize and apply the different financial statement and disclosure
formats used by companies in practice and analyze the gross profit
percentage.
5-14 through 5-29
4. Analyze a company’s performance based on return on assets and its
components and the effect of transactions on financial ratios.
5-30 through 5-35
Chapter Take-Aways
1. Recognize the people involved in the accounting communication process (regulators, managers,
directors, auditors, information intermediaries, and users), their roles in the process, and the
guidance they receive from legal and professional standards.
Management of the reporting company must decide on the appropriate format (categories) and level
of detail to present in its financial reports. Independent audits increase the credibility of the
information. Directors monitor managers’ compliance with reporting standards and hire the auditor.
Financial statement announcements from public companies usually are first transmitted to users
through electronic information services. The SEC staff reviews public financial reports for
compliance with legal and professional standards, investigates irregularities, and punishes violators.
Analysts play a major role in making financial statement and other information available to average
investors through their stock recommendations and earnings forecasts.
Chapter 05 – Communicating and Interpreting Accounting Information
5-3
Chapter Take-Aways, Continued
2. Identify the steps in the accounting communication process, including the issuance of press
releases, annual reports, quarterly reports, and SEC filings as well as the role of electronic
information services in this process.
Earnings are first made public in press releases. Companies follow these announcements with annual
and quarterly reports containing statements, notes, and additional information. Public companies must
file additional reports with the SEC, including the 10-K, 10-Q, and 8-K, which contain more details
about the company. Electronic information services are the key source of dissemination of this
information to sophisticated users.
3. Recognize and apply the different financial statement and disclosure formats used by
companies in practice and analyze the gross profit percentage.
Most statements are classified and include subtotals that are relevant to analysis. On the balance
sheet, the most important distinctions are between current and noncurrent assets and liabilities. On the
income and cash flow statements, the distinction between operating and nonoperating items is most
important. The notes to the statements provide descriptions of the accounting rules applied, add more
information about items disclosed on the statements, and present information about economic events
not included in the statements.
4. Analyze a company’s performance based on return on assets and its components and the effect
of transactions on financial ratios.
ROA measures how well management used the stockholders’ investment during the period. Its two
determinants, net profit margin and asset turnover, indicate why ROA differs from prior levels or the
ROAs of competitors. They also suggest strategies to improve ROA in future periods. The effect of
an individual transaction on a financial ratio depends on its effects on both the numerator and
denominator of the ratio.
Key Ratios
Gross profit percentage measures the excess of sales prices over the costs to purchase or produce the
goods or services sold as a percentage. It is computed as follows:
Gross profit percentage = Gross Profit Net Sales
Return on assets (ROA) measures how much the firm earned for each dollar of investment. It is
computed as follows:
Return on Assets = Net Income Average Total Assets
Chapter 05 – Communicating and Interpreting Accounting Information
5-4
Finding Financial Information
BALANCE SHEET
INCOME STATEMENT
Assets (by order of liquidity)
Current assets (short-term)
Noncurrent assets
Total assets
Liabilities (by order of time to maturity)
Current liabilities (short-term)
Long-term liabilities
Total liabilities
Stockholders’ equity (by source)
Common stock and Additional paid-in
capital (by owners)
Retained earnings (accumulated earnings
minus accumulated dividends declared)
Total stockholders’ equity
Total liabilities and stockholders’
equity
Net sales
– Cost of goods sold
Gross margin
– Operating expenses
Income from operations
+/– Nonoperating revenues/expenses
and gains/losses
Income before income taxes
– Income tax expense
Net income
Earnings per share
STATEMENT OF CASH FLOWS
NOTES
Operating activities:
Net income
+/– Adjustments for noncash items
Cash provided by operating activities
Investing activities:
Financing activities:
Key Classifications:
Descriptions of accounting rules applied
in the statements
Additional detail supporting reported
numbers
Relevant financial information not
disclosed on the statements
STATEMENT OF STOCKHOLDERS’ EQUITY
Common Stock
Add’t Paid-In
Capital
Retained
Earnings
Total
Stockholders’
Equity
Beginning
balance
xx
xx
xx
xx
Net income
xx
xx
Dividends
declared
(xx)
(xx)
Stock issued
xx
xx
Stock retired
(xx)
(xx)
Ending balance
xx
xx
xx
xx
Chapter 05 – Communicating and Interpreting Accounting Information
5-5
Chapter Outline
Teaching Notes
LO 1 – Recognize the people involved in the accounting communication process (regulators,
managers, directors, auditors, information intermediaries, and users), their roles in the process,
and the guidance they receive from legal and professional standards.
