(1) -$286,176
(2)
+$286,176
+137,590
+$137,590
(3)
+$68,480
Issued
stock
+$68,480
LO 1 BT: AP Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting
BRIEF EXERCISE 0-4
(a)
(b)
(c)
(d)
(e)
(f)
Accounts Payable
Advertising Expense
Service Revenue
Accounts Receivable
Retained Earnings
Dividends
Debit
Effect
Credit
Effect
Normal
Balance
Decrease
Increase
Decrease
Increase
Decrease
Increase
Increase
Decrease
Increase
Decrease
Increase
Decrease
Credit
Debit
Credit
Debit
Credit
Debit
LO 2 BT: K Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting
BRIEF EXERCISE 0-5
June 1
2
3
12
Account Debited
Cash
Equipment
Rent Expense
Accounts Receivable
Account Credited
Common Stock
Accounts Payable
Cash
Service Revenue
LO 2 BT: C Difficulty: Medium TOT: 3 min. AACSB: None AICPA FC: Reporting
BRIEF EXERCISE 0-6
June
1
2
Cash ...................................................................................
Common Stock ..................................................................
5,000
Equipment ..........................................................................
Accounts Payable..............................................................
1,100
5,000
1,100
3
12
Rent Expense .....................................................................
Cash ...........................................................................
740
Accounts Receivable ........................................................
Service Revenue .......................................................
700
740
700
LO 2 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting
BRIEF EXERCISE 0-7
(a)
Basic Analysis
(b)
Debit-Credit Analysis
Aug. 1
The asset Cash is increased;
the stockholders’ equity
account Common Stock is
increased.
Debits increase assets:
debit Cash $10,000. Credits
increase stockholders’ equity:
credit Common Stock $10,000.
4
The asset Prepaid Insurance
is increased; the asset Cash
is decreased.
Debits increase assets:
debit Prepaid Insurance $1,500.
Credits decrease assets:
credit Cash $1,500.
16
The asset Cash is increased;
the revenue Service Revenue
is increased.
Debits increase assets:
debit Cash $900.
Credits increase revenues:
credit Service Revenue $900.
27
The expense Salaries and
Wages Expense is increased;
the asset Cash is decreased.
Debits increase expenses:
debit Salaries and Wages
Expense $620.
Credits decrease assets:
credit Cash $620.
LO 2 BT: C Difficulty: Medium TOT: 8 min. AACSB: None AICPA FC: Reporting
BRIEF EXERCISE 0-8
Aug.
1
4
Cash ....................................................................................
Common Stock ..........................................................
10,000
Prepaid Insurance ..............................................................
Cash ...........................................................................
1,500
10,000
1,500
16
27
Cash ....................................................................................
Service Revenue........................................................
900
Salaries and Wages Expense ............................................
Cash ...........................................................................
620
LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting
900
620
BRIEF EXERCISE 0-9
Cash
5/12
5/15
5/5
Service Revenue
1,600
2,000
Accounts Receivable
3,800 5/12
5/5
5/15
3,800
2,000
1,600
LO 3 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting
BRIEF EXERCISE 0-10
PEETE COMPANY
Trial Balance
June 30, 2017
Cash ...........................................................................................
Accounts Receivable ................................................................
Equipment .................................................................................
Accounts Payable .....................................................................
Common Stock .........................................................................
Dividends...................................................................................
Service Revenue .......................................................................
Salaries and Wages Expense ..................................................
Rent Expense ............................................................................
Debit
$ 5,400
3,000
13,000
Credit
$ 1,000
18,000
1,200
8,600
4,000
1,000
$27,600
(Total of debit account balances = Total of credit account balances)
LO 4 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting
$27,600
BRIEF EXERCISE 0-11
BIRELLIE COMPANY
Trial Balance
December 31, 2017
Cash ...........................................................................................
Prepaid Insurance .....................................................................
Accounts Payable .....................................................................
Unearned Service Revenue......................................................
Common Stock .........................................................................
Retained Earnings ....................................................................
Dividends...................................................................................
Service Revenue .......................................................................
Salaries and Wages Expense ..................................................
Rent Expense ............................................................................
Debit
$20,800
3,500
Credit
$ 2,500
1,800
10,000
6,600
5,000
25,600
14,600
2,600
$46,500
$46,500
(Assets, expenses, and dividends have debit balances)
LO 4 BT: AN Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting
BRIEF EXERCISE 0-12
(a)
(b)
(c)
(d)
(e)
(f)
Cash
$–100
0
0
+800
–2,500
0
Net Income
$0
–20
+1,300
0
0
–600
LO 5 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting
BRIEF EXERCISE 0-13
(a)
Prepaid Insurance—to recognize insurance expired during the period.
(b)
Depreciation Expense—to allocate the cost of an asset to expense during the
current period.
(c)
Unearned Service Revenue—to account for unearned revenue for which services
were provided during the period.
(d)
Interest Payable—to recognize interest accrued but unpaid on notes payable
during the current period.
LO 5 BT: C Difficulty: Medium TOT: 4 min. AACSB: None AICPA FC: Reporting
BRIEF EXERCISE 0-14
Item
(1)
Type of Adjustment
(2)
Accounts Before Adjustment
(a)
Prepaid Expenses
Assets Overstated
Expenses Understated
(b)
Accrued Revenues
Assets Understated
Revenues Understated
(c)
Accrued Expenses
Expenses Understated
Liabilities Understated
(d)
Unearned Revenues
Liabilities Overstated
Revenues Understated
LO 5 BT: AN Difficulty: Hard TOT: 6 min. AACSB: Analytic AICPA FC: Reporting
BRIEF EXERCISE 0-15
Dec. 31
12/31 Bal.
Supplies Expense .........................................................
Supplies ...............................................................
Supplies
8,800 12/31
1,100
7,700
12/31
7,700
Supplies Expense
7,700
LO 5 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting
7,700
BRIEF EXERCISE 0-16
Dec. 31
Depreciation Expense ..................................................
Accumulated Depreciation—
Equipment ........................................................
2,750
Accumulated Depreciation—
Equipment
12/31
2,750
Depreciation Expense
2,750
12/31
2,750
Balance Sheet:
Equipment ................................................................................
Less: Accumulated depreciation—equipment .....................
$22,000
2,750
$19,250
LO 5 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting
BRIEF EXERCISE 0-17
July
1
Dec. 31
Prepaid Insurance ........................................................
Cash......................................................................
12,400
Insurance Expense ($12,400 X 6/24) ...........................
Prepaid Insurance ...............................................
3,100
Prepaid Insurance
7/1
12,400 12/31
12/31 Bal.
9,300
3,100
12/31
12,400
Insurance Expense
3,100
LO 5 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting
3,100
BRIEF EXERCISE 0-18
July
1
Dec. 31
Cash ..............................................................................
Unearned Service Revenue ................................
12,400
Unearned Service Revenue .........................................
Service Revenue ($12,400 X 6/24) ......................
3,100
Unearned Service Revenue
12/31
3,100 7/1
12,400
12/31 Bal.
9,300
12,400
3,100
Service Revenue
12/31
3,100
LO 5 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting
BRIEF EXERCISE 0-19
(a)
(b)
(c)
Dec. 31
31
31
Interest Expense ..................................................
Interest Payable ..........................................
300
Accounts Receivable ..........................................
Service Revenue .........................................
1,700
Salaries and Wages Expense .............................
Salaries and Wages Payable .....................
780
300
LO 5 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting
1,700
780
BRIEF EXERCISE 0-20
(1)
Type of Adjustment
Account
(2)
Related Account
(a)
Accounts Receivable
Accrued Revenues
Service Revenue
(b)
Prepaid Insurance
Prepaid Expenses
Insurance Expense
(c)
Equipment
Not required
Not required
(d)
Accum. Depreciation—
Equipment
Prepaid Expenses
Depreciation Expense
(e)
Notes Payable
Not required
Not required
(f)
Interest Payable
Accrued Expenses
Interest Expense
(g)
Unearned Service
Revenue
Unearned Revenues
Service Revenue
LO 6 BT: AN Difficulty: Hard TOT: 6 min. AACSB: Analytic AICPA FC: Reporting
BRIEF EXERCISE 0-21
LEVIN CORPORATION
Income Statement
For the Year Ended December 31, 2017
Revenues
Service revenue ..................................................................
Expenses
Salaries and wages expense..............................................
Rent expense.......................................................................
Insurance expense ..............................................................
Supplies expense ................................................................
Depreciation expense .........................................................
$32,000
$14,000
3,900
1,800
1,500
1,000
Total expenses .............................................................................
Net income ...................................................................................
[Revenues – Expenses = Net income or (loss)]
LO 7 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting
22,200
$ 9,800
BRIEF EXERCISE 0-22
LEVIN CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2017
Retained earnings, January 1 ...........................................................................
Add: Net income / (Loss) .................................................................................
Less: Dividends ................................................................................................
Retained earnings, December 31......................................................................
$17,200
10,400
27,600
6,000
$21,600
(Beginning retained earnings ± Changes to retained earnings = Ending retained
earnings)
LO 7 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting
BRIEF EXERCISE 0-23
Account
(a)
(b)
(c)
(d)
(e)
(f)
(g)
Accumulated Depreciation
Depreciation Expense
Retained Earnings (beginning)
Dividends
Service Revenue
Supplies
Accounts Payable
Balance Sheet
Income Statement
Retained Earnings Statement
Retained Earnings Statement
Income Statement
Balance Sheet
Balance Sheet
LO 7 BT: K Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting
BRIEF EXERCISE 0-24
(a) Closing Entries
July 31
Service Revenue ..................................................
Income Summary ........................................
(To close revenue account)
16,000
Income Summary ................................................
Salaries and Wages Expense .....................
Maintenance and Repairs
Expense........................................................
Income Tax Expense ...................................
(To close expense accounts)
11,900
16,000
8,400
2,500
1,000
Income Summary ................................................
Retained Earnings .......................................
(To close net income to
retained earnings)
4,100
Retained Earnings ...............................................
Dividends .....................................................
(To close dividends to retained
earnings)
1,300
4,100
(Income statement accounts are closed to the Income Summary account)
(b) Retained Earnings
1,300
7/1 Bal.
7/31 Bal.
20,000
4,100
22,800
LO 8 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting
1,300
BRIEF EXERCISE 0-25
The accounts that will appear in the post-closing trial balance are:
Accumulated Depreciation
Retained Earnings (ending)
Supplies
Accounts Payable
LO 9 BT: K Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting
SOLUTIONS TO DO IT! REVIEW EXERCISES
DO IT! 0-1
Assets
=
Accounts
Cash
+ Receivable =
(1)
(2)
Liabilities
Accounts
Payable
+
Common
Stock
+$20,000
+$20,000
Stockholders’ Equity
Retained Earnings
+ Revenues – Expenses – Dividends
+$20,000
–20,000
(3)
(4)
+
–$1,800
+$1,800
–3,000
–$3,000
LO 1 BT: AP Difficulty: Medium TOT: 3 min. AACSB: Analytic AICPA FC: Reporting
DO IT! 0-2
Boyd would likely need the following accounts in which to record the transactions
necessary to ready his photography studio for opening day:
Cash (debit balance)
Supplies (debit balance)
Notes Payable (credit balance)
Equipment (debit balance)
Accounts Payable (credit balance)
Common Stock (credit balance)
LO 2 BT: C Difficulty: Easy TOT: 2 min. AACSB: None AICPA FC: Reporting
DO IT! 0-3
Each transaction that is recorded is entered in the general journal. The three activities
would be recorded as follows:
1.
2.
3.
Cash .......................................................................................
Common Stock ..............................................................
8,000
Supplies ...............................................................................
Accounts Payable .........................................................
Cash ...............................................................................
950
No entry because no transaction has occurred.
LO 2 BT: AP Difficulty: Medium TOT: 4 min. AACSB: Analytic AICPA FC: Reporting
8,000
550
400
DO IT! 0-4
4/1
4/3
4/30
Cash
1,900 4/16
3,400 4/20
4,500
500
300
LO 3 BT: AP Difficulty: Easy TOT: 3 min. AACSB: Analytic AICPA FC: Reporting
DO IT! 0-5
CHILLIN’ COMPANY
Trial Balance
December 31, 2017
Cash ...........................................................................................
Accounts Receivable ................................................................
Supplies .....................................................................................
Equipment .................................................................................
Notes Payable ...........................................................................
Accounts Payable .....................................................................
Salaries and Wages Payable ....................................................
Common Stock..........................................................................
Dividends ...................................................................................
Service Revenue .......................................................................
Rent Expense ............................................................................
Salaries and Wages Expense...................................................
Debit
$ 6,000
8,000
5,000
76,000
Credit
$ 20,000
9,000
3,000
25,000
8,000
86,000
2,000
38,000
$143,000
(Liabilities, Common stock, and Revenues have credit balances)
LO 4 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting
$143,000
DO IT! 0-6
1. (d)
2. (e)
3. (h)
4. (c)
LO 5 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting
DO IT! 0-7
1.
2.
3.
4.
Insurance Expense .......................................................................
Prepaid Insurance .................................................................
(To record insurance expired)
300
Supplies Expense .........................................................................
Supplies .................................................................................
(To record supplies used)
1,600
Depreciation Expense ..................................................................
Accumulated Depreciation—Equipment ............................
(To record monthly depreciation)
200
Unearned Service Revenue ..........................................................
Service Revenue ....................................................................
(To record revenue for services provided)
4,000
300
1,600
200
4,000
LO 5 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting
DO IT! 0-8
1.
2.
3.
Salaries and Wages Expense.......................................................
Salaries and Wages Payable ................................................
(To record accrued salaries)
1,100
Interest Expense ($20,000 X .09 X 1/12) ......................................
Interest Payable .....................................................................
(To record accrued interest)
150
Accounts Receivable ...................................................................
Service Revenue ....................................................................
(To record revenue for service provided)
1,600
LO 5 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting
1,100
150
1,600
DO IT! 0-9a
Income statement: Service Revenue, Utilities Expense
Balance sheet: Accounts Receivable, Accumulated Depreciation, Notes Payable,
Common Stock.
LO 7 BT: C Difficulty: Easy TOT: 3 min. AACSB: None AICPA FC: Reporting
DO IT! 0-10a
Dec. 31
Dec. 31
Dec. 31
Dec. 31
Service Revenue ..................................................................... 108,000
Income Summary ...........................................................
(To close revenue to income summary)
108,000
Income Summary....................................................................
Salaries and Wages Expense ........................................
Rent Expense ..................................................................
Utilities Expense .............................................................
Supplies Expense ...........................................................
(To close expenses to income summary)
72,000
40,000
18,000
8,000
6,000
Income Summary....................................................................
Retained Earnings ..........................................................
(To close net income to retained earnings)
36,000
Retained Earnings ..................................................................
Dividends ........................................................................
(To close dividends to retained earnings)
22,000
36,000
LO 8 BT: AP Difficulty: Medium TOT: 6 min. AACSB: Analytic AICPA FC: Reporting
22,000
SOLUTIONS TO EXERCISES
EXERCISE 0-1
1.
2.
3.
4.
5.
6.
7.
8.
9.
Increase in assets and increase in stockholders’ equity.
Decrease in assets and decrease in stockholders’ equity.
Increase in assets and increase in stockholders’ equity.
Increase in assets and increase in stockholders’ equity.
Decrease in assets and decrease in stockholders’ equity.
Increase in liabilities and decrease in stockholders’ equity.
Increase in assets and decrease in assets.
Increase in assets and decrease in assets.
Increase in assets and increase in liabilities.
LO 1 BT: C Difficulty: Medium TOT: 5 min. AACSB: None AICPA FC: Reporting
EXERCISE 0-2
Assets
Cash
(1)
+
=
Liabilities
+
Accounts
Receivable + Equipment =
Accounts
Payable
+
+$40,000
+$30,000
Issued Stock
+$30,000
–4,000
(4)
–$4,000
+$19,000
(5)
+5,000
(6)
–8,000
(7)
–30,000
Rent Expense
+$19,000
Service Revenue
+5,000
Service Revenue
–8,000
Utilities Expense
–1,300
Advertising Expense
–30,000
(8)
(9)
Common
Retained Earnings
Stock + Revenues – Expenses
+$40,000
(2)
(3)
Stockholders’ Equity
+1,300
+12,000
–12,000
$15,000 +
$7,000
$52,000
+
$30,000
=
$ 1,300
+
$40,000 +
$24,000 –
$13,300
$52,000
LO 1 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting
Exercise 0-3
Cash
(1)
+$100,000
(2)
+45,000
(3)
–60,000
(4)
+16,000
Assets
Accounts
+ Receivable + Supplies +
Equipment
Liabilities
Accounts
Bonds
= Payable + Payable
+
Common
+
Stock
Stockholders’ Equity
Retained Earnings
+ Revenues – Expenses – Dividends
+$100,000
Issued Stock
+$45,000
+$60,000
+$16,000
(5)
(6)
=
+$4,700
+$4,700
–5,200
(7)
–$5,200
+$10,000
(8)
–28,000
(9)
–11,000
$ 56,800 +
Service Revenue
Rent Expense
+10,000
Service Revenue
–28,000
Salaries and
Wages Expense
–$11,000
$10,000
+
$4,700
$131,500
+
$60,000
$4,700
+
$45,000 +
$100,000 +
+$26,000 –
$131,500
LO 1 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting
$33,200
–
$11,000
Dividends
EXERCISE 0-4 (Essay)
1.
Stockholders invested $20,000 cash in the business.
2.
Purchased equipment for $5,000, paying $1,000 in cash and the balance of
$4,000 on account.
3.
Paid $750 cash for supplies.
4.
Earned $9,500 in revenue, receiving $4,100 cash and $5,400 on
account.
5.
Paid $1,500 cash on accounts payable.
6.
Paid $2,000 cash dividends to stockholders.
7.
Paid $800 cash for rent.
8.
Collected $450 cash from customers on account.
9.
Paid salaries of $3,000.
10.
Incurred $300 of utilities expense on account.
EXERCISE 0-4
(b)
Issued common stock .............................................................................
Service revenue .......................................................................................
Dividends ..................................................................................................
Rent expense............................................................................................
Salaries and wages expense...................................................................
Utilities expense .......................................................................................
Increase in stockholders’ equity ............................................................
$20,000
9,500
(2,000)
(800)
(3,000)
(300)
$23,400
[Revenues – Expenses = Net income or (loss)]
(Changes in stockholders’ equity = Additional investment – dividends ± Net income or
Loss)
(c)
Service revenue .......................................................................................
Rent expense............................................................................................
Salaries and wages expense...................................................................
Utilities expense .......................................................................................
Net income................................................................................................
$9,500
(800)
(3,000)
(300)
$ 5,400
LO 1 BT: AP Difficulty: Medium TOT. 12 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-5
Account
SM
(a)
Normal Balance Debit
or Credit
.., Solutions Manual
(b)
Balance Sheet or Income
Statement
(For Instructor Use Only)
3-21
Accounts payable
Accounts receivable
Common stock
Depreciation expense
Interest expense
Interest income
Inventories
Prepaid expenses
Property and equipment
Revenues
Credit
Debit
Credit
Debit
Debit
Credit
Debit
Debit
Debit
Credit
Balance sheet
Balance sheet
Balance sheet
Income statement
Income statement
Income statement
Balance sheet
Balance sheet
Balance sheet
Income statement
LO 2 BT: K Difficulty: Easy TOT: 5 min. AACSB: None AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-22
EXERCISE 0-06
3-18
(a)
SM
Account Debited
(b)
(c)
Specific
Account
Effect
(d)
Normal
Balance
(a)
Basic
Type
Account Credited
(b)
(c)
Specific
Account
Effect
.., Solutions Manual
Transaction
(a)
Basic
Type
(d)
Normal
Balance
1.
Asset
Cash
Increase
Debit
Stockholders’
Equity
Common
Stock
Increase
Credit
2.
Asset
Equipment
Increase
Debit
Asset
Cash
Decrease
Debit
3.
Asset
Supplies
Increase
Debit
Liability
Accounts
Payable
Increase
Credit
4.
Asset
Accounts
Receivable
Increase
Debit
Stockholders’
Equity
Service
Revenue
Increase
Credit
5.
Stockholders’
Equity
Advertising
Expense
Increase
Debit
Asset
Cash
Decrease
Debit
6.
Asset
Cash
Increase
Debit
Asset
Accounts
Receivable
Decrease
Debit
7.
Liability
Accounts
Payable
Decrease
Credit
Asset
Cash
Decrease
Debit
8.
Stockholders’
Equity
Dividends
Increase
Debit
Asset
Cash
Decrease
Debit
(For Instructor Use Only
EXERCISE 0-6 (Continued)
(b)
General Journal
Trans.
1.
2.
3.
4.
5.
6.
Account Titles
Cash
Common Stock ......................................................
Debit
15,000
Equipment .......................................................................
Cash ........................................................................
10,000
Supplies ..........................................................................
Accounts Payable ..................................................
300
Accounts Receivable .....................................................
Service Revenue ....................................................
3,700
Advertising Expense ......................................................
Cash ........................................................................
200
15,000
Cash
10,000
300
3,700
200
1,100
Accounts Receivable ............................................
7.
8.
Credit
1,100
Accounts Payable...........................................................
Cash ........................................................................
300
Dividends ........................................................................
Cash ........................................................................
400
300
400
LO 2 BT: AP Difficulty: Medium TOT: 15 AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-7
Oct. 1
SM
Debits increase assets: debit Cash $30,000.
Credits increase stockholders’ equity: credit Common Stock
$30,000.
2
No accounting transaction.
3
Debits increase assets: debit Equipment $3,800.
Credits increase liabilities: credit Accounts Payable $3,800.
.., Solutions Manual
(For Instructor Use Only)
3-24
EXERCISE 0-7 (Continued)
Oct. 6
Debits increase assets: debit Accounts Receivable $10,800.
Credits increase revenues: credit Service Revenue $10,800.
10
Debits increase assets: debit Cash $140.
Credits increase revenues: credit Service Revenue $140.
27
Debits decrease liabilities: debit Accounts Payable $700.
Credits decrease assets: credit Cash $700.
30
Debits increase expenses: debit Salaries and Wages
Expense $3,000.
Credits decrease assets: credit Cash $3,000.
LO 2 BT: C Difficulty: Medium TOT: 10 min. AACSB: None AICPA FC: Reporting
EXERCISE 0-8
General Journal
Date
Oct. 1
Account Titles
Cash
Common Stock .....................................................
Debit
30,000
30,000
2
No entry.
3
Equipment .....................................................................
Accounts Payable ................................................
3,800
Accounts Receivable ....................................................
Service Revenue ..................................................
10,800
6
10
Cash
3,800
10,800
140
Service Revenue ..................................................
27
30
Credit
140
Accounts Payable .........................................................
Cash ......................................................................
700
Salaries and Wages Expense .......................................
Cash ......................................................................
3,000
700
3,000
LO 2 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-25
EXERCISE 0-9
General Journal
Date
May 4
7
8
9
17
22
29
Account Titles
Accounts Payable .........................................................
Cash ......................................................................
Debit
700
Accounts Receivable ....................................................
Service Revenue ..................................................
6,800
Supplies .........................................................................
Accounts Payable ................................................
850
Equipment .....................................................................
Cash ......................................................................
1,000
Salaries and Wages Expense .......................................
Cash ......................................................................
530
Maintenance and Repairs Expense .............................
Accounts Payable ................................................
900
Prepaid Insurance .........................................................
Cash ......................................................................
1,200
Credit
700
6,800
850
1,000
530
900
1,200
LO 2 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-26
EXERCISE 0-10
General Journal
Date
March
1
3
5
Account Titles
Rent Expense .................................................................
Cash .......................................................................
Debit
1,200
Accounts Receivable .....................................................
Service Revenue ...................................................
140
Cash
75
1,200
140
Service Revenue ...................................................
8
12
75
Equipment ......................................................................
Cash .......................................................................
Accounts Payable .................................................
600
Cash
140
80
520
Accounts Receivable ............................................
14
22
24
140
Salaries and Wages Expense .......................................
Cash .......................................................................
525
Utilities Expense ............................................................
Cash .......................................................................
72
Cash
525
72
1,500
Notes Payable .......................................................
27
28
30
Credit
1,500
Maintenance and Repairs Expense ..............................
Cash .......................................................................
220
Accounts Payable ..........................................................
Cash .......................................................................
520
Prepaid Insurance..........................................................
Cash .......................................................................
1,800
220
520
1,800
LO 2 BT: AP Difficulty: Medium TOT: 8 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-11
SM
.., Solutions Manual
(For Instructor Use Only)
3-27
Trans.
1.
2.
Account Titles
Cash
Common Stock ......................................................
Cash
Debit
24,000
24,000
7,000
Notes Payable ........................................................
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
7,000
Equipment .......................................................................
Cash ........................................................................
11,000
Rent Expense ..................................................................
Cash ........................................................................
1,200
Supplies ..........................................................................
Cash ........................................................................
1,450
Advertising Expense ......................................................
Accounts Payable ..................................................
600
Cash
Accounts Receivable .....................................................
Service Revenue ....................................................
2,000
16,000
Dividends ........................................................................
Cash ........................................................................
400
Utilities Expense .............................................................
Cash ........................................................................
2,000
Accounts Payable...........................................................
Cash ........................................................................
600
Interest Expense .............................................................
Cash ........................................................................
40
Salaries and Wages Expense ........................................
Cash ........................................................................
6,400
Cash
12,000
11,000
1,200
1,450
600
18,000
400
2,000
600
40
6,400
Accounts Receivable ............................................
14.
Credit
Income Tax Expense ......................................................
Cash ........................................................................
12,000
1,500
1,500
LO 2 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-28
EXERCISE 0-12
(a)
Assets
=
Accounts
Cash
+
Sept. 1
+$20,000
5
–3,000
8
Receivable
Liabilities
Accounts
+ Equipment =
Payable
Stockholders’ Equity
+
Retained Earnings
Common
+
Stock
–1,200
25
–4,000
30
–500
$ 11,300 +
Exp.
–
Div.
+$20,000
+$9,000
Issued stock
+$ 6,000
+$18,000
14
–
+ Revenues
+$18,000
Ser. Rev.
–$1,200
Salar. Exp.
–4,000
–$500
$18,000
$38,300
+
$9,000
=
$ 2,000+
+
$20,000
..
+
–
$18,000
$1,200
–
Dividends
$500
$38,300
(b)
General Journal
Date
Sept. 1
5
8
14
25
30
SM
J1
Account Titles
Cash
Common Stock ..................................................
Debit
20,000
Equipment ...................................................................
Accounts Payable ..............................................
Cash ....................................................................
9,000
Accounts Receivable .................................................
Service Revenue ................................................
18,000
Salaries and Wages Expense ....................................
Cash ....................................................................
1,200
Accounts Payable.......................................................
Cash ....................................................................
4,000
Dividends ....................................................................
Cash ....................................................................
500
.., Solutions Manual
Credit
20,000
6,000
3,000
18,000
1,200
4,000
(For Instructor Use Only)
500
3-29
EXERCISE 0-12 (Continued)
(c)
Bal.
Cash
20,000 9/5
9/14
9/25
9/30
11,300
9/8
Bal.
Accounts Receivable
18,000
18,000
9/1
9/5
Bal.
9/25
SM
Common Stock
9/1
Bal.
3,000
1,200
4,000
500
9/30
Bal.
Dividends
500
500
Service Revenue
9/8
Bal.
Equipment
9,000
9,000
20,000
20,000
18,000
18,000
Salaries and Wages Expense
9/14
1,200
Bal.
1,200
Accounts Payable
4,000 9/5
Bal.
6,000
2,000
.., Solutions Manual
(For Instructor Use Only)
3-30
LO 3 BT: AP Difficulty: Hard TOT:20 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-13
(a)
Oct. 1
10
Bal.
Oct. 6
Bal.
Oct. 3
Bal.
Cash
30,000 Oct. 27
140
30
26,440
700
3,000
Oct. 27
Accounts Payable
700 Oct. 3
Bal.
3,800
3,100
Common Stock
Oct. 1
Bal.
30,000
30,000
Service Revenue
Oct. 6
10
Bal.
10,800
140
10,940
Accounts Receivable
10,800
10,800
Equipment
3,800
3,800
Salaries and Wages Expense
Oct. 30
3,000
Bal.
3,000
(b)
MCCALL REAL ESTATE AGENCY
Trial Balance
October 31, 2017
Cash ..................................................................................
Accounts Receivable .......................................................
Equipment.........................................................................
Accounts Payable ............................................................
Common Stock .................................................................
Service Revenue ..............................................................
Salaries and Wages Expense ..........................................
Debit
$26,440
10,800
3,800
3,000
$44,040
Credit
$ 3,100
30,000
10,940
.
$44,040
(Total of debit account balances = Total of credit account balances)
LO 4, BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-31
EXERCISE 0-14
(a)
Date
Apr.
1
4
7
12
General Journal
Account Titles and Explanation
Cash
Common Stock .....................................................
(Issued stock for cash)
Debit
15,000
15,000
Supplies .........................................................................
Accounts Payable ................................................
(Purchased supplies on account)
5,200
Accounts Receivable ....................................................
Service Revenue ..................................................
(Billed clients for services
rendered)
3,400
Cash
5,200
3,400
700
Service Revenue ..................................................
(Received cash for revenue
earned)
15
25
29
700
Salaries and Wages Expense .......................................
Cash ......................................................................
(Paid salaries)
800
Accounts Payable .........................................................
Cash ......................................................................
(Paid creditors on account)
3,500
Cash
800
3,500
800
Accounts Receivable ...........................................
(Received cash in payment of
account)
30
Cash
800
900
Unearned Service Revenue .................................
(Received cash for future
services)
SM
Credit
.., Solutions Manual
(For Instructor Use Only)
900
3-32
EXERCISE 0-14 (Continued)
(b)
SALVADOR’s GARDENING COMPANY, INC.
Trial Balance
April 30, 2017
Cash ..................................................................................
Accounts Receivable .......................................................
Supplies ............................................................................
Accounts Payable ............................................................
Unearned Service Revenue .............................................
Common Stock .................................................................
Service Revenue ..............................................................
Salaries and Wages Expense ..........................................
Debit
$13,100
2,600
5,200
Credit
$ 1,700
900
15,000
4,100
800
$21,700
$21,700
(Assets and Expenses have debit balances)
LO 4 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-33
EXERCISE 0-15
(a)
Aug. 1
10
31
Bal.
Cash
8,000 Aug. 12
1,700
600
9,100
1,200
Accounts Receivable
Aug. 25
3,400 Aug. 31
Bal.
2,800
Aug. 12
Bal.
(b)
Notes Payable
Aug. 12
Bal.
5,000
5,000
Common Stock
Aug. 1
Bal.
8,000
8,000
Service Revenue
Aug. 10
25
Bal.
1,700
3,400
5,100
600
Equipment
6,200
6,200
BAYLEE INC.
Trial Balance
August 31, 2017
Cash ..................................................................................
Accounts Receivable .......................................................
Equipment.........................................................................
Notes Payable...................................................................
Common Stock .................................................................
Service Revenue ..............................................................
Debit
$ 9,100
2,800
6,200
$18,100
Credit
$ 5,000
8,000
5,100
$18,100
(Liabilities, Common stock, and Revenues have credit balances)
LO 4, BT: AP Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-34
EXERCISE 0-16
(a)
Oct.
1
10
10
20
20
SM
Cash ............................................................................
Common Stock ..................................................
(Issued stock for cash)
7,000
Cash ............................................................................
Service Revenue ................................................
(Received cash for services
provided)
980
Cash ............................................................................
Notes Payable ....................................................
(Issued note payable for cash)
8,000
Cash ............................................................................
Accounts Receivable ........................................
(Received cash in payment of
account)
700
Accounts Receivable .................................................
Service Revenue ................................................
(Billed clients for services
provided)
920
.., Solutions Manual
7,000
980
8,000
700
(For Instructor Use Only)
920
3-35
EXERCISE 0-16 (Continued)
(b)
KRISCOE CO.
Trial Balance
October 31, 2017
Cash ..................................................................................
Accounts Receivable .......................................................
Supplies ............................................................................
Equipment.........................................................................
Notes Payable...................................................................
Accounts Payable ............................................................
Common Stock .................................................................
Dividends ..........................................................................
Service Revenue ..............................................................
Salaries and Wages Expense ..........................................
Supplies Expense ............................................................
Rent Expense ...................................................................
Debit
$15,730
1,020
220
3,000
Credit
$ 8,000
1,500
9,000
300
2,700
500
180
250
$21,200
$21,200
(Liabilities, Common stock, and Service revenues have credit balances)
LO 4 BT: AN Difficulty: Medium TOT: 12 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-36
EXERCISE 0-17
(a)
Date
Oct.
1
Account Titles
Cash
Common Stock .....................................................
Debit
66,000
66,000
2
No entry
4
Rent Expense .................................................................
Cash .......................................................................
2,000
Equipment ......................................................................
Cash .......................................................................
Accounts Payable .................................................
18,000
Advertising Expense .....................................................
Cash .......................................................................
500
Maintenance and Repairs Expense ..............................
Accounts Payable .................................................
390
Accounts Receivable .....................................................
Service Revenue ...................................................
3,200
Supplies ..........................................................................
Accounts Payable .................................................
410
Accounts Payable ..........................................................
Cash .......................................................................
14,000
Utilities Expense ............................................................
Cash .......................................................................
148
7
8
10
12
16
21
24
27
Cash
2,000
4,000
14,000
500
390
3,200
410
14,000
148
3,200
Accounts Receivable ............................................
31
SM
Credit
Salaries and Wages Expense .......................................
Cash .......................................................................
.., Solutions Manual
3,200
5,100
(For Instructor Use Only)
5,100
3-37
EXERCISE 0-17 (Continued)
(b)
Bal.
Cash
66,000 10/4
3,200 10/7
10/8
10/21
10/24
10/31
43,452
10/12
Accounts Receivable
3,200 10/27
10/1
10/27
10/16
Bal.
Supplies
410
410
10/7
Bal.
Equipment
18,000
18,000
10/21
SM
Service Revenue
10/12
Bal.
2,000
4,000
500
14,000
148
5,100
10/8
Bal.
3,200
Salaries and Wages Expense
10/31
5,100
Bal.
5,100
3,200
3,200
Advertising Expense
500
500
Maintenance & Repairs Expense
10/10
390
Bal.
390
Accounts Payable
14,000 10/7
10/10
10/16
Bal.
14,000
390
410
800
Common Stock
10/1
Bal.
66,000
66,000
.., Solutions Manual
10/4
Bal.
Rent Expense
2,000
2,000
10/24
Bal.
Utilities Expense
148
148
(For Instructor Use Only)
3-38
EXERCISE 0-17 (Continued)
(c)
BEYERS CORPORATION
Trial Balance
October 31, 2017
Debit
$43,452
410
18,000
Cash ..................................................................................
Supplies ............................................................................
Equipment.........................................................................
Accounts Payable ............................................................
Common Stock .................................................................
Service Revenue ..............................................................
Advertising Expense ........................................................
Salaries and Wages Expense ..........................................
Maintenance and Repairs Expense ................................
Rent Expense ...................................................................
Utilities Expense ..............................................................
Credit
$800
66,000
3,200
500
5,100
390
2,000
148
$70,000
$70,000
(Total of debit account balances = Total of credit account balances)
LO 4 BT: AP Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-18
Error
1.
2.
3.
4.
5.
6.
(a)
In Balance
No
Yes
Yes
No
Yes
No
(b)
Difference
$400
—
—
$300
—
$36
(c)
Larger Column
Debit
—
—
Credit
—
Credit
LO 4 BT: AN Difficulty: Hard TOT: 12 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
4-39
EXERCISE 0-19
The revenue recognition principle requires that companies recognize revenue in the
accounting period in which the performance obligation is satisfied.
(a)
Since the sales effort is not complete until the flight actually occurs, revenue
should not be recognized until December. Southwest Airlines should recognize the
revenue in December when the customer has been provided with the flight.
(b)
Sales revenue should be recognized at the time of delivery.
(c)
Revenue should be recognized on a per game basis over the season from April
through October.
(d)
Interest revenue should be accrued and recognized by RBC evenly over the term of
the loan.
(e)
Revenue should be recognized when the sweater is shipped to the customer in
September.
LO 5 BT: C Difficulty: Medium TOT: 10 min. AACSB: None AICPA FC: Measurement
EXERCISE 0-20
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
8.
1.
7.
3.
6.
4.
2.
5.
Going concern assumption.
Economic entity assumption.
Full disclosure principle.
Monetary unit assumption.
Materiality.
Periodicity assumption.
Expense recognition principle.
Historical cost principle.
LO 5 BT: K Difficulty: Easy TOT: 5 min. AACSB: None AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
4-40
EXERCISE 0-21
(a)
(b)
(c)
(d)
(e)
(f)
Revenue recognition principle.
Periodicity assumption.
No violation.
Going concern assumption.
Historical cost principle.
Economic entity assumption.
LO 5 BT: C Difficulty: Medium TOT: 10 min. AACSB: None AICPA FC: Reporting
EXERCISE 0-22
$ 33,640
+ 3,400
– 2,800
+ 1,300
– 1,460
– 2,000
+ 2,400
– 1,400
+ 1,100
$ 34,180
Cash basis earnings.
Accounts receivable arise from sales that have been made, thus revenue
must be recognized for balance outstanding at the end of the current
year.
Accounts receivable collected in current year, for sales made in
previous year must be deducted from earnings.
Supplies on hand at year end should be set up as an asset rather than
expensed, this increases earnings.
Supplies on hand at the end of the previous year should be
expensed this year, this decreases earnings.
Wages owing at the end of the current year should be accrued, thus
reducing earnings.
Wages owed at the end of the previous year should not be
deducted from the current year’s earnings, thus increasing
earnings.
Other unpaid amounts owed at the end of the current year should be
accrued, thus reducing earnings.
Other unpaid amounts owed at the end of the previous year should not
be deducted from the current year’s earnings, thus increasing earnings.
Accrual basis earnings.
LO 5 BT: AP Difficulty: Hard TOT: 12 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
4-41
EXERCISE 0-23
(a)
Service Revenue
– Operating Expenses
– Insurance Expense
Net Income
(b)
Cash Basis
$22,000
12,000
2,400
$ 7,600
Accrual Basis
$28,000
15,800
—
$12,200
The accrual basis of accounting provides more useful information for decision
makers because it recognizes revenues when the performance obligation is
satisfied and expenses when incurred.
LO 5 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-24
(a)
Event
180-day financing
for customers
Cash Accounting
Revenue is recorded as
cash is received.
Accrual Accounting
Revenue is recorded when the
performance obligation is
satisfied. BizCon records
revenue (and a receivable) as
soon as services are provided
but may wait up to 180 days to
receive cash.
Payment to
equipment
suppliers upon
delivery of goods
Equipment expense is
recorded as an
expense as soon as
equipment is received and
paid for.
Equipment is recorded as an
asset and depreciated.
Prepayment for 2
years of insurance
coverage
Insurance expense is
recorded as soon as
payment is made.
Prepayment is recorded as an
asset and recognized as an
expense as time passes.
One month’s
salaries owed at
year-end
No salary expense is
recorded until salaries are
paid.
Salary expense is recorded as
employees perform work.
Amounts owed at year-end
would be recorded as a liability.
Proper accrual accounting would require adjusting entries for depreciation, prepaid
insurance, and accrued salaries.
SM
.., Solutions Manual
(For Instructor Use Only)
4-42
EXERCISE 0-24 (Continued)
(b) Accrual accounting rules require that revenue be recognized as a company
performs services and expenses be matched with the revenue they help produce.
Receipt or payment of cash does not influence the calculation of net income.
BizCon has provided many services during the year and thus has positive net
income. Since BizCon allowed its largest customers to take up to 180 days to pay,
but was forced to pay cash for all purchases, it is likely that the company has very
little cash at year-end. New companies frequently experience cash shortages
because they extend credit to attract customers but are unable to receive credit
from their suppliers. As time passes, the cash supply should increase as payments
on accounts receivable come in and offset current purchases.
LO 5 BT: C Difficulty: Hard TOT: 20 min. AACSB: Analytic AICPA FC: Measurement AICPA FC:
Reporting
EXERCISE 0-25
Item
(1)
Type of Adjustment
(2)
Accounts Before Adjustment
(a)
Accrued Revenues
Assets Understated
Revenues Understated
(b)
Prepaid Expenses
Assets Overstated
Expenses Understated
(c)
Accrued Expenses
Expenses Understated
Liabilities Understated
(d)
Unearned Revenues
Liabilities Overstated
Revenues Understated
(e)
Accrued Expenses
Expenses Understated
Liabilities Understated
(f)
Prepaid Expenses
Assets Overstated
Expenses Understated
LO 5 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
4-43
EXERCISE 0-26
1.
2.
3.
4.
5.
Mar. 31
31
31
31
31
Depreciation Expense ($280 X 3)..............................
Accumulated Depreciation—
Equipment .....................................................
840
Unearned Rent Revenue ...........................................
Rent Revenue ($12,400 X 1/2) ..........................
6,200
Interest Expense ........................................................
Interest Payable ................................................
400
Supplies Expense ......................................................
Supplies ($3,000 – $850)...................................
2,150
Insurance Expense ($400 X 3) ..................................
Prepaid Insurance .............................................
1,200
840
6,200
400
2,150
1,200
LO 5 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-27
1.
2.
3.
Jan. 31
31
31
31
4.
5.
31
31
Accounts Receivable .................................................
Service Revenue ...............................................
760
Utilities Expense ........................................................
Accounts Payable .............................................
450
Depreciation Expense ...............................................
Accumulated Depreciation—
Equipment .....................................................
400
Interest Expense ........................................................
Interest Payable ................................................
500
Insurance Expense ($24,000 ÷ 12) ............................
Prepaid Insurance .............................................
2,000
Supplies Expense ($1,750 – $550) ............................
Supplies .............................................................
1,200
760
450
400
500
2,000
1,200
LO 5 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
4-44
EXERCISE 0-28
1.
2.
3.
4.
5.
6.
7.
Oct. 31
31
31
31
31
31
31
Supplies Expense ......................................................
Supplies ($2,500 – $500)...................................
2,000
Insurance Expense ....................................................
Prepaid Insurance .............................................
100
Depreciation Expense ...............................................
Accumulated Depreciation—
Equipment .....................................................
75
Unearned Service Revenue ......................................
Service Revenue ...............................................
800
Accounts Receivable .................................................
Service Revenue ...............................................
280
Interest Expense ........................................................
Interest Payable ................................................
70
Salaries and Wages Expense ...................................
Salaries and Wages Payable............................
1,400
2,000
100
75
800
280
70
1,400
LO 5 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
4-45
EXERCISE 0-29
Date
July 31
31
31
31
31
31
31
Account Titles
Debit
Interest Receivable ($20,000  .06  1/12) .................... 100
Interest Revenue ...................................................
Credit
100
Supplies Expense ($24,000 – $18,600) ......................... 5,400
Supplies .................................................................
5,400
Rent Expense ($3,600  4) .............................................
Prepaid Rent ..........................................................
900
900
Salaries and Wages Expense........................................ 3,100
Salaries and Wages Payable ................................
Depreciation Expense ($6,000  12) .............................
Accumulated Depreciation—Buildings ...............
3,100
500
500
Unearned Service Revenue ........................................... 4,700
Service Revenue ...................................................
4,700
Maintenance and Repairs Expense .............................. 2,300
Accounts Payable .................................................
2,300
LO 5 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
4-46
EXERCISE 0-30
(a)
July 10
14
15
20
SM
Supplies ......................................................................
Cash ...................................................................
200
Cash ............................................................................
Service Revenue ...............................................
3,800
Salaries and Wages Expense ...................................
Cash ...................................................................
1,000
Cash ............................................................................
Unearned Service Revenue..............................
600
.., Solutions Manual
200
3,800
1,000
(For Instructor Use Only)
600
4-47
EXERCISE 0-30 (Continued)
(b)
July 31
31
31
31
Supplies Expense ......................................................
Supplies .............................................................
750
Accounts Receivable .................................................
Service Revenue ...............................................
500
Salaries and Wages Expense ...................................
Salaries and Wages Payable............................
1,000
Unearned Service Revenue ......................................
Service Revenue ...............................................
900
750
500
1,000
900
LO 5 BT: AN Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-31
Answer
Computation
(a)
Supplies balance = $1,350
Supplies expense
Add: Supplies (1/31)
Less: Supplies purchased
Supplies (1/1)
(b)
Total premium = $6,240
Total premium = Monthly premium X 12; $520
X 12 = $6,240
Purchase date = May 1, 2016
Purchase date: On Jan. 31, there are 3 months
coverage remaining ($520 X 3). Thus, the
purchase date was 9 months earlier on May 1,
2016.
SM
.., Solutions Manual
(For Instructor Use Only)
$ 950)
700)
(300)
$1,350)
4-48
EXERCISE 0-31 (Continued)
(c)
Salaries and wages
payable = $1,760
Cash paid
Salaries and wages
payable (1/31/17)
$2,500
1,060
3,560
Less: Salaries and wages
expense
Salaries and wages
payable (12/31/16)
(d)
Unearned service
revenue = $2,950
Service revenue
Unearned revenue (1/31/17)
Cash received in Jan.
Unearned revenue (12/31/16)
1,800
$1,760
$4,000
750
4,750
1,800
$2,950
LO 5 BT: AN Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
4-49
EXERCISE 0-32
Net Income
Total
Assets
Total
Liabilities
Stockholders’
Equity
Incorrect balances
$70,000
$150,000
$70,000
$80,000
Effects of:
Salaries and Wages
(10,000)
10,000
(10,000)
Rent Revenue
4,000
(4,000)
4,000
Depreciation
(9,000)
(9,000)
$55,000
$141,000
Item
Correct balances
(9,000)
$76,000
$65,000
(Revenues increase Net income and Stockholders’ equity and expenses do the
opposite)
LO 5 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-33
(a)
2017
June
Aug.
Sept.
Nov.
Dec.
SM
1
31
4
30
5
Prepaid Insurance...................................................
Cash .................................................................
1,800
Prepaid Rent............................................................
Cash .................................................................
6,500
Cash .........................................................................
Unearned Service Revenue ...........................
3,600
Prepaid Cleaning ....................................................
Cash .................................................................
2,000
Cash .........................................................................
Unearned Service Revenue ...........................
1,500
.., Solutions Manual
1,800
6,500
3,600
2,000
(For Instructor Use Only)
1,500
4-50
EXERCISE 0-33 (Continued)
(b) 2017
Dec.
31
31
31
31
31
SM
Insurance Expense .................................................
Prepaid Insurance ........................................
($1,800 × 7/12 months = $1,050)
1,050
Rent Expense ..........................................................
Prepaid Rent .................................................
($6,500 × 4/5 months = $5,200)
5,200
Unearned Service Revenue....................................
Service Revenue ..........................................
($3,600 × 4/9 months = $1,600)
1,600
Maintenance and Repairs Expense .......................
Prepaid Cleaning ..........................................
1,000
Unearned Service Revenue....................................
Service Revenue ..........................................
($1,500 – $475 not played = $1,025 played)
1,025
.., Solutions Manual
1,050
5,200
1,600
1,000
(For Instructor Use Only)
1,025
4-51
EXERCISE 0-33 (Continued)
(c)
Prepaid Insurance
June 1
1,800 Dec. 31 Adj.
Dec. 31 Bal.
750
1,050
Prepaid Rent
6,500 Dec. 31 Adj.
1,300
5,200
Aug. 31
Dec. 31 Bal.
Unearned Service Revenue
Dec. 31 Adj.
1,600 Sept. 4
3,600
Dec. 31 Adj.
1,025 Dec. 5
1,500
Dec. 31 Bal.
2,475
Prepaid Cleaning
Nov. 30
2,000 Dec. 31 Adj.
Dec. 31 Bal.
1,000
1,000
Insurance Expense
Dec. 31 Adj.
1,050
Dec. 31 Adj.
Rent Expense
5,200
Service Revenue
Dec. 31 Adj.
Dec. 31 Adj.
Dec. 31 Bal.
1,600
1,025
2,625
Maintenance and Repairs Expense
Dec. 31 Adj.
1,000
SM
.., Solutions Manual
(For Instructor Use Only)
4-52
Note: The Cash account has not been included in this solution, as per the instructions.
LO 5 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-34
(a)
2017
Dec.
31
31
31
31
31
(b)
2018
Jan.
11
4
1
4
2
Utilities Expense .....................................................
Accounts Payable ........................................
425
Salaries and Wages Expense ................................
Salaries and Wages Payable .......................
($3,500 × 4/7 days = $2,000)
2,000
Interest Expense .....................................................
Interest Payable ...........................................
($45,000 × 5% × 2/12 months = $375 (rounded))
375
Accounts Receivable ..............................................
Service Revenue ..........................................
300
Accounts Receivable ..............................................
Rent Revenue ...............................................
6,000
Accounts Payable ...................................................
Cash .................................................................
425
Salaries and Wages Payable..................................
Salaries and Wages Expense ................................
Cash .................................................................
2,000
1,500
Interest Payable ......................................................
Cash .................................................................
375
Cash .........................................................................
Accounts Receivable ......................................
300
Cash .........................................................................
Accounts Receivable ......................................
6,000
425
2,000
375
300
6,000
425
3,500
375
300
6,000
LO 5 BT: AP Difficulty: Medium TOT: 15 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-53
EXERCISE 0-35
Aug. 31
31
31
31
31
31
Accounts Receivable ................................................
Service Revenue .......................................................
600
Supplies Expense ..............................................................
Supplies .....................................................................
2,000
Insurance Expense ............................................................
Prepaid Insurance .....................................................
1,500
Depreciation Expense ........................................................
Accumulated Depreciation—Equipment .................
1,200
Salaries and Wages Expense ............................................
Salaries and Wages Payable ....................................
1,100
Unearned Rent Revenue ....................................................
Rent Revenue ............................................................
1,000
600
2,000
1,500
1,200
1,100
1,000
LO 6 BT: AN Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-36
(a)
FRANKEN COMPANY
Income Statement
For the Six Months Ended April 30, 2017
Revenues
Service revenue ($32,150 + $540) ................................
Expenses
Income tax expense......................................................
Salaries and wages expense ($2,600 + $420) .............
Depreciation expense [($9,200 ÷ 4) X 6/12].................
Rent expense ($1,225 – $175) ......................................
Utilities expense ...........................................................
Advertising expense.....................................................
$32,690
$10,000
3,020
1,150
1,050
970
375
Total expenses ......................................................................
Net income .............................................................................
16,565
$16,125
[Revenues – Expenses = Net income or (loss)]
SM
.., Solutions Manual
(For Instructor Use Only)
3-54
EXERCISE 0-36 (Continued)
(b)
FRANKEN COMPANY
Balance Sheet
April 30, 2017
Assets
Current Assets
Cash ............................................................................
Accounts receivable ..................................................
Prepaid rent ................................................................
Total current assets...........................................
Property, plant, and equipment
Equipment ..................................................................
Less: Accumulated
depreciation—equipment .......................................
Total assets ........................................................
$27,780
540
175
$28,495
9,200
1,150
8,050
$36,545
Liabilities and Stockholders’ Equity
Current Liabilities
Salaries and wages payable ....................................
Stockholders’ equity
Common stock ..........................................................
Retained earnings.....................................................
Total stockholders’ equity ........................
Total liabilities and stockholders’
equity ..............................................................
$
420
$20,000
16,125
36,125
$36,545
(Assets = Liabilities + Stockholders’ equity)
LO 7 BT: AP Difficulty: Hard TOT: 15 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-55
EXERCISE 0-37
NORSKI CO.
Income Statement
For the Month Ended July 31, 2017
Revenues
Service revenue ($5,500 + $700) ...........................................
Expenses
Salaries and wages expense ($2,100 + $360) ......................
Supplies expense ($900 – $200) ...........................................
Utilities expense .....................................................................
Insurance expense .................................................................
Depreciation expense ............................................................
Total expenses ..............................................................
Net income ......................................................................................
$6,200
$2,460
700
500
350
150
4,160
$2,040
[Revenues – Expenses = Net income or (loss)]
LO 7 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-38
RYAN COMPANY
Income Statement
For the Year Ended August 31, 2017
Revenues
Service revenue ..................................................................
Rent revenue .......................................................................
Total revenues ............................................................
Expenses
Salaries and wages expense..............................................
Rent expense.......................................................................
Supplies expense ................................................................
Insurance expense ..............................................................
Depreciation expense .........................................................
Total expenses ...........................................................
Net income ...................................................................................
SM
.., Solutions Manual
$34,600
13,100
$47,700
18,100
10,800
2,000
1,500
1,200
33,600
$14,100
(For Instructor Use Only)
3-56
EXERCISE 0-38 (Continued)
RYAN COMPANY
Retained Earnings Statement
For the Year Ended August 31, 2017
Retained earnings, September 1, 2016 ..........................................
Add: Net income ............................................................................
Less: Dividends ..............................................................................
Retained earnings, August 31, 2017 ..............................................
$ 5,500
14,100
19,600
2,800
$16,800
RYAN COMPANY
Balance Sheet
August 31, 2017
Assets
Current Assets
Cash ......................................................................................
Accounts receivable ............................................................
Supplies ................................................................................
Prepaid insurance ................................................................
Total current assets ....................................................
Equipment ............................................................................
Less: Accum. depreciation—equipment .............................
Total assets .................................................................
$10,900
9,400
500
2,500
$23,300
16,000
4,800
11,200
$34,500
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts payable ................................................................
Salaries and wages payable................................................
Unearned rent revenue ........................................................
Total current liabilities ................................................
Stockholders’ equity
Common stock .....................................................................
Retained earnings ................................................................
Total stockholders’ equity .....................................
Total liabilities and stockholders’ equity ..................
$ 5,800
1,100
800
$ 7,700
10,000
16,800
26,800
$34,500
(Ending retained earnings = Beginning retained earnings ± Changes to retained
earnings)
LO 7 BT: AP Difficulty: Medium TOT: 20 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-57
EXERCISE 0-39
Jan. 31
31
31
Service Revenue ................................................................
Income Summary ......................................................
4,000
Income Summary ...............................................................
Salaries and Wages Expense ...................................
Supplies Expense .....................................................
Insurance Expense ...................................................
3,270
Income Summary ...............................................................
Retained Earnings.....................................................
730
4,000
1,800
950
520
730
LO 8 BT: AP Difficulty: Medium TOT: 5 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-40
(a)
Date
Dec.
31
31
31
31
SM
Account Titles
Debit
Service Revenue ......................................................... 183,800
Rent Revenue .............................................................. 6,200
Income Summary ...............................................
190,000
Income Summary ........................................................ 109,300
Salaries and Wages Expense ............................
Depreciation Expense........................................
Rent Expense .....................................................
Supplies Expense ..............................................
91,100
13,200
3,600
1,400
Income Summary ........................................................ 80,700
Retained Earnings .............................................
80,700
Retained Earnings ...................................................... 26,300
Dividends ............................................................
26,300
.., Solutions Manual
Credit
(For Instructor Use Only)
3-58
EXERCISE 0-40 (Continued)
(b)
Dec. 31
Retained Earnings
26,300 Jan. 1
Dec. 31
Bal.
61,800
80,700
116,200
LO 8 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting
EXERCISE 0-41
Aug. 31
31
31
31
Service Revenue ..........................................................
Rent Revenue ...............................................................
Income Summary ................................................
34,600
13,100
Income Summary .........................................................
Salaries and Wages Expense .............................
Rent Expense ......................................................
Supplies Expense ...............................................
Insurance Expense .............................................
Depreciation Expense .........................................
33,600
Income Summary .........................................................
Retained Earnings...............................................
14,100
Retained Earnings........................................................
Dividends .............................................................
2,800
47,700
18,100
10,800
2,000
1,500
1,200
14,100
2,800
LO 8 BT: AP Difficulty: Medium TOT: 10 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-59
WONDER TRAVEL AGENCY INC.
1.
+
Cash
Accounts
Receivable
+ Supplies + Equipment
+$30,000
–900
3.
–3,400
=
Accounts
Payable
+
Common
Stock
+
+$30,000
Retained Earnings
Revenues – Expenses –
Dividends
–$900
Rent Expense
–200
Advertising Expense
+$3,400
4.
+$200
(For Instructor Use Only)
5.
–500
+$500
6.
+3,000
7.
–400
8.
–200
9.
–1,800
10.
+9,000
–9,000
$34,800 +
$
+$9,000
+$12,000
Service Revenue
–$400
Dividends
–200
–1,800
0
+
$38,700
$500
+
$3,400
=
$
0
+
$30,000
+
$12,000
$38,700
–
$2,900
Salaries and Wages
Expense
–
$400
OLUTIONS
TO PROBLEMS
PROBLEM
0-1A
.., Solutions Manual
2.
Stockholders’ Equity
= Liabilities +
Assets
SOLUTIONS TO PROBLEMS
Copyright © 2016 John Wiley & Sons, Inc.
(a)
3-39
PROBLEM 0-1A (Continued)
(b)
Service Revenue ....................................................................
Expenses
Salaries and Wages Expense .......................................
Rent Expense ................................................................
Advertising Expense.....................................................
Net Income ............................................................
$12,000
$1,800
900
200
2,900
$ 9,100
OR
Revenues ...............................................................................
Less: Expenses .....................................................................
Net Income..............................................................................
$12,000
2,900
$ 9,100
[Revenues – Expenses = Net Income or (Loss)]
LO 1 BT: AP Difficulty: Hard TOT: 45 min. AACSB: Analytic AICPA FC: Reporting
PROBLEM 0-2A
Date
Mar.
1
Account Titles and Explanation
Debit
Cash
50,000
Common Stock ....................................................
(Issued stock for cash)
3
5
6
SM
50,000
Land
Buildings.......................................................................
Equipment ....................................................................
Cash .....................................................................
(Purchased Snead’s Golf Land)
23,000
9,000
6,000
Advertising Expense....................................................
Cash .....................................................................
(Paid for advertising)
1,200
Prepaid Insurance ........................................................
Cash .....................................................................
(Paid for one-year insurance policy)
2,400
.., Solutions Manual
Credit
38,000
1,200
(For Instructor Use Only)
2,400
3-61
10
18
Equipment ....................................................................
Accounts Payable ...............................................
(Purchased equipment on account)
5,500
Cash
1,600
5,500
Service Revenue .................................................
(Received cash for revenue earned)
19
25
SM
1,600
Cash (100 X $25) ..........................................................
Unearned Service Revenue ................................
(Received cash for coupon books
sold)
2,500
Dividends ......................................................................
Cash .....................................................................
(Payment of cash dividend)
500
.., Solutions Manual
2,500
(For Instructor Use Only)
500
3-62
PROBLEM 0-2A (Continued)
Date
Account Titles and Explanation
Mar. 30
Salaries and Wages Expense ......................................
Cash .....................................................................
(Paid salaries expense)
800
Accounts Payable ........................................................
Cash .....................................................................
(Paid creditor on account)
5,500
30
31
Debit
Cash
Credit
800
5,500
900
Service Revenue .................................................
(Received cash for revenue earned)
900
LO 2 BT: AP Difficulty: Medium TOT: 25 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-63
PROBLEM 0-3A
(a)
Date
Apr.
1
Account Titles and Explanation
Cash
Common Stock....................................................
(Issued shares of stock for cash)
Debit
118,0000
18,000
1
No entry.
2
Rent Expense ...............................................................
Cash .....................................................................
(Paid monthly office rent)
900
Supplies ........................................................................
Accounts Payable ...............................................
(Purchased supplies on account
from Burmingham Company)
1,300
Accounts Receivable ...................................................
Service Revenue .................................................
(Billed clients for services rendered)
1,900
3
10
11
Cash
900
1,300
1,900
700
Unearned Service Revenue ................................
(Received cash advance for future
service)
20
Cash
700
2,800
Service Revenue .................................................
(Received cash for service performed)
30
30
SM
Credit
2,800
Salaries and Wages Expense .....................................
Cash .....................................................................
(Paid monthly salary)
1,500
Accounts Payable ........................................................
Cash .....................................................................
(Paid Burmingham Company
on account)
300
.., Solutions Manual
1,500
300
(For Instructor Use Only)
3-64
PROBLEM 0-3A (Continued)
(b)
4/1
4/11
4/20
Bal.
Cash
18,000 4/2
700 4/30
2,800 4/30
18,800
900
1,500
300
4/10
Bal.
Accounts Receivable
1,900
1,900
4/3
Bal.
Supplies
1,300
1,300
4/30
SM
Salaries and Wages Expense
4/30
1,500
Bal.
1,500
4/2
Bal.
Accounts Payable
300 4/3
Bal.
1,300
1,000
Unearned Service Revenue
4/11
Bal.
700
700
Common Stock
4/1
Bal.
18,000
18,000
Service Revenue
4/10
4/20
Bal.
1,900
2,800
4,700
.., Solutions Manual
Rent Expense
900
900
(For Instructor Use Only)
3-65
PROBLEM 0-3A (Continued)
(c)
AYALA ARCHITECTS INC.
Trial Balance
April 30, 2017
Cash ..................................................................................
Accounts Receivable .......................................................
Supplies ............................................................................
Accounts Payable ............................................................
Unearned Service Revenue .............................................
Common Stock .................................................................
Service Revenue ..............................................................
Salaries and Wages Expense ..........................................
Rent Expense ...................................................................
Debit
$18,800
1,900
1,300
Credit
$ 1,000
700
18,000
4,700
1,500
900
$24,400
$24,400
(Assets and Expenses have debit balances)
LO 4 BT: AP Difficulty: Hard TOT: 35 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-66
PROBLEM 0-4A
(a) & (c)
10/1 Bal.
10/5
10/17
Bal.
Cash
19,200 10/15
1,300 10/20
600 10/29
10/31
17,300
1,200
1,900
300
400
Accounts Receivable
10/1 Bal.
2,600 10/5
10/10
5,100
Bal.
6,400
10/1 Bal.
Bal.
Supplies
2,100
2,100
10/1 Bal.
Bal.
Equipment
8,000
8,000
10/20
1,300
10/29
Bal.
Common Stock
10/1 Bal.
Bal.
15,000
15,000
Retained Earnings
10/1 Bal.
Bal.
11,000
11,000
Dividends
300
300
Service Revenue
10/10
10/17
Bal.
5,100
600
5,700
Salaries and Wages Expense
10/15
1,200
Bal.
1,200
Accounts Payable
1,900 10/1 Bal.
Bal.
4,800
2,900
10/31
Bal.
Utilities Expense
400
400
Unearned Service Revenue
10/1 Bal.
1,100
Bal.
1,100
SM
.., Solutions Manual
(For Instructor Use Only)
3-67
PROBLEM 0-4A (Continued)
(b)
Date
Account Titles and Explanation
Debit
Oct. 5
Cash
1,300
Accounts Receivable ..........................................
(Received collections from
customers on account)
10
15
17
1,300
Accounts Receivable ...................................................
Service Revenue .................................................
(Billed customers for services
performed)
5,100
Salaries and Wages Expense ......................................
Cash .....................................................................
(Paid employee salaries)
1,200
Cash
600
5,100
1,200
Service Revenue .................................................
(Performed services for customers)
20
29
31
SM
600
Accounts Payable ........................................................
Cash .....................................................................
(Paid creditors on account)
1,900
Dividends ......................................................................
Cash .....................................................................
(Payment of cash dividend)
300
Utilities Expense ..........................................................
Cash .....................................................................
(Paid utilities)
400
.., Solutions Manual
Credit
1,900
300
(For Instructor Use Only)
400
3-68
PROBLEM 0-4A (Continued)
(d)
LACEY COMPANY
Trial Balance
October 31, 2017
Cash ..................................................................................
Accounts Receivable .......................................................
Supplies ............................................................................
Equipment.........................................................................
Accounts Payable ............................................................
Unearned Service Revenue .............................................
Common Stock .................................................................
Retained Earnings ............................................................
Dividends ..........................................................................
Service Revenue ..............................................................
Salaries and Wages Expense ..........................................
Utilities Expense ..............................................................
Debit
$ 17,300
6,400
2,100
8,000
Credit
$ 2,900
1,100
15,000
11,000
300
5,700
1,200
400
$35,700
$35,700
(Liabilities, Common stock, Retained earnings, and Service revenue have credit
balances)
LO 4 BT: AP Difficulty: Hard TOT: 45 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-69
PROBLEM 0-5A
WASHBURN CO.
Trial Balance
June 30, 2017
Cash ($3,090 – $760 + $706) ..............................
Accounts Receivable* .......................................
Supplies ($800 – $340) .......................................
Equipment ($3,000 + $340) ................................
Accounts Payable ($3,686 – $206 – $260) ........
Unearned Service Revenue ...............................
Common Stock ..................................................
Dividends ($800 + $600) ....................................
Service Revenue ................................................
Salaries and Wages Expense
($3,600 + $700 – $600).....................................
Utilities Expense ................................................
Debit
$ 3,036
4,054
460
3,340
Credit
$ 3,220
1,200
9,000
1,400
3,480
3,700
910
$16,900
$16,900
*$3,190 + $760 – $706 – $90 + $900
(Each journal entry must balance and reflect the actual amount of the transaction)
LO 4 BT: AN Difficulty: Hard TOT: 35 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-70
PROBLEM 0-6A
(a) & (c)
3/1 Bal.
3/9
3/20
3/31
3/31
Bal.
3/31
Bal.
3/1 Bal.
Bal.
Cash
16,000 3/2
9,900 3/10
8,300 3/12
750 3/20
20,000 3/31
32,750
Accounts Receivable
750
750
Land
38,000
38,000
3/1 Bal.
Bal.
Buildings
22,000
22,000
3/1 Bal.
Bal.
Equipment
16,000
16,000
3/10
SM
2,000
10,900
500
5,000
3,800
Accounts Payable
10,900 3/1 Bal.
3/2
Bal.
12,000
8,000
9,100
.., Solutions Manual
Common Stock
3/1 Bal.
Bal.
80,000
80,000
Service Revenue
3/9
3/20
3/31
Bal.
9,900
8,300
20,000
38,200
Sales Revenue
3/31
Bal.
1,500
1,500
3/12
Bal.
Advertising Expense
500
500
3/2
3/20
Bal.
Rent Expense
10,000
5,000
15,000
Salaries and Wages Expense
3/31
3,800
Bal.
3,800
(For Instructor Use Only)
3-71
PROBLEM 0-6A (Continued)
(b)
Date
Account Titles and Explanation
Debit
Mar. 2
Rent Expense ...............................................................
Accounts Payable ...............................................
Cash .....................................................................
(Rented films for cash and on
account)
10,000
3
No entry—not a transaction.
9
Cash
8,000
2,000
9,900
Service Revenue .................................................
(Received cash for admissions)
10
Accounts Payable ($8,000 + $2,900) ..........................
Cash .....................................................................
(Paid creditors on account)
11
No entry—not a transaction.
12
Advertising Expense ...................................................
Cash .....................................................................
(Paid advertising expenses)
20
Cash
9,900
10,900
10,900
500
500
8,300
Service Revenue .................................................
(Received cash for admissions)
20
31
SM
Credit
8,300
Rent Expense ...............................................................
Cash .....................................................................
(Paid film rental)
5,000
Salaries and Wages Expense .....................................
Cash .....................................................................
(Paid salaries expense)
3,800
.., Solutions Manual
5,000
(For Instructor Use Only)
3,800
3-72
PROBLEM 0-6A (Continued)
Date
Mar. 31
31
Account Titles and Explanation
Cash
Accounts Receivable ...................................................
Sales Revenue (15% X $10,000) ..............................
(Received cash and balance on
account for concessions)
Debit
750
750
Cash
20,000
Credit
1,500
Service Revenue ..................................................
(Received cash for admissions)
(d)
20,000
TRIQUEL THEATER INC.
Trial Balance
March 31, 2017
Cash ..................................................................................
Accounts Receivable .......................................................
Land ..................................................................................
Buildings ...........................................................................
Equipment.........................................................................
Accounts Payable ............................................................
Common Stock .................................................................
Service Revenue ..............................................................
Sales Revenue ..................................................................
Advertising Expense ........................................................
Rent Expense ...................................................................
Salaries and Wages Expense ..........................................
Debit
$ 32,750
750
38,000
22,000
16,000
Credit
$
500
15,000
3,800
$128,800
9,100
80,000
38,200
1,500
$128,800
(Assets and Expenses have debit balances)
LO 4 BT: AP Difficulty: Hard TOT: 45 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-73
PROBLEM 0-7A
(a) & (c)
7/31
8/3
8/5
8/7
8/18
8/26
Bal.
Cash
4,000 8/6
1,200 8/12
1,300 8/14
3,000 8/20
3,500 8/31
2,000
6,225
7/31
8/7
8/24
Bal.
Accounts Receivable
1,500 8/3
3,500 8/18
1,000
1,300
7/31
Bal.
Supplies
500
500
7/31
8/12
Bal.
Equipment
5,000
1,200
6,200
8/6
Common Stock
7/31
8/5
Bal.
SM
2,700
400
4,675
500
500
8/20
Bal.
Dividends
500
500
Service Revenue
8/7
8/24
Bal.
1,200
3,500
3,400
3,400
6,500
1,000
7,500
Salaries and Wages Expense
8/14
3,500
Bal.
3,500
Accounts Payable
2,700 7/31
8/12
8/28
Bal.
Notes Payable
8/26
Bal.
Retained Earnings
7/31
Bal.
4,100
800
275
2,475
2,000
2,000
3,500
1,300
4,800
.., Solutions Manual
8/14
Bal.
Rent Expense
900
900
8/14
Bal.
Advertising Expense
275
275
8/28
Bal.
Utilities Expense
275
275
8/31
Bal.
Income Tax Expense
500
500
(For Instructor Use Only)
3-74
PROBLEM 0-7A (Continued)
(b)
Date
Aug.
3
5
Account Titles
Debit
Cash
1,200
Accounts Receivable .............................................
Cash
7
12
14
18
1,300
Accounts Payable ...........................................................
Cash ........................................................................
2,700
Cash
Accounts Receivable ......................................................
Service Revenue.....................................................
3,000
3,500
Equipment........................................................................
Cash ........................................................................
Accounts Payable ..................................................
1,200
Salaries and Wages Expense .........................................
Rent Expense ..................................................................
Advertising Expense .......................................................
Cash ........................................................................
3,500
900
275
Cash
3,500
2,700
6,500
400
800
4,675
Accounts Receivable .............................................
20
24
26
3,500
Dividends .........................................................................
Cash ........................................................................
500
Accounts Receivable ......................................................
Service Revenue.....................................................
1,000
Cash
2,000
500
1,000
Notes Payable .........................................................
SM
2,000
27
No entry
28
Utilities Expense .............................................................
Accounts Payable ..................................................
275
Income Tax Expense .......................................................
Cash ........................................................................
500
31
1,200
1,300
Common Stock .......................................................
6
Credit
.., Solutions Manual
275
(For Instructor Use Only)
500
3-75
PROBLEM 0-7A (Continued)
(d)
HILLS LEGAL SERVICES INC.
Trial Balance
August 31, 2017
Cash ..................................................................................
Accounts Receivable .......................................................
Supplies ............................................................................
Equipment.........................................................................
Accounts Payable ............................................................
Notes Payable...................................................................
Common Stock .................................................................
Retained Earnings ............................................................
Dividends ..........................................................................
Service Revenue ..............................................................
Advertising Expense ........................................................
Salaries and Wages Expense ..........................................
Rent Expense ...................................................................
Utilities Expense ..............................................................
Income Tax Expense ........................................................
Debit
$ 6,225
1,300
500
6,200
Credit
$ 2,475
2,000
4,800
3,400
500
7,500
275
3,500
900
275
500
$20,175
$20,175
(Assets, Dividends, and Expenses have debit balances)
LO 4 BT: AP Difficulty: Hard TOT: 55 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-76
PROBLEM 0-8A
(a) & (c)
Apr. 30
May 7
8
15
22
29
Bal.
Cash
5,000 May
1,500
1,200
800
1,000
1,700
1,000
1,100
1,200
1,000
400
50
1,200
150
5,100
Apr. 30
Bal.
Supplies
500
500
Apr. 30
Bal.
Equipment
24,000
24,000
May 4
May 21
1
4
14
21
25
31
31
31
Accounts Payable
1,100 Apr. 30
1,000 May 22
25
Bal.
Notes Payable
Apr. 30
Bal.
2,100
700
500
1,200
10,000
10,000
Unearned Service Revenue
May 15
700 Apr. 30
1,000
29
600 May 7
1,500
Bal.
1,200
SM
.., Solutions Manual
Common Stock
Apr. 30
Bal.
5,000
5,000
Retained Earnings
Apr. 30
Bal.
11,400
11,400
Service Revenue
May
8
15
15
22
29
29
Bal.
1,200
800
700
1,000
1,700
600
6,000
Salaries and Wages Expense
May 14
1,200
31
1,200
Bal.
2,400
May 1
Bal.
Rent Expense
1,000
1,000
May 22
Bal.
Supplies Expense
700
700
May 25
Bal.
Advertising Expense
500
500
(For Instructor Use Only)
3-77
PROBLEM 0-8A (Continued)
May 25
Bal.
Utilities Expense
400
400
May 31
Bal.
Interest Expense
50
50
May 31
Bal.
Income Tax Expense
150
150
SM
.., Solutions Manual
(For Instructor Use Only)
3-78
PROBLEM 0-8A (Continued)
(b)
Date
May
1
4
7
Account Titles
Debit
Rent Expense ..................................................................
1,000
Cash ........................................................................
Accounts Payable ...........................................................
Cash ........................................................................
1,100
Cash
1,500
Cash
1,500
1,200
Service Revenue.....................................................
14
15
Salaries and Wages Expense .........................................
Cash ........................................................................
Cash
1,200
1,200
1,200
800
Service Revenue.....................................................
15
21
22
800
Unearned Service Revenue ............................................
Service Revenue.....................................................
700
Accounts Payable ...........................................................
Cash ........................................................................
1,000
Cash
1,000
700
1,000
Service Revenue.....................................................
22
SM
1,000
1,100
Unearned Service Revenue ...................................
8
Credit
Supplies Expense ...........................................................
Accounts Payable ..................................................
.., Solutions Manual
1,000
700
(For Instructor Use Only)
700
3-79
PROBLEM 0-8A (Continued)
May
25
25
29
Advertising Expense .......................................................
Accounts Payable ..................................................
500
Utilities Expense .............................................................
Cash ........................................................................
400
Cash
500
400
1,700
Service Revenue.....................................................
29
31
31
31
SM
1,700
Unearned Service Revenue ............................................
Service Revenue.....................................................
600
Interest Expense .............................................................
Cash ........................................................................
50
Salaries and Wages Expense .........................................
Cash ........................................................................
1,200
Income Tax Expense .......................................................
Cash ........................................................................
150
.., Solutions Manual
600
50
1,200
(For Instructor Use Only)
150
3-80
PROBLEM 0-8A (Continued)
(d)
PAMPER ME SALON INC.
Trial Balance
May 31, 2017
Cash ..................................................................................
Supplies ............................................................................
Equipment.........................................................................
Accounts payable ............................................................
Notes payable ...................................................................
Unearned service revenue...............................................
Common stock .................................................................
Retained earnings ............................................................
Service revenue ................................................................
Salaries and wages expense ...........................................
Rent expense ....................................................................
Supplies expense .............................................................
Advertising expense ........................................................
Utilities expense ...............................................................
Interest expense ...............................................................
Income tax expense .........................................................
Totals.............................................................................
Debit
$ 5,100
500
24,000
Credit
$ 1,200
10,000
1,200
5,000
11,400
6,000
2,400
1,000
700
500
400
50
150
$34,800
$34,800
(Assets and Expenses have debit balances)
LO 4 BT: AP Difficulty: Hard TOT: 55 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-81
PROBLEM 0-9A
Error
(a) In Balance
(b) Difference
(c) Larger Column
1.
No
$600
Debit
2.
Yes
None
N/A
3.
Yes
None
N/A
4.
No
$680
Credit
5.
Yes
None
N/A
6.
Yes
None
N/A
7.
No
$900
Debit
8.
Yes
None
N/A
LO 4 BT: AN Difficulty: Hard TOT: 35 min. AACSB: Analytic AICPA FC: Reporting
SM
.., Solutions Manual
(For Instructor Use Only)
3-82
PROBLEM 0-10A
(a)
1.
2.
3.
Cash ...................................................................................
Accounts Receivable .................................................
19,000
Unearned Sales Revenue .................................................
Sales Revenue ............................................................
23,000
Cash ...................................................................................
Unearned Sales Revenue ..........................................
44,000
Unearned Sales Revenue
($44,000 – $20,000).........................................................
Sales Revenue ............................................................
4.
5.
(b)
19,000
23,000
44,000
24,000
24,000
Accounts Receivable ........................................................
Service Revenue ........................................................
151,000
Cash ...................................................................................
Accounts Receivable ($151,000 – $15,000) ................
136,000
151,000
136,000
Cash received with respect to fees and dues
1.
3.
5.
1.
3.
5.
2017 Bal.
Collection of 2016 dues
Sale of tickets
Collection of 2017 dues
Cash
19,000
44,000
136,000
199,000
Accounts Receivable
2016 Bal.
19,000
4.
151,000 1.
19,000
5.
136,000
2017 Bal.
15,000
$ 19,000
44,000
136,000
$199,000
2.
3.
Unearned Sales Revenue
2016 Bal.
23,000
23,000 3.
44,000
24,000
2017 Bal.
20,000
Service Revenue
4.
2017 Bal.
151,000
151,000
Sales Revenue
2.
3.
2017 Bal.
23,000
24,000
47,000
LO 5 BT: AP Difficulty: Medium TOT: 30 min. AACSB Analytic AICPA FC: Reporting
PROBLEM 0-11A
1.
2.
3.
4.
Dec. 31
Dec. 31
Dec. 31
Dec. 31
Insurance Expense ....................................................
Prepaid Insurance .............................................
[($9,600 ÷ 3)
= $3,200
[($7,200 X 12/18) = 4,800
$8,000]
8,000
Unearned Rent Revenue ...........................................
Rent Revenue ....................................................
[[Nov. 5 X $5,000 X 2 = 50,000
[Dec.
4 X $8,500 X 1 = 34,000
$84,000]
84,000
Interest Expense ........................................................
Interest Payable
($40,000 X 7% X 3/12).....................................
700
Salaries and Wages Expense ...................................
Salaries and Wages Payable............................
[5 X $600 X 3/5 =
$1,800
[3 X $700 X 3/5 =
1,260
$3,060]
3,060
8,000
84,000
700
3,060
LO 5 BT: AP Difficulty: Medium TOT: 40 min. AACSB: Analytic AICPA FC: Reporting
PROBLEM 0-12A
(a)
1.
2.
3.
Date
2017
Account Titles
Debit
June 30
Supplies Expense .................................................
Supplies ($2,000 – $720)..............................
1,280
Utilities Expense ...................................................
Accounts Payable ........................................
180
Insurance Expense ...............................................
240
30
30
Credit
1,280
180
Prepaid Insurance
($2,880 ÷ 12 months)................................
4.
5.
6.
7.
30
30
30
30
240
Unearned Service Revenue..................................
Service Revenue ..........................................
4,100
Salaries and Wages Expense ..............................
Salaries and Wages Payable .......................
1,250
Depreciation Expense ..........................................
Accumulated Depreciation—
Equipment ................................................
250
Accounts Receivable ............................................
Service Revenue ..........................................
3,900
4,100
1,250
250
3,900
(b)
6/30 Bal.
Cash
6,850
Accounts Receivable
6/30 Bal.
7,000
6/30
3,900
6/30 Bal.
10,900
6/30 Bal.
6/30 Bal.
Supplies
2,000 6/30
720
1,280
6/30 Bal.
6/30 Bal.
Prepaid Insurance
2,880 6/30
2,640
240
PROBLEM 0-12A (Continued)
6/30 Bal.
Equipment
15,000
6/30 Bal.
Accumulated Depreciation—
Equipment
6/30
250
6/30 Bal.
250
Accounts Payable
6/30 Bal.
6/30
6/30
4,230
180
4,410
Salaries and Wages Payable
6/30
1,250
6/30 Bal.
1,250
6/30
Unearned Service Revenue
4,100 6/30 Bal.
5,200
6/30 Bal.
1,100
Common Stock
6/30 Bal.
22,000
Service Revenue
6/30 Bal.
6/30
6/30
6/30 Bal.
8,300
4,100
3,900
16,300
Salaries and Wages Expense
6/30 Bal.
4,000
6/30
1,250
6/30 Bal.
5,250
Rent Expense
2,000
Depreciation Expense
6/30
250
6/30 Bal.
250
Insurance Expense
6/30
240
6/30 Bal.
240
6/30
6/30 Bal.
Utilities Expense
180
180
6/30
6/30 Bal.
Supplies Expense
1,280
1,280
PROBLEM 0-12A (Continued)
(c)
KUMAR CONSULTING
Adjusted Trial Balance
June 30, 2017
Cash ..................................................................................
Accounts Receivable .......................................................
Supplies ............................................................................
Prepaid Insurance ............................................................
Equipment.........................................................................
Accumulated Depreciation—Equipment ........................
Accounts Payable ............................................................
Salaries and Wages Payable ...........................................
Unearned Service Revenue .............................................
Common Stock .................................................................
Service Revenue ..............................................................
Salaries and Wages Expense ..........................................
Rent Expense ...................................................................
Depreciation Expense ......................................................
Insurance Expense ..........................................................
Utilities Expense ..............................................................
Supplies Expense ............................................................
Debit
$ 6,850
10,900
720
2,640
15,000
Credit
$
5,250
2,000
250
240
180
1,280
$45,310
(Total debits = Total credits)
LO 6 BT: AP Difficulty: Medium TOT: 50 min. AACSB: Analytic AICPA FC: Reporting
250
4,410
1,250
1,100
22,000
16,300
$45,310
PROBLEM 0-13A
(a) 1.
2.
3.
4.
5.
6.
7.
June
30
30
30
30
30
30
30
Rent Revenue .............................................
Unearned Rent Revenue ................
57,000
Supplies Expense ......................................
Supplies ($8,200 – $1,800) .............
6,400
57,000
6,400
Insurance Expense
($14,400 X 3/12) .......................................
Prepaid Insurance...........................
3,600
Maintenance and
Repairs Expense .....................................
Utilities Expense ........................................
Advertising Expense..................................
Accounts Payable ...........................
4,450
215
110
Salaries and Wages Expense
($300 X 4) .................................................
Salaries and Wages
Payable .........................................
Interest Expense
($14,000 X 6% X 2/12) ..............................
Interest Payable .............................
Income Tax Expense..................................
Income Taxes Payable ...................
3,600
4,775
1,200
1,200
140
140
13,400
13,400
PROBLEM 0-13A (Continued)
(b)
ROADSIDE TRAVEL COURT
Income Statement
For the Quarter Ended June 30, 2017
Revenues
Rent revenue ($212,000 – $57,000).....................................
Expenses
Salaries and wages expense
($80,500 + $1,200) .............................................................
Income tax expense ............................................................
Maintenance and repairs expense
($4,300 + $4,450) ...............................................................
Supplies expense ................................................................
Advertising expense ($3,800 + $110) .................................
Insurance expense ..............................................................
Depreciation expense ............................................. 2,700
Utilities expense ($900 + $215) ...........................................
Interest expense ..................................................................
Total expenses.....................................................................
Net income ...........................................................................
$155,000
$ 81,700
13,400
8,750
6,400
3,910
3,600
1,115
140
121,715
$ 33,285
(Revenues are recognized when a service has been provided and expenses are
recognized when an asset has been used up or a service incurred.)
PROBLEM 0-13A (Continued)
(c)
The generally accepted accounting principles pertaining to the income statement
not recognized by Betty were the revenue recognition principle and the expense
recognition principle.
The revenue recognition principle states that revenue is recognized when the
performance obligation is satisfied. The cash payments of $57,000 for summer
rentals have not been earned and, therefore, should not be reported as income
for the quarter ended June 30.
The expense recognition principle dictates that efforts (expenses) be matched
with accomplishments (revenue) whenever it is reasonable and practicable to do so.
This means that the expenses should include amounts incurred in June but not paid
until July, and any other costs related to the operations of the business during the
period April–June.
The difference in reported expenses was $29,515 ($121,715 – $92,200). The
overstatement of revenues ($57,000) plus the understatement of expenses
($29,515) equals the difference in reported income of $86,515 ($119,800 – $33,285).
LO 7 BT: AN Difficulty: Hard TOT: 40 min. AACSB: Analytic AICPA FC: Measurement AICPA FC:
Reporting
PROBLEM 0-14A
(a), (c) & (e)
11/1 Bal.
11/10
11/12
11/29
11/30 Bal.
Cash
2,790 11/8
1,800 11/20
3,700 11/22
750 11/25
3,840
Accounts Receivable
11/1 Bal.
2,910 11/10
11/27
900
11/30 Bal.
2,010
11/1 Bal.
11/17
11/30 Bal.
Supplies
1,120 11/30
1,300
1,100
11/1 Bal.
11/15
11/30 Bal.
Equipment
10,000
3,600
13,600
1,220
2,500
480
1,000
1,800
1,320
Accumulated Depreciation—Equipment
11/1 Bal.
500
11/30
250
11/30 Bal.
750
11/20
11/30
Accounts Payable
2,500 11/1 Bal.
11/15
11/17
11/30 Bal.
2,300
3,600
1,300
4,700
Unearned
Service Revenue
500 11/1 Bal.
11/29
11/30 Bal.
400
750
650
Salaries and Wages Payable
11/8
620 11/1 Bal.
11/30
11/30 Bal.
620
480
480
Common Stock
11/1 Bal.
11/30 Bal.
10,000
10,000
Retained Earnings
11/1 Bal.
11/30 Bal.
3,000
3,000
PROBLEM 0-14A (Continued)
Service Revenue
11/12
11/27
11/30
11/30 Bal.
Depreciation Expense
11/30
250
11/30 Bal.
250
Supplies Expense
11/30
1,320
11/30 Bal.
1,320
3,700
900
500
5,100
Salaries and Wages Expense
11/8
600
11/25
1,000
11/30
480
11/30 Bal.
2,080
11/22
11/30 Bal.
Rent Expense
480
480
PROBLEM 0-14A (Continued)
(b)
General Journal
Date
Nov.
8
10
Account Titles
Salaries and Wages Payable .......................................
Salaries and Wages Expense ......................................
Cash ......................................................................
Debit
620
600
Cash
1,800
1,220
Accounts Receivable ..........................................
12
Cash
1,800
3,700
Service Revenue ..................................................
15
17
20
22
25
27
29
Credit
3,700
Equipment .....................................................................
Accounts Payable................................................
3,600
Supplies ........................................................................
Accounts Payable................................................
1,300
Accounts Payable.........................................................
Cash ......................................................................
2,500
Rent Expense ................................................................
Cash ......................................................................
480
Salaries and Wages Expense ......................................
Cash ......................................................................
1,000
Accounts Receivable ...................................................
Service Revenue ..................................................
900
Cash
750
Unearned Service Revenue ................................
3,600
1,300
2,500
480
1,000
900
750
PROBLEM 0-14A (Continued)
(d) & (f)
SOHO EQUIPMENT REPAIR
Trial Balances
November 30, 2017
Before
Adjustment
Cash .....................................................
Accounts Receivable ..........................
Supplies ...............................................
Equipment ...........................................
Accumulated Depreciation—
Equipment
Accounts Payable ...............................
Unearned Service Revenue ................
Salaries and Wages Payable ..............
Common Stock ....................................
Retained Earnings...............................
Service Revenue .................................
Depreciation Expense .........................
Supplies Expense ..............................
Salaries and Wages Expense ............
Rent Expense ......................................
Dr.
$ 3,840
2,010
2,420
13,600
Cr.
$
After
Adjustment
Dr.
$ 3,840
2,010
1,100
13,600
500
4,700
1,150
$
10,000
3,000
4,600
1,600
480
$23,950
$23,950
Cr.
250
1,320
2,080
480
$24,680
750
4,700
650
480
10,000
3,000
5,100
$24,680
PROBLEM 0-14A (Continued)
(e)
Nov. 30
30
30
30
(g)
Supplies Expense .......................................................
