MANAGEMENT ACCOUNTING - Solutions Manual

CHAPTER 3
UNDERSTANDING FINANCIAL STATEMENTS
I. Questions
1. A financial statement is a means of communicating information about an
enterprise in financial (i.e., peso) terms. It represents information that the
accountant believes is a true and fair representation of the financial
activity of the enterprise.
2. Every financial statement relates to time in one way or another. A
statement of financial position, or balance sheet, represent a picture! of
the enterprise at a point in time (e.g., the end of a month or year). An
income statement and a statement of cash flows, on the other hand, cover
activity that too" place over a period of time (e.g., a month or year).
#. a. $reditors are interested in financial statements to assist them in
evaluating the ability of a business to repay its debts. %o one wants
to e&tend credit to a company that is unable to meet its obligations as
they come due.
b. 'otential investors use financial statements in selecting among
alternative investment opportunities. (hey are interested in investing
in companies in which the value of their investment will increase as a
result of future profitable operations.
c. )abor unions are interested in financial statements because the
financial position of a company and its profits are important factors in
the company*s ability to pay higher wages and to employ more
people.
+. ,usiness transactions affect a company*s financial position, and as a
result they change the statement of financial position or balance sheet. (he
other financial statements - the income statement and the statement of
cash flows - are detailed e&pansions of certain aspects of the statement of
financial position and help e&plain how the company*s position changed
over time.
.. (he cost principle indicates that many assets are included in the financial
records, and therefore, in the statement of financial position, at their
original cost to the reporting enterprise. (his principle affects accounting
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Chapt! 3 Understanding Financial Statements
for assets in several ways, one of which is that the amount of most assets
is not ad/usted periodically for changes in the mar"et value of the assets.
Instead, cost is retained as the basic method of accounting, regardless of
changes in the mar"et value of those assets.
0. (he going concern assumption states that in the absence of evidence to the
contrary (i.e., ban"ruptcy proceedings), an enterprise is e&pected to
continue to operate in the foreseeable future. (his means, for e&ample,
that it will continue to use the assets it has in its financial statements for
the purpose for which they were ac1uired.
2. (he three categories and the information included in each are3
4perating activities - $ash provided by and used in revenue and e&pense
transactions.
Investing activities - $ash provided by and used as a result of investments
in assets, such as machinery, e1uipment, land, and buildings.
5inancial activities - $ash provided by and used in debt and e1uity
financing, such as borrowing and repaying loans, and investments from
and dividends paid to the enterprise*s owners.
6. Ade1uate disclosure refers to the re1uirement that financial statements,
including accompanying notes, must include information necessary for
reasonably informed users of financial statements to understand the
company*s financial activities. (his re1uirement is often met, in part, by
the addition of notes to the financial statements. 5inancial statement notes
include both 1uantitative and 1ualitative information that is not included
in the body of the financial statements.
7. A strong income statement is one that has significantly more pesos of
revenue than e&penses, resulting in net income that is a relatively high
percentage of the revenue figure. A trend of relatively high income
numbers over time signals a particularly strong income situation.
18. A strong statement of cash flows is one that shows significant amounts of
cash generated from operating activities. (his means that the enterprise is
generating cash from its ongoing activities and is not re1uired to rely on
continuous debt and e1uity financing, or the sale of its ma/or assets.
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Understanding Financial Statements Chapt! 3
11. (he purpose of classifications in financial statements is to develop useful
subtotals, which help users analy9e the statements. (he most commonly
used classifications are3
In a balance sheet3 current assets, plant and e1uipment, other assets,
current liabilities, long:term liabilities and e1uity.
In a multiple-step income statement3 revenue, cost of goods sold,
operating e&penses, and nonoperating items. (he operating e&pense
section often includes subclassifications for selling e&penses and for
general and administrative e&penses.
In a statement of cash flows3 operating activities, investing activities, and
financing activities.
12. In classified financial statements, similar items are grouped together to
produce subtotals which may assist users in their analyses. Comparative
financial statements show financial statements for two or more time
periods in side:by:side columns. Consolidated statements include not
only the financial statement amounts for the company itself but also for
any subsidiary companies that it owns. (he financial statements of large
corporations often possess all three of these characteristics.
1#. In a multiple:step income statement, different categories of e&penses are
deducted from revenue in a series of steps, thus resulting in various
subtotals, such as gross profit and operating income. In a single:step
income statement, all e&penses are combined and deducted from total
revenue in a single step. ,oth formats result in the same amount of net
income.
II. Matching Type
1.
1. d #. a .. e 2. f 7. c
2. g +. / 0. h 6. b 18. i
2.
1. d #. i .. m 2. h 7. f 11. b 1#. e
2. a +. g 0. c 6. n 18. " 12. / 1+. l
#.
a. 5 c. 5 e. I g. 5 I. I ". 5
b. I d. I f. 5 h. 5 /. 5 l. I
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Chapt! 3 Understanding Financial Statements
III. Problems
P!o#l$ 1 %P!pa!in& a 'alan( Sht ) A S(on* P!o#l$+
Requirement (a)
;< 5arms
,alance ;heet
;eptember #8, 288.
