2-1
CHAPTER 2
Financial Statements
and the Annual Report
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Estimated
Time in
Learning Outcomes Exercises Minutes Level
Module 1
1. Describe the objectives of financial reporting.
Module 2
3. Explain the concept and purpose of a classified balance sheet 2 10 Mod
and prepare the statement. 3 10 Easy
Module 3
5. Explain the difference between a single-step and a 6 10 Easy
multiple-step income statement and prepare each type 7 10 Mod
of income statement. 12* 10 Mod
13* 15 Mod
14* 5 Easy
Module 4
9. Read and use the financial statements and other elements 11 20 Diff
in the annual report of a publicly held company.
2-2 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
Problems Estimated
and Time in
Learning Outcomes Alternates Minutes Level
Module 1
1. Describe the objectives of financial reporting. 12* 45 Diff
Module 2
3. Explain the concept and purpose of a classified balance sheet 3 50 Mod
and prepare the statement.
Module 3
5. Explain the difference between a single-step and a 6 30 Mod
multiple-step income statement and prepare each type 7 45 Mod
of income statement. 11* 20 Mod
prepare the statement. 12* 45 Diff
Module 4
9. Read and use the financial statements and other elements 9 30 Diff
in the annual report of a publicly held company.
CHAPTER 2 • FINANCIAL STATEMENTS AND THE ANNUAL REPORT 2-3
Estimated
Time in
Learning Outcomes Cases Minutes Level
Module 1
1. Describe the objectives of financial reporting.
Module 2
3. Explain the concept and purpose of a classified balance sheet
and prepare the statement.
Module 3
5. Explain the difference between a single-step and a
multiple-step income statement and prepare each type
of income statement.
Module 4
9. Read and use the financial statements and other elements 4 20 Mod
in the annual report of a publicly held company.
2-4 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
EXERCISES
LO 2 EXERCISE 2-1 CHARACTERISTICS OF USEFUL ACCOUNTING INFORMATION
1. materiality 4. consistency
LO 3 EXERCISE 2-2 THE OPERATING CYCLE
1. For a company that sells a product, the operating cycle begins when the cash is in-
vested in inventory and ends when cash is collected by the company from its cus-
2. The operating cycle for Baxter, the manufacturer of the bikes, would normally be
longer than Two Wheeler’s. This is because a manufacturer incurs various costs to
LO 3 EXERCISE 2-3 CLASSIFICATION OF FINANCIAL STATEMENT ITEMS
1. CA 6. NCA
CHAPTER 2 • FINANCIAL STATEMENTS AND THE ANNUAL REPORT 2-5
LO 4 EXERCISE 2-4 CURRENT RATIO
1. Current Ratio = Current Assets/Current Liabilities
December 31, 2015:
2. Baldwin’s current ratio decreased from 2.0 at the end of 2015 to 1.5 at the end of
2016. In general, the higher the current ratio, the more liquid the company.
3. Cash decreased by 50%, from $6,000 to $3,000, and accounts receivable increased
LO 3 EXERCISE 2-5 CLASSIFICATION OF ASSETS AND LIABILITIES
1. CA 4. NCA 7. CA
LO 5 EXERCISE 2-6 SELLING EXPENSES AND GENERAL AND ADMINISTRATIVE EXPENSES
1. Advertising expense—S
2. Depreciation expense—store furniture and fixtures—S
3. Office rent expense—G&A
2-6 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
LO 5 EXERCISE 2-7 MISSING INCOME STATEMENT AMOUNTS
Sara’s Amy’s Jane’s
Coffee Shop Deli Bagels
Net sales $35,000 (3) $63,000 $78,000
Cost of goods sold (1) 28,000 45,000 (7) 39,000
Solved as follows (in the order listed):
(1) $35,000 – $7,000 = $28,000
(2) $3,000 + $1,500 = $4,500
LO 6 EXERCISE 2-8 INCOME STATEMENT RATIO
Profit margin:
Net Income/Revenues = $45,000*/$134,800 = 33.4%
CHAPTER 2 • FINANCIAL STATEMENTS AND THE ANNUAL REPORT 2-7
LO 7 EXERCISE 2-9 STATEMENT OF RETAINED EARNINGS
LANDON CORPORATION
STATEMENT OF RETAINED EARNINGS
FOR THE YEAR ENDED DECEMBER 31, 2016
Retained earnings, January 1, 2016……………………………. $130,520*
Net income for 2016 …………………………………………………. 145,480
Dividends declared and paid ……………………………………… (40,000)
Retained earnings, December 31, 2016 ………………………. $236,000
LO 8 EXERCISE 2-10 COMPONENTS OF THE STATEMENT OF CASH FLOWS
1. Paid for supplies—O
2. Collected cash from customers—O
2-8 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
LO 9 EXERCISE 2-11 BASIC ELEMENTS OF FINANCIAL REPORTS
1. Management discussion and analysis—The information in this section of the an-
nual report is prepared by management and is management’s opportunity to explain
various items that appear in the financial statements. Increases and decreases in
various items are highlighted and reasons for these changes are given. The informa-
tion in this section is not subject to any outside review or support. Users must rely on
the integrity of management that the information contained in the report is reliable.
