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CHAPTER 5
FINANCIAL POSITION AND CASH FLOWS
CHAPTER STUDY OBJECTIVES
1. Understand the statement of financial position and statement of cash flows from a business perspective. It is important to understand how users of financial statements use the SFP and the cash flow statement. For example, potential investors in a company may use the SFP to analyze a company’s liquidity and solvency in order to assess risk of investing. In addition, the SFP provides details about the company’s financial structure. Users may use a company’s statement of cash flows to assess its earnings quality and obtain information about its operating, investing, and financing activities.
2. Identify the uses and limitations of a statement of financial position. The SFP provides information about the nature and amounts of investments in enterprise resources, obligations to creditors, and the owners’ equity in net resources. The SFP contributes to financial reporting by providing a basis for (1) calculating rates of return, (2) evaluating the enterprise’s capital structure, and (3) assessing the enterprise’s liquidity, solvency, and financial flexibility. The limitations of a SFP are as follows: (1) The SFP often does not reflect current value, because accountants have adopted a historical cost basis in valuing and reporting many assets and liabilities. (2) Judgments and estimates must be used in preparing a SFP. (3) The SFP leaves out many items that are of financial value to the business but cannot be recorded objectively, such as its human resources, customer base, and reputation.
3. Identify the major classifications of a statement of financial position. The SFP’s general elements are assets, liabilities, and equity. The major classifications within the SFP on the asset side are current assets; investments; property, plant, and equipment; intangible assets; and other assets. The major classifications of liabilities are current and long-term liabilities. In a corporation, owners’ equity is generally classified as shares, contributed surplus, retained earnings, and accumulated other comprehensive income.
4. Prepare a classified statement of financial position. The most common format lists liabilities and shareholders’ equity directly below assets on the same page.
5. Identify statement of financial position information that requires supplemental disclosure. Five types of information are normally supplemental to account titles and amounts presented in the SFP. (1) Contingencies: Material events that have an uncertain outcome. (2) Accounting policies: Explanations of the valuation methods that are used or the basic assumptions that are made for inventory valuation, amortization methods, investments in subsidiaries, and so on. (3) Contractual situations: Explanations of certain restrictions or covenants that are attached to specific assets or, more likely, to liabilities. (4) Additional information: Clarification by giving more detail about the composition of SFP items. (5) Subsequent events: Events that happen after the date of the SFP.
6. Identify major disclosure techniques for the statement of financial position. There are four methods of disclosing pertinent information in the SFP: (1) Parenthetical explanations: Additional information or description is often provided by giving explanations in parentheses that follow the item. (2) Notes: Notes are used if additional explanations or descriptions cannot be shown conveniently as parenthetical explanations. (3) Cross-reference and contra items: A direct relationship between an asset and a liability is cross-referenced on the SFP. (4) Supporting schedules: Often a separate schedule is needed to present more detailed information about certain assets or liabilities because the SFP provides just a single summary item.
7. Indicate the purpose and identify the content of the statement of cash flows. The main purpose of a statement of cash flows is to provide relevant information about an enterprise’s cash receipts and cash payments during a period. Reporting the sources, uses, and net increase or decrease in cash lets investors, creditors, and others know what is happening to a company’s most liquid resource. Cash receipts and cash payments during a period are classified in the statement of cash flows into three different activities: (1) Operating activities: Involve the cash effects of transactions that enter into the determination of net income. (2) Investing activities: Include making and collecting loans and acquiring and disposing of investments (both debt and equity) and property, plant, and equipment. (3) Financing activities: Involve liability and owners’ equity items and include (a) obtaining capital from owners and providing them with a return on their investment and (b) borrowing money from creditors and repaying the amounts borrowed.
8. Prepare a statement of cash flows using the indirect method. This involves determining cash flows from operations by starting with net income and adjusting it for noncash activities, such as changes in accounts receivable (and other current asset/liability) balances, depreciation, and gains/losses. It is important to look carefully at prior years’ operating activities that might affect cash this year, such as cash collected this year from last year’s credit sales and cash spent this year for last year’s accrued expenses. The cash flows from investing and financing activities can then be determined by analyzing changes in SFP accounts and the cash account.
9. Understand the usefulness of the statement of cash flows. Creditors examine the statement of cash flows carefully because they are concerned about being paid. The amount of net cash flow provided by operating activities in relation to the company’s liabilities is helpful in making this assessment. In addition, measures such as a free cash flow analysis provide creditors and shareholders with a better picture of the company’s financial flexibility.
10. Identify differences in accounting between ASPE and IFRS. Illustration 5-24 outlines the major differences in how both sets of standards account for and present items on the SFP and statement of cash flows. Both sets of standards largely require that the same SFP elements be presented. In addition, IFRS requires presentation of biological assets, investment properties, and provisions. The statement of cash flow presentation requirements are similar.
11. Identify the significant changes planned by the IASB regarding financial statement presentation. The IASB has been planning to change the way financial statements are presented by issuing a new standard on financial statement presentation. However, the project was paused in 2011 “until the IASB concludes its ongoing deliberations about its future work plan.” In June 2014, the IASB issued a more targeted Exposure Draft called the “Disclosure Initiative—Proposed Amendments to IAS 7.” It proposes amendments to provide additional information to financial statement users about financing activities (other than those that relate to equity items).
12. Identify the major types of financial ratios and what they measure (Appendix 5A).
Ratios express the mathematical relationship between one quantity and another, in terms of a percentage, a rate, or a proportion. Liquidity ratios measure the short-term ability to pay maturing obligations. Activity ratios measure how effectively assets are being used. Profitability ratios measure an enterprise’s success or failure. Coverage ratios measure the degree of protection for long-term creditors and investors.
Multiple Choice QUESTIONS
Answer No. Description
b1.Earnings quality
d2.Limitation of the balance sheet
d3.Uses of the statement of financial position
b4.Uses of the statement of financial position
c5.Uses of the statement of financial position
d6.Definition of solvency
a7.Definition of financial flexibility
b8.Risk of business failure
d9.Limitations of the statement of financial position
d10.Monetary assets
c11.Monetary assets
b12.Financial instruments
c13.Non-monetary assets
b14.Non-monetary assets
c15.Basis of classifying assets
d16.Definition of operating cycle
a17.Identification of current asset
d18.Identification of non-current asset
c19.Classification of securities
b20.Intangible assets
c21.Identification of current liabilities
d22.Definition of working capital
b23.Identification of working capital items
b24.Definition of liabilities
a25.Identification of long-term liabilities
d26.Classification of equity section accounts
c27.Classification of shareholders’ equity
d28.Current assets on the balance sheet
b29.Value of receivables
c 30.Calculate total current assets
b31.Calculate total current assets
d32.Calculate total current liabilities
b33.Calculate retained earnings balance
b34.Calculate current and long-term liabilities
d35.Supplementary disclosure
b36.Supplementary disclosure
c37.Summary of significant accounting policies
d38.Methods of disclosure
d39.Contra account
d40.Accounting policies
c41.Definition of statement of cash flows
a42.Disclosure of revenue-producing activities on the statement of cash flows
b43.Identify an investing activity
c44.Identify a financing activity
a45.Identify an investing activity
c46.Statement of cash flow
b47.Classification of investing activity
c48.Classification of investing activity
a49.Classification of operating activity
d50.Classification of financing activity
b51.Classification of investing activity
a52.Preparation of statement of cash flows under indirect method
c53.Cash flows from operating activities
d54.Preparation of statement of cash flows under indirect method
c55.Preparation of statement of cash flows under direct method
b56.Preparation of statement of cash flows under direct method
c57.Classification of operating activity
b58.Cash debt coverage ratio
c59.Current cash debt coverage ratio
d60.Financial flexibility measure
c61.Calculation of free cash flow
b62.Financial flexibility
c63.Calculation of free cash flow
a64.Disclosures under ASPE
c65.Disclosures under IFRS
c66.Reclassification of current debt
d67.Special disclosure under IFRS
b68.Listing of current assets
c69.Reporting requirements for SFP
c 70.Upcoming IABS and FASB changes to financial statement presentation
a71.New definitions in Exposure Draft
c72.New proposals in Exposure Draft
b*73.Definition of activity ratios
c*74.Definition of solvency ratios
d*75.Definition of asset turnover
c*76.Calculate asset turnover ratio
d*77.Calculate rate of return on assets
c*78.Financial or capital market risks
*This topic is dealt with in an Appendix to the chapter.
Exercises
Item Description
E5-79 Earnings quality
E5-80 Creditworthiness; debt to total assets
E5-81 Liquidity, solvency, and financial flexibility
E5-82 Limitations of the statement of financial position
E5-83 Terminology
E5-84 Definitions
E5-85 Account classification
E5-86 Current liabilities
E5-87 Current assets
E5-88 Account classification
E5-89 Valuation of statement of financial position items
E5-90 Statement of financial position classifications
E5-91 Statement of financial position classifications
E5-92 Statement of financial position classifications
E5-93 Statement of financial position
E5-94 Statement of financial position presentation
E5-95 Subsequent events
E5-96 Contractual disclosures and ethical consideration
E5-97 Notes
E5-98 Contra or adjunct accounts
E5-99 Statement of cash flows
E5-100 Statement of cash flows purpose
E5101 Statement of cash flows basic format
E5-102 Cash provided (used) by operating activities
E5-103 Ending cash balance
E5-104 Statement of cash flows ratios
E5-105 Calculation of cash flow and ratio
*E5-106 Calculation of ratios
*E5-107 Interpretation of ratios
*E5-108 Calculation of ratios
*E5-109 Calculation of ratios
*This topic is dealt with in an Appendix to the chapter.
PROBLEMS
Item Description
P5-110 Statement of financial position format
P5-111 Statement of financial position presentation
P5-112 Calculation of ending retained earnings
P5-113 Statement of cash flows – direct method
P5-114 Statement of cash flows – indirect method
*P5-115 Calculation of ratios
*This topic is dealt with in an Appendix to the chapter.
