Chap 003

AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise and problem in Intermediate Accounting, 5e with the following AACSB learning skills:

Questions AACSB Tags Exercises (cont.)

AACSB Tags

3-1 Reflective thinking 3-4 Analytic3-2 Reflective thinking 3-5 Analytic3-3 Reflective thinking 3-6 Analytic3-4 Reflective thinking 3-7 Analytic3-5 Reflective thinking 3-8 Analytic3-6 Reflective thinking 3-9 Analytic3-7 Reflective thinking 3-10 Reflective thinking3-8 Reflective thinking 3-11 Reflective thinking3-9 Reflective thinking 3-12 Reflective thinking

3-10 Reflective thinking 3-13 Analytic3-11 Reflective thinking 3-14 Analytic3-12 Reflective thinking 3-15 Analytic3-13 Reflective thinking 3-16 Analytic3-14 Reflective thinking 3-17 Analytic3-15 Reflective thinking 3-18 Reflective thinking,

Diversity3-16 Reflective thinking CPA/CMA3-17 Reflective thinking 3-1 Analytic3-18 Reflective thinking 3-2 Analytic3-19 Reflective thinking 3-3 Reflective thinking3-20 Reflective thinking 3-4 Analytic

Brief Exercises

3-5 Reflective thinking

3-1 Reflective thinking 3-6 Analytic3-2 Analytic 3-1 Reflective thinking3-3 Analytic 3-2 Analytic3-4 Analytic 3-3 Reflective thinking3-5 Analytic Problems3-6 Analytic 3-1 Analytic3-7 Analytic 3-2 Analytic3-8 Reflective thinking 3-3 Analytic3-9 Analytic 3-4 Analytic

3-10 Analytic 3-5 Analytic3-11 Analytic 3-6 Analytic, Reflective thinking

Exercises 3-7 Analytic

3-1 Analytic 3-8 Analytic3-2 Reflective thinking 3-9 Analytic

© The McGraw-Hill Companies, Inc., 2009Solutions Manual, Vol.1, Chapter 3 3-1

Chapter 3 The Balance Sheet and Financial Disclosures

3-3 Reflective thinking 3-10 Analytic

© The McGraw-Hill Companies, Inc., 20093-2 Intermediate Accounting, 5/e

Question 3-1The purpose of the balance sheet, also known as the statement of financial position, is to

present the financial position of the company on a particular date. Unlike the income statement, which is a change statement that reports events occurring during a period of time, the balance sheet is a statement that presents an organized array of assets, liabilities, and shareholders’ equity at a point in time. It is a freeze frame or snapshot picture of financial position at the end of a particular day marking the end of an accounting period.

Question 3-2 The balance sheet does not portray the market value of the entity (number of common stock

shares outstanding multiplied by price per share) for a number of reasons. Most assets are not reported at fair value, but instead are measured according to historical cost. Also, there are certain resources, such as trained employees, an experienced management team, and a good reputation, that are not recorded as assets at all. Therefore, the assets of a company minus its liabilities, as shown in the balance sheet, will not be representative of the company’s market value.

Question 3-3 Current assets include cash and other assets that are reasonably expected to be converted to

cash or consumed during one year, or within the normal operating cycle of the business if the operating cycle is longer than one year. The typical asset categories classified as current assets include:

— Cash and cash equivalents— Short-term investments— Accounts receivable— Inventories— Prepaid expenses

Question 3-4Current liabilities are those obligations that are expected to be satisfied through the use of

current assets or the creation of other current liabilities. So, this classification will include all liabilities that are scheduled to be liquidated within one year or the operating cycle, whichever is longer, except those that management intends to refinance on a long-term basis. The typical liability categories classified as current liabilities include:

— Accounts payable— Short-term notes payable— Accrued liabilities— Current maturities of long-term debt


QUESTIONS FOR REVIEW OF KEY TOPICS

Answers to Questions (continued)

Question 3-5 The operating cycle for a typical manufacturing company refers to the period of time required

to convert cash to raw materials, raw materials to a finished product, finished product to receivables, and then finally receivables back to cash.

Question 3-6 Investments in equity securities are classified as current if the company’s management (1)

intends to liquidate the investment in the next year or operating cycle, whichever is longer, and (2) has the ability to do so, i.e., the investment is marketable. If either of these criteria does not hold, the investment is classified as noncurrent.

Question 3-7 The common characteristics that these assets have in common are that they are tangible, long-

lived assets used in the operations of the business. They usually are the primary revenue-generating assets of the business. These assets include land, buildings, equipment, machinery, furniture and other assets used in the operations of the business, as well as natural resources, such as mineral mines, timber tracts and oil wells.

Question 3-8 Property, plant, and equipment and intangible assets each represent assets that are long-lived

and are used in the operations of the business. The difference is that property, plant, and equipment represent physical assets, while intangibles lack physical substance. Generally, intangibles represent the ownership of an exclusive right, such as a patent, copyright or franchise.

Question 3-9 A note payable of $100,000 due in five years would be classified as a long-term liability. A

$100,000 note due in five annual installments of $20,000 each would be classified as a $20,000 current liability — current maturities of long-term debt — and an $80,000 long-term liability.

Question 3-10 Paid-in-capital consists of amounts invested by shareholders in the corporation. Retained

earnings equals net income less dividends paid to shareholders from the inception of the corporation.



Question 3-11Disclosure notes provide additional detail concerning specific financial statement items.

Included are such data as the fair values of financial instruments and off-balance-sheet risk associated with financial instruments and details of pension plans, leases, debt, and assets. Common to all companies’ disclosures are certain specific notes such as a summary of significant accounting policies, descriptions of subsequent events, and related third-party transactions. However, many notes are designed to fit the disclosure needs of the particular reporting company. In fact, any explanation that helps investors and creditors make decisions should be included.

Question 3-12 The disclosure of the company’s significant accounting policies is extremely important to

external users in terms of their ability to compare financial information across companies. It is critical to a financial analyst involved in assessing future cash flows of two construction companies to know that one company uses the percentage-of-completion method in recognizing gross profit, while the other company uses the completed contract method.

Question 3-13 A subsequent event is an event that occurs after the date of the financial statements but prior to

the date on which the statements are actually issued. It may help to clarify a previously existing situation or it may represent a new event not directly affecting financial position at the end of the reporting period.

Question 3-14The discussion provides management’s views on significant events, trends and uncertainties

pertaining to the company’s (a) operations, (b) liquidity, and (c) capital resources. Certainly the Management Discussion and Analysis section may be slanted to management’s biased perspective and therefore can lack objectivity. However, management can offer an informed insight that might not be available elsewhere, so if the reader maintains awareness of the information’s source, it can offer a unique view of the situation.



Question 3-15Depending on the circumstances, the auditor will issue a (an):

1. Unqualified opinion – The auditors are satisfied that the financial statements “present fairly” the financial position, results of operations, and cash flows and are “prepared in accordance with generally accepted accounting principles.”

2. Qualified opinion – This contains an exception to the standard unqualified opinion, but not of sufficient seriousness to invalidate the financial statements as a whole. Examples of exceptions are (a) unconformity with generally accepted accounting principles, (b) inadequate disclosures, and (c) a limitation or restriction of the scope of the examination.

