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Chapter 3 The Balance Sheet

True/False Questions

1. The balance sheet reports a company's financial position at a point in time.

Answer: True Learning Objective: 1 Level of Learning: 1

2. Liquidity refers to the riskiness of a company with regard to the amount of liabilities in its
capital structure.

Answer: False Learning Objective: 9 Level of Learning: 1

3. All current assets are either cash or assets that will be converted into cash within twelve
months or the operating cycle, if that is longer than one year.

Answer: False Learning Objective: 2 Level of Learning: 1

4. The criteria for determining which items comprise cash equivalents must be disclosed in the
summary of significant accounting policies.

Answer: True Learning Objective: 5 Level of Learning: 1

5. The balance of net receivables represents the amount expected to be collected.

Answer: True Learning Objective: 3 Level of Learning: 1

6. All prepaid expenses are classified as current assets because they are expected to be converted
into cash within twelve months or the operating cycle, if that is longer.

Answer: False Learning Objective: 3 Level of Learning: 1

7. Operational assets include property, plant, equipment and inventories.

Answer: False Learning Objective: 3 Level of Learning: 1

8. The cost of intangible assets reported in the balance sheet mainly consists of the research and
development costs incurred to develop them.

Answer: False Learning Objective: 3 Level of Learning: 2

9. Accrued payroll liabilities represent salary and wages that have been earned by employees
prior to their payment.

Answer: True Learning Objective: 4 Level of Learning: 1

10. Payment terms, interest rates, and other details of long-term liabilities usually are reported in
disclosure notes.

Answer: True Learning Objective: 5 Level of Learning: 2

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Chapter 3 The Balance Sheet

11. Subsequent events are significant developments that take place after a firm's year-end, and
after the financial statements are issued.

Answer: False Learning Objective: 5 Level of Learning: 1

12. A payment on account has no effect on working capital but will increase the current ratio if it
is already greater than 1.0.

Answer: True Learning Objective: 9 Level of Learning: 2

Matching Pair Questions

Use the following to answer questions 13-17:

13-17. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term placing the letter designating the best term
in the space provided by the phrase.

Terms:
A. Accrued liabilities
B. Current liabilities
C. Intangible asset
D. Liquidity
E. Long-term solvency
F. Notes receivable
G. Qualified opinion
H. Segment information
I. Times interest earned ratio
J. Unqualified opinion
Phrases:
13. ____ Will be satisfied through the use of working capital accounts.
14. ____ Presented fairly in conformity with GAAP.
15. ____ The larger the better from a debt holder's perspective.
16. ____ Supported by a negotiable instrument.
17. ____ Supplemental disaggregated data.

Answer: 13-B; 14-J; 15-I; 16-F; 17-H

78 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 3 The Balance Sheet

Use the following to answer questions 18-22:

18-22. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term placing the letter designating the best term
in the space provided by the phrase.

Terms:
A. Accrued liabilities
B. Current liabilities
C. Intangible asset
D. Liquidity
E. Long-term solvency
F. Notes receivable
G. Qualified opinion
H. Segment information
I. Times interest earned ratio
J. Unqualified opinion
Phrases:
18. ____ Scope limitation or a departure from GAAP.
19. ____ Related to the debt to equity ratio.
20. ____ Relates to the amount of time before an asset is converted to cash or a liability is paid.
21. ____ Recorded when an expense is incurred but not yet paid.
22. ____ Ownership of an exclusive right.

Answer: 18-G; 19-E; 20-D; 21-A; 22-C

Use the following to answer questions 23-27:

23-27. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term placing the letter designating the best term
in the space provided by the phrase.

Terms:
A. Cash equivalent
B. Current assets
C. Debt to equity ratio
D. Disclaimer
E. Inventories
F. Operational assets
G. Proxy statement
H. Short-term investments
I. Subsequent events
J. Summary of significant accounting policies
Phrases:
23. ____ One-month certificate of deposit.
24. ____ Occurs after the fiscal year-end, but before the statements are issued.
25. ____ Liquid investments not classified as cash equivalents.
26. ____ Items expected to be converted to cash or consumed within one year or the operating
cycle.
27. ____ Includes fixed and intangible assets.

Answer: 23-A; 24-I; 25-H; 26-B; 27-F

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Chapter 3 The Balance Sheet

Use the following to answer questions 28-32:

28-32. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term placing the letter designating the best term
in the space provided by the phrase.

Terms:
A. Cash equivalent
B. Current assets
C. Debt to equity ratio
D. Disclaimer
E. Inventories
F. Operational assets
G. Proxy statement
H. Short-term investments
I. Subsequent events
J. Summary of significant accounting policies
Phrases:
28. ____ Includes disclosures of executive compensation.
29. ____ Important in comparing financial information across companies.
30. ____ If four to one, 80% of assets are debt financed.
31. ____ Goods to be sold in the ordinary course of business.
32. ____ Given by an auditor when information is insufficient to express an opinion.

Answer: 28-G; 29-J; 30-C; 31-E; 32-D

Use the following to answer questions 33-37:

33-37. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term placing the letter designating the best term
in the space provided by the phrase.

Terms:
A. Acid-test ratio
B. Adverse opinion
C. Balance sheet
D. Deficit
E. Investments and funds
F. Operating cycle
G. Other assets
H. Prepaid expenses
I. Trade receivables
J. Working capital
Phrases:

33. ____ Due to substantial reporting errors, qualified opinion is not appropriate.
34. ____ Due from customers in the ordinary course of business.
35. ____ Current assets minus current liabilities.
36. ____ Insurance premiums paid in advance.
37. ____ Converting cash to inventory to receivables to cash.

Answer: 33-B; 34-I; 35-J; 36-H; 37-F

80 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 3 The Balance Sheet

Use the following to answer questions 38-42:

38-42. Listed below are ten terms followed by a list of phrases that describe or characterize five of
the terms. Match each phrase with the correct term placing the letter designating the best term
in the space provided by the phrase.

