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Department
ABE - Biological & Agricultural Systems Engineering
Course
BSC 1005
Professor
John Paul
Semester
Spring

Description
Chapter 3 The Balance Sheet and Financial Disclosures AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise, and problem in Intermediate Accounting, 7e with the following AACSB learning skills: Questions AACSB Tags Exercises (cont.) AACSB Tags 3–1 Reflective thinking 3–3 Reflective thinking 3–2 Reflective thinking 3–4 Analytic 3–3 Reflective thinking 3–5 Analytic 3–4 Reflective thinking 3–6 Analytic 3–5 Reflective thinking 3–7 Analytic 3–6 Reflective thinking 3–8 Analytic 3–7 Reflective thinking 3–9 Analytic 3–8 Reflective thinking 3–10 Reflective thinking 3–9 Reflective thinking 3–11 Reflective thinking 3–10 Reflective thinking 3–12 Reflective thinking 3–11 Reflective thinking 3–13 Communications 3–12 Reflective thinking 3–14 Communications 3–13 Reflective thinking 3–15 Reflective thinking 3–14 Reflective thinking 3–16 Analytic 3–15 Reflective thinking 3–17 Analytic 3–16 Reflective thinking 3–18 Analytic 3–17 Reflective thinking 3–19 Analytic 3–18 Reflective thinking 3–20 Analytic 3–19 Reflective thinking 3–21 Analytic 3–20 Reflective thinking 3–22 Reflective thinking, Diversity 3–21 Reflective thinking CPA/CMA 3–22 Reflective thinking 1 Analytic 3–23 Reflective thinking 2 Analytic Brief Exercises 3 Reflective thinking 3–1 Reflective thinking 4 Analytic 3–2 Analytic 5 Reflective thinking 3–3 Analytic 6 Analytic 3–4 Analytic 7 Diversity, Reflective thinking 3–5 Analytic 8 Diversity, Reflective thinking 3–6 Analytic 1 Reflective thinking 3–7 Analytic 2 Analytic 3–8 Analytic 3 Reflective thinking 3–9 Analytic Problems 3–10 Reflective thinking 3–1 Analytic 3–11 Analytic 3–2 Analytic Exercises 3–3 Analytic 3–1 Analytic 3–4 Analytic 3–2 Reflective thinking 3–5 Analytic Problems cont. 3–6 Analytic, Reflective thinking © The McGraw-Hill Companies, Inc., 2013 Solutions Manual, Vol.1, Chapter 3 3–1 3–7 Analytic 3–8 Analytic 3–9 Analytic 3–10 Analytic © The McGraw-Hill Companies, Inc., 2013 3–2 Intermediate Accounting, 7/e QUESTIONS FOR REVIEW OF KEY TOPICS Question 3 –1 The purpose of the balance sheet, also known as the statement of financial position, is to present the financial position of the company on a particular date. Unlike the income statement, which is a change statement that reports events occurring during a period of time, the balance sheet is a statement that presents an organized array of assets, liabilities, and shareholders’ equity at a point in time. It is a freeze-frame or snapshot picture of financial position at the end of a particular day marking the end of an accounting period. Question 3–2 The balance sheet does not portray the market value of the entity (number of common stock shares outstanding multiplied by price per share) for a number of reasons. Most assets are not reported at fair value, but instead are measured according to historical cost. Also, there are certain resources, such as trained employees, an experienced management team, and a good reputation, that are not recorded as assets at all. Therefore, the assets of a company minus its liabilities, as shown in the balance sheet, willnot be representative of the company’s market value. Question 3–3 Current assets include cash and other assets that are reasonably expected to be converted to cash or consumed during one year, or within the normal operating cycle of the business if the operating cycle is longer than one year. The typical asset categories classified as current assets include: — Cash and cash equivalents — Short-term investments — Accounts receivable — Inventories — Prepaid expenses Question 3–4 Current liabilities are those obligations that are expected to be satisfied through the use of current assets or the creation of other current liabilities. So, this classification will include all liabilities that are scheduled to be liquidated within one year or the operating cycle, whichever is longer, except those that management intends to refinance on a long-term basis. The typical liability categories classified as current liabilities include: — Accounts payable — Short-term notes payable — Accrued liabilities — Current maturities of long-term debt © The McGraw-Hill Companies, Inc., 2013 Solutions Manual, Vol.1, Chapter 3 3–3 Answers to Questions (continued) Question 3–5 The operating cycle for a typical manufacturing company refers to the period of time required to convert cash to raw materials, raw materials to a finished product, finished product to receivables, and then finallyreceivables back to cash. Question 3–6 Investments in equity securities are classified as current if the company’s management (1) intends to liquidate the investment in the next year or operating cycle, whichever is longer, and (2) has the ability to do so, that is, the investment is marketable. If either of these criteria does not hold, the investment is classified as noncurrent. Question 3–7 The common characteristics that these assets have in common are that they are tangible, long- lived assets used in the operations of the business. They usually are the primary revenue-generating assets of the business. These assets include land, buildings, equipment, machinery, furniture, and other assets used in the operations of the business, as well as natural resources, such as mineral mines, timber tracts, and oil wells. Question 3–8 Property, plant, and equipment and intangible assets each represent assets that are long-lived and are used in the operations of the business. The difference is that property, plant, and equipment represent physical assets, while intangible assets lack physical substance. Generally, intangible assets represent the ownership of an exclusive right, such as