Principles of Financial Accounting 12th Edition Needles Solutions Manual Download

Solution Manual for Principles of Financial
Accounting 12th Edition Needles Powers

1133940560 9781133940562
Download full solution manual at:
https://testbankpack.com/p/solution-manual-for-principles-of-financial-accounting-
12th-edition-needles-powers-1133940560-9781133940562/
Download full test bank at:

https://testbankpack.com/p/test-bank-for-principles-of-financial-accounting-12th-
edition-needles-powers-1133940560-9781133940562/
CHAPTER 5—Solutions
FOUNDATIONS OF FINANCIAL REPORTING
AND THE CLASSIFIED BALANCE SHEET
Discussion Questions
DQ1. The balance sheet provides information about a company's resources (assets) and
claims to those resources (liabilities and owner's equity). The income statement,
statement of cash flows, and statement of owner's equity provide information about
how the resources are used and claims to them are accounted for.
DQ2. To record depreciation expense, it is necessary to estimate the useful life of the
asset. To record the amount of unearned revenue that is now earned or the amount
of accrued revenue on a project, it is necessary to estimate the amount of revenue
earned.
DQ3. Consistency in accounting applies only to the use of the accounting principles for
presenting the financial information. It does not apply to the conditions that are
represented in the financial statements. For example, changes in business opera-
tions or the economy may make financial information incomparable from year to
year, even though the same accounting policies have been followed.
DQ4. Illegal acts, such as stealing $1,000, are important to management even though
for a multimillion-dollar business it might not be important to the auditors. It would
not be material to the overall fairness of the financial statements.
DQ5. They are classified as investments because they are not used in normal business
operations and management does not plan to convert them to cash within the next
year. Also, the investment category gives users some idea of resources the com-
pany may be able to draw on without disturbing the current business operations.
DQ6. When calculating ratios to measure performance, analysts need benchmarks to

measure whether the performance was good or bad. Past performance of the com-
pany is one measure, but a better measure is the financial performance of similar
companies. This is done by examining industry averages.
DQ7. The statement is false because neither measure is better than the other. However,
the return on assets ratio is a more comprehensive measure of profitability because
it reflects both profit margin and asset turnover.
5-1
© 2014 Cengage Learning. All Rights Reserved. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
Short Exercises
SE1. Objectives and Qualitative Characteristics
a. O
b. Q
c. O
d. Q
e. O
SE2. Enhancing Qualitative Characteristics and Accounting Conventions
1. Full disclosure
2. Materiality
3. Cost constraint
4. Conservatism
5. Comparability and consistency
6. Verifiabiltiy
7. Timeliness
SE3. Classification of Accounts: Balance Sheet
1. Property, plant, and equipment

2. Current liability
3. Current liability
4. Not on balance sheet
5. Owner's equity
6. Current asset
7. Intangible asset
8. Current asset
9. Investment
5-2
SE4. Classified Balance Sheet
Balance Sheet
May 31, 2014
Assets
Current assets:
Cash $ 400
Accounts receivable 2,200
Merchandise inventory 1,200
Total current assets $3,800
Investments 1,000
Property, plant, and equipment:
Equipment $6,000
Less accumulated depreciation 1,400
Total property, plant, and equipment 4,600
Intangible assets:
Franchise 400
Total assets $9,800
Liabilities
Current liabilities:
Accounts payable $1,600
Wages payable 200
Total current liabilities $1,800
Long-term liabilities:
Notes payable 800
Total liabilities $2,600
Owner's Equity
Owner's capital $7,200 *
Total owner's equity 7,200
Total liabilities and owner's equity $9,800
*Balancing amount ( $9,800 – $2,600 )
5-3
SE5. Liquidity Ratios
Current Assets = $2,000 + $1,000 + $5,000 + $6,000

= $14,000
Working Capital = Current Assets – Current Liabilities
$10,500 = $14,000 – $3,500
Current Assets $14,000

Current Ratio = = = 4.0
Current Liabilities $3,500
SE6. Profitability Ratios
Net Income $40,000 *

1. Profit Margin = = = 15.4%**
Net Sales $260,000
*$260,000 – $140,000 – $80,000 = $40,000
Net Sales $260,000

2. Asset Turnover = = = 1.2 times**
Average Total Assets $220,000*
*($240,000 + $200,000) / 2 = $220,000
Net Income $40,000

