Accounting for Business Transactions.docx

Accounting for Business Transactions   True / False Questions   1. Revenues are gross increases in equity from a company's earning activities.  True    False   2. A loss arises when revenues exceed expenses.  True    False   3. Expenses decrease equity and are the costs of assets or services used to earn revenues.  True    False   4. Liabilities are the owner's claim on assets.  True    False   5. Creditor claims on the assets of a firm supersede those of an owner.  True    False   6. Equity represents the claims of the owners on the assets of a company.  True    False   7. Withdrawals are expenses.  True    False   8. The accounting equation can be restated as: Assets - Equity = Liabilities.  True    False   9. A company might provide a service or product on credit. "On credit" implies that the cash receipt will occur on a later date.  True    False   10. Owner's investments are gross increases in equity from a company's earnings activities.  True    False   11. The legitimate claims of a business's creditors take precedence over the claims of the business owner.  True    False   12. Net income is the excess of expenses over revenues, whereas net loss is the excess of revenues over expenses.  True    False   13. An external transaction is an exchange of value within an organization.  True    False   14. An accounting transaction is a recordable event when a measurable exchange of value takes place.  True    False   15. From an accounting perspective, an event is a happening that affects an entity's accounting equation, but cannot be measured.  True    False   16. Owner's equity is increased when cash is received from customers in payment of previously recorded accounts receivable.  True    False   17. Net assets always increase when revenue is recorded.  True    False   18. The net assets of a firm decrease as withdrawals by the owner increase.  True    False   19. The three basic financial statements discussed in this chapter include the balance sheet, income statement, statement of owner's equity.  True    False   20. An income statement reports on investing and financing activities.  True    False   21. A balance sheet covers a period of time such as a month or year.  True    False   22. The balance sheet is also known as the statement of financial position.  True    False   23. The first section of the income statement reports cash from operations.  True    False   24. The balance sheet is based on the accounting equation.  True    False   25. Owner's contributions and withdrawals are reported on the income statement.  True    False   26. An income statement shows the results of operations at a point in time.  True    False   27. The purchase of supplies appears on the balance sheet as an expense.  True    False   28. The income statement reports on operating activities at a point in time.  True    False   29. A net loss on an income statement results when expenses are greater than revenues.  True    False   30. Both Accounts Receivable and Revenue increase when a service is performed and the customer agrees to pay in the future.  True    False   31. The financial statement that reflects the financial position of a firm at a specific point in time is the Statement of Owner's Equity.  True    False   32. Owner investments and withdrawals impact the profitability of the firm.  True    False   33. The statement of Owner's Equity reports the changes in equity of the owner over time.  True    False     Multiple Choice Questions   34. Net Income:  A. Decreases equity. B. Represents the amount of assets owners put into a business. C. Equals assets minus liabilities. D. Is the excess of revenues over expenses. E. Represents owners' claims against assets.   35. If equity is 400,000 and liabilities are $220,000, then assets equal:  A. $180,000. B. $220,000. C. $400,000. D. $620,000. E. $720,000.   36. Resources owned or controlled by a company that are expected to yield benefits are:  A. Assets. B. Revenues. C. Liabilities. D. Owner's Equity. E. Expenses.   37. Gross increases in equity from a company's earnings activities are:  A. Assets. B. Revenues. C. Liabilities. D. Owner's Equity. E. Expenses.   38. Creditors' claims on the assets of a company are called:  A. Net losses. B. Expenses. C. Revenues. D. Equity. E. Liabilities.   39. Decreases in equity that represent costs of assets or services used to earn revenues are called:  A. Liabilities. B. Equity. C. Withdrawals. D. Expenses. E. Owner's Investment.   40. Expenses:  A. Increase equity. B. Are gross increases in equity from a company's earning activity. C. Are the costs of assets or services used to earn revenues. D. Occur when equity exceeds revenue. E. Are creditors' claims on assets.   41. The Phrase "On Credit" indicates:  A. That payment has already been made B. That payment will likely never be collected C. That the customer has a credit balance D. That the customer will need to pay their balance within 10 days E. That cash payment will occur at a later dated   42. If assets are $109,000 and liabilities are $32,000, then equity equals:  A. $32,000. B. $77,000. C. $109,000. D. $141,000. E. $198,000.   43. Another name for equity is:  A. Net income. B. Expenses. C. Net assets. D. Revenue. E. Net loss.   44. The excess of expenses over revenues for a period is:  A. Net assets. B. Equity. C. Net loss. D. Net income. E. A liability.   45. Which of the following statements is true about assets?  A. They are economic resources owned or controlled by the business. B. They are expected to provide future benefits to the business. C. They appear on the balance sheet. D. Claims on them are shared between creditors and owners. E. All of these.   46. Net assets of a company are reflected in which of the following equations:  A. Assets = liabilities + equity. B. Assets + liabilities = equity. C. Assets - liabilities = equity. D. Assets + equity = liabilities. E. None of the above.   47. A payment to an owner is called a(n):  A. Liability. B. Withdrawal. C. Expense. D. Contribution. E. Investment.   48. Liabilities include:  A. accounts payable. B. wages payable. C. unearned revenue. D. loans payable. E. All of the above.   49. Distributions by a business to its owners are called:  A. Withdrawals. B. Expenses. C. Assets. D. Retained earnings. E. Net Income.   50. Equity increase when:  A. An owner contributes cash or assets to the company. B. The company provides a service or sells a product. C. The company expenses exceed their revenues. D. Both a and b. E. All of the above.   51. The assets of a company total $900,000; the liabilities, $200,000. What are the claims of the owners?  A. $900,000. B. $700,000. C. $500,000. D. $200,000. E. It is impossible to determine unless the amount of this owners' investment is known.   52. On June 30 of the current year, the assets and liabilities of Phoenix Phildell are as follows: Cash $20,500; Accounts Receivable, $7,250; Supplies, $650; Equipment, $12,000; Accounts Payable, $9,300. What is the amount of owner's equity as of July 1 of the current year?  A. $8,300 B. $13,050 C. $20,500 D. $31,100 E. $40,400   53. Assets created by selling goods and services on credit are:  A. Accounts payable. B. Accounts receivable. C. Liabilities. D. Expenses. E. Equity.   54. Photometer Company paid off $30,000 of its accounts payable in cash. What would be the effects of this transaction on the accounting equation?  A. Assets, $30,000 increase; liabilities, no effect; equity, $30,000 increase. B. Assets, $30,000 decrease; liabilities, $30,000 decrease; equity, no effect. C. Assets, $30,000 decrease; liabilities, $30,000 increase; equity, no effect. D. Assets, no effect; liabilities, $30,000 decrease; equity, $30,000 increase. E. Assets, $30,000 decrease; liabilities, no effect; equity $30,000 decrease.   55. How would the accounting equation of Boston Company be affected by the billing of a client for $10,000 of consulting work completed?  A. +$10,000 accounts receivable, -$10,000 accounts payable. B. +$10,000 accounts receivable, +$10,000 accounts payable. C. +$10,000 accounts receivable, +$10,000 cash. D. +$10,000 accounts receivable, +$10,000 revenue. E. +$10,000 accounts receivable, -$10,000 revenue.   56. Zion Company has assets of $600,000, liabilities of $250,000, and equity of $350,000. It buys office equipment on credit for $75,000. The effect of this transaction include:  A. Assets increase by $75,000 and expenses increase by $75,000. B. Assets increase by $75,000 and expenses decrease by $75,000. C. Liabilities increase by $75,000 and expenses decrease by $75,000. D. Assets decrease by $75,000 and expenses decrease by $75,000. E. Assets increase by $75,000 and liabilities increase by $75,000.   57. Viscount Company collected $42,000 cash on its accounts receivable. The effects of this transaction as reflected in the accounting equation are:  A. Total assets decrease and equity increases. B. Both total assets and total liabilities decrease. C. Total assets, total liabilities, and equity are unchanged. D. Both total assets and equity are unchanged and liabilities increase. E. Total assets increase and equity decreases.   58. If the liabilities of a business increased $75,000 during a period of time and the owner's equity in the business decreased $30,000 during the same period, the assets of the business must have:  A. Decreased $105,000. B. Decreased $45,000. C. Increased $30,000. D. Increased $45,000. E. Increased $105,000.   59. If the liabilities of a company increased $74,000 during a period of time and equity in the company decreased $19,000 during the same period, what was the effect on the assets?  