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Chapter 3
Accrual Accounting & Income
Short Exercises
(10 min.) S 3-1
Millions
Sales revenue…………………………………………….
960
Cost of goods sold………………………………………
(270 )
All other expenses………………………………………
(300 )
Net income………………………………………………..
$ 390
Beginning cash…………………………………………..
$ 105
Collections ($700 $30)−………………………………..
935
Payments for: inventory……………………………….
(370 )
everything else……………………….
(285 )
Ending cash………………………………………………
$ 385
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(10 min.) S 3-2
Statement Reports (Amounts in millions)Income statement Interest
expense……………….$1.8
Balance sheet Notes payable($3.9 + $2.3 $2.0)−
………….$4.2
Interest payable………………..
0.1
(10 min.) S 3-3
At the end of each accounting period, the business reports its performance through the preparation of financial statements. In order to be useful to the various users of financial statements they must be up-to-date. Accounts such as cash, Equipment, Accounts Payable, Common Stock and Dividends are up-to date and require no adjustment at the end of the accounting period. Accounts such as Accounts Receivable, Supplies, Salary Expense and Salaries Payable may not be up to date as of the last day of the accounting period. Why? Because certain transactions that took place in the month may not have been recorded.
The accrued salaries, which are owed to the employees yet have not been paid, are an expense related to the current period. The salaries that are owed to the employees but are unpaid also represent a liability or debt that is owed by the business. The business must make an adjusting entry to record the accrued salary owed as both an increase in Salary Expense and an increase in Salaries Payable. If the business does not make this adjustment the expenses will be understated and net income will be overstated. In addition, liabilities will be understated.
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(10 min.) S 3-4
The large auto manufacturer should record sales
revenue when the revenue is earned by delivering
automobiles to Acme or Harris. The large auto
manufacturer should not record any revenue prior to
delivery of the vehicles because the large auto
manufacturer hasn’t earned the revenue yet. The revenue
principle governs this decision.
When the large auto manufacturer records the revenue
from the sale, at that time —not before or after — the
large auto manufacturer should also record cost of goods
sold, the expense. The matching principle tells when to
record expenses.
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(10 min.) S 3-5
Depreciation is the periodic allocation of the cost of a
tangible long- lived asset, less its estimated residual
value, over its estimated useful life. All long- lived or
plant assets, except for land decline in usefulness during
their life and this decline is an expense. Accountants
must allocate the cost of each plant asset, except for
land, over the asset’s useful life. Depreciation is the
process of allocating the cost of a plant asset to expense.
Depreciation also decreases the book value of the asset
to reflect its usage.
(10 min.) S 3-6 a. The Matching Principle
b. The Time Period Concept
c. The Revenue Principle
d. The Revenue Principle
e. The Matching Principle
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(10 min.) S 3-7
a.
Mar. 31 Rent Expense ($4,800 × 1/6)……..
800
Prepaid Rent……………………..
800
To record rent expense.
Prepaid Rent Rent ExpenseMar. 1
4,800 Mar. 31 800 Mar. 31
800
Bal. 4,000 Bal. 800
b.
Dec. 31 Supplies Expense ($900 −$700)….
200
Supplies…………………………….
200
To record supplies expense.
Supplies Supplies ExpenseDec. 1
900 Mar. 31
200 Marc. 31
200
Bal. 700 Bal. 200
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(10 min.) S 3-8
Req. 1
(a)Jan.
1Computer Equipment…………….…..
80,000
Cash…………………………………..
80,000
Purchased computer equipment.
(b)
Dec. 31
Depreciation Expense −
Computer Equipment ($80,000 / 4)…
20,000
Accumulated Depreciation −Computer
Equipment……………...20,00
0
Req. 2
Computer Equipment
Accumulated Depreciatio
n − Computer Equipment
DepreciationExpense −Computer Equipment
Jan. 80,000
Dec. 31
20,000
Dec. 31
20,000
Bal. 80,000
Bal. 20,000
Bal. 20,000
Req. 3
Computer equipment………………………………….
$80,000
Less Accumulated depreciation…………………….
(20,000 )
Book $60,000
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value………………………………………………
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(10 min.) S 3-9
(Amounts in millions)
Income statement: 2010Salary expense ($38.3 + $2.8)
…..$41.1
Balance sheet: 2010Salary payable………………... $ 2.8
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(10 min.) S 3-10
Req. 1
Oct. 31 Interest Expense……………………………….
500
Interest Payable……………………………..
500
To accrue interest expense for October.
Nov. 30 Interest Expense……………………………….
500
Interest Payable……………………………..
500
To accrue interest expense for November.
Dec. 31
Interest Expense……………………………….
500
Interest Payable……………………………..
500
To accrue interest expense for December.
Req. 2
Interest PayableOct.
31500
Nov. 30
500
Dec. 31
500
Bal. 1,500
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Req. 3
Dec. 31
Interest Payable……………………………...
1,500
Cash…………………………………………
1,500
To pay interest.
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(10 min.) S 3-11
Req. 1
Oct. 31 Interest Receivable…………………………..
500
Interest Revenue…………………………..
500
To accrue interest revenue for October.
Nov. 30 Interest Receivable…………………………..
500
Interest Revenue……...…………………..
500
To accrue interest revenue for November.
Dec. 31 Interest Receivable…………………………..
500
Interest Revenue……...……………….…..
500
To accrue interest revenue for December.
Req. 2
Interest ReceivableOct. 31
500
Nov. 30 500Dec. 31 500Bal. 1,500
Req. 3
Dec. Cash……………………………………… 1,50
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31 …… 0Interest
Receivable………………………1,50
0To collect interest.
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(5- 10 min.) S 3-12
Unearned revenues are liabilities because The Globe and
Trail has received cash from subscribers in advance of
providing them with newspapers. Receiving the cash in
advance creates an obligation (a liability) for The Globe
and Trail. As The Globe and Trail delivers newspapers to
subscribers, The Globe and Trail earns the revenue, and
the dollar amount of the unearned revenue then goes into
the revenue account.
a. Cash…………………………………………
50,000
Unearned Subscription Revenue…...
50,000
Received cash for revenue in advance.
b. Unearned Subscription Revenue.............. ..
50,000
Subscription Revenue…………………….
50,000
To record the earning of subscriptionrevenue that was collected in advance.
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(5- 10 min.) S 3-13
Prepaid Rent at December 31:a. Unadjusted amount…………………………. $24,00
0b. Adjusted amount ($24,000 $8,000)−
……….16,000
Rent Expense at December 31:c. Unadjusted amount…………………………. $ 0d. Adjusted amount ($24,000 / 3)
……………….8,000
(10 min.) S 3-14
a. Accounts Receivable…………………….
60,000
Service Revenue……………………….
60,000
Cash…………………………………………
45,000
Accounts Receivable…………………
45,000
b. Cash…………………………………………
7,500
Unearned Service Revenue………….
7,500
Unearned Service Revenue…………….
3,500
Service Revenue……………………….
3,500
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(15- 30 min.) S 3-15
Vulture Sporting Goods CompanyIncome Statement
Year Ended March 31, 2010Thousands
Net revenues…………………………….
$ 174,000
Cost of goods sold…………………….
136,800
All other expenses……………………..
26,000
Net income………………………………
$ 11,200
Vulture Sporting Goods CompanyStatement of Retained Earnings
Year Ended March 31, 2010Thousand
sRetained earnings, March 31, 2009…...
$2,000
Add: Net income………………………..
11,200
Retained earnings, March 31, 2010.…..
$13,200
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(continued) S 3-15
Vulture Sporting Goods CompanyBalance SheetMarch 31, 2010
ThousandsASSETS
Current:
Cash………………………………………
$ 1,300
Accounts receivable…………………..
28,200
Inventories………………………………
37,000
Other current assets…………………..
5,200
Total current assets………………..
71,700
Property and equipment, net……………
6,000
Other assets……………………………….
28,0 00
Total assets…………………………………...
$105,700
LIABILITIESTotal current
liabilities…………………..$53,00
0Long-term liabilities………………….
….. 12,5
00Total liabilities………………………………..
65,500
STOCKHOLDERS’ EQUITYCommon
stock……………………………27,000
Retained earnings………………………..
13,2 00
Total stockholders’ equity………….….......
40,2 00
Total liabilities and stockholders’ equity..
$105,700
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(5- 10 min.) S 3-16
CLOSING ENTRIESThousands
Mar. 31
Net Revenues…………………………
174,000
Retained Earnings………………...
174,000
31
Retained Earnings……………………
162,800
Cost of Goods Sold……………….
136,800
All Other Expenses………………..
26,000
Retained EarningsMar. 31, 2010 Expenses
162,800
Mar. 31, 2009 Bal. 2,000
Mar. 31, 2010 Revenues
174,000
Mar. 31, 2010 Bal. 13,200
Retained Earnings’ ending balance agrees with the
amount reported on the statement of retained earnings
and the balance sheet (in S 3-15).
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(5 min.) S 3-17
Req. 1
(Dollars in thousands)
Current ratio =
Total current assets
=
$71,700 = 1.3
5Total current liabilities
$53,000
Req. 2
Debt ratio =
Total liabilities
=
$65,500 = 0.6
2Total assets $105,700
These ratio values are neither strong nor weak. They are
middle- of-the- road values.
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(10 min.) S 3-18
1. Earned revenue of $8,000 on account:
a. Current ratio =
$71,700 + $8,000 = 1.50
$53,000
b. Debit ratio =
$65,500= 0.58$105,700 +
$8,000
2. Paid accounts payable of $8,000:
a. Current ratio =
$71,700 − $8,000 = 1.42$53,000 − $8,000
b. Debit ratio =
$65,500 − $8,000 = 0.59$105,700 − $8,000
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Exercises
Group A
(5- 10 min.) E 3-19A
Statement Reports1. Income statement Sales
revenue…………$4,10
0Operating expenses…
1,400
Balance sheet Accounts receivable…
$ 700
Accounts payable……
1,300
2. Cash basis would report only the cash collections of $4,900 from customers and the payment of operating expenses ($1,400). Their balance sheet should have included neither accounts receivable nor accounts payable.
