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FN-580 Financial Statement Analysis 1) Distinguish between a reversing entry and an adjusting entry. Are reversing entries required?

Reversing entries are not a mandatory step in accounting cycle; it is only optional step of bookkeeping. A reversing entry will be made for certain adjusting entries at the beginning of the next accounting period. This reversing entry will be exact opposite of the adjusting entry prepared at the time of end of the year. 2) Indicate, in the sequence in which they are made, the three required steps in the three required steps in the accounting cycle that involve journalizing. Steps: - Analyzing the business transaction - Arranging the transactions in chronological order - Preparation of the correct format of the journal - Preparing the journal entries for that transaction 3) Identify, in the sequence in which they are prepared, the three trial balances that are often used to report financial information about a company. - Preparation of normal trial balances - Preparation of adjusted trial balances - Preparation of post closing trial balances 4) How do correcting entities differ from adjusting entries? Adjusting entries essential for accounting cycle, but correcting entries are unnecessary if the records are error free. Adjusting journal entries will be made only at the end of an accounting period, but correcting entries will make whenever they discover and error. Adjusting entries will affect at least one income statement account and one balance sheet account but correcting entries may involve any combination of accounts in need of correction, and correcting entries will post before the closing entries. 5) What standard classifications are used in preparing a classified balance sheet? Assets: - Current assets - Long term investments - Property, plant, and equipment - Intangible assets Liabilities and Stockholder Equity: - Current liabilities 1 of 13

FN-580 Financial Statement Analysis Long term liabilities Stockholders equity

6) What is meant by the term operating cycle? An operating cycle indicates that average time that it takes to purchase raw materials, sell it on account to customers, and then collect cash from customers. Usually most of the business this cycle is less than one year, hence they use cutoff for one year. But big industries this cycle will take longer time for one year. 7) Define current assets. What basis is used for arranging individual items within the current assets section? Current assets are the assets which convert into cash or use up within one year or one operating cycle whichever is longer. Current assets will report in balance sheet in the order in which they expect to convert them into cash. Companies will report the following order: - Cash and cash equivalents - Short term investments - Accounts receivable - Inventories - Prepaid expenses and other current assets 8) Distinguish between long-term investments and property, plant, and equipment. Long term investment is the investment which a company invests their funds in other companys bonds or stocks. But company invests cash into purchase of their fixed tangible assets are called Property, plant, equipment. Long term investments are not useful for operating their business activities. Property, plant and equipment are useful to operate companys day to day business activities. Long term investments are reported in the section of long term investments of the balance sheet. But these tangible fixed assets (building, land, etc) are reported in property, plant and equipment section of the balance sheet. 9) (a) What is the term used to describe the owners equity section of a corporation? (b) Identify the two owners equity accounts in a corporation and indicate the purpose of each. Stockholders are actual company owners, since their equity is reported in balance sheet under stockholders equity section. Usually 2 of 13

FN-580 Financial Statement Analysis companies will show common stock, retained earnings accounts under this section, since these are the compulsory accounts of the section. Common stock accounts indicate that total paid up capital, and total outstanding shares of the company. Retained earnings account will report total funds available to stockholders collection from the income statement as net income, and also dividend will be distributed from this account only. 10) Using PepsiCos annual report, determine the current liabilities at December 26, 2009, and December 27, 2008. Were current liabilities higher or lower than current assets in these two years? Current Liabilities and Current Assets analysis for PepsiCo for 2009 and 2008: Current Liabilities for the two years: December 26, 2009 December 27, 2008 Amount $ Amount $ 8,756 8,787 Current Assets for the two years: December 26, 2009 December 27, 2008 Amount $ Amount $ 12,571 10,806 The current liabilities of PepsiCo for both years 2009 and 2008 are lower than its current assets. 11) Sanchez Company prepares reversing entries. If the adjusting entry for interest payable is reversed, what type of an account balance, if any, will there be in Interest Payable and Interest Expense after the reversing entry is posted? The normal entry for an Interest Payable amount is:
Date Account Title and Explanation Ref. Debit $ Credit $

Interest Expense Interest Payable (To record interest expenses payable) In case the above entry is reversed:
Date Account Title and Explanation Ref.

