Libby 4ce Solutions Manual - Ch03

Chapter 3
Operating Decisions and the Income Statement

Revised April 25, 2011
ANSWERS TO QUESTIONS
1. A typical business operating cycle for a small gift store would be as follows:
inventory is purchased, cash is paid to suppliers, the product is sold on credit, or
cash. The cash is then collected from the customers if they bought on credit.
2. The Periodicity assumption means that the financial condition and performance of a
business can be reported periodically, usually every month, quarter, or year, even
though the life of the business is much longer.
3. Profit = Revenues + Gains – Expenses – Losses

Each element is defined as follows:
Revenues -- increases in assets or settlements of liabilities from ongoing
operations.
Gains -- increases in assets or settlements of liabilities from peripheral
transactions.
Expenses -- decreases in assets or increases in liabilities from ongoing operations.
Losses -- decreases in assets or increases in liabilities from peripheral
transactions.
4. Both revenues and gains are inflows of net assets. However, revenues occur in the
normal course of operations, whereas gains occur from transactions peripheral to
the central activities of the company. An example is selling land at a price above cost
(at a gain) for companies not in the business of selling land.
Both expenses and losses are outflows of net assets. However, expenses occur in the
normal course of operations, whereas losses occur from transactions peripheral to
the central activities of the company. An example is a loss suffered from fire
damage.
5. Accrual accounting requires recording revenues when earned and recording

expenses when incurred, regardless of the timing of cash receipts or payments.
Cash basis accounting means recording revenues when cash is received and
expenses when cash is paid.
Financial Accounting, 4ce, Libby, Libby, Short, Kanaan, Gowing © 2011 McGraw-Hill Ryerson Limited. All rights reserved.
3-1
6. The five criteria that must be met for revenue to be recognized under the accrual
basis of accounting are: (1) The entity has transferred to the buyer the significant
risks and rewards of ownership of the goods, (2) the entity retains neither
continuing managerial involvement to the degree usually associated with ownership
nor effective control over the goods sold, (3) the amount of revenue can be
measured reliably, (4) it is probable that the economic benefits associated with the
transaction will flow to the entity and (5) the costs incurred or expected to be
incurred in respect of the transaction can be measured reliably.
7. The matching process requires that expenses be recorded in the period during
which the related revenue is recognized. For example, the cost of inventory sold
during a period is recorded in the same period as the sale, not when the goods are
produced and held for sale.
8. Profit is added to retained earnings and is part of shareholders’ equity. It is
calculated as revenues minus expenses. Because revenue increases profit it also
increases shareholders’ equity. Expenses decrease profit and shareholders’ equity.
9. Revenues increase shareholders’ equity and expenses decrease shareholders’
equity. To increase shareholders’ equity, a shareholders’ equity account must be
credited; to decrease shareholders’ equity, a shareholders’ equity account must be
debited. Therefore revenues are recorded as credits and expenses as debits.
10. Item Increase Decrease

Revenues Credit Debit
Expenses Debit Credit
Gains Credit Debit
Losses Debit Credit
11. Item Debit Credit

Revenues Decrease Increase
Expenses Increase Decrease
Gains Decrease Increase
Losses Increase Decrease
12. Operating, Investing,

Item or Financing Direction
Cash paid to suppliers Operating –
Sale of goods on account* None None
Cash received from customers Operating +
Purchase of investments Investing –
Cash paid for interest Operating –
Issuance of shares for cash Financing +
* This transaction did not involves an exchange of cash.
3-2
13. The total asset turnover ratio is calculated as Sales  Average total assets. The asset
turnover ratio measures the sales generated per dollar of assets. A high ratio
suggests that the company is managing its assets (resources used to generate
revenues) efficiently.
14. Return on assets = Profit / Average Total Assets
ROA measures how much the firm earned for each dollar of investment. It is the
broadest measure of profitability and management effectiveness, independent of
financing strategy. ROA allows investors to compare management’s investment
performance against alternative investment options.
3-3
Authors' Recommended Solution Time
(Time in minutes)
Alternate Cases and

Exercises Problems Problems Projects
No. Time No. Time No. Time No. Time
1 5E 1 15 M 1 15 M 1 35 D
2 20 E 2 15 E 2 25 M 2 50 M
3 20 E 3 50 M 3 45 M 3 25 M
4 5E 4 20 M 4 20 M 4 30 M
5 20 M 5 45 M 5 50 M 5 70 D
6 25 M 6 10 M 6 10 M 6 35 M
7 20 M 7 25 M 7 25 M 7 30 M
8 20 M 8 40 D 8 *
9 10 E 9 15 E
10 10 M
11 20 M
12 20 M
13 30 M
14 30 M
15 25 E
16 25 E
17 20 M
18 40 D
19 20 E
20 20 E
21 30 M
22 20 E
23 5E
24 20 E
25 10 E
E = Easy M = Moderate D = Difficult
* Due to the nature of these cases and projects, it is very difficult to estimate the amount of
time students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While
students often benefit from the extra effort, we find that some become frustrated by the
perceived difficulty of the task. You can reduce student frustration and anxiety by making
your expectations clear. For example, when our goal is to sharpen research skills, we
devote class time discussing research strategies. When we want the students to focus on a
real accounting issue, we offer suggestions about possible companies or industries.
3-4
EXERCISES
E3-1
Case A Case B Case C Case D Case E

Sales revenue $900 $700 $410 $1,190* $750*
Cost of goods sold 500* 380 200* 500 310
Gross profit 400 320* 210* 690* 440
Other operating expenses:

Selling expense 50* 150 80 400 250
Administrative expense 150 80* 60 100 80
200* 230* 140* 500* 330*
Profit before income tax 200 90 70* 190 110*

Income tax expense 30* 30 20 40 30
Profit $170 $60* $50 $150* $80
*Amounts not given in the exercise.
E3-2
VILLAGE CORPORATION
Income Statement
For the Year Ended, December 31, 2011
Computations in Order
Sales revenue................................................. Given $70,000
Cost of sales....................................................(a) $70,000 – $24,500 45,500
Gross profit..................................................... Given 24,500
Other operating expenses:
Selling expense........................................... Given $ 8,000
Administrative expense..........................(c) $14,500 – $8,000 6,500
Total other operating expenses............(b) $24,500 – $10,000 14,500
Profit before income tax........................... Given 10,000
Income tax expense....................................(d) $10,000 x 30%* 3,000
Profit..................................................................(e) $10,000 – $3,000 $ 7,000
Earnings per share ($7,000 ¸ 4,000 shares*) $1.75
*Given
Note that in this exercise Profit before income tax ($10,000) is the same as Operating profit.
3-5
E3-3
Cash Basis Accrual Basis

Income Statement Income Statement
Revenues: Revenues:
Cash sales $4,000 Sales to customers $10,000
Customer deposits 1,000
Expenses: Expenses:
Inventory purchases 2,000 Cost of sales 7,000
Wages paid 600 Wages expense 600
Utilities expense 200
Profit $2,400 Profit $2,200
The cash basis considers only the cash receipts and cash payments regardless of the
revenues generated in March and the related expenses. Revenues under the cash basis
would include amounts received for sales made in earlier months, and exclude sales for
which collection will occur in the future. Similarly, expenses under the cash basis do not
take into consideration those expenses that benefited the company in March but will be
paid in future months. In this particular case, the cash-basis profit shows a better
performance than the accrual-basis profit, but the latter provides a better indication of the
operating performance of the company in a given accounting period.
3-6
E3–4
Amount of Revenue Earned in

September
Event of Accounts Affected and OR
Transaction Type of Account Revenue Criteria Not Met
a. Trade receivables (+A) $20,000
Sales revenue (+R  +SE)
b. Cash (+A) $21,000
Sales revenue (+R  +SE)
c. None No transaction has occurred, exchange
of promises only. A transaction is
recorded when delivery occurs.
d. Trade receivables (+A) $18,000
Sales revenue (+R +SE)
e. Cash (+A) Payment related to revenue previously
Trade receivables (A) recorded in (d).
f. Cash (+A) No revenue earned in September;
Deferred revenue (+L) earnings process is not yet complete.
g. Cash (+A) No revenue is earned as the issuance of
Share capital (+SE) shares is a financing activity.
h. Cash (+A) No revenue earned in September;
i. Cash (A) $100 = ($10,000 x 12%  12 months)
Customer loans receivable (+A) times one month, since it is now the end
Interest revenue (+R +SE) of September.
Interest receivable (+A)
j. Cash (+A) No revenue earned in September;
k. Trade receivables (+A) $100
Sales revenue (+R +SE)
Note: an increase in revenue [transactions (a), (b), (d), (i) and (k)] also results in an
increase in shareholders’ equity.
3-7
E3–5
Amount of Expense Incurred in
January
Event of Accounts Affected and OR
Transaction Type of Account Why an Expense is Not Recognized
a. Salary payable (L) $42,500 incurred in January.
Salary expense (+E SE) The remaining half was incurred in
Cash (A) December.
b. Cash (A) $1,500 incurred in January.
Prepaid insurance (+A) The remainder is not incurred until
Insurance expense (+E SE) February and March.
c. Utilities expense (+E SE) $1,200
Utilities payable (+L)
d. Inventory (A) $4,500
Cost of sales (+E SE)
e. Inventory (+A) Expense will be recorded in the future
Trade payables (+L) when the related revenue has been
earned, i.e., when the books are sold.
f. Cash (+A)
Sales revenue (+R+SE) $31,500 = 450 books x $70 per book
Inventory (A)
Cost of sales (+E SE)
g. Cash (A) December expense, but only paid in
Commissions payable (L) January.
h. Commissions payable (+L) $4,200
Commissions expense (+E SE)
i. Cash (A) Expense will be recorded as

Equipment (+A) “amortization” over the useful life of
the equipment.
j. Cash (A) $700 (this represents the amount of
Supplies (+A) when purchased supplies used during January, i.e.,
Supplies (A) when used $700 = $1,000 + $600 - $900).
Supplies expense (+E SE)
k. Wages payable (+L) $120
Wages expense (+E SE)
l. Cash (A) $300 (= $3,600 / 12 x 1)
Prepaid insurance (+A)
Prepaid Insurance is increased when
Insurance expense (+E SE) purchased and decreased when used
up.
m. Accounts payable (+L) $280
Repairs expense (+E SE)
3-8
E3–5 (continued)
Amount of Expense Incurred in

