Libby 4Ce Solutions Manual - Ch01.doc

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Department
Accounting & Financial Management
Course
AFM 101
Professor
Jyothika Grewal
Semester
Fall

Description
Chapter 1 Financial Statements and Business Decisions Revised April 25, 2010 ANSWERS TO QUESTIONS 1. Accounting is a system that collects and processes (analyzes, measures, and records) financial information about an organization and reports that information to decision makers. 2. Financial accounting involves preparation of the basic financial statements and related disclosures for external decision makers. Reporting is generally on a quarterly and annual basis. Managerial accounting involves the preparation of detailed plans, budgets, forecasts, and performance reports for internal decision makers. Reporting is on an ongoing basis. 3. Financial reports are used by both internal and external groups and individuals. The internal users are the various managers of the entity, e.g. marketing, credit and purchasing. The external groups include the owners, investors, creditors, governmental agencies, other interested parties, and the public at large. 4. Investors purchase all or part of a business and hope to gain by receiving part of what the company earns and/or selling the company in the future at a higher price than they paid. Creditors lend money to a company for a specific length of time and hope to gain by charging interest on the loan. 5. An accounting entity is the organization for which financial data are to be collected. Typical accounting entities are a business, a church, a governmental unit, a university and other nonprofit organizations such as a hospital. A business is defined and treated as a separate entity because the owners, creditors, investors, and other interested parties need to evaluate its performance and its potential separately from other entities and from its owners. 6. The heading of each of the four required financial statements should include the following: (a) Name of the entity (b) Title of the statement (c) Specific date or period of the statement, or the period of time it covers Financial Accounting, 4ce, Libby, Libby,© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-1 (d) Unit of measure 7. (a) The purpose of the income statement is to present information about the revenues, expenses, and the profit of the entity for a specified period of time, in order to help assess its financial performance during that period. (b) The purpose of the statement of financial position is to report the financial position of an entity at a given date, that is, to report information about the assets, obligations and shareholders’ equity of the entity as of a specific date. (c) The purpose of the statement of cash flows is to present information about the flow of cash into the entity (sources), the flow of cash out of the entity (uses), and the net increase or decrease in cash during the period. (d) The statement of changes in equity reports the way that profit, the distribution of prof(dividends), and other changes to shareholders’ equity affected the company’s financial position during the accounting period. The focus in this chapter is on retained earnings. Profit earned during the year increases the balance of retained earnings whereas the declaration of dividends to the shareholders decreases retained earnings. 8. The income statement and the statement of cash flows are dated “For the Year Ended December 31, 2011,” because they report the inflows and outflows of resources during a period of time. In contrast, the statement of financial position is dated “As at December 31, 2011” because it represents the resources, obligations and shareholders’ equity as at a specific date, December 31, 2011. 9. Assets are important to investors and creditors because assets provide a basis for judging whether sufficient resources are available to operate the company. Liabilities are important to creditors and investors because the company must be able to generate sufficient cash from operations or further borrowing to meet the payments required by debt agreements. If a business does not pay its creditors, the law may give the creditors the right to force the sale of assets sufficient to meet their claims. 10. Profit is the excess of total revenues over total expenses. Loss is the excess of total expenses over total revenues. 