BASIC FINANCIAL STATEMENTS
Brief
Learning
Exercises
Topic
Objectives
Skills
B. Ex. 2.1
Recording transactions
2 - 3
Analysis, communication
B. Ex. 2.2
Recording transactions
2 - 3
Analysis, communication
B. Ex. 2.3
Computing retained earnings
2 - 4
Analysis
B. Ex. 2.4
Computing total liabilities
2 - 4
Analysis
B. Ex. 2.5
Computing net income
2 - 5
Analysis
B. Ex. 2.6
Computing net income
2 - 5
Analysis
B. Ex. 2.7
Computing change in cash
2 - 6
Analysis
B. Ex. 2.8
Alternative forms of equity
2 - 8
Analysis
B. Ex. 2.9
Alternative forms of equity
2 - 8
Analysis
B. Ex. 2.10
Articulation of financial statements
2 - 7
Analysis
Learning
Exercises
Topic
Objectives
Skills
2.1
Real World: American Airlines,
2 - 3
Communication
Boston Redsox
Nature of assets and liabilities
2.2
Preparing a balance sheet
2 - 4
Analysis
2.3
Preparing a balance sheet
2 - 4
Analysis
2.4
2 - 2
Communication, judgment
2.5
Using the accounting equation
2 - 3
Analysis
2.6
Accounting equation
2 - 3
Analysis
2.7
Effects of business transactions
2 - 3
Analysis
2.8
Forms of business organizations
2 - 8
Analysis
2.9
Factors contributing to solvency
2 - 9
Analysis, judgment
2.10
Professional judgment
2 - 2
Communication
2.11
Statement of cash flows
2 - 6
Analysis
2.12
Income statement
2 - 5
Analysis
2.13
Income statement
2 - 5
Analysis
2.14
Statement of cash flows
2 - 6
Analysis
2.15
Window dressing financial statement
2 - 9
Analysis
2.16
Real World: Home Depot
Analysis, communication
Home Depot financial statements
2.17
Real World: McKesson Corporation
2 - 5
Analysis, communication

Assessing financial results
2–4 through
2 - 6
CHAPTER 2
Accounting principles and asset valuation
OVERVIEW OF BRIEF EXERCISES, EXERCISES, AND CRITICAL THINKING
CASES
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Problems
Learning
Sets A, B
Topic
Objectives
Skills
2.1 A,B
2 - 4
Analysis, communication
2.2 A,B
Effects of transactions
2 - 3
Analysis
2.3 A,B
Effects of transactions
2 - 3
Analysis
2.4 A,B
Effects of transactions
2 - 3
Analysis
2.5 A,B
Preparing a balance sheet, effects of
2 - 4
Communication, judgment
transactions

2.6 A,B
Preparing a balance sheet, effects of
2 - 4
Analysis, communication
transactions

2.7 A,B
Preparing a balance sheet and statement
2 - 3, 2 - 4, 2 - Analysis, communication
of cash flows, effects of transactions

2.8 A,B
Preparing financial statements, effects of
2- 4 through
Analysis, communication
of transactions, evaluating solvency

2.9 A,B
2 - 4, 2 - 8
2.10 A,B
2 - 2, 2 - 4
Preparing and evaluating a balance sheet
Preparing a balance sheet, discussion of
GAAP
Preparing a balance sheet, discussion of
GAAP
Analysis, communication,
judgment
Analysis, communication,
judgment
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2.1
Prepare a realistic balance sheet for a
2 - 4
hypothetical entity
2.2
Real World: Company of student choice
2.3
Using a balance sheet
2 - 4
2.4
Using a statement of cash flows
2 - 6
2.5
Window dressing
2 - 4
2.6
2 - 4

(Ethics, fraud & corporate governance)
2.7
2 - 4, 2 - 5
DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES
Problems (Sets A and B)
2.1 A,B
15 Easy
2.2 A,B
15 Easy
2.3 A,B
15 Medium
2.4 A,B
15 Medium
Locate and evaluate the financial statements of
a publicly owned company
Critical Thinking Cases
Analysis, communication,
judgment
Communication, research,
technology
Analysis, communication,
research

