QUESTIONS. Questions 229

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1 1460T_c05.qxd 12:22: :56 Page 229 Questions 229 QUESTIONS 1. How does information from the balance sheet help users of the financial statements? 2. What is meant by solvency? What information in the balance sheet can be used to assess a company s solvency? 3. A recent financial magazine indicated that the airline industry has poor financial flexibility. What is meant by financial flexibility, and why is it important? 4. Discuss at least two situations in which estimates could affect the usefulness of information in the balance sheet. 5. Safin Company reported an increase in inventories in the past year. Discuss the effect of this change on the current ratio (current assets current liabilities). What does this tell a statement user about Safin Company s liquidity? 6. What is meant by liquidity? Rank the following assets from one to five in order of liquidity. (a) Goodwill. (b) Inventories. (c) Buildings. (d) Short-term investments. (e) Accounts receivable. 7. What are the major limitations of the balance sheet as a source of information? 8. Discuss at least two items that are important to the value of companies like Intel or IBM but that are not recorded in their balance sheets. What are some reasons why these items are not recorded in the balance sheet? 9. How does separating current assets from property, plant, and equipment in the balance sheet help analysts? 10. In its December 31, 2007, balance sheet Oakley Corporation reported as an asset, Net notes and accounts receivable, $7,100,000. What other disclosures are necessary? 11. Should available-for-sale securities always be reported as a current asset? Explain. 12. What is the relationship between current assets and current liabilities? 13. The New York Knicks, Inc. sold 10,000 season tickets at $2,000 each. By December 31, 2007, 18 of the 40 home games had been played. What amount should be reported as a current liability at December 31, 2007? 14. What is working capital? How does working capital relate to the operating cycle? 15. In what section of the balance sheet should the following items appear, and what balance sheet terminology would you use? (a) Treasury stock (recorded at cost). (b) Checking account at bank. (c) Land (held as an investment). (d) Sinking fund. (e) Unamortized premium on bonds payable. (f) Copyrights. (g) Pension fund assets. (h) Premium on capital stock. (i) Long-term investments (pledged against bank loans payable). 16. Where should the following items be shown on the balance sheet, if shown at all? (a) Allowance for doubtful accounts receivable. (b) Merchandise held on consignment. (c) Advances received on sales contract. (d) Cash surrender value of life insurance. (e) Land. (f) Merchandise out on consignment. (g) Franchises. (h) Accumulated depreciation of plant and equipment. (i) Materials in transit purchased f.o.b. destination. 17. State the generally accepted accounting principle applicable to the balance sheet valuation of each of the following assets. (a) Trade accounts receivable. (b) Land. (c) Inventories. (d) Trading securities (common stock of other companies). (e) Prepaid expenses. 18. Refer to the definition of assets on page 173. Discuss how a leased building might qualify as an asset of the lessee (tenant) under this definition. 19. Christine Agazzi says, Retained earnings should be reported as an asset, since it is earnings which are reinvested in the business. How would you respond to Agazzi? 20. The creditors of Nick Anderson Company agree to accept promissory notes for the amount of its indebtedness with a proviso that two-thirds of the annual profits must be applied to their liquidation. How should these notes be reported on the balance sheet of the issuing company? Give a reason for your answer. 21. What are some of the techniques of disclosure for the balance sheet? 22. What is a Summary of Significant Accounting Policies? 23. What types of contractual obligations must be disclosed in great detail in the notes to the balance sheet? Why do you think these detailed provisions should be disclosed? 24. What is the profession s recommendation in regard to the use of the term surplus? Explain.

2 1460T_c05.qxd 1/10/06 05:23 am Page Chapter 5 Balance Sheet and Statement of Cash Flows 25. What is the purpose of a statement of cash flows? How does it differ from a balance sheet and an income statement? 26. The net income for the year for Won Long, Inc. is $750,000, but the statement of cash flows reports that the cash provided by operating activities is $640,000. What might account for the difference? 27. Net income for the year for Jenkins, Inc. was $750,000, but the statement of cash flows reports that cash provided by operating activities was $860,000. What might account for the difference? 28. Differentiate between operating activities, investing activities, and financing activities. 29. Each of the following items must be considered in preparing a statement of cash flows. Indicate where each item is to be reported in the statement, if at all. Assume that net income is reported as $90,000. (a) Accounts receivable increased from $32,000 to $39,000 from the beginning to the end of the year. (b) During the year, 10,000 shares of preferred stock with a par value of $100 a share were issued at $115 per share. (c) Depreciation expense amounted to $14,000, and bond premium amortization amounted to $5,000. (d) Land increased from $10,000 to $30, Marker Co. has net cash provided by operating activities of $900,000. Its average current liabilities for the period are $1,000,000, and its average total liabilities are $1,500,000. Comment on the company s liquidity and financial flexibility, given this information. 31. Net income for the year for Hatfield, Inc. was $750,000, but the statement of cash flows reports that cash provided by operating activities was $860,000. Hatfield also reported capital expenditures of $75,000 and paid dividends in the amount of $20,000. Compute Hatfield s free cash flow. 32. What is the purpose of a free cash flow analysis? BRIEF EXERCISES BE5-1 La Bouche Corporation has the following accounts included in its December 31, 2007, trial balance: Accounts Receivable $110,000; Inventories $290,000; Allowance for Doubtful Accounts $8,000; Patents $72,000; Prepaid Insurance $9,500; Accounts Payable $77,000; Cash $27,000. Prepare the current assets section of the balance sheet listing the accounts in proper sequence. BE5-2 Jodi Corporation s adjusted trial balance contained the following asset accounts at December 31, 2007: Cash $7,000; Land $40,000; Patents $12,500; Accounts Receivable $90,000; Prepaid Insurance $5,200; Inventory $34,000; Allowance for Doubtful Accounts $4,000; Trading Securities $11,000. Prepare the current assets section of the balance sheet, listing the accounts in proper sequence. BE5-3 Included in Goo Goo Dolls Company s December 31, 2007, trial balance are the following accounts: Prepaid Rent $5,200; Held-to-Maturity Securities $61,000; Unearned Fees $17,000; Land Held for Investment $39,000; Long-term Receivables $42,000. Prepare the long-term investments section of the balance sheet. BE5-4 Adam Ant Company s December 31, 2007, trial balance includes the following accounts: Inventories $120,000; Buildings $207,000; Accumulated Depreciation Equipment $19,000; Equipment $190,000; Land Held for Investment $46,000; Accumulated Depreciation Buildings $45,000; Land $61,000; Timberland $70,000. Prepare the property, plant, and equipment section of the balance sheet. BE5-5 Mason Corporation has the following accounts included in its December 31, 2007, trial balance: Trading Securities $21,000; Goodwill $150,000; Prepaid Insurance $12,000; Patents $220,000; Franchises $110,000. Prepare the intangible assets section of the balance sheet. BE5-6 Mickey Snyder Corporation s adjusted trial balance contained the following asset accounts at December 31, 2007: Prepaid Rent $12,000; Goodwill $40,000; Franchise Fees Receivable $2,000; Franchises $47,000; Patents $33,000; Trademarks $10,000. Prepare the intangible assets section of the balance sheet. BE5-7 John Hawk Corporation s adjusted trial balance contained the following liability accounts at December 31, Bonds Payable (due in 3 years) $100,000; Accounts Payable $72,000; Notes Payable (due in 90 days) $12,500; Accrued Salaries $4,000; Income Taxes Payable $7,000. Prepare the current liabilities section of the balance sheet. BE5-8 Included in Ewing Company s December 31, 2007, trial balance are the following accounts: Accounts Payable $240,000; Pension Liability $375,000; Discount on Bonds Payable $24,000; Advances from Customers $41,000; Bonds Payable $400,000; Wages Payable $27,000; Interest Payable $12,000; Income Taxes Payable $29,000. Prepare the current liabilities section of the balance sheet.

