Chapter 3 Balance Sheet

QUESTIONS 3-1. Assets - Resources of the firm Liabilities Debts or obligations of the firm; creditors' interest Owners' Equity - Owners' interest in the firm 3-2. a b . . c . a. L L A TA d e . .f . c. A A A IA g h . .i . L A A e. IA f. CA j k . .l . E E A m n . . o . g. TA h. CA L L A p q . . r . i. TA j. CA A A A s. A k. IV l. TA

3-3. 3-4. 3-5.

b. CA

d. CA

They are listed in order of liquidity, which is the ease with which they can be converted to cash. Marketable securities are held as temporary investments or idle cash. They are short-term, low risk, highly liquid, low yield. Examples are treasury bills and commercial paper. Investments are long-term, held for control or future use in operations. They are usually less liquid and expected to earn a higher return. Accounts receivable represents the money that the firm expects to collect; accounts payable represents the debts for goods purchased by a firm. A retailing firm will have only finished goods and supplies. A manufacturing firm will have raw materials, work in process, finished goods, and supplies. Depreciation represents the allocation of an assets cost over the period it is utilized. Tools, machinery, and buildings are depreciated because they wear out. Land is not depreciated, since its value typically does not decline. If the land has minerals or natural resources, it may be subject to depletion. Straight-line depreciation is better for reporting, since it results in higher profits than does accelerated depreciation. Double-declining balance is preferable for tax purposes, since it allows the highest depreciation and,

3- 6. 3-7. 3-8.

3-9.

thereby, lower taxes in the early years of the life of the asset. Using doubledeclining-balance for taxes increases the firm's cash flow in the short run.

3-10.

The rent is treated as a liability because it is unearned. The rental agency owes the tenant the use of the property until the end of the term of the agreement. The rent should be recognized as income over the period covered by the rent. a. A bond will sell at a discount if its stated rate of interest is less than the market rate. It sells to yield the market rate. It might also sell low if there were a great deal of risk involved. The discount is shown as a reduction of the liability. $ 1000 (170) $ 830 The bond discount is amortized, with the amortization shown as an increase to interest expense on the income statement.

3-11.

b.

Bonds payable Less: bond discount

3-12. 3-13. 3-14.

Include noncontrolling interest as a long-term liability for primary analysis. Historical cost causes difficulties in analysis because cost does not measure the current worth or value of the asset. At the option of the bondholder (creditor), the bond is exchanged for a specified number of common shares (and the bondholder becomes a common stockholder). Often convertible bonds are issued when the common stock price is low, in the opinion of management, and the firm eventually wants to increase its common equity. By issuing a convertible bond, the firm may get more for the specified number of common shares. When the common stock price increases sufficiently, the bondholder will convert the bond to common stock. a . b . c . d . e . CA CA CL CL E f . g . h . i . j . CA E NA CA E k l. .m . n . o . CL NL CL CA E p . q . r . s . N A C A C L C A

3-15.

3-16.

a .

With the cumulative feature, if a corporation fails to declare the dividend on the cumulative preferred stock, the amount of passed usual dividends becomes dividends in arrears. Common stockholders cannot be paid any dividends until the preferred dividends in arrears and the current preferred dividends are paid.

b.

When preferred stock is participating, preferred stockholders may receive an extra dividend beyond the stated rate. The terms of the participation depend on the terms included with the stock certificates. Convertible preferred stock contains a provision that allows the preferred stockholders, at their option, to convert the share of preferred stock at a specific exchange ratio into another security of the corporation. Callable preferred stock may be retired (recalled) by the corporation at its option. Should the corporation liquidate, the preferred stockholders normally have preference to have their claims settled prior to any payment to common stockholders.

c.

d. e.

3-17.

The account unrealized exchange gains or losses is an owners' equity account that is used to record gains or losses from translating foreign currency financial statements incorporated into the financial statements of an enterprise by consolidation, combination, or the equity method of accounting. Treasury stock represents the stock of the company that has been sold, repurchased, and not retired. It is subtracted from stockholders' equity so that net stockholders' equity is for shares outstanding only. The $60, or any portion, will occur as cost of sales if the goods are sold and as inventory if they are not sold. These subsidiaries are presented as an investment on the parent's balance sheet. Noncontrolling interest is presented on a balance sheet when an entity in which the parent company has less than 100% ownership is consolidated. If DeLand Company owns 100% of Little Florida, Inc., it will not have a noncontrolling interest, since noncontrolling interest reflects ownership of noncontrolling shareholders in the equity of consolidated subsidiaries that are not wholly owned. If it only owns 60%, then there would be a noncontrolling interest. Little Florida would not be consolidated when control is temporary or does not rest with the majority owner. The account unrealized decline in market value of noncurrent equity investments is an owners' equity account that is used to record unrealized losses on long-term equity investments.

