CH 1 - End of Chapter Exercises Solutions

CHAPTER 1
Introduction to Financial Statements

ANSWERS TO QUESTIONS
1. The three basic forms of business organizations are (1) sole proprietorship, (2) partnership,
and (3) corporation.
2. Advantages of a corporation are limited liability (stockholders not being personally liable for
corporate debts), easy transferability of ownership, and ease of raising funds. Disadvantages
of a corporation are increased taxation and government regulations.
3. Proprietorships and partnerships receive favorable tax treatment compared to corporations and
are easier to form than corporations. They are also owner controlled. Disadvantages of
proprietorships and partnerships are unlimited liability (proprietors/partners are personally
liable for all debts) and difficulty in obtaining financing compared to corporations.
4. Yes. A person cannot earn a living, spend money, buy on credit, make an investment, or pay
taxes without receiving, using, or dispensing financial information. Accounting provides
financial information to interested users through the preparation and distribution of financial
statements.
5. Internal users are managers who plan, organize, and run a business. To assist management,
accounting provides timely internal reports. Examples include financial comparisons of
operating alternatives, projections of income from new sales campaigns, forecasts of cash
needs for the next year, and financial statements.
6. External users are those outside the business who have either a present or potential direct
financial interest (investors and creditors) or an indirect financial interest (taxing authorities,
regulatory agencies, labor unions, customers, and economic planners).
7. The three types of business activities are financing activities, investing activities, and operating
activities. Financing activities include borrowing money and selling shares of stock. Investing
activities include the purchase and sale of property, plant, and equipment. Operating activities
include selling goods, performing services, and purchasing inventory.
8. (a) Income statement. (d) Balance sheet.

(b) Balance sheet. (e) Balance sheet.
(c) Income statement. (f) Balance sheet.
9. When a company pays dividends, it reduces the amount of assets available to pay creditors.
Therefore, banks and other creditors monitor dividend payments to ensure they do not put a
company’s ability to make debt payments at risk.
10. Yes. Net income does appear on the income statement—it is the result of subtracting
expenses from revenues. In addition, net income appears in the retained earnings statement—it
is shown as an addition to the beginning-of-period retained earnings. Indirectly, the net income
Copyright © 2013 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 7/e, Solutions Manual (For Instructor Use Only) 1-1
of a company is also included in the balance sheet. It is included in the retained earnings
account which appears in the stockholders’ equity section of the balance sheet.
11. The primary purpose of the statement of cash flows is to provide financial information about
the cash receipts and cash payments of a business for a specific period of time.
1-2 Copyright © 2013 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 7/e, Solutions Manual (For Instructor Use Only)
Questions Chapter 1 (Continued)
12. The three categories of the statement of cash flows are operating activities, investing activities,
and financing activities. The categories were chosen because they represent the three
principal types of business activities.
13. Retained earnings is the net income retained in a corporation. Retained earnings is increased
by net income and is decreased by dividends and a net loss.
14. The basic accounting equation is Assets = Liabilities + Stockholders’ Equity.
15. (a) Assets are resources owned by a business. Liabilities are amounts owed to creditors. Put
more simply, liabilities are existing debts and obligations. Stockholders’ equity is the
ownership claim on net assets.
(b) The items that affect stockholders’ equity are common stock, retained earnings,
dividends, revenues, and expenses.
16. The liabilities are (b) Accounts payable and (g) Salaries and wages payable.
17. (a) Net income from the income statement is reported as an increase to retained earnings on
the retained earnings statement.
(b) The ending amount on the retained earnings statement is reported as the retained
earnings amount on the balance sheet.
(c) The ending amount on the statement of cash flows is reported as the cash amount on the
balance sheet.
18. The purpose of the management discussion and analysis section is to provide
management’s views on its ability to pay short-term obligations, its ability to fund operations
and expansion, and its results of operations. The MD&A section is a required part of the
annual report.
19. An unqualified opinion shows that, in the opinion of an independent auditor, the financial state-
ments have been presented fairly, in conformity with generally accepted accounting principles.
This gives investors more confidence that they can rely on the figures reported in the financial
statements.
20. Information included in the notes to the financial statements clarifies information presented in
the financial statements and includes descriptions of accounting policies, explanations of
uncertainties and contingencies, and statistics and details too voluminous to be reported in the
financial statements.
21. Using dollar amounts, Tootsie Roll’s accounting equation is:
Assets Liabilities Stockholders’ Equity

= +
$857,856,000 $191,921,000* $665,935,000
*$58,355,000 + $133,566,000
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 1-1
(a) P Shared control, tax advantages, increased skills and

resources.
(b) SP Simple to set up and maintains control with founder.
(c) C Easier to transfer ownership and raise funds, no personal
liability.
BRIEF EXERCISE 1-2
(a) 4 Investors in common stock

(b) 3 Marketing managers
(c) 2 Creditors
(d) 5 Chief Financial Officer
(e) 1 Internal Revenue Service
BRIEF EXERCISE 1-3
O (a) Cash received from customers.