3 1460T_c05.qxd 12:22: :56 Page 231 Exercises 231 (L0 8) (L0 8) (L0 8) (L0 8) (L0 9) BE5-9 Use the information presented in BE5 8 for Ewing Company to prepare the long-term liabilities section of the balance sheet. BE5-10 Kevin Flynn Corporation s adjusted trial balance contained the following accounts at December 31, 2007: Retained Earnings $120,000; Common Stock $700,000; Bonds Payable $100,000; Additional Paid-in Capital $200,000; Goodwill $55,000; Accumulated Other Comprehensive Loss $150,000. Prepare the stockholders equity section of the balance sheet. BE5-11 Young Company s December 31, 2007, trial balance includes the following accounts: Investment in Common Stock $70,000; Retained Earnings $114,000; Trademarks $31,000; Preferred Stock $172,000; Common Stock $55,000; Deferred Income Taxes $88,000; Additional Paid-in Capital $174,000. Prepare the stockholders equity section of the balance sheet. BE5-12 Midwest Beverage Company reported the following items in the most recent year. Net income $40,000 Dividends paid 5,000 Increase in accounts receivable 10,000 Increase in accounts payable 5,000 Purchase of equipment (capital expenditure) 8,000 Depreciation expense 4,000 Issue of notes payable 20,000 Compute net cash provided by operating activities, the net change in cash during the year, and free cash flow. BE5-13 Kes Company reported 2007 net income of $151,000. During 2007, accounts receivable increased by $13,000 and accounts payable increased by $9,500. Depreciation expense was $39,000. Prepare the cash flows from operating activities section of the statement of cash flows. BE5-14 Yorkis Perez Corporation engaged in the following cash transactions during Sale of land and building $181,000 Purchase of treasury stock 40,000 Purchase of land 37,000 Payment of cash dividend 85,000 Purchase of equipment 53,000 Issuance of common stock 147,000 Retirement of bonds 100,000 Compute the net cash provided (used) by investing activities. BE5-15 Use the information presented in BE5-14 for Yorkis Perez Corporation to compute the net cash used (provided) by financing activities. BE5-16 Using the information in BE5-14, determine Yorkis Perez s free cash flow, assuming that it reported net cash provided by operating activities of $400,000. EXERCISES (L0 2, 3) E5-1 (Balance Sheet Classifications) Presented below are a number of balance sheet accounts of Deep Blue Something, Inc. (a) Investment in Preferred Stock. (h) Accrued Interest on Notes Payable. (b) Treasury Stock. (i) Deficit. (c) Common Stock. (j) Trading Securities. (d) Cash Dividends Payable. (k) Income Taxes Payable. (e) Accumulated Depreciation. (l) Unearned Subscription Revenue. (f) Warehouse in Process of Construction. (m) Work in Process. (g) Petty Cash. (n) Accrued Vacation Pay. For each of the accounts above, indicate the proper balance sheet classification. In the case of borderline items, indicate the additional information that would be required to determine the proper classification. (L0 2, 3) E5-2 (Classification of Balance Sheet Accounts) Presented on the next page are the captions of Faulk Company s balance sheet.

4 1460T_c05.qxd 12:22: :56 Page Chapter 5 Balance Sheet and Statement of Cash Flows (a) Current assets. (f) Current liabilities. (b) Investments. (g) Non-current liabilities. (c) Property, plant, and equipment. (h) Capital stock. (d) Intangible assets. (i) Additional paid-in capital. (e) Other assets. (j) Retained earnings. Indicate by letter where each of the following items would be classified. 1. Preferred stock. 11. Cash surrender value of life insurance. 2. Goodwill. 12. Notes payable (due next year). 3. Wages payable. 13. Office supplies. 4. Trade accounts payable. 14. Common stock. 5. Buildings. 15. Land. 6. Trading securities. 16. Bond sinking fund. 7. Current portion of long-term debt. 17. Merchandise inventory. 8. Premium on bonds payable. 18. Prepaid insurance. 9. Allowance for doubtful accounts. 19. Bonds payable. 10. Accounts receivable. 20. Taxes payable. (L0 2, 3) E5-3 (Classification of Balance Sheet Accounts) Assume that Fielder Enterprises uses the following headings on its balance sheet. (a) Current assets. (f) Current liabilities. (b) Investments. (g) Long-term liabilities. (c) Property, plant, and equipment. (h) Capital stock. (d) Intangible assets. (i) Paid-in capital in excess of par. (e) Other assets. (j) Retained earnings. Indicate by letter how each of the following usually should be classified. If an item should appear in a note to the financial statements, use the letter N to indicate this fact. If an item need not be reported at all on the balance sheet, use the letter X. 1. Unexpired insurance. 12. Twenty-year issue of bonds payable that will 2. Stock owned in affiliated companies. mature within the next year. (No sinking fund 3. Unearned subscriptions revenue. exists, and refunding is not planned.) 4. Advances to suppliers. 13. Machinery retired from use and held for sale. 5. Unearned rent revenue. 14. Fully depreciated machine still in use. 6. Preferred stock. 15. Accrued interest on bonds payable. 7. Premium on preferred stock. 16. Salaries that company budget shows will be paid 8. Copyrights. to employees within the next year. 9. Petty cash fund. 17. Discount on bonds payable. (Assume related to 10. Sales tax payable. bonds payable in No. 12.) 11. Accrued interest on notes receivable. 18. Accumulated depreciation. (L0 2, 3) E5-4 (Preparation of a Classified Balance Sheet) Assume that Denis Savard Inc. has the following accounts at the end of the current year. 1. Common Stock. 14. Accumulated Depreciation Buildings. 2. Discount on Bonds Payable. 15. Cash Restricted for Plant Expansion. 3. Treasury Stock (at cost). 16. Land Held for Future Plant Site. 4. Note Payable, short-term. 17. Allowance for Doubtful Accounts 5. Raw Materials. Accounts Receivable. 6. Preferred Stock Investments Long-term. 18. Retained Earnings. 7. Unearned Rent Revenue. 19. Premium on Common Stock. 8. Work in Process. 20. Unearned Subscriptions Revenue. 9. Copyrights. 21. Receivables Officers (due in one year). 10. Buildings. 22. Finished Goods. 11. Notes Receivable (short-term). 23. Accounts Receivable. 12. Cash. 24. Bonds Payable (due in 4 years). 13. Accrued Salaries Payable. Prepare a classified balance sheet in good form. (No monetary amounts are necessary.)

