Chapter 2: The Basic Financial Statements 15

CHAPTER 2: THE BASIC FINANCIAL STATEMENTS

Text Problem Solutions

1. a. Income statement and balance sheet for Aspen Industries:

Exhibit 2 - 1
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Exhibit 2 - 2
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Exhibit 2 - 3
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Exhibit 2 - 4
Chapter 2: The Basic Financial Statements 19
b. Statement of cash flows for Aspen:

Exhibit 2 - 5
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Exhibit 2 - 6
Chapter 2: The Basic Financial Statements 21
d. If sales were $320,000 instead of $285,000 in 2004, the following income statement and balance sheet would
result. This change of $35,000 in sales produces an increase of nearly $23,000 in net income and an increase
of nearly $16,000 in accumulated retained earnings.

Exhibit 2 - 7 Sales Change

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Exhibit 2 - 8 Sales Change
Chapter 2: The Basic Financial Statements 23
Exhibit 2 - 9 Sales Change
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Exhibit 2 - 10 Sales Change
Chapter 2: The Basic Financial Statements 25
e. If the tax rate for Aspen is changed to 40% from 35%, the following income statement and balance sheet
result. Net Income is reduced by $220 and accumulated retained earnings are reduced by $154.

Exhibit 2 - 11 Tax Change

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Exhibit 2 - 12 Tax Change
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Exhibit 2 - 13 Tax Change
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Exhibit 2 - 14 Tax Change
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2. a. Aspen Industries 2003 and 2004 common-size income statement:

Exhibit 2 - 15
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Exhibit 2 - 16
Chapter 2: The Basic Financial Statements 31
b. Aspen’s 2003 and 2004 common-size balance sheet:

Exhibit 2 - 17
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Exhibit 2 - 18
Chapter 2: The Basic Financial Statements 33

Instructor’s Manual Problem Set

1. Change the Elvis Products International financial statement examples in Chapter 2 in the text in the following
manner and discuss the changes that take place:

Income Statement
Depreciation 2004 (C10) - change to $18,900.

Balance Sheet
Accumulated Depreciation 2004 (C10) - change to a formula adding 2003 accumulated depreciation and the
income statement depreciation charge for 2004.
Accounts Receivable 2003 (E6) - change to $340,000.
Cash & Equivalents 2003 (E5) - increase by the change in A/R above.
Cash & Equivalents 2004 (C5) - reduce by the change in depreciation.

2. Prepare the income statement, balance sheet and statement of cash flows for Betsen Boutique using the
following information. Include common size statements for the income statement and the balance sheet and
outline of major totals for the statement of cash flows.

Exhibit 2 - 19

Item 2004 2003

Accounts Payable 12,000 10,700
Accounts Receivable 54,400 55,300
Accumulated Depreciation 30,200 27,900
Cash & Equivalents 10,500 9,700
Common Stock 40,500 40,500
Cost of Goods Sold 108,400 92,600
Depreciation 2,300 2,250
Fixed Expenses 7,600 7,000
Interest 3,400 2,900
Inventory 42,700 37,800
Long-term Debt 32,000 29,800
Other Current Liabilities 8,400 8,600
Plant & Equipment 56,900 53,000
Retained Earnings 22,700 18,200
Sales 150,500 138,200
Selling and G&A 15,500 13,400
Short Term Notes 18,700 20,100
Tax Rate 30% 30%
34 Chapter 2: The Basic Financial Statements

3. Chandler Cement sells two grades of cement. In 2004 sales for the two grades were $1,255,000 for Grade 1 and
$675,500 for Grade 2. Cost of goods sold for the two grades were 70% and 60% of sales, respectively. Selling
and G&A expenses continued to increase at 10% a year. Fixed expenses increased to $52,000, and depreciation
of $88,000 was taken. Chandler has $157,800 in short-term debt at 11% interest and has increased its long-term
debt by $100,000 to partially pay for new equipment of $224,400. The remainder of the equipment was paid in
cash. All long-term debt carries an interest rate of 9.5%. The corporation's tax rate is 30%. Accounts
receivable was at 50% of sales and inventory at year-end was 27% of sales. Accounts payable held at 25% of
the cost of goods sold. Other current liabilities were $9,790. Common stock remained constant. The firm
retained only 10% of its earnings, paying the remaining net income out as dividends. (Round retained earnings
up to the next dollar.) Prepare Chandler's income statement, balance sheet and statement of cash flows for
December 31, 2004. The firm's 2003 statements were:

Exhibit 2 - 20
Chapter 2: The Basic Financial Statements 35

Exhibit 2 - 21
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Internet Exercise

4. Using EdgarScan described in the Internet exercise in the text problems, obtain the income statements and
balance sheets for Metro-Goldwyn-Mayer, Inc. (MGM) for the last two years. Format these financial
statements for easier reading, change any total containing figures to total calculations, and create the appropriate
common-size columns for both worksheets. List several observations about MGM’s financial position that are
obtainable from these statements.
Chapter 2: The Basic Financial Statements 37

Instructor’s Manual Problem Set Solutions

1. When Elvis Products International's financial statements are changed as indicated, the following takes place:

Income Statement:
A decrease of $1,100 to $18,900 in depreciation expense causes a decrease in its percent of sales to .49% and an
increase in both dollar and percent of sales for EBIT, earnings before taxes, taxes, and net income.

Exhibit 2 - 22
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Exhibit 2 - 23
Chapter 2: The Basic Financial Statements 39
Balance Sheet:
Since we have reduced the depreciation expense, we must also reduce the amount of cash recorded by the same
$1,100. This change will decrease the total current assets while it increases the net fixed assets, leaving total
assets the same. The decrease in 2003 accounts receivable means that we have collected this amount ($11,200)
in cash. The 2003 cash and equivalents line item increases to $68,800. Since both adjustments are made in
current assets, total current assets for 2003 remains unchanged. No changes have occurred in the liabilities and
owner's equity section.

Exhibit 2 - 24
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Exhibit 2 - 25
Chapter 2: The Basic Financial Statements 41
Statement of Cash Flows:
Based on the changes made, net income increases to $44,880 due to the reduction in depreciation expense to
$18,900 and the change in accounts receivable indicates an expenditure of cash of $62,000. Because of the
increase in net income, the payout in dividends also increases to $22,660. The resulting change in totals is:
Total cash flows from operations ($85,420); Total cash flows from financing $103,520; and Net change in
cash balance ($17,900).

Exhibit 2 - 26
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Exhibit 2 - 27
Chapter 2: The Basic Financial Statements 43
2. Betsen Boutique's financial statements are as follows:

Exhibit 2 - 28

Exhibit 2 - 29
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Chapter 2: The Basic Financial Statements 45
Exhibit 2 - 30
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Exhibit 2 - 31
Chapter 2: The Basic Financial Statements 47
Exhibit 2 - 32
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Exhibit 2 - 33
Chapter 2: The Basic Financial Statements 49
3. Chandler Cement's financial statements appear below. The amount of 0.2 added to 2004 retained earnings on
the balance sheet serves merely to round the figure to the next dollar to balance Total Assets and Total
Liabilities and Owner's Equity.

Exhibit 2 - 34

Exhibit 2 - 35
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Exhibit 2 - 36
Chapter 2: The Basic Financial Statements 51
Exhibit 2 - 37
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Exhibit 2 - 38
Chapter 2: The Basic Financial Statements 53

Exhibit 2 - 39
54 Chapter 2: The Basic Financial Statements
4. MGM, Inc. income statements and balance sheets for 2001 and 2002 are presented below as possible solutions.
Observations about MGM available from these statements would include positive or negative changes in line
items from 2001 to 2002, and financial ratios based on total assets or total sales in either year.

Exhibit 2 - 40
Chapter 2: The Basic Financial Statements 55

Exhibit 2 - 41
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Exhibit 2 - 42
Chapter 2: The Basic Financial Statements 57

Exhibit 2 - 43
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Chapter 2: The Basic Financial Statements 59
Exhibit 2 - 44
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Chapter 2: The Basic Financial Statements 61