F (b) Cash paid to stockholders (dividends).
F (c) Cash received from issuing new common stock.
O (d) Cash paid to suppliers.
I (e) Cash paid to purchase a new office building.
BRIEF EXERCISE 1-4
E (a) Advertising expense

R (b) Service revenue
E (c) Insurance expense
E (d) Salaries and wages expense
D (e) Dividends
R (f) Rent revenue
E (g) Utilities expense
NSE (h) Cash purchase of equipment
C (i) Issued common stock for cash.
BRIEF EXERCISE 1-5
BURNETT COMPANY
Balance Sheet
December 31, 2014
Assets
Cash ................................................................................. $22,000
Accounts receivable ....................................................... 71,000
Total assets ..................................................................... $93,000
Liabilities and Stockholders’ Equity

Liabilities
Accounts payable ................................................... $65,000
Stockholders’ equity
Common stock ........................................................ $18,000
Retained earnings ................................................... 10,000 28,000
Total liabilities and stockholders’ equity ..................... $93,000
BRIEF EXERCISE 1-6
IS (a) Income tax expense

BS (b) Inventory
BS (c) Accounts payable
BS (d) Retained earnings
BS (e) Equipment
IS (f) Sales revenue
IS (g) Cost of goods sold
BS (h) Common stock
BS (i) Accounts Receivable
IS (j) Interest expense
BRIEF EXERCISE 1-7
IS (a) Revenue during the period.

BS (b) Supplies on hand at the end of the year.
SCF (c) Cash received from issuing new bonds during the period.
BS (d) Total debts outstanding at the end of the period.
BRIEF EXERCISE 1-8
(a) $90,000 + $230,000 = $320,000 (Total assets)
(b) $170,000 – $80,000 = $90,000 (Total liabilities)
(c) $800,000 – 0.25($800,000) = $600,000 (Stockholders’ equity)
BRIEF EXERCISE 1-9
(a) ($800,000 + $150,000) – ($500,000 – $80,000) = $530,000

(Stockholders’ equity)
(b) ($500,000 + $100,000) + ($800,000 – $500,000 – $70,000) = $830,000

(Assets)
(c) ($800,000 – $80,000) – ($800,000 – $500,000 + $110,000) = $310,000

(Liabilities)
BRIEF EXERCISE 1-10
A (a) Accounts receivable

L (b) Salaries and wages payable
A (c) Equipment
A (d) Supplies
SE (e) Common stock
L (f) Notes payable
BRIEF EXERCISE 1-11
(d) All of these are required.
SOLUTIONS TO DO IT! REVIEW EXERCISES
DO IT! 1-1
(a) Easier to transfer ownership: corporation

(b) Easier to raise funds: corporation
(c) More owner control: sole proprietorship
(d) Tax advantages: sole proprietorship and partnership
(e) No personal legal liability: corporation
DO IT! 1-2
(a) Issuance of ownership shares is classified as common stock.

(b) Land purchased is classified as an asset.
(c) Amounts owed to suppliers are classified as liabilities.
(d) Bonds payable are classified as liabilities.
(e) Amount earned from selling a product is classified as revenue.
(f) Cost of advertising is classified as expense.
DO IT! 1-3
MARSH CORPORATION
Income Statement
For the Year Ended December 31, 2014
Revenues
Service revenue ............................................. $25,000
Expenses
Rent expense ................................................. $10,000
Advertising expense ..................................... 4,000
Supplies expense .......................................... 1,700
Total expenses ................................... 15,700
Net income ............................................................ $ 9,300
DO IT! 1-3 (Continued)
MARSH CORPORATION
Retained Earnings Statement
Retained earnings, January 1 ................................... $ –0–

Add: Net income ...................................................... 9,300
9,300
Less: Dividends ......................................................... 2,500
Retained earnings, December 31 ............................. $6,800
MARSH CORPORATION
Balance Sheet
December 31, 2014
Assets
Cash ............................................................................. $ 3,100

Accounts receivable .................................................. 2,000
Supplies ...................................................................... 1,900
Equipment ................................................................... 26,800
Total assets................................................................. $33,800
Liabilities
Notes payable ..................................................... $ 7,000
Account payable ................................................. 5,000
Total liabilities .......................................... $12,000
Stockholder’s equity
Common stock .................................................... 15,000
Retained earnings .............................................. 6,800
Total stockholders’ equity ...................... 21,800
Total liabilities and stockholder’s equity ................ $33,800
DO IT! 1-4
(1) Description of ability to pay near-term obligations: MD&A