I. Players in the Accounting Communication Process
Summarized in Exhibit 5.1
A. Regulators (SEC, FASB, PACOB, Stock Exchanges)
1. U.S. Securities and Exchange Commission (SEC) –
mission is to protect investors and maintain the integrity
of the securities markets
See a Question of Ethics
feature “The Fraud
Triangle”
2. SEC oversees the work of the:
a. Financial Accounting Standards Board (FASB), which
sets generally accepted accounting principles (GAAP)
b. Public Company Accounting Oversight Board
(PCAOB), which sets auditing standards for
independent auditors (CPAs) of public companies,
c. Stock exchanges (e.g., New York Stock Exchange),
which, along with state governments, set overall
corporate governance standards
3. SEC staff reviews the reports filed with it for compliance
with its standards, investigates irregularities, and punishes
violators
B. Managers (CEO, CFO, and Accounting Staff)
1. The primary responsibility for the information in a
company’s financial statements and related disclosures
lies with management, specifically the:
a. Highest officer in the company, often called the
chairman and chief executive officer (CEO)
b. Highest officer associated with the financial and
accounting side of the business, often called the chief
financial officer (CFO)
2. Each officer must certify:
a. Each report filed with the SEC does not contain any
untrue material statement or omit a material fact and
fairly presents in all material respects the financial
condition, results of operations, and cash flows of the
company
b. There are no significant deficiencies and material
weaknesses in the internal controls over financial
reporting
c. They have disclosed to the auditors and audit
committee of the board any weaknesses in internal
controls or any fraud involving management or other
employees who have a significant role in financial
reporting
3. An executive who knowingly certifies false financial
reports is subject to a $5 million fine and a 20-year prison
term
Chapter 05 – Communicating and Interpreting Accounting Information
5-6
C. Board of Directors (Audit Committee)
1. Board of directors
a. Elected by the stockholders to represent their interests
b. Responsible for maintaining the integrity of the
company’s financial reports
2. Audit committee of the board
a. Must be composed of nonmanagement (independent)
directors with financial knowledge
b. Responsible for hiring the company’s independent
auditors
D. Auditors
1. SEC requires publicly traded companies to have their
statements and their control systems over the financial
reporting process audited by an independent registered
public accounting firm (independent auditor) following
auditing standards established by the PCAOB
2. Many privately owned companies also have their
financial statements audited
3. Unqualified (clean) audit opinion – an auditor’s statement
that the financial statements are fair presentations in all
material respects in conformity with GAAP
a. The opinion adds credibility to the statements and is
often required by agreements with lenders and private
investors.
b. Independent verification reduces the risk that the
company’s financial condition is misrepresented
E. Information Intermediaries: Analysts and
Information Services
Communication process
illustrated in Exhibit 5.2
1. Filing of SEC Forms performed electronically through the
EDGAR (Electronic Data Gathering and Retrieval)
Service
a. Each fact in the report is now tagged to identify its
source and meaning using a language called XBRL
b. Users can retrieve information from EDGAR within
24 hours of its submission, long before it is available
through the mail
c. EDGAR is free; under “Filings & Forms” at
www.sec.gov
2. Information services
a. Allow investors to gather their own information about
the company and monitor the recommendations of a
variety of analysts
b. Financial analysts and other sophisticated users obtain
much of the information they use from the wide
variety of commercial online information services
Illustrated in Exhibit 5.2
c. Most companies also provide direct access to their
financial statements and other information over the
Web
Chapter 05 – Communicating and Interpreting Accounting Information
5-7
3. Financial analysts obtain and analyze information about
the company
a. Receive accounting reports and other information
from electronic information services
b. Gather information through conversations with
company executives and visits to company facilities
and competitors
c. Results of their analyses are combined into analysts’
reports, which include:
i. Earnings forecasts – predictions of earnings for
future accounting periods
ii. A buy, hold, or sell recommendation for the
company’s shares
See Financial Analysis
iii. Explanations for these judgments
feature “Information Services
d. Often specialize in particular industries
and Your Job Search”
F. Users: Institutional and Private Investors, Creditors, and
Others
1. Institutional investors – managers of pension, mutual,
endowment, and other funds that invest on the behalf of
others
a. Institutional investors usually employ their own
analysts who also rely on the information
intermediaries discussed above
b. Institutional shareholders control the majority of
publicly traded shares of U.S. companies
2. Private investors – include individuals who purchase
shares in companies
3. Lenders (creditors) – include suppliers and financial
institutions that lend money to companies
4. Cost effectiveness
a. Suggests that the benefits of accounting for and
reporting information should outweigh the cost
b. Accounting regulators consider when they consider
requiring new disclosures
c. Small amounts do not have to be reported separately
or accounted for precisely according to GAAP if they
would not influence users’ decisions.
