CHAPTER 2

A further look at FINANCIAL STATEMENTS

Summary of Question TYPEs by LEARNING Objective, Level of difficulty, BLOOM’S TAXONOMY, CPA CODES, and AACSB Codes

LOD: E = Easy M = Medium H = Hard

Bloom’s: AP = Application C = Comprehension K = Knowledge

CPA: F = Financial Reporting C = Communication

AACSB: AN = Analytic

Summary of Question TYPEs by LEARNING Objective, Level of difficulty, BLOOM’S TAXONOMY, CPA CODES, and AACSB Codes

(Cont’d)

LOD: E = Easy M = Medium H = Hard

Bloom’s: AP = Application C = Comprehension K = Knowledge

CPA: F = Financial Reporting C = Communication

AACSB: AN = Analytic

Summary of Question TYPEs by LEARNING Objective, Level of difficulty, BLOOM’S TAXONOMY, CPA CODES, and AACSB Codes

(Cont’d)

LOD: E = Easy M = Medium H = Hard

Bloom’s: AN = Analysis AP = Application C = Comprehension K = Knowledge

CPA: F = Financial Reporting C = Communication

AACSB: AN = Analytic

SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Note: TF = True/False MC = Multiple Choice Ma = Matching

Ex = Exercise SAE = Short-Answer Essay CP = CPA

CHAPTER LEARNING OBJECTIVES

1. Identify the sections of a classified statement of financial position. In a classified statement of financial position, we classify assets as current or non-current assets. In the non-current asset category, assets are further classified as long-term investments; property, plant, and equipment; intangible assets and goodwill; or other assets. We classify liabilities as either current or non-current. A shareholders’ equity section reports share capital and retained earnings, and other equity items if any exist.

2. Identify and calculate ratios for analyzing a company’s liquidity, solvency, and profitability. Liquidity ratios, such as working capital and the current ratio, measure a company’s short-term ability to pay its maturing obligations and meet unexpected needs for cash. Solvency ratios, such as debt to total assets, measure a company’s ability to survive over a long period by having enough assets to settle its liabilities as they fall due. Profitability ratios, such as basic earnings per share and the price-earnings ratio, measure a company’s operating success for a specific period of time.

3. Describe the framework for the preparation and presentation of financial statements. The key components of the conceptual framework are (1) the objective of general-purpose financial reporting; (2) qualitative characteristics of useful financial information (fundamental and enhancing characteristics); (3) the cost constraint; (4) the going concern assumption underlying the accounting process; (5) elements of the financial statements; and (6) measurement of the elements of financial statements (historical cost and fair value).

TRUE-FALSE STATEMENTS

1. Long-term investments appear in the property, plant, and equipment section of the statement of financial position.

2. Special rights and privileges that provide a future economic benefit to the company are classified as intangible assets.

3. A liability is normally classified as a current liability if it is to be paid within the coming year.

4. Mortgages and pension liabilities are examples of non-current liabilities.

5. The investment classification on the statement of financial position normally includes investments that are intended to be held for a short period of time (less than one year).

6. The main difference between intangible assets and property, plant, and equipment is the length of the asset’s life.

7. Listing assets and liabilities in reverse order of liquidity is not permitted in Canada.

8. The statement of financial position is normally presented as follows, when listed in order of liquidity: Current assets, current liabilities, non-current assets, non-current liabilities, and shareholders’ equity.

9. Intracompany comparisons are based on comparisons with competitors in the same industry.

10. Calculating financial ratios can give clues to underlying conditions that may not be noticed by examining each financial statement item separately.

11. Liquidity ratios are concerned with the frequency and amounts of dividend payments.

12. Analysis of financial statements is enhanced with the use of comparative data.

13. Solvency ratios measure the entity’s ability to survive over a long period.

14. A single ratio by itself is not very meaningful.

15. Profitability means having enough funds on hand to pay debts when they are due.

16. The most liquid resource is inventory.

17. Solvency ratios measure the short-term ability of the company to pay its maturing obligations.

18. The debt to total assets ratio measures the percentage of assets financed by creditors rather than shareholders.

19. From a creditor’s point of view, the higher the total debt to total assets ratio, the lower the risk that the company may be unable to pay its obligations.