3-18.

3-19. 3-20. 3-21. 3-22.

3-23.

3-24.

Redeemable preferred stock is subject to mandatory redemption requirements or has a redemption feature that is outside the control of the issuer. Coupled with the typical characteristics of no vote and fixed return, this security is more like debt than equity for the issuing firm. Fair value is the price that a company would receive to sell an asset (or transfer a liability) in an orderly transaction between market participants on the date of measurement. This represents the most objective active market. Level 3 valuation can be very subjective. A quasi-reorganization is an accounting procedure equivalent to an accounting fresh start. A quasi-reorganization involves the reclassification of a deficit in retained earnings to paid-in capital. It changes the carrying values of assets and liabilities to reflect current values. An ESOP is a qualified stock-bonus, or combination stock-bonus and money-purchase pension plan, designed to invest primarily in the employer's securities. These institutions are willing to grant a reduced rate of interest because they are permitted an exclusion from income for 50% of the interest received on loans used to finance an ESOP's acquisition of company stock. Some firms do not find an ESOP attractive because it can result in a significant amount of voting stock in the hands of employees. This will likely dilute the control of management. This firm records the commitment as a liability and as a deferred compensation deduction within stockholders' equity. Depreciation is the process of allocating the cost of building and machinery over the periods of benefit. Spreading the cost of an intangible asset is called amortization, while spreading the cost of a natural resource is called depletion. The three factors usually considered when computing depreciation are asset cost, estimated length of the life of the asset, and the estimated salvage value when it is retired from service.

3-25.

3-26. 3-27. 3-28.

3-29.

3-30.

3-31.

3-32. 3-33.

3-34.

3-35.

A firm will often want to depreciate slowly for the financial statements because this results in the highest immediate income. The same firm would want to depreciate at a fast pace for income tax returns because this results in the lowest immediate income and thus lower income taxes. Over the life of an asset, the total depreciation will be the same, regardless of the depreciation method selected. Yes. Depreciation is the process of allocating the cost of buildings and machinery over the periods of benefit. Conceptually, this account balance represents retained earnings from other comprehensive income. Donated capital results from donations to the company by stockholders, creditors, or other parties. The land account under assets would be increased and the donated capital account in stockholders equity would be increased. The donated land would be recorded at the appraisal amounts.

3-36. 3-37. 3-38. 3-39. 3-40.

PROBLEMS PROBLEM 3-1 Current liabilities: Accounts payable Income taxes payable Interest payable Notes payable, due April 15, 2013 Salaries payable Total current liabilities $ 7,500 32,65 2,200 6,500 7,400 $ 56,25

PROBLEM 3-2 A) $122,000 ($3,000 Prepaid Expenses + $7,000 Cash + $17,000 Accounts Receivable + $75,000 Land + $20,000 Inventory = $122,000) $35,000 ($15,000 Accounts Payable + $15,000 Notes Payable + $5,000 Salaries Payable = $35,000) $87,000 ($122,000 Total Assets - $35,000 Total Liabilities = $87,000)

B)

C)

PROBLEM 3-3

Alleg, Inc. Balance Sheet December 31, 2010

ASSETS Current assets: Cash Marketable securities Accounts receivable Inventories Total current assets $ 13,000 17,000 26,000 30,000 86,000 Plant and equipment: Land and buildings Machinery and equipment

Less: Accumulated deprecia Total plant and equipme Intangibles: Goodwill Patents Other assets Total assets

LIABILITIES AND STOCKH

Current liabilities: Accounts payable Current maturities of long-te Total current liabilities Long-term liabilities: Mortgages payable Bonds payable Deferred income taxes Total long-term liabilities

Stockholders equity: Comm stock, no par value 21,000 shares authorized a 10,000 shares issued Additional paid-in capital Retained earnings Total stockholders equity Total liabilities and stockhol

PROBLEM 3-4

a. b. c. d. e. f. g. h. i.

