Homework Problems - Accounting and Finance Problems

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1

Introduction to Financial Statements

 CHAPTER PREVIEW 

The Chapter Preview describes the purpose of the chapter and highlights major topics.

How do you start a business? How do you determine whether your business is making or losing money? How should you �inance expansion—should you borrow, should you issue stock, should you use your own funds? How do you convince banks to lend you money or investors to buy your stock? Success in business requires making countless decisions, and decisions require �inancial information.

The purpose of this chapter is to show you what role accounting plays in providing �inancial information.

The Chapter Outline presents the chapter's topics and subtopics, as well as practice opportunities.

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The Feature Story helps you picture how the chapter topic relates to the real world of accounting and business.

Knowing the Numbers

Many students who take this course do not plan to be accountants. If you are in that group, you might be thinking, “If I'm not going to be an accountant, why do I need to know accounting?” Well, consider this quote from Harold Geneen, the former chairman of IT&T: “To be good at your business, you have to know the numbers—cold.” In business, accounting and �inancial statements are the means for communicating the numbers. If you don't know how to read �inancial statements, you can't really know your business.

Knowing the numbers is sometimes even a matter of corporate survival. Consider the story of Columbia Sportswear Company, headquartered in Portland, Oregon. Gert Boyle's family �led Nazi Germany when she was 13 years old and then purchased a small hat company in Oregon, Columbia Hat Company. In 1971, Gert's husband, who was then running the company, died suddenly of a heart attack. The company was in the midst of an aggressive expansion, which had taken its sales above $1 million for the �irst time but which had also left the company �inancially stressed. Gert took over the small, struggling company with help from her son Tim, who was then a senior at the University of Oregon. Somehow, they kept the company a�loat. Today, Columbia has more than 4,000 employees and annual sales in excess of $1 billion. Its brands include Columbia, Mountain Hardwear, Sorel, and Montrail. Gert still heads up the Board of Directors, and Tim is the company's President and CEO.

Columbia doesn't just focus on �inancial success. The company is very committed to corporate, social, and environmental responsibility. For example, several of its factories have participated in a project to increase health awareness of female factory workers in developing countries. Columbia was also a founding member of the Sustainable Apparel Coalition, which is a group that strives to reduce the environmental and social impact of the apparel industry. In addition, it monitors all of the independent factories that produce its products to ensure that they comply with the company's Standards of Manufacturing Practices. These standards address issues including forced labor, child labor, harassment, wages and bene�its, health and safety, and the environment.

Employers such as Columbia Sportswear generally assume that managers in all areas of the company are “�inancially literate.” To help prepare you for that, in this textbook you will learn how to read and prepare �inancial statements, and how to use basic tools to evaluate �inancial results.

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LEARNING OBJECTIVE 1

Identify the forms of business organization and the uses of accounting information. 

Suppose you graduate with a business degree and decide you want to start your own business. But what kind of business? You enjoy working with people, especially teaching them new skills. You also spend most of your free time outdoors, kayaking, backpacking, skiing, rock climbing, and mountain biking. You think you might be successful in opening an outdoor guide service where you grew up, in the Sierra Nevada mountains.

FORMS OF BUSINESS ORGANIZATION Your next decision is to determine the organizational form of your business. You have three choices—sole proprietorship, partnership, or corporation.

SOLE PROPRIETORSHIP

You might choose the sole proprietorship form for your outdoor guide service. A business owned by one person is a sole proprietorship. It is simple to set up and gives you control over the business. Small owner-operated businesses such as barber shops, law of�ices, and auto repair shops are often sole proprietorships, as are farms and small retail stores.

PARTNERSHIP

Another possibility is for you to join forces with other individuals to form a partnership. A business owned by two or more persons associated as partners is a partnership. Partnerships often are formed because one individual does not have enough economic resources to initiate or expand the business. Sometimes partners bring unique skills or resources to the partnership. You and your partners should formalize your duties and contributions in a written partnership agreement. Retail and service-type businesses, including professional practices (lawyers, doctors, architects, and certi�ied public accountants), often organize as partnerships.

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Alternative Terminology notes present synonymous terms that you may come across in practice.

CORPORATION

As a third alternative, you might organize as a corporation. A business organized as a separate legal entity owned by stockholders is a corporation. Investors in a corporation receive shares of stock to indicate their ownership claim. Buying stock in a corporation is often more attractive than investing in a partnership because shares of stock are easy to sell (transfer ownership). Selling a proprietorship or partnership interest is much more involved. Also, individuals can become stockholders by investing relatively small amounts of money. Therefore, it is easier for corporations to raise funds. Successful corporations often have thousands of stockholders, and their stock is traded on organized stock exchanges like the New York Stock Exchange. Many businesses start as sole proprietorships or partnerships and eventually incorporate.

Other factors to consider in deciding which organizational form to choose are taxes and legal liability. If you choose a sole proprietorship or partnership, you generally receive more favorable tax treatment than a corporation. However, proprietors and partners are personally liable for all debts and legal obligations of the business; corporate stockholders are not. In other words, corporate stockholders generally pay higher taxes but have no personal legal liability. We will discuss these issues in more depth in a later chapter.

Finally, while sole proprietorships, partnerships, and corporations represent the main types of business organizations, hybrid forms are now allowed in all states. These hybrid business forms combine the tax advantages of partnerships with the limited liability of corporations. Probably the most common among

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these hybrids types are limited liability companies (LLCs) and subchapter S corporations. These forms are discussed extensively in business law classes.

The combined number of proprietorships and partnerships in the United States is more than �ive times the number of corporations. However, the revenue produced by corporations is eight times greater. Most of the largest businesses in the United States—for example, Coca-Cola, ExxonMobil, General Motors, Citigroup, and Microsoft—are corporations. Because the majority of U.S. business is done by corporations, the emphasis in this textbook is on the corporate form of organization.

ALTERNATIVE TERMINOLOGY

Stockholders are sometimes called shareholders.

USERS AND USES OF FINANCIAL INFORMATION The purpose of �inancial information is to provide inputs for decision-making. Accounting is the information system that identi�ies, records, and communicates the economic events of an organization to interested users. Users of accounting information can be divided broadly into two groups: internal users and external users.

Internal Users

Internal users of accounting information are managers who plan, organize, and run a business. These include marketing managers, production supervisors, �inance directors, and company of�icers. In running a business, managers must answer many important questions, as shown in Illustration 1-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo1#c01-�ig-0001) .

ILLUSTRATION 1-1 Questions that internal users ask

Accounting Across the Organization boxes show applications of accounting information in various business functions.

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To answer these and other questions, you need detailed information on a timely basis. For internal users, accounting provides internal reports, such as �inancial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year. In addition, companies present summarized �inancial information in the form of �inancial statements.

 ACCOUNTING ACROSS THE ORGANIZATION 

Clif Bar & Company

Owning a Piece of the Bar

The original Clif Bar® energy bar was created in 1990 after six months of experimentation by Gary Erickson and his mother in her kitchen. Today, the company has almost 300 employees and is considered one of the leading Landor's Breakaway Brands®. One of Clif Bar & Company's proudest moments was the creation of an employee stock ownership plan (ESOP) in 2010. This plan gives its employees 20% ownership of the company. The ESOP also resulted in Clif Bar enacting an open-book management program, including the commitment to educate all employee-owners about its �inances. Armed with basic accounting knowledge, employees are more aware of the �inancial impact of their actions, which leads to better decisions.

What are the bene�its to the company and to the employees of making the �inancial statements available to all employees? (Go to WileyPLUS for this answer and additional questions.)

External Users

There are several types of external users of accounting information. Investors (owners) use accounting information to make decisions to buy, hold, or sell stock. Creditors such as suppliers and bankers use accounting information to evaluate the risks of selling on credit or lending money. Some questions that investors and creditors may ask about a company are shown in Illustration 1-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo1#c01-�ig-0002) .

ILLUSTRATION 1-2 Questions that external users ask

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The information needs and questions of other external users vary considerably. Taxing authorities, such as the Internal Revenue Service, want to know whether the company complies with the tax laws. Customers are interested in whether a company like General Motors will continue to honor product warranties and otherwise support its product lines. Labor unions, such as the Major League Baseball Players Association, want to know whether the owners have the ability to pay increased wages and bene�its. Regulatory agencies, such as the Securities and Exchange Commission or the Federal Trade Commission, want to know whether the company is operating within prescribed rules. For example, Enron, Dynegy, Duke Energy, and other big energy-trading companies reported record pro�its at the same time as California was paying extremely high prices for energy and suffering from blackouts. This disparity caused regulators to investigate the energy traders to make sure that the pro�its were earned by legitimate and fair practices.

ACCOUNTING ACROSS THE ORGANIZATION

Spinning the Career Wheel

How will the study of accounting help you? A working knowledge of accounting is desirable for virtually every �ield of business. Some examples of how accounting is used in business careers include the following.

General management: Managers of Ford Motors, Massachusetts General Hospital, California State University– Fullerton, a McDonald's franchise, and a Trek bike shop all need to understand accounting data in order to make wise business decisions.

Marketing: Marketing specialists at Procter & Gamble must be sensitive to costs and bene�its, which accounting helps them quantify and understand. Making a sale is meaningless unless it is a pro�itable sale.

Finance: Do you want to be a banker for Citicorp, an investment analyst for Goldman Sachs, or a stock broker for Merrill Lynch? These �ields rely heavily on accounting knowledge to analyze �inancial statements. In fact, it is dif�icult to get a good job in a �inance function without two or three courses in accounting.

Real estate: Are you interested in being a real estate broker for Prudential Real Estate? Because a third party—the bank —is almost always involved in �inancing a real estate transaction, brokers must understand the numbers involved: Can the buyer afford to make the payments to the bank? Does the cash �low from an industrial property justify the purchase price? What are the tax bene�its of the purchase?

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How might accounting help you? (Go to WileyPLUS for this answer and additional questions.)

ETHICS IN FINANCIAL REPORTING People won't gamble in a casino if they think it is “rigged.” Similarly, people won't “play” the stock market if they think stock prices are rigged. At one time, the �inancial press was full of articles about �inancial scandals at Enron, WorldCom, HealthSouth, and AIG. As more scandals came to light, a mistrust of �inancial reporting in general seemed to be developing. One article in the Wall Street Journal noted that “repeated disclosures about questionable accounting practices have bruised investors' faith in the reliability of earnings reports, which in turn has sent stock prices tumbling.” Imagine trying to carry on a business or invest money if you could not depend on the �inancial statements to be honestly prepared. Information would have no credibility. There is no doubt that a sound, well-functioning economy depends on accurate and dependable �inancial reporting.

United States regulators and lawmakers were very concerned that the economy would suffer if investors lost con�idence in corporate accounting because of unethical �inancial reporting. Congress passed the Sarbanes-Oxley Act (SOX) to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals. As a result of SOX, top management must now certify the accuracy of �inancial information. In addition, penalties for fraudulent �inancial activity are much more severe. Also, SOX increased both the independence of the outside auditors who review the accuracy of corporate �inancial statements and the oversight role of boards of directors.

ETHICS NOTE

Circus-founder P.T. Barnum is alleged to have said, “Trust everyone, but cut the deck.” What Sarbanes-Oxley does is to provide measures that (like cutting the deck of playing cards) help ensure that fraud will not occur.

Ethics Notes help sensitize you to some of the ethical issues in accounting.

Effective �inancial reporting depends on sound ethical behavior. To sensitize you to ethical situations and to give you practice at solving ethical dilemmas, we address ethics in a number of ways in this textbook. (1) A number of the Feature Stories and other parts of the text discuss the central importance of ethical behavior to �inancial reporting. (2) Ethics Insight boxes and marginal Ethics Notes highlight ethics situations and issues in actual business settings. (3) Many of the People, Planet, and Pro�it Insight boxes focus on ethical issues that companies face in measuring and reporting social and environmental issues. (4) At the end of each chapter, an Ethics Case simulates a business situation and asks you to put yourself in the position of a decision-maker in that case.