A. Assets would have increased $55,000. B. Assets would have decreased $55,000. C. Assets would have increased $19,000. D. Assets would have decreased $19,000. E. None of the above.   60. If assets are $365,000 and equity is $120,000, then liabilities are:  A. $120,000. B. $245,000. C. $365,000. D. $485,000. E. $610,000.   61. The statement of owner's equity:  A. Reports how equity changes at a point in time. B. Reports how equity changes over a period of time. C. Reports on cash flows for operating, financing, and investing activities over a period of time. D. Reports on cash flows for operating, financing, and investing activities at a point in time. E. Reports on amounts for assets, liabilities, and equity at a point in time.   62. The financial statement that shows the beginning balance of owner's equity; the changes in equity that resulted from new investments by the owner, net income (or net loss), and withdrawals; and the ending balance, is the:  A. Statement of financial position. B. Statement of cash flows. C. Balance sheet. D. Income statement. E. Statement of owner's equity.   63. Accounts payable appear on which of the following statements?  A. Balance sheet. B. Income statement. C. Statement of owner's equity. D. a and b above. E. All of the above.   64. Determine the net income of a company for which the following information is available for the month of May.     A. $190,000. B. $210,000. C. $230,000. D. $400,000. E. $610,000.   65. Rent expense that is paid with cash appears on which of the following statements?  A. Balance sheet. B. Income statement. C. Statement of owner's equity. D. a and b above. E. All of the above.   66. Fees earned (but not yet received in cash) by a business in exchange for services it provided appear on which of the following statements?  A. Balance sheet. B. Income statement. C. Statement of owner's equity. D. Bank reconciliation report. E. Both A and B.   67. A company's balance sheet shows: cash $22,000, accounts receivable $16,000, office equipment $50,000, and accounts payable $17,000. What is the amount of owner's equity?  A. $17,000. B. $29,000. C. $71,000. D. $88,000. E. $105,000.   68. A company reported total equity of $155,000 on its December 31, 2009 balance sheet. The following information is available for the year ended December 31, 2010:    What are the total assets of the company at December 31, 2010?  A. $25,000. B. $120,000. C. $300,000. D. $325,000. E. $420,000.   69. Fast Forward has beginning equity of $257,000, net income of $51,000, withdrawals of $40,000 and investments by owners of $6,000. Its ending equity is:  A. $223,000. B. $240,000. C. $268,000. D. $274,000. E. $208,000.     Essay Questions   70. Classify each of the following as an Asset, Liability or Owner's Equity account for numbers 1 through 6 into the appropriate category a, b, and c. a. Asset b. Liability c. Owner's Equity Cash Accounts Payable Expenses Notes Payable Revenue Supplies          71. Match each of the following items 1 through 6 with the financial statement a through c in which each item would most likely appear. An item may appear on more than one statement. a. Income statement b. Statement of owner's equity c. Balance sheet Assets. Withdrawals. Revenues. Costs and expenses. Liabilities. Equity.          72. Select the appropriate financial statement for each of the following accounts. (Note: Some items may appear on more than one financial statement.) a. Income statement b. Statement of owner's equity c. Balance sheet Cash Withdrawals Notes payable Fees earned Jay Miller, Capital Accounts receivable Rent Expense Supplies Expense          73. Select the appropriate financial statement for each of the following items. (Note: some items may appear on more than one financial statement.) a. Income statement b. Statement of owner's equity c. Balance sheet Supplies Cash withdrawals by owner. Ahmad Khan, Capital Advertising Expense The purchase of equipment Cash investments by owner Consulting Revenue          74. Identify the accounts affected in the following transactions. Each question will have at least TWO answers. a. Cash b. Equipment c. Accounts Payable d. Accounts Receivable e. Drawing f. Expenses g. Capital h. Revenue Cash received from sale of used office equipment. Sold merchandise to customer on account. Cash received from customers who bought on credit. Cash received from owner contributions. Cash paid for utilities. Bought a machine on credit.          75. Describe the relation between revenues, expenses, and net income.          76. Explain the accounting equation, and define its terms.          77. What distinguishes liabilities from equity?          78. Identify and describe the three financial statements discussed in this chapter.          79. Lorton's Web Services has assets of $265,000 and liabilities of $130,000. Calculate the amount of equity.          80. At the beginning of the year, a company had $120,000 worth of liabilities. During the year, assets increased by $160,000 and at year-end they equaled $360,000. Liabilities decreased $20,000 during the year. Calculate the beginning and ending values of equity.          81. The accounts of Garfield Company with the increases or decreases that occurred during the past year are as follows:    Except for net income, an investment of $3,000 by the owner, and a withdrawal of $11,000 by the owner, no other items affected the owner's capital account. Using the balance sheet equation, compute net income for the past year.          82. A company spent $52,000 in cash for this period's advertising activities. Enter the appropriate amounts that reflect this transaction into the accounting equation format shown below.             83. A company performed testing services for a client. The client paid the company $3,000 in cash. Enter the appropriate amounts that reflect this transaction into the company's accounting equation format shown below.             84. Harry Burton began a Web Consulting practice and completed these transactions during September of the current year:    Show the effects of the above transactions on the accounting equation of Halley Burton, Consultant. Use the following format for your answers. The first item is shown as an example.             85. For each of the following transactions, identify the effects as reflected in the accounting equation. Use "+" to indicate an increase and "-" to indicate a decrease. Use "A", "L", and "E" to indicate assets, liabilities, and equity, respectively. Part A has been completed as an example.             86. The following schedule reflects the first month's transactions of the Bill Blue Real Estate Company:    Provide descriptions for each transaction.          87. Fast Forward reported net income of $17,500 for the past year. At the beginning of the year the company had $200,000 in assets and $70,000 in liabilities. By the end of the year, assets had increased to $300,000. Fast Forward did not pay a dividend or receive additional investment capital. What amount of liabilities existed at the end of the current year?          88. Par Four's total liabilities are $130,000 and its equity is $340,000. Calculate the company's total assets.          89. Determine the ending balance of each applicable account using the beginning balances listed below. Note: This is not intended to balance as all normal accounts are not present.    Samolis LLC bought a. $4500 worth of supplies from Tavella Warehouse on account, b. withdrew $420 for personal use, c. bought $350 in supplies on account, d. received payment of $650 from customers on account, e. paid salaries of $1,290.           On November 1 of the current year, Lois Bell began Lois Bell, Interior Design with an initial investment of $50,000 cash. On November 30 her records showed the following (alphabetically arranged) items and amounts:      90. From the information given, prepare a November income statement.          91. From the information given, prepare a November statement of owner's equity.          92. From the information given, prepare a November 30 balance sheet.          93. The following information is available for the Skate and Boards Rental.    Using the above information prepare an Income Statement and Statement of Owner's Equity, for the Skate and Boards Rental for 2010. Also prepare its Balance Sheet as of December 31, 2010.          94. Data for Madison Realty are as follows:    The owner, Mary Madison, withdrew a total of $30,000 for personal use during 2010. From the above data, prepare Madison Realty's Statement of Owner's Equity for the year ended December 31, 2010.          95. Use the following information to complete an Income Statement for Robbins Concrete for the month of March, 2010: Revenues: $23,950 Advertising Expense: $3,670 Wages Expense: $11,250 Maintenance Expense: $2,310 Insurance Expense: $2,900           The records of Skymaster Airplane Rentals show the following information as of December 31, 2010:    Skymaster withdrew $52,000 during 2010 for personal expenses.   96. Using the above information, prepare an income statement for 2010.          97. Using the above information, prepare a Statement of Owner's Equity for 2010          98. Using the above information, prepare a balance sheet at December 31, 2010.            Fill in the Blank Questions   99. The accounting equation is: Assets = ___________ + Equity.  ________________________________________   100. Assets removed from the business by the business owner for personal use are called ____________.  ________________________________________   101. The ______________ reports revenues earned and expenses incurred by a business over a period of time.  ________________________________________   102. ____________ are the gross increases in equity from a company's earnings activities.  ________________________________________   103. A common characteristic of __________ is their ability to provide expected future benefits to a business.  ________________________________________   104. _____________ is increased by owner's investments and revenues. It is decreased by withdrawals and expenses.  ________________________________________   105. Creditors claims on assets that reflect obligations to transfer assets are called _____________.  ________________________________________   106. The owner's claim on assets is called __________________.  ________________________________________   107. During the accounting period, the assets of a business increased $64,000 and liabilities decreased $17,000; consequently, equity in the business must have __________________ (increased, decreased) $__________________________.  ________________________________________   108. The term __________________ refers to a liability that promises a future outflow of resources.  ________________________________________   109. Using the accounting equation, equity is equal to ________________________.  ________________________________________   110. For a proprietorship, owner investment and revenues increase __________________ and owner withdrawals and expenses decrease it.  ________________________________________   111. A __________________ occurs when expenses exceed revenues.  ________________________________________   112. ______________________ means that payment will occur at a later date.  ________________________________________   113. ________________________________ reports changes in the owner's claim on the business's assets over a period of time.  ________________________________________   114. The _________________________ describes a company's financial position and types and amounts of assets, liabilities, and equity at a point in time.  ________________________________________   115. Indicate the three basic financial statements and the order in which they are prepared._______________________________________________.  ________________________________________   Chapter 02 Accounting for Business Transactions Answer Key     True / False Questions   1. Revenues are gross increases in equity from a company's earning activities.  TRUE   2. A loss arises when revenues exceed expenses.  FALSE   3. Expenses decrease equity and are the costs of assets or services used to earn revenues.  TRUE   4. Liabilities are the owner's claim on assets.  FALSE   5. Creditor claims on the assets of a firm supersede those of an owner.  TRUE   6. Equity represents the claims of the owners on the assets of a company.  TRUE   7. Withdrawals are expenses.  FALSE   8. The accounting equation can be restated as: Assets - Equity = Liabilities.  TRUE   9. A company might provide a service or product on credit. "On credit" implies that the cash receipt will occur on a later date.  TRUE   10. Owner's investments are gross increases in equity from a company's earnings activities.  FALSE   11. The legitimate claims of a business's creditors take precedence over the claims of the business owner.  TRUE   12. Net income is the excess of expenses over revenues, whereas net loss is the excess of revenues over expenses.  FALSE   13. An external transaction is an exchange of value within an organization.  FALSE   14. An accounting transaction is a recordable event when a measurable exchange of value takes place.  TRUE   15. From an accounting perspective, an event is a happening that affects an entity's accounting equation, but cannot be measured.  FALSE   16. Owner's equity is increased when cash is received from customers in payment of previously recorded accounts receivable.  FALSE   17. Net assets always increase when revenue is recorded.  TRUE   18. The net assets of a firm decrease as withdrawals by the owner increase.  TRUE   19. The three basic financial statements discussed in this chapter include the balance sheet, income statement, statement of owner's equity.  TRUE   20. An income statement reports on investing and financing activities.  FALSE   21. A balance sheet covers a period of time such as a month or year.  FALSE   22. The balance sheet is also known as the statement of financial position.  TRUE   23. The first section of the income statement reports cash from operations.  FALSE   24. The balance sheet is based on the accounting equation.  TRUE   25. Owner's contributions and withdrawals are reported on the income statement.  FALSE   26. An income statement shows the results of operations at a point in time.  FALSE   27. The purchase of supplies appears on the balance sheet as an expense.  FALSE   28. The income statement reports on operating activities at a point in time.  FALSE   29. A net loss on an income statement results when expenses are greater than revenues.  TRUE   30. Both Accounts Receivable and Revenue increase when a service is performed and the customer agrees to pay in the future.  TRUE   31. The financial statement that reflects the financial position of a firm at a specific point in time is the Statement of Owner's Equity.  FALSE   32. Owner investments and withdrawals impact the profitability of the firm.  FALSE   33. The statement of Owner's Equity reports the changes in equity of the owner over time.  TRUE     Multiple Choice Questions   34. Net Income:  A. Decreases equity. B. Represents the amount of assets owners put into a business. C. Equals assets minus liabilities. D. Is the excess of revenues over expenses. E. Represents owners' claims against assets.   35. If equity is 400,000 and liabilities are $220,000, then assets equal:  A. $180,000. B. $220,000. C. $400,000. D. $620,000. E. $720,000. Assets = $220,000 + $400,000 = $620,000   36. Resources owned or controlled by a company that are expected to yield benefits are:  A. Assets. B. Revenues. C. Liabilities. D. Owner's Equity. E. Expenses.   37. Gross increases in equity from a company's earnings activities are:  A. Assets. B. Revenues. C. Liabilities. D. Owner's Equity. E. Expenses.   38. Creditors' claims on the assets of a company are called:  A. Net losses. B. Expenses. C. Revenues. D. Equity. E. Liabilities.   39. Decreases in equity that represent costs of assets or services used to earn revenues are called:  A. Liabilities. B. Equity. C. Withdrawals. D. Expenses. E. Owner's Investment.   40. Expenses:  A. Increase equity. B. Are gross increases in equity from a company's earning activity. C. Are the costs of assets or services used to earn revenues. D. Occur when equity exceeds revenue. E. Are creditors' claims on assets.   41. The Phrase "On Credit" indicates:  A. That payment has already been made B. That payment will likely never be collected C. That the customer has a credit balance D. That the customer will need to pay their balance within 10 days E. That cash payment will occur at a later dated   42. If assets are $109,000 and liabilities are $32,000, then equity equals:  A. $32,000. B. $77,000. C. $109,000. D. $141,000. E. $198,000. Feedback: Equity = $109,000 - $32,000 = $77,000   43. Another name for equity is:  A. Net income. B. Expenses. C. Net assets. D. Revenue. E. Net loss.   44. The excess of expenses over revenues for a period is:  A. Net assets. B. Equity. C. Net loss. D. Net income. E. A liability.   45. Which of the following statements is true about assets?  A. They are economic resources owned or controlled by the business. B. They are expected to provide future benefits to the business. C. They appear on the balance sheet. D. Claims on them are shared between creditors and owners. E. All of these.   46. Net assets of a company are reflected in which of the following equations:  A. Assets = liabilities + equity. B. Assets + liabilities = equity. C. Assets - liabilities = equity. D. Assets + equity = liabilities. E. None of the above.   47. A payment to an owner is called a(n):  A. Liability. B. Withdrawal. C. Expense. D. Contribution. E. Investment.   48. Liabilities include:  A. accounts payable. B. wages payable. C. unearned revenue. D. loans payable. E. All of the above.   49. Distributions by a business to its owners are called:  A. Withdrawals. B. Expenses. C. Assets. D. Retained earnings. E. Net Income.   50. Equity increase when:  A. An owner contributes cash or assets to the company. B. The company provides a service or sells a product. C. The company expenses exceed their revenues. D. Both a and b. E. All of the above.   51. The assets of a company total $900,000; the liabilities, $200,000. What are the claims of the owners?  A. $900,000. B. $700,000. C. $500,000. D. $200,000. E. It is impossible to determine unless the amount of this owners' investment is known. $900,000 - $200,000 = $700,000   52. On June 30 of the current year, the assets and liabilities of Phoenix Phildell are as follows: Cash $20,500; Accounts Receivable, $7,250; Supplies, $650; Equipment, $12,000; Accounts Payable, $9,300. What is the amount of owner's equity as of July 1 of the current year?  A. $8,300 B. $13,050 C. $20,500 D. $31,100 E. $40,400   53. Assets created by selling goods and services on credit are:  A. Accounts payable. B. Accounts receivable. C. Liabilities. D. Expenses. E. Equity.   54. Photometer Company paid off $30,000 of its accounts payable in cash. What would be the effects of this transaction on the accounting equation?  A. Assets, $30,000 increase; liabilities, no effect; equity, $30,000 increase. B. Assets, $30,000 decrease; liabilities, $30,000 decrease; equity, no effect. C. Assets, $30,000 decrease; liabilities, $30,000 increase; equity, no effect. D. Assets, no effect; liabilities, $30,000 decrease; equity, $30,000 increase. E. Assets, $30,000 decrease; liabilities, no effect; equity $30,000 decrease.   