1 - 64 SOLUTIONS TO ANALYZE, THINK, COMMUNICATE – CHAPTER 1 ATC 1 – 1 (All dollar amounts are in millions.) a. $ 2,937 b. Net income increased by $ 23 STOCKHOLDERS’ c. ASSETS = LIABILITIES + EQUITY $ 41,290 = $29,993* + $ 11,297 * Liabilities must be computed by subtracting equity from assets. d. Sales increased by 3.7 % from 2017 to 2018 . ($ 74,443  $71,786)  $71,786 = 3.7% Cost of sales increased by 4 .3 % from 2017 to 2018 . ($ 53,299  $ 51, 125)  $51, 125 = 4 .3% Selling, general and administrative expenses increased by 3.9 % from 2017 to 2018. ($ 15,723  $ 15,140)  $ 15,140 = 3.9 % The largest percentage increase was for cost of sales expenses. 1 - 65 ATC 1 - 2 a. Income Statements (amounts given are in millions) Year 6 Year 5 Year 4 Year 3 Revenue $ 860 $1,520 (a) $2,720 $1,200 Cost and Expenses (a) (840) (a) (1,070) (2,400) (860) Income from Cont. Op. (b) 20 450 320 (a) 340 Unusual Items - 0 - 175 (b) (145) (b) ( 40) Net Income $ 20 (b) $ 625 $ 175 $ 300 Balance Sheets Cash and Marketable Sec. $ 350 $1,720 (c) $ 750 $ 940 Other Assets 1,900 (c) 1,180 2,500 (c) 2,560 Total Assets $2,250 $2,900 (d) $3,250 $3,500 Liabilities (c) $ 730 (d) $1,555 $1,001 (d) $1,300 Stockholders’ Equity Common Stock $ 880 $ 720 (e) $ 1,449 $ 800 Retained Earnings (d) 640 (e) 625 800 (e) 1,400 Total Stockholders’ Equity 1,520 1,345 (f) 2,249 2,200 Total Liab. and Stk. Equity $2,250 (f) $2,900 $3,250 $3,500 1 - 66 ATC 1 - 3 This solution is based on McDonald’s 2017 financial report. a. McDonald’s net income for 2017, 2016, and 2015 were as follows: 2017: $5,192.3 million 2016: 4,686.5 2015: 4,529.3 b. The company had $33,803.7 million of assets at the end of 2017. c. The company had $48,325.8 million of retained earnings at the end of 2017. d. For 2017, the company’s: net cash flow from operating activities were $5,551.2 million net cash flow from investing activities were $562.0 million. net cash flow from financing activities were ($5,310.8) million. 1 - 67 ATC 1 - 4 This problem is designed to test written communication skills. The memo should describe the balance sheet and the income statement. It should explain that the balance sheet is a statement of assets, liabilities, and stockholders’ equity at the date of the financial statement. The incom e statement gives the amount of revenues and expenses for the designated period. The memo should also define each of the following terms: Assets Liabilities Stockholders’ Equity Revenue Expense Net Income 1 - 1 ANSWERS TO QUESTIONS - CHAPTER 1 1. Stakeholders are the parties that use accounting information. Stakeholders with a direct interest include owners, managers, creditors, suppliers, and employees. These individuals are directly affected by what happens to the business. Stakeholders with an indirect interest include financial analysts, brokers, attorneys, government regulators, and news reporters. These individuals use information in the financial reports to advise and influence their clients. Students may give many different answers under the above categories depending on their level of experience in business. All students are direct users of accounting information related to tuition and fees, financial aid, and account balances. 2. Accounting provides information that is useful in making decisions by all participants in the market for resource goods and services, both profit - oriented and nonprofit oriented. Because accounting’s role is so important, it is often called the languag e of business. 3. The primary mechanism used to allocate resources in the U.S. is competition for resources in the open market. 4. A market is a group of people or organizations that come together for the purpose of exchanging items of value. 5. The market for business resources involves three distinct participants: consumers, conversion agents, and resource owners. See Exhibit 1 - 1 that illustrates how market trilogy is involved in resource allocation. 1 - 2 6. Financial Resource : money Physical Resource : natural resources (i.e. land, forests, mine ore, petroleum, etc.), buildings, machinery and equipment, furniture and fixtures Labor Resource : includes both intellectual and physical labor; i.e. employees 7. Investors expect a distribution of the business’s profits as a return on their financial investment (capital allocation). Creditors lend financial resources to businesses and receive interest as a return or profit on the loan. 8. Financial accounting provides information that is useful to external resource providers. Managerial accounting provides information that is useful to managers in operating an organization (i.e., internal users). 9. Not - for - profit or nonprofit entities provide goods or services to consumers for humanitarian or special reasons rather than to earn a profit for owners. For example, certain not - for - profit entities allocate resources to provide for research of diseases or social/environmental welfare; others allocate resources to promote the arts and provide education. 10. The U.S. rules of accounting information measurement are called generally accepted accounting principles (GAAP). 