TABLE OF CONTENTS

S. No. DESCRIPTION PAGE No.

1 REVIEW OF BASIC CONCEPTS OF ACCOUNTING 1
2 DEPRECIATION 9
3 LIABILITIES COMMON TO BUSINESS 13
ORGANIZATION
4 PARTERNERSHIPS 18
5 CORPORATIONS 23
6 CASH FLOW STATEMENTS 37
7 RATIO ANALYSIS 45
8 GAAP 55

REVIEW OF BASIC CONCEPTS OF ACCOUNTING

Q. NO. 1
1. Khalid invested in business cash Rs.40000, Furniture Rs.24,000, equipment Rs.15000
2. Purchase merchandise for cash Rs. 6000
3. Purchase office stationary for Rs.2000
4. Purchase goods on credit from Zahid Rs.10000
5. Sold merchandise on credit to Amir Rs.10000

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6. Paid rent Expense Rs.600.
7. Sold merchandise for cash Rs. 3500
8. Billed to Mr. Bilal for service rendered Rs. 10000
9. Purchase supplies on credit from Aleem Rs. 800
10. Paid traveling Expense Rs. 650.
11. Sold merchandise to Mr. Kareem Rs. 4000 on credit.
12. Received cash from Mr. Kareem Rs.1500
13. Khalid withdrew cash for personal use Rs. 3000
14. Paid insurance for the month Rs. 500
15. Received cash from Mr. Bilal Rs.8000

INSTRUCTION
A: Prepare journal entries

B: Post to ledger accounts

C: Prepare a trial balance at July 31,2002

Q-2  Helen Ingersoll owns and operates an interior design studio called Ingersoll Interiors. The following
amounts summarize the financial position of her business on August 31, 2002:

Owner's
  Assets = Liabilities + Equity

Helen
Accounts Accounts Ingersoll,
  Cash + Receivable + Supplies + Land = Payable + Capital

Bal. 2,250   1,500       12,000   8,000   7,750

During September 2002, the following events occurred.

a. Ingersoll inherited $20,000 and deposited the cash in the business bank account.

b. Performed services for a client and received cash of $700.

c. Paid off the beginning balance of accounts payable.

d. Purchased supplies on account, $1,000.

e. Collected cash from a customer on account, $1,000.

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f. Invested personal cash of $1,000 in the business.

g. Consulted on the interior design of a major office building and billed the client for services rendered, $2,400.

h. Recorded the following business Expenses for the month:

1. Paid office rent, $900.

2. Paid advertising, $100.

i. Sold supplies to another business for $150 cash, which was the cost of the supplies.

j. Withdrew cash of $1,100 for personal use.

Required

1. Prepare General Journal entries of above transactions.

2. Prepare General Ledger.

3. Prepare Trial Balance for the month ended September 30,2002

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Q#3. Mr. Rashid is involved in the business of shoes trading. Following are few of the
transactions conducted by him in the month of April,2011.
2nd April Opened a bank account in MCB by depositing cash Rs.500,000 in bank.
th
4 April Purchased Computers of Rs.50,000.
5th April Purchased merchandise in cash Rs.54,000.
6th April Purchased shoes on credit from Kamran of 35,000 with terms 3/10,
6th April n/30.
Sold merchandise on cash of Rs.50,000.
8th April Sold goods to Atif on credit worth, Rs.25,000 with credit terms
10th April 2/10,n/20.
Merchandise returned to Kamran , amounting Rs.2,500.
11th April Issued a cheque to Kamran for the outstanding amount and availed
14th April discount.
Goods returned by Atif of Rs.2,000.
19th April Received a cheque from Atif for the outstanding amount.
20th April Purchased shoe rack from Habitt of Rs.10,000. Issued a cheque of
Rs.4,000 to Habitt. Outstanding amount will be paid in 3 monthly
23rd April installments
Withdraw of Rs.2,000
cash from bankeach.
of Rs.55,000.
25th April Purchased merchandise of Rs.25,000 & issued a cheque for the
28th April purchase.
Sold goods of Rs.30,000 & received a cheque for the said amount.
29th April Mr. Rashid purchased a cell phone of Rs.15,000. He intends to present
this cell phone to his son for his birthday on 1st of May,2011.
30th April Paid salaries for office staff, Rs.35,000.
st
31 April Paid rent for office, Rs.25,000.
31st April Paid Insurance expense for April, Rs.20,000.
31st April Invested additional cash in business Rs.10,000 and machinery
REQUIRED: Rs.15,000.
a) Prepare necessary General Journal entries of the transactions conducted
by Mr.Rashid during month of April,2011.
b) Post necessary postings to General Ledger.
c) Prepare Trial Balance as on 30th April, 2011.
d) Prepare Income Statement
e) Prepare Balance Sheet

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Q-4 Prepare Balance Sheet from the given data, but be careful, every item will not be appeared in Balance Sheet.

Land 25,000
Building 1,25,000

A/c payable 30,000

Cash 15,000

Note payable 25,800

Sales 5,50,000

Offi ce supplies 5,000

Bank 17,000

A/c receivable 15,000

Amir-capital ?
Salaries payable 32,500
Short-term investment 58,000

Offi ce salaries expense 12,500

Prepaid adverti sing 36,000

Commission revenue 2,56,900

Q-5 An incorrect Balance sheet of Ahmad Merchant is given here, you are required to prepare
correct and classifi ed Balance Sheet on December 31,2002.

Q A/c payable 14,000 Land 68,000

A/c receivable 800 Machinery 65,000

Building 52,000 Note Payable 29,000

Cash 9,200 Salaries Payable 3,000

Salman-capital ? Supplies 400

Q-6 Following Balance Sheet presented by Sajid and sons on March 31, 2002

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ASSETS EQUITIES
Following
CURRENT ASSETS LIABILITIES
transacti ons
CASH 125,000 A/C PAYABLE 85000 occurred during
the month of
A/C RECEIVABLE 45000 LOAN FROM AKRAM 100,000
April
NOTE RECEIVABLE 25000 NOTE PAYABLE 25000

PREPAID ADVERTISING 2500

1. Collected
OWNER'S EQUITY from
customer
FIXED ASSETS CAPITAL 502500 Rs.
15000
EQUIPMENT 65000
2. Paid to
BUILDING 450,000 supplier
Rs.
TOTAL ASSETS 712,500 EQUITIES 712500 65000
3. Note

receivable matured and received Rs.10000

4. Sajid invest additi onal capital in business in the form of cash Rs.100,000 and equipment
Rs.25000
5. Sajid obtained bank loan from Standard Chartered on fi ve year term Rs. 200,000
6. Note payable paid by fi rm Rs.5000
7. Sajid withdrew Cash Rs. 20,000 for personal use.

Required:

1. Prepare Journal entries for the above transacti ons

2. Draw General ledger for the accounts eff ected
3. Prepare Balance Sheet as at April 30 t h ,2002

Q No. 7 The Trial Balance from the given data of Funfood Enterprises on August 31 s t ,2005.

Prepaid insurance 4500

Cash 15600

Offi ce stati onary 5600

Sales revenue 1175000

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Commission income 25000

Offi ce salaries 56000

Capital- Haroon 575000

Drawing-Haroon 45000
Equipment 45000

A/c payable 56000

Uti lity expense 12000

Bank overdraft 75000

Insurance expense 5000

Note payable 32000

Building 750000
Prepaid rent 40000
A/c Receivable 60000

Loan from bank 300000

Marketable securiti es 50000

Interest expense 12000

Operati ng expenses 1125,300

Prepare:

1. Trial Balance ( if not equal, use suspense account)

2. Income Statement
3. Balance Sheet

Q No.8       The balance sheet contains numerous errors. In particular, the bookkeeper knew that the balance
sheet should balance, so he plugged in the owner's equity amount needed to achieve this balance. The
owner's equity amount, however, is not correct. All other amounts are accurate, but some are out of place.

TRÉSORO PUBLISHING CO.

Balance Sheet
Month Ended July 31, 20X3

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Assets   Liabilities

Cash $12,000   Accounts Receivable $  3,000

Office Supplies     1,000   Service revenue   68,000

Land   44,000   Property tax expense        800

Salary expense     2,500   Accounts payable     9,000

Office furniture     8,000      

Note payable   16,000   Owner's Equity

Rent expense     4,000   Owner's Equity     6,700

$87,500 $87,500
Total assets   Total liabilities

Required

1. Prepare the correct balance sheet. Compute total assets, total liabilities, and owner's equity.

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QUESTION # 9:

Olympic Sporting Goods

Trial Balance
For the year ended December 31,1994
S.No. HEAD OF ACCOUNT DEBIT CREDIT
1 Cash 19,400  
2 Accounts Receivable 48,300  
3 Office supplies 7,000  
4 Inventory - Jan.1,1993 60,000  
5 Land 52,000  
6 Building 160,000  
7 Accumulated Depreciation-Building   56,000
8 Notes Payable   82,000
9 Accounts Payable   55,000
10 Capital   115,000
11 Drawing 26,000  
12 Sales   627,000
13 Sales Return 12,000  
14 Sales Discounts 5,000  
15 Purchases 375,000  
16 Purchases Returns   10,000
17 Transportation-In 11,000  
18 Salaries Expense 74,000  
19 Prepaid Advertising 29,000  
20 Insurance Expense 55,000  
21 Utilities Expense 2,100  
22 Rent Expense 1,000  
23 Interest Expense 8,200  
     
  TOTAL 945,000 945,000
Additional Information:
1 Depreciation Expense is chargeable to Building @ Rs.8,000/ year.
2 Allowances for Bad debts to charged @ 4% of A/R
3 Accrued interest on Notes Payable @ 5%.
4 Prepaid Advertising of Rs.8,000 has been expired during the period.
5 Salaries of Rs.12,000 is still outstanding.
6 Office supplies of Rs.3,000 has been expired.
7 Merchandise Inventory on Dec. 31. is Rs.30,000
REQUIRED

(A) Pass necessary adjusting entries.

(B) Pass closing entry of closing stock.
(C) Prepare an adjusted trial balance.

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DEPRECIATION
PLANT & EQUIPMENT: The term, “Plant & Equipment” is used to describe the long lived assets
acquired for use in the operation and not intended for resale to customers.

DEPRECIATION ON PLANT & EQUIPMENT

 Depreciation is the allocation of the cost of a asset to expense over the years of its estimated useful life.
 In other words, it is the allocation of the cost of a asset to expense in the periods in which services are
received from the asset.
TYPES OF EXPENDITURES

1. Revenue Expenditures:
2. Capital Expenditures:
1. Revenue Expenditures:

All the expenditures which are incurred in the day to day conduct and administration of a business and the effect-
of which is completely exhausted within the current accounting year are known as "revenue expenditures".

These expenditures are recurring in nature & are charged to income statement. e.g. salaries, postages, rent,
traveling expenses, fuel, interest etc.

2. Capital Expenditures:

An expenditure which results in the acquisition of permanent asset which is intended to be permanently used in
the business for the purpose of earning revenue, is known as capital expenditure.

These expenditures are 'non-recurring' by nature & are appeared in the balance sheet. For example, money
spent on the purchase of building, machinery, furniture etc.

DEPRECIATION METHODS:

1. Straight Line Method

2. Diminishing Balance Method/ Reducing Balance Method/WDV Method / Book Value Method.
3. Number of Hours used method.
4. Number of units produced method.
5. MACRS Method
IMPORTANT TERMS ASSOCIATED WITH DEPRECIATION:

Cost of Asset: The cost of plant & equipment includes all expenditures reasonable & necessary in acquiring the asset
& placing it in a position & condition for use in the operation of the business.

Book Value / WDV (Written Down Value ) :

The cost of plant asset minus the accumulated depreciation.

Residual Value / Scrap Value/ Salvage Value:

The portion of an asset’s cost expected to be recovered through sale at the end of its useful life.

