Solutions Manual for Core Concepts of Accounting 2nd Edition By Cecily A. Raiborn
Core Concepts of Accounting 2e Cecily A. Raiborn (Solutions Manual All Chapters, 100% Original Verified, A+ Grade) CHAPTER 1 SOLUTIONS TO END OF CHAPTER MATERIAL QUESTIONS 1. The three general types of business are typically categorized as follows: service, manufacturing and merchandising. Service example: Manufacturing example: Merchandising example:
airline company, e.g. Southwest steel manufacturing company, e.g. US Steel wholesaler company, e.g. Costco
2. The three common forms of business organizations are sole proprietorships, partnerships and corporations. The major differences between these forms of business organizations are in terms of ownership, liability and taxation. A sole proprietorship is owned by a single individual, who has unlimited liability; profits of the proprietorship flow through to the owner, who individually pays taxes on those profits. A partnership is owned by two or more individuals, who each have unlimited liability. Profits of the business flow through to the partners, who individually pay taxes on their specific share of those profits. A corporation is owned by stockholders; liability for organizational debts is limited to the amount of funds invested by owners, who cannot be held individually responsible for the debts. A corporation files a tax return and pays taxes. (Stockholders receiving dividends from a corporation commonly must pay taxes on those dividends…even though the corporation paid taxes on the profits from which the dividends are paid. Thus, it is said that corporate profits are effectively taxed twice: once upon being earned and once upon being distributed.) The most common form of business in the United States is the sole proprietorship. 3. The primary function of a business’s accounting function is to provide quantitative information, primarily financial in nature, about economic entities. The information is intended to be useful in making economic decisions for internal and external users of the information. 4. The four major financial statements are the balance sheet, income statement, statement of cash flows and statement of stockholder’s equity. Balance Sheet: Summarizes the assets (resources an organization owns), liabilities (debts that the organization owes), and stockholders’ equity (amounts owners have contributed and the net amount that the entity has earned for them) of an entity at a specific time. Income Statement: Summarizes a business’s revenues and expenses for a specific time period.
Statement of Cash Flows: Reveals how a business generated and spent cash during a given accounting period. Businesses issue financial statements because financial statements provide information about an organization’s financial performance over a period of time. These statements are useful to third parties such as investors, bankers, CEOs and management during their decision making. 5. This statement is false because a company’s fiscal year may begin on any date. For example, the Walt Disney Company has a fiscal year that runs from October 1 to September 30. 6. The three types of activities are operating, investing, and financing. Operating activities: Reflect the day-to-day activities of a business that generate revenues by providing products or services and that create the costs of generating those revenues Investing activities: Involve the acquisition and sale of (1) long-term assets used in the business and (2) non-operating investment assets Financing activities: Involve cash inflows and outflows from transactions with creditors and investors. The Statement of Cash Flows uses the above three business activities as section headings. 7. GAAP is a group of accounting rules, concepts and principles that are used as a standard framework of guidelines in the preparation of financial statements. GAAP’s primary purpose is use as a guideline in conducting and reviewing accounting transactions. The FASB is the principal accounting board in charge of establishing GAAP. 8. Private accounting involves internal work within a business entity, not-for-profit organization, or government agency. Public accounting involves external work as an independent firm with various firms in business. Individuals in private accounting may have job titles such as controller, internal auditor, financial accountant, cost analyst and tax accountant. 9. Public accounting firms offer auditing, tax preparation and advice, certain types of consulting, and bookkeeping services. Auditing is the most important service offered by public accounting firms because it involves the determination of the fairness, fullness and compliance with GAAP for financial statements and accounting records of companies. These financial statements provide third parties with vital information in the making of economic decisions.
10. The collapse of the stock market in 1929 led Congress to establish the SEC in the early 1930s with the intent to deter the abusive accounting and financial reporting practices that contributed to the stock market’s collapse. The SEC ensures that publicly owned companies provide third parties with sufficient information to make informed economic decisions regarding the securities these firms sell.
EXERCISES 11. (a) (b) (c) (d) (e) (f) (g) (h) (i)
(j) (k)
T T F The FASB is the board that issues most of the new accounting rules in the U.S. F Corporations account for the most business revenues each year. T F The Balance Sheet is a statement of position at a specific point in time; the Income Statement and the Statement of Cash Flows cover a fiscal year. T T F Accounting contributes significantly to the success of business organizations by providing useful information on the transactions and results of transactions for those entities. T F Owners of LLPs, LLCs, and Subchapter S corporations pay taxes for their companies.