55. How would the accounting equation of Boston Company be affected by the billing of a client for $10,000 of consulting work completed?  A. +$10,000 accounts receivable, -$10,000 accounts payable. B. +$10,000 accounts receivable, +$10,000 accounts payable. C. +$10,000 accounts receivable, +$10,000 cash. D. +$10,000 accounts receivable, +$10,000 revenue. E. +$10,000 accounts receivable, -$10,000 revenue.   56. Zion Company has assets of $600,000, liabilities of $250,000, and equity of $350,000. It buys office equipment on credit for $75,000. The effect of this transaction include:  A. Assets increase by $75,000 and expenses increase by $75,000. B. Assets increase by $75,000 and expenses decrease by $75,000. C. Liabilities increase by $75,000 and expenses decrease by $75,000. D. Assets decrease by $75,000 and expenses decrease by $75,000. E. Assets increase by $75,000 and liabilities increase by $75,000.   57. Viscount Company collected $42,000 cash on its accounts receivable. The effects of this transaction as reflected in the accounting equation are:  A. Total assets decrease and equity increases. B. Both total assets and total liabilities decrease. C. Total assets, total liabilities, and equity are unchanged. D. Both total assets and equity are unchanged and liabilities increase. E. Total assets increase and equity decreases.   58. If the liabilities of a business increased $75,000 during a period of time and the owner's equity in the business decreased $30,000 during the same period, the assets of the business must have:  A. Decreased $105,000. B. Decreased $45,000. C. Increased $30,000. D. Increased $45,000. E. Increased $105,000. Change in Assets = Change in Liabilities + Change in Owner's Equity Change in Assets = $75,000 + (-$30,000) = +$45,000   59. If the liabilities of a company increased $74,000 during a period of time and equity in the company decreased $19,000 during the same period, what was the effect on the assets?  A. Assets would have increased $55,000. B. Assets would have decreased $55,000. C. Assets would have increased $19,000. D. Assets would have decreased $19,000. E. None of the above. Assets = Liabilities + Equity Assets = $74,000 + (-$19,000) = $55,000   60. If assets are $365,000 and equity is $120,000, then liabilities are:  A. $120,000. B. $245,000. C. $365,000. D. $485,000. E. $610,000. Liabilities = $365,000 - $120,000 = $245,000   61. The statement of owner's equity:  A. Reports how equity changes at a point in time. B. Reports how equity changes over a period of time. C. Reports on cash flows for operating, financing, and investing activities over a period of time. D. Reports on cash flows for operating, financing, and investing activities at a point in time. E. Reports on amounts for assets, liabilities, and equity at a point in time.   62. The financial statement that shows the beginning balance of owner's equity; the changes in equity that resulted from new investments by the owner, net income (or net loss), and withdrawals; and the ending balance, is the:  A. Statement of financial position. B. Statement of cash flows. C. Balance sheet. D. Income statement. E. Statement of owner's equity.   63. Accounts payable appear on which of the following statements?  A. Balance sheet. B. Income statement. C. Statement of owner's equity. D. a and b above. E. All of the above.   64. Determine the net income of a company for which the following information is available for the month of May.     A. $190,000. B. $210,000. C. $230,000. D. $400,000. E. $610,000. Expenses: $180,000 + $10,000 + $20,000 = $210,000 Net income = $400,000 - $210,000 = $190,000   65. Rent expense that is paid with cash appears on which of the following statements?  A. Balance sheet. B. Income statement. C. Statement of owner's equity. D. a and b above. E. All of the above.   66. Fees earned (but not yet received in cash) by a business in exchange for services it provided appear on which of the following statements?  A. Balance sheet. B. Income statement. C. Statement of owner's equity. D. Bank reconciliation report. E. Both A and B.   67. A company's balance sheet shows: cash $22,000, accounts receivable $16,000, office equipment $50,000, and accounts payable $17,000. What is the amount of owner's equity?  A. $17,000. B. $29,000. C. $71,000. D. $88,000. E. $105,000. Assets = $22,000 + $16,000 + $50,000 = $88,000 Liabilities = $17,000 Owner's Equity = $88,000 - $17,000 = $71,000   68. A company reported total equity of $155,000 on its December 31, 2009 balance sheet. The following information is available for the year ended December 31, 2010:    What are the total assets of the company at December 31, 2010?  A. $25,000. B. $120,000. C. $300,000. D. $325,000. E. $420,000. Net income = $325,000 - $180,000 = $145,000 2010 equity = $145,000 + $155,000 = $300,000 2010 assets = $300,000 + $120,000 = $420,000   69. Fast Forward has beginning equity of $257,000, net income of $51,000, withdrawals of $40,000 and investments by owners of $6,000. Its ending equity is:  A. $223,000. B. $240,000. C. $268,000. D. $274,000. E. $208,000. $257,000 + $51,000 - $40,000 + $6,000 = $274,000     Essay Questions   70. Classify each of the following as an Asset, Liability or Owner's Equity account for numbers 1 through 6 into the appropriate category a, b, and c. a. Asset b. Liability c. Owner's Equity Cash Accounts Payable Expenses Notes Payable Revenue Supplies  1. a, 2. b, 3. c, 4. b, 5. c, 6. a   71. Match each of the following items 1 through 6 with the financial statement a through c in which each item would most likely appear. An item may appear on more than one statement. a. Income statement b. Statement of owner's equity c. Balance sheet Assets. Withdrawals. Revenues. Costs and expenses. Liabilities. Equity.  1. c, 2. b, 3. a, 4. a, 5. c. 6. b. & c.   72. Select the appropriate financial statement for each of the following accounts. (Note: Some items may appear on more than one financial statement.) a. Income statement b. Statement of owner's equity c. Balance sheet Cash Withdrawals Notes payable Fees earned Jay Miller, Capital Accounts receivable Rent Expense Supplies Expense  1. c, 2. b, 3. c, 4. a, 5. b, c, 6. c, 7. a, 8. a   73. Select the appropriate financial statement for each of the following items. (Note: some items may appear on more than one financial statement.) a. Income statement b. Statement of owner's equity c. Balance sheet Supplies Cash withdrawals by owner. Ahmad Khan, Capital Advertising Expense The purchase of equipment Cash investments by owner Consulting Revenue  1. c, 2. b, 3. b, c, 4. a, 5. c, 6. b, 7. a   74. Identify the accounts affected in the following transactions. Each question will have at least TWO answers. a. Cash b. Equipment c. Accounts Payable d. Accounts Receivable e. Drawing f. Expenses g. Capital h. Revenue Cash received from sale of used office equipment. Sold merchandise to customer on account. Cash received from customers who bought on credit. Cash received from owner contributions. Cash paid for utilities. Bought a machine on credit.  1. a, b, 2. h, d, 3. a, d, 4. a, g, 5. a, f, 6. b, c   75. Describe the relation between revenues, expenses, and net income.  Revenues are the gross increases in equity from a company's earnings activities. Expenses are the costs of assets or services used to earn revenues. Net income is the excess of revenues over expenses.   76. Explain the accounting equation, and define its terms.  The accounting equation is stated as: Assets = Liabilities + Equity. Assets are resources owned or controlled by a business. Creditors' claims on assets are called liabilities. The owner's claim on assets is called equity. The accounting equation shows that the ownership of business assets can be shared between creditors and owners.   77. What distinguishes liabilities from equity?  Liabilities are creditors' claims on assets. They reflect obligations to transfer assets or provide products or services to others. Equity is owner's claim to assets. Equity is also called net assets or residual interest.   78. Identify and describe the three financial statements discussed in this chapter.  The four basic financial statements are the balance sheet, income statement, statement of owner's equity, and statement of cash flows. The balance sheet describes the company's financial position and lists the types and amounts of assets, liabilities, and equity at a point in time. The income statement describes the company's revenues, expenses, and net income over a period of time. The statement of owner's equity explains changes in equity from net income or loss, and from owner investments and withdrawals over a period of time.   79. Lorton's Web Services has assets of $265,000 and liabilities of $130,000. Calculate the amount of equity.       80. At the beginning of the year, a company had $120,000 worth of liabilities. During the year, assets increased by $160,000 and at year-end they equaled $360,000. Liabilities decreased $20,000 during the year. Calculate the beginning and ending values of equity.  Beginning equity = $80,000 Ending equity = $260,000   81. The accounts of Garfield Company with the increases or decreases that occurred during the past year are as follows:    Except for net income, an investment of $3,000 by the owner, and a withdrawal of $11,000 by the owner, no other items affected the owner's capital account. Using the balance sheet equation, compute net income for the past year.  To maintain the balance sheet equation, Assets = Liabilities + Equity, net income must be $23,000.   