Cornerstones Of Financial Accounting, First Canadian Edition Solution Manual

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1.Accounting is a system for identifying, measuring, recording, and communicating financialinformation about an organization’s activities to permit informed decisions by users of theinformation. Bookkeeping is the process—made up of mechanical “steps”—of recordingtransactions and maintaining accounting records. While bookkeeping is part of accounting,accounting is viewed as the complete information system that communicates the economicactivities of a company to interested parties. Accounting is often referred to as the “languageof business” because it communicates information about economic activities of a companythat help people make decisions.2.Accounting information is demanded or needed by decision-makers both inside and outside thebusiness to provide information about business activities and finances so that informed decisionscan be made. Five groups that create the demand for accounting information and their uses ofaccounting information are described below.(1)Managers need accounting information to plan and make decisions about the business(e.g., predicting the consequences of their actions and deciding on which actions to take)and to control its operations (e.g., evaluating the effectiveness of their past decisions).(2)Employees use accounting information about their employer to aid in planning their careers(e.g., judging the future prospects of the company).(3)Investors (owners) need accounting information about a business to evaluate the futureprospects of a business and to decide where to invest their money.(4)Creditors (lenders) need accounting information to decide whether or not to lend money orextend credit to a business.(5)Governments need accounting information about businesses to determine taxes owed bybusinesses, to implement a variety of regulatory objectives, and to make national economicpolicy decisions.3.An accounting entity is a company that has an identity separate from that of its owners andmanagers and for which accounting records are kept. There are three main forms thataccounting entities take: a sole proprietorship, a partnership, and a corporation.4.A sole proprietorship is a business entity owned by one person. A partnership is a business entityowned jointly by two or more individuals. Proprietorships and partnerships are not legally separatefrom the personal affairs of the owners. That is, the owners are responsible for the debts of thebusiness. A corporation is a separate legal entity formed by one or more persons calledshareholders. A corporation is legally separate from the affairs of its owners, which limits theshareholders’ legal responsibility for the debts of the business to the amount that the shareholdersinvested in the business. Corporate shareholders may pay more taxes than owners of soleproprietorships or partnerships. The majority of business in Canada is conducted by corporations.1ACCOUNTING AND THEFINANCIAL STATEMENTSDISCUSSION QUESTIONS

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Chapter 1: Accounting and the Financial Statements5.The three main types of business activities are financing activities, investing activities,and operating activities. Financing activities involve obtaining the funds necessary to begin andoperate a business. These funds come from either issuing shares or borrowing money.Investing activities involve buying and selling assets that enable a corporation to operate.Operating activities are the normal business activities that a company engages in as itconducts its business. These activities involve selling products or services, purchasinginventory, collecting amounts due from customers, and paying suppliers.6.Assets are the economic resources or future economic benefits obtained or controlled by abusiness. Liabilities are the creditors’ claims on the resources of a business. Shareholders’equity is the ownership claims on the resources of a business. Shareholders’ equity isconsidered a residual interest in the assets of a business that remain after deducting thebusiness’s liabilities. All three items appear on the statement of financial position, forming thefollowing equation:Assets = Liabilities + Shareholders’ Equity7.Revenues are the increases in assets (resources) that result from the sale of products orservices. Expenses are the costs of assets (resources) used, or the liabilities created, in theoperation of the business. If revenues are greater than expenses, a corporation has earned netincome. If expenses are greater than revenues, a corporation has incurred a net loss.8.The four primary financial statements are:(1)The statement of financial position: a presentation of information about a company’seconomic resources (its assets) and the claims against those resources by creditors andowners (liabilities and shareholders’ equity) at a specific point in time.(2)The income statement: a report on how well a company has performed its operations—the profitability of a company—over a period of time.(3)The statement of retained earnings: a report on how much of the company’s income wasretained in the business and how much was distributed to owners over a period of time.(4)The statement of cash flows: a report on the changes in a company’s cash during aperiod of time. The statement of cash flows provides information about the company’scash inflows (sources) and outflows (uses) from operating, investing, and financingactivities.9.There are many questions that can be answered based on each of the financial statements:(1)The statement of financial position:a.What is the total amount of assets (economic resources) of a corporation? What isthe total amount of liabilities (claims against the resources) for a corporation?b.How much equity do the owners of the corporation have in its assets?c.Is the corporation able to pay its debts as they become due?(2)The income statement:a.How much revenue was earned last month? Last quarter? Last year?b.What was the total amount of expenses incurred to earn that revenue?c.How much better off is the corporation at the end of the year than it was at thebeginning of the year?d.Was the corporation profitable, and what are the prospects for the corporation’sfuture profitability?e.What are the prospects for the future growth of the corporation?1-2