Analysis, communication
judgment
Analysis, communication,
judgment
Note: Additional Internet assignments for this chapter are available in Appendix B.
Memphis Moving Company/Prosperity
Rocky Mountain Lodge/Tri-State Lodge
Shown below are brief descriptions of each problem and case. These descriptions are accompanied by
the estimated time (in minutes) required for completion and by a difficulty rating. The time estimates
assume use of the partially filled-in working papers.
Real World: Public Company Accounting
Oversight Board
Technology
Real World: Cisco Systems
(Internet)
Introduction to EDGAR
2 - 4 through
2 - 6
Judgment
Phillips Truck Rental/MaxxTrucking
Show in tabular form the effects of various business transactions
upon the accounting equation. (Alternate to Problem 2–3.)
Prepare a balance sheet from a list of balance sheet items in
random order. Determine the amount of one item as a plug figure.
Also evaluate the company’s solvency.
Effects of transactions upon the accounting equation are illustrated
in tabular form. Students are asked to write a sentence or two
explaining the nature of each transaction.
Maxwell Communications/Delta Corporation
Show in tabular form the effects of various business transactions
upon the accounting equation. (Problem 2–4 is an alternate.)
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Problems (cont'd)
Here Come the Clowns/Circus World
Alexander Farms, Inc./Maple Valley Farms
Franklin Bakery/Collier Butcher Shop
The Soda Shop/The Sweet Shop
Spencer Playhouse/Old Town Playhouse
Big Screen Scripts/Star Scripts
Critical Thinking Cases
Content of a Balance Sheet
Using Financial Statements
*Omits time required to obtain an annual report.
2.5 A,B
20 Medium
2.6 A,B
20 Medium
Preparation of a balance sheet for a circus—an entity with an unusual variety
of asset accounts. Also requires students to explain the effects upon this
balance sheet of a fire that destroys one of the assets. (Problem 2–6 is an
alternate.)
Prepare a balance sheet for a farm—an entity with a wide variety of assets.
Also, explain the effects upon this balance sheet of the destruction of one of
the assets. (Alternate to Problem 2–5.)
2.7 A,B
35 Medium
2.8 A,B
40 Strong
Prepare a balance sheet from an alphabetical listing of accounts, and prepare a
second balance sheet and a statement of cash flows after some additional
transactions. Evaluate the company’s relative solvency at each date.
The student is asked to prepare a balance sheet from an alphabetical list of
accounts and then to prepare a second balance sheet as well as an income
statement and a statement of cash flows, after several transactions. Evaluate
the company’s relative solvency at each date.
35 Strong
2.10 A,B
30 Strong
Given an improperly prepared balance sheet, student is asked to prepare a
corrected balance sheet and to explain the proper valuation of assets,
liabilities, and owners’ equity. Stresses generally accepted accounting
principles.
Given a balance sheet and supplementary information concerning the assets
and liabilities, the student is asked to prepare a corrected balance sheet and to
explain the violations that exist as to asset valuation and the entity concept.
Stresses GAAP.
2.9 A,B
30 Medium
2.2
30 Strong*
Students are to obtain an annual report from the library and answer questions
about the company’s balance sheet, income statement, and statement of cash
flows. Suitable assignment for groups or individuals.
Students are to prepare a realistic balance sheet for a hypothetical
business—the nature of which is specified by the instructor. Challenges the
student to think about the types of assets and liabilities arising in an actual
business. Suitable assignment either for groups or individuals.
2.1
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Using a Balance Sheet
Using Statements of Cash Flow
on hand.
Ethics and Window Dressing
2.6 Public Company Accounting Oversight Board
30 Easy
Ethics, Fraud & Corporate Governance
Gathering Financial Information
Internet
30 Medium
Students locate the PCAOB and state the mission, identify the members, and
describe the authority and responsibility of the PCAOB.
2.5
2.3
2.4
2.7
25 Easy
Visit EDGAR, the SEC’s database, and gather financial information about
Cisco Systems. A user-friendly “meet EDGAR” type of problem.
30 Medium
A tried-and-true case in which students are to evaluate the financial position of
two similar companies first from the viewpoint of a short-term creditor and
then from the viewpoint of a buyer of the business. We always use this one.
35 Medium
Students are presented with abbreviated cash flow information and asked to
decide which is in a stronger position. An excellent way to show that how a
company generates its cash is equally important to how much cash it has
Students are to distinguish between legitimate window dressing and fraudulent
misrepresentation. Allows introduction of ethics, securities laws, and the role
of independent audits.
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1.
2.
3.
4.
5.
6.
The basic accounting equation is assets = liabilities + owners’ equity. Assets are resources
owned by the company that are used in carrying out its business activities. Liabilities are
debts owed by the enterprise, and owners’ equity is the interest of the owners in the
enterprise’s assets.
The going concern assumption states that in the absence of evidence to the contrary (i.e.,
bankruptcy proceedings), an enterprise is expected to continue to operate in the foreseeable
future. This means, for example, that it will continue to use the assets it has in its financial
statements for the purpose for which they were acquired. Under the going concern
assumption, all elements in the financial statements are based on an assumption that the
business will continue for the foreseeable future.
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
Many of these questions are well suited to classroom discussions. These discussions can stimulate
students’ interest, help develop verbal skills, and provide instructors with an opportunity to introduce
ideas and situations not discussed in the text. If class size permits, we also encourage instructors to
review and evaluate selected written assignments throughout the course.
The basic purpose of accounting is to provide decision makers with information useful in
making economic decisions.
A knowledge of accounting terms and concepts is useful to persons other than professional
accountants because nearly everyone working in business, government, or the professions
will encounter these terms and concepts. Supervisors and managers at every level use
financial statements, budgets, or other forms of accounting reports. Investment in securities
or real estate also calls for the understanding and use of accounting information. In every