3. Adverse opinion – This is necessary when the exceptions (a) and (b) above are so serious that a qualified opinion is not justified. Adverse opinions are rare because auditors usually are able to persuade management to rectify problems to avoid this undesirable report.

4. Disclaimer – An auditor will disclaim an opinion if item (c) above applies and therefore insufficient information has been gathered to express an opinion.

Question 3-16A proxy statement must be sent each year to all shareholders. It usually is in the same mailing

with the annual report. The statement invites shareholders to the shareholders’ meeting to elect board members and to vote on issues before the shareholders. It also permits shareholders to vote using an enclosed proxy card. The proxy statement also provides for more disclosures on compensation to directors and executives, and in particular, stock options granted to executives.

Question 3-17 Working capital is the difference between current assets and current liabilities. The current

ratio is computed by dividing current assets by current liabilities. The acid-test ratio (or quick ratio) is computed by dividing quick assets (cash and cash equivalents, marketable securities, and accounts receivable) by current liabilities.

Question 3-18

Debt to equity ratio = Total liabilities Shareholders' equity

Times interest earned ratio = Net income + interest + taxes Interest


Answers to Questions (concluded)

Question 3-19An operating segment is a component of an enterprise:

1. That engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same enterprise).

2. Whose operating results are regularly reviewed by the enterprise's chief operating decision-maker to make decisions about resources to be allocated to the segment, and to assess its performance.

3. For which discrete financial information is available.

Question 3-20For areas determined to be reportable operating segments, the following disclosures are required:

1. General information about the operating segment,2. Information about reported segment profit or loss, including certain revenues and expenses

included in reported segment profit or loss, segments assets, and the basis of measurement.3. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other

significant items to corresponding enterprise amounts.4. Interim period information.

(a) Current(b) Current(c) Noncurrent(d) Current(e) Noncurrent(f) Noncurrent

Current Assets:

$16,000 + 11,000 + 25,000 = $52,000

Current liabilities:$14,000 + 9,000 + 1,000 = $24,000

Assets: $ 52,000 current assets

80,000 equipment


BRIEF EXERCISESBrief Exercise 3-1

Brief Exercise 3-2

Brief Exercise 3-3

$132,000 total assetsminusLiabilities $ 24,000 current liabilities

30,000 notes payable54,000 total liabilities

equalsShareholders’ equity $78,000

(50,000) common stock$28,000 retained earnings


$28,000 is the amount needed to cause total assets to equal total liabilities and shareholders’ equity. This is calculated in BE 3-3.


Brief Exercise 3-4

K and J Nursery, Inc.Balance Sheet

At December 31, 2009

AssetsCurrent assets:

Cash .................................................................. $ 16,000Accounts receivable .......................................... 11,000Inventories ........................................................ 25,000

Total current assets ...................................... 52,000

Property, plant, and equipment:Equipment ......................................................... $140,000Less: Accumulated depreciation ........................ (60,000 )

Net property, plant, and equipment .............. 80,000Total assets ................................................ $132,000

Liabilities and Shareholders' EquityCurrent liabilities:

Accounts payable .............................................. $ 14,000Wages payable .................................................. 9,000Interest payable ................................................. 1,000

Total current liabilities ................................. 24,000

Long-term liabilities:Note payable ..................................................... 30,000

Shareholders’ equity:Common stock .................................................. $50,000Retained earnings* ............................................ 28,000

Total shareholders’ equity ............................ 78,000 Total liabilities and shareholders’ equity $132,000


Brief Exercise 3-5

1. The $30,000 should be classified as a noncurrent asset, under the investments classification.


Culver City Lighting, Inc.Balance Sheet



Cash .................................................................. $ 55,000Accounts receivable .......................................... 39,000Inventories ........................................................ 45,000Prepaid insurance .............................................. 15,000


Property, plant, and equipment:Equipment ......................................................... $100,000Less: Accumulated depreciation ........................ (34,000 )

Net property, plant, and equipment .............. 66,000

Intangibles:Patent ............................................................. 40,000

Total assets ................................................ $260,000


Accounts payable .............................................. $ 12,000Interest payable.................................................. 2,000Current maturities of long-term debt ................. 10,000



Shareholders’ equity:Common stock .................................................. $70,000Retained earnings .............................................. 76,000


Brief Exercise 3-6

2. $10,000, next year’s installment, should be classified as a current liability, current maturities of long-term debt. The remaining $90,000 is included in long-term liabilities.

3. Two-thirds of the unearned revenue, $40,000, should be classified as a current liability, the remaining $20,000 as a long-term liability.

Current assets – cash and cash equivalents – accounts receivable = Inventories

$235,000 – 40,000 – 120,000 = $75,000

Total assets – current assets = property, plant, and equipment $400,000 – 235,000 = $165,000

Total assets – accounts payable – note payable – common stock = retained earnings

$400,000 – 32,000 – 50,000 – 100,000 = $218,000

(1) A

(2) B(3) B(4) A(5) B(6) A


Brief Exercise 3-7

Brief Exercise 3-8

(a) Current assets current liabilities

($55,000 + 39,000 + 45,000 + 15,000) ($12,000 + 2,000 + 10,000) $154,000 $24,000 = 6.42

(b) (Cash + short-term investments + accounts receivable) current liabilities ($55,000 + 0 + 39,000) $24,000 = 3.92

(c) Total liabilities shareholders’ equity$24,000 current liabilities + 90,000 long-term liabilities = $114,000$70,000 common stock + 76,000 retained earnings = $146,000$114,000 $146,000 = .78

Paying accounts payable reduces both current assets and current liabilities. If the ratio before the payment were above 1.0, the transaction would cause

the ratio to increase. However, if the ratio before the transaction were less than 1.0, the ratio would decrease.

Acid-test ratio = (cash + short-term investments + A/R) current liabilities

1.5 = ($20,000 + 0 + 40,000) current liabilities1.5 x current liabilities = $60,000current liabilities = $60,000 1.5current liabilities = $40,000

Current ratio = current assets current liabilities2.0 = current assets $40,000current assets = $40,000 x 2.0current assets = $80,000 $80,000 – 20,000(cash) – 40,000(A/R) = $20,000 inventories

1. Total current assets

Current liabilities = $44,000 + 15,000 + 1,000 (accrued interest)= $60,000

Since the current ratio is 1.5:1, current assets = 1.5 x $60,000 = $90,000© The McGraw-Hill Companies, Inc., 2009

Solutions Manual, Vol.1, Chapter 3 3-13

Brief Exercise 3-9

Brief Exercise 3-10

Brief Exercise 3-11

EXERCISESExercise 3-1

2. Short-term investments

$90,000 - 5,000 - 20,000 - 60,000 = $5,000

3. Retained earnings

Current assets + Noncurrent assets = Current liabilities + Long-term liabilities + Paid-in capital + Retained earnings (RE)

$90,000 + 120,000 = $60,000 + 30,000 (Note payable) + 100,000 + RE

RE = $20,000

1. c Equipment 10. a Inventories2. f Accounts payable 11. d _ Patent3. -a _ Allowance for uncollectible accounts 12. c Land, in use 4. b _ Land, held for investment 13. f _ Accrued liabilities5. g _ Note payable, due in 5 years 14. a Prepaid rent6. f Unearned rent revenue 15. h _ Common stock7. f Note payable, due in 6 months 16. c Building, in use8. i Income less dividends, accumulated 17. a Cash9. b Investment in XYZ Corp., long-term 18. f Taxes payable

