financial accounting- chapter 1

CHAPTER 1

COVERAGE OF LEARNING OBJECTIVESLEARNING OBJECTIVES QUESTIONS EXERCISE

SPROBLEMS OTHER

LO1: Explain how accounting information assists in making decisions.

1,2,3,4,5,25

LO2: Describe the components of the balance sheet.

6,7 28, 33 42, 43 54,55,56

LO3: Analyze business transactions and relate them to changes in the balance sheet.

8,9,10, 24 29,30 35,36,37,38,39,40

53

LO4: Prepare a balance sheet from transactions data.

31,32 35, 36, 37, 38, 39, 40, 41, 44,45

53

LO5: Compare the features of sole proprietorships, partnerships, and corporations.

11,12,13,14, 26

LO6: Identify how the owners’ equity section in a corporate balance sheet differs from that in a sole proprietorship or a partnership.

15,16 33, 34 46,47,48,49

LO7: Explain the regulation of financial reporting, including differences between U.S. GAAP and IFRS.

17,18 50

LO8: Describe auditing and how it enhances the value of financial information.

18,19,27 50,51 56

LO9: Evaluate the role of ethics in the accounting process.

20,21 52

LO10: Recognize career opportunities in accounting, and understand that accounting is important to both for-profit and nonprofit organizations.

22, 23

1Copyright ©2014 Pearson Education, Inc.

CHAPTER 1

1-1 Accounting is a process of identifying, recording, summarizing, and reporting economic information to decision makers.

1-2 No. Accounting is real information about real companies. In learning accounting it is helpful to see accounting reports from various companies. This helps put the rules and techniques of accounting into an understandable framework and provides familiarity with the diversity of practice.

1-3 Examples of decisions that are likely to be influenced by financial statements include choosing where to expand or reduce operations, lending money, investing ownership capital, and rewarding mangers.

1-4 Users of financial statements include investors, managers, lenders, suppliers, owners, income tax authorities, and government regulators.

1-5 The major distinction between financial accounting and management accounting is their use by two classes of decision makers. Management accounting is concerned mainly with how accounting can serve internal decision makers such as the chief executive officer and other executives. Financial accounting is concerned with supplying information to external users.

1-6 The balance sheet equation is Assets = Liabilities + Owners’ equity. It is the fundamental framework of accounting. The left side lists the resources of the organization, and the right side lists the claims against those resources.

1-7 No. Every transaction should leave the balance sheet equation in balance. Accounting is often called “double-entry” because accountants must enter at least two numbers for each transaction to keep the equation in balance.

1-8 This is true. When a company buys inventory for cash, one asset is traded for another, and neither total assets nor total liabilities change. Thus, the balance sheet equation stays in balance. When a company buys inventory on credit, both inventory and accounts payable increase. Thus, both total assets and total liabilities increase by the same amount, again keeping the balance sheet equation in balance.

1-9 The evidence for a note payable includes a promissory note, but the evidence for an account payable does not. A note payable is generally to a lender while an account payable is generally to a supplier.

1-10 Balance sheets for companies in the same industry will not necessarily look similar. For example, companies in the same industry may have quite different strategies. One might be capital intensive, with large amounts of property, plant, and equipment. Another may rely less on fixed assets, but it may have large accounts receivable because of a lenient credit policy. In addition, one may have large bank loans while another has greater owner investment and thus larger owners’ equity or stockholders’ equity.


1-11 Ownership shares in most large corporations are easily traded in the stock markets, corporate owners have limited liability, and the owners of sole proprietorships or partnerships are usually also managers in the company while most corporations hire professional managers.

1-12 Limited liability means that corporate owners are not personally liable for the debts of the corporation. Creditors’ claims can be satisfied only by the assets of the particular corporation.

1-13 The corporation is the most prominent type of entity, and corporations do by far the largest volume of business.

1-14 Yes. In the United Kingdom corporations frequently use the word limited (Ltd.) in their name. In many countries whose laws trace back to Spain, the initials S.A. refer to a “society anonymous,” meaning that multiple unidentified owners stand behind the company, which is essentially the same structure as a corporation.

1-15 Almost all states forbid the issuance of stock at below par; thus, par values are customarily set at very low amounts and have no real importance in affecting economic behavior of the issuing entity.

1-16 The board of directors is the elected link between stockholders and the actual managers. It is the board’s duty to ensure that managers act in the best interests of shareholders.

