Introduction to Financial Accounting II

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2 Introduction to Financial Accounting II Contributing Authors Khloud Kourani, Passaic County Community College

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3 Original Publication Year 2023 Introduction to Financial Accounting I by Khloud Kourani is licensed under a Creative Commons Attribution Non Commercial Share Alike 4.0 International License , except where otherwise noted. To learn more about the Open Textbook Collaborative, visit https://middlesexcc.libguides.com/OTCProject Under this license, any user of this textbook or the textbook contents herein must provide proper attribution as follows: If you redistribute this textbook in a digital or print format (including but not limited to PDF and HTML), then you must retain this attribution statement on your licensing page. If you redistribute part of this textbook, then you must include citation information including the link to the original document and original license on your licensing page. If you use this textbook as a bibliographic reference, please include the link to this work https://opennj.net/...... as your citation. For questions regarding this licensing, please contact library@middlesexcc.edu Funding Statement This material was funded by the Fund for the Improvement of Postsecondary Education (FIPSE) of the U.S. Department of Education for the Open Textbooks Pilot grant awarded to Middlesex College (Edison, NJ) for the Open Textbook Collaborative . Open Textbook Collaborative The Open Textbook Collaborative along with assistance from Brookdale Community College, Ocean County College , Passaic County Community College, and Rowan University . The project engages a consortium of New Jersey community colleges, four year four year colleges and universities, and workforce partners to develop open educational resources (OER) in career and technical education STEM courses. The courses align to , including health services, technology, energy, and global manufacturing and supply chain management as identified by the New Jersey Council of Community Colleges.

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4 Table of Contents Chapter 11: Partnerships Chapter 12: Corporations: Organization and Capital Stock Transactions Chapter 13: Dividends, Stock Splits, and Prior Period Adjustments Chapter 14: Bonds, Long Term Notes , & and Amortization Chapter 15: Statement of Cash Flow Chapter 16: Financial Analysis (Horizontal, Vertical, and Ratios)

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5 Chapter 11 Partnerships Learning Outcomes: 1. Understand the characteristics of the partnership form of business . 2. Develop the journal entries required when creating a partnership . 3. . 4. Develop the journal entries required for the admission of new partners via a personal transaction . 5. Develop the journal entries required for the Withdrawal w ithdrawal of partners from the partnership via a personal transaction . 6. Understand the steps in for liquidating a partnership and distributing cash to each partner . (Learning Outcome 1) Understand the characteristics of the partnership form of business Anyone starting a business must first decide on the type of business: service, merchandising, manufacturing, or a combination of both. The next step is deciding what form of business to use, such as a sole proprietorship, partnership, corporation, or limit ed liability company. Each form has its own unique characteristics. In this chapter we will concentrate exclusively on the partnership. A partnershi p is a form of business consisting of two or more individuals who combine their skills, talents, and resources to conduct a business. The partnership itself can be a general partnership , or a limited type partnership: General Partnership In this form of partnership, each partner is a part owner of the business. General partners are personally liable for partnership liabilities and share in the profits and losses of the business. Limited Partnership In this form of business, there is at least one general partner who is personally and totally liable for partnership liabilities. The other, non general partner (s) , s are considered limited partners , and have limited liability for partnership debt, up to the amount of their individual investment s in the partnership. Commented [CB1]: These sections should have titles and numbers, perhaps with the Learning Outcomes offset to the Formatted: No underline Commented [CB2]:

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6 Limited Liability Partnership (LLP) In this form of business , each partner (usually general partners) has liability protection from the wrongful acts of other partners. LLPs are normally found in medical, law, and accounting firms. Partnership Characteristics 1. While not mandatory, a written agreement should form the basis for all partnerships. A written agreement can be developed to establish the rules under which the partnership will operate. Such a document will, and should , include elements such as like the following: a) Name n ame , address, etc. , of the partnership and partners b) Individual i ndividual partner investments and responsibilities c) How h ow decisions on behalf of the partnership will be made (see mutual M utual agency A gency , below) d) How h ow profits will be shared among partners e) Requirements r equirements for admitting new partners . f) Means m eans by which existing partners may withdraw g) How h ow unforeseen circumstances ( e.g. death of a partner) will be handled h) The t he procedure for dissolving the partnership A Limited l imited partnership s especially should especially be based on a written agreement defining the limited liability of such partners to their investment in the partnership. It merits noting that absent a written agreement, the laws of the state prevail, and though they may not be what the partners intended. 2. Limited Life Like sole proprietorships, partnerships have a limited life. For example, the death of a partner ends the partnership. It should be noted that ending a partnership does not necessarily mean its liquidation. To alleviate this type of situation, the written partnership agreement should describe how a the death of a partner will be addressed by the partnership. Absent this, state law will prevail , and the partnership may be dissolved. 3. Mutual Agency Mutual agency applies to general partners. It means that an individual general partner s may enter the partnership into business contracts without the knowledge of other general partners. However, for mutual agency to be enforced, the individual general partner (s) must have acted Commented [CB3]: I bolded and capitalized the headers below for clarity. Number 1 here should also have a header Formatted: Bulleted + Level: 1 + Aligned at: 0.75" + Indent at: 1" Formatted: Font: Bold Formatted: Font: Bold

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7 within the normal business practices of the partnership. The example below should clarify what is normally a complicated topic: Example # 1 : A general partner in a storefront pizzeria which delivers pizzas takes it upon himself to The other partners were unaware of this and, had they been asked, would not have made the purchase. Since tables and chairs are a normal part of t his business, mutual agency is applicable , and the company must keep the new furniture and pay for it. Example # 2: A general partner in a storefront pizzeria which delivers pizzas, takes it upon himself to purchase a nearby residential building to generate rental income, without consulting the other partners. Had the other general partners been asked, they would not have purchased the building. Since owning a residential building is not a normal practice for this type of business, mutual agency does not apply. Mutual agency is certainly a topic that should be specifically addressed in a written partnership agreement. 4. Unlimited Liability Like As in a sole proprietorship, general partners have unlimited liability for all partnership debts. Limited partners are only liable to the extent of their investments. 5. Co ownership of property Property When a partnership is formed, any property (cash, receivables, equipment, etc.) transferred by the partners into the partnership becomes the property of the partnership as a whole. It does not go back to the original partner(s), should the original partner (s) decide to leave the partnership. 6. No partnership Partnership income Income tax Tax A partnership does not pay income taxes on its profits. All profits and losses are passed on a prorated basis to the individual partners, who then include their respective share in their own personal income tax returns. However, the partnership does file an information only tax return for the business as a whole. Formatted: Indent: Left: 0.5" Formatted: Font: Bold Formatted: Font: Bold Formatted: Font: Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Formatted: No underline Formatted: Font: Not Bold, Italic, No underline Formatted: No underline

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8 Advantages Disadvantages Easy to create Unlimited liability of general partners , and resources Mutual Agency a gency Does not pay income taxes Limited life Less government regulation s Commented [CB4]: For clarity and ease of reference, all tables should be labeled as per APA rules. https://apastyle.apa.org/style grammar guidelines/tables figures/tables could omit the sentence above it. If necessary, there could

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9 (Learning Outcome 2) Develop the journal entries required when creating a partnership The journal entries required when forming a partnership, while similar in some respect to that th ose required of a sole proprietor, are a bit more complicated. The basic rules are best learned by example, as shown below: Bill Dewey owns and operates an accounting and tax service company. His friend, Frank Howe, owns and operates a book keeping firm. Both are sole proprietors. On January 1 , they merge d their companies to form the D & H partnership. Each of their T heir respective sole proprietorship balance sheet accounts as t hey appeared just before forming the new partnership is are shown below : , just before forming the new partnership. Balance Sheet Accounts Dewey Howe Cash $15,000 $12,000 Accounts receivable 4,800 4,000 Allowance for doubtful accounts (AFDA) 500 500 Inventory 4,000 3,000 Equipment 7,500 6,000 Accumulated Depreciation Equipment 1,500 1,200 Accounts payable 4,500 4,000 Notes payable 7,000 3,800 Salaries and wages payable 2,400 1,800 Dewey , and Howe agree on the following fair market values for the assets shown below: Dewey Howe Net Accounts Receivable $3,800 $4,000 Inventory 3,500 2,400 Equipment 6,400 5,400 They also agree that the partnership will continue to pay all liabilities. Instructions: Develop the required journal entries to form the new partnership. Commented [CB5]: For these charts, either all major words should be capitalized (Accounts Receivable, Allowance for Doubtful Accounts) or only the first word (Accounts receivable, Allowance for doubtful accounts). I see examples of both upon Googling balance sheet As per APA, in the body of the text, these would all be lowercased (excepting the acronyms, like AFDA) unless they are part of a trademarked name. Formatted: No underline

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10 Solution: Developing the journal entry for each partner is a 3 step process applied to each individual partner: 1. Determine which of their respective sole proprietorship accounts will transfer into the partnership. 2. . 3. 1. Not all accounts are transferred into the new partnership. However, those accounts that do transfer do so at their respective fair market value s . In some cases, the fair market value is determined by the partners. To determine which accounts transfer over, you must learn the rules for transferring accounts from a sole proprietorship into a partnership. These are: a) Some accounts transfer over into the partnership at their sole proprietor value s . In the example above, these would be the Cash c ash , the A/R (gross), and the liability accounts (unless the problem states otherwise). b) Some accounts may change in value, as long as the partners agree on the new values. In the example above , these would be the tangible assets ( Inventory i nventory and Equipment e quipment ), and the Allowance a llowance for Doubtful d oubtful Accounts a ccounts (AFDA). A change to the AFDA affects the net receivable ( see below ). c) Some accounts are completely disregarded . In the example above, this would be the accumulated depreciation account. The partnership begins with zero accumulated depreciation and begins to depreciate the applicable long term tangible asset accounts all over again. d) All accounts are journalized on their Normal n ormal Balance b alance Sides s ides (the side the account goes up on). Recall that , asset accounts go up on their debit (left) sides, liability and Capital c apital accounts go up on their credit (right) sides. Contra asset accounts go up on their credit side s . An account which that sometimes gives students trouble is accounts receivable , ; especially when the term net receivables is used. As such For clarity and net receivables. The Accounts a ccounts Receivable r eceivable account for the Dewey and Howe balance sheets above refers to the gross receivables : , that is, the total amount owed by customers. To find the Net n et Receivables r eceivables (i.e., what is expected to be collected) , you must subtract the amount shown in Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Bold Formatted: Font: Bold Formatted: Font: Bold Formatted: Font: Bold Formatted: Font: Bold Formatted: Font: Not Bold Formatted: Font: Not Bold, Italic Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Italic, No underline Formatted: Font: Not Bold

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11 the Allowance a llowance for Doubtful d oubtful Accounts a ccounts (AFDA) from the gross receivables. That is: Net Receivables r eceivables = A/R AFDA When developing the journal entry to form a partnership, you must always remember to transfer the gross receivables into the partnership at the exact value that appears on the sole proprietorship balance sheet. Any change (adjustment) to the gross receivables is done thru the AFDA account, which can be changed by the partners . for a given sole proprietorship the has gross receivables , ( A/R ) is of $100,000 and the an AFDA is of $5,000. In this case, the sole proprietorship has net receivables ( amount they expect s to collect) of: Net Receivables r eceivables = A/R AFDA Net Receivables r eceivables = $100,000 $5,000 Net Receivables r eceivables = $95,000 Thus, in this example, the partnership expects to collect $95,000 of the $100,000 in gross receivables. partnership is $88,000 instead of the $100,000 in gross receivables. When you create the journal entry in the formation of the partnership, do not value the A/R account at $ 88,000. DO NOT VALUE THE A/R ACCOUNT AT $88,000 . You must still value it at its gross amount of , $100,000. After all, if customers owed the sole proprietor $100,000 in accounts receivable s , the same agreed that only $88,000 of the gross receivables is expected to be collected. Thus, this $88,000 is really the Net n et Accounts a ccounts Receivables r eceivable . To resolve this, just show transfer the full $100,000 into the A/R account, and change the AFDA account to $12,000. Once you do this, the new net accounts receivable s will be: Net Receivables r eceivables = A/R AFDA Net Receivables r eceivables = $100,000 $12,000 (the new AFDA agreed to by the partners) Formatted: No underline Formatted: No underline Commented [CB6]: Bolding and/or capitalizing for wanted to retain emphasis for this and similar items, you could have them in bulleted lists under a bolded header Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: No underline

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12 Net Receivables r eceivables = $88,000 Note that the A/R is still shown as $100,000 , but the AFDA changes from the $5,000 value in the sole proprietorship to the $12,000 value in the new partnership. And Thus, the amount expected to be collected becomes is $88,000. 2. Determin ing means ( m M ore specifically ) : a) problem states otherwise. b) A/R and AFDA should be treated as discussed above. Note that the AFDA can change. c) The values of inventory and equipment can be changed by the partners. New values will be provided. d) The accumulated depreciation account is totally ignored. It will not be transferred over into the partnership. e) All liabilities , such as A/P, Notes n otes Payable p ayable , and Salaries s alaries & Wages w ages Payable p ayable , transfer over at the value s unless the problem states otherwise. f) Show all accounts on their Normal n ormal Balance b alance sides. 3. thus far , and add up accounts with debit balances , and subtract all accounts with a credit balance s . Thus, for Dewey, the journal entry becomes: Date Account Debit Credit Comment(s) 1/1 Cash Carries over as what it is at its in the sole proprietorship value A/R Gross amount of A/R carries over at what it as is Inventory Revalued by partners Equipment Revalued by partners AFDA Adjusted to get net receivables A/P Carries over as is unless problem states otherwise Notes Payable Carries over as is unless problem states otherwise Salaries & Wages Payable Carries over as is unless problem states otherwise Dewey, Capital Debits minus credits To record investment by Dewey Formatted Table

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13 Note . accumulated A ccumulated depreciation is not shown because it does not transfer into the partnership. The partnership gets to start depreciation of the depreciable long term assets all over again. And, For Howe , th e journal entry becomes: Date Account Debit Credit Comment(S) 1/1 Cash Carries over as what it is in the at its sole proprietorship value A/R Gross amount of A/R carries over at what it as is Inventory Revalued by partners Equipment Revalued by partners AFDA Adjusted to get net receivables A/P Carries over as is unless problem states otherwise Notes Payable Carries over as is unless problem states otherwise Salaries & Wages Payable Carries over as is unless problem states otherwise Howe, Capital Debits minus credits To record investment by Howe Note . again that accumulated A ccumulated depreciation is not shown. And there you have it. This is how you go about developing the accounting journal entries when sole proprietorships merge to form a partnership. Formatted: Font: Italic Formatted Table Formatted: Font: Italic

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14 (Learning Outcome 3) through the closing process. In a partnership, the process is the same. However, since there is more than one owner, a method must be employed to determ income or loss. We refer to this as allocating net income or loss among partners . To allocate net income or loss among the partners, you need to consider three things ( in the order shown below ) : 1. Has any partner received a salary allowance? A salary allowance is a portion of net income or loss assigned to a specific partner(s), usually because the partner is an owner and works for the partnership. 2. Has any partner received an interest allowance? An interest allowance is a portion of net income or loss assigned to each partner on the basis of based on their respective investment in the partnership. It is usually a percent age of the 3. Is there any remainder? The total of the salary and interest allowance is compared to the net income or loss for the period . If the total of the salary allowance and interest allowance equals the net income or loss for the period, then the remainder is zero. However, if the total of the salary and interest allowance does not equal the net income or loss for the period, then the re is a remainder. The remainder can be positive or negative , and it is only used to adjust the total of the salary and interest allowances so that it is equal to the net income or loss for the period. This remainder must be allocated to the partners in accordance with income sharing ratios . Example # 1 The partnership of Henry and James had net income of $60,000. Each partner shares income equally. Allocate the net income amount among the partners , and show the closing journal entry to for transfer ring Solution: In this exercise there is no salary or interest allowance. Since there are only two partners who share net income equally, they are each is entitled to $30,000. Recalling that positive net income increases Formatted: No underline Formatted: Font: Not Bold, No underline Formatted: No underline Formatted: No underline Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Formatted: Font: Italic, No underline

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15 Date Account Debit Credit Comment(S) Income Summary 60,000 Henry, Capital 30,000 James, Capital 30,000 To allocate net income among partners. Example # 2 Cather, Elliot, and Williams share income on the basis of 3:4:3. During the year, Cather and Elliot received a salary allowance of $20,000 and $15,000 , respectively. If the net income for the year was $80,000, calculate how much net income should be allocated to each partner , and show the closing journal entry to for transfer ring s . Solution: This exercise is a bit more complicated. Note that there is a salary allowance , but no interest allowance. Also note that the total of the salary allowance equals $35,000 ; well below the net income amount. This indicates that there is a positive remainder of $45,000 ($80,000 $35,000) , which is shared in Cather: 3/10 x $45,000 = $13,500 Elliot: 4/10 x $45,000 = $18,000 Williams: 3/10 x $45,000 = $13,500 The table below shows the allocation of the $80,000 of net income among the three partners. Net Income = $80,000 Cather Elliot Williams Total Salary Allowance $20,000 $15,000 $35,000 Remainder = $45,000 13,500 18,000 13,500 45,000 Totals $35,500 $33,000 $13,500 $80,000 Since the individual partners totals are positive, their respective capital accounts will increase as shown by the journal entry below: Date Account Debit Credit Comment(S) Income Summary 80,000

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16 Cather, Capital 35,500 Elliot, Capital 33,000 Williams, Capital 13,500 To allocate net income among partners. Example # 3 The partnership of Ashley, Bruno, and Castro shares income based on a 5:3:2 ratio . During the year, the partners received salary allowances of $40,000 ; and $35,000 ; and $30,000 , respectively. They also received a 10% interest allowance on the basis of their beginning capital balances, which were , $100,000 ; , $75,000 ; and $60,000 , respectively. If the net income for the year was $100,000, calculate how much net income should be allocated to each partner , and show the closing journal entry to for transfer ring s . Solution: This exercise is a bit more complicated. Note that there is a salary allowance and an interest allowance. Also note that the sum of the salary allowance and the interest allowance equals $128,500 ; well above the net income amount. This indicates that there is a negative remainder of $28,500 ($100,000 $105,000 Thus, the remainder will be shared as follows: Ashley: 5/10 x $28,500 = $14,250 Bruno: 3/10 x $28,500 = $8,550 Castro: 2/10 x $28,500 = $5,700 The table below shows the allocation of the $100,000 of net income among the three partners : . Net Income = $100,000 Ashley Bruno Castro Total Salary Allowance $40,000 $35,000 $30,000 $105,000 Interest Allowance 10,000 7,500 6,000 23,500 Remainder = $28,500 14,250 8,550 5,700 28,500 Totals $35,750 $33,950 $30,300 $100,000 Since the individual partners totals are positive, their respective capital accounts will increase as shown by the journal entry below: Formatted: No underline Formatted: No underline

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17 Date Account Debit Credit Comment(S) Income Summary 100,000 Ashley, Capital 35,750 Bruno, Capital 33,950 Williams, Capital 30,300 To allocate net income among partners. Partnership Financial Statements At the end of the accounting period , the partnership prepares the four (4) basic financial statements that other companies prepare , and ( in the following order ) : 1. Income statement 2. 3. Balance sheet 4. Statement of cash flow However, there are some features related to 1, 2, and 3 that merit s noting. Income Statement The income statement for a partnership will include a section on the division of net income (see above) , after the net income has been determined. Statement Heading Total Revenue $320,000 Total Expenses $180,000 Net Income or Loss $140,000 Allocation of Net Income or Loss Partner A $80,000 Partner B $40,000 Partner C $20,000 Total Net Income or Loss Allocated to Partners $140,000

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18 beginning of each accounting period and how it changed during the period as a result of profits or losses, additional investments , and withdrawals, if any. In a sense, the Statement s tatement of o Equity e quity for a sole proprietorship , except that it includes results for individual partners. Statement Heading Partner A Partner B Partner C Beginning Capital $100,000 $60,000 $40,000 Plus/minus net income/loss $80,000 $40,000 $20,000 Plus additional investments Minus Withdrawals $12,000 $8,000 $10,000 Ending Capital $168,000 $92,000 $50,000 Balance Sheet Shown below is a typical format for a simple partnership balance sheet. Note that , each Capital c apital Statement s tatement ) is shown, as well as the total partnership ending capital as of the end of the accounting period. Name of Partnership Balance Sheet Commented [CB7]: Table needs realignment for clarity

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19 Date Assets Liabilities Cash A/P A/R, net Notes Payable Inventory Equipment, net Partner A Partner B Partner C Total Assets

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20 (Learning Outcome 4) Develop the Journal Entries for the Admission of New Partners via a Personal Transaction Key Concepts: 1. This is strictly a personal transaction between partners. The Partnership p artnership is NOT not involved. 2. Total partnership equity and cash DO NOT CHANGE. do not change. 3. The amount of money given by a new partner coming in , or the amount given to a withdrawing partner is not included in the journal entry ( matter ). 4. Only the 5. The journal entry only shows affected partner (s) capital accounts. 6. As always, capital increases on the right (credit) and decreases on the left (debit) Example of Admission of a New Partner via a Personal Transaction Eg. Example 1: Assume 3 three partners with capital balances as shown below: Thomas, Capital Williams , Capital Jones, Capital 20,000 30,000 25,000 Say Ortiz is joining the partnership , and that Thomas agrees to sell Ortiz one half (50%) of his capital to Ortiz for $30,000. Analysis: Thomas is giving up 50% of his Capital c apital or (50%) x $20,000 = $10,000. Thomas will have to debit his Capital c apital account to reduce it by this amount. On the other hand, Ortiz is getting this $10,000 Capital c apital credit from Thomas. As such Therefore , Ortiz will credit his Capital c apital account by the same amount. The journal entry becomes: Thomas, Capital 10,000 Formatted: Font: Not Italic

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21 Ortiz, Capital 10,000 To record admission of a new partner via a personal transaction Note that the amount of cash exchanged does not get recorded , because this is a personal transaction. The fact that Thomas is receiving $30,000 in cash for only $10,000 of his capital credit is irrelevant to the journal entry. This cash is NOT not going to the partnership. It is going to Thomas. After the transaction is journalized , the partnership accounts are as follows: Thomas, Capital Williams Capital Jones, Capital Ortiz, Capital 10,000 30,000 25,000 10,000 Note. The total partnership capital does not change as a result of a personal transaction. It is still $75,000 total for the (n ow) four partners. NOTE THAT THE TOTAL PARTNERSHIP CAPITAL DOES NOT CHANGE AS A RESULT OF A PERSONAL TRANSACTION. IT IS STILL $75,000 TOTAL FOR THE NOW 4 PARTNERS. Eg. Example 2: Assume the same 3 three partners with capital balances as shown below: Thomas, Capital Williams , Capital Jones, Capital 20,000 30,000 25,000 Commented [CB8]: Table needs realignment, bordering Commented [CB9]: Table needs realignment Formatted: Font: Italic Formatted: Font: Not Bold

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22 Say Ortiz is joining the partnership , and that Williams and Jones each agree s to sell Ortiz one quarter (25%) of their capital balances for $12,000 and $9,000 , respectively. Analysis: In this example, Williams is giving up 25% of his Capital c apital or (25% ) x $30,000 = $7,500 ), and Jones is giving up 25% of his Capital c apital or ( 25% x $25,000 = $6,250 ) . Both Williams and Jones will have to debit their respective Capital c apital accounts to reduce them by their respective amounts. On the other hand, Ortiz is getting a capital credit equal to $7,500 + $6,250 , or $13,750. As such a result , Ortiz will credit his Capital c apital account by this amount. The journal entry becomes: Williams, Capital 7,500 Jones, Capital 6,250 Ortiz, Capital 13,750 To record admission of a new partner via a personal transaction Note . that the T he amount of cash being received by each partner does not get recorded , because this is a personal transaction. This cash is NOT not going to the partnership. It is going to Williams and Jones, who in turn are giving up some of their Capital c apital to Ortiz. After the transaction is journalized , the partnership accounts are as follows: Thomas, Capital Williams Capital Jones, Capital Ortiz, Capital 20,000 22,500 18,750 13,750 Note. As before, the total partnership capital does not change as a result of the personal transaction and remains at $75,000 for the four partners. Commented [CB10]: Alignment needed Formatted: Font: Italic Commented [CB11]: Alignment needed Formatted: Font: Not Bold

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23 NOTE THAT THE TOTAL PARTNERSHIP CAPITAL DOES NOT CHANGE AS A RESULT OF A PERSONAL TRANSACTION. IT IS STILL $75,000 TOTAL FOR THE NOW 4 PARTNERS.

