Accounting Tools for Business Decision Making_1

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Solutions Manual Test Bank

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1. What is meant by the term operating cycle?

2. Define current assets. What basis is used for ordering individual items within the current assets section?

3. Distinguish between long-term investments and property, plant, and equipment.

4. How do current liabilities differ from long-term liabilities?

5. Identify the two parts of stockholders equity in a corporation and indicate the purpose of each.

6. (a) Julia Alter believes that the analysis of financial statements is directed at two characteristics of a company: liquidity and profitability. Is Julia correct? Explain.

(b) Are short-term creditors, long-term creditors, and stockholders primarily interested in the same characteristics of a company? Explain.

7. Name ratios useful in assessing (a) liquidity,

(b) solvency, and (c) profitability.

8. Jon Baird, the founder of Waterboots Inc. needs to raise $500,000 to expand his companys operations. He has been told that raising the money through debt will increase the riskiness of his company much more than issuing stock. He doesnt understand why this is true. Explain it to him.

9. What do these classes of ratios measure?

(a) Liquidity ratios.

(b) Profitability ratios.

10. Holding all other factors constant, indicate whether each of the following signals generally good or bad news about a company.

(a) Increase in earnings per share.

(b) Increase in the current ratio.

(d) Decrease in free cash flow.

11. Which ratio or ratios from this chapter do you think should be of greatest interest to:

(a) a pension fund considering investing in a corporations 20-year bonds?

(b) a bank contemplating a short-term loan?

12. (a) What are generally accepted accounting principles (GAAP)?

(b) What body provides authoritative support for GAAP?

13. (a) What is the primary objective of financial reporting?

(b) Identify the characteristics of useful accounting information.

14. Dan Fineman, the president of King Company, is pleased. King substantially increased its net income in 2012 while keeping its unit inventory relatively the same. Howard Gross, chief accountant, cautions Dan, however. Gross says that since King changed its method of inventory valuation, there is a consistency problem and it is difficult to determine whether King is better off. Is Gross correct? Why or why not?

15. What is the distinction between comparability and consistency?

16. Describe the two constraints inherent in the presentation of accounting information.

17. Your roommate believes that international accounting standards are uniform throughout the world. Is your roommate correct? Explain.

18. Laurie Belk is president of Better Books. She has no accounting background. Belk cannot understand why fair value is not used as the basis for all accounting measurement and reporting. Discuss.

19. What is the economic entity assumption? Give an example of its violation.

20. What was Tootsie Roll s largest current asset, largest current liability, and largest item under Other assets at December 31, 2009?

Brief Exercises

BE2-1 The following are the major balance sheet classifications:

Current assets (CA) Current liabilities (CL)

Long-term investments (LTI) Long-term liabilities (LTL)

Property, plant, and equipment (PPE) Common stock (CS)

Intangible assets (IA) Retained earnings (RE)

Match each of the following accounts to its proper balance sheet classification.

_____ Accounts payable _____ Income taxes payable

_____ Accounts receivable _____ Investment in long-term bonds

_____ Accumulated depreciation _____ Land

_____ Buildings _____ Inventory

_____ Cash _____ Patent

_____ Goodwill _____ Supplies

BE2-2 A list of financial statement items for Georges Company includes the following: accounts receivable $14,000; prepaid insurance $2,600; cash $10,400; supplies $3,800, and short-term investments $8,200. Prepare the current assets section of the balance sheet listing the items in the proper sequence.

BE2-3 The following information (in millions of dollars) is available for Limited Brands for 2008: Sales revenue $9,043; net income $220; preferred stock dividend $0; average shares outstanding 333 million. Compute the earnings per share for Limited Brands for 2008.

BE2-4 For each of the following events affecting the stockholders equity of Willis, indicate whether the event would: increase retained earnings (IRE), decrease retained earnings (DRE), increase common stock (ICS), or decrease common stock (DCS).

_____ (a) Issued new shares of common stock.

_____ (b) Paid a cash dividend.

_____ (c) Reported net income of $75,000.

_____ (d) Reported a net loss of $20,000.

BE2-5 These selected condensed data are taken from a recent balance sheet of Bob Evans Farms (in millions of dollars).

