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understanding financial accounting

Financial Accounting In An Economic Context 3rd Edition Jamie Pratt - Solutions

Describe goodwill, and explain why it is never accrued but often appears on the balance sheets of tnajor U.S. companies.
Explain why a company might prefer the equity method to consolidated statements when accounting for a long-term equity investment.
Why is goodwill accounting controversial and possibly puts U.S. chief executives at a dis¬ advantage when bidding against foreign competition for acquisitions?
(Appendix) Under the purchase method, why is it important to consider the net market value of the subsidiary’s assets instead of the book value? Is adding the assets and liabili¬ ties of the subsidiary to the balance sheet of the parent a violation of the historical cost principle? Why or why
(Appendix) Under what conditions is goodwill recognized on the balance sheet of the par¬ ent?
(Appendix) Under what conditions is minority interest recognized on the balance sheet of the parent?
(Appendix) How are the values of goodwill and minority interest determined when both are recognized in an acquisition?
(Appendix) Why are the revenues and expenses of a subsidiary that are recognized prior to an acquisition not included in consolidated income under the purchase method?
(Appendix) Define intercompany receivables, payables, revenues, and expenses, and explain how and why they are eliminated when preparing consolidated financial statements.
(Appendix) Describe the three basic steps followed by multinationals when they prepare consolidated financial statements.
(Appendix) Distinguish between a Type I and a Type II foreign subsidiary. In which cate¬ gory are subsidiaries that operate in hyperinflation countries included?
Where on the financial statements are the translation adjustments disclosed for each type of subsidiary?
Why is the second criterion so difficult to apply?
How can managers window dress by structuring their investments in securities?
Are all realized and unrealized gains/losses on short-term security investments recognized?
Why does the recognition of goodwill imply lower future net income numbers?
What is minority interest? Is it considered a liability or an element of stock¬ holders’ equity? Why?
Monroe Auto Supplies engaged in several transactions involving short-term equity securities during 1997, shown in the following list. The company had never invested in equity securities prior to 1997. All securities were classified as trading securities. 1. Purchased 1,000 shares of IBM for $50 per
The following information was extracted from the December 31, 1996 current asset section of the balance sheets of four different companies. Wearever Frames Pacific Video Fabrics Corp. Transport Magic Trading securities $800,000 $490,000 $645,000 $210,000 Available-for-sale securities 130,000 40,000
The following information relates to the activity in the short-term investment account of Lido International, which held no short-term investments as of January 1. (1) January 28 (2) February 18 (3) March 15 (4) April 29 (5) May 18 (6) June 1 (7) June 30 Purchased ten shares of Able Co. stock at
On November 11, 1997, Wadsworth Company purchased 20 shares of ZZZ for $8 per share. Wadsworth held the investment for the remainder of 1997, and as of December 31 the per share market value of ZZZ had risen to $10. During 1998 Wadsworth sold 10 shares of ZZZ for $9 each, and at the end of 1998 the
Tom Miller and Larry Rogers each started a business on December 1, 1996 by contributing $6,000 of their own funds. Early in December both men purchased 120 shares of Diskette com¬ mon stock, which was selling at the time for $26 per share, and classified the investment as available-for-sale
Indicate the answers that would complete the following chart with the appropriate method of accounting for long-term equity investments: (1) mark-to-market method, (2) cost method, (3) equity method, (4) consolidated financial statements. Are the Securities Marketable? Yes No Percentage of
Hartney Consulting Services is involved in the following investments as of December 31, 1996. 1. Owns 40 percent of the common stock issued by Doyle Corporation. Doyle Corporation’s stock is actively traded, and Hartney Consulting intends to hold this investment for at least five years. Chapter 8
Refer to the data provided in E8-8. REQUIRED:a. Assume that the stock of Thayers International and Bayhe Enterprises is considered mar¬ ketable, and Mystic Lakes Food Company wishes to hold all investments indefinitely. Prepare journal entries to record these transactions.b. Assume that the market
On January 1, 1996, Nover Solar Systems purchased 10,000 shares of Reilly Manufacturing for $190,000. The investment represented 25 percent of Reilly’s outstanding common stock. Nover intended to hold the investment indefinitely. During 1996 Reilly earned net income of $75,000, and during 1997