1-17 In the U.S. GAAP is generally set by the Financial Accounting Standards Board. The SEC has formal authority for specifying accounting standards for companies with publicly held stock, as delegated by Congress, but it usually accepts the standards promulgated by the FASB. Internationally, a majority of countries accept IFRS as set by the International Accounting Standards Board as their GAAP.

1-18 Until recently this was true. However, now the SEC allows companies headquartered outside the U. S. to report using IFRS.

1-19 Audits have value because they add credibility to a company’s financial statements. Provided that auditors have the expertise to assess the accuracy of financial statements and the integrity to report any problems they discover, the investing public can put more faith in statements that are audited.

1-20 A CPA is a certified public accountant. One becomes a CPA by a combination of education, qualifying experience, and the passing of a two-day national examination. A CA (chartered accountant) is the equivalent of a CPA in many parts of the world, including most former British Commonwealth countries.


1-21 Public accountants must obey standards of independence and integrity. In addition, there are many more ethical standards that pertain to accountants. Some folks call accounting the moral guardian of companies. This reputation has been sullied recently by corporate scandals that went undetected (or, at least, unreported by accountants), but accountants are working to regain the high ethical regard they have traditionally maintained.

1-22 All managers find accounting useful for making decisions, and often their superiors use accounting numbers in evaluating them. In addition, experience in accounting is valuable to anyone in an organization. Many operating executives got their start in accounting. It provided them a broad knowledge of the company and brought them into contact with managers throughout the organization.

1-23 No. The fundamental accounting principles apply equally to nonprofit (also called not-for-profit) and profit-seeking organizations. Managers and accountants in hospitals, universities, government agencies, and other nonprofit organizations use financial statements. They need to raise and spend money, prepare budgets, and judge financial performance. Nonprofit organizations need to use their limited resources wisely, and financial statements are essential for judging their use of resources.

1-24 Double-entry refers to the concept that every transaction involves two or more accounts with the effect being to retain the balance in the balance sheet equation. The double-entry concept is important because it emphasizes that there are assets and claims on assets. In the balance sheet, for example, borrowing money provides an asset, cash, and creates a liability. In addition to this conceptual benefit there is a clerical benefit. Maintaining a balanced relationship provides an indicator of errors. If the balance sheet equation does not balance, an error has been made.

1-25 Historians are primarily concerned with events that have already occurred. In that sense, a company’s financial statements do report on history—transactions that are complete. The negative side of this is that many important things that affect the value of a firm are based on what will happen in the future. Thus, investors often worry about expectations and predictions. Of course, there is no way to agree on the accuracy of expectations and predictions. The positive side of historical financial statements is that they present a no-nonsense perspective on what actually happened, where the company was at a point in time, or what it accomplished over a period of time. It is easier to predict the future when you know where you are and how you got there. You might liken the importance of historical financial statements to the importance of navigation instruments. If you do not know where you are and where you are headed, it is very hard to get to where you want to go.

Most people who refer to accountants as historians intend it as a criticism, although, as indicated above, a historical focus ensures that the data are measurable and verifiable.


1-26 Such arguments are fun but can never be truly resolved. The notion behind the importance of the corporation is that for any substantial growth to occur there must be a system for organizing resources and using them over long periods of time. The corporate form of ownership helps companies raise large amounts of capital via stock issuance as well as borrowing. It allows us to separate ownership from management. It protects the personal assets of shareholders, and because their maximum losses can be limited, more risky undertakings can be financed. Finally, it has perpetual life so its activity is not disrupted by the death of any shareholder. Corporations operate under a set of established rules of behavior for entering into contracts and being sure that other parties can be relied upon to uphold their side of an agreement.

Accounting helped corporations emerge as the dominant economic organization in the world. Without accounting it would be difficult to coordinate the activities of large corporations. It would be especially difficult to separate management from ownership if accounting did not provide information about the performance of managements.

1-27 The auditor increases the value of financial statements by reassuring the reader of the statements that an “independent” and a “qualified” third party has reviewed management’s disclosures and believes they fairly present the company’s performance. The fact that you personally do not recognize the name of the audit firm should not be a problem, because only CPAs can perform public audits and sign audit opinions. Every state has strict procedures for licensing CPAs, so such people are qualified. Nevertheless, audit firms develop reputations, and ones with a positive public image may give some financial statement users more confidence in the financial statements they audit.

