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Cornerstones Of Financial Accounting, First Canadian Edition Solution Manual

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

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    Chapter 1: Accounting and the Financial Statements 5. The three main types of business activities are financing activities, investing activities, and operating activities. Financing activities involve obtaining the funds necessary to begin and operate a business. These funds come from either issuing shares or borrowing money. Investing activities involve buying and selling assets that enable a corporation to operate. Operating activities are the normal business activities that a company engages in as it conducts its business. These activities involve selling products or services, purchasing inventory, collecting amounts due from customers, and paying suppliers. 6. A ssets are the economic resources or future economic benefits obtained or controlled by a business. Liabilities are the creditors’ claims on the resources of a business. Shareholders’ equity is the ownership claims on the resources of a business. Shareholders’ equity is considered a residual interest in the assets of a business that remain after deducting the business’s liabilities. All three items appear on the statement of financial position, forming the following equation: Assets = Liabilities + Shareholders’ Equity 7. Revenues are the increases in assets (resources) that result from the sale of products or services. Expenses are the costs of assets (resources) used, or the liabilities created, in the operation of the business. If revenues are greater than expenses, a corporation has earned net income. If expenses are greater than revenues, a corporation has incurred a net loss. 8. The four primary financial statements are: (1) The statement of financial position: a presentation of information about a company’s economic resources (its assets) and the claims against those resources by creditors and owners (liabilities and shareholders’ equity) at a specific point in time. (2) The income statement: a report on how well a company has performed its operations— the profitability of a company—over a period of time. (3) The statement of retained earnings: a report on how much of the company’s income was retained in the business and how much was distributed to owners over a period of time. (4) The statement of cash flows: a report on the changes in a company’s cash during a period of time. The statement of cash flows provides information about the company’s cash inflows (sources) and outflows (uses) from operating, investing, and financing activities. 9. There are many questions that can be answered based on each of the financial statements: (1) The statement of financial position: a. What is the total amount of assets (economic resources) of a corporation? What is the total amount of liabilities (claims against the resources) for a corporation? b. How much equity do the owners of the corporation have in its assets? c. Is the corporation able to pay its debts as they become due? (2) The income statement: a. How much revenue was earned last month? Last quarter? Last year? b. What was the total amount of expenses incurred to earn that revenue? c. How much better off is the corporation at the end of the year than it was at the beginning of the year? d. Was the corporation profitable, and what are the prospects for the corporation’s future profitability? e. What are the prospects for the future growth of the corporation? 1-2

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

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    Chapter 1: Accounting and the Financial Statements 17. The single-step income statement format takes into account only two categories: total revenues and total expenses. Total expenses are subtracted from total revenues in a single step to arrive at net income. The multiple-step income statement format contains three important subtotals: gross margin (gross profit), income from operations, and net income. Gross margin is the difference between net sales and cost of sales (or cost of goods sold). Income from operations is the difference between gross margin and operating expenses. Net income is the difference between income from operations and any nonoperating revenues and expenses. 18. A statement of retained earnings summarizes and explains the changes in retained earnings during an accounting period. Retained earnings is the income earned by the company but not paid to the owners in the form of dividends. The statement of retained earnings starts with the balance in retained earnings at the beginning of the period. To this balance, add net income (or subtract the net loss) obtained from the income statement. Next, subtract any dividends the company declared during the period. The total is the retained earnings at the end of the period that is reported on the statement of financial position. 19. The statement of cash flows classifies cash flows into three categories: (1) cash flows from operating activities, (2) cash flows from investing activities, and (3) cash flows from financing activities. Cash flows from operating activities are the cash flows related to the normal operations of the business in earning income, and include cash sales and collections of accounts receivable less cash paid for goods, services, wages, salaries, and interest. Cash flows from investing activities are cash flows related to the acquisition or sale of investments and long-term assets, including cash received from the sales of property, plant, and equipment; investments; and other long-lived assets less the cash spent to purchase long-term assets. The cash flows from investing activities by a healthy, growing business will usually represent an excess of expenditures over receipts. Cash flows from financing activities are the cash flows related to obtaining the capital of the company, including the cash contributed by owners and borrowed from creditors less amounts paid as dividends and repayments of liabilities. A business can finance its growth either internally with cash generated by operations or externally with cash from owners and creditors. 20. The statement of retained earnings describes the changes in retained earnings, a statement of finan account, that occurs between two statement of financial position dates. One of the major sources of retained earnings is the net income (or net loss) for the year, which is determined on the income statement. The other major source of change in retained earnings is dividends, which are not considered a part of income. 21. Other than the financial statements, users will find notes to the financial statements, management’s discussion and analysis of the condition of the company, and the auditor’s report in the annual report of a company. The notes to the financial statements are an integral part of the financial statements that clarify and expand upon the information in the financial statements. Management’s discussion and analysis provides a discussion and explanation of various items reported in the financial statements. Additionally, management uses this opportunity to highlight favourable and unfavourable trends and significant risks facing the company. The auditor’s report expresses the opinion of the auditor as to whether the financial statements fairly present the financial position and results of operations of the company. 1-4

