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© The McGraw-Hill Companies, Inc., 2013

Solutions Manual, Vol.1, Chapter 3 3–1

AACSB assurance of learning standards in accounting and business education require

documentation of outcomes assessment. Although schools, departments, and faculty may approachassessment and its documentation differently, one approach is to provide specific questions onexams that become the basis for assessment. To aid faculty in this endeavor, we have labeled eachquestion, exercise, and problem in Intermediate Accounting, 7e with the following AACSB learningskills:

Questions AACSB Tags Exercises (cont.) AACSB Tags3–1 Reflective thinking 3–3 Reflective thinking3–2 Reflective thinking 3–4 Analytic3–3 Reflective thinking 3–5 Analytic3–4 Reflective thinking 3–6 Analytic

3–5 Reflective thinking 3–7 Analytic

3–6 Reflective thinking 3–8 Analytic3–7 Reflective thinking 3–9 Analytic3–8 Reflective thinking 3–10 Reflective thinking3–9 Reflective thinking 3–11 Reflective thinking

3–10 Reflective thinking 3–12 Reflective thinking3–11 Reflective thinking 3–13 Communications3–12 Reflective thinking 3–14 Communications3–13 Reflective thinking 3–15 Reflective thinking

3–14 Reflective thinking 3–16 Analytic3–15 Reflective thinking 3–17 Analytic3–16 Reflective thinking 3–18 Analytic3–17 Reflective thinking 3–19 Analytic3–18 Reflective thinking 3–20 Analytic

3–19 Reflective thinking 3–21 Analytic3–20 Reflective thinking 3–22 Reflective thinking, Diversit3–21 Reflective thinking CPA/CMA

3–22 Reflective thinking 1 Analytic3–23 Reflective thinking 2 Analytic

Brief Exercises 3 Reflective thinking

3–1 Reflective thinking 4 Analytic

3–2 Analytic 5 Reflective thinking3–3 Analytic 6 Analytic3–4 Analytic 7 Diversity, Reflective thinkin3–5 Analytic 8 Diversity, Reflective thinkin

3–6 Analytic 1 Reflective thinking3–7 Analytic 2 Analytic3–8 Analytic 3 Reflective thinking3–9 Analytic Problems 3–10 Reflective thinking 3–1 Analytic3–11 Analytic 3–2 Analytic

Exercises 3–3 Analytic

3–1 Analytic 3–4 Analytic3–2 Reflective thinking 3–5 Analytic

Chapter 3 The Balance Sheet and Financial Disclosures




3–2 Intermediate Accounting, 7/e

Problems cont. 3–6 Analytic, Reflective thinking

3–7 Analytic3–8 Analytic

3–9 Analytic3–10 Analytic





Question 3–1

The 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 statementwhich is a change statement that reports events occurring during a period of time, the balance sheetis 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 particularday marking the end of an accounting period.

Question 3–2The 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 notreported 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, thatare not recorded as assets at all. Therefore, the assets of a company minus its liabilities, as shown inthe balance sheet, will not be representative of the company’s market value.

Question 3–3Current 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 theoperating cycle is longer than one year. The typical asset categories classified as current assetsinclude:

— 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 alliabilities that are scheduled to be liquidated within one year or the operating cycle, whichever islonger, except those that management intends to refinance on a long-term basis. The typical liabilitycategories 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 3–5The operating cycle for a typical manufacturing company refers to the period of time requiredto convert cash to raw materials, raw materials to a finished product, finished product to receivables,and then finally receivables back to cash.

Question 3–6Investments 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, that is, the investment is marketable. If either of these criteria does not hold,the investment is classified as noncurrent.

Question 3–7The 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-generatingassets of the business. These assets include land, buildings, equipment, machinery, furniture, andother assets used in the operations of the business, as well as natural resources, such as mineralmines, timber tracts, and oil wells.

Question 3–8Property, 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 equipmentrepresent physical assets, while intangible assets lack physical substance. Generally, intangible

assets represent the ownership of an exclusive right, such as a patent, copyright, or franchise.

Question 3–9A 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 $20,000current liability—current maturities of long-term debt—and an $80,000 long-term liability.

Question 3–10Paid-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 3–11

Disclosure notes provide additional detail concerning specific financial statement itemsIncluded are such data as the fair values of financial instruments and off-balance-sheet riskassociated with financial instruments and details of pension plans, leases, debt, and assets. Commonto 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, manynotes are designed to fit the disclosure needs of the particular reporting company. In fact, anyexplanation that helps investors and creditors make decisions should be included.

Question 3–12The 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 companiesto know that one company uses the percentage-of-completion method in recognizing gross profitwhile the other company uses the completed contract method.

Question 3–13A 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 or “available to be issued.” It may help toclarify 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 theManagement Discussion and Analysis section may be slanted toward management’s biased

perspective and therefore can lack objectivity. However, management can offer an informed insightthat might not be available elsewhere, so if the reader maintains awareness of the information’ssource, 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 withgenerally accepted accounting principles.”

2. Qualified opinion —This contains an exception to the standard unqualified opinion, but not ofsufficient seriousness to invalidate the financial statements as a whole. Examples of exceptionsare (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 aqualified 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 voteusing an enclosed proxy card. The proxy statement also provides for more disclosures oncompensation to directors and executives, and in particular, stock options granted to executives.

Question 3–17Working 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 accountsreceivable) by current liabilities.

