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Chapter 03 - The Balance Sheet and Financial Disclosures

Chapter 3

The Balance Sheet and Financial Disclosures

QUESTIONS FOR REVIEW OF KEYQuestion TOPICS 3-1


The purpose of the balance sheet, also known as the statement of financial position, is to present the financial position of the company on a particular date. Unlike the income statement, which is a change statement that reports events occurring during a period of time, the balance sheet is a statement that presents an organized array of assets, liabilities, and shareholders equity at a point in time. It is a freeze frame or snapshot picture of financial position at the end of a particular day marking the end of an accounting period.

Question 3-2
The balance sheet does not portray the market value of the entity (number of common stock shares outstanding multiplied by price per share) for a number of reasons. Most assets are not reported at fair value, but instead are measured according to historical cost. Also, there are certain resources, such as trained employees, an experienced management team, and a good reputation, that are not recorded as assets at all. Therefore, the assets of a company minus its liabilities, as shown in the balance sheet, will not be representative of the companys market value.

Question 3-3
Current assets include cash and other assets that are reasonably expected to be converted to cash or consumed during one year, or within the normal operating cycle of the business if the operating cycle is longer than one year. The typical asset categories classified as current assets include: Cash and cash equivalents Short-term investments Accounts receivable Inventories Prepaid expenses

Question 3-4
Current liabilities are those obligations that are expected to be satisfied through the use of current assets or the creation of other current liabilities. So, this classification will include all liabilities that are scheduled to be liquidated within one year or the operating cycle, whichever is longer, except those that management intends to refinance on a long-term basis. The typical liability categories classified as current liabilities include: Accounts payable Short-term notes payable Accrued liabilities Current maturities of long-term debt

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Chapter 03 - The Balance Sheet and Financial Disclosures

Answers to Questions (continued) Question 3-5


The operating cycle for a typical manufacturing company refers to the period of time required to convert cash to raw materials, raw materials to a finished product, finished product to receivables, and then finally receivables back to cash.

Question 3-6
Investments in equity securities are classified as current if the companys management (1) intends to liquidate the investment in the next year or operating cycle, whichever is longer, and (2) has the ability to do so, i.e., the investment is marketable. If either of these criteria does not hold, the investment is classified as noncurrent.

Question 3-7
The common characteristics that these assets have in common are that they are tangible, longlived assets used in the operations of the business. They usually are the primary revenue-generating assets of the business. These assets include land, buildings, equipment, machinery, furniture and other assets used in the operations of the business, as well as natural resources, such as mineral mines, timber tracts and oil wells.

Question 3-8
Property, plant, and equipment and intangible assets each represent assets that are long-lived and are used in the operations of the business. The difference is that property, plant, and equipment represent physical assets, while intangible assets lack physical substance. Generally, intangible assets represent the ownership of an exclusive right, such as a patent, copyright or franchise.

Question 3-9
A note payable of $100,000 due in five years would be classified as a long-term liability. A $100,000 note due in five annual installments of $20,000 each would be classified as a $20,000 current liability current maturities of long-term debt and an $80,000 long-term liability.

Question 3-10
Paid-in-capital consists of amounts invested by shareholders in the corporation. Retained earnings equals net income less dividends paid to shareholders from the inception of the corporation.

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Chapter 03 - The Balance Sheet and Financial Disclosures

Answers to Questions (continued) Question 3-11


Disclosure notes provide additional detail concerning specific financial statement items. Included are such data as the fair values of financial instruments and off-balance-sheet risk associated with financial instruments and details of pension plans, leases, debt, and assets. Common to all companies disclosures are certain specific notes such as a summary of significant accounting policies, descriptions of subsequent events, and related third-party transactions. However, many notes are designed to fit the disclosure needs of the particular reporting company. In fact, any explanation that helps investors and creditors make decisions should be included.

Question 3-12
The disclosure of the companys significant accounting policies is extremely important to external users in terms of their ability to compare financial information across companies. It is critical to a financial analyst involved in assessing future cash flows of two construction companies to know that one company uses the percentage-of-completion method in recognizing gross profit, while the other company uses the completed contract method.

Question 3-13
A subsequent event is an event that occurs after the date of the financial statements but prior to the date on which the statements are actually issued or available to be issued. It may help to clarify a previously existing situation or it may represent a new event not directly affecting financial position at the end of the reporting period.

Question 3-14
The discussion provides managements views on significant events, trends and uncertainties pertaining to the companys (a) operations, (b) liquidity, and (c) capital resources. Certainly the Management Discussion and Analysis section may be slanted to managements biased perspective and therefore can lack objectivity. However, management can offer an informed insight that might not be available elsewhere, so if the reader maintains awareness of the informations source, it can offer a unique view of the situation.

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Chapter 03 - The Balance Sheet and Financial Disclosures

Answers to Questions (continued) Question 3-15


Depending on the circumstances, the auditor will issue a (an): 1. Unqualified opinion The auditors are satisfied that the financial statements present fairly the financial position, results of operations, and cash flows and are prepared in accordance with generally accepted accounting principles. 2. Qualified opinion This contains an exception to the standard unqualified opinion, but not of sufficient seriousness to invalidate the financial statements as a whole. Examples of exceptions are (a) unconformity with generally accepted accounting principles, (b) inadequate disclosures, and (c) a limitation or restriction of the scope of the examination. 3. Adverse opinion This is necessary when the exceptions (a) and (b) above are so serious that a qualified opinion is not justified. Adverse opinions are rare because auditors usually are able to persuade management to rectify problems to avoid this undesirable report. 4. Disclaimer An auditor will disclaim an opinion if item (c) above applies and therefore insufficient information has been gathered to express an opinion.

Question 3-16
A proxy statement must be sent each year to all shareholders. It usually is in the same mailing with the annual report. The statement invites shareholders to the shareholders meeting to elect board members and to vote on issues before the shareholders. It also permits shareholders to vote using an enclosed proxy card. The proxy statement also provides for more disclosures on compensation to directors and executives, and in particular, stock options granted to executives.

Question 3-17
Working capital is the difference between current assets and current liabilities. The current ratio is computed by dividing current assets by current liabilities. The acid-test ratio (or quick ratio) is computed by dividing quick assets (cash and cash equivalents, marketable securities, and accounts receivable) by current liabilities.

Question 3-18
Debt to equity ratio Times interest earned ratio = = Total liabilities Shareholders' equity Net income + interest + taxes Interest

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Chapter 03 - The Balance Sheet and Financial Disclosures

Answers to Questions (concluded) Question 3-19


IAS No.1, revised, Presentation of Financial Statements, provides authoritative guidance for balance sheet presentation under IFRS.

Question 3-20
Differences in balance sheet presentation between U.S. GAAP and IFRS include: 1. International standards specify a minimum list of items to be presented in the balance sheet. U.S. GAAP has no minimum requirements. 2. IAS No. 1, revised, changed the title of the balance sheet to statement of financial position, although companies are not required to use that title. Some U.S. companies use the statement of financial position title as well. 3. Under U.S. GAAP, we present current assets and liabilities before noncurrent assets and liabilities. IAS No. 1 doesnt prescribe the format of the balance sheet, but balance sheets prepared using IFRS often report noncurrent items first.

Question 3-21
An operating segment is a component of an enterprise: 1. That engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same enterprise). 2. Whose operating results are regularly reviewed by the enterprise's chief operating decision-maker to make decisions about resources to be allocated to the segment, and to assess its performance. 3. For which discrete financial information is available.

Question 3-22
For areas determined to be reportable operating segments, the following disclosures are required: 1. General information about the operating segment, 2. Information about reported segment profit or loss, including certain revenues and expenses included in reported segment profit or loss, segments assets, and the basis of measurement. 3. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other significant items to corresponding enterprise amounts. 4. Interim period information.

Question 3-23
U.S. GAAP requires companies to report information about reported segment profit or loss, including certain revenues and expenses included in reported segment profit or loss, segment assets, and the basis of measurement. The international standard on segment reporting, IFRS No. 8, requires that companies also disclose the total liabilities of its reportable segments.

