Chapter 5 – Presentation of financial position and the worksheet

TRUE/FALSE

1. Liquidity refers to the ease with which assets can be converted to cash in the normal
course of business.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: The purpose of the balance sheet.

2. The historical cost assumption requires that an asset that is used for personal use and
not for business use should be recorded at cost in the business balance sheet.

ANS: F PTS: 1 AACSB: Knowledge, Analytical

TOP: Definition of the balance sheet.

3. The business entity assumption requires that an asset that is used for personal use and
not for business use should not be recorded in the business balance sheet.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Definition of the balance sheet.

4. A balance sheet provides information on the liquidity of the entity.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: The purpose of the balance sheet.

5. An operating cycle may exceed 12 months and be longer than an accounting cycle.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Elements of the balance sheet.

6. A mortgage payable that had only 12 months left before due for repayment would be
reclassified from a non-current liability to a current liability.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Elements of the balance sheet.

7. A piece of equipment purchased for resale within the entity’s operating cycle would be
classified as a current asset.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Elements of the balance sheet.

8. Current assets are always classified according to their nature and not their function.

ANS: F PTS: 1 AACSB: Knowledge, Analytical

TOP: Elements of the balance sheet.

9. The future benefits of a non-current asset are difficult to determine, due to the
uncertainty of measuring the unexpired benefit.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Elements of the balance sheet.
 10. A major difference between current and non-current assets is that the future benefits of
current assets will expire in a short period of time, whereas the future benefits of all non-current assets
will decline over a longer period.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Elements of the balance sheet.

11. Whether an asset should be reported as current or non-current, depends on whether the
asset is in the form of cash or will be realised or consumed within the ensuing operating cycle of the
entity.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Elements of the balance sheet.

12. To be classified as a current liability, a debt must be expected to be paid within the
current accounting period or within the entity’s operating cycle, whichever is the longer.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Elements of the balance sheet.

13. In the situation where an entity is insolvent, equity holders will be paid only whatever
remains after all liabilities are paid.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Elements of the balance sheet.

14. The balance sheet equation can be represented as: Assets – Liabilities = Equity

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: The balance sheet equation.

15. The ‘net assets’ of a business is equal to current assets plus current liabilities.

ANS: F PTS: 1 AACSB: Knowledge, Analytical

TOP: The balance sheet equation.

16. In relation to the format of a balance sheet, large and complex organisations will
summarise assets under broad headings.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Influences on the format of the balance sheet.

17. If assets increase, then, applying the principle of duality, we must increase liabilities,
decrease another asset or increase owners’ equity.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: A simple balance sheet.

18. The worksheet illustrates the basics underlying double-entry bookkeeping.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Business activities and the worksheet.

19. A double-entry error will cause an imbalance in the worksheet which is twice the
amount recorded.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Business activities and the worksheet.

20. If a worksheet does not balance and the imbalance is not caused by a transposition,
single-entry or double-entry error, then it must be an addition or subtraction error.

ANS: T PTS: 1 AACSB: Knowledge, Analytical

TOP: Business activities and the worksheet.

21. An addition or subtraction error will cause the worksheet to be out of balance by half
the amount of the transaction.

ANS: F PTS: 1 AACSB: Knowledge, Analytical

TOP: Business activities and the worksheet.

MULTIPLE CHOICE

1. Which of the following statements is incorrect?

A. A balance sheet reports assets, liabilities and equity at a point in time.
B. The exclusion of an asset from the business balance sheet because it is for private use is due
to the going concern assumption.
C. The average period between the purchase of merchandise and the conversion of this
merchandise back into cash is the operating cycle.
D. In order for a resource to be classified as an asset of the entity, the benefits must accrue to
the entity.
ANS: B PTS: 1 AACSB: Knowledge, Analytical
TOP: Chapter 5.

2. A balance sheet is a statement that shows the resources controlled and the obligations
owed by an entity:
A. in the previous financial year.
B. for the financial year.
C. for the accounting period.
D. at a point in time.
ANS: D PTS: 1 AACSB: Knowledge, Analytical
TOP: Definition of the balance sheet.

