Principles of Financial Accounting

Midterm Exam I
SOLUTIONS
Professor Aleksander A. Aleszczyk

Name ________________________________________
Section ________________________________________

General instructions:
Please observe the Stern School’s Code of Conduct requirements. Do not discuss the
content of this exam with anyone until this evening. Failure to comply with this condition
will result in harsh consequences.

1. You have 1 hour and 10 minutes to complete the exam.

2. This exam is closed book. You may use nonprogrammable calculators.
3. This exam packet should have 12 pages.
4. Please check that you have all the pages. Do not begin until instructed to do so.
5. If a question is ambiguous, write your assumptions on the exam along with your answer.
You will receive credit provided your assumptions are necessary and reasonable.
6. Circle your answer in multiple choice questions and write your answers neatly in the space
provided.
7. Please use a pen – do not write in pencil.
8. You must turn in your exam packet before you leave.
9. Allocate your time appropriately, monitor your time and good luck!

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Part I: Shorter questions (45 points = about 30 minutes)
1. The primary objective of financial reporting is to provide useful information to external decision
makers. (3 points)
A) True.
B) False.

2. The expense recognition (matching) principle requires expenses to be recorded on the income
statement in the same period they are incurred in generating revenues. (3 points)
A) True.
B) False.

3. How do you record an increase in the following accounts? Mark the correct answer
(3 pt/account, total 15 points)

Dividend payable DEBIT CREDIT

Prepaid rent expense DEBIT CREDIT

Cash DEBIT CREDIT

Contributed capital DEBIT CREDIT

Depreciation expense DEBIT CREDIT

4. In what order are current assets listed on a balance sheet of a US public firm? (4 points)
A) By dollar amount (largest first).
B) By date of acquisition (earliest first).
C) By liquidity.
D) By relevance to the operation of the business.

5. Which of the following statements is false? (4 points)

A) An expense is a cost incurred to generate revenues.
B) Revenues result in an increase in net income and additional paid-in capital.
C) Revenues are reported on the income statement as they are earned.
D) Incurring an expense occurs with a decrease in assets or an increase in liabilities.

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 Name _____________________________
NYU email _____________________

6. Colby Corporation has provided the following information:

• Total assets at year-end $85,200.

• Operating revenues from customers $199,700.
• Operating expenses for the store $111,000.
• Interest expense $9,200.
• Dividend payments to Colby's stockholders $7,700.
• Income tax expense $36,000.

How much was Colby's net income? Hint: ignore irrelevant balance(s). (4 points)
A) $43,500.
B) $35,800.
C) $121,000.
D) $128,700.

Calculations:

Net income = 199,700 – 111,000 – 9,200 – 36,000 = 43,500

2 points if dividend payments included (i.e. net income = 35,800)

1 point if any correct calculations

7. Which account is unlikely to appear in an adjusting entry? (4 points)

A) Salary payable.
B) Prepaid rent.
C) Cash.
D) Depreciation expense.

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8. On January 1, $11,500 of machinery was purchased. $1,500 cash was paid down and
a 3-month, 18% annual rate note payable was signed for the balance. The January 1 transaction
was properly recorded. The appropriate adjusting journal entry for the interest as of January 31
is: (4 points):
A) Dr Accrued interest payable 450
Cr Interest expense 450
B) Dr Interest expense 2,070
Cr Accrued interest payable 2,070
C) Dr Accrued interest payable 150
Cr Interest expense 150
D) Dr Interest expense 150
Cr Accrued interest payable 150

Calculations:
if correct: (4 points)

If incorrect
(1 point for note payable balance) 11,500-1,500 = 10,000
(1 point for annual interest calculation) 10,000 x 18% = 1,800 per annum
(1 point for monthly interest calc) = 150 per month

(1 point for correct both accounts but wrong amount): Dr Interest Expense
Cr Accrued interest payable

9. Which of the following transactions has the same effect on the income statement prepared
under both the cash basis and accrual basis? (4 points)
A) Selling shares in exchange for cash.
B) Declaring and paying a cash dividend.
C) Selling a product to a customer which creates an account receivable.
D) Paying employee wages as they are earned.

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Part II: Longer questions (20 points = about 15 minutes)
10. A company's January 1, 2018 balance sheet reported total assets of $250,000 and total
liabilities of $60,000. During January 2018, the company completed the following transactions:
i. paid a note payable using $10,000 cash;
ii. issued $15,000 of common stock;
iii. paid off $8,000 accounts payable; and
iv. purchased a truck for $6,000 cash and by signing a $9,000 note payable from a bank.
The company's January 31, 2018 balance sheet would report which of the following? (6 points)
A) Assets Liabilities Stockholders' Equity
$250,000 $60,000 $190,000
B) Assets Liabilities Stockholders' Equity
$256,000 $56,000 $200,000
C) Assets Liabilities Stockholders' Equity
$250,000 $45,000 $205,000
D) Assets Liabilities Stockholders' Equity
$256,000 $51,000 $205,000

Calculations:
If incorrect:
A = L + E

Calculate equity 250 60 190 (1 point)

i. (10) (10) -
ii. +15 - +15
iii. (8) (8) -
iv. +15 -6 (or +9) 9 -

total 256 51 205

1 point per each correct transaction

1/2 point for each correct total

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11. Give an example of an economic transaction that would result in an increase in common stock,
and provide a sample journal entry. (4 points)