1. f Accrued interest payable 10. a Supplies2. d Franchise 11. c Machinery3. -c Accumulated depreciation 12. c Land, in use4. e Prepaid insurance, for 2011 13.___ f Unearned revenue5. g Bonds payable, due in 10 years 14. d _ Copyrights6. f Current maturities of long-term debt 15. h _ Preferred stock7. f Note payable, due in 3 months 16. b _ Land, held for speculation8. b Long-term receivables 17. a Cash equivalents9. b Bond sinking fund, will be used to 18. f Wages payable

retire bonds in 10 years


Exercise 3-2

Exercise 3-3


Exercise 3-4 JACKSON CORPORATIONBalance Sheet

At December 31, 2009Assets

Current assets:Cash .................................................................. $ 40,000Marketable securities ........................................ 10,000Accounts receivable .......................................... 34,000Inventories ........................................................ 75,000Prepaid rent ....................................................... 16,000


Property, plant, and equipment:Machinery ......................................................... $145,000Less: Accumulated depreciation ........................ (11,000 )

Net property, plant, and equipment .............. 134,000

Intangibles:Patent ............................................................. 83,000

Total assets ................................................ $392,000


Accounts payable .............................................. $ 8,000Wages payable .................................................. 4,000Taxes payable ................................................... 32,000


Long-term liabilities:Bonds payable ................................................... 200,000



Exercise 3-5VALLEY PUMP CORPORATIONBalance Sheet


Current assets:Cash .............................................................................. $ 25,000Marketable securities .................................................... 22,000Accounts receivable, net of allowance for uncollectible accounts of $5,000 ............................. 51,000Inventories .................................................................... 81,000Prepaid expenses ........................................................... 32,000

Total current assets .................................................. 211,000

Investments:Marketable securities .................................................... $22,000Land .............................................................................. 20,000

Total investments .................................................... 42,000

Property, plant, and equipment:Land .............................................................................. 100,000Buildings ....................................................................... 300,000Equipment ..................................................................... 75,000

475,000Less: Accumulated depreciation .................................... (125,000 )

Net property, plant, and equipment ......................... 350,000

Intangibles:Copyright ...................................................................... 12,000

Total assets ........................................................... $615,000 Liabilities and Shareholders' Equity

Current liabilities:Accounts payable .......................................................... $ 65,000Interest payable ............................................................. 10,000 Unearned revenues ........................................................ 20,000Note payable ................................................................. 100,000Current maturities of long-term debt ............................. 50,000

Total current liabilities ............................................ 245,000

Long-term liabilities:Note payable ................................................................. 100,000

Shareholders’ equity:Common stock .............................................................. $200,000Retained earnings .......................................................... 70,000

Total shareholders’ equity ....................................... 270,000 Total liabilities and shareholders’ equity .............. $615,000

Exercise 3-6

Current assets: Cash $20,000 Accounts receivable 130,000 Less: allowance for uncollectible accounts (13,000) Note receivable 100,000 Interest receivable 3,000 Marketable securities 32,000 Raw materials 24,000 Work in process 42,000 Finished goods 89,000 Prepaid rent (one-half of $60,000) 30,000 Total current assets $457,000

Current liabilities: Unearned revenue (one half of $36,000) 18,000 Accounts payable 180,000 Interest payable 5,000 Total current liabilities (203,000)

Working capital $254,000


Exercise 3-7

See calculations below the balance sheet.


LOS GATOS CORPORATIONBalance Sheet


Current assets:Cash ....................................................................... $ 20,000Accounts receivable, net of allowance for uncollectible accounts of $5,000 ......................... 55,000Inventories .............................................................. 55,000

Total current assets ............................................ 130,000

Investments:Bond sinking fund .................................................. $ 20,000Note receivable ....................................................... 20,000

Total investments .............................................. 40,000

Property, plant, and equipment:Machinery .............................................................. 190,000Less: Accumulated depreciation ............................. (70,000 )

Net property, plant, and equipment ................... 120,000

Intangibles:Franchise ................................................................ 30,000

Total assets ..................................................... $320,000 Liabilities and Shareholders' Equity

Current liabilities:Accounts payable ................................................... $ 50,000Interest payable ...................................................... 5,000 Note payable ........................................................... 50,000

Total current liabilities ...................................... 105,000

Long-term liabilities:Bonds payable ........................................................ 110,000

Shareholders’ equity:Common stock, no par value; 100,000 shares authorized; 50,000 shares issued and outstanding $ 70,000Retained earnings ................................................... 35,000

Total shareholders’ equity ................................. 105,000 Total liabilities and shareholders’ equity ........ $320,000

Exercise 3-8

CONE CORPORATIONBalance Sheet (Partial)At December 31, 2009


Marketable securities ........................................ $ 40,000Prepaid rent ....................................................... 12,000

Investments:Bond sinking fund ............................................. 50,000Marketable securities ........................................ 40,000

Other assets:Prepaid rent (1) .................................................. 12,000


Interest payable ................................................. $ 12,000 Current maturities of long-term debt ................. 20,000


(1) Note: In practice, companies often report all prepaid expenses as current assets.

Exercise 3-9


Korver Supply CompanyBalance Sheet



Cash .................................................................. $168,000Accounts receivable .......................................... 320,000Inventories ........................................................ 250,000


Property, plant, and equipment:Furniture and fixtures ........................................ $300,000Less: Accumulated depreciation ........................ (170,000 )

Net property, plant, and equipment .............. 130,000Total assets ................................................ $868,000


Accounts payable .............................................. $180,000Interest payable ................................................. 6,000Note payable ..................................................... 200,000




Exercise 3-9 (concluded)

Beginning balance in cash $120,000+ Cash collected from customers 780,000- Cash paid to suppliers (560,000)- Cash paid for operating expenses (160,000)- Cash paid for interest (12,000)Ending cash balance $168,000

Beginning balance in accounts receivable $300,000+ Credit sales 800,000- Cash collected from customers (780,000)Ending balance in accounts receivable $320,000

Beginning balance in inventories $200,000+ Purchases 550,000- Cost of merchandise sold (500,000)Ending balance in inventories $250,000

Beginning balance in furniture and fixtures, net $150,000- Depreciation for the year (20,000)Ending balance in furniture and fixtures, net $130,000

Beginning balance in accounts payable $190,000+ Purchases on account 550,000- Cash paid to suppliers (560,000)Ending balance in accounts payable $180,000

Beginning balance in retained earnings $274,000+ Sales revenue 800,000- Cost of goods sold (500,000)- Operating expenses (160,000)- Depreciation expense (20,000)- Interest expense (12,000)Ending balance in retained earnings $382,000

Accrued interest on note ($200,000 x 6% x 6/12) $6,0001. Inventory costing method A


Exercise 3-10

2. Information on related party transactions B 3. Composition of property, plant, and equipment B 4. Depreciation method A 5. Subsequent event information B 6. Basis of revenue recognition on long-term contracts A 7. Important merger occurring after year-end B 8. Composition of receivables B

1. When related-party transactions occur, companies must disclose the nature of the relationship, provide a description of the transaction, and report the dollar amounts of the

transactions and any amounts due from or to related parties.2. When an event that has a material effect on the company’s financial position

occurs after the fiscal year-end, but before the financial statements actually are issued, the event is disclosed in a subsequent event disclosure note.