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24 (Learning Outcome 5) Develop the Journal Entries for the Withdrawal of Partners from the Partnership via a Personal Transaction Key Concepts : ( Note, the concepts applied in the Admission case above, also apply to the Withdrawal case ) : 1. This is strictly a personal transaction between partners. The Partnership is NOT involved. 2. Total partnership equity and cash DO NOT CHANGE. 3. The amount of money given by a new partner coming in, or given to a withdrawing partner is not included in the journal entry ( ). 4. 5. The journal entry only shows affected partner(s) capital accounts. 6. As always, capital increases on the right (credit) and decreases on the left (debit) Example of Withdrawal of an Existing Partner via a personal P ersonal transaction T ransaction Eg. Example 1: Assume 3 partners with capital balances as shown below: Sam, Capital Molly, Capital Oda Mae, Capital 20,000 30,000 25,000 Say Oda Mae decides to leave the partnership , and Sam agrees to buy out her capital interest for $40,000. Analysis: Since Oda Mae is leaving the partnership, she is giving up her entire capital credit of $25,000. Oda Mae will have to debit her Capital c apital account to reduce it by this amount. On the other hand, Sam will be gaining $25,000 in additional capital credit because he is paying her for it. Remember, this is a personal transaction . As such, ; Sam will credit his Capital c apital account by the $25,000 capital credit Oda Mae is giving up. The journal entry becomes: Commented [CB12]: It is probably unnecessary to repeat these here verbatim. Instead, there could be a very short paragraph explaining that the key concepts are identical to the admission of a new partner, and summarizing in a sentence or two that the money involved in the personal transaction is irrelevant to total equity, and only the affected accounts are included in the entry.

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25 Oda Mae, Capital 25,000 Sam, Capital 25,000 To record withdrawal of an old partner via a personal transaction Note . that As before, the amount of cash exchanged does not get recorded , because this is a personal transaction. The fact that Sam is receiving an additional $25,000 capital credit for the $40,000 he is giving Oda Mae is irrelevant to the journal entry. Another way of looking at this is Sam is only getting an additional $25,000 in Capital, for the $40,000 in cash he is giving Oda Mae. Regardless of whether it seems right or not, the amount of cash exchanged via a personal because the partnership is not getting the cash involved in the personal tr ansaction . After the transaction is journalized the partnership accounts are as follows: Sam, Capital Molly, Capital 45,000 30,000 Note. As before, the total partnership capital does not change as a result of the personal transaction and remains at $75,000 for two remaining partners. NOTE THAT THE TOTAL PARTNERSHIP CAPITAL DOES NOT CHANGE AS A RESULT OF A PERSONAL TRANSACTION. IT IS STILL $75,000 FOR THE 2 REMAINING PARTNERS. Eg Example . 2: Assume the same 3 partners with capital balances as shown below: Sam, Capital Molly, Capital Oda Mae, Capital 20,000 30,000 25,000 Commented [CB13]: Alignment needed Formatted: Font: Italic

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26 In this example, say Sam decides to leave the partnership , and Molly and Oda Mae each agree to give Sam $12,500 each for his capital interest. Molly and Oda Mae each receive 50% of Analysis: Since Sam is leaving the partnership, he is giving up his entire capital credit of $20,000. Thus, Sam will have to debit his Capital c apital account to reduce it in its entirety. Molly and Oda Mae will each receive 50% or ( $10,000 ) Capital c apital , and both will also have to credit their respective Capital c apital accounts for the additional Capital c apital they are receiving. Disregard the amounts of cash being exchanged. The journal entry becomes: Sam, Capital 20,000 Molly, Capital 10,000 Oda Mae, Capital 10,000 To record withdrawal of an old partner via a personal transaction Again note Note. Again, that the amount of cash exchanged does not get recorded , because this is a personal transaction. After the transaction is journalized , the partnership accounts are as follows: Molly, Capital Oda Mae, Capital 40,000 35,000 Note. Again, the total part nership capital does not change and remains at $75,000. NOTE THAT THE TOTAL PARTNERSHIP CAPITAL DOES NOT CHANGE AS A RESULT OF A PERSONAL TRANSACTION. IT IS STILL $75,000 FOR THE 2 REMAINING PARTNERS. Commented [CB14]: Alignment needed Formatted: Font: Italic

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28 (Learning Outcome 6) Understand the steps in liquidating a partnership and distributing cash to each partner Liquidating a partnership means terminating it. The liquidation L iquidation process is a 4 step process , performed in sequential steps. Each step requires a journal entry: 1. Sell all noncash assets and realize a gain or a loss on the sale. 2. Allocate the gain or loss to the partners in accordance with their income sharing ratios. 3. Pay all partnership liabilities. 4. Distribute remaining cash to partners in accordance with their capital balances. This assumes the capital balances are on the credit side. If one or more any is are on the debit side, the remaining cash cannot be distributed until the partners with the debit balances have had their debit balances zeroed out. The method for doing this may be found below. However, before step four (4) can be completed , you have to check to see if any partner has a debit balance in his capital account. If he does, this condition is known as a capital deficiency and must be resolved before ANY any cash can be distributed to any partner. Resolving the capital deficiency depends on how the partner with the deficiency intends to correct it. He can do so in one of two (2) ways: 1. He can invest additional cash into the partnership, equal to the amount of the capital deficiency. In this case, the following journal entry is made: Cash debit Deficient Partner, Capital credit To record investment to eliminate capital deficiency At this point, the partnership cash balance will be equal to the sum of the remaining capital deficiency does not receive any cash. Or 2. If the partner with the capital deficiency is unwilling to contribute any cash into the partnership to eliminate his capital deficiency, the remaining partners must reduce their capital balances, prorated in accordance with their income sharing ratios, so Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold, Italic Commented [CB15]: Alignment needed Formatted: No underline Formatted: Font: Not Bold Formatted: No underline Formatted: No underline

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29 that the capital deficiency is eliminated. In this case, the following journal entry is made: Non deficient Partner 1, Capital debit Non deficient Partner N, Capital debit Deficient Partner, Capital credit To record investment to eliminate capital deficiency At this point, the partnership cash balance will be equal to the sum of the remaining As such, there are four (4) major journal entries and the possibility of a fifth ( but only if there is a capital deficiency). there is a capital gain from the sale of noncash assets. Example 1 (with gain on sale of noncash assets; If there is any capital deficiency, assume it will be resolved by the partners without the deficiency) : . The balance sheet for the KSU (Kirk, Spock, Uhura) partnership is shown below, just before liquidation. The partners Income i ncome sharing ratio is 5:3:2. Develop a partnership liquidation schedule and all appropriate journal entries, assuming the noncash assets are sold for $100,000 and all liabilities are paid. KSU Partnership Balance Sheet December 31, 2018 Assets Liabilities & Owners Capital Commented [CB16]: Alignment needed Formatted: Font: Not Bold Commented [CB17]: here are students deducing that there are 4 or 5 entries from the previous material, or is it simply introducing them to a new concept? Are there 4 major journal entries as a point of fact, or is it 1 journal entry out of 4 or 5 possible the 5? All this should be made clearer here Commented [CB18]: For clarity, this example header 1: Calculating Cash Distribution When There Is a Gain on

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30 Cash $6,000 Accounts Payable $20,000 A/R 30,000 Notes Payable 9,500 AFDA (1,500) Kirk, Capital 27,000 Merchandise Inventory 15,000 Spock, Capital 25,000 Supplies 5,000 Uhura, Capital 3,000 Equipment 40,000 Accum ulated Depr. Equip. (10,000) $84,500 $84,500 Solution: Step # 1: Sell all noncash assets and realize a gain or a loss on the sale. To complete this step, you must determine the book value (B/V) of the noncash assets . You do this by adding up the values of the noncash asset accounts and subtracting the values of the contra asset accounts. In the above example, B/V of noncash assets = A/R AFDA + Merchandise Inventory + Supplies + Equipment Accum ulated Depr. B/V of noncash assets = $30,000 $1,500 + $15,000 + $5,000 +$ 40,000 $10,000 Book Value of noncash assets = $78,500 If you sell the non cash noncash assets for more than their book value, you have a gain. Alternately, if you sell the non cash noncash assets for less than their book value, you have a loss. In this example the non cash noncash assets were sold for $100,000 , which is significantly greater than their book value. As such, there is a gain on sale: Gain on sale = Cash received from sale of non cash noncash assets book value of noncash assets Gain on sale = $100,000 $78,500 = $21,500 Commented [CB19]: Alignment, bordering needed Formatted: No underline Commented [CB20]: This section would scan better if the arithmetic were presented differently from the text. All the arithmetic and appropriate labels could be combined into one clear table, or you could indent the arithmetic and make it vertical. This way you can highlight the actual math without the need for bold type

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31 non cash noncash First, you should remember that the values shown for the noncash assets are normally found on the Normal n ormal Balance b alance Side s ide . This is the side the account goes up on. Recall that the normal balance side for asset accounts is the debit or ( left ) right or credit (right) , Date Account Debit Credit Comment 12/31 Cash 100,000 Amount received from sale of noncash assets AFDA 1,500 A contra asset account. Debit to zero out. Accum ulated Depreciation Equip. 10,000 A contra asset account. Debit to zero out. A/R 30,000 Credit to zero out. Merchandise Inventory 15,000 Credit to zero out. Supplies 5,000 Credit to zero out. Equipment 40,000 Credit to zero out. Gain on Sale 21,500 Gains are credited because they increase equity. To record sale of noncash assets and record gain on sale Note . In , . the Gains g ains are credited. Had there been a loss, the account , debited. Also note that the Gain g ain on Sale s ale 2 nd second step in the sequence. Step 2: Allocate the gain or loss to the partners in accordance with their income sharing ratios. To complete this step, you need to know the amount of the gain (or loss, as the case Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted Table Formatted: Font: Italic Commented [CB21]: These might be combined into one table note

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32 In this case, the gain was calculated as $21,500 and The t he 5:3:2. Each partner will be allocated his or her respective pro rata share of the gain: Kirk: 5/10 x $ 41 2 1 ,500 = $10,750 Spock: 3/10 x $ 41 2 1 ,500 = $6,450 Uhura: 2/10 x $ 41 2 1 ,500 = $4,300 This is how the gains (or losses) are allocated among the partners. Capital c apital account increases. As a result, each Capital c apital account is going to get credited. The Gain g ain on Sale s ale account, since it is also being eliminated in this step, will be debited. Thus, the journal entry becomes: Date Account Debit Credit Comment 12/31 Gain on Sale 21,500 Debit Gain on Sale to zero it out Kirk, Capital 10,750 Credit Capital to increase Spock, Capital 6,450 Credit Capital to increase Uhura, Capital 4,300 Credit Capital to increase To allocate gain among partners and zero out Gain on Sale account. Step 3: Pay all partnership liabilities. The partnership has two liability accounts: A/P of $20,000 and Notes Payable of $9,500 The Normal n ormal Balance b alance Side s ide for these two liability accounts is the credit or ( right ) side.

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33 As such Therefore , the liability accounts will be debited when they are paid off , and the Cash c ash account will be credited since it is being decreased. The journal entry for paying off the liabilities is: Date Account Debit Credit Comment 12/31 A/P 20,000 Debit to zero out Notes Payable 9,500 Debit to zero out Cash 29,500 Credit to zero out To record payment of liabilities. Step 4: Distribute remaining cash to partners in accordance with their capital credit. But wait. Remember , . Before b efore you distribute the remaining cash, to check to see if capital deficiency. In this example there is no capital deficiency. That makes it a little easier. At this stage, the only remaining accounts look like this: Cash Kirk, Capital Spock, Capital Uhura, Capital 6,000 29,500 27,000 25,000 3,000 100,000 10,750 6,450 4,300 76,500 = Bal. 37,750 = Bal. 31,450 = Bal. 7,300 = Bal . Since all Capital c apital accounts have credit balances, there is NO CAPITAL DEFICIENCY no capital deficiency, and , Total Partnership Capital = $27,750 + $31,450 + $7,300 = $76,500 Formatted: Font: Not Bold Commented [CB22]: Alignment needed

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34 Which w hich is exactly the amount of remaining cash. Total cash = beginning cash + cash received from sale of noncash assets cash payments to eliminate liabilities. Total Cash = $6,000 + $100,000 $29,500 Total Cash = $76,500 as shown in the T account above. Now you can distribute the remaining cash Capital c apital balance , thus zeroing out the Capital c apital balances. Remember: Final distribution of cash Capital c apital account balances , not on the basis of the income sharing ratio. The final journal entry becomes: Date Account Debit Credit Comment 12/31 Kirk, Capital 37,750 Debit to zero out Kirk Spock, Capital 31,450 Debit to zero out Spock Uhura, Capital 7,300 Debit to zero out Uhura Cash 76,500 Credit to zero out Cash To record final distribution of cash to remaining partners. And the T he partnership is now liquidated. Example 2 (with a loss on sale of noncash assets) : Using the balance sheet from example E xample # 1 above , assume the non cash noncash assets are sold for $60,000 and the partners income sharing ratio remains at 5:3:2. Develop a partnership liquidation schedule and all appropriate journal entries. Commented [CB23]: This could be better presented in a single table Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Commented [CB24]: As before, this should be large font,

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35 Solution: Step # 1: Sell all noncash assets and realize a gain or a loss on the sale. To complete this step, you must determine the book value (B/V) of the noncash assets . You do this by adding up the values of the noncash asset accounts and subtracting the values of the contra asset accounts. In the above example, B/V of noncash assets = A /R AFDA + Merchandise Inventory + Supplies + Equipment Accum ulated Depreciation B/V of noncash assets = $30,000 $1,500 + $15,000 + $5,000 +$ 40,000 $10,000 Book Value of noncash assets = $78,500 If you sell the non cash noncash assets for less than their book value, you have a loss. In this example the non cash noncash assets were sold for $60,500 , which is significantly less than their book value. As such Therefore , there is a loss on sale: Loss on sale = Cash received from sale of non cash noncash assets book value of noncash assets Loss on sale = $60,500 $78,500 = $18,000 non cash noncash First, you should remember that the values shown for the noncash assets are normally found on the Normal n ormal Balance b alance Side s ide . This is the side the account goes up on. Recall the normal balance side for asset accounts is the debit or ( left ) right or credit (right) , Date Account Debit Credit Comment 12/31 Cash 60,500 Amount received from sale of noncash assets Formatted: No underline Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Commented [CB25]: As in Example 1, this will be easier to read in a table or with the math indented and verticalized Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold

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36 AFDA 1,500 A contra asset account. Debit to zero out. Accum ulated Depr eciation Equip. 10,000 A contra asset account. Debit to zero out. Loss on Sale 18,000 A/R 30,000 Credit to zero out. Merchandise Inventory 15,000 Credit to zero out. Supplies 5,000 Credit to zero out. Equipment 40,000 Credit to zero out. To record sale of noncash assets and record loss on sale 2 nd second step in the sequence. Step 2: Allocate the loss to the partners in accordance with their income sharing ratios. income sharing ratio. In this case, the loss was calculated as $18,000 , and The t he 5:3:2. Each partner will be allocated his or her respective pro rata share of the gain loss : Kirk: 5/10 x $18,000 = $9,000 Spock: 3/10 x $18,000 = $5,400 Uhura: 2/10 x $18,000 = $3,600 This is how losses (or gains) are allocated among the partners. capital Capital c apital account is going to get debited. The Loss l oss on Sale s ale account, since it is also being eliminated in this step, will be credited. Thus, the journal entry becomes: Date Account Debit Credit Comment Commented [CB26]: Can be combined into a single Table note Formatted: Font: Not Bold Commented [CB27]: The numbers on the right should all be negative if using 18,000, but it might make more sense to use 18,000 here since in the table below, the losses are all expressed as positive numbers

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37 12/31 Kirk, Capital 9,000 Debit Capital to decrease Spock, Capital 5,400 Debit Capital to decrease Uhura, Capital 3,600 Debit Capital to decrease Loss on Sale 18,000 Credit Loss on Sale to zero it out To allocate loss among partners and zero out Loss on Sale account. Step 3: Pay all partnership liabilities. The partnership has two liability accounts: A/P of $20,000 , and Notes Payable of $9,500 The Normal n ormal Balance b alance Side s ide for these two liability accounts is the credit or ( right ) side. As such Therefore , the liability accounts will be debited when they are paid off , and the Cash c ash account will be credited since it is being decreased. The journal entry for paying off the liabilities is: Date Account Debit Credit Comment 12/31 A/P 20,000 Debit to zero out Notes Payable 9,500 Debit to zero out Cash 29,500 Credit to zero out To record payment of liabilities. Step 4: Distribute remaining cash to partners in accordance with their capital credit.

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38 But wait. Remember , . b B efore you distribute the remaining cash, to check to see if any capital deficiency. In this example there is no capital deficiency. That makes it a little easier. At this stage, the only remaining accounts look like this: Cash Kirk, Capital Spock, Capital Uhura, Capital 6,000 29,500 9,000 27,000 5,400 25,000 3,600 3,000 60,500 Bal. = 37,000 Bal. = 18,000 Bal. = 19,600 Bal . = 600 Note . Capital c apital account has a debit balance, whereas Kirk and Spock have credit balances. Whenever any partner (s) has a debit balance , the condition is known as a CAPITAL DEFICIENCY capital deficiency, and , the remaining cash CANNOT cannot be distributed to any partner until the capital deficiency has been eliminated. Since remaining cash must be distributed on the basis of capital balances, it cannot be distributed at this time. Kirk deficiency , which must be addressed before any cash can be distributed to Kirk and Spock. Eliminating Capital Deficiencies: As previously stated, there are two ways to eliminate a capital deficiency: 1. The partner with the capital deficiency contributes an amount of cash equal to the capital deficiency . , or 2. The partners with credit balances reduce their respective capital balances proportionately, in accordance with their income ratios. Method # 1: The partner with the capital deficiency contributes an amount of cash equal to the capital deficiency. This method is the more straightforward one . Formatted: Font: Not Bold Commented [CB28]: Alignment needed Formatted: Font: Italic Formatted: No underline Formatted: Font: Bold Commented [CB29]: Should be a larger font Formatted: Font: Bold

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39 Assume Uhura contributes $600 of her personal cash to the partnership, thus resulting in the following journal entry: Account Debit Credit Cash 600 Uhura Capital 600 To eliminate capital deficiency. Cash Kirk, Capital Spock, Capital Uhura, Capital 6,000 29,500 9,000 27,000 5,400 25,000 3,600 3,000 60,500 600 600 Bal. = 37,600 Bal. = 18,000 Bal. = 19,600 Bal . = 0 $37,600, which is now equal to the sum of Kirk $19,600). At this point, the remaining cash is distributed in accordance with the capital balances of the partners with credit balances. Kirk will receive $18,000 , and Spock will receive $19,600, thus zeroing out their respective capital balance s , as shown by the following journal entry : . Account Debit Credit Comment Kirk, Capital 18,000 Debit to zero out Kirk Spock, Capital 19,600 Debit to zero out Spock Cash 37,600 Credit to zero out Cash To record final distribution of cash to remaining partners. Commented [CB30]: Alignment needed

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40 Because Uhura has a zero capital credit balance, she does not receive any final cash distribution. The partnership is now dissolved. Method # 2: The partners with credit balances reduce their respective capital balances proportionately, in accordance with their income ratios. This method assumes that Uhura is unable or unwilling to eliminate her $600 capital deficiency. As such a result , the partners with capital credit balances must reduce their capital credit balances proportionately in accordance with their credit balances income ratios , as follows: Kirk: 5/8 x $600 = $375 Spock: 3/8 x $600 = $225 Account Debit Credit Kirk, Capital 375 Spock, Capital 225 Uhura, Capital 600 The capital balances at this point are as follows: Cash Kirk, Capital Spock, Capital Uhura, Capital 6,000 29,500 9,000 27,000 5,400 25,000 3,600 3,000 60,500 375 225 600 Bal. = 37,000 Bal. = 17,625 Bal. = 19,375 Bal . = 0 Commented [CB31]: Alignment needed

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41 Note . after A fter zero, and the remaining cash is equal to the sum of Kirk , or which is $37,000 ($17,625 + $$19,375). Now you can distribute the remaining cash Capital c apital balance , thus zeroing out the Capital c apital balances. Remember: Final distribution of cash is always done on the basis of Capital c apital account balances , not on the basis of the income sharing ratio. The final journal entry becomes: Date Account Debit Credit Comment 12/31 Kirk, Capital 17,625 Debit to zero out Spock, Capital 19,375 Debit to zero out Cash 37,000 Credit to zero out To record final distribution of cash to remaining partners. And the The partnership is now liquidated. Exercises: Formatted: Font: Italic Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: Font: Not Bold Commented [CB32]: Larger font

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42 Ex ercise 11.1 On January 9th, Steve and Josh form a partnership to provide snow shoveling services to the County c ounty area. Steve contributes cash of $4,000 cash as well as a piece of equipment valued at $3,680. Josh contributes cash of $8,820 cash as well as a vehicle valued at $9,800. The partnership also assume s d responsibility for Josh's long term note payable of $2,300 related to the vehicle. REQUIRED: 1. Prepare the journal entry to record Steve's initial capital investment. Date Account Debit Credit Comment(S) 2. Prepare the journal entry to record Josh's initial capital investment. Date Account Debit Credit Comment(S) 3. If net income is $42,000, prepare the journal entry to allocate income between the two partners (assume the partnership agreement state s that net income should be divided 1/3 for Steve and 2/3 for Josh).

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43 Date Account Debit Credit Comment(S) Ex ercise 11.2 At the beginning of 2021, Steve has a capital balance of $60,000 , and Josh has a capital balance of $90,000. The partnership of Steve and Josh earn s ed a total net income of $100,000 in 2021. Prepare a schedule to show the division of net income among two partners. Prepare the ONE a single journal entry to allocate net income between the two partners if the partners have agreed on the following: Steve and Josh will receive annual salary allowances of $50,000 and $30,500 , respectively. A 1% interest allowance will be paid on each partner's beginning capital balance. Remainder will be shared equally. Ex ercise 11.3 On January 3, Steve agrees to sell Josh 50% of his capital , which is $42,000 of his partnership interest , for $25,000 cash. This is a personal transaction between the partners, but the other existing partners of the firm agree with this arrangement. Prepare the journal entry for this transaction. Date Account Debit Credit Comment(S) Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold

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44 Financial Accounting II Chapter 11 Test Partnerships True / False 1. T F All partnership agreements must be in writing. 2. T F A partnership is considered an accounting entity for financial reporting purposes. 3. T F The concept of mutual agency applies to limited partners. 4. T F Specific assets contributed to a partnership by a specific partner are returned to that partner upon his withdrawal from the partnership. 5. T F Mutual agency is a major disadvantage of the sole proprietorship form of business. 6. T F Since partnerships pay income taxes on partnership income, individual partners do not pay personal income taxes on their share of the partnership income.

