The Balance Sheet and Notes To The Financial Statements: Hapter
The Balance Sheet and Notes To The Financial Statements: Hapter
The Balance Sheet and Notes To The Financial Statements: Hapter
1 Definition of solvency
2 Definition of a liability
3 Accrued revenues as current assets
4 Classification of current assets
5 Presentation order of current assets
6 Unearned rent as current liability
7 Classification of investment securities
8 Identification of long-term investments
9 Example of change in liability from current to noncurrent
10 Example of change in liability from noncurrent to current
11 Classification of current liabilities
12 Elements of working capital
13 Contingent liability--pending litigation
14 Definition of an asset
15 Share information reported on the balance sheet
16 Recording a loss contingency
17 Items not included in stockholders' equity
18 Definition of contributed capital
19 Recording a loss contingency
20 Disclosing a loss contingency
21 Definition of subsequent event
22 Limitations and weaknesses of a balance sheet
23 Definition of the operating cycle
Computational Questions
24 Computation based on the accounting equation
25 Computation of stockholders' equity
26 Computation of net income from the accounting equation
27 Computation of current liabilities
28 Computation of borrowing ability using debt-to-equity ratio
63
64 Chapter 3 The Balance Sheet and Notes to the Financial Statements
PROBLEMS
1 Prepare schedule of working capital
2 Prepare properly classified balance sheet in report form
3 Prepare properly classified balance sheet, identify items to be disclosed
4 Prepare corrected and properly classified balance sheet
5 Correct account balances, give totals for current assets, liabilities
6 Correct account balances, give totals for long-term assets, liabilities
7 Calculate account balances, give total of assets
8 Calculate account balances, give total of liabilities
9 Summary of accounting policies
10 Accounting for human resources
11 Reporting receivables on the balance sheet
12 Limitations of the balance sheet
b 17. Which of the following would not be reported in the stockholders’ equity
LO1 section of the balance sheet?
a. Retained earnings appropriated for future plant expansion
b. Dividends declared on preferred stock
c. Paid-in capital in excess of par value
d. Deficit in retained earnings
c 24. Lobo Co. was incorporated on July 1, 2001, with $200,000 from the
LO1 issuance of stock and borrowed funds of $30,000. During the first year of
operations, net income was $10,000. On December 15, Lobo paid an $800
cash dividend. No additional activities affected owners' equity in 2001. At
December 31, 2001, Lobo's liabilities had increased to $37,600. In Lobo's
December 31, 2001, balance sheet, total assets should be reported at
a. $239,200.
b. $240,000.
c. $246,800.
d. $276,800.
a 25. Mejarus Co.'s adjusted trial balance at December 31, 2001, includes the
LO1 following account balances:
Patriot paid dividends of $39,000 during the year. There were no changes
in Retained Earnings for 2001 except dividends and net income. What was
Patriot’s net income for 2001?
a. $12,000
b. $27,000
c. $39,000
d. $51,000
a 27. Blues Corporation’s trial balance included the following account balances
LO1 at December 31, 2001:
Accounts Payable............................................ $ 45,000
Bonds Payable, due 2002............................... 75,000
Discount on Bonds Payable, due 2002........... 9,000
Dividends Payable January 31, 2002.............. 24,000
Notes Payable, due January 31, 2005............ 60,000
d 28. Hogi-Yogi Co. has total debt of $252,000 and stockholders' equity of
LO3 $420,000. Hogi-Yogi is seeking capital to fund an expansion. Hogi-Yogi is
planning to issue an additional $180,000 in common stock, and is
negotiating with a bank to borrow additional funds. The bank requires a
maximum debt ratio of .75. What is the maximum additional amount Hogi-
Yogi will be able to borrow after the common stock is issued?
