CH 2 Homework Solutions

Ch 2 Homework Solutions
E2.20
Preparing the Basic Financial Statements.
Transaction:
Assets
Cash
Total assets
Issue
Stock
Borro
w
Cash
5,000
15,0
00
Pay
Rent
(4,200
)
Purcha
se
Pay
Fresh Utilitie
Flowers
s
(2,500
)
(1,200
)
Floral
Sales
12,00
0
Balanc
e Sheet
24,100
24,100
Liabilities
15,00
0
Loan payable
Total liabilities
Shareholders
Equity
Common stock
Retained earnings
Revenue
Lease Expense
Floral Expense
15,000
15,000
5,000
(4,20
0)
12,00
0
(2,500
)
Utilities Expense
Total
shareholders'
equity
5,000
4,100
(1,200
)
9,100
Floral Shop
Income Statement
For Year 1
Revenue
Less: Lease expense
Floral expense
Utilities expense
Net income
Beginning balance
Net income
Dividends paid
$12,000
(4,200)
(2,500)
(1,200)
$4,100
Floral Shop
Statement of Shareholders Equity
For Year 1
Common
Retained
Stock
Earnings
$0$0-4,100
--0-
Total
$04,100
-0-
Issuance of Common stock

Balance at year-end
5,000
$5,000
NOTE: Statement of Shareholders Equity not required in text question
Continued next page
-$4,100
5,000
$9,100
Continued
Assets
Cash
Total
$24,100
$24,100
Floral Shop
Balance Sheet
At End of Year 1
Equities
Liabilities
Loan payable
Total
Shareholders equity
Common stock
Retained earnings
Total
Total
Floral Shop
Statement of Cash Flow
For Year 1
Operating activities
Revenues
Lease expense
Floral expense
Utilities expense
Cash flow from operations
Investing activities
Cash flow from investing
Financing activities
Common stock issuance
Loan payable
Cash flow from financing
Change in cash
Cash, beginning of year
Cash, end of year
$15,000
15,000
5,000
4,100
9,100
$24,100
$12,000
(4,200)
(2,500)
(1,200)
4,100
-05,000
15,000
20,000
24,100
0
$24,100
Although Marilyns net income and cash flow from operations are both positive
($4,100), it would probably be unwise as a start-up business to try to pay half
($7,500) of her parents loan back at the end of the first year. A more realistic
payment might be $3,000, although that amount is also arbitrary.
E2.21
Preparing Cash Flow Data.

Floral Shop
For Year 2
Operating activities
Revenues
Operating expenses
$15,000
(7,000)
8,000
Investing activities
Purchase of equipment
(2,500)
(2,500)
Financing activities
Sale of equity interest
Dividend payment
Change in cash
Cash, end of year
13,000
(2,800)
10,200
15,700
12,000
$27,700
Marilyns cash management strategy appears solid. The dividend payment of

$2,800 appears quite reasonable given her net income of $11,000 and cash
flow from operations of $8,000.
P2.22
Accounting Event Analysis and Financial Statement Preparation.

Smith & Co.
Transaction:
Assets
60,00
0 (40,000)
Cash
18,0
00
Balanc
e
Sheet
(11,00
0)
(1,00
0)
26,000
16,0
00
Accounts receivable
Land
16,000
40,000
82,00
0
40,000
Total assets
Liabilities
18,00
0
Loan payable
Total liabilities
Shareholders Equity
Common stock
Retained earnings
18,000
18,000
60,0
00
16,0
00
Revenue
Operating expense
60,000
4,000
(11,00
0)
Dividends
Total shareholders' equity
(1,00
0)
64,000
Smith & Co.

Income Statement
For Year 1
Revenues
$16,000
Less: Expenses
(11,000)
Net income
$5,000
Smith & Co.
For Year 1
Retained
Commo
Earning
n
s
Stock
Beginning balance
Net income
Dividends
$05,000
(1,000)
$0---
Total
$05,000
(1,000)
Stock sales
Balance at year-end
Continued next page
$4,000
60,000
$60,000
60,000
$64,000
Continued
Smith & Co.
Balance Sheet
At End of Year 1
Assets
Cash
Accounts receivable
Land
$26,000
16,000
40,000
Total
$82,000
Liabilities
Loan payable
Shareholders equity
Common stock
Retained earnings
Total
Smith & Co.