3. Return on Assets = = = 18.2%**
Average Total Assets $220,000
Debt to Total Liabilities $60,000

4. = = = 33.3%**
Equity Ratio Total $180,000
Owner's Equity
Net Income $40,000

5. Return on Equity = = = 25.0%
Average Total $160,000 *
Owner's Equity
*($180,000 + $140,000) / 2 = $160,000
**Rounded
SE7. Profitability Ratios
Profit Margin × Asset Turnover = Return on Assets

12.0% × 6.4 times = 76.8%
If the debt to equity ratio equals 50 percent, then owner's equity is two-thirds of total
assets.
Return on Assets / 2/3 Return on Equity

76.8% / 2/3 115.2%
5-4
Exercises: Set A
E1A. Financial Accounting Concepts
1. g 12. c
2. a 13. h
3. b 14. d
4. a 15. f
5. a 16. a
6. d 17. e
7. a 18. d
8. a 19. f
9. h 20. a
10. g 21. a
11. g 22. c
E2A. Qualitative Characteristics and Accounting Conventions
1. Consistency and comparability

2. Conservatism
3. Cost constraint
4. Full disclsoure
5. Materiality
6. Relevance
7. Faithful representation
8. Understandabilty
9. Comparability and consistency
10. Timeliness
11. Verifiability
E3A. Classification of Accounts: Balance Sheet
1. d 9. c
2. f 10. h
3. c 11. c
4. a 12. h
5. g 13. a
6. e 14. c
7. f 15. e
8. c 16. b
5-5
E4A. Classified Balance Sheet Preparation
Wagoner Company
Balance Sheet
December 31, 2014
Assets
Current assets:
Cash $12,480
Short-term investments 6,560
Inventory 16,000
Prepaid rent 480
Total current assets $ 50,720
Investments:
Investment in corporate securities 8,000
Land $ 3,200
Building $28,000
Less accumulated depreciation 5,600 22,400
Equipment $60,800
Intangible assets:
Copyright 2,480
Total assets $140,800
Liabilities
Revenue received in advance 1,120
Total current liabilities $ 21,520
Bonds payable 24,000
Total liabilities $ 45,520
Owner's Equity
Y. Wagoner, capital $95,280
5-6
E5A. Liquidity Ratios
1. Current Assets:
Cash $ 1,200
Marketable Securities 10,080
Notes Receivable (90 days) 20,800
Accounts Receivable 8,160
Merchandise Inventory 20,320
Prepaid Insurance 320
Supplies 280
Total Current Assets $61,160
Current Liabilities:
Notes Payable (90 days) $12,000
Accounts Payable 13,280
Current Portion of Long-Term Debt 8,000
Salaries Payable 680
Property Taxes Payable 1,000
Unearned Revenue 600
Total Current Liabilities 35,560
Working Capital $25,600

2. Current Ratio = = = 1.72 *
*Rounded
5-7
E6A. Profitability Ratios
Net Income
1. Profit Margin =
Net Sales
$118,000 *
= = 15.1% **
$782,000
*$782,000 – $486,000 – $178,000 = $118,000
Net Sales
2. Asset Turnover =
Average Total Assets
$782,000
=
( $426,000 + $351,000 * ) / 2
$782,000
= = 2.0 times**
$388,500
*$426,000 – $75,000 = $351,000
Return on Net Income

3. =
Assets Average Total Assets
$118,000
= = 30.4% **
$388,500
4. Debt to = Total Liabilities

Equity Ratio Total Owner's Equity
$172,000
= = 67.7% **
$254,000
5. Return on Net Income

=
Equity Average Owner's Equity
$118,000
=
( $254,000 + $176,000 * ) / 2
$118,000
= = 54.9% **
$215,000
*$254,000 – $118,000 + $40,000 = $176,000
**Rounded
5-8
E7A. Liquidity and Profitability Ratios
1. a. Current Assets $ 50,000

Current Liabilities (20,000)
Working Capital $ 30,000

b. Current Ratio = = = 2.5
Net Income $25,000

2. a. Profit Margin = = = 6.1%*
Net Sales $410,000
Net Sales
b. Asset Turnover =
$410,000
=
( $220,000 + $180,000 ) / 2
$410,000
= = 2.1 times*
$200,000
c. Return Net Income $25,000

= = = 12.5%
on Assets Average Total Assets $200,000
Total Liabilities $50,000

d. Debt to = = = 29.4%*
Equity Ratio Total $170,000
Owner's Equity
e. Return Net Income