January
Event of Accounts Affected and OR Why an Expense in Not
Transaction Type of Account Recorded
n. Accounts payable (+L) $230
Utilities Expense (+E SE)
o. Cash (A) $2,100
Consulting Expense (+E SE)
p. Cash (A) December expense, but only paid in
Accounts payable (L) January.
E3–6
Req. 1 and 2
Cash Amount of Revenue Earned or
Accounts Affected and Received Expense Incurred in July
Type of Account (Paid) in OR
July Why a Revenue or an Expense
Is Not Recognized
(a) Cash (+A) $10,000
Game fees revenue (+R+SE) $10,000
(b) Cash (+A) $3,000
Trade receivables (+A)
Equipment sales revenue $ 5,000
(+R+SE)
Cost of sales (+E SE) $(2,800)
Inventory (A)
(c) Cash (+A) $1,000 No revenue earned in July; collections in
Trade receivables (A) July related to earnings in June.
(d) Cash (+A) $1,500 No revenue earned in July; earnings
Deferred revenue (+L) process is not yet complete.
(e) Accounts payable (+L)
Cash (A) $(2,000)
Utilities expense (+E SE) $(2,200) incurred in July;
(f) Cash (A) $(4,000)
Wages expense (+E SE) $(4,000)
(g) Cash (A) $(1,200)
Prepaid expense (+A)
Insurance expense (+E SE) $(400) incurred in July; 1/3 of the
insurance has been used up in July.
3-9
E3–6 (continued)
(h) Cash (A) $(1,000)

Repairs and maintenance $(1,000)
expense (+E SE)
Totals $7,300 $4,600
Req. 3
The net cash flow from these transactions is $7,300, but the difference between revenues
and expenses is $4,600. The reason for the difference of $2,700 is that some cash receipts in
July relate to sales made in June, and other cash receipts in July relate to revenue to be
earned in the future. At the same time, collection of some revenue earned in July will be
made in future months. Furthermore, some of the cash paid in July relates to expenses
incurred in July or in prior periods (e.g. utility bill). Finally some of the cash paid in July
relates to expenses that will be recognized in future periods (e.g. insurance).
E3-7
In order for revenue to be recognized the following criteria must be met:
(a) The entity has transferred to the buyer the significant risks and rewards of ownership
of the goods.
(b) The entity retains neither continuing managerial involvement to the degree usually
associated with ownership nor effective control over the goods sold;
(c) The amount of revenue can be measured reliably.
(d) It is probable that the economic benefits associated with the transaction will flow to
the entity. The consideration received for the sale of goods is either cash or the
customer’s promise.
(e) The costs incurred or to be incurred in respect of the transaction can be measured
reliably.
Until the equipment is manufactured the revenue generation is not complete and revenue
cannot be recognized. Given that this equipment is special ordered it could be argued that
once the manufacturing is complete on May 12, the revenue should be recognized. The item
has already been sold. Alternatively in most cases, the transfer of the risks and rewards of
ownership coincides with the transfer of the legal title or the passing of possession to the
buyer. Modern Equipment shipped the equipment to KMC on May 13. Assuming that this is
the date that title passes the revenue should be recognized on this date. If title does not
pass until the equipment is received the revenue should be recognized on May 14. There is
no need to wait until the invoice is issued – although in most cases issuing the invoice is
what triggers the recognition in the accounting records. If the invoice was not issued by
month or year-end an accrual would be required. Unless there is significant uncertainty in
the ultimate receipt of cash recognition should not be tied to cash receipts.
Note to instructor: This discussion may go beyond what is explicitly discussed in the text. The idea is to
get students thinking critically about the different criteria for recognition of revenue.
3-10
E3–8
Statement of Financial Position Income Statement

Shareholders’
Assets Liabilities Equity Revenues Expenses Profit
a. +10,000 NE +10,000 +10,000 NE +10,000
b. +5,000 NE +5,000 +5,000 NE +5,000
–2,800 NE –2,800 +2,800 –2,800
c. +1,000 NE NE NE NE NE
–1,000
d. +1,500 +1,500 NE NE NE NE
e. –2,000 +200 –2,200 NE +2,200 –2,200
f. –4,000 NE –4,000 NE +4,000 –4,000
g. –1,200 NE – 400 NE + 400 – 400

+ 800
h. –1,000 NE –1,000 NE +1,000 –1,000
Transaction (c) results in an increase in an asset (cash) and a decrease in an asset (trade
receivables). Therefore, there is no net effect on assets.
Transaction (g) results in a decrease in an asset (cash) and an increase in another asset
(prepayments). Therefore, the net effect on assets is a decrease of $400.
E3–9
BOB’S BOWLING INC.
Income Statement
For the Month of July 2011
Revenue $15,000
Expenses:
Cost of sales $ 2,800
Utilities 2,200
Salaries 4,000
Insurance (1,200 / 3 months) 400
Repairs 1,000 10,400
Profit before income taxes 4,600
Income tax expense (@ 40%) 1,840
Profit $ 2,760
3-11
E3–10

Shareholders’
a. + NE + NE NE NE
b. + + NE NE NE NE
c. + + NE NE NE NE
d. + NE + + NE +
e. NE + – NE + –
f. + NE + + NE +
g. – – NE NE NE NE
h. – NE – NE + –
i. + NE + + NE +
j. – NE – NE + –
k. – NE – NE NE NE
l. +/– NE NE NE NE NE
m. – + – NE + –
n. – NE – NE + –
Transaction (l) results in an increase in an asset (cash) and a decrease in another asset
(trade receivables). Therefore, there is no net effect on assets.
3-12
E3–11

Shareholders’
a. +53 NE +53 NE NE NE
b. +30,563 +30,563 NE NE NE NE
c. –34 –34 NE NE NE NE
d. +50,710 NE +17,373 +50,710 +33,337 +17,373

–33,337
e. –2,048 NE –2,048 NE NE NE
f. +889 NE NE NE NE NE
–889
g. –1,460 +2,920 –4,380 NE +4,380 –4,380
h. +353 NE +353 +353 NE +353
i. NE +185 –185 NE +185 –185
Transaction (d) results in an increase in an asset (Trade receivables) and a decrease in

another asset (inventory).
Transaction (f) results in an increase in an asset (property, plant and equipment) and a
decrease in another asset (cash). Therefore, there is no net effect on assets.
Transaction (h) results in an increase in two asset accounts, namely cash and interest
receivable, for a total of $353.
E3–12
a. Cash (+A) ............................................................................................................. 80M

Notes payable (+L) .................................................................................... 80M
Debits equal credits. Assets and liabilities increase by the same amount.
b. Cash (+A) ............................................................................................................. 5.1B

Trade receivables (+A) ................................................................................. 32.4B
Service revenue (+R+SE) ................................................................... 37.5B
Debits equal credits. Revenue increases retained earnings (part of shareholders’
equity). Shareholders’ equity and assets increase by the same amount.
3-13
E3–12 (continued)
c. Plant and equipment (+A) .......................................................................... 515.9M

Cash (-A) ......................................................................................................... 515.9M
Debits equal credits. Assets increase and decrease by the same amount.
d. Inventory (+A) .................................................................................................. 29.2B

Trade payables (+L) .................................................................................. 29.2B
Debits equal credits. Assets and liabilities increase by the same amount
e. Salaries expense (+E SE) ...................................................................... 2.3B

Cash (A) ........................................................................................................ 2.3B
Debits equal credits. Expenses decrease retained earnings (part of shareholders’
equity). Shareholders’ equity and assets decrease by the same amount.
f. Cash (+A) ............................................................................................................. 36.4B

Trade receivables (A) ............................................................................ 36.4B
g. Fuel expense (+E  -SE) ............................................................................. 637 M

Cash (A) ........................................................................................................ 637M
h. Retained earnings (SE) .............................................................................. 497.4M

Cash (A) ........................................................................................................ 497.4M
Debits equal credits. Assets and shareholders’ equity decrease by the same amount.
i. Trade payables (L) ....................................................................................... 26.2B

Cash (A) ........................................................................................................ 26.2B
Debits equal credits. Assets and liabilities decrease by the same amount.
j. Utilities expense (+E SE) ...................................................................... 47M

Cash (A) ........................................................................................................ 30M
Accounts payable (+L) .............................................................................. 17M
equity). Together, shareholders’ equity and liabilities decrease by the same amount
as assets.
3-14
E3–13
Req. 1
a. Cash (+A) 600,000

Note payable (+L) 600,000
b. Computer software (+A) 30,000

Cash (A) 30,000
c. Inventories (+A) 10,000,000

Trade payables (+L) 10,000,000
d. Selling expense (+E SE) 2,200,000

Cash (A) 2,200,000
e. Cash (+A) 8,400,000

Deferred revenue (+L) 8,400,000
Debits equal credits. Since the cash is received before RIM provides service, revenue
is deferred until it is earned. Assets and liabilities increase by the same amount.
f. Cash (+A) 100,000,000

Sales revenue (+R+SE) 100,000,000
Debits equal credits. Revenue increases retained earnings (a part of shareholders’
g. Trade receivables (+A) 87,000,000

Sales revenue (+R+SE) 87,000,000
Debits equal credits. Revenue increases retained earnings (a part of shareholders’
h. Cash (+A) 2,000,000

Deferred revenue (+L) 2,000,000
Debits equal credits. Since cash is received before the delivery of the wireless
products, revenue is deferred until it is earned. Assets and liabilities increase by the
same amount.
3-15
E3–13 (continued)
i. Trade payables (L) 5,000,000

Cash (A) 5,000,000
Debits equal credits. Assets and liabilities decrease by the same amount.
j. Cash (+A) 60,000,000

Trade receivables (A) 60,000,000
k. Wages expense (+E SE) 15,000,000

Cash (A) 15,000,000
Debits equal credits. Expenses decrease retained earnings (a part of shareholders’
Req. 2
Transaction Effect on Profit Effect on Cash

a. NE ↑ $600,000
b. NE ↓ 30,000
c. NE NE
d. ↓ 2,200,000 ↓ 2,200,000
e. NE ↑ 8,400,000
f. ↑ 100,000,000 ↑ 100,000,000
g. ↑ 87,000,000 NE
h. NE ↑ 2,000,000
i. NE ↓ 5,000,000
j. NE ↑ 60,000,000
k. ↓ 15,000,000 ↓ 15,000,000
Req. 3
Trade Receivables (in thousands)
Beg. bal. 12,000 (j) 60,000
(g) 87,000
End. bal. 39,000
3-16
E3–14
Req. 1
Feb. 1 Rent expense (+E SE) ............................................................................. 1,900

Cash (A) .................................................................................................. 1,900
Feb. 2 Fuel expense (+E SE) ............................................................................. 450

Accounts payable (+L) ....................................................................... 450
This assumes the fuel is put on the plane and used in the
current month.
Feb. 4 Cash (+A) ............................................................................................................. 950
Deferred revenue (+L) ……………………………………………...... 950
......
Feb. 7 Cash (+A) ............................................................................................................. 1,240

Transport revenue (+R+SE) ....................................................... 1,240
Feb. 10 Wages payable (L) ........................................................................................ 4,000

