M2-21 (20 minutes)

Net income computation

Service revenue (record when earned) ...............................
$100,000
Wages expense (record when incurred, even if unpaid)...........(40,000)
Net income ................................................................ $ 60,000

($25,000 + $15,000)

Net cash flow computation

Cash inflow from services rendered ............................
$50,000
Cash outflow for wages paid.........................................
(25,000)
Net cash inflow ...............................................................
$25,000

($30,000 + $20,000)

Cash inflow from services rendered will be $50,000 less than service
revenue per the income statement because Healy only collected $50,000 of
revenues in cash but reported $100,000 as revenue. Cash outflow for
wages paid will be $15,000 less than wages expense on the income
statement because $15,000 remained unpaid at year end. The combined
effects of these two items yields an overall difference of $35,000 between
net income and net cash inflow ($60,000 net income - $50,000 + $15,000 =
$25,000 net cash inflows).

M2-22 (15 minutes)

a.

b.

c.

d.

e.

f.

g.

h.

Cambridge Business Publishers, 2008

Solutions Manual, Module 2

2-5

M2-23 (15 minutes)

Beginning retained earnings ..............................

Add: Net income (loss) .....................................
Less: Dividends ...................................................
Ending retained earnings....................................

2005

2006

$89,089
(19,455)
0
$69,634

$ 69,634
48,192
(15,060)
$102,766

M2-24 (10 minutes)

Johnson & Johnson
Statement of Retained Earnings
For Year Ended January 1, 2006
Retained earnings, January 2, 2005.......................................

$35,223

Add: Net income.....................................................................

10,411

Less: Dividends .......................................................................

(3,793)

Other retained earnings changes................................

(370)

Retained earnings, January 1, 2006.......................................

$41,471

M2-25 (15 minutes)

Revenues ..............................................................
Expenses ..............................................................
Net income............................................................

2007
$350,000
200,000
$150,000

2008
$ 0
0
$ 0

Explanation: All of the revenue is reported in 2007 when it is earnedper

the revenue recognition principle. Likewise, the expense is reported in 2007
when it is incurredper the matching principle. The receipt or payment of
cash does not affect the recording of revenues, expenses, and net income.
There is no revenue or expenses in 2008

Cambridge Business Publishers, 2008

2-6

Financial Accounting for MBAs, 3rd Edition

M2-26 (15 minutes)

Balance Sheet
Transaction
Cash
CS

Cash
Noncash
+
Asset
Assets

Income Statement

LiabilContrib.
Earned
=
+
+
ities
Capital
Capital

Revenues

ExpenNet
=
ses
Income

1,000
1,000

Cash
1,000
CS
1,000

+1,000

a. Issue
+1,000
Cash
stock for
$1,000 cash

Common
Stock

INV
500
Cash
500

INV
500
Cash
500

b. Purchase
-500
inventory
Cash
for $500
cash

+500
Inventory

AR
2,000
Sales
2,000
COGS 500
INV
500

AR
2,000
Sales
2,000

c. Sell
inventory
for $2,000
on
account

COGS
500

+2,000
Accounts
Receivable

-500

+1,500 +2,000

Retained
Earnings

Sales

+500

Cost of
Goods
Sold

+1,500

Inventory

INV
500
Cash
AR

2,000
2,000

Cash
2,000
AR
2,000

d. Collect
$2,000 on +2,000
account
Cash
receivable

-2,000
Accounts
Receivable

Cambridge Business Publishers, 2008

Solutions Manual, Module 2

2-7

E2-28 (15 minutes)

Baiman Corporation
Income Statement
For Month ended January 31

Baiman Corporation
Balance Sheet
January

Sales.............................. $30,000
Wage expense.............. 12,000
Net income (loss) ......... $18,000

Cash ..................................................
$
0
Accounts receivable........................
30,000
Total assets ................................ $30,000
Wages payable................................
$12,000
Retained earnings............................
18,000
Total liabilities and equity ...............
$30,000

E2-29 (30 minutes)

Demers Company
Income Statement
For Month Ended March 31
Sales revenue.......................................................

$18,000

($4,000 + $14,000)

Expenses ..............................................................
Rent expense........................................................
$3,200
Wage expense......................................................
4,800
Net income............................................................

