BASIC FINANCIAL STATEMENTS
Brief Learning
Exercises Topic Objectives Skills
B. Ex. 2.1 Recording transactions 2 – 3 Analysis, communication
B. Ex. 2.2 Recording transactions 2 – 3 Analysis, communication
B. Ex. 2.3 Computing retained earnings 2 – 4 Analysis
B. Ex. 2.4 Computing total liabilities 2 – 4 Analysis
B. Ex. 2.5 Computing net income 2 – 5 Analysis
B. Ex. 2.6 Computing net income 2 – 5 Analysis
B. Ex. 2.7 Computing change in cash 2 – 6 Analysis
B. Ex. 2.8 Alternative forms of equity 2 – 8 Analysis
B. Ex. 2.9 Alternative forms of equity 2 – 8 Analysis
B. Ex. 2.10 Articulation of financial statements 2 – 7 Analysis
Learning
Exercises Topic Objectives Skills
2.1 Real World: American Airlines, 2 – 3 Communication
Boston Redsox
Nature of assets and liabilities
2.2 Preparing a balance sheet 2 – 4 Analysis
2.3 Preparing a balance sheet 2 – 4 Analysis
2.4 2 – 2 Communication, judgment
2.5 Using the accounting equation 2 – 3 Analysis
2.6 Accounting equation 2 – 3 Analysis
2.7 Effects of business transactions 2 – 3 Analysis
2.8 Forms of business organizations 2 – 8 Analysis
2.9 Factors contributing to solvency 2 – 9 Analysis, judgment
2.10 Professional judgment 2 – 2 Communication
2.11 Statement of cash flows 2 – 6 Analysis
2.12 Income statement 2 – 5 Analysis
2.13 Income statement 2 – 5 Analysis
2.14 Statement of cash flows 2 – 6 Analysis
2.15 Window dressing financial statement 2 – 9 Analysis
2.16 Real World: Home Depot Analysis, communication
Home Depot financial statements
2.17 Real World: McKesson Corporation 2 – 5 Analysis, communication
Assessing financial results
CHAPTER 2
Accounting principles and asset valuation
OVERVIEW OF BRIEF EXERCISES, EXERCISES, AND CRITICAL THINKING
CASES
2–4 through
2 – 6
Problems Learning
Sets A, B Topic Objectives Skills
2.1 A,B 2 – 4 Analysis, communication
2.2 A,B Effects of transactions 2 – 3 Analysis
2.3 A,B Effects of transactions 2 – 3 Analysis
2.4 A,B Effects of transactions 2 – 3 Analysis
2.5 A,B
Preparing a balance sheet, effects of
transactions (2–6 is an alternate)
2 – 4 Communication, judgment
transactions
2.6 A,B
Preparing a balance sheet, effects of
transactions (Alternate to Problem 2–5)
2 – 4 Analysis, communication
transactions
2.7 A,B
Preparing a balance sheet and statement
of cash flows, effects of transactions
Analysis, communication
of cash flows, effects of transactions
2.8 A,B
Preparing financial statements, effects of
Analysis, communication
of transactions, evaluating solvency
2.9 A,B 2 – 4, 2 – 8
2.10 A,B 2 – 2, 2 – 4
Preparing and evaluating a balance sheet
Analysis, communication,
judgment
Analysis, communication,
judgment
2 – 3, 2 – 4,
2 – 6
2 – 4, 2 – 5,
2 – 6
2.1
Prepare a realistic balance sheet for a
2 – 4
hypothetical entity
2.2 Real World: Company of student choice
2.3 Using a balance sheet 2 – 4
2.4 Using a statement of cash flows 2 – 6
2.5 Window dressing 2 – 4
2.6 2 – 4
(Ethics, fraud & corporate governance)
2.7 2 – 4, 2 – 5
DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES
Problems (Sets A and B)
2.1 A,B 15 Easy
2.2 A,B
15 Easy
2.3 A,B 15 Medium
2.4 A,B 15 Medium
Locate and evaluate the financial statements of
a publicly owned company
Critical Thinking Cases
Note: Additional Internet assignments for this chapter are available in Appendix B.
Rocky Mountain Lodge/Tri-State Lodge
Shown below are brief descriptions of each problem and case. These descriptions are accompanied by
the estimated time (in minutes) required for completion and by a difficulty rating. The time estimates
assume use of the partially filled-in working papers.
Real World: Public Company Accounting
Oversight Board
Technology
Real World: Cisco Systems
(Internet)
Introduction to EDGAR
Show in tabular form the effects of various business transactions
upon the accounting equation. (Alternate to Problem 2–3.)