(5- 10 min.) E 3-20A
a. Cash Basis b. Accrual Basis
Revenues…………………...
$590,000 $580,000
Expenses…………………...
460,000 480,000
Net income…………………
$130,000 $ 100,000
The accrual basis measures net income better because
its information on revenues and expenses is more
complete than the information provided by the cash basis.
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(5- 10 min.) E 3-21A
Million
a. Revenue……………………………………………….
$800
The revenue principle says to record revenue when it has been earned , regardless of when cash is collected. Therefore, report the amount of revenue earned, regardless of when the company collects cash.
b. Total expense…………………………………….…..
$590
The matching principle governs accounting for expenses.
c. The income statement reports revenues and expenses.The statement of cash flows reports cash receipts and cash payments.
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(15- 20 min.) E 3-22A
Req. 1
Adjusting EntriesDATE ACCOUNT TITLES DEBIT CREDIT
a. Insurance Expense……………………………...
1,000
Prepaid Insurance ($500+$1,500−$1,000)..
1,000
b. Interest Receivable………………………...……
1,100
Interest Revenue…………………………......
1,100
c. Unearned Service Revenue ($1,200 −$400)..
800
Service Revenue……………………………
800
d. Depreciation Expense……………………..…..
4,900
Accumulated Depreciation………………...
4,900
e. Salary Expense ($14,000 × 3/5)………………
8,400
Salary Payable……………………….…..…..
8,400
f. Income Tax Expense ($22,000 × .25)……..…
5,500
Income Tax Payable…………………..…….
5,500
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(continued) E 3-22A
Req. 2
Net income understated by omission of:
Interest revenue……………………………..
$ 1,100
Service revenue……………………………...
800
Total understatement……………………….
$ 1,900
Net income overstated by omission of:Insurance
expense………………………….$1,000
Depreciation expense………………………
4,900
Salary expense………………………………
8,400
Income tax expense…………………………
5,500
Total overstatement…………………………
19,800
Overall effect — net income overstated by..
$17,90 0
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(10- 15 min.) E 3-23A
Missing amounts in italics .
1 2 3 4Beginning Supplies $ 100 $600 $
1,400$ 900
Add: Payments for supplies
during the year 1,300 600 800
700
Total amount to account for
1,400 1,200 2,200 1,600
Less: Ending Supplies (200 )
(200 )
(1,00 0 )
(300 )
Supplies Expense $ 1,200 $1,000 $ 1,200
$1,300
Journal entries:
Situation 1:
Supplies……………………………
1,300
Cash………………………….….
1,300
Situation 2:
Supplies Expense………………..
1,000
Supplies………………………...
1,000
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(10- 20 min.) E 3-24A
Adjusting EntriesDATE ACCOUNT TITLES DEBIT CREDIT
a. Interest Expense………………………………
9,500
Interest Payable…………………………….
9,500
b. Interest Receivable……………………………
4,500
Interest Revenue…………………….……..
4,500
c. Unearned Rent Revenue ($13,600 / 2 × 6/12)
3,400
Rent Revenue……………………………….
3,400
d. Salary Expense ($1,800 × 3)………………....
5,400
Salary Payable………………………………
5,400
e. Supplies Expense……………………………..
2,100
Supplies ($3,300 1,200)−……………….….
2,100
f. Depreciation Expense ($100,000 / 5)………...
20,000
Accumulated Depreciation……………….
20,000
Book value = $80,000 ($100,000 $20,000)−
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(10- 20 min.) E 3-25A
Accounts Receivable Supplies1,600 600 (a) 500
(c) 800 Bal. 100Bal. 2,400
Salary Payable Unearned Service Revenue
(b) 300 (d) 200 900Bal. 300 Bal. 700
Service Revenue Salary Expense4,800 2,500
(c) 800 (b) 300(d) 200 Bal. 2800Bal. 5,800
Supplies Expense(a) 500Bal. 500
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(20- 30 min.) E 3-26A
Delicious Hams, Inc.Income Statement
Year Ended December 31, 2010Thousands
Revenues:Sales revenue………………...
$41,400
Expenses:Cost of goods
sold…………..$25,10
0Selling, administrative,
andgeneral
expense………….. 10,70
0Total
expenses……………. 35,80
0Income before tax………………
5,600
Income tax expense…………….
2,30 0
Net income……………………….
$ 3,300
Delicious Hams, Inc..Statement of Retained EarningsYear Ended December 31, 2010
ThousandsRetained earnings, December 31, 2009…
$4,700
Add: Net income ………………………….
3,300
8,000Less:
Dividends……………………………. (1,500 )
Retained earnings, December 31, 2010…
$6,500
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(continued) E 3-26A
Delicious Hams, Inc.Balance Sheet
December 31, 2010Thousands
ASSETS LIABILITIESCash…………………………
….$
3,800 Accounts payable………
$ 7,600
Accounts receivable…………
1,500 Income tax payable……..
600
Inventories…………………….
1,100 Other liabilities…………..
2,20 0
Prepaid expenses…………….
1,700 Total liabilities…………...
10,400
Prop., plant, equip.
$ 6,500 STOCKHOLDERS’
Less: Accum. EQUITY deprec…… .
(2,300 )
4,200 Common stock…………..
4,700
Other assets…………………..
9,300 Retained earnings………
6,50 0
Total stockholders’ equity
11,20
Total liabilities and
Total assets……………………
$21,600
stockholders’ equity...
$21,600
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(10- 20 min.) E 3-27A
One mechanism for solving this exercise is to prepare the
relevant T-accounts, insert the given information, and
solve for the unknown amounts, shown in italics .
Amounts in millions
ReceivablesBeg. bal. 270Sales revenue 20,200 Collections 20,08
0End. bal. 390
Prepaid InsuranceBeg. bal. 160
Payment 420Insurance expense 39
0End. bal. 190
Accrued Liabilities PayableBeg. bal. 610
Payments 4,100Other operating
expenses 4,220End. bal. 730
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(10 min.) E 3-28A
Req. 1
Mother Meghan’s income statement:Service revenue ($6,000 × 1/2)
………………….....$3,000
Mother Meghan’s balance sheet:Unearned service revenue ($6,000 × 1/2)
………..$3,000
Req. 2
Boston’s income statement:Medical expense ($6,000 × 1/2)
……………………$3,000
Boston’s balance sheet:Prepaid medical expense ($6,000 × 1/2)
…………$3,000
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(10- 15 min.) E 3-29A
Req. 1
Millions
Income statementService revenue (£460 £110)−
……………………£350
Balance sheetUnearned service
revenue………………………...£110
Req. 2
Income statementService revenue (£55 + £460 £110)−
…………….£405
Balance sheetUnearned service
revenue………………………...£110
Service revenue is greater in (2) because Nanofone
began the year owing more phone service to customers.
With collections for the year and the amount of the ending
liability unchanged, Nanofone must have earned more
revenue in situation 2 than in situation 1.
Not required but helpful:
Unearned Service RevenueBeg. bal. 55
Earned revenue
405
Collected cash
460
End. bal. 110
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(10- 20 min.) E 3-30A
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Closing EntriesDec.
31 Service Revenue…………………………
24,000
Other Revenue……………………………
300
Retained Earnings…………………….
24,300
31 Retained Earnings……………………….
23,600
Cost of Services Sold………………...
11,300
Selling, General, and Administrative
Expense……………………………...
6,700
Depreciation Expense………………..
4,800
Income Tax Expense………………….
800
31 Retained Earnings……………………….
600
Dividends…………………………….…
600
Net income for 2010 was $700 ($24,300 $23,600).−
Retained EarningsDec. 31, 2009
2,100
Dividends
600 Net income 700
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Dec. 31, 2010
2,200
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(15- 25 min.) E 3-31A
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT
CREDIT
Adjusting EntriesDec. 31 Unearned Service
Revenue……………….6,500
Service Revenue ($20,100 −$13,600)...
6,500
31 Salary Expense ($5,100 $4,600)−………...
500
Salary Payable……………………….…...
500
31 Rent Expense ($1,300 $1,000)−…………..
300
Prepaid Rent………………………………
300
31 Depreciation Expense ($400 $0)−………..
400
Accumulated Depreciation……………..
400
31 Income Tax Expense ($1,000 $0)−……….
1,000
Income Tax Payable……………………..
1,000
Closing Entries31 Service
Revenue…………………………….20,10
0Retained
Earnings……………………….20,10
0
31 Retained Earnings…………………………..
7,800
Salary Expense…………………………...
5,100
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Rent Expense……………………………..
1,300
Depreciation Expense…………………...
400
Income Tax Expense…………………….
1,000
31 Retained Earnings…………………………..
1,300
Dividends…………………………….……
1,300
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(20- 30 min.) E 3-32A
Req. 1
Draper Production CompanyBalance Sheet
December 31, 2009ASSETS
Current:Cash…………………………………..…….... $14,800
Prepaid rent ($1,000 $300)……..……….− 700Total current assets…………..…….….. 15,500
Plant:
Equipment…………………………………...
$44,000
Less accumulated depreciation($3,100 + $400)…………………….
…….. (3,500 )
40,50 0
Total assets……………………………………… $56,000
LIABILITIESCurrent:
Accounts payable………………………….. $ 5,100
Salary payable ($5,100 $4,600)………− 500Unearned service revenue ($9,300 $6,500)− 2,800Income tax payable……………………..…. 1,00
0Total current liabilities……………….... 9,400
Note payable, long-term…………………..… 13,000Total liabilities……………………………….… 22,400
STOCKHOLDERS’ EQUITYCommon stock………………………………… 8,500Retained earnings
($14,100+$20,100 $5,100 $1,300 $400− − − $1,000 $1,300)…….……………………− − 25,10
0Total stockholders’ equity………………… 33,600 Total liabilities and stockholders’ equity… $56,000
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(continued) E 3-32A
Req. 2
CurrentYear
PriorYear
Current ratio
=
Total current assets
=
$15,500 = 1.65 1.70Total current
liabilities$9,400
The ability to pay current liabilities with current assets deteriorated.
Debt ratio =
Total liabilities
=
$22,400 = 0.40 0.30Total assets $56,000
The overall ability to pay total liabilities deteriorated a little.