xxx xxx

Debit $

Credit $

Interest Payable Interest Expense (To record reversing entry

xxx xxx

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FN-580 Financial Statement Analysis for interest expenses payable) After the reversing of the entry, the amount would be nullified or if there is any balance left then Interest Expense will have a credit ledger balance while Interest Payable will nullify. 12) At December 31, accrued salaries payable totaled $3,500. On January 10, total salaries of $8,000 are paid. (a) Assume that reversing entries are made at January 1. Give the January 10 entry, and indicate that Salaries and Wages Expense account balance after the entry is posted. (b) Repeat part (a) assuming reversing entries are not made. (a) Assuming that Reversing entries are made at Jan 1
Date Account Title and Explanation Ref. Debit $ Credit $

Dec 31

Jan 1

Jan 10

Salaries and Wage Expenses Salaries and Wage Payable (Accrued Salaries) Salaries and Wage Payable Salaries and Wage Expenses (Reversing of Dec 31 entry) Salaries and Wage Expense Cash (Total Salaries paid)
Account Title and Explanation

J3

3,500 3.500

J3

3,500 3,500

J3

8,000 8,000

Date

Ref.

Debit $

Credit $Balance $

Dec 31 Dec 31 Dec 31

Salaries and Wage Payable Salaries and Wage Payable Cash

J3 J3 J3

3,500 3,500 8,000

3,500 8,000

(b) Assuming when reversing entries are not made

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FN-580 Financial Statement Analysis


Date Account Title and Explanation Ref. Debit $ Credit $

Dec 31

Jan 10

Salaries and Wage Expenses Salaries and Wage Payable (Accrued Salaries) Salaries and Wage Expense Cash (Total Salaries paid)
Explanation

J3

3,500 3,500

J3

8,000 8,000

Date

Ref.

Debit $

Credit $

Balance $

Dec 31 Jan 10

Salaries and Wages Payable Cash

J3 J3

3,500 11,500

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FN-580 Financial Statement Analysis

Chapter 5 page 238-239


1) (a) The steps in the accounting cycle for a merchandising company are different from the accounting cycle for a service company. Do you agree or disagree? (b) Is there measurement of net income for a merchandising company conceptually the same as for a service company? Explain. (a) Disagree, since each of the required steps in the accounting cycle for a service company applies to a merchandising company (b) Measurement of net income: The measurement of net income is conceptually same. In both types of companies, net Income (or loss) results from the matching of expenses with revenues. 2) Why is the normal operating cycle for a merchandising company likely to be longer than for a service company? The normal operating cycle for a merchandising company is likely to be longer than in a service company. The purchase of merchandise inventory and its eventual sale followed by the credit sales lengthen the operating cycle. In case of servicing company all these things will not be there, they receive cash for the service provided or record as receivable on the service provided. 3) (a) How do the components of revenues and expenses differ between merchandising and service companies? (b) Explain the income measurements process in a merchandising company. (a) Particulars Merchansiding Service Revenues Sales Fee, Rent, charge Expenses Cost of Goods Sold, etc. and Operating (only) Operating (b) Sales Reven ue (-) Less Cost = of Equal Goods s Sold Gross Profit (-) Less Operati = ng Equal Expense s s Net Incom e

4) How does income measurement differ between a merchandising and a service company? Income measurement for a merchandising company differs from a service company as follows: 6 of 13

FN-580 Financial Statement Analysis a) Sales are the primary source of revenue in the merchandising company while fee, rent and service charges are the sources of revenue in the service companies. b) Expenses is divided into two main categories: cost of goods sold and operating expenses in merchandising companies while the expenses are mainly operating in service companies. c) Cost of goods should be considered in calculating the income for merchandising company while operating expenses are the major expenses and there will not be any cost of goods sold or inventory. 5) When is cost of goods sold determined in a perpetual inventory system? In a perpetual inventory system, cost of goods sold is determined each time when a sale occurs. As the name suggests it is an updated record for the cost of goods sold. When in periodic inventory system the cost of goods sold is determined at the end of each period. 6) Distinguish between FOB shipping point and FOB destination. Identify the freight terms that will result in a debit to Inventory by the buyer and a debit to Freight-out by the seller. FOB Shipping Point: The letters FOB means, Free on Board. FOB shipping point means that goods are placed on board of the carrier for free by the seller. The buyer then pays the freight and debits Merchandise Inventory. FOB Destination: FOB destination means that the goods are placed free on board to the buyers place of business. Thus, the seller pays the freight and debits Freight-out. 7) Explain the meaning of the credit terms 2/10, n/30. Meaning of 2/10: Credit terms of 2/10 means a 2% cash discount will be given if payment is made within 10 days of the invoice date. Meaning of n/30: If the payee fails to pay within the credit term period then he has to pay the invoice price, less any returns, within 30 days from the invoice date. 8) Goods costing $2,000 are purchased on account on July 15 with credit terms of 2/10, n/30. On July 18, a $200 credit memo is received from the supplier for damaged goods. Give the journal entry on July 24 to