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When analyzing these various ethics cases and your own ethical experiences, you should apply the three steps outlined in Illustration 1-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo1#c01-�ig-0003) .

ILLUSTRATION 1-3 Steps in analyzing ethics cases

 ETHICS INSIGHT 

Dewey & LeBoeuf LLP

I Felt the Pressure—Would You?

“I felt the pressure.” That's what some of the employees of the now- defunct law �irm of Dewey & LeBoeuf LLP indicated when they helped to overstate revenue and use accounting tricks to hide losses and cover up cash shortages. These employees worked for the former �inance director and former chief �inancial of�icer (CFO) of the �irm. Here are some of their comments:

“I was instructed by the CFO to create invoices, knowing they would not be sent to clients. When I created these invoices, I knew that it was inappropriate.”

“I intentionally gave the auditors incorrect information in the course of the audit.”

What happened here is that a small group of lower-level employees over a period of years carried out the instructions of their bosses. Their bosses, however, seemed to have no concern as evidenced by various e-mails with one another in which they referred to their �inancial manipulations as accounting tricks, cooking the books, and fake income.

Source: Ashby Jones, “Guilty Pleas of Dewey Staff Detail the Alleged Fraud,” Wall Street Journal (March 28, 2014).

Why did these employees lie, and what do you believe should be their penalty for these lies? (Go to WileyPLUS for this answer and additional questions.)

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Insight boxes provide examples of business situations from various perspectives—ethics, investor, international, and corporate social responsibility. Guideline answers to the critical thinking questions are available in WileyPLUS and at www.wiley.com/college/weygandt (http://www.wiley.com/college/weygandt) . Additional questions are offered in WileyPLUS.

DO IT! 1

Business Organization Forms

DO IT! exercises prompt you to stop and review the key points you have just studied. The Action Plan offers you tips about how to approach the problem.

In choosing the organizational form for your outdoor guide service, you should consider the pros and cons of each. Identify each of the following organizational characteristics with the organizational form or forms with which it is associated.

1. Easier to raise funds.

2. Simple to establish.

3. No personal legal liability.

4. Tax advantages.

5. Easier to transfer ownership.

Action Plan ✓ Know which organizational form best matches the business

type, size, and preferences of the owner(s).

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SOLUTION

1. Easier to raise funds: Corporation.

2. Simple to establish: Sole proprietorship and partnership.

3. No personal legal liability: Corporation.

4. Tax advantages: Sole proprietorship and partnership.

5. Easier to transfer ownership: Corporation.

Related exercise material: BE1-1 and DO IT! 1-1.

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LEARNING OBJECTIVE 2

Explain the three principal types of business activity. 

All businesses are involved in three types of activity—�inancing, investing, and operating. For example, Gert Boyle's parents, the founders of Columbia Sportswear, obtained cash through �inancing to start and grow their business. Some of this �inancing came from personal savings, and some likely came from outside sources like banks. The family then invested the cash in equipment to run the business, such as sewing equipment and delivery vehicles. Once this equipment was in place, they could begin the operating activities of making and selling clothing.

The accounting information system keeps track of the results of each of the various business activities— �inancing, investing, and operating. Let's look at each type of business activity in more detail.

FINANCING ACTIVITIES It takes money to make money. The two primary sources of outside funds for corporations are borrowing money (debt �inancing) and issuing (selling) shares of stock in exchange for cash (equity �inancing).

Columbia Sportswear may borrow money in a variety of ways. For example, it can take out a loan at a bank or borrow directly from investors by issuing debt securities called bonds. Persons or entities to whom Columbia owes money are its creditors. Amounts owed to creditors—in the form of debt and other obligations—are called liabilities. Speci�ic names are given to different types of liabilities, depending on their source. Columbia may have a note payable to a bank for the money borrowed to purchase delivery trucks. Debt securities sold to investors that must be repaid at a particular date some years in the future are bonds payable.

Corporations also obtain funds by selling shares of stock to investors. Common stock is the term used to describe the total amount paid in by stockholders for the shares they purchase.

The claims of creditors differ from those of stockholders. If you loan money to a company, you are one of its creditors. In lending money, you specify a payment schedule (e.g., payment at the end of three months). As a creditor, you have a legal right to be paid at the agreed time. In the event of nonpayment, you may legally force the company to sell property to pay its debts. In the case of �inancial dif�iculty, creditor claims must be paid before stockholders' claims.

Stockholders, on the other hand, have no claim to corporate cash until the claims of creditors are satis�ied. Suppose you buy a company's stock instead of loaning it money. You have no legal right to expect any payments from your stock ownership until all of the company's creditors are paid amounts currently due. However, many corporations make payments to stockholders on a regular basis as long as there is suf�icient cash to cover required payments to creditors. These cash payments to stockholders are called dividends.

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INVESTING ACTIVITIES Once the company has raised cash through �inancing activities, it uses that cash in investing activities. Investing activities involve the purchase of the resources a company needs in order to operate. A growing company purchases many resources, such as computers, delivery trucks, furniture, and buildings. Resources owned by a business are called assets. Different types of assets are given different names. For example, Columbia Sportswear's sewing equipment is a type of asset referred to as property, plant, and equipment.

Cash is one of the more important assets owned by Columbia or any other business. If a company has excess cash that it does not need for a while, it might choose to invest in securities (stocks or bonds) of other corporations. Investments are another example of an investing activity.

ALTERNATIVE TERMINOLOGY

Property, plant, and equipment is sometimes called �ixed assets.

OPERATING ACTIVITIES Once a business has the assets it needs to get started, it begins operations. Columbia Sportswear is in the business of selling outdoor clothing and footwear. It sells TurboDown jackets, Millenium snowboard pants,

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Sorel® snow boots, Bugaboots™, rainwear, and anything else you might need to protect you from the elements. We call amounts earned on the sale of these products revenues. Revenue is the increase in assets or decrease in liabilities resulting from the sale of goods or the performance of services in the normal course of business. For example, Columbia records revenue when it sells a footwear product.

Revenues arise from different sources and are identi�ied by various names depending on the nature of the business. For instance, Columbia's primary source of revenue is the sale of sportswear. However, it also generates interest revenue on debt securities held as investments. Sources of revenue common to many businesses are sales revenue, service revenue, and interest revenue.

The company purchases its longer-lived assets through investing activities as described earlier. Other assets with shorter lives, however, result from operating activities. For example, supplies are assets used in day-to-day operations. Goods available for future sales to customers are assets called inventory. Also, if Columbia sells goods to a customer and does not receive cash immediately, then the company has a right to expect payment from that customer in the near future. This right to receive money in the future is called an account receivable.

Before Columbia can sell a single Sorel® boot, it must purchase wool, rubber, leather, metal lace loops, laces, and other materials. It then must process, wrap, and ship the �inished product. It also incurs costs like salaries, rents, and utilities. All of these costs, referred to as expenses, are necessary to produce and sell the product. In accounting language, expenses are the cost of assets consumed or services used in the process of generating revenues.

Expenses take many forms and are identi�ied by various names depending on the type of asset consumed or service used. For example, Columbia keeps track of these types of expenses: cost of goods sold (such as the cost of materials), selling expenses (such as the cost of salespersons' salaries), marketing expenses (such as the cost of advertising), administrative expenses (such as the salaries of administrative staff, and telephone and heating costs incurred at the corporate of�ice), interest expense (amounts of interest paid on various debts), and income taxes (corporate taxes paid to the government).

Columbia may also have liabilities arising from these expenses. For example, it may purchase goods on credit from suppliers. The obligations to pay for these goods are called accounts payable. Additionally, Columbia may have interest payable on the outstanding amounts owed to the bank. It may also have wages payable to its employees and sales taxes payable, property taxes payable, and income taxes payable to the government.

Columbia compares the revenues of a period with the expenses of that period to determine whether it earned a pro�it. When revenues exceed expenses, net income results. When expenses exceed revenues, a

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net loss results.

DO IT! 2

Business Activities

Classify each item as an asset, liability, common stock, revenue, or expense.

1. Cost of renting property.

2. Truck purchased.

3. Notes payable.

4. Issuance of ownership shares.

5. Amount earned from performing service.

6. Amounts owed to suppliers.

Action Plan ✓ Classify each item based on its economic characteristics.

Proper classi�ication of items is critical if accounting is to provide useful information.

SOLUTION

1. Cost of renting property: Expense.

2. Truck purchased: Asset.

3. Notes payable: Liabilities.

4. Issuance of ownership shares: Common stock.

5. Amount earned from performing service: Revenue.

6. Amounts owed to suppliers: Liabilities.

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Related exercise material: BE1-3 and DO IT! 1-2, and E1-3.

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LEARNING OBJECTIVE 3

Describe the four �inancial statements and how they are prepared. 

Assets, liabilities, expenses, and revenues are of interest to users of accounting information. This information is arranged in the format of four different �inancial statements, which form the backbone of �inancial accounting:

To show how successfully your business performed during a period of time, you report its revenues and expenses in an income statement.

To indicate how much of previous income was distributed to you and the other owners of your business in the form of dividends, and how much was retained in the business to allow for future growth, you present a retained earnings statement.

To present a picture at a point in time of what your business owns (its assets) and what it owes (its liabilities), you prepare a balance sheet.

To show where your business obtained cash during a period of time and how that cash was used, you present a statement of cash �lows.

INTERNATIONAL NOTE The primary types of �inancial statements required by International Financial Reporting Standards (IFRS) and U.S. generally accepted accounting principles (GAAP) are the same. Neither IFRS nor GAAP is very speci�ic regarding format requirements for the primary �inancial statements. However, in practice, some format differences do exist in presentations commonly employed by IFRS companies as compared to GAAP companies.

International Notes highlight differences between U.S. and international accounting standards.

To introduce you to these statements, we have prepared the �inancial statements for your outdoor guide service, Sierra Corporation, after your �irst month of operations. To summarize, you of�icially started your business in Truckee, California, on October 1, 2017. Sierra provides guide services in the Lake Tahoe area of the Sierra Nevada mountains. Its promotional materials describe outdoor day trips, such as rafting,

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snowshoeing, and hiking, as well as multi-day backcountry experiences. To minimize your initial investment, at this point the company has limited outdoor equipment for customer use. Instead, your customers either bring their own equipment or rent equipment through local out�itters. The �inancial statements for Sierra's �irst month of business are provided in the following pages.

INCOME STATEMENT

Decision Tools that are useful for business decisionmaking are highlighted throughout the textbook. A summary of the Decision Tools, such as the one on page 21, is provided in each chapter.

The income statement reports a company's revenues and expenses and resulting net income or loss for a period of time. To indicate that its income statement reports the results of operations for a speci�ic period of time, Sierra dates the income statement “For the Month Ended October 31, 2017.” The income statement lists the company's revenues followed by its expenses. Finally, Sierra determines the net income (or net loss) by deducting expenses from revenues. Sierra Corporation's income statement is shown in Illustration 1-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0004) (page 12). Congratulations, you are already showing a pro�it!

ILLUSTRATION 1-4 Sierra Corporation's income statement

Why are �inancial statement users interested in net income? Investors are interested in a company's past net income because it provides useful information for predicting future net income. Investors buy and sell stock based on their beliefs about a company's future performance. If investors believe that Sierra will be successful in the future and that this will result in a higher stock price, they will buy its stock. Creditors also use the income statement to predict future earnings. When a bank loans money to a company, it believes that it will be repaid in the future. If it didn't think it would be repaid, it wouldn't loan the money. Therefore, prior to making the loan the bank loan of�icer uses the income statement as a source of information to predict whether the company will be pro�itable enough to repay its loan. Thus,

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reporting a strong pro�it will make it easier for Sierra to raise additional cash either by issuing shares of stock or borrowing.

