CH 1 - End of Chapter Exercises Solutions
CH 1 - End of Chapter Exercises Solutions
CH 1 - End of Chapter Exercises Solutions
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.
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
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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.
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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.
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.
*$58,355,000 + $133,566,000
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SOLUTIONS TO BRIEF EXERCISES
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BRIEF EXERCISE 1-5
BURNETT COMPANY
Balance Sheet
December 31, 2014
Assets
Cash ................................................................................. $22,000
Accounts receivable ....................................................... 71,000
Total assets ..................................................................... $93,000
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BRIEF EXERCISE 1-8
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SOLUTIONS TO DO IT! REVIEW EXERCISES
DO IT! 1-1
DO IT! 1-2
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
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DO IT! 1-3 (Continued)
MARSH CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2014
MARSH CORPORATION
Balance Sheet
December 31, 2014
Assets
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
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DO IT! 1-4
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SOLUTIONS TO EXERCISES
EXERCISE 1-1
EXERCISE 1-2
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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
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EXERCISE 1-4
MOLINA CO.
Income Statement
For the Year Ended December 31, 2014
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 Statement
For the Year Ended December 31, 2014
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EXERCISE 1-5
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
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EXERCISE 1-5 (Continued)
EXERCISE 1-6
DEVITO INC.
Retained Earnings Statement
For the Year Ended December 31, 2014
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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.
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
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
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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
Revenue – Cost of goods sold – Salaries and wages expense = Net income
EXERCISE 1-10
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EXERCISE 1-10 (Continued)
Assets
Cash ..................................................................... $ 8,500
Supplies ............................................................... 5,500
Equipment ........................................................... 114,000
Total assets ......................................................... $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.
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EXERCISE 1-11
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
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EXERCISE 1-12
(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.
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EXERCISE 1-13
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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
*$31,500 – $8,000
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EXERCISE 1-15
(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
(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).
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EXERCISE 1-16
EXERCISE 1-17
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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.
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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.
(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.
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PROBLEM 1-3A
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
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PROBLEM 1-3A (Continued)
Assets
Cash ............................................................................. $ 4,600
Accounts receivable ................................................... 4,000
Supplies ....................................................................... 2,400
Equipment ................................................................... 26,000
Total assets ................................................................. $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).
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PROBLEM 1-4A
WENGER CORPORATION
Statement of Cash Flows
For the Year Ended December 31, 2014
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PROBLEM 1-5A
Assets
Cash ............................................................................ $20,000*
Accounts receivable .................................................. 40,000*
Inventory ..................................................................... 25,000*
Total assets ................................................................ $85,000*
Liabilities and Stockholders’ Equity
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)
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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.
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PROBLEM 1-2B
(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.
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PROBLEM 1-3B
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
Retained Earnings Statement
For the Month Ended May 31, 2014
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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
(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).
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PROBLEM 1-4B
PREACHER CORPORATION
Statement of Cash Flows
For the Year Ended December 31, 2014
(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.
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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.
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