Terms:
A. Acid-test ratio
B. Adverse opinion
C. Balance sheet
D. Deficit
E. Investments and funds
F. Operating cycle
G. Other assets
H. Prepaid expenses
I. Trade receivables
J. Working capital
Phrases:
38. _____ Assets not used directly in operations.
39. ____ An organized array of assets, liabilities and equity at a point in time.
40. ____ Also known as the quick ratio.
41. ____ A discouraging retained earnings balance.
42. ____ A catch-all classification.

Answer: 38-E; 39-C; 40-A; 41-D; 42-G

Multiple Choice Questions

43. The balance sheet reports:


A) Net income at a point in time.
B) Cash flows for a period of time.
C) Assets and equities at a point in time.
D) Assets and liabilities for a period of time.

Answer: C Learning Objective: 1 Level of Learning: 2

44. Liquidity refers to:


A) The amount of cash on hand at a given time.
B) The readiness of an asset to be converted to cash.
C) The period of time until cash is used and refinancing becomes necessary.
D) Financial leverage.

Answer: B Learning Objective: 9 Level of Learning: 1

45. Lack of long-term solvency refers to:


A) Risk of non-payment relative to liabilities in the capital structure.
B) The length of time before long-term debt becomes due.
C) The ability to refinance long-term debt when it becomes due.
D) Long-term assets.

Answer: A Learning Objective: 9 Level of Learning: 1

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Chapter 3 The Balance Sheet

46. Assets do not include:


A) Property, plant, and equipment.
B) Investments and funds.
C) Paid-in capital.
D) Unexpired insurance.

Answer: C Learning Objective: 3 Level of Learning: 1

47. Current assets include cash and all other assets expected to become cash or be consumed:
A) Within one year.
B) Within one operating cycle.
C) Within one year or one operating cycle, whichever is shorter.
D) Within one year or one operating cycle, whichever is longer.

Answer: D Learning Objective: 2 Level of Learning: 1

48. New Oaks Winery requires two months to make wine, two years to age it, one month to bottle
it, two months to sell it, and one month to collect the receivable. Its operating cycle is:
A) Twelve months.
B) Thirty months.
C) Six months.
D) Three months.

Answer: B Learning Objective: 2 Level of Learning: 2

49. Cash equivalents would not include:


A) Cash not available for current operations.
B) Money market funds.
C) United States treasury bills.
D) Bank drafts.

Answer: A Learning Objective: 3 Level of Learning: 1

50. Cash equivalents would include:


A) Highly liquid equity securities.
B) Accounts receivable from a financial institution.
C) A sinking fund for bonds that mature in three years.
D) Debt instruments with maturity dates of less than three months from the date of the
purchase.

Answer: D Learning Objective: 3 Level of Learning: 1

51. Red Onion Restaurant classifies a six-month prepaid insurance policy as a current asset. Its
rationale is based on:
A) Materiality.
B) Operating cycle.
C) Definition.
D) Liquidity.

Answer: C Learning Objective: 2 Level of Learning: 1

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Chapter 3 The Balance Sheet

52. Assets that are not expected to provide economic benefits within one year or the operating
cycle are :
A) Goodwill.
B) Noncurrent assets.
C) Capital assets.
D) Capital.

Answer: B Learning Objective: 2 Level of Learning: 1

53. Nonoperating assets include:


A) Inventory held for sale.
B) Construction in progress.
C) Trade receivables.
D) Land held for a possible future plant site.

Answer: D Learning Objective: 2 Level of Learning: 2

54. The usual difference between accounts payable and notes payable is:
A) Legally enforceable debt.
B) Current-noncurrent classification.
C) Known payment terms.
D) Explicitly stated interest.

Answer: D Learning Objective: 4 Level of Learning: 2

55. Accrued expenses:


A) Are generally paid in services rather than cash.
B) Result from payment before services are received.
C) Result from services received before payment.
D) Are deferred charges to expense.

Answer: C Learning Objective: 3 Level of Learning: 1

56. Disclosure notes would not include:


A) Depreciation methods used and estimated useful life.
B) Definitions of cash equivalents.
C) Details of pension plans.
D) Data to adjust the financial statements so that they are not misleading.

Answer: D Learning Objective: 5 Level of Learning: 2

57. A subsequent event for an entity with a December 31, 2006, year-end would not include:
A) A change in the estimated useful lives of equipment in January 2007.
B) An issuance of bonds in January 2007.
C) An acquisition of another company in January 2007.
D) A major uncertainty at December 31, resolved in January 2007.

Answer: A Learning Objective: 5 Level of Learning: 2

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Chapter 3 The Balance Sheet

58. An example of fraud would be:


A) Issuing a purchase order without first securing bids.
B) Buying raw materials from an affiliated company.
C) Knowingly classifying a noncurrent receivable as a current receivable.
D) Forgetting to accrue salaries and wages payable.

Answer: C Learning Objective:7 Level of Learning: 2

59. An example of an error would be:


A) Purchasing inventory from a related party.
B) Carelessly counting an inventory item twice when taking a physical inventory.
C) Holding back invoices so that accounts payable are understated.
D) Receiving kickbacks in exchange for issuing a purchase order to a vender.

Answer: B Learning Objective: 7 Level of Learning: 2

60. The Management Discussion and Analysis section of the annual report can best be described
as:
A) Frank but objective.
B) Independent but precise.
C) Legalistic and lengthy.
D) Biased but informative.

Answer: D Learning Objective: 6 Level of Learning: 1

61. An exception leading to a qualified opinion would not include:


A) Material uncertainty.
B) Inadequate disclosures.
C) Limitations on scope.
D) Lack of conformity with GAAP.

Answer: A Learning Objective: 7 Level of Learning: 2

62. The current ratio is given by:


A) Current assets divided by noncurrent assets.
B) Current assets divided by total assets.
C) Current assets divided by current liabilities.
D) Current assets divided by total liabilities.

Answer: C Learning Objective: 9 Level of Learning: 1

63. The acid-test ratio is also known as the:


A) Current ratio.
B) Debt equity ratio.
C) Times interest earned ratio.
D) Quick ratio.