MULTIPLE CHOICE QUESTIONS
1. When assessing earnings quality, financial analysts are concerned that management may attempt to manipulate information to make earnings appear better or worse than they really are. Which of the following would NOT suggest poor earnings quality?
a) reduction of the allowance for doubtful accounts
b) consistent application of GAAP
c) significantly higher net income than cash flows from operations
d) reliance on share issuances to offset repeated negative cash flow from operations
Answer: b
Difficulty: Easy
Learning Objective: Understand the statement of financial position and statement of cash flows from a business perspective.
Section Reference: Usefulness of the Statements of Financial Position and Cash Flows from a Business Perspective
CPA: Audit and Assurance
CPA: Financial Reporting
CPA: Strategy & Governance
Bloomcode: Knowledge
2. Which of the following is a limitation of the balance sheet?
a) Many items that are of financial value are omitted.
b) Judgments and estimates are used.
c) Current fair value is not reported.
d) All of these answer choices are correct.
Answer: d
Difficulty: Easy
Learning Objective: Understand the statement of financial position and statement of cash flows from a business perspective.
Section Reference: Usefulness of the Statements of Financial Position and Cash Flows from a Business Perspective
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
3. The statement of financial position is useful for all of the following EXCEPT
a) assessing a company’s risk.
b) evaluating a company’s liquidity.
c) evaluating a company’s financial flexibility.
d) determining free cash flows.
Answer: d
Difficulty: Easy
Learning Objective: Understand the statement of financial position and statement of cash flows from a business perspective.
Section Reference: Usefulness of the Statements of Financial Position and Cash Flows from a Business Perspective
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
4. The statement of financial position is useful for all of the following EXCEPT to
a) compute rates of return.
b) analyze cash inflows and outflows for the period.
c) evaluate capital structure.
d) assess future cash flows.
Answer: b
Difficulty: Easy
Learning Objective: Understand the statement of financial position and statement of cash flows from a business perspective.
Section Reference: Usefulness of the Statements of Financial Position and Cash Flows from a Business Perspective
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
5. The statement of financial position is useful for analyzing all of the following EXCEPT
a) liquidity.
b) solvency.
c) profitability.
d) financial flexibility.
Answer: c
Difficulty: Easy
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
6. An enterprise’s ability to pay its debts and related interest is called
a) liquidity.
b) financial flexibility.
c) the amount of time expected to pass until an asset is realized.
d) solvency.
Answer: d
Difficulty: Medium
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
7. An enterprise’s ability to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities is called
a) financial flexibility.
b) liquidity.
c) the quick ratio.
d) solvency.
Answer: a
Difficulty: Easy
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
8. Generally, as financial flexibility increases, the risk of enterprise or business failure will
a) increase.
b) decrease.
c) stay the same.
d) be eliminated.
Answer: b
Difficulty: Easy
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
9. Which of the following is NOT a limitation of the statement of financial position?
a) Many assets are reported at historical cost.
b) Judgments and estimates are used.
c) Only “hard” numbers are reported.
d) Disclosure of all pertinent information in the notes.
Answer: d
Difficulty: Medium
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
10. Monetary assets represent
a) only cash.
b) contractual rights to receive cash.
c) equity investments in other companies.
d) cash or claims to future cash flows that are fixed and determinable in amounts and timing.
Answer: d
Difficulty: Easy
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
11. Monetary assets include
a) cash, accounts receivable and inventory.
b) accounts and notes receivable and inventory.
c) cash, accounts and notes receivable.
d) accounts receivable and property, plant and equipment.
Answer: c
Difficulty: Medium
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
12. Financial instruments do NOT include
a) cash.
b) inventory.
c) derivatives.
d) accounts payable.
Answer: b
Difficulty: Medium
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
13. Non-monetary assets include
a) accounts and notes receivable and inventory.
b) accounts receivable and property, plant and equipment.
c) inventory, property, plant and equipment, and intangibles.
d) accounts receivable and investments.
Answer: c
Difficulty: Easy
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
14. Non-monetary assets
a) are those for which the cash value is determinable in amount and timing.
b) are often measured at historical cost.
c) are always classified as non-current.
d) will required future cash outflows from the company.
Answer: b
Difficulty: Medium
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Knowledge
15. The basis for classifying assets as current or non-current is conversion to cash within
a) the accounting cycle or one year, whichever is shorter.
b) the accounting cycle or one year, whichever is longer.
c) the operating cycle or one year, whichever is longer.
d) the operating cycle or one year, whichever is shorter.
Answer: c
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
16. The operating cycle is the time between
a) selling products to customers and the realization of cash.
b) purchase of inventory and selling to customers.
c) manufacture of products and receiving cash from customers.
d) acquisition of assets for processing and the realization in cash or cash equivalents.
Answer: d
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
17. Which of the following is a current asset?
a) trade instalment receivables normally collectible in eighteen months
b) intangible assets
c) investment in associates (significant influence investments)
d) cash designated for the purchase of property, plant and equipment
Answer: a
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
18. Which of the following should NOT be considered current assets in the statement of financial position?
a) instalment notes receivable due over eighteen months, in accordance with normal trade practice
b) prepaid taxes, which cover assessments for the current year
c) equity or debt securities purchased with cash available for current operations
d) franchises and copyrights
Answer: d
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
19. Equity or debt securities held to finance future construction of additional plants should be classified on a statement of financial position as
a) current assets.
b) property, plant, and equipment.
c) non-current investments.
d) intangible assets.
Answer: c
Difficulty: Easy
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
20. Which of the following statements about intangible assets is INCORRECT?
a) They are capital assets that have no physical substance.
b) Intangibles with finite lives are amortized but not tested for impairment.
c) Intangibles with infinite lives are not amortized but are tested for impairment.
d) Internally recognized intangibles are never recognized on the statement of financial position.
Answer: b
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
21. Which of the following is NOT a current liability?
a) unearned revenue
b) derivatives
c) stock dividends distributable
d) trade accounts payable
Answer: c
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
22. Working capital is
a) capital which has been reinvested in the business.
b) cash invested by owners.
c) cash and receivables less current liabilities.
d) current assets less current liabilities.
Answer: d
Difficulty: Easy
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
23. An example of an item which is NOT an element of working capital is
a) accrued interest on notes receivable.
b) goodwill.
c) inventory.
d) short-term investments.
Answer: b
Difficulty: Easy
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
24. Which of the following statements best describes a liability?
a) Any obligation, whether enforceable or not, is a liability.
b) A liability is an enforceable economic burden or obligation.
c) A liability is a legal economic benefit.
d) Deferred income taxes are always shown as liabilities.
Answer: b
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
25. Which of the following should be EXCLUDED from long-term liabilities?
a) derivatives
b) employee future benefits obligations
c) long-term liabilities maturing within the operating cycle, but will be paid from a sinking fund
d) bonds payable maturing in five years
Answer: a
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
26. Which of the following would NOT appear in the equity section of a statement of financial position?
a) preferred shares
b) accumulated other comprehensive income
c) stock dividend distributable
d) investment in affiliate
Answer: d
Difficulty: Easy
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
27. The shareholders’ equity section is usually divided into which four parts?
a) preferred shares, common shares, retained earnings, contributed surplus
b) preferred shares, common shares, retained earnings, other comprehensive income
c) capital shares, contributed surplus, retained earnings, accumulated other comprehensive income
d) capital shares, appropriated retained earnings, unappropriated retained earnings, contributed surplus
Answer: c
Difficulty: Easy
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
28. The current assets section of the balance sheet should include
a) machinery.
b) patents.
c) goodwill.
d) inventory.
Answer: d
Difficulty: Easy
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
29. Receivables are valued based on their ______.
a) fair value
b) estimated amount collectible
c) lower of cost or market value
d) historical cost
Answer: b
Difficulty: Easy
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Knowledge
30. Pluto Corp.’s trial balance included the following account balances at December 31, 2017:
Accounts receivable (net)$41,000
Trading securities7,000
Accumulated depreciation on equipment and furniture15,000
Cash10,000
Inventory27,000
Equipment25,000
Patent4,000
Prepaid expenses1,500
Land held for future business site18,000
In Pluto’s December 31, 2017 statement of financial position, the current assets total is
a) $104,500.
b) $90,500.
c) $86,500.
d) $73,500.
Answer: c
Difficulty: Easy
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
Feedback: $41,000 + $7,000 + $10,000 + $27,000 + $1,500 = $86,500
Use the following information for questions 31–33.
Venus Corp.’s trial balance at December 31, 2017 is properly adjusted except for the income tax expense adjustment.
Venus Corp.
Trial Balance
December 31, 2017
Dr. Cr.
Cash$ 675,000
Accounts receivable (net)2,895,000
Inventory2,385,000
Property, plant, and equipment (net)8,366,000
Accounts payable and accrued liabilities$ 1,981,000
Income taxes payable684,000
Future income tax liability75,000
Common stock3,350,000
Contributed surplus2,680,000
Retained earnings, Jan 1, 20174,650,000
Net sales and other revenues12,360,000
Costs and expenses10,080,000
Income tax expenses 1,379,000
$25,780,000$25,780,000
Other financial data for the year ended December 31, 2017:
- Included in accounts receivable is $720,000 due from a customer and payable in quarterly instalments of $90,000. The last payment is due December 29, 2019.
- The balance in the future income tax liability account relates to a temporary difference that arose in a prior year, of which $30,000 is classified as a current liability.
- During the year, estimated tax payments of $465,000 were charged to income tax expense. The current and future tax rate on all types of income is 35 percent.
31. In Venus’s December 31, 2017 statement of financial position, the current assets total is
a) $5,955,000.
b) $5,595,000.
c) $3,060,000.
d) $4,495,000.