election, propositions on the ballot and in the platforms of candidates can be much better
understood by voters who are familiar with accounting. Accounting information is also
useful to individuals in handling their personal financial affairs. In short, all economic
activity is supported by accounting information.
Revenues result from transactions in which goods or services are transferred (i.e., sold) to
customers. Expenses are costs associated with earning revenues. Revenues result in positive
cash flows, while expenses result in negative cash flows. An enterprise’s net income is
determined as the excess of revenues over expenses for a period of time. If expenses exceed
revenues, however, the difference is called a net loss.
Business transactions affect a company’s financial position, and as a result, they change the
statement of financial position or balance sheet. The other financial statements—the income
statement and the statement of cash flows—are detailed expansions of certain aspects of the
statement of financial position and help explain in greater detail how the company’s
financial position changed over time.
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7.
8. a.
b.
9.
10.
11.
12. Adequate disclosure refers to the requirement that financial statements, including
accompanying notes, must include information necessary for reasonably informed users of
financial statements to understand the company’s financial activities. This requirement is met,
in part, by the addition of notes to the financial statements. Financial statement notes include
both quantitative and qualitative information that is not included in the body of the financial
statements.
Operating activities—Cash provided by and used in revenue and expense transactions.
Investing activities—Cash provided by and used as a result of investments in assets, such as
machinery, equipment, land, and buildings.
Financial statements—the balance sheet, income statement, statement of cash flows—are all
based on the same underlying transactions. They reflect different aspects of the enterprise’s
activities. Their relationship is referred to as “articulation.” For example, the revenues and
expenses in the income statement result from changes in the assets and liabilities in the
balance sheet and their cash effects are presented in the operating activities section of the
statement of cash flows.
Financing activities—Cash provided by and used in debt and equity financing, such as
borrowing and repaying loans, and new capital received from investors and dividends paid to
the enterprise’s owners.
Positive cash flows means that cash increases. Negative cash flows means that cash decreases.
Generally, revenues result in positive cash flows—either at the time of the revenue transaction,
earlier, or later. Expenses result in negative cash flows—either at the time the expense is
incurred, earlier, or later.
The three categories and the information included in each are:
No, a business transaction could not affect only a single asset. There must be an offsetting
change elsewhere in the accounting equation. If the transaction increases an asset, for
example, it must reduce another asset, increase a liability, or increase owners’ equity (or some
combination of these). On the other hand, if the transaction decreases an asset, it must increase
another asset, decrease a liability, or decrease owners’ equity (or some combination of these).
An example of a transaction that would cause one asset to increase and another asset to
decrease without any effect on the liabilities or owners’ equity is the receipt of cash in
collection of an account receivable. Another common example is the payment of cash to
buy land, a building, office equipment, or other assets.
An example of a transaction that would cause both total assets and total liabilities to
increase without any effect on the owners’ equity is the purchase of an asset on credit. The
acquisition of the asset could be entirely on credit or could involve a partial cash payment
with the balance on credit. Another example is an increase in cash as a result of borrowing
from a bank.
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13.
14.
15.
A strong income statement is one that has significantly more dollars of revenue than expenses,
resulting in net income that is a relatively high percentage of the revenue figure. A trend of
relatively high income numbers over several accounting periods signals a particularly strong
income situation.
A strong statement of cash flows is one that shows significant amounts of cash generated from
operating activities. This means that the enterprise is generating cash from its ongoing
activities and is not required to rely heavily on debt and equity financing, or on the sale of its
major assets, to finance its daily operations. A trend of relatively high cash flows provided by
operations numbers over several accounting periods signals a particularly strong cash flow
situation.
The term “window dressing” refers to enhancing the appearance of the enterprise’s financial
statements by taking certain steps near the end of the financial reporting period. While some
steps that may be taken, or delayed, are appropriate, care must be taken that steps taken are not
unethical or illegal.
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B. Ex. 2.1
B. Ex. 2.2
B. Ex. 2.3
B. Ex. 2.4
B. Ex. 2.5
B. Ex. 2.6
B. Ex. 2.7
Increases in cash:
Revenues
$100,000
Sale of land
10,000
Borrowing from bank
15,000
$125,000
Decreases in cash:
Expenses
56,000
Purchase of truck
25,000
(81,000)
Net increase in cash
$44,000
B. Ex. 2.8
Joe Solway, Capital
$25,000
Tom Solway, Capital
25,000
$50,000
B. Ex. 2.9
Capital stock
$40,000
Retained earnings
10,000
$50,000
$70,000 (total equity) - $50,000 (capital stock) = $20,000 (retained earnings)
SOLUTIONS TO BRIEF EXERCISES
Walters Company's assets (machinery) will increase by $20,000. The company's liabilities will
also increase by $20,000 to include the new obligation the company has assumed.
Foster Inc.'s assets will increase by a net amount of $30,000. Cash will decrease by $5,000 and
the truck account will increase by $35,000, a net increase of $30,000. The company's liabilities
will also increase by $30,000 to reflect the new obligation that has been assumed.
$155,000 (assets) - $85,000 (liabilities) = $70,000 (total equity)
$135,000 (revenues) - $50,000 (expenses) = $85,000 net income
Note: The year-end cash balance of $35,000 does not affect the amount of net income.
Yes, the company has liabilities because its assets exceed its capital stock and its retained
earnings. $780,000 (assets - [$500,000 + 150,000](equity) = $130,000 (liabilities)
$300,000 (revenues) - $205,000 (expenses) = $95,000 (net income)
Note: The purchase of land for $55,000 does not affect net income.
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B. Ex. 2.10
50,000
$
Add:
20,000

