Issuu

CHAPTER

Accounting—Present and Past

CHAPTER OUTLINE: I. What Is Accounting? A. Definition B. Uses of Accounting Information C. Classifications 1. Financial Accounting 2. Managerial Accounting / Cost Accounting 3. Auditing — Public Accounting 4. Internal Auditing 5. Governmental and Not-for-Profit Accounting 6. Income Tax Accounting II. How Has Accounting Developed? A. Early History B. The Accounting Profession in the United States C. Financial Accounting Standard Setting at the Present Time 1. Financial Accounting Standards Board 2. Standards are Evolving D. Standards for Other Types of Accounting 1. Managerial Accounting / Cost Accounting 2. Auditing 3. Governmental and Not-for-Profit Accounting 4. Income Tax Accounting E. International Accounting Standards F. Ethics and the Accounting Profession III. The Conceptual Framework A. Context B. Summary of Concepts Statement No. 8, Chapter 1 — The Objective of General Purpose Financial Reporting C. Objectives of Financial Reporting for Nonbusiness Organizations IV. Plan of the Book

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES: Principal: 1. To present a definition of accounting. 2. To identify and describe different classifications of accounting. 3. To emphasize that financial accounting standards are not a “fixed code of rules,” but are established in response to user needs and business developments. Accountants need to apply professional judgment in the application of accounting principles. 4. To emphasize the role and sources of ethics for the accounting profession. Supporting: 5. To summarize how accounting has evolved over time. 6. To identify sources of standards for other types of accounting and to contrast these with financial accounting standards. 7. To introduce the issues associated with the development of international accounting standards. 8. To describe the context of the FASB Conceptual Framework project. 9. To summarize Concepts Statement No. 8, Chapter 1 — The Objective of General Purpose Financial Reporting. 10. To relate the objectives of financial reporting for nonbusiness organizations to those of business enterprises. TEACHING OBSERVATIONS/ASSIGNMENT SUGGESTIONS: 1. Students should be put on notice about the jargon of accounting, the use of synonymous terms, the importance of the context within which a term is used, and the need for precision in the use of terminology. The first example of jargon is the term entity. 2. When discussing "Auditing — Public Accounting," have students find the auditors' opinion in the Campbell Soup Company 2020 Annual Report (see pages 87-88 of the Appendix). Emphasize that a "clean opinion" is not a "clean bill of health." 3. Discuss the Summary of Concepts Statement No. 8, Chapter 1 — The Objective of Financial Reporting, in detail.

Instructor’s Manual / Solutions Manual 4. Assign Exercise 1-1. Encourage students to experiment with websites that are of interest. In addition, or as an alternative to having students request their own annual reports, distribute reports that have been obtained by the instructor. 5. Use Exercise 1-5 to generate discussion about the importance of ethical standards in general and independence (in both appearance and fact) in particular. Follow up with a brief look at Exercise 1-7 concerning audit independence standards.

SOLUTIONS: E1.3.

This exercise provides an opportunity to gauge where the students are in terms of their prior background in accounting, be it practical or educational, and to clear up some of the common misconceptions (i.e., to explain that accounting goes beyond the “how to” aspects of bookkeeping and involves the use of judgment).

E1.4.

This exercise provides an opportunity to align student and instructor expectations. For first-time instructors in this course, or for those having a diverse student group, you will get a glimpse at the common perceptions students have concerning the course content, level of difficulty, and methods of presentation, testing/evaluation, and grading.

E1.5.

The principal factors Jim Sandrolini must consider are his competence and independence. Is he competent to prepare financial statements for a company that operates in a different industry than the one in which he works? Accepting a contingent fee arrangement would normally cause an impairment of his independence because he would directly benefit if the loan were to be approved.

E1.6.

Suggested discussion strategy: Q: Why does a business have value? A: It provides the owners an opportunity to earn a profit, an opportunity for personal fulfillment from being in charge, and an opportunity to provide a product or service that is useful to others. Q: How can this value be measured? A: Financial information will have the most to do with evaluating the firm’s profitability, and the financial statements include this information. Q: How is an asking price for the sale of a business established? A: The asking price should be a function of the profit, resources, and obligations related to the business as shown in the financial statements. Note: This exercise also provides an opportunity to point out some of the basic limitations of the data provided by the accounting process (e.g., historical cost information — how useful are past earnings results in predicting future earnings and cash flows?). Be careful not to get too carried away with details. Let the students lead this discussion.

Instructor’s Manual / Solutions Manual

E1.7.

Answers will vary depending on the search engines used by students to locate the requested information.

E1.8.

Answers will vary depending on the company selected. Note that requirement d provides an opportunity to discuss some of the financial statement terms that are introduced in Chapter 2, for those instructors wishing to get a head start.

Instructor’s Manual / Solutions Manual

CHAPTER

Financial Statements and Accounting Concepts/Principles

CHAPTER OUTLINE: I. Financial Statements A. From Transactions to Financial Statements B. Financial Statements Illustrated 1. Explanations and Definitions a. Balance Sheet b. Income Statement c. Statement of Changes in Stockholders' Equity d. Statement of Cash Flows 2. Comparative Statements in Subsequent Years 3. Illustration of Financial Statement Relationships II. Accounting Concepts and Principles A. Schematic Model of Concepts and Principles B. Concepts/Principles Related to the Entire Model C. Concepts/Principles Related to Transactions D. Concepts/Principles Related to Bookkeeping Procedures and the Accounting Process E. Concepts/Principles Related to Financial Statements F. Limitations of Financial Statements III. The Corporation’s Annual Report

Instructor’s Manual / Solutions Manual TEACHING/LEARNING OBJECTIVES: Principal: 1. To illustrate the four principal financial statements and their basic form. 2. To introduce students to the terminology of financial statements. 3. To present the accounting equation. 4. To explain several of the concepts of financial accounting and financial statement presentation. Supporting: 5. To explain that financial statements are the product of financial accounting and that the statements represent a historical summary of transactions. 6. To explain some of the limitations of financial statements. 7. To illustrate that the financial statements are included in the corporation’s annual report. 8. To introduce and explain several business procedures and their terminology.

TEACHING OBSERVATIONS: 1. This is the keystone chapter of the text, and the material presented here becomes a foundation for all subsequent financial accounting topics. The instructor must resist trying to teach the entire course from this one chapter! Instead, try to help students sort out the key ideas that must be learned now from those that they should be acquainted with, but that will really be learned when subsequent material is covered. Items to be learned now include: a. What a transaction is. b. The name of each financial statement and what it shows. c. The accounting equation. d. Financial statement relationships. e. Limitations of financial statements. 2. A significant amount of time should be spent illustrating and explaining the purpose and content—by account category (asset, liability, stockholders' equity, revenue, expense)—of each financial statement, and how the financial statements tie together. Some instructors may wish to discuss gains and losses at this point, but the key is to keep it as simple as possible!

Instructor’s Manual / Solutions Manual 3. It is recommended that the following models be emphasized: a. Balance Sheet: Assets Beginning of Period $ Changes During Period End of Period b. Income Statement:

+/-

= Liabilities $ +/-

+ Stockholders' Equity $ +/$

Revenues - Expenses = Net Income

c. Statement of Changes in Stockholders’ Equity:

+ + =

Beginning Balance of Stockholders' Equity Stockholders' Investment Net Income Dividends Ending Balance of Stockholders' Equity

(As with the discussion of gains and losses, some instructors may wish to acknowledge “other” sources of changes in stockholders’ equity such as treasury stock, accumulated other comprehensive income, prior period adjustments, etc. This is a function of instructor preference and the extent to which students have been previously exposed to real world financial statements. An early dose of “reality” can be refreshing for graduate students, but might be distracting to a younger, less experienced audience.) d. Statement of Cash Flows:

+/+/+/=

Net Income Net cash provided (used) by operating activities Net cash provided (used) by investing activities Net cash provided (used) by financing activities Net increase (decrease) in cash for the year

4. It is helpful to spend time with the concepts and principles model, explaining what each concept/principle means and showing how it relates to the "Transactions to Financial Statements" process. 5. It is appropriate to emphasize the limitations of financial statements now, because they can create a mindset that helps students understand more specific accounting principles when they are covered later. 6. The Business In Practice boxes are designed to enhance student understanding by removing some jargon and explanation from the flow of the text material, while providing a context for that material. These provide good class discussion topics. 2-3 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual ASSIGNMENT OVERVIEW: This chapter provides a wide variety of assignments to choose from—ranging from the basic association-type mini-exercises and exercises, to the more challenging, analytical-type problems. Be careful not to over-assign or under-assign homework from this chapter. NO. M2.1. M2.2. M2.3.

LEARNING OBJECTIVES 2, 3 2, 3 2, 3

DIFFICULTY & TIME ESTIMATE Easy, 3-5 min. Easy, 3-5 min. Med., 7-10 min.

M2.4.

2, 3

Med., 7-10 min.

M2.5. M2.6. M2.7. M2.8. E2.9. E2.10. E2.11.

2. 4 2, 4 2, 4 2, 4 2, 4 2, 4 2, 3

Easy, 3-5 min. Easy, 3-5 min. Easy, 2-3 min. Easy, 2-3 min. Easy, 3-5 min. Easy, 3-5 min. Med., 5-8 min.

E2.12. E2.13.

2, 3 2, 3

Med., 5-8 min. Easy, 3-5 min.

E2.14. E2.15.

2, 3 2, 3

Easy, 3-5 min. Med., 5-10 min.

E2.16. P2.17.

2, 3 2, 3, 6

Med., 5-10 min. Med., 7-10 min.

P2.18. P2.19.

2, 3, 6 2, 3, 4

Hard, 15-20 min. Med., 15-20 min.

P2.20. P2.21.

2, 3, 4 2, 3, 4

Med., 15-20 min. Med., 20-25 min.

P2.22. P2.23. P2.24. P2.25. P2.26. P2.27.

2, 3, 4 2, 3 2, 3, 6 2, 3, 5 2, 3, 5, 6 2, 4

Med., 20-25 min. Med., 5-8 min. Med.-Hard, 15-20. Med., 7-10 min. Med., 10-12 min. Med., 10-12 min.

P2.28.

2, 4

Med., 10-12 min.

C2.29.

2, 4, 6, 7

Med., 15-20 min.

OTHER COMMENTS Similar to E2.11.-E2.16. See M2.1. Good in-class demo exercise. Challenging mini-exercise. Requires clear-cut understanding of income statement relationships. Encourage use of Exhibit 2-2 as a solution model. See M2.3. Good way to review and reinforce the structure of the income statement in class. Emphasize the structure of the statement of cash flows. See M2.5. Good in-class demo exercise. Refer to Exhibit 2-4. Basic identification of asset accounts. Basic identification of income statement accounts. Simple account identification exercise. See E2.9. Reinforces the balance sheet equation, and stresses the distinction between PIC and RE. See E2.11. Good homework assignment. “RE is affected only by net income (loss) and dividends.” This is a bit of a fiction, but it works effectively in the Chapter 2. Other effects on retained earnings (i.e., stock dividends, certain treasury stock transactions, and prior period adjustments) are not discussed until Chapter 8. See E2.13. Good homework assignment. The worksheet format is used to help students understand financial statement relationships. Explain that “net assets” = A-L = SE. See E2.15. Good in-class demonstration exercise. Not explicitly covered in Chapter 2. Most instructors omit P.2.17. and P2.18. Can be used to emphasize the difference between cash and stockholders’ equity. See P2.17. Interesting application of the accounting equation. Straight-forward problem emphasizing financial statement relationships. Students respond well. See P2.19. Similar to P2.17., P2.186. but requires the preparation of financial statements. Good for in-class demonstration. See P2.21. Good homework assignment. Can use later as a Chapter 4 assignment. Group learning problem. Good in-class demonstration problem. Stress the importance of the historical cost principle. Group learning problem. See P2.25. Group learning problem. Emphasizes the structure of the income statement. Explain why “Other Income, net” is excluded from operating income. Excellent conceptual case but be sure to relate student responses back to the terminology introduced in the chapter.

