Chapter 2, Problem 7AP

a.

To determine

Prepare a balance sheet at August 1, current year.

Explanation of Solution

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

The balance sheet of Company FB is prepared as follows:

Company FB
Balance Sheet
For the Year Ended August 1, current year
Assets	Amount ($)	Liabilities & Owners' Equity	Amount ($)
Cash	6,940	Liabilities:
Accounts receivable	11,260	Notes payable	74,900
Supplies	7,000	Accounts payable	16,200
Equipment & fixtures	44,500	Salaries payable	8,900
Building	84,000	Total liabilities	100,000
Land	67,000	Owners' equity:
		Capital stock	80,000
		Retained earnings  (1)	40,700
Total Assets	220,700	Total Liabilities and  Owners' equity	220,700

Table (1)

Working note:

Calculate the amount of retained earnings:

$\begin{array}{c}\text{Retained}\text{Earnings}\text{=}\text{Total}\text{assets}-\text{Total}\text{liabilities}-\text{Capital}\text{stock}\\ \text{=\$220,700}-\text{\$100,000}-\text{\$80,000}\\ \text{=\$40,700}\end{array}$ (1)

b.

To determine

Prepare a balance sheet at August 3, current year and prepare a statement of cash flows for the period August 1-3.

Explanation of Solution

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

Statement of cash flows: This statement reports all the cash transactions which are responsible for inflow and outflow of cash, and result of these transactions is reported as ending balance of cash at the end of reported period. Statement of cash flows includes the changes in cash balance due to operating, investing, and financing activities. Operating activities include cash inflows and outflows from business operations. Investing activities includes cash inflows and cash outflows from purchase and sale of land or equipment, or investments. Financing activities includes cash inflows and outflows from issuance of common stock and debt, payment of debt and dividends.

The balance sheet of Company FB is prepared as follows:

Company FB
Balance Sheet
For the Year Ended August 3, current year
Assets	Amount ($)	Liabilities & Owners' Equity	Amount ($)
Cash	14,490	Liabilities:
Accounts receivable	11,260	Notes payable	74,900
Supplies (4)	8,250	Accounts payable  ( refer to note)	7,200
Equipment & fixtures (3)	51,700	Salaries payable	8,900
Building	84,000	Total liabilities	91,000
Land	67,000	Owners' equity:
		Capital stock  (2)	105,000
		Retained earnings	40,700
Total Assets	236,700	Total  Liabilities and stockholders' equity	236,700

Table (2)

Note: Accounts payable was paid in full on August 2 and the amount for accounts payable was 7,200 since the equipment was purchased on credit on August 3.

Working note:

Calculate the value of capital stock on August 3, current year:

$\begin{array}{c}\text{Capital}\text{stock}\text{=}\text{Value}\text{of}\text{capital}\text{stock}\text{on}\text{August}\text{1}\text{+}\text{Additional}\text{capital}\text{stock}\text{sold}\\ \text{=}\text{\$80,000+\$25,000}\\ \text{=\$105,000}\end{array}$ (2)

Calculate the value of equipment on August 3, current year:

$\begin{array}{c}\text{Equipment}\text{=}\text{Value}\text{of}\text{equipment}\text{on}\text{August}\text{1}\text{+}\text{Purchase}\text{of}\text{equipment}\\ \text{=}\text{\$44,500+\$7,200}\\ \text{=\$51,700}\end{array}$ (3)

Calculate the value of supplies on August 3, current year:

$\begin{array}{c}\text{Suppplies}\text{=}\text{Value}\text{of}\text{supplies}\text{on}\text{August}\text{1}\text{+}\text{Purchase}\text{of}\text{supplies}\\ \text{=\$7,000+\$1,250}\\ \text{=\$8,250}\end{array}$ (4)

The statement of cash flows for Company FB is prepared as follows:

Company FB
Statement of Cash Flows
For the Period August 1-3, current year
Cash flows from operating activities:	Amount ($)	Amount ($)
Cash payment of accounts payable	(16,200)
Cash purchase of supplies	(1,250)
Cash used in operating activities:		(17,450)
Cash flows from investing activities:
None
Cash flows from financing activities:
Sale of capital stock		25,000
Increase in cash		7,550
Cash balance, August 1, current year		6,940
Cash balance, August 3, current year		14,490

Table (3)

Therefore, the cash flow statement reported net increase in cash of $7,550.

c.

To determine

Find out whether Company FB is in a stronger financial position on August 1 or on August 3 and explain briefly.

Explanation of Solution

• On August 1, the liquid assets (cash and accounts receivable) amounted to $18,200 but the debt in the near future (accounts payable and salaries payable) amounted to $25,100.
• On August 3, the liquid assets amounted to $25,750 after additional infusion of cash from the sale of stock and the debts that has to be paid in the near future amounted to $16,100.
• Company FB is in a stronger financial position on August 3 than on August 1 since the liquid assets are greater than the debt that has to be paid in the near future as of August 3 balance sheet.