1-28 (10 min.) Amounts are in millions.

1. Assets = Liabilities + Owners’ Equity

$7 = $4 + $3

2. Assets and liabilities would increase by $2 million. Owners’ equity would be unaffected.


1-29 (15-20 min.)

May 2 Owners invested $6,000 additional cash in Radloff’s Furniture Company.

3 Owners invested an additional $4,000 into the company by contributing additional store fixtures valued at $4,000.

4 Radloff’s Furniture Company purchased additional furniture inventory for $3,000 cash.

5 Radloff’s Furniture Company purchased furniture inventory on account for $6,000.

6 Radloff’s Furniture Company sold store fixtures for $3,000 cash.

7 Radloff’s Furniture Company purchased $6,000 of store fixtures, paying $5,000 cash now and agreeing to pay $1,000 later.

8 Radloff’s Furniture Company paid $2,000 on accounts payable.

9 Radloff’s Furniture Company returned $400 of merchandise (furniture inventory) for credit against accounts payable.

10 Owners withdrew $3,000 cash from Radloff’s Furniture Company.

1-30 (10-20 min.)

Nov. 2 Melbourne purchased $2,500 of store fixtures on account.

3 Owner or owners withdrew $2,000 cash.

4 Melbourne returned $5,000 of its inventory of computers for $5,000 credit against its accounts payable.

5 Computers (inventory) valued at $7,000 were invested in the company by owners.

8 Melbourne paid $500 on accounts payable.

9 Melbourne purchased $3,500 of store fixtures, paying $1,000 now and agreeing to pay $2,500 later.

10 Melbourne returned $500 of store fixtures for credit against accounts payable.


1-31 (15-25 min.)

JACKSONVILLE CORPORATIONBalance Sheet

March 31, 20X1

Liabilities and Assets Stockholders’ Equity Cash $ 5,000 (a) Liabilities:Merchandise inventory 43,000 (b) Accounts payable $ 11,000 (f)Furniture and fixtures 2,000 (c) Notes payable 10,000Machinery and equipment 27,000 (d) Long-term debt 27,000 (g)Land 39,000 (e) Total liabilities 48,000Building 24,000 Stockholders’ equity:Total assets $140,000 Paid-in capital 92,000 (h)

Total liab. & stk. equity $140,000

(a) Cash: $14,000 + $1,000 – $10,000 = $5,000(b) Merchandise inventory: $40,000 + $3,000 = $43,000(c) Furniture and fixtures: $3,000 – $1,000 = $2,000(d) Machinery and equipment: $15,000 + $12,000 = $27,000(e) Land: $14,000 + $25,000 = $39,000(f) Accounts payable: $8,000 + $3,000 = $11,000(g) Long-term debt: $12,000 + $15,000 = $27,000(h) Paid-in capital: $80,000 + $12,000 = $92,000

Note: Event 5 requires no change in the balance sheet.


1-32 (25-35 min.)

SOUTHAMPTON COMPANYBalance Sheet

November 30, 20X1

Liabilities and Assets Stockholders’ Equity Cash £ 17,000 (a) Liabilities:Merchandise inventory 29,000 Accounts payable £ 9,000 (d)Furniture and fixtures 8,000 Notes payable 30,000 (e)Machinery and equip. 33,000 (b) Long-term debt payable 111,000 (f)Land 35,000 (c) Total liabilities 150,000Building 241,000 Stockholders’ equity:Total assets £ 363,000 Paid-in Capital 213,000 (g)

Total liab. & stk. equity £ 363,000

(a) Cash: £22,000 – £4,000 – £7,000 + £6,000 = £17,000(b) Machinery and equipment: £20,000 + £13,000 = £33,000(c) Land: £41,000 – £6,000 = £35,000(d) Accounts payable: £16,000 – £7,000 = £9,000(e) Notes payable: £21,000 + (£13,000 – £4,000) = £30,000(f) Long-term debt payable: £134,000 – £23,000 = £111,000(g) Paid-in capital: £190,000 + £23,000 = £213,000

Note: Event 4 requires no change in the balance sheet.

1-33 (5-10 min.)