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FORMULAS FOR DEPRECIATION COMPUTATION  

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1. STRAIGHT LINE METHOD  
   
Dep. Exp = Cost of Asset - Salvage Value  
  Estimated useful life in years  
   
  OR  
   
Dep. Exp= ( Cost of Asset - Salvage Value ) x Rate of Depreciation
   
 
2. BOOK VALUE METHOD / DIMISHING BALANCE METHOD / DECLINING BALANCE
METHOD / REDUCING BALANCE METHOD/ WDV METHOD :  
   
Dep. Exp = Book Value x Rate of Depreciation  
   
3. HOURS USED METHOD  
   
Dep. Exp. = Cost of Asset - Salvage Value x Hours used in a year
  Estimated life in hours  
   
4. UNITS PRODUCED METHOD  
   
Units produced in a
Dep. Exp. = Cost of Asset - Salvage Value x year
  Estimated life in units  
   
 
 
 
 
                 

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PRACTICE MATERIAL FOR DEPRECIATION
Q No.1

ABC Co. purchase offi ce equipment for Rs. 125,000 on credit from Hamid & Co. Co paid
transportati on charges Rs.5000. Esti mated life of the asset is 10 years and scrap value Rs.10,000.

Co decided to use straight line method for depreciati on assets

Required:

1: Compute total cost of offi ce equipment

2: Compute depreciati on for fi rst three years

3: Present Schedule of depreciati on showing book value

4: Prepare Allowance for depreciati on account

Q No.2 Company bought machine at Rs. 40,000 on Jan.1 1998. Paid installation charges Rs.5000 Estimated life of the
machine is Expected to be four years and residual value is 4000.

Prepare Schedule showing cost, depreciation and book value under given method separately showing four years
depreciation and residual value.

1) STRAIGHT LINE METHOD

2) DIMINISHING BALANCE METHOD ( rate 25% )

Q No. 3: On 1st March, 2001, ABC & Co imported machine from Italy at Rs.1256,000, In addition to its purchase price,
company also paid the following Expenses related to its purchase.

a) paid freight charges Rs.75,000

b) insurance in transit Rs.25000
c) Co also paid import duty Rs.235,000 and transportation charges Rs.5000.
d) On its way from airport to office premises, a challan of Rs.1,000 was paid to traffic police for breaking the
traffic rule.
e) Foundation and installation cost incurred Rs. 125,000.
f) Test run cost incurred Rs.15,000.
g) An amount of Rs.10,000 has been paid to insurance company on account of fire insurance for 3 years.
Estimated life of the machine is 20 years and Expected scrap value is Rs.250,000.

Required:

1) Compute total cost of the machine

2) Compute depreciation Expense under following methods for three years: (2001-03)

 Straight line method

 Diminishing balance method( rate 20% )
3) Pass necessary journal entries for cost of machine & depreciation Expense charged each year.

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4) Prepare ledgers for Machine Account, Depreciation Account & Accumulated Depreciation Account.

5) Prepare partial balance sheet for 3 years. ( 2001 to 2003 )

6 ) Suppose if the machine was sold at the end of year 2002 at a value of Rs.14,00,000. Record the journal entry for
the disposal of the machine.

7) On December 2002, suppose if the machine was exchanged with a new machine costing Rs.20,00,000. Trade-in-
allowance of old machine was agreed as Rs.10,00,000. Pass journal entry for the gain or disposal of machine.

Q No.4

Salim & Co bought machine at a cost of Rs.500,000 on January 1,1997 on credit from Sheeraz brothers. Estimated life
of the machine is 5 years and scrap value is Rs.160,000.

Required:

Present schedule of depreciation for 5 years under Diminishing Balance method(Rate 20%).

Last year depreciation should be adjusted to arrive at scrap value:

Q No.5

Merchant & Co bought machine at a cost of Rs.200,000 on September 1,1999 on credit from Hamid brothers. Paid
installation cost Rs.20,000. During installation certain part of machine damage and repaired at a cost of
Rs.5000.Estimated life of the machine is 5 years and scrap value is Rs.40,000.

Required:

Present schedule of depreciation under following methods for 5 years. Last year depreciation should be adjusted to
arrive at scrap value:

Straight line method

Diminishing Balance method(Rate 30%)

MACRS Method

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LIABILITIES COMMON TO BUSINESS ORGANIZATIONS
Liabilities: Liabilities may be defined as debts or obligations arising from past transactions or events and requiring
settlement at a future date.

Distinction b/w Debt and Equity: Businesses have two basic sources of financing: Debt and equity. Liabilities differ
from owner’s equity in several respects. The feature which most clearly distinguishes the creditor’s claim from
owner’s equity is that all liabilities eventually mature- that is they come due. Owner’s equity does not mature. The
date upon which liability comes due is called maturity date.

CURRENT LIABILITIES: These are obligations that must be paid within 1 year.

Accounts Payable: These are short term obligations to suppliers for purchases or merchandise.

Notes Payable: These are issued whenever bank loans are obtained. Other transactions which may give rise to notes
payable include the purchase of real estate or costly equipment, the purchase of merchandise. Notes payable
generally requires the borrower to pay an interest charge.

Current Portion of Long Term Debt: The principal of long term liability which is becoming due in the next 12 months.
It will be presented in balance sheet as current liabilities.

Accrued Liabilities: Accrued Liabilities arise from the recognition of expenses for which payment will be made in
future periods. Thus accrued liabilities also may be called accrued expenses. Examples of accrued liabilities include
interest payable, income taxes payable and payroll liabilities.

Interest Payable: Interest- the cost of borrowing-accrues with the passage of time. When companies enter into long
term borrowing agreements, they may become committed to paying large amounts of interest for many years to
come. At any balance sheet date, however only a small portion of this total interest obligation represent a liability.

Income Taxes Payable: Profitable corporations are required to pay income taxes equal to a portion of their taxable
income. Income taxes expense accrues as profits are earned.

Payroll Liabilities: The largest of the accrued liabilities is the obligation to pay employees for services rendered during
the period. Employers must compute numerous taxes which the government levies either upon employees or upon
the employer. The employer then is responsible is to deduct those taxes from employees’ paychecks and submitting
the same to the govt. accounts.

LONG TERM LIABILITES:

 Long Term Loan

 Debenture Payable
 Bonds Payable
 Mortgage Loan Payable

ESTIMATED LIABILIITES:
Loss Contingencies: It is a possible loss (or expense), stemming from past events, that will be resolved as to
existence and amount by some future events. The manner in which the loss contingencies are presented in

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financial statements depends upon the degree of uncertainty involved. Loss contingencies are recorded in the
accounting records only when both of the following criteria are met:

1. it is probable that a loss has been incurred, and

2. the amount of loss can be reasonably estimated.

e;g Doubtful Accounts Receivable.

Pending lawsuits
PRACTICE QUESTIONS
1. Which of the following is a characteristic of liabilities, rather than of equity? ( More than 1 answer may be
correct )
(a) The obligation matures.
(b) The capital providers frequently are entitled to receive interest payments.
(c) The capital provider’s claims are residual in the event of liquidation of the business.
(d) The capital providers normally have the right to exercise control over business operations.

2. Which of the following situations require recording a liability in 1994 ? ( More than 1 answer may be
correct )
(a) In 1994, a theater group receives payments in advance from season ticket holders for productions to be
performed in 1995.
(b) A company is a defendant in a legal action. At the end of 1994, the company’s attorney feels it is
impossible the company will lose, and that the amount of the loss might be material.
(c) During 1994, a Midwest agricultural co-operative is concerned about the risk of loss if inclement weather
destroys the crops.
3. On May 1, 1994 , Venus Company borrowed Rs.350,000 from the bank and agreed to repay that amount plus
12% interest at the end of one year. Venus’s financial statements for the year ended December 31, 1994
include:
(a) Interest expense of Rs.42,000.
(b) An overall current liability for this loan of Rs.392,000.
(c) An overall current liability for this loan of Rs.378,000.
(d) Unamortized discount on notes payable of Rs.14,000.

4. On November 1,2009 Peter Company borrows Rs.10,000 from its bank for a period of six months at an
annual interest rate of 12% . Pass the necessary journal entries on Nov.1 2009, Dec.31 2009 & 30 April 2010.
Assume that the company closes it books of account each year on December 31.

5. High Tech stores obtained a long term loan from HSBC bank of Rs.500,000 for a period of 5 years at an
interest rate of 12%. Although the principal amount of this loan will not be due for 5 years, interest is to be
paid monthly – on the first day of each month. What amount of interest payable should in the balance sheet
at year end ?

6. Jonas Company issues a 90 day, 12% note payable to replace an account payable to Smith Supply Company in
the amount of Rs.8,000. Draft the journal entries to record the issuance of the note payable and the payment
of the note at the maturity date.

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7. Listed below are the selected items from the financial statements of G& H Manufacturing Company for the
year ended December 31, 1994.
Note Payable to MCB……………………………………………………………………………………………..Rs.100,000
Income Taxes Payable………………………………………………………………………………..…….……………63,000
Loss Contingency………………………………………………………………………………………..….……………200,000
Accounts Payable…………………………………………………………………………………………..….…………163,000
Mortgage Note Payable………………………………………………………………………………………..……..240,000
Accrued Interest ( Mortgage Note)….………………………………………………………………………………1,600
Accrued Payroll………………………………………………………………………………………………………..……18,700
Amounts withheld from employees’ pay……………………………………………………………………… 3,000
Payroll taxes payable……………………………………………………………………………………………………….1300
Unearned Revenue……………………………………………………………………………………….………………25,000

Other Information:
a) The note payable to MCB is due in 30 days. G & H has arranged with this bank to renew the note for
an additional 2 years.
b) G & H has been sued for Rs.200,000 by someone claiming the company’s pumps are excessively
noisy. It is reasonably possible but not probable, that a loss has been sustained.
c) The mortgage note is payable at Rs.8,000 over the next 3 years. During the next 12 months, the
principal amount of this note will be reduced to Rs.170,000.

REQUIRED: Using the information, prepare the current liabilities and long term liabilities and long-term
liabilities sections of the balance sheet at December 31,1994.

8. Payroll expense for the month of July 2011 for Maxwell Corporation amounts to Rs.300,000. Before making
the net payment to their employees. Maxwell has to make following deductions from the payroll.
a. Social Security 6%
b. EOBI 0.5%
c. Income Tax 5%
d. Provident Fund 10%

Required: Pass necessary Journal entries.

9. Company was named as defendant in a lawsuit alleging patent infringement and claiming damages of $408
million. The company denies all charges in the case and is preparing its defenses against them. The company
is advised by legal counsel that it is not possible at this time to determine the ultimate legal or financial
responsibility.
10. Due to violating a certain law, Corning Co. has been taken to the court by Govt. and accrued a $25 million
liability for pending and future lawsuits and claims. Although the company cannot estimate with precision the
outcome of the current and future lawsuits, it apparently believes that the losses of atleast $25 million
appear “probable”.

11. Using the following information, prepare a listing and description of the
Financial amounts which you would classify as (a) current liabilities and (b) long-term
Statement liabilities. If you don’t list part or all of an item in either classification, briefly
Presentation of explain your reasoning
Liabilities

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Interest expense that will arise on interest bearing notes over the
Next 12 months…………………………………………………………………………….. $134,000
*long term mortgage note payable (of which $3,200 will be
Paid within the next 12 months)………………………………..…………………… 800,000
Accrued interest payable on the mortgage note payable……..………… 2,600
Lawsuit pending against the company, claiming $500,000 in
Damages. Legal counsel can make no reasonable estimate
Of company’s potential liability at this time…………………………………… 500,000
Note payable due in 60 days, but which will be extended for an
Additional 18 months……………………………………………………………………. 75,000
Three year commitment to Charlene Doyle as chief financial officer
At a salary of $140,000 per year …………………………………………………… 420,000
*Amount withheld from employees paychecks …………………………….. 6100

12. On November 1, metals exchange Inc., borrowed $250,000 from a bank and
Two Formed for promised to repay that amount plus 12% interest per year at the end of 6 months
Notes Payable (remember that the interest is stated at an annual rate). You are to prepare two
Different presentation of the liability to the bank on metal exchange’s December
31 balance sheet, assuming that the note payable to the bank was drawn as
Follows:
a) For $250,000, with interest stated separately and payable at maturity

b) With the total interest charge include in the face amount of the note

13. Late in 1992, macro construction borrowed $1 million, signing a 5 year, 7.2% note
The nature of payable, the note calls for payment of interest charges monthly, on the sixteenth
An accrued day of each month. Compute the following amount relating to this note payable:
Liability
a) total interest that will be paid over the life of note.
b) interest expense that will be appear in Macros income statement for 1994,
c) accrued interest payable that will appear in Macro’s balance sheet at December
31, 1994 (compute interest payable based on a360-day year)

14. Blue cays marina has a $200,000 mortgage liability, this mortgage is payable in
Use of an monthly installment of $2,057, which include interest computed at the rate of Amortization
12% per year (1% per month)
Table

INSTRUCTIONS: a) prepare a partial amortization table showing the original balance of this loan
and the allocations of the first two monthly payments between interest expense
And reduction in the unpaid balance (round amounts to the nearest dollar)
b) prepare the journal entry to record the second monthly payment.