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Chapter 03 - The Balance Sheet and Financial Disclosures

BRIEF EXERCISES
Brief Exercise 3-1
(b) (c) (d) (e) (f) Current Noncurrent Current Noncurrent Noncurrent (a) Current

Brief Exercise 3-2

Current Assets:

$16,000 + 11,000 + 25,000 = $52,000 Current liabilities: $14,000 + 9,000 + 1,000 = $24,000

Brief Exercise 3-3


minus Liabilities equals Shareholders equity

Assets:

$ 52,000 current assets

80,000 equipment $132,000 total assets $ 24,000 current liabilities 30,000 notes payable 54,000 total liabilities $78,000 (50,000) common stock $28,000 retained earnings

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Chapter 03 - The Balance Sheet and Financial Disclosures

Brief Exercise 3-4


K and J Nursery, Inc. Balance Sheet At December 31, 2011 Assets Current assets: Cash .................................................................... Accounts receivable ............................................ Inventories .......................................................... Total current assets ........................................ Property, plant, and equipment: Equipment ........................................................... Less: Accumulated depreciation ......................... Net property, plant, and equipment ............... Total assets ................................................. $140,000 (60,000) 80,000 $132,000 $ 16,000 11,000 25,000 52,000

Liabilities and Shareholders' Equity Current liabilities: Accounts payable ............................................... Wages payable ................................................... Interest payable .................................................. Total current liabilities ................................... Long-term liabilities: Note payable ....................................................... Shareholders equity: Common stock .................................................... Retained earnings* ............................................. Total shareholders equity ............................. Total liabilities and shareholders equity $50,000 28,000

$ 14,000 9,000 1,000 24,000 30,000

78,000 $132,000

$28,000 is the amount needed to cause total assets to equal total liabilities and shareholders equity. This is calculated in BE 3-3.

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Chapter 03 - The Balance Sheet and Financial Disclosures

Brief Exercise 3-5 Brief ExerciseCulver 3-6 City Lighting, Inc.


Balance Sheet At December 31, 2011 Assets Current assets: Cash .................................................................... Accounts receivable ............................................ Inventories .......................................................... Prepaid insurance ................................................ Total current assets ........................................ Property, plant, and equipment: Equipment ........................................................... Less: Accumulated depreciation ......................... Net property, plant, and equipment ............... Intangible assets: Patent ............................................................... Total assets ................................................. Liabilities and Shareholders' Equity Current liabilities: Accounts payable ............................................... Interest payable................................................... Current maturities of long-term debt ................... Total current liabilities ................................... Long-term liabilities: Note payable ....................................................... Shareholders equity: Common stock .................................................... Retained earnings ............................................... Total shareholders equity ............................. Total liabilities and shareholders equity 1. $70,000 76,000 146,000 $260,000 $100,000 (34,000) 66,000 40,000 $260,000 $ 55,000 39,000 45,000 15,000 154,000

$ 12,000 2,000 10,000 24,000 90,000

The $30,000 should be classified as a noncurrent asset, under the investments classification.

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Chapter 03 - The Balance Sheet and Financial Disclosures

2. 3.

$10,000, next years installment, should be classified as a current liability, current maturities of long-term debt. The remaining $90,000 is included in long-term liabilities. Two-thirds of the unearned revenue, $40,000, should be classified as a current liability, the remaining $20,000 as a long-term liability. Current assets cash and cash equivalents accounts receivable = Inventories 40,000 120,000 = $75,000

Brief Exercise 3-7


$235,000

Total assets current assets = property, plant, and equipment $400,000 235,000 = $165,000 Total assets accounts payable note payable common stock = retained earnings $400,000 32,000 50,000 100,000 = $218,000 (1) A

Brief Exercise 3-8


(2) (3) (4) (5) (6) B B A B A

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Chapter 03 - The Balance Sheet and Financial Disclosures

Brief Exercise 3-9

(a)

Current assets

current liabilities ($55,000 + 39,000 + 45,000 + 15,000) ($12,000 + 2,000 + 10,000) $154,000 $24,000 = 6.42

(b) (Cash + short-term investments + accounts receivable) current liabilities ($55,000 + 0 + 39,000) $24,000 = 3.92 (c) Total liabilities shareholders equity $24,000 current liabilities + 90,000 long-term liabilities = $114,000 $70,000 common stock + 76,000 retained earnings = $146,000 $114,000 $146,000 = .78 Paying accounts payable reduces both current Brief Exercise 3-10 assets and current liabilities. If the ratio before the payment were above 1.0, the transaction would cause the ratio to increase. However, if the ratio before the transaction were less than 1.0, the ratio would decrease. Acid-test ratio = (cash + short-term investments + Brief Exercise 3-11 A/R) current liabilities 1.5 = ($20,000 + 0 + 40,000) current liabilities 1.5 x current liabilities = $60,000 current liabilities = $60,000 1.5 current liabilities = $40,000 Current ratio = current assets current liabilities 2.0 = current assets $40,000 current assets = $40,000 x 2.0 current assets = $80,000 $80,000 20,000(cash) 40,000(A/R) = $20,000 inventories

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Chapter 03 - The Balance Sheet and Financial Disclosures

EXERCISES
Exercise 3-1
1. Total current assets Current liabilities = $44,000 + 15,000 + 1,000 (accrued interest) = $60,000 Since the current ratio is 1.5:1, current assets = 1.5 x $60,000 = $90,000 2. Short-term investments $90,000 - 5,000 - 20,000 - 60,000 = $5,000 3. Retained earnings Current assets + Noncurrent assets = Current liabilities + Long-term liabilities + Paid-in capital + Retained earnings (RE) $90,000 + 120,000 = $60,000 + 30,000 (Note payable) + 100,000 + RE RE = $20,000

Exercise 3-2
1. 2. 3. 4. 5. 6. 7. 8. 9. c f -a _ b_ g_ f f i b Equipment Accounts payable Allowance for uncollectible accounts Land, held for investment Note payable, due in 5 years Unearned rent revenue Note payable, due in 6 months Income less dividends, accumulated Investment in XYZ Corp., long-term 10. 11. 12. 13. 14. 15. 16. 17. 18. a Inventories d _ Patent c Land, in use f _ Accrued liabilities a Prepaid rent h _ Common stock c Building, in use a Cash f _ Taxes payable

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Chapter 03 - The Balance Sheet and Financial Disclosures

Exercise 3-3
1. f 2. d 3. -c 4. e revenue 5. g 6. f 7. f 8. b 9. b _____ Accrued interest payable 10. a Franchise 11. c Accumulated depreciation 12. c Prepaid insurance, for 2011 13.___ Bonds payable, due in 10 years Current maturities of long-term debt Note payable, due in 3 months Long-term receivables Bond sinking fund, will be used to retire bonds in 10 years 14. 15. 16. 17. 18. d h b a f Supplies Machinery Land, in use f Unearned

_ Copyrights _ Preferred stock _ Land, held for speculation Cash equivalents _ Wages payable

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Chapter 03 - The Balance Sheet and Financial Disclosures

3-5 VALLEY JACKSON PUMP CORPORATION CORPORATION Exercise 3-4Exercise


Balance Sheet Balance Sheet At December 31, 2011 At December 31, 2011 Exercise 3-6 Assets

Current assets: Current assets: Cash ................................................................................. Cash .................................................................... Marketable securities ....................................................... Marketable securities Accounts receivable, net of .......................................... allowance for uncollectible accounts ............................................ of $5,000 ............................... Accounts receivable Inventories ....................................................................... Inventories .......................................................... Prepaid expenses ............................................................. Prepaid rent ........................................................ Total current assets ................................................... Investments: Marketable plant, securities ....................................................... Property, and equipment: Land ................................................................................ Machinery ........................................................... Total investments ......................................................

Assets

$ 25,000 $22,000 40,000

Total current assets ........................................

10,000 51,000 34,000 81,000 75,000 32,000 16,000 211,000 175,000

Less: Accumulated depreciation ......................... Property, plant, and equipment: Net property, plant, and equipment ...............
Land ................................................................................ Buildings .......................................................................... Intangible assets: Equipment ....................................................................... Net property, plant, and equipment ...........................

$145,000 (11,000)
100,000 300,000 75,000 475,000 (125,000)

$22,000 20,000

42,000

134,000 83,000 $392,000


350,000 12,000 $ 8,000 $615,000

Patent ............................................................... Total assets ................................................. Less: Accumulated depreciation ......................................

Liabilities and Shareholders' Equity Intangible assets: Current liabilities: Copyright ........................................................................ Accounts payable ............................................... Total assets ............................................................. Wages payable ................................................... Liabilities and Shareholders' Equity Taxes payable ..................................................... Current liabilities: Total current liabilities ................................... Accounts payable ............................................................ Long-term liabilities: Unearned revenues .......................................................... Note payable .................................................................... Bonds payable ....................................................
Current maturities of long-term debt ............................... Total current equity: liabilities ............................................... Shareholders Interest payable ...............................................................