Answer: b
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
Feedback: $675,000 + [$2,895,000 – ($90,000 x 4)] + $2,385,000 = $5,595,000
32. In Venus’s December 31, 2017 statement of financial position, the current liabilities total is
a) $2,435,000.
b) $2,695,000.
c) $2,200,000.
d) $2,114,000.
Answer: d
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
Feedback: Note the adjusted income tax expense will be $798,000 [($12,360,000 – $10,080,000) x 35%] = $798,000. When the expense is reduced by $581,000 ($1,379,000 – $798,000 = $581,000), the liability will also be reduced by the same amount to $103,000 ($1,981,000 + $103,000) + $30,000 = $2,114,000
33. In Venus’s December 31, 2017 statement of financial position, the final retained earnings balance is
a) $5,551,000.
b) $6,132,000.
c) $5,135,000.
d) $6,016,000.
Answer: b
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
Feedback: $4,650,000 + $12,360,000 – $10,080,000 – $798,000 (income tax exp) = $6,132,000
34. On January 1, 2017, Mars Inc. leased a building to Vulcan Corp. for a ten-year term at an annual rental of $160,000. At inception of the lease, Mars received $640,000, which covered the first two years rent of $320,000 and a security deposit of $320,000. This deposit will not be returned to Vulcan upon expiration of the lease, but will be applied to payment of rent for the last two years of the lease. What portion of the $640,000 should be shown as a current and long-term liability in Mars’s December 31, 2017 statement of financial position?
Current LiabilityLong-term Liability
a) $0 $640,000
b) $160,000 $320,000
c) $320,000 $320,000
d) $320,000 $160,000
Answer: b
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
35. Which of the following balance sheet classifications would normally require the greatest amount of supplementary disclosure?
a) Current assets
b) Current liabilities
c) Plant assets
d) Long-term liabilities
Answer: d
Difficulty: Easy
Learning Objective: Identify statement of financial position information that requires supplemental disclosure.
Section Reference: Additional Information Reported
CPA: Financial Reporting
Bloomcode: Knowledge
36. Which of the following is NOT a required supplemental disclosure for the balance sheet?
a) Contingencies
b) Financial forecasts
c) Accounting policies
d) Contractual situations
Answer: b
Difficulty: Easy
Learning Objective: Identify statement of financial position information that requires supplemental disclosure.
Section Reference: Additional Information Reported
CPA: Financial Reporting
Bloomcode: Knowledge
37. Which of the following facts concerning depreciable assets should be included in the summary of significant accounting policies?
Depreciation Method Composition
a) No Yes
b) Yes Yes
c) Yes No
d) No No
Answer: c
Difficulty: Medium
Learning Objective: Identify statement of financial position information that requires supplemental disclosure.
Section Reference: Additional Information Reported
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
38. Which of the following is NOT a method of disclosing additional information in the financial statements?
a) supporting schedules
b) parenthetical explanations
c) cross-reference and contra items
d) press releases
Answer: d
Difficulty: Medium
Learning Objective: Identify major disclosure techniques for the statement of financial position.
Section Reference: Techniques of Disclosure
CPA: Financial Reporting
Bloomcode: Knowledge
39. Which of the following is a contra account?
a) Premium on bonds payable
b) Unearned revenue
c) Patents
d) Accumulated depreciation
Answer: d
Difficulty: Medium
Learning Objective: Identify major disclosure techniques for the statement of financial position.
Section Reference: Techniques of Disclosure
CPA: Financial Reporting
Bloomcode: Knowledge
40. Significant accounting policies may NOT be
a) selected on the basis of judgment.
b) selected from existing acceptable alternatives.
c) unusual or innovative in application.
d) omitted from financial-statement disclosure.
Answer: d
Difficulty: Medium
Learning Objective: Identify major disclosure techniques for the statement of financial position.
Section Reference: Techniques of Disclosure
CPA: Financial Reporting
Bloomcode: Knowledge
41. The financial statement which summarizes operating, investing, and financing activities of an entity for a period of time is the
a) retained earnings statement.
b) income statement.
c) statement of cash flows.
d) statement of financial position.
Answer: c
Difficulty: Easy
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
42. On a statement of cash flows, the enterprise’s main revenue-producing activities are disclosed in the
a) operating activities.
b) investing activities.
c) financing activities.
d) both operating and investing activities.
Answer: a
Difficulty: Easy
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
43. Making and collecting loans and disposing of property, plant, and equipment are
a) operating activities.
b) investing activities.
c) financing activities.
d) liquidity activities.
Answer: b
Difficulty: Easy
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
44. In preparing a statement of cash flows, repurchase of a company’s own shares at an amount greater than cost would be classified as a(n)
a) operating activity.
b) extraordinary activity.
c) financing activity.
d) investing activity.
Answer: c
Difficulty: Easy
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
45. In preparing a statement of cash flows, which of the following transactions would be considered an investing activity?
a) sale of equipment at book value
b) sale of merchandise on credit
c) declaration of a cash dividend
d) issuance of bonds payable at a discount
Answer: a
Difficulty: Medium
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
46. The statement of cash flows reports all of the following EXCEPT
a) the net change in cash for the period.
b) the cash effects of operations during the period.
c) the free cash flows generated during the period.
d) investing transactions.
Answer: c
Difficulty: Medium
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
47. In a statement of cash flows, payments to acquire debt instruments of other entities (other than cash equivalents) should be classified as cash outflows for
a) operating activities.
b) investing activities.
c) financing activities.
d) lending activities.
Answer: b
Difficulty: Easy
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
48. In a statement of cash flows, receipts from sales of property, plant, and equipment and other productive assets should be classified as cash inflows from
a) operating activities.
b) financing activities.
c) investing activities.
d) selling activities.
Answer: c
Difficulty: Medium
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
49. In a statement of cash flows, interest payments to lenders and other creditors should be classified as cash outflows for
a) operating activities.
b) borrowing activities.
c) lending activities.
d) financing activities.
Answer: a
Difficulty: Easy
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
50. In a statement of cash flows, proceeds from issuing equity instruments should be classified as cash inflows from
a) lending activities.
b) operating activities.
c) investing activities.
d) financing activities.
Answer: d
Difficulty: Easy
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
51. In a statement of cash flows, payments to acquire debt instruments of other entities (other than cash equivalents) should be classified as cash outflows for
a) operating activities.
b) investing activities.
c) financing activities.
d) lending activities.
Answer: b
Difficulty: Easy
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
52. A statement of cash flows prepared under the INDIRECT method adds and subtracts certain items to the base number. Decreases in unearned revenues would be shown as
a) a deduction from net income.
b) an addition to net income.
c) a deduction from sales.
d) an addition to sales.
Answer: a
Difficulty: Medium
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
53. In preparing a statement of cash flows under the INDIRECT method, cash flows from operating activities
a) are always equal to accrual accounting income.
b) are calculated as the difference between revenues and expenses.
c) can be calculated by appropriately adding to or deducting from net income those items in the income statement that do not affect cash.
d) can be calculated by appropriately adding to or deducting from net income those items in the income statement that do affect cash.
Answer: c
Difficulty: Medium
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
54. Preparing a statement of cash flows under the INDIRECT method involves all of the following EXCEPT determining the
a) cash provided by operations.
b) cash provided by or used in investing and financing activities.
c) change in cash during the period.
d) cash collections from customers during the period.
Answer: d
Difficulty: Medium
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
55. A statement of cash flows prepared under the DIRECT method starts with
a) net income.
b) gross profit.
c) cash received from customers.
d) income from operations.
Answer: c
Difficulty: Easy
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
56. Which of the following is NOT included in a statement of cash flows prepared under the DIRECT method?
a) cash flows from operating activities
b) gross profit
c) cash paid to suppliers and employees
d) interest paid or received
Answer: b
Difficulty: Easy
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
57. Yule Corporation reports the following information:
Net income$480,000
Depreciation expense140,000
Increase in accounts receivable60,000
Yule should report cash provided by operating activities of
a) $280,000.
b) $400,000.
c) $560,000.
d) $680,000.
Answer: c
Difficulty: Medium
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
Feedback: $480,000 + $140,000 – $60,000 = $560,000.
58. The cash debt coverage ratio is calculated by dividing net cash provided by operating activities by
a) average long-term liabilities.
b) average total liabilities.
c) ending long-term liabilities.
d) ending total liabilities.
Answer: b
Difficulty: Medium
Learning Objective: Understand the usefulness of the statement of cash flows.
Section Reference: Usefulness of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
59. The current cash debt coverage ratio is often used to assess
a) financial flexibility.
b) solvency.
c) liquidity.
d) profitability.
Answer: c
Difficulty: Medium
Learning Objective: Understand the usefulness of the statement of cash flows.
Section Reference: Usefulness of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
60. A measure of a company’s financial flexibility is the
a) cash debt coverage ratio.
b) current cash debt coverage ratio.
c) free cash flow.
d) cash debt coverage ratio and free cash flow.
Answer: d
Difficulty: Medium
Learning Objective: Understand the usefulness of the statement of cash flows.
Section Reference: Usefulness of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
61. Free cash flow is calculated as net cash provided by operating activities less
a) capital expenditures.
b) dividends.
c) capital expenditures and dividends.
d) capital expenditures and depreciation.
Answer: c
Difficulty: Medium
Learning Objective: Understand the usefulness of the statement of cash flows.
Section Reference: Usefulness of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Knowledge
62. One of the benefits of the statement of cash flows is that it helps users evaluate financial flexibility. Which of the following explanations is a description of financial flexibility?
a) the nearness to cash of assets and liabilities
b) the firm’s ability to respond and adapt to financial adversity and unexpected needs and opportunities
c) the firm’s ability to pay its debts as they mature
d) the firm’s ability to invest in a number of projects with different objectives and costs
Answer: b
Difficulty: Medium
Learning Objective: Understand the usefulness of the statement of cash flows.
