Chapter Review Problems
Unit 17.1 Income statements
1. When revenues exceed expenses, is the result (a) net income or (b) net loss? (a) net income
2. Do income statements reflect profits of a business (a) on a certain date or (b) over a given period of time? (b) over a
given period of time
3. Cost of goods sold is an important part of an income statement for service companies. (T or F) False
For Problems 4–6, fill in the missing amounts. Each problem represents a different situation. Negative values are in parentheses.
4.
5.
6.
Revenues
$108,000
$120,000
$ 69,000
Total expenses
$ 28,000
$130,000
$42,000
Net income (or loss)
$ 80,000
($10,000)
$27,000
7. Calculate net sales based on gross sales of $805,000; sales returns of $5,400; and sales discounts of $15,700.
Net sales = Gross sales - Sales returns - Sales discounts = $805,000 - $5,400 - $15,700 = $783,900
8. Calculate cost of goods sold based on $82,400 beginning inventory; $264,000 cost of goods purchased; and $94,800
ending inventory.
Cost of goods sold = Beginning inventory + Cost of goods purchased - Ending inventory
= $82,400 + $264,000 - $94,800 = $251,600
9. Refer to Problems 7 and 8. Calculate gross profit.
Gross profit = Net sales - Cost of goods sold = $783,900 - $251,600 = $532,300
10. Refer to Problem 9. Calculate net income based on operating expenses of $371,300.
Net income = Gross profit - Operating expenses = $532,300 - $371,300 = $161,000
Unit 17.2 Balance sheets
For Problems 11–20, identify the item by placing the appropriate letter in the space.
Item
11. A Accounts receivable
12. E
Accounts payable
13. B
Office equipment
14. G Owner’s equity
15. A Cash
16. C Land held for future expansion
17. D Trademark
18. E&F* Mortgage payable (monthly payments)
19. B
Building and land for present location
20. G Retained earnings
Choose from
A. Current asset
B. Plant and equipment
C. Investment asset
D. Intangible asset
E. Current liability
F. Long-term liability
G. Equity item
*Note: For Problem 18, part of the mortgage will be paid within 1 year (or operating cycle); this amount (principal portion only, without interest) is a current
liability. The remainder of the mortgage balance is a long-term liability.
21. Bihn Pham owns an engineering consulting business. Total assets are $135,700. Total liabilities are $24,800. What is
Bihn’s equity in the business?
Owner’s equity = Assets - Liabilities = $135,700 - $24,800 = $110,900
22. Assets should be shown on balance sheets at current value, not original cost. (T or F) False
Chapter Review Problems
383
For Problems 23–25, fill in the missing amounts. Each problem represents a different situation.
23.
24
25.
Total assets
$128,000
$820,000
$219,000
Total liabilities
$ 65,000
$148,000
$192,000
Equity
$ 63,000
$672,000
$27,000
26. For corporations, the equity section of a balance sheet is called corporate equity. (T or F)
called stockholders’ equity.
False. The equity section is
27. For a personal financial statement, assets are often shown at current value, not at cost. (T or F) True
28. For a personal financial statement, the difference between assets and liabilities is referred to as personal equity. (T or F)
False. The difference is called net worth.
Unit 17.3 Trend and ratio analysis
29. Vertical and horizontal analysis are used to evaluate the progress of a company over two or more accounting periods.
(T or F) True
30. Comparative data for BBB Office Supply is given in the first two columns of the following pair of tables. Complete the
remaining columns using vertical and horizontal analysis. Show percents with 1 decimal place.
BBB OFFICE SUPPLY, INC.
Comparative Income Statement (2005 vs 2004)
Annual Amounts
2005
2004
Gross sales
Sales returns
Net sales
Cost of goods sold
Gross profit
Total operating expenses
Net income (before income taxes)
Less income taxes
Net income (after income taxes)
$346,200
$364,900
Percent of Net Sales
2005
2004
101.1
100.5
3,800
1,700
1.1
0.5
$342,400
$363,200
100.0
100.0
153,100
148,700
44.7
40.9
$189,300
$214,500
55.3
59.1
Increase (or Decrease)
Amount
Percent
($18,700)
2,100
($20,800)
4,400
($25,200)
(5.1)
123.5
(5.7)
3.0
(11.7)
177,700
153,400
51.9
42.2
24,300
15.8
$11,600
$61,100
3.4
16.8
($49,500)
(81.0)
4,000
22,000
1.2
6.1
(18,000)
(81.8)
$7,600
$39,100
2.2
10.8
($31,500)
(80.6)
BBB OFFICE SUPPLY, INC.