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Chapter 1: Accounting and the Financial Statements(3)The statement of retained earnings:a.How much income was distributed in dividends by the corporation?b.What amount of equity in the business has been generated internally?(4)The statement of cash flows:a.How much cash was taken in or paid out as a result of operations?b.How much cash was invested in new equipment?c.How much cash was used to pay off business debt?10.Point-in-time measurement means as of a particular date. The statement of financial position isa point-in-time measurement. The period-of-time description applies to what has happenedover a time interval. The income statement is a period-of-time measurement that explains thebusiness activities between statement of financial position dates. The statement of cash flowsand the statement of retained earnings are also period-of-time measurements.11.The fundamental accounting equation is:Assets = Liabilities + Shareholders’ EquityThe equation is significant because it means that the statement of financial position mustalways balance. This implies that what a company owns (its resources) must always be equalto the claims of its creditors (liabilities) and investors (shareholders’ equity).12.Each financial statement includes a heading that is comprised of (a) the name of the company,(b) the title of the financial statement, and (c) the time period covered—either a point-in-timemeasurement (an exact date) or a period-of-time description (e.g., a year ended on a specificdate).13.Current assets are cash and other assets that are reasonably expected to be converted to cashwithin one year or the operating cycle, whichever is longer. Current liabilities are obligations thatwill be satisfied within one year or the operating cycle, whichever is longer.Since current assets are presented separately from other assets, statement users can see ifthe firm is likely to have enough resources available to meet its current liabilities as they comedue. If current assets were presented among other assets, such a determination would be difficult.Current liabilities are separated from long-term liabilities because current liabilities will requireasset outflows (or replacement with another liability) much sooner than will long-term liabilities. Ifall liabilities were presented together, financial statement users would have difficulty in determiningthe assets (economic resources) required in the near future to satisfy the current liabilities.14.Current assets are generally listed on the statement of financial position in order of liquidity ornearness to cash, whereas current liabilities are usually listed in the order in which they will be paid.15.The two main components of equity are contributed capital and retained earnings. Contributedcapital is increased by investments of new capital in a company by its owners (the issue ofcommon shares to shareholders). Retained earnings is the accumulated net income of a companythat has not been distributed to owners. Retained earnings is increased by net income anddecreased by net losses and dividends.16.Net Income = Total Revenues – Total Expenses1-3

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Chapter 1: Accounting and the Financial Statements17.The single-step income statement format takes into account only two categories: total revenuesand total expenses. Total expenses are subtracted from total revenues in a single step to arrive atnet income. The multiple-step income statement format contains three important subtotals: grossmargin (gross profit), income from operations, and net income. Gross margin is the differencebetween net sales and cost of sales (or cost of goods sold). Income from operations is thedifference between gross margin and operating expenses. Net income is the difference betweenincome from operations and any nonoperating revenues and expenses.18.Astatement of retained earnings summarizes and explains the changes in retained earningsduring an accounting period. Retained earnings is the income earned by the company but notpaid to the owners in the form of dividends. The statement of retained earnings starts with thebalance in retained earnings at the beginning of the period. To this balance, add net income (orsubtract the net loss) obtained from the income statement. Next, subtract any dividends thecompany declared during the period. The total is the retained earnings at the end of the periodthat is reported on the statement of financial position.19.The statement of cash flows classifies cash flows into three categories: (1) cash flows fromoperating activities, (2) cash flows from investing activities, and (3) cash flows from financingactivities. Cash flows from operating activities are the cash flows related to the normal operationsof the business in earning income, and include cash sales and collections of accounts receivableless cash paid for goods, services, wages, salaries, and interest. Cash flows from investingactivities are cash flows related to the acquisition or sale of investments and long-term assets,including cash received from the sales of property, plant, and equipment; investments; and otherlong-lived assets less the cash spent to purchase long-term assets. The cash flows from investingactivities by a healthy, growing business will usually represent an excess of expenditures overreceipts. Cash flows from financing activities are the cash flows related to obtaining the capital ofthe company, including the cash contributed by owners and borrowed from creditors less amountspaid as dividends and repayments of liabilities. A business can finance its growth either internallywith cash generated by operations or externally with cash from owners and creditors.20.The statement of retained earnings describes the changes in retained earnings, a statement of finanaccount, that occurs between two statement of financial position dates. One of the major sources ofretained earnings is the net income (or net loss) for the year, which is determined on the incomestatement. The other major source of change in retained earnings is dividends, which are notconsidered a part of income.21.Other than the financial statements, users will find notes to the financial statements, management’sdiscussion and analysis of the condition of the company, and the auditor’s report in the annualreport of a company. The notes to the financial statements are an integral part of the financialstatements that clarify and expand upon the information in the financial statements. Management’sdiscussion and analysis provides a discussion and explanation of various items reported in thefinancial statements. Additionally, management uses this opportunity to highlight favourable andunfavourable trends and significant risks facing the company. The auditor’s report expresses theopinion of the auditor as to whether the financial statements fairly present the financial positionand results of operations of the company.1-4