Cash (A) .................................................................................................. 4,000
The above journal entry assumes that the liability for
wages had been set up at the end of January.
Feb. 14 Advertising expense (+E SE) .............................................................. 600
Cash (A) .................................................................................................. 600
Feb. 18 Cash (+A) ............................................................................................................. 500

Trade receivables (+A) ................................................................................. 1,300
Transport revenue (+R+SE) ....................................................... 1,800
Feb. 25 Parts inventory (+A) ...................................................................................... 1,350

Trade payables (+L) ............................................................................ 1,350
Feb. 27 Dividends declared (or Retained earnings) (SE) .......................... 1,300

Dividends payable (+L) ..................................................................... 1,300
3-17
E3–14 continued)
Req. 2

Feb. 1 ↓ 1,900 ↓ 1,900
Feb. 2 ↓ 450 NE
Feb. 4 NE ↑ 950
Feb. 7 ↑ 1,240 ↑ 1,240
Feb. 10 NE ↓ 4,000
Feb. 14 ↓ 600 ↓ 600
Feb. 18 ↑ 1,800 ↑ 500
Feb. 25 NE NE
Feb. 27 NE NE
3-18
E3–15
Req. 1 and 2
Cash Trade Receivables Supplies

10,000 1,900 (g) 50,000 8,000 (d) 2,400
(a) 500 8,500 (i) (k) 800
(b) 500 3,000 (j)
(c) 16,000 800 (k)
(d) 8,000
20,800 42,000 3,200
Equipment Land Building

16,000 12,000 64,000
(h) 850
16,850 12,000 64,000
Deferred Revenue
Trade Payables (deposits) Note Payable
(g) 1,900 16,000 6,400 80,000
420 (e) 500 (a)
14,520 6,900 80,000
Rebuilding Fees
Share Capital Retained Earnings Revenue
16,000 (j) 3,000 36,000 16,000 (c)
850 (h)
16,850 33,000 16,000
Rent Revenue Wages Expense Utilities Expense

500 (b) (i) 8,500 (e) 420
500 8,500 420
Item (f) is not a transaction; there has been no exchange.

In item (h) it is assumed that share capital was issued in exchange for the tool.
Req. 3
Revenues $16,500 ($16,000 + 500)

– Expenses 8,920 ($8,500 + 420)
Profit $ 7,580
Assets $158,850 ($20,800 + 42,000 + 3,200 + 16,850 + 12,000 + 64,000)

= Liabilities 101,420 ($14,520 + 6,900 + 80,000)
+ Shareholders’ Equity 57,430 ($16,850 + 33,000 + 7,580 Profit)
3-19
E3–15 (continued)
Req. 4
Profit using the cash basis of accounting would be $13,800. Cash revenues of $25,000 were
received (transactions a through d) and cash expenses of $11,200 were paid (transactions
g, i, and k).
The cash basis profit includes all cash receipts whether they were earned during January
2011 or not. Similarly, the expenses include all cash payments for operations in January
regardless of whether they relate to the January operations or not.
The difference between profit using the cash basis $13,800 and the increase in cash
$10,800 is the dividend of $3,000 paid to shareholders. Dividends are a distribution of
profit to shareholders, not an expense incurred to earn revenue, but they do reduce the
cash balance.
Req. 5
ROA = Profit ÷ Average Total Assets*
*(Beginning total assets + Ending total assets) ÷ 2
ROA = $7,580 ÷ [($154,400 + $158,850) ÷ 2] = 0.0484 or 4.84%
In January 2011, the ROA is less than one half its previous levels in November and
December 2010. This suggests that the company’s business may be seasonal and slows
down in January. I would indicate in my report that comparison should be made with the
ROA achieved in previous months as well, which may provide a better reference for
comparison purposes if, in fact, the business is seasonal.
E3–16
Operating, Investing or Direction and Amount of
Transaction Financing Effect the Effect
(a) O +500
(b) O +500
(c) O +16,000
(d) O +8,000
(e) None
(f) None
(g) O -1,900
(h) None
(i) O -8,500
(j) F -3,000
(k) O -800
Transaction (h) is omitted from the statement of cash flows because the transaction does
not involve cash. However, as discussed in future chapters, this type of transaction is a
noncash investing and financing activity that should be disclosed in the notes to the
financial statements, if it is significant.
3-20
E3–17
Req. 1 a.
SBROCCHI’S PIANO REBUILDING COMPANY
Income Statement
For the Month of January 2011
Sales Revenue
Rebuilding fees $16,000
Rent 500
Total revenues 16,500
Operating Expenses:
Wages 8,500
Utilities 420
Total expenses 8,920
Profit $ 7,580
Req. 1 b.
SBROCCHI’S PIANO REBUILDING COMPANY
Partial Statement of Cash Flows
Operating activities
Cash received from customers (a, b, c, d) $25,000
Cash paid:
to suppliers (g) $1,900
to employees (i) 8,500
for supplies (k) 800
Operating cash outflow 11,200
Net cash flow from operating activities $13,800
Req. 2
Operating activities contributed $13,800 during January 2011 compared to Profit of
$7,580. The difference between these two amounts is due to the fact that revenue is
recognized when earned, regardless of when cash is received, and expenses are recognized
when incurred, regardless of when cash is paid. The difference of $6,220 can be explained
as follows:
Profit……………………………………………………………………. $ 7,580
Add: cash received for service provided in previous months…….……... 8,000
Add: deposit received for revenue not yet reported on the income
statement…………………………………………………………….………. 500
Add: electricity and gas utility bill for January, not paid yet….…………… 420
Deduct: payment to suppliers for expenses reported on previous
income statements……………………………………………………….… (1,900)
Deduct: payment for supplies not yet reported as expenses on the
Income statement…………………………………………………………... (800)
Cash flow from operating activities ………………………………………… $13,800

3-21
E3–18
Req. 1 and 2
Cash Trade receivables Supplies

(a) 20,000 12,000 (b) (a) 2,000 (a) 1,200
(c) 25,000 8,830 (d) (f) 2,000
(e) 10,900 314 (h)
(f) 1,200 5,080 (i)
600 (j)
24,870 (k)
5,406 4,000 1,200
Equipment Building Trade payables

(a) 19,800 (b) 60,000 320 (g)
(k) 15,000 (k) 9,870
34,800 69,870 320
Note Payable Mortgage Payable Share Capital

25,000 (c) 48,000 (b) 43,000 (a)
25,000 48,000 43,000
Retained Catering Sales Revenue

Earnings (Deficit)* Food Sales Revenue
(j) 600 10,900 (e) 3,200 (f)
600 10,900 3,200
Cost of Food and Paper

Products Utilities Expense Wages Expense
(d) 8,830 (g) 320 (i) 5,080
8,830 320 5,080
Gasoline Expense
(h) 314
314
* The dividends as a result of the profit that the company realized in March.
3-22
E3–18 (continued)
Req. 3

a. NE ↑ $20,000
b. NE ↓ 12,000
c. NE ↑ 25,000
d. ↓ 8,830 ↓ 8,830
e. ↑ 10,900 ↑ 10,900
f. ↑ 3,200 ↑ 1,200
g. ↓ 320 NE
h. ↓ 314 ↓ 314
i. ↓ 5,080 ↓ 5,080
j. NE ↓ 600
k. NE ↓ 24,870
E3–19
Operating, Investing or Direction and Amount

Transaction Financing Effect of the Effect
(a) F +20,000
(b) I -12,000
(c) F +25,000
(d) O - 8,830
(e) O +10,900
(f) O + 1,200
(g) None
(h) O - 314
(i) O - 5,080
(j) F - 600
(k) I -24,870
The non-cash assets received in transactions (a) and (b) and related financing are not
reflected in the statement of cash flows. However, the non-cash portion of these investing
and financing activities should be disclosed in the notes to the financial statements, if they
are significant.
3-23
E3–20
Req. 1 a.
TRAVELLING GOURMET, INC.

Income Statement
For the Month of March 2012
Sales Revenue
Food sales revenue $10,900
Catering sales revenue 3,200
Operating Expenses:
Cost of food and paper products 8,830
Wages 5,080
Utilities 320
Gasoline expense 314
Operating loss $ (444)
Req. 1 b.
TRAVELLERS GOURMET COMPANY, INC.
Statement of Cash Flows
For the Month of March 2012
Cash received from customers (e, f) $12,100
Cash paid:
to suppliers (d) $8,830
to employees (i) 5,080
for other expenses (h) 314
Net cash flow used for operating activities $ (2,124)
Req. 2
Operating activities used $2,124 during March 2012 compared to an operating loss of
$444. The difference between these two amounts is due to the fact that revenue is
when incurred, regardless when cash is paid. The difference of $1,680 can be explained as
follows:
Net loss………………………………………………………………………... $ (444)
Deduct: catering revenue not received in cash yet……………….………. (2,000)
Add: telephone bill for March, not paid yet….…………………………...… 320
Net cash flow used for operating activities ………………………………… $(2,124)
3-24
E3–21
Req. 1
Transaction Brief Explanation

A Issued shares for $50,000 cash.
B Purchased store fixtures for $10,000 cash.
C Purchased $20,000 of inventory, paying $5,000 cash and the balance on account.
D Sold $10,000 of goods or services to customers, receiving $7,000 cash and the
balance on account. The cost of sales was $3,000.
E Paid $2,000 in cash for rent, $500 related to the current month and $1,500
related to three future months.
F Paid $1,000 to employees for work performed in the period.
G Used $1,200 of utilities during the month, not yet paid.
H Received $3,000 cash from customers, $1,000 related to current sales and $2,000
related to goods or services to be provided in the future.
Req. 2
KIERNAN KITE COMPANY

Income Statement
For the Month Ended April 30, 2012
Sales revenue $ 11,000

Operating expenses:
Cost of sales 3,000
Wages expense 1,000
Rent expense 500
Utilities expense 1,200
Profit $ 5,300
Note: income taxes have been ignored.
3-25
E3–21 (continued)
KIERNAN KITE COMPANY

Statement of Financial Position
As at April 30, 2012
Assets Liabilities
Current Assets Current Liabilities
Cash $42,000 Trade payables $16,200
Trade receivables 3,000 Deferred revenue 2,000
Inventory 17,000 Total current liabilities 18,200
Prepayments 1,500 Shareholders’ Equity
Total Current Assets 63,500 Share capital 50,000
Store fixtures 10,000 Retained earnings 5,300
Total Shareholders’ Equity 55,300
Total Liabilities & Shareholders’
Total Assets $73,500 Equity $73,500
E3–22
2011 2010
Asset = Sales $154,000 = 2.8 $144,000 = 3.2
Turnover Average Total Assets $55,000* $45,000**
Return on = Profit $5,000 = 0.091 $3,800 = 0.084

