Brief Exercise 7-7 (Static) How face value bonds affect financial statements LO 7-7 Madison Company is a land management company that generates most of its revenues through leasing land. The company experienced the following events during Year 2: 1. Madison Company issued $800,000 of 10-year, 6 percent bonds on January 1, Year 2. The bonds were issued at face value. Interest is payable in cash on December 31 of each year. 2. Madison Company immediately invested all the proceeds from the bond issue in land. 3. The land was immediately leased for an annual $110,000 of cash revenue, which was collected on December 31 of each year, beginning December 31, Year 2. 4. Madison Company paid the interest on the bond on December 31, Year 2. Required: Use a horizontal financial statements model to show how each event affects the balance sheet, income statement, and statement of cash flows. More specifically, record the amounts of the events into the model. Also, in the Statement of Cash Flows column, classify the cash flows as operating activities (OA), investing activities (IA), or financing activities (FA). The following horizontal model shows the company's beginning balances prior to the events. Note: Enter any decreases to account balances and cash outflows with a minus sign. Leave cells blank if no input is needed. Event Number Beginning balance 1. 2. 3. 4. Total *NC = Net change in cash Assets Cash + 500,000 + + + + 500,000 + Land Balance Sheet Liabilities Bonds Payable = = |= 0 = 4 + + + 0 + Stockholders' Equity Retained Earnings Common Stock 300,000 + + 300,000 + 200,000 200,000 Revenue 0 Income Statement - Expenses = Net Income = = = = 0 = 0 Statement of Cash Flows 0 NC
Reporting Cash Flows
Reporting of cash flows means a statement of cash flow which is a financial statement. A cash flow statement is prepared by gathering all the data regarding inflows and outflows of a company. The cash flow statement includes cash inflows and outflows from various activities such as operating, financing, and investment. Reporting this statement is important because it is the main financial statement of the company.
Balance Sheet
A balance sheet is an integral part of the set of financial statements of an organization that reports the assets, liabilities, equity (shareholding) capital, other short and long-term debts, along with other related items. A balance sheet is one of the most critical measures of the financial performance and position of the company, and as the name suggests, the statement must balance the assets against the liabilities and equity. The assets are what the company owns, and the liabilities represent what the company owes. Equity represents the amount invested in the business, either by the promoters of the company or by external shareholders. The total assets must match total liabilities plus equity.
Financial Statements
Financial statements are written records of an organization which provide a true and real picture of business activities. It shows the financial position and the operating performance of the company. It is prepared at the end of every financial cycle. It includes three main components that are balance sheet, income statement and cash flow statement.
Owner's Capital
Before we begin to understand what Owner’s capital is and what Equity financing is to an organization, it is important to understand some basic accounting terminologies. A double-entry bookkeeping system Normal account balances are those which are expected to have either a debit balance or a credit balance, depending on the nature of the account. An asset account will have a debit balance as normal balance because an asset is a debit account. Similarly, a liability account will have the normal balance as a credit balance because it is amount owed, representing a credit account. Equity is also said to have a credit balance as its normal balance. However, sometimes the normal balances may be reversed, often due to incorrect journal or posting entries or other accounting/ clerical errors.
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