Answer: D Learning Objective: 9 Level of Learning: 1

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Chapter 3 The Balance Sheet

64. The quick ratio is:


A) The liquidity ratio divided by the equity ratio.
B) Current assets minus inventory divided by current liabilities minus accounts payable.
C) Current assets minus inventory and prepaid items divided by current liabilities.
D) Cash divided by accounts payable.

Answer: C Learning Objective: 9 Level of Learning: 1

65. The principal concern with accounting for related party transactions is:
A) The lack of arms-length negotiations.
B) Differences between economic substance and legal form.
C) The absence of legally binding contracts.
D) The lack of accurate data to record transactions.

Answer: A Learning Objective: 5 Level of Learning: 2

66. Working capital is equal to:


A) Current assets.
B) Current liabilities.
C) Current assets plus current liabilities.
D) Current assets minus current liabilities.

Answer: D Learning Objective: 9 Level of Learning: 1

67. Which of the following is not a financing ratio?


A) Time interest earned ratio
B) The debt to equity ratio
C) The current ratio
D) All of the above are financing ratios.

Answer: C Learning Objective: 9 Level of Learning: 2

68. When a company pays its bill from a plumber for previous services on account,:
A) Its debt to equity ratio always decreases.
B) Its acid-test ratio always remains unchanged.
C) Its current ratio always remains unchanged.
D) All of the above are correct.

Answer: A Learning Objective: 9 Level of Learning: 2

69. When a company accrues federal income taxes at the end of the accounting period,:
A) Its acid-test ratio increases.
B) Its current ratio increases.
C) Its debt to equity ratio decreases.
D) None of the above is correct.

Answer: D Learning Objective: 9 Level of Learning: 2

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Chapter 3 The Balance Sheet

70. When a company sells land for cash and makes a $25,000 gain,:
A) Its acid-test ratio decreases.
B) Its current ratio decreases.
C) Its debt to equity ratio decreases.
D) Cannot determine from the given information.

Answer: C Learning Objective: 9 Level of Learning: 3

71. Assume a company's liquidity and financing ratios all are less than 1.0 before it purchases
inventory on credit. When it makes the purchase,:
A) Its current ratio decreases.
B) Its quick ratio decreases.
C) Its current ratio remains unchanged.
D) Its quick ratio remains unchanged.

Answer: B Learning Objective: 9 Level of Learning: 2

72. Which of the following accounts are closed at the end of the accounting period?
A) Allowance for uncollectibles
B) Unearned revenue
C) Retained earnings
D) Provision for income taxes

Answer: D Learning Objective: 2 Level of Learning: 1

73. Which is a shareholders' equity account on the balance sheet?


A) Accumulated depreciation
B) Paid-in capital
C) Dividends payable
D) Marketable securities

Answer: B Learning Objective: 2 Level of Learning: 1

74. Rent collected in advance is:


A) An asset account in the balance sheet.
B) A liability account in the balance sheet.
C) A shareholders' equity account in the balance sheet.
D) A temporary account, not in the balance sheet at all.

Answer: B Learning Objective: 2 Level of Learning: 1

75. Notes payable:


A) Is a current liability account.
B) Usually has a debit balance.
C) Is a non-current liability account.
D) Cannot determine its classification without additional information.

Answer: D Learning Objective: 2 Level of Learning: 1

86 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 3 The Balance Sheet

76. Which of the following is never a current liability account?


A) Accrued payroll
B) Dividends payable
C) Prepaid rent
D) Subscriptions collected in advance

Answer: C Learning Objective: 2 Level of Learning: 1

Use the following to answer questions 77-80:

The following is a partial balance sheet ($$$ in thousands) for Paisano Seafood Inc. is shown below.

Current assets: Current Liabilities:

Cash $ 60 Accounts payable $240


Accounts receivable (net) 170 Other liabilities 80
Notes receivable 50 Total current liabilities 320
Inventories 200 Long-term liabilities 110
Prepaid expenses 25 Total liabilities 430
Total current assets 505 Shareholders' equity:
Plant assets (net) 255 Capital stock 150
Retained earnings 180
Total shareholders' equity 330
Total assets $760 Total liabilities and equity $760

77. The current ratio is:


A) 1.98.
B) 1.58.
C) 1.17.
D) 0.66.

Answer: B Learning Objective: 9 Level of Learning: 3

Rationale: Current ratio: $505/$320 = 1.58

78. Working capital is:


A) $505.
B) $265.
C) $185.
D) $75.

Answer: C Learning Objective: 9 Level of Learning: 3

Rationale: Working capital: $505 - 320 = 185

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Chapter 3 The Balance Sheet

79. Quick assets total:


A) $60.
B) $230.
C) $280.
D) $305.

Answer: C Learning Objective: 9 Level of Learning: 3

Rationale: Quick assets: $505 200- 25 = 280

80. The acid-test ratio is:


A) 0.25.
B) 0.88.
C) 1.17.
D) 1.58.

Answer: B Learning Objective: 9 Level of Learning: 3

Rationale: Acid test ratio: ($505 200 25)/$320 = .88

Use the following to answer questions 81-83:

Recent financial statement data for Harmony Health Foods (HHF) Inc. is shown below.

Current liabilities $ 180 Income before interest and taxes $ 125


10% Bonds, long-term 360 Interest expense 36
Total liabilities 540 Income before tax 89
Shareholders' equity Income tax 27
Capital stock 200 Net income $ 62
Retained earnings 280
Total shareholders' equity 480
Total liabilities and equity $1,020

81. HHF's debt-to-equity ratio is:


A) 0.75.
B) 1.13.
C) 0.53.
D) 1.80.

Answer: B Learning Objective: 9 Level of Learning: 3

Rationale: Debt-to-equity ratio: $540/$480 = 1.13

82. HHF's times interest earned ratio is:


A) 3.47.
B) 1.73.
C) 2.47.
D) 10.0.

Answer: A Learning Objective: 9 Level of Learning: 3

Rationale: Times interest earned ratio:125/$36 = 3.47

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Chapter 3 The Balance Sheet

83. HHF's long term debt-to-equity ratio equity is:


A) 133.3%.
B) 75%.
C) 180%.
D) 0%.