4,000 32,000 44,000 $ 65,000


10,000 20,000 100,000 200,000 50,000 245,000

Common stock .................................................... Long-term liabilities: Retained ............................................... Note payableearnings .................................................................... Total shareholders equity ............................. Shareholders equity: Total liabilities and shareholders equity Common stock ................................................................ Retained earnings ............................................................ Total shareholders equity ......................................... Total liabilities and shareholders equity ................ Current assets:
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$100,000 48,000
$200,000 70,000

100,000

148,000 $392,000

270,000 $615,000

Chapter 03 - The Balance Sheet and Financial Disclosures

Cash Accounts receivable Less: allowance for uncollectible accounts Note receivable Interest receivable Marketable securities Raw materials Work in process Finished goods Prepaid rent (one-half of $60,000) Total current assets Current liabilities: Unearned revenue (one half of $36,000) Accounts payable Interest payable Total current liabilities Working capital

$20,000 130,000 (13,000) 100,000 3,000 32,000 24,000 42,000 89,000 30,000 $457,000 18,000 180,000 5,000 (203,000) $254,000

Exercise 3-7

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Exercise 3-8

LOS GATOS CORPORATION Balance Sheet At December 31, 2011 Assets $ 20,000 55,000 55,000 130,000 $ 20,000 20,000 40,000 190,000 (70,000) 120,000 30,000 $320,000 $ 50,000 5,000 50,000 105,000 110,000

Current assets: Cash ........................................................................ Accounts receivable, net of allowance for uncollectible accounts of $5,000 ......................... Inventories ............................................................... Total current assets ............................................ Investments: Bond sinking fund ................................................... Note receivable ........................................................ Total investments ............................................... Property, plant, and equipment: Machinery ............................................................... Less: Accumulated depreciation .............................. Net property, plant, and equipment ....................

Intangible assets: Franchise ................................................................. Total assets ...................................................... Liabilities and Shareholders' Equity Current liabilities: Accounts payable .................................................... Interest payable ....................................................... Note payable ........................................................... Total current liabilities ....................................... Long-term liabilities: Bonds payable ......................................................... Shareholders equity: Common stock, no par value; 100,000 shares authorized; 50,000 shares issued and outstanding Retained earnings .................................................... Total shareholders equity .................................. Total liabilities and shareholders equity ........

$ 70,000 35,000 105,000 $320,000

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Chapter 03 - The Balance Sheet and Financial Disclosures

Exercise 3-9

CONE CORPORATION Balance Sheet (Partial) At December 31, 2011 Assets

Current assets: Marketable securities .......................................... Prepaid rent ........................................................ Investments: Bond sinking fund ............................................... Marketable securities .......................................... Other assets: Prepaid rent (1) ................................................... Liabilities and Shareholders' Equity Current liabilities: Interest payable .................................................. Current maturities of long-term debt ................... Long-term liabilities: Note payable ....................................................... current assets. See calculations below the balance sheet.

$ 40,000 12,000 50,000 40,000 12,000

$ 12,000 20,000 180,000

(1) Note: In practice, companies often report all prepaid expenses as

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Chapter 03 - The Balance Sheet and Financial Disclosures

Korver Supply Company Balance Sheet At December 31, 2011 Assets Current assets: Cash .................................................................... Accounts receivable ............................................ Inventories .......................................................... Total current assets ........................................ Property, plant, and equipment: Furniture and fixtures .......................................... Less: Accumulated depreciation ......................... Net property, plant, and equipment ............... Total assets ................................................. Current liabilities: Accounts payable ............................................... Interest payable .................................................. Note payable ....................................................... Total current liabilities ................................... Shareholders equity: Common stock .................................................... Retained earnings ............................................... Total shareholders equity ............................. Total liabilities and shareholders equity $100,000 382,000 482,000 $868,000 $300,000 (170,000) 130,000 $868,000 $168,000 320,000 250,000 738,000

Liabilities and Shareholders' Equity $180,000 6,000 200,000 386,000

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Chapter 03 - The Balance Sheet and Financial Disclosures

Exercise 3-9 (concluded) Beginning balance in cash + Cash collected from customers - Cash paid to suppliers - Cash paid for operating expenses - Cash paid for interest Ending cash balance Beginning balance in accounts receivable + Credit sales - Cash collected from customers Ending balance in accounts receivable Beginning balance in inventories + Purchases - Cost of merchandise sold Ending balance in inventories Beginning balance in furniture and fixtures, net - Depreciation for the year Ending balance in furniture and fixtures, net Beginning balance in accounts payable + Purchases on account - Cash paid to suppliers Ending balance in accounts payable Beginning balance in retained earnings + Sales revenue - Cost of goods sold - Operating expenses - Depreciation expense - Interest expense Ending balance in retained earnings Accrued interest on note ($200,000 x 6% x 6/12) $120,000 780,000 (560,000) (160,000) (12,000) $168,000 $300,000 800,000 (780,000) $320,000 $200,000 550,000 (500,000) $250,000 $150,000 (20,000) $130,000 $190,000 550,000 (560,000) $180,000 $274,000 800,000 (500,000) (160,000) (20,000) (12,000) $382,000 $6,000

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Chapter 03 - The Balance Sheet and Financial Disclosures

Exercise 3-10
1. 2. 3. 4. 5. 6. 7. 8.

Inventory costing method Information on related party transactions Composition of property, plant, and equipment Depreciation method Subsequent event information Basis of revenue recognition on long-term contracts Important merger occurring after year-end Composition of receivables 1.

A B B A B A B B

When related-party transactions occur, companies must disclose Exercise 3-11 the nature of the relationship, provide a description of the transaction, and report the dollar amounts of the transactions and any amounts due from or to related parties. 2. When an event that has a material effect on the companys financial position occurs after the fiscal year-end, but before the financial statements actually are issued, the event is disclosed in a subsequent event disclosure note. 3. The choice of the straight-line method to determine depreciation typically is disclosed in the companys summary of significant accounting policies disclosure note. 4. This information would be included in a disclosure note describing the companys debt. 5. The choice of the FIFO method to determine value inventory typically is disclosed in the companys summary of significant accounting policies disclosure note.

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Chapter 03 - The Balance Sheet and Financial Disclosures

Exercise 3-12
2. 3. 4. 5. 6. 7. 8.

1.

(B) in a separate disclosure note.

(A) in the summary of significant policies note. (C) on the face of the balance sheet. (B) in a separate disclosure note. (B) in a separate disclosure note. (A) in the summary of significant policies note. (C) on the face of the balance sheet. (B) in a separate disclosure note.

Exercise 3-13Requirement 1

The topic number that provides guidance on information contained in the notes to the financial statements is ASC Topic 235: Notes to the Financial Statements. Requirement 2 The specific citation that describes the information that companies must disclose in the accounting policies note is FASB ASC 23510503: Notes to Financial StatementsOverallDisclosureWhat to Disclose. Requirement 3

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Chapter 03 - The Balance Sheet and Financial Disclosures

Disclosure of accounting policies should identify and describe the accounting principles the company follows and the methods of applying those principles that materially affect the determination of financial position, cash flows, or results of operations. In general, the disclosure encompasses important judgments as to appropriateness of principles relating to recognition of revenue and allocation of asset costs to current and future periods. In particular, it encompasses those accounting principles and methods that involve any of the following: a. A selection from existing acceptable alternatives. b. Principles and methods peculiar to the industry in which the entity operates, even if such principles and methods are predominantly followed in that industry. c. Unusual or innovative applications of GAAP.

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Exercise 3-14

The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. What is the balance sheet classification for a note payable due in six months which is used to purchase a building? FASB ASC 21010459: Notes to Financial StatementsOverallOther Presentation MattersOther Liabilities. Other liabilities whose regular and ordinary liquidation is expected to occur within a relatively short period of time, usually 12 months, are also generally included, such as the following: a. Short-term debts arising from the acquisition of capital assets. b. Serial maturities of long-term obligations. c. Amounts required to be expended within one year under sinking fund provisions. d. Agency obligations arising from the collection or acceptance of cash or other assets for the account of third persons. Loans accompanied by pledge of life insurance policies would be classified as current liabilities if, by their terms or by intent, they are to be repaid within 12 months. The pledging of life insurance policies does not affect the classification of the asset any more than does the pledging of receivables, inventories, real estate, or other assets as collateral for a short-term loan. However, when a loan on a life insurance policy is obtained from the insurance entity with the intent that it will not be paid but will be liquidated by deduction from the proceeds of the policy upon maturity or cancellation, the obligation shall be excluded from current liabilities.

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Exercise 3-14 (continued) 2. Which assets may be excluded from current assets? FASB ASC 21010454: Notes to Financial StatementsOverallOther Presentation Matters. The concept of the nature of current assets contemplates the exclusion from that classification of such resources as the following: a. Cash and claims to cash that are restricted as to withdrawal or use for other than current operations, are designated for expenditure in the acquisition or construction of noncurrent assets, or are segregated for the liquidation of long-term debts. Even though not actually set aside in special accounts, funds that are clearly to be used in the near future for the liquidation of long-term debts, payments to sinking funds, or for similar purposes shall also, under this concept, be excluded from current assets. However, if such funds are considered to offset maturing debt that has properly been set up as a current liability, they may be included within the current asset classification. b. Investments in securities (whether marketable or not) or advances that have been made for the purposes of control, affiliation, or other continuing business advantage. c. Receivables arising from unusual transactions (such as the sale of capital assets, or loans or advances to affiliates, officers, or employees) that are not expected to be collected within 12 months. d. Cash surrender value of life insurance policies. e. Land and other natural resources. f. Depreciable assets. g. Long-term prepayments that are fairly chargeable to the operations of several years, or deferred charges such as bonus payments under a longterm lease, costs of rearrangement of factory layout or removal to a new location.
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Exercise 3-14 (continued) 3. Should a note receivable from a related party be included in the balance sheet with notes receivable from customers? FASB ASC 85010502: Related Party DisclosuresOverall Disclosure. Notes or accounts receivable from officers, employees, or affiliated entities must be shown separately and not included under a general heading such as notes receivable or accounts receivable.