Comparative Balance Sheet (Dec. 31, 2005 vs Dec. 31, 2004)
Year-end Amounts
2005
2004
Assets
Current assets
Cash
Increase (or Decrease)
Amount
Percent
$23,100
$36,100
17.7
22.1
($13,000)
(36.0)
Accounts receivable
42,000
45,100
32.2
27.6
(3,100)
(6.9)
Merchandise inventory
58,100
73,800
44.5
45.2
(15,700)
(21.3)
300
300
0.2
0.2
0
0
$123,500
$155,300
94.6
95.2
($31,800)
(20.5)
7,100
7,900
5.4
4.8
(800)
(10.1)
$130,600
$163,200
100.0
100.0
($32,600)
(20.0)
Liabilities
Accounts payable
$18,000
$19,000
13.8
11.6
($1,000)
(5.3)
Total liabilities
$18,000
$19,000
13.8
11.6
($1,000)
(5.3)
$100,000
$100,000
76.6
61.3
$0
0
12,600
44,200
9.6
27.1
(31,600)
(71.5)
Prepaid expenses
Total current assets
Plant and equipment, net
Total assets
Stockholders’ Equity
Common stock
Retained earnings
384
Percent of Total
2005
2004
Total stockholders’ equity
$112,600
$144,200
86.2
88.4
($31,600)
(21.9)
Total liabilities and SH equity
$130,600
$163,200
100.0
100.0
($32,600)
(20.0)
Chapter 17 Financial Statements: How to Read and Interpret
31. Refer to Problem 30. List a few noteworthy items that might make stockholders happy or concerned.
The answer is a bit subjective, but here are a few ideas.
• Sales decreased 5.1%.
• Cost of goods sold increased 3.0%, even though sales decreased.
• Expenses increased 15.8%, even though sales decreased.
• Total stockholders’ equity decreased $31,600.
For Problems 32–38, use the data of Problem 30 to calculate the requested ratio or percent for 2005. Use one decimal place in all ratios
or percents. Then, state what the ratio means.
32. Current ratio. Current ratio =
Current assets = $123,500 ≈ 6.9
Current liabilities
$18,000
For each dollar of current liabilities, BBB has about $6.90 of current assets.
33. Acid-test ratio.
Acid-test ratio = Cash + Accounts receivable = $23,100 + $42,000 = $65,100 ≈ 3.6
Current liabilities
$18,000
$18,000
For each dollar of current liabilities, BBB has about $3.60 of highly liquid assets.
34. Debt ratio.
Debt ratio = Total liabilities = $18,000 ≈ .138 ≈ 13.8%
Total assets
$130,600
For each dollar of assets, BBB owes 13.8¢.
35. Inventory turnover.
Inventory turnover = Cost of goods sold =
Average inventory
$153,100
= $153,100 ≈ 2.3
($73,800 + $58,100) ÷ 2
$65,950
Inventory was sold 2.3 times during the year.
36. Cost of goods sold as % of net sales.
Cost of goods sold as % of net sales = Cost of goods sold = $153,100 ≈ .447 ≈ 44.7%
Net sales
$342,400
BBB’s goods cost 44.7% of what they sold for.
37. Profit margin, before tax.
Profit margin, before tax = Net income, before tax =
Net sales
$11,600 ≈ 0.034 ≈ 3.4%
$342,400
BBB’s profit is 3.4% of net sales.
38. Return on equity.
Return on equity = Net income, after tax =
Equity
$7,600 ≈ .067 ≈ 6.7%
$112,600
BBB’s profit, after tax, is 6.7% of stockholders’ equity.