8,000
$10,000

Cambridge Business Publishers, 2008

Solutions Manual, Module 2

2-9

P2-44 (40 minutes)

a. Depreciation is added back to undo the effect it had on the income
statement. Verizon deducted $14,047 depreciation in computing net
income. Depreciation is a non-cash expense so Verizon did not actually
use $14,047 cash to pay depreciation. Thus, to determine how much
cash was generated, net income is too low by the depreciation amount
of $14,047. The depreciation add-back is NOT a source of cash as some
mistakenly believe. Cash is, ultimately, generated by profitable
operations, not by depreciation.
b. The depreciation add-back is twice the level of net income. This signifies
a highly capital-intensive industry.
c. The MD&A section of the 10-K provides managements assessment of
the operating results and investment activities of the company. This is a
source of useful information that includes less promotion material than
other statements by the company since it is regulated by SEC
disclosure rules.
d. Repaying long-term debt with short-term notes is cause for concern, as
this activity does nothing to alleviate the short term demands for cash.
Refinancing with longer term debt would address liquidity concerns. On
the other hand, short-term rates are typically lower than long-term rates
and refinancing might save some interest expense. However, in 2005
interest rates were climbing so repaying older, lower-rate debt with
newer higher-rate debt seems counterproductive.
e. Dividends are not a contractual obligation until declared by the board of
directors. Although stock price may fall if the company reduces
dividends, shareholders cannot force the company into bankruptcy like
debt holders can. Dividends differ significantly from debt.
f. Verizons operations generated a significant amount of cash. Its capital
expenditures are significant as the company continues to upgrade its
infrastructure to implement new technology to remain competitive with
other telecom and cable companies. High capital outlays would,
ordinarily, not be a problem were it not for the companys significant
existing debt load. Verizons debt repayment obligation for 2005 was
nearly $4 billion, in addition to the interest expense that is recorded in
its income statement. Although the company is financial strong,
balancing its debt level with the cash flow needs for capital
expenditures to support its operating activities and dividends to support
its stock price is a difficult challenge facing the company.
Cambridge Business Publishers, 2008
2-28

Financial Accounting for MBAs, 3rd Edition

P2-45 (25 minutes)

Balance Sheet
Cash
Transaction
Asset
Cash
NP
CS

Income Statement

Noncash
LiabilContrib.
Earned Rev+
=
+
+
Assets
ities
Capital
Capital enues

Expenses

Net
Income

155,000
55,000
100,000

a. Received
$100,000
Cash
cash for
155,000
common
+155,000
stock and
Cash
NP
borrowed
55,000
$55,000
CS
cash

+55,000
Note
Payable

+100,000
+ Common
Stock

100,000
PPE 50,000
NP
40,000
Cash
10,000
PPE
50,000
NP
40,000
Cash
10,000

b.
Purchased
$50,000 of
equipment,
paying
$10,000
cash and
$40,000
note
payable

-10,000 + +50,000

c.
Purchased
$80,000 of
inventory
for cash

-80,000 + +80,000

Cash

PPE

+40,000
Note
Payable

INV
80,000
Cash
80,000
INV
80,000
Cash
80,000

Cash

Inventory

AR
40,000
Cash
60,000
COGS 70,000
Sales 100,000
INV
70,000

AR
40,000
Cash
60,000
COGS
70,000
Sales

d.
Purchased
Inventory
+40,000
for $60,000
Accounts
cash and
+60,000
Receivable
+
$40,000 on
Cash
-70,000
credit, cost
Inventory
of
inventory
$70,000

+30,000+100,000
Retained
Earnings

Sales

+70,000
Cost of
Goods Sold

100,000

INV
70,000

Cambridge Business Publishers, 2008

Solutions Manual, Module 2

2-29

+30,000

P2-45continued.
PPDA
10,000
Cash 10,000
PPDA
10,000
Cash
10,000

AE

7,500
PPDA
7,500
AE
7,500
PPDA
7,500

e. Paid

$10,000 cash
+10,000
-10,000
for future
+ Prepaid
Cash
Advertising
advertising
time

f. $7,500 of

the
advertising
time in e is
aired

-7,500
Prepaid
Advertising

-7,500

Retained
Earnings

+7,500

Advertising
Expense

-7,500

WE
15,000
Cash 15,000

g.
WE
15,000
Cash
15,000

WE
WP

Employees
paid $15,000 -15,000
Cash
cash in
wages

-15,000

Retained
Earnings

+15,000
Wages
Expense

-15,000

1,000
1,000

h. Employees
earn $1,000 in
wages not yet
paid

WE
1,000
WP

+1,000

-1,000

Wages
Payable

Retained
Earnings

+1,000

Wages
Expense

Depreciation
Expense

-1,000

1,000

DE
PPE

2,000
2,000

DE
2,000
PPE
2,000

i. Record
depreciation
of $2,000 on
equipment*

-2,000
PPE

-2,000
Retained
Earnings

+2,000

-2,000

* Property and Equipment, gross less Accumulated Depreciation.

Cambridge Business Publishers, 2008

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Financial Accounting for MBAs, 3rd Edition