Supplies ($2,420 – $1,100) ................................
1,320
Salaries and Wages Expense ....................................
Salaries and Wages Payable ............................
480
Depreciation Expense ................................................
Accumulated Depreciation-Equipment............
250
Unearned Service Revenue .......................................
Service Revenue ................................................
500
1,320
480
250
500
SOHO EQUIPMENT REPAIR
Income Statement
For the Month Ended November 30, 2017
Revenues
Service revenue ...........................................................
Expenses
Salaries and wages expense .......................................
Supplies expense .........................................................
Rent expense ................................................................
Depreciation expense ..................................................
Total expenses ....................................................
Net income.............................................................................
( $5,100)
$2,080
1,320
480
250
4,130)
$ 970
SOHO EQUIPMENT REPAIR
Retained Earnings Statement
For the Month Ended November 30, 2017
Retained earnings, November 1 .........................................
Add: Net income ..................................................................
Retained earnings, November 30 .......................................
$3,000
970
$3,970
PROBLEM 0-14A (Continued)
SOHO EQUIPMENT REPAIR
Balance Sheet
November 30, 2017
Assets
Current assets
Cash .................................................................................
Accounts receivable .......................................................
Supplies ...........................................................................
Total current assets ...............................................
Property, plant and equipment
Equipment .......................................................................
Less: Accumulated depreciation—
equipment ..........................................................
Total assets ............................................................
$ 3,840
2,010
1,100
$ 6,950
13,600
750
12,850
$19,800
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable ...........................................................
Unearned service revenue .............................................
Salaries and wages payable ...........................................
Total current liabilities ...........................................
Stockholders’ equity
Common stock ................................................................
Retained earnings ...........................................................
Total stockholders’ equity ................................
Total liabilities and stockholders’
equity ...................................................................
$ 4,700
650
480
$ 5,830
10,000
3,970
(Ending retained earnings = Beginning retained earnings ± Changes to retained
earnings)
LO 7 BT: AP Difficulty: Hard TOT: 70 min. AACSB: Analytic AICPA FC: Reporting
13,970
$19,800
PROBLEM 0-15A
(a)
1.
2.
3.
May 31
31
31
31
4.
5.
6.
31
31
31
Insurance Expense .............................................
Prepaid Insurance ......................................
450
Supplies Expense ...............................................
Supplies ($2,600 – $1,050) .........................
1,550
Depreciation Expense
($3,600 X 1/12) .................................................
Accumulated Depreciation—
Building...................................................
Depreciation Expense
($3,000 X 1/12) .................................................
Accumulated Depreciation—
Equipment ..............................................
450
1,550
300
300
250
250
Interest Expense .................................................
Interest Payable
[($36,000 X 6%) X 1/12] ..........................
180
Unearned Rent Revenue ....................................
Rent Revenue .............................................
2,500
Salaries and Wages Expense.............................
Salaries and Wages Payable .....................
900
180
2,500
900
(b)
5/31 Bal.
Cash
2,500
5/31 Bal.
5/31 Bal.
Supplies
2,600 5/31
1,050
5/31 Bal.
5/31 Bal.
1,550
5/31 Bal.
Prepaid Insurance
1,800 5/31
1,350
Land
15,000
450
PROBLEM 0-15A (Continued)
5/31 Bal.
Building
70,000
Accumulated Depreciation—
Building
5/31
300
5/31 Bal.
300
5/31 Bal.
Equipment
16,800
Accumulated Depreciation—
Equipment
5/31
250
5/31 Bal.
250
Accounts Payable
5/31 Bal.
5/31
4,700
Salaries and Wages Payable
5/31
5/31 Bal.
Interest Payable
5/31
5/31 Bal.
3,300
800
36,000
Common Stock
5/31 Bal.
60,000
Rent Revenue
5/31 Bal.
5/31
5/31 Bal.
9,000
2,500
11,500
Salaries and Wages Expense
5/31 Bal.
3,000
5/31
900
5/31 Bal.
3,900
5/31 Bal.
Unearned Rent Revenue
2,500 5/31 Bal.
5/31 Bal.
Mortgage Payable
5/31 Bal.
Utilities Expense
800
Advertising Expense
5/31 Bal.
500
Interest Expense
180
180
900
900
5/31
5/31 Bal.
180
180
Insurance Expense
5/31
450
5/31 Bal.
450
PROBLEM 0-15A (Continued)
5/31
5/31 Bal.
Supplies Expense
1,550
1,550
Depreciation Expense
5/31
300
5/31
250
5/31 Bal.
550
(c)
MOTO HOTEL
Adjusted Trial Balance
May 31, 2017
Cash ..................................................................................
Supplies ............................................................................
Prepaid Insurance ............................................................
Land ..................................................................................
Building .............................................................................
Accumulated Depreciation—Building ............................
Equipment.........................................................................
Accumulated Depreciation—Equipment ........................
Accounts Payable ............................................................
Unearned Rent Revenue ..................................................
Salaries and Wages Payable ...........................................
Interest Payable ................................................................
Mortgage Payable ............................................................
Common Stock .................................................................
Rent Revenue ...................................................................
Salaries and Wages Expense ..........................................
Utilities Expense ..............................................................
Advertising Expense ........................................................
Interest Expense ..............................................................
Insurance Expense ..........................................................
Supplies Expense ............................................................
Depreciation Expense ......................................................
(Total debits = Total credits)
Debit
$ 2,500
1,050
1,350
15,000
70,000
Credit
$
300
16,800
250
4,700
800
900
180
36,000
60,000
11,500
3,900
800
500
180
450
1,550
550
$114,630
$114,630
PROBLEM 0-15A (Continued)
(d)
MOTO HOTEL
Income Statement
For the Month Ended May 31, 2017
Revenues
Rent revenue................................................................
Expenses
Salaries and wages expense ......................................
Supplies expense ........................................................
Utilities expense ..........................................................
Depreciation expense .................................................
Advertising expense ...................................................
Insurance expense ......................................................
Interest expense ..........................................................
Total expenses ...................................................
Net income ............................................................................
$11,500
$3,900
1,550
800
550
500
450
180
7,930
$ 3,570
MOTO HOTEL
Retained Earnings Statement
For the Month Ended May 31, 2017
Retained earnings, May 1 ....................................................
Add: Net income .................................................................
Retained earnings, May 31 ..................................................
$
0
3,570
$3,570
PROBLEM 0-15A (Continued)
MOTO HOTEL
Balance Sheet
May 31, 2017
Assets
Current Assets
Cash ............................................................. $ 2,500
Supplies .......................................................
Prepaid insurance .......................................
Total current assets ...........................
Property, plant, and equipment
Land ............................................................. 15,000
Building ........................................................
$70,000
1,050
1,350
$
4,900
Less: Accumulated
deprec.—Building ....................................
Equipment....................................................
Less: Accumulated
deprec.—equipment .................................
Total assets ........................................
300
16,800
69,700
250
16,550
101,250
$106,150
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts payable ........................................................
$ 4,700
Salaries and wages payable .......................................
900
Unearned rent revenue ................................................
800
Interest payable ...........................................................
180
Total current liabilities ........................................
$ 6,580
Long-term Liabilities
Mortgage payable ........................................................
36,000
Total liabilities .....................................................
42,580
Stockholders’ equity
Common stock .............................................................
60,000
Retained earnings ........................................................
3,570
Total stockholders’ equity .........................
63,570
Total liabilities and stockholders’
equity ...............................................................
$106,150
(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)
PROBLEM 0-15A (Continued)
(e)
The following accounts would be closed:
Rent Revenue, Salaries and Wages Expense, Utilities Expense,
Advertising Expense, Interest Expense, Insurance Expense,
Supplies Expense, Depreciation Expense.
LO 8 BT: AP Difficulty: Hard TOT: 60 min. AACSB: Analytic AICPA FC: Reporting
PROBLEM 0-16A
(a)
Sept. 30
30
30
30
30
30
30
(b)
Accounts Receivable ................................................
Service Revenue...............................................
600
Rent Expense.............................................................
Prepaid Rent .....................................................
900
Supplies Expense......................................................
Supplies ............................................................
1,020
Depreciation Expense ...............................................
Accum. Depreciation—Equipment..................
350
Interest Expense........................................................
Interest Payable ................................................
50
Unearned Rent Revenue ...........................................
Rent Revenue ...................................................
200
Salaries and Wages Expense ...................................
Salaries and Wages Payable ...........................
600
600
900
1,020
350
50
200
600
SALT CREEK GOLF INC.
Income Statement
For the Quarter Ended September 30, 2017
Revenues
Service revenue ...........................................................
Rent revenue................................................................
Total revenues ....................................................
Expenses
Salaries and wages expense ......................................
Rent expense ...............................................................
Supplies expense ........................................................
Utilities expense ..........................................................
Depreciation expense .................................................
Interest expense ..........................................................
Total expenses ...................................................
Net income ............................................................................
$14,700
900
$15,600
9,400
1,800
1,020
470
350
50
13,090
$ 2,510
PROBLEM 0-16A (Continued)
SALT CREEK GOLF INC.
Retained Earnings Statement
For the Quarter Ended September 30, 2017
Retained earnings, July 1, 2017 ..................................................................
Add: Net income.........................................................................................
Less: Dividends ...........................................................................................
Retained earnings, September 30, 2017 .....................................................
$
0
2,510
2,510
600
$1,910
SALT CREEK GOLF INC.
Balance Sheet
September 30, 2017
Assets
Current Assets
Cash ............................................................................
Accounts receivable ..................................................
Supplies ......................................................................
Prepaid rent ................................................................
Total current assets ..........................................
Property, Plant and Equipment
Equipment ...................................................................
Less: Accumulated depreciation—
equipment ......................................................
Total assets ........................................................
$ 6,700
1,000
180
900
$ 8,780
15,000
350
14,650
$23,430
Liabilities and Stockholders’ Equity
Current Liabilities
Notes payable .............................................................
Accounts payable .......................................................
Unearned rent revenue ..............................................
Salaries and wages payable ......................................
Interest payable ..........................................................
Total current liabilities ......................................
Stockholders’ equity
Common stock ...........................................................
Retained earnings ......................................................
Total stockholders’ equity ............................
Total liabilities and stockholders’
equity ..............................................................
$ 5,000
1,070
800
600
50
$ 7,520
14,000
1,910
15,910
$23,430
(Ending retained earnings = Beginning retained earnings ± Changes to retained earnings)
PROBLEM 0-16A (Continued)
(c) The following accounts would be closed: Service Revenue, Rent
Revenue, Salaries and Wages Expense, Rent Expense, Utilities Expense,
Depreciation Expense, Supplies Expense, Interest Expense, Dividends.
(d)
Interest of 12% per year equals a monthly rate of 1%; monthly interest
is $50 ($5,000 X 1%). Since total interest payable is $50, the note has
been outstanding one month.
LO 8 BT: AP Diffciulty: Hard TOT: 50 min. AACSB: Analytic AICPA FC: Reporting
Chapter 1
Financial Accounting and Accounting Standards
Assignment Classification Table (By Topic)
Topics
Questions
1.
Environment of
accounting, principles,
objectives, standards,
accounting theory.
2.
7.
8.
Authoritative
5,6, 7,8
pronouncements and
rule-making bodies.
Conceptual framework9, 10
general, objective of
financial reporting.
Qualitative characteristics of 11,12, 13, 14,
accounting.
15, 16,17
Elements of
18, 19
financial
statements.
Basic assumptions and
20, 21, 22, 23,
principles.
24, 25, 26, 27,
28, 29, 30,31
Cost constraint.
32,33,34
Role of pressure groups.
35, 36
9.
Ethical issues.
3.
4.
5.
6.
1,2, 3,4
37, 38,39,40
Brief
Exercises
Exercises
Critical
Thinking
1
1
1
2
2
2
3
3,4
3,4, 5, 6, 7
4,5,6
5, 10
8, 9
7
10, 11, 12,
13, 14
4, 8, 9, 10,
11, 12
6, 7, 8, 9, 11
12, 14, 15, 16,
17
13
Assignment Classification Table (By Learning Objective)
Learning Objectives
Questions
Brief
Exercises
Exercises
Critical
Thinking
1.
Describe the financial reporting
environment, major standardsetting bodies, and the meaning
of generally accepted accounting
principles (GAAP).
1, 2, 3, 4,
5, 6, 7, 8
1, 2
1, 2
2.
Describe the components and
usefulness of the conceptual
framework.
9, 10, 11, 12,
13, 14, 15, 16,
17, 18, 19
3, 5, 6,
7, 8,9
3, 4, 5, 6, 7
2,3,4, 5,
10
3.
Discuss the basic assumptions
and principles of accounting.
4, 10, 11,
12, 13, 14
8, 9, 10, 11,
12
6, 7, 8, 9,
11, 12
4.
Identify the major challenges in
the financial reporting
environment.
20, 21, 22, 23,
24, 25, 26, 27,
28, 29, 31,
32, 33, 34
30, 35, 36, 37,
38, 39,40
2
11, 13, 14,
15, 16
1
Assignment Characteristics Table (Time on Task)
Item
Description
Level of
Difficulty
Time
(minutes)
E1.1
E1.2
E1.3
E1.4
Simple
Simple
Simple
Simple
15-20
15-20
15-20
15-20
E1.5
E1.6
E1.7
E1.8
E1.9
E1.10
E1.11
E1.12
Need for GAAP.
Financial reporting and accounting standards.
Usefulness, objective of financial reporting.
Usefulness, objective of financial reporting,
qualitative characteristics.
Qualitative characteristics.
Qualitative characteristics.
Elements of financial statements.
Assumptions, principles, and constraint.
Assumptions, principles, and constraint.
Full disclosure principle.
Accounting principles and assumptionscomprehensive.
Accounting principles-comprehensive.
Moderate
Simple
Simple
Simple
Moderate
Complex
Moderate
Moderate
20-30
15-20
15-20
15-20
20-25
20-25
20-25
20-25
CT1.1
CT1.2
CT1.3
CT1.4
CT1.5
CT1.6
CT1.7
CT1.8
CT1.9
CT1.10
CT1.11
CT1.12
CT1.13
CT1.14
CT1.15
CT1.16
Securities and Exchange Commission.
Conceptual framework-general.
Conceptual framework-general.
Objective of financial reporting.
Qualitative characteristics.
Revenue recognition principle.
Expense recognition principle.
Expense recognition principle.
Expense recognition principle.
Qualitative characteristics.
Expense recognition principle.
Cost Constraint.
Rule-making Issues.
Models for setting GAAP.
Economic consequences.
GAAP and economic consequences.
Moderate
Simple
Simple
Moderate
Moderate
Complex
Complex
Moderate
Moderate
Moderate
Moderate
Moderate
Complex
Simple
Moderate
Moderate
30-40
20-25
25-35
25-35
30-35
25-30
20-25
20-25
20-30
20-30
20-25
30-35
20-25
15-20
25-35
25-35
Answers to Questions
1.
If a company’s financial performance is measured accurately, fairly, and on a timely basis, the right
managers and companies can attract investment capital. Unreliable and irrelevant information leads
to poor capital allocation, which adversely affects the efficiency of the securities market.
LO: 1, Bloom: K, Difficulty: Simple, Time: 1-3, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
2.
The objective of general purpose financial reporting is to provide financial information about the
reporting entity that is useful to present and potential equity investors, lenders, and other creditors in
making decisions about providing resources to the entity through equity investments and loans or
other forms of credit. Information that is decision-useful to capital providers (investors) may also be
useful to other users of financial reporting who are not investors.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Decision Making
3.
Investors are interested in financial reporting because it provides information that is useful for
making decisions (referred to as the decision-usefulness approach). When making these decisions,
investors are interested in assessing the company’s (1) ability to generate net cash inflows and (2)
management’s ability to protect and enhance the capital providers’ investments. Financial reporting
should therefore help investors assess the amounts, timing, and uncertainty of prospective cash
inflows from dividends or interest, and the proceeds from the sale, redemption, or maturity of
securities or loans. For investors to make these assessments, the economic resources of an
enterprise, the claims to those resources, and the changes in them must be understood.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Decision Making
4.
A common set of financial accounting and reporting standards applied by all businesses and entities
should produce financial statements which are reasonably comparable. Without a common set of
standards, each enterprise could, and would, develop a theory structure and set of practices,
resulting in noncomparability among the financial statements of enterprises.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
5.
The SEC has the power to prescribe, in whatever detail it desires, the accounting practices and
principles to be employed by companies that fall within its jurisdiction. Because the SEC receives
audited financial statements from nearly all companies that issue securities to the public or are listed
on stock exchanges, it is greatly interested in the content, accuracy, and credibility of the statements.
For many years, the SEC relied on the AICPA to regulate the profession and develop and enforce
accounting principles. Lately, the SEC has assumed a more active role in the development of
accounting standards, especially in the area of disclosure requirements. In December 1973, in ASR
No. 150, the SEC said the FASB’s statements would be presumed to carry substantial authoritative
support and anything contrary to them to lack such support. It thereby supports the development of
accounting principles in the private sector.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
6.
The explanation should note that generally accepted accounting principles or standards have
“substantial authoritative support.” They consist of accounting practices, procedures, concepts, and
methods that are recognized by a large majority of practicing accountants as well as other members
of the business and financial community. Statements issued by the Financial Accounting Standards
Board constitute “substantial authoritative support.”
LO: 1, Bloom: K, Difficulty: Simple, 5-10, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 1 (Continued)
7.
The FASB Accounting Standards Codification (Codification) is a compilation of all GAAP in one place.
Its purpose is to integrate and synthesize existing GAAP, not to create new GAAP. It creates one level
of GAAP which is considered authoritative. The FASB Codification Research Systems (CRS) is an
online real-time database that provides easy access to the Codification. The Codification and the
related CRS provide a topically organized structure that is subdivided into topics, subtopics, sections,
and paragraphs.
LO: 1, Bloom: K, Difficulty: Moderate, Time: 5-7, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
8.
It is hoped that the Codification will help users to better understand what GAAP is. If this occurs,
companies will be more likely to comply with GAAP and the time to research accounting issues will be
substantially reduced. In addition, through the electronic web-based format, GAAP can be easily
updated which will help users stay current.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
9.
A conceptual framework is a coherent system of interrelated objectives and fundamentals that can
lead to consistent standards and that prescribes the nature, function, and limits of financial accounting
and financial statements. A conceptual framework is necessary for financial accounting for the
following reasons:
(1) It enables the FASB to issue more useful and consistent standards in the future.
(2) New issues will be more quickly solvable by reference to an existing framework of basic theory.
(3) It increases financial statement users’ understanding of and confidence in financial reporting.
(4) It enhances comparability among companies’ financial statements.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
10. The objective of financial reporting is to provide financial information about the reporting entity that
is useful to present and potential equity investors, lenders, and other creditors in making decisions
about providing resources to the entity.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
11. “Qualitative characteristics of accounting information” are those characteristics that contribute to the
quality or value of the information. The overriding qualitative characteristic of accounting information
is usefulness for decision-making.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
12. Relevance and faithful representation are the two fundamental qualities of useful accounting
information. For information to be relevant, it should be capable of making a difference in a decision
by helping users to form predictions about the outcomes of past, present, and future events or to
confirm or correct expectations. Faithful representation rests on whether the numbers and
descriptions match what really existed or happened.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 1 (Continued)
13. The concept of materiality refers to the relative significance of an amount, activity, or item to
informative disclosure, proper presentation of financial position, and the results of operations.
Materiality has qualitative and quantitative aspects; both the nature of the item and its relative size
enter into its evaluation.
An accounting misstatement is said to be material if knowledge of the misstatement could affect the
decisions of the average informed reader of the financial statements. Financial statements are
misleading if they omit a material fact or include so many immaterial matters as to be confusing. In
the examination, the auditor concentrates efforts in proportion to degrees of materiality and relative
risk and disregards immaterial items.
The relevant criteria for assessing materiality will depend upon the circumstances and the nature of
the item and will vary greatly among companies. For example, an error in current assets or current
liabilities will be more important for a company with a flow of funds problem than for one with
adequate working capital.
The effect upon net income (or earnings per share) is the most commonly used measure of
materiality. This reflects the prime importance attached to net income by investors and other users
of the statements. The effects upon assets and equities are also important, as are misstatements of
individual accounts and subtotals included in the financial statements. The FASB defines materiality
to be consistent with the legal concept of materiality, as established in the securities laws.
Specifically, information is material “if there is a substantial likelihood that the omitted or misstated
item would have been viewed by a reasonable resource provider as having significantly altered the
total mix of information.”
There are no rigid standards or guidelines for assessing materiality. The lower bound of materiality
has been variously estimated at 5% of net income, but the determination will vary based upon the
individual case and might not fall within these limits. Certain items, such as a questionable loan to a
company officer, may be considered material even when minor amounts are involved. In contrast, a
large misclassification among expense accounts may not be deemed material if there is no
misstatement of net income.
LO: 2, Bloom: C, Difficulty: Simple, Time: 5-7, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Decision Making
14. The enhancing characteristics are comparability, verifiability, timeliness, and understandability.
Enhancing qualities are qualitative characteristics that are complementary to the fundamental
qualitative characteristics. These characteristics distinguish more useful information from less useful
information.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
15. In providing information to users of financial statements, the FASB relies on general-purpose
financial statements. The intent of such statements is to provide the most useful information possible
at minimal cost to various user groups. Underlying these objectives is the notion that a user needs
a reasonable knowledge of business and financial accounting matters to understand
the information contained in financial statements. This point is important. It means that in the
preparation of financial statements, a level of reasonable competence for the user can be assumed;
this has an impact on the way and the extent to which information is reported.
LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: AICPA AC: Reporting, AICPA PC: Communication
16. Comparability facilitates comparisons between information about two different enterprises at a
particular point in time. Consistency, a type of comparability, facilitates comparisons between
information about the same enterprise at two different points in time.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 1 (Continued)
17. The accounting literature contains many terms that have specific meanings. Some of these terms have
been in use for a long time, and their meanings have changed over time. Since the elements of
financial statements are the building blocks with which the statements are constructed, it is necessary
to develop a basic definitional framework for them.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
18. Distributions to owners differ from expenses and losses in that they represent transfers to owners,
and they do not arise from activities intended to produce income. Expenses differ from losses in that
they arise from the entity’s ongoing major or central operations. Losses arise from peripheral or
incidental transactions.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
19. Investments by owners differ from revenues and gains in that they represent transfers by owners to
the entity, and they do not arise from activities intended to produce income. Revenues differ from
gains in that they arise from the entity’s ongoing major or central operations. Gains arise from
peripheral or incidental transactions.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
20. The four basic assumptions that underlie the financial accounting structure are:
(1) The economic entity assumption.
(2) The going concern assumption.
(3) The monetary unit assumption.
(4) The periodicity assumption.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
21. (a) In accounting, it is generally agreed that any measures of the success of an enterprise for
periods less than its total life are at best provisional and subject to correction. Measurement of
progress and status for arbitrary time periods is a practical necessity to serve those who must
make decisions. It is not the result of postulating specific time periods as measurable segments
of total life.
(b) The practice of periodic measurement has led to many of the most difficult accounting problems,
such as inventory pricing, depreciation of long-term assets, and the necessity for revenue
recognition tests. The accrual system calls for associating related revenues and expenses. This
becomes difficult for an arbitrary time period with incomplete transactions in process at both the
beginning and the end of the period. Many accounting practices such as adjusting entries or
the reporting of corrections of prior periods result directly from efforts to make each period’s
calculations as accurate as possible and yet recognizing that they are only provisional.
LO: 3, Bloom: C, Difficulty: Simple, Time: 5-7, AACSB: Communication, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
22. The monetary unit assumption assumes that the unit of measure (the dollar) remains reasonably
stable so that dollars of different years can be added without any adjustment. When the value of the
dollar fluctuates greatly over time, the monetary unit assumption loses its validity.
The FASB in Concept No. 5 indicated that it expects the dollar unadjusted for inflation or deflation
to be used to measure items recognized in financial statements. Only if circumstances change
dramatically will the FASB consider a more stable measurement unit.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Questions Chapter 1 (Continued)
23. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date.” Fair value is,
therefore, a market-based measure.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: AICPA PC: None
24. The fair value hierarchy provides insight into the priority of valuation techniques that are used to
determine fair value. The fair value hierarchy is divided into three broad levels.
Fair Value Hierarchy
Level 1: Observable inputs that reflect quoted prices for
identical assets or liabilities in active markets.
Least Subjective
Level 2: Inputs other than quoted prices included in Level 1 that
are observable for the asset or liability either directly or
through corroboration with observable data.
Level 3: Unobservable inputs (for example, a company’s own
data or assumptions).
Most Subjective
As indicated, Level 1 is the most reliable because it is based on quoted prices, such as a closing
stock price in the Wall Street Journal. Level 2 is the next most reliable and would rely on evaluating
similar assets or liabilities in active markets. At the least-reliable level, Level 3, much judgment is
needed based on the best information available to arrive at a relevant and representationally faithful
fair value measurement.
LO: 3, Bloom: K, Difficulty: Simple, Time: 5-7, AACSB: Communication, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
25. The revenue recognition principle requires that companies recognize revenue in the accounting
period in which the performance obligation is satisfied. In the case of services, revenue is recognized
when the services are performed. In the case of selling a product, the performance obligation is met
when the product is delivered. Companies follow a five-step process to analyze revenue
arrangements to determine when revenue should be recognized: (1) Identify the contract(s) with the
customer; (2) Identify the separate performance obligations in the contract; (3) Determine the
transaction price; (4) Allocate the transaction price to separate performance obligations, and; (5)
Recognize revenue when each performance obligation is satisfied.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
26. A performance obligation is a promise to deliver a product or provide a service to a customer. The
revenue recognition principle requires that companies recognize revenue in the accounting period
in which the performance obligation is satisfied. In the case of services, revenue is recognized when
the services are performed. In the case of selling a product, the performance obligation is met when
the product is delivered.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
Questions Chapter 1 (Continued)
27. The five steps in the revenue recognition process are:
Step 1
Identify the contract(s) with the customer. A contract is an agreement between two
parties that creates enforceable rights or obligations.
Step 2
Identify the separate performance obligations in the contract. A performance
obligation is either a promise to provide a service or deliver a product, or both.
Step 3. Determine the transaction price. The transaction price is the amount of consideration
that a company expects to receive from a customer in exchange for transferring a good or
service.
Step 4. Allocate the transaction price to separate performance obligations. This is usually
done by estimating the value of consideration attributable to each product or service.
Step 5. Recognize revenue when each performance obligation is satisfied. This occurs when
the service is provided or the product is delivered.
Note that many revenue transactions pose few problems because the transaction is initiated and
completed at the same time.
LO: 3, Bloom: C, Difficulty: Simple, Time: 5-7, AACSB: Communication, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
28. Revenues are recognized when a performance obligation is satisfied–in the case of services, revenue
is recognized when the services are performed. Therefore, revenue for Selane Eatery should be
recognized at the time the luncheon is served.
LO: 3, Bloom: AN, Difficulty: Simple, Time: 3-5, Analytic, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
29. The cause and effect relationship can seldom be conclusively demonstrated, but many costs appear
to be related to particular revenues, and recognizing them as expenses accompany recognition of
the revenue. Examples of expenses that are recognized by associating cause and effect are sales
commissions and the cost of products sold or services provided.
Systematic and rational allocation means that in the absence of a direct means of associating cause
and effect, and where the asset provides benefits for several periods, its cost should be allocated to
the periods in a systematic and rational manner. Examples of expenses that are recognized in a
systematic and rational manner are depreciation of plant assets, amortization of intangible assets,
and allocation of rent and insurance.
Some costs are immediately expensed because the costs have no discernible future benefits or the
allocation among several accounting periods is not considered to serve any useful purpose.
Examples include officers’ salaries, most selling costs, amounts paid to settle lawsuits, and costs of
resources used in unsuccessful efforts.
LO: 3, Bloom: AN, Difficulty: Simple, Time: 5-7, Analytic, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
30. (a) To be recognized in the main body of financial statements, an item must meet the definition of
an element. In addition, the item must have been measured, recorded in the books, and passed
through the double-entry system of accounting.
(b) Information provided in the notes to the financial statements amplifies or explains the items
presented in the main body of the statements and is essential to an understanding of the performance and position of the enterprise. Information in the notes does not have to be quantifiable, nor does it need to qualify as an element.
(c) Supplementary information includes information that presents a different perspective from that
adopted in the financial statements. It also includes management’s explanation of the financial
information and a discussion of the significance of that information.
LO: 4, Bloom: C, Difficulty: Simple, Time: 5-7, AACSB: Communication, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
Questions Chapter 1 (Continued)
31. The general guide followed with regard to the full disclosure principle is to disclose in the financial
statements any facts of sufficient importance to influence the judgment of an informed reader.
The fact that the amount of outstanding common stock doubled in January of the subsequent
reporting period probably should be disclosed because such a situation is of importance to present
stockholders. Even though the event occurred after December 31, 2025 (referred to as a subsequent
event), it should be disclosed on the balance sheet as of December 31, 2025, in order to make
adequate disclosure. (The major point that should be emphasized throughout the entire discussion
on full disclosure is that there is normally no “black” or “white” but varying shades of grey and it takes
experience and good judgment to arrive at an appropriate answer).
LO: 3, Bloom: AN, Difficulty: Simple, Time: 3-5, Analytic, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
32. Accounting information is subject to the cost constraint. Information should not be provided unless
the benefits exceed the costs of preparing it.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, Analytic, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
33. The costs of providing accounting information include costs of collecting and processing,
disseminating, auditing, potential litigation, disclosure to competitors, and analysis and
interpretation. Benefits to preparers may include greater management control and access to capital
at a lower cost. Users may receive better information for allocation of resources, tax assessment,
and rate regulation. Occasionally new accounting standards require the presentation of information
that is not readily assembled by the accounting systems of most companies. A determination should
be made as to whether the incremental or additional costs of providing the proposed information
exceed the incremental benefits to be obtained. This determination requires careful judgment since
the benefits of the proposed information may not be readily apparent.
LO: 3, Bloom: AN, Difficulty: Simple, Time: 3-5, Analytic, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
34. In general, conservatism should not be the basis for determining the accounting for transactions
because it conflicts with the conceptual framework quality of neutrality.
(a) Acceptable if reasonably accurate estimation is possible. To the extent that warranty costs can
be estimated accurately, they should be recorded when an obligation exists, usually in the period
of the sale.
(b) Not acceptable. Most accounts are collectible, or the company will be out of business very soon.
Hence, sales can be recorded when made. Also, other companies record sales when made rather
than when collected, so if accounts for Landowska Co. are to be compared with other companies,
they must be kept on a comparable basis. However, estimates for uncollectible accounts should
be recorded if there is a reasonably accurate basis for estimating bad debts.
(c) Not acceptable. A provision for the possible loss can be made through an appropriation of
retained earnings, but until judgment has been rendered on the suit or it is otherwise settled, entry
of the loss usually represents anticipation. Recording it earlier is probably an unwise legal strategy
as well. For the loss to be recognized at this point, the loss would have to be probable and
reasonably estimable. (See FASB ASC 450-10-05 for additional discussion if desired.) Note
disclosure is required if the loss is not recorded.
LO: 3, Bloom: AN, Difficulty: Simple, Time: 3-5, Analytic, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC: None
35. The sources of pressure are innumerable, but the most intense and continuous pressure to change
or influence accounting principles or standards come from individual companies, industry
associations, governmental agencies, practicing accountants, academicians, professional accounting organizations, and public opinion.
LO: 4, Bloom: K, Difficulty: Simple, 5-10, AACSB: Communication, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 1 (Continued)
36. Economic consequences mean the impact of accounting reports on the wealth positions of issuers
and users of financial information and the decision-making behavior resulting from that impact. In
other words, accounting information impacts various users in many different ways, which leads to
wealth transfers among these various groups.
If politics plays an important role in the development of accounting rules, the rules will be subject to
manipulation to further whatever policy prevails at the moment. No matter how well-intentioned the
rule maker may be, if the information is designed to indicate that investing in a particular enterprise
involves less risk than it actually does, or is designed to encourage investment in a particular
segment of the economy, financial reporting will suffer an irreplaceable loss of credibility.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: Communication
37
Concern exists about fraudulent financial reporting because it can undermine the entire financial
reporting process. Failure to provide accurate information to users can lead to inappropriate
allocations of resources in our economy. In addition, failure to detect massive fraud can lead to
additional governmental oversight of the accounting profession.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: Communication
38. The expectations gap is the difference between what people think accountants should be doing and
what accountants think they can do. It is a difficult gap to close. The accounting profession recognizes
it must play an important role in narrowing this gap. To meet the needs of society, the profession is
continuing its efforts in developing accounting standards, such as numerous pronouncements issued
by the FASB, to serve as guidelines for recording and processing business transactions in the changing
economic environment.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
39. Some major challenges facing the accounting profession relate to the following items:
Nonfinancial measurement—how to report significant key performance measurements such as
customer satisfaction indexes, backlog information and reject rates on goods purchased.
Forward-looking information—how to report more future-oriented information.
Soft assets—how to report on intangible assets, such as market know-how, market dominance,
and well-trained employees.
Timeliness—how to report more real-time information.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
40. Accountants must perceive the ethical dimensions of some situations because GAAP does not
define or cover all specific features that are to be reported in financial statements. In these instances,
accountants must choose among alternatives. These accounting choices influence whether particular stakeholders may be harmed or benefited. Ethical decision-making involves awareness of
potential harm or benefit and taking responsibility for the choices.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Ethics, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Ethical Conduct
Solutions to Brief Exercises
Brief Exercise 1.1
1.
2.
3.
4.
True
False. Any company claiming compliance with GAAP must comply with all standards and
interpretations, including disclosure requirements.
True
False. In establishing financial accounting standards, the FASB relies on two basic premises:
(1) the FASB should be responsive to the needs and viewpoints of the entire economic community,
not just the public accounting profession, and (2) it should operate in full view of the public through
a “due process” system that gives interested people ample opportunities to make their view known.
LO: 1, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: None, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 1.2
(a) AICPA. American Institute of Certified Public Accountants. The national organization of practicing
certified public accountants.
(b) FAF. Financial Accounting Foundation. An organization whose purpose is to select members of
the FASB and its Advisory Councils, fund their activities, and exercise general oversight.
(c) FASAC. Financial Accounting Standards Advisory Council. An organization whose purpose is to
consult with the FASB on issues, project priorities, and select task forces.
(d) GAAP. Generally Accepted Accounting Principles. A common set of standards, principles, and
procedures which have substantial authoritative support and have been accepted as appropriate
because of universal application.
(e) CPA. Certified Public Accountant. An accountant who has fulfilled certain education and experience
requirements and passed a rigorous examination. Most CPAs offer auditing, tax, and management
consulting services to the general public.
(f)
FASB. Financial Accounting Standards Board. The primary body that currently establishes and
improves financial accounting and reporting standards for the guidance of issuers, auditors, users,
and others.
(g) SEC. Securities and Exchange Commission. An independent regulatory agency of the United
States government which administers the Securities Acts of 1933 and 1934 and other acts.
(h) IASB. International Accounting Standards Board. An international group, formed in 2001 (replacing
a predecessor body that was formed in 1973), actively developing and issuing accounting standards
that will have international appeal and hopefully support.
LO: 1, Bloom: K, Difficulty: Moderate, Time: 5-10, AACSB: None, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 1.3
(a)
(b)
(c)
(d)
(e)
5. Comparability
8. Timeliness
3. Predictive value
1. Relevance
7. Neutrality
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Decision Making
Brief Exercise 1.4
(a)
(b)
(c)
(d)
(e)
5. Faithful representation
8. Confirmatory value
3. Free from error
2. Completeness
4. Understandability
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: Decision Making
Brief Exercise 1.5
(a)
If the company changed its method for inventory valuation, the
consistency, and therefore the comparability, of the financial statements
have been affected by a change in the method of applying the
accounting principles employed. The change would require comment in
the auditor’s report in an explanatory paragraph.
(b)
If the company disposed of one of its two subsidiaries that had been
included in its consolidated statements for prior years, no comment as
to consistency needs to be made in the CPA’s audit report. The comparability of the financial statements has been affected by a business transaction, but there has been no change in any accounting principle
employed or in the method of its application. (The transaction would
probably require informative disclosure in the financial statements).
BE 1.5 (Continued)
(c)
If the company reduced the estimated remaining useful life of plant
property because of obsolescence, the comparability of the financial
statements has been affected. The change is not a matter of consistency;
it is a change in accounting estimate required by altered conditions and
involves no change in accounting principles employed or in their
method of application. The change might be disclosed by a note in the
financial statements if the effect was material. If commented upon in
the audit report, it would be a matter of disclosure rather than
consistency.
LO: 2, Bloom: AN, Difficulty: Hard, Time: 10-15, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
Brief Exercise 1.6
(a)
(b)
(c)
(d)
Verifiability
Comparability
Comparability (consistency)
Timeliness
LO: 2, Bloom: K, Difficulty: Simple, Time: 5-7, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 1.7
Companies and their auditors, for the most part, have adopted the general
rule of thumb that anything under 5% of net income is considered not material.
Recently, the SEC has indicated that it is okay to use this percentage for the
initial assessment of materiality, but other factors must be considered. For
example, companies can no longer fail to record items to meet consensus
analyst’s earnings numbers, preserve a positive earnings trend, convert a
loss to a profit or vice versa, increase management compensation, or hide an
illegal transaction like a bribe. In other words, both quantitative and
qualitative factors must be considered in determining when an item is
material.
(a)
Because the change was used to create a positive trend in earnings,
the change is considered material.
(b)
Each item must be considered separately and not netted. Therefore,
each transaction is considered material.
BE 1.7 (Continued)
(c)
In general, companies that follow an “expense all capital items below a
certain amount” policy are not in violation of the materiality concept.
Because the same practice has been followed from year to year,
Damon’s actions are acceptable.
LO: 2, Bloom: K, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 1.8
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
Equity
Revenues
Equity
Assets
Expenses
Losses
Liabilities
Distributions to owners
Gains
Investments by owners
LO: 2, Bloom: K, Difficulty: Simple, Time: 7-10, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 1.9
(a)
Debit to the Land account, as it is a cost incurred in acquiring land.
(b)
Debit to an asset account, preferably Land Improvements. The driveway
will last for many years, and therefore should be capitalized and
depreciated.
(c)
Debit to an asset account, preferably Equipment, as the machine will
last for a number of years and contribute to the operations of those
years.
(d)
If the fiscal year ends December 31, this expenditure will be an expense
of the current year so will be debited to an expense account. If financial
statements are prepared on some date before December 31, part of this
cost would be an expense and part would be an asset. Depending upon
the circumstances, the original entry, as well as the adjusting entry for
statement purposes, should take the financial statement date into
account.
BE 1.9 (Continued)
(e)
Debit to the Building account, as it is a part of the cost of that plant
asset which will contribute to operations for many years.
(f)
Debit to an expense account, as the service has already been received;
the contribution to operations occurred in this period.
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 1.10
(a)
(b)
(c)
(d)
Periodicity
Monetary unit
Going concern
Economic entity
LO: 3, Bloom: K, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 1.11
(a)
Net realizable value.
(b)
Would not be disclosed.
(c)
Would not be disclosed. Depreciation would be inappropriate if the
going concern assumption no longer applies.
(d)
Net realizable value.
(e)
Net realizable value (i.e., redeemable value).
LO: 3, Bloom: K, Difficulty Moderate, Time: 10-15, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 1.12
(a)
(b)
(c)
(d)
Revenue recognition
Expense recognition
Full disclosure
Measurement (historical cost)
LO: 3, Bloom: K, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, AICPA BC: None, AICPA AC: AICPA AC: Reporting, AICPA PC: None
Brief Exercise 1.13
Investment (1)—Level 3
Investment (2)—Level 1
Investment (3)—Level 2
LO: 3, Bloom: AN, Difficulty: Moderate, Time: 5-10, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 1.14
(a)
(b)
(c)
Full disclosure
Expense recognition
Historical cost
LO: 3, Bloom: C, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Solutions to Exercises
Exercise 1.1
It is not appropriate to abandon mandatory accounting rules and allow each company to voluntarily disclose
the type of information it considers important. Without a coherent body of accounting theory and standards,
each accountant or enterprise would have to develop its own theory structure and set of practices, and
readers of financial statements would have to familiarize themselves with every company’s peculiar
accounting and reporting practices. As a result, it would be almost impossible to prepare state-ments that
could be compared.
In addition, voluntary disclosure may not be an efficient way of disseminating information. A company is
likely to disclose less information if it has the discretion to do so. Thus, the company can reduce its cost
of assembling and disseminating information. However, an investor wishing additional information has to
pay to receive additional information desired. Different investors may be interested in different types of
information. Since the company may not be equipped to provide the requested information, it would have
to spend additional resources to fulfill such needs; or the company may refuse to furnish such information
if it is too costly to do so. As a result, investors may not get the desired information or they may have to
pay a significant amount of money for it. Furthermore, redundancy in gathering and distributing
information occurs when different investors ask for the same information at different points in time. To
society as a whole, this would not be an efficient way of utilizing resources.
LO: 1, 4, Bloom: AN, Difficulty: Simple, Time: 15-20, AACSB: Reflective Thinking, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: None
Exercise 1.2
1.
2.
3.
4.
5.
6.
7.
8.
(d)
(d)
(d)
(a)
(a)
(b)
(d)
(b)
LO: 1, 2, Bloom: K, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, AICPA BC: None, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA
PC: None
Exercise 1.3
(a)
(b)
(c)
True.
False – General-purpose financial reports help users who lack the
ability to demand all the financial information they need from an entity
and, therefore, must rely on, at least partly, the information in financial
reports.
False – Standard-setting based on personal conceptual frameworks
will lead to different conclusions about identical or similar issues. As
a result, standards will not be consistent with one another, and past
decisions may not be indicative of future ones.
Exercise 1.3 (Continued)
(d)
(e)
(f)
False – Information that is decision-useful to capital providers may also
be useful to users of financial reporting who are not capital providers.
False – An implicit assumption is that all users need reasonable knowledge of business and financial accounting matters to understand the
information contained in the financial statements.
True.
LO: 2 Bloom: C, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: None
Exercise 1.4
(a)
(b)
(c)
(d)
(e)
(f)
False – The fundamental qualitative characteristics that make accounting
information useful are relevance and faithful representation.
False – Relevant information must also be material.
False – Information that is relevant is characterized as having predictive
or confirmatory value or both.
False – Comparability also refers to comparisons of a firm over time
(consistency).
False – Verifiability is an enhancing characteristic that relates to both
relevance and faithful representation.
True.
LO: 2, Bloom: C, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: Decision Making
Exercise 1.5
(a)
(b)
(c)
(d)
(e)
(f)
Confirmatory value.
Cost.
Neutrality.
Comparability (Consistency).
Neutrality.
Relevance and Faithful
representation.
(g)
(h)
(i)
(j)
Timeliness.
Relevance.
Comparability.
Verifiability.
LO: 2, Bloom: C, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 1.6
(a)
(b)
(c)
(d)
(e)
(f)
(g)
Comparability.
Confirmatory value.
Comparability (Consistency).
Neutrality.
Verifiability.
Relevance.
Comparability, Verifiability,
Timeliness, and
Understandability.
(h) Materiality.
(i) Faithful representation.
(j) Relevance and Faithful
representation.
(k) Timeliness.
LO: 2, Bloom: C, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None Bloom:
Exercise 1.7
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(l)
Gains, losses.
Liabilities.
Investments by owners, comprehensive income.
(also, possible would be revenues and gains).
Distributions to owners.
(Note to instructor: net effect is to reduce equity and assets).
Comprehensive income
(also, possible would be revenues and gains).
Assets.
Comprehensive income.
Revenues, expenses.
Equity.
Revenues.
Distributions to owners.
Comprehensive income.
LO: 2, Bloom: C, Difficulty: Moderate, Time: 15-20, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 1.8
(a)
(b)
(c)
(d)
(e)
(f)
(g)
7.
5.
8.
2.
1.
4.
3.
Expense recognition principle.
Measurement principle (historical cost.)
Full disclosure principle.
Going concern assumption.
Economic entity assumption.
Periodicity assumption.
Monetary unit assumption.
LO: 3, Bloom: C, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 1.9
(a) Measurement principle
(i) Expense recognition and
(historical cost).
revenue recognition principles.
(b) Full disclosure principle.
(j) Economic entity assumption.
(c) Expense recognition principle. (k) Periodicity assumption.
(d) Measurement (fair value)
(l) Measurement principle,
principle.
Expense recognition principle.
(e) Economic entity assumption.
(m) Measurement principle
(f) Full disclosure principle.
(historical cost).
(g) Revenue recognition principle. (n) Expense recognition principle.
(h) Full disclosure principle.
LO: 3, Bloom: C, Moderate, Time: 10-15, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 1.10
(a)
It is well established in accounting that revenues, expenses, and cost
of goods sold must be disclosed in an income statement. It might be
noted to students that such was not always the case. At one time, only
net income was reported, but over time, we have evolved to the present
reporting format.
(b)
The proper accounting for this situation is to report the equipment as
an asset and the notes payable as a liability on the balance sheet.
Offsetting is permitted in only limited situations where certain assets
are contractually committed to pay off liabilities.
Exercise 1.10 (Continued)
(c)
According to GAAP, the basis upon which inventory amounts are stated
(lower of cost or market) and the method used in determining cost (LIFO,
FIFO, average cost, etc.) should also be reported. The disclosure
requirement related to the method used in determining cost should be
emphasized, indicating that where possible alternatives exist in
financial reporting, disclosure in some format is required.
(d)
Consistency requires that disclosure of changes in accounting principles
be made in the financial statements. To do otherwise, would result in
misleading financial statements. Financial statements are more useful if
they can be compared with similar reports for prior years.
LO: 3, Bloom: C, Difficulty: Hard, Time: 20-25, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 1.11
(a)
This entry violates the economic entity assumption. This assumption
in accounting indicates that economic activity can be identified with a
particular unit of accountability. In this situation, the company erred by
charging this cost to the wrong economic entity.
(b)
The historical cost principle indicates that assets and liabilities are
accounted for on the basis of cost. If we were to select sales value, for
example, we would have an extremely difficult time in attempting to
establish a sales value for a given item without selling it. It should
further be noted that the revenue recognition principle provides the
answer to when revenue should be recognized. Revenue should be
recognized when a performance obligation is satisfied. In this case, the
obligation is not satisfied until goods are delivered to a customer.
(c)
The expense recognition principle indicates that expenses should be
allocated to the appropriate periods involved. In this case, there
appears to be a high degree of uncertainty about whether the company
will have to pay. GAAP requires that a loss should be accrued only
(1) when it is probable that the company would lose the suit and (2) the
amount of the loss can be reasonably estimated. (Note to instructor:
The student will probably be unfamiliar with the guidance (FASB ASC
450; formerly FASB Statement No. 5). The purpose of this question is to
develop some decision framework when the probability of a future
event must be assumed.)
Exercise 1.11 (Continued)
(d)
At present, accountants do not recognize price-level adjustments in the
accounts. Hence, it is misleading to deviate from the measurement
principle (historical cost) because conjecture or opinion can take
place. It should also be noted that depreciation is not so much a matter
of valuation as it is a means of cost allocation. Assets are not depreciated
on the basis of a decline in their fair value but are depreciated using
systematic charges of expired costs against revenues. (Note to
instructor: It might be called to the students’ attention that the FASB
does encourage supplemental disclosure of price-level information.)
(e)
The answer to this situation is the same as (b).
LO: 3, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 1.12
(a)
Depreciation is an allocation of cost, not an attempt to value assets. As
a consequence, even if the fair value of the building increased, costs
related to this building should be matched with revenues on the income
statement, not as a charge against retained earnings.
(b)
Accountants follow the measurement principle (historical cost)
approach and write-ups of assets are not permitted. It should also be
noted that the revenue recognition principle states that revenue should
not be recognized until a performance obligation is satisfied. In this
case, revenue (gross profit) would not be recognized until the goods
are delivered to the customer. Further, this is not a peripheral
transaction so recording a gain is not appropriate.
Exercise 1.12 (Continued)
(c)
Assets should be recorded at the fair value of what is given up or the
fair value of what is received, whichever is more clearly evident. It
should be emphasized that it is not a violation of the measurement
principle (historical cost) to use the fair value of the stock. Recording
the asset at the par value of the stock has no conceptual validity. Par
value is merely an arbitrary amount usually set at the date of
incorporation.
(d)
The gain should be recognized when the equipment is delivered to the
customer. Deferral of the gain is not permitted, because the company
has satisfied the performance obligation.
(e)
It appears from the information that the sale should be recorded in 2026
instead of 2025. Revenue should be recognized when a performance
obligation is satisfied. In this case, the performance obligation is met
when the order is delivered to the buyer. Accounts receivable and Sales
revenue should be recorded in 2026. It should be noted that if the
company is employing a perpetual inventory system in dollars and
quantities, a debit to Cost of Goods Sold and a credit to Inventory is
also necessary in 2026.
LO: 3, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Solutions to Using Your Judgement
UYJ 1.1 Financial Reporting Problem
(a) From Note 1 – Summary of Significant Accounting Policies:
Our revenue is primarily generated from the sale of the finished product to customers. Those
sales predominantly contain a single performance obligation and revenue is recognized at a
single point in time when ownership, risks, and rewards transfer, which can be on the date of
shipment or the date of receipt by the customer. A provision for payment discounts and product
return allowances is recorded as a reduction of sales in the same period the revenue is
recognized. The revenue recorded is presented net of sales and other taxes we collect on behalf
of governmental authorities. The revenue includes shipping and handling costs, which generally
are included in the list price to the customer.
Trade promotions, consisting primarily of customer pricing allowances, merchandising funds, and
consumer coupons, are offered through various programs to customers and consumers. Sales
are recorded net of trade promotion spending, which is recognized as incurred at the time of the
sale. Most of these arrangements have terms of approximately one year. Accruals for expected
payouts under these programs are included as accrued marketing and promotion in the Accrued
and other liabilities line item in the Consolidated Balance Sheets.
(b) Historical Cost
Buildings, machinery, and equipment
Property, plant, and equipment is recorded at cost reduced by accumulated depreciation.
Fair Value
Investments (U.S. government securities, corporate bond securities, other investments),
derivatives (relating to foreign currency hedges, other foreign currency instruments, interest rates,
net investment hedges) are reported at fair value. Certain financial instruments are required to be
recorded at fair value.
(c) On July 1, 2019, we adopted ASU 2016-02, "Leases (Topic 842)." The new accounting
standard requires the recognition of right-of-use assets and lease liabilities for all long-term
leases, including operating leases, on the balance sheet. In January 2017, the FASB issued
ASU 2017-04, "Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill
Impairment." We will adopt the standard effective July 1, 2020. The impact of the new
standard will be dependent on the specific facts and circumstances of future individual
impairments if any.
(d) Accounting Policy Related to Advertising
Advertising makes up a portion of Selling, general and administrative expense (SG&A). Selling,
general and administrative expense is primarily comprised of marketing expenses, selling
expenses, research and development costs, administrative and other indirect overhead costs,
depreciation and amortization expense on non-manufacturing assets, and other miscellaneous
operating items. Advertising costs, charged to expense as incurred, include worldwide television,
print, radio, internet, and in-store advertising expenses and were $7.3 billion in 2020, $6.8 billion in
2019, and $7.1 billion in 2018.
LO: 4, Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BC: None, AICPA AC: Measurement, Analysis and Interpretation, Reporting,
Research, AICPA PC: Communication
UYJ 1.2 Comparative Analysis Case
(a)
Coca-Cola
Comparative Analysis
(a) Coca-Cola
Operating Segments (Note 1)
The Company's operating structure is the basis for our internal financial reporting. Our
operating structure includes the following operating segments, which are sometimes
referred to as "operating groups" or "groups":
• Europe, Middle East and Africa
• Latin America
• North America
• Asia Pacific
• Global Ventures
• Bottling Investments
Our operating structure also includes Corporate, which consists of two components: (1) a
center focused on strategic initiatives, policy and governance; and (2) an enabling services
organization focused on both simplifying and standardizing key transactional processes
and providing support to business units through global centers of excellence.
They own or license and market numerous nonalcoholic beverage brands, which we group
into the following category clusters: sparkling soft drinks; water, enhanced water and
sports drinks; juice, dairy and plant-based beverages; tea and coffee; and energy drinks.
They also own and market four of the world's top five nonalcoholic sparkling soft drink
brands: Coca-Cola, Diet Coke, Fanta and Sprite.
PepsiCo
Our Divisions (Note 1)
We are organized into seven reportable segments (also referred to as divisions), as follows:
1) FLNA, which includes our branded food and snack businesses in the United States and
Canada;
2) QFNA, which includes our cereal, rice, pasta and other branded food businesses in the
United States and Canada;
3) PBNA, which includes our beverage businesses in the United States and Canada;
4) LatAm, which includes all of our beverage, food and snack businesses in Latin America;
5) Europe, which includes all of our beverage, food and snack businesses in Europe;
UYJ 1.2 (Continued)
6) AMESA, which includes all of our beverage, food and snack businesses in Africa, the
Middle East and South Asia; and
7) APAC, which includes all of our beverage, food and snack businesses in Asia Pacific,
Australia and New Zealand and China region.
Through our operations, authorized bottlers, contract manufacturers and other third parties, we
make, market, distribute and sell a wide variety of convenient beverages, foods and snacks,
serving customers and consumers in more than 200 countries and territories with our largest
operations in the United States, Mexico, Russia, Canada, the United Kingdom, China and South
Africa.
(b)
Dominant Position - Beverage Sales: Coke or Pepsi
Coca-Cola: Net operating revenues for 2020 were $33,014 million, comprised primarily of
beverage sales.
Pepsi: Net revenue for 2020 was $70,372 million, of which beverages are estimated at 45%
($31,667) million.
Coca-Cola has the dominant position for beverage sales.
(c)
Inventories, cost allocation method, the effect on comparability. As indicated, the companies
use essentially the same inventory valuation method. Therefore, comparability is not affected.
Coca-Cola
Inventories consist primarily of raw materials and packaging (which includes ingredients and
supplies) and finished goods (which include concentrates and syrups in our concentrate
operations and finished beverages in our finished product operations). Inventories are valued at
the lower of cost or net realizable value. We determine cost on the basis of the average cost or
first-in, first-out methods.
PepsiCo
Inventory
(c) Inventories – Note 15. Inventories are valued at the lower of cost or net realizable value.
Cost is determined using the averages; first-in first-out (FIFO); or, in limited instances, last-in,
first-out (LIFO) methods.
UYJ 1.2 (Continued)
(d)
Change in accounting policy
Coca-Cola
Recently Issued Accounting Pronouncements – Adopted
In August 2017, the Financial Accounting Standards Board ("FASB") issued ASU 2017 -12,
Targeted Improvements to Accounting for Hedging Activities ("ASU 2017-12"), which
eliminates the requirement to separately measure and report hedge ineffectiveness and
requires companies to recognize all elements of hedge accounting that impact earnings in
the same line item in the statement of income where the hedged item resides. The
amendments in this update include new alternatives for measuring the hedged item for fair
value hedges of interest rate risk and ease the requirements for effectiveness testing,
hedge documentation and applying the critical terms match method. We adopted ASU
2017-12 effective January 1, 2019 using the modified retrospective method. We recognized
a cumulative-effect adjustment to decrease the opening balance of reinvested earnings as
of January 1, 2019 by $12 million, net of tax. Refer to Note 5 for additional disclosures
required by this ASU.
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects
from Accumulated Other Comprehensive Income ("ASU 2018-02"), which permits entities to
reclassify the disproportionate income tax effects of the Tax Cuts and Jobs Act of 2017
("Tax Reform Act") on items within AOCI to reinvested earnings. These disproportionate
income tax effect items are referred to as "stranded tax effects." The amendments in this
update only relate to the reclassification of the income tax effects of the Tax Reform Act.
Other accounting guidance that requires the effect of changes in tax laws or rates to be
included in net income is not affected by this update. We adopted ASU 2018-02 effective
January 1, 2019. We recognized a cumulative effect adjustment to increase the opening
balance of reinvested earnings as of January 1, 2019 by $558 million related to the effect
that the change in the income tax rate had on the gross deferred tax amount s of items
remaining in AOCI.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers.
ASU 2014-09, and its amendments, were primarily included in ASC 606,Revenue from
Contracts with Customers, which we adopted effective January 1, 2018 using the modified
retrospective method. We recognized a cumulative effect adjustment to decrease the
opening balance of reinvested earnings as of January 1, 2018 by $257 million, net of tax.
UYJ 1.2 (Continued)
In January 2016, the FASB issued ASU 2016-01, which addresses certain aspects of the
recognition, measurement, presentation and disclosure of financial instruments. ASU 201601 was effective for the Company beginning January 1, 2018, and we are now recognizing
any changes in the fair value of certain equity investments in net income as prescribed by
the new standard rather than in other comprehensive income ("OCI"). We recognized a
cumulative effect adjustment to increase the opening balance of reinvested earnings as of
January 1, 2018 by $409 million, net of tax.
In October 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other
Than Inventory ("ASU 2016-16"), which requires the Company to recognize the income tax
consequences of an intra-entity transfer of an asset other than inventory when the transfer
occurs. ASU 2016-16 was effective for the Company beginning January 1, 2018 and was
adopted using a modified retrospective basis. We recorded a $2.9 billion cumulative effect
adjustment to increase the opening balance of reinvested earnings as of January 1, 2018,
with the majority of the offset being recorded in the line item deferred income tax assets in
our consolidated balance sheet.
In March 2018, the FASB issued ASU 2018-05, Amendments to SEC Paragraphs Pursuant
to SEC Staff Accounting Bulletin No. 118. The amendments in this update provide guidance
on when to record and disclose provisional amounts for certain income tax effects of the
Tax Reform Act. The amendments also require any provisional amounts or subsequent
adjustments to be included in net income. Additionally, this ASU discusses required
disclosures that an entity must make with regard to the Tax Reform Act. This ASU is
effective immediately as new information is available to adjust provisional amoun ts that
were previously recorded. The Company adopted this standard and subsequently finalized
the accounting based on the guidance, interpretations and data available as of December
31, 2018.
Pepsico
Recently Issued Accounting Pronouncements - Adopted
In 2016, the Financial Accounting Standards Board (FASB) issued guidance that changes the
impairment model used to measure credit losses for most financial assets. Under the new
model we are required to estimate expected credit losses over the life of our trade
receivables, certain other receivables and certain other financial instruments. The new
model replaced the existing incurred credit loss model and generally results in earlier
recognition of allowances for credit losses. We adopted this guidance in the first quarter of
2020 and the adoption did not have a material impact on our consolidated financial
statements or disclosures. On initial recognition, we recorded an after-tax cumulative effect
decrease to retained earnings of $34 million ($44 million pre-tax) as of the beginning of
2020.
UYJ 1.2 (Continued)
Recently Issued Accounting Pronouncements - Not Yet Adopted
In 2019, the FASB issued guidance to simplify the accounting for income taxes. The
guidance primarily addresses how to (1) recognize a deferred tax liability after we transition
to or from the equity method of accounting, (2) evaluate if a step-up in the tax basis of
goodwill is related to a business combination or is a separate transaction, (3) recognize all
of the effects of a change in tax law in the period of enactment, including adjusting the
estimated annual tax rate, and (4) Include the amount of tax based on income in the
income tax provision and any incremental amount as a tax not based on income for hybrid
tax regimes. The guidance is effective in the first quarter of 2021 with early adoption
permitted. We will adopt the guidance when it becomes effective in the first quarter of 2021.
The guidance is not expected to have a material impact on our consolidated financial
statements or related disclosures.
LO: 4, Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Measurement Analysis and Interpretation,
Reporting, Research, AICPA PC: Communication
UYJ 1.3 Accounting, Analysis, and Principles
Accounting
Caddie Shack Driving Range
Statement of Financial Position
May 31, 2025
Assets
Cash
Building
Equipment
Total Assets
***$15,100
6,000
800
$21,900
Liabilities
Advertising payable
Utilities payable
$
Owners’ Equity
Owners’ capital
Total Liabilities
Equity
*21,650
150
100
&
$21,900
Accrual income = $4,700 – $1,000 – $750 – $400 – $100 = $2,450****
Owners’ capital balance = $20,000** + $2,450 – $800 = $21,650*
Murray might conclude that his business earned a profit of $1,650 ($21,650* $20,000**) because of the difference between his ending Owner’s Capital and
beginning Owner's Capital. The conclusion that his business lost $4,900 ($20,000*
- $15,100***) might come from the change in the business’s cash balance, which
started at $20,000** and ended the month at $15,100***.
Analysis
The income measure of $2,450**** is most relevant for assessing the future
profitability and hence the payoffs to the owners. For example, charging the cost
of the building and equipment to expense in the first month of operations
understates income in the first month. These costs should be allocated to future
periods of benefit through depreciation expense. Similarly, although not paid, the
utilities were used to generate revenues, so they should be recognized when
incurred, not when paid.
UYJ 1.3 (Continued)
Principles
GAAP income is the accrual income computed above as $2,450 (excluding
depreciation expense.) The key concept illustrated in the difference between the
loss of $4,900 and profit of $1,650 is the expense recognition principle, which calls
for recognition of expenses when incurred, not when paid. Excluding the cash
withdrawal from the measurement of income [the difference between income
measures in parts (c) and (d)] is an application of the definition of basic elements.
Cash withdrawals are distributions to owners, not an element of income (expenses
or losses).
LO: 2, 3, 4, Bloom: AN, Difficulty, Moderate, Time: 20-25, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Measurement Analysis and
Interpretation, Reporting, AICPA PC: Communication
Solutions to Critical Thinking Cases
CT 1.1
(a) The Securities and Exchange Commission (SEC) is an independent federal agency that receives its
authority from federal legislation enacted by Congress. The Securities and Exchange Act of 1934
created the SEC.
(b) As a result of the Securities and Exchange Act of 1934, the SEC has legal authority relative to
accounting practices. The U.S. Congress has given the SEC broad regulatory power to control
accounting principles and procedures to fulfill its goal of full and fair disclosure.
(c) There is no direct relationship as the SEC was created by Congress and the Financial Accounting
Standards Board (FASB) was created by the private sector. However, the SEC historically has
followed a policy of relying on the private sector to establish financial accounting and reporting standards known as generally accepted accounting principles (GAAP). The SEC does not necessarily
agree with all of the pronouncements of the FASB. In cases of unresolved differences, the SEC rules
take precedence over FASB rules for companies within SEC jurisdiction.
LO: 2, Bloom: K, Difficulty: Moderate, Time: 30-40, AACSB: Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
CT 1.2
(a) A conceptual framework is a coherent system of concepts that flow from an objective. Some
compare it to a constitution. Its objective is to provide a coherent system of interrelated objectives
and fundamentals that can lead to consistent standards and that prescribes the nature, function,
and limits of financial accounting and financial statements.
A conceptual framework is necessary so that standard-setting is useful, i.e., standard-setting should
build on and relate to an established body of concepts and objectives. A well-developed conceptual
framework should enable the FASB to issue more useful and consistent standards in the future.
Specific benefits that may arise are:
(1) A coherent set of standards and rules should result.
(2) New and emerging practical problems should be more quickly soluble by reference to an existing
framework.
(3) It should increase financial statement users’ understanding of and confidence in financial reporting.
(4) It should enhance comparability among companies’ financial statements.
(5) It should provide guidance on identifying the boundaries of judgment in preparing financial
statements.
(6) It should provide guidance to the body responsible for establishing accounting standards.
(b) The FASB has issued eight Statements of Financial Accounting Concepts (SFAC) that relate to
business enterprises. Their titles and a brief description of the focus of seven of these Statements are
as follows:
(1) SFAC No. 1, “Objectives of Financial Reporting by Business Enterprises,” presents the goals
and purposes of accounting (superseded by SFAC No. 8, Chapter 1.)
(2) SFAC No. 2, “Qualitative Characteristics of Accounting Information,” examines the
characteristics that make accounting information useful (SFAC No. 8, Chapter 3.)
(3) SFAC No. 3, “Elements of Financial Statements of Business Enterprises,” provides definitions
of items in financial statements such as assets, liabilities, revenues, and expenses.
(4) SFAC No. 5, “Recognition and Measurement in Financial Statements of Business Enterprises,”
sets forth fundamental recognition and measurement criteria and guidance on what information
should be formally incorporated into financial statements and when.
(5) SFAC No. 6, “Elements of Financial Statements,” replaces SFAC No. 3, “Elements of Financial
Statements of Business Enterprises,” and expands its scope to include not-for-profit organizations.
(6) SFAC No. 7, “Using Cash Flow Information and Present Value in Accounting Measurements,”
provides a framework for using expected future cash flows and present values as a basis for
measurement.
(7) SFAC No. 8, Chapter 1, “The Objective of General Purpose Financial Reporting,” Chapter 3,
“Qualitative Characteristics of Useful Financial Information,” replaces SFAC No. 1 and No. 2,
and Chapter 8: Notes to Financial Statements.
LO: 2, Bloom: K, Difficulty: Simple, Time: 20-25, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
CT 1.3
(a) FASB’s Conceptual Framework should provide benefits to the accounting community such as:
(1) A coherent set of standards and rules should result.
(2) New and emerging practical problems should be more quickly soluble by reference to an existing
framework.
CT 1.3 (Continued)
(b) The most important quality of accounting information is its usefulness for decision-making. Relevance
and faithful representation are the primary qualities leading to this decision-usefulness. Usefulness is
the most important quality because, without usefulness, there would be no benefits from information to
set against its costs.
(c) There are a number of key characteristics or qualities that make accounting information useful for
decision-making. The importance of three of these characteristics or qualities is discussed below.
(1) Understandability—information provided by financial reporting should be comprehensible to
those who have a reasonable understanding of business and economic activities and are willing
to study the information with reasonable diligence. Financial information is a tool and, like most
tools, cannot be of much direct help to those who are unable or unwilling to use it, or who misuse
it.
(2) Relevance—the accounting information is capable of making a difference in a decision by
helping users to form predictions about the outcomes of past, present, and future events or to
confirm or correct expectations (including materiality).
(3) Faithful representation—the faithful representation of a measure rests on whether the numbers
and descriptions matched what really existed or happened, including completeness, neutrality,
and free from error.
(Note to instructor: Other qualities might be discussed by the student, such as enhancing qualities. All
of these qualities are defined in the textbook).
LO: 2, Bloom: K, Difficulty: Simple, Time: 25-35, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Decision Making
CT 1.4
(a) The objective of financial reporting is to provide financial information about the reporting entity that
is useful to present and potential equity investors, lenders, and other creditors in making decisions
about providing resources to the entity.
(b) The purpose of this statement is to set forth fundamentals on which financial accounting and
reporting standards may be based. Without some basic set of objectives that everyone can agree
on, inconsistent standards will be developed. For example, some believe that accountability should
be the primary objective of financial reporting. Others argue that the prediction of future cash flows
is more important. It follows that individuals who believe that accountability is the primary objective
may arrive at different financial reporting standards than others who argue for the prediction of cash
flow. Only by establishing some consistent starting point can accounting ever achieve some
underlying consistency in establishing accounting principles.
It should be emphasized to the students that the FASB itself is likely to be the major user and thus
the most direct beneficiary of the guidance provided by this pronouncement. However, knowledge
of the objectives and concepts the FASB uses should enable all who are affected by or interested
in financial accounting standards to better understand the content and limitations of the information
provided by financial accounting and reporting, thereby furthering their ability to use that information
effectively and enhancing confidence in financial accounting and reporting. That knowledge, if used
with care, may also provide guidance in resolving new or emerging problems of financial accounting
and reporting in the absence of applicable authoritative pronouncements.
LO: 2, Bloom: C, Difficulty: Simple, Time: 25-35, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
CT 1.5
(a) (1) Relevance is one of the two primary decision-specific characteristics of useful accounting
information. Relevant information is capable of making a difference in a decision. Relevant
information helps users to make predictions about the outcomes of past, present, and future
events, or to confirm or correct prior expectations. Only material information is considered
to be relevant and therefore, must be disclosed. If the information is not likely to make a
difference to a decision-maker, then it need not be disclosed. Information must also be
timely to be relevant.
(2) Faithful representation is one of the two primary decision-specific characteristics of useful
accounting information. Faithful representation means that numbers and descriptions
match what really existed or happened. Representational faithfulness is correspondence or
agreement between accounting information and the economic phenomena it is intended to
represent stemming from completeness, neutrality, and free from error.
(3)
Understandability is a user-specific characteristic of information. Information is understandable
when it permits reasonably informed users to perceive its significance. Understandability is a link
between users, who vary widely in their capacity to comprehend or utilize the information, and
the decision-specific qualities of information.
(4) Comparability means that information about enterprises has been prepared and presented in a
similar manner. Comparability enhances comparisons between information about two different
enterprises at a particular point in time.
(5) Consistency means that unchanging policies and procedures have been used by an enterprise
from one period to another. Consistency enhances comparisons between information about the
same enterprise at two different points in time.
(b) (Note to instructor: Many answers are possible here. The suggestions below are intended to serve
as examples).
(1)
Forecasts of future operating results and projections of future cash flows may be highly relevant
to some decision-makers. However, they would not be as free from error as historical cost
information about past transactions.
(2) Proposed new accounting methods may be more relevant to many decision-makers than existing
methods. However, if adopted, they would impair consistency and make trend comparisons of an
enterprise’s results over time difficult or impossible.
(3) There presently exists much diversity among acceptable accounting methods and procedures. In
order to facilitate comparability between enterprises, the use of only one accepted accounting
method for a particular type of transaction could be required. However, consistency would be
impaired for those firms changing to the new required methods.
(4) Occasionally, relevant information is exceedingly complex. Judgment is required in determining
the optimum trade-off between relevance and understandability. Information about the impact of
general and specific price changes may be highly relevant but not understandable by all users.
(c) Although trade-offs result in the sacrifice of some desirable quality of information, the overall result
should be information that is more useful for decision-making.
LO: 2, Bloom: C, Difficulty: Moderate, Time: 30-35, AACSB: Knowledge, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
CT 1.6
(a)
Recognition when cash is received is not appropriate unless the magazines are delivered to the
customer at the same time. The revenue recognition principle indicates that companies recognize
revenue when each performance obligation is satisfied. This occurs when the products are
delivered – in this case, the magazines.
(b)
Recognition when the magazines are published each month is not appropriate. The revenue
recognition principle indicates that companies recognize revenue as each performance obligation
is satisfied. This occurs when the product is delivered – publication of the magazines is a necessary
step in the process, but until the magazines are delivered, the performance obligation has not been
satisfied.
(c)
Recognition over time, as the magazines are delivered to customers, is appropriate. The revenue
recognition principle indicates that companies recognize revenue as each performance obligation
is satisfied. This occurs when the product is delivered, which is the case when the magazines are
delivered to customers each month. When the customer pays for the annual subscription, the
company has a performance obligation (a liability – Unearned Revenue) that is satisfied over time
as magazines are published and delivered to customers.
(Note to instructor: CT 1.6 might also be assigned in conjunction with Chapter 17.)
LO: 3, Bloom: AP, Difficulty: Hard, Time: 25-30, AACSB: Analytic, Knowledge, AICPA BC: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: None
CT 1.7
(a) Some costs are recognized as expenses on the basis of a presumed direct association with specific
revenue. This presumed direct association has been identified both as “associating cause and
effect” and as “matching (expense recognition principle).”
Direct cause-and-effect relationships can seldom be conclusively demonstrated, but many costs
appear to be related to particular revenue, and recognition of them as expenses accompanies
recognition of the revenue. Generally, the expense recognition principle requires that the revenue
recognized and the expenses incurred to produce the revenue be given concurrent period recognition in the accounting records. Only if the effort is properly related to accomplishment will the
results, called earnings, have useful significance concerning the efficient utilization of business
resources. Thus, applying the expense recognition principle is recognition of the cause-and-effect
relationship that exists between expense and revenue.
Examples of expenses that are usually recognized by associating cause and effect are sales
commissions, freight-out on merchandise sold, and cost of goods sold or services provided.
(b) Some costs are assigned as expenses to the current accounting period because:
(1) their incurrence during the period provides no discernible future benefits;
(2) they are measures of assets recorded in previous periods from which no future benefits are
expected or can be discerned;
(3) they must be incurred each accounting year, and no build-up of expected future benefits occurs;
(4) by their nature, they relate to current revenues even though they cannot be directly associated
with any specific revenues;
(5) the amount of cost to be deferred can be measured only in an arbitrary manner or great
uncertainty exists regarding the realization of future benefits or both;
(6) and uncertainty exists regarding whether allocating them to current and future periods will serve
any useful purpose.
CT 1.7 (Continued)
Thus, many costs are called “period costs” and are treated as expenses in the period incurred
because they have neither a direct relationship with revenue earned nor can their occurrence be
directly shown to give rise to an asset. The application of this principle of expense recognition results
in charging many costs to expense in the period in which they are paid or accrued for payment.
Examples of costs treated as period expenses would include officers’ salaries, advertising, research
and development, and auditors’ fees.
(c) A cost should be capitalized, that is, recorded as an asset when it is expected that the expenditure
will produce benefits in future periods. The important concept here is that the incurrence of the cost
has resulted in the acquisition of an asset with future service potential. If a cost is incurred that
resulted in the acquisition of an asset from which benefits are not expected beyond the current
period, the cost may be expensed as a measure of the service potential that expired in producing
the current period’s revenues. Not only should the incurrence of the cost result in the acquisition of
an asset from which future benefits are expected, but also the cost should be measurable with a
reasonable degree of objectivity, and there should be reasonable grounds for associating it with the
asset acquired. Examples of costs that should be treated as measures of assets are the costs of
merchandise on hand at the end of an accounting period, costs of insurance coverage relating to
future periods, and the cost of self-constructed plant or equipment.
(d) In the absence of a direct basis for associating asset cost with revenue and if the asset provides
benefits for two or more accounting periods, its cost should be allocated to these periods (as an
expense) in a systematic and rational manner. Thus, when it is impractical, or impossible, to find a
close cause-and-effect relationship between revenue and cost, this relationship is often assumed to
exist. Therefore, the asset cost is allocated to the accounting periods by some method. The
allocation method used should appear reasonable to an unbiased observer and should be followed
consistently from period to period. Examples of systematic and rational allocation of asset cost would
include depreciation of fixed assets, amortization of intangibles, and allocation of rent and insurance.
(e) A cost should be treated as a loss when no revenue results. The matching of losses to specific
revenue should not be attempted because, by definition, they are expired service potentials not
related to revenue produced. That is, losses result from events that are not anticipated as necessary
in the process of producing revenue.
LO: 3, Bloom: AN, Difficulty: Hard, Time: 20-25, AACSB: Analytic, Knowledge, AICPA BC: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: Decision Making
CT 1.8
(a) Costs should be recognized as expiring in a given period if they are not chargeable to a prior period
and do not apply to future periods. Recognition in the current period is required when any of the
following conditions or criteria are present:
(1) A direct association of charges with revenue of the period, such as goods shipped to customers.
(2) An indirect association with the revenue of the period, such as insurance or rent.
(3) A period charge where no association with revenue in the future can be made, so the expense
is charged this period, such as officers’ salaries, or a measurable expiration of asset costs
during the period, even though not associated with the production of revenue for the current
period, such as a fire or casualty loss.
CT 1.8 (Continued)
(b) (1) Although it is generally agreed that inventory costs should include all costs attributable to placing
the goods in a salable state, receiving and handling costs are often treated as cost expirations in
the period incurred because they are irregular or are not in uniform proportion to sales.
The portion of the receiving and handling costs attributable to the unsold goods processed during
the period should be inventoried. These costs might be more readily apportioned if they are
assigned by some device such as an applied rate. Abnormally high receiving and handling costs
should be charged off as a period cost.
(2) Cash discounts on purchases are treated as “other revenues” in some financial statements in
violation of the revenue and expense recognition principles. Revenue is not recognized when
goods are purchased or cash disbursed. Furthermore, inventories valued at gross invoice price
are recorded at an amount greater than their cash outlay resulting in a misstatement of inventory
cost in the current period and inventory cost expirations in future periods.
Close adherence to the expense recognition principle requires that cash discounts be recorded
as a reduction of the cost of purchases and that inventories be priced at net invoice prices.
Where inventories are priced at gross invoice prices for expediency, however, there is a slight
distortion of the financial statements if the beginning and ending inventories are not materially
different.
LO: 3, Bloom: AP, Difficulty: Hard, Time: 20-25, AACSB: Analytic, Knowledge, AICPA BC: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: Decision Making
CT 1.9
(a) The preferable treatment of the costs of the sample display houses is expensing them over more
than one period. These sample display houses are assets because they represent rights to future
service potentials or economic benefits.
(1) The alternative of expensing the costs of sample display houses in the period in which the
expenditure is made is based primarily upon the expense recognition principle. These costs are
of a promotional nature. Promotional costs often are considered expenses of the period in which
the expenditures occur due to the uncertainty in determining the time periods benefited (do they
meet the definition of an asset?). It is likely that no decision is made concerning the life of a
sample display house at the time it is erected. Past experience may provide some guidance in
determining the probable life. A decision to tear down or alter a house probably is made when
sales begin to lag or when a new model with greater potential becomes available.
There is uncertainty not only as to the life of a sample display house but also as to whether a
sample display house will be torn down or altered. If it is altered rather than torn down, a portion
of the cost of the original house may be attributable to the new model.
(2) According to the expense recognition principle, the costs of service potentials should be
amortized as the benefits are received. Thus, costs of the sample display houses should be
matched with the revenue from the sale of the houses, which is receivable over a period of more
than one year. As the sample houses are left on display for three to seven years, Daniel
Barenboim apparently expects to benefit from the displays for at least that length of time.
(b) There is uncertainty regarding the number of homes of a particular model which will be sold as a
result of the display sample. The success of this amortization method is dependent upon accurate
estimates of the number and selling price of shell houses to be sold. The estimate of the number of
units of a particular model which will be sold as a result of a display model should include
not only units sold while the model is on display but also units sold after the display house is torn
down or altered.
CT 1.9 (Continued)
(1) Cost amortization solely on the basis of time may be preferable when the life of the models can
be estimated with a great deal more accuracy than can the number of units that will be sold. If
unit sales and selling prices are uniform over the life of the sample, a satisfactory matching of
costs and revenues may be achieved if the straight-line amortization procedure is used.
(2) If all of the shell houses are to be sold at the same price, it may be appropriate to allocate the
costs of the display houses on the basis of the number of shell houses sold. This allocation would
be similar to the units-of-production method of depreciation and would result in a good matching
of costs with revenues. On the other hand, if the shell houses are to be sold at different prices,
it may be preferable to allocate costs on the basis of the revenue contribution of the shell houses
sold.
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic,, AICPA BC: Strategic Perspective, AICPA AC: Measurement, Reporting, AICPA PC:
Decision Making
CT 1.10
Dear Uncle Carlos,
I received the information on Neville Corp. and appreciate your interest in sharing this venture with me.
However, I think that basing an investment decision on these financial statements would be unwise
because they are neither relevant nor representationally faithful.
One of the most important characteristics of accounting information is that it is relevant, i.e., it will make
a difference in my decision. To be relevant, this information must be timely. Because Neville’s financial
statements are a year old, they have lost their ability to influence my decision: a lot could have changed
in that one year.
Another element of relevance is predictive value. Once again, Neville’s accounting information proves
irrelevant. Shown without reference to other years’ profitability, it cannot help me predict future profitability
because I cannot see any trends developing. Closely related to predictive value is confirmatory value.
These financial statements do not provide feedback on any strategies which the company may have used
to increase profits.
These financial statements are also not representationally faithful. To be representationally faithful, their
assertions must be verifiable by several independent parties. Because no independent auditor has
verified these amounts, there is no way of knowing whether or not they are represented faithfully. For
instance, I would like to believe that this company earned $2,424,240 and that it had a very favorable
debt-to-equity ratio. However, unaudited financial statements do not give me any reasonable assurance
about these claims.
Finally, the fact that Ms. Neville herself prepared these statements indicates a lack of neutrality. Because
she is not a disinterested third party, I cannot be sure that she did not prepare the financial statements
in favor of her husband’s business.
I do appreciate the trouble you went through to get me this information. Under the circumstances,
however, I do not wish to invest in the Neville bonds and would caution you against doing so. Before you
make a decision in this matter, please call me.
Sincerely,
Your Nephew/Niece
LO: 2, Bloom: C, Difficulty: Moderate, Time: 20-30, AACSB: Knowledge, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication,
Decision Making
CT 1.11
(a) The stakeholders are investors, creditors, etc.; i.e., users of financial statements, current, and future.
(b) Honesty and integrity of financial reporting, job protection, profit.
(c) Applying the expense recognition principle and recording expense during the plant’s life, or not
applying it. That is, record the mothball costs in the future.
(d) The major question may be whether or not the expense of mothballing can be estimated properly
so that the integrity of financial reporting is maintained. Applying the expense recognition principle
will result in lower profits and possibly higher rates for consumers. Could this cost anyone his or her
job? Will investors and creditors have more useful information? On the other hand, failure to apply
the expense recognition principle means higher profits, lower rates, and greater potential job
security.
(e) Students’ recommendations will vary.
Note: Other stakeholders possibly affected are present and future consumers of electric power.
Delay in allocating the expense will benefit today’s consumers of electric power at the expense of
future consumers.
LO: 3, Bloom: E, Difficulty, Moderate, Time: 20-25, AACSB: Ethics, Analytic, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Professional
Behavior, Decision Making
CT 1.12
1.
Information about competitors might be useful for benchmarking the company’s results but if
management does not have expertise in providing the information, it could be highly subjective. In
addition, it is likely costly for management to gather sufficiently verifiable information of this nature.
2.
While users of financial statements might benefit from receiving internal information, such as
company plans and budgets, competitors might also be able to use this information to gain a
competitive advantage relative to the disclosing company.
3.
To produce forecasted financial statements, management would have to make numerous
assumptions and estimates, which would be costly in terms of time and data collection. Because of
the subjectivity involved, the forecasted statements would not be faithful representations, thereby
detracting from any potential benefits. In addition, while management’s forecasts of future
profitability or balance sheet amounts could be of benefit, companies could be subject to shareholder
lawsuits if the amounts in the forecasted statements are not realized.
4.
It would be excessively costly for companies to gather and report information that is not used in
managing the business.
5.
Flexible reporting allows companies to “fine-tune” their financial reporting to meet the information
needs of its varied users. In this way, they can avoid the cost of providing information that is not
demanded by its users.
6.
Similar to number 3, concerning forecasted financial statements, if managers report forward-looking
information, the company could be exposed to liability if investors unduly rely on the information in
making investment decisions. Thus, if companies get protection from unwarranted lawsuits (called
a safe harbor), then they might be willing to provide potentially beneficial forward-looking
information.
LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
CT 1.13
(a) Inclusion or omission of information that materially affects net income harms particular stakeholders.
Accountants must recognize that their decision to implement (or delay) reporting requirements will
have immediate consequences for some stakeholders.
(b) Yes. Because the FASB rule results in a fairer representation, it should be implemented as soon as
possible—regardless of its impact on net income. SEC Staff Bulletin No. 74 (December 30, 1987)
requires a statement as to what the expected impact of the standard will be.
(c) The accountant’s responsibility is to provide financial statements that present fairly the financial
condition of the company. By advocating early implementation, Weller fulfills this task.
(d) Potential lenders and investors, who read the financial statements and rely on their fair representation of the financial condition of the company have the most to gain by early implementation. A
stockholder who is considering the sale of stock may be harmed by early implementation that lowers
net income (and may lower the value of the stock).
LO: 4, Bloom: K, Difficulty: Hard, Time: 20-25, AACSB: Ethics, AICPA BC: Strategic Perspective, AICPA AC: Reporting, AICPA PC: Professional Behavior,
Decision Making
CT 1.14
(a) The public/private mixed approach is the way rules are established in the United States. In many respects,
the FASB is a quasi-governmental agency in that its pronouncements are required to be followed
because the SEC has provided support for this approach. The SEC has the ultimate power to
establish GAAP but has chosen to permit the private sector to develop these rules. By accepting the
standards established by the FASB as authoritative, it has granted much power to the FASB.
(b) Publicly reported accounting numbers influence the distribution of scarce resources. Resources are
channeled where needed at returns commensurate with perceived risk. Thus, reported accounting
numbers have economic effects in that resources are transferred among entities and individuals as a
consequence of these numbers. It is not surprising then that individuals affected by these numbers
will be extremely interested in any proposed changes in the financial reporting environment.
(c) The Accounting Standards Executive Committee (AcSEC of the AICPA), among other groups, has
presented a potential challenge to the exclusive right of the FASB to establish accounting principles.
Also, Congress has been attempting to legislate certain accounting practices, particularly to help
struggling industries.
Some possible reasons why other groups might wish to establish GAAP are:
1. As indicated in the previous answer, these rules have economic effects and therefore certain
groups would prefer to make their own rules to ensure that they receive just treatment.
2. Some believe the FASB does not act quickly to resolve accounting matters, either because it is
not that interested in the subject area or because it lacks the resources to do so.
3.
Some argue that the FASB does not have the competence to legislate GAAP in certain areas.
For example, many have argued that the FASB should not legislate GAAP for not-for-profit
enterprises because the problems are unique and not well understood by the FASB.
LO: 2, 4 Bloom: C, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC: None
CT 1.15
(a) Considering the economic consequences of GAAP, it is not surprising that special interest groups
become vocal and critical (some supporting, some opposing) when rules are being formulated. The
FASB’s derivative accounting pronouncement is no exception. Many from the banking industry, for
example, criticized the rule as too complex and leading to unnecessary earnings volatility. They also
indicated that the proposal may discourage prudent risk management activities and in some cases
could present misleading financial information.
As a result, Congress is often approached to put pressure on the FASB to change its rulings. In the
stock option controversy, industry was quite effective in going to Congress to force the FASB to change
its conclusions. In the derivative controversy, Rep. Richard Baker introduced a bill that would force the
SEC to formally approve each standard issued by the FASB. Not only would this process delay
adoption, but could lead to additional politicization of the rule-making process. Dingell commented that
Congress should stay out of the rule-making process and defended the FASB’s approach to
establishing GAAP.
(b) Attempting to set GAAP by a political process will probably lead to the following consequences:
(a) Too many alternatives.
(b) Lack of clarity that will lead to inconsistent application.
(c) Lack of disclosure that reduces transparency.
(d) Not comprehensive in scope.
Without an independent process, GAAP will be based on political compromise. A classic illustration is
what happened in the savings and loan industry. Applying generally accepted accounting
principles to the S&L industry would have forced regulators to restrict activities of many S&Ls.
Unfortunately, accounting principles were overridden by regulatory rules and the resulting lack of
transparency masked the problems. William Siedman, former FDIC Chairman noted later that it was
“the worst mistake in the history of government.”
Another indication of the problem of government intervention is shown in the accounting standards
used by some countries around the world. Completeness and transparency of information needed
by investors and creditors are not available in order to meet or achieve other objectives.
LO: 4, Bloom: C, Difficulty: Moderate, Time: 25-30, AACSB: None, AICPA BC: Governance Perspective, AICPA AC: Reporting, Research, AICPA PC: None
CT 1.16
(a) The “due process” system involves the following:
1. Identifying topics and placing them on the FASB’s agenda.
2. Research and analysis are conducted and preliminary views of pros and cons are issued.
3. A public hearing is often held.
4. The FASB evaluates research and public responses and issues exposure draft.
5. The FASB evaluates responses and changes the exposure draft if necessary. The final
statement is then issued.
(b) Economic consequences mean the impact of accounting reports on the wealth positions of issuers
and users of financial information and the decision-making behavior resulting from that impact.
(c) Economic consequences indicated in the letter are (1) concerns related to the potential impact on
the capital markets, (2) the weakening of companies’ ability to manage risk, and (3) the adverse
control implications of implementing costly and complex new rules imposed at the same time as
other major initiatives, including the Year 2000 issues and a single European currency.