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FN-580 Financial Statement Analysis record payment of the balance due within the discount period using a perpetual inventory system. Purchase of inventory on account:
Date Account Title Debit $ Credit $

15-Jul Inventory Accounts payable To record purchase of inventory on account. Return of goods:
Date Account Title

2,000 2,000

Debit $

Credit $

18-Jul Accounts payable Inventory To record return of goods purchased. Payment of balance due:
Date Account Title

200 200

Debit $

Credit $

24-Jul Accounts payable ($2,000-$200) Cash Inventory To record payment within discount period. ($1,800 ($1,800*2%))

1,800 1,764 36

Note: Calculation of amount paid Purchase on credit $2,000 Less-Purchase return ($200) Balance $1800 Less-Cash discount ($1800*2%) (36) Amount paid $1,764 9) Joan Roland believes revenues from credit sales may be earned before they are collected in cash. Do you agree? Explain. Yes, the statement is correct. On accrual basis, the revenue is considered to be earned before it is collected in cash, once the legal title to the goods that is the risks and rewards of ownership is transferred to the buyer.

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FN-580 Financial Statement Analysis 10) (a) What is the primary source document for recording (1) cash sales, (2) credit sales. (b) Using XXs for amounts, give the journal entry for each of the transactions in part (a). (a) The primary source documents: The primary source documents for the cash sales and credit sale are as follows; 1) Cash sale: Cash register tapes are the sources for cash sales. 2) Credit sales: Sales invoices are the sources for credit sales. (b) Journal entries: For cash sales: Dat Particulars L/F Dr$ Cr$ e Cash xxx Sales xxx (Entry to record the cash sales) Cost of goods sold Merchandise inventory (Entry to record the cost of goods sold) Dat e For credit sales: Particulars Accounts receivables Sales (Entry to record the credit sales) Cost of goods sold Merchandise inventory (Entry to record the cost of goods sold) L/F xxx xxx

Dr$ xxx

Cr$ xxx

xxx xxx

11) A credit sale is made on July 10 for $900, terms 2/10, n/30. On July 12, $100 of goods are returned for credit. Give the journal entry on July 19 to record the receipt of the balance due within the discount period.
Date Account title Debit $ Credit $

10-Jul

Accounts receivable Sales revenue To record sales on account.


Account title

900 900
Debit Credit $

Date

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FN-580 Financial Statement Analysis


$

10-Jul

Cost of goods sold Inventory To record cost of goods sold.


Account title

900 900
Debit $ Credit $

Date

12-Jul

Sales returns Accounts receivable To record sale returns.


Account title

100 100
Debit $ Credit $

Date

12-Jul

Inventory Cost of goods sold To record fair value of goods returned.

100 100

Date

Account title

Debit $

Credit $

19-Jul

Cash Sales discounts Accounts receivable ($900-$100) To record collection of accounts receivable within the discount period. ($800-(800*2%)) Notes: Cash received Credit sales $900 Less-sales return ($100) Net sales $800 Less-discount ($800*2%) ($16) Cash receipt $784

784 16 800

12) Explain why the Inventory account will usually require adjustment at year-end. Adjustments are required for the inventory account at the year-end. Since the perpetual inventory records for merchandise inventory may

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FN-580 Financial Statement Analysis be incorrect due to a variety of causes such as recording errors, theft or waste etc. 13) Prepare the closing entries for the Sales Revenue account, assuming a balance of $200,000 and the Cost of Goods Sold account with a $145,000 balance.
Date Account title Debit $ Credit $

31-Dec

Sales revenue Income summary To record closing of sales revenue account to the income summary account.