2. Product/markets of company—Management provides information in the annual
report about the company’s products and markets. The detail provided by manage-
3. Financial statements—These are the responsibility of management and are nor-
mally prepared by the controller. They include the income statement, balance sheet,
statement of changes in stockholders’ equity, and statement of cash flows. The in-
formation provided in the financial statements is subject to verification as part of the
external audit.
4. Notes to financial statements—These are also the responsibility of management,
and they include detailed explanations about the various items appearing in the
5. Independent accountants’ report—As the name implies, this report is prepared by
the independent auditors. It includes information about the scope of the audit (the
statements included in the audit), the auditing standards followed in conducting the
CHAPTER 2 • FINANCIAL STATEMENTS AND THE ANNUAL REPORT 2-9
MULTI-CONCEPT EXERCISES
LO 3,5,7 EXERCISE 2-12 FINANCIAL STATEMENT CLASSIFICATION
BS = Balance sheet; IS = Income statement; RE = Retained earnings statement
1. Accounts payable—BS 11. Land held for future expansion—BS
5. Bonds payable—BS 15. Patent amortization expense—IS
6. Buildings—BS 16. Prepaid insurance—BS
7. Cash—BS 17. Retained earnings—BS and RE
LO 5,6 EXERCISE 2-13 SINGLE- AND MULTIPLE-STEP INCOME STATEMENT
1. Sales—B 7. Net income—B
2. Cost of goods sold—B 8. Supplies on hand—N
2-10 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
LO 5,6 EXERCISE 2-14 MULTIPLE-STEP INCOME STATEMENT
Profit margin:
Net Income/Sales = $614,200*/$1,200,000 = 51.2%
*$1,200,000 – $450,000 – $60,800 – $75,000 = $614,200*
PROBLEMS
LO 2 PROBLEM 2-1 MATERIALITY
1. Among the questions that might be answered by the analysis that was performed
are these: Is the usage of any of the items cyclical? Is there a relationship between
the usage of any two or more of the items? Is the amount being spent on these
items material? Would it be feasible to set up an account at an office supply store for
CHAPTER 2 • FINANCIAL STATEMENTS AND THE ANNUAL REPORT 2-11
LO 2 PROBLEM 2-2 COSTS AND EXPENSES
1. Display fixtures in a retail store—Only a portion of the cost would appear in the
period of acquisition; the fixtures should be depreciated over their useful lives.
5. Cost of a franchise—This is a cost that should benefit several future periods, and
only a portion should be expensed in the current period; the cost of the franchise
should be treated as an intangible asset and amortized over the periods during
which benefits are expected.
6. Office supplies—The portion of the supplies used should be recognized as an
expense in the current period; the unused portion should be reported as a current
asset.
2-12 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
LO 3 PROBLEM 2-3 CLASSIFIED BALANCE SHEET
1. Classified balance sheet:
RUTH CORPORATION
BALANCE SHEET
DECEMBER 31, 2016
Assets
Current assets:
Cash …………………………………………………………………. $ 13,230
Accounts receivable ……………………………………………. 23,450
Inventory ……………………………………………………………. 45,730
Prepaid rent ……………………………………………………….. 1,500
Office supplies ……………………………………………………. 2,340
Liabilities
Current liabilities:
Accounts payable ……………………………………………….. $ 18,255
Income taxes payable ………………………………………….. 6,200
CHAPTER 2 • FINANCIAL STATEMENTS AND THE ANNUAL REPORT 2-13
PROBLEM 2-3 (Concluded)
Stockholders’ Equity
Contributed capital:
Capital stock, $10 par value,
2. Current Ratio = Current Assets/Current Liabilities
$86,250/$40,155 = 2.15 to 1
LO 4 PROBLEM 2-4 FINANCIAL STATEMENT RATIOS
1. a. Working capital at 12/31/16:
Current assets: $27,830 + $20,200 + $450 + $24,600 + $6,250 + $3,600 = $82,930
Current liabilities: $8,400 + $1,450 + $1,200 = $11,050
Working capital: $82,930 – $11,050 = $71,880
2-14 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
PROBLEM 2-4 (Concluded)
2. Both the absolute liquidity position of the company and the relative liquidity position
of the company have improved during 2016. First, the absolute position, as indicated