Prepare a balance sheet from a list of balance sheet items in
random order. Determine the amount of one item as a plug
figure. Also evaluate the company’s solvency.
Effects of transactions upon the accounting equation are
illustrated in tabular form. Students are asked to write a sentence
or two explaining the nature of each transaction.
Maxwell Communications/Delta Corporation
Show in tabular form the effects of various business transactions
upon the accounting equation. (Problem 2–4 is an alternate.)
Memphis Moving Company/Prosperity
Phillips Truck Rental/MaxxTrucking
Analysis, communication,
judgment
Communication, research,
technology
Analysis, communication,
research
Analysis, communication
judgment
Analysis, communication,
judgment
2 – 4, 2 – 5,
2 – 6
Judgment
Problems (cont’d)
Here Come the Clowns/Circus World
Alexander Farms, Inc./Maple Valley Farms
Franklin Bakery/Collier Butcher Shop
The Soda Shop/The Sweet Shop
Spencer Playhouse/Old Town Playhouse
Big Screen Scripts/Star Scripts
Critical Thinking Cases
Content of a Balance Sheet
Using Financial Statements
*Omits time required to obtain an annual report.
30 Medium
2.2
30 Strong*
Students are to obtain an annual report from the library and answer questions
about the company’s balance sheet, income statement, and statement of cash
flows. Suitable assignment for groups or individuals.
Students are to prepare a realistic balance sheet for a hypothetical
business—the nature of which is specified by the instructor. Challenges the
student to think about the types of assets and liabilities arising in an actual
business. Suitable assignment either for groups or individuals.
2.1
35 Strong
2.10 A,B
30 Strong
Given an improperly prepared balance sheet, student is asked to prepare a
corrected balance sheet and to explain the proper valuation of assets,
liabilities, and owners’ equity. Stresses generally accepted accounting
principles.
Given a balance sheet and supplementary information concerning the assets
and liabilities, the student is asked to prepare a corrected balance sheet and to
explain the violations that exist as to asset valuation and the entity concept.
Stresses GAAP.
2.9 A,B
2.7 A,B
35 Medium
2.8 A,B
40 Strong
Prepare a balance sheet from an alphabetical listing of accounts, and prepare a
second balance sheet and a statement of cash flows after some additional
transactions. Evaluate the company’s relative solvency at each date.
The student is asked to prepare a balance sheet from an alphabetical list of
accounts and then to prepare a second balance sheet as well as an income
statement and a statement of cash flows, after several transactions. Evaluate
the company’s relative solvency at each date.
2.5 A,B
20 Medium
2.6 A,B
20 Medium
Preparation of a balance sheet for a circus—an entity with an unusual variety
of asset accounts. Also requires students to explain the effects upon this
balance sheet of a fire that destroys one of the assets. (Problem 2–6 is an
alternate.)
Prepare a balance sheet for a farm—an entity with a wide variety of assets.
Also, explain the effects upon this balance sheet of the destruction of one of
the assets. (Alternate to Problem 2–5.)
Using a Balance Sheet
Using Statements of Cash Flow
Ethics and Window Dressing
2.6 Public Company Accounting Oversight Board 30 Easy
Ethics, Fraud & Corporate Governance
Gathering Financial Information
Internet
2.3
30 Medium
A tried-and-true case in which students are to evaluate the financial position
of two similar companies first from the viewpoint of a short-term creditor and
then from the viewpoint of a buyer of the business. We always use this one.
35 Medium
Students are presented with abbreviated cash flow information and asked to
decide which is in a stronger position. An excellent way to show that how a
company generates its cash is equally important to how much cash it has on
hand.
Students are to distinguish between legitimate window dressing and fraudulent
misrepresentation. Allows introduction of ethics, securities laws, and the role
of independent audits.
30 Medium
2.4
2.7
25 Easy
Visit EDGAR, the SEC’s database, and gather financial information about
Cisco Systems. A user-friendly “meet EDGAR” type of problem.
Students locate the PCAOB and state the mission, identify the members, and
describe the authority and responsibility of the PCAOB.
2.5
2.
3.
4.
5.
6.
The basic accounting equation is assets = liabilities + owners’ equity. Assets are resources
The going concern assumption states that in the absence of evidence to the contrary (i.e.,
bankruptcy proceedings), an enterprise is expected to continue to operate in the foreseeable
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
Many of these questions are well suited to classroom discussions. These discussions can stimulate
students’ interest, help develop verbal skills, and provide instructors with an opportunity to
introduce ideas and situations not discussed in the text. If class size permits, we also encourage
instructors to review and evaluate selected written assignments throughout the course.