Instructor’s Manual / Solutions Manual SOLUTIONS: M2.1. A = L + SE Beginning: $58,000 = $35,000 + ? Changes: = +11,000 net income (increase to retained earnings) -3,000 dividends (decrease to retained earnings) Ending: = + ? . Solution approach: Beginning stockholders’ equity = $58,000 - $35,000 = $23,000. Net income increases retained earnings and dividends decrease retained earnings. Retained earnings are part of stockholders’ equity, so assuming no other changes occurred during the year, ending stockholders’ equity = $23,000 + $11,000 - $3,000 = $31,000. M2.2. SE Beginning: $246,000 Changes: +30,000 common stock issued at par value (increase to paid-in capital) +36,000 net income (increase to retained earnings) -9,000 dividends (decrease to retained earnings) Ending: ? . Solution approach: No information is given about assets or liabilities, so the focus is entirely on stockholders’ equity. Beginning stockholders’ equity +/- changes during the year = ending stockholders’ equity. $246,000 + $30,000 + $36,000 - $9,000 = $303,000. M2.3. Net sales ....... ........... ........... ........... ........... ........... ........... Cost of goods sold ... ........... ........... ........... ........... ........... Gross profit .. ........... ........... ........... ........... ........... ........... Selling, general, and administrative expenses ......... ........... Income from operations ....... ........... ........... ........... ........... Interest expense ....... ........... ........... ........... ........... ........... Income before taxes . ........... ........... ........... ........... ........... Income tax expense.. ........... ........... ........... ........... ........... Net income ... ........... ........... ........... ........... ........... ...........

$400,000 ? .= 240,000 (1) $160,000 73,000 ? = 87,000 (2) ? .= 12,000 (4) $ ? = 75,000 (3) 15,000 $ 60,000

Solution approach: Set up an income statement using the structure and format as shown in Exhibit 2-2, then solve for missing amounts. One possible calculation sequence: (1) $400,000 - $160,000 = $240,000 cost of goods sold. (2) $160,000 - $73,000 = $87,000 income from operations. (3) $60,000 + $15,000 = $75,000 income before taxes. (4) $87,000 - $75,000 = $12,000 interest expense

Instructor’s Manual / Solutions Manual M2.4. Net sales ....... ........... ........... ........... ........... ........... ........... Cost of goods sold ... ........... ........... ........... ........... ........... Gross profit .. ........... ........... ........... ........... ........... ........... Selling, general, and administrative expenses ......... ........... Income from operations ....... ........... ........... ........... ........... Interest expense ....... ........... ........... ........... ........... ........... Income before taxes . ........... ........... ........... ........... ........... Income tax expense.. ........... ........... ........... ........... ........... Net income ... ........... ........... ........... ........... ........... ...........

$ ? = 300,000 (4) 120,000. $ ? = 180,000 (3) 66,000 114,000 18,000. $ ? = 96,000 (1) 24,000 $ ? . = 72,000 (2)

Solution approach: Set up an income statement using the structure and format as shown in Exhibit 2-2, then solve for missing amounts. Calculation sequence: (1) $114,000 - $18,000 = $96,000 income before taxes. (2) $96,000 - $24,000 = $72,000 net income. (3) $114,000 + $66,000 = $180,000 gross profit. (4) $180,000 + $120,000 = $300,000 net sales. An alternative calculation sequence would have been to solve for gross profit and net sales first, and to then solve for income before taxes and net income.

M2.5.

Net cash provided by operating activities .... ........... ........... 201,000 Net cash used by investing activities........... ........... ........... (168,000) Net cash provided by financing activities ... ........... ........... . 47,000 Net increase in cash for the year ..... ........... ........... ........... $80,000 Solution approach: Set up a skeletal statement of cash flows using the structure and format as shown in Exhibit 2-4, then solve for the missing amount. $201,000 - $168,000 + $47,000 = $80,000 net increase in cash for the year.

M2.6. Net cash provided by operating activities ... ........... ........... 145,000 Net cash used by investing activities........... ........... ........... (96,000) Net cash used by financing activities .......... ........... ........... . ? . = (11,000) Net increase in cash for the year ..... ........... ........... ........... $ 38,000 Solution approach: Set up a skeletal statement of cash flows using the structure and format as shown in Exhibit 2-4, then solve for the missing amount. $145,000 - $96,000 - $38,000 = $(11,000) net cash used by financing activities.

Instructor’s Manual / Solutions Manual M2.7. Common stock and retained earnings are stockholders’ equity accounts; cost of goods sold and interest expense are expenses; sales is a revenue account; long-term debt and accounts payable are liabilities. The assets listed are: land, merchandise inventory, equipment, accounts receivable, supplies, cash, and buildings.

M2.8. Sales and service revenues are revenues accounts on the income statement; income tax expense, cost of goods sold, and rent expense are expenses on the income statement. Land, equipment, accounts receivable, supplies, buildings, and cash are assets on the balance sheet; accumulated depreciation is a contra-asset on the balance sheet; notes payable is a liability on the balance sheet; and common stock is a stockholders’ equity account on the balance sheet.

E2.9. Cash…………………………………………… Accounts payable…………….……………….. Common stock………………………………… Depreciation expense………………………….. Net sales……………………………………….. Income tax expense……………………………. Short-term investments………………………... Gain on sale of land……………………………. Retained earnings……………………………… Dividends payable…………………………….. Accounts receivable…………………………… Short-term debt…………………………………

Category A L SE E R E A G SE L A L

Financial Statement(s) BS BS BS IS IS IS BS IS BS BS BS BS

Instructor’s Manual / Solutions Manual E2.10. Accumulated depreciation……………………... Long-term debt………………………………… Equipment……………………………………… Loss on sale of investments…………..………... Net income……………………………………… Merchandise inventory………………………… Other accrued liabilities………………………… Dividends paid…………………………………. Cost of goods sold……………………………… Additional paid-in capital………………………. Interest income…………………………………. Selling expenses………………………………..

Category A L A LS SE* A L SE E SE R E

Financial Statement(s) BS BS BS IS IS BS BS Neither** IS BS IS IS

* Although net income appears as a caption on the income statement, it represents an increase to retained earnings, which is a stockholders’ equity account. ** Trick question! “Dividends paid” appears only on the Statement of Changes in Stockholders’ Equity. Dividends paid are distributions of earnings that reduce retained earnings on the balance sheet. Dividends paid are not expenses, and thus do not appear on the income statement.

Instructor’s Manual / Solutions Manual E2.11. Use the accounting equation to solve for the missing information: Firm A: A = L + PIC + ( Beg. RE + NI - DIV = End. RE) $405,000 = $295,000 + $42,000 + ( $26,000 + ? - $18,000 = ? )

In this case, the ending balance of retained earnings must be determined first: $405,000 = $295,000 + $42,000 + End. RE Retained earnings, 12/31/22 = $68,000 Once the ending balance of retained earnings is known, net income can be determined within the parenthetical portion of the expanded balance sheet equation above, which represents the statement of stockholders’ equity: $26,000 + NI – $18,000 = $68,000 Net income for 2022 = $60,000 Firm B: A = L + PIC + ( Beg. RE + NI DIV = End. RE ) $190,000 = $55,000 + ? + ( ? + $33,000 - $11,000 = $108,000 )

$190,000 = $55,000 + PIC + $108,000 Paid-in capital, 12/31/22 = $27,000 Beg. RE + $33,000 - $11,000 = $108,000 Retained earnings, 1/1/22 = $86,000 Firm C: A = L + PIC + ( Beg. RE + NI - DIV = End. RE ) $202,000 = ? + $30,000 + ( $44,000 + $71,000 - $24,000 = ? )

In this case, the ending balance of retained earnings must be determined first: $44,000 + $71,000 - $24,000 = End. RE Retained earnings, 12/31/22 = $91,000 Once the ending balance of retained earnings is known, liabilities can be determined: $202,000 = L + $30,000 + $91,000 Total liabilities, 12/31/22 = $81,000

Instructor’s Manual / Solutions Manual Use the accounting equation to solve for the missing information: Firm A: A = L + PIC + ( Beg. RE + NI - DIV = End. RE ) $ ? = $160,000 + $110,000 + ($100,000 + 136,000 - $24,000 = ? )

In this case, the ending balance of retained earnings must be determined first: $100,000 + $136,000 - $24,000 = End. RE Retained earnings, 12/31/22 = $212,000 Once the ending balance of retained earnings is known, total assets can be determined: A = $160,000 + $110,000 + $212,000 Total assets, 12/31/22 = $482,000 Firm B: A = L + PIC + ( Beg. RE + NI - DIV = End. RE ) $870,000 = ? + $118,000 + ( $248,000 + $220,000 - ? = $372,000 )

$870,000 = L + $118,000 + $372,000 Total liabilities, 12/31/22 = $380,000 $248,000 + $220,000 - DIV = $372,000 Dividends declared and paid during 2022 = $96,000 Firm C: A

PIC

+ ( Beg. RE +

$310,000 = $150,000 + $90,000 + (

- DIV = End. RE ) + $50,000 - $32,000 = ? )

In this case, the ending balance of retained earnings must be determined first: $310,000 = $150,000 + $90,000 + End. RE Retained earnings, 12/31/22 = $70,000 Once the ending balance of retained earnings is known, the beginning balance of retained earnings can be determined: Beg. RE + $50,000 - $32,000 = $70,000 Retained earnings, 1/1/22 = $52,000

Instructor’s Manual / Solutions Manual

E2.13. Prepare the retained earnings portion of a statement of changes in stockholders' equity for the year ended December 31, 2022: Retained Earnings, December 31, 2021………………………………… Less: Net loss for the year ended December 31, 2022………………….. Less: Dividends declared and paid in 2022…..…………………………. Retained Earnings, December 31, 2022…………………………………

$ 453,400 (13,700) (28,300) $411,400

Retained Earnings, December 31, 2021……………………………….… Add: Net income for the year ended December 31, 2022……………….. Less: Dividends declared and paid in 2022…..………………………….. Retained Earnings, December 31, 2022………………………………….

? 67,800 (13,500) $630,900

E2.14.

Solving the model, retained earnings at December 31, 2021 was $576,600. E2.15.

Beginning: Changes: Ending:

SE . A = L + PIC + RE $67,600 = $33,000 + $ 0 + $34,600 ? = -5,000 + 0 + 20,400 (net income) ? (dividends) ? = ? + 0 + $48,000

Solution approach: (Remember that net assets = Assets - Liabilities = Stockholders’ equity = PIC + RE ). Since paid-in capital did not change during the year, assume that the beginning and ending balances are $0. Thus, beginning retained earnings = $67,600 - $33,000 = $34,600, and ending retained earnings = net assets at the end of the year = $48,000 (again, assuming ending paid-in capital = $0). By looking at the RE column, it can be seen that dividends must have been $7,000. This is calculated as: $34,600 + $20,400 = 55,000 - $48,000 = $7,000). Also by looking at the liabilities column, it can be seen that ending liabilities are $28,000, and therefore ending assets must be $76,000 which is equal to sum of the ending balances on the right-hand side of the balance sheet ($28,000 + $0 + $48,000 = $76,000). Thus, total assets increased by $8,400 during the year ($76,000 - $68,600), which is equal to the net increase on the right-hand side of the balance sheet (-$5,000 liabilities + $20,400 net income - $7,000 dividends = $8,400 net increase in assets).

Instructor’s Manual / Solutions Manual

E2.16.

Beginning: Changes:

SE A = L + PIC + ? = $160,000 + $15,000 + +33,000 = -9,000 + ? +

Ending:

RE ? ? (net income or loss) -12,000 (dividends) + $ 96,000 + ? ($215,000 total SE)

Solution approach: Ending retained earnings = $215,000 total stockholders’ equity - $96,000 paid-in capital = $119,000. Ending liabilities = $160,000 beginning liabilities - $9,000 decrease = $151,000. Thus, ending assets = $151,000 liabilities + $215,000 stockholders’ equity = $366,000. Beginning assets = $366,000 ending assets $33,000 increase = $333,000. Beginning retained earnings = $333,000 assets $160,000 liabilities - $15,000 paid-in capital = $158,000. Once the beginning and ending retained earnings balances are known, the net income or loss for the year can be determined as follows: Retained earnings, beginning ........... ........... ........... ........... ........... $158,000 Less: Net income or loss for the year ........... ........... ........... ........... ? Less: Dividends declared and paid during the year .. ........... ........... (12,000) Retained earnings, ending ..... ........... ........... ........... ........... ........... $119,000 Solving the model, the net loss of the year = $(27,000).

P2.17.

Note to Instructors: P2.17 and P2.18 are presented as interesting applications of the accounting equation. Calculating cash available upon liquidation of a business is not a learning objective of Chapter 2 and thus is not explicitly covered in the chapter. Solutions approach: Set up the accounting equation and show the effects of the transactions described. Since total assets must equal total liabilities and stockholders’ equity, the unadjusted stockholders’ equity can be calculated by subtracting liabilities from the total of the assets given. A

Accounts Plant & Stockholders’ Cash + Receivable + Inventory + Equipment = Liabilities + Equity Data given

$ 50,000 + 240,000

+ 110,000 + 500,000 = 620,000 + 280,000

Collection of accounts receivable

+216,000 - 240,000

-24,000

Inventory liquidation

+77,000

Sale of plant & equipment

+360,000

Payment of liabilities

-620,000

Balance

$ 83,000

- 110,000

-33,000 - 500,000

-140,000 -620,000

$ 83,000

*The effects of these transactions on stockholders’ equity represent losses from the sale (or collection) of the non-cash assets. 2-12 © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC.