1. Total liabilities = Total assets stockholders’ equity= $26,271,000,000 $12,002,000,000= $14,269,000,000

2. Common stock, par value = $.005 × 434,266,000 = $2,171,330.

Like other items on Costco’s balance sheet, the amount would be rounded off to millions:

Common stock, par value $2


1-34 (5 – 10 min.)The Mammal Center

Balance SheetJuly 1, 20X1

Assets Liabilities and Stockholder’s EquityCash $45,000 Accounts payable $14,000Account receivable 13,000 Bank loan payable 9,000Property, plant, and equipment 25,000 Capital stock at par 2,000Total assets $83,000 Additional paid-in capital $58,000

Total liab. and stockholder’s equity $83,000

1-35 (20-30 min.) See Exhibit 1-35. Equipment and furniture could be in two separate accounts rather than combined.

1-36 (20-35 min.)

1. See Exhibit 1-36.

2. JBW CORPORATIONBalance Sheet

January 31, 20X1 (In Thousands of Dollars)

Liabilities and Assets Stockholders’ Equity

Liabilities:Cash $153 Accounts payable $108

Note payable 30Merchandise inventory 249 Total liabilities $138

Stockholders’ equity:Equipment 36 Capital stock,

$1 par, 30,000 shares issued and outstanding $ 30Additional paid-in capital

in excess of par value 270 300Total assets $438 Total liabilities & stockholders’ equity $438


EXHIBIT 1–35MARYMOUNT SERVICES, INC.

Analysis of April 20X1 Transactions(In Thousands of Dollars)

Assets Liabilities and Stockholders’ Equity Equipment Note Accounts Paid-in

Description of Transactions Cash + and Furniture = Payable + Payable + Capital 1. Issuance of stock +60 = +602. Issuance of stock +20 = +203. Borrowing +35 = +354. Acquisition for cash –33 +33 =5. Acquisition on account +10 = +106. Payments to creditors – 4 = – 47. Sale of equipment + 8 – 8 =8. No entry =

+66 +55 = +35 + 6 + 80

121 121

MARYMOUNT SERVICES, INC.Balance SheetApril 30, 20X1

Assets Liabilities and Stockholders’ Equity Accounts payable $ 6,000

Cash $ 66,000 Note payable 35,000Equipment and furniture 55,000 Paid-in Capital 80,000Total assets $121,000 Total liab. & stk. equity $121,000


EXHIBIT 1–36

JBW CORPORATIONJanuary 20X1

Analysis of Transactions(In Thousands of Dollars)

Assets Liabilities + Stockholders’ Equity Merch- Capital Additionalandise Equip- Notes Accounts Stock Paid-in

Description of Transactions Cash + Inventory + ment = Payable + Payable + (at par) + Capital 1. Original incorporation +300 = + 30 + 270 2. Inventory purchased –75 +75 = 3. Inventory purchased +85 = + 85 4. Return of inventory to

supplier –11 = – 11 5. Purchase of equipment –10 +40 = +30 6. Sale of equipment + 4 – 4 = 7. Payment to creditor –16 = – 16 8. Inventory purchased –50 +100 = + 50 9. No entry except on

detailed underlyingrecords =

Balance, January 31, 20X1 +153 +249 +36 = +30 +108 + 30 + 270

438 438


1-37 (20-35 min.)


2. AUTOPARTES LISBONBalance Sheet

March 31, 20X1

Assets Liabilities and Owner’s Equity Cash €62,800 Liabilities:Inventory 16,600 Accounts payable € 4,500Equipment 17,500 Note payable 8,000

Total liabilities 12,500 You, capital 84,400

Total assets €96,900 Total liabilities and owner’s equity €96,900

1-38 (25-40 min.) Note that transaction 9 is not covered directly in the text. However, it should be possible to figure out the accounting for it from similar items that are covered. However, some instructors may want to omit transaction 9.


2. LEIDA CRUZ, ATTORNEY-AT-LAWBalance Sheet

December 31, 20X0

Liabilities and Assets Owner’s Equity

Liabilities:Cash in bank $50,000 Accounts payable $ 1,000Note receivable 3,000 Note payable 3,000Rental damage deposit 1,000 Total liabilities $ 4,000Legal supplies on hand 1,000 Owner’s equity:Computer 5,000 Leida Cruz, capital 60,000Office furniture 4,000 Total liabilities andTotal assets $64,000 owner’s equity $64,000

1-39 (15-25 min.) See Exhibit 1-39.