a. $639,000
b. $852,000
c. $1,236,000
d. $1,548,000
b 29. The following data were taken from the financial statements of Jensen
LO3 Corporation for the year ended December 31, 2001:
Net sales.......................................................... $ 120,000
Net income....................................................... 30,000
Total assets, January 1, 2001......................... 400,000
Total assets, December 31, 2001................... 600,000
Test Bank, Intermediate Accounting, 14th ed. 71
b 30. Barney Co.'s current ratio is 2:1. Which of the following transactions would
LO3 normally increase Barney’s current ratio?
a. Purchasing inventory on account
b. Borrowing money by signing a long-term note
c. Collecting an account receivable
d. Purchasing land for cash
b 31. The accounts and balances shown below were gathered from Paynter
LO1 Corporation’s trial balance on December 31, 2001. All adjusting entries
have been made
Wages Payable……………………………………………….. $ 25,600
.................................................................Cash
……………………………………………………………. 17,700
...........................................Mortgage Payable
…………………………………………….151,600
Dividends Payable……………………………………………. 14,000
Prepaid Rent....................................................................... 13,600
Inventory............................................................................. 81,800
Sinking Fund Assets........................................................... 52,400
Short-Term Investments..................................................... 15,200
Premium on Bonds Payable............................................... 4,600
Stock Investment in Subsidiary.......................................... 102,400
Taxes Payable.................................................................... 22,800
Accounts Payable............................................................... 24,800
Accounts Receivable.......................................................... 36,600
On Neptune's December 31, 2001, balance sheet, the current assets total
should be
a. $189,000.
b. $201,000.
c. $219,000.
d. $243,000.
a 33. The accounts and balances shown below were gathered from Paynter
LO1 Corporation’s trial balance on December 31, 2001. All adjusting entries
have been made.
Wages Payable................................................................... $ 25,600
Cash.................................................................................... 17,700
Mortgage Payable............................................................... 151,600
Dividends Payable.............................................................. 14,000
Prepaid Rent....................................................................... 13,600
Inventory............................................................................. 81,800
Sinking Fund Assets........................................................... 52,400
Short-Term Investments..................................................... 15,200
Premium on Bonds Payable............................................... 4,600
Stock Investment in Subsidiary.......................................... 102,400
Taxes Payable.................................................................... 22,800
Accounts Payable............................................................... 24,800
Accounts Receivable.......................................................... 36,600
d 35. Baggins Company prepared a draft of its 2001 balance sheet. The draft
LO1 statement reported total assets of $437,500. Included in this total assets
figure were the following items:
Treasury stock of Baggins Company at cost, which
approximates market value on December 31................ $12,000
Unamortized patents.......................................................... 5,600
Cash surrender value of life insurance on corporate
executives....................................................................... 6,850
Unrealized holding losses on available-for-sale
securities......................................................................... 4,200
c 37. Troy Co. began operations on January 1, 2001, with $100,000 from the
LO1 issuance of stock and borrowed funds of $15,000. Net income for 2001
was $5,000 and Troy paid a $400 cash dividend on December 15. No
additional activities affected owners' equity in 1999. At December 31, 2001,
Troy's liabilities had increased to $18,800. In Troy's December 31, 2001,
balance sheet, total assets should be reported at
a. $119,600.
b. $120,000.
c. $123,400.
d. $138,400.
b 38. Eagle Co. prepared a draft of its 2001 balance sheet. The draft statement
LO1 reported current liabilities totaling $200,000. However, none of the follow-
ing items were included in this preliminary total at December 31, 2001:
Accounts payable............................................................... $30,000
Bonds payable, due 2002................................................... 50,000
Discount on bonds payable, due 2002............................... 6,000
Dividends payable on January 31, 2002............................ 16,000
Notes payable, due 2003.................................................... 40,000
At which amount should Eagle's current liabilities be correctly reported in
the December 31, 2001, balance sheet?
a. $230,000
b. $290,000
c. $296,000
d. $302,000
b 39. The December 31, 2001, balance sheet of Madden Inc., reported total
LO1 assets of $1,050,000 and total liabilities of $680,000. The following
information relates to the year 2002:
• Madden Inc. issued an additional 5,000 shares of common stock at $25
per share on July 1, 2002.