=
on Equity Average
Owner's Equity
$25,000
=
( $170,000 + $140,000 ) / 2
$25,000
= = 16.1%*
$155,000
*Rounded
5-9
E8A. Liquidity and Profitability Ratios
Current Current Working Current Ratio

1.(a) Assets Liabilities Capital
2013 $ 85,000 $25,000 $60,000 3.40
2014 100,000 45,000 55,000 2.22 *
Decrease in working capital $ 5,000
Decrease in current ratio 1.18
Average
Net Average Assets Return on Owner’s Return on
1.(b) Income Sales Profit Margin Total Asset Turnover Assets Equity Equity
2013 $ 40,000 $525,000 7.62%* $350,000 1.50 11.43%* $300,000 13.33%*
2014 30,000 600,000 5.00% 397,500 1.51* 7.55%* 312,500 9.60%
Increase (decrease) $(10,000) $ 75,000 –2.62% $ 47,500 0.01 –3.88% $ 12,500 –3.73%
*Rounded
5-10
E8A. Liquidity and Profitability Ratios (Concluded)
2. Both working capital and the current ratio declined between 2013 and 2014 because
the $10,000 increase in current liabilities ($45,000 − $25,000) was greater than the
$15,000 increase in current assets.
Net income decreased by $10,000 despite an increase in sales of $75,000 and an in-
crease in average total assets of $47,500. Thus, the profit margin fell from 7.62 per-
cent to 5.00 percent, and return on assets fell from 11.43 percent to 7.55 percent.
Asset turnover showed almost no change and so did not contribute to the decline in
profitability. The decrease in return on equity, from 13.33 percent to 9.60 percent,
was not as great as the decrease in return on assets because the growth in total as-
sets was financed mainly by debt rather than by owner’s equity, as shown in the
capital structure analysis below.
Total Owner’s Debt to Equity

Liabilities Equity Ratio
2013 $ 50,000 $305,000 16.39%*
2014 120,000 320,000 37.50%
Increase $ 70,000 $ 15,000 21.11%
*Rounded
Total liabilities increased by $70,000, while owner’s equity increased by $15,000.

Thus, the amount of the business financed by debt in relation to the amount financed
by owner’s equity increased between 2013 and 2014.
Both liquidity and profitability have declined. Villegas will probably have to focus on
improving current operations before expanding or getting a bank loan.
Note to Instructor: Solutions for Exercises: Set B are provided separately on the Instructor's
Resource CD and website.
5-11
Problems
P1. Qualitative Characteristics and Accounting Conventions
1. The change in depreciation methods is a violation of the comparability and consis-

tency convention. However, management can change its accounting methods if it
complies with the convention of full disclosure by reporting the change in the notes
to its financial statements.
2. This is an acceptable application of the cost-benefit convention if management has

determined that the benefits of the new classification system outweigh the costs.
3. This is an unacceptable application of the materiality convention because illegal

actions by a company's personnel—whatever the amount involved—are inherently
important to the users of financial statements. Full disclosure would require that
this kind of illegal activity be disclosed.
4. This is an unacceptable application of the conservatism convention because con-

servatism can be used only when two equally acceptable accounting methods are
available. Expensing an item of property, plant, and equipment—and that's what
the addition is—is not an acceptable method. Uncertainties are always present. The
going-concern assumption requires that the addition be recorded as property, plant,
and equipment and be depreciated over a number of years.
5. The failure to disclose the inventory method is a violation of the full disclosure con-
vention. To interpret the statements, users of financial statements must know which
method is used, even though the method used has not changed in a number of years.
6. The failure to include the buildings is a violation of the completeness concept, which
is a component of faithful representation.
7. The practice of making financial statements as attractive as possible for the bank is
a violation of the neutrality concept, which is a component of faithful representation.
8. The inability of independent experts to reproduce estimates is a violation of the en-

hancing qualitative characteristic of verifiability.
5-12
P2. Classified Balance Sheet
1. Jason's Hardware Company