Question 3–18

Debt to equity ratio = Total liabilitiesShareholders' equity

Times interest earned ratio = Net income + interest + taxesInterest





Answers to Questions (concluded)

Question 3–19 IAS No.1, revised, “Presentation of Financial Statements,” provides authoritative guidance for

balance sheet presentation under IFRS.

Question 3–20Differences in balance sheet presentation between U.S. GAAP and IFRS include:

1. International standards specify a minimum list of items to be presented in the balance sheet

U.S. GAAP has no minimum requirements.2. IAS No. 1, revised , changed the title of the balance sheet to statement of financial position,

although companies are not required to use that title. Some U.S. companies use the statement ofinancial position title as well.

3. Under U.S. GAAP, we present current assets and liabilities before noncurrent assets andliabilities. IAS No. 1 doesn’t prescribe the format of the balance sheet, but balance sheets prepared using IFRS often report noncurrent items first.

Question 3–21An 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 sameenterprise).

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 3–22For 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, 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.

Question 3–23U.S. GAAP requires companies to report information about reported segment profit or loss

including certain revenues and expenses included in reported segment profit or loss, segment assetsand the basis of measurement. The international standard on segment reporting, IFRS No. 8, requiresthat companies also disclose the total liabilities of its reportable segments.





Brief Exercise 3–1(a) Current

(b) Current

(c) Noncurrent

(d) Current

(e) Noncurrent

(f) Noncurrent

Brief Exercise 3–2Current assets:

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

Current liabilities:

$14,000 + 9,000 + 1,000 = $24,000

Brief Exercise 3–3

Assets: $ 52,000 current assets80,000 equipment

$132,000 total assetsminus

Liabilities $ 24,000 current liabilities30,000 notes payable

$ 54,000 total liabilitiesequals

Shareholders’ equity $78,000(50,000) common stock

$28,000 retained earnings

BRIEF EXERCISES






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

K AND J NURSERY, INC. Balance Sheet

At December 31, 2013

Assets Current 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 ................................................... $50,000

Retained earnings* ............................................. 28,000Total shareholders’ equity ............................ 78,000Total liabilities and shareholders’ equity $132,000






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

Intangible assets: Patent ............................................................... 40,000

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

Liabilities and Shareholders' Equity

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

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

Long-term liabilities: Note payable ...................................................... 90,000


Common stock ................................................... $70,000Retained earnings ............................................... 76,000

Total shareholders’ equity ............................ 146,000Total liabilities and shareholders’ equity $260,000





Brief Exercise 3–61. The $30,000 should be classified as a noncurrent asset, under the

investments classification.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 inlong-term liabilities.

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

Brief Exercise 3–7Current 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 = Retainedearnings

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

Brief Exercise 3–8(1) A(2)

B(3) B(4) A(5)

B(6) A





Brief Exercise 3–9(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

Brief Exercise 3–10Paying accounts payable reduces both current assets and current liabilities. If

the ratio before the payment was above 1.0, the transaction would cause the ratioto increase. However, if the ratio before the transaction was less than 1.0, theratio would decrease.

Brief Exercise 3–11Acid-test ratio = (Cash + Short-term investments + A/R) Current liabilities

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

Current liabilities = $60,000 1.5

Current liabilities = $40,000

Current ratio = Current assets Current liabilities

2.0 = Current assets $40,000

Current assets = $40,000 x 2.0Current assets = $80,000

$80,000 – 20,000(cash) – 40,000(A/R) = $20,000 inventories





Exercise 3–11. 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

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

Exercise 3–2

1. c Equipment 10. a Inventories2. f Accounts payable 11. d Patent3. -a Allowance for uncollectible accounts 12. c Land, in use4. 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

EXERCISES





Exercise 3–3

1. f Accrued interest payable 10. a Supplies2. d Franchise 11. c Machinery

3. -c Accumulated depreciation 12. c Land, in use4. a Prepaid insurance, for 2014 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 3–4

JACKSON CORPORATION Balance Sheet



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

Intangible assets: Patent ............................................................... 83,000

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


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


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


Common stock ................................................... $100,000Retained earnings ............................................... 48,000






Exercise 3–5

VALLEY PUMP CORPORATION

Balance SheetAt December 31, 2013

Assets

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 ...................................................... $22,000

Land ................................................................................ 20,000Total 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

Intangible assets:

Copyright ........................................................................ 12,000Total assets ............................................................ $615,000


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

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

Long-term liabilities:

Note payable ................................................................... 100,000


Common stock ................................................................ $200,000Retained earnings ........................................................... 70,000

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





Exercise 3–6

Current assets:Cash $20,000

Accounts receivable 130,000Less: Allowance for uncollectible accounts (13,000)

Note receivable 100,000Interest receivable 3,000Marketable securities 32,000Raw materials 24,000Work in process 42,000Finished goods 89,000Prepaid rent (one-half of $60,000) 30,000

Total current assets $457,000

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

Total current liabilities (203,000)

Working capital $254,000





Exercise 3–7

LOS GATOS CORPORATION



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 ................................................... $ 20,000 Note receivable ........................................................ 20,000

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


Machinery ................................................................ 190,000Less: Accumulated depreciation ............................. (70,000)

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

Intangible assets: Franchise .................................................................. 30,000

Total assets ...................................................... $320,000


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


Common stock, no par value; 100,000 shares

authorized; 50,000 shares issued and outstanding $ 70,000Retained earnings .................................................... 35,000

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





Exercise 3–8

CONE CORPORATION

Balance Sheet (Partial)At December 31, 2013


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

Long-term liabilities: Note payable ....................................................... 180,000

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





Exercise 3–9See calculations below the balance sheet.