CT 1.16 (Continued)
(d) The principal point of this letter is to delay the finalization of the derivatives standard. As indicated in
the letter, the authors of this letter urge the FASB to expose its new proposal for public comment,
following the established due process procedures that are essential to acceptance of its standards
and providing sufficient time for affected parties to understand and assess the new approach. (Authors
note: The FASB indicated in a follow-up letter that all due process procedures had been followed and
all affected parties had more than ample time to comment. In addition, the FASB issued a follow-up
standard, which delayed the effective date of the standard, in part to give companies more time to
develop the information systems needed for implementation of the standard).
(e) The reason why the letter was sent to Congress was to put additional pressure on the FASB to delay
or drop the issuance of a rule on derivatives. Unfortunately, in too many cases, when the business
community does not like the answer proposed by the FASB, it resorts to lobbying members of
Congress. The lobbying efforts usually involve developing some type of legislation that will negate
the rule. In some cases, efforts involve challenging the FASB’s authority to develop rules in certain
areas with additional Congressional oversight.
LO: 4, Bloom: E, Difficulty: Moderate, Time: 25-30, AACSB: Communication, AICPA BC: Governance Perspective, AICPA AC: Reporting, AICPA PC:
Communication
Solutions to Codification Exercises
CE1.1
The information at this link describes the elements offered in The FASB Accounting Standards
Codification. As indicated, the website offers several resources to enhance your working knowledge of
the Codification and the Codification Research System. This page includes links to help pages that
describe specific functions and features of the Codification. Links to frequently asked questions, the
FASB Learning Guide, and the Notice to Constituents are also available on this page.
Help pages
FAQ
Learning Guide
About the Codification—Notice of Constituents
LO: 3, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Technology, AICPA BC: None, AICPA AC: Research, Reporting, Technology and Tools, AICPA PC:
Communication
CE1.2
The following information is provided at the Providing Feedback link:
The Codification includes a feature that can be used to submit content-related feedback or general,
system-related comments. The feedback system is not designed for comments on proposed Accounting
Standards Updates.
Content-related feedback
As a registered user of the FASB Accounting Standards Codification Research System website, you are
able and are encouraged to provide feedback, at the paragraph level, to the FASB about any contentrelated matters. For specific information about the Codification and the feedback process, please read
the Notice to Constituents.
To provide content-related feedback:
Click the Submit feedback button beneath the paragraph for which you want to provide feedback. Enter
or copy/paste your comments in the text box. Note that formatting (lists, bold, etc.) is not retained and
there is a 4,000 character limit on feedback submissions.
Click SUBMIT. Your comments are sent to the FASB and reviewed by FASB staff. You can also
submit multiple comments for any given paragraph, if, for example, you determine that more information
would be useful to the FASB staff.
General feedback
Click here to provide general feedback on the Codification in general, the Codification Research System
website, and other system-related items that are not content-specific.
LO: 3, Bloom: K, Difficulty: Simple, Time: 10-15, AACSB: Communication, Technology, AICPA BC: None, AICPA AC: Research, Reporting, Technology and
Tools, AICPA PC: Communication
CE1.3
The “What’s New” page provides links to Codification content that has been recently issued. During the
verification phase, updates may result from either the issuance of Codification update instructions that
accompany new Standards or from changes to the Codification due to incorporation of constituent
feedback.
LO: 3, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Communication, Technology, AICPA BC: None, AICPA AC: Research, Reporting, Technology and Tools,
AICPA PC: Communication
CE1.4
(a)
The master glossary provides three definitions of fair value that are found in GAAP:
Fair Value—The amount at which an asset (or liability) could be bought (or incurred) or settled in a
current transaction between willing parties, that is, other than in a forced or liquidation sale.
Fair Value is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.
(b)
Revenue—Revenue earned by an entity from its direct distribution, exploitation, or licensing of a
film, before deduction for any of the entity’s direct costs of distribution. For markets and territories
in which an entity’s fully or jointly-owned films are distributed by third parties, revenue is the net
amounts payable to the entity by third-party distributors. Revenue is reduced by appropriate
allowances, estimated returns, price concessions, or similar adjustments, as applicable.
The glossary references a revenue definition for the SEC: (Revenue (SEC))—See paragraph
942.235-S599-1, Regulation S-X Rule 9-05(c)(2), for the definition of revenue for purposes of
Regulation S-X Rule 9-05.
This definition relates to segment reporting requirements for public companies.
(c)
Comprehensive Income is defined as the change in equity (net assets) of a business entity during
a period from transactions and other events and circumstances from nonowner sources. It includes
all changes in equity during a period except those resulting from investments by owners and
distributions to owners.
LO: 2, 3, Bloom: K, Difficulty: Simple, Time: 10-15, AACSB: Communication, Technology, AICPA BC: None, AICPA AC: Research, Reporting, Technology and
Tools, AICPA PC: Communication
CE1.5
The FASB Codification’s organization is closely aligned with the elements of financial statements, as
articulated in the Conceptual Framework. This is apparent in the layout of the “Browse” section, which
has primary links for Assets, Liabilities, Equity, Revenues, and Expenses.
LO: 2, Bloom: K, Difficulty: Simple, Time: 5, AACSB: Communication, Technology, AICPA BC: None, AICPA AC: Reporting, Research, Technology and Tools,
AICPA PC: Communication
Solutions to Codification Research Case
Search Strings: concept statement, “materiality”, “articulation”
(a)
According to Concepts Statement 8 (CON 8, Chapter 3): Qualitative
Characteristics of Accounting Information, “Glossary”:
“Materiality is defined as the magnitude of an omission or misstatement
of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person
relying on the information could have been changed or influenced by
the omission or misstatement.”
(b)
CON 8 refers to several SEC cases which apply materiality. Students
might also research SEC literature (e.g. Staff Accounting Bulletin No. 99),
although SEC literature is not in the FARS database.
CON 8, Chapter 3. provides the following examples of screens that might
be used to determine materiality:
a. An accounting change in circumstances that puts an enterprise
in danger of being in breach of a covenant regarding its financial
condition may justify a lower materiality threshold than if its
position were stronger.
b. A failure to disclose separately a nonrecurrent item of revenue
may be material at a lower threshold than would otherwise be the
case if the revenue turns a loss into a profit or reverses the trend
of earnings from a downward to an upward trend.
c. A misclassification of assets that would not be material in amount
if it affected two categories of plant or equipment might be
material if it changed the classification between a noncurrent and
a current asset category.
d. Amounts too small to warrant disclosure or correction in normal
circumstances may be considered material if they arise from
abnormal or unusual transactions or events.
Codification Research Case (Continued)
However, the FASB notes that more than magnitude must be
considered in evaluating materiality:
The relative rather than the absolute size of a judgment item almost
always determines whether it should be considered material in a given
situation. Losses from bad debts or pilferage that could be shrugged
off as routine by a large business may threaten the continued existence
of a small one. An error in inventory valuation may be material in a
small enterprise for which it cut earnings in half but immaterial in an
enterprise for which it might make a barely perceptible ripple in the
earnings. Some of the empirical investigations referred to in Appendix
C throw light on the considerations that enter into materiality
judgments.
Some hold the view that the Board should promulgate a set of
quantitative materiality guides or criteria covering a wide variety of
situations that preparers could look to for authoritative support. That
appears to be a minority view, however. The predominant view is that
materiality judgments can properly be made only by those who have all
the facts. The Board’s present position is that no general standards of
materiality could be formulated to take into account all the
considerations that enter into an experienced human judgment.
(c)
SFAC No. 6, Paras. 20-21. The two classes of elements are related in
such a way that (a) assets, liabilities, and equity are changed by
elements of the other class and at any time are their cumulative result
and (b) an increase (decrease) in an asset cannot occur without a
corresponding decrease (increase) in another asset or a corresponding
increase (decrease) in a liability or equity. Those relationships are
sometimes collectively referred to as “articulation.” They result in
financial statements that are fundamentally interrelated so that
statements that show elements of the second class depend on
statements that show elements of the first class and vice versa.
LO: 3, Bloom: C, Moderate, Time: 25-30, AACSB: Communication, AICPA BC: None, AICPA AC: Measurement Analysis and Interpretation, Reporting, Research,
Technology and Tools, AICPA PC: Communication
Chapter 2
The Accounting Information System
Assignment Classification Table (By Topic)
Topics
Questions
Brief
Exercises
Exercises
Problems
1.
Transaction Identification.
1, 2, 3, 5
1, 2
1, 2, 3, 4, 17
1
2.
Nominal Accounts.
4, 7
3.
Trial Balance.
6, 10
2, 3, 4
1
4.
Adjusting Entries.
8, 11, 13, 14
5, 6, 7, 8,
9, 10, 20
1, 2, 3, 4,
5, 6, 7, 8,
9, 10, 12
5.
Financial Statements.
11, 12, 15,
22, 23
1, 2, 4, 6,
7, 8
6.
Closing.
12
13, 14, 16
1, 4, 9,
10, 12
7.
Inventory And Cost
Of Goods Sold.
9
8.
Comprehensive
Accounting Cycle.
*9.
Cash Vs. Accrual Basis.
15, 16, 17
12
18, 19
*10.
Reversing Entries.
18
13
20
*11.
Worksheet.
19
3, 4, 5, 6, 7,
8, 9, 10
11
14, 15
1, 4, 12
*These topics are dealt with in an Appendix to the Chapter.
21, 22, 23
11
12
Assignment Classification Table (By Learning Objective)
Learning Objectives
Questions
Brief
Exercises
Exercises
Problems
1.
Explain the basic concepts of an
accounting information system.
1, 2, 3,
4, 5, 7
2.
Record and summarize accounting
transactions.
3, 6
1, 2, 3, 4,
5, 6,
1, 2, 3,
4, 9, 17
1, 9,10
3.
Identify and prepare adjusting entries.
8, 11,
13, 14
3, 4, 5, 6,
7, 8, 9, 10
5, 6, 7, 8,
9, 10, 20
2, 3, 4, 5,
6, 7, 8, 9,
10, 12
4.
Prepare financial statements from the
adjusted trial balance and prepare
closing entries.
10, 12
11
11, 12, 13,
14, 16
1, 2, 4, 6,
7, 8, 9, 10,
12
5.
Prepare financial statements for a
merchandising company.
9
13, 15
4,
*6.
Differentiate the cash basis of
accounting from the accrual basis of
accounting.
15, 16,
17
12
18, 19
11
*7.
Identify adjusting entries that may be
reversed.
18
13
20
*8.
Prepare a 10-column worksheet.
19
*These topics are dealt with in an Appendix to the Chapter.
21, 22, 23
12
Assignment Characteristics Table
Level Of
Difficulty
Time
(Minutes)
Transaction Analysis–Service Company.
Corrected Trial Balance.
Corrected Trial Balance.
Corrected Trial Balance.
Adjusting Entries.
Adjusting Entries.
Analyze Adjusted Data.
Adjusting Entries.
Adjusting Entries.
Adjusting Entries.
Prepare Financial Statements.
Prepare Financial Statements.
Closing Entries.
Closing Entries.
Missing Amounts.
Closing Entries for a Corporation.
Transactions of a Corporation, Including Investment
and Dividend.
Cash to Accrual Basis.
Cash and Accrual Basis.
Adjusting and Reversing Entries.
Worksheet.
Worksheet and Balance Sheet Presentation.
Partial Worksheet Preparation.
Simple
Simple
Simple
Simple
Moderate
Moderate
Complex
Moderate
Moderate
Complex
Moderate
Moderate
Simple
Moderate
Simple
Moderate
Moderate
15–20
10–15
15–20
10–15
10–15
10–15
15–20
10–15
15–20
25–30
20–25
20–25
10–15
10–15
10–15
10–15
10–15
Moderate
Moderate
Complex
Simple
Moderate
Moderate
15–20
10–15
20–25
10–15
20–25
10–15
Transactions, Financial Statements–Service Company.
Adjusting Entries and Financial Statements.
Adjusting Entries.
Financial Statements, Adjusting and Closing Entries.
Adjusting Entries.
Adjusting Entries and Financial Statements.
Adjusting Entries and Financial Statements.
Adjusting Entries and Financial Statements.
Adjusting and Closing.
Adjusting and Closing.
Cash and Accrual Basis.
Worksheet, Balance Sheet, Adjusting and Closing
Entries.
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Complex
25–35
35–40
25–30
40–50
15–20
25–35
25–35
25–35
30–40
30–35
35–40
40–50
Item
Description
E2.1
E2.2
E2.3
E2.4
E2.5
E2.6
E2.7
E2.8
E2.9
E2.10
E2.11
E2.12
E2.13
E2.14
E2.15
E2.16
E2.17
*E2.18
*E2.19
*E2.20
*E2.21
*E2.22
*E2.23
P2.1
P2.2
P2.3
P2.4
P2.5
P2.6
P2.7
P2.8
P2.9
P2.10
*P2.11
*P2.12
Answers to Questions
1.
Examples are:
(a) Payment of accounts payable.
(b) Collection of accounts receivable from a customer. Also, a purchase of supplies or equipment
for cash.
(c) Conversion of accounts payable to note payable.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AICPA BB: Communication, AICPA FC: Reporting, AICPA PC: None
2.
Transactions (a), (b), (d) are considered business transactions and are recorded in the accounting
records because a change in assets, liabilities, and/or owners’/stockholders’ equity has been
effected as a result of a transfer of values from one party to another. Transactions (c) and (e) are
not business transactions because a transfer of values has not resulted, nor can the event be
considered financial in nature and capable of being expressed in terms of money.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AICPA BB: Communication, AICPA FC: Reporting, AICPA PC: None
3.
Transaction (a):
Transaction (b):
Transaction (c):
Transaction (d):
Accounts Receivable (debit), Service Revenue (credit).
Cash (debit), Accounts Receivable (credit).
Supplies (debit), Accounts Payable (credit).
Delivery Expense (debit), Cash (credit).
LO: 1, 2, Bloom: K, Difficulty: Simple, Time: 3-5, AICPA BB: Communication, AICPA FC: Reporting, AICPA PC: None
4.
Revenue and expense accounts are referred to as temporary or nominal accounts because each
period they are closed out to Income Summary in the closing process. Their balances are reduced
to zero at the end of the accounting period; therefore, the term temporary or nominal is given to
these accounts.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AICPA BB: Communication, AICPA FC: Reporting, AICPA PC: None
5.
Andrea is not correct. The double-entry system means that for every debit amount there must be a
credit amount and vice-versa. At least two accounts are affected and debits must equal credits. It
does not mean that each transaction must be recorded twice.
LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AICPA BB: Communication, AICPA FC: Reporting, AICPA PC: None
6.
Although it is not absolutely necessary that a trial balance be prepared periodically, it is customary
and desirable. The trial balance accomplishes two principal purposes:
(1) It tests the accuracy of the entries in that it proves that debits and credits of an equal amount
are in the ledger.
(2) It provides a list of ledger accounts and their balances, which may be used in preparing the
financial statements and in supplying financial data about the concern.
LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AICPA BB: Communication, AICPA FC: Reporting, AICPA PC: None
7.
(a) Real account; balance sheet.
(b) Real account; balance sheet.
(c) Inventory is generally considered a real account appearing on the balance sheet. (Note: Inventory
has the elements of a nominal account when the periodic inventory system is used. It may appear
on the income statement when the multiple-step format is used under a periodic inventory
system.)
(d) Real account; balance sheet.
(e) Real account; balance sheet.
(f) Nominal account; income statement.
(g) Nominal account; income statement.
(h) Real account; balance sheet.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AICPA BB: Communication, AICPA FC: Reporting, AICPA PC: None
Questions Chapter 2 (Continued)
8.
At December 31, the three days’ wages due to the employees represent an accrued expense which
creates a current liability, salaries and wages payable. The related expense must be recorded in
this period to properly reflect the expense incurred.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AICPA FC: Reporting, AICPA PC: None
9.
(a) In a service company, revenues are service revenues and expenses are operating expenses.
In a merchandising company, revenues are sales revenues and expenses consist of cost of
goods sold plus operating expenses.
(b) The measurement process in a merchandising company consists of comparing the sales price
of the merchandise inventory to the cost of goods sold and operating expenses.
LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AICPA FC: Reporting, AICPA PC: None
10. (a)
(b)
(c)
(d)
No change.
Before closing, balances exist in these accounts; after closing, no balances exist.
Before closing, balances exist in these accounts; after closing, no balances exist.
Before closing, a balance exists in this account exclusive of any dividends or the net income or
net loss for the period; after closing, the balance is increased or decreased by the amount of net
income or net loss and decreased by dividends declared.
(e) No change.
LO: 4, Bloom: C, Difficulty: Simple, Time: 3-5, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
11. Adjusting entries are prepared prior to the preparation of financial statements in order to bring the
accounts up to date and are necessary (1) to achieve a proper recognition of revenues and expenses
in measuring income and (2) to achieve an accurate presentation of assets, liabilities and
stockholders’ equity.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
12. Closing entries are prepared to transfer the balances of nominal accounts to capital (retained
earnings) after the adjusting entries have been recorded and the financial statements prepared.
Closing entries are necessary to reduce the balances in nominal accounts to zero in order to prepare
the accounts for the next period’s transactions.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
13. Cost – Salvage Value = Depreciable Cost: $4,000 – $0 = $4,000. Depreciable Cost ÷ Useful Life =
Depreciation Expense for One Year $4,000 ÷ 5 years = $800 per year. The asset was used for
6 months (7/1 – 12/31), therefore 1/2-year of depreciation expense should be reported. Annual
depreciation X 6/12 = amount to be reported on the 2025 income statement: $800 X 6/12 = $400.
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
14.
December 31
Interest Receivable ...........................................................................................
Interest Revenue .......................................................................................
(To record accrued interest revenue on loan)
10,000
10,000
Accrued expenses result from the same causes as accrued revenues. In fact, an accrued expense
on the books of one company (the borrower) is an accrued revenue to another company (the lender).
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Questions Chapter 2 (Continued)
*15. Under the cash basis of accounting, revenue is recorded only when cash is received and expenses
are recorded only when paid. Under the accrual basis of accounting, revenue is recognized when a
performance obligation is satisfied and expenses are recognized when incurred, without regard to
the time of the receipt or payment of cash.
A cash-basis balance sheet and income statement are incomplete and inaccurate in comparison to
accrual-basis financial statements. The accrual-basis matches effort (expenses) with
accomplishment (revenues) in the income statement while the cash basis only presents cash
receipts and cash disbursements. The accrual basis balance sheet contains receivables, payables,
accruals, prepayments, and deferrals while a cash-basis balance sheet shows none of these.
LO:6, Bloom: C, Difficulty: Simple, Time: 3-5, AICPA FC: Measurement, Reporting, AICPA PC: None
*16. Salaries and wages paid during the year will include the payment of any wages attributable to the
prior year but unpaid at the end of the prior year. This amount is an expense of the prior year and
not of the current year, and thus should be subtracted in determining salaries and wages expense.
Similarly, salaries and wages paid during the year will not include any salaries and wages
attributable to hours worked during the current year but not actually paid until the following year.
This should be added in determining salaries and wages expense.
LO: 6, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
*17. Although similar to the strict cash basis, the modified cash basis of accounting requires that
expenditures for capital items be charged against income over all the periods to be benefited. This
is done through conventional accounting methods, such as depreciation and amortization and
inventory. Under the strict cash basis, expenditures would be recognized as expenses in the period
in which the corresponding cash disbursements are made.
LO:6, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
*18. Reversing entries are made at the beginning of the period to reverse accruals and some deferrals.
Reversing entries are not required. They are made to simplify the recording of certain transactions
that will occur later in the period that relate to previous adjustments. The same net results will be
attained whether or not reversing entries are recorded.
LO:7, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
*19. Disagree. A worksheet is not a permanent accounting record and its use is not required in the accounting cycle. The worksheet is an informal device for accumulating and sorting information needed
for the financial statements. Its use is optional in helping to prepare financial statements.
LO:8, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Solutions to Brief Exercises
Brief Exercise 2.1
May
1
3
13
21
Cash ...........................................................
Common Stock ..................................
4,000
Equipment .................................................
Accounts Payable ..............................
1,100
Rent Expense ............................................
Cash ....................................................
400
Accounts Receivable ................................
Service Revenue ................................
500
4,000
1,100
400
500
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Brief Exercise 2.2
Aug.
2
7
12
15
19
Cash ............................................................
Equipment...................................................
Owner’s Capital ...................................
12,000
2,500
Supplies ......................................................
Accounts Payable ...............................
500
Cash ............................................................
Accounts Receivable .................................
Service Revenue .................................
1,300
670
Rent Expense ..............................................
Cash ......................................................
600
Supplies Expense........................................
Supplies ($500 – $270) .........................
230
14,500
500
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
1,970
600
230
Brief Exercise 2.3
July
Dec.
1
31
Prepaid Insurance .......................................
Cash ......................................................
15,000
Insurance Expense ......................................
Prepaid Insurance
($15,000 X 6/12 X 1/3) .......................
2,500
15,000
2,500
LO: 2, 3, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
Brief Exercise 2.4
July
Dec.
1
31
Cash .............................................................
Unearned Service Revenue .................
15,000
Unearned Service Revenue ............... 3,000
Service Revenue
($15,000 X 6/12 X 1/3) .......................
2,500
15,000
2,500
LO: 2, 3, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
Brief Exercise 2.5
Feb.
1
June 30
Prepaid Insurance .......................................
Cash ......................................................
720,000
Insurance Expense ......................................
Prepaid Insurance
($720,000 X 5/24)...............................
150,000
720,000
150,000
LO: 2, 3, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
Brief Exercise 2.6
Nov.
Dec.
1
31
Cash .............................................................
Unearned Rent Revenue ......................
2,400
Unearned Rent Revenue .............................
Rent Revenue
($2,400 X 2/3) ....................................
1,600
2,400
LO: 2, 3, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
1,600
Brief Exercise 2.7
Dec.
Jan.
31
2
Salaries and Wages Expense ....................
Salaries and Wages Payable
($8,000 X 3/5) ...................................
4,800
Salaries and Wages Payable .....................
Salaries and Wages Expense ....................
Cash .....................................................
4,800
3,200
4,800
8,000
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
Brief Exercise 2.8
Dec.
Feb.
31
1
Interest Receivable .....................................
Interest Revenue .................................
300
Cash ............................................................
Notes Receivable ................................
Interest Receivable .............................
Interest Revenue ($12,000 X 10% X1/12) .
12,400
300
12,000
300
100
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
Brief Exercise 2.9
Aug.
31
31
31
31
Interest Expense.........................................
Interest Payable ..................................
300
Accounts Receivable .................................
Service Revenue .................................
1,400
Salaries and Wages Expense ....................
Salaries and Wages Payable ..............
700
Bad Debt Expense ......................................
Allowance for Doubtful Accounts ......
900
300
1,400
700
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
900
Brief Exercise 2.10
Depreciation Expense ..............................................
Accumulated Depreciation—Equipment .........
2,000
Equipment ................................................................
Less: Accumulated Depreciation—Equipment .....
$30,000
2,000
2,000
$28,000
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
Brief Exercise 2.11
Sales Revenue..........................................................
Interest Revenue ......................................................
Income Summary ..............................................
808,900
13,500
Income Summary .....................................................
Cost of Goods Sold ..........................................
Administrative Expenses .................................
Income Tax Expense ........................................
780,300
Income Summary ($822,400 - $780,300) .................
Retained Earnings ............................................
42,100
Retained Earnings....................................................
Dividends ..........................................................
18,900
822,400
556,200
189,000
35,100
42,100
18,900
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
*Brief Exercise 2.12
(a)
(b)
Cash receipts ..................................................
+ Increase in accounts receivable
($18,600 – $13,000) ..................................
Service revenue ..............................................
$142,000
Payments for operating expenses .................
– Increase in prepaid expenses
($23,200 – $17,500) ..................................
Operating expenses ........................................
$ 97,000
5,600
$147,600
(5,700)
$ 91,300
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 7-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
*Brief Exercise 2.13
(a)
(b)
(c)
Salaries and Wages Payable ..............................
Salaries and Wages Expense .....................
4,200
Salaries and Wages Expense.............................
Cash .............................................................
7,000
Salaries and Wages Payable ..............................
Salaries and Wages Expense ($7,000 - $4,200).
Cash .............................................................
4,200
2,800
4,200
7,000
LO: 7, Bloom: C, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
7,000
Solutions to Exercises
Exercise 2.1 (15–20 Minutes)
Apr.
2
Cash .............................................................
Equipment ....................................................
Owner’s Capital ....................................
32,000
14,000
46,000
2
No Entry—Not A Transaction.
3
Supplies .......................................................
Accounts Payable ................................
700
Rent Expense ...............................................
Cash ......................................................
600
Accounts Receivable ..................................
Service Revenue ..................................
1,100
Cash .............................................................
Unearned Service Revenue .................
3,200
Cash .............................................................
Service Revenue ..................................
2,300
Insurance Expense ......................................
Cash ......................................................
110
Salaries And Wages Expense .....................
Cash ......................................................
1,160
Supplies Expense ........................................
Supplies ................................................
120
Equipment ....................................................
Owner’s Capital ....................................
6,100
7
11
12
17
21
30
30
30
700
600
1,100
3,200
2,300
110
1,160
120
LO: 2, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
6,100
Exercise 2.2 (10–15 minutes)
Wanda Landowska Company
Trial Balance
April 30, 2025
Debit
Cash .....................................................................
Accounts Receivable ..........................................
Prepaid Insurance ($700 + $100) ........................
Equipment ...........................................................
Accounts Payable ($4,500 – $100) .....................
Property Taxes Payable......................................
Owner’s Capital ($11,200 + $1,500) ........................
Owner’s Drawing .................................................
Service Revenue .................................................
Salaries and Wages Expense .............................
Advertising Expense ($1,100 + $300) ................
Property Tax Expense ($800 + $100) .................
Credit
$ 4,800
2,750
800
8,000
$ 4,400
560
12,700
1,500
6,690
4,200
1,400
900
$24,350
$24,350
LO: 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Exercise 2.3 (15–20 minutes)
The ledger accounts are reproduced below, and corrections are shown in the
accounts.
Accounts Payable
Bal.
7,044
Accounts Receivable
Bal.
5,240 (1)
450
Bal,
4,790
Common Stock
Bal.
8,000
Supplies
2,967
Retained Earnings
Bal.
2,000
Bal.
(1)
Bal.
Bal.
Cash
5,912 (4)
450
6,172
190
(1) [$1,830 - $1,380] (4) [$95 + $95]
Exercise 2.3 (Continued)
Bal.
(2)
Bal.
Equipment
6,100
3,200
9,300
Service Revenue
Bal.
(3)
(5)
Bal.
Bal.
Bal.
5,200
2,025
80
7,305
Office Expense
4,320 (2)
1,120
3,200
(3)[$2,250 - $225]
Blues Traveler Corporation
Trial Balance (corrected)
April 30, 2025
Debit
Cash
..............................................................................
..............................................................................
Accounts Receivable ..........................................
Supplies ...............................................................
Equipment ...........................................................
Accounts Payable ...............................................
Common Stock ....................................................
Retained Earnings...............................................
Service Revenue .................................................
Office Expense ....................................................
Credit
$ 6,172
4,790
2,967
9,300
$ 7,044
8,000
2,000
7,305
1,120
$24,349
LO: 2, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
$24,349
Exercise 2.4 (10–15 minutes)
Watteau Co.
Trial Balance
June 30, 2025
Debit
Cash ($2,870 + $180 – $65 – $65) ...................................
Accounts Receivable ($3,231 – $180) ............................
Supplies ($800 – $500) ....................................................
Equipment ($3,800 + $500) .............................................
Accounts Payable ($2,666 – $206 – $260) .....................
Unearned Service Revenue ($1,200 – $325) ..................
Common Stock ...............................................................
Dividends.........................................................................
Retained Earnings ..........................................................
Service Revenue ($2,380 + $801 [$890 – $89] + $325) ..
Salaries and Wages Expense ($3,400 + $670 – $575) ...
Office Expense ................................................................
Credit
$ 2,920
3,051
300
4,300
$ 2,200
875
6,000
575
3,000
3,506
3,495
940
$15,581
$15,581
LO: 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Exercise 2.5 (10–15 minutes)
1.
2.
3.
4.
5.
Depreciation Expense ($250 X 3) ............................
Accumulated Depreciation—Equipment .........
750
Unearned Rent Revenue ($9,300 X 1/3) ..................
Rent Revenue ....................................................
3,100
Interest Expense ......................................................
Interest Payable ................................................
500
Supplies Expense ....................................................
Supplies ($2,800 – $850)...................................
1,950
Insurance Expense ($300 X 3) .................................
Prepaid Insurance.............................................
900
750
3,100
500
1,950
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
900
Exercise 2.6 (10–15 minutes)
1.
2.
3.
4.
5.
Accounts Receivable ...................................................
Service Revenue ...................................................
750
Utilities Expenses ........................................................
Accounts Payable .................................................
520
Depreciation Expense ..................................................
Accumulated Depreciation – Equipment.............
400
Interest Expense ..........................................................
Interest Payable ....................................................
500
Insurance Expense ($12,000 X 1/12) ...........................
Prepaid Insurance .................................................
1,000
Supplies Expense ($1,600 – $500) ..............................
Supplies .................................................................
1,100
750
520
400
500
1,000
1,100
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Exercise 2.7 (15–20 minutes)
(a)
Ending balance of supplies
Add: Adjusting entry
Deduct: Purchases
Beginning balance of supplies
(b)
Total prepaid insurance
Amount used (6 X $400)
Present balance
$700
950
850
$800
$4,800
2,400
$2,400
($400 X 12)
The policy was purchased six months ago (August 1, 2024)
(c)
The entry in January to record salary and wages expense was
Salaries and Wages Expense .............................
Salaries and Wages Payable ..............................
Cash ...............................................................
1,800
700
2,500
Exercise 2.7 (Continued)
The “T” account for salaries and wages
payable is
Salaries and Wages Payable
Paid
700 Beg. Bal.
?
January
End Bal.
800
The beginning balance is therefore
(d)
Ending balance of salaries and wages payable
Plus: Reduction of salaries and wages payable
Beginning balance of salaries and wages payable
$ 800
700
$1,500
Service revenue
Cash received
Unearned revenue reduced
$2,000
(1,600)
$ 400
Ending unearned revenue January 31, 2025
Plus: Unearned revenue reduced
Beginning unearned revenue December 31, 2024
$ 750
400
$1,150
LO: 3, Bloom: AP, Difficulty: Complex, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Exercise 2.8 (10–15 minutes)
1.
2.
3.
4.
Salaries and Wages Expense .......................................
Salaries and Wages Payable .................................
1,900
Utilities Expenses .........................................................
Accounts Payable ..................................................
600
Interest Expense ($30,000 X 8% X 1/12) ......................
Interest Payable .....................................................
200
Telephone and Internet Expense .................................
Accounts Payable ..................................................
117
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
1,900
600
200
117
Exercise 2.9 (15–20 minutes)
(a)
10/15
10/17
10/20
(b)
10/31
10/31
10/31
10/31
Salaries and Wages Expense ........................
Cash .........................................................
(To record payment of October 15
payroll)
800
Accounts Receivable .....................................
Service Revenue .....................................
(To record revenue for services
performed for which payment has
not yet been received)
2,400
Cash ................................................................
Unearned Service Revenue ....................
(To record receipt of cash for
services not yet performed)
650
Supplies Expense ...........................................
Supplies ...................................................
(To record the use of supplies during
October)
470
Accounts Receivable .....................................
Service Revenue .....................................
(To record revenue for services
performed for which payment has
not yet been received)
1,650
Salaries and Wages Expense ........................
Salaries and Wages Payable ..................
(To record liability for accrued payroll)
600
Unearned Service Revenue ...........................
Service Revenue .....................................
(To reduce the Unearned Service
Revenue account for service that
has been performed)
400
800
2,400
650
470
1,650
600
LO: 2, 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
400
Exercise 2.10 (25–30 minutes)
(a)
1. Aug. 31 Insurance Expense ($4,500 X 3/12) ..........
Prepaid Insurance .............................
1,125
2. Aug. 31 Supplies Expense ($2,600 – $450) ...........
Supplies .............................................
2,150
3. Aug. 31 Depreciation Expense ..............................
Accumulated Depreciation—
Buildings .........................................
($120,000 – $12,000* = $108,000;
$108,000 X 4% = $4,320 per year;
$4,320 X 3/12 = $1,080)
*$120,000 X 10%
1,080
Aug. 31 Depreciation Expense ..............................
Accumulated Depreciation—
Equipment .......................................
($16,000 – $1,600** = $14,400;
$14,400 X 10% = $1,440;
$1,440 X 3/12 = $360)
**$16,000 X 10%
360
4. Aug. 31 Unearned Rent Revenue ..........................
Rent Revenue ....................................
3,800
5. Aug. 31 Salaries and Wages Expense...................
Salaries and Wages Payable ............
375
6. Aug. 31 Accounts Receivable ................................
Rent Revenue ....................................
800
7. Aug. 31 Interest Expense .......................................
Interest Payable .................................
[($60,000 X 8%) X 3/12]
1,200
1,125
2,150
1,080
360
3,800
375
800
1,200
Exercise 2.10 (Continued)
(b)
Greco Resort
Adjusted Trial Balance
August 31, 2025
Debit
Cash .........................................................................
Accounts Receivable ..............................................
Prepaid Insurance ($4,500 – $1,125) ......................
Supplies ($2,600 – $2,150) ......................................
Land .........................................................................
Buildings..................................................................
Accumulated Depreciation—Buildings .................
Equipment ...............................................................
Accumulated Depreciation—Equipment ...............
Accounts Payable ...................................................
Unearned Rent Revenue ($4,600 – $3,800) ............
Salaries and Wages Payable ..................................
Interest Payable ......................................................
Mortgage Payable ...................................................
Common Stock ........................................................
Retained Earnings...................................................
Dividends .................................................................
Rent Revenue ($76,200 + $3,800 + $800) ...............
Salaries and Wages Expense ($44,800 + $375) .....
Utilities Expenses ...................................................
Maintenance and Repair Expense .........................
Insurance Expense .................................................
Supplies Expense ...................................................
Depreciation Expense ($1,080 + $360)...................
Interest Expense .....................................................
Credit
$ 10,600
800
3,375
450
20,000
120,000
$
1,080
16,000
360
4,500
800
375
1,200
60,000
91,000
0
5,000
80,800
45,175
9,200
3,600
1,125
2,150
1,440
1,200
$240,115
LO: 3, Bloom: AP, Difficulty: Complex, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
$240,115
Exercise 2.11 (20–25 minutes)
(a)
OLIVER CO.
Income Statement
For the Year Ended December 31, 2025
Revenues
Service revenue .................................................
Expenses
Salaries and wages expense ............................
Rent expense .....................................................
Depreciation expense .......................................
Interest expense ................................................
Net Income ...................................................................
(b)
$11,590
$6,840
2,260
145
83
OLIVER CO.
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, January 1 ........................................................
Add: Net income .............................................................................
Less: Dividends ..............................................................................
Retained earnings, December 31 ...................................................
(c)
9,328
$ 2,262
$11,310
2,262
13,572
3,000
$10,572
OLIVER CO.
Balance Sheet
December 31, 2025
Assets
Current Assets
Cash ..............................................................
Accounts receivable ....................................
Prepaid rent ..................................................
Total current assets ...............................
Property, plant, and equipment
Equipment ....................................................
Accumulated depreciation –
equipment ...................................................
Total assets.................................................................
$19,472
6,920
2,280
28,672
$18,050
(4,895)
13,155
$41,827
Exercise 2.11 (Continued)
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable .................................................
Interest payable ..............................................
Accounts payable ..........................................
Total current liabilities .............................
Stockholders’ equity
Common stock ...............................................
Retained earnings ..........................................
Total liabilities and stockholders’ equity ....................
$ 5,700
83
5,472
11,255
$20,000
10,572*
30,572
$41,827
*Beg. Balance + Net Income – Dividends = Ending Balance
$11,310
+ $2,262 – $3,000 =
$10,572
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Exercise 2.12 (20–25 Minutes)
(a)
SANTO DESIGN
Income Statement
For the Year Ended December 31, 2025
Revenues
Service revenue ...................................................
Expenses
Salaries and wages expense ..............................
Depreciation expense..........................................
Rent expense .......................................................
Supplies expense ................................................
Insurance expense ..............................................
Interest expense ..................................................
Total expenses ..............................................
Net income......................................................................
$61,500
$11,300
7,000
4,000
3,400
850
150
26,700
$34,800
SANTO DESIGN
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, January 1 .........................................................
Add: Net income...............................................................................
Retained earnings, December 31 ....................................................
Exercise 2.12 (Continued)
$ 3,500
34,800
$38,300
(a) Continued
SANTO DESIGN
Balance Sheet
December 31, 2025
Assets
Cash .................................................................................
Accounts receivable .......................................................
Supplies ...........................................................................
Prepaid insurance ...........................................................
Equipment .......................................................................
Less: Accumulated depreciation – equipment...................
Total assets ...........................................................
$11,350
21,500
5,000
2,500
$60,000
35,000
25,000
$65,350
Liabilities and Stockholders’ Equity
Liabilities
Notes payable.............................................................
Accounts payable ......................................................
Interest payable..........................................................
Unearned service revenue ........................................
Salaries and wages payable ......................................
Total liabilities ......................................................
Stockholders’ equity
Common stock ...........................................................
Retained earnings ......................................................
Total liabilities and stockholders’ equity ...........
$ 5,000
5,000
150
5,600
1,300
$17,050
$10,000
38,300
48,300
$65,350
(b) (1) Based on interest payable at December 31, 2025, interest is $25 per
month ($150/6 months) or 0.5% of the note payable. 0.5% X 12 = 6%
interest per year.
(2) Salaries and Wages Expense, $11,300 less Salaries and Wages
Payable 12/31/25, $1,300 = $10,000. Total payments, $17,500 – $10,000
= $7,500 Salaries and Wages Payable 12/31/24.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Exercise 2.13 (10–15 minutes)
(a)
Sales revenue ......................................................
Less: Sales returns and allowances ..................
Sales discounts.........................................
Net sales ..............................................................
$800,000
$24,000
15,000
(b) Sales Revenue .....................................................
Income Summary .........................................
800,000
Income Summary ................................................
Sales Returns and Allowances ...................
Sales Discounts ...........................................
39,000
39,000
$761,000
800,000
24,000
15,000
LO: 4, 5 Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Exercise 2.14 (10–15 minutes)
Sales Revenue .....................................................
Income Summary .........................................
350,000
Income Summary ................................................
Cost of Goods Sold .....................................
Sales Returns and Allowances ...................
Sales Discounts ...........................................
Delivery Expense .........................................
Insurance Expense ......................................
Rent Expense ...............................................
Salaries and Wages Expense ......................
329,000
Income Summary ($350,000 - $329,000) ............
Retained Earnings .......................................
21,000
350,000
208,000
13,000
8,000
7,000
12,000
20,000
61,000
21,000
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Exercise 2.15 (10–15 minutes)
(a) $9,000 ($90,000 − $81,000)
(b) $25,000 ($81,000 − $56,000)
(c) $10,000 ($25,000 − $15,000)
(d) $100,000 ($95,000 + $5,000)
(e) $57,000 ($95,000 − $38,000)
LO: 5, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Exercise 2.16 (10–15 minutes)
Sales Revenue........................................................
Cost of Goods Sold ........................................
Sales Returns and Allowances ......................
Sales Discounts ..............................................
Selling Expenses ............................................
Administrative Expenses ...............................
Income Tax Expense ......................................
Income Summary ............................................
410,000
225,700
12,000
15,000
16,000
38,000
30,000
73,300
(or)
Sales Revenue........................................................
Income Summary ............................................
410,000
Income Summary ...................................................
Cost of Goods Sold ........................................
Sales Returns and Allowances ......................
Sales Discounts ..............................................
Selling Expenses ............................................
Administrative Expenses ...............................
Income Tax Expense ......................................
336,700
Income Summary ($410,000 - $336,700) ...............
Retained Earnings ..........................................
73,300
Retained Earnings .................................................
Dividends ........................................................
18,000
410,000
225,700
12,000
15,000
16,000
38,000
30,000
73,300
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
18,000
Exercise 2.17 (10–15 minutes)
Date
Mar.
Account Titles and Explanation
1 Cash
Ref.
Debit
J1
Credit
50,000
Common Stock
(Investment of cash in business)
50,000
3 Land
Buildings
Equipment
Cash
(Purchased Michelle Wie’s Golf Land)
10,000
22,000
6,000
5 Advertising Expense
Cash
(Paid for advertising)
1,600
6 Prepaid Insurance
Cash
(Paid for one-year insurance policy)
1,480
10 Equipment
Accounts Payable
(Purchased equipment on account)
2,500
18 Cash
1,200
38,000
1,600
1,480
2,500
Service Revenue
(Received cash for services performed)
1,200
25 Dividends
Cash
(Declared and paid a $500 cash dividend)
500
30 Salaries and Wages Expense
Cash
(Paid wages expense)
900
30 Accounts Payable
Cash
(Paid creditor on account)
500
900
2,500
31 Cash
2,500
750
Service Revenue
(Received cash for services performed)
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
750
*Exercise 2.18 (15–20 minutes)
Jill Accardo, M.D.
Conversion of Cash Basis to Accrual Basis
For the Year 2025
Excess of cash collected over cash disbursed
($142,600 – $55,470)
Add increase in accounts receivable ($9,250 – $15, 927)
Deduct increase in unearned service revenue ($2,840 – $4,111)
Add decrease in accrued expenses ($3,435 – $2,108)
Add increase in prepaid expenses ($1,917 – $3,232)
Net income on an accrual basis
$87,130
6,677
(1,271)
1,327
1,315
$95,178
Alternate solution:
Jill Accardo, M.D.
Conversion of Income Statement Data
from Cash Basis to Accrual Basis
For the Year 2025
Cash
Adjustments
Basis
Add
Deduct
Collections from customers:
$142,600
Accrual
Basis
$142,600
–Accounts receivable, Jan. 1
$9,250
($9,250)
+Accounts receivable, Dec. 31
$15,927
$15,927
+Unearned service revenue, Jan. 1
$2,840
$2,840
–Unearned service revenue, Dec. 31
Service revenue
Disbursements for expenses:
$142,600
$18,767
$4,111
($4,111)
$13,361
$148,006
$55,470
–Accrued expenses, Jan. 1
$3,435
+Accrued expenses, Dec. 31
$2,108
+Prepaid expenses, Jan. 1
$1,917
–Prepaid expenses, Dec. 31
_______
_______
$3,232
Operating expenses
$55,470
$4,025
$ 6,667
Net income—cash basis
$ 87,130
Net income—accrual basis
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
52,828
$ 95,178
*Exercise 2.19 (10–15 minutes)
(a)
Wayne Rogers Corp.
Income Statement (Cash Basis)
For the Year Ended December 31,
2024
$295,000
225,000
$ 70,000
Sales revenue
Expenses
Net income
(b)
2025
$515,000
272,000
$243,000
Wayne Rogers Corp.
Income Statement (Accrual Basis)
For the Year Ended December 31,
Sales revenue*
Expenses**
Net income
*2024:
2025:
**2024:
2025:
2024
$485,000
277,000
$208,000
2025
$445,000
255,000
$190,000
$295,000 + $160,000 + $30,000 = $485,000
$355,000 + $90,000 = $445,000
$185,000 + $67,000 + $25,000 = $277,000
$40,000 + $160,000 + $55,000 = $255,000
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: None
*Exercise 2.20 (20–25 minutes)
(a)
Adjusting Entries:
1. Dec. 31 Insurance Expense ($5,280 X 5/24)....
Prepaid Insurance ..........................
2.
3.
4.
1,100
1,100
Dec. 31 Rent Revenue ($1,800 X 1/3) ..............
Unearned Rent Revenue................
600
Dec. 31 Supplies ..............................................
Advertising Expense .....................
290
Dec. 31 Interest Expense .................................
Interest Payable .............................
770
600
290
770
*Exercise 2.20 (Continued)
(b)
Reversing Entries:
1. No reversing entry required.
2.
3.
4.
Unearned Rent Revenue ..................................
Rent Revenue ............................................
600
Advertising Expense ........................................
Supplies .....................................................
290
Interest Payable ................................................
Interest Expense ........................................
770
600
290
770
LO: 7, Bloom: AP, Difficulty: Complex, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
*Exercise 2.21 (10–15 minutes)
Accounts
Cash
Inventory
Sales Revenue
Sales Returns and
Allowances
Sales Discounts
Cost of Goods Sold
Adjusted Trial
Balance
Income
Statement
Dr.
9,000
80,000
Dr.
Cr.
450,000
10,000
5,000
250,000
Cr.
Balance Sheet
Dr.
9,000
80,000
450,000
10,000
5,000
250,000
LO: 8, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Cr.
*Exercise 2.22 (20–25 minutes)
Ed Bradley Co.
Worksheet (partial)
For the Month Ended April 30, 2025
Adjusted Trial
Balance
Income
Statement
Account Titles
Cash
Accounts Receivable
Prepaid Rent
Equipment
Accum. Depreciation –
Equipment
Notes Payable
Accounts Payable
Common Stock
Retained Earnings
Dividends
Service Revenue
Salaries and
Wages Expense
Rent Expense
Depreciation Expense
Interest Expense
Interest Payable
Dr.
24,522
6,920
2,280
18,050
Dr.
Totals
Net income
63,700
Totals
Cr.
Cr.
Balance Sheet
Dr.
24,522
6,920
2,280
18,050
4,895
5,700
4,472
34,960
1,000
Cr.
4,895
5,700
4,472
34,960
1,000
1,100
1,100
12,590
6,840
3,760
145
83
12,590
6,840
3,760
145
83
83
83
63,700 10,828 12,590 52,872
1,762
51,110
1,762
12,590 12,590 52,872
52,872
*Exercise 2.22 (Continued)
Ed Bradley Co.
Balance Sheet
April 30, 2025
Assets
Current Assets
Cash
$24,522
Accounts receivable ....................................
Prepaid rent ..................................................
Total current assets ............................
Property, plant, and equipment
Equipment.....................................................
Accumulated depreciation –
equipment ...................................................
Total assets
Liabilities and Stockholders’ Equity
Liabilities
Notes payable ...............................................
Accounts payable.........................................
Interest payable ............................................
Total current liabilities ........................
Stockholders’ equity
Common stock .............................................
Retained earnings ........................................
Total liabilities and Stockholders’ equity.................
6,920
2,280
$33,722
18,050
(4,895)
13,155
$46,877
$ 5,700
4,472
83
$10,255
34,960
1,662*
*Beg. Balance + Net Income – Dividends = Ending Balance
$1,000
+ $1,762
– $1,100 =
$1,662
LO: 8, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
36,622
$46,877
*Exercise 2.23 (10–15 minutes)
Jurassic Park Co.
Worksheet (partial)
For Month Ended February 28, 2025
Trial
Balance
Account Titles
Supplies
Dr.
Adjustments
Cr.
Dr.
Cr.
1,756
Adjusted
Income
Balance
Trial Balance
Statementa
Sheet
Dr.
Dr.
Dr.
Cr.
Cr.
715
Cr.
(a)
1,041
715
6,939
(b)
257
7,196
7,196
150
(c)
50
200
200
Accumulated
depreciation –
equipment
Interest
payable
Supplies
expense
1,500
(a) 1,041
2,541
2,541
Depreciation
expense
257
(b)
257
514
514
50
(c)
50
100
100
Interest
expense
The following accounts and amounts would be shown in the February
income statementa:
Supplies expense
Depreciation expense
Interest expense
$2,541
514
100
LO: 8, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Time and Purpose of Problems
Problem 2.1 (Time 25–35 minutes)
Purpose—to provide an opportunity for the student to post daily transactions to a “T” account ledger,
prepare a trial balance, prepare an income statement, a balance sheet and a retained earnings
statement, close the ledger, and prepare a post-closing trial balance. The problem deals with routine
transactions of a professional service firm and provides a good integration of the accounting process.
Problem 2.2 (Time 35–40 minutes)
Purpose—to provide an opportunity for the student to prepare adjusting entries, and prepare financial
statements (income statement, balance sheet, and retained earnings statement). The student also is
asked to analyze two transactions to find missing amounts.
Problem 2.3 (Time 25–30 minutes)
Purpose—to provide an opportunity for the student to prepare adjusting entries. The adjusting entries are
fairly complex in nature.
Problem 2.4 (Time 40–50 minutes)
Purpose—to provide an opportunity for the student to prepare adjusting entries and an adjusted trial
balance and then prepare an income statement, a retained earnings statement, and a balance sheet. In
addition, closing entries must be made and a post-closing trial balance prepared.
Problem 2.5 (Time 15–20 minutes)
Purpose—to provide the student with an opportunity to determine what adjusting entries need to be made
to specific accounts listed in a partial trial balance. The student is also required to determine the amounts
of certain revenue and expense items to be reported in the income statement.
Problem 2.6 (Time 25–35 minutes)
Purpose—to provide the student with an opportunity to prepare year-end adjusting entries from a trial
balance and related information presented. The problem also requires the student to prepare an income
statement, a balance sheet, and a retained earnings statement. The problem covers the basics of the
end-of-period adjusting process.
Problem 2.7 (Time 25–35 minutes)
Purpose—to provide an opportunity for the student to figure out the year-end adjusting entries that were
made from a trial balance and an adjusted trial balance. The student is also required to prepare an income
statement, a retained earnings statement, and a balance sheet. In addition, the student needs to answer
a number of questions related to specific accounts.
Problem 2.8 (Time 25–35 minutes)
Purpose—to provide an opportunity for the student to figure out the year-end adjusting entries that were
made from a trial balance and an adjusted trial balance. The student is also required to prepare an income
statement, a retained earnings statement, and a balance sheet. In addition, the student needs to answer
a number of questions related to specific accounts.
Problem 2.9 (Time 30–40 minutes)
Purpose—to provide an opportunity for the student to prepare adjusting, and closing entries. This problem
presents basic adjustments including a number of accruals and deferrals. It provides the student with an
integrated flow of the year-end accounting process.
Problem 2.10 (Time 30–35 minutes)
Purpose—to provide an opportunity for the student to prepare adjusting and closing entries from a trial
balance and related information. The student is also required to post the entries to “T” accounts.
Time and Purpose of Problems (Continued)
*Problem 2.11 (Time 35–40 minutes)
Purpose—to provide an opportunity for the student to prepare and compare (a) cash-basis and accrualbasis income statements, (b) cash-basis and accrual-basis balance sheets, and (c) to discuss the
weaknesses of cash-basis accounting.
*Problem 2.12 (Time 40–50 minutes)
Purpose—to provide an opportunity for the student to complete a worksheet and then prepare a classified
balance sheet. In addition, adjusting and closing entries must be made and a post-closing trial balance
prepared.
Solutions to Problems
Problem 2.1
(a)
(Explanations are omitted.) and (d)
Cash
Sept. 1
20,000 Sept. 4
8
1,690
5
20
980
10
18
19
30
30
30 Bal 12,133
680
942
430
3,600
3,000
1,800
85
Sept.
2
Common Stock
Sept.
Sept. 30
Accounts Receivable
Sept. 14
5,82 Sept. 20
0
Bal. 30
Sept.
4
Sept. 5
Bal. 30
2,11
0
6,95
0
20,000
Bal.
30
Retained Earnings
3,000 Sept.
30
Bal.
30
20,000
19
Dividends
3,000 Sept.30
Sept.
30
18
Sept.
Sept.
10
30
2
17,280
Bal.
30
13,680
8
14
25
1,690
5,820
2,110
9,620
680
330
Office Expense
430 Sept. 30
85
515
515
515
Salaries and Wages Expense
30
1,800 Sept. 30
1,800
30
3,000
3,600 Sept.
Sept.
30
Service Revenue
9,620 Sept.
9,620
Sept.
6,007
3,007
Accounts Payable
Rent Expense
680 Sept. 30
Supplies
942 Sept.
612
1
980
Sept.
25
Equipment
17,280
Supplies Expense
330 Sept. 30
Problem 2.1 (Continued)
330
Accumulated Depreciation—Equipment
Sept. 30
288
Depreciation Expense
Sept.
30
288 Sept. 30
Income Summary
288
Sept.
30
30
30
30
30
30 Inc.
680 Sept.
515
1,800
330
288
6,007
9,620
(b)
30
9,620
9,620
YASUNARI KAWABATA, D.D.S.
Trial Balance
September 30
Debit
Cash
................................................................................
................................................................................
Accounts Receivable ............................................
Supplies .................................................................
Equipment .............................................................
Accumulated Depreciation—Equipment .............
Accounts Payable .................................................
Common Stock......................................................
Retained Earnings.................................................
Dividends ...............................................................
Service Revenue ...................................................
Rent Expense ........................................................
Office Expense ......................................................
Salaries and Wages Expense ...............................
Supplies Expense .................................................
Depreciation Expense...........................................
Totals ...........................................................
Credit
$12,133
6,950
612
17,280
$ 288
13,680
20,000
0
3,000
9,620
680
515
1,800
330
288
$43,588
$43,588
Problem 2.1 (Continued)
(c)
YASUNARI KAWABATA, D.D.S.
Income Statement
For the Month of September
Service revenue ......................................................
Expenses:
Salaries and wages expense ..................
Rent expense ...........................................
Supplies expense ....................................
Depreciation expense .............................
Office expense .........................................
Total expenses ....................................
Net income ..............................................................
$9,620
$1,800
680
330
288
515
3,613
$6,007
YASUNARI KAWABATA, D.D.S.
Retained Earnings Statement
For the Month of September
Balance, September 1..........................................................
Add: Net income ................................................................
Less: Dividends ...................................................................
Balance, September 30........................................................
$
0
6,007
6,007
3,000
$3,007
YASUNARI KAWABATA, D.D.S.
Balance Sheet
September 30
Assets
Cash ............................. $12,133
Accounts receivable ...
6,950
Supplies.......................
612
Equipment. ..................
17,280
Accum. depreciation—
equipment................
(288)
Total assets ......... $36,687
Liabilities and Stockholders’
Equity
Accounts payable ......... $13,680
Common Stock ................
20,000
Retained earnings ...........
3,007
Total liabilities and
stockholders’ equity .... $36,687
Problem 2.1 (Continued)
(d)
YASUNARI KAWABATA, D.D.S.
Post-Closing Trial Balance
September 30
Debit
Cash
.....................................................................
.....................................................................
Accounts Receivable .................................
Supplies ......................................................
Equipment ..................................................
Accumulated Depreciation—Equipment ..
Accounts Payable ......................................
Common Stock ...........................................
Retained Earnings......................................
Totals................................................
Credit
$12,133
6,950
612
17,280
$
$36,975
LO: 2, 4, Bloom: AP, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
288
13,680
20,000
3,007
$36,975
Problem 2.2
(a) Dec. 31 Accounts Receivable ($23,500 − $20,000)............ 3,500
Service Revenue.............................................
3,500
31 Unearned Service Revenue ($7,000 − $5,600)...... 1,400
Service Revenue.............................................
1,400
31 Supplies Expense .................................................. 5,400
Supplies ($8,400 − $3,000) .............................
5,400
31 Depreciation Expense ........................................... 5,000
Accumulated Depreciation—
Equipment ($33,000 − $28,000) ...................
5,000
31 Interest Expense($500 − $350) ..............................
Interest Payable ..............................................
150
31 Insurance Expense ................................................
Prepaid Insurance ($3,350 - $2,500) ..............
850
150
850
31 Salaries and Wages Expense ($11,300 − $10,000) 1,300
Salaries and Wages Payable .........................
1,300
(b)
MASON ADVERTISING
Income Statement
For the Year Ended December 31, 2025
Revenues
Service revenue ................................
Expenses
Salaries and wages expense ............
Supplies expense ..............................
Depreciation expense .......................
Rent expense.....................................
Insurance expense ............................
Interest expense ................................
Total expenses ...........................
Net income ...................................................
$63,500
$11,300
5,400
5,000
4,000
850
500
27,050
$36,450
Problem 2.2 (Continued)
MASON ADVERTISING
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, January 1 ................................
Add: Net income ....................................................
Retained earnings, December 31...........................
$ 3,500
36,450
$39,950
MASON ADVERTISING
Balance Sheet
December 31, 2025
Assets
Cash ...........................................................................
Accounts receivable..................................................
Supplies .....................................................................
Prepaid insurance .....................................................
Equipment ..................................................................
Less: Accumulated depreciation—equipment .......
Total assets .................................................
$11,000
23,500
3,000
2,500
$60,000
33,000
27,000
$67,000
Liabilities and Stockholders’ Equity
Liabilities
Notes payable ..................................................
Accounts payable ............................................
Unearned service revenue ..............................
Salaries and wages payable ...........................
Interest payable ...............................................
Total liabilities ...........................................
Stockholders’ equity
Common stock.................................................
Retained earnings ...........................................
Total liabilities and stockholders’
equity .....................................................
$ 5,000
5,000
5,600
1,300
150
$17,050
10,000
39,950
49,950
$67,000
(c) 1. Interest is $50 per month or 1% of the note payable. 1% X 12 = 12%
interest per year.
2. Salaries and Wages Expense, $11,300 less Salaries and Wages
Payable 12/31/25, $1,300 = $10,000. Total Payments, $12,500 –
$10,000 = $2,500 Salaries and Wages Payable 12/31/24.
LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 35-40, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Problem 2.3
1.
Dec. 31 Salaries and Wages Expense........................
Salaries and Wages Payable..................
(5 X $700 X 2/5) = $1,400
(3 X $600 X 2/5) =
720
Total accrued salaries $2,120
2,120
2,120
2.
31 Unearned Rent Revenue ............................... 94,000
Rent Revenue .........................................
94,000
(5 X $6,000 X 2) =
$60,000
(4 X $8,500 X 1) =
34,000
Total rent recognized $94,000
3.
31 Advertising Expense .....................................
Prepaid Advertising ................................
(A650 – $500 ($6,000/12) per month
for 8 months) = $4,000
(B974 – $300 per month
($7,200/24) for 3 months) =
900
Total advertising expense
$4,900
4,900
31 Interest Expense ............................................
Interest Payable
($60,000 X 12% X 7/12) .......................
4,200
4.
4,900
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
4,200
Problem 2.4
(a) Nov. 30 Supplies Expense ($5,500 − $1,500) .....
Supplies...........................................
4,000
30 Depreciation Expense............................
Accumulated Depreciation—
Equipment ...................................
15,000
30 Interest Expense ....................................
Interest Payable ..............................
11,000
4,000
15,000
11,000
Problem 2.4 (Continued)
(b)
BELLEMY FASHION CENTER
Adjusted Trial Balance
November 30, 2025
Dr.
Cash ..................................................................... $ 28,700
Accounts Receivable ..........................................
33,700
Inventory ..............................................................
45,000
Supplies ($5,500 - $4,000) ...................................
1,500
Equipment ...........................................................
133,000
Accumulated Depr.— Equipment
($24,000 + $15,000) ..................................
Notes Payable .....................................................
Accounts Payable ...............................................
Common Stock ....................................................
Retained Earnings...............................................
Sales Revenue.....................................................
Sales Returns and Allowances ..........................
4,200
Cost of Goods Sold .............................................
495,400
Salaries and Wages Expense .............................
140,000
Advertising Expense...........................................
26,400
Utilities Expenses ...............................................
14,000
Maintenance and Repairs Expense ...................
12,100
Delivery Expense ................................................
16,700
Rent Expense ......................................................
24,000
Supplies Expense ($0 + $4,000) .........................
4,000
Depreciation Expense ($0 + $15,000).................
15,000
Interest Expense ($0 + $11,000) .........................
11,000
Interest Payable ($0 + $11,000) ..........................
Totals ............................................................. $1,004,700
Cr.
$
39,000
51,000
48,500
90,000
8,000
757,200
11,000
$1,004,700
Problem 2.4 (Continued)
(c)
BELLEMY FASHION CENTER
Income Statement
For the Year Ended November 30, 2025
Revenues
Sales revenue...................................
Less: Sales returns and
allowances ............................
Net sales ...........................................
Cost of goods sold .....................................
Gross profit.................................................
Operating expenses
Selling expenses
Salaries and wages expense
($140,000 X 70%) .................
Advertising expense ...............
Rent expense
($24,000 X 80%) ...................
Delivery expense ....................
Utilities expenses
($14,000 X 80%) ...................
Depreciation expense .............
Supplies expense ...................
Total selling expenses .....
Administrative expenses
Salaries and wages expense
($140,000 X 30%) .................
Maintenance and repairs
expense ................................
Rent expense
($24,000 X 20%) ...................
Utilities expenses
($14,000 X 20%) ...................
Total admin. expenses ....
Total oper. expenses .
Income from operations ...........................
Other expenses and losses
Interest expense ..............................
Net loss .................................................
$757,200
4,200
753,000
495,400
257,600
$98,000
26,400
19,200
16,700
11,200
15,000
4,000
$190,500
42,000
12,100
4,800
2,800
61,700
252,200
5,400
($5,000)
11,000
($ 5,600)
Problem 2.4 (Continued)
BELLEMY FASHION CENTER
Retained Earnings Statement
For the Year Ended November 30, 2025
Retained earnings, December 1, 2024 ...........
Less: Net loss.................................................
Retained earnings, November 30, 2025 .........
$8,000
5,600
$2,400
BELLEMY FASHION CENTER
Balance Sheet
November 30, 2025
Assets
Current assets
Cash
..................................................................
Accounts receivable ................................
Inventory ..................................................
Supplies ...................................................
Total current assets .......................
Property, plant, and equipment
Equipment ................................................
Less: Accumulated depreciation—
equipment .......................................
Total assets.....................................
$28,700
33,700
45,000
1,500
$108,900
133,000
39,000
94,000
$202,900
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable due next year ..................
Accounts payable ....................................
Interest payable .......................................
Total current liabilities ...................
Long-term liabilities
Notes payable ($51,000 - $30,000) ..........
Total liabilities ................................
Stockholders’ equity
Common stock ........................................
Retained earnings ...................................
Total liabilities and stockholders’
equity...........................................
$30,000
48,500
11,000
$ 89,500
21,000
110,500
90,000
2,400
92,400
$202,900
Problem 2.4 (Continued)
(d) Nov. 30 Sales Revenue............................................
Income Summary ................................
757,200
30 Income Summary .......................................
Sales Returns and Allowances ..........
Cost of Goods Sold ............................
Salaries and Wages Expense.............
Advertising Expense ..........................
Utilities Expenses ...............................
Maintenance and Repair Expense .....
Delivery Expense ................................
Rent Expense ......................................
Supplies Expense ...............................
Depreciation Expense ........................
Interest Expense .................................
762,800
30 Retained Earnings .....................................
Income Summary ($757,200 - $762,800) .
5,600
(e)
757,200
4,200
495,400
140,000
26,400
14,000
12,100
16,700
24,000
4,000
15,000
11,000
5,600
BELLEMY FASHION CENTER
Post-Closing Trial Balance
November 30, 2025
Debit
Cash
...........................................................................
...........................................................................
Accounts Receivable .......................................
Inventory ...........................................................
Supplies
................................................................
Equipment ........................................................
Accumulated Depreciation—Equipment ........
Notes Payable ..................................................
Accounts Payable ............................................
Interest Payable................................................
Common Stock .................................................
Retained Earnings ............................................
Credit
$ 28,700
33,700
45,000
1,500
133,000
$241,900
LO: 3, 4, 5, Bloom: AP, Difficulty: Moderate, Time: 40-50, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
$ 39,000
51,000
48,500
11,000
90,000
2,400
$241,900
Problem 2.5
(a)
-1Dec. 31 Depreciation Expense .............................
Accum. Depreciation—Equipment
(1/16 X [$192,000 − $24,000]) ............
-2Dec. 31 Interest Expense ......................................
Interest Payable
($90,000 X 8% X 72/360) .....................
-3Dec. 31 Admissions Revenue ..............................
Unearned Admissions Revenue
(2,000 X $30) .......................................
10,500
10,500
1,440*
1,440*
60,000
60,000
-4Dec. 31 Prepaid Advertising .................................
Advertising Expense .............................
1,100
-5Dec. 31 Salaries and Wages Expense .................
Salaries and Wages Payable ................
4,700
(b) 1.
2.
3.
4.
1,100
4,700
Interest expense, $2,840 ($1,400 + $1,440).
Admissions revenue, $320,000 ($380,000 – $60,000).
Advertising expense, $12,580 ($13,680 – $1,100).
Salaries and wages expense, $62,300 ($57,600 + $4,700).
*Note to instructor: If 30-day months are assumed, interest expense =
$1,400 ($90,000 X 8% X 70/360).
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Problem 2.6
(a)
-1Dec. 31 Service Revenue ........................................
Unearned Service Revenue ....................
6,000
-2Dec. 31 Accounts Receivable .................................
Service Revenue.....................................
4,900
-3Dec. 31 Bad Debt Expense......................................
Allowance for Doubtful Accounts ..........
1,430
-4Dec. 31 Insurance Expense ....................................
Prepaid Insurance ...................................
480
-5Dec. 31 Depreciation Expense ................................
Accumulated Depreciation—Equipment
($25,000 X 10%) .............................
-6Dec. 31 Interest Expense ........................................
Interest Payable
($7,200 X 10% X 30/360) .................
6,000
4,900
1,430
480
2,500
2,500
60
60
-7Dec. 31 Prepaid Rent ...............................................
Rent Expense ..........................................
750
-8Dec. 31 Salaries and Wages Expense ....................
Salaries and Wages Payable ..................
2,510
750
2,510
Problem 2.6 (Continued)
(b)
PEREZ CONSULTING ENGINEERS
Income Statement
For the Year Ended December 31, 2025
Service revenue ($100,000 – $6,000 + $4,900) ........
Expenses
Salaries and wages expense
($30,500 + $2,510) .........................................
Rent expense ($9,750 – $750) ..........................
Depreciation expense ......................................
Bad debt expense ............................................
Utilities expenses .............................................
Office expense..................................................
Insurance expense ...........................................
Interest expense ...............................................
Total expenses ............................................
Net income ..............................................................
$98,900
$33,010
9,000
2,500
1,430
1,080
720
480
60
48,280
$50,620
PEREZ CONSULTING ENGINEERS
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained Earnings, January 1 .................................
Add: Net income .......................................................
Less: Dividends........................................................
Retained Earnings, December 31 ............................
$ 42,010a
50,620
17,000
$ 75,630
(a)
$ 25,010
17,000
$ 42,010
Retained Earnings—trial balance .........................
2025 Dividend recorded in Retained Earnings ....
Retained Earnings, as of January 1, 2025 ..............
Problem 2.6 (Continued)
PEREZ CONSULTING ENGINEERS
Balance Sheet
December 31, 2025
Assets
Current assets
Cash .........................................
Accounts receivable
($49,600 + $4,900) ................
Less: Allowance for
doubtful accounts ........
Supplies ...................................
Prepaid insurance
($1,100 – $480) .....................
Prepaid rent .............................
Total current assets .........
Equipment ......................................
Less: Accumulated depreciation ..
Total assets ......................
Liabilities and stockholders’ equity
Current liabilities
Notes payable ...........................
Unearned service revenue .......
Salaries and wages payable ....
Interest payable ........................
Common Stock ................................
Retained earnings ...........................
Total liabilities and
stockholders’ equity ......
$29,500
$54,500
2,180*
52,320
1,960
620
750
$ 85,150
25,000
8,750**
16,250
$101,400
$7,200
6,000
2,510
60
$ 15,770
10,000
75,630
85,630
*($750 + $1,430)
**($6,250 + $2,500)
LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
$101,400
Problem 2.7
(a)
Sep. 30 Accounts Receivable ($1,000 - $400) ..............
Service Revenue .......................................
600
30 Rent Expense....................................................
Prepaid Rent ($1,800 - $900) .....................
900
30 Supplies Expense .............................................
Supplies ($1,200 - $180) ............................
1,020
30 Depreciation Expense ......................................
Accumulated Depreciation—Equipment .
350
30 Interest Expense ...............................................
Interest Payable.........................................
50
30 Unearned Rent Revenue ($1,000 - $800) .........
Rent Revenue ............................................
200
30 Salaries and Wages Expense ($9,400 - $8,800) ..
Salaries and Wages Payable ....................
600
(b)
600
900
1,020
350
50
200
600
ROLLING HILLS GOLF INC.
Income Statement
For the Quarter Ended September 30, 2025
Revenues
Service revenue ...............................................
Rent revenue ....................................................
Total revenue.............................................
Expenses
Salaries and wages expense ...........................
Rent expense ...................................................
Supplies expense.............................................
Utilities expenses.............................................
Depreciation expense ......................................
Interest expense...............................................
Total expenses ............................................
Net income ...............................................................
$14,700
900
$15,600
$9,400
1,800
1,020
470
350
50
13,090
$ 2,510
Problem 2.7 (Continued)
ROLLING HILLS GOLF INC.
Retained Earnings Statement
For the Quarter Ended September 30, 2025
Retained earnings, July 1, 2025 ...........................................
Add: Net income ...................................................................
Less: Dividends ....................................................................
Retained earnings, September 30, 2025 ..............................
$
0
2,510
600
$1,910
ROLLING HILLS GOLF INC.
Balance Sheet
September 30, 2025
Assets
Current assets
Cash .........................................
Accounts receivable ................
Supplies ...................................
Prepaid rent .............................
Total current assets ..........
Equipment .......................................
Less: Accumulated depreciation..
Total assets .......................
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable ...........................
Accounts payable.....................
Unearned rent revenue ............
Salaries and wages payable ....
Interest payable ........................
Stockholders’ Equity
Common stock ................................
Retained earnings ...........................
Total stockholders’ equity
Total liabilities and
stockholders’ equity ........
$ 6,700
1,000
180
900
$ 8,780
15,000
350
$ 5,000
1,070
800
600
50
14,650
$23,430
$ 7,520
14,000
1,910
15,910
$23,430
Problem 2.7 (Continued)
(c) The following accounts would be closed: Service Revenue, Rent Revenue,
Salaries and Wages Expense, Rent Expense, Utilities Expenses,
Depreciation Expense, Supplies Expense, Interest Expense, Dividends.
(d) Interest of 12% per year equals a monthly rate of 1%; monthly interest
is $50 ($5,000 X 1%). Since total interest expense is $50, the note has
been outstanding one month.
LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Problem 2.8
(a)
Dec. 31 Accounts Receivable ($19,500 − $16,000).......
Service Revenue........................................
(b)
3,500
3,500
31 Supplies Expense .............................................
Supplies ($9,400 − $6,500) ........................
2,900
31 Insurance Expense ...........................................
Prepaid Insurance ($3,350 − $1,790) ........
1,560
31 Depreciation Expense ......................................
Accumulated Depreciation—Equipment .
($30,000 - $25,000)
5,000
31 Interest Expense ...............................................
Interest Payable .........................................
560
31 Unearned Service Revenue ($5,000 − $3,100).
Service Revenue........................................
1,900
31 Salaries and Wages Expense ($9,820 - $9,000) ..
Salaries and Wages Payable ....................
820
2,900
1,560
5,000
560
1,900
820
VEDULA ADVERTISING
Income Statement
For the Year Ended December 31, 2025
Revenues
Service revenue ................................................
Expenses
Salaries and wages expense ............................
Depreciation expense .......................................
Rent expense.....................................................
Supplies expense ..............................................
Insurance expense ............................................
Interest expense ................................................
Total expenses .............................................
Net income.................................................................
$63,000
$9,820
5,000
4,350
2,900
1,560
560
24,190
$38,810
Problem 2.8 (Continued)
VEDULA ADVERTISING
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, January 1 .............................
Add: Net income ..................................................
Less: Dividends ...................................................
Retained earnings, December 31........................
$ 5,500
38,810
10,000
$34,310
VEDULA ADVERTISING
Balance Sheet
December 31, 2025
Assets
Current assets
Cash .......................................................... $11,000
Accounts receivable ................................. 19,500
Supplies ....................................................
6,500
Prepaid insurance ....................................
1,790
Total current assets ...........................
Equipment ....................................................
60,000
Less: Accumulated depreciation ................
30,000
Total assets ........................................
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable ........................................
Accounts payable ..................................
Unearned service revenue ....................
Salaries and wages payable ..................
Interest payable.....................................
Stockholders’ Equity
Common stock .......................................
Retained earnings ..................................
Total stockholders’ equity ..................
Total liabilities and
stockholders’ equity.....................
$ 8,000
2,000
3,100
820
560
$38,790
30,000
$68,790
$ 14,480
20,000
34,310
54,310
$68,790
Problem 2.8 (Continued)
(c) Service Revenue, Salaries and Wages Expense, Depreciation Expense,
Rent Expense, Supplies Expense, Insurance Expense, Interest Expense,
Dividends.
(d) Interest is $56 per month or 0.7% of the note payable ($56 ÷ $8,000).
0.7% X 12 = 8.4% interest per year.
(e) Salaries and Wages Expense, $9,820, less Salaries and Wages Payable
12/31/25, $820 = $9,000. Total payments, $10,500 – $9,000 = $1,500 Salaries
and Wages Payable 12/31/24.
LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
Problem 2.9
(a), (b), (d)
Bal.
Cash
15,000
Prepaid Insurance
9,000 Adj.
3,500
5,500
Bal.
Salaries and Wages Expense
Bal.
80,000 Close 83,600
Adj.
3,600
83,600
83,600
Common Stock
Bal.
400,000
Accounts Receivable
Bal.
13,000
Retained Earnings
Bal.
82,000
Inc.
31,640
113,640
Allow. for Doubtful Accts.
Bal. 1,100
Adj.
460
1,560
Dues Revenue
8,900 Bal.
200,000
191,100
200,000
200,000
Adj.
Cls.
Land
Bal.
350,000
Close
120,000
Accum. Depr.—Buildings
Rent Receivable
Adj.
$1,600
5,900 Bal.
19,200 Bal.
Adj.
19,200
Depr. Expense
4,000 Close 19,000
15,000
19,000
Equipment
5,900
Rent Revenue
Close
Bal. 38,400
Adj. 4,000
42,400
Adj.
Adj.
Green Fees Revenue
Buildings
Bal.
Maintenance and Repairs
Expense
Bal.
24,000 Close 24,000
Bal.
150,000
Accum. Depr.—Equipment
17,600
1,600
19,200
Bal.
Adj.
Utilities Expenses
70,000
15,000
85,000
Insurance Expense
Bal.
54,000 Close
54,000
Adj.
Bad Debt Expense
460 Close
460
Adj.
Exp.
Inc.
3,500 Close
3,500
Income Summary
184,560
216,200
31,640
216,200
216,200
Problem 2.9 (Continued)
Salaries and Wages Payable
Adj.
3,600
(b)
Unearned Dues Revenue
Adj.
8,900
-1Dec. 31 Depreciation Expense .............................
Accumulated Depreciation—Buildings
(1/30 X $120,000) ..................................
-2Dec. 31 Depreciation Expense .............................
Accumulated Depreciation—
Equipment (10% X $150,000)………
4,000
4,000
15,000
15,000
-3Dec. 31 Insurance Expense ..................................
Prepaid Insurance .................................
3,500
-4Dec. 31 Rent Receivable .......................................
Rent Revenue (1/11 X $17,600)……
1,600
-5Dec. 31 Bad Debt Expense ...................................
Allowance for Doubtful Accounts
[($13,000 X 12%) – $1,100] .................
3,500
1,600
460
460
-6Dec. 31 Salaries and Wages Expense .................
Salaries and Wages Payable ................
3,600
-7Dec. 31 Dues Revenue ..........................................
Unearned Dues Revenue .....................
8,900
3,600
8,900
Problem 2.9 (Continued)
(c)
CRESTWOOD GOLF CLUB, INC.
Adjusted Trial Balance
December 31, XXXX
Cash ...............................................................
Accounts Receivable ....................................
Allowance for Doubtful Accounts ................
Rent Receivable .............................................
Prepaid Insurance ……………………………..
Land
........................................................................
........................................................................
Buildings ........................................................
Accum. Depreciation—Buildings .................
Equipment ......................................................
Accum. Depreciation—Equipment ...............
Salaries and Wages Payable ........................
Unearned Dues Revenue ..............................
Common Stock …………………………………
Retained Earnings .........................................
Dues Revenue................................................
Green Fees Revenue .....................................
Rent Revenue ................................................
Utilities Expenses ..........................................
Salaries and Wages Expense .......................
Maintenance and Repairs Expense ..............
Bad Debt Expense .........................................
Depreciation Expense ($15,000 + $4,000) ....
Insurance Expense ........................................
Totals ...................................................
Dr.
$ 15,000
13,000
Cr.
$
1,560
1,600
5,500
350,000
120,000
42,400
150,000
85,000
3,600
8,900
400,000
82,000
191,100
5,900
19,200
54,000
83,600
24,000
460
19,000
3,500
$839,660
$839,660
Problem 2.9 (Continued)
(d)
-Dec. 31Dues Revenue ........................................................
Green Fees Revenue .............................................
Rent Revenue .........................................................
Income Summary ............................................
-Dec 31Income Summary ...................................................
Utilities Expenses ...........................................
Bad Debt Expense ..........................................
Salaries and Wages Expense ........................
Maintenance and Repairs Expense ...............
Depreciation Expense ....................................
Insurance Expense .........................................
-Dec 31Income Summary ($216,200 -$184,560b) .............
Retained Earnings ..........................................
a
191,100
5,900
19,200
216,200a
184,560b
54,000
460
83,600
24,000
19,000
3,500
31,640
LO: 2, 3, 4,, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
31,640
Problem 2.10
(a), (b), (c)
Bal.
Cash
18,500
Bal.
Inventory
80,000
Bal.
Accounts Receivable
32,000
Allogw. for Doubtful Accts.
Bal.
700
Adj.
1,400
2,100
Bal.
Equipment
84,000
Accum. Depr.—Equipment
Bal.
35,000
Adj.
12,000
47,000
Prepaid Insurance
Bal.
5,100 Adj. 2,550
2,550
Notes Payable
Bal.
28,000
Adj.
Common Stock
Bal. 80,600
Sales Revenue
600,000 Bal.
600,000
Insurance Expense
Bal.
2,550 Cls.
2,550
Salaries and Wages
Expense (Sales)
Bal.
50,000 Cls. 52,400
Adj.
2,400
52,400
52,400
Bad Debt Expense
Adj.
1,400 Cls. 1,400
Interest Payable
Adj. 3,360
Adj.
Supplies
1,500
Retained Earnings
Bal. 10,000
Inc. 45,790
Bal. 55,790
Cls.
Bal.
Bal.
Adj.
Advertising Expense
6,700 Adj.
700
Cls.
6,000
6,700
6,700
Supplies Expense
5,000 Adj.
1,500
Cls.
3,500
5,000
5,000
Depr. Exp.
12,000 Cls.
12,000
Salaries and Wages Payable
Adj.
2,400
Cost of Goods Sold
Bal.
408,000 Cls.
408,000
Interest Expense
3,360 Cls.
3,360
Salaries and Wages Expense
(Administrative)
Adj.
65,000 Cls.
65,000
Prepaid Advertising
Adj.
700
Exp.
Inc.
Income Summary
554,210 Sales 600,000
45,790
600,000
600,000
Problem 2.10 (Continued)
(b)
-1Dec. 31 Bad Debt Expense ...................................
Allowance for Doubtful Accounts........
-2Dec. 31 Depreciation Expense ($84,000 ÷ 7) .......
Accumulated Depreciation—
Equipment ..................................
1,400
1,400
12,000
12,000
-3Dec. 31 Insurance Expense ..................................
Prepaid Insurance .................................
2,550
-4Dec. 31 Interest Expense ......................................
Interest Payable ....................................
3,360
-5Dec. 31 Salaries and Wages Expense (Sales) .....
Salaries and Wages Payable ................
2,400
-6Dec. 31 Prepaid Advertising .................................
Advertising Expense ............................
700
-7Dec. 31 Supplies ...................................................
Supplies Expense .................................
1,500
2,550
3,360
2,400
700
1,500
Problem 2.10 (Continued)
(c)
Dec. 31
Sales Revenue....................................................
Income Summary ........................................
Dec. 31
Income Summary ...............................................
Cost of Goods Sold ....................................
Advertising Expense ..................................
Salaries and Wages Expense (Admin.) .....
Salaries and Wages Expense (Sales) ........
Supplies Expense .......................................
Insurance Expense .....................................
Bad Debt Expense ......................................
600,000
600,000a
554,210b
408,000
6,000
65,000
52,400
3,500
2,550
1,400
Depreciation Expense ................................
Interest Expense .........................................
Dec. 31
Income Summary ($600,000a - $554,210b) ........
Retained Earnings ......................................
12,000
3,360
45,790
LO: 2, 3, 4 Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
45,790
*Problem 2.11
(a)
ARKANSAS SALES AND SERVICE
Income Statement
For the Month Ended January 31, 2025
(1)
Cash Basis
(2)
Accrual Basis
$ 75,000
$98,400*
Revenues .............................................
Expenses
Cost of computers & printers:
Purchased and paid ............
Cost of goods sold..............
Salaries and wages ...................
Rent............................................
Other operating expenses ........
Total expenses ..................
Net income (loss) ................................
*($2,550 X 30) + ($3,600 X 4) + ($500 X 15)
**($1,500 X 40) + ($2,500 X 6) + ($300 X 25)
***($1,500 X 30) + ($2,500 X 4) + ($300 X 15)
a
($6,000 / 3 months)
b
($8,400 + $2,000)
82,500**
9,600
6,000
8,400
106,500
$(31,500)
59,500***
12,600
2,000a
10,400b
84,500
$13,900
*Problem 2.11 (Continued)
(b)
ARKANSAS SALES AND SERVICE
Balance Sheet
As of January 31, 2025
Assets
Cash ................................................
Accounts receivable ......................
Inventory .........................................
Prepaid rent ($6,000 - $2,000) ........
Total assets ...............................
Liabilities and owners’ equity
Salaries and wages payable ..........
Accounts payable ..........................
Owner’s capital...............................
Total liabilities and owner’s
equity ......................................
a
Original investment
Cash sales
Cash purchases
Rent paid
Salaries paid
Other operating expenses
Cash balance Jan. 31
b
c
(1)
Cash Basis
(2)
Accrual
Basis
$58,500a
$ 58,500a
23,400
23,000b
4,000
$108,900
$58,500
$
$58,500c
3,000
2,000
103,900d
$58,500
$108,900
$ 90,000
75,000
(82,500)
(6,000)
(9,600)
(8,400)
$ 58,500
[(40 – 30) @ $1,500] + (2 @ $2,500) + (10 @ $300).
Initial investment minus net loss: $90,000 – $31,500.
d
Initial investment plus net income: $90,000 + $13,900.
*Problem 2.11 (Continued)
(c)
1.
The $23,400 in receivables from customers is an asset and a future
cash flow resulting from sales that is ignored. The cash basis
understates the amount of revenues and inflow of assets in January
from the sale of computers and printers by $23,400.
2.
The cost of computers and printers sold in January is overstated by
$23,000. The unsold computers and printers are an asset of $23,000
in the form of inventory.
3.
The cash basis ignores $3,000 of the salaries that have been earned
by the employees in January and will be paid in February.
4.
Rent expense on the cash basis is overstated by $4,000. This
prepayment is an asset in the form of two months’ future right to
the use of office, showroom, and repair space and should appear
on the balance sheet.
5.
Other operating expenses on a cash basis are understated by $2,000
as is the liability for the unpaid portion of these expenses incurred
in January.
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 35-40, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC:
Communication
3,000
59,200
506,500
5,800
506,500
3,000
6,000
247,000
5,800
280,500
280,500
280,500
Cr.
259,500
259,500
14,000
80,000
120,000
3,900
4,200
37,400
Dr.
259,500
33,500
226,000
3,000
6,000
14,600
700
50,000
107,700
2,000
42,000
Cr.
Balance Sheet
Key: (a) Expired Insurance ($31,900 - $3,900); (b) Supplies Used ($18,600 - $4,200); (c) Depreciation Expensed ($42,000 - $36,200); (d) Service
Revenue Recognized ($2,700 - $700); (e) Accrued Property Taxes ($21,000 - $18,000); (f) Taxes Accrued ($0 - $6,000)
33,500
(e)
6,000
14,400
28,000
12,000
21,000
280,500
59,200
5,800
(f)
14,400
28,000
12,000
21,000
30,500
9,400
16,900
109,000
Dr.
Totals
(c)
14,400
28,000
6,000
3,000
280,500
14,600
700
50,000
107,700
2,000
42,000
Cr.
Income Statement
Net Income
Totals
Prop. Taxes Payable
Depreciation Expense
Interest Payable
(a)
(b)
491,700
(f)
Supplies Expense
491,700
6,000
Insurance Expense
Totals
Interest Expense
(e)
18,000
14,000
Prop. Tax Expense
2,000
80,000
120,000
3,900
4,200
30,500
9,400
16,900
278,500
(d)
5,800
28,000
14,400
37,400
Dr.
30,500
9,400
16,900
2,000
(c)
(a)
(b)
Cr.
109,000
(d)
Dr.
Adjusted Trial Balance
109,000
14,000
14,600
2,700
50,000
107,700
2,000
36,200
Cr.
Adjustments
For the Year Ended September 30, 2025
Worksheet
COOKE COMPANY
Accounts Payable
Unearned Service Rev.
Mortgage Payable
Common Stock
Retained Earnings
Dividends
Service Revenue
Sal. and Wages Exp.
Maintenance
and Repairs Expense
Advertising Expense
Utilities Expenses
80,000
120,000
31,900
Prepaid Insurance
Land
Equipment
Accum. Depr.-Equip.
18,600
Supplies
Dr.
Trial Balance
37,400
Account Titles
Cash
(a)
*Problem 2.12
*Problem 2.12 (Continued)
(b)
COOKE COMPANY
Balance Sheet
September 30, 2025
Assets
Current assets
Cash
......................................................
Supplies .......................................
Prepaid insurance .......................
Total current assets ...........
Property, plant, and equipment
Land
......................................................
Equipment ...................................
Less: Accum. depreciation –
equipment ..................................
Total assets ........................
$37,400
4,200
3,900
$ 45,500
80,000
$120,000
42,000
78,000
158,000
$203,500
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable ..........................................
Current maturity of long-term debt ...............
Interest payable ..............................................
Property taxes payable ..................................
Unearned service revenue.............................
Total current liabilities ..........................
Long-term liabilities
Mortgage payable ($50,000 - $10,000*) .........
Total liabilities .......................................
Stockholders’ equity
Common stock ………………………………….
Retained earnings
($2,000 + $33,500 – $14,000) ........................
Total liabilities and stockholders’ equity .....
$14,600
10,000*
6,000
3,000
700
$ 34,300
40,000
74,300
107,700
21,500
129,200
$203,500
*Problem 2.12 (Continued)
(c) Sep. 30 Insurance Expense ...................................
Prepaid Insurance .............................
28,000
30 Supplies Expense .....................................
Supplies .............................................
14,400
30 Depreciation Expense ..............................
Accum. Depreciation—
Equipment .......................................
5,800
30 Unearned Service Revenue ($2,700 - $700)
Service Revenue ................................
2,000
30 Property Tax Expense ..............................
Property Taxes Payable ....................
3,000
30 Interest Expense .......................................
Interest Payable .................................
6,000
(d) Sep. 30 Service Revenue .....................................
Income Summary ............................
280,500
30 Income Summary ....................................
Salaries and Wages Expense .........
Maintenance and Repairs
Expense ........................................
Insurance Expense ..........................
Property Tax Expense .....................
Supplies Expense ............................
Utilities Expenses ............................
Interest Expense ..............................
Advertising Expense .......................
Depreciation Expense .....................
247,000b
30 Income Summary ($280,500a - $247,000b)..
Retained Earnings ..........................
33,500
30 Retained Earnings .................................
Dividends ........................................
14,000d
28,000
14,400
5,800
2,000
3,000
6,000
280,500a
109,000
30,500
28,000
21,000
14,400
16,900
12,000
9,400
5,800
33,500c
14,000
*Problem 2.12 (Continued)
(e)
COOKE COMPANY
Post-Closing Trial Balance
September 30, 2025
Debit
Cash
.......................................................................
.......................................................................
Supplies ........................................................
Prepaid Insurance ........................................
Land
.......................................................................
.......................................................................
Equipment ....................................................
Accumulated Depreciation – Equipment ....