a patent, copyright, or franchise. Question 3–9 A note payable of $100,000 due in five years would be classified as a long-term liability. A $100,000 note due in five annual installments of $20,000 each would be classified as a $20,000 current liability—current maturities of long-term debt—and an $80,000 long-term liability. Question 3–10 Paid-in capital consists of amounts invested by shareholders in the corporation. Retained earnings equals net income less dividends paid to shareholders from the inception of the corporation. © The McGraw-Hill Companies, Inc., 2013 3–4 Intermediate Accounting, 7/e Answers to Questions (continued) Question 3–11 Disclosure notes provide additional detail concerning specific financial statement items. Included are such data as the fair values of financial instruments and off-balance-sheet risk associated with financial instruments and details of pension plans, leases, debt, and assets. Common to all companies’ disclosures are certain specific notes such as a summary of significant accounting policies, descriptions of subsequent events, and related third-party transactions. However, many notes are designed to fit the disclosure needs of the particular reporting company. In fact, any explanation that helps investors and creditors make decisions should be included. Question 3–12 The disclosure of the company’s significant accounting policies is extremely important to external users in terms of their ability to compare financial information across companies. It is critical to a financial analyst involved in assessing future cash flows of two construction companies to know that one company uses the percentage-of-completion method in recognizing gross profit, while the other company uses the completed contract method. Question 3–13 A subsequent event is an event that occurs after the date of the financial statements but prior to the date on which the statements are actually issued or “available to be issued.” It may help to clarify a previously existing situation or it may represent a new event not directly affecting financial position at the end of the reporting period. Question 3–14 The discussion provides management’s views on significant events, trends, and uncertainties pertaining to the company’s (a) operations, (b) liquidity, and (c) capital resources. Certainly the Management Discussion and Analysis section may be slanted toward management’s biased perspective and therefore can lack objectivity. However, management can offer an informed insight that might not be available elsewhere, so if the reader maintains awareness of the information’s source, it can offer a unique view of the situation. © The McGraw-Hill Companies, Inc., 2013 Solutions Manual, Vol.1, Chapter 3 3–5 Answers to Questions (continued) Question 3–15 Depending on the circumstances, the auditor willissue a (an): 1. Unqualified opinion—The auditors are satisfied that the financial statements “present fairly” the financial position, results of operations, and cash flows and are “prepared in accordance with generallyaccepted accounting principles.” 2. Qualified opinion—This contains an exception to the standard unqualified opinion, but not of sufficient seriousness to invalidate the financial statements as a whole. Examples of exceptions are (a) unconformity with generally accepted accounting principles, (b) inadequate disclosures, and (c) a limitation or restriction of the scope of the examination. 3. Adverse opinion—This is necessary when the exceptions (a) and (b) above are so serious that a qualified opinion is not justified. Adverse opinions are rare because auditors usually are able to persuade management to rectify problems to avoid this undesirable report. 4. Disclaimer—An auditor will disclaim an opinion if item (c) above applies and, therefore, insufficient information has been gathered to express an opinion. Question 3–16 A proxy statement must be sent each year to all shareholders. It usually is in the same mailing with the annual report. The statement invites shareholders to the shareholders’ meeting to elect board members and to vote on issues before the shareholders. It also permits shareholders to vote using an enclosed proxy card. The proxy statement also provides for more disclosures on compensation to directors and executives, and in particular, stock options granted to executives. Question 3–17 Working capital is the difference between current assets and current liabilities. The current ratio is computed by dividing current assets by current liabilities. The acid-test ratio (or quick ratio) is computed by dividing quick assets (cash and cash equivalents, marketable securities, and accounts receivable) by current liabilities. Question 3–18 Debt to equity ratio = Total liabilities Shareholders' equity Times interest earned ratio = Net income + interest + taxes Interest © The McGraw-Hill Companies, Inc., 2013 3–6 Intermediate Accounting, 7/e Answers to Questions (concluded) Question 3–19 IAS No.1, revised, “Presentation of Financial Statements,” provides authoritative guidance for balance sheet presentation under IFRS. Question 3–20 Differences in balance sheet presentation between U.S. GAAP and IFRS include: 1. International standards specify a minimum list of items to be presented in the balance sheet. U.S. GAAP has no minimumrequirements. 2. IAS No. 1, revised, changed the title of the balance sheet to statement of financial position, although companies are not required to use that title. Some U.S. companies use the statement of financial position title as well. 3. Under U.S. GAAP, we present current assets and liabilities before noncurrent assets and liabilities. IAS No. 1 doesn’t prescribe the format of the balance sheet, but balance sheets prepared using IFRS often report noncurrent items first. Question 3–21 An operating segment is a component of an enterprise: 1. That engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same enterprise). 