EXHIBIT 1–37

AUTOPARTES LISBONAnalysis of Transactions (in Euros)

For the Month Ended March 31, 20X1

Assets Liabilities + Owner’s Equity Equip- Accounts Note You,

Description of Transactions Cash + Inventory + ment = Payable + Payable + Capital 1. Initial investment +80,000 = +80,000 2. Inventory acquired for cash 10,000 +10,000 = 3. Inventory acquired on credit + 8,000 = + 8,000 4. Equipment acquired – 5,000 +15,000 = +10,000 5. No entry = 6. Tires for family – 600 = - 600 7. Parts returned to

supplier for cash + 300 – 300 = 8. No effect on total inventory* = 9. Parts returned to

supplier for credit – 500 = – 50010. Payment on note – 2,000 = –2,00011. Equipment acquired + 5,000 = +5,000 12. Payment to creditors – 3,000 = –3,00013. No entry14. No entry15. Exchange of equipment + 2,500 – 4,000 =

+ 1,500

+ 62,800 +16,600 +17,500 = +4,500 + 8,000 +84,400

96,900 96,900

*Entries could have reduced both inventory and accounts payable by €800 and then increased the same two accounts by €800. The net effect is no change in either account.


EXHIBIT 1–38

LEIDA CRUZ ATTORNEYAnalysis of Business Transactions

(In Thousands of Dollars)

Assets = Liabilities and Owner’s Equity Owner’s

Cash Note Rental Legal Office Liabilities Equity Description in Receiv- Damage Supplies Furni- Note Account L. Cruz of Transactions Bank able Deposit on Hand Computer ture Payable Payable Capital 2. Opening

investment +60 = +604. Rental deposit – 1 +1 =5. Purchased computer – 2 +5 = +36. Purchased supplies +1 = +17. Purchased

furniture – 4 +4 =9. Note receivable

from Whitman – 3 +3 = Balance, December

31, 20X0 +50 +3 +1 +1 +5 +4 = +3 +1 +60

64 64General Comments:• Transactions 1 and 3 are personal rather than business transactions.• In transaction 4, no obligation (liability) is set up for the rent because it is not payable until January 2 and no rental services will

occur until January.• Transaction 8 requires no entry because no services have been performed during December.


EXHIBIT 1–39

WALGREEN COMPANYAnalysis of Transactions(In Millions of Dollars)

Assets Liabilities and Stockholders’ Equity Property Stock-

Inven- and Other Notes Accounts Other holders’Description of Transactions Cash + tories + Assets = Payable + Payable + Liabilities + Equity Balance August 31 1,556 8,044 17,854 = 4,810 7,797 14,8471. Issuance of stock for cash +30 = + 302. Issuance of stock for equipment +42 = + 423. Borrowing +13 = +134. Acquisition of equipment for cash –18 +18 =5. Acquisition of inventory on account +89 = +896. Payments to creditors –35 = –357. Sale of equipment +2 - 2 =

Balance September 2 1,548 8,133 17,912 = 13 4,864 7,797 14,919

27,593 27,593

WALGREEN COMPANYBalance Sheet

September 2, 2011(In Millions of Dollars)

Assets Liabilities and Stockholders’ Equity Cash $ 1,548 Notes payable $ 13Inventories 8,133 Accounts payable 4,864Property and other assets 17,912 Other liabilities 7,797

Stockholders’ equity 14,919Total assets $27,593 Total liab. and stockholders’ equity $27,593


1-40 (20-35 min.)


2. NIKE, INC.Balance SheetJune 3, 2011(In Millions)

Liabilities and Assets Stockholders’ Equity

Cash $ 2,086 Total liabilities $ 5,213Inventories 2,758 Stockholders’ equity 9,933Property, plant, and equipment 2,089Other assets 8,213 Total $15,146 Total liabilities & stk. equity $15,146

1-41 (15-20 min.)JENNIFER GRANT, REALTOR

Balance SheetNovember 30, 20X1

Liabilities and Assets Owners’ Equity Cash $ 6,000 Liabilities:Undeveloped land 170,000 Accounts payable $ 6,000 Office furniture 16,000 (a) Mortgage payable 85,000Franchise 18,000 (b) Total liabilities 91,000

Owner’s equity: Jennifer Grant, capital 119,000 (c)

Total assets $210,000 Total liabilities and owner’s equity $210,000

(a) $17,000 – $1,000 = $16,000(b) A franchise is an economic resource that has been purchased to benefit future operations.(c) $210,000 – $91,000 = $119,000

Note that Rubenstein’s death may have considerable negative influence on future operations, but accounting does not formally measure its monetary impact. Moreover, transactions 3 and 4 are personal rather than business transactions.