For Year 1
Operating expenses
Bank loan
Common stock
Dividends paid
Increase in cash
Cash, end of year
$18,000
60,000
4,000
$82,000
($11,000)
(40,000)
$18,000
60,000
(1,000)
77,000
26,000
0
$26,000
Smith & Co. generated positive net income of $5,000 during its first year of
operations, but its cash flow from operations was ($11,000) since none of its
revenues were received in cash. This situation will presumably rectify itself in
the second year when the uncollected sales are collected. Considering that it is
the companys first year of operations and that its cash flow from operations
was negative, the decision to pay a dividend of $1,000 was ill-conceived.
P2.23
Accounting Event Analysis and Financial Statement Preparation

Wilmot Real Estate Co.
Transaction:
Assets
Cash
50,0
00
40,0
00
(30,0
(10,000
00)
)
Accounts receivable
5
20,0
00
5,00
0
6
(11,00
0)
30,0
00
Land
Balan
ce
Sheet
22,00
0
(5,000
)
76,000
5,000
15,00
0
96,00
0
(15,00
0)
Total assets
Liabilities
40,0
00
Loan payable
40,000
40,00
0
Total liabilities
Shareholders
Equity
Common stock
50,0
00
50,000
Retained earnings
6,000
25,0
00
Revenue
Lease expense
(10,000
)
Misc. expenses
Gain on sale
Dividends
Total stockholders'
equity

Income Statement
For Year 1
Revenues
$25,000
Less:
Lease expense
(10,000)
Misc. expenses
(11,000)
Operating income
4,000
Gain on land sale
7,000
Net income
$11,000
Continued next page
(11,00
0)
7,000
(5,00
0)
56,00
0
Continued
For Year 1
Common
Retained
Stock
Earnings
Beginning balance
Net income
Dividends
Stock sales
Balance at year-end
$0--50,000
$50,000
$011,000
(5,000)
-$6,000
Total
$011,000
(5,000)
50,000
$56,000

Balance Sheet
At End of Year 1
Assets
Cash
Accounts receivable
Land
Total
$76,000
5,000
15,000
$96,000
Liabilities & Shareholders Equity

Bank loan
Common stock
Retained earnings
Total

For Year 1
Lease payments
$(10,000)
Cash from customers
20,000
Miscellaneous cash payments
(11,000)
Purchase of land
(30,000)
Proceeds from land sale
22,000
Bank loan
40,000
Common stock
50,000
Dividends paid
(5,000)
Increase in cash
Cash, end of year
$40,000
50,000
6,000
$96,000
$(1,000)
(8,000)
85,000
76,000
0
$76,000
The company generated positive net income of $11,000 during its first of
operations, but its cash flow from operations was ($1,000). The decision to pay
a dividend of $5,000 at this early stage and in the face of negative cash flows
from operations was ill-conceived.
P2.24
Accounting Event Analysis and the Balance Sheet. The December 1, 2013
balance sheet of the Mayfair Company would appear as follows:
1.
Mayfair Company
Balance Sheet
December 1, 2013
Assets
Current Assets:
Cash
Accounts Receivable
Notes Receivable
Inventory
Liabilities and Shareholders Equity

Liabilities:
Accounts Payable
Notes Payable
Bank Loan
Total Liabilities
$10,000
15,000
2,000
3,000
30,000
Noncurrent Assets:
Land
Building (net)
Machinery & Equip. (net)
Goodwill
Total Assets
$10,000
9,500
10,500
30,000
Shareholders Equity:
Common Stock
Addl Paid-in-capital
Retained Earnings
40,000
30,000
15,000
8,000
93,000
5,000
76,000
12,000
93,000
Total Liabilities and