2. Whose operating results are regularly reviewed by the enterprise's chief operating decision-maker to make decisions about resources to be allocated to the segment, and to assess its performance. 3. For which discrete financial information is available. Question 3–22 For areas determined to be reportable operating segments, the following disclosures are required: 1. General information about the operating segment. 2. Information about reported segment profit or loss, including certain revenues and expenses included in reported segment profit or loss, segment assets, and the basis of measurement. 3. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other significant items to corresponding enterprise amounts. 4. Interim period information. Question 3–23 U.S. GAAP requires companies to report information about reported segment profit or loss, including certain revenues and expenses included in reported segment profit or loss, segment assets, and the basis of measurement. The international standard on segment reporting, IFRS No. 8, requires that companies also disclose the total liabilities of its reportable segments. BRIEF EXERCBrief Exercise 3–1 (a) Current (b) Current (c) Noncurrent (d) Current © The McGraw-Hill Companies, Inc., 2013 Solutions Manual, Vol.1, Chapter 3 3–7 (e) Noncurrent (f) Noncurrent Current assets: Brief Exercise 3–2 $16,000 + 11,000 + 25,000 = $52,000 Current liabilities: $14,000 + 9,000 + 1,000 = $24,000 Assets: $ 52,000 current assets Brief Exercise 3–3 80,000 equipment $132,000 total assets minus Liabilities $ 24,000 current liabilities 30,000 notes payable $ 54,000 total liabilities equals Shareholders’ equity $78,000 (50,000) common stock $28,000 retained earnings 3–8he McGraw-Hill Companies, Inc., 2013 Intermediate Accounting, 7/e Brief Exercise 3–4 K AND J NURSERY, INC. Balance Sheet At December 31, 2013 Assets Current assets: Cash ................................................................$ 16,000 Accounts receivable ............................................ 11,000 Inventories .......................................................... 25,000 Total current assets ........................................ 52,000 Property, plant, and equipment: Equipment ............................................$140,000....... Less: Accumulated depreciation .........................(60,000) Net property, plant, and equipment ............... 80,000 Total assets ................................................. $132,000 Liabilities and Shareholders' Equity Current liabilities: Accounts payable ............................................... $ 14,000 Wages payable ................................................... 9,000 Interest payable .................................................. 1,000 Total current liabilities ................................... 24,000 Long-term liabilities: Note payable ....................................................... 30,000 Shareholders’ equity: Common stock ..........................................$50,000... Retained earnings* ......................................28,000. Total shareholders’ equity ............................. 78,000 Total liabilities and shareholders’ equity $132,000 $28,000 is the amount needed to cause total assets to equal total liabilities and shareholders’ equity. This is calculated in BE 3–3. Solutions Manual, Vol.1, Chapter 3 © The McGraw-Hill Companies,3–9c., 2013 1. Brief Exercise 3–5Brief Exercise 3–6 CULVER CITY LIGHTING, INC. Balance Sheet At December 31, 2013 Assets Current assets: Cash ................................................................$ 55,000 Accounts receivable ............................................ 39,000 Inventories .......................................................... 45,000 Prepaid insurance ................................................ 15,000 Total current assets ........................................ 154,000 Property, plant, and equipment: Equipment .............................................$100,000...... Less: Accumulated depreciation ......................... (34,000) Net property, plant, and equipment ............... 66,000 Intangible assets: Patent ...............................................................40,000 Total assets ................................................. $260,000 Liabilities and Shareholders' Equity Current liabilities: Accounts payable ............................................... $ 12,000 Interest payable................................................... 2,000 Current maturities of long-term debt ................... 10,000 Total current liabilities ................................... 24,000 Long-term liabilities: Note payable ....................................................... 90,000 Shareholders’ equity: Common stock ...........................................$70,000.. Retained earnings .......................................76,000.. Total shareholders’ equity ............................. 146,000 Total liabilities and shareholders’ equity $260,000 1. The $30,000 should be classified as a noncurrent asset, under the investments classification. 3–10e McGraw-Hill Companies, Inc., 2013 Intermediate Accounting, 7/e 2. $10,000, next year’s installment, should be classified as a current liability, current maturities of long-term debt. The remaining $90,000 is included in long-term liabilities. 