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CHAPTER 4
THE BALANCE SHEET AND STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
CONTENT ANALYSIS OF EXERCISES AND PROBLEMS
Time Range
Number Content (minutes)
E4-1 Current Assets. (Easy) Partial balance sheet preparation from 5-10
listed accounts.
E4-2 Plant and Equipment. (Easy) Partial balance sheet preparation 10-15
from general information.
E4-3 Stockholders' Equity. (Easy) Partial balance sheet preparation 5-10
from listed accounts.
E4-4 Balance Sheet. (Moderate) Matching various accounts with 5-10
major sections.
E4-5 Balance Sheet. (Moderate) Matching various accounts with 5-10
major sections.
E4-6 Balance Sheet. (Moderate) Preparation from accounts listed in 15-20
random order. Calculation of debt ratio.
E4-7 Balance Sheet. (Moderate) Preparation from accounts listed in 20-25
alphabetical order. Calculation of working capital and current
ratio. IFRS discussion.
E4-8 Balance Sheet Calculations. (Moderate) Calculate missing 15-25
information, given amounts of selected balance sheet
elements.
E4-9 Balance Sheet Calculations. (Moderate) Calculate missing 25-35
information, given amounts of selected balance sheet
elements.
E4-10 Corrections. (Moderate) Preparation of a properly classified 10-15
balance sheet from one prepared erroneously.
E4-11 Changes in Stockholders' Equity. (Moderate) Stock issuance, 10-15
income earned, dividends paid. Statement of changes in
stockholders' equity.
E4-12 Changes in Stockholders' Equity. (Moderate) Stock issuance, 10-15
income earned, dividends paid. Statement of changes in
stockholders' equity.
4-1
Time Range
Number Content (minutes)
P4-1 Balance Sheet. (Moderate) Matching various accounts with 15-30
major sections.
P4-2 Balance Sheet. (Moderate) Format preparation, no amounts. 20-40
P4-3 Balance Sheet. (Moderate) Preparation from accounts listed in 30-45
alphabetical order. Identification of possible disclosures.
Computation of working capital and current ratio.
P4-4 Balance Sheet. (Moderate) Preparation from accounts listed in 30-45
random order under U.S. GAAP and under IFRS.
P4-5 Balance Sheet. (Moderate) Preparation from alphabetical 20-30
adjusted trial balance. Calculation of debt ratio.
P4-6 Balance Sheet. (Challenging) Preparation from accounts listed 60-75
in random order. Notes. Calculation of current ratio, liquid
assets, and separable assets.
P4-7 Comprehensive. (Challenging) Preparation of balance sheet 75-90
from accounts listed in alphabetical order. Notes. Statement
of changes in stockholders' equity. Calculation of debt ratio
and discussion.
P4-8 Corrections. (Moderate) Preparation of a properly classified 30-45
balance sheet from one prepared incorrectly, using account
breakdowns.
P4-9 Corrections. (Moderate) Preparation of a properly classified 30-45
balance sheet from one prepared incorrectly, using additional
available information.
P4-10 Balance Sheet Calculations. (Moderate) Calculate missing 30-40
information, given amounts of selected balance sheet
elements.
P4-11 Errors. (Moderate) Identification of balance sheet errors. 30-45
Preparation of a properly classified balance sheet from one
prepared erroneously.
P4-12 (AICPA adapted). Complex Balance Sheet. (Challenging) 60-75
Preparation of corrected balance sheet from unaudited
balance sheet and additional information.
P4-13 Changes in Stockholders' Equity. (Moderate) Stock issuance, 15-20
treasury stock, paid dividends, donation, earned income.
Statement of changes in stockholders' equity.
P4-14 Balance Sheet Disclosures. (Moderate) Questions relating to 20-40
the review of The Coca-Cola Company balance sheet
disclosures in Appendix A.
4-2
ANSWERS TO QUESTIONS
Q4-1 The major financial statements of a company are:
1. A balance sheet, which shows the company's financial position at the end of
the accounting period.
2. An income statement, which shows the results of operations of the company for
the accounting period.
3. A statement of cash flows, which shows the cash inflows and cash outflows of a
company for the accounting period.
Many companies also include a statement of changes in stockholders' equity, which
shows the changes in each item of a company's stockholders' equity for the
accounting period, as a fourth major financial statement.
Q4-2 The financial position of a company includes its economic resources (i.e., assets),
economic obligations (i.e., liabilities), and equity, and their relationships to each other
at a moment in time.
Q4-3 One purpose of a company's balance sheet is to provide information about its
liquidity, financial flexibility, and operating capability. A second purpose of the
balance sheet is to provide a basis for evaluating the company's income-producing
performance during a period.
Q4-4 Liquidity refers to how quickly a company can convert an asset into cash to pay its
bills. Financial flexibility refers to the ability of a company to use its financial resources
to adapt to change. Operating capability refers to the ability of a company to
maintain a given physical level of operations.
Q4-5 Financial capital is the monetary value of the net assets invested by stockholders, as
well as from earnings retained by the corporation. Capital maintenance refers to
maintaining the stockholders' equity of the corporation to provide a return of
investment. Information about the maintenance of a corporation's capital is
important in assessing the adequacy of a corporation's profitability and its ability to
provide a return on investment.
Q4-6 Recognition is the process of formally recording and reporting an element in the
financial statements. It includes depiction of an element in both words and numbers,
with the amount included in the totals.
Q4-7 An asset is a probable future economic benefit obtained or controlled by a
company as a result of a past transaction or event. To be considered an asset, an
economic resource must have three characteristics. First, the resource must singly, or
in combination with other resources, have the capacity to contribute directly or
indirectly to the company's future net cash inflows. Second, the company must be
able to obtain the future benefit and control others' access to it. Third, the
transaction or event giving the company the right to or control over the benefit must
have occurred.
4-3
Q4-8 A liability is a probable future sacrifice of economic benefits arising from a present
obligation of a company to transfer assets or provide services in the future as a result
of a past transaction or event. An obligation of a company must have three
characteristics to be considered a liability. First, it must entail a responsibility to
another entity or entities that will be settled by a sacrifice involving the transfer of
assets, providing services, or other use of assets at a specified or determinable date,
on occurrence of a specified event, or on demand. Second, the responsibility must
obligate the company so that it has little or no discretion to avoid the future sacrifice.
Third, the transaction or other event obligating the company must have occurred.
Q4-9 Stockholders' equity is the residual interest in the assets of a corporation that remains
after deducting its liabilities.
Q4-10 The two alternatives for measuring (valuing) assets are historical cost and fair value.
Historical cost is the exchange price in the transaction in which an asset was
acquired. Fair value is the price that a company would receive to sell an asset in an
orderly transaction between market participants on the date of measurement.
Q4-11 A company's balance sheet is divided into three major sections each with the
components as follows:
1. Assets
a. Current assets
b. Long-term investments
c. Property, plant, and equipment
d. Intangible assets
e. Other assets
2. Liabilities
a. Current liabilities
b. Long-term liabilities
c. Other liabilities
3. Stockholders' equity
a. Contributed capital
(1) Capital stock
(2) Additional paid-in capital
b. Retained earnings
c. Accumulated other comprehensive income
Q4-12 Current assets are cash and other assets that a company expects to convert into
cash, sell, or consume within one year or the normal operating cycle, whichever is
longer.
Current assets may include five items: (1) cash (and cash equivalents), (2) temporary
investments in marketable securities, (3) receivables, (4) inventories, and (5) prepaid
items.
4-4
Q4-12 (continued)
Current liabilities are obligations of a company that it expects to liquidate by using
existing current assets, or creating other current liabilities within one year or the
normal operating cycle, whichever is longer.
Examples of current liabilities are accounts payable, taxes payable, unearned rent,
salaries payable, estimated liabilities for warranties, and the current portion of long-
term debt.
Q4-13 A company's operating cycle is the average time taken by the company to spend
cash for inventory, process and sell the inventory, and collect the receivables,
converting them back into cash.
Working capital of a company relates primarily to the financial resources it uses in its
operating cycle.
Working capital is computed by subtracting current liabilities from current assets.
Q4-14 a. If a company expects to hold investments for more than one year or the
operating cycle, whichever is longer, these investments are classified as long-
term. Long-term investments include:
1. Noncurrent investments in available-for-sale debt and equity securities.
2. Investments in held-to-maturity debt securities.
3. Investments in noncurrent notes receivable of unaffiliated companies and
long-term advances to unconsolidated affiliated companies.
4. Financial instruments (such as options to buy stock) that are noncurrent.
5. Investments in property and equipment being held for use in future
operations.
6. Special funds established for long-term purposes, such as the retirement of
bonds or the acquisition of equipment.
7. Miscellaneous investments, such as the cash surrender value of life insurance.
b. All tangible assets used in the operations of a company are classified as property,
plant, and equipment. They include:
1. Land
2. Buildings
3. Equipment
4. Natural resources
5. Leased equipment under capital leases
4-5
Q4-14 (continued)
c. Economic resources that are used in the operations of the business but that have
no physical existence are classified as intangible assets. They include:
1. Patents
2. Copyrights
3. Franchises
4. Trademarks
5. Goodwill
Q4-15 a. Obligations that a company does not expect to liquidate using current assets or
creating current liabilities within one year or the normal operating cycle
(whichever is longer) are classified as long-term liabilities. They include:
1. Bonds payable
2. Long-term notes payable
3. Capital lease contract obligations
4. Mortgages payable
5. Pension obligations
6. Obligations under noncurrent financial instruments
b. Other liabilities are miscellaneous liabilities not meeting the definition of either a
current or long-term liability. They include:
1. Deferred income taxes payable
2. Obligations of a segment of the company that is being discontinued
3. Long-term advances from customers
Q4-16 A bond is a written promise to pay a specified interest rate and to repay a specific
amount (its face value) at some future maturity date.
Bonds payable may be disclosed on a company's balance sheet as follows:
Long-term liabilities
10% bonds payable outstanding, due
January 1, 2016 $100,000
Less: Unamortized bond discount (15,000)
$ 85,000
Q4-17 a. Capital stock are the shares of stock that a corporation is authorized to issue as
evidence of ownership in that corporation. There are two types of capital
stock, preferred stock and common stock. Preferred stock has a preference
over common stock as to dividends. Common stock carries the right to vote at
the annual stockholders' meeting and to share in residual profits.
b. Additional paid-in capital is the amount paid to the corporation by stockholders
in excess of the par value of the stock issued.
c. Treasury stock is the capital stock of a corporation that has been issued but
reacquired by the corporation.