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    Chapter 1: Accounting and the Financial Statements 22. Examples of unethical behaviour will differ from one student to another. One example is an accountant who gives in to personal pressure to prepare financial statements that overstate the income of the company by bending or violating generally accepted accounting principles. Overstated income may lead decision-makers to make the wrong choices. Decision-makers both inside and outside the business must be able to rely on the financial information they receive to make proper decisions. Therefore, ethical behaviour by accountants is necessary. Acting ethically is not always easy. However, because of the important role of accounting in society, accountants are expected to maintain the highest level of ethical behaviour. 1-5

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    Chapter 1: Accounting and the Financial Statements 1-1. a 1-2. b 1-3. a ($10,500 – $5,800) 1-4. b 1-5. d 1-6. d 1-7. b ($8,200 + $3,700 + $3,900) 1-8. c ($5,900 + $12,200) 1-9. a 1-10. b ($165,500 – $92,100 – $43,850 – $15,000) 1-11. c 1-12. c 1-13. b MULTIPLE-CHOICE EXERCISES 1-6

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

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    Chapter 1: Accounting and the Financial Statements CE 1-16 a. statement of financial position (SFP) b. Statement of cash flows (CF) c. statement of financial position (SFP) d. Income statement (I) e. Statement of cash flows (CF) f. Income statement (I) g. statement of financial position (SFP) h. statement of retained earnings (RE) CE 1-17 1. d 2. b 3. a 4. f 5. e 6. a 7. c 8. g ( Note: While net income and dividends are reported on other financial statements, the definition of retained earnings is income that has not been distributed to shareholders. Therefore, by definition, this item is part of a company’s retained earnings.) 9. b 10. a 1-8

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    Chapter 1: Accounting and the Financial Statements CE 1-18 Cash…………………………………………………………………………… $3,200 Accounts receivable………………………………………………………… 4,500 Supplies……………………………………………………………………… 8,100 Total assets…………………………………………………………… $15,800 Liabilities: Notes payable………………………………………………………… $5,000 Total liabilities……………………………………………………… $5,000 Shareholders’ equity: Common share………………………………………………………… $7,000 Retained earnings……………………………………………………… 3,800 Total shareholders’ equity ……………………………………… 10,800 Total liabilities and shareholders’ equity……………………………… $15,800 CE 1-19 Net Income = Total Revenue – Total Expenses Net Income = $78,000 – ($33,200 + $20,500) Net Income = $24,300 Note: The dividends do not appear on the income statement in arriving at net income. Dividends do not affect the income statement. Dividends are a reduction of the balance in retained earnings. CE 1-20 Beginning retained earnings ……………………………………………………………… $25,000 + Net i($74,000 – $57,000) ……………………………………………………………… 17,000 – Dividends ……………………………………………………………………………… (8,000) = Ending retained earnings………………………………………………………………$34,000 Liabilities and Shareholders’ Equity Assets Cavernous Homes Ltd. Statement of Financial Position 31-Dec-14 1-9

