Ch03 SM 9e

Chapter 3

Accrual Accounting & Income

Short Exercises

(10 min.) S 3-1

MillionsSales revenue……………………………………………. 850Cost of goods sold……………………………………… (290)All other expenses……………………………………… (325 )Net income……………………………………………….. $ 235

Beginning cash………………………………………….. $ 75Collections ($850 − $27)……………………………….. 823Payments for: inventory………………………………. (380)

everything else………………………. (255 )Ending cash……………………………………………… $ 263

(10 min.) S 3-2

Statement Reports (Amounts in millions)Income statement Interest expense……………………… $ .8

Balance sheet Notes payable ($4.1 + $1.7 − $1.6)…. $4.2

Interest payable………………………. 0.3

Chapter 3 Accrual Accounting & Income 3- 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 during the month may not have been

recorded.

The accrued salaries, which are owed to the employees but have not

been paid, are an expense related to the current period but 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, net income will be overstated, and liabilities will be

understated.

3-2 Financial Accounting 9/e Solutions

(10 min.) S 3-4

The large auto manufacturer should record sales revenue when the

revenue is earned by delivering automobiles to Budget or Hertz. 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 expense recognition

principle tells when to record expenses.

(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 3-6a. The Expense Recognition Principle

b. The Time Period Concept

c. The Revenue Principle

d. The Revenue Principle

e. The Expense Recognition Principle

(10 min.) S 3-7

a.

Oct. 31 Rent Expense ($3,000 × 1/6)…………... 500Prepaid Rent…………………………. 500

To record rent expense.

Prepaid Rent Rent Expense

Oct. 1 3,000 Oct. 31 500 Oct. 31 500

Bal. 2,500 Bal. 500

b.

Oct. 31 Supplies Expense ($950 − $400)……… 550Supplies……………………………….. 550

To record supplies expense.

Supplies Supplies Expense

Oct. 1 950 Oct. 31 550 Oct. 31 550

Bal. 400 Bal. 550


(10 min.) S 3-8

Req. 1

(a) Jan. 1 Computer Equipment…………….……….. 50,000Cash………………………………………. 50,000

Purchased computer equipment.

(b) Dec. 31 Depreciation Expense − Computer Equipment ($50,000 / 5)……. 10,000

Accumulated Depreciation − Computer Equipment…………….......

Record depreciation expense.10,000

Req. 2

Computer Equipment

Accumulated Depreciation −

Computer Equipment

DepreciationExpense −

Computer Equipment

Jan. 1

50,000 Dec. 31 10,000 Dec. 31 10,000

Bal. 50,000 Bal. 10,000 Bal. 10,000

Req. 3

Computer equipment…………………………………. $50,000

Less: Accumulated depreciation…………………… (10,000 )

Book value……………………………………………… $40,000


(10 min.) S 3-9

(Amounts in millions)

Income statement: 2012Salary expense ($42.4 + $2.2)….. $44.6

Balance sheet: 2012Salary payable………………......... $ 2.2

(10 min.) S 3-10

Req. 1

Oct. 31 Interest Expense………………………………….. 250Interest Payable……………………………….. 250

To accrue interest expense for October.

Nov. 30 Interest Expense………………………………….. 250Interest Payable……………………………….. 250

To accrue interest expense for November.

Dec. 31 Interest Expense…………………………………... 250Interest Payable………………………………… 250

To accrue interest expense for December.

Req. 2

Interest Payable

Oct. 31 250Nov. 30 250Dec. 31 250

Bal. 750

Req. 3

Dec. 31 Interest Payable…………………………….......... 750Cash…………………………………………….. 750

To pay interest.


(10 min.) S 3-11

Req. 1

Oct. 31 Interest Receivable……………………………… 250Interest Revenue…………………………….. 250

To accrue interest revenue for October.

Nov. 30 Interest Receivable……………………………… 250Interest Revenue……...……………………… 250

To accrue interest revenue for November.

Dec. 31 Interest Receivable……………………………… 250Interest Revenue……...……………….…….. 250

To accrue interest revenue for December.

Req. 2

Interest Receivable

Oct. 31 250

Nov. 30 250

Dec. 31 250

Bal. 750

Req. 3

Dec. 31 Cash………………………………………………. 750Interest Receivable…………………………. 750

To collect interest.


(5-10 min.) S 3-12

Unearned revenues are liabilities because The World Star has received

cash from subscribers in advance of providing them with newspapers.

Receiving the cash in advance creates an obligation (a liability) for The

World Star. As The World Star delivers newspapers to subscribers, The

World Star earns the revenue, and the dollar amount of the unearned

revenue then goes into the revenue account.

a. Cash……………………………………………. 60,000Unearned Subscription Revenue…....... 60,000

Received cash for revenue in advance.

b. Unearned Subscription Revenue.................. 40,000Subscription Revenue…………………… 40,000

To record the earning of subscriptionrevenue that was collected in advance.

(5-10 min.) S 3-13

Prepaid Rent at December 31:

a. Unadjusted amount……………………………. $18,000

b. Adjusted amount ($18,000 − $6,000)……….. 12,000

Rent Expense at December 31:

c. Unadjusted amount…………………………… $ - 0 -

d. Adjusted amount ($18,000 / 3)………………. 6,000


(10 min.) S 3-14

a. Accounts Receivable………………………... 55,000Service Revenue………………………….. 55,000

Cash……………………………………………. 35,000Accounts Receivable……………………. 35,000

b. Cash……………………………………………. 9,000Unearned Service Revenue…………….. 9,000

Unearned Service Revenue………………… 7,000Service Revenue………………………….. 7,000

(15-30 min.) S 3-15

Sparrow Sporting Goods CompanyIncome Statement

For the Year Ended March 31, 2012Thousands

Net revenues……………………………. $175,500

Cost of goods sold……………………. 136,000

All other expenses…………………….. 29,000

Net income……………………………… $ 10,500

Sparrow Sporting Goods Company

Statement of Retained Earnings

For the Year Ended March 31, 2012

Thousands

Retained earnings, March 31, 2011…... $21,500

Add: Net income………………………… 10,500

Retained earnings, March 31, 2012.….. $32,000


(continued) S 3-15

Sparrow Sporting Goods CompanyBalance SheetMarch 31, 2012

ThousandsASSETS

Current:

Cash........................................................ $ 20,800

Ac counts receivable.............................. 28,000

Inventories.............................................. 35,000

Other current assets.............................. 5,000

Total current assets.......................... 88,800

Property and equipment, net................. 6,300

Other assets............................................ 22,000

Total assets.................................................. $117,100

LIABILITIES

Total current liabilities........................... $ 55,100

Long-term liabilities............................... 7,500

Total liabilities.............................................. 62,600

STOCKHOLDERS’ EQUITY

Common stock....................................... 22,500

Retained earnings.................................. 32,000

Total stockholders’ equity.......................... 54,500

Total liabilities and stockholders’ equity... $117,100


(5-10 min.) S 3-16

CLOSING ENTRIESThousands

Mar. 31 Net Revenues ……………………………. 175,500Retained Earnings………………....... 175,500

31 Retained Earnings………………………. 165,000Cost of Goods Sold…………………. 136,000

All Other Expenses………………….. 29,000

Retained Earnings

Mar. 31, 2012 Expenses 165,000 Mar. 31, 2011 Bal. 21,500

Mar. 31, 2012 Revenues 175,500

Mar. 31, 2012 Bal. 32,000

Retained Earnings’ ending balance agrees with the amount reported on

the statement of retained earnings and the balance sheet (in S 3-15).


(5 min.) S 3-17(Dollars in thousands)

Req. 1

Net working capital = Total current assets - Total current liabilities

$33,700 = $88,800 - $55,100

Req. 2

Current ratio =Total current assets

=$88,800

= 1.61Total current liabilities $55,100

Req. 3

Debt ratio =Total liabilities

=$62,600

= 0.53Total assets $117,100

Req. 4

Net working capital of $33,700 means current assets exceed current

liabilities—a positive sign. The current ratio and debt ratio values are

strong.


(10 min.) S 3-18

1. Earned revenue of $10,000 on account:

a. Net working capital = $43,700 [($88,800 + $10,000)- $55,100]

b. Current ratio =$98,800

= 1.79$55,100

c. Debt ratio =$62,600

= 0.49$127,100 ($117,100 +$10,000)

2. Paid accounts payable of $10,000:

a. Net working capital = $33,700 [($88,800 - $10,000) - ($55,100- $10,000)]

b. Current ratio =$78,800

= 1.74$45,100

c. Debt ratio =$52,600 ($62,600 - $10,000)

= 0.49$107,100 ($117,100 -$10,000)


Exercises

(5-10 min.) E 3-19A

Statement Reports (in millions)

1. Income statement Sales revenue………… $4,300

Operating expenses…. 1,200

Balance sheet Accounts receivable… $ 900

Accounts payable……. 1,000

2. Cash basis would report only the cash collections of $4,500 from customers and the payment of operating expenses ($1,200). 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…………………... $540,000 $530,000

Expenses…………………... 420,000 440,000

Net income………………… $120,000 $ 90,000

The accrual basis measures net income better because its information

about revenues and expenses is more complete than the information

provided by the cash basis.


