Kimmel, Weygandt, Kieso, Trenholm Edition

Financial Accounting, Second Canadian

CHAPTER 1
Introduction to Financial Statements
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives 1. Describe the primary forms of business organization. 2. Identify the users and uses of accounting. 3. Explain the three principal types of business activity. 4. Describe the content and purpose of each of the financial statements. 5. Explain the meaning of assets, liabilities, and shareholders equity and state the basic accounting equation. 6. Explain the basic assumptions and principles underlying financial statements. Questions 1, 2 Brief Exercises 1 Exercises 1 A Problems B Problems 1A 1B

3, 4, 5, 6 7, 8

2, 3 4

1 1

4A 2A, 3A

4B 2B, 3B

9, 10, 11, 12, 13 14, 15, 16, 17, 18, 19

5, 6

1, 2, 3, 4, 3A, 4A, 5A, 3B, 4B, 5B, 5, 6, 7, 8, 6A, 7A, 8A 6B, 7B, 8B 9, 10 10, 11 8A 8B

7, 8, 9, 10, 11

20, 21

12, 13

9A

9B

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Financial Accounting, Second Canadian

ASSIGNMENT CHARACTERISTICS TABLE

Problem Number 1A 2A 3A 4A 5A 6A 7A 8A 9A 1B 2B 3B 4B 5B 6B 7B 8B 9B Description Determine forms of business organization. Identify business activities. Classify accounts. Identify users and uses of financial statements. Prepare statements of earnings and retained earnings and balance sheet. Prepare cash flow statement. Comment on proper accounting treatment and prepare a corrected statement of earnings. Use financial statement relationships to calculate missing amounts. Identify the assumption or principle violated. Determine forms of business organization. Identify business activities. Classify accounts. Identify users and uses of financial statements. Prepare statements of earnings and retained earnings and balance sheet. Prepare cash flow statement. Comment on proper accounting treatment and prepare corrected balance sheet. Use financial statement relationships to calculate missing amounts. Identify the assumption or principle violated. Difficulty Level Moderate Simple Moderate Complex Moderate Moderate Moderate Moderate Moderate Moderate Simple Moderate Complex Moderate Moderate Moderate Moderate Moderate Time Allotted (min.) 25-30 25-30 25-30 40-50 40-50 30-40 40-50 20-30 20-30 25-30 25-30 25-30 40-50 40-50 30-40 40-50 20-30 20-30

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Financial Accounting, Second Canadian

ANSWERS TO QUESTIONS
1. 2. The three basic forms of business organizations are (1) proprietorship, (2) partnership, and (3) corporation. Advantages of a corporation are limited liability (shareholders not being personally liable for corporate debts) and easy transferability of ownership. Disadvantages of a corporation are increased government regulations and the fact that corporations are taxed as a separate legal entity. Corporations may receive more favourable tax treatment than other forms of business organizations. Partnerships and proprietorships are easier to form (and dissolve) than corporations. Proprietorships and partnerships are not taxed as separate entities. The partners and proprietors pay personal income tax on their share of profits. Depending on the circumstances this may be an advantage or disadvantage. Disadvantages of proprietorships and partnerships are unlimited liability (proprietors/partners are personally liable for all debts) and difficulty in obtaining financing compared to corporations. A person cannot earn a living, spend money, buy on credit, make an investment, or pay taxes without receiving, using, or dispensing financial information. Accounting provides financial information to interested users through the preparation and distribution of financial statements. Internal users are those who manage the business and therefore are officers and other decision-makers. To assist management, accounting provides internal reports. Examples include financial comparisons of operating alternatives, projections of earnings from new sales campaigns, and forecasts of cash needs for the next year. External users are those outside the business who have either a present or potential direct financial interest (investors and creditors) or an indirect financial interest (taxing authorities, regulatory agencies, labour unions, customers, and economic planners). Ethics are important because without the expectation of ethical behaviour, the information presented in the financial statements would have no credibility for the accounting profession. It would therefore be useless to financial statement users. Two primary kinds of financing activities for a corporation are borrowing money (debt) and selling shares (equity). A bank would want to ensure that the company has sufficient cash available to repay any loans owed to the bank. If the company paid out all its cash in the form of dividends there would be no funds available to repay this debt.

3.

4.

5.

6.

7. 8.

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Financial Accounting, Second Canadian

Questions (Continued)
9. The balance sheet is prepared as at a specific point in time because it shows what the business owns (its assets) and what it owes (its liabilities). These items are constantly changing. In order to present them it is necessary to select one point in time. The other statements (earnings, retained earnings and cash flow) cover a period of time as they report activities and measure performance that takes place over time. Retained earnings are the cumulative earnings retained in a corporation. Retained earnings are increased by net earnings and are decreased by dividends and a net loss. The primary purpose of the cash flow statement is to provide financial information about the cash receipts and cash payments of an enterprise for a specific period of time. The three categories of the cash flow statement are operating activities, investing activities, and financing activities. The categories were chosen because they represent the three principal types of business activity. (a) The statement of earnings reports net earnings for the period. The net earnings figure from the statement of earnings is shown on the statement of retained earnings as an addition to beginning retained earnings. If there is a loss it is deducted from the opening balance in retained earnings. The statement of retained earnings explains the change in the retained earnings section of the balance sheet from one period to the next. The cash flow statement explains the change in the cash balance from one balance sheet to the next.

10. 11. 12.

13.

(b) (c) 14. 15.