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45 7. T F The income summary account is used to close out the net income of a sole proprietorship but not a partnership net income . 8. T F The last step in liquidating a partnership is to distribute cash to the partners on the basis of their income ratios. 9. T F capital balances. 10. T F Individual s and sole proprietors may join together and form a partnership Multiple Choice 11. Jack and Jill invest $50,000 and $80,000 , re spectively , and form the J&J partnership. They agree to divide net income in such a way as to provide a salary allowance s of $15,000 and $25,000 , respectively ; , an interest allowance of 10% on their original investments ; , net income if the partnership earns $60,000 in net income? a) $20,000 b) $23,500 c) $33,000 d) $36,500 Commented [CB33]: Realignment of text needed

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46 12. Robert and Alvin agreed to an income ratio of 5:3 when they decide to liquidate their partnership. After selling all of the partnership assets for cash, allocating gains or losses, and paying off all liabilities, their respective capital credit balance s are Robert, is $26,000 and Alvin $22,000. How much of the remaining $48,000 will be distributed to Robert? a) $18,000 b) $22,000 c) $26,000 d) $30,000 13. Non cash Noncash assets invested in a partnership are recorded at their a) initial cost b) fair market value c) depreciable cost d) incremental cost . 14. If a new partner is admitted into a partnership by purchasing an existing partner's interest in whole or in part, then total partnership capital a) increases b) decreases c) Remains r emains the same d) None n one of the above 15. P artnership AB has an income sharing ratio is of 5:5. In the current year , the partnership has a net loss of $15,000. Partner A receives a salary allowance of $18,000 and Partner B a salary allowance of $15 ,000 . Partners A and B also receive an interest allowance of $2,000 each. Determine how to allocate the net loss among the two partners. a) Partner A , ($6,000) and Partner B , ($ 9 ,000 ) b) Partner A , ($ 7,500 ) and Partner B , ($ 7,5 00) c) Partner A , ($ 20 ,000) and Partner B , ($ 17 ,000) d) None none of the above 16. Company A, Company B , and Company C join ed and to form ed the ABC partnership. $6,000 , and its fair market value is $7,000. When entering this equipment on the books of the new partnership, it should be entered at a) $4,000

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47 b) $6,000 c) $7,000 d) $9,000 e) $11,000 17. Upon liquidation, any cash remaining cash after all liabilities have been paid should be distributed to the partners on the basis of their : __________________________ Ans.: _________________________ Commented [CB34]:

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48 18. Which of the following statements related to partnerships is correct ? a) Partnership assets are owned by the individual partners that who initially contributed them. b) Mutual agency is a disadvantage in a partnership. c) A partnership cannot be formed with more than two sole proprietorships. d) In the liquidation of a partnership, after all liabilities have been paid, individual partner capital accounts will always have credit balances. 19. Jones is investing in a partnership with James. Jones initial contribution consists of Accounts a ccounts Receivable r eceivable of $100,000; an Allowance a llowance for Doubtful d oubtful Accounts a ccounts of $10,000; and $60,000 in cash. The entry that s initial contribution includes a a) credit to Jones, Capital for $160,000 b) credit to Jones, Capital for $150,000 c) debit to Accounts Receivable for $90,000 d) credit to Allowance for Doubtful Accounts for $90,000 20. The name of the owners' equity statement for a partnership is the _________________ a) Ans.: _________________________ Other Questions 21. Identify 3 advantages and 3 disadvantages of a partnership. Advantages: Disadvantages: Formatted: Font: Not Italic Commented [CB35]: Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt, Expanded by 0.3 pt Formatted: Normal, Indent: Left: 0.5", No bullets or numbering Commented [CB36]: Formatted: Font: 12 pt Commented [CB37]: Larger font

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49 22. In forming a partnership, a partner contributes $200,000 of accounts receivable. All of the partners agree that 95 % of the A/R should be col lectible. Journalize this transaction. Date Account Ref Debit Credit

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50 23. Mitt Romney contributed land, equipment , and $ 60 ,000 in cash to form a partnership with his buddy Barack Obama . The land had a book value of $40,000 and a market value of $68,000. The equipment had a book value of $ 30 ,000 and a market value of $ 35 ,000. The partnership also assumed a $ 1 0,000 note payable owed by Mitt that was associated . Show the journal entry contribution tp to the partnership. Date Account Ref Debit Credit 24. Gloria Sanchez and Pierre Mason have a partnership in which they share income equally. Their capital balances are $200,000 and $150,000 , respectively. They agree that Mason will sell ¼ of his partnership interest to Michelle Rogers. Show the journal entry that must be made if the sales price is (a) $35,000 ? (b) $40,000 ? Date Account Ref Debit Credit 25. Obama , Bush, and Clinton are forming a partnership. Obama is transferring $150,000 of personal cash and $50,000 of accounts receivable to the partnership. Bush is contributing land, a building, and equipment valued at $100,000, $300,000, and $50,000 , respectively. Clinton is contributing cash of $100,000 cas h , accounts receivable of $80,000 , and equipment worth $40,000. They all agree that the partnership will Instructions Commented [CB38]: The use of past tense makes it seem like an actual historical event, already distracted as a reader with thoughts of politics (or if I were too young to remember Romney, of confusion). I would at least use present tense, and possibly change the names

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51 a) the partnership. b) Instead of separate journal entries as in (a) above, show what a single compound journal entry would look like. c) What is the total partnership capital after all the contributions have been made? Ans wer . (a) Date Account Ref Debit Credit Ans wer . (b) Date Account Ref Debit Credit

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52 Ans wer . (c) _______________ 26. On December 31, 2013, The Candy Company has $ 4 5,000 in cash, noncash assets of $120,000, and liabil ities of $50,000. The capital balances of the two partners , are Tootsie $70,000 and Pops , are $70,000 and $45,000 , respectively . The firm is liqui dated, and $120,000 is received for the noncash assets. Tootsie and Pop s income ratios are 70% and 30%, respectively. Instructions Develop a cash distribution schedule and show the journal entry for each step in the liquidation process. Ans wer: . Date Account Ref Debit Credit

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53 27. George, Abraham, and John have a partnership. George has a capital balance of is capital balance is $50,000 , capital balance is $60,000. George is leaving the partnership and is selling his interest equally to Abraham and John for $30,000 and $45,000 respectively . Show the journal entry made when George leaves the partnership. Date Account Ref Debit Credit Commented [CB39]: Does this mean George is selling 50% of his interest to each partner, but for different prices?

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54 Chapter 1 2 Corporations: Organization and Capital Stock Transactions Learning Outcomes: 1. Gain familiarization with the general concepts of a corporation . 2. Become familiar with the format and content of the shareholder equity section . 3. Develop the Journal j ournal Entries e ntries Related r elated to Initial i nitial Issuance i ssuance of Common c ommon and Preferred p referred Stock s tock . 4. Develop General g eneral Journal j ournal Entries e ntries Related r elated to Treasury t reasury Stock s tock (T/S) . (LO1) Gain familiarization with the general concepts of a corporation Discussion Unlike a sole proprietorship or a partnership , which can be created by the owner or partners at will, a corporation is a business entity created under the laws of the State s tate in which it is incorporated, and it is separate from its managers and shareholders (owners). A corporation may be private or public, depending on how the shares of stock are owned. The stocks (or shares) of a private corporation are held by one or a few investors. The shares of a private co mpany are not publicly sold or traded. Examples of private corporations are PetSmart, Wa wa (a convenience store with gas stations), and have their shares traded on national stock exchanges, such as the New York Stock Exchange or Nasdaq. Examples of publicly held corporations are Microsoft, Amazon, Google, and Coca Cola , etc . Many of the characteristics of a the corporation can be categorized as advantages or disadvantages, as follows: Advantages: 1. Unlike a sole proprietorship or partnership, which ends with the death or withdrawal of a partner, the life of the corporation is continuous. Formatted: Bulleted + Level: 1 + Aligned at: 0.75" + Indent at: 1"

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55 2. The stockholders , or ( owners ) of the corporation , have limited liability. That is, they can not only lose an amount up to the more money than the amount of money they invested in the business. 3. The stockholders can sell their investment in the corporation at any time, without any effect on the corporation. Disadvantages: 1. More government regulation 2. Double taxation Forming a Corporation Authorization by the state of incorporation is required in order to form a corporation. Once established, the corporation may issue shares of stock to denote ownership in the corporation . A stock (or share) is the term used to indicate ownership in a corporation. These stocks may be purchased by investors (institutional, individual, e.g.). The following are definitions the student should become familiar with: 1. Authorized shares The maximum number of shares a corporation may issue. 2. Issued shares The number of authorized shares that have been sold. A company may sell some or all of the authorized shares. Buyers may include institutions (pension funds, mutual funds), company insiders, or individual investors. 3. Outstanding shares These are the number of shares owned by investors . Outstanding shares may be as high as the number of shares issued. However, outstanding shares do not include treasury stock. 4. Treasury shares A company can always b u y back some of their its own sh ares previously issued and/or outstanding. When a Formatted: Bulleted + Level: 1 + Aligned at: 0.75" + Indent at: 1" Commented [CB40]: These should be sentences, as in Formatted: Font: Bold Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline

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56 company repurchases its own stock, the repurchased shares are called treasury stock department . Treasury stock is not considered outstanding . However, they are it is considered issued. Example # 1: A company is authorized to sell 500,000 shares of its own stock. It sells 300,000 shares. In this case, there are 300,000 shares issued and outstanding. Example # 2: A company is authorized to sell 500,000 shares of its own stock. It sells 300,000 shares. Later , it repurchases 50,000 of the shares previously issued. In this case, we say there are 50,000 shares of treasury stock held in the treasury department, and only 450,000 shares are outstanding. The number of shares issued is still 300,000 because treasury s hares are considered issued but not outstanding. Example # 3: Assume all authorized shares have been sold and there are 75,000 treasury shares and 550,000 shares outstanding. How many shares were authorized? Recall that , treasury stock is considered issued but not outstanding. Thus, there are 625,000 shares that were issued. In this case, this is also the number of shares authorized. Types of Stock In general, a corporation may issue two types of stock s are issued : Common c ommon stock and Preferred p referred Stock s tock . While there may be subclasses of these types, we will concentrate on the generic types. Preferred Stock Preferred stock is referred to as such because preferred stockholders have certain advantages over common shareholders . Some of these include the right to receive a dividend before common stockholders, the right to cumulative dividends (for cumulative type preferred stock) and in receiving payments as a result of Formatted: No underline Formatted: No underline Formatted: Font: Not Bold, No underline Commented [CB41]: Edit for clarity/formatting. Header get its incorporation authorized by the state in which it be its own single sentence paragraph introducing the definitions. Definitions should be in a bulleted list, with the key terms in bold lowercase followed by a colon. First word following the key term should be capitalized if a full sentence and lowercase if not, and in both cases end with a period.

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57 liquidation of the corporation. Before a company can issue preferred stock, it must have issued common stock. Common Stock Denotes ownership in the corporation. Common stockholders may have voting rights on matters important to the company and may receive dividends or payouts from company earnings. (LO2) Become familiar with the format and content of the shareholder equity section The Shareholder Equity Section of a Balance Sheet Unlike the shareholder equity section for a sole proprietorship and a partnership. The shareholder equity section on a balance sheet is more complicated than the shareholder equity section for a sole proprietor ship or partnership . Its most basic format is: Paid in Paid in Capital Capital Stock Preferred Stock Common Stock Total capital Stock Additional Paid in Paid in Capital Preferred Stock Excess over Par Value Common Stock Excess over Par or Stated Value Excess from Treasury Stock Total additional Paid in Paid in Capital Total Paid in Paid in Capital Retained Earnings Commented [CB42]: Common stock should appear before preferred, since the definition of preferred includes are related (and fairly short), this would probably scan better as a single paragraph

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58 Total Paid in Paid in Capital and Retained Earnings Less Treasury stocks Total Stockholder Equity Note the terms par value and stated value . Par Value v alue is an arbitrary value assigned by a company on a per share basis. For : ; a penny. The par value for New Jersey Resources, an energy services company, is $2.50 per share. For accounting purpose, par value per share is used to calculate the value for the preferred stock and common stock accounts. In some cases, a stock may not have a par value. In such a case, the board of directors assigns a Stated s tated Value v alue , which serves the same purpose as the par value. The Par p ar or Stated s tated values have no relationship to the selling or market price of an individual stock. For any share(s) issued or sold at a price that exceeds the par or stated value, the excess dollar amount over the par or stated that value is referred to as Excess e xcess over par (or stated) value (or stated value) for the preferred ( or common ) stock. Example: A company issue s d 1,000 shares of it $1.00 per share par value common stock for $5.00 per share. Since the par value is $1.00, the common stock account is valued at $1,000 ($1.00 par value per share x 1,000 shares issued). The Excess e xcess over par is $4.00 ($5.00 per share issue or market price minus the $1.00 per share par value). Thus, the total excess over par is $4,000 ($4.00 excess over par per share x 1,000 shares issued). If a stock had a stated value, we would say excess over stated value. The math would be identical. Commented [CB43]: In order to actually describe/present the basic format, this needs to either be in a figure/table form (i.e. a blank version of the Tiger Corp. sheet below), or it should describe the basic format in shareholder equity paid in capital, beginning with preferred Formatted: Font: Italic Formatted: Font: Italic Formatted: Font: Not Bold Formatted: Font: Not Italic Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold

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59 Tiger Corporation Account balances shown on Balance Sheet (partial) Normal Balance Side December 31, 20xx This is a representative shareholder equity section as may be found on a corporate Balance Sheet. Preferred Stock Values indicated below come from the balances in the accounts shown on the right. 125,000 Common Stock 120,000 PIC in Excess of P/V P/S 125,000 PIC in Excess of P/V C/S 480,000 PIC from T/S See note below Shareholder Equity Paid in Paid in Capital Capital Stock Preferred stock, 8%, $25 par value, cumulative, 8,000 shares issued and outstanding $125,000 Common stock, $2 par value, 60,000 shares issued, 50,000 shares outstanding 120,000 Total Capital Stock 245,000 Paid in Paid in capital in excess of P/V P/S 125,000 Paid in Paid in capital in excess of P/V C/S 480,000 Paid in Paid in capital from Treasury Stock 0 Total additional paid in Paid in capital 605,000 Total paid in Paid in capital 850,000 Retained Earnings 1,050,000 Total paid in Paid in capital and retained earnings 1,900,000 Less: Treasury Stock (10,000 shares) (80,000) Total shareholder equity $2,285,000

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60 Retained Earnings Assumptions: 1,200,000 Preferred Stock issued at $60 per share Common Stock issued at $10 per share Treasury Stock S purchase at $8 per share Treasury Stock Paid in Paid in capital from T/S is zero because none of the 10,000 shares of T/S have been reissued. 80,000 Commented [CB44]: Formatting/alignment needed. The arrows and extra lines on the left are confusing, and dollar also not clear how the material on the right relates to the balance sheet itself.

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1 (LO3) Develop the Journal Entries Related to Initial Issuance of Common and Preferred Stock Issuing Common Stock (C/S) For Cash Case 1 : Issuing Common Stock (C/S) for cash, above par value (p/v): Date Account Name Debit Credit Comment Dt. Cash D = # of shares issued x sales price per share Common Stock C = # of shares issued x par value per share Paid in Paid in Capital in excess of par value C/S C = # of shares issued x (sales price per share par value per share) To record issuance of C/S above par value Example 1: On March 1, the ABC Company issued 1,000 shares of its $1.00 par value common stock for $10.00 per share. Show the journal entry that would be made. Date Account Name Debit Credit Comment Dt. Cash 10,000 = 1,000 shares issued x $10.00 per share price Common Stock 1,000 = 1,000 shares issued x $1.00 par value per share Paid in Paid in Capital in excess of par value C/S 9,000 = 1,000 shares issued x ($10.00 per share price $1.00 per share par value) To record issuance of C/S above par value Case 2 : Issuing Common Stock (C/S) for cash, above stated value (s/v): Commented [CB45]: headers in a row with no numbering or text underneath them. Each of these should be followed by some sort of description/explanation, e.g: In this section, we will go through a series of examples showing journal entries for various types of stock 12.6.1 Issuing Common Stock for Cash The following examples show the method for journal entries when a corporation issues common stock (C/S) for cash. In the first example, the stock has a par value (p/v), and in the Commented [CB46]: in chart after that. This should scan a lot better than the current format. Commented [CB47]: the journal entry below? Formatted: No underline Commented [CB48]: As above, this can be eliminated,

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2 Date Account Name Debit Credit Comment Dt. Cash D = # of shares issued x sales price per share Common Stock C = # of shares issued x stated value per share Paid in Paid in Capital in excess of stated value C/S C = # of shares issued x (sales price per share stated value per share) stated value per share) To record issuance of C/S above stated value Example 2: On July 15, the ABC Company issued 1,000 shares of its $1.00 stated value common stock for $10.00 per share. Show the journal entry that would be made. Date Account Name Debit Cr e dit Comment Dt. Cash 10,00 0 = 1,000 shares issued x $10.00 per share price Common Stock 1,000 = 1,000 shares issued x $1.00 stated value per share Paid in Paid in Capital in stated of Stated value C/S 9,000 = 1,000 shares issued x ($10.00 per share price $1.00 per share par value) To record issuance of C/S above par value Issuing Preferred Stock (P/S) For Cash Case 1 : Issuing Preferred Stock (P/S) for cash, at par value : Formatted: No underline Formatted: Font: 12 pt Commented [CB49]: Preferred Stock (P/S) For Cash (Optionally have some introductory text here maybe not necessary since the example title is fairly explicit) And so on through the section Formatted: Font: 12 pt

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3 Date Account Name Debit Credit Comment Dt. Cash D = # of shares issued x sales price per share Preferred Stock C = # of shares issued x sales price per share To record issuance of P/S at par value Example 1: On August 1, the ABC Company issued 2,000 shares of its $5.00 par value stock for $5.00 per share . Show the journal entry that would be made . Note, in this case, that there is no excess over par. Thus, the par value and the selling price are equal. Date Account Name Debit Credit Comment Dt. Cash 10,000 = 2,000 shares issued x $5.00 sales price per share Preferred Stock 10,000 = 2,000 shares issued x $5.00 par value per share To record issuance of P/S at par value Case 2 : Issuing Preferred Stock (P/S) for cash, above par value: Date Account Name Debit Credit Comment Dt. Cash D = # of shares issued x sales price per share Preferred Stock C = # of shares issued x par value per share Paid in Paid in Capital in excess of par value P/S C = # of shares issued x (sales price per share par value per share) Formatted Table Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt Formatted Table Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt

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4 Example 2: On August 20, the ABC Company issued 5,000 shares of its $5.00 par value stock for $20.00 per share . Show the journal entry that would be made. To record issuance of P/S above par value Date Account Name Debit Credit Comment Dt. Cash 100,000 = 5,000 shares issued x $20.00 per share sales price Preferred Stock 25,000 = 5,000 shares issued x $5.00 par value per share Paid in Paid in Capital in excess of par value P/S 75,000 = 5,000 shares issued x ($20.00 per share sales price $5.00 par value per share) To record issuance of P/S above par value Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt

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5 Issuing Common Stock (C/S) For Non cash Cash Asset or Service Note: To determine at what value to price the for shares of stock issued for the noncash asset or service, use the fair market value of the consideration given up or received, whichever is the more clearly determinable. The more clearly determinable This value is usually evidenced by a bill for the service received in exchange for the stock, the fair value of an asset received in exchange for the stock, or by the value of a stock that is freely traded on an organized stock exchange (e.g., New York Stock Exchange or , NASDAQ). Case 1 : Issuing Common Stock (C/S), for a service , above par value: Date Account Name Debit Credit Comment Dt. Account name exp. D See note above on how to determine value Common Stock C = # of shares issued x par value per share Paid in Paid in Capital in excess of par value C/S C = the difference between the two amounts above Example 1: On February 15, the XYZ Company issued 5,000 shares of its $2.00 par value stock in exchange for professional services by a legal firm. The attorney s billed the company $25,000. Note , in I n this case, the for the legal the value of the stock its value . As such Therefore bill. The total par value is $10,000 (5,000 shares x the $2.00 par value per share), and the excess over par is $15,000 ($25,000 the $10,000 total par value). The journal entry thus be comes: Formatted: Font: 12 pt Formatted: Font: 12 pt, Not Italic Formatted: Font: 12 pt, Not Italic Formatted: Font: 12 pt, Not Bold, No underline Formatted: Font: 12 pt, Not Italic Formatted: Font: 12 pt, Not Italic Formatted: Font: 12 pt, Not Bold, Not Italic Formatted: Font: 12 pt, Not Italic Commented [CB50]: This should go underneath the table simply make this an introductory paragraph to the section. Formatted: Font: 12 pt, Not Italic Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt Formatted Table Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt

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6 Date Account Name Debit Credit Comment Dt. Legal exp. 25,000 The amount of the legal bill, in this case Common Stock 10,000 = 5,000 shares issued x $2.00 par value per share Paid in Paid in Capital in excess of par value C/S 15,000 = the difference between the two amounts To record Case 2 : Issuing Common Stock (C/S), for an asset , above par value: Date Account Name Debit Credit Comment Dt. Asset name D See note above on how to determine value Common Stock C = # of shares issued x par value per share Paid in Paid in Capital in excess of par value C/S C = the difference between the two accounts above To record issuance of C/S for Example 2 1 : On March 30, the XYZ Company issued 50,000 shares of its $2.00 par value in exchange for a its fair market value is $225,000. Show the journal entry that would be made. Note , in I n Since the stock is not publicly traded, we do not know the its value of the stock . As such Therefore , we must value the transaction on the fair market value of the building. The total par value is $100,000 (50,000 shares x the $2.00 par value per share), and the excess over par is $125,000 ($225,000 the $100,000 total par value). The journal entry thus becomes: Formatted Table Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt

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7 Date Account Name Debit Credit Comment Dt. Building 225,000 The amount of the building, in this case Common Stock 100,000 = 50,000 shares issued x $2.00 par value per share Paid in Paid in Capital in excess of par value C/S 125,000 = the difference between the two amounts To Example 3 2 2 : On July 15, the XYZ Company issued 100,000 shares of its $2.00 par value common stock in exchange for land on which it will erect a new office building. The stock is publicly traded on the New York Stock Exchange. On this day, the stock is trading for $6.0 0 per share. Show the journal entry that would be made. Note , in I n the stock is publicly traded, we know its share price at any given time. As such, we must value the transaction on the publicly traded value of the stock. The total par val ue is $200,000 (100,000 shares x the $2.00 par value per share), and the excess over par is $125,000 ($225,000 the $100,000 total par value). The journal entry thus becomes: Date Account Name Debit Credit Comment Dt. Building Land 600,000 The amount of the building land , in this case Common Stock 200,000 = 100,000 shares issued x $2.00 par value per share Paid in Paid in Capital in excess of par value C/S 400,000 = the difference between the two amounts To record Formatted Table Commented [CB51]: Explain why the land is a $600,000 debit (600k 200k)? Formatted Table

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8

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9 (LO4) Develop General Journal Entries Related to Treasury Stock (T/S) Note : reacquired by the issuing company. It is also the name of the account used to record such transaction s . The treasury stock account is a contra equity account. Any balance in the account reduces total shareholder equity or capital. There are 5 five cases we will consider regarding treasury stock. The first simply considers the transaction related to the initial (or subsequent) purchase by a company , of its own previously issued and publicly traded stock. The remaining 4 four cases deal with the disposal or resale of the previously purchased treasury stock. Theory and examples will be shown for each of the following situations related to treasury stock: 1. The t he initial (or subsequent) purchase 2. Reselling r eselling (disposal) of the stock at the original purchase price 3. Reselling r eselling (disposal) of the stock at a price higher than the original purchase price 4. Reselling r eselling (disposal) of the stock at a price lower than the original purchase price 5. Reselling r eselling (disposal) of the stock at a price significantly lower than the original purchase price Case 1 : Initial (or subsequent) Purchase of Treasury Stock : When a company repurchases its own stock, it is effectively reducing the number of its outstanding shares, thus reducing its total shareholder equity. In the journal entry below, the treasury stock account is debited. Since the treasury stock account is a contra equity account, the debit reduces equity. The Cash c ash account is credited (reduced). the asset cash. The typical journal entry that would be made in this case is shown below. Formatted: No underline Commented [CB52]: specific example (as in law, for instance), and having both a recommending below is that each example be given a single, bolded, large number and a description (i.e. the material included in the ordering of tables/text for flow. Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Italic Formatted: Font: Not Bold Commented [CB53]: As before, this can be given a number (e.g. 12.8.1 Initial or Subsequent Purchase of Treasury Stock). Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold

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10 Date Account Name Debit Credit Comment Dt. Treasury Stock D = # of shares purchased x market price per share on date of purchase Cash C = # of shares purchased x market price per share on date of purchase To record purchase of (include #of shares of T/S purchased and market price per share) Example 1: On May 12, the ABC Company purchased 5,000 of its own outstanding shares at a price of $25 per share. Date Account Name Debit Credit Comment 5/12 Treasury Stock 125,000 = 5,000 shares purchased x $25.00 market price per share Cash 125,000 = 5,000 shares purchased x $25.00 market price per share To record purchase of (include #of shares of T/S purchased and market price per share) Once a company has repurchased its treasury stock, the question becomes what to do with it. the treasury stock. One option is to cancel the treasury stock altogether. Another option might be to use the treasury stock internally for incentives, such as employee bonuses. These two options will not be considered herein. Instead, we will consider the option where a com pany resells the treasury stock at a later date, at the market price then in effect. Assuming the company is going to resell the treasury stock, there are 4 four scenarios that must be considered. The treasury stock may be resold at: a) Case 2 The t he same original purchase price it was purchased. b) Case 3 A a market price higher than the original purchase price . c) Case 4 A a market price lower than the original purchase price . d) Case 5 A a market price significantly lower than the original purchase price . Formatted Table Formatted: Font: 12 pt Formatted Table Formatted: Font: Italic Commented [CB54]: This section should under a new label each example with the relevant descriptor (e.g.