Amounts received from issuing stock are not revenues, and amounts paid out as dividends are not expenses. As a result, they are not reported on the income statement. For example, Sierra Corporation does not treat as revenue the $10,000 of cash received from issuing new stock (see Illustration 1-7 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0007) ), nor does it regard as a business expense the $500 of dividends paid (see Illustration 1-5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0005) ).

DECISION TOOLS

The income statement helps users determine if the company's operations are pro�itable.

▼ HELPFUL HINT

The �inancial statement heading identi�ies the company, the type of statement, and the time period covered. Sometimes, another line indicates the unit of measure, e.g., “in thousands” or “in millions.”

ETHICS NOTE

When companies �ind errors in previously released income statements, they restate those numbers. Perhaps because of the increased scrutiny shortly after Sarbanes-Oxley was implemented, companies �iled a record 1,195 restatements.

RETAINED EARNINGS STATEMENT If Sierra is pro�itable, at the end of each period it must decide what portion of pro�its to pay to shareholders in dividends. In theory, it could pay all of its current-period pro�its, but few companies do this. Why? Because they want to retain part of the pro�its to allow for further expansion. High-growth companies, such as Google and Facebook, often pay no dividends. Retained earnings is the net income retained in the corporation.

The retained earnings statement shows the amounts and causes of changes in retained earnings for a speci�ic time period. The time period is the same as that covered by the income statement. The beginning

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retained earnings amount appears on the �irst line of the statement. Then, the company adds net income and deducts dividends to determine the retained earnings at the end of the period. If a company has a net loss, it deducts (rather than adds) that amount in the retained earnings statement. Illustration 1-5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0005) presents Sierra Corporation's retained earnings statement.

ILLUSTRATION 1-5 Sierra Corporation's retained earnings statement

By monitoring the retained earnings statement, �inancial statement users can evaluate dividend payment practices. Some investors seek companies, such as Dow Chemical, that have a history of paying high dividends. Other investors seek companies, such as Amazon.com, that reinvest earnings to increase the company's growth instead of paying dividends. Lenders monitor their corporate customers' dividend payments because any money paid in dividends reduces a company's ability to repay its debts.

DECISION TOOLS

The retained earnings statement helps users determine the company's policy toward dividends and growth.

▼ HELPFUL HINT

The heading of this statement identi�ies the company, the type of statement, and the time period covered by the statement.

BALANCE SHEET The balance sheet reports assets and claims to assets at a speci�ic point in time. Claims to assets are subdivided into two categories: claims of creditors and claims of owners. As noted earlier, claims of creditors are called liabilities. The owners' claim to assets is called stockholders' equity.

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Illustration 1-6 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0006) shows the relationship among the categories on the balance sheet in equation form. This equation is referred to as the basic accounting equation.

ILLUSTRATION 1-6 Basic accounting equation

This relationship is where the name “balance sheet” comes from. Assets must balance with the claims to assets.

As you can see from looking at Sierra's balance sheet in Illustration 1-7 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0007) , the balance sheet presents the company's �inancial position as of a speci�ic date—in this case, October 31, 2017. It lists assets �irst, followed by liabilities and stockholders' equity. Stockholders' equity is comprised of two parts: (1) common stock and (2) retained earnings. As noted earlier, common stock results when the company sells new shares of stock; retained earnings is the net income retained in the corporation. Sierra has common stock of $10,000 and retained earnings of $2,360, for total stockholders' equity of $12,360.

ILLUSTRATION 1-7 Sierra Corporation's balance sheet

Creditors analyze a company's balance sheet to determine the likelihood that they will be repaid. They carefully evaluate the nature of the company's assets and liabilities. In operating the Sierra Corporation guide service, the balance sheet will be used to determine whether cash on hand is suf�icient for immediate cash needs. The balance sheet will also be used to evaluate the relationship between debt and

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stockholders' equity to determine whether the company has a satisfactory proportion of debt and common stock �inancing.

DECISION TOOLS

The balance sheet helps users determine if the company relies on debt or stockholders' equity to �inance its assets.

ALTERNATIVE TERMINOLOGY

Liabilities are also referred to as debt.

▼ HELPFUL HINT

The heading of a balance sheet must identify the company, the statement, and the date.

STATEMENT OF CASH FLOWS The primary purpose of a statement of cash �lows is to provide �inancial information about the cash receipts and cash payments of a business for a speci�ic period of time. To help investors, creditors, and others in their analysis of a company's cash position, the statement of cash �lows reports the cash effects of a company's operating, investing, and �inancing activities. In addition, the statement shows the net increase or decrease in cash during the period, and the amount of cash at the end of the period.

Users are interested in the statement of cash �lows because they want to know what is happening to a company's most important resource. The statement of cash �lows provides answers to these simple but important questions:

Where did cash come from during the period?

How was cash used during the period?

What was the change in the cash balance during the period?

The statement of cash �lows for Sierra, in Illustration 1-8 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0008) , shows that cash increased $15,200 during the month. This increase resulted because operating activities (services to

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clients) increased cash $5,700, and �inancing activities increased cash $14,500. Investing activities used $5,000 of cash for the purchase of equipment.

ILLUSTRATION 1-8 Sierra Corporation's statement of cash �lows

PEOPLE, PLANET, AND PROFIT INSIGHT Beyond Financial Statements

Should we expand our corporate reports beyond the income statement, retained earnings statement, balance sheet, and statement of cash �lows? Some believe we should take into account ecological and social performance, in addition to �inancial results, in evaluating a company. The argument is that a company's responsibility lies with anyone who is in�luenced by its actions. In other words, a company should be interested in bene�iting many different parties, instead of only maximizing stockholders' interests.

A socially responsible business does not exploit or endanger any group of individuals. It follows fair trade practices, provides safe environments for workers, and bears responsibility for environmental damage. Granted, measurement of these factors is dif�icult. How to report this information is also controversial. But many interesting and useful efforts are underway. Throughout this textbook, we provide additional insights into how companies are attempting to meet the challenge of measuring and reporting their contributions to society, as well as their �inancial results, to stockholders.

Why might a company's stockholders be interested in its environmental and social performance? (Go to WileyPLUS for this answer and additional questions.)

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DECISION TOOLS

The statement of cash �lows helps users determine if the company generates enough cash from operations to fund its investing activities.

▼ HELPFUL HINT

The heading of this statement identi�ies the company, the type of statement, and the time period covered by the statement. Negative numbers are shown in parentheses.

INTERRELATIONSHIPS OF STATEMENTS Illustration 1-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0009) (page 16) shows the �inancial statements of Sierra Corporation. Because the results on some �inancial statements become inputs to other statements, the statements are interrelated. These interrelationships can be seen in Sierra's �inancial statements, as follows.

1. The retained earnings statement uses the results of the income statement. Sierra reported net income of $2,860 for the period. Net income is added to the beginning amount of retained earnings to determine ending retained earnings.

2. The balance sheet and retained earnings statement are also interrelated. Sierra reports the ending amount of $2,360 on the retained earnings statement as the retained earnings amount on the balance sheet.

3. Finally, the statement of cash �lows relates to information on the balance sheet. The statement of cash �lows shows how the Cash account changed during the period. It shows the amount of cash at the beginning of the period, the sources and uses of cash during the period, and the $15,200 of cash at the end of the period. The ending amount of cash shown on the statement of cash �lows must agree with the amount of cash on the balance sheet.

Study these interrelationships carefully. To prepare �inancial statements, you must understand the sequence in which these amounts are determined and how each statement impacts the next.

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ILLUSTRATION 1-9 Sierra Corporation's �inancial statements

DO IT! 3a

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Financial Statements

CSU Corporation began operations on January 1, 2017. The following information is available for CSU on December 31, 2017:

Accounts receivable 1,800 Retained earnings ? Supplies expense 200 Accounts payable 2,000 Equipment 16,000 Cash 1,400 Rent expense 9,000 Insurance expense 1,000 Dividends 600 Notes payable 5,000 Service revenue 17,000 Common stock 10,000 Supplies 4,000

Prepare an income statement, a retained earnings statement, and a balance sheet.

Action Plan ✓ Report the revenues and expenses for a period of time in an

income statement.

✓ Show the amounts and causes (net income and dividends) of changes in retained earnings during the period in the retained earnings statement.

✓ Present the assets and claims to those assets (liabilities and equity) at a speci�ic point in time in the balance sheet.

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SOLUTION

Related exercise material: BE1-5, BE1-6, BE1-7, BE1-8, BE1-9, BE1-10, DO IT! 1-3a, E1- 4, E1-5, E1-6, E1-7, E1-8, E1-9, E1-10, E1-11, and E1-14.

▼ HELPFUL HINT

Note that �inal sums are double-underlined.

▼ HELPFUL HINT

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The arrows in this illustration show interrelationships of the four �inancial statements.

▼ HELPFUL HINT

Negative amounts are presented in parentheses.

OTHER ELEMENTS OF AN ANNUAL REPORT Publicly traded U.S. companies must provide shareholders with an annual report. The annual report always includes the �inancial statements introduced in this chapter. The annual report also includes other important information such as a management discussion and analysis section, notes to the �inancial statements, and an independent auditor's report. No analysis of a company's �inancial situation and performance is complete without a review of these items.

Management Discussion and Analysis

The management discussion and analysis (MD&A) section presents management's views on the company's ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations. Management must highlight favorable or unfavorable trends and identify signi�icant events and uncertainties that affect these three factors. This discussion obviously involves a number of subjective estimates and opinions. A brief excerpt from the MD&A section of Columbia Sportswear's annual report, which addresses its liquidity requirements, is presented in Illustration 1-10 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0010) .

ILLUSTRATION 1-10 Columbia Sportswear's management discussion and analysis

Notes to the Financial Statements

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Explanatory notes and supporting schedules accompany every set of �inancial statements and are an integral part of the statements. The notes to the �inancial statements clarify the �inancial statements and provide additional detail. Information in the notes does not have to be quanti�iable (numeric). Examples of notes are descriptions of the signi�icant accounting policies and methods used in preparing the statements, explanations of uncertainties and contingencies, and various statistics and details too voluminous to be included in the statements. The notes are essential to understanding a company's operating performance and �inancial position.

Illustration 1-11 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0011) is an excerpt from the notes to Columbia Sportswear's �inancial statements. It describes the methods that the company uses to account for revenues.

ILLUSTRATION 1-11 Notes to Columbia Sportswear's �inancial statements

Auditor's Report

An auditor's report is prepared by an independent outside auditor. It states the auditor's opinion as to the fairness of the presentation of the �inancial position and results of operations and their conformance with generally accepted accounting principles.

An auditor is an accounting professional who conducts an independent examination of a company's �inancial statements. Only accountants who meet certain criteria and thereby attain the designation certi�ied public accountant (CPA) may perform audits. If the auditor is satis�ied that the �inancial statements provide a fair representation of the company's �inancial position and results of operations in accordance with generally accepted accounting principles, then the auditor expresses an unquali�ied opinion. If the auditor expresses anything other than an unquali�ied opinion, then readers should only use the �inancial statements with caution. That is, without an unquali�ied opinion, we cannot have complete con�idence that the �inancial statements give an accurate picture of the company's �inancial health. For example, recently Blockbuster, Inc.'s auditor stated that its �inancial situation raised “substantial doubt about the Company's ability to continue as a going concern.”

Illustration 1-12 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0012) is an excerpt from the auditor's report from Columbia Sportswear's 2014 annual report. Columbia received an unquali�ied opinion from its auditor, Deloitte & Touche.