3. Two-thirds of the unearned revenue, $40,000, should be classified as a current liability, the remaining $20,000 as a long-term liability. Current assets – Cash and cash equivalents – Accounts Brief Exercise 3–7 receivable = Inventories $235,000 – 40,000 – 120,000 = $75,000 Total assets – Current assets = Property, plant, and equipment $400,000 – 235,000 = $165,000 Total assets – Accounts payable – Note payable – Common stock = Retained earnings $400,000 – 32,000 – 50,000 – 100,000 = $218,000 (1) A Brief Exercise 3–8 (2) B (3) B (4) A (5) B (6) A Solutions Manual, Vol.1, Chapter 3 © The McGraw-Hill Compa3–11, Inc., 2013 (a) Current assets ÷ Brief Exercise 3–9 Current liabilities ($55,000 + 39,000 + 45,000 + 15,000) ÷ ($12,000 + 2,000 + 10,000) $154,000 ÷ $24,000 = 6.42 (b)(Cash + Short-term investments + Accounts receivable) ÷ Current liabilities ($55,000 + 0 + 39,000) ÷ $24,000 = 3.92 (c) Total liabilities ÷ Shareholders’ equity $24,000 Current liabilities + 90,000 Long-term liabilities = $114,000 $70,000 Common stock + 76,000 Retained earnings = $146,000 $114,000 ÷ $146,000 = .78 Paying accounts payable reduces both current Brief Exercise 3–10 assets and current liabilities. If the ratio before the payment was above 1.0, the transaction would cause the ratio to increase. However, if the ratio before the transaction was less than 1.0, the ratio would decrease. Acid-test ratio = (Cash + Short-term investments Brief Exercise 3–11 + A/R) ÷ Current liabilities 1.5 = ($20,000 + 0 + 40,000) ÷ Current liabilities 1.5 x Current liabilities = $60,000 Current liabilities = $60,000 ÷ 1.5 Current liabilities = $40,000 Current ratio = Current assets ÷ Current liabilities 2.0 = Current assets ÷ $40,000 Current assets = $40,000 x 2.0 Current assets = $80,000 $80,000 – 20,000(cash) – 40,000(A/R) = $20,000 inventories Exercise 3–1RCISES 1. Total current assets Current liabilities = $44,000 + 15,000 + 1,000 (accrued interest) = $60,000 3–12e McGraw-Hill Companies, Inc., 2013 Intermediate Accounting, 7/e Since the current ratio is 1.5:1, Current assets = 1.5 x $60,000 = $90,000 2. Short-term investments $90,000 – 5,000 – 20,000 – 60,000 = $5,000 3. Retained earnings Current assets + Noncurrent assets = Current liabilities + Long-term liabilities + Paid-in capital + Retained earnings (RE) $90,000 + 120,000 = $60,000 + 30,000 (note payable) + 100,000 + RE RE = $20,000 Exercise 3–2 1. c Equipment 10. a Inventories 2. f Accounts payable 11. d _ Patent 3. -a _ Allowance for uncollectible accounts 12. c Land, in use 4. b _ Land, held for investment 13. f _ Accrued liabilities 5. g _ Note payable, due in 5 years 14. a Prepaid rent 6. f Unearned rent revenue 15. h _ Common stock 7. f Note payable, due in 6 months 16. c Building, in use 8. i Income less dividends, accumulated 17. a Cash 9. b Investment in XYZ Corp., long-term 18. f _ Taxes payable Exercise 3–3 1. f Accrued interest payable 10. a Supplies 2. d Franchise 11. c Machinery 3. -c Accumulated depreciation 12. c Land, in use 4. a Prepaid insurance, for 2014 13.___ f Unearned revenue 5. g Bonds payable, due in 10 years 14. d _ Copyrights 6. f Current maturities of long-term debt 15. h _ Preferred stock 7. f Note payable, due in 3 months 16. b _ Land, held for speculation 8. b Long-term receivables 17. a Cash equivalents 9. b Bond sinking fund, willbe used to 18. f _ Wages payable retire bonds in 10 years © The McGraw-Hill Companies, Inc., 2013 Solutions Manual, Vol.1, Chapter 3 3–13 Exercise 3–4 Exercise 3VAJExercise 3–6 OORRPOOR ATTIONN Balance Sheet At December 31, 2013 AAssets CuCurrent assets: Cash ...........................................................$ 25,000.............. Marketable securities ............................................22,000..... Accounts receivable, net of allowance for......................... 10,000 Accounts receivable ............................................5134,000 InInventories ......................................................75,000......... PrPrepaid rent .....................................................16,000.... Total current assets .........................................211,000... Total current assets ........................................ 175,000 Investments: Property, plant, and equipment:......................$22,000................. LaMachinery ........................................$145,000......................... Less: Accumulated depreciation ....................(11,000).....42,000... Property, plant, and equipment: Land ................................................100,000......................... Buildings ...........................................300,000........................ Equipment ............................................75,000..................... Patent ...........................................475,000........83,000 Less: Accumulated depreciation .....................(125,000)........,000 Net property, plant, and equipment ...........................350,000 Liabilities and Shareholders' Equity Intangible assets: Copyright ........................................................12,000.......... AccTotal assets ..............................................$615,000....... Wages payable ................................................... 4,000 Taxes payable ....................................................32,000 CurrentTotal current liabilities ................................... 44,000 Accounts payable ...............................................$ 65,000..... Interest payable .................................................10,000........ Unearned revenues ................................................20,000.... NoBonds payable ...................................................200,000....... Current maturities of long-term debt .............................50,000 Shareholders’ equity:ilities ....................................245,000.... Common stock .....................................$100,000....... LongRetained earnings ..................................48,000....... Note payable ....................................................100,000......... Shareholders’ equity:ders’ equity ............................. 