4-6
Q4-17 (continued)
d. Retained earnings is the total amount of corporate net income that has not
been distributed to stockholders as dividends.
e. Deficit is the term used to describe a negative retained earnings balance.
f. Accumulated other comprehensive income is the other comprehensive
income [from items such as unrealized increases (gains)or decreases (losses) in
the fair value of investments in available-for-sale securities] that a corporation
has accumulated to date.
Q4-18 Investments by owners are increases in the equity of a company resulting from
transfers of something valuable to the company from other entities to obtain or
increase ownership interests. Distributions to owners are decreases in the equity of a
company caused by transferring assets, rendering services, or incurring liabilities to
owners. Many companies report these items in a statement of changes in
stockholders' equity.
Q4-19 Examples of accounting policies that are disclosed in the notes accompanying a
company's financial statements include:
1. Basis for consolidation
2. Depreciation and amortization methods
3. Inventory pricing method
4. Method for recognition of profits on long-term contracts
5. Revenue recognition method for franchise and leasing operations
6. Methods of foreign currency translation
The disclosure of accounting policies is important because it enables the external
users of financial statements to see:
1. What method is employed by the company among existing acceptable
alternatives.
2. Whether any method peculiar to the industry is used by the company.
3. Whether there are any unusual or innovative applications of GAAP.
Q4-20 Financial instruments include items such as notes payable and receivable, contracts
for loan commitments, collateralized mortgages, interest rate swaps, and put and
call options on stocks. A company is also required to disclose the fair value of all its
financial instruments (both assets and liabilities), whether recognized or not on the
balance sheet, as well as all significant concentrations of credit risk due to its
financial instruments. A company is required to disclose information such as the types
of derivative financial instruments it holds, its objectives in holding the instruments,
and its strategies for achieving these objectives. The description must indicate the
company's risk management policy in regard to each type of instrument.
4-7
Q4-21 A loss contingency is a situation that exists for a company on its balance sheet date
involving uncertainty as to possible losses that it may incur if some future event
occurs.
The following criteria are required for a company to accrue a loss contingency:
1. It is probable that a liability has been incurred (or an asset impaired), and
2. The amount of the loss can be reasonably estimated.
If one of these criteria is not met, a company discloses a loss contingency in a note
accompanying its financial statements.
Q4-22 Usually a time lag of several weeks or months exists between the end of a company's
accounting period and the date when it issues its annual report. During this time, it is
possible for significant business events and transactions to occur, which, if not
disclosed in the company's annual report, would cause this report to be misleading.
When subsequent events occur that provide additional evidence about conditions
that existed on the balance sheet date and significantly affect the estimates the
company used in its financial statements, an adjustment is made to the financial
statements. Subsequent events that provide evidence concerning conditions that
did not exist on the balance sheet date but occurred after that date are disclosed in
the form of a note, in pro-forma ("as if") statements, or in an explanatory paragraph in
the audit report, depending on the materiality of the financial impact.
Q4-23 For related-party transactions, a company must disclose (1) the nature of the
relationship involved, (2) a description of the transactions, (3) the dollar amount of
the transactions, and (4) any amounts due to or from the related parties on the
balance sheet date.
Q4-24 Comparative financial statements provide current as well as past financial
information about a company. This information enables a trend to be drawn of the
company's activities, thus yielding useful insights into the prediction of the company's
future performance.
Q4-25 In an audit the certified public accountant is responsible for making an examination
of the accounting system, records, and reports of a company in accordance with
generally accepted auditing standards and, based on this examination, expressing
an opinion as to the effectiveness of the company’s internal control over its financial
reporting, and the fairness of the company's financial statements and
accompanying notes in accordance with generally accepted accounting
principles. The opinion, or auditor's report, usually provides external users with
additional confidence that the reported financial statements and notes are a fair
presentation of the company's financial resources, obligations, and activities.
Q4-26 The SEC "integrated" disclosures that most regulated companies include in their
annual reports are:
(1) Comparative financial statements. These include comparative balance sheets
for two years and comparative income statements and statements of cash
flows for three years.
4-8
Q4-26 (continued)
(2) Selected financial data. These include (for a five-year period) net sales or
operating revenues, income (loss) from continuing operations and related
earnings per share, total assets, long-term obligations and redeemable stock,
and cash dividends declared per share.
(3) Management's discussion and analysis. This involves a discussion and analysis of
the company's financial condition, changes in financial condition, and results of
operations. It includes, at a minimum, specific information about short-term
and long-term liquidity and capital resources, a narrative discussion of the
impact of inflation on sales and on income from continuing operations,
explanations of material changes in financial statement items between years,
and known events and uncertainties expected to impact future operations.
(4) Common stock market prices and dividends. Information included here
consists of the principal trading markets for the company's common stock, the
high and low market prices for each quarter in the last two years, the
approximate number of stockholders, the dividends paid in the last two years,
and any dividend restrictions.
Q4-27 On a balance sheet prepared using IFRS, a company will normally report noncurrent
assets (property, plant, and equipment, investments, long-term receivables, and
intangible assets) first followed by current assets. The liabilities and owners’ equity
sections are also usually ordered differently. Usually, capital and reserves (e.g.,
common stock, additional paid-in capital) are listed first, followed by noncurrent
liabilities. Current liabilities are listed last.
Q4-28 The report form of the balance sheet takes a vertical format in which the asset
accounts are listed first and the liability and stockholders' equity accounts are listed in
sequential order directly below the assets. In the account form, the balance sheet is
organized in a horizontal fashion, with the asset accounts listed on the left-hand side
and liabilities and stockholders' equity accounts listed on the right-hand side.
Q4-29 Additional information not included in the accounts reported on a company's
financial statements can be disclosed by the following alternative methods.
1. Notes are used to describe narrative information and to provide additional
monetary amounts (and sometimes supplemental schedules).
Examples include:
1. Summary of significant accounting policies
b. Contingent liabilities
2. Supporting schedules are used to complement an entire financial statement or
explain a summary amount on a specific financial statement. Examples include:
a. Retained earnings statement
b. Categories of inventories
3. Parenthetical notations are used to explain items such as the method of valuation
or of determining the ending inventory, or to cross-reference certain related asset
and liability accounts. Examples include:
4-9
Q4-29 (continued)
3. (continued)
a. Lower of cost or market method of valuing inventories
b. The FIFO method of valuing ending inventory
c. Cross-referencing a bond sinking fund to the related bonds payable
Q4-30 When preparing and writing financial reporting notes, the accountant should (1)
specify what data are to be disclosed (by reference to related generally accepted
accounting principles), (2) outline the desired format, (3) use short sentences, (4) use
terminology understandable to the non-accountant, and (5) be concise but
complete.
ANSWERS TO MULTIPLE CHOICE
1. d 3. a 5. a 7. c 9. d
2. d 4. a 6. b 8. c 10. b
4-10
SOLUTIONS TO REVIEW EXERCISES
RE4-1
(1) Assets-C
(2) Liabilities-A
(3) Stockholders’ Equity-B
RE4-2
Current Assets*
Cash $ 1,500
Marketable securities 3,000
Accounts receivable $ 7,600
Less: Allowance for doubtful accounts (1,100) 6,500
Inventories 23,600
Prepaid rent 2,400
Total current assets $37,000
*Note: Accounts payable is not included in the current assets section of the balance
sheet.
RE4-3
Current Liabilities*
Accounts payable $ 7,200
Salaries payable 5,800
Income taxes payable 4,000
Dividends payable 750
Short-term notes payable 2,500
Total current liabilities $20,250
*Note: Investment in held-to-maturity bonds is not included in the current liabilities
section of the balance sheet.
RE4-4
Working capital = Current assets – Current liabilities
Working capital = $37,000 - $20,250
Working capital = $16,750
RE4-5
Long-Term Investments*
Investment in held-to-maturity bonds $ 6,500
Fund to retire long-term bonds payable 7,750
Long-term advances to unconsolidated affiliates 3,500
Total long-term investments $17,750
4-11
RE4-5 (continued)
*Note: Trademarks are not included in the long-term investments section of the balance
sheet.
RE4-6
Property, Plant, and Equipment*
Land $ 50,000
Buildings $175,000
Less: Accumulated depreciation (57,500) 117,500
Equipment $ 95,000
Less: Accumulated depreciation (25,000) 70,000
Total property, plant, and equipment $237,500
*Note: Patents and Investment in held-to-maturity bonds are not included in the
property, plant, and equipment section of the balance sheet.
RE4-7
Intangible Assets*
Trademarks $ 37,000
Patents 13,000
Computer software costs 8,500
Goodwill 11,000
Total intangible assets $ 69,500
*Note: Prepaid rent, land, and inventories are included in the intangible assets section
of the balance sheet.
RE4-8
Long-Term Liabilities*
Bonds payable $ 4,500
Less: Unamortized bond discount (600) $ 3,900
Mortgage payable 5,000
Accrued pension cost 9,000
Total long-term liabilities $17,900
*Note: Fund to retire long-term bonds payable is not included on the long-term liabilities
section of the balance sheet.
RE4-9
Cash* 1,250,000
Common stock, $2 par 100,000
Additional paid-in capital on common stock 1,150,000
4-12
RE4-10
Stockholders’ Equity*
Contributed Capital
Common stock, $5 par $ 50,000
Additional paid-in capital on common stock 200,000
Total contributed capital $250,000
Retained earnings 120,000
Accumulated other comprehensive income 24,500
Total stockholders’ Equity $394,500
*Note: Income taxes payable is not included in the stockholders’ equity section of the
balance sheet.
SOLUTIONS TO EXERCISES
E4-1
JENKINS COMPANY
Current Asset Section of Balance Sheet
December 31, 2010
Current Assets
Cash:
On hand $ 1,120
In bank 5,400 $ 6,520
Marketable securities (short-term) 3,380
Accounts receivable $15,600
Less: Allowance for doubtful accounts (1,100) 14,500
Inventory 19,700
Prepaid items:
Insurance $ 1,530
Office supplies 970 2,500
Total current assets $46,600
4-13
E4-2
MOEN CORPORATION
Property, Plant, and Equipment Section of
Balance Sheet
December 31, 2010
Accumulated Book
Cost Depreciation Value
Land $ 19,000 – $ 19,000
Buildings* 170,000 $51,000 119,000
Factory machinery 44,000 31,100 12,900
Office equipment 14,500 8,200 6,300
Office furniture 17,900 6,500 11,400
Totals $265,400 $96,800 $168,600
*Includes office building with cost and accumulated depreciation of
$50,000 and $15,000, respectively, and factory building with cost
and accumulated depreciation of $120,000 and $36,000, respectively.