11. The accounting equation for the income statement is Revenues - Expenses = Profit. Revenues result from the sale of goods and services to customers, regardless of the timing of collection of cash from customers. Expenses represent the monetary value of resources the entity used up, or consumed, to earn revenues during the period. Profit is simply the excess of revenues over expenses. Financial Accounting, 4ce, Libby, Libby, Shor© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-2 12. The accounting equation for the statement of financial position is: Assets = Liabilities + Shareholders’ Equity Assets are the probable (expected) future economic benefits owned by the entity as a result of past transactions. They are the resources owned by the business at a given point in time such as cash, trade receivables, merchandise inventory, machinery, buildings, land, and patents. Liabilities are probable (expected) debts or obligations of the entity as a result of past transactions which will be discharged with assets (usually, cash) or services in the future. They are the obligations of the entity such as trade payables, notes payable, and bonds payable. Shareholders’ equity is financing provided by owners of the business and by the profit generated from the operations of the business. It is the claim of the owners to the assets of the business after the creditor claims have been satisfied. Shareholders’ equity may be thought of as the residual interest because it represents assets minus liabilities. 13. The accounting equation for the statement of cash flows is: Cash flows from operating activities +/– Cash flows from investing activities +/– Cash flows from financing activities = Change in cash for the period. The net cash flows for the period represent the increase or decrease in cash that occurred during the period. Cash flows from operating activities are cash flows directly related to earning income (normal business activity including interest paid and income taxes paid). Cash flows from investing activities comprise cash flows that are directly related to the acquisition or sale of productive assets used by the company, such as plant and equipment. Cash flows from financing activities consist of cash flows that are directly related to the financing of the enterprise, such as issuing shares to investors. 14. The accounting equation for retained earnings is: Beginning Retained Earnings + Profit – Dividends = Ending Retained Earnings The equation begins with beginning-of-the-year Retained Earnings i.e., the prior year’s ending retained earnings reported on the statement of financial position. The current year's Profit reported on the income statement is added to this amount and the Dividends declared during the current year are subtracted from this amount. The ending Retained Earnings amount is reported on the end-of-period statement of financial position. Financial Accounting, 4ce, Libby, Libby, Shor© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-3 15. Credit managers use customers' financial statements to decide whether to extend them credit for their purchases. Purchasing managers use potential suppliers' financial statements to judge whether the suppliers have the resources necessary to meet current and future demand. Human resource managers use financial statements as a basis for contract negotiations to determine, for example, what pay rates the company can afford. The profit figure can also serve as a basis to pay bonuses not only to management, but to other employees through profit sharing plans. Financial Accounting, 4ce, Libby, Libby, Short© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-4 16. In Canada, provincial securities legislation created securities commissions, most notably the Ontario Securities Commission (OSC) ,to regulate Canadian capital markets and the flow of financial information provided by publicly traded companies whose shares trade on Canadian stock exchanges, such as the Toronto Stock Exchange. Similar to the SEC, the OSC plays an influential role in promoting sound accounting practices by publicly traded companies. Since their establishment, these securities commissions have worked with organizations of professional accountants to establish groups that are given the primary responsibilities to work out the detailed rules that Canadian entities must use. The name of the current Canadian group that has this responsibility is the Accounting Standards Board (AcSB). The AcSB is responsible for establishing standards of accounting and reporting by Canadian companies and not-for-profit organizations. 17. The officers of the company, usually the CEO and the CFO, must personally sign a certification that they have designed or supervised the design, implementation and evaluation of effective, appropriate financial accounting and reporting processes. The executives and officers of the company bear primary responsibility for information prepared and reported in the financial statements and other information contained in the annual report. Top management also nominates members to the Board of Directors to oversee the integrity of the first two safeguards. Those owning shares of the firm vote to elect the Board of Directors which holds the officers of the company accountable to the shareholders for defects in the internal control and reporting system. It also appoints external, independent auditors who provide advice to companies on how to best comply with regulations on financial reporting. 