Accounts Payable ........................................
Unearned Service Revenue .........................
Interest Payable............................................
Property Tax Payable ...................................
Mortgage Payable ........................................
Common Stock .............................................
Retained Earnings
($2,000 + $33,500c - $14,000d) .............
Credit
$ 37,400
4,200
3,900
80,000
120,000
$ 42,000
14,600
700
6,000
3,000
50,000
107,700
$245,500
21,500
$245,500
LO: 3, 4, 8, , Bloom: AP, Difficulty: Complex, Time: 40-50, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: None
UYJ2.1 Financial Reporting Problem
(a)
June 30, 2020 total assets: $120,700 million.
June 30, 2019 total assets: $115,095 million.
(b)
June 30, 2020 cash and cash equivalents: $16,181 million.
(c)
2020 research and development costs: $1,834 million.
2019 research and development costs: $1,861 million.
(d)
2020 net sales: $70,950 million.
2019 net sales: $67,684 million.
(e)
An adjusting entry for deferrals is necessary when the receipt/disbursement precedes the recognition in the financial statements. Accounts
such as prepaid insurance and prepaid rent may be included in the
Prepaid Expenses and Other Current Assets ($2,130 million at June 30,
2020). Both of these accounts would require an adjusting entry to
recognize the proper amount of expense incurred during the period. In
addition, depreciation expense is an adjusting entry related to a
deferral.
An adjusting entry for an accrual is necessary when recognition in the
financial statements precedes the cash receipt/disbursement, such as
interest or taxes payable. Other adjusting entries probably made by
P&G include interest revenue and expense and interest receivable and
interest payable. P&G reports $9,722 million of Accrued and Other
Liabilities at June 30, 2020.
(f)
2020 Depreciation and amortization expense: $3,013 million
2019 Depreciation and amortization expense: $2,824 million
(From the Statement of Cash Flows)
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Communication
UYJ2.2 Comparative Analysis Case
(a)
The Coca-Cola Company percentage increase is computed as follows:
Total assets (December 31, 2020) ..........................................
Less: Total assets (December 31, 2019) ...............................
Difference ................................................................................
$87,296
86,381b
$915a
$915a ÷ $86,381b = 1.1%
PepsiCo, Inc.’s percentage increase is computed as follows:
Total assets (December 26, 2020) ..........................................
Less: Total assets (December 28, 2019) ...............................
Difference ................................................................................
$92,918
78,547c
$14,371d
$14,371d ÷ $78,547c = 18.3%
Coca-Cola Company had a very small increase; but, PepsiCo had a larger
increase.
(b)
3-Year Growth Rate
Net sales
Net income
e
($33,014 ÷ $34,300)-1
f
($7,768 ÷ $6,476)-1
(c)
The Coca-Cola Company
(3.75)%e
19.95%f
PepsiCo, Inc.
8.83%g
(42.87)%h
g
($70,372 ÷ $64,661) -1
h
($7,175 ÷ $12,559) -1
The Coca-Cola Company had depreciation and amortization expense
of $1,536 million; PepsiCo, Inc. had depreciation and amortization
expense of $2,548 million.
Comparative Analysis Case (Continued)
PepsiCo has substantially more property, plant, and equipment than
does Coca-Cola. PepsiCo is engaged in three different types of
businesses: soft drinks, snack-food, and juices. As a result, it has more
tangible fixed assets. PepsiCo also has substantially more amortizable
intangible assets. Amortizable intangible assets for Coke and Pepsi
increase the amount of amortization expense recorded in income. The
amount of property, plant, and equipment and amortizable intangible
assets reported for these two companies is as follows: (000,000)
The Coca-Cola Company
Property, plant, and
equipment (net)
Amortizable intangible
assets (net)
PepsiCo, Inc.
$ 10,777
$21,369
649
$11,426
1,703
$23,072
LO: 3, 4, Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, Research, AICPA PC:
Communication
UYJ2.3 Financial Statement Analysis
Current
Year
Prior
Year
2 Years
Ago
%
Change
Current
year
%
Change
Last year
$14,580
$14,792
$14,197
-1.43%
4.19
Operating Profit
1,024
2,837
1,562
-63.91%
81.63%
Net Cash Flow less
Capital Expenditures
1,211
1,170
1,225
3.50%
-4.49%
633
1,808
961
-64.99%
88.14%
(a)
Sales
Net Earnings
(b)
Kellogg experienced a slight decrease in sales in the current year
which followed an increase in the previous year. The gross profit
percentage decreased after an increase in the prior year. This
coincides with declining operating profit but a solid increase in cash
flows, compared to prior years, suggests it faces a challenging period
and might be starting to recover. This may bode well for the strength
and flexibility of its business model.
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Communication
UYJ2.4 Accounting, Analysis, and Principles
Accounting
Dec. 31
Dec. 31
Dec. 31
Dec. 31
Dec. 31
Depreciation Expense ..............................
Accumulated Depreciation—
Equipment ..................................
($9,500 = ($192,000 – $40,000) ÷ 16)
9,500a
Interest Expense .......................................
Interest Payable .................................
$8,250 = ($90,000 X 10%) X 11/12)
8,250d
Unearned Service Revenue......................
Service Revenue................................
($10,000 = ($50 X 200))
10,000
Advertising Expense ................................
Prepaid Advertising ..........................
2,500b
Salaries and Wages Expense ..................
Salaries and Wages Payable ............
3,500c
9,500
8,250
10,000
2,500
3,500
Accounting, Analysis, and Principles (Continued)
Analysis
Ticket revenue
Less:
Depreciation expense
Advertising expense
Salaries and wages
expense
Interest expense
Net income
Income before
Adjustments
$360,000
Adjustments
$10,000
Income after
Adjustments
$370,000
(18,680)
(9,500)a
(2,500)b
(9,500)
(21,180)
(3,500)c
(8,250)d
(71,100)
(9,650)
$258,570
(67,600)
(1,400)
$272,320
Without recording the adjusting entries, Amato’s income is overstated.
In addition, without the adjustments, Amato’s current liabilities and
current assets are misstated, which could affect the evaluation of
Amato's liquidity.
Principles
The tradeoffs are between the timeliness of the reports, which
contributes to relevance, and verifiability, the lack of which detracts
from faithful representation. That is, by preparing reports more
frequently, the company provides more timely information, which can
make a difference to a statement reader who needs to make a decision.
However, preparing statements more frequently requires more subjective
estimates, which reduces faithful representation.
LO: 3, 4, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC:
Communication
Codification Research Case
(a) The three essential characteristics of assets.
Search String: asset and characteristics.
CON6, Par26. An asset has three essential characteristics: (a) it
embodies a probable future benefit that involves a capacity, singly or in
combination with other assets, to contribute directly or indirectly to
future net cash inflows, (b) a particular entity can obtain the benefit and
control others’ access to it, and (c) the transaction or other event giving
rise to the entity’s right to or control of the benefit has already occurred.
(b) Three essential characteristics of liabilities.
Search String: liability and characteristic.
CON6, Par36. A liability has three essential characteristics: (a) it
embodies a present duty or responsibility to one or more other entities
that entails settlement by probable future transfer or use of assets at a
specified or determinable date, on occurrence of a specified event, or on
demand, (b) the duty or responsibility obligates a particular entity,
leaving it little or no discretion to avoid the future sacrifice, and (c) the
transaction or other event obligating the entity has already happened.
(c) Uncertainty, and its effects on financial statements.
Search Strings: “uncertainty”, effect of uncertainty.
CON6, Par44. Uncertainty about economic and business activities and
results is pervasive, and it often clouds whether a particular item qualifies
as an asset or a liability of a particular entity at the time the definitions are
applied. The presence or absence of future economic benefit that can be
obtained and controlled by the entity or of the entity’s legal, equitable, or
constructive obligation to sacrifice assets in the future can often be
discerned reliably only with hindsight. As a result, some items that with
hindsight actually qualified as assets or liabilities of the entity under the
definitions may, as a practical matter, have been recognized as expenses,
losses,
revenues,
or
gains
or
Codification Research Case (Continued)
remained unrecognized in its financial statements because of uncertainty
about whether they qualified as assets or liabilities of the entity or
because of recognition and measurement considerations stemming from
uncertainty at the time of assessment. Conversely, some items that with
hindsight did not qualify under the definitions may have been included as
assets or liabilities because of judgments made in the face of uncertainty
at the time of assessment.
CON6, Par45. An effect of uncertainty is to increase the costs of financial reporting in general and the costs of recognition and measurement
in particular. Some items that qualify as assets or liabilities under the
definitions may, therefore, be recognized as expenses, losses, revenues,
or gains or remain unrecognized as a result of cost and benefit analyses
indicating that their formal incorporation in financial statements is not
useful enough to justify the time and effort needed to do it. It may be
possible, for example, to make the information more reliable in the face
of uncertainty by exerting greater effort or by spending more money, but
it also may not be worth the added cost.
Note to instructors: The FASB codification does not contain the
Concepts Statements. However, the Concepts Statements can be
accessed at another link on the FASB website.
(d) The difference between realization and recognition
Search String: realization, recognition.
CON6, Par143. Realization in the most precise sense means the
process of converting noncash resources and rights into money and is
most precisely used in accounting and financial reporting to refer to
sales of assets for cash or claims to cash. The related terms realized and
unrealized, therefore, identify revenues or gains or losses on assets sold
and unsold, respectively. Those are the meanings of realization and
related terms in the Board’s conceptual framework. Recognition is the
process of formally recording or incorporating an item in the financial
statements of an entity. Thus, an asset, liability, revenue, expense, gain,
or loss may be recognized (recorded) or unrecognized (unrecorded).
Realization and recognition are not used as synonyms, as they
sometimes are in accounting and financial literature.
LO: 1, Bloom: C, Difficulty: Moderate, Time: 25-30, AACSB: Communication, Technology, AICPA BB: Technology, AICPA FC: Measurement, Reporting,
Research, AICPA PC: Communication
CHAPTER 3
Income Statement and Related Information
Assignment Classification Table (By Topic)
Topics
Questions
1.
Income measurement
concepts, quality of
earnings.
1, 2, 3, 5,
6, 7, 8, 9, 10,
22, 28, 29, 30,
38, 39, 40, 41
2.
Computation of net
income from balance
sheets and selected
accounts.
3.
Multiple-step income
statements; earrings
per share.
4.
Brief
Exercises
Exercises
2, 3, 4, 6
1
1, 2, 3, 8
10, 11,
12,13, 14,
15, 20, 21,
22, 23, 24
3, 4 5, 6
5, 6, 7, 9, 11 1, 4
Single-step income
statements.
8, 11,
25, 26
1, 2, 8
4, 5, 7, 13,
16
2, 3, 4, 5
5.
Discontinued
operations; Intraperiod
tax allocation.
16, 17, 18,
19, 21, 22,
23, 25, 26,
27, 32
4, 5
8, 9, 13,
3, 5, 7
6.
Comprehensive
income.
31
8
14, 15, 16
7.
Retained earnings
statement; statement
of stockholders’ equity
27
7, 8
9, 10, 12,
15, 16
8.
Revenue recognition
33, 34, 35,
36, 37, 38
9, 10, 11,
12, 13,14
17, 18, 19
*9.
Accounting changes;
prior period
adjustments; errors.
4, 11, 41
15, 16, 17
20
*This material covered in an appendix.
Critical
Thinking
Problems
1, 5
7
1, 2, 4, 5, 6
Assignment Classification Table (By Learning Objective)
Learning Objectives
Questions
Brief
Exercises
Exercises
Problems
Critical
Thinking
1.
Identify the uses,
limitations, and basic
content of an income
statement.
1, 2, 3, 5,
6, 7, 8, 9,
10, 11, 12,
13, 14, 15,
17, 19, 20,
27, 28, 29
1, 2, 3, 4,
5, 6
1, 2, 3, 4, 5,
6, 7, 8, 9,
10, 11, 13,
16
1, 2, 3, 4,
5, 6, 7
1, 4, 5, 6
2.
Discuss the accounting
for unusual income
items.
12, 16, 17,
18, 21, 22,
23, 25, ,
27, 30, 31,
4, , 8
2, 8, 13, 14,
16
1, 3,
6, 7
1, 4, 5, 6, 7
3.
Explain the reporting of
stockholders’ equity.
3, 10,11,
24, 26, 28,
7,
9, 12, 15, 16
1, 2, , 4,
5, 6, 7
6
4.
Explain the revenue
recognition principle.
32,33, 34,
35, 36, 37,
9, 10, 11
12, 13, 14
17, 18, 19
5.
Describe the concept of
earnings quality.
38,39, 40
*6. Explain the reporting of
accounting changes,
estimates, and errors.
4, 10,11,
41
*This material covered in an appendix.
2,
15, 16, 17
20
3
6
Assignment Characteristics Table
Level of
Difficulty
Time
(minutes)
Computation of net income.
Compute income measures.
Income statement items.
Single-step income statement.
Multiple-step and single-step statements
Multiple-step statement
Multiple-step and single-step statements
Income statement, EPS.
Multiple-step statement with retained earnings statement
Earnings per share.
Condensed income statement—periodic inventory
method.
Retained earnings statement.
Earnings per share.
Comprehensive income.
Comprehensive income.
Various reporting formats.
Fundamentals of revenue recognition
Determine transaction price
Allocate transaction price
Change in accounting principle.
Simple
Simple
Simple
Moderate
Simple
Moderate
Moderate
Simple
Simple
Simple
Moderate
18–20
10–15
25–35
20–25
30–35
30–35
30–40
15–20
30–35
20–25
20–25
Simple
Moderate
Simple
Moderate
Moderate
Simple
Simple
Moderate
Moderate
20–25
15–20
15–20
15–20
30–35
10–15
10–15
15–20
15–20
Moderate
Simple
30–35
25–30
Moderate
Moderate
30–40
45–55
P3.5
P3.6
P3.7
Multiple-step statement, retained earnings statement
Single-step statement, retained earnings statement,
periodic inventory.
Various income-related items.
Multiple- and single-step statements, retained earnings
statement.
Unusual or infrequent items.
Retained earnings statement, prior period adjustment.
Income statement, irregular items.
Moderate
Moderate
Moderate
20–25
25–35
25–35
CT3.1
CT3.2
CT3.3
CT3.4
CT3.5
CT3.6
CT3.7
Identification of income statement deficiencies.
Earnings management.
Earnings management.
Income reporting items.
Identification of income statement weaknesses.
Classification of income statement items.
Comprehensive income.
Simple
Moderate
Simple
Moderate
Moderate
Moderate
Simple
20–25
20–25
15–20
30–35
30–40
20–25
10–15
Item
Description
E3.1
E3.2
E3.3
E3.4
E3.5
E3.6
E3.7
E3.8
E3.9
E3.10
E3.11
E3.12
E3.13
E3.14
E3.15
E3.16
E3.17
E3.18
E3.19
E3.20
P3.1
P3.2
P3.3
P3.4
Answers to Questions
1. The income statement is important because it provides investors and creditors with information that
helps them predict the amount, timing, and uncertainty of future cash flows. It helps investors and
creditors predict future cash flows in a number of different ways. First, investors and creditors can use
the information on the income statement to evaluate the past performance of the company. Second,
the income statement helps users of the financial statements to determine the risk (level of
uncertainty) of income—revenues, expenses, gains, and losses—and highlights the relationship
among these various components.
It should be emphasized that the income statement is used by parties other than investors and
creditors. For example, customers can use the income statement to determine a company’s ability
to provide needed goods or services, unions examine earnings closely as a basis for salary discussions, and the government uses the income statements of companies as a basis for formulating
tax and economic policy.
LO: 1, Bloom: K, Difficulty: Simple, Time: 5-7, AACSB: knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
2. Information on past transactions can be used to identify important trends that, if continued, provide
information about future performance. If a reasonable correlation exists between past and future
performance, predictions about future earnings and cash flows can be made. For example, a loan
analyst can develop a prediction of future performance by estimating the rate of growth of past
income over the past several periods and project this into the next period. Additional information
about current economic and industry factors can be used to adjust the trend rate based on historical
information.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
3. Some situations in which changes in value are not recorded in income are:
(a) Unrealized gains or losses on available-for-sale debt investments,
(b) Changes in the fair values of long-term liabilities, such as bonds payable,
(c) Changes (increases) in value of property, plant and equipment, such as land, natural resources,
or equipment,
(d) Changes (increases) in the values of intangible assets such as customer goodwill, brand value,
or intellectual capital.
Note that some of these omissions arise because the items (e.g., brand value) are not recognized
in financial statements, while others (value of land) are recorded in financial statements but measurement is at historical cost.
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4. Some situations in which application of different accounting methods or estimates lead to comparison
problems include:
(a) Inventory methods—LIFO vs. FIFO,
(b) Depreciation Methods—straight-line vs. accelerated,
(c) Accounting for long-term contracts—percentage-of-completion vs. completed-contract,
(d) Estimates of useful lives or salvage values for depreciable assets,
(e) Estimates of bad debts,
(f) Estimates of warranty costs.
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Questions Chapter 3 (Continued)
5. The transaction approach focuses on the activities that have occurred during a given period and
instead of presenting only a net change, a description of the components that comprise the change is
included. In the capital maintenance approach, only the net change (income) is reflected whereas the
transaction approach not only provides the net change (income) but the components of income
(revenues and expenses, gains and losses). The final net income figure should be the same under
either approach given the same valuation base.
LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge,Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
6. Caution should be exercised because many assumptions and estimates are made in accounting
and the net income figure is a reflection of these assumptions. If for any reason the assumptions are
not well-founded, distortions will appear in the income reported. The objectives of the application of
generally accepted accounting principles to the income statement are to measure and report the
results of operations as they occur for a specified period without recognizing any artificial exclusions
or modifications.
LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge,Communication, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation,
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7. The major distinction between revenues and gains (or expenses and losses) depends on the typical
activities of the company. Revenues (expenses) can occur from a variety of different sources, but
these sources constitute the entity’s ongoing major or central operations. Gains (losses) also can
arise from many different sources, but these sources occur from peripheral or incidental transactions
of an entity.
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8. The advantages of the single-step income statement are: (1) simplicity and conciseness, (2) probably
better understood by the layperson, (3) emphasis on total costs and expenses, and net income, and
(4) does not imply priority of one revenue or expense over another. The disadvantages are that it does
not show the relationship between sales revenue and cost of goods sold and it does not show other
important relationships and information, such as income from operations, income before income tax,
etc.
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9. Operating items are the expenses and revenues which relate directly to the principal activity of the
company; they are the revenue and expenses which contribute to the sale of goods or services for
which a company was organized. The nonoperating section of an income statement is a report of
the revenues and expenses resulting from secondary or auxiliary activities of the company. In
addition, gains and losses that are infrequent or unusual, or both, are normally reported in the
section. Generally these breakdown into two main subsections: "Other revenues and gains" and
"Other expenses and losses."
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10. (a) This transaction will be shown in the income statement in the "Other revenues and gains"
section.
(b) The bonus should be shown as an operating expense in the income statement. Although the
basis of computation is a percentage of net income, it is an ordinary operating expense to the
company and represents a cost of the service received from employees.
(c) If the amount is immaterial, it may be combined with the depreciation expense for the year and
included as a part of the depreciation expense appearing in the income statement. If the amount
is material, it should be shown in the retained earnings statement as an adjustment to the
beginning balance of retained earnings.
(d) This should be shown in the income statement. One treatment would be to show it in the
statement as a deduction from the rent expense, as it reduces an operating expense and
therefore is directly related to operations. Another treatment is to show it in the other revenues
and gains section of the income statement.
Questions Chapter 3 (Continued)
(e) Assuming that a provision for the loss had not been made at the time the patent infringement
suit was instituted, the loss should be recognized in the current period in computing net
income. It should be reported as an unusual loss in the other expenses and losses section.
(f) This should be reported in the income statement in the operating section because it relates to
usual business operations of the company.
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Reporting, AICPA PC: Communication
11. (a) The remaining book value of the equipment should be depreciated over the remainder of the
five-year period. The additional depreciation ($425,000) is not a correction of an error and is not
shown as an adjustment to retained earnings. The change is considered a change in estimate.
(b) The loss should be shown in the other expenses and losses section of the income statement.
(c) The write-off should be shown as other expenses and losses in the income statement.
*(d) A correction of an error should be considered a prior period adjustment and the beginning
balance of Retained Earnings should be restated, if material.
*(e) The cumulative effect of the change is reported as an adjustment to beginning retained
earnings. Prior years’ statements are recast on a basis consistent with the new standard.
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12. (a) Other expenses and losses section.
(b) Other expenses and losses section.
(c) Operating expense section, as a selling expense, but sometimes reflected as an administrative
expense.
(d) Separate section after income from continuing operations, entitled discontinued operations.
(e) Other revenues and gains section or in a separate section, appropriately labeled as an unusual
item, if unusual or infrequent.
(f) Other revenues and gains section.
(g) Operating expense section, normally administrative. If a manufacturing concern, may be included
in cost of goods sold.
(h) Other expenses and losses section.
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13. Perlman and Sheehan should not report the sales in a similar manner. This type of transaction appears
to be typical of Perlman’s central operations. Therefore, Perlman should report revenues of $160,000
and expenses of $100,000 ($70,000 + $30,000). However, Sheehan’s transaction appears to be a
peripheral or incidental activity not related to its central operations. Thus, Sheehan should report a
gain of $60,000 ($160,000 – $100,000). Note that although the classification is different, the effect on
net income is the same ($60,000 increase).
LO: 1, Bloom: C, Difficulty: Moderate, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement Anallysis and Interpretatio,
Reporting, AICPA PC: Communication
Questions Chapter 3 (Continued)
14. You should tell Greg that a company’s reported net income is the same whether the single-step or
multiple-step format is used. Either way, the company has the same revenues, gains, expenses,
and losses; they are simply organized in a different format.
LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
15. Both formats are acceptable. The amount of detail reported in the income statement is left to the
judgment of the company whose goal in making this decision should be to present financial
statements which are most useful to decision makers. We want to present a simple, understandable statement so that a reader can easily discover the facts of importance; therefore, a single
amount for selling expenses might be preferable. However, we also want to fully disclose the results
of all activities; thus, a separate listing of expenses may be preferred. Note that if the condensed
version is used, it should be accompanied by a supporting schedule of the eight components in the
notes to the financial statements.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge,Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
16. Intraperiod tax allocation should not affect the reporting of an unusual gain. The FASB specifically
prohibits a “net-of-tax” treatment for such items to ensure that users of financial statements can
easily differentiate items that are unusual or infrequent. “Net-of-tax” treatment is reserved for
discontinued operations, prior period adjustments, and other comprehensive income.
LO: 2, Bloom: K, Difficulty: Complex, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
17. (a) A loss on discontinued operations is reported net of tax in the income statement between
income from continuing operations and net income.
(b) Noncontrolling interest allocation is reported in the income statement after the net income.
(c) Earnings per share is shown in the income statement after the noncontrolling interest allocation.
(d) A gain on sale of equipment is shown under other revenues and gains in the income statement.
LO: 1, 2, Bloom: K, Difficulty: Moderate, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
18. Intraperiod tax allocation has no effect on reported net income, although it does affect the amounts
reported for various components of income. The effects on these components offset each other so
net income remains the same. Intraperiod tax allocation merely takes the total income tax expense
and allocates it to the various items which affect the tax amount.
LO: 2, Bloom: K, Difficulty: Moderate, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
19. If Neumann has preferred stock outstanding, the numerator in its computation may be incorrect.
A better description of “earnings per share” is “earnings per common share.” The numerator should
include only the earnings available to common shareholders. Therefore, the numerator should be
net income less preferred dividends.
The denominator is also incorrect if Neumann h ad any common stock transactions during the year.
Since the numerator represents the results for the entire year, the denominator should reflect the
weighted-average number of common shares outstanding during the year, not the shares
outstanding at one point in time (year-end).
LO: 3, Bloom: C, Difficulty: Simple, Time: 5-7, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation,
Reporting, AICPA PC: Communication
20. The earnings per share trend is not favorable. Discontinued items are often one-time occurrences
which are not expected to be reported in the future. Therefore, earnings per share on income from
continuing operations is more useful because it represents the results of ordinary business activity.
Considering this EPS amount, EPS has decreased from $7.21 to $6.40.
LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, Analysis, AACSB: Knowledge,Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 3 (Continued)
21. Tax allocation within a period is the practice of allocating the income tax expense for a period to
such items as income from continuing operations, and discontinued items.
The justification for tax allocation within a period is to produce financial statements which disclose
an appropriate relationship, for example, between income tax expense and (a) income before from
continuing operations versus (b) discontinued operations.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
22. Tax allocation within a period (intraperiod) becomes necessary when a firm encounters such items
as discontinued operations, or corrections of errors. Such allocation is necessary to bring about an
appropriate relationship between income tax expense and income from continuing operations and
discontinued operations.
Tax allocation within a period is handled by first computing the tax expense attributable to income
before discontinued operations. This is computed by ascertaining the income tax expense related to
revenue and expense transactions entering into the determination of such income. Next, the remaining
income tax expense attributable to other items is determined by the tax consequences of transactions
involving these items. The applicable tax effect of these items should be disclosed separately because
of their materiality.
LO: 2, Bloom: K, Difficulty: Moderate, Time: 5-7, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
23.
LISELOTTE COMPANY
Partial Income Statement
For the Year Ended December 31, 2025
Income before income tax ...........................................................
Income tax ($1,500,000 x 34%) ..................................................
Income from continuing operations .............................................
Discontinued operations—
Gain on disposal of assets ..................................................
Less: Applicable income tax ($450,000 x 30%)...................
Net income..................................................................................
$1,500,000
510,000
990,000
$450,000
135,000
315,000
$1,305,000
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
24. The damages are reported in Frazier Corporation’s financial statements in the other expenses and
losses section. The damages would not be reported as a correction of an error (prior period
adjustment).
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
25. No, these sales would not be reported as discontinued operations after income from continuing
operations. A discontinued operation occurs when two things happen: (1) A company eliminates the
results of operations of a component or group of components of the business. A component comprises
operations and cash flows that can be clearly distinguished operationally and for financial reporting
purposes. (2) The elimination represents a strategic shift, having a major effect on the company’s
operations and financial results.
LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
26. The major items reported in the retained earnings statement are: (1) adjustments of the beginning
balance for corrections of errors or changes in accounting principle, (2) the net income or loss for
the period, (3) dividends for the year, and (4) restrictions (appropriations) of retained earnings. It
should be noted that the retained earnings statement is sometimes composed of two parts, free and
appropriated.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 3 (Continued)
27. Generally accepted accounting principles are ordinarily concerned only with a “fair presentation” of
business income. In contrast, taxable income is a statutory concept which defines the base for
raising tax revenues by the government, and any method of accounting which meets the statutory
definition will “clearly reflect” taxable income as defined by the Internal Revenue Code. It should be
noted that the Code prohibits use of the cash receipts and disbursements method as a method which
will clearly reflect income in accounting for purchases and sales if inventories are involved.
The cash receipts and disbursements method will not usually fairly present income because:
(1) The completed transaction, not receipt or disbursement of cash, increases or diminishes
income. Thus, a sale on account produces revenue and increases income, and the incurrence of
expense reduces income without regard to the time of payment of cash.
(2) The expense recognition principle generally results in costs being matched against related
revenues produced. In most situations the cash receipts and disbursements method will violate
this principle.
(3) Consistency requires that accountable events receive the same accounting treatment from
accounting period to accounting period. The cash receipts and disbursements method permits
manipulation of the timing of revenues and expenses and may result in treatments which are
not consistent, detracting from the usefulness of comparative statements.
LO: 1, Bloom: K, Difficulty: Moderate, Time: 5-7, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
28. From the revenue side, there are many types of revenue transactions which require estimation. For
example, it is difficult to estimate the amount of revenue to recognize for a long-term contract in a
given period. Other estimation involving revenue include high rates of return on products sold, net
versus gross sales issues, sales with buyback options, estimating revenues in licensing
arrangements and so on. During a single fiscal period it often is difficult to determine the expiration
of certain costs which may benefit several periods. Business is continuous and estimates have to
be made of the future if we are to systematically apportion costs to fiscal periods. Examples of items
which present serious obstacles include such items as institutional advertising costs.
Accountants have established certain rules for handling revenues and costs which are applied consistently and in a systematic manner. From period to period, application of these rules generally
results in a satisfactory matching of costs and revenues unless there are large changes from one
period to another. These rules, influenced by conservatism in the face of the uncertainties involved,
tend to charge costs to expense earlier than might be ideally desirable if we had more knowledge of
the future.
Costs or expenses of the types mentioned above, by their very nature, defy any attempt to relate
them to revenues of a specific period or periods. Although it is known that advertising will yield
benefits beyond the present, both the amount of such benefits and when they will be enjoyed are
shrouded in uncertainty. The degree of certainty with which their time distribution can be forecast is
so small and the results, therefore, so unreliable that the accountant writes them off as applicable
to the period or periods in which the expense was incurred.
LO: 1, 3, Bloom: C, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation,
Reporting, AICPA PC: Communication
Questions Chapter 3 (Continued)
29. Elements are the basic ingredients which comprise the income statement; that is, revenues, gains,
expenses, and losses. Items are descriptions of the elements such as rent revenue, rent expense, etc.
In order to predict the future, the amounts of individual items may have to be reported. For example,
if “income from continuing operations” is significantly lower this year and is reported as a single
amount, users would not know whether to attribute the decrease to a temporary increase in an
expense item (for example, an unusually large bad debt), a structural change (for example, a change
in the relationship between variable and fixed expenses), or some other factor. Another example is
income data that are distorted because of large discretionary expenses.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation,
Reporting, AICPA PC: Communication
30. Other comprehensive income must be displayed (reported) in one of two ways: (1) a single
continuous income statement (one statement approach) or (2) two separate but consecutive
statements of net income and other comprehensive income (two statement approach).
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
31. The results of continuing operations should be reported separately from discontinued operations,
and any gain or loss from disposal of a component of a business should be reported with the related
results of discontinued operations. The following format illustrates the proper disclosure:
Income before income tax......................................................................
Income tax .............................................................................................
Income from continuing operations ........................................................
Discontinued operations
Income (loss) from operations of discontinued
Division X, net of tax ($–XX)………………………….
Gain (loss) on disposal of Division X
net of tax ($–XX) ..............................................................................
Net income ............................................................................................
$XXX
XXX
XXX
XXX
XXX
XXX
$XXX
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
32. The five steps in the revenue recognition process are:
1. Identify the contract(s) with customers.
2. Identify the separate performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the separate performance obligations.
5. Recognize revenue when each performance obligation is satisfied.
LO: 4, Bloom: K, Difficulty: Simple, Time: 1, AACSB: Knowledge,, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Problem Solving
33. The first step in the revenue recognition process is the identification of a contract or contracts with
the customer. A contract is an agreement between two or more parties that creates enforceable
rights or obligations. That is, the contract identifies the performance obligations in a revenue
arrangement. Contracts can be written, oral, or implied from customary business practice. In some
cases, there may be multiple contracts related to the transaction, and accounting for each contract
may or may not occur, depending on the circumstances. These situations often develop when not
only a product is provided but some type of service is performed as well.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3, AACSB: Knowledge,, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Problem Solving
34. Change in control is the deciding factor in determining when a performance obligation is satisfied.
Control is transferred when the customer has the ability to direct the use of and obtain substantially
all the remaining benefits from the asset or service. Control is also indicated if the customer has the
ability to prevent other companies from directing the use of, or receiving the benefit, from the asset
or service.
LO: 4, Bloom: K, Difficulty: Moderate, Time: 2, AACSB: Knowledge,, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Problem Solving
Questions Chapter 3 (Continued)
35. To determine whether a performance obligation exists, the company must provide a distinct product
or service to the customer. To determine whether a company has to account for multiple
performance obligations, the company’s promise to sell the good or service to the customer must
be separately identifiable from other promises within the contract (that is, the good or service must
be distinct within the contract). In other words, the objective is to determine whether the nature of a
company’s promise is to transfer individual goods and services to the customer or to transfer a
combined item (or items) for which individual goods or services are inputs.
LO: 4, Blloom: C, Difficulty: Simple, Time: 3, AACSB: Knowledge,, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Problem Solving
36. The transaction price is the amount of consideration that a company expects to receive from a
customer in exchange for transferring goods and services. The transaction price in a contract is
often easily obtained because the customer agrees to pay a fixed amount to the company over a
short period of time. In other contracts, companies must consider the following factors:
(1) Variable consideration, (2) Time value of money, (3) Noncash consideration, and
(4) Consideration paid or payable to customer.
LO: 4, Bloom: K, Difficulty: Simple, Time: 2, AACSB: Knowledge,, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Problem Solving
37. The revenue recognition principle indicates that revenue is recognized in the accounting period
when a performance obligation is satisfied. That is, a company recognizes revenue to depict the
transfer of goods or services to customers in an amount that reflects the consideration that it
receives, or expects to receive, in exchange for those goods or services.
LO: 4, Bloom: K, Difficulty: Simple, Time: 1, AACSB: Knowledge,, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretationn, AICPA PC: Problem
Solving
38. Earnings management is often defined as the planned timing of revenues, expenses, gains and
losses to smooth out bumps in earnings. In most cases, earnings management is used to increase
income in the current year at the expense of income in future years. For example, companies
prematurely recognize sales in order to boost earnings. Earnings management can also be used to
decrease current earnings in order to increase income in the future. The classic case is the use of
“cookie jar” reserves, which are established by using unrealistic assumptions to estimate liabilities for
such items as loan losses, restructuring charges and warranty claims.
LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement Anallysis and Interpretation,
Reporting, AICPA PC: Communication
39. Earnings management has a negative effect on the quality of earnings if it distorts the information in
a way that is less useful for predicting future cash flows. Within the Conceptual Framework, useful
information is both relevant and representationally faithful. However, earnings management reduces
the reliability of income, because the income measure is biased (up or down) and/or the reported
income is not representationally faithful to that which it is supposed to report (e.g., volatile earnings
are made to look more smooth).
LO: 5, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
40. The term “quality of earnings” refers to the credibility of the earnings number reported. Companies
that use aggressive accounting policies report higher income numbers in the short-run. In such
cases, we say that the quality of earnings is low. Similarly, if higher expenses are recorded in the
current period, in order to report higher income in the future, then the quality of earnings is also
considered low.
LO: 5, Bloom: C, Difficulty: Moderate, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation,
Reporting, AICPA PC: Communication
*41. Items considered corrections of errors should be charged or credited to the opening balance of
retained earnings as a prior period adjustment.
LO: 6, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Solutions to Brief Exercises
Brief Exercise 3.1
STARR CO.
Income Statement
For the Year 2025
Revenues
Sales revenue ....................................................
Expenses
Cost of goods sold ............................................
Salaries and wages expense ............................
Other operating expenses.................................
Income tax expense...........................................
Total expenses ..........................................
$540,000
$330,000
120,000
10,000
25,000
485,000
Net income
............................................................................
$ 55,000
Earnings per share.......................................................
$0.55*
*$55,000 ÷ 100,000 shares.
Note: The increase in value of the company reputation and the unrealized
gain on the value of patents are not reported.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: None
Brief Exercise 3.2
BRISKY CORPORATION
Income Statement
For the Year Ended December 31, 2025
Revenues
Net sales .....................................................
Interest revenue ..........................................
Total revenues ....................................
Expenses
Cost of goods sold .....................................
Selling expenses ........................................
Administrative expenses ...........................
Interest expense .........................................
Income tax expense* ..................................
Total expenses...................................
$2,400,000
31,000
2,431,000
$1,450,000
280,000
212,000
45,000
133,200
2,120,200
Net income ............................................................
$ 310,800
Earnings per share** ............................................
$4.44
*($2,431,000 – $1,450,000 – $280,000 – $212,000 – $45,000) x 30% = $133,200.
**$310,800 ÷ 70,000 shares.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: None
Brief Exercise 3.3
BRISKY CORPORATION
Income Statement
For the Year Ended December 31, 2025
Net sales ..............................................................
Cost of goods sold..............................................
Gross profit ...............................................
Selling expenses .................................................
Administrative expenses ....................................
Income from operations .....................................
Other revenue and gains
Interest revenue ........................................
Other expenses and losses
Interest expense .......................................
Income before income tax ..................................
Income tax expense ($444,000 x 30%) ...............
Net income...........................................................
Earnings per share..............................................
$2,400,000
1,450,000
950,000
$280,000
212,000
492,000
458,000
$31,000
45,000
(14,000)
444,000
133,200
$ 310,800
$4.44*
*$310,800 ÷ 70,000 shares.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Innterpretation, Reporting,
AICPA PC: None
Brief Exercise 3.4
Income from continuing operations ..................
Discontinued operations
Loss from operations of discontinued
restaurant division net of tax ................
Loss on disposal of restaurant
division net of tax ..................................
Net income ..........................................................
Earnings per share .............................................
Income from continuing operations .........
Loss from operations of discontinued
division, net of tax .................................
Loss on disposal of discontinued
operation, net of tax ..............................
Discontinued operations, net of tax .........
Net income .................................................
*$10,600,000 ÷ 10,000,000 shares
$10,600,000
$315,000
(504,000)
189,000
$10,096,000
$1.06*
0.03**
0.02***
(0.05)**
$1.01
**$315,000 ÷ 10,000,000 shares
***$189,000 ÷ 10,000,000 shares
LO: 1, 2, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: None
Brief Exercise 3.5
Income from operations ......................................
Other revenues and gains
Interest revenue ..............................................
Other Expenses and Losses
Loss due to volcano eruption ........................ $770,000
Impairment loss - building .............................
53,000
Income before income tax .....................................
Income tax ($6,394,000 x .30) .....................
Net income ...............................................................
Per share of common stock:
Net income ($4,475,800 ÷ 5,000,000) .............
$7,200,000
17,000
7,217,000
823,000
6,394,000
1,918,200
$4,475,800
$ .90*
*Rounded
LO: 1, , Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: None
Brief Exercise 3.6
$1,000,000 – $250,000
190,000
=
$3.95 per share*
*Rounded
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analllysis and Interpretation, Reporting,
AICPA PC: None
Brief Exercise 3.7
PORTMAN CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, January 1 .......................................
Add: Net income ..........................................................
Less: Cash dividends ...................................................
Retained earnings, December 31 ..................................
$ 675,000
1,400,000
75,000
$2,000,000
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 3.8
(a)
Net income (Interest revenue) ..............................
$3,000
(b)
Net income ............................................................
Unrealized holding gain (net of tax) .....................
Comprehensive income ........................................
$3,000
4,000
$7,000
(c)
Unrealized holding gain (net of tax)
Other comprehensive income ..............................
$4,000
(d)
Accumulated other comprehensive income,
January 1, 2025 .................................................
Unrealized holding gain (net of tax) .....................
Accumulated other comprehensive income,
December 31, 2025 ............................................
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
$
0
4,000
$4,000
Brief Exercise 3.9
(a) In applying the 5-step process, it appears that a valid contract exists
between Leno Computers and Fallon Electronics for the following reasons:
1. The contract has commercial substance—Fallon Electronics has
agreed to pay cash for the computers.
2. The parties have approved the contract and are committed to
perform—Fallon Electronics has made a commitment to purchase
the computers and Leno has approved the selling of the computers.
In fact, Leno has delivered the computers to Fallon.
3. The identification of the rights of the parties—Fallon has the right to
the computers and Leno has the right to payment.
4. The identification of the payment terms—Fallon has agreed to pay
$20,000 within 30 days for the computers.
5. It is probable that the consideration will be collected—although no
cash has yet been paid by Fallon. Fallon has a good credit rating
which indicates that the consideration will be collected.
(b) The contract may not be valid if the contract is wholly unperformed and
each party can unilaterally terminate the contract without consideration. In
addition, if Fallon has a poor credit rating and it is not probable that the
consideration will be collected on the contract, a valid contract does not
exist.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Brief Exercise 3.10
There is one performance obligation in this situation, which is the providing
of the licensed software and customer support together. Both the software
license and the custom customer support services are distinct, but they are
not distinct within the contract. It appears that Hillside’s objective is to
transfer a combined product. That is, the customer support services are
highly interrelated and interdependent with the licensed software and
therefore, these customer support services should be combined with the
licensed software in determining the performance obligation.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 3, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Brief Exercise 3.11
Three performance obligations exist in this contract—manufacture of the 3D printer, installation services and the maintenance services. Destin does
clearly have a performance obligation for the manufacture of the 3-D printer.
Destin may or may not have a performance obligation for the installation of
the 3-D printer as installation can be done by another company. In other
words, there is no indication that installation is required by Destin. Also,
Destin may or may not have a separate performance obligation for the
maintenance agreement, as it can be provided by other companies. In
summary, there are three performance obligations related to this contract,
some of which may end up being performed by companies other than Destin.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 2, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation, AICPA PC:
Communication
Brief Exercise 3.12
Ismail accounts for the bundle of goods and services as a single
performance obligation because the goods or services in the bundle are
highly interrelated. Ismail also provides a significant service by integrating
the goods or services into the combined item (that is, the hospital) for which
the customer has contracted. In addition, the goods or services are
significantly modified and customized to fulfill the contract. In other words,
the company’s objective is to transfer a combined item. Revenue for the
performance obligation would be recognized over time by selecting an
appropriate measure of progress toward satisfaction of the performance
obligation.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 2, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretatio, AICPA PC:
Communicatio
Brief Exercise 3.13
The transaction price should include management’s estimate of the amount
of consideration to which the entity will be entitled. Given the multiple
outcomes and probabilities available based on prior experience, the
probability-weighted method is the most predictive approach for estimating
the variable consideration in this situation:
Completion Date
August 1
August 8
August 15
After August 15
Probability
Expected Value
70% chance of $1,150,000 = $ 805,000
20% chance of $1,100,000 = 220,000
5% chance of $1,050,000 =
52,500
5% chance of $1,000,000 =
50,000
$1,127,500
Thus, the total transaction price is $1,127,500 based on the probabilityweighted estimate.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation, AICPA PC:
None
Brief Exercise 3.14
(a) No revenue is earned on June 15, 2025, as Mount has not satisfied the
performance obligation.
Note to instructor: No entry is required on May 1, 2025 because neither party
has performed on the contract. On June 15, 2025, Eric agreed to pay the full
price and therefore, Mount has an unconditional right to those funds on that
date. On receiving the cash on June 15, 2025, Mount records the following
entry.
June 15, 2025
Cash
25,000
Unearned Sales Revenue
25,000
(b) On satisfying the performance obligation on September 30, 2025, Mount
records revenue of $25,000 with the following entry
September 30, 2025
Unearned Sales Revenue
25,000
Sales Revenue
25,000
LO: 4, Bloom: AP, Difficulty: Simple, Time: 4, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
*Brief Exercise 3.15
Income before income tax
Income tax (30%)
Net Income
2025
$180,000
54,000
$126,000
2024
$145,000
43,500
$101,500
2023
$170,000
51,000
$119,000
Note: The company must report income under the weighted-average method
for all three years.
LO: 6, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Iterpretation, Reporting, AICPA
PC: None
*Brief Exercise 3.16
Vandross would not report any cumulative effect because a change in estimate
is not handled retrospectively. Vandross would report bad debt expense of
$120,000 in 2025.
LO: 6, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and Iterpretation
, Reporting, AICPA PC: Communication
*Brief Exercise 3.17
PORTMAN CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, January 1, as reported ..................
Correction for overstatement of expenses in
prior period (net of tax) .......................................
Retained earnings, January 1, as adjusted ..................
Add: Net income ..........................................................
Less: Cash dividends ...................................................
Retained earnings, December 31 ..................................
LO: 6 Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
$ 675,000
80,000
755,000
1,400,000
2,155,000
75,000
$2,080,000
Solutions to Exercises
Exercise 3.1 (18–20 minutes)
Computation of net income
Change in assets .....................................................
Less: Change in liabilities ......................................
$204,000 Increase (a)
31,000 Increase (b)
Change in stockholders’ equity .............................
$173,000 Increase
(a) $79,000 + $45,000 + $127,000 – $47,000
(b) $82,000 – $51,000
Change in stockholders’ equity accounted for as follows:
Net increase .............................................................
$ 173,000
Increase in common stock .................................. $125,000
Increase in paid-in capital in excess of par ........
13,000
Decrease in retained earnings due to
dividend declaration..........................................
(19,000)
Net increase accounted for ....................................
(119,000)
Increase in retained earnings due to net income ..
$ 54,000
LO: 1, Bloom: AN, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Iterpretation , Reporting,
AICPA PC: None
Exercise 3.2 (10–15 minutes)
Sales revenue ...................................................................
Cost of goods sold ...........................................................
Gross profit .......................................................................
Selling and administrative expenses ..............................
Income from operations ...................................................
Other revenues and gains
Gain on sale of plant assets ...................................
Other expenses and losses
Interest expense ......................................................
Income from continuing operations ................................
Loss on discontinued operations ...................................
Net income ........................................................................
$310,000
140,000
170,000
50,000
120,000(a)
30,000
6,000
24,000
144,000
(12,000)
$132,000(b)
Net income ........................................................................
$132,000
Unrealized gain on available-for-sale debt investments
10,000
Comprehensive income ...................................................
$142,000(c)
Net income ........................................................................
$132,000
Dividends ..........................................................................
(5,000)
12/31/25 Retained earnings .............................................
$127,000(d)
(a)
(b)
(c)
(d)
Income from operations
Net income
Comprehensive income
Retained earnings balance
$120,000
$132,000
$142,000
$127,000
LO: 1, 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 3.3 (25–35 minutes)
(a) Total net revenue:
Sales revenue ...............................................
Less: Sales discounts .................................
Sales returns and allowances ..........
Net sales........................................................
Dividend revenue..........................................
Rent revenue .................................................
Total net revenue ..................................
(b) Net income:
Total net revenue (from a) ............................
Expenses:
Cost of goods sold .................................
Selling expenses ....................................
Administrative expenses........................
Interest expense .....................................
Total expenses ..................................
Income before income tax ...........................
Income tax.....................................................
Net income ..............................................
$390,000
$ 7,800
12,400
20,200
369,800
71,000
6,500
$447,300
$447,300
$184,400
99,400
82,500
12,700
LO: 1, , Bloom: AP, Difficulty: Simple, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
379,000
68,300
31,000
$ 37,300
Exercise 3.4 (20–25 minutes)
LEROI JONES INC.
Income Statement
For Year Ended December 31, 2025
Revenues
Net sales ($1,250,000(b) – $17,000) .............
Expenses
Cost of goods sold .....................................
Selling expenses ........................................
Administrative expenses ...........................
Interest expense .........................................
Total expenses ...................................
Income before income tax ....................................
Income tax ($213,000 X 30%) .....................
Net income ............................................................
Earnings per share(d) .............................................
*Rounded
$1,233,000
$500,000
400,000(c)
100,000(a)
20,000
1,020,000
213,000
63,900
$ 149,100
$
7.46*
Exercise 3.4 (Continued)
Determination of amounts
(a)
Administrative expenses
= 20% of cost of good sold
= 20% x $500,000
= $100,000
(b)
Gross sales x 8%
= administrative expenses
= $100,000 ÷ .08
= $1,250,000
(c)
Selling expenses
= four times administrative expenses.
(operating expenses consist of selling
and administrative expenses; since
selling expenses are 4/5 of operating
expenses, selling expenses are 4
times administrative expenses.)
= 4 x $100,000
= $400,000
(d) Earnings per share $7.46 ($149,100 ÷ 20,000)
Note: An alternative income statement format is to show income tax as part
of expenses, and not as a separate item. In this case, total expenses are
$1,083,900.
LO: 1 Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Iterpretation, Reporting, AICPA
PC: None
Exercise 3.5 (30–35 minutes)
(a)
Multiple-Step Form
P. BRIDE COMPANY
Income Statement
For the Year Ended December 31, 2025
(In thousands, except earnings per share)
Sales revenue .................................................
Cost of goods sold.........................................
Gross profit ....................................................
Operating expenses:
$96,500
60,570
35,930
Selling expenses
Sales commissions ............................
Depr. of sales equipment ...................
Delivery expense ................................
Administrative expenses
Officers’ salaries ................................
Depr. of office furn. and equip...........
$7,980
6,480
2,690
$17,150
4,900
3,960
8,860
26,010
Income from operations ...............
Other revenues and gains:
Rent revenue ............................................
Other expenses and losses:
Interest expense .......................................
Income before income tax .............................
Income tax ................................................
Net income......................................................
9,920
1,860
25,290
9,070
$16,220
Earnings per share ($16,220 ÷ 40,550) ..........
$.40
17,230
Exercise 3.5 (Continued)
(b)
Single-Step Form
P. BRIDE COMPANY
Income Statement
For the Year Ended December 31, 2025
(In thousands, except earnings per share)
Revenues
Net sales ................................................................
Rental revenue ......................................................
Total revenues.................................................
$ 96,500
17,230
Expenses
Cost of goods sold ...............................................
Selling expenses ...................................................
Administrative expenses ......................................
Interest expense ...................................................
Total expenses ................................................
60,570
17,150
8,860
1,860
Income before income tax ........................................
Income tax .................................................................
Net income ............................................................
Earnings per share ....................................................
0
113,730
88,440
25,290
9,070
$ 16,220
$.40
Note: An alternative income statement format for the single-step form is to
show income tax as part of expenses, and not as a separate item.
(c)
Single-step:
1.
Simplicity and conciseness.
2.
Probably better understood by users.
3.
Emphasis on total costs and expenses and net income.
4.
Does not imply priority of one revenue or expense over another.
Exercise 3.5 (Continued)
Multiple-step:
1.
Provides more information through segregation of operating and
nonoperating items.
2.
Expenses are matched with related revenue.
Note to instructor: Students’ answers will vary due to the nature of the
question; i.e., it asks for an opinion. However, the discussion supporting
the answer should include the previous points.
LO: 1 Bloom: AP, Difficulty: Simple, Time: 30-35, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 3.6 (30–35 minutes)
ALONZO CORP.
Income Statement
For the Year Ended December 31, 2025
Revenue
Sales revenue ........................................................
Less: Sales returns and allowances ....................
Sales discounts ..........................................
Net sales ................................................................
Cost of goods sold ................................................
Gross profit .................................................................
Operating expenses
Selling expenses ................................................
Administrative and general expenses ..............
Income from operations .............................................
$1,380,000
$150,000
45,000
194,000
97,000
195,000
1,185,000
621,000
564,000
291,000
273,000
Exercise 3.6 (Continued)
Other revenues and gains
Interest revenue .......................................................
86,000
359,000
Other expenses and losses
Loss from earthquake damage ...............................
Interest expense ......................................................
Income before income tax ..............................................
Income tax ($149,000 x .20).....................................
Net income.......................................................................
150,000
60,000
149,000
29,800
$119,200
Per share of common stock:
Net income ($119,200 ÷ 100,000) ............................
$ 1.19*
*Rounded
LO: 1, , Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Iterpretation, Reporting,
AICPA PC: None
Exercise 3.7 (30–40 minutes)
(a)
Multiple-Step Form
LATIFA SHOE CO.
Income Statement
For the Year Ended December 31, 2025
Net sales ......................................................
Cost of goods sold......................................
Gross profit ................................................
Operating Expenses
$980,000
496,000
484,000
Selling expenses
Salaries and wages expense ..........
Depreciation exp. (70% x $65,000) .
Supplies ...........................................
Administrative expenses
Salaries and wages expense ..........
Other admin. expenses ...................
Depreciation exp. (30% x $65,000) .
Income from operations .............................
Other Revenues and Gains
Rent revenue .........................................
$114,800
45,500
17,600 $177,900
135,900
51,700
19,500
207,100
385,000
99,000
29,000
128,000
Other Expenses and Losses
Interest expense ....................................
Income before income tax ..........................
Income tax .............................................
Net income...................................................
18,000
110,000
23,100
$ 86,900
Earnings per share ($86,900 ÷ 20,000).......
$4.35*
*Rounded
Exercise 3.7 (Continued)
(b)
Single-Step Form
LATIFA SHOE CO.
Income Statement
For the Year Ended December 31, 2025
Revenues
Net sales .......................................................................
Rent revenue ................................................................
Total revenues ........................................................
Expenses
Cost of goods sold.......................................................
Selling expenses(**).......................................................
Administrative expenses(***) .........................................
Interest expense ...........................................................
Total expenses .......................................................
Income before income tax .................................................
Income tax ....................................................................
Net income .........................................................................
Earnings per share ($86,900 ÷ 20,000)..............................
$ 980,000
29,000
1,009,000
496,000
177,900
207,100
18,000
899,000
110,000
23,100
$ 86,900
$4.35*
*Rounded
** $114,800 + (70% x $65,000) + $17,600 = $177,900
*** $135,900 + $51,700 + (30% x $65,000) = $207,100
Note: An alternative income statement format for the single-step form is to
show income tax as part of expenses, and not as a separate item.
(c)
Single-step:
1. Simplicity and conciseness.
2. Probably better understood by users.
Exercise 3.7 (Continued)
3. Emphasis on total costs and expenses and net income.
4. Does not imply priority of one revenue or expense over another.
Multiple-step:
1. Provides more information through segregation of operating and
nonoperating items.
2. Expenses are matched with related revenue.
Note to instructor: Students’ answers will vary due to the nature of the
question, i.e., it asks for an opinion. However, the discussion supporting the
answer should include the above points.
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and
Iterpretation, Reporting, AICPA PC: Communication
Exercise 3.8 (15–20 minutes)
(a) Net sales
Cost of goods sold
Administrative expenses
Selling expenses
Discontinued operations-loss
Income before income tax
Income tax ($110,000 x .20)
Net income
$ 540,000
(210,000)
(100,000)
(80,000)
(40,000)
110,000
22,000
$ 88,000
(b) Income from continuing operations before income tax
Income tax ($150,000 x .20)
Income from continuing operations
Loss or discontinued operations, net of ($8,000)
Net income
$150,000*
30,000
120,000
32,000
$ 88,000
*Income before income tax from part(a)
Discontinued operations
$110,000
40,000
$150,000
Exercise 3.8 (Continued)
Earnings per share:
Income from continuing operations ($120,000 ÷ 10,000)
$12.00
Loss on discontinued operations, net of tax ($32,000 ÷ 10,000) (3.20)
Net Income ($88,000 ÷ 10,000)
$ 8.80
LO: 1, 2, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Iterpretation, Reporting,
AICPA PC: None
Exercise 3.9 (30–35 minutes)
(a)
IVAN CALDERON CORP.
Income Statement
For the Year Ended December 31, 2025
Revenue
Net sales ..................................................................
$1,300,000
Cost of goods sold..................................................
780,000
Gross profit ..................................................
520,000
Operating expenses
Selling expenses ................................................ $65,000
Administrative expenses ...................................
48,000
113,000
Income from operations ...............................................
407,000
Other revenues and gains
Dividend revenue ...............................................
20,000
Interest revenue ..................................................
7,000
27,000
434,000
Other expenses and losses
Casualty loss ......................................................
50,000
Write-off of inventory due to obsolescence .........
80,000
130,000
Income before income tax ..................................................
304,000
Income tax ($304,000 x .20)................................
60,800
Net income
$ 243,200
.............................................................................
Per share of common stock:
Net income ($243,200 ÷ 60,000) .........................
$4.05*
*Rounded
Exercise 3.9 (Continued)
(b)
IVAN CALDERON CORP.
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, Jan. 1, as reported ....................................
Correction for overstatement of net income in prior period
(depreciation error) (net of $11,000* tax) ......................
Retained earnings, Jan. 1, as adjusted....................................
Add: Net income........................................................................
$
980,000
(44,000)
936,000
243,200
1,179,200
45,000
$1,134,200
Less: Dividends declared .........................................................
Retained earnings, Dec. 31 .......................................................
*$55,000 x .20
LO: 1, , 3, Bloom: AP, Difficulty: Simple, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 3.10 (20–25 minutes)
Net income.........................................................................
Less: Preferred dividends
(.08 x $4,500,000) ...........................................................
Income available to common stockholders ....................
Weighted-average common shares outstanding ............
Earnings per share............................................................
360,000
32,640,000
÷ 10,000,000
$3.26*
Income statement presentation
Earnings per common share ......................................
$3.26
*Rounded
LO: 1, Bloom: AP, Difficulty: Simple, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
$33,000,000
Exercise 3.11 (20–25 minutes)
SPOCK CORPORATION
Income Statement
For the Year Ended December 31, 2025
Net sales(a) .............................................................
Cost of goods sold(b).............................................
Gross profit .....................................................
Selling expenses(c) ................................................
Administrative expenses(d) ...................................
Income from operations .................................
Rent revenue .........................................................
Casualty loss.........................................................
Interest expense....................................................
Income before income tax ....................................
Income tax ($364,000 x .20) ............................
Net income ............................................................
$4,162,000
2,665,000
1,497,000
$636,000
491,000
240,000
(70,000)
(176,000)
Earnings per share ($900,000 ÷ $10 par value = 90,000 shares)
($291,200 ÷ 90,000) ..................................................................
1,127,000
370,000
(6,000)
364,000
72,800
$ 291,200
$3.24*
*Rounded
Supporting computations
(a) Net sales:
$4,275,000 – $34,000 – $79,000 = $4,162,000
(b) Cost of goods sold:
$535,000 + ($2,786,000 + $72,000 – $27,000 – $15,000) – $686,000 =
$2,665,000
(c) Selling expenses:
$284,000 + $83,000 + $69,000 + $54,000 + $93,000 + $36,000 + $17,000 =
$636,000
(d) Administrative expenses:
$346,000 + $33,000 + $24,000 + $48,000 + $32,000 + $8,000 = $491,000
LO: 1, , Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Iterpretation , Reporting,
AICPA PC: None
Exercise 3.12 (20–25 minutes)
(a)
EDDIE ZAMBRANO CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2025
Balance, January 1, as reported ...........................................
Correction for depreciation error (net of $5,000 tax) ...........
Balance, January 1, as adjusted ...........................................
Add: Net income.....................................................................
Less: Dividends declared ......................................................
Balance, December 31 ...........................................................
$225,000*
(20,000)
205,000
192,000**
397,000
100,000
$297,000
*($40,000 + $125,000 + $160,000) – ($50,000 + $50,000)
**[$240,000 – (20% x $240,000)]
(b) Total retained earnings would still be reported as $297,000. A restriction
does not affect total retained earnings; it merely labels part of the retained
earnings as being unavailable for dividend distribution. Retained earnings
would be reported as follows:
Retained earnings:
Appropriated .....................................
Unappropriated .................................
Total .................................................
$ 70,000
227,000
$297,000
LO: 3, Bloom: AP, Difficulty: Simple, Time: 20-25, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and
Iterpretation, Reporting, AICPA PC: Communication
Exercise 3.13 (15–20 minutes)
Net income:
Income from continuing operations
before income tax .......................................
Income tax (17% x $23,650,000) .....................
Income from continuing operations ..............
Discontinued operations
Loss before income tax ............................
Less: Applicable income tax (17%) ..........
Net income ......................................................
$23,650,000
4,020,500
19,629,500
$3,225,000
548,250
(2,676,750)
$16,952,750
Preferred dividends declared:..............................
$ 1,075,000
Weighted average common shares outstanding ....
4,000,000
Earnings per share
Income from continuing operations ..............
Loss from discontinued operations, net of tax
Net income ......................................................
$4.64*
.67**
$3.97***
*($19,629,500 – $1,075,000) ÷ 4,000,000. (Rounded)
**$2,676,750 ÷ 4,000,000. (Rounded)
***($16,952,750 – $1,075,000) ÷ 4,000,000.
LO: 1, 2, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Iterpretation, Reporting,
AICPA PC: None
Exercise 3.14 (15–20 minutes)
(a)
ROXANNE CARTER CORPORATION
Statement of Comprehensive Income
For the Year Ended December 31, 2025
Net sales ...............................................................................
Cost of goods sold................................................................
Gross profit ...........................................................................
Selling and administrative expenses ...................................
Net income.............................................................................
Other comprehensive income,
unrealized holding gain .....................................................
Comprehensive income ........................................................
$1,200,000
750,000
450,000
320,000
130,000
18,000
$ 148,000
(b)
ROXANNE CARTER CORPORATION
Income Statement
For the Year Ended December 31, 2025
Net sales ...............................................................................
Cost of goods sold................................................................
Gross profit ...........................................................................
Selling and administrative expenses ...................................
Net income.............................................................................
$1,200,000
750,000
450,000
320,000
$ 130,000
ROXANNE CARTER CORPORATION
Comprehensive Income Statement
For the Year Ended December 31, 2025
Net income.............................................................................
Other comprehensive income,
unrealized holding gain .....................................................
Comprehensive income ........................................................
LO: 2, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
$ 130,000
18,000
$ 148,000
Exercise 3.15 (15–20 minutes)
C. REITHER CO.
Statement of Stockholders’ Equity
For the Year Ended December 31, 2025
Accumulated
Other
Retained
Comprehensive
Common
Total
Earnings
Income
Stock
Beginning balance
$520,000
$ 90,000
$80,000
$350,000
Net income*
120,000
120,000
Other comprehensive income
Unrealized holding loss
Dividends
Ending balance
(60,000)
(60,000)
(10,000)
(10,000)
$570,000
$200,000
$20,000
$350,000
*($700,000 – $500,000 – $80,000).
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 3.16 (30–35 minutes)
(a)
ROLAND CARLSON INC.
Income Statement
For the Year Ended December 31, 2025
Revenues
Sales revenue
..................................................................................
..................................................................................
..................................................................................
Rent revenue ................................................
Total revenues ....................................
Expenses
Cost of goods sold .......................................
Selling expenses ..........................................
Administrative expenses .............................
Total expenses .....................................
Income from operations ................................
Other revenues and gains
Gain on sale of equipment ............................
Other expenses and losses
Inventory loss.................................................
Income before income tax ......................................
Income tax ......................................................
Income from continuing operations ......................
Discontinued operations
Loss on discontinued operations
(net of $25,500 tax) .........................................
Net income...............................................................
$1,900,000
40,000
$1,940,000
850,000
300,000
240,000
1,390,000
550,000
95,000
60,000
Per share of common stock:
Income from continuing operations ($398,000 ÷ 100,000) .....
Loss on discontinued operations ($49,500 ÷ 100,000) ......
Net income ($348,500 ÷ 100,000).........................................
* Rounded
35,000
585,000
187,000
398,000
49,500
$ 348,500
$3.98
.50*
$3.48*
Exercise 3.16 (Continued)
(b)
ROLAND CARLSON INC.
Comprehensive Income Statement
For the Year Ended December 31, 2025
Net income ............................................................................
Other comprehensive income
Unrealized holding gain, net of tax ................................
Comprehensive income........................................................
(c)
$348,500
15,000
$363,500
ROLAND CARLSON INC.
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, January 1 ......................................................
Add: Net income ...........................................................................
Less: Dividends declared .............................................................
Retained earnings, December 31 .................................................
LO: 1, 2, 3, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
$600,000
348,500
948,500
150,000
$798,500
Exercise 3.17 (10–15 minutes)
(1) This statement is not correct. This criterion was used in previous GAAP
but often proved difficult to implement in practice. In the new standard,
indicators that control has passed to the customer include having (1) a
present obligation to pay, (2) physical possession, (3) legal title, (4) risks
and rewards of ownership, and (5) acceptance of the asset.
(2) This statement is not correct. For a valid contract to exist, the collection
of revenue must be probable.
(3) A wholly unperformed contract is not recorded until one or both of the
parties have performed. The new revenue standard uses an assetliability approach for recognizing revenue. In this model, until one of the
parties performs, a net asset or net liability does not exist, and therefore,
there is no effect on the company’s financial position.
(4) This statement is true. One of the difficulties in the revenue recognition
process is identifying the performance obligations in the contract.
(5) Elaina should account for this additional option. Whether the option
provides for free goods or goods at a discount, the option is a separate
performance obligation which affects the current transaction price.
Consideration payable to a customer is a reduction of the transaction
price unless the payment is for a distinct good or service.
(6) Under the GAAP, the collectability criterion is designed to prevent
companies from applying the revenue model to problematic contracts
and recognizing revenue and a large impairment loss at the same time.
However, if the company determines that it is probable that it will collect
the funds, then the normal risks of nonpayment are not considered at
the time the revenue is reported.
LO: 4, Bloom: C, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 3.18 (20-25 minutes)
(a)
The transaction price for this contract should be computed as follows:
Contract price
Expected value of the bonus
Transaction price
Completion Time
$200,000
34,000
$234,000
Probability of
completion
On time
Within one week
Within two weeks
Total expected value of
bonus
55%
30%
15%
x
Bonus
Amounts*
= Expected
Value
$40,000
30,000
20,000
$22,000
9,000
3,000
$34,000
* ($10,000 decrease/week)
(b)
The transaction price for this contract should be computed as follow:
Contract price
Expected value of the bonus
Transaction price
$200,000
39,000
$239,000
Completion Time
Probability of
Completion
X Bonus
Amounts*
= Expected
Value
On time
Within one week
Computation of
expected value
90%
10%
$40,000
30,000
$36,000
3,000
$39,000
* ($10,000 decrease/week)
Note to instructor: Given just two outcomes, the company could determine
the bonus component of the transaction price based on the most likely
outcome ($40,000). If reliable, use of probability outcomes is more accurate.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 3.19 (10–15 minutes)
(a)
Shaw recognizes revenue of $370,000 on the sale of the goods, which
were delivered (performance obligation satisfied) on January 2, 2025.
Note to instructor: The entries to record the sale and related cost of goods
sold are as follows:
January 2, 2025
(b)
Accounts Receivable
Sales Revenue
Unearned Service Revenue
410,000
Cost of Goods Sold
Inventory
300,000
370,000
40,000
300,000
Income on the arrangement to be recorded in the first quarter is as
follows.
Sales revenue
Cost of goods sold
Gross profit
$370,000
300,000
$ 70,000
The revenue for installation will be recognized in the second quarter.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
* Exercise 3.20 (15–20 minutes)
(a)
2025
$450,000
90,000
$360,000
Income before income tax
Income tax (.20 x $450,000)
Net Income
(b)
Cumulative effect for years prior to 2025.
Year
2023
2024
WeightedAverage
$370,000
390,000
Tax Rate
FIFO
Difference
(20%) Net Effect
$395,000
$25,000
430,000
40,000
Total
$65,000
$13,000
$52,000
(c)
Income before income tax
Income tax (20%)
Net income
2025
2024
$450,000 $430,000
90,000
86,000
$360,000 $344,000
2023
$395,000
79,000
$316,000
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: None
Time and Purpose of Problems
Problem 3.1 (Time 30–35 minutes)
Purpose—to provide the student with an opportunity to prepare a multi-step income statement and a
retained earnings statement. A number of special items such as loss from discontinued operations,
unusual items, and ordinary gains and losses are presented in the problem for analysis purposes.
Problem 3.2 (Time 25–30 minutes)
Purpose—to provide the student with an opportunity to prepare a single-step income statement and a
retained earnings statement. The student must determine through analysis the ending balance in retained
earnings.
Problem 3.3 (Time 30–40 minutes)
Purpose—to provide the student with an opportunity to analyze a number of transactions and to prepare a
partial income statement. The problem includes discontinued operations and the effect of a change in
accounting principle.
Problem 3.4 (Time 45–55 minutes)
Purpose—to provide the student with the opportunity to prepare multiple-step and single-step income
statements and a retained earnings statement from the same underlying information. A substantial
number of operating expenses must be reported in this problem unlike Problem 3.1. As a consequence,
the problem is time-consuming and emphasizes the differences between the multiple-step and singlestep income statement.
Problem 3.5 (Time 20–25 minutes)
Purpose—to provide the student with a problem on the income statement treatment of (1) a change that
is usual but infrequently occurring, (2) loss on sale of equipment, (3) a correction of an error, and (4)
earnings per share. The student is required not only to identify the proper income statement treatment
but also to provide the rationale for such treatment.
Problem 3.6 (Time 25–35 minutes)
Purpose—to provide the student with an opportunity to prepare a retained earnings statement. A number
of special items must be reclassified and reported in the income statement. This problem illustrates the
fact that ending retained earnings is unaffected by the choice of disclosing items in the income statement
or the retained earnings statement, although the income reported would be different.
Problem 3.7 (Time 25–35 minutes)
Purpose—to provide the student with a problem to determine the reporting of several items, which may
get special treatment as irregular items. This is a good problem for a group assignment.
Solutions to Problems
Problem 3.1
DICKINSON COMPANY
Income Statement
For the Year Ended December 31, 2025
Sales revenue...............................................................
$25,000,000
Cost of goods sold ......................................................
16,000,000
Gross profit ..................................................................
9,000,000
Selling and administrative expenses..........................
4,700,000
Income from operations ..............................................
4,300,000
Other revenues and gains
Interest revenue ................................................. $ 70,000
Gain on the sale of investments ....................... 110,000
180,000
4,480,000
Other expenses and losses
Loss from flood damage
390,000
Write-off of goodwill .......................................... 820,000 (1,210,000)
Income before income tax .................................................
3,270,000
Income tax ....................................................................
1,244,000
Income from continuing operations ...........................
2,026,000
Discontinued operations
Loss from operation of wholesale division,
net of applicable tax ................................
90,000
Loss on disposal of wholesale division, net of
applicable tax ........................................... 440,000
(530,000)
Net income ...................................................................
$ 1,496,000
Earnings per share:
Income from continuing operations .................
Loss from operations of discontinued
division, net of tax ..............................
Loss on disposal of discontinued
division, net of tax ..............................
Net income .........................................................
a
$2,026,000 – $80,000
500,000 shares
=
$3.89
$1,496,000 – $80,000
500,000 shares
=
$2.83
b
$ 3.89a
$0.18
0.88
(1.06)
$ 2.83b
Problem 3.1 (Continued)
DICKINSON COMPANY
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, January 1 ..............................
Add: Net income .................................................
Less: Dividends declared on:
Preferred stock ..........................................
Common stock ...........................................
Retained earnings, December 31 .........................
$
$ 80,000
250,000
LO: 1, 2, 3, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
980,000
1,496,000
2,476,000
330,000
$2,146,000
Problem 3.2
THOMPSON CORPORATION
Income Statement
For the Year Ended December 31, 2025
Revenues
Net sales ($1,100,000 – $14,500 – $17,500)....
Gain on sale of land........................................
Rent revenue ...................................................
Total revenues .......................................
Expenses
Cost of goods sold* ........................................
Selling expenses ............................................
Administrative expenses ...............................
Total expenses.......................................
Income before income tax ........................................
Income tax .......................................................
Net income
.........................................................................
Earnings per share ($86,100 ÷ 30,000) .....................
*Cost of goods sold: Can be verified as follows:
Inventory, Jan. 1 ...................................................
Purchases .............................................................
Less: Purchase discounts ..................................
Net purchases ......................................................
Add: Freight-in ...................................................
Inventory available for sale .................................
Less: Inventory, Dec. 31 .....................................
Cost of goods sold ............................................
$1,068,000
30,000
18,000
$1,116,000
645,000
232,000
99,000
976,000
140,000
53,900
$ 86,100
$2.87
$ 89,000
$610,000
10,000
600,000
20,000
620,000
709,000
64,000
$645,000
Problem 3.2 (Continued)
THOMPSON CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, January 1 ............................................
Add: Net income ...............................................................
Less: Cash dividends ........................................................
Retained earnings, December 31 .......................................
$160,000
86,100
246,100
45,000
$201,100
LO: 1, , 3, Bloom: AP, Difficulty: Simple, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: None
Problem 3.3
MAHER INC.
Income Statement (Partial)
For the Year Ended December 31, 2025
$748,500(a)
193,350(b)
555,150
Income before income tax .....................................
Income tax ....................................................
Income from continuing operations .....................
Discontinued operations
Loss on disposal of recreational
division Less applicable income tax of
34,500 (1)……………………………………….
Net income..............................................................
(1) $115,000  30%
(80,500)
$474,650
Per share
Income from continuing operations
($555,150 ÷ 120,000)
Loss on disposal of discontinued
operation, net of tax ................................
Net income ($474,650 ÷ 120,000) ................
$4.63*
(0.67)*
$3.96
*Rounded
(a)
Computation of income before taxes:
As previously stated .............................................
Loss on sale of securities .....................................
Gain on proceeds of life insurance
policy ($150,000 – $46,000) ...............................
Flood Loss
Error in computation of depreciation
As computed ($54,000 ÷ 6) ........................................
Corrected ($54,000 – $9,000) ÷ 6 ...............................
As restated .................................................................
$790,000
57,000
104,000
90,000
$9,000
(7,500)
1,500
$748,500
Problem 3.3 (Continued)
(b)
Computation of income tax:
Income before taxes ........................................................
Nontaxable income (gain on life insurance) ..................
Taxable income ...............................................................
Tax rate ............................................................................
Income tax .......................................................................
$748,500
(104,000)
644,500
x
.30
$193,350
Note: No adjustment is needed for the inventory method change, since the
new method is reported in 2025 income. The cumulative effect on prior years
of retroactive application of the new inventory method will be recorded in
retained earnings.
LO: 1, 2, *6 Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation,
Reporting, AICPA PC: None
Problem 3.4
(a)
TWAIN CORPORATION
Income Statement
For the Year Ended June 30, 2025
Sales
Sales revenue .........................................
Less: Sales discounts ..........................
Sales returns and allowances ...
Net sales .................................................
Cost of goods sold ......................................
Gross profit ..................................................
Operating expenses
Selling expenses
Sales commissions ............................
Salaries and wages expense .............
Travel expense ...................................
Delivery expense ................................
Entertainment expense ......................
Telephone and Internet expense.......
Maintenance and repairs expense ....
Depreciation expense ........................
Bad debt expense ..............................
Miscellaneous selling expenses .......
Administrative Expenses
Maintenance and repairs expense ............
Property tax expense ....................................
Depreciation expense ................................
Supplies expense.......................................
Telephone and Internet expense ..............
Office expenses .........................................
Income from operations .....................................
$1,578,500
$31,150
62,300
97,600
56,260
28,930
21,400
14,820
9,030
6,200
4,980
4,850
4,715
9,130
7,320
7,250
3,450
2,820
6,000
93,450
1,485,050
896,770
588,280
248,785
35,970
303,525
Problem 3.4 (Continued)
Other revenues and gains
Dividend revenue ............................................
38,000
Other expenses and losses
Interest expense .............................................
Income before income tax..................................
Income tax expense ........................................
Net income ..........................................................
Earnings per common share
[($221,525 – $9,000) ÷ 80,000] ........................
18,000
20,000
323,525
102,000
$221,525
$2.66*
*Rounded
TWAIN CORPORATION
Retained Earnings Statement
For the Year Ended June 30, 2025
Retained earnings, July 1, 2024, as reported .....
Correction of depreciation understatement,
net of tax ...........................................................
Retained earnings, July 1, 2024, as adjusted .....
Add: Net income ..................................................
$337,000
(17,700)
319,300
221,525
540,825
Less:
Dividends declared on preferred stock.....
Dividends declared on common stock .....
Retained earnings, June 30, 2025 .......................
$ 9,000
37,000
46,000
$494,825
Problem 3.4 (Continued)
(b)
TWAIN CORPORATION
Income Statement
For the Year Ended June 30, 2025
Revenues
Net sales ............................................................
Dividend revenue ..............................................
Total revenues ..........................................
Expenses
Cost of goods sold ............................................
Selling expenses ...............................................
Administrative expenses ..................................
Interest expense ................................................
Total expenses .........................................
Income before income tax ..........................................
Income tax .........................................................
Net income ...................................................................
Earnings per common share [($221,525 - $9,000) ÷
80,000]
* Rounded
$1,485,050
38,000
1,523,050
896,770
248,785
35,970
18,000
1,199,525
323,525
102,000
$ 221,525
$2.66*
TWAIN CORPORATION
Retained Earnings Statement
For the Year Ended June 30, 2025
Retained earnings, July 1, 2024, as reported ...
Correction of depreciation understatement,
net of tax .........................................................
Retained earnings, July 1, 2024 as adjusted ....
Add: Net income ................................................
$337,000
(17,700)
319,300
221,525
540,825
Less:
Dividends declared on preferred stock ..
Dividends declared on common stock ...
Retained earnings, June 30, 2025 .....................
$ 9,000
37,000
LO: 1, , 3 Bloom: AP, Difficulty: Moderate, Time: 45-55, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
46,000
$494,825
Problem 3.5
1.
The usual but infrequently occurring charge of $8,500,000 should be
disclosed separately, assuming it is material. This charge is shown
above income before income tax and would not be reported net of tax.
This item should be separately disclosed to inform the users of the
financial statements that this item is nonrecurring and therefore may
not impact next year’s results.
2.
The loss on sale of equipment of $6,000,000 should be reported as an
"Other expense or loss". It should not be reported net of tax. As with
the first item, if material, it should be separately reported.
3.
The adjustment required for a change in estimated useful life is
inappropriately labeled. It also should not be reported in the retained
earnings statement. Changes in estimate should be handled in current
and future periods through the income statement. Catch-up
adjustments are not permitted. To restate financial statements every
time a change in estimate occurred would be extremely costly. In
addition, adjusting the beginning balance of retained earnings is
inappropriate as the increased charge in this case affects current and
future income statements.
4.
Earnings per share should be reported on the face of the income
statement and not in the notes to the financial statements. Because
such importance is ascribed to this statistic, the profession believes it
necessary to highlight the earnings per share figure.
LO: 1, , 3, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
Problem 3.6
(a)
ACADIAN CORP.
Retained Earnings Statement
For the Year Ended December 31, 2025
Retained earnings, January 1, as reported ...........................
Correction of error from prior period (net of tax) .................
Adjustment for change in accounting principle
(net of tax) ............................................................................
Retained earnings, January 1, as adjusted ...........................
Add: Net income ...................................................................
Less: Cash dividends declared ............................................
Retained earnings, December 31 ...........................................
$257,600
25,400
(23,200)
259,800
52,300*
32,000
$280,100
*$52,300 = ($84,500 + $41,200 + $21,600 – $35,000 – $60,000)
(b)
1. Gain on sale of investments—body of income statement. This gain
should not be shown net of tax on the income statement.
2. Refund on litigation with government—body of income statement,
possibly unusual item. This refund should not be shown net of tax
on the income statement.
3. Loss on discontinued operations—body of the income statement,
following the caption, “Income from continuing operations.”
4. Write-off of goodwill—body of income statement, possibly unusual
item. The write-off should not be shown net of tax on the income
statement.
LO: 1, 2, 3, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and
Interpretation , Reporting, AICPA PC: Communication
Problem 3.7
WADE CORP.
Income Statement (Partial)
For the Year Ended December 31, 2025
Income before income tax ................................
Income tax ................................................
Income from continuing operations ................
Discontinued operations
Loss from operations of subsidiary,
less applicable income tax of $17,100
Loss on disposal of subsidiary,
less applicable income tax of $19,000
Net income ........................................................
$1,200,000*
228,000**
972,000
$ 72,900
81,000
(153,900)
$ 818,100
Per share of common stock:
Income from continuing operations
($972,000 ÷ 150,000).......................................................
Loss from operations of discontinued
subsidiary, net of tax ....................................................
Loss on disposal of discontinued operations, net of tax.........
Net income ($818,100 ÷ 150,000).......................................
0.49
0.54
$5.45
*Computation of income from continuing operations
before income tax:
As previously stated
Loss on sale of equipment [$40,000 – ($80,000 – $30,000)]
Restated
$1,210,000
(10,000)
$1,200,000
$6.48
**Computation of income tax:
$1,200,000 x .19 = $228,000
Note: The gain on condemnation is appropriately included in income from
continuing operations (and is taxed at 19%). The error related to the
intangible asset was correctly charged to retained earnings.
LO: 1, 2, 3, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation ,
Reporting, AICPA PC: None
UYJ 3.1 Financial Reporting Problem
(a) P&G uses the multiple-step income statement because it separates
operating from nonoperating activities. A multiple-step income statement is
used to recognize additional relationships related to revenues and
expenses. P&G recognizes a separation of operating transactions from
nonoperating transactions. As a result, trends in income from continuing
operations should be easier to understand and analyze. Disclosure of
operating income may assist in comparing different companies and
assessing operating efficiencies.
(b) P&G operates in the consumer products market. The company separates
its operations into five global segments: (sales by segment)
Fabric and Home Care
Beauty
Baby, Feminine and Family Care
Health Care
Grooming
33%
19%
26%
13%
9%
(c) P&G’s gross profit (Net Sales – Cost of Products Sold) was $35,700 million
in 2020, $32,916 million in 2019, and $32,400 million in 2018. P&G’s gross
profit increased by approximately 8.5% in 2020 compared to 2019. The
increase in gross profit percentage from 2019 to 2020 was probably due to
a number of factors. The MD&A explains that net sales increased 5% with
a 4% increase in unit volume. It looks like P&G may have increased its
sales price while keeping its cost of products stable.
(d) P&G probably makes a distinction between operating and nonoperating
revenue for the reasons mentioned in the solution to Part (a). By
separating out these revenue and expense items, the statement reader
can see the separate impacts of operating and financing activities.
(e) P&G reports the following ratios in its 5-year “Financial Summary”
section: Earnings and Dividends per share. It also reports a ratio similar
to profit margin on sales. P&G reports net earning margin from
continuing operations which is calculated as income from continuing
operations ÷ Net Sales. The Financial Summary also reports income
statement items, such as advertising and research and development
expenses and operating income.
LO: 1, 2, Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, Research, AICPA PC:
Communication
UYJ 3.2 Comparative Analysis Case
(a)
Both companies use the multiple-step format in presenting income
statement information. Companies use the multiple-step income
statement to recognize additional relationships related to revenues and
expenses. Both companies distinguish between operating and
nonoperating transactions. As a result, trends in income from continuing
operations should be easier to understand and analyze. Disclosure of
operating income may assist in comparing different companies and
assessing operating efficiencies.
(b)
The gross profit, operating profit, and net income for these two companies
are as follows:
PepsiCo
Sales revenue ………
Cost of Goods sold ...
Gross Profit ...............
2020
$70,372
31,797
38,575
2019
$67,161
30,132
37,029
2018
$64,661
29,381
35,280
% Change
8.83%
8.22%
9.34%
Operating Profit ........
10,080
10,291
10,110
−0.30%
Net Income ................
$ 7,120
$ 7,314
$12,513
−43.11%
Coca-Cola
2020
Sales revenue............ $33,014
Cost of goods sold
13,433
.............................
Gross Profit ...............
19,581
2019
$37,266
14,619
2018
$34,300
13,067
% Change
−3.75%
2.80%
22,647
21,233
−7.78%
Operating Profit ........
8,997
10,086
9,152
−1.69%
Net Income ................
$ 7,747
$ 8,920
$ 6,434
20.41%
As shown in the table above, PepsiCo is performing better than CocaCola when comparing 2020's sales revenue, gross profit, and operating
profit to 2018's.
The changes in net income are very different. Coca-Cola experienced a
significant improvement, 20%, while PepsiCo had a very large
decrease, 43%.
UYJ 3.2 Comparative Analysis Case (Continued)
These large swings are due to unusual events. PepsiCo recorded a
larger than usual income tax benefit during 2018 that is explained in
Note 5.
In contrast Coca-Cola recorded larger than usual Other losses. Note 17
explains that the company recognized several impairment charges
during 2018.
These results illustrate the importance of disclosing nonrecurring
activities and events when using financial statements to predict future
performance.
(c)
Both companies use the two-statement approach in reporting
comprehensive income.
LO: 1, 2, Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Measurement Anaysis and
Interpretation, Reporting, Research, AICPA PC: Communication
UYJ 3.3 Financial Statement Analysis Case
(a)
Given the ready availability, the analysis for Walgreens is provided
below:
Z-Score Analysis
Z=
Working Capital
Total Assets
X 1.2 +
Retained Earnings
X 1.4 +
Total Assets
EBIT
Sales
X 3.3 +
Total Assets
Total Assets
X .99 +
MV Equity
X 0.6
Total Liabilities
Walgreens ($ 000,000)
2020
2019
Total Assets
$ 87,174
$ 67,598
Current Assets
$ 18,073
$ 18,700
Current Liabilities
$ 27,070
$ 25,769
$ −8,997
$ −7,069
Multiple
−0.1032
−0.105
$ 34,210
$ 35,815
0.392
0.530
Working Capital
Working Capital/Assets
Retained Earnings
Retained Earnings/Assets
EBIT
EBIT/Assets
$
1,382
$
0.077
$ 139,537
$ 136,866
1.601
2.025
MV Equity
$ 32,910*
$45,835**
Total Liabilities
$ 66,038
$ 43,447
0.498
1.055
Sales/Assets
MV Equity/Total Liabilities
*$38.02  865,603,519 shares
**$51.19  895,387,502 shares
Z-Score
2020
2019
1.2
−0.1236
−0.1260
1.4
0.5488
0.7420
3.3
0.0528
0.2541
0.99
1.5850
2.0048
0.6
0.2988
0.6330
Z-Score
2.3618
3.5079
5,231
0.016
Sales
Z-Score
UYJ 3.3 Financial Statement Analysis Case (Continued)
(b)
Walgreens’ Z-score in 2020 has decreased and is below the cutoff score
for companies that are unlikely to fail. The company has deteriorated all
components of the Z-score. Investors have noted greater risk as
indicated by lower stock prices.
Note to instructors—as an extension, students could be asked to
conduct the analysis on companies which are in financial distress (e.g.,
Xerox) to examine whether their financial distress could have been
predicted in advance.
(c)
EBIT is an operating income measure. By adding back items less
relevant to predicting future operating results (interest, taxes),
management views it as a better indicator of future profitability.
LO 1, 2, 3, 5 Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and
Interpretation, Reporting, Research, AICPA PC: Communication
UYJ 3.4 Financial Statement Analysis Case
(a)
Assumptions and estimates related to items such as bad debt expense,
warranties, or the useful lives or residual values for fixed assets could
result in income being overstated.
(b)
See the table below.
December 31, 2020
Tootsie Roll
Hershey
Price
(a)
$ 28.75
$151.52
EPS
(b)
$0.89
$6.11
Sales
per
Share
(c)
$ 7.03*
$39.14**
P/E
(a) ÷ (b)
32.3034
24.7987
Price to
Sales
(a) ÷ (c)
4.09
3.87
*$467,427 ÷ 66,512 shares
**$8,149,719,000 ÷ 208,227,127 shares per note 14
(c)
Tootsie Roll has a higher P/E relative to Hershey by approximately 30%.
Tootsie Roll’s PSR is higher than Hershey’s. Thus, Tootsie Roll’s stock
may be overpriced.
LO: 5, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
UYJ 3.5 Accounting, Analysis, And Principles
Accounting
COUNTING CROWS, INC.
Income Statement
For the Year Ending December 31, 2025
Revenues
Sales revenue
Rent revenue
Total revenues
$1,900,000
102,700
$2,002,700
Expenses
Cost of goods sold
Selling expenses
Administrative expenses
Income tax
Total expenses
850,000
300,000
240,000
187,000
1,577,000
Income from continuing operations
Discontinued operations
Loss on discontinued operations, less
applicable income tax $60,500
Net income
Per share of common stock:
Income from continuing operations ($425,700 ÷ 100,000)
Loss on discontinued operations, net of tax
Net income ($376,200 ÷ 100,000)
All EPS are rounded
$ 425,700
$
49,500
$ 376,200
$4.26
(0.50)
$3.76
UYJ 3.5 Accounting, Analysis, And Principles (Continued)
COUNTING CROWS, INC.
Retained Earnings Statement
For the Year ended December 31, 2025
Retained earnings, January 1
Net income
$600,000
376,200
976,200
Dividends declared
(80,000)
Retained earnings, December 31 $896,200
COUNTING CROWS, INC.
Comprehensive Income Statement
For the Year ended December 31, 2025
Net income
$376,200
Other comprehensive income:
Unrealized holding gain, net of $2,000 tax
15,000
Comprehensive income
$391,200
Analysis
The multiple-step income statement recognizes important relationships
between income statement elements. For example, by separating operating
transactions from nonoperating transactions, the statement user can
distinguish between elements with differing implications for future operating
results. In addition, the multiple-step format generally groups costs and
expenses with related revenues (e.g., cost of goods sold with sales revenue
to yield a gross profit measure). Finally, the multiple-step format highlights
certain intermediate components of income that analysts use to compute
ratios for assessing the performance of the company.