Assets Average Total Assets $55,000* $45,000**
* ($50,000 + $60,000) ÷ 2
** ($40,000 + $50,000) ÷ 2
The decrease in the asset turnover ratio suggests that the company is managing its assets
less efficiently, generating fewer sales per dollar of assets in 2011 than in 2010.
The increase in the return on assets suggests that the company was able to improve on its
management of assets for the benefit of shareholders, even though the asset turnover ratio
indicates a decrease in management’s effectiveness of utilizing its assets to generate sales.
This was accomplished by improving on the control of expenses.
3-26
E3–23
Req. 1
Assets $21,000 ($3,000 + 10,000 + 8,000)

= Liabilities $11,000 ($3,000 + 6,000 + 2,000)
+ Shareholders’ Equity $10,000 ($6,000 + 4,000)
Req. 2
Trade Long-Term Investments
Cash Receivables
3,000 55,800 (d) 10,000 7,700 (a) 8,000
(a) 7,700 600 (f) (b) 20,000
(b) 50,000
(c) 500
(g) 2,000
6,800 22,300 8,000
Trade Deferred Long-Term

Payables Revenue Borrowings
(d) 2,000 3,000 6,000 2,000
1,300 (e) 2,000 (g)
2,300 8,000 2,000
Share Capital Retained Earnings

6,000 (f) 600 4,000
6,000 3,400
Consulting Fee Revenue Investment

Income
70,000 (b) 500 (c)
70,000 500
Wages Expense Travel Expense Utilities Expense

(d) 20,000 (d) 21,800 (e) 1,300
20,000 21,800 1,300
Rent Expense
(d) 12,000
12,000
3-27
E3–23 (continued)
Req. 3
Revenues, $70,500 ($70,000 + 500)
– Expenses, $55,100 ($20,000 + 21,800 + 1,300 + 12,000)
= Profit, $15,400
Assets, $37,100 ($6,800 + 22,300 + 8,000)

= Liabilities, $12,300 ($2,300 + 8,000 + 2,000)
+ Shareholders’ Equity, $24,800 ($6,000 + 3,400 + 15,400 Profit)
Req. 4
Asset Turnover = Sales = $70,500 = 2.43
Average Total Assets $29,050 *
* ($21,000 + $37,100) ÷ 2
It can be argued that investment income ($500) is merely incidental, and could be excluded
from the numerator in the above calculation. This change in approach would not affect the
asset turnover ratio significantly in this case.
The increasing trend in the asset turnover ratio from 1.80 in 2009 and 2.00 in 2010 to 2.43
in 2011 suggests that the company is managing its assets more efficiently over time. It
could also suggest that capital assets are getting older and the assets are not being
replaced. This would result in lower average total assets as the carrying amount of the
assets is reduced (through depreciation).
3-28
E3–24
Req. 1
Trade receivables increase with customer sales on account and decrease with cash
payments received from customers.
Prepaid expenses increase with cash payments of expenses related to future periods and
decrease as these expenses are incurred over time.
Deferred revenue increases with cash payments received from customers for goods or
services to be provided in the future and decreases when those goods and services are
provided.
Req. 2
Trade receivables Prepayments Deferred Revenue

1/1 313 1/1 25 240 1/1
2,573 2,591 42 315 328
43
12/31 295 12/31 26 253 12/31
Computations:
Beginning + “+”  “” = Ending
Trade 313 + 2,573  X = 295
receivables X = 2,591
Prepayments 25 + 43  X = 26
X = 42
Deferred 240 + 328  X = 253
revenues X = 315
3-29
E3–25
Req. 1
Bianca Corp. 2013 2012 2011 2010

Total assets $ 40,000 $ 50,000 $ 60,000 $ 65,000
Revenue 130,000 144,000 154,000 150,000
Profit 25,000 3,800 5,000 4,800
Interest expense net of tax 1,000 800 700 800
Average total assets 45,000 55,000 62,500
Total asset turnover ratio 2.89 2.62 2.46
Return on assets ratio 0.58 0.08 0.09
Uzma, Inc.
Total Assets $ 65,000 $ 60,000 $ 50,000 $ 40,000
Revenue 150,000 154,000 144,000 130,000
Profit 4,800 5,000 3,800 25,000
Interest expense net of tax 400 500 400 300
Average total assets 62,500 55,000 45,000
Total asset turnover ratio 2.40 2.80 3.20
Return on assets ratio 0.08 0.10 0.09
Req. 2
Based on the total asset turnover ratios, Bianca outperformed Uzma in 2013 only. With
respect to the ROA Bianca outperformed Uzma in 2013 but not in 2012, and they were
equal in 2010. A more careful examination of the components of each of the two ratios will
help determine which company is more efficient in managing its assets.
The total assets of Bianca declined since 2010, which means its assets are shrinking while
for Uzma the reverse is true; its assets are increasing. The growth in this company’s assets
takes time to be reflected in revenue, which may explain why Uzma’s asset turnover ratio is
lower than Bianca’s in 2013. Nevertheless, Uzma’s revenues are growing steadily but not
as quickly as its assets.
The dramatic increase in profit for Bianca in 2013 is likely due to a gain in sale of assets
and this highlights the importance of seeking further information by inspecting the income
statement closely. If true, then Bianca’s ROA of 0.58 may not be repeated in the future.
Uzma’s ROA has been fairly steady despite its growth in assets which suggests that Uzma’s
management is controlling the growing operations well.
Overall, Uzma Inc. appears to be more efficient in managing its resources.
3-30
PROBLEMS
P3–1
Transaction Debit Credit

a. 5 1, 8
b. 1 11
c. 14 1
d. 1 13
e. 1 2
f. 2 13
g. 14 1
h. 7 1
i. 14 7
j. 3 1
k. 14 3
l. 6 1
m. 8, 14 1
n. 15 1, 10
o. 4 1
Debit “9” in transaction (c) if it is assumed that the liability for salaries and wages was
previously accrued.
P3–2
May 1 Cash (+A)............................................................................................................. 35,000

Share capital (+SE)................................................................................. 35,000
May 1 Cash (+A)............................................................................................................. 40,000
Long-term debt (+L).............................................................................. 40,000
May 1 Rent expense (+E SE)............................................................................ 1,200
Prepaid rent (+A)............................................................................................ 1,200
Cash (A)..................................................................................................... 2,400
May 1 Prepaid insurance (+A)................................................................................ 1,800

Cash (A) .................................................................................................... 1,800
May 3 Furniture and fixtures (+A)....................................................................... 18,000

Accounts payable (+L) ......................................................................... 18,000
May 4 Inventory (+A).................................................................................................. 2,100
Cash (A) .................................................................................................... 2,100
3-31
P3–2 (continued)
May 5 Advertising expense (+E SE).............................................................. 360

Cash (A) .................................................................................................... 360
May 9 Cash (+A)............................................................................................................. 250

Trade receivables (+A)................................................................................. 250
Sales revenue (+R+SE) .................................................................... 500
Cost of sales (+E SE)............................................................................... 250

Inventory (A) ......................................................................................... 250
May 10 Accounts payable (L).................................................................................. 18,000

Cash (A) .................................................................................................... 18,000
May 14 Cash (+A)............................................................................................................. 100

Trade receivables (A) ........................................................................ 100
Req. 2

Shareholders’
May 1 + NE + NE NE NE
May 1 + + NE NE NE NE
May 1 +/– NE – NE + –
May 1 +/– NE NE NE NE NE
May 3 + + NE NE NE NE
May 5 – NE – NE + –
May 9 +/– NE + + + +
May 10 – – NE NE NE NE
3-32
P3–3
Req. 1 and 2
Cash Trade Receivables Supplies

(a) 15,000 2,400 (b) (h) 275 50 (k) (c) 400
(e) 10,000 400 (c)
(h) 1,525 10,000 (f)
(k) 50 425 (g)
(m) 2,600 500 (i)
510 (j)
134 (l)
14,806 225 400
Merchandise Inventory
Prepaid Rent Equipment
(d) 5,000 1,000 (h) (b) 2,400 (f) 2,000
1,400 (m)
2,600 2,400 2,000
Furniture and Fixtures Trade Payables Notes Payable

(f) 8,000 (i) 500 5,000 (d) 10,000 (e)
8,000 4,500 10,000
Interest Payable Share Capital Sales Revenue

400 (n) 15,000 (a) 1,800 (h)
2,600 (m)
400 15,000 4,400
Cost of Sales Advertising Expense Wages Expense

(h) 1,000 (g) 425 (j) 510
(m) 1,400
2,400 425 510
Repair Expense Interest Expense

(l) 134 (n) 400
134 400
3-33
P3–3 (continued)
Req. 3
PAULA’S PASSIONS INC.
Income Statement (unadjusted)
For the Month Ended February 28, 2011
Sales revenue $4,400
Cost of sales 2,400
Gross margin 2,000
Operating expenses:
Advertising expense 425
Wages expense 510
Repair expense 134
1,069
Non-operating expenses
Interest expense 400
Profit $ 531
Note: Income taxes have been ignored.
Req. 4
Date: (today’s date)
To: Paula Abboud
From: (your name)
After analyzing the effects of transactions for Paula’s Passions, Inc. for February, the
company has realized a profit of $531. This is 12.1% of sales revenue. However, this is
based on unadjusted amounts. There are several additional expenses that will decrease the
profit amount. These include rent, supplies, and amortization. Therefore, the company
does not appear to be profitable, which is common for small businesses at the beginning of
their operations. A focus on maintaining control over expenses while increasing revenues
should result in profit in future periods. It would also be useful to prepare a cash flow
budget each month for the upcoming year to decide how potential cash shortages will be
overcome.
Req. 5
2012 2013
Asset Sales $75,000 =1.88 $85,000 = 1.36
=
Turnover Average $40,000* $62,500**
Total Assets
Profit + Interest $10,000
Return on Expense (net of tax) +400 x .70 $20,000 = 0.32
Assets = =0.26
Average $40,000* $62,500**
Total Assets
* ($35,000 + $45,000) ÷ 2 ** ($45,000 + $80,000) ÷ 2
3-34
P3–3 (continued)
The asset turnover ratio for 2013 is lower than it otherwise would have been because of
Paula’s decision to open a second store. The inventory purchases have increased the
average total assets used and therefore decreased the turnover ratio. With future sales
expected to grow, the ratio should increase in coming years. The return on assets shows a
significant increase in the profitability of the company from 2012 to 2013. If the ratios are
calculated for 2013 using the opening instead of the average total assets the asset turnover
is 1.88 and the return on assets 0.44. Based on this rationale, I should be promoted.
(Note that the numerator of the Return on Assets ratio does not include interest expense as
this amount is not reported for 2012 and 2013.)
P3-4
(a) F +15,000
(b) O – 2,400
(c) O – 400
(d) None
(e) F +10,000
(f) I –10,000
(g) O – 425
(h) O + 1,525
(i) O – 500
(j) O – 510
(k) O + 50
(l) O – 134
(m) O + 2,600
(n) O – 400
3-35
P3–5
Req. 1 and 2
ASSETS:
Cash Receivables Non-current Assets

