Balance Sheet and Statement of Cash Flows

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Chapter 5 Balance Sheet and Statement of Cash Flows

QUESTIONS
S
1. How does information from the balance sheet help users of the financial statements?
2. What is meant by solvency? What information in the balance sheet can be used to assess a company’s solvency?
3. A recent financial magazine indicated that the airline industry has poor financial flexibility. What is meant by financial flexibility, and why is it important?
4. Discuss at least two situations in which estimates could affect the usefulness of information in the balance sheet.
5. Perez Company reported an increase in inventories in the past year. Discuss the effect of this change on the current ratio (current assets 4 current liabilities). What does this tell a statement user about Perez Company’s liquidity?
6. What is meant by liquidity? Rank the following assets from one to five in order of liquidity.
(a) Goodwill.
(b) Inventory.
(c) Buildings.
(d) Short-term investments.
(e) Accounts receivable.
7. What are the major limitations of the balance sheet as a source of information?
8. Discuss at least two items that are important to the value of companies like Intel or IBM but that are not recorded in their balance sheets. What are some reasons why these items are not recorded in the balance sheet?
9. How does separating current assets from property, plant, and equipment in the balance sheet help analysts?
10. In its December 31, 2014, balance sheet Oakley Corporation reported as an asset, “Net notes and accounts receivable, $7,100,000.” What other disclosures are necessary?
11. Should available-for-sale securities always be reported as a current asset? Explain.
12. What is the relationship between current assets and current liabilities?
13. The New York Knicks, Inc. sold 10,000 season tickets at $2,000 each. By December 31, 2014, 16 of the 40 home games had been played. What amount should be reported as a current liability at December 31, 2014?
14. What is working capital? How does working capital relate to the operating cycle?
15. In what section of the balance sheet should the following items appear, and what balance sheet terminology would you use?
(a) Treasury stock (recorded at cost).
(b) Checking account at bank.
(c) Land (held as an investment).
(d) Sinking fund.
(e) Unamortized premium on bonds payable.
(f) Copyrights.
(g) Pension fund assets.
(h) Premium on capital stock.
(i) Long-term investments (pledged against bank loans payable).
16. Where should the following items be shown on the balance sheet, if shown at all?
(a) Allowance for doubtful accounts.
(b) Merchandise held on consignment.
(c) Advances received on sales contract.
(d) Cash surrender value of life insurance.
(e) Land.
(f) Merchandise out on consignment.
(g) Franchises.
(h) Accumulated depreciation of equipment.
(i) Materials in transit—purchased f.o.b. destination.
17. State the generally accepted accounting principle applicable to balance sheet valuation of each of the following assets.
(a) Trade accounts receivable.
(b) Land.
(c) Inventories.
(d) Trading securities (common stock of other companies).
(e) Prepaid expenses.
18. Refer to the definition of assets on page 216. Discuss how a leased building might qualify as an asset of the lessee (tenant) under this definition.
19. Kathleen Battle says, “Retained earnings should be reported as an asset, since it is earnings which are reinvested in the business.” How would you respond to Battle?
20. The creditors of Chester Company agree to accept promissory notes for the amount of its indebtedness with a proviso that two-thirds of the annual profits must be applied to their liquidation. How should these notes be reported on the balance sheet of the issuing company? Give a reason for your answer.
21. What is the purpose of a statement of cash flows? How does it differ from a balance sheet and an income statement?
22. The net income for the year for Genesis, Inc. is $750,000, but the statement of cash flows reports that the net cash provided by operating activities is $640,000. What might account for the difference?
23. Net income for the year for Carrie, Inc. was $750,000, but the statement of cash flows reports that net cash provided by operating activities was $860,000. What might account for the difference?
24. Differentiate between operating activities, investing activities, and financing activities.
25. Each of the following items must be considered in preparing a statement of cash flows. Indicate where each item is to be reported in the statement, if at all. Assume that net income is reported as $90,000.
(a) Accounts receivable increased from $34,000 to $39,000 from the beginning to the end of the year.
(b) During the year, 10,000 shares of preferred stock with a par value of $100 per share were issued at $115 per share.
(c) Depreciation expense amounted to $14,000, and bond premium amortization amounted to $5,000.
(d) Land increased from $10,000 to $30,000.
26. Sergey Co. has net cash provided by operating activities of $1,200,000. Its average current liabilities for the period are $1,000,000, and its average total liabilities are $1,500,000.
Comment on the company’s liquidity and financial flexibility, given this information.
27. Net income for the year for Tanizaki, Inc. was $750,000, but the statement of cash flows reports that net cash provided by operating activities was $860,000. Tanizaki also reported capital expenditures of $75,000 and paid dividends in the amount of $30,000. Compute Tanizaki’s free cash flow.
28. What is the purpose of a free cash flow analysis?
29. What are some of the techniques of disclosure for the balance sheet?
30. What is a “Summary of Significant Accounting Policies”?
31. What types of contractual obligations must be disclosed in great detail in the notes to the balance sheet? Why do you think these detailed provisions should be disclosed?
32. What is the profession’s recommendation in regard to the use of the term “surplus”? Explain. 

