ACC 206 Week 11 Quiz Final Exam – New

ACC 206 Accounting Principles Week 11 Final Exam – Strayer

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CHAPTER 14

CORPORATIONS:DIVIDENDS, RETAINED EARNINGS, AND INCOME REPORTING

CHAPTERSTUDY OBJECTIVES

1. Prepare the entries for cash dividends and stock dividends.

2. Identify the items reported in a retained earnings statement.

3. Prepare and analyze a comprehensive stockholders’ equity section.

4. Describe the form and content of corporation income statements.

5. Compute earnings per share.

TRUE-FALSESTATEMENTS

1. Dividends may be declared and paid in cash or stock.

2. Cash dividends are not a liability of the corporation until they are declared by the board of directors.

3. The amount of a cash dividend liability is recorded on the date of record because it is on that date that the persons or entities who will receive the dividend are identified.

4. A 10% stock dividend will increase the number of shares outstanding but the book value per share will decrease.

5. A 3 for 1 common stock split will increase total stockholders’ equity but reduce the par or stated value per share of common stock.

6. Retained earnings represents the amount of cash available for dividends.

7. Net income of a corporation should be closed to retained earnings and net losses should be closed to paid-in capital accounts.

8. A debit balance in the Retained Earnings account is identified as a deficit.

9. A correction in income of a prior period involves either a debit or credit to the Retained Earningsaccount.

10. Prior period adjustments to income are reported in the current year’s income statement.

11. Retained earnings that are restricted are unavailable for dividends.

12. Restricted retained earnings are available for preferred stock dividends but unavailable for common stock dividends.

13. A retained earnings statement shows the same information as a corporation income statement.

14. A detailed stockholders’ equity section in the balance sheet will list the names of individuals who are eligible to receive dividends on the date of record.

15. Common Stock Dividends Distributable is shown within the Paid-in Capital subdivision of the stockholders’ equity section of the balance sheet.

16. Return on common stockholders’ equity is computed by dividing net income by ending stockholders’ equity.

17. Many companies prepare a stockholders’ equity statement instead of presenting a detailed stockholders’ equity section in the balance sheet.

18. A major difference among corporations, proprietorships, and partnerships is that a corporation’s income statement reports income tax expense.

19. A corporation incurs income tax expense only if it pays dividends to stockholders.
Corporations:Dividends, Retained Earnings, and Income Reporting 14 – 5

20. Income tax expense usually appears as a separate section on a corporation income statement.

21. Earnings per share is calculated by dividing net income by the weighted average number of shares of preferred stock and common stock outstanding.

22. Preferred dividends paid are added back to net income in calculating earnings per share for common stockholders.

23. Earnings per share indicates the net income earned by each share of outstanding common stock.

24. Earnings per share is reported for both preferred and common stock.

25. Most companies are required to report earnings per share on the face of the income statement.

Additional True-False Questions

26. A dividend based on paid-in capital is termed a liquidating dividend.

27. Common Stock Dividends Distributable is reported as additional paid-in capital in the stockholders’ equity section.

28. A prior period adjustment is reported as an adjustment of the beginning balance of RetainedEarnings.

29. Income tax expense and the related liability for income taxes payable are recorded when taxes are paid.

30. Earnings per share is reported only for common stock.

MULTIPLECHOICE QUESTIONS

31. Each of the following decreases retained earnings except a a. cash dividend.
b. liquidating dividend. c. stock dividend.
d. All of these decrease retained earnings.

32. Each of the following decreases total stockholders’ equity except a a. cash dividend.
b. liquidating dividend. c. stock dividend.
d. All of these decrease total stockholders’ equity.

33. Which one of the following is not necessary in order for a corporation to pay a cash dividend?
a. Adequate cash
b. Approval of stockholders
c. Declaration of dividends by the board of directors d. Retained earnings

34. If a corporation declares a dividend based upon paid-in capital, it is known as a a. scrip dividend.
b. property dividend. c. paid dividend.
d. liquidating dividend.

35. The date on which a cash dividend becomes a binding legal obligation is on the a. declaration date.
b. date of record. c. payment date.
d. last day of the fiscal year-end.

36. The effect of the declaration of a cash dividend by the board of directors is to

Increase
a. Stockholders’ equity b. Assets
c. Liabilities d. Liabilities
Decrease
Assets Liabilities
Stockholders’ equity Assets

37. The cumulative effect of the declaration and payment of a cash dividend on a company’s financial statements is to
a. decrease total liabilities and stockholders’ equity. b. increase total expenses and total liabilities.
c. increase total assets and stockholders’ equity. d. decrease total assets and stockholders’ equity.
Corporations:Dividends, Retained Earnings, and Income Reporting 14 – 7

38. Common Stock Dividends Distributable is classified as a(n) a. asset account.
b. stockholders’ equity account. c. expense account.
d. liability account.

39. The effect of a stock dividend is to
a. decrease total assets and stockholders’ equity. b. change the composition of stockholders’ equity. c. decrease total assets and total liabilities.
d. increase the book value per share of common stock.

40. If a corporation declares a 10% stock dividend on its common stock, the account to be debited on the date of declaration is
a. Common Stock Dividends Distributable. b. Common Stock.
c. Paid-in Capital in Excess of Par. d. Retained Earnings.

41. Which one of the following events would not require a formal journal entry on a corporation’s books?
a. 2 for 1 stock split
b. 100% stock dividend c. 2% stock dividend
d. $1 per share cash dividend

42. Stock dividends and stock splits have the following effects on retained earnings:

Stock Splits a. Increase b. No change c. Decrease d. No change
Stock Dividends No change
Decrease Decrease No change

43. Dividends are predominantlypaid in a. scrip.
b. property. c. cash.
d. stock.

44. If a stockholder receives a dividend consisting of a promissory note, the stockholder has received a
a. stock dividend. b. cash dividend.
c. contingent dividend. d. scrip dividend.

45. Of the four dividends types, the two most common types in practice are a. cash and scrip.
b. cash and property. c. cash and stock.
d. property and stock.
14 – 8

46. Regular dividends are declared out of
a. Paid-in Capital in Excess of Par Value. b. Treasury Stock.
c. Common Stock.
d. Retained Earnings.

47. A corporation is committed to a legal obligation when it declares a. a cash dividend.
b. either a cash dividend or a stock dividend. c. a stock dividend.
d. a stock split.

48. Which of the following is not a significant date with respect to dividends? a. The declaration date
b. The incorporation date c. The record date
d. The payment date

49. On the dividend record date,
a. a dividend becomes a current obligation. b. no entry is required.
c. an entry may be required if it is a stock dividend. d. Dividends Payable is debited.

50. Which of the following statements regarding the date of a cash dividend declaration is not accurate?
a. The dividend can be rescinded once it has been declared. b. The corporation is committed to a legal, binding obligation.
c. The board of directors formally authorizes the cash dividend. d. A liability account must be increased.

51. Dividends Payable is classified as a a. long-term liability.
b. contra stockholders’ equity account to Retained Earnings. c. current liability.
d. stockholders’ equity account.

52. Indicate the respective effects of the declaration of a cash dividend on the following balance sheet sections:

Total Assets a. Increase b. No change c. Decrease d. Decrease
Total Liabilities Decrease Increase Increase No change
Total Stockholders’ Equity No change
Decrease Decrease Increase

53. Which of the following statements about dividends is not accurate? a. Many companies declare and pay cash quarterly dividends.
b. Low dividends may mean high stock returns.
c. The board of directors is obligated to declare dividends. d. A legal dividend may not be a feasible one.
Corporations:Dividends, Retained Earnings, and Income Reporting 14 – 9

54. The cumulative effect of the declaration and payment of a cash dividend on a company’s balance sheet is to
a. decrease current liabilities and stockholders’ equity. b. increase total assets and stockholders’ equity.
c. increase current liabilities and stockholders’ equity. d. decrease stockholders’ equity and total assets.

55. The declaration and distribution of a stock dividend will a. increase total stockholders’ equity.
b. increase total assets. c. decrease total assets.
d. have no effect on total assets.

56. ABC, Inc. has 1,000 shares of 4%, $100 par value, cumulative preferred stock and 50,000 shares of $1 par value common stock outstanding at December 31, 2008. What is the annual dividend on the preferred stock?
a. $40 per share b. $4,000 in total c. $400 in total d. $.40 per share

57. Agler, Inc. has 10,000 shares of 6%, $100 par value, cumulative preferred stock and 100,000 shares of $1 par value common stock outstanding at December 31, 2008. If the board of directors declares a $50,000 dividend, the
a. preferred shareholders will receive 1/10th of what the common shareholders will receive.
b. preferred shareholders will receive the entire $50,000.
c. $50,000 will be held as restricted retained earnings and paid out at some future date. d. preferred shareholders will receive $25,000 and the common shareholders will receive
$25,000.

58. Manner, Inc. has 5,000 shares of 6%, $100 par value, noncumulative preferred stock and 20,000 shares of $1 par value common stock outstanding at December 31, 2008. There were no dividends declared in 2007. The board of directors declares and pays a $55,000 dividend in 2008. What is the amount of dividends received by the common stockholders in 2008?
a. $0
b. $30,000 c. $55,000 d. $25,000

59. Lopez, Inc. has 2,000 shares of 6%, $50 par value, cumulative preferred stock and 50,000 shares of $1 par value common stock outstanding at December 31, 2007, and December 31, 2008. The board of directors declared and paid a $4,000 dividend in 2007. In 2008, $20,000 of dividends are declared and paid. What are the dividends received by the preferred and common shareholdersin 2008?

Preferred a. $12,000 b. $10,000 c. $8,000 d. $6,000
Common $8,000 $10,000 $12,000 $14,000
14 – 10

60. Norton, Inc. has 10,000 shares of 6%, $100 par value, noncumulative preferred stock and 100,000 shares of $1 par value common stock outstanding at December 31, 2008, and December 31, 2009. The board of directors declared and paid a $50,000 dividend in 2008. In 2009, $100,000 of dividends are declared and paid. What are the dividends received by the preferred and common shareholders in 2009?

Preferred a. $0
b. $60,000 c. $50,000 d. $100,000
Common $100,000 $40,000 $50,000 $0

61. The board of directors must assign a per share value to a stock dividend declared that is a. greater than the par or stated value.
b. less than the par or stated value. c. equal to the par or stated value.
d. at least equal to the par or stated value.

62. Corporationsgenerally issue stock dividends in order to a. increase the market price per share.
b. exceed stockholders’ dividend expectations. c. increase the marketability of the stock.
d. decrease the amount of capital in the corporation.

63. A stockholder who receives a stock dividend would a. expect the market price per share to increase. b. own more shares of stock.
c. expect retained earnings to increase.
d. expect the par value of the stock to change.

64. When stock dividends are distributed,
a. Common Stock Dividends Distributable is decreased. b. Retained Earnings is decreased.
c. Paid-in Capital in Excess of Par Value is debited if it is a small stock dividend. d. no entry is necessary if it is a large stock dividend.

65. A small stock dividend is defined as
a. less than 30% but greater than 25% of the corporation’s issued stock. b. between 50% and 100% of the corporation’s issued stock.
c. more than 30% of the corporation’s issued stock.
d. less than 20–25% of the corporation’s issued stock.

66. The per share amount normally assigned by the board of directors to a large stock dividend is
a. the market value of the stock on the date of declaration.
b. the average price paid by stockholders on outstanding shares. c. the par or stated value of the stock.
d. zero.
Corporations:Dividends, Retained Earnings, and Income Reporting 14 – 11

67. The per share amount normally assigned by the board of directors to a small stock dividend is
a. the market value of the stock on the date of declaration.
b. the average price paid by stockholders on outstanding shares. c. the par or stated value of the stock.
d. zero.

68. Identify the effect the declaration of a stock dividend has on the par value per share and book value per share.

Par Value per Share a. Increase
b. No effect c. Decrease d. No effect
Book Value per Share Decrease Increase Decrease Decrease

69. The declaration of a stock dividend will a. increase paid-in capital.
b. change the total of stockholders’ equity. c. increase total liabilities.
d. increase total assets.

70. Which of the following show the proper effect of a stock split and a stock dividend?

Item
a. Total paid-in capital b. Total retained earnings
c. Total par value (common) d. Par value per share
Stock Split Increase
Decrease Decrease Decrease
Stock Dividend Increase Decrease Increase No change

71. A stock split
a. may occur in the absence of retained earnings. b. will increase total paid-in capital.
c. will increase the total par value of the stock.
d. will have no effect on the par value per share of stock.

72. Outstanding stock of the Apex Corporation included 20,000 shares of $5 par common stock and 5,000 shares of 6%, $10 par noncumulative preferred stock. In 2007, Apex declared and paid dividends of $2,000. In 2008, Apex declared and paid dividends of $6,000. How much of the 2008 dividend was distributed to preferred shareholders?
a. $4,000 b. $7,000 c. $3,000
d. None of the above

73. Outstanding stock of the Bell Corporation included 20,000 shares of $5 par common stock and 10,000 shares of 6%, $10 par noncumulative preferred stock. In 2007, Bell declared and paid dividends of $4,000. In 2008, Bell declared and paid dividends of $12,000. How much of the 2008 dividend was distributed to preferred shareholders?
a. $8,000 b. $14,000 c. $6,000
d. None of the above
14 – 12

74. On January 1, Bluefield Corporation had 800,000 shares of $10 par value common stock outstanding. On March 31, the company declared a 10% stock dividend. Market value of the stock was $15/share. As a result of this event,
a. Bluefield’s Paid-in Capital in Excess of Par Value account increased $400,000. b. Bluefield’s total stockholders’ equity was unaffected.
c. Bluefield’s Retained Earnings account decreased $1,200,000. d. All of the above.

75. On January 1, Garrison Corporation had 1,000,000 shares of $10 par value common stock outstanding. On March 31, the company declared a 10% stock dividend. Market value of the stock was $15/share. As a result of this event,
a. Garrison’s Paid-in Capital in Excess of Par Value account increased $500,000. b. Garrison’s total stockholders’ equity was unaffected.
c. Garrison’s Retained Earnings account decreased $1,500,000. d All of the above.

76. Sun Inc. has 5,000 shares of 6%, $100 par value, cumulative preferred stock and 50,000 shares of $1 par value common stock outstanding at December 31, 2008. What is the annual dividend on the preferred stock?
a. $60 per share b. $30,000 in total c. $3,000 in total d. $0.60 per share

77. Allstate, Inc., has 20,000 shares of 6%, $100 par value, noncumulative preferred stock and 100,000 shares of $1 par value common stock outstanding at December 31, 2008. If the board of directors declares a $200,000 dividend, the
a. preferred stockholders will receive 2/10th of what the common stockholders will receive.
b. preferred stockholders will receive the entire $200,000.
c. $120,000 will be held as restricted retained earnings and paid out at some future date. d. preferred stockholders will receive $120,000 and the common stockholders will
receive $80,000.

78. Archer, Inc., has 10,000 shares of 8%, $100 par value, noncumulative preferred stock and 40,000 shares of $1 par value common stock outstanding at December 31, 2008. There were no dividends declared in 2007. The board of directors declares and pays a $120,000 dividend in 2008. What is the amount of dividends received by the common stockholders in 2008?
a. $0
b. $80,000 c. $120,000 d. $40,000

79. Luther Inc., has 2,000 shares of 8%, $50 par value, cumulative preferred stock and 100,000 shares of $1 par value common stock outstanding at December 31, 2008, and December 31, 2007. The board of directors declared and paid a $6,000 dividend in 2007. In 2008, $24,000 of dividends are declared and paid. What are the dividends received by the preferred stockholders in 2008?
Corporations:Dividends, Retained Earnings, and Income Reporting 14 – 13

a. $14,000 b. $12,000 c. $10,000 d. $8,000

`80. Anders, Inc., has 5,000 shares of 6%, $100 par value, cumulative preferred stock and 20,000 shares of $1 par value common stock outstanding at December 31, 2009. There were no dividends declared in 2007. The board of directors declares and pays a $50,000 dividend in 2008 and in 2009. What is the amount of dividends received by the common stockholders in 2009?
a. $10,000 b. $30,000 c. $50,000 d. $0

81. Cuther Inc., has 1,000 shares of 8%, $50 par value, cumulative preferred stock and 50,000 shares of $1 par value common stock outstanding at December 31, 2007, and December 31, 2008. The board of directors declared and paid a $3,000 dividend in 2007. In 2008, $12,000 of dividends are declared and paid. What are the dividends received by the common stockholders in 2008?
a. $7,000 b. $6,000 c. $5,000 d. $4,000

82. On January 1, Brunner Corporation had 60,000 shares of $10 par value common stock outstanding. On March 17, the company declared a 10% stock dividend to stockholders of record on March 20. Market value of the stock was $13 on March 17. The entry to record the transaction of March 17 would include a
a. credit to Retained Earnings for $18,000. b. credit to Cash for $78,000.
c. credit to Common Stock Dividends Distributablefor $60,000. d. debit to Common Stock Dividends Distributablefor $60,000.

83. On January 1, Brunner Corporation had 60,000 shares of $10 par value common stock outstanding. On March 17, the company declared a 10% stock dividend to stockholders of record on March 20. Market value of the stock was $13 on March 17. The stock was distributed on March 30. The entry to record the transaction of March 30 would include a
a. credit to Cash for $60,000.
b. debit to Common Stock Dividends Distributable for $60,000. c. credit to Paid-in Capital in Excess of Par Value for $18,000. d. debit to Retained Earnings for $18,000.

84. On January 1, Sandford Corporation had 80,000 shares of $10 par value common stock outstanding. On June 17, the company declared a 10% stock dividend to stockholders of record on June 20. Market value of the stock was $15 on June 17. The entry to record the transaction of June 17 would include a
a. debit to Retained Earnings for $120,000. b. credit to Cash for $120,000.
c. credit to Common Stock Dividends Distributablefor $120,000. d. credit to Common Stock Dividends Distributablefor $40,000.
14 – 14

85. On January 1, Sanford Corporation had 80,000 shares of $10 par value common stock outstanding. On June 17, the company declared a 10% stock dividend to stockholders of record on June 20. Market value of the stock was $15 on June 17. The stock was distributed on June 30. The entry to record the transaction of June 30 would include a
a. credit to Common Stock for $80,000.
b. debit to Common Stock Dividends Distributablefor $120,000. c. credit to Paid-in Capital in Excess of Par Value for $40,000. d. debit to Retained Earnings for $40,000.

86. The following selected amounts are available for Sanders Company.

Retainedearnings (beginning) $1,000 Net loss 100 Cash dividends declared 100 Stock dividends declared 50

What is its ending retained earnings balance? a. $850
b. $900 c. $750 d. $800

87. Turquoise and Topaz Sisters had retained earnings of $10,000 on the balance sheet but disclosed in the footnotes that $2,000 of retained earnings was restricted for plant expansion and $1,000 was restricted for bond repayments. Cash of $2,000 had been set aside for the plant expansion. How much of retained earnings is available for dividends?
a. $7,000 b. $8,000 c. $10,000 d. $5,000

88. Irwin, Inc. had 300,000 shares of common stock outstanding before a stock split occurred, and 600,000 shares outstanding after the stock split. The stock split was
a. 3 for 6. b. 6 for 1. c. 1 for 6. d. 2 for 1.

89. Restricting retained earnings for the cost of treasury stock purchased is a a. contractual restriction.
b. legal restriction. c. stock restriction.
d. voluntary restriction.

90. A prior period adjustment that corrects income of a prior period requires that an entry be made to
a. an income statement account.
b. a current year revenue or expense account. c. the retained earnings account.
d. an asset account.
Corporations:Dividends, Retained Earnings, and Income Reporting 14 – 15

91. If the board of directors authorizes a $100,000 restriction of retained earnings for a future plant expansion, the effect of this action is to
a. decrease total assets and total stockholders’ equity.
b. increase stockholders’ equity and decrease total liabilities.
c. decrease total retained earnings and increase total liabilities.
d. reduce the amount of retained earnings available for dividend declarations.

92. A credit balance in retained earnings represents a. the amount of cash retained in the business. b. a claim on specific assets of the corporation.
c. a claim on the aggregate assets of the corporation.
d. the amount of stockholders’ equity exempted from the stockholders’ claim on total assets.

93. A net loss
a. occurs if operating expenses exceed cost of goods sold.
b. is not closed to Retained Earnings if it would result in a debit balance. c. is closed to Retained Earnings even if it would result in a debit balance.
d. is closed to the paid-in capital account of the stockholders’ equity section of the balance sheet.

94. Prior period adjustments are reported
a. in the footnotes of the current year’s financial statements. b. on the current year’s balance sheet.
c. on the current year’s income statement.
d. on the current year’s retained earnings statement.

95. Retained earnings are occasionally restricted a. to set aside cash for dividends.
b. to keep the legal capital associated with paid-in capital intact. c. due to contractual loan restrictions.
d. if preferred dividends are in arrears.

96. Retained earnings is increased by each of the following except a. net income.
b. prior period adjustments.
c. some disposals of treasury stock.
d. All of these increase retained earnings.

97. A prior period adjustment for understatement of net income will a. be credited to the Retained Earnings account.
b. be debited to the Retained Earnings account.
c. show as a gain on the current year’s Income Statement. d. show as an asset on the current year’s Balance Sheet.

98. The retained earnings statement
a. is the owners’ equity statement for a corporation.
b. will show an addition to the beginning retained earnings balance for an understate-ment of net income in a prior year.
c. will not reflect net losses.
d. will, in some cases, fail to reconcile the beginning and ending retained earnings balances.
14 – 16

99. In the stockholders’ equity section of the balance sheet,
a. Common Stock Dividends Distributable will be classified as part of additional paid-in capital.
b. Common Stock Dividends Distributable will appear in its own subsection of the stock-holders’ equity.
c. Additional Paid-in Capital appears under the subsection Paid-in Capital. d. Dividends in arrears will appear as a restriction of Retained Earnings.

100. The return on common stockholders’ equity is computed by dividing net income available to common stockholdersby
a. ending total stockholders’ equity.
b. ending common stockholders’ equity. c. average total stockholders’ equity.
d. average common stockholders’ equity.

101. The return on common stockholders’ equity is computed by dividing a. net income by ending common stockholders’ equity.
b. net income by average common stockholders’equity.
c. net income less preferred dividends by ending common stockholders’ equity. d. net income less preferred dividends by average common stockholders’ equity.

Use the following information for questions 102–103.

Carter Corporation had net income of $250,000 and paid dividends of $50,000 to common stockholders and $20,000 to preferred stockholders in 2008. Carter Corporation’s common stockholders’ equity at the beginning and end of 2008 was $870,000 and $1,130,000, respectively. There are 100,000 weighted-averageshares of common stock outstanding.

102. Carter Corporation’s return on common stockholders’ equity was a. 25%.
b. 23%. c. 20%. d. 18%.

103. Carter Corporation’s earnings per share for 2008 was a. $2.50.
b. $2.30. c. $2.00. d. $1.80.

Use the following information for questions 104–105.

The following information pertains to Greenwich Company. Assume that all balance sheet amounts represent average balance figures.

Stockholders’ equity—common Total stockholders’ equity Sales
Net income
Numberof shares of common stock Commonstock dividends Preferredstock dividends
$150,000 200,000 100,000 25,000 10,000 10,000 4,000
Corporations:Dividends, Retained Earnings, and Income Reporting 14 – 17

104. What is the return on common stockholders’ equity ratio for Greenwich? a. 16.7%
b. 14.0% c. 12.7% d. 10.5%

105. What is the earnings per share for Greenwich? a. $2.50
b. $2.10 c. $1.50 d. $1.10

106. A corporation differs from a proprietorship and a partnership in that
a. assets and liabilities are presented differently on the balance sheet.
b. a corporation is considered a separate legal entity for taxation purposes. c. the cost principle only applies to proprietorships and partnerships.
d the owners of the corporation do not have a claim on the net assets of the business.

107. Income statements for corporations are the same as the statements for proprietorships exceptfor the reporting of
a. gross profit.
b. income from operations. c. income tax expense.
d. other revenues and gains.

108. Income statements for corporations are the same as the income statements for proprietorships except for the reporting of
a. cost of goods sold. b. income taxes.
c. gross profit.
d. other revenues and other expenses.

109. Corporation income tax expense is
a. usually accrued in the adjusting entry process.
b. not usually accrued because it is not known what the exact liability will be until the tax return is filed.
c. not reported in a separate section of a corporate income statement. d. reported similarly for corporations and partnerships.

110. When computing earnings per share,
a. an adjustment related to preferred stock dividends is made in the numerator and denominator of the earnings per share formula.
b. an adjustment for the preferred dividends is made in the denominator of the earnings per share formula.
c. the dividends for cumulative preferred stock are deducted from net income only if the preferred dividends have been declared.
d. the dividends for cumulative preferred stock are deducted from net income whether or not preferred dividends have been declared.
14 – 18

111. Each of the following statements is correct except that earnings per share is reported a. below net income.
b. for both common and preferred stock. c. on the face of the income statement.
d. based on the weighted-averagenumber of common shares outstanding.

112. West, Inc. has a net income of $400,000 for 2008, and there are 200,000 weighted-average shares of common stock outstanding. Dividends declared and paid during the year amounted to $80,000 on the preferred stock and $120,000 on the common stock. The earnings per share for 2008 is
a. $2.00. b. $.60. c. $1.60. d. $1.00.

113. The formula for computing earnings per share is net income a. divided by the ending common shares outstanding.
b. divided by the weighted-averagenumber of common shares outstanding.
c. less preferred dividends divided by the ending common shares outstanding.
d. less preferred dividends divided by the weighted-average number of common shares outstanding.

Additional Multiple Choice Questions

114. Which of the following statements about a cash dividend is incorrect? a. The legality of a cash dividend depends on state corporation laws.
b. The legality of a dividend does not indicate a company’s ability to pay a dividend. c. Dividends are not a liability until declared.
d. Shareholders usually vote to determine the amount of income to be distributed in the form of a dividend.

115. The date a cash dividend becomes a binding legal obligation to a corporation is the a. declaration date.
b. earnings date. c. payment date. d. record date.

116. Abbott Corporation splits its common stock 4 for 1, when the market value is $40 per share. Prior to the split, Abbott had 50,000 shares of $10 par value common stock issued and outstanding. After the split, the par value of the stock
a. remains the same.
b. is reduced to $2 per share.
c. is reduced to $2.50 per share. d. is reduced to $10 per share.
Corporations:Dividends, Retained Earnings, and Income Reporting 14 – 19

117. Which of the following statements about retained earnings restrictions is incorrect?
a. Many states require a corporation to restrict retained earnings for the cost of treasury stock purchased.
b. Long-term debt contracts may impose a restriction on retained earnings as a condition for the loan.
c. The board of directors of a corporation may voluntarily create retained earnings restrictions for specific purposes.
d. Retained earnings restrictions are generally disclosed through a journal entry on the booksof a company.

118. Prior period adjustments
a. may only increase retained earnings. b. may only decrease retained earnings.
c. may either increase or decrease retained earnings. d. do not affect retained earnings.

119. Jennifer Company reports the following amounts for 2008:

Net income Averagestockholders’ equity Preferreddividends
Par value preferred stock
$125,000 500,000 35,000 100,000

The 2008 rate of return on common stockholders’ equity is a. 18.0%.
b. 22.5%. c. 25.0%. d. 31.3%.

120. The return on common stockholders’ equity is computed by dividing a. net income by ending common stockholders’ equity.
b. net income by average common stockholders’equity.
c. net income minus preferred dividends by ending common stockholders’equity. d. net income minus preferred dividends by average common stockholders’ equity.

121. Milner Corporation had 200,000 shares of common stock outstanding during the year. Milner declared and paid cash dividends of $200,000 on the common stock and $160,000 on the preferred stock. Net income for the year was $880,000. What is Milner’s earnings per share?
a. $2.60 b. $3.40 c. $3.60 d. $4.40

122. When a corporation has both preferred and common stock outstanding, earnings per share is computed by dividing net income
a. by ending common shares outstanding.
b. by weighted average common shares outstanding.
c. less preferred dividends by ending common shares outstanding.
d. less preferred dividends by the weighted average of common shares outstanding.
14 – 20

123. In determining earnings per share, dividends for the current year on noncumulative preferred stock should be
a. disregarded.
b. added back to net income whether declared or not. c. deducted from net income only if declared.
d. deducted from net income whether declared or not.

BRIEFEXERCISES

BE 124

On November 27, the board of directors of India Star Company declared a $.35 per share dividend. The dividend is payable to shareholders of record on December 7 on December 24. India Star has 25,500 shares of $1 par common stock outstanding at November 27. Journalize the entries needed on the declaration and payment dates.

BE 125

On October 10, the board of directors of Pitcher Corporation declared a 5% stock dividend. On October 10, the company had 10,000 shares of $1 par common stock issued and outstanding with a market price of $15 per share. The stock dividend will be distributed on October 31 to shareholders of record on October 25. Journalize the entries needed for the declaration and distribution of the stock dividend.

BE 126

Devons Company has 24,000 shares of $1 par common stock issued and outstanding. The company also has 2,000 shares of $100 par 3% cumulative preferred stock outstanding. The company did not pay the preferred dividends in 2007 or 2008. What amount of dividends must the company pay the preferred shareholders in 2009 if they wish to pay the common stockholders a dividend?

BE 127

On November 1, 2008, Mates Corporation’s stockholders’ equity section is as follows:

Commonstock, $10 par value
Paid-in capital in excess of par value Retainedearnings
Total stockholders’ equity
$600,000 180,000
200,000 $980,000

On November 1, Mates declares and distributes a 10% stock dividend when the market value of the stock is $14 per share.

Instructions

Indicate the balances in the stockholders’ equity accounts after the stock dividend has been distributed.

BE 128

Match each item/event pair below with the indicated change in the item. An individual classification may be used more than once, or not at all. For each dividend, assume that both declaration and payment or distribution has occurred.

Classifications
A. Item increases B. Item decreases
C. Item is unchanged
D. Direction of change cannot be determined

Item

1. Book value per share

2. Total retained earnings
Event Stock Dividend
Stock Split

3. Total stockholders’ equity

4. Earningsper common share 5. Total retained earnings
6. Total paid-in capital
Prior period adjustment increases last year’s net income

Restrictionof retained Earnings Cash dividend
Stock dividend

BE 129

Identify which of the following items would be reported as additions (A) or deductions (D) in a RetainedEarnings Statement.
1. Net Income 2. Net Loss
3. Cash Dividends 4. Stock Dividends
5. Prior period adjustments to correct for overstatement of prior years’ net income 6. Prior period adjustments to correct for understatement of prior years’ net income
Corporations:Dividends, Retained Earnings, and Income Reporting 14 – 23

BE 130

The balance in retained earnings on January 1, 2008, for Ettenger Inc, was $600,000. During the year, the corporation paid cash dividends of $70,000 and distributed a stock dividend of $8,000. In addition, the company determined that it had overstated its depreciation expense in prior years by $50,000. Net income for 2008 was $100,000.

Instructions

Preparethe retained earnings statement for 2008.

BE 131

The following information is available for Wheeler Corporation

Averagecommon stockholders’ equity Averagetotal stockholders’ equity Commondividends declared and paid Preferreddividends declared and paid Net income
2008
$1,500,000 2,000,000 72,000 30,000 300,000
2007
$1,000,000 1,500,000 50,000 30,000 250,000

Instructions
Computethe return on common stockholders’ equity ratio for both years. Briefly comment on your findings.

BE 132

The following information is available for Ryder Corporation for the year ended December 31, 2008:

Correctedoverstatement of 2007 depreciation expense Cost of goods sold
Declaredcash dividends Operatingexpenses
Other expenses and losses Other revenues and gains Sales
Tax rate
$ 15,000 600,000 50,000 170,000 40,000 50,000 1,000,000 30%

Instructions

Preparea corporate income statement in good form.

EXERCISES

Ex. 133

The stockholders’ equity section of Ellis Corporation at December 31, 2007, included the following:

6% preferred stock, $100 par value, cumulative,
10,000 shares authorized, 8,000 shares issued and outstanding……. $ 800,000

Commonstock, $10 par value, 250,000 shares authorized,
200,000shares issued and outstanding …………………………………….. $2,000,000

Dividendswere not declared on the preferred stock in 2007 and are in arrears.

On September 15, 2008, the board of directors of Ellis Corporation declared dividends on the preferred stock for 2007 and 2008, to stockholders of record on October 1, 2008, payable on October 15, 2008.

On November 1, 2008, the board of directors declared a $.90 per share dividend on the common stock, payable November 30, 2008, to stockholders of record on November 15, 2008.

Instructions
Prepare the journal entries that should be made by Ellis Corporation on the dates indicated below:
September 15, 2008 November 1, 2008 October 1, 2008 November 15, 2008 October 15, 2008 November 30, 2008

Ex. 134

Richman Corporation has 120,000 shares of $5 par value common stock outstanding. It declared a 15% stock dividend on June 1 when the market price per share was $12. The shares were issued on June 30.

Instructions

Preparethe necessary entries for the declarationand payment of the stock dividend.

Ex. 135

Irving Corporation’s stockholders’ equity section at December 31, 2007 appears below:

Stockholders’ equity Paid-in capital
Commonstock, $10 par, 60,000 outstanding Paid-in capital in excess of par
Total paid-in capital Retainedearnings
Total stockholders’ equity

$600,000
150,000

$750,000
150,000 $900,000

On June 30, 2008, the board of directors of Irving Corporation declared a 15% stock dividend, payable on July 31, 2008, to stockholders of record on July 15, 2008. The fair market value of Irving Corporation’s stock on June 30, 2008, was $15.

On December 1, 2008, the board of directors declared a 2 for 1 stock split effective December 15, 2008. Irving Corporation’s stock was selling for $20 on December 1, 2008, before the stock split was declared. Par value of the stock was adjusted. Net income for 2008 was $190,000 and there were no cash dividends declared.

Instructions

(a) Prepare the journal entries on the appropriate dates to record the stock dividend and the stock split.

(b) Fill in the amount that would appear in the stockholders’ equity section for Irving Corporation at December 31, 2008, for the following items:

1. Commonstock $

2. Numberof shares outstanding

3. Par value per share $

4. Paid-in capital in excess of par $

5. Retainedearnings $

6. Total stockholders’ equity $
Corporations:Dividends, Retained Earnings, and Income Reporting 14 – 27

Ex. 136

Derek Corporation was organized on January 1, 2007. During its first year, the corporation issued 40,000 shares of $5 par value preferred stock and 400,000 shares of $1 par value common stock. At December 31, the company declared the following cash dividends:

2007 $10,000 2008 $30,000 2009 $70,000

Instructions

(a) Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 6% and not cumulative.

(b) Show the allocation of dividends to each class of stock, assuming the preferred stock dividend is 8% and cumulative.

(c) Journalize the declaration of the cash dividend at December 31, 2009 using the assumption of part (b).

Ex. 137

On November 1, 2008, Lambert Corporation’s stockholders’ equity section is as follows:

Commonstock, $10 par value
Paid-in capital in excess of par value Retainedearnings
Total stockholders’ equity
$ 600,000 205,000
240,000 $1,045,000

On November 1, Lambert declares and distributes a 10% stock dividend when the market value of the stock is $13 per share.

Instructions
(a) Compute the book value per share (1) before the stock dividend and (2) after the stock dividend.

(b) Indicate the balances in the stockholders’ equity accounts after the stock dividend has been distributed.

Ex. 138

During 2008, Pine Corporation had the following transactions and events: 1. Issued par value preferred stock for cash at par value.
2. Issued par value common stock for cash at an amount greater than par value.
3. Completed a 2 for 1 stock split in which the $10 par value common stock was changed to $5 par value stock.
4. Declared a small stock dividend when the market value was higher than the par value. 5. Declared a cash dividend.
6. Made a prior period adjustment for understatementof net income. 7. Issued par value common stock for cash at par value.
8. Paid the cash dividend.
9. Issued the shares of common stock required by the stock dividend declaration in 4. above.

Instructions

Indicate the effect(s) of each of the foregoing items on the subdivisions of stockholders’ equity. Present your answers in tabular form with the following columns. Use (I) for increase, (D) for decrease, and (NE) for no effect.

Item

Ex. 139

The following information is available for Ellis Corporation:

Common Stock ($5 par) RetainedEarnings
$1,500,000 600,000

A 10% stock dividend is declared and paid when the market value was $15 per share.

Instructions
Computeeach of the following after the stock dividend. (a) Total stockholders’ equity.
(b) Number of shares outstanding. (c) Book value per share.

Ex. 140

On January 1, 2008, Bolten Corporation had $2,000,000 of $10 par value common stock outstanding that was issued at par and retained earnings of $1,000,000. The company issued 200,000 shares of common stock at $13 per share on July 1. On December 15, the board of directors declared a 10% stock dividend to stockholders of record on December 31, 2008, payable on January 15, 2009. The market value of Bolten Corporation stock was $15 per share on December 15 and $16 per share on December 31. Net income for 2008 was $500,000.

Instructions
(1) Journalize the issuance of stock on July 1 and the declaration of the stock dividend on December15.

(2) Prepare the stockholders’ equity section of the balance sheet for Bolten Corporation at December31, 2008.