12. (a) (1) M (2) S (3) S (4) R (5) M (b) (1) Determine the estimated amount of goods needed to be produced to meet the market demand of products. Accountants can provide the inventory accounts balances. (2) Determine the amount of cash from operations. Accountants can provide the Cash Flow from operating activities statement. (3) Determine the ability of a customer to repay loans. Accountants can analyze the customer’s financial statements. (4) Determine the growth in revenues during the last fiscal period. Accountants can compare the income statement of the current fiscal period and the preceding fiscal period. (5) Determine the cost of manufacturing a product. Accountants can calculate the total costs incurred in the manufacturing of a product. 13. (a) Proprietorship vs. Corporation Advantages ▪ no double taxation ▪ easy to start up
▪ cheap to establish ▪ no particular record keeping requirements ▪ no one to share profits with Disadvantages ▪ self-employment tax rate ▪ unlimited liability ▪ lack of financing strength (b) Partnership vs. Corporation Advantages ▪ no double taxation ▪ easy to set up ▪ can establish with friends or relatives Disadvantages ▪ unlimited liability ▪ joint and several liability (c) LLP (limited liability partnership); LLC (limited liability company); and Subchapter S (Sub S) corporation The distinguishing characteristics of these forms of business organizations are that they possess key features of other forms of business. Each of these business types is a hybrid between a corporation and a partnership. Owners are provided with limited liability (as in a corporation) and are only taxed as individuals (as in a partnership). 14. (a) Net Income – Management Inventory cost per unit – Retailer Total liability – Loan Officer Total sales by geographical area of business operations – Marketing department Five-year trend in total sales – Investor Employee salaries by department – Management (b) To measure profitability of company To determine selling price per unit To measure risk of business To understand the market of product To determine stability of company To allocate payroll by department 15. TO: JIM HARDY FROM: ACCOUNTANTS DATE: JULY 1, 20X1 SUBJECT: FINANCIAL STATEMENTS It has come to our attention that your business, Jim’s Bike Shop, has not been keeping any accounting records of its financial activity since operations commenced. Financial statements are an integral part of any business organization. These statements reflect the company’s revenues and expenses and, thus, profitability, for a specific period. The financial statements also show the company’s financial position through detailing the
assets owned, liabilities owed, and the capital balances of the owner. The company’s cash flow is also reflected in the financial statements, so that it is apparent where money is being generated and used. The statements provide readers with useful information necessary to make vital economic decisions. The information needs to be provided in a timely manner for it to be useful. Thus, there is an urgent need for you to prepare monthly financial statements for your business. With reasonably accurate and timely financial statements users can easily determine the profitability and risk of your business. You can also keep track of your income, expenses, cash flows, assets, and debts. 16. Transactions: (a) Purchased equipment for $12,500 cash (b) Fuente & Demond bought additional $17,000 of stock in firm (c) Paid $1,500 owed to an office supply store for a purchase made the previous month (d) Purchased supplies for $4,000 on credit
Assets
=
Liabilities
+
Equity
+$12,500 – $12,500
=
$0
+
$0
$17,000
=
$0
+
$17,000
-$1,500
=
-$1,500
+
$0
$4,000
=
$4,000
+
$0
PROBLEMS 17. (a) (1) Stockholders: Determine return on investment; estimate future returns and profitability (2) Executives: Determine the next year’s budget; whether the company met its current financial objectives (3) Bankers: Determine ability to repay loans and pay for purchases. (b) (1) Stockholders: Why the rate of return on revenues is so low (2) Executives: The interest rate and tax rate the company is paying; the proportion of operating expenses that is cost of goods sold; what comprises “other revenue” (3) Bankers: Why the rate of return on revenues is so low; how the company intends to decrease costs in future years 18. (a) Lifestyle Magazines Total Net Income = ($207,300,000 + $246,300,000 + $264,000,000) = $717,600,000 Big Win = $45,360,000 Quick & Yummy Foods = $288,019,000 (b) BigWin Hotel & Casino = [(2009 NI – 2007 NI) ÷ 2007 NI] = [$18,745,000 – $10,649,000) ÷ $10,649,000] = $8,096,000 ÷ $10,649,000 = 76.03% Lifestyle Magazines = $56,700,000 ÷ $207,300,000 = 27.35% Quick & Yummy Foods = $29,553,000 ÷ $80,517,000 = 36.70%
(c) Lifestyle Magazine ▪ Customer demand affected by other competitors ▪ Customer demand affected by presence of alternative sources like the internet BigWin Hotel & Casino ▪ Barriers of entry to industry create a monopoly situation ▪ State rules and regulations affect profitability of business Quick & Yummy Foods, Inc. ▪ Easy entry into industry creates competition ▪ Location of restaurants vital to profitability ▪ Food is generally perishable, thus small profit margins are realized by food industry 19. (a)
Assets $510,000 a a
= = = =
Liabilities a $510,000 $200,000
+ + -
Equity $318,000 $318,000
Net Income b b
= = =
Revenues $510,000 $190,000
-
Expenses $320,000
Assets
= = =
Liabilities $430,000 $770,000
+ +
Equity $320,000
Net Income $210,000 d
= = =
Revenues $870,000 $660,000
-
Expenses d
Assets $950,000 e e
= = = =
Liabilities $367,000 $950,000 $583,000
+ + -
Equity e $367,000
Net Income $331,000 f f
= = = =
Revenues f $331,000 $1,009,000
+
Expenses $678,000 $678,000
(b)
(c) c c (d)
(e)
(f)
20. (a) Selling Price – Cost = $3,000,000 = $1,000,000 = $2,000,000 loss (b) $2,000,000 ÷ 5 years = $400,000 per year (c) The special accounting treatment for losses on sale of certain securities is misleading to financial statement users because net income is overstated during the year of loss on sale and understated in succeeding years when the loss is offset by income.
CASES 21. (a) Year begins on December 1st Year ends on November 30th (b) Balance sheet information = 2 years (c) Income statement information = 3 years (d) Cash flow information = 3 years (e) Shareholders’ equity information = 3 years (f) (1) Balance Sheet 2007, Statement of Cash Flows 2007 (2) Statement of Cash Flows 2007, Balance Sheet 2006 (3) Balance Sheet 2007, Statement of Shareholders’ Equity 2007 (4) Income Statement 2007, Statement of Shareholders’ Equity 2007 (5) Balance Sheet 2007, Statement of Shareholders’ Equity 2007 (g) PricewaterhouseCoopers LLP 22. (a) The Securities Exchange Commission has statutory authority to establish financial accounting and reporting standards for publicly held companies under the Securities Exchange Act of 1934. (b) Since 1973 (c) The mission of FASB is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors and users of financial information. (d) As of November 2009, it was Robert H. Herz. Current board personnel can be checked at http://www.fasb.org. (e) Ways topics are added to the FASB agenda ▪ Pervasiveness of the issue ▪ Alternative solutions ▪ Technical feasibility ▪ Convergence possibilities ▪ Cooperative opportunities ▪ Resources (f) Upon reaching conclusions on researched issues, the FASB prepares a proposed Exposure Draft for consideration by the Board. After further discussion and revisions, Board members vote whether to issue the Exposure Draft. A majority vote of the Board is required to approve a document for issuance as an Exposure Draft. Alternative views, if any, are explained in the document and posted on the FASB website. The Exposure Draft sets forth the proposed standards of financial accounting and reporting, the proposed effective date and method of transition, background information, and an explanation of the basis for the Board’s conclusions. At the end of the exposure period, comment letters and position papers are analyzed to search for new information and persuasive arguments regarding the issues (rather than being simply a "nose count" of how many support or oppose a given point of view). In addition to studying this analysis, Board members review the comment letters to help them in reaching conclusions. When the Board is satisfied that all reasonable alternatives have been considered adequately, the staff is directed to prepare a draft of a final document for consideration by the Board.
(g) This answer depends on the point in time that the web site is searched.