3. The choice of the straight-line method to determine depreciation typically is disclosed in the company’s summary of significant accounting policies disclosure note.

4. This information would be included in a disclosure note describing the company’s debt.

5. The choice of the FIFO method to determine value inventory typically is disclosed in the company’s summary of significant accounting policies disclosure note.


Exercise 3-11

List A List B

d 1. Balance sheet a. Will be satisfied through the use of current assets. h 2. Liquidity b. Items expected to be converted to cash or consumed

within one year or the operating cycle. b 3. Current assets c. The statements are presented fairly in conformity

with GAAP. j 4. Operating cycle d. An organized array of assets, liabilities and equity. a 5. Current liabilities e. Important to a user in comparing financial

information across companies. k 6. Cash equivalent f. Scope limitation or a departure from GAAP. m 7. Intangible asset g. Recorded when an expense is incurred but not yet

paid. l 8. Working capital h. Relates to the amount of time before an asset is

converted to cash or a liability is paid. g 9. Accrued liabilities i. Occurs after the fiscal year-end but before the

statements are issued. e 10. Summary of significant j. Cash to cash.

accounting policies i 11. Subsequent events k. One-month U.S. treasury bill. c 12. Unqualified opinion l. Current assets minus current liabilities. f 13. Qualified opinion m. Lacks physical existence.

1. Current ratio [$200 + 150 + 200 + 350] ÷ $400 = 2.25

2. Acid-test ratio [$200 + 150 + 200] ÷ $400 = 1.3753. Debt to equity ratio [$400 + 350] ÷ [$750 + 400] = .654. Times interest earned ratio [$160 + 40 + 100] ÷ $40 = 7.5 times


Exercise 3-12

Exercise 3-13

Requirement 1

a. Current ratio $1,401,233 ÷ $341,169 = 4.11b. Acid-test ratio [$384,409 + 570,440 + 148,694] ÷ $341,169 = 3.23c. Debt to equity ratio [$341,169 + 41,246] ÷ $1,411,532 = .27d. Times interest earned ratio [$85,787 + 97 + 24,038] ÷ $97 = 1,133 times

Requirement 2Activision’s current and acid-test ratios are both considerably higher than the

industry averages indicating relatively high liquidity. While the debt to equity ratio is slightly higher than the industry average, it indicates that the company’s assets are primarily financed with equity rather than liabilities. Also, the company’s extremely high times interest earned ratio is a result of very little interest-bearing debt in the company’s capital structure. Activision is more liquid than the average company in its industry and appears to be in no danger of becoming insolvent.

1. Acid-test ratio = Quick assets ÷ Current liabilities = 1.20Quick assets = Current assets - Inventories

Quick assets = Current assets - $840,000

Current assets ÷ Current liabilities = 2.25Current assets - $840,000 ÷ Current liabilities = 1 .20 $840,000 ÷ Current liabilities = 1.05Current liabilities = $800,000Current assets ÷ $800,000 = 2.25Current assets = $1,800,000

2. Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1.8Total liabilities + Shareholders' equity = Total assetsTotal liabilities + Shareholders' equity = $2,800,000Let x equal shareholders' equity1.8 x + x = $2,800,000x = $1,000,000 = Shareholders' equity

3. Noncurrent assets = Total assets - Current assetsNoncurrent assets = $2,800,000 – 1,800,000 = $1,000,000

4. Long-term liabilities = Total assets - Current liabilities - Shareholders' equityLong-term liabilities = $2,800,000 - 800,000 - 1,000,000 = $1,000,000


Exercise 3-14

Exercise 3-15

Current Acid-test Debt to Action Ratio Ratio

Equity Ratio1. Issuance of long-term bonds I I I 2. Issuance of short-term notes I I I 3. Payment of accounts payable D D D 4. Purchase of inventory on account I D I 5. Purchase of inventory for cash N D N 6. Purchase of equipment with a 4-year note N N I 7. Retirement of bonds D D D 8. Sale of common stock I I D 9. Write-off of obsolete inventory D N I

10. Purchase of short-term investment for cash N N N 11. Decision to refinance on a long-term basis

some currently maturing debt I I N


Exercise 3-16

Requirement 1

The pharmaceuticals, plastics and farm equipment segments are reportable. Only segments representing 10% or more of total company revenues, assets or net income must be reported. The electronics segment does not meet this criterion.

Requirement 2For segments determined to be reportable, the following disclosures are required:

a. General information about the operating segment.b. Information about reported segment profit or loss, including certain revenues and

expenses included in reported segment profit or loss, segments assets, and the basis of measurement.

c. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other significant items to corresponding enterprise amounts.

d. Interim period information.In addition to revenues, profit or loss, and assets, international

standards also require the disclosure of total liabilities for each of the reportable segments.


Exercise 3-17

Exercise 3-18

CPA Exam Questions

1. b. The principal would have to be due in 2010 to be considered as a noncurrent asset at April 30, 2009. The accrued interest for eight months (since August 31, 2008) is a current asset at April 30, 2009. Since the principal is due August 31, 2010, additional interest would have to be recorded for the period September 1, 2009 to August 31, 2010.

2. a. Current liabilities are obligations that are expected to be paid within one year or the operating cycle whichever is longer.

Accounts payable $15,000Bonds payable 22,000Dividends payable 8,000 Total current liabilities $45,000

The notes payable are not classified as current liabilities because they are not due until 2011.

3. a. Inventory pricing is a significant accounting policy which should be disclosed according to APB Opinion No. 22 but the composition of plant assets is not a policy disclosure.


CPA / CMA REVIEW QUESTIONS

CPA Exam Questions (concluded)

4. b. Current ratio -- increased; Quick ratio -- decreased.

Current ratio = Current assets ÷ Current liabilities.

When the current ratio is greater than 1 to 1, an equal decrease in current assets and current liabilities will result in an increase in the current ratio. The decrease in current liabilities (the smaller number) is proportionately greater than the decrease in current assets, resulting in an increase in the ratio.

Quick ratio = (Cash + Marketable Securities + Accounts receivable) ÷ Current liabilities

When the quick ratio is less than 1:1, an equal decrease in quick assets and current liabilities will result in a decrease in the ratio. The decrease in current liabilities (the larger number) is proportionately smaller than the decrease in quick assets, resulting in a decrease in the ratio.

5. c. The auditors’ standard report includes a statement that the financial statements are the responsibility of the Company's management and that the auditors’ responsibility is to express an opinion on the financial statements.

6. a. Since inventory is not included in the quick ratio, the write-off of obsolete inventory would have no effect on the quick ratio; however, it would decrease the current ratio as the write-off would reduce current assets.


CMA Exam Questions

1. d. SFAS 57 requires disclosure of related-party transactions except for compensation agreements, expense allowances, and transactions eliminated in consolidated working papers. Required disclosures include the relationship(s) of the related parties; a description and dollar amounts of transactions for each period presented and the effects of any change in the method of establishing their terms; and amounts due to or from the related parties and, if not apparent, the terms and manner of settlement. The effect on the cash flow statement need not be disclosed.