Ex. 141

On January 1, 2008, Dolan Corporation had 60,000 shares of $1 par value common stock issued and outstanding. During the year, the following transactions occurred:

Mar. 1 Issued 20,000 shares of common stock for $400,000.

June 1 Declareda cash dividend of $2.00 per share to stockholders of record on June 15. June 30 Paid the $2.00 cash dividend.
Dec. 1 Purchased4,000 shares of common stock for the treasury for $22 per share.

Dec. 15 Declared a cash dividend on outstanding shares of $2.25 per share to stockholders of record on December 31.

Instructions

Preparejournal entries to record the above transactions.

Ex. 142

Recordthe following transactions for Harper Corporation on the dates indicated.

1. On March 31, 2008, Harper Corporation discovered that Depreciation Expense on factory equipment for the year ended December 31, 2007, had been recorded twice, for a total amount of $50,000 instead of the correct amount of $25,000.

2. On June 30, 2008, the company’s internal auditors discovered that the April 2008 telephone bill for $2,500 had erroneously been charged to the Interest Expense account.

3. On August 14, 2008, cash dividends on preferred stock of $110,000 declared on July 1, 2008, were paid.

Ex. 143

The following information is available for Orson Corporation:

RetainedEarnings, December 31, 2008
Net Income for the year ended December 31, 2009

$1,500,000 $ 250,000

The company accountant, in preparing financial statements for the year ending December 31, 2009, has discovered the following information:

The company’s previous bookkeeper, who has been fired, had recorded depreciation expense on a machine in 2007 and 2008 using the double-declining-balance method of depreciation. The bookkeeper neglected to use the straight-line method of depreciation which is the company’s policy. The cumulative effects of the error on prior years was $15,000, ignoring income taxes. Depreciation was computed by the straight-line method in 2009.

Instructions

(a) Prepare the entry for the prior period adjustment. (b) Prepare the retained earnings statement for 2009.

Ex. 144

The following information is available for Sanders Inc.:

Beginningretained earnings Cash dividends declared Net income for 2008
Stock dividend declared
Understatementof last year’s depreciation expense

$600,000 50,000 120,000 10,000 40,000

Instructions

Based on the preceding information, prepare a retained earnings statement for 2008.

Ex. 145

On January 1, 2008, Windom Corporation had Retained Earnings of $378,000. During the year, Windom had the following selected transactions:
1. Declared stock dividends of $40,000. 2. Declared cash dividends of $90,000.
3. A 2 for 1 stock split involving the issuance of 200,000 shares of $5 par value common stock for 100,000 shares of $10 par value common stock.
4. Suffered a net loss of $70,000.
5. Corrected understatementof 2007 net income because of an inventory error of $68,000.

Instructions

Preparea retained earnings statement for the year.

Ex. 146

The following accounts appear in the ledger of Norland Inc. after the books are closed at December31, 2008.

CommonStock, $1 par value, 500,000 shares authorized, 400,000 shares issued
CommonStock Dividends Distributable
Paid-in Capital in Excess of Par Value—CommonStock
PreferredStock, $100 par value, 8%, 10,000 shares authorized; 2,000 shares issued
RetainedEarnings
TreasuryStock (10,000 common shares)
Paid-in Capital in Excess of Par Value—PreferredStock

$400,000 80,000 650,000

200,000 950,000 85,000 310,000

Instructions
Prepare the stockholders’ equity section at December 31, 2008, assuming that retained earnings is restrictedfor plant expansion in the amount of $200,000.

Ex. 147

The following information is available for Wenger Corporation:

Beginningstockholders’ equity Dividendspaid to common stockholders Dividendspaid to preferred stockholders Ending stockholders’ equity
Net income
$700,000 50,000 30,000 800,000 165,000

Instructions

Based on the preceding information, calculate return on common stockholders’ equity.

Ex. 148

Preparea 2008 income statement for Carney Corporation based on the following information:

Cost of goods sold Operatingexpenses
Other expenses and losses Sales
Tax rate
$420,000 100,000 30,000 700,000 30%

Ex. 149

Feldman Corporation gathered the following information for the fiscal year ended December 31, 2008:
Sales $1,600,000 Selling and administrative expenses 160,000 Cost of goods sold 1,040,000 Loss on sale of equipment 40,000

FeldmanCorporation is subject to a 30% income tax rate.

Instructions

Preparea partial income statement, beginning with income from operations.

Ex. 150

At December 31, 2008, Rossi Company has $500,000 of $100 par value, 8%, cumulative preferred stock outstanding and $2,000,000 of $10 par value common stock issued. Rossi’s net income for the year is $500,000.

Instructions

Compute earnings per share of common stock for 2008 under the following independent situations. (Round to two decimals.)

(a) The dividend to preferred stockholders was declared, and there has been no change in the number of shares of common stock outstanding during the year.

(b) The dividend to preferred stockholders was not declared, and 10,000 shares of common treasury stock were held throughout the year. The preferred stock is cumulative.

Ex. 151

The following information is available for Vincent Corporation:

Dividendspaid to common stockholders Dividendspaid to preferred stockholders Net income
Weightedaverage common shares outstanding
$ 45,000 20,000 145,000 100,000

Instructions
Computethe earnings per share of common stock.

COMPLETION STATEMENTS

152. Three important dates associated with dividends are the: (1) , (2) , and (3) .

153. The entry to record the declaration of a stock dividend increases , and decreases .

154. Both a stock split and a stock dividend will the number of shares outstanding and have on total stockholders’ equity.

155. Corporations sometimes segregate retained earnings into two categories: (1) retained earnings and (2) retained earnings.

156. The correction of an error in previously issued financial statements is known as a

.

157. The return on shows how many dollars of net income were earned for each dollar invested by owners.

158. The return on common stockholders’ equity is computed by dividing minus dividends by average common stockholders’ equity.

159. Income statements for corporations report in a separate section before net income.

160. Earnings per share is reported only for .

161. Earnings per share is calculated by dividing available for common stockholders by the number of common shares outstanding.

MATCHING

162. Match the items below by entering the appropriate code letter in the space provided.

A. Deficit
B. Prior period adjustment C. Liquidatingdividend
D. Retainedearnings restrictions E. Earningsper share
F. Return on common stockholders’ equity G. Cash dividend
H. Declarationdate I. Stock dividend J. Stock split

1. A dividend declared out of paid-in capital.

2. Retained earnings currently unavailable for dividends.

3. The correction of an error in previously issued financial statements.

4. A pro rata distribution of cash to stockholders.

5. A debit balance in retained earnings.

6. A pro rata distribution of the corporation’s own stock to stockholders.

7. Shows how many dollars of net income were earned for each dollar invested by the owners.

8. The date the board of directors formally declares the dividend and announces it to stockholders.

9. The issuance of additional shares of stock to stockholders accompanied by a reduction in the par or stated value per share.

10. Widely used by stockholders and potential investors in evaluating the profitability of a company.

SHORT-ANSWERESSAY QUESTIONS
S-AE 163
The ultimate effect of incurring an expense is to reduce stockholders’ equity. The declaration of a cash dividend also reduces stockholders’ equity. Explain the difference between an expense and a cash dividend and explain why they have the same effect on stockholders’ equity.

S-AE 164

A large stock dividend and stock split can frequently have the same effect on the market price of a corporation’s stock. Explain how stock dividends and stock splits affect the market price of a corporation’s stock.

S-AE 165

Whymust a corporation have sufficient retained earnings before it may declare cash dividends?

S-AE 166 (Ethics)

Jake Hightower, the president and CEO of Earth Systems, Inc., a waste management firm, was recently hospitalized, suffering from exhaustion and a heart ailment. Immediately prior to his hospitalization, Earth Systems had experienced a sharp decline in its stock price, and trading activity became almost nonexistent. The primary reason for this was concern expressed in the media over a new untested waste management system implemented by the company. Mr. Hightower had been unwilling to submit the procedure to testing before implementation, but he reluctantly agreed to limited tests after the system was operational. No problems have been identified by the tests to date.

The other members of management called a meeting to determine what they should do. Roger Donovan, the marketing manager, suggested that the company purchase a large number of shares of treasury stock. In that way, investors might notice that activity had picked up, and might decide to buy some more shares. This plan would use up most of the company’s available cash, so that there will be no money available for a cash dividend. Earth Systems has paid cash dividends every quarter for over ten years.

Required:

1. Is Mr. Donovan’s suggestion ethical? Explain.
2. Is it ethical to discontinue the cash dividend? Explain.

S-AE 167 (Communication)

As part of a Careers in Accounting program sponsored by accounting organizations and supported by your company, you will be taking a group of high-school students through the accounting department in your company. You will also provide them with various materials to explain the work of an accountant. One of the materials you will provide is the Stockholders’ Equity section of a recent balance sheet.

S-AE 167 (cont.)

Required:
Prepare a sentence or two explaining each major section: Common Stock, Additional Paid-in Capital, and Retained Earnings. You should try to be brief but clear.

CHAPTER 15

LONG-TERMLIABILITIES

CHAPTERSTUDY OBJECTIVES

1. Explain why bonds are issued.

2. Prepare the entries for the issuance of bonds and interest expense.

3. Describe the entries when bonds are redeemed or converted.

4. Describe the accounting for long-term notes payable.

5. Contrast the accounting for operating and capital leases.

6. Identify the methods for the presentation and analysis of long-term liabilities.

7. Compute the market price of a bond.

8. Apply the effective-interest method of amortizing bond discount and bond premium.

a9. Apply the straight-line method of amortizing bond discount and bond premium.

TRUE-FALSESTATEMENTS

1. Each bondholder may vote for the board of directors in proportion to the number of bonds held.

2. Bond interest paid by a corporation is an expense, whereas dividends paid are not an expense of the corporation.

3. Registered bonds are bonds that are delivered to owners by U.S. registered mail service.

4. A debenture bond is an unsecured bond which is issued against the general credit of the borrower.

5. Bonds are a form of interest-bearingnotes payable.

6. Neither corporate bond interest nor dividends are deductible for tax purposes.

7. A 10% stock dividend is the equivalent of a $1,000 par value bond paying annual interest of 10%.

8. The holder of a convertible bond can convert an interest payment received into a cash dividend paid on common stock if the dividend is greater than the interest payment.

9. The board of directors may authorize more bonds than are issued.

10. The contractual interest rate is always equal to the market interest rate on the date that bonds are issued.

11. If $150,000 face value bonds are issued at 102, the proceeds received will be $102,000.

12. Discount on bonds is an additional cost of borrowing and should be recorded as interest expense over the life of the bonds.

13. If a corporation issued bonds at an amount less than face value, it indicates that the corporation has a weak credit rating.
Long-Term Liabilities 15 – 5

14. A corporation that issues bonds at a discount will recognize interest expense at a rate which is greater than the market interest rate.

15. If bonds are issued at a discount, the issuing corporation will pay a principal amount less than the face amount of the bonds on the maturity date.

16. If bonds are issued at a premium, the carrying value of the bonds will be greater than the face value of the bonds for all periods prior to the bond maturity date.

17. If the market interest rate is greater than the contractual interest rate, bonds will sell at a discount.

18. If $800,000, 8% bonds are issued on January 1, and pay interest semiannually, the amount of interest paid on July 1 will be $32,000.

19. If bonds sell at a premium, the interest expense recognized each year will be greater than the contractual interest rate.

20. The carrying value of bonds is calculated by adding the balance of the Discount on Bonds Payable account to the balance in the Bonds Payable account.

21. The loss on bond redemption is the difference between the cash paid and the carrying value of the bonds.

22. If $200,000 par value bonds with a carrying value of $190,400 are redeemed at 97, a loss on redemption will be recorded.

23. Gains and losses are not recognized when convertible bonds are converted into common stock.

24. Generally, convertible bonds do not pay interest.

25. Each payment on a mortgage note payable consists of interest on the original balance of the loan and a reduction of the loan principal.

26. A long-term note that pledges title to specific property as security for a loan is known as a mortgage payable.

27. A capital lease requires the lessee to record the lease as a purchase of an asset.

28. The times interest earned ratio is computed by dividing net income by interest expense.

a29. The present value of a bond is a function of two variables: (1) the payment amounts and (2) the interest (discount) rate.

a30. The effective-interest method of amortization results in varying amounts of amortization and interest expense per period but a constant interest rate.

Additional True-False Questions

31. Bonds that mature at a single specified future date are called term bonds.
15 – 6

32. The terms of the bond issue are set forth in a formal legal document called a bond indenture.

33. The carrying value of bonds at maturity should be equal to the face value of the bonds.

34. Premium on Bonds Payable is a contra account to Bonds Payable.

35. When bonds are converted into common stock, the carrying value of the bonds is transferred to paid-in capital accounts.

36. Operating leases are leases that the lessee must capitalize on its balance sheet as an asset.

37. Under a capital lease, the lease/asset is reported on the balance sheet under plant assets.

38. Long-term liabilities are reported in a separate section of the balance sheet immediately following current liabilities.

MULTIPLECHOICE QUESTIONS

39. Each of the following is correct regarding bonds except they are a. a form of interest-bearing notes payable.
b. attractive to many investors.
c. issued by corporations and governmentalagencies. d. sold in large denominations.

40. From the standpoint of the issuing company, a disadvantage of using bonds as a means of long-term financing is that
a. bond interest is deductible for tax purposes.
b. interest must be paid on a periodic basis regardless of earnings.
c. income to stockholders may increase as a result of trading on the equity. d. the bondholders do not have voting rights.

41. If a corporation issued $2,000,000 in bonds which pay 10% annual interest, what is the annual net cash cost of this borrowing if the income tax rate is 30%?
a. $2,000,000 b. $60,000
c. $200,000 d. $140,000
Long-Term Liabilities 15 – 7

42. Secured bonds are bonds that
a. are in the possession of a bank.
b. are registered in the name of the owner.
c. have specific assets of the issuer pledged as collateral. d. have detachable interest coupons.

43. A legal document which summarizes the rights and privileges of bondholders as well as the obligations and commitmentsof the issuing company is called
a. a bond indenture. b. a bond debenture.
c. trading on the equity. d. a term bond.

44. Stockholders of a company may be reluctant to finance expansion through issuing more equity because
a. leveraging with debt is always a better idea. b. their earnings per share may decrease.
c. the price of the stock will automaticallydecrease. d. dividends must be paid on a periodic basis.

45. Which of the following is not an advantage of issuing bonds instead of common stock? a. Stockholder control is not affected.
b. Earnings per share on common stock may be lower. c. Income to common shareholdersmay increase.
d. Tax savings result.

46. Bonds that are secured by real estate are termed a. mortgage bonds.
b. serial bonds. c. debentures. d. bearer bonds.

47. Bonds that mature at a single specified future date are called a. coupon bonds.
b. term bonds. c. serial bonds. d. debentures.

48. Bonds that may be exchanged for common stock at the option of the bondholders are called
a. options.
b. stock bonds.
c. convertible bonds. d. callable bonds.

49. Bonds that are subject to retirement at a stated dollar amount prior to maturity at the option of the issuer are called
a. callable bonds.
b. early retirement bonds. c. options.
d. debentures.
15 – 8

50. Investors who receive checks in their names for interest earned on bonds must hold a. registered bonds.
b. coupon bonds. c. bearer bonds. d. direct bonds.

51. A bondholder that sends in a coupon to receive interest payments must have a(n) a. unsecured bond.
b. bearer bond.
c. mortgage bond. d. serial bond.

52. Bonds that may be directly transferred to another party by delivery are a. coupon bonds.
b. debentures.
c. registered bonds.
d. transportable bonds.

53. Bonds that must be cancelled and reissued as new bonds in order to have ownership interest transferred are
a. coupon bonds. b. bearer bonds. c. serial bonds.
d. registered bonds.

54. Corporations are granted the power to issue bonds through a. tax laws.
b. state laws.
c. federal security laws. d. bond debentures.

55. The party who has the right to exercise a call option on bonds is the a. investment banker.
b. bondholder. c. bearer.
d. issuer.

56. A major disadvantageresulting from the use of bonds is that a. earnings per share may be lowered.
b. interest must be paid on a periodic basis. c. bondholders have voting rights.
d. taxes may increase.

57. Bonds will always fall into all but which one of the following categories? a. Callable or convertible
b. Term or serial
c. Registered or bearer d. Secured or unsecured
Long-Term Liabilities 15 – 9

58. Which of the following statements concerning bonds is not a true statement? a. Bonds are generally sold through an investment company.
b. The bond indenture is prepared after the bonds are printed.
c. The bond indenture and bond certificate are separate documents. d. The trustee keeps records of each bondholder.

59. A bond trustee does not a. issue the bonds.
b. keep a record of each bondholder.
c. hold conditional title to pledged property. d. maintain custody of unsold bonds.

60. The contractual interest rate is always stated as a(n) a. monthly rate.
b. daily rate.
c. semiannual rate. d. annual rate.

61. When authorizing bonds to be issued, the board of directors does not specify the a. total number of bonds authorized to be sold.
b. contractual interest rate. c. selling price.
d. total face value of the bonds.

Use the following exhibit for questions 62–63.

Bonds Close K mart 8 3/8 17 100¼
Yield Volume 8.4 35
Net Change +7/8

62. The contractual interest rate of the K mart bonds is a. greater than the market interest rate.
b. less than the market interest rate. c. equal to the market interest rate. d. not determinable.

63. On the day of trading referred to above, a. no K mart bonds were traded.
b. bonds with market prices of $3,500 were traded.
c. at closing, the selling price of the bond was higher than the previous day’s price. d. the bond sold for $100.25

64. A $1,000 face value bond with a quoted price of 98 is selling for a. $1,000.
b. $980. c. $908. d. $98.

65. A bond with a face value of $100,000 and a quoted price of 102¼ has a selling price of a. $120,225.
b. $102,025. c. $100,225. d. $102,250.
15 – 10

66. Premium on Bonds Payable a. has a debit balance.
b. is a contra account.
c. is considered to be a reduction in the cost of borrowing. d. is deducted from bonds payable on the balance sheet.

67. If the market interest rate is greater than the contractual interest rate, bonds will sell a. at a premium.
b. at face value. c. at a discount.
d. only after the stated interest rate is increased.

68. On January 1, 2008, Grant Corporation issued $3,000,000, 10-year, 8% bonds at 102. Interest is payable semiannually on January 1 and July 1. The journal entry to record this transaction on January 1, 2008 is
a. Cash………………………………………………………………………… 3,000,000
Bonds Payable…………………………………………………… 3,000,000

b. Cash………………………………………………………………………… Bonds Payable……………………………………………………

c. Premiumon Bonds Payable………………………………………… Cash………………………………………………………………………… Bonds Payable……………………………………………………

d. Cash………………………………………………………………………… Bonds Payable…………………………………………………… Premiumon Bonds Payable…………………………………
3,060,000

60,000 3,000,000

3,060,000

3,060,000

3,060,000

3,000,000 60,000

69. The total cost of borrowing is increased only if the a. bonds were issued at a premium.
b. bonds were issued at a discount. c. bonds were sold at face value.
d. market interest rate is less than the contractual interest rate on that date.

70. If the market interest rate is 10%, a $10,000, 12%, 10-year bond, that pays interest semiannually would sell at an amount
a. less than face value. b. equal to face value.
c. greater than face value.
d. that cannot be determined.

71. The present value of a $10,000, 5-year bond, will be less than $10,000 if the a. contractual interest rate is less than the market interest rate.
b. contractual interest rate is greater than the market interest rate. c. bond is convertible.
d. contractual interest rate is equal to the market interest rate.

72. Gomez Corporation issues 1,000, 10-year, 8%, $1,000 bonds dated January 1, 2008, at 98. The journal entry to record the issuance will show a
a. debit to Cash of $1,000,000.
b. credit to Discount on Bonds Payable for $20,000. c. credit to Bonds Payable for $980,000.
d. debit to Cash for $980,000.
Long-Term Liabilities 15 – 11

73. The market interest rate is often called the a. stated rate.
b. effective rate. c. coupon rate.
d. contractual rate.

74. If bonds are issued at a discount, it means that the a. financial strength of the issuer is suspect.
b. market interest rate is higher than the contractual interest rate. c. market interest rate is lower than the contractual interest rate.
d. bondholder will receive effectively less interest than the contractual interest rate.

75. Each of the following accounts is reported as long-term liabilities except a. Bond Interest Payable.
b. Bonds Payable.
c. Discount on Bonds Payable. d. Premium on Bonds Payable.

76. The statement that “Bond prices vary inversely with changes in the market interest rate” means that if the
a. market interest rate increases, the contractual interest rate will decrease. b. contractual interest rate increases, then bond prices will go down.
c. market interest rate decreases, then bond prices will go up.
d. contractual interest rate increases, the market interest rate will decrease.

77. The carrying value of bonds will equal the market price a. at the close of every trading day.
b. at the end of the fiscal period. c. on the date of issuance.
d. every six months on the date interest is paid.

78. The sale of bonds above face value a. is a rare occurrence.
b. will cause the total cost of borrowing to be less than the bond interest paid. c. will cause the total cost of borrowing to be more than the bond interest paid. d. will have no net effect on Interest Expense by the time the bonds mature.

79. In the balance sheet, the account, Premium on Bonds Payable, is a. added to bonds payable.
b. deducted from bonds payable.
c. classified as a stockholders’ equity account. d. classified as a revenue account.

80. Two thousand bonds with a face value of $1,000 each, are sold at 103. The entry to record the issuance is
a. Cash ………………………………………………………………………… 2,060,000
Bonds Payable ………………………………………………….. 2,060,000

b. Cash ………………………………………………………………………… 2,000,000 Premiumon Bonds Payable ………………………………………… 60,000
Bonds Payable ………………………………………………….. 2,060,000
15 – 12

c. Cash ……………………………………………………………………….. 2,060,000 Premiumon Bonds Payable ………………………………..
Bonds Payable …………………………………………………..

60,000 2,000,000

d. Cash ……………………………………………………………………….. 2,060,000 Discounton Bonds Payable …………………………………
Bonds Payable …………………………………………………..

60,000 2,000,000

81. Bond interest paid is
a. higher when bonds sell at a discount. b. lower when bonds sell at a premium.
c. the same whether bonds sell at a discount or a premium.
d. higher when bonds sell at a discount and lower when bonds sell at a premium.

82. Mendez Corporation issues 2,000, 10-year, 8%, $1,000 bonds dated January 1, 2008, at 103. The journal entry to record the issuance will show a
a. debit to Cash of $2,000,000.
b. credit to Premium on Bonds Payable for $60,000. c. credit to Bonds Payable for $2,030,000.
d. credit to Cash for $2,060,000.

Use the following information for questions 83–86.

Golden Company received proceeds of $94,250 on 10-year, 8% bonds issued on January 1, 2007. The bonds had a face value of $100,000, pay interest semi-annually on June 30 and December31, and have a call price of 101. Golden uses the straight-line method of amortization.

83. What is the amount of interest Golden must pay the bondholders in 2007? a. $7,540
b. $8,000 c. $8,575 d. $7,425

a84. What is the amount of interest expense Golden will show with relation to these bonds for the year ended December 31, 2008?
a. $8,000 b. $7,540 c. $8,575 d. $7,425

a85. What is the carrying value of the bonds on January 1, 2009? a. $100,000
b. $95,400 c. $98,850 d. $94,825

86. Golden Company decided to redeem the bonds on January 1, 2009. What amount of gain or loss would Golden report on its 2009 income statement?
a. $4,600 gain b. $5,600 gain c. $5,600 loss d. $4,600 loss
Long-Term Liabilities 15 – 13

87. Bryce Company has $500,000 of bonds outstanding. The unamortized premium is $7,200. If the company redeemed the bonds at 101, what would be the gain or loss on the redemption?
a. $2,200 gain b. $2,200 loss c. $5,000 gain d. $5,000 loss

88. The current carrying value of Jensen’s $600,000 face value bonds is $597,750. If the bonds are retired at 102, what would be the amount Jensen would pay its bondholders? a. $597,750
b. $600,000 c. $603,000 d. $612,000

89. Lahey Corporation retires its $500,000 face value bonds at 105 on January 1, following the payment of annual interest. The carrying value of the bonds at the redemption date is $518,725. The entry to record the redemption will include a
a. credit of $18,725 to Loss on Bond Redemption. b. debit of $18,725 to Premium on Bonds Payable. c. credit of $6,275 to Gain on Bond Redemption. d. debit of $25,000 to Premium on Bonds Payable.

90. A $900,000 bond was retired at 103 when the carrying value of the bond was $933,000. The entry to record the retirement would include a
a. gain on bond redemption of $27,000. b. loss on bond redemption of $6,000. c. loss on bond redemption of $27,000. d. gain on bond redemption of $6,000.

91. If forty $1,000 convertible bonds with a carrying value of $46,000 are converted into 6,000 shares of $5 par value common stock, the journal entry to record the conversion is
a. Bonds Payable ………………………………………………………….. 46,000 CommonStock ………………………………………………….. 46,000

b. Bonds Payable ………………………………………………………….. 40,000 Premiumon Bonds Payable ………………………………………… 6,000
CommonStock ………………………………………………….. 46,000

c. Bonds Payable ………………………………………………………….. 40,000 Premiumon Bonds Payable ………………………………………… 6,000
CommonStock ………………………………………………….. 30,000 Paid-in Capital in Excess of Par …………………………… 16,000

d. Bonds Payable ………………………………………………………….. 46,000
Discount on Bonds Payable ………………………………… 6,000 CommonStock ………………………………………………….. 30,000 Paid-in Capital in Excess of Par …………………………… 10,000

92. A corporation recognizes a gain or loss
a. only when bonds are converted into common stock. b. only when bonds are redeemed before maturity.
c. when bonds are redeemed at or before maturity.
d. when bonds are converted into common stock and when they are redeemed before maturity.
15 – 14

93. If there is a loss on bonds redeemed early, it is a. debited directly to Retained Earnings.
b. reported as an “Other Expense” on the income statement.
c. reported as an “Extraordinary Item” on the income statement. d. debited to Interest Expense, as a cost of financing.

94. If bonds can be converted into common stock,
a. they will sell at a lower price than comparable bonds without a conversion feature.
b. they will carry a higher interest rate than comparable bonds without the conversion feature.
c. they will be converted only if the issuer calls them in for conversion.
d. the bondholder may benefit if the market price of the common stock increases substantially.

95. When bonds are converted into common stock,
a. the market price of the stock on the date of conversion is credited to the Common Stock account.
b. the market price of the bonds on the date of conversion is credited to the Common Stock account.
c. the market price of the stock and the bonds is ignored when recording the conversion. d. gains or losses on the conversion are recognized.

96. If bonds with a face value of $90,000 are converted into common stock when the carrying value of the bonds is $81,000, the entry to record the conversion will include a debit to
a. Bonds Payable for $90,000. b. Bonds Payable for $81,000.
c. Discount on Bonds Payable for $9,000.
d. Bonds Payable equal to the market price of the bonds on the date of conversion.

97. A $900,000 bond was retired at 98 when the carrying value of the bond was $888,000. The entry to record the retirement would include a
a. gain on bond redemption of $12,000. b. loss on bond redemption of $6,000. c. loss on bond redemption of $12,000. d. gain on bond redemption of $6,000.

98. Twenty $1,000 bonds with a carrying value of $25,600 are converted into 2,000 shares of $5 par value common stock. The common stock had a market value of $9 per share on the date of conversion. The entry to record the conversion is
a. Bonds Payable …………………………………………………………. 25,600 CommonStock …………………………………………………. 10,000 Paid-in Capital in Excess of Par……………………………. 15,600
b. Bonds Payable …………………………………………………………. 20,000 Premiumon Bonds Payable ……………………………………….. 5,600
CommonStock …………………………………………………. 18,000 Paid-in Capital in Excess of Par …………………………… 7,600
c. Bonds Payable …………………………………………………………. 20,000 Premiumon Bonds Payable ……………………………………….. 5,600
CommonStock …………………………………………………. 10,000 Paid-in Capital in Excess of Par……………………………. 15,600
d. Bonds Payable …………………………………………………………. 25,600 CommonStock …………………………………………………. 18,000 Paid-in Capital in Excess of Par……………………………. 7,600
Long-Term Liabilities 15 – 15

99. Which one of the following amounts increases each period when accounting for long-term notes payable?
a. Cash payment b. Interest expense
c. Principal balance
d. Reduction of principal

100. In the balance sheet, mortgage notes payable are reported as a. a current liability only.
b. a long-term liability only.
c. both a current and a long-term liability.
d. a current liability except for the reduction in principal amount.

101. A mortgage note payable with a fixed interest rate requires the borrower to make installment payments over the term of the loan. Each installment payment includes interest on the unpaid balance of the loan and a payment on the principal. With each installment payment, indicate the effect on the portion allocated to interest expense and the portion allocated to principal.

Portion Allocated to Interest Expense
a. Increases b. Increases c. Decreases d. Decreases
Portion Allocated to Payment of Principal
Increases Decreases Decreases Increases

102. The entry to record an installment payment on a long-term note payable is a. Mortgage Notes Payable
Cash
b. Interest Expense Cash
c. Mortgage Notes Payable Interest Expense
Cash
d. Bonds Payable Cash

Use the following information for questions 103–104.

Delmar Company purchased a building on January 2 by signing a long-term $840,000 mortgage with monthly payments of $7,700. The mortgage carries an interest rate of 10 percent.

103. The entry to record the first monthly payment will include a a. debit to the Cash account for $7,700.
b. credit to the Cash account for $7,000.
c. debit to the Interest Expense account for $7,000. d. credit to the Mortgage Payable account for $7,700.

104. The amount owed on the mortgage after the first payment will be a. $840,000.
b. $839,300. c. $833,000. d. $832,300.
15 – 16

Use the following information for questions 105–106.

Diamond Company borrowed $500,000 from BankTwo on January 1, 2007 in order to expand its mining capabilities. The five-year note required annual payments of $130,218 and carried an annual interest rate of 9.5%.

105. What is the amount of expense Diamond must recognize on its 2008 income statement? a. $47,500
b. $39,642 c. $35,129 d. $31,037

106. What is the balance in the notes payable account at December 31, 2008? a. $500,000
b. $326,706 c. $417,282 d. $405,000

107. The lessee has substantially all of the benefits and risks of ownership in a(n) a. apartment lease.
b. capital lease.
c. operating lease.
d. operating lease and a capital lease.

108. A lease where the intent is temporary use of the property by the lessee with continued ownership of the property by the lessor is called
a. off-balance sheet financing. b. an operating lease.
c. a capital lease.
d. a purchase of property.

109. Which of the following is not a condition which would require the recording of a lease contract as a capital lease?
a. The lease transfers ownership of the property to the lessee. b. The lease contains a bargain purchase option.
c. The lease term is less than 75% of the economic life of the leased property.
d. The present value of the lease payments equals or exceeds 90% of the fair market value of the leased property.

110. In a lease contract,
a. the owner of the property is called the lessee.
b. the presence of a bargain purchase option indicates that it is a capital lease. c. the renter of the property is called the lessor.
d. there is always a transfer of ownership at the end of the lease term.

111. Which of the following statements concerning leases is true? a. Capital leases are favored by lessees.
b. The appearance of the account, Leased Asset, on the balance sheet, signifies an operating lease.
c. The portion of a lease liability expected to be paid in the next year is reported as a current liability.
d. Present value is irrelevant in accounting for leases.
Long-Term Liabilities 15 – 17

112. If the present value of lease payments equals or exceeds 90% of the fair market value of the leased property, the
a. conditions are met for the lease to be considered a capital lease. b. lease is uneconomical and should not be entered into.
c. lease may be classified as an operating lease.
d. recording of a lease liability is optional—that is, the off-balance sheet approach can be elected.

113. Each of the following may be shown in a supporting schedule instead of the balance sheet exceptthe
a. current maturities of long-term debt. b. conversion privileges.
c. interest rates. d. maturity dates.

114. The times interest earned ratio is computed by dividing a. net income by interest expense.
b. income before income taxes by interest expense.
c. income before interest expense by interest expense.
d. income before income taxes and interest expense by interest expense.

115. The discount on bonds payable or premium on bonds payable is shown on the balance sheet as an adjustment to bonds payable to arrive at the carrying value of the bonds. Indicate the appropriateaddition or subtraction to bonds payable:

Premiumon Bonds Payable
a. Add b. Deduct c. Add d. Deduct
Discounton Bonds Payable Add Add Deduct Deduct

116. In a recent year Dart Corporation had net income of $140,000, interest expense of $30,000, and tax expense of $20,000. What was Dart Corporation’s times interest earned ratio for the year?
a. 6.33 b. 4.66 c. 5.33 d. 6.00

117. In a recent year Day Corporation had net income of $150,000, interest expense of $30,000, and a times interest earned ratio of 9. What was Day Corporation’s income before taxes for the year?
a. $300,000 b. $270,000 c. $240,000
d. None of the above.
15 – 18

118. The adjusted trial balance for Lifesaver Corp. at the end of the current year, 2008, contained the following accounts.

5-year Bonds Payable 8% Bond Interest Payable Premiumon Bonds Payable Notes Payable (3 mo.) Notes Payable (5 yr.)
MortgagePayable ($15,000 due currently) Salaries Payable
Taxes Payable (due 3/15 of 2009)
$1,000,000 50,000 100,000 40,000 165,000 200,000 18,000 25,000

The total long-term liabilities reported on the balance sheet are a. $1,365,000.
b. $1,350,000. c. $1,465,000. d. $1,450,000.

119. The 2008 financial statements of Shadow Co. contain the following selected data (in millions).

Current Assets $ 75 Total Assets 120 Current Liabilities 40 Total Liabilities 85 Cash 8

The debt to total assets ratio is a. 70.8%.
b. 53.3%. c. 29.2%. d. 1.41%.

a120. The present value of a bond is also known as its a. face value.
b. market price. c. future value. d. deferred value.

a121. $3 million, 10%, 10-year bonds are issued at face value. Interest will be paid semi-annually. When calculating the market price of the bond, the present value of
a. $300,000 received for 10 periods must be calculated. b. $3 million received in 10 periods must be calculated. c. $3 million received in 20 periods must be calculated. d. $150,000 received for 10 periods must be calculated.

a122. Either the straight-line method or the effective-interest method of amortization will always result in
a. the same amount of interest expense being recognized over the term of the bonds. b. the same amount of interest expense being recognized each year.
c. more interest expense being recognized than if premium or discounts were not amortized.
d. the same carrying value each year during the term of the bonds.
Long-Term Liabilities 15 – 19

a123. A corporation issued $300,000, 10%, 5-year bonds on January 1, 2008 for $324,333, which reflects an effective-interest rate of 8%. Interest is paid semiannually on January 1 and July 1. If the corporation uses the effective-interest method of amortization of bond premium, the amount of bond interest expense to be recognized on July 1, 2008, is
a. $15,000. b. $12,000. c. $16,217. d. $12,973.

a124. A bond discount must
a. always be amortized using straight-line amortization.
b. always be amortized using the effective-interest method.
c. be amortized using the effective-interest method if it yields annual amounts that are materially different than the straight-line method.
d. be amortized using the straight-line method if it yields annual amounts that are materially different than the effective-interestmethod.

a125. When the effective-interestmethod of bond discount amortization is used,
a. the applicable interest rate used to compute interest expense is the prevailing market interest rate on the date of each interest payment date.
b. the carrying value of the bonds will decrease each period.
c. interest expense will not be a constant dollar amount over the life of the bond.
d. interest paid to bondholders will be a function of the effective-interest rate on the date the bonds are issued.

a126. When the effective-interest method of bond premium amortization is used, the a. amount of premium amortized will get larger with successive amortization. b. carrying value of the bonds will increase with successive amortization.
c. interest paid to bondholders will increase after each interest payment date. d. interest rate used to calculate interest expense will be the contractual rate.

Use the following information for questions 127–129.

Silcon Company issued $800,000 of 6%, 10-year bonds on one of its interest dates for $690,960 to yield an effective annual rate of 8%. The effective-interest method of amortization is to be used.

a127. What amount of discount (to the nearest dollar) should be amortized for the first interest period?
a. $22,542 b. $10,904 c. $14,554 d. $7,277

a128. The journal entry on the first interest payment date, to record the payment of interest and amortization of discount will include a
a. debit to Bond Interest Expense for $48,000. b. credit to Cash for $55,277.
c. credit to Discount on Bonds Payable for $7,277. d. debit to Bond Interest Expense for $64,000.
15 – 20

a129. How much bond interest expense (to the nearest dollar) should be reported on the income statement for the end of the first year?
a. $55,422 b. $55,277 c. $55,131 d. $48,000

a130. On January 1, Jean Loptein Inc. issued $3,000,000, 9% bonds for $2,817,000. The market rate of interest for these bonds is 10%. Interest is payable annually on December 31. Jean Loptein uses the effective-interest method of amortizing bond discount. At the end of the first year, Jean Loptein should report unamortized bond discount of
a. $164,700. b. $171,300. c. $154,830. d. $153,000.

a131. On January 1, Cleopatra Corporation issued $2,000,000, 14%, 5-year bonds with interest payable on December 31. The bonds sold for $2,144,192. The market rate of interest for these bonds was 12%. On the first interest date, using the effective-interest method, the debit entry to Bond Interest Expense is for
a. $240,000. b. $251,162. c. $257,304. d. $280,000.

a132. On January 1, Hurley Corporation issues $1,000,000, 5-year, 12% bonds at 96 with interest payable on July 1 and January 1. The entry on December 31 to record accrued bond interest and the amortization of bond discount using the straight-line method will include a
a. debit to Interest Expense, $60,000. b. debit to Interest Expense, $120,000.
c. credit to Discount on Bonds Payable, $4,000. d. credit to Discount on Bonds Payable, $8,000.