Restricted cash in sinking fund should be classified as long-term investment. Investment in Subsidiary Company is long-term. Measurement basis of marketable securities should be disclosed. Preferable to show land and buildings separately, since land is not depreciable. Treasury stock should be deducted from stockholders' equity. Discount on bonds payable is a contra liability and should be classified as a deduction from bonds payable. Prepaid expenses should be classified as a current asset. For most industries, liabilities should be classified as current and long-term. Preferred and common stock should be separated, as should capital in excess of par.

PROBLEM 3-5 a. b. c. d. e. f. g. Heading date is wrong. It should read December 31, 2010. Preferable to disclose allowance for doubtful accounts on face of statement. Some firms disclose this account in a note. Treasury stock should be deducted from stockholders' equity. Land and building are disclosed net. Accumulated depreciation should be disclosed. Short-term U.S. Notes should be classified under current assets. Supplies should be classified under current assets. For most industries, liabilities should be classified as current and long-term. Short-term bonds should be under current liabilities. Long-term bonds payable should be under long-term liabilities. Redeemable preferred stock should be presented before stockholders' equity.

h.

PROBLEM 3-6

a. b. c. d. e. f. g. h.

Balance sheet should be in the heading. $10,000 cash should be classified under other assets (restricted for payment of long-term note). Disclose accumulated depreciation related to building. Patent should be classified under intangibles. Organizational costs should be disclosed under intangibles. Prepaid insurance should be under current assets. Dividends payable should be classified as a current liability. Notes payable and bonds payable due in the years 2012 and 2016 respectively, should not be classified as a current liability.

PROBLEM 3-7 a. The dividends would not be shown on the balance sheet. The dividends have reduced retained earnings. The ending balance of retained earnings is shown on the balance sheet. You would disclose a contingent liability in note format. No accounting recognition is given for possible general business risks for which losses cannot be estimated. This subsequent event requires a note. Restricted cash should be classified as a long-term asset. Securities held for control should be classified as long-term investments. Land must be listed at cost. It will have to be written back down. This would be disclosed in a note. (Also on the income statement, the loss will be disclosed as an extraordinary item.)

b. c. d. e. f. g. h.

PROBLEM 3-8

a.

Noncontrolling interest will be 20% of the total equity of $300,000, or $60,000. To be conservative classify minority interest as a liability for financial analysis. The noncontrolling interest share of earnings will be 20% of $50,000, or $10,000.

b.

PROBLEM 3-9 a. Year 1 Year 2 Preferred Cumulative from year 1 10,000 shares x $100 par value = $1,000,000 x 10% Year 2 dividend 10,000 shares x $100 par value = $1,000,000 x 10% Total Year 3 Preferred Year 3 dividend 10,000 shares x $100 par value = $1,000,000 x 10% The common gets the remaining dividends because the preferred is nonparticipating Total Common Preferred 0 Common 0

$100,000

100,000 $200,000

$100,000 $ 120,000 $ 120,000

$100,000

b. Year 1 Year 2 Preferred Arrears [See computation in (a)] Year 2 dividend [See computation in (a)] Total Year 3 Preferred Year 3 dividend [See computation in (a)] Common 80,000 shares x $5 = $400,000 x 10% = 40,000 2% to preferred (2% x $1,000,000) 2% to common (2% x $400,000) Remaining dividend to common Total

Preferred 0 $100,000 100,000 $200,000

Common 0

$100,000 $ 40,000 20,000 8,000 $120,000 52,000 $ 100,000

c. Year 1 Year 2 Preferred Arrears [See computation in (a)] Year 2 Dividend [See computation in (a)] Total Year 3 Preferred Year 3 dividend [See computation in (a)] Common 80,000 shares x $5 = $400,000 x 10% = 40,000

Preferred 0

Common 0

$100,000 100,000 $200,000

$100,000

$ 40,000

Fully participating; therefore, the remaining dividend will be split between preferred and common in proportion to their outstanding stock at total par value. Total par value of preferred $1,000,000 71.43% Total par value of common $ 400,000 28.57% Total $1,400,000 100.00% Preferred 71.43% x $80,000 = Common 28.57% x $80,000 = Total 57,144 $157,144 22,856 $ 62,856

d. Year 1 Year 2 Preferred Year 2 dividend [See computation in (a)] Common Remainder to common Total Year 3 Preferred Year 3 dividend [See computation in (a)] Common Remainder to common Total