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ILLUSTRATION 1-12 Excerpt from auditor's report on Columbia Sportswear's �inancial statements

DO IT! 3b

Components of Annual Reports

State whether each of the following items is most closely associated with the management discussion and analysis (MD&A), the notes to the �inancial statements, or the auditor's report.

1. Descriptions of signi�icant accounting policies.

2. Unquali�ied opinion.

3. Explanations of uncertainties and contingencies.

4. Description of ability to fund operations and expansion.

5. Description of results of operations.

6. Certi�ied public accountant (CPA).

Action Plan ✓ Realize that �inancial statements provide information about a

company's performance and �inancial position.

✓ Be familiar with the other elements of the annual report in order to gain a fuller understanding of a company.

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SOLUTION

1. Descriptions of signi�icant accounting policies: Notes.

2. Unquali�ied opinion: Auditor's report.

3. Explanations of uncertainties and contingencies: Notes.

4. Description of ability to fund operations and expansion: MD&A.

5. Description of results of operations: MD&A.

6. Certi�ied public accountant (CPA): Auditor's report.

Related exercise material: BE1-11, DO IT! 1-3b, and E1-17.

USING DECISION TOOLS—VF CORPORATION There is a good chance that you may have never heard of VF Corporation. There is also a very good chance that you are wearing one of VF's products right now. VF owns North Face, Lee, Vans, Nautica, Wrangler, Timberland, and numerous other brands. VF is a direct competitor to Columbia Sportswear. Suppose that you are considering investing in shares of VF's common stock.

INSTRUCTIONS

Answer these questions related to your decision whether to invest.

(a) What �inancial statements should you evaluate?

(b) What should these �inancial statements tell you?

(c) Do you care if the �inancial statements have been audited? Explain.

(d) Appendix B (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a02#a02) at the end of this textbook contains �inancial statements for Columbia, and Appendix C (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a03#a03) contains those for VF. You can make many comparisons between Columbia and VF in terms of their respective results from operations and �inancial position. Compare their respective total assets, total revenues, and net cash provided by operating activities.

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SOLUTION (a) Before you invest, you should evaluate the income statement, retained earnings

statement, balance sheet, and statement of cash �lows.

(b) You would probably be most interested in the income statement because it tells about past performance and thus gives an indication of future performance. The retained earnings statement provides a record of the company's dividend history. The balance sheet reveals the relationship between assets and liabilities. The statement of cash �lows reveals where the company is getting and spending its cash. This is especially important for a company that wants to grow.

(c) You would want audited �inancial statements. These statements indicate that a CPA (certi�ied public accountant) has examined and expressed an opinion that the statements present fairly the �inancial position and results of operations of the company. Investors and creditors should not make decisions without studying audited �inancial statements.

(d) Many interesting comparisons can be made between the two companies (all numbers are in thousands). Columbia is smaller, with total assets of $1,792,209 versus $9,980,140 for VF, and it has lower revenue—$2,100,590 versus $12,282,161 for VF. In addition, Columbia's net cash provided by operating activities of $185,783 is less than VF's $1,697,629. However, while useful, these basic measures are not enough to determine whether one company is a better investment than the other. In later chapters, you will learn tools that will allow you to compare the relative pro�itability and �inancial health of these and other companies.

Using Decision Tools comprehensive exercises ask you to apply business information and the decision tools presented in the chapter. Most of these exercises are based on the companies highlighted in the Feature Story.

The Review and Practice section provides opportunities for students to review key concepts and terms as well as complete multiple-choice questions, exercises, and a comprehensive problem. Detailed solutions are also included.

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REVIEW AND PRACTICE

LEARNING OBJECTIVES REVIEW 1. Identify the forms of business organization and the uses of accounting

information. A sole proprietorship is a business owned by one person. A partnership is a business owned by two or more people associated as partners. A corporation is a separate legal entity for which evidence of ownership is provided by shares of stock.

Internal users are managers who need accounting information to plan, organize, and run business operations. The primary external users are investors and creditors. Investors (stockholders) use accounting information to decide whether to buy, hold, or sell shares of a company's stock. Creditors (suppliers and bankers) use accounting information to assess the risk of granting credit or loaning money to a business. Other groups who have an indirect interest in a business are taxing authorities, customers, labor unions, and regulatory agencies.

2. Explain the three principal types of business activity. Financing activities involve collecting the necessary funds to support the business. Investing activities involve acquiring the resources necessary to run the business. Operating activities involve putting the resources of the business into action to generate a pro�it.

3. Describe the four �inancial statements and how they are prepared. An income statement presents the revenues and expenses of a company for a speci�ic period of time. A retained earnings statement summarizes the changes in retained earnings that have occurred for a speci�ic period of time. A balance sheet reports the assets, liabilities, and stockholders' equity of a business at a speci�ic date. A statement of cash �lows summarizes information concerning the cash in�lows (receipts) and out�lows (payments) for a speci�ic period of time.

Assets are resources owned by a business. Liabilities are the debts and obligations of the business. Liabilities represent claims of creditors on the assets of the business. Stockholders' equity represents the claims of owners on the assets of the business. Stockholders' equity is subdivided into two parts: common stock and retained earnings. The basic accounting equation is Assets=Liabilities+Stockholders' Equity.

Within the annual report, the management discussion and analysis provides management's interpretation of the company's results and �inancial position as well as a discussion of plans for the future. Notes to the �inancial statements provide additional explanation or detail to make the �inancial statements more informative. The auditor's report expresses an opinion as to whether the �inancial statements present fairly the company's results of operations and �inancial position.

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DECISION TOOLS REVIEW

GLOSSARY REVIEW Accounting The information system that identi�ies, records, and communicates the

economic events of an organization to interested users.

Annual report A report prepared by corporate management that presents �inancial information including �inancial statements, a management discussion and analysis section, notes, and an independent auditor's report.

Assets Resources owned by a business.

Auditor's report A report prepared by an independent outside auditor stating the auditor's opinion as to the fairness of the presentation of the �inancial position and results of operations and their conformance with generally accepted accounting principles.

Balance sheet A �inancial statement that reports the assets and claims to those assets at a speci�ic point in time.

Basic accounting equation Assets=Liabilities+Stockholders' Equity.

Certi�ied public accountant (CPA) An individual who has met certain criteria and is thus allowed to perform audits of corporations.

Common stock Term used to describe the total amount paid in by stockholders for the shares they purchase.

Corporation A business organized as a separate legal entity owned by stockholders.

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Dividends Payments of cash from a corporation to its stockholders.

Expenses The cost of assets consumed or services used in the process of generating revenues.

Income statement A �inancial statement that reports a company's revenues and expenses and resulting net income or net loss for a speci�ic period of time.

Liabilities Amounts owed to creditors in the form of debts and other obligations.

Management discussion and analysis (MD&A) A section of the annual report that presents management's views on the company's ability to pay near-term obligations, its ability to fund operations and expansion, and its results of operations.

Net income The amount by which revenues exceed expenses.

Net loss The amount by which expenses exceed revenues.

Notes to the �inancial statements Notes clarify information presented in the �inancial statements and provide additional detail.

Partnership A business owned by two or more persons associated as partners.

Retained earnings statement A �inancial statement that summarizes the amounts and causes of changes in retained earnings for a speci�ic time period.

Retained earnings The amount of net income retained in the corporation.

Revenue The increase in assets or decrease in liabilities resulting from the sale of goods or the performance of services in the normal course of business.

Sarbanes-Oxley Act (SOX) Regulations passed by Congress to reduce unethical corporate behavior.

Sole proprietorship A business owned by one person.

Statement of cash �lows A �inancial statement that provides �inancial information about the cash receipts and cash payments of a business for a speci�ic period of time.

Stockholders' equity The owners' claim to assets.

PRACTICE MULTIPLE-CHOICE QUESTIONS (LO 1)

1. Which is not one of the three forms of business organization?

(a) Sole proprietorship.

(b) Creditorship.

(c) Partnership.

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(d) Corporation.

(LO 1)

2. Which is an advantage of corporations relative to partnerships and sole proprietorships?

(a) Lower taxes.

(b) Harder to transfer ownership.

(c) Reduced legal liability for investors.

(d) Most common form of organization.

(LO 1)

3. Which statement about users of accounting information is incorrect?

(a) Management is considered an internal user.

(b) Taxing authorities are considered external users.

(c) Present creditors are considered external users.

(d) Regulatory authorities are considered internal users.

(LO 1)

4. Which of the following did not result from the Sarbanes-Oxley Act?

(a) Top management must now certify the accuracy of �inancial information.

(b) Penalties for fraudulent activity increased.

(c) Independence of auditors increased.

(d) Tax rates on corporations increased.

(LO 2)

5. Which is not one of the three primary business activities?

(a) Financing.

(b) Operating.

(c) Advertising.

(d) Investing.

(LO 2)

6. Which of the following is an example of a �inancing activity?

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(a) Issuing shares of common stock.

(b) Selling goods on account.

(c) Buying delivery equipment.

(d) Buying inventory.

(LO 2)

7. Net income will result during a time period when:

(a) assets exceed liabilities.

(b) assets exceed revenues.

(c) expenses exceed revenues.

(d) revenues exceed expenses.

(LO 3)

8. The �inancial statements for Macias Corporation contained the following information.

Accounts receivable $ 5,000 Sales revenue 75,000 Cash 15,000 Salaries and wages expense 20,000 Rent expense 10,000

What was Macias Corporation's net income?

(a) $60,000.

(b) $15,000.

(c) $65,000.

(d) $45,000.

(LO 3)

9. What section of a statement of cash �lows indicates the cash spent on new equipment during the past accounting period?

(a) The investing activities section.

(b) The operating activities section.

(c) The �inancing activities section.

(d) The statement of cash �lows does not give this information.

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(LO 3)

10. Which statement presents information as of a speci�ic point in time?

(a) Income statement.

(b) Balance sheet.

(c) Statement of cash �lows.

(d) Retained earnings statement.

(LO 3)

11. Which �inancial statement reports assets, liabilities, and stockholders' equity?

(a) Income statement.

(b) Retained earnings statement.

(c) Balance sheet.

(d) Statement of cash �lows.

(LO 3)

12. Stockholders' equity represents:

(a) claims of creditors.

(b) claims of employees.

(c) the difference between revenues and expenses.

(d) claims of owners.

(LO 3)

13. As of December 31, 2017, Rockford Corporation has assets of $3,500 and stockholders' equity of $1,500. What are the liabilities for Rockford Corporation as of December 31, 2017?

(a) $1,500.

(b) $1,000.

(c) $2,500.

(d) $2,000.

(LO 3)

14. The element of a corporation's annual report that describes the corporation's accounting methods is/are the:

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(a) notes to the �inancial statements.

(b) management discussion and analysis.

(c) auditor's report.

(d) income statement.

(LO 3)

15. The element of the annual report that presents an opinion regarding the fairness of the presentation of the �inancial position and results of operations is/are the:

(a) income statement.

(b) auditor's opinion.

(c) balance sheet.

(d) comparative statements.

SOLUTIONS

1. (b) Creditorship is not a form of business organization. The other choices are incorrect because (a) sole proprietorship, (c) partnership, and (d) corporation are all forms of business organization.

2. (c) An advantage of corporations is that investors are not personally liable for debts of the business. The other choices are incorrect because (a) lower taxes, (b) harder to transfer ownership, and (d) most common form of organization are not true of corporations.

3. (d) Regulatory authorities are considered external, not internal, users. The other choices are true statements.

4. (d) The Sarbanes-Oxley Act (SOX) was created to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals, not to address tax rates. The other choices are incorrect because (a) top management must now certify the accuracy of �inancial information, (b) penalties for fraudulent activity increased, and (c) increased independence of auditors all resulted from SOX.