25,000

95,000
$
Net income for 2015……………………………
Balance, December 31, 2015…………………………………
The end-of-year balance of owner’s equity in the balance sheet is $95,000.
This amount articulates with the amount of net income in the income
statement because net income is added to the amount of beginning owner’s
equity, plus additional investment, to determine the ending balance that
appears in the December 31 statement of financial position. The
accounting equation stays in balance because the amount of net income is
reflected in changes in the balances of various assets and liabilities that are
also presented in the balance sheet.
Ben Washington, owner’s equity:
Balance, January 1, 2015……………………………………
Investment during 2015…………………………
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Ex. 2.1
a.
1.
2.
b.
1.
2.
Liabilities:
$79,000
$288,000
70,000
36,000
14,000
$324,000
165,000
Owners’ equity:
80,000
92,000
70,000
62,000
$478,000
$478,000
Capital stock……………………..
SOLUTIONS TO EXERCISES
Assets are economic resources owned by the business entity.
Among the assets of American Airlines we might expect to find
investments, accounts receivable (say, from travel agents), fuel (in
storage), maintenance supplies, aircraft, and various types of equipment.
The company also owns land and buildings—as, for example, its corporate
headquarters.
Among the assets of a professional sports team are investments (in stocks and
bonds), notes receivable (often from players), training equipment, supplies, and
office furniture. (The balance sheet of a professional sports team may not
include land or buildings, as they generally do not own the stadiums in which
they play.)
Liabilities & Owners' Equity
Notes payable …………………….
Accounts payable …………………
Total liabilities………………..
Assets
Cash ……………………….
Accounts receivable ………
Supplies ……………………
Automobiles ………………
Building …………………..
Land …………………..
Total ………………………
Total…………………………………
Retained earnings………………..
Note to instructor: You may wish to expand this solution to include intangible assets, such as the
team’s league franchise, and player contracts, the right to receive the future services of a given
player. (Player contracts only appear as an asset if they have a cost—that is, if they were
purchased from other teams. Advance payments to players usually are shown as prepaid
expenses.) We address intangible assets in Chapter 9, but the concept is consistent with the
discussion of assets in Chapter 2.
Liabilities are existing debts and other obligations of the entity.
Among the liabilities of American Airlines, we might expect to find accounts
payable, notes payable (or mortgages or bonds payable) stemming from
purchases of aircraft, salaries payable, interest payable, rent payable (for space
in airports), and income taxes payable.
The balance sheet of a professional sports team might include accounts payable,
rent payable (for the stadium), salaries payable, interest payable, and income
taxes payable.
Note to instructor: In a classroom discussion, you might want to point out that both an airline
and a professional sports team may have liabilities for unearned revenue. The airline sells many
tickets in advance, thus incurring an obligation to render services (flights) or to refund the
customers’ money. A sports team has a similar obligation with respect to advance sales of tickets,
particularly season tickets. We discuss unearned revenue in Chapter 4, but the concept can be
introduced earlier at the instructor’s discretion.
Ex. 2.2
WILLIS TRANSPORTATION SERVICE
Balance Sheet
February 28, 2015
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$36,300
Liabilities:
56,700
Notes payable ………………………… $207,000
12,400
Accounts payable ………………………
43,800
210,000
$250,800
90,000
Owners’ equity:
Capital stock ……………………………
88,000
66,600
$405,400
$405,400
Ex. 2.4
a.
b.
c.
Ex. 2.5
a.
b.
c.
The amount of retained earnings is calculated as the difference between total assets
and liabilities plus capital stock: $405,400 – ($250,800 + $88,000) = $66,600
The supplies should be presented at $1,400 in World-Wide’s balance sheet.
Presenting the supplies at their estimated liquidation value violates the assumption
that World-Wide is a going concern, and will use these supplies in normal business
operations, rather than sell them on the open market. The $500 amount also
violates the objectivity principle, as it is largely a matter of personal opinion.
$293,000: Assets $635,000  liabilities $342,000 = owners’ equity $293,000
$1,172,500: Liabilities $562,500 + owners’ equity $610,000 = assets $1,172,500
$120,300: Assets $307,500  owners’ equity $187,200 = liabilities $120,300
The presentation of the two land parcels at a combined value of $340,000 in the
2015 balance sheet conforms to generally accepted accounting principles. This
treatment illustrates both the cost principle and the stable-dollar assumption.
The presentation of the computer system at $14,000 in the December 31, 2015
balance sheet conforms to generally accepted accounting principles, as this is the
cost of the system, and at the balance sheet date, it was an asset owned by the
company. The retail value of $20,000 is not presented in the balance sheet, as his
amount is not the cost incurred by the entity, nor is it an objective measurement.
However, the company’s failure to disclose the loss of the equipment subsequent to
the balance sheet date may violate the principle of adequate disclosure. To properly
interpret the company’s balance sheet, users may need to be aware that this asset
no longer exists. Several issues must be considered in deciding whether or not
disclosure of the burglary loss is necessary. For example, was the asset insured?
And is a $14,000 asset significant (material) in relation to the assets and operations
of this business? Is this amount large enough that it might impact investors’ and
creditors’ decisions regarding the company?
Balance Sheet
December 31, 2011
Total………………………………………
Retained earnings ……………………
Total …………………………
Total liabilities…………………………
Liabilities & Owners' Equity
Cash …………………………
Ex. 2.3
KINER COMPANY
Assets
Accounts receivable …………
Office Equipment ……………
Building ……………………..
Land…………….


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Ex. 2.6
Assets
=
Liabilities
+
Owners’
I
I
NE
NE*
NE
NE
D
D
NE
D
D
NE
I
NE
I
I
I
NE
I
NE
I
NE*
NE
NE
NE*
NE
NE
Ex. 2.7
a.
b.
c.
d.
e.
Ex. 2.8
a.
$ 390,000
$ 240,000
150,000
$ 390,000
$ 270,000
120,000
$ 390,000
Retained earnings ……………………………………………………
Total stockholders' equity ………………………………………
*Capital stock = 27 x $10,000 = $270,000. Retained earnings = $390,000 
$270,000 capital stock = $120,000.
Total …………………………………………………………….
*Yato’s capital = $390,000  Spencer's capital, $240,000 = $150,000.
(3) Stockholders' equity:
Capital Stock …………………………………………………………
(2) Partners' equity:
f
g
h
i
Note to instructor: These are examples, but many others exist.
(1) Owner's equity
Transaction
a
b
c
d
e
Johanna Spencer, capital ……………………………………………
Mikki Yato, capital …………………………………………………
*Could be I/D offsetting
The purchase of office equipment (or any other asset) on credit will cause an increase
in the asset (office equipment) and an increase in a liability.
The cash payment of an account payable or note payable will cause a decrease in the
asset cash and a decrease in the liability paid.
The collection of an account receivable will cause an increase in one asset (cash) and
a decrease in another asset (accounts receivable). Other examples include the
purchase of land for cash, and the sale of land for cash.
The investment of cash in the business by the owners will cause an increase in an
asset (cash) and an increase in the owners’ equity.
The purchase of an automobile (or other asset) paying part of the cost in cash and
promising to pay the remainder at a later time would cause an increase in one asset
(automobile), a decrease in another asset (cash), and an increase in a liability by the
amount of the unpaid portion.
Johanna Spencer, capital ………………………………………….
*$850,000 in assets  $460,000 in liabilities = $390,000.
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b.
Ex. 2.9
a.
b.
c.
d.
Ex. 2.10
a.
b.
The situations encountered in the practice of accounting and auditing are too
complex and too varied for all specific answers to be set forth in a body of official
rules. Therefore, individual accountants must resolve many situations based upon
their general knowledge of accounting, their experience, and their ethical
standards—in short, their professional judgment.
Accountants must rely on their professional judgment in such matters as
determining (three required) (1) how to record an unusual transaction that is not
discussed in accounting literature, (2) whether or not a specific situation requires
disclosure, (3) what information will be most useful to specific decision makers, (4)
how an accounting system should be designed to operate most efficiently, (5) the
audit procedures necessary in a given situation, (6) what constitutes a fair
presentation of financial information, (7) whether specific actions are ethical and
are in keeping with the accountants’ responsibilities to serve the public interests.
Accounts payable is a liability that requires payment, usually in the near future and
usually by paying cash. Thus, existing accounts payable detract from liquidity.
Accounts receivable are assets that will shortly convert into cash as payments are
received from customers. Therefore, they contribute to the company’s liquidity.
The capital stock account is the owners’ equity in the business. It represents
amounts originally invested in the business by the owners, but says nothing about
the form in which the company now holds these resources—nor even whether the
resources are still on hand. Thus, the capital stock account has no direct effect upon
liquidity. On the other hand, the amount of the owners’ equity, related to the
amount of the liabilities is an important factor in evaluating liquidity.
Yes; the form of Spencer's organization is relevant to a lender. If the company is
not incorporated, the owner or owners are personally liable for the debts of the
business organization. Thus, if the business is organized as a sole proprietorship, it
is actually Spencer’s personal debt-paying ability that determines the collectibility
of loans to the business. If the business is a partnership, all of the partners are
personally liable for the company’s debts.
On the other hand, if Spencer is organized as a corporation, a lender may look only
to the corporate entity for payment.
Note to instructor: You may wish to point out that some lenders would not make sizable loans to a
small corporation unless one or more of the stockholders personally guaranteed the loan. This is
accomplished by having the stockholder(s) cosign the note.
Cash is the most liquid of all assets. In fact, companies must use cash in paying most
bills. Therefore, cash contributes more to a company’s liquidity than any other
asset.
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Cash received from revenues …………………………………
Cash paid for expenses ………………………………………
Net cash provided by operating activities ……………………