E4-3
GRAF CORPORATION
Stockholders' Equity Section of
Balance Sheet
December 31, 2010
Contributed Capital
Preferred stock, $100 par $ 65,400
Common stock, $10 par 47,100
Premium on preferred stock 39,600
Premium on common stock 53,900
Total contributed capital $206,000
Retained Earnings 209,000
Accumulated Other Comprehensive Income 8,200
Total $423,200
Less: Treasury stock (at cost) (7,600)
Total Stockholders' Equity $415,600
4-14
E4-4
1. A 5. G 9. F 13. F
2. G√ 6. D 10. G 14. C
3. I 7. K√+ 11. D 15. B
4. A 8. I 12. J√*
+The unrealized decrease is a negative (although not strictly a contra-
account) component of Accumulated Other Comprehensive Income.
*Although the letter is checked, the Deficit account is not a contra-account
to retained earnings. Instead, it is the title given to a negative retained
earnings balance.
E4-5
1. A 8. F 15. H 21. X Treasury stock (at cost) should be
2. G 9. C√ 16. I subtracted from the sum of contributed
3. C 10. D 17. G capital, retained earnings, and
4. J√* 11. B 18. A accumulated other comprehensive
5. A 12. A√ 19. I income to arrive at total stockholders'
6. D 13. B 20. C equity.
7. B 14. F 22. K
*Although the letter is checked, the Deficit account is not a contra-account to
retained earnings. Instead, it is the title given to a negative retained earnings
balance.
4-15
E4-6
1. BAGGETT COMPANY
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $ 4,300
Accounts receivable $ 12,600
Less: Allowance for doubtful accounts (1,600) 11,000
Inventory 7,400
Prepaid items 1,800
Total current assets $ 24,500
Long-Term Investments
Notes receivable (due 2012) $16,400
Sinking fund to retire bonds payable 5,000
Total long-term investments 21,400
Property, Plant, and Equipment
Land $12,200
Buildings $ 57,400
Less: Accumulated depreciation (21,000) 36,400
Equipment $ 28,700
Less: Accumulated depreciation (9,700) 19,000
Total property, plant, and equipment 67,600
Intangible Assets
Patents (net) 4,600
Total Assets $118,100
Liabilities
Current Liabilities
Accounts payable $13,100
Income taxes payable 3,800
Wages payable 1,400
Total current liabilities $ 18,300
Long-Term Liabilities
Bonds payable (due 2020) $ 23,000
Premium on bonds payable 1,400 $24,400
Notes payable (due 2013) 6,000
Total long-term liabilities 30,400
Other Liabilities
Advances from customers (long-term) 2,600
Total Liabilities $ 51,300
(continued on next page)
4-16
E4-6 (continued)
1. (continued)
Stockholders' Equity
Contributed Capital
Preferred stock, $100 par $18,600
Common stock, $10 par 12,700
Premium on preferred stock 7,900
Premium on common stock 9,300
Total contributed capital $ 48,500
Retained Earnings 18,300
Total Stockholders' Equity $ 66,800
Total Liabilities and Stockholders' Equity $118,100
2. Debt ratio = Total liabilities ÷ Total assets
43.4% = $51,300 ÷ $118,100
E4-7
1. HITT COMPANY
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $ 2,900
Marketable securities (short-term) 6,100
Accounts receivable $ 21,500
Less: Allowance for doubtful accounts (800) 20,700
Inventory 37,200
Total current assets $ 66,900
Property, Plant, and Equipment
Land $30,000
Buildings $144,000
Less: Accumulated depreciation (53,000) 91,000
Equipment $ 72,400
Less: Accumulated depreciation (35,100) 37,300
Total property, plant, and equipment 158,300
Intangible Assets
Patents (net) $ 9,800
Trademarks 3,700
Total intangible assets 13,500
Total Assets $238,700
(continued on next page)
4-17
E4-7 (continued)
1. (continued)
Liabilities
Current Liabilities
Accounts payable $22,400
Current taxes payable 10,400
Salaries payable 2,000
Total current liabilities $ 34,800
Long-Term Liabilities
Bonds payable (due 2021) $77,000
Less: Discount on bonds payable (6,900)
Total long-term liabilities 70,100
Total Liabilities $104,900
Stockholders' Equity
Contributed Capital
Preferred stock, $100 par $21,000
Common stock, $10 par 30,000
Additional paid-in capital on preferred stock 11,500
Additional paid-in capital on common stock 24,000
Total contributed capital $ 86,500
Retained Earnings 46,200
Accumulated Other Comprehensive Income
Unrealized increase in value of marketable securities 1,100
Total Stockholders' Equity $133,800
Total Liabilities and Stockholders' Equity $238,700
2. Working capital = Current assets - Current liabilities
$32,100 = $66,900 - $34,800
Current ratio = Current assets ÷ Current liabilities
1.92 = $66,900 ÷ $34,800
3, If the Hitt Company used IFRS, it would list the non-current assets first and
would not separate them into Property, Plant, and Equipment and Intangible
Assets. The total of the Non-current Assets section would be $171,800
($158,300 + $13,500). The Current Assets section would be listed next at
$66,900 so the Total Assets would be $238,700, the same as Requirement 1.
In the lower portion of the balance sheet, Stockholders’ Equity (or simply,
Equity) would be listed first, and there would be some different account titles.
Then Non-current Liabilities would be listed next, followed by Current
Liabilities. The total of these three sections would be $238,700, the same as
Requirement 1.
4-18
E4-8
Note to Instructor: The solution is shown in a balance sheet format. The answers are
lettered (a) through (l).
DAWSON COMPANY
Balance Sheet
December 31
2010 2011
Current assets $ 26,900(a) $ 25,000
Long-term investments 19,200 22,200(h)
Property, plant, and equipment (net) 85,700 92,800
Intangible assets 10,400 9,200
Total assets $142,200 $149,200(j)
Current liabilities $ 14,500 $ 12,300
Long-term liabilities 35,800(b) 34,900
Total liabilities $ 50,300(d) $ 47,200(i)
Capital stock, $5 par $ 20,000(e) $ 20,000
Additional paid-in capital 15,000 15,000(k)
Total contributed capital $ 35,000(c) $ 35,000(g)
Retained earnings 50,000 60,000
Accumulated other comprehensive income 6,900 7,000
Total stockholders' equity $ 91,900(f) $102,000(l)
Total liabilities & stockholders' equity $142,200 $149,200
4-19
E4-9
Note to Instructor: The solution is shown in a balance sheet format. The answers are
numbered (1) through (14).
FERMER COMPANY
Balance Sheet
December 31
2010 2011
Current assets $ 19,100 $ 20,000(8)a
Long-term investments 23,700 21,200(13)
Property, plant, and equipment (net) 79,400(3) 87,500
Intangible assets 12,600 12,000
Total assets $134,800(5) $140,700(11)
Current liabilities $ 9,200(2)a $ 9,800
Long-term liabilities 28,900(4) 30,200
Total liabilities $ 38,100 $ 40,000(14)
Capital stock, $10 par $ 17,000(6)b $ 18,000(12)c
Additional paid-in capital 34,000(7)b 36,000
Total contributed capital $ 51,000 $ 54,000(9)
Retained earnings 40,900 41,700(10)
Accumulated other comprehensive income 4,800 5,000
Total stockholders' equity $ 96,700(1) $100,700
Total liabilities & stockholders' equity $134,800 $140,700
aWorking capital = Current assets - Current liabilities;
2010: $9,900 = $19,100 - $9,200(2); 2011: $10,200 = $20,000(8) - $9,800
bContributed capital = Common stock(x) + Additional paid-in capital(2x)
$51,000 = x + 2x; $51,000 = 3x; x = $17,000, 2x = $34,000
c$17,000 + (100 shares x $10 par)
4-20
E4-10
STEVENS COMPANY
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $ 2,300
Temporary investments in marketable
securities 3,200
Accounts receivable $ 5,900
Less: Allowance for doubtful accounts (800) 5,100
Inventory 6,000
Prepaid items:
Insurance $ 1,200
Office supplies 800 2,000
Total current assets $18,600
Long-Term Investments
Investment in held-to-maturity bonds 10,000
Plant and Equipment
Land $ 8,100
Buildings and equipment $35,600
Less: Accumulated depreciation (9,200) 26,400
Total plant and equipment 34,500
Intangible Assets
Patents (net) 5,000
Total Assets $68,100
Liabilities
Current Liabilities
Accounts payable $ 9,900
Salaries payable 1,500
Taxes payable 2,500
Unearned rent 900
Total current liabilities $14,800
Long-Term Liabilities
Bonds payable (due 2013) $11,000
Less: Discount on bonds payable (1,000)
Total long-term liabilities 10,000
Total Liabilities $24,800
(continued on next page)
4-21
E4-10 (continued)
Stockholders' Equity
Contributed Capital
Common stock, $10 par $12,000
Premium on common stock 10,400
Total contributed capital $22,400
Retained Earnings 24,200
Total contributed capital and retained earnings $46,600
Less: Treasury stock (at cost) (3,300)
Total Stockholders' Equity $43,300
Total Liabilities and Stockholders' Equity $68,100
4-22
E4-11
POWDER COMPANY
Statement of Changes in Stockholders' Equity
For Year Ended December 31, 2010
Additional Additional
Preferred Common Paid-in Capital Paid-in Capital
Stock Stock on Preferred on Common Retained
$100 par $5 par Stock Stock Earnings Total
Balances, 1/1/10 $ 92,800 $37,400 $21,500 $58,700 $185,700 $396,100
Common stock issued 9,000 14,400 23,400
Preferred stock issued 34,000 10,200 44,200
Net income 38,950 38,950
4-23
Cash dividend paid on
preferred* ( 8,876) (8,876)
Cash dividend paid on
common+ ________ _______ _______ _______ (9,280) (9,280)
Balances, 12/31/10 $126,800 $46,400 $31,700 $73,100 $206,494 $484,494
*Preferred dividend: $7 x (928 + 340 shares) = $8,876.