5 1460T_c05.qxd 12:22: :56 Page 233 Exercises 233 E5-5 (Preparation of a Corrected Balance Sheet) Uhura Company has decided to expand its operations. The bookkeeper recently completed the balance sheet presented below in order to obtain additional funds for expansion. UHURA COMPANY BALANCE SHEET FOR THE YEAR ENDED 2007 Current assets Cash $230,000 Accounts receivable (net) 340,000 Inventories at lower of average cost or market 401,000 Trading securities at cost (fair value $120,000) 140,000 Property, plant, and equipment Building (net) 570,000 Office equipment (net) 160,000 Land held for future use 175,000 Intangible assets Goodwill 80,000 Cash surrender value of life insurance 90,000 Prepaid expenses 12,000 Current liabilities Accounts payable 135,000 Notes payable (due next year) 125,000 Pension obligation 82,000 Rent payable 49,000 Premium on bonds payable 53,000 Long-term liabilities Bonds payable 500,000 Stockholders equity Common stock, $1.00 par, authorized 400,000 shares, issued 290, ,000 Additional paid-in capital 160,000 Retained earnings? Prepare a revised balance sheet given the available information. Assume that the accumulated depreciation balance for the buildings is $160,000 and for the office equipment, $105,000. The allowance for doubtful accounts has a balance of $17,000. The pension obligation is considered a long-term liability. (L0 2, 3) E5-6 (Corrections of a Balance Sheet) The bookkeeper for Geronimo Company has prepared the following balance sheet as of July 31, GERONIMO COMPANY BALANCE SHEET AS OFJULY 31, 2007 Cash $ 69,000 Notes and accounts payable $ 44,000 Accounts receivable (net) 40,500 Long-term liabilities 75,000 Inventories 60,000 Stockholders equity 155,500 Equipment (net) 84,000 Patents 21,000 $274,500 $274,500 The following additional information is provided. 1. Cash includes $1,200 in a petty cash fund and $15,000 in a bond sinking fund. 2. The net accounts receivable balance is comprised of the following three items: (a) accounts receivable debit balances $52,000; (b) accounts receivable credit balances $8,000; (c) allowance for doubtful accounts $3, Merchandise inventory costing $5,300 was shipped out on consignment on July 31, The ending inventory balance does not include the consigned goods. Receivables in the amount of $5,300 were recognized on these consigned goods.

6 1460T_c05.qxd 1/4/06 05:40 am Page Chapter 5 Balance Sheet and Statement of Cash Flows 4. Equipment had a cost of $112,000 and an accumulated depreciation balance of $28, Taxes payable of $6,000 were accrued on July 31. Geronimo Company, however, had set up a cash fund to meet this obligation. This cash fund was not included in the cash balance, but was offset against the taxes payable amount. Prepare a corrected classified balance sheet as of July 31, 2007, from the available information, adjusting the account balances using the additional information. E5-7 (Current Assets Section of the Balance Sheet) Presented below are selected accounts of Yasunari Kawabata Company at December 31, Finished Goods $ 52,000 Cost of Goods Sold $2,100,000 Revenue Received in Advance 90,000 Notes Receivable 40,000 Equipment 253,000 Accounts Receivable 161,000 Work-in-Process 34,000 Raw Materials 207,000 Cash 37,000 Supplies Expense 60,000 Short-term Investments in Stock 31,000 Allowance for Doubtful Accounts 12,000 Customer Advances 36,000 Licenses 18,000 Cash Restricted for Plant Expansion 50,000 Additional Paid-in Capital 88,000 Treasury Stock 22,000 The following additional information is available. 1. Inventories are valued at lower of cost or market using LIFO. 2. Equipment is recorded at cost. Accumulated depreciation, computed on a straight-line basis, is $50, The short-term investments have a fair value of $29,000. (Assume they are trading securities.) 4. The notes receivable are due April 30, 2009, with interest receivable every April 30. The notes bear interest at 6%. (Hint: Accrue interest due on December 31, 2007.) 5. The allowance for doubtful accounts applies to the accounts receivable. Accounts receivable of $50,000 are pledged as collateral on a bank loan. 6. Licenses are recorded net of accumulated amortization of $14, Treasury stock is recorded at cost. Prepare the current assets section of Yasunari Kawabata Company s December 31, 2007, balance sheet, with appropriate disclosures. (L0 2) E5-8 (Current vs. Long-term Liabilities) Frederic Chopin Corporation is preparing its December 31, 2007, balance sheet. The following items may be reported as either a current or long-term liability. 1. On December 15, 2007, Chopin declared a cash dividend of $2.50 per share to stockholders of record on December 31. The dividend is payable on January 15, Chopin has issued 1,000,000 shares of common stock, of which 50,000 shares are held in treasury. 2. At December 31, bonds payable of $100,000,000 are outstanding. The bonds pay 12% interest every September 30 and mature in installments of $25,000,000 every September 30, beginning September 30, At December 31, 2006, customer advances were $12,000,000. During 2007, Chopin collected $30,000,000 of customer advances, and advances of $25,000,000 were earned. For each item above indicate the dollar amounts to be reported as a current liability and as a long-term liability, if any. (L0 2, 3) E5-9 (Current Assets and Current Liabilities) The current assets and current liabilities sections of the balance sheet of Allessandro Scarlatti Company appear as follows. ALLESSANDRO SCARLATTI COMPANY BALANCE SHEET (PARTIAL) DECEMBER 31, 2007 Cash $ 40,000 Accounts payable $ 61,000 Accounts receivable $89,000 Notes payable 67,000 Less: Allowance for $128,000 doubtful accounts 7,000 82,000 Inventories 171,000 Prepaid expenses 9,000 $302,000