Shareholders Equity
$123,000
$123,000
2.
Mayfair Company
Transaction:
Assets
Cash
Accounts
receivable
Notes
receivable
Inventory
Land
Building (net)
Machinery &
equip.
Goodwill
Total assets
Liabilities
Accounts
payable
Notes payable
Bal.
Sheet
Dec. 1,
2013
3*
10,000
2,000
(8,000 (3,000
)
)
15,000
2,000
3,000
40,000
30,000
1,000
15,000
(2,00
0)
3,00
0
25,000
12,00
0
15,000
8,000
no
entry
3,00
0
6,000
65,000
30,000
27,000
8,000
152,00
0
123,000
10,000
9,500
Bal.
Sheet
Dec.
31,
2013
(8,000
)
5,000
31,500
22,00
0
Bank loan
Total
liabilities
10,500
10,500
30,000
47,000
Continued next page
2. Continued
Table continued
Mayfair Company
Transaction:
Shareholders
Equity
Common stock
APIC
Retained earnings
Total
shareholders
equity
Bal.
Sheet
Dec. 1,
2013
5,000
76,000
12,000
3*
Bal.
Sheet
Dec. 31,
2013
12,0
00
17,000
76,000
12,000
105,00
93,000
*No entry under U.S. GAAP. Under IASB GAAP, increase Building Asset Revaluation Reserve by $15,000
3.
Assets
Current assets:
Cash
Accounts receivable
Notes receivable
Inventory
Noncurrent assets:
Land
Building (net)
Mach. & Equip. (net)
Goodwill
Total assets
Mayfair Company
Balance Sheet
December 31, 2013
Liabilities and Shareholders Equity
Liabilities:
$ 1,000
Accounts payable
$ 5,000
15,000
Notes payable
31,500
0
Bank loan
10,500
6,000
Total liabilities
47,000
22,000
Shareholders equity:
65,000
Common stock
17,000
30,000
Addl Paid-in-capital
76,000
27,000
Retained earnings
12,000
8,000
Total shareholders equity
105,000
130,000
Total liabilities &
$152,000
shareholders equity
$152,000
4. The Mayfair Companys use of financial leverage increased from the

beginning to the end of the year. Assuming notes payable and the bank loan
are both long-term debt, the companys long-term debt-to-total assets ratio
increased from 16% to 28%, suggesting that the company became more
reliant on debt financing during the year. Most of this increase in financial
leverage is reflected in the notes payable account, which was used to
partially finance the purchase of land (see transaction number 6).
P2.29
The Operating Cycle and Financial Statements.

1.
The Little Corporation
2.
Income Statement
For Year Ended 12/31/13
Sales
$2,000,00
0
Less: Cost of goods sold
(800,000)
Gross profit
1,200,000
Less: Wage expense

Miscellaneous expense
$447,000
98,000
Rent expense
180,000
Deprec. expense-Equipment
144,000
Deprec. expense-Machinery
124,000
Amortization expense
22,500
(1,015,500
)
Operating income (loss)

Interest expense
Loss on sale of machinery
Net income (loss)
184,500
(240,000)
(40,000)
$(95,500)
3.
Beginning balance
Net loss
Dividends declared
Common stock issued
Ending balance
Retained
Earnings
Common
Stock
Total
$1,548,000
$1,200,00
0
--450,000
$1,650,00
0
$2,748,00
0
(95,500)
(100,000)
450,000
$3,002,50
0
(95,500)
(100,000)
$1,352,500

Balance Sheet
12/31/13
Assets
Cash
Marketable securities
Accounts receivable
Inventory
Prepaid rent
Total current assets
Long-term investments
Equipment
Less: Accum deprec.
$752,000
200,000
414,000
620,000
42,000
2,028,000
496,500
1,440,000
(432,000)
Machinery
Less: Accum deprec.
2,480,000
(626,500)
1,008,000
Intangible assets (net)
1,853,500
202,500
Total assets
5,588,500
Continued next page

