FN-580 Financial Statement Analysis

1) Distinguish between a reversing entry and an adjusting entry. Are

reversing entries required?
Reversing entries are not a mandatory step in accounting cycle; it is
only optional step of bookkeeping. A reversing entry will be made for
certain adjusting entries at the beginning of the next accounting
period. This reversing entry will be exact opposite of the adjusting
entry prepared at the time of end of the year.

2) Indicate, in the sequence in which they are made, the three required
steps in the three required steps in the accounting cycle that involve
journalizing.
Steps:
- Analyzing the business transaction
- Arranging the transactions in chronological order
- Preparation of the correct format of the journal
- Preparing the journal entries for that transaction

3) Identify, in the sequence in which they are prepared, the three trial
balances that are often used to report financial information about a
company.
- Preparation of normal trial balances
- Preparation of adjusted trial balances
- Preparation of post closing trial balances

4) How do correcting entities differ from adjusting entries?

Adjusting entries essential for accounting cycle, but correcting entries
are unnecessary if the records are error free. Adjusting journal entries
will be made only at the end of an accounting period, but correcting
entries will make whenever they discover and error. Adjusting entries
will affect at least one income statement account and one balance
sheet account but correcting entries may involve any combination of
accounts in need of correction, and correcting entries will post before
the closing entries.

5) What standard classifications are used in preparing a classified balance

sheet?
Assets:
- Current assets
- Long term investments
- Property, plant, and equipment
- Intangible assets
Liabilities and Stockholder Equity:
- Current liabilities

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- Long term liabilities
- Stockholders equity

6) What is meant by the term operating cycle?

An operating cycle indicates that average time that it takes to
purchase raw materials, sell it on account to customers, and then
collect cash from customers. Usually most of the business this cycle is
less than one year, hence they use cutoff for one year. But big
industries this cycle will take longer time for one year.

7) Define current assets. What basis is used for arranging individual items
within the current assets section?
Current assets are the assets which convert into cash or use up within
one year or one operating cycle whichever is longer. Current assets
will report in balance sheet in the order in which they expect to convert
them into cash.
Companies will report the following order:
- Cash and cash equivalents
- Short term investments
- Accounts receivable
- Inventories
- Prepaid expenses and other current assets

8) Distinguish between long-term investments and property, plant, and

equipment.
Long term investment is the investment which a company invests their
funds in other companys bonds or stocks. But company invests cash
into purchase of their fixed tangible assets are called Property, plant,
equipment. Long term investments are not useful for operating their
business activities. Property, plant and equipment are useful to
operate companys day to day business activities. Long term
investments are reported in the section of long term investments of
the balance sheet. But these tangible fixed assets (building, land, etc)
are reported in property, plant and equipment section of the balance
sheet.

9) (a) What is the term used to describe the owners equity section of a
corporation? (b) Identify the two owners equity accounts in a
corporation and indicate the purpose of each.
Stockholders are actual company owners, since their equity is reported
in balance sheet under stockholders equity section. Usually

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companies will show common stock, retained earnings accounts under
this section, since these are the compulsory accounts of the section.
Common stock accounts indicate that total paid up capital, and total
outstanding shares of the company. Retained earnings account will
report total funds available to stockholders collection from the income
statement as net income, and also dividend will be distributed from
this account only.

10) Using PepsiCos annual report, determine the current liabilities at

December 26, 2009, and December 27, 2008. Were current liabilities
higher or lower than current assets in these two years?
Current Liabilities and Current Assets analysis for PepsiCo for 2009 and
2008:
Current Liabilities for the two years:
December 26, 2009 December 27, 2008
Amount $ Amount $
8,756 8,787

Current Assets for the two years:

December 26, 2009 December 27, 2008
Amount $ Amount $
12,571 10,806

The current liabilities of PepsiCo for both years 2009 and 2008 are
lower than its current assets.