148,000 Common stock .......................................$200,000................. Retained earnings ....................................70,000.................. Total shareholders’ equity ...................................270,000 Total liabilities and shareholders’ equity ................$615,000 Current assets: © The McGraw-Hill Companies, Inc., 2013 3–14 Intermediate Accounting, 7/e Cash $20,000 Accounts receivable 130,000 Less: Allowance for uncollectible accounts (13,000) Note receivable 100,000 Interest receivable 3,000 Marketable securities 32,000 Raw materials 24,000 Work in process 42,000 Finished goods 89,000 Prepaid rent (one-half of $60,000) 30,000 Total current assets $457,000 Current liabilities: Unearned revenue (one half of $36,000) 18,000 Accounts payable 180,000 Interest payable 5,000 Total current liabilities (203,000) Working capital $254,000 Exercise 3–7 Solutions Manual, Vol.1, Chapter 3 © The McGraw-Hill Compani3–15Inc., 2013 LOS GATOS CORPORATION Exercise 3–8 Balance Sheet At December 31, 2013 Assets Current assets: Cash .....................................................................$ 20,000 Accounts receivable, net of allowance for uncollectible accounts of $5,000 ......................... 55,000 Inventories ............................................................... 55,000 Total current assets ............................................ 130,000 Investments: Bond sinking fund ..........................................$ 20,000. Note receivable ..............................................20,000.... Total investments ............................................... 40,000 Property, plant, and equipment: Machinery ..................................................190,000...... Less: Accumulated depreciation ..............................(70,000) Net property, plant, and equipment .................... 120,000 Intangible assets: Franchise ................................................................. 30,000 Total assets ...................................................... $320,000 Liabilities and Shareholders' Equity Current liabilities: Accounts payable .................................................... $ 50,000 Interest payable ....................................................... 5,000 Note payable ........................................................... 50,000 Total current liabilities ....................................... 105,000 Long-term liabilities: Bonds payable ......................................................... 110,000 Shareholders’ equity: Common stock, no par value; 100,000 shares authorized; 50,000 shares issued and outstanding $ 70,000 Retained earnings ............................................35,000.. Total shareholders’ equity .................................. 105,000 Total liabilities and shareholders’ equity ........ $320,000 © The McGraw-Hill Companies, Inc., 2013 3–16 Intermediate Accounting, 7/e Exercise 3–9 CONE CORPORATION Balance Sheet (Partial) At December 31, 2013 Assets Current assets: Marketable securities .......................................... $ 40,000 Prepaid rent ........................................................ 12,000 Investments: Bond sinking fund ............................................... 50,000 Marketable securities .......................................... 40,000 Other assets: Prepaid rent (1) ................................................... 12,000 Liabilities and Shareholders' Equity Current liabilities: Interest payable .................................................. $ 12,000 Current maturities of long-term debt ................... 20,000 Long-term liabilities: Note payable ....................................................... 180,000 (1)Note: In practice, companies often report all prepaid expenses as current assets. See calculations below the balance sheet. © The McGraw-Hill Companies, Inc., 2013 Solutions Manual, Vol.1, Chapter 3 3–17 KORVER SUPPLY COMPANY Balance Sheet At December 31, 2013 Assets Current assets: Cash ................................................................$168,000 Accounts receivable ............................................ 320,000 Inventories ..........................................................250,000 Total current assets ........................................ 738,000 Property, plant, and equipment: Furniture and fixtures ...............................$300,000... Less: Accumulated depreciation ........................(170,000) Net property, plant, and equipment ............... 130,000 Total assets ................................................. $868,000 Liabilities and Shareholders' Equity Current liabilities: Accounts payable ............................................... $180,000 Interest payable .................................................. 6,000 Note payable ....................................................... 200,000 Total current liabilities ................................... 386,000 Shareholders’ equity: Common stock .........................................$100,000... Retained earnings .....................................382,000... Total shareholders’ equity ............................. 