39. LMN, Inc., has a current ratio of 1.3. The industry average for its type of business is 1.8. Is LMN’s current ratio (a) better
or (b) worse than the industry average? (b) Worse
40. Refer to Problem 39. What can LMN do to improve its current ratio?
a. Increase profits. By increasing profits, LMN will have more cash or accounts receivable, thereby increasing current
assets.
b. Increase long-term financing. By doing this, LMN will increase long-term liabilities and increase cash. Because longterm liabilities do not affect the current ratio, the ratio will be improved.
c. Reduce dividends. By reducing dividends, cash will not decrease as much.
d. Sell additional stock. By doing this, cash will be increased without affecting current liabilities.
41. Would a business prefer having a (a) high or (b) low inventory turnover? (a) High. Businesses prefer selling their inventory quickly.
42. What can be done to improve inventory turnover?
a. Do more advertising. By doing more advertising, sales should increase, thereby contributing to a quicker inventory
turnover.
b. Improve sales staff. Maybe the sales staff is not assisting customers adequately. By giving better assistance, sales should
increase.
c. Reduce inventory. If inventory is excessive, reducing inventory may be a good strategy. However, if the inventory is
not excessive, decreasing inventory may lead to a decrease in sales.
Chapter Review Problems
385
Challenge problems
For Problems 43–47, answer from the following choices: sole proprietorship, general partnership, corporation, LLC.
43. For which entity or entities are the owner(s) personally responsible for the company’s debts?
partnership
Sole proprietorship and
44. Which entity or entities file a federal income tax return? Partnership, corporation, and LLC
45. Which entity or entities pay federal income tax directly to the IRS? Corporation
46. For which entity or entities are distributions of extra cash taxable to the owners? Corporation
47. Which entity or entities can be owned by only one person? Sole proprietorship, corporation, and LLC
48. A three-person general partnership quits doing business and has only $60,000 with which to pay $90,000 of debt. Which
statement is true? (a) The partners are not personally liable for the $30,000 difference; (b) each partner is liable for exactly
$10,000; (c) any of the partners may be sued for the entire $30,000 difference. (c)
49. ABC Corporation had annual profit of $1,200,000. Assume that the corporation pays 40% of federal and state income
taxes; the remainder is paid to stockholders as dividends. Assuming that stockholders pay 35% of dividends as federal and
state income taxes, determine the total percent of income taxes paid as a result of the $1,200,000 profit.
Income tax paid by corporation: $1,200,000 × 40%
Income tax paid by stockholders:
Profit
$1,200,000
Less income tax paid by corporation
- 480,000
Available for dividends
$ 720,000 × 35%
Total
$480,000
+ 252,000
$732,000
$732,000 = .610 = 61%
Percent of profit paid as income tax = $1,200,000
50. Prepare an income statement for Fisher’s Clothing Store, Inc. Income statement items for the first 3 months of 2006 were
as follows: gross sales, $1,653,800; sales returns, $143,700; beginning inventory, $436,000; purchases, $922,800; purchase returns, $5,300; purchase discounts, $13,800; transportation in, $3,400; ending inventory, $461,900; total operating expenses, $296,600; income taxes, $110,000. Use the format of Illustration 17-3.
FISHER’S CLOTHING STORE, INC.
Income Statement for the Quarter Ended March 31, 2006
Revenue from sales
Gross sales
Less: Sales returns
Net sales
Cost of goods sold
Merchandise inventory, January 1, 2006
Purchases
Less: Purchase returns
$5,300
Purchase discounts
13,800
Subtotal
Net purchases
Add transportation in
Cost of goods purchased
Goods available for sale
Merchandise inventory, March 31, 2006
Cost of goods sold
Gross profit from sales
Less operating expenses
Net income (before income taxes)
Less income tax expense
Net income (after income taxes)
386
$1,653,800
143,700
$1,510,100
$436,000
$922,800
19,100
$903,700
3,400
Chapter 17 Financial Statements: How to Read and Interpret
907,100
$1,343,100
461,900
881,200
$628,900
296,600
$332,300
110,000
$222,300
51. Wayne’s Corner Market, Inc., had assets and liabilities on June 30, 2006, as follows: cash, $22,800; accounts payable,
$38,100; store equipment, $42,000 less accumulated depreciation of $10,500; merchandise inventory, $42,200; notes
payable, $5,000 (the entire amount is due in 18 months); prepaid expenses, $800. So far, 1,000 shares of stock have been
issued (at $20 per share). Prepare a classified balance sheet like that of Illustration 17-4. In the process, determine the
amount of retained earnings.