Balance Sheet
June 30, 2014
Assets
Current assets:
Cash $ 32,000
Notes receivable 10,000
Prepaid rent 1,600
Prepaid insurance 4,800
Sales supplies 1,280
Office supplies 440
Deposit for future advertising 3,680
Investments:
Building, not in use 49,600
Land $ 23,400
Delivery equipment $41,200
Intangible assets:
Trademark 4,000
Liabilities
Salaries payable 5,200
Interest payable 840
Long-term notes payable 80,000
Owner's Equity
J. Smith, capital $396,960
5-13
P2. Classified Balance Sheet (Concluded)
Current Assets
2. a. Current Ratio =
Current Liabilities
$507,800
= = 4.2 *
$120,640
Debt to Equity Total Liabilities

b. =
Ratio Owner's Equity
$200,640
= = 50.5%*
$396,960
*Rounded
3. A user of the classified balance sheet would want to know the current ratio because
it is a good indicator of a company's ability to pay its bills and to repay outstanding
loans. The other measure, the debt to equity ratio, shows the proportion of the com-
pany financed by creditors in comparison with that financed by owners. That measure
is very important to liquidity analysis because it is related to debt and its repayment.
It is also relevant to profitability analysis because the amount of debt affects the
amount of interest expense and the owner's return on investment.
5-14
P3. Liquidity and Profitability Ratios
1. a. Working Capital
2014 2013
Current Assets $45,000 $35,000
Current Liabilities (20,000) (10,000)
Working Capital $25,000 $25,000
Current Assets
b. Current Ratio =
Current Liabilities
$45,000
2014: = 2.3 *
$20,000
$35,000
2013: = 3.5
$10,000
Although the amount of working capital has stayed the same, the current ratio has de-
clined from 3.5 to 2.3. And although both current assets and current liabilities increased
by $10,000, the current liabilities in the denominator increased 100 percent ($10,000 to
$20,000) at the same time that the numerator was increasing only 28.6 percent ($35,000
to $45,000). This decrease in the current ratio is a warning: The company's liquidity
should be monitored regularly.
Net Income
2. a. Profit Margin =
Net Sales
$16,000
2014: = 6.1%*
$262,000
$11,000
2013: = 5.5%
$200,000
*Rounded
5-15
P3. Liquidity and Profitability Ratios (Continued)
Net Sales
b. Asset Turnover =
$262,000
2014:
( $145,000 + $110,000 ) / 2
$262,000
= = 2.1 times*
$127,500
$200,000
2013:
( $110,000 + $90,000 ) / 2
$200,000
= = 2.0 times
$100,000
Net Income
c. Return on Assets =
$16,000
2014:
( $145,000 + $110,000 ) / 2
$16,000
= = 12.5%*
$127,500
$11,000
2013:
( $110,000 + $90,000 ) / 2
$11,000
= = 11.0%
$100,000
Total Liabilities
d. Debt to Equity Ratio =
Owner's Equity
$40,000
2014: = 38.1%*
$105,000
$10,000
2013: = 10.0%
$100,000
*Rounded
5-16
P3. Liquidity and Profitability Ratios (Concluded)
Net Income
e. Return on Equity =
Average Owner's Equity
$16,000
2014:
( $105,000 + $100,000 ) / 2
$16,000
= = 15.6%*
$102,500
$11,000
2013:
( $100,000 + $80,000 ) / 2
$11,000
= = 12.2%*
$90,000
*Rounded
Both profit margin and asset turnover increased from 2013 to 2014, causing return
on assets to increase by 1.5 percent. Return on equity increased by 3.4 percent be-
cause the company increased its debt to equity ratio. It used more assets to produce
income by increasing its debt proportionally more than it increased owner's equity.
Although management may view the level of profitability as disappointing, the com-
pany has shown improvement in the key performance measures of return on assets
and return on equity.
5-17
1. Cullen's Hardware Company

Balance Sheet
June 30, 2014
Assets
Current assets:
Cash $ 42,800
Prepaid rent 2,100
Office supplies 440
Investments:
Land $ 31,400
Intangible assets:
Trademark 4,000
Liabilities
Owner's Equity
E. Cullen, capital $412,660
5-18
Current Assets
Current Liabilities
$531,400
= = 4.0 *
$133,140

b. =
Ratio Owner's Equity
$213,140
= = 51.7%*
$412,660
*Rounded
3. A user of the classified balance sheet would want to know the current ratio be-
cause it is a good indicator of a company's ability to pay its bills and to repay
outstanding loans. The other measure, the debt to equity ratio, shows the pro-
portion of the company financed by creditors in comparison with that financed
by owners. That measure is very important to liquidity analysis because it is re-
lated to debt and its repayment. It is also relevant to profitability analysis be-
cause the amount of debt affects the amount of interest expense and the
owner's return on investment.
5-19
Alternate Problems
P5. Accounting Conventions
1. Valuing inventory at lower of cost or market is a generally accepted application of