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Chapter 1: Accounting and the Financial Statements22.Examples of unethical behaviour will differ from one student to another. One example is anaccountant who gives in to personal pressure to prepare financial statements that overstate theincome of the company by bending or violating generally accepted accounting principles.Overstated income may lead decision-makers to make the wrong choices. Decision-makers bothinside and outside the business must be able to rely on the financial information they receive tomake proper decisions. Therefore, ethical behaviour by accountants is necessary. Acting ethicallyis not always easy. However, because of the important role of accounting in society, accountantsare expected to maintain the highest level of ethical behaviour.1-5

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Chapter 1: Accounting and the Financial Statements1-1.a1-2.b1-3.a($10,500 – $5,800)1-4.b1-5.d1-6.d1-7.b($8,200 + $3,700 + $3,900)1-8.c($5,900 + $12,200)1-9.a1-10.b($165,500 – $92,100 – $43,850 – $15,000)1-11.c1-12.c1-13.bMULTIPLE-CHOICE EXERCISES1-6

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Chapter 1: Accounting and the Financial StatementsCE 1-14Scenario 1:=Liabilities+=$33,000+=$77,000Scenario 2:=X+=$42,000Scenario 3:=$32,000+X=$17,000CE 1-15Note:Be sure to treat situations b. through d. independently.a.Assets=Liabilities+ Equity$440,000=$285,000+ XX=$155,000at the beginning of the yearb.Assets=Liabilities+ Equity$525,000*=$323,000**+ XX=$202,000*$440,000 + $85,000**$285,000 + $38,000c.Assets=Liabilities+ Equity$375,000*=X+ $200,000**X=$175,000*$440,000 – $65,000**$155,000 (from part a) + $45,000d.Assets=Liabilities+EquityX=$380,000*+ $80,000**X=$460,000*$285,000 + $95,000**$155,000 (from part a) – $75,000$110,000$49,000Equity$44,000$68,000CORNERSTONE EXERCISESAssetsXXXX1-7

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Chapter 1: Accounting and the Financial StatementsCE 1-16a.statement of financial position (SFP)b.Statement of cash flows (CF)c.statement of financial position (SFP)d.Income statement (I)e.Statement of cash flows (CF)f.Income statement (I)g.statement of financial position (SFP)h.statement of retained earnings (RE)CE 1-171.d2.b3.a4.f5.e6.a7.c8.g(Note:While net income and dividends are reported on other financialstatements, the definition of retained earnings is income that has not beendistributed to shareholders. Therefore, by definition, this item is part of acompany’s retained earnings.)9.b10.a1-8