Principles
Non-GAAP reporting is inconsistent with the conceptual framework’s qualitative characteristic of comparability. For example, similar to the discussion in
the opening story, if Counting Crows Inc. classifies some items in a pro
forma manner but other companies do not, investors and creditors will not
be able to compare the reported incomes. This is the reason the SEC issued
Regulation G, which requires companies that issue pro forma income
reports to provide a reconciliation to net income measured under GAAP,
which interested parties can then compare across companies.
LO: 1, 2, 3 Bloom: S, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and
Interpretation, Reporting, AICPA PC: Communication
Time and Purpose of Critical Thinking
CT3.1 (Time 20–25 minutes)
Purpose—to provide the student with the opportunity to comment on deficiencies in an income statement
format. The student is required to comment on such items as inappropriate heading, incorrect
classification of special items, proper net of tax treatment, and presentation of per share data.
CT3.2 (Time 20–25 minutes)
Purpose—to provide the student an illustration of how earnings can be managed. The case allows
students to see the effects of warranty expense timing on the trend of income and illustrates the potential
use of accruals to smooth earnings.
CT3.3 (Time 15–20 minutes)
Purpose—to provide the student an illustration of how earnings can be managed by how losses are
reported, including ethical issues.
CT3.4 (Time 30–35 minutes)
Purpose—to provide the student with an unstructured case to comment on the reporting of discontinued
operations. In addition, the student is asked to comment on materiality considerations and earnings per
share implications.
CT3.5 (Time 30–40 minutes)
Purpose—to provide the student with the opportunity to comment on deficiencies in an income statement.
This case includes discussion of discontinued items, and gains and losses. The case is complete and
therefore provides a broad overview to a number of items discussed in the textbook.
CT3.6 (Time 20–25 minutes)
Purpose—to provide the student with a variety of situations involving classification of special items. This
case is different from CT3.5 in that an income statement is not presented. Instead, short factual situations
are described. A good comprehensive case for discussing the presentation of special items.
CT3.7 (Time 10–15 minutes)
Purpose—to provide the student with an opportunity to show how comprehensive income should be
reported.
Solutions to Critical Thinking
CT3.1
The deficiencies of O’Malley Corporation’s income statement are as follows:
1.
2.
The heading is inappropriate. The heading should include the period of time for which the income
statement is presented.
Insert Revenues: as first line in body of statement and then list the detail in a left hand column with
subtotal in right hand column.
3.
Change Less: to Expenses:
4.
Gain on recovery of insurance proceeds is properly classified in a single-step income statement.
5.
Cost of goods sold is usually listed as the first expense, followed by selling, administrative, and other
expenses.
6.
Advertising expense is a selling expense and should usually be classified as such, unless this
expense is unusually different from previous periods.
7.
Loss on obsolescence of inventories is properly classified in a single step income statement.
8.
Loss on discontinued operations requires a separate classification after income from continuing
operations.
9.
Intraperiod income tax allocation is required to relate income tax expense to income from continuing
operations and loss on discontinued operations.
10. Per share data is a required presentation for income from continuing operations, discontinued
operations, and net income.
LO: 1, 2, Bloom: C, Difficulty: Simple, Time: 20-25, AACSB: knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
CT3.2
(a) Earnings management is often defined as the planned timing of revenues, expenses, gains and
losses to smooth out bumps in earnings. In most cases, earnings management is used to increase
income in the current year at the expense of income in future years. For example, companies
prematurely recognize sales in order to boost earnings. Earnings management can also be used to
decrease current earnings in order to increase income in the future. The classic case is the use of
“cookie jar” reserves, which are established, by using unrealistic assumptions to estimate liabilities
for such items as loan losses, restructuring charges and warranty returns.
(b) Proposed Accounting
Income before warranty expense
Warranty expense
Income
2022
2023
2024
$20,000
$25,000
$30,000
2025
$43,000
7,000
$36,000
2026
$43,000
3,000
$40,000
Assuming the same income before warranty expense for both 2025 and 2026 and total warranty
expense over the 2-year period of $10,000, this proposed accounting results in steadily increasing
income over the two-year period.
CT3.2 (Continued)
(c) Appropriate Accounting
Income before warranty expense
Warranty expense
Income
2022
2023
2024
$20,000
$25,000
$30,000
2025
$43,000
5,000
$38,000
2026
$43,000
5,000
$38,000
The appropriate accounting would be to record $5,000 of warranty expense in 2025, resulting in
income of $38,000. However, with the same amount of warranty expense in 2026, Bobek no longer
shows an increasing trend in income. Thus, by taking more expense in 2025, Bobek can save some
income (a classic case of “cookie-jar” reserves) and maintain growth in income.
LO: 5, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation,
Reporting, AICPA PC: Communication
CT3.3
(a) The ethical issues involved are integrity and honesty in financial reporting, full disclosure,
accountant’s professionalism, and job security for Charlie.
(b) If Charlie believes the losses are relevant information important to users of the income statement,
he should disclose the losses separately. If they are considered incidental to the company’s normal
activities—i.e., the major activities of the Kelly Corporation do not include selling equipment—the
transactions should be reported among any gains and losses that occurred during the year.
LO: 5, Bloom: E, Difficulty: Simple, Time: 15-20, AACSB: Ethics, Communication, AICPA BB: None, , AICPA AC: Reporting, AICPA PC: Ethical Conduct
CT3.4
(a) It appears that the sale of the Casino Knights Division would qualify as a discontinued operation.
The operation of gambling facilities appears to meet the criteria for discontinued operations for
Simpson Corp. and, therefore, the accounting requirements related to discontinued operations
should be followed. Although the financial vice-president might be correct theoretically, professional
pronouncements require that such segregation be made. A separate classification is required for
disposals meeting the requirements of discontinued operations. If this disposal did not meet the
requirements for disposal of a component of a business, treatment as “other gain or loss” might be
considered appropriate.
(b) The “walkout” or strike generally does not get special reporting. Events of this nature are a general
risk that any business enterprise takes and should not warrant special treatment. Such events may
call for expanded disclosure if the effects are significant.
(c) The financial vice-president is incorrect in his/her observations concerning the materiality of irregular
items. The materiality of each item must be considered individually. It is not appropriate to consider
only the materiality of the net effect. Each irregular item must be reported separately on the income
statement.
(d) Earnings per share for income from continuing operations and discontinued operations, and net
income, must be reported on the face of the income statement.
LO: 1, 2, Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Decision Making,
Communication
CT3.5
The income statement of Walters Corporation contains the following weaknesses in classification and
disclosure:
1.
Sales taxes. Sales taxes have been erroneously included in both gross sales and cost of goods
sold on the income statement of Walters Corporation. Failure to deduct these taxes directly from
customer billings results in a deceptive inflation of the amount of sales. These taxes should be
deducted from gross sales because the corporation acts as an agent in collecting and remitting such
taxes to the state government.
2.
Purchase discounts. Purchase discounts should not be treated as revenue by being lumped with
other revenues such as dividends and interest. A purchase discount is more logically a reduction of
the cost of purchases because revenue is not created by purchasing goods and paying for them. In
a cash transaction, cost is measured by the amount of the cash consideration. In a credit transaction,
however, cost is measured by the amount of cash required to settle immediately the obligation
incurred. The discount should reduce the cost of goods sold to the amount of cash that would be
required to settle the obligation immediately.
3.
Recoveries of accounts written off in prior years. These collections should be credited to the
allowance for doubtful accounts unless the direct write-off method was used in accounting for bad
debt expense. Generally, the direct write-off method is not allowed.
4.
Delivery expense. Although delivery expense (sometimes referred to as freight-out) is an expense
of selling and is therefore reported properly in the statement, freight-in is an inventoriable cost and
should have been included in the computation of cost of goods sold. The value assigned to inventory
should represent the value of the economic resources given up in obtaining goods and readying
them for sale.
5.
Loss on discontinued styles. This type of loss, though often substantial, should not be treated as
discontinued operation unless it eliminates a component of the business of the corporation and/or
represents a strategic shift. Otherwise it should be reported as “Other expenses and losses” before
Income before taxes.
6.
Loss on sale of marketable securities. This item should be reported as a separate component of
income from continuing operations as an "Other expense or loss."
7.
Loss on sale of warehouse. This type of item does not get special treatment, even if the loss is
the direct result of a major casualty, an expropriation, or a prohibition under a newly enacted law or
regulation. This item should be separately disclosed as an unusual item, if either unusual in nature
and/or infrequent in occurrence. Note that as a result of a recent FASB ASU, special extraordinary
item treatment of unusual and infrequent items is no longer allowed.
8.
Federal Income taxes. The provision for federal income taxes and intraperiod tax allocation are not
presented in the income statement. This omission implies that the federal income tax is a distribution
of net income instead of an operating expense and a determinant of net income. This assumption is
not as relevant to the majority of financial statement users as the concept of net income to investors,
stockholders, or residual equity holders. Also, by law the corporation must pay federal income taxes
whether the benefits it receives from the government are direct or indirect. Finally, those who base
their decisions upon financial statements are thought to look to net income as being a more relevant
measure of income than income before taxes.
LO: 1, 2 Bloom: C, Difficulty: Moderate, Time: 30-40, AACSB: knowledge Communication, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation,
Reporting, AICPA PC: Communication
CT3.6
Classification
1.
No disclosure.
Rationale
Error has “reversed out”; that is, subsequent
income statement compensated for the error.
However, prior year income statements should
be restated if the amount of the error is material.
2.
Reported in body of the income statement,
as Other revenues and gains.
While unusual in nature, and infrequent in
occurrence, GAAP requires reporting in income
from continuing operations.
3.
Depreciation expense in body of income
statement, based on new useful life.
Material item, but change in estimated useful life
is considered part of normal business activity.
*4. No separate disclosure unless material.
Change in estimate, considered part of normal
business activity.
5.
Reported in body of the income statement,
possibly as an unusual item.
Sale does not meet criteria for the disposal of a
component of the business.
6.
Adjustment to the beginning balance of
retained earnings.
A change in inventory methods is a change in
accounting principle and prior periods are
adjusted.
7.
Reported in body of the income statement,
as Other expenses and losses.
Loss on preparation of such proposals does not
get special reporting.
8.
Reported in body of the income statement,
as Other expenses and losses.
Strikes are the result of general business risk and
do not receive special reporting.
9.
Prior period adjustment, adjust beginning
retained earnings.
Corrections of errors are shown as prior period
adjustments.
10.
Reported in body of the income statement,
possibly as an unusual item (other losses).
While unusual in nature, and infrequent in
occurrence, GAAP requires reporting in income
from continuing operations.
11.
Discontinued operations section.
Division’s assets, results of operations, and
activities are clearly distinguishable physically,
operationally, and for financial reporting
purposes. As indicated the charge reflects a
strategic shift for the company.
LO: 1, 2, 3, *6, Bloom: C, Difficulty: Moderate, Time: 20-25, AACSB: knowledge, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and
Interpretation, Reporting, AICPA PC: Communication
CT3.7
(a) Separate Statement
. . . income components . . .
Net income .......................................................................
Comprehensive Income Statement
Net income .......................................................................
Unrealized gains ...............................................................
Comprehensive income ....................................................
(b) Combined Format
. . . income components . . .
Net income .......................................................................
Other comprehensive income
Unrealized gains ...............................................................
Comprehensive income ....................................................
Current Year
Prior Year
$400,000
$410,000
$400,000
15,000
$415,000
$410,000
$400,000
$410,000
15,000
$415,000
$410,000
$410,000
(c) Nelson can choose either approach, according to FASB ASC 220-10-45. The method chosen should
be based on which one provides the most useful information. For example, Nelson should not
choose the combined format because the gains result in an increasing trend in comprehensive
income, while net income is declining.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Codification Exercises
CE3.1
According to the Glossary:
(a) A change in accounting estimate is a change that has the effect of adjusting the carrying amount of
an existing asset or liability or altering the subsequent accounting for existing or future assets or
liabilities. Changes in accounting estimates result from new information. Examples of items for which
estimates are necessary are uncollectible receivables, inventory obsolescence, service lives and
salvage value of depreciable assets, and warranty obligations. A change in accounting estimate is a
necessary consequence of the assessment, in conjunction with the periodic presentation of financial
statements, of the present status and expected future benefits and obligations associated with
assets and liabilities.
(b) A change in accounting principle reflects a change from one generally accepted accounting principle
to another generally accepted accounting principle when there are two or more generally accepted
accounting principles that apply or when the accounting principle formerly used is no longer
generally accepted. A change in the method of applying an accounting principle also is considered
a change in accounting principle. A “Change in Accounting Estimate Effected by a Change in
Accounting Principle” is a change in accounting estimate that is inseparable from the effect of a
related change in accounting principle. An example of a change in estimate effected by a change in
principle is a change in the method of depreciation, amortization, or depletion for long-lived,
nonfinancial assets.
(c) Comprehensive Income is defined as the change in equity (net assets) of a business during a period
from transactions and other events and circumstances from nonowner sources. It includes all
changes in equity during a period except those resulting from investments by owners and
distributions to owners.
LO: 2, 3, *6 Bloom: K, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, Communication, AICPA BB: None AICPA AC: Reporting, Research, Technology & Tools,
AICPA PC: Communication
CE3.2
According to FASB ASC 810-10-45-21 (Attributing Net Income and Comprehensive Income to the Parent
and the Noncontrolling Interest)
45-21 Losses attributable to the parent and the noncontrolling interest in a subsidiary may exceed their
interests in the subsidiary's equity. The excess, and any further losses attributable to the parent
and the noncontrolling interest, shall be attributed to those interests. That is, the noncontrolling
interest shall continue to be attributed its share of losses even if that attribution results in a deficit
noncontrolling interest balance.
LO: 2, Bloom: K, Difficulty: Simple, Time: 5, AACSB: Knowledge Communication, AICPA BB: None, AICPA AC: Reporting, Research, Technology & Tools, AICPA
PC: Communication
CE3.3
Entering “effect of preferred stock” in the search window yields the following link (FASB ASC 260-10S55): 260 Earnings per Share > 10 Overall > S55 Implementation Guidance and Illustrations.
General
Effect of Preferred Stock Dividends and Accretion of Carrying Amount of Preferred Stock on Earnings
Per Share S55-1 See paragraph 225-10-S99-5, SAB . . . views on this topic.
Following that link yields the following guidance:
Income or Loss Applicable to Common Stock
S99-5 The following is the text of SAB Topic 6.B, Accounting Series Release 280—General Revision Of
Regulation S-X: Income Or Loss Applicable To Common Stock.
Facts: A registrant has various classes of preferred stock. Dividends on those preferred stocks
and accretions of their carrying amounts cause income applicable to common stock to be less than
reported net income.
Question: In ASR 280, the Commission stated that although it had determined not to mandate
presentation of income or loss applicable to common stock in all cases, it believes that disclosure
of that amount is of value in certain situations. In what situations should the amount be reported,
where should it be reported, and how should it be computed?
Interpretive Response: Income or loss applicable to common stock should be reported on the
face of the income statement (FN1) when it is materially different in quantitative terms from
reported net income or loss (FN2) or when it is indicative of significant trends or other qualitative
considerations. The amount to be reported should be computed for each period as net income
or loss less: (a) dividends on preferred stock, including undeclared or unpaid dividends if
cumulative; and (b) periodic increases in the carrying amounts of instruments reported as
redeemable preferred stock (as discussed in Topic 3.C) or increasing rate preferred stock (as
discussed in Topic 5.Q).
(FN1) If a registrant elects to follow the encouraged disclosure discussed in paragraph 23 of
Statement 130, and displays the components of other comprehensive income and the total for
comprehensive income using a one-statement approach, the registrant must continue to follow the
guidance set forth in the SAB Topic. One approach may be to provide a separate reconciliation of
net income to income available to common stock below comprehensive income reported on a
statement of income and comprehensive income.
(FN2) The assessment of materiality is the responsibility of each registrant. However, absent
concerns about trends or other qualitative considerations, the staff generally will not insist on the
reporting of income or loss applicable to common stock if the amount differs from net income or
loss by less than ten percent.
LO: 2, 3, *6, Bloom: K, Difficulty: Simple, Time: 10-15, AACSB: knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, Research, Technology & Tools,
AICPA PC: Communication
Codification Research Case
(a)
FASB ASC 220 – Presentation, Comprehensive Income. The predecessor
standard for this topic is FAS No. 130 Reporting Comprehensive Income
(Issued June, 1997). By following this Codification String: Presentation
> 220 Comprehensive Income > 10 Overall > 5 Background and then click
on Printer-Friendly with sources, FAS 130 is identified; you can then go
to www.fasb.org/st/ to find the issue date.
(b)
The definition of comprehensive income (Master Glossary of ASC): The
change in equity (net assets) of a business entity during a period from
transactions and other events and circumstances from nonowner
sources. It includes all changes in equity during a period except those
resulting from investments by owners and distributions to owners.
(c)
Classifications within net income and examples (FASB ASC 220-10-45-7):
45-7
(d)
[Items included in net income are displayed in various
classifications. Those classifications can include income from
continuing operations and discontinued operations. This
Subtopic does not change those classifications or other
requirements for reporting results of operations.]
The classifications within other comprehensive income (220-10-45-13):
Accounting Standards Update No. 2011-05–Comprehensive Income
(Topic 220)
Under the amendments to Topic 220, comprehensive Income, in this
Update, an entity has the option to present the total of comprehensive
income, the components of net income, and the components of other
comprehensive income either in a single continuous statement of
comprehensive income or in two separate but consecutive statements.
In both choices, an entity is required to present each component of net
income along with total net income, each component of other
comprehensive income along with a total for other comprehensive
income, and a total amount for comprehensive income. This Update
eliminates the option to present the components of other
comprehensive income as part of the statement of changes in
stockholders' equity. The amendments in this Update do not change
the items that must be reported in other comprehensive income or
when an item of other comprehensive income must be reclassified to
net income.
Codification Research Case (Continued)
(e)
Reclassification adjustments (FASB ASC 220-10-45-15)
45-15 Reclassification adjustments shall be made to avoid double
counting in comprehensive income items that are displayed as
part of net income for a period that also had been displayed
as part of other comprehensive income in that period or earlier
periods. For example, gains on investment securities that were
realized and included in net income of the current period that
also had been included in other comprehensive income as unrealized holding gains in the period in which they arose must be
deducted through other comprehensive income of the period in
which they are included in net income to avoid including them in
comprehensive income twice (see paragraph 320-10-40-2).
LO: 6, Bloom: C, Difficulty: Moderate, Time: 25-30, AACSB: Knowledge, Communication, Technology, AICPA BB: None, AICPA FC: Reporting, Research,
Technology & Tools, AICPA PC: Communication
CHAPTER 4
Balance Sheet and Statement of Cash Flows
Assignment Classification Table (By Topic)
Brief
Exercises
Exercises
Critical
Thinking
Topics
Questions
Problems
1.
Disclosure principles,
uses of the balance
sheet, financial
flexibility.
1, 2, 3, 4, 5,
6, 7, 8, 9,
10, 18, 29,
30, 31
2.
Classification of items
in the balance sheet.
Issues of disclosure
terminology and
valuation.
11, 12, 13,
14, 15, 16,
18, 19, 20,
29, 30, 31,
32
1, 2, 3, 4, 5,
6, 7, 8, 9,
10, 11
1, 2, 3, 8,
9, 10
3.
Statement of cash
flows.
21, 22, 23,
24, 25, 26,
27, 28
12, 13, 14,
15, 16
13, 14, 15,
16, 17, 18
6, 7
5
4.
Preparation of balance 15, 16, 17,
sheet.
1, 2, 3, 4, 5,
6, 7, 8, 9,
10, 11
4, 5, 6, 7, 9,
11, 12, 17
1, 2, 3, 4,
5, 6, 7
2, 3, 4
3, 4
1, 2, 3, 4
Assignment Classification Table (By Learning Objective)
Learning Objectives
Questions
Brief
Exercises
Exercises
Problems
Critical
Thinking
1.
Explain the uses,
limitations, and content
of the balance sheet.
1, 2, 3, 4, 5,
6, 7, 8, 9,10,
11, 12, 13,
14, 15, 16,
17, 18,19, 20
1, 2, 3, 4, 5,
6, 7, 8, 9, 10,
11
1, 2, 3, 4,
5, 6, 7, 8,
9, 10, 11,
12, 17
1, 2, 3, 4,
5, 6, 7
1
2
3
4
2.
Explain the purpose,
content, preparation,
and usefulness of the
statement of cash
flows.
21, 22, 23,
24, 25, 26,
27, 28,
12, 13, 14,
15, 16
13, 14, 15,
16, 17, 18
6, 7
5
3.
Describe additional
types of information
provided.
20, 29, 30,
31, 32
4.
Identify the major
types of financial ratios
and what they
measure.
5
Assignment Characteristics Table
Level of
Difficulty
Time
(minutes)
Balance sheet classifications.
Classification of balance sheet accounts.
Classification of balance sheet accounts.
Preparation of a classified balance sheet.
Preparation of a corrected balance sheet.
Corrections of a balance sheet.
Current assets section of the balance sheet.
Current vs. long-term liabilities.
Current assets and current liabilities.
Current liabilities.
Balance sheet preparation.
Preparation of a balance sheet.
Statement of cash flows—classifications.
Preparation of a statement of cash flows.
Preparation of a statement of cash flows.
Preparation of a statement of cash flows.
Preparation of a statement of cash flows and a
balance sheet.
Preparation of a statement of cash flows, analysis.
Simple
Simple
Simple
Simple
Simple
Complex
Moderate
Moderate
Complex
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
15–20
15–20
15–20
30–35
30–35
30–35
15–20
10–15
30–35
15–20
25–30
30–35
5-10
25–35
25–35
25–35
30–35
Moderate
25–35
Preparation of a classified balance sheet, periodic
inventory.
Balance sheet preparation.
Balance sheet adjustment and preparation.
Preparation of a corrected balance sheet.
Balance sheet adjustment and preparation.
Preparation of a statement of cash flows and
a balance sheet.
Preparation of a statement of cash flows and
balance sheet.
Moderate
30–35
Moderate
Moderate
Complex
Complex
Complex
35–40
40–45
40–45
40–45
35–45
Complex
40–50
Reporting the financial effects of varied transactions.
Identifying balance sheet deficiencies.
Critique of balance sheet format and content.
Presentation of property, plant, and equipment.
Cash flow analysis.
Moderate
Moderate
Simple
Simple
Complex
20–25
20–25
20–25
20–25
40–50
Item
Description
E4.1
E4.2
E4.3
E4.4
E4.5
E4.6
E4.7
E4.8
E4.9
E4.10
E4.11
E4.12
E4.13
E4.14
E4.15
E4.16
E4.17
E4.18
P4.1
P4.2
P4.3
P4.4
P4.5
P4.6
P4.7
CT4.1
CT4.2
CT4.3
CT4.4
CT4.5
Answers to Questions
1. The balance sheet provides information about the nature and amounts of investments in enterprise
resources, obligations to creditors, and the owners’ equity in net enterprise resources. That information
not only complements information about the components of income, but also contributes to financial
reporting by providing a basis for (1) computing rates of return, (2) evaluating the capital structure of
the enterprise, and (3) assessing the liquidity solvency, and financial flexibility of the enterprise.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
2. Solvency refers to the ability of a company to pay its debts as they mature. For example, when a
company carries a high level of long-term debt relative to assets, it has lower solvency. Information
on long-term obligations, such as long-term debt and notes payable, in comparison to total assets,
can be used to assess resources that will be needed to meet these fixed obligations (such as interest
and principal payments).
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
3. Financial flexibility is the ability of a company to take effective actions to alter the amounts and timing
of cash flows so it can respond to unexpected needs and opportunities. An enterprise with a high
degree of financial flexibility is better able to survive bad times, to recover from unexpected setbacks,
and to take advantage of profitable and unexpected investment opportunities. Generally, the greater
the financial flexibility, the lower the risk of enterprise failure.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
4. Some situations in which estimates affect amounts reported in the balance sheet include:
(a)
allowance for doubtful accounts.
(b)
depreciable lives and estimated salvage values for plant and equipment.
(c)
warranty returns.
(d)
determining the amount of revenues that should be recorded as unearned.
When estimates are required, there is subjectivity in determining the amounts. Such subjectivity can
impact the usefulness of the information by reducing the degree to which the measures are faithful
representations, either because of bias or lack of verifiability.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement, Reporting, AICPA PC:
Communication
5. A higher level of inventories increases current assets, which is in the numerator of the current ratio.
Therefore, a higher inventory will increase the current ratio. In general, a higher current ratio
indicates a company has better liquidity since there are more current assets relative to current
liabilities.
Note to instructors—When inventories increase faster than sales, this may not be a good signal
about liquidity. That is, inventory can only be used to meet current obligations when it is sold (and
converted to cash). That is why some analysts use a liquidity ratio—the acid-test ratio—that excludes
inventories from current assets in the numerator.
LO: 1, 4, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
6. Liquidity describes the amount of time that is expected to elapse until an asset is converted into
cash or until a liability has to be paid. The ranking of the assets given in order of liquidity is:
(1) (d) Short-term investments
(2) (e) Accounts receivable
(3) (b) Inventory
(4) (c) Buildings
(5) (a) Goodwill
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 4 (Continued)
7. The major limitations of the balance sheet are:
(a)
The values stated are generally historical and not at fair value.
(b)
Judgements and estimates are used in many instances, such as in determining the
collectability of receivables or finding the approximate useful life of long-term tangible and
intangible assets.
(c)
Many items, even though they have financial value to the business, are not recorded. One
example is the value of a company’s human resources.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
8. Some items of value to technology companies such as Intel or IBM are the value of research and
development (new products that are being developed but which are not yet marketable), the value
of the “intellectual capital” of its workforce (the ability of the companies’ employees to come up with
new ideas and products in the fast-changing technology industry), and the value of the companies’
reputation or name brand. In most cases, the reasons why the value of these items are not recorded
in the balance sheet concern the lack of faithful representation of the estimates of the future cash
flows that will be generated by these “assets” (for all three types) and the ability to control the use
of the asset (in the case of employees). Being able to reliably measure the expected future benefits
and to control the use of an item are essential elements of the definition of an asset, according to
the Conceptual Framework.
LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement, Reporting, AICPA PC:
Communication
9. Classification in financial statements helps users by grouping items with similar characteristics and
separating items with different characteristics. Current assets are expected to be converted to cash
within one year or the operating cycle, whichever is longer—property, plant, and equipment will
provide cash inflows over a longer period of time. Thus, separating long-term assets from current
assets facilitates computation of useful ratios, especially liquidity ratios such as the current ratio.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
10. Separate amounts should be reported for accounts receivable and notes receivable. The amounts
should be reported gross, and an amount for the allowance for doubtful accounts should be
deducted. The amount and nature of any nontrade receivables and any amounts designated or
pledged as collateral should be clearly identified.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement, Reporting, AICPA PC:
Communication
11. No. Available-for-sale securities should be reported as a current asset only if management expects
to convert them into cash as needed within one year or the operating cycle, whichever is longer. If
available-for-sale securities are not held with this expectation, they should be reported as long-term
investments.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
12. The relationship between current assets and current liabilities is that current liabilities are those
obligations that are reasonably expected to be liquidated either through the use of current assets or
the creation of other current liabilities.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
13. The total selling price of the season tickets is $20,000,000 (10,000 x $2,000). Of this amount,
$8,000,000 has been earned by 12/31/25 (16/40 x $20,000,000). The remaining $12,000,000 should
be reported as unearned revenue, a current liability in the 12/31/25 balance sheet (24/40 x
$20,000,000) or ($20,000,000 - $8,000,000).
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: Communication
Questions Chapter 4 (Continued)
14. Working capital is the excess of total current assets over total current liabilities. This excess is
sometimes called net working capital. Working capital represents the net amount of a company’s
relatively liquid resources. That is, it is the liquidity buffer available to meet the financial demands of
the operating cycle.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
15. (a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
Stockholders’ Equity. “Treasury stock (at cost).”
Note: This is a reduction of total stockholders’ equity (reported as contra-equity).
Current Assets. Included in “Cash.”
Long-Term Investments. “Land held as an investment.”
Long-Term Investments, “Sinking Fund.”
Long-Term Debt (adjunct account to bonds payable). “Unamortized premium on bonds payable.”
Intangible Assets. “Copyrights.”
Long-Term Investments. “Employees’ pension fund,” with subcaptions of “Cash” and “Securities”
if desired. (Assumes that the company still owns these assets.)
Stockholders’ Equity. “Additional paid-in capital.”
Investments. Nature of investments should be given together with parenthetical information
as follows: “pledged to secure loans payable to banks.”
LO: 1, Bloom: K, Difficulty: Simple, Time: 5-7, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
16. (a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
Allowance for doubtful accounts (a contra-asset) should be deducted from accounts
receivable in current assets.
Merchandise held on consignment should not appear on the consignee’s balance sheet
except possibly as a note to the financial statements.
Advances received on sales contract are normally a current liability and should be shown as
such in the balance sheet.
Cash surrender value of life insurance should be shown as a long-term investment.
Land should be reported in property, plant, and equipment unless held for investment.
Merchandise out on consignment should be shown among current assets under the heading
of inventory.
Franchises should be itemized in a section for intangible assets.
Accumulated depreciation of plant and equipment (a contra-asset) should be deducted from
the equipment account.
Materials in transit should not be shown on the balance sheet of the buyer if purchased f.o.b.
destination.
LO: 1, Bloom: K, Difficulty: Simple, Time: 5-7, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
17. (a)
(b)
(c)
(d)
(e)
Trade accounts receivable should be stated at their estimated amount collectible, often
referred to as net realizable value. The method most generally followed is to deduct from the
total accounts receivable the amount of the allowance for doubtful accounts.
Land is generally stated in the balance sheet at cost.
Inventories are generally stated at the lower-of-cost-or-net realizable value. If LIFO or retail
inventory methods are used, market is used instead of net realizable value.
Trading securities are stated at fair value.
Prepaid expenses should be stated at cost less the amount apportioned to and written off over
the previous accounting periods.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
18. Assets are defined as probable future economic benefits obtained or controlled by a particular entity
as a result of past transactions or events. If a building is leased under a lease, the future economic
benefits of using the building (the right-of-use asset) are controlled by the lessee (tenant) as the
result of a past event (the signing of a lease agreement).
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 4 (Continued)
19. Battle is incorrect. Retained earnings is a source of assets, but is not an asset itself. For example,
even though the funds obtained from issuing a note payable are invested in the business, the note
payable is not reported as an asset. It is a source of assets, but it is reported as a liability because
the company has an obligation to repay the note in the future. Similarly, even though the earnings
are invested in the business, retained earnings is not reported as an asset. It is reported as part of
shareholders’ equity because it is, in effect, an investment by owners which increases the ownership
interest in the assets of an entity.
LO: 1, Bloom: C Difficulty: Moderate, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
20. The notes should appear as long-term liabilities with full disclosure as to their terms. Each year, as
the profit is determined, notes of an amount equal to two-thirds of the year’s profits should be
transferred from the long-term liabilities to current liabilities until all of the notes have been liquidated.
LO: 1, 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
21. The purpose of a statement of cash flows is to provide relevant information about the cash receipts
and cash payments of an enterprise during a period. It differs from the balance sheet and the income
statement in that it reports the sources and uses of cash by operating, investing, and financing
activity classifications. While the income statement and the balance sheet are accrual basis
statements, the statement of cash flows is a cash basis statement—noncash items are omitted.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
22. The difference between these two amounts may be due to increases in current assets (e.g., an
increase in accounts receivable from a sale on account would result in an increase in revenue and
net income but have no effect yet on cash). Similarly, a cash payment that results in a decrease in
an existing current liability (e.g., payment of accounts payable would decrease cash provided by
operations without affecting net income).
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
23. The difference between these two amounts could be due to noncash charges that appear in the
income statement. Examples of noncash charges are depreciation, depletion, and amortization of
intangibles. Expenses recorded but unpaid (e.g., increase in accounts payable) and collection of
previously recorded sales on credit (i.e., now decreasing accounts receivable) also would cause
cash provided by operating activities to exceed net income.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
24. Operating activities involve the cash effects of transactions that enter into the determination of net
income. Investing activities include making and collecting loans and acquiring and disposing of
debt and equity instruments; property, plant, and equipment and intangibles. Financing activities
involve liability and stockholders’ equity items and include obtaining resources from owners and
providing them with a return on (dividends) and a return of their investment and borrowing money
from creditors and repaying the amounts borrowed.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 4 (Continued)
25. (a)
Net income is adjusted downward by deducting $5,000 ($39,000 - $34,000) from $90,000 and
reporting cash provided by operating activities as $85,000.
(b)
The issuance of the preferred stock is a financing activity. The issuance is reported as follows:
Cash flows from financing activities
Issuance of preferred stock (10,000 shares x $115).....................
$1,150,000
(c)
Net income is adjusted as follows:
Cash flows from operating activities
Net income ........................................................................................
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense...................................................................
Bond premium amortization..........................................................
Net cash provided by operating activities ..........................................
(d)
$90,000
14,000
(5,000)
$99,000
The increase of $20,000 reflects an investing activity. The increase in Land is reported as
follows:
Cash flows from investing activities:
Purchase land ($10,000 - $30,000) ..............................................
$(20,000)
LO: 2, Bloom: C, Difficulty: Simple, Time: 5-7, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
26. The company appears to have good liquidity and reasonable financial flexibility. Its current cash debt
 $1,200,000 
 , which indicates that it can pay off its current liabilities in a given
 $1,000,000 
coverage is 1.20 
year
from
its
operations.
In
addition,
its
cash
debt
coverage
is
also
good
at
 $1,200,000
0.80 
 , which indicates that it can pay off approximately 80% of its debt out of current
 $1,500,000
operations.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
27. Free cash flow = $860,000 – $75,000 – $30,000 = $755,000.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
28. Free cash flow is net cash provided by operating activities less capital expenditures and dividends.
The purpose of free cash flow analysis is to determine the amount of discretionary cash flow a
company has for purchasing additional investments, retiring its debt, purchasing treasury stock, or
simply adding to its liquidity and financial flexibility.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 4 (Continued)
*29. Some of the techniques of disclosure for the balance sheet are:
(a) Parenthetical explanations.
(b) Notes to the financial statements.
(c)
Cross-references and contra items.
(d) Supporting schedules.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
*30. A note entitled “Summary of Significant Accounting Policies” would indicate the basic accounting
principles used by that enterprise. This note should be very useful from a comparative standpoint
since it should be easy to determine whether the company uses the same accounting policies as
other companies in the same industry.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
*31. General debt obligations, lease contracts, pension arrangements and stock compensation plans are
four items for which disclosure is mandatory in the financial statements. The reason for disclosing
these contractual situations is that these commitments are of a long-term nature, are often significant
in amount, and are very important to the company’s well-being.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
*32. The profession has recommended that the use of the term “surplus” be discontinued in balance
sheet presentations of stockholders’ equity. This term has a connotation outside accounting that is
quite different from its meaning in the accounts or in the balance sheet. The use of the terms capital
surplus, paid-in surplus, and earned surplus is confusing to the nonaccountant and leads to
misinterpretation.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Solutions to Brief Exercises
Brief Exercise 4.1
Current assets
Cash .................................................................
Accounts receivable .......................................
Less: Allowance for doubtful accounts ..
Inventory .........................................................
Prepaid insurance ...........................................
Total current assets ............................
$ 30,000
$110,000
8,000
102,000
290,000
9,500
$431,500
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.2
Current assets
Cash and cash equivalents ............................
Equity Investments ........................................
Accounts receivable .......................................
Less: Allowance for doubtful accounts ..
Inventory .........................................................
Prepaid insurance ...........................................
Total current assets ............................
$
$90,000
4,000
7,000
11,000
86,000
30,000
5,200
$139,200
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.3
Long-term investments
Debt investments ............................................
Land held for investment ...............................
Notes receivable (long-term)..........................
Total investments .....................................
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
$ 56,000
39,000
42,000
$137,000
Brief Exercise 4.4
Property, plant, and equipment
Land .................................................................
Buildings .........................................................
Less: Accumulated depreciation .............
Equipment .......................................................
Less: Accumulated depreciation ............
Timberland ......................................................
Total property, plant, and equipment ..
$ 71,000
$207,000
45,000
190,000
19,000
162,000
171,000
70,000
$474,000
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.5
Intangible assets
Goodwill ..........................................................
Patents ............................................................
Franchises ......................................................
Total intangible assets .............................
$150,000
220,000
130,000
$500,000
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.6
Intangible assets
Goodwill ..........................................................
Franchises ......................................................
Patents ............................................................
Trademarks .....................................................
Total intangible assets .............................
$ 50,000
47,000
33,000
10,000
$140,000
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.7
Current liabilities
Notes payable .................................................
Accounts payable ...........................................
Salaries and wages payable ..........................
Income taxes payable.....................................
Total current liabilities ........................
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
$ 22,500
72,000
4,000
7,000
$105,500
Brief Exercise 4.8
Current liabilities
Accounts payable ...........................................
Unearned rent revenue ...................................
Salaries and wages payable...........................
Interest payable ..............................................
Income taxes payable .....................................
Total current liabilities ........................
$220,000
41,000
27,000
12,000
29,000
$329,000
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.9
Long-term liabilities
Bonds payable ................................................
Less: Discount on bonds payable ...........
Pension liability ..............................................
Total long-term liabilities ....................
$400,000
29,000
$371,000
375,000
$746,000
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.10
Stockholders’ equity
Common stock ................................................
Paid-in capital in excess of par ......................
Retained earnings ...........................................
Accumulated other comprehensive loss ......
Total stockholders’ equity..............................
$750,000
200,000
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
$950,000
120,000
(150,000)
$920,000
Brief Exercise 4.11
Stockholders’ equity
Preferred stock ...............................................
Common stock ................................................
Additional paid-in capital in excess of par ...
Retained earnings...........................................
Total stockholders’ equity .......................
$152,000
55,000
174,000
114,000
$495,000
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.12
Cash Flow Statement
Operating Activities
Net income .......................................................
Depreciation expense ......................................
Increase in accounts receivable .....................
Increase in accounts payable .........................
Net cash provided by operating activities....
$40,000
$ 4,000
(10,000)
7,000
Investing Activities
Purchase of equipment ...................................
Financing Activities
Issue notes payable .........................................
Dividends paid .................................................
Net cash flow from financing activities ....
Net increase in cash ($41,000 – $8,000 + $15,000) ..
1,000
41,000
(8,000)
20,000
(5,000)
15,000
$48,000
Free Cash Flow = $41,000 (Net cash provided by operating activities) – $8,000
(Purchase of equipment) – $5,000 (Dividends) = $28,000.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Brief Exercise 4.13
Cash flows from operating activities
Net income ........................................................
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation expense ................................
Increase in accounts payable ....................
Increase in accounts receivable................
Net cash provided by operating activities ......
$151,000
$44,000
9,500
(13,000)
40,500
$191,500
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.14
Sale of land and building .......................................
Purchase of land ....................................................
Purchase of equipment..........................................
Net cash provided by investing activities ......
$191,000
(37,000)
(53,000)
$101,000
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.15
Issuance of common stock ...................................
Purchase of treasury stock ...................................
Payment of cash dividend .....................................
Retirement of bonds ..............................................
Net cash used by financing activities .............
$147,000
(40,000)
(95,000)
(100,000)
$ (88,000)
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 4.16
Free Cash Flow Analysis
Net cash provided by operating activities ............
Purchase of equipment .............................
Purchase of land* ......................................
Dividends ...................................................
Free cash flow ........................................................
$400,000
(53,000)
(37,000)
(95,000)
$215,000
*If the land were purchased as an investment, it would be excluded in the
computation of free cash flow.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Solutions to Exercises
Exercise 4.1 (15–20 minutes)
(a)
If the debt investment (bonds) is readily marketable and held primarily
for sale in the near term to generate income on short-term price
differences, then the account should appear as a current asset and be
included with trading securities. Available-for-sale securities are
classified as current or noncurrent depending upon the circumstances.
If the debt investment is a held-to-maturity investment, then it would be
reported as noncurrent.
(b)
Treasury stock (a contra-stockholders’ equity account) is shown as a
reduction of total stockholders’ equity.
(c)
Stockholders’ equity.
(d)
Current liability.
(e)
Property, plant, and equipment (as a deduction).
(f)
If the asset in process of construction is being constructed for another
party, it is classified as an inventory account in the current assets
section. If not, then classified as property, plant, and equipment.
(g)
Current asset.
(h)
Current liability.
(i)
Stockholder’s equity (Retained earnings).
Exercise 4.1 (Continued)
(j)
Equity investments are reported as current assets if the shares are
expected to be sold within one year. Otherwise, the equity investment
is reported in the Long-term investments section.
(k)
Current liability.
(l)
Current liability.
(m)
Current asset (inventory).
(n)
Current liability.
LO: 1, Bloom: C, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.2 (15–20 minutes)
1.
2.
3.
4.
5
6.
7.
8.
9.
10.
(h)
(d)
(f)
(f)
(c)
(a)
(f)
(g)
(a)
(a)
11.
12.
13.
14.
15.
16.
17.
18.
(f)
(a)
(h)
(c)
(a)
(a)
(g)
(f)
LO: 1, Bloom: C, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.3 (15–20 minutes)
1.
2.
3.
4.
5
6.
7.
8.
9.
(a)
(b)
(f)
(a)
(f)
(h)
(i)
(d)
(a)
10.
11.
12.
13.
14.
15.
16.
17.
18.
(f)
(a)
(f)
(a) or (e) (preferably (a))
(c) and (n)
(f)
(x)
(f)
(c)
LO: 1; Bloom: C, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.4 (30–35 minutes)
Denis Savard Inc.
Balance Sheet
December 31, 20–
Assets
Current assets
Cash ..........................................................
Less: Cash restricted for plant
expansion ........................................
Accounts receivable ................................
Less: Allowance for doubtful
accounts ..........................................
Notes receivable.......................................
Receivables—officers ..............................
Inventories
Finished goods ...................................
Work in process .................................
Raw materials .....................................
Total current assets .....................
Long-term investments
Equity stock investments ........................
Land held for future plant site .................
Restricted cash (plant expansion) ..........
Total long-term investments........
Property, plant, and equipment
Buildings...................................................
Less: Accum. depreciation—
buildings ..........................................
Intangible assets
Copyrights ................................................
Total assets .......................................
$XXX
XXX
XXX
$XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
$XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
$XXX
Exercise 4.4 (Continued)
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable, short-term ............................
Salaries and wages payable .........................
Unearned subscriptions revenue.................
Unearned rent revenue .................................
Total current liabilities ............................
$XXX
XXX
XXX
XXX
Long-term debt
Bonds payable, due in four years ................
Less: Discount on bonds payable ...............
Total liabilities .........................................
$XXX
XXX
Stockholders’ equity
Capital stock:
Common stock ........................................
Additional paid-in capital:
Paid-in capital in excess of par
(common stock) ....................................
Total paid-in capital...........................
Retained earnings .........................................
Total paid-in capital and
retained earnings ...........................
Less: Treasury stock, at cost ................
Total stockholders’ equity ................
Total liabilities and
stockholders’ equity ......................
$XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
$XXX
Note to instructor: An assumption made here is that cash included the
restricted cash for plant expansion. If it did not, then a subtraction from cash
would not be necessary.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.5 (30–35 minutes)
Uhura Company
Balance Sheet
December 31, 2025
Assets
Current assets
Cash ........................................................
Equity investments, at fair value ...........
Accounts receivable ($340,000 + $17,000)
Less: Allowance for doubtful
accounts ........................................
Inventory, at lower-of-average
cost-or-NRV .........................................
Prepaid expenses ...................................
Total current assets .........................
$230,000
120,000
$357,000
17,000
340,000
401,000
12,000
$1,103,000
Long-term investments
Land held for future use ........................
Held to maturity debt investment ..........
175,000
90,000
265,000
Property, plant, and equipment
Buildings ($570,000 + $160,000) .................
Less: Accum. depr.—buildings .......
Equipment ($160,000 + $105,000) ...............
Less: Accum. depr.—equipment .....
Intangible assets
Goodwill ..................................................
Total assets .....................................
$730,000
160,000
265,000
105,000
570,000
160,000
730,000
80,000
$2,178,000
Exercise 4.5 (Continued)
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable (due 2026) ....................
Accounts payable ................................
Rent payable.........................................
Total current liabilities ...................
Long-term liabilities
Bonds payable .....................................
Add: Premium on bonds payable .......
Pension obligation ...............................
Total liabilities ................................
Stockholders’ equity
Common stock, $1 par, authorized
400,000 shares, issued 290,000
shares ................................................
Additional paid-in capital ....................
Retained earnings ................................
Total stockholders’ equity .............
Total liabilities and
stockholders’ equity ...................
$ 125,000
135,000
49,000
$309,000
$500,000
53,000
290,000
160,000
553,000
82,000
635,000
944,000
450,000
784,000*
1,234,000
$2,178,000
*$2,178,000 – $944,000 – $450,000
LO: 1, Bloom: AN, Difficulty: Simple, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 4.6 (30–35 minutes)
Geronimo Company
Balance Sheet
July 31, 2025
Assets
Current assets
Cash ......................................................
Accounts receivable ............................
Less: Allowance for doubtful
accounts ......................................
Inventory ...............................................
Total current assets .......................
$60,000*
$38,700**
3,500
35,200
65,300***
$160,500
Long-term investments
Certificate of deposit............................
Property, plant, and equipment
Equipment ............................................
Less: Accumulated depreciation—
equipment ..............................
Intangible assets
Patents ..................................................
Total assets ...................................
*($69,000 – $15,000 + $6,000)
**($44,000 – $5,300)
***($60,000 + $5,300)
15,000
112,000
28,000
84,000
21,000
$280,500
Exercise 4.6 (Continued)
Liabilities and Stockholders’ Equity
Current liabilities
Notes and accounts payable ........................
Income taxes payable ...................................
Total current liabilities ............................
$ 44,000
6,000
$ 50,000
Long-term liabilities ............................................
Total liabilities .........................................
75,000
125,000
Stockholders’ equity ...........................................
Total liabilities and stockholders’
equity .......................................................
155,500
$280,500
LO: 1, Bloom: AN, Difficulty: Complex, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.7 (15–20 minutes)
Current assets
Cash .................................................................
Less: Restricted cash (plant expansion) .......
Debt investments (at fair value; cost,
$31,000) .........................................................
Accounts receivable (of which $50,000 is
pledged as collateral on a bank loan) .........
Less: Allowance for doubtful accounts .........
Interest receivable [($40,000 x 6%) x 8/12] ....
Inventories at lower of cost (determined
using LIFO) or market
Finished goods ..........................................
Work in process ........................................
Raw materials ............................................
Total current assets ............................
$ 87,000*
50,000
$ 37,000
29,000
161,000
12,000
52,000
34,000
207,000
149,000
1,600
293,000
$509,600
* ($37,000 + $50,000). An acceptable alternative is to report cash at $37,000
and simply report the restricted cash (plant expansion) in the Long-term
investments section.
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation, Reporting,
AICPA PC: Communication
Exercise 4.8 (10–15 minutes)
1.
Dividends payable of $2,375,000 will be reported as a current liability
[(1,000,000 – 50,000) x $2.50].
2.
Bonds payable of $25,000,000 and interest payable of $3,000,000
($100,000,000 x 12% x 3/12) will be reported as current liabilities. Bonds
payable of $75,000,000 ($100,000,000 - $25,000,000) will be reported as
a long-term liability.
3.
Customer advances of $17,000,000 will be reported as a current liability
($12,000,000 + $30,000,000 – $25,000,000).
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.9 (30–35 minutes)
(a)
Allessandro Scarlatti Company
Balance Sheet (Partial)
December 31, 2025
Current assets
Cash ......................................................
Accounts receivable ............................
Less: Allowance for doubtful
accounts ................................
Inventory ...............................................
Prepaid expenses .................................
Total current assets .......................
$ 34,396*
$ 91,300**
7,000
*Cash balance
Add: Cash disbursement after discount
($39,000 x .98)
Less: Cash sales in January ($30,000 – $21,500)
Cash collected on account
Bank loan proceeds ($35,324 – $23,324)
Adjusted cash
**Accounts receivable balance
Add: Accounts reduced from January collection
($23,324 ÷ .98)
84,300
159,000***
9,000
$286,696
$ 40,000
38,220
78,220
$ 8,500
23,324
12,000
43,824
$ 34,396
$ 89,000
Deduct: Accounts receivable in January
Adjusted accounts receivable
23,800
112,800
21,500
$ 91,300
***Inventory
Less: Inventory received on consignment
Adjusted inventory
$171,000
12,000
$159,000
Exercise 4.9 (Continued)
Current liabilities
Notes payable ................................................
Accounts payable .........................................
Total current liabilities ............................
(b)
$55,000a
115,000b
$170,000
a
Notes payable balance
Less: Proceeds of bank loan
Adjusted notes payable
$ 67,000
12,000
$ 55,000
b
Accounts payable balance
Add: Cash disbursements
Purchase invoice omitted
($27,000 – $12,000)
Adjusted accounts payable
$ 61,000
Adjustment to retained earnings balance:
Add: January sales discounts
[($23,324 ÷ .98) X .02] ...........................
Deduct: January sales ......................................
January purchase discounts
($39,000 X .02) .................................
December purchases ($27,000 - $12,000)
Consignment inventory .....................
Change (decrease) to retained earnings ..........
$39,000
15,000
54,000
$115,000
$
476
$30,000
780
15,000
12,000
(57,780)
$(57,304)
LO: 1, Bloom: AN, Difficulty: Complex, Time: 30-35, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
Exercise 4.10 (15–20 minutes)
(a)
A current liability of $150,000 should be recorded.
(b)
A current liability for accrued interest of $4,000 ($600,000 X 8% X 1/12)
should be reported. Also, the $600,000 notes payable should be a current
liability if payable in one year. Otherwise, the $600,000 notes payable
would be a long-term liability.
(c)
Bad Debt Expense of $300,000 ($10,000,000 x .03) should be debited
and the Allowance for Doubtful Accounts credited for $300,000,
assuming that there is a $0 balance in the Allowance for Doubtful
Accounts. However, this does not result in a liability as Baylor does
not have an obligation to expend assets. The allowance for doubtful
accounts is a valuation account (contra asset) and is deducted from
accounts receivable on the balance sheet so that receivables are
reported at net realizable value, or the amount expected to be collected.
(d)
A current liability of $80,000 ($2.00 x 40,000) should be reported. The
liability is recorded on the date of declaration.
(e)
Customer advances of $110,000 ($160,000 – $50,000) will be reported
as a current liability.
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
Exercise 4.11 (25–30 minutes)
Kelly Corporation
Balance Sheet
December 31, 2025
Assets
Current assets:
Cash ...................................................................
Supplies .............................................................
Prepaid insurance .............................................
Total current assets ...................................
Property, plant and equipment:
Equipment .......................................................
Less: Accumulated depr.—equipment ..........
Intangible assets:
Trademarks......................................................
Total assets ..................................................
$ 6,850 *
1,200
1,000
$ 9,050
48,000
4,000
44,000
950
$54,000
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable .............................................
Salaries and wages payable .............................
Unearned service revenue................................
Total current liabilities ..............................
Long-term liabilities
Bonds payable (due 2032) ................................
Total liabilities ............................................
Stockholders’ equity
Common stock ..................................................
Retained earnings ($25,000 – $2,500**) ...........
Total stockholders’ equity ..........................
Total liabilities and stockholders’ equity.......
$10,000
500
2,000
$12,500
9,000
21,500
10,000
22,500
32,500
$54,000
Exercise 4.11 (Continued)
*[$54,000 - $950 - $44,000 - $1,000 - $1,200]
**[$10,000 – ($9,000 + $1,400 + $1,200 + $900)]
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.12 (30–35 minutes)
Scott Butler Corporation
Balance Sheet
December 31, 2025
Assets
Current assets
Cash .....................................................
Debt investments (Trading) ................
Accounts receivable ...........................
Less: Allowance for doubtful
accounts ...................................
Inventory..............................................
Total current assets .....................
$197,000
153,000
$435,000
25,000
Long-term investments
Debt investments ................................
Equity investments .............................
Total long-term investments ......
Property, plant, and equipment
Land .....................................................
Buildings ............................................. 1,040,000
Less: Accum. depreciation—
building ......................................
152,000
Equipment ..........................................
600,000
Less: Accum. depreciation—
equipment ..................................
60,000
Total property, plant, and
equipment ..................................
Intangible assets
Franchises....................................................
Patents .................................................
Total intangible assets..................
Total assets ...................................
410,000
597,000
1,357,000
299,000
277,000
576,000
260,000
888,000
540,000
1,688,000
160,000
195,000
355,000
$3,976,000
Exercise 4.12 (Continued)
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable (short-term) ............
Accounts payable ..........................
Dividends payable ..........................
Accrued liabilities ..........................
Total current liabilities ...........
Long-term debt
Notes payable (long-term) .............
Bonds payable.................................
Total long-term liabilities ..........
Total liabilities ....................
Stockholders’ equity
Paid-in capital
Common stock ($5 par)............ $1,000,000
Additional paid-in capital .........
80,000
Retained earnings* ..........................
Total paid-in capital and
retained earnings .................
Less: Treasury stock ......................
Total stockholders’ equity ......
Total liabilities and
stockholders’ equity.............
$ 90,000
455,000
136,000
96,000
$ 777,000
900,000
1,000,000
1,900,000
2,677,000
1,080,000
410,000
1,490,000
191,000
1,299,000
$3,976,000
Exercise 4.12 (Continued)
*Computation of Retained Earnings:
Sales revenue
Investment revenue
Gain
Cost of goods sold
Selling expenses
Administrative expenses
Interest expense
Net income
Beginning retained earnings
Net income
Ending retained earnings
$8,100,000
63,000
80,000
(4,800,000)
(2,000,000)
(900,000)
(211,000)
$ 332,000
$ 78,000
332,000
$410,000
Or ending retained earnings can be computed as follows:
Total stockholders’ equity ($3,976,000 - $2,677,000)
Add: Treasury stock
Less: Total paid-in capital ($1,000,000 + $80,000)
Ending retained earnings
$1,299,000
191,000
1,080,000
$ 410,000
Note to instructor: There is no dividends account. Thus, the 12/31/25 retained
earnings balance already reflects any dividends declared, if any.
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.13 (15–20 minutes)
(a)
(b)
(c)
(d)
(e)
4.
3.
4.
3.
1.
(f)
(g)
(h)
(i)
(j)
1.
5.
4.
5.
4.
(k) 1.
(l) 2.
(m) 2.
LO: 2, Bloom: C, Difficulty: Moderate, Time: 5-10, AACSB: Knowledge, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 4.14 (25–35 minutes)
Constantine Cavamanlis Inc.
Statement of Cash Flows
For the Year Ended December 31, 2025
Cash flows from operating activities
Net income .........................................................
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation expense .................................
Increase in accounts receivable.................
Increase in accounts payable .....................
Net cash provided by operating activities .......
Cash flows from investing activities
Purchase of equipment.....................................
Cash flows from financing activities
Issuance of common stock ..............................
Payment of cash dividends ..............................
Net cash used by financing activities ..............
Net increase in cash ...............................................
Cash at beginning of year ......................................
Cash at end of year .................................................
$44,000
$ 6,000
(3,000)
5,000
8,000
52,000
(17,000)
20,000
(23,000)
(3,000)
32,000
13,000
$45,000
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.15 (25–35 minutes)
(a)
Zubin Mehta Corporation
Statement of Cash Flows
For the Year Ended December 31, 2025
Cash flows from operating activities
Net income ........................................................
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation expense ($106,000 - $89,000) ....
Loss on sale of investments ......................
Decrease in accounts receivable ...............
Decrease in current liabilities.....................
Net cash provided by operating activities.......
Cash flows from investing activities
Sale of investments ..........................................
[($74,000 – $52,000) – $10,000]
Purchase of equipment ($298,000 - $240,000) .....
Net cash used by investing activities ..............
Cash flows from financing activities
Payment of cash dividends ..............................
Net increase in cash ...............................................
Cash at beginning of year ......................................
Cash at end of year .................................................
(b)
$160,000
$17,000
10,000
5,000
(17,000)
15,000
175,000
12,000
(58,000)
(46,000)
(30,000)
99,000
78,000
$177,000
Free Cash Flow Analysis
Net cash provided by operating activities.............
Purchase of equipment................................
Dividends ......................................................
Free cash flow .........................................................
$175,000
(58,000)
(30,000)
$ 87,000
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.16 (25–35 minutes)
(a)
Shabbona Corporation
Statement of Cash Flows
For the Year Ended December 31, 2025
Cash flows from operating activities
Net income ..........................................................
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation expense ($69,000 - $42,000) .......
Increase in accounts receivable..................
Decrease in inventory ..................................
Decrease in accounts payable ....................
Net cash provided by operating activities ........
Cash flows from investing activities
Sale of land ($110,000 - $71,000)............................
Purchase of equipment ($260,000 - $200,000).......
Net cash used by investing activities ...............
Cash flows from financing activities
Payment of cash dividends ...............................
Net increase in cash ................................................
Cash at beginning of year .......................................
Cash at end of year ..................................................
$125,000
$27,000
(16,000)
9,000
(13,000)
7,000
132,000
39,000
(60,000)
Noncash investing and financing activities
Issued common stock to retire $50,000 of bonds outstanding
(21,000)
(60,000)
51,000
22,000
$ 73,000
Exercise 4.16 (Continued)
(b) Current cash debt coverage =
Net cash provided by operating activities
Average current liabilities
$132,000
($34,000 + $47,000) / 2
3.26 to 1
Cash debt coverage =
Net cash provided by operating activities
Average total liabilities
$132,000 ÷
$184,000 + $247,000
2
=
=
.61 to 1
Free Cash Flow Analysis
Net cash provided by operating activities .......................
Purchase of equipment...........................................
Dividends .................................................................
Free cash flow ....................................................................
$132,000
(60,000)
(60,000)
$ 12,000
Shabbona has excellent liquidity. Its financial flexibility is good. It might be
noted that it substantially reduced its long-term debt in 2025, which
improved its financial flexibility.
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communcation
Exercise 4.17 (30–35 minutes)
(a)
Grant Wood Corporation
Statement of Cash Flows
For the Year Ended December 31, 2025
Cash flows from operating activities
Net income .............................................................
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation expense ($9,000 + $4,000) ........ 13,000
Patent amortization .........................................
2,500
Loss on sale of equipment ............................. $ 2,000*
Increase in current assets (other than cash) .... (29,000)
Increase in current liabilities .......................... 13,000
Net cash provided by operating activities ...........
Cash flows from investing activities
Sale of equipment .................................................
Addition to building ..............................................
Investment in stock ...............................................
Net cash used by investing activities ..................
Cash flows from financing activities
Issuance of bonds .................................................
Payment of dividends ...........................................
Purchase of treasury stock ..................................
Net cash provided by financing activities ...........
Net increase in cash ...................................................
Cash at the beginning of the year ............................
Cash at the end of the year ......................................
$55,000
1,500
56,500
10,000
(27,000)
(16,000)
(33,000)
50,000
(30,000)
(11,000)
9,000
32,500a
82,000
$114,500
*[$10,000 – ($20,000 – $8,000)]
a
An additional proof to arrive at the increase in cash is provided as follows:
Total current assets—end of period ……………
Total current assets—beginning of period ……
Increase in current assets during the period ...
Increase in current assets other than cash …..
Increase in cash during year …………………….
$296,500 [from part (b)]
235,000
61,500
(29,000)
$ 32,500
Exercise 4.17 (Continued)
(b)
Grant Wood Corporation
Balance Sheet
December 31, 2025
Assets
Current assets ................................................
$296,500b
Equity investments (Long-term) ...................
16,000
Property, plant, and equipment
Land ..........................................................
$ 30,000
Buildings ($120,000 + $27,000)................ $147,000
Less: Accum. depreciation—buildings
($30,000 + $4,000)..................................
34,000 113,000
Equipment ($90,000 – $20,000) ...............
70,000
Less: Accum. depreciation—equipment
($11,000 – $8,000 + $9,000) ...................
12,000
58,000
Total property, plant, and equipment .....
201,000
Intangible assets—patents
($40,000 – $2,500) ..................................
37,500
Total assets .......................................
$551,000
Liabilities and Stockholders’ Equity
Current liabilities ($150,000 + $13,000) .....................
Long-term liabilities
Bonds payable ($100,000 + $50,000) ..................
Total liabilities ................................................
Stockholders’ equity
Paid-in capital
Common stock ........................................................
Retained earnings ($44,000 + $55,000 – $30,000) ...........
Total paid-in capital and retained earnings ....
Less: Treasury stock (at cost) ............................
Total stockholders’ equity .............................
Total liabilities and stockholders’ equity .....
$163,000
150,000
313,000
$180,000
69,000
249,000
11,000
238,000
$551,000
b The amount determined for current assets could be computed last and then is a “plug”
figure. That is, total liabilities and stockholders’ equity is computed because
information is available to determine this amount. Because the total assets amount is
the same as total liabilities and stockholders’ equity amount, the amount of total assets
is determined. Information is available to compute all the asset amounts except current
assets and therefore current assets can be determined by deducting the total of all the
other asset balances from the total asset balance (i.e., $551,000 – $37,500 – $201,000 –
$16,000). Another way to compute this amount, given the information, is that beginning
current assets plus the $29,000 increase in current assets other than cash plus the
$32,500 increase in cash equals $296,500.
LO: 1, 2, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 4.18 (25–35 minutes)
(a)
Madrasah Corporation
Statement of Cash Flows
For the Year Ended December 31, 2025
Cash flows from operating activities
Net income .........................................................
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation expense .......................................
Increase in accounts payable...........................
Increase in accounts receivable ......................
Net cash provided by operating activities .......
$44,000
$ 6,000
5,000
(18,000)
Cash flows from investing activities
Purchase of equipment.....................................
Cash flows from financing activities
Issuance of stock ..............................................
Payment of dividends .......................................
Net cash used by financing activities ..............
Net increase in cash ...............................................
Cash at beginning of year ......................................
Cash at end of year .................................................
(b) Current ratio
Dec. 31, 2025
6.3
($20,000 + $106,000)
$ 20,000
(7,000)
37,000
(17,000)
20,000
(33,000)
(13,000)
7,000
13,000
$20,000
Jan. 1, 2025
6.73
($13,000 + $88,000)
$ 15,000
Free Cash Flow Analysis
Net cash provided by operating activities ..................
Purchase of equipment .....................................
Paid dividends ...................................................
Free cash flow ..............................................................
$ 37,000
(17,000)
(33,000)
$ (13,000)
(c) Although Madrasah’s current ratio has declined from Jan. 1 to Dec. 31, it
is still in excess of 6. It appears the company has good liquidity and
financial flexibility, even though it has a negative free cash flow.
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Time and Purpose of Problems
Problem 4.1 (Time 30–35 minutes)
Purpose—to provide the student with the opportunity to prepare a balance sheet, given a set of accounts.
No monetary amounts are to be reported.
Problem 4.2 (Time 35–40 minutes)
Purpose—to provide the student with the opportunity to prepare a complete balance sheet, involving
dollar amounts. A unique feature of this problem is that the student must solve for the retained earnings
balance.
Problem 4.3 (Time 40–45 minutes)
Purpose—to provide an opportunity for the student to prepare a balance sheet in good form. Emphasis
is given in this problem to additional important information that should be disclosed. For example, an
inventory valuation method, bank loans secured by long-term investments, and information related to the
capital stock accounts must be disclosed.
Problem 4.4 (Time 40–45 minutes)
Purpose—to provide the student with the opportunity to analyze a balance sheet and correct it where
appropriate. The balance sheet as reported is incomplete, uses poor terminology, and is in error. A
challenging problem.
Problem 4.5 (Time 40–45 minutes)
Purpose—to provide the student with the opportunity to prepare a balance sheet in good form. Additional
information is provided on each asset and liability category for purposes of preparing the balance sheet.
A challenging problem.
Problem 4.6 (Time 35–45 minutes)
Purpose—to provide the student with an opportunity to prepare a complete statement of cash flows. A
condensed balance sheet is also required. The student is also required to explain the usefulness of the
statement of cash flows. Because the textbook does not explain in Chapter 4 all of the steps involved in
preparing the statement of cash flows, assignment of this problem is dependent upon additional
instruction by the instructor or knowledge gained in elementary financial accounting.
Problem 4.7 (Time 40–50 minutes)
Purpose—to provide the student with an opportunity to prepare a balance sheet in good form and a more
complex cash flow statement.
Solutions to Problems
Problem 4.1
COMPANY NAME
Balance Sheet
December 31, 20XX
Assets
Current assets
Cash on hand (including petty cash) ............
Cash in bank ...................................................
Accounts receivable ......................................
Less: Allowance for doubtful
accounts ........................................
Interest receivable ..........................................
Advances to employees ................................
Inventory (ending) ..........................................
Prepaid rent ....................................................
Total current assets .................................
$XXX
XXX
XXX
XXX
Intangible assets
Patents ............................................................
Total assets ...............................................
XXX
XXX
XXX
XXX
XXX
$XXX
Long-term investments
Bond sinking fund………………………………
Cash surrender value of life insurance……..
Land for future plant site ...............................
Total long-term investments ...................
Property, plant, and equipment
Land ................................................................
Buildings.........................................................
Less: Accum. depreciation—buildings ....
Equipment ......................................................
Less: Accum. depreciation—equipment ...
Total property, plant, and equipment......
$XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
$XXX
Problem 4.1 (Continued)
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable.................................................
Payroll taxes payable.....................................
Salaries and wages payable ..........................
Unearned subscriptions revenue..................
Total current liabilities .............................
Long-term liabilities
Bonds payable ...............................................
Add: Premium on bonds payable ...........
Pension liability..............................................
Total long-term liabilities .........................
Total liabilities ..........................................
Stockholders’ equity
Capital stock
Preferred stock (description) ..................
Common stock (description) ...................
Paid-in capital in excess of par –
Preferred stock
Total paid-in capital .................................
Retained earnings ..........................................
Total paid-in capital and
retained earnings .................................
Accumulated other comprehensive
income ......................................................
Less: Treasury stock ....................................
Total stockholders’ equity .......................
Total liabilities and
stockholders’ equity .............................
$XXX
XXX
XXX
XXX
$XXX
$XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
XXX
$XXX
LO: 1, Bloom: C, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, Knowledge, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Problem 4.2
MONTOYA, INC.
Balance Sheet
December 31, 2025
Assets
Current assets
Cash .................................................
Debt investments (trading) .............
Notes receivable..............................
Income taxes receivable ..................
Inventory ..........................................
Prepaid expenses ............................
Total current assets ..................
Property, plant, and equipment
Land .................................................
Buildings..........................................
Less: Accum. depreciation—
buildings .........................
Equipment .......................................
Less: Accum. depreciation—
equipment .......................
Intangible assets
Goodwill ...........................................
Total assets ...............................
$ 360,000
121,000
445,700
97,630
239,800
87,920
$1,352,050
480,000
$1,640,000
270,200
1,470,000
1,369,800
292,000
1,178,000
3,027,800
125,000
$4,504,850
Problem 4.2 (Continued)
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable...................................
Accounts payable ...........................
Payroll taxes payable.......................
Income taxes payable ......................
Rent payable.....................................
Total current liabilities ...............
Long-term liabilities
Notes payable (long-term) ………….
Bonds payable .................................
Less: Discount on bonds
payable .............................
Rent payable (long-term) ................
Total long-term liabilities ...........
Total liabilities .................................
Stockholders’ equity
Capital stock
Preferred stock, $10 par; 20,000
shares authorized, 15,000
shares issued ..........................
Common stock, $1 par;
400,000 shares authorized,
200,000 issued .........................
Retained earnings
($1,063,897 – $350,000) .................
Total stockholders’ equity
($4,504,850 – $3,440,953) ........
Total liabilities and
stockholders’ equity ...............
$ 265,000
490,000
177,591
98,362
45,000
$1,075,953
1,600,000
$300,000
15,000
285,000
480,000
2,365,000
3,440,953
150,000
200,000
350,000
713,897
1,063,897
$4,504,850
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 35-40, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Problem 4.3
EASTWOOD COMPANY
Balance Sheet
December 31, 2025
Assets
Current assets
Cash ....................................................
Accounts receivable ..........................
Less: Allowance for doubtful
accounts ............................
Inventory (at lower of LIFO cost or
market) ......................................................
Prepaid insurance ..............................
Total current assets .....................
$ 41,000
$163,500
8,700
154,800
208,500
5,900
$ 410,200
Long-term investments
Equity investments
($120,000 have been pledged as
security for notes payable)—
at fair value ......................................
Property, plant, and equipment
Land ...................................................
Construction in process
(building) ...................................
Equipment ..........................................
Less: Accum. depreciation—
equipt. ................................
Intangible assets
Patents (less $4,000 amortization) ....
Total assets ..................................
339,000
85,000
124,000
400,000
240,000
160,000
369,000
36,000
$1,154,200
Problem 4.3 (Continued)
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable (secured by
investments of $120,000)...................
Accounts payable ...............................
Accrued liabilities ...............................
Total current liabilities ..................
$ 94,000
148,000
49,200
$ 291,200
Long-term liabilities
8% Bonds payable, due
January 1, 2036 ................................
Less: Discount on bonds payable ....
Total liabilities ...............................
Stockholders’ equity
Paid in capital
Common stock
Authorized 600,000 shares of $1
par value; issued and
outstanding, 500,000 shares .......
Additional paid in capital in excess
of par—common stock .............................
Retained earnings ...............................
Total liabilities and
stockholders’ equity ..................
200,000
20,000
180,000
471,200
$500,000
45,000
545,000
138,000
683,000
$1,154,200
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 40-45, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Problem 4.4
KISHWAUKEE CORPORATION
Balance Sheet
December 31, 2025
Assets
Current assets
Cash ...................................................
Accounts receivable .........................
Inventory ............................................
Total current assets ....................
$175,900
170,000
312,100
$ 658,000
Long-term investments
Assets allocated to trustee for plant
expansion:
Cash in bank ...............................
Debt investments
(held-to-maturity)....................
Property, plant, and equipment
Land ...................................................
Buildings............................................
Less: Accum. depreciation—
buildings ...........................
Total assets .................................
70,000
138,000
208,000
950,000
$1,070,000
410,000
a
660,000
1,610,000
$2,476,000
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable—current installment ..
Income taxes payable .......................
Total current liabilities ................
$100,000
75,000
$ 175,000
Problem 4.4 (Continued)
Long-term liabilities
Notes payable ($600,000 - $100,000).......
Total liabilities ................................
Stockholders’ equity
Paid in capitall
Common stock, no par; 1,000,000
shares authorized and issued;
950,000d shares outstanding ............
Retained earnings ......................................
Total paid in capital and retained
earnings………………………
Less: Treasury stock, at cost
(50,000 shares)...........................
Total stockholders’ equity .............
Total liabilities and
stockholders’ equity ...................
500,000b
675,000
1,150,000
738,000c
1,888,000
87,000
1,801,000
$2,476,000
$1,640,000 – $570,000 (to eliminate the excess of appraisal value over cost
from the Buildings account. Note that the Appreciation Capital account is
also deleted).
a
$600,000 – $100,000 (to reclassify the currently maturing portion of the
notes payable as a current liability).
b
$858,000 – $120,000 (to remove the value of goodwill from retained earnings.
Note 2 indicates that retained earnings was credited. Note that the Goodwill
account is also deleted).
c
d
1,000,000 shares issued – 50,000 Treasury shares
Note: As an alternate presentation, the cash restricted for plant expansion
would be added to the general cash account and then subtracted. The
amount reported in the investments section would not change.
LO: 1, Bloom: AN, Difficulty: Complex, Time: 40-45, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Problem 4.5
SARGENT CORPORATION
Balance Sheet
December 31, 2025
Assets
Current assets
Cash ...................................................
Equity investments (at fair value) ....
Accounts receivable .........................
Less: Allowance for doubtful
accounts ...........................
Inventory (lower-of-FIFO cost or-net realizable value) .................
Total current assets ....................
$150,000
80,000
$ 170,000
10,000
180,000
$ 570,000
Long-term investments
Equity investments
(at fair value) ...................................
Bond sinking fund .............................
Cash surrender value of life
insurance ........................................
Land held for future use ...................
Property, plant, and equipment
Land ...................................................
Buildings............................................
Less: Accum. depreciation—
buildings ...........................
Equipment .........................................
Less: Accum. depreciation—
equipment .........................
Intangible assets
Franchise ...........................................
Goodwill .............................................
Total assets .................................
160,000
270,000
250,000
40,000
270,000
830,000
500,000
1,040,000
360,000
450,000
680,000
180,000
270,000
165,000
100,000
1,450,000
265,000
$3,115,000
Problem 4.5 (Continued)
Liabilities and Stockholders’ Equity
Current liabilities
Notes payable....................................
Accounts payable .............................
Income taxes payable .......................
Unearned rent revenue .....................
Total current liabilities .................
$ 80,000
140,000
40,000
5,000
$ 265,000
Long-term liabilities
Notes payable....................................
7% Bonds payable, due 2033 ........... $1,000,000
Less: Discount on bonds payable ..
40,000
Total liabilities ..............................
Stockholders’ equity
Paid in capital
Capital stock
Preferred stock, no par value;
200,000 shares authorized,
70,000 issued and outstanding ...
Common stock, $1 par value;
400,000 shares authorized,
100,000 issued and outstanding .
Additional paid-in capital in
excess of par—
common stock [100,000 X
($10 – $1)] ...................................
Retained earnings .............................
Total stockholders’ equity ...........
Total liabilities and
stockholders’ equity .................
120,000
960,000
1,080,000
1,345,000
450,000
100,000
900,000
1,450,000
320,000
1,770,000
$3,115,000
LO: 1, Bloom: AN, Difficulty: Complex, Time: 40-45, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Problem 4.6
(a)
LANSBURY INC.
Statement of Cash Flows
For the Year Ended December 31, 2025
Cash flows from operating activities
Net income .........................................................
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation expense .................................
Gain on sale of investments .......................
Increase in account receivable
($41,600 – $21,200) ...................................
Net cash provided by operating activities .......
$32,000
$ 11,000
(3,400)
(20,400)
Cash flows from investing activities
Sale of investments ..........................................
Purchase of land ...............................................
Net cash provided by investing activities .......
15,000
(13,000)
Cash flows from financing activities
Issuance of common stock ..............................
Retirement of notes payable ............................
Payment of cash dividends ..............................
Net cash used by financing activities ..............
20,000
(16,000)
(8,200)
(12,800)
19,200
2,000
Net increase in cash ...............................................
Cash at beginning of year ......................................
Cash at end of year .................................................
Noncash investing and financing activities
Land purchased through issuance of $35,000 of bonds
(4,200)
17,000
20,000
$37,000
Problem 4.6 (Continued)
(b)
LANSBURY INC.
Balance Sheet
December 31, 2025
Assets
Cash
Accounts
receivable
Debt
investments
Plant assets (net)
Land
$37,000
41,600
20,400 (1)
70,000 (2)
88,000 (3)
$257,000
Liabilities and Stockholders’ Equity
Accounts payable
$30,000
Notes payable
(long-term)
25,000 (4)
Bonds payable
35,000 (5)
Common stock
120,000 (6)
Retained earnings
47,000 (7)
$257,000
(1) $32,000 – ($15,000 – $3,400)
(2) $81,000 – $11,000
(3) $40,000 + $13,000 + $35,000
(4) $41,000 – $16,000
(5) $0 + $35,000
(6) $100,000 + $20,000
(7) $23,200 + $32,000 – $8,200
(c)
Cash flow information is useful for assessing the amount, timing, and
uncertainty of future cash flows. For example, by showing the specific
inflows and outflows from operating activities, investing activities, and
financing activities, the user has a better understanding of the liquidity
and financial flexibility of the enterprise. Similarly, these reports are
useful in providing feedback about the flow of enterprise resources. This
information should help users make more accurate predictions of
future cash flows.
Note to Instructor: In addition, some individuals have expressed concern
about the quality of the earnings because the measurement of the income
depends on a number of accruals and estimates which may be somewhat
subjective. As a result, the higher the ratio of cash provided by operating
activities to net income, the more comfort some users have in the reliability
of the earnings. In this problem, the ratio of cash provided by operating
activities to net income is 60% ($19,200 ÷ $32,000).
Problem 4.6 (Continued)
An analysis of Lansbury’s free cash flow indicates it is negative as shown
below:
Free Cash Flow Analysis
Net cash provided by operating activities ..........................
Purchase of land .....................................................
Dividends .................................................................
Free cash flow ......................................................................
$19,200
(13,000)
(8,200)
$ (2,000)
Current cash debt coverage = $19,200 ÷ $30,000 = .64 to 1.
Cash debt coverage = $19,200 ÷ [($71,000 + $90,000)/2] = .24 to 1.
Current cash debt coverage ratio and cash debt coverage ratios are
reasonable.
Overall, it appears that its liquidity position is average and overall financial
flexibility and solvency should be improved.
LO: 1, 2, Bloom: AN, Difficulty: Complex, Time: 35-45, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
Problem 4.7
(a)
AERO INC.
Statement of Cash Flows
For the Year Ended December 31, 2025
Cash flows from operating activities
Net income ........................................................
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation expense .................................
Loss on sale of investments ......................
Increase in accounts payable
($40,000 – $30,000) ................................
Increase in accounts receivable
($42,000 – $21,200) ................................
Net cash provided by operating activities.......
$35,000
$12,000
5,000
10,000
(20,800)
Cash flows from investing activities
Sale of debt investments ($32,000 - $5,000) ....
Purchase of land ...............................................
Net cash used by investing activities ..............
27,000
(38,000)
Cash flows from financing activities
Issuance of common stock ..............................
Payment of cash dividends ..............................
Net cash provided by financing activities .......
30,000
(10,000)
6,200
41,200
(11,000)
Net increase in cash ...............................................
Cash at beginning of year ......................................
Cash at end of year .................................................
Noncash investing and financing activities
Land purchased through issuance of $30,000 of bonds
20,000
50,200
20,000
$70,200
Problem 4.7 (Continued)
(b)
AERO INC.
Balance Sheet
December 31, 2025
Assets
Cash
Accounts
receivable
Plant assets (net)
Land
$ 70,200
42,000
69,000 (1)
108,000 (2)
$289,200
Liabilities and Stockholders’ Equity
Accounts payable
$ 40,000
Bonds payable
71,000 (3)
Common stock
130,000 (4)
Retained earnings
48,200 (5)
$289,200
(1) $81,000 – $12,000
(2) $40,000 + $38,000 + $30,000
(3) $41,000 + $30,000
(4) $100,000 + $30,000
(5) $23,200 + $35,000 – $10,000
(c)
An analysis of Aero’s free cash flow indicates it is negative as shown
below:
Free Cash Flow Analysis
Net cash provided by operating activities ...........................
Purchase of land ......................................................
Dividends ..................................................................
Free cash flow .......................................................................
$41,200
(38,000)
(10,000)
$ (6,800)
Problem 4.7 (Continued)
$41,200
. Overall, it appears that
$35,000 *
its liquidity position is average and overall financial flexibility should be
improved.
Its current cash debt coverage is 1.18 to 1:
*($30,000 + $40,000) ÷ 2
(d)
This type of information is useful for assessing the amount, timing, and
uncertainty of future cash flows. For example, by showing the specific
inflows and outflows from operating activities, investing activities, and
financing activities, the user has a better understanding of the liquidity
and financial flexibility of the enterprise. Similarly, these reports are
useful in providing feedback about the flow of enterprise resources.
This information should help users make more accurate predictions of
future cash flow.
Note to Instructor: In addition, some individuals have expressed concern
about the quality of the earnings because the measurement of the income
depends on a number of accruals and estimates which may be somewhat
subjective. As a result, the higher the ratio of cash provided by operating
activities to net income, the more comfort some users have in the reliability
of the earnings.
LO: 1, 2, Bloom: AN, Difficulty: Complex, Time: 40-50, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
UYJ4.1 Financial Reporting Problem
(a)
P&G uses the report form.
(b)
The techniques of disclosing pertinent information include (1) parenthetical explanations, (2) notes, (3) cross-reference and contra items,
and (4) supporting schedules. P&G uses parenthetical explanations
and notes (see notes to financial statements section) and supporting
schedules.
(c)
There are available-for-sale investments reported on P&G’s balance sheet
under current assets. Note 1 (Significant Accounting Policies) states
Available-for-Sale Debt securities are included as Other noncurrent
assets in the Consolidated Balance Sheets. These securities are
reported at fair value. Unrealized gains and losses relating to
investments classified as available-for-sale are recorded as a component
of accumulated other comprehensive income in shareholders’ equity.
As of June 30, 2020, P&G had negative working capital (current assets
less than current liabilities) of $4,989 million. At June 30, 2019, P&G’s
negative working capital was $7,538 million.
(d)
The following table summarizes P&G’s cash flows from operating,
investing, and financing activities in the 2018–2020 time period
(in millions).
Net cash provided by operating activities
Net cash provided in investing activities
Net cash provided in financing activities
2020
$ 17,403
(3,045)
(8,367)
2019
$15,242
(3,490)
(9,994)
2018
$ 14,867
(3,511)
(14,375)
Financial Reporting Problem (Continued)
P&G’s net cash provided by operating activities increased by 2.5% from
2018 to 2019 and by 14.2% from 2019 to 2020. When accounts payable,
accrued and other liabilities increase, cost of goods sold and operating
expenses are higher on an accrued basis than they are on a cash basis.
To convert to net cash provided by operating activities, the increase in
accounts payable, and accrued and other liabilities must be added to net
income.
(e)
1.
Net Cash Provided by Operating Activities ÷ Average Current
Liabilities = Current Cash Debt Coverage
$17,403 ÷
2.
= .55:1
Net Cash Provided by Operating Activities ÷ Average Total
Liabilities = Cash Debt Coverage
$17,403 ÷
3.
($32,976 + $30,011)
2
($73,822 + $67,516)
2
= 0.25:1
Net cash provided by operating activities less capital expenditures
and dividends
Net cash provided by operating activities ......
Less: Capital expenditures .............................
Dividends ...............................................
Free cash flow ...................................................
$17,403
$3,073
7,789
10,862
$ 6,541
Note that P&G also used cash ($7,405 million) to repurchase
common stock, which reduces its free cash flow to negative $864
million. P&G’s financial position appears adequate. Twenty five
percent of its total liabilities can be covered by the current year’s
operating cash flow and its free cash flow position indicates it is
easily meeting its capital investment and financing demands from
current free cash flow.
LO: 1, 2, Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, Research, AICPA PC:
Communication
UYJ4.2 Comparative Analysis Case
(a)
Both the Coca-Cola Company and PepsiCo, Inc. use the report form.
(b) The Coca-Cola Company has working capital of $4,639 million
($19,240 million – $14,601 million): PepsiCo, Inc. has working capital of
negative $371 million ($23,001 million – $23,372 million). The Coca-Cola
Company indicates in its management discussion and analysis section
that its ability to generate cash from operating activities is one of its
fundamental financial strengths. This posture, coupled with use debt
financing lowers the overall cost of capital and increases the return on
shareowners’ equity. PepsiCo has a similar strategy (see discussion in
“Liquidity and Capital Resources.”)
(c)
Total assets
Annual
Three-Year
The Coca-Cola Company
PepsiCo, Inc.
1.06%
18.30%
4.90%
19.67%
45.82%
38.50%
58.19%
42.68%
Long-term debt
The Coca-Cola Company
PepsiCo, Inc.
(d) The Coca-Cola Company has increased net cash provided by operating
activities from 2018 to 2020 by $2,217 million or 29.1%. PepsiCo, Inc.
has increased net cash provided by operating activities by $1,198 million
or 12.7%. Both Coca-Cola and Pepsi had favorable trends in the
generation of internal funds from operations.
Comparative Analysis Case (Continued)
(e)
The Coca-Cola Company
Current Cash Debt Ratio
($14,601 + $26,973)
2
$9,844 ÷
= 0.47:1
Cash Debt Coverage Ratio
$9,844 ÷
($66,012* + $65,283**)
2
= .15:1
*$14,601 + $40,125 + $9,453 + $1,833 = $66,012
**$26,973 + $27,516 + $8,510 + $2,284 = $65,283
($ millions)
Free cash flow
Net cash provided by operating activities ................
Capital expenditures .......................................
Dividends .........................................................
Free cash flow ............................................................
$9,844
(1,177)
(7,047)
$1,620
Coca-Cola Company’s free cash flow is $1,620. Note that Coca-Cola is
also using cash to repurchase shares.
PepsiCo, Inc.
Current Cash Debt Coverage
$10,613 ÷
$23,372 + $20,461 = 0.48:1
2
Cash Debt Coverage
$10,613 ÷
$79,366 + $63,679 = 0.15:1
2
Comparative Analysis Case (Continued)
Free cash flow
Net cash provided by operating activities...................
Less: Capital spending ................................................
Dividends ...........................................................
Free cash flow ...............................................................
$10,613
4,240
5,509
$ 864
PepsiCo also used cash to repurchase shares.
PepsiCo appears to have similar liquidity and financial flexibility as
Coca-Cola.
LO: 1, 2, 4, Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, Research, AICPA
PC: Communication
UYJ4.3 Financial Statement Analysis Case - UTC
(a)
The raw materials price increase is not a required disclosure. However, the
company might well want to inform shareholders in the management
discussion and analysis section, especially as a means for company
management to point out an area of success. If the company had not
been able to successfully meet the challenge, then the reporting in the
discussion and analysis section would be for the purpose of explaining
poorer than expected operating results.
(b) The information in item (2) should be reported as follows: The $4,000,000
outstanding should, of course, be included in the balance sheet as a part
of liabilities (current- or long-term, depending on the terms of the loan). The
fact that an additional $11,000,000 or so is available for borrowing
should be disclosed in the notes to the financial statements, as should
the fact that the loan is based on the accounts receivable.
LO: 1, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, Research, AICPA PC:
Communication
UYJ4.4 Financial Statement Analysis Case – Sherwin-Williams
(a)
These accounts are shown in the order in which Sherwin-Williams
actually presented the accounts. The order shown may be modified
somewhat; however, cash should certainly be listed first and other
current assets last within the current assets category; common stock
should be listed first and retained earnings last in the stockholders’
equity category. For the remaining items, the order may be different
than that shown.
CURRENT ASSETS
Cash and cash equivalents
Short-term investments
Accounts receivable, less allowance
Finished goods inventories
Work in process and raw materials inventories
Other current assets
PROPERTY, PLANT, AND EQUIPMENT
Land
Buildings
Machinery and equipment
INTANGIBLE ASSETS
Intangibles
OTHER ASSETS
CURRENT LIABILITIES
Accounts payable
Employee compensation payable
Taxes payable
Other accruals
Accrued taxes
LONG-TERM LIABILITIES
Long-term debt
Postretirement obligations other than pensions
Other long-term liabilities
STOCKHOLDERS’ EQUITY
Common stock
Other capital
Retained earnings
Financial Statement Analysis Case (Continued)
(b)
There is some latitude for judgment in this question. The general
answer is that the assets and liabilities specific to the automotive
division will decrease and that cash will increase. Some students may
be aware that retained earnings will increase or decrease, depending
upon whether the assets were sold above or below historical cost.
 Cash and cash equivalents—increase from the sale of the assets
 Accounts receivable, less allowance—decrease from the sale of the
Automotive Division’s receivables
 Finished goods inventories—decrease
 Work in process and raw materials inventories—decrease
 Land—decrease
 Buildings—decrease
 Machinery and equipment—decrease
 Current liabilities - decrease
 Long-term debt—decrease
 Retained earnings—increase or decrease, depending on whether the
assets were sold above or below cost
LO: 1, Bloom: C, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, Research, AICPA PC:
Communication
UYJ4.5 Financial Statement Analysis Case - Deere
(a)
Working Capital, Current Ratio
Without Contractual Obligations
Working Capital
Current Ratio
$50,060 – $21,394 = $28,666
$50,060 ÷ $21,394 = 2.34
With Contractual Obligations
Off-balance sheet current obligations (Purchase obligations and
operating leases) = $3,091 ($2,970 + $121)
Working Capital
Current Ratio
$50,060 – ($21,394 + $3,091)
= $25,575
$50,060 ÷ ($21,394 + $3,091)
= 2.04
Without information on contractual obligations, an analyst would
overstate Deere’s liquidity, as measured by working capital and the
current ratio.