605 74 (c) 582 652 (e) 2,034
(a) 60 396 (d) (a) 720 (b) 816
(e) 652 380 (g)
(f) 90 49 (h)
184 (i)
324 650 2,850
Prepayments Investments (long-term) Other Noncurrent Assets

71 965 1,334
(c) 10
81 965 1,334
LIABILITIES:
Other Noncurrent
Trade Payables Accrued Liabilities Liabilities
469 509 2,803
(i) 184
285 509 2,803
Deferred Revenues Long-term Borrowings

203 74
816 (b)
90 (f)
203 980
SHAREHOLDERS' EQUITY:
Equity of Canada
1,533
1,533
3-36
P3-5 (continued)
REVENUES AND EXPENSES:
Delivery Service Revenue Rent Expense Repair Expense

780 (a) (c) 64 (d) 396
780 64 396
Wages Expense Supplies Expense

(g) 380 (h) 49
380 49
Item (j) does not represent an exchange transaction and is therefore not reflected in the T-
accounts.
Req. 3

a. ↑ $780 ↑ $60
b. NE NE
c. ↓ 64 ↓ 74
d. ↓ 396 ↓ 396
e. NE ↑ 652
f. NE ↑ 90
g. ↓ 380 ↓ 380
h. ↓ 49 ↓ 49
i. NE ↓ 184
j. NE NE
3-37
P3–5 (continued)
Req. 4
CANADA POST CORPORATION
Income Statement
For the Month Ended January 31, 2009
(in millions)
Revenues:
Delivery service revenue $ 780
Operating expenses:
Rental expense 64
Wage expense 380
Supplies expense 49
Repair expense 396
Total expenses 889
Profit (loss) $(109)
Req. 5
As at January 31, 2009
(in millions)
Assets
Current assets:
Cash $ 324
Receivables 650
Prepayments 81
Total current assets: 1,055
Investments 965
Non-current assets 2,850
Other assets 1,334
Total assets $6,204
Liabilities and Equity

Current liabilities:
Trade payables $ 285
Accrued liabilities 509
Deferred revenues 203
Total current liabilities: 997
Long-term borrowings 980
Other noncurrent liabilities 2,803
Total liabilities 4,780
Equity of Canada* 1,424

Total liabilities and equity of Canada $6,204
3-38
P3–5 (continued)
* Canada Post uses the title Equity of Canada instead of Shareholders’ Equity. The
Corporation is authorized to issue shares to the Government of Canada but no
shares have been issued yet. For this reason, the company uses the title Contributed
Capital instead of Share Capital. This also explains the use of the term Equity of
Canada rather than Shareholders’ Equity. For the purpose of simplification, we did
not show the components of the Equity in Canada ($1,533 – 109).
Req. 6

Statement of Cash Flows
Cash received from customers (a, e) $ 712
Cash paid:
to suppliers (i) $ 184
to employees (g) 380
for other expenses (c, d, h) 519
Net cash flow used for operating activities $ (371)
Operating activities required the use of $371 compared to an accrual accounting loss of
$109. The difference between these two amounts is due to the fact that revenue is
when incurred, regardless when cash is paid. The difference of $262 can be explained as
follows:
Loss ………………………………………………………………………..………………………………. $ (109)

Deduct: sales not received in cash yet ($720 – $652) ………………………………… (68)
Deduct: payment for rent not reported on the income statement ………………. (10)
Deduct: payment to suppliers for expenses reported on previous
income statements ………………………………………………………………………………… (184)
Net cash flow used for operating activities ……………………………………………….. $ (371)
3-39
P3–5 (continued)
Req. 7
Total Asset = Sales = $780 = 0.132

Turnover Ratio Average Total Assets $5,898
Profit (Loss) + Interest

Return on Assets
= Expense (net of tax) = $(109) = –0.018
Average Total Assets $5,898
* ($6,204 + $5,591) ÷ 2
The asset turnover ratio suggests that during January the company obtained $0.13 in sales
for every $1 in assets. Assuming that sales are spread equally throughout the year, the
annual asset turnover would be approximately 1.58. The annualized rate of 1.58 suggests
that Canada Post is efficient in using its resources. However, Canada Post incurred a loss
which resulted in a negative return on assets for the period. The loss for January may be
offset with profit in future months.
P3-6
Gross profit or Gross margin = Net sales – Cost of sales

Operating income (loss) = Gross profit – Operating expenses
ROA = Profit ÷ Average Total Assets
Transaction Gross Profit Operating Income (Loss) Return on Assets

a. + + +
b. NE – –
c. NE NE –
d. NE NE +
c. Decreases ROA because it increases the denominator, total assets

d. Increases ROA because it decreases the denominator, total assets.
3-40
P3-7
Req. 1
2008 2007 2006 2005 2004

Barrick Gold
Total Asset Turnover Ratio 0.34 0.29 0.40 0.36 0.33
Return on Assets (ROA) 3.47% 5.56% 11.34% 6.17% 4.50%
West Jet Airlines

Return on Assets (ROA) 7.38% 8.75% 6.64% 3.08% 0.95%
Le Groupe Jean Coutu

Return on Assets (ROA) –11.53% 9.03% 4.38% 6.16% 9.39%
Req. 2
The assets of Barrick Gold and WestJet Airlines have grown over time. Le Groupe Jean
Coutu grew significantly from 2004 to 2005 but then shrunk in the following two years.
Barrick Gold grew significantly from 2005 to 2006 and 2006 to 2007. WestJet’s growth has
been steady throughout the time period.
The asset turnover ratio reflects how much revenue was produced per dollar of assets.
Based on this measure of efficiency, the results have been mixed over the five years, with
Barrick Gold having the highest ratio of 11.34% in 2006 and Le Groupe Jean Coutu having
the lowest (a loss) in 2008. WestJet appears to have the best trend with a steadily rising
ratio from 2004 to 2008.
The ROA indicates how much each company earned in profit per dollar of assets. Based on
this measure, WestJet has shown fairly steady growth in its efficient utilization of resources
over time from 2004 to 2007 with a slight decline in 2008. Jean Coutu saw its ROA rise and
fall over time, particularly in 2007 and 2008. Barrick Gold showed an increase from 2004
to 2006, and then a decline in 2007 and 2008.
It is rather difficult to determine conclusively which company has best managed its assets
over time because of the very large change in the asset base of Barrick Gold. It appears an
investor would be likely to prefer the steady asset growth and rising ratios of WestJet
Airlines.
3-41
P3–7 (continued)
Req. 3
The operating cash flows for the three companies indicate that Barrick Gold has generated
the highest amount of cash flows. This is not surprising because Barrick Gold has a larger
asset base than the other two companies. As a result, Barrick Gold appears to be in the best
position to pay off its short-term liabilities at the end of 2008. However, we need to
compare the operating cash flows of each company to the size of its short-term liabilities. If
these amounts were known, then one could compute the ratio of operating cash flows to
current liabilities to determine the percentage of current liabilities that are covered by
operating cash flows.
P3–8
Req. 1
a. Cash (+A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 566,266

Admissions revenue (+R+SE). . . . . . . . . . . . . . . . 566,266
b. Operating expenses (+E SE). . . . . . . . . . . . . . . . . . . 418,550

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 398,574
Trade payables (+L). . . . . . …………………………... 19,976
c. Interest expense (+E SE). . . . . . . . . . . . . . . . . . . . . . 129,561

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129,561
Entry (c) is based on the assumption that no previous
accrual had been booked for the interest obligation.
d. Cash (+A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 355,917

Food, merchandise, and games revenue (+R+ SE) 355,917
e. Cost of products sold (+E SE). . . . . . . . . . . . . . . . . . 90,626

Food and merchandise inventory (A). . . . . . . . . . . . 90,626
f. Property and equipment (+A). . . . . . . . . . . . . . . . . . . . . 83,481

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83,481
g. Amortization expense (+E SE). . . . . . . . . . . . . . . . . . 124,500

Accumulated amortization (A). . . . . . . . . . . . . . . . . . 124,500
h. Cash (+A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73,612

Trade receivables (+A). . . . . . . . . . . . . . . . . . . . . . . . 437
Accommodations revenue (+R+SE). . . . . . . . . . . . . 74,049
i. Notes payable (L). . . . . . . . . . . . . . . . . . . . . . . . . . 17,450

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,450
3-42
P3–8 (continued)
j. Food and merchandise inventory (+A) ……………………………… 92,326

Cash (A) …………………………………………………………………... 90,538
Trade payables (+L) …………………………………………………… 1,788
k. Selling, general and admin. expenses (+E SE) …………….. 131,882

Cash (A) …………………………………………………………………... 130,539
Trade payables (+L) …………………………………………………… 1,343
l. Trade payables (L) ………………………………………………………. 6,452

Cash (A) …………………………………………………………………... 6,452
Req. 2

a. ↑ $566,266 ↑ $566,266
b. ↓ 418,550 ↓ 398,574
c. ↓ 129,561 ↓ 129,561
d. ↑ 355,917 ↑ 355,917
e. ↓ 90,626 NE
f. NE ↓ 83,481
g. ↓ 124,500 NE
h. ↑ 74,049 ↑ 73,612
i. NE ↓ 17,450
j. NE ↓ 90,538
k. ↓ 131,882 ↓ 130,539
l. NE ↓ 6,452
Req. 3
Effect on Total Asset

Transaction Turnover Ratio Explanation
(a) Increase Both sales and total assets would increase. Since the
ratio is less than 1.0, the increase in sales (the
numerator) is proportionally higher than the increase in
total assets (the denominator).
(b) Increase The payment of cash reduces total assets. Since sales are
not affected, the ratio increases.
3-43
P3–8 (continued)
Req. 3
(c) Increase The payment of cash reduces total assets. Since sales are
not affected, the ratio increases.
(d) Increase Same reasoning as in (a).
(e) Increase The Cost of sales reduces the cost of inventory, hence
total assets decrease (without affecting sales). This
leads to an increase in the ratio.
(f) No effect Total assets remain unchanged (cash decreases, capital
assets increase) and sales are not affected.
(g) Increase Accounting for amortization reduces the book value of
assets, which increases the ratio.
(h) Increase Same reasoning as in (a).
(i) Increase The decrease in cash reduces total assets but does not
affect sales.
(j) Decrease This transaction leads to a net increase in total assets,
but does not affect sales.
(k) Increase The payment of cash reduced total assets but does not
affect sales.
(l) Increase Same reasoning as in (i).
P3-9