BRIEF EXERCISES

BE5-1 Harding Corporation has the following accounts included in its December 31, 2014, trial balance:
Accounts Receivable $110,000; Inventory $290,000; Allowance for Doubtful Accounts $8,000; Patents $72,000; Prepaid Insurance $9,500; Accounts Payable $77,000; Cash $30,000. Prepare the current assets section of the balance sheet, listing the accounts in proper sequence.
BE5-2 Koch Corporation’s adjusted trial balance contained the following asset accounts at December 31,
2014: Cash $7,000; Land $40,000; Patents $12,500; Accounts Receivable $90,000; Prepaid Insurance $5,200;
Inventory $30,000; Allowance for Doubtful Accounts $4,000; Equity Investments (trading) $11,000. Prepare the current assets section of the balance sheet, listing the accounts in proper sequence.
BE5-3 Included in Outkast Company’s December 31, 2014, trial balance are the following accounts:
Prepaid Rent $5,200; Debt Investments (trading) $56,000; Unearned Fees $17,000; Land (held for investment) $39,000; Notes Receivable (long-term) $42,000. Prepare the long-term investments section of the balance sheet.
BE5-4 Lowell Company’s December 31, 2014, trial balance includes the following accounts: Inventory $120,000; Buildings $207,000; Accumulated Depreciation—Equipment $19,000; Equipment $190,000; Land
(held for investment) $46,000; Accumulated Depreciation—Buildings $45,000; Land $71,000; Timberland $70,000. Prepare the property, plant, and equipment section of the balance sheet.
BE5-5 Crane Corporation has the following accounts included in its December 31, 2014, trial balance:
Equity Investments (trading) $21,000; Goodwill $150,000; Prepaid Insurance $12,000; Patents $220,000;
Franchises $130,000. Prepare the intangible assets section of the balance sheet.
BE5-6 Patrick Corporation’s adjusted trial balance contained the following asset accounts at December
31, 2014: Prepaid Rent $12,000; Goodwill $50,000; Franchise Fees Receivable $2,000; Franchises $47,000; Patents $33,000; Trademarks $10,000. Prepare the intangible assets section of the balance sheet.
BE5-7 Thomas Corporation’s adjusted trial balance contained the following liability accounts at December
31, 2014: Bonds Payable (due in 3 years) $100,000; Accounts Payable $72,000; Notes Payable (due in 90 days) $22,500; Salaries and Wages Payable $4,000; Income Taxes Payable $7,000. Prepare the current liabilities section of the balance sheet.
BE5-8 Included in Adams Company’s December 31, 2014, trial balance are the following accounts:
Accounts Payable $220,000; Pension Liability $375,000; Discount on Bonds Payable $29,000; Unearned Rent
Revenue $41,000; Bonds Payable $400,000; Salaries and Wages Payable $27,000; Interest Payable $12,000;
Income Taxes Payable $29,000. Prepare the current liabilities section of the balance sheet.
BE5-9 Use the information presented in BE5-8 for Adams Company to prepare the long-term liabilities section of the balance sheet.
BE5-10 Hawthorn Corporation’s adjusted trial balance contained the following accounts at December
31, 2014: Retained Earnings $120,000; Common Stock $750,000; Bonds Payable $100,000; Paid-in
Capital in Excess of Par—Common Stock $200,000; Goodwill $55,000; Accumulated Other Comprehensive
Loss $150,000; Noncontrolling Interest $35,000. Prepare the stockholders’ equity section of the balance sheet.
BE5-11 Stowe Company’s December 31, 2014, trial balance includes the following accounts: Investment in Common Stock $70,000; Retained Earnings $114,000; Trademarks $31,000; Preferred Stock $152,000;
Common Stock $55,000; Deferred Income Taxes $88,000; Paid-in Capital in Excess of Par—Common
Stock $174,000; Noncontrolling Interest $63,000. Prepare the stockholders’ equity section of the balance sheet.
BE5-12 Keyser Beverage Company reported the following items in the most recent year.
Net income $40,000
Dividends paid 5,000
Increase in accounts receivable 10,000
Increase in accounts payable 7,000
Purchase of equipment (capital expenditure) 8,000
Depreciation expense 4,000
Issue of notes payable 20,000
Compute net cash provided by operating activities, the net change in cash during the year, and free cash flow.
BE5-13 Ames Company reported 2014 net income of $151,000. During 2014, accounts receivable increased by $13,000 and accounts payable increased by $9,500. Depreciation expense was $44,000. Prepare the cash flows from operating activities section of the statement of cash flows.
BE5-14 Martinez Corporation engaged in the following cash transactions during 2014.
Sale of land and building $191,000
Purchase of treasury stock 40,000
Purchase of land 37,000
Payment of cash dividend 95,000
Purchase of equipment 53,000
Issuance of common stock 147,000
Retirement of bonds 100,000
Compute the net cash provided (used) by investing activities.
BE5-15 Use the information presented in BE5-14 for Martinez Corporation to compute the net cash used
(provided) by financing activities.
BE5-16 Using the information in BE5-14, determine Martinez’s free cash flow, assuming that it reported net cash provided by operating activities of $400,000.