Section Reference: Usefulness of the Statement of Cash Flows
CPA: Finance
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
63. Free cash flow is calculated as net cash provided by operating activities less
a) capital expenditures.
b) dividends.
c) capital expenditures and dividends.
d) capital expenditures and depreciation.
Answer: c
Difficulty: Medium
Learning Objective: Understand the usefulness of the statement of cash flows.
Section Reference: Usefulness of the Statement of Cash Flows
CPA: Finance
CPA: Financial Reporting
Bloomcode: Knowledge
64. A company that follows ASPE
a) must not disclose cash flow per share.
b) may disclose cash flow per share.
c) may disclose cash flow per share if it makes a special election to do so.
d) must disclose cash flow per share.
Answer: a
Difficulty: Medium
Learning Objective: Identify differences in accounting between IFRS and ASPE.
Section Reference: A Comparison of IFRS and ASPE
CPA: Financial Reporting
Bloomcode: Knowledge
65. A company that follows IFRS
a) may disclose cash flow per share if it makes a special election to do so.
b) must not disclose cash flow per share.
c) is generally allowed to disclose cash flow per share.
d) only discloses cash flow per share if there are more than two shareholders.
Answer: c
Difficulty: Medium
Learning Objective: Identify differences in accounting between IFRS and ASPE.
Section Reference: A Comparison of IFRS and ASPE
CPA: Financial Reporting
Bloomcode: Knowledge
66. When current debt is refinanced by the issue date of financial statements, it may generally be presented as non-current
a) if the company follows IFRS.
b) under either ASPE or IFRS.
c) if the company follows ASPE.
d) only if the company is a subsidiary.
Answer: c
Difficulty: Medium
Learning Objective: Identify differences in accounting between IFRS and ASPE.
Section Reference: A Comparison of IFRS and ASPE
CPA: Financial Reporting
Bloomcode: Knowledge
67. Which of the following items would require special disclosure under IFRS?
a) investment property only
b) biological assets and investment property only
c) provisions and biological assets
d) biological assets, investment property and provisions
Answer: d
Difficulty: Hard
Learning Objective: Identify differences in accounting between IFRS and ASPE.
Section Reference: A Comparison of IFRS and ASPE
CPA: Financial Reporting
Bloomcode: Knowledge
68. Under IFRS, current assets are listed in
a) the order of liquidity.
b) the reverse order of liquidity.
c) the ascending order of their balances.
d) the descending order of their balances.
Answer: b
Difficulty: Easy
Learning Objective: Identify differences in accounting between IFRS and ASPE.
Section Reference: A Comparison of IFRS and ASPE
CPA: Financial Reporting
Bloomcode: Knowledge
69. Which of the following statements about IFRS and ASPE accounting and reporting requirements for the statement of financial position is NOT correct?
a) The presentation formats required by IFRS and ASPE for the statement of financial position are similar.
b) One difference between the reporting requirements under IFRS and those of ASPE statement of financial position is that an IFRS balance sheet may list long-term assets first.
c) Both IFRS and ASPE require that cash flow per share information be reported on the statement of financial position.
d) Both IFRS and ASPE require that comparative information be reported.
Answer: c
Difficulty: Hard
Learning Objective: Identify differences in accounting between IFRS and ASPE.
Section Reference: A Comparison of IFRS and ASPE
CPA: Financial Reporting
Bloomcode: Knowledge
70. Significant changes to the presentation of financial statements are currently being developed by the IASB and FASB. Which of the following best describes the focus of these changes?
a) to better highlight the company’s assets, liabilities and equity
b) to segregate the company’s operating, financing and investing activities
c) to highlight the company’s major business and financing activities
d) to increase the number of notes to be attached to financial statements
Answer: c
Difficulty: Medium
Learning Objective: Identify the significant changes planned by the IASB regarding financial statement presentation.
Section Reference: Looking Ahead
CPA: Financial Reporting
Bloomcode: Knowledge
71. The IASB issued an Exposure Draft (ED) in May 2015 entitled “Conceptual Framework for Financial Reporting” including proposed changes to the definitions of assets and liabilities. For most assets and liabilities, applying the new definition
a) yields the same accounting results as the current definition.
b) results in more conservative reporting of assets, and more aggressive reporting of liabilities.
c) results in more aggressive reporting of assets and more conservative reporting of liabilities.
d) results in more conservative reporting of both assets and liabilities.
Answer: a
Difficulty: Medium
Learning Objective: Identify the significant changes planned by the IASB regarding financial statement presentation.
Section Reference: Looking Ahead
CPA: Financial Reporting
Bloomcode: Knowledge
72. The Exposure Draft (ED) called the “Disclosure Initiative—Proposed Amendments to IAS7” proposes
a) replacement of IAS 7: Statement of Cash flows.
b) amendments that would provide additional information about investing activities.
c) amendments that would provide additional information about financing activities.
d) amendments that would provide additional information about operating activities.
Answer: c
Difficulty: Medium
Learning Objective: Identify the significant changes planned by the IASB regarding financial statement presentation.
Section Reference: Looking Ahead
CPA: Financial Reporting
Bloomcode: Knowledge
*73. Ratios that measure how effectively an entity is using is assets are called
a) liquidity ratios.
b) activity ratios.
c) solvency ratios.
d) profitability ratios.
Answer: b
Difficulty: Medium
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Financial Reporting
Bloomcode: Knowledge
*74. Ratios that measure the degree of protection for long-term creditors and investors or the ability to meet long-term obligations are called
a) liquidity ratios.
b) activity ratios.
c) solvency ratios.
d) profitability ratios.
Answer: c
Difficulty: Medium
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Financial Reporting
Bloomcode: Knowledge
*75. Net sales divided by average total assets is called
a) inventory turnover.
b) receivables turnover.
c) rate of return on assets.
d) asset turnover.
Answer: d
Difficulty: Medium
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Financial Reporting
Bloomcode: Knowledge
*76. Thrifty’s Inc. gives you the following information pertaining to the year 2017:
Net sales$800,000
Cost of goods sold500,000
Current assets500,000
Current liabilities250,000
Average total assets900,000
Total liabilities550,000
Net income 150,000
The asset turnover ratio of Thrifty’s Inc. is
a) 0.56.
b) 0.17.
c) 0.89.
d) 1.13.
Answer: c
Difficulty: Medium
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
Feedback: $800,000 ÷ $900,000 = 0.89.
*77. Thrifty’s Inc. gives you the following information pertaining to the year 2017:
Net sales$850,000
Cost of goods sold500,000
Current assets500,000
Current liabilities250,000
Average total assets900,000
Total liabilities550,000
Net income150,000
The rate of return on assets Thrifty’s Inc. is
a) 55.5%.
b) 30.0%.
c) 18.7%.
d) 16.6%.
Answer: d
Difficulty: Medium
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
Feedback: $150,000 ÷ $900,000 = 16.6%
*78. Financial or capital market risks are related to
a) financing activities only.
b) investing activities only.
c) both financing and investing activities.
d) operating and financing activities.
Answer: c
Difficulty: Medium
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
Exercises
Ex. 5-79 Earnings quality
An analysis of the financial statements of Scion Inc. shows that net income is significantly higher than cash flows from operations. What does this indicate about the quality of Scion’s earnings? Where else can analysts look for further information?
Solution 5-79
A net income significantly higher than cash flows from operations could be a sign of poor earnings quality that may require further analysis. Analysts should look to the financing activities section to see if Scion is relying on issuance of shares or other financing activities to generate cash flow. They could also look towards industry reports and analyst expectations to see if Scion’s cash flow and earnings quality are expected to improve.
Difficulty: Medium
Learning Objective: Understand the statement of financial position and statement of cash flows from a business perspective.
Section Reference: Usefulness of the Statements of Financial Position and Cash Flows from a Business Perspective
CPA: Communication
CPA: Finance
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-80 Creditworthiness; debt to total assets
Explain why a high debt to total assets ratio means a company has a higher risk of bankruptcy.
Solution 5-80
The debt to total assets ratio is a coverage ratio that measures the percentage of total assets provided by creditors. Coverage ratios are said to measure the degree of protection for long-term creditors and investors. A company whose assets are heavily financed by creditors (also known as heavily leveraged) is liable to pay those creditors back first in the event they are forced to liquidate. Where leveraged assets represent the majority of a company’s value, it is likely that there would be little or nothing left after repaying these creditors, and that the company would declare bankruptcy before repaying investors or other equity providers.
Difficulty: Medium
Learning Objective: Understand the statement of financial position and statement of cash flows from a business perspective.
Section Reference: Usefulness of the Statements of Financial Position and Cash Flows from a Business Perspective
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Communication
CPA: Finance
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-81 Liquidity, solvency, and financial flexibility
Explain the relation between the concepts of liquidity, solvency and financial flexibility.
Solution 5-81
Liquidity depends on the amount of time expected to pass until an asset is realized (converted into cash) or until a liability is paid. Solvency reflects an enterprise’s ability to pay its debts and related interest.
Together, liquidity and solvency affect an entity’s financial flexibility, a measure of the enterprise’s ability to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities. For example, if a company’s cash sources to finance expansion or pay off maturing debt are limited it will have difficulty surviving bad times, recovering from unexpected setbacks, and taking advantage of investment opportunities.
Difficulty: Medium
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-82 Limitations of the statement of financial position
The statement of financial position has many limitations. One of these limitations is that it necessarily leaves out many items. Of greatest concern to investors are omitted liabilities. Explain why some liabilities are left off the statement of financial position, and how investors can identify and measure potentially omitted items.
Solution 5-82
Assets or liabilities may be left off the statement of financial position because they cannot be recorded objectively. To preserve the quality of their liquidity and solvency ratios (which measure the enterprise’s short-term ability to pay maturing obligations) a company may be particularly biased against including liabilities in the financial statements.