(a) O +566,266
(b) O –398,574
(c) O –129,561
(d) O +355,917
(e) None NE
(f) I – 83,481
(g) None NE
(h) O + 73,612
(i) F – 17,450
(j) O – 90,538
(k) O –130,539
(l) O – 6,452
3-44
ALTERNATE PROBLEMS
AP3–1
Transaction Debit Credit

a. 1 11
b. 2 13
c. 3 7
d. 4 1
e. 5 1, 8
f. 1 2
g. 9 1
h. 7 1
i. 7 1
j. 14 7
k. 1 13
l. 14 3
m. 15 10
n. 12 1
o. 8, 14 1
p. None None
Item (p) is not an exchange transaction that affects the corporation.
3-45
AP3–2
Req. 1
April 2 Office supplies (+A) ........................................................................................ 500

Accounts payable (+L) ........................................................................ 500
3 Utilities expense (+E SE) ....................................................................... 245

Accounts payable (+L) ........................................................................ 245
5 Trade receivables (+A) .................................................................................. 1,950

Service revenue (+R+SE) .............................................................. 1,950
8 Accounts payable (L) ................................................................................... 250

Cash (A) ................................................................................................... 250
8 Advertising expense (+E SE) ............................................................... 400

Cash (A) ................................................................................................... 400
9 Equipment (+A) ................................................................................................ 2,300

Cash (A) ................................................................................................... 2,300
10 Wages expense (+E SE) ......................................................................... 1,000

Wages payable (L) ........................................................................................ 200
Cash (A) ................................................................................................... 1,200
11 Cash (+A) .............................................................................................................. 1,000

Trade receivables (A) ....................................................................... 1,000
12 Land (+A) ............................................................................................................. 10,000

Cash (A) ................................................................................................... 2,000
Note payable (+L) ................................................................................. 8,000
13 Cash (+A) .............................................................................................................. 80,000

Share capital (+SE) ............................................................................... 80,000
14 Trade receivables (+A) .................................................................................. 2,000

Service revenue (+R+SE) .............................................................. 2,000
3-46
AP3–2
Req. 2
Shareholders’
Date Assets Liabilities Equity Revenues Expenses Profit
April 2 + + NE NE NE NE
April 3 NE + – NE + –
April 5 + NE + + NE +
April 8 – – NE NE NE NE
April 8 – NE – NE + –
April 9 +/– NE NE NE NE NE
April 10 – – – NE + –
April 11 +/– NE NE NE NE NE
April 12 +/– + NE NE NE NE
April 13 + NE + NE NE NE
April 14 + NE + + NE +
AP3–3
Req. 1 and 2
Trade Receivables Supplies
Cash
(a) 75,000 25,000 (b) (c) 15,260 3,000 (i) (f) 4,630
840 (g)
(d) 16,300 1,700 (h)
(e) 1,800 5,600 (j)
(i) 3,000 1,800 (k)
2,500 (m)
58,660 12,260 4,630
Barns Land Prepaid Insurance

(a)100,000 (a) 75,000 (k) 1,800
(b) 50,000
150,000 75,000 1,800
Long-term
Trade Payables Deferred Revenue Note Payable
(h) 1,700 4,630 (f) 1,800 (e) 25,000 (b)
2,130 (l)
5,060 1,800 25,000
3-47
AP3–3 (continued)

250,000 (a) (m) 2,500
250,000 2,500
Animal Care Revenue Rental Revenue

15,260 (c) 16,300 (d)
15,260 16,300
Utilities Expense Wages Expense

(g) 840 (j) 5,600
(l) 2,130
2,970 5,600
Req. 3
GREEN STABLES, INC.

Income Statement
For the Month Ended April 30, 2011
Revenues:
Animal care revenue $15,260
Rental revenue 16,300
Operating expenses:
Wages expense 5,600
Utilities expense 2,970
Profit $22,990
Note: Income taxes have been ignored.
3-48
AP3–3 (continued)
GREEN STABLES, INC.

As at April 30, 2011
Assets
Current assets:
Cash $ 58,660
Trade receivables 12,260
Supplies 4,630
Prepaid insurance 1,800
Total current assets 77,350
Barns 150,000
Land 75,000
Total Assets $302,350
Liabilities
Trade payables $ 5,060
Deferred revenue 1,800
Total current liabilities 6,860
Note payable 25,000
Total Liabilities 31,860
Shareholders’ Equity
Share Capital 250,000
Retained Earnings* 20,490
Total Shareholders’ Equity 270,490
Total Liabilities and Shareholders’ Equity $302,350
* RE, April 30 = Profit, $22,990 – Dividends, $2,500 = $20,490
Req. 4
Date: (today’s date)

To: Shareholders of Green Stables, Inc.
From: (your name)
After analyzing the effects of the transactions for Green Stables, Inc. for April, the
company appears to have earned a profit of $22,990, which is 73% of sales revenue (a very
high return on sales!). However, it is extremely important to note that this calculation of
profit is based on unadjusted amounts. There are several additional expenses that will
decrease the unadjusted profit of $22,990. These include amortization (of the barns),
supplies used, insurance, interest, wages and income taxes. It would be useful to forecast
the income and cash flows each month for the upcoming year to assess whether the income
and positive cash flows are likely to continue into the foreseeable future.
3-49
AP3–3 (continued)
Req. 5
2012: Asset = Sales = $400,000 = $400,000 = 1.29

Turnover Average ($300,000 + $320,000)÷2 $310,000
Total Assets
Return on = Profit = $30,000 = $30,000 = 0.097

Assets Average ($300,000 + $320,000)÷2 $310,000
Total Assets
2013: Asset = Sales = $450,000 = $450,000 = 1.13

Turnover Average ($320,000 + $480,000)÷2 $400,000
Total Assets
Return on = Profit = $50,000 = $50,000 = 0.125

Assets Average ($320,000 + $480,000)÷2 $400,000
Total Assets
The asset turnover ratio has decreased since I joined the company three years ago. The
ratio for 2013 is lower than it otherwise would have been given the shareholders’ decision
to build a riding arena. The new building has increased the average total assets used and
therefore decreased the turnover ratio. The ROA has increased from 2012 to 2013. If the
ratios are calculated for 2013 using the opening rather than average assets ROA is 1.41 and
Asset turnover is 0.156. Notice that sales increased in the past two years and will likely
increase further when the new riding arena if fully utilized. The asset turnover ratio will
increase starting in 2014. Accordingly, I should be promoted to the position of CFO.
AP3-4
Operating, Investing, or Direction and Amount
(a) F +75,000
(b) I -25,000
(c) None
(d) O +16,300
(e) O + 1,800
(f) None
(g) O - 840
(h) O - 1,700
(i) O + 3,000
(j) O - 5,600
(k) O - 1,800
(l) None
(m) F - 2,500
3-50
AP3–5
Req. 1 and 2 (in millions)
ASSETS:
Cash Trade Receivables Inventories
635 1 (c) 1,503 900 (b) 551 300 (d)
(b) 900 100 (e) (d) 500 (g) 23
150 (f)
12 (h)
11 (i)
8 (j)
1,253 1,103 274
Property and Equipment, Other Non-current Assets

Prepayments net
16 10,759 1,126
(h) 12 (a) 150
28 10,909 1,126
Patents
(j) 8
8
LIABILITIES:
Trade Payables Income Tax Payable

1,822 (f) 150 300
23 (g)
1,845 150
Long-term Borrowings Deferred Incomes Taxes

(i) 10 2,229 2,518
150 (a)
2,369 2,518
SHAREHOLDERS' EQUITY:

3,455 4,266
3,455 4,266
3-51
AP3–5 (continued)
Sales Revenue Cost of Sales Wages Expense

500 (d) (d) 300 (e) 100
500 300 100
Utilities Expense Interest Expense

(c) 1 (i) 1
1 1
Req. 3

a. NE NE
b. NE ↑ $900
c. ↓1 ↓1
d. ↑ 200 NE
e. ↓ 100 ↓ 100
f. NE ↓ 150
g. NE NE
h. NE ↓ 12
i. ↓1 ↓ 11
j. NE ↓8
Req. 4
GILDAN ACTIVEWEAR
Income Statement
(in millions)
Revenues:
Sales revenue $500
Cost of sales 300
Gross profit 200
Operating expenses:
Wage expense 100
Utilities expense 1
Interest expense 1
Total expenses 102
Profit $ 98
Income taxes have been ignored.
3-52
AP3–5 (continued)
GILDAN ACTIVEWEAR
As at January 31, 2011
(in millions)
Assets
Current assets:
Cash $ 1,253
Trade receivables 1,103
Inventories 274
Prepayments 28
Property and equipment (net) 10,909
Patents 8
Other non-current assets 1,126
Total assets $14,701
Liabilities
Trade payables $ 1,845
Income tax payable 150
Long-term borrowings 2,369
Future income taxes 2,518
Total liabilities 6,882
Shareholders' Equity
Share capital 3,455
Retained earnings* 4,364
Total shareholders’ equity 7,819
Total liabilities and shareholders' equity $14,701
* RE, Jan. 31 = RE, Jan. 1, $4,266 + Profit, $98 = $4,364
3-53
AP3–5 (continued)
Req. 5
GILDAN ACTIVEWEAR
Partial Statement of Cash Flows
(in millions)
Cash received from customers (b) $900
Cash paid:
to employees (e) $100
for taxes (f) 150
for interest (i) 1
for utilities and rent (c, h) 13
Operating cash outflow 264
Net cash flow from operating activities $636
Operating activities contributed $636 million during January 2011 compared to profit of
$98 million. The difference between these two amounts is due to the fact that revenue is
when incurred, regardless when cash is paid. The difference of $538 million can be
explained as follows:
Profit……………………………………………………………………. $ 98
Add: cash received for service provided in previous months…….……... 900
Deduct: sales revenue not received in cash yet………………….………. (500)
Add: cost of sales paid for in previous months
(used from inventory)………………………………………….. 300
Deduct: payment for income tax expenses reported on previous
income statements……………………………………………….……….… (150)
Deduct: payment for expenses (insurance) not yet reported
as expenses on the income statement…………………………………... (12)
Net cash flow from operating activities ………………………………….… $636
Req. 6
Total Asset = Sales = $500 = 0.0341

Turnover Ratio Average Total Assets $14,645.5*
* ($14,590 + $14,701) ÷ 2
The asset turnover ratio suggests that the company obtained only $0.0341 in sales for the
month for every $1 in assets. Assuming that sales are spread equally throughout the year,
the annual asset turnover ratio would be approximately $0.41. The ratio is rather low
because of the relatively small amount used for revenue in this hypothetical month.
3-54
AP3-6
Gross profit or Gross margin = Net sales – Cost of sales

