SOLUTIO N MANUAL FORm m
Finance m Applicationsm and m Theory m 6em Cornett
Chapterm 2-20
CHAPTERm2m–mREVIEWINGmFINANCIALmSTATEMENTS
Questions
LG2-1 1.m m List m and mdescribemthemfourmmajormfinancialmstatements.
Them fourmbasicm financialmstatementsm are:
1. Thembalancemsheetmreportsm a mfirm’sm assets,m liabilities,mand m equity mat ma mparticularmpoint m in m time.
2. Themincomemstatementmshowsmthemtotalmrevenuesmthat mamfirm mearnsmandmthemtotalmexpenses
mthe mfirm mincursmto mgenerate mthose mrevenuesmoverma mspecific mperiod mof mtime—
generally monemyear.
3. Themstatementmofmcashmflowsmshowsmthemfirm’smcash mflowsmovermamgivenmperiod mofmtime.mT
hismstatement mreportsmthemamountsmofmcashmthemfirm mgeneratedmand mdistributedmduringmampar
ticularmtimemperiod.mThembottommlinemonmthemstatementmofmcash mflows―themdifferencembetw
een mcashmsourcesmandmuses―equalsmthemchangemin mcash mandmmarketablemsecuritiesmonmthemfi
rm’smbalancemsheet mfrom mthempreviousmyear’smbalance.
4. Themstatementmofmretainedmearningsmprovidesmadditionalmdetailsmaboutmchangesmin mretai
ned mearningsmduringma mreportingmperiod.mThismfinancialmstatement mreconcilesmnetmincomem
earned mduringmamgivenmperiod mminusmanymcashmdividendsmpaid mwithin mthatmperiodmtomthem
changemin mretained mearningsmbetween mthembeginningmand mendingmof mthemperiod.
LG2-1
2.m On mwhich mof mthemfourmmajormfinancialmstatementsm(balancemsheet,mincomemstatem
ent,mstatementmofmcashmflows,mormstatement mof mretained mearnings)mwould myoumfind mthemfollowi
ngmitems?
a. earningsm beforemtaxesm -mincomemstatement
b. net mplant m and m equipment m -mbalancemsheet
c. increasemin m fixed m assetsm -mstatement mof mcash m flows
d. grossm profitsm -mincomemstatement
e. balancemof mretained mearnings,mDecemberm31,m20xx m-
mstatement mof mretained mearningsmand mbalance msheet
f. common m stock mand m paid-in m surplusm -mbalancem sheet
g. net mcash m flowmfrom minvestingmactivitiesm -mstatement mof m cash m flows
h. accrued m wagesm and m taxesm – mbalancemsheet
i. increasemin m inventory m-mstatement m of m cash m flows
LG2-1 3.m m What m ism themdifferencembetween m current m liabilitiesm and m long-term m debt?
©mMcGraw mHill mLLC.mAllmrights mreserved.mNo mreproductionmormdistributionmwithoutmthempriormwrittenmconsentmofmMcGr
aw mHill mLLC.
, Current mliabilitiesmconstitutemthemfirm’smobligationsmduemwithin monemyear,mincludingmaccrued mwagesm
and mtaxes,maccountsmpayable,mand mnotesmpayable.mLong-term mdebt mincludesmlong-
term mloansmand mbondsmwith mmaturitiesmof mmoremthan monemyear.
LG2-1
4.m Howmdoesmthemchoicemofmaccountingmmethod musedmtomrecord mfixedmasset mde
preciation maffect mmanagement mof mthembalancemsheet?
Firm mmanagersmcanmchoosemthemaccountingmmethodmtheymusemtomrecord mdepreciation magainst mthei
rmfixed massets.mTwo mchoicesmincludemthemstraight-
linemmethodmand mthemmodifiedmacceleratedmcostmrecovery msystemm(MACRS).mCompaniesmoftenmc
alculatemdepreciation musingmMACRSmwhen mthey mfiguremthemfirm’smtaxesmand mthemstraight-
linemmethodmwhenmreportingmincomemtomthemfirm’smstockholders.mThemMACRSmmethodmaccelerat
esmdeprecation,mwhichmresultsmin mhighermdepreciationmexpenses,mlowermtaxablemincome,mand m low
ermtaxesm in m themearly myearsm of ma mproject’sm life.mThemstraight-
linemmethodmresultsmin mlowermdepreciationmexpenses,mbut malsomresultsmin mhighermtaxesmin mthemearl
y myearsmofmamproject’smlife.mFirmsmseekingmtomlowermtheirmcashmoutflowsmfrommtaxmpaymentsmwil
lmfavormthemMACRSmdepreciation mmethod.