2. b. The MD&A section is included in SEC filings. It addresses in a nonquantified manner the prospects of a company. The SEC examines it with care to determine that management has disclosed material information affecting the company’s future results. Disclosures about commitments and events that may affect operations or liquidity are mandatory. Thus, the MD&A section pertains to liquidity, capital resources, and results of operations.

3. a. The current ratio equals current assets divided by current liabilities. An equal increase in both the numerator and denominator of a current ratio less than 1.0 causes the ratio to increase. Windham Company’s current ratio is .8 ($400,000/ $500,000). The purchase of $100,000 of inventory on account would increase the current assets to $500,000 and the current liabilities to $600,000, resulting in a new current ratio of .833.


PROBLEMSProblem 3-1

Requirement 1Inventories:Current assets - Cash and cash equivalents - Short-term investments -


Balance SheetAssets

Current assets:Cash Short-term investmentsAccounts receivable, net of allowance for uncollectible accountsInterest receivableInventoriesPrepaid expenses

Total current assets

Investments:Bond sinking fund Long-term investmentsNotes receivable

Total investments

Property, plant, and equipment:LandBuildingsEquipmentLess: Accumulated depreciation

Net property, plant, and equipment

Intangibles:PatentCopyright

Total intangibles Total assets


Accounts payable Rent payable Taxes payableWages payableNotes payable

Total current liabilities

Long-term liabilities:Bonds payable

Shareholders’ equity:Common stockPreferred stockRetained earnings

Total shareholders’ equity Total liabilities and shareholders’ equity

Problem 3-2

Accounts receivable - Prepaid expenses = Inventories$1,594,927 - 239,186 - 353,700 - 504,944 - 83,259 = $413,838

Total assets:Total liabilities + Shareholders’ equity = Total assets$956,140 + 1,370,627 = $2,326,767

Property and equipment (net):Total assets - Current assets - Long-term receivables = Property and equipment$2,326,767 - 1,594,927 - 110,800 = $621,040

Accounts payable:Total current liabilities - Notes payable and short-term debt - Accrued liabilities - Other current liabilities = Accounts payable$693,564 - 31,116 - 421,772 - 181,604 = $59,072

Long-term debt and deferred taxes:Total liabilities - Current liabilities = Long-term debt and deferred taxes$956,140 - 693,564 = $262,576


Problem 3-2 (concluded)

Requirement 2


AMDAHL CORPORATIONBalance Sheet

Assets($ in thousands)

Current assets:Cash and cash equivalents ............................ $ 239,186Short-term investments ................................ 353,700Accounts receivable, net of allowance for uncollectible accounts ............................ 504,944Inventories ................................................... 413,838Prepaid expenses .......................................... 83,259

Total current assets ................................. 1,594,927

Investments:Long-term receivables .................................. 110,800

Property and equipment (net).......................... 621,040 Total assets ........................................... $2,326,767


Notes payable and short-term debt ................ $ 31,116Accounts payable .......................................... 59,072Accrued liabilities ......................................... 421,772 Other current liabilities ................................. 181,604

Total current liabilities ............................. 693,564

Long-term debt and deferred taxes ................. 262,576

Shareholders’ equity ........................................ 1,370,627 Total liabilities and shareholders’ equity $2,326,767

Problem 3-3 ALMWAY CORPORATIONBalance Sheet



Cash and cash equivalents .................................................... $ 30,000Short-term investments ........................................................ 80,000Accounts receivable, net of allowance for uncollectible accounts of $8,000 ..................................... 60,000Inventories ........................................................................... 200,000Prepaid insurance ................................................................. 9,000

Total current assets ........................................................ 379,000

Investments:Marketable securities ........................................................... $ 30,000Land held for sale ................................................................ 25,000Bond sinking fund ............................................................... 15,000

Total investments .......................................................... 70,000

Property, plant, and equipment:Land .................................................................................... 65,000Buildings ............................................................................. 420,000Equipment ........................................................................... 110,000

595,000Less: Accumulated depreciation ........................................... (160,000 )

Net property, plant, and equipment ................................ 435,000

Intangibles:Patents ................................................................................. 10,000

Total assets .................................................................... $894,000


Accounts payable ................................................................. $ 75,000Interest payable .................................................................... 20,000 Note payable ........................................................................ 30,000 Current maturities of long-term debt .................................... 10,000

Total current liabilities .................................................. 135,000

Long-term liabilities:Notes payable ...................................................................... $ 90,000Bonds payable ..................................................................... 240,000

Total long-term liabilities .............................................. 330,000

Shareholders’ equity:Common stock, no par value; 500,000 shares authorized; 100,000 shares issued and outstanding ............ 300,000Retained earnings ................................................................ 129,000

Total shareholders’ equity .............................................. 429,000 Total liabilities and shareholders’ equity ..................... $894,000

Problem 3-4

WEISMULLER PUBLISHING COMPANYBalance Sheet



Cash and cash equivalents (1) .............................................. $ 95,000Short-term investments ........................................................ 110,000Accounts receivable, net of allowance for uncollectible accounts of $16,000 .......................................................... 144,000Inventories ........................................................................... 285,000Prepaid expenses (2)............................................................. 88,000


Property, plant, and equipment:Machinery and equipment .................................................... $320,000 Less: Accumulated depreciation ........................................... (110,000 )


Other assets:Prepaid expenses 60,000

Total assets ................................................................ $992,000

Liabilities and Shareholders' Equity

Current liabilities:Accounts payable ................................................................. $ 60,000Interest payable .................................................................... 20,000Unearned revenues ............................................................... 80,000Taxes payable ...................................................................... 30,000Note payable ........................................................................ 40,000 Current maturities of long-term debt .................................... 20,000


Long-term liabilities:Notes payable ...................................................................... 140,000



(1) Includes $30,000 in U.S. treasury bills. (2) Excludes $60,000 in prepaid rent for the second year on the building lease.

Requirement 1


Problem 3-5EXCELL COMPANY

Balance SheetAt June 30, 2009


Cash and cash equivalents (1) .............................................. $101,000Short-term investments ........................................................ 47,000Accounts receivable, net of allowance for uncollectible accounts of $15,000 .......................................................... 210,000Interest receivable ................................................................ 5,000Prepaid expenses ................................................................. 32,000


Investments:Note receivable .................................................................... $65,000Land held for sale ................................................................ 25,000 90,000

Property, plant, and equipment:Land .................................................................................... 50,000Buildings ............................................................................. 320,000Equipment ........................................................................... 265,000

635,000Less: Accumulated depreciation ........................................... (280,000 )

Net property, plant, and equipment ................................ 355,000 Total assets ................................................................ $840,000


Accounts payable ................................................................. $173,000Accrued expenses ................................................................ 45,000 Note payable ........................................................................ 50,000Current maturities of long-term debt .................................... 10,000


Long-term liabilities:Note payable ........................................................................ 50,000Mortgage payable ................................................................ 240,000

Total long-term liabilities .............................................. 290,000



(1) Includes $18,000 in U.S. treasury bills Problem 3-6


VOSBURGH ELECTRONICS CORPORATIONBalance Sheet



Cash and cash equivalents (1)........................................ $ 117,000Marketable securities (2)................................................ 132,000Accounts receivable (net) .............................................. 115,000Loans to employees ....................................................... 40,000Interest receivable ......................................................... 12,000Note receivable – current portion .................................. 50,000Inventories .................................................................... 215,000Prepaid expenses ........................................................... 16,000