Instructor’s Manual / Solutions Manual

P2.18. a. The solution approach is similar to that shown in Problem 2-17. Gains or losses can be calculated for the sale (or collection) of each of Kimber Co.’s non-cash assets, as follows: Cash received upon Gain (loss) recorded and sale or collection of asset effect on Stockholders’ Equity Accounts receivable . . . . $90,000 * 80% = $ 72,000 Merchandise inventory . . $150,000 * 70% = 105,000 Buildings & Equipment . . BV^ + $60,000 = 340,000 Land. . . . . . . . . . . . . . . . . Appraised amount = 85,000 Total cash received $602,000

$90,000 * 20% = $150,000 * 30% = Amount above BV = $85,000 - $50,000 = Net gain

$(18,000) (45,000) 60,000 35,000 $ 32,000

^ $400,000 - $120,000 accumulated depreciation = $280,000 book value of buildings & equipment. The $602,000 cash received from the liquidation of non-cash assets would be added to the beginning cash balance of $30,000, and $632,000 is the amount of cash available to pay the claims of creditors and stockholders. Liabilities would be paid first (including the amounts that are not shown on the balance sheet), and the balance would be paid to the stockholders: Total cash available ... ........... ........... ........... ........... ........... $632,000 Accounts payable ...... ........... ........... ........... ........... ........... $ 80,000 Notes payable ........... ........... ........... ........... ........... ........... 110,000 Wages payable (not shown on balance sheet) ........... ........... 5,000 Interest payable (not shown on balance sheet) .......... ........... 10,000 Long-term debt .......... ........... ........... ........... ........... ........... 130,000 (335,000) Total cash available to stockholders .......... ........... ........... $297,000 The total cash available to stockholders upon liquidation can be verified, as follows: Total stockholders’ equity (unadjusted, from balance sheet) ........... Add: Gain on sale of buildings & equipment ........... ........... ........... Add: Gain on sale of land ...... ........... ........... ........... ........... ........... Less: Loss on collection of accounts receivable ....... ........... ........... Less: Loss on liquidation of merchandise inventory . ........... ........... Less: Unrecorded wages expense ...... ........... ........... ........... ........... Less: Unrecorded interest expense .... ........... ........... ........... ........... Total stockholders’ equity, as adjusted ...... ........... ........... ...........

$280,000 60,000 35,000 (18,000) (45,000) (5,000) (10,000) $297,000

A summary reconciliation is as follows: Total stockholders’ equity (unadjusted, from balance sheet) ........... Add: Net gain from liquidation of all assets (see calculations above)…. Less: Unrecorded liabilities for wages and interest………………… Total stockholders’ equity, as adjusted ...... ........... ........... ...........

$280,000 32,000 (15,000) $297,000

Instructor’s Manual / Solutions Manual

P2.18.

(continued) b. As shown in the schedule in part a), total stockholders’ equity on the balance sheet had not been adjusted for the gains and losses from the sale (or collection) of the non-cash assets; nor was it adjusted for the effects of the expense/liability accruals for wages and interest.

P2.19. a. Cash .. ........... ........... ........... ........... ........... ........... ........... ........... Accounts receivable .. ........... ........... ........... ........... ........... ........... Supplies ........ ........... ........... ........... ........... ........... ........... ........... Merchandise inventory .......... ........... ........... ........... ........... ........... Total current assets .... ........... ........... ........... ........... ........... ...........

$ 54,000 218,000 36,000 180,000 $488,000

b. Accounts payable ..... ........... ........... ........... ........... ........... ........... Long-term debt .......... ........... ........... ........... ........... ........... ........... Common stock........... ........... ........... ........... ........... ........... ........... Retained earnings ...... ........... ........... ........... ........... ........... ........... Total liabilities and stockholders’ equity ..... ........... ........... ...........

$138,000 240,000 70,000 370,000 $818,000

c. Net Sales ........ ........... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... Gross profit .... ........... ........... ........... ........... ........... ........... ........... Service revenue ......... ........... ........... ........... ........... ........... ........... Depreciation expense ........... ........... ........... ........... ........... ........... Supplies expense ....... ........... ........... ........... ........... ........... ........... Earnings from operations (operating income) ........... ........... ...........

$890,000 (590,000) $300,000 120,000 (72,000) (84,000) $264,000

d. Earnings from operations (operating income) ........... ........... ........... Interest expense ......... ........... ........... ........... ........... ........... ........... Earnings before taxes ........... ........... ........... ........... ........... ........... Income tax expense ... ........... ........... ........... ........... ........... ........... Net income .... ........... ........... ........... ........... ........... ........... ...........

$264,000 (24,000) $240,000 (84,000) $156,000

e. $84,000 income tax expense / $240,000 earnings before taxes = 35% average tax rate f. Retained earnings, January 1, 2022 .. ........... ........... ........... ........... Net income for the year ......... ........... ........... ........... ........... ........... Dividends declared and paid during the year ........... ........... ........... Retained earnings, December 31, 2022 ......... ........... ........... ...........

? $156,000 (96,000) $370,000

Solving the model, the beginning retained earnings balance must have been $310,000, because the account balance increased by $60,000 during the year to an ending balance of $370,000.

Instructor’s Manual / Solutions Manual

P2.20. a. Cash ... ........... ........... ........... ........... ........... ........... ........... ........... $ 20,000 Accounts receivable .. ........... ........... ........... ........... ........... ........... 28,000 Merchandise inventory .......... ........... ........... ........... ........... ........... 106,000 Total current assets .... ........... ........... ........... ........... ........... ........... $ 154,000 Less: Accounts payable * ...... ........... ........... ........... ........... ........... (13,000) Current assets less current liabilities . ........... ........... ........... ........... $ 141,000 * No other current liabilities are included in the problem. b. Total current assets .... ........... ........... ........... ........... ........... ........... $ 154,000 Land ... ........... ........... ........... ........... ........... ........... ........... ........... 19,000 Equipment ..... ........... ........... ........... ........... ........... ........... ........... 10,000 Accumulated depreciation ..... ........... ........... ........... ........... ........... (3,000) Total assets .... ........... ........... ........... ........... ........... ........... ........... $ 180,000 c. Net Sales ........ ........... ........... ........... ........... ........... ........... ........... $ 310,000 Cost of goods sold ..... ........... ........... ........... ........... ........... ........... (220,000) Gross profit .... ........... ........... ........... ........... ........... ........... ........... $ 90,000 Rent expense . ........... ........... ........... ........... ........... ........... ........... (9,000) Depreciation expense ........... ........... ........... ........... ........... ........... (1,500) Earnings from operations (operating income) ........... ........... ........... $ 79,500 d. Earnings from operations (operating income) ........... ........... ........... $ 79,500 Interest expense ......... ........... ........... ........... ........... ........... ........... (4,500) Earning before taxes .. ........... ........... ........... ........... ........... ........... $ 75,000 Income tax expense ... ........... ........... ........... ........... ........... ........... (30,000) Net income .... ........... ........... ........... ........... ........... ........... ........... $ 45,000 e. $30,000 income tax expense / $75,000 earnings before taxes = 40% average tax rate f. Retained earnings, January 1, 2022 ... ........... ........... ........... ........... Net income for the year ......... ........... ........... ........... ........... ........... Dividends declared and paid during the year ........... ........... ........... Retained earnings, December 31, 2022 ......... ........... ........... ...........

? $ 45,000 (32,000) $122,000

Solving the model, the beginning retained earnings balance must have been $109,000, because the account balance increased by $13,000 during the year to an ending balance of $122,000.

Instructor’s Manual / Solutions Manual P2.21. a.

BREANNA, INC. Income Statement For the Year Ended December 31, 2022 Net Sales ........ ........... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... Gross profit .... ........... ........... ........... ........... ........... ........... ........... Selling, general, and administrative expenses .......... ........... ........... Earnings from operations (operating income) ........... ........... ........... Interest expense ......... ........... ........... ........... ........... ........... ........... Earnings before taxes ........... ........... ........... ........... ........... ........... Income tax expense ... ........... ........... ........... ........... ........... ........... Net income .... ........... ........... ........... ........... ........... ........... ...........

$420,000 (280,000) $140,000 ( 59,000) $ 81,000 ( 6,000) $ 75,000 (15,000) $ 60,000

BREANNA, INC. Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2022 Paid-in capital: Common stock .......... ........... ........... ........... ........... ........... $180,000 Retained earnings: Beginning balance ..... ........... ........... ........... ........... ........... $ 34,000 Net income for the year ........ ........... ........... ........... ........... 60,000 Less: Dividends declared and paid during the year ... ........... (24,000) Ending balance ......... ........... ........... ........... ........... ........... 70,000 Total stockholders’ equity ..... ........... ........... ........... ........... $250,000 BREANNA, INC. Balance Sheet December 31, 2022 Assets: Cash .. ........... ........... ........... ........... ........... ........... ........... $130,000 Accounts receivable .. ........... ........... ........... ........... ........... 40,000 Merchandise inventory .......... ........... ........... ........... ........... 54,000 Total current assets .... ........... ........... ........... ........... ........... $224,000 Equipment ..... ........... ........... ........... ........... ........... ........... 240,000 Less: Accumulated depreciation ....... ........... ........... ........... (104,000) 136,000 Total assets .... ........... ........... ........... ........... ........... ........... $360,000 Liabilities: Accounts payable ...... ........... ........... ........... ........... ........... $ 30,000 Long-term debt .......... ........... ........... ........... ........... ........... 80,000 Total liabilities........... ........... ........... ........... ........... ........... $110,000 Stockholders’ Equity: Common stock .......... ........... ........... ........... ........... ........... $180,000 Retained earnings ..... ........... ........... ........... ........... ........... 70,000 Total stockholders’ equity ..... ........... ........... ........... ........... $250,000 Total liabilities and stockholders’ equity ...... ........... ........... $360,000

Instructor’s Manual / Solutions Manual 2.21.

(continued) b. $15,000 income tax expense / $75,000 earnings before taxes = 20% average tax rate. c. $6,000 interest expense / $80,000 long-term debt = 7.5% interest rate. This assumes that the year-end balance of long-term debt is representative of the average long-term debt account balance throughout the year. d. $180,000 common stock / 36,000 shares = $5 per share par value. e. $24,000 dividends declared and paid / $60,000 net income = 40%. This assumes that the board of directors has a policy to pay dividends in proportion to earnings.

P2.22. a.

SHAE, INC. Income Statement For the Year Ended December 31, 2022 Net Sales ....... ........... ........... ........... ........... ........... ........... ........... Cost of goods sold ..... ........... ........... ........... ........... ........... ........... Gross profit ... ........... ........... ........... ........... ........... ........... ........... Selling, general, and administrative expenses ......... ........... ........... Earnings from operations (operating income) .......... ........... ........... Interest expense ......... ........... ........... ........... ........... ........... ........... Earnings before taxes ........... ........... ........... ........... ........... ........... Income tax expense ... ........... ........... ........... ........... ........... ........... Net income .... ........... ........... ........... ........... ........... ........... ...........

$300,000 (180,000) $120,000 (24,000) $ 96,000 (16,000) $ 80,000 (28,000) $ 52,000

SHAE, INC. Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2022 Paid-in capital: Common stock ......... ........... ........... ........... ........... ........... $ 70,000 Retained earnings: Beginning balance ..... ........... ........... ........... ........... ........... $ 43,000 Net income for the year ........ ........... ........... ........... ........... 52,000 Less: Dividends declared and paid during the year .. ........... (13,000) Ending balance ......... ........... ........... ........... ........... ........... 82,000 Total stockholders’ equity..... ........... ........... ........... ........... $152,000

Instructor’s Manual / Solutions Manual P2.22. (continued) a.

SHAE, INC. Balance Sheet December 31, 2022

Assets: Cash .. ........... ........... ........... ........... ........... ........... ........... $ 64,000 Accounts receivable . ........... ........... ........... ........... ........... 40,000 Merchandise inventory .......... ........... ........... ........... ........... 88,000 Total current assets ... ........... ........... ........... ........... ........... $192,000 Buildings and equipment ...... ........... ........... ........... ........... 168,000 Less: Accumulated depreciation ....... ........... ........... ........... (72,000) 96,000 Total assets .... ........... ........... ........... ........... ........... ........... $288,000 Liabilities: Accounts payable ...... ........... ........... ........... ........... ........... $ 30,000 Accrued liabilities ..... ........... ........... ........... ........... ........... 6,000 Notes payable (long term) ..... ........... ........... ........... ........... 100,000 Total liabilities .......... ........... ........... ........... ........... ...........