Operating income (loss) = Gross profit – Operating expenses
ROA = [Profit + Interest expense (net of tax)] ÷ Average total assets
Transaction Operating Income (Loss) Profit Return on Assets

a. NE + +
b. NE NE –
c. – – +
d. NE NE –
b and d decrease return on assets as profit is unchanged but total (average) assets increase.
AP3-7
Req. 1
2008 2007 2006 2005
Gildan Activewear
Total Asset Turnover Ratio 1.26 1.21 1.17 1.20
Return on Assets (ROA) 15.25% 16.76% 16.58% 16.50%
Research in Motion
Andrew Peller
3-55
AP3-7 (continued)
Req. 2
The asset turnover ratio reflects how much revenue was produced per dollar of assets.
Based on this measure of efficiency, Gildan Activewear has outperformed the other two
companies in all years.
The ROA indicates how much each company earned in profit per dollar of assets. Based on
this measure, Research in Motion has outperformed the other two companies by a large
margin in 2007 and 2008. Gildan Activewear was the top performer in 2005 and 2006.
Req. 3
The asset turnover ratio and ROA of GIldan Activewear suggest that it is a relatively stable
company. On the other hand, Research in Motion (RIM) has a high ROA in the latest two
years. Andrew Peller has a declining asset turnover ratio and an inconsistent ROA. An
investor who does not mind taking some risk on his/her investment, would likely invest in
RIM’s shares. However, an investor who is risk averse may be worried about RIM’s ability
to manage its future growth and would prefer to invest in the more stable Gildan
Activewear. The investor should also compare the return on shareholders’ equity which
relates profit to the shareholders’ investment.
3-56
CASES AND PROJECTS
FINDING AND INTERPRETING ACCOUNTING INFORMATION
CP3–1
Req. 1
The largest expense on Cadbury’s 2008 income statement is “trading costs”, which amounts
to £4,803 million. It includes the cost of sales, distribution, marketing and selling, and
administrative expenses, as indicated in Note 3 to the financial statements. As goods were
sold throughout the year, the related expenses were incurred and recorded by debiting the
various expense accounts and crediting cash, inventory, or accounts payable.
Req. 2
Interest expense (+ E  –SE).................................................... 141,000,000

Interest payable (–A)..........................................................................................141,000,000
This amount is reported in Note 10 to the financial statements.
Req. 3
Assuming all sales are on credit, Cadbury collected £5,546 million from customers. The
calculation (in millions) follows:
Trade Receivables
Beginning 997
Sales 5,384 5,546 Collections
Ending 835
The beginning and ending trade receivables are reported in Note 20 to the financial
statements.
Req. 4
An income statement reports the financial performance of a company over a period of time
in terms of revenues, gains, expenses, and losses. A statement of financial position lists the
economic resources owned by an entity and the claims to those resources from creditors
and investors at a point in time. They are linked through retained earnings.
3-57
CP3–1 (continued)
Req. 5
Total Asset = Sales £5,384 = 0.53

=
Turnover Average Total Assets 10,116.5*
Ratio
Return on = Profit + Interest expense (net of tax) = £588.5** = 5.8%

Assets Average Total Assets 10,116.5
*Average total assets = (£11,338 + 8,895)/2 = £10,116.5
**Profit + Interest expense (net of tax) = £487 + 141 x (1 – 156/559)
Note: The amounts of profit, interest and income tax are taken from the column labeled
“Underlying” in the consolidated income statement.
The asset turnover ratio measures the sales generated from the use of assets. Cadbury’s
ratio is relatively low.
The return on assets relates profit and after-tax interest expense to the carrying amount of
assets that are financed by shareholders and creditors. For fiscal year 2008, Cadbury
earned 5.8 percent on the assets that it utilized during the year.
CP3–2
Req. 1
Both companies call their income statements “Consolidated income statements.”

“Consolidated” implies that the statements of two or more companies (usually the
company and other companies under its control) have been combined into a single
statement for financial reporting purposes.
Req. 2
Nestlé reported a profit of €19,051 whereas Cadbury’s profit is £366, which is equivalent
to €728 (£366 x 1.99). Cadbury is a much smaller company than Nestlé.
3-58
CP3–2 (continued)
Req. 3
Nestlé Cadbury
Total Asset = Sales €109,908 = 0.99 £5,384 = 0.53
Turnover Average Total Assets €110,7881 £10,116.5 2
Ratio
Profit + Interest
Return on = Expense (net of tax) €19,877.53 = 0.179 £588.54 = 0.058
Assets Average Total Assets €110,7881 £10,116.52
1
(€115,361 + 106,215) ÷ 2 2
(£11,338 + 8,895) ÷ 2
3
Profit + Interest expense (net of tax) = €19,051 + 1,000 x (1 – 3,787/21,833)
Note: Interest expense is net of interest income as reported in note 5 to the financial
statements.
4
Profit + Interest expense (net of tax) = £487 + 141 x (1 – 156/559)
Note: The amounts of profit, interest and income tax are taken from the column labeled
“Underlying” in the consolidated income statement.
Nestlé utilized its assets more effectively to generate sales than Cadbury during 2008.
Nestlé’s asset turnover ratio is almost double that of Cadbury and its return on assets is
more than three times that of Cadbury.
Req. 5
Nestlé’s net cash flow from operations totaled €10,763, compared to €13,439 during the
previous year. The precentage change is a decrease of 19.9%, calculated as €10,763 –
€13,439) ÷ €13,439]. Cadbury reported a net cash from operations equal to £469,
compared to £812 for 2007, a decrease of 42.2%, calculated as £469 – £812) ÷ £812].
Req. 6
Nestlé paid €3,207 in taxes as reported in note 22.6, Interest, taxes, and dividends).
Cadbury paid £197, as disclosed in Note 34, Notes to the cash flow statement.
Req. 7
Cadbury segments its operations by major geographic regions as reported on page 86-89 of
its annual report. Nestlé segments its operations in two ways: (1) by management
responsibility and geographic area, and (2) by product group, as disclosed in Note 3.
3-59
CP3–3
Req. 1
2007: Asset = Sales = €107,552 = 0.99

Turnover Average (€101,805 + 115,361) ÷ 2
Total Assets
2008: Asset = Sales = €109,908 = 0.99

Turnover Average (€115,361 + 106,215) ÷ 2
Total Assets
Req. 2
2007: Debt-to-Equity = Total Liabilities = €60,585 = 1.11

Ratio Shareholders’ Equity €54,776
2008: Debt-to-Equity = Total Liabilities = €51,299 = 0.93

Ratio Shareholders’ Equity €54,916
Req. 3
The ratios above for two years are not sufficient to detect any trend. Ratios for three to four
years would be a minimum number of observations that would be needed for such an
analysis.
Nestlé’s asset turnover ratio stayed the same from 2007 to 2008, indicating no change in
the effectiveness of utilizing assets to generate sales. Its debt-to-equity ratio decreased
from 2007 to 2008, indicating that Nestlé financed its assets with a lower level of debt in
2008 than in 2007. Nestlé’s financial risk declined during 2008, while maintaining the
same utilization of its assets to generate sales during the same period.
3-60
FINANCIAL REPORTING AND ANALYSIS CASES
CP3–4
Req. 1
Accrual accounting is defined in the article as follows:
“By accruing, or allotting, revenues to specific periods, they (accountants) aim to

allocate income to the quarter or year in which it was effectively earned, though not
necessarily received. Likewise, expenses are allocated to the period when sales were
made, not necessarily when the money was spent.” (from Business Week, October 4,
2004, p. 78)
Req. 2
The author of the article suggests that “fuzzy numbers” result from the judgments
companies make to come up with revenues and expenses on an accrual basis. Companies
are given wide discretion in determining estimates to use to compute net income under
current accounting rules, and users of the financial statements need to read statements
carefully to understand the impact of management judgments and accounting rules. Even
then, the author suggests that financial statements are often unclear, incomplete, or too
complex.
Req. 3
Congress and the SEC have adopted reforms to attempt to address the rising concerns
about financial reporting. The article suggests that many of the reforms will not help to
make financial statements clearer and more consistent. Instead, many of the reforms are
aimed at policing managers and auditors and not at clarifying estimates managers make.
3-61
CRITICAL THINKING CASES
CP3–5
Req. 1
Martinez used the cash basis of accounting. We can infer this from his references to income
collected rather than earned, expenses paid rather than incurred, and supplies purchased
rather than used. Accrual accounting should be used because it correctly assigns revenues
and expenses to the accounting period in which they are earned or incurred.
Req. 2
(a) Building (+A) ..................................................................................................... 21,000

Tools and equipment (+A) .......................................................................... 17,000
Land (+A) ............................................................................................................. 20,000
Cash (+A) .............................................................................................................. 1,000
Share capital (+SE) .............................................................................. 59,000
(b) Cash (+A)............................................................................................................... 55,000

Accounts receivable (+A).............................................................................. 52,000
Deferred revenue (+L) ........................................................................ 20,000
Service fee revenue (+R +SE) ..................................................... 87,000
(c) No entry
(d) Operating expenses (+E SE) ................................................................ 61,000

Accounts payable (+L) ........................................................................ 39,000
Cash (A) ................................................................................................... 22,000
(e) Supplies expense (+E SE)* ................................................................... 2,500

Supplies (A) ..................................................................................................... 700
Cash (A) ................................................................................................... 3,200
Supplies purchased, $3,200  Supplies on hand at end of 2009,
$700 = $2,500 supplies used.
Other
(1) Loss from theft (+E SE) ......................................................................... 500
Cash (A) ................................................................................................... 500
(2) Tools and equipment (+A) .......................................................................... 1,000

Cash (A) ................................................................................................... 1,000
3-62
CP3–5 (continued)
ASSETS:
Cash Accounts Receivable Supplies
(a) 1,000 22,000 (d) (b) 52,000 (e) 700
(b) 55,000 3,200 (e)
500 (1)
1,000 (2)
29,300 52,000 700
Building Land Tools and Equipment

(a) 21,000 (a) 20,000 (a) 17,000
(2) 1,000
21,000 20,000 18,000
LIABILITIES:
Accounts Payable Deferred Revenue
39,000 (d) 20,000 (b)
39,000 20,000
SHAREHOLDER’S EQUITY:
59,000 (a)
59,000

Service Fees Revenue Operating Expenses Supplies Expense
87,000 (b) (d) 61,000 (e) 2,500
87,000 61,000 2,500
Loss from Theft

(1) 500
500
3-63
CP3–5 (continued)
Req. 3
MARTINEZ COMPANY
(a) Income Statement
(b) For the Year Ended December 31, 2012
(c) Revenues:
(d) Service fees revenue $87,000
(e)
(f) Expenses:
(g) Operating expenses 61,000
(h) Supplies expense 2,500
(i) Loss from theft 500
(j) Total expenses 64,000
(k) Profit $23,000
Income taxes have been ignored.
(a) Use the standard title.