CHAPTER 2 SOLUTIONS TO END OF CHAPTER MATERIAL QUESTIONS 1. The principal focus of financial accounting is to serve the needs of external decisionmakers. These users need financial data about a business to make sound economic decisions. External parties, such as investors, lenders, and other groups (such as the IRS and regulatory bodies) benefit from standardized financial reporting in that information is consistent from year to year and comparable from company to company. 2. The balance sheet equation is Assets = Liabilities + Owners’ Equity Assets represent all the items owned by a company. Assets have future economic value in that they can be converted to cash or used to generate revenues. Most assets are tangible and have some type of physical substance. However, some assets such as accounts receivable, patents, and leases have no true physical substance except to be represented by a document. Liabilities represent all debts owed by a company to other companies or individuals. All that a company has (assets) minus all it owes (liabilities) is a company’s worth, which is known as owners’ equity. Equity can come from two sources. It can be contributed by owners; for example, an owner gives $10,000 of his personal money to the company in exchange for $10,000 of company equity. Or equity can also be generated by a profitable company. 3. The operating cycle is determined by the time period between the use of cash for normal business operating activities and the receipt or collection of cash from the entity’s customers. The operating cycle for a homebuilder could be three to six months, while the operating cycle for winery could be over a year or more. The operating cycle for a service firm could be a matter of days or weeks. On the balance sheet, assets are classified as current (typically listed first in balance sheet order) if those items will be converted into cash, sold, or used up within the next year or operating cycle, whichever is longer. 4. Retained Earnings does not contain cash. This account is a representation of how the equity in a business has increased because of profitable operations. Each year, the net profit is added to Retained Earnings; profit equals revenues earned minus both the costs
of doing business (expenses) and any distributions to owners (dividends). If there is a net loss, it is deducted from Retained Earnings. Therefore, Retained Earnings is the sum of yearly [revenues – expenses – dividends] since the company began. 5. The income statement is a “period-of-time” statement because the statement will reveal what revenues were earned and expenses incurred during a defined period (e.g., a month or a year). The statement of cash flows and the statement of stockholders’ equity are also “period-of-time” statements. In contrast, the balance sheet is a “point-in-time” statement in that it shows the assets, liabilities, and stockholders’ equity at only one specific moment in time. “Period-of-time” statements allow the user to understand what happened over time, while “point-in-time” statements give information that presents a single moment. 6. Revenues are increases in assets or decreases in liabilities that result from the profitoriented activities of the business. Gross profit is the difference between the net revenues generated and the cost of goods sold during a particular period. Net income is computed by subtracting operating expenses from gross profit and is also known as the “bottom line” of the income statement. Net income is commonly known as profit. 7. Answers will vary based on companies chosen. 8. The common theme of the three financial reporting objectives of business entities is the need for the financial statements to provide external parties the necessary information to make informed decisions about economic events. Without this information, users of financial statements would not be to make appropriate business and investment decisions. 9. Accounting information that is deemed to be reliable has the following three characteristics: verifiability, neutrality, and representational faithfulness. To be verifiable, accounting information should be able to be validated by more than one person. To be neutral, accounting information must be without bias. To be representationally faithful, accounting information must express the business’s true economic resources, obligations, and transactions. 10. The principal reason that historical cost is used as the basis for assets is that it can be verified thorough documentation (bill of sale, etc.). Current values may differ depending on whose opinion is obtained. The use of historical costs could result in the undervaluation of assets on the balance sheet. Alternatively, liabilities are generally current amounts. This differentiation in valuations causes a net “book value” that borders on meaningless.
11. Revenues should be both realized (assets exchanged for cash or a claim to cash) and earned (provided a product or service) before they are entered in the accounting records of an entity. There are some instances where the point of sale rule does not apply. For example, many construction projects create economic impacts over multiple years. In such cases, revenues may need to be spread over several accounting periods rather than recorded totally at the end of the project. 12. A general journal contains a chronological listing of transactions and how these transactions affected individual accounts. A general ledger contains individual accounts and shows all the changes made to the account by transactions. Two separate records are used because events occur that alter two or more accounts simultaneously. A record of the event is found in the general journal. However financial reporting is done on an account basis, so the general journal is used to track changes to individual accounts. A general ledger facilitates for the posting of journal entries into individual accounts and this easies the process of compiling financial statements.
EXERCISES 13. (a) F Intangible assets are not current assets; they will not be used up or converted to cash within one year. (b) T Unfortunately, however, management may engage in improper accounting to shift revenues and expenses into inappropriate time periods. (c) T (d) F Revenues minus expenses is equal to net income. Or revenues minus cost of goods sold is equal to gross profit. (e) F This statement describes the full-disclosure principle. (f) T (g) F Matching refers to the presentation of expenses related to recognized revenues on the income statement. (h) T (i) F The statement that reconciles beginning and ending cash is the Statement of Cash Flows. (j) T (k) F Business transactions are recorded in the general journal and then posted to the general ledger. (l) F The accounting cycle is not always longer than a company’s operating cycle. For example, construction projects and some food products (such as those that must be aged) may have an accounting cycle that is shorter than the operating cycle.
14. (a) A = L + SE A = L + $2,000,000 2X = X + $2,000,000 X = $1,000,000 = Liabilities A = $2,000,000 (b) SE = $2,000,000 SE = CS + PIC + RE $2,000,000 = $958,000 + RE RE = $1,042,000 15. Intangible assets Accounts payable Inventory Cash Notes payable (due in ten years) Prepaid expenses PPE Common stock Accounts receivable Retained earnings Notes payable (due in six months) Additional paid-in capital
long term asset current liability current asset current asset long term liability current asset long-term asset stockholders’ equity current asset stockholders’ equity current liability stockholders’ equity
16. (a) Cash, Short-term investments, Accounts receivable, Inventory, Prepaid expenses (b) Assets should be listed on the balance sheet in order of liquidity or the ability to turn the assets into cash. The more liquid the asset, the closer to the top of the current asset list it should appear.