KORVER SUPPLY COMPANYBalance Sheet



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



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



Accounts payable ............................................... $180,000

Interest payable .................................................. 6,000 Note payable ...................................................... 200,000



Common stock ................................................... $100,000Retained earnings .............................................. 382,000






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) $6,000





Exercise 3–101. Inventory costing method A2. Information on related-party transactions B

3. Composition of property, plant, and equipment B4. Depreciation method A5. Subsequent event information B6. Basis of revenue recognition on long-term contracts A7. Important merger occurring after year-end B8. Composition of receivables B

Exercise 3–111. When related-party transactions occur, companies must disclose the nature of the

relationship, provide a description of the transaction, and report the dollaramounts 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 positionoccurs after the fiscal year-end, but before the financial statements actually areissued, the event is disclosed in a subsequent event disclosure note.

3. The choice of the straight-line method to determine depreciation typically isdisclosed in the company’s summary of significant accounting policies disclosurenote.

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 disclosurenote.





Exercise 3–121. (B) in a separate disclosure note.2. (A) in the summary of significant policies note.3. (C) on the face of the balance sheet.

4.

(B) in a separate disclosure note.5. (B) in a separate disclosure note.6. (A) in the summary of significant policies note.7. (C) on the face of the balance sheet.8. (B) in a separate disclosure note.





Exercise 3–13

Requirement 1The topic number that provides guidance on information contained in the notes to

the financial statements is ASC Topic 235: “Notes to the Financial Statements.”

Requirement 2The specific citation that describes the information that companies must disclose

in the accounting policies note is FASB ASC 235–10–50–3: “Notes to FinancialStatements–Overall–Disclosure–What to Disclose.”

Requirement 3

Disclosure of accounting policies should identify and describe the accounting principles the company follows and the methods of applying those principles thatmaterially affect the determination of financial position, cash flows, or results ofoperations. In general, the disclosure encompasses important judgments as toappropriateness of principles relating to recognition of revenue and allocation of assetcosts to current and future periods. In particular, it encompasses those accounting

principles and methods that involve any of the following:

a. A selection from existing acceptable alternatives. b. Principles and methods peculiar to the industry in which the entity operates,

even if such principles and methods are predominantly followed in thatindustry.

c. Unusual or innovative applications of GAAP.





Exercise 3–14

The FASB Accounting Standards Codification represents the single source of

authoritative U.S. generally accepted accounting principles. The specificcitation for each of the following items is:

1. What is the balance sheet classification for a note payable due in sixmonths that was used to purchase a building?

FASB ASC 210–10–45–9: “Notes to Financial Statements–Overall– Other Presentation Matters–Other Liabilities.”Other liabilities whose regular and ordinary liquidation is expected tooccur within a relatively short period of time, usually 12 months, are alsogenerally included, such as the following:a. Short-term debts arising from the acquisition of capital assets.

b. Serial maturities of long-term obligations.

c. Amounts required to be expended within one year under sinking fund provisions.

d. Agency obligations arising from the collection or acceptance of cashor other assets for the account of third persons. Loans accompanied by

pledge of life insurance policies would be classified as current liabilitiesif, by their terms or by intent, they are to be repaid within 12 months. The

pledging of life insurance policies does not affect the classification of theasset any more than does the pledging of receivables, inventories, realestate, or other assets as collateral for a short-term loan. However, when aloan on a life insurance policy is obtained from the insurance entity withthe intent that it will not be paid but will be liquidated by deduction fromthe proceeds of the policy upon maturity or cancellation, the obligationshall be excluded from current liabilities.





Exercise 3–14 (continued)

2.

Which assets may be excluded from current assets?

FASB ASC 210–10–45–4: “Notes to Financial Statements–Overall– Other Presentation Matters.”

The concept of the nature of current assets contemplates the exclusionfrom that classification of such resources as the following:a. Cash and claims to cash that are restricted as to withdrawal or use forother than current operations, are designated for expenditure in theacquisition or construction of noncurrent assets, or are segregated for theliquidation of long-term debts. Even though not actually set aside in

special accounts, funds that are clearly to be used in the near future forthe liquidation of long-term debts, payments to sinking funds, or forsimilar purposes shall also, under this concept, be excluded from currentassets. However, if such funds are considered to offset maturing debt thathas properly been set up as a current liability, they may be includedwithin the current asset classification.

b. Investments in securities (whether marketable or not) or advances thathave been made for the purposes of control, affiliation, or othercontinuing business advantage.

c. Receivables arising from unusual transactions (such as the sale ofcapital assets, or loans or advances to affiliates, officers, or employees)that are not expected to be collected within 12 months.

d. Cash surrender value of life insurance policies.

e. Land and other natural resources.

f. Depreciable assets.

g. Long-term prepayments that are fairly chargeable to the operations ofseveral years, or deferred charges such as bonus payments under a long-term lease, costs of rearrangement of factory layout or removal to a newlocation.





Exercise 3–14 (continued)

3.

Should a note receivable from a related party be included in thebalance sheet with notes receivable from customers?

FASB ASC 850–10–50–2: “Related Party Disclosures–Overall– Disclosure.”

Notes or accounts receivable from officers, employees, or affiliatedentities must be shown separately and not included under a generalheading such as notes receivable or accounts receivable.