133. On January 1, 2008, $1,000,000, 10-year, 10% bonds, were issued for $970,000. Interest is paid annually on January 1. If the issuing corporation uses the straight-line method to amortize discount on bonds payable, the monthly amortization amount is
a. $9,700. b. $3,000. c. $808. d. $250.

134. A corporation issues $100,000, 10%, 5-year bonds on January 1, 2008, for $95,800. Interest is paid annually on January 1. If the corporation uses the straight-line method of amortization of bond discount, the amount of bond interest expense to be recognized in December 31, 2008’s adjusting entry is
a. $10,840. b. $10,000. c. $9,160. d. $840.
Long-Term Liabilities 15 – 21

a135. Roman Company issued $400,000 of 6%, 5-year bonds at 98, with interest paid annually. Assumingstraight-line amortization, what is the total interest cost of the bonds?
a. $120,000 b. $128,000 c. $112,000 d. $116,000

a136. Sunwood Company issued $500,000 of 6%, 5-year bonds at 98, with interest paid annually. Assuming straight-line amortization, what is the carrying value of the bonds after one year?
a. $490,000 b. $491,000 c. $492,000 d. $494,000

a137. Terrance Company issued $200,000 of 8%, 5-year bonds at 106. Assuming straight-line amortization and annual interest payments, how much bond interest expense is recorded on the next interest date?
a. $16,000 b. $18,400 c. $13,600 d. $2,400

a138. Garcia Company issued $800,000 of 8%, 5-year bonds at 106, with interest paid annually. Assuming straight-line amortization, what is the carrying value of the bonds after one year?
a. $848,000 b. $843,200 c. $838,400 d. $852,800

a139. On January 1, 2008, $5,000,000, 5-year, 10% bonds, were issued for $4,850,000. Interest is paid semiannually on January 1 and July 1. If the issuing corporation uses the straight-line method to amortize discount on bonds payable, the monthly amortization amount is
a. $29,040. b. $30,000. c. $2,420. d. $2,500.

a140. A corporation issues $300,000, 10%, 5-year bonds on January 1, 2008 for $287,400. Interest is paid semiannually on January 1 and July 1. If the corporation uses the straight-line method of amortization of bond discount, the amount of bond interest expense to be recognized on July 1, 2008 is
a. $31,260. b. $15,000. c. $16,260. d. $13,740.

a141. Over the term of the bonds, the balance in the Discount on Bonds Payable account will a. fluctuate up and down if the market is volatile.
b. decrease. c. increase.
d. be unaffected until the bonds mature.
15 – 22

a142. Bond discount should be amortized to comply with a. the historical cost principle.
b. the matching principle.
c. the revenue recognition principle. d. conservatism.

a143. If bonds have been issued at a discount, over the life of the bonds, the a. carrying value of the bonds will decrease.
b. carrying value of the bonds will increase.
c. interest expense will increase, if the discount is being amortized on a straight-line basis.
d. unamortized discount will increase.

Additional Multiple Choice Questions

144. The market value (present value) of a bond is a function of all of the following except the a. dollar amounts to be received.
b. length of time until the amounts are received. c. market rate of interest.
d. length of time until the bond is sold.

145. On the date of issue, Chudzick Corporation sells $2 million of 5-year bonds at 97. The entry to record the sale will include the following debits and credits:

Bonds Payable a. $1,940,000 Cr. b. $2,000,000 Cr. c. $2,000,000 Cr. d. $2,000,000 Cr.
Discount on Bonds Payable $0 Dr.
$60,000 Dr. $500,000 Dr. $6,000 Dr.

146. The market rate of interest for a bond issue which sells for more than its face value is a. independent of the interest rate stated on the bond.
b. higher than the interest rate stated on the bond. c. equal to the interest rate stated on the bond.
d. less than the interest rate stated on the bond.

147. When a company retires bonds before maturity, the gain or loss on redemption is the difference between the cash paid and the
a. carrying value of the bonds. b. face value of the bonds.
c. original selling price of the bonds. d. maturity value of the bonds.

148. Hoffman Corporation retires its bonds at 106 on January 1, following the payment of semi-annual interest. The face value of the bonds is $400,000. The carrying value of the bonds at the redemption date is $419,800.The entry to record the redemption will include a
a. credit of $19,800 to Loss on Bond Redemption. b. debit of $24,000 to Premium on Bonds Payable. c. credit of $4,200 to Gain on Bond Redemption. d. debit of $19,800 to Premium on Bonds Payable.
Long-Term Liabilities 15 – 23

149. Each payment on a mortgage note payable consists of a. interest on the original balance of the loan.
b. reduction of loan principal only.
c. interest on the original balance of the loan and reduction of loan principal. d. interest on the unpaid balance of the loan and reduction of loan principal.

150. Which of the following is not a condition under which the lessee must record the lease of an asset?
a. The lease contains a bargain purchase option.
b. The lease transfers ownership of the property to the lessee.
c. The lease term is equal to 60% of the economic life of the lease property.
d. The present value of the lease payments is 90% of the fair market value of the leased property.

151. The lessee must record a lease as an asset if the lease a. transfers ownership of the property to the lessor.
b. contains a purchase option.
c. term is 75% or more of the useful life of the leased property.
d. payments equal or exceed 90% of the fair market value of the leased property.

152. Buffon Electronics Company issues an $800,000, 10%, 20-year mortgage note on January 1. The terms provide for semiannual installment payments, exclusive of real estate taxes and insurance, of $46,621. After the first installment payment, the principal balance is
a. $800,000. b. $786,427. c. $793,379. d. $779,125.

153. The debt to total assets ratio is computed by dividing a. long-term liabilities by total assets.
b. total debt by total assets. c. total assets by total debt.
d. total assets by long-term liabilities.

a154. The market price of a bond is the
a. present value of its principal amount at maturity plus the present value of all future interest payments.
b. principal amount plus the present value of all future interest payments. c. principal amount plus all future interest payments.
d. present value of its principal amount only.

BRIEFEXERCISES
BE 155
ShafferInc. is considering two alternatives to finance its construction of a new $5 million plant. (a) Issuance of 500,000 shares of common stock at the market price of $10 per share.
(b) Issuance of $5 million, 8% bonds at par.

Instructions
Completethe following table.

Incomebefore interest and taxes

Issue Stock $1,400,000

Issue Bonds $1,400,000

Interest expense from bonds

Incomebefore income taxes $ $

Incometax expense (30%)

Net income $ $

Outstandingshares 700,000

Earningsper share

BE 156

On January 1, 2008, Beltway Enterprises issued 11%, 5-year bonds with a face amount of $900,000at par. Interest is payable semiannually on June 30 and December 31.

Instructions
Prepare the entries to record the issuance of the bonds and the first semiannual interest payment.

BE 157

On January 1, 2008, Kentwood Company issued bonds with a face value of $500,000. The bonds carry a stated interest of 7% payable each January 1 and July 1.

Instructions

a. Prepare the journal entry for the issuance assuming the bonds are issued at 97. b. Prepare the journal entry for the issuance assuming the bonds are issued at 102.

BE 158

On July 1, 2008, Frodo Corporation issued $800,000, 6%, 10-year bonds at face value. Interest is payable semiannuallyon January 1 and July 1. Frodo Corporation has a calendar year end.

Instructions

Prepareall entries related to the bond issue for 2008.

BE 159

On January 1, 2008, Zooland Enterprises sold 12%, 10-year bonds with a face amount of $1,000,000for $970,000. Interest is payable semiannuallyon July 1 and January 1.

Instructions
Calculatethe carrying value of the bond at December 31, 2008 and 2009.

BE 160

Delta Company issued bonds with a face amount of $1,000,000 in 2003. As of January 1, 2008, the balance in Discount on Bonds Payable is $4,800. At that time, Delta redeemed the bonds at 102.

Instructions

Assumingthat no interest is payable, make the entry to record the redemption.

BE 161

Nicholson Inc. issues an $800,000, 10%, 10-year mortgage note on December 31, 2008, to obtain financing for a new building. The terms provide for semiannual installment payments of $64,194.

Instructions

Prepare the entry to record the mortgage loan on December 31, 2008, and the first installment payment.

BE 162

Franco Corporation reports the following selected financial statement information at December 31, 2008:
Total Assets $89,000 Total Liabilities 65,000 Net Income 27,000 InterestIncome 1,600 Interest Expense 900 Tax Expense 300

Instructions
Calculatethe debt to total assets and times interest earned ratios.

BE 163

On January 1, 2008, Fabian Enterprises issued 9%, 10-year bonds with a face amount of $700,000 at 96. Interest is payable semiannually on June 30 and December 31. The bonds were issued for an effective interest rate of 10%.

Instructions
Prepare the entries to record the issuance of the bonds and the first semiannual interest payment assuming that the company uses effective-interestamortization.

BE 164

On January 1, 2008, Halston Enterprises issued 8%, 20-year bonds with a face amount of $3,000,000at 101. Interest is payable semiannuallyon June 30 and December 31.

Instructions

Prepare the entries to record the issuance of the bonds and the first semiannual interest payment assuming that the company uses straight-line amortization.

EXERCISES
Ex. 165
Banks Company is considering two alternatives to finance its purchase of a new $4,000,000 office building.
(a) Issue 400,000 shares of common stock at $10 per share. (b) Issue 8%, 10-year bonds at par ($4,000,000).

Income before interest and taxes is expected to be $2,000,000. The company has a 30% tax rate and has 600,000 shares of common stock outstanding prior to the new financing.

Instructions
Calculateeach of the following for each alternative: (1) Net income.
(2) Earnings per share.
Long-Term Liabilities 15 – 29

Ex. 166

The board of directors of Finley Corporation is considering two plans for financing the purchase of new plant equipment. Plan #1 would require the issuance of $4,000,000, 6%, 20-year bonds at face value. Plan #2 would require the issuance of 100,000 shares of $5 par value common stock which is selling for $40 per share on the open market. Finley Corporation currently has 100,000 shares of common stock outstanding and the income tax rate is expected to be 30%. Assume that income before interest and income taxes is expected to be $700,000 if the new factory equipment is purchased.

Instructions

Prepare a schedule which shows the expected net income after taxes and the earnings per share on common stock under each of the plans that the board of directors is considering.

Ex. 167

United Health is considering two alternatives for the financing of some high technology medical equipment. These two alternatives are:

1. Issue 50,000 shares of $10 par value common stock at $50 per share. 2. Issue $2,500,000, 10%, 10-year bonds at par.
15 – 30

Ex. 167 (cont.)

It is estimated that the company will earn $800,000 before interest and taxes as a result of acquiring the medical equipment. The company has an estimated tax rate of 30% and has 100,000shares of common stock outstanding prior to the new financing.

Instructions
Determinethe effect on net income and earnings per share for these two methods of financing.

Ex. 168

Three plans for financing a $20,000,000 corporation are under consideration by its organizers. Under each of the following plans, the securities will be issued at their par or face amount and the income tax rate is estimated at 30%.
Plan 1 Plan 2 Plan 3
9% Bonds — — $10,000,000 6% Preferred Stock, $100 par — $10,000,000 5,000,000 CommonStock, $10 par $20,000,000 10,000,000 5,000,000 Total $20,000,000 $20,000,000 $20,000,000

It is estimated that income before interest and taxes will be $4,000,000.

Instructions

Determinefor each plan, the expected net income and the earnings per share on common stock.
Long-Term Liabilities 15 – 31

Ex. 169

Taylor Corporation issued $3 million, 10-year, 6% bonds on January 1, 2008.

Instructions
Preparethe entry to record the sale of these bonds, assuming they were issued at (a) 98.
(b) 103.

Ex. 170

On January 1, 2008, Kohl Corporation issued $700,000, 8%, 10-year bonds at face value. Interest is payable semiannually on July 1 and January 1. Kohl Corporation has a calendar year end.

Instructions
Prepareall entries related to the bond issue for 2008.

Ex. 171

On January 1, Porter Corporation issued $800,000, 6%, 5-year bonds at face value. Interest is payable semiannuallyon July 1 and January 1.

Instructions
Preparejournal entries to record the (a) Issuance of the bonds.
(b) Payment of interest on July 1, assuming no previous accrual of interest. (c) Accrual of interest on December 31.

Ex. 172

Wood Company retired $300,000 face value, 9% bonds on June 30, 2008 at 98. The carrying value of the bonds at the redemption date was $305,000.

Instructions
Preparethe journal entry to record the redemption of the bonds.

Ex. 173

Presentedbelow are three independent situations:

(a) Howell Corporation purchased $250,000 of its bonds on June 30, 2008, at 102 and immediately retired them. The carrying value of the bonds on the retirement date was $229,500. The bonds pay semiannual interest and the interest payment due on June 30, 2008, has been made and recorded.

(b) Justice, Inc. purchased $200,000 of its bonds at 97 on June 30, 2008, and immediately retired them. The carrying value of the bonds on the retirement date was $196,500. The bonds pay semiannual interest and the interest payment due on June 30, 2008, has been made and recorded.

(c) Starr Company has $80,000, 10%, 12-year convertible bonds outstanding. These bonds were sold at face value and pay semiannual interest on June 30 and December 31 of each year. The bonds are convertible into 40 shares of Starr $5 par value common stock for each $1,000 par value bond. On December 31, 2008, after the bond interest has been paid, $30,000 par value of bonds were converted. The market value of Starr’s common stock was $38 per share on December 31, 2008.

Instructions

For each of the independent situations, prepare the journal entry to record the retirement or conversion of the bonds.

Ex. 174

Riley Company issued a $1,500,000, 10%, 10-year mortgage note payable to finance the construction of a building at December 31, 2008. The terms provide for semiannual installment payments of $120,365.

Instructions
Preparethe entry to record:
(a) the mortgage loan on December 31, 2008. (b) the first installment payment.

Ex. 175

Downey Corporation issues a $2,000,000, 12%, 20-year mortgage note payable on December 31, 2008, to obtain needed financing for the construction of a building addition. The terms provide for semiannual installment payments of $132,924 on June 30 and December 31.

Instructions

(a) Prepare the journal entries to record the mortgage loan on December 31, 2008, and the first installment payment.

(b) Will the amount of principal reduction in the second installment payment be more or less than with the first installment payment?

Ex. 176

Presented below are three different aircraft lease transactions that occurred for Midwest Airways in 2008. All the leases start on January 1, 2008. In no case does Midwest receive title to the aircraft during or at the end of the lease period; nor is there a bargain purchase option.

Lessor

Type of property Yearlyrental Lease term
Estimatedeconomic life Fair market value of
leased asset Presentvalue of lease
rental payments
Vannoy Insurance

747 Aircraft $7,445,064 15 years 25 years

$69,300,000

$63,000,000
Mark Leasing

727 Aircraft $5,449,423 15 years 25 years

$54,000,000

$46,000,000
Gregg Leasing

L-1011 Aircraft $2,851,861
20 years 25 years

$32,000,000

$28,000,000

Instructions
(a) Which of the above leases are operating leases and which are capital leases? Explain your answer.
(b) How should the lease transaction with Vannoy Insurance be recorded in 2008? (c) How should the lease transaction with Mark Leasing be recorded in 2008?

Ex. 177

Ley Corporation entered into the following transactions:

1. Gant Car Rental leased a car to Ley Corporation for one year. Terms of the operating lease call for monthly payments of $750.

2. On January 1, 2008, Ley Corporation entered into an agreement to lease 20 machines from Weiss Corporation. The terms of the lease agreement require an initial payment of $300,000 and then three annual rental payments of $360,000 beginning on December 31, 2008. The present value of the three rental payments is $895,265. The lease is a capital lease.

Instructions

Prepare the appropriate journal entries to be made by Ley Corporation in January related to the lease transactions.

Ex. 178

On January 1, 2008, Rilee Inc. entered into an agreement to lease equipment from Finley Corporation. The lease agreement requires five annual rental payments of $70,000 beginning December 31, 2008. The present value of the rental payments is $265,356. The lease transfers substantially all the benefits and risks of ownership to Rilee.

Instructions
Preparethe entry to record the lease agreement on the books of Rilee Inc. on January 1, 2008.

Ex. 179

The adjusted trial balance for Payne Corporation at the end of the current year contained the following accounts:

Bonds payable, 10%……………………………………………………. Bond interest payable………………………………………………….. Discounton bonds payable………………………………………….. Lease liability……………………………………………………………… Mortgagenotes payable, 9%, due 2011…………………………. Accountspayable………………………………………………………..
$800,000 20,000 40,000 60,000 80,000 120,000

Instructions
(a) Prepare the long-term liabilities section of the balance sheet.
(b) Indicate the proper balance sheet classification for the accounts listed above that do not belong in the long-term liabilities section.

Ex. 180

On January 1, 2008, Quayle Corporation issued $400,000, 9%, 5-year bonds for $384,556. The bonds were sold to yield an effective-interest rate of 10%. Interest is paid semiannually on June 30 and December 31. The company uses the effective-interest method of amortization.

Instructions
(a) Prepare a bond discount amortization schedule which shows the amortization of discount for the first two interest payment dates. (Round to the nearest dollar.)

(b) Prepare the journal entries that Quayle Corporation would make on January 1, June 30, and December31, 2008, related to the bond issue.

Ex. 181

On June 30, 2008, Wayne, Inc. sold $2,000,000 (face value) of bonds. The bonds are dated June 30, 2008, pay interest semiannually on December 31 and June 30, and will mature on June 30, 2011. The following schedule was prepared by the accountant for 2008.

Semi-Annual Interest Period

1
Interestto

be Paid

$80,000
Interest Expense

$87,750

Amortization

$7,750
Unamortized
Amount
$50,000 42,250
Bond Carrying Value
$1,950,000 1,957,750

Instructions
On the basis of the above information, answer the following questions. (Round your answer to the nearest dollar or percent.)

1. What is the stated interest rate for this bond issue?

2. What is the market interest rate for this bond issue?

3. What was the selling price of the bonds as a percentage of the face value?

4. Prepare the journal entry to record the sale of the bond issue on June 30, 2008.

5. Prepare the journal entry to record the payment of interest and amortization on December 31, 2008.

Ex. 182

On January 1, 2008, Lester Corporation issued $2,000,000, 9%, 5-year bonds dated January 1, 2008, at 96. The bonds pay semiannual interest on January 1 and July 1. The company uses the straight-line method of amortization and has a calendar year end.

Instructions
Prepare all the journal entries that Lester Corporation would make related to this bond issue through January 1, 2009. Be sure to indicate the date on which the entries would be made.

Ex. 183

Unruh Company issued $900,000, 10%, 20-year bonds on January 1, 2008, at 104. Interest is payable semiannually on July 1 and January 1. Unruh uses the straight-line method of amortization and has a calendar year end.

Instructions

Prepareall journal entries made in 2008 related to the bond issue.

Ex. 184

Karly Company issued $250,000, 11%, 10-year bonds on December 31, 2008, for $230,000. Interest is payable semiannually on June 30 and December 31. Karly uses the straight-line method of amortization and has a calendar year end.

Instructions
Preparethe appropriatejournal entries on (a) December 31, 2008.
(b) June 30, 2009.

COMPLETION STATEMENTS

185. Bonds that mature at a single specified future date are called bonds, whereas bonds that mature in installments are called bonds.

186. The terms of a bond issue are set forth in a formal legal document called a bond

.

187. Unsecured bonds that are issued against the general credit of the borrower are called

bonds.

188. If bonds were issued at a premium, then the contractual interest rate was

than the market interest rate.

189. Discount on Bonds Payable is (from)(to) bonds payable on the balance sheet. Premium on Bonds Payable is (from)(to) bonds payable on the balance sheet.

190. If bonds are issued at face value (par), it indicates that the interest rate must be equal to the interest rate.

191. If a $1 million, 10%, 10-year bond issue was sold at 96, the cash proceeds from the issuance of the bonds amounted to $ .

192. When bonds are converted into common stock and the conversion is recorded, the

of the bonds is transferred to paid-in capital accounts.

193. A lease may be classified as an lease or as a

lease.

a194. The market price of a bond is obtained by discounting to its present value the

paid at maturity, and all payments to be made over the term of the bond.

a195. When there is a difference between the straight-line and effective-interest methods of amortization, the method is required under GAAP.

a196. A method of amortizing bond discount or premium that allocates an equal amount each period is the method.

a197. The straight-line method of amortization allocates the same amount to

in each interest period.

MATCHING

198. Match the items below by entering the appropriate code letter in the space provided.

A. Serial bonds
B. Debenturebonds C. Bond indenture
D. Premiumon bonds payable E. Discounton bonds payable
F. Effective-interestmethod of amortization
G. Straight-linemethod of amortization H. Bonds
I. Debt to total assets ratio J. Capital lease
K. Operatinglease L. Registeredbonds

1. A contractual arrangement which is in effect a purchase of property.

2. A legal document that sets forth the terms of a bond issue.

3. Bonds that mature in installments.

a4. Produces a periodic interest expense equal to a constant percentage of the carrying value of the bonds.

5. Bonds issued in the name of the owner.

6. A form of interest-bearing notes payable used by corporations.

7. Occurs when the contractual interest rate is greater than the market interest rate.

8. Unsecured bonds issued against the general credit of the borrower.

9. A contractual arrangement that gives the lessee temporary use of property.

10. A solvency measure that indicates the percentage of assets provided by creditors.

11. Occurs when the contractual interest rate is less than the market interest rate.

a12. Produces a periodic interest expense that is the same amount each interest period.

SHORT-ANSWERESSAY QUESTIONS
S-AE 199
Bonds are frequently issued at amounts greater or less than face value. Describe how the market interest rate, relative to the contractual interest rate, affects the selling price of bonds. Also explain the rationale for requiring an investor to pay accrued interest when a bond is purchased between interest payment dates.

S-AE 200

A company desires to replace its current plant equipment with new equipment that costs $10,000,000. One possibility would be for the company to issue $10,000,000 of bonds and use the proceeds to purchase the equipment. Another possibility is to acquire the use of the equipment by signing a long-term capital lease with a leasing company. Describe and compare the financial statement effects of these two alternatives.

S-AE 201

When a bond sells at a discount, what is probably true about the market interest rate versus the stated interest rate? Discuss.

S-AE 202

Bonds may be redeemed (retired) before maturity by the issuing corporation. Explain why a company would decide to retire bonds before maturity and the necessary steps to record the redemption.

S-AE 203 (Ethics)

Jeff Weaver, a 26-year-old entrepreneur, started Bells & Whistles (B&W), Inc., a firm that specializes in top-of-the-line add-ons for computer systems. The firm has a capital structure of approximately 60% debt. This was necessitated by the rapid growth of B&W, and Mr. Weaver’s lack of personal funds to sustain the growth. The 60% debt amount is quite high for firms in this field, and in fact slightly exceeds the debt covenants negotiated with the bank. B&W recently received notice that the bank considers the company’s debt to be excessive, and that some accelerated repayment schedule will be adopted. The notice came at a particularly bad time. B&W is in the midst of a major upgrade of its own computer system. The hardware was to have been purchased outright, financed by the seller, Mike Bogg, longtime friend of Mr. Weaver.

Mr. Bogg really needs Mr. Weaver’s business. Both believe in the long-term strength of B&W. He therefore suggests to Mr. Weaver that the equipment be purchased by means of a short-term lease. Mr. Weaver could renew the lease annually.

Required:
1. Is Mr. Bogg’s suggestion ethical? Explain.
2. If Mr. Weaver accepts the suggestion, is he behaving ethically? Explain.

S-AE 204 (Communication)

Betty Jones works for Trend Press, a fairly large book publishing firm. Her best friend and rival, Rita, works for Walden Books, a smaller publisher. Both companies issue $100,000 in bonds on July 1. Trend’s bonds were issued at a discount, while Walden’s were issued at a premium. Rita sent Betty a fax the next day. She told Betty that it was obvious who the better publisher was— the market had shown its preference! She reminded Betty again of her recent increase in salary as further proof of the superiority of Walden Books.

Required:

Draft a short note for Betty to send to Rita. Explain how such a result could occur.

CHAPTER 16

INVESTMENTS

CHAPTERSTUDY OBJECTIVES

1. Discuss why corporations invest in debt and stock securities.

2. Explain the accounting for debt investments.

3. Explain the accounting for stock investments.

4. Describe the use of consolidated financial statements.

5. Indicate how debt and stock investments are reported in financial statements.

6. Distinguish between short-term and long-term investments.

TRUE-FALSESTATEMENTS

1. Corporations purchase investments in debt or stock securities generally for one of two reasons.

2. A reason some companies purchase investments is because they generate a significant portion of their earnings from investment income.

3. The accounting for short-term debt investments and for long-term debt investments is similar.

4. For short-term debt investments, any bond premium or discount is amortized to interest revenue over the remaining term of the bonds.

5. Debt investmentsare investments in government and corporation bonds.

6. In accordance with the cost principle, brokerage fees should be added to the cost of an investment.

7. In accordance with the cost principle, the cost of debt investments includes brokerage fees and accrued interest.

8. In accounting for stock investments of less than 20%, the equity method is used.

9. Dividends received on stock investments of less than 20% should be credited to the Stock Investmentsaccount.

10. If an investor owns between 20% and 50% of an investee’s common stock, it is presumed that the investor has significant influence on the investee.

11. The Stock Investments account is debited at acquisition under both the equity method and cost method of accounting for investments in common stock.

12. Under the equity method, the investment in common stock is initially recorded at cost, and the Stock Investments account is adjusted annually.

13. Under the equity method, the receipt of dividends from the investee company results in an increase in the Stock Investments account.

14. Consolidated financial statements are appropriate when an investor controls an investee by ownership of more than 50% of the investee’s common stock.

15. Consolidated financial statements are prepared in place of the financial statements for the parent and subsidiary companies.

16. Consolidated financial statements should be prepared only when a subsidiary company has a controlling interest in the parent company.

17. The valuation of available-for-sale securities is similar to the procedures followed for trading securities, except that changes in fair value are not recognized in current income.
Investments 16 – 5

18. An unrealized gain or loss on trading securities is reported as a separate component of stockholders’ equity.

19. For available-for-sale securities, the unrealized gain or loss account is carried forward to future periods.

20. A decline in the fair value of a trading security is recorded by debiting an unrealized loss account and crediting the Market Adjustment account.

21. If the fair value of an available-for-sale security exceeds its cost, the security should be written up to fair value and a realized gain should be recognized.

22. The Market Adjustment account can only have a credit balance or a zero balance.

23. To be classified as a short-term investment, the investment must be readily marketable and intended to be converted into cash within the next year or operating cycle.

24. An investment is readily marketable if it is management’s intent to sell the investment.

25. Stocks traded on the New York Stock Exchangeare considered readily marketable.

Additional True-False Questions

26. One of the reasons a corporation may purchase investments is that it has excess cash.

27. When recording bond interest, Interest Receivable is reported as a fixed asset in the balance sheet.

28. Under the cost method, the investment is recorded at cost and revenue is recognized only when cash dividends are received.

29. Consolidated financial statements present a condensed version of the financial statements so investors will not experience information overload.

30. Available-for-sale securities are securities bought and held primarily for sale in the near term to generate income on short-term price differences.

31. “Intent to convert” does not include an investment used as a resource that will be used whenever the need for cash arises.

MULTIPLECHOICE QUESTIONS

32. Corporations invest excess cash for short periods of time in each of the following except a. equity securities.
b. highly liquid securities. c. low-risk securities.
d. government securities.

33. Corporations invest in other companiesfor all of the following reasons except to a. house excess cash until needed.
b. generate earnings. c. meet strategic goals.
d. increase trading of the other companies’ stock.

34. A typical investment to house excess cash until needed is a. stocks of companies in a related industry.
b. debt securities.
c. low-risk, highly liquid securities. d. stock securities.

35. A company may purchase a noncontrolling interest in another firm in a related industry a. to house excess cash until needed.
b. to generate earnings. c. for strategic reasons.
d. for speculative reasons.

36. Pension funds and mutual funds regularly invest in debt and stock securities to a. generate earnings.
b. house excess cash until needed. c. meet strategic goals.
d. control the company in which they invest.

37. At the time of acquisition of a debt investment, a. no journal entry is required.
b. the cost principle applies.
c. the Stock Investments account is debited when bonds are purchased. d. the Investment account is credited for its cost plus brokerage fees.

38. Which of the following is not a true statement regarding short-term debt investments? a. The securities usually pay interest.
b. Investmentsare frequently government or corporate bonds.
c. This type of investment must be currently traded in the securities market. d. Any bond premium or discount is amortized to interest revenue.

Use the following information for questions 39–41.

On January 1, 2008, Turner Company purchased at face value, a $1,000, 7% bond that pays interest on January 1 and July 1. Turner Company has a calendar year end.
Investments 16 – 7

39. The entry for the receipt of interest on July 1, 2008, is

a. Cash…………………………………………………………………………. 35

Interest Revenue………………………………………………… 35

b. Cash…………………………………………………………………………. 70
Interest Revenue………………………………………………… 70

c. Interest Receivable……………………………………………………… 35
Interest Revenue………………………………………………… 35

d. Interest Receivable……………………………………………………… 70
Interest Revenue………………………………………………… 70

40. The adjusting entry on December 31, 2008, is a. not required.

b. Cash…………………………………………………………………………. 35
Interest Revenue………………………………………………… 35

c. Interest Receivable……………………………………………………… 35
Interest Revenue………………………………………………… 35

d. Interest Receivable……………………………………………………… 35

Debt Investments………………………………………………… 35

41. The entry for the receipt of interest on January 1, 2009 is

a. Cash…………………………………………………………………………. 70

Interest Revenue………………………………………………… 70

b. Cash…………………………………………………………………………. 70
Interest Receivable……………………………………………… 70

c. Cash…………………………………………………………………………. 35
Interest Revenue………………………………………………… 35

d. Cash…………………………………………………………………………. 35
Interest Receivable……………………………………………… 35

42. On January 1, Barone Company purchased as a short-term investment a $1,000, 8% bond for $1,050. The bond pays interest on January 1 and July 1. The bond is sold on October 1 for $1,200 plus accrued interest. Interest has not been accrued since the last interest payment date. What is the entry to record the cash proceeds at the time the bond is sold?

a. Cash…………………………………………………………………………. 1,200
Debt Investments ……………………………………………….. 1,200

b. Cash…………………………………………………………………………. 1,220
Debt Investments………………………………………………… 1,050 Gain on Sale of Debt Investments…………………………. 150 Interest Revenue………………………………………………… 20

c. Cash…………………………………………………………………………. 1,220
Debt Investments………………………………………………… 1,200 Interest Revenue………………………………………………… 20

d. Cash…………………………………………………………………………. 1,200
Debt Investments………………………………………………… 1,050 Gain on Sale of Debt Investments…………………………. 150
16 – 8

43. Which of the following is not a true statement about the accounting for long-term debt investments?
a. The investment is initially recorded at cost. b. The cost includes any brokerage fees.
c. The accounting for long-term debt investments is similar to the accounting for short-term debt investments.
d. The cost includes any accrued interest.

44. The cost of debt investments includes each of the following except a. brokerage fees.
b. commissions.
c. accrued interest. d. the price paid.

45. If a short-term debt investment is sold, the Investment account is a. credited for the book value of the bonds at the sale date.
b. credited for the cost of the bonds at the sale date.
c. credited for the fair value of the bonds at the sale date. d. debited for the cost of the bonds at the sale date.

46. Any premium or discount on a long-term debt investment is amortized a. to interest expense over the remaining term of the bonds.
b. only if the effective-interestmethod is used.
c. to interest revenue over the remaining term of the bonds. d. if the investor owns 20% or more of the bonds.

Use the following information for questions 47–49.

Pima Company acquires 50, 10%, 5 year, $1,000 Community bonds on January 1, 2008 for $51,250. This includes a brokerage commission of $1,250.

47. The journal entry to record this investment includes a debit to a. Debt Investmentsfor $50,000.
b. Debt Investments for $51,250. c. Cash for $51,250.
d. Stock Investments for $50,000.

48. Assume Community pays interest on January 1 and July 1, and the July 1 entry was done correctly. The journal entry at December 31, 2008 would include a credit to
a. Interest Receivable for $2,500. b. Interest Revenue for $5,000. c. Accrued Expense for $5,000. d. Interest Revenue for $2,500.

49. If Pima sells all of its Community bonds for $52,000 and pays $1,500 in brokerage commissions, what gain or loss is recognized?
a. Gain of $2,000 b. Loss of $750 c. Gain of $750 d. Gain of $3,000
Investments 16 – 9

50. Steven Co. purchased 30, 6% Johnston Company bonds for $30,000 cash plus brokerage fees of $300. Interest is payable semiannually on July 1 and January 1. The entry to record the July 1 semiannual interest payment would include a
a. debit to Interest Receivable for $900. b. credit to Interest Revenue for $900. c. credit to Interest Revenue for $909. d. credit to Debt Investments for $909.

51. Steven Co. purchased 30, 6% Johnston Company bonds for $30,000 cash plus brokerage fees of $300. Interest is payable semiannually on July 1 and January 1. The entry to record the December 31 interest accrual would include a
a. debit to Interest Receivable for $900. b. debit to Interest Revenue for $900. c. credit to Interest Revenue for $909. d. debit to Debt Investments for $900.

52. Tolan Co. purchased 60, 6% Irick Company bonds for $60,000 cash plus brokerage fees of $600. Interest is payable semiannually on July 1 and January 1. If 15 of the securities are sold on July 1 for $31,000 less $300 brokerage fees, the entry would include a credit to Gain on Sale of Debt Investmentsfor
a. $1,000. b. $700. c. $1,300. d. $400.

53. On January 1, Burkett Company purchased as an investment a $1,000, 8% bond for $1,020. The bond pays interest on January 1 and July 1. What is the entry to record the interest accrual on December 31?
a. Interest Receivable……………………………………………………… 40
Interest Revenue ……………………………………………….. 40 b. Debt Investments ………………………………………………………. 40
Interest Revenue ……………………………………………….. 40 c. Interest Receivable……………………………………………………… 80
Interest Revenue ……………………………………………….. 80 d. Debt Investments ………………………………………………………. 80
Interest Revenue ……………………………………………….. 80

54. Darnet Corporation sells 100 shares of common stock being held as an investment. The shares were acquired six months ago at a cost of $30 a share. Darnet sold the shares for $40 a share. The entry to record the sale is
a. Cash…………………………………………………………………………. 3,000 Loss on Sale of Stock Investments ………………………………. 1,000
Stock Investments ……………………………………………… 4,000

b. Stock Investments ……………………………………………………… 4,000
Cash ………………………………………………………………… 4,000

c. Cash…………………………………………………………………………. 4,000
Gain on Sale of Stock Investments ………………………. 1,000 Stock Investments ……………………………………………… 3,000

d. Cash…………………………………………………………………………. 4,000
Stock Investments ……………………………………………… 4,000
16 – 10

55. Browne Corporation sells 200 shares of common stock being held as an investment. The shares were acquired six months ago at a cost of $50 a share. Browne sold the shares for $40 a share. The entry to record the sale is
a. Cash………………………………………………………………………… 8,000 Loss on Sale of Stock Investments ………………………………. 2,000
Stock Investments …………………………………………….. 10,000

b. Cash………………………………………………………………………… 10,000
Gain on Sale of Stock Investments ………………………. 2,000 Stock Investments …………………………………………….. 8,000

c. Cash………………………………………………………………………… 8,000
Stock Investments …………………………………………….. 8,000

d. Stock Investments …………………………………………………….. 8,000 Loss on Sale of Stock Investments ………………………………. 2,000
Cash ………………………………………………………………… 10,000

Use the following information for questions 56–58.

Nagen Company had these transactions pertaining to stock investments:

Feb. 1 Purchased 2,000 shares of Cagney Company (10%) for $33,200 cash plus brokerage fees of $800.
June 1 Received cash dividends of $2 per share on Cagney stock.
Oct. 1 Sold 800 shares of Cagney stock for $16,000 less brokerage fees of $400.

56. The entry to record the purchase of the Cagney stock would include a a. debit to Stock Investments for $33,200.
b. credit to Cash for $33,200.
c. debit to Stock Investments for $34,000. d. debit to Investment Expense for $800.

57. The entry to record the receipt of the dividends on June 1 would include a a. debit to Stock Investments for $4,000.
b. credit to Dividend Revenue for $4,000. c. debit to Dividend Revenue for $4,000. d. credit to Stock Investments for $4,000.

58. The entry to record the sale of the stock would include a a. debit to Cash for $16,000.
b. credit to Gain on Sale of Stock Investmentsfor $800. c. debit to Stock Investments for $13,600.
d. credit to Gain on Sale of Stock Investmentsfor $2,000.