Mainmont Industries uses the equity method to account for its long-term equity investments. The following information from the financial statements of Mainmont refers to an investment in the securities of Tumbleweed Construction, a company 30 percent owned by Mainmont. 1997 1996 Long-term
Multiplex purchased 100 percent of the outstanding common stock of Lipley Company for $900,000. At the time of the acquisition, the fair market values of Lipley’s individual assets and liabilities follow. Cash $ 90,000 Accounts receivable 60,000 Inventory 160,000 Plant and equipment 560,000
The following chart describes six transactions where 100 percent of a subsidiary’s voting stock was purchased for cash. Provide the missing values. Purchase Price Net Book Value Net FMV in Excess of Book Value Goodwill 1. 9 • $ 7,000 $ 1,000 $1,000 2. $ 6,000 6,000 9 • 0 3. 12,000 9 • 4,000
The book value of a share of Camden common stock on December 31 is $12. The balance sheet value and the market value of the company’s assets and liabilities as of that date follow. Chapter 8 Investments in Equity Securities 399 Balance Sheet Value Market Value $ 15,000 24,000 25,000 47,000
Maxwell Industries paid $18 per share for 80 percent of the 10,000 outstanding shares of Kendall Hall. The balance sheet of Kendall Hall and additional market value information fol¬ low. Compute the amounts of goodwill and minority interest recognized by Maxwell. Historical Cost FMV Current assets
Glover Chemical purchased 100 percent of the outstanding stock ofWard Supply on December 31 for $100,000 cash. As of that date the FMVs of the inventory and fixed assets of Ward equaled $70,000 and $125,000, respectively. Assume that cash, accounts receivable, and the liabilities are on the books
O’Leary Enterprises began investing in short-term equity securities in 1996. The following information was extracted from its 1996 internal financial records. Houser and Miller were classified as trading securities, while Letter and Nordic were classified as available-for-sale securities.
Anderson Cabinets began operations during 1990. During the initial years of operations, the company invested primarily in fixed assets to promote growth. Dqring 1996 H. Hurst, the com¬ pany president, decided that the company was sufficiently stable that it could now invest in short-term
On October 18, 1996 Daley, Inc. purchased 100 shares of Orthon @ $32 per share. The invest¬ ment was classified as available-for-sale securities. The shares were held throughout the remainder of 1996 and 1997, and by December 31, 1996 and 1997 the per share market price Charter 8 Investments in
Levy Company and Guyer Books made the same equity investment—200 shares of Watson Manufacturing at a cost of $12 per share—on November 18. On December 31, the market value of Watson had risen to $45 per share. Guyer Books held its investment in Watson, while Levy sold the shares and immediately
Rochester Enterprises purchased 500 shares of Newark Corporation for $15 per share on June 15, 1996, when Newark had approximately 10,000 equity shares outstanding. Rochester held the investment throughout 1996, and as of December 31 the per share market price had risen to $18. On January 16, 1997
The following information was taken from the 1996 annual report of Orleans Enterprises. 1996 1995 Trading securities $25,440 $27,000 402 Part 3 Assets: A Closer Look Related Footnote: The 1996 and 1995 balances in the trading securities account consist of 1,600 and 1,800 equity shares of Atwater
A summary of the December 31, 1995 balance sheet of Masonite Tires follows. (Long-term equity investments: the markto-market method versus the equity method) Assets $160,000 Liabilities $ 70,000 Stockholders’ equity 90,000 Total $160,000 Total $160,000 On January 1, 1996, Masonite purchased
A summary of the 1996 balance sheet of Alsop, Ltd., follows: (The equity method versus consolidated financial statements) Assets $ 180,000 Total $ 180,000 Liabilities $ 90,000 Stockholders’ equity 90,000 Total $ 180,000 On January 1, 1996, Alsop acquired 100 percent of the outstanding common
Excerpts from the financial statements of Macy Limited are provided below. (Numbers are in thousands.) 1997 1996 Balance Sheet Assets: Short-term investments Investment in affiliate Stockholders’ equity: Unrealized price decrease on short-term investments Income Statement Realized gain on
The condensed balance sheets as of December 31 for Rice and Associates and Rachel Excavation are provided below. Rice Rachel Assets Cash Accounts receivable Inventory Fixed assets Total assets $ 196,000 $ 10,000 150,000 40,000 300,000 40,000 400,000 130,000 $1,046,000 $220,000 Liabilities and
This problem refers to P8-10. Assume that Rice and Associates purchased 80 percent of the outstanding stock of Rachel for $136,000 cash. REQUIRED:a. Prepare the journal entry recorded by Rice to recognize the acquisition.b. Prepare a consolidated work sheet and a consolidated balance sheet.