• Madden Inc. paid dividends totaling $80,000.
• Net income for 2002 was $110,000.
• No other changes occurred in stockholders’ equity during 2002.
The stockholders’ equity section of the December 31, 2002, balance sheet
would report a balance of
a. $400,000.
b. $525,000.
c. $685,000.
d. $835,000.
a 41. Seahawk Company's adjusted trial balance at December 31, 2001, includes
LO1 the following account balances:
Common Stock, $3 par............................................... $ 300,000
Additional Paid-In Capital........................................... 400,000
Treasury Stock, at cost............................................... 25,000
Net Unrealized Holding Loss on Available-For-Sale
Securities............................................................... 10,000
Retained Earnings--Appropriated for Uninsured
Earthquake Losses............................................... 75,000
Retained Earnings--Unappropriated.......................... 100,000
a 45. What is the effect of the collection of accounts receivable on the current
LO3 ratio and net working capital, respectively?
c 47. Which item describes whether the following accounts would be included in
LO3 the calculation of the acid-test (quick) ratio?
PROBLEMS
Problem 1
Below are selected accounts and their balances for the Stonefly Company as of
December 31, 2001:
Accounts Payable.................................................................. $ 98,000
Accounts Receivable............................................................. 216,000
Allowance for Doubtful Notes and Accounts......................... 25,000
Cash...................................................................................... 22,400
Wages Payable..................................................................... 10,800
Trademarks........................................................................... 45,000
Long-Term Advances to Officers.......................................... 150,000
Inventory................................................................................ 83,000
Income Taxes Payable.......................................................... 72,000
Notes Receivable (short-term).............................................. 97,000
Bond Redemption Fund........................................................ 180,000
Bonds Payable...................................................................... 500,000
Premium on Bonds Payable.................................................. 40,000
Treasury Stock...................................................................... 57,600
Current assets:
Cash ............................................ $ 22,400
Notes receivable........................... $ 97,000
Accounts receivable..................... 216,000
$313,000
Less allowance for doubtful notes
and accounts........................... 25,000 288,000
Inventory....................................... 83,000 $ 393,400
Current liabilities:
Accounts payable......................... $ 98,000
Wages payable............................. 10,800
Income taxes payable.................. 72,000 180,800
Working capital................................ $ 212,600
Problem 2
Account balances and supplemental information for the Bighorn Corporation as of
December 31, 2001, are given below:
Accounts Payable.......................................................................... $ 75,900
Accounts Receivable........................................................................ 141,600
Accumulated Depreciation--Equipment........................................... 84,000
Bonds Payable................................................................................. 300,000
Cash................................................................................................. 243,900
Common Stock.................................................................................1,560,000
Deferred Income Tax Liability (noncurrent)..................................... 6,900
Dividends Payable............................................................................ 45,000
Equipment........................................................................................ 840,000
Income Taxes Payable..................................................................... 91,500
Inventory........................................................................................... 395,100
Investment in Land........................................................................... 510,000
Investment in Stock of Subsidiary.................................................... 492,000
Note Payable.................................................................................... 120,000
Notes Receivable............................................................................. 150,000
Prepaid Insurance............................................................................ 7,200
Retained Earnings............................................................................ 453,600
Salaries and Wages Payable........................................................... 42,900
(a) $300,000 of 12% bonds were sold on November 1, 2001, at par.
(b) 40,000 shares of $30 par value common stock were sold for $1,560,000.
(c) All the equipment was purchased on January 2, 2000. The depreciation
rate is 10 percent per year.
(d) 5 percent of accounts receivable are expected to be uncollectible.
(e) A two-year insurance policy was purchased on May 1, 2001, for $7,200.
