The financial statements and notes of ZETA Corporation are as follows:

ZETA CORPORATION

Consolidated Balance Sheet

As of Decenmber 31, 2011 and 2010

($ thousands) 2011 2010

Assets

Current assets

Cash. $ 2,000 2,000

Receivables.. 25,000 20,000

Inventories (notes 1 and 2).. 56,000 38,000

Prepaid expenses. 1,000 1,000

Total current assets.. 84,000 61,000

Investment in associated companies. 14,000 11,000

Property, plant, and equipment. 61,000 52,000

Less: Accumulated depreciation (23,000) (19,000)

Net property, plant, and equipment.. 38,000 33,000

Goodwill 2,000 0

Total assets 138,000 105,000

Liabilities and Stockholders' Equity

Current liabilities

Notes payable to banks. $ 16,000 14,000

Accounts payable and accruals. 29,000 23,000

Income tax payable.. 7,000 2,000

Current portion of long-term debt (note 6).. 2,000 1,000

Total current liabilities.. 54,000 40,000

Long-term debt (note 6).. 25,000 15,200

Deferred income taxes (note 5). 3,600 2,000

Minority Interest 1,400 800

Stockholders' equity (note 7)

Common stock, $5 par value.. 5,500 5,000

Paid-in capital.. 24,500 15,000

Retained earnings. 24,000 27,000

Total stockholders' equity 54,000 47,000

Total liabilites and stockholders' equity. 138,000 105,000

ZETA CORPORATION

Consolidated Income Statement

For Years Ended December 31, 2011 and 2010

($ thousands) 2011 2010

Net sales... $ 186,000 155,000

Equity in income (loss) of associated companies. 2,000 (1,000)

Expenses

Cost of sales 120,000 99,000

1

Selling and administrative expenses 37,000 33,000

Interest expenses. 10,000 6,000

Total costs and expenses.. 167,000 138,000

Income before taxes and minority interest.. 21,000 16,000

Income tax expense (note 5) 10,000 7,800

Income before minority interest 11,000 8,200

Minority interest 200 0

Income from continuing operations. 10,800 8,200

Discontinued operations (note 4)

Operations, net of tax.. (1,100) (1,200)

Loss on disposal, net of tax.. (700) 0

Total gain (loss) from discontinued operations (1,800) (1,200)

Income before cumulative effect of accounting change.. 9,000 7,000

Cumulative effect of change in accounting, net of tax (note 1) 1,000 0

Net income 10,000 7,000

ZETA CORPORATION

Consolicated Statement of Cash Flows

For Years Ended December 31, 2011 and 2010

($ thousands) 2011 2010

Cash provided from (used for) operations

Net income. .... $ 10,000 7,000

Add (deduct) adjustments to cash basis:

Depreciation. .... 6,000 4,000

Deferred income taxes. .... 1,600 1,000

Minority interest.. .... 200 0

Undistributed income of associated companies.. .... (1,400) 1,300

Loss on discontinued operations. .... 700 0

Increase in accounts receivable (5,000-2,000).. .... (3,000) (2,400)

Increase in inventories (18,000+100*-2,200) .... (15,900) (6,000)

Increase in prepaid expenses .... 0 (200)

Increase in accounts payable and accruals

(6,000-300*-3,200) .... 2,500 2,000

Increase in income taxes payable (5,000+700)*. .... 5,700 1,000

Net cash provided from (used for) operations. .... 6,400 7,700

Cash provided from (used for) investing activities

Additions to property, plant, and equipment. .... (6,500) (5,800)

Acquisition of TRO Company (excluding cash of $4,200)

Property, plant, and equipment.. (6,000)

Goodwill. (2,000)

Long-term debt 4,800

Minority interest.. 400

Current assets (receivables and inventories) (4,200)

Current liabilities.. 3,200 (3,800) 0

Investment in associated companies. .... (1,600) 0

2

Proceeds from disposal of equipment .... 500 0

Net cash used for investing activities. .... (11,400) (5,800)

Cash provided from (used for) financing activities

Issuance of long-term debt. .... 7,500 5,000

Reduction in long-term debt.. .... (1,500) (1,000)

Dividends paid .... (3,000) (2,000)

Increase (decrease) in notes payable to bank. .... 2,000 (3,500)

Net cash provided from (used for) financing activities.. .... 5,000 (1,500)

Net increase (decrease) in cash.. .... 0 400

* Adjustments of noncash transactions arising from discontinued operations (see note 4)

Adjustments relating to acquisition of TRO Co (note 3)

Supplemental disclosures of cash flow information 2011 2010

Cash paid for interest 10,000 6,000

Cash paid for income taxes 2,600 4,800

Schedule of noncash activities:

Capital lease of $1,000 incurred on the lease of equipment

ZETA CORPORATION

Notes to Consolidated Financial Statements ($ thousands)

Note1: Change in accounting principle

During 2011 the company broadened its definition of overhead costs to be included in the determination of inventories to more properly match costs with revenues. The effect of the change in 2011 is to increase income from continuing operations by $400. The adjustment of $1,000 (after reduction for income taxes of $1,000) for the cumulative effect for prior years is shown in the net income for 2011.

Note 2: Inventories

Inventories are priced at cost (principally last-in, first-out [LIFO] method of determination) not in excess of replacement market. If the first-in, first-out (FIFO) method of inventory accounting had been used, inventories would have been $6,000 and $4,500 higher than reported at December 31, 2011 and December 31, 2010 respectively.