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Chapter 1: Accounting and the Financial StatementsCE 1-18Cash……………………………………………………………………………$3,200Accounts receivable…………………………………………………………4,500Supplies………………………………………………………………………8,100Total assets……………………………………………………………$15,800Liabilities:Notes payable…………………………………………………………$5,000Total liabilities………………………………………………………$5,000Shareholders’ equity:Common share…………………………………………………………$7,000Retained earnings………………………………………………………3,800Total shareholders’ equity ………………………………………10,800Total liabilities and shareholders’ equity………………………………$15,800CE 1-19Net Income=Total Revenue–Total ExpensesNet Income=$78,000–($33,200 + $20,500)Net Income=$24,300Note:The dividends do not appear on the income statement in arrivingat net income. Dividends do not affect the income statement. Dividendsare a reduction of the balance in retained earnings.CE 1-20Beginning retained earnings ……………………………………………………………… $25,000+Net i($74,000 – $57,000) ………………………………………………………………17,000–Dividends ………………………………………………………………………………(8,000)=Ending retained earnings………………………………………………………………$34,000Liabilities and Shareholders’ EquityAssetsCavernous Homes Ltd.Statement of Financial Position31-Dec-141-9

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Chapter 1: Accounting and the Financial StatementsE 1-211.Bank (B)2.Government (G)3.Business managers (M)4.Investor (I)5.Labor union (U)E 1-221.Sole proprietorship: 1, 2, 4, 5Partnership: 2, 3, 4, 5, 7Corporation: 2, 3, 4, 5, 6, 82.There are many advantages and disadvantages to each particular type of businessentity as listed below.a.Sole Proprietorship• Advantages:(i)The business is easily formed(ii)Control over the operations of the business is maintained by owner(iii)Sole proprietorships may pay less tax relative to corporations• Disadvantages:(i)The owner is personally liable for the debts of the business(ii)The life of the business is limited to the owner’s lifeb.Partnership:• Advantages:(i)Increased access to the financial resources and individual skills ofeach of the partners(ii)Partnerships may pay less tax relative to corporations• Disadvantages:(i)Control over the operations of the business is shared among thepartners(ii)The partners are personally liable for the debts of the business(iii)The life of the business is limited to life of the partnersc.Corporation:• Advantages:(i)Can more easily raise large amounts of money(ii)Ownership of the business can be easily transferred by selling shares(iii)The owners’ liability is limited to the amount invested in the business• Disadvantages:(i)The formation and organization of the business is more complex(ii)Corporations generally pay higher taxesEXERCISES1-10

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Chapter 1: Accounting and the Financial StatementsE 1-23a.Investing (I)b.Financing (F)c.Operating (O)d.Investing (I)e.Operating (O)f.Financing (F)g.Financing (F)E 1-24a.Financing (F)b.Investing (I)c.Investing (I)d.Operating (O)e.Operating (O)f.Financing (F)g.Operating (O)h.Operating (O)i.Investing (I)j.Financing (F)E 1-251.c2.e3.b4.g5.d6.f7.aE 1-26=Liabilities+Equity1.$ 61,800$ 51,0002.162,500112,5003.15,00043,200*$112,800 – $51,000**$275,000 – $162,500***$15,000 + $43,20058,200Assets$112,800275,000******1-11

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Chapter 1: Accounting and the Financial StatementsE 1-271.Current assets:CashAccounts receivableInventoryPrepaid insuranceTotal current assetsProperty, plant, and equipment:BuildingEquipmentLess: Accumulated depreciationIntangible assets:TrademarksTotal assetsLiabilities:Current liabilities:Accounts payableIncome taxes payableWages payableTotal current liabilitiesLong-term liabilities:Notes payableBonds payableTotal long-term liabilitiesTotal liabilitiesShareholders’ equity:Common shareRetained earningsTotal shareholders’ equityTotal liabilities and shareholders’ equity2.To assess liquidity, it would be helpful to have information on Huang Company’scurrent assets (cash, accounts receivable, inventory, and prepaid insurance)and current liabilities (accounts payable, income taxes payable, and wages payable).With this information, a user could compute a company’s working capital (currentassets less current liabilities) and current ratio (current assets ÷ current liabilities).These two measures are helpful in assessing a company’s ability to pay its debtsas they become due.AssetsLiabilities and Shareholders’ EquityHuang CompanyStatement of Financial PositionSpecific Point in Time1-12