i. Accountants usually designate such items and
amounts as immaterial
ii. Determining material amounts is often very
subjective
Refer students to Pause for
Feedback – Self-Study Quiz
Chapter 05 – Communicating and Interpreting Accounting Information
5-8
LO 2 – Identify the steps in the accounting communication process, including the issuance of press
releases, annual reports, quarterly reports, and SEC filings as well as the role of electronic
information services in this process
II. The Disclosure Process
A. Press Releases – A written public news announcement
normally distributed to major news services
Illustrated in Exhibit 5.3
1. Public companies announce quarterly and annual earnings
through a press release as soon as the verified figures are
available
See Financial Analysis
feature “How Does the Stock
Market React to Earnings
Announcements?”
2. Press releases related to earnings often precede the
issuance of the quarterly or annual report by 15 to 45 days
B. Annual Reports and Form 10-K
1. Private companies
a. Annual reports are relatively simple documents
b. Normally include only the following:
i. Four basic financial statements
ii. Related notes (footnotes)
iii. Report of Independent Accountants (Auditor’s
Opinion) if the statements are audited
2. Public companies – annual reports on Form 10-K contain
two sections:
a. Nonfinancial section, which includes:
i. Letter to stockholders from the chairman and CEO
ii. Descriptions of the company’s management
philosophy, products, successes and failures; etc.
b. Financial section includes:
• Summarized financial data for 5- or 10-year period
• Management’s Discussion and Analysis of
Financial Condition and Results of Operations and
Disclosures about Market Risk
• The four basic financial statements
• Notes (footnotes)
• Report of Independent Accountants (Auditor’s
Opinion) and the Management Certification
• Recent stock price information
• Summaries of unaudited quarterly financial data
• Lists of directors and officers of the company and
relevant addresses
C. Quarterly Reports and Form 10-Q
1. Private companies also normally prepare quarterly reports
on Form 10-Q for their lenders
2. Public companies prepare quarterly reports that include:
a. Letter to shareholders
b. Condensed income statement for the quarter (less
detail) and condensed balance sheet as of end of
quarter; not required to be audited
c. Cash flow statement, statement of stockholders’
equity, and some notes are omitted
Chapter 05 – Communicating and Interpreting Accounting Information
5-9
D. Other SEC Reports
1. Form 8-K – used to disclose any material event not
previously reported that is important to investors (e.g.,
auditor changes, mergers, etc.)
2. Other filing requirements for public companies are
described on the SEC website.
LO 3 – Recognize and apply the different financial statement and disclosure formats used by
companies in practice
III. A Closer Look at Financial Statement Formats and Notes
(Slightly different formats and classifications are used by
different companies)
Use Supplemental
Enrichment Activity #1
A. Additional characteristics of financial statements and the
related disclosures designed to make them more useful:
1. Comparative financial statements
a. To allow users to compare performance from period to
period, companies report financial statement values
for the current period and one or more prior periods
b. Most U.S. companies present two years’ balance
sheets and three years’ income statements, cash flow
statements, and statements of stockholders’ equity
2. Additional subtotals and classifications in financial
statements; slightly different statement formats used by
different companies
3. Additional disclosures
a. Most companies present voluminous notes that are
necessary to understand a company’s performance and
financial condition.
b. In addition, certain complex transactions require
additional statement disclosures
B. Classified Balance Sheet
Illustrated in Exhibit 5.4
1. Assets (by order of liquidity)
a. Current assets (short-term)
b. Noncurrent assets
c. Total assets
2. Liabilities (by order of time to maturity)
a. Current liabilities (short-term)
b. Long-term liabilities
c. Total liabilities
3. Stockholders’ equity (by source)
a. Contributed capital (by owners) – often shown as two
accounts: Common Stock and Additional Paid-in
Capital
i. Each share of common stock usually has a par
value printed on the face of the certificate.
ii. Par value is a legal amount per share established by
the board of directors; it has no relationship to the
market price of the stock.