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(30 min.) E 3-33A
a. Current ratio =
$30= 1.6
7Debt ratio =
$30 + 8= 0.56$10 +
$8$60 + $8
The purchase of equipment on account hurts both ratios.
b. Current ratio =
$30 − $11 = .95 Debt
ratio =
$30 − $11 = 0.39$20 $60 − $11
The payment of long-term debit hurts the current ratio and improves the debt ratio.
c. Current ratio = $30 + $6 = 1.3
8Debt ratio = $30 + $6 = 0.55$20 + $6 $60 + $6
Collecting cash in advance hurts both ratios.
d. Current ratio = $30 = 1.3
0Debt ratio = $30 + $3 = 0.55$20 + $3 $60
Accruing an expense hurts both ratios.
e. Current ratio =
$30 + $11= 2.0
5 Debt ratio =$30
= .42$20 $60 + $11
A cash sale improves both ratios.
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Exercises
Group B
(5- 10 min.) E 3-34B
Statement Reports1. Income statement Sales
revenue…………$4,80
0Operating expenses…
1,100
Balance sheet Accounts receivable…
$ 300
Accounts payable……
500
2. Cash basis would report only the cash collections of $4,900 from customers and the payment of operating expenses ($1,100).The balance sheet would include neither accounts receivable nor accounts payable.
(5- 10 min.) E 3-35B
a. Cash Basis b. Accrual Basis
Revenues…………………...
$580,000 $510,000
Expenses…………………...
440,000 470,000
Net income…………………
$140,000 $ 40,000
The accrual basis measures net income better because
its information on revenues and expenses is more
complete than the information provided by the cash basis.
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(5- 10 min.) E 3-36B
Million
a. Revenue……………………………………………….
$740
The revenue principle says to record revenue when it has been earned , regardless of when cash is collected. Therefore, report the amount of revenue earned, regardless of when the company collects cash.
b. Total expense…………………………………….…..
$560
The matching principle governs accounting for expenses.
c. The income statement reports revenues and expenses.The statement of cash flows reports cash receipts and cash payments.
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(15- 20 min.) E 3-37B
Req. 1
Adjusting EntriesDATE ACCOUNT TITLES DEBIT CREDIT
a. Insurance Expense……………………………...
1,600
Prepaid Insurance ($800+$2,400-$1,600)…
1,600
b. Interest Receivable…………………..…………
1,000
Interest Revenue……………………..……...
1,000
c. Unearned Service Revenue ($1,500 −$400)..
1,100
Service Revenue……………………..………
1,100
d. Depreciation Expense…………………..……..
4,600
Accumulated Depreciation…………..…….
4,600
e. Salary Expense ($16,000 × 3/5)………….……
9,600
Salary Payable……………………….…..…...
9,600
f. Income Tax Expense ($21,000 × .25)…………
5,250
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Income Tax Payable………………………….
5,250
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(continued) E 3-37B
Req. 2
Net income understated by omission of:
Interest revenue……………………………..
$ 1,000
Service revenue……………………………...
1,100
Total understatement……………………….
$ 2,100
Net income overstated by omission of:Insurance
expense………………………….$1,600
Depreciation expense………………………
4,600
Salary expense………………………………
9,600
Income tax expense…………………………
5,250
Total overstatement…………………………
21,050
Overall effect — net income overstated by..
$18,95 0
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(10- 15 min.) E 3-38B
Missing amounts in italics .
1 2 3 4Beginning Supplies $ 100 $400 $
1,200$ 800
Add: Payments for supplies
during the year 1,400 1,000 800 800 Total amount to account for
1,500 1,400 2,000 1,600
Less: Ending Supplies (400 )
(500 )
(700 ) (500 )
Supplies Expense $ 1,100
$ 900 $ 1,300 $1,100
Journal entries:
Situation 1:
Supplies……………………………
1,400
Cash………………………….….
1,400
Situation 2:
Supplies Expense………………..
900
Supplies………………………...
900
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(10- 20 min.) E 3-39B
Adjusting EntriesDATE ACCOUNT TITLES DEBIT CREDIT
a. Interest Expense………………………………
9,200
Interest Payable…………………………….
9,200
b. Interest Receivable……………………………
4,200
Interest Revenue…………………….……..
4,200
c. Unearned Rent Revenue ($12,600 / 2 × 6/12)
3,150
Rent Revenue……………………………….
3,150
d. Salary Expense ($1,900 × 3)………………....
5700
Salary Payable………………………………
5,700
e. Supplies Expense……………………………..
1,400
Supplies ($2,600 1,200)−……………….….
1,400
f. Depreciation Expense ($160,000 / 5)………...
32,000
Accumulated Depreciation……………….
32,000
Book value = $128,000 ($160,000 $32,000)−
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(10- 20 min.) E 3-40B
Accounts Receivable Supplies1,200 300 (a) 100
(c) 800 Bal. 200Bal. 2,000
Salary Payable Unearned Service Revenue
(b) 600 (d) 100 800Bal. 600 Bal. 700
Service Revenue Salary Expense4,400 1,900
(c) 800 (b) 600(d) 100 Bal. 2,500Bal. 5,300
Supplies Expense(a) 100Bal. 100
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(20- 30 min.) E 3-41B
Holiday Hams, Inc.Income Statement
Year Ended December 31, 2010Thousands
Revenues:Sales revenue………………...
$39,900
Expenses:Cost of goods
sold…………..$25,40
0Selling, administrative,
andgeneral
expense………….. 10,40
0Total
expenses……………. 35,80
0Income before tax………………
4,100
Income tax expense…………….
2,40 0
Net income……………………….
$ 1,700
Holiday Hams, Inc.Statement of Retained EarningsYear Ended December 31, 2010
ThousandsRetained earnings, December 31, 2009…
$4,700
Add: Net income ………………………….
1,700
6,400Less:
Dividends……………………………. (1,200 )
Retained earnings, December 31, 2010…
$5,200
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(continued) E 3-41B
Holiday Hams, Inc.Balance Sheet
December 31, 2010Thousands
ASSETS LIABILITIESCash…………………………
….$
3,500 Accounts payable………
$ 7,900
Accounts receivable…………
1,700 Income tax payable……..
900
Inventories…………………….
1,200 Other liabilities…………..
2,70 0
Prepaid expenses…………….
1,600 Total liabilities…………...
11,500
Prop., plant, equip.
$ 6,700 STOCKHOLDERS’
Less: Accum. EQUITY deprec…… .
(2,700 )
4,000 Common stock…………..
4,800
Other assets…………………..
9,500 Retained earnings………
5,20 0
Total stockholders’ equity
10,00
Total liabilities and
Total assets……………………
$21,500
stockholders’ equity...
$21,500
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(10- 20 min.) E 3-42B
One mechanism for solving this exercise is to prepare the
relevant T-accounts, insert the given information, and
solve for the unknown amounts, shown in italics .
Amounts in millions
ReceivablesBeg. bal. 250Sales revenue 20,68
0Collections 20,60
0End. bal. 330
Prepaid InsuranceBeg. bal. 130
Payment 450Insurance expense 44
0End. bal. 140
Accrued Liabilities PayableBeg. bal. 600
Payments 4,100Other operating
expenses 4,260End. bal. 760
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(10 min.) E 3-43B
Req. 1
Mother Elizabeth’s income statement:Service revenue ($9,600 × 1/2)
………………….....$4,800
Mother Elizabeth’s balance sheet:Unearned service revenue ($9,600 × 1/2)
………..$4,800
Req. 2
Portland’s income statement:Medical expense ($9,600 × 1/2)
……………………$4,800
Boston’s balance sheet:Prepaid medical expense ($9,600 × 1/2)
…………$4,800
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(10 min.) E 3-44B
Req. 1
Millions
Income statementService revenue (£400 £105)−
……………………£295
Balance sheetUnearned service
revenue………………………...£105
Req. 2
Income statementService revenue (£95 + £400 £105)−
…………….£390
Balance sheetUnearned service
revenue………………………...£105
Service revenue is greater in (2) because Direct began
the year owing more phone service to customers. With
collections for the year and the amount of the ending
liability unchanged, Direct must have earned more
revenue in situation 2 than in situation 1.
Not required but helpful:
Unearned Service RevenueBeg. bal. 95
Earned revenue
390
Collected cash
400
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(10- 20 min.) E 3-45B
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Closing EntriesDec.
31 Service Revenue…………………………
24,100
Other Revenue……………………………
500
Retained Earnings…………………….
24,600
31 Retained Earnings……………………….
22,500
Cost of Services Sold………………...
11,200
Selling, General, and Administrative
Expense……………………………...
6,100
Depreciation Expense………………..
4,800
Income Tax Expense………………….
400
31 Retained Earnings……………………….
900
Dividends…………………………….…
900
Net income for 2010 was $2,100 ($24,600 $22,500).−
Retained EarningsDec. 31, 2009 2,400
Dividends
900 Net income 2,100
Dec. 31, 2010 3,600
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(15- 25 min.) E 3-46B
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Adjusting EntriesDec. 31 Unearned Service
Revenue……………….6,500
Service Revenue ($19,900 −$13,400)...
6,500
31 Salary Expense ($4,900 $4,500)−………...
400
Salary Payable……………………….…...
400
31 Rent Expense ($1,400 $900)−…………..
500
Prepaid Rent………………………………
500
31 Depreciation Expense ($600 $0)−………..
600
Accumulated Depreciation……………..
600
31 Income Tax Expense ($1,700 $0)−……….
1,700
Income Tax Payable……………………..
1,700
Closing Entries31 Service
Revenue…………………………….19,90
0Retained
Earnings……………………….19,90
0
31 Retained Earnings…………………………..
8,600
Salary Expense…………………………...
4,900
Rent 1,400
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Expense……………………………..Depreciation
Expense…………………...600
Income Tax Expense…………………….
1,700
31 Retained Earnings…………………………..
1,000
Dividends…………………………….……
1,000
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(20- 30 min.) E 3-47B
Req. 1
Wallace Production CompanyBalance Sheet
December 31, 2009ASSETS
Current:Cash…………………………………………………..
