QB P 12

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QB P 12

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Title: QB P 12

1
QB P 12

Sales and net income would be reported in the
income statement. Net income would also be
reported in the statement of stockholders
equity. Total assets and total liabilities would
be reported in the balance sheet. Net cash flows
from operating activities would be reported in
the statement of cash flows.
Total expenses would be 3,398 million, the
difference between sales and net income.
Stockholders equity would be 1,463 million, the
difference between total assets and total
liabilities. The net income to sales ratio would
be 8.2, or net income divided by sales.

2
QB P 19

Krispy Kremes earnings failed to live up to
expectations. The market price of the stock was
based on the markets expectations for earnings
and cash flow. Failure to meet their published
earnings estimates caused the market to lower its
expectations for future earnings and cash flow.
The economic consequence of the downward
adjustment in expectations was a downward
adjustment to the value the market had placed on
the stock. Since managers probably owned
significant amounts of Krispy Kreme stock (or
options to buy Krispy Kreme stock), the drop in
the stock price almost certainly had a
significant adverse impact on the personal wealth
of those managers.

3
QB P 22

Adecco and PricewaterhouseCoopers would have had
a conversation about the magnitude and scope of
the accounting irregularities, the impact on the
financial statements and the extent to which the
errors may have affected decisions made (or to be
made) by persons relying on the accuracy of the
2003 financial statements. If it was determined
that the financial statements were materially in
error, corrections to the financial statements
would have been discussed. Possible restatement
of prior years financial statements may also
have been discussed.

4
ID 1-13

a. Home Depot is a large retailing company,
focusing on hardware sales to consumers and
contractors. It is a retailer because it does
not manufacture the goods that it sells. It buys
products from vendors and offers those products
for sale in its stores.
b. The firm of KPMG audits the financial
statements of Home Depot. The audit report
consists of 4 paragraphs. The first paragraph
states what years and financial statements were
audited and therefore being commented upon by
this audit report. The second paragraph explains
what an audit is intended to do and how the
company has gone about doing this audit. The
third paragraph states the auditors opinion
regarding the financial statements that have been
audited. The final paragraph indicates a change
in accounting methods by the company.

5
ID 1-13

c. Net income in 2003 was 4,304,000,000, for
2002 net income was 3,664,000,000 and for 2001
net income was 3,044,000,000.
d.
2003 2002
.
Current liabilities 9,554 27.7
8,035 26.8
Long-term liabilities 2,476 7.2
2,174 7.2
Total assets 34,437
30,011
From 2002 to 2003 Home Depot increased its
current liabilities by 1.5 billion and increased
its long-term liabilities by 300 million. As a
percentage of total assets, however, long-term
liabilities remained constant. The ratio of
current liabilities to total assets increased by
nearly a percentage point. This shows that the
increase in total assets (over 4 billion) was
generated by the increase in current liabilities
and net income.
e. Cash from operating activities was
6,545,000,000 in 2003, in 2002 it was
4,802,000,000 and in 2001 was 5,963,000,000.
f. Home Depot is considered to be one of the
best-managed companies in the US. The company is
extremely profitable (see c above), growing and
well-capitalized. This financial condition is
reflected in the companys cash balance of over
2.8 billion and shareholders equity of over 22
billion.

6
Ex 2-1

Financing
Operating
Operating
Investing
Financing
Financing
Investing
Operating

7
QB P 36

McDonalds Corporations current assets consist
mostly of cash and short-term investments,
receivables from franchisees, and inventories.
Those amounts would be relatively small given the
fast turnover involved in providing restaurant
services, compared to the relatively large
required investment in real estate, fixtures, and
equipment.

8
QBs p 39

Short-term investments are made in readily
marketable debt and equity securities to earn
income on otherwise idle funds. An insurance
company such as Aetna maintains a high level of
short-term investments to insure that they will
be able to pay claims, make refunds, and so on,
on a timely basis.
The principal activities of banks such as Bank of
America are to earn net interest income by
gathering deposits and in turn loaning those
funds out to others, as well as providing
fee-based services. The largest asset category
involved in this process is the loan portfolio.
Retailers such as Home Depot and manufacturers
such as Goodyear Tire Rubber are in the
business of selling products, and carry
significant amounts of inventory. Service
enterprises such as Yahoo and financial
institutions such as Bank of America do not deal
in products and therefore do not have inventories.