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Exercise 3-14 (concluded) 4. What items are nonrecognized subsequent events that require a disclosure in the notes to the financial statements? FASB ASC 85510552: Subsequent EventsOverallImplementation Guidance and IllustrationsNonrecognized Subsequent Events. The following are examples of nonrecognized subsequent events addressed in paragraph 855-10-25-3: a. Sale of a bond or capital stock issued after the balance sheet date but before financial statements are issued or are available to be issued. b. A business combination that occurs after the balance sheet date but before financial statements are issued or are available to be. c. Settlement of litigation when the event giving rise to the claim took place after the balance sheet date but before financial statements are issued or are available to be issued. d. Loss of plant or inventories as a result of fire or natural disaster that occurred after the balance sheet date but before financial statements are issued or are available to be issued. e. Losses on receivables resulting from conditions (such as a customers major casualty) arising after the balance sheet date but before financial statements are issued or are available to be issued. f. Changes in the fair value of assets or liabilities (financial or nonfinancial) or foreign exchange rates after the balance sheet date but before financial statements are issued or are available to be issued. g. Entering into significant commitments or contingent liabilities, for example, by issuing significant guarantees after the balance sheet date but before financial statements are issued or are available to be issued.

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Exercise 3-15
List A d h b j a 1. Balance sheet 2. Liquidity 3. Current assets 4. Operating cycle 5. Current liabilities List B a. Will be satisfied through the use of current assets. b. Items expected to be converted to cash or consumed within one year or the operating cycle, whichever is longer. c. The statements are presented fairly in conformity with GAAP. d. An organized array of assets, liabilities, and equity. e. Important to a user in comparing financial information across companies. f. Scope limitation or a departure from GAAP. g. Recorded when an expense is incurred but not yet paid. h. Relates to the amount of time before an asset is converted to cash or a liability is paid. i. Occurs after the fiscal year-end but before the statements are issued. j. Cash to cash.

k 6. Cash equivalent m 7. Intangible asset l g 8. Working capital 9. Accrued liabilities

e 10. Summary of significant accounting policies i 11. Subsequent events k. One-month U.S. treasury bill. c 12. Unqualified opinion l. Current assets minus current liabilities. f 13. Qualified opinion m. Lacks physical substance. 1. Current ratio [$200 + 150 + 200 + 350] $400 = 2.25

Exercise 3-16

2. Acid-test ratio 3. Debt to equity ratio 4. Times interest earned ratio

[$200 + 150 + 200] $400 = 1.375 [$400 + 350] [$750 + 400] = .65 [$160 + 40 + 100] $40 = 7.5 times

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Chapter 03 - The Balance Sheet and Financial Disclosures

Exercise 3-17Requirement 1
a. Current ratio b. Acid-test ratio c. Debt to equity ratio d. Times interest earned ratio $8,192 $8,435 = .97 [$498 + 11 + 1,868] $8,435 = .28 [$8,435 + 2,748] $4,643 = 2.4 [$1,003 + 94 + 674] $94 = 19 times

Requirement 2 Best Buys current and acid-test ratios both are lower than the industry averages, indicating questionable liquidity. The debt to equity ratio is significantly higher than the industry average, indicating that the companys assets are primarily financed with liabilities rather than equity. However, the companys times interest earned ratio is significantly higher than the industry average. Even with high leverage, Best Buy seems quite capable of meeting its debt interest obligations. Exercise 3-181. Acid-test ratio = Quick assets Current liabilities = 1.20 Quick assets = Current assets - Inventories Quick assets = Current assets - $840,000 Current assets Current liabilities = Current assets - $840,000 Current liabilities = $840,000 Current liabilities = Current liabilities = $800,000 Current assets $800,000 = 2.25 Current assets = $1,800,000 2.25 1.20 1.05

2. Debt to equity ratio = Total liabilities Shareholders equity = 1.8 Total liabilities + Shareholders' equity = Total assets Total liabilities + Shareholders' equity = $2,800,000 Let x equal shareholders' equity 1.8 x + x = $2,800,000 x = $1,000,000 = Shareholders' equity 3. Noncurrent assets = Total assets - Current assets Noncurrent assets = $2,800,000 1,800,000 = $1,000,000 4. Long-term liabilities = Total assets - Current liabilities - Shareholders' equity Long-term liabilities = $2,800,000 - 800,000 - 1,000,000 = $1,000,000

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Chapter 03 - The Balance Sheet and Financial Disclosures

Exercise 3-191. Debt to equity ratio = Total liabilities Shareholders equity = 1.4
Total liabilities $2,500,000 = 1.4 Shareholders equity x 1.4 = total liabilities $2,500,000 x 1.4 = $3,500,000 = total liabilities

Total liabilities + equity = total assets $3,500,000 + 2,500,000 = $6,000,000 = total assets Total assets noncurrent assets = current assets $6,000,000 2,400,000 = $3,600,000 = current assets Current ratio = Current assets current liabilities 2.0 = $3,600,000 current liabilities Current liabilities = $3,600,000 2 = $1,800,000 2. Total assets = total liabilities + shareholders equity Total assets = current liabilities + long-term liabilities + shareholders equity $6,000,000 = $1,800,000 + long-term liabilities + $2,500,000 Long-term liabilities = $1,700,000 3. Current assets = Cash + accounts receivable + prepaid expenses $3,600,000 = $1,300,000 + accounts receivable + $360,000 Accounts receivable = $1,940,000 4. Acid-test ratio = Quick assets Current liabilities Quick assets = Cash + accounts receivable Quick assets = $1,300,000 + 1,940,000 = $3,240,000 Acid-test ratio = $3,240,000 $1,800,000 = 1.8

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Chapter 03 - The Balance Sheet and Financial Disclosures

Exercise 3-20
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Equity Ratio Issuance of long-term bonds Issuance of short-term notes Payment of accounts payable Purchase of inventory on account Purchase of inventory for cash Purchase of equipment with a 4-year note Retirement of bonds Sale of common stock Write-off of obsolete inventory Purchase of short-term investment for cash Decision to refinance on a long-term basis some currently maturing debt

Current Debt to Action I I D I N N D I D N I Ratio I I D D D N D I N N I

Acid-test Ratio I I D I N I D D I N N

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Chapter 03 - The Balance Sheet and Financial Disclosures

Exercise 3-21Requirement 1
The pharmaceuticals, plastics and farm equipment segments are reportable. Only segments representing 10% or more of total company revenues, assets or net income must be reported. The electronics segment does not meet this criterion. Requirement 2 For segments determined to be reportable, the following disclosures are required: a. General information about the operating segment. b. Information about reported segment profit or loss, including certain revenues and expenses included in reported segment profit or loss, segments assets, and the basis of measurement. c. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other significant items to corresponding enterprise amounts. d. Interim period information. In addition to revenues, profit or loss, and assets, IFRS also Exercise 3-22require the disclosure of total liabilities for each of the reportable segments.

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Chapter 03 - The Balance Sheet and Financial Disclosures

CPA / CMA REVIEW QUESTIONS


CPA Exam Questions
1. b.
The principal would have to be due after April 30, 2012 to be considered as a noncurrent asset at April 30, 2011. The accrued interest for eight months (since August 31, 2010) is a current asset at April 30, 2011. Since the principal is due August 31, 2012, additional interest would have to be recorded for the period September 1, 2011 to August 31, 2012.

2. a.

Current liabilities are obligations that are expected to be paid within one year or the operating cycle whichever is longer. Accounts payable Bonds payable Dividends payable Total current liabilities $15,000 22,000 8,000 $45,000

The notes payable are not classified as current liabilities because they are not due until 2013. 3. a.
Inventory pricing is a significant accounting policy which should be disclosed according to generally accepted accounting principles, but the composition of plant assets is not a policy disclosure.

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CPA Exam Questions (concluded) 4. c. The auditors standard report includes a statement that the financial statements are the responsibility of the Company's management and that the auditors responsibility is to express an opinion on the financial statements.
5. b. Current ratio -- increased; Quick ratio -- decreased.