Exercise 3–14 (concluded)

4.

What items are nonrecognized subsequent events that require a

disclosure in the notes to the financial statements?FASB ASC 855–10–55–2: “Subsequent Events–Overall–ImplementationGuidance and Illustrations–Nonrecognized Subsequent Events.”The following are examples of nonrecognized subsequent eventsaddressed in paragraph 855–10–55–2:a. Sale of a bond or capital stock issued after the balance sheet date but

before financial statements are issued or are available to be issued.

b. A business combination that occurs after the balance sheet date but before financial statements are issued or are available to be.

c. Settlement of litigation when the event giving rise to the claim took place after the balance sheet date but before financial statements areissued or are available to be issued.

d. Loss of plant or inventories as a result of fire or natural disaster thatoccurred after the balance sheet date but before financial statements areissued or are available to be issued.

e. Losses on receivables resulting from conditions (such as a customer’smajor casualty) arising after the balance sheet date but before financialstatements are issued or are available to be issued.

f. Changes in the fair value of assets or liabilities (financial ornonfinancial) or foreign exchange rates after the balance sheet date but


g. Entering into significant commitments or contingent liabilities, forexample, by issuing significant guarantees after the balance sheet date but






Exercise 3–15

List A List B

d 1. Balance sheet a. Will be satisfied through the use of currentassets.

h 2. Liquidity b. Items expected to be converted to cash orconsumed within one year or the operatingcycle, whichever is longer.

b 3. Current assets c. The statements are presented fairly inconformity with GAAP.

j 4. Operating cycle d. An organized array of assets, liabilities, andequity.

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 policiesi 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 substance.





Exercise 3–161. 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 3–17

Requirement 1a. Current ratio $10,473 ÷ $8,663 = 1.21

b. Acid-test ratio [$1,103 + 22 + 2,348] ÷ $8,663 = .40c. Debt to equity ratio [$8,663 + 1,894] ÷ $7,292 = 1.45d. Times interest earned ratio [$1,277 + 87 + 714] ÷ $87 = 24 times

Requirement 2Best Buy’s current ratio is almost identical to the industry average but the acid-

test ratio is lower than the industry average. The debt to equity ratio is significantly

higher than the industry average, indicating that the company’s assets are primarilyfinanced with liabilities rather than equity. However, the company’s times interestearned ratio is significantly higher than the industry average. Even with highleverage, Best Buy seems quite capable of meeting its debt interest obligations.





Exercise 3–18a. Acid-test ratio = Quick assets ÷ Current liabilities = 1.20

Quick assets = Current assets – InventoriesQuick 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 = 2.25

Current assets = $1,800,000

b. Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1.8Total liabilities + Shareholders' equity = Total assets

Total liabilities + Shareholders' equity = $2,800,000Let x equal shareholders' equity1.8 x + x = $2,800,000

x = $1,000,000 = Shareholders' equity

c. Noncurrent assets = Total assets – Current assets

Noncurrent assets = $2,800,000 – 1,800,000 = $1,000,000

d. Long-term liabilities = Total assets – Current liabilities – Shareholders' equity

Long-term liabilities = $2,800,000 – 800,000 – 1,000,000 = $1,000,000





Exercise 3–191. Debt to equity ratio = Total liabilities ÷ Shareholders’ equity = 1.4

Total liabilities ÷ $2,500,000 = 1.4

Shareholders’ equity x 1.4 = Total liabilities

$2,500,000 x 1.4 = $3,500,000 = Total liabilities

Total liabilities + Equity = Total assets$3,500,000 + 2,500,000 = $6,000,000 = Total assets

Total assets – Noncurrent assets = Current assets$6,000,000 – 2,400,000 = $3,600,000 = Current assets

Current ratio = Current assets ÷ Current liabilities

2.0 = $3,600,000 ÷ Current liabilitiesCurrent liabilities = $3,600,000 2 = $1,800,000

2. Total assets = Total liabilities + Shareholders’ equityTotal assets = Current liabilities + Long-term liabilities + Shareholders’ equity$6,000,000 = $1,800,000 + Long-term liabilities + 2,500,000

Long-term liabilities = $1,700,000

3. Current assets = Cash + Accounts receivable + Prepaid expenses$3,600,000 = $1,300,000 + Accounts receivable + 360,000

Accounts receivable = $1,940,000

4. Acid-test ratio = Quick assets ÷ Current liabilitiesQuick assets = Cash + Accounts receivableQuick assets = $1,300,000 + 1,940,000 = $3,240,000

Acid-test ratio = $3,240,000 ÷ $1,800,000 = 1.8





Exercise 3–20Current Acid-test Debt to

Action Ratio Ratio Equity Ratio

1. Issuance of long-term bonds I I I2. Issuance of short-term notes I I I3. Payment of accounts payable D D D4. Purchase of inventory on account I D I5. Purchase of inventory for cash N D N6. Purchase of equipment with a 4-year note N N I7. Retirement of bonds D D D8. Sale of common stock I I D9. Write-off of obsolete inventory D N I

10. Purchase of short-term investment for cash N N N11. Decision to refinance on a long-term basis

some currently maturing debt I I N





Exercise 3–21

Requirement 1The pharmaceuticals, plastics, and farm equipment segments are reportable

Only segments representing 10% or more of total company revenues, assets, or netincome 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, segment 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.