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11 Case 2 Situation (a) : Disposal (resale) of Treasury Stock for cash, at a market price equal to its purchase price: Note: Disposal ( resell res ale ) of T/S means that the company that had originally purchased back its own stock is now reselling that same stock back into the market. Whenever T/S is disposed of, regardless of the selling price at which when they are resold , the T/S account must be credited at the original (initial) cost of the treasury stock on the date of its original (initial) purchase . Example 2 1 (a) 2 : Disposal (Resale) of Treasury Stock for Cash at a Market Price Equal to its Purchase Price Recall that on May 12, the ABC Company purchased 5,000 of its own outstanding shares at a price of $25 per share. For this and the treasury stock in increments of 1,000 over a period of several months. For this example, assume on June 30, the company resold 1,000 shares of its treasury stock for $25.00 per share. Note, the selling price in this case equals the original purchase price. As such Thus , there is no increase or decrease over the purchase price. The company receives cash equal to the reduction in the value of the treasury stock it had previously issued. The journal entry becomes: Date Account Name Debit Credit Comment Dt. Cash D = # of shares disposed of x market price per share on date of sale Treasury Stock C = # of shares disposed of x price per share on date of purchase To record disposal of T/S (include #of shares of T/S sold and sales price per share) Date Account Name Debit Credit Comment Commented [CB55]: This can be scrapped and its label Formatted: Font: Not Italic Formatted: Font: Not Italic Formatted: Font: Not Bold, Not Italic Formatted: Font: Not Italic Formatted: Font: Not Italic, No underline Formatted: Font: Not Italic, No underline Formatted: Font: Not Italic Formatted: Font: Not Bold, Not Italic Formatted: Font: Not Bold, Not Italic, No underline Formatted: Font: Not Bold, Not Italic Formatted: Font: Not Bold, Not Italic, No underline Commented [CB56]: As before, this could be a table note for the table below and moved underneath Commented [CB57]: first, followed by the template table, followed by the Formatted: Font: Not Bold, No underline

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12 The effect of this transaction is to increase the asset cash and increase the shareholder equity since the treasury stock account is being credited. Case 3 Situation (b) : Example 3 : Disposal ( resale R esale ) of Treasury Stock for cash C ash , at a market price higher than its original purchase price: Market Price Higher Than its Original Purchase Price Note: Disposal of T/S means above the original purchase price means that the company is receiving say we have a gain on the sale. However, a company does not recognize gains (or losses) on the sale of its own stock. The increase over the original purchase price is considered an increase in Paid in Paid in Capital from , and its no rmal balance side (the side the account increases on) is the credit side. As stated in the previous case, whenever T/S is disposed of, regardless of the selling price at which when they are disposed , the T/S account must be credited at the original (initial) cost of the treasury stock on the date of its original (initial) purchase . The Paid in Paid in Capital from Treasury Stock account is credited the difference (in total) between the cash received and the reduction in the treasury stock account. The format for the journal entry in this case is shown below: 6/30 Cash 25,000 = 1,000 shares disposed of x $25.00 market price per share on date of sale Treasury Stock 25,000 = 1,000 shares disposed of x $25.00 per share on date of purchase To record disposal of 1,000 shares of T/S at $25.00 per share. Date Account Name Debit Credit Comment Dt. Cash D = # of shares disposed of x market price per share on date of sale Formatted: Font: Not Bold Formatted: No underline Formatted: No underline Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold

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13 Example 3 1 (b) Recall that on May 12, the ABC Company purchased 5,000 of its own outstanding shares at a price of $25 per share. Also, on June 30, the company resold 1,000 shares of its treasury stock 31 resold another 1,000 shares of its treasury stock at a price of $30.00 per share. Prepare the journal entry for this transaction. Note that , the selling price per share in this case is higher than the original purchase price ($30.00 vs. $25.00). As such Therefore , there is a $5.00 increase over the purchase price. The total cash the company receives is based on the market price it received for each share sold ($30.00 per share times the number of shares sold). As previously stated, whenever T/S is disposed of, regardless of the selling price at which they are disposed , the T/S account must be credited at the original (initial) cost of the treasury stock on the date of its original (initial) purchase ($25.00 per share times the number of shares sold). The Paid in Paid in Capital from Treasury Stock account is credited the difference (in total) between the cash received and the reduction in the treasury stock account . In i n this case, $5,000 (the $5.00 increase per share over the original purchase price times the number of shares sold). The journal entry becomes: Treasury Stock C = # of shares disposed of x price per share on date of purchase Paid in Paid in Capital From T/S = the difference between the two amounts above To record disposal of T/S (include #of shares of T/S sold and sales price per share) Date Account Name Debit Credit Comment 6/30 7/31 Cash 30,000 = 1,000 shares disposed of x $25.00 market price per share on date of sale Treasury Stock 25,000 = 1,000 shares disposed of x $25.00 per share on date of purchase Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: No underline Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Commented [CB58]: This can be condensed into a few sentences since much of it has been previously stated in recent paragraphs. For example: purchase price, so the company receives $30,000 cash ($30 per share times 1,000 shares). As before, the T/S account is credited at the original cost of the stock ($25 per share times 1,000 shares, or $25,000), and the Paid in Capital

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14 The effect of this transaction is to increase the asset cash and increase the two shareholder equity accounts ; : since the treasury stock account is being credited, it serves to increase shareholder equity, as does the excess cash received from reselling the treasury stock at a price higher than it was originally purchased for. The three cases examples covered above are relatively straight forward. The next two are not. The student should s tudy cases #4 & #5 Examples 4 and 5 below very carefully. Case 4 Situation (c) : Disposal (resale) of Treasury Stock for cash, at a market price below the original purchase price: This case example differs from case #3 Example 3 above in that the T/S was resold at a sales price below its original purchase price. Whenever this happens, the Paid in Paid in Capital from T/S account will require a debit ( IF THERE IS AN EXISTING BALANCE ON ITS CREDIT SIDE if there is an existing balance on its credit side ). Also, keep in mind that the balance in the Paid in Paid in Capital from T/S account CANNOT cannot go below zero . As such , therefore limiting the amount that can be debited is limited, since the balance in the account cannot go below zero . If an additional debit amount is still needed to balance the transaction, it must come from the RETAIEND EARNINGS retained earnings account (see case #5 Example 5 , below). In this case, the format for the journal entry will look like this: Paid in Paid in Capital from T/S 5,000 = 1,000 shares disposed x $5.00 excess over the original purchase price. To record disposal of 1,000 shares of T/S at $30.00 per share. Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Commented [CB59]: See above this can also be Formatted: No underline Formatted: Font: Not Italic Formatted: Font: Not Italic, No underline Formatted: Font: Not Italic Formatted: Font: Not Italic Formatted: Font: Not Italic Formatted: Font: Not Italic Formatted: Font: Not Italic Formatted: Font: Not Italic

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15 Example 4 1 (c) Recall that on May 12, the ABC Company purchased 5,000 of its own outstanding shares at a price of $25 per share. Also, on June 30, the company resold 1,000 shares of its treasury stock for $25.00 per share. Then, on July 31, the company resold another 1,000 shares of its treasury stock at a price of $30.00 per share. For this example, assume that on August 31 the company resold another 1,000 shares of its treasury stock for $22.00 per share. Prepare the journal entry for the August 31 transaction. Note that , the selling price per share in this case is lower than the original purchase price ($22.00 vs. $25.00). As such Therefore , there is a $3.00 reduction from the purchase price. The total cash the company receives is based on the market price it received for each share sold ($22.00 per share times the number of shares sold). As previously stated, whenever T/S is disposed of, regardless of the selling price at which they are disposed , the T/S account must be credited at the original (initial) cost of the treasury stock on the date of its original (initial) purchase ($25.00 per share times the number of shares sold). The Paid in Paid in Capital from Treasury Stock account is debited the difference ( up to the credit balance in that account ) , because the balance in the paid in Paid in capital from treasury stock this account cannot CANNOT go below zero as well. At t his point, the development of the journal entry looks like this: Date Account Name Debit Credit Comment Dt. Cash D = # of shares disposed of x market price on date of sale Paid in Paid in Capital From T/S D See notes above Treasury Stock C = # of shares disposed of x price per share on date of original purchase To record disposal of T/S below original cost Date Account Name Debit Credit Comment Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: No underline Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: No underline Commented [CB60]: This can likewise be condensed

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16 paid in Paid in capital account from T/S Paid in Capital from T/S account . The amount needed is $3,000 (the difference between the price of the shares originally purchased and the selling price). The question is, We need to determine if there is there any balance in the paid in Paid in capital from T/S this account, and is it if it is at least $3,000. In the previous transition, where the T/S was sold above the original purchase price, the paid in Paid in capital C apital account was credited $5,000. As such, we We can therefore reduce it by the $3,000 needed in this case. As such, the T he completed journal entry becomes: After completing this transaction, the remaining credit balance in the paid in Paid in capital C apital from treasury T reasury stock S tock account is now a $2,000. Case 5 Situation (d) : Disposal (resale) of Treasury Stock for cash, at a market price significantly below the original purchase price: This case example differs from case Example # 4 above in that the T/S was resold at a sales price significantly below its original purchase price. Recall that in the previous case, 8/31 Cash 22,000 = 1,000 shares sold of x $22.00 per share market price on date of sale Paid in Paid in Capital From T/S D See explanation below Treasury Stock 25,000 = 1,000 shares sold x $25.00 per share on date of original purchase To record disposal of T/S below original cost Date Account Name Debit Credit Comment 8/31 Cash 22,000 = 1,000 shares sold of x $22.00 per share market price on date of sale Paid in Paid in Capital From T/S 3,000 See explanation below Treasury Stock 25,000 = 1,000 shares sold x $25.00 per share on date of original purchase To record disposal of T/S below original cost Commented [CB61]: See above for formatting suggestion Formatted: Font: Italic, No underline

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17 we had a sufficient credit balance in the paid in Paid in capital C apital from T/S account the paid in Paid in capital from T/S this account is not enough in and of by itself to cover any deficiency. ( Hint: We use the Retained Earnings account to make up any shortfall once the paid in Paid in capital C apital from T/S account balance is zeroed out ) . Example 5 1 (d) In this final example, assume the company sells its remaining shares at $20.00 per share on September 30. Prepare the journal entry for the August 31 transaction. First, note in this transaction the company is selling the 2,000 remaining shares. Also, the selling price per share is well below the original purchase price ($20.00 vs. $25.00). As such, there is a $5.00 reduction from the purchase price. The total cash the company receives is based on the market price it received for each share sold ($20.00 per share times the number of shares sold). As previously stated, whenever T/S is disposed of, regardless of the selling price at which they are disposed , the T/S acc ount must be credited at the original (initial) cost of the treasury stock on the date of its original (initial) purchase ($25.00 per share times the number of shares sold). The Paid in Paid in Capital from Treasury Stock account is debited the difference ( up to the credit balance in that account) , because the balance in the paid in Paid in capital from treasury stock account CANNOT go below zero as well. At t his point, the development of the journal entry looks like this: Date Account Name Debit Credit Comment 8/31 Cash 40,000 = 1,000 shares sold of x $22.00 per share market price on date of sale Paid in Paid in Capital From T/S D See explanation below Retained Earnings D Treasury Stock 50,000 = 1,000 shares sold x $25.00 per share on date of original purchase

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18 paid in Paid in capital account from T/S and the Retained Earnings account. The total amount needed to cover the deficiency is amount needed is $10,000 (the difference between the price of the shares originally purchased and the selling price). The question is, is there any balance in the paid in Paid in capital from T/S account, and is it at least $10,000. There is only a $2,000 credit balance in the paid in Paid in the account the full amount since its balance cannot go below zero. We still need another $8,000. The only other account from which it can come from is Retained Earnings. As such, the completed journal entry becomes: After completing this transaction, the remaining balance in the paid in Paid in capital from treasury stock account is zero. Exercises: Ex ercise 12.1 1. shares of its $2 par value common stock , assuming the shares sell for: a) $10 per share To record disposal of T/S below original cost Date Account Name Debit Credit Comment 8/31 Cash 40,000 = 2,000 shares sold of x $20.00 per share market price on date of sale Paid in Paid in Capital From T/S 2,000 See explanation above Retained Earnings 8,000 = the total deficiency less the amount debited to the paid in Paid in capital from T/S account ($10,000 $2,000) Treasury Stock 50,000 = 1,000 shares sold x $25.00 per share on date of original purchase To record disposal of T/S below original cost Commented [CB62]: Two issues here. Firstly, there are incorrect dates, values, and math in both these tables (probably copy/paste errors from previous graphs). Second, important factor for this example is simply that there needs to be a deficiency of funds in the Paid in Capital account and not that the sale price per share needs to be some large percent below original value. If the latter were the case, why not make the sales price $10, or $5? If the former, it would be less confusing to reframe this example along the Commented [CB63]: Larger font

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19 b) $20 per share 2. par value stock , assuming the shares sell for $30 per share. 3. Prepare the common stock , assuming the stock is given in exchange for a building valued at $420,000. Date Account Titles & Explanation Ref. Debits Credits Date Account Titles & Explanation Ref. Debits Credits Date Account Titles & Explanation Ref. Debits Credits Date Account Titles & Explanation Ref. Debits Credits

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20 Ex ercise 12.2 Make Journal journal entries for each of the following situations for Hamilton Inc : . 1. On April 6, Hamilton Inc . purchased 2 ,000 shares of its own shares of stock in the open market for a total amount of $20,000. 2. On May 20 Hamilton Inc . sold 550 shares of its treasury stock for $ 1 2 per share. 3. On July 17, Hamilton Inc . sold 200 shares of its treasury stock for $8 per share. Date Account Titles & Explanation Ref. Debits Credits Date Account Titles & Explanation Ref. Debits Credits Date Account Titles & Explanation Ref. Debits Credits Formatted: Font: Not Bold Formatted: List Paragraph, Right: 0.75", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.34" + Indent at: 0.59" Formatted: List Paragraph, Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.34" + Indent at: 0.59" Formatted: List Paragraph, Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.34" + Indent at: 0.59"

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21 4. On October 21, Hamilton Inc sold the remaining shares of its treasury stock for $7 per share. Date Account Titles & Explanation Ref. Debits Credits Formatted: List Paragraph, Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.34" + Indent at: 0.59"

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22 Financial Accounting II Chapter 1 2 Test Corporations True / False 1. T F Under Federal law, a corporation is considered a separate legal entity. 2. T F If a corporation issues its own stock s , it cannot repurchase them. 3. T F If a company buys back its own common stock, it debits the common stock account and credits the cash account. 4. T F Purchasing treasury stock increases stockholder equity. 5. T F The retained earnings account represents cash collected by the company. 6. T F When a company issues common stock above the par value, a capital gain is realized. 7. T F On a balance sheet, treasury stock is shown as a reduction of shareholder equity. Multiple Choice 8. Which of the following statements is correct? a) A corporation is taxed in a manner similar to a partnership. d) Stockholders liability is limited to the value of the shares each owns. 9. The Sam Company is authorized to issue up to 2,000 , . 000 shares of $ 2 par value Commented [CB64]: This header should match the chapter header Formatted: Normal, Left Commented [CB65]: alignment

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23 common stock , and 400,000 of its 5%, $20 par value per share preferred stock . During the year, Sam had the following transactions: May 1 I ssued 500,000 shares of common stock for $10 per share. May 12 I ssued 5 0,000 shares of common stock for an empty lot on which it plans to construct a building . The lot was advertised for $1,000,000. Its fair value, however, is $800,000. May 12 The purchase of the empty lot was handled by attorneys, who accepted 20,000 May 25 Purchased 15,000 shares of common stock for the treasury at $9 per share. Dec. 6 I ssued 50,000 shares of its preferred stock for $20 per share. Commented [CB66]: Needs to be realigned and should be made into bulleted (or lettered) list for clarity

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24 Instructions Journalize the transactions for the Sam company Company . Date Account Debit Credit 10. Corporations can issue ? a) Preferred p referred stock if common stock had been previously issued b) Common c ommon Stock s tock c) Treasury t reasury stock if previously repurchased d) All a ll of the above 11. The Edsel company C ompany provided the following balance sheet information ( note: these are the only shares issued during a single initial public offering): 6%, $50.00 par value preferred stock $ 150,000 Common stock, $1.00 par value 300,000 Paid in capital in excess of par value P/S 510,000 Paid in capital in excess of par value C/S 900,000 Retained earnings 90,000

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25 Treasury Stock (7,500 shares) (22,500) Total shareholder equity ? Determine the following: a) Total shareholder equity _______________ b) No. of preferred shares issued _______________ c) Common shares issued _______________ d) Price treasury shares were purchased at _______________ e) Preferred shares outstanding _______________ f) Common shares outstanding _______________ g) Preferred dividend per share _______________ h) Total annual preferred dividend _______________ 12. The following information was obtained from the Mike Common stock, $5 par value $300,000 Paid in capital in excess of par value common stock 200,000 Preferred stock, $50 par value 250,000 Paid in capital in excess of par value preferred stock 150,000 Retained earnings 400,000 Fill in the following: questions: a) Preferred stock issued: ____________________ shares b) Common Stock s tock issued: ____________________ shares c) Total paid in capital: $ ____________________ d) Total stockholder equity: $____________________ 13. Given the following information, determine the total stockholder equity: Common Stock s tock $120,000 Paid in Capital c apital in Excess e xcess of Par p ar 280,000 Retained Earnings e arnings $475,000 Treasury Stock s tock 50,000 a) $400,000 b) $825,000 c) $875,000 d) $925,000 14. Define treasury stock and provide reasons why a company may purchase treasury Formatted: Font: Not Bold Formatted: Indent: First line: 0" Formatted: Indent: Left: 1", Hanging: 0.19", Numbered + Level: 1 + Numbering Style: a, b, c, + Start at: 1 + Alignment: Left + Aligned at: 1" + Indent Formatted: Indent: Left: 1.25", No bullets or numbering

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26 stock it . Answer: 15. Which of the following statements is incorrect? a) Treasury stocks are not considered outstanding; however, they are considered issued. b) Treasury stock purchases reduce stockholder equity. c) Treasury stock reissued at a price higher than that purchase price d results in a capital gain. d) Treasury stock reissued at a price higher than the purchase d price increases shareholder equity. 16. Treasury stock is a) not considered issued . b) not considered authorized . c) considered authorized, issued , and outstanding . d) considered authorized and , issued but not outstanding . 17. Treasury stock a) Is i s issued by the US government and is similar to savings bonds. b) Is i s but not outstanding. c) Is i s and outstanding. d) Is i s neither authorized, issued or outstanding. 18. On June 15, Penelope corporation C orporation initially purchased 1,500 shares of its own common stock at $18 per share. The stated value of the stock is $0.60 per share. On July 15 , it reissued 300 shares at $20 per share. The remaining shares were reissued on July 31 , at $12 per share. Journalize the above transactions. Commented [CB67]: alignment

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27 Date Account Debit Credit 19. The Engle Company purchased 5,000 of its own shares at $12. Later, one half the shares were sold for $12 per share. Afterwards , all remaining shares were sold for $15 per share. Journalize the above transactions. Date Account Debit Credit 20. The Rube Company had the following treasury stock transactions during August 2013: August 1 Purchased 20,000 shares of its own stock for $20 per share. August 3 Sold 5,000 shares of treasury stock for $25 per share.