EXERCISES

E5-1 (Balance Sheet Classifications) Presented below are a number of balance sheet accounts of Deep
Blue Something, Inc.
(a) Investment in Preferred Stock. (h) Interest Payable.
(b) Treasury Stock. (i) Deficit.
(c) Common Stock. (j) Equity Investments (trading).
(d) Dividends Payable. (k) Income Taxes Payable.
(e) Accumulated Depreciation—Equipment. (l) Unearned Subscriptions Revenue.
(f) Construction in Process. (m) Work in Process.
(g) Petty Cash. (n) Salaries and Wages Payable.
Instructions
For each of the accounts above, indicate the proper balance sheet classification. In the case of borderline items, indicate the additional information that would be required to determine the proper classification.
E5-2 (Classification of Balance Sheet Accounts) Presented below are the captions of Faulk Company’s balance sheet.
(a) Current assets. (f) Current liabilities.
(b) Investments. (g) Noncurrent liabilities.
(c) Property, plant, and equipment. (h) Capital stock.
(d) Intangible assets. (i) Additional paid-in capital.
(e) Other assets. (j) Retained earnings.
Instructions
Indicate by letter where each of the following items would be classified.
1. Preferred stock. 11. Cash surrender value of life insurance.
2. Goodwill. 12. Notes payable (due next year).
3. Salaries and wages payable. 13. Supplies.
4. Accounts payable. 14. Common stock.
5. Buildings. 15. Land.
6. Equity investments (trading). 16. Bond sinking fund.
7. Current maturity of long-term debt. 17. Inventory.
8. Premium on bonds payable. 18. Prepaid insurance.
9. Allowance for doubtful accounts. 19. Bonds payable.
10. Accounts receivable. 20. Income taxes payable.