Cash $ 29.3

Accounts receivable 20.5

Inventory 28.7

Other current assets 24.0

Total current assets $102.5

Total current liabilities $201.2

Compute working capital and the current ratio.

BE2-6 Kalbs Books & Music Inc. reported the following selected information at March 31. 2012

Total current assets $262,787

Total assets 439,832

Total current liabilities 293,625

Total liabilities 376,002

Cash provided by operating activities 62,300 Calculate (a) the current ratio, (b) the debt to total assets ratio, and (c) free cash flow for March 31, 2012. The company paid dividends of $12,000 and spent $24,787 on capital expenditures. BE2-7 Indicate whether each statement is true or false. (a) GAAP is a set of rules and practices established by accounting standard-setting bodies to serve as a general guide for financial reporting purposes. (b) Substantial authoritative support for GAAP usually comes from two standards-setting bodies: the FASB and the IRS.

BE2-9 Given the characteristics of useful accounting information, complete each of the following statements.

(a) For information to be _____, it should have predictive and confirmatory value.

(b) _____ is the quality of information that gives assurance that it is free from error and bias.

BE2-10 Here are some qualitative characteristics of useful accounting information:

1. Predictive value 3. Verifiable

2. Neutral 4. Timely

Match each qualitative characteristic to one of the following statements.

(a) Accounting information should help provide accurate expectations about future events.

(b) Accounting information cannot be selected, prepared, or presented to favor one set of interested users over another.

(d) Accounting information must be available to decision makers before it loses its capacity to influence their decisions.

BE2-11 The full disclosure principle dictates that:

(a) financial statements should disclose all assets at their cost.

(b) financial statements should disclose only those events that can be measured in dollars.

(c) financial statements should disclose all events and circumstances that would matter to users of financial statements.

(d) financial statements should not be relied on unless an auditor has expressed an unqualified opinion on them.

2-1 Heather Corporation has collected the following information related to its December 31, 2012, balance sheet.

Accounts receivable $22,000 Equipment $180,000

Accumulated depreciationequipment 50,000 Inventory 58,000

Cash 13,000 Supplies 7,000

Prepare the assets section of Heather Corporations balance sheet. Do it!

2-2 The following financial statement items were taken from the financial statements of Jing Corp.

____ Trademarks ____ Inventory

____ Current maturities of long-term debt ____ Accumulated depreciation

____ Interest revenue ____ Land improvements

____ Income taxes payable ____ Common stock

____ Long-term marketable debt securities ____ Advertising expense

____ Unearned consulting fees ____ Mortgage payable (due in 3 years)

Match each of the financial statement items to its proper balance sheet classification. (See E2-1, on page 79, for a list of the balance sheet classifications.) If the item would not appear on a balance sheet, use NA.

2-3 The following information is available for Gerard Corporation. 2012 2011

Current assets $ 54,000 $ 36,000

Total assets 240,000 205,000

Current liabilities 22,000 30,000

Total liabilities 72,000 100,000

Net income 80,000 40,000

Cash provided by operating activities 90,000 56,000

Preferred stock dividends 6,000 6,000

Common stock dividends 3,000 1,500

Expenditures on property, plant, and equipment 27,000 12,000

Shares outstanding at beginning of year 40,000 30,000

Shares outstanding at end of year 75,000 40,000

(a) Compute earnings per share for 2012 and 2011 for Gerard, and comment on the change. Gerards primary competitor, Thorpe Corporation, had earnings per share of $1 per share in 2012. Comment on the difference in the ratios of the two companies.

(b) Compute the current ratio and debt to total assets ratio for each year, and comment on the changes.

2-4 The following are characteristics, assumptions, principles, or constraints that guide the FASB when it creates accounting standards.

Relevance Periodicity assumption

Faithful representation Going concern assumption

Comparability Cost principle

Consistency Full disclosure principle

Monetary unit assumption Materiality constraint

Economic entity assumption Cost constraint

Match each item above with a description below.