A knowledge of accounting terms and concepts is useful to persons other than professional
accountants because nearly everyone working in business, government, or the professions
Revenues result from transactions in which goods or services are transferred (i.e., sold) to
Business transactions affect a company’s financial position, and as a result, they change the
7.
8. a.
b.
9.
10.
11.
12.
Positive cash flows means that cash increases. Negative cash flows means that cash
The three categories and the information included in each are:
No, a business transaction could not affect only a single asset. There must be an offsetting
change elsewhere in the accounting equation. If the transaction increases an asset, for
An example of a transaction that would cause one asset to increase and another asset to
decrease without any effect on the liabilities or owners’ equity is the receipt of cash in
An example of a transaction that would cause both total assets and total liabilities to
Adequate disclosure refers to the requirement that financial statements, including
accompanying notes, must include information necessary for reasonably informed users of
Operating activities—Cash provided by and used in revenue and expense transactions.
Financial statements—the balance sheet, income statement, statement of cash flows—are all
based on the same underlying transactions. They reflect different aspects of the enterprise’s
13.
14.
15.
A strong income statement is one that has significantly more dollars of revenue than expenses,
A strong statement of cash flows is one that shows significant amounts of cash generated from
operating activities. This means that the enterprise is generating cash from its ongoing
The term “window dressing” refers to enhancing the appearance of the enterprise’s financial
B. Ex. 2.1
B. Ex. 2.2
B. Ex. 2.3
B. Ex. 2.4
B. Ex. 2.5
B. Ex. 2.6
B. Ex. 2.7
Increases in cash:
Revenues $100,000
Sale of land 10,000
B. Ex. 2.8
B. Ex. 2.9
SOLUTIONS TO BRIEF EXERCISES
B. Ex. 2.10
50,000$
Ben Washington, owner’s equity:
Balance, January 1, current year……………………………………………………………….
Net income for current year…………………………………………………………..
Investment during current year……………………………………………………….
Ex. 2.1 a.
1.
2.
b.
1.
Liabilities:
$94,800 $345,600
84,000 43,200
84,000 74,400
Supplies ……………………
Automobiles ……………….
Building …………………..
Land …………………..
Total ……………………….
Capital stock……………………..
Retained earnings………………..
Assets
Cash ……………………….
Accounts receivable ……….
Notes payable …………………….
Accounts payable …………………
SOLUTIONS TO EXERCISES
Assets are economic resources owned by the business entity.
Among the assets of American Airlines we might expect to find
investments, accounts receivable (say, from travel agents), fuel (in
Among the assets of a professional sports team are investments (in stocks and
Liabilities & Owners’ Equity
Note to instructor: You may wish to expand this solution to include intangible assets, such as the
Liabilities are existing debts and other obligations of the entity.
Among the liabilities of American Airlines, we might expect to find accounts
Ex. 2.2
WILLIS TRANSPORTATION SERVICE
Balance Sheet
February 28, Current Year
2.
The balance sheet of a professional sports team might include accounts payable,
$36,300 Liabilities:
56,700
Notes payable ……………………………….
$207,000
12,400
Accounts payable …………………………..
43,800
Ex. 2.4 a.
b.
c.
Ex. 2.5 a.
b.
c.
Ex. 2.3
KINER COMPANY
Assets
Accounts receivable ………….
Office Equipment ………………………….
Balance Sheet
December 31, Current Year
Liabilities & Owners’ Equity
Cash ………………………….
The supplies should be presented at $1,400 in World-Wide’s balance sheet.
Presenting the supplies at their estimated liquidation value violates the
The presentation of the two land parcels at a combined value of $340,000 in the
The presentation of the computer system at $14,000 in the December 31, Year-1
balance sheet conforms to generally accepted accounting principles, as this is the
Capital stock ……………………………….
88,000
66,600
Building ……………………..
Retained earnings ………………………….
Total ………………………….
Ex. 2.6 Assets = Liabilities +
Owners’
I I NE
Ex. 2.7
a.
The cash payment of an account payable or note payable will cause a decrease in the
c.
The investment of cash in the business by the owners will cause an increase in an
e.
Ex. 2.8 a.
$ 468,000
$ 288,000
180,000
$ 468,000
$ 324,000
144,000
$ 468,000
Johanna Spencer, capital …………………………………………….
Mikki Yato, capital …………………………………………………
(2) Partners’ equity:
Retained earnings …………………………………………………………..
Total stockholders’ equity ……………………………………………….
Total …………………………………………………………….
(3) Stockholders’ equity:
Capital Stock ………………………………………………………………………..
The purchase of office equipment (or any other asset) on credit will cause an
The collection of an account receivable will cause an increase in one asset (cash) and
Johanna Spencer, capital ………………………………………….