EXHIBIT 1–40NIKE, INC.

Analysis of Transactions(In Millions of Dollars)

AssetsLiabilities and

Stockholders’ Equity

Description of Transactions Cash +Inven-tories +

Property, Plant, and

Equip. +Other Assets

=

Total Liabil-

ities +

Stock-holders’ Equity

Balance May 31 1,955 2,715 2,115 8,213 5,155 9,8431. Inventory purchased 28 +28 =2. Inventory purchased +19 = +193. Return of inventory

to supplier 4 = 44. Purchase of equipment 5 +14 = +95. Sale of equipment +40 40 =6. No entry =7. Payment to creditor 16 = 168. Borrowed from bank +50 = +509. Issued common stock +90 = +90

10. No entry except ondetailed underlyingrecords =

Balance, June 3 2,086 2,758 2,089 8,213 = 5,213 9,933

15,146 15,146


1-42 (10 min.)

1. Cash would increase by $1,000 and the liability, Deposits, would increase by the same amount.

2. Deposits are liabilities because Wells Fargo owes these amounts to depositors. They are depositors’ claims on the assets of the bank.

3. Loans Receivable would increase and Cash would decrease by $75,000.

4. Both Deposits and Cash would decrease by $5,000.

1-43 (10 min.) Amounts are in millions.

1. a. Cash = Total assets Noncash assets= €27,739 €24,860= €2,879

b. Stockholders’ equity = Total assets Total liabilities= €27,739 €21,512= €6,227

2. Total liabilities and stockholders’ equity = total assets = €27,739.


1-44 (20-30 min.)

UNITED TECHNOLOGIES CORPORATIONBalance Sheet

September 30, 2011(In Millions of Dollars)

Liabilities and Assets Stockholders’ Equity Cash $ 5,966 (1) Accounts payable $ 5,597Inventories 8,617 Other liabilities 22,935Fixed assets 6,137 Long term debt 9,501Other assets 41,228 Total liabilities 38,033

Common stock $13,330Other stockholders’ equity 10,585 (3)Total stockholders’ equity 23,915 (2)

Total liabilities andTotal assets $61,948 stockholders’ equity $61,948

Notations (1), (2), and (3) designate the answers to the requirements. (1) The $5,966 cash was computed by taking total assets minus all assets except cash. To calculate (2) and (3), note that total assets must equal total liabilities plus stockholders’ equity, $61,948. Furthermore, total liabilities equal ($5,597 + $22,935 + $9,501) = $38,033. Therefore, total stockholders’ equity is ($61,948 – $38,033) = $23,915, denoted by (2) above. Other stockholders’ equity is ($23,915 – $13,330) = $10,585, denoted by (3) above.


1-45 (20 min.)

MACY’S, INC.Balance Sheet

October 29, 2011(In Millions of Dollars)

Liabilities and Assets Shareholders’ Equity

Cash $ 1,097 (1) Merchandise accounts Inventories 7,158 payable $ 3,576Property, plant, Long-term debt 6,151 and equipment 8,423 Other liabilities 6,684 Total liabilities $16,411 (2)Other assets 5,585 Shareholders’ equity 5,852 (3)

Total liabilities andTotal assets $22,263 shareholders’ equity $22,263

Notations (1), (2), and (3) designate the answers to the requirements. Cash is calculated by subtracting the values given for the other assets from total assets: ($22,263 $7,158$8,423 $5,585) = $1,097. Cash is the smallest individual asset. Companies try to keep cash balances small because they do not earn large returns on cash accounts.

To calculate (2), simply add the components ($3,576 + $6,151 + $6,684).

For (3), note that total liabilities and shareholders’ equity equals total assets, $22,263, so shareholders’ equity is $22,263 less total liabilities of $16,411, which equals $5,852.


1-46 (10 min.)