3. The balance sheet shows the position of the entity:

A. at a point in time.
B. when it is insolvent only.
C. when it is making profits.
D. for a specified period of time.
ANS: A PTS: 1 AACSB: Knowledge, Analytical
TOP: Definition of the balance sheet.
4. Which of the following best describes the purpose of the balance sheet?
A. To summarise assets and liabilities for the accounting period
B. To report the inflows and outflows of cash
C. To balance current period revenues with those of the previous period
D. To report assets, liabilities and owners’ equity as of a specific date
ANS: D PTS: 1 AACSB: Knowledge, Analytical
TOP: The purpose of the balance sheet.

5. The most liquid type of asset is:

A. bills receivable.
B. cash.
C. investment in listed shares.
D. inventory.
ANS: B PTS: 1 AACSB: Knowledge, Analytical
TOP: Elements of the balance sheet.

6. Which of the following best represents examples of liquid assets?

A. Cash and office equipment
B. Cash and accounts receivable
C. Cash and inventory
D. Cash and prepaid assets
ANS: B PTS: 1 AACSB: Analytical
TOP: Elements of the balance sheet.

7. Which statement below is true about a company’s operating cycle?

A. It may not exceed one year.
B. It must be one year.
C. It may be longer than a year.
D. It is always longer than a year.
ANS: C PTS: 1 AACSB: Knowledge, Analytical
TOP: Elements of the balance sheet.

8. Non-current assets are best described as:

A. assets that extend benefits beyond the coming financial year or operating cycle.
B. tangible assets that extend benefits beyond the coming year or operating cycle, whichever
is longer.
C. assets that are depreciated for a maximum of 40 years.
D. assets that provide economic benefits over the coming year.
ANS: A PTS: 1 AACSB: Knowledge, Analytical
TOP: Elements of the balance sheet.

9. Which of the following would not explain the difference between current and non-
current assets?
A. The future benefit of current assets will generally be used up within the entity’s operating
cycle.
B. An expenditure is classified as a non-current asset if it is considered to be material.
C. An asset is classified as non-current if it is intended to be used within the business for a
considerable period of time.
D. The nature and intention of the business can help determine whether an expenditure should
be classified as a non-current asset.
ANS: B PTS: 1 AACSB: Knowledge, Analytical
TOP: Elements of the balance sheet.

10. Gibson, Inc. a retailer, reports the following information:

 Accounts Payable $600 Accounts Receivable $5200
Cash 7000 Loan Payable 4400
Retained Profits 7800 Inventory 10 200
Buildings 17 600 Office Supplies 1600

What is the most likely amount for the firm’s current assets?
A. $41 600
B. $24 000
C. $22 400
D. $13 800
ANS: B PTS: 1 AACSB: Analytical
TOP: Chapter 5.

11. Which of the following is classified as a liability?

A. Wages expense
B. Accounts payable
C. Owners’ drawings
D. Retained profits
ANS: B PTS: 1 AACSB: Analytical
TOP: Elements of the balance sheet.

12. Amounts owed by a business enterprise to external parties are described as:
A. assets.
B. liabilities.
C. equities.
D. revenue.
ANS: B PTS: 1 AACSB: Knowledge, Analytical
TOP: Elements of the balance sheet.

13. Owners’ equity is:

A. the owners’ interest in the total assets of the firm.
B. only profits retained in the business.
C. the contributions by the proprietor plus all profits retained by the business.
D. only contributions by the proprietor.
ANS: C PTS: 1 AACSB: Knowledge, Analytical
TOP: Elements of the balance sheet.

14. How many of the following would be found on the balance sheet: Unearned revenue,
Non-current assets, Current liabilities, Equity, Accounts receivable, Owners’ equity, Inventory, Wages
expense, and Interest income.
A. Five
B. Six
C. Seven
D. Eight
ANS: C PTS: 1 AACSB: Analytical
TOP: Chapter 5.