This problem refers to P8-10. Assume that Rice and Associates purchased 80 percent of the 10,000 shares of outstanding stock of Rachel for $140,000 cash. REQUIRED:a. Prepare the journal entries recorded by Rice to recognize the acquisition.b. Prepare a consolidated work sheet and a consolidated
This problem refers to P8-10. Assume the same facts as in P8-10 except that the FMVs for the inventory and fixed assets of Rachel are not as precisely specified. That is, appraisers have indi¬ cated that the FMV of the inventory is between $65,000 and $75,000 and that the FMV of the fixed assets
Safeton owns 100 percent of the outstanding stock of Mayliner. When Safeton prepared its consolidated financial statements on December 31, the accountant noticed that Safeton loaned $80,000 to Mayliner on July 1 of that year. Accrued but unpaid interest on the loan as of December 31 totaled $6,800.
Groomer purchased a controlling interest in three companies during 1996. Financial informa¬ tion concerning the three companies follows. Company X Company Y Company Z Cash $ 6,000 $ 4,000 $ 2,000 Accounts receivable 12,000 9,000 7,000 Inventory 30,000 12,000 18,000 Fixed assets 70,000 30,000
Mammoth Enterprises purchased 50 percent of the outstanding stock of Atom, Inc., on December 31 for $60,000 cash. On that date the book value of Atom’s net assets was $70,000. The market value of Atom’s assets was $180,000, $20,000 above book value. Mammoth’s con¬ densed balance sheet,
In 1994 Texaco reported net income of $910 million, $494 million of which was income rec¬ ognized on investments in affiliate companies accounted for under the equity method. In that same year Texaco received much less than that amount in dividends from these affiliates. Some accountants have
Several years ago wholly owned finance subsidiaries of major U.S. companies were accounted for by the parent using the equity method. These companies justified the procedure by claim¬ ing that the operations of the subsidiaries were so unlike those of the parents that consolidat¬ ing the
Barbara Thomas, in an article published in Business Law (August 1983), noted that “The inter¬ nationalization of capital markets and the dramatic increase in the foreign direct investments of multinational enterprises have increased the need for relevant, timely, and comparable infor¬ mation
When Time, Inc., and Warner Communications merged, it represented one of the largest busi¬ ness combinations of all time. Since then the company has reported consistent net losses despite relatively strong operating cash flows. In its 1994 annual report Time Warner often emphasized EBITDA
An article appearing in Fortune (February 13, 1989) entitled “What Foreigners Will Buy Next” points out that foreign companies bidding to acquire U.S. companies often pay huge premiums over the market prices of the target companies’ outstanding stocks. Examples include Bridgestone’s
Refer to the annual report of MCI in Appendix, and answer the questions below.a. What portion of total assets is comprised of marketable securities? What percentage of these investments are reported as short-term, and how is short-term defined?b. Describe the kinds of securities (debt or equity)
The Wall Street Journal (May 3, 1989) reported that Eastman Kodak was “battered” by unfa¬ vorable currency exchange rates in its key imaging subsidiary. The latest earnings for the first quarter of 1989 were far below expectations and Kodak stock fell $3.25 in response to the news. The imaging
In what two fundamental ways are financial accounting numbers used? Provide three examples of each.
Discuss the concept of earning power, and differentiate it from the concept of solvency. How are they related? How can financial accounting numbers be used to assess each?
What are the basic differences between equity and debt investments, and why would equity and debt investors be interested in both earning power and solvency? Would equi¬ ty investors tend to be more interested in both earning power or solvency? Would debt investors tend to be more interested in
Why might a company’s stockholders want its managers to be paid bonuses in the form of cash or shares of stock instead of a straight salary? How might such a compensation scheme be implemented?
Why do debt covenants often restrict the borrowing company to a certain minimum ratio of current assets to current liabilities? Why might the same covenant contain a provision that limits the annual payment of dividends to a percentage of net income?
Describe how audit reports may deviate from “clean” opinions. Explain why financial statement users should review them closely.
Do most U.S. companies have their financial statements audited? Why or why not? If you were the manager of a small business, under what conditions would you have your finan¬ cial statements audited?
Why are comparisons of financial statement numbers important to financial statement analysis? In what three ways can such comparisons be made?