Chapter 05 – Communicating and Interpreting Accounting Information
5-10
iii. Its significance is that it establishes the minimum
amount that a stockholder must contribute
v. When a corporation issues stock, amount received
is recorded in part as Common Stock (Number of
Shares × Par Value per Share) and the excess
above par is recorded as Additional Paid-In Capital
(also called Paid-In Capital or Contributed Capital
in Excess of Par)
b. Retained earnings (accumulated earnings minus
accumulated dividends declared)
c. Total stockholders’ equity
Use Supplemental
Enrichment Activity #2
d. Total liabilities and stockholders’ equity
C. Classified Income Statement – Basic structure:
Illustrated in Exhibit 5.5
1. Basic structure:
Net sales
− Cost of goods sold
Gross profit (not always reported)
− Operating expenses
Operating income (or Income from operations)
+/− Nonoperating revenues/expenses and gains/losses
Income before income taxes
− Income tax expense
Net income
Use Supplemental
Enrichment Activity #3
2. Nonoperating (other)
a. Revenues, expenses, gains, and losses that do not
relate to the company’s primary operations
b. Nonoperating items are added to or subtracted from
income from operations to obtain Income before
Income Taxes (also called Pretax Earnings)
3. Nonrecurring items – two types:
a. Discontinued Operations
i. Result from abandoning or selling a major business
component
ii. Income generated by the discontinued component
and any gain or loss on the disposal are included
b. Extraordinary Items (very rare) – gains or losses that
are considered both unusual in nature and infrequent
in occurrence
c. If one or both of these items exists, an additional
subtotal is presented for Income from Continuing
Operations (or Income before Nonrecurring Items),
after which the nonrecurring items are presented
d. These two items are presented separately because they
are not useful in predicting the future income of the
company given their nonrecurring nature
See Focus on Cash Flows
feature “Statement of
Comprehensive Income”
4. Finally, earnings per share is reported; calculated as:
(Net income – Preferred dividends) ÷ Average number of
shares of common stock outstanding during the period
Refer students to Pause for
Feedback – Self-Study Quiz
Chapter 05 – Communicating and Interpreting Accounting Information
5-11
D. Key Ratio Analysis – Gross Profit Percentage
1. Gross Profit Percentage = Gross Profit ÷ Net Sales
2. Measures a company’s ability to charge premium prices
and produce goods and services at low cost
3. All other things equal, a higher gross profit results in
higher net income.
4. Business strategy, as well as competition, affects the
gross profit percentage.
a. Companies pursuing a product-differentiation strategy
use research and development and product promotion
activities to convince customers of the superiority or
distinctiveness of the company’s products; this allows
them to charge premium prices, producing a higher
gross profit percentage
b. Companies following a low-cost strategy rely on more
efficient management of production to reduce costs
and increase the gross profit percentage
5. A Few Cautions
a. To assess the company’s ability to sustain its gross
profits, you must understand the sources of any
change in the gross profit percentage.
b. Higher prices must often be sustained with higher
R&D and advertising costs, which reduce net income
and can offset any increase in gross profit.
D. Statement of Stockholders’ Equity
Illustrated in Exhibit 5.6
1. Reports the changes in each of the company’s
stockholders’ equity accounts during the accounting
period.
2. Format:
a. The statement has a column for each stockholders’
equity account and one for the effect on total
stockholders’ equity
b. The first row of the statement starts with the beginning
balances in each account, which correspond to the
prior year’s ending balances on the balance sheet
c. Each row that follows lists each event that occurred
during the period that affected any stockholders’
equity accounts.
d. The final row lists the ending balances in the accounts,
which correspond to the ending balances on the
balance sheet
E. Statement of Cash Flows – three statement classifications:
Illustrated in Exhibit 5.6
1. Cash Flows from Operating Activities – cash flows
associated with earning income
See Focus on Cash Flows
feature “Operating Activities
(Indirect Method)”
2. Cash Flows from Investing Activities – cash flows in this
section are associated with the purchase and sale of (1)
productive assets (other than inventory) and (2)
investments in other companies
Chapter 05 – Communicating and Interpreting Accounting Information
5-12
3. Cash Flows from Financing Activities. – cash flows
related to financing the business through borrowing and
repaying loans, stock (equity) issuances and repurchases,
and dividend payments
E. Notes to Financial Statements
1. Users require additional details to facilitate their analysis
a. Accounting Rules Applied in the Company’s
Statements
b. Additional Detail Supporting Reported Numbers
c. Relevant Financial Information Not Disclosed on the
Statements
F. Voluntary Disclosures
See International Perspective
1. GAAP and SEC regulations set only the minimum level
of required financial disclosures.
feature “Differences in
Accounting Methods
Acceptable Under IFRS and
U.S. GAAP”
2. Many companies provide important disclosures beyond
those required.