11) Sanchez Company prepares reversing entries. If the adjusting entry

for interest payable is reversed, what type of an account balance, if
any, will there be in Interest Payable and Interest Expense after the
reversing entry is posted?
The normal entry for an Interest Payable amount is:
Date Account Title and Ref. Debit Credit
Explanation $ $
Interest Expense xxx
Interest Payable xxx
(To record interest
expenses payable)

In case the above entry is reversed:

Date Account Title and Ref. Debit Credit
Explanation $ $
Interest Payable xxx
Interest Expense xxx
(To record reversing entry

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for interest expenses
payable)
After the reversing of the entry, the amount would be nullified or if
there is any balance left then Interest Expense will have a credit ledger
balance while Interest Payable will nullify.

12) At December 31, accrued salaries payable totaled $3,500. On January

10, total salaries of $8,000 are paid. (a) Assume that reversing entries
are made at January 1. Give the January 10 entry, and indicate that
Salaries and Wages Expense account balance after the entry is posted.
(b) Repeat part (a) assuming reversing entries are not made.

(a) Assuming that Reversing entries are made at Jan 1

Date Account Title and Ref. Debit Credit

Explanation $ $
Dec Salaries and Wage J3 3,500
31 Expenses 3.500
Salaries and Wage
Payable
(Accrued
Salaries)
Jan 1 Salaries and Wage Payable J3 3,500
Salaries and Wage 3,500
Expenses
(Reversing of Dec 31
entry)
Jan Salaries and Wage J3 8,000
10 Expense 8,000
Cash
(Total Salaries
paid)

Date Account Title and Ref. Debit Credit $Balance

Explanation $ $
Dec Salaries and Wage J3 3,500 3,500
31 Payable
Dec Salaries and Wage J3 3,500 -
31 Payable
Dec Cash J3 8,000 8,000
31

(b) Assuming when reversing entries are not made

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FN-580 Financial Statement Analysis
Date Account Title and Ref. Debit Credit
Explanation $ $
Dec Salaries and Wage J3 3,500
31 Expenses 3,500
Salaries and Wage
Payable
(Accrued Salaries)
Jan Salaries and Wage J3 8,000
10 Expense 8,000
Cash
(Total Salaries paid)

Date Explanation Ref. Debit Credit Balance

$ $ $
Dec Salaries and Wages J3 3,500
31 Payable
Jan Cash J3 11,500
10

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FN-580 Financial Statement Analysis

Chapter 5 page 238-239

1) (a) The steps in the accounting cycle for a merchandising company

are different from the accounting cycle for a service company. Do
you agree or disagree? (b) Is there measurement of net income for a
merchandising company conceptually the same as for a service
company? Explain.
(a) Disagree, since each of the required steps in the accounting cycle
for a service company applies to a merchandising company
(b) Measurement of net income:
The measurement of net income is conceptually same. In both
types of companies, net Income (or loss) results from the matching
of expenses with revenues.

2) Why is the normal operating cycle for a merchandising company likely

to be longer than for a service company?
The normal operating cycle for a merchandising company is likely to be
longer than in a service company. The purchase of merchandise
inventory and its eventual sale followed by the credit sales lengthen
the operating cycle. In case of servicing company all these things will
not be there, they receive cash for the service provided or record as
receivable on the service provided.

3) (a) How do the components of revenues and expenses differ between

merchandising and service companies? (b) Explain the income
measurements process in a merchandising company.
(a)
Particulars Merchansiding Service
Revenues Sales Fee, Rent, charge
Expenses Cost of Goods Sold, etc.
and Operating (only)
Operating

(b)
Sales (-) Cost = Gross (-) Operati = Net
Reven Less of Equal Profit Less ng Equal Incom
ue Goods s Expense s e
Sold s

4) How does income measurement differ between a merchandising and a

service company?
Income measurement for a merchandising company differs from a
service company as follows:

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a) Sales are the primary source of revenue in the merchandising
company while fee, rent and service charges are the sources of
revenue in the service companies.
b) Expenses is divided into two main categories: cost of goods sold
and operating expenses in merchandising companies while the
expenses are mainly operating in service companies.
c) Cost of goods should be considered in calculating the income for
merchandising company while operating expenses are the major
expenses and there will not be any cost of goods sold or inventory.