E5-3 (Classification of Balance Sheet Accounts) Assume that Fielder Enterprises uses the following headings on its balance sheet.
(a) Current assets. (f) Current liabilities.
(b) Investments. (g) Long-term liabilities.
(c) Property, plant, and equipment. (h) Capital stock.
(d) Intangible assets. (i) Paid-in capital in excess of par.
(e) Other assets. (j) Retained earnings.
Instructions
Indicate by letter how each of the following usually should be classified. If an item should appear in a note to the financial statements, use the letter “N” to indicate this fact. If an item need not be reported at all on the balance sheet, use the letter “X.”

E5-4 (Preparation of a Classified Balance Sheet) Assume that Denis Savard Inc. has the following accounts at the end of the current year.
Instructions
Prepare a classified balance sheet in good form. (No monetary amounts are necessary.)

E5-5 (Preparation of a Corrected Balance Sheet) Uhura Company has decided to expand its operations.
The bookkeeper recently completed the balance sheet presented below in order to obtain additional funds for expansion.
 Instructions
Prepare a revised balance sheet given the available information. Assume that the accumulated depreciation balance for the buildings is $160,000 and for the equipment, $105,000. The allowance for doubtful accounts has a balance of $17,000. The pension obligation is considered a long-term liability.

E5-6 (Corrections of a Balance Sheet) The bookkeeper for Geronimo Company has prepared the following balance sheet as of July 31, 2014.
The following additional information is provided.
1. Cash includes $1,200 in a petty cash fund and $15,000 in a bond sinking fund.
2. The net accounts receivable balance is comprised of the following two items: (a) accounts receivable $44,000 and (b) allowance for doubtful accounts $3,500.
3. Inventory costing $5,300 was shipped out on consignment on July 31, 2014. The ending inventory balance does not include the consigned goods. Receivables in the amount of $5,300 were recognized on these consigned goods.
4. Equipment had a cost of $112,000 and an accumulated depreciation balance of $28,000.
5. Income taxes payable of $6,000 were accrued on July 31. Geronimo Company, however, had set up a cash fund to meet this obligation. This cash fund was not included in the cash balance but was offset against the income taxes payable amount.
Instructions
Prepare a corrected classified balance sheet as of July 31, 2014, from the available information, adjusting the account balances using the additional information.

E5-7 (Current Assets Section of the Balance Sheet) Presented below are selected accounts of Yasunari
Kawabata Company at December 31, 2014.
Inventory (fi nished goods) $ 52,000 Cost of Goods Sold $2,100,000
Unearned Service Revenue 90,000 Notes Receivable 40,000
Equipment 253,000 Accounts Receivable 161,000
Inventory (work in process) 34,000 Inventory (raw materials) 207,000
Cash 37,000 Supplies Expense 60,000
Equity Investments (short-term) 31,000 Allowance for Doubtful Accounts 12,000
Customer Advances 36,000 Licenses 18,000
Restricted Cash for Plant Expansion 50,000 Additional Paid-in Capital 88,000
Treasury Stock 22,000
The following additional information is available.
1. Inventories are valued at lower-of-cost-or-market using LIFO.
2. Equipment is recorded at cost. Accumulated depreciation, computed on a straight-line basis, is $50,600.
3. The short-term investments have a fair value of $29,000. (Assume they are trading securities.)
4. The notes receivable are due April 30, 2016, with interest receivable every April 30. The notes bear interest at 6%. (Hint: Accrued interest due on December 31, 2014.)
5. The allowance for doubtful accounts applies to the accounts receivable. Accounts receivable of $50,000 are pledged as collateral on a bank loan.
6. Licenses are recorded net of accumulated amortization of $14,000.
7. Treasury stock is recorded at cost.
Instructions
Prepare the current assets section of Yasunari Kawabata Company’s December 31, 2014, balance sheet, with appropriate disclosures.