(f) Accrued interest on $150,000 of short-term notes receivable from
customers was $5,100 at December 31, 2001.
(g) $120,000 was borrowed from the bank on a 5-year, 10% note payable
dated December 31, 2001. The loan is to be repaid in 10 semiannual
payments of $12,000 plus interest, with the first payment due June 30,
2002.
Prepare a properly classified balance sheet in report form for Bighorn Corporation
as of December 31, 2001.
Solution 2
LO1
Bighorn Corporation
Balance Sheet
December 31, 2001
Assets
Current assets:
Cash......................................................................... $ 243,900
Notes receivable...................................................... 150,000
Accounts receivable, less allowance for doubtful
accounts of $7,080............................................. 134,520
Interest receivable................................................... 5,100
Inventory.................................................................. 395,100
Prepaid insurance.................................................... 4,800 $ 933,420
Investments:
Investment in land.................................................... $ 510,000
Investment in stock of subsidiary............................. 492,000 1,002,000
Equipment.................................................................... $ 840,000
Less accumulated depreciation--equipment............... 168,000 672,000
Total assets.................................................................. $ 2,607,420
Liabilities
Current liabilities:
Accounts payable..................................................... $ 75,900
Dividends payable.................................................... 45,000
Income taxes payable.............................................. 91,500
Salaries and wages payable.................................... 42,900
Interest payable....................................................... 6,000
Current portion of long-term note payable.............. 24,000 $ 285,300
Noncurrent liabilities:
Long-term debt:
Note payable...................................................... $ 96,000
Bonds payable.................................................... 300,000
Deferred income tax liability.................................... 6,900 402,900
Total liabilities............................................................... $ 688,200
Owners’ Equity
Contributed capital:
Common stock, $30 par.......................................... $ 1,200,000
Additional paid-in capital.......................................... 360,000
Retained earnings ($453,600 - $7,080 + $5,100 - $2,400 -
$84,000 - $6,000 = $359,220)........................................... 359,220 1,919,220
Total liabilities and owners’ equity............................... $ 2,607,420
Problem 3
McMaster, Inc., a nonpublic enterprise, is negotiating a loan for expansion
purposes and the bank requires audited financial statements. Before closing the
accounting records for the year ended December 31, 2001, McMaster’s controller
prepared the following comparative financial statements for 2001 and 2000:
McMaster, Inc.
Balance Sheets
December 31, 2001 and 2000
2001 2000
Cash.......................................................................... $ 550,000 $ 300,000
Investment securities (reported at market; cost, $142,000). 156,000 0
Accounts receivable.................................................. 974,000 784,000
Allowance for doubtful accounts............................... (100,000) (64,000)
Inventories................................................................. 850,000 770,000
Property and equipment............................................ 620,000 434,000
Accumulated depreciation......................................... (300,000) (242,000)
Total assets........................................................... $2,750,000 $1,982,000
Accounts payable...................................................... $ 180,000 $ 154,000
Accrued expenses..................................................... 160,000 40,000
Note payable, 5-year................................................. 600,000 600,000
Estimated contingent liability..................................... 200,000 0
Common stock, $10 par............................................ 420,000 420,000
Additional paid-in capital........................................... 260,000 260,000
Retained earnings..................................................... 930,000 508,000
Total liabilities & owners’ equity............................ $ 2,750,000 $1,982,000
McMaster, Inc.
Income Statements
For the Years Ended December 31, 2001 and 2001
2001 2000
Net sales................................................................... $ 3,160,000 $ 2,500,000
Operating expenses:
Cost of sales.......................................................... $ 1,510,000 $ 1,380,000
Selling & administrative......................................... 984,000 730,000
Depreciation.......................................................... 58,000 36,000
Estimated loss from lawsuit.................................. 200,000 0
$ 2,752,000 $ 2,146,000
Operating income...................................................... $ 408,000 $ 354,000
Unrealized gain on investment securities................. 14,000 0
Net income................................................................ $ 422,000 $ 354,000
(c) On January 2, 2001, the cost of equipment purchased for $80,000 was
mistakenly charged to repairs and maintenance. McMaster depreciates this
type of equipment over a 5-year life using the straight-line method, with no
residual or salvage value.