17. (a) At the end of the current year, Farewell should report $90,000 as a long-term liability, and $30,000 in the current liability section of the balance sheet. (b) It is important to accurately list the items on the balance sheet so that current and potential creditors and assess the ability of the firm to pay its debts as they come due. 18. (a) Two factors that might contribute to the difference in gross profit for the companies might include the types of shoes that are carried by each wholesaler, the distribution chains that are used by each wholesaler, and the size of the orders placed by each wholesaler’s retailing clients. The stores might also have different suppliers of merchandise, which could contribute to a difference in respective cost of goods sold. (b) As president of Company B, I might investigate the cost of the company’s goods (shoes), try to find more reasonable suppliers of merchandise, investigate the
possibility of reducing overhead or distributions costs, and sell in larger quantities to retailers…all of which should lower some costs. 19. Operating items are generated from operating activities (that is, by providing a product or service to a customer). Nonoperating items are generated from investing and financing activities or by events incidental to the operations of a business. These definitions provide the rationale for the items below. Sales revenue Cafeteria revenue Interest revenue Cost of goods sold Utility expense FICA (Social Security) matched amounts Shipping expense Income tax expense Property tax expense
operating revenue nonoperating income nonoperating income operating expense operating expense operating expense (part of salaries/wages) operating expense (relates to inventory) nonoperating expense operating expense (assume on property in use in the business, such a manufacturing facility or headquarters)
20. Gross Profit = Revenues – Cost of Goods Sold Gross Profit = $750,000 - $480,000 Gross Profit = $270,000 Gross Profit Percentage = Gross Profit ÷ Revenues Gross Profit Percentage = $270,000 ÷ $750,000 Gross Profit Percentage = 36% Oehlke Co. may not have a high enough markup on the product, especially given how high salary costs are in the business. After paying for the product, Oehlke only has 36% of what customers paid for the goods, and Oehlke still has to pay other expenses out of that. 21. (a) (b) (c) (d) (e)
relevance materiality comparability understandability reliability
22. (a) The operating cycle would be 135 days. (90 days + 35 days) (b) Normally, anything that is receivable or payable within the accounting cycle is classified as current; anything receivable or payable beyond the accounting cycle is classified as long term.
23 Several common examples of accrued liabilities at the end of an accounting cycle are salaries owed to employees for work already performed, interest on notes payable, local/state/federal taxes, and utilities.
PROBLEMS 24. (a) Gross Profit = Net Sales – Cost of Goods Sold Gross Profit = $315,000 - $130,750 Gross Profit = $184,250 Operating Income = Gross Profit – SG&A Exp. Operating Income = $184,250 - $90,050 Operating Income = $53,500 Income before Taxes = Operating Income + Interest Revenue Income before Taxes = $53,500 + $5,000 Income before Taxes = $58,500 Net Income = Income before Taxes – Income Tax Expense Net Income = $58,500 - $2,500 Net Income = $56,000
(b)
Valimer Corporation Income Statement For Period Ended Date Net Sales Cost of Goods Sold Gross Profit Selling and Administrative Expenses Operating Income Interest Revenue Income Before Income Taxes Income Tax Expense Net Income
$315,000 (130,750) $184,250 (90,050) $ 94,250 5,000 $ 99,250 2,500 $ 96,750
25. (a) $35,000 ÷ 5 years = $7,000 per year. (b) $7,000 per year x 3 years = $21,000 of Accumulated Depreciation (c) The matching principle requires that revenues generated in a particular accounting cycle be matched with the expenses incurred during that same accounting cycle. This purchase reflects an item that should be capitalized and depreciated over the life of the asset rather than expensed immediately on the income statement.
26. (a)
Revenue per unit = 2 x cost per unit Revenue per unit = 2 x $27.50 Revenue per unit = $55.00 Sales (2008) = units sold x revenue per unit Sales (2008) = 10,000 units x $55 Sales (2008) = $550,000
(b)
Cost of Goods Sold (CGS) = units sold x cost per unit CGS = 10,000 x $27.50 CGS = $275,000 Gross Profit = Sales (2008) - CGS Gross Profit = $550,000 - $275,000 Gross Profit = $275,000
(c)
Gross Profit = Sales – CGS Sales (2009) = CGS + Gross Profit Sales (2009) = $225,000 + $200,000 Sales (2009) = $425,000 Gross Profit % = Gross Profit ÷ Net Sales Gross Profit % = $200,000 ÷ $425,000 Gross Profit % = 47.1%
27. (a) The ending balances on the Statement of Stockholders’ Equity for Common Stock, Additional Paid-In Capital, and Retained Earnings are presented on the balance sheet in the Stockholders’ Equity section. (b) The sale of common stock accounted for an increase in stockholders’ equity of $540,000 (par value of $240,000 + additional paid-in capital of $300,000). 28. (a) Green Realty Corp. probably uses this format because the real estate industry’s most important asset is its investments. Cash and other types of current assets appear to be almost insignificant amounts to Green Realty. (b) Restricted cash would primarily consist of security deposits held on behalf of tenants as well as capital improvement and real estate tax escrows required under certain loan agreements. (c) Comparability would not exist within the industry if Green Realty Corp. uses a different format for its balance sheet.
29. (a) Potential investors might want to have prior years’ audited financial statements, detailed information about current obligations (both short-term and long-term), and ratio analysis for liquidity. They may also want to see projections for the future, including information about the city/state/country economic health. (b) The audited financial statements should help satisfy the following objectives: (1) providing information that is useful in making investing and lending decisions, (2) providing information about assets, liabilities and other transactions that might impact these items, and (3) providing information to allow decision makers to help predict future cash flows. (c) The income statement would probably be the most useful for potential investors to examine because it indicates the company’s profitability for the period. However, this statement should not be examined without also reviewing the Statement of Cash Flows. Investors would want information about the cash inflows and outflows from operating, investing, and financing activities so as to be able to make judgments about the ability of the firm to meet current obligations as well as determine what type of activities are providing the cash resources that allow the company to meet those obligations.
30. I could not justify inflating sales or net income, even if it meant that possible loss of jobs. Tim should have the accountant project earning s for the next several years with and without the purchase of this piece of equipment. Tim should then take these projections to the bank with him when he goes to see the banker. Tim possibly does not want to appear at fault because of declining profits over the past years. 31. (a and b) Whitecotton has violated both principles of comparability and consistency with the third change in as many years. These principles make the financial statements more reliable to users, so changing methods of depreciation on a yearly basis might make financial statements unreliable. Hethcox has followed the principle of full disclosure. Even though the sales happened after the end of the most recent accounting cycle, the operations of these divisions did have an impact on the information being presented currently. Still Gardening is appropriately applying the lower of cost or market rule (conservatism) for valuing inventory on the balance sheet. Mason has followed full disclosure of lease payments. This information should be disclosed to financial statement readers and would be of interest to current and potential investors and creditors.