the conservatism convention. This method of valuing inventory is less likely to over-
state assets and income than the cost method, especially if inventory costs are de-
creasing or inventory faces obsolescence.
2. Charging items of small unit value as an expense rather than incurring the cost of
capitalizing and depreciating them is an acceptable application of the materiality
convention. The fact that several chairs are purchased during the year does not
affect the decision unless such a substantial quantity is purchased that a distortion
of the financial position results.
3. Not disclosing the fire loss in a note to the 2013 financial statements is a violation of
the full disclosure convention. Although the fire loss did not affect 2013 operations,
it will have a significant or material effect on 2014, which means that knowledge
of it is important to users of the financial statements.
4. This is an acceptable application of the cost-benefit convention if management has

determined that the benefits of the new reporting system outweigh the costs.
5. The change in the method of accounting for inventory is a violation of the consis-
tency convention. If a company changes its method of accounting for inventory, it
must disclose the change, the effect of the change on net income, and why the
newly adopted accounting principle is preferable in the notes to its financial state-
ments so that the reader will be aware of the inconsistency. The change in the
method of accounting for inventory is also a violation of the enhancing qualitative
characteristic of comparability.
6. Delays in issuing financial statements is a violation of the enhancing qualitative

characteristic of timeliness.
7. Use of uncommon technical terms in the financial statements is a violation of the

enhancing qualitative characteristic of understandability.
8. Producing financial statements that are not helpful in assessing future prospects is
a violation of the predictive value concept, which is a component of relevance.
5-20
1. Matt's Hardware Company

Balance Sheet
April 30, 2014
Assets
Current assets:
Cash $ 31,000
Prepaid rent 1,600
Office supplies 440
Investments:
Land $ 22,400
Intangible assets:
Trademark 4,000
Liabilities
Owner's Equity
M. Shah, capital $394,960
5-21
Current Assets
Current Liabilities
$506,800
2014 = 4.2 *
$120,640

b. =
Ratio Total Owner's Equity
$200,640
2014 = 50.8%*
$394,960
*Rounded
pany financed by creditors in comparison with that financed by owners. That meas
ure is very important to liquidity analysis because it is related to debt and its repay-
ment. It is also relevant to profitability analysis because the amount of debt affects
the amount of interest expense and the owner's return on investment.
5-22
P7. Liquidity and Profitability Ratios
1. a. Working Capital
2014 2013
Current Assets $366,000 $310,000
Current Liabilities (180,000) (120,000)
Working Capital $186,000 $190,000
Current Assets
b. Current Ratio =
Current Liabilities
$366,000
2014: = 2.0 *
$180,000
$310,000
2013: = 2.6 *
$120,000
Although the amount of working capital has stayed almost the same, the current
ratio has declined from 2.6 to 2.0. Current assets increased by $56,000 and current
liabilities increased by $60,000, but the current liabilities in the denominator in-
creased 50 percent ($120,000 to $180,000) at the same time that the numerator was
increasing only 18.1 percent ($310,000 to $366,000). This decrease in the current
ratio is worrisome and should be monitored regularly.
Net Income
2. a. Profit Margin =
Net Sales
$300,000
2014: = 6.5%*
$4,600,000
$204,000
2013: = 5.9%*
$3,480,000
*Rounded
5-23
P7. Liquidity and Profitability Ratios (Continued)
Net Sales
b. Asset Turnover =
$4,600,000
2014:
( $2,320,000 + $1,740,000 ) / 2
$4,600,000
= = 2.3 times*
$2,030,000
$3,480,000
2013:
( $1,740,000 + $1,360,000 ) / 2
$3,480,000
= = 2.2 times*
$1,550,000
Net Income
c. Return on Assets =
$300,000
2014:
( $2,320,000 + $1,740,000 ) / 2
$300,000
= = 14.8%*
$2,030,000
$204,000
2013:
( $1,740,000 + $1,360,000 ) / 2
$204,000
= = 13.2%*
$1,550,000
Total Liabilities
d. Debt to Equity Ratio =
Owner's Equity
$980,000
2014: = 73.1%*
$1,340,000
$700,000
2013: = 67.3%*
$1,040,000
*Rounded
5-24
P7. Liquidity and Profitability Ratios (Concluded)
Net Income
e. Return on Equity =
Average Owner's Equity
$300,000
2014:
( $1,340,000 + $1,040,000 ) / 2
$300,000
= = 25.2%*
$1,190,000
$204,000
2013:
( $1,040,000 + $840,000 ) / 2
$204,000
= = 21.7%*
$940,000
*Rounded
Both profit margin and asset turnover increased from 2013 to 2014, causing return on
assets to increase by 1.6 percent. Return on equity increased by 3.5 percent because
the company increased its debt to equity ratio. It used more assets to produce in-
come by increasing its debt proportionally more than it increased owner's equity.
Although management may view the level of profitability as disappointing, the com-
pany has shown improvement in the key performance measures of return on assets
and return on equity.
5-25
1. Rodriguez's Tools Company