5. (c) Advertising is a type of operating activity. The other choices are incorrect because (a) �inancing, (b) operating, and (d) investing are the three primary business activities.

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6. (a) Issuing shares of common stock is a �inancing activity. The other choices are incorrect because (b) selling goods on account is an operating activity, (c) buying delivery equipment is an investing activity, and (d) buying inventory is an operating activity.

7. (d) When a company earns more revenues than expenses, it will report net income during a time period. The other choices are incorrect because (a) assets and liabilities are on the balance sheet, not the income statement; (b) assets are on the balance sheet, not the income statement; and (c) net income results when revenues exceed expenses, not when expenses exceed revenues.

8. (d) Net income=Sales revenue ($75,000)−Salaries and wages expense ($20,000)−Rent expense ($10,000)=$45,000. The other choices are therefore incorrect.

9. (a) The investing activities section of the statement of cash �lows provides information about property, plant, and equipment accounts, not (b) the operating activities section or (c) the �inancing activities section. Choice (d) is incorrect as the statement of cash �lows does provide this information.

10. (b) The balance sheet presents information as of a speci�ic point in time. The other choices are incorrect because the (a) income statement, (c) statement of cash �lows, and (d) retained earnings statement all cover a period of time.

11. (c) The balance sheet is a formal presentation of the accounting equation, such that Assets=Liabilities+Stockholders' Equity, not the (a) income statement, (b) retained earnings statement, or (d) statement of cash �lows.

12. (d) Stockholders' equity represents claims of owners. The other choices are incorrect because (a) claims of creditors and (b) claims of employees are liabilities. Choice (c) is incorrect because the difference between revenues and expenses is net income.

13. (d) Using the accounting equation, liabilities can be computed by subtracting stockholders' equity from assets, or $3,500− $1,500=$2,000, not (a) $1,500, (b) $1,000, or (c) $2,500.

14. (a) The corporation's accounting methods are described in the notes to the �inancial statements, not in the (b) management discussion and analysis, (c) auditor's report, or (d) income statement.

15. (b) The element of the annual report that presents an opinion regarding the fairness of the presentation of the �inancial position and results of operations is the auditor's opinion, not the (a)

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income statement, (c) balance sheet, or (d) comparative statements.

PRACTICE EXERCISES

Prepare an income statement.

(LO 3)

1. The following items and amounts were taken from Ricardo Inc.'s 2017 income statement and balance sheet.

Cash $  84,700 Inventory $  64,618 Retained earnings 123,192 Accounts receivable 88,419 Cost of goods sold 483,854 Sales revenue 693,485 Salaries and wages expense 125,000 Income taxes payable 6,499 Prepaid insurance 7,818 Accounts payable 49,384 Interest expense 994 Service revenue 8,998

INSTRUCTIONS

Prepare an income statement for Ricardo Inc. for the year ended December 31, 2017.

SOLUTION

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Compute net income and prepare a balance sheet.

(LO 3)

2. Cozy Bear is a private camping ground near the Mountain Home Recreation Area. It has compiled the following �inancial information as of December 31, 2017.

Service revenue (from camping fees)

$148,000 Dividends $    9,000

Sales revenue (from general store) 35,000 Notes payable 50,000 Accounts payable 16,000 Expenses during 2017 135,000 Cash 18,500 Supplies 12,500 Equipment 129,000 Common stock 40,000 Retained earnings

(1/1/2017) 15,000

INSTRUCTIONS (a) Determine net income from Cozy Bear for 2017.

(b) Prepare a retained earnings statement and a balance sheet for Cozy Bear as of December 31, 2017.

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SOLUTION

2. (a)

(b)

PRACTICE PROBLEM

Prepare �inancial statements.

(LO 3)

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Jeff Andringa, a former college hockey player, quit his job and started Ice Camp, a hockey camp for kids ages 8 to 18. Eventually, he would like to open hockey camps nationwide. Jeff has asked you to help him prepare �inancial statements at the end of his �irst year of operations. He relates the following facts about his business activities.

In order to get the business off the ground, Jeff decided to incorporate. He sold shares of common stock to a few close friends, as well as bought some of the shares himself. He initially raised $25,000 through the sale of these shares. In addition, the company took out a $10,000 loan at a local bank.

Ice Camp purchased, for $12,000 cash, a bus for transporting kids. The company also bought hockey goals and other miscellaneous equipment with $1,500 cash. The company earned camp tuition during the year of $100,000 but had collected only $80,000 of this amount. Thus, at the end of the year, its customers still owed $20,000. The company rents time at a local rink for $50 per hour. Total rink rental costs during the year were $8,000, insurance was $10,000, salary expense was $20,000, and supplies used totaled $9,000, all of which were paid in cash. The company incurred $800 in interest expense on the bank loan, which it still owed at the end of the year.

The company paid dividends during the year of $5,000 cash. The balance in the corporate bank account at December 31, 2017, was $49,500.

INSTRUCTIONS

Using the format of the Sierra Corporation statements in this chapter, prepare an income statement, retained earnings statement, balance sheet, and statement of cash �lows. (Hint: Prepare the statements in the order stated to take advantage of the �low of information from one statement to the next, as shown in Illustration 1-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0009) on page 16.)

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SOLUTION

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WileyPLUS Brief Exercises, DO IT! Exercises, Exercises, Problems, and many additional resources are available for practice in WileyPLUS.

The tool icon indicates that an activity employs one of the decision tools presented in the chapter. The indicates that an activity relates to a business function beyond accounting. The pencil icon indicates that an activity requires written communication.

QUESTIONS 1. What are the three basic forms of business organizations?

2. What are the advantages to a business of being formed as a corporation? What are the disadvantages?

3. What are the advantages to a business of being formed as a partnership or sole proprietorship? What are the disadvantages?

4. “Accounting is ingrained in our society and is vital to our economic system.” Do you agree? Explain.

5. Who are the internal users of accounting data? How does accounting provide relevant data to the internal users?

6. Who are the external users of accounting data? Give examples.

7. What are the three main types of business activity? Give examples of each activity.

8. Listed here are some items found in the �inancial statements of Finzelberg. Indicate in which �inancial statement(s) each item would appear. (a) Service revenue.

(b) Equipment.

(c) Advertising expense.

(e) Accounts receivable.

(f ) Common stock.

(g) Interest payable.

9. Why would a bank want to monitor the dividend payment practices of the corporations to which it lends money?

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10. “A company's net income appears directly on the income statement and the retained earnings statement, and it is included indirectly in the company's balance sheet.” Do you agree? Explain.

11. What is the primary purpose of the statement of cash �lows?

12. What are the three main categories of the statement of cash �lows? Why do you think these categories were chosen?

13. What is retained earnings? What items increase the balance in retained earnings? What items decrease the balance in retained earnings?

14. What is the basic accounting equation?

15. (a) De�ine the terms assets, liabilities, and stockholders' equity.

(b) What items affect stockholders' equity?

16. Which of these items are liabilities of White Glove Cleaning Service? (a) Cash.

(b) Accounts payable.

(c) Dividends.

(d) Accounts receivable.

(e) Supplies.

(f ) Equipment.

(g) Salaries and wages payable.

(h) Service revenue.

(i) Rent expense.

17. How are each of the following �inancial statements interrelated? (a) Retained earnings statement and income statement. (b) Retained earnings statement and balance sheet. (c) Balance sheet and statement of cash �lows.

18. What is the purpose of the management discussion and analysis section (MD&A)?

19. Why is it important for �inancial statements to receive an unquali�ied auditor's opinion?

20. What types of information are presented in the notes to the �inancial statements?

21. The accounting equation is Assets=Liabilities+Stockholders' Equity. Appendix A (a01.xhtml) , at the end of this textbook, reproduces Apple's �inancial statements. Replacing words in the equation with dollar amounts, what is Apple's accounting equation at September 27, 2014?

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BRIEF EXERCISES

Describe forms of business organization.

(LO 1), K

BE1-1 Match each of the following forms of business organization with a set of characteristics: sole proprietorship (SP), partnership (P), corporation (C).

(a) _______ Shared control, tax advantages, increased skills and resources.

(b) _______ Simple to set up and maintains control with owner.

(c) _______ Easier to transfer ownership and raise funds, no personal liability.

Identify users of accounting information.

(LO 1), K

BE1-2 Match each of the following types of evaluation with one of the listed users of accounting information.

1. Trying to determine whether the company complied with tax laws.

2. Trying to determine whether the company can pay its obligations.

3. Trying to determine whether an advertising proposal will be cost-effective.

4. Trying to determine whether the company's net income will result in a stock price increase.

5. Trying to determine whether the company should employ debt or equity �inancing.

(a) _______ Investors in common stock.

(b) _______ Marketing managers.

(c) _______ Creditors.

(d) _______ Chief Financial Of�icer.

(e) _______ Internal Revenue Service.

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Classify items by activity.

(LO 2), K

BE1-3 Indicate in which part of the statement of cash �lows each item would appear: operating activities (O), investing activities (I), or �inancing activities (F).

(a) _______ Cash received from customers.

(b) _______ Cash paid to stockholders (dividends).

(c) _______ Cash received from issuing new common stock.

(d) _______ Cash paid to suppliers.

(e) _______ Cash paid to purchase a new of�ice building.

Determine effect of transactions on stockholders' equity.

(LO 3), C

BE1-4 Presented below are a number of transactions. Determine whether each transaction affects common stock (C), dividends (D), revenues (R), expenses (E), or does not affect stockholders' equity (NSE). Provide titles for the revenues and expenses.

(a) Costs incurred for advertising.

(b) Cash received for services performed.

(c) Costs incurred for insurance.

(d) Amounts paid to employees.

(e) Cash distributed to stockholders.

(f ) Cash received in exchange for allowing the use of the company's building.

(g) Costs incurred for utilities used.

(h) Cash purchase of equipment.

(i) Cash received from investors.

Prepare a balance sheet.

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(LO 3), AP

BE1-5 In alphabetical order below are balance sheet items for Karol Company at December 31, 2017. Prepare a balance sheet following the format of Illustration 1-7 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0007) (page 13).

Accounts payable $65,000 Accounts receivable 71,000 Cash 22,000 Common stock 18,000 Retained earnings 10,000

Determine where items appear on �inancial statements.

(LO 3), K

BE1-6 Eskimo Pie Corporation markets a broad range of frozen treats, including its famous Eskimo Pie ice cream bars. The following items were taken from a recent income statement and balance sheet. In each case, identify whether the item would appear on the balance sheet (BS) or income statement (IS).

(a) _______ Income tax expense.

(b) _______ Inventory.

(c) _______ Accounts payable.

(d) _______ Retained earnings.

(e) _______ Equipment.

(f ) _______ Sales revenue.

(g) _______ Cost of goods sold.

(h) _______ Common stock.

(i) _______ Accounts receivable.

(j) _______ Interest expense.

Determine proper �inancial statement.

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(LO 3), K

BE1-7 Indicate which statement you would examine to �ind each of the following items: income statement (IS), balance sheet (BS), retained earnings statement (RES), or statement of cash �lows (SCF).

(a) Revenue during the period.

(b) Supplies on hand at the end of the year.

(c) Cash received from issuing new bonds during the period.

(d) Total debts outstanding at the end of the period.

Use basic accounting equation.

(LO 3), AP

BE1-8 Use the basic accounting equation to answer these questions.

(a) The liabilities of Lantz Company are $90,000 and the stockholders' equity is $230,000. What is the amount of Lantz Company's total assets?

(b) The total assets of Salley Company are $170,000 and its stockholders' equity is $80,000. What is the amount of its total liabilities?

(c) The total assets of Brandon Co. are $800,000 and its liabilities are equal to one-fourth of its total assets. What is the amount of Brandon Co.'s stockholders' equity?