When reviewing a company, an analyst’s knowledge of the business and industry can make it possible to identify and measure off-balance sheet items that often represent additional risk to the company. For example, manufacturers or utilities companies may have capital lease obligations which have not been capitalised. Analysts can search for corresponding note disclosures and industry stats to estimate and incorporate these lease obligations into the liquidity and solvency ratios.
Difficulty: Medium
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-83 Terminology
In the space provided at the right, write the word or phrase that is defined or indicated.
1. A company’s ability to take effective ______
actions to alter the amounts and timing
of cash flows so it can respond to
unexpected needs and opportunities
2. Claims to future cash flows that are ______
fixed and determinable
3. Short-term, highly liquid investments ______
that are readily convertible into known
amounts of cash
4. Assets that are held for sale in the ______
ordinary course of business
5. Expenditures already made for benefits ______
that will be received within one year
or the operating cycle
6. Assets of physical substance that are ______
used in ongoing business operations
7. Assets that have no physical substance ______
8. The excess of total current assets over ______
total current liabilities
9. Unrealized gains and losses included ______
as part of equity
Solution 5-83
1. Financial flexibility
2. Monetary assets
3. Cash equivalents
4. Inventories
5. Prepaid expenses
6. Property, plant, and equipment
7. Intangible assets
8. Working capital
9. Accumulated other comprehensive income
Difficulty: Easy
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-84 Definitions
Provide clear, concise answers for the following:
1. Explain the merits of classified financial statements.
2. What are financial instruments?
3. What are inventories?
4. What are other assets?
5. What statement of financial position information requires supplemental disclosure?
6. Explain the purpose of the statement of cash flows.
7. Explain the concept of free cash flow.
Solution 5-84
1. Classification of financial statements increases their information content. This is accomplished through the grouping of items with similar characteristics and separating items with different characteristics.
2. Financial instruments are contracts between two or more parties that create financial assets for one party and a financial liability or equity instrument for the other and include cash, the right to receive cash or another financial instrument, and investments in other companies.
3. Inventories are assets that are held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the rendering of service.
4. “Other assets” includes assets that are not included anywhere else. They commonly include items such as non-current receivables and assets in special funds and require the disclosure of sufficient detail.
5. Supplemental disclosure is required for contingencies, accounting policies, contractual situations, and subsequent events. Additional information is also required for many individual statement of financial position items.
6. The purpose of the statement of cash flows is to allow users to assess an entity’s capacity to generate cash and cash equivalents and its needs for cash resources. The statement identifies the sources of cash inflows and uses of cash during the period.
7. Free cash flow can be defined as a measure of a company’s level of financial flexibility and is calculated as cash flow from operating activities less capital expenditures and dividends.
Difficulty: Medium
Learning Objective: Identify the uses and limitations of a statement of financial position.
Section Reference: Usefulness and Limitations of the Statement of Financial Position
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
Learning Objective: Identify statement of financial position information that requires supplemental disclosure.
Section Reference: Additional Information Reported
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
Learning Objective: Understand the usefulness of the statement of cash flows.
Section Reference: Usefulness of the Statement of Cash Flows
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-85 Account classification
Although the Statement of Financial Position can be classified and presented in several ways, the major subdivisions noted in Illustration 5-1 tend to be closely followed. Explain how following these classifications contributes to the financial statement objectives of representational faithfulness and transparency.
Solution 5-85
Standard classifications make it easier to calculate important ratios, such as the current ratio for assessing liquidity and debt to equity ratios for assessing solvency. Breaking down assets and liabilities into categories helps users calculate which assets are more significant than other and how these relationships change over time. This gives insight into management’s strategy and stewardship. If classifications were uncommon across companies and years this type of intra- and inter-company analysis would not be possible, and some adjustment would be necessary to bring statements to a comparable and transparent format. Keeping the same format enhances transparency. Where there is a change in presentation to preserve representational faithfulness, the company should disclose any supplementary information, including, but not limited to, comparative data for prior years, to facilitate analysis and enhance the understanding of financial statement users.
Difficulty: Medium
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-86 Current liabilities
Define current liabilities without using the word “liability.”
Solution 5-86
Current liabilities are legally enforceable obligations that are due within one year from the date of the statement of financial position or the operating cycle, whichever is longer.
Difficulty: Easy
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-87 Current assets
Define current assets without using the word “asset.”
Solution 5-87
Current assets are resources (future economic benefits) expected to be converted to cash, sold, or consumed in one year or the operating cycle, whichever is longer.
Difficulty: Easy
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-88 Account classification
ASSETSLIABILITIES AND CAPITAL
a) Current assets f) Current liabilities
b) Investments g) Long-term liabilities
c) Property, plant and equipment h) Preferred shares
d) Intangibles i) Common shares
e) Other assets j) Contributed surplus
k) Retained earnings
l) Items excluded from statement of financial
position
Using the letters above, classify the following accounts according to the preferred statement of financial position presentation.
1.Bond sinking fund
2.Common stock dividend distributable
3.Appropriation for plant expansion
4.Bank overdraft
5.Bonds payable (due 2024)
6.Premium on common shares
7.Securities owned by another company which are collateral for that company’s note
8.Trading securities
9.Inventory
10.Unamortized discount on bonds payable (due 2024)
11.Patents
12.Unearned revenue
Solution 5-88
1. b
2. k
3. k
4. f
5. g
6. j
7. l
8. b
9. a
10. g
11. d
12. f
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-89 Valuation of statement of financial position items
Use the code letters listed below (a – k) to indicate, for each statement of financial position item (1 – 13) listed below, the usual valuation reported on the statement of financial position.
a) No par value
b) Current cost of replacement
c) Amount payable when due, less unamortized discount or plus unamortized premium
d) Amount payable when due
e) Fair value at statement of financial position date
f) Net realizable value
g) Lower of cost or net realizable value
h) Original cost less accumulated depreciation/amortization
i) Original cost less accumulated depletion
j) Historical cost
k) Unexpired or unconsumed cost
1.Common shares8.Long-term bonds payable
2.Prepaid expenses9.Land (in use)
3.Natural resources10.Land (future plant site)
4.Property, plant, and equipment11.Patents
5.Trade accounts receivable12.Trading securities
6.Copyrights13.Trade accounts payable
7.Merchandise inventory
Solution 5-89
1. a
2. k
3. i
4. h
5. f
6. h
7. g
8. c
9. j
10. j
11. h
12. e
13. d
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-90 Statement of financial position classifications
Typical statement of financial position (SFP) classifications are as follows:
a) Current Assets g) Long-Term Liabilities
b) Investments h) Capital Shares
c) Plant Assets i) Contributed Surplus
d) Intangible Assets j) Retained Earnings
e) Other Assets k) Notes to Financial Statements
f) Current Liabilities l) Not Reported on SFP
Indicate by use of the above letters how each of the following items would be classified on a statement of financial position prepared at December 31, 2014. If a contra account, or any amount that is negative or opposite the normal balance, place parentheses around the letter selected. A letter may be used more than once or not at all.
_____ 1. Accrued salaries and wages
_____ 2. Rental revenues for three months collected in advance
_____ 3. Land used as plant site
_____ 4. Equity securities classified as short term
_____ 5. Cash
_____ 6. Accrued interest payable due in thirty days
_____ 7. Premium on preferred shares issued
_____ 8. Dividends in arrears on preferred shares
_____ 9. Petty cash fund
_____ 10. Unamortized discount on bonds payable due in 2020
_____ 11. Common shares at no par value
_____ 12. Bond indenture covenants
_____ 13. Unamortized premium on bonds payable due in 2020
_____ 14. Allowance for doubtful accounts
_____ 15. Accumulated depletion, oil well
_____ 16. Natural resources—timberlands
_____ 17. Deficit (no income earned since beginning of company)
_____ 18. Goodwill
_____ 19. Ninety-day notes payable
_____ 20. Investment in bonds in another company; that will be held to 2018 maturity
_____ 21. Land held for speculation
_____ 22. Death of company president
_____ 23. Current maturity of bonds payable
_____ 24. Investment in subsidiary; no plans to sell in the near future
_____ 25. Trade accounts payable
_____ 26. Preferred shares, no par value
_____ 27. Prepaid expenses for next twelve months
_____ 28. Copyright
_____ 29. Accumulated depreciation, equipment
_____ 30. Earnings, not distributed to shareholders
Solution 5-90
1. f 16. c
2. f 17. j
3. c 18. d
4. a 19. f
5. a 20. b
6. f 21. b
7. I 22. l
8. k 23. f
9. a 24. b
10. g 25. f
11. h 26. h
12. k 27. a
13. g 28. d
14. a 29. c
15. c 30. j
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-91 Statement of financial position classifications
The various classifications listed below have been used in the past by Mercury Ltd. in its statement of financial position. The corporation asks your professional opinion concerning the appropriate classification of each of the items 1–14 below.
a) Current Assets f) Current Liabilities
b) Investments g) Long-Term Liabilities
c) Property, Plant and Equipment h) Capital Shares
d) Intangible Assets i) Retained Earnings
e) Other Assets
Indicate by letter how each of the following items should be classified. If an item need not be reported on the statement of financial position, use the letter “X.” A letter may be used more than once or not at all. If an item can be classified in more than one category, choose the category most favoured by the authors of your textbook.