LG2-1
5.m What mismbonusmdepreciation?mHowmdid mthemTax mCutsmand mJobsmAct mof m2017mt
emporarily mextend mand mmodify mbonusmdepreciation?
Sincem2001,mbusinessesmhavemhadmthemability mtomimmediately mdeduct mampercentagemof mthemacquis
ition mcost mof mqualifyingmassetsmasm"bonusmdepreciation."mThismadditionalmdepreciation mdeductionm
wasmallowed mtomencouragembusinessminvestment.mHowever,mbonusmdepreciation mwasmamtemporary
mprovision; mthemratemwould mhavembeen m50mpercent min m2017,m40mpercent min m2018,mandm30mpercent
min m 2019,mbefore mphasingmout min m2020.mThe mTaxmCutsmandmJobsmAct mofm2017mextended mandmmo
dified m bonusmdepreciation,mallowingmbusinessesmtomimmediatelymdeductm100 mpercentmofmthemcost
mof meligible mproperty min mthe myearmit mismplacedmin mservice,mthrough m2022.mThemamount mofmallowab
lembonusmdepreciationmwillmthen mbemphasedmdownmovermfourmyears: m80 mpercent mwillmbemallowed m
formpropertymplacedmin mservicemin m2023,m60mpercentmin m2024,m40mpercentmin m2025,mand m20 mperce
ntmin m2026.
MACRSmormstraight-
linemdepreciation mismapplied mto many mcostsmthat mdo mnot mqualify mformbonusmdepreciation.
LG2-1 6.m m What maremthemcostsm and mbenefitsmof mholdingmliquid msecuritiesmon m a mfirm’smbalancemsheet?
Themmoremliquid m assetsm amfirm m holds,mthemlessm likely mthemfirmmwillmbemto m experiencemfinancia
lmdistress.mHowever,mliquid massetsmgeneratemlittlemormnomprofitsmformamfirm.mFormexample,mcashm
ismthemmost mliquid mofmallmassets,mbut mitmearnsmlittle,mif many,mreturnmformthemfirm.mInmcontrast,mfix
ed massetsmaremilliquid,mbut mprovidemthemmeansmtomgeneratemrevenue.mThus,mmanagersmmust mcons
idermthemtrade-
off mbetweenmthemadvantagesmofmliquiditymonmthembalancemsheet mandmthemdisadvantagesmofmhavin
gmmoney msitmidlemrathermthan mgeneratingmprofits.
©mMcGraw mHill mLLC.mAllmrights mreserved.mNo mreproductionmormdistributionmwithoutmthempriormwrittenmconsentmofmMcGr
aw mHill mLLC.
,LG2-2 7.m m Why mcan m thembook mvaluemand m market mvaluemof ma mfirm mdiffer?
©mMcGraw mHill mLLC.mAllmrights mreserved.mNo mreproductionmormdistributionmwithoutmthempriormwrittenmconsentmofmMcGr
aw mHill mLLC.
, Amfirm’smbalancemsheetmshowsmitsmbookm(ormhistoricalmcost)mvaluembased mon mGenerally mAccept
ed mAccountingmPrinciplesm(GAAP).mUndermGAAP,massetsmappearmon mthembalancemsheet matmwha
tmthem firm mpaid mformthem,mregardlessmofmwhat massetsmmight mbemworthmtodaymif mthemfirm mweremt
o msellmthem.mInflation mandmmarket mforcesmmakemmany massetsmworthmmoremnowmthanmthey mwere
mwhen mthe mfirmmbought mthem.mSo min mmost mcases,mbookmvaluesmdiffermwidely mfrommthe mmarket m
valuesmformthemsamemassets—
themamount mthat mthemassetsmwould mfetch mif mthemfirmmactually msold mthem.mFormthemfirm’smcurrent
massets—
thosemthat mmaturemwithin mamyear―thembookmvaluemand mmarket mvaluemofmany mparticularmassetmw
illmremain mvery mclose.mFormexample,mthembalancemsheet mlistsmcashmand mmarketablemsecuritiesmat
mtheirmmarket mvalue.mSimilarly,mfirmsmacquire maccountsmreceivable mand minventory mandmthenmcon
vert mthesemshort-
term massetsmintomcash mfairly mquickly,mso mthembookmvaluemof mthesemassetsmismgenerally mclosemtomt
heirmmarket mvalue.
LG2-2
8.m From ma mfirmmmanager’smorminvestor’smpointmofmview,mwhichmismmoremimportant―the
mbook mvaluemof ma mfirm mormthemmarket mvaluemof mthemfirm?