Current ratio = Current assets Current liabilities. When the current ratio is greater than 1 to 1, an equal decrease in current assets and current liabilities will result in an increase in the current ratio. The decrease in current liabilities (the smaller number) is proportionately greater than the decrease in current assets, resulting in an increase in the ratio.
Quick ratio = (Cash + Marketable Securities + Accounts receivable) Current liabilities

When the quick ratio is less than 1:1, an equal decrease in quick assets and current liabilities will result in a decrease in the ratio. The decrease in current liabilities (the larger number) is proportionately smaller than the decrease in quick assets, resulting in a decrease in the ratio.

6.

a.

Since inventory is not included in the quick ratio, the write-off of obsolete inventory would have no effect on the quick ratio; however, it would decrease the current ratio as the write-off would reduce current assets.

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Chapter 03 - The Balance Sheet and Financial Disclosures

CMA Exam Questions


1. d. GAAP requires disclosure of related-party transactions except for compensation agreements, expense allowances, and transactions eliminated in consolidated working papers. Required disclosures include the relationship(s) of the related parties; a description and dollar amounts of transactions for each period presented and the effects of any change in the method of establishing their terms; and amounts due to or from the related parties and, if not apparent, the terms and manner of settlement. The effect on the cash flow statement need not be disclosed. 2. b. The MD&A section is included in SEC filings. It addresses in a nonquantified manner the prospects of a company. The SEC examines it with care to determine that management has disclosed material information affecting the companys future results. Disclosures about commitments and events that may affect operations or liquidity are mandatory. Thus, the MD&A section pertains to liquidity, capital resources, and results of operations. 3. a. The current ratio equals current assets divided by current liabilities. An equal increase in both the numerator and denominator of a current ratio less than 1.0 causes the ratio to increase. Windham Companys current ratio is .8 ($400,000/ $500,000). The purchase of $100,000 of inventory on account would increase the current assets to $500,000 and the current liabilities to $600,000, resulting in a new current ratio of .833.

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Chapter 03 - The Balance Sheet and Financial Disclosures

PROBLEMS
Problem 3-1

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Chapter 03 - The Balance Sheet and Financial Disclosures

Balance Sheet Assets Current assets: Cash Short-term investments Accounts receivable, net of allowance for uncollectible accounts Interest receivable Inventories Prepaid expenses Total current assets Investments: Bond sinking fund Long-term investments Notes receivable Total investments Property, plant, and equipment: Land Buildings Equipment Less: Accumulated depreciation Net property, plant, and equipment Intangible assets: Patent Copyright Total intangible assets Total assets Liabilities and Shareholders' Equity Current liabilities: Accounts payable Rent payable Taxes payable Wages payable Notes payable Total current liabilities Long-term liabilities: Bonds payable Shareholders equity: Common stock Preferred stock Retained earnings Total shareholders equity Total liabilities and shareholders equity

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Chapter 03 - The Balance Sheet and Financial Disclosures

Requirement 1

Problem 3-2
Inventories: Current assets - Cash and cash equivalents - Short-term investments Accounts receivable - Prepaid expenses = Inventories $1,594,927 - 239,186 - 353,700 - 504,944 - 83,259 = $413,838 Total assets: Total liabilities + Shareholders equity = Total assets $956,140 + 1,370,627 = $2,326,767 Property and equipment (net): Total assets - Current assets - Long-term receivables = Property and equipment $2,326,767 - 1,594,927 - 110,800 = $621,040 Accounts payable: Total current liabilities - Notes payable and short-term debt - Accrued liabilities Other current liabilities = Accounts payable $693,564 - 31,116 - 421,772 - 181,604 = $59,072 Long-term debt and deferred taxes: Total liabilities - Current liabilities = Long-term debt and deferred taxes $956,140 - 693,564 = $262,576

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Chapter 03 - The Balance Sheet and Financial Disclosures

Problem 3-2 (concluded) Requirement 2

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Chapter 03 - The Balance Sheet and Financial Disclosures

Problem 3-3

ALMWAY CORPORATION TRIDENT CORPORATION Balance Sheet Problem 3-4 AtBalance December Sheet 31, 2011

Assets Assets Current assets: Cash and cash equivalents ...................................................... Short-term investments ........................................................... Current assets: Accounts receivable, net of allowance for Cash and cash equivalents ............................. uncollectible accounts of $8,000 ....................................... Short-term investments .................................. Inventories .............................................................................. Prepaid insurance ................................................................... Accounts receivable, net of allowance for Total current assets .......................................................... uncollectible accounts ............................. Investments: Inventories ..................................................... Marketable securities .............................................................. Prepaid expenses ........................................... Land held for sale ................................................................... Total current assets .................................. Bond sinking fund .................................................................. Total investments ............................................................. $ 30,000 25,000 15,000

($ in thousands) $ 30,000
80,000

$ 239,186 60,000 353,700 200,000


9,000 379,000 504,944

413,838 83,259 1,594,927


70,000

Investments: Property, plant, and equipment: Land ....................................................................................... Long-term receivables ...................................

Property and equipment (net)........................... Total assets ............................................ Less: Accumulated depreciation .............................................
Net property, plant, and equipment ..................................

Buildings ................................................................................ Equipment ..............................................................................

65,000 420,000 110,000 595,000 (160,000)

110,800 621,040 $2,326,767


435,000 10,000 $894,000 31,116

Liabilities and Shareholders' Equity Intangible assets: Patents .................................................................................... Current liabilities: Total assets ...................................................................... Notes payable and short-term debt .................
Current liabilities: Accrued liabilities ........................................... Accounts payable ................................................................... Other liabilities ................................... Interest current payable ...................................................................... Note payable .......................................................................... Total current liabilities ............................... Current maturities of long-term debt ....................................... Total current liabilities .....................................................

Accounts payable

Liabilities and Shareholders' Equity ...........................................

59,072 421,772 $ 75,000 181,604 20,000 30,000 693,564 262,576


$ 90,000 240,000 10,000 135,000

Long-term debt and deferred taxes ..................

Long-term liabilities: Notes payable ......................................................................... Shareholders equity ......................................... Bonds payable ........................................................................ Total liabilities and................................................. shareholders equity Total long-term liabilities Shareholders equity: Common stock, no par value; 500,000 shares authorized; 100,000 shares issued and outstanding ............. Retained earnings ................................................................... Total shareholders equity ................................................ Total liabilities and shareholders equity .......................

1,370,627 $2,326,767 330,000

300,000 129,000 429,000 $894,000

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Chapter 03 - The Balance Sheet and Financial Disclosures

WEISMULLER PUBLISHING COMPANY Balance Sheet At December 31, 2011 Assets Current assets: Cash and cash equivalents (1) ................................................ Short-term investments ........................................................... Accounts receivable, net of allowance for uncollectible accounts of $16,000 ............................................................ Inventories .............................................................................. Prepaid expenses (2)................................................................ Total current assets .......................................................... Property, plant, and equipment: Machinery and equipment ....................................................... Less: Accumulated depreciation ............................................. Net property, plant, and equipment .................................. Other assets: Prepaid expenses Total assets ................................................................... Liabilities and Shareholders' Equity Current liabilities: Accounts payable ................................................................... Interest payable ...................................................................... Unearned revenues .................................................................. Taxes payable ........................................................................ Note payable .......................................................................... Current maturities of long-term debt ....................................... Total current liabilities ..................................................... Long-term liabilities: Notes payable ......................................................................... Shareholders equity: Common stock, no par value; 800,000 shares authorized; 400,000 shares issued and outstanding ............. Retained earnings ................................................................... Total shareholders equity ................................................ Total liabilities and shareholders equity ....................... $ 60,000 20,000 80,000 30,000 40,000 20,000 250,000 140,000 $320,000 (110,000) 210,000 60,000 $992,000

$ 95,000 110,000 144,000 285,000 88,000 722,000

400,000 202,000 602,000 $992,000

(1) Includes $30,000 in U.S. treasury bills. (2) Excludes $60,000 in prepaid rent for the second year on the building lease.