82. A company spent $52,000 in cash for this period's advertising activities. Enter the appropriate amounts that reflect this transaction into the accounting equation format shown below.          83. A company performed testing services for a client. The client paid the company $3,000 in cash. Enter the appropriate amounts that reflect this transaction into the company's accounting equation format shown below.          84. Harry Burton began a Web Consulting practice and completed these transactions during September of the current year:    Show the effects of the above transactions on the accounting equation of Halley Burton, Consultant. Use the following format for your answers. The first item is shown as an example.          85. For each of the following transactions, identify the effects as reflected in the accounting equation. Use "+" to indicate an increase and "-" to indicate a decrease. Use "A", "L", and "E" to indicate assets, liabilities, and equity, respectively. Part A has been completed as an example.          86. The following schedule reflects the first month's transactions of the Bill Blue Real Estate Company:    Provide descriptions for each transaction.  1. Investment of cash in business by owner performed services for cash. 2. Purchased equipment for cash. 3. Purchased supplies on credit. 4. Performed services for cash investment of cash in business by owner. 5. Performed services for both cash and on credit. 6. Paid accounts payable. 7. Received cash for an account receivable. 8. Used supplies in business. 9. Withdrawal of cash from business by owner for personal use or paid expense of business.   87. Fast Forward reported net income of $17,500 for the past year. At the beginning of the year the company had $200,000 in assets and $70,000 in liabilities. By the end of the year, assets had increased to $300,000. Fast Forward did not pay a dividend or receive additional investment capital. What amount of liabilities existed at the end of the current year?  $200,000 = 70,000 + $130,000 end of prior year $300,000 = L + $130,000 + $17,500 Liabilities = $152,500   88. Par Four's total liabilities are $130,000 and its equity is $340,000. Calculate the company's total assets.  $130,000 + $340,000 = $470,000.   89. Determine the ending balance of each applicable account using the beginning balances listed below. Note: This is not intended to balance as all normal accounts are not present.    Samolis LLC bought a. $4500 worth of supplies from Tavella Warehouse on account, b. withdrew $420 for personal use, c. bought $350 in supplies on account, d. received payment of $650 from customers on account, e. paid salaries of $1,290.  Cash: $42,400 -b. $420 + d. $650 -e. $1,290 = $41,340 Supplies: $350 + a. $4,500 + c. $350 = $5,200 Accounts Receivable: $5,000 -e. $650 = $4,350 Drawing: $350 + b. $420 = $770 Accounts Payable: a. $4,500 +$1,200 + c. $350 = $6,050 Expenses: $4,000 + e. $1,290 = $5,290    On November 1 of the current year, Lois Bell began Lois Bell, Interior Design with an initial investment of $50,000 cash. On November 30 her records showed the following (alphabetically arranged) items and amounts:      90. From the information given, prepare a November income statement.       91. From the information given, prepare a November statement of owner's equity.       92. From the information given, prepare a November 30 balance sheet.       93. The following information is available for the Skate and Boards Rental.    Using the above information prepare an Income Statement and Statement of Owner's Equity, for the Skate and Boards Rental for 2010. Also prepare its Balance Sheet as of December 31, 2010.       94. Data for Madison Realty are as follows:    The owner, Mary Madison, withdrew a total of $30,000 for personal use during 2010. From the above data, prepare Madison Realty's Statement of Owner's Equity for the year ended December 31, 2010.       95. Use the following information to complete an Income Statement for Robbins Concrete for the month of March, 2010: Revenues: $23,950 Advertising Expense: $3,670 Wages Expense: $11,250 Maintenance Expense: $2,310 Insurance Expense: $2,900        The records of Skymaster Airplane Rentals show the following information as of December 31, 2010:    Skymaster withdrew $52,000 during 2010 for personal expenses.   96. Using the above information, prepare an income statement for 2010.       97. Using the above information, prepare a Statement of Owner's Equity for 2010       98. Using the above information, prepare a balance sheet at December 31, 2010.         Fill in the Blank Questions   99. The accounting equation is: Assets = ___________ + Equity.  Liabilities   100. Assets removed from the business by the business owner for personal use are called ____________.  Withdrawals   101. The ______________ reports revenues earned and expenses incurred by a business over a period of time.  Income statement   102. ____________ are the gross increases in equity from a company's earnings activities.  Revenues   103. A common characteristic of __________ is their ability to provide expected future benefits to a business.  Assets   104. _____________ is increased by owner's investments and revenues. It is decreased by withdrawals and expenses.  Owner's equity   105. Creditors claims on assets that reflect obligations to transfer assets are called _____________.  Liabilities   106. The owner's claim on assets is called __________________.  Equity   107. During the accounting period, the assets of a business increased $64,000 and liabilities decreased $17,000; consequently, equity in the business must have __________________ (increased, decreased) $__________________________.  Increased $81,000   108. The term __________________ refers to a liability that promises a future outflow of resources.  Payable   109. Using the accounting equation, equity is equal to ________________________.  Assets minus liabilities   110. For a proprietorship, owner investment and revenues increase __________________ and owner withdrawals and expenses decrease it.  Equity   111. A __________________ occurs when expenses exceed revenues.  Net loss   112. ______________________ means that payment will occur at a later date.  On Credit   113. ________________________________ reports changes in the owner's claim on the business's assets over a period of time.  The statement of owner's equity   114. The _________________________ describes a company's financial position and types and amounts of assets, liabilities, and equity at a point in time.  Balance Sheet   115. Indicate the three basic financial statements and the order in which they are prepared._______________________________________________.  Income Statement, Statement of Owners' Equity, Balance Sheet   Chapter 2 Accounting for Business Combinations 1. SFAS 141R requires that all business combinations be accounted for using a. the pooling of interests method. b. the acquisition method. c. either the acquisition or the pooling of interests methods. neither the acquisition nor the pooling of interests methods. 2. Under the acquisition method, if the fair values of identifiable net assets exceed the value implied by the purchase Pratt of the acquired company, the excess should be a. accounted for as goodwill. b. allocated to reduce current and long-lived assets. c. allocated to reduce current assets and classify any remainder as an extraordinary gain. d. allocated to reduce any previously recorded goodwill and classify any remainder as an ordinary gain. 3. In a period in which an impairment loss occurs, SFAS No. 142 requires each of the following note disclosures except a. a description of the facts and circumstances leading to the impairment. b. the amount of goodwill by reporting segment. c. the method of determining the fair value of the reporting unit. d. the amounts of any adjustments made to impairment estimates from earlier periods, if significant. 4. Once a reporting unit is determined to have a fair value below its carrying value, the goodwill impairment loss is computed by comparing the a. fair value of the reporting unit and the fair value of the identifiable net assets. b. carrying value of the goodwill to its implied fair value. c. fair value of the reporting unit to its carrying amount (goodwill included). d. carrying value of the reporting unit to the fair value of the identifiable net assets. 5. SFAS 141R requires that the acquirer disclose each of the following for each material business combination except the a. name and a description of the acquiree. b. percentage of voting equity instruments acquired. c. fair value of the consideration transferred. d. Each of the above is a required disclosure 6. In a leveraged buyout, the portion of the net assets of the new corporation provided by the management group is recorded at a. appraisal value. b. book value. c. fair value. d. lower of cost or market. 7. When the acquisition price of an acquired firm is less than the fair value of the identifiable net assets, all of the following are recorded at fair value except a. Assumed liabilities. b. Current assets. c. Long-lived assets. d. Each of the above is recorded at fair value. 8. Under SFAS 141R, a. both direct and indirect costs are to be capitalized. b. both direct and indirect costs are to be expensed. c. direct costs are to be capitalized and indirect costs are to be expensed. d. indirect costs are to be capitalized and direct costs are to be expensed. 