20. The price-earnings ratio is a measure of liquidity.

21. The higher the price-earnings ratio, the higher are investors’ expectations of the company’s future profitability.

22. Companies using Accounting Standards for Private Enterprises (ASPE) are not required to present basic earnings per share information in their financial statements.

23. The conceptual framework is fundamentally similar for both Canadian publicly traded companies and Canadian private companies.

24. Faithful representation means that accounting information must be complete, neutral, and free from error.

25. Financial reporting does not have to present the economic substance of a transaction in order to provide a faithful representation of what really happened.

26. Materiality and relevance are both defined in terms of what influences or makes a difference to a decision maker.

27. Enhancing qualitative characteristics include timeliness and comparability.

28. Under the going concern assumption, reporting assets, such as land, at their cost may be more appropriate than reporting land at its fair value.

29. In order for information to be relevant, it must be reported on a timely basis.

30. Consistency aids comparability when a company uses the same accounting principles and methods from year to year or when companies with similar circumstances use the same accounting principles.

31. Comparability in accounting means that a company uses the same generally accepted accounting principles from one accounting period to the next.

32. Comparability and understandability are examples of enhancing qualitative characteristics.

33. Information has verifiability if the information is comparable.

34. Using a simplified version of Canadian GAAP for small companies in order to reduce the cost of providing financial information is an example of the application of materiality.

35. Elements of financial statements include assets, equity, and expenses, but not liabilities.

36. Two measurement principles are historical cost and current value.

37. In general, standard setters require that most assets be recorded using historical cost because cost is representationally faithful.

38. The cost basis of accounting states that assets and liabilities should be recorded at their cost not only when originally acquired, but also during the time the entity holds them.

39. Qualitative characteristics help ensure that the information provided in financial statements is useful.

40. A conceptual framework is still under development for companies using International Financial Reporting Standards (IFRS).

Answers to True-False Statements

MULTIPLE CHOICE QUESTIONS

41. On a statement of financial position

(a) Cash and Office Supplies are both classified as current assets.

(b) Inventories and Prepaid Expenses are classified as long-term investments.

(c) Land and Buildings are classified as long-term investments.

(d) Depreciation Expense is classified as property, plant and equipment.

Answer: A

42. Shareholders’ equity

(a) is divided into at least two parts: share capital and retained earnings.

(b) consists of two parts: common and preferred shares.

(c) reflects two parts: dividends declared and share capital.

(d) reflects retained earnings only.

Answer: A

43. All property, plant and equipment

(a) have estimated useful lives over which they are expected to generate revenue.

(b) are depreciated over their estimated useful lives.

(c) with finite lives, including land, are depreciated.

(d) contribute to the generation of revenue.

Answer: D

44. On a classified statement of financial position, prepaid expenses are classified as

(a) a current liability.

(b) property, plant, and equipment.

(c) a current asset.

(d) a long-term investment.

Answer: C

45. A current asset is

(a) the last asset purchased by a business.

(b) an asset that is not currently being used to produce a product or service.

(c) usually found as a separate classification in the statement of income.

(d) expected to be converted to cash or used in the business within a relatively short period of time.

Answer: D

46. Which of the following is not classified as a current asset?

(a) supplies

(b) trading investments

(c) a fund to be used to purchase a building within the next year

(d) equipment with an estimated useful life of five years

Answer: D

47. An intangible asset

(a) derives its value from the rights and privileges it provides the company.

(b) is worthless because it has no physical substance.

(c) is converted into a tangible asset during the year.

(d) cannot be classified on the statement of financial position because it lacks physical substance.