LO 4 – Analyze a company’s performance based on return on equity and its components and the
effect of transactions on financial ratios.
IV. ROA Analysis: A Framework for Evaluating Company
Performance
A. Return on Assets (ROA)
1. Return on Asset = Net Income ÷ Average Total Assets
2. Measures how much the firm earned for each dollar of
investment
3. Firms with higher ROA are doing a better job of selecting
and managing investments
4. Also used to evaluate performance at any level within the
organization (e.g., on a division or product line basis)
B. ROA Profit Driver Analysis and Business Strategy
1. ROA profit driver analysis (ROA decomposition or
DuPont analysis) breaks down ROA into two factors
2. Factors are called profit drivers or profit levers because
they describe the ways that ROA can be improved
a. Net profit margin
i. Net Profit Margin = Net Income ÷ Net Sales
ii. Measures how much of every sales dollar is profit
iii. Can be increased by:
• Increasing sales volume
• Increasing sales price
• Decreasing cost of goods sold and operating
expenses
Chapter 05 – Communicating and Interpreting Accounting Information
5-13
b. Total asset turnover (efficiency)
i. Total Asset Turnover = Net Sales ÷ Average Total
Assets
ii. Measures how many sales dollars the company
generates with each dollar of assets.
iii. Can be increased by:
• Collecting accounts receivable more quickly
• Centralizing distribution to reduce inventory
kept on hand
• Consolidating production facilities in fewer
factories to reduce the amount of assets
necessary to generate each dollar of sales
C. Profit Drivers and Business Strategy
1. High value or product-differentiation strategy
a. Strategies relies on research and development and
product promotion to convince customers of
superiority or distinctiveness of products
b. Allows the company to charge higher prices and earn
a higher net profit margin
2. Low-cost strategy – relies on efficient management of
accounts receivable, inventory, and productive assets to
produce high asset turnover
Refer students to Pause for
Feedback – Self-Study Quiz
D. How Transactions Affect Ratios
1. Three-step processs to compute the effects of transactions
on ratios:
a. Journalize the transaction to determine its effects on
various accounts
b. Determine which accounts belong to the financial
statement subtotals or totals in the numerator (top) and
denominator (bottom) of the ratio and the direction of
their effects
c. Evaluate the combined effects from step 2 on the ratio.
Refer students to Pause for
Feedback – Self-Study Quiz
Chapter 05 – Communicating and Interpreting Accounting Information
5-14
Supplemental Enrichment Activities
Note: These activities would be suitable for individual or group activities.
1. Handout 5-1
Use Handout 5-1 for an in-class activity to review the classification of accounts in the financial
statements. The solution follows the handout master.
2. Handout 5-2
Use Handout 5-2 for an in-class activity to review the preparation of a classified balance sheet. The
solution follows the handout master
3. Handout 5-3
Use Handout 5-3 for an in-class activity to review the preparation of a multistep income statement.
The solution follows the handout master.
Chapter 05 – Communicating and Interpreting Accounting Information
5-15
HANDOUT 5 – 1
CLASSIFYING ACCOUNTS ON FINANCIAL STATEMENTS
The following is a list of financial statement items and amounts from a recent income statement and
balance sheet of Basic Corporation. All accounts have normal balances. The company’s year ended on
December 31, 2014.
For each financial statement item listed, indicate whether it appears on the income statement or balance
sheet.