(e) On January 24, 2002, before the 2001 financial statements were issued,
McMaster was notified that one of its largest customers had filed for
bankruptcy as the result of a flood that destroyed a substantial portion of
the company’s assets on January 16, 2002. The customer’s accounts
receivable balance at December 31, 2001, was $144,000.
(f) $100,000 of 5-year notes payable will mature September 30, 2002. In view
of McMaster’s plans for expansion, management is seriously considering
refinancing the notes when they become due.
(2) Identify the events and other information that should be disclosed in the notes
to McMaster’s financial statements. (Do not prepare the notes.)
Solution 3
LO1
Assets
Current assets:
Cash.............................................................. $ 550,000
Investment securities (reported at market;
cost, $142,000)................................................ 156,000 (a)
Accounts receivable...................................... $ 974,000
Less allowance for doubtful accounts........ 100,000 874,000
Inventories..................................................... 820,000 (b)
Total current assets...................................... $2,400,000
Property and equipment............................... $ 700,000
Less accumulated depreciation................. 316,000 384,000 (c)
Total assets....................................................... $2,784,000
Liabilities & Stockholders’ Equity
Current liabilities:
Accounts payable.......................................... $ 180,000
Accrued expenses........................................ 160,000
Notes payable (due September 30, 2002). . . 100,000
Total current liabilities....................................... $ 440,000
Long-term notes payable.............................. 500,000
Total liabilities.................................................... $ 940,000
Contributed capital:
Common stock, $10 par................................ $ 420,000
Additional paid-in capital............................... 260,000 680,000
Retained earnings [$930,000 - $30,000 (b) +
$80,000 (c) - $16,000 (c) + $200,000 (d)].................. 1,164,000
Total liabilities & stockholders’ equity............... $2,784,000
Assets
Cash.................................................................................................. $ 271,500
Investment securities......................................................................... 315,000
Accounts receivable........................................................................... 270,000
Inventories......................................................................................... 501,000
Total current assets....................................................................... $ 1,357,500
Land, buildings, and equipment........................................................ 1,452,000
Total assets........................................................................................ $ 2,809,500
Additional information:
(a) Cash is held in a checking account and a savings account with balances of
$69,450 and $202,050, respectively. The cash in the savings account will
be used to support operations in the event of a crop failure.
(d) “Land, buildings, and equipment” includes 5 tractors that were purchased
near the end of the year for $360,000 (shown net of a $300,000, 5-year
loan used to buy the tractors). The balance of the account consists of land
that was purchased for $1,200,000 and buildings that were purchased for
$255,000 (shown net of depreciation of $63,000).
(f) The company has 90,000 shares of $5 par common stock issued and
outstanding. The common stock was originally sold for $7 per share, and
the premium was included in “Retained earnings.”
(g) After reading a U.S. Meteorological Service report, the president believes
that next year will be a bad crop year due to freak hailstorms and estimates
the company will lose about $360,000. An appropriation of Retained
Earnings has been made for this amount.
Using the balance sheet and the additional information, prepare a properly
classified and corrected balance sheet.