The basic accounting equation is Assets = Liabilities + Shareholders Equity. Cost is used as a basis for accounting treatment and reporting because it is both relevant and reliable. Cost is relevant because it represents the price paid, the assets sacrificed, or the commitment made at the date of acquisition. It is the amount for which someone or some entity should be accountable. Cost is reliable because it is objectively measurable, factual, and verifiable. It is the result of an arm's-length exchange transaction. As a result, cost is the basis used in preparing financial statements. (a) (b) Assets are resources owned by a business. Liabilities are claims of creditors against assets. Put more simply, liabilities are existing debts and obligations. Shareholders equity is the ownership claim on total assets. The items that affect shareholders equity are common shares (investment by shareholders) and retained earnings (through dividends, revenues, and expenses).

16.

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Financial Accounting, Second Canadian

Questions (Continued)
17. 18. The liabilities are (b) Accounts payable and (g) Salaries payable. (a) (b) (c) (d) Statement of earnings Balance sheet (assets) Statement of earnings Balance sheet (assets) (e) (f) (g) (h) Balance sheet (shareholders equity) Balance sheet (liabilities) Cash flow statement Statement of retained earnings

19.

One possible complication is that the number of days included in each fiscal year will vary, thus causing reported sales to vary from year to year simply because the number of days varies. The economic entity assumption states the economic events can be identified with a particular unit of accountability. This assumption requires that the activities of the entity be kept separate and distinct from (1) the activities of its owners (the shareholders) and (2) all other economic entities. A shareholder of a company charging personal living costs as expenses of the company is an example of a violation of the economic entity assumption. The going concern assumption lends credibility to the cost principle because it is assumed that the assets will be used in the business and what you gave up to acquire these assets is more relevant than what the assets could be sold for. If the company was not a going concern, items would be reported at liquidation value.

20.

21.

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Financial Accounting, Second Canadian

SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 1-1
(a) (b) (c) P PP C

BRIEF EXERCISE 1-2

(a) (b) (c) (d) (e) 4 3 2 5 1

BRIEF EXERCISE 1-3

(a) The accountants behaviour is very unethical. The correct action would have been to adjust the accounting records so that they agreed to the physical inventory count. Taking home the extra supplies is theft. If the company accountant feels that she should be compensated for her extra work, she should address her concerns by discussing the matter with her employer. (b) To ensure all employees adhere to appropriate ethical behaviour, the company should implement clear policies outlining expectations of ethical behaviour. As well, top management must illustrate, through their own actions, that ethical behaviour is expected of all employees.

BRIEF EXERCISE 1-4

(a) (b) (c) (d) (e) O F F F I

BRIEF EXERCISE 1-5

(a) (b) (c) (d) (e) (f) BS BS SE BS BS SE (g) (h) (i) (j) (k) (l) SE BS BS SE SE BS

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BRIEF EXERCISE 1-6

SE BS CF BS (a) (b) (c) (d) Revenue during the period Supplies on hand at the end of the year Cash received from borrowing money during the period Total debt at the end of the period

BRIEF EXERCISE 1-7

(a) (b) (c) $90,000 $50,000 = $40,000 (Shareholders equity) $48,000 + $70,000 = $118,000 (Assets) $94,000 $72,000 = $22,000 (Liabilities)

BRIEF EXERCISE 1-8

(a) Total assets = = = = = = = = = Total liabilities + Shareholders equity $100,000 + $240,000 $340,000 Total assets Shareholders equity $170,000 $100,000 $70,000 Total assets Total liabilities $700,000 ($700,000/2) $350,000

(b)

Total liabilities

(c)

Shareholders equity

BRIEF EXERCISE 1-9

(a) (b) (c) ($800,000 + $150,000) ($500,000 $80,000) = $530,000 (Shareholders equity) ($500,000 + $100,000) + ($800,000 $500,000 $70,000) = $830,000 (Assets) ($800,000 $90,000) ($800,000 $500,000 + $110,000) = $300,000 (Liabilities)

BRIEF EXERCISE 1-10

(a) (b) (c) A L A (d) (e) (f) A SE L

BRIEF EXERCISE 1-11

(a) (b) (c) (d) (e) (f) (g) NE C R E E D R

SOLUTIONS TO EXERCISES
EXERCISE 1-1
(a) (b) (c) (d) (e) (f) (g) (h) 8 5 6 1 7 2 3 4 Ethics Corporation Common shares Accounts payable Accounts receivable Creditor Financing activities Retained earnings

EXERCISE 1-2
KON INC. Statement of Earnings Year Ended December 31, 2004 Revenues Service revenue Expenses Salaries expense Rent expense Utilities expense Advertising expense Total expenses0 Earnings before income tax Income tax expense Net earnings

$61,000 $28,000 10,400 2,400 1,800 42,600 18,400 6,000 $12,400

KON INC. Statement of Retained Earnings Year Ended December 31, 2004 Retained earnings, January 1 Add: Net earnings Less: Dividends Retained earnings, December 31 $57,000 12,400 69,400 7,000 $62,400

EXERCISE 1-3
AURORA LTD. Balance Sheet December 31, 2004 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities and Shareholders Equity Liabilities Accounts payable Shareholders equity Common shares Retained earnings Total shareholders equity Total liabilities and shareholders equity *$27,500 $7,000 = $20,500 $20,000 40,000 20,500* 60,500 $80,500 $18,500 10,000 8,000 0 44,000 $80,500

EXERCISE 1-4
(a) Camping fee revenue General store revenue Total revenue Expenses ($142,000 + $6,000) Net earnings $137,000 20,000 157,000 148,000 $ 9,000