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15. Listed below are selected items from the accounting records of GOOD ‘N’
balance sheet LITE CANDY CO. for the year ended dec. 31 1994:
presentation liabilities
Notes payables of northwest bank…………………………………………… $200,000
Discounts on notes payables to northwest bank……………………… 2,000
Income tax payable…………………………………………………………………. 43,000
Accrued expenses and payroll taxes………………………………………. 59,800
Mortgage note payable…………………………………………………………… 301,080
Accrued interest on mortgage note payable…………………………... 2,508
Trade accounts payable…………………………………………………………… 129,345
Unearned revenue…………………………………………………………………. 52,100
Potential liability in pending lawsuit………………………………………… 750,000

OTHER
INFORMATION 1 The note payable to northwest bank is due in 60 days. Arrangements have
been made to renew this note for an additional 12 months.

2 The mortagage note payable requires payments of $10,000 per month for
the next 36 months . An amortization table shows that as of dec. 31,1995,
this note will be paid down to $ 212,430.

3 Accrued interest on the mortagage note payable is paid monthly.

4 GOOD ‘N’ LITE has been sued for $750,000 in a contract dispute . It is not
Possible at this time to make a reasonable estimate of the possible loss , if
Any which the company may have sustained.

16. On December 31, 1994, kay-Architectural services purchased equipment at a cost of

Amortization $20,215, paying $5,000 cash and issuing a 2-year installment not payable for $15,215
Table and in- this notes calls for four semiannual installment of $4,800 which include interest com-
stallment debt putted at the annual rate of 20% per year (10% per semiannual period) payments are
Due on June 30 and December 31. The first payment is due June 30, 1995 and the note
Will be fully amortized at December 31, 1996.
Kay can retire his note at any interest payment date by paying the unpaid balance
Plus any accrued interest

INSTRUCTIONS a) prepare an amortization table showing the allocation of each of the four semi-
Annual payment between interest expense and reductions in the principal amount
of note.
b) prepare journal entries to record the issuance of this note and each of the four
Semiannual payment in 1995 and 1996.

c) assume that on December 31, 1995, kay decided to pay the entire unpaid-ball-
Acne of this note. Prepare a journal entry to record the early retirement of this note
(Assume that semiannual payment due on this date already has been paid)

d) Illustrate the presentation of this note in the company’s balance sheet at December
31, 1994 (show separately the current and long-term portions of this debt).

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PARTNERSHIP
Question#1: The partnership of ear ton and lie was formed on July1, when Tina Barton and Sam liu
Formation of an agreed to invest equal amounts and to share profits and losses equally
Partnership: the investment by Barton consists of $40,000 cash and an inventory of merchandise
Closing the valued at $56000.
Income sum- Liu also is to contribute a total of $96,000. However, is it an agreed that his
Mary acco contribution will consist of the following assists of his business along with the transfer
To the partnership of his business liabilities. The agreed values of the various items as
Well as their carrying values on Luis records are listed below lie also contribute
Enough cash to bring his capital account to $96,000.
Investment by LIU
Balances on agreed
Liu records value

Account receivable …………………………………………………………. $89,600 $89,600

Allowance for doubtful accounts…………………………………….. 3840 8,000
Inventory …………………………………………………………………………. 9,600 12, 8000
Office equipment (net)…………………………………………………….. 12,800 9,000
Accounts payable ……………………………………………………………. 28,800 28,800

INSTRUCTIONS : a) Draft entries (in general journal form) to record the investment of Bartorn and
Liu in the new partnership

Question#2: A business owned by fern douglas was short of cash and douglas therefore decided
Formation of a to form a partnership with Andy MCKuen , who was able to contribute cash to the
Partnership new partnership. The assets contributed by douglas appeared as follows in the
balance sheet of her business : cash ,$600;accounts receivable ,$34,900 with an
allowance for doubtful accounts of $960 , inventory ,$45,600 and store equipment
$21,600. Douglas had recorded depreciation of $1800 during her use of the store
Equipment in her sole proprietorship.
Douglas and McKuen agreed that the allowance for doubtful accounts was in-
adequate and should be $1800. They also agreed that a fair value for the inventory
was its replacement cost of $54000 and that tha fair value of the store equipment
was $19,000 . You are to open the partnership accounts by making a general journal
entry to record tha investment by douglas.

Question#3 Explain briefly the effect of each of the transaction given below on a partner’s
Parnter’s Capital capital and drawing accounts.
And Drawing a) Partner borrows funds from the business
Account
b ) Partners collect a partnership account receivable while on vacation and uses the funds for
personal purpose.
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c ) Partner receive in cash the salary allowance provided in the partnership
agreement
d) Partner takes home merchandise (cost $80, selling price $120) for personal
use.
e) Partners has loaned money to the partnership. The principle together with
interest at 15% is now repaid to the partner in cash.

Question#4 Guenther and Firmin, both of whom are CPAs , form a partnership , with Guenther
Dividing investing $100,000 and Firmin , $80,000. They agree to share net income as follows:
Partnership
Income 1 Salary allowances of $80,000 to Guenther and $60,000 to Firmin.

2 Interest allowances at 15% of beginning capital account balance.

3 Any partnership earnings in excess of the amount required cover the interest
and salary allowance to be divided 60% to Guenther and 40% to Firmin.

Instructions: The partnership net income for the first year of operations amounted to $247,000
before interest and salary allowance. Show how this $247,000 should be divided
between the two partners. Use a three column schedule. List on separate lines the
amount of interest , salaries and the residual amount divided.

Question#5: The adjusted balance of B & G distributors indicates the following account
Dividing partnership balance at the end of the current year
Income stat-
Mint financial
Statement
Debit Credit
Cash……………………………………………………………………….. $ 32,620
Account receivable (net)………………………………………… 81,000
Inventory……………………………………………………………….. 28,200
Prepaid expenses …………………………………………………… 3,900
Equipment ………………………………………………………….. 90,000
Accumulated depreciation ……………………………………….. $ 18,000
Notes payable ………………………………………………………… 9,600
Accounts payable ………………………………………………….. 38,250
Accrued expense ………………………………………………….. 2,880
Bolton, capital (beg of the year)…………………………… 70,000
Bolton, drawing 10,080
Gorman, capital (beg of the year)…………………………. 60,000
Gorman. Drawing …………………………………………………. 7,200
Sales………………………………………………………………………. 648,960
Cost of goods sold…………………………………………………. 390,960
Selling expenses ………………………………………………….. 112,380
Administrative expenses………………………………………….. 91,620
Totals ……………………………………………………………………………..$847,960 $847,960

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There were no changes in partners’ capital accounts during the year. A perpetual
Inventory system is used by the company. The partnership agreement provided
That partners are to be allowed 10% interest on invested capital as of the beg—
Ingo of the year and that the residual net income is to be divided equally.

INSTRUCTIONS: a) prepare an income statement for the current year, using the appropriate
Accounts from the above list. At the bottom of the income statement, prepare
a schedule showing the division of net income
b) prepare a statement of partners capitals for the current year
c) prepare a balance sheet at the end of the current year.

Question#6 Alicia Dunn and Roberto Pascal, both real estate appraisers, formed a part-
Dividing part- nership with Dunn investing $40,000, and Pascal investing $60,000, during
nership income the first year the net income of partnership amounted to $45,000.

INSTRUCTIONS : Determine how the $45,000 net income would be divided under each of the
following four independent assumption as to the agreement for sharing profits
and losses. Using schedules of the types illustrated on pages 571-573, show all
Steps in division of net income between the partners.

Question#7 Financial planners has three partners –Reed, Stein and Trump. During the
Dividing partnership current year their capital balances were reed $140,000, stein $100,000
Profit and losses and trump $60,000. The partnership agreement provides that partner shall
Receive salary allowances as follows: Reed none, stein $60,000 and trump
$38,000. The partners shall also be allowed 12% interest annually on their
capital Balances, residual profit or loss is to be divided Reed, 50%,Stein 30%,
Trump 20%.

INSTRUCTIONS: Prepare separate schedules showing how income or loss will be divided
among the three partners in each of the following cases. The figure given in
Each is the annual partnership net income or loss to be allocated among the
Partners
a) Income of $554,000
b) Income of $83,000
c) Loss of $19,000

Question#8 Aspen Lodge is partnership with a record of profitable operations. At the end of
Admission of current year the capital amounts of the three partners and the ratio of sharing
New partner profit and losses are as shown in the following schedule. At this date, it’s agreed
that a new partner, Wolfgang Ritter, is to be admitted to the firm
Capital profit sharing Ratio

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Olga Svenson …………………………………………………………. $300,000 50%
Jill kidd…………………………………………………………………… 240,000 30%
Miles kohl………………………………………………………………. 180,000 10%

INSTRUCTUONS : For each of the following situations involving the admission of Ritter to the
partnership, give the necessary journal entry to record his admission

a) Ritter purchase on – half of Kidd’s interest in the firm, paying personally

$150,000.
b) Reiter buys a one-quarter interest in the firm for $200, 0000 by purchasing
one Fourth of the present interest of the each of the three partners.
Ritter pays the Three individually directly.
c) Ritter invest $200,000 in the firm and receives a one-fourth invest in the
capital and the profits of the business, in addition to the journal entry
to record Ritter’s admission show computation of the equality interest
received and bonus (if Any) to either the old partners or to Ritter.

d) Ritter invest $360,000 in the firm and receives a one-fourth invest in the
capital and the profits of the business, in addition to the journal entry
to record Ritter’s admission show computation of the equality interest
received and bonus (if Any) to either the old partners or to Ritter.

Question#9 Research Consultants has three partners –Alex Brandt and Conrad. During the
Dividing part- the current year their capital balances were Alex, $ 180,000, Brandft $ 140,000
nerhsip profit and Conred $80,000. The partnership agreement provides that partner shall
And loss receives salary allowances as fellows: Axle $10,000, Brandt, $50,000, conred
$28,000. The partners shall also be allowed 12% interest annually on their capital
Balances residual profit or loss is to be divided Axle, one half; Brandft , one third;
Corned, one-sixth.

INSTRUCTIONS: prepare separate schedules showing how income will be divided among the three
Partners in each of the following cases. The figure given in each case is the annual
Partnership net income or loss to be allocated among the partners.
A. income of $526,000
B. income of $67,000
C. loss of $32,000

Question#10: Art of Asia is a partnership organized by Howell and So. A condensed balance sheet
Admission of a for the gallery at September 30 is shown on the next page. On this date the two
New partner partners agreed to admit a new partner, Lee, Howell and So have been dividing profit
In a ratio of 3:2 (that is 60% and 40%). The new partnership will have a profit and loss
Sharing ratio of Lee 50%, Howell 25% , and so 25%.

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Art of Asia
Balance sheet
September 30
Current assets ……………………………………$180,000 liabilities…………………………………………….$160,000
Plant & equipment (net)…………………… $420,000 partners capitals:
Howell capital …………..$280,000
So Capital …………………$160,000 $440,000
Total…………………………………………………$600,000 Total………………………………………………….$600,000

INSTRUCTIONS: Described below are four different situations under which Lee might be admitted to
Partnership. Considering each independently, prepare the journal entries necessary
To record the admission of Lee to the firm.