7 1460T_c05.qxd 1/4/06 05:40 am Page 235 Exercises 235 The following errors in the corporation s accounting have been discovered: 1. January 2008 cash disbursements entered as of December 2007 included payments of accounts payable in the amount of $39,000, on which a cash discount of 2% was taken. 2. The inventory included $27,000 of merchandise that had been received at December 31 but for which no purchase invoices had been received or entered. Of this amount, $12,000 had been received on consignment; the remainder was purchased f.o.b. destination, terms 2/10, n/ Sales for the first four days in January 2008 in the amount of $30,000 were entered in the sales book as of December 31, Of these, $21,500 were sales on account and the remainder were cash sales. 4. Cash, not including cash sales, collected in January 2008 and entered as of December 31, 2007, totaled $35,324. Of this amount, $23,324 was received on account after cash discounts of 2% had been deducted; the remainder represented the proceeds of a bank loan. (L0 3, 4) (a) Restate the current assets and current liabilities sections of the balance sheet in accordance with good accounting practice. (Assume that both accounts receivable and accounts payable are recorded gross.) (b) State the net effect of your adjustments on Allesandro Scarlatti Company s retained earnings balance. E5-10 (Current Liabilities) Norma Smith is the controller of Baylor Corporation and is responsible for the preparation of the year-end financial statements. The following transactions occurred during the year. (a) On December 20, 2007, an employee filed a legal action against Baylor for $100,000 for wrongful dismissal. Management believes the action to be frivolous and without merit. The likelihood of payment to the employee is remote. (b) Bonuses to key employees based on net income for 2007 are estimated to be $150,000. (c) On December 1, 2007, the company borrowed $600,000 at 8% per year. Interest is paid quarterly. (d) Credit sales for the year amounted to $10,000,000. Baylor s expense provision for doubtful accounts is estimated to be 3% of credit sales. (e) On December 15, 2007, the company declared a $2.00 per share dividend on the 40,000 shares of common stock outstanding, to be paid on January 5, (f) During the year, customer advances of $160,000 were received; $50,000 of this amount was earned by December 31, For each item above, indicate the dollar amount to be reported as a current liability. If a liability is not reported, explain why. E5-11 (Balance Sheet Preparation) Presented below is the adjusted trial balance of Kelly Corporation at December 31, Debits Credits Cash $? Office Supplies 1,200 Prepaid Insurance 1,000 Equipment 48,000 Accumulated Depreciation Equipment $ 4,000 Trademarks 950 Accounts Payable 10,000 Wages Payable 500 Unearned Service Revenue 2,000 Bonds Payable, due ,000 Common Stock 10,000 Retained Earnings 25,000 Service Revenue 10,000 Wages Expense 9,000 Insurance Expense 1,400 Rent Expense 1,200 Interest Expense 900 Total $? $? Additional information: 1. Net loss for the year was $2, No dividends were declared during 2007.

8 1460T_c05.qxd 1/4/06 05:40 am Page Chapter 5 Balance Sheet and Statement of Cash Flows Prepare a classified balance sheet as of December 31, E5-12 (Preparation of a Balance Sheet) Presented below is the trial balance of John Nalezny Corporation at December 31, Debits Credits Cash $ 197,000 Sales $ 8,100,000 Trading Securities (at cost, $145,000) 153,000 Cost of Goods Sold 4,800,000 Long-term Investments in Bonds 299,000 Long-term Investments in Stocks 277,000 Short-term Notes Payable 90,000 Accounts Payable 455,000 Selling Expenses 2,000,000 Investment Revenue 63,000 Land 260,000 Buildings 1,040,000 Dividends Payable 136,000 Accrued Liabilities 96,000 Accounts Receivable 435,000 Accumulated Depreciation Buildings 152,000 Allowance for Doubtful Accounts 25,000 Administrative Expenses 900,000 Interest Expense 211,000 Inventories 597,000 Extraordinary Gain 80,000 Long-term Notes Payable 900,000 Equipment 600,000 Bonds Payable 1,000,000 Accumulated Depreciation Equipment 60,000 Franchise 160,000 Common Stock ($5 par) 1,000,000 Treasury Stock 191,000 Patent 195,000 Retained Earnings 78,000 Additional Paid-in Capital 80,000 Totals $12,315,000 $12,315,000 Prepare a balance sheet at December 31, 2007, for John Nalezny Corporation. Ignore income taxes. (L0 7) E5-13 (Statement of Cash Flows Classifications) The major classifications of activities reported in the statement of cash flows are operating, investing, and financing. Classify each of the transactions listed below as: 1. Operating activity add to net income. 2. Operating activity deduct from net income. 3. Investing activity. 4. Financing activity. 5. Reported as significant noncash activity. The transactions are as follows. (a) Issuance of capital stock. (h) Payment of cash dividends. (b) Purchase of land and building. (i) Exchange of furniture for office equipment. (c) Redemption of bonds. (j) Purchase of treasury stock. (d) Sale of equipment. (k) Loss on sale of equipment. (e) Depreciation of machinery. (l) Increase in accounts receivable during the year. (f) Amortization of patent. (m) Decrease in accounts payable during the year. (g) Issuance of bonds for plant assets. (L0 8) E5-14 (Preparation of a Statement of Cash Flows) The comparative balance sheets of Constantine Cavamanlis Inc. at the beginning and the end of the year 2007 appear on the next page.