Balance Sheet
April 30, 2014
Assets
Current assets:
Cash $ 31,000
Prepaid rent 1,800
Office supplies 540
Investments:
Land $ 34,700
Intangible assets:
Trademark 4,000
Liabilities
Owner's Equity
C. Rodriguez, capital $337,340
5-26
Current Assets
Current Liabilities
$446,840
2014 = 3.3 *
$135,130

b. =
Ratio Total Owner's Equity
$234,130
2014 = 69.4%*
$337,340
*Rounded
pany financed by creditors in comparison with that financed by owners. That meas-
ure is very important to liquidity analysis because it is related to debt and its repay-
ment. It is also relevant to profitability analysis because the amount of debt affects
the amount of interest expense and the owner's return on investment.
5-27
Cases
C1. Conceptual Understanding: Consistency, Full Disclosure, and Materiality
Consistency requires that an accounting procedure, once adopted by a company, remain

in use from one accounting period to another unless management decides that a new
procedure is preferable and discloses information about the change in its financial state-
ments. Such consistency ensures the comparability of financial results from one period
to another. In this case, a change from cash method to the accrual method would violate
the consistency convention if the change is not disclosed in the financial statements.
Full disclosure requires that financial statements and accompanying notes present all in-
formation relevant to the user's understanding of the statements. In this case, the notes
should disclose the nature of the change, the justification for making it, and its probable
effect on net income. Thus, readers of the financial statements will know that a change
has been made and can assess its effects.
Materiality refers to the relative importance of an item or event. In general, an item is

material if there is a reasonable expectation that knowledge of it would influence the
decisions of users of financial statements. In this case, the change from the cash to the
accrual method would have a 5 percent ($62,500 / $1,250,000) effect on net income.
Many people consider 5 percent to be the point at which an amount starts to matter
to decision makers. So this is a material effect, and the change in accounting method
should be disclosed. (An adjustment may also be made to the beginning of the year,
which could mitigate the year-end effect on the financial statements.)
C2. Conceptual Understanding: Materiality
Materiality refers to the relative importance of an item or event. In general, an item is

material if there is a reasonable expectation that knowledge of it would influence the
decisions of users of financial statements. The $120,000 inventory loss represents 4 per-
cent of net income ($120,000 / $3,000,000). Whether or not this loss is material depends
on who is using the financial statements. To management, it represents a loss of income
that impairs the company's ability to improve operations and results. To the auditors, the
loss is reflected in the financial statements and thus is not misstated. In most retail oper-
ations, some inventory loss is expected. It is unlikely that external users of financial state-
ments would change their decisions because of an item that represents only 4 percent
of net income. The auditors may become concerned if the loss is greater in the future or
if management does not take action to try to reduce it.
5-28
C3. Interpreting Financial Reports: Comparison of Profitability
1. The Gap Abercrombie & Fitch*

Net Income $833 $128
Net Sales $14,549 $4,158
Profit Margin 5.7% 3.1%
Net Sales $14,549 $4,158
Average Total Assets ( $7,065 + $7,422 ) / 2 = $7,243.5 ( $2,941 + $3,048 ) / 2 = $2,994.5
Asset Turnover 2.0 times 1.4 times
Average Total Assets (from above) $7,243.5 $2,994.5
Return on Assets 11.5% 4.3%
Total Liabilities $4,667 $1,186
Total Stockholders' Equity $2,755 $1,862
Debt to Equity Ratio 169.4% 63.7%
Average Stockholders' Equity ( $4,080 + $2,755 ) / 2 = $3,417.5 ( $1,891 + $1,862 ) / 2 = $1,876.5
Return on Equity 24.4% 6.8%
From these figures, it is clear that The Gap was the more profitable company for the period analyzed. Its profit margin, asset
turnover, return on assets, and return on equity were superior to the same measures for Abercrombie & Fitch.
*Abercrombie & Fitch's data are rounded to the nearest whole dollar.
5-29
C3. Interpreting Financial Reports: Comparison of Profitability (Concluded)
2. Return on assets is a combination of profit margin and asset turnover. The grocery
industry has low profit margins. The profit margins of the two companies are 5.7 and
3.1 percent. The industry tries to overcome its low profit margin by turning over its
assets many times during the year. The Gap has an asset turnover of 2.0 times, which
exceeds that of Abercrombie & Fitch's of 1.4. The relationships of the two companies'
ratios and the industry ratios are as follows:
Profit Margin × Asset Turnover = Return on Assets