Note 3: Acquisition of TRO Company

Effective December 31, 2011, the company purchased most of the outstanding common stock of TRO Company for $8,000 in cash. The excess of the acquisition cost over fair value of the net assets acquired $2,000 will be recorded as goodwill and not amortized. The following unaudited supplemental pro forma information shows the condensed results of operations as though TRO Company had been acquired as of January 1, 2010.

3

2011 2010

Revenues. $ 205,000 172,000

Net income.. 10,700 7,400

Details of acquisition (resources and obligations assumed):

Cash $ 4,200

Accounts Receivable.. 2,000

Inventories. 2,200

Property,Plant & Equipment.. 6,000

Long-Term Debt 4,800

Accounts Payable & Accruals 3,200

Note 4: Discontinued operations

As of October 31, 2011, the board of directors adopted a plan authorizing the disposition of the assets and business of its wholly owned subsidiary, Zachary Corporation. The Loss on Disposal is $700 (net of income tax credits of $700) and is based upon the estimated realizable value of the assets to be sold plus a provision for costs of $300 for operating the business until its expected disposition in early 2012. Property, plant and equipment is reduced by $1,000 and inventories are reduced by $100 to net realizable value. The provision for costs of $300 is included in Accounts payable and accruals" and is reduced to $200 at year-end. Net sales of the operations to be discontinued are $18,000 in 2011 and $23,000 in 2010.

Note 5: Income taxes

The income tax expense consists of the following

2011 2010

Current. $ 8,400 6,800

Deferred 1,600 1,000

Total.. 10,000 7,800

The effective tax rates of 47.6% and 48 8% for 2011 and 2010, respectively, differ from the statutory federal income tax rate of 50% due to research and development tax credits of $500 in 2011 and $200 in 2010. Deferred taxes result from the use of accelerated depreciation methods for income tax reporting and the straight-line method for financial reporting.

Note 6: Long-term debt

2011 2010

10% promissory notes to institutional investors payable

in annual installments of $900 through $ 13,000 13,900

4

2015..

Unsecured notes to banks-interest 1% over prime 4,000 0

Capitalized lease obligations-payable to 2014 with an

average interest rate of 8%......................................... 1,000 0

11% subordinated note payable in annual installments of

$500 from 2012 through 5,000 0

2021

Other mortages and notes.. 4,000 2,300

27,000 16,200

Less current 2,000 1,000

maturities..

Total long-term debt.. 25,000 15,200

The various loan agreements place certain restrictions on the corporation including the payment of cash dividends on common stock and require the maintenance of working capital as defined of not less than $18, 000. Approximately $10,000 of retained earnings is available for payment of cash dividends on common stock at December 31, 2011. The corporation entered into several long-term noncancelable leases of equipment during 2011which have been capitalized for financial reporting. There are no other significant lease arrangements.

Note 7: Stockholders' equity

The corporation has 5 million shares of authorized common stock, par value $5. There are 1 million shares outstanding at December 31, 2010 and this is increased by a 10% dividend payable in common stock during 2011. The changes in retained earnings are as follows:

2011 2010

Beginning $ 27,000 22,000

balance.

Add net income 10,000 7,000

Less cash dividends.. (3,000) (2,000)

Less 10% stock dividend.. (10,000) 0

Ending balance. 24,000 27,000

Required:

1. What transactions and events explain the $7000 increase in stockholders equity for year 6?
2. Note 6 discloses, Capitalized lease obligations of $1000. What accounts are increased in Year 6, and by what amounts, to reflect these leases? Explain. How are these leases reflected in the statement of cash flows?
3. Use T-account analysis to determine how much long-term debt is paid in Year 6. Does your answer agree with the amount reported by ZETA?
4. Note 1 describes a change in accounting principle.
   1. What effect did this change in accounting have on the year 6 balance sheet and income statement?
   2. Describe the necessary adjustments in the Year 5 balance sheet and income statement for an effective comparison of year 5 with year 6.
   3. How would the $1000 cumulative effect for year 6 be reported in a statement of cash flows (direct method). (Hint: Reconstruct the accounts and amounts affected to record the $1000 effects)
5. Note 3 describes ZETAs acquisition of TRO Company.
   1. IS TRO a separate legal entity at December 31, Year 6, or is it dissolved in ZETA?
   2. What effect did the acquisition of TRO Company have at December 31, Year 6 (date of acquisition), on:
      1. ZITA balance sheet
      2. Consolidated balance sheet
   3. What are TROs revenues for Year 6?
6. For the asset Investment in associated company:
   1. Explain all changes during Year 6
   2. Identify all effects in the statement of cash flows relating to this investment
7. For the minority interest reported in the balance sheet:
   1. Explain all changes during Year 6
   2. Show how this account relates to the asset Investment in associated companies
8. If the FIFO method of inventory valuation is used (instead of LIFO) how much would year 6 net income be increased or decreased?
9. Note 4 describes discontinued operations:
   1. What accounts (and amounts) are affected on October 31, Year 6, to record the loss on disposal?
   2. What effect did the loss on disposal of $700 have on the statement of cash flows? Identify specific items and amounts.
   3. How should the discontinued operations and $1100 operating loss be reported in a statement of cash flows using the direct format, assuming we desire to include this operations amount cash inflows and outflows?
10. How is goodwill reflected in year 7 (next year) statement of cash flows?
11. Explain all changes during year 6 in the Net property, plant, and equipment account.