A. Lee purchases a one half interest (50% of the entire ownership equity) in the partnership
from Howell for $260,000. Payment is made to Howell as an individual.
B. Lee purchases one half of Howell, interest and one half if So’s interest, paying Howell
$198,000 and So $96,000.
C. Lee invest $300,000 in the firm and receive a one half interest in capital and income. In
addition to the journal entry to record Lee’s admission show computation of the equity
interest received and bonus (if any) to either the old partners to Lee.
D. Lee invests $560,000 in the firm and receives a one half interest in the capital and profits of
the business. In addition to the journal entry to record Lee’s admission, shows computation
of the equity interest received and bonus (if any) to either the old partners or to lee.

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CORPORATIONS: ORGANIZATION AND SHAREHOLDER’S / STOCKHOLDERS’S
EQUITY
CORPORATION: A corporation is a legal entity having an existence separate and distinct that from that of its owners.
In the eyes of the law a corporation is an “artificial person,” having many of the rights and responsibilities of a real
person.
A corporation as a separate legal entity, may own property on its own name. Thus, the assets of a corporation belong
to the corporation itself, not to the stockholders/shareholders. A corporation has legal status in court- that is, it may
sue and be sued as if it were a person. As a legal entity, a corporation may enter into contracts, is responsible for its
own debts, and pay income taxes on its earnings.
KEY TERMS:
1. Promoters
2. BOD
3. Agency Theory
Advantages of the Corporate Form of Organization:
1. No personal liability for stock holders
2. Ease of accumulating capital
3. Readily transferable ownership of shares.
4. Continuous existence
Disadvantages of the Corporate Form of Organization:
1. Heavy Taxation
2. Greater Regulation
3. Separation of ownership & control

Rights of Shareholders/Shareholders:
1. Right to vote for directors, for mergers and acquisitions, selection of the independent auditor.
2. Right to receive dividend.
3. Right to have share in the distribution of assets in the case of liquidation of corporation.
SHAREHOLDER’s EQUITY
In the balance sheet of a corporation, the term stockholder’s equity is used instead of owner’s equity. The two
sources of equity are:
1. Investment by shareholders ( paid-up Capital )
2. Earnings from profitable operation of the business. ( Retained Earnings )

Capital Stock/Share Capital: It represents the amount invested by owner of the business. When the owners of the
corporation invest cash or other assets in the business, the corporation issues capital stock as evidence of the
investor’s ownership equity.
Authorized Capital: The articles of incorporation specify the number of shares of capital stock which a corporation is
authorized to issue and the par value, if any, per share.
Face Value:
Par Value: Par value (or stated value) represents the legal capital per share – the amount below which shareholder’s
equity cannot be reduced by except by losses from business operations or special legal action.

Additional Paid-up Capital/ Share Premium: When shares are sold for more than par-value, the Capital stock/Share
Capital account is credited by the par value of the shares issued, and a separate account, Additional Paid-up
Capital/Share Premium, is credited for the excess of selling price over par.
Assuming that 50,000 shares of Rs.10 par value have been authorized and that 10,000 of these authorized shares are
issued at a price of Rs.25 each.
Share Discount: When shares are issued at a price less then the par value.

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TYPES OF STOCK/SHARES
1. Common Stock / Ordinary Shares: The basic type of shares issued by a corporation is called common stock. It
posses the traditional rights of ownership i;e voting rights, participation in dividends and a residual claim to
assets in the event of liquidation.
2. Preferred Stock/ Preference Shares: Any other type of shares being issued by corporation, shares being
termed as preference shares.
Characteristics of Preferred Stock:
1. Preferred as to dividends
2. Cumulative dividend rights.
3. Preferred as to assets in the event of liquidation
4. Callable at the option of the corporation
5. No voting power
Market Price of Preference Shares: An inverse relationship exists b/w interest rates and the market price of
preference shares. So far the rate of return on preference shares is higher than the interest rate, market price will
continue to decline and vice versa. BALANCE SHEET PRESENTATION

SHAREHOLDER’S EQUITY:

Authorized Capital:
- 9% cumulative,100,000 preference shares of Rs.100 each Rs.100,000,000
- 3,000,000 ordinary shares of Rs.5 each Rs. 15,000,000
Issued & Paid-up Capital:
- 9% cumulative preference shares, 50,000 shares of Rs.100 each Rs.5,000,000
- 2,000,000 ordinary shares of Rs.5 each 10,000,000
Share Premium/Additional Paid-up Capital
Preference Shares 200,000
Ordinary Shares 20,000,000
Total Paid-up Capital 35,200,000
Retained Earnings 13,500,000
Reserves ( If any ) -
Total Shareholder Equity 4,8700,000

Market Price of Ordinary Shares: Interest rates also have a significant effect upon the market prices of common
stocks. However, common stock dividends are not fixed in amount. If the company prospers, these dividends are
likely to increase-perhaps every year. Therefore, investors’ expectations as to the profitability of future operations
greatly affect the market value of ordinary shares.

Stocks issued for assets other than cash: Sometimes, a corporation may issue shares of its capital stock in a direct
exchange for land, buildings, or other assets. When a corporation issues capital stock in exchange for services or for
assets other than cash, the transaction should be recorded at the current market value of the goods or services
received.

Book Value per share of Common Stock: Book Value per share is equal to the net assets represented by one share
of stock. The term net asset means total asset minus total liabilities. In other words, net assets are equal to total
shareholder’s equity.

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For corporation which has issued ordinary shares only:

Book Value per Share = Total Shareholder Equity

Number of Shares outstanding

Book Value when a company has both ordinary and preferred shares:

Book Value per Share = Total Shareholder equity – Call price of preferred stock – Dividends in arrears

Number of Ordinary shares outstanding

Cumulative Preferred Stock Example:

A corporation was organized January 1, 1992 with 10,000 shares of Rs.100 cumulative (8%) preferred shares and
50,000 ordinary shares. Dividends paid in 1992 were at the rate of Rs.8 on cumulative preferred shares while at Rs.2
on ordinary shares. In 1993, earnings declined sharply and the only dividend paid was Rs.2 per share on preferred
stock. No dividends were paid in 1994. What is the status of preferred stock on Dec.31, 1994?

Dividends in arrears (Rs.6 per share of 1993 and Rs. 8 per share of 1994)

14 x 10,000 shares of preferred stock Rs.140,000

NOTE: Dividends in arrears are not listed among the liabilities of a corporation, because no liability has exists until a
dividend is declared by the board of directors. Nevertheless, the amount of any dividend in arrears on a preferred
stock is an important factor to investors and should always be disclosed.

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PRACTICE QUESTIONS FOR CORPORATION
Problem No: 1
Jawaid company has an authorized capital of Rs 20,00,000 divided into 20,000 shares of Rs 100 each. The
company offered 9,000 shares of Rs 100 each at a discount of 20% to the public for subscription.
Applications were received for 7,500 shares. All the applicants paid the money due.

Required:
Prepare entries in the general; journal of the company
Prepare initial balance sheet of the company.

Problem No: 2
Kohinoor company limited has an authorized capital of Rs 30,00,000 divided into 30,000 shares of Rs 100
each, 16,000 shares were issued to public at Rs 105 per share payable in full with application. The company's
banker reported that application had been received for 19,000 shares. The directors allotted 16,000 shares and
directed the bankers to return the excess of the application money.

The company purchased a machine at a cost of Rs.1,26,000 and issued 1,200 shares in payments of its price

The company also issued 500 shares of Rs 105 each to directors in reorganization of their service to the
company.

Required:
Entries in the general journal of the company to record the above transaction.

Problem No: 3
1. Bukhari Company limited completed the following transactions. The par value of the company's
shares is Rs 10 each.
2. issued 2000 shares at Rs 10 each for cash
3. issued 17,000 shares at Rs 12 each for cash
4. issued 2,000 shares at Rs 10 each for furniture
5. issued 2000 shares at Rs 10 each for equipment purchased worth Rs 28,000
6. Declared at stock dividend of Rs 90,000 and issued shares in payment of the same.
7. issued 3500 shares at par value to the promotes of the company
8. Purchased building costing Rs 4,80,000 issuing shares of Rs 10 each. The market value of the shares
was Rs 12 per share.

Required: Give the necessary entries in the general journal of the company to record the above transactions.

Problem No: 4
Mehboob limited was registered with the authorized capital of Rs 30,00,000 divided into 3,00,000 shares of
Rs 10 each. The company offered to the public 1,90,000 shares for subscription at par. The applications for
1,80,000 shares were received. The underwriters, under the agreement subscribed for the remaining 10,000
shares. The company paid 2% underwriting commission. The company also completed the following
transactions.

Issued 5,600 shares at par to the promoters in consideration of their services for the promotion of the
company.

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Purchased equipment for Rs 1,20,000 and issued 11,600 shares of Rs 10 each.

Purchased machinery for Rs 3,50,000 and issued 34,000 shares of Rs 10 each as purchse consideration.

Required:
Record the above transactions in the general journal of the company.

DEMONSTRATION PROBLEM FOR YOUR REVIEW

At the close of the current year, the stockholders’ equity section of Rockhurst Corporation’s balance sheet
was as follows;

Stockholder’s equity:

$6 preferred stock, $100 par value, callable at $102, 200,000 shares authorized………………… $12,000,000

Common stock, $5 par value, 5,000,000 shares authorized……….…………………………………………$10,000,000

Additional paid-in capital:

Preferred………………………………………………………..$ 360,000

Common ………………………………………………………… 30,800,000 31,160,000

Retained earnings……………………………………………………………………………… 2,680,000

Total stockholders’ equity ……………………………………………………..$55,840,000

INSTRUCTIONS
On the basis of this information, answer the following questions and show any necessary supporting
computations.

a) How many shares of preferred stock have been issued?

b) What is the total annual dividend requirement on the outstanding preferred stock?
c) How many shares of common stock have been issued or subscribed?
d) What was the average price per share received by the corporation for its common stock?
e) What is the total amount of legal capital ?
f) What is the total paid-in capital?
g) What is the book value per share of common stock? (Assume dividends in arrears for 3 years.)

SOLUTION TO DEMONSTRATION PROBLEM

a) 120,000 shares ($12,000,000 total par value, dividend by $100 par value per share)

b) $720,000 (120,000 shares X $6 per share)

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c) $2,00,000 shares ($10,000,000 total par value, dividend by $5 par value per share)
d) Par value of common shares Issued and subscribed………………..$10,000,000
Additional paid-in capital on common shares………………………….. 30,800,000
Total Issue price of common shares ……………………………………..……..$40,800,000
Shares Issued (part c)…………………………………………………………………… 2,000,000
Average Issue price per share ($44,800,000/2,000,000 shares)…..… $20.4

e) $22,000,000 ($12,000,000 preferred, $10,000,000 common)

f) $53,160,000 ($22,000,000 legal capital, plus $31,160,000 additional paid-in capital)

SELF-TEST QUESTIONS

Choose the best answer. More than one answer may be

1) When a business is organized as a corporation:

a) Stockholders are liable for the debts of the business only in proportion to their percentage
ownership of capital stock.
b) Stockholders do not have to pay personal income taxes on dividends received, because the
corporation is subject to income taxes on its earning.
c) Fluctuations in the market value of outstanding shares of capital stock do not affect the amount of
stockholders’ equity shown in the balance sheet.
d) Each stockholder has the right to bind the corporation to contracts and to make other managerial
decisions.

2) Great Plains Corporations was organized with authorization to issue 100,000 shares of $1 par value
common stock. Forty thousand shares were issued to Tom Morgan, the company’s founder, at a price of
$5 per share. No other shares have yet been issued.
a) Morgan own 40% of the stockholders’ equity of the corporation.
b) The corporation should recognize a $160,000 gain on the issuance of these shares.
c) If the balance sheet includes retained earnings of $50,000, total paid-in capital amounts to
$250,000.
d) In the balance sheet, the Additional Paid-in Capital account will have a $160,000 balance, regardless
of the profits earned or losses incurred since the corporation was organized.