9 1460T_c05.qxd 1/4/06 05:40 am Page 237 Exercises 237 CONSTANTINE CAVAMANLIS INC. BALANCE SHEETS Assets Dec. 31, 2007 Jan. 1, 2007 Inc./Dec. Cash $ 45,000 $ 13,000 $32,000 Inc. Accounts receivable 91,000 88,000 $$3,000 Inc. Equipment 39,000 22,000 $17,000 Inc. Less: Accumulated depreciation (17,000) (11,000) $$6,000 Inc. Total $158,000 $112,000 Liabilities and Stockholders Equity Accounts payable $ 20,000 $ 15,000 25,000 Inc. Common stock 100,000 80,000 20,000 Inc. Retained earnings 38,000 17,000 21,000 Inc. Total $158,000 $112,000 Net income of $44,000 was reported, and dividends of $23,000 were paid in New equipment was purchased and none was sold. Prepare a statement of cash flows for the year (L0 8, 9) E5-15 (Preparation of a Statement of Cash Flows) Presented below is a condensed version of the comparative balance sheets for Zubin Mehta Corporation for the last two years at December Cash $177,000 $ 78,000 Accounts receivable 180, ,000 Investments 52,000 74,000 Equipment 298, ,000 Less: Accumulated depreciation (106,000) (89,000) Current liabilities 134, ,000 Capital stock 160, ,000 Retained earnings 307, ,000 Additional information: Investments were sold at a loss (not extraordinary) of $10,000; no equipment was sold; cash dividends paid were $30,000; and net income was $160,000. (a) Prepare a statement of cash flows for 2007 for Zubin Mehta Corporation. (b) Determine Zubin Mehta Corporation s free cash flow. (L0 8, 9) E5-16 (Preparation of a Statement of Cash Flows) A comparative balance sheet for Shabbona Corporation is presented below. December 31 Assets Cash $ 73,000 $ 22,000 Accounts receivable 82,000 66,000 Inventories 180, ,000 Land 71, ,000 Equipment 260, ,000 Accumulated depreciation equipment (69,000) (42,000) Total $597,000 $545,000 Liabilities and Stockholders Equity Accounts payable $ 34,000 $ 47,000 Bonds payable 150, ,000 Common stock ($1 par) 214, ,000 Retained earnings 199, ,000 Total $597,000 $545,000

10 1460T_c05.qxd 01:04: :55 AM Page Chapter 5 Balance Sheet and Statement of Cash Flows Additional information: 1. Net income for 2007 was $125, Cash dividends of $60,000 were declared and paid. 3. Bonds payable amounting to $50,000 were retired through issuance of common stock. (a) Prepare a statement of cash flows for 2007 for Shabbona Corporation. (b) Determine Shabbona Corporation s current cash debt coverage ratio, cash debt coverage ratio, and free cash flow. Comment on its liquidity and financial flexibility. (L0 3, 8) E5-17 (Preparation of a Statement of Cash Flows and a Balance Sheet) Grant Wood Corporation s balance sheet at the end of 2006 included the following items. Current assets $235,000 Current liabilities $150,000 Land 30,000 Bonds payable 100,000 Building 120,000 Common stock 180,000 Equipment 90,000 Retained earnings 44,000 Accum. depr. building (30,000) Accum. depr. equipment (11,000) Total $474,000 Patents 40,000 Total $474,000 The following information is available for Net income was $55, Equipment (cost $20,000 and accumulated depreciation $8,000) was sold for $10, Depreciation expense was $4,000 on the building and $9,000 on equipment. 4. Patent amortization was $2, Current assets other than cash increased by $29,000. Current liabilities increased by $13, An addition to the building was completed at a cost of $27, A long-term investment in stock was purchased for $16, Bonds payable of $50,000 were issued. 9. Cash dividends of $30,000 were declared and paid. 10. Treasury stock was purchased at a cost of $11,000. (Show only totals for current assets and current liabilities.) (a) Prepare a statement of cash flows for (b) Prepare a balance sheet at December 31, (L0 8, 9) E5-18 (Preparation of a Statement of Cash Flows, Analysis) The comparative balance sheets of Madrasah Corporation at the beginning and end of the year 2007 appear below. MADRASAH CORPORATION BALANCE SHEETS Assets Dec. 31, 2007 Jan. 1, 2007 Inc./Dec. Cash $ 20,000 $ 13,000 $ 7,000 Inc. Accounts receivable 106,000 88,000 18,000 Inc. Equipment 39,000 22,000 17,000 Inc. Less: Accumulated depreciation (17,000) (11,000) 6,000 Inc. Total $148,000 $112,000 Liabilities and Stockholders Equity Accounts payable $ 20,000 $ 15,000 5,000 Inc. Common stock 100,000 80,000 20,000 Inc. Retained earnings 28,000 17,000 11,000 Inc. Total $148,000 $112,000 Net income of $44,000 was reported, and dividends of $33,000 were paid in New equipment was purchased and none was sold.

11 1460T_c05.qxd 1/4/06 05:40 am Page 239 wiley.com/college/kieso Problems 239 (a) Prepare a statement of cash flows for the year (b) Compute the current ratio (current assets current liabilities) as of January 1, 2007, and December 31, 2007, and compute free cash flow for the year (c) In light of the analysis in (b), comment on Madrasah s liquidity and financial flexibility. See the book s website, for Additional Exercises. PROBLEMS P5-1 (Preparation of a Classified Balance Sheet, Periodic Inventory) Presented below is a list of accounts in alphabetical order. Accounts Receivable Land Accrued Wages Land for Future Plant Site Accumulated Depreciation Buildings Loss from Flood Accumulated Depreciation Equipment Notes Payable (due next year) Advances to Employees Patent Advertising Expense Payroll Taxes Payable Allowance for Doubtful Accounts Pension Obligations Bond Sinking Fund Petty Cash Bonds Payable Preferred Stock Building Premium on Bonds Payable Cash in Bank Premium on Preferred Stock Cash on Hand Prepaid Rent Cash Surrender Value of Life Insurance Purchases Commission Expense Purchase Returns and Allowances Common Stock Retained Earnings Copyright Sales Dividends Payable Sales Discounts Equipment Sales Salaries Gain on Sale of Equipment Trading Securities Interest Receivable Transportation-in Inventory Beginning Treasury Stock (at cost) Inventory Ending Unearned Subscriptions Revenue Prepare a classified balance sheet in good form. (No monetary amounts are to be shown.) P5-2 (Balance Sheet Preparation) Presented below are a number of balance sheet items for Letterman, Inc., for the current year, Goodwill $ 125,000 Accumulated depreciation Payroll taxes payable 177,591 equipment $ 292,000 Bonds payable 300,000 Inventories 239,800 Discount on bonds payable 15,000 Rent payable short-term 45,000 Cash 360,000 Taxes payable 98,362 Land 480,000 Long-term rental obligations 480,000 Notes receivable 545,700 Common stock, $1 par value 200,000 Notes payable to banks 265,000 Preferred stock, $10 par value 150,000 Accounts payable 590,000 Prepaid expenses 87,920 Retained earnings? Equipment 1,470,000 Income taxes receivable 97,630 Trading securities 121,000 Unsecured notes payable Accumulated depreciation (long-term) 1,600,000 building 170,200 Building 1,640,000 Prepare a classified balance sheet in good form. Common stock authorized was 400,000 shares, and preferred stock authorized was 20,000 shares. Assume that notes receivable and notes payable are short-term, unless stated otherwise. Cost and fair value of trading securities are the same. P5 3 (Balance Sheet Adjustment and Preparation) The adjusted trial balance of Side Kicks Company and other related information for the year 2007 are presented on the next page.