by the amount of working capital, has improved from $70,710 to $71,880. The
LO 4 PROBLEM 2-5 WORKING CAPITAL AND CURRENT RATIO
1. Current Ratio = Current Assets/Current Liabilities
= ($23,000 + $13,000 + $45,000 + $800)/($54,900 + $1,200)
= $81,800/$56,100 = 1.46 to 1
Working Capital = Current Assets – Current Liabilities
= $81,800 – $56,100 = $25,700
CHAPTER 2 • FINANCIAL STATEMENTS AND THE ANNUAL REPORT 2-15
LO 5 PROBLEM 2-6 SINGLE-STEP INCOME STATEMENT
1. Single-step income statement:
SHAW CORPORATION
INCOME STATEMENT
FOR THE CURRENT YEAR
Revenues:
Sales ………………………………………………………………… $48,300
Interest ……………………………………………………………… 1,340
Rent ………………………………………………………………….. 6,700
Total revenues ………………………………………………………… $56,340
2. A single-step income statement does not lend itself as readily to analysis as does a
multiple-step statement. The lack of any grouping of the various expenses makes
2-16 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
LO 5 PROBLEM 2-7 MULTIPLE-STEP INCOME STATEMENT AND PROFIT MARGIN
1. Multiple-step income statement:
SHAW CORPORATION
INCOME STATEMENT
FOR THE CURRENT YEAR
Sales ……………………………………………………………………… $48,300
Cost of goods sold …………………………………………………… 29,200
Gross profit …………………………………………………………….. $ 19,100
Operating expenses:
Selling expenses:
Advertising …………………………………. $ 1,500
Total operating expenses ………………………………………….. 22,515
Loss from operations ……………………………………………….. $ (3,415)
Other revenues and expenses:
Interest expense …………………………………………………. $ 1,400
Interest revenue ………………………………………………….. 1,340
Rent revenue ……………………………………………………… 6,700
2. The main advantages of the multiple-step income statement are the groupings of
various items and the provision of important subtotals such as income from opera-
tions.
CHAPTER 2 • FINANCIAL STATEMENTS AND THE ANNUAL REPORT 2-17
LO 8 PROBLEM 2-8 STATEMENT OF CASH FLOWS
1. COLORADO CORPORATION
STATEMENT OF CASH FLOWS
FOR THE FIRST YEAR
Cash flows from operating activities:
Cash collected from customers ………………………… $ 93,970
Cash paid for inventory ……………………………………. (65,600)
Cash paid in salaries and wages ………………………. (20,400)
Proceeds from issuance of stock ………………………. $250,000
Proceeds from long-term note ………………………….. 60,000
Dividends declared and paid ……………………………. (5,600)
Net cash provided by financing activities ………………… 304,400
2. First, the statement of cash flows reports on operations on a cash basis, as opposed
to the income statement which is prepared on an accrual basis. Second, investing
and financing activities are also reported on a statement of cash flows. For example,
2-18 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
LO 9 PROBLEM 2-9 BASIC ELEMENTS OF FINANCIAL REPORTS
Letter from the President to Stockholders of Grammar Inc.:
On the surface, 2016 does not appear to have been a successful year for Grammar Inc.
One specific event, however, caused the net loss we experienced for the year. Operat-
MULTI-CONCEPT PROBLEMS
LO 2,4 PROBLEM 2-10 MAKING BUSINESS DECISIONS: LOANING MONEY TO THE
COCA-COLA COMPANY
.
Part A. Ratio Decision Model
1. Formulate the Question:
Is The Coca-Cola Company liquid enough to pay its obligations as they come due?
Current Assets: $8,958 + $9,052 + $3,665 + $4,466 + $3,100 + $3,066 + $679 =
$32,986
Current Liabilities: $9,234 + $19,130 + $3,552 + $400 + $58 = $32,374
Current Ratio = $32,986 = 1.02 to 1
$32,374
CHAPTER 2 • FINANCIAL STATEMENTS AND THE ANNUAL REPORT 2-19
PROBLEM 2-10 (Continued)
4. Compare the Ratio with Other Ratios:
Current Ratio
The Coca-Cola Company PepsiCo
December 31, 2014 December 31, 2013 December 27, 2014 December 28, 2013
1.02 to 1 1.13 to 1 1.14 to 1 1.24 to 1
Calculations:
The Coca-Cola Company at December 31, 2013:
5. Interpret the Ratios:
The Coca-Cola Company’s current ratio is slightly lower at the end of 2014 com-
pared to the end of 2013, 1.02 compared to 1.13. Similarly, PepsiCo’s current ratio
decreased slightly from one year to the next, 1.14 compared to 1.24. On the basis of
the current ratios alone, the two companies are similar in terms of liquidity at the end
of 2014.