$136,000

Stockholders’ Equity: Common stock ......... ........... ........... ........... ........... ........... $ 70,000 Retained earnings ..... ........... ........... ........... ........... ........... 82,000 Total stockholders’ equity..... ........... ........... ........... ........... Total liabilities and stockholders’ equity ...... ........... ...........

$152,000 $288,000

b. $28,000 income tax expense / $80,000 earnings before taxes = 35% average tax rate. c. $16,000 interest expense / $100,000 notes payable (long-term) = 16% interest rate. This assumes that the year-end balance of long-term debt is representative of the average long-term debt account balance throughout the year. If large amounts of cash had been borrowed near the end of the year, then the interest rate charged on long-term debt would be greater than 16% because the average debt outstanding would have been less than $100,000. Likewise, if large repayments of long-term debt had occurred near year-end, then the interest rate was less than 16% because the average outstanding long-term debt would have been greater than $100,000. d. $70,000 common stock / 14,000 shares = $5 per share par value. e. $13,000 dividends declared and paid / $52,000 net income = 25%. This assumes that the board of directors has a policy to pay dividends in proportion to earnings.

Instructor’s Manual / Solutions Manual P2.23. a. b. c. d. e. f. g. h. i.

Assets = Liabilities + Borrowed cash on a bank loan + + Paid an account payable Sold common stock + NE Purchased merchandise inventory on account + + Declared and paid dividends NE Collected an account receivable NE NE Sold inventory on account at a profit + NE Paid operating expenses in cash NE Repaid principal and interest on a bank loan -

Stockholders’ Equity NE NE + NE NE + -

P2.24. a. August 1, 2022 totals....... ............. .............. ............. ............. August 3, borrowed $50,000 in cash from the bank ………….. New totals………………………………………………… August 7, bought merchandise inventory valued at $75,000 on account ........ ............. .............. ............. ……….. New totals .... ............. ............. .............. ............. ............. August 10, paid $25,000 cash operating expenses ...... ............. New totals .... ............. ............. .............. ............. ............. August 14, received $120,000 in cash from sales ...... ............. of merchandise that had cost $72,000 ........ ............. ............. New totals .... ............. ............. .............. ............. ............. August 17, paid $60,000 owed on accounts payable….. ........... New totals .... ............. ............. .............. ............. ............. August 21, collected $44,000 of accounts receivable…. ........... New totals ..... ............. ............. .............. ............. ............. August 24, repaid $30,000 to the bank, plus $1,000 interest ..... New totals ..... ............. ............. .............. ............. ............. August 29, paid Rudy Gandolfi a $15,000 cash dividend ........ August 31, 2022 totals..... ............. .............. ............. .............

Stockholder’s Assets = Liabilities + Equity $700,000 $500,000 $200,000 + 50,000 + 50,000 0 $750,000 $550,000 $200,000 +75,000 +75,000 0 $825,000 $625,000 $200,000 –25,000 0 –25,000 $800,000 $625,000 $175,000 +120,000 +120,000 –72,000 0 – 72,000 $848,000 $625,000 $223,000 –60,000 –60,000 0 $788,000 $565,000 $223,000 0 0 0 $788,000 $565,000 $223,000 –31,000 –30,000 –1,000 $757,000 $535,000 $222,000 – 15,000 0 –15,000 $742,000 = $535,000 + $207,000

b. Total revenues were $120,000 (from sales) and total expenses were $98,000 (which included $72,000 of cost of goods sold, $25,000 of operating expenses, and $1,000 of interest expense). Thus, net income was $22,000 ($120,000 - $98,000). Alternative calculation: Stockholder’s equity increased by $7,000 during the month of August (see answer to part c), even though a $15,000 cash dividend was declared and paid to Rudy Gandolfi. Since there were no capital stock transactions during the month, net income was $22,000. ($200,000 beginning stockholder’s equity, plus $22,000 net income, minus $15,000 dividends, equals $207,000 ending stockholder’s equity.) c. Total assets .... ........... ........... ........... Total liabilities........... ........... ........... Total stockholder’s equity ..... ...........

August 1 $700,000 500,000 200,000

August 31 $742,000 535,000 207,000

Net Change $42,000 35,000 7,000

Instructor’s Manual / Solutions Manual

P2.24. (continued) d. Rudy Gandolfi’s stockholder’s equity increased by $48,000 as a result of the sale on August 14th ($120,000 revenue - $72,000 cost of goods sold). His stockholder’s equity decreased by $25,000 for the operating expenses recorded on August 10th, by $1,000 for the interest expense recorded on August 24th, and by $15,000 for the cash dividend recorded on August 29th. In other words, his stockholder’s equity was increased by revenues, and it was decreased by expenses and dividends. e. Interest is an expense because it represents a necessary payment to others (i.e., creditors) for the use of their money—thus, it is a “cost” of doing business. Dividends are instead a distribution of profits to the owners/stockholders of the firm and thus represent a partial liquidation of the firm. A dividend is not an expense because it represents a profit distribution; it is not a “cost” of doing business. f. When money is borrowed from the bank, an asset (cash) is increased and a liability (notes payable) is also increased by an equal amount. Net income is increased only when revenue has been earned—and money borrowed from the bank represents a liability that must be repaid, not revenue that has been earned. g. Paying off accounts payable decreases an asset (cash) and decreases a liability (accounts payable) by an equal amount. Collecting an account receivable increases an asset (cash) and decreases another asset (accounts receivable) by equal amounts. In both cases, only balance sheet accounts are involved. Net income is increased by revenues and decreased by expenses. The expense associated with a cash payment of an account payable would have been recorded in an earlier transaction (when the expense was incurred and the account payable was established); by the same logic, the revenue associated with the collection of an account receivable would have been recorded in an earlier transaction (when the revenue was earned and the account receivable was established).

Instructor’s Manual / Solutions Manual P2.25. Amounts shown in the balance sheet below reflect the following use of the data given: a. An asset should have a "probable future economic benefit"; therefore the accounts receivable are stated at the amount expected to be collected from customers. b. Assets are reported at original cost, not current "worth." Depreciation in accounting reflects the spreading of the cost of an asset over its estimated useful life. c. Assets are reported at original cost, not at an assessed or appraised value. d. The amount of the note payable is calculated using the accounting equation, A = L + SE. Total assets can be determined based on items (a), (b), and (c); total stockholders' equity is known after considering item (e); and the note payable is the difference between total liabilities and the accounts payable. e. The retained earnings account balance represents the difference between cumulative net income and cumulative dividends. P2.25.

(continued) Assets: Cash ...... ............... ............... ............... $ 5,000 Accounts receivable .............. ............... 51,000 Land ...... ............... ............... ............... 75,000 Equipment ............. ............... ............... $160,000 Less: Accumulated depreciation ............ (40,000) 120,000 Total assets……………………………

$251,000

Liabilities and Stockholders’ Equity: Note payable .... ............... .............. $ 20,000 Accounts payable............. .............. 36,000 Total liabilities ............. .............. $ 56,000 Common stock ............... .............. 60,000 Retained earnings ........... .............. 135,000 Total stockholders’ equity .......... 195,000 Total liab.and stockholders’ equity.. $251,000

Instructor’s Manual / Solutions Manual P2.26. EPSICO, INC. Balance Sheets December 31, 2022 and 2021 (Amounts in thousands) Assets 2022 Current assets: Cash ....... ............... ............... $ 456 Accounts receivable .............. 1,512 Inventory ............... ............... 2,892 Total current assets ............. $4,860 Land ...... ............... ............... $ 300 Equipment ............. ............... 4,680 Less: Accum. depreciation… (2,160) Total land & equipment ...... $2,820 Total assets ............ ............... $7,680

2021

Liabilities 2022 Current liabilities: $ 360 Note payable ....... ............... ................. $ 588 1,440 Accounts payable …….………………. 1,476 2,760 Total current liabilities .... ………. … $2,064 $4,560 Long-term debt ... ............... …….… … $ 720 Total liabilities……………………… $2,784 $ 300 Stockholders’ Equity 4,500 Common stock.... ............... ……… … $2,400 (1,920) Retained earnings……………… …… 2,496 $2,880 Total stockholders’ equity. … ….… $4,896 $7,440 Total liabilities & stockholders’ equity. $7,680

2021 $ 480 1,320 $1,800 $ 960 $2,760 $2,400 2,280 $4,680 $7,440

Solution approach: 1. Retained earnings, 12/31/21 ......... ........... ........... ........... ........... ........... $2,280 Net income for 2022 (given) ........ ........... ........... ........... ........... ........... 312 Dividends for 2022 (given) .......... ........... ........... ........... ........... ........... (96) Retained earnings, 12/31/22 ........ ........... ........... ........... ........... ........... $2,496 2. Cash at 12/31/22 is $96 more than at 12/31/21. 3. Cost of equipment at 12/31/22 is $180 more than the balance at 12/31/21. 4. Land balance at 12/31/22 is the same as at 12/31/21. Fair market value is irrelevant. 5. Calculate total current assets, total land and equipment, and total assets. 6. Total assets can then be used for total liabilities and stockholders’ equity. 7. Total stockholders’ equity is calculated and added to total current liabilities. This amount is subtracted from total liabilities and stockholders’ equity to determine long-term debt. 8. Total liabilities is equal to total current liabilities plus long-term debt.

Instructor’s Manual / Solutions Manual P2.27. 2020

2019

For the years ended February 2 and 3, respectively: Net sales…...…………………...................................... Cost of sales……........………………........................... Gross profit…………………….................................... Total operating expenses……………………................ Operating income ……….……...….............................. Interest expense and other, net……………………....... Earnings before provision for income taxes.......……… Provision for income taxes………….............................. Net earnings…………………............................………

$110,225 72, 653 37,572 21,729* 15,843 1,128** 14,715 3,473 $ 11,242

$108,203 71,043 37,160 21,630* 15,530 974** 14,556 3,435 $ 11,211

* Includes the following items: Selling, general, and administrative ….……………. Depreciation and amortization……………………… Impairment loss……..……………………………….

$ 19,740 1,989 ---

$ 19,513 1,870 247

21,729

21,630

** Includes the following items: Interest and investment income ……………………. Interest expense…………………..………………… Other………………..………………………………. As at February 2 and 3, respectively: Total assets……............................................................... Total liabilities...……...................................................… Total stockholders' (deficit) equity...................................

(73) 1,201

1,128

(93) 1,051 16 974

$ 51,236 54,352 (3,116)

$ 44,003 45,881 (1,878)

Instructor’s Manual / Solutions Manual P2.28. a. Net sales ........ ........... ........... ........... ........... ........... Cost of sales .. ........... ........... ........... …………….. Gross profit .... ........... ........... ........... ........... ........... Gross profit/net sales . ........... ........... ........... ...........

2020 $274,515 (169,559) $104,956 38.2%

2019 $260,174 (161,782) $ 98,392 37.8%

Apple was able to achieve amazingly high sales growth rates for more than a decade since the introduction of the iPod in 2001, and in subsequent years with the introduction of the iPhone in 2007 and iPad in 2010. The company has now grown to a size and scale of operations where it has become difficult to maintain high sales growth rates on a percentage basis, although in absolute terms the $14.3 billion increase in net sales from 2019 to 2020 is still a remarkable achievement. The 0.4% increase in the gross profit/net sales ratio during the year ended September 26, 2020 was not terribly significant. For your reference, here is Apple’s remarkably consistent 5-year trend for these data: 2020 2019 2018 2017 2016 Net sales ........ ........... $274,515 $260,174 $265,595 $229,234 $215,639 Cost of sales .. ........... (169,559) (161,782) (163,756) (141,048) (131,376) Gross profit .... ........... $104,956 $ 98,392 $101,839 $ 88,186 $84,263 Gross profit/net sales . 38.2% 37.8% 38.3% 38.5% 39.1% b. Gross profit (from part a above) ....... ........... ........... Research and development expenses ........... ........... Selling, general, and administrative expenses .......... Operating income ...... ........... ........... ........... ...........

2020 $104,956 18,752 19,916 $66,288

2019 $98,392 16,217 18,245 $63,930

Operating income/net sales ... ........... ........... ...........

63.2%

65.0%

Operating income as a percentage of net sales decreased slightly (by only 1.8%) during the fiscal year ended on September 26, 2020, which reflects well on Apple’s consistency of operations and predictability of earnings. It’s also worth noting that Apple’s results for this measure are extraordinarily high relative to most companies due to their economies of scale and relative price inelasticity. c. Operating income (from part b above) ......... ........... Other income, net ..... ........... ........... ........... ........... Income before provision for income taxes .... ........... Provision for income taxes .... ........... ........... ........... Net income .... ........... ........... ........... ........... ...........