Answer: B Learning Objective: 9 Level of Learning: 3

Rationale: Long Term Debt-to-equity ratio: $360/$480 = 75%

Use the following to answer questions 84-87:

Listed below are account balances (in $millions) taken from the records of Symphony Stores. All of
these are permanent accounts, except the last two that have yet to be closed. The installment
receivables are current. Symphony uses a perpetual inventory system.

Debit Credit
Accounts receivable-trade 680
Building and equipment 920
Cash-checking 34
Installment receivables 65
Interest receivable 30
Inventory 16
Land 150
Notes receivable Long-term 450
Petty cash funds 5
Prepaid expenses (for coming year) 20
Supplies 8
Trademark 40
Accounts payable-trade 560
Accumulated depreciation 80
Additional paid-in capital, common 485
Allowance for uncollectible accounts 20
Cash dividends payable 30
Common stock, at par 15
Deferred gross profit 15
Income tax payable 65
Notes payable (long-term) 800
Retained earnings 48
Unearned revenues 40
Cash dividends declared-common 120
Income summary 380
_____ _____
TOTALS 2,538 2,538

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Chapter 3 The Balance Sheet

84. What would Symphony report as total current assets?


A) $823.
B) $838.
C) $843.
D) $1,696.

Answer: A Learning Objective: 2 Level of Learning: 3

Rationale: Total current assets: ($680 20) + 34 + ($65 15) + 30 + 16 + 5 + 20 + 8 = $823

85. What would Symphony report as total assets?


A) $2,338.
B) $2,323.
C) $2,318.
D) $2,303.

Answer: D Learning Objective: 3 Level of Learning: 3

Rationale: Total assets: ($680 20) + ($920 80) + 34 + ($65 15) + 30 + 16 + 150 + 450 +
5 + 20 + 8 + 40 = $2,303

86. What would Symphony report as total shareholders' equity?


A) $548.
B) $808.
C) $838.
D) $778.

Answer: B Learning Objective: 3 Level of Learning: 3

Rationale: Total shareholders equity: $485 + 15 + 48 120 + 380 = $808

87. What is the amount of working capital for Symphony?


A) $ 98.
B) $143.
C) $128.
D) $113.

Answer: C Learning Objective: 3 Level of Learning: 3

Rationale:
Current assets: ($680 20) + 34 + ($65 15) + 30 + 16 + 5 + 20 + 8 = $823
Current liabilities: $560 + 30 + 65 + 40 = 695
Working capital $128

90 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 3 The Balance Sheet

Problems

Use the following to answer questions 88-98:

Indicate whether each of the actions listed below will immediately increase (I), decrease (D), or have
no effect (N) on the ratios shown. Assume each ratio is greater than 1.0 before the action is taken.

88.
Current ratio Acid-test ratio Total debt-to-equity ratio
Prepay rent costs for 3 months

Answer:
Current ratio Acid-test ratio Total debt-to-equity ratio
Prepay rent costs for 3 months N D N

Learning Objective: 9 Level of Learning: 3

89.
Current ratio Acid-test ratio Total debt-to-equity ratio
Cash sale of land for a gain

Answer:
Current ratio Acid-test ratio Total debt-to-equity ratio
Cash sale of land for a gain I I D

Learning Objective: 9 Level of Learning: 3

90.
Current ratio Acid-test ratio Total debt-to-equity ratio
Purchase of inventory on account

Answer:
Current ratio Acid-test ratio Total debt-to-equity ratio
Purchase of inventory on account D D I

Learning Objective: 9 Level of Learning: 3

91.
Current ratio Acid-test ratio Total debt-to-equity ratio
Write off of uncollectible accounts
receivable

Answer:
Current ratio Acid-test ratio Total debt-to-equity ratio
Write off of uncollectible accounts
receivable N N N

Learning Objective: 9 Level of Learning: 3

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Chapter 3 The Balance Sheet

92.
Current ratio Acid-test ratio Total debt-to-equity ratio
Refinancing currently-maturing debt
for five more years

Answer:
Current ratio Acid-test ratio Total debt-to-equity ratio
Refinancing currently-maturing debt
for five more years I I N

Learning Objective: 9 Level of Learning: 3

93.
Current ratio Acid-test ratio Total debt-to-equity ratio
Purchase advertising on 30-day
credit

Answer:
Current ratio Acid-test ratio Total debt-to-equity ratio
Purchase advertising on 30-day
credit D D I

Learning Objective: 9 Level of Learning: 3

94.
Current ratio Acid-test ratio Total debt-to-equity ratio
Payment of recently accrued income
taxes

Answer:
Current ratio Acid-test ratio Total debt-to-equity ratio
Payment of recently accrued income
taxes I I D

Learning Objective: 9 Level of Learning: 3

95.
Current ratio Acid-test ratio Total debt-to-equity ratio
Cash sale of inventory for a profit

Answer:
Current ratio Acid-test ratio Total debt-to-equity ratio
Cash sale of inventory for a profit I I D

Learning Objective: 9 Level of Learning: 3

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Chapter 3 The Balance Sheet

96.
Current ratio Acid-test ratio Total debt-to-equity ratio
Purchase of a warehouse with a 6-
month note

Answer:
Current ratio Acid-test ratio Total debt-to-equity ratio
Purchase of warehouse with a 6-
month note D D I

Learning Objective: 9 Level of Learning: 3

97.
Current ratio Acid-test ratio Total debt-to-equity ratio
Issuance of long-term debt for cash

Answer:
Current ratio Acid-test ratio Total debt-to-equity ratio
Issuance of long-term debt for cash I I I

Learning Objective: 9 Level of Learning: 3

98.
Current ratio Acid-test ratio Total debt-to-equity ratio
Record annual depreciation on office
equipment

Answer:

Current ratio Acid-test ratio Total debt-to-equity ratio


Record annual depreciation on office
equipment N N I

Learning Objective: 9 Level of Learning: 3

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Chapter 3 The Balance Sheet

99. The December 31, 2006, post-closing trial balance (in $ thousands) for Libby Corporation is
presented below:

Debits Credits
Cash 22,500
Investments 55,000
Accounts receivable 30,000
Allowance for uncollectible accounts 7,500
Prepaid insurance 4,500
Inventories 100,000
Land 45,000
Buildings 140,000
Accumulated depreciation - buildings 50,000
Equipment 132,500
Accumulated depreciation - equipment 30,000
Patents (unamortized balance) 5,000
Accounts payable 37,500
Notes payable, due 2007 65,000
Interest payable 10,000
Bonds payable, due 2021 120,000
Common stock 150,000
Retained earnings _______ 64,500
Totals 534,500 534,500

Required: Prepare a classified balance sheet for Libby Corporation at December 31, 2006.