Exercise 3–22In addition to revenues, profit or loss, and assets, IFRS also require the disclosure

of total liabilities for each of the reportable segments.





CPA / CMA REVIEW QUESTIONSCPA Exam Questions

1. a. The principal would have to be due after April 30, 2014, to be considered asa noncurrent asset at April 30, 2013. The accrued interest for eight months(since August 31, 2012) is a current asset at April 30, 2013. Since the

principal is due August 31, 2014, additional interest would have to berecorded for the period September 1, 2013 to August 31, 2014.

2. a. Current liabilities are obligations that are expected to be paid within one yearor 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 notdue until 2015.

3.a. Inventory pricing is a significant accounting policy that should be disclosedaccording to generally accepted accounting principles, but the composition of plantassets is not a policy disclosure.





CPA Exam Questions (concluded)

4. c. The auditors’ standard report includes a statement that the financialstatements are the responsibility of the Company's management and that the

auditors’ responsibility is to express an opinion on the financial statements.

5. 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 currentassets and current liabilities will result in an increase in the current ratio. Thedecrease in current liabilities (the smaller number) is proportionately greaterthan 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 assetsand current liabilities will result in a decrease in the ratio. The decreasein current liabilities (the larger number) is proportionately smaller thanthe decrease in quick assets, resulting in a decrease in the ratio.

6. a. Since inventory is not included in the quick ratio, the write-off of obsoleteinventory would have no effect on the quick ratio; however, it would

decrease the current ratio as the write-off would reduce current assets.

7. d. Under U.S. GAAP, we present current assets and liabilities beforenoncurrent assets and liabilities. Balance sheets prepared using IFRS oftenreport noncurrent items first, but IAS No. 1 doesn’t prescribe the format ofthe balance sheet.

8. a. IFRS requires that companies disclose total liabilities of its reportablesegments. This disclosure is not required under U.S. GAAP





CMA Exam Questions

1 d . GAAP requires disclosure of related-party transactions except forcompensation agreements, expense allowances, and transactions eliminatedin consolidated working papers. Required disclosures include therelationship(s) of the related parties; a description and dollar amounts oftransactions for each period presented and the effects of any change in themethod of establishing their terms; and amounts due to or from the related

parties and, if not apparent, the terms and manner of settlement. The effecton 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 itwith care to determine that management has disclosed material informationaffecting the company’s future results. Disclosures about commitments andevents that may affect operations or liquidity are mandatory. Thus, theMD&A section pertains to liquidity, capital resources, and results ofoperations.

3. a. The current ratio equals current assets divided by current liabilities. Anequal increase in both the numerator and denominator of a current ratio lessthan 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 accountwould increase the current assets to $500,000 and the current liabilities to$600,000, resulting in a new current ratio of .833.





Problem 3–1

PROBLEMS

Balance Sheet

Assets

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

Total current assets

Investments:

Bond sinking fundLong-term investments

Notes receivableTotal investments

Property, plant, and equipment: LandBuildingsEquipmentLess: Accumulated depreciation

Net property, plant, and equipment

Intangible assets: PatentCopyright

Total intangible assetsTotal assets


Accounts payableRent payableTaxes payableWages payable Notes payable

Total current liabilities

Long-term liabilities: Bonds payable

Shareholders’ equity: Common stockPreferred stockRetained earnings

Total shareholders’ equityTotal liabilities and shareholders’ equity





Problem 3–2

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

TRIDENT CORPORATION

Balance 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) ........................... 621,040Total assets ............................................ $2,326,767


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

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

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

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





Problem 3–3

ALMWAY CORPORATION



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

Intangible assets: Patents .................................................................................... 10,000

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


Accounts payable ................................................................... $ 75,000Interest payable ....................................................................... 20,000 Note payable ........................................................................... 30,000Current 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 ................................................ 330,000Shareholders’ equity:

Common stock, no par value; 500,000 sharesauthorized; 100,000 shares issued and outstanding ............. 300,000

Retained earnings ................................................................... 129,000Total shareholders’ equity ............................................... 429,000

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





Problem 3–4

(1) Includes $30,000 in U.S. treasury bills.

(2) Excludes $60,000 in prepaid rent for the second year on the building lease.

WEISMULLER PUBLISHING COMPANY



Cash and cash equivalents (1) ................................................ $ 95,000

Short-term investments ........................................................... 110,000Accounts receivable, net of allowance for uncollectible

accounts of $16,000 ............................................................. 144,000Inventories .............................................................................. 285,000

Prepaid expenses (2) ................................................................ 88,000


Property, plant, and equipment : Machinery and equipment ...................................................... $320,000

Less: Accumulated depreciation ............................................. (110,000) Net property, plant, and equipment .................................. 210,000

Other assets:

Prepaid expenses 60,000Total assets ................................................................... $992,000


Current liabilities: Accounts payable ................................................................... $ 60,000Interest payable ....................................................................... 20,000Unearned revenues ................................................................. 80,000Taxes payable ......................................................................... 30,000

Note payable ........................................................................... 40,000Current maturities of long-term debt ...................................... 20,000


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

Shareholders’ equity: Common stock, no par value; 800,000 shares

authorized; 400,000 shares issued and outstanding ............. 400,000Retained earnings ................................................................... 202,000

Total shareholders’ equity ............................................... 602,000Total liabilities and shareholders’ equity ...................... $992,000





Problem 3–5

EXCELL COMPANYBalance Sheet

At June 30, 2013


Cash and cash equivalents (1) ................................................ $101,000

Short-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 ....................................................................... $ 65,000

Land held for sale ................................................................... 25,000 90,000Property, plant, and equipment :

Land ....................................................................................... 50,000Buildings ................................................................................ 320,000Equipment .............................................................................. 265,000

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

Net property, plant, and equipment ................................. 355,000Total 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

Shareholders’ equity: Common stock, no par value; 500,000 shares

authorized; 200,000 shares issued and outstanding ............ 100,000

Retained earnings ................................................................... 172,000Total shareholders’ equity ............................................... 272,000

Total liabilities and shareholders’ equity ..................... $840,000

(1) Includes $18,000 in U.S. treasury bills.