15. Which of the following equations is correct?

A. Assets = Liabilities + Owners’ Equity – (Income – Expenses)
 B. Assets + (Income + Expenses) = Liabilities + Owners’ Equity
C. Assets + Liabilities + Owners’ Equity = Income – Expenses
D. Assets – Liabilities = Owners’ Equity + (Income – Expenses)
ANS: D PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

16. Which of the following is not a valid expression of the balance sheet equation?
A. Assets = Liabilities + Owners’ Equity
B. Assets – Liabilities = Owners’ Equity
C. Assets – Owners’ Equity = Liabilities
D. Liabilities + Assets = Owners’ Equity
ANS: D PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

17. An entity’s owners’ equity is one-third of its total assets. Its liabilities total $100 000.
What is the amount of its total assets?
A. $100 000
B. $150 000
C. $200 000
D. $300 000
ANS: B PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

18. An entity’s owners’ equity is one-third of its total liabilities. Its assets total $200 000.
What is the amount of its owners’ equity?
A. $50 000
B. $66 667
C. $150 000
D. $300 000
ANS: A PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

19. The purchase of an asset for cash will:

A. not affect total assets, liabilities, and owners’ equity.
B. increase total assets and increase total liabilities.
C. increase total assets and increase total owners’ equity.
D. increase total assets.
ANS: A PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

20. When an organisation purchases a machine for cash, which of the following is true?
A. Total assets increase.
B. Total liabilities decrease.
C. Total expenses increase.
D. Total equity stays the same.
ANS: D PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

21. The Davis Company purchases a new delivery truck by making a 10% cash down
payment and signing a note payable for the balance. How will assets, liabilities and owners’ equity be
affected by this transaction?

Assets Liabilities Owners’ Equity

A. decrease increase no change
B. increase increase no change
C. increase decrease increase
D. no change increase decrease
ANS: B PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

22. On 31 May, after many months of planning, Macy opened a bike shop by investing
$10 000 of his own money. On 31 May he spent 20% of it to pay the rent for three months from 1 June
on a store location, and the balance on furnishings and fixtures that had been delivered and set up the
night before. A friend had loaned Macy $6000, all of which he used to purchase inventory on 31 May,
prior to opening. If Macy prepared a balance sheet as at 31 May, what would be the balances for total
assets and total liabilities?

Total Assets Total Liabilities

A. $10 000 $6000
B. $14 000 $6000
C. $16 000 $6000
D. $16 000 $10 000
ANS: C PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

23. Blanche started a business by contributing $24 000 cash and a truck valued at $40 000.
The company then purchased equipment by paying the $24 000 cash as a down payment (which
accounted for half its purchase price), and financed the other half by signing a note payable at the
bank. After the above transactions, Blanche’s company balance sheet is:

Assets Liabilities Owners’ Equity

A. $64 000 $0 $64 000
B. $88 000 $0 $88 000
C. $88 000 $24 000 $64 000
D. $112 000 $24 000 $88 000
ANS: C PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

24. George Corporation had the following transactions during the month of August:
1. Owners started the company by investing $400 000 in cash.
2. Purchased $200 000 of equipment by making a $100 000 cash down payment and
signed a 90-day note payable for the balance.
3. Purchased land for $500 000, signing a note payable for the full amount.
4. Earned $60 000 of services revenue (of which $40 000 was received in cash with the
balance on accounts receivable).

What are total assets for George Corporation at the end of August?
A. $1 060 000
B. $1 100 000
C. $1 140 000
 D. $1 160 000
ANS: A PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

25. Chocolate Heaven, Inc. had a balance of $200 000 in shareholders’ equity at the end of
last year (i.e. 31 December). During this year, the company recorded a net profit of $50 000, dis-
tributed dividends of $30 000, and borrowed $10 000. What was the company’s shareholders’ equity at
the end of this year as at 31 December?
A. $200 000
B. $210 000
C. $220 000
D. $230 000
ANS: C PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

26. The accounting records of Margo Catering show the following balances at 31
December:
Cash $600 Notes Payable $200
Office Equipment 2400 Owners’ Equity 1000
Accounts Receivable 400 Retained Profits 900
Accounts Payable 800 Expenses 3400

Total assets as of 31 December are:

A. $3000
B. $3400
C. $4400
D. $5300
ANS: B PTS: 1 AACSB: Analytical
TOP: Elements of the balance sheet.

27. Which one of the following statements is generally true regarding the relationship
between the items mentioned?
A. An increase in assets will always cause an increase in owners’ equity.
B. A decrease in assets will always cause a decrease in liabilities.
C. An increase in revenues normally increases owners’ equity.
D. Expenses decrease revenues.
ANS: C PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