….$13,600
Prepaid rent ($1,100 $500)−………………………....
600
Total current assets………………………………..
14,200
Plant:
Equipment…………………………………..
$48,000
Less accumulated depreciation($3,800 + $300)…………………….
….. (4,200 )
43,80 0
Total assets………………………………………………….
$58,000
LIABILITIESCurrent:
Accounts payable……………………………………….
$ 4,400
Salary payable ($4,900 $4,500)−…………………..…
400
Unearned service revenue($8,500 $6,500)−
……………………………………...2,000
Income tax payable…………………………………..…
1,70 0
Total current liabilities………………………………
8,500
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Note payable, long-term…………………………………..
10,000
Total liabilities………………………………………………
18,500
STOCKHOLDERS’ EQUITYCommon stock……………………………………………...
8,400
Retained earnings($20,800 + $19,900 $4,900 $1,400 − − −$600
$1,700 $1,000)…….− −…………………………………
31,10 0
Total stockholders’ equity…………………………….….
39,50 0
Total liabilities and stockholders’ equity………………
$58,000
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(continued) E 3-47B
Req. 2
CurrentYear
PriorYear
Current ratio
=
Total current assets
=
$14,200 = 1.67 1.45Total current
liabilities$8,500
The ability to pay current liabilities with current assets improved.
Debt ratio =
Total liabilities
=
$18,500 = 0.32 0.35Total assets $58,000
The overall ability to pay total liabilities improved a little.
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(30 min.) E 3-48B
a. Current ratio = $40 = 1.11 Debt ratio = $30 + 6 = 0.55$30 + $6 $60 + $6
The purchase of equipment on account hurts both ratios.
b. Current ratio =
$40 − $11 = .97 Debt ratio =
$30 − $11 = 0.39$30 $60 − $11
The payment of long-term debit hurts the current ratio and improves the debt ratio.
c. Current ratio = $40 + $8 = 1.26 Debt ratio = $30 + $8 = 0.56$30 + $8 $60 + $8
Collecting cash in advance hurts both ratios.
d. Current ratio = $40 = 1.08 Debt ratio = $30 + $7 = 0.62$30 + $7 $60
Accruing an expense hurts both ratios.
e. Current ratio =
$40 + $11 = 1.7 Debt ratio =
$30
= 0.42$30 $60 + $11
A cash sale improves both ratios.
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Serial Exercises
(3 hours) E 3-49
Reqs. 1, 3, 6, and 8
Cash Accounts ReceivableMar.
27,000 Mar.
2600 Mar.
182,100 Jan.
282,100
9 1,200 3 2,400 Bal. 021 1,800 12 300 Adj. 1,60028 2,100 26 500 Bal. 1,600
31 1,400Bal. 6,900
Supplies EquipmentMar. 5
500 Adj. 400 Mar. 3
2,400
Bal. 100
Accumulated Depreciation –
Equipment FurnitureAdj. 40 Mar.
47,500
Accumulated Depreciation –
Furniture Accounts PayableAdj. 125 Mar.
26500 Mar.
47,500
5
500
Bal. 7,500
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(continued) E 3-49
Reqs. 1, 3, 6, and 8
Salary Payable Unearned Service RevenueAdj. 600 Adj. 600 Mar.
211,800
Bal. 1,200
Common Stock Retained EarningsMar. 2
7,000 Clo. 2,065 Clo. 5,500
Clo. 1,400Bal. 2,03
5
Dividends Service RevenueMar. 31
1,400 Clo. 1,400 Mar. 9
1,200
18
2,100
Bal. 3,300
Adj. 1,600
Adj. 600Clo. 3,800 Bal. 5,50
0
Rent Expense Utilities ExpenseMar. 2
600 Clo. 600 Mar. 12
300 Clo. 300
Salary ExpenseDepreciation Expense –
EquipmentAdj. 600 Clo. 600 Adj. 40 Clo. 40
Depreciation Expense –Furniture Supplies Expense
Adj. 125 Clo. 125 Adj. 400 Clo. 400
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(continued) E 3-49
Req. 2
March 2 through 18 entries are repeated from Solution to Exercise 2-36.
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Mar. 2
Cash……………………………………..
7,000
Common Stock……………………..
7,000
2
Rent Expense…………………………..
600
Cash…………………………………..
600
3
Equipment………………………………
2,400
Cash…………………………………..
2,400
4
Furniture………………………………..
7,500
Accounts Payable………………….
7,500
5
Supplies…………………………………
500
Accounts Payable………………….
500
9
Cash……………………………………..
1,200
Service Revenue……………………
1,200
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12 Utilities Expense………………………
300
Cash…………………………………..
300
18 Accounts Receivable…………………
2,100
Service Revenue……………………
2,100
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(continued) E 3-49
Req. 2
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Mar.
21 Cash……………………………………..
1,800
Unearned Service Revenue………
1,800
21 No entry; no transaction yet
26 Accounts Payable…………………….
500
Cash………………………………….
500
28 Cash……………………………………..
2,100
Accounts Receivable……………
2,100
31 Dividends………………………………
1,400
Cash………………………………….
1,400
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(continued) E 3-49Reqs. 4 and 5
Jerome Smith, Certified Public Accountant, P.C.Adjusted Trial Balance
March 31, 2009TRIAL BALANCE ADJUSTMENTS ADJUSTED TRIAL
BALANCEACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
Cash 6,900 6,900Accounts receivable 0 (a) 1,600 1,600Supplies 500 (c) 400 100Equipment 2,400 2,400Accumulated depr. – equip. — (d1) 40 40Furniture 7,500 7,500Accumulated depr. – furn. — ( d2) 125 125Accounts payable 7,500 7,500Salary payable — (e) 600 600Unearned service revenue 1,800 (b) 600 1,200Common stock 7,000 7,000Retained earnings — —Dividends 1,400 1,400Service revenue 3,300 (a)1,600 5,500
(b) 600Rent expense 600 600Utilities expense 300 300Salary expense (e) 600 600Depreciation expense – equip.
(d1) 40 40
Depreciation expense – furn.
(d2) 125 125
Supplies expense (c) 400 400 19,600 19,600 3,365 3,365 21,965 21,965
Chapter 3 Accrual Accounting & Income 233
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(continued) E 3-49
Req. 6
Journal DATE ACCOUNT TITLES AND EXPLANATION DEBIT
CREDIT
Adjusting Entries(a) Mar.
31 Accounts Receivable…………………..
1,600
Service Revenue……………………..
1,600
(b) 31 Unearned Service Revenue…………
600
Service Revenue……………………..
600
(c) 31 Supplies Expense ($500 $100)−……..
400
Supplies………………………………..
400
(d1) 31 Depreciation Expense – Equipment…
40
Accumulated Depreciation – Equip
40
(d2) 31 Depreciation Expense – Furniture…
125
Accumulated Depreciation – Furn..
125
(e) 31 Salary Expense………………………….
600
Salary Payable………………………..
600
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(continued) E 3-49
Req. 7
Jerome Smith, Certified Public Accountant, P.C.Income Statement
Month Ended March 31, 2009Revenues:
Service revenue $5,500
Expenses:Salary expense $600Supplies expense 400Rent expense 600Utilities expense 300Depreciation expense –
furniture40
Depreciation expense – equipment
12 5
Total expenses 2,06 5
Net income $3,435
Jerome Smith, Certified Public Accountant, P.C.Statement of Retained Earnings
Month Ended March 31, 2009Retained earnings, March 1, 2010 $ 0Add: Net income 3,435
3,435Less: Dividends (1,400 )Retained earnings, March 31, 2010 $ 2,035
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(continued) E 3-49
Req. 7
Jerome Smith, Certified Public Accountant, P.C.Balance SheetMarch 31, 2009
ASSETS LIABILITIESCurrent assets: Current liabilities:
Cash $ 6,900
Accounts payable $ 7,500
Accounts receivable 1,600 Salary payable 600Supplies 10
0Unearned service
Total current assets
8,600 revenue 1,200
Plant assets: Total current liabilities 9,300Equipment $2,400
Less accum. STOCKHOLDERS’ EQUITYdepr.
(40 )2,360 Common stock 7,000
Furniture $7,500 Retained earnings 2,035Less accum. Total stockholders’
equity9,035
depr. (125)
7,37 5
Total liabilities and ______
Total assets $18,335
stockholders' equity $18,335
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(continued) E 3-49
Req. 8
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Closing EntriesMar.
31 Service Revenue…………………………..
5,500
Retained Earnings……………………..
5,500
31 Retained Earnings………………………..
2,065
Rent Expense…………………………..
600
Utilities Expense……………………….
300
Salary Expense…………………………
600
Depreciation Expense – Equipment..
40
Depreciation Expense – Furniture….
125
Supplies Expense……………………...
400
31 Retained Earnings………………………..
1,400
Dividends………………………………..
1,400
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(continued) E 3-49
Req. 9
Current ratio =
Total current assets
=
$8,600 = 0.92Total current
liabilities$9,30
0
Debt ratio =
Total liabilities =
$9,300
= 0.51Total assets $18,33
5
These ratios indicate a weak financial position. The
business has only $0.92 in current assets for every $1.00
of current liabilities. It could face serious trouble in
paying current liabilities with current assets. The debt
ratio of 51% is not too high, which suggests that, overall,
the business should be able to pay its debts — if it can
generate enough cash to get its current ratio higher.
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Challenge Exercises
(20- 25 min.) E 3-50
(Dollar amounts in thousands)
December 31, 2010
Current=
$1,800 + $5,300 + $2,300 + $1,100 =
$10,500= 1.78
ratio $2,800 + $1,100 + $2,000 $5,900
December 31, 2011
Current=
$400 1 + $6,500 2 + $2,300 3 + $700 4 =
$9,900= 2.11
ratio $1,300 5 + $1,100 6 + $2,300 7 $4,700_____Computations of December 31, 2010 balances:
1Cash = $1,800 $7,400 + $7,500 $1,500 = $400− −
2Receivables = $5,300 + $8,700 $7,500 = $6,500−
3No change in the Inventory balance.