4,400

(2,500)

Cash flows from financing activities:
Cash received from sale of capital stock ……………………
Cash used to repay bank loans ………………………………
Net cash provided by financing activities ……………………
4,500
6,400
$
Cash balance, October 1, 2011 …………………………………
7,450

13,850
$
$ 9,850
Expenses ……………………………………………………………………….. 5,465
$ 4,385
$ 17,000
7,800
$ 9,200
 Investment by stockholders
 Loan from bank
 Payments to long-term creditors
 Purchase of land
The following four items represent cash flows, but are not revenues or expenses that
are in the income statement:
Income Statement
For the Month Ended August 31, 2015
Service revenues ……………………………………���…………………………
(3,000)
$
Net income ………………………………………………………………………
PRESTWICK COMPANY
Expenses …………………………………………………………………………
Revenues …………………………………………………………………………
Net income ………………………………………………………………………
Income Statement
Ex. 2.11
WELLER COMPANY
Statement of Cash Flows
For the Month Ended October 31, 2015
Ex. 2.13
Ex. 2.12
JIMINEZ, INC.
Cash paid for equipment ……………………………………………….
For the Month Ended March 31, 2015
The cash received from bank loans is a positive cash flow—financing activity—in the
statement of cash flows, but is not included in the income statement. Dividends paid to
stockholders are a negative cash flow—financing activity—in the statement of cash
flows, but are not included in the income statement.
Cash flows from operating activities:
12,000
$
(7,600)
$
Increase in cash ……………………………………………………
Cash flows from investing activities:
Cash balance, October 31, 2011 …………………………………
7,500
$
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17,000
$
(7,800)


9,200
(16,000)
15,000
$
5,000

(11,700)

8,300

1,500
$

7,200


8,700

Cash flows from financing activities:
Cash balance, August 1, 2015 …………���………………………
Cash balance, August 31, 2015 ……………………………………
Statement of Cash Flows
For the Month Ended August 31, 2015

Increase in cash
Cash received from investment by stockholders ……………
Cash paid to long-term creditors ……………………………
Cash received from bank loan ……………………………
Ex. 2.14
Cash received from revenues …………………………………
Cash paid for expenses ………………………………………
Net cash provided by operating activities ……………………
Cash paid for purchase of land ………………………………
Cash flows from operating activities:
Cash flows from investing activities:
PRESTWICK COMPANY
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Ex. 2.15
Steps to Window Dress
IS—No impact
BS—Higher cash balance
BS—Higher cash and liability balances
Impact on Financial Statements*
BS—Higher cash balance
IS—No impact
SCF—Higher cash from operating activities
SCF—Higher cash flow from financing activities
SCF—Lower cash used in investing activities
BS—Reduced cash and liability balances
Delay cash payment of expenses
at year-end (assume expense
already incurred)
Accelerate payment of liabilities
at year-end
SCF—Lower cash balance
Delay purchase of equipment (or
other noncurrent asset)
BS—Higher receivables and owners’ equity
IS—No impact
Note to instructor: Many examples of steps to improve the financial statements could
be cited. The ones listed below are those that the authors believe are most likely to be
identified by students.
SCF—No impact (assuming receivables not
Acceleration of credit sales at
year-end
IS—No impact
SCF—Higher cash flow from financing activities
IS—No impact
balances
Year-end borrowing
BS—Higher cash and owners’ equity balances
*BS = Balance sheet; IS = Income statement; SCF = Statement of cash flows
Year-end investment by owner
IS—Higher sales and net income
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Ex. 2.16
a.
b.
End
Beginning
c.
debt ($9,475 million), followed by accounts payable ($5,376 million).
Ex. 2.17
Net income as a percentage of revenue for each year is as follows:
2010: $1,263/$108,702 = 1.16%
2011: $1,202/$112,084 = 1.07%
Home Depot reports a net income (earnings) of $4,535 million for the year ended
February 3, 2013.
Cash balances at the beginning and end of the year were:
$2,494 million
$1,987 million
The trend is variable. In all three years, the percentage of net income to revenues is slightly
above 1%. Despite this somewhat negative trend in the percentage of net income to revenue, the
absolute dollar amounts of net income are quite large, and the most current year (2012) is a
significant improvment over 2011. Revenues have grown steadily over the period, which is a
positive sign. It declines in 2011, then returns in 2012 to almost the same percentage as in 2010.
The three largest causes of decreases in cash during the year were capital
expenditures ($1,312 million), repurchases of common stock ($3,984 million), and
cash dividends paid to stockholders ($1,743 million).
2012: $1,403/$122,734 = 1.14%
The largest asset is property and equipment ($38,491 million - $14,422 million:
$24,069 million) followed by merchandise inventory ($10,710 million). The
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a.
Liabilities & Owners' Equity
Cash
31,400
$
Liabilities:
Accounts receivable
10,600