(b) SEA SURF CAMPGROUND, INC. Statement of Retained Earnings Year Ended December 31, 2004 Retained earnings, January 1 Add: Net earnings Less: Dividends Retained earnings, December 31 SEA SURF CAMPGROUND, INC. Balance Sheet December 31, 2004 Assets Cash Supplies Equipment Total assets Liabilities and Shareholders Equity Liabilities Accounts payable Notes payable Total liabilities Shareholders equity Common shares Retained earnings Total shareholders equity Total liabilities and shareholders equity $ 11,000 50,000 61,000 40,000 22,000 62,000 $123,000 $ 10,500 2,500 0 110,000 $123,000 $17,000 9,000 26,000 4,000 $22,000

EXERCISE 1-5
LANGILLE PROFESSIONAL CORPORATION Statement of Retained Earnings Year Ended December 31, 2004 Retained earnings, January 1 Add: Net earnings Less: Dividends Retained earnings, December 31 $150,000 190,000* 340,000 76,000 $264,000

*Total revenue Total expenses Net earnings

$395,000 205,000 $190,000

EXERCISE 1-6
(a) (b) (c) Assets - Liabilities = Shareholders equity $90,000 - $80,000 = $10,000 Total liabilities + Shareholders equity = Total assets $120,000 + $40,000 = $160,000 Ending balance Beginning balance = Change in shareholders equity $40,000 - $10,000 = $30,000 Revenue Expenses = Net earnings $215,000 - $165,000 = $50,000 Total change in shareholders equity Net earnings = Dividends $30,000 - $50,000 = $20,000 (d) (e) (f) Total Assets - Shareholders equity = Total liabilities $130,000 - $95,000 = $35,000 Assets - Liabilities = Shareholders equity $180,000 - $55,000 = $125,000 Ending balance - Beginning balance = Change in shareholders equity $125,000 - $95,000 = $30,000 Change in shareholders equity + Dividends = Net earnings $30,000 + $5,000 = $35,000 Net earnings + Expenses = Revenue $35,000 + $80,000 = $115,000

EXERCISE 1-7
(a) Yu Corporation is distributing nearly all of this year's net earnings as dividends. This suggests that Yu is not pursuing rapid growth. Companies that have a lot of opportunities for growth normally retain their earnings and pay low dividends. Surya Corporation is not generating sufficient cash from operating activities to fund its investing activities. This is common for companies in their early years of existence. Naguib is financing its assets mainly through equity. The company has $400,000 ($150,000 + $250,000) of total assets, which are funded 37.5% ($150,000/$400,000) by liabilities and 62.5% ($250,000/$400,000) by equity. Since equity does not have to be repaid and does not require interest payments, the company appears to be in a healthy financial position.

(b) (c)

EXERCISE 1-8
VAN TRAN CORPORATION Cash Flow Statement Year Ended December 31, 2004 Operating activities Cash received from customers Cash paid to suppliers Cash provided by operating activities Investing activities Cash paid for new equipment Cash used by investing activities Financing activities Cash received from lenders Cash dividends paid Cash provided by financing activities Net increase in cash Cash, January 1, 2004 Cash, December 31, 2004 $50,000 (30,000) $20,000 $(25,000) (25,000) $20,000 (6,000) 14,000 9,000 10,000 $19,000

EXERCISE 1-9
LANDS END Cash Flow Statement Year Ended February 1, 2002 Operating activities Cash received from customers Cash paid for goods and services Cash provided by operating activities Investing activities Cash paid for new buildings and equipment Cash used by investing activities Financing activities Cash paid for repayment of debt Cash received from issue of common shares Cash provided by financing activities Net increase in cash Cash, January 27, 2001 Cash, February 1, 2002 $1,575,573 (1,502,068) $ 73,505 $(40,514) (40,514) $ (771) 14,520 13,749 46,740 75,351 $122,091

EXERCISE 1-10
(a) A SE E E A A A (b) COOLBRANDS INTERNATIONAL INC. Statement of Earnings Year Ended August 31, 2002 Revenues Sales Franchising revenues Rental and other income Total revenues Expenses Cost of goods sold Selling, general and administrative expenses Interest expense Total expenses Earnings before income tax Income tax expense Net earnings $236,028 5,187 1,007 242,222 129,246 77,558 2,544 209,348 32,874 11,890 $ 20,984 Cash and short-term investments Retained earnings Cost of goods sold Selling, general and administrative expenses Prepaid expenses Inventories Receivables E R L L R R E Income tax expense Sales Income taxes payable Accounts payable Franchising revenues Rental and other income Interest expense

EXERCISE 1-11
(a) L A A A A A L A L A SE SE (b) Assets Cash Accounts receivable Inventory Prepaid and other expenses Capital assets Goodwill and other intangibles Other assets Total assets Liabilities Accounts payable and accrued liabilities Other liabilities Long-term debt Total liabilities Shareholders equity Share capital Retained earnings Total shareholders equity $ 523 38,275 268,519 11,123 142,236 38,684 7,452 $506,812 $209,873 57,516 35,700 $303,089 $124,866 78,857 $203,723 Accounts payable and accrued liabilities Accounts receivable Capital assets Cash Goodwill and other intangibles Inventory Long-term debt Other assets Other liabilities Prepaid and other expenses Retained earnings Share capital

Total assets = Total liabilities + Shareholders equity $506,812 = $303,089 + $203,723

EXERCISE 1-12
(a) (b) (c) (d) (e) (f) 5 6 3 4 2 1 Going concern assumption Economic entity assumption Monetary unit assumption Time period assumption Cost principle Full disclosure principle

EXERCISE 1-13
(a) (b) This is a violation of the cost principle. The inventory was written up to its market value when it should have remained at cost. This is a violation of the economic entity assumption. The treatment of the transaction treats Deanna Durnford and Marietta Corp. as one entity when they are two separate entities. This is a violation of the time period assumption. This assumption states that the economic life of a business can be divided into artificial time periods (months, quarters or a year). By adding two more weeks to the year, Marietta Corp. would be misleading financial statement readers. In addition, 2004 results would not be comparable to previous years' results.