(b)
1.
Based on the analysis in Part (a), Deere has a pretty good liquidity
cushion. It would be able to pay a loan of up $25,575 billion if due
in one year.
2.
Additional contractual obligations of $13,119 in years 2 and 3 and
$8,211 in years 4 and 5 are relevant to assessing whether Deere
can repay a loan maturing in 5 years. In evaluating a longer-term
loan, an analyst would need to develop a prediction of Deere’s
cash flows over the next 5 years that would be used to repay a
longer-term loan.
In summary, the schedule of contractual obligations provides
information about off-balance sheet obligations—both the amounts
and when due. This helps the analyst assess both liquidity and
solvency of a company.
LO: 1, 2, 3, 4, Bloom: AN, Difficulty: Complex, Time: 15-20, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, Research, AICPA
PC: Communication
UYJ4.6 Financial Statement Analysis Case - Amazon
(a)
($ in millions)
Current assets ....................................
Total assets ........................................
Current liabilities ................................
Total liabilities ....................................
(1) Cash provided by operations .......
(2) Capital expenditures.....................
(3) Dividends paid ..............................
Net Income (loss) ...............................
Sales ...................................................
Free Cash Flow...................................
(1) – (2) – (3)
Current
Year
$31,327
54,505
28,089
43,764
6,842
4,893
(241)
88,988
Prior
Year
$24,625
40,159
22,980
30,413
5,475
3,444
274
74,452
1,949
2,031
As indicated above, Amazon’s free cash flow in the current and prior
year was $1,949 million and $2,031 million respectively. Amazon
showed a declining trend in profitability but an increase in cash
provided by operations. Depending on the investment required to build
the warehouses, it appears they might not have been able to finance
the warehouses with internal funds at that time.
(b)
Cash provided by operations has increased in the current year relative
to the prior year by $1,367 million. This is the face of lower profitability
but with a net increase in working capital and other non-cash income
adjustments.
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, Research, AICPA PC:
Communication
UYJ4.7 Accounting, Analysis, and Principles
Accounting
Hopkins Company
Balance Sheet
December 31, 2025
Assets
Current assets
Cash ($75,000 – $15,000)
Accounts receivable ($52,000 – $9,000)
Less: Allowance for doubtful accounts
($13,500 – $9,000)
Inventory
Total current assets
$ 60,000
$ 43,000
4,500
38,500
65,300
$163,800
Long-term investments
Bond sinking fund
Property, plant, and equipment
Equipment
Less: Accumulated depreciation—equipment
Intangible assets
Patents
Total assets
112,000
28,000
Liabilities and Stockholders’ Equity
Current liabilities
Notes and accounts payable
Long-term liabilities
Notes payable (due 2027)
Total liabilities
$ 52,000
Stockholders’ equity
Common stock
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
100,000
50,800
15,000
84,000
15,000
$277,800
75,000
$127,000
150,800
$277,800
Accounting, Analysis, and Principles (Continued)
Analysis
The classified balance sheet provides subtotals for current assets and
current liabilities, which are assets expected to be converted to cash (or
liabilities expected to be paid from cash) in the next year or operating cycle
(also referred to as liquidity). Thus, an analysis of current assets relative to
current liabilities provides information relevant to assessing Hopkins’ ability
to repay a loan within the next year. Specifically, current assets in excess of
current liabilities (working capital) is $111,800 ($163,800 – $52,000.) This
seems to be a safe liquidity cushion relative to an additional loan of $45,000.
Of course, the loan officer also would evaluate Hopkins’ earnings and cash
flows in the analysis.
Principles
The primary objection that the bank is likely to raise about this supplemental
information is the subjectivity (which reduces faithful representation) of the
estimates of fair values for the long-lived assets and the internally generated
intangibles. In addition, the loan officer might not consider information about
these long-term assets to be that relevant to the loan decision, because the
loan is short-term.
LO: 1, Bloom: AN, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
Time and Purpose of Critical Thinking
CT 4.1 (Time 20–25 minutes)
Purpose—to provide a varied number of financial transactions and then determine how each of these
items should be reported in the financial statements. Accounting changes, additional assessments of
income taxes, prior period adjustments, and changes in estimates are some of the financial transactions
presented.
CT 4.2 (Time 20–25 minutes)
Purpose—to present the asset section of a partial balance sheet that must be analyzed to assess its
deficiencies. Items such as improper classifications, terminology, and disclosure must be considered.
CT 4.3 (Time 20–25 minutes)
Purpose—to present a balance sheet that must be analyzed to assess its deficiencies. Items such as
improper classification, terminology, and disclosure must be considered.
CT 4.4 (Time 20–25 minutes)
Purpose—to present the student an ethical issue related to the presentation of balance sheet information.
The reporting involves “net presentation” of property, plant, and equipment.
CT 4.5 (Time 40–50 minutes)
Purpose—to present a cash flow statement that must be analyzed to explain differences in cash flow and
net income, and sources and uses of cash flow and ways to improve cash flow.
Solutions to Critical Thinking
CT 4.1
1.
The new estimate would be used in computing depreciation expense for 2025. No adjustment of the
balance in accumulated depreciation at the beginning of the year would be made. Instead, the
remaining depreciable cost would be divided by the estimated remaining life. This is a change in an
estimate and is accounted for prospectively (in the current and future years). Disclosure in the notes
to the financial statements is appropriate if material.
2.
The additional assessment should be shown on the current period’s income statement. If material,
it should be shown separately; if immaterial it could be included with the current year’s income tax
expense. This transaction does not represent a prior period adjustment.
3.
The effect of the error at December 31, 2024, should be shown as an adjustment of the beginning
balance of retained earnings on the retained earnings statement. The current year’s expense should
be adjusted (if necessary) for the possible carryforward of the error into the 2025 salaries expense
computation.
4.
Generally, an entry is made for a cash dividend on the date of declaration. The appropriate
entry would be a debit to Retained Earnings (or Dividends) for the amount to be paid, with a
corresponding credit to Dividends Payable. Dividends Payable is reported as a current liability.
LO: 1, Bloom: C, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
CT 4.2
1. Unclaimed payroll checks should be shown as a current liability if these are claims by employees.
2. Debt investments (trading) should be reported at fair value, not cost.
3. Bad debt reserve is an improper terminology; Allowance for doubtful accounts is considered more
appropriate. The amount of estimated uncollectible accounts should be disclosed.
4. Next-in, First-out (NIFO) is not an acceptable inventory valuation method.
5. Heading “Tangible assets” should be changed to “Property, Plant, and Equipment”; also label for
corresponding $630,000 should be changed to “Net property, plant, and equipment.”
6. Land should not be depreciated.
7. Buildings and equipment and their related accumulated depreciation balances should be separately
disclosed.
8. The valuation basis for stocks should be disclosed (fair value or equity) and the description should
be Debt investment (Available-for-Sale) or Equity investment in X Company. The Long-term
investments section should precede Property, plant, and equipment.
9. Treasury stock is not an asset and should be shown in the stockholders’ equity section as a deduction.
10. Discount on bonds payable is not an asset and should be shown as a deduction from bonds payable.
11. Sinking fund should be reported in the long-term investments section.
LO: 1, Bloom: C, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
CT 4.3
Criticisms of the balance sheet of the Sameed Brothers Corporation:
1. The basis for the valuation of marketable securities should be shown. Marketable securities are
valued at fair value. In addition, they should be classified as either debt or equity and as either debt
trading securities, debt available-for-sale securities, or debt held-to-maturity securities.
2. An allowance for doubtful accounts receivable is not indicated.
3. The basis for the valuation and the method of pricing for inventory are not indicated.
4. A stock investment in a subsidiary company is not ordinarily held to be sold within one year or the
operating cycle, whichever is longer. As such, this account should not be classified as a current
asset, but rather should be included under the heading “Investments.” The basis of valuation of the
investment should be shown.
5. Treasury stock is not an asset. It should be presented as a deduction in the shareholders’ equity
section of the balance sheet. The class of stock, number of shares, and basis of valuation should
be indicated.
6. Buildings and land should be segregated. The Reserve for Depreciation should be shown as a
subtraction from the Buildings account only. Also, the term “reserve for” should be replaced by
“accumulated.”
7. Cash surrender value of life insurance would be more appropriately shown under the heading of
“Investments.”
8. Reserve for Income Taxes should appropriately be entitled Income Tax Payable.
9. Customers’ Accounts with Credit Balances is an immaterial amount. As such, this account need not
be shown separately. The $1,000 credit could readily be netted against Accounts Receivable without
any material misstatement.
10. Unamortized Premium on Bonds Payable should be appropriately shown as an addition to the
related Bonds Payable in the long-term liability section. The use of the term deferred credits is
inappropriate.
11. Bonds Payable is inadequately disclosed. The interest rate, interest payment dates, and maturity
date should be indicated.
12. Should have a Stockholders’ equity line below the Total liabilities line.
13. Additional disclosure relative to the Common Stock account is needed. This disclosure should
include the number of shares authorized, issued, and outstanding.
14. Earned Surplus should appropriately be entitled Retained Earnings. Also, a separate heading should
be shown for this account; it should not be shown under the heading “Common Stock.” A more
appropriate heading would be “Shareholders’ or Stockholders’ Equity.”
15. Cash Dividends Declared should be disclosed on the retained earnings statement as a reduction of
retained earnings. Dividends Payable, in the amount of $8,000, should be shown on the balance
sheet among the current liabilities, assuming payment has not occurred.
LO: 1 2, Bloom: C, Difficulty: Simple, Time: 20-25, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Measurement Analysis and Interpretation,
Reporting, AICPA PC: Communication
CT 4.4
(a). The ethical issues involved are integrity and honesty in financial reporting, full disclosure,
transparency, and the accountant’s professionalism.
(b). While presenting property, plant, and equipment net of depreciation on the balance sheet may be
acceptable under GAAP, it is inappropriate to attempt to hide information from financial statement
users. Information must be useful, and the presentation Keene is considering would not be. Users
would not grasp the age of plant assets and the company’s need to concentrate its future cash
outflows on replacement of these assets. This information could be provided in a note disclosure.
Because of the significant impact on the financial statements of the depreciation method(s) used,
the following disclosures should be made.
a.
b.
c.
d.
Depreciation expense for the period.
Balances of major classes of depreciable assets, by nature and function.
Accumulated depreciation, either by major classes of depreciable assets or in total.
A general description of the method or methods used in computing depreciation with respect
to major classes of depreciable assets.
LO: 1, Bloom: E, Difficulty: Simple, Time: 20-25, AACSB: Ethics, Communication, AICPA AC: Reporting, AICPA PC: Communication Ethical Conduct
CT 4.5
Date
President Kappeler, CEO
Kappeler Corporation
125 Wall Street
Middleton, Kansas 67458
Dear Mr. Kappeler:
I have good news and bad news about the financial statements for the year ended December 31, 2025.
The good news is that net income of $100,000 is close to what we predicted in the strategic plan last
year, indicating strong performance this year. The bad news is that the cash balance is seriously low.
Enclosed is the Statement of Cash Flows, which best illustrates how these situations occurred
simultaneously.
If you look at the operating activities, you can see that no cash was generated by operations due to the
increase in accounts receivable and inventory and reduction in accounts payable. In effect, these events
caused net cash flow provided by operating activities to be lower than net income; they reduced your
cash balance by $116,000.
The corporation made significant investments in equipment and land. These were paid from cash
reserves. These purchases used 75% of the company’s cash. In addition, the redemption of the bonds
improved the equity of the corporation and reduced interest expense. However, it also used 25% of the
corporation’s cash. It is normal to use cash for investing and financing activities. But when cash is used,
it must also be replenished.
Operations normally provide the cash for investing and financing activities. Since there is a finite amount
of assets to sell and funds to borrow or raise from the sale of capital stock, operating activities are the
only renewable source of cash. That is why it is important to keep the operating cash flows positive. Cash
management requires careful and continuous planning.
CT 4.5 (Continued)
There are several possible remedies for the current cash problem. First, prepare a detailed analysis of
monthly cash requirements for the next year. Second, investigate the changes in accounts receivable
and inventory and work to return them to more normal levels. Third, look for more favorable terms with
suppliers to allow the accounts payable to increase without loss of discounts or other costs. Finally, since
the land represents a long-term commitment without immediate plans for use, consider shopping for a
low interest loan to finance the acquisition for a few years and return the cash balance to a more normal
level.
If you have additional questions or need one of our staff to address this problem, please contact me at
your convenience.
Sincerely yours,
Partner in Charge
LO: 2, Bloom: AN, Difficulty: Complex, Time: 40-50, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Codification Exercises
CE4.1
(a) Current assets is used to designate cash and other assets or resources commonly identified as
those that are reasonably expected to be realized in cash or sold or consumed during the normal
operating cycle of the business.
(b) Intangible assets are assets (not including financial assets) that lack physical substance. (The term
intangible assets is used to refer to intangible assets other than goodwill.) Clicking on the first link
yields the following FASB ASC string: 350 Intangibles—Goodwill and Other > 10 Overall.
(c) Cash equivalents are short-term, highly liquid investments that have both of the following
characteristics:
a.
Readily convertible to known amounts of cash
b.
So near their maturity that they present insignificant risk of changes in value because of changes
in interest rates.
Generally, only investments with original maturities of three months or less qualify under that
definition. Original maturity means original maturity to the entity holding the investment. For
example, both a three-month U.S. Treasury bill and a three-year Treasury note purchased three
months from maturity qualify as cash equivalents. However, a Treasury note purchased three years
ago does not become a cash equivalent when its remaining maturity is three months. Examples of
items commonly considered to be cash equivalents are Treasury bills, commercial paper, money
market funds, and federal funds sold (for an entity with banking operations).
(d) Financing activities include obtaining resources from owners and providing them with a return on,
and a return of, their investment; receiving restricted resources that by donor stipulation must be
used for long-term purposes; borrowing money and repaying amounts borrowed, or otherwise
settling the obligation; and obtaining and paying for other resources obtained from creditors on longterm credit.
LO: 1,2, Bloom: K, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, Communication, Technology, AICPA BB: None, AICPA AC: Reporting, Research, Technology
and Tools, AICPA PC: Communication
CE4.2
See FASC ASC 210-10-45 (Other Presentation Matters)
Classification of Current Liabilities
45-5A
Total of current liabilities shall be presented in classified balance sheets.
45-6
The concept of current liabilities shall include estimated or accrued amounts that are expected
to be required to cover expenditures within the year for known obligations the amount of which
can be determined only approximately (as in the case of provisions for accruing bonus
payments) or where the specific person or persons to whom payment will be made cannot as
yet be designated (as in the case of estimated costs to be incurred in connection with
guaranteed servicing or repair of products already sold).
CE4.2 (Continued)
45-7
Section 470-10-45 includes guidance on various debt transactions that may result in current
liability classification. These transactions are the following:
a.
b.
c.
Due on demand loan agreements
Callable debt agreements
Short-term obligations expected to be refinanced.
LO: 1, Bloom: K, Difficulty: Simple, Time: 15-20, AACSB: Knowledge, Communication, Technology, AICPA BB: None AICPA AC: Reporting, Research, Technology
and Tools, AICPA PC: Communication
CE4.3
The following discussion is provided at 235-10-50 Disclosure
> Accounting Policies Disclosure
50-1
Information about the accounting policies adopted by an entity is essential for financial
statement users. When financial statements are issued purporting to present fairly the financial
position, cash flows, and results of operations in accordance with generally accepted accounting
principles (GAAP), a description of all significant accounting policies of the entity shall be
included as an integral part of the financial statements. In circumstances where it may be
appropriate to issue one or more of the basic financial statements without the others, purporting
to present fairly the information given in accordance with GAAP, statements so presented also
shall include disclosure of the pertinent accounting policies.
> Accounting Policies Disclosure in Interim Periods
50-2
The provisions of the preceding paragraph are not intended to apply to unaudited financial
statements issued as of a date between annual reporting dates (for example, each quarter) if
the reporting entity has not changed its accounting policies since the end of its preceding fiscal
year.
> What to Disclose
50-3
Disclosure of accounting policies shall identify and describe the accounting principles followed
by the entity and the methods of applying those principles that materially affect the determination of financial position, cash flows, or results of operations. In general, the disclosure shall
encompass important judgments as to the appropriateness of principles relating to recognition
of revenue and allocation of asset costs to current and future periods; in particular, it shall
encompass those accounting principles and methods that involve any of the following:
a.
b.
c.
A selection from existing acceptable alternatives
Principles and methods peculiar to the industry in which the entity operations, even if such
principles and methods are predominantly followed in that industry
Unusual or innovative applications of GAAP.
> Examples of Disclosures
50-4
Examples of disclosures by an entity commonly required with respect to accounting policies
would include, among others, those relating to the following:
a.
b.
Basis of consolidation
Depreciation methods
CE4.3 (Continued)
c.
d.
e.
f.
Amortization of intangibles
Inventory pricing
Accounting for recognition of profit on long-term construction-type contracts
Recognition of revenue from franchising and leasing operations.
> Avoid Duplicate Details of Disclosures
50-5
Financial statement disclosure of accounting policies shall not duplicate details (for example,
the composition of inventories or of plant assets) presented elsewhere as part of the financial
statements. In some cases, the disclosure of accounting policies shall refer to related details
presented elsewhere as part of the financial statements; for example, changes in accounting
policies during the period shall be described with a cross-reference to the disclosure required
by Topic 250.
> Format
50-6
This Subtopic recognizes the need for flexibility in matters of format (including the location) of
disclosure of accounting policies provided that the entity identifies and describes its significant
accounting policies as an integral part of its financial statements in accordance with the provisions of this Subtopic. Disclosure is preferred in a separate summary of significant accounting
policies preceding the notes to financial statements, or as the initial note, under the same or a
similar title.
LO: 3, Bloom: K, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Communication, Technology, AICPA BB: Nonne, AICPA AC: Reporting, Research, Technology
and Tools, AICPA PC: Communication
CE4.4
The following section: 230-10-05 Overview and Background provides a discussion of the objectives of
the Statement of Cash Flows.
05-1
The Statement of Cash Flows Topic presents standards for reporting cash flows in generalpurpose financial statements.
05-2
Specific guidance is provided on all of the following:
a.
b.
c.
d.
Classifying in the statement of cash flows of cash receipts and payments as either
operating, investing, or financing activities
Applying the direct method and the indirect method of reporting cash flows
Presenting the required information about noncash investing and financing activity and
other events
Classifying cash receipts and payments related to hedging activities.
230-10-10 Objectives
10-1
The primary objective of a statement of cash flows is to provide relevant information about the
cash receipts and cash payments of an entity during a period.
CE4.4 (Continued)
10-2
The information provided in a statement of cash flows, if used with related disclosures and
information in the other financial statements, should help investors, creditors, and others (including
donors) to do all of the following:
a.
b.
c.
d.
Assess the entity’s ability to generate positive future net cash flows
Assess the entity’s ability to meet its obligations, its ability to pay dividends, and its needs
for external financing
Assess the reasons for differences between net income and associated cash receipts and
payments
Assess the effects on an entity’s financial position of both its cash and noncash investing
and financing transactions during the period.
LO: 2, Bloom: K, Difficulty: Simple, Time: 20-25, AACSB: Knowledge, Communication, Technology, AICPA BB: None, AICPA AC: Reporting, Research, Technology
and Tools, AICPA PC: Communication
Codification Research Case
(a)
Codification String: FASB ASC 235-10-05—Presentation > 235 Notes to
Financial Statements > 10 Overall > 05 Overview and Background
(Predecessor Standard – [APB 22])
(b)
Codification String: Presentation > 235 Notes to Financial Statements
> 10 Overall > 05 Overview and Background
05-3 The accounting policies of an entity are the specific accounting
principles and the methods of applying those principles that are
judged by the management of the entity to be the most appropriate
in the circumstances to present fairly financial position, cash flows,
and results of operations in accordance with generally accepted
accounting principles (GAAP) and that, accordingly, have been
adopted for preparing the financial statements.
(c)
Codification String: Presentation > 235 Notes to Financial Statements
> 10 Overall > 50 Disclosure
50-3 Disclosure of accounting policies shall identify and describe the
accounting principles followed by the entity and the methods of
applying those principles that materially affect the determination
of financial position, cash flows, or results of operations. In
general, the disclosure shall encompass important judgments as
to the appropriateness of principles relating to recognition of
revenue and allocation of asset costs to current and future
periods; in particular, it shall encompass those accounting
principles and methods that involve any of the following:
a.
b.
c.
A selection from existing acceptable alternatives.
Principles and methods peculiar to the industry in which the
entity operates, even if such principles and methods are
predominantly followed in that industry.
Unusual or innovative applications of GAAP.
Codification Research Case (Continued)
(d)
50-4 Codification String: Presentation > 235 Notes to Financial
Statements > 10 Overall > 05 Background
Examples of disclosures by an entity commonly required with
respect to accounting policies would include, among others, those
relating to the following:
a.
b.
c.
d.
e.
g.
Basis of consolidation
Depreciation methods
Amortization of intangibles
Inventory pricing
Accounting for recognition of profit on long-term
construction-type contracts
Recognition of revenue from franchising and leasing
operations.
LO: 3, Bloom: K, Difficulty: Simple, Time: 20-25, AACSB: Knowledge Communication, Technology, AICPA BB: None, AICPA AC: Reporting, Research,
Technology and Tools, AICPA PC: Communication
CHAPTER 5
Accounting and the Time Value of Money
Assignment Classification Table (By Topic)
Topics
Questions
1.
Present value concepts.
1, 2, 3,
5, 9, 17
2.
Use of tables.
13, 14
3.
Present and future value
problems:
Brief
Exercises
Exercises
Problems
1
a. Unknown future amount.
7, 19
1, 5, 13
2, 3, 4, 7
b. Unknown payments.
10, 11, 12
6, 12,
15, 17
8, 16, 17
2, 6
4, 9
10, 15
2
c. Unknown number of
periods.
d. Unknown interest rate.
15, 18
3, 11, 16
9, 10, 11, 14
2, 7
e. Unknown present value.
8, 19
2, 7, 8,
10, 14
3, 4, 5, 6,
8, 12, 17,
18, 19
1, 4, 7, 9,
13, 14
4.
Value of a series of irregular
deposits; changing interest
rates.
5.
Valuation of leases,
pensions, bonds; choice
between projects.
6
6.
Deferred annuity.
16
7.
Expected cash flows.
4
*8.
Technology tools
* This material covered in the appendix.
3, 5, 8
15
18, 19
7, 12, 13,
14, 15
3, 5, 6, 8, 9,
10, 11, 12,
13, 14, 15
20, 21, 22
13, 14, 15
23, 24, 25
16
Assignment Classification Table (By Learning Objective)
Learning Objectives
Questions
Brief
Exercises
Exercises
Problems
1.
Describe the fundamental concepts
related to the time value of money.
1, 2, 3, 5, 6
2.
Solve future and present value of 1
problems.
7, 8, 17
1, 2, 3,
4, 7, 8
2, 3, 6, 9,
10, 15
1, 2, 3, 5,
7, 9, 10
3.
Solve future value of ordinary and
annuity due problems.
9, 11, 12,
13, 17
5, 6, 9, 13
3, 4, 6,
15, 16
2, 7
4.
Solve present value of ordinary and
annuity due problems.
10, 14, 15,
16, 17, 18
10, 11, 12,
14, 16, 17
3, 4, 5, 6,
11, 12, 17,
18, 19
1, 2, 3, 4,
5, 7, 8, 9,
10, 13, 14
5.
Solve present value problems related
to deferred annuities, bonds, and
expected cash flows.
4, 19
15
7, 8, 13, 14,
20, 21, 22
6, 11, 12,
13, 14, 15
18,19
23, 24, 25
16
*6. Solve time value of money problems
using Excel and financial calculators.
* This material covered in the appendix.
1, 2
Assignment Characteristics Table
Item
Description
Level of
Difficulty
Time
(minutes)
E5.1
E5.2
E5.3
E5.4
E5.5
E5.6
E5.7
E5.8
E5.9
E5.10
E5.11
E5.12
E5.13
E5.14
E5.15
E5.16
E5.17
E5.18
E5.19
E5.20
E5.21
E5.22
*E5.23
*E5.24
*E5.25
Using interest tables.
Simple and compound interest computations.
Computation of future values and present values.
Computation of future values and present values.
Computation of present value.
Future value and present value problems.
Computation of bond prices.
Computations for a retirement fund.
Unknown rate.
Unknown periods and unknown interest rate.
Evaluation of purchase options.
Analysis of alternatives.
Computation of bond liability.
Computation of pension liability.
Investment decision.
Retirement of debt.
Computation of amount of rentals.
Least costly payoff.
Least costly payoff.
Expected cash flows.
Expected cash flows and present value.
Fair value estimate.
Computing number of periods.
Solve for interest rate.
Solving for present and future values.
Simple
Simple
Simple
Moderate
Simple
Moderate
Moderate
Simple
Moderate
Simple
Moderate
Simple
Moderate
Moderate
Moderate
Simple
Simple
Simple
Simple
Simple
Moderate
Moderate
Moderate
Moderate
Moderate
5–10
5–10
10–15
15–20
10–15
15–20
12–17
10–15
5–10
10–15
10–15
10–15
15–20
15–20
15–20
10–15
10–15
10–15
10–15
5–10
15–20
15–20
15–20
15–20
15–20
P5.1
P5.2
P5.3
P5.4
P5.5
P5.6
P5.7
P5.8
P5.9
P5.10
P5.11
P5.12
P5.13
P5.14
P5.15
*P5.16
Various time value situations.
Various time value situations.
Analysis of alternatives.
Evaluating payment alternatives.
Analysis of alternatives.
Purchase price of a business.
Time value concepts applied to solve business problems.
Analysis of alternatives.
Analysis of business problems.
Analysis of lease vs. purchase.
Pension funding.
Pension funding.
Expected cash flows and present value.
Expected cash flows and present value.
Fair value estimate.
Future value of single sum and annuity.
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Complex
Moderate
Complex
Complex
Complex
Moderate
Moderate
Moderate
Complex
Moderate
15–20
15–20
20–30
20–30
20–25
25–30
30–35
20–30
30–35
30–35
25–30
20–25
20–25
20–25
20–25
15-20
Answers to Questions
1. Money has value because with it one can acquire assets and services and discharge obligations.
The holding, borrowing or lending of money can result in costs or earnings. And the longer the
time period involved, the greater the costs or the earnings. The cost or earning of money as a
function of time is the time value of money.
Accountants must have a working knowledge of compound interest, annuities, and present value
concepts because of their application to numerous types of business events and transactions
which require proper valuation and presentation. These concepts are applied in the following
areas: (1) stock-based compensation, (2) environmental liabilities, (3) pensions and other
postretirement benefits, (4) long-term assets, (5) leases, (6) notes receivable and payable, (7)
business combinations, and (8) disclosures.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
2. Some situations in which present value measures are used in accounting include:
(a) Notes receivable and payable—these involve single sums (the face amounts) and may
involve annuities if there are periodic interest payments.
(b) Leases—involve measurement of assets and obligations based on the present value of
annuities (lease payments) and single sums (if there are residual values and/or bargain
purchase options to be paid at the conclusion of the lease).
(c) Pensions and other deferred compensation arrangements—involve discounted future
annuity payments that are estimated to be paid to employees upon retirement (may be
annuities or single sum and annuities).
(d) Bond pricing—the price of bonds payable is comprised of the present value of the principal
or face value of the bond plus the present value of the annuity of interest payments.
(e) Long-term assets—evaluating various long-term investments or assessing whether an asset
is impaired requires determining the present value of the estimated cash flows associated with
an investment or long-term asset (may be single sums and/or an annuity).
LO: 1, 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
3. Interest is the payment for the use of money. It may represent a cost or earnings depending upon
whether the money is being borrowed or loaned. The earning or incurring of interest is a function
of the time, as well as the amount of money, and the risk involved (risk may be reflected in the
interest rate).
Simple interest is computed on the amount of the principal only, while compound interest is computed on the amount of the principal plus any accumulated interest. Compound interest involves
interest on interest while simple interest does not.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
4. The interest rate generally has three components:
(a) Pure rate of interest—This is the amount a lender would charge if there were no possibilities
of default and no expectation of inflation.
(b) Expected inflation rate of interest—Lenders recognize that in an inflationary economy, they
are being paid back with less valuable (future) dollars. As a result, they increase their interest
rate to compensate for this loss in purchasing power. When inflationary expectations are high,
interest rates are high.
(c) Credit risk rate of interest—The U.S. government has little or no credit risk (i.e., risk of
nonpayment) when it issues bonds. A business enterprise, however, depending upon its
financial stability, profitability, etc. can have a low or a high credit risk.
Accountants must have knowledge about these components because these components are
essential in identifying an appropriate interest rate for a given company or investor at any given
moment.
LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 5 (Continued)
5. (a)
(b)
(c)
(d)
Present value of an ordinary annuity at 8% for 10 periods (Table 5.4).
Future value of 1 at 8% for 10 periods (Table 5.1).
Present value of 1 at 8% for 10 periods (Table 5.2).
Future value of an ordinary annuity at 8% for 10 periods (Table 5.3).
LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
6. He should choose quarterly compounding, because the balance in the account on which interest
will be earned will be increased more frequently, thereby resulting in more interest earned on the
investment. This is shown in the following calculation:
Semiannual compounding, assuming the amount is invested for 2 years:
n = 4 (2 x 2)
$1,500 X (FVF 4, 4%) = $1,500 x 1.16986 = $1,755
Table 5.1
i = 4% (8% ÷ 2)
Quarterly compounding, assuming the amount is invested for 2 years:
n = 8 (2 x 4)
$1,500 X (FVF 8, 2%) = $1,500 x 1.17166 = $1,757
Table 5.1
i = 2% (8% ÷ 4)
Thus, with quarterly compounding, Jose could earn $2 more.
LO: 1, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
7. $26,898 = $20,000 x 1.34489 (future value factor of 1 at 21/2% for 12 periods). Table 5.1
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
8. $44,671 = $80,000 x .55839 (present value factor of 1 at 6% for 10 periods). Table 5.2
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
9. An annuity involves (1) periodic payments or receipts, called rents, (2) of the same amount,
(3) spread over equal intervals, (4) with interest compounded once each interval.
Rents occur at the end of the intervals for ordinary annuities while the rents occur at the beginning
of each of the intervals for annuities due.
LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
10. Amount paid each year = $40,000 *(present value factor of an ordinary annuity at 12% for 4
*3.03735 years). Table 5.4
Amount paid each year = $13,169.37.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
11. Amount deposited each year = $200,000 (**future value factor of an ordinary annuity at 10% for
**4.64100 4 years). Table 5.4
Amount deposited each year = $43,094.16.
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
12. Amount deposited each year = $200,000 [future value factor of an annuity due at 10% for 4 years
5.10510 (4.64100 x 1.10)]. Table 5.3
Amount deposited each year = $39,176.51.
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Questions Chapter 5 (Continued)
13. The process for converting the future value of an annuity due using the future value of an ordinary
annuity interest table is to multiply the corresponding future value of the ordinary annuity by one
plus the interest rate. For example, the factor for the future value of an annuity due for 4 years at
12% is equal to the factor for the future value of an ordinary annuity times 1.12.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
14. The basis for converting the present value of an ordinary annuity table to the present value of an
annuity due table involves multiplying the present value of an ordinary annuity factor by one plus
the interest rate.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
15. Present value = present value of an ordinary annuity of $25,000 for 20 periods at ? percent.
$245,000
= present value of an ordinary annuity of $25,000 for 20 periods at ? percent.
Present value of an ordinary annuity for 20 periods at ? percent = $245,000 = 9.8.
$25,000
The factor 9.8 is closest to 9.81815 in the 20 period, 8% column (Table 5.4).
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
16.
4.96764 Present value of ordinary annuity at 12% for eight periods. (Table 5.4)
(2.40183) Present value of ordinary annuity at 12% for three periods. (Table 5.4)
2.56581 Present value of ordinary annuity at 12% for eight periods, deferred three periods.
The present value of the five rents is computed as follows:
2.56581 X $20,000 = $51,316.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
17. (a)
(b)
(c)
(d)
Present value of an annuity due.
Present value of 1.
Future value of an annuity due.
Future value of 1.
LO: 2, 3, 4, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
18. $27,600 = PV of an ordinary annuity of $6,900 for five periods at ? percent.
$27,600 = PV of an ordinary annuity for five periods at ? percent.
$6,900
4.0 = PV of an ordinary annuity for five periods at ? (3.99271 in Table 5.4)
4.0 = approximately 8%.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
19. The IRS argues that the future reserves should be discounted to present value. The result would
be smaller reserves and therefore less of a charge to income. As a result, income would be higher
and income taxes may, therefore, be higher as well.
LO: 5, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Knowledge, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Solutions to Brief Exercises
Brief Exercise 5.1
8% annual interest
i = 8%
PV = $15,000
FV = ?
0
1
2
3
n=3
FV = $15,000 (FVF3, 8%)
FV = $15,000 (1.25971)
FV = $18,896
8% annual interest, compounded semi-annually
i = 4% (.08 ÷ 2)
PV = $15,000
0
FV = ?
1
2
3
4
5
n = 6 (3 yrs. x 2)
FV = $15,000 (FVF6, 4%)
FV = $15,000 (1.26532)
FV = $18,980
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
6
Brief Exercise 5.2
12% annual interest
i = 12%
PV = ?
FV = $25,000
0
1
2
n=4
3
4
PV = $25,000 (PVF4, 12%)
PV = $25,000 (.63552)
PV = $15,888
12% annual interest, compounded quarterly
i = 3% (.12 ÷ 4)
PV = ?
0
FV = $25,000
1
2
14
15
n = 16 (4 yrs. X 4)
PV = $25,000 (PVF16, 3%)
PV = $25,000 (.62317)
PV = $15,579
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
16
Brief Exercise 5.3
i=?
PV = $30,000
0
1
FV = $150,000
2
19
20
21
n = 21
FV = PV (FVF21, i)
PV = FV (PVF21, i)
OR
$150,000 = $30,000 (FVF21, i)
$30,000 = $150,000 (PVF21, i)
FVF21, i = 5.0000
PVF21, i = .20000
i = 8% approximately
i = 8% approximately
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.4
i = 5%
PV = $10,000
FV = $17,100
0
?
n=?
FV = PV (FVFn, 5%)
PV = FV (PVFn, 5%)
OR
$17,100 = $10,000 (FVFn, 5%)
$10,000 = $17,100 (PVFn, 5%)
FVFn, 5% = 1.71000
PVFn, 5% = .58480
n = 11 years (approx.)
n = 11 years (approx.)
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.5
First payment today (Annuity Due)
i = 6%
R=
FV–AD =
$8,000 $8,000 $8,000
0
1
$8,000 $8,000
2
18
19
?
20
n = 20
FV–AD = $8,000 (FVF–OA20, 6%) 1.06
FV–AD = $8,000 (36.78559) 1.06
FV–AD = $311,942
First payment at year-end (Ordinary Annuity)
i = 6%
FV–OA =
?
$8,000 $8,000 $8,000
$8,000 $8,000
0
1
2
18
19
n = 20
FV–OA = $8,000 (FVF–OA20, 6%)
FV–OA = $8,000 (36.78559)
FV–OA = $294,285
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
20
Brief Exercise 5.6
i = 5%
0
R=?
?
?
FV–OA =
? $250,000
1
2
8
9
10
n = 10
$250,000 = R (FVF–OA10, 5%)
$250,000 = R (12.57789)
$250,000
=R
12.57789
R = $19,876
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.7
8% annual interest
i = 8%
PV = ?
0
FV = $300,000
1
2
3
4
n=5
PV = $300,000 (PVF5, 8%)
PV = $300,000 (.68058)
PV = $204,174
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
5
Brief Exercise 5.8
With quarterly compounding, there will be 20 (5 x 4) quarterly compounding
periods, at 1/4 the interest rate (.08 ÷ 4 = 2%):
PV = $300,000 (PVF20, 2%)
PV = $300,000 (.67297)
PV = $201,891
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.9
i = 5%
FV–OA =
R=
$100,000
$9,069 $9,069
0
1
$9,069
2
n
n=?
$100,000 = $9,069 (FVF–OAn, 5%)
$100,000
FVF–OAn, 10% =
= 11.0266
$9,069
Therefore, n = 9 years (approximately)
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.10
First withdrawal at year-end – ordinary annuity
i = 8%
PV–OA = R =
? $30,000 $30,000
0
1
$30,000 $30,000 $30,000
2
8
9
10
n = 10
PV–OA = $30,000 (PVF–OA10, 8%)
PV–OA = $30,000 (6.71008)
PV–OA = $201,302
First withdrawal immediately – annuity due
i = 8%
PV–AD =
?
R=
$30,000 $30,000 $30,000
0
1
$30,000 $30,000
2
8
9
n = 10
PV–AD = $30,000 (PVF–AD10, 8%)
PV–AD = $30,000 (7.24689)
PV–AD = $217,407
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
10
Brief Exercise 5.11
i=?
PV =
$793.15
R=
$75
$75
$75
$75
$75
0
1
2
10
11
12
n = 12
$793.15 = $75 (PVF–OA12, i)
$793.15
PVF12, i =
= 10.57533
$75
Therefore, i = 2% per month or 24% (12 x 2%) per year.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.12
i = 4%
PV =
$300,000 R = ?
0
1
?
?
?
?
2
18
19
20
n = 20
$300,000 = R (PVF–OA20, 4%)
$300,000 = R (13.59033)
$300,000
=R
13.59033
R = $22,075
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.13
i = 6%
R=
$30,000 $30,000
$30,000 $30,000 $30,000
12/31/25 12/31/26 12/31/27
12/31/30 12/31/31 12/31/32
n=8
FV–OA = $30,000 (FVF–OA8, 6%)
FV–OA = $30,000 (9.89747)
FV–OA = $296,924
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.14
i = 8%
PV–OA =
R=
?
0
$25,000 $25,000
1
2
3
4
5
n=4
$25,000 $25,000
6
11
12
n=8
PV–OA = $25,000 (PVF–OA12–4, 8%)
PV–OA = $25,000 (PVF–OA8, 8%)(PVF4, 8%)
OR
PV–OA = $25,000 (7.53608 – 3.31213)
PV–OA = $25,000 (5.74664)(.73503)
PV–OA = $105,599
PV–OA = $105,599
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.15
i = 8%
PV = ?
PV–OA = R =
? $140,000 $140,000
0
1
$2,000,000
$140,000 $140,000 $140,000*
2
8
9
10
n = 10
$2,000,000 (PVF10, 8%) = $2,000,000 (.46319) = $ 926,380
$140,000* (PVF–OA10, 8%) = $140,000 (6.71008) =
939,411
$1,865,791
*($2,000,000 x .07)
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.16
PV–OA = $20,000
$4,727.53 $4,727.53
0
1
$20,000
(PV–OA6, i%)
(PV–OA6, i%)
Therefore, i%
2
$4,727.53 $4,727.53
5
6
= $4,727.53 (PV–OA6, i%)
= $20,000 ÷ $4,727.53
= 4.23054
= 11%
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 5.17
PV–AD = $20,000
$?
$?
$?
$?
0
2
5
1
6
$20,000 = Payment (PV–AD6, 11%)
$20,000 ÷ (PV–AD6, 11%) = Payment
$20,000 ÷ 4.6959 = $4,259
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
*Brief Exercise 5.18
The future value is $42,076.55.
In Excel:
Calculator Solution:
LO: 6, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
*Brief Exercise 5.19
The present value is $35,649.31.
Excel Solution:
Calculator Solution:
LO: 6, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Solutions to Exercises
Exercise 5.1 (5–10 minutes)
1. a.
b.
c.
2. a.
b.
c.
(a)
Rate of Interest
9%
3% (.12 ÷ 4)
5% (.10 ÷ 2)
(b)
Number of Periods
9
20 (5 x 4)
30 (15 x 2)
9%
25
30
28
5% (.10 ÷ 2)
3% (.12 ÷ 4)
LO: 1, Bloom: C, Difficulty: Simple, Time: 5-10, AACSB: Knowledge, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
Exercise 5.2 (5–10 minutes)
(a)
Simple interest of $1,600 ($20,000 x .08) per year x 8
Principal
Total withdrawn
(b)
Interest compounded annually—Future value of
1 @ 8% for 8 periods
Total withdrawn
(c)
Interest compounded semiannually—Future
value of 1 @ 4% (.08 ÷ 2) for 16 (8 x 2) periods
Total withdrawn
LO: 1, 2, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.3 (10–15 minutes)
(a)
$7,000 (FVF 5, 8%) = $7,000 x 1.46933 = $10,285.
(b)
$7,000 (PVF 8, 6%) = $7,000 x .62741 = $4,392.
(c)
$7,000 (FVF-OA 15,10%) = $7,000 x 31.77248 = $222,407.
(d)
$7,000 (PVF-OA 20,5%) = $7,000 x 12.46221 = $87,235.
LO: 2, 3, 4, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
$12,800
20,000
$32,800
1.85093
x $20,000
$37,019
1.87298
x $20,000
$37,460
Exercise 5.4 (15–20 minutes)
(a)
Future value of an ordinary
annuity of $4,000 a period
for 20 periods at 8%
$183,047.84 ($4,000 x 45.76196)
Factor (1 + .08)
x
1.08
Future value of an annuity
due of $4,000 a period at 8% $197,692
(b)
Present value of an ordinary
annuity of $2,500 for 30
periods at 5%
Factor (1 + .05)
Present value of annuity
due of $2,500 for 30 periods
at 5%
(c)
(d)
Future value of an ordinary
annuity of $2,000 a period
for 15 periods at 10%
Factor (1 + 10)
Future value of an annuity
due of $2,000 a period
for 15 periods at 10%
Present value of an ordinary
annuity of $1,000 for 6
periods at 9%
Factor (1 + .09)
Present value of an annuity
date of $1,000 for 6 periods
at 9%
$38,431.13 ($2,500 x 15.37245)
x 1.05
$40,353 (Or see Table 5.5 which
gives $40,352.68)
$63,544.96 ($2,000 x 31.77248)
x
1.10
$69,899
$4,485.92 ($1,000 x 4.48592)
x
1.09
$4,890
(Or see Table 5.5)
LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.5 (10–15 minutes)
(a)
$30,000 (PVF–OA 8, 12%) = $30,000 x 4.96764 = $149,029.
(b)
$30,00 (PVF–OA 16, 9%) = $30,000 x 8.31256 = $249,377.
(5.65022*– 4.11141**) x $30,000 = $46,164.
*(PVF–OA 10, 12%)
**(PVF–OA 6, 12%)
LO: 4, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.6 (15–20 minutes)
(a)
(b)
(c)
Future value of $12,000 @ 5% for 10 years
($12,000 x 1.62889) =
$19,547
Future value of an ordinary annuity of $600,000
at 10% for 15 years ($600,000 x 31.77248)
Deficiency ($20,000,000 – $19,063,488)
$19,063,488
$936,512
$70,000 discounted at 4% for 10 years:
$70,000 x .67556* =
*(PVF 10, 4%)
Accept the bonus of $55,000 now.
$47,289
LO: 2, 3, 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.7 (12–17 minutes)
(a)
$100,000 x .55526*
+ $5,000 x 11.11839**
*(PVF15, 4%)
=
=
$ 55,526
55,592
$111,118
**(PVF–OA 15, 4%)
(b)
$100,000 x .48102* (PVF15, 5%)
+ $5,000 x 10.37966** (PVF–OA 15, 5%)
=
=
$ 48,102
51,898
$100,000
(c)
$100,000 x .41727*
+ $5,000 x 9.71225**
=
=
$41,727
48,561
$90,288
*(PVF15, 6%)
**(PVF–OA 15, 6%)
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.8 (10–15 minutes)
(a)
(b)
Present value of an ordinary annuity of 1
for 4 periods @ 8%
Annual withdrawal
Required fund balance on June 30, 2028
Fund balance at June 30, 2028
$66,243
Future value of an ordinary annuity at 8%
4.50611
for 4 years
Amount of each of the four contributions is $14,701.
3.31213
x $20,000
$66,243
= $14,701
LO: 5, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.9 (10 minutes)
The rate of interest is determined by dividing the future value by the
present value and then finding the factor in the FVF table with n = 2 that
approximates that number:
or
$123,210 = $100,000 (FVF2, i%)
$100,000 = $123,210 (PVF2, i%)
$123,210 ÷ $100,000 = (FVF2, i%)
$100,000 ÷ $123,210 = PFVF2, i%)
1.2321 = (FVF2, i%)
.81162 = (PVF2, i%)
—reading across the n = 2 row reveals that i = 11%.
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.10 (10–15 minutes)
(a)
The number of interest periods is calculated by first dividing the
future value of $1,000,000 by $92,296, which is 10.83471—the value
$1.00 would accumulate to, at 10% for the unknown number of interest
periods. The factor 10.83471 or its approximate is then located in the
Future Value of 1 Table by reading down the 10% column to the
25-period line; thus, 25 is the unknown number of years Mike must
wait to become a millionaire.
(b)
The unknown interest rate is calculated by first dividing the future
value of $1,000,000 by the present investment of $182,696, which is
5.47357—the amount $1.00 would accumulate to, in 15 years at an
unknown interest rate. The factor or its approximate is then located in
the Future Value of 1 Table by reading across the 15-period line to the
12% column; thus, 12% is the interest rate Sally must earn on her
investment to become a millionaire.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.11 (10–15 minutes)
(a)
Total interest = Total payments—Amount owed today
$162,745 (10 x $16,274.53) – $100,000 = $62,745.
(b)
Rizzo should borrow from the bank, since the 9% rate is lower than
the manufacturer’s 10% rate determined below.
PV–OA10, i% = $100,000 ÷ $16,274.53
= 6.14457—Inspection of the 10-period row reveals a rate
of 10%.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.12 (10–15 minutes)
Building A—PV = $600,000.
Building B—
Rent x (PV of annuity due of 25 periods at 12%) = PV
$69,000 x 8.78432 = PV
$606,118 = PV
Building C—
Rent (PV of ordinary annuity of 25 periods at 12%) = PV
$7,000 x 7.84314 = PV
$54,902 = PV
Cash purchase price
PV of rental income
Net present value
$650,000
– 54,902
$595,098
Answer: Lease Building C since the present value of its net cost is the
smallest.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.13 (15–20 minutes)
Time diagram:
Hincapie, Inc.
i = 5% (.10 ÷ 2)
PV = ?
PV–OA = ?
*$110,000
0
$110,000 $110,000
1
2
Principal
$2,000,000
interest
$110,000 $110,000 $110,000
3
28
n = 30 (15 x 2)
*Interest = ($2,000,000 x .11 x ½)
29
30
Formula for the interest payments:
PV–OA = R (PVF–OAn, i)
PV–OA = *$110,000 (PVF–OA30, 5%)
PV–OA = $110,000 (15.37245)
PV–OA = $1,690,970
Formula for the principal:
PV = FV (PVFn, i)
PV = $2,000,000 (PVF30, 5%)
PV = $2,000,000 (0.23138)
PV = $462,760
The selling price of the bonds = PV of Interest Payments + PV of Principal
= $1,690,970 + $462,760 = $2,153,730.
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.14 (15–20 minutes)
Time diagram:
i = 8%
R=
PV–OA = ?
0
1
$700,000
2
n = 15
15
16
n = 10
$700,000 $700,000
24
25
Formula: PV–OA = R (PVF–OAn, i)
PV–OA = $700,000 (PVF–OA25–15, 8%)
PV–OA = $700,000 (10.67478 – 8.55948)
PV–OA = $700,000 (2.11530)
PV–OA = $1,480,710
OR
Time diagram:
i = 8%
R=
PV–OA = ?
0
1
FV(PVn, i)
$700,000
2
15
16
(PV–OAn, i)
$700,000 $700,000
24
25
Exercise 5.14 (Continued)
(i)
Present value of the expected annual pension payments at the end of
the 10th year:
PV–OA = R (PVF–OAn, i)
PV–OA = $700,000 (PVF–OA10, 8%)
PV–OA = $700,000 (6.71008)
PV–OA = $4,697,056*
(ii)
Present value of the expected annual pension payments at the
beginning of the current year:
PV = FV (PVFn, i)
PV = $4,697,056* (PVF15,8%)
PV = $4,697,056 x 0.31524
PV = $1,480,700
The company’s pension obligation (liability) is $1,480,700.
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.15 (15–20 minutes)
(a)
i = 8%
PV = $1,000,000
0
FV = $1,999,000
1
2
or
FVF(n, 8%) = $1,999,000 ÷ $1,000,000
= 1.999
n=?
PVF(n, 8%) = $1,000,000 ÷ $1,999,000
= .50025
reading down the 8% column, 1.999 (Table 5.1)
corresponds to 9 periods.
(b)
and .50025 (Table 5.2)
By setting aside $300,000 now, Andrew can gradually build the fund
to an amount to establish the foundation.
PV = $300,000
0
FV
FV = ?
1
2
8
9
= $300,000 (FVF9, 8%)
= $300,000 (1.999)
= $599,700—Thus, the amount needed from the annuity:
$1,999,000 – $599,700 = $1,399,300.
0
$?
$?
$? FV = $1,399,300
1
2
8
9
Payments = FV ÷ (FV–OA9, 8%)
= $1,399,300 ÷ 12.48756
= $112,056
LO: 2, 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.16 (10–15 minutes)
Amount to be repaid on March 1, 2028.
Time diagram:
i = 3% per six months (.06 ÷ 2)
PV = $70,000
3/1/23
FV = ?
3/1/24
3/1/25
3/1/31
3/1/32
n = 20 six-month periods
Formula: FV = PV (FVFn, i)
FV = $70,000 (FVF20, 3%)
FV = $70,000 (1.80611)
FV = $126,428
Amount of annual contribution to retirement fund.
Time diagram:
R
R=?
R
?
3/1/28 3/1/29
i = 5%
R
R
?
?
3/1/30
R
?
3/1/31 3/1/32
FV–AD =
$126,428
3/1/33
3/1/33
Exercise 5.16 (Continued)
1.
2.
3.
4.
Future value of ordinary annuity of 1 for 5 periods
at 5%
Factor (1 + .5)
*Future value of an annuity due of 1 for 5 periods
at 5%
Periodic rent ($126,428 ÷ 5.8019*)
(*Rounded)
LO: 3, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.17 (10–15 minutes)
Time diagram:
i = 11%
R
PV–OA = $365,755 ?
R
?
R
?
0
24
25
1
n = 25
Formula:
PV–OA = R (PV–OAn, i)
$365,755 = R (PVF–OA25, 11%)
$365,755 = R (8.42174)
R = $365,755 ÷ 8.42174
R = $43,430
LO: 4, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
5.52563
x 1.05000
5.8019
$21,791
Exercise 5.18 (10–15 minutes)
Time diagram:
i = 8%
PV–OA = ? $300,000
0
$300,000
1
2
$300,000 $300,000 $300,000
13
14
15
n = 15
Formula:
PV–OA = R (PVF–OAn, i)
PV–OA = $300,000 (PVF–OA15, 8%)
PV–OA = $300,000 (8.55948)
R = $2,567,844
The recommended method of payment would be the 15 annual payments of
$300,000, since the present value of those payments ($2,567,844) is less
than the alternative immediate cash payment of $2,600,000.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
Exercise 5.19 (10–15 minutes)
Time diagram:
i = 8%
PV–AD = ?
R=
$300,000 $300,000 $300,000
0
1
$300,000 $300,000
2
13
14
15
n = 15
Formula:
Using Table 5.4
Using Table 5.5
PV–AD = R (PVF–OAn, i)
PV–AD = R (PVF–ADn, i)
PV–AD = $300,000 (8.55948 X 1.08)
PV–AD = $300,000 (PVF–AD15, 8%)
PV–AD = $300,000 (9.24424)
PV–AD = $300,000 (9.24424)
PV–AD = $2,773,272
PV–AD = $2,773,272
The recommended method of payment would be the immediate cash
payment of $2,600,000, since that amount is less than the present value of
the 15 annual payments of $300,000, ($2,773,272).
LO: 4, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
Exercise 5.20 (15–20 minutes)
Expected
Cash Flow
Probability
Cash
Estimate x Assessment = Flow
(a) $ 4,800
20%
$ 960
6,300
50%
3,150
7,500
30%
2,250
Total Expected
Value
$ 6,360
(b) $ 5,400
7,200
8,400
(c) $(1,000)
3,000
5,000
30%
50%
20%
Total Expected
Value
$ 1,620
3,600
1,680
10%
80%
10%
Total Expected
Value
$ (100)
2,400
500
$ 6,900
$ 2,800
LO: 5, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.21 (10–15 minutes)
Estimated
Cash
Probability
Expected
Outflow x Assessment = Cash Flow
$200
10%
$ 20
450
30%
135
600
50%
300
750
10%
75
x PV
Factor,
n = 2, i = 6% = Present Value
$ 530 x 0.89000 =
$472
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: None
Exercise 5.22 (15–20 minutes)
(a)
This exercise determines the present value of an ordinary annuity or
expected cash flows as a fair value estimate.
Cash flow
Estimate x
$ 380,000
630,000
750,000
Probability
Expected
Assessment = Cash Flow
20%
$ 76,000
50%
315,000
30%
225,000 x PV-OA
Factor,
n = 8, I = 8% =
Present
Value
$ 616,000 x 5.74664 = $3,539,930
The fair value estimate of the trade name exceeds the carrying value;
thus, no impairment is recorded.
(b)
This fair value is based on unobservable inputs—Killroy’s own data on
the expected future cash flows associated with the trade name. This
fair value estimate is considered Level 3, as discussed in Chapter 1.
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
*Exercise 5.23 (15-20 minutes)
The number of periods is 26 years.
The Excel solution:
The calculator solution:
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
*Execise 5.24 (15-20 minutes)
The interest rate is 7.88%.
Excel solution:
The calculator solution:
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
* Exercise 5.25 (15-20 minutes)
a) The future value is $477,270.99.
Excel solution:
Calculator solution:
b) The present value is $82,142.97.
Excel solution:
Calculator solution:
c) The rate is 6.30%
Excel solution:
Calculator solution:
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 15-20, nalytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
Time and Purpose of Problems
Problem 5.1 (Time 15–20 minutes)
Purpose—to present an opportunity for the student to determine how to use the present value tables in
various situations. Each of the situations presented emphasizes either a present value of 1 or a present
value of an ordinary annuity situation. Two of the situations will be more difficult for the student because
a noninterest-bearing note and bonds are involved.
Problem 5.2 (Time 15–20 minutes)
Purpose—to present an opportunity for the student to determine solutions to four present and future
value situations. The student is required to determine the number of years over which certain amounts
will accumulate, the rate of interest required to accumulate a given amount, and the unknown amount
of periodic payments. The problem develops the student’s ability to set up present and future value
equations and solve for unknown quantities.
Problem 5.3 (Time 20–30 minutes)
Purpose—to present the student with an opportunity to determine the present value of the costs of
competing contracts. The student is required to decide which contract to accept.
Problem 5.4 (Time 20–30 minutes)
Purpose—to present the student with an opportunity to determine the present value of two lottery
payout alternatives. The student is required to decide which payout option to choose.
Problem 5.5 (Time 20–25 minutes)
Purpose—to provide the student with an opportunity to determine which of four insurance options results
in the largest present value. The student is required to determine the present value of options which
include the immediate receipt of cash, an ordinary annuity, an annuity due, and an annuity of changing
amounts. The student must also deal with interest compounded quarterly. This problem is a good
summary of the application of present value techniques.
Problem 5.6 (Time 25–30 minutes)
Purpose—to present an opportunity for the student to determine the present value of a series of
deferred annuities. The student must deal with both cash inflows and outflows to arrive at a present
value of net cash inflows. A good problem to develop the student’s ability to manipulate the present
value table factors to efficiently solve the problem.
Problem 5.7 (Time 30–35 minutes)
Purpose—to present the student an opportunity to use time value concepts in business situations.
Some of the situations are fairly complex and will require the student to think a great deal before
answering the question. For example, in one situation a student must discount a note and in another
must find the proper interest rate to use in a purchase transaction.
Problem 5.8 (Time 20–30 minutes)
Purpose—to present the student with an opportunity to determine the present value of an ordinary
annuity and annuity due for three different cash payment situations. The student must then decide
which cash payment plan should be undertaken.
Time and Purpose of Problems (Continued)
Problem 5.9 (Time 30–35 minutes)
Purpose—to present the student with the opportunity to work three different problems related to time
value concepts: purchase versus lease, determination of fair value of a note, and appropriateness of
taking a cash discount.
Problem 5.10 (Time 30–35 minutes)
Purpose—to present the student with the opportunity to assess whether a company should purchase or
lease. The computations for this problem are relatively complicated.
Problem 5.11 (Time 25–30 minutes)
Purpose—to present the student an opportunity to apply present value to retirement funding problems,
including deferred annuities.
Problem 5.12 (Time 20–25 minutes)
Purpose—to provide the student an opportunity to explore the ethical issues inherent in applying time
value of money concepts to retirement plan decisions.
Problem 5.13 (Time 20–25 minutes)
Purpose—to present the student an opportunity to compute expected cash flows and then apply
present value techniques to determine a warranty liability.
Problem 5.14 (Time 20–25 minutes)
Purpose—to present the student an opportunity to compute expected cash flows and then apply
present value techniques to determine the fair value of an asset.
Problems 5.15 (Time 20–25 minutes)
Purpose—to present the student an opportunity to estimate fair value by computing expected cash
flows and then applying present value techniques to value an asset retirement obligation.
* Problems 5.16 (Time 15–20 minutes)
Purpose—to present the student an opportunity to solve present value problems using Excel and
calculator tools.
Solutions to Problems
Problem 5.1
(a)
Given no established fair value for the building, the fair value of the
note would be used to estimate the fair value of the building.
Time diagram:
i = 9%
PV = ?
1/1/25
FV = $240,000
1/1/26
1/1/27
1/1/28
n=3
Formula: PV = FV (PVFn, i)
PV = $240,000 (PVF3, 9%)
PV = $240,000 (.77218)
PV = $185,323
Cash equivalent selling price of building ......................
Less: Book value ($250,000 – $100,000) .......................
Gain on disposal of the building ...............................
$185,323
150,000
$ 35,323
Problem 5.1 (Continued)
(b)
Time diagram:
i = 11%
PV–OA = ? $27,000
$27,000
1/1/25
1/1/27
1/1/26
$27,000
1/1/34
Principal
$300,000 (300 x $1,000)
Interest
$27,000 ($300,000 x .09)
1/1/35
n = 10
Present value of the principal
FV (PVF10, 11%) = $300,000 (.35218) ....................
$105,654
Present value of the interest payments
(c)
R (PVF–OA10, 11%) = $27,000 (5.88923) ...............
159,009
Combined present value (purchase price) ................
$264,663
Time diagram:
i = 8%
PV–OA = ? $4,000
0
1
$4,000
$4,000
$4,000
$4,000
2
8
9
10
n = 10
Formula: PV–OA = R (PVF–OAn,i)
PV–OA = $4,000 (PVF–OA10, 8%)
PV–OA = $4,000 (6.71008)
PV–OA = $26,840 (cost of machine)
Problem 5.1 (Continued)
(d)
Time diagram:
i = 12%
PV–OA = ?
$20,000 $5,000
0
$5,000
$5,000
$5,000
$5,000
$5,000
$5,000
$5,000
2
3
4
n=8
5
6
7
8
1
Formula: PV–OA = R (PVF–OAn,i)
PV–OA = $5,000 (PVF–OA8, 12%)
PV–OA = $5,000 (4.96764)
PV–OA = $24,838
Cost of tractor = $20,000 + $24,838 = $44,838
(e)
Time diagram:
i = 11%
PV–OA = ? $120,000 $120,000
0
1
$120,000 $120,000
2
8
9
n=9
Formula: PV–OA = R (PVF–OAn, i)
PV–OA = $120,000 (PVF–OA9, 11%)
PV–OA = $120,000 (5.53705)
PV–OA = $664,446
LO: 2, 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.2
(a)
Time diagram:
FV –OA = $90,000
i = 8%
0
R
R=?
R
?
R
?
R
?
R
?
R
?
R
?
R
?
1
2
3
4
n=8
5
6
7
8
Formula:
FV–OA = R (FVF–OAn,i)
$90,000 = R (FVF–OA8, 8%)
$90,000 = R (10.63663)
R = $90,000 ÷ 10.63663
R = $8,461
(b)
Time diagram:
i = 8%
R
R=?
R
?
R
?
R
?
40
41
42
64
n = 25
FV –AD =
500,000
65
Problem 5.2 (Continued)
1.
2.
3.
4.
(c)
Future value of an ordinary annuity of 1 for
25 periods at 8% ................................................
Factor (1 + .08) ......................................................
*Future value of an annuity due of 1 for 25
periods at 8% .....................................................
73.10594
x 1.0800
78.95442
Periodic rent ($500,000 ÷ 78.95442).....................
$6,333
Time diagram:
i = 9%
PV = $20,000
0
FV = $47,347
1
2
3
n
Future value approach
Present value approach
FV = PV (FVFn, i)
PV = FV (PVFn, i)
or
$47,347 = $20,000 (FVFn, 9%)
FVFn,9%
= $47,347 ÷ $20,000
= 2.36735
2.36735 is approximately the
value of $1 invested at 9%
for 10 years.
$20,000 = $47,347 (PVFn, 9%)
PVFn, 9%
= $20,000 ÷ $47,347
= .42241
.42241 is approximately the
present value of $1 discounted
at 9% for 10 years.
Problem 5.2 (Continued)
(d)
Time diagram:
i=?
PV =
$19,553
0
FV =
$27,600
1
2
n=4
3
4
Future value approach
Present value approach
FV = PV (FVFn, i)
PV = FV (PVFn, i)
or
$27,600 = $19,553 (FVF4, i)
FVF4, i
= $27,600 ÷ $19,553
= 1.41155
1.41158 is the value of $1
invested at 9% for 4 years.
$19,553 = $27,600 (PVF4, i)
PVF4, i
= $19,553 ÷ $27,600
= .70844
.70843 is the present value of $1
discounted at 9% for 4 years.
LO: 2, 3, 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.3
Time diagram (Bid A):
i = 9%
$69,000
PV–OA = R =
?
3,000
3,000
3,000
3,000
69,000
3,000
3,000
3,000
3,000
0
0
1
2
3
4
5
n=9
6
7
8
9
10
Present value of initial cost
12,000 x $5.75 = $69,000 (incurred today) ...................
$ 69,000
Present value of maintenance cost (years 1–4)
12,000 x $.25 = $3,000
R (PVF–OA 4, 9%) = $3,000 (3.23972) .............................
9,719
Present value of resurfacing
FV (PVF5, 9%) = $69,000 (.64993)....................................
44,845
Present value of maintenance cost (years 6–9)
R (PVF–OA 9–5, 9%) = $3,000 (5.99525 – 3.88965) ..........
6,317
Present value of outflows for Bid A ...............................
$129,881
Problem 5.3 (Continued)
Time diagram (Bid B):
i = 9%
$126,000
PV–OA = R =
?
1,080
1,080
1,080
1,080
1,080
1,080
1,080
1,080
1,080
0
0
1
2
3
4
5
6
7
8
9
10
n=9
Present value of initial cost
12,000 x $10.50 = $126,000 (incurred today)...........
$126,000
Present value of maintenance cost
12,000 x $.09 = $1,080
R (PVF–OA9, 9%) = $1,080 (5.99525) ..........................
6,475
Present value of outflows for Bid B ...........................
$132,475
Bid A should be accepted since its present value is lower.
LO: 2, 4, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.4
Lump sum alternative: Present Value = $500,000 x (1 – .46) = $270,000.
Annuity alternative: Payments = $36,000 x (1 – .25) = $27,000.
Present Value = Payments (PV–AD20, 8%)
= $27,000 (10.60360)
= $286,297.
Long should choose the annuity payout; its present value is $16,297
($286,297 – $270,000) greater.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.5
(a)
The present value of $55,000 cash paid today is $55,000.
(b)
Time diagram:
i = 21/2% per quarter
PV–OA =
R=
?
$4,000
0
1
$4,000
$4,000
2
18
n = 20 quarters (5 x 4)
$4,000
$4,000
19
20
Formula: PV–OA = R (PVF–OAn, i)
PV–OA = $4,000 (PVF–OA20, 21/2%)
PV–OA = $4,000 (15.58916)
PV–OA = $62,357
(c)
Time diagram:
i = 21/2% per quarter
$18,000
PV–AD =
R = $1,800
$1,800
0
1
$1,800
$1,800
2
38
n = 40 quarters (10 x 4)
$1,800
39
Formula: PV–AD = R (PVF–ADn, i)
PV–AD = $1,800 (PVF–AD40, 21/2%)
PV–AD = $1,800 (25.73034)
PV–AD = $46,315
The present value of option (c) is $18,000 + $46,315, or
$64,315.
40
Problem 5.5 (Continued)
(d)
Time diagram:
i = 21/2% per quarter
PV–OA =
?
PV–OA = R =
?
$4,000
0
R=
$1,500
$4,000
1
11
n = 12 quarters
$1,500
$1,500 $1,500
$4,000
12
13
14
n = 25 quarters
36
37
Formulas:
PV- OA = R (PVF–OAn,i)
PV–OA = R (PVF–OAn,i)
PV-OA = $4,000 (PVF–OA12, 21/2%)
PV–OA = $1,500 (PVF–OA37–12, 21/2%)
PV–OA = $4,000 (10.25776)
PV–OA = $1,500 (23.95732 – 10.25776)
PV–OA = $41,031*
PV–OA = $20,549**
The present value of option (d) is $41,031* + $20,549**, or
$61,580.
Present values:
(a)
$55,000.
(b)
$62,357.
(c)
$64,315.
(d)
$61,580.
Option (c) is the best option, based upon present values alone.
LO: 2, 4, Bloom: AP, Difficulty: Moderate, Time: 20-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
5-46
© 2022 WILEY
Copyright
Problem 5.6
© 2022 WILEY
Manual
Copyright
Kieso,
Intermediate
18/e,Instructor
SolutionsUse
Only)
Accounting,
Manual
Kieso, Intermediate
18/e,
Solutions Accounting,
(For
Time diagram:
i = 6%
PV–OA = ? R =
($39,000)
0
($39,000) $18,000 $18,000 $68,000 $68,000 $68,000 $68,000 $38,000 $38,000 $38,000
1
5
6
10 11
12
29 30 31
39 40
n=5
n=5
n = 20
n = 10
(0 – $30,000 – $9,000)
($60,000 – $30,000 –
$12,000)
($110,000 – $30,000 –
$12,000)
($80,000 – $30,000 –
$12,000)
Formulas:
PV–OA = R (PVF–OAn, i)
PV–OA = R (PVF–OAn, i)
PV–OA = R (PVF–OAn, i)
PV–OA = R (PVF–OAn, i)
PV–OA = ($39,000)(PVF–OA5, 6%)
PV–OA = $18,000 (PVF–OA10-5, 6%)
PV–OA = $68,000 (PVF–OA30–10, 6%)
PV–OA = $38,000 (PVF–OA40–30, 6%)
PV–OA = ($39,000)(4.21236)
PV–OA = $18,000 (7.36009 – 4.21236) PV–OA = $68,000 (13.76483 – 7.36009) PV–OA = $38,000 (15.04630 – 13.76483)
PV–OA = ($164,282)
PV–OA = $18,000 (3.14773)
PV–OA = $68,000 (6.40474)
PV–OA = $38,000 (1.28147)
PV–OA = $56,659
PV–OA = $435,522
PV–OA = $48,696
Present value of future net cash inflows:
Only)
(For Instructor Use 5-49
$(164,282)
56,659
435,522
48,696
$ 376,595
Stacy McGill should accept no less than $376,596 for her vineyard business.
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.7
(a)
Time diagram (alternative one):
i=?
PV–OA =
$600,000
R=
$80,000
$80,000
$80,000
$80,000
$80,000
1
2
10
11
12
0
n = 12
Formulas: PV–OA = R (PVF–OAn, i)
$600,000 = $80,000 (PVF–OA12, i)
PVF–OA12, i = $600,000 ÷ $80,000
PVF–OA12, i = 7.50
7.50 is the approximate present value of an annuity factor of $1 for 12
years discounted at approximately 8%.
Time diagram (alternative two):
i=?
PV = $600,000
0
FV = $1,900,000
1
2
11
n = 12
12
Problem 5.7 (Continued)
Future value approach
Present value approach
FV = PV (FVFn, i)
PV = FV (PVFn, i)
or
$1,900,000 = $600,000 (FVF12, i)
$600,000 = $1,900,000 (PVF12, i)
FVF12, I
= $1,900,000 ÷ $600,000
PVF12, i = $600,000 ÷ $1,900,000
FVF12, I
= 3.16667
PVF12, i = .31579
3.16667 is the approximate future
value factor of $1 invested at
.31579 is the approximate present
value factor of $1 discounted
10% for 12 years.
at 10% for 12 years.
Dubois should choose alternative two since it provides a higher rate
of return.
(b)
Time diagram:
i=?
($824,150 – $200,000)
PV–OA = R =
$624,150
$76,952
0
1
$76,952
$76,952
8
9
n = 10 six-month periods
$76,952
10
Problem 5.7 (Continued)
Formulas: PV–OA = R (PVF–OAn, i)
$624,150 = $76,952 (PVF–OA10, i)
PV–OA10, i = $624,150 ÷ $76,952
PV–OA10, i = 8.11090
8.11090 is the present value of a 10-period annuity of $1 discounted at
4%. The interest rate is 4% semi-annually or 8% annually.
(c)
Time diagram:
i = 5% per six months (.10 ÷ 2)
PV = ?
PV–OA =
R=
?
$32,000
0
1
$32,000
$32,000
$32,000 $32,000 ($800,000 X 8% X 6/12)
2
8
9
10
n = 10 six-month periods [(7 – 2) X 2]
Formulas:
PV–OA = R (PVF–OAn, i)
PV = FV (PVFn, i)
PV–OA = $32,000 (PVF–OA10, 5%) PV = $800,000 (PVF10, 5%)
PV–OA = $32,000 (7.72173)
PV–OA = $247,095*
PV = $800,000 (.61391)
PV = $491,128**
Combined present value (amount received on sale of note):
$247,095* + $491,128** = $738,223
Problem 5.7 (Continued)
(d)
Time diagram (future value of $200,000 deposit)
i = 21/2% per quarter (.10 ÷ 4)
PV =
$200,000
FV = ?
12/31/25
12/31/26
12/31/34
12/31/35
n = 40 quarters (10 x 4)
Formula: FV = PV (FVFn, i)
FV = $200,000 (FVF40, 2 1/2%)
FV = $200,000 (2.68506)
FV = $537,012
Amount to which quarterly deposits must grow:
$1,300,000 – $537,012 = $762,988.
Time diagram (future value of quarterly deposits)
i = 21/2% per quarter
R
R=?
12/31/25
R
?
R
?
R
?
R
?
12/31/26
12/31/34
n = 40 quarters
R
?
R
?
FV = $762,988
R
R
?
?
12/31/35
Problem 5.7 (Continued)
Formulas:
FV–OA = R (FVF–OAn, i)
$762,988 = R (FVF–OA40, 2 1/2%)
$762,988 = R (67.40255)
R = $762,988 ÷ 67.40255
R = $11,320
LO: 2, 3, 4, Bloom: AP, Difficulty: Complex, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.8
Vendor A:
$ 18,000 Payment
Xx 6.14457 (PV of ordinary annuity 10%, 10 periods)
$ 110,602
+ 55,000 down payment
+ 10,000 maintenance contract
$ 175,602 total cost from Vendor A
Vendor B:
$
9,500 semiannual payment
x 18.01704 (PV of annuity due 5% (.10 ÷ 2), 40 periods)
$ 171,162
Vendor C:
$
1,000
x 3.79079 (PV of ordinary annuity of 5 periods, 10%)
$
3,791 PV of first 5 years of maintenance
$
2,000 [PV of ordinary annuity 15 per., 10% (7.60608) –
x 3.81529
PV of ordinary annuity 5 per., 10% (3.79079)]
$
7,631 PV of next 10 years of maintenance
$
x
$
3,000 [(PV of ordinary annuity 20 per., 10% (8.51356) –
.90748
PV of ordinary annuity 15 per., 10% (7.60608)]
2,722 PV of last 5 years of maintenance
Total cost of press and maintenance Vendor C:
$ 150,000 cash purchase price
3,791 maintenance years 1–5
7,631 maintenance years 6–15
2,722 maintenance years 16–20
$ 164,144
The press should be purchased from Vendor C, since the present value of
the cash outflows for this option is the lowest of the three options.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.9
(a)
Time diagram for the first ten payments:
i = 10%
PV–AD = ?
R=
$800,000 $800,000 $800,000 $800,000
0
1
2
$800,000 $800,000 $800,000
3
7
8
9
10
n = 10
Formula for the first ten payments:
PV–AD = R (PVF–ADn, i)
PV–AD = $800,000 (PVF–AD10, 10%)
PV–AD = $800,000 (6.75902)
PV–AD = $5,407,216a
Formula for the last ten payments:
or
PV–OA = R (PVF–OAn, i)
PV–AD = R (PVF–ADn, i)
PV–OA = $400,000 (PVF–OA19 – 9, 10%)
PV–AD = $400,000 (PVF–OA20 – 10, 10%)
PV–OA = $400,000 (8.36492 – 5.75902)
PV–AD = $400,000 (9.36492 – 6.75902)
PV–OA = $400,000 (2.6059)
PV–AD = $400,000 (2.6059)
PV–OA = $1,042,360b
PV–AD = $1,042,360
a
The present value of an ordinary annuity is used here, not the
present value of an annuity due.
Problem 5.9 (Continued)
The total cost for leasing the facilities is:
$5,407,216a + $1,042,360b = $6,449,576.
OR
Time diagram for the last ten payments:
i = 10%
PV = ?
0
R=
1
2
$400,000
9
FVF x (PVFn, i)
10
R x (PVF–OAn, i)
Formulas for the last ten payments:
(i)
Present value of the last ten payments:
PV–OA = R (PVF–OAn, i)
PV–OA = $400,000 (PVF–OA10, 10%)
PV–OA = $400,000 (6.14457)
PV–OA = $2,457,828
$400,000 $400,000 $400,000
17
18
19
Problem 5.9 (Continued)
(ii) Present value of the last ten payments at the beginning of current
year:
PV = FV (PVFn, i)
PV = $2,457,828 (PVF9, 10%)
PV = $2,457,828 (.42410)
PV = $1,042,365*
*$5 difference due to rounding.
Cost for leasing the facilities $5,407,216 + $1,042,365 = $6,449,581
Since the present value of the cost for leasing the facilities,
$6,449,576, is less than the cost for purchasing the facilities,
$7,200,000, McDowell Enterprises made the correct decision to
lease the facilities.
(b)
Time diagram:
i = 11%
PV–OA = ?
R=
$15,000 $15,000 $15,000
0
1
2
3
$15,000 $15,000 $15,000 $15,000
6
n=9
7
8
9
Problem 5.9 (Continued)
Formula: PV–OA = R (PVF–OAn, i)
PV–OA = $15,000 (PVF–OA9, 11%)
PV–OA = $15,000 (5.53705)
PV–OA = $83,056
The fair value of the note is $83,056.
(c)
Time diagram:
Amount paid =
$792,000
0
10
30
Amount paid =
$800,000
Cash discount = $800,000 x .01 = $8,000
Net payment = $800,000 – $8,000 = $792,000
If the company decides not to take the cash discount, then the company
can use the $792,000 for an additional 20 days. The implied interest
rate for postponing the payment can be calculated as follows:
(i)
Implied interest for the period from the end of the discount period
to the due date:
Cash discount lost if not paid within the discount period
Net payment being postponed
= $8,000/$792,000
= 0.01010
Problem 5.9 (Continued)
(ii) Convert the implied interest rate to annual basis:
Daily interest = 0.010101/20 = 0.00051
Annual interest = 0.00051 x 365 = 18.62%
Since McDowell’s cost of funds, 10%, is less than the implied
interest rate for cash discount, 18.62%, it should continue the
policy of taking the cash discount.
LO: 2, 4, Bloom: AP, Difficulty: Complex, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.10
1.
Purchase.
Time diagrams:
Installments
i = 10%
PV–OA = ?
R=
$350,000
$350,000
$350,000
$350,000
$350,000
1
2
3
n=5
4
5
0
Property taxes and other costs
i = 10%
PV–OA = ?
R=
$56,000 $56,000
0
1
2
$56,000
9
n = 12
$56,000 $56,000 $56,000
10
11
12
Problem 5.10 (Continued)
Insurance
i = 10%
PV–AD = ?
R=
$27,000 $27,000 $27,000
0
1
$27,000 $27,000 $27,000
2
9
10
11
12
n = 12
Salvage Value
i = 10%
PV = ?
0
FV = $500,000
1
2
9
n = 12
Formula for installments:
PV–OA = R (PVF–OAn, i)
PV–OA = $350,000 (PVF–OA5, 10%)
PV–OA = $350,000 (3.79079)
PV–OA = $1,326,777
10
11
12
Problem 5.10 (Continued)
Formula for property taxes and other costs:
PV–OA = R (PVF–OAn, i)
PV–OA = $56,000 (PVF–OA12, 10%)
PV–OA = $56,000 (6.81369)
PV–OA = $381,567
Formula for insurance:
PV–AD = R (PVF–ADn, i)
PV–AD = $27,000 (PVF–AD12, 10%)
PV–AD = $27,000 (7.49506)
PV–AD = $202,367
Formula for salvage value:
PV = FV (PVFn, i)
PV = $500,000 (PVF12, 10%)
PV = $500,000 (0.31863)
PV = $159,315
Problem 5.10 (Continued)
Present value of net purchase costs:
Down payment........................................................
Installments ............................................................
Property taxes and other costs .............................
Insurance ................................................................
Total costs ..............................................................
Less: Salvage value ..............................................
Net costs .................................................................
2.
$ 400,000
1,326,777
381,567
202,367
2,310,711
159,315
$2,151,396
Lease.
Time diagrams:
Lease payments
i = 10%
PV–AD = ?
R=
$270,000 $270,000 $270,000
0
1
2
$270,000 $270,000
10
11
12
n = 12
Interest lost on the deposit
i = 10%
PV–OA = ?
R=
$10,000 $10,000
0
1
2
$10,000 $10,000 $10,000
10
n = 12
11
12
Problem 5.10 (Continued)
Formula for lease payments:
PV–AD = R (PVF–ADn, i)
PV–AD = $270,000 (PVF–AD12, 10%)
PV–AD = $270,000 (7.49506)
PV–AD = $2,023,666
Formula for interest lost on the deposit:
Interest lost on the deposit per year = $100,000 (10%) = $10,000
PV–OA = R (PVF–OAn, i)
PV–OA = $10,000 (PVF–OA12, 10%)
PV–OA = $10,000 (6.81369)
PV–OA = $68,137*
Cost for leasing the facilities = $2,023,666 + $68,137 = $2,091,803
Dunn Inc. should lease the facilities because the present value of the
costs for leasing the facilities, $2,091,803, is less than the present
value of the costs for purchasing the facilities, $2,151,396.
*OR: $100,000 – ($100,000 X .31863a) = $68,137
a
[PV12, 10%]
LO: 2, 4, Bloom: AP, Difficulty: Complex, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.11
(a)
Annual retirement benefits.
Jean–current salary
$ 48,000
x 2.56330 (future value of 1, 24 periods, 4%)
123,038 annual salary during last year of
work
x
.50 retirement benefit %
$ 61,519 annual retirement benefit
Colin–current salary
$ 36,000
x 3.11865 (future value of 1, 29 periods, 4%)
112,271 annual salary during last year of
work
x
.40 retirement benefit %
$ 44,908 annual retirement benefit
Anita–current salary
$ 18,000
x 2.10685 (future value of 1, 19 periods, 4%)
37,923 annual salary during last year of
work
x
.40 retirement benefit %
$ 15,169 annual retirement benefit
Gavin–current salary
$ 15,000
x 1.73168 (future value of 1, 14 periods, 4%)
25,975 annual salary during last year of
work
x
.40 retirement benefit %
$ 10,390 annual retirement benefit
Problem 5.11 (Continued)
(b)
Fund requirements after 15 years of deposits at 12%.
Jean will retire 10 years after deposits stop.
$ 61,519 annual plan benefit
[PV of an annuity due for 30 periods – PV of an
x 2.69356 annuity due for 10 periods (9.02181 – 6.32825)]
$ 165,705
Colin will retire 15 years after deposits stop.
$ 44,908 annual plan benefit
x 1.52839 [PV of an annuity due for 35 periods – PV of an annuity
due for 15 periods (9.15656 – 7.62817)]
$ 68,637
Anita will retire 5 years after deposits stop.
$ 15,169 annual plan benefit
x 4.74697 [PV of an annuity due for 25 periods – PV of an annuity
due for 5 periods (8.78432 – 4.03735)]
$ 72,007
Gavin will retire the same day after deposits stop.
$ 10,390 annual plan benefit
x 8.36578 (PV of an annuity due for 20 periods)
$ 86,920
Problem 5.11 (Continued)
$165,705 Jean
68,637 Colin
72,007 Anita
86,920 Gavin
$393,269 Required fund balance at the end of the 15 years of
deposits.
(c)
Required annual beginning-of-the-year deposits at 12%:
Deposit x (future value of an annuity due for 15 periods at 12%) = FV
Deposit x (37.27972 x 1.12) = $393,269
Deposit = $393,269 ÷ 41.75329
Deposit = $9,419.
LO: 5, Bloom: AP, Difficulty: Complex, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.12
(a)
The time value of money would suggest that NET Life’s discount rate
was substantially higher than First Security’s. The actuaries at NET Life
are making different assumptions about inflation, employee turnover,
life expectancy of the workforce, future salary, and wage levels, return
on pension fund assets, etc. NET Life may operate at lower gross and
net margins and it may provide fewer services.
(b)
As the controller of STL, Brokaw assumes a fiduciary role to the
present and future retirees of the corporation. As a result, he is
responsible for ensuring that the pension assets are adequately
funded and are adequately protected from most controllable risks. At
the same time, Brokaw is responsible for the financial condition of
STL. In other words, he is obligated to find ethical ways of increasing
the profits of STL, even if it means switching pension funds to a less
costly plan. At times, Brokaw’s responsibility to retirees and his
efforts to increase short-term profitability can be in conflict,
especially if Brokaw is a member of a professional group such as
CPAs or CMAs.
(c)
If STL switched to NET Life
The primary beneficiaries of Brokaw’s decision would be the corporation
and its many stockholders by virtue of reducing 8 million dollars of
annual pension costs.
The present and future retirees of STL may be negatively affected by
Brokaw’s decision because the chance of losing a future benefit may
be increased by virtue of higher risks (as reflected in the discount rate
and NET Life’s weaker reputation). The corporation and its
shareholders could ultimately be hurt too. This is a short-term versus
long-term perspective problem.
Problem 5.12 (Continued)
If STL stayed with First Security
In the short run, the primary beneficiaries of Brokaw’s decision would
be the employees and retirees of STL given the lower risk pension
asset plan.
STL and its many stakeholders could be negatively affected by Brokaw’s
decision to stay with First Security because of the company’s inability
to trim 8 million dollars from its operating expenses. Then again,
damage STL’s reputation and its future liability to make up shortfalls
in its pension plan could ultimately hurt shareholders too.
LO: 5, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, Communication, Ethics, AICPA BB: None, AICPA AC: Measurement, Analysis,
AICPA PC: Communication, Professional Demeanor
Problem 5.13
Cash Flow Probability
Estimate x Assessment = Expected Cash Flow
2026 $2,500
20%
$ 500
4,000
60%
2,400
5,000
20%
1,000
x PV
Factor,
n = 1, I = 5% Present Value
$3,900 x 0.95238 =
$ 3,714
2027
2028
$3,000
5,000
6,000
30%
50%
20%
$ 900
2,500
1,200
$4,000
6,000
7,000
30%
40%
30%
$1,200
2,400
2,100
x PV
Factor,
n = 2, I = 5% Present Value
$4,600 x 0.90703 =
$ 4,172
x PV
Factor,
n = 3, I = 5% Present Value
$5,700 x 0.86384 =
$ 4,924
Total Estimated Liability
$12,810
LO: 4, 5, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.14
Cash Flow Probability
Estimate x Assessment = Expected Cash Flow
2026 $6,000
40%
$2,400
9,000
60%
5,400
x PV
Factor,
n = 1, I = 6% Present Value
$7,800 x 0.94340 =
$ 7,359
2027
$ (500)
2,000
4,000
Scrap
Value
Received
at the End
of 2027
$
500
900
20%
60%
20%
$ (100)
1,200
800
50%
50%
$ 250
450
x PV
Factor,
n = 2, I = 6% Present Value
$1,900 x 0.89000
=
$ 1,691
x PV
Factor,
n = 2, I = 6% Present Value
$ 700 x 0.89000 =
$ 623
Estimated Fair Value
$9,673
LO: 4, 5, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: None
Problem 5.15
(a)
The expected cash flows to meet the asset retirement obligation represent a deferred annuity. Developing a fair value estimate requires
determining the present value of the annuity of expected cash flows
to be paid in three years and then determine the present value of that
amount today.
Cash Flow
Estimate x
$15,000
22,000
25,000
30,000
Probability
Assessment = Expected Cash Flow
10%
$ 1,500
30%
6,600
50%
12,500
10%
3,000 x PV-OA
Factor,
n = 3, I = 5% Present Value
(deferred 10 yrs)
$23,600 x 2.72325 = $64,269
The value today of the annuity payments to commence in ten years is:
$ 64,269 Present value of annuity
x .61391 PV of a lump sum to be paid in 10 periods.
$ 39,455
Alternatively, the present value of the deferred annuity can be computed
as follows:
$ 23,600 Expected cash outflows
x 1.67184 [PV of an ordinary annuity for 13 periods – PV of an
ordinary annuity for 10 periods (9.39357 – 7.72173)]
$ 39,455
(b)
This fair value estimate is based on unobservable inputs—Murphy’s
own data on the expected future cash flows associated with the
obligation to restore the site. This fair value estimate is considered
Level 3, as discussed in Chapter 1.
LO: 5, Bloom: AP, Difficulty: Complex, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: Communication
*Problem 5.16
a) The future value is $190,193.49.
Excel solution:
Calculator solution:
b) The future value is $193,575.74.
Excel solution:
Calculator Solution:
c) The present value is $331,505.45.
Excel solution:
Calculator solution:
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA AC: Measurement, Analysis, AICPA PC: Communication
UYJ 5.1 Financial Reporting Problem
(a)
1.
Long-lived assets, goodwill
For impairment of goodwill and long-lived assets, fair value is determined using a discounted cash flow analysis.
(b)
2.
Short-term and long-term debt
3.
Postretirement benefit plans
4.
Employee stock ownership plans
(1) The following rates are disclosed in the accompanying notes:
Debt
Weighted-Average Effective Interest Rate
At December 31
Short-Term
Long-Term
2020
.70%
2.3%
2019
.50%
2.4%
Financial Reporting Problem (Continued)
Benefit Plans
Pension Benefits
United States
2020
2019
Assumptions used to
determine net periodic
benefit cost.
Discount rate
Expected return on assets
1.5%
6.6%
1.9%
6.6%
Stock-Based Compensation
Assumptions
Weighted average interest rate
used in Stock Option Valuation
2020
1.3%
Other Retiree
Benefits
2020
2019
3.1%
8.4%
3.7%
8.3%
2019
2.6%
(2) There are different rates for various reasons:
1. The maturity dates—short-term vs. long-term.
2. The security or lack of security for debts—mortgages and collateral vs. unsecured loans.
3. Fixed rates and variable rates.
4. Issuances of securities at different dates when differing market
rates were in effect.
5. Different risks involved or assumed.
6. Foreign currency differences—some investments and
payables are denominated in different currencies.