Why is it helpful to compare financial accounting numbers across time? Why must such comparisons be viewed cautiously?
Where can industry-wide statistics be found? Of what use are they to the financial state¬ ment analyst, and how can they be misleading?
Define the concept of earnings persistence, and explain how it is useful to financial state¬ ment users. What kind of income statement items tend to have the most persistence?
Provide five examples of significant transactions, and in each case, explain how knowl¬ edge of that transaction might influence the way you analyze the financial information of a given company.
Where can you find credit-rating information, why is it important, and in general how is it established?
What is solvency, and what three factors must be considered in its assessment? Define these factors, and explain how they are related.
Assume that ABC Company raised $4 million with an equity issuance and used the pro¬ ceeds to acquire additional property, plant, and equipment. Provide a plausible explana¬ tion for how these transactions would affect ABC’s earning power, financial flexibility, and liquidity. How would ABC’s
Identify and briefly describe the limitations of financial accounting numbers described in this chapter. What kind of relevant information is ignored on financial accounting statements? Why is it ignored?
Name five ways in which managers can bias financial statements and still remain within the guidelines of generally accepted accounting principles.
Write a short paragraph to define the concept of quality of earnings, and explain why a company’s stock price may be more responsive to announcements of high quality earn¬ ings than to announcements of low quality earnings.
Why can’t financial accounting numbers be used to identify undervalued securities that are traded on the major U.S. exchanges? In what other ways and situations can financial accounting numbers be used?
Explain some of the major difficulties involved when analyzing financial statements pro¬ vided by companies from foreign countries.
Excerpts from the financial statements of Marley and Thomas are provided below. 1997 1996 1995 Balance Sheet Current assets $ 14,000 $13,000 $ 9,000 Long-term assets 98,000 62,000 52,000 Current liabilities 14,000 12,000 7,000 Long-term debt 30,000 20,000 15,000 Stockholders’ equity 68,000 43,000
E3-2 (Analyzing financial statements) Excerpts from the financial statements of Mayberry are provided below. 1997 1996 1995 Balance Sheet Current assets $40,000 $44,000 $ 47,000 Long-term assets 86,000 90,000 95,000 Current liabilities 30,000 30,000 25,000 Long-term debt 50,000 40,000 30,000
E3—3 (Analyzing financial statements) The chief executive officer of Ginny’s Fashions has included the following financial statements in a loan application submitted to Priority Bank. The company intends to acquire additional equipment and wishes to finance the purchase with a long-term note.
The 1996 and 1997 financial statements of Ken’s Sportswear follow. Balance Sheet 1997 1996 Assets Cash $ 9,000 $ 7,000 Accounts receivable 12,000 9,000 Inventory 18,000 15,000 Long-lived assets (net) 60,000 50,000 Total assets $99,000 $81,000 Liabilities and Stockholders’ Equity Accounts
Financial information from the records of Blanchard Masonry follows. The company began operations in 1994. Assume that the year-end 1994 balances are the average balances during 1994. 1997 1996 1995 1994 Cash Accounts receivable Inventory Total current assets $ 7,000 $ 7,000 20,000 14,000 15,000
Beecham Limited began operations in early 1995. Summaries of the statements of cash flows for 1995, 1996, and 1997 follow. 1997 1996 1995 Net cash provided (used) by operating activities $ ? $(252) $ ? Net cash provided (used) by investing activities 150 9 • (400) Net cash provided (used) by
The following information was extracted from the 1997 financial report of the Generic Clothing Company. 1997 1996 Current assets: Cash $ 15,000 $ 30,000 Short-term marketable securities 225,000 10,000 Accounts receivable (net) 90,000 95,000 Inventory 50,000 225,000 Prepaid insurance 20,000 25,000
PLP Corporation began operations on January 1, 1994. The initial investment by the owners was $100,000. The following information was extracted from the company’s records. Net Income December 31 December 31 Cost of Stockholders’ Equity Inventory Goods Sold 1994 $510,000 $100,000 1995 490,000
The financial information below was taken from the records of Lotechnic Enterprises. The company pays no dividends. Current assets Noncurrent assets Total assets Current liabilities Long-term liabilities Capital stock Retained earnings Total liabilities and stockholders’ equity Net cash provided
Conlon Travel Supplies entered into the following transactions during 1996. 1. Purchased inventory on account. 2. Purchased plant machinery by issuing long-term debt. 3. Made a principal payment on long-term debt. 4. Paid wages. 5. Sold inventory on account for 20 percent over cost. 6. Issued stock
At the end of 1996, Montvale Associates borrowed $120,000 from the Bayliner Bank. The debt covenant specified that Montvale’s debt/equity ratio could not exceed 1.5:1 during the period of the loan. A summary of Montvale’s balance sheet after the loan follows. 1 996 Assets Current assets
The information below refers to the financial records of Morrissey Brothers over a five-year period. 1997 1996 1995 1994 1993 Net income $60,000 $50,000 $40,000 $24,000 $20,000 Dividends declared $24,000 $15,000 $ 16,000 $10,000 $12,000 Closing per-share price $ 42 $ 37 $ 30 $ 35 $ 30 Number of
Kinney Conglomerate generated $1,585,000 in net income for the year ended December 31, 1997. 1. The company declared and paid $1,500,000 in dividends on December 31, 1997. 2. Kinney Conglomerate stock was selling for $30 per share on January 1, 1997, and for $35 per share on December 31, 1997. 3.