(5-10 min.) E 3-21A

Millions

a. Revenue………………………………………………. $840

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…………………………………….….. $500

The expense recognition principle governs accounting for expenses.

c. The income statement reports revenues and expenses.The statement of cash flows reports cash receipts and cash payments.


(15-20 min.) E 3-22AReq. 1

Adjusting EntriesDATE ACCOUNT TITLES DEBIT CREDIT

a. Insurance Expense................................................ 900Prepaid Insurance ($400+$1,200−$700).......... 900

b. Interest Receivable................................................ 1,600Interest Revenue............................................... 1,600

c. Unearned Service Revenue ($1,100 − $500)........ 600Service Revenue............................................... 600

d. Depreciation Expense........................................... 4,800Accumulated Depreciation.............................. 4,800

e. Salary Expense ($18,000 × 3/5)............................. 10,800Salary Payable…............................................... 10,800

f. Income Tax Expense ($21,000 × .25).................... 5,250Income Tax Payable…...................................... 5,250

Req. 2

Net income understated by omission of:Interest revenue……………………………… $ 1,600Service revenue…………………………….... 600 Total understatement……………………….. $ (2,200)

Net income overstated by omission of:Insurance expense…………………………… $ 900Depreciation expense……………………….. 4,800Salary expense……………………………….. 10,800Income tax expense…………………………. 5,250 Total overstatement…………………………. 21,750

Overall effect — net income overstated by… $19,550


(10-15 min.) E 3-23A

Missing amounts in italics.

1 2 3 4

Beginning Supplies $ 500 $ 400 1,000 $1,000

Add: Payments for supplies

during the year 1,700 800 1,000 400

Total amount to account for 2,200 1,200 2,000 1,400

Less: Ending Supplies (500 ) (500 ) (700 ) (500 )

Supplies Expense $1,700 $ 700 $1,300 $ 900

Journal entries:

Situation 1: Supplies…......................................... 1,700Cash............................................ 1,700

Situation 2: Supplies Expense............................. 700Supplies..................................... 700


(10-20 min.) E 3-24A

Req. 1


a. Interest Expense.................................................... 9,600Interest Payable............................................ 9,600

b. Interest Receivable…............................................ 4,900Interest Revenue…....................................... 4,900

c. Unearned Rent Revenue ($12,000 / 2 × 6/12)....... 3,000Rent Revenue................................................ 3,000

d. Salary Expense ($1,900 × 3)….............................. 7,600Salary Payable............................................... 7,600

e. Supplies Expense.................................................. 1,800Supplies ($3,200 − $1,400)............................ 1,800

f. Depreciation Expense ($80,000 / 5)...................... 16,000Accumulated Depreciation........................... 16,000

Req. 2

Book value = $64,000 ($80,000 − $16,000)


(10-20 min.) E 3-25A

Accounts Receivable Supplies

Bal. 1,500 Bal. 500 (a) 200

(c) 900 Bal. 300

Bal. 2,400

Salary Payable Unearned Service Revenue

(b) 400 (d) 500 Bal. 600

Bal. 400 Bal. 100

Service Revenue Salary Expense

Bal. 4,200 Bal. 1,900

(c) 900 (b) 400

(d) 500 Bal. 2,300

Bal. 5,600

Supplies Expense

(a) 200

Bal. 200


(20-30 min.) E 3-26A

Honeyglazed Hams, Inc.Income Statement

Year Ended December 31, 2012Thousands

Revenues:

Sales revenue............................ $40,900

Expenses:

Cost of goods sold.................... $25,000

Selling, administrative, and

general expense.................. 10,300

Total expenses...................... 35,300

Income before tax........................... 5,600

Income tax expense….................... 2,100

Net income....................................... $ 3,500

Honeyglazed Hams, Inc..

Statement of Retained Earnings

Year Ended December 31, 2012

Thousands

Retained earnings, December 31, 2011………. $4,700

Add: Net income …………………………………. 3,500

8,200

Less: Dividends………………………………….. (1,500 )

Retained earnings, December 31, 2012………. $6,700


(continued) E 3-26A

Honeyglazed Hams, Inc.Balance Sheet

December 31, 2012Thousands

ASSETS LIABILITIES

Cash……………………………. $ 3,700 Accounts payable……… $ 7,900

Accounts receivable………… 1,700 Income tax payable…….. 500

Inventories……………………. 1,600 Other liabilities………….. 2,400

Prepaid expenses……………. 1,600 Total liabilities…………... 10,800

Prop., plant, equip. $ 6,800 STOCKHOLDERS’

Less: Accum. EQUITY

deprec.……. (2,800 ) 4,000 Common stock………….. 4,600

Other assets………………….. 9,500 Retained earnings……… 6,700

Total stockholders’ equity 11,300

Total liabilities and

Total assets…………………… $22,100 stockholders’ equity... $22,100


(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

Receivables

Beg. bal. 220

Sales revenue 20,550 Collections 20,400

End. bal. 370

Prepaid Insurance

Beg. bal. 150

Payment 440 Insurance expense 420

End. bal. 170

Accrued Liabilities Payable

Beg. bal. 600

Payments 4,300

Other operating expenses 4,400

End. bal. 700


(10-15 min.) E 3-28A

Req. 1

MillionsIncome statement

Service revenue (£430 − £80)……………………. £350

Balance sheetUnearned service revenue………………………... £80

Req. 2

Income statementService revenue (£65 + £430 − £80)…………….. £415


Service revenue is greater in (2) because Bennett began the year owing

more phone service to customers. With collections for the year and the

amount of the ending liability unchanged, Bennett must have earned

more revenue in situation 2 than in situation 1.

Not required but helpful:

Unearned Service Revenue

Beg. bal. 65

Earned revenue 415 Collected cash 430

End. bal. 80


(10-20 min.) E 3-29A

Req. 1

JournalDATE ACCOUNT TITLES DEBIT CREDIT

Closing EntriesDec. 31 Service Revenue........................................ 23,900

Other Revenue........................................... 400Retained Earnings............................... 24,300

31 Retained Earnings..................................... 22,000Cost of Services Sold.......................... 11,000Selling, General, and Administrative Expense........................................... 6,400Depreciation Expense......................... 4,100Income Tax Expense........................... 500

31 Retained Earnings..................................... 300Dividends.............................................. 300

Net income for 2012 was $2,300 ($24,300 − $22,000).

Req. 2

Retained Earnings

Expenses 22,000

Dec. 31, 2011 2,600

Dividends 300 Revenues 24,300

Dec. 31, 2012 4,600


(15-25 min.) E 3-30A


Adjusting Entries

Dec. 31 Unearned Service Revenue............................. 6,300Service Revenue ($19,500 − $13,200)........ 6,600

31 Salary Expense ($4,600 − $4,300)................... 300Salary Payable............................................. 300

31 Rent Expense ($1,600 − $1,300)...................... 300Prepaid Rent................................................ 300

31 Depreciation Expense ($700 − $0).................. 700Accumulated Depreciation......................... 700

31 Income Tax Expense ($1,500 − $0)................. 1,500Income Tax Payable.................................... 1,500

Closing Entries

31 Service Revenue............................................... 19,500Retained Earnings...................................... 19,500

31 Retained Earnings............................................ 8,400Salary Expense........................................... 4,600Rent Expense.............................................. 1,600Depreciation Expense................................ 700Income Tax Expense.................................. 1,500

31 Retained Earnings............................................ 1,400Dividends..................................................... 1,400


(20-30 min.) E 3-31A

Req. 1

Anderson Production CompanyBalance Sheet

December 31, 2012

ASSETS

Current Assets:

Cash................................................................................ $14,100

Prepaid rent ($800 − $300)............................................ 500

Total current assets.................................................. 14,600

Plant Assets:

Equipment…………………………………...... $42,000

Less accumulated depreciation

($3,400 + $700)…………………….……… (4,100 ) 37,900

Total assets......................................................................... $52,500

LIABILITIES

Current:

Accounts payable.......................................................... $ 5,100

Salary payable ($4,600 − $4,300)….............................. 300

Unearned service revenue ($9,100 − $6,300).............. 2,800

Income tax payable….................................................... 1,500

Total current liabilities............................................. 9,700

Note payable, long-term..................................................... 16,000

Total liabilities..................................................................... 25,700


Common stock…................................................................ 8,600

Retained earnings ($8,500 + $19,500 − $4,600 − $1,600 −

$700 − $1,500 − $1,400)…….......................................... 18,200

Total stockholders’ equity….............................................. 26,800

Total liabilities and stockholders’ equity.......................... $52,500


(continued) E 3-31A

Req. 2

CurrentYear

PriorYear

Net working capital

= Total current assets - current liabilities

$14,600 - $9,700

= $4,900 $5,000

Current ratio

=Total current assets

=$14,600

= 1.51 1.55Total current liabilities $9,700

Both net working capital and the current ratio have decreased indicating that the ability to pay current liabilities with current assets has deteriorated.