LO: 1, 5, Bloom: AN, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, Research, AICPA PC: Communication
UYJ 5.2 Financial Statement Analysis Case
(a)
(b)
(c)
Cash inflows of $375,000 less cash outflows of $125,000 = Net cash
flows of $250,000.
$250,000 x 2.48685* = $621,713
*(PVF–OA3, 10%)
Cash inflows of $275,000 less cash outflows of $155,000 = Net cash
flows of $120,000.
$120,000 x 2.48685* = $298,422
*(PVF–OA3,10%)
The estimate of future cash flows is very useful. It provides an understanding of whether the value of gas and oil properties is increasing
or decreasing from year to year. Although it is an estimate, it does
provide an understanding of the direction of change in value. Also, it
can provide useful information to record a write-down of the assets.
LO: 1, 4, 5, Bloom: SYN, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA AC: Reporting, AICPA PC: Communication
UYJ 5.3 Accounting, Analysis, and Principles
Accounting
(a)
The present value of the note is presumably equal to the fair value of
the inventory. The note has 20 semi-annual periods to maturity.
$679,517 = $50,000 x PVF-OA20,i
PVF-OA20,i = $679,517 ÷ $50,000
PVF-OA20,i = 13.59034
Searching across the interest rate columns on the 20-period row
reveals that the interest rate is 4% semi-annually or 8 percent annually.
(b)
Johnson should initially record the note at its fair value, $679,517.
Analysis
If interest rates increase, the fair value of the note will decline. This is
because the remaining cash flows are being discounted at a higher rate.
That is, the present value of the future cash flows is less at a higher
discount rate.
Principles
Fair value versus historical cost potentially involves a trade-off between
the primary qualities of relevance and faithful representation. The fair
values of various assets (and liabilities) is potentially more relevant to
financial statement readers. However, it is often a more subjective measure
than historical cost. Thus, fair value may not be as neutral and as free from
error as historical cost. Fair value is more subjective because it often must
be estimated, requiring assumptions about discount rates and, as later
chapters illustrate, about the amounts and timing of future cash flows.
LO: 1, 4, 5, Bloom: SYN, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, Communication, AICPA BB: None, AICPA AC: Reporting, AICPA PC:
Communication
Codification Exercises
CE5.1
(a) According to the Master Glossary, present value is a tool used to link uncertain future amounts
(cash flows or values) to a present amount using a discount rate (an application of the income
approach). Present value techniques differ in how they adjust for risk and in the type of cash flows
they use.
(b) The discount rate adjustment technique is a present value technique that uses a risk-adjusted
discount rate and contractual, promised, or most likely cash flows.
LO: 1, Bloom: K, Difficulty: Moderate, Time: 10-15, AACSB: Knowledge, Communication, Technology, AICPA BB: None, AICPA AC: Research, Technology &
Tools, AICPA PC: Communication
CE5.2
(a) See 350 Intangibles—Goodwill and Other > 20 Goodwill > 50 Disclosure > Goodwill Impairment
Loss > Information for Each Period for Which a Statement of Financial Position Is Presented
> Goodwill Impairment Loss
50-2 For each goodwill impairment loss recognized, all of the following information shall be disclosed in the notes to the financial statements that include the period in which the impairment loss is recognized:
a. A description of the facts and circumstances leading to the impairment.
b. The amount of the impairment loss and the method of determining the fair value of the
associated reporting unit (whether based on quoted market prices, prices of comparable
businesses, a present value or other valuation technique, or a combination thereof).
c. If a recognized impairment loss is an estimate that has not yet been finalized (see
paragraphs 350-20-35-18 through 19), that fact and the reasons therefore and, in subsequent periods, the nature and amount of any significant adjustments made to the initial
estimate of the impairment loss.
LO: 1, 5, Bloom: K, Difficulty: Moderate, Time: 20-25, AACSB: Knowledge, Communication, Technology, AICPA BB: None, AICPA AC: Research, Technology &
Tools, AICPA PC: Communication
CE5.3
Interest cost includes interest recognized on obligations having explicit interest rates, interest imputed
on certain types of payables in accordance with Subtopic 835-30, and interest related to a capital lease
determined in accordance with Subtopic 840-30. With respect to obligations having explicit interest
rates, interest cost includes amounts resulting from periodic amortization of discount or premium and
issue costs on debt.
According to the discussion at 835 Interest> 30 Imputation of Interest
05-1
This Subtopic addresses the imputation of interest.
05-2
Business transactions often involve the exchange of cash or property, goods, or services for a
note or similar instrument. When a note is exchanged for property, goods, or services in a
bargained transaction entered into at arm’s length, there should be a general presumption that
the rate of interest stipulated by the parties to the transaction represents fair and adequate
compensation to the supplier for the use of the related funds. That presumption, however, must
not permit the form of the transaction to prevail over its economic substance and thus would not
apply if interest is not stated, the stated interest rate is unreasonable, or the stated face amount
of the note is materially different from the current cash sales price for the same or similar items
or from the value of the note at the date of the transaction. The use of an interest rate that varies
from prevailing interest rates warrants evaluation of whether the face amount and
the stated interest rate of a note or obligation provide reliable evidence for properly recording the
exchange and subsequent related interest.
05-3
This Subtopic provides guidance for the appropriate accounting when the face amount of a note
does not reasonably represent the present value of the consideration given or received in the
exchange. This circumstance may arise if the note is non-interest-bearing or has a stated
interest rate that is different from the rate of interest appropriate for the debt at the date of the
transaction. Unless the note is recorded at its present value in this circumstance, the sales price
and profit to a seller in the year of the transaction and the purchase price and cost to the buyer
are misstated, and interest income and interest expense in subsequent periods are also
misstated.
LO: 1, 5, Bloom: K, Difficulty: Simple, Time: 10-15, AACSB: Knowledge, Communication, Technology, AICPA BB: None, AICPA AC: Research, Technology &
Tools, AICPA PC: Communication
Codification Research Case
Search strings: “present value”, present and value, Present value $, “best
estimate”, “estimated cash flow”, “expected cash flow”, “fresh-start
measurement”, “interest methods of allocation”
(a) Statement of Financial Accounting Concepts No. 7, “Using Cash Flow
Information and Present Value in Accounting Measurements (FASB
2000).
(b) See Appendix B: APPLICATIONS OF PRESENT VALUE IN FASB
STATEMENTS AND APB OPINIONS, CON7, Par. 119
119. . . . The accompanying table is presented to assist readers in
understanding the differences between the conclusions reached in this
Statement and those found in FASB Statements and APB Opinions that
employ present value techniques in recognition, measurement, or
amortization (period-to-period allocation) of assets and liabilities in the
statement of financial position.
Some examples are:
• Debt payable and related premium or discount
• Asset acquired by incurring liabilities in a business combination—“An
asset acquired by incurring liabilities is recorded at cost—that is, at
the present value of the amounts to be paid” (paragraph 67(b)).
• Interest on Receivables and Payables—Note exchanged for
property, goods, or services.
• Capital lease or operating lease— . . . The lessee’s incremental
borrowing rate is used unless (a) the lessor’s implicit rate can be
determined and (b) the implicit rate is less than the incremental
borrowing rate.
• Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Lease . . .
Origination fees and costs are reflected over the life of the loan as
an adjustment of the yield on the net investment in the loan.
Codification Research Case (Continued)
• Employers’ Accounting for Postretirement Benefits Other Than
Pensions . . . Effective settlement rate—“. . . as opposed to ‘settling’
the obligation, which incorporates the insurer’s risk factor,
‘effectively settling’ the obligation focuses only on the time value of
money and ignores the insurer’s cost for assuming the risk of
experience losses” (paragraph 188).
• Accounting for the Impairment of Long-Lived Assets and for LongLived Assets to Be Disposed Of . . . The objective is to estimate the
fair value of the impaired asset. . . .
(c) 1. CON7, Glossary of terms: Best estimate: The single most-likely
amount in a range of possible estimated amounts; in statistics, the
estimated mode. In the past, accounting pronouncements have used
the term best estimate in a variety of contexts that range in meaning
from “unbiased” to “most likely.” This Statement uses best estimate
in the latter meaning, as distinguished from the expected amounts
described below.
2. CON7, Glossary of terms: Estimated Cash Flow and Expected Cash
Flow: In the past, accounting pronouncements have used the terms
estimated cash flow and expected cash flow interchangeably. In this
Statement: Estimated cash flow refers to a single amount to be
received or paid in the future. Expected cash flow refers to the sum
of probability-weighted amounts in a range of possible estimated
amounts; the estimated mean or average.
3. CON7, Glossary of terms: Fresh-Start Measurements: Measurements
in periods following initial recognition that establishes a new
carrying amount unrelated to previous amounts and accounting
conventions. Some fresh-start measurements are used every period,
as in the reporting of some marketable securities at fair value under
FASB Statement No.115, Accounting for Certain Investments in Debt
and Equity Securities. In other situations, fresh-start measurements
are prompted by an exception or “trigger,” as in a remeasurement of
assets under FASB Statement No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be
Disposed Of.
Codification Research Case (Continued)
4. CON7, Glossary of terms: Interest Methods of Allocation: Reporting
conventions that use present value techniques in the absence of a
fresh-start measurement to compute changes in the carrying amount
of an asset or liability from one period to the next. Like depreciation
and amortization conventions, interest methods are grounded in
notions of historical cost. The term interest methods of allocation
refers both to the convention for periodic reporting and to the
several approaches to dealing with changes in estimated future cash
flows.
Note to instructor: The concepts statements are not in the codification.
Thus, the references to previous FASB standards
above do not have codification sections indicated.
A good extension of this research case would have
students track down codification references for the
items above.
LO: 1, 5, Bloom: K, Difficulty: Simple, Time: 25-30, AACSB: Knowledge, Communication, Technology, AICPA BB: None, AICPA AC: Reporting,
Research, Technology & Tools, AICPA PC: Communication
CHAPTER 6
Cash and Receivables
Assignment Classification Table (By Topic)
Topics
Questions
1.
Accounting for cash.
2.
Brief
Exercises
Critical
Thinking
Exercises
Problems
1, 2, 3, 4, 22, 1
23
1, 2
1
Accounting for
accounts receivable,
bad debts, other
allowances.
5, 6, 7, 8, 9,
10, 11, 12,
13, 14
2, 3, 4, 5, 6
3, 4, 5, 6,
7, 8, 9, 10,
11, 12, 16
2, 3, 4,
5, 6
1, 2, 3, 4,
9, 10
3.
Accounting for notes
receivable.
15, 16
7, 8
13, 14
7, 8, 9
2, 4, 5, 6, 7,
8
4.
Assignment and
factoring of accounts
receivable.
17, 18, 19
9, 10, 11,
12, 13
12, 15, 16,
17, 18, 19,
21
10, 11
2, 5, 7
5.
Analysis of
receivables.
20, 21
14
20, 21
*6.
Petty cash and bank
reconciliations.
23
15, 16, 17
22, 23,
24, 25
12, 13, 14
*7.
Allowance estimate
using expected cash
flow.
24, 25
18
26, 27
15
*This material is covered in an Appendix to the chapter.
Assignment Classification Table (By Learning Objective)
Learning Objectives
Questions
Brief
Exercises
Exercises
Problems
Critical
Thinking
1.
Indicate how to report
cash and related items.
1, 2, 3, 4,
22
1
1, 2
1
2.
Define receivables and
explain accounting issues
related to their recognition.
5, 6
2, 3, 4
3, 4, 5, 6,
12, 16
6
2, 4, 9
3.
Explain accounting issues
related to valuation of
accounts receivable.
7, 8, 9, 10,
11, 12, 13,
14
5, 6
7, 8, 9, 10,
11, 12, 16
2, 3, 4, 5,
6
1, 3, 9, 10
4.
Explain accounting issues
related to recognition and
valuation of notes
receivable.
15, 16
7, 8
13, 14
7, 8, 9
4, 6, 7, 8
5.
Explain additional
accounting issues related
to accounts and notes
receivable.
17, 18, 19,
20, 21
9, 10, 11,
12, 13, 14
12, 14, 15,
16, 17, 18,
19, 20, 21
10, 11
2, 5, 7
*6.
Explain common
techniques employed to
control cash.
23
15, 16, 17
22, 23, 24,
25
12, 13, 14
*7.
Describe the estimation of
the allowance based on
expected cash flows.
24, 25
18
26, 27
15
Assignment Characteristics Table
Item
Description
Level of
Difficulty
Time
(minutes)
E6.1
E6.2
E6.3
E6.4
E6.5
E6.6
E6.7
E6.8
E6.9
E6.10
E6.11
E6.12
E6.13
E6.14
E6.15
E6.16
E6.17
E6.18
E6.19
E6.20
E6.21
*E6.22
*E6.23
*E6.24
*E6.25
*E6.26
*E6.27
Determining cash balance.
Determining cash balance.
Financial statement presentation of receivables.
Determining ending accounts receivable.
Recording sales gross and net.
Recording sales transactions.
Recording bad debts.
Recording bad debts.
Computing bad debts and preparing journal entries.
Bad-debt reporting.
Bad debts—aging.
Journalizing various receivable transactions.
Note transactions at unrealistic interest rates.
Notes receivable with unrealistic interest rate.
Assigning accounts receivable.
Journalizing various receivable transactions.
Transfer of receivables with recourse.
Transfer of receivables with recourse.
Transfer of receivables without recourse.
Analysis of receivables.
Transfer of receivables.
Petty cash.
Petty cash.
Bank reconciliation and adjusting entries.
Bank reconciliation and adjusting entries.
Expected cash flows.
Expected cash flows.
Moderate
Moderate
Moderate
Simple
Simple
Moderate
Moderate
Simple
Simple
Simple
Simple
Simple
Simple
Moderate
Simple
Simple
Simple
Moderate
Simple
Moderate
Moderate
Simple
Simple
Moderate
Simple
Moderate
Moderate
10–15
10–15
10–15
10–15
15–20
5–10
10–15
5–10
8–10
10–12
8–10
15–20
10–15
20–25
10–15
15–18
10–15
15–20
10–15
10–15
10–15
5–10
10–15
15–20
15–20
15–25
15–25
P6.1
P6.2
P6.3
P6.4
P6.5
P6.6
P6.7
P6.8
P6.9
P6.10
P6.11
*P6.12
*P6.13
*P6.14
*P6.15
Determine proper cash balance.
Bad-debt reporting.
Bad-debt reporting—aging.
Bad-debt reporting.
Bad-debt reporting.
Journalize various accounts receivable transactions.
Notes receivable with realistic interest rate.
Notes receivable journal entries.
Comprehensive receivables problem.
Assigned accounts receivable—journal entries.
Income effects of receivables transactions.
Petty cash, bank reconciliation.
Bank reconciliation and adjusting entries.
Bank reconciliation and adjusting entries.
Expected cash flows.
Simple
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Complex
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
20–25
20–25
20–30
25–35
20–30
25–35
30–35
30–35
40–50
25–30
20–25
20–25
20–30
20–30
30–40
Assignment Characteristics Table (Continued)
Item
Description
CT6.1
CT6.2
CT6.3
CT6.4
CT6.5
CT6.6
CT6.7
Bad-debt accounting.
Various receivable accounting issues.
Bad-debt reporting issues.
Basic note and accounts receivable transactions.
Sale of notes receivable.
Zero-interest-bearing note receivable.
Reporting of notes receivable, interest, and sale
of receivables.
Accounting for zero-interest-bearing note.
Receivables management.
Bad-debt reporting, ethics.
CT6.8
CT6.9
CT6.10
Level of
Difficulty
Time
(minutes)
Simple
Simple
Moderate
Moderate
Moderate
Moderate
Moderate
10–15
15–20
25–30
25–30
20–25
20–30
25–30
Moderate
Moderate
Moderate
25–30
25–30
25–30
Answers to Questions
1. Cash normally consists of coins and currency on hand, bank deposits, and various kinds of orders
for cash such as bank checks, money orders, travelers’ checks, demand bills of exchange, bank
drafts, and cashiers’ checks. Balances on deposit in banks that are subject to immediate withdrawal
are properly included in cash. Money market funds that provide checking account privileges may be
classified as cash. There is some question as to whether deposits not subject to immediate
withdrawal are properly included in cash or whether they should be set out separately. Savings
accounts, certificates of deposit, and time deposits fall in this latter category. Unless restrictions on
these kinds of deposits are such that they cannot be converted (withdrawn) within one year or the
operating cycle of the entity, whichever is longer, they are properly classified as current assets. At
the same time, they may well be presented separately from other cash and the restrictions as to
convertibility reported.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
2. (a) Cash.
(b) Investments.
(c) Temporary investments.
(d) Accounts receivable.
(e) Accounts receivable, a loss if uncollectible.
(f) Other assets if not expendable, cash if expendable for goods and services in the foreign country.
(g) Receivable if collection expected within one
year; otherwise, other asset.
(h) Investments, possibly other assets.
(i) Cash.
(j) Trading securities.
(k) Cash.
(l) Cash.
(m) Postage expense, or prepaid expense, or supplies inventory.
(n) Receivable from employee if the
company is to be reimbursed;
otherwise, prepaid expense.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
3. A compensating balance is that portion of any demand deposit maintained by a corporation that
constitutes support for existing borrowing arrangements of a corporation with a lending institution.
A compensating balance representing a legally restricted deposit held against short-term borrowing
arrangements should be stated separately among the cash and cash equivalent items. A restricted
deposit held as a compensating balance against long-term borrowing arrangements should be
separately classified as a noncurrent asset in either the investments or other assets section.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
4. Restricted cash for debt redemption would be reported in the long-term asset section, probably in
the investments section. Another alternative is the other assets section. Given that the debt is longterm, the restricted cash should also be reported as long-term.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
5. The seller normally uses trade discounts to avoid frequent changes in its catalogs, to quote different
prices for different quantities purchased, and to hide the true invoice price from competitors. Trade
discounts are not recorded in the accounts because the price finally quoted is generally an accurate
statement of the fair market value of the product on that date. In addition, no subsequent changes
can occur to affect this value from an accounting standpoint. With a cash discount, the buyer receives
a choice, and events after the original transaction dictate that additional entries may be needed.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Questions Chapter 6 (Continued)
6. Two methods of recording accounts receivable are:
1. Record receivables and sales gross (without regard to discount).
2. Record receivables and sales net of discount.
The net method is desirable from a theoretical standpoint because it values the receivable at its net
realizable value. In addition, recording the sales at net provides a better assessment of the revenue
that was recognized from the sale of the product. If the purchasing company fails to take the discount,
then the company should reflect this amount as income. The gross method for receivables and sales
is used in practice normally because it is expedient, and its use does not generally have any
significant effect on the presentation of the financial statements.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
7.
When companies sell a product with a sales allowance for possible dissatisfaction or other issues,
they should record the accounts receivable and related revenue at the amount of consideration
expected to be received. The use of a Sales Returns and Allowances account is helpful to
management because it highlights the problems associated with inferior merchandise, inefficiencies
in filling orders, or delivery or shipment mistakes. Thus, since management must estimate expected
allowances to be granted in the future, which affects the final transaction price, sales allowances
result in variable consideration.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
8. The basic problems that relate to the valuation of receivables are (1) the determination of the face
value of the receivable, (2) the probability of future collection of the receivable, and (3) the length of
time the receivable will be outstanding. The determination of the face value of the receivable is a
function of the trade discount, cash discount, and certain allowance accounts such as the Allowance
for Sales Returns and Allowances.
LO: 3, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
9. The theoretical superiority of the allowance method over the direct write-off method of accounting
for bad debts is two-fold. First, since revenue is considered to be recognized at the point of sale on
the assumption that the resulting receivables are valid liquid assets merely awaiting collection, periodic
income will be overstated to the extent of any receivables that eventually become uncollectible. The
proper matching of revenue and expense requires that gross sales in the income statement be
partially offset by a charge to bad debt expense that is based on an estimate of the receivables
arising from gross sales that will not be converted into cash.
Second, accounts receivable on the balance sheet should be stated at the net amount expected to
be collected. The allowance method accomplishes this by deducting from gross receivables the
allowance for doubtful accounts. The latter is derived from the charges for bad debt expense on the
income statement.
LO: 3, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
10. The percentage of receivables method based on an aging schedule calculates each year’s debit to
the expense account and credit to the allowance account by evaluating the collectibility of open
accounts receivable at the close of the year. An analysis of the accounts according to their due dates
is a common procedure. For each of the age categories established in the analysis, average
percentage rates may be developed based on past experience and applied to the accounts in the
respective age categories. This method may also utilize individual analysis for some accounts,
especially those that are considerably past due, in arriving at estimated uncollectible receivables.
Based on the foregoing analysis, the balance in the valuation account is then adjusted to the amount
estimated to be uncollectible.
Questions Chapter 6 (Continued)
This method of providing for uncollectible accounts is quite accurate for purposes of reporting
accounts receivable at the net amount expected to be collected in the balance sheet. From the
standpoint of the income statement, however, the aging method may not match accurately bad debt
expenses with the sales which caused them because the charge to bad debt expense is not based
on sales. The accuracy of both the charge to bad debt expense and the reported value of receivables
depends on the current estimate of uncollectible accounts. The accuracy of the expense charge,
however, is additionally dependent upon the timing of actual write-offs.
Other methods that companies may use employ estimates based on historical loss ratios for
customers with different credit ratings as a basis for estimating uncollectible accounts. Or, a
company may utilize a probability-weighted discounted cash flow model (as illustrated in Chapter 6)
to estimate expected credit losses.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
11. A major part of accounting is the measurement of financial data. Estimates of uncollectibility should
be recognized so that receivables are reported at the net amount expected to be collected and for
accounting to provide useful information on a periodic basis.
The very existence of accounts receivable is based on the decision that a credit sale is an objective
indication that revenue should be recognized. The alternative is to wait until the debt is paid in cash.
If revenue is to be recognized and an asset recorded at the time of a credit sale, the need for fairness
in the statements requires that both expenses and the asset be adjusted for the estimated amounts
of the asset that experience indicates will not be collected.
The argument may be persuasive that the evidence supporting write-offs permits a more accurate
decision than that which supports the allowance method. The latter method, however, is “objective” in
the sense in which accountants use the term and is justified by the need for fair presentation of
receivables and income. The direct write-off method is not wholly objective; it requires the use of
judgment in determining when an account has become uncollectible.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
12. The allowance method has three essential features:
1. Companies estimate uncollectible accounts receivable and compare the new estimate to
the current balance in the allowance account.
2. Companies debit estimated increases in uncollectibles to Bad Debt Expense and credit
them to Allowance for Doubtful Accounts, a contra asset account, through an adjusting
entry at the end of each period.
3. When companies write off a specific customer account, they debit actual uncollectibles to
Allowance for Doubtful Accounts and credit that amount to Accounts Receivable.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
13. The receivable due from Bernstein Company should be written off to an appropriately named loss
account and reported in the income statement as part of income from operations. In this case,
classification as an unusual item would seem appropriate. The loss may properly be reduced by the
portion of the allowance for doubtful accounts at the end of the preceding year that was allocable to
the Bernstein Company account.
Estimates for doubtful accounts are based on a firm’s prior bad debt experience with due consideration
given to changes in credit policy and forecasted general or industry business conditions.
The purpose of the allowance method is to anticipate only that amount of bad debt expense which
can be reasonably forecasted in the normal course of events.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Questions Chapter 6 (Continued)
14. If the direct write-off method is used, the only alternative is to debit Cash and credit a revenue
account entitled Uncollectible Amounts Recovered. If the allowance method is used, then the
accountant would debit Accounts Receivable and credit the Allowance for Doubtful Accounts. An
entry is then made to credit the customer’s account and debit Cash upon receipt of the remittance.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
15. The journal entry on Lombard’s books would be:
Notes Receivable .............................................................................
Discount on Notes Receivable ($1,000,000 - $640,000) .............
Sales Revenue............................................................................
1,000,000
360,000
640,000*
*Assumes that seller is a dealer in this property. If not, Land might be credited, and a loss on sale
of $50,000 would be recognized with a debit entry.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
16. Imputed interest is the interest ascribed or attributed to a situation or circumstance which is void of
a stated or otherwise appropriate interest factor. Imputed interest is the result of a process of interest
rate estimation called imputation.
An interest rate is imputed for notes receivable when (1) no interest rate is stated for the transaction,
or (2) the stated interest rate is unreasonable, or (3) the stated face amount of the note is materially
different from the current cash price for the same or similar items or from the current market value
of the debt instrument.
In imputing an appropriate interest rate, consideration should be given to the prevailing interest rates
for similar instruments of issuers with similar credit ratings, the collateral, and restrictive covenants.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
17. A company might sell receivables because money is tight and access to normal credit is not available
or prohibitively expensive. Also, a company may have to sell its receivables, instead of borrowing,
to avoid violating existing lending arrangements. In addition, billing and collection of receivables are
often time-consuming and costly.
LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
18. The financial components approach is used when receivables are sold but there is continuing
involvement by the seller in the receivable. Examples of continuing involvement are recourse
provisions or continuing rights to service the receivable. A transfer of receivables should be recorded
as a sale when the following three conditions are met:
(a) The transferred asset has been isolated from the transferor (put beyond reach of the transferor
and its creditors).
(b) The transferees have obtained the right to pledge or exchange either the transferred assets or
beneficial interests in the transferred assets.
(c) The transferor does not maintain effective control over the transferred assets through an
agreement to repurchase or redeem them before their maturity.
LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Questions Chapter 6 (Continued)
19. Recourse is a guarantee from Moon that if any of the sold receivables are uncollectible, Moon will
pay the factor for the amount of the uncollectible account. This recourse obligation represents
continuing involvement by Moon after the sale. Under the financial components model, the estimated fair value of the recourse obligation will be reported as a liability on Moon’s balance sheet.
LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
20. Several acceptable solutions are possible depending upon assumptions made as to whether certain
items are collectible within the operating cycle or not. The following illustrates one possibility:
Current Assets
Accounts receivable—Trade (of which accounts in the amount
of $75,000 has been assigned as security for loans payable)
($523,000 + $75,000) ........................................................................................
Federal income tax refund receivable ..................................................................
Advance payments on purchases ........................................................................
Non-Trade receivables
Advance to subsidiary .........................................................................................
Other Assets
Travel advance to employees ..............................................................................
Notes receivable past due plus accrued interest ..................................................
$598,000
15,500
61,000
45,500
22,000
47,000
LO: 5, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
21. The accounts receivable turnover is computed by dividing net sales by average net receivables
outstanding during the year. This ratio is used to assess the liquidity of the receivables. It measures
the number of times, on average, receivables are collected during the period. It provides some
indication of the quality of the receivables and how successful the company is in collecting its
outstanding receivables.
LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
22. Because the restricted cash cannot be used by Woodlawn to meet current obligations, it should not
be reported as a current asset—it should be reported in investments or other assets. Thus, although
this item has cash in its label, it should not be reflected in liquidity measures, such as the current or
acid-test ratios.
LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
*23. (1)
The general checking account is the principal bank account of most companies and frequently the only bank account of small companies. Most if not all transactions are cycled
through the general checking account, either directly or on an imprest basis.
(2)
Imprest bank accounts are used to disburse cash (checks) for a specific purpose, such as
dividends, payroll, commissions, or travel expenses. Money is deposited in the imprest fund
from the general fund in an amount necessary to cover a specific group of disbursements.
(3)
Lockbox accounts are local post office boxes to which a multi-location company instructs its
customers to mail remittances. A local bank is authorized to empty the box daily and credit the
company’s accounts for collections.
LO: 6, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Questions Chapter 6 (Continued)
*24. A loan is considered impaired when it is probable that the creditor will be unable to collect all
amounts due (both principal and interest) according to the contractual terms of the loan. If a loan is
considered impaired, the loss due to impairment should be measured as the difference between the
investment in the loan and the expected future cash flows discounted at the loan’s historical effective
interest rate. The loss is recorded on the books of the creditor. The debtor would not be aware of
the entry made by the creditor and would not make an entry until settlement or if a modification of
terms resulted.
LO: 7, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
*25. Companies commonly evaluate loans (long-term notes receivable) for collectibility based on an
analysis of the expected contractual cash flows. They then apply discounted expected cash flow
methods to measure the allowance to report the loan at the net amount expected to be collected.
The allowance for doubtful accounts and related bad debt expense on a loan or note receivable can
be estimated as the difference between the investment in the loan (generally the principal plus
accrued interest or amortized cost) and the expected future cash flows discounted at the loan’s
historical effective-interest rate.
LO: 7, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Solutions to Brief Exercises
Brief Exercise 6.1
Cash in bank—savings account ...............................
Cash on hand .............................................................
Checking account balance .......................................
Cash to be reported ...................................................
$68,000
9,300
17,000
$94,300
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.2
June 1
June 12
Accounts Receivable.........................
Sales Revenue ..........................
50,000
Cash ($50,000 - $1,500) .....................
Sales Discounts ($50,000 x .03) ........
Accounts Receivable ................
48,500
1,500
50,000
50,000
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.3
June 1
June 12
Accounts Receivable.........................
Sales Revenue ..........................
48,500*
Cash ...................................................
Accounts Receivable ................
48,500
48,500
48,500
*[$50,000 – ($50,000 X .03)] = $48,500
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.4
(a)
Accounts Receivable...........................
Sales Revenue ............................
9,000
9,000
Brief Exercise 6.4 (Continued)
(b)
(c)
Sales Returns and Allowances .........
Accounts Receivable ................
700
Sales Returns and Allowances .........
Refund Liability ........................
200
700
200
LO: 2, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.5
Bad Debt Expense ....................................................
Allowance for Doubtful Accounts ..................
17,600
17,600
[($250,000 X .08) – $2,400]
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.6
(a)
(b)
Bad Debt Expense .........................................
Allowance for Doubtful Accounts
[(.10 X $250,000) + $1,900] ................
26,900
Bad Debt Expense .........................................
Allowance for Doubtful Accounts
($24,600 – $2,400) ..............................
22,200
26,900
22,200
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.7
11/1/25
Notes Receivable ..................................
Sales Revenue .............................
30,000*
12/31/25 Interest Receivable ...............................
Interest Revenue
($30,000* X .06 X 2/12) ..............
300
30,000
300
Brief Exercise 6.7 (Continued)
5/1/26
Cash ($30,000 + $300 + $600) ...............
Notes Receivable .........................
Interest Receivable ......................
Interest Revenue
($30,000 X .06 X 4/12) .................
30,900
30,000
300
600
LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.8
Notes Receivable ....................................................
Discount on Notes Receivable .....................
($20,000 - $16,529a)
Cash ...............................................................
20,000
Discount on Notes Receivable ..............................
Interest Revenue ($16,529a X .10)………….
1,653b
Discount on Notes Receivable ..............................
Interest Revenue
[($16,529a + $1,653b) X .10] .........................
1,818
Cash
.................................................................................
.................................................................................
Notes Receivable
........................................................................
20,000
3,471
16,529a
1,653
1,818
LO: 4, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
20,000
Brief Exercise 6.9
Chung, Inc.
Cash ($750,000 - $20,000)
..............................................................................
..............................................................................
Interest Expense ($1,000,000 X .02) ....................
Notes Payable .............................................
730,000
20,000
750,000
Seneca National Bank
Notes Receivable .................................................
Cash ($750,000 - $20,000) ..........................
Interest Revenue ($1,000,000 X .02) ..........
750,000
730,000
20,000
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.10
Wood
Cash ($150,000 − $9,000* − $3,000**)
..............................................................................
..............................................................................
Receivable from Factor .......................................
Loss on Sale of Receivables ...............................
Accounts Receivable..................................
138,000
9,000*
3,000**
150,000
*.06 X $150,000 = $9,000
**.02 X $150,000 = $3,000
Engram
Accounts Receivable ...........................................
Due to Customer (Wood)............................
Interest Revenue .........................................
Cash ($150,000 - $9,000 - $3,000)...............
150,000***
LO: 5, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
9,000*
3,000**
138,000
Brief Exercise 6.11
Wood
Cash ($150,000 - $9,000 - $3,000)
..............................................................................
..............................................................................
Receivable from Factor .......................................
Loss on Sale of Receivables...............................
Accounts Receivable .................................
Recourse Liability.......................................
138,000
9,000*
10,500**
150,000
7,500
*.06 X $150,000 = $9,000
**.02 X $150,000 = $3,000 + $7,500 = $10,500
LO: 5, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.12
Cash ($250,000 – $12,500a - $10,000b).................
Receivable from Factor ($250,000 X .04) ............
Loss on Sale of Receivables...............................
Accounts Receivable .................................
Recourse Liability.......................................
227,500
10,000b
20,500*
250,000
8,000c
*[($250,000 X .05)a + $8,000c]
LO: 5, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.13
The entry for the sale now would be:
Cash ($250,000 – $12,500 - $10,000)
.....................................................................
Receivable from Factor ($250,000 X .04) ............
Loss on Sale of Receivables...............................
Account Receivable ...................................
Recourse Liability.......................................
227,500
10,000
16,500*
250,000
4,000
*[($250,000 X .05) + $4,000]
This lower estimate for the recourse liability reduces the amount of the
loss—this will result in higher income in the year of the sale. Arness’s
liabilities will be lower by $4,000.
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Brief Exercise 6.14
The accounts receivable turnover is computed as follows:
Net Sales
$12,442,000,000
=
= 13.34 times
Average Trade Receivables (net)
($912,000,000 + $953,000,000)
2
The days outstanding (average collection period) for accounts receivable in
days is
365 days
Accounts Receivable Turnover
=
365 = 27.36 days
13.34
As indicated by these ratios, General Mills’ accounts receivable turnover
appears quite strong.
LO: 5, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
*Brief Exercise 6.15
Petty Cash .....................................................................
Cash .....................................................................
200
Supplies ........................................................................
Miscellaneous Expense ...............................................
Cash Over and Short [$185 – ($94 + $87)]...................
Cash ($200 – $15) ................................................
94
87
4
200
185
LO: 6, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
*Brief Exercise 6.16
(a)
(b)
(c)
(d)
(e)
Added to balance per bank statement (1)
Deducted from balance per books (4)
Added to balance per books (3)
Deducted from balance per bank statement (2)
Deducted from balance per books (4)
LO: 6, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
*Brief Exercise 6.17
(b)
(c)
(e)
Office Expense .....................................................
Cash .............................................................
25
Cash
...............................................................................
...............................................................................
Interest Revenue .........................................
31
Accounts Receivable ...........................................
Cash .............................................................
377
25
31
377
Thus, all “Balance per books” adjustments in the reconciliation require a
journal entry.
LO: 6, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
*Brief Exercise 6.18
National American Bank (Creditor):
Bad Debt Expense .....................................................
Allowance for Doubtful Accounts......................
225,000
LO: 7, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
225,000
Solutions to Exercises
Exercise 6.1 (10–15 minutes)
(a) Cash includes the following:
1. Commercial savings account—
First National Bank of Yojimbo
1. Commercial checking account—
First National Bank of Yojimbo
2. Money market fund—Volonte
5. Petty cash
11. Commercial Paper (cash equivalent)
12. Currency and coin on hand
Cash reported on December 31, 2025, balance sheet
(b)
$ 600,000
900,000
5,000,000
1,000
2,100,000
7,700
$8,608,700
Other items classified as follows:
3. Travel advances (reimbursed by employee)* should be reported
as receivable—employee in the amount of $180,000.
4. Cash restricted in the amount of $1,500,000 for the retirement of
long-term debt should be reported as a noncurrent asset
identified as “Cash restricted for retirement of long-term debt.”
6. An IOU from Marianne Koch should be reported as an account
receivable in the amount of $190,000.
7. The bank overdraft of $110,000 should be reported as a current
liability.**
8. Certificates of deposits of $500,000 each should be classified as
temporary investments.
9. Postdated check of $125,000 should be reported as an accounts
receivable.
10. The compensating balance of $500,000 requirement does not
affect the balance in cash. A note disclosure indicating the
arrangement and the amounts involved should be described in
the notes.
Exercise 6.1 (Continued)
*If not to be reimbursed, charge to prepaid expense.
**If cash is present in another account in the same bank on which the
overdraft occurred, offsetting is required.
LO: 1, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.2 (10–15 minutes)
1.
Cash balance of $925,000. Only the checking account balance
should be reported as cash.
The certificate of deposit of $1,400,000 should be reported as a
temporary investment, the cash advance to the subsidiary of $980,000
should be reported as a non-trade receivable, and the utility deposit of
$180 should be identified as a non-trade receivable from the gas
company.
2.
Cash balance is $584,650 computed as follows:
Checking account balance
Overdraft
Petty cash
Coins and currency
$600,000
(17,000)
300
1,350
$584,650
Cash held in a bond sinking fund of $200,000 is restricted. Assuming
that the bonds are noncurrent, the restricted cash is also reported as
noncurrent.
Exercise 6.2 (Continued)
3.
Cash balance is $599,800 computed as follows:
Checking account balance
Certified check from customer
$590,000
9,800
$599,800
The post-dated check of $11,000 should be reported as an account
receivable. Cash restricted due to compensating balance of $100,000
should be described in a note indicating the type of arrangement and
amount. Postage stamps on hand of $620 are reported as part of
supplies or prepaid expenses.
4.
Cash balance is $85,000 computed as follows:
Checking account balance
Money market mutual fund
$37,000
48,000
$85,000
The NSF check received from the customer should be reported as an
account receivable.
5.
Cash balance is $700,900 computed as follows:
Checking account balance
Cash advance received from customer
$700,000
900
$700,900
Cash restricted for future plant expansion of $500,000 should be
reported as a noncurrent asset. Short-term Treasury bills of $180,000
should be reported as a temporary investment. Cash advance received
from a customer of $900 should also be reported as a liability; cash
advance of $7,000 to company executive should be reported as a
receivable; refundable deposit of $26,000 paid to the federal
government should be reported as a receivable.
LO: 1, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.3 (10–15 minutes)
Current assets
Accounts receivable:
Customers accounts (of which
accounts in the amount of
$40,000 have been pledged as
security for a bank loan)
Installment accounts collectible
due in 2026
Installment accounts collectible
due after December 31, 2026,*
Other** ($2,640 + $1,500)
$79,000
23,000
34,000
$136,000
4,140
Non-trade receivables
Advance to a subsidiary company
$140,140
81,000
*This classification assumes that these receivables are collectible within the
operating cycle of the business.
**These items could be separately classified, if considered material.
LO: 2, Bloom: AN, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.4 (10–15 minutes)
Computation of cost of goods sold:
Merchandise purchased
Less: Ending inventory
Cost of goods sold
$320,000
90,000
$230,000
Exercise 6.4 (Continued)
Selling price = 1.4 (Cost of goods sold)
= 1.4 ($230,000*)
= $322,000
Sales on account
Less: Collections
Uncollected balance
Balance per ledger
Apparent shortage
$322,000
198,000
124,000
82,000
$ 42,000 —Enough for a new car
LO: 2, Bloom: AN, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.5 (15–20 minutes)
(a) (1) June 3 Accounts Receivable—Chester .................
Sales Revenue ...................................
3,000
June 12 Cash ($3,000 - $60)
.....................................................................
.....................................................................
Sales Discounts ($3,000 X .02) ...................
Accounts Receivable—Chester ........
2,940
(2) June 3 Accounts Receivable—Chester .................
Sales Revenue ($3,000 X .98) ............
2,940
June 12 Cash .............................................................
Accounts Receivable—Chester ........
2,940
3,000
60
3,000
2,940
2,940
Exercise 6.5 (Continued)
(b)
July 29 Cash .........................................................
3,000
Accounts Receivable—Chester ....
2,940
Sales Discounts Forfeited .............
60*
*($3,000 X .02)
(Note to instructor: Sales discounts forfeited could have been
recognized at the time the discount period lapsed. The company,
however, would probably not record this forfeiture until final cash
settlement.)
LO: 2, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.6 (5–10 minutes)
July 1
July 10
July 17
July 30
Accounts Receivable ................................
Sales Revenue .................................
Sales Returns and Allowances ................
Refund Liability………………….......
20,000
Cash ($20,000 - $600) ................................
Sales Discounts ($20,000 X .03) ...............
Accounts Receivable ......................
19,400
600
Accounts Receivable ................................
Sales Revenue .................................
200,000
Cash
....................................................................
....................................................................
Accounts Receivable ......................
200,000
20,000
1,300
1,300
20,000
200,000
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
200,000
Exercise 6.7 (10–15 minutes)
(a)
Bad Debt Expense ......................................
Allowance for Doubtful Accounts .....
Step 1:
Step 2:
(b)
Step 2:
3,000
.05 X $100,000 = $5,000 (desired credit balance in allowance
account)
$5,000 – $2,000 = $3,000 (required credit entry to bring allowance
account to $5,000 credit balance)
Bad Debt Expense ......................................
Allowance for Doubtful Accounts .....
Step 1:
3,000
6,500
6,500
.05 X $100,000 = $5,000 (desired credit balance in allowance
account)
$5,000 + $1,500 = $6,500 (required credit entry to bring allowance
account to $5,000 credit balance)
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.8 (5-10 minutes)
(a)
Allowance for Doubtful Accounts ..................
Accounts Receivable..............................
6,000
6,000
(b)
Accounts Receivable
Less: Allowance for Doubtful Accounts
Net amount expected to be collected
$800,000
40,000
$760,000
(c)
Accounts Receivable ($800,000 - $6,000)
Less: Allowance for Doubtful Accounts
($40,000 - $6,000)
Net amount expected to be collected
$794,000
34,000
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
$760,000
Exercise 6.9 (8–10 minutes)
(a)
(b)
Bad Debt Expense ...........................................
Allowance for Doubtful Accounts..........
[($90,000 X .04) + $1,750]
5,350
Bad Debt Expense ...........................................
Allowance for Doubtful Accounts..........
[($90,000 X .05) – $1,700]
2,800b
5,350
2,800
LO: 3, Bloom: AP, Difficulty: Simple, Time: 8-10, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.10 (10–12 minutes)
(a)
The direct write-off approach used by Dickinson is not theoretically
justifiable even though required for income tax purposes. The direct
write-off method does not match expenses with revenues of the period,
nor does it result in receivables being stated at estimated realizable
value on the balance sheet.
(b)
Bad Debt Expense – ($77,000 X .12) = $9,240
Bad Debt Expense – Direct Write-Off = $31,330 ($7,800 + $6,700 +
$7,000 + $9,830)
Assuming accounts written off were for sales in a prior year, net
income would be $22,090 ($31,330 – $9,240) higher under the
percentage-of-receivables approach.
LO: 3, Bloom: AP, Difficulty: Simple, Time: 10-12, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 6.11 (8–10 minutes)
Balance 1/1 ($700 – $155)
4/12 (#2412) [($1,710 – $1,000 – $300*)]
11/18 (#5681) [($2,000 – $1,250)]
$ 545 Over one year
410 Eight months and 19 days
750 One month and 13 days
$1,705
*($790 – $490)
Since later invoices have been paid in full, all three of these amounts should
be investigated to determine why Hopkins Co. has not paid them. The
amounts in the beginning balance and #2412 should be of particular
concern.
LO: 3, Bloom: AP, Difficulty: Simple, Time: 8-10, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
Exercise 6.12 (15–20 minutes)
7/1 Accounts Receivable—Harding Co. ....................
Sales Revenue ($8,000 X .98) ......................
7,840
7/5 Cash [$9,000 - $810]
......................................................................
Loss on Sale of Receivables ($9,000 x .09) .........
Accounts Receivable ($9,000 X .98) ...........
Sales Discounts Forfeited ($9,000 x .02) .....
8,190
7,840
810
8,820
180
(Note: It is possible that the company already recorded the Sales
Discounts Forfeited. In this case, the credit to Accounts Receivable
would be for $9,000. The same point applies to the next entry as well.)
Exercise 6.12 (Continued)
7/9
7/11
Accounts Receivable ..................................
Sales Discounts Forfeited
($9,000 X .02)...................................
180
Cash ($6,000 - $360) ....................................
Interest Expense ($6,000 X .06) ..................
Notes Payable .....................................
5,640
360
Account Receivable—Harding Co. .............
Sales Discounts Forfeited..................
($8,000 X .02)
160
180
6,000
160
This entry may be made the next time financial statements are prepared
or it may be recorded on 12/29 when Harding Company’s receivable is
adjusted.
12/29 Allowance for Doubtful Accounts ..............
Accounts Receivable—Harding Co. ....
[$7,840 + $160 = $8,000;
$8,000 – (.10 X $8,000) = $7,200]
7,200
LO: 2, 3, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
7,200
Exercise 6.13 (10–15 minutes)
1.
7/1/25
Notes Receivable ................................
Discount on Notes Receivable .
Land............................................
Gain on Disposal of Land .........
($700,000 – $590,000)
1,101,460
401,460
590,000
110,000
Computation of the discount
$1,101,460 Face value of note
.63552 Present value of 1 for 4 periods at 12%
700,000 Present value of note
1,101,460 Face value of note
$ 401,460 Discount on notes receivable
2.
7/1/25
Notes Receivable ................................
Discount on Notes Receivable .
Service Revenue ........................
400,000.00
178,836.32
221,163.68
Computation of the present value of the note:
Maturity value
$400,000.00
Present value of $400,000 due
in 8 years at 12%—$400,000 X .40388
$161,552.00
Present value of $12,000 ($400,000 X .03)
payable annually for 8 years
at 12% annually—$12,000 X 4.96764
59,611.68
Present value of the note
221,163.68
Discount on notes receivable
$178,836.32
LO: 4, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.14 (20–25 minutes)
(a)
Notes Receivable ............................................
Discount on Notes Receivable ..............
($200,000 - $165,290*)
Service Revenue ....................................
200,000
34,710
165,290*
*Computation of present value of note:
PV of $200,000 due in 2 years at 10%
$200,000 X .82645 = $165,290
(b)
Discount on Notes Receivable .......................
Interest Revenue ...................................
16,529**
16,529
$165,290* X .10 = $16,529**
(c)
Discount on Notes Receivable .......................
Interest Revenue ....................................
18,181***
18,181
***($34,710 – $16,529) or [($165,290 + $16,529) X .10]
Cash
..........................................................................
..........................................................................
Notes Receivable ..................................
200,000
200,000
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.15 (10–15 minutes)
(a)
Cash ($200,000 - $8,000*) ...............................
Interest Expense ($400,000 x .02) ..................
Notes Payable ........................................
192,000
8,000*
200,000
(b)
Cash ................................................................
Accounts Receivable.............................
350,000
350,000
Exercise 6.15 (Continued)
(c)
Notes Payable ..............................................
Interest Expense ..........................................
Cash ($200,000 + $5,000)....................
200,000
5,000*
205,000
*($200,000 X .10 X 3/12)
LO: 5, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.16 (15–18 minutes)
1.
2.
3.
4.
Cash ($25,000 - $2,500) ................................
Loss on Sale of Receivables ........................
($25,000 X .10)
Accounts Receivable ...........................
22,500
2,500
Cash ($55,000 - $4,400) ................................
Interest Expense ($55,000 X .08) ..................
Notes Payable ......................................
50,600
4,400
Bad Debt Expense ........................................
Allowance for Doubtful Accounts.......
[($82,000 X .05) + $2,120]
6,220
Bad Debt Expense ........................................
Allowance for Doubtful Accounts.......
($5,800 – $1,100)
4,700
25,000
55,000
6,220
LO: 2, 3, 5, Bloom: AP, Difficulty: Simple, Time: 15-18, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
4,700
Exercise 6.17 (10–15 minutes)
Computation of net proceeds:
Cash received
Less: Recourse liability
Net proceeds
$160,000
1,000
$159,000
Computation of gain or loss:
Carrying value
Net proceeds
Loss on sale of receivables
$200,000
159,000
$ 41,000
The following journal entry would be made:
Cash ..................................................................
Loss on Sale of Receivables ...........................
Recourse Liability ....................................
Accounts Receivable ...............................
$160,000
41,000
1,000
200,000
LO: 5, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.18 (15–20 minutes)
(a) To be recorded as a sale, all of the following conditions would be met:
(1) The transferred asset has been isolated from the transferor (put
beyond the reach of the transferor and its creditors).
(2) The transferees have obtained the right to pledge or to exchange
either the transferred assets or beneficial interests in the transferred
assets.
(3) The transferor does not maintain effective control over the
transferred assets through an agreement to repurchase or redeem
them before their maturity.
Exercise 6.18 (Continued)
(b) Computation of net proceeds:
Cash received [$175,000 X (1 - .04 - .02)]
Receivable from factor ($175,000 X .04)
Less: Recourse liability
Net proceeds
$164,500
7,000
Computation of gain or loss:
Carrying value
Net proceeds
Loss on sale of receivables
The following journal entry would be made:
August 15
Cash ............................................................
Receivable from Factor ..............................
Loss on Sale of Receivables .....................
Recourse Liability ..............................
Accounts Receivable .........................
$171,500
2,000
$169,500
$175,000
169,500
$ 5,500
164,500
7,000
5,500
2,000
175,000
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.19 (10–15 minutes)
(a) July 1
Cash ($300,000 - $12,000 - $4,500) .......
Receivable from Factor .........................
Loss on Sale of Receivables .................
Accounts Receivable....................
283,500
12,000*
4,500**
300,000
Exercise 6.19 (Continued)
(b) July 1
Accounts Receivable ............................
Due to Customer (JFK Corp.)......
Interest Revenue ..........................
Cash ($300,000 - $12,000 - $4,500) ....
300,000
12,000*
4,500**
283,500
**(.04 X $300,000) = $12,000
**(.015 X $300,000) = $4,500
LO: 5, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.20 (10–15 minutes)
(a) Accounts Receivable ........................................
Sales Revenue ..........................................
100,000
Cash
............................................................................
............................................................................
Accounts Receivable ...............................
70,000
(b)
Accounts Receivable Turnover
Net Sales
Average Accounts Receivable (net)
=
=
100,000
70,000
Net Sales
Average Accounts Receivable (net)
$100,000
= 3.33 times
($15,000 + $45,000*)/2
*$15,000 + $100,000 – $70,000
Days to collect accounts
receivable
(c)
=
365
= 109.61 days
3.33
Jones Company’s accounts receivable turnover has declined
significantly. That is, it is turning receivables 3.33 times a year and
collections on receivables took 110 days. In the prior year, the turnover
was almost double (6.0) and collections took only 61 days. This is a bad
trend in liquidity. Jones should consider offering early payment
discounts and/or tightened credit and collection policies.
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Exercise 6.21 (10-15 minutes)
(a) Cash [$25,000 X (1 – .09)]
...................................................................
Receivable from Factor .....................................
Loss on Sale of Accounts Receivable .............
Accounts Receivable ...............................
Recourse Liability ....................................
22,750b
1,250a
2,200d
25,000
1,200
Computation of cash received
Accounts receivable ..................................
Less: Receivable from
factor (.05 X $25,000) ........................
Finance charge (.04 X $25,000)
$25,000
1,250a
1,000
$22,750b
Cash received ......................................
Computation of net proceeds (cash and other
assets received, less any liabilities incurred)
Cash received .............................................
Receivable from factor ...............................
Less: Recourse liability .............................
Net proceeds........................................
$22,750b
1,250a
Computation of loss
Carrying (Book) value ................................
Less: Net proceeds ....................................
Loss on sale of receivables ................
(b)
Accounts Receivable Turnover
Net Sales
Average Accounts Receivable (net)
$24,000
1,200
$22,800c
$25,000
22,800c
$ 2,200d
Net Sales
Average Accounts Receivable
(net)
=
$100,000
= 5.71 times
($15,000 + $20,000*)/2
=
*($15,000 + $100,000 – $70,000 –
$25,000)
Days to collect accounts receivable =
365
= 63.92 days
5.71
Exercise 6.21 (Continued)
With the factoring transaction, Jones Company’s turnover ratio still declines
but by less than in the earlier exercise. While Jones’ collections have slowed,
by factoring the receivables, Jones can convert them to cash. The cost of
this approach to converting receivables to cash is captured in the Loss on
Sale of Accounts Receivable account.
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
*Exercise 6.22 (5–10 minutes)
1.
2.
3.
April 1 Petty Cash ................................................
Cash.................................................
200
April 10 Freight-In (or Inventory) ..........................
Supplies Expense ....................................
Postage Expense .....................................
Accounts Receivable—Employees.........
Miscellaneous Expense...........................
Cash Over and Short ($173 - $171) .........
Cash ($200 – $27)............................
*[($60 + $25 + $33 + $17 + $36) - $173]
60
25
33
17
36
2*
April 20 Petty Cash ................................................
Cash.................................................
100
200
173
LO: 6, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
100
*Exercise 6.23 (10–15 minutes)
Accounts Receivable—Employees .....................
74.00
($40.00 + $34.00)
Owner’s Drawings** .............................................
170.00
Office Supplies Expense ......................................
14.35
Postage Expense ($20.00 – $2.90) .......................
17.10
Prepaid Postage ...................................................
2.90
Cash Over and Short ............................................
6.45*
Cash ($300.00 – $15.20) ..............................
*[($74.00 + $170.00 + $14.35 + $17.10 + $2.90) - $284.80]
**Note: This debit might also be made to the capital account.
284.80
LO: 6, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
*Exercise 6.24 (15–20 minutes)
(a)
Angela Lansbury Company
Bank Reconciliation
July 31
Balance per bank statement, July 31
Add: Deposits in transit
Deduct: Outstanding checks
Correct cash balance, July 31
$8,650
2,350a
(1,100)b
$9,900
Balance per books, July 31
Add: Collection of note
Less: Bank service charge
NSF check
Correct cash balance, July 31
$9,250
1,000
$ 15
335
(350)
$9,900
*Exercise 6.24 (Continued)
Computation of deposits in transit
Deposits per books
Deposits per bank in July
Less deposits in transit (June)
Deposits mailed and received in
July
Deposits in transit, July 31
$5,810
$5,000
(1,540)
(3,460)
$2,350a
Computation of outstanding checks
Checks written per books
$3,100
Checks cleared by bank in July
$4,000
Less outstanding checks
(June)*
(2,000)
Checks written and cleared in
July
(2,000)
Outstanding checks, July 31
$1,100b
*Assumed to clear bank in July
(b) Cash ($1,000 - $15 - $335) .................................
Office Expenses—bank service charges .........
Accounts Receivable ........................................
Notes Receivable ......................................
650
15
335
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
1,000
*Exercise 6.25 (15–20 minutes)
(a)
Logan Bruno Company
Bank Reconciliation, August 31, 2025
County National Bank
Balance per bank statement, August 31, 2025
Add: Cash on hand
Deposits in transit
$ 8,089
$ 310
3,800
4,110
Deduct: Outstanding checks
12,199
1,050
Correct cash balance
$11,149
Balance per books, August 31, 2025
($10,050 + $35,000 – $34,903)
Add: Note ($1,000a) and interest ($40b) collected
$10,147
1,040
11,187
Deduct: Bank service charges
Understated check for supplies
($164.50 - $146.50)
Correct cash balance
$ 20
18
(b) Cash ..........................................................................
Notes Receivable.............................................
Interest Revenue .............................................
(To record collection of note and interest)
1,040
38
$11,149
1,000
40
*Exercise 6.25 (Continued)
Office Expense—bank service charges ..................
Cash .................................................................
(To record August bank charges)
20
Supplies Expense .....................................................
Cash .................................................................
(To record error in recording check for
supplies)
18
20
18
(c) The correct cash balance of $11,149 would be reported in the August
31, 2025, balance sheet.
LO: 6, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
*Exercise 6.26 (15-25 minutes)
(a)
Journal entry to record issuance of loan by Paris Bank:
December 31, 2025
Notes Receivable .....................................................
100,000
Discount on Notes Receivable .....................
($100,000 - $62,092a)
Cash................................................................
37,908
62,092
$100,000 X Present value of 1 for 5 periods at 10%
$100,000 X .62092 = $62,092a
(b)
Note Amortization Schedule
(Before Impairment)
Date
12/31/25
12/31/26
12/31/27
Cash
Received
(0%)
$0
0
Interest
Revenue
(10%)
$6,209
6,830
Increase in
Carrying
Amount
Carrying
Amount of
Note
$6,209
6,830
$62,092
68,301
75,131
*Exercise 6.26 (Continued)
Computation of the impairment loss:
Carrying amount of investment (12/31/27).................
Less: Present value of $75,000 due in 3 years
at 10% ($75,000 X .75132) ................................
Loss due to impairment ..............................................
$75,131
56,349
$18,782
The entry to record the loss by Paris Bank is as follows:
Bad Debt Expense ....................................................
Allowance for Doubtful Accounts ..................
18,782
18,782
Note: Iva Majoli Company, the debtor, makes no entry because it still
legally owes $100,000.
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 15-25, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
*Exercise 6.27 (15-25 minutes)
(a) Cash received by Conchita Martinez Company on December 31, 2025:
Present value of principal of $1,000,000 due
in 5 years at 12% ($1,000,000 X .56743) .....................
Present value of interest of $100,000*
($1,000,000 X .10) due in 5 years at 12%
($100,000 X 3.60478) .................................................
Cash received ..............................................................
(b)
$567,430
360,478
$927,908
Note Amortization Schedule
(Before Impairment)
Date
12/31/25
12/31/26
12/31/27
Cash
Received
(10%)
$100,000
100,000
Interest
Revenue
(12%)
$111,349
112,711
Increase in
Carrying
Amount
Carrying
Amount of
Note
$11,349
12,711
$927,908
939,257
951,968
*Exercise 6.27 (Continued)
(c) Loss due to impairment:
Carrying amount of loan (12/31/27) ................
$951,968b
Less: Present value of $600,000 due in
3 years at 12% ($600,000 X .71178) ..... $427,068
Present value of $100,000 payable annually
for 3 years at 12% ($100,000 X 2.40183) ..... 240,183
667,251
Loss due to impairment ..................................
$284,717
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 15-25, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Time and Purpose of Problems
Problem 6.1 (Time 20–25 minutes)
Purpose—provides the student with an understanding of the balance sheet effect that occurs when the
cash book is left open. In addition, the student is asked to adjust the present balance sheet to an adjusted
balance sheet, reflecting the proper cash presentation.
Problem 6.2 (Time 20–25 minutes)
Purpose—provides the student with the opportunity to determine various items related to accounts
receivable and the allowance for doubtful accounts. Five independent situations are provided.
Problem 6.3 (Time 20–30 minutes)
Purpose—provides a short problem related to the aging of accounts receivable. The appropriate balance for
doubtful accounts must be determined. In addition, the manner of reporting accounts receivable on the
balance sheet must be shown.
Problem 6.4 (Time 25–35 minutes)
Purpose—the student prepares an analysis of the changes in the allowance for doubtful accounts and
supports it with an aging schedule.
Problem 6.5 (Time 20–30 minutes)
Purpose—a short problem that must be analyzed to make the necessary correcting entries. It is not a
pencil-pushing problem but requires a great deal of conceptualization. A good problem for indicating the
types of adjustments that might occur in the receivables area.
Problem 6.6 (Time 25–35 minutes)
Purpose—provides the student with a number of business transactions related to accounts receivable
that must be journalized. Recoveries of receivables and write-offs are the types of transactions presented.
The problem provides a good cross-section of a number of accounting issues related to receivables.
Problem 6.7 (Time 30–35 minutes)
Purpose—provides the student with a simple note receivable problem with no imputation of interest.
Problem 6.8 (Time 30–35 minutes)
Purpose—provides the student with a problem requiring the imputation of interest. The student is required
to make journal entries on a series of dates when note installments are collected. A relatively
straightforward problem.
Problem 6.9 (Time 40–50 minutes)
Purpose—the student calculates the current portion of long-term receivables and interest receivable, and
prepares the long-term receivables section of the balance sheet. Then the student prepares a schedule
showing interest income. The problem includes interest-bearing and zero-interest-bearing notes and an
installment receivable.
Problem 6.10 (Time 25–30 minutes)
Purpose—a short problem involving the reporting problems associated with the assignment of accounts
receivable. The student is required to make the journal entries necessary to record an assignment.
A straightforward problem.
Problem 6.11 (Time 20–25 minutes)
Purpose—provides the student the opportunity to determine the income statement effects of receivables
transactions.
Time and Purpose of Problems (Continued)
*Problem 6.12 (Time 20–25 minutes)
Purpose—provides the student with the opportunity to do the accounting for petty cash and a bank
reconciliation.
*Problem 6.13 (Time 20–30 minutes)
Purpose—provides the student with the opportunity to prepare a bank reconciliation that is reconciled to a
corrected balance. Traditional types of adjustments are presented. Journal entries are also required.
*Problem 6.14 (Time 20–30 minutes)
Purpose—provides the student with the opportunity to prepare a bank reconciliation that goes from
balance per bank to corrected balance. Traditional types of adjustments are presented such as deposits in
transit, bank service charges, NSF checks, and so on. Journal entries are also required.
*Problem 6.15 (Time 30–40 minutes)
Purpose—provides the student with a loan situation that requires entries by both the debtor and the
creditor and an analysis of the loss on impairment.
Solutions to Problems
Problem 6.1
(a)
December 31
(1) Accounts Receivable ($17,640 + $360) ....
Sales Revenue ...........................................
Cash ..................................................
Sales Discounts................................
18,000
28,000
45,640
360
December 31
(2) Cash
....................................................................
....................................................................
Purchase Discounts ..................................
Accounts Payable ............................
(b)
22,200
250
22,450
Per Balance
After
Sheet
Adjustment
Current assets
Cash ($39,000 – $45,640 + $22,200) ....
Accounts Receivable
($42,000 + $18,000) .........................
Inventory ..............................................
Total ................................................
$ 39,000
$ 15,560
42,000
67,000
(1) 148,000
60,000
67,000
142,560
Current liabilities
Accounts payable
($45,000 + $22,450) ..........................
45,000
Other current liabilities .......................
14,200
Total ................................................
(2) 59,200
Working capital .................................... (1) – (2) $ 88,800
67,450
14,200
81,650
$ 60,910
Current ratio............................................... (1) ÷ (2) 2.5 to 1
1.75 to 1
LO: 1, Bloom: AN, Difficulty: Simple, Time: 20-25, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Problem 6.2
1. Accounts receivables ..........................................................
Percentage estimate ............................................................
Allowance needed ...............................................................
Allowance (Dr).......................................................................
Bad Debt Expense................................................................
$
2. Accounts receivable ............................................................
Amounts estimated to be uncollectible..............................
Net realizable value..............................................................
$1,750,000
(180,000)
$1,570,000
3. Allowance for doubtful accounts 1/1/25 .............................
Collection of accounts written off in prior years ...............
Customer accounts written off in 2025 ..............................
Bad debt expense for 2025……………………………………
Allowance for doubtful accounts 12/31/25 .........................
$
$
17,000
8,000
(30,000)
57,000
52,000
4. Bad debt expense for 2025..................................................
Customer accounts written off as uncollectible
during 2025.......................................................................
Allowance for doubtful accounts balance 12/31/25...........
$
84,000
$
(24,000)
60,000
Accounts receivable, net of allowance
for doubtful accounts ......................................................
Allowance for doubtful accounts balance 12/31/25...........
Accounts receivable, before deducting
allowance for doubtful accounts ....................................
5. Accounts receivable ............................................................
Percentage estimate ............................................................
Bad debt expense, before adjustment ...............................
Allowance for doubtful accounts (debit balance)..............
Bad debt expense, as adjusted ...........................................
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
$
53,000
7%
3,710
4,000
7,710
$ 950,000
60,000
$1,010,000
$ 310,000
3%
9,300
14,000
$ 23,300
Problem 6.3
(a)
The Allowance for Doubtful Accounts should have a balance of $45,000
at year-end. The supporting calculations are shown below:
Expected
Days Account
Percentage
Outstanding
Amount
Uncollectible
0–15 days
$300,000
1 - .98 = .02
16–30 days
100,000
1 - .90 = .10
31–45 days
80,000
1 - .85 = .15
46–60 days
40,000
1 - .80 = .20
61–75 days
20,000
1 - .55 = .45
Balance for Allowance for Doubtful Accounts
Estimated
Uncollectible
$ 6,000
10,000
12,000
8,000
9,000
$45,000a
The accounts which have been outstanding over 75 days ($15,000) and
have zero probability of collection would be written off immediately by
debing Allowance for Doubtful Accounts for $15,000 and crediting
Accounts Receivable for $15,000. These accounts are not considered
when determining the proper amount for the Allowance for Doubtful
Accounts.
(b)
Accounts receivable ($555,000 – $15,000) ........................
Less: Allowance for doubtful accounts ...........................
Accounts receivable (net) ..................................................
(c)
The year-end bad debt adjustment would decrease before-tax income
$20,000 as computed below:
Estimated amount required in the Allowance
for Doubtful Accounts ......................................................
Balance in the account after write-off of uncollectible
accounts but before adjustment ($40,000 – $15,000) .....
Required charge to expense ................................................
$540,000
45,000
$495,000
$45,000
25,000
$20,000
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC:
Communication
Problem 6.4
(a)
FORTNER CORPORATION
Analysis of Changes in the
Allowance for Doubtful Accounts
For the Year Ended December 31, 2025
Balance at January 1, 2025..............................................
Provision for doubtful accounts .....................................
Recovery in 2025 of bad debts written off previously ...
$130,000
180,000
15,000
325,000
150,000
Deduct write-offs for 2025 ($90,000 + $60,000) ..............
Balance at December 31, 2025, before change
in accounting estimate ................................................
Increase due to change in accounting estimate
during 2025 ($263,600 – $175,000) ..............................
Balance at December 31, 2020, adjusted (Schedule 1)..
175,000
88,600
$263,600*
Schedule 1
Computation of Allowance for Doubtful Accounts
at December 31, 2025
Aging
Category
Nov.–Dec.
July–Oct.
Jan.–June
Prior to 1/1/20
Balance
%
$1,080,000
650,000
420,000
90,000(a)
2
10
25
80
Doubtful
Accounts
$ 21,600
65,000
105,000
72,000
$263,600*
(a) $150,000 – $60,000
(b) The journal entry to record this transaction is as follows:
Bad Debt Expense ........................................
Allowance for Doubtful Accounts ...........
(To increase the allowance for
doubtful accounts at December 31,
2025, resulting from a change
in accounting estimate)
88,600
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
88,600
Problem 6.5
Bad Debt Expense ..................................................
Accounts Receivable ....................................
(To correct bad debt expense and
write off accounts receivable)
3,240
Accounts Receivable .............................................
Unearned Sales Revenue ..............................
(To reclassify credit balance
in accounts receivable)
4,840
Allowance for Doubtful Accounts .........................
Accounts Receivable ....................................
(To write off $3,700 of uncollectible
accounts)
3,700
3,240
4,840
3,700
(Note to instructor: Many students will not make this entry at this point.
Because $3,700 is totally uncollectible, a write-off immediately seems most
appropriate. The remainder of the solution, therefore, assumes that the student
made this entry.)
Allowance for Doubtful Accounts .........................
Bad Debt Expense .........................................
(To reduce allowance for doubtful
account balance)
7,279.64
Balance ($8,750 + $18,620 – $3,240 – $3,700) ........
Corrected balance (see below) ...............................
Adjustment...............................................................
$20,430.00
13,150.36a
$ 7,279.64
7,279.64
Age
Balance
Aging
Schedule
Under 60 days
60–90 days
91–120 days
Over 120 days
$172,342
141,330 ($136,490 + $4,840)
36,684 ($39,924 – $3,240)
19,944 ($23,644 – $3,700)
1%
3%
6%
25%
$ 1,723.42
4,239.90
2,201.04
4,986.00
$13,150.36a
Problem 6.5 (Continued)
If the student did not make the entry to record the $3,700 write-off earlier, the
following would change in the problem. After the adjusting entry for $7,279.64,
an entry would have to be made to write off the $3,700.
Balance ($8,750 + $18,620 – $3,240) ...............
Corrected balance (see below) .......................
Adjustment .......................................................
$24,130.00
16,850.36b
$ 7,279.64
Age
Balance
Aging
Schedule
Under 60 days
60–90 days
91–120 days
Over 120 days
$172,342
141,330
36,684
23,644
1%
3%
6%
—
$ 1,723.42
4,239.90
2,201.04
8,686.00*
$16,850.36b
*$3,700 + (25% X $19,944)
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Problem 6.6
–1–
Cash ($138,000 - $1,200) ..........................................
Sales Discounts ($60,000 X.02) ...............................
Accounts Receivable ......................................
136,800
1,200
–2–
Accounts Receivable ...............................................
Allowance for Doubtful Accounts ..................
5,300
Cash ..........................................................................
Accounts Receivable ......................................
–3–
Allowance for Doubtful Accounts ...........................
Accounts Receivable ......................................
–4–
Bad Debt Expense ....................................................
Allowance for Doubtful Accounts ..................
*($17,300 + $5,300 – $17,500 = $5,100;
$20,000 – $5,100 = $14,900)
138,000
5,300
5,300
5,300
17,500
17,500
14,900
LO: 2, 3, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
14,900*
Problem 6.7
10/1/25
12/31/25
Notes Receivable...................................
Sales Revenue ..............................
120,000
Interest Receivable................................
Interest Revenue ..........................
2,400*
120,000
2,400
*$120,000 X .08 X 3/12 = $2,400
10/1/26
Cash .......................................................
Interest Receivable ($9,600 - $7,200) ..
Interest Revenue ..........................
9,600*
2,400
7,200**
*$120,000 X .08 = $9,600
**$120,000 X .08 X 9/12 = $7,200
12/31/26
10/1/27
Interest Receivable................................
Interest Revenue ..........................
2,400
Cash .......................................................
Interest Receivable ($9,600 - $7,200) ..
Interest Revenue ..........................
9,600*
Cash .......................................................
Notes Receivable .........................
120,000
2,400
2,400
7,200**
120,000
*$120,000 X .08 = $9,600
**$120,000 X .08 X 9/12 = $7,200
Note: Entries at 10/1/26 and 10/1/27 assume reversing entries were not made
on January 1, 2026, and January 1, 2027.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Problem 6.8
(a)
Date
12/31/25
12/31/26
12/31/27
12/31/28
12/31/29
a
December 31, 2025
Schedule of Note Discount Amortization
Cash
Received
Interest
Revenue
(11%)
Decrease
Carrying
Amount
(1)
(2)
(1) - (2)
—
$20,000
20,000
20,000
20,000
—
a
$6,825
5,376
3,768
1,982
Carrying
Amount of
Note
$62,049
b
48,874
34,250
18,018
—
$13,175
14,624
16,232
18,018
$6,825 = $62,049 X .11
$48,874 = $62,049 + $6,825 – $20,000
b
Cash ......................................................................
Notes Receivable ..................................................
Discount on Notes Receivable ...................
($80,000 - $62,049)
Service Revenue ..........................................
40,000
80,000
17,951
102,049
To record revenue at the present value of the
note plus the immediate cash payment:
PV of $20,000 annuity at 11% for
4 years ($20,000 X 3.10245)............
$ 62,049
Down payment ...................................
40,000
Capitalized value of services ............
$102,049
(b)
December 31, 2026
Cash ...........................................................................
Notes Receivable..............................................
Discount on Notes Receivable .................................
Interest Revenue ..............................................
20,000
20,000
6,825
6,825
Problem 6.8 (Continued)
(c)
December 31, 2027
Cash...........................................................................
Notes Receivable .............................................
Discount on Notes Receivable ................................
Interest Revenue..............................................
(d)
December 31, 2028
Cash...........................................................................
Notes Receivable .............................................
Discount on Notes Receivable ................................
Interest Revenue..............................................
(e)
December 31, 2029
Cash...........................................................................
Notes Receivable .............................................
Discount on Notes Receivable ................................
Interest Revenue..............................................
20,000
20,000
5,376
5,376
20,000
20,000
3,768
3,768
20,000
20,000
1,982
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
1,982
Problem 6.9
(a)
BRADDOCK INC.
Long-Term Receivables Section of Balance Sheet
December 31, 2025
9% note receivable from sale of division, due
in annual installments of $500,000 to
May 1, 2027, less current installment ...............
8% note receivable from officer, due Dec. 31,
2027, collateralized by 10,000 shares
of Braddock, Inc., common stock
with a fair value of $450,000 (10,000 X $45)......
Zero-interest-bearing note from sale of patent,
net of 12% imputed interest, due
April 1, 2027........................................................
Installment contract receivable, due in annual
installments of $45,125 to July 1, 2026,
less current installment .....................................
Total long-term receivables............................
(b)
$ 500,000
(1)
400,000
86,873
(2)
110,275
$1,097,148
(3)
BRADDOCK INC.
Selected Balance Sheet Balances
December 31, 2025
Current portion of long-term receivables:
Note receivable from sale of division ..................
Installment contract receivable............................
Total current portion of long-term
receivables ...................................................
Accrued interest receivable:
Note receivable from sale of division ..................
Installment contract receivable............................
Total accrued interest receivable...................
$500,000
29,725
(1)
(3)
$529,725
$ 60,000
7,700
$ 67,700
(4)
(5)
Problem 6.9 (Continued)
(c)
BRADDOCK INC.
Interest Revenue from Long-Term Receivables
For the Year Ended December 31, 2025
Interest revenue:
Note receivable from sale of division ......................
Note receivable from sale of patent .........................
Note receivable from officer .....................................
Installment contract receivable from sale of land ..
Total interest revenue for year ended 12/31/25 .
$105,000
7,173
32,000
7,700
$151,873
(6)
(2)
(7)
(5)
Explanation of Amounts
(1) Long-term Portion of 9% Note Receivable at 12/31/25
Face amount, 5/1/24 ..............................................
Less: Installment received 5/1/25 .......................
Balance, 12/31/25 ..................................................
Less: Installment due 5/1/26 ...............................
Long-term portion, 12/31/25 .................................
$1,500,000
500,000
1,000,000
500,000
$ 500,000
(2) Zero-interest-bearing Note, Net of Imputed Interest at
12/31/25
Face amount 4/1/25 ...............................................
Less: Imputed interest
[$100,000 – ($100,000 X 0.797)] ................
Balance, 4/1/25 ......................................................
Add: Interest earned to 12/31/25
($79,700 X .12 X 9/12) ................................
Balance, 12/31/25 ..................................................
$ 100,000
20,300
79,700
$
7,173
86,873
Problem 6.9 (Continued)
(3)
(4)
(5)
(6)
(7)
Long-term Portion of Installment Contract
Receivable at 12/31/25
Contract selling price, 7/1/25 ................................
Less: Down payment, 7/1/25 ................................
Balance, 12/31/25 ...................................................
Less: Installment due, 7/1/26
[$45,125 – ($140,000 X .11)]........................
Long-term portion, 12/31/25 ..................................
$ 200,000
60,000
140,000
29,725
$ 110,275
Accrued Interest—Note Receivable, Sale of
Division at 12/31/25
Interest accrued from 5/1 to 12/31/25
($1,000,000 X .09 X 8/12) .....................................
$
60,000
Accrued Interest—Installment Contract at 12/31/25
Interest accrued from 7/1 to 12/31/25
($140,000 X .11 X 1/2) ..........................................
$
7,700
$
45,000
Interest Revenue—Note Receivable, Sale of
Division, for 2020
Interest earned from 1/1 to 5/1/25
($1,500,000 X.09 X 4/12) ......................................
Interest earned from 5/1 to 12/31/25
($1,000,000 X .09 X 8/12) .....................................
Interest income ......................................................
Interest Revenue—Note Receivable, Officer, for 2025
Interest earned 1/1 to 12/31/25
($400,000 X .08) ...................................................
60,000
$ 105,000
$
LO: 4, Bloom: AP, Difficulty: Complex, Time: 40-50, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Problem 6.10
32,000
July 1, 2025
Cash ($120,000 - $750) .....................................................
Interest Expense (.005 X $150,000) .................................
Notes Payable (.80 X $150,000) ..............................
119,250
750
July 31, 2025
Notes Payable ...................................................................
Accounts Receivable ..............................................
80,000
Interest Expense ...............................................................
Interest Payable [.005 X ($150,000 - $80,000)] .......
August 31, 2025
Notes Payable ($120,000 - $80,000) .................................
Cash* .................................................................................
Interest Expense [.005 X ($150,000 –
$80,000 – $50,000)] ........................................................
Interest Payable ................................................................
Accounts Receivable ..............................................
*Total cash collection .......................................................
Less: Interest payable (from previous entry) ................
Interest expense (current month) [.005 X
($150,000 – $80,000 – $50,000)] ..........................
Notes payable (balance) ($120,000 – $80,000) .....
Cash collected ..................................................................
120,000
80,000
350
350
40,000
9,550
100
350
50,000
$50,000
(350)
(100)
(40,000)
$ 9,550
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
Problem 6.11
SANDBURG COMPANY
Income Statement Effects
For the Year Ended December 31, 2025
Expenses resulting from accounts receivable
assigned (Schedule 1) ............................................
Loss resulting from accounts receivable
sold ($300,000 – $270,000) .....................................
Total expenses.....................................................
$22,320
30,000
$52,320
Schedule 1
Computation of Expense
for Accounts Receivable Assigned
Assignment expense:
Accounts receivable assigned ...........................
Advance by Keller Finance Company ................
$400,000
X .80
320,000
X .03
Interest expense ........................................................
Total expenses .....................................................
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
$ 9,600
12,720
$22,320
*Problem 6.12
(a)
(b)
May 10 Petty Cash.................................................
Cash ...............................................
250.00
May 31 Postage Expense......................................
Supplies ....................................................
Accounts Receivable (Employees) .........
Freight-Out................................................
Advertising Expense ................................
Miscellaneous Expense ...........................
Cash ($250.00 – $26.40) .................
33.00
65.00
30.00
57.45
22.80
15.35
May 31 Petty Cash..................................................
Cash ................................................
50.00
Balances per bank: .................................................
Add:
Cash on hand .................................................
Deposit in transit ............................................
250.00
223.60
50.00
$6,522
$ 246
3,000
Deduct: Checks outstanding ..................................
Correct cash balance, May 31 .......................
Balance per books: .................................................
Add: Note receivable (collected with interest) .....
3,246
9,768
850
$8,918
$8,015*
930
8,945
27
$8,918
Deduct: Bank service charges ..............................
Correct cash balance, May 31 .......................
*($8,850 + $31,000 – $31,835)
(c)
Cash .........................................................................
Notes Receivable ...........................................
Interest Revenue ............................................
930
Office Expense (bank charges) ..............................
Cash ................................................................
27
$8,918 + $300 (Petty Cash) = $9,218.
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
900
30
27
*Problem 6.13
(a)
AGUILAR CO.
Bank Reconciliation
June 30, 2025
Balance per bank, June 30 ........................................
Add: Deposits in transit............................................
Deduct: Outstanding checks....................................
Correct cash balance, June 30..................................
$4,150.00
3,390.00
(2,136.05)
$5,403.95
Balance per books, June 30 ......................................
Add: Error in recording deposit ($90 – $60) ...........
Error on check no. 747
($582.00 – $58.20) .........................................
Note collection ($1,200 + $36).........................
$3,969.85
Deduct: NSF check ...................................................
Error on check no. 742 ($491 – $419) .........
Bank service charges ($25 + $5.50) ...........
$
30.00
523.80
1,236.00
253.20
72.00
30.50
Correct cash balance, June 30..................................
1,789.80
5,759.65
(355.70)
$5,403.95
(b) Cash .....................................................................
Accounts Receivable ....................................
Accounts Payable .........................................
Notes Receivable ..........................................
Interest Revenue ...........................................
1,789.80
Accounts Receivable ..........................................
Accounts Payable ...............................................
Office Expense (bank charges) ..........................
Cash ...............................................................
253.20
72.00
30.50
30.00
523.80
1,200.00
36.00
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
355.70
*Problem 6.14
(a)
HASELHOF INC.
Bank Reconciliation
November 30
Balance per bank statement, November 30 ..
Add:
Cash on hand, not deposited ...................
Deduct:
Outstanding checks
#1224....................................................
#1230....................................................
#1232....................................................
#1233....................................................
Correct cash balance, Nov. 30 .......................
$56,274.20
1,915.40
58,189.60
$
1,635.29
2,468.30
2,125.15
482.17
Balance per books, November 30 ..................
Add:
Bond interest collected by bank ..............
Deduct:
Bank charges not recorded in books ......
Customer’s check returned NSF..............
Correct cash balance, Nov. 30 .......................
*Computation of balance per books,
November 30
Balance per books, October 31 ................
Add receipts for November .......................
Deduct disbursements for November ......
Balance per books, November 30 ........... 0
6,710.91
$51,478.69
$50,478.22*
1,400.00
51,878.22
$
27.40
372.13
$ 41,847.85
173,523.91
215,371.76
164,893.54
$ 50,478.22
399.53
$51,478.69
*Problem 6.14 (Continued)
(b)
November 30
Cash ..........................................................................
Interest Revenue .............................................
1,400.00
November 30
Office Expense (bank charges) ...............................
Cash .................................................................
27.40
November 30
Accounts Receivable ...............................................
Cash .................................................................
372.13
1,400.00
27.40
LO: 6, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BC: None, AICPA AC: Reporting, AICPA PC: None
372.13
*Problem 6.15
(a)
The entries for the issuance of the note on January 1, 2025:
The present value of the note is: $1,200,000 X .68058 (PVF5, 8%) =
$816,700 (Rounded by $4).
Botosan Company (Debtor):
Cash ................................................................
Discount on Notes Payable ...........................
Notes Payable ...........................................
816,700
383,300
1,200,000
National Organization Bank (Creditor):
Notes Receivable ............................................ 1,200,000
Discount on Notes Receivable .................
Cash ...........................................................
383,300
816,700
(b)
Schedule of Interest and Discount Amortization
Effective-Interest Method
$1,200,000 Note Issued to Yield 8%
Date
1/1/25
12/31/25
12/31/26
12/31/27
12/31/28
12/31/29
Total
Cash
Paid
$0
0
0
0
0
$0
Interest
Expense
(8%)
$ 65,336*
70,563
76,208
82,305
88,888
$383,300
*$816,700 X .08 = $65,336.
**$816,700 + $65,336 = $882,036.
Discount
Amortized
$ 65,336
70,563
76,208
82,305
88,888
$383,300
Carrying
Amount of
Note
$ 816,700
882,036**
952,599
1,028,807
1,111,112
1,200,000
*Problem 6.15 (Continued)
(c)
The note can be considered to be impaired only when it is probable that,
based on current information and events, National Organization Bank
will be unable to collect all amounts due (both principal and interest)
according to the contractual terms of the loan.
(d) The loss is computed as follows:
Carrying amount of loan (12/31/26) .........................
Less: Present value of $800,000 due
in 3 years at 8% .............................................
Loss due to impairment ...........................................
a
$952,599a
635,064b
$317,535
See amortization schedule in answer (b).
$800,000 X .79383 = $635,064.
b
December 31, 2026
National Organization Bank (Creditor):
Bad Debt Expense ...........................................
Allowance for Doubtful Accounts ............
317,535
317,535
Note: Botosan Company (Debtor) has no entry.
LO: 7, Bloom: N/A, Difficulty: Moderate, Time: 30-40, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC:
Communication
Financial Reporting Problem
UYJ6.1
(a)
P&G has $16,181 billion in cash and cash equivalents. As disclosed in
the Consolidated Statement of Cash Flows, P&G indicates that in the
year ended 6/30/20 cash was used for capital expenditures ($3,073
million), cash dividends ($7,789 million), purchase of treasury stock
($7,405), and reductions of long-term debt ($2,447 million).
(b)
As indicated in Note 1, the company’s products are sold in more than
180 countries and territories primarily through mass merchandisers, ecommerce, grocery stores, membership club stores, drug stores,
department stores, distributors, wholesalers, baby stores, specialty
beauty stores (including airport duty-free stores), high-frequency
stores, pharmacies, electronics stores, and professional channels.
P&G has on-the-ground operations in approximately 70 countries. In
fact, in its segment note (Note 2), P&G indicates that 15% of its sales in
2020 were to a single large customer—Walmart, Inc. Thus, to the extent
that its customers have credit profiles similar to Walmart Inc., it is
reasonable that bad debt expense might not be material.
LO: 1, Bloom: AN, Difficulty: Simple, Time: 5-10, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, Research, AICPA PC:
Communication
Comparative Analysis Case
UYJ6.2
(a)
Cash and cash equivalents: ($ millions) at year-end 2020:
Coca-Cola,
$6,795
PepsiCo,
$8,185
Coca-Cola classifies cash equivalents as “time deposits and other
investments that are highly liquid and have maturities of three months or
less at the date of purchase.”
PepsiCo classifies cash equivalents as “highly liquid investments with
original maturities of three months or less.”
(b)
Accounts receivable (net):
Coca-Cola,
$3,144
PepsiCo,
$6,892 - $201 = $6,691
Allowance for doubtful accounts:
Coca-Cola,
Balance, $526
Percent of receivables, 14.33%*
*[$526 / ($3,144 + $526)]
(c)
PepsiCo,
Balance, $201
Percent of receivables, 2.92%**
** [$201 / $6,892
Accounts receivable turnover and days outstanding for receivables:
Coca-Cola
$33,014
$3,144 + $3,971
2
= 9.28 times
365 ÷ 9.28 = 39.3 days
PepsiCo
$70,372
$6,691 + $6,342***
2
= 10.80 times
365 ÷ 10.80 = 33.8 days
***$6,447 - $105
PepsiCo’s turnover ratio is higher, resulting in fewer days in receivables. It
is likely that these companies use similar receivables management
practices.
LO: 1, 2, 7, Bloom: AN, Difficulty: Simple, Time: 10-15, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, Research, AICPA PC:
Communication
Financial Statement Analysis Case
UYJ6.3 Financial Statement Analysis Case
(a)
Cash may consist of funds on deposit at the bank, negotiable instruments such as money orders, certified checks, cashier’s checks,
personal checks, bank drafts, and money market funds that provide
checking account privileges.
(b)
Cash equivalents are short-term, highly liquid investments that are
both (a) readily convertible to known amounts of cash, and (b) so near
their maturity that they present insignificant risk from changes in
interest rates. Generally, only investments with original maturities of
3 months or less qualify. Examples of cash equivalents are Treasury
bills, commercial paper, and money market funds.
(c)
A compensating balance is that portion of any cash deposit maintained
by an enterprise that constitutes support for existing borrowing
arrangements with a lending institution.
A compensating balance representing a legally restricted deposit held
against short-term borrowing arrangements should be stated separately
among cash and cash equivalent items. A restricted deposit held as a
compensating balance against long-term borrowing arrangements
should be separately classified as a noncurrent asset in either the
investments or other assets section.
(d)
Short-term investments are investments held temporarily in place of
cash that can be readily converted to cash when current financing
needs make such conversion desirable. Examples of short-term investments include stock, Treasury notes, and other short-term securities.
The major differences between cash equivalents and short-term
investments are (1) cash equivalents typically have shorter maturities
(less than three months) whereas short-term investments either have
longer maturities (e.g., short-term bonds) or no maturity date (e.g., stock),
and (2) cash equivalents are readily convertible to known amounts of cash
whereas a company may have a gain or loss when selling its short-term
investments.
Financial Statement Analysis Case - UYJ6.3 (Continued)
(e)
Occidental would record a loss of $30,000,000 as revealed in the
following entry to record the transaction:
Cash ..................................................
Loss on Sale of Receivables ...........
Accounts Receivable ............
Recourse Liability ..................
(f)
345,000,000
30,000,000
360,000,000
15,000,000
The transaction in (e) will decrease Occidental’s liquidity position.
Current assets decrease by $15,000,000 and current liabilities are
increased by $15,000,000 (for the recourse liability).
LO: 1, 6, 7, Bloom: K, Difficulty: Simple, Time: 15-20, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, Research, AICPA PC:
Communication
Financial Statement Analysis Case: Microsoft
UYJ6.4
Part 1
(a)
Cash equivalents are short-term, highly liquid investments that are
both (a) readily convertible to known amounts of cash and (b) so near
their maturity that they present insignificant risk from changes in
interest rates. Generally, only investments with original maturities of 3
months or less qualify. Examples of cash equivalents are Treasury
bills, commercial paper, and money market funds.
(b)
(in millions)
(1) Current ratio
(2) Working capital
Microsoft
$181,915
$72,310
= 2.52
$181,915 – $72,310 = $109,605
Oracle
$52,140
$17,200
= 3.03
$52,140 – $17,200 = $34,940
Oracle’s current ratio is higher. Based on these measures, Oracle is more
liquid.