1. EL-HASHEM PARTNERS

Balance SheetJune 15, 20X0

Assets Liabilities and Owners’ EquityRental house $350,000 Mortgage loan payable $260,000

Owners’ equity Muhab El-Hashem, Capital 45,000

Ghassan El-Hashem, Capital 45,000Total assets $350,000 Total liabilities and owners’equity $350,000

2. EL-HASHEM CORPORATION

Balance SheetJune 15, 20X0

Assets Liabilities & Stockholders’ EquityRental house $350,000 Mortgage loan payable $260,000

Stockholders’ equity Common stock, par value 2,000

Additional paid-in capital 88,000Total assets $350,000 Total liabilities and stockholders’ equity $350,000

1-47 (10 min.)

1. The par value line would increase by (500,000,000 × $.01) = $5,000,000 and the number of shares issued and outstanding would increase by 500 million. Additional paid-in capital would increase by [500,000,000 × ($25.00 – $.01)] = $12,495,000,000.

2. IBM shows all of its paid-in capital as a one-line item. Therefore, its common stock line would increase by $180,000,000, and the number of issued and outstanding shares would increase by 1 million.


1-48 (5-10 min.)

The common stock line should show (2,442,676,580 × $.75) = $1,832 million; note that balance sheet amounts are rounded to the nearest million. The total price per share paid by the original investors for the Chevron common stock was ($15,110 million + $1,832 million) = $16,942 million; the average price per share was ($16,942 million ÷ 2,442,676,580) = $6.94. Note that the par value is small, $.75, as compared to $6.94.

The relatively large difference between the original issuance price ($6.94) and the current market price (nearly $100 in early 2012) is quite typical of many large successful companies. This is usually caused by increased investment attractiveness based on a record of profitable operations over many years.

1-49 (5-10 min.)

1. The par value of Honda’s shares is (¥86,067,000,000 ÷ 1,811,428,430) = ¥47.5.

2. The average price per share paid by the original investors was ¥142.76: (¥86,067 million + ¥172,529 million) = ¥258,596 million; (¥258,596 million ÷ 1,811,428,430) = ¥142.76. Note that the ¥142.76 easily exceeds the par value of ¥47.5.

3. The large difference between the original issuance price of ¥142.76 and the market price of ¥3,000 at the end of fiscal 2011 is typical for many successful companies. This phenomenon is usually caused by increased investment attractiveness based on a record of profitable operations over many years.

1-50 (10 min.)

There are two popular sets of generally accepted accounting principles (GAAP) in the world—IFRS set by the International Accounting Standards Board, and U.S. GAAP set by the Financial Accounting Standards Board. In 2005 the European Union adopted IFRS to be used by all companies in its member nations. Thus, Carrefour, a French company, must issue financial statements that comply with IFRS. Its auditors will examine its financial statements to ensure compliance with IFRS and must confirm this in the audit opinion. Although not mentioned in the chapter, the phrase “as adopted by the European Union” is also significant. Countries that adopt IFRS may not accept 100% of its standards, and the European Union makes a few adjustments to the standards.

In contrast, companies based in the United States, such as Safeway, must use U.S. GAAP, not IFRS. Thus, Safeway’s audit opinion clearly states that its statements comply with U. S. GAAP.

Both companies use Deloitte & Touche LLP as an auditor, but the auditor must apply different standards when auditing Carrefour than when auditing Safeway.


1-51 (15-20 min.)

NOTE TO INSTRUCTOR: You may want to assign a more recent annual report, and the composition on the board may have changed. However, the general mix of backgrounds of the board members is unlikely to change.

1. The board of directors of General Mills has 13 members, of which only one is a General Mills executive—Kendall J. Powell, the CEO and chairman of the board.

2. Of the 12 independent directors, 9 are either current or retired executives of other companies, one is an attorney, one is a venture capitalist, and one is an academic (dean of Dartmouth’s Tuck School). However, two retired executives and the attorney are currently academics, also. The board should have sufficient independent directors to avoid too much management influence and should have extensive and varied experiences to bring to the board discussions.

3. There are five members of the audit committee. None are General Mills executives; they are all independent directors. The attorney chairs the audit committee. The audit committee was given extensive power by the Sarbanes-Oxley Act. It is charged with responsibility for overseeing the financial reporting of the company, a task that is extremely important to shareholders, who rely on the financial reports for important information.


1-52 (10 min)

Credibility of accounting reports is essential. Decision makers both within and outside of an organization rely on accounting reports for important decisions. For accounting reports to have credibility, users must have confidence in both the preparers and the auditors of those reports.