Investments:Marketable securities..................................................... $ 35,000Note receivable ............................................................. 200,000

Total investments .................................................... 235,000

Property, plant, and equipment:Land .............................................................................. 280,000Buildings ....................................................................... 1,550,000Machinery and equipment ............................................. 637,000

2,467,000Less: Accumulated depreciation .................................... (830,000 )

Net property, plant, and equipment ......................... 1,637,000

Intangibles:Patent ............................................................................ 152,000Franchise ....................................................................... 40,000

Total intangibles ................................................... 192,000 Total assets ........................................................... $2,761,000

Problem 3-6 (continued)

Liabilities and Shareholders' Equity

Current liabilities:Accounts payable .......................................................... $ 189,000Dividends payable ......................................................... 10,000Interest payable ............................................................. 16,000Taxes payable ............................................................... 40,000Unearned revenue (3)..................................................... 48,000


Long-term liabilities:Notes payable ................................................................ 300,000Unearned revenue (3)..................................................... 12,000 Total long-term liabilities ...................................... 312,000

Shareholders’ equity:Common stock, no par value; 1,000,000 shares authorized; 500,000 shares issued and outstanding ..... $2,000,000Retained earnings .......................................................... 146,000

Total shareholders’ equity ....................................... 2,146,000 Total liabilities and shareholders’ equity .............. $2,761,000



(1) $67,000 + $50,000 in treasury bills considered a cash equivalent. (2) $182,000 - $50,000 in treasury bills considered a cash equivalent.(3) $60,000 in unearned revenue, 80%, $48,000, current and 20%, $12,000,

long-term.

Requirement 2Cash equivalents - the policy used to determine what items are considered to be

cash equivalents.Accounts receivable, net - disclosure on the face of the statement of the

allowance for uncollectible accounts, if material.Investments - information about the types of investments and the accounting

method used to value the investments.Inventories - disclosure in Accounting Policies note of the cost method used.

Also, for a manufacturer, note disclosure of the breakout of inventory into raw materials, work in process and finished goods.

Property, plant and equipment - original cost by major category should be disclosed along with the accumulated depreciation either on the face of the statement or in a note. Also, the method used to compute depreciation should be disclosed in the Accounting Policies disclosure note.

Long-term liabilities - disclosure in a note of the various debt instruments comprising long-term liabilities to include information such as payment terms, interest rates, and collateral pledged as security for the debt.


Problem 3-7

(1) $250,000 - $50,000 in land held for sale - $70,000 increase in land (2) $380,000 - $70,000 increase in land

Solve for missing amounts:

Liabilities Equity = 1.2$18,000 Equity = 1.2Equity = $18,000 1.2 = $15,000


HUBBARD CORPORATIONBalance Sheet



Cash .................................................................................... $ 60,000Marketable securities ........................................................... 20,000Accounts receivable (net) ..................................................... 120,000Inventories ........................................................................... 160,000


Investments:Marketable securities............................................................ $ 40,000Land held for sale ................................................................ 50,000


Property, plant, and equipment:Land (1) .............................................................................. 130,000Buildings ............................................................................. 750,000Machinery ........................................................................... 280,000

1,160,000Less: Accumulated depreciation ........................................... (255,000 )


Intangibles:Patent .................................................................................. 100,000

Total assets ................................................................ $1,455,000


Accounts payable ................................................................. $ 215,000Current maturities of long-term debt .................................... 25,000


Long-term liabilities:Notes payable ...................................................................... 475,000

Shareholders’ equity:Common stock, no par value; 100,000 shares authorized; 100,000 shares issued and outstanding ............ $ 430,000Retained earnings (2) ........................................................... 310,000

Total shareholders’ equity .............................................. 740,000 Total liabilities and shareholders’ equity ..................... $1,455,000

Problem 3-8

Beginning retained earnings + net income – dividends = Ending retained earnings $4,000 + 1,560 – 560 = $5,000

Total equity – retained earnings = Common stock $15,000 – 5,000 = $10,000

Assets = Liabilities + equityAssets = $18,000 + 15,000 = $33,000

$33,000 – all other assets = Patent$33,000 – 27,600 = $5,400




Sanderson Manufacturing CompanyBalance Sheet

At December 31, 2009($ in 000s, except share data)


Cash .............................................................................. $ 1,250Short-term investments ................................................. 3,000Accounts receivable, net of $400 allowance for uncollectible accounts ................................................ 3,100Inventories: Raw materials and work in process ............................ $ 2,250 Finished goods ........................................................... 6,000 8,250Prepaid expenses ........................................................... 1,200


Property, plant, and equipment:Equipment ..................................................................... 15,000Less: Accumulated depreciation .................................... (4,200 )

Net property, plant, and equipment ......................... 10,800

Intangibles:Patent ......................................................................... 5,400

Total assets ........................................................... $33,000


Accounts payable .......................................................... $ 5,200Interest payable.............................................................. 300Unearned revenue ......................................................... 1,500Current maturities of long-term debt ............................. 1,000


Long-term liabilities:Unearned revenue ......................................................... 1,500Note payable ................................................................. 3,000Bonds payable ............................................................... 5,500 10,000

Shareholders’ equity:Common stock, no par, 400,000 shares authorized,........ 250,000 shares issued and outstanding 10,000Retained earnings .......................................................... 5,000

Total shareholders’ equity ....................................... 15,000 Total liabilities and shareholders’ equity $33,000

Problem 3-9

HHD, Inc.Balance Sheet


Current assets:Cash .................................................................................... $ 150,000Investment in stocks ............................................................ 90,000Accounts receivable ............................................................. 200,000Inventories ........................................................................... 225,000Prepaid insurance ................................................................. 25,000


Investments:Investment in stocks ............................................................ $ 160,000Bond sinking fund ............................................................... 250,000


Property, plant, and equipment:Land .................................................................................... 800,000Buildings ............................................................................. 1,500,000Equipment ........................................................................... 500,000

2,800,000Less: Accumulated depreciation ........................................... (800,000 )

Net property, plant, and equipment ................................ 2,000,000

Intangibles:Patent .................................................................................. 110,000Copyright ............................................................................ 90,000

Total intangibles ............................................................ 200,000 Total assets ................................................................ $3,300,000


Accounts payable ............................................................... $ 100,000Notes payable .................................................................... 150,000Taxes payable .................................................................... 60,000

Total current liabilities ................................................. 310,000Long-term liabilities:

Notes payable .................................................................... $ 90,000Bonds payable ................................................................... 1,100,000

Total long-term liabilities ............................................ 1,190,000Shareholders’ equity:

Common stock, no par, 500,000 shares authorized, 200,000 shares issued and outstanding ............................. 1,000,000Retained earnings ............................................................... 800,000

Total shareholders’ equity ............................................ 1,800,000 Total liabilities and shareholders’ equity ................... $3,300,000

Problem 3-10

MELODY LANE MUSIC COMPANYBalance Sheet



Cash (1) ............................................................. $167,000 Inventories ........................................................ 100,000Prepaid rent ....................................................... 3,000


Property, plant, and equipment:Equipment and furniture .................................... $ 40,000Less: Accumulated depreciation ........................ (4,000 )

Net property, plant, and equipment .............. 36,000 Total assets ................................................ $306,000


Accounts payable (2) ......................................... $ 21,000Interest payable ................................................. 9,000Loan payable ..................................................... 100,000


Shareholders’ equity:Common stock, no par, 100,000 shares authorized, 20,000 shares issued and outstanding ...... $100,000Retained earnings (3) ......................................... 76,000

Total shareholders’ equity ............................ 176,000 Total liabilities and shareholders’ equity . . . $306,000

(1) Cash receipts of $560,000 less cash disbursements of $393,000

(2) $20,000 owed to suppliers + $1,000 owed to utility company

(3) Net income for the year

IBM manufactures and sells personal and main frame computers. The computers included as current assets in the balance sheet for the company represent the cost of inventory available for sale. In addition, IBM uses computers in its operations. The cost of these computers is included in the property, plant, and equipment category in the balance sheet.