Problem 3-5

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Chapter 03 - The Balance Sheet and Financial Disclosures

EXCELL COMPANY Balance Sheet At June 30, 2011 Assets Current assets: Cash and cash equivalents (1) ................................................ Short-term investments ........................................................... Accounts receivable, net of allowance for uncollectible accounts of $15,000 ............................................................ Interest receivable ................................................................... Prepaid expenses .................................................................... Total current assets .......................................................... Investments: Note receivable ....................................................................... Land held for sale ................................................................... Property, plant, and equipment: Land ....................................................................................... Buildings ................................................................................ Equipment .............................................................................. Less: Accumulated depreciation ............................................. Net property, plant, and equipment .................................. Total assets ................................................................... Liabilities and Shareholders' Equity Current liabilities: Accounts payable ................................................................... Accrued expenses ................................................................... Note payable .......................................................................... Current maturities of long-term debt ....................................... Total current liabilities ..................................................... Long-term liabilities: Note payable .......................................................................... Mortgage payable ................................................................... Total long-term liabilities ................................................. Shareholders equity: Common stock, no par value; 500,000 shares authorized; 200,000 shares issued and outstanding ............. Retained earnings ................................................................... Total shareholders equity ................................................ Total liabilities and shareholders equity ....................... (1) Includes $18,000 in U.S. treasury bills 50,000 240,000 290,000 $65,000 25,000 50,000 320,000 265,000 635,000 (280,000) 355,000 $840,000

$101,000 47,000 210,000 5,000 32,000 395,000

90,000

$173,000 45,000 50,000 10,000 278,000

100,000 172,000 272,000 $840,000

Problem 3-6

Requirement 1

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Chapter 03 - The Balance Sheet and Financial Disclosures

VOSBURGH ELECTRONICS CORPORATION Balance Sheet At December 31, 2011 Assets


Current assets: Cash and cash equivalents (1).......................................... Marketable securities (2).................................................. Accounts receivable (net) ................................................ Loans to employees ......................................................... Interest receivable ........................................................... Note receivable current portion .................................... Inventories ....................................................................... Prepaid expenses ............................................................. Total current assets ................................................... Investments: Marketable securities........................................................ Note receivable ................................................................ Total investments ...................................................... Property, plant, and equipment: Land ................................................................................ Buildings .......................................................................... Machinery and equipment ............................................... Less: Accumulated depreciation ...................................... Net property, plant, and equipment ........................... Intangible assets: Patent .............................................................................. Franchise ......................................................................... Total intangible assets ............................................ Total assets ............................................................. $ 35,000 200,000 235,000 280,000 1,550,000 637,000 2,467,000 (830,000) 1,637,000 152,000 40,000 192,000 $2,761,000 $ 117,000 132,000 115,000 40,000 12,000 50,000 215,000 16,000 697,000

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Chapter 03 - The Balance Sheet and Financial Disclosures

Problem 3-6 (continued) Liabilities and Shareholders' Equity


Current liabilities: Accounts payable ............................................................ Dividends payable ............................................................ Interest payable ............................................................... Taxes payable .................................................................. Unearned revenue (3)....................................................... Total current liabilities ............................................... Long-term liabilities: Notes payable .................................................................. Unearned revenue (3)....................................................... Total long-term liabilities ........................................ Shareholders equity: Common stock, no par value; 1,000,000 shares authorized; 500,000 shares issued and outstanding ..... Retained earnings ............................................................ Total shareholders equity ......................................... Total liabilities and shareholders equity ................ $ 300,000 12,000 312,000 $ 189,000 10,000 16,000 40,000 48,000 303,000

2,000,000 146,000 2,146,000 $2,761,000

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Chapter 03 - The Balance Sheet and Financial Disclosures

Problem 3-6 (concluded) (1) $67,000 + $50,000 in treasury bills considered a cash equivalent. (2) $182,000 - $50,000 in treasury bills considered a cash equivalent. (3) $60,000 in unearned revenue, 80%, $48,000, current and 20%, $12,000, long-term. Requirement 2 Cash equivalents - the policy used to determine what items are considered to be cash equivalents. Accounts receivable, net - disclosure on the face of the statement of the allowance for uncollectible accounts, if material. Investments - information about the types of investments and the accounting method used to value the investments. Inventories - disclosure in Accounting Policies note of the cost method used. Also, for a manufacturer, note disclosure of the breakout of inventory into raw materials, work in process and finished goods. Property, plant and equipment - original cost by major category should be disclosed along with the accumulated depreciation either on the face of the statement or in a note. Also, the method used to compute depreciation should be disclosed in the Accounting Policies disclosure note. Long-term liabilities - disclosure in a note of the various debt instruments comprising long-term liabilities to include information such as payment terms, interest rates, and collateral pledged as security for the debt.

Problem 3-7

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Chapter 03 - The Balance Sheet and Financial Disclosures

HUBBARD CORPORATION Balance Sheet At December 31, 2011 Assets Current assets: Cash ....................................................................................... Marketable securities .............................................................. Accounts receivable (net) ....................................................... Inventories .............................................................................. Total current assets .......................................................... Investments: Marketable securities............................................................... Land held for sale ................................................................... Total investments ............................................................. Property, plant, and equipment: Land (1) ................................................................................. Buildings ................................................................................ Machinery .............................................................................. Less: Accumulated depreciation ............................................. Net property, plant, and equipment .................................. Intangible assets: Patent ..................................................................................... Total assets ................................................................... Liabilities and Shareholders' Equity Current liabilities: Accounts payable ................................................................... Current maturities of long-term debt ....................................... Total current liabilities ..................................................... Long-term liabilities: Notes payable ......................................................................... Shareholders equity: Common stock, no par value; 100,000 shares authorized; 100,000 shares issued and outstanding ............. Retained earnings (2) .............................................................. Total shareholders equity ................................................ Total liabilities and shareholders equity ....................... $ 40,000 50,000 90,000 130,000 750,000 280,000 1,160,000 (255,000) 905,000 100,000 $1,455,000 $ 60,000 20,000 120,000 160,000 360,000

$ 215,000 25,000 240,000 475,000

$ 430,000 310,000 740,000 $1,455,000

(1) $250,000 - $50,000 in land held for sale - $70,000 increase in land (2) $380,000 - $70,000 increase in land

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Chapter 03 - The Balance Sheet and Financial Disclosures

Problem 3-8

Solve for missing amounts: Liabilities Equity = 1.2 $18,000 Equity = 1.2 Equity = $18,000 1.2 = $15,000 Beginning retained earnings + net income dividends = Ending retained earnings $4,000 + 1,560 560 = $5,000 Total equity retained earnings = Common stock $15,000 5,000 = $10,000 Assets = Liabilities + equity Assets = $18,000 + 15,000 = $33,000 $33,000 all other assets = Patent $33,000 27,600 = $5,400

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Chapter 03 - The Balance Sheet and Financial Disclosures

Problem 3-8 (concluded)


Sanderson Manufacturing Company Balance Sheet At December 31, 2011
($ in 000s, except share data)

Assets Current assets: Cash ................................................................................. Short-term investments ................................................... Accounts receivable, net of $400 allowance for uncollectible accounts .................................................. Inventories: Raw materials and work in process .............................. Finished goods ............................................................. Prepaid expenses ............................................................. Total current assets ................................................... Property, plant, and equipment: Equipment ....................................................................... Less: Accumulated depreciation ...................................... Net property, plant, and equipment ........................... Intangible assets: Patent ........................................................................... Total assets ............................................................. Liabilities and Shareholders' Equity Current liabilities: Accounts payable ............................................................ Interest payable................................................................ Unearned revenue ............................................................ Current maturities of long-term debt ............................... Total current liabilities ............................................... Long-term liabilities: Unearned revenue ............................................................ Note payable .................................................................... Bonds payable ................................................................. Shareholders equity: Common stock, no par, 400,000 shares authorized,........ 250,000 shares issued and outstanding Retained earnings ............................................................ Total shareholders equity ......................................... Total liabilities and shareholders equity

$ 1,250 3,000 3,100 $ 2,250 6,000 8,250 1,200 16,800

15,000 (4,200) 10,800 5,400 $33,000

$ 5,200 300 1,500 1,000 8,000 1,500 3,000 5,500

10,000

10,000 5,000 15,000 $33,000

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Chapter 03 - The Balance Sheet and Financial Disclosures

Problem 3-9

3-48

HHD, Inc. Balance Sheet At December 31, 2011 Chapter 03 - The Balance Sheet and Financial Disclosures Assets Current assets: Cash ............................................................................................... Investment in stocks ............................................................................................... Accounts receivable ............................................................................................... Inventories ............................................................................................... Prepaid insurance ............................................................................................... Total current assets ......................................................................................... Investments: Investment in stocks ............................................................................................... Bond sinking fund ............................................................................................... Total investments ......................................................................................... Property, plant, and equipment: Land ............................................................................................... Buildings ............................................................................................... Equipment ............................................................................................... Less: Accumulated depreciation ............................................................................................... Net property, plant, and equipment ......................................................................................... Intangible assets: Patent ............................................................................................... Copyright ............................................................................................... Total intangible assets ......................................................................................... Total assets ...................................................................................... $ 160,000 250,000

150,000 90,000 200,000 225,000 25,000 690,000

410,000

800,000 1,500,000 500,000 2,800,000 (800,000) 2,000,000

110,000 90,000 200,000 $3,300,000

Liabilities and Shareholders' Equity Current liabilities: Accounts payable ................................................................. Notes payable ....................................................................... Taxes payable ....................................................................... Total current liabilities ................................................... Long-term liabilities: Notes payable ....................................................................... $ 90,000 Bonds payable ...................................................................... 1,100,000 Total long-term liabilities ............................................... Shareholders equity: 3-49 Common stock, no par, 500,000 shares authorized, 200,000 shares issued and outstanding ............................... 1,000,000 Retained earnings ................................................................. 800,000

100,000 150,000 60,000 310,000

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Chapter 03 - The Balance Sheet and Financial Disclosures

Problem 3-10
MELODY LANE MUSIC COMPANY Balance Sheet At December 31, 2011 Assets Current assets: Cash (1) ............................................................... Inventories .......................................................... Prepaid rent ........................................................ Total current assets ........................................ Property, plant, and equipment: Equipment and furniture ..................................... Less: Accumulated depreciation ......................... Net property, plant, and equipment ............... Total assets ................................................. Current liabilities: Accounts payable (2) ........................................... Interest payable .................................................. Loan payable ...................................................... Total current liabilities ................................... Shareholders equity: Common stock, no par, 100,000 shares $ 40,000 (4,000) 36,000 $306,000 $167,000 100,000 3,000 270,000

Liabilities and Shareholders' Equity $ 21,000 9,000 100,000 130,000

authorized, 20,000 shares issued and outstanding ...... Retained earnings (3) ..........................................