Problem 3–6

Requirement 1

VOSBURGH ELECTRONICS CORPORATION Balance Sheet


Assets

Current assets:

Cash and cash equivalents (1) ......................................... $ 117,000

Marketable securities (2) ................................................. 132,000

Accounts receivable (net) ............................................... 115,000Loans to employees ........................................................ 40,000

Interest receivable .......................................................... 12,000 Note receivable—current portion ................................... 50,000Inventories ...................................................................... 215,000Prepaid expenses ............................................................ 16,000


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

Intangible assets:

Patent .............................................................................. 152,000

Franchise ........................................................................ 40,000Total intangible assets ........................................... 192,000Total assets ............................................................ $2,761,000





Problem 3–6 (continued)


Current liabilities: Accounts payable ............................................................ $ 189,000Dividends payable .......................................................... 10,000Interest payable ............................................................... 16,000Taxes payable ................................................................. 40,000

Unearned revenue (3) ...................................................... 48,000


Long-term liabilities: Notes payable ................................................................. $ 300,000

Unearned 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 ........................................ 2,146,000Total 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 2

Cash equivalents—the policy used to determine what items are considered to becash equivalents.

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

Investments—information about the types of investments and the accountingmethod used to value the investments.

Inventories—disclosure in Accounting Policies note of the cost method usedAlso, for a manufacturer, note disclosure of the breakout of inventory into rawmaterials, work in process, and finished goods.

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

Long-term liabilities—disclosure in a note of the various debt instrumentscomprising long-term liabilities to include information such as payment terms, interestrates, 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.

HUBBARD CORPORATIONBalance Sheet


Assets

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


Investments: Marketable securities .............................................................. $ 40,000

Land held for sale ................................................................... 50,000Total investments ............................................................. 90,000


Land (1) .................................................................................. 130,000

Buildings ................................................................................ 750,000Machinery .............................................................................. 280,000

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

Net property, plant, and equipment ................................. 905,000

Intangible assets: 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


Common stock, no par value; 100,000 sharesauthorized; 100,000 shares issued and outstanding ............ $ 430,000

Retained earnings (2) ............................................................. 310,000

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





Problem 3–8

Solve for missing amounts:

Liabilities Equity = 1.2$18,000 Equity = 1.2

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

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


($ 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



Equipment ...................................................................... 15,000Less: Accumulated depreciation .................................... (4,200)

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

Intangible assets: 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 ........................................................... 1,500 Note payable ................................................................... 3,000Bonds payable ................................................................ 5,500 10,000


Common stock, no par, 400,000 shares authorized, ........250,000 shares issued and outstanding 10,000

Retained earnings ........................................................... 5,000Total shareholders’ equity ........................................ 15,000

Total liabilities and shareholders’ equity $33,000







Problem 3–10

(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.

MELODY LANE MUSIC COMPANY Balance Sheet



Cash (1) .............................................................. $167,000

Inventories ......................................................... 100,000Prepaid rent ........................................................ 3,000


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



Accounts payable (2) ......................................... $ 21,000

Interest payable .................................................. 9,000Loan payable ...................................................... 100,000Total current liabilities ................................. 130,000

Shareholders’ equity: Common stock, no par, 100,000 shares

authorized, 20,000 shares issued andoutstanding ........................................................

$100,000

Retained earnings (3) ......................................... 76,000

Total shareholders’ equity ............................ 176,000

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





Communication Case 3–1IBM manufactures and sells personal and mainframe computers. The computers

included as current assets in the balance sheet for the company represent the cost ofinventory available for sale. In addition, IBM uses computers in its operations. Thecost of these computers is included in the property, plant, and equipment category inthe balance sheet.

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

Analysis Case 3–2Requirement 1

Current assets include cash and other assets that are reasonably expected to beconverted to cash or consumed during one year, or within the normal operating cycleof the business if the operating cycle is longer than one year. Current liabilitiesinclude all liabilities that are scheduled to be liquidated within one year or theoperating cycle, whichever is longer, except those that management intends torefinance 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 2 Assets:

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.

Unearned revenue Depends on the period the revenue will be earned.

CASES





Communication Case 3–3The 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, andequipment. 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 othergroup 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 GAAP [FASB ASC Master Glossary] is

“goods awaiting sale, goods in the course of production, and goods to be consumeddirectly in production.” The chickens certainly represent goods awaiting sale, sincethey will eventually be sold to soup companies. However, they also represent

property, plant, and equipment, since they are used in the production of product—theeggs.

2. The definition of a current asset.GAAP [FASB ASC Master Glossary and FASB ASC 210–10–45–1 through 4:

“Balance Sheet–Overall–Other Presentation Matters–General–Classification ofCurrent Assets”] provides the following definition of a current asset:

“C urrent 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 the

business.”