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Chapter 1: Accounting and the Financial StatementsE 1-281.Since the operating cycle is six months, Dunn would use one year as thebreakpoint between current and noncurrent items.a.There are 17 months of prepaid rent ($8,500 ÷ $500). Dunn should include$6,000 (12 months × $500 per month) as a current asset and $2,500 (the(remaining 5 months × $500 per month) as a long-term asset.b.The $9,700 is a current liability.c.Since all items are expected to be sold within 12 months, the entire$46,230 is a current asset.d.The $700 portion of marketable securities is a current asset. Theremaining $1,200 is a long-term investment.e.The $1,050 of cash is a current asset.f.The $60,000 note due in March 2019 is a long-term liability. The $3,750interest related to 2014 is a current liability. The remaining interest of $750will not be recognized until 2015 and, therefore, is not on the 2014 statementof financial position.g.The entire $2,850 is a current asset.h.The store equipment and its accumulated depreciation are not currentassets. Instead, they are classified as property, plant, and equipment.Current assets:Cash………………………………………………………………… $ 1,050Short-term investment in marketable securities……………700Accounts receivable………………………………………………2,850Inventory……………………………………………………………46,230Prepaid rent………………………………………………………6,000Total current assets…………………………………………$56,830Current liabilities:Accounts payable…………………………………………………$ 9,700Interest payable on equipment loan (see f above)…………3,750Total current liabilities………………………………………$13,450Dunn Sporting GoodsPartial Statement of Financial PositionDecember 31, 20141-13

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Chapter 1: Accounting and the Financial StatementsE 1-28 (Contd)2.Working Capital=Current Assets – Current Liabilities=$56,830 – $13,450=$43,380Current Ratio=Current Assets ÷ Current Liabilities=$56,830 ÷ $13,450=4.233.These ratios give users insights into a company’s liquidity—that is a company’sability to pay obligations as they become due. These ratios show that DunnSporting Goods has adequate current assets to cover all of the current liabilitiesthat will become due in the near future. Comparing these ratios to othercompanies in the same industry and examining the trend in these measuresover time will yield additional insights.E 1-291.Current assets:Cash……………………………………………………………………………………$475Accounts receivable…………………………………………………………………8,000Notes receivable………………………………………………………………………1,200Supplies………………………………………………………………………………8,800Total current assets……………………………………………………………… $18,475Current liabilities:Accounts payable…………………………………………………………………… $ 1,800Notes payable …………………………………………………………………………7,600Total current liabilities……………………………………………………………$ 9,400The accounts receivable of $4,000 due in 18 months will be classified as a long-term asset. The construction equipment and related accumulated depreciationare classified as property, plant, and equipment (a noncurrent asset).2.Hanson Construction’s liquidity may be evaluated by examining its current ratioand working capital. Its current ratio is 1.97 ($18,475 ÷ $9,400) and its workingcapital is $9,075 ($18,475 – $9,400). Because current assets well exceed thecurrent liabilities, Hanson appears to be able to pay its debts that become duewithin the next year.Hanson ConstructionPartial Statement of Financial PositionDecember 31, 20141-14

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Chapter 1: Accounting and the Financial StatementsE 1-30The statement of financial position at December 31, 2014, will show equipment at itshistorical cost of $425,000 reduced by accumulated depreciation (a contra-asset) of$40,000. Therefore, the net book value (or carrying value) of the equipment is$385,000. (Note:The concepts ofbook valueandcarrying valuewill be coveredin more detail in later chapters.) The equipment and accumulated depreciationwill be reported under the caption “Property, plant, and equipment” in the assetsection of the statement of financial position.The 2014 income statement will show depreciation expense of $40,000. In amultiple-step income statement, depreciation expense will be reported as anoperating expense.E 1-31Shareholders’ equity:Common share……………………………………………………$135,600Retained earnings………………………………………………25,300Total shareholders’ equity…………………………………$160,900Note: Transactions among shareholders do not change shareholders’ equitybalances.E 1-321.Current assets:Cash………………………………………………………………$ 13,300Accounts receivable………………………………………..……6,700Inventory .…………………………………………………………481,400Prepaid rent ……….……………………………………..………54,000Total current assets…………………………………………$555,400Long-term investments:Investment ……………………...…………………………...……110,900Property, plant, and equipment:Furniture ……………. …………………………………………88,000Less: Accumulated depreciation……………………………(23,700)64,300Total assets ……………………………………………..……………$730,600AssetsCollege SpiritStatement of Financial Position31-Dec-14Mulcahy Manufacturing Inc.Partial Satement of Financial PositionDecember 31, 20141-15

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