(2) Unqualified opinion: auditor’s report
(3) Details concerning liabilities, too voluminous to be included in the
statements: notes
(4) Description of favorable and unfavorable trends: MD&A
(5) Certified Public Accountant (CPA): auditor’s report
(6) Descriptions of significant accounting policies: notes
SOLUTIONS TO EXERCISES
EXERCISE 1-1
(a) 8. Auditor’s opinion

(b) 1. Corporation
(c) 6. Common stock
(d) 7. Accounts payable
(e) 3. Accounts receivable
(f) 2. Creditor
(g) 5. Stockholder
(h) 4. Partnership
EXERCISE 1-2
(a) Answers will vary.
Financing Investing Operating

Abitibi Consolidated Sale of stock Purchase long-term Sale of
Inc. investments newsprint
Cal State—Northridge Borrow money Purchase office Payment of
Stdt Union from a bank equipment wages and
benefits
Oracle Corporation Sale of bonds Purchase other Payment of
companies research
expenses
Sportsco Investments Payment of Purchase hockey Payment for
dividends to equipment rink rentals
stockholders
Grant Thornton LLP Distribute Purchase Bill clients for
earnings to computers professional
partners services
Southwest Airlines Sale of stock Purchase Payment for
airplanes jet fuel
EXERCISE 1-2 (Continued)
(b) Financing
Sale of stock is common to all corporations. Borrowing from a bank
is common to all businesses. Payment of dividends is common to all
corporations. Sale of bonds is common to large corporations.
Investing
Purchase and sale of property, plant, and equipment would be
common to all businesses—the types of assets would vary according
to the type of business and some types of businesses require a
larger investment in long-lived assets. A new business or expanding
business would be more apt to acquire property, plant, and
equipment while a mature or declining business would be more apt
to sell it.
Operating
The general activities identified would be common to most
businesses, although the service or product would differ.
EXERCISE 1-3
(a) (b)
Accounts payable L O
Accounts receivable A O
Equipment A I
Sales revenue R O
Service revenue R O
Inventory A O
Mortgage payable L F
Supplies expense E O
Rent expense E O
Salaries and wages expense E O
EXERCISE 1-4
MOLINA CO.
Income Statement
Revenues
Service revenue ........................................................ $58,000
Expenses
Salaries and wages expense................................... $30,000
Rent expense ............................................................ 10,400
Utilities expense ....................................................... 2,400
Advertising expense ................................................ 1,800
Total expenses .................................................. 44,600
Net income ........................................................................ $13,400
MOLINA CO.
Retained earnings, January 1 ........................................................... $67,000

Add: Net income .............................................................................. 13,400
80,400
Less: Dividends ................................................................................. 6,000
Retained earnings, December 31 ..................................................... $74,400
EXERCISE 1-5
(a) MERCK AND CO.

Income Statement
(in millions)
Revenues
Sales revenue ................................................... $38,576.0
Expenses
Cost of goods sold .......................................... $ 9,018.9
Selling and administrative expenses ............ 8,543.2
Research and development expense ............ 5,845.0
Income tax expense......................................... 2,267.6
Total expenses ............................................. 25,674.7
Net income ................................................................ $12,901.3
MERCK AND CO.

(in millions)
Retained earnings, January 1.................................. $43,698.8

Add: Net income ..................................................... 12,901.3
56,600.1
Less: Dividends ....................................................... 3,597.7
Retained earnings, December 31 ............................ $53,002.4
(b) The short-term implication would be a decrease in expenses of

$2,922.5 ($5,845 X 50%) resulting in a corresponding increase in income
(ignoring income taxes). If all other revenues and expenses remain
unchanged, decreasing research and development expenses would
produce 22.7% more net income ($2,922.5 ÷ $12,901.3).
The long-term implications would be more difficult to quantify but it

is safe to predict that a reduction in research and development
expenses would probably result in lower sales revenues in the future.
Pharmaceutical companies are usually able to charge higher prices
for newly developed products while lower cost generic versions
usually replace older products. Decreasing research and
development activities will probably mean fewer new products.
The stock market’s initial reaction might be positive since Merck’s

net income would increase significantly. Such a reaction would
probably be very short-lived as more knowledgeable investors
reviewed Merck’s financial statements and discovered the cause of
the increase.
EXERCISE 1-6
DEVITO INC.
Retained earnings, January 1 .................................. $130,000

Add: Net income ..................................................... 225,000*
355,000
Less: Dividends ........................................................ 65,000
Retained earnings, December 31 ............................ $290,000
*Service revenue ....................................................... $400,000

*Total expenses ......................................................... 175,000
*Net income................................................................ $225,000
EXERCISE 1-7
(a) Grant Corporation is distributing nearly all of this year’s net income
as dividends. This suggests that Grant is not pursuing rapid growth.
Companies that have a lot of opportunities for growth pay low
dividends.
(b) Remington Corporation is not generating sufficient cash provided by

operating activities to fund its investing activities. Instead it
generates additional cash through financing activities. This is
common for companies in their early years of existence.
EXERCISE 1-8
(a) A Cash
SE Retained earnings
E Cost of goods sold
E Salaries and wages expense
A Prepaid insurance
A Inventory
A Accounts receivable
R Sales revenue
L Notes payable
L Accounts payable
R Service revenue
E Interest expense
(b) MOTTE INC.