GAAP [FASB ASC 210–10–45–3] also states that a one-year time period is to beused where there are several operating cycles occurring within a year. In this case, itcould be argued that the operating cycle is two years, since the chickens are not solduntil after the laying life and, therefore, the cost of the flock should be classified as acurrent asset. However, if the chickens are considered productive assets, then the

concept of an operating cycle is not relevant. According to this argument, thechickens should be classified as a noncurrent asset, that is, a producing asset, and not asaleable asset. It appears that the primary benefits of the chickens come from the saleof eggs, not the sale of the chickens themselves.





Case 3–3 (concluded)

3. Regardless of the classification of the cost of the chickens, the cost capitalizedwhen the chickens begin to lay eggs must be depreciated down to an estimated salvagevalue at the end of the egg-laying life. This is necessary to properly match expenseswith revenues.

(Industry practice is to classify the costs of the egg-producing flock as inventoryin the current asset section of the balance sheet, but to depreciate the inventory downto 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 tocontribute to the group discussion by (a) offering information on relevant issues, and

(b) clarifying or modifying ideas already expressed, or (c) suggesting alternativedirection.





IFRS Case 3–4

Requirement 1A major difference is the format of Vodafone’s balance sheets (statements of

financial position). Under U.S. GAAP, we present current assets and liabilities beforenoncurrent assets and liabilities. IAS No. 1 doesn’t prescribe the format of the balancesheet, but balance sheets prepared using IFRS often report noncurrent items first.Vodafone’s balance sheets present noncurrent assets and liabilities before currentassets and liabilities and also present equity before liabilities.

Another difference is the order of the individual line items within categories. Forexample, in the United States, current assets generally are listed in order of liquidity,with cash and cash equivalents listed first, followed by short-term investments,accounts receivable, and then inventories. Vodafone’s current assets appear to belisted in the reverse order of liquidity.

There also are differences in terminology. The term “equity” in Vodafone’s balance sheets is titled shareholders’ equity or stockholders’ equity in a U.S. balancesheet. The term “provisions” is not generally seen in U.S. balance sheets. (See thesolution to Requirement 2 for a discussion of this term.)

Requirement 2The dictionary defines the term provision as “a measure taken beforehand to deal

with a need or contingency.” This indicates that Vodafone’s “provisions” liabilitiesare contingent. A loss contingency is defined in Chapter 13 as an uncertain situation

involving potential loss depending on whether some future event occurs. Vodafone’sannual report includes a “Provisions” disclosure note describing these liabilities.They include liabilities for pending legal actions against the company, restructuringobligations, and asset retirement obligations.





Judgment Case 3–5DEFICIENCIES:

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 asa current asset. The $50,000 note receivable should be classified in thenoncurrent 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

Also, disclosures include information about the types of investments and theaccounting method used to value the investments.

5. Prepaid expenses—in the absence of information to the contrary, should beclassified 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 accumulateddepreciation to arrive at the net amount. Also, the method used to computedepreciation should be disclosed in a note.

8. Patent—should be classified in the intangible assets category of noncurrentassets.

9. Note payable—$20,000, the next installment, should be classified as a currentliability 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.





Judgment Case 3–6Accounts receivable, net—disclosure on the face of the statement of the

allowance for uncollectible accounts, if material.

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

Investments—information about the types of investments and the accountingmethod used to value the investments.

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

Long-term liabilities—disclosure in a note of the various debt instrumentscomprising long-term liabilities to include information such as payment terms, interestrates, and collateral pledged as security for the debt.

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





Real World Case 3–7

Requirement 1The asset classifications are (1) Current assets, (2) Property and equipment, (3)

Property under capital leases, (4) Goodwill, and (5) Other assets and deferred charges.

Requirement 2a. Total assets = $180,663 million b. Current assets = $51,893 million c. Current liabilities = $58,484 million d. Total shareholders' equity = $71,247 million e. Retained earnings = $63,967 million f. Inventories = $36,318 million

Requirement 3The par value is $.10 per share. 11,000 million shares are authorized and 3,516

million shares are issued and outstanding.

Requirement 4Current ratio = Current assets divided by Current liabilitiesCurrent ratio = $51,893 ÷ $58,484 = .89

Requirement 5

a. The company values inventories at the lower of cost or marketdetermined primarily by the retail method of accounting, using thelast-in, first-out (LIFO) method for U.S. inventories and the first-in,first-out (FIFO) method for foreign operations.

b. All highly liquid investments with a maturity of three months or lesswhen purchased are considered to be cash equivalents.







Research Case 3–9

Requirement 1Generally accepted accounting principles require the disclosure of related-party

transactions. The required information is outlined in FASB ASC 850–10–50–1“Related Party Disclosures–Overall–Disclosure.”

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 dollaramounts of the transactions and any amounts due from or to related parties.

Requirement 3

The related-party transactions disclosure note describes transactions with limited partnerships whose general partner’s managing member is a senior officer of EnronThe 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 transactionsinvolved the sale of dark fiber inventory to the related party in exchange for $30million 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 thesales price of the inventory in a normal transaction to an unrelated party? Is theinterest rate charged by Enron on the note a fair interest rate? If the answer to thesequestions is no, then income (wealth) has been transferred from one party to the otherto the detriment of the shareholders of one of the entities and the benefit of the other.