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3) Which of the following is not a characteristic of the common stock of a large, publicly owned
corporation?
a) The shares may be transferred from one investor to another without disrupting the continuity of
business operations.
b) Voting rights in the election of the board of directors.
c) A cumulative right to receive dividends.
d) After issuance, the market value of the stock is unrelated to its par value.
4) Tri-State Electric is a profitable utility company that has increased its dividend to common stockholders
every year for 62 consecutive years. Which of the following is least likely to affect the market price of
the company’s preferred stock?
a) The company’s earnings are expected to increase significantly over the next several years.
b) An increase in long-term interest rates.
c) The annual dividend paid to preferred shareholders.
d) Whether or not the preferred stock carries a conversion privilege.
5) The following information is taken from the balance sheet and related disclosures of Blue Oyster
Corporation:
Total paid-in capital…………………………………………………………………………$5,400,000
Outstanding shares:
Common stock, $5 par value………………………………………………..100,000 shares
6% preferred stock, $100 par value, callable at $108 per share …………. 10,000 shares
Preferred dividends in arrears………………………………………………….. 2 years
Total stockholders’ equity………………………………………………………… $4,700,000

Which of the following statements is true? (More than one answer may be correct.)
a) The preferred dividend in arrears amount to $120,000 and should appear as a liability in the
corporate balance sheet.
b) The book value per share of common stock is $35.
c) The stockholders’ equity section of the balance sheet should include a deficit of $700,000.
d) The company has paid no dividend on its common stock during the past two years.

ASSIGNMENT MATERIAL

DISCUSSION QUESTIONS

1) Why are large corporations often said to be publicly owned?

2) Distinguish between corporations and partnerships in terms of the following
charasteristics:
a) Owners’ liability for debts of the business
b) Transferability of ownership interest

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c) Continuity of existence
d) Federal taxation on income
3) What are the basic rights of the owner of a share of corporate stock? In what way are
these basic rights commonly modified with respect to the owner of a share of
preferred stock?
4) Explain the meaning of the term double taxationas it applies to corporate profits.
5) Distinguish between paid-in capital and retained earnings of a corporation. Why is
such a distinction useful?
6) If the Retained Earnings account has a debit balance, how it is presented in the
balance sheet and what is it called?
7) Explain the significance of par value. Does par value indicate the reasonable market
price for a share of stock? Explain.
8) Describe the usual nature of the following features as they apply to a share of
preferred stock: (a) cumulative, (b) convertible, and (c) callable.
9) Why is noncumulative preferred stock considered a very unattractive form of
investment?
10) When stock is issued by a corporation in exchange for assets other than cash,
accountants face the problem of determining the dollar amount at which to record
the transaction. Discuss the factors to be considered and explain their significance.
11) State the classification (asset, liability, stockholders’s equity, revenue, or
expense) of each of the following accounts:
a) Subscription receivables
b) Organization costs
c) Preferred stock
d) Retained earnings
e) Capital stock subscribed
f) Additional paid-in capitals
g) Income taxes payable
12) A professional baseball team received as a gift from the city the land upon
which to build a stadium. What effect, if any, will the receipt of this gift have upon the
baseball team’s balance sheet and income statement? Explain.
13) Explain the following terms:
a) Stock transfer agent
b) Stockholders subsidiary ledger

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c) Underwriter
d) Stock registrar
14) What does book value per share of common stock represent? Does it represent
the amount common stockholders would receive in the event of liquidation of the
corporation? Explain briefly.
15) How is book value per share of common stock computed when a company has
both preferred and common stock outstanding?

EXERCISES
Question#1: Listed below are nine technical accounting terms introduces or emphasized

In this chapter

Retained earnings Preferred stock Par value

Deficit Common stock Book value

Dividend in arrears Paid in capital Market value

Each of the following statements may (or may not) describe one of these terms. For each

Statement, indicate the term described, or answer “None” if the statement does not correctly

describe any of the terms.

a) That portion of stockholders' equity arising from the issuance of capital stock.
b) The type of capital stock most likely to increase in value as a corporation becomes
increasingly profitable.
c) The net assets are represented by one share of common stock.
d) A distribution of cash by corporation to its owners.
e) The type of capital stock for which the dividend usually is fixed in amount.
f) Cash provided by profitable operations that is available for distribution to stockholders
as dividends
g) The per-share value of common stock that reflects investor expectations of future
profitability.
h) A dividend paid to common stock holders that is smaller than the dividend paid in the
prior year.

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Question#2: Johnson Pump, Inc., began operations in 1993. In that year, the corporation
earned net income of $195,000 and paid dividends of $2.25 per share on its 40,000
outstanding shares of capital stock. In 1994 corporation incurred a net loss of $127,000
and paid no dividends.

a) Prepare the journal entry to close the income summary account at December 31
1994 (the year of the$127, 000 net loss).
b) Compute the amount of retain earnings or deficit which will appear in the
company’s balance sheet at December 31, 1994.

Question#3: Westfall Corporation has outstanding 60,000 shares of $2 par value common
stock which were issued for $22 per share. The net income in the first year of operations was
$235000. On December 31, the board of directors declared a dividend of $1.50 per share,
payable on January 31 of the following year.

a) Prepare the journal entries at December 31 of the first year (1) to close the Income
summary account and (2) to record declaration of the dividend.
b) Prepare the journal entries to record payment of the dividend on January 31 of the
second year.
c) Compute the amount of retained earnings reported in Westfall’s balance sheet at
December 31, at the end of the first year of operations.
d) Assume that the board of directors of Westfall did not meet on December 31 as above,
but waited until January 15 of the second year because the chairman was on vacation.
On January 15, they declared the dividend of $1.50 per share, payable on February 15.
Compute the amount of retain earnings that would have been reported in Westfall’s
balance sheet at December 31, the end of the first year of operations in this situation.

Question#4:When Enviro systems, Inc, was formed the company was authorized to issue
5000 shares of $100 par value, 8% cumulative preferred stock, and 100,000 shares of $2
stated value common stock. The preferred stock is callable at $106.

Half of the preferred stock was issued at a price of $103 per share, and 70,000 shares of
the common stock were sold for $13 per share. At the end of the current year, Enviro
systems, Inc has retained earnings of 297,000. Prepare the stockholders equity section of
the company’s balance sheet at the end of the current year.

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Question#5: The stock holder’s equity section from the December 31, 1994 balance sheet
of Palermo Corporation appears below.

Stockholder’s Equity:
Preferred stock, 9% cumulative, $50 par, 40,000 authorized and Issued……….…...$2,000,000

Preferred stock, 12% non cumulative, $100 par, 8000 shares authorized and issued…...800,000

Common stock, $5 par, 40000 shares authorized and issued…………………….……2,000,000

Additional paid in capital: common……………………………………………….…..2,800,000

Retain earnings……………………………………………………….………………….890,000

Total stockholders' equity………………………………..…………………….…….$8,490,000

Assume that all the stock was issued on January 1, 1992 and that no dividend were paid
during the first two years of operations. During 1994 Palermo Corporation declared and
paid total cash dividends of $736,000.

a) Compute the amount of cash dividends paid during 1994 to each three classes of
stock.
b) Compute the dividend paid per share during 1994 for each of the three classes of
stock.
c) Palermo Corporations generated a net loss of $190,000 in 1992 and earned net
income of $627,000 in 1993. Compute the amount of net income (or net loss)
generated by Palermo Corporations during 1994.

Question#6: Wolfe Company has outstanding two classes of $100 per value stock: 5000
shares of 8% cumulative preferred and 25000 shares of common. The company had an
$50,000 deficit at the beginning of the current year, and preferred dividends had not been
paid for two years. During the current year the company earned $300,000. What will be the
balance in the retain earnings at the end of the current year, if the company pays a dividend of
$2 per share on the common stock?

Question#7:The year- end balance sheet of Mavi corporations includes the following
stockholders' equity (with certain details omitted):

Stockholders' Equity:
$8.25 cumulative preferred stock, $100 par value, callable at 105..…$12,000,000
Common stock, $5 par value, 5,000,000 shares authorized….……....$20,000,000

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Additional paid-in capital
Preferred…………………………………………240,000
Common…………………………………………31,200,000
Retain earnings…………………………………..57,160,000
Total stock holder’s equity……………………..$120,600,000

From this information, compute answers to the following questions:

a) How many shares of preferred stock have been issued?
b) What is the total amount of annual dividends paid to preferred stockholders?
c) What was the average issuance price per share of common stock?
d) What is the amount of legal capital and the amount of total paid in capital?
e) What is book value per share of common stock?

Question#8: Kato manufacturing issues 45000 shares of common stock in exchange for land
with the fair market value of $790,000. Prepare the journal entry to record this transaction
under each of the following independent assumptions:

a) The stock has a $2 par value

b) The stock has a $10 par value
c) The stock has no par value or stated value.

Question#9: Presented below is the information necessary to compute the net assets
(stockholder’s equity) and book value per share of common stock for Ahora Advertising, Inc:

8% cumulative preferred stock, $100 par (callable at $110)…………$300,000

Common stock, $5 par, authorized 100,000 shares…………………....450,000

Additional paid-in capital…………………………………………..….679,200

Deficit…………………………………………………………….……130,200

Dividends in arrears on preferred stock, 1 full year………………….....24,000

a) Compute the amount of net assets (stockholder’s equity)

b) Compute the book value per share of common stock.

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COMPANY ACCOUNTS-FINANCIAL STATEMENT

Q No.10: Afzal company provided information on December 31,2004.

TITLE OF ACCOUNT DEBIT CREDIT
Plant assets Rs.37,50,000
Cash 100,000
Account Receivable 162,500
Merchandise Inventory-beg 62,500
Sales return 7,000
Purchases 12,45,000
Transportation in 20,000
Salaries expense 1,45,000
Prepaid advertising 20,000
Director’s fee 2,15,000
Sales revenue 18,75,000
Commission income 20,000
Accumulated depreciation 3,50,000
Retained earning 3,67,500
Paid up capital 20,00,000
Share Capital 5,00,000
10% debentures payable 5,00,000
Account payable 1,12,500
Purchases return 2,000
57,27,000 57,27,000

Additional information:
1. Merchandise Inventory-ending Rs.45,000
2. Advertising expired Rs.15000
3. Director’s fee commission payable Rs.30,000
4. Prepaid salaries Rs.25000
5. Provide depreciation on plant assets 5%
6. Commission earned but not received Rs.5000
7. Tax rate is applied 40%
8. Directors resolved:
a) To declare cash dividend @ 5%.
b) To appropriate for plant expansion Rs.32,500 and for contingency Rs.50,000.

Required:

a) Income Statement
b) Statement of Retained Earning
c) Balance Sheet

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Q No.11: Delux company authorized capital is 500,000 shares of Rs.10 each. Following information provided on
December 31,2004.

TITLE OF ACCOUNT DEBIT CREDIT

Cash 120,000
Account receivable 155,000
Account payable 145,000
Merchandise inventory 125,000
Purchases 1500,000
Paid up capital 1800,000
Transportation 20,000
Salaries expense 120,000
Sales 1830,000
Building 1800,000
Auditor’s fee 70,000
Furniture 50,000
Retained earnings 225,000
Fire insurance 10,000
Utility expenses 30,000
4000,000 4000,000

Additional information:
1. Merchandise Inventory ending Rs.140,000
2. Salaries unpaid Rs.10,000
3. Accrued utility expenses Rs.5000
4. One-fifth of insurance is unexpired.
5. Provide depreciation on furniture 20% and building at 2%.
6. Income tax 40%
As per board of directors approval
a) Reserve for contingencies Rs.30000
b) Interim dividend declared @ 10% on paid up capital

Required:
a) Income Statement
b) Statement of Retained Earning
c) Balance Sheet

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CASH FLOW STATEMENT
Cash flow statement represents the classification of inflow and outflow of cash during the period from operating,
investing and financial activities.
An enterprise should prepare a Cash Flow Statement in accordance with the requirement of IAS-7 (Revised 1992) and
should present it as an integral part of its financial statements for each period for which financial statements are
presented.
IAS-7 (Revised 1992) supersedes IAS-7, Statement in Changes in Financial position, approved in July 1977.
IAS-7 (Revised 1992) becomes operative for financial statements covering period beginning on or after 1 January
1994.
Objectives of Cash Flow Statement
Objectives and purpose of cash flow statement is to report a firm’s cash inflow and outflows during a period of time,
segregated into three categories: operating, investing and financing activities. It is helpful to the financial managers
and other users to assess and identify the following:
 A company’s ability to generate future net cash inflows from operations to pay debts, interest and dividend
 A company’s need for external financing
 The reasons for differences between net income and net cash flow from operating activities.
 The effect of cash and non-cash investing and financing transactions.
PRESENTATION OF CASH FLOW STATEMENTS
Cash Flow Statement should report the input or output of cash during the period classified as follows
1. Operating Activities
2. Investing Activities
3. Financing Activities

Definitions
Cash
It means cash on hand and Demand Draft (bank balance/bank O/D also)
Cash Equivalents
These are short term, highly liquid investments that are readily convertible to known amount of cash and which are
subject to an insignificant risk of changes in value.
Cash Flows
These are inflows and outflows of cash by operating, investing, and financing activities.
Operating Activities
These are principal revenue-producing activities such as sales and purchases of goods and services.
These activities usually deal with current assets and current liabilities.
Income tax paid is the operating activities.
When it is possible to identify the tax cash flow with an individual transaction that gives rise to cash flows that are
classified as investing or financing activities the tax cash flow is classified as an investing or financing activity as
appropriate.
An enterprise should report cash flows from operating activities using either;
I. Direct Method
a. Whereby major classes of gross (actual) cash receipts and gross (actual) cash payments are disclosed:
or
II. Indirect Method
Whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of
past or future operating cash receipts or payments, and items of income or expense associated with investing or
financing cash flows.