Balancemsheetmassetsmaremlisted matmhistoricalmcost.mManagersmwould mthusmseemlittlemrelation mbetwe
en mthemtotalmassetmvaluemlistedmonmthembalancemsheetmand mthemcurrentmmarket mvaluemofmthemfirm’sm
assets.
Similarly,mthemstockowners’mequity mlistedmonmthembalancemsheet mgenerally mdiffersmfrommthemtruemmar
ket mvaluemof mthemequity—
in mthismcase,mthemmarket mvaluemmaymbemhighermormlowermthan mthemvaluemlisted mon mthemfirm’smaccoun
tingmbooks.mSo,mfinancialmmanagersmandminvestorsmoftenmfind mthatmbalancemsheet mvaluesmaremnotmalw
aysmthemmost mrelevant mnumbers.
LG2-3 9.m m Howmdid m themTax mCutsm and mJobsm Actmof m2017 m changemcorporatemtax mlaws?
ThemTax mCutsmand mJobsmAct m(TCJA)mofm2017mismthemmostmrecentmrevisionmofmcorporatemtax mlawsm
and mrepresentsmonemofmthemmost msignificantmchangesmin mmoremthan m30myears.mThemActmpermanentl
y mlowersmcorporatemtaxesmfrommamprogressivemschedulemthat msawmtaxmratesmasmhigh masm35mpercentm
to ma mflat m21 mpercent mstartingmin m2018.
LG2-3 10.m m What mism themdifferencembetween man m averagemtax mratemand m a mmarginalmtax mrate?
Amfirm mcan mfiguremthemaveragemtaxmratemasmthempercentagemof meachmdollarmof mtaxablemincomemthat
mthe mfirm mpaysmin mtaxes.mFrommyourmeconomicsmclasses,myou mcan mprobably mguessmthatmthe mfirm’sm
marginalmtax m ratem ism them amountm ofm additionalm taxesm am firmm must m paymoutm form everym additional
m dollarm of mtaxable mincome mit mearns.
LG2-3
11.m m Howmdid mthemTaxmCutsmandmJobsmActmofm2017 mchangemthemtaxmdeducti
bility mof mcorporateminterest min mdebt?
©mMcGraw mHill mLLC.mAllmrights mreserved.mNo mreproductionmormdistributionmwithoutmthempriormwrittenmconsentmofmMcGr
aw mHill mLLC.
Finance m Applicationsm and m Theory m 6em Cornett
Chapterm 2-20
CHAPTERm2m–mREVIEWINGmFINANCIALmSTATEMENTS
Questions
LG2-1 1.m m List m and mdescribemthemfourmmajormfinancialmstatements.
Them fourmbasicm financialmstatementsm are:
1. Thembalancemsheetmreportsm a mfirm’sm assets,m liabilities,mand m equity mat ma mparticularmpoint m in m time.
2. Themincomemstatementmshowsmthemtotalmrevenuesmthat mamfirm mearnsmandmthemtotalmexpenses
mthe mfirm mincursmto mgenerate mthose mrevenuesmoverma mspecific mperiod mof mtime—
generally monemyear.
3. Themstatementmofmcashmflowsmshowsmthemfirm’smcash mflowsmovermamgivenmperiod mofmtime.mT
hismstatement mreportsmthemamountsmofmcashmthemfirm mgeneratedmand mdistributedmduringmampar
ticularmtimemperiod.mThembottommlinemonmthemstatementmofmcash mflows―themdifferencembetw
een mcashmsourcesmandmuses―equalsmthemchangemin mcash mandmmarketablemsecuritiesmonmthemfi
rm’smbalancemsheet mfrom mthempreviousmyear’smbalance.
4. Themstatementmofmretainedmearningsmprovidesmadditionalmdetailsmaboutmchangesmin mretai
ned mearningsmduringma mreportingmperiod.mThismfinancialmstatement mreconcilesmnetmincomem
earned mduringmamgivenmperiod mminusmanymcashmdividendsmpaid mwithin mthatmperiodmtomthem
changemin mretained mearningsmbetween mthembeginningmand mendingmof mthemperiod.
LG2-1
2.m On mwhich mof mthemfourmmajormfinancialmstatementsm(balancemsheet,mincomemstatem
ent,mstatementmofmcashmflows,mormstatement mof mretained mearnings)mwould myoumfind mthemfollowi
ngmitems?
a. earningsm beforemtaxesm -mincomemstatement
b. net mplant m and m equipment m -mbalancemsheet
c. increasemin m fixed m assetsm -mstatement mof mcash m flows
d. grossm profitsm -mincomemstatement
e. balancemof mretained mearnings,mDecemberm31,m20xx m-
mstatement mof mretained mearningsmand mbalance msheet
f. common m stock mand m paid-in m surplusm -mbalancem sheet
g. net mcash m flowmfrom minvestingmactivitiesm -mstatement mof m cash m flows
h. accrued m wagesm and m taxesm – mbalancemsheet
i. increasemin m inventory m-mstatement m of m cash m flows
LG2-1 3.m m What m ism themdifferencembetween m current m liabilitiesm and m long-term m debt?