28. When a liability is paid, which of the following is true?

A. Total assets and total liabilities remain the same.
B. Total assets and total owners’ equity decrease.
C. Total assets decrease by the same amount that total liabilities increase.
D. Total assets and total liabilities decrease.
ANS: D PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

29. The Club of Winston Churchill has the following items disclosed on its balance sheet.
The only item missing is owners’ equity:
 Accounts receivable $25 000 Motor vehicles $30 000
Cash 40 000 Notes Payable 15 000
Bank overdraft 15 000 Goodwill 25 000
Loan payable 150 000 Prepaid Rent 3500
Office Building 90 000 Plant & Equipment 80 000

What are the values of the club’s total assets and net assets?
A. Total assets $293 500 and net assets $113 500
B. Total assets $293 500 and net assets $110 000
C. Total assets $308 500 and net assets $98 500
D. Total assets $238 500 and net assets $110 000
ANS: A PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

30. The Club of Winston Churchill has the following items disclosed on its balance sheet
as at 30 June:

Accounts receivable $25 000 Motor vehicles $30 000

Cash at bank 40 000 Notes Payable 15 000
Bank overdraft 15 000 Goodwill 25 000
Loan payable 150 000 Prepaid rent to 31 December 3500
Office Building 90 000 Plant & equipment 80 000

What is the value of the club’s current assets as at 30 June?

A. $25 000
B. $65 000
C. $68 500
D. $93 500
ANS: C PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

31. On a balance sheet, assets are usually classified as:

A. Current Assets, Fixed Assets, Plant and Equipment, and Intangible Assets.
B. Current Assets, Long Term Assets, Plant and Equipment, and Intangible Assets.
C. Current Assets, Fixed Assets and Long-term Investments.
D. Current Assets and Non-current Assets.
ANS: D PTS: 1 AACSB: Knowledge, Analytical
TOP: Elements of the balance sheet.

32. What is the value of total assets if current assets equal $2200, current liabilities equal
$1500, non-current liabilities equal $800 and shareholders’ equity equals $2500?
A. $2200
B. $3700
C. $4800
D. $7000
ANS: C PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

33. During an accounting period, total assets decreased by $5m while owners’ equity
increased by $8m. The change in total liabilities during this period must have been a:
 A. $3m increase.
B. $3m decrease.
C. $13m increase.
D. $13m decrease.
ANS: D PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

34. Bart Corporation reports these balances in its accounting system. Determine the
balance of the Retained Profits account.

Accounts Payable $40 000 Loan Payable $100 000

Land and buildings 320 000 Supplies Inventory 8000
Notes Payable 16 000 Paid up Capital 220 000
Equipment 140 000 Interest Payable 4000
Cash 80 000 Retained Profits ?
Accounts Receivable 120 000
Inventory 72 000

A. $360 000
B. $580 000
C. $620 000
D. $780 000
ANS: A PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

35. Double-entry bookkeeping is based on a rule known as:

A. accrual accounting.
B. going concern principle.
C. the principle of duality.
D. the business entity principle.
ANS: C PTS: 1 AACSB: Knowledge, Analytical
TOP: A simple balance sheet.

36. When applying the principle of duality to the balance sheet equation, an increase in
assets will not normally result in:
A. an increase in liabilities.
B. an increase in another asset.
C. an increase in owners’ equity.
D. a decrease in another asset.
ANS: B PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

37. Which of the following is not a characteristic of a worksheet?

A. It is set out in the form of the balance sheet equation.
B. It provides a vehicle for recording accounting transactions.
C. It requires the use of a computerised system to ensure accuracy.
D. It applies the principles of double-entry bookkeeping.
ANS: C PTS: 1 AACSB: Knowledge, Analytical
TOP: Business activities and the worksheet.
 38. Two transactions are recorded incorrectly in a worksheet. The first error is a transac-
tion of $1000 which is recorded twice on the assets side of the worksheet. The second error is a
transaction of $500 recorded only on the assets side of the worksheet. What will be the difference
between the assets side of the worksheet and the liabilities + owners’ equity side of the worksheet?
A. $500
B. $1500
C. $2000
D. $2500
ANS: D PTS: 1 AACSB: Analytical
TOP: Business activities and the worksheet.