Real World Case 3–10

Requirement 3a. Note 16 reports the following subsequent event:

In February 2011, we entered into an agreement to acquire HauteLook, Inc., anonline private sale retailer, for $180 in Nordstrom stock, with a portion subjectto ongoing vesting requirements. In addition, the agreement provides foradditional payments of up to $90 in Nordstrom stock under a three-year earn-out provision which is subject to HauteLook’s performance and vestingrequirements for HauteLook’s existing management team. The transaction isexpected to close in the first quarter of 2011 and is subject to customary closingconditions, including regulatory and HauteLook shareholder approvals.

b. The company's auditor was Deloitte & Touche LLP. The firm rendered anunqualified opinion on the company's financial statements.

Requirement 4a. Michael G. Koppel is listed as EVP (Executive Vice-president) and CFO (Chief

Financial Officer.

b. The annual salary for Mr. Koppel was $518,722.





Judgment Case 3–11Comparative 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

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

Alternative 2 generated a higher return for each dollar invested by shareholdersThis 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 financialleverage. However, alternative 2 also results in a riskier capital structure. The debt inAlternative 2 requires fixed payments of interest and principal to be made. Thecompany's income before interest and income taxes could drop to zero underAlternative 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 therequired interest payments of $1,600,000, the company could become insolvent andeventually go bankrupt.





Analysis Case 3–12The 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 copiesof the same annual report and compare responses. Another approach is to divide the

class into teams who evaluate reports from a group perspective.

Analysis Case 3–13The 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. Youmay wish to provide students with multiple copies of the same annual reports andcompare responses. Another approach is to divide the class into teams who evaluatereports from a group perspective.





Analysis Case 3–14

Requirement 1The balance sheet includes seven asset classifications: Current assets; Property,

plant, and equipment, net; Investments; Long-term financing receivables, netGoodwill; Purchased intangible assets, net; and Other noncurrent assets; and fourliability classifications: Current liabilities; Long-term debt; Long-term deferredservices revenue; and Other noncurrent 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 services revenue, sometimes called unearned revenue, represents cash

received from customers in advance of providing 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 explanationthat 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.





Case 3–14 (concluded)

Requirement 6

Dell reported the completion of an acquisition in its subsequent events disclosurenote:

In February 2011, Dell completed its acquisitions of Compellent Technologies,Inc. (“Compellent”), a provider of virtual storage solutions for enterprise and cloudcomputing environments, and SecureWorks Inc. (“SecureWorks”), a global providerof information security service, for approximately $938 million and $612 million,respectively. Both Compellent and SecureWorks will be integrated into Dell’sCommercial segments. Because the acquisitions have recently closed, Dell has notcompleted the purchase accounting and initial purchase price allocation for theseacquisitions. Dell expects to complete the purchase accounting and initial purchase

price allocations in the first quarter of fiscal 2012.The acquisition of MessageOne was identified and acknowledged by Dell’s

board of directors as a related-party transaction because Michael Dell and his familyheld indirect ownership interests in MessageOne. Consequently, Dell’s board directedmanagement to implement a series of measures designed to ensure that the transactionwas considered, analyzed, negotiated, and approved objectively and independent ofany control or influence from the related parties.





Analysis Case 3–15

Requirement 1Segment disclosures assist in analyzing and understanding financial statements

by permitting better assessment of past performance and future prospectsDisaggregated information provides more precise details of the uncertaintiessurrounding the timing and the amount of expected cash flows, because the varioussegments 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:

1. That engages in business activities from which it may earn revenues and incur

expenses (including revenues and expenses relating to transactions with othercomponents of the same enterprise).

2. Whose operating results are regularly reviewed by the enterprise's chiefoperating decision maker to make decisions about resources to be allocated tothe 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.

Requirement 4

If Levens Co. prepares its segment disclosure according to IFRS, in addition torevenues, profit or loss, and assets, IFRS also require the disclosure of total liabilitiesfor each of the reportable segments.





Ethics Case 3–16Discussion should include these elements.

Facts:

The impact of following the controller's suggestions would be to obscurefinancial information by aggregating the financial data of segment operations andinvestments. Aggregation of data makes projections of future performance forAfrican or European segments difficult and does not reveal relative investments foreach segment. GAAP suggests that reportable segments are those for whom financialdata is available and whose results are regularly reviewed by company management inassessing performance. The data for South Africa, Egypt, France, and Denmark areavailable and most likely reviewed for performance purposes by the controller andhigher 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 byaggregating the financial data of segment operations and investments?

Who is affected?

You, as a staff accountantController and other managers

Other employeesShareholdersPotential shareholdersCreditorsFinancial 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 SouthAfrican segment. Injured parties include current and future investors and creditorswith economic, social, and political concerns regarding Africa and Europe. Ifinvestors and creditors later learn about undisclosed segment operations that proveunprofitable or violate their value systems, they may take action against McCarver-Lynn.



Air France–KLM CaseUnder U.S. GAAP, we present current assets and liabilities before noncurrent

assets and liabilities. IAS No. 1 doesn’t prescribe the format of the balance

sheet, but balance sheets prepared using IFRS often report noncurrent items firstAF’s balance sheet presents noncurrent assets and liabilities before current assets andliabilities and also presents equity before liabilities.

Another difference is the order of the individual line items within categories. Forexample, in the United States, current assets generally are listed in order of liquidity,with cash and cash equivalents listed first, followed by short-term investments,accounts receivable, and then inventories. AF’s current assets appear to be listed inthe reverse order of liquidity.

Documents

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