Income Statement
Revenues
Sales revenue ....................................... $584,951
Service revenue ................................... 4,806
Total revenues .................................. $589,757
Expenses
Cost of goods sold .............................. 438,458
Salaries and wages expense .............. 115,131
Interest expense .................................. 1,882
Total expenses ................................. 555,471
Net income ................................................... $ 34,286
EXERCISE 1-9
First note that the retained earnings statement shows that (b) equals
$27,000.
Accounts payable + Common stock + Retained earnings = Total liabilities and stockholders’
equity
$5,000 + a + $27,000 = $62,000

a + $32,000 = $62,000
a = $30,000
Beginning retained earnings + Net income – Dividends = Ending retained earnings
$12,000 + e – $5,000 = $27,000

$7,000 + e = $27,000
e = $20,000
From above, we know that net income (d) equals $20,000.
Revenue – Cost of goods sold – Salaries and wages expense = Net income
$85,000 – c – $10,000 = $20,000

$75,000 – c = $20,000
c = $55,000
EXERCISE 1-10
(a) Service revenue .............................................. $132,000

Sales revenue ................................................. 25,000
Total revenue .......................................... $157,000
Expenses ......................................................... 126,000
Net income ...................................................... $ 31,000
(b) FLINT HILLS PARK

Retained earnings, January 1 .................................................. $ 5,000

Add: Net income...................................................................... 31,000
36,000
Less: Dividends ........................................................................ 9,000
Retained earnings, December 31 ............................................ $27,000
FLINT HILLS PARK

Balance Sheet
December 31, 2014
Assets
Cash ..................................................................... $ 8,500
Supplies ............................................................... 5,500
Equipment ........................................................... 114,000
Total assets ......................................................... $128,000

Liabilities
Notes payable .............................................. $50,000
Accounts payable ....................................... 11,000
Total liabilities ..................................... $ 61,000
Common stock ............................................ 40,000
Retained earnings ....................................... 27,000 67,000
Total liabilities and stockholders’ equity ......... $128,000
(c) The income statement indicates that revenues from the general store
were only about 16% ($25,000 ÷ $157,000) of total revenue which
tends to support Joe’s opinion. In order to decide if the store is “more
trouble than it is worth,” I would need to know the amount of
expenses attributable to the general store. The income statement
reports all expenses in a single category rather than separating them
into camping and general store expenses to correspond with
revenues. A break down into two categories would help me decide if
the general store is generating a profit or loss.
Even if the general store is operating at a loss, I might recommend

retaining it if campers indicated that the convenience of having a
general store on site was an important amenity in selecting a camp
ground.
EXERCISE 1-11
(a) SE Retained earnings

E Cost of goods sold
E Selling and administrative expenses
A Cash
L Notes payable
E Interest expense
L Bonds payable
A Inventory
R Sales revenue
L Accounts payable
SE Common stock
E Income tax expense
(b) KELLOGG COMPANY

Income Statement
(in millions)
Revenues
Sales revenue ............................................ $12,575
Expenses
Cost of goods sold .................................... $7,184
Selling and administrative expenses ...... 3,390
Income tax expense .................................. 498
Interest expense ........................................ 295
Total expenses ................................... 11,367
Net income ......................................................... $ 1,208
EXERCISE 1-12
(a) DYCKMAN CORPORATION

Statement of Cash Flows
Cash flows from operating activities

Cash received from customers ....................... $ 50,000)
Cash paid to suppliers...................................... (16,000)
Net cash provided by operating activities...... $ 34,000)
Cash flows from investing activities
Cash paid for new equipment .......................... (28,000)
Net cash used by investing activities ............. (28,000)
Cash flows from financing activities
Cash received from lenders ............................. 20,000
Cash dividends paid ......................................... (8,000)
Net cash provided by financing activities ...... 12,000
Net increase in cash ................................................. ) 18,000
Cash at beginning of period .................................... 12,000
Cash at end of period ............................................... $ 30,000
(b) As a creditor, I would feel reasonably confident that Dyckman has the
ability to repay its lenders. During 2014, Dyckman generated $34,000
of cash from its operating activities. This amount more than covered
its expenditures for new equipment but not both equipment
purchases and dividends.
EXERCISE 1-13
(a) SOUTHWEST AIRLINES