Assets Liabilities and Equity
$ash ' 10,218 )iabilities3
Accounts receivable 22,#0. %otes payable '.#8,888
)and ..8,888 Accounts payable 22,87.
,arns and sheds 26,#88 'roperty ta&es payable 7,1#.
$itrus trees 20,0.8 =ages payable 1,628
)ivestoc" 128,268 (otal liabilities '016,8.8
Irrigation system 28,12. E1uity3
5arm machinery +2,728 ;hare capital 2.8,888
5ences > gates ##,.28 ?etained earnings@ 7#,+28
(otal '701,+28 (otal '701,+28
@ (otal assets, '701,+28, minus total liabilities, '016,8.8, less share capital,
'2.8,888.
Requirement (b)
(he loss of an asset, ,arns and ;heds, from a typhoon would cause a decrease
in total assets. =hen total assets are decreased, the balance sheet total of
liabilities and e1uity must also decrease. ;ince there is no change in liabilities
as a result of the destruction of an asset, the decrease on the right:hand side of
the balance sheet must be in the retained earnings account. (he amount of the
decrease in ,arns and ;heds, in the e1uity, and in both balance sheet totals, is
'2#,688.
P!o#l$ " %P!pa!in& a 'alan( Sht an* Cash Flo, Stat$nt- E..(ts
o. 'usinss T!ansa(tions+
Requirement (a)
(he (asty ,a"ery
,alance ;heet
August 1, 288.
Assets Liabilities and Equity
$ash ' 0,7+8 )iabilities3
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Understanding Financial Statements Chapt! 3
Accounts receivable 11,208 %otes payable ' 2+,788
;upplies 2,888 Accounts payable 10,288
)and 02,888 ;alaries payable 6,788
,uilding 6+,888 (otal liabilities '188,888
E1uipment and fi&tures ++,.88 E1uity3
;hare capital 68,888
?etained earnings +8,288
(otal '228,288 (otal '228,288
Requirement (b)
(he (asty ,a"ery
,alance ;heet
August #, 288.
Assets Liabilities and Equity
$ash ' 1+,+78 )iabilities3
Accounts receivable 11,208 %otes payable ' 2+,788
;upplies 6,2.8 Accounts payable 2,288
)and 02,888 ;alaries payable 6,788
,uilding 6+,888 (otal liabilities ' 71,888
E1uipment and fi&tures .1,288 E1uity3
;hare capital 18.,888
?etained earnings +8,288
(otal '2#0,288 (otal '2#0,288
(he (asty ,a"ery
;tatement of $ash 5lows
5or the 'eriod August 1 : #, 288.
$ash flows from operating activities3
$ash payment of accounts payable '(10,288)
$ash purchase of supplies (1,2.8)
$ash used in operating activities '(12,+.8)
$ash flows from investing activities3
%one
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Chapt! 3 Understanding Financial Statements
$ash flows from financing activities3
;ale of share capital '2.,888
Increase in cash ' 2,..8
$ash balance, August 1, 288. 0,7+8
$ash balance, August #, 288. '1+,+78
Requirement (c)
(he (asty ,a"ery is in a stronger financial position on August # than it was
on August 1.
4n August 1, the highly li1uid assets (cash and accounts receivable) total only
'16,288, but the company has '2.,188 in debts due in the near future
(accounts payable plus salaries payable).
4n August #, after additional infusion of cash from the sale of stoc", the
li1uid assets total '2.,2.8, and debts due in the near future amount to
'10,188.
ote to !nstructor3 (he analysis of financial position strength in re1uirement
(c) is based solely upon the balance sheets at August 1 and August #.
Aopefully, students will raise many legitimate issues regarding necessity of
information about operations, rate at which cash flows into the business, etc.
In this problem, the improvement in financial position results solely from the
sale of share capital.
P!o#l$ 3 %P!pa!in& Finan(ial Stat$nts- E..(ts o. 'usinss
T!ansa(tions+
Requirement (a)
(he 5irst <alt ;hop
,alance ;heet
;eptember #8, 288.
Assets Liabilities and Equity
$ash ' 2,+88 )iabilities3
Accounts receivable 1,2.8 %otes payable@ ' 28,888
;upplies #,++8 Accounts payable 6,.88
)and ..,888 (otal liabilities ' 26,.88
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Understanding Financial Statements Chapt! 3
,uilding +.,.88 E1uity3
;hare capital .8,888
5urniture > fi&tures 28,888 ?etained earnings +,878
(otal '1#2,.78 (otal '1#2,.78
@ (otal assets, '1#2,.78, less e1uity, '.+,878, less accounts payable, '6,.88, e1uals
notes payable.
Requirement (b)
(he 5irst <alt ;hop
,alance ;heet
4ctober 0, 288.