CASES 32. (a) (1) Interest income is separated from is income generated from nonoperating activities like investing and financing activities. Thus, interest income is listed as a separate line item because it is not income generated from the principal activities (providing cruise services) of Carnival. (2) Carnival primarily provides a service, although the company does sell some products. For this reason, Carnival’s cost of goods sold would be a relatively small portion of its expenses. In fact, the company does not list cost of goods sold separately and does not calculate Gross Profit. (3) Primary operating revenues are ticket sales for cruises, sales of sightseeing packages, sales of items to passengers, etc. (b) (1) Total Assets = $34,181,000,000 (2) A trademark is a symbol or sign used by a business to identify its product or services. Trademarks distinguish a business’s services and products and have a considerable intangible value. Trademarks are shown as assets because they have the potential to produce future benefits. (3) Cost of PPE $32,540,000,000 Depreciation $5,901,000,000 (4) The historical cost principal dictates that most assets are shown on the financial statements at their original cost. Use of historical cost as the valuation basis for assets stems from the fact that historical cost is more verifiable and less subject to estimation than current values. (5) Customer deposits represent money a customer gave Carnival for a future cruise. Until Carnival provides the cruise service to its customer, the money that has been paid by the customer is unearned. Thus, an unearned revenue account is established and this account is classified as current liability because Carnival owes the customer a cruise or a refund. (6) The current portion of long-term debt is shown in footnote 5 as $1,028,000,000. This amount represents the portion of long-term debt that comes due within the next accounting period. (7) Profits generated but not distributed to owners are shown in Retained Earnings. As of November 30, 2007, Carnival’s Retained Earnings was $12,921,000,000. During fiscal year 2007, Carnival paid out total dividends of $990,000,000.
33. (a) For accounting information to be useful, it must possess a high degree of relevance by being timely and having feedback and/or predictive value. The information
contained in Note 7 can help predict amounts that Carnival may owe in the future. Therefore, it is relevant. (b) Materiality refers to the relative importance of specific items of accounting information. An item is deemed material if its size (quantitative materiality) or informational content (qualitative materiality) is significant enough to influence a financial statement user’s decision. The contingent obligations for Carnival Corporation as of November 30, 2007, amounted to $1.07 billion. This amount is significant and it could have adverse effects on the financial statements if recognized. (c) Objective 1: Financial reports should provide information that is useful in making investing, lending, and other economic decisions. Objective 2: Financial reports should provide information that is useful to decisionmakers in predicting the future cash flows of businesses and future cash dividends from those businesses. Objective 3: Financial reports should provide information about the assets and liabilities of businesses and the transactions and other events that have resulted in changes in those assets and liabilities. (d) Objective 1 would be violated if Note 7 was omitted. Although the amounts described in Note 7 are uncertain, they have the potential to increase expenses or decrease earnings. An investor or lender would want to know this information before making a decision on investment or lending. Also, an investor may not be interested in investing in a company with a potential lawsuit related to The Americans with Disabilities Act. Objective 2 would also be violated if Note 7 was omitted. Without the information in Note 7, future cash flows might be overestimated. Objective 3 addresses current and historical numbers. Because the amounts in Note 7 represent the future, Objective 3 would not be violated if Note 7 was omitted.
CHAPTER 3 SOLUTIONS TO END OF CHAPTER MATERIAL QUESTIONS 1. Assets Liabilities Stockholders’ Equity
Land and Equipment Accounts Payable and Unearned Revenue Common Stock and Retained Earnings
2. The sale of stock in an entity, recording of net income (or net loss) for a period, and dividends declared for company stockholders affect stockholders’ equity. Example 1: Issued 5,000 shares of XYZ Co.’s $1 par value common stock. Checks totaling $5,000 were received from stockholders. Example 2: A dividend of $1,000 was declared and paid by the corporation. 3. Common types of source documents include invoices, sales slips, legal contracts, checks, and purchase orders. Invoices – Purchase transaction details. Sales slips – Sale transaction detail. Legal contract – The terms and conditions of the agreement between parties. Checks – The amount paid, signature of drawer, and name of drawee. Purchase orders – The quantity and type of goods ordered. 4. The general journal records economic events in chronological order. Posting financial information from the general journal to the general ledger is very important because the information is then presented per account rather than per transaction (as is in the general journal). Posting simplifies the representation of data and increases the efficiency of accounting transactions. 5. A trial balance is a statement listing the debit and credit account balances from the general ledger accounts. A trial balance’s purpose is to assure that the accounting system is “in balance” (total debits and total credits are equal) at the point in time at which the trial balance is prepared. The fact that a trial balance is “in balance” does not necessarily mean that all transactions have been recorded correctly. For example, if the debit or credit of a journal entry were posted to an incorrect account, the debit and credit columns of the trial balance would be equal although at least one of the accounts would be incorrect. Additionally, if the wrong amount were recorded in the journal entry, the debit and credit columns of the trial balance would be equal although at least two accounts would be incorrect.
6. A deferred expense is actually an asset that has been created by a prepayment of an expense, such as insurance and property taxes. If a portion of the prepayment has been “used up,” failure to adjust the deferred expense (prepaid asset) at the end of an accounting cycle will cause the balance in the asset account to be overstated and the balance in the expense account to be understated. 7. A deferred revenue is a liability because the organization has received cash in advance of the earning process. Examples of deferred revenues include unearned magazine subscriptions revenues and unearned rental income. If the company earns a portion or all of the deferred revenue, failure to adjust the balance will result in liabilities that are overstated and revenues that are understated. 8. An accrued revenue is an asset because it represents a receivable that has resulted from revenues earned, but not yet received. Examples of accrued revenues include Interest Receivable and Accounts Receivable. If revenues are earned but not accrued, revenues and assets are understated. The adjusting entry corrects these understatements. 9. The net income or net loss for a period must be transferred from the temporary revenue and expense accounts to Retained Earnings (a balance sheet account). This process is necessary so that the balance sheet will be in balance after the temporary accounts are closed. 10. The Retained Earnings account is presented in the stockholders’ equity section of the balance sheet; it is also on the statement of stockholders’ equity. This account represents the earnings of the organization that have not been distributed in the form of dividends to the stockholders. 11. Dividends are distributions to stockholders for their investment in the organization. Dividends are found on the Statement of Stockholder’ Equity as a reduction of retained earnings. Dividends will also be found on the balance sheet in current liabilities as Dividends Payable if those dividends have been declared but not paid. Dividends are not considered expenses because they are not actual costs of operating a business. Instead, dividends are returns on investments to the business’ investors. 12. Permanent accounts are not closed at the end of the cycle and are found on the balance sheet. Temporary accounts (or nominal) accounts are closed at the end of the accounting cycle. Two temporary accounts (revenues and expenses) are found on the income statement; one temporary account (Dividends) is shown on the Statement of Retained Earnings. The terms permanent and temporary are appropriate because those terms reflect the degree of continuity of the accounts on the financial statements. Permanent accounts continue from period to period, while temporary accounts are reduced to zero at the end of one period so that completely new information can be recorded in those accounts in the next period.