Answer:
Libby Corporation Balance Sheet
At December 31, 2006
(in thousands)

Assets
Cash $ 22,500
Accounts receivable 30,000
Less: Allowance for uncollectible accounts 7,500 $22,500
Inventories 100,000
Prepaid insurance 4,500
Total current assets 149,500
Investments 55,000
Property, plant, and equipment:
Land 45,000
Buildings 140,000
Equipment 132,500
317,500
Less: Accumulated depreciation 80,000
Net property, plant, and equipment 237,500
Intangibles:
Patents 5,000
Total assets $447,000

94 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 3 The Balance Sheet

Liabilities and Shareholders' Equity

Current liabilities:
Accounts payable $ 37,500
Notes payable, due 2007 65,000
Interest payable 10,000
Total current liabilities 112,500
Long-term liabilities:
Bonds payable, due 2021 120,000
Shareholders' equity:
Common stock $150,000
Retained earnings 64,500
Total shareholders' equity 214,500
Total liabilities and shareholders' equity $447,000

Learning Objective: 1 Level of Learning: 3

Use the following to answer questions 100-104:

The condensed balance sheet and income statement for Marjoram Company are presented below.

Marjoram Company
Balance Sheet
At December 31, 2006
Cash $ 19,000
Temporary investments in marketable 35,000
securities
Accounts receivable (net) 48,400
Merchandise inventory 70,600
Property, plant, and equipment (net) 250,000
Intangible assets 12,400
Total assets $435,400

Current liabilities $108,400


11% Bonds payable, long-term 100,000
Paid-in capital 70,000
Retained earnings 157,000
Total liabilities and equity $435,400

Marjoram Company
Income Statement
For the Year ended December 31, 2006
Sales $704,000
Cost of goods sold 422,400
Gross profit $281,600
Operating expenses 166,200
Operating income $115,400
Interest expense 11,000
Income before income taxes $104,400
Income taxes 31,320
Net income $ 73,080

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Chapter 3 The Balance Sheet

100. Compute the current ratio for Marjoram Company.

Answer: ($19,000 + 35,000 + 48,400 + 70,600) /$108,400 = 1.60 Current ratio

Learning Objective: 9 Level of Learning: 3

101. Compute the acid-test ratio for Marjoram Company.

Answer: ($19,000 + 35,000 + 48,400) /$108,400 = .94 Acid-test ratio

Learning Objective: 9 Level of Learning: 3

102. Compute the debt-to-equity ratio for Marjoram Company.

Answer: ($108,400 + 100,000) / ($70,000 + 157,000) = .92 Debt-to-equity ratio

Learning Objective: 9 Level of Learning: 3

103. Compute the times interest earned ratio for Marjoram Company.

Answer: ($73,080 + 31,320 + 11,000) /$11,000 = 10.49 Times interest earned ratio

Learning Objective: 9 Level of Learning: 3

104. Compute the return on shareholders' equity ratio for Marjoram Company.

Answer: $73,080 / ($70,000 + 157,000) = 32% Return on shareholders' equity

Learning Objective: 9 Level of Learning: 3

96 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 3 The Balance Sheet

Use the following to answer questions 105-109:

The balance sheet for Altoid Co. is shown below.

Altoid Co.
Balance Sheet
At December 31, 2006
Assets:
Cash $ 150
Short-term investments 200
Accounts receivable (net) 300
Inventories 450
Property, plant, and equipment (net) 1,100
Total assets $2,200

Liabilities and Shareholders' Equity:


Current liabilities $ 450
Long-term liabilities 600
Paid-in capital 150
Retained earnings 1,000
Total liabilities and shareholders' equity $2,200

Selected 2006 income statement information for Altoid Co. includes:

Net sales $7,700


Interest expense 90
Income tax expense 150
Net income 350

Required: Compute the following financial statements ratios for 2006:

105. Altoid Co.'s current ratio.

Answer: Current ratio: $(150 + 200 + 300 + 450) /$450 = 2.44

Learning Objective: 9 Level of Learning: 3

106. Altoid Co.'s acid-test ratio.

Answer: Acid-test ratio: $(150 + 200 + 300) /$450 = 1.44

Learning Objective: 9 Level of Learning: 3

107. Altoid Co.'s debt-to-equity ratio

Answer: Debt-to-equity ratio: $(450 + 600) /$(150 + 1,000) = .91

Learning Objective: 9 Level of Learning: 3

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Chapter 3 The Balance Sheet

108. Altoid Co.'s times interest earned ratio

Answer: Times interest earned ratio: $(350 + 150 + 90) /$90 = 6.56

Learning Objective: 9 Level of Learning: 3

109. Altoid Co.'s long term debt-to-equity ratio

Answer: Long term debt-to-equity $600/$1,150 = .52

Learning Objective: 9 Level of Learning: 3

Use the following to answer questions 110-116:

The following balance sheet and income statement information (in $ millions) comes from the Annual
Report to Shareholders of Kentucky Colonel Inc. (KCI) for the year ended, June 30, 2005:

Cash 975
Receivables 1,010
Inventory 1,055
Deferred Tax Asset 241
Current Assets 3,437
Total Assets 16,540

Accounts Payable 1,217


Income Tax Expense 239
Current Liabilities 5,747
Deferred Tax Liability 336
Long Term Debt 5,591
Total Liabilities 12,964
Retained Earnings 2,568
Shareholders' Equity 3,576

Net Sales 7,949


Total Operating Revenue 7,949
Cost of Goods Sold 4,767
Sales, General & Administrative 1,909
Interest Expense 416
Income Before Tax 667
Net Income 458

Required: Compute the following amounts for KCI:

110. Its working capital on June 30, 2005.

Answer: Working capital = $3,437 - 5,747 = - $2,310.