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28 August 11 Sold 3,000 shares of treasury stock for $30 per share. August 18 Sold 5,000 shares of treasury stock for $20 per share. August 22 Sold 4,000 shares of treasury stock for $15 per share. August 31 Sold the remaining shares of treasury stock for $1per share. Journalize the above transactions. You may omit reasons. Date Account Debit Credit Commented [CB68]: This and the similar list in Question 9 need to be formatted and/or bulleted in the same way

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29 Chapter 13 Dividends, Stock Splits, and Prior Period Adjustments Learning Outcomes: 7. 1. Understand the characteristics of dividends . 8. 2. Develop the journal entries required for cash dividends a. For f or Common c ommon Stock s tock b. For f or Preferred p referred Stock s tock 9. 3. Develop the journal entries required for stock dividends . 10. 4. Understand the characteristics of a stock split . 11. 5. Develop the journal entries required for a prior period adjustment. 12. 6. Become familiar with the Statement s tatement of retained Earnings e arnings . (LO1) Understand the characteristics of dividends A dividend is a payment, usually in the form of cash, to existing shareholders as of a certain date. Sometimes, instead of a cash dividend, a company may issue additional stock , on a prorated basis. If the dividend is in the form of cash, it is referred to as a cash dividend. If it is in the form of additional shares of stock, it is referred to as a stock dividend. Most dividends are in the form of cash. Dividends are not guaranteed. That is, a company does not have to pay out or issue any type of dividend if it does not want to. A cash dividend may be construed as a sign of a financially healthy company. However, too high a dividend may portend trouble in the future. On the other hand, the lack of a dividend does not necessarily mean a company is in financial distress. The company can simply be reinvesting all of its cash back into the business as a way to expand or grow the business. There are three (3) important dates associated with dividends: Formatted: Font: 12 pt Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.34" + Indent at: 0.59" Formatted: Font: 12 pt Formatted: Numbered + Level: 2 + Numbering Style: a, b, c, + Start at: 1 + Alignment: Left + Aligned at: 0.84" + Indent at: 1.09" Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.34" + Indent at: 0.59" Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt Commented [CB69]: Not sure why this is a bulleted list. It would read better as a paragraph Formatted: Font: 12 pt

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30 1. Declaration Date On this date , the Board b oard of Directors d irectors declares a dividend , and the company becomes liable for the payment or the issuance of stock. A journal entry is required. 2. Record Date Owners of the shares on this date will receive the dividend. No journal entry is required. 3. Payment Date (or issue date if a stock dividend) On this date, the cash payment is made, or the additional shares of stock are issued in the case of a stock dividend. A journal entry is required. (LO2a) Develop the journal entries required for cash dividends For Common Stock When developing the journal entries for dividends, it is very important to determine the number of shares outstanding on the day the BOD declares the dividend. Cash dividends are usually declared and paid out on a quarterly basis to existing shareholders. On the Declaration d eclaration Date d ate , the company becomes liable for the dividend. The Cash c ash Dividend d ividend account is a contra capital account an d reduces total shareholder equity. The format of the journal entry to be made on the declaration date is shown below: Date Account Name Debit Credit Comment Dt. Cash Dividend D = # of shares outstanding x dividend per share Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt, Not Bold Formatted: Font: 12 pt Formatted: Font: 12 pt, Not Bold Formatted: Font: 12 pt Formatted: Font: 12 pt, Bold Formatted: Font: 12 pt Formatted: Font: 12 pt, Not Bold Formatted: Font: 12 pt Formatted: Font: 12 pt, Not Bold, No underline Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt Formatted: Font: 12 pt, No underline Formatted: Font: 12 pt Formatted: Font: 12 pt, Not Bold Formatted: Font: 12 pt

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31 Dividends Payable C = # of shares outstanding x dividend per share To record declaration of a cash dividend. The following example shows the journal entry required on a Declaration d eclaration Date d ate . Example 1: On March 3, the BOD of a company declares a $0.20 quarterly dividend on its common stock, payable on April 1 to shareholders of record on March 16 . The company has 100,000 shares of common stock outstanding on the declaration date. Analysis: On the declaration date ( March 3 ), the company becomes liable for a cash dividend. The cash dividend will be paid at a later date ( Payment p ayment Date d ate ). outstanding). In addition to the liability, cash dividends reduce total shareholder equity by the same $20,000. The actual journal entry for the transaction is: Date Account Name Debit Credit Comment 3/3 Cash Dividend 20,000 = 100,000 shares outstanding x $0.20 dividend per share Dividends Payable 20,00 0 = 100,000 shares outstanding x $0.20 dividend per share To record declaration of a cash dividend. The following note shows the journal entry required on a Record r ecord Date d ate . The next date of importance is the Record r ecord Date d ate . dividend. Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold

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32 Since this is an administrative activity in the company, NO JOURNAL ENTRY IS REQUIRED . On the Payment Date: The company pays the cash dividend. Thus, it reduces its liability by the amount of the dividend, as well as its cash account. The format of the journal entry to be made on the declaration payment date is shown below: Date Account Name Debit Credit Comment Dt. Dividends Payable D The amount of the cash dividend owed. Cash C The amount of the cash dividend paid out. To record payment of the cash dividend. In Example 1 , above, the cash dividend is payable on April 1 to shareholders of record on March 16 . The company has 100,000 shares of common stock outstanding on the declaration date. The journal entry on the Payment p ayment Date d ate is: Date Account Name Debit Credit Comment 4/1 Dividends Payable 20,000 Reduction of the liability. Cash 20,000 Reduction of cash when dividend is paid. To record payment of the cash dividend. (LO2b) Develop the journal entries required for cash dividends For Preferred Stock Commented [CB70]: Confusing as presented. There just be a concise paragraph of 2 3 sentences that highlights the fact that this is an administrative activity requiring no journal entry, and which bypasses the need for capitalized, bolded phrases. Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold

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33 The accounts used with preferred stock cash dividends are identical to those covered above for common stock, with respect to the declaration, record, and payment dates. The main difference is with respect to the value of the dividend. When calculating the amount of the cash dividend on preferred stock, the following may have to be considered: a. The dividend per share of preferred stock. b. Whether the dividends are cumulative or noncumulative. c. The total value of the dividend. It is the total value of the dividend, which is used in the journal entries. To calculate the cash dividend for a single share of preferred stock: The following is typical of the information provided for preferred stock on a shareholder equity statement (see sample statement in previous chapter): Note that the value of the cash dividend per share is not given. This is typical for preferred stock. To calculate the cash dividend per share of preferred stock, simply multiply the % (percent) given times the par value : Cash dividend per share of preferred stock = % x P/V In this case, the cash dividend per share of preferred stock is $2.00 per share (8% x $25.00) . Thus, the owners of the preferred stock will receive an annual cash dividend of $2.00 for each share owned. To calculate the total cash dividend for the preferred stock , Multiply the dividend per share times the number of preferred shares outstanding. Using the illustration example above: Total cash dividend = dividend per share x number of preferred shares outstanding, or $2.00 cash dividend per share x 8,000 shares preferred stock outstanding = $16,000 The effect on a cash dividend on noncumulative and cumulative preferred stock: Preferred stock may be issued as noncumulative or cumulative. Noncumulative Preferred Stock Preferred stock, 8%, $25 par value, cumulative, 8,000 shares issued and outstanding $16,000 Commented [CB71]: Would be better presented in a paragraph Formatted: Font: Not Bold Formatted: Font: Not Bold

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34 Is a type of preferred stock which DOES NOT PAY does not pay any previously unpaid cash dividends. As such, if If a company reinstates a cash dividend that it previously stopped paying, the company only pays and not any unpaid dividends (dividends in arrears). Cumulative Preferred Stock A type of preferred stock requiring that unpaid dividends (dividends in arrears) must be cash dividends. dividend. Dividends on cumulative preferred stock is normally paid before noncumulative preferred shares and common shares receive their dividends. Journal Entries for preferred stock (Noncumulative and Cumulative). Example 1 ( Noncumulative n oncumulative preferred stock): The ABC Company provided the following information, from the ir shareholder equity section of the ir balance sheet, related to their noncumulative preferred stock: The Board of Directors declared a cash dividend on June 1, payable on June 30, to shareholders of record on June 15. Journalize the transactions related to this dividend. Analysis: Since the preferred stock is noncumulative , the journal entries will be the same as for common stock. However, unlike common stock, we need to calculate the total dividend. As previously stated, this consists of two (2) steps: 1. 2. Calculate the total dividend. This is simply the dividend per share (calculated in step 1 above) times the total number of shares outstanding. The dividend per share = 10% x $50.00 or $5.00 per share. Since this type of preferred stock is noncumulative, the total dividend equals : , Preferred stock, 10%, $50 par value, noncumulative , 10,000 shares issued and outstanding Formatted: No underline Formatted: No underline Commented [CB72]: Way too many bulleted lists here. Almost all of this can be written as better flowing lists consisting of a single item. The formula for caclulating cash dividend and any numbered headers you want to include can be bold type they will stand out better if the rest of this text is written in paragraph form with normal type. Commented [CB73]: This header is essentially the same as LO2b, so it might be better to skip it and instead label Example 1: Journal Entry for Noncumulative Preferred Stock Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Commented [CB74]: Should be paragraph

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35 $5.00 per share x 10,000 shares outstanding = $50,000. The journal entry on the declaration date is therefore: Date Account Name Debit Credit Comment 6/1 Cash Dividend 50,000 = 10,000 shares outstanding x $5.00 dividend per share Dividends Payable 50,000 Same as above To record the declaration of a cash dividend on noncumulative preferred stock. The next date of importance is the Record r ecord Date d ate . Stockholders shown on will receive the dividend. Since this is an administrative activity in the company, NO JOURNAL ENTRY IS REQUIRED no journal entry is required . The next date of importance is the Payment p ayment Date d ate . The journal entry on the payment date is: Date Account Name Debit Credit Comment 6/30 Dividends Payable 50,000 = 10,000 shares outstanding x $5.00 dividend per share Cash 50,00 0 Same as above To record the payment of the cash dividend on noncumulative preferred stock. Example 2 (Cumulative preferred stock): Commented [CB75]: This might read better if you include the actual math under the step numbers. So, you would Calculate dividend per share. This is format for step 2. Formatted: Font: Not Bold Formatted Table Commented [CB76]:

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36 The XYZ Company provided the following information from its the shareholder equity section of their balance sheet: The company also declared , on January 1 , that it would reinstate its cash dividend on its cumulative preferred stock, payable on January 31 to shareholders of record on January 15. The dividend had been suspended for the past two years. Analysis: Since this is cumulative preferred stock, the journal entries will be the same as for common stock. However, we must calculate the total dividend, which consists of two (2) parts: a) PLUS , b) any dividends owed for the two previous years. This consists of three (3) steps: 1. Calculate the dividend per share. 2. This is simply the dividend per share (step 1 above) times the total number of shares outstanding. 3. Add any dividends owed from previous years (assume the dividends owed for each year is the same as the current annual dividend). a. The dividend per share = 5 % x $50.00 or $2.50 per share. b. The current year dividend = $2.50 per share x 6,000 shares outstanding = $15,000. c. The dividends in arrears for two (2) years = 2 x $15,000 = $30,000. Thus, the total dividend will be $ 60,000 45,000 ($ 15 20 ,000 in the current year + $ 30 45 ,000 owed). The journal entry on the declaration date is therefore: Date Account Name Debit Credit Comment 1/1 Cash Dividend 45,000 dividends owed Dividends Payable 45,000 Same as above Preferred stock, 5%, $50 par value, cumulative , 6,000 shares issued and outstanding Formatted: No underline Formatted: Font: Not Bold Commented [CB77]: Too many lists paragraph, then have the three steps with the relevant

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37 To record declaration of a cash dividend and dividends in arrears for cumulative preferred stocks. The next date of importance is the record date. Stockholders shown on dividend. Since this is an administrative activity in the company, NO JOURNAL ENTRY IS REQUIRED. no journal entry is required. The journal entry on the payment date is: Date Account Name Debit Credit Comment 1/31 Dividends Payable 45,000 dividends owed Cash 45,000 Same as above To record payment of cash dividend and dividends in arrears for cumulative preferred stocks. Now You Try It: 1. On November 27, the board of directors of Beth Company declared a $.60 per share dividend. The dividend is payable on December 24 to shareholders of record on December 7. Beth has 25,500 shares of $1 par common stock outstanding at November 27. Journalize the entries needed on the declaration and payment dates. Dt. Account Name Debit Credit 11/27 Cash Dividend Dividend Payable 12/7 No Journal Entry 12/24 Dividend Payable Cash Commented [CB78]: the payment date is confusing. You could simply have this Formatted: Font: Not Bold Formatted: Font: Not Italic

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38 2. Outstanding stock of the Larson Corporation include s d 40,000 shares of $5 par common stock and 10,000 shares of 5%, $10 par noncumulative preferred stock. In 2019, Larson declared and paid dividends of $4,000. In 2020, Larson declared and paid dividends of $12,000. How much of the 2020 dividend was distributed to preferred shareholders? a. $6,000 b. $7,000 c . $5,000 d. $12,000 3. Bodkin, Inc. has 5,000 shares of 5%, $100 par value, noncumulative preferred stock and 50,000 shares of $1 par value common stock outstanding at December 31, 2019, and December 31, 2020. The board of directors declared and paid a $25,000 dividend in 2019. In 2020, $55,000 of dividends w ere are declared and paid. What are were the dividends received by the preferred and common shareholders in 2020? Preferred Common a. $0 $55,000 b. $25,000 $30,000 c. $27,500 $27,500 d. $35,000 $20,000 4. Burnell, Inc. has 5,000 shares of 4%, $50 par value, cumulative preferred stock and 100,000 shares of $1 par value common stock outstanding at December 31, 2019, and December 31, 2018. The board of directors declared and paid a $8,000 dividend in 2019. In 2020, $30,000 of dividends are were declared and paid. What are were the dividends received by the preferred and common shareholders in 2020? Formatted: Font: Not Bold Commented [CB79]: What is the box for?

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39 Preferred Common a. $18,000 $12,000 b. $15,000 $15,000 c. $12,000 $18,000 d. $10,000 $20,000 5. The cumulative effect of the declaration and payment of a cash dividend on a company's financial statements is to a. decrease total liabilities and stockholders' equity. b. increase total expenses and total liabilities. c. increase total assets and stockholders' equity. d. decrease total assets and stockholders' equity. (LO3) Develop the Journal Entries Required for Stock dividends Sometimes a cash dividend paying company may need to conserve its cash. Instead of reducing or discontinuing its cash dividend, the company may substitute a stock dividend in the place of the cash dividend. The stock dividend enables each shareholder to receive additional shares proportional to the amount of shares currently owned, relative to other shareholders. As a result, the percent ownership that each shareholder has in the company remains unchanged, since each shareholder receives a proportionate number of new shares. Journalizing stock dividends is a bit more complicated than that of a journalizing cash dividend s . As such, it It is important to familiarize yourself with the step by step step by step process. Step 1 Determine how many shares of stock are outstanding when the stock dividend is declared. This is important because the total number of new shares to be issued will be a percent of the current shares outstanding. Step 2 Commented [CB80]: paragraph Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline

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40 Determine how many new shares are going to be issued as a result of the stock dividend. To calculate how many new shares will be issued, you multiply the number of shares outstanding ( Step 1 above) by the percent (%) of the stock dividend. The % will be given in the problem statement. Step 3 Determine the following: a) market price of the stock on the declaration date (the price the stock is selling for in the market) b) par value of the stock c) Paid in p aid in Capital c apital in excess of par value Common c ommon Stock s tock (the difference between total market price and total par value) Step 4 Prepare the following Journal j ournal Entries e ntries : 1) On the declaration date : Date Account Name Debit Credit Comment Dt. Stock Dividend D = # of new shares x the market price per share Common Stock Dividend Distributable (CSDD) C = # of new shares x the par value per share Paid in Paid in Capital in Excess of P/V C/S C = the difference between the two accounts above. To record declaration of a X% stock dividend. The Stock Dividend account is a contra equity account and, like the Cash Dividend account, it reduces shareholder equity. o The other two accounts (CSDD and Paid in Paid in Capital in Excess of P/V C/S) are normal capital accounts and serve to increase shareholder equity . o As such Therefore , a stock dividend has no overall effect on shareholder equity since the debits must equal the credits. 2) On the record date : No n o journal entry is required. Owners of existing shares on this date will receive their respective prorate shares on the issue date. Formatted: No underline Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Formatted: No underline Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Formatted: Font: Not Bold, No underline Commented [CB81]: paragraph Formatted: Font: Not Bold, No underline

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41 3) On the distribution date : The owners of current shares on the record date will receive their new shares. Date Account Name Debit Credit Comment Dt. Common Stock Dividend Distributable (CSDD) D Same as on declaration date Common Stock C Same as above. To record issuance of new stock. Since the CSDD and Common Stock accounts are normal capital accounts, and , since one is debited and the other credited, there is no effect on total shareholder equity when the new shares are distributed to the existing shareholders. To summarize: The declaration of a stock dividend does not affect total shareholder equity. The reduction of capital resulting from the debit to Stock Dividends is offset by the increase in capital from the credits to the CSDD and PIC in excess of P/V C/S or S/V C/S accounts. Finally, when W hen the new shares are issued, there is also no effect on shareholder equity. Example 1 (Stock Dividend) : On March 1, 2020 , the ABC Company had 200,000 shares of its $5 par value common stock outstanding when its board of directors declared a 10% stock dividend. At the time of the declaration, the market price per share was $15.00. The stock dividend will be distributed on Mar ch 31 to shareholders of record on March 15. Instructions Show all required journal entries. Solution: On the declaration date, there were 200,000 shares outstanding. Since the stock dividend is 10 %, an additional 20,000 new shares (10 % x 200,000 shares currently outstanding) must be issued on the issue date. Also note, the market price is $15.00 per share and the par value is $5.00 per share. Formatted: Font: Font color: Text 1 Formatted: Normal, Indent: Left: 0.5", No bullets or numbering Formatted: Font: Not Bold

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42 You now have all of the information needed to create the journal entry on the declaration date, as shown below: Journal entry on the Declaration d eclaration Date d ate : Date Account Name Debit Credit Comment 3/1 Stock Dividend 300,000 = 20,000 new shares x the $15.00 market price per share Common Stock Dividend Distributable (CSDD) 100,000 = 20,000 new shares x the $5.00 par value per share Paid in Paid in Capital in Excess of P/V C/S 200,000 = the difference between the two accounts above. To record declaration of a 10 % stock dividend. On the Declaration Date record date : no journal entry is required. NO JOURNAL ENTRY IS REQUIRED on the record date. Journal entry on the Issue i ssue Date d ate (issuance of new stock): Date Account Name Debit Credit Comment Dt. Common Stock Dividend Distributable (CSDD) 100,000 Same as on declaration date Common Stock 100,000 Same as above. To record issuance of new stock. Now You Try It: 1. On October 10, the board of directors of Pinto Corporation declared a 10% stock dividend. On October 10, the company had 10,000 shares of $1 par common stock issued and outstanding with a market price of $16 per share. The stock dividend will be distribute d on October 31 to shareholders of record on October 25. Journalize the entries needed for the declaration and distribution of the stock dividend. Commented [CB82]: paragraph Formatted Table Formatted: No underline Formatted: No underline Formatted: Font: Not Italic

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43 Date Account Name Debit Credit Comment 2. Nola, Inc. declare d s a 10% common stock dividend when it ha d s 60,000 shares of $10 par value common stock outstanding. a. If the market value of $24 per share is used, what are the amounts debited to Stock Dividends and credited to Paid in Capital in Excess of Par? b. Journalize the stock dividend transactions assuming the stock dividend was declared on March 1. The new stocks will be issued on March 31 to shareholders on of record on March 15. Paid in Capital in Stock Dividends Excess of Par a. $60,000 $0 b. $144,000 $84,000 c. $144,000 $60,000 d. $60,000 $84,000 Commented [CB83]: Too many lettered lists here these could be split into two separate questions and they would scan better

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44 a. Solution (see journal entries, below: b. Date Account Name Debit Credit Comment

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45 (LO4) Understand the characteristics of a stock split Stock Splits Basic Information From an accounting perspective: o o Stock splits are an administrative task. o No journal entries are required. o Total shares outstanding changes after the split. o Par value per share changes after the split. o Market value per share changes after the split. o Total shareholder equity DOES NOT CHANGE after the split. o Total par value DOES NOT CHANGE after the split. o Total Market Value DOES NOT CHANGE after the split. Types of stock splits o Forward splits (2 for 1; 3 for 2; etc.) Increase number of shares outstanding Decrease market price and par value per share more important reason for a stock split). However, the market value of the company at the time of the split has not changed. o Reverse splits (1 for 10; 1 for 20; etc.) Decrease number of shares outstanding Increase market price and par value per share avoid delisting from a stock exchange); However, the market value of the company at the time of the split has not changed. Stock Splits Examples Example No. 1: Commented [CB84]: Again, this should all be in paragraph form, perhaps with a condensed bulleted list at the end by way of a summary. It should include sentences Commented [CB85]: Replace this with a sentence or

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46 A company has 100,000 shares of its $2.00 par value per share common stock outstanding when it declares a 2:1 stock split. The market price of the stock at the time of the split was is $24 per share. Determine: a. Shares s hares outstanding before the split : b. PV per share and total PV before the split : c. MV per share and total MV before the split : d. Shares s hares outstanding after the split : e. PV per share and total PV before after the split : f. MV per share and total MV after the split : Solution (See additional reasoning, below) : a. Shares s hares outstanding before the split: 100,000 shs. b. PV per share and total PV before the split: $2; 100,000 shs shares . x $2 = $200,000 c. MV per share and total MV before the split: $24; 100,000 x $24 = $2,400,000 d. Shares s hares outstanding after the split: 100,000 x 2:1 = 200,000 shs. shares e. PV per share and total PV before after the split: ½ x $2 = $1.00; 200,000 shs. s hares x $1.00 = $200,000 f. MV per share and total MV after the split: ½ x $24 = $12; 200,000 shs. shares x $12 = $2,400,000 Notes: 1. Since this is a forward split, there will be more shares outstanding after the split. Outstanding shares after the split = 200,000 (100,000 x 2/1) 2. Recall, total par value before and after the split does not change . Total p/v before the split = $200,000 (100,000 shares outstanding x $2.00 per share p/v) Therefore, after the split, the total p/v must also equal $200,000. In order to achieve this, the new p/v per share must be equal to $1.00 ($2.00 per share p/v x the inverse of the forward split, which is ½) Total p/v after the split = shares outstanding after the split x new p/v per share, or 200,000 shares x $1.00 p/v per share = $200,000. 3. Recall, the total market value just before and after the stock split does not change. Total market price before the split = $2,400,000 (100,000 shares outstanding just before the split x $24.00 per share). Therefore, after the split, the total market value must also equal $2,400,000. Formatted: Font: Not Bold Formatted: Font: Not Bold Commented [CB86]: What is the additional reasoning? Is that the notes section? Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Commented [CB87]: This will be much more readable if per share before the split is $2.00. Therefore, the total PV Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold

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47 In order to achieve this, the new market value per share must be equal to $12.00 ($24.00 per share market value before the split x the inverse of the forward split, which is ½). Total market value just after the split = shares outstanding after the split x new market value per share just after the split, or 200,000 shares x $12.00 market value per share = $2,400,000. From this point forward, the par value per share for any further stock transactions is the newly determined par value. That is, the $1.00 per share value. Example No. 2: A company has 100,000 shares of its $3.00 par value per share common stock outstanding when it declares a 3:2 stock split. The market price of the stock at the time of the split was is $24 per share. Determine: a. The t he number of shares outstanding after the split : b. The t he new PV per share and total PV after the split : c. The t he new MV per share and total MV after the split : Notes: 1. Since this is also a forward split, there will be more shares outstanding after the split. Outstanding shares after the split = 150,000 (100,000 x 3/2) 2. Recall, total par value before and after the split does not change . Total p/v before the split = $300,000 (100,000 shares outstanding x $3.00 per share p/v) Therefore, after the split, the total p/v must also equal $300,000. In order to achieve this, the new p/v per share must be equal to $2.00 ($3.00 per share p/v x the inverse of the forward split, which is 2/3). Total p/v after the split = shares outstanding after the split x new p/v per share, or 150,000 shares x $2.00 p/v per share = $300,000. 3. Recall, the total market value just before and after the stock split does not change. Total market price before the split = $2,400,000 (100,000 shares outstanding just before the split x $24.00 per share). Therefore, after the split, the total market value must also equal $2,400,000. In order to achieve this, the new market value per share must be equal to $16.00 ($24.00 per share market value before the split x the inverse of the forward split, which is 2/3). Commented [CB88]: It makes much more sense to include these notes with the appropriate solution steps (i.e. note 1 would be included in letter d, note 2 with letter e, etc). Formatted: Font: Not Bold

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48 Total market value just after the split = shares outstanding after the split x new market value per share just after the split, or 150,000 shares x $16.00 market value per share = $2,400,000. From this point forward, the par value per share for any further stock transactions is the newly determined par value. That is, the $2.00 per share value. Now You Try It : ! Example No. 1: 1. A company has 200,000 shares of its $4.00 par value per share common stock outstanding when it declares a 2:1 stock split. The market price of the stock at the time of the split was is $24 per share. Determine: a. the T he number of shares outstanding after the split : b. The t he new PV per share and total PV after the split : c. The t he new MV per share and total MV after the split : Example No. 2: 2. A company has 100,000 shares of its $3.00 par value per share common stock outstanding when it declares a 3:2 stock split. The market price of the stock at the time of the split was is $24 per share. Determine: a. The t he number of shares outstanding after the split : b. The t he new PV per share and total PV after the split : c. The t he new MV per share and total MV after the split : Example No. 3: Hint: This is a reverse stock split. 3. A company has 100,000 shares of its $2.00 par value per share common stock outstanding when it declares a 1:2 stock split (hint: this is a reverse stock split) . The market price of the stock at the time of the split was is $24 per share. Determine: a. The t he number of shares outstanding after the split : Commented [CB89]: Format this like Example 1 (Solution section as lettered list, Notes folded into the appropriate letters) Formatted: Font: Not Italic Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Font: Not Bold Formatted: Font: Not Bold

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49 b. The t he new PV per share and total PV after the split : c. The t he new MV per share and total MV after the split :

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50 (LO5) Develop the journal entries required for a prior period adjustment. General Discussion: There may come a time when an accounting error from a previously closed accounting period is discovered. The effect of the error would have been reflected in the financial statements for the period in which the error occurred. If the error is not discovered and corrected, it would continue to be carried over in the financial statements in future periods. Addressing Errors from Prior Periods: If the accounting period in which the error was made was closed, then you cannot fix the error in that period. You would have to address it in the current period. To address such an error, the effect of the error on the affected accounts and the effect on net income or net loss (profits and losses) must be understood. The following situations will demonstrate this: 1. An expense account was understated If the error involved an expense account that was previously understated, then the effect of the error caused net income for that period to be overstated. As a result, retained earnings would have increased more than it should have, thus causing shareholder equity to be more than it should. To fix this error, the retained earnings account would have to be debited (reduced) by the amount of the error to reduce the increase due to the error. Develop the necessary journal entry to correct the effect of the error. Example 1: In 20 21 , a company understated the depreciation expense account by $15,000, after which the books were closed for the year. The error was discovered in 20 22 . How should the error be addressed in 20 21 ? Discussion: Commented [CB90]: make that section a paragraph starting with your first sentence. Include a definition of prior period adjustment, following examples, we will examine different situations in which a prior period adjustment is/may be necessary, and we will learn how to create the appropriate journal Commented [CB91]: This could be formatted better. Have this labeled something like also be in paragraph form.