(in millions)

Cash received from customers .......................... $9,823
Cash paid for goods and services ..................... (6,978)
Net cash provided by operating activities ........ $2,845
Cash paid for property and equipment ............. (1,529)
Net cash used by investing activities................ (1,529)
Cash received from issuance of
long-term debt .................................................. 500
Cash received from issuance of
common stock .................................................. 144
Cash paid for repurchase of common stock ..... (1,001)
Cash paid for repayment of debt ........................ (122)
Cash paid for dividends ...................................... (14)
Net cash used by financing activities ................ (493)
Net increase in cash ................................................... 823
Cash at beginning of period ...................................... 1,390
Cash at end of period ................................................. $2,213
(b) Southwest reported $2,845,000,000 cash from operating activities but

spent $1,529,000,000 to invest in new property and equipment. Its
cash from operating activities was sufficient to finance its investing
activities. Southwest supplemented the cash from operating activities
by issuing long-term debt and additional shares of common stock. It
used excess cash to repurchase stock, pay down debt, and pay
dividends. In total, it generated more cash from operating activities
than it paid for investing and financing activities resulting in a net
increase in cash for 2014.
EXERCISE 1-14
EDMINSON COMPANY
Balance Sheet
December 31, 2014
Assets
Cash ................................................................................. $18,000
Accounts receivable ....................................................... 12,000
Supplies ........................................................................... 9,500
Equipment ....................................................................... 40,000
Total assets ..................................................................... $79,500

Liabilities
Accounts payable ................................................... $16,000
Common stock ........................................................ $40,000
Retained earnings ................................................... 23,500* 63,500
Total liabilities and stockholders’ equity ..................... $79,500
*$31,500 – $8,000
EXERCISE 1-15
All dollars are in millions.
(a) Assets
Cash ............................................................................................. $ 2,291.1
Accounts receivable .................................................................. 2,883.9
Inventory ..................................................................................... 2,357.0
Equipment ................................................................................... 1,957.7
Buildings ..................................................................................... 3,759.9
Total assets ................................................................................. $13,249.6
Liabilities
Notes payable ............................................................................. $ 342.9
Accounts payable....................................................................... 2,815.8
Mortgage payable ....................................................................... 1,311.5
Income taxes payable ................................................................ 86.3
Total liabilities ............................................................................ $ 4,556.5
Stockholders’ Equity
Common stock ........................................................................... $ 2,874.2
Retained earnings ...................................................................... 5,818.9
Total stockholders’ equity ......................................................... $ 8,693.1
(b) Assets Liabilities Stockholders’ Equity

= +
$13,249.6 $4,556.5 $8,693.1
(c) Nike has relied more heavily on equity than debt to finance its assets.
Debt (liabilities) financed 34% of its assets ($4,556.5 ÷ $13,249.6)
compared to equity financing of 66% ($8,693.1 ÷ $13,249.6).
EXERCISE 1-16
(a) Assets = Liabilities + Stockholders’ Equity

$110,000 = $70,000 + (a)
(a) = $40,000
(b) Assets = Liabilities + Stockholders’ Equity

(b) = $120,000 + $60,000
(b) = $180,000
(c) Beginning + Revenues – Expenses – Dividends = Ending

Stockholders’ Stockholders’
Equity Equity
$40,000(a) + 215,000 – 165,000 – (c) = $60,000
$ 90,000 – (c) = $60,000
(c) = $30,000
(d) Assets = Liabilities + Stockholders’ Equity

$150,000 = (d) + $70,000
(d) = $80,000
(e) Assets = Liabilities + Stockholders’ Equity

$180,000 = $ 55,000 + (e)
(e) = $125,000
(f) Beginning + Revenues – Expenses – Dividends = Ending

Stockholders’ Stockholders’
Equity Equity
$70,000 + (f) – 80,000 – 5,000 = $125,000(e)
(f) = $140,000
EXERCISE 1-17
(a) Financial statements

(b) Auditor’s opinion
(c) Notes to the financial statements
(d) Financial statements
(e) Management discussion and analysis
(f) Not disclosed
SOLUTIONS TO PROBLEMS
PROBLEM 1-1A
(a) The concern over legal liability would make the corporate form a
better choice over a partnership. Also, the corporate form will allow
the business to raise cash more easily, which may be of importance
in a rapidly growing industry.
(b) AI should run his business as a sole proprietor. He has no real need
to raise funds, and he doesn’t need the expertise provided by other
partners. The sole proprietorship form would provide the easiest
form. One should avoid a more complicated form of business unless
the characteristics of that form are needed.
(c) The fact that the combined business expects that it will need to raise
significant funds in the near future makes the corporate form more
desirable in this case.
(d) It is likely that this business would form as a partnership. Its needs
for additional funds would probably be minimal in the foreseeable
future. Also, the three know each other well and would appear to be
contributing equally to the firm. Service firms, like consulting
businesses, are frequently formed as partnerships.
(e) One way to ensure control would be for Jack to form a sole
proprietorship. However, in order for this business to thrive it will
need a substantial investment of funds early. This would suggest the
corporate form of business. In order for Jack to maintain control
over the business he would need to own more than 50 percent of the
voting shares of common stock. In order for the business to grow,
he may have to be willing to give up some control.
PROBLEM 1-2A
(a) In deciding whether to extend credit for 30 days, The North Face
would be most interested in the balance sheet because the balance
sheet shows the assets on hand that would be available for
settlement of the debt in the near-term.
(b) In purchasing an investment that will be held for an extended period,