59. Mouns Company owns 40% interest in the stock of Darian Corporation. During the year, Darian pays $20,000 in dividends to Mouns, and reports $100,000 in net income. Mouns Company’s investment in Darian will increase Mouns’ net income by
a. $20,000. b. $40,000. c. $32,000. d. $8,000.
Investments 16 – 11

60. Mouns Company owns 40% interest in the stock of Darian Corporation. During the year, Darian pays $25,000 in dividends to Mouns, and reports $100,000 in net income. Mouns Company’s investment in Darian will increase by
a. $25,000. b. $40,000. c. $32,000. d. $15,000.

61. On January 1, 2008, Jonsey Corporation purchased 30% of the common stock outstanding of Karsen Corporation for $200,000. During 2008, Karsen Corporation reported net income of $80,000 and paid cash dividends of $40,000. The balance of the Stock Investments—Karsenaccount on the books of Jonsey Corporation at December 31, 2008 is
a. $200,000. b. $240,000. c. $280,000. d. $212,000.

62. Decker Corporation purchased 1,000 shares of Kent common stock at $70 per share plus $3,000 brokerage fees as a short-term investment. The shares were subsequently sold at $80 per share less $3,400 brokerage fees. The cost of the securities purchased and gain or loss on the sale were
Cost Gain or Loss a. $70,000 $10,000gain b. $70,000 $3,600gain c. $73,000 $7,000gain d. $73,000 $3,600gain

63. In accounting for stock investments between 20% and 50%, the method is used. a. consolidated statements
b. controlling interest c. cost
d. equity

64. When a company holds stock of several different corporations, the group of securities is identified as a(n)
a. affiliated investment. b. consolidated portfolio. c. investment portfolio. d. controlling interest.

65. Jacobs Corporation makes a short-term investment in 100 shares of Starr Company’s common stock. The stock is purchased for $50 a share plus brokerage fees of $300. The entry for the purchase is

a. Debt Investments……………………………………………………….. 5,000 Cash…………………………………………………………………. 5,000

b. Stock Investments………………………………………………………. 5,300 Cash…………………………………………………………………. 5,300

c. Stock Investments………………………………………………………. 5,000 BrokerageFee Expense………………………………………………. 300
Cash…………………………………………………………………. 5,300
16 – 12

d. Stock Investments……………………………………………………… 5,000
Cash ………………………………………………………………… 5,000

66. Dobson Corporation sells 200 shares of common stock being held as a short-term investment. The shares were acquired six months ago at a cost of $50 a share. Dobson sold the shares for $40 a share. The entry to record the sale is

a. Cash………………………………………………………………………… 8,000 Loss on Sale of Stock Investments……………………………….. 2,000
Stock Investments ……………………………………………… 10,000

b. Cash………………………………………………………………………… 10,000
Gain on Sale of Stock Investments……………………….. 2,000 Stock Investments ……………………………………………… 8,000

c. Cash………………………………………………………………………… 8,000
Stock Investments ……………………………………………… 8,000

d. Stock Investments……………………………………………………… 8,000 Loss on Sale of Stock Investments……………………………….. 2,000
Cash ………………………………………………………………… 10,000

67. For accounting purposes, the method used to account for long-term investments in common stock is determined by
a. the amount paid for the stock by the investor.
b. the extent of an investor’s influence on the operating and financial affairs of the investee.
c. whether the stock has paid dividends in past years.
d. whether the acquisition of the stock by the investor was “friendly” or “hostile.”

68. If an investor owns less than 20% of the common stock of another corporation as a long-term investment,
a. the equity method of accounting for the investment should be employed. b. no dividends can be expected.
c. it is presumed that the investor has relatively little influence on the investee. d. it is presumed that the investor has significant influence on the investee.

69. If the cost method is used to account for a long-term investment in common stock, dividends received should be
a. credited to the Stock Investments account. b. credited to the Dividend Revenue account. c. debited to the Stock Investments account.
d. recorded only when 20% or more of the stock is owned.

70. If 10% of the common stock of an investee company is purchased as a long-term investment, the appropriate method of accounting for the investment is
a. the cost method. b. the equity method.
c. the preparation of consolidated financial statements.
d. determined by agreement with whomever owns the remaining 90% of the stock.
Investments 16 – 13

71. The cost method of accounting for long-term investments in stock should be employed when the
a. investor owns more than 50% of the investee’s stock.
b. investor has significant influence on the investee and the stock held by the investor are marketable equity securities.
c. market value of the shares held is greater than their historical cost. d. investor’s influence on the investee is insignificant.

72. When an investor owns between 20% and 50% of the common stock of a corporation, it is generally presumed that the investor
a. has insignificant influence on the investee and that the cost method should be used to account for the investment.
b. should apply the cost method in accounting for the investment. c. will prepare consolidated financial statements.
d. has significant influence on the investee and that the equity method should be used to account for the investment.

73. Under the equity method of accounting for long-term investments in common stock, when a dividend is received from the investee company,
a. the Dividend Revenue account is credited. b. the Stock Investments account is increased.
c. the Stock Investments account is decreased. d. no entry is necessary.

74. On January 1, 2008, Calis Corporation purchased 25% of the common stock outstanding of Lane Corporation for $700,000. During 2008, Lane Corporation reported net income of $200,000 and paid cash dividends of $100,000. The balance of the Stock Investments— Lane account on the books of Calis Corporation at December 31, 2008 is
a. $700,000. b. $725,000. c. $750,000. d. $675,000.

75. Under the equity method, the Stock Investments account is increased when the a. investee company reports net income.
b. investee company pays a dividend. c. investee company reports a loss. d. stock investment is sold at a gain.

76. The account, Stock Investments, is a. a subsidiary ledger account.
b. a long-term liability account.
c. a general ledger control account.
d. another name for Debt Investments.

77. Which of the following would not be considered a motive for making a stock investment in another corporation?
a. Appreciationin the market value of the stock investment b. Use of the investment for expanding its own operations c. Use of the investment to diversify its own operations
d. An increase in the amount of interest revenue from the stock investment
16 – 14

78. Revenue is recognized when cash dividends are received under a. the controlling interest method.
b. the cost method. c. the equity method.
d. both the cost and equity methods.

79. Which of the following is the correct matching concerning an investor’s influence on the operations and financial affairs of an investee?

% of Investor Ownership a. Less than 20%
b. Between20%-50% c. More than 50%
d. Between20%-50%
Presumed Influence Short-term Significant
Long-term Controlling

80. Which of the following is the correct matching concerning the appropriate accounting for long-term stock investments?

% of Investor Ownership a. Less than 20%
b. Between20%–50% c. More than 50%
d. Between20%–50%
Accounting Guidelines Cost method
Cost method
Cost or equity method Consolidated financial statements

81. If the cost method is used to account for a long-term investment in common stock, a. it is presumed that the investor has significant influence on the investee.
b. the earning of net income by the investee is considered a proper basis for recognition of income by the investor.
c. net income of the investee is not considered earned by the investor until dividends are declared by the investee.
d. the Investment account may be, at times, greater than the acquisition cost.

82. If a company acquires a 40% common stock interest in another company, a. the equity method is usually applicable.
b. all influence is classified as controlling. c. the cost method is usually applicable.
d. the ability to exert significant influence over the activities of the investee does not exist.

83. If a common stock investment is sold at a gain, the gain a. is reported as operating revenue.
b. is reported under a special section, “Discontinued investments,” on the income statement.
c. is reported in the Other Revenue and Gain section of the income statement. d. contributesto gross profit on the income statement.

84. If the equity method is being used, cash dividends received a. are credited to Dividend Revenue.
b. require no entry because investee net income has already been recorded at the proper proportion on the investor’s books.
c. are credited to the Stock Investments account.
d. are credited to the Revenue from Investment in Stock account.
Investments 16 – 15

85. If the equity method is being used, the Revenue from Investment in Stock account is a. just another name for a Dividend Revenue account.
b. credited when dividends are declared by the investee. c. credited when net income is reported by the investee. d. debited when dividends are declared by the investee.

86. Under the equity method, the Stock Investments account is credited when the a. investee reports net income.
b. investee reports a net loss.
c. investment is originally acquired.
d. investee reports net income and when the investment is originally acquired.

87. Consolidated financial statements are prepared when a company owns of the common stock of another company.
a. less than 20%
b. between 20% and 50% c. less than 50%
d. more than 50%

88. Consolidated financial statements present all of the following except the a. individual assets and liabilities of the parent company
b. individual assets and liabilities of the subsidiary. c. total revenues and expenses of the subsidiary.
d. All of these are presented in consolidated financial statements.

89. The company whose stock is owned by the parent company is called the a. controlled company.
b. subsidiary company. c. investee company. d. sibling company.

90. A company that owns more than 50% of the common stock of another company is known as the
a. charge company.
b. subsidiary company. c. parent company.
d. management company.

91. If one company owns more than 50% of the common stock of another company, a. the cost method should be used to account for the investment.
b. a partnership exists.
c. a parent-subsidiary relationship exists.
d. the company whose stock is owned must be liquidated.

92. If a parent company has two wholly owned subsidiaries, how many legal and economic entities are there from the viewpoint of the shareholders of the parent company?

Legal Economic a. 3 3
b. 1 2 c. 3 1 d. 2 1
16 – 16

93. When a company owns more than 50% of the common stock of another company, a. affiliated financial statements are prepared.
b. consolidated financial statements are prepared. c. controlling financial statements are prepared. d. significant financial statements are prepared.

94. Changes from cost are reported as part of net income for a. available-for-salesecurities.
b. held-to-maturitysecurities. c. debt securities.
d. trading securities.

95. Short-term investments are listed on the balance sheet immediatelybelow a. cash.
b. inventory.
c. accounts receivable. d. prepaid expenses.

96. Short-term stock investments should be valued on the balance sheet at a. the lower of cost or fair value.
b. the higher of cost or fair value. c. cost.
d. fair value.

97. In recognizing a decline in the fair value of short-term stock investments, an unrealized loss account is debited because
a. management intends to realize this loss in the near future. b. the securities have not been sold.
c. the stock market is volatile.
d. management cannot determine the exact amount of the loss in value.

98. The Market Adjustment account
a. is set up for each security in the company’s portfolio.
b. relates to the entire portfolio of securities held by the company. c. is closed at the end of each accounting period.
d. appears on the income statement as Other Expenses and Losses.

99. The contra-account, Market Adjustment, is also called a(n) a. offset account.
b. adjustment account. c. valuation account. d. opposite account.

100. Reporting investments at fair value is a. applicable to stock securities only. b. applicable to debt securities only.
c. applicable to both debt and stock securities.
d. a conservative approach because only losses are recognized.
Investments 16 – 17

Use the following information for questions 101–102.

Grier Corporation’strading portfolio at the end of the year is as follows:

Security
CommonStock A CommonStock B
Cost
$10,000
9,000 $19,000
Market Value $12,000
5,000 $17,000

101. At the end of the year, Grier Corporation should
a. set up a Market Adjustment account for Stock B.
b. set up a Market Adjustment account for the portfolio.
c. recognize an Unrealized Gain or Loss—Incomefor $4,000.
d. report a loss on the income statement for $4,000 under “Other Expenses and Losses.”

102. Grier subsequentlysells Stock B for $12,000. What entry is made to record the sale?

a. Cash…………………………………………………………………………. 12,000
Stock Investments………………………………………………. 12,000

b. Cash…………………………………………………………………………. 12,000
Market Adjustment………………………………………………. 3,000 Stock Investments………………………………………………. 9,000

c. Cash…………………………………………………………………………. 12,000
Stock Investments………………………………………………. 9,000 Gain on Sale of Stock Investments ……………………….. 3,000

d. Cash…………………………………………………………………………. 12,000
Stock Investments………………………………………………. 5,000 Gain on Sale of Stock Investments ……………………….. 7,000

103. Which of the following would not be reported under “Other Revenues and Gains” on the income statement?
a. Unrealized gain on available-for-salesecurities b. Dividend revenue
c. Interest revenue
d. Gain on sale of short-term debt investments

104. The balance in the Unrealized Loss—Equityaccount will a. appear on the balance sheet as a contra asset.
b. appear on the income statement under Other Expenses and Losses. c. appear as a deduction in the stockholders’ equity section.
d. not be shown on the financial statements until the securities are sold.

105. If the cost of an available-for-sale security exceeds its fair value by $40,000, the entry to recognize the loss
a. is not required since the share prices will likely rebound in the long run. b. will show a debit to an expense account.
c. will show a credit to a contra-asset account that appears in the stockholders’ equity section of the balance sheet.
d. will show a debit to an unrealized loss account that is deducted in the stockholders’ equity section of the balance sheet.
16 – 18

106. The balance sheet presentation of an unrealized loss on an available-for-sale security is similar to the statement presentation of
a. treasury stock.
b. discount on bonds payable.
c. allowance for doubtful accounts. d. prepaid expenses.

Use the following information for questions 107–108.

At the end of its first year, the trading securities portfolio consisted of the following common stocks.
Cost Market Able Corporation $ 46,400 $ 50,000 Baker Inc. 60,000 53,800 Cole Corporation 80,000 76,000
$186,400 $179,800

107. The unrealized loss to be recognized under the fair value method is a. $6,200.
b. $10,200. c. $6,600. d. $4,000.

108. In the following year, the Baker common stock is sold for cash proceeds of $58,000. The gain or loss to be recognized on the sale is a
a. gain of $4,200. b. loss of $2,000. c. gain of $2,200. d. loss of $400.

109. At the end of the first year of operations, the total cost of the trading securities portfolio is $240,000. Total fair value is $250,000. The financial statements should show
a. an addition to an asset of $10,000 and a realized gain of $10,000.
b. an addition to an asset of $10,000 and an unrealized gain of $10,000 in the stockholders’ equity section.
c. an addition to an asset of $10,000 in the current assets section and an unrealized gain of $10,000 in ―Other revenues and gains.‖
d. an addition to an asset of $10,000 in the current assets section and a realized gain of $10,000in ―Other revenues and gains.‖

110. Noell Corp. has common stock of $5,000,000, retained earnings of $3,000,000, unrealized gains on trading securities of $100,000 and unrealized losses on available-for-sale securities of $200,000. What is the total amount of its stockholders’ equity?
a. $7,800,000 b. $8,000,000 c. $7,900,000 d. $8,100,000

111. Available-for-salesecurities are classified as a. short-term investments only.
b. long-term investments only.
c. either short-term or long-term investments. d. current assets only.
Investments 16 – 19

112. Which one of the following would not be classified as a short-term investment? a. Marketable stock securities
b. Equity method investments c. Marketable debt securities d. Short-term paper

113. Short-term investments are securities that are readily marketable and intended to be converted into cash within the next
a. year.
b. two years.
c. year or operating cycle, whichever is shorter. d. year or operating cycle, whichever is longer.

114. Which of the following would not be classified as a short-term investment? a. Short-term commercial paper
b. Idle cash in a bank checking account c. Marketable stock securities
d. Marketable debt securities

Additional Multiple Choice Questions

115. Which of the following reasons best explains why a company that experiences seasonal fluctuations in sales may purchase investments in debt or stock securities?
a. The company may have excess cash.
b. The company may generate a significant portion of its earnings from investment income.
c. The company may invest for the strategic reason of establishing a presence in a related industry.
d. The company may invest for speculative reasons to increase the value in pension funds.

116. When bonds are sold, the gain or loss on sale is the difference between the a. sales price and the cost of the bonds.
b. net proceeds and the cost of the bonds.
c. sales price and the market value of the bonds. d. net proceeds and the market value of the bonds.

117. Which of the following is a major difference when accounting for long-term debt investments versus short-term debt investments?
a. When selling long-term investments, no gain or loss is recognized.
b. At the end of the year, any unrealized gain or loss on long-term debt investments must be recognized in the stockholders’ equity section of the balance sheet.
c. Interest revenue is not recognized for long-term investments.
d. For short-term investments, bond premium or discount is not amortized to interest revenue.

118. Under the equity method, the investor records dividends received by crediting a. Dividend Revenue.
b. Investment Income.
c. Revenue from Investment. d. Stock Investments.
16 – 20

119. A company that acquires less than 20% ownership interest in another company should account for the stock investment in that company using
a. the cost method. b. the equity method.
c. the significant method.
d. consolidated financial statements.

120. The equity method of accounting for an investment in the common stock of another company should be used by the investor when the investment
a. is composed of common stock and it is the investor’s intent to vote the common stock. b. ensures a source of supply of raw materials for the investor.
c. enables the investor to exercise significant influence over the investee. d. is obtained by an exchange of stock for stock.

121. On January 2, Matthews Corporation acquired 20% of the outstanding common stock of Dennehy Company for $450,000. For the year ended December 31, Dennehy reported net income of $90,000 and paid cash dividends of $30,000 on its common stock. At December 31, the carrying value of Matthews’ investment in Dennehy under the equity method is
a. $444,000. b. $450,000. c. $456,000. d. $462,000.

122. An unrealized loss on available-for-sale securities is
a. reported under Other Expenses and Losses in the income statement. b. closed-out at the end of the accounting period.
c. reported as a separate component of stockholders’ equity. d. deducted from the cost of the investment.

123. Securities bought and held primarily for sale in the near term to generate income on short-term price differences are
a. trading securities.
b. available-for-salesecurities. c. never-sell securities.
d. held-to-maturitysecurities.

124. Short-term investments are
a. (1) readily marketable and (2) intended to be converted into cash after the current year or operating cycle, whichever is shorter.
b. (1) readily marketable and (2) intended to be converted into cash within the current year or operating cycle, whichever is longer.
c. (1) readily marketable and (2) intended to be converted into cash after the current year or operating cycle, whichever is longer.
d. (1) readily marketable and (2) intended to be converted into cash within the current year or operating cycle, whichever is shorter.
Investments 16 – 21

125. Short-term investments are securities held by a company that are a. readily marketable.
b. intended to be converted into cash within the next year.
c. readily marketable and intended to be converted into cash within the next year or operating cycle, whichever is longer.
d. readily marketable and intended to be held until maturity.

BRIEFEXERCISES

BE 126

On January 14, Blackwell Corporation purchased 20, 11%, $1,000 Gooding Company bonds for $20,000, plus brokerage fees of $400. On November 30, the company sold 10 of the Gooding Company bonds for $11,000, less $300 brokerage fees. Prepare journal entries for the purchase and sale of the Gooding Company bonds.

BE 127

On January 2, Westies Company purchased 30, 10%, $1,000 Arkansas Company bonds for $31,000 cash, plus brokerage fees of $1,000. Interest is payable semiannually on July 1 and January 1. On July 1, the company received a semiannual interest payment on the Arkansas Company bonds. Journalize the entries to record the purchase of the bonds and the receipt of the interest payment.

BE 128

On April 25, Braxton Company buys 4,200 shares of Computech common stock for $82,000, plus brokerage fees of $2,000. On October 31, Braxton sells 600 shares of Computech stock for $15,500, less brokerage fees of $500. Prepare journal entries for the purchase and sale of the Computechcommon stock.

BE 129

On January 1, Hillard Corporation purchased a 40% equity in Lewis Company for $360,000. At December 31, Lewis declared and paid a $40,000 cash dividend and reported net income of $98,000. Prepare the necessary journal entries for Hillard Corporation.

BE 130

Stein Company had the following transactions pertaining to its short-term stock investments.

Jan. 1 Purchased 600 shares of Rice Company stock for $6,700 cash plus brokerage fees of $350.

June 1 Received cash dividends of $0.50 per share on the Rice Company stock.

Sept. 15 Sold 300 shares of the Rice Company stock for $3,600 less brokerage fees of $200.

Instructions Journalizethe transactions.

BE 131

On January 1, 2008, Owen Company purchased 5,000 shares of Jen Company stock for $300,000. Owen’s investment represents 30 percent of the total outstanding shares of Jen. During 2008, Jen paid total dividends of $100,000 and reported net income of $250,000. What revenue does Owen report related to this investment and what is the amount to be reported as an investment in Jen stock at December 31?

BE 132

At January 1, 2008, the trading securities portfolio held by the Darin Corporation consisted of the following investments:

1. 2,000 shares of Stitch common stock purchased for $42 per share. 2. 1,500 shares of Marvel common stock purchased for $50 per share.

At December 31, 2008, the fair values per share were Stitch $36 and Marvel $54.

Instructions
(a) Prepare a schedule showing the cost and fair value of the portfolio at December 31, 2008.

(b) Prepare the adjusting entry to report the portfolio at fair value at December 31, 2008.

BE 133

At December 31, 2008, the trading securities for Carter Company are as follows:

Security X Y
Cost
$17,000
34,000 $51,000
Fair Value $20,000
33,000 $53,000

Preparethe adjusting entry at December 31, 2008, to report the securities at fair value.

BE 134

At January 1, 2008, Gulfport Corporation held one available-for-sale security: 1,500 shares of Netblaster common stock purchased for $40 per share. At December 31, 2008, the market value per share for Netblaster was $44. Prepare the adjusting entry to report the portfolio at fair value at December 31, 2008.
Investments 16 – 25

BE 135

Terra Firma Company has the following data at December 31, 2008 for its securities:

Securities Available-for-sale Trading
Cost
$35,000 45,000
Fair Value $38,000
40,000

EXERCISES

Ex. 136

Milner Corporation had the following transactions pertaining to debt investments.

Jan. 1 Purchased 80, 8%, $1,000 Vanoy Company bonds for $80,000, plus brokerage fees of $800.

July 1 Sold 20 Vanoy Company bonds for $24,000, less $400 brokeragefees.

Instructions
Preparejournal entries for the purchase and sale of the Vanoy Company bonds.

Ex. 137

Glaser Company had the following transactions pertaining to debt securities held as a short-term investment.

Jan. 1 Purchased 40, 8%, $1,000 Cotter Company bonds for $40,000 cash plus brokerage fees of $800. Interest is payable semiannuallyon July 1 and January 1.

July 1 Received semiannual interest on Cotter Company bonds.

Oct. 1 Sold 30 Cotter Company bonds for $32,000 plus accrued interest less $500 brokerage fees.

Instructions

(a) Journalize the transactions.

(b) Prepare the adjusting entry for the accrual of interest on December 31.

Ex. 138

The following transactions were made by Waite Company. Assume all investments are short-term and are readily marketable.

June 2 July 1 30
Sept. 15 Dec. 31
31
Purchased300 shares of Beaty Corporation common stock for $45 per share. Purchased200 Meng Corporation bonds for $220,000.
Receiveda cash dividend of $2 per share from Beaty Corporation. Sold 90 shares of Beaty Corporation stock for $50 per share.
Receivedsemiannual interest check for $11,000 from Meng Corporation.

Receiveda cash dividend of $2 per share from Beaty Corporation.

Instructions Journalizethe transactions.
Investments 16 – 27

Ex. 139

On April 1, Smith Company buys 3,000 shares of Thomas common stock for $60,000, plus brokerage fees of $900. On October 1, Smith sells 1,000 shares of Thomas stock for $23,000, less brokerage fees of $500.

Instructions
Preparejournal entries for the purchase and sale of the Thomas common stock.

Ex. 140

Stone Company had the following transactions pertaining to short-term investments in equity securities.

Jan. 1

June 1 Sept. 15
Dec. 1
Purchased 1,000 shares of Renfro Company stock for $9,450 cash plus brokerage fees of $300.

Receivedcash dividends of $.50 per share on Renfro Company stock.

Sold 400 shares of Renfro Company stock for $3,800 less brokerage fees of $100.

Receivedcash dividends of $.50 per share on Renfro Company stock.

Instructions
(a) Journalize the transactions.
(b) Indicate the income statement effects of the transactions.

Ex. 141

Stine Corporation’s balance sheet at December 31, 2007, showed the following: Short-term investments, at fair value $46,500

Stine Corporation’s trading portfolio of stock investments consisted of the following at December 31, 2007:

Stock
DooleyCommon Stock Adler Preferred Stock GriggsCommon Stock
Number of Shares 200
400 300
Cost
$30,000 6,000
9,000 $45,000
Investments 16 – 29

Ex. 141 (cont.)

During 2008, the following transactions took place:

Feb. 5 Sold 50 shares of Dooley common stock for $8,000. Mar. 30 Purchased25 shares of Griggs common stock for $950.
Sept. 9 Purchased50 shares of Griggs common stock for $2,000.

At year end on December 31, 2008, the market values per share were:

DooleyCommon Stock Adler Preferred Stock GriggsCommon Stock
Market Value Per Share $158.00
$14.00 $25.00

Instructions
(a) Prepare the journal entries to record the 2008 stock transactions.
(b) On December 31, 2008, prepare any adjusting entry that might be necessary relative to the trading portfolio.
(c) Show how the stock investments will appear on Stine Corporation’s balance sheet at December31, 2008.

Ex. 142

On January 5, 2008, Storey Company purchased the following stock securities as a long-term investment:

300 shares Marks Corporation common stock for $4,200. 500 sharesWood Corporation common stock for $10,000. 600 shares Logen Corporation common stock for $19,800.

Assume that Storey Company cannot exercise significant influence over the activities of the investee companies and that the cost method is used to account for the investments.

On June 30, 2008, Storey Company received the following cash dividends:

Marks Corporation…………………………………. Wood Corporation…………………………………. LogenCorporation………………………………….
$2.00 per share $1.00 per share $1.50 per share

On November 15, 2008, Storey Company sold 200 shares of Logen Corporation common stock for $7,500.

On December 31, 2008, the fair value of the securities held by Storey Company is as follows:

Marks Corporation common stock Wood Corporation common stock LogenCorporation common stock
Per Share $10
16 32

Instructions
Preparethe appropriatejournal entries that Storey Company should make on the following dates:

January5, 2008 June 30, 2008 November 15, 2008 December31, 2008

Ex. 143

Seely Company purchased 42,000 shares of common stock of Otto Corporation as a long-term investment for $1,000,000. During the year, Otto Corporation reported net income of $300,000 and paid dividends of $100,000.

Instructions
(a) Assuming that the 42,000 shares represent a 15% interest in Otto Corporation: 1. Prepare the journal entry to record the investment in Otto stock.
2. Prepare any entries that Seely Company should make in accounting for its investment in Otto stock during the year.
3. What is the balance of the Stock Investments account on Seely Company’s books at the end of the year?

(b) Repeat requirement (a) above except assume that the 42,000 shares represent a 25% interest in Otto Corporation.

Ex. 144

On January 1, Neely Corporation purchased a 30% equity in Poole Company for $120,000. At December 31, Poole declared and paid a $40,000 cash dividend and reported net income of $100,000.

Instructions

Preparethe necessary journal entries for Neely Corporation.

Ex. 145

Informationpertaining to long-term stock investments in 2008 by Tate Corporation follows:

Acquired 10% of the 250,000 shares of common stock of Friend Company at a total cost of $8 per share on January 1, 2008. On July 1, Friend Company declared and paid a cash dividend of $2 per share. On December 31, Friend’s reported net income was $654,000 for the year.
Investments 16 – 33

Ex. 145 (cont.)

Obtained significant influence over Unruh Company by buying 25% of Unruh’s 100,000 outstanding shares of common stock at a total cost of $22 per share on January 1, 2008. On June 15, Unruh Company declared and paid a cash dividend of $1.50 per share. On December 31, Unruh’s reported net income was $280,000.

Instructions
Prepareall necessary journal entries for 2008 for Tate Corporation.

Ex. 146

At December 31, 2008, the trading securities for Carter Company are as follows:

Security A B
Cost
$25,000
46,000 $71,000
Fair Value $28,000
40,000 $68,000

Instructions

Preparethe adjusting entry at December 31, 2008, to report the securities at fair value.

Ex. 147

Rison Corporation has the following trading portfolio of stock investments as of December 31, 2008.

Security A
B C
Cost
$19,000 22,000
34,000 $75,000
Fair Value $16,000
26,000
31,000 $73,000

On January 22, 2009, Rison Corporation sold security C for $30,000.

Instructions
(a) Prepare the adjusting entry for Rison Corporation on December 31, 2008, to report the portfolio at fair value.

(b) Indicate the balance sheet and income statement presentation of the fair value data for Rison Corporation at December 31, 2008.

(c) Prepare the journal entry for the 2009 sale.

Ex. 148

The following information is available for Clooney Corporation’s available-for-sale securities at December31, 2008.

Security X Y
Cost
$35,000
22,000 $57,000
Fair Value $33,000
28,000 $61,000

Instructions
Preparethe adjusting entry to record the securities at fair value at December 31, 2008.
Investments 16 – 35

Ex. 149

At January 1, 2008, the available-for-salesecurities portfolio held by Howe Corporation consisted of the following investments:

1. 2,500 shares of Meller common stock purchased for $42 per share. 2. 1,500 shares of Kane common stock purchased for $60 per share.

At December 31, 2008, the market values per share were Meller $36 and Kane $66.

Instructions

(a) Prepare a schedule showing the cost and fair value of the portfolio at December 31, 2008.

(b) Prepare the adjusting entry to report the portfolio at fair value at December 31, 2008.

Ex. 150

Weaver Company has the following data at December 31, 2008 for its securities.

Securities Trading
Available-for-sale
Cost
$90,000 75,000
Fair Value $93,000
71,000

Instructions
(a) Prepare the adjusting entries to report the securities at fair value.
(b) Indicate the statement presentation of the related unrealized gain (loss) accounts for each class of securities.

COMPLETION STATEMENTS

151. Debt investmentsare investments in government and bonds.

152. For long-term debt investments, any bond premium or is amortized to

over the remaining term of the bonds.

153. When an investor owns between 20% and 50% of the common stock of a corporation, it is generally presumed that the investor has influence over the investee and therefore, the appropriate method of accounting for this type of investment is the
method.

154. Under the cost method, dividends received from an investee company are credited to the

account, whereas under the equity method, dividends received from an investee company are credited to the account.

155. At the beginning of the year, Grant Corporation acquired 15% of Downs Company common stock for $400,000. Downs Company reported net income for the year of $75,000 and paid $25,000 cash dividends during the year. The balance of the Stock Investments account on the books of Grant Corporation at the end of the year should be $ .

156. A company that owns more than 50% of the common stock of another company is known as the company and financial statements are usually prepared.

157. securities are bought and held primarily for sale in the near future.

158. Market Adjustment is a valuation account which is

to (from) the cost of the investments.

159. At the end of an accounting period, if the fair value of the trading portfolio is less than its cost, then the company should recognize an which is reported on the
.

160. An unrealized loss on trading securities is reported under Other

on the income statement.

161. An unrealized gain or loss on available-for-sale securities is reported as a separate component of .

162. Short-term investments are securities that are and to be converted into cash within the next year.

MATCHING

163. Match the items below by entering the appropriate code letter in the space provided.

A. Available-for-salesecurities B. Subsidiary company
C. Equity method
D. Unrealized Gain or Loss—Equity E. Fair value
F. Consolidated financial statements G. Controlling interest
H. Market Adjustment I. Parent company
J. Long-term investments

1. Valuation allowance account.

2. Amount for which a security could be sold.

3. Ownership of more than 50% of another company’s common stock.

4. Securities that may be sold in the future.

5. Investments that are not readily marketable and not intended to be converted into cash within the next year.

6. Financial statements that present the total assets and liabilities controlled by the parent and the total revenues and expenses of the subsidiary companies.

7. The Stock Investments account is adjusted for net income and dividends received.

8. A company that owns more than 50% of the common stock of another entity.

9. Entity whose stock is owned by the parent company.

10. An account that is reported in the stockholders’ equity section.

SHORT-ANSWERESSAY QUESTIONS
S-AE 164
The Market Adjustment account is a balance sheet account. Identify the asset account it is related to. Explain how this account is increased and describe the procedure followed when its related asset account is disposed of.

S-AE 165

A consolidated balance sheet reports the financial position of two or more legal entities just as if they were one reporting unit. Explain why all the individual items appearing on the separate balance sheets of each of the affiliated companies cannot be added together to arrive at a consolidated total for each item.

S-AE 166

When a year-end adjustment is made to reduce the trading securities portfolio to market, what effect, if any, will the adjustment have on the balance sheet and the income statement?

S-AE 167 (Ethics)

Greyhound Stables, Inc. operates several dog racing tracks throughout the United States. Since most facilities are outdoor tracks only, most of the cash receipts for Greyhound are received from April through October. These funds are usually invested in short-term, very liquid investments, such as stocks and bonds. Among the stocks purchased last year, was Servitronics, a company specializing in automatic vending equipment.
Investments 16 – 39

S-AE 167 (cont.)

The company decided not to sell its Servitronics stock at the end of last year, and has purchased more of the stock this year. The company intends to continue to purchase stock until it holds enough to make a takeover bid for the company. The accountants have been instructed to continue to classify the investment as short-term until the takeover is accomplished, so that less attention will be directed to it. (Presently, Greyhound has no long-term investment in stock at all.)

Required:
1. Is it ethical for Greyhound to attempt to take over another company? Explain.

2. Is it ethical for Greyhound to leave its investment in the short-term investment category? Explain.

S-AE 168 (Communication)

Ann Harman is the daughter of Fred Harman, the founder and president of Big Sky Enterprises. She has been working in various departments during school vacations throughout high school. She burst into the accounting department excitedly one morning. She said that the stock price of several of the firm’s available-for-sale securities are up, and that her father said that the company had made over $10,000 because of this jump in stock prices. She asks to see how the increase is recorded. It is a very busy time in the accountingdepartment, and so her question is deferred.

Required:

Preparea brief note to answer Ann’s question.

CHAPTER 17

THESTATEMENT OF CASH FLOWS

CHAPTERSTUDY OBJECTIVES

1. Indicate the usefulness of the statement of cash flows.

2. Distinguish among operating, investing, and financing activities.

3. Prepare a statement of cash flows using the indirect method.

4. Analyze the statement of cash flows.

5. Explain how to use a worksheet to prepare the statement of cash flows using the indirect method.

6. Prepare a statement of cash flows using the direct method.

TRUE-FALSESTATEMENTS

1. The statement of cash flows is a required statement that must be prepared along with an income statement, balance sheet, and retained earnings statement.

2. For external reporting, a company must prepare either an income statement or a statement of cash flows, but not both.

3. A primary objective of the statement of cash flows is to show the income or loss on investing and financing transactions.

4. A statement of cash flows indicates the sources and uses of cash during a period.

5. In preparing a statement of cash flows, cash equivalents are subtractedfrom cash in order to compute the net change in cash during a period.

6. Cash equivalents are highly-liquid investments that have maturities of less than three months.

7. The use of cash to purchase highly liquid short-term investments (cash equivalents) would be reported on the statement of cash flows as an investing activity.

8. In preparing a statement of cash flows, the issuance of debt should be reported separately from the retirement of debt.

9. Noncash investing and financing activities must be reported in the body of a statement of cash flows.

10. The statement of cash flows classifies cash receipts and payments as operating, nonoperating, financial, and extraordinaryactivities.

11. The sale of land for cash would be classified as a cash inflow from an investing activity.

12. Cash flow from investing activities is considered the most important category on the statement of cash flows because it is considered the best measure of expected income.

13. The receipt of dividends from long-term investments in stock is classified as a cash inflow from investing activities.
The Statement of Cash Flows 17 – 5

14. The payment of interest on bonds payable is classified as a cash outflow from operating activities.

15. Any item that appears on the income statement would be considered as either a cash inflow or cash outflow from operating activities.

16. The acquisition of a building by issuing bonds would be considered an investing and financing activity that did not affect cash.

17. All major financing and investing activities affect cash.

18. Cash provided by operations is generally equal to operating income.

19. Using the indirect method, an increase in accounts receivable during a period is deducted from net income in calculating cash provided by operations.

20. Using the indirect method, an increase in accounts payable during a period is deducted from net income in calculating cash provided by operations.

21. A loss on sale of equipment is added to net income in determining cash provided by operations under the indirect method.

22. In preparing a statement of cash flows, an increase in the Common Stock and Treasury Stock accounts during a period would be an investing activity.

23. Cash provided by operating activities fails to take into account that a company must invest in new fixed assets just to maintain its current level of operations.

24. Free cash flow equals cash provided by operations less capital expenditures and cash dividends.

a25. The use of a worksheet to prepare a statement of cash flows is optional.

a26. During the year, Income Tax Expense amounted to $30,000 and Income Taxes Payable increased by $3,000; therefore, the cash paid for income taxes was $27,000.

a27. In preparing net cash flow from operating activities using the direct method, each item in the income statement is adjusted from the accrual basis to the cash basis.

a28. Using the direct method, major classes of investing and financing activities are listed in the operating activities section.

a29. During a period, cost of goods sold + an increase in inventory + an increase in accounts payable = cash paid to suppliers.

a30. Operating expenses + an increase in prepaid expenses – a decrease in accrued expenses payable = cash payments for operating expenses.
17 – 6

Additional True-False Questions

31. The statement of cash flows classifies cash receipts and cash payments into two categories: operating activities and nonoperating activities.

32. Financing activities include the obtaining of cash from issuing debt and repaying the amounts borrowed.

33. The adjusted trial balance is the only item needed to prepare the Statement of Cash Flows.

34. Under the indirect method, retained earnings is adjusted for items that affected reported net income but did not affect cash.

a35. The reconciling entry for depreciation expense in a worksheet is a credit to Accumulated Depreciation and a debit to Operating-DepreciationExpense.

a36. Under the direct method, the formula for computing cash collections from customers is sales revenues plus the increase in accounts receivable or minus the decrease in accounts receivable.