13. Adjusting entries are made at the end of each accounting cycle to bring all revenue and expense accounts up-to-date so that those accounts reflect the appropriate amounts of revenues earned and expenses incurred during that particular cycle. Closing entries are made at the end of each accounting cycle to bring all temporary accounts to zero balances, which enable the organization to start the next accounting cycle with a “fresh slate.”
EXERCISES 14. (a) F A journal entry may affect as many accounts as necessary as long as the dollar amount of the debits and credits are equal. (b) F An “in balance” trial balance does not mean that the accounting records are free of error because a misstatement in recording may still exist. (c) T (d) F By not recording a transaction in its entirety, the debits and credits of the business will still be in balance; however, the amounts of certain account balances will be incorrect. (e) T (f) F The closing process starts with preparing closing entries. (g) T (h) T (i) T (j) F Only the temporary accounts of an organization begin the period with zero balances. (k) T (l) F Double-entry bookkeeping is used in countries around the world. 15. a. & b. A L Q X R
Alcoa DR CR CR DR CR
Honeywell L CR A DR A DR X DR A DR
Darden’s Restaurants X DR A DR L CR Q CR A DR
16. (a) Purchased $400 of supplies for cash. Paid $270 of interest expense in cash. Purchased $4,000 of equipment by signing a note payable. (b) Instead of increasing Equipment and Notes Payable each by $4,000, the bookkeeper would have decreased both accounts by $4,000. Therefore, both would have been understated by $8,000. Assuming no other transactions in these accounts, Equipment would have had an abnormal credit balance of $4,000 and Notes Payable would have been an abnormal debit balance of $4,000.
(c) The trial balance would still have balanced because equality between debits and credits would have existed, but the trial balance would not have been accurate. 17. (a) Cash Unearned Rent Revenue
24,000
Prepaid Advertising Cash
6,000
24,000
6,000
(b) Prepaid Rent Cash
24,000 24,000
Cash Unearned Advertising Revenue
6,000 6,000
(c) The first transaction increased assets (cash) by $24,000 The second transaction increased one asset (prepaid advertising) by $6,000 and decreased another asset (cash) by $6,000; thus, there was no effect on total assets. 18. (a) Cash would be classified as a current asset and Accounts Payable would be classified as a current liability. (b) Assets have debit balances. Liabilities have credit balances. (c) Cash has a debit balance of $18,400. Accounts payable has a credit balance of $5,200. Cash 14,000 9,000 8,000 18,400
10,000 600 2,000 Balance
Accounts Payable 4,000 5,000 1,000 Balance
6,000 8,200 1,000 5,200
(d) The debit to Cash represents an increase to the company’s cash. It could have been a result of an $8,000 payment on account by one of the company’s customers or an $8,000 cash sale. (e) The debit to Accounts Payable represents a reduction to accounts payable. It could have been a result of a $5,000 payment on account by the company or a return of $5,000 of merchandise to a supplier.
19. (a-c)
Cash
Office Supplies
12,400 420 6,750
840 420___ 1,260
6,350 2,658 9,722 Accounts Receivable 9,300 6,750 2,550
Accounts Payable 14,200 7,560 6,350___ 15,410
Inventory 6,100 7,560___ 13,660
Utility Expense 0 2,658___ 2,658
(d) The purpose of posting journal entries to the ledger accounts is to help consolidate the information by accounts so as to aid in financial statement preparation and to provide specific information on balances in particular accounts. 20. (a-b) The following accounts would likely need an adjusting entry: Property, Plant, and Equipment would necessitate the recording of Depreciation Expense and the increasing of Accumulated Depreciation. Unearned Rent Revenue would necessitate the recording of the revenue earned during the period by decreasing that account and increasing Rent Revenue. Prepaid Rent would necessitate the recording of the Rent Expense incurred for the period and the reduction of Prepaid Rent. Notes Payable would necessitate an adjusting entry to record Interest Expense and Interest Payable for the period. (c)
The non-affected accounts (cash, common stock, land, and retained earnings) are not adjusted because their balances do not change simply by the passage of time.
21. (a) Current liabilities that may have been recorded during the adjusting entry process include accounts payable, accrued compensation, other accrued expenses and income taxes payable. (b) The $200,000,000 of long-term debt that was coming due in the upcoming year would have been transferred from a long-term debt account to a current liability.