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51 Since the books were closed for the year 20 21 , you cannot revise the financial statements for 20 21 . The effect of the error must be determined and incorporated onto the value in the Retained Earnings account in the year of discovery. This will help you to develop the necessary journal entry for 20 22 (the year of discovery) to correct the effect of the error. Solution: In 20 21 , the depreciation expense account was understated. Thus, total expenses were less than they should have been. Since total expenses were less than they should have been, net income for 20 21 was greater than it should have been (total revenue minus total expenses = net income). In 20 21 , this greater profit went into the retained earnings account during the closing process. To fix the error: The retained Earnings account must be reduced . This requires a debit to the retained earnings account. The other account would be the accumulated depreciation equipment account to reflect the additional depreciation that should have been included. The journal entry to fix this error in the current accounting period is: Date Account Name Debit Credit Comment Dt. Retained Earnings 15,000 Amount of the error. Accumulated Depreciation Equipment 15,000 Same as above. To correct a prior period error. 2. An expense account was overstated If the error involved an expense account that was overstated, then the effect of the error caused net income for that period to be understated. As a result, retained earnings would have increased less than it they should have, thus causing shareholder equity to be less than it should. To fix this error, the retained earnings account would have to be credited by the amount of the error to reduce the increase due to the error it caused .

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52 Example 1: In 20 21 a company purchased supplies for $25,000 and incorrectly debited the supplies expense account as shown below, after which the books were closed for the year. The error was discovered in 20 22 . How should the error be addressed in 20 22 ? Date Account Name Debit Credit Comment Dt. Supplies Exp. 25,000 Cash 25,000 Purchased Supplies. Discussion: Since the books were closed for the year 20 21 , you cannot revise the financial statements for 20 21 . To address the error, you must determine the effect of the error on the 20 21 financial statements. This will help you to develop the necessary journal entry for 20 22 (the year of discovery) to correct the effect of the error. In 20 21 , the supplies expense was debited, thus increasing total expenses unnecessarily. Since total expenses were greater than they should have been, net income for 20 21 was less than it should have been (total revenue minus total expenses = net income). This lower profit went into the retained earnings account during the closing process. As such, to T o fix the error, we must increase the retained earnings account , thus increasing it to reflect the higher net income that should have transferred into retained earnings in 20 21 . This requires a credit to the retained earnings account. The other account would be the supplies account since it was never used in the first place. The journal entry to fix this error in the current accounting period is: Date Account Name Debit Credit Comment Dt. Supplies 25,000 Amount of the error. Commented [CB92]: As before, this can be reformatted (Example 2: Overstatement of an Expense Account, move

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53 Retained Earnings 25,000 Same as above. To correct a prior period error. (LO6) Become Familiar with the Statement of Retained Earnings The Statement s tatement of Retained r etained Earnings e arnings shows the cumulative profits and losses of the corporation over time, as well as the effect from dividends paid out and prior period adjustments. The sample statements shown below are intended to enable the student to become familiar with some of the content found in such statements. All numbers contained therein are assumed values. Sample Retained Earnings Statements (No adjustments) Woods Corporation Statement of Retained Earnings Year Ended December 31, 20 22 Retained Earnings, Jan. 1, 20 22 $600,000 Plus, Net Income 170,00 0 Retained Earnings, Dec. 31, 20 22 $770,000 Sample Statement of Retained Earnings (with Dividends) Woods Corporation Statement of Retained Earnings

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54 Year Ended December 31, 20 22 Retained Earnings, Jan. 1, 20 22 $600,000 Plus, Net Income 170,000 $770,000 Less Dividends (25,000) Retained Earnings, Dec. 31, 20 22 $745,000 Sample Statement of Retained Earnings (with Dividends and Prior Period Adjustment) Woods Corporation Statement of Retained Earnings Year Ended December 31, 20 22 Retained Earnings, Jan. 1, 20 22 $600,000 Plus Effect from Understated Depreciation Expense from 20 21 20,00 0 Corrected Retained Earnings, January 1, 20 22 $620,000 Plus, Net Income 170,000 $790,000 Less Dividends (25,000) Retained Earnings, Dec. 31, 20 22 $765,000

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55 Try out the following comprehensive problem: On January 1, 20 22 , the Cordero Company had the following shares outstanding: Preferred Stock: 30,000 shares, 8%, $50.00 par value . Common Stock: 60,000 shares, $6.00 par value . The following 3 transactions took place during the year and, where necessary, were appropriately recorded: January 15 : Issued an additional 20,000 common shares . February 28 : Split its common shares 2:1. June 30 : Issued an additional 40,000 shares of common stock However, on August 1, the board of directors declared a 15% stock dividend. The stocks will be distributed on August 31 to shareholders of record on August 15. The market price of the common shares was $20.00 per share when the stock dividend was declared. Instructions : Show the analysis used to (a) determine (a) the number of common shares is currently outstanding on the declaration date and (b) how you determined the number of new common shares that will be issued. Then, show all necessary journal entries in the journal section below. Date Account Name Debit Credit Comment Commented [CB93]: This should be a header, such as continuation of section LO6. Formatted: Indent: Left: 0.5"

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56 Date Account Name Debit Credit Comment Exercises: Ex 13.1 On May 1 st , Super company declared a cash dividend of $0.75 per common share to the shareholders of record on May 19th. The cash dividend will be paid on May 30 th . The company has 500,000 shares authorized and 220,000 shares outstanding (par value of stock is $5 per share). Required: Prepare the required journal entries (if any) on May 1st, May 19 th , and May 30th. · Commented [CB94]: previous exercise/problem Formatted: Superscript

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57 Financial Accounting II Chapter 13 Test Cash Dividends, Stock Dividends, Stock Splits, Prior Period Adjustments 21. 1. T F On the day the Board of Directors of a corporation declares a cash dividend, the company debits the account dividends payable, which is a current liability account , and credits the cash account, which is a current asset account. 22. 2. T F Dividends in arrears must be distributed to noncumulative preferred stockholders Before b efore common stockholder s can receive their dividends. 23. 3. T F A stock dividend is a distribution of cash to the shareholders. 24. 4. T F The declaration and issuance of a stock dividend s affects assets and liabilities. 25. 5. T F When a company declares a stock dividend, a journal entry is not required because a stock dividend does not involve cash and cannot be expressed in monetary terms. 26. 6. T F Neither a stock split nor a stock dividend requires a journal entry. 27. 7. T F Since a stock dividend results in the issuance of more stocks, an percentage ownership in the company increases as a result. 28. 8. The journal entry for the declaration of a $0.60 per share dividend on 50,000 shares of outstanding common stock requires a : a) $30,000 credit to the to the cash account b) $30,000 credit to the cash dividend account c) $30,000 credit to the dividend payable account d) None n one of the above is correct Commented [CB95]: Format for all tests should be similar should be labeled the same way here for consistency Commented [CB96]: This header should match chapter header Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Commented [CB97]: Alignment of text Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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58 29. 9. On the payment date, a cash dividend of $12,000 will require a : a) Credit c redit to cash for $12,000 b) Credit c redit to dividend payable for $12,000 c) Credit c redit to stock dividend for $12,000 d) None n one of the above is correct Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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59 30. 10. The declaration of a cash dividend a) Increases i ncreases an asset b) Increases i ncreases a liability c) Increases i ncreases revenue d) Increases i ncreases an expense e) None n one of the above 31. 11. The Goodbar company has 6,000 shares of 6%, $60 par value preferred stock outstanding. Determine the dividend for each individual share and in total . : a) $6.00 and $36,000 b) $0.06 and $360.00 c) $3.60 and $2,160 d) $3.60 and $21,600 e) Cannot c annot be determined with the information provided 32. 12. Define the following terms: a) Par p ar value b) Market m arket value c) Book b ook value d) Earnings e arnings per share 33. 13. Show the typical journal entries for a cash dividend on the declaration, record, and issue date s . Account Debit Credit Comment 34. 14. On board of directors declared a $ 0 . 24 per share dividend on it s 30,000 shares of outstanding common stock . The stock has a $2 per share par value. The dividend is payable on May 12 to shareholders of record on April 15 and payable on May 12 . Show the journal entries the company would make on Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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60 each of the pertinent dates. Account Debit Credit Comment 35. 15. On board of directors declared a 6% cash dividend on it s 20,000 shares of outstanding preferred stock . The stock has a $5 per share par value. The dividend is payable on May 12 to shareholders of record on April 15 and payable on May 12 . Show the journal entries the company would make on each of the pertinent dates. Account Debit Credit Comment 36. 16. Show the typical journal entry for a stock dividend on the declaration, record, and issue date s . Commented [CB98]: column? Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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61 Date Account Debit Credit Comment 37. 17. When a stock dividend is declared, the ____________________ account is valued at the market price and the ____________________ is valued at the par value. 38. 18. On July 1, a company had 150,000 shares of its $1.00 par value common stock outstanding. On July 15, the company declared a 4:3 stock split, with the shares issued on August 1. On November 1, the company declared a 10% stock dividend to shareholders of rec ord on December 1. The shares from the stock dividend were issued on December 31. The stock had a market price of $20 on the declaration date. Show all appropriate journal entries, including any that may not require a journal entry. Date Account Debit Credit Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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62 39. 19. What is a forward stock split and a reverse stock split? Discuss. Ans wer . : 40. 20. The Baker Company had the following transactions during the current year: April 1 Issued 6,000 shares of 8%, $50 preferred stock for $80 per share. April 6 Issued 60,000 shares of $2 par value common stock for $12 per share. June 1 Declared a 2 for 1 stock split to record holders on June 15 June 30 The shares for the stock split are were issued. August 1 Declared a 15% stock dividend on the common stock. The market price on this day is was $30 August 15 The record date for the stock dividend August 31 The stock dividend is was distributed Prepare the appropriate journal entries. You may omit reasons. Date Account Ref Debit Credit Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Commented [CB99]: What specifically do you mean by Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Commented [CB100]: Realign and make into bulleted or lettered list for clarity

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63 41. 21. The Canuga Company has 76,000 of its $15 par value common stock issued and outstanding , when the company it declares a 3:2 stock split. The number of shares outstanding after the stocks are distributed and the new par value are: Determine the following: a) Shares s hares outstanding after the split = _______________ b) Par p ar Value v alue after the split = _______________ 42. 22. The Yeltsin Corporation has 250,000 shares of $1.50 par value common stock outstanding. When the market price of the stock reached reache s $24.00 per share, the company split s the stock 1:2. Determine the following: a) Shares s hares outstanding after the split ____________________ b) Par p ar value per share after the split ____________________ c) Market m arket value per share after the split ____________________ 43. 23. Retained earnings represents a(an) a) Accumulated an a ccumulated contra cash account . b) Conversion c onversion of net income to a cash basis . c) Conversion c onversion of net income to an accrual basis d) Accumulated a ccumulated profits and losses . 44. 24. What is the formula for calculating earnings per share? Ans. Answer : _________________________________________ 45. 25. During the current year, the Biscuit Company generated net income of $700,000. The company has 25,000 shares of 6%, $60 preferred stock and 100,000 shares of $2 stated value common stock outstanding. Earnings per share for the current year is: Ans wer: . ____________________ 46. 26. On May 1, the Illinois Company had 100,000 shares of its $1.50 par value common stock issued and outstanding. On May 15 , the company declared a 15 % stock dividend , when the market price was $20, to be distributed on June 15 to record holders on May 31. Show all applicable journal entries. Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Indent: First line: 0.5" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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64 Date Account Ref Debit Credit 47. 27. If a corporation with a $1.50 par value common stock splits 3:1, the new par value per share is Ans wer: . ___________________ 48. 28. In the following table, describe the effect of each of these transactions on the listed accounts with by writing "(I) Increase", "(D) Decrease", or "(NE) No effect". Items Capital stock Paid in Capital Retained Earnings Total Stockholders' Equity Sold treasury stock above the purchase price Issue d preferred stock above par Declared a cash dividend Declared a 10% stock dividend Declared a stock split Paid a cash dividend Distributed the stock dividend Distributed the stock split Prior period adjustment for overstatement of net income Prior period adjustment for understatement of net income Sold treasury stock below the purchase price and any available PIC from T/S Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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65

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66 Financial Accounting II Chapter 1 4 Bonds, Mortgage Note Amortization , Leases 49. 1. T F If a corporation issues bonds at a discount, the discount is considered an additional cost of borrowing . 50. 2. T F A capital lease is included on the balance sheet since the corporation is considered to have purchased the asset . 51. 3. T F The times interest earned ratio is calculated by dividing the interest expense by the income before income taxes. 52. 4. T F If a lease term is equal to 70% of the economic life of the leased property, the lease is considered to be an operating lease . ? 53. 5. T F Serial bonds and callable bonds mature at the same time. 54. 6. T F At maturity, a bond which originally sold at a premium will be redeemed at a value higher than the face value. 55. 7. T F A premium on bonds payable is shown as a deduction on the balance sheet. 56. 8. T F Discount on bonds payable is a contra account and is deducted from bonds payable on the balance sheet. 57. 9. What is the semiannual interest on a $600,000, 8% bond s issued on January 1 ? . Commented [CB101]: This is a different header from the TOC (Bonds, Long Term Notices, and Amortization). Also, where is the actual chapter material? Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Commented [CB102]: Alignment, labeling for True/False section and subsequent sections should match previous tests Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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67 Ans wer . : _______________ 58. 10. A $12,000 face value bond selling at 104 sells for Ans wer . : _______________ 59. 11. On January 1, 20 23 , The Max Corporation issued $6,000,000, 10 year, 5% bonds at 100. Interest is payable semiannually on July 1 and January 1. Show the journal entry to record the sale of the bonds, the interest accrued on June 30 and paid on July 1, and the interest accrued on December 31 and paid on January 1 of the following year. Date Account Ref Debit Credit 60. 12. On January 1, 20 2 3, The Max Corporation issued $6,000,000, 10 year, 5% bonds at 90. Interest is payable semiannually on July 1 and January 1. Show the journal entry to record the sale of the bonds, the interest accrued on June 30 together with the amortization of the discount, and the payment of interest on July 1. Date Account Ref Debit Credit Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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68 61. 13. On January 1, 20 2 3, The Max Corporation issued $6,000,000, 10 year, 5% bonds at 105. Interest is payable semiannually on July 1 and January 1. Show the journal entry to record the sale of the bonds, the interest accrued on June 30 together with the amortization of the premium, and the payment of interest on July 1. Date Account Ref Debit Credit Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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69 62. 14. The JLO Bus Company has hired you to evaluate two alternative financing methods for construction of a new bus terminal facility in downtown Boston. JLO requires $5,000,000 in funding. The Alternatives a lternatives are : 1. Issue i ssue a new $5,000,000 bond offering at 6% . 2. Issue i ssue of 100,000 new shares of its common stock at a market price of $50 per share . federal tax rate 35%, evaluate each alternative through net income and earnings per share. The company currently has 500,000 shares of common stock outstanding. What advice would you provide JLO on choosing one or the other alternative? Answer: Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Indent: Left: 0.56" Formatted: Bulleted + Level: 1 + Aligned at: 1" + Indent at: 1.25"

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70 63. 15. Which of the following is correct with respect to choosing between issuing bonds or stocks in order to raise funds? a) Stock dividends will be deductible as an expense. b) Issuing stocks will not create a liability on the balance sheet. c) Issuing stocks will not affect earnings per share. d) None n one of the above are correct 64. 16. The Jingle Company issues bonds at a discount. Amortization of the discount will : a) reduce bond interest expense . b) increase bond interest expense . c) reduce the amount paid at maturity . d) None n one of the above is correct. 65. 17. On December 31, 201 7 , the Mylar Corporation bought land with a vacant office building for $1,000,000. The company made a $100,000 cash down payment and signed a 20 year, 5%, $900,000 mortgage note payable. The mortgage note requires semiannual payments of $36,110 payable on Ju ne 30 and December 31. a. Show the journal entry for the initial borrowing and the first two semiannual payments. b. Also show S how the current and long term liability amounts that would appear on the December 31, 201 7 balance sheet. Ans . wer ( a : ) Date Account Ref Debit Credit Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56" Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.31" + Indent at: 0.56"

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71 Ans .: wer ( b : ) Current liability portion of the mortgage note payable on the December 31, 201 7 Balance Sheet is $_______________. Long Long term liability portion of the mortgage note payable on December 31, 201 7 Balance Sheet is $_______________ .

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72 Chapter 15 Statement of Cash Flow Learning Outcomes: 1. Understand the purpose and use of the statement of cash flow . 2. Develop a statement of cash flow . 3. Perform analysis using the statement of cash flow . Learning Outcome #1 Understand the purpose and use of the statement of cash flow The Statement s tatement of Cash c ash Flow f low (SCF) is the 4th fourth financial statement prepared after the a) Income i ncome Statement s tatement , b) Statement s tatement of Retained r etained Earnings e arnings , and c) Balance b alance Sheet s heet . The SCF provides information on the cash inflows, outflows, and net changes in cash during the accounting period. It also serves to prove the amount of the ending cash balance shown on the balance sheet in the current period. The main body of the SCF consists of three sections (and a Notes section at the bottom): 1. Operating Activities 2. Investing Activities 3. Financing Activities Operating Activities: The operating activities section is the most important because it shows the cash inflows and outflows resulting from the main activities of the business. Operating activities are reflected in the Current c urrent Assets a ssets and Current c urrent Liabilities l iabilities sections of the balance sheet as well as on the income statement (net income, depreciation expense, and any gains and losses on the sale of investments and/or long term assets). Investing Activities: investing activities. Commented [CB103]: This can be more clearly presented as a paragraph, e.g.: statement prepared, following the income statement, statement of retained earnings, and balance sheet. It provides information on the cash inflows, outflows, and net changes in cash during the accounting period. The SFC also serves to prove the amount of the ending cash balance shown on the balance sheet in the current period. The main body of the SFC consists of three sections: operating activities, investing activities, and financing activities. In addition, there is a notes section at the bottom to record significant noncash transactions. Each of these Commented [CB104]: paragraph

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73 Investing activities include but are not limited to the purchase and/or sale of long term assets (land, buildings , and equipment, etc.). This section also includes the purchase and sale of investments by the company , in other institutions. Financing Activities: financing activities. bonds , ; the repurchase (treasury stock) of stocks or redemption of bonds , ; and the payment of dividends. Non Cash Noncash Activities At the bottom of the SCF, notes may be added to denote significant non cash noncash transactions , such as the conversion of convertible bonds into stock and other similar events. These events do not involve the outlay of cash. Learning Outcome #2 Develop a Statement of Cash Flow: Two methods may be used to develop the SCF: 1. The direct method 2. The Indirect methods We will develop a SCF using the indirect method because it is the more popular method and it can be developed from readily available information. In order to prepare a SCF, the following is needed: Comparative c omparative balance sheet (at least two years) Income i ncome Statement s tatement Other o ther information The comparative balance sheet will show the changes in assets, liabilities, and equity from one accounting period to the next. The income statement will provide the results of the operations of the business. To prepare the operating activities section: Commented [CB105]: paragraph Commented [CB106]: Paragraph Formatted: Normal, Indent: Left: 0.25", No bullets or numbering Commented [CB107]: What are the direct and indirect methods? An additional sentence or two to explain this would be helpful. Commented [CB108]: This can be a single paragraph with the bulleted list inside it as presented Commented [CB109]: This should be a header for clarity

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74 Start with net income and adjust as follows: 1. Add back any depreciation expense . While depreciation is a legitimate expense and reduces revenue, it does not require a cash outlay. 2. Add back any losses on the sale of any investment or long term long term asset. For the SCF, the complete sale must be separated into two parts: 1. the amount of the loss (proceeds book value), and 2. the total cash received . The dollar amount of the loss on the sale of an investment or long term long term income statement. The amount of the loss shows by how much the book value of the item exceeded the proceeds received from its sale. While a loss offsets revenue, it is not a cash outlay. Since net income was reduced by the amount of the loss, and the loss is not a cash outlay, it must be added back into net income in the operating activities section. The total cash received from the sale is included in the investing activities section of the SCF. Thus, events resulting in a gain or loss are addressed in two separate sections of the SCF . 3. Deduct any gain on the sale of any investment or long term asset. For the SCF, the complete sale must be separated into two parts: 1. the amount of the gain (proceeds book value), and 2. the total cash received . The dollar amount of the gain on the sale of an investment or long term statement. The amount of the gain shows by how much the proceeds received from its sale of the item exceeded its book value. While a gain increases revenue, it is not a cash receipt. Since net income was increased by the amount of the gain, and the gain is not a cash receipt, it must be deducted from net income in the operating activities section. The total cash received from the sale is included in the investing activities section of the SCF. Thus, events resulting in a gain or loss are addressed in two separate sections of the SCF . Formatted: List Paragraph, Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 1" + Indent at: 1.25" Formatted: Font: Bold Formatted: Normal, Indent: Left: 1.75", No bullets or numbering Formatted: List Paragraph, Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 1" + Indent at: 1.25" Formatted: Font: Bold Formatted: No underline Formatted: Font: Bold Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: List Paragraph, Indent: Left: 0.94", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 2.25" + Indent at: 2.5" Formatted: Font: Bold Formatted: No underline Formatted: Font: Bold Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline

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75 After completing the above adjustments, go to the balance sheet and look at each current asset other than cash . , and For each noncash asset, determine the amount of the change from the prior period to the current period , and the direction: whether the change was an increase or a decrease. One purpose of the SCF is to prove the cash at the end of the current period. As such Therefore , the cash account is never adjusted. In general, deduct from net income any increase in a current asset, and increase net income by any decrease in a current asset. For example: For A/R: Add back any decrease in A/R. An overall decrease in A/R indicates collection of amounts owed by customers. Deduct any increase in A/R. An overall increase in A/R indicates less (slower) collections from customers. For Inventory: Add back any decrease in Inventory. An overall decrease in inventory indicates sales are being made and cash is coming in. Deduct any increase in Inventory. An overall increase in Inventory indicates cash is going out to buy more inventories. For Prepaid (P/P) Expenses ( these would be current assets such as supplies, P/P rent, insurance, advertising, etc. ): Add back any decrease in P/P Expenses. Deduct any increase in P/P Expenses. After completing the required adjustments for current assets, go to the balance sheet and look at each current liability . and determine D etermine the amount of the change from the prior period to the current period , and the direction: whether the change was an increase or a decrease. In general, deduct from net income any reduction in a current liability, and increase net income by any increase in a current liability. For example: Formatted: Font: Not Bold, No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Commented [CB110]: For each of these items, the two steps can be presented as a numbered list with the description/notes in the same line: For A/R: 1. Add back any decrease in A/R. An overall

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76 For A/P: Add back any increase in A/P. An overall increase in A/P indicates payables are increasing and cash is being conserved, which is equivalent to coming in. Deduct any decrease in A/P. An overall decrease in A/P indicates cash is going out to pay debts. After making the required adjustments for current assets and current liabilities, net out their effects against net income and show a total amount along the line If the sum of net income and all of the adjustments is positive, it means the operating activities provided (inflow) cash (inflow) . If the sum of net income and all of the adjustments is negative, it means the operating activities used (outflow) up cash (outflow) . To prepare the investing activities section: Review the long term asset (fixed assets, property, plant and equipment) section of the balance sheet and any investments the company may have made. For each account, determine the amount of the change from the prior period to the current period, and the direction: increase or decrease. Any long term asset or investment that increases from the prior period to the current period implies a purchase. Thus, cash flows into (positive) the company. Any long term asset or investment that decreases from the prior period to the current period implies a sale. Thus, cash flows out (negative) from the company. The sale of any long term asset or investment may result in a gain or loss (see above). The amount of the gain or los s t is addressed in the operating activities section of the SCF as indicated in the discussion on preparing the operating activities section. The cash actually received from any sale is included in its entirety in this investing activity section as an inflow of cash. Thus, any sale of a long term asset or investment , may have to be addressed in two separate sections. To prepare the financing activities section: Go to the balance sheet and look at the long term liabilities and the shareholder equity sections. Look for any dividends the company paid out. This may be found on the income Formatted: No underline Formatted: No underline Commented [CB111]: Numbered list for clarity Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Commented [CB112]: Numbered section header here Formatted: Font: Not Bold Formatted: Font: Not Bold Commented [CB113]: The first two items are serial and should be in a numbered list. The remaining items could be a paragraph below the list, or some of the items could be included in each numbered item as a single paragraph Commented [CB114]: Numbered section header Formatted: No underline

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77 look at the change in retained earnings to determine if there was a dividend. See below for information on how to determine if there is a dividend and how to determine the amount. In the long term liabilities section of the balance sheet, you are looking for accounts such as long term bonds and notes payable. o If bonds payable or notes payable decrease in value: It means the company is paying down its debt and cash is flowing out (negative) of the company (negative) . The amount of the decrease will be deducted from the cash provided/used by financing activities. o If bonds payable or notes payable increase in value: It means the company is borrowing and cash is flowing into (positive) the company (positive) . The amount of the increase will be added to the cash provided/used by financing activities. In the shareholder equity section of the balance sheet, you are looking at the various stock accounts (common, preferred, treasury). o Exclude retained earnings, except for possible dividends. Otherwise the retained earnings account is addressed indirectly thru the operating activities section and this section. o If the common or preferred stock account increased in value: It means the company issued additional shares of stock and cash flowed into (positive) the company (positive) . The amount of the increase will be added to the cash provided/used by financing activities. o If the common or preferred stock account decreases in value (also see treasury stock, below): It means the company is buying back some of its own stock and cash flowed out (negative) of the company (negative) . The amount of the decrease will be deducted from the cash provided/used by financing activities. o If the treasury stock account increases in value: It means the company is buying back some of its own shares and cash flowed out (negative) of the company (negative) . o The amount of the increase will be deducted from the cash provided/used by financing activities. o If the treasury stock account decreases in value: It means the company re issued some of its previously purchased treasury stock and cash flowed into (positive) the company (positive) . Commented [CB115]: These two serial items can be a numbered list Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline

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78 The amount of the decrease is added to the cash provided/used by operating activities. o If a dividend is paid out: The amount of the dividend is deducted from the cash provided/used by financing activities as this is indicative of a cash outflow. After completing the three sections , summarize the values calculated as follows: Net cash provided/used by operating activities +/ Net cash provided/used by investing activities +/ Net cash provided/used by financing activities = Net increase (+) or decrease ( ) in cash (to this amount, add the beginning cash) + Beginning cash (the cash at the beginning of the current period or end of prior period) = Cash at end of the current period (thus completing the SCF) The cash at the end of the current period should be the same as the value shown on the balance sheet for the end of the current period, thus proving the cash amount after determining all of the above cash inflows and outflows. Non Cash Noncash section identifies significant operating, investing , and financing activities deemed necessary, such as the conversion of convertible bonds into common stocks, issuance of stocks or bonds for the acquisition of a building, and other similar activities. Learning Outcome #3 Perform analysis using the statement of cash flow: Formatted: No underline Commented [CB116]: Here, I would recommend term payable or notes payable decrease in value, it means the Formatted: No underline Commented [CB117]: Numbered section header here for

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79 Determining the dividend: Reference to a dividend may not be provide d . As such, W w hen developing the SCF, therefore, it is important to determine whether or not there was a cash dividend payment ( and its value , if so) . This is necessary because the payment of a cash dividend is a cash outflow (negative) in the To determine if there is a dividend , when none is shown, look for net income on the current period income statement and the change in retained earnings on the balance sheet from the prior period to the current period. o If the retained earnings account changed by the same amount as the net income, then there were no dividend payments. o If the change in retained earnings is less than the net income, then subtract the change in the retained earnings account from the net income and that will give you the amount of the dividend. o While there may be other reasons for the change in retained earnings, such as a correction to a prior period error, these discussions are beyond the scope of this topical report. Example: Assume net income was $55,000 for the year 2020 , and the balances in the retained earnings account were as shown below: 2020 2019 Retained Earnings Retained Earnings $100,000 $75,000 For a corporation, profits flow into the retained earnings account. As you can see, the balance in the 2020 retained earnings account increased by $25,000 from the prior year, but the net income for the same year was $55,000. Thus $30,000 ($55,000 $25,00 0) must have been siphoned off as a dividend payment. The following is an example of a statement of cash flow: Commented [CB118]: Numbered header Commented [CB119]: paragraph Commented [CB120]: This should be a paragraph containing the first two bulleted items the third should be a final sentence

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80 The ABC Company Statement of Cash Flow Quarter Ending June 30, XXXX Cash Flow from Operating Activities: Net Income $300,000 Adjustments: Depreciation Expense $3,000 Gain on sale (1,000) Increase in A/R (15,000) Increase in inventory (20,000) Decrease in supplies + 6,000 Decrease in A/P (12,000) $39,000 Net Cash Provided by Operating Activities +$339,000 Cash Flow from Investing Activities: Purchase of land ($100,000) Purchase of Equipment (50,000) Purchase of investment (30,000) Net Cash Used by Investing Activities ($180,000) Cash Flow from Financing Activities: Payment of dividend ($15,000) Repurchase of common stock (10,000) Issuance of bonds 30,000 Net Cash Provided by Financing Activities +$5,000 Net Increase or Decrease in Cash $164,000 + Cash at Beginning of Period XXXXX = Cash at End of Period YYYYY Notes: A review of the above SCF shows that most of the cash flow was provided by the operating activities ( $339,000 ) ; there was vs . an outflow of $180,000 from investing activities and an inflow of $5,000 from financing activities. As such, This means the business is generating most of its cash from its main business activities , which is desirable.

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81 The business also seems to have sufficient cash to make the purchases shown on the investing activities section . , and finally, it It did not have to raise sufficient funds thru financing , and its dividend appears safe. It merits noting that while everything appears fine in the example above , ; fall so neatly into place. o Worse results do not necessarily mean a company is in financial distress. o For example, a company may have purchased another company with the expectation of significant sales later on. o This might affect significantly the investing and financing activities at the expense of cash flow from operations. o Free Cash Flow: Another form of analysis is referred to as Free f ree Cash c ash Flow f low , or FCF. FCF refers to the cash used/provided by operating activities after subtracting invested capital and any dividend payment, or FCF = cash used/provided by operating activities capital expenditures cash dividends Invested capital or capital expenditures refers to cash outlays the company uses to purchase physical assets , such as land, buildings, and equipment , in order to improve operations. Although a positive FCF is desired, it could also be negative , assuming over extension of capital expenditures or weak cash flow from operating activities. A positive FCF indicates the company has excess cash , which it can put back into the business for to further growth, or increase dividend payouts , or reduce the number of shares outstanding. All of these are looked upon favorably. Appendix: How to prepare each activity? Cash flows from operating activities Net income $## Add: Depreciation expense (Noncash Expenses) + Add: Loss on disposal of plant assets + Commented [CB121]: This would read better as two paragraphs first two bullets being one and the last being another Commented [CB122]: Numbered header Commented [CB123]: paragraph Commented [CB124]: to prepare each of the three activities for an SCF. Each table lists the items to appear on the section, along with the

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82 Less: Gain on disposal of plant assets Add: Decrease in Current Assets (Exclude Cash) + Dec. in AR + Less: Increase in Current Assets (Exclude Cash) Inc. in Inventory Add: Increase in Current Liability + Less: Decrease in Current Liability Add: Receive Interest + Add: Receive Dividends + Less: Pay Interest Net cash provided or (used) by operating activities XX Cash flows from Investing i nvesting activities Sale of any Prorerty Plant & Equipment + Purchase of any Prorerty Plant & Equipment Sale of long term investment + Purchase a stocks in another company Lend on a LT note receivable Received a principle on LT note receivable + Net cash provided or (used) by Investing i nvesting activities XX Cash flows from Financing f inancing activities Issue Bonds + Issue Stocks + Commented [CB125]: This should be presented as a bordered table with number, title, headings, and notes if necessary Commented [CB126]: Bordered table with number, title, headings etc

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83 Borrowed on LT Note Payable + Pay back a LT Note Payable Issue Mortgage + Purchase TS Bonds Redeemed Pay dividends Increase in paid in p aid in capital in excess of par + Net cash provided or (used) by Financing f inancing activities XX Exercises: Ex ercise 15.1 Lopez Company reports net income of $80,000 for the year ended December 31, 2022. It also reports a $10,200 depreciation expense and a $7,500 gain on sale of equipment. Its comparative balance sheet reveals a $30,500 decrease in account receivable, a $3,300 decrease in inventory, a $600 increase in office supplies, a $12,700 increase in account payable, and a $980 increase in income tax payable. Prepare the operating activity section of the statement of cash flow for 2022. Use the indirect method. Ex ercise 15.2 Net Income $825,000 Sale of a parcel of Building $980,000 Sale of other long term assets $525,000 Issuance of Bonds $800,000 Purchase of equipment for cash $180,000 Commented [CB127]: Bordered table with number, title etc

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84 Paid a cash dividend $230,000 Received a cash dividend from an investment $25,000 Prepare the investing activity section of the statement of cash flow for 2022. Ex ercise 15.3 Lee Company provided the following information for the year 2022: Decrease in account receivable $80,000 Payment of cash dividends $100,000 Increase in accounts payable $120,000 Depreciation expense $40,000 Increase in bonds payable $650,000 Sale of investments $200,000 Issuance of common stock $290,000 Prepare the financing activity section of the statement of cash flow for 2022. Ex ercise 15.4 The Brown corporation financial statements are presented below: Brown Corp. Income Statement For the year ended December 31, 20 22 Sales $ 2,988,000 Cost of Goods Sold (1,791 ,000)

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85 Gross Profit 1 , 1 97,000 Operating Expenses: Depreciation Expense $ 8 1 ,000 Other Expenses 751 ,500 (832,500) Net Income before taxes 364,500 Income Taxes (63,000) Net Income after taxes $ 301 ,500 Brown Corp. Balance Sheet As of December 31, 20 22 20 22 20 21 Cash $ 26 1 ,000 $ 1 75,500 Accounts Rece i vable 139,500 1 2 1 ,500 Merchandise Inventory 913,500 801,000 Equipment 499,500 445,500 Accum. Dep r. -Equip ( 234,000) (153,000) Total Assets $ 1 ,579,500 $ 1 ,390,500 Additional Information a) Purchased equipment for $54,000 cash. No equipment was sold during 20 22 . b) Issued 3 0 ,000 shares of common stock for $ 3 per share . c) Declared and paid $166,500 of cash dividends. Required: Prepare a Statement s tatement of Cash c ash Flows f lows using the indirect method . Accounts Payable $ 1 03,500 $ 1 44,000 Income Taxes Payable 40,500 36,000 Common Stock, $1 par 873,000 837,000 Additional paid in capital 297,000 243,000 Retained Earnings 265,500 130,500 Total Liab + Equity $1 , 579,500 $ 1 , 390,500 Commented [CB128]: These should be presented as bordered tables and need realignment

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86 Financial Accounting II Chapter 15 Test The Statement of Cash Flow 1. Identify which of the three sections ( o perating, i nvesting, f inancing) in the body of the statement of cash flow is affected by each of the items below. If an item is a noncash item, indicate by designating it as with NC. Also indicate with a ( + ) or a ( ) or ( N /A) if it is a cash inflow, outflow, or neither, respectively. if it Item Statement Section Inflow or Outflow Purchased land Sold merchandise for cash Paid employee salaries Stock dividend was distributed Payment made on account Paid a cash dividend Received a cash dividend Sold treasury stock above cost Stocks were issued to replace a convertible bond Paid interest owed Issued common stock for land 2. T F If a company is using the indirect method to prepare a statement of cash flow, the depreciation expense would be added when reconciling net income to cash provided by operating activities. 3. T F If a company is using the indirect method to prepare a statement of cash flow, any gain on the sale of a long term asset is subtracted when reconciling net income to cash provided by operating activities. Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Commented [CB129]: Text alignment.

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87 4. A company purchased equipment seven years ago at a cost of $60,000. In the current year, the company sold the equipment at a loss of $6,000. The equipment had accumulated depreciation of $48,000 at the time of sale. If the company uses the indirect method to prepare a statement of cash flow, what amounts would be reported on the following sections, if any: Operating section _______________ inflow or outflow (circle the correct answer) Investing section _ ______________ inflow or outflow (circle the correct answer) Financing section _______________ inflow or outflow (circle the correct answer) 5. By what amount does cash increase or decrease if the statement of cash flow shows the following: Cash provided by operating activities $17,500 Cash used by investing activities $12,250 Cash used by financing $4,300 Ans wer: . _______________ increase or decrease (circle the correct answer) 6. The Perseus Corporation generated $52,000 in net income during 2013. The following income statement and balance sheet information was also provided: Depreciation expense $18,000 Loss on sale of a long term asset 3,500 Decrease in A/R 14,000 Decrease in inventory 21,000 Decrease in A/P 12,000 Decrease in salaries and wages payable 8,500 Increase in taxes payable 11,000 Purchased equipment for cash 125,000 Using the indirect method, develop the operating activities section of the statement of cash flow. 7. The Athena Corporation experienced a net loss of $43,000 during 20 2 3. In addition, the s increased by $22,000, inventory decreased by $1,500, accounts payable increased by $34,000, taxes payable decreased by $9,500 and the

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88 depreciation expense was $17,000. Determine the amount of cash provided or used by operating activities during the year. Amount: _______________ Provided p rovided or used (circle the correct answer) Answer the following True False true/false questions with respect to adjustments that must be made in the operating activities section when developing the statement of cash flow: 8. T F Increases in A/R are added to net income. 9. T F Increases to A/P are added to net income. 10. T F Increases to Income Tax Payable id deducted from net income. 11. T F Purchase of equipment for cash is deducted from net income. 12. T F Gains on sale of long term assets are added to net income. 13. T F Depreciation expense is deducted from net income. 14. T F Losses on sale of a long term asset are deducted from net income. 15. T F An increase in prepaid expenses is added to net income. 16. During 20 2 3, the Grande Corporation generated $460,000 , in net income $210,000 . During the same year, the depreciation expense totaled $42,000, A/R increased by $22,000, Inventory decreased by $36,000, prepaid expenses increased by $6,000, A/P decreased by $18,000. The G rande corporation also experienced a loss of $6,000 on the sale of a long term asset. The asset was sold for $15,000. Determine how much cash was provided or used by operating activities. Answer _______________ Provided p rovided or used (circle the correct answer) 17. Assume a company uses the indirect method to prepare a statement of cash flow. Amortization of a long term intangible asset is: Commented [CB130]: Not quite sure what this means. Is it 460k gross and 210k net? Clearer wording needed

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89 a ) . is subtracted from net income in the operating activities section b ) . is added as a cash inflow in the investing activities section c ) . is added to net income in the operating activities section d ) . does not appear on the statement of cash flow because it is not an outlay of cash . 18. King Coal provided the following information: Proceeds from the sale of a parcel of land $250,000 Proceeds from the sale of other long term assets $125,000 Proceeds from the issuance of additional common stock $140,000 Purchase long term assets for cash $60,000 Paid a cash dividend $120,000 Received a cash dividend from an investment $12,000 The Determine how much cash was provided or used by investment activities . is: Answer _______________ provided or used by investing activities (circle the right correct answer) 19. Queen Coal provided the following information: Increase in accounts payable $120,000 Increase in bonds payable 400,000 Sale of investments 150,000 Issuance of common stock 180,000 Payment of cash dividends 90,000 Net cash provided by financing activities is: a ) . $280,000 . b ) . $490,000 . c ) . $460,000 . d ) . $520,000 . 20. The Solar Power Company provided the following information for its 20 2 3 fiscal year: Total Sales 105,000 Net Income $60,000 Cash Provided by Operating Activities 31,000 Capital Expenditures 15 , 000 Dividends Paid 4,000 Determine the free cash flow for the 20 2 3 . ? 21. The 20 23 and 20 22 balance sheets for the Woods Corporation are shown below: Commented [CB131]: Font and format for this question should match the others closer spacing, line on which to write answer

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90 The Woods Corporation Balance Sheet End of Year 20 23 20 22 Assets Cash $ 60,000 $30,000 Accounts receivable 20,000 12,000 Merchandise Inventory 30,000 16,000 Prepaid expenses 7,000 10,000 Investments ( long term ) 0 22,000 Equipment 58,000 28,000 Accumulated depreciation equipment (21,000 ) (13,000 ) Total assets $154,000 $105,000 Liabilities and Shareholder Equity Accounts payable $ 25,000 $ 9,000 Bonds payable 45,000 54,000 Common stock 52,000 30,000 Retained earnings 32,000 12,000 Total liabilities and shareholder equity $154,000 $105,000 Additional information for the year 20 23 : 1. Total sales were $230,000. 2. Total net income was $40,000. 3. A long term investment that cost $22,000 was sold for $16,000. 4. Paid total cash dividends of $20,000. Instructions Using the indirect method, prepare a complete statement of cash flow for the year ended December 20 2 3.