the investor must try to predict the future performance of
Amazon.com. The income statement provides the most useful
information for predicting future performance.
(c) In extending a loan for a relatively long period of time, the lender is
most interested in the probability that the company will generate
sufficient income to meet its interest payments and repay its principal.
The lender would therefore be interested in predicting future net
income using the income statement. It should be noted, however, that
the lender would also be very interested in both the balance sheet and
statement of cash flows—the balance sheet because it would show
the amount of debt the company had already incurred, as well as
assets that could be liquidated to repay the loan. And the company
would be interested in the statement of cash flows because it would
provide useful information for predicting the company’s ability to
generate cash to repay its obligations.
(d) The president would probably be most interested in the statement of

cash flows since it shows how much cash the company generates
and how that cash is used. The statement of cash flows can be used
to predict the company’s future cash-generating ability.
PROBLEM 1-3A
(a) HIGHTOWER SERVICE CO.

Income Statement
For the Month Ended June 30, 2014
Revenues
Service revenue ................................................. $7,500
Expenses
Salaries and wages expense ........................... $1,400
Supplies expense .............................................. 1,000
Maintenance and repairs expense .................. 600
Advertising expense ......................................... 400
Utilities expense ................................................ 300
Total expenses .......................................... 3,700
Net income .................................................................. $3,800
HIGHTOWER SERVICE CO.

For the Month Ended June 30, 2014
Retained earnings, June 1 ......................................................... $ 0

Add: Net income ....................................................................... 3,800
3,800
Less: Dividends ......................................................................... 1,400
Retained earnings, June 30 ....................................................... $2,400
PROBLEM 1-3A (Continued)
HIGHTOWER SERVICE CO.

Balance Sheet
June 30, 2014
Assets
Cash ............................................................................. $ 4,600
Accounts receivable ................................................... 4,000
Supplies ....................................................................... 2,400
Equipment ................................................................... 26,000
Total assets ................................................................. $37,000

Liabilities
Notes payable...................................................... $12,000
Accounts payable ............................................... 500
Total liabilities ............................................. $12,500
Common stock .................................................... 22,100
Retained earnings ............................................... 2,400 24,500
Total liabilities and stockholders’ equity .................... $37,000
(b) Hightower had a very successful first month, earning $3,800 or 51%
of service revenues ($3,800 ÷ $7,500). Its net income represents a
17% return on the initial investment ($3,800 ÷ $22,100).
(c) Distributing a dividend after only one month of operations is probably

unusual. Most new businesses choose to build up a cash balance to
provide for future operating and investing activities or pay down debt.
Hightower distributed 37% ($1,400 ÷ $3,800) of its first month’s
income but it had adequate cash to do so and still showed a
significant increase in retained earnings.
PROBLEM 1-4A
(a) Wenger Corporation should include the following items in its

statement of cash flows:
Cash paid to suppliers

Cash dividends paid
Cash paid to purchase equipment
Cash received from customers
Cash received from issuing common stock
WENGER CORPORATION

Cash received from customers ......................... $132,000)
Cash paid to suppliers ....................................... (104,000)
Net cash provided by operating activities ....... $28,000)
Cash paid to purchase equipment.................... (12,000)
Net cash used by investing activities............... (12,000)
Cash received from issuing common stock .... 22,000)
Cash dividends paid ........................................... (7,000)
Net cash provided by financing activities ....... 15,000)
Net increase in cash ................................................. 31,000)
Cash at beginning of period..................................... 9,000
Cash at end of period ............................................... $40,000
(b) Wenger Corporation’s operating activities provided $28,000 cash

which was adequate to fund its investing activities ($12,000) and make
($7,000) of dividend payments.
PROBLEM 1-5A
(a) 1. Since the boat actually belongs to Bill Jensen—not to Merando