MULTIPLECHOICE QUESTIONS

37. The statement of cash flows should help investors and creditors assess each of the following except the
a. entity’s ability to generate future income. b. entity’s ability to pay dividends.
c. reasons for the difference between net income and net cash provided by operating activities.
d. cash investing and financing transactions during the period.

38. The statement of cash flows
a. must be prepared on a daily basis.
b. summarizes the operating, financing, and investing activities of an entity. c. is another name for the income statement.
d. is a special section of the income statement.
The Statement of Cash Flows 17 – 7

39. Which one of the following items is not generally used in preparing a statement of cash flows?
a. Adjusted trial balance
b. Comparative balance sheets c. Current income statement d. Additional information

40. The primary purpose of the statement of cash flows is to
a. provide information about the investing and financing activities during a period. b. prove that revenues exceed expenses if there is a net income.
c. provide information about the cash receipts and cash payments during a period. d. facilitate banking relationships.

41. If a company reports a net loss, it
a. may still have a net increase in cash. b. will not be able to pay cash dividends. c. will not be able to get a loan.
d. will not be able to make capital expenditures.

42. In addition to the three basic financial statements, which of the following is also a required financial statement?
a. the “Cash Budget”
b. the Statement of Cash Flows
c. the Statement of Cash Inflows and Outflows d. the “Cash Reconciliation”

43. The statement of cash flows will not report the
a. amount of checks outstanding at the end of the period. b. sources of cash in the current period.
c. uses of cash in the current period.
d. change in the cash balance for the current period.

44. Cash equivalents do not include a. short-term corporate notes. b. treasury bills.
c. money market funds.
d. 2-year certificates of deposit.

45. Which of the following characteristics does not apply to cash equivalents? a. Short-term
b. Highly-liquid
c. Readily convertible into cash
d. Sensitive to interest rate changes

46. Cash equivalents are generally investments with maturities of a. $1,000 or more.
b. three months or less. c. at least six months.
d. one year or the operating cycle, whichever is less.
17 – 8

47. The best measure of a company’s ability to generate sufficient cash to continue as a going concern is net cash provided by
a. financing activities. b. investing activities. c. operating activities. d. processing activities.

48. The acquisition of land by issuing common stock is
a. a noncash transaction which is not reported in the body of a statement of cash flows. b. a cash transaction and would be reported in the body of a statement of cash flows.
c. a noncash transaction and would be reported in the body of a statement of cash flows. d. only reported if the statement of cash flows is prepared using the direct method.

49. The order of presentation of activities on the statement of cash flows is a. operating, investing, and financing.
b. operating, financing, and investing. c. financing, operating, and investing. d. financing, investing, and operating.

50. Financing activities involve a. lending money.
b. acquiring investments. c. issuing debt.
d. acquiring long-lived assets.

51. Investing activities include
a. collecting cash on loans made. b. obtaining cash from creditors. c. obtaining capital from owners.
d. repaying money previously borrowed.

52. Generally, the most important category on the statement of cash flows is cash flows from a. operating activities.
b. investing activities. c. financing activities.
d. significant noncash activities.

53. The category that is generally considered to be the best measure of a company’s ability to continue as a going concern is
a. cash flows from operating activities. b. cash flows from investing activities. c. cash flows from financing activities. d. usually different from year to year.

54. Cash receipts from interest and dividends are classified as a. financing activities.
b. investing activities. c. operating activities.
d. either financing or investing activities.
The Statement of Cash Flows 17 – 9

55. Each of the following is an example of a significant noncash activity except a. conversion of bonds into common stock.
b. exchanges of plant assets.
c. issuance of debt to purchase assets. d. stock dividends.

56. If a company has both an inflow and outflow of cash related to property, plant, and equipment, the
a. two cash effects can be netted and presented as one item in the investing activities section.
b. cash inflow and cash outflow should be reported separately in the investing activities section.
c. two cash effects can be netted and presented as one item in the financing activities section.
d. cash inflow and cash outflow should be reported separately in the financing activities section.

57. Of the items below, the one that appears first on the statement of cash flows is a. noncash investing and financing activities.
b. net increase (decrease) in cash. c. cash at the end of the period.
d. cash at the beginning of the period.

58. Which of the following transactions does not affect cash during a period? a. Write-off of an uncollectible account
b. Collection of an accounts receivable c. Sale of treasury stock
d. Exercise of the call option on bonds payable

59. Significant noncash transactions would not include a. conversion of bonds into common stock. b. asset acquisition through bond issuance.
c. treasury stock acquisition. d. exchange of plant assets.

60. In preparing a statement of cash flows, a conversion of bonds into common stock will be reported in
a. the financing section.
b. the “extraordinary” section.
c. a separate schedule or note to the financial statements. d. the stockholders’ equity section.

Use the following information for questions 61–64.

For each of the following transactions, indicate where, if at all, it would be classified on the statement of cash flows. Assume the indirect method is used.

61. Paid income taxes.
a. Operating activities section b. Investing activities section c. Financing activities section
d. Does not represent a cash flow
17 – 10

62. Issued common stock for cash. a. Operating activities section b. Investing activities section c. Financing activities section
d. Does not represent a cash flow

63. Purchased land for cash.
a. Operating activities section b. Investing activities section c. Financing activities section
d. Does not represent a cash flow

64. Purchased land and building with a mortgage. a. Operating activities section
b. Investing activities section c. Financing activities section
d. Does not represent a cash flow

Use the following information for questions 65–66.

Joy Elle’s Vegetable Market had the following transactions during 2008:

1. Issued $25,000 of par value common stock for cash.
2. Repaid a 6 year note payable in the amount of $11,000.
3. Acquired land by issuing common stock of par value $50,000. 4. Declared and paid a cash dividend of $1,000.
5. Sold a long-term investment (cost $3,000) for cash of $3,000. 6. Acquired an investment in IBM stock for cash of $6,000.

65. What is the net cash provided by financing activities? a. $13,000
b. $25,000 c. $14,000 d. $9,000

66. What is the net cash provided by investing activities? a. $6,000
b. $16,000 c. ($3,000) d. $3,000

67. Miller Company purchased treasury stock with a cost of $15,000 during 2008. During the year, the company paid dividends of $20,000 and issued bonds payable for proceeds of $816,000. Cash flows from financing activities for 2008 total
a. $796,000 net cash inflow. b. $811,000 net cash inflow. c. $5,000 net cash outflow. d. $781,000 net cash inflow.
The Statement of Cash Flows 17 – 11

68. Cline Company issued common stock for proceeds of $186,000 during 2008. The company paid dividends of $33,000 and issued a long-term note payable for $45,000 in exchange for equipment during the year. The company also purchased treasury stock that had a cost of $7,000. The financing section of the statement of cash flows will report net cash inflows of
a. $146,000. b. $202,000. c. $153,000. d. $179,000.

69. In Gentry Company, land decreased $120,000 because of a cash sale for $120,000, the equipment account increased $40,000 as a result of a cash purchase, and Bonds Payable increased $130,000 from issuance for cash at face value. The net cash provided by investing activities is
a. $120,000. b. $210,000. c. $80,000. d. $90,000.

70. Accounts receivable arising from sales to customers amounted to $80,000 and $70,000 at the beginning and end of the year, respectively. Income reported on the income statement for the year was $240,000. Exclusive of the effect of other adjustments, the cash flows from operating activities to be reported on the statement of cash flows is
a. $240,000. b. $250,000. c. $310,000. d. $230,000.

71. Accounts receivable arising from sales to customers amounted to $35,000 and $40,000 at the beginning and end of the year, respectively. Income reported on the income statement for the year was $120,000. Exclusive of the effect of other adjustments, the cash flows from operating activities to be reported on the statement of cash flows is
a. $120,000. b. $125,000. c. $155,000. d. $115,000.

72. Wilton Company reported net income of $40,000 for the year. During the year, accounts receivable decreased by $7,000, accounts payable increased by $3,000 and depreciation expense of $5,000 was recorded. Net cash provided by operating activities for the year is a. $30,000.
b. $55,000. c. $39,000. d. $35,000.

73. Buster Company reported a net loss of $3,000 for the year ended December 31, 2008. During the year, accounts receivable increased $7,000, merchandise inventory decreased $5,000, accounts payable decreased by $10,000, and depreciation expense of $5,000 was recorded. During 2007, operating activities
a. used net cash of $10,000. b. used net cash of $14,000.
c. provided net cash of $14,000. d. provided net cash of $9,000.
17 – 12

74. The net income reported on the income statement for the current year was $205,000. Depreciation recorded on plant assets was $38,000. Accounts receivable and inventories increased by $2,000 and $8,000, respectively. Prepaid expenses and accounts payable decreased by $1,000 and $11,000 respectively. How much cash was provided by operating activities?
a. $185,000 b. $223,000 c. $205,000 d. $239,000

75. The net income reported on the income statement for the current year was $220,000. Depreciation was $50,000. Account receivable and inventories decreased by $10,000 and $30,000, respectively. Prepaid expenses and accounts payable increased, respectively, by $1,000 and $8,000. How much cash was provided by operating activities?
a. $281,000 b. $317,000 c. $301,000 d. $309,000

76. If a gain of $10,000 is incurred in selling (for cash) office equipment having a book value of $100,000, the total amount reported in the cash flows from investing activities section of the statement of cash flows is
a. $90,000. b. $110,000. c. $100,000. d. $10,000.

77. If a loss of $12,500 is incurred in selling (for cash) office equipment having a book value of $50,000,the total amount reported in the cash flows from investing activities section of the statement of cash flows is
a. $37,500. b. $50,000. c. $62,500. d. $12,500.

78. Harbor Company reported net income of $60,000 for the year ended December 31, 2008. During the year, inventories decreased by $12,000, accounts payable decreased by $18,000, depreciation expense was $20,000 and a gain on disposal of equipment of $9,000 was recorded. Net cash provided by operating activities in 2008 using the indirect method was
a. $119,000. b. $65,000. c. $77,000. d. $55,000.

79. The third (final) step in preparing the statement of cash flows is to a. analyze changes in noncurrent asset and liability accounts.
b. compare the net change in cash with the change in the cash account reported on the balance sheet.
c. determine net cash provided by operating activities. d. list the noncash activities.
The Statement of Cash Flows 17 – 13

80. Which one of the following items is not necessary in preparing a statement of cash flows? a. Determine the change in cash
b. Determine the cash provided by operations
c. Determine cash from financing and investing activities d. Determine the cash in all bank accounts

81. If accounts receivable have increased during the period,
a. revenues on an accrual basis are less than revenues on a cash basis.
b. revenues on an accrual basis are greater than revenues on a cash basis. c. revenues on an accrual basis are the same as revenues on a cash basis. d. expenses on an accrual basis are greater than expenses on a cash basis.

82. If accounts payable have increased during a period,
a. revenues on an accrual basis are less than revenues on a cash basis. b. expenses on an accrual basis are less than expenses on a cash basis.
c. expenses on an accrual basis are greater than expenses on a cash basis. d. expenses on an accrual basis are the same as expenses on a cash basis.

83. Which one of the following affects cash during a period? a. Recording depreciation expense
b. Declaration of a cash dividend
c. Write-off of an uncollectible account receivable d. Payment of an accounts payable

84. In calculating cash flows from operating activities using the indirect method, a gain on the sale of equipment is
a. added to net income.
b. deducted from net income.
c. ignored because it does not affect cash. d. not reported on a statement of cash flows.

85. Meyer Company reported net income of $50,000 for the year. During the year, accounts receivable increased by $7,000, accounts payable decreased by $3,000 and depreciation expense of $5,000 was recorded. Net cash provided by operating activities for the year is a. $45,000.
b. $65,000. c. $49,000. d. $50,000.

86. Flynn Company reported a net loss of $20,000 for the year ended December 31, 2008. During the year, accounts receivable decreased $10,000, merchandise inventory increased $16,000, accounts payable increased by $20,000, and depreciation expense of $10,000was recorded. During 2008, operating activities
a. used net cash of $4,000. b. used net cash of $16,000.
c. provided net cash of $4,000. d. provided net cash of $16,000.
17 – 14

87. Starting with net income and adjusting it for items that affected reported net income but which did not affect cash is called the
a. direct method. b. indirect method.
c. working capital method. d. cost-benefit method.

88. In calculating net cash provided by operating activities using the indirect method, an increase in prepaid expenses during a period is
a. deducted from net income. b. added to net income.
c. ignored because it does not affect income. d. ignored because it does not affect expenses.

89. Using the indirect method, patent amortization expense for the period a. is deductedfrom net income.
b. causes cash to increase. c. causes cash to decrease. d. is added to net income.

90. In developing the cash flows from operating activities, most companies in the U. S. a. use the direct method.
b. use the indirect method.
c. present both the indirect and direct methods in their financial reports. d. prepare the operating activities section on the accrual basis.

91. Each of the following is added to net income in computing net cash provided by operating activities except
a. amortization expense.
b. an increase in accrued expenses payable. c. a gain on sale of equipment.
d. a decrease in inventory.

92. Which of the following would be subtracted from net income using the indirect method? a. Depreciation expense
b. An increase in accounts receivable c. An increase in accounts payable d. A decrease in prepaid expenses

93. Which of the following would be added to net income using the indirect method? a. An increase in accounts receivable
b. An increase in prepaid expenses c. Depreciation expense
d. A decrease in accounts payable

94. Which of the following would not be an adjustment to net income using the indirect method?
a. Depreciation Expense
b. An increase in Prepaid Insurance c. Amortization Expense
d. An increase in Land
The Statement of Cash Flows 17 – 15

95. In calculating cash flows from operating activities using the indirect method, a loss on the sale of equipment will appear as a(n)
a. subtraction from net income. b. addition to net income.
c. addition to cash flow from investing activities.
d. subtraction from cash flow from investing activities.

96. Which of the following adjustments to convert net income to net cash provided by operating activities is correct?

a. AccountsReceivable b. Prepaid Expenses
c. Inventory
d. Taxes Payable
Add to Net Income increase increase decrease decrease
Deduct from Net Income decrease decrease increase increase

97. Which of the following adjustments to convert net income to net cash provided by operating activities is incorrect?

a. AccountsReceivable b. Prepaid Expenses
c. Inventory
d. AccountsPayable
Add to Net Income decrease increase decrease increase
Deduct from Net Income increase decrease increase decrease

98. Which of the following adjustments to convert net income to net cash provided by operating activities is not added to net income?
a. Gain on Sale of Equipment b. Depreciation Expense
c. Patent Amortization Expense d. Depletion Expense

99. Using the indirect method, if equipment is sold at a gain, the
a. sale proceeds received are deducted in the operating activities section. b. sale proceeds received are added in the operating activities section.
c. amount of the gain is added in the operating activities section.
d. amount of the gain is deducted in the operating activities section.

100. A company had net income of $180,000. Depreciation expense is $26,000. During the year, Accounts Receivable and Inventory increased $15,000 and $40,000, respectively. Prepaid Expenses and Accounts Payable decreased $2,000 and $4,000, respectively. There was also a loss on the sale of equipment of $3,000. How much cash was provided by operating activities?
a. $146,000 b. $152,000 c. $226,000 d. $238,000

101. On the statement of cash flows using the indirect method, patent amortization expense will a. be added to net income in the operating section.
b. be deducted from net income in the operating section. c. appear as an inflow of cash in the investing section. d. appear as an outflow of cash in the investing section.
17 – 16

102. The indirect and direct methods of preparing the statement of cash flows are identical exceptfor the
a. significant noncash activity section. b. operating activities section.
c. investing activities section. d. financing activities section.

103. Land acquired from the issuance of common stock is reported a. as a financing activity.
b. as an investing activity. c. as an operating activity.
d. in a separate schedule at the bottom of the statement.

104. If $250,000 of bonds are issued during the year but $150,000 of old bonds are retired during the year, the statement of cash flows will show a(n)
a. net increase in cash of $100,000. b. net decrease in cash of $100,000.
c. increase in cash of $250,000 and a decrease in cash of $150,000. d. net gain on retirement of bonds of $100,000.

105. Which of the following changes in retained earnings during a period will be reported in the financing activities section of the statement of cash flows?

1. Declaration of a cash dividend paid during the period. 2. Net income for the period.
a. 1 b. 2
c. Neither 1 nor 2. d. Both 1 and 2.

106. The statement of cash flows
a. is prepared instead of an income statement under generally accepted accounting principles.
b. is used to assess an entity’s ability to pay dividends and meet obligations. c. is prepared from comparative income statements.
d. reflects earnings per share figures on a cash basis and on an accrual basis in the body of the statement.

107. In preparing the statement of cash flows, determining the net increase or decrease in cash requires the use of
a. the adjusted trial balance.
b. the current period’s balance sheet. c. a comparative balance sheet.
d. a comparative income statement.

108. To determine the net cash provided (used) by operating activities, it is necessary to analyze a. the current year’s income statement.
b. a comparative balance sheet. c. additional information.
d. all of these.
The Statement of Cash Flows 17 – 17

109. Which of the following would not be needed to determine net cash provided by operating activities?
a. Depreciation expense
b. Change in accounts receivable c. Payment of cash dividends
d. Change in prepaid expenses

110. When equipment is sold for cash, the amount received is reflected as a cash a. inflow in the operating section.
b. inflow in the financing section. c. inflow in the investing section. d. outflow in the operating section.

111. The statement of cash flows will not provide insight into a. why dividends were not increased.
b. whether cash flow is greater than net income. c. the exact proceeds of a future bond issue.
d. how the retirement of debt was accomplished.

112. Which of the following transactions would not be classified as a financing activity? a. Purchase of treasury stock
b. Payment of dividends
c. Issuance of bonds at a discount
d. Purchase of a long-term investment in bonds

113. A measure that describes the cash remaining from operations after adjustment for capital expenditures and dividends is
a. adjusted cash from operations. b. cash provided by operations. c. free cash flow.
d. net cash provided by operating activities.

114. Free cash flow equals cash provided by
a. operations less capital expenditures and cash dividends. b. operations less cash dividends.
c. investing activities less capital expenditures and cash dividends. d. operations less capital expenditures.

115. DV’s Pest Control Products has the following information available:

Net Income
Cash Provided by Operations Cash Sales
Capital Expenditures DividendsPaid

What is DV’s free cash flow? a. $18,000
$15,000 21,000 65,000 11,000 3,000

b. $10,000 c. $7,000 d. $1,000
17 – 18

a116. When listing accounts in the statement of cash flows worksheet, the accumulated depreciation account is shown
a. with accounts that have credit balances. b. with accounts that have debit balances. c. as a credit under the reconciling items. d. as a debit under the reconciling items.

a117. In the bottom portion of the statement of cash flows worksheet, a. inflows of cash are debits in the reconciling columns.
b. outflows of cash are debits in the reconciling columns.
c. information pertaining to investing and financing activities only is entered. d. only significant noncash transactions are entered.

a118. On the statement of cash flows worksheet,
a. significant noncash investing and financing activities are not entered in the reconciling columns.
b. a decrease in cash will be offset by a debit in the reconciling items columns at the bottom of the worksheet.
c. an increase in cash will be offset by a debit in the reconciling items column at the bottom of the worksheet.
d. income statement accounts are listed after balance sheet accounts in the top half of the worksheet under the indirect method.

a119. Each of the following would be reported under operating activities except cash receipts a. from sales of goods.
b. from sales of investments. c. of interest on loans.
d. of dividends from investments.

a120. Which of the following statements concerning the statement of cash flows is true?
a. The statement of cash flows is usually more accurate when using the indirect method. b. If the direct method is used, a supplementary schedule reconciling the net income to a
net cash from operating activities must still be provided.
c. The statement of cash flows reflects both earnings per share and cash per share.
d. The statement of cash flows is an optional financial statement for external reporting purposes.

a121. Carter Company reports the following:

Inventory AccountsPayable
End of Year $25,000
30,000
Beginning of Year $40,000
10,000

If cost of goods sold for the year is $170,000, the amount of cash paid to suppliers is a. $175,000.
b. $165,000. c. $135,000. d. $205,000.
The Statement of Cash Flows 17 – 19

a122. During the year, Salaries Payable decreased by $6,000. If Salary Expense amounted to $190,000 for the year, the cash paid to employees (including deductions from gross pay) is a. $196,000.
b. $190,000. c. $184,000. d. $202,000.

a123. Gary Company reports a $15,000 increase in inventory and a $5,000 increase in accounts payable during the year. Cost of Goods Sold for the year was $180,000. The cash payments made to suppliers were
a. $180,000. b. $190,000. c. $160,000. d. $175,000.

a124. Rader Company had credit sales of $600,000. The beginning accounts receivable balance was $40,000 and the ending accounts receivable balance was $140,000. What were the cash collections from customers during the period?
a. $700,000 b. $600,000 c. $500,000 d. $640,000

a125. Goren Inc. had cash sales of $300,000 and credit sales of $1,150,000. The accounts receivable balance increased $15,000 during the year. How much cash did Goren receive from its customers during the year?
a. $1,435,000 b. $1,465,000 c. $1,135,000 d. $1,165,000

a126. Stine Company had a cost of purchases of $220,000. The comparative balance sheet analysis revealed a $10,000 decrease in inventory and a $20,000 increase in accounts payable. What were Stine’s cash payments to suppliers?
a. $200,000 b. $190,000 c. $230,000 d. $250,000

a127. Wayne Company had an increase in inventory of $40,000. The cost of goods sold was $80,000. There was a $5,000 decrease in accounts payable from the prior period. What were Wayne’s cash payments to suppliers?
a. $125,000 b. $75,000 c. $115,000 d. $85,000

a128. Which of the following items does not appear in the statement of cash flows under the direct method?
a. Cash payments to suppliers
b. Cash collections from customers c. Depreciation Expense
d. Cash from the sale of equipment
17 – 20

a129. Nixon Company has other operating expenses of $90,000. There has been a decrease in prepaid expenses of $4,000 during the year, and accrued liabilities are $6,000 larger than in the prior period. What were Nixon’s cash payments for operating expenses?
a. $92,000 b. $88,000 c. $80,000 d. $90,000

a130. Carsen Corporation shows income tax expense of $90,000. There has been a $5,000 decrease in federal income taxes payable and a $7,000 increase in state income taxes payable during the year. What was Carsen’s cash payment for income taxes?
a. $90,000 b. $88,000 c. $85,000 d. $92,000

a131. Which of the following would not appear in the operating activities section of a statement of cash flows prepared under the direct method?
a. Cash receipts from customers b. Cash paid for income taxes
c. Gain on sale of equipment d. Cash paid to employees

a132. The cost of goods sold during the year was $165,000. Merchandise inventory decreased by $6,000 during the year and accounts payable decreased by $3,000 during the year. Using the direct method of reporting cash flows from operating activities, cash payments for merchandisetotal
a. $168,000. b. $162,000. c. $156,000. d. $174,000.

a133. Bent Company reports a $20,000 increase in inventory and a $5,000 decrease in accounts payable during the year. Cost of Goods Sold for the year was $150,000. Using the direct method of reporting cash flows from operating activities, cash payments made to suppliers were
a. $150,000. b. $165,000. c. $175,000. d. $135,000.

a134. During 2008, Unruh Company had $160,000 in cash sales and $1,400,000 in credit sales. The accounts receivable balances were $180,000 and $212,000 at December 31, 2007 and 2008, respectively. Using the direct method of reporting cash flows from operating activities, what was the total cash collected from all customers during 2008?
a. $1,368,000 b. $1,592,000 c. $1,560,000 d. $1,528,000
The Statement of Cash Flows 17 – 21

a135. Logan Company has other operating expenses of $260,000. There has been an increase in prepaid expenses of $16,000 during the year, and accrued liabilities are $24,000 lower than in the prior period. Using the direct method of reporting cash flows from operating activities, what were Logan’s cash payments for operating expenses?
a. $248,000 b. $252,000 c. $220,000 d. $300,000

Additional Multiple Choice Questions

136. Which of the following steps is not required in preparing the statement of cash flows? a. Determine the change in cash.
b. Determine the net cash provided by operating activities. c. Determine cash from investing and financing activities. d. Determine the change in current assets.

137. Financing activities involve
a. lending money to other entities and collecting on those loans. b. cash receipts from sales of goods and services.
c. acquiring and disposing of productive long-lived assets. d. long-term liability and owners’ equity items.

138. The information to prepare the statement of cash flows usually comes from each of the following except
a. the comparative balance sheet. b. the retained earnings statement. c. additional information.
d. the current income statement.

139. The statement of cash flows is prepared from all of the following except a. the adjusted trial balance.
b. comparative balance sheets. c. selected transaction data.
d. the current income statement.

140. The information in a statement of cash flows will not help investors to assess the entity’s ability to
a. generate future cash flows.
b. obtain favorable borrowing terms at a bank. c. pay dividends.
d. pay its obligations when they become due.

141. In converting net income to net cash provided by operating activities, under the indirect method:
a. decreases in accounts receivable and increases in prepaid expenses are added. b. decreases in inventory and increases in accrued liabilities are added.
c. decreases in accounts payable and decreases in inventory are deducted.
d. increases in accounts receivable and increases in accrued liabilities are deducted.
17 – 22

142. In the Freyfogle Company, land decreased $60,000 because of a cash sale for $60,000, the equipment account increased $20,000 as a result of a cash purchase, and Bonds Payable increased $70,000 from an issuance for cash at face value. The net cash provided by investing activities is
a. $60,000. b. $110,000. c. $40,000. d. $50,000.

a143. Cribbets Company uses the direct method in determining net cash provided by operating activities, During the year, operating expenses were $260,000, prepaid expenses increased $20,000, and accrued expenses payable increased $30,000. Cash payments for operating expenses were
a. $210,000. b. $310,000. c. $270,000. d. $250,000.

a144. Bainbridge Company uses the direct method in determining net cash provided by operating activities. The income statement shows income tax expense $60,000. Income taxes payable were $25,000 at the beginning of the year and $18,000 at the end of the year. Cash payments for income taxes are
a. $53,000. b. $60,000. c. $67,000. d. $78,000.

a145. When a worksheet is used, all but one of the following statements is correct. The incorrect statementis
a. Reconciling items on the worksheet are not journalized or posted.
b. The bottom portion of the worksheet shows the statement of cash flows effects.
c. The balance sheet accounts portion of the worksheet is divided into two parts: assets, and liabilities and stockholders’ equity.
d. Each line pertaining to a balance sheet account should foot across.

BRIEFEXERCISES
BE 146
Selectedtransactions for the Eldon Company are listed below.

1. Collected accounts receivable.
2. Declared and paid dividends on common stock. 3. Sold long-term investments for cash.
4. Issued stock for equipment.
5. Repaid five year note payable. 6. Paid employee wages.
7. Converted bonds payable to common stock. 8. Acquired long-term investment with cash.
9. Sold buildings and equipment for cash. 10. Sold merchandiseto customers.

Instructions

Classify each transaction as either (a) an operating activity, (b) an investing activity, (c) a financing activity, or (d) a noncash investing and financing activity.

BE 147

Bertucci Company had net income of $204,000 in 2008. Depreciation expense for the year is $45,000. During the year, Accounts Receivable increased $9,000 and Prepaid Expenses decreased $1,000. The company also sold equipment at a loss of $2,000.

Instructions
Calculatenet cash flows from operating activities using the indirect method.

BE 148

During 2008, Baxter Company sold a building with a book value of $145,000 for proceeds of $132,000. The company also sold long-term investments for proceeds of $45,000. The company purchased land and a new building for $320,000 by signing a long-term note payable. No other transactions impacted long-term asset accounts during 2008.

Instructions
Computenet cash flows from investing activities.

BE 149

Mover Company issued common stock for proceeds of $14,000 during 2008. The company paid dividends of $2,000. The company also issued a long-term note payable for $30,000 in exchange for equipment during the year. The company sold treasury stock that had a cost of $2,000 for $4,000.

Instructions
Computenet cash flows from financing activities.

BE 150

At January 1, 2008, Bergman Enterprises reported a balance in the Equipment account of $45,000. During the year the company purchased equipment with a cost of $60,000 and sold equipment with a book value of $30,000. The company reported a loss on the sale of equipment of $2,000. Assume the indirect method is used.

Instructions

Determine what amount will be reported in (a) the operating activities section and (b) the investing activities section with regard to the purchase and sale of equipment.

BE 151

Assume the indirect method is used to compute cash flows from operations. For each item listed below, indicate the effect on net income in arriving at cash flows from operations by choosing one of the following code letters.
Code Cash Flows From Operating Activities
Add to Net Income A Deduct from Net Income D

1. Increase in accounts receivable 2. Increase in inventory
3. Decrease in prepaid expenses 4. Decrease in accounts payable 5. Increase in accrued liabilities
6. Increase in income taxes payable 7. Depreciation expense
8. Loss on sale of investment
9. Gain on disposal of equipment 10. Amortization expense

BE 152

Dutton Company prepared the tabulation below at December 31, 2008.

Net Income……………………………………………………………………………………………….. $275,000

Adjustmentsto reconcile net income to net cash provided by operating activities:

Depreciation expense, $25,000…………………………………………………………….

Decrease in accounts receivable, $55,000……………………………………………..

Increase in inventory, $12,000 ……………………………………………………………..

Decrease in accounts payable, $6,600 ………………………………………………….

Increase in income taxes payable, $1,500……………………………………………..

Loss on sale of land, $5,000…………………………………………………………………

Net cash provided (used) by operating activities……………………………………..

Instructions

Show how each item should be reported in the statement of cash flows. Use parentheses for deductions.

BE 153

Daimler Enterprises reported cash flow from operations of $342,000. The company made capital expenditures of $112,000 and paid dividends of $34,000.

Instructions Computefree cash flow.

BE 154

Schick Company reported cost of goods sold of $192,000 on its 2008 income statement. The company’s beginning inventory was $35,000. The ending inventory was valued at $40,000. The Accounts Payable balance at January 1 was $25,000. The December 31 balance in Accounts Payable was $22,000.

Instructions
Computecash payments to suppliers.

BE 155

Hiller Company had total operating expenses of $135,000 in 2008, which included Depreciation Expense of $25,000. Also during 2008, prepaid expenses decreased by $9,000 and accrued expenses increased by $5,500.

Instructions

Calculatethe amount of cash payments for operating expenses in 2008 using the direct method.

EXERCISES
Ex. 156
Classifyeach of the following as a(n):

A. Operating Activity B. Investing Activity C. Financing Activity

1 Issuanceof bonds. 2. Sale of equipment.
3. Amortizationexpense.

4. Purchaseof treasury stock.

5. Receipt of dividends on investment. 6. Purchaseof land.

Ex. 157

Selectedtransactions of Eller Company are listed below.

1. Common stock is sold for cash above par value. 2. Bonds payable are issued for cash at a discount.
3. Interest receivable on a short-term note receivable is collected. 4. Land is sold for cash at book value.
5. Accounts payable are paid in cash.
6. Equipment is purchased by signing a 3-year, 10% note payable. 7. Cash dividends on common stock are declared and paid.
8. 100 shares of XYZ common stock are purchased for cash. 9. Merchandise is sold to customers for cash.
10. Bonds payable are converted into common stock.

Instructions

Classify each transaction as either (a) an operating activity, (b) an investing activity, (c) a financing activity, or (d) a noncash investing and financing activity.

Ex. 158

(a) Identify several alternatives for presenting significant noncash activities in financial statements.

(b) Give three examples of significant noncash transactions.

Ex. 159

The following information is available for Snider Company:

Receiptsfrom customers Dividendsfrom stock investments Proceedsfrom sale of equipment Proceedsfrom issuance of stock Paymentsfor goods Paymentsfor operating expenses Interest paid
Taxes paid Dividendspaid
$180,000 3,000 18,000 90,000 100,000 70,000 5,000 4,000 20,000

Instructions
Based on the preceding information, compute the net cash provided by operating activities.

Ex. 160

Pierce Company reported net income of $200,000 for the current year. Depreciation recorded on buildings and equipment amounted to $80,000 for the year. Balances of the current asset and current liability accounts at the beginning and end of the year are as follows:

Cash Accountsreceivable Inventories
Prepaid expenses Accountspayable Incometaxes payable
End of Year $20,000
24,000 50,000 7,500 12,000 1,600
Beginning of Year $15,000
32,000 65,000 5,000 18,000 1,200

Instructions
Preparethe cash flows from the operating activities section of the statement of cash flows using the indirect method.

Ex. 161

Neal Company reported net income of $120,000. For 2008, depreciation was $30,000, and the company reported a gain on sale of investments of $10,000. Accounts receivable increased $25,000and accounts payable decreased $15,000.

Instructions

Computenet cash provided by operating activities using the indirect method.

Ex. 162

Assuming a statement of cash flows is prepared, indicate the reporting of the transactions and events listed below by major categories on the statement. Use the following code letters to indicate the appropriate category under which the item would appear on the statement of cash flows.

Code Cash Flows From Operating Activities
Add to Net Income A Deduct from Net Income D Cash Flows From Investing Activities IA
Cash Flows From Financing Activities FA
Category

1. Common stock is issued for cash at an amount above par value. 2. Merchandise inventory increased during the period.
3. Depreciation expense recorded for the period. 4. Building was purchased for cash.
5. Bonds payable were acquired and retired at their carrying value. 6. Accounts payable decreased during the period.
7. Prepaid expenses decreased during the period. 8. Treasury stock was acquired for cash.
9. Land is sold for cash at an amount equal to book value. 10. Patent amortization expense recorded for a period.

Ex. 163

A comparative balance sheet for Lyon Company appears below:

LYON COMPANY ComparativeBalance Sheet

Assets Cash
Accountsreceivable Inventory
Prepaid expenses Long-terminvestments Equipment
Accumulateddepreciation—equipment Total assets
Dec. 31, 2008

$ 23,000 18,000 27,000 6,000
-0-60,000
(18,000) $116,000
Dec. 31, 2007

$10,000 14,000 18,000 9,000 18,000 32,000
(14,000) $87,000

Liabilities and Stockholders’ Equity

Accountspayable Bonds payable Commonstock Retainedearnings
Total liabilities and stockholders’ equity
$ 17,000 37,000 40,000
22,000 $116,000
$ 7,000 47,000 23,000
10,000 $87,000

Additional information:
1. Net income for the year ending December 31, 2008 was $24,000. 2. Cash dividends of $12,000 were declared and paid during the year.
3. Long-term investments that had a cost of $18,000 were sold for $16,000. 4. Sales for 2008 were $120,000.

Instructions
Prepare a statement of cash flows for the year ended December 31, 2008, using the indirect method.

Ex. 164

A comparative balance sheet for Jenner Corporation is presented below:

Cash Accountsreceivable (net) Prepaid insurance
Land Equipment
Accumulateddepreciation Total Assets
JENNER CORPORATION ComparativeBalance Sheet

Assets

2008 2007

$ 36,000 $ 31,000 80,000 60,000 25,000 17,000 18,000 40,000 70,000 60,000
(20,000) (13,000) $209,000 $195,000

Liabilities and Stockholders’ Equity Accountspayable $ 11,000 Bonds payable 27,000 Commonstock 140,000 Retainedearnings 31,000
Total liabilities and stockholders’ equity $209,000

$ 6,000 19,000 115,000
55,000 $195,000

Ex
164 (cont.) Additional information:
1. Net loss for 2008 is $15,000.

2. Cash dividends of $9,000 were declared and paid in 2008.

3. Land was sold for cash at a loss of $7,000. This was the only land transaction during the year.

4. Equipment with a cost of $15,000 and accumulated depreciation of $10,000 was sold for $5,000 cash.

5. $12,000 of bonds were retired during the year at carrying (book) value.

6. Equipment was acquired for common stock. The fair market value of the stock at the time of the exchange was $25,000.

Instructions

Preparea statement of cash flows for the year ended 2008, using the indirect method.

Ex. 165

The following information is available for Fryer Corporation for the year ended December 31, 2008:

Collectionof principal on long-term loan to a supplier Acquisitionof equipment for cash
Proceedsfrom the sale of long-term investment at book value Issuanceof common stock for cash
Depreciation expense
Redemptionof bonds payable at carrying (book) value Payment of cash dividends
Net income
Purchaseof land by issuing bonds payable
$15,000 10,000 27,000 20,000 35,000 24,000 14,000 30,000 40,000

In addition, the following information is available from the comparative balance sheet for Fryer at the end of 2007 and 2008:

Cash Accountsreceivable (net) Prepaid insurance
Total current assets

Accountspayable Salaries payable Total current liabilities
2008
$ 87,000 20,000
17,000 $124,000

$ 25,000
4,000 $ 29,000
2007
$14,000 15,000
13,000 $42,000

$19,000
7,000 $26,000

Instructions
Prepare Fryer’s statement of cash flows for the year ended December 31, 2008 using the indirect method.
17 – 36

Ex. 166

Trent Company prepared the tabulation below at December 31, 2008.

Net Income……………………………………………………………………………………………….. $300,000 Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense, $35,000……………………………………………………………. Increasein accounts receivable, $60,000……………………………………………… Decreasein inventory, $13,000……………………………………………………………. Amortizationof patent, $4,000……………………………………………………………… Increasein accounts payable, $5,600…………………………………………………… Decreasein interest receivable, $4,000………………………………………………… Increasein prepaid expenses, $6,000…………………………………………………… Decreasein income taxes payable, $1,500……………………………………………. Gain on sale of land, $5,000………………………………………………………………… Net cash provided (used) by operating activities……………………………………..

