1 CHAPTER 1 THE ROLE OF ACCOUNTING IN BUSINESS CLASS DISCUSSION QUESTIONS 1. The objective of most businesses is to maximize profits. Profit is the difference between the amounts received from customers for goods or services pro- vided and the amounts paid for the in- puts used to provide those goods or services. 2. A manufacturing business changes ba- sic inputs into products that are sold to customers. In contrast, a merchandising business purchases products in a form that can be sold to customers without any additional changes. Examples of manu- facturing businesses include Alcoa, Boe- ing, Caterpillar, and Dow Chemical. Examples of merchandising businesses include Best Buy, Macy’s, Target, and Wal-Mart. 3. A manufacturing business changes ba- sic inputs into products that are sold to customers. A service business provides services rather than products to cus- tomers. A restaurant, such as McDo- nald’s, has characteristics of both a manufacturing and a service business in that McDonald’s takes raw inputs, such as cheese, fish, and beef, and processes them into products for con- sumption by its customers. At the same time, McDonald’s provides services of waiting on its customers. 4. The corporate form allows the company to obtain large amounts of resources by issuing stock. In addition, in a corpora- tion the stockholders’ liability to creditors for the debts of the company is limited to their investment in the corporation. For these reasons, most large companies that require large investments in proper- ty, plant, and equipment are organized as corporations. 5. The business emphasis of KIA is a low- cost emphasis. In contrast, the business emphasis of BMW is a premium-price emphasis. The difference in emphases is directly reflected in the prices of the autos. For example, a new KIA starts for just over $15,000, but a new BMW starts for just over $30,000. 6. Super Wal-Mart will compete for customers us- ing a low-cost strategy. The size and buying power of Wal-Mart Corporation provides Wal- Mart a competitive advantage over your friend in the ability to offer low prices. Thus, your friend should attempt to compete using a premium- price emphasis. For example, your friend could offer personalized service to customers such as knowing customers’ names and providing a friendly atmosphere, home delivery of medi- cines, help in filing insurance forms, 24-hour call service, etc. 7. eBay services its customers by developing a Web-based community in which buyers and sel- lers are brought together in an efficient format to browse, buy, and sell items such as collectibles, automobiles, high-end or premium art pieces, jewelry, consumer electronics, and a host of practical and miscellaneous items. 8. No. The stakeholders within a group do not al- ways share the same interests. For example, bankers are primarily concerned about the ability of the business to repay its debt, including inter- est. In contrast, stockholders are more con- cerned about the long-term profitability of the business, the business’s ability to pay dividends, and the future appreciation of their stock. 9. Examples of financing activities for Southwest Airlines could include issuing stock, borrowing from banks, and paying dividends. Examples of investing activities could include purchasing new aircraft, acquiring new terminal facilities, and upgrading its computerized reservation systems. Examples of operating activities could include transporting passengers and freight. 10. The role of accounting is to provide information for managers to use in operating the business. In addition, accounting provides information to other stakeholders to use in assessing the eco- nomic performance and condition of the busi- ness. 11. The income statement presents a summary of the revenues and expenses of a business for a specific period of time. The statement of stock- holders’ equity indicates the changes in retained 2 earnings that have occurred over a spe- cific period of time. The balance sheet presents a listing of the assets, liabilities, and stockholders’ equity of a business as of a specific date. The statement of cash flows presents a summary of the cash receipts and cash payments of a business entity for a specific period of time. 12. Net loss of $1,636 million ($72,618 million – $74,254 million). 13. Net income or net loss will appear on the income statement and the statement of stockholders’ equity. The Retained Earnings and Common Stock balances at the end of the period will appear on the statement of stockholders’ equity and the balance sheet. Finally, the Cash bal- ance at the end of the period will appear on the balance sheet and the statement of cash flows. 14. No. The business entity concept limits the re- cording of economic data to transactions directly affecting the activities of the business. The pay- ment of the interest of $6,000 is a personal transaction of Billy Jessop and should not be recorded by Valley Delivery Service. 15. The land should be recorded at its cost of $110,000 to Wok Repair Service. This is consis- tent with the cost concept. 16. No. The offer of $975,000 and the increase in the assessed value should not be recognized in the accounting records. This is consistent with the cost concept. 3 EXERCISES E1–1 1. service 2. merchandise 3. manufacturing 4. manufacturing 5. service 6. merchandise 7. manufacturing 8. manufacturing 9. service 10. manufacturing 11. manufacturing 12. service 13. service 14. service 15. merchandise E1–2 1. a—low-cost 2. a—low-cost 3. b—premium- price 4. a—low-cost 5. a—low-cost 6. b—premium-price 7. a—low-cost 8. b—premium-price 9. b—premium-price 10. a—low-cost 11. b—premium-price 12. b—premium-price E1–3 Best Buy stockholders’ equity: $15,256 – $10,261 = $4,995 Gamestop stockholders’ equity: $4,246 – $2,179 = $2,067 E1–4 Apple: $290,479 – $171,124 = $119,355 Dell: $103,206 – $76,475 = $26,731 E1–5 a. $475,000 ($175,000 + $300,000) b. $355,000 ($880,000 – $525,000) c. $1,500,000 ($2,100,000 – $600,000) 4 E1–6 a. $10,617 ($33,440 – $22,823) b. $27,407 ($41,404 – $13,997) c. $203,706 ($122,312 + $81,394) E1–7 It would be incorrect to say the business had incurred a net loss of $10,000. The excess of the dividends over the net income for the period is a decrease in the amount of retained earnings in the business. E1–8 Company Chang Stockholders’ equity at end of year ($900,000 – $300,000) .................... $600,000 Stockholders’ equity at beginning of year ($775,000 – $400,000) ......... 