1.Employees’ payroll deductions
2.Cash in sinking fund
3.Rent revenue collected in advance
4.Factory building retired from use and held for sale
5.Patents
6.Payroll cash fund
7.Goods held on consignment
8.Accrued revenue on short-term investments
9.Advances to salespersons
10.Premium on bonds payable due two years from date
11.Bank overdraft
12.Salaries which company budget shows will be paid to employees within the next year
13.Work in process
14.Appropriation of retained earnings for bonded indebtedness
Solution 5-91
1. f
2. b
3. f
4. a or e
5. d
6. a
7. x
8. a
9. a
10. g
11. f
12. x
13. a
14. i
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-92 Statement of financial position classifications
The various classifications listed below have been used in the past by Droid Inc. in its statement of financial position.
a) Current Assets e) Current Liabilities
b) Investments f) Long-term Liabilities
c) Plant and Equipmentg)Common Shares
d) Intangible Assets h) Retained Earnings
Instructions
Indicate by letter how each of the items below should be classified at December 31, 2014. If an item is not reported on the December 31, 2014 statement of financial position, use the letter “X” for your answer. If the item is a contra account within the particular classification, place parentheses around the letter. A letter may be used more than once or not at all.
Sample question and answer:
a__ Allowance for doubtful accounts
1.Customers’ accounts with credit balances
2.Bond sinking fund
3.Salaries which the company’s cash budget shows will be paid to employees in 2015
4.Accumulated depreciation
5.Appropriation of retained earnings for plant expansion
6.Impairment of goodwill for 2014
7.On December 31, 2014, Droid signed a purchase commitment to buy all of its raw materials from Jupiter Inc. for the next two years
8.Discount on bonds payable due March 31, 2017
9.Launching of Droid’s internet retailing division in February, 2014
10. Cash dividends declared on December 15, 2014, payable on January 15, 2015
Solution 5-92
1. e
2. b
3. x
4. c
5. h
6. x
7. x
8. f
9. x
10. e
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-93 Statement of financial position
The following statement of financial position was prepared by the bookkeeper for Hauser Company as of December 31, 2017:
Hauser Company
Statement of Financial Position
as of December 31, 2017
Cash $ 95,000 Accounts payable $ 85,000
Accounts receivable (net) 52,200 Bonds payable 100,000
Inventory 62,000 Stockholders’ equity 238,500
Investments 76,300
Equipment (net) 106,000
Patents 32,000
$423,500$423,500
The following additional information is provided:
1. Cash includes the cash surrender value of a life insurance policy $9,400, and a bank overdraft of $2,500 has been deducted.
2. The net accounts receivable balance includes:
(a) accounts receivable—debit balances $60,000;
(b) accounts receivable—credit balances $4,000;
(c) allowance for doubtful accounts $3,800.
3. Inventory does not include goods costing $3,000 shipped out on consignment. Receivables of $3,000 were recorded on these goods.
4. Investments include investments in common stock, trading $19,000 and available-for-sale $48,300, and franchises $9,000.
5. Equipment costing $5,000 with accumulated depreciation $4,000 is no longer used and is held for sale. Accumulated depreciation on the other equipment is $40,000.
Instructions
Prepare a statement of financial position in good form (stockholders’ equity details can be omitted.) Assume Hauser reports in accordance with ASPE.
Solution 5-93
Hauser Company
Statement of Financial Position
As of December 31, 2017
Assets
Current assets
Cash$ 88,100(1)
Trading securities19,000
Accounts receivable$ 57,000(2)
Less: Allowance for doubtful accounts 3,800 53,200
Inventories65,000(3)
*Equipment held for sale 1,000 (4)
Total current assets226,300
Investments
Available-for-sale securities 48,300
Cash surrender value 9,400 57,700
Property, plant, and equipment
Equipment145,000(5)
Less: accumulated depreciation 40,000105,000
Intangible assets
Patents32,000
Franchises 9,000 41,000
Total assets$430,000
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable$ 85,000
Bank overdraft 2,500
Unearned revenue 4,000(6)
Total current liabilities91,500
Long-term liabilities
Bonds payable 100,000
Total liabilities 191,500
Stockholders’ equity 238,500
Total liabilities and stockholders’ equity$430,000
(1) ($95,000 – $9,400 + $2,500)
(2) ($60,000 – $3,000)
(3) ($62,000 + $3,000)
(4) ($5,000 – $4,000)
(5) ($106,000 + $40,000 – $5,000 + $4,000)
(6) Credit balances in accounts receivable
*An alternative is to show it as another asset.
Difficulty: Hard
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Bloomcode: Synthesis
Ex. 5-94 Statement of financial position presentation
Given the following account information for Howard Corporation, prepare a balance sheet in report form for the company as of December 31, 2017. All accounts have normal balances.
Equipment60,000
Interest Expense2,400
Interest Payable600
Retained Earnings?
Dividends50,400
Land137,320
Accounts Receivable102,000
Bonds Payable78,000
Notes Payable (due in 6 months)29,400
Common Stock70,000
Accumulated Depreciation—Equip10,000
Prepaid Advertising5,000
Service Revenue341,400
Buildings80,400
Supplies1,860
Income Taxes Payable3,000
Utilities Expense1,320
Advertising Expense1,560
Salaries and Wages Expense53,040
Salaries and Wages Payable900
Accumulated Depr.—Bld15,000
Cash45,000
Depreciation Expense8,000
Solution 5-94
Leong Corporation
Balance Sheet
December 31, 2017
Assets
Cash $ 45,000
Accounts Receivable 102,000
Supplies 1,860
Prepaid advertising 5,000
Total current assets $ 153,860
Land 137,320
Building $ 80,400
Accumulated depreciation – bld (15,000) 65,400
Equipment 60,000
Accumulated depreciation—eq (10,000) 50,000 252,720
Total assets$ 406,580
Liabilities & Stockholders’ Equity
Notes payable $ 29,400
Taxes payable 3,000
Salaries and wages payable 900
Interest payable 600
Total current liabilities $ 33,900
Long-term liabilities
Bonds payable 78,000
Total liabilities 111,900
Common stock 70,000
Retained earnings ($275,080*- $50,400) 224,680
Total stockholders’ equity 294,680
Total liabilities & stockholders’ equity $ 406,580
*$341,400 – $53,040 – $8,000 – $2,400 – $1,560 – $1,320
Difficulty: Hard
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Bloomcode: Synthesis
Ex. 5-95 Subsequent events
Explain the importance of considering subsequent events before financial statements are issued. What two types of subsequent events should be considered prior to financial statement issuance?
Solution 5-95
There are generally several weeks or months after the year end before the financial statements are issued. This time is to count inventory, reconcile subsidiary ledgers with controlling accounts, prepare necessary adjusting entries, ensure all transactions have been entered and obtain an audit. It’s possible that, in this period, important transactions and events may occur that materially affect the company’s financial position. These events are known as subsequent events, and fall into two types:
- Events that provide further evidence of conditions that existed at the date of the Statement of Financial Position
- Events that indicate conditions that occurred after the financial statement date.
Difficulty: Easy
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Audit and Assurance
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-96 Contractual disclosures and ethical consideration
Contractual obligations should be disclosed in the notes to financial statements when they are significant. Considerable judgment is needed to determine whether leaving out such information is misleading. What principle should the accountant’s judgment consider in this situation? Describe anything that should be factored into the disclosure decision.
Solution 5-96
The basis for including additional information is the full disclosure principle; that is, the information needs to be important enough to influence the decisions of an informed user. When in doubt, it is better to disclose a little too much information than not enough. However, the accountant’s judgment should also include ethical considerations, because the way of disclosing accounting principles, methods, and other items that have important effects on the enterprise may reflect the interests of a particular stakeholder in subtle ways that are at the expense of other stakeholders. For example, a reader might benefit from comprehensive note disclosures that potentially jeopardize the company’s competitive advantage or its stance with regard to a legal matter.
Difficulty: Easy
Learning Objective: Identify statement of financial position information that requires supplemental disclosure.
Section Reference: Additional Information Reported
CPA: Communication
CPA: Financial Reporting
CPA: Professional and Ethical behaviour
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-97 Notes
Describe the purpose and appropriate use of notes to the financial statements. How should notes be presented, and what information should they provide? Name an area of the financial statements for which notes are frequently used.
Solution 5-97
Notes are used if additional explanations cannot be shown conveniently as parenthetical explanations or to reduce the amount of detail on the face of the statement. The notes should present all essential facts as completely and concisely as possible. Loose wording can mislead readers instead of helpful them. Notes should add to the total information made available in the financial statements, not raise unanswered questions or contradict other parts of the statements.
An area of the financial statements often accompanied by notes is the property, plant, and equipment portion.
Difficulty: Easy
Learning Objective: Identify major disclosure techniques for the statement of financial position.
Section Reference: Techniques of Disclosure
CPA: Audit and Assurance
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-98 Contra or adjunct accounts
The use of contra or adjunct accounts is common in financial statement preparation. Though the function of these accounts is similar, they are slightly different in nature. Describe each, and name one scenario in which it would be used.
Solution 5-98
Contra Account—Is an SFP item that reduces an asset, liability, or owners’ equity account. Examples include Accumulated Depreciation and Allowance for Doubtful Accounts.
Adjunct Account—Is an SFP item that increases an asset, liability, or owners’ equity account. An example is Premium on Bonds Payable.
Difficulty: Easy
Learning Objective: Identify major disclosure techniques for the statement of financial position.
Section Reference: Techniques of Disclosure
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-99 Statement of cash flows
For each event listed below, select the appropriate category, which describes its effect on a statement of cash flows:
a) Cash provided/used by operating activities
b) Cash provided/used by investing activities
c) Cash provided/used by financing activities
d) Not a cash flow
1.Payment on long-term debt
2.Issuance of bonds at a premium
3.Collection of accounts receivable
4.Cash dividends declared
5.Issuance of shares to acquire land
6.Sale of marketable securities (long-term)
7.Payment of employees’ wages
8.Issuance of common shares for cash
9.Payment of income taxes payable
10.Purchase of equipment
11.Purchase of treasury stock (common)
12.Sale of real estate held as a long-term investment
Solution 5-99
1. c
2. c
3. a
4. d
5. d
6. b
7. a
8. c
9. a
10. b
11. c
12. b
Difficulty: Medium
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-100 Statement of cash flows purpose
What simple but important questions does the statement of cash flows help answer?