Avery Corporation reported the following selected items as part of its 1997 financial report. Cash $ 15,000 Short-term marketable securities (at cost) 150,000 Accounts receivable 100,000 Inventory 100,000 Total assets 970,000 Accounts payable 95,000 Interest payable 50,000 Mortgage payable* 300,000
Edgemont Repairs began operations on January 1, 1995. The 1995, 1996, and 1997 financial statements follow. 1997 1996 1995 Assets Current assets $ 30,000 $10,000 $ 8,000 Noncurrent assets 83,000 45,000 41,000 Total assets $113,000 $55,000 $49,000 Liabilities and Stockholders’ Equity Current
You are considering investing in Gidley Electronics. As part of your investigation of Gidley Electronics, you obtained the following balance sheets for the years ended December 31, 1996 and 1997. 1997 1996 Assets Current assets: Cash $ 110,000 $ 115,000 Short-term marketable securities 175,000
(This problem relates to P3-3). You have just been hired as a stock analyst for a large stock brokerage company. Your first assignment is to analyze the performance of Gidley Electronics. Presented below are the company’s income statement and statement of retained earnings for the years ended
Marcia Smithson has operated a small service company for several years, and the following financial statements were prepared by her accountant. 1997 1996 1995 Balance Sheet Current assets $ 18,000 $ 16,000 $14,000 Long-term assets 36,000 30,000 28,000 Current liabilities 14,000 8,000 2,000
The following information was obtained from the 1997 financial reports of Hathaway Toy Company and Yakima Manufacturing. Hathaway Toy Yakima Mfg. Interest expense — $ 195,000 Net income $ 875,000 $ 755,000 Current liabilities $ 240,000 $ 25,000 Mortgage payable — 1,850,000 Common stock ($10 par
The following selected financial information was obtained from the 1997 financial reports of Robotronics, Inc., and Technology, Limited. Interest expense Unusual gain (net of taxes of $320,000) Net income (including unusual items) Current liabilities Bonds payable Mortgage payable Common stock
Tumwater Canyon Campsites began operations on January 1, 1997. The following information is available at year end. Assume that all sales were on credit. Net income $25,000 Receivables turnover 8 Inventory turnover 5 Return on sales 8% Gross margin 40% Quick ratio 50% Accounts payable $200,000
Bob Cleary, the controller of Mountain-Pacific Railroad, has prepared the following financial statements for 1996 and 1997. The market prices of the company’s stock as ofJanuary 1, 1996, December 31, 1996, and December 31, 1997, were $50, $45, and $70 per share, respectively. Assume an income tax
(This problem is related to P3-9.) Mountain-Pacific Railroad is interested in comparing itself to the rest of the industry. Bob Cleary, the controller, has obtained the following industry averages from a trade journal. (The industry averages were the same for 1996 and 1997.) Return on equity .50
You have just been hired as a loan officer for Washington Mutual Savings. Selig Equipment and Mountain Bike, Inc., have both applied for $125,000 nine-month loans to acquire addi¬ tional plant equipment. Neither company offered any security for the loans. It is the strict pol¬ icy of the bank to
Watson Metal Products is planning to expand its operations to France in response to increased demand from the French for quality metal products to use in production processes. Ben Watson, president of Watson Metal Products, and his consultants have estimated that the expansion will require an

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