+Common dividend: $1 x (7,480 + 1,800 shares) = $9,280.
4-23
E4-12
E3-11
OSBORNE COMPANY
Statement of Changes in Stockholders' Equity
For Year Ended December 31, 2010
Additional Additional
Preferred Common Paid-in Capital Paid-in
Stock Stock on Preferred Capital Retained
$100 par $5 par Stock on Common Total
Stock Earnings
Balances, 1/1/10 $ 60,000 $80,000 $12,000 $170,000 $209,000 $531,000
Common stock issued 6,000 24,000 30,000
4-24
Preferred stock issued 50,000 12,500 62,500
3-30
Net income 99,000 99,000
Cash dividend paid on
preferred* ( 8,800) (8,800)
Cash dividend paid on
common+ _______ _______ _______ ________ (64,500) (64,500)
Balances, 12/31/10 110,000 $86,000 $24,500 $194,000 $234,700 $649,200
*Preferred dividend: $8 x [($60,000 ÷ $100 par) + 500] = $8,800.
+Common dividend: $1.50 x [($80,000 ÷ $2 par) + 3,000] = $64,500.
4-24
SOLUTIONS TO PROBLEMS
P4-1
1. D
2. F
3. A
4. F
5. G√
6. C
7. C
8. B
9. C Timberland is considered to be a natural resource.
10. X Treasury stock (at cost) should be subtracted from the sum of
contributed capital, retained earnings, and accumulated other
comprehensive income to arrive at total stockholders' equity.
11. A Advances to sales personnel are considered to be prepaid items.
12. E
13. H
14. A
15. B
16. C
17. E
18. X This is a miscellaneous item of stockholders' equity
19. D
20. A
21. F
22. B
23. A
24. J
25. B
26. B
27. C
28. I
29. A
30. A
31. G This represents the company's obligation for future pension payments to
retiring employees.
32. G
33. B
34. F
35. F
36. K√ The unrealized decrease is a negative (although not strictly a contra-
account) component of Accumulated Other Comprehensive Income
37. A
4-25
P4-2 OLIVER MANUFACTURING COMPANY
Balance Sheet
December 31, 2010
Assets Liabilities
Current Assets Current Liabilities
Cash on hand Notes payable (short-term)
Cash in bank Accounts payable
Temporary investments in Salaries payable
marketable securities Mortgage payable (current portion)
Notes receivable (short-term) Interest payable
Accounts receivable Dividends payable
Less: Allowance for doubtful accounts Income taxes payable
Interest receivable Unearned rent
Inventory Estimated warranty obligations
Raw materials Total current liabilities
Work in process
Finished goods Long-Term Liabilities
Prepaid items Bonds payable (due 2022)
3-30
Insurance Premium on bonds payable
Office supplies Mortgage payable (long-term portion)
Total current assets Accrued pension cost
Total long-term liabilities
Long-Term Investments
Investment in available-for-sale Other Liabilities
securities Deferred taxes payable
Land for future plant site Total other liabilities
Bond sinking fund
Cash surrender value of life
insurance
Total long-term investments Total Liabilities
Property, Plant, and Equipment
Land Stockholders' Equity
Buildings
Less: Accumulated depreciation Contributed Capital
Machinery Preferred stock
Less: Accumulated depreciation Common stock
Equipment Additional paid-in capital on:
Less: Accumulated depreciation Preferred stock
Total property, plant, and Common stock
equipment Total contributed capital
Retained Earnings
Intangible Assets Accumulated Other Comprehensive
Trademarks Income
Patents (net) Unrealized increase in value of
Total intangible assets available-for-sale securities
Total contributed capital, retained
earnings, and accumulated other
comprehensive income
Less: Treasury stock, at cost
Total Stockholders' Equity
Total Assets Total Liabilities and Stockholders' Equity
4-26
P4-3
GREEN MANUFACTURING COMPANY
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $ 7,200
Marketable securities (short-term) 8,400
Accounts receivable $15,300
Less: Allowance for doubtful accounts (1,000) 14,300
Inventory
Raw materials $10,100
Work in process 14,700
Finished goods 23,800 48,600
Prepaid insurance 2,600
Total current assets $ 81,100
Long-Term Investments
Bond sinking fund $ 7,700
Investment in available-for-sale stock 16,400
Total long-term investments 24,100
Property, Plant, and Equipment
Land $17,000
Buildings $92,500
Less: Accumulated depreciation (32,400) 60,100
Machinery and equipment $57,800
Less: Accumulated depreciation (30,000) 27,800
Total property, plant, and equipment 104,900
Intangible Assets
Patents (net) 8,600
Total Assets $218,700
(continued on next page)
4-27
P4-3 (continued)
Liabilities
Current Liabilities
Notes payable $ 5,000
Accounts payable 20,900
Interest payable 500
Wages payable 2,700
Dividends payable 5,600
Income taxes payable 8,900
Unearned rent 5,000
Total current liabilities $ 48,600
Long-Term Liabilities
Bonds payable (due 2024) $29,000
Less: Discount on bonds payable (2,500) $26,500
Accrued pension cost 13,300
3-30
Total long-term liabilities 39,800
Other Liabilities
Deferred taxes payable 2,800
Total Liabilities $ 91,200
Stockholders' Equity
Contributed Capital
Preferred stock, $100 par $30,000
Common stock, $10 par 44,100
Premium on preferred stock 7,000
Premium on common stock 16,300
Total contributed capital $ 97,400
Retained Earnings 28,100
Accumulated Other Comprehensive Income
Unrealized increase in value of
available-for-sale stock 2,000
Total Stockholders' Equity $127,500
Total Liabilities and Stockholders' Equity $218,700
Additional parenthetical or note disclosures which might be made include:
1. Inventory costing and valuation methods(s) for raw materials, goods in
process, and finished goods.
2. Valuation method for marketable securities and investment in stock.
3. Number of shares of preferred and common stocks authorized and issued.
4. Pension plan information.
5. Bond indenture provisions, including sinking fund information.
4-28
P4-3 (continued)
Working capital = Current assets - Current liabilities
$32,500 = $81,100 - $48,600
Current ratio = Current assets ÷ Current liabilities
1.67 = $81,100 ÷ $48,600
P4-4
1.
INTERNATIONAL PRODUCTS COMPANY
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $ 8,200
Accounts receivable $13,800
Less: Allowance for doubtful accounts (700) 13,100
Inventory 24,400
Prepaid items
Insurance $ 900
Office supplies 1,900 2,800
Total current assets $ 48,500
Long-Term Investments
Investment in held-to-maturity bonds $ 9,000
Sinking fund for bond retirement 4,000
Total long-term investments 13,000
Property, Plant, and Equipment
Land $ 9,500
Buildings $50,000
Less: Accumulated depreciation (12,400) 37,600
Equipment $29,000
Less: Accumulated depreciation (8,300) 20,700
Total property, plant, and equipment 67,800
Intangible Assets
Patents (net) 2,400
Total Assets $131,700
(continued on next page)
4-29
P4-4 (continued)
1. (continued)
Liabilities
Current Liabilities
Accounts payable $16,500
Current interest payable 2,900
Dividends payable 1,800
Accrued wages 3,700
Current income taxes payable 4,200
Total current liabilities $ 29,100
Long-Term Liabilities
Bonds payable (due 2016) $29,000
Less: Discount on bonds payable (2,000)
$27,000
Notes payable (due 1/1/2013) 17,000
Total long-term liabilities 44,000
3-30
Total Liabilities $ 73,100
Stockholders' Equity
Contributed Capital
Preferred stock $50 par $10,000
Common stock, $10 par 15,000
Additional paid-in capital on preferred stock 1,600
Additional paid-in capital on common stock 7,700
Total contributed capital $34,300
Retained Earnings 25,800
Total contributed capital and retained earnings $60,100
Less: Treasury stock (at cost) (1,500)
Total Stockholders' Equity $ 58,600
Total Liabilities and Stockholders' Equity $131,700
4-30
P4-4 (continued)
2. Note: The account titles in this IFRS solution are the same as in the book. They may
be different in an actual IFRS balance sheet.