482,000 Total liabilities and shareholders’ equity $868,000 © The McGraw-Hill Companies, Inc., 2013 3–18 Intermediate Accounting, 7/e Exercise 3–9 (concluded) Beginning balance in cash $120,000 + Cash collected from customers 780,000 – Cash paid to suppliers (560,000) – Cash paid for operating expenses (160,000) – Cash paid for interest (12,000) Ending cash balance $168,000 Beginning balance in accounts receivable $300,000 + Credit sales 800,000 – Cash collected from customers (780,000) Ending balance in accounts receivable $320,000 Beginning balance in inventories $200,000 + Purchases 550,000 – Cost of merchandise sold (500,000) Ending balance in inventories $250,000 Beginning balance in furniture and fixtures, net $150,000 – Depreciation for the year (20,000) Ending balance in furniture and fixtures, net $130,000 Beginning balance in accounts payable $190,000 + Purchases on account 550,000 – Cash paid to suppliers (560,000) Ending balance in accounts payable $180,000 Beginning balance in retained earnings $274,000 + Sales revenue 800,000 – Cost of goods sold (500,000) – Operating expenses (160,000) – Depreciation expense (20,000) – Interest expense (12,000) Ending balance in retained earnings $382,000 6 Accrued interest on note ($200,000 x 6% x / 12) $6,000 1. Inventory costing Exercise 3–10 method A 2. Information on related-party transactions B Solutions Manual, Vol.1, Chapter 3 © The McGraw-Hill Compani3–19Inc., 2013 3. Composition of property, plant, and equipment B 4. Depreciation method A 5. Subsequent event information B 6. Basis of revenue recognition on long-term contracts A 7. Important merger occurring after year-end B 8. Composition of receivables B 1. When related-party transactions occur, companies must Exercise 3–11 disclose the nature of the relationship, provide a description of the transaction, and report the dollar amounts of the transactions and any amounts due from or to related parties. 2. When an event that has a material effect on the company’s financial position occurs after the fiscal year-end, but before the financial statements actually are issued, the event is disclosed in a subsequent event disclosure note. 3. The choice of the straight-line method to determine depreciation typically is disclosed in the company’s summary of significant accounting policies disclosure note. 4. This information would be included in a disclosure note describing the company’s debt. 5. The choice of the FIFO method to determine value inventory typically is disclosed in the company’s summary of significant accounting policies disclosure note. 1. (B) in a separate disclosure note. Exercise 3–12 2. (A) in the summary of significant policies note. 3. (C) on the face of the balance sheet. 4. (B) in a separate disclosure note. 5. (B) in a separate disclosure note. 6. (A) in the summary of significant policies note. 7. (C) on the face of the balance sheet. 8. (B) in a separate disclosure note. 3–20e McGraw-Hill Companies, Inc., 2013 Intermediate Accounting, 7/e Exercise 3–13 Requirement 1 The topic number that provides guidance on information contained in the notes to the financial statements is ASC Topic 235: “Notes to the Financial Statements.” Requirement 2 The specific citation that describes the information that companies must disclose in the accounting policies note is FASB ASC 235–10–50–3: “Notes to Financial Statements–Overall–Disclosure–What to Disclose.” Requirement 3 Disclosure of accounting policies should identify and describe the accounting principles the company follows and the methods of applying those principles that materially affect the determination of financial position, cash flows, or results of operations. In general, the disclosure encompasses important judgments as to appropriateness of principles relating to recognition of revenue and allocation of asset costs to current and future periods. In particular, it encompasses those accounting principles and methods that involve any of the following: a. A selection from existing acceptable alternatives. b. Principles and methods peculiar to the industry in which the entity operates, even if such principles and methods are predominantly followed in that industry. c. Unusual or innovative applications of GAAP. <> Exercise 3–14 The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. What is the balance sheet classification for a note payable due in six months that was used to purchase a building? Solutions Manual, Vol.1, Chapter 3 © The McGraw-Hill Compani3–21Inc., 2013 FASB ASC 210–10–45–9: “Notes to Financial Statements–Overall–Other Presentation Matters–Other Liabilities.” Other liabilities whose regular and ordinary liquidation is expected to occur within a relatively short period of time, usually 12 months, are also generally included, such as the following: a. Short-term debts arising from the acquisition of capital assets. b. Serial maturities of long-term obligations. c. Amounts required to be expended within one year under sinking fund provisions. d. Agency obligations arising from the collection or acceptance of cash or other assets for the account of third persons. Loans accompanied by pledge of life insurance policies would be classified as current liabilities if, by their terms or by intent, they are to be repaid within 12 months. The pledging of life insurance policies does not affect the classification of the asset any more than does the pledging of receivables, inventories, real estate, or other assets as collateral for a short-term loan. However, when a loan on a life insurance policy is obtained from the insurance entity with the intent that it will not be paid but will be liquidated by deduction from the proceeds of the policy upon maturity or cancellation, the obligation shall be excluded from current liabilities. Exercise 3–14 (continued) 2. Which assets may be excluded from current assets? FASB ASC 210–10–45–4: “Notes to Financial Statements–Overall–Other Presentation Matters.” The concept of the nature of current assets contemplates the exclusion from that classification of such resources as the following: © The McGraw-Hill Companies, Inc., 2013 3–22 Intermediate Accounting, 7/e a. Cash and claims to cash that are restricted as to withdrawal or use for other than current operations, are designated for expenditure in the acquisition or construction of noncurrent assets, or are segregated for the liquidation of long-term debts. Even though not actually set aside in special accounts, funds