12 1460T_c05.qxd 1/4/06 05:40 am Page Chapter 5 Balance Sheet and Statement of Cash Flows SIDE KICKS COMPANY ADJUSTED TRIAL BALANCE DECEMBER 31, 2007 Debits Credits Cash $ 41,000 Accounts Receivable 163,500 Allowance for Doubtful Accounts $ 8,700 Prepaid Insurance 5,900 Inventory 308,500 Long-term Investments 339,000 Land 85,000 Construction Work in Progress 124,000 Patents 36,000 Equipment 400,000 Accumulated Depreciation of Equipment 140,000 Unamortized Discount on Bonds Payable 20,000 Accounts Payable 148,000 Accrued Expenses 49,200 Notes Payable 94,000 Bonds Payable 400,000 Common Stock 500,000 Premium on Common Stock 45,000 Retained Earnings 138,000 $1,522,900 $1,522,900 Additional information: 1. The LIFO method of inventory value is used. 2. The cost and fair value of the long-term investments that consist of stocks and bonds is the same. 3. The amount of the Construction Work in Progress account represents the costs expended to date on a building in the process of construction. (The company rents factory space at the present time.) The land on which the building is being constructed cost $85,000, as shown in the trial balance. 4. The patents were purchased by the company at a cost of $40,000 and are being amortized on a straight-line basis. 5. Of the unamortized discount on bonds payable, $2,000 will be amortized in The notes payable represent bank loans that are secured by long-term investments carried at $120,000. These bank loans are due in The bonds payable bear interest at 8% payable every December 31, and are due January 1, ,000 shares of common stock of a par value of $1 were authorized, of which 500,000 shares were issued and outstanding. (L0 3, 4) Prepare a balance sheet as of December 31, 2007, so that all important information is fully disclosed. P5-4 (Preparation of a Corrected Balance Sheet) Presented below and on the next page is the balance sheet of Russell Crowe Corporation as of December 31, RUSSELL CROWE CORPORATION BALANCE SHEET DECEMBER 31, 2007 Assets Goodwill (Note 2) $ 120,000 Buildings (Note 1) 1,640,000 Inventories 312,100 Land 750,000 Accounts receivable 170,000 Treasury stock (50,000 shares) 87,000 Cash on hand 175,900 Assets allocated to trustee for plant expansion Cash in bank 70,000 U.S. Treasury notes, at cost and fair value 138,000 $3,463,000

13 1460T_c05.qxd 1/4/06 05:40 am Page 241 Problems 241 Equities Notes payable (Note 3) $ 600,000 Common stock, authorized and issued, 1,000,000 shares, no par 1,150,000 Retained earnings 658,000 Appreciation capital (Note 1) 570,000 Federal income taxes payable 75,000 Reserve for depreciation recorded to date on the building 410,000 $3,463,000 Note 1: Buildings are stated at cost, except for one building that was recorded at appraised value. The excess of appraisal value over cost was $570,000. Depreciation has been recorded based on cost. Note 2: Goodwill in the amount of $120,000 was recognized because the company believed that book value was not an accurate representation of the fair market value of the company. The gain of $120,000 was credited to Retained Earnings. Note 3: Notes payable are long-term except for the current installment due of $100,000. Prepare a corrected classified balance sheet in good form. The notes above are for information only. P5-5 (Balance Sheet Adjustment and Preparation) Presented below is the balance sheet of Stephen King Corporation for the current year, STEPHEN KING CORPORATION BALANCE SHEET DECEMBER 31, 2007 Current assets $ 449,000 Current liabilities $ 344,000 Investments 640,000 Long-term liabilities 1,000,000 Property, plant, and equipment 1,720,000 Stockholders equity 1,770,000 Intangible assets 305,000 $3,114,000 $3,114,000 The following information is presented. 1. The current assets section includes: cash $114,000, accounts receivable $170,000 less $10,000 for allowance for doubtful accounts, inventories $180,000, and unearned revenue $5,000. Inventories are stated on the lower of FIFO cost or market. 2. The investments section includes: the cash surrender value of a life insurance contract $40,000; investments in common stock, short-term (trading) $80,000 and long-term (available-for-sale) $270,000, and bond sinking fund $250,000. The cost and fair value of investments in common stock are the same. 3. Property, plant, and equipment includes: buildings $1,040,000 less accumulated depreciation $360,000; equipment $450,000 less accumulated depreciation $180,000; land $500,000; and land held for future use $270, Intangible assets include: a franchise $165,000; goodwill $100,000; and discount on bonds payable $40, Current liabilities include: accounts payable $104,000; notes payable short-term $80,000 and longterm $120,000; and taxes payable $40, Long-term liabilities are composed solely of 7% bonds payable due Stockholders equity has: preferred stock, no par value, authorized 200,000 shares, issued 70,000 shares for $450,000; and common stock, $1.00 par value, authorized 400,000 shares, issued 100,000 shares at an average price of $10. In addition, the corporation has retained earnings of $320,000. Prepare a balance sheet in good form, adjusting the amounts in each balance sheet classification as affected by the information given above. (L0 3, 8, 9) P5-6 (Preparation of a Statement of Cash Flows and a Balance Sheet) Alistair Cooke Inc. had the balance sheet shown on the following page at December 31, 2006.