1. __________ Items not easily quantified in dollar terms are not reported in the financial statements.

2. __________ Accounting information must be complete, neutral, and free from error.

3. __________ Personal transactions are not mixed with the companys transactions.

4. __________ The cost to provide information should be weighed against the benefit that users will gain from having the information available.

5. __________ A companys use of the same accounting principles from year to year.

6. __________ Assets are recorded and reported at original purchase price.

7. __________ Accounting information should help users predict future events, and should confirm or correct prior expectations.

8. __________ The life of a business can be divided into artificial segments of time.

9. __________ The reporting of all information that would make a difference to financial statement users.

10. __________ The judgment concerning whether an items size makes it likely to influence a decision maker.

11. __________ Assumes a business will remain in operation for the foreseeable future.

12. __________ Different companies use the same accounting principles.

Exercises

E2-1 The following are the major balance sheet classifications.

Current assets (CA) Current liabilities (CL)

Long-term investments (LTI) Long-term liabilities (LTL)

Property, plant, and equipment (PPE) Stockholders equity (SE)

Intangible assets (IA)

Instructions

Classify each of the following financial statement items taken from Inshore Corporations balance sheet.

____ Accounts payable ____ Income taxes payable

____ Accounts receivable ____ Inventory

____ Accumulated depreciation ____ Investments equipment ____ Land

____ Buildings ____ Mortgage payable

____ Cash ____ Supplies

____ Interest payable ____ Equipment

____ Goodwill ____ Prepaid rent

E2-2 The major balance sheet classifications are listed in E2-1 above.

Instructions

Classify each of the following financial statement items based upon the major balance sheet classifications listed in E2-1.

____ Prepaid advertising ____ Patents

____ Equipment ____ Bonds payable

____ Trademarks ____ Common stock

____ Salaries and wages payable ____ Accumulated depreciation

____ Income taxes payable equipment

____ Retained earnings ____ Unearned sales revenue

____ Accounts receivable ____ Inventory

____ Land held for future use

E2-3 The following items were taken from the December 31, 2009, assets section of the Boeing Company balance sheet. (All dollars are in millions.)

Inventories $16,933 Other current assets $ 966

Notes receivabledue after Property, plant, and

December 31, 2010 5,466 equipment 21,579

Notes receivabledue before Cash and cash equivalents 9,215

December 31, 2010 368 Accounts receivable 5,785

Accumulated depreciation 12,795 Short-term investments 2,008

Intangible and other assets 12,528

Instructions

Prepare the assets section of a classified balance sheet, listing the current assets in order of their liquidity.

E2-4 The following information (in thousands of dollars) is available for H.J. Heinz Company famous for ketchup and other fine food productsfor the year ended April 29, 2009. / Prepaid expenses $ 125,765 Inventories $1,237,613

Land 76,193 Buildings and equipment 4,033,369

Other current assets 36,701 Cash and cash equivalents 373,145

Intangible assets 3,982,954 Accounts receivable 1,171,797

Other noncurrent assets 757,907 Accumulated depreciation 2,131,260

Instructions

Prepare the assets section of a classified balance sheet, listing the items in proper sequence and including a statement heading.

E2-5 These items are taken from the financial statements of Victory Co. at December 31, 2012.

Buildings $105,800

Accounts receivable 12,600

Insurance expense 780

Depreciation expense 5,300

Common stock 60,000

Retained earnings (January 1, 2012) 40,000

Accumulated depreciationbuildings 45,600

Accounts payable 9,500

Notes payable 93,600

Accumulated depreciationequipment 18,720

Interest payable 3,600

Service revenue 14,700

Instructions

Prepare a classified balance sheet. Assume that $13,600 of the note payable will be paid in 2013.

E2-6 The following items were taken from the 2009 financial statements of Texas Instruments, Inc. (All dollars are in millions.)