=$25,700

= 0.49 0.30Total assets $52,500

The overall ability to pay total liabilities deteriorated a little.


(30 min.) E 3-32A

a. Current ratio =$50

= 1.11 Debt ratio =$40 + $5

= 0.60$40 + $5 $70 + $5

The purchase of equipment on account hurts both ratios.

b. Current ratio =$50 − $6

= 1.10 Debt ratio =$40 − $6

= 0.53$40 $70 − $6

The payment of long-term debt hurts the current ratio and improves the debt ratio.

c. Current ratio =$50 + $5

= 1.22 Debt ratio =$40 + $5

= 0.60$40 + $5 $70 + $5

Collecting cash in advance hurts both ratios.

d. Current ratio =$50

= 1.19 Debt ratio =$40 + $2

= 0.60$40 + $2 $70

Accruing an expense hurts both ratios.

e. Current ratio =$50 + $6

= 1.40 Debt ratio =$40

= .53$40 $70 + $6

A cash sale improves both ratios.


(5-10 min.) E 3-33B

Statement Reports (in millions)

1. Income statement Sales revenue…………….. $4,400

Operating expenses……... 1,300

Balance sheet Accounts receivable…….. $ 700

Accounts payable……….. 1,200

2. Cash basis would report only the cash collections of $4,600 from customers and the payment of operating expenses ($1,300).The balance sheet would include neither accounts receivable nor accounts payable.

(5-10 min.) E 3-34B

a. Cash Basis b. Accrual Basis

Revenues…………………... $510,000 $500,000

Expenses…………………... 410,000 450,000

Net income………………… $100,000 $ 50,000

The accrual basis measures net income better because its information

about revenues and expenses is more complete than the information

provided by the cash basis.


(5-10 min.) E 3-35B

Millions

a. Revenue………………………………………………. $780

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…………………………………….….. $530

The expense recognition principle governs accounting for expenses.

c. The income statement reports revenues and expenses.The statement of cash flows reports cash receipts and cash payments.


(15-20 min.) E 3-36BReq. 1


a. Insurance Expense................................................... 700Prepaid Insurance ($300 + $900 − $500)............ 700

b. Interest Receivable…................................................ 1,300Interest Revenue.................................................. 1,300

c. Unearned Service Revenue ($1,200 − $300)........... 900Service Revenue…............................................... 900

d. Depreciation Expense............................................... 4,400Accumulated Depreciation.................................. 4,400

e. Salary Expense ($17,000 × 3/5)................................ 10,200Salary Payable...................................................... 10,200

f. Income Tax Expense ($26,000 × .25)....................... 6,500Income Tax Payable............................................. 6,500

Req. 2

Net income understated by omission of:Interest revenue…………………………………….. $ 1,300Service revenue……………………………............. 900 Total understatement……………………………… $ (2,200)

Net income overstated by omission of:Insurance expense………………………………… $ 700Depreciation expense…………………………….. 4,400Salary expense…………………………………….. 10,200Income tax expense………………………............ 6,500 Total overstatement………………………............ 21,800

Overall effect — net income overstated by………. $19,600


(10-15 min.) E 3-37B

Missing amounts in italics.

1 2 3 4

Beginning Supplies $ 400 $ 600 $1,100 $ 900

Add: Payments for supplies

during the year 1,600 1,100 1,500 600

Total amount to account for 2,000 1,700 2,600 1,500

Less: Ending Supplies (200 ) (300 ) (1,000 ) (300 )

Supplies Expense $1,800 $ 1,400 $1,600 $1,200

Journal entries:

Situation 1: Supplies………………………………. 1,600Cash……………………………….. 1,600

Situation 2: Supplies Expense…………………… 1,400Supplies………………………....... 1,400


(10-20 min.) E 3-38BReq. 1


a. Interest Expense....................................................... 9,000Interest Payable.................................................... 9,000

b. Interest Receivable................................................... 4,300Interest Revenue.................................................. 4,300

c. Unearned Rent Revenue ($13,900 / 2 × 6/12).......... 3,475Rent Revenue....................................................... 3,475

d. Salary Expense ($1,300 × 3)..................................... 3,900Salary Payable...................................................... 3,900

e. Supplies Expense..................................................... 1,300Supplies ($2,900 − $1,600)................................... 1,300

f. Depreciation Expense ($140,000 / 5)....................... 28,000Accumulated Depreciation.................................. 28,000

Req. 2

Book value = $112,000 ($140,000 − $28,000)


(10-20 min.) E 3-39B

Accounts Receivable Supplies

Bal. 1,400 Bal. 300 (a) 200

(c) 500 Bal. 100

Bal. 1,900


(b) 700 (d) 200 1,000

Bal. 700 Bal. 800

Service Revenue Salary Expense

Bal. 4,600 Bal. 2,400

(c) 500 (b) 700

(d) 200 Bal. 3,100

Bal. 5,300

Supplies Expense

(a) 200

Bal. 200


(20-30 min.) E 3-40B

Honeybee Hams, Inc.Income Statement

Year Ended December 31, 2012Thousands

Revenues:

Sales revenue.......................... $42,200

Expenses:

Cost of goods sold.................. $25,500

Selling, administrative, and

general expense................. 10,000

Total expenses................. 35,500

Income before tax............................. 6,700

Income tax expense.......................... 2,500

Net income......................................... $ 4,200

Honeybee Hams, Inc.Statement of Retained EarningsYear Ended December 31, 2012

Thousands

Retained earnings, December 31, 2011….. $4,600

Add: Net income ……………………………. 4,200

8,800

Less: Dividends……………………………… (1,400 )

Retained earnings, December 31, 2012….. $7,400


(continued) E 3-40B

Honeybee Hams, Inc.Balance Sheet

December 31, 2012Thousands

ASSETS LIABILITIES

Cash……………………………. $ 3,400 Accounts payable………. $ 7,700

Accounts receivable………… 1,900 Income tax payable…….. 600

Inventories……………………. 1,700 Other liabilities………….. 2,400

Prepaid expenses…………… 1,700 Total liabilities…………... 10,700

Prop., plant, equip. $ 6,700 STOCKHOLDERS’

Less: Accum. EQUITY

deprec……. (2,500 ) 4,200 Common stock………….. 4,500

Other assets………………….. 9,700 Retained earnings……… 7,400



Total assets…………………… $22,600 stockholders’ equity... $22,600


(10-20 min.) E 3-41B

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

Receivables

Beg. bal. 210

Sales revenue 21,010 Collections 20,900

End. bal. 320

Prepaid Insurance

Beg. bal. 160

Payment 470 Insurance expense 430

End. bal. 200

Accrued Liabilities Payable

Beg. bal. 640

Payments 4,200Other operating

expenses 4,290

End. bal. 730


(10 min.) E 3-42B

Req. 1

MillionsIncome statement

Service revenue (£380 − £95)…………………….. £285


Req. 2

Income statementService revenue (£75 + £380 − £95)……………… £360


Service revenue is greater in (2) because Terra began the year owing

more phone service to customers. With collections for the year and the

amount of the ending liability unchanged, Terra must have earned more

revenue in situation 2 than in situation 1.

Not required but helpful:

Unearned Service Revenue

Beg. bal. 75

Earned revenue 360 Collected cash 380

End. bal. 95


(10-20 min.) E 3-43B

Req. 1


Closing EntriesDec. 31 Service Revenue........................................... 24,300

Other Revenue…........................................... 200Retained Earnings................................... 24,500

31 Retained Earnings........................................ 22,500Cost of Services Sold.............................. 11,400Selling, General, and Administrative Expense…............................................ 6,000Depreciation Expense............................. 4,500Income Tax Expense............................... 600

31 Retained Earnings........................................ 400Dividends.................................................. 400

Net income for 2012 was $2,000 ($24,500 − $22,500).