2020 $66,288 803 $67,091 (9,680) $57,411

2019 $63,930 1,807 $65,737 (10,481) $55,256

Solution approach: The “Income before provision for income taxes” (income before taxes) line has been added to emphasize the importance of understanding the difference between operating items and non-operating items on the income statement. The problem could be solved without calculating this number.

Instructor’s Manual / Solutions Manual C2.29. In parts a, b and d, if students are willing to share the different kinds of assets, liabilities, revenues, expenses, and cash flows they have identified, this case can be used to review the basic characteristics of the balance sheet, income statement, and statement of cash flows. In part c, the point is that projected income activity for the current period has a direct impact on the projected balance sheet. In part e, the point is that income and cash flow are two different things entirely. Possible explanations might include: •

Receipt of student loan proceeds (or scholarships, grants) towards the end of the semester.

•

Certain costs of attending college (i.e., tuition, room and board, meal plans) might be incurred by the student, but not yet paid.

•

A student may be employed on a part-time (or full-time) basis throughout the semester, which may generate more cash flow than she was able to accumulate during the summer preceding the fall semester.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ —CHAPTER 2

NAME______________________

Presented below is the Statement of Cash Flows for Marstore, Inc., for the year ended December 31, 2022. Also shown is a partially completed comparative balance sheet as of December 31, 2022 and 2021. MARSTORE, INC. Statement of Cash Flows For the Year Ended December 31, 2022 Cash flows from operating activities: Net Income ......... ........... ........... ........... ........... ........... ........... ........... $ 23,000 Add (deduct) items not affecting cash: Depreciation expense .. ........... ........... ........... ........... ........... ........... 6,000 Decrease in accounts receivable.......... ........... ........... ........... ........... 8,000 Decrease in accounts payable.. ........... ........... ........... ........... ........... (6,000) Net cash provided by operating activities ........... ........... ........... ........... $31,000 Cash flows from investing activities: Purchase of store fixtures ........... ........... ........... ........... ........... ...........

$(4,000)

Cash flows from financing activities: Repayment of long-term debt...... ........... ........... ........... ........... ........... $ (2,000) Payment of cash dividends on common stock .... ........... ........... ........... (5,000) Net cash used by financing activities ...... ........... ........... ........... ........... $(7,000) Increase in cash for the year ........ ........... ........... ........... ........... ........... $20,000 MARSTORE, INC. Balance Sheets December 31, 2022 and 2021 2022 2021 2022 2021 Current assets: Cash…………………….. $ 37,000 $______ Accounts payable……. $ ______ $18,000 Accounts receivable…….. ______ 39,000 Long-term debt………. 18,000 ______ Total current assets….. $ $ Total liabilities…….. $ ______ $______ Store fixtures…………… $______ $ 24,000 Common stock………. $ ______ $ 20,000 Less: Accumulated Retained earnings…….. ______ ______ depreciation………….. (13,000) ______ Total s’holders’ equity $ ______ ______ Net store fixtures……….. $______ $______ Total liabilities and Total assets……………… $______ $______ s’holders’ equity…… $ ______ $______

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ —CHAPTER 2 (continued) 1. Complete the balance sheets for Marstore, Inc., at December 31, 2022 and 2021. Identify your strategy by listing, in general, the sequence of steps you used to find the unknown amounts.

2. Does the amount shown on the balance sheet for Net Store Fixtures represent the current fair market value of the store fixtures? Explain your answer.

3. Prepare a Statement of Changes in Retained Earnings for the year ended December 31, 2022.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ KEY—CHAPTER 2 1. • Use information in the statement of cash flows to determine either the beginning or ending amounts for assets and liabilities. For example, accounts receivable decreased $8,000, so at the end of 2022 the balance was $31,000. • Based on total assets and total liabilities at the beginning and end of the year, determine total stockholders' equity at each date. • Using total stockholders' equity at the end of 2021, solve for retained earnings at that date. • The cash flows from financing activities on the statement of cash flows does not show any cash from the sale of additional stock, so the ending balance is the same as the beginning balance. Knowing this, retained earnings at the end of the year can be determined. • Or, use information about net income and dividends from the statement of cash flows, and the beginning balance of retained earnings (as determined above) to calculate ending retained earnings. Then, capital stock at the end of the year can be determined. MARSTORE, INC. Balance Sheets December 31, 2022 and 2021 2022 Current assets: Cash…………………… $37,000 Accounts receivable…… 31,000 Total current assets…. $68,000 Store fixtures………….. $28,000 Less: Accumulated depreciation………… (13,000) Net store fixtures……… $15,000 Total assets……………. $83,000

2021

2022

2021

$17,000 Accounts payable…….. $12,000 $18,000 39,000 Long-term debt………. 18,000 20,000 $56,000 Total liabilities……….. $30,000 $38,000 $24,000 Common stock……….. $20,000 $20,000 Retained earnings……. 33,000 15,000 (7,000) Total s’holders’ equity.. $53,000 $35,000 $17,000 Total liabilities and $73,000 s’holders’ equity…... $83,000 $73,000

2. No. The balance sheet shows the original cost of assets, less accumulated depreciation, which for accounting purposes is that portion of the cost of the asset that has been "used up." 3. Retained earnings, 12/31/21 ........ ........... ........... ........... ........... ........... ........... Add: Net income for the year ...... ........... ........... ........... ........... ........... ........... Less: Dividends declared and paid .......... ........... ........... ........... ........... ........... Retained earnings, 12/31/22 ........ ........... ........... ........... ........... ........... ...........

$15,000 23,000 (5,000) $33,000

Instructor’s Manual / Solutions Manual

CHAPTER

Fundamental Interpretations Made From Financial Statement Data

CHAPTER OUTLINE: I. Financial Ratios and Trend Analysis A. Company Data Over Time B. Company Data Compared to Industry Data Over Time II. Return on Investment A. Significance B. Method of Calculating III. The DuPont Model—An Expansion of the ROI Calculation A. Margin and Turnover B. Significance of Model C. Rules of Thumb for ROI, Margin, and Turnover IV. Return on Equity and Rules of Thumb V. Working Capital and Measures of Liquidity A. Working Capital B. Current Ratio C. Acid-test Ratio D. Rules of Thumb for Current Ratio and Acid-test Ratio VI. Illustration of Trend Analysis A. Profitability and Liquidity Data B. Return on Investment and Return on Equity C. Margin and Turnover D. Working Capital and Current Ratio

Instructor’s Manual / Solutions Manual

PEDAGOGICAL NOTES: Chapter 3 introduces students to some fundamental financial statement analysis concepts that provide a framework for their understanding of financial accounting as they proceed through Chapters 4-10. Chapter 11 presents a comprehensive explanation of how to use financial statement data, including a full complement of financial ratios as well as common size analysis. Many instructors prefer to defer coverage of the ROI, ROE, and liquidity measures until students have a better understanding of financial accounting concepts, and therefore assign Chapters 3 and 11 concurrently. In our experience, front-loading profitability and liquidity measures in Chapter 3 has proven successful in the following ways: 1) it introduces students to the “big picture” of real-world financial reporting before they get caught up in accounting details, 2) it shows students the relevance of studying financial accounting, 3) it provides students with a perspective that can be used in subsequent chapters and homework assignments, and 4) it encourages students—early on—to think about the impact of transactions on the financial statements. Some instructors also cover the concept of financial leverage (including the debt ratio and the debt/equity ratio) when Chapter 3 is assigned—to emphasize the “magnification effect” that long-term debt has on ROE. In our opinion, this approach should be used with caution—while this provides an opportunity to emphasize the importance of a firm’s capital structure, and the risks/rewards of borrowing, it may be too much too soon for many students.

TEACHING/LEARNING OBJECTIVES: Principal: 1. To explain the return on investment (ROI) calculation, its significance as a measure of investment performance, and to emphasize that the expanded (DuPont) model using margin and turnover focuses on the two key components of investment performance—profitability and utilization of assets. 2. To explain the return on equity (ROE) calculation, and the significance of ROE. 3. To explain the calculation and significance of working capital, the current ratio, and the acid-test ratio. 4. To provide some broad "rules of thumb" so students can form a perspective about the ratio measurements of specific companies. Supporting: 5. To introduce some of the interpretations of financial statement data made by users to support their decisions and informed judgments.

Instructor’s Manual / Solutions Manual 6. To emphasize that trends of ratios are significant, and that ratio measurements at a single point in time are not very descriptive without reference to an external benchmark. 7. To illustrate trend analysis using the measurements introduced in this chapter.

TEACHING OBSERVATIONS: 1. In our opinion, the return on investment concept is one of the most important ideas that students should understand about business operations. The ROI concept (using the DuPont model) should be emphasized as a key tool for evaluating the results of any business activity. The concept is introduced at this early point in the text because it is so important, and because it represents a key use of financial statement data. The ROI concept provides a context within which students will be able to evaluate the effects of alternative accounting methods as they are discussed in later chapters. Frequent reference is made to the ROI concept throughout the text with the assumption that the reader understands its significance. 2. The DuPont model can be used to contrast the profitability components of two or more industries that achieve comparable total profitability. For example: Grocery stores Heavy equipment manufacturers Retail jewelry outlets

Margin 1% 15% ?

* * *

Turnover = ROI 15 = 15% 1 = 15% ? ?

Get students involved in the discussion by asking them to make educated guesses about the industry averages for margin and turnover in the jewelry and computer industries. Balance sheet components affecting turnover can easily be identified by most students—but be sure to emphasize that the denominator used in the turnover (and ROI) calculation is average total assets—and not just inventory! Ask them, “Which of the firm’s assets really turn-over, as such?” Point out to students that manufacturers make substantial investments in long-term assets (such as property, plant, and equipment) that—although productive—are not expected to turn over. Thus, the firm’s gross margin from selling inventory will be substantially higher than its overall profit margin (which is what “margin” in the ROI calculation represents). Ask them to find and compare the gross margin and net income amounts in Campbell’s 2020 income statement. This should help them to understand the importance of earning a return on all assets employed by the firm. 3. The impact on an industry that achieves above average profitability can be used to illustrate the cyclical pattern of industry profitability over time. When industry profits are unusually high, more firms enter the industry. This leads to increased competition, which leads to lower ROI, which leads to a shakeout, which leads to less competition, which leads to rising ROI. Students' economic literacy can be increased by comparing the ROI for specific companies with the rules-of-thumb given in the text. Case 3-26 (Apple Inc.) provides an opportunity to illustrate this point, or you may wish to assign Case 3-25, which allows each student to evaluate the focus company that they selected in Exercise 1-1.

Instructor’s Manual / Solutions Manual 4. It should be emphasized that financial statements are the sources of data used in these ratios. As such, students should be alerted to the impact on the data and ratios of generally accepted accounting principles that have already been introduced (e.g., original cost principle, unit of measurement assumption). In other words, the quantitative results of ratio analysis should be interpreted with a basic understanding of the limitations of financial statement data (as discussed in Chapter 2).

ASSIGNMENT OVERVIEW: NO. M3.1. M3.2. M3.3. M3.4. M3.5 M3.6. M3.7. M3.8. E3.9. E3.10. E3.11. E3.12. E3.13. E3.14. E3.15.

L.O. 3 3 4 3, 4 6 6 6 6 2 2 2 2 3 3 4

LEVEL AND TIME Easy, 5-7 min. Easy, 5-7 min. Med., 5-8 min. Med., 5-8 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Easy, 3-5 min. Med., 5-8 min. Med., 7-10 min. Med., 7-10 min. Med., 7-10 min. Easy, 3-5 min.

OTHER COMMENTS Quick in-class exercise to reinforce DuPont model. See M3.1. Students must calculate the average stockholders’ equity before ROE. Give students hint: “Divide sales by turnover for average total assets.” Straightforward working capital and current ratio exercise. See M. 3.5. Identification of current asset and current liability accounts. See M.3.7. Practical way to introduce the risk / return tradeoff. See E3.8. Emphasizes that ROI should exceed the cost of debt. See E3.11. Good homework assignment for basic spreadsheet skills. Good in-class demonstration of ROI using the DuPont model. See E3.13. Good homework assignment. Explain “net assets” as, NET ASSETS = A - L = SE.

E3.16. E3.17.

3, 4 6

Med., 5-10 min. Med., 7-10 min.

E3.18. P3.19.

6 3, 4, 6

Med., 7-10 min. Easy, 10-12 min.

P3.20. P3.21.

3, 4, 6 6

Med., 15-20 min. Easy, 5-8 min.

P3.22. P3.23.