Answer: A

48. Which of the following is not considered to be an asset?

(a) equipment

(b) dividends declared

(c) accounts receivable

(d) inventory

Answer: B

49. The difference between cost and accumulated depreciation is referred to as

(a) net depreciation.

(b) carrying amount.

(c) fair value.

(d) cost value.

Answer: B

50. Trademarks would appear in which section of the statement of financial position?

(a) Shareholders’ equity

(b) Investments

(c) Intangible assets

(d) Current assets

Answer: C

51. Liabilities are generally classified on a statement of financial position as

(a) small liabilities and large liabilities.

(b) present liabilities and future liabilities.

(c) tangible liabilities and intangible liabilities.

(d) current liabilities and non-current liabilities.

Answer: D

52. Which of the following would not normally be classified as a non-current liability?

(a) current portion of non-current debt

(b) bonds payable

(c) mortgage payable

(d) lease liabilities

Answer: A

53. Which of the following is not normally a current liability?

(a) salaries payable

(b) accounts payable

(c) income tax payable

(d) bonds payable

Answer: D

54. Office equipment is classified on the statement of financial position as

(a) a current asset.

(b) property, plant, and equipment.

(c) shareholders’ equity.

(d) a long-term investment.

Answer: B

55. Current liabilities are expected to be

(a) converted to cash within one year.

(b) paid within one year.

(c) used in the business within one year.

(d) acquired within one year.

Answer: B

56. On a classified statement of financial position, current assets are often listed

(a) in alphabetical order.

(b) with the largest dollar amounts first.

(c) in the order in which they are expected to be converted into cash.

(d) in the order of acquisition.

Answer: C

57. Long-lived assets without physical substance are

(a) listed directly under current assets on the statement of financial position.

(b) not listed on the statement of financial position because they do not have physical substance.

(c) are listed as intangible assets on the statement of financial position.

(d) listed as a long-term investment on the statement of financial position.

Answer: C

Use the following information to answer questions 58–62.

58. The dollar amount of current liabilities is

(a) $196,000.

(b) $170,000.

(c) $ 40,000.

(d) $ 30,000.

Ex. 131

Companies group similar types of assets and similar types of liabilities together. In the table below, the standard classifications on a statement of financial position are identified:

Instructions

Rearrange the table to reflect the general order in which the standard classifications should be presented on a statement of financial position.

Ex. 132

The following descriptors relate to the order in which items on the statement of financial position may be presented:

(a) Order of liquidity

(b) No general prescribed order

(c) Order of permanency

(d) Reverse order of liquidity

(c) Largest to smallest

(f) Smallest to largest

Instructions

Assuming a firm uses the standard order used by North American companies (excluding real estate companies), match the key letter of the correct term above with the descriptive statement below. Please note: the above descriptors may be used more than once when assigned to the items below:

_____ 1. Current assets

_____ 2. Property, plant & equipment

_____ 3. Non-current liabilities

_____ 4. Current liabilities

_____ 5. Qualitative enhancing characteristics

Ex. 133

Identify the errors, corrections required, and corrected subtotals required in the following classified statement of financial position. Then prepare a corrected statement of financial position.

RUMPBELL INC.

Statement of Financial Position

Year Ended December 31, 2022

Assets

Current assets

Accounts receivable (net of accounts payable of $2,000) $12,000

Prepaid insurance 1,500

Goodwill 1,200

14,700

Property, plant and equipment $4,300

Less: Accounted depreciation 1,100

Other assets (non-current) 1,720 4,920

Total assets $19,620

Liabilities

Bank loan payable (due in 6 months) $9,500

Long-term debt 6,700

Total liabilities 16,200

Shareholders’ equity

Retained earnings $2,460

Less: Dividends declared 150

Common shares 1,110 3,420

Total $19,620

Ex. 134

The following information is available for Dysoni Ltd. At December 31, 2022:

Accounts payable $14,500

Accounts receivable 2,500

Accumulated amortization, patents 3,500

Accumulated depreciation, equipment 3,000

Retained earnings 6,400

Cash 41,900

Common shares 40,000

Equipment 3,500

Land 15,000

Long-term investments 500

Bank loan payable (due in 5 years) 4,200

Patents 5,500

Trading investments 2,700

Instructions

Use the above information to prepare a classified statement of financial position at December 31, 2022.