Req. 2

Retained Earnings

Expenses 22,500

Dec. 31, 2011 2,200

Dividends 400 Revenues 24,500

Dec. 31, 2012 3,800


(15-25 min.) E 3-44B


Adjusting EntriesDec. 31 Unearned Service Revenue.......................... 6,300

Service Revenue ($19,600 − $13,300)..... 6,300

31 Salary Expense ($5,600 − $4,700)................ 900Salary Payable.......................................... 900

31 Rent Expense ($2,300 − $1,500)................... 800Prepaid Rent............................................. 800

31 Depreciation Expense ($600 − $0)............... 600Accumulated Depreciation...................... 600

31 Income Tax Expense ($1,200 − $0).............. 1,200Income Tax Payable................................. 1,200

Closing Entries31 Service Revenue........................................... 19,600

Retained Earnings................................... 19,600

31 Retained Earnings........................................ 9,700Salary Expense........................................ 5,600Rent Expense........................................… 2,300Depreciation Expense............................. 600Income Tax Expense............................... 1,200

31 Retained Earnings........................................ 1,100Dividends.................................................. 1,100


(20-30 min.) E 3-45BReq. 1

Durkin Production CompanyBalance Sheet

December 31, 2011

ASSETS

Current:

Cash…………………………………………………..…….. $14,200

Prepaid rent ($1,500 − $800)………………………......... 700

Total current assets…………………………………… 14,900

Plant:

Equipment…………………………………….. $44,000

Less accumulated depreciation

($3,500 + $600)…………………….…....... (4,100 ) 39,900

Total assets………………………………………………………. $54,800

LIABILITIES

Current:

Accounts payable.................................................................. $ 4,700

Salary payable ($5,600 − $4,700).......................................... 900

Unearned service revenue ($8,400 − $6,300)....................... 2,100

Income tax payable................................................................ 1,200

Total current liabilities..................................................... 8,900

Note payable, long-term….......................................................... 17,000

Total liabilities….......................................................................... 25,900


Common stock............................................................................. 8,700

Retained earnings ($11,400 + $9,900* − $1,100)........................ 20,200

Total stockholders’ equity.......................................................... 28,900

Total liabilities and stockholders’ equity.................................. $54,800

* Net income = $9,900 ($19,600 − $5,600 − $2,300 − $600 - $1,200)


(continued) E 3-45B

Req. 2Current

YearPriorYear

Net working capital

= Total current assets - current liabilities =

$14,900 - $8,900

= $6,000 $7,000

Current ratio

=Total current assets

=$14,900


Both net working capital and the current ratio have decreased indicating that the ability to pay current liabilities with current assets has deteriorated.


=$25,900

= 0.47 0.40Total assets $54,800

The overall ability to pay total liabilities deteriorated a little.


(30 min.) E 3-46B

a. Current ratio =$60

= 1.03 Debt ratio =$70 + $8

= 0.80$50 + $8 $90 + $8

The purchase of equipment on account hurts both ratios.

b. Current ratio =$60 − $5

= 1.10 Debt ratio =$70 − $5

= 0.76$50 $90 − $5

The payment of long-term debt hurts the current ratio and improves the debt ratio.

c. Current ratio =$60 + $4

= 1.19 Debt ratio =$70 + $4

= 0.79$50 +$4 $90 + $4

Collecting cash in advance hurts both ratios.

d. Current ratio =$60

= 1.11 Debt ratio =$70 + $4

= 0.82$50 + $4 $90

Accruing an expense hurts both ratios.

e. Current ratio =$60 + $8

= 1.36 Debt ratio =$70

= 0.71$50 $90 + $8

A cash sale improves both ratios.


Serial Exercise

(3 hours) E 3-47

Reqs. 1, 2, 5, and 7

Cash Accounts Receivable

Jan. 2 11,000 Jan. 2 700 Jan. 18 1,500 Jan. 28 1,500

9 1,000 3 3,900 Bal. 0

21 2,400 12 200 Adj. 2,000

28 1,500 26 400 Bal. 2,000

31 1,200

Bal. 9,500

Supplies Equipment

Jan. 5 400 Adj. 200 Jan. 3 3,900

Bal. 200 Bal. 3,900

Accumulated Depreciation –Equipment Furniture

Adj. 65 Jan. 4 4,700

Bal. 65 Bal. 4,700

Accumulated Depreciation –Furniture Accounts Payable

Adj. 78 Jan. 26 400 Jan. 4 4,700

Bal. 78 5 400

Bal. 4,700


(continued) E 3-47

Reqs. 1, 2, 5, and 7


Adj. 500 Adj. 800 Jan. 21 2,400

Bal. 500 Bal. 1,600

Common Stock Retained Earnings

Jan. 2 11,000 Clo. 1,743 Clo. 5,300

Bal. 11,000 Clo. 1,200

Bal. 2,357

Dividends Service Revenue

Jan. 31 1,200 Clo. 1,200 Jan. 9 1,000

18 1,500

Bal. 2,500

Adj. 2,000

Adj. 800

Clo. 5,300 Bal. 5,300

Rent Expense Utilities Expense

Jan. 2 700 Clo. 700 Jan. 12 200 Clo. 200

Salary ExpenseDepreciation Expense –

Equipment

Adj. 500 Clo. 500 Adj. 65 Clo. 65

Depreciation Expense –Furniture Supplies Expense

Adj. 78 Clo. 78 Adj. 200 Clo. 200


(continued) E 3-47

Req. 1

January 2 through 18 entries are repeated from Solution to E 2-36.


Jan. 2 Cash........................................................... 11,000Common Stock...................................... 11,000

2 Rent Expense............................................ 700Cash....................................................... 700

3 Equipment…............................................. 3,900Cash....................................................... 3,900

4 Furniture.................................................... 4,700Accounts Payable................................. 4,700

5 Supplies.................................................... 400Accounts Payable................................. 400

9 Cash........................................................... 1,000Service Revenue................................... 1,000

12 Utilities Expense....................................... 200Cash....................................................... 200

18 Accounts Receivable............................... 1,500Service Revenue................................... 1,500

21 Cash............................................................ 2,400Unearned Service Revenue................... 2,400

21 No entry; no transaction yet

26 Accounts Payable...................................... 400Cash........................................................ 400

28 Cash............................................................ 1,500Accounts Receivable............................. 1,500

31 Dividends................................................... 1,200


Cash...................................................... 1,200


(continued) E 3-47Reqs. 3 and 4

Steve Ruiz, Certified Public Accountant, P.C.Adjusted Trial Balance

January 31, 2012TRIAL BALANCE ADJUSTMENTS ADJUSTED TRIAL BALANCE

ACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDITCash 9,500 9,500Accounts receivable — (a) 2,000 2,000Supplies 400 (c) 200 200Equipment 3,900 3,900Accumulated depr. – equip. — (d1) 65 65Furniture 4,700 4,700Accumulated depr. – furn. — (d2) 78 78Accounts payable 4,700 4,700Salary payable — (e) 500 500Unearned service revenue 2,400 (b) 800 1,600Common stock 11,000 11,000Retained earnings — —Dividends 1,200 1,200Service revenue 2,500 (a)2,000 5,300

(b) 800Rent expense 700 700Utilities expense 200 200Salary expense (e) 500 500Depreciation expense – equip. (d1) 65 65Depreciation expense – furn. (d2) 78 78Supplies expense (c) 200 200

20,600 20,600 3,64 3 3,64 3 23,24 3 23,24 3


(continued) E 3-47

Req. 5

Journal DATE ACCOUNT TITLES DEBIT CREDIT

Adjusting Entries(a) Jan. 31 Accounts Receivable............................... 2,000

Service Revenue................................... 2,000

(b) 31 Unearned Service Revenue..................... 800Service Revenue................................... 800

(c) 31 Supplies Expense ($400 − $200)............. 200Supplies................................................. 200

(d1) 31 Depreciation Expense – Equipment....... 65Accumulated Depreciation – Equip..... 65

(d2) 31 Depreciation Expense – Furniture.......... 78Accumulated Depreciation – Furn....... 78

(e) 31 Salary Expense......................................... 500Salary Payable....................................... 500


(continued) E 3-47

Req. 6

Steve Ruiz, Certified Public Accountant, P.C.Income Statement

Month Ended January 31, 2012

Revenues:

Service revenue $5,300

Expenses:

Rent expense $700

Salary expense 500

Supplies expense 200

Utilities expense 200

Depreciation expense – furniture 65

Depreciation expense – equipment 78

Total expenses 1,743

Net income $3,557

Steve Ruiz, Certified Public Accountant, P.C.Statement of Retained EarningsMonth Ended January 31, 2012

Retained earnings, January 1, 2012 $ 0

Add: Net income 3,557

3,557

Less: Dividends (1,200 )

Retained earnings, January 31, 2012 $ 2,357


(continued) E 3-47

Req. 6

Steve Ruiz, Certified Public Accountant, P.C.Balance Sheet

January 31, 2012ASSETS LIABILITIES

Current assets: Current liabilities:

Cash $ 9,500 Accounts payable $ 4,700

Accounts receivable 2,000 Salary payable 500

Supplies 200 Unearned service

Total current assets 11,700 revenue 1,600

Plant assets: Total current liabilities 6,800

Equipment $3,900

Less: accum. STOCKHOLDERS’ EQUITY

depr. (65) 3,835 Common stock 11,000

Retained earnings 2,357

Furniture $4,700

Less: accum.

Total stockholders’ equity

13,357

depr. (78) 4,622 Total liabilities and ______

Total assets $20,157 stockholders' equity $20,157


(continued) E 3-47

Req. 7


Closing EntriesJan. 31 Service Revenue……………………………… 5,300

Retained Earnings……………………….. 5,300

31 Retained Earnings…………………………… 1,743Rent Expense……………………………… 700Utilities Expense………………………….. 200Salary Expense…………………………… 500Depreciation Expense – Equipment…... 65Depreciation Expense – Furniture…….. 78Supplies Expense……………………....... 200

31 Retained Earnings…………………………… 1,200Dividends………………………………….. 1,200


(continued) E 3-47

Req. 8

Net working capital


$11,700 - $6,800

= $4,900


=$11,700

= 1.72Total current liabilities $6,800


=$6,800

= 0.34Total assets $20,157

The company has an excess of current assets over its current liabilities.

