Chapter 2, Problem 7BP

a.

To determine

Prepare a balance sheet at July 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 CB is prepared as follows:

Company CB
Balance Sheet
For the year ended July 1, current year
Assets	Amount ($)	Liabilities & Owners' Equity	Amount ($)
Cash	4,920	Liabilities:
Accounts receivable	9,840	Notes payable	48,000
Supplies	8,400	Accounts payable	8,400
Equipment & fixtures	30,000	Salaries payable	4,440
Building	108,000	Total liabilities	60,840
Land	60,000	Owners' equity:
		Capital stock	120,000
		Retained earnings (1)	40,320
Total Assets	221,160	Total Liabilities & Owners' Equity	221,160

Table (1)

Working note:

Calculate the amount of retained earnings:

$\begin{array}{c}\text{Retained}\text{Earnings}\text{=}\text{Total}\text{assets}-\text{Total}\text{liabilities}-\text{Capital}\text{stock}\\ \text{=\$221,160}-\text{\$60,840}-\text{\$120,000}\\ \text{=\$40,320}\end{array}$ (1)

b.

To determine

Prepare a balance sheet at July 5, current year and prepare a statement of cash flows for the period July 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 CB is prepared as follows:

Company CB
Balance Sheet
For the Year Ended July 5, current year
Assets	Amount ($)	Liabilities & Owners' Equity	Amount ($)
Cash	31,320	Liabilities:
Accounts receivable	9,840	Notes payable	48,000
Supplies (4)	9,600	Accounts payable	7,200
Equipment & fixtures (3)	37,200	Salaries payable	4,440
Building	108,000	Total liabilities	59,640
Land	60,000	Owners' equity:
		Capital stock  (2)	156,000
		Retained earnings	40,320
Total Assets	255,960	Total Liabilities & Owners Equity	255,960

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 July 5.

Working note:

Calculate the value of capital stock on July 5, current year:

$\begin{array}{c}\text{Capital}\text{stock}\text{=}\text{Value}\text{of}\text{capital}\text{stock}\text{on}\text{August}\text{1}\text{+}\text{Additional}\text{capital}\text{stock}\text{sold}\\ \text{=}\text{\$120,000+\$36,000}\\ \text{=\$156,000}\end{array}$ (2)

Calculate the value of equipment on July 5, current year:

$\begin{array}{c}\text{Equipment}\text{=}\text{Value}\text{of}\text{equipment}\text{on}\text{August}\text{1}\text{+}\text{Purchase}\text{of}\text{equipment}\\ \text{=}\text{\$30,000+\$7,200}\\ \text{=\$37,200}\end{array}$ (3)

Calculate the value of supplies on July 5, current year:

$\begin{array}{c}\text{Suppplies}\text{=}\text{Value}\text{of}\text{supplies}\text{on}\text{August}\text{1}\text{+}\text{Purchase}\text{of}\text{supplies}\\ \text{=\$8,400+\$1,200}\\ \text{=\$9,600}\end{array}$ (4)

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

Company CB
Statement of Cash Flows
For the Period July 1-5, current year
Cash flows from operating activities:
Cash payment of accounts payable	(8,400)
Cash purchase of supplies	(1,200)
Cash used in operating activities		(9,600)
Cash flows from investing activities:
None
Cash flows from financing activities:
Sale of capital stock		36,000
Increase in cash		26,400
Cash balance, July 1, current year		4,920
Cash balance, July 5, current year		31,320

Table (3)

Therefore, the cash flow statement reported net increase in cash of $26,400.

c.

To determine

Find out whether Company CB is in a stronger financial position on July 1 or on July 5 and explain briefly.

Explanation of Solution

• On July 1, the liquid assets (cash and accounts receivable) amounted to $14,760 but the debt in the near future (accounts payable and salaries payable) amounted to $12,840.
• On July 5, the liquid assets amounted to $41,160 after additional infusion of cash from the sale of stock and the debts that has to be paid in the near future amounted to $11,640.
• Company CB is in a stronger financial position on July 5 than on July 1 since the liquid assets are greater than the debt that has to be paid in the near future as of July 5 balance sheet.