Accounts payable
54,800
$
Furnishings
58,700

Salaries payable
33,500

Equipment
39,200

Interest payable
12,000

Snowmobiles
15,400

Notes payable
620,000

Buildings
500,000

720,300
$
Land
425,000

Owners' equity:
Capital stock
135,000

Retained earnings (1)
225,000

Total
1,080,300
$
Total
1,080,300
$
(1) Computed as total assets, $1,080,300, less total liabilities, $720,300, less capital stock,
$ 135,000.
b.
SOLUTIONS TO PROBLEMS SET A
PROBLEM 2.1A
ROCKY MOUNTAIN LODGE
15 Minutes, Easy
Note to instructor: Students were asked to base their answers to part b on the balance sheet alone.
Students may correctly point out that a balance sheet does not indicate the rate at which cash
flows into a business. Perhaps the company can generate enough cash from daily operations to pay
its debts. A recent statement of cash flows would be useful in making a more complete analysis of
the company's financial position.
Assets
ROCKY MOUNTAIN LODGE
Balance Sheet
December 31, 2015
The balance sheet indicates that Rocky Mountain Lodge is in a weak financial position.
The highly liquid assets—cash and receivables—total only $42,000, but the company has
$100,300 of debts due in the near future (accounts payable, salaries payable, and interest
payable).
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15 Minutes, Easy
a.
b.
c.
d.
e.
f.
PROBLEM 2.2A
$15,000 cash was received from the sale of capital stock.
Purchased equipment on account for $7,500.
MEMPHIS MOVING COMPANY
Purchased equipment at a cost of $13,500; paid $3,500 cash as down payment and incurred a
liability (account payable) for the remaining $10,000.
Paid $14,500 of accounts payable.
Received $900 cash from collection of accounts receivable.
Purchased equipment for cash at a cost of $3,200.
Description of transactions:
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15 Minutes, Medium
Owners'
Assets
=
Equity
Office
Notes
Accounts
Capital
Cash + Equipment + Building +
Land =
Payable +
Payable +
Stock
December 31 balances
37,000
$
51,250
$
125,000
$
95,000
$
80,000
$
28,250
$
200,000
$
(1)
35,000

35,000

Balances
72,000
$
51,250
$
125,000
$
95,000
$
80,000
$
28,250
$
235,000
$
(2)
(22,500)

55,000

35,000
67,500

Balances
49,500
$
51,250
$
180,000
$
130,000
$
147,500
$
28,250
$
235,000
$
(3)

9,500

9,500

Balances
49,500
$
60,750
$
180,000
$
130,000
$
147,500
$
37,750
$
235,000
$
(4)
20,000

20,000


Balances
69,500
$
60,750
$
180,000
$
130,000
$
167,500
$
37,750
$
235,000
$
(5)
(22,250)
$

(22,250)
$
Balances
47,250
$
60,750
$
180,000
$
130,000
$
167,500
$
15,500
$
235,000
$


MAXWELL COMMUNICATIONS
Liabilities +
PROBLEM 2.3A
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15 Minutes, Medium
Owners'
Assets
=
Equity
Accounts
Office
Notes
Accounts
Capital
Cash + Receivable + Equipment + Trucks = Payable +
Payable +
Stock
December 31 balances
9,500
$
13,900
$
3,800
$
68,000
$
20,000
$
10,200
$
65,000
$
(1)
(2,700)

2,700

Balances
6,800
$
13,900
$
6,500
$
68,000
$
20,000
$
10,200
$
65,000
$
(2)
4,000

(4,000)


Balances
10,800
$
9,900
$
6,500
$
68,000
$
20,000
$
10,200
$
65,000
$
(3)
(3,200)


(3,200)

Balances
7,600
$
9,900
$
6,500
$
68,000
$
20,000
$
7,000
$
65,000
$
(4)
10,000

10,000


Balances
17,600
$
9,900
$
6,500
$
68,000
$
30,000
$
7,000
$
65,000
$
(5)
(15,000)

30,500

15,500

Balances
2,600
$
9,900
$
6,500
$
98,500
$
45,500
$
7,000
$
65,000
$
(6)
85,000

85,000

Balances
87,600
$
9,900
$
6,500
$
98,500
$
45,500
$
7,000
$
150,000
$
PHILLIPS TRUCK RENTAL
Liabilities +
PROBLEM 2.4A
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20 Minutes, Medium
a.
Liabilities & Owners' Equity
Cash *
22,520
$
Liabilities:
Notes receivable
9,500

Notes payable
180,000
$
Accounts receivable
7,450

Accounts payable
26,100

Animals
189,060

Salaries payable
9,750

Cages
24,630

Total liabilities
215,850
$
Costumes
31,500

Owners' equity:
89,580

Capital stock
300,000

Tents
63,000

Retained earnings
27,230

Trucks & wagons
105,840



Total
$543,080
Total
$543,080

*
b.

PROBLEM 2.5A
HERE COME THE CLOWNS!
The loss of an asset, Tents, from a fire would require a revised balance sheet that reflects a decrease
in total assets. When total assets are decreased, the other balance sheet total (that is, the total of
liabilities and owners’ equity) must also decrease. Since there is no change in liabilities as a result of
the destruction of an asset, the decrease on the right-hand side of the balance sheet must be in owners'
equity---specifically, the retained earnings account. The amount of the decrease in the assets Tents,
in Retained earnings, and in both balance sheet totals, is $14,300.
HERE COME THE CLOWNS!
Balance Sheet
Props and equipment
June 30, 2015
Assets
Total liabilities and owners' equity, $543,080, minus total of all other assets, $520,560 ($9,500 +
$7,450 + $189,060 + $24,630 + $31,500 + $89,580 + $63,000 + $105,840).
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20 Minutes, Medium
a.
Liabilities & Owners' Equity
Cash
16,710
$
Liabilities:
Accounts receivable
22,365