Enterprises are encouraged to report cash flows from operating activities using the direct method.

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Investing Activities
These activities deal with sales and purchase of fixed assets and other long term investments.
Dividends and interest received on investment are the investing activities because they are the return on investment.
Financing Activities
These activities deal with shareholder’s (owner’s) equity and long term liabilities.
Dividend and interest paid is the financing activities because they are costs of obtaining financial resources.
Cash flow statement is the Reconciliation of Net Profit to the Net Cash Flows.
Cash Flow Statement
For the Period Ended December 20XX
Using indirect Method

Cash flow from operation activities

Net profit before interest and tax and extra ordinary items xxx
Adjustment for; (non-cash items) xxx
Add:
Depreciation (for the period) xxx
Bed Debts expense xxx
Amortization of Goodwill, patent or intangible assets xxx
Amortization of discount on debenture or share xxx
Loss of sale of fixed assets xxx xxx
Less:
Gain on sale of fixed assets xxx
Dividend and interest received on investment xxx (xxx)
Operating profit xxx
Increase in current assets (except cash/bank) (xxx)
Decrease in current assets (except cash/bank) xxx
Increase in current liabilities (except tax, interest and dividend payable) xxx
Decrease in current liabilities (except tax, interest and dividend payable) (xxx) (xxx)
Cash generated from operation xxx
Interest paid (actual cash paid) (xxx)
Income tax paid (actual cash paid) (xxx)
Net Cash from operating activities xxx
Cash flow from investing activities
Purchase of fixed assets (actual cash paid) (xxx)
Sale of fixed assets (actual cash received) xxx
Interest received (actual cash received) xxx
Dividend received (actual cash received) xxx
xxx
Cash flow from financing activities
Issue of share capital (actual cash received) xxx
Issue of debenture (actual cash received) xxx
Received from long term loans (actual cash received) xxx
Payment of long term loans (actual cash paid) (xxx)
Dividend paid (actual cash paid) (xxx)
Cash generated from operations xxx
Increase (decrease) in net cash during the period xxx
Add:
Cash and cash equivalents at beginning of period xxx
Cash and cash equivalents at ending of period xxx

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Cash flow statement is the Reconciliation of Net Profit to the Net Cash Flows.
Cash Flow Statement
For the Period Ended December 20XX
Using Direct Method

Cash flow from operation activities

Cash receipts from customers xxx
Cash paid to suppliers and employees (xxx)
Cash generated from operations xxx
Interest paid (xxx)
Income tax paid (xxx)
Net Cash from operating activities xxx
Cash flow from investing activities
Purchase of fixed assets (actual cash paid) (xxx)
Sale of fixed assets (actual cash received) xxx
Interest received (actual cash received) xxx
Dividend received (actual cash received) xxx
Net Cash flow from investing activities xxx
Cash flow from financing activities
Issue of share capital (actual cash received) xxx
Issue of debenture (actual cash received) xxx
Received from long term loans (actual cash received) xxx
Payment of long term loans (actual cash paid) (xxx)
Dividend paid (actual cash paid) (xxx)
Cash generated from operations xxx
Increase (decrease) in net cash during the period xxx
Add:
Cash and cash equivalents at beginning of period xxx
Cash and cash equivalents at ending of period xxx

PROBLEM 1: The accounting staff of Educators’ Outlet Inc. has assembled the following information for the year
ended December 31, 19--.
Cash sales - ----------------------------------------------------------------------------------------------------------- $800000
Credit sales ------------------------------------------------------------------------------------------------------------ 2500000
Collections on accounts receivable ------------------------------------------------------------------------------ 2200000
Cash transferred from the money market fund to the general bank account --------------------------250000
Interest and dividends received ------------------------------------------------------------------------------------100000
Purchases (all on account) ----------------------------------------------------------------------------------------- 1800000
Payments on accounts payable to merchandise suppliers ------------------------------------------------ -1500000
Cash payment for operating expenses ------------------------------------------------------------------------- -1050000
Interest paid ------------------------------------------------------------------------------------------------------------- 180000
Income tax paid ---------------------------------------------------------------------------------------------------------- 95000
Loans made to borrowers -------------------------------------------------------------------------------------------- 500000
Collections on loans (excluding receipts of interest) ---------------------------------------------------------- 260000
Cash paid to acquire plant assets --------------------------------------------------------------------------------- 3100000

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Book value of plant assets sold ------------------------------------------------------------------------------------- 660000
Loss on sales of plant assets ------------------------------------------------------------------------------------------ 80000
Proceeds from issuing bonds payable ------------------------------------------------------------------------- 25000000
Dividend paid ----------------------------------------------------------------------------------------------------------- 120000
Cash and cash equivalents, beginning of year ------------------------------------------------------------------ 446000
Cash and cash equivalents, end of year --------------------------------------------------------------------------------?---

INSTRUCTIONS Prepare a statement of cash flows using direct method of reporting cash flows from operating
activities.
Many of the items above will be listed in your statement without change. However, you will have to combine certain
given information to compute the amounts of (1) collections from customers, (2) cash paid to suppliers and
employees, and (3) proceeds from sales of plant assets. (Hint: Not every item listed above is used in preparing a
statement of cash flow.)

PROBLEM # 2: The accounting staff of TeleGift Corporation has assembled the following information for the year
ended December 31, 19--.
Cash sales ----------------------------------------------------------------------------------------------------------- $402000
Credit sales ------------------------------------------------------------------------------------------------------------ 3420000
Collections on accounts receivable ------------------------------------------------------------------------------ 3193000
Cash transferred from the money market fund to the general bank account --------------------------180000
Interest and dividends received ------------------------------------------------------------------------------------- 40000
Purchases (all on account) ----------------------------------------------------------------------------------------- 1950000
Payments on accounts payable to merchandise suppliers ------------------------------------------------- 2036000
Cash payment for operating expenses ------------------------------------------------------------------------- -- 822000
Interest paid -------------------------------------------------------------------------------------------------------------- 99000
Income tax paid -------------------------------------------------------------------------------------------------------- 180000
Loans made to borrowers -------------------------------------------------------------------------------------------- 220000
Collections on loans (excluding receipts of interest) ---------------------------------------------------------- 145000
Cash paid to acquire plant assets --------------------------------------------------------------------------------- 1640000
Book value of plant assets sold --------------------------------------------------------------------------------------- 70000
Loss on sales of plant assets ------------------------------------------------------------------------------------------- 35000
Proceeds from issuing capital stock ------------------------------------------------------------------------------ 1355000
Dividend paid ----------------------------------------------------------------------------------------------------------- 180000
Cash and cash equivalents, beginning of year ------------------------------------------------------------------ 297000
Cash and cash equivalents, end of year --------------------------------------------------------------------------------?---

INSTRUCTIONS Prepare a statement of cash flows using direct method of reporting cash flows from operating
activities.
Many of the items above will be listed in your statement without change. However, you will have to combine certain
given information to compute the amounts of (1) collections from customers, (2) cash paid to suppliers and
employees, and (3) proceeds from sales of plant assets. (Hint: Not every item listed above is used in preparing a
statement of cash flow.)

PROBLEM # 3: During the current year, Grafton Labs made cash sales of $250000 and credit sales of $490000. During
the year, accounts receivable decreased by$32000.

a. Compute for the current year the amounts of;

1. Net sales reported as revenues in the income statement.
2. Cash received from collecting accounts receivable.
3. Cash received from customers.

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b. Write a brief statement explaining why cash received from customers differs from the amount of net sales.

PROBLEM # 4: The accounting staff of Carolina Crafts, Inc. has assembled the following information for the year
ended December 31, 1994.
Cash and cash equivalents, beginning of year ------------------------------------------------------------------ $45200
Cash and cash equivalents, end of year --------------------------------------------------------------------------- 64200
Cash paid to acquire plant assets ----------------------------------------------------------------------------------- 21000
Proceeds from short term borrowing------------------------------------------------------------------------------ 10000
Loans made to borrowers ---------------------------------------------------------------------------------------------- 5000
Collections on loans (excluding receipts of interest) ------------------------------------------------------------ 4000
Interest and dividends received ------------------------------------------------------------------------------------- 17000
Cash received from customers -------------------------------------------------------------------------------------795000
Proceeds from sale of plant assets ----------------------------------------------------------------------------------- 9000
Dividend paid ------------------------------------------------------------------------------------------------------------ 65000
Cash paid to suppliers and employees ---------------------------------------------------------------------------635000
Interest paid ------------------------------------------------------------------------------------------------------------- 19000
Income tax paid --------------------------------------------------------------------------------------------------------- 71000

INSTRUCTIONS

Using this information, prepare a formal statement of cash flows. Include a proper heading for the financial
statement, and classify the given information into the categories of operating activities, investing, and financing
activities. Net cash flows from operating activities are determined by the direct method. Place brackets around the
dollar amounts of all cash disbursements

PROBLEM # 5: The data below are taken from the income statement and balance sheet of All Night Pharmacies, Inc.

Dec. 31 Jan. 1
1994 1994
Income statement:
Net income $400000
Depreciation expense 120000
Amortization of intangible assets 40000
Gain on sale of plant assets 80000
Loss on sale of investments 35000
Balance sheets:
Accounts receivable $335000 $380000
Inventory 503000 575000
Prepaid expenses 22000 10000
Accounts payables (to merchandise suppliers) 379000 410000
Accrued expenses payable 180000 155000

Instructions:

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Using this information, prepare a partial statement of cash flows for the year ended December 31, 1994, showing the
computation of net cash from operating activities by the indirect method.

PROBLEM # 6: Preparing the statement of cash flows—indirect method.

Plywood Products Corporation of America accountants have assembled the following data for the year ended
December 31, 19X7
1997 1996
-------- -----------
Current accounts ( all result from operations)
Current assets:
Cash and cash equivalents..............................................................$85,700 $22,700
Accounts recievable......................................................................... 59,700 64,200
Inventories........................................................................................88,600 83,000
Prepaid expenses................................................................................5,300 4,100
Current liabilities:
Notes payable (for inventory purchases)........................................$22,600 $18,300
Accounts payable..............................................................................52,900 55,800
Income tax payable...........................................................................18,600 16,700
Accrued liablities.............................................................................. 25,500 27,200
Transaction data for 19X7:
Acquisition of long term Sale of equipment......................... $58,000
Investment..........................................$ 31,600 Amortization expense................... 5,300
Acquisition of land by issuing long Purchase of treasury stock........... 14,300
term notepayable..............................113,000 Loss sale of equipment.................. 11,700
Stock dividends.....................................31,800 Payment of cash dividends.............18,300
Collection of loan................................... 8,700 Issuance of long term note
Depreciation expense.......................... 26,800 payable to borrow cash…………….....34,400
Acquisition of building........................ 125,300 net income………………………………......67,100
Retirement of bondspayable Issuance of common stock
by issuing common stock.....65,000 for cash............................................41,200
REQUIRED:
Prepare Plywood products' statement of cash flows, using the indirect method to report operating activities. Include
an accompanying schedule of noncash investing and financing activities.