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91 Answer:

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92 Chapter 16 Financial Analysis (Horizontal, Vertical, and Ratios) Learning Outcomes: 4. 1. Understand the meaning of financial analysis. 5. 2. Perform horizontal analysis . 6. 3. Perform vertical analysis . 7. 4. Perform ratio analysis . (LO1) Understand the meaning of financial analysis. Evaluate e valuate term debt) Evaluate e valuate . Assess a ssess term debt obligations (solvency) . h H is performing . Identify i dentify problems areas . Help h elp investors choose between different investments . Financial analysis is used by many organizations and professions, such as: Accountants a ccountants Financial f inancial advisors Investment i nvestment advisors Investment i nvestment Bank b ank s Tools used in financial analysis may consist of, but not be limited to: Horizontal h orizontal analysis Vertical v ertical analysis (common sizing) Ratio r atio analysis Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Tab after: 0.5" + Indent at: 0.5"

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93 Financial analysis can be performed on an basis intracompany basis, an intercompany basis, or an industry basis . An intracompany analysis compares a financial numbers over several years. An inter company analysis compares the financial numbers of one company with that those of its competitor(s) . Industry analysis compares the financial numbers of a company to that those of industry averages . To perform financial analysis : a A Ideally the statements should have been audited by an independent CPA firm. Regardless of the type of analysis performed ( ratio, horizontal, or vertical ), the analyst should keep in mind that each type supplements the other. As such, Therefore, the analyst should not depend on or prefer any one type, but rather use the three together. (LO2) Perform Horizontal Analysis Horizontal analysis (HA) is an analytical tool that can be used to analyze historical financial information across multiple accounting periods. It Is i s sometimes referred to as trend analysis, and it can also be used for forecasting or to detect trends , or patterns , and for forecasting . Results from HA can be expressed in nominal (dollars) terms and/or as a percentage. Because it requires selecting a base year and a future year, the analyst needs to be aware that results can be manipulated by the choice of years. For examples, a poor year can be deliberately selected as the base year in order to show significant improvem ent from one year to the next. . The use of horizontal analysis is best shown by example: Study Exercise Example 1: Horizontal Analysis of an Income Statement Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: No underline Formatted: Font: Not Bold Commented [CB132]: Again, paragraphs would be better for flow and consistency with earlier chapters. An statements. It is used by many organizations such as accountnats, financial advisors, investment advisors, and investment banks. The purpose of conducting a financial analysis is to:" and then have your first bulleted list. horizontal, vertical, and ratio. We will examine each of Formatted: Font: (Default) +Body (Calibri) Formatted: Font: (Default) +Body (Calibri) Formatted: Font: (Default) +Body (Calibri) Formatted: Font: (Default) +Body (Calibri) Formatted: Font: (Default) +Body (Calibri) Commented [CB133]: paragraph Formatted: Font: (Default) +Body (Calibri) Commented [CB134]: titled them here

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94 The table below shows a comparative income statement for the years ending 2018 and 2019. The results of HA are shown in the Nominal and % Change columns : . W. Faulkner Company Income Statement Years Ending December 31, 2019 and 2018 2019 2018 Nominal Change % Change $ $ $ Sales 959,000 820,000 139,000 +16.95 Less: Cost of Goods Sold 440,000 360,000 80,000 +22.22 Gross Profit 519,000 460,000 59,000 +12.83 Less: Selling Expenses 76,000 64,000 12,000 +18.75 Administrative Expenses 63,000 51,000 12,000 +23.53 Income from Operations 380,000 345,000 35,000 +10.14 Less: Interest Expense 4,000 4,000 0 0 Income Before Income Taxes 376,000 341,000 35,000 +10.26 Less: Income Taxes @30% 112,800 102,300 10,500 +10.26 Net Income 263,200 238,700 24,500 +10.26 Discussion: Any year can be designated as the base year. In this example, the earlier year (2018) is considered the base year. Looking at Sales: Notice the change is positive: + $139,000. This is the nominal (in dollars) change. To calculate the % change, divide the nominal change by the base year amount: Commented [CB135]: than as a discussion

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95 o % Change = Nominal Change ÷ Base Year Amount X 100% o % Change = +$139,000 ÷ $820,000 x 100% = + 16.95 % The analysis shows that sales increased by 16.95 % between 2018 and 2019. Is this a good thing or not? As is true in many cases, the answer is, it depends. What do you think? (LO3) Vertical Analysis In vertical analysis (also referred to as common sizing ) : , Each account on the income statement and balance sheet is expressed as a percentage of a o For the income statement, the common account is gross or net sales; o For the balance sheet, it is total assets. Hence, each account in the income statement is expressed as a percentage of gross or net sales, along with its nominal (dollar) value, while For the balance sheet each account is expressed as a percentage of total assets, along with its nominal dollar value. Vertical analysis is also can be used for intra company analysis, intercompany analysis, and industry analysis, and it is not limited to the size of the companies . various accounts. Keep in mind that just because the value of an account changes from one accounting ge is good or bad. For example, say administrative and selling expenses were 5% of revenue in 2016 and 7% in 2017. This merits looking into. Why did these expenses increase? The change may be reasonable if sales also increased. However, if sales decreased , while the expenses increased during this time , then management must look elsewhere as to why the expenses increased to explain the increase in expenses . for the various accounts and use vertical analysis to determine if the standard amounts are being met. For example, say the management Commented [CB136]: This is the actual horizontal analysis, right? This should be made more explicit here. Notice the positive change from 2018 to 2019 of includes the formula indented, with the solution below that, also indented, and the final sentence aligned left. Commented [CB137]: What does it depend on? This choice of analysis method. Formatted: No underline Commented [CB138]: paragraph Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: No underline Commented [CB139]: What does this mean? Formatted: Font: Not Bold Formatted: Font: Not Bold

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96 establishes that sales return and allowances should not exceed 1% of revenue. In any period where when the percent is exceeded, management will have to determine why. As you can see, the use of percentages , instead of dollar amounts in the different accounts , facilitates analysis. The exercise example s below show s the student how to do vertical analysis for an income statement and a balance sheet and how to interpret the results. Study Exercise 1 Example 2 : Vertical Analysis of an Income Statement W. Faulkner Company Income Statement

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97 Year Ending December 31, 2019 and 2018 2019 2018 $ $ Sales 959,000 820,000 Less: Cost of Goods Sold 440,000 360,000 Gross Profit 519,000 460,000 Less: Selling Expenses 76,000 64,000 Administrative Expenses 63,000 51,000 Income from Operations 380,000 345,000 Less: Interest Expense 4,000 4,000 Income Before Income Taxes 376,000 341,000 Less: Income Taxes @30% 112,800 102,300 Net Income 263,200 238,700 Solution: W. Faulkner Company Income Statement Year Ending December 31, 2018 2018 2017 $ % $ % Sales 959,000 100.0% 820,000 100.0%

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98 Less: Cost of Goods Sold 440,000 45.9% 360,000 43.9% Gross Profit 519,000 54.1% 460,000 56.1% Less: Selling Expenses 76,000 7.9% 64,000 7.8% Administrative Expenses 63,000 6.6% 51,000 6.2% Income from Operations 380,000 39.6% 345,000 42.1% Less: Interest Expense 4,000 0.4% 4,000 0.5% Income Before Income Taxes 376,000 39.2% 341,000 41.6% Less: Income Taxes @30% 112,800 11.8% 102,300 12.5% Net Income 263,200 27.4% 238,700 29.1% Note that the common sized income statement shows nominal (dollar) values and percentages. Also note how each percentage is calculated. The nominal value of each account is divided by the sales account and multiplied by 100%.

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99 (LO4) Perform Ratio Analysis Ratios are numerical values derived from the specific balances in a company's financial statements for period. Ratios are grouped by categories: liquidity, opera bility, profitability , and solvency. term debt obligations , such as payroll, taxes, suppliers, lenders, etc. its long term debt obligations, while profitability ratios measure the profitability of a company. Table 18 1 List of Ratios, Purpose, and Formulas Ratios Purpose Formula Comment * Liquidity Current Ratio ability to meet its short term debt obligations . Current Assets ÷ Current Liabilities A reasonable value is industry specific. A value > 1 is reasonable (higher is better). E.g., A ratio of 1.25 means a company has $1.25 for every $1.00 of current liabilities. Acid Test or Quick Ratio A stricter measure of a its short term debt obligations (Current Assets Inventory) ÷ Current Liabilities A reasonable value is industry specific. Will be less than the current ratio. Look for a value close to 1 (higher is better). A ratio of 0.5, for example, means a company has $0.50 for every $1.00 of current liabilities. Receivables Turnover A measure of how often during the year a company collects or turns over its accounts receivable . Net credit sales ÷ Average accounts Receivables A reasonable value is industry specific. Generally, higher and/or increasing values are better. Calculated value should be used together with days in receivable and company credit policies. Days in Receivable The averages number of days it takes a company to 365 Days ÷ Receivables Turnover A reasonable value is industry specific. Commented [CB140]: Define operability ratios? Commented [CB141]: This number will be different pending numbering of previous tables

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100 Solvency Debt Ratio A measure of a total debt to total assets as a percent . (Total Liabilities ÷ Total Assets) x 100% A reasonable value is industry specific. A lower percentage (less debt, < 50%) is generally better. A decreasing value is also a positive sign. Times Interest Earned A measure of how many times a company can meet its interest obligations on its debts . (Earnings Before Interest expense and Taxes) ÷ Interest Expense A reasonable value is industry specific. The higher the better. Look for values >>1.0 . Profitability (DIR) collect its accounts receivable s. are 2/10, net 30, a value of less than 30 days is good. Generally, look for a low or decreasing number of days Inventory Turnover A measure of how often a company sells and replaces its inventory . Cost of Goods Sold ÷ Average Inventory A reasonable value is industry specific. Generally, a higher and/or increasing value is better. Calculated value should be used together with days in inventory. Days in Inventory (DII) The average number of days it takes a company to sell its inventory 365 Days ÷ Inventory Turnover A reasonable value is industry specific. Generally, look for a low or decreasing number. Asset Turnover A measure of how well the uses its total assets to generate revenue . Net Sales ÷ Average Total Assets A reasonable value is industry specific. Generally, a higher and/or increasing value is better. E.g., a value of 0.75 means the company is generating $0.75 for every $1.00 of assets. Generally, look for a value near 1.0 . Commented [CB142]: Table headers need to continue here for clarity

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101 Gross Profit Margin A top line measure of profitability after subtracting COGS . (Gross Profit ÷ Net Revenue) x 100% A percentage. The higher the better. Also referred to as Gross Margin. Profit Margin A bottom line bottom line measure of overall profitability . (Net Income ÷ Net Revenue) x 100% A percentage. The higher the better. Return on Assets profits on its investment in total assets . Net Income ÷ Average Total Assets A percentage. The higher the better. Return on Equity profits based on investments by shareholders . { Net Income Preferred Stock Dividends) ÷ Average Shareholder Equity A percentage. The higher the better. Earnings Per Share (EPS) expressed on a per share basis . (Net Income Preferred Stock Dividends) ÷ (Average Number of Shares Outstanding The units are dollars per share. The higher the better. Price to Earnings (P/E) Mostly used for valuing the price of a stock . Market Price of Common Stock Per Share ÷ EPS A unit less number. Payout Ratio Percent of net income a company pays out in dividends . Cash dividends paid to common shareholders ÷ (Net Income Preferred Stock Dividends, if any) A percentage.

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102 Study Exercise 1 Example 3 : The Balance Sheet and Income Statement for the Mary Shelley Company is shown below. Perform a complete ratio analysis for 2018 and 2017, using all of the ratios shown in table 18 1 above, and indicate whether the ratio has improved (I) or deteriorated (D) from one year to the next. Mary Shelley Company Comparative Balance Sheet December 31, 2018 2018 2017 2016 Assets Current Assets Cash $30,000 $40,000 $46,000 Marketable Securities 5,000 6,000 1,000 Accounts Receivables, Net 40,000 45,000 35,000 Merchandise Inventory 50,000 55,000 60,000 Prepaid Expenses 5,000 6,000 4,000 Total Current Assets $130,000 $152,000 $146,000 Land $75,000 $75,000 $75,000 Plant & Equipment, net 105,000 70,000 70,000 Total Assets $310,000 $297,000 $291,000 Liabilities & Shareholder Equity Liabilities Current Liabilities Accounts Payable $90,000 $95,000 $84,000 Deferred Liabilities 15,000 12,000 22,000 Total Current Liabilities $105,000 $107,000 $106,000 Bonds Payable 75,000 80,000 90,000 Commented [CB143]: Should have title like the previous two Commented [CB144]: This number will be different pending numbering of previous tables

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103 Total Liabilities $180,000 $187,000 $196,000 Shareholder Equity Common Stock ($1.00 par value) $25,000 $25,000 $25,000 Additional Paid in Paid in Capital 30,000 30,000 30,000 Retained Earnings 75,000 55,000 40,000 Total Shareholder Equity $130,000 $110,000 $95,000 Total Liabilities & Shareholder Equity $310,000 $297,000 $291,000 Notes: Assume 25,000 shares are outstanding . Assume , in 2018, the shares were trading at $7.00 per share in 2018 . Assume , in 2017, the shares traded at $5.00 per share in 2017. Mary Shelley Company Income Statement December 31, 2018 2018 2017 Sales $900,000 $825,000 Less: Cost of Sales 650,000 600,000 Gross Profit $250,000 $225,000 Less: Selling & Administrative Expenses 180,000 165,000 Income from Operations $70,000 $60,000 Less: Interest Expense 15,000 13,000 Income Before Income Taxes $55,000 $47,000 Less: Income Taxes 19,250 16,450

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104 Solution: Net Income $35,750 $30,550 Notes: In 2018, dividends of $15,750 were paid to common stockholders. In 2017, dividends of $15,550 were paid to common stockholders. Commented [CB145]: Tables need alignment, first table missing column headings

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105 Solvency 2018 2017 I / D Comments Debt Ratio (Total Liabilities ÷ Total Assets) x 100% 58 % 63 % I Going down, but still high. Times Interest Earned ( E arnings B efore I nterest expense and T axes) ÷ Interest Expense 4.67 4.62 I While it did improve, it could be higher. Liquidity Ratios Formula 2018 2017 I / D Comments Liquidity Current Ratio Current Assets ÷ Current Liabilities 1.24 1.42 D While both values are greater than 1, there was a slight reduction, but OK. Acid Test (Quick Ratio) (Cash + Marketable Securities + Net Receivables) ÷ Current Liabilities 0.71 0.89 D In both cases the values were less than 1 and decreased further. May need further review. Receivables Turnover Net credit sales ÷ Average accounts Receivables 21.2 20.67 I In this case , there was a slight improvement. Days in Receivable 365 Days ÷ Receivables Turnover 17.2 days 17.7 days I OK if under normal credit terms. Inventory Turnover Cost of Goods Sold ÷ Average Inventory 12.38 10.43 I In this case, value increased. May be OK depending on the type of inventory. Days in Inventory 365 Days ÷ Inventory Turnover 29.5 days 35 days I In this case, days in inventory decreased. Seems high. Depends on type of inventory. Asset Turnover Net Sales ÷ Average Total Assets 2.97 2.81 I Over 1 is good, considering total assets turnover.

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106 Profitability Ratios Formula 2018 2017 I / D Comments Gross Profit Margin (Gross Profit ÷ Net Revenue) x 100% 27.8 % 27.3 % I Profit Margin (Net Income ÷ Net Revenue) x 100% 3.97 % 3.7 % I Return on Assets Net Income ÷ Average Total Assets 11.79 % 10.07 % I Return on Equity Net Income Preferred Stock Dividends} ÷ Average Shareholder Equity 29.8 % 29.9 % D Earnings Per Share (EPS) (Net Income Preferred Stock Dividends) ÷ ( Average Number of Shares Outstanding $1.43 $1.22 I Price to Earnings (P/E) Market Price of Common Stock Per Share ÷ EPS 4.9 4.1 I Payout Ratio Cash dividends paid to common shareholders ÷ ( Net Income Preferred Stock Dividends, if any) 44 % 50.1 % I Normally should be lower than 50%.

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107 Exercises : 1. The Elias Corporation reported net income for its three most recent years: 2019 $22,000 2018 $21,000 2017 $28,000 Determine the following: Nominal change from 2017 to 2018 Percent change from 2018 to 2019 2. Circle the type of Ratio r atio (L = Liquidity; S = Solvency; P = Profitability) and calculate the ratios for 2019. a. L, S, or P Ratio Current Ratio ____________ i. L, S, or P Ratio Times Interest Earned _________ b. L, S, or P Ratio Acid Test _______________ j. L, S, or P Ratio Gross Margin ________________ c. L, S, or P Ratio Quick Ratio _____________ k. L, S, or P Ratio Profit Margin ________________ d. L, S, or P Ratio Receivables T/O _________ l. L, S, or P Ratio Return on Assets _____________ e. L, S, or P Ratio Days in Receivables ______ m. L, S, or P Ratio Return on Equity _____________ f. L, S, or P Ratio Inventory T/O ___________ n. L, S, or P Ratio Price to Earnings Ratio ________ g. L, S, or P Ratio Days in Inventory ________ o. L, S, or P Ratio Earnings per Share ___________ h. L, S, or P Ratio Debt Ratio ______________ p. L, S, or P Ratio Payout Ratio ________________ 3. Define the following terms: Liquidity Profitability Solvency Commented [CB146]: Format for this chapter should Commented [CB147]: Where are the data needed to make these calculations? Also, space can be saved by instructing students to indicate the letter on the line Formatted: Font: 11 pt Formatted: Font: 11 pt Formatted: Font: (Default) +Body (Calibri), 11 pt

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108 Financial Accounting II Chapter 16 Test Analyzing Companies 22. 1. T F V ertical analysis of the income statement requires that only expense accounts are shown as a percentage of the base amount net sales. 23. 2. T F Analysis of financial information within the same company for different accounting periods is referred to as intercompany analysis. 24. 3. T F financials is referred to as intra company analysis. 25. 4. T F There is no such thing as industry analysis. 26. 5. T F Another name for Vertical v ertical analysis is Common c ommon Size s ize analysis. 27. 6. T F Days in receivables shows how long, on average, it takes a company to sell its Inventory i nventory . 28. 7. T F The current ratio, the acid test , and the quick ratio are all used to ability to meet its short term debt obligations. .. 29. 8. T F The inventory turnover ratio is a measure of the average number of days an item is in inventory before it is sold. 30. 9. Evaluating an increase or decrease in sales, either nominally or as a percent , would most likely be a form of Commented [CB148]: Should match chapter header Formatted: Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Commented [CB149]: True/false section needs to be labeled and realigned Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5"

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109 what type of analysis? Answer _______________________________ 31. 10. In performing a vertical analysis, the base for a current asset is a ) . total current assets . b ) . total assets . c ) . total liabilities and stockholders' equity . d ) . prepaid expenses . 32. 11. In performing a vertical analysis for a service company , the base amount for service revenue is a ) . service revenue . b ) . net income ... c ) . a and b d ) . none of the above . Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5"

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110 33. 12. In vertical analysis, Which of the following is true of vertical analysis? a ) . a A base amount is required for the balance sheet and the income statement . b ) . a A base amount is required for the income statement but not the balance sheet . c ) . the T he same base amount is used for the balance sheet and the income statement . d ) . Nome none of the above is correct . 34. 13. Bella , Inc. shows the following on its income statement (in millions of dollars ): Bella , INC. Income Statement For the Year Ended December 31, 20 23 Net Sales $300 Cost of Goods Sold 120 Gross Profit 180 Operating Expenses 44 Net Income $136 Using vertical analysis, what percentage is assigned to Gross g ross Profit p rofit ? a ) . 30% b ) . 40% c ) . 60% d ) . None n one of the above 35. 14. Bella , Inc. shows the following on its income statement (in millions of dollars ): Bella , INC. Income Statement For the Year Ended December 31, 20 23 Net Sales $300 Cost of Goods Sold 120 Gross Profit 180 Operating Expenses 44 Net Income $136 Using vertical analysis, what percentage is assigned to Operating operating Expenses expenses ? a ) . 14.7% b ) . 24.4% c ) . 32.4% d ) . 36.7% 36. 15. The Steele Corporation reported net income for its three most recent years: Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5"

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111 201 9 $22,000 201 8 $21,000 201 7 $28,000 Determine the following: Nominal change from 201 7 to 201 8 ; 201 8 to 201 9 . Percent change from 201 7 to 201 8 ; 201 8 to 201 9 . Answers: a) Nominal n ominal change from 201 7 to 201 8 _______________ b) Nominal n ominal change from 201 8 to 201 9 _______________ c) Percent p ercent change from 201 7 to 201 8 _______________ d) Percent p ercent change from 201 8 to 201 9 _______________ 37. 16. Define and give the formulae for the following terms: a) Inventory i nventory turnover: b) What is the formula for Inventory Turnover? c) b) Days d ays in Inventory i nventory : d) What is the formula for Days in Inventory? 38. 17. Define and give the formulae for the following terms: a) Receivables r eceivables turnover: b) What is the formula for Receivables Turnover? c) Days d ays in Receivables r eceivables : d) What is the formula for Days in Receivable? 39. 18. goods sold for the year 20 23 was $2,400,000. It s inventory at the Formatted: Space After: 0 pt, Tab stops: Not at 0.52" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5"

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112 beginning and end of the year were $172,000 and $128,000 , respectively. Determine the average inventory turnover and days in inventory. following: Answer: a) Average a verage Inventory i nventory Turnover t urnover _______________ b) Days d ays in Inventory i nventory _______________ 40. 19. The Bellaire Company had net credit sales of $1,825,000 during 20 23 . Its average net receivables for the year were $180,000. The receivables turnover for 20 23 was ____________________ : Answer: a) Receivables Turnover _______________ 41. 20. What does the times interest earn ed ratio show? 42. 21. What is the formula for the times interest earned ratio? 43. 22. The Credence Corporation generated $420,000 of net income for the year. At the beginning and end of the year , the common stockholder equity was $620,000 and $640,000 , respectively. The company also had 3,000 shares of 6%, $50 par value preferred stock. Answer: _______________ 44. 23. s : Credit sales $1,250,000 Cost of Goods Sold $725,000 Interest expense $28,000 Net income $148,000 Income tax expense $69,000 Answer _______________ Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5"

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113 45. 24. If net income is $605,000, income tax expense is $104,000 , and interest expense is $150,000, the times interest earned would be: Answer: _______________ 46. 25. The Quick Corporation has 4,000 shares of 8%, 100 par value preferred stock and 100,000 shares of common stock outstanding. If net income at the end of the year is determined to be $375,000, what were the Quick Answer: _______________ 47. 26. The Gemini Company has 10,000 shares of 12%, $50 par value preferred stock and 300,000 shares of common stock outstanding. Net income for the year is $1,500,000. The earnings per share of common stock is: Answer _______________ 48. 27. The following information was provided by the Noor Corporation for the 20 2 3 and 20 2 2 tax years . Using this information, determine the ratios listed below: : 20 23 20 22 Cash $900,000 $700,000 Accounts Receivable 240,000 290,000 Allowance for doubtful accounts 12,000 14,000 Merchandise Inventory 220,000 190,000 Accounts Payable 205,000 165,000 Salaries and wages payable 22,000 18,000 Long term debt 350,000 280,000 Net sales (all sales on account) 1,050,000 840,000 Cost of goods sold 725,000 640,000 Salaries and wages expense Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5" Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5"

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114 Interest expense 60,000 55,000 Income tax expense 75,000 60,000 Net income 150,000 85,000 Instructions Using the information above, Determine d etermine the following ratios for the most recent year: a) Current Ratio r atio : _______________ b) Acid Test t est : _______________ c) Inventory turnover: _______________ d) Days in Inventory: _______________ e) Receivables turnover: _______________ f) Days in receivables: _______________ g) Times interest earned: _______________ Commented [CB150]: Border and align this table for clarity

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115 49. 28. The following information pertains to was provided by the Clarise Corporation: Clarise Corporation Comparative Balance Sheet End of Year Assets 20 23 20 22 Cash ................................ ................................ ................................ ............. $ 30,000 $ 45,000 Short term investments ................................ ................................ .............. 10,000 40,000 Accounts receivable (net) ................................ ................................ ........... 60,000 50,000 Merchandise Inventory ................................ ................................ ............... 60,000 80,000 Property, plant and equipment (net) ................................ .......................... 200,000 325,000 Total assets ................................ ................................ ................... $360,000 $540,000 Liabilities and shareholder equity Accounts payable ................................ ................................ ........................ $ 15,000 $ 35,000 Short term notes payable ................................ ................................ ........... 25,000 100,000 Bonds payable ................................ ................................ ............................. 75,000 200,000 Common stock ................................ ................................ ............................ 140,000 140,000 Retained earnings ................................ ................................ ....................... 105,000 65,000 Total liabilities and shareholder equity ................................ ........... $360,000 $540,000 Clarise Corporation Income Statement End of Year 20 23 Net sales ................................ ................................ ................................ ...... $600,000 Cost of goods sold ................................ ................................ ....................... 250,000 Formatted: Indent: Left: 0", First line: 0", Numbered + Level: 1 + Numbering Style: 1, 2, 3, + Start at: 1 + Alignment: Left + Aligned at: 0.25" + Indent at: 0.5"

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116 Gross profit ................................ ................................ ................................ . 350,000 Expenses Operating expenses ................................ ................................ .............. $160,000 Interest expense ................................ ................................ ................... 40,000 Total expenses ................................ ................................ ............... 200,000 Income before income taxes ................................ ................................ ...... 150,000 Income tax expense ................................ ................................ .................... 52,500 Net income ................................ ................................ ................................ .. $ 97,500 Additional information: 1. The value of the common stock at year end 20 23 was $20.00 per share. 2. Common stock outstanding was 50,000 shares during each year. 3. Cash dividends of $57,500 were paid in 20 23 . 4. There are no preferred shares outstanding. Instructions Determine the following ratios for the most recent year: a. a) Current ratio _______________ b. b) Acid Test t est _______________ c. c) Quick ratio _______________ d. d) Receivables turnover _______________ e. e) Days in receivables _______________ f. f) Inventory turnover _______________ g. g) Days in inventory _______________ h. h) Times interest earned _______________ i. i) Debt ratio _______________ j. j) Gross Margin m argin _______________ k. k) Profit margin _______________ l. l) Return on assets _______________ Commented [CB151]: Add borders for clarity Formatted: Numbered + Level: 1 + Numbering Style: a, b, c, + Start at: 1 + Alignment: Left + Aligned at: 0.17" + Indent at: 0.5"

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117 m. m) Return on equity _______________ n. n) Price earnings ratio _______________ o. o) Earnings per share _______________ p. p) Payout ratio _______________