9. A business combination is accounted for properly as an acquisition. Which of the following expenses related to effecting the business combination should enter into the determination of net income of the combined corporation for the period in which the expenses are incurred? Security Overhead allocated issue costs to the merger a. Yes Yes b. Yes No c. No Yes d. No No 10. In a business combination, which of the following costs are assigned to the valuation of the security? Professional or Security consulting fees issue costs a. Yes Yes b. Yes No c. No Yes d. No No 11. Par Company and Sub Company were combined in an acquisition transaction. Par was able to acquire Sub at a bargain Pratt. The sum of the fair values of identifiable assets acquired less the fair value of liabilities assumed exceeded the cost to Par. After eliminating previously recorded goodwill, there was still some "negative goodwill." Proper accounting treatment by Par is to report the amount as a. paid-in capital. b. a deferred credit, which is amortized. c. an ordinary gain. d. an extraordinary gain. 12. With an acquisition, direct and indirect expenses are a. expensed in the period incurred. b. capitalized and amortized over a discretionary period. c. considered a part of the total cost of the acquired company. d. charged to retained earnings when incurred. 13. In a business combination accounted for as an acquisition, how should the excess of fair value of net assets acquired over the consideration paid be treated? a. Amortized as a credit to income over a period not to exceed forty years. b. Amortized as a charge to expense over a period not to exceed forty years. c. Amortized directly to retained earnings over a period not to exceed forty years. d. Recorded as an ordinary gain. 14. P Corporation issued 10,000 shares of common stock with a fair value of $25 per share for all the outstanding common stock of S Company in a business combination properly accounted for as an acquisition. The fair value of S Company's net assets on that date was $220,000. P Company also agreed to issue an additional 2,000 shares of common stock with a fair value of $50,000 to the former stockholders of S Company as an earnings contingency. Assuming that the contingency is expected to be met, the $50,000 fair value of the additional shares to be issued should be treated as a(n) a. decrease in noncurrent liabilities of S Company that were assumed by P Company. b. decrease in consolidated retained earnings. c. increase in consolidated goodwill. d. decrease in consolidated other contributed capital. 15. On February 5, Pryor Corporation paid $1,600,000 for all the issued and outstanding common stock of Shaw, Inc., in a transaction properly accounted for as an acquisition. The book values and fair values of Shaw's assets and liabilities on February 5 were as follows Book Value Fair Value Cash $ 160,000 $ 160,000 Receivables (net) 180,000 180,000 Inventory 315,000 300,000 Plant and equipment (net) 820,000 920,000 Liabilities (350,000) (350,000) Net assets $1,125,000 $1,210,000 What is the amount of goodwill resulting from the business combination? a. $-0-. b. $475,000. c. $85,000. d. $390,000. 16. P Company purchased the net assets of S Company for $225,000. On the date of P's purchase, S Company had no investments in marketable securities and $30,000 (book and fair value) of liabilities. The fair values of S Company's assets, when acquired, were Current assets $ 120,000 Noncurrent assets 180,000 Total $300,000 How should the $45,000 difference between the fair value of the net assets acquired ($270,000) and the consideration paid ($225,000) be accounted for by P Company? a. The noncurrent assets should be recorded at $ 135,000. b. The $45,000 difference should be credited to retained earnings. c. The current assets should be recorded at $102,000, and the noncurrent assets should be recorded at $153,000. An ordinary gain of $45,000 should be recorded. 17. If the value implied by the purchase price of an acquired company exceeds the fair values of identifiable net assets, the excess should be allocated to reduce any previously recorded goodwill and classify any remainder as an ordinary gain. allocated to reduce current and long-lived assets. allocated to reduce long-lived assets. accounted for as goodwill. 18. P Co. issued 5,000 shares of its common stock, valued at $200,000, to the former shareholders of S Company two years after S Company was acquired in an all-stock transaction. The additional shares were issued because P Company agreed to issue additional shares of common stock if the average post combination earnings over the next two years exceeded $500,000. P Company will treat the issuance of the additional shares as a (decrease in) consolidated retained earnings. consolidated goodwill. consolidated paid-in capital. non-current liabilities of S Company assumed by P Company. 19. In a business combination in which the total fair value of the identifiable assets acquired over liabilities assumed is greater than the consideration paid, the excess fair value is: classified as an extraordinary gain. allocated first to eliminate any previously recorded goodwill, and any remaining excess over the consideration paid is classified as an ordinary gain. allocated first to reduce proportionately non-current assets then to non-monetary current assets, and any remaining excess over cost is classified as a deferred credit. allocated first to reduce proportionately non-current, depreciable assets to zero, and any remaining excess over cost is classified as a deferred credit. 20. The first step in determining goodwill impairment involves comparing the implied value of a reporting unit to its carrying amount (goodwill excluded). fair value of a reporting unit to its carrying amount (goodwill excluded). implied value of a reporting unit to its carrying amount (goodwill included). fair value of a reporting unit to its carrying amount (goodwill included). 21. If an impairment loss is recorded on previously recognized goodwill due to the transitional goodwill impairment test, the loss should be treated as a(n): loss from a change in accounting principles. extraordinary loss loss from continuing operations. loss from discontinuing operations. 22. P Company acquires all of the voting stock of S Company for $930,000 cash. The book values of S Company’s assets are $800,000, but the fair values are $840,000 because land has a fair value above its book value. Goodwill from the combination is computed as: $130,000. $90,000. $40,000. $0. 23. Under SFAS 141R, what value of the assets and liabilities are reflected in the financial statements on the acquisition date of a business combination? Carrying value Fair value Book value Average value Use the following information to answer questions 24 & 25. Pratt Company issued 24,000 shares of its $20 par value common stock for the net assets of Sele Company in business combination under which Sele Company will be merged into Pratt Company. On the date of the combination, Pratt Company common stock had a fair value of $30 per share. Balance sheets for Pratt Company and Sele Company immediately prior to the combination were as follows: Pratt Sele Current Assets $1,314,000 $192,000 Plant and Equipment (net) 1,725,000 408,000 Total $3,039,000 $600,000 Liabilities $ 900,000 $150,000 Common Stock, $20 par value 1,650,000 240,000 Other Contributed Capital 218,000 60,000 Retained Earnings 271,000 150,000 Total $3,039,000 $600,000 24. If the business combination is treated as an acquisition and Sele Company’s net assets have a fair value of $686,400, Pratt Company’s balance sheet immediately after the combination will include goodwill of $30,600. $38,400. $33,600. $56,400. 25. If the business combination is treated as an acquisition and the fair value of Sele Company’s current assets is $270,000, its plant and equipment is $726,000, and its liabilities are $168,000, Pratt Company’s financial statements immediately after the combination will include Negative goodwill of $108,000. Plant and equipment of $2,451,000. Plant and equipment of $2,343,000. An ordinary gain of $108,000. 26. On May 1, 2011, the Phil Company paid $1,200,000 for 80% of the outstanding common stock of Sage Corporation in a transaction properly accounted for as an acquisition. The recorded assets and liabilities of Sage Corporation on May 1, 2011, follow: Cash $100,000 Inventory 200,000 Property & equipment (Net of accumulated depreciation) 800,000 Liabilities (160,000) On May 1, 2011, it was determined that the inventory of Sage had a fair value of $220,000 and the property and equipment (net) has a fair value of $1,200,000. What is the amount of goodwill resulting from the business combination? $0. $112,000. $140,000. $28,000. Use the following information to answer questions 27 & 28. Posch Company issued 12,000 shares of its $20 par value common stock for the net assets of Sato Company in a business combination under which Sato Company will be merged into Posch Company. On the date of the combination, Posch Company common stock had a fair value of $30 per share. Balance sheets for Posch Company and Sato Company immediately prior to the combination were as follows: Posch Sato Current Assets $ 657,000 $ 96,000 Plant and Equipment (net) 863,000 204,000 Total $1,520,000 $300,000 Liabilities $ 450,000 $ 75,000 Common Stock, $20 par value 825,000 120,000 Other Contributed Capital 109,000 30,000 Retained Earnings 136,000 75,000 Total $1,520,000 $300,000 27. If the business combination is treated as an acquisition and Sato Company’s net assets have a fair value of $343,200, Posch Company’s balance sheet immediately after the combination will include goodwill of $15,300. $19,200. $16,800. $28,200. 28. If the business combination is treated as an acquisition and the fair value of Sato Company’s current assets is $135,000, its plant and equipment is $363,000, and its liabilities are $84,000, Posch Company’s financial statements immediately after the combination will include Negative goodwill of $54,000. Plant and equipment of $1,226,000. Plant and equipment of $1,172,000. An ordinary gain of $54,000. 