14 1460T_c05.qxd 1/4/06 05:40 am Page Chapter 5 Balance Sheet and Statement of Cash Flows ALISTAIR COOKE INC. BALANCE SHEET DECEMBER 31, 2006 Cash $ 20,000 Accounts payable $ 30,000 Accounts receivable 21,200 Long-term notes payable 41,000 Investments 32,000 Common stock 100,000 Plant assets (net) 81,000 Retained earnings 23,200 Land 40,000 $194,200 $194,200 During 2007 the following occurred. 1. Alistair Cooke Inc. sold part of its investment portfolio for $17,000. This transaction resulted in a gain of $3,400 for the firm. The company classifies its investments as available-for-sale. 2. A tract of land was purchased for $18,000 cash. 3. Long-term notes payable in the amount of $16,000 were retired before maturity by paying $16,000 cash. 4. An additional $24,000 in common stock was issued at par. 5. Dividends totalling $8,200 were declared and paid to stockholders. 6. Net income for 2007 was $32,000 after allowing for depreciation of $12, Land was purchased through the issuance of $30,000 in bonds. 8. At December 31, 2007, Cash was $39,000, Accounts Receivable was $41,600, and Accounts Payable remained at $30,000. (a) Prepare a statement of cash flows for (b) Prepare an unclassified balance sheet as it would appear at December 31, (c) How might the statement of cash flows help the user of the financial statements? Compute two cash flow ratios. (L0 1, 3, 8, 9) P5-7 (Preparation of a Statement of Cash Flows and Balance Sheet) Jay Leno Inc. had the following balance sheet at December 31, JAY LENO INC. BALANCE SHEET DECEMBER 31, 2006 Cash $ 20,000 Accounts payable $ 30,000 Accounts receivable 21,200 Bonds payable 41,000 Investments 32,000 Common stock 100,000 Plant assets (net) 81,000 Retained earnings 23,200 Land 40,000 $194,200 $194,200 During 2007 the following occurred. 1. Leno liquidated its available-for-sale investment portfolio at a loss of $3, A tract of land was purchased for $38, An additional $26,000 in common stock was issued at par. 4. Dividends totaling $10,000 were declared and paid to stockholders. 5. Net income for 2007 was $35,000, including $12,000 in depreciation expense. 6. Land was purchased through the issuance of $30,000 in additional bonds. 7. At December 31, 2007, Cash was $66,200, Accounts Receivable was $42,000, and Accounts Payable was $40,000. (a) Prepare a statement of cash flows for the year 2007 for Leno. (b) Prepare the balance sheet as it would appear at December 31, (c) Compute Leno s free cash flow and the current cash debt coverage ratio for (d) Use the analysis of Leno to illustrate how information in the balance sheet and statement of cash flows helps the user of the financial statements.

15 1460T_c05.qxd 12:22: :56 Page 243 Concepts for Analysis 243 CONCEPTS FOR ANALYSIS CA5-1 (Reporting the Financial Effects of Varied Transactions) In an examination of Juan Acevedo Corporation as of December 31, 2007, you have learned that the following situations exist. No entries have been made in the accounting records for these items. 1. The corporation erected its present factory building in Depreciation was calculated by the straight-line method, using an estimated life of 35 years. Early in 2007, the board of directors conducted a careful survey and estimated that the factory building had a remaining useful life of 25 years as of January 1, An additional assessment of 2006 income taxes was levied and paid in When calculating the accrual for officers salaries at December 31, 2007, it was discovered that the accrual for officers salaries for December 31, 2006, had been overstated. 4. On December 15, 2007, Acevedo Corporation declared a cash dividend on its common stock outstanding, payable February 1, 2008, to the common stockholders of record December 31, Describe fully how each of the items above should be reported in the financial statements of Acevedo Corporation for the year CA5-2 (Current Asset and Liability Classification) Below are the titles of a number of debit and credit accounts as they might appear on the balance sheet of Ethan Allen Corporation as of October 31, Debits Credits Interest Accrued on U.S. Government Capital Stock Preferred Securities 11% First Mortgage Bonds, due in 2014 Notes Receivable Preferred Cash Dividend, payable Nov. 1, 2007 Petty Cash Fund Allowance for Doubtful Accounts Receivable U.S. Government Securities Federal Income Taxes Payable Treasury Stock Customers Advances (on contracts to be Unamortized Bond Discount completed next year) Cash in Bank Premium on Bonds Redeemable in 2007 Land Officers 2007 Bonus Accrued Inventory of Operating Parts and Supplies Accrued Payroll Inventory of Raw Materials Notes Payable Patents Accrued Interest on Bonds Cash and U.S. Government Bonds Set Aside Accumulated Depreciation for Property Additions Accounts Payable Investment in Subsidiary Capital in Excess of Par Accounts Receivable: Accrued Interest on Notes Payable U.S. Government Contracts 8% First Mortgage Bonds, to be redeemed in 2007 Regular out of current assets Installments Due Next Year Installments Due After Next year Goodwill Inventory of Finished Goods Inventory of Work in Process Deficit Select the current asset and current liability items from among these debits and credits. If there appear to be certain borderline cases that you are unable to classify without further information, mention them and explain your difficulty, or give your reasons for making questionable classifications, if any. (AICPA adapted) CA5-3 (Identifying Balance Sheet Deficiencies) The assets of Annika Sorenstam Corporation are presented on the next page (000s omitted).