200,00 0 200,000

Date

Account title

Debit $

Credit $

31-Dec

Income summary Cost of goods sold To record closing of cost of goods sold account to the income summary account.

145,00 0 145,000

Note: Expenses and revenues will be transferred to the income statement. 14) What merchandising account(s) will appear in the post-closing trial balance? Of the merchandising accounts, only Merchandise Inventory will appear in the post-closing trial balance.

15) Reese Co. has sales revenue of $105,000, cost of goods sold of $70,000, and operating expenses of $20,000. What are its gross profit and its gross profit rate? Gross profit is the difference between the sales revenue and cost of goods sold. Gross profit = Sales revenue Cost of goods sold = $105,000-$70,000 11 of 13

FN-580 Financial Statement Analysis = $35,000 Therefore the gross profit=$35,000 Gross profit rate is ratio of gross profit to net sales. Gross profit rate = Gross profit Net sales = $35,000 $105,000 = 33.33% Therefore the gross profit rate=33.33% 16) Ann Fort Company reports net sales of $800,000, gross profit of $370,000, and net income of $240,000. What are its operating expenses?

Operating expenses are the difference between the gross profit and net income. Operating expenses = Gross profit-Net profit = $370,000-$240,000 = $130,000 Therefore the operating expenses=$130,000 17) Identify the distinguishing features of an income statement for a merchandising company. There are three distinguishing features of an income statement for a merchandising company: - Sales revenues section - Cost of goods sold section - Gross profit 18) Identify the sections of a multiple-step income statement that relate to (a) operating activities, and (b) non-operating activities. (a) The operating activities section of the multi-step income statement has three parts: - Sales revenues - Cost of goods sold - Operating expenses (b) The non-operating activities section of the multi-step income statement consists of two parts: 12 of 13

FN-580 Financial Statement Analysis Other revenues and gains Other expenses and losses

19) How does the single-step form of income statement differ from the multiple-step form? The single step income statement differs from the multiple step income statement as follows: 1- Total data is the be classified into two categories: revenues and expenses 2- Only one step, subtracting total expenses from total revenues, is required in determining net income (or net loss). 3- Where in multi step income statement several parts to be calculated to determine the net income. 20) Determine PepsiCos gross profit rate for 2009 and 2008. Indicate whether it increased or decreased from 2008-2009. Gross profit rate = Gross profit x100 Net sales 2009 Amount in millions $ 43,232 20,099 23,133 2008 Amount in millions $ 43,251 20,351 22,900

Particulars

Net revenue (a) Less: Cost of sales (b) Gross Profit ( c) = (a) (b) Gross Profit rate (c ) 53.51% 52.95% \ (a) Gross profit rate 2009=53.51% 2008=52.95% The gross profit rate has increased marginally in 2009 by 0.56% (53.51%-52.95%) when compared to 2008. 21) Identify the accounts that are added to or deducted from Purchases to determine the cost of goods purchased. For each account, indicate whether it is added or deducted. Cost of good purchased: Accounts that are added to or deducted from the purchase to determine the cost of goods purchased are as follows: - Accounts to be deducted: - Purchase returns and allowances - Purchase discounts 13 of 13

FN-580 Financial Statement Analysis Accounts to be added: - Freight-in

22) Goods costing $3,000 are purchased on account on July 15 with credit terms of 2/10, n/30. On July 18, a $200 credit was received from the supplier for damaged goods. Give the journal entry on July 24 to record payment of the balance due within the discount period, assuming a periodic inventory system. Date 24-Jul Account title Accounts payable ($3,000-$200) Cash ($2,800 ($2,800*2%)) Purchase discounts ($2,800*2%) To record payment of accounts payable within the discount period. Note: Calculation of amount paid Purchase on credit $3,000 Less-Purchase returns ($200) Balance $2,800 Less-cash discount ($2,800*2%) ($56) Amount paid $2,744 23) Indicate the columns of the worksheet in which (a) inventory and (b) cost of goods sold will be shown. (a) Merchandise inventory: - Trial balance-Debit side - Adjusted trial balance-Debit side - Balance sheet-Assets side (b) Cost of Goods Sold: - Trial Balance-Debit side - Adjusted Trial Balance-Debit side - Income Statement-Debit side Debit $ 2,800 Credit $ 2,744 56

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