Corporation—it should not be reported on the corporation’s
balance sheet. Likewise, the boat loan is a personal loan of Bill’s—
not a liability of Merando Corporation.
2. The inventory should be reported at $25,000, the amount paid

when it was purchased. Merando Corporation will record $36,000
as revenues when the inventory is sold.
3. The $10,000 receivable is not an asset of Merando Corporation—

it is a personal asset of Bill Jensen.
(b) MERANDO CORPORATION

Balance Sheet
December 31, 2014
Assets
Cash ............................................................................ $20,000*
Accounts receivable .................................................. 40,000*
Inventory ..................................................................... 25,000*
Total assets ................................................................ $85,000*
Liabilities
Notes payable ........................................................ $15,000 *
Accounts payable ................................................. 30,000
Total liabilities ............................................................ $45,000*
Stockholders’ equity ................................................. 40,000**
Total liabilities and stockholders’ equity ................ $85,000*
**$50,000 – $10,000
**$85,000 – $45,000 (Total assets minus total liabilities)
PROBLEM 1-1B
(a) Randy should run his business as a sole proprietor. He has no real
need to raise funds, and he doesn’t need the expertise provided by
other partners. The sole proprietorship form would provide the
easiest form. One should avoid a more complicated form of business
unless the characteristics of that form are needed.
(b) The fact that the combined business expects that it will need to raise
significant funds in the near future makes the corporate form more
desirable in this case.
(c) The concern over legal liability would make the corporate form a
better choice over a partnership. Also, the corporate form will allow
the business to raise cash more easily, which may be of importance in
a rapidly growing industry.
(d) One way to ensure control would be for Marty to form a sole
proprietorship. However, in order for this business to thrive it will
need a substantial investment of funds early. This would suggest the
corporate form of business. In order for Marty to maintain control
over the business she would need to own more than 50 percent of
the voting shares of common stock. In order for the business to
grow, she may have to be willing to give up some control.
(e) It is likely that this business would form as a partnership. Its needs
for additional funds would probably be minimal in the foreseeable
future. Also, the two know each other well and would appear to be
contributing equally to the firm. Service firms, like consulting
businesses, are frequently formed as partnerships.
PROBLEM 1-2B
(a) In purchasing an investment that will be held for an extended period,

the investor must try to predict the future performance of 24/7
Fitness. The income statement provides the most useful information
for predicting future performance.
(b) In deciding whether to extend credit for 60 days Xerox would be

most interested in the balance sheet because the balance sheet
shows the assets on hand that would be available for settlement of
the debt in the near-term.
(c) The president would probably be most interested in the statement of

cash flows since it shows how much cash the company generates
and how that cash is used. The statement of cash flows can be used
to predict the company’s future cash-generating ability.
(d) In extending a loan for a relatively long period of time the lender is
most interested in the probability that the company will generate
sufficient income to meet its interest payments and repay its principal.
The lender would therefore be interested in predicting future income
using the income statement. It should be noted, however, that the
lender would also be very interested in both the balance sheet and
the statement of cash flows—the balance sheet because it would
show the amount of debt the company had already incurred, as well
as assets that could be liquidated to repay the loan. And the
company would be interested in the statement of cash flows because
it would provide useful information for predicting the company’s
ability to generate cash to repay its obligations.
PROBLEM 1-3B
(a) SHAW’S GARDEN

Income Statement
For the Month Ended May 31, 2014
Revenues
Service revenue ................................... $10,400
Expenses
Maintenance and repairs expense .... $2,100
Salaries and wages expense ............. 1,900
Advertising expense ........................... 1,800
Insurance expense .............................. 400
Total expenses ............................. 6,200
Net income ................................................... $ 4,200
SHAW’S GARDEN
For the Month Ended May 31, 2014
Retained earnings, May 1 ........................................................... $ 0

Add: Net income ....................................................................... 4,200
4,200
Less: Dividends .......................................................................... 1,600
Retained earnings, May 31 ......................................................... $2,600
PROBLEM 1-3B (Continued)
SHAW’S GARDEN
Balance Sheet
May 31, 2014
Assets
Cash .......................................................................... $10,800
Accounts receivable ............................................... 8,400
Equipment ................................................................ 58,800
Total assets .............................................................. $78,000

Liabilities
Notes payable ................................................... $26,000
Accounts payable ............................................ 4,400
Total liabilities ......................................... $30,400
Common stock ................................................. 45,000
Retained earnings ............................................ 2,600 47,600
Total liabilities and stockholders’ equity ............. $78,000
(b) Shaw’s Garden was very profitable during its first month of operations.
Net income of $4,200 represents a 9.3% return on the $45,000 invest-
ment as well as 40.4% of service revenues ($4,200 ÷ $10,400).
(c) Many companies choose to “reinvest” in themselves by building up a

larger balance in retained earnings rather than distributing dividends
as soon as income is earned so Shaw’s Garden decision might be
seen as risky. Lenders might view such an action negatively since
Shaw’s Garden owes $26,000 in notes payable. On the other hand, the
company still “retained” more than 62% of its earnings ($4,200) and it
had adequate cash to cover the $1,600 dividend.
PROBLEM 1-4B
(a) Preacher Corporation should include the following items in its

statement of cash flows:
Cash paid to suppliers

Cash dividends paid
Cash paid to purchase equipment
Cash received from customers
Cash received from issuing bonds payable
PREACHER CORPORATION