Liabilities
Accounts payable
$150,000
Wages payable
-0Interest payable
36,000
Bank loan
450,000
Bonds payable
1,950,000
Total liabilities
2,586,000
Shareholders equity
Common stock
1,650,000
Retained earnings
1,352,500
Total shareholders equity
$3,002,500
Total liabilities and

shareholders equity
$5,588,500
3. Continued
Net loss
Amortization expense
Depreciation expense (144,000 + 124,000)
Loss on sale of machinery
Accounts receivable
Inventory
Prepaid rent
Accounts payable
Wages payable
Interest payable
Sale of machinery
Marketable securities
Sale of common stock
Dividends paid
Increase in cash
Cash, end of year
$
(95,500)
22,500
268,000
40,000
150,000
100,000
180,000
(500,000
)
(173,000
)
(20,000)
(28,000)
120,000
(200,000
)
(80,000)
450,000
(100,000
)
350,000
242,000
510,000
$752,00
0
Instructor note: The indirect method format is presented above although

it is not introduced to students until Chapter 3. The direct method format
can be readily prepared from the cash column of the companys
spreadsheet.
4. Financial leverage
2012: $6,027,000 / $2,748,000 = 2.19
2013: $5,588,500 / $3,002,500 = 1.86
Financial leverage declined from 2012 to 2013 for The Little Corporation.
P2.31
Preparing Financial Statements from Accounting Events.

Spreadsheet at March 31, 2003:
Island Foods, Inc.
Transaction:
2
3
4
5
6
7
120,00 (26,00 (12,00 (1,20 (2,700 (68,00
Cash
10,000
0
0)
0)
0)
)
0)
Kitchen equipment
26,000
12,00
Computer equipment
0
Food prep equipment
1,200
Furniture and fixtures
2,700
Equipment
Leasehold
improvements
68,000
10,00
Total assets
0
120,00
0
Loan payable
Total liabilities
--
Common stock
Retained earnings
Total
shareholders
equity
10,000
10,00
0
Bal.
Sheet
3/31/13
20,100
26,000
12,000
1,200
2,700
-68,000
130,00
0
120,00
0
120,00
0
10,000
-10,000
1.
Island Foods, Inc.
Balance Sheet
As of March 31, 2003
Assets
Cash
Kitchen equipment
Computer system
Food prep equipment
Furniture and fixtures
Leasehold improvements
Total assets
$20,100
26,000
12,000
1,200
2,700
68,000
$130,000
Liabilities:
Loan payable
Shareholders equity:
Common stock
Total liabilities & shareholders
equity
$120,000
10,000
$130,000
2. Financial Statements for 2003.
Assets
Island Foods, Inc.

Balance Sheet
As of December 31, 2003
Current
Cash
Accounts receivable
Prepaid insurance
Total
Noncurrent:
Kitchen equipment (net)
Computer system (net)
Food preparation equipment (net)
Furniture and equipment (net)
Leasehold improvements (net)
Total Assets
Continued next page
$63,000
3,000
13,500
79,500
22,100
10,500
900
2,025
57,800
$172,825
Liabilities
Accounts payable
Utilities payable
Employee wages payable
Accrued interest payable
Income taxes payable
Loan payable-current
Loan payable-noncurrent
Total liabilities
Shareholders Equity:
Common stock
Retained earnings
Total
Total Liabilities & Shareholders
Equity
$9,000
1,000
1,100
6,750
7,496
12,000
37,346
108,000
145,346
10,000
17,479
27,479
$172,825
2. Continued
Island Foods, Inc.
Income Statement
For the 9 months ended December 31, 2003
Sales revenue
$215,000
Less:
Food costs
$69,000
Supply costs
4,800
Utility charges
9,000
Employee wage expense
45,100
Business license fee
900
Lease expense
8,400
Depreciation expense*
16,575
Interest expense
6,750
Insurance expense
4,500
(165,025)
Net income before tax
49,975
Income taxes (15%)
(7,496)
Net income after tax
$42,479
*(3,900 + 1,500 + 975 + 10,200); ($68,000/5 years) x 9/12 = $10,200.
Island Foods, Inc.
For 9 months ended 12/31/03
Operations
Net income
Depreciation
Accounts receivable
Prepaid insurance
Accounts payable
Utilities payable
Accrued interest payable
$42,479
16,575
(3,000)
(13,500)
9,000
1,000
1,100
7,496
6,750
67,900
Investing
-Cash flow from investing
--0-
Financing
Dividends
(25,000)
(25,000)
Change in cash
Cash, end of year
42,900
20,100
$63,000
3. Financial Statements for 2004.
Assets
Current
Cash
Accounts receivable
Prepaid insurance
Total
Noncurrent
Kitchen equipment (net)
Computer system (net)
Food preparation
equipment (net)
Furniture and equipment
(net)
Leasehold improvements
(net)
Total Assets
Island Foods, Inc.