PROBLEM # 7: Prepare the 19X3 statement of cash flows for Robins Corporation, using the indirect method to report
cash flows from operating activities. In a separate schedule, report robins noncash investing and financing activities.

December 31
_________________________
19X3 19X2
_________________________
Current assets:
Cash and cash equivalents $19,000 $3,000
Accounts receivable 22,000 23,000
Inventories 34,000 31,000
Prepaid expenses 1,000 3,000
Current liabilities:
Notes payable (for inventory purchase) $11,000 $7,000
Accounts payable 24,000 19,000

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Accrued liabilities 7,000 9,000
Income tax payable 10,000 10,000

Transection data for 19X3:

Purchase of equipment $98,000
Payments of cash dividend 18,000
Net income 26,000
Issuance of common stock to retire bonds payable 13,000
Purchase of long term investment 8,000
Issuance of long term note payable to purchase patent 37,000
Depreciation expense 7,000
Issuance of long term note payable to borrow cash 7,000
Issuance of common stock for cash 19,000
Sale of building 74,000
Amortization expense 3,000
Purchase of treasury stock 5,000
Loss on sale of building 2,000

PROBLEM # 8: Prepare the statement of cash flows using -indirect method.

Accountants for Creve Coeur Manufacturing have assembled the following data for the year ended December 31,
19X4: 19X4 19X3
-------------------------------------------
Current accounts (all result from operations):
Current assets:
Cash and cash equivalents.........................................................................$30,600 $34,800
Accounts recievable.................................................................................... 70,100 73,700
Inventories...................................................................................................90,600 96,500
Prepaid expenses...........................................................................................3,200 2,100
Current liabilities:
Notes payable (for inventory purchases)..................................................$36,300 $36,800
Accounts payable........................................................................................72,100 67,500
Income tax payable.......................................................................................5,900 6,800
Accrued liablities........................................................................................ 28,300 23,200

Transaction data for 19X4:

Acquisition of long term investment..................................................................................$ 44,800
Acquisition of building by issuing long term note payable..................................................162,000
Stock dividents.......................................................................................................................12,600
Collection of loan.................................................................................................................. 10,300
Depreciation expense............................................................................................................19,200
Acquisition of equipment.......................................................................................................69,000
Payment of long term debt by issuing common stock...........................................................89,400
Sale of long term investment.................................................................................................12,200
Amortization expense.............................................................................................................. 1,100
Payment of long term debt....................................................................................................47,800
Gain on sale of investment...................................................................................................... 3,500
Payment of cash dividends.....................................................................................................48,300
Issuance of long term debt to borrow cash........................................................................... 21,000
Net income.............................................................................................................................92,500
Issuance of preferred stock for cash......................................................................................36,200

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REQUIRED:
Prepare statement of cash flows, using the indirect method to report operating activities. Include an accompanying
schedule of noncash Investing and financing activities.

PROBLEM # 9:
The comparative Balance Sheet of ABC Company for two years is as under;
Assets Dec. 31, 02 Dec. 31, 01
Cash Rs.87500 Rs.105000
Inventory 162500 175000
Prepaid rent 40000 45000
Accounts receivable 175000 160000
Plant assets 440000 415000
905000 900000
Liabilities and shareholder’s equities
Share capital Rs.605000 Rs.570000
Accounts payable 90000 100000
Salaries payable 15000 15000
Unearned Rent 15000 10000
Long term loan 60000 100000
Retained Earnings 120000 105000
905000 900000
Additional data:
Net income for the year 2002 Rs.90000. Cash dividend paid Rs.75000.
Required:
Prepare cash flow statement.

PROBLEM # 10: The balances of accounts of Multan Cement Co. Ltd. at end of 2002 and 2003 are as follows;

Assets 2003 2002

Cash Rs.60000 Rs.100000
Accounts receivable 150000 175000
Inventory 325000 250000
Land 75000 -------
Plant assets 800000 625000
Machine 90000 100000
1500000 1250000

Accumulated Depreciation Rs.260000 Rs.200000

Accounts payable 155000 75000
Long term loan 25000 -----
Common Stock 1000000 875000
Retained Earnings 60000 100000
1500000 1250000

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Additional data:
Company reported net loss for the year 2003 Rs.40000.

Required:
Prepare cash flow statement

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RATIO ANALYSIS
RATIO means comparison of one figure with the other relevant figure or figures.

ACCOUNTING RATIO means comparison of one accounting figure with the other relevant accounting figure or figure
of a concern over a period of time or of different concerns for the same period.

RATIO ANALYSIS is a widely used tool of financial analysis. It is defined as the systematic use of ratio to interpret the
financial statement so that the strength and weakness of a firm, as well as the historical performance and current
financial condition can be determined.

Purpose of Ratio Analysis

Ratio analysis of different items of financial statements are used as a yardstick to measure the financial position,
profitability and operational efficiency of a concern on current dates

USERS OF FINANCIAL STATEMENT ANALYSIS

The following are the users or groups of financial statement analysis:
 INVESTORS OR SHAREHOLDERS
Shareholders are main users of the financial analysis and seek information relating to return on investment and
the earning per share that will form the basis of dividend declarations
 CREDITORS
Creditors are concerned with the security of their debts and seek information relating th the liquidity of the
company
 MANAGEMENT
Management is concerned with the liquidity of the merchandise inventory and seeks information relating to the
trend and level of profits, since this is the main measure if the success.
 OTHERS
Bank managers and financial institutions are interested in the liquidity and profit potential of the company.

USE OF RATIOS
The following are the limitation of ratio analysis:
 Helps in tracing the weak spots of business and taking corrective and remedial measures
 Helps in comparing operational efficiency of business over a period of time
 Helps in formulating future plans and programs on the basis of past performance
 Helps the financial institutions to take decisions regarding grant of loan to a company
 Helps the interested parties like the potential investors to take decision about their investment plan.

LIMITATIONS OF RATIO ANALYSIS

The following are the limitation of ratio analysis:
 It does not help to prepare budgets and estimates since the ratio are computed on the basis of past results.
 It is very difficult to determine the normal ratio to make adequate comparison, because it varies from firm to
firm and industry to industry
 The correct picture can not be drawn up by the ratio analysis as in most cases the figures of financial
statements are window dressed
 Ratio analysis becomes more meaningful if trend analysis is possible instead of analyzing the result of a
particular year. But from a practical point of view this is not always possible.

TYPES OF RATIOS
Ratio are classified into following four major categories
1. Liquidity Ratios

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2. Activity Ratios
3. Profitability Ratios
4. Capital structure/Leverage Ratio

1. LIQUIDITY RATIO
Liquidity ratios reflect the short-term financial strength of a firm. In other words these ratios measure the ability
of a firm to meet its short-term obligations. The liquidity ratio include

Net working capital = Net current assets – Current liabilities

Working Capital is not a ratio, but it is employed to measure the liquidity position of a company. This
tern is used to indicate the excess of current assets over current liabilities.

Current Ratio = Net current Assets

Current liabilities

Current Ratio measures the ability of a company to meet the short-term obligations. It provides a
margin of safety to the creditors.

Acid Test Ratio or Quick Ratio = Quick assets

Current liabilities

Quick assets = Current assets-(Inventory & store + Prepaid Expenses)

OR
Quick assets = Cash+ short-term marketable security+ debtors (net)

ACTIVITY OR TURNOVER OR EFFICIENCY RATIOS

The turnover ratio is used in order to determine that how quickly certain assets are converted in to cash. The
turnover ratios are as follows

Finished Goods Inventory Turnover = Cost of goods sold

(Average finished goods inventory)

Debtors Turnover Ratio = Net Credit Sales

(Average debtors+ Average bills Rec)

Total Assets Turnover = Net Sales

Average total assets

Fixed Assets Turnover = Net Sales

Average fixed assets

Current Assets Turnover = Net Sales

Average current assets

Creditors Turnover Ratio = Net Credit Purchase

(Average creditors)

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3. PROFITABILITY RATIOS
Profitability ratios measure the operating efficiency and ability of a company to pay adequate return to its
shareholders. Management and shareholders are interested in profitability ratios can be computed on the basis
of either sales or investment.
(A) RATIOS RELATED TO SALES (INCOME STATEMENT APPROACH)
Gross Profit Ratio or Margin = Gross Profit
Total Net Sales

Net Profit Ratio or Margin = Earning After Tax (EAT)

Total Net Sales

Operating Profit Ratio or Margin = Earning Before Interest and Tax (EBIT)
Total Net Sales

(B) RATIOS RELATED TOTAL INVESTMENT (BALANCE SHEET APPROACH)

Return on Total Assets ( Return on Investment) = Earning after Tax + Interest
Average Total Assets

Return on Capital Employment = Earning After Tax + Interest

Average Capital Employed
Capital Employed =Working Capital + Net Fixed Assets – Fictitious Assets
OR
Capital Employed = Shareholder’s Equity + Long Term Debts – Fictitious Assets

Return on Shareholders’ Equity = Earning After Tax

Average Total Shareholders’ Equity

Note: Shareholders’ Equity = Share Capital + Reserves + Surplus

(C) RELATED TO SHAREHOLDERS’ EQUITY

Equity Ratio or Proprietary Ratio = Shareholders’ equity
Total Assets

Earning per Share(EPS) = NP available or equity (Ord.) Shareholders

Number of Equity Shares

Dividend Per Share(DPS) = Dividend paid to Equity Shareholders

Number of Equity Shares

Book Value Per Share = Ord. Shareholders’ Equity

Number of Equity Shares

Dividend Pay-out Ratio = Dividend Per Share (DPS)

Earning Per Share (EPS)

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Dividend Yield Ratio = Dividend Per Share (DPS)
Market Price Per Share

Price Earning Ratio = Market Price Share

Earning per Share

4. CAPITAL STRUCTURE RATIO/ LEVERAGE RATIO / SOLVENCY RATIO

Capital structure or leverage ratios measure the long-term solvency and ability to pay to its long-term creditors.
Following are the types of capital structure ratios
 Debt Ratio: we may use several debt ratios:
 Debts to Equity Ratio
 Debts to Total Capital
 Debts to Total Assets
 Interest Coverage Ratio
 Dividend Coverage Ratio
 Total Coverage Ratio

Dept Equity Ratio reflects the relative contribution of creditors and owners of business.

Dept Equity Ratio = Long-Term Debts

Shareholders’ Equity*
OR
Total Debts**
Shareholders’ Equity
*Shareholders Equity = Equity Share Capital + Preference share capital + reserves & supplies
**Total Debts = Long-term liabilities + Current liabilities

Debts to total Capital Ratio indicates the relationship between creditor’s fund and owner’s capital.

Debt to Total Capital* = Total Debts**

Shareholders’ equity + Total debts

*Total Capital = Shareholders’ equity + Total debts

**Total Debts = Long-term liabilities + Current liabilities
Debts to total Assets Ratio indicate the relationship between creditor’s and fund and total assets, or
creditor’s fund and total assets, or creditor’s contribution to total assets of business.

Debts to Total Assets = Total Debts*

Total Assets

Total Debts* = Long-term liabilities+ Current liabilities

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Interest Coverage Ratio measure the debt servicing capability of a company

Interest Coverage Ratio = Earning Before Interest and Tax (EBIT)

Interest

FINANCIAL RATIOS & SIGNIFICANCE/COMMENTS

S# RATIO OR RATE SIGNIFICANCE OR COMMENTS

1 Working Capital(Net) It measures the Short Term Debt paying ability and also
shows that how much amount/working capital is
available in the business to operate the business
efficiently and conveniently.

2 Working Capital Ratio or Current It measures the short term debt paying ability out of
Ratio Current Assets available.

3 Acid Test or Quick or liquid Test Ratio It measures the short term debt paying ability out of the
liquid cash and cash equivalents

4 Receivables turnover ratio Indicates how quickly receivables are collected.

5 Days to collect Average Accounts R/A It indicates that how many days are required to collect
the Receivables.

6 Inventory Turnover Ratio It indicates how quickly Inventory sells.

7 Days required to sell the Average It indicates that how many days are required to sell the
Inventory inventory.

8 Operating Cycle or Average Age of It indicates in days how quickly Cash is being invested in
Operating Cycle to inventory and converts back into Cash

9 Debt Ratio It shows the percentage of Assets financed by the

Creditors; indicates also the relative size of the equity
position.