Solution 5-100
The statement of cash flows helps answer the following simple bur important questions:
- Where did cash come from during the period?
- What was cash used for during the period?
- What was the change in the cash balance during the period?
Difficulty: Easy
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-101 Statement of cash flows basic format
Illustrate the basic format of the statement of cash flows.
Solution 5-101
Statement of Cash Flows
Cash flows from operating activities$xxx
Cash flows from investing activitiesxxx
Cash flows from financing activitiesxxx
Net increase (decrease) in cashxxx
Cash at beginning of yearxxx
Cash at end of year$xxx
Difficulty: Easy
Learning Objective: Indicate the purpose and identify the content of the statement of cash flows.
Section Reference: Purpose, Content, and Format of a Statement of Cash Flows
CPA: Communication
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-102 Cash provided (used) by operating activities
Willows Corporation reports the following information:
Net income$320,000
Depreciation expense70,000
Increase in accounts receivable30,000
What amount should Willows report under the cash provided (used) by operating activities portion of their statement of cash flows?
Solution 5-102
Willows should report cash provided by operating activites of $360,000.
Calculation:
$320,000 + $70,000 – $30,000 = $360,000
Difficulty: Easy
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Communication
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-103 Ending cash balance
Caldwell Corporation reports:
Cash provided by operating activities$280,000
Cash used by investing activities110,000
Cash provided by financing activities140,000
Beginning cash balance70,000
What is Caldwell’s ending cash balance?
Solution 5-103
Caldwell’s ending cash balance is $380,000.
Calculation:
$70,000 + $280,000 – $110,000 + $140,000 = $380,000
Difficulty: Easy
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Communication
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-104 Statement of cash flows ratios
Financial statements for Comet Ltd. are presented below:
Comet Ltd.
Statement of Financial Position
December 31, 2017
AssetsLiabilities & Shareholders’ Equity
Cash $ 44,000 Accounts payable $ 28,000
Accounts receivable 39,000 Bonds payable 54,000
Buildings and equipment 154,000
Accumulated depreciation—
buildings and equipment(46,000)Common shares69,000
Patents 24,000 Retained earnings 64,000
$215,000$215,000
Comet Ltd.
Statement of Cash Flows
For the Year Ended December 31, 2017
Cash flows from operating activities
Net income$ 60,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Increase in accounts receivable$(19,000)
Increase in accounts payable7,000
Depreciation—buildings and equipment12,000
Gain on sale of equipment(7,000)
Amortization of patents 3,000 (4,000)
Net cash provided by operating activities 56,000
Cash flows from investing activities
Sale of equipment14,000
Purchase of land(27,000)
Purchase of buildings and equipment(52,000)
Net cash used by investing activities (65,000)
Cash flows from financing activities
Payment of cash dividend(25,000)
Sale of bonds 45,000
Net cash provided by financing activities 20,000
Net increase in cash 11,000
Cash, January 1, 2017 33,000
Cash, December 31, 2017 $ 44,000
At the beginning of 2017, the accounts payable balance was $21,000, and the bonds payable balance was $9,000. All Asteroid’s bonds have been issued at par.
Instructions
Calculate the following for Comet Ltd.:
a) Current cash debt coverage ratio
b) Cash debt coverage ratio
c) Free cash flow
Solution 5-104
Net cash provided by operating activities
a) Current cash debt coverage ratio = ——————————————————
Average current liabilities
$56,000$56,000
=——————————— =———— = 2.29:1
($21,000 + $28,000) ÷ 2$24,500
Net cash provided by operating activities
b) Cash debt coverage ratio = ——————————————————
Average total liabilities
=$56,000 _____ = $56,000 = 1:1
($30,000 + $82,000) ÷ 2$56,000
c) Free cash flow = Net cash provided by operating activities –
capital expenditures and dividends
=$56,000 – *$79,000 – $25,000 = $(48,000)
*$27,000 + $52,000
Difficulty: Medium
Learning Objective: Understand the usefulness of the statement of cash flows.
Section Reference: Usefulness of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Comprehension
Bloomcode: Knowledge
Ex. 5-105 Calculation of cash flow and ratio
Dawe Corporation reports the following information:
Net cash provided by operating activities$285,000
Average current liabilities150,000
Average long-term liabilities100,000
Dividends declared60,000
Capital expenditures110,000
Payments of debt35,000
Instructions
Calculate the following:
a) Cash Debt Coverage Ratio
b) Free Cash Flow
Solution 5-105
a) $285,000 ÷ ($150,000 + $100,000) = 1.14
b) $285,000 – $60,000 – $110,000 = $115,000
Difficulty: Easy
Learning Objective: Understand the usefulness of the statement of cash flows.
Section Reference: Usefulness of the Statement of Cash Flows
CPA: Finance
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
*Ex. 5-106 Calculation of ratios
Keefe Enterprises reported the following:
Net sales$285,000
Average trade receivables150,000
Cost of Goods Sold100,000
Average Inventory60,000
Average total assets110,000
Average current liabilities35,000
Instructions
Calculate the activity ratios of Keefe Enterprises.
Solution 5-106
a) Receivables turnover: Net sales / Average trade receivables = $285,000 / $150,000 = 1.9
b) Inventory turnover: Cost of goods sold / Average inventory = $100,000 / $60,000 = 1.67
c) Asset turnover: Net sales / Average total assets = $285,000 / $110,000 = 2.59
Difficulty: Medium
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Finance
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
*Ex. 5-107 Interpretation of ratios
For each ratio you calculated for Keefe Enterprises in exercise 5-xx explain what the ratio measures and provide a brief interpretation of the ratio you calculated for Keefe Enterprises.
Solution 5-107
a) Receivables turnover: Liquidity of receivables. Keefe’s receivables are fairly liquid and turnovers 1.9 times per period. This indicates a healthy rate of collection, though we’d need to look more closely at the customer terms to know this for certain.
b) Inventory turnover: Liquidity of inventory. Keefe’s inventory is also fairly liquid, and is turning over 1.67 times per period.
c) Asset turnover: How efficiently assets are used to generate sales. Keefe appears to make efficient use of their assets, generating sales at over two times the assets’ value.
Difficulty: Medium
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Finance
CPA: Financial Reporting
Bloomcode: Knowledge
*Ex. 5-108 Calculation of ratios
A company reported current assets of $120,000 and current liabilities of $150,000.
Instructions
Calculate the following:
a) Working capital
b) Current ratio
Solution 5-108
(a) Working capital: $120,000 – $150,000 = $30,000 negative
(b) Current ratio: $120,000 / $150,000 = 0.80
Difficulty: Easy
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Finance
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
*Ex. 5-109 Calculation of ratios
A company reported current assets of $450,000, current liabilities of $250,000, and total assets of $1 million.
Instructions
Calculate the following:
a) Working capital
b) Current ratio
Solution 5-109
(a) Working capital: $450,000 – $250,000 = $200,000
(b) Current ratio: $450,000 / $250,000 = 1.80
Difficulty: Easy
Learning Objective: Identify the major types of financial ratios and what they measure.
Section Reference: Ratio Analysis: A Reference (Appendix 5A)
CPA: Finance
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
PROBLEMS
Pr. 5-110 Statement of financial position format
The following statement of financial position has been submitted to you by an inexperienced bookkeeper. List your suggestions for improvements in the format of the statement of financial position. Consider both terminology deficiencies as well as classification inaccuracies.
Hathaway Industries Inc.
Statement of Financial Position
For the Period Ended December 31, 2017
Assets
Fixed Assets—Tangible
Equipment$110,000
Less: reserve for depreciation (40,000)$ 70,000
Factory supplies22,000
Land and buildings400,000
Less: reserve for depreciation(150,000)250,000
Plant site held for future use 90,000 $ 432,000
Current Assets
Accounts receivable175,000
Cash80,000
Inventory220,000
Treasury stock (at cost) 20,000 495,000
Fixed Assets—Intangible
Goodwill80,000
Notes receivable 40,000
Patents 26,000 146,000
Deferred Charges
Advances to salespersons60,000
Prepaid rent27,000
Returnable containers 75,000 162,000
TOTAL ASSETS$1,235,000
Liabilities
Current Liabilities
Accounts payable$140,000
Allowance for doubtful accounts8,000
Common stock dividend distributable35,000
Income taxes payable 42,000
Sales taxes payable 17,000 $ 242,000
Long-Term Liabilities, 5% debenture bonds, due 2020 500,000
Reserve for contingencies 150,000 650,000
TOTAL LIABILITIES 892,000
Equity
Common shares, no par value, issued 12,000 shares with
60 shares held as treasury stock$240,000
Dividends paid(20,000)
Earned surplus23,000
Other accumulated past earnings 100,000
TOTAL EQUITY 343,000
TOTAL LIABILITIES AND EQUITY$1,235,000
Note 1. The reserve for contingencies has been created by charges to earned surplus and has been established to provide a cushion for future uncertainties.
Note 2. The inventory account includes only items physically present at the main plant and warehouse. Items located at the company’s branch sales office, amounting to $30,000, are excluded since the company has consistently followed this procedure for many years.
Solution 5-110
1. The heading should be at a specific date rather than for a period of time.
2. “Fixed Assets – Tangible” and “Reserve for Depreciation” is poor terminology; should be Property, Plant and Equipment and Accumulated Depreciation.
3. Land and buildings should be segregated into two accounts. The Accumulated Depreciation account should only be reported for the buildings.
4. Plant site held for future use should be shown in the Investments section.
5. Popular practice lists current assets first; as well, current assets are usually listed in order of liquidity. Factory supplies should be shown as a current asset.