Instructions
Show how each item should be reported in the statement of cash flows. Use parentheses for deductions.

Ex. 167

The following information is available for Visser Corporation:

Capital expenditures Cash dividends
Cash provided by operations Net income
Sales
$115,000 65,000 200,000 130,000 500,000

Instructions
ComputeVisser Corporation’sfree cash flow.

Ex. 168

Leiter Company has begun a worksheet for preparing a statement of cash flows. The following additional information is provided:
1. Cash dividends of $15,000 were paid during the year.
2. Land which originally cost $60,000 was sold for $55,000. 3. Common stock was issued at par value for cash.

Instructions
Completethe worksheet for Leiter Company.

aEx. 168 (cont.)

LEITERCOMPANY Worksheet
Statementof Cash Flows
For the Year Ended December 31, 2008

Balance Sheet Accounts Debits
Cash Accountsreceivable Inventory
Land Equipment
Total

Credits Accountspayable Bonds payable
Accumulateddepreciation— equipment
Commonstock Retainedearnings
Total

Statement of Cash Flows Effects Operatingactivities
Net income
Balance 12/31/07

30,000 40,000 90,000 60,000 131,000 351,000

15,000 25,000

81,000 170,000
60,000 351,000
Reconciling Items Debits Credits

21,000
Balance 12/31/08

55,000 58,000 110,000
-0-145,000 368,000

12,000 10,000

95,000 180,000
71,000 368,000

Ex. 169

Dolan Company’s income statement showed revenues of $250,000 and operating expenses of $160,000. Accounts receivable decreased by $60,000 and accounts payable increased by $40,000during the year.

Instructions
Compute (a) cash receipts from customers and (b) cash payments for operating expenses using the direct method.

Ex. 170

Banner Company had total operating expenses of $140,000 in 2008, which included Depreciation Expense of $20,000. Also, during 2008, prepaid expenses increased by $5,000 and accrued expenses decreased by $6,700.

Instructions
Calculatethe amount of cash payments for operating expenses in 2008 using the direct method.

Ex. 171

The general ledger of Lopez Company provides the following information:

AccountsReceivable Inventory AccountsPayable
End of Year $ 55,000
350,000 40,000
Beginning of Year $ 94,000
210,000 65,000

The company’s net sales for the year was $2,100,000 and cost of goods sold amounted to $1,500,000.

Instructions Computethe following:
(a) Cash receipts from customers. (b) Cash payments to suppliers.

Ex. 172

The income statement of Redman Inc. for the year ended December 31, 2008, reported the following condensed information:

Service revenue Operatingexpenses Incomefrom operations Incometax expense Net income
$600,000
360,000 240,000
60,000 $180,000

Redman’sbalance sheet contained the following comparative data at December 31:

Accountsreceivable Accountspayable Incometaxes payable
2008
$50,000 35,000 6,000
2007
$40,000 50,000 3,000

Redmanhas no depreciable assets. Accounts payable pertains to operating expenses.

Instructions

Preparethe operating activities section of the statement of cash flows using the direct method.

Ex. 173

The income statement of Haslett Company is shown below:

HASLETT COMPANY IncomeStatement
For the Year Ended December 31, 2008

Sales
Cost of goods sold Gross profit Operatingexpenses
Selling expenses Administrativeexpense Depreciation expense Amortizationexpense
Net income

$500,000 700,000 90,000
30,000
$8,000,000
5,400,000 2,600,000

1,320,000 $1,280,000

Ex. 173 (cont.)

Additionalinformation:
1. Accounts receivable increased $500,000 during the year. 2. Inventory increased $250,000 during the year.
3. Prepaid expenses increased $200,000 during the year.
4. Accounts payable to merchandisesuppliers increased $150,000 during the year. 5. Accrued expenses payable increased $180,000 during the year.

Instructions
Prepare the operating activities section of the statement of cash flows for the year ended December31, 2008, for Haslett Company, using the direct method.

Ex. 174

The financial statementsof Larkin Company appear below:

Cash Accountsreceivable Merchandiseinventory
Property, plant, and equipment Accumulateddepreciation
Total
LARKIN COMPANY ComparativeBalance Sheet December31

Assets

2008 2007

$ 43,000 $ 23,000 26,000 34,000 25,000 15,000 50,000 78,000
(20,000) (24,000) $124,000 $126,000

Accountspayable Incometaxes payable Bonds payable Commonstock Retainedearnings
Total
Liabilities and Stockholders’ Equity

$ 17,000 13,000 7,000 41,000
46,000 $124,000

$ 23,000 8,000 33,000 24,000
38,000 $126,000

LARKIN COMPANY Income Statement
For the Year Ended December 31, 2008

Sales
Cost of goods sold Gross profit Selling expenses
Administrativeexpenses Incomefrom operations Interest expense Incomebefore income taxes Incometax expense
Net income

$20,000
16,000
$360,000
280,000 80,000

36,000 44,000
4,000 40,000
12,000 $ 28,000

The following additional data were provided:
1. Dividends declared and paid were $20,000.
2. During the year, equipment was sold for $12,000 cash. This equipment cost $28,000 originally and had a book value of $12,000 at the time of sale.
3. All depreciation expense is in the selling expense category. 4. All sales and purchases are on account.
5. Accounts payable pertain to merchandisesuppliers.
6. All operating expenses except for depreciation were paid in cash.

Instructions
Preparea statement of cash flows for Larkin Company using the direct method.

Ex. 175

Condensedfinancial data of Stiner Company appear below:

Cash Accountsreceivable Inventories
Prepaid expenses Investments
Plant assets Accumulateddepreciation
Total
STINER COMPANY ComparativeBalance Sheet December31

Assets

2008 2007

$ 71,000 $ 35,000 85,000 53,000 120,000 132,000 19,000 25,000 90,000 75,000 315,000 250,000
(65,000) (60,000) $635,000 $510,000

Accountspayable Accruedexpenses payable Bonds payable Commonstock Retainedearnings
Total
Liabilities and Stockholders’ Equity

$ 93,000 29,000 130,000 245,000
138,000 $635,000

$ 75,000 24,000 160,000 170,000
81,000 $510,000

STINERCOMPANY Income Statement
For the Year Ended December 31, 2008

Sales Less:
Cost of goods sold
Operatingexpenses (excluding depreciation) Depreciation expense
Incometaxes Interest expense
Loss on sale of plant assets Net income

$280,000 60,000 17,000 15,000 18,000
3,000
$470,000

393,000 $ 77,000

Additionalinformation:
1. New plant assets costing $90,000 were purchased for cash in 2008.
2. Old plant assets costing $25,000 were sold for $10,000 cash when book value was $13,000. 3. Bonds with a face value of $30,000 were converted into $30,000 of common stock.
4. A cash dividend of $20,000 was declared and paid during the year. 5. Accounts payable pertain to merchandise purchases.

Instructions

Preparea statement of cash flows for the year using the direct method.

Ex. 176

The income statement for Javier Company showed cost of goods sold of $95,000 and operating expenses of $50,000. The comparative balance sheets for the year show that inventory decreased $3,000, prepaid expenses increased $7,000, accounts payable increased $4,000, and accrued expenses payable decreased $5,000.

Instructions

Compute (a) cash payments to suppliers and (b) cash payments for operating expenses using the direct method.

COMPLETION STATEMENTS

177. A statement of cash flows summarizes the operating, , and activitiesof an entity.

178. The cash effects of selling goods and services appears in the activities section of a statement of cash flows.

179. The operating activities section of the statement of cash flows may be prepared using the

method or the method.

180. Net income from operations is generally not the same as cash provided from operations because revenues and expenses are recognized in the income statement on the
basis.

181. Using the indirect approach, noncash charges in the income statement are

to net income and noncash credits are to compute cash provided by operations.

182. If accounts receivable increase during a period, revenues on an accrual basis are

than revenues on a cash basis.

183. The sale of equipment at less than its book value is a(n) of cash that is reported in the activities section.

184. Free equals cash provided by operations less capital expenditures and cash dividends.

a185. Under the direct method, noncash charges, such as depreciation, are

in the statement of cash flows.

a186. Under the direct method, the two largest classes of items in the operating activities section for a merchandising company are cash and cash
.

a187. Cost of goods sold for the year amounted to $150,000, and during the year, accounts payable by $8,000 and inventory by $7,000 resulting in cash paid to suppliers of $135,000.

a188. In computing cash payments for operating expenses, a decrease in prepaid expenses is

and an increase in accrued expenses payable is to (from) operating expenses, exclusive of depreciation.

a189. In computing cash payments for income taxes, a decrease in income taxes payable is

to (from) income tax expense.

MATCHING

Set 1 — Indirect Method

190. For each of the following items, indicate by using the appropriate code letter, how the item should be reported in the statement of cash flows, using the indirect method.

A. Added to net income
B. Deducted from net income
C. Cash outflow—investing activity D. Cash inflow—investing activity E. Cash outflow—financing activity F. Cash inflow—financingactivity
G. Significant noncash investing and financing activity

1. Decreasein accounts payable during a period

2. Declarationand payment of a cash dividend.

3. Loss on sale of land.

4. Decreasein accounts receivable during a period.

5. Redemptionof bonds for cash.

6. Proceedsfrom sale of equipment at book value.

7. Issuanceof common stock for cash.

8. Purchaseof a building for cash.

9. Acquisitionof land in exchange for common stock.

10. Increasein merchandise inventory during a period.

Set 2 — Direct Method

a191. For each of the following items, indicate by using the appropriate code letter, how the item should be reported in the statement of cash flows, using the direct method.

A. Added in determining cash receipts from customers
B. Deducted in determining cash receipts from customers C. Added in determining cash payments to suppliers
D. Deducted in determining cash payments to suppliers E. Cash outflow—investing activity
F. Cash inflow—investingactivity G. Cash outflow—financing activity H. Cash inflow—financingactivity
I. Significant noncash investing and financing activity J. Is not shown

1. Decreasein accounts payable during a period.

2. Declarationand payment of a cash dividend.

3. Decreasein accounts receivable during a period.

4. Depreciation expense.

5. Conversionof bonds payable into common stock.

6. Decreasein merchandise inventory during a period.

7. Sale of equipment for cash at book value.

8. Issuanceof preferred stock for cash.

9. Purchaseof land for cash.

10. Loss on sale of a plant asset.

SHORT-ANSWERESSAY QUESTIONS
S-AE 192
The statement of cash flows is the only required financial statement that is not prepared from an adjusted trial balance. What are the sources of information for preparing a statement of cash flows? Explain how the accrual basis of accounting affects the statement of cash flows.

S-AE 193

Cash flows from operating activities can be calculated using the indirect or direct method. Briefly describe how the two methods differ yet arrive at the same information about the net cash flows from operating activities.

S-AE 194

How is it possible for a company to suffer a net loss for a given year, yet produce a positive net cash flow from operating activities?

S-AE 195 (Ethics)

Flint Hills Company’s most recent financial statements showed dismal performance. There was a net loss of $10,000 and the statement of cash flows showed a net cash decrease in all categories. The company president called all the managers together and asked them to do all they could to make sure the next quarter’s performance was better.

Mel Law, manager of the manufacturing division, sold off old manufacturing equipment. He also reclassified several workers to part time (30 hours per week) and hired additional temporary workers to take up the slack. This saved the company money, since part-time workers do not have the same insurance and other benefits as full-time workers.

John Reed, financial manager, immediately suspended payments on all accounts except those on which interest would accrue. He also instituted aggressive collection procedures.

Required:
1. Were Mel Law’s actions ethical? Explain.
2. Were John Reed’s actions ethical? Explain.
3. Were the company president’s actions ethical? Explain.

S-AE 196 (Communication)

You are the accountant for a small manufacturing firm. Your company is privately held, so there is no current requirement to issue financial statements using GAAP. You were hired four years ago, and at that time you instituted a cash budgeting system. Presently, you present a schedule of predicted cash sources and cash needs at the end of each week for the following week.
The Statement of Cash Flows 17 – 53

S-AE 196 (cont.)

Ken Harmon, the company’s president, has asked whether a statement of cash flows would also be useful.

Required:
Prepare a short memorandum to the president indicating whether you believe such an addition to the financial statements to be useful. Include in your memo the benefits that might be expected from a statement of cash flows and whether those are different from the benefits of a cash sourcesand cash needs listing.

CHAPTER 18

FINANCIALSTATEMENT ANALYSIS

CHAPTERSTUDY OBJECTIVES

1. Discuss the need for comparative analysis.

2. Identify the tools of financial statement analysis.

3. Explain and apply horizontal (trend) analysis.

4. Describe and apply vertical analysis.

5. Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency.

6. Understand the concept of earning power, and indicate how irregular items are presented.

7. Understand the concept of quality of earnings.

TRUE-FALSESTATEMENTS

1. Intracompany comparisons of the same financial statement items can often detect changes in financial relationships and significant trends.

2. Calculating financial ratios is a financial reporting requirement under generally accepted accounting principles.

3. Measures of a company’s liquidity are concerned with the frequency and amounts of dividend payments.

4. Analysis of financial statements is enhanced with the use of comparative data.

5. Comparisons of company data with industry averages can provide some insight into the company’s relative position in the industry.

6. Vertical and horizontal analyses are concerned with the format used to prepare financial statements.

7. Horizontal, vertical, and circular analyses are the most common tools of financial statement analysis.

8. Horizontal analysis is a technique for evaluating a financial statement item in the current year with other items in the current year.

9. Another name for trend analysis is horizontal analysis.

10. If a company has sales of $110 in 2008 and $154 in 2009, the percentage increase in sales from 2008 to 2009 is 140%.

11. In horizontal analysis, if an item has a negative amount in the base year, and a positive amount in the following year, no percentage change for that item can be computed.

12. Common size analysis expresses each item within a financial statement in terms of a percent of a base amount.

13. Vertical analysis is a more sophisticated analytical tool than horizontal analysis.

14. Vertical analysis is useful in making comparisonsof companies of different sizes.

15. Meaningful analysis of financial statements will include either horizontal or vertical analysis, but not both.

16. Using vertical analysis of the income statement, a company’s net income as a percentage of net sales is 10%; therefore, the cost of goods sold as a percentage of sales must be 90%.

17. In the vertical analysis of the income statement, each item is generally stated as a percentage of net income.

18. A ratio can be expressed as a percentage, a rate, or a proportion.

19. A solvency ratio measures the income or operating success of an enterprise for a given period of time.

20. The current ratio is a measure of all the ratios calculated for the current year.

21. Inventory turnover measures the number of times on the average the inventory was sold during the period.

22. Profitability ratios are frequently used as a basis for evaluating management’s operating effectiveness.

23. The rate of return on total assets will be greater than the rate of return on common stockholders’ equity if the company has been successful in trading on the equity at a gain.

24. From a creditor’s point of view, the higher the total debt to total assets ratio, the lower the risk that the company may be unable to pay its obligations.

25. A current ratio of 1.2 to 1 indicates that a company’s current assets exceed its current liabilities.

26. Using borrowed money to increase the rate of return on common stockholders’ equity is called “trading on the equity.”

27. When the disposal of a significant segment occurs, the income statement should report both income from continuing operations and income (loss) from discontinued operations.

28. An event or transaction should be classified as an extraordinary item if it is unusual in nature or if it occurs infrequently.

29. Variations among companies in the application of generally accepted accounting principles may reduce quality of earnings.

30. Pro forma income usually excludes items that the company thinks are unusual or nonrecurring.

Additional True-False Questions

31. The three basic tools of analysis are horizontal analysis, vertical analysis, and ratio analysis.

32. A percentage change can be computed only if the base amount is zero or positive.

33. In vertical analysis, the base amount in an income statement is usually net sales.

34. Profitability ratios measure the ability of the enterprise to survive over a long period of time.

35. The days in inventory is computed by multiplying inventory turnover by 365.

36. Extraordinary items are reported net of applicable taxes in a separate section of the income statement.

MULTIPLECHOICE QUESTIONS

37. Which one of the following is primarily interested in the liquidity of a company? a. Federal government
b. Stockholders
c. Long-term creditors d. Short-term creditors

38. Which one of the following is not a characteristic generally evaluated in analyzing financial statements?
a. Liquidity
b. Profitability c. Marketability d. Solvency

39. In analyzing the financial statements of a company, a single item on the financial statements
a. should be reported in bold-face type.
b. is more meaningful if compared to other financial information. c. is significant only if it is large.
d. should be accompanied by a footnote.

40. Short-term creditors are usually most interested in evaluating a. solvency.
b. liquidity.
c. marketability. d. profitability.

41. Long-term creditors are usually most interested in evaluating a. liquidity and solvency.
b. solvency and marketability. c. liquidity and profitability.
d. profitabilityand solvency.

42. Stockholders are most interested in evaluating a. liquidity and solvency.
b. profitabilityand solvency. c. liquidity and profitability.
d. marketability and solvency.
FinancialStatement Analysis 18 – 7

43. A stockholder is interested in the ability of a firm to a. pay consistent dividends.
b. appreciate in share price. c. survive over a long period. d. all of these.

44. Comparisons of financial data made within a company are called a. intracompanycomparisons.
b. interior comparisons.
c. intercompanycomparisons. d. intramural comparisons.

45. A technique for evaluating financial statements that expresses the relationship among selected items of financial statement data is
a. common size analysis. b. horizontal analysis.
c. ratio analysis.
d. vertical analysis.

46. Which one of the following is not a tool in financial statement analysis? a. Horizontal analysis
b. Circular analysis c. Vertical analysis d. Ratio analysis

47. In analyzing financial statements, horizontal analysis is a a. requirement.
b. tool.
c. principle. d. theory.

48. Horizontal analysis is also called a. linear analysis.
b. vertical analysis. c. trend analysis.
d. common size analysis.

49. Vertical analysis is also known as a. perpendicular analysis.
b. common size analysis. c. trend analysis.
d. straight-line analysis.

50. In ratio analysis, the ratios are never expressed as a a. rate.
b. negative figure. c. percentage.
d. simple proportion.
18 – 8

51. The formula for horizontal analysis of changes since the base period is the current year amount
a. divided by the base year amount.
b. minus the base year amount divided by the base year amount. c. minus the base year amount divided by the current year amount. d. plus the base year amount divided by the base year amount.

52. Horizontal analysis evaluates a series of financial statement data over a period of time a. that has been arranged from the highest number to the lowest number.
b. that has been arranged from the lowest number to the highest number. c. to determine which items are in error.
d. to determine the amount and/or percentage increase or decrease that has taken place.

53. Horizontal analysis evaluates financial statement data a. within a period of time.
b. over a period of time. c. on a certain date.
d. as it may appear in the future.

54. Assume the following sales data for a company:

2010 $1,000,000 2009 900,000 2008 750,000 2007 600,000

If 2007 is the base year, what is the percentage increase in sales from 2007 to 2009? a. 100%
b. 150% c. 50% d. 66.7%

55. Comparative balance sheets are usually prepared for a. one year.
b. two years. c. three years. d. four years.

56. Horizontal analysis is appropriately performed a. only on the income statement.
b. only on the balance sheet.
c. only on the statement of retained earnings. d. on all three of these statements.

57. A horizontal analysis performed on a statement of retained earnings would not show a percentage change in
a. dividends paid. b. net income.
c. expenses.
d. beginning retained earnings.
FinancialStatement Analysis 18 – 9

58. Under which of the following cases may a percentage change be computed? a. The trend of the balances is decreasing but all balances are positive.
b. There is no balance in the base year.
c. There is a positive balance in the base year and a negative balance in the subsequent year.
d. There is a negative balance in the base year and a positive balance in the subsequent year.

59. Assume the following sales data for a company:

2009 $945,000 2008 780,000 2007 650,000

If 2007 is the base year, what is the percentage increase in sales from 2007 to 2008? a. 25%
b. 20% c. 125% d. 143%

60. Assume the following cost of goods sold data for a company:

2009 $1,500,000 2008 1,200,000 2007 900,000

If 2007 is the base year, what is the percentage increase in cost of goods sold from 2007 to 2009?
a. 167% b. 67% c. 60% d. 40%

Use the following information for questions 61–62:

Moon Beam, Inc. has the following income statement (in millions):

MOON BEAM, INC. IncomeStatement
For the Year Ended December 31, 2008

Net Sales $180 Cost of Goods Sold 120 Gross Profit 60 OperatingExpenses 33 Net Income $ 27

61. Using vertical analysis, what percentage is assigned to Cost of Goods Sold? a. 67%
b. 33% c. 100%
d. None of the above
18 – 10

62. Using vertical analysis, what percentage is assigned to Net Income? a. 100%
b. 85% c. 15%
d. None of the above

63. Vertical analysis is also called a. common size analysis.
b. horizontal analysis. c. ratio analysis.
d. trend analysis.

64. Vertical analysis is a technique which expresses each item within a financial statement a. in dollars and cents.
b. in terms of a percentage of the item in the previous year. c. in terms of a percent of a base amount.
d. starting with the highest value down to the lowest value.

65. In common size analysis,
a. a base amount is required. b. a base amount is optional.
c. the same base is used across all financial statements analyzed.
d. the results of the horizontal analysis are necessary inputs for performing the analysis.

66. In performing a vertical analysis, the base for prepaid expenses is a. total current assets.
b. total assets.
c. total liabilities and stockholders’ equity. d. prepaid expenses.

67. In performing a vertical analysis, the base for sales revenues on the income statement is a. net sales.
b. sales.
c. net income.
d. cost of goods available for sale.

68. In performing a vertical analysis, the base for sales returns and allowances is a. sales.
b. sales discounts. c. net sales.
d. total revenues.

69. In performing a vertical analysis, the base for cost of goods sold is a. total selling expenses.
b. net sales.
c. total revenues. d. total expenses.
FinancialStatement Analysis 18 – 11

70. Each of the following is a liquidity ratio except the a. acid-test ratio.
b. current ratio.
c. debt to total assets ratio. d. inventory turnover.

71. A ratio calculated in the analysis of financial statements
a. expresses a mathematical relationship between two numbers. b. shows the percentage increase from one year to another.
c. restates all items on a financial statement in terms of dollars of the same purchasing power.
d. is meaningful only if the numerator is greater than the denominator.

72. A liquidity ratio measures the
a. income or operating success of an enterprise over a period of time. b. ability of the enterprise to survive over a long period of time.
c. short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash.
d. number of times interest is earned.

73. The current ratio is
a. calculated by dividing current liabilities by current assets.
b. used to evaluate a company’s liquidity and short-term debt paying ability. c. used to evaluate a company’s solvency and long-term debt paying ability. d. calculated by subtracting current liabilities from current assets.

74. The acid-test (quick) ratio
a. is used to quickly determine a company’s solvency and long-term debt paying ability. b. relates cash, short-term investments, and net receivables to current liabilities.
c. is calculated by taking one item from the income statement and one item from the balance sheet.
d. is the same as the current ratio except it is rounded to the nearest whole percent.

75. Walker Clothing Store had a balance in the Accounts Receivable account of $780,000 at the beginning of the year and a balance of $820,000 at the end of the year. Net credit sales during the year amounted to $8,000,000. The average collection period of the receivables in terms of days was
a. 30 days. b. 365 days. c. 10 days. d. 37 days.

76. Parr Hardware Store had net credit sales of $5,200,000 and cost of goods sold of $4,000,000 for the year. The Accounts Receivable balances at the beginning and end of the year were $600,000and $700,000, respectively. The receivables turnover was
a. 7.4 times. b. 8.7 times. c. 6.2 times. d. 8 times.
18 – 12

Use the following information for questions 77–78.

Waters Department Store had net credit sales of $12,000,000 and cost of goods sold of $9,000,000for the year. The average inventory for the year amounted to $2,000,000.

77. Inventory turnover for the year is a. 6 times.
b. 10.5 times. c. 4.5 times. d. 3 times.

78. The average number of days in inventory during the year was a. 122 days.
b. 81 days. c. 61 days. d. 35 days.

79. Each of the following is included in computing the acid-test ratio except a. cash.
b. inventory. c. receivables.
d. short-term investments.

80. Which one of the following would not be considered a liquidity ratio? a. Current ratio
b. Inventory turnover c. Acid-test ratio
d. Return on assets

81. Asset turnover measures
a. how often a company replaces its assets.
b. how efficiently a company uses its assets to generate sales. c. the portion of the assets that have been financed by creditors. d. the overall rate of return on assets.

82. Profit margin is calculated by dividing a. sales by cost of goods sold.
b. gross profit by net sales.
c. net income by stockholders’ equity. d. net income by net sales.

Use the following information for questions 83–84.

Raney Corporation had net income of $200,000 and paid dividends to common stockholders of $50,000 in 2008. The weighted average number of shares outstanding in 2008 was 50,000 shares. Raney Corporation’s common stock is selling for $40 per share on the New York Stock Exchange.

83. Raney Corporation’s price-earningsratio is a. 2.5 times.
b. 10 times. c. 13.3 times. d. 4 times.
FinancialStatement Analysis 18 – 13

84 Raney Corporation’s payout ratio for 2008 is a. $4 per share.
b 33.3%. c. 25%. d. 10%.

85 Holt Company reported the following on its income statement:

Incomebefore income taxes Incometax expense
Net income
$420,000
120,000 $300,000

An analysis of the income statement revealed that interest expense was $50,000. Holt Company’s times interest earned was
a. 9 times. b. 8 times. c. 7 times. d. 6 times.

86. The debt to total assets ratio measures a. the company’s profitability.
b. whether interest can be paid on debt in the current year. c. the proportion of interest paid relative to dividends paid. d. the percentage of the total assets provided by creditors.

87. Trading on the equity (leverage) refers to the a. amount of working capital.
b. amount of capital provided by owners.
c. use of borrowed money to increase the return to owners. d. number of times interest is earned.

88. The current assets of Kile Company are $150,000. The current liabilities are $120,000. The current ratio expressed as a proportion is
a. 125%. b. 1.25 : 1 c. .80 : 1
d. $150,000 ÷ $120,000.

89. The current ratio may also be referred to as the a. short run ratio.
b. acid-test ratio.
c. working capital ratio. d. contemporary ratio.

90. A weakness of the current ratio is a. the difficulty of the calculation.
b. that it doesn’t take into account the composition of the current assets. c. that it is rarely used by sophisticated analysts.
d. that it can be expressed as a percentage, as a rate, or as a proportion.
18 – 14

91. A supplier to a company would be most interested in the company’s a. asset turnover.
b. profit margin. c. current ratio.
d. earnings per share.

92. Which one of the following ratios would not likely be used by a short-term creditor in evaluating whether to sell on credit to a company?
a. Current ratio b. Acid-test ratio c. Asset turnover
d. Receivables turnover

93. Ratios are used as tools in financial analysis a. instead of horizontal and vertical analyses.
b. because they may provide information that is not apparent from inspection of the individual components of the ratio.
c. because even single ratios by themselves are quite meaningful. d. because they are prescribed by GAAP.

94. The ratios that are used to determine a company’s short-term debt paying ability are a. asset turnover, times interest earned, current ratio, and receivables turnover.
b. times interest earned, inventory turnover, current ratio, and receivables turnover. c. times interest earned, acid-test ratio, current ratio, and inventory turnover.
d. current ratio, acid-test ratio, receivables turnover, and inventory turnover.

95. A measure of the percentage of each dollar of sales that results in net income is a. profit margin.
b. return on assets.
c. return on common stockholders’ equity. d. earnings per share.

Use the following information for questions 96–97.

Risen Company had $250,000 of current assets and $90,000 of current liabilities before borrowing $50,000 from the bank with a 3-month note payable.

96. What effect did the borrowing transaction have on the amount of Risen Company’s working capital?
a. No effect
b. $50,000 increase c. $90,000 increase d. $50,000 decrease

97. What effect did the borrowing transaction have on Risen Company’s current ratio? a. The ratio remained unchanged.
b. The change in the current ratio cannot be determined. c. The ratio decreased.
d. The ratio increased.
FinancialStatement Analysis 18 – 15

98. If equal amounts are added to the numerator and the denominator of the current ratio, the ratio will always
a. increase. b. decrease.
c. stay the same. d. equal zero.

99. The acid-test ratio
a. is a quick calculation of an approximationof the current ratio. b. does not include all current liabilities in the calculation.
c. does not include inventory as part of the numerator.
d. does include prepaid expenses as part of the numerator.

100. If a company has an acid-test ratio of 1.2:1, what respective effects will the borrowing of cash by short-term debt and collection of accounts receivable have on the ratio?

Short-term Borrowing a. Increase
b. Increase c. Decrease d. Decrease
Collection of Receivable No effect Increase
No effect Decrease

101. A company has a receivables turnover of 10 times. The average netceivables during the period are $500,000. What is the amount of net credit sales for the period?
a. $50,000
b. $5,000,000 c. $600,000
d. Cannot be determined from the information given

102. If the average collection period is 35 days, what is the receivables turnover? a. 9.49 times
b. 10.43 times c. 5.22 times
d. None of these

103. A general rule to use in assessing the average collection period is that a. it should not exceed 30 days.
b. it can be any length as long as the customer continues to buy merchandise. c. it should not greatly exceed the discount period.
d. it should not greatly exceed the credit term period.

104. Inventory turnover is calculated by dividing
a. cost of goods sold by the ending inventory.
b. cost of goods sold by the beginning inventory. c. cost of goods sold by the average inventory. d. average inventory by cost of goods sold.

105. A company has an average inventory on hand of $100,000 and the days in inventory is 73 days. What is the cost of goods sold?
a. $500,000 b. $7,300,000 c. $1,000,000 d. $3,650,000
18 – 16

106. A successful grocery store would probably have a. a low inventory turnover.
b. a high inventory turnover. c. zero profit margin.
d. low volume.

107. An aircraft company would most likely have a. a high inventory turnover.
b. low profit margin. c. high volume.
d. a low inventory turnover.

108. Net sales are $4,500,000, beginning total assets are $2,100,000, and the asset turnover is 3.0 times. What is the ending total asset balance?
a. $1,500,000 b. $900,000 c. $2,100,000 d. $1,200,000

109. Earnings per share is calculated a. only for common stock.
b. only for preferred stock.
c. for common and preferred stock. d. only for treasury stock.

110. Which of the following is not a profitability ratio? a. Payout ratio
b. Profit margin
c. Times interest earned
d. Return on common stockholders’ equity

111. Times interest earned is also called the a. money multiplier.
b. interest coverage ratio. c. coupon coverage ratio. d. premium ratio.

112. The ratio that uses weighted average common shares outstanding in the denominator is the
a. price-earnings ratio.
b. return on common stockholders’ equity. c. earnings per share.
d. payout ratio.

113. Net income does not appear in the numerator of the a. profit margin.
b. return on assets.
c. return on common stockholders’ equity. d. payout ratio.
FinancialStatement Analysis 18 – 17

114. Fall Clothing Store had a balance in the Accounts Receivable account of $820,000 at the beginning of the year and a balance of $880,000 at the end of the year. Net credit sales during the year amounted to $6,120,000. The receivables turnover ratio was
a. 7.2 times. b. 7 times. c. 6.9 times. d. 6.8 times.

115. Fall Clothing Store had a balance in the Accounts Receivable account of $810,000 at the beginning of the year and a balance of $850,000 at the end of the year. Net credit sales during the year amounted to $5,814,980. The average collection period of the receivables in terms of days was
a. 50 days. b. 52.1 days. c. 365 days. d. 52.9 days.

Use the following information for questions 116–117.

Luthor Corporation had net income of $160,000 and paid dividends to common stockholders of $40,000 in 2008. The weighted average number of shares outstanding in 2008 was 50,000 shares. Luthor Corporation’s common stock is selling for $50 per share on the New York Stock Exchange.

116. Luthor Corporation’s price-earningsratio is a. 3.2 times.
b. 15.6 times. c. 10 times. d. 5 times.

117. Luthor Corporation’s payout ratio for 2008 is a. $5 per share.
b. 25%. c. 20%. d. 12.5%.

118. Raye Company reported the following on its income statement:

Incomebefore income taxes Incometax expense
Net income
$500,000
150,000 $350,000

An analysis of the income statement revealed that interest expense was $80,000. Raye Company’s times interest earned was
a. 8 times.
b. 7.25 times. c. 6.25 times. d. 4.4 times.
18 – 18

Use the following information for questions 119-125.

The following information pertains to Soho Company. Assume that all balance sheet amounts represent both average and ending balance figures. Assume that all sales were on credit.

Assets

Cash and short-term investments Accountsreceivable (net) Inventory
Property, plant and equipment Total Assets

Liabilities and Stockholders’ Equity Current liabilities
Long-termliabilities Stockholders’ equity—common
Total Liabilities and Stockholders’Equity

$ 40,000 25,000 20,000
210,000 $295,000

$ 60,000 85,000
150,000 $295,000

Sales
Cost of goods sold Gross margin Operatingexpenses
Net income
Income Statement
$ 85,000
45,000 40,000
20,000 $ 20,000

Numberof shares of common stock 6,000 Market price of common stock $20 Dividendsper share .90

119. What is the current ratio for this company? a. 1.42
b. .80 c. 1.16 d. .60

120. What is the receivables turnover for this company? a. 2.8 times
b. 2 times c. 3.4 times d. 3 times

121. What is the inventory turnover for this company? a. 2 times
b. 2.25 times c. 1 time
d. .44 times

122. What is the return on assets for this company? a. 6.8%
b. 10.5% c. 11.7% d. 26.7%
FinancialStatement Analysis 18 – 19

123. What is the profit margin for this company? a. 42.86%
b. 18.75% c. 23.5% d. 15.0%

124. What is the return on common stockholders’ equity for this company? a. 13.3%
b. 5%
c. 23.3% d. 53.3%

125. What is the price-earnings ratio for this company? a. 6 times
b. 2.5 times c. 8 times d. 4 times

Use the following information for questions 126–129.

The following information pertains to Cashe Company. Assume that all balance sheet amounts represent both average and ending balance figures. Assume that all sales were on credit.

Assets Cash and short-term investments Accountsreceivable (net)
Inventory
Property, plant and equipment Total Assets

$ 40,000 30,000 25,000
215,000 $310,000

Liabilities and Stockholders’ Equity Current liabilities
Long-termliabilities Stockholders’ equity—common
Total Liabilities and Stockholders’Equity

$ 60,000 95,000
155,000 $310,000

Sales
Cost of goods sold Gross margin Operatingexpenses
Net income
Income Statement
$ 90,000
45,000 45,000
20,000 $ 25,000

Numberof shares of common stock 6,000 Market price of common stock $20 Dividendsper share 1.00

126. What is the return on assets for this company? a. 6.8%
b. 10.5% c. 8.1% d. 16.1%
18 – 20

127. What is the profit margin for this company? a. 50.0%
b. 55.6% c. 23.5% d. 27.8%

128. What is the return on common stockholders’ equity for this company? a. 7.3%
b. 16.1% c. 23.5% d. 53.3%

129. What is the price-earnings ratio for this company? a. 6 times
b. 4.2 times c. 8 times d. 4.8 times

Use the following information for questions 130–131.

The following information is available for Charles Company:

Accountsreceivable Inventory
Net credit sales Cost of goods sold Net income
2008
$ 360,000 280,000 3,000,000 1,200,000 300,000
2007
$ 400,000 320,000 1,400,000 1,060,000 170,000

130. The receivables turnover ratio for 2008 is a. 8.3 times.
b. 3.9 times. c. 7.9 times. d. 10.0 times.

131. The inventory turnover ratio for 2008 is a. 4.3 times.
b. 4.0 times. c. 2.0 times. d. 2.4 times.

Use the following information for questions 132–134.

The following amounts were taken from the financial statements of Palmer Company:

Total assets Net sales Gross profit Net income
Weightedaverage number of common shares outstanding Market price of common stock
2008
$800,000 720,000 352,000 144,000 120,000 $36
2007
$1,000,000 650,000 320,000 117,000 120,000 $40
FinancialStatement Analysis 18 – 21

132. The return on assets ratio for 2008 is a. 18%.
b. 16%. c. 36%. d. 32%.

133. The profit margin ratio for 2008 is a. 10%.
b. 15%. c. 20%. d. 30%.

134. The price-earnings ratio for 2008 is a. 30 times.
b. 20 times. c. 10 times. d. 5 times.

Use the following information for questions 135–136.

Panza Corporation had net income of $250,000 and paid dividends to common stockholders of $50,000 in 2008. The weighted average number of shares outstanding in 2008 was 50,000 shares. Panza Corporation’s common stock is selling for $40 per share on the New York Stock Exchange.

135. Panza Corporation’s price-earningsratio is a. 2 times.
b. 8 times. c. 10 times. d. 5 times.

136. Panza Corporation’s payout ratio for 2008 is a. $5 per share.
b. 25%. c. 20%. d. 12.5%.

137. Ester’s Bunny Barn has experienced a $40,000 loss due to tornado damage to its inventory. Tornados have never before occurred in this area. Assuming that the company’s tax rate is 30%, what amount will be reported for this loss on the income statement?
a. $40,000 b. $28,000 c. $12,000 d. $36,000

138. Wenger Company reported income before taxes of $600,000 and an extraordinary loss of $150,000. Assume that the company’s tax rate is 30%. What amounts will be reported on the income statement for income before irregular items and extraordinary items, respectively?
a. $420,000 and $150,000 b. $420,000 and $105,000 c. $495,000 and $150,000 d. $495,000 and $105,000
18 – 22

139. Kandy Kane Corporation has income before taxes of $400,000 and an extraordinary gain of $100,000. If the income tax rate is 25% on all items, the income statement should show income before irregular items and extraordinary items, respectively, of
a. $325,000 and $100,000. b. $325,000 and $75,000. c. $300,000 and $100,000. d. $300,000 and $75,000.