39. Which of the following errors will not cause an imbalance in the worksheet?
A. A single-entry or double-entry error.
B. Not recording a transaction or recording a transaction twice.
C. A subtraction or transposition error.
D. An addition or subtraction error.
ANS: B PTS: 1 AACSB: Knowledge, Analytical
TOP: Business activities and the worksheet.

40. A common error encountered when examining a worksheet that does not balance is the
discovery that the error is mathematically divisible by nine. This type of error is commonly referred to
as:
A. an addition or subtraction error.
B. a single-entry error.
C. a transposition error.
D. a double-entry error.
ANS: C PTS: 1 AACSB: Knowledge, Analytical
TOP: Business activities and the worksheet.

41. During an accounting period, a transaction occurred involving the purchase of

equipment for $9000. On reviewing the worksheet, it was discovered that the transaction had not been
recorded. The most likely reason that the omission was picked up is:
A. the worksheet did not balance by $9000.
B. the imbalance was divisible by 9.
C. the omission was picked up by a diligent bookkeeper.
D. the worksheet did not balance by $4500.
ANS: C PTS: 1 AACSB: Knowledge, Analytical
TOP: Business activities and the worksheet.

42. A Ltd sold a car for $75 000 which it had recorded in its accounts at $60 000. The
effect on A Ltd’s accounts is:

Assets Liabilities Equity

A. increase no change increase
B. decrease decrease increase
C. increase no change no change
D. no change decrease no change
ANS: A PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.
 43. The worksheet is a form of:
A. journal.
B. financial statement.
C. working paper.
D. ledger.
ANS: C PTS: 1 AACSB: Knowledge, Analytical
TOP: Business activities and the worksheet.

44. Aria was trying to determine the amount of total equity in her music business. An
exclusive list of accounts is listed below:

Piano $12 000

Cash $2000
Office equipment $4000
Bank overdraft $2000
Profit for the period $2000

Based on this information, the total owners’ equity in Aria’s business was:
A. $2000
B. $10 000
C. $14 000
D. $16 000
ANS: D PTS: 1 AACSB: Analytical
TOP: The balance sheet equation.

SHORT ANSWER

1. What is meant by the concept of duality? Illustrate your answer with respect to the
following three transactions (events):
• Entity paid wages for services provided in the preceding fortnight.
• Entity issued shares for land.
• Entity paid $30 000 cash for equipment to be used in the business

ANS:
The concept of duality refers to the fact that all events (transactions) have a two-fold effect on the
accounting equation. With respect to three examples provided: (i) wages: decrease assets (cash),
decrease owners equity (increase in expenses); (ii) equity issue: increase assets (land); increase
owners’ equity (share capital); (iii) equipment: decrease assets (cash) and increase assets (equipment).

PTS: 1 AACSB: Knowledge, Analytical

TOP: The balance sheet equation.

2. Briefly describe four sources of the common types of errors that may be made in
recording transactions (events) in the worksheet.

ANS:
(i) single-entry error i.e., the incomplete application of the principle of duality; (ii) double-entry errors
i.e., duality is applied incorrectly; (iii) errors of addition and subtraction; and (iv) errors of transposi-
tion.

PTS: 1 AACSB: Knowledge, Analytical, Communication

TOP: Business activities and the worksheet.
 3. What is the operating cycle of a business? How does this impact the classification of
assets into current and non-current categories?

ANS:
Operating cycle: refers to the time between the acquisition of materials entering into a process and the
realisation of the materials as cash or an instrument that is readily convertible into cash (e.g., a
financial asset, such as accounts receivable). The concept plays an important part in distinguishing
current and non-current assets, in that assets that are expected to be realised or are held for sale or
consumption in the normal course of the entity’s operating cycle represent current assets. All assets
other than current assets are classified in non-current assets.

PTS: 1 AACSB: Knowledge, Analytical, Communication

TOP: Elements of the balance sheet.

4. What role does the business entity principle play in accounting for the transactions,
assets and liabilities of an entity?

ANS:
The business entity principle holds that the business is a separate entity from the owner, all business
transactions are entered into from the perspective of the business, the assets are considered to be the
resources of the business entity and the liabilities and owners’ equity claims on those assets.