Financial Statement Item
Amount
Income
Statement
Balance
Sheet
Accounts Payable
$ 41,000
Accounts Receivable
262,000
Accrued Expenses Payable
37,000
Additional Paid-in Capital
70,000
Cash and Cash Equivalents
125,000
Common Stock ($10 par value)
100,000
Cost of Sales
350,000
General and Administrative Expenses
75,000
Income Tax Expense
32,000
Intangible Assets, Net
85,000
Interest and Other Income, Net
10,000
Inventory
167,000
Notes Payable (due In 2012)
433,000
Other Current Assets
5,000
Other Current Liabilities
89,000
Other Noncurrent Assets
15,000
Prepaid Expenses
31,000
Property, Plant and Equipment, Net
184,000
Research and Development Costs
250,000
Retained Earnings
161,000
Sales and Service Revenues
943,000
Selling Expenses
125,000
Short-Term Investments
57,000
Chapter 05 – Communicating and Interpreting Accounting Information
5-16
HANDOUT 5 – 1 SOLUTION
CLASSIFYING ACCOUNTS ON FINANCIAL STATEMENTS
The following is a list of financial statement items and amounts from a recent income statement and
balance sheet of Basic Corporation. All accounts have normal balances. The company’s year ended on
December 31, 2014.
For each financial statement item listed, indicate whether it appears on the income statement or balance
sheet.
Financial Statement Item
Amount
Income
Statement
Balance
Sheet
Accounts Payable
$ 41,000
X
Accounts Receivable
262,000
X
Accrued Expenses Payable
37,000
X
Additional Paid-in Capital
70,000
X
Cash and Cash Equivalents
125,000
X
Common Stock ($10 par value)
100,000
X
Cost of Sales
350,000
X
General and Administrative Expenses
75,000
X
Income Tax Expense
32,000
X
Intangible Assets, Net
85,000
X
Interest and Other Income, Net
10,000
X
Inventory
167,000
X
Notes Payable (due In 2012)
433,000
X
Other Current Assets
5,000
X
Other Current Liabilities
89,000
X
Other Noncurrent Assets
15,000
X
Prepaid Expenses
31,000
X
Property, Plant and Equipment, Net
184,000
X
Research and Development Costs
250,000
X
Retained Earnings
161,000
X
Sales and Service Revenues
943,000
X
Selling Expenses
125,000
X
Short-Term Investments
57,000
X
Chapter 05 – Communicating and Interpreting Accounting Information
5-17
HANDOUT 5 – 2
PREPARATION OF BALANCE SHEET
Using the information provided in Handout 5-1, prepare in good form a classified balance sheet as of
December 31, 2014.
Chapter 05 – Communicating and Interpreting Accounting Information
5-18
HANDOUT 5 – 2 SOLUTION
PREPARATION OF BALANCE SHEET
Using the information provided in Handout 5-1, prepare in good form a classified balance sheet as of
December 31, 2014.
Basic Corporation
Balance Sheet
December 31, 2014
Assets
Current Assets:
Cash and Cash Equivalents
$125,000
Short-Term Investments
57,000
Accounts Receivable
262,000
Inventory
167,000
Prepaid Expenses
31,000
Other Current Assets
5,000
Total Current Assets
647,000
Property, Plant and Equipment, Net
184,000
Intangible Assets, Net
85,000
Other Noncurrent Assets
15,000
Total Assets
$931,000
Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts Payable
$ 41,000
Accrued Expenses Payable
37,000
Other Current Liabilities
89,000
Total Current Liabilities
$167,000
Other Noncurrent Liabilities:
Notes Payable
433,000
Total Liabilities
600,000
Stockholders’ Equity:
Common Stock ($10 par value)
100,000
Additional Paid-in Capital
70,000
Retained Earnings
161,000
Total Stockholders’ Equity
331,000
Total Liabilities and Stockholders’ Equity
$931,000
Chapter 05 – Communicating and Interpreting Accounting Information
5-19
HANDOUT 5 – 3
PREPARATION OF INCOME STATEMENT
Using the information provided in Handout 5-1, prepare in good form a multistep income statement for
the year ended December 31, 2014.
Chapter 05 – Communicating and Interpreting Accounting Information
5-20
HANDOUT 5 – 3 SOLUTION
PREPARATION OF INCOME STATEMENT
Using the information provided in Handout 5-1, prepare in good form a multistep income statement for
the year ended December 31, 2014.
Basic Corporation
Income Statement
for the year ended December 31, 2014
Sales and Service Revenues
$943,000
Cost of Sales
350,000
Gross Profit
593,000
Operating Expenses:
General and Administrative Expenses
75,000
Selling Expenses
125,000
Research and Development Costs
250,000
Total Operating Expenses
450,000
Income From Operations
143,000
Interest and Other Income, Net
10,000
Income Before Income Taxes
153,000
Income Tax Expense
32,000
Net Income
$121,000