Preferred 0

Common 0

$100,000 $ 100,000 $ 100,000

$100,000

$100,000 $100,000 $ 120,000 $ 120,000

PROBLEM 3-10 a. Year 1 Preferred 5,000 x $100 x 9% = $45,000 Year 2 Preferred Cumulative 5,000 x $100 x 9% = $45,000 Common 10,000 x $10 x 9% = 9,000 Fully participating; therefore, the remaining dividend will be split between preferred and common in proportion to their outstanding stock at total par value. Total par value of preferred $500,000 83.3% Total par value of common $ 100,000 16.7 % Total $ 600,000 100.00 % $65,000 - $5,000 - $45,000 - $9,000 = $6,000 Preferred $ 40,000 $ 5,000 45,000 $ 9,000 Common 0

5,000 $ 55,000

1,000 $ 10,000

b. Year 1 Preferred 5,000 x $100 x 9% = $45,000 Year 2 Preferred 5,000 x $100 x 9% = $45,000 Common Remaining divided to common ($65,000 - $45,000)

Preferred $ 40,000 $ 45,000

Common 0

$ 45,000

$ 20,000 $ 20,000

c. Year 1 Preferred 5,000 x $100 x 9% = $45,000 Year 2 Preferred Cumulative 5,000 x $100 x 9% = $45,000 Common $10,000 x $10 x 9% = Additional % to preferred and common: Preferred: Common: 5,000 x $100 x 1% 10,000 x $10 x 1%

Preferred $ 40,000 $ 5,000 $ 45,000

Common 0

9,000

5,00 0 $ 55,000

1,000 $ 10,000

d. Year 1 Preferred 5,000 x $100 x 9% = $45,000 Year 2 Preferred Cumulative 5,000 x $100 x 9% = $45,000 Remaining to common

Preferred $ 40,000 $ 5,000 $ 45,000 $ 50,000

Common 0

$ 15,000 $ 15,000

PROBLEM 3-11

a. Straight-line method = $100,000 - $10,000 = $9,000 10 per year b. Declining-balance method Year 1 1/10 x 2 x $100,000 = Year 2 1/10 x 2 x $ 80,000 = Year 3 1/10 x 2 x $ 64,000 = c. Sum-of-the-years-digits method Year 1 10/55 x $90,000 = Year 2 9/55 x $90,000 = Year 3 8/55 x $90,000 = $13,090.91 $16,363.63 $14,727.27 $12,800

$20,000 $16,000

PROBLEM 3-12 $60,000 - $10,000 = $2.00 per hour 25,000 hrs. Year 1 5,000 x $2.00 Year 2 6,000 x $2.00 Year 3 4,000 x $2.00 = = = $10,000 $12,000 $ 8,000

PROBLEM 3-13

a.

The straight line method will result in the lowest depreciation in the first year. With the depreciation being the lowest for straight-line, the income will be the highest using the straight-line method. The straight-line method should be used for the financial statements. The declining-balance method will result in the maximum depreciation in the first year. With the depreciation being the highest, the income will be the lowest. The declining-balance method should be used for taxes. Straight-line ($50,000 - $10,000)/5 = $8,000 Double-declining-balance method = 1/5 x 2 x $50,000 = $20,000 Sum-of-the-years-digits = 5/15 x ($50,000 - $10,000) = $13,333.33

b.

It is permissible to use different depreciation methods in financial statements than in tax returns.

a. b. c. d. e. f. g. h. i. j. k. l.

4 1 3 5 4 4 3 1 2 1 4 1

Gain from the sale of land would be on the statement of income. Cash restricted for the retirement of bonds would be under other assets. Accounts payable is usually one of the larger current liabilities. Construction in process is part of plant and equipment. Bonds payable is usually long term. Redeemable preferred stock is shown above shareholders equity. Accounts receivable is a current asset. Research and development is expensed. Assets $100,000 = Liabilities $60,000 + Stockholders Equity Inventory is a current asset. Pension liabilities are usually long-term. Unearned rent income is a current liability. Treasury stock represents a reduction of stockholders equity. Statements 1, 2, 3, and 4 are true. IFRS model balance sheet does not put an emphasis on liquidity. ? .

m. 3 n. o. 5 3