Solution 4
LO1
Liabilities
Current liabilities:
Accounts payable..................................................... $ 237,420
Salaries payable...................................................... 150,000
Advances from customers....................................... 105,000
Total current liabilities.............................................. $ 492,420
Long-term debt:
5-year loan payable................................................. $ 300,000
10% bonds payable................................................. 525,000 825,000
Total liabilities............................................................... $ 1,317,420
Stockholders’ Equity
Contributed capital:
Common stock ($5 par, 90,000 shares issued and
outstanding)............................................................... $ 450,000
Additional paid-in capital.......................................... 180,000 $ 630,000
Retained earnings:
Appropriated for future losses................................. $ 360,000
Unappropriated [$982,080 - $4,500 (b) - $180,000(f) +
$360,000(g) = $1,157,580 (adjusted total retained earnings);
$1,157,580 - $360,000 = $797,580].................................. 797,580 1,157,580
Total stockholders’ equity............................................ $ 1,787,580
Total liabilities and stockholders’ equity...................... $ 3,105,000
Problem 5
The following totals are taken from the December 31, 2001, balance sheet of
Streamer Company:
Additional information:
(a) Cash of $38,000 has been placed in a fund for the retirement of long-term
debt. The cash and long-term debt have been offset and are not reflected
in the financial statements.
(c) Cash of $14,000 has been set aside to pay taxes due. The cash and taxes
payable have been offset and do not appear in the financial statements.
After making any necessary changes, what are the totals for Streamer’s current
assets and current liabilities?
Solution 5
LO1
Additional information:
(b) Cash in the amount of $45,000 is in a restricted fund for the purchase of
equipment. This cash has been included in Current Assets.
(c) Long-term liabilities include a bank loan of $80,000. Of this loan, $15,000
must be repaid within the coming year.
After making any necessary changes, what are the totals for Bartholomew’s long-
term assets and long-term liabilities?
Solution 6
LO1
Long-Term Assets Long-Term Liabilities
Beginning.....................................................$ 800,000 $ 270,000
(a) Offsetting building and mortgage.... 100,000 100,000
(b) Restricted fund................................ 45,000
(c) Current portion of long-term debt.... (15,000)
(d) Long-term investment..................... 27,000
Totals...............................................$ 972,000 $ 355,000
Problem 7
Berton Company reported assets totaling $870,000 as of December 31, 2001. The
following information relates to those assets:
(b) Berton purchased a patent from a small research firm for $75,000.
Subsequent research has shown that the patented technology doesn’t work
as well as originally thought and the technology actually has no economic
use. Berton reports the patent at its amortized cost of $60,000.
(d) Near the end of the year, Berton paid $30,000 for the exclusive right to
market electronic equipment to be imported from abroad. Berton reported
this as a $30,000 “Intangible Asset.”
(e) When Berton started business three years ago, it was required to deposit
$5,000 with the local electric utility. The deposit is refundable if Berton
cancels its electric service. Berton earns no interest on the deposit. The
deposit is recorded as an “Other Long-Term Asset.”
After considering the items above, what should be the total of Berton’s reported
assets?
Solution 7
LO1
Reported Assets
Beginning................................................................................ $ 870,000
(a) Employees under contract.......................................... (100,000)
(b) Obsolete patent.......................................................... (60,000)
(c) Unpurchased goodwill................................................ (120,000)
(d) No adjustment
(e) No adjustment
Total...................................................................... $ 590,000
Problem 8
Orvis Company reported liabilities totaling $1,230,000 as of December 31, 2001.
The following information relates to those liabilities:
(a) Orvis reported a $100,000 bank loan payable. However, Orvis intends to
repay this loan on January 10, 2002.
(b) Orvis has reported a $40,000 liability for the estimated cost of future
warranty repairs based on product sales for the past year.
(d) Orvis receives consulting services from a local CPA. Expected services by
the CPA for the coming year will cost $35,000. No liability has been
recorded.
(e) Orvis has reached an agreement with a major customer. Orvis expects to
provide services totaling $400,000 over the coming three years. The
customer has already paid Orvis $100,000. No liability has been recorded.
After considering these items, what should be the total of Orvis’ reported liabilities?