Common stock $2,826 Cash and cash equivalents $1,182

Prepaid expenses 164 Accumulated depreciation 3,547

Property, plant, and equipment 6,705 Accounts payable 1,344

Other current assets 546 Other noncurrent assets 2,210

Other current liabilities 115 Noncurrent liabilities 810

Long-term investments 637 Retained earnings 6,896

Short-term investments 1,743 Accounts receivable 1,277

Income taxes payable 128 Inventories 1,202

Instructions

Prepare a classified balance sheet in good form as of December 31, 2009.

E2-7 The following information is available for Callaway Golf Company for the years 2008 and 2007. (Dollars are in thousands, except share information.)

Net sales $ 1,117,204 $ 1,124,591

Net income (loss) 66,176 54,587

Total assets 855,338 838,078

Share information

Shares outstanding at year-end 64,507,000 66,282,000

Preferred dividends 0 0

There were 73,139,000 shares outstanding at the end of 2006.

Instructions

(a) What was the companys earnings per share for each year?

(b) Based on your findings above, how did the companys profitability change from 2007 to 2008?

(c) Suppose the company had paid dividends on preferred stock and on common stock during the year. How would this affect your calculation in part (a)?

E2-8 These financial statement items are for Whitnall Corporation at year-end, July 31, 2012.

Salaries and wages payable $ 2,080

Salaries and wages expense 57,500

Supplies expense 15,600

Equipment $18,500

Accounts payable 4,100

Service revenue 66,100

Rent revenue 8,500

Notes payable (due in 2015) 1,800

Common stock 16,000

Cash 29,200

Accounts receivable 9,780

Accumulated depreciationequipment 6,000

Dividends 4,000

Depreciation expense 4,000

Retained earnings (beginning of the year) 34,000

Instructions

(a) Prepare an income statement and a retained earnings statement for the year. Whitnall Corporation did not issue any new stock during the year.

(b) Prepare a classified balance sheet at July 31.

(d) Suppose that you are the president of Crescent Equipment. Your sales manager has approached you with a proposal to sell $20,000 of equipment to Whitnall. He would like to provide a loan to Whitnall in the form of a 10%, 5-year note payable. Evaluate how this loan would change Whitnalls current ratio and debt to total assets ratio, and discuss whether you would make the sale.

E2-9 Nordstrom, Inc. operates department stores in numerous states. Selected financial statement data (in millions of dollars) for the year ended January 31, 2009, follow.

End of Year Beginning of Year

Cash and cash equivalents $ 72 $ 358

Receivables (net) 1,942 1,788

Merchandise inventory 900 956

Other current assets 303 259

Total current assets $3,217 $3,361

Total current liabilities $1,601 $1,635

Instructions

(a) Compute working capital and the current ratio at the beginning of the year and at the end of the current year.

(b) Did Nordstroms liquidity improve or worsen during the year?

E2-10 The chief financial officer (CFO) of Padilla Corporation requested that the accounting department prepare a preliminary balance sheet on December 30, 2012, so that the CFO could get an idea of how the company stood. He knows that certain debt agreements with its creditors require the company to maintain a current ratio of at least 2:1.

The preliminary balance sheet is as follows.

PADILLA CORP. Balance Sheet December 30, 2012

Current assets Current liabilities

Cash $25,000 Accounts payable $ 20,000

Accounts receivable 30,000 Salaries and wages payable 10,000 $ 30,000

Prepaid insurance 5,000 $ 60,000 Long-term liabilities

Equipment (net) 200,000 Notes payable 80,000

Total assets $260,000 Total liabilities 110,000

Stockholders equity

Common stock 100,000

Retained earnings 50,000 150,000

Total liabilities and

stockholders equity $260,000

Instructions

(a) Calculate the current ratio and working capital based on the preliminary balance sheet.

(b) Based on the results in (a), the CFO requested that $20,000 of cash be used to pay off the balance of the accounts payable account on December 31, 2012. Calculate the new current ratio and working capital after the company takes these actions.

(d) Was it unethical for the CFO to take these steps?

E2-11 The following data were taken from the 2009 and 2008 financial statements of American Eagle Outfitters. (All dollars are in thousands.)

