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1、CHAPTER 2ACCOUNTING STATEMENTS, TAXES AND CASH FLOWAnswers to Concepts Review and Critical Thinking Questions1.Liquidity measures how quickly and easily an asset can be converted to cash without significant loss in value. Its desirable for firms to have high liquidity so that they have a large facto
2、r of safety in meeting short-term creditor demands. However, since liquidity also has an opportunity cost associated with it - namely that higher returns can generally be found by investing the cash into productive assets - low liquidity levels are also desirable to the firm. Its up to the firms fin
3、ancial management staff to find a reasonable compromise between these opposing needs2.The recognition and matching principles in financial accounting call for revenues, and the costs associated with producing those revenues, to be “booked” when the revenue process is essentially complete, not necess
4、arily when the cash is collected or bills are paid. Note that this way is not necessarily correct; its the way accountants have chosen to do it.3.The bottom line number shows the change in the cash balance on the balance sheet. As such, it is not a useful number for analyzing a company. 4.The major
5、difference is the treatment of interest expense. The accounting statement of cash flows treats interest as an operating cash flow, while the financial cash flows treat interest as a financing cash flow. The logic of the accounting statement of cash flows is that since interest appears on the income
6、statement, which shows the operations for the period, it is an operating cash flow. In reality, interest is a financing expense, which results from the companys choice of debt/equity. We will have more to say about this in a later chapter. When comparing the two cash flow statements, the financial s
7、tatement of cash flows is a more appropriate measure of the companys performance because of its treatment of interest.5.Market values can never be negative. Imagine a share of stock selling for $20. This would mean that if you placed an order for 100 shares, you would get the stock along with a chec
8、k for $2,000. How many shares do you want to buy? More generally, because of corporate and individual bankruptcy laws, net worth for a person or a corporation cannot be negative, implying that liabilities cannot exceed assets in market value.6.For a successful company that is rapidly expanding, for
9、example, capital outlays will be large, possibly leading to negative cash flow from assets. In general, what matters is whether the money is spent wisely, not whether cash flow from assets is positive or negative.7.Its probably not a good sign for an established company, but it would be fairly ordin
10、ary for a start-up, so it depends.8. For example, if a company were to become more efficient in inventory management, the amount of inventory needed would decline. The same might be true if it becomes better at collecting its receivables. In general, anything that leads to a decline in ending NWC re
11、lative to beginning would have this effect. Negative net capital spending would mean more long-lived assets were liquidated than purchased.9.If a company raises more money from selling stock than it pays in dividends in a particular period, its cash flow to stockholders will be negative. If a compan
12、y borrows more than it pays in interest and principal, its cash flow to creditors will be negative.10.The adjustments discussed were purely accounting changes; they had no cash flow or market value consequences unless the new accounting information caused stockholders to revalue the derivatives.Solu
13、tions to Questions and ProblemsNOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the fi
14、nal answer for each problem is found without rounding during any step in the problem.Basic1.To find owners equity, we must construct a balance sheet as follows:Balance SheetCA$5,000CL$4,500NFA 23,000LTD13,000OE ?TA$28,000TL & OE$28,000We know that total liabilities and owners equity (TL & OE) must e
15、qual total assets of $28,000. We also know that TL & OE is equal to current liabilities plus long-term debt plus owners equity, so owners equity is:OE = $28,000 13,000 4,500 = $10,500NWC = CA CL = $5,000 4,500 = $500 2.The income statement for the company is:Income StatementSalesS/.527,000Costs 280,000Depreciation 38,000EBITS/.209,000Interest 15,000EBTS/.194,000Taxes (35%) 67,900Net incomeS/.126,100One equation for net income is: Net income = Dividends + Addition to retained earnings Rearranging, we get:Addition to retained earnings = Net income Dividends Additi