©mMcGraw mHill mLLC.mAllmrights mreserved.mNo mreproductionmormdistributionmwithoutmthempriormwrittenmconsentmofmMcGr
aw mHill mLLC.
, Current mliabilitiesmconstitutemthemfirm’smobligationsmduemwithin monemyear,mincludingmaccrued mwagesm
and mtaxes,maccountsmpayable,mand mnotesmpayable.mLong-term mdebt mincludesmlong-
term mloansmand mbondsmwith mmaturitiesmof mmoremthan monemyear.
LG2-1
4.m Howmdoesmthemchoicemofmaccountingmmethod musedmtomrecord mfixedmasset mde
preciation maffect mmanagement mof mthembalancemsheet?
Firm mmanagersmcanmchoosemthemaccountingmmethodmtheymusemtomrecord mdepreciation magainst mthei
rmfixed massets.mTwo mchoicesmincludemthemstraight-
linemmethodmand mthemmodifiedmacceleratedmcostmrecovery msystemm(MACRS).mCompaniesmoftenmc
alculatemdepreciation musingmMACRSmwhen mthey mfiguremthemfirm’smtaxesmand mthemstraight-
linemmethodmwhenmreportingmincomemtomthemfirm’smstockholders.mThemMACRSmmethodmaccelerat
esmdeprecation,mwhichmresultsmin mhighermdepreciationmexpenses,mlowermtaxablemincome,mand m low
ermtaxesm in m themearly myearsm of ma mproject’sm life.mThemstraight-
linemmethodmresultsmin mlowermdepreciationmexpenses,mbut malsomresultsmin mhighermtaxesmin mthemearl
y myearsmofmamproject’smlife.mFirmsmseekingmtomlowermtheirmcashmoutflowsmfrommtaxmpaymentsmwil
lmfavormthemMACRSmdepreciation mmethod.
LG2-1
5.m What mismbonusmdepreciation?mHowmdid mthemTax mCutsmand mJobsmAct mof m2017mt
emporarily mextend mand mmodify mbonusmdepreciation?
Sincem2001,mbusinessesmhavemhadmthemability mtomimmediately mdeduct mampercentagemof mthemacquis
ition mcost mof mqualifyingmassetsmasm"bonusmdepreciation."mThismadditionalmdepreciation mdeductionm
wasmallowed mtomencouragembusinessminvestment.mHowever,mbonusmdepreciation mwasmamtemporary
mprovision; mthemratemwould mhavembeen m50mpercent min m2017,m40mpercent min m2018,mandm30mpercent
min m 2019,mbefore mphasingmout min m2020.mThe mTaxmCutsmandmJobsmAct mofm2017mextended mandmmo
dified m bonusmdepreciation,mallowingmbusinessesmtomimmediatelymdeductm100 mpercentmofmthemcost
mof meligible mproperty min mthe myearmit mismplacedmin mservice,mthrough m2022.mThemamount mofmallowab
lembonusmdepreciationmwillmthen mbemphasedmdownmovermfourmyears: m80 mpercent mwillmbemallowed m
formpropertymplacedmin mservicemin m2023,m60mpercentmin m2024,m40mpercentmin m2025,mand m20 mperce
ntmin m2026.
MACRSmormstraight-
linemdepreciation mismapplied mto many mcostsmthat mdo mnot mqualify mformbonusmdepreciation.
LG2-1 6.m m What maremthemcostsm and mbenefitsmof mholdingmliquid msecuritiesmon m a mfirm’smbalancemsheet?
Themmoremliquid m assetsm amfirm m holds,mthemlessm likely mthemfirmmwillmbemto m experiencemfinancia
lmdistress.mHowever,mliquid massetsmgeneratemlittlemormnomprofitsmformamfirm.mFormexample,mcashm
ismthemmost mliquid mofmallmassets,mbut mitmearnsmlittle,mif many,mreturnmformthemfirm.mInmcontrast,mfix
ed massetsmaremilliquid,mbut mprovidemthemmeansmtomgeneratemrevenue.mThus,mmanagersmmust mcons
idermthemtrade-
off mbetweenmthemadvantagesmofmliquiditymonmthembalancemsheet mandmthemdisadvantagesmofmhavin
gmmoney msitmidlemrathermthan mgeneratingmprofits.