375,000 Net income (increase in stockholders’ equity) .................................. $225,000 Company Henry Increase in stockholders’ equity (as determined for Chang) ................. $ 225,000 Add dividends ............................................................................................ 90,000 Net income ............................................................................................ $315,000 Company Nagel Increase in stockholders’ equity (as determined for Chang) ................. $ 225,000 Deduct additional issuance of capital stock ........................................... 125,000 Net income ............................................................................................ $ 100,000 Company Wilcox Increase in stockholders’ equity (as determined for Chang) ................. $ 225,000 Deduct additional issuance of capital stock ........................................... 125,000 $ 100,000 Add dividends ............................................................................................ 90,000 Net income ............................................................................................ $ 190,000 5 E1–9 a. (1) $5,008,669 ($10,313,728 – $5,305,059) (2) $6,132,263 ($11,174,876 – $5,042,613) b. $134,526 ($22,492,360 – $16,691,324 – $5,518,665 – $14,236 – $133,609) E1–10 Balance sheet items: 1, 2, 3, 7, 8 E1–11 Income statement items: 4, 5, 6, 9, 10 E1–12 1. a—asset 2. b—liability 3. a—asset 4. e—dividend 5. c—revenue 6. a—asset 7. b—liability 8. d—expense 9. d—expense 10. d—expense 6 E1–13 WEBBER COMPANY Statement of Stockholders’ Equity For the Month Ended June 30, 20Y7 Common Stock Retained Earnings Total Balances, June 1, 20Y7 .................. $60,000 $290,000 $350,000 Issuance of common stock............ 40,000 40,000 Net income ...................................... 175,000 175,000 Dividends ........................................ (30,000) (30,000) Balances, June 30, 20Y7 ................ $100,000 $435,000 $535,000 E1–14 MAYNARD SERVICES Income Statement For the Month Ended August 31, 20Y5 Fees earned........................................................................... $3,400,000 Operating expenses: Wages expense ............................................................... $2,150,000 Rent expense ................................................................... 320,000 Supplies expense ............................................................ 30,000 Miscellaneous expense .................................................. 55,000 Total operating expenses .......................................... (2,555,000) Net income ............................................................................ $ 845,000 7 E1–15 In each case, solve for a single unknown, using the following equation: Stockholders’ Equity (beginning) + Additional Issue of Capital Stock – Dividends + Revenue – Expenses = Stockholders’ Equity (ending) AL Stockholders’ equity at end of year ($800,000 – $450,000)......... $ 350,000 Stockholders’ equity at beginning of year ($400,000 – $200,000).. 200,000 Increase in stockholders’ equity ................................................... $ 150,000 Deduct increase due to net income ($175,000 – $65,000) ........... 110,000 $ 40,000 Add dividends ................................................................................ 50,000 Additional issue of capital stock ............................................. (a) $ 90,000 CO Stockholders’ equity at end of year ($460,000 – $110,000)......... $ 350,000 Stockholders’ equity at beginning of year ($300,000 – $130,000).. 170,000 Increase in stockholders’ equity ................................................... $ 180,000 Add dividends ................................................................................ 20,000 $ 200,000 Deduct additional issue of capital stock ...................................... 50,000 Increase due to net income ........................................................... $ 150,000 Add expenses ................................................................................. 70,000 Revenue ..................................................................................... (b) $ 220,000 KS Stockholders’ equity at end of year ($660,000 – $360,000)......... $ 300,000 Stockholders’ equity at beginning of year ($550,000 – $325,000).. 225,000 Increase in stockholders’ equity ................................................... $ 75,000 Add decrease due to net loss ($115,000 – $130,000) .................. 15,000 $ 90,000 Deduct additional issue of capital stock ...................................... (100,000) Dividends................................................................................... (c) $ (10,000) MT Stockholders’ equity at end of year ($1,200,000 – $700,000)...... $ 500,000 Add decrease due to net loss ($420,000 – $480,000) .................. 60,000 $ 560,000 Add dividends ................................................................................ 90,000 $ 650,000 Deduct additional issue of capital stock ...................................... 100,000 Stockholders’ equity at beginning of year ................................... $ 550,000 Add liabilities at beginning of year ............................................... 350,000 Assets at beginning of year ..................................................... (d) $ 900,000 8 E1–16 a. MONTANA INTERIORS Balance Sheet October 31, 20Y8 Assets Cash ................................................................................. $110,000 Accounts receivable ....................................................... 