Ex. 135

The following accounts were taken from a company’s classified statement of financial position:

Account Classification

Instructions

Classify each of the above accounts as current assets (CA), non-current assets (NCA), current liabilities (CL), non- current liabilities (NCL), or shareholders’ equity (SE).

Ex. 136

Explain the difference between depreciation and amortization in terms of IFRS and ASPE.

Ex. 137

The following items are taken from the financial statements of La Brea Ltd. For the fiscal year ended December 31, 2022. Note they are in alphabetical order.

Accounts payable $ 15,500

Accounts receivable 18,000

Accumulated depreciation—buildings 30,500

Advertising expense 21,000

Cash 15,000

Common shares (10,000 shares) 90,000

Depreciation expense 12,000

Dividends declared 5,000

Income tax expense 10,000

Insurance expense 3,000

Bank loan payable 70,000

Prepaid insurance 6,000

Rent expense 22,000

Retained earnings, January 1, 2022 12,000

Salaries expense 32,000

Salaries payable 3,000

Service revenue 143,000

Supplies 4,000

Supplies expense 6,000

Buildings 210,000

Instructions

(a) Calculate the net income for the year.

(b) Calculate the balance of Retained Earnings that would appear on the statement of financial position at December 31, 2022.

(c) Prepare a classified statement of financial position for La Brea Ltd. At December 31, 2022, assuming the bank loan payable is a non-current liability.

(d) Calculate the current ratio, debt to total assets, and basic earnings per share. Assets at the beginning of 2022 totalled $183,000. No additional shares were issued or redeemed during the year.

Ex. 138

The following items are taken from the financial statements of Pelle Ltd. For the year ended December 31, 2022:

Accounts payable $31,300

Accounts receivable 10,000

Accumulated depreciation—equipment 8,400

Bank loan payable 34,500

Cash 38,500

Common shares (4,375 shares issued) 43,750

Depreciation expense 8,400

Dividends declared 525

Equipment 82,000

Goodwill 12,300

Income tax expense 1,750

Interest expense 6,125

Market price per common share $5.25

Rent Expense 21,000

Retained earnings, beginning 28,000

Salaries expense 14,350

Service revenue 56,875

Supplies 7,875

Instructions

(a) Prepare a statement of income and a classified statement of financial position for Pelle for 2022.

(b) Calculate the following ratios:

1. Current ratio

2. Debt to total assets

3. Basic earnings per share

4. Price-earnings ratio

Ex. 139

Ready Contracting reported net income of $200,000 at the end of 2022. The company did not declare preferred dividends in 2022 but is planning to declare the annual dividend of $10,000 in 2023. The weighted average number of common shares is 30,000.

1. Calculate earnings per share.
2. Calculate earnings per share assuming preferred dividends were declared in 2022.
3. Calculate earnings per share assuming preferred dividends were paid in 2022.

Ex. 140

The following data have been selected from the annual report of Komark Corporation:

Market price per share $60

Price-Earnings ratio 20 times

Total Assets $450,000

Current Liabilities $180,000

Shareholders’ Equity $200,000

Current ratio 1.5:1

Weighted average number of shares 100,000

Instructions

Calculate the following:

(a) Basic earnings per share

(b) Net income

(c) Debt to Total Assets ratio

(d) Current assets

(e) Working capital

Ex. 141

Presented below is information on XBRL Ltd.:

2022 2021

Cash $ 15,000 $ 12,000

Cash provided by financing activities 20,000 0

Cash used in investing activities 18,000 7,000

Common shares 30,000 30,000

Current assets 85,000 75,000

Current liabilities 60,000 45,000

Dividends declared 11,000 15,000

Long-term assets 125,000 110,000

Price-earnings ratio 12 14

Retained earnings 60,000 40,000

Total liabilities 110,000 95,000

Weighted average number of shares issued 1,000 1,000

Instructions

Calculate the following for 2022:

(a) Basic earnings per share

(b) Market price per common share

(c) Working capital

(d) Current ratio

(e) Debt to total assets

Ex. 142

The following data are taken from the financial statements of Kamloops Inc.:

Accounts payable $28,000

Accounts receivable 56,000

Cash 54,000

Dividends declared 10,000

Market price per share 12.75

Other current liabilities 17,000

Net income 44,000

Wages payable 5,000

Weighted average number of common shares 10,000

Instructions

Calculate the following ratios:

(a) Current ratio

(b) Working capital

(c) Basic earnings per share

(d) Price-earnings ratio

Ex. 143

The following data are taken from the financial statements of Sannot Inc.:

Current assets $225,000

Current liabilities 140,625

Dividends declared 6,000

Market price per share 9

Net sales 230,000

Net income 48,000

Total liabilities 153,125

Total assets 218,750

Weighted average number of common shares 8,000

Instructions

Calculate the following ratios:

(a) Current ratio

(b) Working capital

(c) Basic earnings per share

(d) Price-earnings ratio

(e) Debt to total assets

Ex. 144

The following selected data are taken from the financial statements of Lincoln Inc. The data are in alphabetical order.

Accounts payable $ 52,000

Accounts receivable 84,500

Average assets 520,000

Cash 147,200

Market price/share 65.00

Net sales 590,000

Other current liabilities 22,500

Net income 174,000

Salaries payable 19,600

Shareholders’ equity 310,900

Total assets 500,000

Weighted average number of common shares 4,000

Instructions

Calculate the following ratios:

(a) Current ratio

(b) Working capital

(c) Basic earnings per share

(d) Price-earnings ratio

(e) Debt to total assets

Ex. 145

For each of the ratios listed below, indicate by the appropriate code letter, whether it is a liquidity ratio, a profitability ratio, or a solvency ratio.

Code:

L = Liquidity ratio

P = Profitability ratio

S = Solvency ratio

1. Basic earnings per share

2. Debt to total assets

3. Price-earnings ratio

4. Current ratio

Ex. 146

The following information is available from the 2022 financial statements of Ying Corp. and Yang Inc.

(amounts in millions, except share price)

Ying Yang

Beginning total assets $22,233 $43,069

Current assets 15,225 36,981

Current liabilities 9,958 18,688

Ending total assets 28,715 47,015

Net income 735 1,652

Sales 31,812 41,415

Share price $90 $130

Total liabilities 20,170 39,028

Weighted average number of common shares 25 44

Instructions

(a) For each company, calculate the following ratios:

1. Current ratio

2. Debt to total assets

3. Basic earnings per share

4. Price-earnings ratio

(b) Based on your calculations, discuss the relative liquidity, solvency, and profitability of the two companies.

Ex. 147

Selected information from the comparative financial statements of National Falls Inc. for the year ended December 31 appears below:

2022 2021

Accounts receivable $ 142,000 $ 182,000

Bank loan payable 490,000 390,000

Cash 27,000 17,000

Current liabilities 125,000 95,000

Income tax expense 80,000 60,000

Interest expense 40,000 15,000

Inventory 136,000 154,000

Net income 220,000 155,000

Salaries expense 970,000 900,000

Total assets 1,350,000 950,000

Total revenues 2,100,000 1,100,000

Weighted average number of common shares 15,000 7,000

Instructions

Calculate the following ratios for 2022:

(a). Current ratio.

(b) Working capital.

(c) Debt to total assets.