that are clearly to be used in the near future for the liquidation of long-term debts, payments to sinking funds, or for similar purposes shall also, under this concept, be excluded from current assets. However, if such funds are considered to offset maturing debt that has properly been set up as a current liability, they may be included within the current asset classification. b. Investments in securities (whether marketable or not) or advances that have been made for the purposes of control, affiliation, or other continuing business advantage. c. Receivables arising from unusual transactions (such as the sale of capital assets, or loans or advances to affiliates, officers, or employees) that are not expected to be collected within 12 months. d. Cash surrender value of life insurance policies. e. Land and other natural resources. f. Depreciable assets. g. Long-term prepayments that are fairly chargeable to the operations of several years, or deferred charges such as bonus payments under a long- term lease, costs of rearrangement of factory layout or removal to a new location. Exercise 3–14 (continued) 3. Should a note receivable from a related party be included in the balance sheet with notes receivable from customers? © The McGraw-Hill Companies, Inc., 2013 Solutions Manual, Vol.1, Chapter 3 3–23 FASB ASC 850–10–50–2: “Related Party Disclosures–Overall– Disclosure.” Notes or accounts receivable from officers, employees, or affiliated entities must be shown separately and not included under a general heading such as notes receivable or accounts receivable. © The McGraw-Hill Companies, Inc., 2013 3–24 Intermediate Accounting, 7/e Exercise 3–14 (concluded) 4. What items are nonrecognized subsequent events that require a disclosure in the notes to the financial statements? FASB ASC 855–10–55–2: “Subsequent Events–Overall–Implementation Guidance and Illustrations–Nonrecognized Subsequent Events.” The following are examples of nonrecognized subsequent events addressed in paragraph 855–10–55–2: a. Sale of a bond or capital stock issued after the balance sheet date but before financial statements are issued or are available to be issued. b. A business combination that occurs after the balance sheet date but before financial statements are issued or are available to be. c. Settlement of litigation when the event giving rise to the claim took place after the balance sheet date but before financial statements are issued or are available to be issued. d. Loss of plant or inventories as a result of fire or natural disaster that occurred after the balance sheet date but before financial statements are issued or are available to be issued. e. Losses on receivables resulting from conditions (such as a customer’s major casualty) arising after the balance sheet date but before financial statements are issued or are available to be issued. f. Changes in the fair value of assets or liabilities (financial or nonfinancial) or foreign exchange rates after the balance sheet date but before financial statements are issued or are available to be issued. g. Entering into significant commitments or contingent liabilities, for example, by issuing significant guarantees after the balance sheet date but before financial statements are issued or are available to be issued. © The McGraw-Hill Companies, Inc., 2013 Solutions Manual, Vol.1, Chapter 3 3–25 Exercise 3–15 List A List B d 1. Balance sheet a. Will be satisfied through the use of current assets. h 2. Liquidity b. Items expected to be converted to cash or consumed within one year or the operating cycle, whichever is longer. b 3. Current assets c. The statements are presented fairly in conformity with GAAP. j 4. Operating cycle d. An organized array of assets, liabilities, and equity. a 5. Current liabilities e. Important to a user in comparing financial information across companies. k 6. Cash equivalent f. Scope limitation or a departure from GAAP. m 7. Intangible asset g. Recorded when an expense is incurred but not yet paid. l 8. Working capital h. Relates to the amount of time before an asset is converted to cash or a liability is paid. g 9. Accrued liabilities i. Occurs after the fiscal year-end but before the statements are issued. e 10. Summary of significant j. Cash to cash. accounting policies i 11. Subsequent events k. One-month U.S. treasury bill. c 12. Unqualified opinion l. Current assets minus current liabilities. f 13. Qualified opinion m. Lacks physical substance. 1. Current ratio [$200 + 150 + 200 + 350] ÷ $400 = 2.25 Exercise 3–16 2. Acid-test ratio [$200 + 150 + 200] ÷ $400 = 1.375 3. Debt to equity ratio [$400 + 350] ÷ [$750 + 400] = .65 4. Times interest earned ratio [$160 + 40 + 100] ÷ $40 = 7.5 times 3–26e McGraw-Hill Companies, Inc., 2013 Intermediate Accounting, 7/e Exercise 3–17 Requirement 1 a. Current ratio $10,473 ÷ $8,663 = 1.21 b. Acid-test ratio [$1,103 + 22 + 2,348] ÷ $8,663 = .40 c. Debt to equity ratio [$8,663 + 1,894] ÷ $7,292 = 1.45 d. Times interest earned ratio [$1,277 + 87 + 714] ÷ $87 = 24 times Requirement 2 Best Buy’s current ratio is almost identical to the industry average but the acid-test ratio is lower than the industry average. The debt to equity ratio is significantly higher than the industry average, indicating that the company’s assets are primarily financed with liabilities rather than equity. However, the company’s times interest earned ratio is significantly higher than the industry average. Even with high leverage, Best Buy seems quite capable of meeting its debt interest obligations. Exercise 3–18 a.Acid-test ratio = Quick assets ÷ Current liabilities =1.20 Quick assets = Current assets – Inventories Quick assets = Current assets – $840,000 Current assets ÷ Current liabilities = 2.25 Current assets – $840,000 ÷ Current liabilities = 1.20 $840,000 ÷ Current liabilities = 1.05 Current liabilities = $800,000 Current assets ÷ $800,000 = 2.25 Current assets = $1,800,000 b. Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1.8 Total liabilities + Shareholders' equity = Total assets Total liabilities + Shareholders' equity = $2,800,000 Let x equal shareholders' equity 1.8 x + x = $2,800,000 x = $1,000,000 = Shareholders' equity c. Noncurrent assets = Total assets – Current assets Noncurrent assets = $2,800,000 – 1,800,000 = $1,000,000 d. Long-term liabilities = Total assets – Current liabilities – Shareholders' equity Long-term liabilities = $2,800,000 – 800,000 – 1,000,000 = $1,000,000 Solutions Manual, Vol.1, Chapter 3 © The McGraw-Hill Companie3–27nc., 2013 Exercise 3–19 1.Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1.4 Total liabilities ÷ $2,500,000 = 1.4 Shareholders’ equity x 1.4 = Total liabilities $2,500,000 x 1.4 = $3,500,000 = Total liabilities Total liabilities + Equity = Total assets $3,500,000 + 2,500,000 = $6,000,000 = Total assets Total assets – Noncurrent assets = Current assets $6,000,000 – 2,400,000 = $3,600,000 = Current assets Current ratio = Current assets ÷ Current liabilities 2.0 = $3,600,000 ÷ Current liabilities Current liabilities = $3,600,000 ÷ 2 = $1,800,000 2. Total assets = Total liabilities + Shareholders’ equity Total assets = Current liabilities + Long-term liabilities + Shareholders’ equity $6,000,000 = $1,800,000 + Long-term liabilities + 2,500,000 Long-term liabilities = $1,700,000 3. Current assets = Cash + Accounts receivable + Prepaid expenses $3,600,000 = $1,300,000 + Accounts receivable + 360,000 Accounts receivable = $1,940,000 4. Acid-test ratio = Quick assets ÷ Current liabilities Quick assets = Cash + Accounts receivable Quick assets = $1,300,000 + 1,940,000 = $3,240,000 Acid-test ratio = $3,240,000 ÷ $1,800,000 = 1.8 © The McGraw-Hill Companies, Inc., 2013 3–28 Intermediate Accounting, 7/e Current Acid-test Exercise 3–20 Debt to Action Ratio Ratio Equity Ratio 1. Issuance of long-term bonds I I I 2. Issuance of short-term notes I I I 3. Payment of accounts payable D D D 4. Purchase of inventory on account I D I 5. Purchase of inventory for cash N D N 6. Purchase of equipment with a 4-year note N N I 7. Retirement of bonds D D D 8. Sale of common stock I I D 9. Write-off of obsolete inventory D N I 10. Purchase of short-term investment for casN N N 11. Decision to refinance on a long-term basis some currently maturing debt I I N Solutions Manual, Vol.1, Chapter 3 © The McGraw-Hill Com3–29es, Inc., 2013 Exercise 3–21 Requirement 1 The pharmaceuticals, plastics, and farm equipment segments are reportable. Only segments representing 10% or more of total company revenues, assets, or net income must be reported. The electronics segment does not meet this criterion. Requirement 2 For segments determined to be reportable, the following disclosures are required: a. General information about the operating segment. b. Information about reported segment profit or loss, including certain revenues and expenses included in reported segment profit or loss, segment assets, and the basis of measurement. c. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other significant items to corresponding enterprise amounts. d. Interim period information. In addition to revenues, profit or loss, and assets, IFRS also Exercise 3–22 require the disclosure of total liabilities for each of the reportable segments. 3–30e McGraw-Hill Companies, Inc., 2013 Intermediate Accounting, 7/e CPA / CMA REVIEW QUESTIONS CPA Exam Questions 1. a. The principal would have to be due after April 30, 2014, to be considered as a noncurrent asset at April 30, 2013. The accrued interest for eight months (since August 31, 2012) is a current asset at April 30, 2013. Since the principal is due August 31, 2014, additional interest would have to be recorded for the period September 1, 2013 to August 31, 2014. 2. a. Current liabilities are obligations that are expected to be paid within one year or the operating cycle, whichever is longer. Accounts payable $15,000 Bonds payable 22,000 Dividends payable 8,000 Total current liabilities $45,000 The notes payable are not classified as current liabilities because they are not due until 2015. 3.a. Inventory pricing is a significant accounting policy that should be disclosed according to generally accepted accounting principles, but the composition of plant assets is not a policy disclosure. © The McGraw-Hill Companies, Inc., 2013 Solutions Manual, Vol.1, Chapter 3 3–31 CPA Exam Questions (concluded) 4. c. The auditors’ standard report includes a statement that the financial statements are the responsibility of the Company's management and that the auditors’ responsibility is to express an opinion on the financial statements. 5. b. Current ratio—increased; Quick ratio—decreased. Current ratio = Current assets ÷ Current liabilities. When the current ratio is greater than 1 to 1, an equal decrease in current assets and current liabilities will result in an increase in the current ratio. The decrease in current liabilities (the smaller number) is proportionately greater than the decrease in current assets, resulting in an increase in the ratio. Quick ratio = (Cash + Marketable Securities + Accounts receivable)÷ Current liabilities When the quick ratio is less than 1:1, an equal decrease in quick assets and current liabilities will result in a decrease in the ratio. The decrease in current liabilities (the larger number) is proportionately smaller than the decrease in quick assets, resulting in a decrease in the ratio. 6. a. Since inventory is not included in the quick ratio, the write-off of obsolete inventory would have no effect on the quick ratio; however,
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