INTERNATIONAL PRODUCTS COMPANY
Balance Sheet
December 31, 2010
Assets
Noncurrent Assets
Investment in held-to-maturity bonds $ 9,000
Sinking fund for bond retirement 4,000
Land 9,500
Buildings $50,000
Less: Accumulated depreciation (12,400) 37,600
Equipment $29,000
Less: Accumulated depreciation (8,300) 20,700
Patents (net) 2,400
Total noncurrent assets $ 83,200
Current Assets
Cash $ 8,200
Accounts receivable $13,800
Less: Allowance for doubtful accounts (700) 13,100
Inventory 24,400
Prepaid items
Insurance $ 900
Office supplies 1,900 2,800
Total current assets 48,500
Total Assets $131,700
Stockholders' Equity
Contributed Capital
Preferred stock $50 par $10,000
Common stock, $10 par 15,000
Additional paid-in capital on preferred stock 1,600
Additional paid-in capital on common stock 7,700
Total contributed capital $34,300
Retained Earnings 25,800
Total contributed capital and retained earnings $60,100
Less: Treasury stock (at cost) (1,500)
Total Stockholders' Equity $ 58,600
(continued on next page)
4-31
P4-4 (continued)
2. (continued)
Liabilities
Noncurrent Liabilities
Bonds payable (due 2016) $29,000
Less: Discount on bonds payable (2,000)
$27,000
Notes payable (due /1/2013) 17,000
Total noncurrent liabilities $ 44,000
Current Liabilities
Accounts payable $16,500
Current interest payable 2,900
Dividends payable 1,800
Accrued wages 3,700
Current income taxes payable 4,200
Total current liabilities 29,100
3-30
Total Liabilities $ 73,100
Total Stockholders’ Equity and Liabilities $131,700
4-32
P4-5
MEADOWS COMPANY
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $ 7,900
Marketable securities (short-term) 10,100
Accounts receivable 18,000
Inventories 32,000
Prepaid insurance 5,000
Total current assets $ 73,000
Long-Term Investments
Investment in held-to-maturity bonds $ 36,000
Long-term receivables 38,600 74,600
Property, Plant, and Equipment
Property, plant, and equipment $148,000
Less: Accumulated depreciation (44,000) 104,000
Intangible Assets
Patents (net) 13,000
Total Assets $264,600
Liabilities
Current Liabilities
Accounts payable $ 9,800
Accrued payables 6,500
Income taxes payable 7,500
Current portion of long-term debt 6,200
Total current liabilities $ 30,000
Long-Term Liabilities
Long-term debt 56,300
Other Liabilities
Deferred taxes payable 12,500
Total Liabilities $ 98,800
(continued on next page)
4-33
P4-5 (continued)
Stockholders' Equity
Contributed Capital
Common stock, $5 par $ 29,600
Additional paid-in capital 50,600
Total contributed capital $ 80,200
Retained Earnings 86,600a
Accumulated Other Comprehensive Loss
Unrealized decrease in value of
available-for-sale securities (1,000)
Total Stockholders' Equity $165,800
Total Liabilities and Stockholders' Equity $264,600
aBeginning retained earnings + Net income - Dividends; $64,800 + ($278,000 -
$8,000 - $175,500 - $21,500 - $27,560 - $4,300 - $12,340) - $7,000
3-30
Debt ratio = Total liabilities ÷ Total assets
37.3% = $98,800 ÷ $264,600
P4-6
1. EUBANKS COMPANY
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $11,600
Temporary investments in marketable
securities (Note 1) 19,100
Accounts receivable $32,300
Less: Allowance for doubtful accounts (1,500) 30,800
Inventories (Notes 1 and 2) 98,500
Total current assets $160,000
Long-Term Investments
Investment in bonds (Note 1) $25,000
Land held for building site 19,500
Cash surrender value of life insurance 8,900
Total long-term investments 53,400
Property, plant, and equipment (net) (Notes 1 and 3) 229,300
Intangible Assets
Patents (net) (Note 1) 18,200
Total Assets $460,900
(continued on next page)
4-34
P4-6 (continued)
1. (continued)
Liabilities
Current Liabilities
Accounts payable $58,000
Income taxes payable 24,700
Miscellaneous current payables 6,200
Estimated liability for product warranties 7,300
Total current liabilities $ 96,200
Long-Term Liabilities
Bonds payable (mature on 12/31/2015) $80,000
Premium on bonds payable 4,800
Total long-term liabilities 84,800
Total Liabilities $181,000
Stockholders’ Equity
Contributed Capital
Preferred stock, $100 par, 1,000 shares
authorized, 400 shares issued $40,000
Common stock, $10 par, 12,000 shares
authorized, 6,280 shares issued 62,800
Additional paid-in capital on:
Preferred stock 23,400
Common stock 30,300
Total contributed capital $156,500
Retained Earnings 123,400
Total Stockholders’ Equity $279,900
Total Liabilities and Stockholders’ Equity $460,900
2. (1) Summary of significant accounting policies:
a. Inventories are valued at the lower of average cost or market.
b. Property, plant, and equipment are reported at cost less accumulated
depreciation. The straight-line method is used to depreciate all property,
plant, and equipment, except land.
c. Patents are amortized on a straight-line basis directly to the Patent
account.
d. Temporary investments in marketable securities are reported at their
market value.
e. Investment in bonds is carried at original cost (face value) and is being
held to maturity.
4-35
P4-6 (continued)
2. (continued)
(2) Composition of inventories:
The inventories of the company as of December 31, 2010 are made up of
the following components:
Raw materials $22,200
Work in process 34,700
Finished goods 41,600
Total $98,500
(3) Composition of property, plant, and equipment:
The property, plant, and equipment of the company as of December 31,
2010 consists of the following:
3-30
Accumulated Book
Item Cost Depreciation Value
Land $ 32,000 – $ 32,000
Buildings 182,400 $ 62,200 120,200
Machinery 63,900 18,600 45,300
Equipment 53,000 21,200 31,800
Total $331,300 $102,000 $229,300
3. Current ratio = Current assets ÷ Current liabilities
1.66 = $160,000 ÷ $96,200
Liquid Assets Separable Assets
Cash $11,600 Accounts receivable (net) $ 30,800
Temporary investments 19,100 Inventories 98,500
Total $30,700 $129,300
These classifications might be useful in helping to better assess the company's
liquidity and financial flexibility.
4-36
P4-7
1. BLAZER COMPANY
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $ 13,800
Notes receivable 17,000
Accounts receivable $37,100
Less: Allowance for doubtful accounts (1,600) 35,500
Inventory (Note 1) 85,300
Total current assets $151,600
Long-Term Investments
Investment in affiliate, at cost (Note 2) $ 30,000
Bond sinking fund 12,500
Total long-term investments 42,500
Property, Plant, and Equipment (Notes 1 and 3) $296,700
Less: Accumulated depreciation (109,300)
Total property, plant, and equipment 187,400
Total Assets $381,500
Liabilities
Current Liabilities
Accounts payable $ 44,200
Income taxes payable 19,700
Miscellaneous current payables 6,800
Total current liabilities $ 70,700
Long-term liabilities (Note 4) 91,000
Total Liabilities $161,700
Stockholders' Equity
Contributed Capital
Preferred stock, $50 par, 2,000 shares
authorized, 640 shares issued $ 32,000
Common stock, $10 par, 10,000 shares
authorized, 8,000 shares issued 80,000
Additional paid-in capital on:
Preferred stock 3,200
Common stock 20,000
Total contributed capital $135,200
Retained Earnings 84,600
Total Stockholders' Equity $219,800
Total Liabilities and Stockholders' Equity $381,500
4-37
2.
P4-7 (continued)
BLAZER COMPANY
Statement of Changes in Stockholders' Equity
For Year Ended December 31, 2010
Additional Additional
Preferred Common Paid-in Capital Paid-in Capital
Stock Stock on Preferred on Common Retained
$50 par $10 par Stock Stock Earnings Total
Balances, 1/1/10* $25,000 $70,000 $2,500 $17,000 $55,100 $169,600
Common stock issued 10,000 3,000 13,000
4-38
Preferred stock issued 7,000 700 7,700
Net income 50,500 50,500
Dividends paid (21,000) (21,000)
Balances, 12/31/10 $32,000 $80,000 $3,200 $20,000 $84,600 $219,800
*Each of the beginning balances must be derived by taking the ending balances as given and adjusting
for the transactions that occurred during the year affecting each respective account.
P4-7 (continued)
3. (1) Summary of significant accounting policies:
a. The straight-line method is used to depreciate property and equipment
based upon cost, estimated residual value, and estimated useful life.
b. Inventory is valued at the lower of average cost or market.
(2) Guarantee to affiliate:
The company has guaranteed the interest on 12%, $50,000, 15-year
bonds issued by the affiliate.
(3) Composition of property, plant, and equipment:
Accumulated Book
Item Cost Depreciation Value
Land $ 29,500 – $ 29,500
Buildings 164,600 $ 54,600 110,000
Store fixtures 72,600 37,400 35,200
Office equipment 30,000 17,300 12,700
Total $296,700 $109,300 $187,400
(4) Composition of long-term liabilities:
Unamortized Book
Item Maturity Date Face Value Premium (Discount) Value
12% bonds 12/31/2015 $36,000 $(1,000) $35,000
11% bonds 12/31/2019 48,000 1,800 49,800
13% note 01/01/2013 6,200 -- 6,200
Total $90,200 $ 800 $91,000
(5) Subsequent events:
On January 15, 2011, a building with a cost of $20,000 and a book value of
$7,000 was totally destroyed. Insurance proceeds will amount to $5,000.
4. (a) Debt ratio = Total liabilities ÷ Total assets
42.4% = $161,700 ÷ $381,500
The debt ratio for 2010 has increased by over 3% compared to 2009. This
indicates that there may be slightly more risk for investors and creditors because
of higher interest payments that may have to be made by the company. On
the other hand, stockholders may benefit if the company can make a higher
return on the additional debt equity than the interest paid.
4-39
P4-8
CABLE COMPANY
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $12,300
Temporary investments in marketable
securities 17,000
Accounts receivable $ 18,000
Less: Allowance for doubtful accounts (1,400) 16,600
Inventories 32,000
Prepaid items:
Insurance 2,400
Office supplies 3,500
Total current assets $ 83,800
Long-Term Investments
Investment in available-for-sale stock 29,000
Property, Plant, and Equipment
Land $12,000
Buildings and equipment $100,000
Less: Accumulated depreciation (40,000) 60,000
Total property, plant, and equipment 72,000
Total Assets $184,800
Liabilities
Current Liabilities
Accounts payable $22,700
Income taxes payable 16,400
Wages payable 3,600
Total current liabilities $ 42,700
Long-Term Liabilities
Bonds payable (due 2020) $ 33,000
Less: Discount on bonds payable (3,000) $30,000
Notes payable (due 2012) 17,000
Accrued pension cost 6,500
Total long-term liabilities 53,500
Total Liabilities $ 96,200
(continued on next page)
4-40
P4-8 (continued)
Stockholders' Equity
Contributed Capital
Preferred stock, $100 par $12,000
Common stock, $5 par 25,000
Premium on preferred stock 2,600
Premium on common stock 15,600
Total contributed capital $ 55,200
Retained Earnings 40,000
Accumulated Other Comprehensive Loss
Unrealized decrease in value of
available-for-sale securities (1,300)
Total contributed capital, retained earnings,
and accumulated other comprehensive
income $ 93,900
Less: Treasury stock (at cost) (5,300)
Total Stockholders' Equity $ 88,600
Total Liabilities and Stockholders' Equity $184,800
P4-9 BRANDT COMPANY
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $ 3,800
Temporary investments in
available-for-sale securities 4,600
Accounts receivable $18,500
Less: Allowance for doubtful accounts (700) 17,800
Inventory 30,500
Prepaid insurance 2,900
Total current assets $ 59,600
Long-Term Investments
Notes receivable (due 2012) $10,000
Investment in Dray Company bonds 9,000
Sinking fund for bond retirement 7,000
Total long-term investments 26,000
Property, Plant, and Equipment
Land $12,000
Buildings $63,400
Less: Accumulated depreciation (21,000) 42,400
Equipment $29,600
Less: Accumulated depreciation (13,000) 16,600
Total property, plant, and equipment 71,000
(continued on next page)
4-41
P4-9 (continued)
Intangible Assets
Patents (net) $ 5,900
Trademarks 3,700
Total intangible assets 9,600
Total Assets $166,200
Liabilities
Current Liabilities
Accounts payable $19,400
Income taxes payable 7,200
Wages payable 4,100
Current portion of mortgage payable 4,000
Total current liabilities $ 34,700
Long-Term Liabilities
Mortgage payable $16,000
Bonds payable (due 2021) $40,000
Add: Premium on bonds payable 4,300 44,300
Total long-term liabilities 60,300
Total Liabilities $ 95,000
Stockholders' Equity
Contributed Capital
Preferred stock, $100 par $ 6,000
Common stock, $5 par 11,000
Premium on preferred stock 2,400
Premium on common stock 14,700
Total contributed capital $ 34,100
Retained Earnings 37,800
Accumulated Other Comprehensive Income
Unrealized increase in value of
available-for-sale securities 1,100
Total contributed capital, retained earnings,
and accumulated other comprehensive
income $ 73,000
Less: Treasury stock (at cost) (1,800)
Total Stockholders' Equity $ 71,200
Total Liabilities and Stockholders' Equity $166,200
4-42
P4-10
Note to Instructor: The solution is shown in a balance sheet format. The answers are
lettered (a) through (p). The more difficult explanations are explained in footnotes
(1) through (6).