$100,000 76,000 176,000 $306,000

Total shareholders equity ............................. Total liabilities and shareholders equity ....

(1) Cash receipts of $560,000 less cash disbursements of $393,000 (2) $20,000 owed to suppliers + $1,000 owed to utility company (3) Net income for the year

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Chapter 03 - The Balance Sheet and Financial Disclosures

CASES
IBM manufactures and sells personal and main computers. The computers included as current assets in the balance sheet for the company represent the cost of inventory available for sale. In addition, IBM uses computers in its operations. The cost of these computers is included in the property, plant, and equipment category in the balance sheet. Marketable securities could be classified as either current or noncurrent assets depending on the intent of management. If management intends to sell the securities in the next year or operating cycle, they are classified as current assets. If management intends to hold the securities beyond the coming year or operating cycle, they are classified as noncurrent assets.

Communication Case 3-1frame

Analysis Case 3-2Requirement 1

Current assets include cash and other assets that are reasonably expected to be converted to cash or consumed during one year, or within the normal operating cycle of the business if the operating cycle is longer than one year. Current liabilities include all liabilities that are scheduled to be liquidated within one year or the operating cycle, whichever is longer, except those that management intends to refinance on a long-term basis. Therefore, key factors determining classification are the nature of the asset or liability, managements intent, and the length of the operating cycle. Requirement 2 Assets: Cash Receivables Marketable securities Prepaid expenses Liabilities: Notes payable Unearned revenue

Normally classified as current, however, if restriction prohibits use of the cash, could be classified as noncurrent. Depends on the expected date of collection. Depends on when management intends to sell the securities. Depends on the period of time prepaid. Depends on scheduled payment date and managements intent to pay or refinance. Depends on the period the revenue will be earned.

The critical question that student groups should address is whether the cost of the egg-producing flock should be classified as inventory or as property, plant, and equipment. There is no right or wrong answer. The process of developing the proposed solutions will likely

Communication Case 3-3

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Chapter 03 - The Balance Sheet and Financial Disclosures

be more beneficial than the solutions themselves. Students should benefit from participating in the process, interacting first with other group members, then with the class as a whole. Solutions should address the following issues: 1. The definitions of inventory and property, plant, and equipment. The definition of inventory according to GAAP [FASB ASC Master Glossary] is goods awaiting sale, goods in the course of production, and goods to be consumed directly in production. The chickens certainly represent goods awaiting sale, since they will eventually be sold to soup companies. However, they also represent property, plant, and equipment, since they are used in the production of product the eggs. 2. The definition of a current asset. GAAP [FASB ASC Master Glossary and FASB ASC 20110451 through 4: Balance SheetOverallOther Presentation MattersGeneralClassification of Current Assets] provides the following definition of a current asset: Current assets is used to designate cash and other assets or resources commonly identified as those which are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business. GAAP [FASB ASC 21010453] also states that a one-year time period is to be used where there are several operating cycles occurring within a year. In this case, it could be argued that the operating cycle is two years, since the chickens are not sold until after the laying life and, therefore, the cost of the flock should be classified as a current asset. However, if the chickens are considered productive assets, then the concept of an operating cycle is not relevant. According to this argument, the chickens should be classified as a noncurrent asset, i.e., a producing asset, and not a saleable asset. It appears that the primary benefits of the chickens come from the sale of eggs, not the sale of the chickens themselves.

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Case 3-3 (concluded) 3. Regardless of the classification of the cost of the chickens, the cost capitalized when the chickens begin to lay must be depreciated down to an estimated salvage value at the end of the laying life. This is necessary to properly match expenses with revenues. (Industry practice is to classify the costs of the egg-producing flock as inventory in the current asset section of the balance sheet, but to depreciate the inventory down to estimated salvage value.) It is important that each student actively participate in the process. Domination by one or two individuals should be discouraged. Students should be encouraged to contribute to the group discussion by (a) offering information on relevant issues, and (b) clarifying or modifying ideas already expressed, or (c) suggesting alternative direction.

IFRS Case 3-4Requirement 1


A major difference is the format of Vodafones balance sheet. Under U.S. GAAP, we present current assets and liabilities before noncurrent assets and liabilities. IAS No. 1 doesnt prescribe the format of the balance sheet, but balance sheets prepared using IFRS often report noncurrent items first. Vodafones balance presents noncurrent assets and liabilities before current assets and liabilities and also presents equity before liabilities. Another difference is the order of the individual line items within categories. For example, in the U.S., current assets generally are listed in order of liquidity, with cash and cash equivalents listed first, followed by short-term investments, accounts receivable, and then inventories. Vodafones current assets appear to be listed in the reverse order of liquidity. There also are differences in terminology. The term equity in Vodafones balance sheet is titled shareholders equity or stockholders equity in a U.S. balance sheet. The term provisions is not generally seen in U.S. balance sheets. (See the solution to Requirement 2 for a discussion of this term.) Requirement 2 The dictionary defines the term provision as a measure taken beforehand to deal with a need or contingency. This indicates that Vodafones provisions liabilities are contingent. A loss contingency is defined in Chapter 13 as an uncertain situation involving potential loss depending on whether some future event occurs. Vodafones annual report includes a Provisions disclosure note describing these liabilities. They
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Chapter 03 - The Balance Sheet and Financial Disclosures

include liabilities for pending legal actions against the company, restructuring obligations and asset retirement obligations. DEFICIENCIES:

Judgment Case 3-5

1. Accounts receivable - if material, the allowance for uncollectible accounts should be disclosed. 2. Note receivable - only the interest receivable of $3,000 should be classified as a current asset. The $50,000 note receivable should be classified in the noncurrent Investments category. 3. Inventories - the method used to cost inventory should be disclosed in a note. 4. Investments - should be classified in the noncurrent Investments category. Also, disclosures include information about the types of investments and the accounting method used to value the investments. 5. Prepaid expenses - in the absence of information to the contrary, should be classified as a current asset. 6. Land - should be classified in the noncurrent Investments category. 7. Equipment, net - should be classified in the Property, plant, and equipment category. Original cost should be disclosed along with the accumulated depreciation to arrive at the net amount. Also, the method used to compute depreciation should be disclosed in a note. 8. Patent - should be classified in the Intangible assets category of noncurrent assets. 9. Note payable - $20,000, the next installment, should be classified as a current liability as current maturities of long-term debt. Also, note disclosure is required for the note and bonds payable that provides information such as payment terms, interest rates, and collateral pledged as security for the debt. 10. Interest payable - should be classified as a current liability. 11. Common stock - the par value, if any, and the number of shares authorized, issued and outstanding should be disclosed. Accounts receivable, net - disclosure on the face of the Judgment Case 3-6statement of the allowance for uncollectible accounts, if material. Inventories - disclosure in Accounting Policies note of the cost method used. Also, for a manufacturer, note disclosure of the breakout of inventory into raw materials, work in process and finished goods. Investments - information about the types of investments and the accounting method used to value the investments. Property, plant and equipment - original cost by major category should be disclosed along with the accumulated depreciation either on the face of the statement or in a note. Also, the method used to compute depreciation should be disclosed in the Accounting Policies disclosure note.
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Long-term liabilities - disclosure in a note of the various debt instruments comprising long-term liabilities to include information such as payment terms, interest rates, and collateral pledged as security for the debt. Common stock - disclosure on the face of the statement of par value, if any, and the number of shares authorized, issued and outstanding.