11. Careers in public accounting consist of providing services to the general public from a public accounting firm. These services include auditing, tax , and consulting services. Careers in private accounting usually consist of working for a specific company (which would be a client of the public accounting firm) providing a wide variety of services to the company including recording transactions, prepari ng financial statements, internal auditing , and others. 1 - 3 12. Items reported on the financial statements are organized into classes or categories called elements. The ten elements of financial statements are: 1. Assets 2. Liabilities 3. Equity (Stockholders’ Equity) 4. Investments by Owners (Contributed Capital) 5. Revenue 6. Expenses 7. Distributions (Dividends) 8. Net Income 9. Gains 10. Losses Accounts are specific items or subclassifications of the elements. Examples of accounts include cash, land , and common stock. 13. Assets, the economic resources of a business, are used to produce earnings. 14. The assets of a business belong to that business entity and there may be claims on the assets. Claims on the assets belong to resource providers. 15. Creditors are individuals and/or institutions that have provided goods or services to the business which are not yet paid for, or loaned money to the business. These parties have first claim to the assets of the business, and the owners have a residua l interest in the assets. 16. The term “liabilities” is used to describe creditors' claims on the assets of a business. 1 - 4 17. The accounting equation is: ASSETS – LIABILITIES = STOCKHOLDERS’ EQUITY or ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY Assets are the economic resources used by a business for the production of revenue. Liabilities are obligations of a business to relinquish assets, provide services, or accept other obligations. Equity , also called “residual interest” or “net assets , ” is the portion of the assets remaining after the creditors' claims have been satisfied (i.e., Assets – Liabilities). 18. The owners ultimately bear the risk and collect the rewards associated with operating a business. 19. A double - entry bookkeeping system is one in which every transaction affects at least two accounts. A transaction can affect both assets and claims (liabilities and equity) or only assets or only claims. In order to “balance” the accounting equation, every transaction requires a “double entry.” 20. Capital is acquired from owners by issuing stock to them. When stock is issued, the assets of the business increase and the stockholders’ equity increases. 21. Assets that are acquired by issuing common stock are the result of investments by owners. Assets that are acquired by using retained earnings are assets the business acquires through its earnings activities. 22. Revenue increases the asset side of the accounting equation and also increases the retained earnings account in the stockholders’ equity section of the equation. 23. The three primary sources of assets are (1) investments by owners (issue of stock), (2) borrowing from creditors, and (3) earnings activities. 1 - 5 24. Retained earnings are a result of a business retaining its earned assets, rather than distributing those earnings to its owners. 25. Distributions to owners, called dividends, decrease the asset side of the accounting equation and also decrease the retained earnings account in the stockholders’ equity section of the equation. 26. Dividends and expenses are similar in that they both decrease assets and affect the accounting equation in the same way (i.e. reduction of retained earnings). However, dividends differ from expenses because of the nature of the decline in assets. Exp enses reduce assets as the result of a firm's efforts to earn revenue. Dividends reduce assets because of a transfer of wealth to the owners. 27. (1) Income Statement - measures the difference between the asset increases and the asset decreases that were associated with operating a business during a particular accounting period. (2) Statement of Changes in Stockholders’ Equity - explains the effects of transactions on stockholders’ equity during the accounting period. (3) Balance Sheet - lists the assets and the corresponding claims against the entity as of a particular date. (4) Statement of Cash Flows - explains how a company obtained and used cash during the accounting period. 28. The balance sheet provides information about the enterprise at a particular point in time. 29. A net loss occurs when expenses exceed revenues in a given accounting period. 1 - 6 30. (1) Operating activities - explain the cash generated from revenue and the cash paid for expenses. (2) Investing activities - include cash received or spent by the business on productive assets used in the business, and investments in debt or equity of other companies. (3) Financing activities - include cash inflows and outflows from the company's transactions with its owners and inflows and outflows from its borrowing activities. 31. Asset accounts are arranged on the balance sheet in accordance with their level of liquidity (those that can be most quickly converted to cash are listed first). 32. Articulation refers to the interrelationships among the various elements of the financial statements. 33. Temporary accounts are used to capture information for a single accounting period. The balances in temporary accounts are transferred out of the accounts at the end of the accounting period. Temporary accounts have zero balances at the beginning of an ac counting period. Temporary accounts include revenue accounts, expense accounts and dividends. Permanent accounts carry over from one accounting period to the next. Retained Earnings is a permanent account. 