E5-8 (Current vs. Long-term Liabilities) Frederic Chopin Corporation is preparing its December 31, 2014, balance sheet. The following items may be reported as either a current or long-term liability.
1. On December 15, 2014, Chopin declared a cash dividend of $2.50 per share to stockholders of record on December 31. The dividend is payable on January 15, 2015. Chopin has issued 1,000,000 shares of common stock, of which 50,000 shares are held in treasury.
2. At December 31, bonds payable of $100,000,000 are outstanding. The bonds pay 12% interest every
September 30 and mature in installments of $25,000,000 every September 30, beginning September 30,
2015.
3. At December 31, 2013, customer advances were $12,000,000. During 2014, Chopin collected $30,000,000 of customer advances; advances of $25,000,000 should be recognized in income.
Instructions
For each item above, indicate the dollar amounts to be reported as a current liability and as a long-term liability, if any.

E5-9 (Current Assets and Current Liabilities) The current assets and current liabilities sections of the balance sheet of Allessandro Scarlatti Company appear as follows.
The following errors in the corporation’s accounting have been discovered:
1. January 2015 cash disbursements entered as of December 2014 included payments of accounts payable in the amount of $39,000, on which a cash discount of 2% was taken.
2. The inventory included $27,000 of merchandise that had been received at December 31 but for which no purchase invoices had been received or entered. Of this amount, $12,000 had been received on consignment; the remainder was purchased f.o.b. destination, terms 2/10, n/30.
3. Sales for the first four days in January 2015 in the amount of $30,000 were entered in the sales journal as of December 31, 2014. Of these, $21,500 were sales on account and the remainder were cash sales.
4. Cash, not including cash sales, collected in January 2015 and entered as of December 31, 2014, totaled $35,324. Of this amount, $23,324 was received on account after cash discounts of 2% had been deducted; the remainder represented the proceeds of a bank loan.
Instructions
(a) Restate the current assets and current liabilities sections of the balance sheet in accordance with good accounting practice. (Assume that both accounts receivable and accounts payable are recorded gross.)
(b) State the net effect of your adjustments on Allessandro Scarlatti Company’s retained earnings balance.

E5-10 (Current Liabilities) Norma Smith is the controller of Baylor Corporation and is responsible for the preparation of the year-end financial statements. The following transactions occurred during the year.
(a) On December 20, 2014, a former employee filed a legal action against Baylor for $100,000 for wrongful dismissal. Management believes the action to be frivolous and without merit. The likelihood of payment to the employee is remote.
(b) Bonuses to key employees based on net income for 2014 are estimated to be $150,000.
(c) On December 1, 2014, the company borrowed $600,000 at 8% per year. Interest is paid quarterly.
(d) Credit sales for the year amounted to $10,000,000. Baylor’s expense provision for doubtful accounts is estimated to be 3% of credit sales.
(e) On December 15, 2014, the company declared a $2.00 per share dividend on the 40,000 shares of common stock outstanding, to be paid on January 5, 2015.
(f) During the year, customer advances of $160,000 were received; $50,000 of this amount was earned by December 31, 2014.
Instructions
For each item above, indicate the dollar amount to be reported as a current liability. If a liability is not reported, explain why.

E5-11 (Balance Sheet Preparation) Presented below is the adjusted trial balance of Kelly Corporation at
December 31, 2014.
Additional information:
1. Net loss for the year was $2,500.
2. No dividends were declared during 2014.
Instructions
Prepare a classified balance sheet as of December 31, 2014.

E5-12 (Preparation of a Balance Sheet) Presented below is the trial balance of Scott Butler Corporation at
December 31, 2014.
Instructions
Prepare a balance sheet at December 31, 2014, for Scott Butler Corporation. (Ignore income taxes.)