Marketable securities could be classified as either current or noncurrent assets depending on the intent of management. If management intends to sell the securities in the next year or operating cycle, they are classified as current assets. If management intends to hold the securities beyond the coming year or operating cycle, they are classified as noncurrent assets.

Requirement 1

Current assets include cash and other assets that are reasonably expected to be converted to cash or consumed during one year, or within the normal operating cycle of the business if the operating cycle is longer than one year. Current liabilities include all liabilities that are scheduled to be liquidated within one year or the operating cycle, whichever is longer, except those that management intends to refinance on a long-term basis.

Therefore, key factors determining classification are the nature of the asset or liability, management’s intent, and the length of the operating cycle.

Requirement 2Assets:

Cash Normally classified as current, however, if restriction prohibits use of the cash, could be classified as noncurrent.

Receivables Depends on the expected date of collection.

Marketable Depends on when management intends to sell the securities. securities

Prepaid expenses Depends on the period of time prepaid.

Liabilities:Notes payable Depends on scheduled payment date and management’s

intent to pay or refinance.


CASESCommunication Case 3-1

Analysis Case 3-2

Unearned revenue Depends on the period the revenue will be earned.The critical question that student groups should

address is whether the cost of the egg-producing flock should be classified as inventory or as property, plant, and equipment. There is no right or wrong answer. The process of developing the proposed solutions will likely be more beneficial than the solutions themselves. Students should benefit from participating in the process, interacting first with other group members, then with the class as a whole.

Solutions should address the following issues:

1. The definitions of inventory and property, plant, and equipment.The definition of inventory according to ARB No. 43 is “goods awaiting sale,

goods in the course of production, and goods to be consumed directly in production.” The chickens certainly represent goods awaiting sale, since they will eventually be sold to soup companies. However, they also represent property, plant, and equipment, since they are used in the production of product — the eggs.

2. The definition of a current asset.ARB No. 43 also provides the following definition of a current asset:

“..., the term current assets is used to designate cash andother assets or resources commonly identified as thosewhich are reasonably expected to be realized in cash or soldor consumed during the normal operating cycle of thebusiness.”

ARB No. 43 also states that a one-year time period is to be used where there are several operating cycles occurring within a year. In this case, it could be argued that the operating cycle is two years, since the chickens are not sold until after the laying life and, therefore, the cost of the flock should be classified as a current asset. However, if the chickens are considered productive assets, then the concept of an operating cycle is not relevant. According to this argument, the chickens should be classified as a noncurrent asset, i.e., a producing asset, and not a saleable asset. It appears that the primary benefits of the chickens come from the sale of eggs, not the sale of the chickens themselves.

3. Regardless of the classification of the cost of the chickens, the cost capitalized when the chickens begin to lay must be depreciated down to an estimated salvage value at the end of the laying life. This is necessary to properly match expenses with revenues.


Communication Case 3-3

Case 3-3 (concluded)

(Industry practice is to classify the costs of the egg-producing flock as inventory in the current asset section of the balance sheet, but to depreciate the inventory down to estimated salvage value.)

It is important that each student actively participate in the process. Domination by one or two individuals should be discouraged. Students should be encouraged to contribute to the group discussion by (a) offering information on relevant issues, and (b) clarifying or modifying ideas already expressed, or (c) suggesting alternative direction.

DEFICIENCIES:

1. Accounts receivable - if material, the allowance for uncollectible accounts should be disclosed.

2. Note receivable - only the interest receivable of $3,000 should be classified as a current asset. The $50,000 note receivable should be classified in the noncurrent Investments category.

3. Inventories - the method used to cost inventory should be disclosed in a note. 4. Investments - should be classified in the noncurrent Investments category. 5. Prepaid expenses - in the absence of information to the contrary, should be

classified as a current asset. 6. Land - should be classified in the noncurrent Investments category. 7. Equipment, net - should be classified in the Property, plant and equipment

category. Original cost should be disclosed along with the accumulated depreciation to arrive at the net amount. Also, the method used to compute depreciation should be disclosed in a note.

8. Patent - should be classified in the Intangibles category of noncurrent assets. 9. Note payable - $20,000, the next installment, should be classified as a current

liability as current maturities of long-term debt. Also, note disclosure is required for the note and bonds payable that provides information such as payment terms, interest rates, and collateral pledged as security for the debt.

10. Interest payable - should be classified as a current liability.11. Common stock - the par value, if any, and the number of shares authorized,

issued and outstanding should be disclosed.

Accounts receivable, net - disclosure on the face of the statement of the allowance for uncollectible accounts, if material.


Judgment Case 3-4

Judgment Case 3-5

Inventories - disclosure in Accounting Policies note of the cost method used. Also, for a manufacturer, note disclosure of the breakout of inventory into raw materials, work in process and finished goods.

Investments - information about the types of investments and the accounting method used to value the investments.

Property, plant and equipment - original cost by major category should be disclosed along with the accumulated depreciation either on the face of the statement or in a note. Also, the method used to compute depreciation should be disclosed in the Accounting Policies disclosure note.

Long-term liabilities - disclosure in a note of the various debt instruments comprising long-term liabilities to include information such as payment terms, interest rates, and collateral pledged as security for the debt.

Common stock - disclosure on the face of the statement of par value, if any, and the number of shares authorized, issued and outstanding.

Requirement 1

The asset classifications are 1) Current assets, 2) Plant, rental machines and other property, 3) Long-term financing receivables, 4) Prepaid pension assets, (5) Goodwill, (6) Intangible assets – net, and (7) Investments and sundry assets

Requirement 2a. Total assets = $103,234 millionb. Current assets = $44,660 millionc. Current liabilities = $40,091 milliond. Total shareholders' equity = $28,506 millione. Retained earnings = $52,432 millionf. Inventories = $2,810 million

Requirement 3The par value is $.20 per share. 4,687,500,000 shares are authorized and

2,008,470,383 shares are issued.

Requirement 4Current ratio = Current assets divided by Current liabilities.Current ratio = $44,660 ÷ $40,091 = 1.11

Requirement 5

a. The lower of average cost or net realizable value.b. The straight-line method.


Real World Case 3-6

c. All highly liquid investments with a maturity of three months or less at date of purchase are carried at fair value and considered to be cash

equivalents.1. This is a significant event occurring after the end of the

fiscal year but prior to the issuance of the financial statements. Details of the merger should be disclosed

in a note to the financial statements.2. This is a significant event occurring after the end of the fiscal year but prior to the

issuance of the financial statements. Details of the issuance of the new debt should be described in a note to the financial statements.