Use basic accounting equation.

(LO 3), AP

BE1-9 At the beginning of the year, Morales Company had total assets of $800,000 and total liabilities of $500,000. (Treat each item independently.)

(a) If total assets increased $150,000 during the year and total liabilities decreased $80,000, what is the amount of stockholders' equity at the end of the year?

(b) During the year, total liabilities increased $100,000 and stockholders' equity decreased $70,000. What is the amount of total assets at the end of the year?

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(c) If total assets decreased $80,000 and stockholders' equity increased $110,000 during the year, what is the amount of total liabilities at the end of the year?

Identify assets, liabilities, and stockholders' equity.

(LO 3), K

BE1-10 Indicate whether each of these items is an asset (A), a liability (L), or part of stockholders' equity (SE).

(a) Accounts receivable.

(b) Salaries and wages payable.

(c) Equipment.

(d) Supplies.

(e) Common stock.

(f ) Notes payable.

Determine required parts of annual report.

(LO 3), K

BE1-11 Which is not a required part of an annual report of a publicly traded company?

(a) Statement of cash �lows.

(b) Notes to the �inancial statements.

(c) Management discussion and analysis.

(d) All of these are required.

DO IT! EXERCISES

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Identify bene�its of business organization forms.

(LO 1), C

DO IT! 1-1 Identify each of the following organizational characteristics with the business organizational form or forms with which it is associated.

(a) Easier to transfer ownership.

(b) Easier to raise funds.

(c) More owner control.

(d) Tax advantages.

(e) No personal legal liability.

Classify �inancial statement elements.

(LO 2), K

DO IT! 1-2 Classify each item as an asset, liability, common stock, revenue, or expense.

(a) Issuance of ownership shares.

(b) Land purchased.

(c) Amounts owed to suppliers.

(d) Bonds payable.

(e) Amount earned from selling a product.

(f ) Cost of advertising.

Prepare �inancial statements.

(LO 3), AP

DO IT! 1-3a Gray Corporation began operations on January 1, 2017. The following information is available for Gray Corporation on December 31, 2017.

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Accounts payable $ 5,000 Notes payable $ 7,000 Accounts receivable 2,000 Rent expense 10,000 Advertising expense 4,000 Retained earnings ? Cash 3,100 Service revenue 25,000 Common stock 15,000 Supplies 1,900 Dividends 2,500 Supplies expense 1,700 Equipment 26,800

Prepare an income statement, a retained earnings statement, and a balance sheet for Gray Corporation.

Identify components of annual reports.

(LO 3), K

DO IT! 1-3b Indicate whether each of the following items is most closely associated with the management discussion and analysis (MD&A), the notes to the �inancial statements, or the auditor's report.

(a) Description of ability to pay near-term obligations.

(b) Unquali�ied opinion.

(c) Details concerning liabilities, too voluminous to be included in the statements.

(d) Description of favorable and unfavorable trends.

(e) Certi�ied public accountant (CPA).

(f ) Descriptions of signi�icant accounting policies.

EXERCISES

Match items with descriptions.

(LO 1, 2, 3), K

E1-1 Here is a list of words or phrases discussed in this chapter:

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1. Corporation

2. Creditor

3. Accounts receivable

4. Partnership

5. Stockholder

6. Common stock

7. Accounts payable

8. Auditor's opinion

Instructions

Match each word or phrase with the best description of it.

(a) ______ An expression about whether �inancial statements conform with generally accepted accounting principles.

(b) ______ A business that raises money by issuing shares of stock.

(c) ______ The portion of stockholders' equity that results from receiving cash from investors.

(d) ______ Obligations to suppliers of goods.

(e) ______ Amounts due from customers.

(f ) ______ A party to whom a business owes money.

(g) ______ A party that invests in common stock.

(h) ______ A business that is owned jointly by two or more individuals but does not issue stock.

Identify business activities.

(LO 2), C

E1-2 All businesses are involved in three types of activities—�inancing, investing, and operating. Listed below are the names and descriptions of companies in several different industries.

Abitibi Consolidated Inc.—manufacturer and marketer of newsprint

Cal State–Northridge Stdt Union—university student union

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Oracle Corporation—computer software developer and retailer

Sportsco Investments—owner of the Vancouver Canucks hockey club

Grant Thornton LLP—professional accounting and business advisory �irm

Southwest Airlines—low-cost airline

Instructions

(a) For each of the above companies, provide examples of (1) a �inancing activity, (2) an investing activity, and (3) an operating activity that the company likely engages in.

(b) Which of the activities that you identi�ied in (a) are common to most businesses? Which activities are not?

Classify accounts.

(LO 2, 3), C

E1-3 The Bonita Vista Golf & Country Club details the following accounts in its �inancial statements.

Accounts payable _______ Accounts receivable _______ Equipment _______ Sales revenue _______ Service revenue _______ Inventory _______ Mortgage payable _______ Supplies expense _______ Rent expense _______ Salaries and wages expense _______

Instructions

Classify each of the above accounts as an asset (A), liability (L), stockholders' equity (SE), revenue (R), or expense (E) item.

Prepare income statement and retained earnings statement.

(LO 3), AP

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E1-4 This information relates to Benser Co. for the year 2017.

Retained earnings, January 1, 2017 $67,000 Advertising expense 1,800 Dividends 6,000 Rent expense 10,400 Service revenue 58,000 Utilities expense 2,400 Salaries and wages expense 30,000

Instructions

After analyzing the data, prepare an income statement and a retained earnings statement for the year ending December 31, 2017.

Prepare income statement and retained earnings statement.

(LO 3), AP

E1-5 Suppose the following information was taken from the 2017 �inancial statements of pharmaceutical giant Merck and Co. (All dollar amounts are in millions.)

Retained earnings, January 1, 2017 $43,698.8 Cost of goods sold 9,018.9 Selling and administrative expenses 8,543.2 Dividends 3,597.7 Sales revenue 38,576.0 Research and development expense 5,845.0 Income tax expense 2,267.6

Instructions

After analyzing the data, prepare an income statement and a retained earnings statement for the year ending December 31, 2017.

Suppose that Merck decided to reduce its research and development expense by 50%. What would be the short-term implications? What would be the long-term implications? How do you think the stock market would react?

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Prepare a retained earnings statement.

(LO 3), AP

E1-6 Presented here is information for Zheng Inc. for 2017.

Retained earnings, January 1 $130,000 Service revenue 400,000 Total expenses 175,000 Dividends 65,000

Instructions

Prepare the 2017 retained earnings statement for Zheng Inc.

Interpret �inancial facts.

(LO 3), AP

E1-7 Consider each of the following independent situations.

(a) The retained earnings statement of Lee Corporation shows dividends of $68,000, while net income for the year was $75,000.

(b) The statement of cash �lows for Steele Corporation shows that cash provided by operating activities was $10,000, cash used in investing activities was $110,000, and cash provided by �inancing activities was $130,000.

Instructions

For each company, provide a brief discussion interpreting these �inancial facts. For example, you might discuss the company's �inancial health or its apparent growth philosophy.

Identify �inancial statement components and prepare income statement.

(LO 3), C

E1-8 The following items and amounts were taken from Lonyear Inc.'s 2017 income statement and balance sheet.

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_______ Cash $ 84,700 _______ Accounts receivable $ 88,419 _______ Retained earnings 123,192 _______ Sales revenue 584,951 _______ Cost of goods sold 438,458 _______ Notes payable 6,499 _______ Salaries and wages expense 115,131 _______ Accounts payable 49,384 _______ Prepaid insurance 7,818 _______ Service revenue 4,806 _______ Inventory 64,618 _______ Interest expense 1,882

Instructions

(a) In each, case, identify on the blank line whether the item is an asset (A), liability (L), stockholders' equity (SE), revenue (R), or expense (E) item.

(b) Prepare an income statement for Lonyear Inc. for the year ended December 31, 2017.

Calculate missing amounts.

(LO 3), AN

E1-9 Here are incomplete �inancial statements for Donavan, Inc.

Instructions

Calculate the missing amounts.

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Compute net income and prepare a balance sheet.

(LO 3), AP

E1-10 Otay Lakes Park is a private camping ground near the Mount Miguel Recreation Area. It has compiled the following �inancial information as of December 31, 2017.

Service revenue (from camping fees) $132,000 Dividends $  9,000 Sales revenue (from general store) 25,000 Notes payable 50,000 Accounts payable 11,000 Expenses during 2017 126,000 Cash 8,500 Supplies 5,500 Equipment 114,000 Common stock 40,000 Retained earnings (1/1/2017) 5,000

Instructions

(a) Determine Otay Lakes Park's net income for 2017.

(b) Prepare a retained earnings statement and a balance sheet for Otay Lakes Park as of December 31, 2017.

(c) Upon seeing this income statement, Walt Jones, the campground manager, immediately concluded, “The general store is more trouble than it is worth—let's get rid of it.” The marketing director isn't so sure this is a good idea. What do you think?

Identify �inancial statement components and prepare an income statement.

(LO 3), AP

E1-11 Kellogg Company is the world's leading producer of ready-to-eat cereal and a leading producer of grain-based convenience foods such as frozen waf�les and cereal bars. Suppose the following items were taken from its 2017 income statement and balance sheet. (All dollars are in millions.)

____ Retained earnings $5,481 ____ Bonds payable $ 4,835 ____ Cost of goods sold 7,184 ____ Inventory 910 ____ Selling and administrative expenses 3,390 ____ Sales revenue 12,575 ____ Accounts payable 1,077 ____ Cash 334 ____ Common stock 105 ____ Notes payable 44 ____ Income tax expense 498 ____ Interest expense 295

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Instructions

(a) In each case, identify whether the item is an asset (A), liability (L), stockholders' equity (SE), revenue (R), or expense (E).

(b) Prepare an income statement for Kellogg Company for the year ended December 31, 2017.

Prepare a statement of cash �lows.

(LO 3), AP

E1-12 This information is for Williams Corporation for the year ended December 31, 2017.

Cash received from lenders $20,000 Cash received from customers 50,000 Cash paid for new equipment 28,000 Cash dividends paid 8,000 Cash paid to suppliers 16,000 Cash balance 1/1/17 12,000

Instructions

(a) Prepare the 2017 statement of cash �lows for Williams Corporation.

(b) Suppose you are one of Williams' creditors. Referring to the statement of cash �lows, evaluate Williams' ability to repay its creditors.

Prepare a statement of cash �lows.

(LO 3), AP

E1-13 Suppose the following data are derived from the 2017 �inancial statements of Southwest Airlines. (All dollars are in millions.) Southwest has a December 31 year-end.

Cash balance, January 1, 2017 $1,390 Cash paid for repayment of debt 122 Cash received from issuance of common stock 144 Cash received from issuance of long-term debt 500 Cash received from customers 9,823

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Cash paid for property and equipment 1,529 Cash paid for dividends 14 Cash paid for repurchase of common stock 1,001 Cash paid for goods and services 6,978

Instructions

(a) After analyzing the data, prepare a statement of cash �lows for Southwest Airlines for the year ended December 31, 2017.

(b) Discuss whether the company's net cash provided by operating activities was suf�icient to �inance its investing activities. If it was not, how did the company �inance its investing activities?

Correct an incorrectly prepared balance sheet.

(LO 3), AP

E1-14 Wayne Holtz is the bookkeeper for Beeson Company. Wayne has been trying to get the balance sheet of Beeson Company to balance. It �inally balanced, but now he's not sure it is correct.

Instructions

Prepare a correct balance sheet.

Classify items as assets, liabilities, and stockholders' equity and prepare accounting equation.

(LO 3), AP

E1-15 Suppose the following items were taken from the balance sheet of Nike, Inc. (All dollars are in millions.)