WAYNE’S CORNER MARKET, INC.
Balance Sheet: June 30, 2006
Assets
Current assets
Cash
Merchandise inventory
Prepaid expenses
Total current assets
Plant and equipment
Store equipment
Less accumulated depreciation
$22,800
42,200
800
$65,800
$42,000
10,500
31,500
$97,300
Total assets
Liabilities
Current liabilities
Accounts payable
Long-term liabilities
Notes payable
Total liabilities
$38,100
5,000
$43,100
Stockholders’ Equity
Common stock: 1,000 shares @ $20
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
$20,000
34,200
54,200
$97,300
Practice Test
1.
What, if anything, is wrong with this income statement heading?
ALPINE ENGINEERING
Income Statement
June 30, 2006
An income statement is for a period of time, not a certain date. The last line should read something like “For June
2006,” “For quarter ending June 30, 2006,” or “For six months ending June 30, 2006.”
2. Given: gross sales, $220,000; sales returns, $1,500; sales discounts, $2,000; beginning inventory, $92,000; cost of goods
purchased, $145,000; ending inventory, $95,000; operating expenses, $30,000. Calculate: (a) net sales, (b) cost of goods
sold, (c) gross profit, and (d) net income.
a.
b.
Net sales = Gross sales - Sales returns - Sales discounts = $220,000 - $1,500 - $2,000 = $216,500
Cost of goods sold = Beginning inventory + Cost of goods purchased - Ending inventory =
$92,000 + $145,000 - $95,000 = $142,000
c. Gross profit = Net sales - Cost of goods sold = $216,500 - $142,000 = $74,500
d. Net income = Gross profit - Operating expenses = $74,500 - $30,000 = $44,500
3. Given: cash, $28,000; accounts receivable, $52,000; merchandise inventory, $60,000; prepaid expenses, $2,000; land for
future expansion, $50,000; accounts payable, $24,000. Calculate the equity of the business.
Assets: $28,000 + $52,000 + $60,000 + $2,000 + $50,000 =
Liabilities
Equity
$192,000
- 24,000
$168,000
Practice Test
387
4. Given: net sales, $152,800; total operating expenses, $42,100. What percent of net sales are operating expenses? Round
to the nearest tenth of a percent. $42,100 ÷ $152,800 ≈ .276 ≈ 27.6%
5. For each item, calculate (a) the dollar amount of increase and (b) the percent change (rounded to the nearest tenth of a
percent).
Increase (or Decrease)
Item
2006
2005
Amount
Percent
Cash
$27,000
$23,000
$4,000
17.4
Accounts receivable
$52,000
$58,000
($6,000)
(10.3)
6. Given: total current assets, $120,000; total assets, $280,000; total current liabilities, $72,000; total liabilities, $150,000;
beginning inventory, $60,000; ending inventory, $68,000; cost of goods sold, $140,000. Calculate (a) current ratio, (b)
debt ratio, and (c) inventory turnover. Use 1 decimal place in each ratio. For each ratio, tell what it means.
a.
Current ratio =
Current assets = $120,000 ≈ 1.7
Current liabilities
$72,000
For each dollar of current liabilities, the company has about $1.70 of current assets.
b. Debt ratio = Total liabilities = $150,000 ≈ .536 ≈ 53.6%
Total assets
$280,000
For each dollar of assets, the company owes about 53.6¢.
c.
Inventory turnover = Cost of goods sold =
Average inventory
$140,000
= $140,000 ≈ 2.2
($60,000 + $68,000) ÷ 2
$64,000
Inventory was sold 2.2 times during the year.
388
Chapter 17 Financial Statements: How to Read and Interpret