2009 2008

Current assets $ 925,359 $1,020,834

Total assets 1,963,676 1,867,680

Current liabilities 401,763 376,178

Total liabilities 554,645 527,216

Total stockholders equity 1,409,031 1,340,464

Cash provided by operating activities 302,193 464,270

Capital expenditures 265,335 250,407

Dividends paid 82,394 80,796

Instructions

Perform each of the following.

(a) Calculate the debt to total assets ratio for each year.

(b) Calculate the free cash flow for each year.

(d) Discuss American Eagles ability to finance its investment activities with cash provided by operating activities, and how any deficiency would be met.

E2-12 Presented below are the assumptions and principles discussed in this chapter.

1. Full disclosure principle. 4. Periodicity assumption.

2. Going concern assumption. 5. Cost principle.

3. Monetary unit assumption. 6. Economic entity assumption.

Instructions

Identify by number the accounting assumption or principle that is described below. Do not use a number more than once.

(a) Is the rationale for why plant assets are not reported at liquidation value. ( Note: Do not use the cost principle.)

(b) Indicates that personal and business record-keeping should be separately maintained.

(d) Separates financial information into time periods for reporting purposes.

(e) Measurement basis used when a reliable estimate of fair value is not available.

(f ) Dictates that companies should disclose all circumstances and events that make a difference to financial statement users.

E2-13 Rosman Co. had three major business transactions during 2012.

(a) Reported at its fair value of $260,000 merchandise inventory with a cost of $208,000.

(b) The president of Rosman Co. Jay Rosman, purchased a truck for personal use and charged it to his expense account.

(c) Rosman Co. wanted to make its 2012 income look better, so it added 2 more weeks to the year (a 54-week year). Previous years were 52 weeks.

Instructions

In each situation, identify the assumption or principle that has been violated, if any, and discuss what the company should have done.

Problems: Set A

P2-1A The following items are taken from the 2008 balance sheet of Yahoo! Inc. (All dollars are in thousands.)

Intangible assets $3,926,749

Common stock 6,282,504

Property and equipment, net 1,536,181

Accounts payable 151,897

Other assets 233,989

Long-term investments 3,247,431

Accounts receivable 1,060,450

Prepaid expenses and other current assets 233,061

Short-term investments 1,159,691

Retained earnings 4,968,438

Service revenue 68,000

Prepaid insurance 3,500

Maintenance and repairs expense 1,800

Depreciation expense 3,600

Accounts receivable 11,700

Insurance expense 2,200

Salaries and wages expense 37,000

Accumulated depreciationequipment 17,600

Instructions

Prepare an income statement, a retained earnings statement, and a classified balance sheet as of December 31, 2012.

P2-3A You are provided with the following information for Merrell Enterprises, effective as of its April 30, 2012, year-end.

Accounts payable $ 834

Accounts receivable 810

Accumulated depreciationequipment 670

Cash 1,270

Common stock 900

Cost of goods sold 1,060

Exercises: Set B and Challenge Exercises

Visit the books companion website, at www.wiley.com/college/kimmel. and choose the Student Companion site to access Exercise Set B and Challenge Exercises.

Depreciation expense $ 335

Mortgage payable 3,500

Notes payable 61

Prepaid insurance 60

Retained earnings (beginning) 1,600

Sales revenue 5,100

Short-term investments 1,200

Salaries and wages expense 700

Salaries and wages payable 222

Instructions

(a) Prepare an income statement and a retained earnings statement for Merrell Enterprises for the year ended April 30, 2012.

(b) Prepare a classified balance sheet for Merrell Enterprises as of April 30, 2012.

P2-4A Comparative financial statement data for Duran Corporation and Kiepert Corporation, two competitors, appear below. All balance sheet data are as of December 31, 2012.

Duran Corporation Kiepert Corporation

2012 2012

Net sales $1,800,000 $620,000

Cost of goods sold 1,175,000 340,000

Operating expenses 283,000 98,000

Interest expense 9,000 3,800

Income tax expense 85,000 36,000

Current assets 407,200 190,336

Plant assets (net) 532,000 139,728

Current liabilities 66,325 33,716

Long-term liabilities 108,500 40,684

Cash from operating activities 138,000 36,000