6 3

Easy, 5-8 min. Med., 8-12 min.

P3.24.

Med.-Hard, 20-30 min.

C3.25.

3, 4, 6, 7

Med.-Hard, 20-40 min.

C3.26.

3, 4, 6, 7

Med.-Hard, 20-40 min.

See E3.15. Good homework assignment. Shows how liquidity measures can be manipulated. Can be used to emphasize the importance of accounting ethics and/or ratio trends. See E3.17. Straight-forward problem using Campbell’s financial statement data. Students respond well if supported with current data from Value Line or Bloomberg’s showing 5-year trends. Straight-forward. Good in-class demonstration problem. Shows that liquidity measures may send conflicting messages, and that cash and net income are not directly related. See P3.21. Good homework assignment. The key to part b is to see that the “investment” amount is reduced. Give this as a hint. Practical way to emphasize the importance of margin and turnover. Spreadsheet skills problem. Parts c-e can be used to generate class discussion, and to point out the importance of qualitative factors. Explain to students that C3.25. is the first of a series of short case assignments that require them to do some basic calculations and a “big picture” analysis of their focus company. Excellent capstone case. Optional continuation provides an opportunity for a good discussion of trend analysis without getting bogged down in computational details.

Instructor’s Manual / Solutions Manual SOLUTIONS: M3.1. The following model can be used to help answer any questions related to ROI: ROI

NET INCOME AVERAGE TOTAL ASSETS =

MARGIN

TURNOVER

NET INCOME SALES

SALES AVERAGE TOTAL ASSETS

$124,800 net income / $960,000 sales = 13% margin $960,000 sales / $640,000 average total assets = 1.5 turnover 13% margin * 1.5 turnover = 19.5% ROI, or $124,800 net income / $640,000 average total assets = 19.5% ROI M3.2. The following model can be used to help answer any questions related to ROI: ROI

NET INCOME AVERAGE TOTAL ASSETS =

MARGIN

TURNOVER

NET INCOME SALES

SALES AVERAGE TOTAL ASSETS

$4,000,000 sales * 9% margin = $360,000 net income $4,000,000 sales / 1.6 turnover = $2,500,000 average total assets 9% margin * 1.6 turnover = 14.4% ROI, or $360,000 net income / $2,500,000 average total assets = 14.4% ROI M3.3. Solution approach: Net assets = Assets – Liabilities = Stockholders’ Equity Thus, “net assets” at the end of the year = ending SE ROE = Net income / Average stockholders' equity Average stockholders’ equity = (beginning SE + ending SE) / 2 Thus, you need to calculate beginning stockholders’ equity in order to be able to determine the average stockholders’ equity. $660,000 ending SE - $162,000 net income + $42,000 dividends = $540,000 beginning SE ($540,000 beginning SE + $660,000 ending SE) / 2 = $600,000 average stockholders’ equity $162,000 net income / $600,000 average stockholders’ equity = 27% ROE

Instructor’s Manual / Solutions Manual

M3.4. The following model can be used to help answer any questions related to ROI: ROI

NET INCOME AVERAGE TOTAL ASSETS =

MARGIN

TURNOVER

NET INCOME SALES

SALES AVERAGE TOTAL ASSETS

$840,000 sales / 1.4 turnover = $600,000 average total assets $840,000 sales * 11% margin = $92,400 net income 11% margin * 1.4 turnover = 15.4% ROI, or $92,400 net income / $600,000 average total assets = 15.4% ROI $92,400 net income / $400,000 average stockholders' equity = 23.1% ROE

M3.5. $169,000 current assets / 2.6 current ratio = $65,000 current liabilities $169,000 current assets - $65,000 current liabilities = $104,000 working capital

M3.6. $56,000 current liabilities * 3.5 current ratio = $196,000 current assets $196,000 current assets - $56,000 current liabilities = $140,00 working capital M3.7. $11,000 cash + $19,000 accounts receivable + $26,000 inventory = $56,000 current assets $24,000 accounts payable + $16,000 other accrued liabilities = $40,000 current liabilities $56,000 current assets - $40,000 current liabilities = $16,000 working capital $56,000 current assets / $40,000 current liabilities = 1.4 current ratio

M3.8. $9,000 cash + $17,000 accounts receivable + $31,000 inventory = $57,000 current assets $16,000 accounts payable + $14,000 short-term debt = $30,000 current liabilities $57,000 current assets - $30,000 current liabilities = $27,000 working capital $57,000 current assets / $30,000 current liabilities = 1.9 current ratio

E3.9. a.

Amount of return ROI = Amount invested

$700 Simone: $5,000 = 14%

$780 Riley: $6,000 = 13%

Simone's investment is preferred because it has the higher ROI. b. Risk is a principal factor to be considered.

Instructor’s Manual / Solutions Manual

E3.10. a. Interest earned on the savings account: $5,000 * 3% * 6/12 = $75.00 b. Interest earned on loan to Victor: ($5,300 amount repaid - $5,000 loan) = $300.00 Rate of return for 6 months is $300 / $5,000 = 6% Rate of return on an annual basis = 6% * 2 = 12% c. The loan to Victor promises a much higher return than the rate earned on the savings account (12% versus 3%), but this may not be enough to compensate your friend for the risks and inconveniences involved with an unsecured personal loan. Query: Does Victor have a good credit history? Will he repay the 5,300 as promised? Will his repayment be on time? Will your friend incur any collection expenses? Is your friend willing to “tie up” his money for six months and lose the convenience of his bank (demand deposit) account?

E3.11. Solution approach: Calculate the amount of return from each alternative, then calculate the ROI of the additional return from the higher-yielding investment relative to the $3,000 that must be invested to get the higher amount of return. ROI * amount invested = amount of return Alternative # 1: 9% * $12,000 = $1,080 return Alternative # 2: 12% * $15,000 = $1,800 return The extra amount of return of $720 on an additional investment of $3,000 is an ROI of 24%. ($720 / $3,000 = 24%). Therefore, you should advise your friend not to pay an interest rate of more than 24% to borrow the additional $3,000 needed for the higher-yielding investment.

Instructor’s Manual / Solutions Manual

E3.12. a. $25,000 * 3% = $750 return b. Return on $30,000 at 6% = $1,800 Cost of $5,000 at 12% = $600 Net return = $1,800 – $600 = $1,200 c. Net return / Investment = ROI $1,200 / $25,000 = 4.8% d. Solution Approach: A “prudent investor” would be wise to take the following factors into consideration before choosing between alternative investment opportunities: 1. How long is the investing horizon of each investment? In this case, both investments were for one year. If this were not the case, the rate of return calculation would have to be "annualized" before a valid comparison could be made between the alternative investments. Rate of Return = Principal x Interest x Time. 2. How flexible is the investment? In this case, the savings account would be more flexible than the certificate of deposit because money can be withdrawn (or deposited) on a day-today basis in a savings account without penalty. 3. What is the relative risk of each investment? In this case, both investments would be considered "risk free" (i.e., certain) because bank savings accounts and certificates of deposit are both backed by the FDIC. If one of the investments were riskier than the other (i.e., an investment in a start-up corporation's common stock), then a prudent investor would demand a higher rate of return on the riskier investment as compensation for the additional risk inherent in the investment. 4. How does each alternative investment fit within the investor's investing objectives? Different people invest for different reasons. A young couple in their 20's or 30's may wish to save for their retirement or for the college education of their children. As such, they would be more inclined to invest in a "growth" portfolio than would be a couple in their 60's or 70's who would be more likely to invest in an "income" oriented portfolio. Subjective factors may also be taken into account, such as level of "social responsibility" taken on by each of the companies whose stock is being considered for investment.

Instructor’s Manual / Solutions Manual

E3.13. The following model can be used to help answer any questions related to ROI: ROI

NET INCOME AVERAGE TOTAL ASSETS =

MARGIN NET INCOME SALES

TURNOVER

SALES AVERAGE TOTAL ASSETS

a. 19.6% ROI = (7% Margin * Turnover) Turnover = (19.6% ROI / 7% Margin) = 2.8 Average total assets = ($980,000 Sales / 2.8 Turnover) = $350,000 b. ROI = ($259,200 Net income / $1,800,000 Average total assets) = 14.4% 0.9 Turnover = (Sales / $1,800,000 Average total assets) Sales = $1,620,000 Margin = ($259,200 Net income / $1,620,000 Sales) = 16% ROI = (16% Margin * 0.9 Turnover) = 14.4% c. 12.6% ROI = (Margin * 1.4 Turnover) Margin = 9% 9% Margin = ($45,360 Net income / Sales) Sales = $504,000 1.4 Turnover = ($504,000 Sales / Average total assets) Average total assets = $360,000

E3.14. a. Margin = ($54,000 Net income / $1,200,000 Sales) = 4.5% Turnover = ($1,200,000 Sales / $750,000 Average total assets) = 1.6 ROI = (4.5% Margin * 1.6 Turnover) = 7.2% b.

Margin * Turnover = ROI ($132,000 Net income / $2,200,000 Sales) * Turnover = 9.6% ROI (6% Margin * Turnover) = 9.6% ROI Turnover = 1.6 1.6 Turnover = ($2,200,000 Sales / Average total assets) Average total assets = $1,375,000

Instructor’s Manual / Solutions Manual E3.14. (continued) c. (Net Income / $1,500,000 Average total assets) = 12% ROI Net Income = $180,000 0.8 Turnover = (Sales / $1,500,000 Average total assets) Sales = $1,200,000 Margin = ($180,000 Net income / $1,200,000 Sales) Margin = 15% 12% ROI = (Margin * 0.8 Turnover) Margin = 15%

E3.15. Remember that "net assets" is the same as "stockholders' equity". Beginning net assets... ........... ........... ........... ........... ........... Add: Net income ........ ........... ........... ........... ........... ........... Less: Dividends.......... ........... ........... ........... ........... ........... Ending net assets ........ ........... ........... ........... ........... ...........

$492,600 70,200 (15,400) $547,400

ROE = Net income / Average stockholders' equity = $70,200 / (($492,600 + $547,400) / 2) = 13.5%

E3.16. a. 12.6% ROI / 2.8 Turnover = 4.5% margin Sales $120,000,000 * 4.5% margin = $5,400,000 net income b. $5,400,000 Net income / $25,000,000 Average stockholders' equity = 21.6%

E3.17. a. Current assets .......... ........... ........... ........... Current liabilities .... ........... ........... ........... Working capital....... ........... ........... ........... Current ratio ........... ...........………. ..........

Do Not Prepay Accounts Payable $300,000 (200,000) $100,000 1.5

Prepay Accounts Payable $225,000 (125,000) $100,000 1.8

Payment of the accounts payable does not affect working capital, but does improve the current ratio. Is this balance sheet "window dressing" worth the opportunity cost of not being able to invest the cash? Remember, once the payment is made, the cash is in someone else’s hands.

Instructor’s Manual / Solutions Manual

E3.17. (continued) b. Current assets ........... ........... ........... ........... Current liabilities ..... ........... ........... ........... Working capital........ ........... ........... ........... Current ratio . ........... ........... ...........………

Without Loan $300,000 (200,000) $100,000 1.5

With Loan $350,000 (250,000) $100,000 1.4

If the loan is taken after the end of the fiscal year, the current ratio on the year-end balance sheet will be higher than if the loan is taken before the end of the year. Working capital is not affected. Thus, it makes sense to wait until after the end of the year to borrow on a short-term basis, unless cash is needed immediately.

E3.18. a. 2.1 Current ratio = (Current assets / $275,000 Current liabilities) Current assets = $577,500 Working capital = $577,500 Current assets - $275,000 Current liabilities = $302,500 b. Both current assets and current liabilities would be $27,500 greater at April 30, if the payment on April 29 had not been made. Working capital = ($577,500 + $27,500) - ($275,000 + $27,500) = $605,000 - $302,500 = $302,500 Current ratio = $605,000 / $302,500 = 2.00 c. Working capital at April 30 is not affected because both current assets and current liabilities decreased by the same amount when the $27,500 payment was made on April 29. However, the current ratio was increased (from 2.0 to 2.1) as a result of the payment because the proportion of current assets to current liabilities changed. When the current ratio is greater than 1.0, any payments of accounts payable will increase the ratio because the denominator is decreased proportionately more than the numerator is decreased.

