Question & Answer

Discuss at least two items that are important to the value of companies like Intel or IBM but that are not recorded in their balance sheets. What are some reasons why these items are not recorded in the balance sheet?

What are the major limitations of the balance sheet as a source of information?

What is meant by liquidity? Rank the following assets from one to five in order of liquidity.

(a) Goodwill.

(b) Inventory.

(c) Buildings.

(d) Short-term investments.

(e) Accounts receivable.

Perez Company reported an increase in inventories in the past year. Discuss the effect of this change on the current ratio (current assets 4 current liabilities). What does this tell a statement user about Perez Company’s liquidity?

Discuss at least two situations in which estimates could affect the usefulness of information in the balance sheet.

A recent financial magazine indicated that the airline industry has poor financial flexibility. What is meant by financial flexibility, and why is it important?

What is meant by solvency? What information in the balance sheet can be used to assess a company’s solvency?

How does information from the balance sheet help users of the financial statements?

The financial statements of P&G are presented in Appendix 5B. The company’s complete annual report, including the notes to the financial statements, can be accessed at the book’s companion website, www.wiley.com/college/kieso.

Instructions

Refer to P&G’s financial statements and the accompanying notes to answer the following questions.

(a) What type of income statement format does P&G use? Indicate why this format might be used to present income statement information.

(b) What are P&G’s primary revenue sources?

(c) Compute P&G’s gross profit for each of the years 2009–2011. Explain why gross profit decreased in 2011.

(d) Why does P&G make a distinction between operating and nonoperating revenue?

(e) What financial ratios did P&G choose to report in its “Financial Summary” section covering the years 2001–2011?

The financial statements of P&G are presented in Appendix 5B. The company’s complete annual report, including the notes to the financial statements, can be accessed at the book’s companion website, www.

wiley.com/college/kieso.

Instructions

Refer to these financial statements and the accompanying notes to answer the following questions.

(a) What were P&G’s total assets at June 30, 2011? At June 30, 2010?

(b) How much cash (and cash equivalents) did P&G have on June 30, 2011?

(c) What were P&G’s research and development costs in 2010? In 2011?

(d) What were P&G’s revenues in 2010? In 2011?

(e) Using P&G’s financial statements and related notes, identify items that may result in adjusting entries for deferrals and accruals.

(f) What were the amounts of P&G’s depreciation and amortization expense in 2009, 2010, and 2011?

The financial statements of P&G are presented in Appendix 5B. The company’s complete annual report, including the notes to the financial statements, can be accessed at the book’s companion website, www.

wiley.com/college/kieso.

Instructions

Refer to P&G’s financial statements and the accompanying notes to answer the following questions.

(a) Using the notes to the consolidated financial statements, determine P&G’s revenue recognitionmpolicies. Discuss the impact of trade promotions on P&G’s financial statements.

(b) Give two examples of where historical cost information is reported in P&G’s financial statements and related notes. Give two examples of the use of fair value information reported in either the financial statements or related notes.

(c) How can we determine that the accounting principles used by P&G are prepared on a basis consistent with those of last year?

(d) What is P&G’s accounting policy related to advertising? What accounting principle does P&G follow regarding accounting for advertising? Where are advertising expenses reported in the financialstatements?

As a newly enrolled accounting major, you are anxious to better understand accounting institutions and sources of accounting literature. As a first step, you decide to explore the FASB Conceptual Framework.

Instructions

Go to the FASB website, http://www.fasb.org, to access the FASB Concepts Statements. When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following items. (Provide paragraph citations.)

(a) What is the objective of financial reporting?

(b) What other means are there of communicating information, besides financial statements?

(c) Indicate some of the users and the information they are most directly concerned with in economic decision-making.

One of the more closely watched ratios by investors is the price/earnings (P/E) ratio. By dividing price per share by earnings per share, analysts get insight into the value the market attaches to a company’s earnings.