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    Chapter 1: Accounting and the Financial Statements E 1-21 1. Bank (B) 2. Government (G) 3. Business managers (M) 4. Investor (I) 5. Labor union (U) E 1-22 1. Sole proprietorship: 1, 2, 4, 5 Partnership: 2, 3, 4, 5, 7 Corporation: 2, 3, 4, 5, 6, 8 2. There are many advantages and disadvantages to each particular type of business entity as listed below. a. Sole Proprietorship • Advantages: (i) The business is easily formed (ii) Control over the operations of the business is maintained by owner (iii) Sole proprietorships may pay less tax relative to corporations • Disadvantages: (i) The owner is personally liable for the debts of the business (ii) The life of the business is limited to the owner’s life b. Partnership: • Advantages: (i) Increased access to the financial resources and individual skills of each of the partners (ii) Partnerships may pay less tax relative to corporations • Disadvantages: (i) Control over the operations of the business is shared among the partners (ii) The partners are personally liable for the debts of the business (iii) The life of the business is limited to life of the partners c. Corporation: • Advantages: (i) Can more easily raise large amounts of money (ii) Ownership of the business can be easily transferred by selling shares (iii) The owners’ liability is limited to the amount invested in the business • Disadvantages: (i) The formation and organization of the business is more complex (ii) Corporations generally pay higher taxes EXERCISES 1-10

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    Chapter 1: Accounting and the Financial Statements E 1-23 a. Investing (I) b. Financing (F) c. Operating (O) d. Investing (I) e. Operating (O) f. Financing (F) g. Financing (F) E 1-24 a. Financing (F) b. Investing (I) c. Investing (I) d. Operating (O) e. Operating (O) f. Financing (F) g. Operating (O) h. Operating (O) i. Investing (I) j. Financing (F) E 1-25 1. c 2. e 3. b 4. g 5. d 6. f 7. a E 1-26 = Liabilities + Equity 1. $ 61,800 $ 51,000 2. 162,500 112,500 3. 15,000 43,200 * $112,800 – $51,000 ** $275,000 – $162,500 *** $15,000 + $43,200 58,200 Assets $112,800 275,000 *** * ** 1-11

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    Chapter 1: Accounting and the Financial Statements E 1-27 1. Current assets: Cash Accounts receivable Inventory Prepaid insurance Total current assets Property, plant, and equipment: Building Equipment Less: Accumulated depreciation Intangible assets: Trademarks Total assets Liabilities: Current liabilities: Accounts payable Income taxes payable Wages payable Total current liabilities Long-term liabilities: Notes payable Bonds payable Total long-term liabilities Total liabilities Shareholders’ equity: Common share Retained earnings Total shareholders’ equity Total liabilities and shareholders’ equity 2. To assess liquidity, it would be helpful to have information on Huang Company’s current assets (cash, accounts receivable, inventory, and prepaid insurance) and current liabilities (accounts payable, income taxes payable, and wages payable). With this information, a user could compute a company’s working capital (current assets less current liabilities) and current ratio (current assets ÷ current liabilities). These two measures are helpful in assessing a company’s ability to pay its debts as they become due. Assets Liabilities and Shareholders’ Equity Huang Company Statement of Financial Position Specific Point in Time 1-12