6. Treasury stock is not an asset, but a deduction from shareholders’ equity.
7. Notes receivable should be reported as a current asset or an investment.
8. The deferred charge items should be reclassified as follows:
Advances to salespersons—current asset
Prepaid rent—current asset
Returnable containers—current asset
9. Allowance for doubtful accounts should be shown as a contra account to accounts receivable.
10. Common stock dividend distributable should be shown in shareholders’ equity.
11. The debenture bonds should be shown on a separate line.
12. Earned surplus is poor terminology. The term “retained earnings” is more appropriate.
13. Other Accumulated Past Earnings is poor terminology. Accumulated Other Comprehensive Income is the term required by IFRS.
14. “Dividends paid” title is a misnomer. It probably is a “dividends declared” item that should be close to retained earnings.
15. No reference in the body of the statement is made to the notes. The order of the notes is wrong.
16. Note 2 indicates that the inventory account is understated by $30,000. Inventory and earned surplus amounts should both be adjusted by increasing it by 30,000.
17. Specific identification and description of all significant accounting principles and methods that involve selection from among alternatives and/or those that are peculiar to a given industry should be disclosed in the annual report.
Difficulty: Medium
Learning Objective: Identify the major classifications of a statement of financial position.
Section Reference: Classification in the Statement of Financial Position
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
Pr. 5-111 Statement of financial position presentation
The following statement of financial position was prepared by the bookkeeper for Badger Corp. at December 31, 2017.
Badger Corp.
Statement of Financial Position
December 31, 2017
Cash $ 90,000 Accounts payable $ 75,000
Accounts receivable (net) 52,200 Long-term liabilities 110,000
Inventories 57,000 Shareholders’ equity 208,500
Investments 76,300
Equipment (net) 86,000
Patents 32,000 ________
$393,500$393,500
The following additional information is provided:
1. “Cash” includes prepaid insurance of $9,400; as well, a bank overdraft of $1,500 has been deducted.
2. The net accounts receivable balance includes:
(a) accounts receivable—debit balances $62,000;
(b) accounts receivable—credit balances $5,000;
(c) allowance for doubtful accounts $4,800.
3. Inventories do not include goods costing $5,000 shipped out on consignment. Receivables of $5,000 were recorded on these goods.
4. Investments include investments in common shares, trading $24,000 and long-term $43,300, and franchises $9,000.
5. Equipment costing $8,000 with accumulated depreciation $6,000 is no longer used and is held for sale. Accumulated depreciation on the other equipment is $40,000.
Instructions
Prepare a statement of financial position in good form (shareholders’ equity details can be omitted.)
Solution 5-111
Badger Corp.
Statement of Financial Position
December 31, 2017
Assets
Current assets
Cash$ 82,100(1)
Trading securities24,000
Accounts receivable$ 57,000(2)
Less allowance for doubtful accounts 4,800 52,200
Inventories62,000(3)
Prepaid insurance9,400
*Equipment held for sale 2,000 (4)
Total current assets231,700
Investments
Long-term securities43,300
Property, plant, and equipment
Equipment124,000(5)
Less accumulated depreciation 40,00084,000
Intangible assets
Patents32,000
Franchises 9,000 41,000
Total assets$400,000
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable$ 80,000(6)
Bank overdraft 1,500
Total current liabilities81,500
Long-term liabilities 110,000
Total liabilities191,500
Shareholders’ equity 208,500
Total liabilities and shareholders’ equity$400,000
(1) ($90,000 – $9,400 + $1,500)
(2) ($62,000 – $5,000)
(3) ($57,000 + $5,000)
(4) ($8,000 – $6,000)
(5) ($86,000 + $40,000 – $8,000 + $6,000)
(6) ($75,000 + $5,000)
*An alternative is to show this as an “other asset.”
Difficulty: Hard
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
Pr. 5-112 Calculation of ending retained earnings
The records of Biloxi Corp. for calendar 2017 reflected the following correct pre-tax amounts: gain from discontinued operations, $50,000; cash dividends declared and paid, $45,000; retained earnings, January 1, 2017, $275,000, correction of accounting error, $35,000 debit; income before income taxes and before discontinued operations, $165,000. The average income tax rate of 40 % applies to all items except the dividends.
Instructions
Calculate the December 31, 2017 ending balance of retained earnings.
Solution 5-112
Beginning balance……………………………..$275,000
Correction of error ($35,000 x 60%)……………..(21,000)
Income ($165,000 x 60%)………………………..99,000
Gain from discontinued operations ($50,000 x 60%)……………….30,000
Dividends…………………………………….(45,000)
Ending balance………………………………$338,000
Difficulty: Medium
Learning Objective: Prepare a classified statement of financial position.
Section Reference: Preparation of the Classified Statement of Financial Position (Balance Sheet)
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
Pr. 5-113 Statement of cash flows – direct method
The controller of Nebula Corporation has provided you with the following information:
Nebula Corporation
Income Statement
For the Year Ended December 31, 2017
Net sales 620,000
Operating expenses 410,000
Income from operations 210,000
Other revenues and expenses
Gain on sale of equipment 30,000
Interest expense 8,000 22,000
Income before income taxes 232,000
Income taxes 92,800
Net income 139,200
Nebula Corporation
Comparative Account Information
Relating to Operations
For the Year Ended December 31, 2017
2014 2013
Accounts receivable 56,000 40,000
Prepaid insurance 5,000 6,000
Accounts payable 59,000 47,000
Interest payable 600 1,500
Income taxes payable 4,200 6,000
Unearned revenue 20,000 14,000
Instructions
Prepare a statement of cash flows (for operating activities only) for the year ended December 31, 2017, using the direct method.
Solution 5-113
Nebula Corporation
Partial Statement of Cash Flows
For the Year Ended December 31, 2017
Cash received from customers $610,000
Cash paid
For operating expenses$397,000
For interest$8,900
For income taxes$94,600$500,500
Net cash provided by operating activities $109,500
Calculations:
Cash received from customers:
Net sales $ 620,000
– Increase in accounts receivable (16,000)
+ Increase in unearned revenue 6,000
$ 610,000
Cash paid for operating expenses:
Operating expenses $ 410,000
– Decrease in prepaid insurance (1,000)
– Increase in accounts payable (12,000)
$ 397,000
Cash paid for interest:
Interest expense $ 8,000
+ Decrease in interest payable 900
$ 8,900
Cash paid for income tax:
Income tax expense $ 92,800
+ Decrease in income tax payable 1,800
$ 94,600
Difficulty: Hard
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Financial Reporting
CPA: Taxation
Bloomcode: Application
Bloomcode: Knowledge
Pr. 5-114 Statement of Cash Flows – indirect method
Use the information provided in Pr. 5-113. Prepare a statement of cash flows (for operating activities only) for the year ended December 31, 2017 using the indirect method.
Solution 5-114
Nebula Corporation
Partial Statement of Cash Flows
For the Year Ended December 31, 2017
Cash flows from operating activities
Net income $139,200
Adjustments:
Gain on sale of equipment (30,000)
Increase in accounts receivable (16,000)
Decrease in prepaid insurance 1,000
Increase in accounts payable 12,000
Decrease in interest payable (900)
Decrease in income taxes payable (1,800)
Increase in unearned revenue 6,000
Net cash provided by operating activities $109,500
Difficulty: Hard
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Financial Reporting
Bloomcode: Application
Bloomcode: Knowledge
*Pr. 5-115 Calculation of ratios
Brandon Systems Inc. has provided you with the following information:
20172016
Cash $ 21,000 $ 47,000
Short-term (trading) investments 28,000 –
Accounts receivable 102,000 116,000
Inventory 86,000 64,000
Prepaid expenses 11,000 9,000
Total assets 1,503,000 1,489,000
Total current liabilities 205,000 241,000
Net sales, all on credit 877,000 850,000
Cost of goods sold 570,000 555,000
Operating income 165,000 158,000
Income tax expense 20,000 18,000
Net income 109,000 100,000
Interest expense 36,000 40,000
Common shares (no preferred) 420,000 420,000
Retained earnings 153,000 74,000
Instructions
Calculate the following ratios for 2017. Round all values to two decimals, including percentages, e.g., 12.34, 34.56%. Show all calculations for full marks.
a) Profit margin on sales
b) Quick (acid-test) ratio
c) Receivables turnover
d) Debt to total assets
e) Times interest earned
f) Rate of return on assets
g) Rate of return on common share equity
Solution 5-115
a) Profit margin on sales = Net income/net sales x 100 =
109,000 x 100 = 12.43%
877,000
b) Quick (acid-test) ratio = Quick assets/current liabilities
= 21,000 + 28,000 + 102,000 =.74 to 1
205,000
c) Receivables turnover = Net sales/average A/R
= _ 877,000 _ = 8.05 (times)
(102,000 + 116,000)/2
d) Debt to total assets = Total liabilities/total assets x 100
= 930,000 x 100 = 61.88%
1,503,000
Total liabilities = 1,503,000 – 420,000 – 153,000 = 930,000
e) Times interest earned = Net income before interest and income taxes/interest exp
= 109,000 + 36,000 + 20,000 (i.e., operating income) = 4.58 (times)
36,000
f) Rate of return on assets = Net income/average total assets
= 109,000 x 100 = 7.29%
1,496,000
average total assets = (1,503,000 + 1,489,000)/2 = 1,496,000
g) Rate of return on common share equity = NI/average comm S/H equity x 100
= 109,000 x 100 = 20.43%
533,500
Average equity = (420,000 + 420,000 + 153,000 + 74,000)/2 = 533,500
Difficulty: Hard
Learning Objective: Prepare a statement of cash flows using the indirect method.
Section Reference: Preparation of the Statement of Cash Flows
CPA: Financial Reporting
CPA: Taxation
Bloomcode: Application
Bloomcode: Knowledge
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