(c)

SOLUTIONS TO PROBLEMS
PROBLEM 1-1A
(a) Dawn will likely operate her vegetable stand as a proprietorship because she is planning on operating it for a short time period and a proprietorship is the simplest and least costly to form and dissolve. Joseph and Sabra should form a corporation when they combine their operations. This is the best form of business for them to choose because they expect to raise significant funds in the coming year. It is easier to raise funds in a corporation. A corporation may also receive more favourable tax treatment. The professors should incorporate their business because of their concerns about the legal liabilities. A corporation is the only form of business that provides limited liability to its owners. Abdur would likely form a corporation because he needs to raise funds to invest in inventories and property, plant, and equipment. He has no savings or personal assets and it is normally easier to raise funds through a corporation. A partnership would be the most likely form of business for Mary and Richard to choose. It is simpler to form than a corporation and less costly.

(b)

(c)

(d)

(e)

PROBLEM 1-2A
(a) Abitibi Consolidated Inc. Students Society Borrow money of McGill University from a bank Corel Corporation Sale of bonds Sportsco Investments Grant Thornton LLP WestJet Airlines Ltd. (b) Financing Sale of shares is common to all corporations. Borrowing from a bank is common to all businesses. Payment of dividends is common to all corporations. Sale of bonds is common to large corporations. Investing Purchase and sale of property, plant, and equipment would be common to all businessesthe types of assets would vary according to the type of business and some types of businesses require a larger investment in long-lived assets. A new business or expanding business would be more apt to acquire assets. Operating The general activities identified would be common to most businesses, although the service or product might change. Financing Sale of shares Investing Purchase longterm investments Purchase office equipment Purchase other companies Purchase hockey equipment Purchase computers Operating Sale of newsprint Payment of wages and benefits Payment of research expenses Payment for rink rentals

Payment of dividends to shareholders Distribute earnings to partners Sale of shares

Bill clients for professional services Purchase airplanes Payment for jet fuel

PROBLEM 1-3A

Accounts payable and accrued liabilities Accounts receivable Bank overdraft Capital assets Food and beverage operations revenue Golf course operations revenue Inventory Long-term debt Office and general expense Professional fees expense Wage and benefits expense

(a) L A L A R R A L E E E

(b) O O * I O O O F O O O

* Bank overdrafts are usually considered to be part of the cash balance on the cash flow statement.

PROBLEM 1-4A
(a) In making an investment in common shares the Ontario investor is becoming a partial owner of the company. In this case, the investment will be held for three years. The information that will be most relevant to him will be on the statement of earnings. The statement of earnings reports the past performance of the company in terms of its revenue, expenses and net earnings. This is the best indicator of the companys future potential. In deciding to extend credit to a new customer, Comeau Lte would focus its attention on the balance sheet. The terms of credit they are extending require repayment in a short period of time. Funds to repay the credit would come from cash on hand. The balance sheet will show if the company has enough cash to meet its obligations. In order to determine whether the company is generating enough cash to increase the amount of dividends paid to investors, the CEO of Hilfiger Corporation needs information on the amount of cash generated and used in various activities of his business. The cash flow statement is the most useful statement for this purpose. This statement presents the amount of cash flow at the beginning and end of the period as well as the details of the amount of cash generated by operating activities and the amount spent on expanding operations (investment activities). In deciding whether to extend a loan, the Laurentian Bank is interested in two things: the ability of the company to make interest payments on an annual basis for the next five years and the ability to repay the principal amount at the end of five years. In order to evaluate both of these factors the focus should be on the cash flow statement. This statement provides information on the cash the company generates from its operating activities on an ongoing basis. This will be the most important factor in determining if the company will survive and be able to repay the loan. Note to instructor: Other answers may be valid provided they are properly supported.

(b)

(c)

(d)

PROBLEM 1-5A
AERO FLYING SCHOOL LTD. Statement of Earnings Month Ended May 31, 2004 Revenues Service revenue Expenses Fuel expense Rent expense Advertising expense Insurance expense Repair expense Total expenses Earnings before income tax Income tax expense Net earnings $9,600 3,400 1,200 900 400 700 0 6,600 3,000 1,100 $1,900

AERO FLYING SCHOOL LTD. Statement of Retained Earnings Month Ended May 31, 2004 Retained earnings, May 1 Add: Net earnings Less: Dividends Retained earnings, May 31 $0,000 0 1,900 1,900 1,000 $ 900

PROBLEM 1-5A (Continued) AERO FLYING SCHOOL LTD. Balance Sheet May 31, 2004 Assets Cash Accounts receivable Equipment Total assets $07,800 11,200 60,300 $79,300

Liabilities and Shareholders Equity Liabilities Notes payable Accounts payable Total liabilities Shareholders equity Common shares Retained earnings Total shareholders equity Total liabilities and shareholders equity * $45,000 + $1,800 = $46,800 $29,200 2,400 31,600 46,800* 900 47,700 $79,300