JOHN COMPANY
Balance Sheet
December 31
2010 2011
Current assets $ 35,200(d)2 $ 39,800
Long-term investments 40,100 42,300(o)
Property, plant, and equipment 153,000(h) 180,000
Less: Accumulated depreciation ( 37,500) (48,600)
Intangible assets 19,100 18,600
Total assets $209,900(e) $232,100(m)
Current liabilities $ 17,300(g)1 $ 20,000(p)2
Long-term liabilities 34,600(a)1 33,100
Total liabilities $ 51,900 $ 53,100(j)
Capital stock, $10 par $ 29,000(b)3 $ 30,000(i)4
Additional paid-in capital 37,700(f) 39,200(n)5
Total contributed capital $ 66,700 $ 69,200(l)
Retained earnings 83,300 100,900(k)6
Accumulated other comprehensive income 8,000 8,900
Total stockholders' equity $158,000(c) $179,000
Total liabilities & stockholders' equity $209,900 $232,100
liabilities = Current liabilities(x) + Long-term liabilities(2x)
1Total
$51,900 = x + 2x; $51,900 = 3x; x = $17,300, 2x = $34,600.
2Workingcapital = Current assets - Current liabilities;
2010: $17,900 = $35,200(d) - $17,300;
2011: $19,800 = $39,800 - $20,000(p).
32,900 shares x $10 par
4$29,000 + ($10 x 100 shares issued)
5$37,700 + [($25 - $10) x 100]
6$83,300 beginning retained earnings + $20,600 net income -
[$1 x (2,900 + 100 shares)] dividends
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P4-11
1. (1) "Balance Report" should be "Balance Sheet."
(2) Balance sheet is reported on a certain date. Therefore, "For year ended
December 31, 2010" should be altered to "December 31, 2010."
(3) Major headings should be included for assets, liabilities, and stockholders'
equity.
(4) Inventory should be valued at the lower of cost or market.
(5) Treasury stock should not be classified under Long-Term Investments. It is a
deduction from the total of contributed capital and retained earnings.
(6) Marketable securities (short-term) should be classified under Current Assets
rather than Long-Term Investments.
(7) Patents should be classified under Intangibles rather than Property, Plant,
and Equipment.
(8) Patents are usually reported at book value.
(9) Cash surrender value of life insurance should be classified under Long-
Term Investments.
(10) Discount on bonds payable is a contra-liability account and should be
placed immediately after the Bonds Payable account under Long-Term
Liabilities.
(11) Accumulated depreciation: buildings is not a current liability. It is a
contra-asset account and should be placed immediately after the
Buildings account in Property, Plant, and Equipment.
(12) Additional paid-in capital on common stock should be included in the
Contributed Capital section of Stockholders' Equity.
(13) Sinking fund to retire bonds is a long-term investment.
(14) Preferred stock should be included in the Contributed Capital section.
(15) Premium on preferred stock should be included in the Contributed Capital
section.
(16) Accumulated depreciation: equipment should be listed as a contra
account to the Equipment account in Property, Plant, and Equipment.
(17) Current taxes payable should be listed as a current liability.
(18) "Stockholders' equity" is a better term than "Owners' equity" for a
corporation.
(19) The unrealized "gain" on write-up of marketable securities should be titled
unrealized "increase" to avoid confusion with a gain reported on the
income statement. Furthermore, it should be reported as a component of
accumulated other comprehensive income.
(20) The unrealized "gain" on write-up of inventory should be eliminated
because generally accepted accounting principles do not allow
inventories to be valued at higher of cost or market.
(21) Allowance for doubtful accounts is a contra-asset account and should be
listed directly after Accounts Receivable.
(22) "Total equities" should be altered to "Total liabilities and stockholders'
equity."
(23) Each section of the balance sheet should be subtotaled.
4-44
P4-11 (continued)
2. CUTLER CORPORATION
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $ 6,300
Marketable securities, short-term 10,000
Accounts receivable $15,900
Less: Allowance for doubtful accounts (700) 15,200
Inventory, at cost (market value, $28,000) 27,200
Total current assets $ 58,700
Long-Term Investments
Investment in D Company bonds (at book value) $ 7,300
Cash surrender value of life insurance 5,000
Sinking fund to retire bonds 6,000
Total long-term investments 18,300
Property, Plant, and Equipment
Land $11,300
Buildings $40,800
Less: Accumulated depreciation (17,100) 23,700
Equipment $19,000
Less: Accumulated depreciation (7,000) 12,000
Total property, plant, and equipment 47,000
Intangibles
Patents (net) $ 5,200
Trademarks 5,700
Total intangibles 10,900
Total Assets $134,900
Liabilities
Current Liabilities
Accounts payable $13,000
Wages payable 3,000
Current taxes payable 9,600
Total current liabilities $ 25,600
Long-Term Liabilities
Bonds payable $46,000
Less: Discount on bonds payable (3,900) 42,100
Total Liabilities $ 67,700
(continued on next page)
4-45
P4-11 (continued)
2. (continued)
Stockholders' Equity
Contributed Capital
Preferred stock, $50 par $15,000
Common stock, $2 par 8,000
Premium on preferred stock 5,100
Additional paid-in capital on common stock 23,200
Total contributed capital $ 51,300
Retained Earnings 16,000
Accumulated Other Comprehensive Income
Unrealized increase in value of available-for-sale securities 1,300
Total contributed capital, retained earnings, and accumulated
other comprehensive income $ 68,600
Less: Treasury stock (at cost) (1,400)
Total Stockholders' Equity $ 67,200
Total Liabilities and Stockholders' Equity $134,900
4-46
P4-12 (AICPA adapted solution)
Note to Instructor: This problem includes many topics that are covered in depth in
later chapters. Students should be able to develop most of the correct answers
from reading Chapter 4, and the content of this problem provides for a good
introduction to the more advanced topics.
ZUES MANUFACTURING CORPORATION
Balance Sheet
December 31, 2010
Assets
Current Assets
Cash $ 109,000a
Accounts receivable (net) 317,700b
Inventories 560,000
Total current assets $ 986,700
Long-Term Investment, at fair value 47,000c,j
Property, Plant, and Equipment at cost
Land $ 200,000d
Building $1,750,000
Machinery and equipment 1,964,000
Total $3,714,000
Less: Accumulated depreciation (420,000) 3,294,000
Total property, plant, & equipment 3,494,000
Intangible Asset
Goodwill 37,000
Other Assets
Cash restricted for building purposes $ 100,000a
Officer's note receivable1 30,000b
Land held for future building site 250,000d 380,000
Total Assets $4,944,700
Liabilities
Current Liabilities
Accounts payable $ 119,800e
Current installments of long-term debt 200,000f,g
Lawsuit liability 80,000
Income taxes payable 21,200h
Deferred tax liability 5,000
Total current liabilities $ 426,000
Long-Term Debt
Mortgage payable $ 800,000f
Note payable 400,000g
Deferred tax liability 23,000
Total long-term debt 1,223,000
Total Liabilities $1,649,000
(continued on next page)
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P4-12 (continued)
Stockholders' Equity
Contributed Capital
Common stock, authorized 100,000 shares
of $50 par value; issued 40,000 shares;
outstanding 39,800 shares $2,000,000i
Additional paid-in capital 231,000i
Total paid-in capital $2,231,000
Accumulated Other Comprehensive Loss
Unrealized decrease in value of long-term
investment (4,300)j
Retained Earnings 1,075,400
Total $3,302,100
Less: Cost of treasury stock (6,400)c
Total Stockholders' Equity 3,295,700
Total Liabilities and Stockholders' Equity $4,944,700
1Alternatively, this could be reported under Long-Term Investments
Explanations of Amounts
aCash, per unaudited balance sheet $225,000
Less: Unrecorded checks in payment of accounts payable (14,000)
NSF check not recorded (2,000)
Cash restricted for building purposes
(reported in other assets) (100,000)
Corrected balance $109,000
bAccounts receivable (net), per unaudited balance sheet $345,700
Add charge-back for NSF check [see (a)] 2,000
Less: Officer's note receivable (reported in other assets) (30,000)
Corrected balance $317,700
cInvestments, per unaudited balance sheet $ 57,700
Less: Long-term investment [reported separately, see (j)] (51,300)
Treasury stock (reported in stockholders' equity) (6,400)
Corrected balance $ 0
dLand, per unaudited balance sheet $450,000
Less: Land acquired for future building site
(reported in other assets) (250,000)
Corrected balance $200,000
(continued on next page)
4-48
P4-12 (continued)
eAccounts payable, per unaudited balance sheet $133,800
Less: Unrecorded payments [see (a)] (14,000)
Corrected balance $119,800
fMortgage payable, per unaudited balance sheet $900,000
Less: Current portion ($50,000 x 2) (100,000)
Refinanced as long-term mortgage payable $800,000
gNote payable, per unaudited balance sheet $500,000
Less: Current portion (100,000)
Long-term note payable $400,000
hIncome taxes payable, per unaudited balance sheet $ 61,200
Less: Prepaid income taxes (40,000)
Corrected balance $ 21,200
iCommon stock, per unaudited balance sheet $2,231,000
Less: Additional paid-in capital in excess of par value (231,000)
Corrected balance $2,000,000
jLong-terminvestment, at cost [see (c)] $ 51,300
Less: Unrealized decrease in value (4,300)
Long-term investment, at fair value $ 47,000
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P4-13
P3-13
KNOX COMPANY
Statement of Changes in Stockholders' Equity
For Year Ended December 31, 2010
Additional Additional
Paid-in Paid-in Accumulated
Preferred Common Capital Capital Other
Stock Stock on Preferred on Common Retained Comprehen- Treasury
$100 par $10 par Stock Stock Earnings Sive Income Stock Total
Balances, 1/1/10 $50,000 $100,000 $6,000 $130,000 $224,000 $510,000
Unrealized increase
in value of
available-for-sale
securities $9,000 9,000
4-50
Common stock issued 20,000 30,000 50,000
3-50
Preferred stock issued 11,000 1,760 12,760
Common stock $(10,400) (10,400)
reacquired 57,000 57,000
Net income
Cash dividend paid on (4,270) (4,270)
preferred*
Cash dividend paid on _______ ________ ______ ________ (14,500) ______ _______ (14,500)
common+ $61,000 $120,000 $7,760 $160,000 $262,230 $9,000 $(10,400) $609,590
Balances, 12/31/10
*Preferred dividend: $7 x (500 + 110 shares) = $4,270.