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1. Cash $2,291.1 2. Accounts receivable 2,883.9 3. Common stock 2,874.2 4. Notes payable 342.9 5. Buildings 3,759.9 6. Mortgage payable 1,311.5 7. Inventory $2,357.0 8. Income taxes payable 86.3 9. Equipment 1,957.7 10. Retained earnings 5,818.9 11. Accounts payable 2,815.8

Instructions

Perform each of the following.

(a) Classify each of these items as an asset, liability, or stockholders' equity, and determine the total dollar amount for each classi�ication.

(b) Determine Nike's accounting equation by calculating the value of total assets, total liabilities, and total stockholders' equity.

(c) To what extent does Nike rely on debt versus equity �inancing?

Use �inancial statement relationships to determine missing amounts.

(LO 3), AN

E1-16 The summaries of data from the balance sheet, income statement, and retained earnings statement for two corporations, Walco Corporation and Gunther Enterprises, are presented as follows for 2017.

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Instructions

Determine the missing amounts. Assume all changes in stockholders' equity are due to changes in retained earnings.

Classify various items in an annual report.

(LO 3), K

E1-17 The annual report provides �inancial information in a variety of formats, including the following.

Management discussion and analysis (MD&A)

Financial statements

Notes to the �inancial statements

Auditor's opinion

Instructions

For each of the following, state in what area of the annual report the item would be presented. If the item would probably not be found in an annual report, state “Not disclosed.”

(a) The total cumulative amount received from stockholders in exchange for common stock.

(b) An independent assessment concerning whether the �inancial statements present a fair depiction of the company's results and �inancial position.

(c) The interest rate that the company is being charged on all outstanding debts.

(d) Total revenue from operating activities.

(e) Management's assessment of the company's results.

(f ) The names and positions of all employees hired in the last year.

EXERCISES: SET B AND CHALLENGE EXERCISES Visit the book's companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , and choose the Student Companion site to access Exercises: Set B and Challenge Exercises.

PROBLEMS: SET A

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Determine forms of business organization.

(LO 1), C

P1-1A Presented below are �ive independent situations.

(a) Three physics professors at MIT have formed a business to improve the speed of information transfer over the Internet for stock exchange transactions. Each has contributed an equal amount of cash and knowledge to the venture. Although their approach looks promising, they are concerned about the legal liabilities that their business might confront.

(b) Bob Colt, a college student looking for summer employment, opened a bait shop in a small shed at a local marina.

(c) Alma Ortiz and Jaime Falco each owned separate shoe manufacturing businesses. They have decided to combine their businesses. They expect that within the coming year they will need signi�icant funds to expand their operations.

(d) Alice, Donna, and Sam recently graduated with marketing degrees. They have been friends since childhood. They have decided to start a consulting business focused on marketing sporting goods over the Internet.

(e) Don Rolls has developed a low-cost GPS device that can be implanted into pets so that they can be easily located when lost. He would like to build a small manufacturing facility to make the devices and then sell them to veterinarians across the country. Don has no savings or personal assets. He wants to maintain control over the business.

Instructions

In each case, explain what form of organization the business is likely to take—sole proprietorship, partnership, or corporation. Give reasons for your choice.

Identify users and uses of �inancial statements.

(LO 3), C

P1-2A Financial decisions often place heavier emphasis on one type of �inancial statement over the others. Consider each of the following hypothetical situations independently.

(a) The North Face is considering extending credit to a new customer. The terms of the credit would require the customer to pay within 30 days of receipt of goods.

(b) An investor is considering purchasing common stock of Amazon.com. The investor plans to hold the investment for at least 5 years.

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(c) JPMorgan Chase Bank is considering extending a loan to a small company. The company would be required to make interest payments at the end of each year for 5 years, and to repay the loan at the end of the �ifth year.

(d) The president of Campbell Soup is trying to determine whether the company is generating enough cash to increase the amount of dividends paid to investors in this and future years, and still have enough cash to buy equipment as it is needed.

Instructions

In each situation, state whether the decision-maker would be most likely to place primary emphasis on information provided by the income statement, balance sheet, or statement of cash �lows. In each case provide a brief justi�ication for your choice. Choose only one �inancial statement in each case.

Prepare an income statement, retained earnings statement, and balance sheet; discuss results.

(LO 3), AP

P1-3A On June 1, 2017, Elite Service Co. was started with an initial investment in the company of $22,100 cash. Here are the assets, liabilities, and common stock of the company at June 30, 2017, and the revenues and expenses for the month of June, its �irst month of operations:

Cash $ 4,600 Notes payable $12,000 Accounts receivable 4,000 Accounts payable 500 Service revenue 7,500 Supplies expense 1,000 Supplies 2,400 Maintenance and repairs expense 600 Advertising expense 400 Utilities expense 300 Equipment 26,000 Salaries and wages expense 1,400 Common stock 22,100

In June, the company issued no additional stock but paid dividends of $1,400.

Check �igures provide a key number to let you know you are on the right track.

Instructions

(a) Net income $ 3,800 Ret. earnings $ 2,400 Tot. assets $37,000

(a) Prepare an income statement and a retained earnings statement for the month of June and a balance sheet at June 30, 2017.

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(b) Brie�ly discuss whether the company's �irst month of operations was a success.

(c) Discuss the company's decision to distribute a dividend.

Determine items included in a statement of cash �lows, prepare the statement, and comment.

(LO 3), AP

P1-4A Presented below is selected �inancial information for Rojo Corporation for December 31, 2017.

Inventory $ 25,000 Cash paid to purchase equipment $ 12,000 Cash paid to suppliers 104,000 Equipment 40,000 Buildings 200,000 Service revenue 100,000 Common stock 50,000 Cash received from customers 132,000 Cash dividends paid 7,000 Cash received from issuing common stock 22,000 Cash at beginning of period 9,000

Instructions

(a) Net increase $31,000

(a) Determine which items should be included in a statement of cash �lows and then prepare the statement for Rojo Corporation.

(b) Comment on the adequacy of net cash provided by operating activities to fund the company's investing activities and dividend payments.

Comment on proper accounting treatment and prepare a corrected balance sheet.

(LO 3), AN

P1-5A Micado Corporation was formed on January 1, 2017. At December 31, 2017, Miko Liu, the president and sole stockholder, decided to prepare a balance sheet, which appeared as follows.

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Miko willingly admits that she is not an accountant by training. She is concerned that her balance sheet might not be correct. She has provided you with the following additional information.

1. The boat actually belongs to Miko, not to Micado Corporation. However, because she thinks she might take customers out on the boat occasionally, she decided to list it as an asset of the company. To be consistent, she also listed as a liability of the corporation her personal loan that she took out at the bank to buy the boat.

2. The inventory was originally purchased for $25,000, but due to a surge in demand Miko now thinks she could sell it for $36,000. She thought it would be best to record it at $36,000.

3. Included in the accounts receivable balance is $10,000 that Miko loaned to her brother 5 years ago. Miko included this in the receivables of Micado Corporation so she wouldn't forget that her brother owes her money.

Instructions

(a) Comment on the proper accounting treatment of the three items above.

(b) Provide a corrected balance sheet for Micado Corporation. (Hint: To get the balance sheet to balance, adjust stockholders' equity.)

(b) Tot. assets $85,000

PROBLEMS: SET B AND SET C Visit the book's companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , and choose the Student Companion site to access Problems: Set B and Set C.

CONTINUING PROBLEM Cookie Creations

The Cookie Creations problem starts in Chapter 1 and continues in every chapter. You can also �ind this problem at the book's companion website.

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CC1 Natalie Koebel spent much of her childhood learning the art of cookie-making from her grandmother. They spent many happy hours mastering every type of cookie imaginable and later devised new recipes that were both healthy and delicious. Now at the start of her second year in college, Natalie is investigating possibilities for starting her own business as part of the entrepreneurship program in which she is enrolled.

A long-time friend insists that Natalie has to include cookies in her business plan. After a series of brainstorming sessions, Natalie settles on the idea of operating a cookie-making school. She will start on a part-time basis and offer her services in people's homes. Now that she has started thinking about it, the possibilities seem endless. During the fall, she will concentrate on holiday cookies. She will offer group sessions (which will probably be more entertainment than education) and individual lessons. Natalie also decides to include children in her target market. The �irst dif�icult decision is coming up with the perfect name for her business. She settles on “Cookie Creations,” and then moves on to more important issues.

Instructions

(a) What form of business organization—proprietorship, partnership, or corporation—do you recommend that Natalie use for her business? Discuss the bene�its and weaknesses of each form that Natalie might consider.

(b) Will Natalie need accounting information? If yes, what information will she need and why? How often will she need this information?

(c) Identify speci�ic asset, liability, revenue, and expense accounts that Cookie Creations will likely use to record its business transactions.

(d) Should Natalie open a separate bank account for the business? Why or why not?

(e) Natalie expects she will have to use her car to drive to people's homes and to pick up supplies, but she also needs to use her car for personal reasons. She recalls from her �irst-year accounting course something about keeping business and personal assets separate. She wonders what she should do for accounting purposes. What do you recommend?

EXPAND YOUR | CRITICAL THINKING

FINANCIAL REPORTING PROBLEM: Apple Inc.

E CT1-1 The �inancial statements of Apple Inc. for 2014 are presented in Appendix A (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a01#a01) .

Instructions

(a) Refer to Apple's �inancial statements and answer the following questions.

(b) What were Apple's total assets at September 27, 2014? At September 28, 2013?

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(c) How much cash (and cash equivalents) did Apple have on September 27, 2014?

(d) What amount of accounts payable did Apple report on September 27, 2014? On September 28, 2013?

(e) What were Apple's net sales in 2012? In 2013? In 2014?

(f ) What is the amount of the change in Apple's net income from 2013 to 2014?

COMPARATIVE ANALYSIS PROBLEM: Columbia Sportswear Company vs. VF Corporation

E CT1-2 Columbia Sportswear Company's �inancial statements are presented in Appendix B (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a02#a02) . Financial statements of VF Corporation are presented in Appendix C (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a03#a03) .

Instructions

(a) Based on the information in these �inancial statements, determine the following for each company.

1. Total liabilities at December 31, 2014.

2. Net property, plant, and equipment at December 31, 2014.

3. Net cash provided or (used) in investing activities for 2014.

4. Net income for 2014.

(b) What conclusions concerning the two companies can you draw from these data?

COMPARATIVE ANALYSIS PROBLEM: Amazon.com, Inc. vs. Wal-Mart Stores, Inc.

E CT1-3 Amazon.com, Inc.'s �inancial statements are presented in Appendix D (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a04#a04) . Financial statements of Wal-Mart Stores, Inc. are presented in Appendix E (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a05#a05) .

Instructions

(a) Based on the information contained in these �inancial statements, determine the following for each company.

1. Total assets at December 31, 2014, for Amazon and for Wal-Mart at January 31, 2015.

2. Receivables (net) at December 31, 2014, for Amazon and for Wal-Mart at January 31, 2015.

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3. Net sales (product only) for the year ended in 2014 (2015 for Wal-Mart).

4. Net income for year ended in 2014 (2015 for Wal-Mart).

(b) What conclusions concerning these two companies can be drawn from these data?

INTERPRETING FINANCIAL STATEMENTS

E CT1-4 Xerox was not having a particularly pleasant year. The company's stock price had already fallen in the previous year from $60 per share to $30. Just when it seemed things couldn't get worse, Xerox's stock fell to $4 per share. The data below were taken from the statement of cash �lows of Xerox. (All dollars are in millions.)

Cash used in operating activities $ (663) Cash used in investing activities (644) Financing activities Dividends paid $ (587) Net cash received from issuing debt  3,498  Cash provided by �inancing activities 2,911 

Instructions

Analyze the information, and then answer the following questions.