Real World Case 3-7Requirement 1


The asset classifications are 1) Current assets, 2) Plant and equipment, 3) Property under capital lease, (4) Goodwill, and (5) Other assets and deferred charges Requirement 2 a. Total assets b. Current assets c. Current liabilities d. Total shareholders' equity e. Retained earnings f. Inventories = = = = = = $163,429 million $ 48,949 million $ 55,390 million $ 65,285 million $ 63,660 million $ 34,511 million

Requirement 3 The par value is $.10 per share. 11,000 million shares are authorized and 3,925 million shares are issued and outstanding. Requirement 4 Current ratio = Current assets divided by Current liabilities Current ratio = $48,949 $55,390 = .88 Requirement 5 The company values inventories at the lower of cost or market determined primarily by the retail method of accounting, using the last-in, first-out (LIFO) method for U.S. inventories and the first-in, first-out (FIFO) method for foreign operations. b. The straight-line method. c. All highly liquid investments with a maturity of three months or less when purchased are considered to be cash equivalents. 1. This is a significant event occurring after the end of the Judgment Case 3-8 fiscal year but prior to the issuance of the financial statements. Details of the merger should be disclosed in a note to the financial statements. 2. This is a significant event occurring after the end of the fiscal year but prior to the issuance of the financial statements. Details of the issuance of the new debt should be described in a note to the financial statements.
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a.

Chapter 03 - The Balance Sheet and Financial Disclosures

3.

This is a significant event occurring after the end of the fiscal year but prior to the issuance of the financial statements. The event should be described in a note to the financial statements along with the amount of uninsured damage.

Research Case 3-9Requirement 1


Generally accepted accounting principles require the disclosure of related party transactions. The required information is outlined in FASB ASC 85010501: Related Party DisclosuresOverallDisclosure. Requirement 2 When related-party transactions occur, companies must disclose the nature of the relationship(s) involved, provide a description of the transactions, and report the dollar amounts of the transactions and any amounts due from or to related parties. Requirement 3 The related party transactions disclosure note describes transactions with limited partnerships whose general partners managing member is a senior officer of Enron. The transactions include various hedging and derivative transactions with the related party, as well as the sale of inventory and other assets to the related party. Requirement 4 The potential problem with related party transactions is that their economic substance may differ from their legal form. One of Enrons disclosed transactions involved the sale of dark fiber inventory to the related party in exchange for $30 million in cash and a $70 million note receivable. Enron recognized gross margin on the sale of $67 million. Is the $100 million sales price a proper representation of the sales price of the inventory in a normal transaction to an unrelated party? Is the interest rate charged by Enron on the note a fair interest rate? If the answer to these questions is no, then income (wealth) has been transferred from one party to the other, to the detriment of the shareholders of one of the entities and the benefit of the other.

Real World Case 3-10Requirement 3

a. Note 18 describes the amendment of the Pershing Square financing arrangement to extend the maturity of the term of the loan to April 1, 2010, and to reduce the exercise price of the warrants to $0.65 per share. b. The company's auditor was Ernst & Young LLP. The firm rendered an unqualified opinion on the company's financial statements.

Requirement 4 a. Ron Marshall is listed as President and Chief Executive Officer. b. The annual salary for Mr. Marshall was $57,692.
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Judgment Case

Comparative income for the first year of operations 3-11resulting from the two alternative financing choices is illustrated below.

DEBT Versus EQUITY Comparative Income for Two Financing Alternatives Alternative 1 $5,000,000 -05,000,000 (2,500,000)** $2,500,000 Alternative 2 $5,000,000 (1,600,000)* 3,400,000 (1,700,000)** $1,700,000

Income before interest and taxes Less: Interest Income before taxes Less: Income taxes Net Income * 8% x $20,000,000. ** 50% x Income before taxes. Return on investment (Net income investment)

$2,500,000 = 5% $50,000,000

$1,700,000 =5.67% $30,000,000

We can see that Alternative 1 generated a higher net income. However, the return on shareholders investment is actually higher for Alternative 2. Alternative 2 generated a higher return for each dollar invested by shareholders. This was made possible because the corporation was able to generate income on borrowed funds at a higher rate than the cost of the debt. This represents financial leverage. However, alternative 2 also results in a riskier capital structure. The debt in Alternative 2 requires fixed payments of interest and principal to be made. The company's income before interest and income taxes could drop to zero under Alternative 1 and the company would still be solvent (i.e., able to pay its debts). Under Alternative 2, however, if income before interest and taxes drops below the required interest payments of $1,600,000, the company could become insolvent and eventually go bankrupt.

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The objective of this case is to motivate students to Analysis Case 3-12obtain hands-on familiarity with an actual annual report. You may wish to provide students with multiple copies of the same annual report and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective. The objectives of this case are to motivate students to Analysis Case 3-13obtain hands-on familiarity with an actual annual report and to apply the techniques learned in the chapter. You may wish to provide students with multiple copies of the same annual reports and compare responses. Another approach is to divide the class into teams who evaluate reports from a group perspective.

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Analysis Case 3-14Requirement 1


The balance sheet includes seven asset classifications: Current assets; Property, plant and equipment, net; Investments; Long-term financing receivables, net; Goodwill; Purchased intangible assets, net; and Other non-current assets; and four liability classifications: Current liabilities; Long-term debt; Long-term deferred service revenue; and Other non-current liabilities. Requirement 2 These assets are shown as current because the company intends to convert them to cash in the next year or operating cycle. Requirement 3 Deferred service revenue, sometimes called unearned revenue, represents cash received from customers in advance of providing services. Requirement 4 Disclosure notes explain or elaborate upon the data presented in the financial statements themselves. They must include certain specific notes such as a summary of significant accounting policies, descriptions of subsequent events, and related thirdparty transactions, but many notes are company specific. Actually, any explanation that contributes to investors and creditors understanding of the results of operations, financial position, or cash flows of the company should be included. Requirement 5 Straight-line. Requirement 6 There are no subsequent events noted. The acquisition of MessageOne was identified and acknowledged by Dells Board of Directors as a related party transaction because Michael Dell and his family held indirect ownership interests in MessageOne. Consequently, Dells Board directed management to implement a series of measures designed to ensure that the transaction was considered, analyzed, negotiated, and approved objectively and independent of any control or influence from the related parties.

Analysis Case 3-15Requirement 1

Segment disclosures assist in analyzing and understanding financial statements by permitting better assessment of past performance and future prospects. Disaggregated information provides more precise details of the uncertainties surrounding the timing and the amount of expected cash flows, because the various segments may have different rates of profitability, degrees and types of risk, opportunities for growth, and future capital demands.
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Chapter 03 - The Balance Sheet and Financial Disclosures

Requirement 2 An operating segment is a component of an enterprise: 1. That engages in business activities from which it may earn revenues and incur expenses (including revenues and expenses relating to transactions with other components of the same enterprise). 2. Whose operating results are regularly reviewed by the enterprise's chief operating decision-maker to make decisions about resources to be allocated to the segment and assess its performance. 3. For which discrete financial information is available. Requirement 3 For areas determined to be reportable operating segments, the following disclosures are required: 1. General information about the operating segment. 2. Information about segment profit or loss, including certain revenues and expenses included in reported segment profit or loss, segment assets, and the basis of measurement. 3. Reconciliations of the totals of segment revenues, reported profit or loss, assets, and other significant items to corresponding enterprise amounts. 4. Interim period information. Requirement 4 If Levens Co. prepares its segment disclosure according to IFRS, in addition to revenues, profit or loss, and assets, IFRS also require the disclosure of total liabilities for each of the reportable segments. Discussion should include these elements.

Ethics Case 3-16

Facts: The impact of following the controller's suggestions would be to obscure financial information by aggregating the financial data of segment operations and investments. Aggregation of data makes projections of future performance for African or European segments difficult and does not reveal relative investments for each segment. GAAP suggests that reportable segments are those for whom financial data is available and whose results are regularly reviewed by company management in assessing performance. The data for South Africa, Egypt, France and Denmark are available and most likely reviewed for performance purposes by the controller and higher management levels. Ethical Dilemma:

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Should you as staff accountant challenge the controller's combination of segments or follow the controller's suggestion to obscure financial information by aggregating the financial data of segment operations and investments? Who is affected? You as a staff accountant Controller and other managers Other employees Shareholders Potential shareholders Creditors Financial analysts Auditors Who benefits and who is injured: Company management may benefit from aggregating the African and European data by attracting more investors to their company and obtaining more loans from creditors than would be the case with more complete disclosure regarding the South African segment. Injured parties include current and future investors and creditors with economic, social and political concerns regarding Africa and Europe. If investors and creditors later learn about undisclosed segment operations that prove unprofitable or violate their value systems, they may take action against McCarver-Lynn. Under U.S. GAAP, we present current assets and British Airways Case liabilities before noncurrent assets and liabilities. IAS No. 1 doesnt prescribe the format of the balance sheet, but balance sheets prepared using IFRS often report noncurrent items first. BAs balance sheet presents noncurrent assets and liabilities before current assets and liabilities and also presents equity before liabilities. Another difference is the order of the individual line items within categories. For example, in the U.S., current assets generally are listed in order of liquidity, with cash and cash equivalents listed first, followed by short-term investments, accounts receivable, and then inventories. BAs current assets appear to be listed in the reverse order of liquidity.

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