(d) Basic earnings per share.

Ex. 148

Channing Corporation reported the following current assets and current liabilities:

Dec. 31, 2022 Dec. 31, 2021

Current assets

Cash $ 40,000 $ 30,000

Short-term investments 40,000 10,000

Accounts receivable 55,000 95,000

Inventory 110,000 90,000

Prepaid insurance 35,000 20,000

Total current assets $280,000 $245,000

Current liabilities

Accounts payable $120,000 $110,000

Salaries payable 40,000 30,000

Income tax payable 20,000 15,000

Total current liabilities $180,000 $155,000

Instructions

(a) Calculate the following ratios for 2022:

1. Current ratio.

2. Working capital.

(b) Explain the purpose of each ratio.

Ex. 149

Selected data from Lift-Off Ltd. are presented below:

Net sales $3,940,000

Net income 620,000

Share price 28.52

Weighted average number of common shares 200,000

Instructions

(a) Based on the above information, calculate two profitability ratios.

(b) Explain the purpose of each ratio.

Ex. 150

Insert the characteristics listed below that are associated with relevance and faithful representation:

Confirmatory value Materiality

Completeness Free from errors

Neutral Predictive value

RELEVANCE FAITHFUL REPRESENTATION

1. 1.

2. 2.

3. 3.

Ex. 151

The following terms relate to the characteristics of useful information. Match the key letter of the correct term with the descriptive statement below:

(a) Confirmatory value

(b) Neutral

(c) Predictive value

(d) Relevance

(e) Faithful representation

(f) Timeliness

(g) Verifiability

_____ 1. Accounting information cannot be selected, prepared, or presented to favour one set of interested users over another.

_____ 2. Providing information in time to make decisions

_____ 3. Providing information that can be confirmed or duplicated by independent parties

_____ 4. Providing information that would make a difference in a business decision

_____ 5. Providing information that represents economic reality

_____ 6. Helping evaluate prior decisions

Ex. 152

For each of the independent situations described below, list the fundamental or enhancing qualitative characteristic that has been violated, if any. List only one term for each case.

(a) Brunswick Corporation is in its third year of operations and has yet to issue financial statements.

(b) Ontario Corporation has used different methods for recording the cost of inventory. In the current year, the cost of goods sold is calculated based on the average cost of inventory. Last year, the cost of inventory was calculated based on the actual cost of each item sold. Next year, the company plans to change back to average cost.

(c) Manitoba Inc. is carrying inventory at its current cost of $110,000. The inventory has a fair value of $135,000.

(d) Saskatchewan Corporation expenses some inexpensive office equipment even though it has a useful life of more than one year.

Ex. 153

Identify whether the following statements are true or false.

_____ 1. The conceptual framework of accounting guides decisions about what to present in financial statements, alternative ways of reporting economic events, and inappropriate ways of communicating this information.

_____ 2. The users identified in the conceptual framework are all external users and, and as such, do not have access to the same financial information as internal users do.

_____ 3. The conceptual framework is fundamentally similar for publicly traded companies in Canada reporting under IFRS and private companies reporting under ASPE.

_____ 4. Two major economies, the United States and China, have yet to adopt IFRS.

_____ 5. All countries use the same conceptual framework or set of accounting standards.

Ex. 154

Identify which qualitative characteristic is being violated in each of the situations below:

(a) Valeem Industries has its financial statements audited on an as needed basis, usually every other year.

(b) Over & Out Communications Inc. did not issue its 2021 financial statements until the end of F2022.

(c) On the statement of financial position, Faithfully Yours reported the cost of machinery equipment used in the manufacturing of the company product in the inventory account.

(d) Oriole Enterprises is the only company in the industry that uses straight-line method of depreciation.

(e) The Controller for Paws Inc. prepares the financial statements with as few classifications and descriptions to make it easier on the reader.

Ex. 155

Explain the difference between the cost constraint and historical cost.