The current and debt ratios indicate an excellent financial position. The

business has $1.72 in current assets for every $1.00 of current liabilities.

The debt ratio of 34% is not too high, which suggests that, overall, the

business should be able to pay its debts.


Quiz

Q3-48 b

Q3-49 b

Q3-50 c

Q3-51 d

Q3-52 a

Q3-53 b

Q3-54 b

Q3-55 a

Q3-56 b ($3,000 × 9/12 = $2,250)

Q3-57 d ($5,000 + $22,000 − $15,000 = revenue of $12,000)

Q3-58 b

Q3-59 a

Q3-60 b

Q3-61 d

Q3-62 d Current ratio = $29,700 / $25,100 = 1.183

Debt ratio =$25,100 + $113,000

= .633$29,700 + $188,500

Q3-63 $7,965 ($8,000 − $510 − $125 + $800 − $200)

Q3-64 d Salary Payable

Beg. bal. 20,000

Payment 136,000 Salary exp. 122,000

End. bal. 6,000


Problems

(15-20 min.) P 3-65A

(All amounts in millions)

1. $40 – x = $6 ; x = $34

2. Revenues…………….. $40

Expenses…………….. (34)

Net income…………... $ 6

3. Beginning receivables…….. $ 10

Add: Revenues……………… 40

Less: Collections…………... (25 )

Ending receivables………… $25

Balance sheetASSETS

Current assets: Receivables……. $ 25

4. Beginning accounts payable………. $ 7

Add: Expenses……………………….. 34

Less: Payments…………………….... (37 )

Ending accounts payable…………… $ 4

Balance sheetLIABILITIES

Current liabilities:Accounts payable……… $ 4


(20-30 min.) P 3-66A

Req. 1

Masters ConsultingAmount of Revenue (Expense) for July

Date Cash Basis Accrual BasisJuly 1 Expense $(2,000) $ 0

4 Expense (1,000) 0

5 Revenue 800 800

8 Expense (700) (700)

11 Revenue 0 3,400

19 0 0

24 Revenue 3,400 0

26 Expense (2,000) 0

29 Expense (1,500) (1,500)

31 Expense 0 $2,000 ÷ 5 = (400)

31 Revenue 0 1,000

ReReq. 2 Income (loss) before tax $ (3,000 ) $2,600

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 July 11, the company earned $3,400 of

revenue and increased its wealth as a result. The accrual basis records this

revenue, but the cash basis ignores it. On July 24, the business collected

the receivable that was created by the revenue earned on account at July

11. The accrual basis records no revenue on July 24 because the

company’s increase in wealth occurred back on July 11. The cash basis

waits until cash is received, on July 24, to record the revenue. This is too

late.


(10-20 min.) P 3-67A


Dec. 31 a. Insurance Expense…………………. 4,650*Prepaid Insurance……………….. 4,650

To record insurance expense.

31 b. Salary Expense ($5,800 × 2/5)…….. 2,320Salary Payable…………………… 2,320

To accrue salary expense.

31 c. Interest Receivable…………………. 600Interest Revenue………………… 600

To accrue interest revenue.

31 d. Supplies Expense………………….. 6,300**Supplies………………………….. 6,300


31 e. Unearned Service Revenue ($12,100 × 60%)……………………... 7,260

Service Revenue………………… 7,260To record revenue collected in advance.

31 f. Depreciation Expense – Office Furniture……………………………

3,000

Depreciation Expense – Equipment.. 6,300Accumulated Depreciation –

Office Furniture……………….. 3,000Accumulated Depreciation –

Equipment……………………… 6,300To record depreciation expense.

_____ * $1,050 + $4,800 − $1,200 = $4,650 ** $2,300 + $6,100 − $2,100 = $6,300


(45-60 min.) P 3-68AReq. 1

Lady, Inc.Adjusted Trial Balance

July 31, 2012TRIAL BALANCE ADJUSTMENTS ADJUSTED TRIAL BALANCE

ACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDITCash 8,800 8,800Accounts receivable 1,600 (a) 1,700 3,300Prepaid rent 3,000 (b 1,000* 2,000Supplies 2,100 (c) 1,630 470Furniture 90,000 90,000Accumulated depreciation 3,000 (d) 1,500** 4,500Accounts payable 3,200 3,200Salary payable (e) 3,000*** 3,000Common stock 14,000 14,000Retained earnings 75,060 75,060Dividends 3,900 3,900Service revenue 17,000 (a) 1,700 18,700Salary expense 2,400 (e) 3,000*** 5,400Rent expense (b) 1,000* 1,000Utilities expense 460 460Depreciation expense (d) 1,500** 1,500Supplies expense (c) 1,630 _____ 1,630

112,260 112,260 8,830 8,830 118,460 118,460 _____

* $3,000 ÷ 3 = $1,000** $90,000 ÷ 5 = $18,000 ÷ 12 = $1,500***$5,000 × 3/5 = $3,000


(continued) P 3-68A

Req. 2

Lady, Inc.Income Statement

Month Ended July 31, 2012

Revenues:


Expenses:

Salary expense $5,400

Supplies expense 1,630

Depreciation expense 1,500

Rent expense 1,000



Net income $ 8,710

Lady, Inc.Statement of Retained Earnings

Month Ended July 31, 2012

Retained earnings, July 1, 2012 $75,060


83,770


Retained earnings, July 31, 2012 $79,870


(continued) P 3-68A

Req. 2 (continued)

Lady, Inc.Balance SheetJuly 31, 2012

ASSETS LIABILITIESCurrent assets: Current liabilities:


Accounts receivable 3,300 Salary payable 3,000

Prepaid rent 2,000 Total current liabilities 6,200

Supplies 470

Total current assets 14,570

Furniture $90,000


Less: Accum. Common stock 14,000

deprec. (4,500) 85,500 Retained earnings 79,870



Total assets $100,070 stockholders’ equity $100,070


(10-20 min.) P 3-69A

Req. 1

JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT

Apr. 30 Accounts Receivable ($6,830 − $6,300).......... 530Rental Revenue………………………………. 530

To accrue rental revenue.

30 Interest Receivable ($500 − $0)……………….. 500Interest Revenue ($1,300 − $800)…….…… 500


30 Supplies Expense ($400 − $0)………………… 400Supplies ($1,200 − $400)…………………… 400


30 Insurance Expense ($1,400 − $0)…………….. 1,400Prepaid Insurance ($2,400 − $1,000)…….. 1,400


30 Depreciation Expense ($1,900 − $0)…………. 1,900Accumulated Depreciation

($11,000 − $9,100)……………………….. 1,900To record depreciation expense.

30 Wage Expense ($2,300 − $1,600)………......... 700Wages Payable ($700 − $0)……….……….. 700

To accrue wage expense.

30 Unearned Rental Revenue ($1,700 − $1,300).. 400Rental Revenue*………………………….. 400

To record revenue that was collected in advance._____ * ($20,630 - $19,700 - $530)


(continued) P 3-69A

Req. 2

Total assets = $80,230 ($8,200 + $6,830 + $500 + $4,900 + $800 + $1,000 + $69,000 − $11,000)

Total liabilities = $8,800 ($6,800 + $700 + $1,300)

Net income = $15,230 ($20,630 + $1,300 − $1,900 − $400 − $100 − $2,300 − $600 − $1,400)

Total equity = $71,430 ($80,230 − $8,800) or ($19,000 + $41,000 + $15,230 - $3,800)


(20-30 min.) P 3-70A

Req. 1

Simpson CorporationIncome Statement

Year Ended March 31, 2012

Revenues:


Expenses:


Rent expense 10,100

Insurance expense 4,000

Interest expense 2,700


Depreciation expense 1,300 60,300

Income before tax 45,200

Income tax expense 7,000

Net income $ 38,200

Simpson CorporationStatement of Retained Earnings

Year Ended March 31, 2012

Retained earnings, March 31, 2011 $ 2,000


40,200


Retained earnings, March 31, 2012 $17,200


(continued) P 3-70A

Req. 1 (continued)

Simpson CorporationBalance SheetMarch 31, 2012

ASSETS LIABILITIES


Accounts receivable 8,800 Interest payable 700

Supplies 2,000 Unearned service revenue 800

Prepaid rent 1,700 Income tax payable 2,400

Note payable 18,400

Equipment $36,000 Total liabilities 25,400

Less: Accum.

deprec. (4,600 ) 31,400 STOCKHOLDERS’ EQUITY

Common stock 3,000

Retained earnings 17,200




Req. 2

Debt ratio:$25,400

= 0.56$45,600

Simpson is in compliance with its debt agreement, which requires the

company to maintain a debt ratio no higher than 0.60.