18. A sole proprietorship is an unincorporated business owned by one individual. A partnership is an unincorporated association of two or more individuals to carry on a business. A corporation is a business that is organized under federal or provincial laws, whereby a charter is granted and the entity is thus authorized to issue shares of stock as evidence of ownership by the owners (i.e., shareholders). Corporations are legal entities separate from their owners, but sole proprietorships and partnerships are not. Financial Accounting, 4ce, Libby, Libby, Sho© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-5 19. Public practice accounting firms normally render three types of service: assurance services, management advisory services, and tax services. Assurance services, including auditing, involves examination of the records and financial statements to determine whether they “fairly present” the financial position and results of operations of the entity in accordance with the applicable accounting standards. Management advisory (consulting) services include providing expert business advice to management. Tax services involve providing tax-planning advice to clients (both individuals and businesses) and preparation of their tax returns. Financial Accounting, 4ce, Libby, Libby, Short,© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-6 Authors' Recommended Solution Time (Time in minutes) Alternate Cases and Exercises Problems Problems Projects No. Time No. Time No. Time No. Time 1 20 M 1 45 M 1 45 M 1 30 E 2 25 M 2 60 D 2 60 D 2 20 E 3 20 M 3 30 M 3 30 M 4 20 M 4 45 M 4 20 M 5 20 M 5 60 M 5 25 M 6 20 E 6 25 M 7 20 E 7 25 M 8 10 E 8 * 9 20 M 10 10 E 11 30 M 12 35 D E = Easy M = Moderate D = Difficult * Due to the nature of these cases and projects, it is very difficult to estimate the amount of time students will need to complete the assignment. As with any open-ended project, it is possible for students to devote a large amount of time to these assignments. While students often benefit from the extra effort, we find that some become frustrated by the perceived difficulty of the task. You can reduce student frustration and anxiety by making your expectations clear. For example, when our goal is to sharpen research skills, we devote class time discussing research strategies. When we want the students to focus on a real accounting issue, we offer suggestions about possible companies or industries. Financial Accounting, 4ce, Libby, Lib© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-7 EXERCISES E1–1 Honda Motor Co., Ltd. Statement of Financial Position As at March 31, 2009 (in millions of Yen) Assets Cash and cash equivalents ¥ 690,369 Trade accounts, notes, and other 854,214 receivables Inventories 1,243,961 Investments 639,069 Other current assets 4,232,916 Property, plant and equipment, net 3,435,520 Other assets 722,86 8 Total assets ¥11,818,9 17 Liabilities and shareholders’ equity Trade payables and other current ¥ liabilities 4,237,368 Long-term borrowings 1,932,637 Other liabilities 1,641,62 4 Total liabilities 7,811,62 9 Share capital 302,561 Retained earnings 3,704,72 7 Total shareholders’ equity 4,007,28 8 Total liabilities and shareholders’ equity ¥11,818,9 17 Financial Accounting, 4ce, Libby, Libby,© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-8 E1–2 Req. 1 READ MORE STORE Statement of Financial Position As at December 31, 2011 ASSETS LIABILITIES AND SHAREHOLDERS’ EQUITY Liabilities Cash $ 48,900 Accounts payable $ 7,000 Accounts receivable 25,000 Note payable 3,000 Store and office 49,000 Interest payable 120 equipment Total liabilities 10,120 Shareholders’ Equity Share capital 100,000 Retained earnings 12,780 Total shareholders’ 112,780 equity Total liabilities and Total assets $122,900 shareholders' equity $122,900 Req. 2 This is the first year of operations and no dividends were declared. Therefore, the balance of retained earnings, $12,780, at year-end consists entirely of the profit earned during the first year. E1–3 THE UNIVERSITY SHOP Income Statement For the Month of September 2012 Revenue from sales $120,000 (*) Expenses: Cost of goods sold $ 40,000 Salaries, rent, supplies, and other expenses 38,000 Utilities 600 Total expenses 78,600 Profit for the period $ 41,400 Financial Accounting, 4ce, Libby, Libby,© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-9 (*) $119,000 + $1,000 = $120,000. (Note: income taxes were ignored in this problem.) Financial Accounting, 4ce, Libby, Libby, Short, Kanaa© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-10 E1–4 Net sales 892,51 3 Cost of sales 424,461 Selling and distribution expenses 43,248 General and administrative