+Common dividend: $1.25 x (10,000 + 2,000 - 400 treasury shares) = $14,500.
4-50
P4-14
1. Current assets, December 31, 2007: $12,105 million (p. 67).
2. Allowance for doubtful accounts, December 31, 2007: $56 million
(p. 67).
3. The common stock has a $0.25 par value; 3,519 million shares had
been issued at the end of 2007 (p. 67).
4. The total amount of inventories on December 31, 2007 was $2,220
million (p. 67). The principal categories of inventory were: Raw
materials and packaging (including ingredients and supplies), and
finished goods (which includes concentrates, syrups, and finished
beverages) (p. 74).
5. Long-term debt, December 31, 2007: $3,277 million (p. 67). Portion
related to 5 3/4% U.S. dollar notes due 2011: $499 million (p. 88).
6. Amount of accumulated depreciation on December 31, 2007: $5,951
million (p. 85). Depreciation is recorded principally by the straight-line
method (p. 74).
7. Accounts payable and accrued expenses, December 31, 2007: $6,915
million (p. 67). Accrued marketing expenses were $1,749 million (p. 87).
8. Inventory costing method for inventories: Average cost or first-in, first-
out (p. 74).
9. Reinvested earnings, December 31, 2007: $36,235 million (p. 67).
10. Total property, plant, and equipment on December 31, 2007: Before
accumulated depreciation, $14,444 million; after accumulated
depreciation, $8,493 million (p. 67 and 85).
11. Total assets on December 31, 2007: $43,269 million (p. 67).
12. Current liabilities, December 31, 2007: $13,225 million (p. 67).
13. Number of shares of treasury stock, December 31, 2007: 1,201 million.
Cost of treasury stock, December 31, 2007: $23,375 million (p. 67).
14. Marketable securities on December 31, 2007: $215 million (p. 67). The
unrealized gain on available for sale securities on December 31, 2007:
$161 million (p. 89).
15. The company was contingently liable for guarantees of indebtedness
of $267 million owed by third parties on December 31, 2007 (p. 95).
Note to Instructor: Some of the preceding answers may be located on other
pages within the financial statements and related notes.
4-51
ANSWERS TO CASES
C4-1
Historical cost is the valuation method primarily used on a company’s balance sheet to
report its assets. It has been criticized, however, because some users of financial
statements argue that the historical cost of an asset is not as relevant as the fair value of
the asset. That is the historical cost of an asset may not represent the amount of future
cash inflows (or cash outflows) that the company is likely to obtain for the asset. As a result,
sometimes a company is required (or elects) to report an asset at its fair value.
Fair value is the price that a company would receive to sell an asset in an orderly
transaction between market participants on the date of measurement. Thus, fair value is
based on market prices and is a measure of exit value. A fair value measurement is the
“selling price” for a particular asset held by a company. The measurement assumes that
the asset is sold in a “hypothetical transaction” on the measurement date. The transaction
is hypothetical because the company is not actually planning to sell the asset. In other
3-52
words, for that particular asset, the company is asking the question, “What price could the
company get for the asset if we sold it now in our usual market?”
To measure fair value, a company must use a valuation method. To increase consistency
and comparability in fair value measurements, a company uses a hierarchy which
prioritizes the inputs it uses in its valuation method. The hierarchy consists of three levels of
inputs as follows:
• Level 1 inputs are quoted prices in active markets for identical assets that the
company can access on the measurement date. A quoted market price is an
“observable value” that provides the most reliable evidence of fair value and is
used whenever available.
• Level 2 inputs are exit values (other than the quoted prices included in Level 1)
that are observable for the asset. These inputs include, for example, quoted
market prices for similar assets in active markets, adjusted for the asset’s
differences. Level 2 inputs are used when Level 1 inputs are not readily available.
• Level 3 inputs are unobservable inputs for the asset. These inputs are used to
measure fair value only when Level 1 or Level 2 inputs are not available, or the
costs of obtaining them exceed the benefits. Unobservable inputs reflect the
company’s assumptions about how market participants would price the asset.
These inputs should be developed based on the best information available,
which might include the company’s own data about its expected cash flows.
C4-2
Loss contingencies are situations that exist on a company's balance sheet date involving
uncertainty as to possible losses that the company may incur if some future event occurs.
Two types of disclosures are generally made relating to loss contingencies:
1. An estimated loss is accrued (reported) if it is probable that a liability has been
incurred and the amount of the loss can be reasonably estimated.
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C4-2 (continued)
2. If either of the above conditions is not met, the company discloses the loss
contingency in the notes to its financial statements.
The disclosure of loss contingencies is important in providing external users with additional
information which may help them in predicting the use of financial resources by the
company in the future.
Subsequent events are significant business events or transactions that occur between a
company's balance sheet date and the date of issuance of its annual report. There are
two different types of subsequent events:
1. Those that provide additional evidence concerning conditions that existed on the
balance sheet date and significantly affect the estimates the company used in
preparing its financial statements. For these subsequent events, an adjustment is
made to the financial statements.
2. Those that provide evidence concerning conditions that did not exist on the
company's balance sheet date, but instead occurred after that date. For these,
disclosure is in the form of a note, pro-forma ("as if") statements, or in an explanatory
paragraph of the audit report.
Since a company's annual report is not issued for some time after the close of the year,
disclosure of subsequent events is necessary for a set of fair, more informative, and
complete financial statements. The failure to report subsequent events may cause its
financial statements to be misleading.
C4-3 (CMA adapted solution)
Note to Instructor: This case is slightly more advanced than the text explanation, but is
useful for class discussion.
1. The major classes of information that must be included in both the annual report to
shareholders and Form 10-K filed with the SEC are:
• audited financial statements.
• five-year summary of selected financial data.
• management's discussion and analysis of financial condition and results of operations.
• market data disclosure for common stock and related security holder matters.
2. a. Incorporation by reference permits the corporation to cross-reference schedules from
other documents. Information from the proxy or corporate annual report may be
substituted by reference for various sections of the 10-K to avoid repetition of already
available data.
b. The integrated disclosure system reduces management's efforts in filing annual
reports with the SEC because the SEC is asking for essentially the same information as
is already provided on the uniform financial statements or other documents. Thus,
repetition of already available data is avoided, and the time and cost to file reports
are reduced.
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C4-3 (continued)
2. (continued)
c. The SEC's principal reasons for making the changes in the annual reporting process
are to improve disclosure to investors and other users of financial information and to
achieve a single disclosure system at a reduced cost.
d. Potential problems the integrated disclosure system could have on the annual
reporting process from the aspect of financial information are that:
• Information overload in the annual report could cause users greater difficulty in
understanding and analyzing the report.
• The quality of disclosure may decline as there may be less control over how data
are presented.
C4-4
To: President
3-54
From: Accountant
I am writing in response to your question concerning the recording of property, plant, and
equipment at its appraised value. Although this method would increase our reported 2010
earnings, it is not appropriate.
According to GAAP, property, plant, and equipment is measured and recorded at the
exchange price (historical cost) minus any accumulated depreciation. Consequently,
reporting it at appraised value would violate this historical cost concept. In addition, by
using appraised value and showing a gain in this year, we would be reducing
comparability, not only between our own financial statements of past years, but also
between our financial statements and those of other companies that follow GAAP. This
would create an ethical issue because we would appear to have higher earnings than a
company using GAAP, which might put us at an unfair advantage regarding the market
price of our stock and our ability to sell stock and borrow money.
Furthermore, because we are using a method which is not in compliance with GAAP, our
auditor would be required to disclose this in the auditor's report. If the difference between
using historical cost and appraised value were material enough, it may prevent the
auditor from giving us an unqualified opinion. Such a result would greatly harm our
reputation to external users.
Although our goal is ultimately to increase the value of our company's stock and satisfy
the investment requirements of our stockholders, using a method which is not GAAP to
manipulate our asset values and earnings is unethical in that it is unfair to (justice criterion),
violates the rights of (rights criterion), and does not optimize the satisfaction (utility
criterion) of our various stakeholders (e.g., current and potential investors, creditors,
suppliers, community, etc). Therefore, it will be more beneficial to our company in the
long run if we report our property, plant, and equipment at historical cost in accordance
with GAAP, even though it results in lower earnings, than to ignore GAAP and mislead our
external users.
4-54
C4-5
Historical cost is used on a company’s balance sheet to report the "value" of its non-
financial assets (and liabilities). In general, each asset is recorded at the exchange price
of the transaction in which the asset is obtained. Usually this exchange price is then
reported in the company’s balance sheet until another exchange has taken place.
Certain modifications to this general rule are made for some non-financial assets. On the
other hand, fair value may be used on a company’s balance sheet to report the value of
its financial assets (and liabilities). The valuation and reporting of specific assets are
discussed below.
Cash is reported at its monetary value. Temporary investments in marketable securities
are reported at their fair value. Receivables are reported at their estimated collectible
amounts (net realizable values). Inventories are reported at their historical cost or market
value (current cost), whichever is lower. Finally, prepaid items are reported at their
historical cost, less any amortized amount.