PROBLEM 1-6A
Frenette Corporation should include the following items in its cash flow statement: Cash, July 1, 2003 Cash paid to suppliers Cash paid for income tax Cash dividends paid Cash paid to buy equipment Cash received from customers FRENETTE CORPORATION Cash Flow Statement Year Ended June 30, 2004 Operating activities Cash received from customers $165,000 Cash paid to suppliers (95,000) Cash paid for income tax (20,000) Cash provided by operating activities 50,000 Investing activities Cash paid to purchase equipment (15,000) Financing activities Cash dividends paid (8,000) Increase in cash 27,000 Cash, July 1, 2003 30,000 Cash, June 30, 2004 $ 57,000

PROBLEM 1-7A
(a) 1. The $7,000 of revenue that the company earned in 2003 should not be included in the 2004 revenues. Including the $7,000 in the current year's statement of earnings would violate the time period assumption. Instead, the $7,000 should be added to the beginning balance of retained earnings. In order to properly calculate the net earnings for the year all expenses must be included in the statement of earnings. Although payment is not due until 2005, the expense relates to 2004. Since the corporation did not incur or pay the $15,000 of rent expense, it should not be included in the statement of earnings. Including the $15,000 as an expense misstates the corporation's net earnings and presents misleading results. Including the $2,000 as vacation expense misstates the corporation's net earnings. It would also be a violation of the economic entity assumption.

2.

3.

4.

(b) KETTLE CORPORATION Statement of Earnings Year Ended December 31, 2004 Revenue ($60,000 - $7,000) Expenses Insurance expense Earnings before income tax Income tax expense Net earnings $53,000 5,000 48,000 12,000 $36,000

PROBLEM 1-8A
(a) i. ii. Total assets = Total liabilities and shareholders equity Total assets = $85,000 Cash = Total assets (Accounts receivable + Land + Buildings and equipment) Cash = $85,000 - ($20,000 + $15,000 + $40,000) Cash = $10,000 Operating expenses = Service revenue - Earnings before income tax Operating expenses = $75,000 - $30,000 Operating expenses = $45,000 Net earnings = Earnings before income tax Income tax expense Net earnings = $30,000 - $15,000 Net earnings = $15,000 Net earnings = $15,000 (same as (iv)) Retained earnings = $20,000 (as per statement of retained earnings) Common shares = Total liabilities and shareholders equity - (Liabilities + Retained earnings) Common shares = $85,000 - ($15,000 + $20,000) Common shares = $50,000 In preparing the financial statements the first statement to be prepared is the statement of earnings. The net earnings figure is used in the statement of retained earnings to calculate the ending balance of retained earnings. The balance sheet is then completed using the balance of retained earnings as calculated in the statement of retained earnings. Finally the cash flow statement is completed using information from the statement of earnings (e.g., net earnings) and balance sheet (e.g., cash balance).

iii.

iv.

v. vi. vii.

(b)

PROBLEM 1-9A
1. Karim Corporation has violated the monetary unit assumption. Although the death of the companys president will have an impact on the company it cannot be measured in monetary terms and therefore cannot be recorded. In order to comply with the full disclosure principle, Topilynyckyj Ltd. must adhere to generally accepted accounting principles. Even though the company is small, investors, creditors and other financial statements users still require information on which to base their decisions. If the shipyard chooses to report its financial results only once every two years, it will be violating the time period assumption. This assumption states that the life of a business can be divided into artificial time periods and that useful reports can be generated covering those periods. As a minimum, reports should be produced annually. Paradis Inc. has violated the economic entity assumption. In order to properly report the financial condition and performance of the company, Marc Paradis personal assets must not be recorded in the companys accounts. The boat is being used primarily for personal pleasure and should not be recorded as an asset of the business. Bourque Corporation is violating the cost principle by recording equipment at an amount higher than they actually paid for it. The amount that the company would have paid for it if there had not been a flood sale is irrelevant.

2.

3.

4.

5.

PROBLEM 1-1B
(a) The professors should incorporate their business because of their concerns about the legal liabilities. A corporation is the only form of business that provides limited liability to it owners. Joseph should run his bait shop as a proprietorship because this is the simplest form of business to establish. It is also the least expensive. He is the only person involved in the business and is planning to operate for a limited time. Robert and Tom should form a corporation when they combine their operations. This is the best form of business for them to choose because they expect to raise significant funds in the coming year and it is easier to raise funds in a corporation. A corporation may also receive more favourable income tax treatment. A partnership would be the most likely form of business for Darcy, Ellen and Meg to choose. It is simpler to form than a corporation and less costly. Herv is most likely to select to operate his business as a proprietorship. He wants to maintain control of the business. Operating as a proprietorship will allow him to do this. He has no savings or personal assets, therefore will not require a corporation to protect his personal assets.

(b)

(c)

(d) (e)

PROBLEM 1-2B
(a) Indigo Books & Music High Liner Foods Incorporated Mountain Equipment Co-op Ganong Bros. Limited Royal Bank The Gap, Inc. (b) Financing Sale of shares is common to all corporations. Issue of debt is common to all corporations. Borrowing from a bank is common to all businesses. Payment of dividends is common to all corporations. Sale of bonds is common to large corporations Investing Purchase and sale of property, plant, and equipment would be common to all businessesthe types of assets would vary according to the nature of the business. Some types of businesses require a larger investment in long-lived assets. A new business or expanding business would be more apt to be acquiring assets. Financing Sale of shares Issue debt securities to investors Borrow money from a bank Payment of dividends to shareholders Sale of bonds Sale of shares Investing Purchase of longterm investments Purchase of production equipment Purchase of store fixtures Purchase of production equipment Purchase office equipment Purchase of store fixtures Operating Sale of books Payment for fish Payment for inventory Payment of utility bill Payment of interest on savings accounts Payment of wages and benefits

PROBLEM 1-2B (Continued) (b) (Continued) Operating The activities identified would be common to most businesses with the exception of the payment of interest on savings accounts. The source of the cash receipt (e.g., sale of books) and cash payment (e.g., payment for fish) would vary by the nature of the business.