Answer:
e.g. Common stock issuance / contribution of capital

Dr Cash xx
Cr Common Stock xx

1 point for giving a transaction

1 point for each account title affected consistent with the transaction
1 point for crediting common stock (increase in capital)

12. Kronic Ltd. sold inventory costing Kronic $500 for $900 on account. Provide the journal entries
required at the time of sale. (6 points)

Answer:

Dr A/R 900
Cr Revenue 900

Dr Cost of goods sold/Cost of sales/Inventory expense 500

Cr Inventory 500

13. Give an example of an economic transaction that would result in an increase in accounts
payable, and provide a sample journal entry. (4 points)

Answer:

e.g. buying inventory on credit receiving some services without cash payment
Dr Inventory xx Dr Service
Cr A/P xx Cr (Accrued) A/P xx

1 point for giving a transaction

1 point for each account title affected consistent with the transaction
1 point for crediting A/P (increase in A/P)

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Part III: Business application (35 points = about 25 minutes)
14. Use Tiffany’s income statement to answer the following questions. (total 8 points)
14a. What was the net income margin for the year ending January 2019? Show all calculations
(3 points)

Answer:

3 points if correct answer

1 point formula: Net Income / Total Revenue
0.5 point for each number: 586.4 / 4,442.1
1 point for net income margin: 0.132 = 13.2%

14b. Did the 2019’s net income margin improve relative to the prior year? Show all calculations.
(2 points)

Answer:

1 point prior year’s margin: 370.1 / 4,169.8 = 0.0888 = 8.88% (or rounded)
1 point for statement: improved/higher margin than in 2018
0.5 point if calculated 2017’s margin

(error carried forward if different 21a)

14c. Assuming that analysts predicted the Tiffany’s bottom line in 2019 to increase by 50% from
2018, would you expect a positive or negative stock market reaction at earnings announcement
(1 pt), and why (2 pt)? Ignore other considerations. (total 3 points)

Answer:

1 point calculate expected top line: 1.50 x 370.1 = 555.15 (or rounded)
1 point for statement: positive stock market reaction
1 point for why: because actual net income was higher (586.4)

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15. Use Tiffany’s balance sheet to answer the following questions. (total 27 points)
15a. What is the largest liability (2 pts) and its value (1 pt) on Tiffany’s balance sheet
at January 31, 2019? (total 3 points)

Answer:
Long-term debt, $883.4m

2 points for correct liability

2 point for corresponding amount (millions can be ignored)
1 point if 2018’s amount: $882.9m
3 out of 4 points if Accounts Payable is given with corresponding amount of $513.4m

15b. Demonstrate that this liability meets its definition. (3 points)

Answer:

1 point each for referring to past/present/future, e.g.

LT debt is a present obligation of an entity (1 point)

As it arose from the past transaction / borrowing from a bank (1 point)
And probable future sacrifice of economic benefits / settlement in cash (1 point)

15c. What is the current ratio in 2018? (3 points)

Answer:
If wrong answer:
1 point formula: Total Current Assets / Total Current Liabilities
0.5 point for each number: 3,983.3 / 724.8
1 point for net income margin: 5.5

1 out of 2 points, if 2018 is calculated: 3,759.5 / 718.1 = 5.2

15d. Examine retained earnings balances on Tiffany’s balance sheet and net income in its income
statement. How much did Tiffany declare and pay in dividends in the year ending January 2019?
Assume no other transactions affected equity balances. Show all calculations. (5 points)

Answer:
If correct answer and no calculations: 3 points
If correct answer and some of steps: 5 points
If wrong:
1 point formula: Beg RE + Net Income – Dividends = end RE
1 point for finding beg RE = 2,114.2
1 point for finding end RE = 2,045.6
1 point for finding Net income = 586.4
1 point for calculating Div = 2,114.2 – 2,045.6 + NI = 655 m

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15e. Examine cash and cash equivalents’ balances on Tiffany’s balance sheet. Assume that
net cash provided by operating activities was $531.8m and net cash used in investing activities
was $(30.0)m (i.e. net outflow). How much net cash was used in financing activities in the year
ending January 2019? (6 points)

Answer:
If correct answer and no calculations: 2 points
If correct answer and few steps/calculations: 6 points

If wrong answer:
2 points for formula Beg Cash + CFO + CFI + CFF = End Cash
1 point for finding beg Cash 970.7m
1 point for finding end Cash 792.6m

2 points for calculation:

CFF = End Cash – Beg Cash – CFO – CFI = 792.6 – 970.7 – 531.8 – (-30.0) = (679.9)
If wrong: 1 point for calculation if (739.9), i.e. subtracted CFI

15f. Ignoring depreciation altogether, examine Tiffany’s property, plant and equipment balances
in 2018 and 2019. Answer the following three subparts:
Did Tiffany overall purchase or sell more PPE during the year ending January 2019 and how do
you deduce this? (3 points)

Answer:

2 points: compare quantitatively 2018’s 990.5m to 2019’s 1026.7m PPE or qualitatively a

decrease in PPE balance

1 point for stating that Tiffany must have purchased more PPE

Would the net cash flow be positive or negative from this purchase/sale? (2 points)

Answer:
negative / cash outflow
(error carried forward if wrong answer above)

Would this purchase/sale be included in the operating, financing or investing cash flows?
(2 points)

Answer:
investing

End of exam, well done!

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 Excerpts from Tiffany 2019’s 10-K

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