Long-term investments can be reported in several ways. They may be listed at their fair
value, historical cost, or book value, depending on the type of investment. Property,
plant, and equipment, on the other hand, are measured and reported at their historical
cost adjusted for depreciation, with the exception of land which is listed at its historical
cost. Property, plant, and equipment that has been impaired is reported at its lower fair
value. In addition, a capital lease is initially recorded as an asset at the present value of
the future lease payments and is amortized in a manner similar to other legally owned
assets of the company. Intangible assets with a finite useful life are reported on the
balance sheet at their book values. Intangible assets that have been impaired are
reported at their lower fair value.
The "value" of the $1,100,000 total assets is determined by summing the "values" reported
for the individual assets. Thus, the $1,100,000 total assets reported in the balance sheet
does not represent the total current value of the company's assets.
With respect to the common stock, the $1,000,000 total value of the outstanding common
stock will ordinarily not agree with the total "value" of the assets reported on the balance
sheet for several reasons. First, as discussed above, the amount reported for total assets
does not reflect the current values of the individual assets. Second, the company may
hold economic resources that are valuable but are not reported on the balance sheet
because they do not meet the definition of an asset. Finally, the accounting equation
states that the total of the assets is equal to the sum of the liabilities and stockholders'
equity; that is, assets are not only financed by common stockholders, but by creditors and
preferred stockholders as well. The comparison has totally ignored the liabilities and
preferred stockholders' equity.
4-55
C4-6
1. A description of all significant accounting policies of a company must be included as an
integral part of its financial statements. Generally, the disclosures should encompass a
discussion of the principles relating to revenue recognition and asset allocation,
particularly when these principles and methods involve (1) a selection from existing
acceptable alternatives, (2) principles and methods peculiar to the industry in which the
company operates, and (3) unusual or innovative applications of generally accepted
accounting principles. Examples cited include, among others, those policies related to
the basis for consolidation, depreciation methods, amortization of intangibles, inventory
pricing, recognition of profits on long-term contracts, and revenue recognition from
franchise and leasing operations.
2. a. The company recognizes revenue when persuasive evidence of an arrangement
exists, delivery of products has occurred, the sales price charged is fixed or
determinable, and collectibility is reasonably assured (p. 71).
b. Marketable securities that are highly liquid and have maturities of three months or less
at the date of purchase are classified as cash equivalents (p. 73).
3-56
c. Inventories are valued at the lower of cost or market. Cost is determined on the basis
of average cost or first-in, first-out (FIFO) methods (p. 74).
d. Property, plant, and equipment are stated at cost and are depreciated principally
by the straight-line method over the estimated useful lives of the assets (p. 74).
e. The company records its trade accounts receivable at net realizable value. It wrote
off $32 million of its trade accounts receivable in 2007 (p. 73).
f. The company expenses production costs of print, radio, television, and other
advertisements as of the first date the advertisements take place. Advertising and
production costs of approximately $224 million were included in prepaid expenses
and other assets and in noncurrent other assets as of December 31, 2007 (p. 72).
C4-7
Note to Instructor: This case does not have a definitive answer. From a financial reporting
perspective, GAAP is identified and summarized. From an ethical perspective, various
issues are raised for discussion purposes.
From a financial reporting perspective, this is considered a subsequent event. If a
subsequent event occurs that provides additional evidence about conditions that existed
on the balance sheet date and significantly affects an estimate used in preparing the
financial statements, an adjustment is made to them. If the subsequent event occurred
after the balance sheet date, an adjustment is not made. Instead, the information is
disclosed in a note, pro forma statements, or an explanatory paragraph in the audit
report, depending on its materiality. Thus, if there is sufficient evidence that some or all of
Travis Company's $50,000 account receivable will not be collected and the uncollectibility
existed at the end of 2010, then recognition of a loss and a writedown of the accounts
receivable should be made in Davenport's 2010 financial statements. If there is sufficient
evidence of the uncollectibility but it did not occur until 2011, then a note (or other)
disclosure is appropriate.
4-56
C4-7 (continued)
From an ethical perspective there are several primary stakeholders, including the creditors
and stockholders of Davenport Corporation, the creditors and stockholders of Travis
Corporation, Jim Davenport, and Ted Travis. If the loss and writedown are recognized, this
will decrease Davenport Corporation's income and working capital which may have an
adverse affect on Davenport's ability to provide a return to stockholders and pay
creditors. It may also affect users' perceptions of Jim Davenport's ability to manage the
company. Recognition of the loss by Davenport may also provide "corroborating"
evidence of Travis Corporation's financial difficulty, which may adversely affect its
creditors, stockholders, and president. Disclosure in the notes (or elsewhere) may have
similar, but less significant effects. From an ethical perspective, the critical questions are
what, if any, reporting of the financial difficulty of Travis in Davenport's annual report is fair
and just, and whether the reporting would respect the rights of stakeholders?
The questions that are important from financial reporting and ethical perspectives in this
situation are how reliable is the newspaper report, what is meant by financial difficulty,
and when did the financial difficulty of Travis occur. Additional information must be
gathered concerning each of these questions. For instance, there are times when
newspaper reports misstate the facts. What is the source of the newspaper report; can it
be corroborated? In regard to financial difficulty, how is this defined and how serious is it?
Financial difficulty may mean that sales or income have decreased, but cash flows are
sufficient to pay creditors. And, if there is serious financial difficulty, was this in existence at
the end of 2010 or did some significant event occur in early 2011 to cause it? There are
three alternative courses of action from financial reporting and ethical perspectives: (1)
recognize the loss, (2) disclose the financial difficulty in a note (or other means) to the
financial statements, or (3) not report anything in regard to Travis. The action to select will
depend on the answers to the preceding questions. If there is sufficient evidence that
Travis Company is in serious enough financial difficulty to jeopardize the collection of its
receivable and the difficulty existed at the end of 2010, then from financial and ethical
perspectives, it is appropriate for Davenport Company to recognize a loss and writedown
the receivable.
C4-8
Note to Instructor: This case does not have a definitive answer. From a financial reporting
perspective, GAAP is identified and summarized. From an ethical perspective, various
issues are raised for discussion purposes.
From a financial reporting perspective, the note receivable from the president is the result
of a related party transaction of Spaedy Company. For this transaction, GAAP requires
disclosures of the nature of the relationship involved, a description of the transaction, the
dollar amount, and the amount due from the president. GAAP does not specify where (or
how) on the balance sheet the receivable from a related party should be classified. The
note could be classified as a current asset if it is expected to be collected in 2011, or as a
noncurrent asset if it is expected to be collected later than 2011.
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C4-8 (continued)
From an ethical perspective, where this note is classified and how it is reported may have
an impact on the rights of, and fairness to, the various stakeholders. These stakeholders
include the creditors, stockholders, and president of Spaedy Company. If the note is
classified as a current asset in the usual manner (which would increase the working capital
and current ratio) as suggested by the president, this might reflect positively on
perceptions of the president's management. However, since there is no specified due
date, there is considerable uncertainty that it will be collected in 2011. Without additional
evidence (say, from the board of directors) that the note will be collected in 2011, a
normal current asset classification would misrepresent the liquidity of and risk associated
with the company. This would violate the rights of and be unfair to creditors who might
expect the proceeds from the collection to be available for payments to them, as well as
the stockholders who might perceive there is less risk of investment in the company
because of its higher current ratio and working capital. Even if it was determined that
repayment by the president is likely to occur in 2011, so that the note is classified as a
current asset, for full disclosure the note should not be reported as a routine note
receivable. Rather, it should be labeled something like "note receivable from officer" so
that users can make whatever adjustments they feel are appropriate to the current ratio
3-58
and working capital. If additional evidence does not support a likely payment in 2011,
then a noncurrent classification with a similar title is appropriate for the note receivable.
ANSWER TO RESEARCH SIMULATION
R4-1
Note to Instructor: Students are expected to cite references to GAAP in their research of
this issue. They might use the FARS electronic database, pronouncements listed on the
FASB web site, the FASB Original Pronouncements, the FASB Current Text, or other primary
sources of GAAP to obtain these references. They may also use the FASB Accounting
Standards Codification which is cited in parentheses.
To: Head Accountant
From: Assistant Accountant
I have researched the issue of how to report the $100,000 note payable (that is due on
March 6, 2011) on the Tyler Corporation's December 31, 2010 balance sheet. Recall that
the company issued common stock for $80,000 on January 5, 2011 and intends to use the
proceeds (plus $20,000 cash it already has on hand) to repay the note payable on March
6. This situation falls under the category of a "short-term obligation expected to be
refinanced." According to FAS 6, par. 9-11, (FASB Cod. #470-10-45-13 and 14) a company
excludes a short-term obligation from its current liabilities if it intends to refinance the
obligation on a long-term basis and it has the ability to do so. The company can
demonstrate its ability to refinance the short-term obligation by issuing equity securities
after the date of its balance sheet but before the date that the balance sheet is issued.
FAS 6, par. 12 (FASB Cod. #470-10-45-16) goes on to state that the amount of the short-
term obligation that is excluded from current liabilities shall not exceed the proceeds of
the equity securities issued. FAS 6, par 11, footnote 2 (FASB Cod. #470-10-45-14) also states
that the amount of the short-term obligation excluded from current liabilities (because of
the issuance of equity securities) is not included in owners' equity. Finally, FAS 6, par. 15
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R4-1 (continued)
(FASB Cod. #470-10-50-4) indicates that the company must include a general description
of the equity securities issued in the refinancing.
The Tyler Corporation intends to refinance the $100,000 note payable on a long-
term basis and has demonstrated its ability to do so by issuing its common stock for
$80,000. Therefore, based on the preceding generally accepted accounting
principles, I recommend that Tyler Corporation report $20,000 of the note payable
as a current liability and $80,000 as a long-term liability. My reasoning in regard to
the amounts is that only the portion of the short-term obligation that is equal to the
proceeds ($80,000) may be excluded from current liabilities. My reasoning as to
the classification of the $80,000 as a long-term liability is that the excluded amount
should not be reported as stockholders' equity because the common stock had
not yet been issued on the balance sheet date. I also recommend that Tyler
Corporation include a note to its financial statements which indicates that $80,000
of the $100,000 note payable is to be refinanced by the issuance of 2,000 shares of
the company's $10 par common stock after the balance sheet date.
4-59
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