Internal accountants have access to much sensitive data, and they have access to information across an entire organization. They need to be trusted to keep certain types of information confidential as well as to report fully and accurately to managers who need information for their decisions. Because of their access to so much information, accountants also often act as the conscience of an organization, identifying areas where managers may intentionally or unintentionally be misusing organizational resources. This is a large responsibility, and it requires the trust of managers throughout the organization.

External audits have value because they add credibility to the financial statements. Management prepares the financial statements and may be prone to overstate operating results either because of natural optimism or because their reputation or compensation is linked to operating performance. If investors and other users of financial statement do not have faith in the competence, fairness, and objectivity of the auditors, audits will have little value. Therefore, developing and maintaining high ethical standards is a hallmark of the auditing profession.

Not only are individual accountants cognizant of the need to develop and maintain a reputation for ethical behavior, but they recognize the need to be collectively regarded as highly ethical. Any breach of ethical conduct by one accountant has spillover effects on others. It is important to all accountants that the profession of accounting be regarded as highly ethical. Therefore, professional accounting organizations have developed standards of ethical conduct. Certification examinations, such as the Certified Public Accountant (CPA) and Certified Management Accountant (CMA) exams, test applicants’ knowledge of ethical standards, and the associations enforce compliance to ethical standards by penalizing those who violate the standards. In this way the public can be reasonably assured that when they deal with a certified accountant he or she will be familiar with ethical standards and will have been in compliance with them.

1-53 (60 or more min.)

The purpose of this exercise is to learn how to find a company’s balance sheet, to pick out significant items on it, and to understand how basic transactions affect the balance sheet. Each student will become an “expert” on one or two types of transactions and will be required to explain the accounting for that transaction to the rest of the group. Requirement 2 is a test of how well the “experts” explained the effects of their transactions. The hypothetical transactions are chosen so that only the selected accounts are affected.


1-54 (15-30 min.)

Each solution is unique and will change each year. The purpose of this problem is for students to recognize the format of a balance sheet and to see how it relates to the balance sheet equation.

1-55 (10-15 min.) NOTE: This solution is based on Starbucks’ 2011 financial statement. If a more recent annual report is used, the numbers will change.

Dollar amounts are in millions.

1. Cash = $1,148.1

2. Cash and cash equivalents $ 1,148.1Inventories 965.8Property, plant, and equipment * 2,355.0Accounts payable 540.0Common stock .7Additional paid-in capital** 1.1Other additional paid-in capital** 39.4

* This was called store equipment in the chapter.** The reason additional paid-in capital is separated into 2 parts is beyond our scope at this time.

3. Assets = Liabilities + Stockholders’ Equity$7,360.4 = $2,973.1 + $4,387.3


1-56 (30-60 min.)

NOTE TO INSTRUCTOR: This solution is based on the web site as it was in 2012 and the financial statements for the year ended June 30, 2011. Be sure to examine the current web site before assigning this problem, as the information there may have changed.

1. Despite the recession, the letter is very optimistic and future oriented. It indicates that “Fiscal 2011 was one of the most transformative years we have seen at Cisco. We prioritized, simplified, and took action to drive Cisco’s continued market leadership. We aggressively changed the way we do business to become a faster and more agile partner, with the goal continuing to be to increase our ability to deliver unique value to our shareholders, customers, partners, and employees.”

2. Cisco was founded in 1984. The company designs, manufactures, and sells Internet Protocol (IP)-based networking and other products related to the communications and information technology (IT) industry and provides services associated with these products.

3. Cisco’s total assets at the end of fiscal 2011 were $87,095 million, its total liabilities were $39,836 million, and total shareholders’ equity was $47,259 million. (The item called “noncontrolling interest” is part of shareholders’ equity that is held by shareholders other than those of Cisco. It will be discussed in Chapter 11.)

4. Inventories are $1,486 million, $159 million more than a year ago. Inventory grew 12% in fiscal 2011, faster than total assets growth of 7%. Although this inventory build-up is not excessive, when inventories grow faster than assets it may be a sign of trouble.

5. The audit report states: “The Company’s management is responsible for these financial statements. . . Our responsibility is to express opinions on these financial statements . . . based on our integrated audits.”

6. Cisco has 12 members of the board of directors. Of these, 2 are part of Cisco’s management team. There is one academic, the president of Stanford University. The others are all executives or retired executives with other companies. There are 5 members on the audit committee.


financial accounting- chapter 1

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