9
QB P 43

The primary source of funding for banks such as
Bank of America is through deposits gathered from
its diverse customer base. Banks do not present
classified balance sheets, but most deposits are
relatively short-term (current). Borrowings are
a secondary source of funding, and are not as
great as the deposit liability. Banks are highly
leveraged, ie, stockholders equity represents a
smaller portion of total assets (usually less
than 10).

10
QB P 44

A deficit in retained earnings means that
Amazon.com has not been profitable on a
cumulative basis since its inception, net of any
distributions to stockholders. This is not an
uncommon situation for young companies,
especially those in Internet related businesses.

11
QBs PP 46 47

Cost of goods sold represents the original cost
of inventory items sold by manufacturers,
wholesalers, and retailers. This inventory cost
is reported separately from other operating
expenses. Service businesses such as H R Block
provide services and do not sell inventory, thus
there is no cost of goods to report.
An excess of other expenses over other revenues
would cause net income to be lower than net
income from operating activities. Investors would
be more concerned about net income from operating
activities which would be expected to recur,
while (significant) other revenues and expenses
tend to be one-time items.

12
Problem 2-1

Presented below are the main section headings
of the balance sheet
a. Current assets
b. Long-term investments
c. Property, plant, and equipment
d. Intangible assets
e. Current liabilities
f. Long-term liabilities
g. Contributed capital
h. Retained earnings

13
Problem 2-1

1. Dividend Payable
2. Payments Received in Advance
3. Allowance for Uncollectible Accounts
4. Inventories
5. Capital Stock
6. Accumulated Depreciation - Building
7. Bonds Payable
8. Machinery and Equipment

E
E, F
A
A
G
C
F
C
14
Problem 2-1

9. Accounts Receivable
10. Short-term Investments
11. Buildings
12. Patents
13. Property
14. Investment Fund for Plant Expansion
15. Wages Payable
16. Cash

A
A
C
D
C
B
E
A
15
Problem 2-1

17. Accumulated Depreciation - Equip
18. Prepaid Rent
19. Trademarks
20. Land Held for Investment
21. Current Portion of Long-Term Debt
22. Accounts Payable
23. Short-term Notes Payable

C
A
D
B
E
E
E
16
Exercise 2-3

Balance Sheet (B) or Income Statement (I)
a. Equipment
b. Fees Earned
c. Retained Earnings
d. Wage Expense
e. Patent
f. Cost of Goods Sold
g. Common Stock
h. Dividend Payable
i. Accumulated Depreciation

B
I
B
I
B
I
B
B
B
17
Exercise 2-3

Balance Sheet (B) or Income Statement (I)
j. Prepaid Expense
k. Gain on Sale of Short-term Investment
l. Rent Revenue
m.Supplies Inventory
n. Accounts Receivable
o. Land
p. Insurance Expense
q. Interest Payable
r. Deferred (Unearned) Revenue

B
I
I
B
B
B
I
B
B
18
ID 2-9

a. 2004
2003
2002 .
Sales 64,816
58,247 53,553
Cost of merchandise
Sold 44,236 68.2
40,139 68.9 37,406 69.8
Operating expenses 13,734 21.2
12,278 21.1 11,215 20.9
Interest expense 62 0
37 0 28 .0
Taxes 2,539
3.9 2,208 3.8 1,913 3.6
Net income 4,304 6.6
3,664 6.3 3,044 5.7
From 2002 to 2004 sales increase dramatically
(21) and net income increased by 41. During
each of these years the cost structure of Home
Depot changed very little. The biggest component
of costs (cost of merchandise sold) fluctuated by
only .3. This would indicate that the increase
in net income from 2002 to 2004 was driven by the
increase in sales. There was no improvement in
the costs as a percentage of sales.

19
ID 2-9

b.
2004
2003 .
Current assets 13,328
38.7 11,917 39.7
Noncurrent assets 21,109
61.3 18,094 60.3
Total assets 34,437
30,011
From 2003 to 2004 there has been a significant
increase in noncurrent assets, 3 billion. The
ratio of current vs. noncurrent assets though
changed only minimally. This indicates that
management is doing a good job of managing its
assets and not becoming imbalanced between
current and noncurrent assets.
c.
2004 2003
.
Current liabilities 9,554 27.7
8,035 26.8
Long-term liabilities 2,476 7.2
2,174 7.2
Total assets 34,437
30,011
From 2003 to 2004 Home Depot increased its
current liabilities by 1.5 billion and its long
-term liabilities by 300 million. However, the
ratio of long-term liabilities to total assets
remained constant. The ratio of current
liabilities to total assets increased by a
relatively small percentage (.9). This shows
that the increase in total assets (4.4 billion)
was generated by the increase in current
liabilities and net income.