140. Hardy Inc. has an investment in available-for-sale securities of $50,000. This investment experienced an unrealized loss of $3,000 during the current year. Assuming a 35% tax rate, the effect of this loss on comprehensive income will be
a. no effect.
b. $50,000 increase. c. $17,500 decrease. d. $3,000 decrease.

141. The disposal of a significant segment of a business is called a. a change in accounting principle.
b. an extraordinary item. c. an other expense.
d. discontinued operations.

142. ABC Company reports income before income taxes of $1,800,000 and had an extra-ordinary loss of $600,000. If the tax rate is 30%,
a. the income before the extraordinary item is $1,440,000.
b. the extraordinary loss would be reported on the income statement at $600,000. c. the income before the extraordinary item is $1,260,000.
d. the extraordinary loss will be reported at $180,000.

143. Evers, Inc. disposes of an unprofitable segment of its business. The operation of the segment suffered a $240,000 loss in the year of disposal. The loss on disposal of the segment was $120,000. If the tax rate is 30%, and income before income taxes was $1,500,000,
a. the income tax expense on the income before discontinued operations is $342,000. b. the income from continuing operations is $1,050,000.
c. net income is $1,140,000.
d. the losses from discontinued operations are reported net of income taxes at $180,000.

144. Each of the following is an extraordinaryitem except the a. effects of major casualties, if rare in the area.
b. effects of a newly enacted law or regulation.
c. expropriation of property by a foreign government. d. losses attributable to labor strikes.

145. The discontinued operations section of the income statement refers to a. discontinuance of a product line.
b. the income or loss on products that have been completed and sold. c. obsolete equipment and discontinued inventory items.
d. the disposal of a significant segment of a business.
FinancialStatement Analysis 18 – 23

146. Which one of the following would be classified as an extraordinaryitem? a. Expropriation of property by a foreign government
b. Losses attributed to a labor strike c. Write-down of inventories
d. Gains or losses from sales of equipment

147. A loss on the write down of obsolete inventory should be reported as a. “other expenses and losses.”
b. part of discontinued operations. c. an operating expense.
d. an extraordinary item.

148. If an item meets one (but not both) of the criteria for an extraordinaryitem, it a. only needs to be disclosed in the footnotes of the financial statements.
b. may be treated as sales revenue (if it is a gain) and as an operating expense (if it is a loss).
c. is reported as an “other revenue or gain” or “other expense and loss,” net of tax.
d. is reported at its gross amount as an “other revenue or gain” or “other expense or loss.”

149. The order of presentation of nontypical items that may appear on the income statement is a. Extraordinaryitems, Discontinued operations, Other revenues and expenses.
b. Discontinued operations, Extraordinary items, Other revenues and expenses. c. Other revenues and expenses, Discontinued operations, Extraordinary items. d. Other revenues and expenses, Extraordinaryitems, Discontinuedoperations.

150. Each of the following is a factor affecting quality of earnings except a. alternative accounting methods.
b. improper recognition. c. pro forma income.
d. extraordinaryitems.

Additional Multiple Choice Questions

151. Comparisonscan be made on each of the following bases except a. industry averages.
b. intercompanybasis. c. intracompanybasis.
d. Each of these is a basis for comparison.

152. Comparisons of data within a company are an example of the following comparative basis:
a. Industry averages b. Intercompany
c. Intracompany d. Interregional
18 – 24

153. Silva Corporation reported net sales of $240,000, $420,000, and $540,000 in the years 2007, 2008, and 2009 respectively. If 2007 is the base year, what is the trend percentage for 2009?
a. 129% b. 135% c. 164% d. 225%

154. In vertical analysis, the base amount for each income statement item is a. gross profit.
b. net income. c. net sales. d. sales.

155. When performing vertical analysis, the base amount for administrative expense is generally
a. administrative expense in a previous year. b. net sales.
c. gross profit. d. fixed assets.

156. Ratios that measure the short-term ability of the company to pay its maturing obligations are
a. liquidity ratios.
b. profitability ratios. c. solvency ratios. d. trend ratios.

157. What type of ratios best measure the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash?
a. Leverage b. Solvency c. Profitability d. Liquidity

158. The acid-test ratio is also known as the a. current ratio.
b. quick ratio. c. fast ratio.
d. times interest earned ratio.

159. The debt to total assets ratio a. is a solvency ratio.
b. is computed by dividing total assets by total debt.
c. measures the total assets provided by stockholders. d. is a profitability ratio.

160. An extraordinaryitem is one that
a. occurs infrequently and is uncontrollable in nature. b. occurs infrequently and is unusual in nature.
c. is material and is unusual in nature.
d. is material and is uncontrollable in nature.
FinancialStatement Analysis 18 – 25

161. Galileo, Inc. decided on January 1 to discontinue its telescope manufacturing division. On July 1, the division’s assets with a book value of $630,000 are sold for $450,000. Operating income from January 1 to June 30 for the division amounted to $75,000. Ignoring income taxes, what total amount should be reported on Galileo’s income statement for the current year under the caption, Discontinued Operations?
a. $75,000
b. $105,000 loss c. $180,000 loss d. $255,000

162. When there has been a change in accounting principle,
a. the old principle should be used in reporting the results of operations for the current year.
b. the cumulative effect of the change should be reported in the current year’s retained earnings statement.
c. the change should be reported retroactively.
d. the new principle should be used un reporting the results of operations of the current year, but there is no change to prior years.

BRIEFEXERCISES
BE 163
The following items were taken from the financial statements of Horace, Inc., over a three-year period:

Item
Net Sales
Cost of Goods Sold Gross Profit
2009
$355,000
214,000 $141,000
2008
$336,000
206,000 $130,000
2007
$300,000
186,000 $114,000

Instructions
Computethe following for each of the above time periods. a. The amount and percentage change from 2007 to 2008. b. The amount and percentage change from 2008 to 2009.

BE 164

If Parthenon Company had net income of $672,300 in 2009 and it experienced a 20% increase in net income over 2008, what was its 2008 net income?

BE 165

Horizontal analysis (trend analysis) percentages for Vishnu Company’s sales, cost of goods sold, and expenses are listed here.

Horizontal Analysis 2009
Sales 98.2% Cost of goods sold 102.5 Expenses 108.6
2008 2007
104.8% 100.0% 98.0 100.0 96.4 100.0
FinancialStatement Analysis 18 – 27

BE 165 (cont.)

Instructions

Explain whether Vishnu’s net income increased, decreased, or remained unchanged over the 3-year period.

BE 166

Using the following operating data for Manchac Corporation, illustrate horizontal analysis.

Net sales
Cost of goods sold Operating expenses Net income
2008 2007
$350,000 $320,000 200,000 180,000 120,000 100,000 30,000 40,000

BE 167

Using the data presented for Manchac Company in BE 166, prepare a schedule showing a vertical analysis for 2008.

BE 168

Using these data from the comparative balance sheet of Luca Company, perform vertical analysis.

Accounts receivable Inventory
Total assets
December 31, 2009 $ 500,000
780,000 3,220,000
December 31, 2008 $ 400,000
600,000 2,800,000

BE 169

For each of the ratios listed below, indicate by the appropriate code letter, whether it is a liquidity ratio (L), a profitability ratio (P), or a solvency ratio (S).

1. Times interest earned ratio 2. Asset turnover
3. Receivables turnover

4. Debt to total assets ratio 5. Current ratio
6. Payout ratio

BE 170

Selected financial statement data for Meyer Company are presented below.

Cash
Short-term investments Accounts receivable Inventories
Total current liabilities
12/31/08 $ 10,000 15,000 60,000 75,000 110,000

Instructions
Compute the following ratios at December 31, 2008: (a) Current.
(b) Acid-test.

BE 171
Breaktown Company had net income of $152,000 and net sales of $625,000 in 2008. The company’s total assets for 2007/2008 averaged $3,900,000. Its common stockholders’ equity for the period averaged $2,340,000. Calculate (a) profit margin, (b) return on assets, and (c) return on common stockholders’ equity.

BE 172

Berman Company reported the following financial information:

Accounts receivable Net credit sales
12/31/08 $ 320,000
2,100,000
12/31/07 $ 360,000
2,420,000

Compute (a) the receivables turnover and (b) the average collection period for 2008.

BE 173

Prepare a partial income statement, beginning with income before income taxes using the following information for Slidell Corporation for the fiscal year ended December 31, 2008:

Sales Extraordinary loss
Selling and administrative expenses Cost of goods sold
Loss on sale of land
$800,000 100,000 180,000 500,000 25,000

Slidell Corporation is subject to a 30% income tax rate.

EXERCISES
Ex. 174
Selected financial information for Bradley Corporation is presented below.

Current assets Long-term liabilities Retained earnings
December 31, 2009 $ 60,000
100,000 115,000
December 31, 2008 $ 50,000
80,000 100,000

Instructions
Prepare a schedule showing a horizontal analysis for 2009 using 2008 as the base year.

Ex. 175

Comparative information taken from the Wells Company financial statements is shown below:

(a) Notes receivable (b) Accounts receivable (c) Retained earnings
(d) Income taxes payable (e) Sales
(f) Operating expenses
2009 2008
$ 20,000 $ -0-182,000 140,000
30,000 (40,000) 44,000 20,000 960,000 750,000 170,000 200,000

Instructions

Using horizontal analysis, show the percentage change from 2008 to 2009 with 2008 as the base year.

Ex. 176

Eaton Corporation had net income of $6,000,000 in 2007. Using 2007 as the base year, net income decreased by 70% in 2008 and increased by 140% in 2009.

Instructions

Compute the net income reported by Eaton Corporation for 2008 and 2009.

Ex. 177

The following items were taken from the financial statements of Ritz, Inc., over a four-year period:

Item
Net Sales
Cost of Goods Sold Gross Profit
2010
$800,000
560,000 $240,000
2009
$700,000
500,000 $200,000
2008
$550,000
420,000 $130,000
2007
$500,000
400,000 $100,000

Instructions
Using horizontal analysis and 2007 as the base year, compute the trend percentages for net sales, cost of goods sold, and gross profit. Explain whether the trends are favorable or unfavorable for each item.

Ex. 178

The comparative balance sheet of Greer Company appears below:

GREER COMPANY Comparative Balance Sheet December 31,
———————————————————————————————————————————

Assets 2009 2008
Current assets ………………………………………………………………………….. $ 330 $280 Plant assets ……………………………………………………………………………… 670 520 Total assets ……………………………………………………………………………… $1,000 $800

Liabilities and stockholders’ equity
Current liabilities ……………………………………………………………………….. $ 160 $120 Long-term debt …………………………………………………………………………. 240 160 Common stock …………………………………………………………………………. 340 320 Retained earnings …………………………………………………………………….. 260 200 Total liabilities and stockholders’ equity ………………………………….. $1,000 $800
FinancialStatement Analysis 18 – 33

Ex. 178 (cont.)

Instructions
(a) Using horizontal analysis, show the percentage change for each balance sheet item using 2008 as a base year.

(b) Using vertical analysis, prepare a common size comparative balance sheet.

Ex. 179

Using the following selected items from the comparative balance sheet of Anders Company, illustrate horizontal and vertical analysis.

Accounts Receivable Inventory
Total Assets
December 31, 2009 $ 900,000
975,000 4,000,000
December 31, 2008 $ 600,000
750,000 2,500,000

Ex. 180

Operating data for Manning Corporation are presented below.

Net sales
Cost of goods sold Operating expenses Net income
2008
$500,000 340,000 120,000 40,000

Instructions
Prepare a schedule showing a vertical analysis for 2008.

Ex. 181

The following information was taken from the financial statements of Lee Company:

Gross profit on sales …………………………………………………… Income before income taxes ………………………………………… Net income………………………………………………………………… Net income as a percentage of net sales………………………..
2009
$750,000 280,000 200,000 8%
2008
$800,000 230,000 180,000 9%

Instructions
(a) Compute the net sales for each year.
(b) Compute the cost of goods sold in dollars and as a percentage of net sales for each year. (c) Compute operating expenses in dollars and as a percentage of net sales for each year.
(Income taxes are not operating expenses).

Ex. 182

Selected financial statement data for Morton Company are presented below.

Cash
Short-term investments Receivables (net) Inventories
Total current liabilities
December 31, 2009 $ 20,000
25,000 100,000 85,000 100,000
December 31, 2008 $30,000
18,000 80,000 65,000 90,000

During 2009, net sales were $810,000, and cost of goods sold was $615,000.

Instructions
Compute the following ratios at December 31, 2009: (a) Current.
(b) Acid-test.
(c) Receivables turnover. (d) Inventory turnover.

Ex. 183

Selected information from the comparative financial statements of Fryman Company for the year ended December 31, appears below:
2009 2008
Accounts receivable (net) $ 180,000 $200,000 Inventory 140,000 160,000 Total assets 1,200,000 800,000 Current liabilities 140,000 110,000 Long-term debt 340,000 300,000 Net credit sales 1,520,000 700,000 Cost of goods sold 750,000 530,000 Interest expense 40,000 25,000 Income tax expense 60,000 29,000 Net income 160,000 85,000

Instructions
Answer the following questions relating to the year ended December 31, 2009. Show computa-tions.

1. Inventory turnover for 2009 is .

2. Times interest earned in 2009 is .

3. The debt to total assets ratio for 2009 is .

4. Receivables turnover for 2009 is .

5. Return on assets for 2009 is .

$750,000
————————————
Ex. 184

The financial statements of Dobson Company appear below:

DOBSON COMPANY Comparative Balance Sheet December 31,
———————————————————————————————————————————

Assets Cash……………………………………………………………………………………. Short-term investments………………………………………………………….. Accounts receivable (net) ………………………………………………………. Inventory……………………………………………………………………………… Property, plant and equipment (net) …………………………………………
Total assets …………………………………………………………………….

Liabilities and stockholders’ equity
Accounts payable………………………………………………………………….. Short-term notes payable……………………………………………………….. Bonds payable……………………………………………………………………… Common stock……………………………………………………………………… Retained earnings…………………………………………………………………. Total liabilities and stockholders’ equity……………………………….
2009
$ 35,000 15,000 50,000 50,000
250,000 $400,000

$ 10,000 40,000 88,000 160,000
102,000 $400,000
2008
$ 40,000 60,000 30,000 70,000
300,000 $500,000

$ 30,000 90,000 160,000 145,000
75,000 $500,000

DOBSON COMPANY Income Statement
For the Year Ended December 31, 2009

Net sales……………………………………………………………………………… Cost of goods sold………………………………………………………………… Gross profit ………………………………………………………………………….. Expenses
Interest expense………………………………………………………………. Selling expenses……………………………………………………………… Administrative expenses…………………………………………………… Total expenses…………………………………………………………… Income before income taxes…………………………………………………… Income tax expense………………………………………………………………. Net income……………………………………………………………………………

$12,000 40,000
59,000
$360,000
198,000 162,000

111,000 51,000
15,000 $ 36,000

Additional information:
a. Cash dividends of $9,000 were declared and paid in 2009.
b. Weighted-average number of shares of common stock outstanding during 2009 was 30,000 shares.
c. Market value of common stock on December 31, 2009, was $21 per share.
———— = 3
$50,000
$12,000
18 – 38

Ex. 184 (cont.)

Instructions
Using the financial statements and additional information, compute the following ratios for Coulter Company for 2009. Show all computations.
Computations

1. Current ratio .

2. Return on common stockholders’ equity .

3. Price-earnings ratio .

4. Acid-test ratio .

5. Receivables turnover .

6. Times interest earned .

7. Profit margin .

8. Days in inventory .

9. Payout ratio .

10. Return on assets .

Ex. 185

The following ratios have been computed for Pratt Company for 2009.

Profit margin
Times interest earned Receivables turnover Acid-test ratio Current ratio
Debt to total assets ratio
20% 15 times
5 times 1.60 : 1
3 : 1 26%

Pratt Company’s 2009 financial statements with missing information follow:

PRATT COMPANY Comparative Balance Sheet December 31,
———————————————————————————————————————————

Assets Cash………………………………………………………………………………. Short-term Investments…………………………………………………….. Accounts receivable (net) …………………………………………………. Inventory………………………………………………………………………… Property, plant, and equipment (net) …………………………………..
Total assets………………………………………………………………

Liabilities and stockholders’ equity
Accounts payable…………………………………………………………….. Short-term notes payable………………………………………………….. Bonds payable………………………………………………………………… Common stock………………………………………………………………… Retained earnings……………………………………………………………. Total liabilities and stockholders’ equity…………………………
2009
$ 25,000 15,000
? (6) ? (8)
200,000
$ ? (9)

$ ? (7) 35,000
? (10) 200,000
59,000
$ ? (11)
2008
$ 35,000 15,000 60,000 50,000
150,000 $310,000

$ 25,000 30,000 20,000 200,000
35,000 $310,000
18 – 40

Ex. 185 (cont.)

PRATT COMPANY Income Statement
For the Year Ended December 31, 2009 ———————————————————————————————————————————

Net sales ………………………………………………………………………… Cost of goods sold……………………………………………………………. Gross profit……………………………………………………………………… Expenses:
Depreciation expense………………………………………………….. Interest expense…………………………………………………………. Selling expenses………………………………………………………… Administrative expenses ……………………………………………… Total expenses……………………………………………………… Income before income taxes……………………………………………… Income tax expense……………………………………………………. Net income………………………………………………………………………
$250,000
125,000 125,000

$ ? (5) 5,000
10,000
15,000
? (4) ? (2)
? (3) $ ? (1)

Instructions

Use the above ratios and information from the Pratt Company financial statements to fill in the missing information on the financial statements. Follow the sequence indicated. Show computations that support your answers.

Ex. 186

Selected data for Nancy’s Store appear below.

Net sales
Cost of goods sold Inventory at end of year
Accounts receivable at end of year

2009 2008
$650,000 $520,000 455,000 345,000 65,000 85,000 80,000 50,000

Instructions
Compute the following for 2009: (a) Gross profit rate.
(b) Inventory turnover. (c) Receivables turnover.

Ex. 187

Selected financial statement data for Holmes Company are presented below.

Net sales
Cost of goods sold Interest expense Net income
Total assets (ending)
Total common stockholders’ equity (ending)
$1,200,000 700,000 10,000 180,000 850,000 650,000

Total assets at the beginning of the year were $750,000; total common stockholders’ equity was $550,000 at the beginning of the period.

Instructions
Compute each of the following: (a) Asset turnover
(b) Profit margin
(c) Return on assets
(d) Return on common stockholders’ equity

Ex. 188

Winter Corporation has issued common stock only. The company has been successful and has a gross profit rate of 20%. The information shown below was taken from the company’s financial statements.

Beginning inventory Purchases
Ending inventory
Average accounts receivable
Average common stockholders’ equity Sales (all on credit)
Net income
$ 482,000 5,636,000
? 700,000
3,500,000 7,000,000 525,000

Instructions
Compute the following:
(a) Receivables turnover and the average collection period. (b) Inventory turnover and the days in inventory.
(c) Return on common stockholders’ equity.

Ex. 189

Boyle Corporation had the following comparative current assets and current liabilities:

Current assets Cash
Short-term investments Accounts receivable Inventory
Prepaid expenses Total current assets

Current liabilities Accounts payable Salaries payable Income tax payable
Total current liabilities
Dec. 31, 2009

$ 20,000 40,000 55,000 110,000
35,000 $260,000

$140,000 40,000
20,000 $200,000
Dec. 31, 2008

$ 30,000 10,000 95,000 90,000
20,000 $245,000

$110,000 30,000
15,000 $155,000

During 2009, credit sales and cost of goods sold were $600,000 and $350,000, respectively.

Instructions
Compute the following liquidity measures for 2009: 1. Current ratio.
2. Working capital. 3. Acid-test ratio.
4. Receivables turnover. 5. Inventory turnover.

Ex. 190

Selected data from Oates Company are presented below:

Total assets Average assets Net income Net sales
Average common stockholders’ equity
$1,600,000 1,750,000 175,000 1,225,000 1,000,000

Instructions
Calculate the profitability ratios that can be computed from the above information.

Ex. 191

The following data are taken from the financial statements of Doyle Company:

Monthly average accounts receivable Net sales on account
Terms for all sales are 2/10, n/30
2009
$ 520,000 5,460,000
2008
$ 500,000 4,500,000

Instructions
(a) Compute the receivables turnover and the average collection period for both years.
(b) What conclusion can an analyst draw about the management of the accounts receivable?
—————
—————
FinancialStatement Analysis 18 – 47

Ex. 192

State the effect of the following transactions on the current ratio. Use increase, decrease, or no effect for your answer.

(a) Collection of an accounts receivable. (b) Declaration of cash dividends.
(c) Additional stock is sold for cash.

(d) Short-term investments are purchased for cash. (e) Equipment is purchased for cash.
(f) Inventory purchases are made for cash. (g) Accounts payable are paid.

Ex. 193

The balance sheet for Farley Corporation at the end of the current year indicates the following:

Bonds payable, 7% …………………………………………………….. 6% Preferred stock, $100 par……………………………………….. Common stock, $10 par……………………………………………….
$4,000,000 1,000,000 3,000,000

Income before income taxes was $1,120,000 and income taxes expense for the current year amounted to $336,000. Cash dividends paid on common stock were $300,000, and the common stock was selling for $45 per share at the end of the year. There were no ownership changes during the year.

Instructions
Determine each of the following:
(a) times that bond interest was earned. (b) earnings per share for common stock. (c) price-earnings ratio.

Ex. 194

The income statement for Stoval Company for the year ended December 31, 2008 appears below.

Sales
Cost of goods sold Gross profit Expenses
Net income
$610,000
380,000 230,000
170,000* $ 60,000

*Includes $30,000 of interest expense and $18,000 of income tax expense.
—————————————

Ex. 194 (cont.) Additional information:
1. Common stock outstanding on January 1, 2008 was 40,000 shares. On July 1, 2008, 10,000 more shares were issued.

2. The market price of Stoval’s stock was $15 at the end of 2008.

3. Cash dividends of $30,000 were paid, $6,000 of which were paid to preferred stockholders.

Instructions
Compute the following ratios for 2008: (a) earnings per share.
(b) price-earnings.
(c) times interest earned.

$60,000 – $6,000 54,000

Ex. 195

Gumble Corporation had income from continuing operations of $300,000 for the year ended December 31, 2008. It also had the following items (before income taxes):
1. Extraordinary flood loss of $150,000.
2. Loss of $60,000 on discontinuance of a division.

All items are subject to income taxes at a 30% tax rate.

Instructions
Prepare a partial income statement, beginning with income from continuing operations.

Ex. 196

Lawrenz Corporation gathered the following information for the fiscal year ended December 31, 2008:
Sales $1,400,000 Extraordinary fire loss 140,000 Selling and administrative expenses 160,000 Cost of goods sold 900,000 Loss on sale of equipment 40,000

Lawrenz Corporation is subject to a 30% income tax rate.

Instructions

Prepare a partial income statement, beginning with income before income taxes.

Ex. 197

Dennehy Corporation had the information listed below available in preparing an income statement for the year ended December 31, 2008. All amounts are before income taxes. Assume a 30% income tax rate for all items.

Sales
Expropriation of property by a foreign government (loss) Income from operation of discontinued cement division Loss from disposal of cement division
Operating expenses
Gain on sale of equipment Cost of goods sold
$ 600,000 $(120,000) $ 100,000 $ (80,000) $ 125,000 $ 85,000 $ 360,000
FinancialStatement Analysis 18 – 51

Ex. 197 (cont.)

Instructions
Prepare a multiple-step income statement in good form which takes into account intraperiod income tax allocation. Ignore EPS computations.

Ex. 198

Indicate whether the following items would be reported as an ordinary or an extraordinary item in Logan Corporation’s income statement.

(a) Loss attributable to labor strike. (b) Gain on sale of fixed assets.
(c) Loss from fire. Logan is a chemical company. (d) Loss from sale of short-term investments.
(e) Expropriation of property by a foreign government.

(f) Loss from tornado damage. Logan Corporation is located in the Midwest’s tornado alley. (g) Loss from government condemnation of property through newly enacted law.

Ex. 199

Potter Company has income from continuing operations of $480,000 for the year ended December 31, 2008. It also has the following items (before considering income taxes):

(1) An extraordinary fire loss of $180,000.

(2) A gain of $110,000 on the discontinuance of a major segment.

(3) A correction of an error in last year’s financial statement that resulted in a $100,000 overstatement of 2007 net income.

Assume all items are subject to income taxes at a 30% tax rate.

Instructions

(a) Prepare an income statement, beginning with income from continuing operations. (b) Indicate the statement presentation of any item not included in (a) above.

COMPLETION STATEMENTS

200. In analyzing and interpreting financial statement information, three major characteristics are generally evaluated: (1) , (2) , and (3) .

201. analysis, also called trend analysis, is a technique for evaluating a percentage increase or decrease for a financial statement item over a period of time.

202. Expressing each item within a financial statement as a percentage of a base amount is called analysis.

203. The ratios used in evaluating a company’s liquidity and short-term debt paying ability that complement each other are the ratio and the ratio.

204. The receivables turnover is calculated by dividing by average

.

205. If inventory turnover is 5 times, and the average inventory was $400,000, the cost of goods sold during the year was $ and the days in inventory was
days.

206. Hansen Corporation had net income for the year of $300,000 and a profit margin of 25%. If total average assets were $400,000, the asset turnover ratio was times.

207. The ratio measures the percentage of earnings distributed in the form of cash dividends.

208. The lower the to ratio, the more equity “buffer” there is available to the creditors.

209. Times interest earned is calculated by dividing before

and by interest expense.

210. Discontinued operations refers to the disposal of a of a business.

211. The two criteria necessary for an item to be classified as an extraordinary item are that the transaction or event must be (1) and (2) .

212. A change in inventory methods during the year would be classified as a change in

.

MATCHING

SET A

213. For each of the ratios listed below, indicate by the appropriate code letter, whether it is a liquidity ratio, a profitability ratio, or a solvency ratio.

Code:
L = Liquidity ratio
P = Profitability ratio S = Solvency ratio

1. Price-earnings ratio

2. Asset turnover

3. Receivables turnover

4. Earnings per share

5. Payout ratio

6. Current ratio

7. Acid-test ratio

8. Debt to total assets ratio

9. Times interest earned

10. Inventory turnover

SET B

214. Match the ratios with the appropriate ratio computation by entering the appropriate letter in the space provided.

A. Current ratio B. Acid-test ratio C. Profit margin D. Asset turnover
E. Price-earnings ratio
F. Times interest earned G. Inventory turnover
H. Average collection period I. Days in inventory
J. Payout ratio

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.
Cost of goods sold Average inventory

—————
Net income Net sales

———————
Cash dividends Net income

———————
Net sales Average assets

————————
Current assets Current liabilities

——————————
365 days Receivables turnover

——————————————
Market price per share of stock Earnings per share

————————
365 days Inventory turnover

——————————————————————
Income before income taxes and interest expense Interest expense

Cash + short-term investments + receivables (net)

Current liabilities

SHORT-ANSWERESSAY QUESTIONS
S-AE 215
Horizontal and vertical analyses are analytical tools frequently used to analyze financial statements. What type of information or insights can be obtained by using these two techniques? Explain how the output of horizontal analysis and vertical analysis can be compared to industry averages and/or competitive companies.

S-AE 216

Manuel Mentirosa, the CEO of Mystical Products, is a successful entrepreneur but a poor student of accounting. He asks you to explain to him, in a memo, the bases of comparison for ratio analysis.

S-AE 217 (Ethics)

A trusted employee of Wilderness Tours was caught in the act of embezzling funds. He confessed to earlier embezzlements, but retracted the confession on the advice of his attorney. Over the course of the most recent quarter, it has been determined that $20,000 was embezzled.

Wilderness Tours has suffered adverse publicity in the recent past because of serious injury to five tourists that occurred during a two week “Winter Wilds Adventure” tour. The company has therefore decided to avoid publicity and has agreed to drop all charges against the embezzling employee. In return, the employee has agreed to a notation of “Terminated—Not to be Rehired” to be appended to his personnel file.

Required:
1. Who are the stakeholders in the decision not to prosecute?

2. Was it ethical for the company to decide not to prosecute? Explain.

S-AE 218 (Communication)

Kwik Express specializes in the overnight transportation of medical equipment and laboratory specimens. The company has selected the following information from its most recent annual report to be the subject of an immediate press release.
• The financial statements are being released.
• Net income this year was $2.2 million. Last year’s net income had been $2.0 million. • The current ratio has changed to 2:1 from last year’s 1.5:1
• The debt/total assets ratio has changed to 4:5 from last year’s 3:5
• The company expanded its truck fleet substantially by purchasing ten new delivery vans. The company already had twelve delivery vans.
• The company is now the largest medical courier in the mid-Atlantic region.

Required:

Prepare a brief press release incorporating the information above. Include all information. Think
carefully which information (if any) is good news for thetcompany, and which (if any) is bad news.

CHAPTER 19

MANAGERIALACCOUNTING

CHAPTERSTUDY OBJECTIVES

1. Explain the distinguishing features of managerial accounting.

2. Identify the three broad functions of management.

3. Define the three classes of manufacturing costs.

4. Distinguish between product and period costs.

5. Explain the difference between a merchandising and a manufacturing income statement.

6. Indicate how cost of goods manufactured is determined.

7. Explain the difference between a merchandising and a manufacturing balance sheet.

TRUE-FALSESTATEMENTS

1. Reports prepared in financial accounting are general-purpose reports, whereas reports prepared in managerial accounting are usually special-purpose reports.

2. Managerial accounting information generally pertains to an entity as a whole and is highly aggregated.

3. Managerial accounting applies to all forms of business organizations.

4. Determining the unit cost of manufacturing a product is an output of financial accounting.

5. Managerial accounting internal reports are prepared more frequently than are classified financial statements.

6. The management function of organizing and directing is mainly concerned with setting goals and objectives for the entity.

7. The Sarbanes-Oxley Act replaces generally accepted accounting principles in a manufacturing company.

8. Controlling is the process of determining whether planned goals are being met.

9. Decision-makingis an integral part of the planning, directing, and controlling functions.

10. Both direct labor cost and indirect labor cost are product costs.

11. Manufacturing costs that cannot be classified as direct materials or direct labor are classified as manufacturing overhead.

12. Raw materials are equal to direct materials minus indirect materials.

13. Raw materials that can be conveniently and directly associated with a finished product are called materials overhead.

14. The total cost of a finished product does not generally contain equal amounts of materials, labor, and overhead costs.

15. Direct materials costs and indirect materials costs are manufacturing overhead.

16. Period costs include selling and administrative expenses.

17. Indirect materials and indirect labor are both inventoriable costs.

18. Direct materials and direct labor are the only product costs.

19. Total period costs are deducted from total cost of work in process to calculate cost of goods manufactured.

20. Period costs are not inventoriable costs.

21. Ending finished goods inventory appears on both the balance sheet and the income statement of a manufacturing company.

22. The beginning work in process inventory appears on both the balance sheet and the cost of goods manufactured schedule of a manufacturing company.

23. In calculating gross profit for a manufacturing company, the cost of goods manufactured is deducted from net sales.

24. Finished goods inventory does not appear on a cost of goods manufactured schedule.

25. If the ending work in process inventory is greater than the beginning work in process inventory, then the cost of goods manufactured will be less than total manufacturing costs for the period.

26. Finished goods inventory for a manufacturing company is equivalent to merchandise inventory for a merchandising company.

27. Raw materials inventory is not an asset until it is used to make a product.

28. Raw materials inventory shows the cost of completed goods available for sale to customers.

29. The supply chain is all the activities associated with providing a product or service.

30. Many companies have significantly lowered inventory levels and costs using just-in-time inventory methods.

Additional True-False Questions

31. Managerial accounting is primarily concerned with managers and external users.

32. Planning involves coordinating the diverse activities and human resources of a company to produce a smooth running operation.

33. When the physical association of raw materials with the finished product is too small to trace in terms of cost, they are usually classified as indirect materials.

34. Product costs are also called inventoriable costs.

35. Direct materials become a cost of the finished goods manufactured when they are acquired, not when they are used.

36. The sum of the direct materials costs, direct labor costs, and beginning work in process is the total manufacturingcosts for the year.

37. In a manufacturing company balance sheet, manufacturing inventories are reported in the current assets section in the order of their expected use in production.

MULTIPLECHOICE QUESTIONS

38. Managerial accounting applies to each of the following types of businesses except a. service firms.
b. merchandisingfirms. c. manufacturingfirms.
d. Managerial accounting applies to all types of firms.

39. Managerial accounting information is generally prepared for a. stockholders.
b. creditors. c. managers.
d. regulatory agencies.

40. Managerial accounting information
a. pertains to the entity as a whole and is highly aggregated. b. pertains to subunits of the entity and may be very detailed. c. is prepared only once a year.
d. is constrained by the requirements of generally accepted accounting principles.

41. The major reporting standard for presenting managerial accounting information is a. relevance.
b. generally accepted accounting principles. c. the cost principle.
d. the current tax law.

42. Managerial accounting is also called a. management accounting.
b. controlling.
c. analytical accounting. d. inside reporting.

43. Which of the following is not an internal user? a. Creditor
b. Department manager c. Controller
d. Treasurer
ManagerialAccounting 19 – 7

44. Managerial accounting does not encompass a. calculating product cost.
b. calculating earnings per share. c. determining cost behavior.
d. profit planning.

45. Managerial accounting is applicable to a. service entities.
b. manufacturing entities. c. not-for-profit entities. d. all of these.

46. Management accountants would not a. assist in budget planning.
b. prepare reports primarily for external users. c. determine cost behavior.
d. be concerned with the impact of cost and volume on profits.

47. Internal reports must be communicated a. daily.
b. monthly. c. annually.
d. as needed.

48. Financial statements for external users can be described as a. user-specific.
b. general-purpose. c. special-purpose.
d. managerial reports.

49. Managerial accounting reports can be described as a. general-purpose.
b. macro-reports. c. special-purpose.
d. classified financial statements.

50. The reporting standard for external financial reports is a. industry-specific.
b. company-specific.
c. generally accepted accounting principles. d. department-specific.

51. Which of the following statements about internal reports is not true?
a. The content of internal reports may extend beyond the double-entry accounting system.
b. Internal reports may show all amounts at market values. c. Internal reports may discuss prospective events.
d. Most internal reports are summarized rather than detailed.
19 – 8

52. In an analogous sense, external user is to internal user as generally accepted accounting principles are to
a. timely.
b. special-purpose.
c. relevance to decision. d. SEC.

53. Internal reports are generally a. aggregated.
b. detailed. c. regulated. d. unreliable.

54. A distinguishingfeature of managerial accounting is a. external users.
b. general-purposereports. c. very detailed reports.
d. quarterly and annual reports.

55. What activities and responsibilities are not associated with management’sfunctions? a. Planning
b. Accountability c. Controlling
d. Directing

56. Planning is a function that involves
a. hiring the right people for a particular job.
b. coordinating the accounting information system. c. setting goals and objectives for an entity.
d. analyzing financial statements.

57. The managerial function of controlling
a. is performed only by the controller of a company.
b. is only applicable when the company sustains a loss.
c. is concerned mainly with operating a manufacturing segment. d. includes performance evaluation by management.

58. Which of the following is not a managementfunction? a. Constraining
b. Planning c. Controlling d. Directing

59. A manager that is establishing objectives is performing which management function? a. Controlling
b. Directing c. Planning
d. Constraining
ManagerialAccounting 19 – 9

60. The management function that requires managers to look ahead and establish objectives is
a. controlling. b. directing. c. planning.
d. constraining.

61. In determining whether planned goals are being met, a manager is performing the function of
a. planning. b. follow-up. c. directing. d. controlling.

62. Which of the following is not a separate management function? a. Planning
b. Directing
c. Decision-making d. Controlling

63. Directing includes
a. providing a framework for management to have criteria to terminate employees when needed.
b. running a department under quality control standards universally accepted.
c. coordinating a company’s diverse activities and human resources to produce a smooth-running operation.
d. developing a complex performance ranking system to give certain high performers good raises.

64. Both direct materials and indirect materials are a. raw materials.
b. manufacturing overhead. c. merchandise inventory.
d. sold directly to customers by a manufacturing company.

65. The work of factory employees that can be physically and directly associated with converting raw materials into finished goods is
a. manufacturing overhead. b. indirect materials.
c. indirect labor. d. direct labor.