Learning Objective: 9 Level of Learning: 3

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Chapter 3 The Balance Sheet

111. Its noncurrent assets on June 30, 2005.

Answer: Noncurrent assets = $16,540 3,437 = $13,103

Learning Objective: 9 Level of Learning: 3

112. Its current ratio on June 30, 2005.

Answer: Current ratio = $3,437/$5,747 = 0.60

Learning Objective: 9 Level of Learning: 3

113. Its acid-test ratio on June 30, 2005.

Answer: Acid-test ratio = ($975 + 1,010)/$5,747 = 0.35

Learning Objective: 9 Level of Learning: 3

114. Its debt-to-equity ratio on June 30, 2005.

Answer: Debt-to-equity ratio: $12,964/$3,576 = 3.63

Learning Objective: 9 Level of Learning: 3

115. Its times interest earned ratio for the year ended June 30, 2005.

Answer: Times interest earned ratio: $(667 + 416) / $416 = 2.60

Learning Objective: 9 Level of Learning: 3

116. Its long term debt-to-equity ratio for the year ended June 30, 2005.

Answer: Long term debt-to-equity ratio: $5,591 / $3,576 = 1.56

Learning Objective: 9 Level of Learning: 3

Use the following to answer questions 117-120:

Bronco Electronics' current assets consist of cash, marketable securities, accounts receivable, and
inventories. The following data was abstracted from a recent financial statement:

Inventories $150,000
Total assets $1,400,000
Current ratio 3
Acid-test ratio 2.25
Debt-to-equity ratio 1.5

Required: Compute the following for Bronco:

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Chapter 3 The Balance Sheet

117. Current assets

Answer:
Current assets (CA)/Current Liabilities (CL) = 3; therefore, CA = 3 CL
Quick assets (QA)/Current Liabilities = 2.25; therefore, QA = 2.25 CL
QA = CA Inventory = CA - $150,000
2.25CL = 3 CL - $150,000
.75CL = $150,000
CL = $200,000
CA = $600,000

Learning Objective: 9 Level of Learning: 3

118. Shareholders' equity

Answer:
Total debt + Total equity = Total assets = $1,400,000
Debt/Equity = 1.5; therefore, Total debt = 1.5 Equity
1.5 Equity + 1 Equity = $1,400,000
2.5 Equity = $1,400,000; Shareholders' equity = $ 560,000

Learning Objective: 9 Level of Learning: 3

119. Noncurrent assets

Answer:
Total assets = Current assets + Noncurrent assets
$1,400,000 = $600,000 + Noncurrent assets
Noncurrent assets = $800,000

Learning Objective: 9 Level of Learning: 3

120. Long-term liabilities

Answer:
Total debt and equity $1,400,000
Total equity 560,000
Total debt $840,000
Current liabilities 200,000
Long-term liabilities $640,000

Learning Objective: 9 Level of Learning: 3

100 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 3 The Balance Sheet

Use the following to answer questions 121-124:

Spartan Sportswear's current assets consist of cash, marketable securities, accounts receivable, and
inventories. The following data was abstracted from a recent financial statement:

Inventories $180,000
Total assets $720,000
Current ratio 2.75
Acid-test ratio 1.5
Debt-to-equity ratio 1.4

Required: Compute the following for Spartan:

121. Current assets

Answer:
Current assets (CA)/Current Liabilities (CL) = 2.75; therefore, CA = 2.75 CL
Quick assets (QA)/Current Liabilities = 1.5; therefore, QA = 1.5 CL
QA = CA Inventory = CA - $180,000
1.5CL = 2.75 CL - $180,000
1.25CL = $180,000
CL = $144,000
CA = $396,000

Learning Objective: 9 Level of Learning: 3

122. Shareholders' equity

Answer:
Total debt + Total equity = Total assets = $720,000
Debt/Equity = 1.4; therefore, Total debt = 1.4 Equity
1.4 Equity + 1 Equity = $720,000
2.4 Equity = $720,000; Shareholders' equity = $ 300,000

Learning Objective: 9 Level of Learning: 3

123. Noncurrent assets

Answer:
Total assets = Current assets + Noncurrent assets
$720,000 = $396,000 + Noncurrent assets
Noncurrent assets = $324,000

Learning Objective: 9 Level of Learning: 3

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Chapter 3 The Balance Sheet

124. Long-term liabilities

Answer:
Total debt and equity $720,000
Total equity 300,000
Total debt $420,000
Current liabilities 144,000
Long-term liabilities $276,000

Learning Objective: 9 Level of Learning: 3

125. The following balance sheet information (in $ millions) comes from the Annual Report to
Shareholders of Marriott International Inc. for the year ended, January 2, 2004. Certain
amounts have been blackened out to test your understanding of balance sheets. In addition,
you are provided with the following information from an analysis of Marriott's financial
position at the same date:
Current ratio = 0.6973; Acid-test ratio = 0.5240; Debt-to-equity ratio = 1.131

Required: Compute the missing amounts (rounded to the nearest $millions) in the Marriott
balance sheet.

ASSETS
Current assets
Cash and equivalents 229
Accounts and notes receivable ?
Prepaid taxes ?
Other 84
Total current assets ?
Property and equipment, net 2,513
Intangible assets, net ?
Investments in affiliates 1,026
Notes and other receivables, net 1,104
Other 850
Total noncurrent assets ?
Total assets ?