More specifically, a high P/E ratio (in comparison to companies in the same industry) may suggest the stock is overpriced. Also, there is some evidence that companies with low P/E ratios are underpriced and tend to outperform the market. However, the ratio can be misleading.

P/E ratios are sometimes misleading because the E (earnings) is subject to a number of assumptions and estimates that could result in overstated earnings and a lower P/E. Some analysts conduct “revenue analysis” to evaluate the quality of an earnings number. Revenues are less subject to management estimates and all earnings must begin with revenues. These analysts also compute the price-to-sales ratio (PSR 5 price per share 4 sales per share) to assess whether a company is performing well compared to similar companies. If a company has a price-to-sales ratio significantly higher than its competitors, investors may be betting on a stock that has yet to prove itself. [Source: Janice Revell, “Beyond P/E,” Fortune (May 28, 2001), p. 174.]

Instructions

(a) Identify some of the estimates or assumptions that could result in overstated earnings.

(b) Compute the P/E ratio and the PSR for Tootsie Roll and Hershey for 2011.

(c) Use these data to compare the quality of each company’s earnings.

provides products and services to oil and natural gas exploration, production, transmission, and processing companies. The following is taken from a recent income statement. (Dollaramounts are in millions.)

Sales revenue $2,697.0

Service revenue 1,933.9

Share of earnings of unconsolidated affi liates 92.4

Total revenues 4,723.3

Cost of sales 1,722.7

Cost of services 1,799.9

Total costs of sales and services 3,522.6

Gross earnings $1,200.7

Selling, engineering, administrative and general expenses (919.8)

Special charges (70.0)

Other income (deductions)

Interest expense (47.4)

Interest earned 19.1

Other, net 4.8

Earnings before income taxes and other items below 187.4

Income taxes (79.4)

Noncontrolling interest (10.3)

Earnings from continuing operations 97.7

Discontinued operations (35.3)

Earnings before extraordinary items 62.4

Extraordinary items (6.3)

Net earnings $ 56.1

Instructions

Assume that 177,636,000 shares of stock were issued and outstanding. Prepare the per share portion of the income statement. Remember to begin with “Earnings from continuing operations.”

The Z-score bankruptcy prediction model uses balance sheet and income information to arrive at a Z Score, which can be used to predict financial distress:

Z 5 Working capital Total assets 3 1.2 1 Retained earnings Total assets 3 1.4 1 EBIT Total assets 3 3.3 1 Sales Total assets 3 .99 1 MV equity Total liabilities 3 0.6

EBIT is earnings before interest and taxes. MV equity is the market value of common equity, which can be determined by multiplying stock price by shares outstanding.

Following extensive testing, it has been shown that companies with Z-scores above 3.0 are unlikely to fail; those with Z-scores below 1.81 are very likely to fail. While the original model was developed for publicly held manufacturing companies, the model has been modified to apply to companies in various industries, emerging companies, and companies not traded in public markets.

Instructions

(a) Use information in the financial statements of a company like Walgreens or Deere & Co. to compute the Z-score for the past 2 years.

(b) Interpret your result. Where does the company fall in the financial distress range?

(c) The Z-score uses EBIT as one of its elements. Why do you think this income measure is used?

Your client took accounting a number of years ago and was unaware of comprehensive income reporting. He is not convinced that any accounting standards exist for comprehensive income.

Instructions

Access the IFRS authoritative literature at the IASB website (http://www.iasb.org/ ). (Click on the IFRS tab and then register for free eIFRS access if necessary.) When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide paragraph citations.)

(a) What IFRS addresses reporting in the statement of comprehensive income? When was it issued?

(b) Provide the definition of total comprehensive income.

(c) Explain the rationale for presenting additional line items, headings, and subtotals in the statement of comprehensive income.

(d) What items of income or expense may be presented either in the statement of comprehensive income or in the notes?

Below is the income statement for a British company, Avon Rubber plc. Avon prepares its financial statements in accordance with IFRS.

Instructions

(a) Review the Avon Rubber income statement and identify at least three differences between the IFRS income statement and an income statement of a U.S. company as presented in the chapter.

