1. 1 K 5. 1 K 9. 2 C 13. 3 K 17. 3 C

Copyright © 2016 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 8/e, Solutions Manual (For Instructor Use Only) 2-1

CHAPTER 2

A Further Look at Financial Statements

Learning Objectives

• Identify the sections of a classified balance sheet.
• Use ratios to evaluate a company’s profitability, liquidity, and solvency.
• Discuss financial reporting concepts.

Summary of Questions by Learning Objectives and Bloom’s Taxonomy

Item LO BT Item LO BT Item LO BT Item LO BT Item LO BT Questions

1. 1 K 5. 1 K 9. 2 C 13. 3 K 17. 3 C

2. 1 K 6. 2 C 10. 2 K 14. 3 C 18. 3 C

3. 1 C 7. 2 K 11. 2 C 15. 3 C 19. 3 C

4. 1 C 8. 2 C 12. 3 K 16. 3 C 20. 1 C

Brief Exercises

1. 1 K 3. 2 AP 5. 2 AP 7. 3 K 9. 3 K

2. 1 AP 4. 2 AP 6. 3 K 8. 3 K 10. 3 K

Do It! Exercises 1a. 1 AP 1b. 1 AP 2. 2 AP 3. 3 K Exercises

1. 1 AP 4. 1 AP 7. 2 AP 10. 2 AP 12. 3 K

2. 1 AP 5. 1 AP 8. 1, 2 AP 11. 2 AP 13. 3 C

3. 1 AP 6. 1 AP 9. 2 AP

Problems: Set A

1. 1 AP 3. 1 AP 5. 2 AP 7. 2 AP

2. 1 AP 4. 2 AN 6. 2 AP 8. 3 E

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2-2 Copyright © 2016 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 8/e, Solutions Manual (For Instructor Use Only)

ASSIGNMENT CHARACTERISTICS TABLE

Problem Number

Description Difficulty Level Time Allotted (min.)

1A Prepare a classified balance sheet. Simple 10–20

2A Prepare financial statements. Moderate 20–30

3A Prepare financial statements. Moderate 20–30

4A Compute ratios; comment on relative profitability, liquidity, and solvency.Moderate 20–30

5A Compute and interpret liquidity, solvency, and profitability ratios.Simple 10–20

6A Compute and interpret liquidity, solvency, and profit- ability ratios.Moderate 15–25

7A Compute ratios and compare liquidity, solvency, and profitability for two companies.Moderate 15–25

8A Comment on the objectives and qualitative characteristics of financial reporting.Simple 10–20

Copyright © 2016 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 8/e, Solutions Manual (For Instructor Use Only) 2-3

ANSWERS TO QUESTIONS

• A company’s operating cycle is the average time that is required to go from cash to cash in prod-

ucing revenue.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Measurement

• Current assets are assets that a company expects to convert to cash or use up within one year of

the balance sheet date or the company’s operating cycle, whichever is longer. Current assets are listed in the order in which they are expected to be converted into cash.

LO 1 BT: K Diff: E TOT: 1 min. AACSB: None AICPA FC: Reporting

• Long-term investments are investments in stocks and bonds of other companies where the

conversion into cash is not expected within one year or the operating cycle, whichever is longer and plant assets not currently in operational use. Property, plant, and equipment are tangible resources of a relatively permanent nature that are being used in the business and not intended for sale.

LO 1 BT: C Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

• Current liabilities are obligations that will be paid within the coming year or operating cycle,

whichever is longer. Long-term liabilities are obligations that will be paid after one year.

LO 1 BT: C Diff: M TOT: 1 min. AACSB: None AICPA FC: Reporting

• The two parts of stockholders’ equity and the purpose of each are: (1) Common stock is used to

record investments of assets in the business by the owners (stockholders). (2) Retained earnings is used to record net income retained in the business.LO 1 BT: K Diff: M TOT: 2 min. AACSB: None AICPA FC: Reporting

• (a) Geena is not correct. There are three characteristics: liquidity, profitability, and solvency.

(b) The three parties are not primarily interested in the same characteristics of a company.Short-term creditors are primarily interested in the liquidity of the company. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company.

LO 2 BT: C Diff: M TOT: 3 min. AACSB: None AICPA FC: Reporting

7. (a) Liquidity ratios: Working capital and current ratio.

(b) Solvency ratios: Debt to assets and free cash flow.

(c) Profitability ratio: Earnings per share.

LO 2 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

2-4 Copyright © 2016 John Wiley & Sons, Inc. Kimmel, Financial Accounting, 8/e, Solutions Manual (For Instructor Use Only)

• Debt financing is riskier than equity financing because debt must be repaid at specific points in

time, whether the company is performing well or not. Thus, the higher the percentage of assets financed by debt, the riskier the company.

LO 2 BT: C Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

• (a) Liquidity ratios measure the short-term ability of the company to pay its maturing obligations

and to meet unexpected needs for cash.

(b) Profitability ratios measure the income or operating success of a company for a given period of time.

(c) Solvency ratios measure the company’s ability to survive over a long period of time.

LO 2 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Reporting

• (a) The increase in earnings per share is good news because it means that profitability has improved.

(b) An increase in the current ratio signals good news because the company improved its ability to meet maturing short-term obligations.

(c) The increase in the debt to assets ratio is bad news because it means that the company has increased its obligations to creditors and has lowered its equity “buffer.”

(d) A decrease in free cash flow is bad news because it means that the company has become less solvent. The higher the free cash flow, the more solvent the company.

LO 2 BT: AN Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

• (a) The debt to assets ratio and free cash flow indicate the company’s ability to repay the face

value of the debt at maturity and make periodic interest payments.

(b) The current ratio and working capital indicate a company’s liquidity and short-term debt- paying ability.

(c) Earnings per share indicates the earning power (profitability) of an investment.

LO 2 BT: C Diff: M TOT: 3 min. AACSB: Analytic AICPA FC: Reporting

• (a) Generally accepted accounting principles (GAAP) are a set of rules and practices, having

substantial support, that are recognized as a general guide for financial reporting purposes.

(b) The body that provides authoritative support for GAAP is the Financial Accounting Standards Board (FASB).

LO 3 BT: K Diff: E TOT: 2 min. AACSB: None AICPA FC: Measurement

• (a) The primary objective of financial reporting is to provide information useful for decision making.

(b) The fundamental qualitative characteristics are relevance and faithful representation. The enhancing qualities are comparability, consistency, verifiability, timeliness, and understandability.