Solution 8
LO1
Reported Liabilities
Beginning............................................................................... $1,230,000
(a) No adjustment
(b) No adjustment
(c) No adjustment
(d) No adjustment
(e) Unearned revenue...................................................... 100,000
Total........................................................................................ $1,330,000
Problem 9
Knowledgeable users of financial statements recognize that the numbers reported
in company’s financial statements depend on the accounting policies used to
generate the numbers. Various choices of accounting policies exist, such as LIFO
vs. FIFO for inventory costing and straight-line vs. double-declining balance for
depreciation. APB Opinion No. 22 requires that a company disclose the accounting
policies used to ensure that statement users have the information they need to
make sound decisions.
What problems or problems arise from the large variety of accounting choices
available?
Solution 9
LO4
The greatest problem posed by the array of accounting choices available is the
difficulty of achieving comparability between firms (and even among firms in the
same industry). A statement user not only must be informed of the basic
differences that exist, but also must adjust balances to achieve comparability. As
might be expected, differences between financial statement items (such as
inventory) can be significant as a result of the use of different accounting policies
and procedures.
Problem 10
Certain assets currently are omitted from the balance sheet. For example, the
value of the human resources of the firm are not reported. Nevertheless, investors
and others might greatly benefit from a knowledge of the extent to which human
assets have increased or decreased during a given period. Values certainly may
be attributed to individuals or groups based on their ability to render future
economic services. A major issue is the method that should be employed in
measuring human assets.
Solution 10
LO4
Possible methods for measuring human assets would include:
1. The historical-cost method in which the costs associated with recruiting,
selecting, hiring, training, and developing an employee are capitalized and
amortized over the expected period over which the enterprise expects to benefit
from the employee’s services.
2. The replacement cost method in which estimated costs of replacing a
firm’s existing human resources are estimated and recorded. Such costs include
all of the costs of recruiting, selecting, hiring, training, and developing new
employees until they reach the competence of old employees.
Problem 11
As a member of the audit staff of Brown & Co., CPAs, you have been assigned to
the audit of a new client, Black Corporation. Upon arriving at the client’s offices,
the controller provides you with copies of the company’s annual financial
statements. You quickly observe that the balance of accounts receivable has
increased materially over the amount reported on the prior year’s balance sheet.
Your inquiry of the controller produces the following response:
“This year we have included several other items with our trade receivables. All of
these items represent receivables and include:
I have included a description of the tax item in the note to the financial statements.
Since the other two items represent internal matters, I saw no reason to disclose
them or present them as separate items on the balance sheet.”
Solution 11
LO1
Trade receivables represent amounts owed by customers for goods sold and
services rendered as part of normal business operations. The term
“accounts receivable: is assumed to connote trade receivables. Inclusion of other
forms of receivables under the caption “accounts receivable” thus may be
confusing and misleading. The nature of the items included with accounts
receivable on the Black Corporation statements suggests that they be classified
and reported as separate items on the balance sheet and in the notes to the
financial statements where necessary. This is particularly true of advances to
officers, employees, and subsidiaries since these represent transactions with
related parties which may not have been conducted at arm’s-length.
Problem 12
The balance sheet provides information concerning liquidity, financial flexibility, and
information for calculating various financial ratios. The balance sheet serves as a
major indicator of an enterprise’s ability to survive. Nevertheless, the analysis of
the balance sheet should be approached with a clear understanding of the
limitations of the statement.
What are the major limitations of the balance sheet that should be recognized in
analyzing the statement?
Solution 12
LO5
Values reported in the balance sheet may represent a mixture of values. Cash is a
current value item but plant assets are not. A summation of these numbers is thus
questionable as are the ratios using these mixed values.
Some entity resources and obligations are not reported on the balance sheet.
Many intangible assets, such as a reputation for superior products or customer
service, are not recognized on the balance sheet. As a result, the numbers on the
balance sheet frequently are not a good reflection of what a company is worth.