4Prepaid expenses = $1,100 $400 = $700−
5Accounts payable = $2,800 $1,500 = $1,300−
6No change in the Unearned Revenues balance.
7Accrued expenses payable = $2,000 + $300 = $2,300
Conclusion: Worthy Hill’s current ratio improved during 2010. The company’s current ratio is very strong.
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(60 min.) E 3-51
a. Net income: Service revenue:($160,000 + $1,620 +
$32,000).$193,620
Expenses:Salary ($34,000 + $3,200)
………$ 37,200
Depreciation – building………..
2,500
Supplies…………………………..3,600
Insurance…………………………1,200
Advertising……………………….7,600
Utilities…………………………… 2,100 54,20
0Net income…………………………..
$139,420
b. Total assets:
Cash…………………………………..
16,600
Accounts receivable($7,000 + $32,000)
………….....39,000
Supplies ($4,200 $3,600)−………..
600
Prepaid insurance($3,400 $1,200)−
………………...2,200
Building………………………………
$107,000
Less: Accum. Depr.($15,000 + $2,500)………….
…… (17,500
)89,500
Land…………………………………..
52,00 0
Total assets………………….…..
$199,900
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(continued) E 3-51
c. Totalliabilities: Accounts
payable……………………. $ 6,500
Salary payable…………………………
3,200
Unearned service revenue($5,400 $1,620)−
…………………... 3,780
Total liabilities…………………………
$ 13,480
d. Total stock-holders’equity: Common
stock………………………... $ 14,000
Retained earnings, beginning….…...
45,000
Add: Net income….…………………...
139,420 198,420
Less:
Dividends......... .. .. ... .. .. .. .. . .. .. .
(12,00 0)
Total stockholders’ equity…………..
$186,420
e. Total assets
= Total liabilities + Total stockholders’ equity
$199,900 = $13,480 + $186,420
Chapter 3 Accrual Accounting & Income 241
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Quiz
Q3-52
b
Q3-53
b
Q3-54
d
Q3-55
b
Q3-56
b
Q3-57
a
Q3-58
b
Q3-59
b
Q3-60
b ($2,700 × 9/12 = $2,025)
Q3-61
a $2,000 + $26,000 $17,000−
= revenue of $11,000
Q3-62
c
Q3-63
d
Q3-64
b
Q3-65
d
Q3-66
c Current ratio
= $29,333 / $24,800
= 1.183 to 1
Debt ratio =
$24,800 + $112,738 = .635 to 1$29,333 + $187,430
Q3- $7,39 ($7,500 $660 $100 + $950 $300)− − −
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67 0
Q3-68
b Salary Payable
Beg. bal. 28,000Payment 139,00
0Salary exp. 126,00
0End. bal. 15,000
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Problems
Group A
(15- 20 min.) P 3-69A
(All amounts in millions)
1. $41 – x = $5 ; x = $36
2. Revenues……………..
$41
Expenses……………..
36
Net income…………...
$ 5
3. Beginning receivables………
$ 4
Add:Sales…………………..
41
Less:Collections…………...
(23 )
Ending receivables………….
$18
Balance sheetASSETS
Current assets:
Receivables………….$ 18
4. Beginning accounts payable……….
$ 8
Add:Expenses………………………
36
Less:Payments……………………...
(41 )
Ending accounts payable……………
$ 3
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Balance sheetLIABILITIES
Current liabilities:Accounts
payable…………… $ 3
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(20- 30 min.) P 3-70A
Req. 1
Elders ConsultingAmount of Revenue (Expense) for August
Date Cash Basis Accrual Basis
Aug. 1 Expense $(500 ) $ 0 4 Expense (800 ) 0 5 Revenue 700 700 8 Expense (500 ) (500 )11 Revenue 0 3,50019 0 024 Revenue 3,500 026 Expense (1,700 ) 029 Expense (800 ) (800 )31 Expense 0 $500 ÷ 5 = (100)31 Revenue
0 600
Req. 2Income (loss) before tax
$ (100 ) $3,400
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(continued) P 3-70A
Req. 3
The accrual- basis measure of net income is preferable
because it accounts for revenues and expenses when
they occur, not when they are received or paid in cash.
For example, on August 11, the company earned $3,500
of revenue and increased its wealth as a result. The
accrual basis records this revenue, but the cash basis
ignores it. On August 24, the business collected the
receivable that was created by the revenue earned on
account at August 11. The accrual basis records no
revenue on August 24 because the company’s increase in
wealth occurred back on August 11. The cash basis waits
until cash is received, on August 24, to record the
revenue. This is too late.
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(10- 20 min.) P 3-71A
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Dec.
31 a. Insurance Expense…………………..
3,200 *
Prepaid Insurance……………......
3,200
To record insurance expense.
31 b. Salary Expense ($6,100 × 2/5)……..
2,440
Salary Payable…………………….
2,440
To accrue salary expense.
31 c. Interest Receivable………………….
400
Interest Revenue………………….
400
To accrue interest revenue.
31 d. Supplies Expense……………………
6,900 **
Supplies…………………………….
6,900
To record supplies expense.
31 e. Unearned Service Revenue($12,000 × 7/12)
……………………...8,400
Service Revenue…………….……
8,400
To record revenue that was collected in advance.
31 f. Depreciation – Office Furniture……
3,000
Depreciation Expense – Equipment
5,400
Accumulated Depreciation –Office
Furniture………………...3,000
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Accumulated Depreciation –
Equipment……………………….5,400
To record depreciation expense.
_____ * $ 900 + $3,600 $1,300= $3,200 − ** $2,700 + $6,400 $2,200 = $6,900−
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(45- 60 min.) P 3-72AReq. 1
London, Inc.Adjusted Trial Balance
December 31, 2010TRIAL BALANCE ADJUSTMENTS ADJUSTED TRIAL
BALANCEACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
Cash 8,900 8,900Accounts receivable 1,200 (a) 2,100 3,300Prepaid rent 2,400 (b) 800* 1,600Supplies 2,500 (c) 2,170 330Furniture 72,000 72,000Accumulated depreciation
3,900 (d) 2,000**
5,900
Accounts payable 3,300 3,300Salary payable (e)
2,880***2,880
Common stock 12,000 12,000Retained earnings 63,110 63,110Dividends 3,500 3,500Service revenue 11,000 (a) 2,100 13,100Salary expense 2,300 (e)
2,880***5,180
Rent expense (b) 800* 800Utilities expense 510 510Depreciation expense (d)
2,000**2,000
Supplies expense (c) 2,170 _____ 2,170 93,310 93,310 9,950 9,950 100,290 100,290
_____* $2,400 ÷ 3 = $800** $72,000 ÷ 3 = $24,000 ÷ 12 = $2,000
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*** $4,800 × 3/5 = $2,880
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(continued) P 3-72A
Req. 2
London, Inc.Income Statement
Month Ended December 31, 2010Revenues:
Service revenue $13,100
Expenses:Salary expense $5,180Supplies expense 2,170Rent expense 800Depreciation expense 2,000Utilities expense 510
Total expenses 10,660
Net income $ 2,440
London, Inc.Statement of Retained Earnings
Month Ended December 31, 2010Retained earnings, December 1, 2010
$63,110
Add: Net income 2,440 65,550
Less: Dividends (3,500 )
Retained earnings, December 31, 2010
$62,050
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(continued) P 3-72A
Req. 2 (continued)
London, Inc.Balance Sheet
December 31, 2010ASSETS LIABILITIES
Current assets: Current liabilities:Cash $
8,900Accounts payable $3,300
Accounts receivable 3,300 Salary payable 2,88 0
Prepaid rent 1,600 Total current liabilities 6,180Supplies 330 Total current assets
14,130
Furniture $72,000
STOCKHOLDERS’ EQUITY
Less: Accum. Common stock 12,000deprec.
(5,900 )66,100 Retained earnings 62,05
0Total stockholders’ equity 74,050
Total liabilities and
Total assets $80,230
stockholders’ equity $80,230
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(10- 20 min.) P 3-73A
Req. 1
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT
CREDIT
Apr. 30 Accounts Receivable ($6,810 −$5,900)...
910
Rental Revenue………………………….
910
To accrue rental revenue.
30 Interest Receivable ($200 $0)−…………..
200
Interest Revenue ($600 $400)−…….…
200
To accrue interest revenue.
30 Supplies Expense ($1,200 $0)−…………
1,200
Supplies ($1,800 $600)−……………….
1,200
To record supplies expense.
30 Insurance Expense ($1,700 $0)−………..
1,700
Prepaid Insurance ($2,300 −$600)…...
1,700
To record insurance expense.
30 Depreciation Expense ($1,400 $0)−…….
1,400
Accumulated Depreciation($8,800 $7,400)−
……………………...1,40
0To record depreciation expense.
30 Wage Expense ($2,300 $1,300)−………...
1,000
Wages Payable ($1,000 $0)− 1,00
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……….… 0To accrue wage expense.
30 Unearned Rental Revenue ($2,100 − 1,600)
500
Rental Revenue………………………….
500
To record revenue that was collected in advance.
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(continued) P 3-73A
Req. 2
Total assets = $82,710 ($8,900 + $6,810 + $200 + $4,400 +
$600 + $600 + $70,000 −$8,800)
Total liabilities
= $ 9,300 ($6,700 + $1,000 + $1,600)
Total equity = $73,410 ($82,710 $9,300)−
Net income = $ 19,710 ($26,510 + $600 $1,400 − − $1,200 $400 $2,300 $400 − − − −$1,700)
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(20- 30 min.) P 3-74A
Req. 1
Schneider CorporationIncome Statement
Year Ended July 31, 2010Revenues:
Service revenue $102,100
Expenses:Salary expense $39,80
0Rent expense 10,300Insurance expense 3,500Interest expense 3,300Supplies expense 2,800Depreciation expense 1,70
0 61,4
00Income before tax 40,700Income tax expense 6,5
00Net income $
34,200
Schneider CorporationStatement of Retained Earnings
Year Ended July 31, 2010Retained earnings, July 31, 2009 $ 5,000Add: Net income 34,200
39,200Less: Dividends
(21,000 )Retained earnings, July 31, 2010 $18,200
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continued) P 3-74A
Req. 1 (continued)
Schneider CorporationBalance SheetJuly 31, 2010
ASSETS LIABILITIESCash $
2,000Accounts payable $ 3,400
Accounts receivable 9,400 Interest payable 200Supplies 2,400 Unearned service
revenue700
Prepaid rent 1,200 Income tax payable 2,000Note payable 18,900
Equipment $36,600 Total liabilities 25,200 Less: Accum.
deprec. (4,20 0 )
32,400 STOCKHOLDERS’ EQUITY
Common stock 4,000Retained earnings
18,200 Total stockholders’ equity
22,200
Total liabilities and
Total assets $47,40 0
stockholders’ equity $47,400
Req. 2
Debt ratio:
$25,200 = 0.53$47,400
Snead is in compliance of its debt agreement, which
requires the company to maintain a debt ratio no higher
than 0.60.