Transaction
a
Note to instructor: These are examples, but many others exist.
(1) Owner’s equity
I I NE
c
e
g
b.
Ex. 2.9 a.
d.
Ex. 2.10 a.
b.
Accountants must rely on their professional judgment in such matters as
The capital stock account is the owners’ equity in the business. It represents
Yes; the form of Spencer’s organization is relevant to a lender. If the company is
Cash is the most liquid of all assets. In fact, companies must use cash in paying
The situations encountered in the practice of accounting and auditing are too
b.
Cash received from revenues ………………………………………..
$ 9,850
Expenses ………………………………………………………………………..
5,465
$ 4,385
Net income ………………………………………………………………………
$ 17,000
7,800
$ 9,200
Net income …………………………………………………………………………….
Expenses ……………………………………………………………………………….
14,400$
Ex. 2.11
WELLER COMPANY
Statement of Cash Flows
For the Month Ended October 31, Current Year
Cash flows from operating activities:
Ex. 2.13
Ex. 2.12
JIMINEZ, INC.
For the Month Ended March 31, Current Year
Income Statement
For the Month Ended August 31, Current Year
Service revenues ………………………………………………………………………
PRESTWICK COMPANY
Revenues …………………………………………………………………………
Income Statement
Cash paid for expenses ………………………………………………
Net cash provided by operating activities ……………………………….
Cash received from sale of capital stock ……………………..
Cash used to repay bank loans …………………………………..
Net cash provided by financing activities ………………………..
Cash balance, October 1, Current Year …………………………………………..
Increase in cash ………………………………………………………….
Cash paid for equipment ……………………………………………….
Cash balance, October 31, Current Year …………………………………………
17,000$
Ex. 2.14
Cash received from revenues ………………………………………….
Cash flows from operating activities:
PRESTWICK COMPANY
Statement of Cash Flows
For the Month Ended August 31, Current Year
Cash paid for expenses …………………………………………………
Net cash provided by operating activities ……………………………..
Cash paid for purchase of land …………………………………………..
Cash flows from investing activities:
Increase in cash
Cash received from investment by stockholders ……………………..
Cash paid to long-term creditors ………………………………………..
Cash received from bank loan ……………………………
Cash flows from financing activities:
Cash balance, August 1, Current Year …………………………………………………
Cash balance, August 31, Current Year ……………………………………………
Ex. 2.15
Steps to Window Dress
Note to instructor: Many examples of steps to improve the financial statements could be
cited. The ones listed below are those that the authors believe are most likely to be
identified by students.
Delay cash payment of expenses
Impact on Financial Statements*
BS—Higher cash balance
Year-end investment by owner
BS—Higher receivables and owners’ equity balances
IS—No impact
BS—Higher cash and liability balances
BS—Higher cash and owners’ equity balances
SCF—No impact (assuming receivables not collected)
IS—No impact
SCF—Higher cash flow from financing activities
BS—Higher cash balance
IS—Higher sales and net income
Year-end borrowing
SCF—Higher cash flow from financing activities
IS—No impact
SCF—Lower cash used in investing activities
SCF—Lower cash balance
BS—Reduced cash and liability balances
at year-end (assume expense
already incurred)
IS—No impact
IS—No impact
SCF—Higher cash from operating activities
Ex. 2.16 a.
b.
Ex. 2.17
Home Depot reports a net income (earnings) of $7,009 million for the year ended
January 31, 2016.
Cash balances at the beginning and end of the year were:
2015: $8,382/$52,465 = 15.98%
2013: $6,136/$45,041 = 13.62%
2014 $7,501/$48,813 = 15.37%
Net income as a percentage of revenue for each year is as follows:
$2,216 million
$1,723 million
The largest asset is property and equipment ($39,266 million – $17,075 million: $22,191
million) followed by merchandise inventory ($11,809 million). The largest liability is
a.
Liabilities & Owners’ Equity
Cash 37,680$ Liabilities:
Accounts receivable 12,720 Accounts payable 65,760$
b.
SOLUTIONS TO PROBLEMS SET A
PROBLEM 2.1A
ROCKY MOUNTAIN LODGE
15 Minutes, Easy
Assets
ROCKY MOUNTAIN LODGE
Balance Sheet
December 31, Year-1
The balance sheet indicates that Rocky Mountain Lodge is in a weak financial position.
15 Minutes, Easy
PROBLEM 2.2A
MEMPHIS MOVING COMPANY
Description of transactions:
$15,000 cash was received from the sale of capital stock.
Purchased equipment on account for $7,500.
Paid $14,500 of accounts payable.
Received $900 cash from collection of accounts receivable.
Purchased equipment for cash at a cost of $3,200.