102 Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition


Chapter 3 The Balance Sheet

LIABILITIES AND SHAREHOLDERS' EQUITY


Current liabilities
Accounts payable 584
Accrued payroll and benefits 412
Self-insurance 43
Other payables and accruals 731
Total current liabilities 1,770
Long-term debt ?
Other long-term liabilities 1,178
Total long-term liabilities ?
Total liabilities ?
Shareholders' equity
Class A common stock, 255.6 million shares issued 3
Additional paid-in capital 3,317
Retained earnings ?
Treasury stock and other (987)
Total shareholders equity ?
Total liabilities and shareholders equity 8,177

Answer:
The completed balance sheet is shown below. To solve the problem, students can start by
using the debt-to-equity ratio to solve for either total liabilities or total shareholders' equity.
Once they determine one, they can compute the other from the total. Then they can determine
the other missing data in the bottom half of the balance sheet by subtraction. With total
liabilities and shareholders' equity known, so are the total assets. The current assets can be
computed by the current ratio. The quick assets can be found from the acid-test ratio. The
difference between the two leads to computing the missing prepaid taxes amount. With that
known, the student can compute the accounts and notes receivable. Finally, with current and
total assets determined, the noncurrent assets can be found, leading to the missing balance in
intangible assets.

ASSETS
Current assets
Cash and equivalents 229
Accounts and notes receivable 699
Prepaid taxes 223
Other 84
Total current assets 1,235
Property and equipment, net 2,513
Intangible assets, net 1,449
Investments in affiliates 1,026
Notes and other receivables, net 1,104
Other 850
Total noncurrent assets 6,942
Total assets 8,177

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Chapter 3 The Balance Sheet

LIABILITIES AND SHAREHOLDERS' EQUITY


Current liabilities
Accounts payable 585
Accrued payroll and benefits 412
Self-insurance 43
Other payables and accruals 731
Total current liabilities 1,771
Long-term debt 1,391
1,1
Other long-term liabilities 78
Total long-term liabilities 2,569
4,34
Total liabilities 0
Shareholders' equity
Class A common stock, 255.6 million shares issued 3
Additional paid-in capital 3,317
Retained earnings 1,504
Treasury stock and other (987)
Total shareholders equity 3,837
Total liabilities and shareholders equity 8,177

Learning Objective: 9 Level of Learning: 3

Essay

The following answers point out the key phrases that should appear in students answers. They are not
intended to be examples of complete student responses. It might be helpful to provide detailed
instructions to students on how brief or in-depth you want their answers to be.

126. Briefly explain the purpose of the disclosure note on significant accounting policies. Provide
two examples of what might be found in this note.

Answer:
There are many areas where management chooses from among equally acceptable alternative
accounting methods. The summary of significant accounting policies conveys valuable
information about the company's choices, which can significantly impact earnings and
financial position. Examples include depreciation methods, inventory methods, revenue
recognition methods and the content of cash equivalents.

Learning Objective: 5 Level of Learning: 3

127. Briefly explain what is meant by a subsequent event. Give two examples of subsequent events.

Answer:
A subsequent event is a significant development that takes place after an entity's fiscal year-
end but before the financial statements have been issued. Examples include issuance of debt
or equity securities, mergers, discontinued operations, and resolution of uncertainties that
existed at the balance sheet date.

Learning Objective: 5 Level of Learning: 3

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Chapter 3 The Balance Sheet

128. Using an example, discuss the techniques that analysts use to transform accounting numbers
into more useful forms.

Answer:
Analysts convert accounting numbers into ratios in order to control for size differences over
time and among firms. In addition, they use horizontal analysis, comparing changes in certain
metrics over time, and vertical analysis, comparing each financial statement item to a base
total, such as sales revenue. Adjustments for differences in accounting methods allow analysts
to compare results from different companies.

Learning Objective: 8 Level of Learning: 3

129. Explain how management's discussion and analysis of its operations and liquidity may be
helpful to investors.

Answer:
Although the financial statement numbers give a partial picture of how well the company has
been performing its operations and how liquid it is, management is in a better position to
describe key factors that influence these measures and what risks and opportunities exist that
may affect future operations and liquidity.

Learning Objective: 6 Level of Learning: 2

130. Describe the nature of current liability accounts that would not require the payment of cash.

Answer:
One type of current liability that would not require the payment of cash is the liability created
when payment is received before services are provided. Examples of these unearned revenues
include unearned airline fares, unearned subscription revenue, etc. Also, current liabilities may
be satisfied by the creation of other liabilities.

Learning Objective: 4 Level of Learning: 3

131. The following is the 2004 report of independent accountants for Delta Airlines:
"We have audited the accompanying consolidated balance sheets of Delta Air Lines, Inc. and
subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated
statements of operations, cash flows and shareowners (deficit) equity for each of the three
years in the period ended December 31, 2004. These financial statements are the responsibility
of the Companys management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

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Chapter 3 The Balance Sheet

In our opinion, such consolidated financial statements referred to above present fairly, in all
material respects, the financial position of the Company as of December 31, 2004 and 2003,
and the results of its operations and its cash flows for each of the three years in the period
ended December 31, 2004, in conformity with accounting principles generally accepted in the
United States of America.

The accompanying consolidated financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the consolidated
financial statements, the Company has had recurring losses from operations, faces significant
liquidity issues, and may need to seek protection under Chapter 11 of the U.S. Bankruptcy
Code. Such matters raise substantial doubt about the Company s ability to continue as a going
concern. Managements plans concerning these matters are also described in Note 1. The
consolidated financial statements do not include any adjustments that might result from the
outcome of this uncertainty.

As discussed in Note 1 to the consolidated financial statements, effective, January 1, 2002, the
Company changed its method of accounting for goodwill and other intangible assets to
conform to Statement of Financial Accounting Standards No.142.

We have also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of the Companys internal control over
financial reporting as of December 31, 2004, based on the criteria established in Internal
Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission and our report dated March 9, 2005 expressed an unqualified opinion
on management s assessment of the effectiveness of the Companys internal control over
financial reporting and an unqualified opinion on the effectiveness of the Companys internal
control over financial reporting."

Required. Interpret the main points indicated in this report by Delta's auditors.