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(20 min.) P 3-75A
Req. 1
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Closing EntriesMar. 31 Service
Revenue……………………..95,000
Retained Earnings………………...
95,000
31 Retained Earnings……………………
35,700
Advertising Expense……………..
10,900
Depreciation Expense……………
1,700
Interest Expense………..…………
900
Salary Expense……………………
17,800
Supplies Expense…………………
4,400
31 Retained Earnings……………………
31,200
Dividends…………………………...
31,200
Req. 2
Retained EarningsMar. 31, 2010 Expenses
35,700
Mar. 31, 2009 Bal. 22,000
Mar. 31, 2010 Dividends
31,200
Mar. 31, 2010 Revenues
95,000
Mar. 31, 2010 Bal. 50,100
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Net income = $59,300 (revenues of $95,000 minus expenses of $35,700.
Req. 3
Retained Earnings increased during the year because net income of $59,300 exceeded dividends of $31,200.
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(25- 40 min.) P 3-76A
Req. 1
Spa View Service, Inc.Balance SheetMarch 31, 2010
ASSETSCurrent assets:
Cash $ 7,900
Accounts receivable 16,100
Prepaid expenses 6,000
Supplies 3,6 00
Total current assets 33,600
Plant assets:Equipment $41,700
Less: Accumulated depreciation
(6,900 )
34,800
Other assets 14,400 Total assets
$82,800 LIABILITIES
Current liabilities:Current portion of note payable $
1,000Accounts payable 14,400Salary payable 2,900Unearned service revenue 2,700
Total current liabilities 21,000Note payable, long-term 6,100 Total liabilities 27,100
STOCKHOLDERS’ EQUITYCommon stock 5,600Retained earnings 50,100 *Total stockholders’ equity 55,700 Total liabilities and stockholders’ equity $82,800
Chapter 3 Accrual Accounting & Income 261
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_____*See next page.
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(continued) P 3-76A
Req. 1 (continued)
*Retained earnings, March 31, 2009……………..
$22,000
Add: Net income ($95,000 $10,900 − −$1,700
$900 $17,800 $4,400)− − −………………...
59,300
81,300 Less:
Dividends………………………………........ (31,200 )
Retained earnings, March 31, 2010……………..
$50,100
Req. 2
2010
2009
Current ratio =
Total current assets =
$33,600 = 1.60 1.25Total current
liabilities$21,00
0
The ability to pay current liabilities with current assets
improved during 2010.
Debt ratio = Total liabilities = $27,100 = 0.33 0.20Total assets $82,800
The overall debt position deteriorated a little during 2010.
The improvement in the current ratio is greater than the
deterioration in the debt ratio. However, Spa Brook’s
overall debt position is strong because a debt ratio of .33
is not troublesome.
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(45- 60 min.) P 3-77AReq. 1
(All amounts in millions )
Current ratio =
Total current assets
=
$15.6 = 1.63Total current
liabilities$
9.6
$15.1
Debt ratio =
Total liabilities =
$9.6 + $5.5= 0.4
9Total assets $31.7
Req. 2
Current Ratio Debt Ratio
a. $15.6 ($9.6 − × 1/2) = 2.25$15.1 ($9.6 × 1/2)−
= 0.38($9.6 × 1/2) $31.7 ($9.6 × 1/2)−
b. $15.6 + $6.0 = 2.25 $15,1+ $6.0 = 0.56$9.6 $31.7 + $6.0
c. $15.6 + $2.5 = 1.89 $15.1 = 0.44$9.6 $31.7 + $2.5
d. $15.6 $.6− = 1.56 $15.1 = 0.48$9.6 $31.7 $.6−
e. $15.6 = 1.51 $15.1 + $0.7 = 0.50$9.6 + $0.7 $31.7
f. $15.6 $1.5− = 1.47 $15.1 + $2.7 = 0.52$9.6 $31.7 + $4.2 $1.5−
g. $15.6 = 1.63 $15,1 = 0.49$9.6 $31.7 $0.8−
(continued) P 3-77A
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Req. 3
a. Revenues usually increase the current ratio.
b. Revenues usually decrease the debt ratio.
c. Expenses usually decrease the current ratio.
Note : Depreciation is an exception to this rule.
d. Expenses usually increase the debt ratio.
e. If a company’s current ratio is greater than 1.0, as it is
for Hartford, paying off a current liability will always
increase the current ratio.
f. Borrowing money on long-term debt will always
increase the current ratio and increase the debt ratio.
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Problems
Group B
(15- 20 min.) P 3-78B
(All amounts in millions)
1. $33 – x = $27; x = $6
2. Revenues……………..
$33
Expenses……………..
27
Net income…………...
$ 6
3. Beginning receivables……...
$ 9
Add:Revenues…………….
33
Less:Collections…………..
(24 )
Ending receivables………….
$ 18
Balance sheetASSETS
Current assets:
Receivables………….$ 18
4. Beginning accounts payable………..
$ 11
Add:Expenses……………………….
27
Less:Payments……………………....
(28 )
Ending accounts payable…………….
$ 10
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Balance sheetLIABILITIES
Current liabilities:Accounts
payable…………….$ 10
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(20- 30 min.) P 3-79B
Req. 1
Kings ConsultingAmount of Revenue (Expense) for May
Date Cash Basis Accrual BasisMay 1 Expense $ (500 ) Expense 0
4 Expense $(600 ) Expense 05 Revenue $1,000 Revenue
$1,0008 Expense $(400 ) Expense $(400 )11
Revenue Revenue $3,100
19
Expense 0 Expense 0
24
Revenue $3,100 Revenue 0
26
Expense $(2,000)
Expense 0
29
Expense $(1,500)
Expense $(1,500)
31
Expense 0 Expense $ (100)
31
Revenue 0 Revenue $500
Req. 2
Income (loss)before tax $(900 ) Income before
tax$2,60
0
Req. 3
The accrual basis better measures net income. For
example, the accrual basis accounts for the prepayment
of insurance on May 1 as an asset because prepaid
insurance gives the business insurance coverage of the Chapter 3 Accrual Accounting & Income 268
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business’ assets for the next five months. The cash basis
ignores the future benefit (asset nature) of the
prepayment and accounts for the prepayment as an
expense.
(10- 20 min.) P 3-
80B
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Mar 31 a. Insurance Expense 3,400 * Prepaid Insurance 3,400 To record insurance expense
31 b. Salary Expense ($5,800 × 3/5)……...
3,480
Salary Payable……………………..
3,480
To accrue salary expense.
31 c. Interest Receivable…………………..
700
Interest Revenue…………………..
700
To accrue interest revenue.
31 d. Supplies Expense…………………….
6,600 **
Supplies……………………………..
6,600
To record supplies expense.
31 e. Unearned Service Revenue($12,100 × 60%)
………………………7,260
Service Revenue…………………..
7,260
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To record revenue that was collected in advance.
31 Depreciation Expense …………...….
8,900
Accumulated Depreciation –Office
Furniture……………3,500
Accumulated Depreciation –Equipment……………..
……5,400
To record depreciation expense._____ * $500 + 3,800 $900 = $3,400−** $2,700 + $6,100 $2,200 = $ 6,600 −
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(45- 60 min.) P 3-81BReq. 1
Kings, Inc.Adjusted Trial Balance
August 31, 2010TRIAL BALANCE ADJUSTMENTS ADJUSTED TRIAL
BALANCEACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
Cash 9,200 9,200Accounts receivable 1,500 (a) 2,000 3,500Prepaid rent 2,400 (b)
800*1,600
Supplies 2,200 (c) 1,820 380Furniture 81,000 81,000Accumulated depreciation
3,900 (d) 1,350**
5,250
Accounts payable 3,500 3,500Salary payable (e)
3,120***3,120
Common stock 15,000 15,000Retained earnings 71,020 71,020Dividends 3,600 3,600Advertising revenue 10,000 (a) 2,000 12,000Salary expense 3,000 (e)
3,120***6,120
Rent expense (b) 800 * 800Utilities expense 520 520Depreciation expense (d)
1,350**1,350
Supplies expense (c) 1,820 _____ 1,820 103,42
0 103,42
0 9,090 9,090 109,890 109,890
___
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* $2,400 ÷ 3 = $800** $81,000 ÷ 5 = $16,200 ÷ 12 = $1,350*** $5,200 × 3/5 = $3,120
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(continued) P 3-81B
Req. 2 (continued)
Kings, Inc.Income Statement
Month Ended August 31, 2010Revenues:
Advertising revenue $12,000
Expenses:Salary expense $6,120Rent expense 800Depreciation expense 1,350Utilities expense 520Supplies expense 1,82
0Total expenses 10,610
Net income $1,390
Kings, Inc.Statement of Retained EarningsMonth Ended August 31, 2010
Retained earnings, August 1, 2010 $71,020Add: Net income 1,390
72,410Less: Dividends (3,600 )Retained earnings, Aug 31, 2010 $68,810
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(continued) P 3-81B
Req. 2 (continued)
Kings, Inc.Balance Sheet
August 31, 2010ASSETS LIABILITIES
Current assets: Current liabilities:Cash $9,200 Accounts payable $
3,500Accounts receivable 3,500 Salary payable 3,12
0Prepaid rent 1,600 Total current liabilities 6,620Supplies 3
80Total current assets 14,680 Furniture
$81,000STOCKHOLDERS’ EQUITY
Less: Accum. Common stock 15,000 deprec.