expenses 187,397 Advertising and promotion expenses 66,917 Interest expense 4,297 Total expenses excluding income taxes 726,32 424,461 + 43,248 0 +187,397 + 66,917 +4,297 Profit before income tax 166,19 892,513 – 726,230 3 Income tax expense 48,60 3 Profit for the year 117,59 166,193 – 48,603 0 E1–5 HOME REALTY, INCORPORATED Income Statement For the Year Ended December 31, 2011 Revenue: Commissions earned ($150,000 + $16,000)$166,000 Rental service fees 15,000 Total revenues $181,000 Expenses: Salaries $ 62,000 Commissions 35,000 Payroll tax 2,500 Rent [($2,200 / 11 months) x 12] 2,400 Utilities 1,600 Promotion and advertising 8,000 Miscellaneous 500 Total expenses, excluding income taxes 112,000 Profit before income taxes 69,000 Income tax expense 18,500 Profit for the period $50,500 Financial Accounting, 4ce, Libby, Libby© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-11 E1–6 A Profit = $100,000 - $82,000 = $18,000; Shareholders’ Equity = $150,000 - $70,000 = $80,000. B Total Revenues = $80,000 + $12,000 = $92,000; Total Liabilities = $112,000 - $60,000 = $52,000. C Profit (Loss) = $80,000 - $86,000 = ($6,000); Shareholders’ Equity = $104,000 - $26,000 = $78,000. D Total Expenses = $50,000 - $13,000 = $37,000; Total Assets = $22,000 + $77,000 = $99,000. E Total Revenues = $81,000 - $6,000 = $75,000; Total Assets = $73,000 + $28,000 = $101,000. E1–7 DUCHARME CORPORATION Summary Income Statement For the Month of January 2011 Total revenues $150,000 Less: Total expenses (excluding income taxes) 100,000 Profit before income taxes 50,000 Less: Income tax expense 15,000 Profit for the year $ 35,000 DUCHARME CORPORATION Statement of Financial Position As at January 31, 2011 Assets Cash $20,000 Receivables from customers 25,000 Merchandise inventory 32,000 Total assets $77,000 Liabilities and Shareholders’ Equity Liabilities: Payables to suppliers $11,000 Income taxes payable 15,000 Total liabilities 26,000 Shareholders’ equity: Share capital (2,600 shares issued) 26,000 Retained earnings (Note 1) 25,000 Total liabilities and shareholders’ equity $77,000 Financial Accounting, 4ce, Libby, Libby© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-12 Note 1: $35,000 – $10,000 E1-8 Retained earnings, January 1, 2011 $ - Profit for 2011 36,000 Dividends for 2011 (15,000) Retained earnings, December 31, 2011 $ 21,000 Retained earnings, January 1, 2012 $ 21,000 Profit for 2012 45,000 Dividends for 2012 (20,000) Retained earnings, December 31, 2012 $ 46,000 E1–9 1. Average amount of monthly revenue, $216,000 ÷ 12 = $18,000. 2. Amount of monthly rent, $21,000 ÷ 12 = $1,750. 3. “Supplies, $25,000” is an expense because it represents the cost of supplies used in performing the services sold. 4. “Interest” is an expense because it represents the cost of borrowing. The company has an outstanding loan (from another party); $8,000 is the amount of interest (owed, if not already paid) on that debt for the year 2010. The interest on the loan for the year 2010 is an expense of the year 2010 (whether or not paid by December 31, 2010). 5. Average income tax rate, $21,000 ÷ $60,000 = 35%. 6. The income statement does not report, or make it possible to determine, the ending cash balance. Cash is reported on the statement of financial position under assets and on the statement of cash flows as the final amount reported. 7. Price/earnings ratio, $468,000÷$39,000 = 12. E1–10 (O) (1) Cash paid to suppliers and employees O (2) Cash received from customers (O) (3) Income taxes paid O (4) Interest and dividends received (O) (5) Interest paid I (6) Proceeds from sale of investment in Conner Peripherals, Inc. (I) (7) Purchases of property, plant, and equipment (F) (8) Repayment of borrowings Financial Accounting, 4ce, Libby, Libby, S© 2011 McGraw-Hill Ryerson Limited. All rights reserved. 1-13 E1–11 NITSU MANUFACTURING CORPORATION Statement of Cash Flows For the Year Ended December 31, 2011 Cash flow from operating activities Cash collected from customers $270,000 Cash paid for operating expenses (180,000) Net cash flow from operating activities $90,000 Cash flow from investing activities Cash received for sale of land 15,000 Cash paid for purchase of new machines (38,000) Net cash flow from (used in) investing activities (23,000) Cash flow from financing activities Cash received from sale of the company’s shares 30,000 Cash paid on long-term notes (80,000) Cash paid for dividends (22,000) Net cash flow from (used in) financing activities (72,000) Net decrease in cash during the year (5,000) Cash at beginning of year 63,000 Cash at end of year $ 58,000 E1–12 Req. 1 PAUL'S PAINTERS Schedule of Cash Flow from Operations For the Month of January 2012 Cash Inflows Cash services $105,000 Cash Outflows: Salaries and wages paid $50,000 Other expenses paid 26,000
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