PROBLEM 1-3B

Accounts payable and accrued charges Accounts receivable Common shares Income and other taxes payable Interest expense Inventories Long-term debt Property and equipment Sales

(a) L A SE L E A L A R

(b) O O F O O O F I O

PROBLEM 1-4B
(a) In deciding to extend credit to a new customer, The North Face Inc. would focus its attention on the balance sheet. The terms of credit they are extending require repayment in a short period of time. Funds to repay the credit would come from cash on hand. The balance sheet will show if the company has enough cash to meet its obligations. An investor purchasing common shares of Books Online that they intend to hold for a long period of time, 5 years, should focus on the companys statement of earnings. The statement of earnings reports the companys past performance in terms of revenues, expenses and net earnings. This is generally regarded as a good indicator of the companys future performance. In deciding whether to extend a loan the Caisse DEconomie Base Montral is interested in two thingsthe ability of the company to make interest payments on an annual basis for the next five years and the ability to repay the principal amount at the end of five years. In order to evaluate both of these factors the focus should be on the cash flow statement. This statement provides information on the cash the company generates from its operations on an ongoing basis. This will be the most important factor in determining if the company will survive and be able to repay the loan. The CEO should focus on the cash flow statement as this statement clearly sets out the cash generated from operating activities and the amount the company has spent in the past on purchasing equipment and paying dividends. Note to instructor: Other answers may be valid provided they are properly supported.

(b)

(c)

(d)

PROBLEM 1-5B

ONE PLANET COSMETICS CORP. Statement of Earnings Month Ended June 30, 2004 Revenues Service revenue Expenses Supplies expense Gas and oil expense Advertising expense Utilities expense Total expenses Earnings before income taxes Income tax expense Net earnings $8,000 1,200 900 500 0 300 2,900 5,100 1,500 $3,600

ONE PLANET COSMETICS CORP. Statement of Retained Earnings Month Ended June 30, 2004 Retained earnings, June 1 Add: Net earnings Less: Dividends Retained earnings, June 30 000$ 0 0 3,600 3,600 1,700 $1,900

PROBLEM 1-5B (Continued) ONE PLANET COSMETICS CORP. Balance Sheet June 30, 2004 Assets Cash Accounts receivable Cosmetic supplies Equipment Total assets $ 6,000 4,000 2,400 30,000 $42,400

Liabilities and Shareholders Equity Liabilities Notes payable Accounts payable Total liabilities Shareholders equity Common shares Retained earnings Total shareholders equity Total liabilities and shareholders equity $13,000 1,300 14,300 26,200 1,900 28,100 $42,400 0

PROBLEM 1-6B

Maison Corporation should include the following items in its cash flow statement: Cash, January 1, 2004 Cash paid to suppliers Cash dividends paid Cash paid to purchase equipment Cash received from customers MAISON CORPORATION Cash Flow Statement Year Ended December 31, 2004 Operating activities Cash received from customers $120,000 Cash paid to suppliers (90,000) Cash provided by operating activities Investing activities Cash paid to purchase equipment Cash used by investing activities Financing activities Cash dividends paid Cash used by financing activities Increase in cash Cash, January 1, 2004 Cash, December 31, 2004 $(15,000)

$30,000

(15,000)

$(11,000)

(11,000) 4,000 50,000 $54,000

(a) 1.

PROBLEM 1-7B
The economic entity assumption states that economic events can be identified with a particular unit of accountability. Since the boat actually belongs to Guy Glinasnot to GG Corporationit should not be reported on the corporation's balance sheet. Likewise, the boat loan is a personal loan of Guy'snot a liability of GG Corporation. The cost principle dictates that assets are recorded at their original cost. Therefore, reporting the inventory at $30,000 would be improper and violates the cost principle. The inventory should be reported at $15,000. Including the personal loan Guy made to his brother would be a violation of the economic entity assumption. The $5,000 is not an asset of GG Corporationit is a personal asset of Guy Glinas. GG CORPORATION Balance Sheet December 31, 2004 Cash Accounts receivable Inventory Total assets Assets $20,000 45,000 15,000 $80,000

2.

3.

(b)

Liabilities and Shareholders Equity Liabilities Accounts payable Notes payable Total liabilities Shareholders equity Total liabilities and shareholders equity *$80,000 $55,000 = $25,000 $40,000 15,000 55,000 25,000* $80,000

PROBLEM 1-8B
(a)

i.

Common shares = Total liabilities and Shareholders equity (Liabilities + Retained earnings) Common shares = $65,000 - ($7,000 + $25,000) Common shares = $33,000 Retained earnings = $25,000 (from statement of retained earnings) Operating expenses = Revenue - Earnings before income tax Operating expenses = $80,000 - $30,000 Operating expenses = $50,000 Net earnings = Earnings before income tax - Income tax expense Net earnings = $30,000 - $10,000 Net earnings = $20,000 Net earnings (from (iv)) = $20,000

ii. iii.

iv.

v. (b)

In preparing the financial statements, the first statement to be prepared is the statement of earnings. The net earnings figure is used in the statement of retained earnings to calculate the ending balance of retained earnings. The balance sheet is then completed using the balance of retained earnings as calculated in the statement of retained earnings. Finally the cash flow statement is completed using information from the statement of earnings (e.g. net earnings) and balance sheet (e.g. cash balance).