(5,250 )75,750 Retained earnings 68,810
Total stockholders’ equity
83,810
______
Total liabilities and ______
Total assets $90,430
stockholders’ equity $90,430
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(10- 20 min.) P 3-82BReq. 1
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT
CREDIT
Dec. 31 Accounts Receivable ($6,880 −$6,000)
880
Rental Revenue…………………………….
880
To accrue rental revenue.
31 Supplies Expense ($900 $0)−……………...
900
Supplies ($1,500 $600)−………………….
900
To record supplies expense.
31 Insurance Expense ($1,700 $0)−…………..
1,700
Prepaid Insurance ($2,500 $800)−……..
1,700
To record insurance expense.
31 Depreciation Expense ($1,500 $0)−………
1,500
Accumulated Depreciation($10,300 $8,800)−
………………………….1,500
To record depreciation expense.
31 Wage Expense ($2,700 $1,900)−………….
800
Wages Payable ($800 $0)−…………..….
800
To accrue salary expense.
31 Interest Receivable ($500 0)……….−…….
500
Interest Income ($500 $0)− 500
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……………..To accrue interest expense.
31 Unearned Rental Revenue($1,500 $1,200)−……………………………
300
Rental Revenue………………………….
300
To record revenue that was collected in advance.
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(continued) P 3-82B
Req. 2
Total assets = $78,380 ($7,900 + $6,880 + $500 + $5,000 + $600 + $800 + $67,000 $10,300)−
Total liabilities
= $8,500 ($6,500 + $800 + $1,200)
Total equity = $69,880 ($78,380 $8,500)−
Net income = $12,780 ($19,480 + $700 $1,500 − −$900 $300 $2,700 $300 − − − −$1,700)
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(20- 30 min.) P 3-83B
Req. 1
Sneed CorporationIncome Statement
Year Ended October 31, 2010 Revenues:
Service revenue $101,700
Expenses:Salary expense $40,50
0Rent expense 10,200Insurance expense 3,600
Interest expense 3,200 Supplies expense 2,900
Depreciation expense 1,20 0
61,600
Income before tax 40,100Income tax expense 7,50
0Net income $
32,600
Sneed CorporationStatement of Retained Earnings
Year Ended October 31, 2010Retained earnings, October 31, 2009
$ 4,000
Add: Net income 32,600 36,600
Less: Dividends (25,000 )
Retained earnings, October 31, 2010
$ 11,600
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(continued) P 3-83B
Req. 1 (continued)
Sneed Corporation.Balance Sheet
October 31, 2010ASSETS LIABILITIES
Cash $ 1,600 Accounts payable $ 3,800
Accounts receivable 8,800 Unearned serviceSupplies 2,100 revenue
900Prepaid rent 1,000 Interest payable 4
00Income tax payable 2,500
Equipment $36,700 Note payable 18,60 0
Less: Accum.
Total liabilities 26,200
deprec.
(4,400 ) 32,300
STOCKHOLDERS’ EQUITYCommon stock 8,0
00Retained earnings 11,60
0 Total stockholders’
equity
19,600
Total liabilities and
Total assets $45,800 stockholders’ equity $45,800
Req. 2
Debt ratio: $26,200 = 0.57$45,800
Sneed Corporation’s debt ratio of 0.57 is in compliance with the lenders’ debt restriction.
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(20 min.) P 3-84BReq. 1
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Closing EntriesMar.
31 Service Revenue………………………
94,100
Retained Earnings…………………
94,100
31 Retained Earnings…………………….
36,300
Salary Expense……………………..
18,100
Supplies Expense………………….
4,300
Advertising Expense………………
11,100
Depreciation Expense…………….
2,000
Interest Expense…………………...
800
31 Retained Earnings…………………….
30,000
Dividends……………………………30,000
Req. 2
Retained EarningsMar. 31, 2010 Expenses
36,300
Mar. 31, 2009 Bal. 22,000
Mar. 31, 2010 Dividends
30,000
Mar. 31, 2010 Revenues
94,100
Mar. 31, 2010 Bal. 49,800
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Net income = $57,800 (revenues of $94,100 minus expenses of $36,300)
Req. 3
Retained Earnings increased during the year because net income of $57,800 exceeded dividends of $30,000.
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(30- 40 min.) P 3-85B
Req. 1
Sunny Stream Service, Inc.Balance SheetMarch 31, 2010
ASSETSCurrent assets:
Cash…………………………………………………….
$ 7,300
Accounts receivable…………………………………
16,400
Supplies………………………………………………..
3,300
Prepaid expenses 5,70 0
Total current assets……………………………...
$32,700
Plant assets:
Equipment…………………………………
$42,500
Less accumulated depreciation….
(7,300 )
35,200
Other assets…………………………………………… ..
14,500
Total assets………………………………………………
$82,400
LIABILITIESCurrent liabilities:
Accounts payable……………………………………
14,300
Current portion of note payable 500
Salary payable………………………………………..
2,600
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Unearned service revenue………………………
2,600
Total current liabilities…………………………...
20,000
Note payable, long-term……………………………….
5,900
Total liabilities…………………………………………...
25,900
STOCKHOLDERS’ EQUITYCommon stock…………………………………………..
6,700
Retained earnings ……………………………………...
49,800 *
Total stockholders’ equity…………………………….
56,500
Total liabilities and stockholders’ equity…………...
$82,400
_____*See next page.
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(continued) P 3-85B
Req. 1 (continued)_____*Computation:
Retained earnings, March 31, 2009………
$ 22,000
Add: Net income ($94,100 $18,100 − −$4,300
$11,100 $2,000 $800)− − −……………...
57,800
79,800Less: Dividends………………………………….
(30,000 )
Retained earnings, March 31, 2010………
$49,800
Req. 2
2010 2009
Current ratio =
Total current assets=
$32,700= 1.64 1.40Total current
liabilities$20,000
The ability to pay current liabilities with current assets
improved during 2010.
Debt ratio =
Total liabilities =
$25,900 = 0.3
10.2
5Total assets $82,400
Sunny Stream Services’ overall debt position deteriorated
a bit from 2009 to 2010. However, the company’s debit
position is still very strong.
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(45- 60 min.) P 3-86BReq. 1
(All amounts in millions)
Current ratio =
Total current assets
=
$15.3 = 1.7
8Total current liabilities
$8.6
$14.0
Debt ratio =Total liabilities
=$8.6 + $5.4 = 0.4
4Total assets $31.7Req. 2
Current Ratio Debt Ratio
a.
$15.3 ($8.6 × 1/2)−
= 2.56
$14.0 ($8.6 ×− 1/2)
= 0.35($8.6 × 1/2) $31.7 ($8.6 ×−
1/2)
b.
$15.3 + $7.0 = 2.59
$14.0 + $7.0 = 0.54$8.6 $31.7 + $7.0
c.
$15.3 + $2.5 = 2.07
$14.0 = 0.41$8.6 $31.7 + $2.5
d.
$15.3 $3.0− = 1.43
$14.0 = 0.49$8.6 $31.7 $3.0−
e.
$15.3 = 1.65
$14.0 + $0.7 = 0.46$8.6 + $0.7 $31.7
f.$15.3 $1.9−
= 1.56
$14.0 + $2.8 = 0.4
9$8.6 $31.7 + $4.7 −$1.9
g.
$15.3 = 1.78
$14.0 = 0.45$8.6 $31.7 $0.6−
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(continued) P 3-86B
Req. 3
a. Revenues usually increase the current ratio.
b. Revenues usually decrease the debt ratio.
c. Expenses usually decrease the current ratio.
Note : Depreciation is an exception to this rule.
d. Expenses usually increase the debt ratio.
e. If a company’s current ratio is greater than 1.0, as for
Hillsboro, paying off a current liability will always
increase the current ratio.
f. Borrowing money on long-term debt will always
increase the current ratio and increase the debt ratio.
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Decision Cases
(25 min.) Decision Case 1
Req. 1 Unadjusted trial balance:
Cash……………………………………..
$8,000
Accounts receivable………………….
4,200
Supplies………………………………...
800
Prepaid rent……………………………
1,200
Land……………………………………..
43,000
Accounts payable…………………….
$12,000
Salary payable…………………………
–0–
Unearned service revenue…………..
700
Note payable, due in 3 years………..
23,400
Common stock………………………...
5,000
Retained earnings…………………….
9,300
Service revenue……………………….
9,100
Salary expense………………………..
3,400
Rent expense…………………………..
–0–
Advertising expense………………….
900
Supplies expense……………………..
– 0 –
Totals……………………………………
$61,500 $59,500
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Out of balance $2,000
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(continued) Decision Case 1
Req. 2 Adjusted trial balance:
Cash……………………………………………...
$8,000
Accounts receivable…………………………..
4,200
Supplies ($800 -400)..………………………….
400
Prepaid rent ($1,200 x 11/12)…………………
1,100
Land ($41,000 + $2,000)……………………….
43,000
Accounts payable……………………………...
12,000
Salary payable………………………………….
1,000
Unearned service revenue ($700 - $500)….
200
Note payable, due in 3 years………………...
25,400
Common stock…………………………………
5,000
Retained earnings……………………………..
9,300
Service revenue ($9,100 + $500)…………….
9,600
Salary expense ($3,400 + $1,000)…………..
4,400
Rent expense ($1,200 x 1/12)………………..
100
Advertising expense…………………………..
900
Supplies expense……………………………...
40 0
Total………………………………………………
$62,500
$62,500
Req. 3
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Current ratio =$8,000 + $4,200 + $400 +
$1,100$12,000 + $1,000 + $200
=
$13,700 = 1.04$13,200
We might have trouble sleeping at night with a current
ratio of 1.04. To be safe, the current ratio should be
around 1.40 or higher.