E5-13 (Statement of Cash Flows—Classifications) The major classifications of activities reported in the statement of cash flows are operating, investing, and financing. Classify each of the transactions listed below as:
1. Operating activity—add to net income.
2. Operating activity—deduct from net income.
3. Investing activity.
4. Financing activity.
5. Reported as significant noncash activity.
The transactions are as follows.
(a) Issuance of common stock. (h) Payment of cash dividends.
(b) Purchase of land and building. (i) Exchange of furniture for office equipment.
(c) Redemption of bonds. (j) Purchase of treasury stock.
(d) Sale of equipment. (k) Loss on sale of equipment.
(e) Depreciation of machinery. (l) Increase in accounts receivable during the year.
(f) Amortization of patent. (m) Decrease in accounts payable during the year.
(g) Issuance of bonds for plant assets.

E5-14 (Preparation of a Statement of Cash Flows) The comparative balance sheets of Constantine
Cavamanlis Inc. at the beginning and the end of the year 2014 are as follows.
Net income of $44,000 was reported, and dividends of $23,000 were paid in 2014. New equipment was purchased and none was sold.
Instructions
Prepare a statement of cash flows for the year 2014.

E5-15 (Preparation of a Statement of Cash Flows) Presented below is a condensed version of the comparative balance sheets for Zubin Mehta Corporation for the last two years at December 31.
2014 2013
Cash $177,000 $ 78,000
Accounts receivable 180,000 185,000
Investments 52,000 74,000
Equipment 298,000 240,000
Accumulated depreciation—equipment (106,000) (89,000)
Current liabilities 134,000 151,000
Common stock 160,000 160,000
Retained earnings 307,000 177,000
Additional information:
Investments were sold at a loss (not extraordinary) of $10,000; no equipment was sold; cash dividends paid were $30,000; and net income was $160,000.
Instructions
(a) Prepare a statement of cash flows for 2014 for Zubin Mehta Corporation.
(b) Determine Zubin Mehta Corporation’s free cash flow.

E5-16 (Preparation of a Statement of Cash Flows) A comparative balance sheet for Shabbona Corporation is presented below.

Additional information:
1. Net income for 2014 was $125,000. No gains or losses were recorded in 2014.
2. Cash dividends of $60,000 were declared and paid.
3. Bonds payable amounting to $50,000 were retired through issuance of common stock.
Instructions
(a) Prepare a statement of cash flows for 2014 for Shabbona Corporation.
(b) Determine Shabbona Corporation’s current cash debt coverage, cash debt coverage, and free cash flow. Comment on its liquidity and financial flexibility.

E5-17 (Preparation of a Statement of Cash Flows and a Balance Sheet) Grant Wood Corporation’s balance sheet at the end of 2013 included the following items.
The following information is available for 2014.
1. Net income was $55,000.
2. Equipment (cost $20,000 and accumulated depreciation $8,000) was sold for $10,000.
3. Depreciation expense was $4,000 on the building and $9,000 on equipment.
4. Patent amortization was $2,500.
5. Current assets other than cash increased by $29,000. Current liabilities increased by $13,000.
6. An addition to the building was completed at a cost of $27,000.
7. A long-term investment in stock was purchased for $16,000.
8. Bonds payable of $50,000 were issued.
9. Cash dividends of $30,000 were declared and paid.
10. Treasury stock was purchased at a cost of $11,000.
Instructions
(Show only totals for current assets and current liabilities.)
(a) Prepare a statement of cash flows for 2014.
(b) Prepare a balance sheet at December 31, 2014.

E5-18 (Preparation of a Statement of Cash Flows, Analysis) The comparative balance sheets of Madrasah
Corporation at the beginning and end of the year 2014 appear below.
Net income of $44,000 was reported, and dividends of $33,000 were paid in 2014. New equipment was purchased and none was sold.
Instructions
(a) Prepare a statement of cash flows for the year 2014.
(b) Compute the current ratio (current assets 4 current liabilities) as of January 1, 2014, and December 31, 2014, and compute free cash flow for the year 2014.
(c) In light of the analysis in (b), comment on Madrasah’s liquidity and financial flexibility.  


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