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    Chapter 1: Accounting and the Financial Statements E 1-28 1. Since the operating cycle is six months, Dunn would use one year as the breakpoint between current and noncurrent items. a. There are 17 months of prepaid rent ($8,500 ÷ $500). Dunn should include $6,000 (12 months × $500 per month) as a current asset and $2,500 (the (remaining 5 months × $500 per month) as a long-term asset. b. The $9,700 is a current liability. c. Since all items are expected to be sold within 12 months, the entire $46,230 is a current asset. d. The $700 portion of marketable securities is a current asset. The remaining $1,200 is a long-term investment. e. The $1,050 of cash is a current asset. f. The $60,000 note due in March 2019 is a long-term liability. The $3,750 interest related to 2014 is a current liability. The remaining interest of $750 will not be recognized until 2015 and, therefore, is not on the 2014 statement of financial position. g. The entire $2,850 is a current asset. h. The store equipment and its accumulated depreciation are not current assets. Instead, they are classified as property, plant, and equipment. Current assets: Cash………………………………………………………………… $ 1,050 Short-term investment in marketable securities…………… 700 Accounts receivable……………………………………………… 2,850 Inventory…………………………………………………………… 46,230 Prepaid rent……………………………………………………… 6,000 Total current assets………………………………………… $56,830 Current liabilities: Accounts payable…………………………………………………$ 9,700 Interest payable on equipment loan (see f above)………… 3,750 Total current liabilities……………………………………… $13,450 Dunn Sporting Goods Partial Statement of Financial Position December 31, 2014 1-13

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    Chapter 1: Accounting and the Financial Statements E 1-28 (Contd) 2. Working Capital = Current Assets – Current Liabilities = $56,830 – $13,450 = $43,380 Current Ratio = Current Assets ÷ Current Liabilities = $56,830 ÷ $13,450 = 4.23 3. These ratios give users insights into a company’s liquidity—that is a company’s ability to pay obligations as they become due. These ratios show that Dunn Sporting Goods has adequate current assets to cover all of the current liabilities that will become due in the near future. Comparing these ratios to other companies in the same industry and examining the trend in these measures over time will yield additional insights. E 1-29 1. Current assets: Cash…………………………………………………………………………………… $ 475 Accounts receivable………………………………………………………………… 8,000 Notes receivable……………………………………………………………………… 1,200 Supplies……………………………………………………………………………… 8,800 Total current assets……………………………………………………………… $18,475 Current liabilities: Accounts payable…………………………………………………………………… $ 1,800 Notes payable ………………………………………………………………………… 7,600 Total current liabilities……………………………………………………………$ 9,400 The accounts receivable of $4,000 due in 18 months will be classified as a long- term asset. The construction equipment and related accumulated depreciation are classified as property, plant, and equipment (a noncurrent asset). 2. Hanson Construction’s liquidity may be evaluated by examining its current ratio and working capital. Its current ratio is 1.97 ($18,475 ÷ $9,400) and its working capital is $9,075 ($18,475 – $9,400). Because current assets well exceed the current liabilities, Hanson appears to be able to pay its debts that become due within the next year. Hanson Construction Partial Statement of Financial Position December 31, 2014 1-14

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    Chapter 1: Accounting and the Financial Statements E 1-30 The statement of financial position at December 31, 2014, will show equipment at its historical cost of $425,000 reduced by accumulated depreciation (a contra-asset) of $40,000. Therefore, the net book value (or carrying value) of the equipment is $385,000. ( Note: The concepts of book value and carrying value will be covered in more detail in later chapters.) The equipment and accumulated depreciation will be reported under the caption “Property, plant, and equipment” in the asset section of the statement of financial position. The 2014 income statement will show depreciation expense of $40,000. In a multiple-step income statement, depreciation expense will be reported as an operating expense. E 1-31 Shareholders’ equity: Common share……………………………………………………$135,600 Retained earnings……………………………………………… 25,300 Total shareholders’ equity………………………………… $160,900 Note: Transactions among shareholders do not change shareholders’ equity balances. E 1-32 1. Current assets: Cash……………………………………………………………… $ 13,300 Accounts receivable………………………………………..…… 6,700 Inventory .………………………………………………………… 481,400 Prepaid rent ……….……………………………………..……… 54,000 Total current assets………………………………………… $555,400 Long-term investments: Investment ……………………...…………………………...…… 110,900 Property, plant, and equipment: Furniture ……………. ………………………………………… 88,000 Less: Accumulated depreciation…………………………… (23,700) 64,300 Total assets ……………………………………………..…………… $730,600 Assets College Spirit Statement of Financial Position 31-Dec-14 Mulcahy Manufacturing Inc. Partial Satement of Financial Position December 31, 2014 1-15

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