16 1460T_c05.qxd 1/4/06 05:40 am Page Chapter 5 Balance Sheet and Statement of Cash Flows ANNIKA SORENSTAM CORPORATION BALANCE SHEET (PARTIAL) DECEMBER 31, 2007 Assets Current assets Cash $ 100,000 Unclaimed payroll checks 27,500 Trading securities (fair value $30,000) at cost 37,000 Accounts receivable (less bad debt reserve) 75,000 Inventories at lower of cost (determined by the next-in, first-out method) or market 240,000 Total current assets 479,500 Tangible assets Land (less accumulated depreciation) 80,000 Buildings and equipment $800,000 Less: Accumulated depreciation 250, ,000 Net tangible assets 630,000 Long-term investments Stocks and bonds 100,000 Treasury stock 70,000 Total long-term investments 170,000 Other assets Discount on bonds payable 19,400 Sinking fund 975,000 Total other assets 994,400 Total assets $2,273,900 Indicate the deficiencies, if any, in the foregoing presentation of Annika Sorenstam Corporation s assets. CA5-4 (Critique of Balance Sheet Format and Content) Presented below and on the next page is the balance sheet of Bellemy Brothers Corporation (000s omitted). BELLEMY BROTHERS CORPORATION BALANCE SHEET DECEMBER 31, 2007 Assets Current assets Cash $26,000 Marketable securities 18,000 Accounts receivable 25,000 Merchandise inventory 20,000 Supplies inventory 4,000 Stock investment in Subsidiary Company 20,000 $113,000 Investments Treasury stock 25,000 Property, plant, and equipment Buildings and land 91,000 Less: Reserve for depreciation 31,000 60,000 Other assets Cash surrender value of life insurance 19,000 Total assets $217,000 Liabilities and Stockholders Equity Current liabilities Accounts payable $22,000 Reserve for income taxes 15,000 Customers accounts with credit balances 1 $ 37,001 Deferred credits Unamortized premium on bonds payable 2,000 Long-term liabilities Bonds payable 60,000 Total liabilities 99,001

17 1460T_c05.qxd 1/4/06 05:40 am Page 245 Concepts for Analysis 245 Common stock Common stock, par $5 85,000 Earned surplus 24,999 Cash dividends declared 8, ,999 Total liabilities and stockholders equity $217,000 Evaluate the balance sheet presented. State briefly the proper treatment of any item criticized. CA5-5 (Presentation of Property, Plant, and Equipment) Andrea Pafko, corporate comptroller for Nicholson Industries, is trying to decide how to present Property, plant, and equipment in the balance sheet. She realizes that the statement of cash flows will show that the company made a significant investment in purchasing new equipment this year, but overall she knows the company s plant assets are rather old. She feels that she can disclose one figure titled Property, plant, and equipment, net of depreciation, and the result will be a low figure. However, it will not disclose the age of the assets. If she chooses to show the cost less accumulated depreciation, the age of the assets will be apparent. She proposes the following. Answer the following questions. (a) What are the ethical issues involved? (b) What should Pafko do? Property, plant, and equipment, net of depreciation $10,000,000 rather than Property, plant, and equipment $50,000,000 Less: Accumulated depreciation (40,000,000) Net book value $10,000,000 CA5-6 (Cash Flow Analysis) The partner in charge of the James Spencer Corporation audit comes by your desk and leaves a letter he has started to the CEO and a copy of the cash flow statement for the year ended December 31, Because he must leave on an emergency, he asks you to finish the letter by explaining: (1) the disparity between net income and cash flow; (2) the importance of operating cash flow; (3) the renewable source(s) of cash flow; and (4) possible suggestions to improve the cash position. JAMES SPENCER CORPORATION STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 Cash flows from operating activities Net income $100,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $ 10,000 Amortization expense 1,000 Loss on sale of fixed assets 5,000 Increase in accounts receivable (net) (40,000) Increase in inventory (35,000) Decrease in accounts payable (41,000) (100,000) Net cash provided by operating activities 0 Cash flows from investing activities Sale of plant assets 25,000 Purchase of equipment (100,000) Purchase of land (200,000) Net cash used by investing activities (275,000) Cash flows from financing activities Payment of dividends (10,000) Redemption of bonds (100,000) Net cash used by financing activities (110,000) Net decrease in cash (385,000) Cash balance, January 1, ,000 Cash balance, December 31, 2007 $ 15,000

18 1460T_c05.qxd 12/27/05 08:40 pm Page 246 wiley.com/college/kieso 246 Chapter 5 Balance Sheet and Statement of Cash Flows Date James Spencer, III, CEO James Spencer Corporation 125 Wall Street Middleton, Kansas Dear Mr. Spencer: I have good news and bad news about the financial statements for the year ended December 31, The good news is that net income of $100,000 is close to what we predicted in the strategic plan last year, indicating strong performance this year. The bad news is that the cash balance is seriously low. Enclosed is the Statement of Cash Flows, which best illustrates how both of these situations occurred simultaneously... Complete the letter to the CEO, including the four components requested by your boss. USING YOUR JUDGMENT Financial Reporting Problem The Procter & Gamble Company (P&G) The financial statements of P&G are presented in Appendix 5B or can be accessed on the KWW website. Refer to P&G s financial statements and the accompanying notes to answer the following questions. (a) What alternative formats could P&G have adopted for its balance sheet? Which format did it adopt? (b) Identify the various techniques of disclosure P&G might have used to disclose additional pertinent financial information. Which technique does it use in its financials? (c) In what classifications are P&G s investments reported? What valuation basis does P&G use to report its investments? How much working capital did P&G have on June 30, 2004? On June 30, 2003? (d) What were P&G s cash flows from its operating, investing, and financing activities for 2004? What were its trends in net cash provided by operating activities over the period 2002 to 2004? Explain why the change in accounts payable and in accrued and other liabilities is added to net income to arrive at net cash provided by operating activities. (e) Compute P&G s (1) current cash debt coverage ratio, (2) cash debt coverage ratio, and (3) free cash flow for What do these ratios indicate about P&G s financial condition? Financial Statement Analysis Cases Case 1 Uniroyal Technology Corporation Uniroyal Technology Corporation (UTC), with corporate offices in Sarasota, Florida, is organized into three operating segments. The high-performance plastics segment is responsible for research, development, and manufacture of a wide variety of products, including orthopedic braces, graffiti-resistant seats for buses and airplanes, and a static-resistant plastic used in the central processing units of microcomputers. The coated fabrics segment manufactures products such as automobile seating, door and instrument panels, and specialty items such as waterproof seats for personal watercraft and stain-resistant, easycleaning upholstery fabrics. The foams and adhesives segment develops and manufactures products used in commercial roofing applications. The following items relate to operations in a recent year. 1 Serious pressure was placed on profitability by sharply increasing raw material prices. Some raw materials increased in price 50% during the past year. Cost containment programs were instituted and product prices were increased whenever possible, which resulted in profit margins actually improving over the course of the year. 2 The company entered into a revolving credit agreement, under which UTC may borrow the lesser of $15,000,000 or 80% of eligible accounts receivable. At the end of the year, approximately $4,000,000