29. Following its acquisition of the net assets of Sandy Company, Potter Company assigned goodwill of $60,000 to one of the reporting divisions. Information for this division follows: Carrying Amount Fair Value Cash $ 20,000 $20,000 Inventory 35,000 40,000 Equipment 125,000 160,000 Goodwill 60,000 Accounts Payable 30,000 30,000 Based on the preceding information, what amount of goodwill will be reported for this division if its fair value is determined to be $200,000?  $0 $60,000 $30,000 $10,000  30. The fair value of net identifiable assets exclusive of goodwill of a reporting unit of X Company is $300,000. On X Company's books, the carrying value of this reporting unit's net assets is $350,000, including $60,000 goodwill. If the fair value of the reporting unit is $335,000, what amount of goodwill impairment will be recognized for this unit?  $0 $10,000 $25,000 $35,000  31. The fair value of net identifiable assets of a reporting unit exclusive of goodwill of Y Company is $270,000. The carrying value of the reporting unit's net assets on Y Company's books is $320,000, including $50,000 goodwill. If the reported goodwill impairment for the unit is $10,000, what would be the fair value of the reporting unit?  $320,000 $310,000 $270,000 $290,000 32. Potter Corporation acquired Sims Company through an exchange of common shares. All of Sims’ assets and liabilities were immediately transferred to Potter. Potter Company’s common stock was trading at $20 per share at the time of exchange. The following selected information is also available: Potter Company What number of shares was issued at the time of the exchange? 5,000 17,500 12,500 10,000 2-1 Balance sheet information for Seitz Corporation at January 1, 2011, is summarized as follows: Current assets $ 920,000 Liabilities $ 1,200,000 Plant assets 1,800,000 Capital stock $10 par 800,000 Retained earnings 720,000 $2,720,000 $ 2,720,000 Seitz’s assets and liabilities are fairly valued except for plant assets that are undervalued by $200,000. On January 2, 2011, Pell Corporation issues 80,000 shares of its $10 par value common stock for all of Seitz’s net assets and Seitz is dissolved. Market quotations for the two stocks on this date are: Pell common: $28 Seitz common: $19 Pell pays the following fees and costs in connection with the combination: Finder’s fee $10,000 Costs of registering and issuing stock 5,000 Legal and accounting fees 6,000 Required: Calculate Pell’s investment cost of Seitz Corporation. Calculate any goodwill from the business combination. 2-2 Peterson Corporation purchased the net assets of Scarberry Corporation on January 2, 2011 for $560,000 and also paid $20,000 in direct acquisition costs. Scarberry’s balance sheet on January 1, 2011 was as follows: Accounts receivable-net $ 180,000 Current liabilities $ 70,000 Inventory 360,000 Long term debt 160,000 Land 40,000 Common stock ($1 par) 20,000 Building-net 60,000 Paid-in capital 430,000 Equipment-net 80,000 Retained earnings 40,000 Total assets $ 720,000 Total liab. & equity $ 720,000 Fair values agree with book values except for inventory, land, and equipment, which have fair values of $400,000, $50,000 and $70,000, respectively. Scarberry has patent rights valued at $20,000. Required: Prepare Peterson’s general journal entry for the cash purchase of Scarberry’s net assets. Assume Peterson Corporation purchased the net assets of Scarberry Corporation for $500,000 rather than $560,000, prepare the general journal entry. 2-3 Pyle Company acquired the assets (except cash) and assumed the liabilities of Sand Company on January 1, 2011, paying $2,600,000 cash. Immediately prior to the acquisition, Sand Company's balance sheet was as follows: BOOK VALUE FAIR VALUE Accounts receivable (net) $ 240,000 $ 220,000 Inventory 290,000 320,000 Land 960,000 1,508,000 Buildings (net) 1,020,000 1,392,000 Total $2,510,000 $3,440,000 Accounts payable $ 270,000 $ 270,000 Note payable 600,000 600,000 Common stock, $5 par 420,000 Other contributed capital 640,000 Retained earnings 580,000 Total $2,510,000 Pyle Company agreed to pay Sand Company's former stockholders $200,000 cash in 2012 if post- combination earnings of the combined company reached $1,000,000 during 2011. Required: A. Prepare the journal entry necessary for Pyle Company to record the acquisition on January 1, 2011. It is expected that the earnings target is likely to be met. B. Prepare the journal entry necessary for Pyle Company in 2012 assuming the earnings contingency was not met. 2-4 Condensed balance sheets for Payne Company and Sigle Company on January 1, 2011 are as follows: Payne Sigle Current Assets $ 440,000 $200,000 Plant and Equipment (net) 1,080,000 340,000 Total Assets $1,520,000 $540,000 Total Liabilities $ 230,000 $ 80,000 Common Stock, $10 par value 840,000 240,000 Other Contributed Capital 300,000 130,000 Retained Earnings 150,000 90,000 Total Equities $1,520,000 $540,000 On January 1, 2011 the stockholders of Payne and Sigle agreed to a consolidation whereby a new corporation, Lawson Company, would be formed to consolidate Payne and Sigle. Lawson Company issued 70,000 shares of its $20 par value common stock for the net assets of Payne and Sigle. On the date of consolidation, the fair values of Payne's and Sigle's current assets and liabilities were equal to their book values. The fair value of plant and equipment for each company was: Payne, $1,270,000; Sigle, $360,000. An investment banking house estimated that the fair value of Lawson Company's common stock was $35 per share. Payne will incur $45,000 of direct acquisition costs and $15,000 in stock issue costs. Required: Prepare the journal entries to record the consolidation on the books of Lawson Company assuming that the consolidation is accounted for as an acquisition. The stockholders’ equities of P Corporation and S Corporation were as follows on January 1, 2011: P Corp. S Corp. Common Stock, $1 par $1,000,000 $ 600,000 Other Contributed Capital 2,800,000 1,100,000 Retained Earnings 600,000 340,000 Total Stockholders’ Equity $4,400,000 $2,040,000 On January 2, 2011 P Corp. issued 100,000 of its shares with a market value of $14 per share in exchange for all of S’s shares, and S Corp. was dissolved. P Corp. paid $10,000 to register and issue the new common shares. Required: Prepare the stockholders’ equity section of P Corp. balance sheet after the business combination on January 2, 2011. 2-6 The managers of Petty Company own 10,000 of its 100,000 outstanding common shares. Swann Company is formed by the managers of Petty Company to take over Petty Company in a leveraged buyout. The managers contribute their shares in Petty Company and Swann Company then borrows $675,000 to purchase the remaining 90,000 shares of Petty Company for $600,000; the remaining $75,000 is used for working capital. Petty Company is then merged into Swann Company effective January 1, 2011. Data relevant to Petty Company immediately prior to the leveraged buyout follow: Book Value Fair Value Current Assets $ 90,000 $ 90,000 Plant Assets 255,000 525,000 Liabilities (45,000) (45,000) Stockholders' Equity $300,000 $570,000 Required: A. Prepare journal entries on Swann Company's books to reflect the effects of the leveraged buyout. B. Determine the balance of each of the following immediately after the merger: 1. Current Assets 2. Plant Assets 3. Note Payable 4. Common Stock 2-7 On January 1, 2010, Presley Company acquired the net assets of Sill Company for $1,580,000 cash. The fair value of Sill’s identifiable net assets was $1,310,000 on his date. Presley Company decided to measure goodwill impairment using the present value of future cash flows to estimate the fair value of the reporting unit (Sill). The information for these subsequent years is as follows: 2011 $1,400,000 $1,160,000 $1,190,000 2012 $1,400,000 $1,120,000 $1,210,000 * Identifiable net assets do not include goodwill. Required: : For each year determine the amount of goodwill impairment, if any. : Prepare the journal entries needed each year to record the goodwill impairment (if any) on Presley’s books. 2-8 The following balance sheets were reported on January 1, 2011, for Piper Company and Sieler Company: Piper Sieler Cash $ 150,000 $ 30,000 Inventory 450,000 150,000 Equipment (net) 1,320,000 570,000 Total $1,920,000 $750,000 Total liabilities $ 450,000 $150,000 Common stock, $20 par value 600,000 300,000 Other contributed capital 375,000 105,000 Retained earnings 495,000 195,000 Total $1,920,000 $750,000 Required: Appraisals reveal that the inventory has a fair value $180,000, and the equipment has a current value of $615,000. The book value and fair value of liabilities are the same. Assuming that Piper Company wishes to acquire Sieler for cash in an asset acquisition, determine the following cutoff amounts: A. The purchase price above which Piper would record goodwill. B. The purchase price at which Piper would record a $50,000 gain. C. The purchase price below which Piper would obtain a “bargain.” D. The purchase price at which Piper would record $75,000 of goodwill. 