PTS: 1 AACSB: Knowledge, Analytical, Communication

TOP: Definition of the balance sheet.

5. At 30 June 2014, the non-current asset section of the balance sheet of Qantas included
leasehold aircraft and engines valued at cost, $17 131 million and after depreciation and impairment, a
written-down value $11 075 million. [Source: Note 15. Property, Plant and Equipment, Qantas Annual
Report 2014, p. 85).

(a) Explain how the definition and recognition criteria of assets would be met in order for
Qantas to report the aircraft as assets in the balance sheet?
(b) How is written-down value calculated?

ANS:
(a) Definition:
future economic benefits
– revenue from the provision of transport;
control
– the aircraft are fundamental to the company’s objectives/operations, and the lease
agreements must vest in the company the capacity to deny and/or regulate the access of
others, including, all other things being equal, the lessor;
past event
– striking of lease agreement.

Recognition: Qantas would need to have determined that it was probable that economic
benefits would accrue to the organisation (demand for its services), and the monetary
measure placed on the aircraft would need to be reliable (without undue error or bias).

(b) Written-down value: cost less accumulated depreciation (or amortisation for leased
aircraft and engines) and impairment charges of $2696 million.

PTS: 1 AACSB: Knowledge, Analytical

TOP: Elements of the balance sheet.

6. What are the three components of the balance sheet? Briefly discuss each.

ANS:
The three components of the balance sheet are assets, liabilities, and owners’ equity.

Assets are an entity’s economic resources that will provide future benefits to the entity. Examples
include cash, accounts receivable, inventory, land, and equipment.

Liabilities are the economic obligations of an entity. Examples include accounts payable, wages
payable, and salaries payable.

Owners’ equity is the owners’ current investment in the assets of the entity. The owners’ equity is a
residual interest, because liabilities have first claim to the assets of the entity.

PTS: 1 AACSB: Knowledge, Analytical, Communication

TOP: Elements of the balance sheet.

PROBLEM

1. The accountant for Tiny Tots has compiled the following information about the
company and its accounts:

Cash $1500 Prepaid Rent $1000

Revenues 4000 Expenses 2000
Accounts Payable 4500 Equipment 10 000
Wages Payable 2500 Notes Payable 1000

(a) What is the total amount of assets belonging to Tiny Tots?

(b) What is the total amount that Tiny Tots owes for liabilities?
(c) Using the accounting equation, what is the amount of Owners’ Equity reported on Tiny
Tots balance sheet?
(d) How much net profit did Tiny Tots have for the year?

ANS:
(a)
Cash 1500
Prepaid Rent 1000
Equipment 10 000
Total Assets 12 500

(b)
Accounts Payable 4500
Wages Payable 2500
Notes Payable 1000
Total Liabilities 8000

(c)
Total Assets 12 500
Total Liabilities 8000
 Owners’ Equity 4500

(d)
Revenues 4000
Expenses 2000
Net Income 2000

PTS: 1 AACSB: Knowledge, Analytical TOP: Chapter 5.

2. Identify the impact of the following events on the balance sheet equation.
a. The owner pays $3000 into the business bank account.
b. The business acquires equipment for $8000, paying a $3000 deposit, with the balance payable in 90
days.
c. The business provides services for $850 cash.
d. Paid salaries and wages $2300.
e. The business provides a potential customer with a quote of $900 for the provision of services.
f. The business purchases supplies for $385 cash.

ANS:
a: increase assets (cash); increases owners’ equity (capital).
b: increase assets (equipment); decrease assets (cash); increase liabilities.
c: increase assets (cash); increase owners’ equity (revenue).
d: decrease assets (cash); decrease owners’ equity (expense).
e: no effect on the balance sheet equation.
f: increase assets (supplies); decrease assets (cash).

PTS: 1 AACSB: Analytical TOP: Balance sheet equation.

3. X Ltd sold 2000 computers in June. The terms of sale included a 12-month warranty.
The warranty provides that X Ltd will meet the cost of repairs that are associated with faulty parts
attributable to manufacture. Past experience indicates that 10% of computer sales lead to warranty
claims at an average cost of $70 for parts and $100 for labour, per computer.

