2

TUTORIAL
Principles of
Accounting

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TUTORIAL 2 OUTLINE

2.1 Shareholders’ Equity

2.2 Financial Statements

2.3 Income Statement

2.4 Statement of Cash Flow

2.5 Revised Net Income

2.6 Accounting Ratios

2.7 Depreciation Methods

2.8 Depreciation Book Values

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Professor R. Jassim Engineering Economy

2.1 SHAREHOLDERS’ EQUITY

LOM Inc. has 200 000 common shares outstanding, valued at $25/unit on the market.
DEF wishes to acquire all of LOM's stock and believes that it can do so by making an
offer to LOM shareholders midway between the market price and LOM's book value
per share. Current Assets (CA) $6 200 000
LOM's balance sheet contains the Net Fixed Assets (NFA) $4 100 000
entries shown here, in which the Other Assets (OA) $300 000
Capital Stock (CS) account has
Current Liabilities (CL) $3 150 000
been omitted.
Long-term Liabilities (LTL) $1 150 000
What should be DEF's bid to
LOM shareholders? Accumulated Retained Earnings (ARE) $2 300 000

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Professor R. Jassim Engineering Economy

2.2 FINANCIAL STATEMENTS

Minnie Mechanic purchased a small engine shop. Accordingly, she invested $8000 of
her personal savings ($1000 cash, $3000 inventory, $4000 equipment).

Over the first month of operation, sales and expenses for the shop were as follows:

Sales $13 500

Inventory purchases $7 000
Salaries $3 000
Advertising Expenses $250
Rental Expenses $600
Utility Expenses $400

In addition, the following information is available:

 Of the inventory purchases, an amount of $6000 was paid cash, while the rest is
still owed (i.e. $1000).
 The inventory now holds $2600 of merchandise.
i) Prepare a balance sheet on opening day.
ii) Prepare an income statement for the period (ignore any depreciation
expense).
iii) If by the end of the period, the shareholder's equity account has a balance of
$9850, determine the balance in the cash account.
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Professor R. Jassim Engineering Economy

2.3 INCOME STATEMENT

Old Henry MacDonald purchased a farm for $75 000. He paid $25 000
cash and financed the balance with a ten-year mortgage carrying an
annual interest of 9 percent due once per year. He then purchased cattle
with a cash payment of $3000, and issued a promissory note of $5000
carrying an annual interest rate of 8 percent for the balance. Revenues
and expenses during the first year of operation of the farm were as follows:
Sale of Calves $8 500
Sale of Hay $1 200
Salaries $1 500
Rental of machinery $2 000
Veterinarian fees $175
50 000 (0.09) + 5000 (0.08)
Fertilizer $200
Property taxes $450
Repairs $375
Interest on debt $4 900
Miscellaneous expenses $125
Depreciation $1 500
Prepare an income statement for the year, providing for income taxes at a
rate of 40 percent.
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Professor R. Jassim Engineering Economy

2.4 STATEMENT OF CASH FLOW

When considering a statement of cash flow, categorize the following
transactions, by the following:
i) Operating/Financing/Investing Cash Flow or None
ii) Source/Use

a) Decrease in Accounts Receivable

b) Decrease in Inventory
c) Increase in Accounts Payable
d) Increase in Note Payable
e) Decrease in Total Fixed Assets
f) Decrease in Long Term Debt
g) Increase in Common Stock
h) Decrease in Retained Earnings
i) Revenue
j) Expenses
k) Depreciation
l) Interest
m) Net income (assume positive)
n) Dividends Paid

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Professor R. Jassim Engineering Economy

2.5 REVISED NET INCOME

Eddy Electric's income statement reports a net income of $150 000.
However, Eddy omitted a depreciation expense of $30 000. Given that the
tax rate is 40 percent, determine the revised net income.

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Professor R. Jassim Engineering Economy

2.6 ACCOUNTING RATIOS

Jack Mechanic Inc.’s Balance Sheet for the year ending 31 December,
1990 is shown below.
JACK MECHANIC INCORPORATED
Balance Sheet as at 31 December, 1990
ASSETS LIABILITIES
Current Current
Cash 10 000 Accounts payable 35 000
Accounts receivable 25 000 Taxes payable 15 000
Inventory 15 000
Prepaid expenses 5 000 Long-term
Mortgage 45 000
Fixed TOTAL LIABILITIES 95 000
Equipment at cost 195 000
Accumulated depreciation 25 000 SHAREHOLDERS' EQUITY
Net 170 000 Capital Stock 115 000
Retained Earnings 30 000
Goodwill 15 000 TOTAL S.E. 145 000
TOTAL ASSETS $240 000 TOTAL LIAB. & S.E. $240 000

i) Determine the firm's quick ratio.

ii) Determine the firm's equity ratio.
iii) Determine the firm's debt to equity ratio.
iv) Determine the firm's book value.
v) Comment on the firm's short-term liquidity position as well as on its degree of leverage.
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Professor R. Jassim Engineering Economy

2.7 DEPRECIATION METHODS

A company purchased an asset costing $55 000 and having an estimated
salvage value of $5000 at the end of a period of use of 5 years.
i) Using declining-balance depreciation, determine the depreciation
charge for accounting purposes in the third year of use of the asset.
ii) Using straight-line depreciation, determine the depreciation charge for
tax purposes in the third year of use of the asset.
iii) Given that the asset's rate of use decreases by 10 percent per year
over its useful life, and using unit-of-production depreciation,
determine its book value for accounting purposes at the end of its
fourth year of use.

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Professor R. Jassim Engineering Economy

2.8 DEPRECIATION BOOK VALUES

You have an asset worth $178 000 that will last 5 years and has an
estimated book value of $15 000. Using depreciation for accounting
purposes, determine the book value of every year for each of the four
depreciation methods described below.
i) Straight-line depreciation
ii) Declining-balance depreciation
iii) Sum-of-the-years depreciation
iv) Unit of production depreciation (40%, 25%, 20%, 10%, 5%)

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