(c) Compensation Expense Accrued Compensation Payable
46.4 M 46.4 M
22. (a) Cash Unearned Design Fees
5,000
(b) Accounts Receivable Unearned Design Fees Design Fee Revenue
5,000 5,000
23. (a) Cleaning Supplies Cash (b) Supply Expense Cleaning Supplies Accounts Receivable Fees Earned
5,000
10,000 6,500 6,500 3,100 3,100 4,100,000 4,100,000
(c) The revenue recognition principle would have been violated if the year-end adjusting entry had not been made. Net income (or net loss) for the current period would have been understated (or overstated), while net income (or net loss) for the following period would be overstated (or understated). Revenue should be reported in the period in which it is earned rather than in the period in which it is collected (which represents the cash basis of accounting). (d) By not recording entries that involve revenues and expenses, companies can manipulate their net income. The omission of Harsha’s adjusting entry would have overstated assets and understated expenses, thereby increasing net income. The omission of Silverman & Sachs’ adjusting entry would have understated assets and revenues, thereby reducing net income. Companies might choose to omit entries to mislead the users of the financial statements. 24. (a) Total Assets = Cash + Equipment + Supplies + Land $36,000 = $5,000 + $10,400 + Supplies + $16,400 Supplies = $36,000 – $5,000 – $10,400 – $16,400 Supplies = $4,200 Total Assets = Total Liabilities + Owner’s Equity Total Liabilities + Owner’s Equity = $36,000 Total Liabilities + Owner’s Equity = A/P + N/P + Owner’s Equity $36,000 = A/P + $10,800 + $18,000 A/P = $36,000 – $10,800 – $18,000) A/P = $7,200
(b) Total Liabilities + Owner’s Equity = A/P + N/P + Owner’s Equity $39,800 = A/P + $10,800 + $18,000 A/P = $39,800 – $10,800 – $18,000 A/P = $11,000 Total Assets = Total Liabilities + Owner’s Equity Total Assets = Cash + Equipment + Supplies + Land $39,800 = $5,000 + $10,400 + Supplies + $16,400 Supplies = $39,800 – $5,000 – $10,400 – $16,400) Supplies = $8,000 (c)
Debits Cash Supplies Equipment Land Accounts Payable Notes Payable Owners’ Equity Total
25. (a) Sales Revenue Income Summary
Credits
$5,000 4,200 10,400 16,400
$36,000
$ 7,200 10,800 18,000 $36,000
50,000 50,000
Income Summary Selling Expenses Income Taxes Expense Utilities Expense
26,000
Income Summary Retained Earnings
24,000
12,000 8,000 6,000
24,000
(b) The company earned $24,000. (c) Cash: Current Asset section of the Balance Sheet Accounts Receivable: Current Asset section of the Balance Sheet Unearned Rental Revenue: Current Liability section of the Balance Sheet Accounts Payable: Current Liability section of the Balance Sheet Prepaid Rent: Current Asset section of the Balance Sheet
26. Mr. Restin: Your books need to be adjusted at the end of every accounting cycle to properly account for all the revenues and expenses that impact your business. Generally accepted accounting principles dictate that these procedures be performed to bring all temporary accounts to proper balances to aid in the preparation of financial statements each period. Once adjusting entries are prepared and posted to the general ledger accounts, your books will be closed to determine your net income or net loss for the accounting period. Each accounting period, your nominal/temporary accounts must start out with a zero balance to account for the revenues and expenses related to the next period.
PROBLEMS 27. (a)
Collection of cash should increase cash (debit) and decrease accounts receivable (credit). Entry A has reversed the debit and credit. A purchase of office supplies should decrease cash (credit) and increase office supplies (debit). Entry B has debited Office Equipment (a long-term asset) rather than office supplies (a current asset). Entry C is correct.
(b)
Cash
4,000
Accounts Receivable To reverse incorrect entry Cash
4,000
4,000
Accounts Receivable To record collection of accounts receivable
4,000
(An alternative to the two above entries is one debit to Cash for $8,000 and one credit to Accounts Receivable for $8,000. Office Supplies Office Equipment To correct classification of office supplies as equipment (c)
900 900
Total assets would have been correct, but individual asset accounts (cash, accounts receivable, office supplies, and office equipment) would have been wrong.
28. (a) 12/1 Supplies Cash
300 300
3 Utilities Payable Cash
250
9 Salary Expense Cash
1,200
250
1,200
16 Cash Interest Receivable
600
22 Cash Accounts Receivable
1,700
26 Prepaid Rent Cash
600
1,700 400 400
30 Cash Unearned Revenue
2,500
31 Equipment Accounts Payable
3,000
2,500
3,000
(b) The entries on December 1, 26, and 31 are deferred expenses. The entry on Dec. 30 is a deferred revenue. The entry on Dec. 9 is an accrued expense. 29. (a) Jan. 06 Cash
40,000 Note Payable
Jan. 7
Jan. 7
Jan. 7
Jan. 8
40,000
Prepaid Rent Cash
1,000
Inventory Cash
4,000
Equipment Cash
650
Cash
350
1,000
4,000
650
Revenue Jan. 10 Wages Expense Cash
350 360 360
Jan. 10 Cash
800 Revenue
800
(b)
Jan. 8 Jan. 10 Balance
Cash 40,000 Jan. 7 Jan. 7 Jan. 7 Jan. 10 350 800 35,140
Jan. 7
Inventory 4,000
Jan. 7
Equipment 650
Jan. 10
Wages Expense 360
Jan. 6
(c)
1,000 4,000 650 360
Jan. 7
Notes Payable Jan. 6
40,000
Revenue Jan. 8 350 Jan. 10 800 Balance 1,150
Tamara Zeevah Trial Balance January 10, 2009
Cash Inventory Prepaid Rent Equipment Notes Payable Revenue Wages Expense Totals
Prepaid Rent 1,000
Debits $35,140 4,000 1,000 650
360 $41,150
Credits
$40,000 1,150 ______ $41,150
(d) Ms. Zeevah: Your current method of record keeping is not sufficient to provide you with the necessary information needed to prepare financial statements. You should record each transaction in a general journal and then post to ledger accounts to help facilitate financial statement preparation. As you currently record items through your checkbook, the possibility of missing a transaction or event is high. For example, the interest on your bank loan would not be recorded until it was paid rather than in the period in which that expense were incurred. Should a client prefer to be billed (rather than pay in cash), your records would not indicate that revenue until it was received rather than when it was earned. Please consider amending your current method of record keeping by using the more appropriate accrual method of accounting. 30. (a)
BCI Trial Balance September 30, 2009
Cash Accounts Receivable Inventory Office Equipment Accumulated Depreciation—Office Equipment Accounts Payable Income Taxes Payable Common Stock Retained Earnings Sales Revenue Operating Expenses Totals
$
Debits 50,000 300,000 250,000 450,000
255,000 $1,305,000
Credits
$ 110,000 350,000 50,000 95,000 100,000 600,000 _________ $1,305,000
(b) Three examples are recording the (1) purchase of supplies for cash as a debit to Office Equipment; (2) payment of accounts payable as a debit to Notes Payable, , and (3) the payment of rent expense as a debit to Utility Expense. (c) BCCI could take the following steps to help ensure the accuracy of its accounting records: (1) automate its accounting system, (2) make sure all transactions are recorded in the records, (3) hire qualified accounting professionals.