(b) Date to indicate time period covered.
(c) Use appropriate caption.
(d) Use accrual figure -- revenue earned, rather than cash collected.
(e) Exclude the dividends because the stock is owned by Tom and not the company --
apply the separate entity assumption.
(f) Use appropriate title.
(g) Use accrual figure -- expenses incurred, not cash paid.
(h) Expense is supplies used, $2,500; the $700 is still an asset until used ($3,200- $2,500
= $700).
(i) Stolen property should be recorded as a loss for the amount not covered by
insurance.
(j) Use appropriate caption.
(k) Use standard terminology.
3-64
CP3–5 (continued)
MARTINEZ COMPANY
As at December 31, 2012
Assets
Current assets:
Cash $ 29,300
Accounts receivable 52,000
Supplies 700
Tools and equipment 18,000
Building 21,000
Land 20,000
Total assets $141,000
Liabilities
Accounts payable $ 39,000
Deferred revenue 20,000
Shareholders' Equity
Share capital 59,000
Retained earnings 23,000
Total shareholders’ equity 82,000
Total liabilities and shareholders' equity $141,000
Req. 4
The above statements do not yet take into account most year-end adjustments, including
depreciation and income taxes. The adjusting entry for income taxes is especially
important because of the implication for future cash flows.
The statements also record the building, land, and tools and equipment originally
contributed in exchange for shares in the new company at their market value at that time.
Their current market value at year-end is more relevant to a loan decision. Current market
values for the building and land are provided ($32,000 and $30,000, respectively), but the
current value of the tools and equipment is also needed.
The shares in ABC Industrial are owned by Tom and not the company. However, they may
be used as collateral if Tom is willing to sign an agreement pledging personal assets as
collateral for the loan. This is a common requirement for small start-up businesses. The
current market value of ABC’s shares would be relevant in this regard. Other personal
assets could also be considered for collateral.
Lastly, pro forma financial statements (or budgets) outlining the expected revenues,
expenses, and cash flows from the expanded business would be helpful to gauge its
viability.
3-65
CP3–5 (continued)
Req. 5
(today’s date)
Dear Mr. Martinez:
We regret to inform you that your request for a $100,000 loan has been denied at this time.
As explained below we require additional information before we can grant the loan.
Your current business appears profitable and appears to generate sufficient cash to
maintain operations, even after additional expenses, such as income taxes, are considered.
However, pro forma financial statements (or budgets) outlining the expected revenues,
expenses, and cash flows from the expanded business would be needed to gauge its future
viability.
We also require that there be sufficient collateral pledged against the loan before we can
consider it. A loan of this size would increase your company’s size by over 70% of its
current asset base. The current market value of the building and land held by the company
are insufficient as collateral. We understand that you are requesting the loan to build a dry
dock so this can be considered as collateral as well. The current value of the tools and
equipment may provide additional collateral, if you provide us with this information. Your
personal investments may also be considered viable collateral if you are willing to sign an
agreement pledging these assets as collateral for the loan. This is a common requirement
for small start-up businesses.
If you would like us to reconsider your application, please provide us with the pro forma
financial statements and with the current market values of any assets you would pledge as
collateral.
Regards,
(your name)
Loan Application Department,

Your Bank
3-66
CP3–6
Req. 1
a. Paula needs to cease recording her transactions on a cash basis because it does not
provide a good basis for measuring performance. Instead, she should start using accrual
basis accounting which is based on the revenue recognition and matching principles.
Her current practices lead to either an over or understatement of profit during a
specified time period, although the discrepancies may not be material given that most
sales are for cash. Nevertheless, Paula can avoid unnecessary disputes with the former
owner if they both agree to an appropriate method of reporting profit.
Paula is understating revenues each month by waiting for her customers to pay their
accounts. Because the agreement is to pay within 30 days and there are not many
accounts the understatement may not be material, however, Paula is not applying the
revenue principle.
b. Paula is paying her family an additional $90,000 in salaries although they are not
rendering service to the bakery on a regular basis. By withdrawing an additional
$90,000 she has made a material change to the basis upon which she will pay Mr. Fiori
his 25% and he could argue this is unfair.
c. Paula is expensing supplies that are not being used in the bakery to generate revenue.
By expensing the family’s groceries, Paula is violating the accounting entity assumption
which requires separation between the bakery’s operations and Paula’s personal affairs.
This is not a fair representation of the transactions necessary to continue the bakery
business, and leads to an understated amount of profit.
Expensing of the amounts as they are purchased rather than as they are used may not
make a material difference to profit as there would likely be only a small amount of
supplies on hand given the nature of the business.
d. Expensing the equipment that will contribute to revenue over several years is a
violation of the matching process. In so doing Paula has understated profit by a
material amount. She should depreciate the cost of this equipment by choosing one of
the acceptable methods and deduct only the annual depreciation expense.
e. By including the personal income tax paid by Paula and her family as tax expense for
the bakery, Paula has once again understated the profit of the bakery. This practice
violates the accounting entity assumption as indicated earlier.
In summary, Paula’s current practices not only violate both the revenue principle and
the matching process but materially understate the profit upon which Mr. Fiori should
receive his share of 25%. She is not presenting fairly the operating results of the
bakery.
3-67
CP3–6 (continued)
Req. 2
The cash flows are affected in the following way:
 Cash inflow will be somewhat lower than revenue.

 Cash outflow to pay Paula and her family will equal the salary expense, assuming
that the salaries are paid before the end of the year.
 Cash outflow to pay supplies expense is practically equal to the supplies expense
for the year.
 Cash outflow related to the equipment is an investing activity, whether or not the
equipment was paid for during the year. However, the equipment expense of
$50,000 reduces profit by the same amount.
 Cash outflow to pay the bakery’s taxes is lower than the income taxes expense
because the latter includes personal income taxes paid by various members of
Paula’s family.
In summary, the net cash flow from operations will be higher than the profit reported
by Paula because of the additional expenses that are included in the computation of
profit without a corresponding cash outflow during the year.
Req. 3
Gianni and Paula should agree that the 25% will be paid based on an audited income
statement prepared according to the applicable financial reporting standards. Gianni may
choose to hire his own auditor to help him verify the accuracy of the computation of profit.
They could also consider using the services of an arbitrator to resolve any differences.
3-68
CP3–7
1. Managers are agents for shareholders. In is inappropriate to act in ways that benefit
the manager while harming the shareholders. Therefore, the ethically correct response
is not to comply with Mr. Kruk’s request.
2. This type of ethical dilemma occurs quite frequently. The situation is difficult
personally because of the possible repercussions to you by your boss, Mr. Kruk , if you
do not meet his request. At the same time, the ethical and professional response is to
follow the revenue recognition rule and account for the cash collection as deferred
revenue (as was done). To record the collection as revenue overstates income in the
current period.
In the short run, Mr. Kruk would benefit by receiving a larger bonus. You also benefit
in the short run because you would not experience any negative repercussions from
your boss. However, there is the risk that sometime in the future, perhaps through an
audit, the error will be found. At that point, both you and Mr. Kruk could be implicated
in a fraud. In addition, this may be the first instance where you are being asked to
account for a transaction in violation of accepted principles or company policies.
There is a very strong possibility Mr. Kruk may ask you for additional favours in the
future if you demonstrate your willingness at this point.
3. In the larger picture, shareholders are harmed by the misleading income figures by
relying on them to purchase shares at inflated prices. In addition, creditors may lend
funds to the insurance company based on the misleading information. The negative
impact of the discovery of misleading financial information will cause stock prices to
fall, causing shareholders to lose on their investment. Creditors will be concerned
about future debt repayment. You will also experience diminished self-respect because
of the violation of your integrity.
4. Explaining your position to Mr. Kruk will not be easy. You may want to tell him that
you understand the reason for his request, but cannot ethically or professionally
comply with it.
FINANCIAL REPORTING AND ANALYSIS TEAM PROJECT
CP3–8
The solution to this case will depend on the company and/or accounting period selected
for analysis.
3-69

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Chapter 3

Operating Decisions and the Income Statement

3. Profit = Revenues + Gains – Expenses – Losses

5. Accrual accounting requires recording revenues when earned and recording

10. Item Increase Decrease

11. Item Debit Credit

12. Operating, Investing,

Alternate Cases and

E = Easy M = Moderate D = Difficult

Case A Case B Case C Case D Case E

Other operating expenses:

Profit before income tax 200 90 70* 190 110*

*Amounts not given in the exercise.

Earnings per share ($7,000 ¸ 4,000 shares*) $1.75

Cash Basis Accrual Basis

Profit $2,400 Profit $2,200

Amount of Revenue Earned in

i. Cash (A) Expense will be recorded as

Amount of Expense Incurred in

(h) Cash (A) $(1,000)

Statement of Financial Position Income Statement

b. +5,000 NE +5,000 +5,000 NE +5,000

–2,800 NE –2,800 +2,800 –2,800

e. –2,000 +200 –2,200 NE +2,200 –2,200

f. –4,000 NE –4,000 NE +4,000 –4,000

g. –1,200 NE – 400 NE + 400 – 400

h. –1,000 NE –1,000 NE +1,000 –1,000

Statement of Financial Position Income Statement

Statement of Financial Position Income Statement

d. +50,710 NE +17,373 +50,710 +33,337 +17,373

g. –1,460 +2,920 –4,380 NE +4,380 –4,380

h. +353 NE +353 +353 NE +353

i. NE +185 –185 NE +185 –185

Transaction (d) results in an increase in an asset (Trade receivables) and a decrease in

a. Cash (+A) ............................................................................................................. 80M

b. Cash (+A) ............................................................................................................. 5.1B

c. Plant and equipment (+A) .......................................................................... 515.9M

d. Inventory (+A) .................................................................................................. 29.2B

e. Salaries expense (+E SE) ...................................................................... 2.3B

f. Cash (+A) ............................................................................................................. 36.4B

g. Fuel expense (+E  -SE) ............................................................................. 637 M

h. Retained earnings (SE) .............................................................................. 497.4M

i. Trade payables (L) ....................................................................................... 26.2B

j. Utilities expense (+E SE) ...................................................................... 47M

a. Cash (+A) 600,000

b. Computer software (+A) 30,000

c. Inventories (+A) 10,000,000

d. Selling expense (+E SE) 2,200,000

e. Cash (+A) 8,400,000

f. Cash (+A) 100,000,000

g. Trade receivables (+A) 87,000,000

h. Cash (+A) 2,000,000

i. Trade payables (L) 5,000,000

j. Cash (+A) 60,000,000

k. Wages expense (+E SE) 15,000,000

Transaction Effect on Profit Effect on Cash

Feb. 1 Rent expense (+E SE) ............................................................................. 1,900