Assets Liabilities and Equity
$ash ' 27,+88 )iabilities3
Accounts receivable 1,2.8 %otes payable ' 28,888
;upplies +,++8 Accounts payable 16,888
)and ..,888 (otal liabilities ' 66,888
,uilding +.,.88 E1uity3
;hare capital 68,888
5urniture > fi&tures #6,888 ?etained earnings .,.78
(otal '12#,.78 (otal '12#,.78
(he 5irst <alt ;hop
Income ;tatement
5or the 'eriod 4ctober 1:0, 288.
?evenues ' .,.88
E&penses (+,888)
%et income ' 1,.88
(he 5irst <alt ;hop
;tatement of $ash 5lows
5or the 'eriod 4ctober 1:0, 288.
$ash flows from operating activities3
$ash received from revenues '.,.88
$ash paid for e&penses (+,888)
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Chapt! 3 Understanding Financial Statements
$ash paid for accounts payable (6,.88)
$ash paid for supplies (1,888)
$ash used in operating activities '(6,888)
$ash flows from investing activities3
%one
$ash flows from financing activities3
$ash received from sale of share capital '#8,888
Increase in cash ' 22,888
$ash balance, 4ctober 1, 288. 2,+88
$ash balance, 4ctober 0, 288. '27,+88
Requirement (c)
(he 5irst <alt ;hop is in a stronger financial position on 4ctober 0 than on
;eptember #8. 4n ;eptember #8, the company had highly li1uid assets (cash
and accounts receivable) of '6,0.8, which barely e&ceeded the '6,.88 in
liabilities (accounts payable) due in the near future. 4n 4ctober 0, after the
additional investment of cash by shareholders, the company*s cash alone
e&ceeded its short:term obligations.
P!o#l$ / %P!pa!in& a 'alan( Sht- Dis(ussion o. A((ountin&
P!in(ipls+
Requirement (")
5il:$inema ;cripts
,alance ;heet
%ovember #8, 288.
Assets Liabilities and Equity
$ash ' #,7+8 )iabilities3
%otes receivable 2,288 %otes payable ' 2#,.88
Accounts receivable 2,+.8 Accounts payable #2,288
)and #7,888 (otal liabilities '180,288
,uilding .+,#28 E1uity3
;hare capital .,888
4ffice furniture@ 12,62. ?etained earnings #,.#.
(otal '11+,2#. (otal '11+,2#.
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Understanding Financial Statements Chapt! 3
@ '6,6.8 B '0,.88 - '2,.2..
Requirement (#)
(1) (he cash in $ru9*s personal savings account is not an asset of the
business entity 5il:$inema ;cripts and should not appear in the balance
sheet of the business. (he money on deposit in the business ban" account
('#,+88) and in the company safe ('.+8) constitute cash owned by the
business. (hus, the cash owned by the business at %ovember #8 totals
'#,7+8.
(2) (he years:old I4C does not 1ualify as a business asset for two reasons.
5irst, it does not belong to the business entity. ;econd, it appears to be
uncollectible. A receivable that cannot be collected is not viewed as an
asset, as it represents no future economic benefit.
(#) (he total amount to be included in 4ffice furniture! for the rug is
'7,+88, the total cost, regardless of whether this amount was paid in cash.
$onse1uently, 4ffice furniture! should be increased by '0,.88. (he
'0,.88 liability arising from the purchase of the rug came into e&istence
prior to the balance sheet date and must be added to the %otes payable!
amount.
(+) (he computer is no longer owned by Aollywood ;cripts and therefore
cannot be included in the assets. (o do so would cause an overstatement
of both assets and e1uity. (he 4ffice furniture! amount must be reduced
by '2,.2..
(.) (he '22,+88 described as 4ther assets! is not an asset, because there is
no valid legal claim or any reasonable e&pectation of recovering the
income ta&es paid. Also, the payment of income ta&es by $ru9 was not a
business transaction by 5il:$inema ;cripts. If a refund were obtained
from the government, it would come to $ru9 personally, not to the
business entity.
(0) (he proper valuation for the land is its historical cost of '#7,888, the
amount established by the transaction in which the land was purchased.
Although the land may have a current fair value in e&cess of its cost, the
offer by the friend to buy the land if $ru9 would move the building
appears to be mere conversation rather than solid, verifiable evidence of
the fair value of the land. (he cost principle,! although less than perfect,
produces far more reliable financial statements than would result if
owners could pull figures out of the air! in recording asset values.
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Chapt! 3 Understanding Financial Statements
(2) (he accounts payable should be limited to the debts of the business,
'#2,288, and should not include $ru9*s personal liabilities.
ID. Multiple Choice Questions
1. E 11. , 21. , #1. ,
2. E 12. $ 22. $ #2. E
#. E 1#. E 2#. A ##. E
+. , 1+. A 2+. , #+. E
.. A 1.. E 2.. A #.. $
0. , 10. A 20. E #0. A
2. E 12. A 22. , #2. A
6. $ 16. , 26. , #6. $
7. , 17. $ 27. E
18. $ 28. $ #8. $
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