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(20- 30 min.) Decision Case 2
Eagle Restaurant, Inc.Income Statement
Month Ended October 31, 2011Sales revenue $32,000Cost of goods sold $12,000Wages expense 5,000Rent expense 4,000Insurance expense 1,000Depreciation expense 1,00
0 23,00
0Net income $
9,000
Eagle Restaurant, Inc.Statement of Retained EarningsMonth Ended October 31, 2011
Retained earnings, beginning $ 0+ Net income 9,000- Dividends (3,000 )
Retained earnings, October 31, 2011 $6,000
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(continued) Decision Case 2
Eagle Restaurant, Inc.Balance Sheet
October 31, 2011ASSETS LIABILITIES
Cash $ 8,000
Accounts payable $ 7,000
Food inventory 5,000 Unearned revenue 3,000 Prepaid insurance 1,000 10,000Dishes, silver 4,000Fixtures
$24,000OWNERS’ EQUITY
Less: Accum.
Common stock $25,000
deprec. (1,000 )
23,00 0
Retained earnings
6,00 0
31,00 0
Total assets $41,000
Total liabilities and equity
$41,000
Recommendation : Do not expand the business. It is
not meeting Marks’ goals for net income
or for total assets.
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(30- 40 min.) Decision Case 3
Req. 1 (your highest price)
Advertising revenue ($22,000 + $4,000)
$26,000
Expenses:Salary $4,000Utilities 900Other (unrecorded) 1,100Salary of your manager 5,000 11,00
0Your expected monthly net income $15,000Multiplier to compute price X 16Your highest price $240,00
0
Req. 2 (Williams’ asking price)
SW Advertising, Inc.Statement of Retained Earnings and Common Stock
June 30, 2010 Beginning retained earnings $
93,000Add: Net income
Revenue ($22,000 + $4,000) $26,000Less: Expenses ($4,000 +
$900 + $1,100) (6,000)
20,000
113,000
Less: Dividends (9,000 )
Ending retained earnings $104,000
Common stock 50,000
Stockholders’ equity, June 30, 2010 $154,000
Multiplier to compute price X
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2__Williams’ asking price $308,00
0
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(continued) Decision Case 3
Req. 3
You may start by offering Williams approximately
$225,000 for the business. His asking price is $308,000
so you are starting out quite far apart. If Williams
appears especially eager to sell out, you may be able to
buy the firm for closer to your highest price of $240,000.
However, if he is not so eager to sell and if you want the
business badly enough, you may have to pay somewhere
between $240,000 and $308,000. It might pay to hire an
expert to value the business’s assets. You may find that
Williams’ price is inflated based on the value of its
assets. You can always raise your offer, but you cannot
decrease it, so start the negotiating process with an offer
around $225,000.
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Ethical Issues
Ethical Issue 1
1. The journal entry to record the revenue is:
Dec. Accounts Receivable………...
XXX
Sales Revenue……………..
XXX
The debit to Accounts Receivable will increase total current assets and, as a result, increase (improve) the current ratio.
The credit to Sales Revenue will increase total owner equity and, as a result, decrease (improve) the debt ratio.
2. a. – c. The issue is whether it is ethical to record the revenue in the current year. The contract has been signed, but the implication is that the company will not have done everything it needs to do in order to earn the revenue in the current year. The stakeholders are the company, the bank, the stockholders, and the company’s other creditors. From an economic standpoint, the entry would obviously improve the company’s short term financial position. However, the advantage would probably be short- lived. When the bank finds out about this entry, they will likely protest, and demand immediate payment, so the longer- term economic impact will likely be negative. From a “legal” standpoint, to record this transaction in December violates GAAP by violating the revenue principle . In this case Cross Timbers has not made the sale (has not delivered the merchandise) to the customer and, therefore, has not earned the revenue prior to December 31 of the current year. From an ethical standpoint, recording this revenue violates the bank’s rights for proper disclosure of the company’s income and assets. Revenue should be recorded no earlier than when it is earned. Cross Timbers expects to earn Chapter 3 Accrual Accounting & Income 298
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the revenue in January of next year. Cross Timbers clearly cannot record this revenue until it is earned. To do so is not in their best economic, legal (GAAP) or ethical best interests.
3. The authors would suggest either of two actions. Cross Timbers can either:
a. Report the current ratio of 1.47 and the debt ratio of .51 because these are the true values. Then tell the bank of the signed contract for additional work and the hope for a better set of ratio values next year. In some cases, banks will agree to sign a waiver of the terms of loan covenants, meaning that, although the company is in violation, the bank will not move to enforce the covenant. They may give Cross Timbers a “grace period” to cure the violation in the covenant.
b. Pay off some current liabilities before year end. This will improve both the current ratio and the debt ratio. This may enable Cross Timbers to bring its ratio values into compliance with the bank’s requirements.
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Ethical Issue 2
1. These transactions — recorded as directed by Almond
— overstate the reported income of the company by
$21,000 ($10,000 + $10,000 + $1,000).
2. It appears that Almond wants to improve the company’s
reported income in order to borrow on favorable terms.
Her action is unethical and probably illegal as well
because she is deliberately overstating the company’s
reported income.
Almond appears to be letting the potential short term
economic advantage of these deliberate misstatements
take precedence. She needs to remember that these
misstatements violate GAAP, and that, depending on
what use is made of the financial statements, could
subject the company to civil or criminal legal
proceedings. If this happens, the short term economic
gains ($21,000) would not even come close to the long-
term economic costs associated with the legal actions,
not to mention the negative publicity. The business
will need a bank loan, and perhaps the money would be
used to pay bills, expand the business, and so on.
However, based on Almond’s lack of integrity, the
money may be destined for her own use. Regardless of
its use, the money is obtained under false pretenses
and cannot be headed for a good outcome.
The bank is harmed by Almond’s and Lail’s actions.
Lending money to Almond under false pretenses may
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lead the bank to charge an unrealistically low interest
rate that robs the bank’s owners of interest revenue. In
the extreme, the public is robbed if taxpayers wind up
financing the bailout of a failed institution.
3. Personal advice will vary from student to student. The
purpose of asking this question is to challenge students
to take the high road of ethical conduct by having
nothing to do with Almond’s scheme. The authors would
advise Lail, the accountant, to take these actions, in
order:
a. Refuse to take any part in Almond’s scheme,
explaining that the result is overstatement of reported
income. This is both illegal and unethical, and will
ultimately have a negative economic impact on the
company, as well. Accountants are bound to
standards of ethical conduct that these actions
violate. The can go to prison when caught falsifying
financial statements.
b. To remain ethical, the accountant must be willing to
lose his/her job. It is better to protect one’s
reputation even if that causes a short- term hardship.
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Focus on Financials: Amazon.com, Inc.
(15- 20 min.)
Req. 1
Accrued expenses are expenses that have been incurred
but that have not yet been paid as of the balance sheet
date. The accrual and matching concepts require that all
expenses be recognized during the period in which they
are incurred in order to earn revenue, regardless of when
they are paid.
Req. 2 and Req. 4 (balances in millions at December 31, 2008)
Accrued expenses and other Cash
Beg. Bal. $902
(a) 902
(a) 902
(b) 1,093 (b) 2,335
End. Bal. $1,093
Operating expenses
(b) 3,428
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(continued) Focus on Financials: Amazon.com, Inc.
Req. 3 (amounts in millions)
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
a. Accrued expenses and other…….…
902
Cash………………….. 902
b. Operating expenses….……………….
3,428
Cash……………………..………... 2,335 Accrued expenses and other…
1,093
The balance of accrued expenses and other agrees with
the financial statements at December 31, 2008.
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(continued) Focus on Financials: Amazon.com, Inc.
Req. 5
Current ratio:2008 2007
(Dollar amounts in millions)
Total current assets=
$6,157= 1.3
0
$5,164= 1.3
9Total current liabilities
$4,746 $3,714
Debt ratio:
Total liabilities =
$5,642*= 0.68
$5,288**= 0.82
Total assets $8,314 $6,485*4,746 + $409 + $487 **3,714 + $1,282 + $292
The current ratio deteriorated slightly, but the debt ratio
improved significantly during 2008. The company used
cash to pay down long-term liabilities. This reveals
strengthening leverage at the expense of only slightly
weaker (but still respectable) liquidity.
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Focus on Analysis: Foot Locker, Inc.
(15- 20 min.)
Req. 1
In fiscal 2006, Foot Locker earned the $59 million.
In fiscal 2007, Foot Locker earned the $50 million, and
$50 million is included in net income for fiscal 2007.
Req. 2
$62 million impacted rent expense in 2007 net income
computation.
$65 million impacted rent expense in 2008 net income.
This amount was still prepaid as of December 31, 2007.
Req. 3
During 2008, Foot Locker, Inc. sold plant assets
(property, plant, and equipment). They must have
removed $67 million from accumulated depreciation for
the plant assets that it sold ($870 + $100 - $903).
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Req. 4
Customer deposits represent unearned income. When
received, these amounts are credited to a current liability
account. When customers redeem the gift cards, these
amounts are debited to customer deposits and credited to
sales revenue.
The entry to record the increase in this account is (in millions):
Cash………………………………………………
1
Customer deposits………………………
1
During 2007, Foot Locker, Inc. collected $1 million from
customers who were buying gift certificates. This
transaction created a liability for Foot Locker, Inc.
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Group Project
(45 min.)
Req. 1
Davis Lawn Service, Inc.Income Statement
Four Months Ended August 31, 2010 Service revenue ($5,600 + $600) $6,200Expenses: Wage expense ($1,900 + $200)
$2,100
Rent expense ($600 × 4/6) 400 Supplies expense ($400 −$50)
350
Repair expense 300 Depreciation expense ($300× 1/3)
10 0
Total expenses 3,250 Net income $2,950
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(continued) Group Project
Req. 2
Davis Lawn Service, Inc.Balance Sheet
August 31, 2010ASSETS LIABILITIES
Current: Current: Cash $2,040 Wages payable $ 200 Accounts receivable 600 Total current liabilities
200 Receivable from Ludwig
(or Prepaid rent) 200 Supplies
50 STOCKHOLDERS’
Total current assets 2,890 EQUITYLong-term: Common stock 400 Trailer $300 Retained earnings Less accum. ($2,950 $460)− 2,490
deprec. (100 ) 200 Total stockholders’ equity
2,890
Total liabilities and
Total assets $3,090 stockholders’ equity $3,090
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