PROBLEM 1-9B
(a) Seco Corporation has violated the full disclosure principle. The information on the lawsuit could have a significant effect on its financial results and condition and would be important to users of its financial statements. By recording the value of its people, Dot.com Corporation is violating the monetary unit assumption. It is estimating and recording the value of the assets but at the present time there is no method to measure this value in monetary terms. Barton, Inc. is violating the cost principle by increasing the amount recorded for its inventory. The inventory must be recorded at its cost to the company that is, the amount the company paid to acquire it. Bonilla Corp. is violating the time period assumption. This assumption states that the life of a business can be divided into artificial time periods and that useful reports can be generated covering those periods. As a minimum, reports should be produced annually. Steph Wolfson has violated the economic entity assumption. In order to properly report the financial condition and performance of the company, her personal assets must not be recorded in the companys accounts. She should have recorded payment of company funds for the purchase of a personal asset as an amount owing by her to the company.

(b)

(c)

(d)

(e)

BYP 1-1 FINANCIAL REPORTING PROBLEM

(a) (b) (c) (d) (e) Loblaws financial statements cover a 52-week period. Its fiscal year end is 52 weeks after the start. It will fall on the closest Saturday to December 31. Loblaws total assets at December 28, 2002 were $11,110 million and its total liabilities and shareholders equity were the same amount of $11,110 million. Loblaws had cash of $823 million and short-term investments of $304 million for a total of $1,127 million on December 28, 2002. Loblaws had accounts payable and accrued liabilities totalling $2,336 million at the end of their 2002 fiscal year and $2,291 million at the end of their 2001 fiscal year. Loblaw reports net sales for two consecutive years as follows: 2002 2001 (f) $23,082 million $21,486 million

From 2001 to 2002, Loblaws net earnings increased $165 million ($728 - $563).

BYP 1-2 COMPARATIVE ANALYSIS PROBLEM

(a) 1. 2. 3. 4. (b) Total assets Receivables Net sales Net earnings Loblaw (amounts in millions) $11,110 605 23,082 728 Sobeys (amounts in millions) $ 3,192.5 285.4 10,414.5 179.0

Loblaw's total assets were approximately 3.5 times greater ($11,110 vs. $3,192.5) than Sobeys total assets. Loblaw's accounts receivable were approximately 212% more than Sobeys and represent 2.6% ($605 $23,085) of its net sales. Sobeys accounts receivable amounted to 2.7% ($285 $10,414.5) of its net sales. Loblaws net sales were approximately 2.2 times as large as Sobeys net sales. In addition, Loblaw's net earnings were almost 4.0 times more than Sobeys. It can be seen from this information that both companies appear profitable but that Loblaws is a much larger business.

BYP 1-3

RESEARCH CASE

(a)

The ten red flags that investors should look for to ensure that the statement of earnings reflects the companys bottom line are: Companies taking a Big Bath Highlighting everything but the bad stuff Companies attempting to move debt off the balance sheet Revisions to the companys pension plan Turning expenses into assets Earnings that are not from operations and not expected to recur The accounting treatment of stock option plans Channel-stuffing or moving inventory to distributors to improve performance Companies which change accounting standards from US to Canadian GAAP or vice versa 10. Information in the notes to the financial statement such as the addition of a going concern note. 1. 2. 3. 4. 5. 6. 7. 8. 9.

(b)

A shareholder should read the notes to the financial statements. According to Al Rosen, the footnotes to the financial statements are a treasure trove of information," He suggests that users "Read the footnotes first. After seeing all the ways a company has bent, spindled and mutilated its earnings, you may have an entirely different outlook on the company."

(c) According to the research article, Toronto-based e-commerce company Microforum Inc. was involved in a scandal in September 2000.

BYP 1-4 INTREPRETING FINANCIAL STATEMENTS

(a) A creditor might be concerned about the decline in the amount of cash and short-term deposits. They may feel that the ability of the company to meet its debt obligations is reduced. In particular they may be concerned that the company spent more on investing and financing activities than they generated from operating activities. They may be concerned that the company is financing property, plant, and equipment from operating funds. Creditors may want to look at the companys balance sheet to examine the overall debt position of the company. An investor would be concerned about the fact that the auditors are questioning the continued viability of this company. The inability of the company to generate cash from operations and the fact that the company is disposing of significant assets to raise cash world cause them to reconsider whether they want to continue to invest in this company. I would be interested in seeing their projections for future sales growth and profitability. I would also want to see their interim financial statements to see how the company is performing in the current year.

(b)

(c)

BYP 1-5 INTERPRETING FINANCIAL STATEMENTS

(a) Its most important economic resources are its human resourcesskills, talent and knowledge of it staff and its customer base. These assets are not currently reported on the balance sheet. The balance sheet does not tell you what the company is worth. It does give you limited information on the value of the company. Cash and accounts receivable are reported at their realizable values. And, if the market value of assets such as inventory, investments or goodwill are lower than their cost, they are written down to market value rather than cost. This is a subject we will study in later chapters. Generally, however, the value of the assets reported on the balance sheet does not indicate the market value of the companys assets (e.g., capital assets) nor does it include the value of unrecorded assets as discussed in (a). (c) The most likely reason for the company preparing its statements in US dollars is that most of the users of the statements (e.g. investors and creditors) are in the United States or in other countries where US dollars are the standard currency.