Cash received from customers ........................ $162,000
Cash paid to suppliers ...................................... (154,000)
Net cash provided by operating activities ...... $8,000
Cash paid to purchase equipment ................... (20,000)
Net cash used by investing activities .............. (20,000)
Cash received from issuing bonds payable ... 40,000
Cash dividends paid .......................................... (2,000)
Net cash provided by financing activities ....... 38,000
Net increase in cash ................................................. 26,000
Cash at beginning of period..................................... 11,000
Cash at end of period ............................................... $37,000
(b) Operating activities provided $8,000 cash, which was not adequate
to cover $20,000 needed for investing activities and $2,000 of
dividend payments. Preacher issued $40,000 of bonds payable to
fund these cash payments and increase its year-end cash balance.
PROBLEM 1-5B
(a) 1. The $3,000 of revenue that the company earned in 2013 should
not be included in the 2014 revenues. Instead, the $3,000 should
be added to the beginning balance of retained earnings to correct
for the omission in 2013.
2. Since the corporation did not incur or pay the $10,000 of rent ex-
pense, it should not be included in the income statement. Inclu-
ding the $10,000 as an expense misstates the corporation’s net
income and presents misleading results.
3. Including the $6,000 as vacation expense misstates the corpo-

ration’s net income.
(b) WALTERS CORPORATION

Income Statement
Revenue ($40,000 – $3,000)* ...................................................... $37,000

Expenses
Insurance expense .............................................................. 7,000
Net income ................................................................................... $30,000
*John incorrectly included revenue of $3,000 in 2014. This revenue

should have been reported in 2013.

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CHAPTER 1

Introduction to Financial Statements

8. (a) Income statement. (d) Balance sheet.

14. The basic accounting equation is Assets = Liabilities + Stockholders’ Equity.

21. Using dollar amounts, Tootsie Roll’s accounting equation is:

Assets Liabilities Stockholders’ Equity

BRIEF EXERCISE 1-1

(a) P Shared control, tax advantages, increased skills and

BRIEF EXERCISE 1-2

(a) 4 Investors in common stock

BRIEF EXERCISE 1-3

O (a) Cash received from customers.

BRIEF EXERCISE 1-4

E (a) Advertising expense

Liabilities and Stockholders’ Equity

BRIEF EXERCISE 1-6

IS (a) Income tax expense

BRIEF EXERCISE 1-7

IS (a) Revenue during the period.

(a) $90,000 + $230,000 = $320,000 (Total assets)

(b) $170,000 – $80,000 = $90,000 (Total liabilities)

(c) $800,000 – 0.25($800,000) = $600,000 (Stockholders’ equity)

BRIEF EXERCISE 1-9

(a) ($800,000 + $150,000) – ($500,000 – $80,000) = $530,000

(b) ($500,000 + $100,000) + ($800,000 – $500,000 – $70,000) = $830,000

(c) ($800,000 – $80,000) – ($800,000 – $500,000 + $110,000) = $310,000

BRIEF EXERCISE 1-10

A (a) Accounts receivable

BRIEF EXERCISE 1-11

(d) All of these are required.

(a) Easier to transfer ownership: corporation

(a) Issuance of ownership shares is classified as common stock.

Retained earnings, January 1 ................................... $ –0–

Cash ............................................................................. $ 3,100

Liabilities and Stockholders’ Equity

(1) Description of ability to pay near-term obligations: MD&A

(a) 8. Auditor’s opinion

(a) Answers will vary.

Financing Investing Operating

Retained earnings, January 1 ........................................................... $67,000

(a) MERCK AND CO.

MERCK AND CO.

Retained earnings, January 1.................................. $43,698.8

(b) The short-term implication would be a decrease in expenses of

The long-term implications would be more difficult to quantify but it

The stock market’s initial reaction might be positive since Merck’s

Retained earnings, January 1 .................................. $130,000

*Service revenue ....................................................... $400,000

(b) Remington Corporation is not generating sufficient cash provided by

(b) MOTTE INC.

$5,000 + a + $27,000 = $62,000

Beginning retained earnings + Net income – Dividends = Ending retained earnings

$12,000 + e – $5,000 = $27,000

From above, we know that net income (d) equals $20,000.

$85,000 – c – $10,000 = $20,000

(a) Service revenue .............................................. $132,000

(b) FLINT HILLS PARK

Retained earnings, January 1 .................................................. $ 5,000

FLINT HILLS PARK