3. This is a significant event occurring after the end of the fiscal year but prior to the issuance of the financial statements. The event should be described in a note to the financial statements along with the amount of uninsured damage.

Requirement 1

Statement of Financial Accounting Standards No. 57, “Related Party Disclosures,” requires the disclosure of related party transactions. This statement was issued in March of 1982 and became effective for fiscal years ending after June 15,1982.

Requirement 2When related-party transactions occur, companies must disclose the nature of the

relationship(s) involved, provide a description of the transactions, and report the dollar amounts of the transactions and any amounts due from or to related parties.

Requirement 3The related party transactions disclosure note describes transactions with limited

partnerships whose general partner’s managing member is a senior officer of Enron. The transactions include various hedging and derivative transactions with the related party, as well as the sale of inventory and other assets to the related party.

Requirement 4The potential problem with related party transactions is that their economic

substance may differ from their legal form. One of Enron’s disclosed transactions involved the sale of dark fiber inventory to the related party in exchange for $30 million in cash and a $70 million note receivable. Enron recognized gross margin on the sale of $67 million. Is the $100 million sales price a proper representation of the sales price of the inventory in a normal transaction to an unrelated party? Is the interest rate charged by Enron on the note a fair interest rate? If the answer to these questions is no, then income (wealth) has been transferred from one party to the other, to the detriment of the shareholders of one of the entities and the benefit of the other.© The McGraw-Hill Companies, Inc., 20093-42 Intermediate Accounting, 5/e

Judgment Case 3-7

Research Case 3-8

Requirement 3

a. The disclosure note describes two subsequent events, (1) the acquisition of Demonware, a company headquartered in Dublin, Ireland, and (2) the commencement of an offer to amend the exercise prices of certain employee stock options.

b. The company's auditor was PricewaterhouseCoopers LLP. The firm rendered an unqualified opinion on the company's financial statements. There is an explanatory paragraph concerning the change in the manner the company accounts for share-based compensation.

Requirement 4a. Robert A. Kotick is listed as Chairman, Chief Executive Officer, and Director.b. The annual salary for Mr. Kotick in 2007 was $797,200.

Comparative income for the first year of operations resulting from the two alternative financing choices is illustrated below.

DEBT Versus EQUITYComparative Income for Two Financing Alternatives

Alternative 1 Alternative 2Income before interest and taxes $5,000,000 $5,000,000 Less: Interest -0- (1,600,000 ) *Income before taxes 5,000,000 3,400,000 Less: Income taxes (2,500,000 ) ** (1,700,000 ) **Net Income $2,500,000 $1,700,000

* 8% x $20,000,000.** 50% x Income before taxes.

Return on investment $2,500,000 $1,700,000

= 5% =5.67%

(Net income ÷ investment) $50,000,000 $30,000,000


Real World Case 3-9

Judgment Case 3-10

We can see that Alternative 1 generated a higher net income. However, the return on shareholders’ investment is actually higher for Alternative 2.

Alternative 2 generated a higher return for each dollar invested by shareholders. This was made possible because the corporation was able to generate income on borrowed funds at a higher rate than the cost of the debt. This represents financial leverage. However, alternative 2 also results in a riskier capital structure. The debt in Alternative 2 requires fixed payments of interest and principal to be made. The company's income before interest and income taxes could drop to zero under Alternative 1 and the company would still be solvent (i.e., able to pay its debts). Under Alternative 2, however, if income before interest and taxes drops below the required interest payments of $1,600,000, the company could become insolvent and eventually go bankrupt.

The objective of this case is to motivate students to obtain hands-on familiarity with an actual annual report. You may wish to provide students with multiple copies of

the same annual report and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective.

The objectives of this case are to motivate students to obtain hands-on familiarity with an actual annual report and to apply the techniques learned in the chapter. You may

wish to provide students with multiple copies of the same annual reports and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective.


Analysis Case 3-11

Analysis Case 3-12

Requirement 1

The balance sheet includes seven asset classifications: Current assets; Prepaid revenue shares, expenses and other assets – non-current; Deferred income taxes, net, non-current; Non-marketable equity securities; Property and equipment, net; Intangible assets, net; and Goodwill, and five liability classifications: Current liabilities; Deferred revenue, long-term; Deferred income taxes, net; Income taxes payable, long-term; and Other long-term liabilities.

Requirement 2These assets are shown as current because the company intends to convert them

to cash in the next year or operating cycle.

Requirement 3Deferred revenue, sometimes called unearned revenue, represents cash received

from customers in advance of providing goods or services.

Requirement 4Disclosure notes explain or elaborate upon the data presented in the financial

statements themselves. They must include certain specific notes such as a summary of significant accounting policies, descriptions of subsequent events, and related third-party transactions, but many notes are company specific. Actually, any explanation that contributes to investors’ and creditors’ understanding of the results of operations, financial position, or cash flows of the company should be included.

Requirement 5Straight-line.

Requirement 6There are no subsequent events noted. The only related party transaction

indicated in the notes is a 2005 contribution to the Google Foundation.

Requirement 1

Segment disclosures assist in analyzing and understanding financial statements by permitting better assessment of past performance and future prospects. Disaggregated information provides more precise details of the uncertainties surrounding the timing and the amount of expected cash flows, because the various segments may have different rates of profitability, degrees and types of risk, opportunities for growth, and future capital demands.

Requirement 2An operating segment is a component of an enterprise:


Analysis Case 3-13

Analysis Case 3-14

1. That engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same enterprise).

2. Whose operating results are regularly reviewed by the enterprise's chief operating decision-maker to make decisions about resources to be allocated to the segment and assess its performance.

3. For which discrete financial information is available.

Requirement 3For areas determined to be reportable operating segments, the following

disclosures are required:1. General information about the operating segment.2. Information about segment profit or loss, including certain revenues and

expenses included in reported segment profit or loss, segment assets, and the basis of measurement.

3. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other significant items to corresponding enterprise amounts.

4. Interim period information.

Discussion should include these elements.

Facts:The impact of following the controller's suggestions would be to obscure

financial information by aggregating the financial data of segment operations and investments. Aggregation of data makes projections of future performance for African or European segments difficult and does not reveal relative investments for each segment. SFAS 131 "Disclosures about Segments of an Enterprise and Related Information," suggests that reportable segments are those for whom financial data is available and whose results are regularly reviewed by company management in assessing performance. The data for South Africa, Egypt, France and Denmark are available and most likely reviewed for performance purposes by the controller and higher management levels.

Ethical Dilemma:Should you as staff accountant challenge the controller's combination of segments

or follow the controller's suggestion to obscure financial information by aggregating the financial data of segment operations and investments?

Who is affected?


Ethics Case 3-15

You as a staff accountantController and other managersOther employeesShareholdersPotential shareholders CreditorsFinancial analystsAuditors

Who benefits and who is injured:Company management may benefit from aggregating the African and European

data by attracting more investors to their company and obtaining more loans from creditors than would be the case with more complete disclosure regarding the South African segment. Injured parties include current and future investors and creditors with economic, social and political concerns regarding Africa and Europe. If investors and creditors later learn about undisclosed segment operations that prove unprofitable or violate their value systems, they may take action against McCarver-Lynn.


Documents

Chap 003