31. (a) Salary Expense Salary Payable
840
Utility Expense Utility Payable
240
Income Tax Expense Income Tax Payable
800
Unearned Fee Revenue Fee Revenue
100
840
240
800
100
no adjusting entry needed Accounts Receivable Fee Revenue
1,400 1,400
(b) Neither expenses nor payables for salaries, utilities, or income taxes would have been recorded until the cash had been paid. The $300 and $680 would have been recorded as revenue when received; the $1,400 left unbilled would not have shown up on the books at all for December, but rather when received in the future. (c) Accrual accounting provides a better and more appropriate matching of revenues and expenses for a business. It allows the business to properly compute net income or net loss for each accounting period. Cash basis accounting only records transactions when there are cash inflows into or outflows from the business; the cash basis really isn’t conductive to preparing informative financial statements. 32. (a) If the advance payment is credited to a revenue account instead of an unearned revenue account, the income statement will reflect $31,000 of revenue that has not been earned. Balance sheet assets will not be affected by this transaction because cash would be debited in the journal entry whether the transaction were recorded properly or improperly. Liabilities will be understated because the advance payment will not be included as an unearned revenue. In the second transaction, rent expense will be understated, making net income overstated on the income statement. Liabilities on the balance sheet will be understated because rent payable would not have been recorded. (b) Both the revenue recognition and the matching principles will be violated if the accountant complies with the business owner.
(c) The ethical thing to do is to record the transactions properly in spite of what the owner wants, although doing so will probably put you in out-of-favor with your boss. If you desperately need the job, you may end up doing what the boss asks, but you probably need to ask yourself if you really want to work for this type of person. The primary people affected by the misrecording of the transaction are the bankers, who will be analyzing incorrect financial statements in determining whether to make the loan. 33. (a)
Schneider Consulting, Inc. Income Statement For the Year Ended December 31, 2009 Revenues Consulting Fees Interest Revenue Total Revenues Expenses Salaries Expense Rent Expense Advertising Expense Depreciation Expense Utilities Expense Interest Expense Total Expenses Operating Income Other Revenues, Gains, Expenses, and Losses Income Tax Expense Net Income
(b)
$460,000 3,000 $463,000 176,000 23,000 22,000 10,000 6,000 5,000 242,000 221,000 (57,000) $164,000
Schneider Consulting, Inc. Statement of Stockholders’ Equity For the Year Ended December 31, 2009
Beginning balance, January 1, 2009 Add: Sale of stock Net income Less: Dividends Ending balance, December 31, 2009
Common Stock $35,000 0 ______ $35,000
Retained Earnings $ 71,000 164,000 (10,000) $225,000
(c)
Schneider Consulting, Inc. Balance Sheet December 31, 2009 ASSETS Current Assets Cash Accounts Receivable Interest Receivable Inventory Prepaid Insurance Total Current Assets Property, Plant, and Equipment Equipment Accumulated Depreciation Total Assets
$ 24,000 71,000 1,000 125,000 6,000 $227,000 $252,000 (41,000)
LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities Accounts Payable Interest Payable Income Taxes Payable Total Current Liabilities Non-Current Liabilities Notes Payable Total Liabilities Stockholders’ Equity Common Stock Retained Earnings Total Liabilities and Stockholders’ Equity
211,000 $438,000
$ 27,000 4,000 57,000 $ 88,000 90,000 $178,000 $ 35,000 225,000
260,000 $438,000
34. (a) Permanent accounts listed are cash, accounts payable, and accumulated depreciation; temporary accounts listed are interest revenue, rental revenue, dividends, salaries expense, and depreciation expense. (b) Interest Revenue Rental Revenue Income Summary
5,000 252,000 257,000
Income Summary Depreciation Expense Salaries Expense
103,000
Income Summary Retained Earnings
154,000
8,000 95,000
154,000
Retained Earnings Dividends
11,000 11,000
(c) Net Income = Total Revenues - Total Expenses Net Income = $257,000 - $103,000 Net Income = $154,000 (d) Ending R/E = Beginning R/E + Net Income – Dividends Ending R/E = $47,000 + $154,000 - $11,000 Ending R/E = $190,000
CASES 35. (a)
3/2
Cash 200,000 Common Stock 200,000 3/3 Supplies 4,000 Accounts Payable 4,000 3/4 Prepaid Rent 3,000 Cash 3,000 3/5 Accounts Receivable 650 Service Revenue 650 3/6 Cash 7,400 Service Revenue 7,400 3/9 Cash 1,000 Unearned Revenue 1,000 (Note: No entry is needed on 3/10 because the printer has only been ordered and not yet received.) 3/11 Accounts Payable 1,200 Cash 1,200 3/12 Cash 450 Accounts Receivable 450 3/13 Salaries Expense 790 Cash 790 3/13 Cash 3,700 Service Revenue 3,700
(b) Cash Debit
3/2 3/4 3/6 3/9 3/11 3/12 3/13 3/13
Issued common stock Paid rent Received revenue Received unearned revenue Paid A/P Collected A/R Paid salaries Received revenue
Credit
200,000 3,000 7,400 1,000 1,200 450 790 3,700
Balance
200,000 197,000 204,400 205,400 204,200 204,650 203,860 207,560
Accounts Receivable Debit
3/5 Provided services 3/12 Received payment
Credit
650 450
Balance
650 200
Supplies Debit
3/3
Bought supplies
Credit
4,000
Balance
4,000
Prepaid Rent Debit
3/4
Paid rent
Credit
3,000
Balance
3,000
Accounts Payable Debit
3/3 Bought supplies 3/11 Paid A/P
Credit
4,000 1,200
Balance
4,000 2,800
Unearned Revenue Debit
3/9
Received unearned revenue
Credit
1,000
Balance
1,000
Common Stock Debit
3/2
Issued common stock
Credit
Balance
200,000
200,000
Credit
Balance
Service Revenue Debit
3/5 Provided services 3/6 Provided services 3/13 Provided services
650 7,400 3,700
650 8,050 11,750
Salaries Expense Debit
3/13 Paid salaries
790
Credit
Balance
790