Notes payable
330,000
$
Barns and sheds
78,300

Accounts payable
77,095

Citrus trees
76,650

Property taxes payable
9,135

Livestock
120,780

Wages payable
5,820

20,125

Total liabilities
422,050
$
Farm machinery
42,970

Owners' equity:
Fences & gates
33,570

Capital stock
290,000

Land
490,000
Retained earnings *
189,420

Total
901,470
$
Total
901,470
$

b.
PROBLEM 2.6A
ALEXANDER FARMS, INC.
September 30, 2015
Assets
*Total assets, $901,470, minus total liabilities, $422,050, less capital stock, $290,000.
The loss of an asset, Barns and Sheds, from a tornado would cause a decrease in total assets. When
total assets are decreased, the balance sheet total of liabilities and owners’ equity must also decrease.
Since there is no change in liabilities as a result of the destruction of an asset, the decrease on the
right-hand side of the balance sheet must be in the retained earnings account. The amount of the
decrease in Barns and Sheds, in the owners’ equity, and in both balance sheet totals, is $14,000.
ALEXANDER FARMS, INC.
Balance Sheet
Irrigation system
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a.
Liabilities & Owners' Equity
Cash
6,940
$
Liabilities:
Accounts receivable
11,260

Notes payable
74,900
$
Supplies
7,000

Accounts payable
16,200

44,500

Salaries payable
8,900

Building
84,000

Total liabilities
100,000
$
Land
67,000
Owners' equity:


Capital stock
80,000



Retained earnings *
40,700

Total
220,700
$
Total
220,700
$

b.
Liabilities & Owners' Equity
Cash
14,490
$
Liabilities:
Accounts receivable
11,260

Notes payable
74,900
$
Supplies
8,250

Accounts payable
7,200

51,700

Salaries payable
8,900

Building
84,000

Total liabilities
91,000
$
67,000

Owners' equity:


Capital stock
105,000



Retained earnings
40,700

Total
236,700
$
Total
236,700
$

PROBLEM 2.7A
FRANKLIN BAKERY
35 Minutes, Medium
FRANKLIN BAKERY
Balance Sheet
Equipment & fixtures
August 1, 2015
Assets
FRANKLIN BAKERY
Balance Sheet
August 3, 2015
*Retained earnings ($40,700) = Total assets ($220,700), less total liabilities ($100,000) and capital stock
($80,000).
Assets
Land
Equipment & fixtures
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Cash flows from operating activities:

(16,200)
$

(1,250)



Cash used in operating activities:

(17,450)
$
None


Sale of capital stock

25,000
$


Increase in cash
7,550
$
Cash balance, August 1, 2015
6,940

Cash balance, August 3, 2015
14,490
$



c.
Note to instructor: The analysis of financial position strength in part c is based solely upon the balance
sheets at August 1 and August 3. Students may raise the issue regarding necessity of information about
operations, and the rate at which cash flows into the business, etc. In this problem, the improvement in
financial position results solely from the sale of capital stock.
Statement of Cash Flows

For the Period August 1-3, 2015
Franklin Bakery is in a stronger financial position on August 3 than it was on August 1.
Cash payment of accounts payable
Cash purchase of supplies
Cash flows from financing activities:
Cash flows from investing activities:
PROBLEM 2.7A
FRANKLIN BAKERY (concluded)
FRANKLIN BAKERY
On August 1, the highly liquid assets (cash and accounts receivable) total only $18,200, but the
company has $25,100 in debts due in the near future (accounts payable plus salaries payable).
On August 3, after additional infusion of cash from the sale of stock, the liquid assets total $25,750,
and debts due in the near future amount to $16,100.
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a.
Liabilities & Owners' Equity
Cash
7,400
$
Liabilities:

Accounts receivable
1,250

Notes payable *
70,000
$
Supplies
3,440

Accounts payable
8,500

20,000

Total liabilities
78,500
$
Building
45,500

Owners' equity:
Land
55,000
Capital stock
50,000



Retained earnings
4,090

Total
132,590
$
Total
132,590
$
b.
Liabilities & Owners' Equity
Cash
29,400
$
Liabilities:
Accounts receivable
1,250

Notes payable
70,000
$
Supplies
4,440

Accounts payable
18,000

Furniture and fixtures
38,000

Total liabilities
88,000
$
Building
45,500

Owners' equity:
Land
55,000
Capital stock
80,000



Retained earnings
5,590

Total
173,590
$
Total
173,590
$
5,500
$
(4,000)

1,500
$




Balance Sheet
October 6, 2015
Assets
Expenses
THE SODA SHOP
Balance Sheet
Furniture and fixtures
September 30, 2015
Assets
PROBLEM 2.8A
THE SODA SHOP
40 Minutes, Strong
THE SODA SHOP
*Total assets, $132,590 less owners’ equity, $54,090 less accounts payable, $8,500, equals notes payable.
Net income
THE SODA SHOP
Income Statement
For the Period October 1-6, 2015
Revenues
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Cash flows from operating activities:

5,500
$
Cash paid for expenses
(4,000)

Cash paid for accounts payable
(8,500)


(1,000)




(8,000)
$
None



30,000
$


Increase in cash
22,000
$
Cash balance, October 1, 2015
7,400

Cash balance, October 6, 2015
29,400
$



c.
PROBLEM 2.8A
THE SODA SHOP (concluded)
THE SODA SHOP
The Soda Shop is in a stronger financial position on October 6 than on September 30. On September
30, the company had highly liquid assets (cash and accounts receivable) of $8,650, which barely
exceeded the $8,500 in liabilities (accounts payable) due in the near future. On October 6, after the
additional investment of cash by stockholders, the company's cash alone exceeded its short-term
obligations.
Statement of Cash Flows

For the Period October 1-6, 2015
Cash received from revenues
Cash paid for supplies
Cash flows from financing activities:
Cash flows from investing activities:
Cash used in operating activities
Cash received from sale of capital stock
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a.
Liabilities & Owner's Equity
Cash
16,900
$
Liabilities:
Accounts receivable
7,200

Notes payable
15,000
$
Props and costumes
18,000

Accounts payable
3,900

Lighting equipment
9,400

Salaries payable
4,200
$


Total liabilities
23,100
$

Owner's equity:


Helen Berkeley, capital
28,400

Total
51,500
$
Total
51,500
$
b. (1)
(2)
(3)
(4)
(5)
(6)
(7)
As the automobile is not used in the business, it appears to be Anita Spencer’s personal asset
rather than an asset of the business entity. Therefore, it should not be included in the balance
sheet of the business. (Note: The advertised sales price of a similar automobile is not an
appropriate valuation figure even if the automobile were to be included.)
The accounts payable should be limited to the debts of the business, $3,900, and should not
include Anita Spencer’s personal liabilities.
Only the amount receivable from Artistic Tours ($7,200) should be included in the company’s
accounts receivable as of September 30. The amounts expected from future tickets sales do not
relate to completed transactions and are not yet assets of the business.
The props and costumes should be shown in the balance sheet at their cost, $18,000 , not at just
the portion of the cost that was paid in cash. The $15,000 note payable is a debt of the business
arising from a completed purchase transaction. Therefore, it should be included among the
company’s liabilities. The date at which this liability must be paid is not relevant.
The theater building is not owned by Spencer Playhouse. Therefore, it is not an asset of this
business entity and should not appear in the balance sheet.
The lighting equipment is an asset of the business and should be presented in the balance sheet at
its cost, $9,400.
The cash in Anita Spencer's personal savings account is not an asset of the business entity
Spencer
Playhouse. Therefore, it should not appear in the balance sheet of the business. The money on
deposit in the business bank account ($15,000) and in the company safe ($1,900) constitute cash
owned by the business. It is not necessary to state separately in the balance sheet amounts of
cash at different locations; thus, the cash owned by the business at September 30 totals
$16,900.
PROBLEM 2.9A
SPENCER PLAYHOUSE
35 Minutes, Strong
SPENCER PLAYHOUSE
Balance Sheet

September 30, 2015
Assets
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(8)
(9)
PROBLEM 2.9A
Owner’s equity is not valued at either the original amount invested or at the estimated market
value of the business. In fact, owner’s equity cannot be valued independently of the amounts
assigned to assets and liabilities. Rather, it is a residual figure—the excess of total assets over
total liabilities. (If liabilities exceed assets, owner's equity would be a negative amount.) Thus,
the amount of Anita Spencer's capital is determined by subtracting the corrected figure for total
liabilities ($23,100) from the corrected amount of total assets ($51,500). This indicates owner's
equity of $28,400.
The amount owed to stagehands for work done through September 30 is the result of completed
transactions and should be included among the liabilities of the business. Even if agreement has
been reached with Mario Dane for him to perform in a future play, he has not yet performed
and therefore, is not yet owed any money. Thus, this $25,000 is not yet a liability of the
business.
SPENCER PLAYHOUSE (concluded)
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a.
Liabilities & Owner's Equity
Cash
3,940
$
Liabilities:
Notes receivable
2,200

Notes payable
73,500
$
Accounts receivable
2,450

Accounts payable
32,700

Office Furniture*
12,825
Total liabilities
106,200
$
Building
54,320

Owner's equity:
39,000

Capital stock
5,000



Retained earnings *
3,535

Total
114,735
$
Total
114,735
$
* $8,850 + $6,500 - $2,525.
* Total assets ($114,735), Less (Total Liabilities, $106,200, + Capital Stock, $5,000)
b. (1)
(2)
(3)
(4)
(5)
(6)
(7) The accounts payable should be limited to the debts of the business, $32,700, and should not
include Pippin’s personal liabilities.
The proper valuation for the land is its historical cost of $39,000, the amount established by the
transaction in which the land was purchased. Although the land may have a current fair value in
excess of its cost, the offer by the friend to buy the land if Pippin would move the building
appears to be mere conversation rather than solid, verifiable evidence of the fair value of the
land. The "cost principle," although less than perfect, produces far more reliable financial
statements than would result if the owners could "pull figures out of the air" in recording asset
values.
The $22,400 described as “Other assets” is not an asset, because there is no valid legal claim or
any reasonable expectation of recovering the income taxes paid. Also, the payment of federal
income taxes by Pippin was not a business transaction by Big Screen Scripts. If a refund were
obtained from the government, it would come to Pippin personally, not to the business entity.
The cash in Pippin’s personal savings account is not an asset of the business entity Big Screen
Scripts and should not appear in the balance sheet of the business. The money on deposit in the
business bank account ($3,400) and in the company safe ($540) constitute cash owned by the
business. Thus, the cash owned by the business at November 30 is $3,940.
The year-old IOU from a poker game does not qualify as a business asset for two reasons. Most
importantly, it does not belong to the business entity. Also, it appears to be uncollectible. Even if
the IOU were an asset of Big Screen Scripts, a receivable that cannot be collected is not viewed
as an asset, as it represents no future economic benefit.
The total amount to be included in “Office furniture” for the rug is $9,400, the total cost,
regardless of whether this amount was paid in cash. Consequently, “Office furniture” should be
increased by $6,500. The $6,500 liability arising from the purchase of the rug came into
existence prior to the balance sheet date and must be added to the "Notes payable" amount.
The computer is no longer owned by Big Screen Scripts and therefore cannot be included in the
assets. To do so would cause an overstatement of both assets and owner's equity. The “Office
furniture” amount must be reduced by $2,525.
PROBLEM 2.10A
BIG SCREEN SCRIPTS
30 Minutes, Strong
BIG SCREEN SCRIPTS
Balance Sheet
Land
November 30, 2015
Assets
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a.
Liabilities & Owners' Equity
Cash
9,100
$
Liabilities:
Accounts receivable
3,300

Accounts payable
27,400
$
Furnishings
22,600

Salaries payable
13,200

Equipment
9,000

Interest payable
4,000

Building
430,000

Notes payable
217,000

Land
140,000

261,600
$


Owners' equity:
Capital stock (1)
127,000

Retained earnings
225,400

Total
614,000
$
Total
614,000
$
(1) Computed as total assets, $614,000, less total liabilities, $261,600, less retained earnings,
$225,400