1. SFAS No. 142 requires that goodwill impairment be tested annually for each reporting unit. Discuss the necessary steps of the goodwill impairment test. 2. Briefly describe the different treatment under SFAS 141 vs. SFAS 141R for the following issues: Business definition Acquisitions costs In-process R&D Contingent consideration Short Answer Questions from the Textbook When contingent consideration in an acquisition is based on security prices, how should this contingency be reflected on the acquisition date? If the estimate changes during the measurement period, how is this handled? If the estimate changes after the end of the measurement period, how is this adjustment handled? Why? What are pro forma financial statements? What is their purpose? How would a company determine whether goodwill has been impaired? AOL announced that because of an accounting change (FASB Statements Nos. 141R [ASC 805] and142 [ASC 350]), earnings would be increasing 2002, Veritas Software Corporation’s CFO resigned after claiming to have an MBA from Stanford University. On the other hand, Bausch & Lomb Inc.’s board re-fused the CEO’s offer to resign following a questionable claim to have an MBA. Suppose you have been retained by the board of a company where the CEO has ‘overstated’ credentials. This company has a code of ethics and conduct which over the next 25 years by $5.9 billion a year. What change(s) required by FASB (in SFAS Nos. 141Rand 142) resulted in an increase in AOL’s in-come? Would you expect this increase in earnings to have a positive impact on AOL’s stock price? Why or why not? Business Ethics Question from Textbook There have been several recent cases of a CEO or CFO resigning or being ousted for misrepresenting academic credentials. For instance, during February 2006,the CEO of RadioShack resigned by ‘mutual agreement’ for inflating his educational background. During states that the employee should always do “the right thing.”(a) What is the board of directors’ responsibility in such matters?(b) What arguments would you make to ask the CEO to resign? What damage might be caused if the decision is made to retain the current CEO? ANSWER KEY 1. b 10. c 19. b 28. d 2. d 11. c 20. d 29. d 3. b 12. a 21. a 30. c 4. b 13. d 22. b 31. b 5. d 14. c 23. b 32. c 6. b 15. d 24. c 7. d 16. d 25. d 8. b 17. d 26. c 9. c 18. c 27. c 2-1 A. FMV of shares issued by Pell (80,000 sh × $28) = $2,240,000 B. Investment cost from Part A $2,240,000 Less: Fair value of Seitz’s net assets ($2,720,000+$200,000–$1,200,000) 1,720,000 Goodwill from investment $ 520,000 2-2 A. Accounts Receivable 180,000 Inventory 400,000 Land 50,000 Building 60,000 Equipment 70,000 Patent 20,000 Goodwill 10,000 Acquisition Expense 20,000 Current Liabilities 70,000 Long-term Debt 160,000 Cash 580,000 B. Acquisition Expense 20,000 Accounts Receivable 180,000 Inventory 400,000 Land 50,000 Building 60,000 Equipment 70,000 Patent 20,000 Current Liabilities 70,000 Long-term Debt 160,000 Cash 520,000 Gain on Acquisition 50,000 2-3 A. Accounts Receivable 240,000 Inventory 320,000 Land 1,508,000 Buildings 1,392,000 Goodwill 30,000 Allowance for Uncollectible Accounts 20,000 Accounts Payable 270,000 Note Payable 600,000 Cash 2,600,000 Goodwill 200,000 Liability for Contingent Consideration 200,000 Cost of acquisition $2,600,000 Fair value of net assets acquired ($3,440,000 – $870,000) 2,570,000 Goodwill $ 30,000 B. Liability for Contingent Consideration 200,000 Income from Change in Estimate 200,000 2-4 Current Assets ($440,000 + $200,000) 640,000 Plant and Equipment ($1,270,000 + $360,000) 1,630,000 Goodwill 490,000 Liabilities ($230,000 + $80,000) 310,000 Common Stock (70,000 shares @ $20/share) 1,400,000 Other Contributed Capital (70,000 × ($35 – $20)) 1,050,000 Acquisition Expense 45,000 Cash 45,000 Other Contributed Capital 15,000 Cash 15,000 2-5 Stockholders’ Equity: Common Stock, $1 par $1,100,000 Other Contributed Capital 4,090,000 [$2,800,000 + (100,000 × $13) – $10,000] Retained Earnings 600,000 Total stockholders’ Equity $ 5,790,000 2-6 A Investment in Petty Company ($300,000 × .10) 30,000 Common Stock 30,000 Cash 675,000 Note Payable 675,000 Investment in Petty Company 600,000 Cash 600,000 Current Assets 90,000 Plant Assets (1) 498,000 Goodwill (2) 87,000 Liabilities 45,000 Investment in Petty 630,000 (1) $255,000 + [.90 × ($525,000 – $255,000)] = $498,000 (2) Cost of shares $600,000 Book value of net assets (.90 × $300,000) = 270,000 Difference between cost and book value $330,000 Allocated to: Plant assets (.90 × ($525,000 – $255,000)) = 243,000 Goodwill 87,000 B 1. Current Assets ($90,000 + $75,000) 165,000 2. Plant Assets ($255,000 + $243,000) 498,000 3. Note Payable 675,000 4. Common Stock 30,000 2-7 A. 2011: Step 1: Fair value of the reporting unit $1,400,000 Carrying value of unit: Carrying value of identifiable net assets $1,160,000 Carrying value of goodwill ($1,580,000 – $1,310,000) 270,000 1,430,000 Excess of carrying value over fair value $30,000 The excess of carrying value over fair value means that step 2 is required. Step 2: Fair value of the reporting unit $1,400,000 Fair value of identifiable net assets 1,190,000 Implied value of goodwill 210,000 Recorded value of goodwill ($1,580,000 – $1,310,000) 270,000 Impairment loss $60,000 2012: Step 1: Fair value of the reporting unit $1,400,000 Carrying value of unit: Carrying value of identifiable net assets $1,120,000 Carrying value of goodwill ($270,000 – $40,000) 230,000 1,350,000 Excess of Fair value over Carrying value $ 50,000 The excess of fair value over carrying value means that step 2 is not required. B. 2011: Impairment Loss—Goodwill 60,000 Goodwill 60,000 2012: No entry 2-8 a. Fair Value of Identifiable Net Assets Book values $750,000 – $150,000 = $600,000 Write up of Inventory and Equipment: ($30,000 + $45,000) = 75,000 Purchase price above which goodwill would result $675,000 b. Any existing goodwill would be eliminated before recording a gain: $675,000 Fair Value of Identifiable Net Assets – $50,000 Gain = $625,000. c. Anything below $675,000 is technicially considered a bargain. d. Goodwill would be $75,000 at a purchase price of $750,000 or ($675,000 + $75,000). 1. In the first step of the goodwill impairment test, the fair value of the reporting unit is compared to its carrying amount. If the fair value is less than the carrying amount, then the carrying value of the goodwill is compared to its implied fair value. A loss is recognized when the carrying value of goodwill is higher than its fair value. 2. Issue SFAS No. 141 SFAS No. 141R Acquisitions costs Capitalize the costs. Expense as incurred. In-process R&D Included as part of purchase price, but then immediately expensed. Included as part of purchase price, treated as an asset. Contingent consideration Record when determinable and reflect subsequent changes in the purchase price. Record at fair value on the acquisition date with subsequent changes recorded on the income statement. Business definition A business is defined as a self-sustaining integrated set of activities and assets conducted and managed for the purpose of providing a return to investors. The definition would exclude early-stage development entities. A business or a group of assets no longer must be self-sustaining. The business or group of assets must be capable of generating a revenue stream. This definition would include early-stage development entities. Short Answer Questions from the Textbook Solutions 1. At the acquisition date, the information available (and through the end of the measurement period) is used to estimate the expected total consideration at fair value. If the subsequent stock issue valuation differs from this assessment, the expected to replace specifies that equity should not be adjusted. The reason is that the valuation was determined at the date of the exchange, and thus the impact on the firm’s equity was measured at that point based on the best information available then. 2. Pro forma financial statements (sometimes referred to as “as if” statements) are financial statements that are prepared to show the effect of planned or contemplated transactions. 3. For purposes of the goodwill impairment test, all goodwill must be assigned to a reporting unit. Goodwill impairment for each reporting unit should be tested in a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying amount (goodwill included) at the date of the periodic review. The fair value of the unit may be based on quoted market prices, prices of comparable businesses, or a present value or other valuation technique. If the fair value at the review date is less than the carrying amount, then the second step is necessary. In the second step, the carrying value of the goodwill is compared to its implied fair value. (The calculation of the implied fair value of goodwill used in the impairment test is similar to the method illustrated throughout this chapter for valuing the goodwill at the date of the combination.) 4. The expected increase was due to the elimination of goodwill amortization expense. However, the impairment loss under the new rules was potentially larger than a periodic amortization charge, and this is in fact what materialized within the first year after adoption (a large impairment loss). If there was any initial stock price impact from elimination of goodwill amortization, it was only a short-term or momentum effect. Another issue is how the stock market responds to the goodwill impairment charge. Some users claim that this charge is a non-cash charge and should be disregarded by the market. However, others argue that the charge is an admission that the price paid was too high, and might result in a stock price decline (unless the market had already adjusted for this overpayment prior to the actual write down). ANSWERS TO BUSINESS ETHICS CASE a and b. The board has responsibility to look into anything that might suggest malfeasance or inappropriate conduct. Such incidents might suggest broader problems with integrity, honesty, and judgment. In other words, can you trust any reports from the CEO? If the CEO is not fired, does this send a message to other employees that ethical lapses are okay? Employees might feel that top executives are treated differently.