Instructor’s Manual / Solutions Manual

P3.19. a. ROI = Margin * Turnover = (Net earnings attributable to Campbell Soup Company / Net sales) * (Net sales / Average total assets) = ($1,628 / $8,691) * ($8,691 / (($13,148 + $12,372) / 2)) = (18.7% Margin * 0.68 turnover) = 12.7% Note that a rounding error is introduced in by solving for ROI indirectly (Margin * Turnover) rather than directly: ROI = (Net earnings attributable to Campbell Soup Company / Average total assets) = $1,628 / (($13,148 + $12,372) / 2) = 12.8% For purposes of this problem, either answer is acceptable. b. ROE = Net earnings attributable to Campbell Soup Company / Average Campbell Soup Company shareholders' equity = $1,628 / (($1,103 + $2,563) / 2) = 88.8% Note: In the text, ROE in 2020 for Campbell’s is shown as 88.5% (see Table 3.1). The difference in results of 0.3% (88.8% - 88.5%) is attributable to the definition used for the denominator in P3.19. (average Campbell Soup Company shareholders’ equity) versus that used in Table 3.1 (average total equity). c. Working capital = Current assets - Current liabilities Current assets ......... ........... ........... ........... ........... ........... - Current liabilities .... ........... ........... ........... ........... ........... = Working capital ...... ........... ........... ........... ........... ...........

8/2/20 $2,385 3,075 $ (690)

7/28/19 $1,967 3,385 $(1,418)

7/30/17 $2,385 3,075 0.78

7/31/16 $1,967 3,385 0.58

d. Current ratio = Current assets / Current liabilities Current assets ......... ........... ........... ........... ........... ……… / Current liabilities .... ........... ........... ........... ........... ……… = Current ratio ........... ........... ........... ........... ........... ………

Instructor’s Manual / Solutions Manual

e. Acid-test ratio = (Cash + Short-term securities + Accounts and Notes receivable) Current liabilities 8/2/20 7/28/19 Cash and cash equivalents ..... ........... ........... ........... ……… $ 859 $ 31 Accounts receivable, net ....... ........... ........... ........... ........... 575 574 Total (quick assets) .... ........... ........... ........... ........... ……… $1,434 $ 605 Total (quick assets) . ........... ........... ........... ........... ……… / Current liabilities .... ........... ........... ........... ........... ........... = Acid-test ratio ......... ........... ........... ........... ........... ...........

$1,434 3,075 0.47

$ 605 3,385 0.18

P3.20. a. ROI = Margin * Turnover = (Net income / Sales) * (Sales / Average total assets) = ($102,000 / $1,700,000) * ($1,700,000 / (($802,000 + $898,000) / 2)) = (6% Margin * 2.0 Turnover) = 12% b. ROE = Net income / Average stockholders' equity = $102,000 / (($448,000 + $552,000) / 2) = 20.4% c. Working capital = $609,000 Current assets - $290,000 Current liabilities = $319,000 d. Current ratio = ($609,000 Current assets / $290,000 Current liabilities) = 2.10 e. Acid test ratio = (Cash + Accounts receivable) / Current liabilities = ($63,000 + $285,000) / $290,000 = 1.20 f. Solution approach: Think about the effects of this entry on the balance sheet, then indicate the impact of these effects on the respective ratios as either increase, decrease, or no effect. Finally, explain why each ratio is affected in the way that it is by reference to the impact on the numerator and denominator of each ratio. •

ROI for the year ended December 31, 2023: Increase. The payment of an account payable decreases current liabilities and also decreases current assets. This entry has no impact on the income statement, so the numerator of the ROI calculation (net income) is unaffected. However, now having less cash, Hames would also have a lower average total assets in the denominator of the ROI calculation. (Average total assets decrease from $850,000 to $800,000, thus causing the ratio to increase from 12% to 12.75%.

Instructor’s Manual / Solutions Manual •

ROE for the year ended December 31, 2023: No effect. In this case, both the numerator and the denominator are unaffected by the entry. Average stockholders’ equity does not change when an account payable is paid off — only current assets and current liabilities are affected.

•

Working capital as at December 31, 2023: No effect. Since working capital is the difference between current assets and current liabilities, a decrease of $50,000 to each category has no effect on the net amount.

•

Current ratio as at December 31, 2023: Increase. If the current ratio is greater than 1.0 to begin with, then the proportionate amount of current assets relative to current liabilities will increase as each category decreases by an equal dollar amount. In this case, the current ratio would increase from 2.10 to 2.33 ($559,000 current assets / $240,000 current liabilities).

P3.20.

(continued)

g. Solution approach: Same as part f above: •

ROI for the year ended December 31, 2023: No effect. The collection of an account receivable increases one current asset and decreases another current asset. This entry has no effect on either net income or average total assets.

•

ROE for the year ended December 31, 2023: No effect. This entry has no effect on either net income or average stockholders’ equity.

•

Working capital as at December 31, 2023: No effect. Although the composition of current assets changed (i.e., more cash and less accounts receivable), total current assets remained the same, and current liabilities are unaffected by the collection of accounts receivable.

•

Current ratio as at December 31, 2023: No effect. No change in total current assets or total current liabilities.

Instructor’s Manual / Solutions Manual P3.21. a. Working capital = Current assets - Current liabilities Current assets ......... ........... ........... ........... ........... ........... ........... - Current liabilities .... ........... ........... ........... ........... ........... ........... = Working capital ...... ........... ........... ........... ........... ........... ........... Current ratio = Current assets / Current liabilities Current assets ......... ........... ........... ........... ........... ........... ........... / Current liabilities .... ........... ........... ........... ........... ........... ........... = Current ratio ........... ........... ........... ........... ........... ........... ………

1/31/23 1/31/22 $ 90 $ 80 (60) (40) $ 30 $ 40 1/31/23 $ 90 60 1.5

1/31/22 $ 80 40 2.0

b. Even though the firm has more cash at January 31, 2023, it is less liquid based on the working capital and current ratio measures. The firm owes more on accounts payable, has less inventory to sell, and has fewer accounts receivable to collect, as compared to January 31, 2022. c. Accounts receivable were collected, inventories were reduced, and current liabilities increased. These changes all have a positive impact on cash, which are not reflected in a net loss because changes in a firm's cash position and its profitability are not directly related under accrual accounting.

P3.22. a. Working capital = Current assets - Current liabilities Current assets ......... ........... ........... ........... ........... ........... ........... - Current liabilities .... ........... ........... ........... ........... ........... ........... = Working capital ...... ........... ........... ........... ........... ........... ...........

8/31/23 $252 (180) $ 72

8/31/22 $273 (130) $143

8/31/23 $252 180 1.4

8/31/22 $273 130 2.1

Current ratio = Current assets / Current liabilities Current assets ......... ........... ........... ........... ........... ........... ........... / Current liabilities .... ........... ........... ........... ........... ........... ........... = Current ratio ........... ........... ........... ........... ........... ........... ………

Instructor’s Manual / Solutions Manual b. Although both working capital and the current ratio at August 31, 2023 are substantially lower than at August 31, 2022, the combined total of cash and marketable securities increased substantially (from $46 to $123). On the other hand, the combined total of accounts receivable and inventories decreased substantially (from $227 to $129) during the year ended August 31, 2023. Thus, in some ways, the firm is actually more liquid at August 31, 2023 than it was at August 31, 2022 due to these favorable shifts in the composition of current assets. The above observations can be seen by calculating the acid-test ratios for each year: Acid-test ratio = (Cash + Marketable securities + Accounts receivable) / Current liabilities Cash ........... ........... ........... ........... ........... ........... ........... ........... Marketable securities ......... ........... ........... ........... ........... ........... Accounts receivable ........... ........... ........... ........... ........... ........... Total quick assets ... ........... ........... ........... ........... ........... ........... / Current liabilities .... ........... ........... ........... ........... ........... ........... = Acid-test ratio ......... ........... ........... ........... ........... ........... ………

8/31/23 $ 51 72 75 $198 180 1.1

8/31/22 $ 12 34 58 $104 130 0.8

Note that the acid-test ratios calculated above were provided for illustration purposes only. P.3.22 does not require the calculation of acid-test ratios. However, it is certainly appropriate to observe the changes in the components of current assets when attempting to make an overall assessment of the change in a company’s liquidity from year to year. Note also that the dollar amounts used in P.3.22 were intentionally skewed to demonstrate how a dramatic shift in the composition of current assets may have the opposite impact on a company’s acid-test ratio than it has on the company’s working capital and current ratio. Aroundsquare, Inc. clearly has less overall liquidity on August 31, 2023 than it had on August 31, 2022. However, the bulk of the company’s current assets on August 31, 2022 were represented by inventory, which is the least liquid current asset. Thus, while working capital and the current ratio were considerably higher in 2022 than in 2023, the acid-test ratio was actually lower in 2022 due to the cash outflows required to build up the company’s inventory; as these inventory levels were lowered during 2023, cash, marketable securities, and accounts receivables increased accordingly.

P3.23. a. 15% ROI = (Margin * 2.0 Turnover) Margin required as a manufacturer = 7.5% 2.0 Turnover = (Sales / $12,000,000 Average total assets) Sales required as a manufacturer = $24,000,000 7.5% Margin = (Net Income / $24,000,000 Sales) Net Income required as a manufacturer = $1,800,000

Instructor’s Manual / Solutions Manual b. 15% ROI = (Net Income / $5,000,000 Average total assets) Net Income required as a service firm = $750,000 15% ROI = (3% Margin * Turnover) Turnover required as a service firm = 5.0 5.0 Turnover = (Sales / $5,000,000 Average total assets) Sales required as a service firm = $25,000,000

P3.24. a. ROI = (40% Margin * 0.6 Turnover) = 24% 0.6 Turnover = (Sales / $3,000,000 Average total assets) Sales = $1,800,000 b. 24% ROI = (30% Margin * Turnover) Turnover = 0.8 0.8 Turnover = (Sales / $3,000,000 Average total assets) Sales = $2,400,000 c. If margin were reduced from 40% to 30% via the price lowering strategy, sales would have to increase by $600,000 (from $1,800,000 to $2,400,000) for Charlie to earn the same 24% ROI. This represents a 33.3% increase over the original sales volume, which is not quite as severe as Charlie makes it sound with his 50% estimate, but his point is certainly well taken. d. By increasing marketing efforts (i.e., kicking off a new advertising campaign, or conducting more extensive market research), Charlie would also be increasing the operating expenses of his business, which would reduce margin. However, successful marketing efforts are likely to increase sales volume enough to cause the resulting increase in turnover to more than offset the decrease in margin. As a result, ROI would be likely to increase.

Instructor’s Manual / Solutions Manual P3.24.

(continued) e. Solution approach: The following strategies may be worth considering for a "high-price, high-service" retail furniture store when faced with new competition: •

Reduction in inventory carrying costs via careful screening of existing inventory. For a furniture store, the inventory available for sale and the building the store is located in are normally the largest assets on the balance sheet. In the short-term, there is probably not much that Charlie can do to control building occupancy costs. However, if Charlie were to limit his inventory to those product lines that generate the highest margins and/or highest turnover, this may allow him to substantially reduce average total assets. By reducing average assets, turnover increases, thereby increasing ROI. An important point to remember when considering the DuPont model of ROI analysis is that asset utilization (i.e., turnover) is just as important as generating high profit margins.

•

Labor saving strategies might also be worth considering. Although the problem does not give much information to work from, one might infer that a "high service" furniture store would be likely to have a large sales force relative to its total floor space. If this were the case, then Charlie might benefit by restructuring his sales force (i.e., pay based on commissions only, and/or reducing staff numbers during non-peak hours). If this could be done without compromising Charlie's "high service" competitive advantage (i.e., no sales lost due to "lower service"), then the labor cost savings would increase the company's margin, and thereby increase ROI.

C3.25. a. It should be possible for most students to find the 5-year trend data for ROE within the “Selected Financial Data” section of the annual report. Net income, net sales, and total assets will ordinarily be presented within the 5-year summary as well, thus making it possible to quickly calculate margin, turnover, and ROI. Total current assets or total current liabilities may or may not be disclosed within the trend data, but these numbers can be found easily enough by looking at prior year balance sheets. Encourage students to download the Adobe Acrobat annual report files for each of the past 3 years for their focus companies; they will need to make reference to some prior year data in subsequent-chapter focus company case assignments. b. The answers will obviously vary depending on the focus company selected by each student. The idea of this particular case isn’t to have students do in-depth analysis, but to demonstrate to them that it’s easy to see the “big picture” of a company’s recent profitability and liquidity trends by quickly evaluating these key measures.