5) When is cost of goods sold determined in a perpetual inventory

system?
In a perpetual inventory system, cost of goods sold is determined each
time when a sale occurs. As the name suggests it is an updated record
for the cost of goods sold. When in periodic inventory system the cost
of goods sold is determined at the end of each period.

6) Distinguish between FOB shipping point and FOB destination. Identify

the freight terms that will result in a debit to Inventory by the buyer
and a debit to Freight-out by the seller.
FOB Shipping Point:
The letters FOB means, Free on Board. FOB shipping point means
that goods are placed on board of the carrier for free by the seller. The
buyer then pays the freight and debits Merchandise Inventory.
FOB Destination:
FOB destination means that the goods are placed free on board to the
buyers place of business. Thus, the seller pays the freight and debits
Freight-out.

7) Explain the meaning of the credit terms 2/10, n/30.

Meaning of 2/10:
Credit terms of 2/10 means a 2% cash discount will be given if
payment is made within 10 days of the invoice date.
Meaning of n/30:
If the payee fails to pay within the credit term period then he has to
pay the invoice price, less any returns, within 30 days from the invoice
date.

8) Goods costing $2,000 are purchased on account on July 15 with credit

terms of 2/10, n/30. On July 18, a $200 credit memo is received from
the supplier for damaged goods. Give the journal entry on July 24 to

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FN-580 Financial Statement Analysis
record payment of the balance due within the discount period using a
perpetual inventory system.

Purchase of inventory on account:

Date Account Title Debit Credit $
$
15-Jul Inventory 2,000
Accounts payable 2,000
To record purchase of inventory on
account.

Return of goods:
Date Account Title Debit Credit $
$
18-Jul Accounts payable 200
Inventory 200
To record return of goods purchased.

Payment of balance due:

Date Account Title Debit Credit $
$
24-Jul Accounts payable ($2,000-$200) 1,800
Cash 1,764
Inventory 36
To record payment within discount
period.
($1,800 ($1,800*2%))

Note:
Calculation of amount paid
Purchase on credit $2,000
Less-Purchase return ($200)
Balance $1800
Less-Cash discount ($1800*2%) (36)
Amount paid $1,764

9) Joan Roland believes revenues from credit sales may be earned before
they are collected in cash. Do you agree? Explain.
Yes, the statement is correct. On accrual basis, the revenue is
considered to be earned before it is collected in cash, once the legal
title to the goods that is the risks and rewards of ownership is
transferred to the buyer.

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

Cost of goods sold xxx

Merchandise inventory xxx
(Entry to record the cost of goods
sold)

For credit sales:

Dat Particulars L/F Dr$ Cr$
e
Accounts receivables xxx
Sales xxx
(Entry to record the credit sales)

Cost of goods sold xxx

Merchandise inventory xxx
(Entry to record the cost of goods
sold)

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

Date Account title Debit Credit $

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FN-580 Financial Statement Analysis
$
10-Jul Cost of goods sold 900
Inventory 900
To record cost of goods sold.

Date Account title Debit Credit $

$
12-Jul Sales returns 100
Accounts receivable 100
To record sale returns.

Date Account title Debit Credit $

$
12-Jul Inventory 100
Cost of goods sold 100
To record fair value of goods
returned.

Date Account title Debit Credit $

$
19-Jul Cash 784
Sales discounts 16
Accounts receivable 800
($900-$100)
To record collection of accounts
receivable within the discount
period.
($800-(800*2%))

Notes:
Cash received
Credit sales $900
Less-sales return ($100)
Net sales $800
Less-discount ($800*2%) ($16)
Cash receipt $784

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

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be incorrect due to a variety of causes such as recording errors, theft
or waste etc.

13) Prepare the closing entries for the Sales Revenue account, assuming a
balance of $200,000 and the Cost of Goods Sold account with a
$145,000 balance.
Date Account title Debit Credit $
$
31-Dec Sales revenue 200,00
0
Income summary 200,000
To record closing of sales revenue
account to the income summary
account.

Date Account title Debit Credit $

$
31-Dec Income summary 145,00
0
Cost of goods sold 145,000
To record closing of cost of goods
sold account to the income
summary account.