Discuss whether the warranty commitment would meet the definition and recognition criteria of a
liability to the firm at 30 June.

ANS:
Definition: the warranty commitment represents an existing legal obligation involving a future outflow
of economic benefits, to another entity (customers), arising out of a past event (sale).
Recognition: The details of the case suggest that outflow is probable (‘past experience indicates …’);
and the measurement is reliable [(2000 x 0.10) x ($100 + 70)] = $34 000

PTS: 1 AACSB: Analytical, Communication

TOP: Elements of the balance sheet.

4. Xavier Plata operates a small manufacturing business, trading under the name of
Plata Products. The following list of financial data relates to the business as at 30 June.
 Cash $131 950 Plant & equipment (net) $183 000
Receivables 70 300 Accounts payable 8500
Inventories 13 026 Salaries payable 1450
Prepaid insurance 1500 Interest-bearing, long-term
Intangibles 8750 Borrowings 155 000
Contributed capital 198 626
Retained profits 44 950

Additional information
• Receivables will be collected within 12 months of 30 June.
• 30% of the figure for interest-bearing borrowings is payable within 12 months of 30 June.

Required
Prepare a fully classified balance sheet for Plata Products as at 30 June.

ANS:

Plata Products
Balance Sheet
As at 30 June
Current Assets
Cash $131 950
Receivables 70 300
Inventories 13 026
Prepayments 1500
Total current assets 216 776

Non-current assets
Plant & equipment 183 000
Intangibles 8750
Total non-current assets 191 750
Total assets 408 526

Current liabilities
Accounts payable 8500
Salaries payable 1450
Interest-bearing borrowings 46 500
Total current liabilities 56 450

Non-current liabilities
Interest-bearing borrowings 108,500
Total non-current liabilities 108 500
164 950
Total liabilities
243 576
Net Assets
Equity
Contributed equity 198 626
Retained profits 44 950
243 576
Total owners’ equity

PTS: 1 AACSB: Analytical TOP: Influences on the format of

the balance sheet.

CASE
 1. In June 2002 WorldCom, a US telecommunications firm, announced that it had
misreported financial information in previous accounting periods – to the sum of USD $3.9 billion –
by recording routine operating expenses as capital expenditure.

Discuss
(a) The impact of the treatment on the financial statements.
(b) The possible reasons for management’s accounting policy choice.
(c) Whether any party is likely to suffer from the misrepresentation.
ANS:
(a) The treatment would have the effect of understating expenses and as a result overstating
profits; and overstating assets and equity.
(b) Possible reasons:
• from the perspective of the economic consequences literature (Chapter 1), the policy
may be linked to:
(i) management’s compensation plans vis-a-vis remuneration tied to performance
bonuses and/or share prices;
(ii) debt contracts vis-a-vis restrictive debt covenants associated with the debt to
equity (assets) ratio and EBIT ratio.
• Management’s desire to misrepresent profits in order to meet market expectations,
possibly driven by forecast growth targets.
(c) Parties likely to suffer from the misrepresentation would include those who have used the
associated information for the purposes of making decisions associated with the alloca-
tion of scarce resources e.g., shareholders and analysts (decisions to hold or sell shares);
lenders; employees; and suppliers. Ultimately, senior executives, directors and auditors
vis-a-vis reputation and potential financial losses from civil proceedings.

PTS: 1 AACSB: Ethics, Communication, Analytical

TOP: Chapter 5; Chapter 1.

ESSAY

1. The balance sheet includes information on the resources, financial structure, solvency
and adaptability of a reporting entity. Discuss.

ANS:
Issues for discussion
Balance sheet: a general purpose financial statement designed to provide information on the following:
• Resources (assets) under the control of the entity at the reporting date. The statement would
include the measurement and classification of assets – by nature and grouping vis-a-vis
solvency.
• Financial structure identifies the basis for funding the resources – the mix of debt and
equity capital.
• Solvency: the capacity of the entity to meet its financial commitments in the short and long-
term.
• Reporting entity: an entity where there exists users who in their own right do not have the
authority to access financial information to meet their information needs and as such they
are dependent users e.g., shareholders, customers, suppliers and employees.

PTS: 1 AACSB: Knowledge, Communication

TOP: Definition of the balance sheet; The purpose of the balance sheet.