The Gap 5.7% × 2.0 times = 11.4%
Abercrombie & Fitch 3.1% × 1.4 times = 4.3%
Industry** 4.2% × 1.5 times = 6.3%
* The figures may differ slightly from the previous page because of rounding.
** Industry figures are provided in Figures 4 through 9 of the text.
The higher profit margin and asset turnover at The Gap makes it more profitable
than Abercrombie & Fitch. The Gap is more profitable than the industry in terms of
asset turnover and return on assets.
3. The Gap has more debt than equity; the debt to equity ratio was 169.4 percent for
The Gap, which is considerably higher than the industry average, and 63.7 percent
for Abercrombie & Fitch, which is lower than the industry average. When debt is ex-
cessive, a company can be in a risky situation. In the case of The Gap, the large
amount of debt in relation to equity may put the company in a vulnerable situation.
The Gap, with the higher debt to equity ratio, helps its return on equity.
5-30
C4. Annual Report Case: Classified Balance Sheet
1. Yes, the company uses a classified balance sheet with current assets, property and
equipment (net), goodwill, intangible assets (net), and other assets. It also has current
assets and several types of long-term liabilities as well as stockholders' equity.
2. Yes. The debt to equity ratio increased from 64.9% in 2010 to 69.6% in 2011.
Total Liabilities
Debt to Equity Ratio =
Total Stockholders' Equity
$26,492 $24,469
2011: = 69.6%* 2010: = 64.9%*
$38,051 $37,700
*Rounded
3. Contributed capital for 2011 was $28,126 million. (Note: CVS has no preferred stock
outstanding.) Also, capital surplus is the same as additional paid-in capital. Retained
earnings were $22,090 million.
5-31
C5. Comparison Case: Financial Performance
Profit margin
Net Income (Loss)
Profit Margin =
Net Sales or Total Operating Revenue
CVS
$3,457 $3,424
2011: = 3.2%* 2010: = 3.6%*
$107,100 $95,778
Southwest
$178 $459
2011: = 1.1%* 2010: = 3.8%*
$15,658 $12,104
Asset turnover
Net Sales
Asset turnover =
CVS
$107,100
2011:
( $64,543 + $62,169 ) / 2
$107,100
= = 1.7 times*
$63,356
$95,778
2010:
( $62,169 + $61,141 ) / 2
$95,778
= = 1.6 times*
$61,655
Southwest
$15,658
2011:
( $18,068 + $15,463 ) / 2
$15,658
= = 0.9 times*
$16,765.5
$12,104
2010:
( $15,463 + $14,269 ) / 2
$12,104
= = 0.8 times*
$14,866
*Rounded
5-32
C5. Comparison Case: Financial Performance (Continued)
Return on assets
Net Income
Return on Assets =
CVS
$3,457
2011:
( $64,543 + $62,169 ) / 2
$3,457
= = 5.5%*
$63,356
$3,424
2010:
( $62,169 + $61,141 ) / 2
$3,424
= = 5.6%*
$61,655
Southwest
$178
2011:
( $18,068 + $15,463 ) / 2
$178
= = 1.1%*
$16,765.5
$459
2010:
( $15,463 + $14,269 ) / 2
$459
= = 3.1%*
$14,866
*Rounded
5-33
C5. Comparison Case: Financial Performance (Concluded)
Return on equity
Net Income
Return on Equity =
Average Stockholders' Equity
CVS
$3,457
2011:
( $38,051 + $37,700 ) / 2
$3,457
= = 9.1%*
$37,875.5
$3,424
2010:
( $37,700 + $35,768 ) / 2
$3,424
= = 9.3%*
$36,734
Southwest
$178
2011:
( $6,877 + $6,237 ) / 2
$178
= = 2.7%*
$6,557
$459
2010:
( $6,237 + $5,454 ) / 2
$459
= = 7.9%*
$5,845.5
*Rounded
In general, CVS's performance exceeds the performance of Southwest in respect to profit-