Dollar amounts shown on the balance sheet represent different levels of
purchasing power. Assets, liabilities, and equities shown on the balance sheet are
reflected in terms of unequal purchasing power units. Variations in purchasing
power of the amounts reported on the balance sheet make comparisons among
companies, and even within single companies, difficult.
Finally, all companies do not classify and report all like items similarly. Titles and
account classifications vary, some companies provide more detail than others, and
different companies report similar transactions in different manners. Comparisons
between companies thus are made more difficult.
CHAPTER 3 -- QUIZ A
Name _________________________
Section ________________________
T F 1. Sinking fund assets consisting of cash and securities held for the redemption
of bonds or stocks are normally classified as investments.
T F 6. The long-term rights and privileges of a physical nature acquired for use in
business operations are often reported under the heading “Intangible assets.”
T F 7. Any obligation that is due on demand or will become due on demand within
one year from the balance sheet date should be classified as current.
T F 9. Current assets are normally listed on the balance sheet in the order of their
dollar value.
T F 10. “Deferred charges“ are typically included in the noncurrent liabilities section
of a classified balance sheet.
95
CHAPTER 3 -- QUIZ B
Name _________________________
Section ________________________
T F 1. Additional paid-in capital may arise only from the issuance of stock.
T F 8. Events that take place during the “subsequent events” period may have an
impact upon the balance sheet and the other basic financial statements for
the preceding year, but these events cannot affect the amounts reported in
the statements.
T F 9. When a corporation has more than one class of stock, all classifications
should be reported as a single amount in the balance sheet.
T F 10. A negative retained earnings balance is reported in the asset section of the
balance sheet.
96
CHAPTER 3 -- QUIZ C
Name _________________________
Section ________________________
Select the term that best fits each of the following definitions and descriptions. Indicate
your answer by placing the appropriate letter in the space provided.
____ 1. A balance sheet that presents assets, liabilities, and owners’ equity sections
in a vertical arrangement.
____ 2. Information often included in the initial note to the financial statements.
____ 3. The residual interest in the assets of an entity that remains after deducting its
liabilities.
____ 4. An occurrence between the balance sheet date and the date financial
statements are issued and made available to external users.
____ 5. The claims of creditors against an entity’s resources.
____ 6. The time required for cash to be converted to inventories; inventories into
receivables; and receivables into cash.
____ 7. Assets that have been accumulated in order to repay a loan.
____ 8. Current assets less current liabilities.
____ 9. Equity in a corporation arising from the stockholders’ investments.
____ 10. A provision in a debt instrument that identifies specific conditions that will
cause the debt to be callable immediately.
____ 11. Stock issued by a corporation but subsequently reacquired by the corporation
and held for possible future reissuance or retirement.
____ 12. The portion of the contribution by stockholders assignable to the shares of
stock as par or stated value.
____ 13. Probable future economic benefits obtained or controlled by a particular
entity as a result of past transactions or events.
____ 14. The ability of an entity to meet its short-term obligations.
____ 15. An excess of dividend payments and losses over retained earnings resulting
in a negative retained earnings balance.
97
CHAPTER 3 -- QUIZ D
Name _________________________
Section ________________________
A. Current assets
B. Noncurrent assets
C. Current liabilities
D. Noncurrent liabilities
E. Contributed capital
F. Not on balance sheet
Identify which category each of the following items would be placed in when
constructing a classified balance sheet. Indicate your answer by placing the
appropriate letter in the space provided.
1. T 1. F 1. E 1. A
2. T 2. F 2. A 2. B
3. F 3. T 3. M 3. C
4. T 4. F 4. J 4. D
5. F 5. F 5. N 5. A
6. F 6. F 6. D 6. D
7. T 7. T 7. C 7. F
8. F 8. F 8. G 8. D
9. F 9. F 9. H 9. C
10. F 10. F 10. K 10. E
11. L 11. A
12. Q 12. C
13. I 13. A
14. B 14. A
15. F 15. D
16. B
17. E
18. B
19. C
20. B
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