(20 min.) P 3-71A

Req. 1


Closing EntriesMar. 31 Service Revenue………………………….. 94,100

Retained Earnings………………......... 94,100

31 Retained Earnings……………………….. 35,200Advertising Expense………………… 11,000Depreciation Expense……………….. 1,000Interest Expense………..……………. 300Salary Expense……………………….. 17,900Supplies Expense……………………. 5,000

31 Retained Earnings……………………….. 32,500Dividends…………………………........ 32,500

Req. 2

Retained Earnings


Mar. 31, 2012 Dividends 32,500 Mar. 31, 2012 Revenues 94,100

Mar. 31, 2012 Bal. 45,900

Net income = $58,900 ($94,100 - $35,200)

Req. 3

Retained Earnings increased during the year because net income of $58,900 exceeded dividends of $32,500.


(25-40 min.) P 3-72A

Req. 1

Mountain Lodge Service, Inc.Balance SheetMarch 31, 2012

ASSETSCurrent assets:

Cash $ 7,500

Accounts receivable 16,600

Prepaid expenses 5,000

Supplies 3,700


Plant assets:

Equipment $42,500

Less: Accumulated depreciation (6,700 ) 35,800

Other assets 13,700

Total assets $82,300LIABILITIES

Current liabilities:

Current portion of note payable $ 400

Accounts payable 14,100

Salary payable 2,500

Unearned service revenue 3,700

Total current liabilities 20,700

Note payable, long-term 5,700

Total liabilities 26,400STOCKHOLDERS’ EQUITY

Common stock 10,000

Retained earnings 45,900 *


Total liabilities and stockholders’ equity $82,300


(continued) P 3-72A

Req. 1 (continued)

*Retained earnings, March 31, 2011………………. $19,500

Add: Net income ($94,100 − $11,000 − $1,000 −

$300 − $17,900 − $5,000)…………………. 58,900

78,400

Less: Dividends………………………………........... (32,500 )

Retained earnings, March 31, 2012……………… $45,900

Req. 2

2012 2011

Net working capital


$32,800 - $20,700

= $12,100 $11,800


=$32,800


The increase in both working capital and the current ratio indicate that

the ability to pay current liabilities with current assets improved during

2012.

2012 2011


=$26,400

= 0.32 0.25Total assets $82,300

The overall debt position deteriorated a little during 2012. The

improvement in the current ratio is greater than the deterioration in the

debt ratio. However, Mountain Lodge’s overall debt position is strong

because a debt ratio of .32 is not troublesome.


(45-60 min.) P 3-73A

Req. 1(All amounts in millions)


=$15.8

= 1.84Total current liabilities $8.6

$13.9


=$8.6 + $5.3

= 0.43Total assets $32.1

Req. 2

Current Ratio Debt Ratio

a.$15.8 − ($8.6 × 1/2)

= 2.67$13.9 − ($8.6 × 1/2)

= 0.35($8.6 × 1/2) $32.1 − ($8.6 × 1/2)

b.$15.8 + $2.0

= 2.07$13.9 + $2.0

= 0.47$8.6 $32.1 + $2.0

c.$15.8 + $2.4

= 2.12 $13.9

= 0.40$8.6 $32.1 + $2.4

d.$15.8 − $.7

= 1.75 $13.9

= 0.44$8.6 $32.1 − $.7

e. $15.8

= 1.74$13.9 + $0.5

= 0.45$8.6 + $0.5 $32.1

f.$15.8 − $1.5

= 1.66 $13.9 + $2.5

= 0.47$8.6 $32.1 + $4.0 − $1.5

g.$15.8

= 1.84 $13.9

= 0.44$8.6 $32.1− $0.4


(continued) P 3-73A

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 Harrington,

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.


(15-20 min.) P 3-74B


1. $37 – x = $7; x = $30

2. Revenues…………….. $37

Expenses…………….. 30

Net income…………... $ 7

3. Beginning receivables……......... $ 11

Add: Revenues…………………… 37

Less: Collections………….. (20 )

Ending receivables……………… $ 28

Balance sheetASSETS

Current assets:Receivables…… $ 28

4. Beginning accounts payable……….. $ 6

Add: Expenses………………………… 30

Less: Payments……………………..... (35 )

Ending accounts payable……………. $ 1

Balance sheetLIABILITIES

Current liabilities:Accounts payable……… $ 1


(20-30 min.) P 3-75B

Req. 1

Healthy Hearts ConsultingAmount of Revenue (Expense) for December

Date Cash Basis Accrual Basis

Dec. 1 Expense $ (3,500) Expense 0

4 Expense $(900) Expense 0

5 Revenue $500 Revenue $500

8 Expense $(200) Expense $(200)

11 Revenue 0 Revenue $3,100

19 Expense 0 Expense 0

24 Revenue $3,100 Revenue 0

26 Expense $(1,800) Expense 0

29 Expense $(800) Expense $(800)

31 Expense 0 Expense $(700)

31 Revenue 0 Revenue $400

Req. 2 Income (loss)before tax $(3,600 ) Income before tax $2,300

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 Dec. 11, the company earned $3,100 of

revenue and increased its wealth as a result. The accrual basis records this

revenue, but the cash basis ignores it. On Dec. 24, the business collected

the receivable that was created by the revenue earned on account at Dec.

11. The accrual basis records no revenue on Dec. 24 because the

company’s increase in wealth occurred back on Dec. 11. The cash basis

waits until cash is received, on Dec. 24, to record the revenue. This is too

late.


(10-20 min.) P 3-76B


Dec. 31 a. Insurance Expense............................ 3,500* Prepaid Insurance......................... 3,500 To record insurance expense

31 b. Salary Expense ($6,200 × 1/5)............ 1,240Salary Payable…........................... 1,240


31 c. Interest Receivable............................. 500Interest Revenue........................... 500


31 d. Supplies Expense............................... 6,800**Supplies......................................... 6,800


31 e. Unearned Service Revenue($11,900 × 70%)................................... 8,330

Service Revenue........................... 8,330To record revenue that was collected in advance.

31 f. Depreciation Expense – Office .........Furniture...................................

Depreciation Expense – Equipment..3,5005,800

Accumulated Depreciation –Office Furniture........................ 3,500

Accumulated Depreciation –Equipment................................. 5,800

To record depreciation expense._____ * $800 + $3,600 − $900 = $3,500** $2,700 + $6,400 − $2,300 = $6,800


(45-60 min.) P 3-77BReq. 1

Princess, Inc.Adjusted Trial Balance

August 31, 2012

TRIAL BALANCE ADJUSTMENTSADJUSTED

TRIAL BALANCEACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT

Cash 8,300 8,300Accounts receivable 1,900 (a) 2,100 4,000Prepaid rent 2,100 (b) 700* 1,400Supplies 2,400 (c) 2,090 310Furniture 63,000 63,000Accumulated depreciation 3,700 (d) 1,750** 5,450Accounts payable 4,000 4,000Salary payable (e) 3,060*** 3,060Common stock 13,000 13,000Retained earnings 53,430 53,430Dividends 4,300 4,300Service revenue 11,000 (a) 2,100 13,100Salary expense 2,600 (e) 3,060*** 5,660Rent expense (b) 700* 700Utilities expense 530 530Depreciation expense (d) 1,750** 1,750Supplies expense (c) 2,090 _____ 2,090

85,130 85,130 9,700 9,700 92,040 92,040

* $2,100 ÷ 3 = $700** $63,000 ÷ 3 = $21,000 ÷ 12 = $1,750*** $5,100 × 3/5 = $3,060


(continued) P 3-77B

Req. 2 (continued)

Princess, Inc.Income Statement

Month Ended August 31, 2012

Revenues:


Expenses:



Depreciation expense 1,750

Rent expense 700



Net income $2,370

Princess, Inc.Statement of Retained EarningsMonth Ended August 31, 2012

Retained earnings, August 1, 2012 $53,430


55,800


Retained earnings, August 31, 2012 $51,500

Financial Accounting 9/e Solutions Manual3-74

(continued) P 3-77B

Req. 2 (continued)

Princess, Inc.Balance Sheet

August 31, 2012ASSETS LIABILITIES

Current assets: Current liabilities:

Cash $8,300 Accounts payable $ 4,000

Accounts receivable 4,000 Salary payable 3,060

Prepaid rent 1,400 Total current liabilities 7,060

Supplies 310


Furniture $63,000 STOCKHOLDERS’ EQUITY

Less: Accum. Common stock 13,000

deprec. (5,450) 57,550 Retained earnings 51,500


______ Total liabilities and ______


Chapter 3 Accrual Accounting and Income 3-75

(10-20 min.) P 3-78BReq. 1


Apr. 30 Accounts Receivable ($6,800 − $6,300)………. 500Rental Revenue…………………………………. 500

To accrue rental revenue.

30 Interest Receivable ($400 − $0)……….………… 400Interest Income ($400 − $0)……………......... 400

30 Supplies Expense ($700 − $0)…………….......... 700Supplies ($1,300 − $600)…………………....... 700


30 Insurance Expense ($1,500 − $0)……………….. 1,500Prepaid Insurance ($2,400 − $900)………….. 1,500


30 Depreciation Expense ($1,400 − $0)………….... 1,400Accumulated Depreciation($10,200 − $8,800)……………………………… 1,400

To record depreciation expense.