ability. CVS's profitability measures are much better than those of Southwest. Even though
CVS has a lower profit margin than Southwest in 2010, it has a higher asset turnover ratio.
5-34
C6. Ethical Dilemma: Ethics and Financial Reporting
This situation is framed so that the difference between 75 percent and 90 percent is ma-
terial but also falls within the range of judgment. Thus, one can take either side of the
issue. Some students may say that the first report is tentative and that a reevaluation
may legitimately result in an estimate of 90 percent completion. Others may argue that
the action is unethical, particularly in view of the bonuses that are tied to revenue, and
there is no indication that the customer has approved or accepted the work performed
to date.
Discussion of whether a student, in assuming the position of the controller, would pre-
pare the report may center on the conflict between the controller's duty to top manage-
ment and his or her personal ethics. The proper action would be to reexamine the pre-
liminary report to see whether new estimates are justified under the circumstances. If
the preliminary report turns out to be the best estimate, then the controller should try to
convince top management that changing the report would be unethical and perhaps
fraudulent. If top management persists, the controller should not prepare the report and
may have to decide whether he or she wants to continue working for the company.
C7. Continuing Case: Annual Report Project
Note to Instructor: Answers will vary depending on the company selected by the students.
5-35

Principles of Financial Accounting 12th Edition Needles Solutions Manual Download

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Principles of Financial Accounting 12th Edition Needles Solutions Manual Download

Uploaded by

Copyright:

Available Formats

Solution Manual for Principles of Financial

Accounting 12th Edition Needles Powers

Download full test bank at:

DQ6. When calculating ratios to measure performance, analysts need benchmarks to

SE1. Objectives and Qualitative Characteristics

SE2. Enhancing Qualitative Characteristics and Accounting Conventions

SE3. Classification of Accounts: Balance Sheet

1. Property, plant, and equipment

*Balancing amount ( $9,800 – $2,600 )

Current Assets = $2,000 + $1,000 + $5,000 + $6,000

Working Capital = Current Assets – Current Liabilities

$10,500 = $14,000 – $3,500

Current Assets $14,000

SE6. Profitability Ratios

Net Income $40,000 *

*$260,000 – $140,000 – $80,000 = $40,000

Net Sales $260,000

*($240,000 + $200,000) / 2 = $220,000

Net Income $40,000

Debt to Total Liabilities $60,000

Net Income $40,000

*($180,000 + $140,000) / 2 = $160,000

SE7. Profitability Ratios

Profit Margin × Asset Turnover = Return on Assets

Return on Assets / 2/3 Return on Equity

E1A. Financial Accounting Concepts

E2A. Qualitative Characteristics and Accounting Conventions

1. Consistency and comparability

E3A. Classification of Accounts: Balance Sheet

Current Assets $61,160

*$782,000 – $486,000 – $178,000 = $118,000

*$426,000 – $75,000 = $351,000

Return on Net Income

4. Debt to = Total Liabilities

5. Return on Net Income

*$254,000 – $118,000 + $40,000 = $176,000

1. a. Current Assets $ 50,000

Current Assets $50,000

Net Income $25,000

c. Return Net Income $25,000

Total Liabilities $50,000

e. Return Net Income

Current Current Working Current Ratio

Total Owner’s Debt to Equity

Total liabilities increased by $70,000, while owner’s equity increased by $15,000.

P1. Qualitative Characteristics and Accounting Conventions

1. The change in depreciation methods is a violation of the comparability and consis-

2. This is an acceptable application of the cost-benefit convention if management has

3. This is an unacceptable application of the materiality convention because illegal

4. This is an unacceptable application of the conservatism convention because con-

8. The inability of independent experts to reproduce estimates is a violation of the en-

1. Jason's Hardware Company

Debt to Equity Total Liabilities

1. Cullen's Hardware Company

Debt to Equity Total Liabilities

P5. Accounting Conventions

1. Valuing inventory at lower of cost or market is a generally accepted application of

4. This is an acceptable application of the cost-benefit convention if management has

6. Delays in issuing financial statements is a violation of the enhancing qualitative

7. Use of uncommon technical terms in the financial statements is a violation of the

1. Matt's Hardware Company

Debt to Equity Total Liabilities

1. Rodriguez's Tools Company

Debt to Equity Total Liabilities