Balance Sheet
As of December 31, 2004
Liabilities
$105,504
Current
5,000
Accounts payable
$12,000
7,500
Utilities payable
1,000
118,004
1,400
Interest payable
6,075
10,991
Loan payable-current
12,000
16,900
43,466
8,500
Noncurrent
Loan payable
96,000
500
Total liabilities
139,466
1,125
44,200
71,225
$189,229
Shareholders Equity
Common stock
Retained earnings
Total
Total Liabilities & Shareholders
Equity
Island Foods, Inc.

Income Statement
For the year ended December 31, 2004
Sales revenue
Less:
Food costs
Supply costs
Utility charges
Employee wage expense
Lease expense
Interest expense*
Insurance expense
Depreciation expense
$329,000
$108,00
0
6,200
12,000
76,300
16,800
8,325
6,000
22,100
Net income before tax

Income taxes (15%)
Net income after tax
*[($120,000 x 7.5% x 3/12) + ($108,000 x 7.5% x 9/12)]
Continued next page
(255,725)
73,275
(10,991)
$62,284
10,000
39,763
49,763
$189,229
3.
Continued
Island Foods, Inc.
Operations
Net income
Depreciation
Accounts receivable
Prepaid insurance
Accounts payable
Utilities payable
Interest payable
$62,284
22,100
(2,000)
6,000
3,000
-300
(675)
3,495
94,504
Investing
-Cash flow from investing
--0-
Financing
Loan payable
Dividends
(12,000)
(40,000)
(52,000)
Change in cash
Cash, end of year
42,504
63,000
$105,504
4. Financial Analysis.
ROE
ROA (levered)
ROA (unlevered)
ROS
Financial leverage
Long-term-debt-to-equity
Interest coverage
Total asset turnover
2003
154.6%
24.6%
27.9%
19.8%
6.29
4.37
8.4
2004
125.2%
32.9%
36.7%
18.9%
3.80
2.17
9.8
1.24x
1.74x
Why do Island Foods profitability ratios (i.e., ROE, ROS, and ROA) look so
positive? Clark and Susan treated their salary withdrawal as a dividend (i.e.,
after calculating net income) rather than as compensation expense (i.e., before
calculating net income). Thus, the restaurants profitability ratios are artificially
high and should be recalculated after treating the dividends as an operating
expense.
Given the strength of the first two years of operations, a bank would most likely
extend Susan and Clark the loan for expansion purposes.

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Ch 2 Homework Solutions

Preparing the Basic Financial Statements.

Issuance of Common stock

NOTE: Statement of Shareholders Equity not required in text question

Continued next page

Preparing Cash Flow Data.

Marilyns cash management strategy appears solid. The dividend payment of

Accounting Event Analysis and Financial Statement Preparation.

Smith & Co.

Smith & Co.

Accounting Event Analysis and Financial Statement Preparation

Wilmot Real Estate Co.

Wilmot Real Estate Co.

Liabilities & Shareholders Equity

Wilmot Real Estate Co.

Liabilities and Shareholders Equity

Total Liabilities and

Continued next page

4. The Mayfair Companys use of financial leverage increased from the

The Operating Cycle and Financial Statements.

Less: Cost of goods sold

Less: Wage expense

Operating income (loss)

The Little Corporation

Intangible assets (net)

Continued next page

Liabilities & Shareholders Equity

Total liabilities and

Instructor note: The indirect method format is presented above although

Preparing Financial Statements from Accounting Events.

2. Financial Statements for 2003.

Island Foods, Inc.

Continued next page

3. Financial Statements for 2004.

Island Foods, Inc.

Island Foods, Inc.

Net income before tax

Continued next page

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