30 Wage Expense ($2,500 − $1,300)………………. 1,200Wages Payable ($1,200 − $0)…………..……. 1,200


30 Unearned Rental Revenue ($2,000 − $1,800)…. 200Rental Revenue*……………………………….. 200

To record revenue that was collected in advance.

_____ * ($15,700 - $15,000 - $500)


(continued) P 3-78B

Req. 2

Total assets = $75,200 ($8,400 + $6,800 + $400 + $5,300 + $600 + $900 + $63,000 − $10,200)

Total liabilities = $9,300 ($6,300 + $1,200 + $1,800)

Net income = $9,200 ($15,700 + $700 − $1,400 − $700 − $400 – $2,500 − $700 − $1,500)

Total equity = $65,900 ($75,200 − $9,300) or ($9,300 + $46,200 + $9,200 - $3,500)


(20-30 min.) P 3-79B

Req. 1

Nicholl CorporationIncome Statement

Year Ended May 31, 2012

Revenues:


Expenses:


Rent expense 10,300

Insurance expense 3,600

Interest expense 2,600


Depreciation expense 1,200 60,400

Income before tax 37,400

Income tax expense 7,100

Net income $30,300

Nicholl CorporationStatement of Retained Earnings

Year Ended May 31, 2012

Retained earnings, May 31, 2011 $ 4,000


34,300

Less: Dividends (20,000)

Retained earnings, May 31, 2012 $14,300


(continued) P 3-79B

Req. 1 (continued)

Nicholl Corporation.Balance SheetMay 31, 2012

ASSETS LIABILITIES


Accounts receivable 8,600 Unearned service

Supplies 2,200 revenue 900

Prepaid rent 1,800 Interest payable 500

Income tax payable 2,100

Equipment $37,300 Note payable 18,800

Less: Accum. Total liabilities 26,000

deprec. (4,100 ) 33,200


Common stock 7,000

Retained earnings 14 ,300




Req. 2

Debt ratio:$26,000

= 0.55$47,300

Nicholl Corporation’s debt ratio of 0.55 is in compliance with the lenders’ debt restriction.


(20 min.) P 3-80BReq. 1


Closing EntriesMar. 31 Service Revenue……………………… 91,500

Retained Earnings………………… 91,500

31 Retained Earnings……………………. 36,300Salary Expense…………………….. 17,700Supplies Expense…………………. 4,800Advertising Expense……………… 11,400Depreciation Expense……………. 2,000Interest Expense…………………... 400

31 Retained Earnings……………………. 32,500Dividends…………………………… 32,500

Req. 2

Retained Earnings


Mar. 31, 2012 Dividends 32,500 Mar. 31, 2012 Revenues 91,500

Mar. 31, 2012 Bal. 42,700

Net income = $55,200 ($91,500 - $36,300)

Req. 3

Retained Earnings increased during the year because net income of $55,200 exceeded dividends of $32,500.


(30-40 min.) P 3-81BReq. 1

Cool River Service, Inc.

Balance Sheet

March 31, 2012

ASSETS

Current assets:

Cash....................................................................... $ 7,400

Accounts receivable............................................. 17,000

Prepaid expenses.................................................. 3,000

Supplies................................................................. 5,500

Total current assets.......................................... 32,900

Plant assets:

Equipment..............................................................$42,800

Less: accumulated depreciation.......................... (6,900 ) 35,900

Other assets................................................................ 14,000

Total assets................................................................. $82,800

LIABILITIES

Current liabilities:

Accounts payable.................................................. $14,400

Current portion of note payable........................... 700

Salary payable....................................................... 2,600

Unearned service revenue.................................... 3,600

Total current liabilities..................................... 21,300

Note payable, long-term............................................. 5,600

Total liabilities............................................................. 26,900


Common stock............................................................ 13,200

Retained earnings ….................................................. 42,7 00 *

Total stockholders’ equity…...................................... 55,900

Total liabilities and stockholders’ equity.................. $82,800


(continued) P 3-81B

Req. 1 (continued)_____*Computation:

Retained earnings, March 31, 2011…………….. $ 20,000Add: Net income ($91,500 − $11,400 − $2,000

− $400 − $17,700 − $4,800)…………….......... 55,200 75,200

Less: Dividends………………………………….. (32,500 )Retained earnings, March 31, 2012…………….. $42,700

Req. 2 2012 2011

Net working capital


$32,900 - $21,300

= $11,600 $11,000


=$32,900


The increase in both working capital and the current ratio indicate that

the ability to pay current liabilities with current assets improved during

2012.


=$26,900

= 0.32 0.35Total assets $82,800

Cool River Services’ overall debt position improved a bit from 2011 to

2012.


(45-60 min.) P 3-82BReq. 1



=$15.4

= 1.64Total current liabilities $9.4

$14.9


=$9.4 + $5.5

= 0.48Total assets $31.2

Req. 2

Current Ratio Debt Ratio

a.$15.4 − ($9.4 × 1/2)

= 2.28$14.9 − ($9.4 × 1/2)

= 0.38($9.4 × 1/2) $31.2 − ($9.4 × 1/2)

b.$15.4 + $3.0

= 1.96$14.9 + $3.0

= 0.52$9.4 $31.2 + $3.0

c.$15.4 + $2.4

= 1.89 $14.9

= 0.44$9.4 $31.2 + $2.4

d.$15.4 − $.6

= 1.57 $14.9

= 0.49$9.4 $31.2 − $.6

e. $15.4

= 1.59$14.9 + $0.3

= 0.49$9.4 + $0.3 $31.2

f.$15.4 − $2.0

= 1.43 $14.9 + $2.9

= 0.52$9.4 $31.2 + $4.9 − $2.0

g.$15.4

= 1.64 $14.9

= 0.49$9.4 $31.2 − $0.9


(continued) P 3-82B

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 Hiaport, 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.


Challenge Exercises and Problem

(20-25 min.) E 3-83

(Dollar amounts in thousands)

December 31, 2011

Current assets = $11,100 ($1,500 + $5,900 + $2,700 + $1,000)

Current liabilities = $6,100 ($2,600 + $1,600 + $1,900)

Net working capital = $5,000 ($11,100 - $6,100)

Current=

$11,100= 1.82

ratio $6,100

December 31, 2012

Current assets = $10,700 ($9001 + $6,8002 + $2,7003 + $3004)

Current liabilities = $5,200 ($1,2005 + $1,6006 + $2,4007)

Net working capital = $5,500 ($10,700 - $5,200)

Current=

$10,700= 2.06

ratio $5,200_____

Computations of December 31, 2012 balances:1Cash = $1,500 − $7,300 + $8,100 − $1,400 = $9002Receivables = $5,900 + $9,000 − $8,100 = $6,8003No change in the Inventory balance.4Prepaid expenses = $1,000 − $700 = $3005Accounts payable = $2,600 − $1,400 = $1,2006No change in the Unearned Revenues balance.7Accrued expenses payable = $1,900 + $500 = $2,400

Conclusion: Valley Forge’s net working capital and current ratio improved during 2012. The company’s current ratio is very strong.


(60 min.) E 3-84

a. Net income:

Service revenue:

($161,000 + $1,650 + $32,200)……………….

Expenses:

Salary ($37,000 + $3,500)…………………….

Depreciation – building………………………

Supplies...………………………………………Insurance……………….………………………

Advertising……………………………………..

Utilities………………………………………….

Net income………………………………………..

$194,850

$ 40,500

2,600

3,100

1,500

7,300

2,000

57,000

$137,850

b. Total assets:

Cash…………………………………………………

Accounts receivable ($7,500 + $32,200)………

Supplies ($4,600 − $3,100)………………………

Prepaid insurance ($3,500 − $1,500)………….

Building……………………………………………

Less: Accum. Depr.

($15,600 + $2,600)………….…………………….

Land…………………………………………………

Total assets………………….…………………

$ 7,300

39,700

1,500

2,000

$110,000

(18,200 ) 91,800

53,000

$195,300


(continued) E 3-84

c. Total liabilities:

Accounts payable.........................................Salary payable...............................................Unearned service revenue

($5,500 − $1,650).......................................Total liabilities...............................................

Total stockholders’ equity:

Common stock..............................................Retained earnings, beginning......................Add: Net income...........................................

Less: Dividends............................................Total stockholders’ equity............................

$ 6,100 3,500

3,850 $ 13,450

d.

$ 14,000

$ 46,000 137,850 197,850 (16,000 )

167,850

$181,850

e. Total assets = Total liabilities + Total stockholders’ equity $195,300 = $13,450 + $181,850


(20 min.) P 3-85

Express Detail Inc.