75,000 Supplies ........................................................................... 15,000 Total assets ..................................................................... $200,000 Liabilities Accounts payable............................................................ $ 40,000 Stockholders’ Equity Capital stock .................................................................... $ 60,000 Retained earnings ........................................................... 100,000* 160,000 Total liabilities and stockholders’ equity ...................... $200,000 *$100,000 = $110,000 + $75,000 + $15,000 – $40,000 – $60,000 MONTANA INTERIORS Balance Sheet November 30, 20Y8 Assets Cash ................................................................................. $ 140,000 Accounts receivable ....................................................... 118,000 Supplies ........................................................................... 20,000 Total assets ..................................................................... $ 278,000 Liabilities Accounts payable............................................................ $ 65,000 Stockholders’ Equity Capital stock .................................................................... $ 60,000 Retained earnings ........................................................... 153,000** 213,000 Total liabilities and stockholders’ equity ...................... $ 278,000 **$153,000 = $140,000 + $118,000 + $20,000 – $65,000 – $60,000 9 E1–16, Concluded b. Retained earnings, November 30 ........................................................ $ 153,000 Retained earnings, October 31 ............................................................ 100,000 Net income ............................................................................................ $ 53,000 c. Retained earnings, November 30 ........................................................ $ 153,000 Retained earnings, October 31 ............................................................ 100,000 Increase in retained earnings .............................................................. $ 53,000 Add dividends ....................................................................................... 20,000 Net income ............................................................................................ $ 73,000 E1–17 Balance sheet: a, b, c, d, f, g, h, i, j, l, m Income statement: e, k, n, o E1–18 1. c—financing activity 2. a—operating activity 3. b—investing activity 4. a—operating activity 5. c—financing activity 6. b—investing activity 7. a—operating activity 8. a—operating activity 9. a—operating activity 10. c—financing activity E1–19 1. c—financing activity 2. a—operating activity 3. a—operating activity 4. b—investing activity 10 E1–20 LOONEY INC. Statement of Cash Flows For the Month Ended July 31, Year 1 Cash flows from operating activities: Cash received from customers ................................... $ 600,000 Cash paid for expenses ............................................... (380,000) Net cash flows from operating activities.................... $220,000 Cash flows from investing activities: Cash paid for purchase of equipment ........................ (95,000) Cash flows from financing activities: Cash received from issuance of common stock ....... $200,000 Cash received from note payable ............................... 75,000 Cash dividends paid to stockholders ......................... (25,000) Net cash flows from financing activities .................... 250,000 Net increase in cash .......................................................... $375,000 July 1, Year 1 cash balance .............................................. 0 July 31, Year 1 cash balance ............................................ $375,000 E1–21 Situation 1: The income statement of Dell would provide the most useful informa- tion on whether the company’s business emphasis is working and, thus, whether the company will be around to provide warranty and other support services for your personal computer. Situation 2: The statement of cash flows would be a primary focus to determine whether LinkedIn is generating positive cash flows from operations. Because LinkedIn is a relatively new company using an innovative business emphasis, it has generated losses on its income statement. Thus, the income statement does not provide as much useful information as the statement of cash flows. In the long run, LinkedIn must generate positive cash flows from its operations to sur- vive and succeed. Situation 3: A current balance sheet would be a primary focus to determine whether the grocery store chain has sufficient cash or other assets such as re- ceivables that will enable the chain to repay the credit within 60 days. The bal- ance sheet would also report any other liabilities of the chain. 11 E1–21, Concluded Situation 4: The income statements of Sears and JCPenney would provide the most useful information on which company’s business emphasis is working best and, thus, generating profits. Situation 5: The statement of cash flows would be a primary focus to determine whether the annual cash flows from operating activities is sufficient to pay the interest on a continuing basis. Most large companies, like Target, will use credit lines to cover cash shortages throughout the year because of the seasonality of the retail industry. E1–22 1. BS 2. BS 3. BS, SCF 4. IS 5. IS 6. IS 7. BS 8. SCF 9. SCF 10. IS 11. IS 12. IS 13. BS 14. IS 15. SE, BS 12 E1–23 AMAZON.COM INC. Income Statement For the Year Ended December 31 (in Millions) Revenues: Net sales .......................................................................... $88,988 Other income ................................................................... 