(a) If you were a creditor of Xerox, what reaction might you have to the above information?

(b) If you were an investor in Xerox, what reaction might you have to the above information?

(c) If you were evaluating the company as either a creditor or a stockholder, what other information would you be interested in seeing?

(d) Xerox decided to pay a cash dividend. This dividend was approximately equal to the amount paid in the previous year. Discuss the issues that were probably considered in making this decision.

REAL-WORLD FOCUS

E CT1-5 Purpose: Identify summary information about companies. This information includes basic descriptions of the company's location, activities, industry, �inancial health, and �inancial performance.

Address: http://biz.yahoo.com/i (http://biz.yahoo.com/i)

Steps

1. Type in a company name, or use the index to �ind company name.

2. Under Financials, choose Income Statement. Perform instructions (a) and (b) below.

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3. Under Company, choose Industry to identify others in this industry. Perform instructions (c)–(e) below.

Instructions

Answer the following questions.

(a) What is the company's net income? Over what period was this measured?

(b) What is the company's total sales? Over what period was this measured?

(c) What is the company's industry?

(d) What are the names of four companies in this industry?

(e) Choose one of the competitors. What is this competitor's name? What is its total sales? What is its net income?

S CT1-6 The June 22, 2011, issue of the Wall Street Journal Online includes an article by Michael Rapoport entitled “Auditors Urged to Tell More.” It provides an interesting discussion of the possible expanding role of CPAs.

Instructions

Read the article and answer the following questions.

(a) What are some of the ideas that the Public Company Accounting Oversight Board proposed for expanding the role of auditors in “passing judgment on more of what a company does and says?”

(b) How might the �inancial crisis in�luence the public's opinion regarding the need for more information from auditors?

(c) Describe the proposed “Auditor's Discussion and Analysis.”

(d) Discuss whether you think that auditors will view these proposals positively or negatively.

DECISION-MAKING ACROSS THE ORGANIZATION

E CT1-7 Sylvia Ayala recently accepted a job in the production department at Apple. Before she starts work, she decides to review the company's annual report to better understand its operations.

The content and organization of corporate annual reports have become fairly standardized. Excluding the public relations part of the report (pictures, products, etc.), the following are the traditional �inancial portions of the annual report:

Financial Highlights

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Letter to the Stockholders

Management's Discussion and Analysis

Financial Statements

Notes to the Financial Statements

Management's Responsibility for Financial Reporting

Management's Report on Internal Control over Financial Reporting

Report of Independent Registered Public Accounting Firm

Selected Financial Data

The of�icial SEC �iling of the annual report is called a Form 10-K, which often omits the public relations pieces found in most standard annual reports. To access Apple's Form 10-K, including notes to the �inancial statements, follow these steps:

1. Go to http://investor.apple.com.

2. Select the Financial Information tab.

3. Select the 10-K annual report dated September 2014.

4. The �inancial portions of the annual report begin on page 21.

Instructions

Use Apple's annual report to answer the following questions.

(a) What CPA �irm performed the audit of Apple's �inancial statements?

(b) What was the amount of Apple's basic earnings per share in 2014?

(c) What are the company's net sales in foreign countries in 2014?

(d) What were net sales in 2012?

(e) How many shares of common stock have been authorized?

(f ) How much cash was spent on capital expenditures in 2014?

(g) Over what life does the company depreciate its buildings?

(h) What was the value of inventory in 2013?

COMMUNICATION ACTIVITY

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S CT1-8 Marci Ling is the bookkeeper for Samco Company, Inc. Marci has been trying to get the company's balance sheet to balance. She �inally got it to balance, but she still isn't sure that it is correct.

Instructions

Explain to Marci Ling in a memo (a) the purpose of a balance sheet, and (b) why this balance sheet is incorrect and what she should do to correct it.

ETHICS CASE

E CT1-9 Rules governing the investment practices of individual certi�ied public accountants prohibit them from investing in the stock of a company that their �irm audits. The Securities and Exchange Commission (SEC) became concerned that some accountants were violating this rule. In response to an SEC investigation, PricewaterhouseCoopers �ired 10 people and spent $25 million educating employees about the investment rules and installing an investment tracking system.

Instructions

Answer the following questions.

(a) Why do you think rules exist that restrict auditors from investing in companies that are audited by their �irms?

(b) Some accountants argue that they should be allowed to invest in a company's stock as long as they themselves aren't involved in working on the company's audit or consulting. What do you think of this idea?

(c) Today, a very high percentage of publicly traded companies are audited by only four very large public accounting �irms. These �irms also do a high percentage of the consulting work that is done for publicly traded companies. How does this fact complicate the decision regarding whether CPAs should be allowed to invest in companies audited by their �irm?

(d) Suppose you were a CPA and you had invested in IBM when IBM was not one of your �irm's clients. Two years later, after IBM's stock price had fallen considerably, your �irm won the IBM audit contract. You will be involved in working with the IBM audit. You know that your �irm's rules require that you sell your shares immediately. If you do sell immediately, you will sustain a large loss. Do you think this is fair? What would you do?

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(e) Why do you think PricewaterhouseCoopers took such extreme steps in response to the SEC investigation?

ALL ABOUT YOU

E CT1-10 Some people are tempted to make their �inances look worse to get �inancial aid. Companies sometimes also manage their �inancial numbers in order to accomplish certain goals. Earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income. In managing earnings, companies' actions vary from being within the range of ethical activity, to being both unethical and illegal attempts to mislead investors and creditors.

Instructions

Provide responses for each of the following questions.

(a) Discuss whether you think each of the following actions (adapted from www.�inaid.org/fafsa/maximize.phtml (http://www.�inaid.org/fafsa/maximize.phtml) ) to increase the chances of receiving �inancial aid is ethical.

(i) Spend down the student's assets and income �irst, before spending parents' assets and income.

(ii) Accelerate necessary expenses to reduce available cash. For example, if you need a new car, buy it before applying for �inancial aid.

(iii) State that a truly �inancially dependent child is independent.

(iv) Have a parent take an unpaid leave of absence for long enough to get below the “threshold” level of income.

(b) What are some reasons why a company might want to overstate its earnings?

(c) What are some reasons why a company might want to understate its earnings?

(d) Under what circumstances might an otherwise ethical person decide to illegally overstate or understate earnings?

FASB CODIFICATION ACTIVITY

C CT1-11 The FASB has developed the Financial Accounting Standards Board Accounting Standards Codi�ication (or more simply “the Codi�ication”). The FASB's primary goal in developing the Codi�ication is to provide in one place all the authoritative literature related to a particular topic. To provide easy access to the Codi�ication, the FASB also developed the Financial Accounting Standards Board Codi�ication Research System (CRS). CRS is an online, real-time database that provides easy access to the Codi�ication. The Codi�ication and the related CRS provide a topically organized structure, subdivided into topic, subtopics, sections, and paragraphs, using a numerical index system.

You may �ind this system useful in your present and future studies, and so we have provided an opportunity to use this online system as part of the Expand Your Critical Thinking section.

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Instructions

Academic access to the FASB Codi�ication is available through university subscriptions, obtained from the American Accounting Association (at http://aaahq.org/FASB/Access.cfm), for an annual fee of $150. This subscription covers an unlimited number of students within a single institution. Once this access has been obtained by your school, you should log in (at http://aaahq.org/ascLogin.cfm) and familiarize yourself with the resources that are accessible at the FASB Codi�ication site.

CONSIDERING PEOPLE, PLANET, AND PROFIT

E CT1-12 Although Clif Bar & Company is not a public company, it does share its �inancial information with its employees as part of its open-book management approach. Further, although it does not publicly share its �inancial information, it does provide a different form of an annual report to external users. In this report, the company provides information regarding its sustainability efforts.

Address: www.cli�bar.com/article/our-�ive-aspirations

Instructions

Access the article at the site shown above and then answer the following questions.

(a) What are the Five Aspirations?

(b) Click on the “All Aspirations Annual Report” link at the bottom of the page. How does this annual report differ from the annual report discussed in the chapter? Are there any similarities?

(c) What are the four key goals of the company's sustainability efforts related to the planet? Give one example of a recent initiative, and a measurable outcome for that initiative, that the company has taken related to each goal.

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LEARNING OBJECTIVE 4

Describe the impact of international accounting standards on U.S. �inancial reporting. 

Most agree that there is a need for one set of international accounting standards. Here is why:

Multinational corporations. Today's companies view the entire world as their market. For example, Coca-Cola, Intel, and McDonald's generate more than 50% of their sales outside the United States. Many foreign companies, such as Toyota, Nestlé, and Sony, �ind their largest market to be the United States.

Mergers and acquisitions. The mergers between Fiat/Chrysler and Vodafone/Mannesmann suggest that we will see even more such business combinations of companies from different countries in the future.

Information technology. As communication barriers continue to topple through advances in technology, companies and individuals in different countries and markets are becoming more comfortable buying and selling goods and services from one another.

Financial markets. Financial markets are of international signi�icance today. Whether it is currency, equity securities (stocks), bonds, or derivatives, there are active markets throughout the world trading these types of instruments.

KEY POINTS

Following are the key similarities and differences between GAAP and IFRS as related to accounting fundamentals.

Similarities

The basic techniques for recording business transactions are the same for U.S. and international companies.

Both international and U.S. accounting standards emphasize transparency in �inancial reporting. Both sets of standards are primarily driven by meeting the needs of investors and creditors.

The three most common forms of business organizations, proprietorships, partnerships, and corporations, are also found in countries that use international accounting standards.

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Differences

International standards are referred to as International Financial Reporting Standards (IFRS), developed by the International Accounting Standards Board. Accounting standards in the United States are referred to as generally accepted accounting principles (GAAP) and are developed by the Financial Accounting Standards Board.

IFRS tends to be simpler in its accounting and disclosure requirements; some people say it is more “principles-based.” GAAP is more detailed; some people say it is more “rules-based.”

The internal control standards applicable to Sarbanes-Oxley (SOX) apply only to large public companies listed on U.S. exchanges. There is continuing debate as to whether non-U.S. companies should have to comply with this extra layer of regulation.

LOOKING TO THE FUTURE

Both the IASB and the FASB are hard at work developing standards that will lead to the elimination of major differences in the way certain transactions are accounted for and reported.

IFRS Practice

IFRS SELF-TEST QUESTIONS

1. Which of the following is not a reason why a single set of high-quality international accounting standards would be bene�icial? (a) Mergers and acquisition activity.

(b) Financial markets.

(c) Multinational corporations.

(d) GAAP is widely considered to be a superior reporting system.

2. The Sarbanes-Oxley Act determines: (a) international tax regulations.

(b) internal control standards as enforced by the IASB.

(c) internal control standards of U.S. publicly traded companies.

(d) U.S. tax regulations.

3. IFRS is considered to be more: (a) principles-based and less rules-based than GAAP.

(b) rules-based and less principles-based than GAAP.

(c) detailed than GAAP.

(d) None of the above.

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IFRS EXERCISES

IFRS1-1 Who are the two key international players in the development of international accounting standards? Explain their role.

IFRS1-2 What is the bene�it of a single set of high-quality accounting standards?

INTERNATIONAL FINANCIAL REPORTING PROBLEM: Louis Vuitton

IFRS1-3 The �inancial statements of Louis Vuitton are presented in Appendix F (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a06#a06) . Instructions for accessing and using the company's complete annual report, including the notes to its �inancial statements, are also provided in Appendix F (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a06#a06) .

Instructions

Visit Louis Vuitton's corporate website and answer the following questions from the company's 2014 annual report.

(a) What accounting �irm performed the audit of Louis Vuitton's �inancial statements?

(b) What is the address of the company's corporate headquarters?

(c) What is the company's reporting currency?

Answers to IFRS Self-Test Questions

1. d 2. c 3. a