Answer:
1. The accountant has conducted an audit of Delta's financial statements, using typical
auditing standards and procedures. There is no limitation indicated in what they
examined. Therefore, the auditor expressed a reasonable basis for forming the opinion on
these statements.
2. The statements were judged to be fairly presented, meaning that they were within a
material range of accuracy relative to generally accepted accounting principles in the U.S..
3. Because of recent losses and liquidity risks, the going concern assumption on which the
financial statements are based is subject to substantial doubt in this situation.
4. Delta made a change in its accounting method for good will and other intangible assets to
comply with SFAS No. 142.
5. The audit also has examined the effectiveness of Delta's internal controls over financial
reporting, in accordance with the Public Company Accounting Oversight Board standards,
and expressed an unqualified opinion about that effectiveness.

Learning Objective: 7 Level of Learning: 3

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Chapter 3 The Balance Sheet

132. List the circumstances under which land would be classified under the following balance sheet
classifications:
(a.) Current assets.
(b.) Investments.
(c.) Property, plant, and equipment.
(d.) Other noncurrent assets.

Answer:
(a.) Land held for short-term speculation would be a short-term investment. Land could also
be held as inventory.
(b.) Land could be held as a long-term investment.
(c.) The most common use of land would be under this category when it is actively used in
operations.
(d.) Land in idle use or held as a future building site could be included in this category.

Learning Objective: 3 Level of Learning: 3

133. The following is an excerpt from the Management Discussion & Analysis section in United
Airlines' 2004 annual report to shareholders:

"Several significant events and trends have adversely impacted our operating revenues since
2000. General economic conditions in the United States began to weaken in 2001, and slower
economic growth adversely impacted airline revenues for several years thereafter. The terrorist
attacks of September 11, 2001, significantly reduced consumer demand for air travel well into
2002 due to ongoing consumer concerns about further terrorist activities. Enhanced airport
security measures were enacted into law shortly after the terrorist attacks, which increased
airport inconvenience and produced some negative customer reaction. Our revenues were also
adversely affected by the enactment of federal taxes on ticket sales to fund those new security
measures, which reduced our net revenues from ticket sales, since such taxes could not easily
be passed on to customers in the form of higher ticket prices. The outbreak of Severe Acute
Respiratory Syndrome in early 2003 further reduced demand for air travel for a time,
particularly for air carriers like us with significant operations in Asia. The growth of low-cost
carriers in the United States has placed further downward pressures on revenues by forcing us
to compete with discounted fares offered by low-cost airlines in a growing percentage of the
markets we serve. The growth of such low-cost carriers has also added new capacity into the
domestic U.S. aviation system, which has further aggravated the imbalance between air
transportation supply and demand. These and other adverse factors caused United mainline
passenger revenue per revenue passenger mile to decline from 13.3 cents in 2000 (the last year
we reported an operating profit) to 10.8 cents in 2004. We have been able to increase mainline
load factors over the same time period to partially compensate for lower ticket prices. In
addition, we have replaced some mainline flying by United with the operation of smaller
aircraft by United Express regional carriers; these revenues have increased by 50% between
2002 and 2004.

During the same time period, our operating expenses have fluctuated as we sought to
restructure our obligations in bankruptcy, adjust our mainline and regional carrier operating
capacity to match marketplace demand, and cope with historically high jet fuel prices
throughout this period. United mainline operating cost per available seat mile increased from
10.6 cents in 2000 to 12.0 cents in 2001, and then declined to 10.2 cents by 2004. In spite of
significant accomplishments in restructuring our operating expenses, including significant
contributions from employees and creditors through the bankruptcy process, high fuel costs
have had a significant adverse affect on unit operating costs, particularly in 2003 and 2004."

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Chapter 3 The Balance Sheet

Required. Briefly explain how this information provides useful information beyond that in the
financial statements of United.

Answer:
These detailed facts from management provide a much clearer sense of the interactions
between economic events (e.g., post 9/11/01) and the company's operations and plans. One
can see the impact on revenue enhancements, capital expenditures, fuel costs, and financial
and operational restructuring.

Learning Objective: 6 Level of Learning: 3

134. You are the independent accountant assigned to the audit of Neophyte Company. The
company's accountant, a graduate of Rival State University, has prepared financial statements
which contained the following questionable items:
a. The balance sheet reports land at $100,000. Included in this amount is a piece of
property purchased for a future warehouse site at a cost of $30,000.
b. Current liabilities include $50,000 for long-term debt that comes due in three
months. The company has received a suitable firm commitment to refinance the debt for
five years and intends to do so.
c. Investments in marketable securities include $20,000 in short-term, high-grade
commercial paper which is a cash equivalent.

Required. Describe the appropriate balance sheet presentation for the above items.

Answer:
a) Land for a future warehouse site should be listed under investment or other assets.
b) Debt to be refinanced under these circumstances should be classified as long-term
liabilities.
c) These items should be reported with cash under the category of cash and cash equivalents.

Learning Objective: 3 Level of Learning: 2

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Chapter 3 The Balance Sheet

135. You are reviewing the December 31, 2006 financial statements of Ellie's Antiques that is
considering an initial public offering of their shares. The following items come to your
attention:
a. Included in long-term investments are ten year U.S. Treasury bonds that mature March 31,
2007. The bonds were purchased November 20, 2006.
b. The property, plant, and equipment account is stated at cost, except that it includes a
parcel of land purchased for investment purposes at a cost of $40,000. Because of rising
land prices, the value of the land has been written up to $60,000. The company has an
independent appraisal that attests to this amount.
c. The accounts receivable account includes $20,000 due from officers and employees and a
two-year, 8% note for $25,000 due from a customer. The loan was to enable the customer
to buy equipment needed to process materials purchased from Ellie's Antiques.

Required: Determine the proper balance sheet presentation for the above items.

Answer:
(a.) These treasury bonds would typically be classified as short-term investments. If purchased
within three months of their maturity, they could be classified as cash equivalents.
(b.) The land should be reported in investments at the original cost of $40,000.
(c.) These receivables should be classified as nontrade receivables. Receivables from officers
and employees require separate disclosure, if material.

Learning Objective: 3 Level of Learning: 2

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 109