(b)

BYP 1-6 A GLOBAL FOCUS

Nestl follows the standards issued by the International Accounting Standards Committee. Ganongs is a Canadian company and therefore follows the standards issued by the Canadian Institute of Chartered Accountants. To the extent that these standards differ, then comparison may be difficult. There are at least two issues here. First, Nestls financial reports are prepared under the historical cost convention. As noted in the chapter, the cost principle underlies Canadian accounting standards. Thus, this would assist comparison. The second issue relates to the full disclosure principle discussed in the chapter. It is noted that Nestl provides dis closures as required by the 4 th and 7th European Union company law directives. To the extent that these disclosure requirements differ from Canadian disclosure requirements comparison may be impeded. There is also a concern related to the monetary unit assumption. In the Canadian financial statements are prepared in terms of Canadian dollars. Nestl prepares its statements in terms of Swiss francs. While conversion from francs to dollars is possible, it will not necessarily capture the full economic situation.

BYP 1-7 FINANCIAL ANALYSIS ON THE WEB

Due to the frequency of change with regard to information available on the World Wide Web, the Accounting on the Web cases are updated as required. Their suggested solutions are also updated whenever necessary, and can be found online in the Instructor Resources section of our home page <www.wiley.com/canada/kimmel>.

BYP 1-8
(a) 1.

COLLABORATIVE LEARNING ACTIVITY

The donation of materials is clearly an expense of the business. The donations of temporary help are also likely an expense of the business, since the donation of the employees' time is made by Kelly Services. The employees still receive their pay, but the employer is not required to pay Kelly. Of course, if the employees donated their own time, these would be personal expenses. However, that is not likely. The donation of the gladiolas was an expense of the business; the planting of the gardens was likely on the employees' own time and therefore any costs incurred were personal expenses of the employees. Clearly a business expense, since the payment is made by Kelly Services to the charity. This may be either a personal expense or a corporate expense. Executives are not paid on an hourly basis and this may not be part of their corporate responsibilities, in which case this would not be a corporate expense. However companies are increasingly encouraging or requiring this type of activity on the part of their executives responsibilities, in which case it would be a corporate expense. For the materials, Advertising Expense is the most likely category of those listed because the company's name was on all the gifts. It might be a Charitable Contribution Expense, but since the gifts were of a general nature and contained the name of the donor, rather than the recipient, it is not as likely. The most likely category for the donation of temporary help is Employee Wages Expense, although it might be categorized as Charitable Contribution Expense since the time was donated. Charitable Contribution Expense is the most likely. It is not Grounds Maintenance Expense because the grounds maintained are not those of the company. The employees' time is not recorded in the company records, of course, since the time was volunteered. Clearly Charitable Contribution Expense. No additional cost was incurred over and above the executives regular remuneration. Therefore it is not recorded in the company's records.

2.

3. 4.

(b)

1.

2.

3. 4.

BYP 1-9 COMMUNICATION ACTIVITY

To: From: Karen Staudinger Student

I have received the balance sheet of Vermon Company, Inc. as of December 31, 2004. The purpose of the balance sheet is to report, at a specific point in time, the assets of the business and any claims to those assets. A number of items in this balance sheet are not properly reported. They are: 1. 2. The balance sheet should be dated as at a specific date, not for a period of time. Therefore, it should be dated "December 31, 2004." On the balance sheet the assets are listed in terms of liquidity, with the most liquid assets being shown first. Therefore, Equipment should be below Supplies on the balance sheet. Accounts receivable should be shown as an asset and reported between Cash and Supplies on the balance sheet. Accounts payable should be shown as a liability, not an asset. The notes payable is also a liability and should be reported in the liability section. Liabilities and shareholders equity should be shown separately on the balance sheet. Common Shares, Retained Earnings, and Dividends are not liabilities. Common Shares, Retained Earnings, and Dividends are part of shareholders equity. The Dividends account is not reported on the balance sheet but is subtracted from Retained Earnings to arrive at the ending balance for Retained Earnings.

3. 4. 5. 6.

BYP 1-9 (Continued)

A correct balance sheet is as follows: VERMON COMPANY, INC. Balance Sheet December 31, 2004 Assets Cash Accounts receivable Supplies Equipment Total assets Liabilities and Shareholders Equity Liabilities Notes payable Accounts payable Total liabilities Shareholders equity Common shares Retained earnings Total shareholders equity Total liabilities and shareholders equity *Retained earnings Less: Dividends Ending retained earnings $10,000 2,000 $ 8,000 $12,000 5,000 17,000 11,000 8,000* 19,000 $36,000 $10,500 3,000 2,000 20,500 $36,000

BYP 1-10
(a) (b)

ETHICS CASE

The stakeholders in this situation are the new CEO and CFO, and the creditors and investors who rely on the financial statements to make business decisions. The CEO and CFO should not sign the certification until they have taken steps to assure themselves that the most recent reports accurately reflect the activities of the business. However, as the current management of the company, they cannot refuse to sign the certification just because they are new. They are the management team now and must accept the responsibility that goes with these positions. The CEO and CFO have no alternative other than to take the steps necessary to assure themselves of the accuracy of the financial information, and, if accurate, sign the certification. If the information is not accurate, they need to make the required corrections to the financial information.

(c)

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