20
ID 2-9

d. Home Depot is continuing to grow its business
by investing heavily in p,pe. During 2004 and
2003 Home Depot spent approximately 6.2 billion
in p,pe additions. This was financed by cash
flow from operations (11.3 billion). During
2004 and 2003 the company used excess cash to
repurchase its own stock (3.5 billion).
e.
2004 2003
2002 .
Net income
4,304 3,664 3,044
Dividends paid 595
492 396
Dividends as a percentage
of net income
13.8 13.4
13.0

21
QB P. 75

Going concern is a fundamental assumption
underlying our accounting model which uses
historical costs as a valuation basis and
classifies assets and liabilities and current and
long-term. In making an evaluation of going
concern status, auditors consider numerous
factors such as negative trends (recurring
operating losses, capital deficiencies, adverse
financial ratios), other indicators of possible
financial difficulties (default on loan
agreements), and internal and external matters
(labor difficulties, loss of a key customer or
supplier). Auditors become concerned about the
viability of a business when solvency and earning
power decline to the point that continuation of
the entity is in jeopardy. The stock market
usually reacts to these issues long before the
audited financial statements are issued.
Improvements in solvency and earning power would
relieve auditors of their concerns about the
viability of a business. Auditors are concerned
with the viability of a business as a going
concern, because if a company were not expected
to stay in business beyond the current year, then
liquidation values would be a more appropriate
valuation basis, and current and long-term
classifications would be meaningless.

22
QB P 86

The change had the effect of spreading revenue
over several future years rather than all in the
first year when the contracts were signed,
thereby reducing current income and increasing
future income. Spreading the revenue is a better
example of the matching process. Certainly the
company will have costs in future years to
service the contracts, and spreading the revenues
forward to those future years provides for a
better matching of the cost of the efforts
with the benefits.

23
Brief Exercise 3-1

1. Reporting period ends on Saturday closest to
Jan. 31.
Fiscal period
2. Consolidated financials include subsidiaries.
Economic entity
3. Inventory valued at lower of cost or market.
Conservatism
4. Reclassifications made to conform with this
years presentation.
Consistency
5. Revenues recognized when motion pictures
exhibited.
Revenue recognition

24
Brief Exercise 3-1(continued)

6. Management believes lawsuit will not have a
material impact on Companys financial position.
Materiality
7. Equipment depreciated over 20 years.
Matching (going concern, fiscal period)
8. Intangible assets carried on B/S at cost.
Objectivity
9. Property and equipment recorded at cost.
Going concern, Objectivity
10.Inflation rates have no effect on the
companys financials.
Stable dollar

25
Question box p. 106

Yes, the pharmaceuticals and the software
companies become more valuable when critical
events occur such as those described.
Nonetheless, those events are not recorded in the
financial statements, because they have not yet
reached the point where their impact on the
financial statements can be objectively
measured.

26
Question box p. 106

The basic accounting equation applied to the
balance sheet of Zimmer Holdings is
Assets Liabilities Stockholders Equity
5,156 2,006 3,150

27
Question box p. 109

Coca Colas purchase of 812 million of
property, plant, and equipment would both
increase and decrease assets by the same amount,
because property, plant, and equipment would
increase and cash would decrease. The borrowing
of 1 billion would increase an asset, cash, and
increase a liability, notes payable.
Lets do E4-10 to see how transactions affect
the accounting equation

28
E4-10

a. Assets Liabilities
Stockholders' Equity
Accounts Notes
Contributed Retained Cash
Receivable Land Payable
Capital Earnings
(1)12,000 12,000
(2) 5,000 5,000
(3)- 10,000 10,000
(4)- 5,000 - 5,000
(5)10,000 4,000 14,000
(6)- 4,000 - 4,000
(7) 2,800 - 3,000
- 200
(8)- 2,200

- 2,200 Total 8,600 4,000
7,000 5,000 12,000 2,600