(b) Identify any irregular items reported by Avon Rubber. Is the reporting of these irregular items in Avon’s income statement similar to reporting of these items in U.S. companies’ income statements?

Explain.

Presented below is information related to Viel Company at December 31, 2014, the end of its first year of operations.

Sales revenue $310,000

Cost of goods sold 140,000

Selling and administrative expenses 50,000

Gain on sale of plant assets 30,000

Unrealized gain on non-trading equity securities 10,000

Interest expense 6,000

Loss on discontinued operations 12,000

Allocation to non-controlling interest 40,000

Dividends declared and paid 5,000

Instructions

Compute the following: (a) income from operations, (b) net income, (c) net income attributable to Viel

Company controlling shareholders, (d) comprehensive income, and (e) retained earnings balance at

December 31, 2014. (Ignore income taxes.)

Bradshaw Company experienced a loss that was deemed to be both unusual in nature and infrequent in occurrence. How should Bradshaw report this item in accordance with IFRS?

Discuss the appropriate treatment in the income statement for the following items:

(a) Loss on discontinued operations.

(b) Non-controlling interest allocation.

Explain the difference between the “nature-of-expense” and “function-of-expense” classifications.

Your client took accounting a number of years ago and was unaware of comprehensive income reporting.

He is not convinced that any accounting standards exist for comprehensive income.

Instructions

Go to http://aahq.org/asclogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses.

(a) What authoritative literature addresses comprehensive income? When was it issued?

(b) Provide the definition of comprehensive income.

(c) Define classifications within net income and give examples.

(d) Define classifications within other comprehensive income and give examples.

(e) What are reclassification adjustments?

Willie Nelson, Jr., controller for Jenkins Corporation, is preparing the company’s financial statements at year-end. Currently, he is focusing on the income statement and determining the format for reporting comprehensive income. During the year, the company earned net income of $400,000 and had unrealized gains on available-for-sale securities of $15,000. In the previous year, net income was $410,000, and the company had no unrealized gains or losses.

Instructions

(a) Show how income and comprehensive income will be reported on a comparative basis for the current and prior years, using the two statement format.

(b) Show how income and comprehensive income will be reported on a comparative basis for the current and prior years, using the one statement format.

(c) Which format should Nelson recommend?

As audit partner for Grupo and Rijo, you are in charge of reviewing the classification of unusual items that have occurred during the current year. The following material items have come to your attention.

1. A merchandising company incorrectly overstated its ending inventory 2 years ago. Inventory for all other periods is correctly computed.

2. An automobile dealer sells for $137,000 an extremely rare 1930 S type Invicta which it purchased for $21,000 10 years ago. The Invicta is the only such display item the dealer owns.

3. A drilling company during the current year extended the estimated useful life of certain drilling equipment from 9 to 15 years. As a result, depreciation for the current year was materially lowered.

4. A retail outlet changed its computation for bad debt expense from 1% to ½ of 1% of sales because of changes in its customer clientele.

5. A mining concern sells a foreign subsidiary engaged in uranium mining, although it (the seller) continues to engage in uranium mining in other countries.

6. A steel company changes from the average-cost method to the FIFO method for inventory costing purposes.

7. A construction company, at great expense, prepared a major proposal for a government loan. The loan is not approved.

8. A water pump manufacturer has had large losses resulting from a strike by its employees early in the year.

9. Depreciation for a prior period was incorrectly understated by $950,000. The error was discovered in the current year.

10. A large sheep rancher suffered a major loss because the state required that all sheep in the state be killed to halt the spread of a rare disease. Such a situation has not occurred in the state for 20 years.

11. A food distributor that sells wholesale to supermarket chains and to fast-food restaurants (two distinguishable

classes of customers) decides to discontinue the division that sells to one of the two classes of customers.

Instructions

From the foregoing information, indicate in what section of the income statement or retained earnings statement these items should be classified. Provide a brief rationale for your position.