76 Total revenue ............................................................. $89,064 Expenses: Cost of sales .................................................................... $62,752 Selling, general, and administrative expenses ............. 26,058 Interest expense .............................................................. 210 Income tax expense ........................................................ 167 Other expense ................................................................. 118 Total expenses ........................................................... (89,305) Net loss.................................................................................. $ (241) E1–24 1. BS 2. BS 3. BS, SCF 4. SCF 5. SE, BS 6. IS 7. IS 8. IS 9. BS 10. BS 11. IS, RE 12. SCF 13. BS 14. BS 15. IS 16. IS 17. BS 18. BS 19. SE, BS 20. IS 13 E1–25 1. All financial statements should contain the name of the business in their headings. The statement of stockholders’ equity is incorrectly headed as “Ju- lie Baxter” rather than Outlaw Realty. The headings of the balance sheet and statement of cash flows need the name of the business. 2. The income statement, retained earnings statement, and statement of cash flows cover a period of time and should be labeled “For the Month Ended August 31, 20Y7.” 3. The year in the heading for the statement of stockholders’ equity should be 20Y7 rather than Year 1. 4. The balance sheet should be labeled “August 31, 20Y7,” rather than “For the Month Ended August 31, 20Y7.” 5. On the income statement, the total operating expenses are incorrectly sub- tracted from the sales commissions, resulting in an incorrect net income amount. The correct net income should be $94,500. This also affects the re- tained earnings statement and the amount of retained earnings that appears on the balance sheet. 6. On the statement of stockholders’ equity, the common stock issued during the month should be shown in the Common Stock column. The dividends should be subtracted rather than added to retained earnings. Beginning re- tained earnings should be zero. Ending amounts reported for common stock, retained earnings, and total stockholders’ equity should agree with the amounts reported on the balance sheet. 7. Accounts payable should be listed as a liability on the balance sheet. 8. Accounts receivable and prepaid expenses should be listed as assets on the balance sheet. 9. The balance sheet assets should equal the sum of the liabilities and stock- holders’ equity. 10. The statement of cash flows omits the cash flows from investing activities section. This section should report cash flows used to purchase land of $60,000. 11. The net cash flows and cash balance should be dated August 31, 20Y7, and should be the same as the ending cash reported on the balance sheet of $51,600. 14 E1–25, Continued Corrected financial statements appear as follows: OUTLAW REALTY Income Statement For the Month Ended August 31, 20Y7 Sales commissions .............................................................. $408,400 Operating expenses: Office salaries expense .................................................. $272,600 Rent expense ................................................................... 31,200 Automobile expense ....................................................... 7,900 Miscellaneous expense .................................................. 2,200 Total operating expenses .......................................... (313,900) Net income ............................................................................ $ 94,500 OUTLAW REALTY Statement of Stockholders’ Equity For the Month Ended August 31, 20Y7 Common Stock Retained Earnings Total Balances, August 1, 20Y7 .............. $ 0 $ 0 $ 0 Issuance of common stock............ 100,000 100,000 Net income ...................................... 94,500 94,500 Dividends ........................................ (12,000) (12,000) Balances, August 30, 20Y7 ............ $100,000 $82,500 $182,500 OUTLAW REALTY Balance Sheet August 31, 20Y7 Assets Cash ....................................................................................... $ 51,600 Accounts receivable ............................................................. 81,200 Prepaid expenses ................................................................. 7,200 Land ....................................................................................... 60,000 Total assets ........................................................................... $ 200,000 Liabilities Accounts payable ................................................................. $ 17,500 Stockholders’ Equity Common stock ...................................................................... $100,000 Retained earnings ................................................................ 82,500 182,500 Total liabilities and stockholders’ equity............................ $ 200,000 15 E1–25, Concluded OUTLAW REALTY Statement of Cash Flows For the Month Ended August 31, 20Y7 Cash flows from operating activities: Cash received from customers ......................................... $327,200 Cash paid for operating expenses .................................... (303,600) Net cash flows from operating activities .......................... $ 23,600 Cash flows from investing activities: Cash paid for purchase of land ......................................... (60,000) Cash flows from financing activities: Cash received from issuance of common stock ............. $100,000 Dividends paid to stockholders ........................................ (12,000) Net cash flows from financing activities .......................... 88,000 Net increase in cash during year ............................................ $ 51,600 Cash as of August 1 ................................................................ 0 Cash as of August 31 .............................................................. $ 51,600 E1–26 1. G 2. D 3. M 4. B 5. O 6. D 7. C 8. U 9. O 10. P E1–27 1. C 2. C 3. X 4. C 5. B 6. C 7. B 8. M 9. X 10. M