10 Interest Coverage Ratio It is an indicator of a company’s ability to meet its

interest payment obligations.

11 Gross profit Rate It measure the profitability of the company’s products

12 Net Profit Rate or Net Income as a An indicator of management’s ability to control costs
Percentage of Sales
13 Operating Expense Ratio An indicator which measures the management’s ability

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to control the expense

14 Earnings Per share/stock Net income applicable to each share issued or

outstanding.

15 Return on Assets It measures the productivity of assets, Regardless of

how much the assets are financed.

16 Return on Equity The rate of return earned on the stockholder equity in

the business.

17 Return on Stockholders’ Equity The rate of return earned on the; common stockholders’
equity appropriate when company has both common
and preferred stocks.

18 Operating Income The profitability of company’s basic business income.

EXERCISE # 1: Compute trend percentages for the following items taken from the financial
Trend statements of Water-Wise Plumbing Fixtures over a five-year period. Treat 1990
Percentage as the base year. State whether the trends are favorable or unfavorable. (Dollar
amounts are stated in thousands.)

1994 1993 1992 1991 1990

Sales………………………………… $85,000 $74,000 $61,500 $53,000 $50,000
Cost of goods sold……………. $58,000 $48,000 $40,500 436,000 $30,000

EXERCISE # 2: Prepare common size income statements for Toyoda Company, a sole proprietor-
Common size ship for the two years shown below by converting the dollar amounts into per-
Income State centages. For each year, sales will appear as 100% and other items will be expre-
ments ssed as a percentage of sales. (Income taxes are not involved as the business is
not incorporated.) Comment on whether the changes from 1993 to 1994 are
favorable or unfavorable.

1994 1993
Sales ……………………………………………………………………… $ 500,000 $400,000
Cost of goods sold…………………………………………………. 330,000268,000
Gross profit…………………………………………………………… $170,000 $132,000
Operating expenses……………………………………………… 140,000116,000
Net income ………………………………………………………….. $30,000 $ 16,000

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EXERCISE # 3 Selected financial data for Vashon’s, a retail store, appear below. Since monthly
Ratio for a figures are not available, the average amounts for inventories and for accounts
Retail store receivable should be based on the amounts shown for the beginning and end of
1994.

1994 1993
Sales (terms 2/10, n/30)…………………………………………….. $750,000 $600,000
Cost of goods sold ……………………………………………………. 495,000 408,000
Inventory at end of year……………………………………………. 85,500 94,500
Accounts receivable at end of year……………………………. 87,500 100,000

Instructions Compute the following for 1994

a) Gross profit percentage
b) Inventory turnover
c) Accounts receivable turnover

Exercise # 4 At the end of the year, the following information was obtained from the
Ratios accounting records of Carleton Office Products:
Consider
Advisability of Incurring
Sales(all on credit)……………………………………………………………………… $2,700,000
Long-
Cost of goods sold……………………………………………………………………… 1,755,000
Term Debt Average Inventory…………………………………………………………………….. 351,000
Average accounts receivable…………………………………………………….. 300,000
Interest expense……………………………………………………………………….. 45,000
Income taxes…………………………………………………………………………….. 84,000
Net income……………………………………………………………………………….. 159,000
Average Investment in assets…………………………………………………… 1,800,000
Average stock holders’ equity…………………………………………………. 795,000

INSTRUCTIONS a) From the information given, compute the following:

1) Inventory turnover
2) Accounts receivable turnover
3) Total operating expenses
4) Gross profit percentage
5) Return on average stockholders’ equity
6) Return on average assets
b) Carleton has an opportunity to obtain a long- term loan at an annual interest
rate of 12% and could use this additional capital at the same rate of profitability
as indicated above. Would obtaining the loan be desirable from the viewpoint
of stockholders? Explain.

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EXERCISE # 5 A condensed balance sheet for Durham Corporation prepared at the end of the
Computing year appears below.
Ratios

Assets Liabilities& stockholders ‘Equity

Cash………..……. $ 55,000 Notes payable( due in 6
Accounts receivable…155,000 Months…………………………………… $ 40,000
Inventory……………………270,000 Accounts payable ………………………. 110,000
Prepaid expenses…….. Long-term liabilities ………………….. 330,000
60,000
Plant& equipment (net) Capital stock ,$ 5 par ………………… 300,000
……………… 570,000
Other assets……... 90,000 Retained earnings …………………….. 420,000
Total…..……….. $1,200,000 Total …………………………………………. $ 1,200,000

During the year the company earned a gross profit of $1,116,000 on sales of
$2,790,000. Accounts receivable, inventory, and plant assets remained almost
constant in amount throughout the year.

INTRUCTIONS: Compute the following

a) Current ratio b) Quick ratio c) Working capital d) Equity ratio
e) Accounts receivable turnover (all sales were on credit) f) Inventory turnover
g ) Book value per share of capital stock

EXERCISE # 6: Selected items from successive annual reports of Hastings, Inc., appear below
Current Ratio,
Debt Ratio,
and Earnings
per share

1994 1993
Total assets (40% of which are current)………………….. $400,000 $325,000
Current liabilities…………………………………………………………. $ 80,000 $100,000
Bonds payable, 12%...................................................... 100,000 50,000
Capital stock $ 5 per value …………………........................ 100,000 100,000
Retained earnings ……………………………………………………… 120,000 75,000
Total liabilities & stockholders’ equity ……………………….. $400,000 $325,000

Dividends of $26,000 were declared and paid in 1994.

INSTRUCTIONS: Compute the following:

a) Current ratio for 1994 and 1993

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b) Debt ratio for 1994 and 1993
c) Earnings per share for 1994

Exercise # 7) GIVEN:-The Balance Sheet of Light Zone Company Ltd at the end of the year as under:-

EQUITIES AMOUNTS ASSETS AMOUNTS

Equity Share Rs.1,000,000 Plant & Equipment Rs.640,000
Capital(Rs.100 par) 368,000 Land & Building 80,000
Retained Earnings 104,000 Cash/Bank 260,000
Sundry Creditors 200,000 Marketable Securities 150,000
Bills P/A 20,000 Notes Receivable 200,000
Other Current Liabilities 200,000 Sundry Debtors 440,000
Long Term Loans 300,000 Less:-Allow for B/D (40,000)
Bonds P/A 80,000 400,000
Inventory 530,000
Prepaid Insurance 12,000
TOTAL
2,272,000 22,72,000

Statement of Profit & Loss for the year ended:-

Sales (All on Credit) Rs.4,000,000

Less: Cost of Goods Sold (3,080,000)
Gross Profit 920,000
Less:- Operating Expenses (680,000)
Net Profit 240,000
Less 30% Income Tax (72,000)
Net Profit After Tax 168,000

Sundry Debtors, Sundry Creditors and Stock at the beginning of the year were Rs.300,000, 500,000 and 400,000
respectively.Credit Purchases during the year were Rs.3,020,000 out of which Rs.20,000 represents the purchase
return & discount.

REQUIRED: - Determine the following:-

1)Debtors Turnover in Times ii) Average collection period/Debtors Turnover (in days)

(iii) Stock turn over in times (iv) Stock Turn over in Days

v) Working Capital vi) Current Ratio

vii) Quick Ratio vii) Gross Profit Percentage viii) Net Profit Percentage

ix) Return on Equity x) Return on Capital Employed xii) Return on Assets

xiii) Total Assets Turnover xiv) Fixed Assets Turnover xv) Debt Ratio

xvi) Equity Ration xvii) Creditors Turnover xviii) Creditors Payment period

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Exercise# 8) Given: - The following are the extracts from the Financial Statement of Star company Ltd. Company

PARTICULARS/ACCOUNT TITLES DEC 31ST 2005 DEC 31ST 20-06

Inventories Rs. 10000 Rs. 25000
Accounts R/A 20000 20000
Bills R/A 10000 5000
Prepaid 2000 ------
Cash/Bank 18000 15000
Accounts P/A 25000 30000
Bills P/A 15000 20000
Bank Overdraft -------- 2000
10% Debenture P/A 200000 200000
Sales for the year 350000 300000
Gross Profit 70000 50000

REQUIRED:-With the help of the above data, calculate for 2005 and 2006:-

1) Working Capital 2) Current Ratio 3) Acid Test Ratio 4) Inventory Turnover( Times and Days) 5) Accounts
R/A(Times and Days) 7) Gross Profit Rate 9) Equity Ratio 10) Assets Turnover Ratio

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Generally Accepted Accounting Principles (GAAP)

The accounting profession has developed standards and concepts that are used for financial reporting
purposes. These common set of standards and concepts is called Generally Accepted Accounting
Principles (GAAP).These standards may also be called standards, assumptions, convention, or concepts.
These standards are the building blocks of accounting.
These concept & standards are the following:

1. The Accounting Entity principle

2. The Going- Concern Assumption.
3. The Time Period Principle.
4. Monetary unit principle
5. The Objectivity Principle.
6. The Historical Cost Principle
7. The Revenue recognition Principle (Realization principle).
8. Expense recognition principle (Matching Principle).
9. The Consistency Principle.
10. The Materiality Principle.

1. The Accounting Entity Principle

It means that the activities of the business entity be kept separate and distinct from:
(i) The activities of its own
(ii) All other economic entities
The reason for this principle is that separate information about each business is necessary for good
decision. A business entity can take one of the three legal forms: proprietorship, partnership, or
corporation.

2. The Going- Concern Assumption.

It means, a basic principle in accounting is assumed that a company will continue to operate for
indefinite time period.

3. The Time Period Principle

It means that for financial reporting purpose, the life of a business must be divided into series of
relatively short accounting periods of equal length, such as, month, quarter, and year. You must
include in the header of any Financial Statement the time period covered by the statement. For
example, an Income Statement may cover the "Six Months Ended December 31, 2013 or Year ended
Dec,31 2013 and so on.

4. Monetary Unit Principle

It states that select only those transactions to record in books of accounts that can be expressed in
terms of currency. Thus, you cannot record such non-quantifiable items as employee skill levels or the
quality of customer service.

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5. The Objectivity Principle
It means that accounting information is supported by independent, unbiased evidence. It demands more
than a person’s opinion. Information is not reliable if it is based only on what a preparer thinks might be
true.

6. The Historical Cost Principle

It means that accounting information is recorded on actual cost price. Cost is measured on a cash or
equal to cash basis. This means if cash is given for a service, its cost is measured as the amount of cash
paid. If something instead of cash is exchanged (such as a truck is traded for a car), cost is measured as
the cash value of what is given up or received.

7. The Revenue Recognition Principle (Realization Principle)

Under the accrual basis of accounting (as opposed to the cash basis of accounting), revenues are
recognized as soon as a product has been sold or a service has been performed, regardless of when the
money is actually received. Under this basic accounting principle, a company could earn and report
Rs20,000 of revenue in its first month of operation but receive Rs 0 in actual cash in that month.

8. Expense Recognition Principle. (Matching Principle).

According to this principle, the expenses are matched with revenues. For example, sales commission’s
expense should be reported in the period in which its related sales have been made.

9. The Consistency Principle.

It means that when a particular accounting method, once adopted, it will not be changed from period to
period. This assumption is important because it assists users of financial statements in interpreting
changes in financial position and changes in net income from the preceding year.

10. The Materiality Principle.

According to this principle, an accountant might be allowed to violate another accounting principle if
an amount is insignificant. Professional judgment is needed to decide whether an amount is
insignificant or immaterial.

An example of an obviously immaterial item is the purchase of a Printer of Rs. 5,000 by a highly
profitable multi-million company. Because the printer will be used for five years, the matching
principle directs the accountant to expense the cost over the five-year period. The materiality guideline
allows this company to violate the matching principle and to expense the entire cost of Rs 5,000 in the
year it is purchased. The justification is that no one would consider it misleading if Rs5,000 is expensed
in the first year instead of Rs1,000 being expensed in each of the five years that it is used.

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