Note:
Expenses and revenues will be transferred to the income statement.

14) What merchandising account(s) will appear in the post-closing trial

balance?
Of the merchandising accounts, only Merchandise Inventory will appear
in the post-closing trial balance.

15) Reese Co. has sales revenue of $105,000, cost of goods sold of
$70,000, and operating expenses of $20,000. What are its gross profit
and its gross profit rate?

Gross profit is the difference between the sales revenue and cost of
goods sold.
Gross profit = Sales revenue Cost of goods sold
= $105,000-$70,000

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= $35,000
Therefore the gross profit=$35,000

Gross profit rate is ratio of gross profit to net sales.

Gross profit rate = Gross profit
Net sales
= $35,000
$105,000
= 33.33%
Therefore the gross profit rate=33.33%

16) Ann Fort Company reports net sales of $800,000, gross profit of
$370,000, and net income of $240,000. What are its operating
expenses?

Operating expenses are the difference between the gross profit and
net income.
Operating expenses = Gross profit-Net profit
= $370,000-$240,000
= $130,000
Therefore the operating expenses=$130,000

17) Identify the distinguishing features of an income statement for a

merchandising company.
There are three distinguishing features of an income statement for a
merchandising company:
- Sales revenues section
- Cost of goods sold section
- Gross profit

18) Identify the sections of a multiple-step income statement that relate to

(a) operating activities, and (b) non-operating activities.
(a) The operating activities section of the multi-step income statement
has three parts:
- Sales revenues
- Cost of goods sold
- Operating expenses

(b) The non-operating activities section of the multi-step income

statement consists of two parts:

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

19) How does the single-step form of income statement differ from the
multiple-step form?
The single step income statement differs from the multiple step
income statement as follows:
1- Total data is the be classified into two categories: revenues and
expenses
2- Only one step, subtracting total expenses from total revenues, is
required in determining net income (or net loss).
3- Where in multi step income statement several parts to be
calculated to determine the net income.

20) Determine PepsiCos gross profit rate for 2009 and 2008. Indicate
whether it increased or decreased from 2008-2009.
Gross profit rate = Gross profit x100
Net sales

2009 2008
Particulars Amount in Amount in
millions $ millions $
Net revenue (a) 43,232 43,251
Less: Cost of sales (b) 20,099 20,351
Gross Profit ( c) = (a) 23,133 22,900
(b)
Gross Profit rate (c ) 53.51% 52.95%
\ (a)
Gross profit rate 2009=53.51%
2008=52.95%
The gross profit rate has increased marginally in 2009 by 0.56%
(53.51%-52.95%) when compared to 2008.

21) Identify the accounts that are added to or deducted from Purchases to
determine the cost of goods purchased. For each account, indicate
whether it is added or deducted.
Cost of good purchased:
Accounts that are added to or deducted from the purchase to
determine the cost of goods purchased are as follows:
- Accounts to be deducted:
- Purchase returns and allowances
- Purchase discounts

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- Accounts to be added:
- Freight-in

22) Goods costing $3,000 are purchased on account on July 15 with credit
terms of 2/10, n/30. On July 18, a $200 credit was received from the
supplier for damaged goods. Give the journal entry on July 24 to
record payment of the balance due within the discount period,
assuming a periodic inventory system.

Date Account title Debit Credit

$ $
24-Jul Accounts payable ($3,000-$200) 2,800
Cash ($2,800 2,744
($2,800*2%))
Purchase discounts 56
($2,800*2%)
To record payment of accounts
payable within the discount period.

Note:
Calculation of amount paid
Purchase on credit $3,000
Less-Purchase returns ($200)
Balance $2,800
Less-cash discount ($2,800*2%) ($56)
Amount paid $2,744

23) Indicate the columns of the worksheet in which (a) inventory and (b)
cost of goods sold will be shown.
(a) Merchandise inventory:
- Trial balance-Debit side
- Adjusted trial balance-Debit side
- Balance sheet-Assets side
(b) Cost of Goods Sold:
- Trial Balance-Debit side
- Adjusted Trial Balance-Debit side
- Income Statement-Debit side

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