©mMcGraw mHill mLLC.mAllmrights mreserved.mNo mreproductionmormdistributionmwithoutmthempriormwrittenmconsentmofmMcGr
aw mHill mLLC.
,LG2-2 7.m m Why mcan m thembook mvaluemand m market mvaluemof ma mfirm mdiffer?
©mMcGraw mHill mLLC.mAllmrights mreserved.mNo mreproductionmormdistributionmwithoutmthempriormwrittenmconsentmofmMcGr
aw mHill mLLC.
, Amfirm’smbalancemsheetmshowsmitsmbookm(ormhistoricalmcost)mvaluembased mon mGenerally mAccept
ed mAccountingmPrinciplesm(GAAP).mUndermGAAP,massetsmappearmon mthembalancemsheet matmwha
tmthem firm mpaid mformthem,mregardlessmofmwhat massetsmmight mbemworthmtodaymif mthemfirm mweremt
o msellmthem.mInflation mandmmarket mforcesmmakemmany massetsmworthmmoremnowmthanmthey mwere
mwhen mthe mfirmmbought mthem.mSo min mmost mcases,mbookmvaluesmdiffermwidely mfrommthe mmarket m
valuesmformthemsamemassets—
themamount mthat mthemassetsmwould mfetch mif mthemfirmmactually msold mthem.mFormthemfirm’smcurrent
massets—
thosemthat mmaturemwithin mamyear―thembookmvaluemand mmarket mvaluemofmany mparticularmassetmw
illmremain mvery mclose.mFormexample,mthembalancemsheet mlistsmcashmand mmarketablemsecuritiesmat
mtheirmmarket mvalue.mSimilarly,mfirmsmacquire maccountsmreceivable mand minventory mandmthenmcon
vert mthesemshort-
term massetsmintomcash mfairly mquickly,mso mthembookmvaluemof mthesemassetsmismgenerally mclosemtomt
heirmmarket mvalue.
LG2-2
8.m From ma mfirmmmanager’smorminvestor’smpointmofmview,mwhichmismmoremimportant―the
mbook mvaluemof ma mfirm mormthemmarket mvaluemof mthemfirm?
Balancemsheetmassetsmaremlisted matmhistoricalmcost.mManagersmwould mthusmseemlittlemrelation mbetwe
en mthemtotalmassetmvaluemlistedmonmthembalancemsheetmand mthemcurrentmmarket mvaluemofmthemfirm’sm
assets.
Similarly,mthemstockowners’mequity mlistedmonmthembalancemsheet mgenerally mdiffersmfrommthemtruemmar
ket mvaluemof mthemequity—
in mthismcase,mthemmarket mvaluemmaymbemhighermormlowermthan mthemvaluemlisted mon mthemfirm’smaccoun
tingmbooks.mSo,mfinancialmmanagersmandminvestorsmoftenmfind mthatmbalancemsheet mvaluesmaremnotmalw
aysmthemmost mrelevant mnumbers.
LG2-3 9.m m Howmdid m themTax mCutsm and mJobsm Actmof m2017 m changemcorporatemtax mlaws?
ThemTax mCutsmand mJobsmAct m(TCJA)mofm2017mismthemmostmrecentmrevisionmofmcorporatemtax mlawsm
and mrepresentsmonemofmthemmost msignificantmchangesmin mmoremthan m30myears.mThemActmpermanentl
y mlowersmcorporatemtaxesmfrommamprogressivemschedulemthat msawmtaxmratesmasmhigh masm35mpercentm
to ma mflat m21 mpercent mstartingmin m2018.
LG2-3 10.m m What mism themdifferencembetween man m averagemtax mratemand m a mmarginalmtax mrate?
Amfirm mcan mfiguremthemaveragemtaxmratemasmthempercentagemof meachmdollarmof mtaxablemincomemthat
mthe mfirm mpaysmin mtaxes.mFrommyourmeconomicsmclasses,myou mcan mprobably mguessmthatmthe mfirm’sm
marginalmtax m ratem ism them amountm ofm additionalm taxesm am firmm must m paymoutm form everym additional
m dollarm of mtaxable mincome mit mearns.
LG2-3
11.m m Howmdid mthemTaxmCutsmandmJobsmActmofm2017 mchangemthemtaxmdeducti
bility mof mcorporateminterest min mdebt?
©mMcGraw mHill mLLC.mAllmrights mreserved.mNo mreproductionmormdistributionmwithoutmthempriormwrittenmconsentmofmMcGr
aw mHill mLLC.