66. Which one of the following would not be classified as manufacturing overhead? a. Indirect labor
b. Direct materials
c. Insurance on factory building d. Indirect materials

67. Manufacturing costs include
a. direct materials and direct labor only.
b. direct materials and manufacturing overhead only. c. direct labor and manufacturing overhead only.
d. direct materials, direct labor, and manufacturing overhead.
19 – 10

68. Which one of the following is not a direct material? a. A tire used for a lawn mower
b. Plastic used in the covered case for a home PC
c. Steel used in the manufacturing of steel-radial tires d. Lubricant for a ball-bearing joint for a large crane

69. Which one of the following is not a cost element in manufacturing a product? a. Manufacturing overhead
b. Direct materials c. Office salaries d. Direct labor

70. A manufacturing process requires small amounts of glue. The glue used in the production process is classified as a(n)
a. period cost.
b. indirect material. c. direct material.
d. miscellaneous expense.

71. The wages of a timekeeper in the factory would be classified as a. a period cost.
b. direct labor. c. indirect labor.
d. compliance costs.

72. Which one of the following is not considered as material costs? a. Partially completed motor engines for a motorcycle plant
b. Bolts used in manufacturing the compressor of an engine c. Rivets for the wings of a new commercial jet aircraft
d. Lumber used to build tables

73. Which of the following is not a manufacturing cost category? a. Cost of goods sold
b. Direct materials c. Direct labor
d. Manufacturing overhead

74. As current technology changes manufacturing processes, it is likely that direct a. labor will increase.
b. labor will decrease.
c. materials will increase. d. materials will decrease.

75. For the work of factory employees to be considered as direct labor, the work must be conveniently and
a. materially associated with raw materials conversion. b. periodically associated with raw materials conversion. c. physically associated with raw materials conversion. d. promptly associated with raw materials conversion.
ManagerialAccounting 19 – 11

76. Which of the following is not classified as direct labor? a. Bottlers of beer in a brewery
b. Copy machine operators at a copy shop c. Wages of supervisors
d. Bakers in a bakery

77. Cotter pins and lubricants used irregularly in a production process are classified as a. miscellaneous expense.
b. direct materials. c. indirect materials.
d. nonmaterial materials.

78. Which of the following is not another name for the term manufacturing overhead? a. Factory overhead
b. Pervasive costs c. Burden
d. Indirect manufacturing costs

79. Because of automation, which component of product cost is declining? a. Direct labor
b. Direct materials
c. Manufacturing overhead d. Advertising

80. The product cost that is most difficult to associate with a product is a. direct materials.
b. direct labor.
c. manufacturing overhead. d. advertising.

81. Manufacturing costs that cannot be classified as either direct materials or direct labor are known as
a. period costs.
b. nonmanufacturingcosts.
c. selling and administrative expenses. d. manufacturing overhead.

82. Which one of the following is an example of a period cost?
a. A change in benefits for the union workers who work in the New York plant of a Fortune1000 manufacturer
b. Workers’ compensation insurance on factory workers’ wages allocated to the factory c. A box cost associated with computers
d. A manager’s salary for work that is done in the corporate head office

83. Which one of the following costs would not be inventoriable? a. Period costs
b. Factory insurance costs c. Indirect materials
d. Indirect labor costs
19 – 12

84. Direct materials and direct labor of a company total $6,000,000. If manufacturing overhead is $3,000,000,what is direct labor cost?
a. $3,000,000 b. $6,000,000 c. $0
d. Cannot be determined from the information provided

85. Which of the following are period costs? a. Raw materials
b. Direct materials and direct labor
c. Direct labor and manufacturing overhead d. Selling expenses

86. Sales commissions are classified as a. overhead costs
b. period costs. c. product costs. d. indirect labor.

87. Product costs consist of
a. direct materials and direct labor only.
b. direct materials, direct labor, and manufacturing overhead. c. selling and administrative expenses.
d. period costs.

88. Which one of the following represents a period cost? a. The VP of Sales’ salary and benefits
b. Overhead allocated to the manufacturing operations c. Labor costs associated with quality control
d. Fringe benefits associated with factory workers

89. Product costs are also called a. direct costs.
b. overhead costs.
c. inventoriable costs. d. capitalizable costs.

90. For inventoriable costs to become expenses under the matching principle, a. the product must be finished and in stock.
b. the product must be expensed based on its percentage-of-completion. c. the product to which they attach must be sold.
d. all accounts payable must be settled.

91. As inventoriable costs expire, they become a. selling expenses.
b. gross profit.
c. cost of goods sold. d. sales revenue.
ManagerialAccounting 19 – 13

92. A manufacturing company calculates cost of goods sold as follows:
a. Beginning FG inventory + cost of goods purchased – ending FG inventory.
b. Ending FG inventory – cost of goods manufactured + beginning FG inventory. c. Beginning FG inventory – cost of goods manufactured – ending FG inventory. d. Beginning FG inventory + cost of goods manufactured – ending FG inventory.

93. A manufacturing company reports cost of goods manufactured as a(n) a. current asset on the balance sheet.
b. administrative expense on the income statement.
c. component in the calculation of cost of goods sold on the income statement. d. component of the raw materials inventory on the balance sheet.

94. The subtotal, “Cost of goods manufactured” appears on a. a merchandising company’s income statement.
b. a manufacturing company’s income statement.
c. both a manufacturing and a merchandising company’s income statement. d. neither a merchandising nor a manufacturing company’s income statement.

95. Cost of goods manufactured in a manufacturingcompany is analogousto a. Ending inventory in a merchandising company.
b. Beginning inventory in a merchandising company.
c. Cost of goods available for sale in a merchandising company. d. Cost of goods purchased in a merchandising company.

96. Cost of goods sold
a. only appears on merchandising companies’ income statements. b. only appears on manufacturingcompanies’ income statements.
c. appears on both manufacturing and merchandising companies’ income statements. d. is calculated exactly the same for merchandising and manufacturing companies.

97. Hollern Combines, Inc. has $10,000 of ending finished goods inventory as of December 31, 2008. If beginning finished goods inventory was $5,000 and cost of goods sold was $20,000,how much would Hollern report for cost of goods manufactured?
a. $22,500 b. $5,000 c. $25,000 d. $15,000

98. Cost of goods manufactured is calculated as follows:
a. Beginning WIP + direct materials used + direct labor + manufacturing overhead + endingWIP.
b. Direct materials used + direct labor + manufacturing overhead – beginning WIP + endingWIP.
c. Beginning WIP + direct materials used + direct labor + manufacturing overhead – endingWIP.
d. Direct materials used + direct labor + manufacturing overhead – ending WIP – beginningWIP.
19 – 14

99. If the amount of “Cost of goods manufactured” during a period exceeds the amount of “Total manufacturing costs” for the period, then
a. ending work in process inventory is greater than or equal to the amount of the beginning work in process inventory.
b. ending work in process is greater than the amount of the beginning work in process inventory.
c. ending work in process is equal to the cost of goods manufactured.
d. ending work in process is less than the amount of the beginning work in process inventory.

100. On the costs of goods manufactured schedule, depreciation on factory equipment
a. is not listed because it is included with Depreciation Expense on the income statement.
b. appears in the manufacturing overhead section. c. is not listed because it is not a product cost.
d. is not an inventoriable cost.

101. On the costs of goods manufactured schedule, the item raw materials inventory (ending) appearsas a(n)
a. addition to raw materials purchases.
b. addition to raw materials available for use.
c. subtractionfrom raw materials available for use. d. subtraction from raw materials purchases.

Use the following information for questions 102–104.

Carly Manufacturing Company’s accounting records reflect the following inventories:

Raw materials inventory Work in process inventory Finishedgoods inventory
Dec. 31, 2008 $310,000
300,000 190,000
Dec. 31, 2007 $260,000
160,000 150,000

During 2008, $500,000 of raw materials were purchased, direct labor costs amounted to $600,000,and manufacturing overhead incurred was $480,000.

102. The total raw materials available for use during 2008 for Carly Manufacturing Company is a. $810,000.
b. $260,000. c. $450,000. d. $760,000.

103. Carly Manufacturing Company’s total manufacturing costs incurred in 2008 amounted to a. $1,530,000.
b. $1,490,000. c. $1,390,000. d. $1,580,000.

104. If Carly Manufacturing Company’s cost of goods manufactured for 2008 amounted to $1,390,000,its cost of goods sold for the year is
a. $1,500,000. b. $1,250,000. c. $1,350,000. d. $1,430,000.
ManagerialAccounting 19 – 15

105. What is work in process inventory generally described as?
a. Costs applicable to units that have been started in production but are only partially completed
b. Costs associated with the end stage of manufacturing that are almost always complete and ready for customers
c. Costs strictly associated with direct labor
d. Beginning stage production costs associated with labor costs dealing with bringing in raw materials from the shipping docks

106. Utley Manufacturing Company reported the following year-end information: beginning work in process inventory, $180,000; cost of goods manufactured, $516,000; beginning finished goods inventory, $252,000; ending work in process inventory, $220,000; and ending finished goods inventory, $264,000. Utley Manufacturing Company’s cost of goods sold for the year is
a. $504,000. b. $528,000. c. $476,000. d. $252,000.

107. Neeley Manufacturing Company reported the following year-end information:

Beginningwork in process inventory Beginningraw materials inventory Ending work in process inventory Ending raw materials inventory
Raw materials purchased Direct labor Manufacturingoverhead
$1,080,000 300,000 900,000 480,000 960,000 900,000 600,000

Neeley Manufacturing Company’s cost of goods manufacturedfor the year is a. $2,280,000.
b. $2,460,000. c. $2,100,000. d. $2,640,000.

Use the following information for questions 108–110.

HopkinsManufacturingInc.’s accounting records reflect the following inventories:

Raw materials inventory Work in process inventory Finishedgoods inventory
Dec. 31, 2007 $ 80,000
104,000 100,000
Dec. 31, 2008 $ 64,000
116,000 92,000

During 2008, Hopkins purchased $760,000 of raw materials, incurred direct labor costs of $100,000,and incurred manufacturing overhead totaling $128,000.

108. How much is raw materials transferred to production during 2008 for Hopkins Manufacturing?
a. $992,000 b. $776,000 c. $760,000 d. $744,000
19 – 16

109. How much is total manufacturing costs incurred during 2008 for Hopkins? a. $992,000
b. $1,004,000 c. $988,000 d. $1,000,000

110. Assume Hopkins Manufacturing‘s cost of goods manufactured for 2008 amounted to $960,000.How much would it report as cost of goods sold for the year?
a. $968,000 b. $1,000,000 c. $1,060,000 d. $952,000

111. McNally Manufacturing Company reported the following year-end information:

Beginningwork in process inventory Beginningraw materials inventory Ending work in process inventory Ending raw materials inventory
Raw materials purchased Direct labor Manufacturingoverhead
$ 46,000 24,000 50,000 20,000 680,000 240,000 100,000

How much is McNally Manufacturing‘s cost of goods manufactured for the year? a. $684,000
b. $1,024,000 c. $1,020,000 d. $1,028,000

Use the following information for questions 112–113.

Modine Manufacturing Inc.’s accounting records reflect the following inventories:

Raw materials inventory Work in process inventory Finishedgoods inventory
Dec. 31, 2007 $120,000
156,000 150,000
Dec. 31, 2008 $ 96,000
174,000 138,000

During 2008, Modine purchased $1,140,000 of raw materials, incurred direct labor costs of $150,000,and incurred manufacturing overhead totaling $192,000.

112. How much is total manufacturing costs incurred during 2008 for Modine? a. $1,488,000
b. $1,506,000 c. $1,482,000 d. $1,500,000

113. How much would Modine Manufacturing report as cost of goods manufactured for 2008? a. $1,464,000
b. $1,524,000 c. $1,518,000 d. $1,488,000
ManagerialAccounting 19 – 17

114. Sauder Manufacturing Company reported the following year-end information:

Beginningwork in process inventory Beginningraw materials inventory Ending work in process inventory Ending raw materials inventory
Raw materials purchased Direct labor Manufacturingoverhead
$ 35,000 18,000 38,000 15,000 510,000 180,000 75,000

How much is Sauder Manufacturing‘stotal cost of work in process for the year? a. $513,000
b. $768,000 c. $765,000 d. $803,000

115. Hardigan Manufacturing Company reported the following year-end information: beginning work in process inventory, $80,000; cost of goods manufactured, $980,000; beginning finished goods inventory, $50,000; ending work in process inventory, $70,000; and ending finished goods inventory, $40,000. How much is Hardigan‘s cost of goods sold for the year?
a. $980,000 b. $990,000 c. $970,000 d. $1,000,000

Use the following information for questions 116–119.

Raw materials inventory, January 1 Raw materials inventory, December 31 Work in process, January 1
Work in process, December 31 Finishedgoods, January 1 Finishedgoods, December 31 Raw materials purchases Direct labor
Factoryutilities Indirect labor Factorydepreciation
Selling and administrative expenses

$ 20,000 40,000 18,000 12,000 40,000 32,000 1,000,000 460,000 150,000 50,000 400,000 420,000

116. Direct materials used is a. $1,060,000. b. $1,020,000. c. $1,000,000.
d. $980,000.

117. Assume your answer to question 116 above is $1,000,000. Total manufacturing costs equal
a. $2,060,000. b. $2,054,000. c. $1,860,000. d. $2,480,000.
19 – 18

118. Assume your answer to question 117 above is $2,000,000. Cost of goods manufactured equals
a. $1,992,000. b. $1,994,000. c. $2,006,000. d. $2,008,000.

119. Assume your answer to question 118 above is $2,040,000. The cost of goods sold is a. $2,046,000.
b. $2,008,000. c. $2,032,000. d. $2,048,000.

Use the following information for questions 120–123:

Raw materials inventory, January 1 Raw materials inventory, December 31 Work in process, January 1
Work in process, December 31 Finishedgoods, January 1 Finishedgoods, December 31 Raw materials purchases Direct labor
Factoryutilities Indirect labor Factorydepreciation
Selling and administrative expenses

$ 30,000 60,000 27,000 18,000 60,000 48,000 1,500,000 690,000 225,000 75,000 600,000 630,000

120. Direct materials used is a. $1,590,000. b. $1,530,000. c. $1,500,000. d. $1,470,000.

121. Assume your answer to question 120 above is $1,500,000. Total manufacturing costs equal
a. $3,090,000. b. $3,081,000. c. $2,790,000. d. $3,720,000.

122. Assume your answer to question 121 above is $3,000,000. Cost of goods manufactured equals
a. $2,988,000. b. $2,991,000. c. $3,009,000. d. $3,012,000.

123. Assume your answer to question 122 above is $3,060,000. The cost of goods sold is a. $3,069,000.
b. $3,012,000. c. $3,048,000. d. $3,072,000.
ManagerialAccounting 19 – 19

124. Samson Company reported total manufacturing costs of $130,000, manufacturing overhead totaling $26,000, and direct materials totaling $32,000. How much is direct labor cost?
a. Cannot be determined from the information provided. b. $188,000
c. $58,000 d. $72,000

125. Given the following data for Mehring Company, compute (A) total manufacturing costs and (B) costs of goods manufactured:

Direct materials used Direct labor Manufacturingoverhead Operatingexpenses
$180,000 75,000 225,000 263,000
Beginningwork in process Ending work in process Beginningfinished goods Ending finished goods
$30,000 15,000 38,000 23,000

(A)
a. $465,000 b. $480,000 c. $480,000 d. $495,000
(B)
$495,000 $465,000 $495,000 $510,000

126. Penner Company reported total manufacturing costs of $195,000, manufacturing overhead totaling $39,000, and direct materials totaling $48,000. How much is direct labor cost?
a. Cannot be determined from the information provided. b. $282,000
c. $87,000 d. $108,000

127. Given the following data for Glennon Company, compute (A) total manufacturing costs and (B) costs of goods manufactured:

Direct materials used Direct labor Manufacturingoverhead Operatingexpenses

(A)
a. $620,000 b. $640,000 c. $640,000 d. $660,000
$240,000 100,000 300,000 350,000

(B)
$660,000 $620,000 $660,000 $680,000
Beginningwork in process Ending work in process Beginningfinished goods Ending finished goods
$40,000 20,000 50,000 30,000

128. What term describes all activities associated with providing a product or service? a. The manufacturingchain
b. The product chain c. The supply chain d. The value chain
19 – 20

129. Which one of the following does not appear on the balance sheet of a manufacturing company?
a. Finished goods inventory b. Work in process inventory
c. Cost of goods manufactured d. Raw materials inventory

130. The equivalent of finished goods inventory for a merchandisingfirm is referred to as a. purchases.
b. cost of goods purchased. c. merchandise inventory. d. raw materials inventory.

131. How have many companies significantly lowered inventory levels and costs? a. They use activity-based costing.
b. They utilize an enterprise resource planning system. c. They have a just-in-time method.
d. They focus on a total quality management system.

Additional Multiple Choice Questions

132. Financial and managerial accounting are similar in that both a. have the same primary users.
b. produce general-purpose reports.
c. have reports that are prepared quarterly and annually. d. deal with the economic events of an enterprise.

133. The function that pertains to keeping the activities of the enterprise on track is a. planning.
b. directing. c. controlling.
d. accounting.

134. Property taxes on a manufacturing plant are an element of a

Product Cost a. Yes
b. Yes c. No d. No
Period Cost No Yes Yes No

135. For a manufacturing company, which of the following is an example of a period cost rather than a product cost?
a. Depreciation on factory equipment b. Wages of salespersons
c. Wages of machine operators
d. Insurance on factory equipment
ManagerialAccounting 19 – 21

136. For a manufacturing firm, cost of goods available for sale is computed by adding the beginning finished goods inventory to
a. cost of goods purchased.
b. cost of goods manufactured. c. net purchases.
d. total manufacturing costs.

137. If the cost of goods manufactured is less than the cost of goods sold, which of the following is correct?
a. Finished Goods Inventory has increased. b. Work in Process Inventory has increased. c. Finished Goods Inventory has decreased. d. Work in Process Inventory has decreased.

138. The principal difference between a merchandisingand a manufacturing income statement is the
a. cost of goods sold section. b. extraordinary item section. c. operating expense section. d. revenue section.

139. If the total manufacturing costs are greater than the cost of goods manufactured, which of the following is correct?
a. Work in Process Inventory has increased. b. Finished Goods Inventory has increased. c. Work in Process Inventory has decreased. d. Finished Goods Inventory has decreased.

140. The sum of the direct materials costs, direct labor costs, and manufacturing overhead incurred is the
a. cost of goods manufactured. b. total manufacturing overhead. c. total manufacturing costs.
d. total cost of work in process.

141. The inventory accounts that show the cost of completed goods on hand and the costs applicable to production that is only partially completed are, respectively
a. Work in Process Inventory and Raw Materials Inventory. b. Finished Goods Inventory and Raw Materials Inventory. c. Finished Goods Inventory and Work in Process Inventory. d. Raw Materials Inventory and Work in Process Inventory.

BRIEFEXERCISES

BE 142

Presented below are Truck Company‘s monthly manufacturing cost data related to its personal computer products.

(a) Taxes on factory building (b) Raw materials
(c) Depreciation on manufacturing equip. (d) Wagesfor assembly line workers
$820,000 66,000 210,000 340,000

Instructions

Enter each cost item in the following table, placing an ―X‖ under the appropriate headings.

Direct Materials (a)
(b) (c) (d)
ProductCosts
Direct Labor Factory Overhead

BE 143

Determine whether each of the following costs should be classified as direct materials (DM), direct labor (DL), or manufacturing overhead (MO).

a. Depreciation on factory equipment

b. Table legs used in manufacturing tables c. Wages paid to assembly line workers
d. Factoryrent

BE 144

Indicate whether each of the following costs of a pencil manufacturer would be classified as direct materials (DM), direct labor (DL), or manufacturing overhead (MO).

a. Depreciation of pencil painting machinery b. Lead inserted into pencils
c. Factoryutilities

d. Wages of assembly line worker e. Salaryof supervisor
f. Factorymachinery maintenance g. Wood
h. Eraser compound

BE 145

Presented below are Cricket Company‘s monthly manufacturing cost data related to its personal computer products.
a. Hard drives and memory sticks $30,000 b. Wagesto assemble equipment $65,000 c. Insuranceon manufacturing building $41,000 d. Wagesfor factory supervisors $64,000

Instructions

Enter each cost item in the following table, placing an ‗X‘ under the appropriate headings.

Product Costs

Direct Materials
Direct Labor
Factory Overhead

a.

b.

c.

d.

BE 146

Identifywhether each of the following is classified as a product cost or a period cost.

1. Direct labor

2. Direct materials

3. Factory utilities

4. Repairs to office equipment

5. Property taxes on factory building

6. Sales salaries

BE 147

Criba Manufacturing Company has the following data: direct labor $630,000, direct materials used $421,000, total manufacturingoverhead $206,000, and beginning work in process $42,000.

Instructions

Compute(a) total manufacturing costs and (b) total cost of work in process.

BE 148

Presentedbelow are incomplete 2009 manufacturing cost data for Swartnez Corporation.

Direct Materials Used

(a) $ 17,000

(b) $148,000
Direct Labor

$42,000

?
FactoryOverhead

?

$112,000
Total Manufacturing Costs

$ 73,000

$420,000

Instructions
Determinethe missing amounts.

BE 149

Presentedbelow are incomplete 2008 manufacturing cost data for Supreme Corporation.

Direct Materials Used

Direct Labor

FactoryOverhead

Total Manufacturing Costs

(a)

$38,000

$72,000

?

$164,000

(b)

$95,000

?

$70,000

$305,000

(c)

?

$80,000

$120,000

$260,000

Instructions

Determinethe missing amounts.

BE 150

Raynor Manufacturing Company has the following data:

Direct labor
Direct materials used
Total manufacturing overhead Ending work in process Beginningwork in process
$46,000 84,000 60,000 30,000 40,000

Instructions
Compute(a) total manufacturing costs and (b) cost of goods manufactured.

BE 151

In alphabetical order below are current asset items for Sudler Company as of December 31, 2008. Prepare the current assets section of the company‘s balance sheet as of the same date.

Accountsreceivable Cash
Finished goods Prepaid expenses Raw materials Work in process
$41,000 56,000 21,000 3,000 12,000 32,000

EXERCISES
Ex. 152

Financial accounting information and managerial accounting information have a number of distinguishing characteristics. For each of the characteristics listed below, indicate which characteristics are more closely related to financial accounting by placing the letter “F” in the space to the left of the item and indicate those characteristics which are more closely associated with managerial accounting by placing the letter “M” to the left of the item.

1. General-purposereports 2. Reportsare used internally
3. Preparedin accordancewith generally accepted accounting principles 4. Special purpose reports
5. Limitedto historical cost data

6. Reporting standard is relevance to the decision to be made 7. Financialstatements
8. Reportsgenerally pertain to the business as a whole 9. Reportsgenerally pertain to subunits
10. Reportsissued quarterly or annually

Ex. 153

Determinewhether each of the following is classified as:

DM: Direct materials DL: Direct labor
MO: Manufacturing overhead

1. Assembly line workers’ wages.

2. Factory supervisors’ salaries.

3. Steel used in manufacturing product.

4. Insurance on factory building.

5. Rivets and screws used in production.

6. Tires used in manufacturing vehicles.

Ex. 154

Presentedbelow is a list of costs and expenses incurred in the factory by Nu-Way Corporation, a manufacturer of recreational vehicles.

1. Propertytaxes on the factory land 2. Nails and glue used in production 3. Cabinet maker’s wages
4. Factorysupervisors‘ salaries 5. Metal used in manufacturing
6. Depreciation on factory machines 7. Factoryutilities
8. Carpetingfor the recreational vehicles 9. Propertytaxes on the factory building
10. Insuranceon factory equipment
ManagerialAccounting 19 – 29

Ex. 154 (cont.)

Instructions
Classifythe above items into the following categories:

DM — Direct Materials DL — Direct Labor
MO — ManufacturingOverhead

Ex. 155

For each item, identify all applicable cost labels. Use the following code in your answer:

1 — Product Cost 2 — Period Cost

a. Advertising

b. Direct materials used c. Sales salaries
d. Indirectfactory labor

e. Repairsto office equipment f. Factorymanager’s salary g. Direct labor used
h. Indirectmaterials

Ex. 156

For each item listed below, indicate in the space to the left whether the item would be considered a product cost or a period cost for a manufacturing company. Use the following code:

Pr = Product cost Pe = Period cost

1. Factorysupervisory salaries

2. Sales commissions

3. Incometax expense

4. Indirectmaterials used

5. Indirect labor

6. Office salaries expense

7. Propertytaxes on factory building

8. Sales manager’s salary

9. Factorywages expense

10. Direct materials used

Ex. 157

Yates Manufacturing Company incurs the following manufacturing costs and expenses during the month of May.
1. Assembly line wages
2. Raw materials used directly in product 3. Depreciation on office equipment
4. Property taxes on factory building 5. Rent on factory building
6. Sales commissions
7. Depreciation on factory equipment 8. Factory utilities
9. Wages for factory maintenance workers 10. Advertising
11. Indirect materials used in production 12. Factory manager’s salary

Instructions
Completethe following matrix by placing an X mark under the appropriate headings.

Cost Item 1.
2. 3. 4. 5. 6. 7. 8. 9. 10. 11.
12.
Direct Direct Materials Labor
Manufacturing Period
Overhead Costs

Ex. 158

Presentedbelow are incomplete 2008 manufacturing cost data for Tardy Corporation.

Total Work in Work in Cost of Direct Materials Direct Manufacturing Manufacturing Process Process Goods
Used Labor Overhead Costs (1/1) (12/31) Manufactured

(a) $38,000 $72,000 $48,000 ? $120,000 $96,000 ?
(b) $149,000 $53,000 $90,000 $292,000 ? $98,000 $331,000 (c) $53,000 $116,000 $121,000 $290,000 $463,000 ? $515,000

Instructions
Determinethe missing amounts.

Ex. 159

Among the items that Gentry Print Shop accounts for are the following:

1. Direct labor

2. Office supplies used

3. Depreciation on printing machines 4. Finished goods inventory, 12/31 5. Raw materials inventory, 1/1
6. Cost of goods manufactured 7. Work in process, 1/1
8. Office supplies inventory, 12/31 9. Indirect labor
10. Heat and electricity for the print shop

GentryPrint Shop prepares the following schedule and financial statements on a yearly basis: (a) Cost of goods manufactured schedule.
(b) Income statement. (c) Balance sheet.

Instructions
For each item, indicate by using the appropriate letter(s) the schedule and/or financial statements in which the item will appear.

Ex. 160

Isaac Company manufactures boats. During September, 2008, the company purchased 100 cellular phones at a cost of $100 each. Isaac withdrew 70 phones from the warehouse during the month. Twenty of these phones were installed in salespersons‘ cars and the remaining 50 phones were put in boats manufacturedduring the month.

Of the boats put into production during September, 2008, 80% were completed and transferred to the company’s storage lot. Fifty percent of the boats completed during the month were sold by September 30.

Instructions
Determine the cost of cellular phones that would appear in each of the following accounts at September 30, 2008:
Raw materials inventory Work in process inventory Finished goods inventory Cost of goods sold Selling expenses

Ex. 161

Manning Manufacturing Company has the following data at June 30, 2008:

Raw materials inventory, June 1 Work in process inventory, June 1 Finishedgoods inventory, June 1 Total manufacturing costs
Sales
Work in process inventory, June 30 Finishedgoods inventory, June 30 Raw materials inventory, June 30
$ 13,800 18,100 43,500 510,000 590,000 30,400 50,200 18,000

Instructions
(a) Prepare an income statement through gross profit for the month of June. (b) Indicate the balance sheet presentation of the June 30 inventories.

Ex. 162

From the account balances listed below, prepare a schedule of cost of goods manufactured for TimmonsManufacturingCompany for the month ended December 31, 2008.

FinishedGoods Inventory, December 31 FactorySupervisory Salaries IncomeTax Expense
Raw Materials Inventory, December 1 WorkIn Process Inventory, December 31 Sales Salaries Expense FactoryDepreciation Expense FinishedGoods Inventory, December 1 Raw Materials Purchases
WorkIn Process Inventory, December 1 FactoryUtilities Expense
Direct Labor
Raw Materials Inventory, December 31 Sales Returns and Allowances
Indirect Labor
Account Balances $42,000
12,000 18,000 12,000 25,000 14,000 8,000 35,000 95,000 30,000 4,000 70,000 19,000 5,000 21,000

Ex. 163

Rabid Manufacturing Company has the following data:

Direct labor
Direct materials used
Total manufacturing overhead Beginningwork in process
$160,000 191,000 208,000 21,000

Instructions
Compute(a) total manufacturing costs and (b) total cost of work in process.

Ex. 164

The following costs and inventory data were taken from the accounts of Reser Company for 2008:

Inventories:
Raw materials Work in process Finishedgoods
January 1, 2008

$ 8,000 15,000 16,000
December 31, 2008

$ 7,000 13,000 10,000

Costs incurred:
Raw materials purchases Direct labor
Factoryrent Factoryutilities Indirectmaterials Indirect labor Selling expenses
Administrativeexpenses

$93,000 42,000 8,000 7,000 4,000 6,000 5,000 12,000

Instructions
a. Prepare a schedule showing the amount of direct materials used in production during the year.

b. Compute the amount of manufacturing overhead incurred during the year.

c. Prepare a schedule of Cost of Goods Manufacturedfor Reser Company for the year ended December31, 2008 in good form.

d. Prepare the Cost of Goods Sold section of the Income Statement for Reser Company for the year ended December 31, 2008 in good form.

Ex. 165

Manufacturingcosts for Carson Companyfor selected months are as follows:

Beginningwork in process Direct materials used Direct labor Manufacturingoverhead Total manufacturing costs
Total cost of work in process Ending work in process Cost of goods manufactured Beginningfinished goods
Cost of goods available for sale Ending finished goods
Cost of goods sold
April July October $ 80,000 (f) $ 98,000
280,000 $190,000 155,000 195,000 170,000 (j)
(a) 150,000 90,000 720,000 510,000 470,000
(b) 650,000 (k) 75,000 (g) (l)
(c) 505,000 385,000 (d) 68,000 (m)
960,000 (h) 450,000 (e) 75,000 (n)
790,000 (i) 355,000

Instructions
Indicatethe missing amounts. (Show computations.)

Ex. 166

Fill in the missing information on the cost of goods manufactured schedule of Maddox ManufacturingCompany:

MADDOX MANUFACTURING COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2008

Work in process (1/1) Direct materials
Raw materials inventory (1/1) Raw materials purchases
Raw materials available for use Raw materials inventory (12/31)
Direct materials used Direct labor Manufacturingoverhead
Indirect labor Factorydepreciation Factoryutilities
Total overhead Total manufacturing costs
Total cost of work in process Less: Work in process (12/31) Cost of goods manufactured

$ ?
271,000 ?
37,000

24,000 38,000 39,000

$280,000 ?

?
$320,000

? ?
292,000 $520,000

Ex. 167

Data for the cost of direct materials for the month ended March 31, 2008, are as follows:

Materials inventory, March 1, 2008 Materialsinventory, March 31, 2008
$76,000 85,000

During March, the company purchased $220,000 of raw materials on account from Pine Company and $72,000 of raw materials for cash from Frye Company. In addition, $50,000 was paid on the Pine account balance.

Instructions

Computethe cost of direct materials used during March.

Ex. 168

Presentedbelow are incomplete 2008 manufacturing cost data for Tardy Corporation.

Direct Materials Factory Total Manufacturing Used Direct Labor Overhead Costs

(a) (b) (c)
$36,000 $72,000 $54,000 ?
? $53,000 $90,000 $272,000 $53,000 ? $101,000 $290,000

Instructions
Determinethe missing amounts.

Ex. 169

Indicatewhether each of the following would appear on the:

A—Cost of goods manufacturedschedule B—Incomestatement
C—Balancesheet

Note: If it would appear in more than just one, indicate which ones.

1. Cost of goods sold

2. Finished goods inventory, 12/31

3. Direct materials used

4. Raw materials inventory, 1/1

5. Insurance on factory equipment

6. Work in process, 12/31

7. Indirect labor

8. Property taxes on office building

Ex. 170

Listed below are current asset items for Klugman Company at December 31, 2008.

Finishedgoods inventory Cash
Prepaid expenses Accountsreceivable
$35,000 20,000 2,000 4,000
Short-terminvestments Raw materials inventory Work in process inventory Supplies
$28,000 12,000 18,000 500

Instructions

Preparethe current assets section of the balance sheet. (Include a complete heading.)

COMPLETION STATEMENTS

171. Financial accounting information is prepared mainly for users, while

managerial accounting information is prepared primarily for users.

172. The types of reports prepared in managerial accounting are often –

purpose reports prepared for a specific decision.

173. Managerial accounting reports generally pertain to of a business and

may be very detailed.

174. Three broad managerial functions are: (1) , (2) , and

(3) .

175. The function is concerned with setting goals and objectives for the

entity.

176. Exercising good judgment in performing the managerial functions and choosing among alternative courses of action is called .

177. The three cost elements in manufacturing a product are (1) ,

(2) , and (3) .

178. The work of factory employees that can be physically and directly associated with

converting raw materials into products is classified as .

179. Indirect materials and indirect labor are classified as .

189. Each of the manufacturing cost components is a cost.

181. A major difference between the income statements of a merchandising company and a manufacturing company is that the cost of goods sold section of a merchandising company shows cost of goods , whereas a manufacturing company shows cost of goods .

182. is added to direct labor and manufacturing overhead to get total

manufacturing costs for the current period.

183. The ending work in process inventory is subtracted from the total cost of work in process to calculate .

184. A manufacturing company computes cost of goods sold by adding cost of goods manufactured to the and subtracting the .

185. A manufacturing company usually has three inventory accounts which are (1) , (2) , and (3) .

MATCHING

186. Match the items in the two columns below by entering the appropriate code letter in the space provided.

A. Managerial accounting B. Financial accounting C. Planning
D. Directing E. Controlling
F. Work in process inventory G. Direct materials
H. Manufacturing overhead I. Period costs
J. Value chain

1. The cost of products that are partially complete.

2. The function of keeping activities in accordance with plans.

3. Primarily concerned with internal users and reports pertain to subunits of the entity.

4. Materials that can be physically and directly associated with manufacturing a product.

5. The function of setting goals and objectives.

6. Indirect costs of manufacturing a product.

7. Primarily concerned with external users and reports pertain to the entity as a whole.

8. Costs that are noninventoriable.

9. All activities associated with providing a product or service.

10. The function of coordinating diverse activities to produce a smooth-running operation.

SHORT-ANSWERESSAY QUESTIONS
S-AE 187
Financial and managerial accounting are both concerned with the economic events of an enterprise. Similarities between financial and managerial accounting do exist, but they do have different focus. Briefly distinguish between financial and managerial accounting as they relate to (1) the primary users, (2) the type and frequency of reports, (3) the purpose of reports, and (4) the content of reports.

S-AE 188

A manufacturing company makes the products that it sells. Briefly identify and define the cost elements that are incurred in making a product. After product cost elements are identified, how is the cost of goods manufacturedfor a period determined?

S-AE 189

Assume you have just taken a position as controller for a new company that manufactures and sells wrought iron wall hangings. Although the founder of the company, who is the president and CEO, is a great artisan, she has very limited knowledge of accounting.

Instructions
To help your new boss better understand accounting for a manufacturing organization, prepare a response to her in which you: (1) identify, (2) describe, and (3) provide examples of the three manufacturing costs and the three inventory accounts used in accounting for a manufacturing company.

S-AE 190 (Ethics)

Million Dollar Mills is a textile manufacturing firm located in the southern United States. The company carefully prepares all financial statements in accordance with GAAP, and gives a copy of all financial statements to each department. In addition, the company keeps records on quality control, safety, and environmental pollution by the company. It then prepares “scorecards” for each department indicating their performance. Recently, the financial impact of the second set of information was added, and the information has been used in the evaluation of employees for merit pay and promotions.

At the most recent employee meeting, Tyler Hanes, marketing manager, expressed his discomfort with the system. He said there was no guarantee that the second set of information was fair, since there were no generally accepted principles for this kind of information. He also said that it was kind of like keeping two sets of books—one following all legal requirements, and the other one actually used by the company.

S-AE 190 (cont.)

Required:
1. Is it ethical to evaluate managers in the way described? Explain briefly.

2. Name at least two safeguards the company could build into its system to ensure the ethical treatment of employees.

S-AE 191 (Communication)

Volumetrica, a producer of audio equipment for large computer systems, is reviewing its policies as part of a biannual self-examination of the company. As part of this process, all managers have been asked to carefully examine costs and determine as closely as possible which costs are direct and which are indirect.

Marie Ramsey and Dan Wilson, managers of different manufacturing departments in the same building, have been working together. They found the following four costs that could be economically traced to the products, but have historically been a part of overhead:

• Cost of setting up the machinery for a different production run.

• Cost of minor assembly componentssuch as knobs and switches. • Cost of packaging, which is quite different for each model.
• Cost of inspecting and testing each model.

None of the costs is significant by itself, but together these four costs make up between 10 and 15% of the total cost of the product. Marie favors “leaving well enough alone,” as she puts it, and leaving these costs in overhead. She is afraid that her volunteering to trace these costs will result in her having to trace many more costs in the future. Dan, on the other hand, prefers to have the product cost as accurate as possible. He points out that these costs are already known, and the process would require little extra work.

Required:
You have been called on in your function as accounting manager to resolve the dispute. Write a memo to Marie and Dan, supporting one or the other position. Be sure to adequately defend your position, but be brief.