Instructor’s Manual / Solutions Manual

C3.26. 2020 a. Cash and cash equivalents ..... ........... ........... ........... ........... ........... $ 38,016 Short-term marketable securities ....... ........... ........... ........... ........... 52,927 Accounts receivable, net ....... ........... ........... ........... ........... ........... 16,120 Total quick assets for acid-test ratio (A) ....... ........... ........... ........... $107,063 Inventories ..... ........... ........... ........... ........... ........... ........... ........... 4,061 Vendor non-trade receivables ........... ........... ........... ........... ........... 21,325 Other current assets ... ........... ........... ........... ........... ........... ........... 11,264 Total current assets (B) ......... ........... ........... ........... ........... ........... $143,713

2019 $ 48,844 51,713 22,926 $123,483 4,106 22,878 12,352 $162,819

Accounts payable ...... ........... ........... ........... ........... ........... ........... $ 42,296 Other current liabilities.......... ........... ........... ........... ........... ........... 42,684 Deferred revenue ....... ........... ........... ........... ........... ........... ........... 6,643 Commercial paper ..... ........... ........... ........... ........... ........... ........... 4,996 Current portion of term debt.. ........... ........... ........... ........... ........... 8,773 Total current liabilities (C) .... ........... ........... ........... ........... ........... $105,392

$ 46,236 37,720 5,522 5,980 10,260 $105,718

Working capital (B - C) ......... ........... ........... ........... ........... ........... $ 38,321 Current ratio (B / C) .. ........... ........... ........... ........... ........... ……… 1.36 Acid-test ratio (A / C) ........... ........... ........... ........... ........... ……… 1.02

$ 57,101 1.54 1.17

b. Common stock and additional paid-in capital, $0.00001 par value .. $ 50,799 $ 45,174 Retained earnings ...... ........... ........... ........... ........... ........... ........... 14,966 45,898 Accumulated other comprehensive income/(loss)…………………. (406) (584) Total shareholders’ equity ..... ........... ........... ........... ........... ........... $ 65,339 $ 90,488 ROE = Net income / Average shareholders’ equity 2020 = $57,411 / (($90,488 + $65,339) / 2) = 73.7% 2019 = $55,256 / (($107,147 + $90,488) / 2) = 55.9%

Instructor’s Manual / Solutions Manual C3.26. (continued) c. ROI = Margin * Turnover = (Net income / Net sales) * (Net sales / Average total assets) 2020 = ($57,411 / $274,515) * ($274,515 / (($338,516 + $323,888) / 2)) = (20.9% Margin * 0.83 Turnover) = 17.3% ROI In 2020, no rounding error results: ROI = Net income / Average total assets = $57,411 / ($338,516 + $323,888) / 2)) = 17.3% 2019 = ($55,256 / $260,174) * ($260,174 / (($365,725 + $338,516) / 2)) = (21.2% Margin * 0.74 Turnover) = 15.7% ROI Likewise in 2020, no rounding error results: ROI = Net income / Average total assets = $55,256 / ($365,725 + $338,516) / 2)) = 15.7%

Instructor’s Manual / Solutions Manual C3.26. (continued) d. Apple’s liquidity position decreased noticeably but not dramatically in fiscal 2020, with working capital decreasing by $19 billion. This was due almost entirely to a net decrease in current assets with total current liabilities remaining virtually unchanged. The current ratio and acid-test ratio results declined in 2020 (falling from 1.54 to 1.36 and from 1.17 to 1.02, respectively). Highlights of these changes include a significant reduction in cash (from $49 billion to $38 billion), accompanied with reduction in accounts receivable (from $23 billion to $16 billion). The changes in current liability balances from the 2019 balance sheet to the 2020 balance sheet were slight and largely offsetting (i.e., accounts payable decreased by $4 billion while other accrued liabilities increased by $5 billion). Notice that Apple also invested $101 billion in long-term marketable securities in 2020 (and $105 billion in 2019). These investments, although not technically current assets in the sense that they are not expected to be converted back to cash within one year, are likely to be readily available sources of cash should the company need to obtain funds in the intermediate term (2 to 4 years). The only reason that such investments are listed as long-term assets rather than current assets is that management intends to hold them for more than one year after the balance sheet date. Essentially, Apple generates more cash from operations than the company can possibly redeploy in its core businesses and product markets. Thus, nearly one-third of the company’s total assets (in both years) are invested in long-term marketable securities (i.e., stock market investments in other non-related companies). This is an extremely unusual situation to observe on any corporate balance sheet, and is the result of Apple’s enormous, ongoing record of business success. Apple’s profitability trends have been extremely strong as well. An ROI of 17.3% (for 2020) is certainly above average for a major corporation, and the 2019 result of 15.7% was quite respectable as well, especially when considering that Apple has been maintaining high levels of ROI for many consecutive years. ROE was dramatically higher than ROI in both 2020 (73.7%) and 2019 (also 55.9%), indicating that the company is making highly effective use of borrowed funds—that is, the company is using borrowed funds to increase the return to its owners/shareholders. (The idea of financial leverage will be introduced in Chapter 7 and expanded upon in Chapter 11.) It should be noted, however, that in Apple’s case, the company does not have a long history of “borrowing” money in the traditional sense. Until 2013, Apple had no long-term debt whatsoever, and most of its liabilities were current liabilities such as accounts payable and accrued expenses (reported as “other current liabilities”) that would then be settled with current assets in the normal course of business. Even in 2020 and 2019 relative to most major companies, Apple’s total non-current liabilities were at modest to average levels in proportion to the company’s total assets. Thus, in Apple’s case, the magnification of ROE (73.7%) relative to ROI (17.3%) in 2020 is likely to be more of an artifact of the calculation process than a true effort on the company’s part to strategically utilize financial leverage to enhance shareholder value. To make a more complete assessment, it would be appropriate to look at the trends of ROI and ROE for Apple, Inc. as compared to the computer industry trends of these measures for at least 5 years.

Instructor’s Manual / Solutions Manual C3.26.

(continued)

2020 2019 Total assets………………….. $323,888 $338,516 Shareholders’ equity..……….. 65,339 90,488 Total liabilities………………. $258,549 248,028

2018 $365,725 107,147 $258,578

2017 2016 $375,319 $321,686 134,047 128,249 $241,272 $193,437

f. Yes, the balance sheet trends in particular show great consistency from 2016 through 2020. Note that 1) total assets, 2) total shareholder’s equity, and 3) cash, cash equivalents, and marketable securities each trended upward from 2016 to 2017 and then downward for each subsequent year presented. This is true not only in absolute dollar terms but also relative proportions; each of these trends is portraying a very similar pattern. In a similar way, 1) net sales, 2) net income, 3) noncurrent portion of term debt, and 4) other non-current liabilities each exhibited consistent and steady growth patterns for all five years presented. However, there was a slight peak in sales and net income in 2018. The “big picture” is that the company has shown steady and consistent sales growth during this period (as well as prior periods, as Apple is well known for). The company’s growth in sales is generally reflected in earnings (net income) as sales levels continue to reach new heights. At the same time, Apple appears to be strategically reducing its investment in total assets and particularly in highly liquid assets (cash, cash equivalents, and marketable securities) while also demonstrating a stronger appetite for long-term debt to allow shareholders to benefit from their effective use of financial leverage. g. The net sales, net income, and total assets trends would each be meaningful to investors, in that they express important growth patterns. Most investors tend to focus on sales growth or earnings growth as opposed to asset growth because asset growth is sometimes financed by debt, as was clearly the case with Apple (the combined total of the non-current portion of term debt and other non-current liabilities trend saw consistent upward movements from $115 billion in 2016 to $153 billion in 2020). Thus, income statement measures tend to be better predictors of the future. Since sales growth patterns are likely to be more stable than earnings growth patterns (i.e., less likely to exhibit wild swings from year to year), the trend in net sales is arguably the most appropriate one for investors to focus on. The trend in shareholders’ equity is meaningful for Apple during the 2016-2020 period, and highly consistent with trend in total assets shown by the data. Yet, shareholders’ equity trends are often quite difficult to interpret for large, highly profitable companies, especially those that do not follow consistent dividend and stock repurchase patterns from year to year. Likewise, Apple’s trends in highly liquid current assets and non-current marketable securities are consistent with the other trends shown by the data, but these trends are not typically very useful as measures to facilitate the interpretation of operating results for most companies. The non-current portion of term debt and other non-current liabilities trends are also worth noting, although they are perhaps the least relevant trends in this case because Apple clearly has the ability to pay down on these debts at any time of their choosing.

Instructor’s Manual / Solutions Manual C3.26.

(continued)

h. Solution Approach: A “prudent investor” would be wise to take the following factors into consideration before choosing between alternative investment opportunities: 1. What is the relative risk of the investment? In this case, although Apple’s common stock may be considered an excellent investment, an investor would be interested in knowing how investment analysts regard the potential risks/rewards of ownership. 2. How does an investment in Apple’s common stock "fit" within the investor's overall portfolio? The text does not cover Modern Portfolio Theory or similar "Finance" topics, but it is worth noting that individual investments must be considered within the context of the investor's overall portfolio. An investment in Apple may appear to be "too risky" when analyzed in isolation, but it may in fact be risk-reducing and return-enhancing when viewed as "part of" an investor's overall portfolio. 3. How does an investment in Apple’s common stock fit within the investor's investing objectives? Different people invest for different reasons. A young couple in their 20's or 30's may wish to save for their retirement or for the college education of their children. As such, they would be more inclined to invest in a "growth" portfolio than would be a couple in their 60's or 70's who would be more likely to invest in an "income" oriented portfolio. 4. Additional historical data concerning Apple and its industry would be helpful in making a more complete trend analysis. These data might include line-item details from Apple’s past income statements, as well as trends in cash flows data, dividends data, stock price data, and price/earnings ratios. 5. It would be helpful to have an understanding of current events surrounding the company and its industry, as well as an understanding of general economic conditions at the time of the investment. This is particularly important for a company such as Apple, because of potential innovations and rapid change within the technology industry.

Instructor’s Manual / Solutions Manual TAKE-HOME QUIZ —CHAPTER 3

NAME______________________

Attached are the financial statements and the ____-year summary from the 20__ Annual Report of ______________________________. REQUIRED: 1. Calculate ROI, showing margin and turnover, for 20__, 20__, and 20__. 2. Calculate the company's working capital, current ratio, and acid-test ratio at [balance sheet dates]. 3. Calculate ROE for as many of the past three years as you can. 4. Assume that you have $5,000 that you would like to invest in the common stock of a company. Evaluate the common stock of ______________________________ as a potential investment. From the data available on the attached financial statements, identify the five most important criteria that you would use to make your investment decision, and explain why each is important. Instructor’s Note: Use or adapt these questions for an annual report (or set of financial statements) that you provide to the students.

Instructor’s Manual / Solutions Manual

CHAPTER

The Bookkeeping Process and Transaction Analysis

CHAPTER OUTLINE: I. The Bookkeeping/Accounting Process II. The Balance Sheet Equation: A = L + SE A. Stockholders' Equity expanded: 1. SE = Paid-in Capital + Retained Earnings 2. Net income causes retained earnings to increase 3. Net income = Revenues - Expenses 4. SE = Paid-in Capital + Retained Earnings (beginning) + Revenues - Expenses B. The Balance Sheet Equation expanded: A = L + PIC + Retained Earnings (beginning) + Revenues - Expenses C. Equation stays in balance after every transaction D. Illustration of the effect of transactions on the equation III. Bookkeeping Jargon and Procedures A. Transactions recorded in a journal, then posted to an account in the ledger. B. Accounts use a "T" format 1. Left side of "T" is debit 2. Right side of "T" is credit C. Normal balances 1. Debit: Assets and expenses 2. Credit: Liabilities, stockholders' equity, and revenues D. Journal entries IV. Effect of Transactions on the Financial Statements (Horizontal Model) V. Adjustments A. Accruals B. Reclassifications C. Understanding cash leads and cash lags

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Instructor’s Manual / Solutions Manual

VI. Transaction Analysis Methodology A. Five questions: 1. What's going on? 2. What accounts are affected? 3. How are they affected? 4. Does the balance sheet balance? (Do the debits equal the credits?) 5. Does my analysis make sense? B. Illustration of applying the five questions C. Understanding the reasons for changes in account balances

TEACHING/LEARNING OBJECTIVES: Principal: 1. To have the student understand how transactions affect the financial statements. a. To accomplish this objective, a horizontal model of the effect of the bookkeeping process on the balance sheet and income statement is developed and presented. b. To understand and use the model, some bookkeeping jargon must be understood. 2. To have the student learn a five-question approach to transaction analysis. 3. To have the student learn to use the financial statement horizontal model to reason through the impact of transactions on the financial statements. Supporting: 4. To have the student learn to use the T-account model and understand the effect of a journal entry. 5. To have the student understand why adjusting entries are necessary, and to see that they result in more meaningful financial statements.

TEACHING OBSERVATIONS: 1. Develop the expanded balance sheet equation by relating net income to stockholders' equity (retained earnings) and explaining that income statement preparation is made easier if revenues and expenses are accumulated separately, rather than within stockholders' equity (retained earnings).

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