Chapter- 2 Solution for 27 and 28

27. Construction of income statement and balance sheet (LO1 and 3) For December 31,
20X1, the balance sheet of Baxter Corporation was as follows:
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Current Assets Liabilities
Cash $15,000 Accounts payable $17,000
Accounts receivable 20,000 Notes payable 25,000
Inventory 30,000 Bonds payable 55,000
Prepaid expenses 12,500
Fixed Assets Stockholders’ Equity
Plant and equipment (gross)…. $255,000 Preferred stock $25,000
Less: Accumulated Common stock 60,000
Depreciation 51,000 Paid-in capital 30,000
Net plant and equipment $204,000 Retained earnings 69,500
Total liabilities and
Total assets $281,500 stockholders’ equity $281,500
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Sales for 20X2 were $245,000, and the cost of goods sold was 60 percent of sales.
Selling and administrative expense was $24,500. Depreciation expense was 8 percent of
plant and equipment (gross) at the beginning of the year. Interest expense for the notes
payable was 10 percent, while the interest rate on the bonds payable was 12 percent.
This interest expense is based on December 31, 20X1 balances. The tax rate averaged
20 percent.
$2,500 in preferred stock dividends were paid, and $5,500 in dividends were paid to
common stockholders. There were 10,000 shares of common stock outstanding.

During 20X2, the cash balance and prepaid expenses balances were unchanged.
Accounts receivable and inventory increased by 10 percent. A new machine was
purchased on December 31, 20X2, at a cost of $40,000.
Accounts payable increased by 20 percent. Notes payable increased by $6,500 and
bonds payable decreased by $12,500, both at the end of the year. The preferred stock,
common stock, and paid-in capital in excess of par accounts did not change.
a. Prepare an income statement for 20X2.
b. Prepare a statement of retained earnings for 20X2.
c. Prepare a balance sheet as of December 31, 20X2.

2-27. Solution:
 Baxter Corporation
20X2 Income Statement
a. Sales $245,000
Cost of goods sold (60%) 147,000
Gross profit $ 98,000
Selling and administrative expense 24,500
Depreciation expense (8%) 20,4001
Operating profit (EBIT) $ 53,100
Interest expense 9,1002
Earnings before taxes (EBT $ 44,000
Taxes (20%) 8,800
Earnings after taxes (EAT) $ 35,200
Preferred stock dividends 2,500
Earnings available to common stockholder $ 32,700

Shares outstanding 10,000

Earnings per share $ 3.27

b. 20X2 Statement of Retained Earnings

1
8% × $255,000 = $20,400
2 (10% × $25,000) + (12% × $55,000) = $9,100
 Retained earnings balance, January 1, 20X2 $69,500
Add: Earnings available to common
Stockholders, 20X2 32,700
Deduct: Cash dividend declared in 20X2 5,500
Retained earnings balance,
December 31, 20X2 $96,700

2-27. Balance Sheet

c. 20X2 Balance Sheet
Current Assets Liabilities
Accounts
Cash………….. $ 15,000 payable $20,400
Accounts
receivable…….. 22,000 Notes payable…. 31,500

Inventory…… 33,000 Bonds payable… 42,500

…
Prepaid
expenses 12,500 _______
$82,500 $94,400

Fixed Assets Stockholders’ Equity

Preferred stock... $ 25,000
Gross $295,000 Common stock... 60,000
plant…...
Accumulated Paid in capital in
depreciation… (71,400)3 excess of par… 30,000
Retained
Net plant…….. 223,600 earnings 96,700
Total liability &
Total assets….. $306,100 equity……….. $306,100

3
$51,000 + $20,400 = $71,400
28. Statement of cash flows (LO4) Refer to the following financial statements for Crosby
Corporation:
a) Prepare a statement of cash flows for the Crosby Corporation using the general
procedures indicated in Table 2–10.
b) Describe the general relationship between net income and net cash flows from
operating activities for the firm.
c) Has the buildup in plant and equipment been financed in a satisfactory manner?
Briefly discuss.
d) Compute the book value per common share for both 20X1 and 20X2 for the Crosby
Corporation.
e) If the market value of a share of common stock is 3.3 times book value for 20X1,
what is the firm’s P/E ratio for 20X2?

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CROSBY CORPORATION
Income Statement
For the Year Ended December 31, 20X2

Sales $2,200,000
Cost of goods sold 1,300,000
Gross profits 900,000
Selling and administrative expense 420,000
Depreciation expense 150,000
Operating income 330,000
Interest expense 90,000
Earnings before taxes 240,000
Taxes 80,000
Earnings after taxes 160,000
Preferred stock dividends 10,000
Earnings available to common stockholders $ 150,000
Shares outstanding 120,000
Earnings per share $ 1.25

Statement of Retained Earnings

For the Year Ended December 31, 20X2
Retained earnings, balance, January 1, 20X2 $500,000
Add: Earnings available to common stockholders, 20X2 150,000
Deduct: Cash dividends declared and paid in 20X2 50,000
Retained earnings, balance, December 31, 20X2 $600,000
 Comparative Balance Sheets
For 20X1 and 20X2
Year-End Year-End
Assets 20X1 20X2
Current assets:
Cash $ 70,000 $100,000
Accounts receivable (net) 300,000 350,000
Inventory 410,000 430,000
Prepaid expenses 50,000 30,000
Total current assets 830,000 910,000
Investments (long-term securities) 80,000 70,000
Plant and equipment 2,000,000 2,400,000
Less: Accumulated depreciation 1,000,000 1,150,000
Net plant and equipment 1,000,000 1,250,000
Total assets $1,910,000 $2,230,000

Liabilities and Stockholders’ Equity

Current liabilities:
Accounts payable $ 250,000 $ 440,000
Notes payable 400,000 400,000
Accrued expenses 70,000 50,000
Total current liabilities 720,000 890,000
Long-term liabilities:
Bonds payable, 20X2 70,000 120,000
Total liabilities 790,000 1,010,000
Stockholders’ equity:
Preferred stock, $100 par value 90,000 90,000
Common stock, $1 par value 120,000 120,000
Capital paid in excess of par 410,000 410,000
Retained earnings 500,000 600,000
Total stockholders’ equity 1,120,000 1,220,000
Total liabilities and stockholders’ equity $1,910,000 $2,230,000
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(The following questions apply to the Crosby Corporation, as presented in Problem 27.)
Solution 2-28 a):
Crosby Corporation
Statement of Cash Flows
For the Year Ended December 31, 20X2
Cash flows from operating activities:
Net income (earnings after taxes) $160,000
Adjustments to determine cash
flow from operating activities:
Add back depreciation $150,000
Increase in accounts receivable (50,000)
Increase in inventory (20,000)
Decrease in prepaid expenses 20,000
Increase in accounts payable 190,000
Decrease in accrued expenses (20,000)
Total adjustments $270,000
Net cash flows from operating
activities $430,000
Cash flows from investing activities:
Decrease in investments 10,000
Increase in plant and equipment (400,000)
Net cash flows from investing activities (390,000)
Cash flows from financing activities:
Increase in bonds payable 50,000
Preferred stock dividends paid (10,000)
Common stock dividends paid (50,000)
Net cash flows from financing (10,000)
Net increase (decrease) in cash flows $ 30,000
The student should observe that the increase in cash flows of $30,000
equals the $30,000 change in the cash account on the balance sheet.
This indicates the statement is correct.