34. The historical cost concept requires that most assets be reported at the amount paid for them regardless of their increase or decrease in value. It is related to the qualitative characteristic of verifiability in that information can be independently verified. The historical cost is verified, while a change in value is subjective. 1 - 7 35. An asset source transaction results in an increase in an asset account and an increase in one of the claims accounts; i.e., investments by owners (equity), borrowing funds from creditors (liabilities), or earnings activities (revenue). An asset use transaction results in a decrease in an asset account and a decrease in either liabilities or equity; i.e., the payment of a liability, the payment of an expense, or a dividend. An asset exchange transaction is a transaction in which one asset is exchanged for another; i.e., purchase of land with cash. A claims exchange transaction will be covered in a later chapter. 36. While the contents of annual reports vary from company to company, all annual reports contain: Management’s discussion and analysis (MD&A) Financial statements Notes to the financial statements Auditor’s report 37. U.S. GAAP, generally accepted accounting principles in the United States, are the measurement rules established by the (FASB) Financial Accounting Standards Board. The FASB is a privately funded organization with the primary authority for establishing acco unting standards in the United States. International Financial Reporting Standards (IFRS) are issued by the International Accounting Standards Board and are an attempt to set a common standard to be used in different countries. IFRS is used by global com panies and there is a move underway to merge GAAP and IFRS. 1 - 8 SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 1 EXERCISE 1 - 1 A The three participants in the free business market are: 1. Resource owners 2. Conversion agents 3. Consumers Note to instructor: The memo should discuss the fact that the resource owners are those who own resources that are desired by others, either in the original form or in a converted form. The conversion agents are the parties that acquire the resource and supply it to consumers either in the original form or in a converted form with valu e added by the conversion. The consumers are the ultimate users of the resources. It should also include a discussion of the public accountant and the allocation of resources. For example, p ublic accountants audit the annual reports that businesses (conversion agents) use to communicate information to investors and creditors (financial resource providers). Based on their findings they may certify or deny that the reports fairly represent the financial condition of the business. In other words, public accountants provide assurance that the information provide d by the business is trustw orthy. Public accountants usually gain the professional designation of Certified Public Accountant (CPA). 1 - 9 EXERCISE 1 - 2 A a. The most common designation held by a public accountant is the CPA license. CPA stands for certified public accountant. CPAs are licensed by the state government (or other jurisdiction). Although the requirements vary from state to state (jurisdiction), CPA candidates normally must have a college degree, pass a demanding technical examination and obtain relevant work experience. b. Designations that private accountants may hold include the CMA, Certified Management Accountant, and the CIA, Certified Internal Auditor. Both require meeting educational requirements, passing a technical examination , and obtaining relevant work experience. These designations are not professional licenses and are not government regulated. 1 - 10 EXERCISE 1 - 3 A Entities mentioned: Effect on cash: Vicky Hill Recovery Fund Increase for cash contributions, $21,000 Decrease for payment of advertising, $1,000 Decrease payment for hospital bills, $12,000 Decrease for donation to National Cyclist Fund, $8,000 Karen White Decrease by contribution, $1,000 WKUX Increase for advertising revenue, $1,000 Public Decrease for contributions, $20,000 Mercy Hospital Increase for medical care, $12,000 National Cyclist Fund Increase for donation, $8,000 1 - 11 EXERCISE 1 - 4 A a. Term Definition a. Assets 7. Economic resources that will be used by a business to produce revenue. b. Common Stock 3. Certificates that evidence ownership in a company. c. Creditors 6. Individuals or institutions that have loaned goods or services to a business. d. Liability 5. An obligation to pay cash in the future. e. Retained Earnings 4. Assets – Liabilities – Common Stock. f. Stockholders 1. Individuals or institutions that have contributed assets or services to a business in exchange for an ownership interest in the business. g. Stockholders’ Equity 2. Common Stock + Retained Earnings. b. Accounting Equation Stockholders’ Equity Common Retained Company Assets = Liabilities + Stock + Earnings A 123,000 = 25,000 + 48,000 + 50,000 B 40,000 = 3,000 + 7,000 + 30,000 C 75,000 = 15,000 + 18,000 + 42,000 D 125,000 = 45,000 + 60,000 + 20,000