Balance Sheet

December 31, 2012

ASSETS LIABILITIES

Cash (a) $ 15,300 Accounts payable (g) $ 3,000

Accounts receivable (c) 1,400 Advertising payable(h) 500

Supplies (d) 1,000 Salary payable (i) 500

Total current assets

Equipment (e) $35,000

Less: Accum.

deprec.(f)(12,000)

17,700

23,000

Unearned gift certificate revenue (b)

Total liabilities1,200

5,200


Total assets

$40,700

Common stock (j)

Retained earnings (k)

Total stockholders’ equity


stockholders’ equity

18,000

17,500

35,500

$40,700


(continued) P 3-85Supporting computations(a) Cash

Bal. 12/31/2011 1,300

Cash collections from customers

Issuance of common stock31,000

8,000

12,500

500

5,000

Salaries paid

Dividends paid

Purchase of equipment

5,500 Payments of accounts payable

1,500 Advertising paid1,500

Bal. 1/31/2012 15,300

(b) Unearned Gift Certificate Revenue

800 Bal. 12/31/2011

Gift certificate revenue earned 600 1,000 Sale of gift certificates

1,200 Bal. 1/31/2012 (given)

(c) Accounts Receivable

Bal. 12/31/2011 2,000

Revenue on account 29,400 30,000 Collections from customers*

Bal. 1/31/2012 1,400

* Excludes the $1,000 for gift certificates which was received in advance, not on account

(d) Supplies

Bal. 12/31/2011 1,500

Purchase of supplies 3,500 4,000 Supplies expense

Bal. 1/31/2012 1,000

(e) Equipment -- $35,000 ($30,000 + $5,000)

(f) Accumulated depreciation -- $12,000 ($6,000 + $6,000)


(continued) P 3- 85

(g) Accounts payable

5,000 Bal. 12/31/2011

Payments on account 5,500 3,500 Purchase of supplies

3,000 Bal. 1/31/2012

(h) $2,000 Advertising expense - $1,500 advertising paid

(i) Salary Payable

1,000 Bal. 12/31/2011

Salaries paid 12,500 12,000 Salary expense

500 Bal. 1/31/2012

(j) Common Stock--$18,000 ($10,000 + $8,000)

(k) Retained Earnings

12,000 Bal. 12/31/2011

Dividends 500 6,000 Net income

17,500 Bal. 1/31/2012


Decision Cases

(25 min.) Decision Case 1

Req. 1 Unadjusted trial balance:Debit Credit

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

Out of balance $2,000


(continued) Decision Case 1

Req. 2 Adjusted trial balance:Debit Credit

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……………………………... 400

Total……………………………………………… $62,500 $62,500

Req. 3

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 1.50 or higher.


(20-30 min.) Decision Case 2

Eagle Restaurant, Inc.Income Statement

Month Ended October 31, 2012

Sales revenue........................................... $32,000

Cost of goods sold................................... $12,000

Wages expense........................................ 5,000

Rent expense............................................ 4,000

Insurance expense................................... 1,000

Depreciation expense.............................. 1,000 23,000

Net income................................................ $ 9,000

Eagle Restaurant, Inc.Statement of Retained EarningsMonth Ended October 31, 2012

Retained earnings, October 1, 2012................... $ 0

Add: Net income................................................. 9,000

Less: Dividends.................................................. (3,000 )

Retained earnings, October 31, 2012................. $6,000



Eagle Restaurant, Inc.Balance Sheet

October 31, 2012

ASSETS LIABILITIES


Food inventory 5,000 Unearned revenue 3,000

Prepaid insurance 1,000 10,000

Dishes, silver 4,000

Fixtures $24,000

OWNERS’ EQUITY

Less: Accum. Common stock $25,000

deprec. (1,000) 23,000 Retained earnings 6,000 31,000

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.


(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 11,000

Your expected monthly net income $15,000Multiplier to compute price X 16 Your highest price $240,000

Req. 2 (Williams’ asking price)

SW Advertising, Inc.Statement of Retained Earnings and Common Stock

June 30, 2012Beginning retained earnings $ 93,000

Add: Net income

Revenue ($22,000 + $4,000) $26,000

Less: Expenses ($4,000 +

$900 + $1,100) (6,000) 20,000

113,000


Ending retained earnings $104,000

Common stock 50,000

Stockholders’ equity, June 30, 2012 $154,000

Multiplier to compute price X 2__

Williams’ asking price $308,000



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.


Ethical Issues

Ethical Issue 1

1. The journal entry to record the revenue is:

Dec. Accounts Receivable………... XXXSales 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 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.


(continued) Ethical Issue 1

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.


Ethical Issue 2

1. These transactions 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 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.


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 (recorded)

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

Beg. Bal. $1,759

(a) 1,759 (b) 2,321

End. Bal. $2,321


(continued) Focus on Financials: Amazon.com, Inc.

Req. 3 (amounts in millions)


a. Accrued expenses and other…….… 1,759Cash………………….. 1,759

b. Operating expenses….………………. 6,237Cash……………………..………... 3,916

Accrued expenses and other… 2,321

The balance of Accrued Expenses and Other agrees with the financial

statements at December 31, 2010.


(continued) Focus on Financials: Amazon.com, Inc.

Req. 5

Current ratio:2010 2009

(Dollar amounts in millions)

Total current assets=

$13,747= 1.33

$9,797= 1.33

Total current liabilities $10,372 $7,364

Working Capital:2010 2009

Current Assets – Current liabilities =

$13,747-$10,372 = $3,375

$9,797 -$7,364 = $2,433

Debt ratio:2010 2009

Total liabilities=

$11,933*= 0.64

$8,556**= 0.62

Total assets $18,797 $13,813

*10,372 + 1,561 **7,364 + 1,192

The current ratio did not change, working capital increased

substantially, and the debt ratio slightly worsened during 2010. This

reveals slightly weakening leverage but with sustained liquidity. Also,

the size of the firm overall has increased (indicated by total assets) and

its working capital has increased as well to support Amazon.com now

that it is a larger firm.


Focus on Analysis: RadioShack, Corp.

(15-20 min.)

Req. 1

The beginning balance of Accounts Receivable, $322.5 million

represents revenue earned in fiscal 2009 but not received until fiscal

2010 The ending balance of Accounts Receivable, $377.5 million,

represents revenue earned in fiscal 2010 but not received until fiscal

2011.

According to footnote 3, the receivables are due from vendors, trade

accounts receivables, and other receivables. The amount due from

vendors likely represents deposits made by RadioShack whereas the

trade accounts receivables are likely due from customers.

Req. 2

Since Deferred Income Taxes is a current asset, it is most likely similar to a

prepaid asset, meaning taxes have been paid but will be expensed sometime

in the future. When the taxes are expensed in the future, the asset, Deferred

Income Taxes will decrease as in the following entry:


Income Tax Expense…………..…….… 8Deferred Income Taxes..………….. 8

Req. 3

Since depreciation expense increases Accumulated Depreciation $70

million, a decrease of $49 million ($799 + $70 - $820) must have occurred


(continued) Focus on Analysis

as well. The decrease is most likely from the sale of property, plant, and

equipment.

Req. 4

Accrued Advertising Payable represents an accrued liability account.

When the company incurs advertising expense, this current liability

account is credited. When the company pays the advertising company,

these amounts are debited to Accrued Advertising Payable.

The expense relating to this accrued advertising was recorded in the

year the expense was incurred—when the advertising first takes place

(Note 2) Accordingly, the $26.9 million accrued advertising represents

advertising incurred in fiscal 2010 but not paid until fiscal 2011.

From 2009 to 2010, RadioShack, Corp.’s advertising expense increased

from $193 million to $206 million.(Note 2). By reconstructing the accrued

liability account, the amount RadioShack paid for advertising during

fiscal 2010 can be derived.

Accrued Advertising Expense (Payable)

Beg. Bal. $31.4

Adv. Paid $211.6 Adv. Exp. 206.1

End. Bal. 26.9


Group Project

(45 min.)

Req. 1

Trozo Lawn Service, Inc.Income Statement

Four Months Ended August 31

Service revenue ($5,600 + $600) $6,200

Expenses:

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) 100


Net income $2,950


(continued) Group Project

Req. 2

Trozo Lawn Service, Inc.Balance Sheet

August 31ASSETS LIABILITIES

Current: Current:

Cash $2,640 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 EQUITY

Long-term: Common stock 1,060

Trailer $300 Retained earnings

Less accum. ($2,950 − $460) 2,490

deprec. (100 ) 200 Total stockholders’ equity 2,890




(continued) Group Project

Req. 3

Trozo Lawn Service, Inc.Statement of Cash Flows

Four Months Ended August 31

Cash flows from operating activities:

Collections from customers………………… $ 5,600

Payments:

For supplies.................................................

To employees..............................................

For rent........................................................

For repairs...................................................

$ 400

1,900

600

300 3,200

Net cash provided by operating activities 2,400

Cash flows from investing activities:

Purchase of trailer...................................... $(300)

Net cash used for investing activities (300)

Cash flows from financing activities:

Issued note payable to father.................... $ 1,500

Repayment of loan to father (1,500)

Payment of dividends................................. (460)

Issuance of common stock........................ 1,000

Net cash used for financing activities...... 540

Net increase in cash…………………………... $ 2,640

Cash balance, beginning……………………….. -0 -

Cash balance, ending…………………………… $ 2,640

Req. 4

Matt was successful because his lawn service was profitable and had a

positive cash flow from operating activities. Matt was also able to pay

off his loan and pay a dividend.


Documents

Ch03 SM 9e