(c)
Yes, a company can have too many liquid assets. Liquid assets earn
little or no return. Investors in companies like Microsoft are
accustomed to returns of 30% on their investment. Thus, Microsoft’s
large amount of liquid assets may eventually create a drag on its ability to
meet investor expectations.
Financial Statement Analysis Case – UYJ6.4 (Continued)
Part 2
Current Year
(a)
Receivables Turnover
$143,015
= $143,015 = 4.65 times
($32,011 + $29,524)/2
$30,768
Or a collection period of 78.5 days (365 ÷ 4.65).
(b)
(c)
Bad Debt Expense ................................................
Allowance for Doubtful Accounts ..............
560
Allowance for Doubtful Accounts .......................
Accounts Receivable ..................................
178
560
178
Accounts receivable is reduced by the amount of bad debts in the
allowance account. This makes the denominator of the turnover ratio
lower, resulting in a higher turnover ratio.
LO: 2, 3, 7, Bloom: AN, Difficulty: Simple, Time: 15-20, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, Research, AICPA PC:
Communication
Accounting, Analysis, and Principles
UYJ6.5
ACCOUNTING
(a)
Accounts Receivable:
Beginning balance
$ 46,000
Credit sales during 2025
255,000
Collections during 2025
(228,000)
Charge-offs
(1,600)
Factored receivables
(10,000)
Ending balance
$ 61,400
Allowance for Doubtful Accounts:
Beginning balance
$ 550
Charge-offs
(1,600)
2025 Bad Debt Expense*
2,585
Ending balance
$1,535
*2025 Bad Debt Expense is the amount needed to make the ending
balance in the Allowance for Doubtful Accounts equal to $1,535
($61,400 X .025). In other words, $550 – $1,600 + Bad Debt Expense =
$1,535. Therefore, Bad Debt Expense = $1,535 + $1,600 – $550 =
$2,585.
(b)
Current assets section of December 31, 2025, The Flatiron Pub’s
balance sheet:
Cash
Accounts receivable (net of $1,535
allowance for uncollectibles)
Interest receivable
Due from factor
Note receivable
Postage stamps
Other current assets
Total current assets
$ 5,575
59,865
50
200
5,000
110
3,925
$74,725
Accounting, Analysis, and Principles - UYJ6.5 (continued)
Calculations:
Cash = $1,575 + $4,000a = $5,575
Accounts receivable, net = $61,400 – $1,535 = $59,865
Interest receivable = ($5,000 X 0.12)(1/12) = $50
Due from factor = ($10,000 X 0.02) = $200
Other current assets = $7,925 - $4,000a
ANALYSIS
(a)
2025 current ratio = $74,725 ÷ ($44,600 + $400) = 1.66
Accounts
Receivable
Turnover
$255,000
$255,000 = 4.84 times
=
[($46,000 – $550) + 59,865]
$52,658
2
Both the current ratio (2024 = ($2,000 + $46,000 - $550 + $8,500) ÷
$37,000 = 1.51) and the accounts receivable turnover (4.37) suggest
that Flatiron’s liquidity has improved in 2025 relative to 2024.
(b)
With a secured borrowing, the receivables would stay on The Flatiron
Pub’s books and a note payable would be recorded. This would reduce
both the current ratio and accounts receivable turnover.
PRINCIPLES
The expense recognition principle requires that bad debt expense should be
recorded in the period of the sale. Otherwise, income will be overstated by
the amount of bad debt expense. In addition, reporting the receivables net of
the allowance provides a more representationally faithful reporting (at net
realizable value) of this asset.
LO: 1, 3, 6, 7, Bloom: SYN, Difficulty: Moderate, 20-25, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC:
Communication
Time and Purpose of Critical Thinking Cases
CT 6.1 (Time 10–15 minutes)
Purpose—provides the student with the opportunity to discuss the deficiencies of the direct write-off
method, the justification for the allowance method for estimating bad debts, and to explain the accounting
for the recoveries of accounts written off previously.
CT 6.2 (Time 15–20 minutes)
Purpose—provides the student with the opportunity to discuss the accounting for cash discounts, trade
discounts, and the factoring of accounts receivable.
CT 6.3 (Time 25–30 minutes)
Purpose—provides the student with the opportunity to discuss the advantages and disadvantages of
handling reporting problems related to the Allowance for Doubtful Accounts balance. Recommendations
must be made concerning whether some type of allowance approach should be employed, how collection
expenses should be handled, and finally, the appropriate accounting treatment for recoveries. A very
complete case that should elicit a good discussion of this issue.
CT 6.4 (Time 25–30 minutes)
Purpose—provides the student the opportunity to discuss when interest revenue from a note receivable
is reported. In Part 2, the student is asked to contrast the estimation of bad debts based on credit sales
with that based on the balance in receivables and to describe the reporting of the allowance account and
the bad debts expense.
CT 6.5 (Time 20–25 minutes)
Purpose—provides the student with a discussion problem related to notes receivable sold without and
with recourse.
CT 6.6 (Time 20–30 minutes)
Purpose—provides the student the opportunity to account for a zero-interest-bearing note exchanged for
a unique machine. The student must consider valuation, financial statement disclosure, and factoring the
note.
CT 6.7 (Time 25–30 minutes)
Purpose—provides the student the opportunity to calculate interest revenue on an interest-bearing note
and a zero-interest-bearing note, and indicate how the notes should be reported on the balance sheet.
The student discusses how to account for collections on assigned accounts receivable and how to
account for factored accounts receivable.
CT 6.8 (Time 25–30 minutes)
Purpose—provides the student with a case related to the imputation of interest. One company has
overstated its income by not imputing an interest element on the zero-interest-bearing note receivable
that it received in the transaction. We have presented a short analysis to indicate what the proper solution
should be. It is unlikely that the students will develop a journal entry with dollar amounts, but they should
be encouraged to do so.
CT 6.9 (Time 25–30 minutes)
Purpose—provides the student with a case to analyze receivables irregularities, including a shortage.
This is a good writing assignment.
CT 6.10 (Time 25–30 minutes)
Purpose—provides the student with a case to analyze ethical issues inherent in bad debt judgments.
Solutions to Critical Thinking Cases
CT 6.1
(a) The direct write-off method overstates the trade accounts receivable on the balance sheet by
reporting them at more than the net amount expected to be collected. Furthermore, because the
write-off often occurs in a period after the revenues were generated, the direct write-off method does
not match bad debt expense with the revenues generated by sales in the same period.
(b) The allowance method estimates bad debts based on the balance in the trade accounts receivable
account. The method focuses on the balance sheet and attempts to value the accounts receivable
at the net amount expected to be collected.
(c) The company should account for the collection of the specific accounts previously written off as
uncollectible as follows:
•
•
Reinstatement of accounts by debiting Accounts Receivable and crediting Allowance for
Doubtful Accounts.
Collection of accounts by debiting Cash and crediting Accounts Receivable.
LO: 3, Bloom: AN, Difficulty: Simple, Time: 10-15, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
CT 6.2
(a) 1. Kimmel should account for the sales discounts at the date of sale using the net method by
recording accounts receivable and sales revenue at the amount of sales less the sales discounts
available.
Revenues should be recorded at the cash-equivalent (transaction) price at the date of sale.
Under the net method, the sale is recorded at an amount that represents the cash-equivalent
price at the date of the exchange (sale).
2. There is no effect on Kimmel’s sales revenues when customers do not take the sales discounts.
Kimmel’s net income is increased by the amount of interest (discount) earned when customers
do not take the sales discounts.
(b) Trade discounts are neither separately recorded in the accounts nor separately reported in the
financial statements. Therefore, the amount recorded as sales revenues and accounts receivable is
net of trade discounts and represents the cash-equivalent price of the asset sold.
(c) To account for the accounts receivable factored on August 1, 2020, Kimmel should decrease
accounts receivable by the amount of accounts receivable factored, increase cash by the amount
received from the factor, and record a loss. The difference between the cash received and the
carrying amount of the receivables is a loss. Factoring of accounts receivable on a without recourse
basis is equivalent to a sale.
(d) Kimmel should report the face amount of the interest-bearing notes receivable and the related
interest receivable for the period from October 1 through December 31 on its balance sheet as
noncurrent assets. Both assets are due on September 30, 2022, which is more than one year from
the date of the balance sheet.
CT 6.2 (Continued)
Kimmel should report interest revenue from the notes receivable on its income statement for the
year ended December 31, 2025. Interest revenue is equal to the amount accrued on the notes
receivable at the appropriate rate for three months.
Interest revenue is realized with the passage of time. Accordingly, interest revenue should be
accounted for as an element of income over the life of the notes receivable.
LO: 2, 6, Bloom: AN, Difficulty: Simple, Time: 15-20, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Measurement, Reporting, AICPA PC:
Communication
CT6.3
(1) Allowances and charge-offs. Method (a) is recommended. In the case of this company which has
a large number of relatively small sales transactions, it is practicable to give effect currently to the
probable bad debt expense and to report receivables at net realizable value. Whenever practicable,
it is advisable to accrue probable bad debt charges and apply them in the accounting periods in
which credit quality decreases. If the percentage is based on actual long-run experience, the
allowance balance is usually adequate to bring the accounts receivable in the balance sheet to
realizable values.
(2) Collection expenses. Method (a) or (b) is recommended. In the case of this company, one strong
argument for method (a) is that it is advisable to have the Bad Debt Expense account show the full
amount of expense relating to efforts to collect and failure to collect balances receivable. On the
other hand, an argument can be made to debit the Allowance account on the theory that bad debts
(including related expenses) are established at the time the allowance is first established. As a result,
the allowance account already has anticipated these expenses, and therefore, as they occur, they
should be charged against the allowance account. It should be noted that there is no “right answer”
to this question. It would seem that alternatives (c) and (d) are not good alternatives because the
expense is not identified with bad debts, which it should be.
(3) Recoveries. Method (c) is recommended. This method treats the recovery as a correction of a
previous write-off. It produces an allowance account that reflects the net experience with bad debts.
Method (a) might be acceptable if the provision for bad debts were based on experience with losses
without considering recoveries, but in this case, it would be advisable to use one account with a
specific designation rather than the broad designation “other revenue.” As indicated in the textbook,
recoveries are usually handled by reestablishing the receivable and allowance account and then
payment recorded. Method (c) is basically that approach.
LO: 3, Bloom: AN, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
CT 6.4
Part 1
Since Wallace Company is a calendar-year company, six months of interest should be accrued on
12/31/25. The remaining interest revenue should be recognized on 6/30/26 when the note is collected.
The rationale for this treatment is: the accrual basis of accounting provides more useful information than
does the cash basis. Therefore, since interest accrues with the passage of time, interest earned on
Wallace’s note receivable should be recognized over the life of the note, regardless of when the cash is
received.
CT 6.4 (Continued)
Part 2
(a) The allowance method based on the balance in accounts receivable is consistent with the expense
recognition principle. It attempts to value accounts receivable at the amount expected to be collected
and records bad debt expense in periods when credit quality decreases. The method is facilitated
by preparing an aging schedule of accounts receivable and plugging bad debt expense with the
adjustment necessary to bring the allowance account to the required balance. Alternatively, the
ending balance in accounts receivable can be used to determine the required balance in the
allowance account without preparing an aging schedule by using a composite percentage. Bad debt
expense is determined in the same manner as when an aging schedule is used.
(b) On Wallace’s balance sheet, the allowance for doubtful accounts is presented as a contra account
to accounts receivable with the resulting difference representing the net accounts receivable (i.e., the
net amount expected to be collected). Bad debt expense would generally be included on Wallace’s
income statement with the other operating (selling/general and administrative) expenses for the
period. However, theoretical arguments can be made for (1) reducing sales revenue by the bad
debts adjustment in the same manner that sales returns and allowances and trade discounts are
considered reductions of the amount to be received from sales of products or (2) classifying the bad
debt expense as a financial expense.
LO: 2, 4, Bloom: AN, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
CT 6.5
(a) The appropriate valuation basis of a note receivable at the date of sale is its discounted (present
value) of the future amounts receivable for principal and interest using the customer’s market rate
of interest, if known or determinable, at the date of the equipment’s sale.
(b) Corrs should increase the carrying amount of the note receivable by the effective-interest revenue
recognized for the period February 1 to May 1, 2025. Corrs should account for the sale of the note
receivable without recourse by increasing cash for the proceeds received, eliminating the carrying
amount of the note receivable, and recognizing a loss (gain) for the resulting difference.
This reporting is appropriate since the note’s carrying amount is correctly recorded at the date it was
sold and the sale of a note receivable without recourse has occurred. Thus the difference between
the cash received and the carrying amount of the note at the date it is sold is reported as a loss
(gain).
(c) 1. For notes receivable not sold, Corrs should recognize bad debt expense possibly using an aging
analysis or a discounted cash flow estimation. The expense equals the adjustment required to
bring the balance of the allowance for doubtful accounts equal to the estimated uncollectible
amounts less the fair values of recoverable equipment.
2. For notes receivable sold with recourse, at the time of sale, Corrs would have recorded a
recourse liability. This liability measures the estimated bad debts at the time of the sale and
increases the loss on the sale.
LO: 5, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
CT 6.6
(a) 1. It was not possible to determine the machine’s fair value directly, so the sales price of the
machine is reported at the note’s September 30, 2024, fair value. The note’s September 30,
2024, fair value equals the present value of the two installments discounted at the buyer’s
September 30, 2024 market rate of interest.
2. Rolen reports 2024 interest revenue determined by multiplying the note’s carrying amount at
September 30, 2024 times the buyer’s market rate of interest at the date of issue, times threetwelfths. Rolen should recognize that there is an interest factor implicit in the note, and this
interest is recognized with the passage of time. Therefore, interest revenue for 2024 should
include three months’ revenue. The rate used should be the market rate established by the
original present value, and this is applied to the carrying amount of the note.
(b) To report the sale of the note receivable with recourse, Rolen should decrease notes receivable by
the carrying amount of the note, increase cash by the amount received, record a recourse liability
for possible customer defaults (the recourse liability is reported on the balance sheet at 12/31/25)
and report the difference as a loss or gain as part of income from continuing operations.
(c) Rolen should decrease cash, increase notes (accounts) receivable past due for all payments caused
by the note’s dishonor and eliminate the recourse liability. The note (accounts) receivable should be
written down to its estimated recoverable amount (or an allowance for doubtful accounts
established), and a loss on uncollectible notes should be recorded for the excess of this difference
over the amount of the recourse liability previously recorded.
LO: 4, Bloom: AN, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
CT 6.7
(a) 1. For the interest-bearing note receivable, the interest revenue for 2025 should be determined by
multiplying the principal (face) amount of the note by the note’s rate of interest by one-half (July 1,
2025, to December 31, 2025). Interest accrues with the passage of time, and it should be accounted
for as an element of revenue over the life of the note receivable.
2. For the zero-interest-bearing note receivable, the interest revenue for 2025 should be determined by multiplying the carrying value of the note by the prevailing rate of interest at the date
of the note by one-third (September 1, 2025, to December 31, 2025). The carrying value of the
note at September 1, 2025, is the face amount discounted for two years at the prevailing interest
rate from the maturity date of August 31, 2027, back to the issuance date of September 1, 2025.
Interest, even if unstated, accrues with the passage of time, and it should be accounted for as an
element of revenue over the life of the note receivable.
(b) The interest-bearing note receivable should be reported at December 31, 2025, as a current asset
at its principal (face) amount.
The zero-interest-bearing note receivable should be reported at December 31, 2025, as a noncurrent asset at its face amount less the unamortized discount on the note at December 31, 2025.
(c) Because the trade accounts receivable are assigned, Moresan should account for the subsequent
collections on the assigned trade accounts receivable by debiting Cash and crediting Accounts
Receivable. The cash collected should then be remitted to Indigo Finance until the amount advanced
by Indigo is settled. The payments to Indigo Finance consist of both principal and interest with interest
computed at the rate of 8% on the balance outstanding.
CT 6.7 (Continued)
(d) Because the trade accounts receivable were factored on a without recourse basis, the factor is
responsible for collection. On November 1, 2025, Moresan should credit Accounts Receivable for
the amount of trade accounts receivable factored, debit Cash for the amount received from the
factor, debit a Receivable from Factor for 5% of the trade accounts receivable factored, and debit
Loss on Sale of Receivables for 3% of the trade accounts receivable factored.
LO: 4, 5, Bloom: AN, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, Communication, AICPA BC: None, AICPA AC: Reporting, AICPA PC: Communication
CT 6.8
The controller of Engone Company cannot justify the manner in which the company has accounted for
the transaction in terms of sound financial accounting principles.
Several problems are inherent in the sale of Henderson Enterprises stock to Bimini Inc. First, the issue
of whether an arm’s-length transaction has occurred may be raised. The controller stated that the stock
has not been marketable for the past six years. Thus, the recognition of revenue is highly questionable
given the limited market for the stock; i.e., has an exchange occurred?
Secondly, the collectibility of the note from Bimini is open to question. Bimini appears to have a liquidity
problem due to its current cash squeeze. The lack of assurance about collectibility raises the question of
whether revenue should be recognized.
Central to the transaction is the issue of imputed interest. If we assume that an arm’s-length exchange
has taken place, then the zero-interest-bearing feature masks the question of whether a gain, no gain or
loss, or a loss occurred.
For a gain to occur, the interest imputation must result in an interest rate of about 5% or less. To illustrate:
Present value of an annuity of $1 at 5% for 10 years = 7.72173; thus, the present value of ten
payments of $400,000 is $3,088,692. The cost of the investment is $3,000,000; thus, only an
$88,692 gain is recognized at 5%.
Selecting a more realistic interest rate (despite the controller’s ill-founded statements about “no cost”
money since he/she is ignoring the opportunity cost) of 8% finds the present value of the annuity of
$400,000 for ten periods equal to $2,684,032 ($400,000 X 6.71008). In this case, a loss of $315,968
must be recognized as illustrated by the following journal entry:
Notes Receivable .................................................................................
Loss on Disposal of Investment ............................................................
Equity Investment (Henderson Stock) ....................................
Discount on Notes Receivable ($4,000,000 - $2,684,032) .....
4,000,000
315,968
3,000,000
1,315,968
LO: 4, Bloom: AN, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, Communication, Reflective Thinking, AICPA BC: Problem Solving, AICPA AC: Reporting,
AICPA PC: Communication
CT 6.9
To:
Mark Price, Branch Manager
From:
Accounting Major
Date:
October 3, 2025
Subject:
Discrepancy in the Accounts Receivable Account
While performing a routine test on accounts receivable balances today, I discovered a $2,000 discrepancy.
I believe that this matter deserves your immediate attention.
To compute the shortage, I determined that the accounts receivable balance should have been based
on the amount of inventory that has been sold. When we opened for business this year, we purchased
$360,000 worth of merchandise inventory, and this morning, the balance in this account was $90,000.
The $270,000 ($360,000 - $90,000) difference plus the 40% markup indicates that sales on account
totaled $378,000 [$270,000 + ($270,000 X .40)] to date. I subtracted the payments of $188,000 made on
account this year and calculated the ending balance to be $190,000. However, the ledger shows a
balance of $192,000.
I realize that this situation is very sensitive and that we should not accuse any one individual without
further evidence. However, to protect the company’s assets, we must begin an immediate investigation
of this disparity.
Aside from me, the only other employee who has access to the accounts receivable ledger is Kelly
Collins, the receivables clerk. I will supervise Collins more closely in the future but suggest that we also
employ an auditor to check into this situation.
Note to Instructors: This situation could result from 1) Collins colluding with a customer, or 2) a
lack of segregation of duties where Collins is also involved with collections.
LO: 2, 3, Bloom: AN, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, Communication, Reflective Thinking, AICPA BC: Problem Solving, Professional Demeanor,
AICPA AC: Reporting, AICPA PC: Communication
CT 6.10
(a)
(1) Steps to Improve
Accounts Receivable Situation
Establish more selective credit-granting
policies, such as more restrictive credit
requirements or more thorough credit
investigations.
(2) Risks and Costs Involved
This policy could result in lost sales and
increased costs of credit evaluation. The
company may be all but forced to adhere
to the prevailing credit-granting policies of
the industry.
CT 6.10 (Continued)
(1) Steps to Improve
(2) Risks and Costs Involved
Accounts Receivable Situation
Establish a more rigorous collection
policy either through external collection
agencies or by its own personnel.
Charge interest on overdue accounts.
Insist on cash on delivery (COD) or cash
on order (COO) for new customers or
poor credit risks.
This policy may offend current customers
and thus risk future sales. Increased
collection costs could result from this
policy.
This policy could result in lost sales and
increased administrative costs.
(b) No, the controller should not be concerned with Marvin Company’s growth rate in estimating the
allowance. The accountant’s proper task is to make a reasonable estimate of uncollectible accounts.
In making the estimate, the controller should consider the previous year’s write-offs and also anticipate economic factors which might affect the company’s industry and influence Marvin’s current
write-off.
(c) Yes, the controller’s interest in disclosing financial information completely and fairly conflicts with the
president’s economic interest in manipulating income to avoid undesirable demands from the parent
company. Such a conflict of interest is an ethical dilemma. The controller must recognize the
dilemma, identify the alternatives, and decide what to do.
LO: 3, Bloom: AN, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, Communication, Reflective Thinking, AICPA BC: Problem Solving, Professional Demeanor,
AICPA AC: Reporting, AICPA PC: Communication
Codification Exercises
CE6.1
From the Master Glossary
(a) Consistent with common usage, cash includes not only currency on hand but demand deposits with
banks or other financial institutions. Cash also includes other kinds of accounts that have the general
characteristics of demand deposits in that the customer may deposit additional funds at any time
and also effectively may withdraw funds at any time without prior notice or penalty. All charges and
credits to those accounts are cash receipts or payments to both the entity owning the account and
the bank holding it. For example, a bank’s granting of a loan by crediting the proceeds to a
customer’s demand deposit account is a cash payment by the bank and a cash receipt of the
customer when the entry is made.
(b) Securitization is the process by which financial assets are transformed into securities.
(c) Recourse is the right of a transferee of receivables to receive payment from the transferor of those
receivables for any of the following:
a. Failure of debtors to pay when due
b. The effects of prepayments
c. Adjustments resulting from defects in the eligibility of the transferred receivables.
LO: 1, 2, 4, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Communication, AICPA BC: Technology, AICPA AC: Reporting, Research, Technology, AICPA PC:
Communication
CE6.2
According to the FASB ASC Subtopic 825-15 - Financial Instruments—Credit Losses:
Recognition
825-15-25-1 At each reporting date, an entity shall recognize an allowance for expected credit losses
on financial assets within the scope of this Subtopic. Expected credit losses are a current estimate of all
contractual cash flows not expected to be collected.
> Recognizing Changes in the Allowance for Expected Credit Losses
825-15-25-7 An entity shall recognize in the statement of financial performance (as a provision for
credit loss) the amount of credit loss (or reversal) required to adjust the allowance for expected credit
losses for the current period in the statement of financial position to that required under this Section.
Thus, adjustments to the allowance reflect estimates of changes in expected future uncollectible
accounts.
LO: 2, 4, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Communication, AICPA BC: Technology, AICPA AC: Reporting, Research, Technology, AICPA PC:
Communication
CE6.3
According to FASB ASC 860-10-05 (Overview and Background)
> Types of Transfers
05–6
Transfers of financial assets take many forms. This guidance provides an overview of the following types of transfers discussed in this Topic:
a.
Securitizations
b.
Factoring
c.
Transfers of receivables with recourse
d.
Securities lending transactions
e.
Repurchase agreements
f.
Loan participations
g.
Banker’s acceptances
>> Factoring
05–14 Factoring arrangements are a means of discounting accounts receivable on a nonrecourse,
notification basis. Accounts receivable are sold outright, usually to a transferee (the factor) that
assumes the full risk of collection, without recourse to the transferor in the event of a loss.
Debtors are directed to send payments to the transferee.
>> Transfers of Receivables with Recourse
05–15 In a transfer of receivables with recourse, the transferor provides the transferee with full or limited
recourse. The transferor is obligated under the terms of the recourse provision to make payments
to the transferee or to repurchase receivables sold under certain circumstances, typically for
defaults up to a specified percentage.
>> Securities Lending Transactions
05–16 Securities lending transactions are initiated by broker-dealers and other financial institutions that
need specific securities to cover a short sale or a customer’s failure to deliver securities sold.
Securities custodians or other agents commonly carry out securities lending activities on behalf
of clients.
>> Repurchase Agreements
05–19 Government securities dealers, banks, other financial institutions, and corporate investors commonly use repurchase agreements to obtain or use short-term funds. Under those agreements,
the transferor (repo party) transfers a security to a transferee (repo counterparty or reverse party)
in exchange for cash and concurrently agrees to reacquire that security at a future date for an
amount equal to the cash exchanged plus a stipulated interest factor. Instead of cash, other
securities or letters of credit sometimes are exchanged. Some repurchase agreements call for
the repurchase of securities that need not be identical to the securities transferred.
>> Loan Participations
05–22 In certain industries, a typical customer’s borrowing needs often exceed its bank’s legal lending
limits. To accommodate the customer, the bank may participate the loan to other banks (that is,
transfer under a participation agreement a portion of the customer’s loan to one or more
participating banks).
CE6.3 (Continued)
>> Banker’s Acceptances
05–24 Banker’s acceptances provide a way for a bank to finance a customer’s purchase of goods from
a vendor for periods usually not exceeding six months. Under an agreement between the bank,
the customer, and the vendor, the bank agrees to pay the customer’s liability to the vendor upon
presentation of specified documents that provide evidence of delivery and acceptance of the
purchased goods. The principal document is a draft or bill of exchange drawn
by the customer that the bank stamps to signify its acceptance of the liability to make payment
on the draft on its due date.
LO: 2, 4, Bloom: K, Difficulty: Simple, 15-20, AACSB: Communication, AICPA BC: Technology, AICPA AC: Reporting, Research, Technology, AICPA PC:
Communication
CE6.4
According to FASB ASC 210-20-45
> Right of Setoff Criteria
45-1
A right of setoff exists when all of the following conditions are met:
a. Each of two parties owes the other determinable amounts.
b. The reporting party has the right to set off the amount owed with the amount owed by the
other party.
c. The reporting party intends to set off.
d. The right of setoff is enforceable at law.
45-2
A debtor having a valid right of setoff may offset the related asset and liability and report the net
amount.
45-3
If the parties meet the criteria specified in paragraph 210-20-45-1, specifying currency or interest
rate requirements is unnecessary. However, if maturities differ, only the party with the nearer
maturity could offset because the party with the longer term maturity must settle in the manner
that the other party selects at the earlier maturity date.
45-4
If a party does not intend to set off even though the ability to set off exists, an offsetting presentation in the statement of financial position is not representationally faithful.
45-5
Acknowledgment of the intent of set off by the reporting party and, if applicable, demonstration
of the execution of the setoff in similar situations meet the criterion of intent.
LO: 2, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Communication, AICPA BC: Technology, AICPA AC: Reporting, Research, Technology, AICPA PC:
Communication
Codification Research Case
(a) Transfer of receivables is addressed in FASB ASC 860-10: Codification
String: Broad Transactions > 860 Transfers and Servicing > 10 Overall >
05 Background >
The predecessor literature can be accessed by clicking on “PrinterFriendly with sources” and then retrieve the previous standard at
www.fasb.org/st/
The previous statement that addressed transfers of receivables:
Statement of Financial Accounting Standards No. 140, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities (September 2000).
(b) Definitions: (Codification String: Broad Transaction > 860 Transfers and
Servicing > 10 Overall > 20 Glossary)
Transfer
The conveyance of a noncash financial asset by and to someone other
than the issuer of that financial asset.
A transfer includes the following:
a. Selling a receivable
b. Putting a receivable into a securitization trust
c. Posting a receivable as collateral.
A transfer excludes the following:
a. The origination of a receivable
b. Settlement of a receivable
c. The restructuring of a receivable into a security in troubled debt
restructuring.
Recourse
The right of a transferee of receivables to receive payment from the
transferor of those receivables for any of the following:
a. Failure of debtors to pay when due
b. The effects of prepayments
Codification Research Case (Continued)
c. Adjustments resulting from defects in the eligibility of the
transferred receivables.
Collateral
Personal or real property in which a security interest has been given.
LO: 4, Bloom: K, Difficulty: Moderate, Time: 10-15, AACSB: Communication, AICPA BC: Technology, AICPA AC: Reporting, Research, Technology, AICPA PC:
Communication
CHAPTER 7
Valuation of Inventories: A Cost-Basis Approach
Assignment Classification Table (By Topic)
Topics
Questions
Brief
Exercises
Exercises
Problems
Critical
Thinking
1, 2, 3, 5
1.
Inventory accounts;
4, 5, 6, 7, 8
determining quantities,
costs, and items to be
included in inventory;
the inventory equation;
balance sheet disclosure.
1, 3
1, 2, 3,
4, 5, 6
1, 2, 3
2.
Perpetual vs. periodic.
1, 2, 3
1, 2
9, 10, 14,
17
4, 5, 6
3.
Recording of discounts.
9, 10
7, 8
3
4
4.
Flow assumptions.
11, 12, 17,
20
9, 10, 11,
12, 13, 14,
15, 16, 17,
18, 19
1, 4, 5,
6, 7
5, 6, 7, 8, 11
15
7
6, 7, 10
8, 9
4, 5, 6
7
5.
Inventory accounting
changes.
6.
Dollar-value LIFO
methods.
13, 14, 15,
16, 18, 19
8, 9
19, 20, 21,
22, 23
1, 8, 9,
10, 11
7.
Inventory errors.
20
10
24, 25,
26
2
Assignment Classification Table (By Learning Objective)
Learning Objectives
Questions
Brief
Exercises
1.
Identify inventory
classifications and different
inventory systems.
1, 2, 3
1, 2
2.
Determine the goods and
costs included in inventory.
4, 5, 6, 7,
8, 9, 10
3
1, 2, 3, 4,
5, 6, 7, 8
3.
Describe and compare the
cost flow assumptions used
to account for inventories.
6, 11, 12
4, 5, 6
1, 2, 4, 5,
9, 10, 11,
12, 13,14, 6, 7
15, 16, 17,
19
6, 7, 10, 11
4.
Identify special issues
related to LIFO.
13, 14, 15,
16, 17, 18,
19
7, 8, 9
18, 19, 20, 8, 9, 10,
21, 22, 23 11
6, 8, 9, 10,
11
5.
Determine the effects of
inventory errors on the
financial statements.
20
10
24, 25, 26
Exercises
Problems
Critical
Thinking
4,5,6
1, 2, 3
1, 2, 3, 4, 5
Assignment Characteristics Table
Item
Description
Level of
Difficulty
E7.1
E7.2
E7.3
E7.4
E7.5
E7.6
E7.7
E7.8
E7.9
E7.10
E7.11
E7.12
E7.13
E7.14
E7.15
E7.16
E7.17
E7.18
E7.19
E7.20
E7.21
E7.22
E7.23
E7.24
E7.25
E7.26
Inventoriable goods and costs.
Inventoriable goods and costs.
Inventoriable goods and costs.
Inventoriable goods and costs—perpetual.
Inventoriable goods and costs—error adjustments.
Determining merchandise amounts—periodic.
Purchases recorded net.
Purchases recorded, gross method.
Periodic versus perpetual entries.
FIFO and LIFO—periodic and perpetual.
FIFO, LIFO and average-cost determination.
FIFO, LIFO, average-cost inventory.
Compute FIFO, LIFO, average-cost—periodic.
FIFO and LIFO—periodic and perpetual.
FIFO and LIFO; income statement presentation.
FIFO and LIFO effects.
FIFO and LIFO—periodic.
LIFO effect.
Alternate inventory methods—comprehensive.
Dollar-value LIFO.
Dollar-value LIFO.
Dollar-value LIFO.
Dollar-value LIFO.
Inventory errors—periodic.
Inventory errors.
Inventory errors.
Moderate
Moderate
Moderate
Moderate
Complex
Moderate
Simple
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Simple
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
15–20
10–15
10–15
10–15
15–20
10–20
10–15
20–25
15–25
15–20
20–25
15–20
15–20
10–15
15–20
20–25
10–15
10–15
25–30
5–10
15–20
20–25
15–20
10–15
10–15
15–20
P7.1
P7.2
P7.3
P7.4
P7.5
P7.6
Various inventory issues.
Inventory adjustments.
Purchases recorded gross and net.
Compute FIFO, LIFO, and average-cost.
Compute FIFO, LIFO, and average-cost.
Compute FIFO, LIFO, and average-cost—periodic
and perpetual.
Financial statement effects of FIFO and LIFO.
Dollar-value LIFO.
Internal indexes—dollar-value LIFO.
Internal indexes—dollar-value LIFO.
Dollar-value LIFO.
Moderate
Moderate
Moderate
Complex
Complex
Moderate
30–40
25–35
20–25
40–55
40–55
25–35
Moderate
Moderate
Moderate
Complex
Moderate
30–40
30–40
25–35
30–35
40–50
P7.7
P7.8
P7.9
P7.10
P7.11
Time
(minutes)
Assignment Characteristics Table (Continued)
Item
Description
Level of
Difficulty
Time
(minutes)
CT7.1
CT7.2
CT7.3
CT7.4
CT7.5
CT7.6
CT7.7
CT7.8
CT7.9
CT7.10
CT7.11
Inventoriable goods and costs.
Inventoriable goods and costs.
Inventoriable goods and costs.
Accounting treatment of purchase discounts.
General inventory issues.
LIFO inventory advantages.
Average-cost, FIFO, and LIFO.
LIFO application and advantages.
Dollar-value LIFO issues.
FIFO and LIFO.
LIFO choices.
Moderate
Moderate
Moderate
Simple
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
15–20
15–25
25–35
15–25
20–25
15–20
15–20
25–30
25–30
30–35
20–25
Answers to Questions
1. In a retailing concern, inventory normally consists of only one category that is the product awaiting
resale. In a manufacturing company, inventories consist of raw materials, work in process, and
finished goods. Sometimes a manufacturing or factory supplies inventory account is also included.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
2. (a)
Inventories are unexpired costs and represent future benefits to the owner. A statement of
financial position includes a listing of all unexpired costs (assets) at a specific point in time.
Because inventories are assets owned at the specific point in time for which a statement of
financial position is prepared, they must be included in order that the owners’ financial position
will be presented fairly.
(b) Beginning and ending inventories are included in the computation of net income only for the
purpose of arriving at the cost of goods sold during the period of time covered by the statement.
Goods included in the beginning inventory which are no longer on hand are expired costs to be
matched against revenues recognized during the period. Goods included in the ending
inventory are unexpired costs to be carried forward to a future period, rather than expensed.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
3. In a perpetual inventory system, data are available at any time on the quantity and dollar amount of
each item of material or type of merchandise on hand. A physical inventory is a physical count of
inventory on hand at a point in time. In a periodic system, the inventory is periodically counted (at
least once a year) but up-to-date records are not necessarily maintained. Discrepancies often occur
between the physical count and the perpetual records because of clerical errors, theft, waste,
misplacement of goods, etc.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
4. No, Mishima, Inc. should not report this amount on its balance sheet. As consignee, it does not own
this merchandise and therefore it is inappropriate for it to recognize this merchandise as part of its
inventory.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analysis, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
5. Sales with returns raise the possibility that legal title may have passed to the purchaser, but the seller
of the goods retains control of the inventory, if the goods are returned. Sales with high rates of return
illustrates the types of problems companies encounter in practice. In industries such as publishing,
music, toys, and sporting goods, formal or informal agreements often exist that permit purchasers to
return inventory for a full or partial refund
In these situations, the seller:
1. Record sales revenue at the amount it expects to receive from the transaction. As discussed in
Chapter 6, this transaction involves variable consideration. Therefore, the transaction price is
adjusted to recognize that a portion of these textbooks will be returned.
2. Establish an estimated inventory return account to recognize that some of the goods will be
returned. The reason for recording estimated inventory return is that control over a significant
number of the textbooks has not passed to Campus Bookstore.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
6. (a)
(b)
(c)
(d)
(e)
(f)
Inventory.
Not shown, possibly in a note to the financial statements if material.
Inventory.
Inventory, separately disclosed as raw materials.
Not shown, possibly a note to the financial statements.
Inventory or manufacturing supplies.
LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: AICPA BB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC:, AICPA BB: None
7. Cost, which has been defined generally as the price paid or consideration given to acquire an asset,
is the primary basis for accounting for inventories. As applied to inventories, cost means the sum of
the applicable expenditures and charges directly or indirectly incurred in bringing an article to its
existing condition and location. These applicable expenditures and charges include all acquisition
and production costs but exclude all selling expenses and that portion of general and administrative
expenses not clearly related to production. Freight charges applicable to the product are considered
a cost of the goods.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: Communication
8. By their nature, product costs “attach” to the inventory and are recorded in the inventory account.
These costs are directly connected with the bringing of goods to the place of business of the buyer
and converting such goods to a salable condition. Such charges would include freight charges on
goods purchased, other direct costs of acquisition, and labor and other production costs incurred in
processing the goods up to the time of sale.
Period costs are not considered to be directly related to the acquisition or production of goods and
therefore are not considered to be a part of inventories.
Conceptually, period costs are as much a cost of the product as the initial purchase price and related
freight charges attached to the product. While selling expenses are generally considered as more
directly related to the cost of goods sold than to the unsold inventory, in most cases, though, the
costs, especially administrative expenses, are so unrelated or indirectly related to the immediate
production process that any allocation is purely arbitrary.
Interest costs are considered a cost of financing and are generally expensed as incurred, when
related to getting inventories ready for sale.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: Communication
9.
Ford Motor Co. should not account for cash discounts (purchase discounts) as financial income
when payments are made. Income should be recognized when the performance obligation is
satisfied (when the company sells the inventory). Furthermore, a company does not recognize
revenue from purchasing goods. Cash discounts should be considered as a reduction in the cost
of the items purchased.
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: Communication
10. $60.00, $63.00, $61.80*. (Freight-In not included for discount.) * $63.00 − ($60  .02) = $61.80
LO: 2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: AICPA BB: None, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC:, AICPA BB: None
11. Arguments for the specific identification method are as follows:
(1) It provides an accurate and ideal matching of costs and revenues because the cost is
specifically identified with the sales price.
(2) The method is realistic and objective since it adheres to the actual physical flow of goods rather
than an artificial flow of costs.
(3) Inventory is valued at actual cost instead of an assumed cost.
Arguments against the specific identification method include the following:
(1) The cost of using it restricts its use to goods of high unit value.
(2) The method is impractical for manufacturing processes or cases in which units are commingled and identity lost.
(3) It allows an artificial determination of income by permitting arbitrary selection of the items to be
sold from a homogeneous group.
(4) It may not be a meaningful method of assigning costs in periods of changing price levels.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: AICPA BB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC:, AICPA BB: None
12. The first-in, first-out method approximates the specific identification method when the physical flow
of goods is on a FIFO basis. When the goods are subject to spoilage or deterioration, FIFO is
particularly appropriate. In comparison to the specific identification method, an attractive aspect of
FIFO is the elimination of the danger of artificial determination of income by the selection of
advantageously priced items to be sold. The basic assumption is that costs should be charged in
the order in which they are incurred. As a result, the inventories are stated at the latest costs. Where
the inventory is consumed and valued in the FIFO manner, there is no accounting recognition of
unrealized gain or loss. A criticism of the FIFO method is that it maximizes the effects of price
fluctuations upon reported income because current revenue is matched with the oldest costs which are
probably least similar to current replacement costs. On the other hand, this method produces a
balance sheet value for the asset close to current replacement costs. It is claimed that FIFO is
deceptive when used in a period of rising prices because the reported income is not fully available
since a part of it must be used to replace inventory at higher cost.
The results achieved by the average-cost method resemble those of the specific identification
method where items are chosen at random or there is a rapid inventory turnover. Compared with
the specific identification method, the average-cost method has the advantage that the goods need
not be individually identified; therefore, accounting is not so costly and the method can be applied
to fungible goods. The average-cost method is also appropriate when there is no marked trend in
price changes. In opposition, it is argued that the method is illogical. Since it assumes that all sales
are made proportionally from all purchases and that inventories will always include units from the
first purchases, it is argued that the method is illogical because it is contrary to the chronological
flow of goods. In addition, in periods of price changes there is a lag between current costs and costs
assigned to income or to the valuation of inventories.
If it is assumed that actual cost is the appropriate method of valuing inventories, last-in, first-out is
not theoretically correct. In general, LIFO is directly averse to the specific identification method
because the goods are not valued in accordance with their usual physical flow. An exception is the
application of LIFO to piled coal or ores which are more or less consumed in a LIFO manner.
Proponents argue that LIFO provides a better matching of current costs and revenues.
During periods of sharp price movements, LIFO has a stabilizing effect upon reported income figures
because it eliminates paper income and losses on inventory and smoothes the impact of income
taxes. LIFO opponents object to the method principally because the inventory valuation reported in
the balance sheet could be seriously misleading. The profit figures can be artificially influenced by
management through contracting or expanding inventory quantities. Temporary involuntary
depletion of LIFO inventories would distort current income by the previously unrecognized price
gains or losses applicable to the inventory reduction.
LO: 3, Bloom: K, Difficulty: Simple, Time: 5-10, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
13. A company may obtain a price index from an outside source (external index)—the government, a
trade association, an exchange—or by computing its own index (internal index) using the double
extension method. Under the double extension method, the ending inventory is priced at both baseyear costs and at current-year costs, with the total current cost divided by the total base cost to
obtain the current year index.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
14. Under the double extension method, LIFO inventory is priced at both base-year costs and currentyear costs. The total current-year cost of the inventory is divided by the total base-year cost to obtain
the current-year index.
The index for the LIFO pool consisting of product A and product B is computed as follows:
Base-Year Cost
Product
Units
Unit
Total
A
25,500
$10.20
$260,100
B
10,350
$37.00
382,950
December 31, 2025 inventory
$643,050
Current-Year Cost
Base-Year Cost
=
$1,007,460
$643,050
Current-Year Cost
Unit
Total
$21.00
$ 535,500
$45.60
471,960
$1,007,460
= 156.67, index at 12/31/25.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analysis, Communication, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC:
Communication
15. The LIFO method results in a smaller net income than FIFO because later costs, which are higher
than earlier costs, are matched against revenue. Conversely, in a period of falling prices, the LIFO
method would result in a higher net income because later costs in this case would be lower than
earlier costs, and these later costs would be matched against revenue.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
16. The dollar-value method uses dollars instead of units to measure increments, or reductions in a
LIFO inventory. After converting the closing inventory to the same price level as the opening
inventory, the increases in inventories, priced at base-year costs, is converted to the current price
level, and added to the opening inventory. Any decrease is subtracted at base-year costs to
determine the ending inventory.
The principal advantage is that it requires less record-keeping. It is not necessary to keep records
or make calculations of opening and closing quantities of individual items. Also, the use of a base
inventory amount gives greater flexibility in the makeup of the base and eliminates many detailed
calculations.
The unit LIFO inventory costing method is applied to each type of item in an inventory. Any type of
item removed from the inventory base (e.g., magnets) and replaced by another type (e.g., coils) will
cause the old cost (magnets) to be removed from the base and to be replaced by the more current
cost of the other item (coils).
The dollar-value LIFO costing method treats the inventory base as being composed of a base of
cost in dollars rather than of units. Therefore, a change in the composition of the inventory (less
magnets and more coils) will not change the cost of inventory base so long as the amount of the
inventory stated in base-year dollars does not change.
LO: 4, Bloom: K, Difficulty: Moderate, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
17. (a) LIFO layer—a LIFO layer (increment) is formed when the ending inventory at base-year prices
exceeds the beginning inventory at base-year prices.
(b) LIFO reserve—the difference between the inventory method used for internal purposes
and LIFO.
(c)
LIFO effect—the change in the LIFO reserve (Allowance to Reduce Inventory to LIFO) from
one period to the next.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
18.
December 31, 2025 inventory at December 31, 2024 prices, $1,053,000 ÷ 1.08 ........
$975,000
Less: Inventory, December 31, 2024 .........................................................................
Increment added during 2025 at base prices ..............................................................
800,000
$175,000
Increment added during 2025 at December 31, 2025 prices, $175,000 × 1.08 ...........
Add: Inventory at December 31, 2024 .........................................................................
Inventory, December 31, 2025, under dollar-value LIFO method ................................
$189,000
800,000
$989,000
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
19. Phantom inventory profits occur when the inventory costs matched against sales are less than the
replacement cost of the inventory. The cost of goods sold therefore is understated and profit is
considered overstated. Phantom profits are said to occur when FIFO is used during periods of rising
prices.
High inventory profits through involuntary liquidation occur if a company is forced to reduce its LIFO
base or layers. If the base or layers of old costs are eliminated, strange results can occur because
old, irrelevant costs can be matched against current revenues. A distortion in reported income for a
given period may result, as well as consequences that are detrimental from an income tax point of
view.
LO: 4, Bloom: K, Difficulty: Moderate, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
20. This omission of titled goods in transit by Clarkson would have no effect upon the net income for the
year since the purchases and the ending inventory are understated in the same amount. With
respect to financial position, both the inventory and the accounts payable would be understated.
Materiality would be a factor in determining whether an adjustment for this item should be made as
omission of a large item would distort the amount of current assets and the amount of current
liabilities. It, therefore, might influence the current ratio to a considerable extent.
LO: 5, Bloom: K, Difficulty: Moderate, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Solutions to Brief Exercises
Brief Exercise 7.1
RIVERA COMPANY
Balance Sheet (Partial)
December 31
Current assets
Cash ................................................................
Receivables (net) ...........................................
Inventories
Finished goods ......................................
Work in process .....................................
Raw materials .........................................
Prepaid insurance ..........................................
Total current assets ...............................
$ 190,000
400,000
$170,000
200,000
335,000
705,000
41,000
$1,336,000
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analysis, AICPA BB: None, AICPA FC: Reporting, AICPA PC: AICPA BB: None
Brief Exercise 7.2
Inventory (150 × $34)...............................................
Accounts Payable ..........................................
5,100
Accounts Payable (6 × $34) ....................................
Inventory.........................................................
204
Accounts Receivable (125 × $50) ...........................
Sales Revenue................................................
6,250
Cost of Goods Sold (125 × $34) .............................
Inventory.........................................................
4,250
5,100
204
6,250
4,250
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analysis, AICPA BB: None, AICPA FC: Reporting, AICPA PC: AICPA BB: None
Brief Exercise 7.3
December 31 inventory per physical count ..........
Goods-in-transit purchased FOB shipping point .
Goods-in-transit sold FOB destination..................
December 31 inventory..................................
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analysis, AICPA BB: None, AICPA FC: Reporting, AICPA PC: AICPA BB: None
Brief Exercise 7.4
$ 200,000
25,000
22,000
$ 247,000
Ending inventory 400 × $11.85 =
$11,850 = $ 11.85
1,000
$ 4,740
Cost of goods available for sale
Deduct ending inventory
Cost of goods sold (600 × $11.85)
$11,850
4,740
$ 7,110
Weighted average cost per unit
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 3-5, AACSB: Analysis, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: AICPA BB: None
Brief Exercise 7.5
April 23
April 15
Ending inventory
350 × $13 = $ 4,550
50 × $12 =
600
$ 5,150
Cost of goods available for sale
Deduct ending inventory
Cost of goods sold
$11,850
5,150
$ 6,700
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 3-5, AACSB: Analysis, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: AICPA BB: None
Brief Exercise 7.6
April 1
April 15
Ending inventory
Cost of goods available for sale
Deduct ending inventory
Cost of goods sold
250 × $10 =
150 × $12 =
$ 2,500
1,800
$ 4,300
$11,850
4,300
$ 7,550
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 3-5, AACSB: Analysis, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: AICPA BB: None
Brief Exercise 7.7
FIFO inventory balance at December 31, 2025 ..............
LIFO inventory balance at December 31, 2025 ..............
LIFO reserve at December 31, 2025 ...............................
$2,900,000
(1,500,000)
1,400,000
LIFO reserve at December 31, 2025 ...............................
$1,400,000
LIFO reserve at January 1, ..............................................
(1,300,000)
LIFO effect for 2025 .........................................................
100,000
At December 31, 2025, the entry to record the LIFO effect
is:
Cost of Goods Sold .................................................. 100,000
Allowance to Reduce Inventory to LIFO ....
100,000
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 3-5, AACSB: Analysis, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: AICPA BB: None
Brief Exercise 7.8
2024
2025
$100,000
$119,900 ÷ 1.10 = $109,000
$100,000 × 1.00 ...........................................................
$9,000* × 1.10 ..............................................................
$100,000
9,900
$109,900
*$109,000 – $100,000
2026
$134,560 ÷ 1.16 = $116,000
$100,000 × 1.00 ...........................................................
$9,000 × 1.10 ...............................................................
$7,000** × 1.16.............................................................
$100,000
9,900
8,120
$118,020
**$116,000 – $109,000
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analysis, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: AICPA BB: None
Brief Exercise 7.9
2025 inventory at base amount ($22,140 ÷ 1.08)
2024 inventory at base amount
Increase in base inventory
2025 inventory under LIFO
Layer one
$19,750 × 1.00
Layer two
$ 750 × 1.08
$ 20,500
(19,750)
$
750
2026 inventory at base amount ($25,935 ÷ 1.14)
2025 inventory at base amount
Increase in base inventory
2026 inventory under LIFO
Layer one
$19,750 × 1.00
Layer two
$ 750 × 1.08
Layer three
$ 2,250 × 1.14
$ 22,750
20,500
$ 2,250
$ 19,750
810
$ 20,560
$ 19,750
810
2,565
$ 23,125
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 3-5, AACSB: Analysis, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: AICPA BB: None
Brief Exercise 7.10
Cost of goods sold as reported ............................................
Overstatement of 12/31/24 inventory ....................................
Overstatement of 12/31/25 inventory ....................................
Corrected cost of goods sold ......................................
$1,400,000
(110,000)
35,000
$1,325,000
12/31/25 retained earnings as reported ................................
Overstatement of 12/31/25 inventory ....................................
Corrected 12/31/25 retained earnings .........................
$5,200,000
(35,000)
$5,165,000
LO: 5, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analysis, AICPA BB: None, AICPA FC: Reporting, AICPA PC: AICPA BB: None
Solutions to Exercises
Exercise 7.1 (15–20 minutes)
Items 1, 3, 5, 8, 11, 13, 14, 16, and 17 would be reported as inventory in the
financial statements.
The following items would not be reported as inventory:
2. Cost of goods sold in the income statement.
4. Not reported in the financial statements.
6. Cost of goods sold in the income statement.
7. Cost of goods sold in the income statement.
9. Interest expense in the income statement.
10. Advertising expense in the income statement.
12. Office supplies in the current assets section of the balance sheet.
15. Not reported in the financial statements.
18. Short-term investments in the current asset section of the balance
sheet.
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, AICPA BB: None, AICPA FC: Reporting, AICPA PC: AICPA BB: None
Exercise 7.2 (10–15 minutes)
Inventory per physical count
Goods in transit to customer, f.o.b. destination
Goods in transit from vendor, f.o.b. seller
Inventory to be reported on balance sheet
$441,000
+ 38,000
+ 51,000
$530,000
The consigned goods of $61,000 are not owned by Jose Oliva and were
properly excluded.
The goods in transit to a customer of $46,000, shipped f.o.b. shipping point,
are properly excluded from the inventory because the title to the goods
passed when they left the seller (Oliva) and therefore a sale and related cost
of goods sold should be recorded in 2025.
The goods in transit from a vendor of $83,000, shipped f.o.b. destination, are
properly excluded from the inventory because the title to the goods does not
pass to Oliva until the buyer (Oliva) receives them.
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analysis, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC:
Communication
Exercise 7.3 (10–15 minutes)
1.
Include. Ownership of the merchandise passes to customer only when
it is shipped.
2.
Do not include. Title did not pass until January 3.
3.
Include in inventory. Product belonged to Harlowe Inc. at December 31,
2025.
4.
Include in inventory. Under invoice terms, title passed when goods
were shipped.
5.
Do not include. Goods received on consignment remain the property
of the consignor.
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analysis, AICPA BB: None, AICPA FC: Reporting, AICPA PC: AICPA BB: None
Exercise 7.4 (10–15 minutes)
1.
2.
Raw Materials Inventory ..............................
Accounts Payable ...............................
8,100
Raw Materials Inventory ..............................
Accounts Payable ...............................
28,000
8,100
28,000
3.
No adjustment necessary.
4.
Accounts Payable ........................................
Raw Materials Inventory .....................
7,500
Raw Materials Inventory ..............................
Accounts Payable ...............................
19,800
5.
7,500
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analysis, AICPA BB: None, AICPA FC: Reporting, AICPA PC: AICPA BB: None
19,800
Exercise 7.5 (15–20 minutes)
(a)
Inventory December 31, 2025 (unadjusted)
Transaction 2
Transaction 3
Transaction 4
Transaction 5
Transaction 6
Transaction 7
Transaction 8
Inventory December 31, 2025 (adjusted)
(b)
Transaction 3
Sales Revenue ............................................
Accounts Receivable .........................
(To reverse sale entry in 2025)
Transaction 4
Purchases (Inventory) ................................
Accounts Payable ..............................
(To record purchase of merchandise
in 2025)
Transaction 8
Sales Returns and Allowances ..................
Accounts Receivable .........................
Inventory………………………………………
Cost of Goods Sold…………………..
$234,890
13,420
-0-08,540
(10,438)
(10,520)
1,500
$237,392
12,800
12,800
15,630
15,630
2,600
2,600
1,500
1,500
LO: 2, Bloom: AP, Difficulty: Hard, Time: 15-20, AACSB: Analysis, AICPA BB: None, AICPA FC: Reporting, AICPA PC: AICPA BB: None
Exercise 7.6 (10–20 minutes)
Sales Revenue
Sales Returns and Allowances
Net Sales
Beginning Inventory
Ending Inventory
Purchases
Purchase Returns and Allowances
Freight-in
Cost of Goods Sold
Gross Profit
2024
2025
2026
$290,000
(11,000)
279,000
20,000
(32,000*)
242,000
(5,000)
8,000
(233,000)
$ 46,000
$360,000
(13,000)
347,000
32,000
(37,000)
260,000
(8,000)
9,000
(256,000)
$ 91,000
$410,000
(20,000)
390,000
37,000**
(44,000)
298,000
(10,000)
12,000
(293,000)
$ 97,000
*This was given as the beginning inventory for 2025.
**This was calculated as the ending inventory for 2025.
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 10-20, AACSB: Analysis, AICPA BB: None, AICPA FC: Reporting, AICPA PC: AICPA BB: None
Exercise 7.7 (10–15 minutes)
(a)
May 10
May 11
May 19
May 24
Purchases .......................................
Accounts Payable..................
($15,000 × .98)
14,700
Purchases .......................................
Accounts Payable..................
($13,200 × .99)
13,068
Accounts Payable ...........................
Cash .......................................
14,700
Purchases .......................................
Accounts Payable
($11,500 × .98) ......................
11,270
14,700
13,068
14,700
11,270
Exercise 7.7 (Continued)
(b)
May 31
Purchase Discounts Lost .............................
Accounts Payable
($13,200 × .01) ...................................
(Discount lost on purchase of
May 11, $13,200, terms 1/15, n/30)
132
132
LO: 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analysis, AICPA BB: None, AICPA FC: Reporting, AICPA PC: AICPA BB: None
Exercise 7.8 (20–25 minutes)
(a)
Feb. 1
Feb. 4
Feb. 13
(b)
Feb. 1
Feb. 4
Feb. 13
(c)
Inventory [$10,800 – ($10,800 × .10)] ......
Accounts Payable ...........................
9,720
Accounts Payable [$2,500 –
($2,500 × .10)] ........................................
Inventory .........................................
2,250
9,720
2,250
Accounts Payable ($9,720 – $2,250) .......
Inventory (.03 × $7,470) ..................
Cash.................................................
7,470
Purchases [$10,800 – ($10,800 × .10)] ....
Accounts Payable ...........................
9,720
Accounts Payable [$2,500 – ($2,500 ×
.10)] ........................................................
Purchase Returns and Allowances ..
2,250
Accounts Payable ($9,720 – $2,250) .......
Purchase Discounts (.03 × $7,470) ...
Cash.................................................
Purchase price (list)
Less: Trade discount (.10 × $10,800)
Price on which cash discount based
Less: Cash discount (.03 × $9,720)
Net price
224.10
7,245.90
9,720
2,250
7,470
224.10
7,245.90
$10,800.00
1,080.00
9,720.00
291.60
$ 9,428.40
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC: AICPA BB: None
Exercise 7.9 (15–25 minutes)
(a)
Jan. 4
Jan. 11
Jan. 13
Jan. 20
Jan. 27
Jan. 31
Accounts Receivable.........................
Sales Revenue (80 × $8) ...........
640
Purchases ($150 × $6) .......................
Accounts Payable.....................
900
Accounts Receivable.........................
Sales Revenue (120 × $8.75) ....
1,050
Purchases (160 × $7) .........................
Accounts Payable.....................
1,120
Accounts Receivable.........................
Sales Revenue (100 × $9) .........
900
Inventory ($7 × 110) ...........................
Cost of Goods Sold ...........................
Purchases ($900 + $1,120) .......
Inventory (100 × $5) ..................
770
1,750*
640
900
1,050
1,120
900
2,020
500
*($500 + $2,020 – $770)
(b)
Sales revenue ($640 + $1,050 + $900)
Cost of goods sold
Gross profit
$2,590
1,750
$ 840
Exercise 7.9 (Continued)
(c)
Jan. 4
Jan. 11
Jan. 13
Jan. 20
Jan. 27
(d)
Accounts Receivable .........................
Sales Revenue (80 × $8) ...........
640
Cost of Goods Sold ...........................
Inventory (80 × $5) ....................
400
Inventory ............................................
Accounts Payable (150 × $6) .....
900
Accounts Receivable .........................
Sales Revenue (120 × $8.75) ....
1,050
Cost of Goods Sold ...........................
Inventory ([(20 × $5) +
(100 × $6)] ...............................
700
Inventory ............................................
Accounts Payable (160 × $7)....
1,120
Accounts Receivable .........................
Sales Revenue (100 × $9) .........
900
Cost of Goods Sold ...........................
Inventory [(50 × $6) +
(50 × $7)] .................................
650
Sales revenue
Cost of goods sold
($400 + $700 + $650)
Gross profit
640
400
900
1,050
700
1,120
900
650
$2,590
1,750
$ 840
Note: FIFO periodic and FIFO perpetual provide the same gross profit and inventory value.
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 15-25, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC: AICPA BB: None
Exercise 7.10 (15–20 minutes)
(a)
Units in ending inventory
Beginning balance
Purchases
Goods available
Sales
Ending balance
300
1,300 (800 + 500)
1,600
(1,000) (200 + 500 + 300)
600
(1)
Cost of Goods Sold
LIFO 500 @ $13 = $ 6,500
500 @ $12 =
6,000
$12,500
Ending Inventory
300 @ $10 =
$3,000
300 @ $12 =
3,600
$6,600
(2)
FIFO
300 @ $10 =
700 @ $12 =
$ 3,000
8,400
$11,400
500 @ $13 =
100 @ $12 =
(b)
LIFO
100 @ $10 =
300 @ $12 =
200 @ $13 =
$ 1,000
3,600
2,600
$ 7,200
(c)
Sales Revenue
Cost of Goods Sold
Gross Profit (FIFO)
$6,500
1,200
$7,700
$25,400 = ($24 @ 200) + ($25 @ 500) +
($27 @ 300)
11,400 = (200 @ $10) + (100 @ $10)
$14,000
+ (400 @ $12) + (300 @ $12)
Note: FIFO periodic and FIFO perpetual provide the same gross profit
and inventory value.
(d)
LIFO matches the most current costs with revenue. When prices are
rising (as is generally the case), this results in a higher amount for cost
of goods sold and a lower gross profit. As indicated in this exercise,
prices were rising, and cost of goods sold under LIFO was higher.
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC: AICPA BB: None
Exercise 7.11 (20–25 minutes)
(a)
(1)
LIFO
600 @ $6.00 = $3,600
100 @ $6.08 =
608
$4,208
(2)
Average cost
Total cost
=
Total units
$33,655*
5,300
= $6.35 average cost per unit
700 (5,300 − 4,600) @ $6.35
*Units
600
1,500
800
1,200
700
500
5,300
(b)
@
@
@
@
@
@
Price
$6.00
$6.08
$6.40
$6.50
$6.60
$6.79
=
=
=
=
=
=
(1)
FIFO
500 @ $6.79 = $3,395
200 @ $6.60 = 1,320
$4,715
(2)
LIFO
100 @ $6.00 = $ 600
100 @ $6.08 =
608
500 @ $6.79 = 3,395
$4,603
= $4,445
Total Cost
$ 3,600
9,120
5,120
7,800
4,620
3,395
$33,655
(c)
Total merchandise available for sale
Less: Inventory (FIFO)
Cost of goods sold
(d)
FIFO.
$33,655
4,715
$28,940
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC: AICPA BB: None
Exercise 7.12 (15–20 minutes)
(a)
Shania Twain Company
COMPUTATION OF INVENTORY FOR PRODUCT
BAP UNDER FIFO INVENTORY METHOD
March 31, 2025
March 26, 2025
February 16, 2025
January 25, 2025 (portion)
March 31, 2025, inventory
(b)
Unit Cost
$12.00
11.00
10.00
Total Cost
$ 7,200
8,800
2,000
$18,000
Shania Twain Company
COMPUTATION OF INVENTORY FOR PRODUCT
BAP UNDER LIFO INVENTORY METHOD
March 31, 2025
Beginning inventory
January 5, 2025 (portion)
March 31, 2025, inventory
(c)
Units
600
800
200
1,600
Units
600
1,000
1,600
Unit Cost
$8.00
9.00
Total Cost
$ 4,800
9,000
$13,800
Shania Twain Company
COMPUTATION OF INVENTORY FOR PRODUCT
BAP UNDER WEIGHTED-AVERAGE INVENTORY METHOD
March 31, 2025
Beginning inventory
January 5, 2025
January 25, 2025
February 16, 2025
March 26, 2025
Units
600
1,200
1,300
800
600
4,500
Weighted average cost
($44,600 ÷ 4,500)
March 31, 2025, inventory
*Rounded.
Unit Cost
$ 8.00
9.00
10.00
11.00
12.00
Total Cost
$ 4,800
10,800
13,000
8,800
7,200
$44,600
$ 9.91*
1,600
$ 9.91
$15,856
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC: AICPA BB: None
Exercise 7.13 (15–20 minutes)
(a)
(1) 2,100 units available for sale – 1,400 units sold = 700 units in the
ending inventory.
500 @ $4.58 = $2,290
200 @ 4.60 =
920
700
$3,210 Ending inventory at FIFO cost.
(2) 100 @ $4.10 =
600 @ 4.20 =
700
$ 410
2,520
$2,930 Ending inventory at LIFO cost.
(3) $9,240 cost of goods available for sale ÷ 2,100 units available for
sale = $4.40 weighted-average unit cost.
700 units × $4.40 = $3,080 Ending inventory at weighted-average
cost.
(b)
(1) LIFO will yield the lowest gross profit because this method will yield
the highest cost of goods sold figure in the situation presented. The
company has experienced rising purchase prices for its inventory
acquisitions. In a period of rising prices, LIFO will yield the highest
cost of goods sold because the most recent purchase prices (which
are the higher prices in this case) are used to price cost of goods
sold while the older (and lower) purchase prices are used to cost
the ending inventory.
(2) LIFO will yield the lowest ending inventory because LIFO uses the
oldest costs to price the ending inventory units. The company has
experienced rising purchase prices. The oldest costs in this case
are the lower costs.
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, Communication, AICPA BB: None Measurement, Reporting, AICPA PC:
Communication
Exercise 7.14 (10–15 minutes)
(a)
(1)
400 @ $30 =
160 @ $25 =
(2)
400 @ $20 =
160 @ $25 =
$12,000
4,000
$16,000
$ 8,000
4,000
$12,000
Exercise 7.14 (Continued)
(b)
(1)
FIFO
$16,000 [same as (a)]
(2)
LIFO
100 @ $20 =
60 @ $25 =
400 @ $30 =
$ 2,000
1,500
12,000
$15,500
LO: 3, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC: AICPA BB: None
Exercise 7.15 (15–20 minutes)
First-in, first-out
Sales revenue (21,000  $50)
Cost of goods sold:
Inventory, Jan. 1
Purchases
Cost of goods available
Inventory, Dec. 31
Cost of goods sold
Gross profit
Operating expenses
Net income
Last-in, first-out
$1,050,000
$120,000
592,000*
712,000
(235,000**)
$1,050,000
$120,000
592,000
712,000
(164,000***)
477,000
573,000
200,000
$ 373,000
548,000
502,000
200,000
$ 302,000
*Purchases
6,000 @ $22 =
$132,000
10,000 @ $25 =
250,000
7,000 @ $30 =
210,000
$592,000
**Computation of inventory, Dec. 31:
First-in, first-out:
7,000 units @ $30 =
$210,000
1,000 units @ $25 =
25,000
$235,000
***Last-in, first-out:
6,000 units @ $20 =
$120,000
2,000 units @ $22 =
44,000
$164,000
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC: AICPA BB: None
Exercise 7.16 (20–25 minutes)
Sandy Alomar Corporation
SCHEDULES OF COST OF GOODS SOLD
For the First Quarter Ended March 31, 2025
Beginning inventory
Plus purchases
Cost of goods available for sale
Less: Ending inventory
Cost of goods sold
Schedule 1
First-in, First-out
$ 40,000
146,200*
186,200
61,300
$124,900
Schedule 2 Last-in,
First-out
$ 40,000
146,200
186,200
56,800
$129,400
*($33,600 + $25,500 + $38,700 + $48,400)
Schedules Computing Ending Inventory
Units
10,000
34,000
44,000
30,000
14,000
Beginning inventory
Plus purchases
Units available for sale
Less sales ($150,000 ÷ 5)
Ending inventory
The unit computation is the same for both assumptions, but the cost
assigned to the units of ending inventory are different.
First-in, First-out (Schedule 1)
11,000 at $4.40 = $48,400
3,000 at $4.30 =
12,900
14,000
$61,300
Last-in, First-out (Schedule 2)
10,000 at $4.00 =
$40,000
4,000 at $4.20 =
16,800
14,000
$56,800
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC: AICPA BB: None
Exercise 7.17 (10–15 minutes)
(a)
FIFO Ending Inventory 12/31/2025
76 @ $10.89* =
$ 827.64
24 @ $11.88** =
285.12
$1,112.76
*[$11.00 – .01 ($11.00)]
**[$12.00 – .01 ($12.00)]
(b)
LIFO Cost of Goods Sold—2025
76 @ $10.89 =
$ 827.64
84 @ $11.88 =
997.92
90 @ $14.85* =
1,336.50
15 @ $15.84** =
237.60
$3,399.66
*[$15.00 – .01 ($15.00)]
**[$16.00 – .01 ($16.00)]
(c)
FIFO matches older costs with revenue. When prices are declining, as
in this case, this results in a higher amount for cost of goods sold.
Therefore, it is recommended that FIFO be used by Brady Sports to
minimize taxable income.
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analysis, Communication, AICPA BB: None Measurement, Reporting, AICPA PC:
Communication
Exercise 7.18 (10–15 minutes)
(a)
The difference between the inventory used for internal reporting
purposes and LIFO is referred to as the Allowance to Reduce Inventory
to LIFO or the LIFO reserve. The change in the allowance balance from
one period to the next is called the LIFO effect (or as shown in this
example, the LIFO adjustment).
(b)
LIFO subtracts inflation from inventory costs by charging the items
purchased recently to cost of goods sold. As a result, ending inventory
(assuming increasing prices) will be lower than FIFO or average cost.
Exercise 7.18 (Continued)
(c)
Cash flow was computed as follows:
Revenue
$3,200,000
Cost of goods sold
(2,800,000)
Operating expenses
(150,000)
Income taxes
(75,600)
Cash flow
$ 174,400
If the company has any sales on account or payables, then the cash
flow number is incorrect. It is assumed here that the cash basis of
accounting is used.
(d)
The company has extra cash because its taxes are less. The reason
taxes are lower is because cost of goods sold (in a period of inflation)
is higher under LIFO than FIFO. As a result, taxable income is lower
which leads to lower income taxes. If prices are decreasing, the
opposite effect results.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
Exercise 7.19 (25–30 minutes)
(a)
(1)
Ending inventory—Specific Identification
Date
No. Units
Unit Cost
December 2
July 20
(2)
Ending inventory—FIFO
Date
No. Units
December 2
September 4
(3)
100
50
150
100
50
150
Ending inventory—LIFO
Date
No. Units
January 1
March 15
100
50
150
Total Cost
$30
25
$3,000
1,250
$4,250
Unit Cost
Total Cost
$30
28
$3,000
1,400
$4,400
Unit Cost
Total Cost
$20
24
$2,000
1,200
$3,200
Exercise 7.19 (Continued)
(4) Ending inventory—Average-Cost
Date
Explanation
January 1
March 15
July 20
September 4
December 2
Beginning inventory
Purchase
Purchase
Purchase
Purchase
No.
Units
Unit
Cost
Total
Cost
100
300
300
200
100
1,000
$20
24
25
28
30
$ 2,000
7,200
7,500
5,600
3,000
$25,300
$25,300 ÷ 1,000 = $25.30
Ending Inventory—Average-Cost
No. Units
Unit Cost
Total Cost
150
$25.30
$3,795
(b)
Double Extension Method
Base-Year Costs
Units
150
Base-Year
Cost Per Unit
$20
Current Costs
Total
$3,000
Units
100
50
Current-Year
Cost Per Unit
$30
$28
Ending Inventory for the Period at Current Cost
Ending Inventory for the Period at Base-Year Cost
=
Total
$3,000
1,400
$4,400
$4,400
= 1.4667
$3,000
Ending inventory at base-year prices ($4,400 ÷ 1.4667)
Base layer (100 units at $20)
Increment in base-year dollars
Current index
Increment in current dollars
Base layer (100 units at $20)
Ending inventory at dollar-value LIFO
$3,000
(2,000)
1,000
X 1.4667
1,467
2,000
$3,467
LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 25-30, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC: AICPA BB: None
Exercise 7.20 (5–10 minutes)
$97,000 – $92,000 = $5,000 increase at base prices.
$98,350 – $92,600 = $5,750 increase in dollar-value LIFO value.
$5,000 × Index = $5,750.
Index = $5,750 ÷ $5,000.
Index = 115
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 5-10, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC: AICPA BB: None
Exercise 7.21 (15–20 minutes)
(a)
(b)
12/31/25 inventory at 1/1/25 prices, $140,000 ÷ 1.12
Inventory 1/1/25
Inventory decrease at base prices
$125,000
160,000
$ 35,000
Inventory at 1/1/25 prices
Less decrease at 1/1/25 prices
Inventory 12/31/25 under dollar-value LIFO method
$160,000
35,000
$125,000
12/31/26 inventory at base prices, $172,500 ÷ 1.15
12/31/25 inventory at base prices
Inventory increment at base prices
$150,000
125,000
$ 25,000
Inventory at 12/31/25
Increment added during 2026 at 12/31/26 prices,
$25,000 × 1.15
Inventory 12/31/26
$125,000
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC: AICPA BB: None
28,750
$153,750
Exercise 7.22 (20–25 minutes)
2022
2023
2024
2025
2026
2027
Current $
$ 80,000
115,500
108,000
122,200
154,000
176,900
Price Index
1.00
1.05
1.20
1.30
1.40
1.45
Base Year $
$ 80,000
110,000
90,000
94,000
110,000
122,000
Change from
Prior Year
—
$ +30,000
(20,000)
+ 4,000
+16,000
+12,000
Ending Inventory—Dollar-value LIFO:
2022
$80,000
2023
$80,000 @ 1.00 =
30,000 @ 1.05 =
$ 80,000
31,500
$111,500
2024
$80,000 @ 1.00 =
10,000 @ 1.05 =
$ 80,000
10,500
$ 90,500
2025
$80,000 @ 1.00 =
10,000 @ 1.05 =
4,000 @ 1.30 =
$ 80,000
10,500
5,200
$ 95,700
2026 $80,000 @ 1.00 =
10,000 @ 1.05 =
4,000 @ 1.30 =
16,000 @ 1.40 =
2027
$ 80,000
10,500
5,200
22,400
$118,100
$80,000 @ 1.00 =
10,000 @ 1.05 =
4,000 @ 1.30 =
16,000 @ 1.40 =
12,000 @ 1.45 =
$ 80,000
10,500
5,200
22,400
17,400
$135,500
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC: AICPA BB: None
Exercise 7.23 (15–20 minutes)
Date
Dec. 31, 2021
Dec. 31, 2022
Dec. 31, 2023
Dec. 31, 2024
Dec. 31, 2025
Current $
$ 70,000
90,300
95,120
105,600
100,000
Price Index
1.00
1.05
1.16
1.20
1.25
Base-Year $
$70,000
86,000
82,000
88,000
80,000
Change from
Prior Year
—
$+16,000
(4,000)
+ 6,000
(8,000)
Ending Inventory—Dollar-value LIFO:
Dec. 31, 2021 $70,000
Dec. 31, 2022 $70,000 @ 1.00 =
16,000 @ 1.05 =
$70,000
16,800
$86,800
Dec. 31, 2023 $70,000 @ 1.00 =
12,000 @ 1.05 =
$70,000
12,600
$82,600
Dec. 31, 2024 $70,000 @ 1.00 =
12,000 @ 1.05 =
6,000 @ 1.20 =
$70,000
12,600
7,200
$89,800
Dec. 31, 2025 $70,000 @ 1.00 =
10,000 @ 1.05 =
$70,000
10,500
$80,500
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC: AICPA BB: None
Exercise 7.24 (10–15 minutes)
1.
Working capital
Current ratio
Retained earnings
Net income
Current Year
Overstated
Overstated
Overstated
Overstated
Subsequent Year
No effect
No effect
No effect
Understated
2.
Working capital
Current ratio
Retained earnings
Net income
No effect
Overstated*
No effect
No effect
No effect
No effect
No effect
No effect
3.
Working capital
Current ratio
Retained earnings
Net income
Overstated
Overstated
Overstated
Overstated
No effect
No effect
No effect
Understated
*Assume that the correct current ratio is greater than one.
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC: AICPA BB: None
Exercise 7.25 (10–15 minutes)
(a)
$370,000
= 1.85 to 1
$200,000
$370,000 + $22,000 – $13,000
$200,000 – $15,000
(b)
=
$379,000
= 2.05 to 1
$185,000
(c)
1.
2.
3.
Event
Understatement of ending
inventory
Overstatement of purchases
Overstatement of ending
inventory
Effect of Error
Decreases net income
Adjust Income
Increase (Decrease)
$22,000
Decreases net income
Increases net income
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 10-15, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC: AICPA BB: None
Exercise 7.26 (15–20 minutes)
15,000
(13,000)
$24,000
Errors in Inventories
Year
2020
2021
2022
2023
2024
2025
Net
Income
Per Books
$ 50,000
52,000
54,000
56,000
58,000
60,000
$330,000
Add
Overstatement Jan. 1
Deduct
Understatement Jan. 1
Deduct
Add
OverstateUnderstatement Dec. 31 ment Dec. 31
$3,000*
9,000
$3,000
9,000
$11,000
$11,000
2,000
2,000
8,000
*The error will reverse in 2021.
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC: AICPA BB: None
Corrected
Net Income
$ 47,000
46,000
74,000
45,000
60,000
50,000
$322,000
Time and Purpose of Problems
Problem 7.1 (Time 30–40 minutes)
Purpose—to provide a multipurpose problem with trade discounts, goods in transit, computing internal
price indexes, dollar-value LIFO, comparative FIFO, LIFO, and average-cost computations, and
inventoriable cost identification.
Problem 7.2 (Time 25–35 minutes)
Purpose—to provide the student with eight different situations that require analysis to determine their
impact on inventory, accounts payable, and net sales.
Problem 7.3 (Time 20–25 minutes)
Purpose—to provide the student with an opportunity to prepare general journal entries to record
purchases on a gross and net basis.
Problem 7.4 (Time 40–55 minutes)
Purpose—to provide a problem where the student must compute the inventory using a FIFO, LIFO, and
average-cost assumption. These inventory value determinations must be made under two differing
assumptions: (1) perpetual inventory records are kept in units only and (2) perpetual records are kept in
dollars. Many detailed computations must be made in this problem.
Problem 7.5 (Time 40–55 minutes)
Purpose—to provide a problem where the student must compute the inventory using a FIFO, LIFO, and
average-cost assumption. These inventory value determinations must be made under two differing
assumptions: (1) perpetual inventory records are kept in units only and (2) perpetual records are kept in
dollars. This problem is very similar to Problem 7.4, except that the differences in inventory values must
be explained.
Problem 7.6 (Time 25–35 minutes)
Purpose—to provide a problem where the student must compute cost of goods sold using FIFO, LIFO,
and weighted average, under both a periodic and perpetual system.
Problem 7.7 (Time 30–40 minutes)
Purpose—to provide a problem where the student must identify the accounts that would be affected if
LIFO had been used rather than FIFO for purposes of computing inventories.
Problem 7.8 (Time 30–40 minutes)
Purpose—to provide a problem which covers the use of inventory pools for dollar-value LIFO. The student
is required to compute ending inventory, cost of goods sold, and gross profit using dollar-value LIFO, first
with one inventory pool and then with three pools.
Problem 7.9 (Time 25–35 minutes)
Purpose—the student computes the internal conversion price indexes for a LIFO inventory pool and then
computes the inventory amounts using the dollar-value LIFO method.
Problem 7.10 (Time 30–35 minutes)
Purpose—to provide the student with the opportunity to compute inventories using the dollar-value
approach. An index must be developed in this problem to price the new layers. This problem will prove
difficult for the student because the indexes are hidden.
Problem 7.11 (Time 40–50 minutes)
Purpose—to provide the student with an opportunity to write a memo on how a dollar-value LIFO
pool works. In addition, the student must explain the step-by-step procedure used to compute dollar value
LIFO.
Solutions to Problems
Problem 7.1
1.
$175,000 – ($175,000 × .20) = $140,000;
$140,000 – ($140,000 × .10) = $126,000, cost of goods purchased
2.
$1,100,000 + $69,000 = $1,169,000. The $69,000 of goods in transit on
which title had passed on December 24 (f.o.b. shipping point) should
be added to 12/31/25 inventory. The $29,000 of goods shipped (f.o.b.
shipping point) on January 3, 2026, should remain part of the 12/31/25
inventory.
3.
Because no date was associated with the units issued or sold, the
periodic (rather than perpetual) inventory method must be assumed.
FIFO inventory cost:
1,000 units at $24
1,000 units at 23
Total
$ 24,000
23,000
$ 47,000
LIFO inventory cost:
1,500 units at $21
500 units at 22
Total
$ 31,500
11,000
$ 42,500
Average-cost:
1,500 at $21
2,000 at 22
3,500 at 23
1,000 at 24
8,000
$ 31,500
44,000
80,500
24,000
$180,000
Totals
$180,000 ÷ 8,000 = $22.50
Ending inventory (2,000 × $22.50) is $45,000.
Problem 7.1 (Continued)
4.
Computation of price indexes:
12/31/25
$264,000 = 1.10 (110)
$240,000
12/31/26
$286,720 = 1.12 (112)
$256,000
Dollar-value LIFO inventory 12/31/25:
Increase $240,000 – $200,000 =
12/31/25 price index
Increase in terms of 110
Base inventory
Dollar-value LIFO inventory
$ 40,000
×
1.10
44,000 2025 Layer
200,000
$244,000
Dollar-value LIFO inventory 12/31/26:
Increase $256,000 – $240,000 =
12/31/26 price index
Increase in terms of 112
2025 layer
Base inventory
Dollar-value LIFO inventory
5.
$ 16,000
×
1.12
17,920 2026 Layer
44,000
200,000
$261,920
The inventoriable costs for 2026 are:
Merchandise purchased ................................
Add: Freight-in ..............................................
Deduct: Purchase returns ............................
Purchase discounts .......................
Inventoriable cost ..........................................
$909,400
22,000
931,400
$16,500
6,800
23,300
$908,100
LO: 2, 3, 4, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC:, AICPA BB: None
Problem 7.2
DIMITRI COMPANY
Schedule of Adjustments
December 31, 2025
Initial amounts
Adjustments:
1.
2.
3.
4.
5.
6.
7.
8.
Total adjustments
Adjusted amounts
Inventory
$1,520,000
Accounts
Payable
$1,200,000
Net Sales
$8,150,000
NONE
76,000
30,000
32,000
26,000
27,000
NONE
4,000
195,000
$1,715,000
NONE
76,000
NONE
NONE
NONE
NONE
56,000
8,000
140,000
$1,340,000
(40,000)
NONE
NONE
(47,000)
NONE
NONE
NONE
NONE
(87,000)
$8,063,000
1.
The $31,000 of tools on the loading dock were properly included in the
physical count. The sale should not be recorded until the goods are
picked up by the common carrier. Therefore, no adjustment is made to
inventory, but sales must be reduced by the $40,000 billing price.
2.
The $76,000 of goods in transit from a vendor to Dimitri were shipped
f.o.b. shipping point on 12/29/25. Title passes to the buyer as soon as
goods are delivered to the common carrier when sold f.o.b. shipping
point. Therefore, these goods are properly includable in Dimitri’s inventory and accounts payable at 12/31/25. Both inventory and accounts
payable must be increased by $76,000.
3.
The work-in-process inventory sent to an outside processor is Dimitri’s
property and should be included in ending inventory. Since this inventory
was not in the plant at the time of the physical count, the inventory
column must be increased by $30,000.
Problem 7.2 (Continued)
4.
The tools costing $32,000 were recorded as sales ($47,000) in 2025.
However, these items were returned by customers on December 31, so
2025 net sales should be reduced by the $47,000 return. Also, $32,000
has to be added to the inventory column since these goods were not
included in the physical count.
5.
The $26,000 of Dimitri’s tools shipped to a customer f.o.b. destination
are still owned by Dimitri while in transit because title does not pass on
these goods until they are received by the buyer. Therefore, $26,000
must be added to the inventory column. No adjustment is necessary in
the sales column because the sale was properly recorded in 2026 when
the customer received the goods.
6.
The goods received from a vendor at 5:00 p.m. on 12/31/25 should be
included in the ending inventory but were not included in the physical
count. Therefore, $27,000 must be added to the inventory column. No
adjustment is made to accounts payable, since the invoice was included in
12/31/25 accounts payable.
7.
The $56,000 of goods received on 12/26/25 were properly included in the
physical count of inventory; $56,000 must be added to accounts payable
since the invoice was not included in the 12/31/25 accounts payable
balance.
8.
Since one-half of the freight-in cost ($8,000) pertains to merchandise
properly included in inventory as of 12/31/25, $4,000 should be added to
the inventory column. The remaining $4,000 debit should be reflected in
cost of goods sold. The full $8,000 must be added to accounts payable
since the liability was not recorded.
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
Problem 7.3
(a)
1.
2.
8/10
Purchases.........................................................
Accounts Payable ...................................
12,000
8/13
Accounts Payable ............................................
Purchase Returns and Allowances ........
1,200
8/15
Purchases.........................................................
Accounts Payable ...................................
16,000
8/25
Purchases.........................................................
Accounts Payable ...................................
20,000
8/28
Accounts Payable ............................................
Cash .........................................................
16,000
12,000
1,200
16,000
20,000
16,000
Purchases—addition to beginning inventory in cost of goods sold
section of income statement.
Purchase returns and allowances—deduction from purchases in
cost of goods sold section of the income statement.
Accounts payable—current liability in the current liabilities section of the balance sheet.
(b)
1.
8/10
Purchases.........................................................
Accounts Payable ($12,000 × .98) ..........
8/13
Accounts Payable ............................................
Purchase Returns and Allowances
($1,200 × .98).........................................
11,760
11,760
1,176
1,176
Problem 7.3 (Continued)
2.
3.
(c)
8/15
Purchases..........................................................
Accounts Payable ($16,000 × .99) ...........
15,840
8/25
Purchases..........................................................
Accounts Payable ($20,000 × .98) ...........
19,600
8/28
Accounts Payable .............................................
Purchase Discounts Lost .................................
Cash ..........................................................
15,840
160
8/31
Purchase Discounts Lost .................................
Accounts Payable
(.02 × [$12,000 – $1,200]) ......................
15,840
19,600
16,000
216
216
Same as part (a) (2) except:
Purchase Discounts Lost—treat as financial expense in income
statement.
The second method is better theoretically because it results in the
inventory being carried net of purchase discounts, and purchase
discounts not taken are shown as an expense. The first method is
normally used, however, for practical reasons.
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
Problem 7.4
(a)
Purchases
Total Units
April 1 (balance on hand)
April 4
April 11
April 18
April 26
April 30
Total units
Total units sold
Total units (ending inventory)
Sales
Total Units
100
400
300
200
600
200
1,800
1,450
350
April 5
April 12
April 27
April 28
Total units
300
200
800
150
1,450
Assuming costs are not computed for each withdrawal:
1.
2.
First-in, first-out.
Date of Invoice
April 30
April 26
No. Units
200
150
Unit Cost
$5.80
5.60
Total Cost
$1,160
840
$2,000
Last-in, first-out.
Date of Invoice
April 1
April 4
No. Units
100
250
Unit Cost
$5.00
5.10
Total Cost
$ 500
1,275
$1,775
Problem 7.4 (Continued)
3.
Average-cost.
Cost of Part X available.
Date of Invoice
No. Units
April 1
100
April 4
400
April 11
300
April 18
200
April 26
600
April 30
200
Total Available
1,800
Unit Cost
$5.00
5.10
5.30
5.35
5.60
5.80
Total Cost
$ 500
2,040
1,590
1,070
3,360
1,160
$9,720
Average-cost per unit = $9,720 ÷ 1,800 = $5.40.
Inventory, April 30 = 350 × $5.40 = $1,890.
(b) Assuming costs are computed for each withdrawal:
1.
First-in, first-out.
The inventory would be the same in amount as in part (a), $2,000.
Problem 7.4 (Continued)
2.
Last-in, first-out.
Purchased
Date
No. of
units
Unit
cost
April 1
100
April 4
400
Unit
cost
Amount
$5.00
100
$5.00
$
5.10
100
5.00
400
5.10
April 26
100
5.00
100
5.10
300
100
5.00
100
5.10
300
5.30
100
5.00
100
5.10
100
5.30
100
5.00
100
5.10
100
5.30
200
5.35
100
5.00
100
5.10
100
5.30
200
5.35
600
5.60
100
5.00
100
5.10
100
5.30
$5.10
5.30
200
200
600
5.60
800
April 28
150
200
5.30
5.35
April 27
April 30
Unit
cost
300
April 12
April 18
No. of
units
Balance*
No. of
units
April 5
April 11
Sold
5.80
600 @
5.60
200 @
5.35
100 @
5.30
100
5.00
50 @
5.10
50
5.10
100
5.00
50
5.10
200
5.80
500
2,540
1,010
2,600
1,540
2,610
5,970
1,540
755
1,915
Inventory, April 30 is $1,915.
*The balance on hand is listed in detail after each transaction.
Problem 7.4 (Continued)
3.
Average-cost.
Purchased
Date
No. of
units
Unit
cost
April 1
100
April 4
400
No. of
units
Unit
cost*
Amount
$5.00
100
$5.0000
$ 500.00
5.10
500
5.0800
2,540.00
200
5.0800
1,016.00
500
5.2120
2,606.00
300
5.2120
1,563.60
300
300
Unit
cost
Balance
No. of
units
April 5
April 11
Sold
$5.0800
5.30
April 12
200
5.2120
April 18
200
5.35
500
5.2672
2,633.60
April 26
600
5.60
1,100
5.4487
5,993.57
April 27
800
5.4487
300
5.4487
1,634.61
April 28
150
5.4487
150
5.4487
817.30
350
5.6494
1,977.30
April 30
200
5.80
Inventory, April 30 is $1,977.30
*Four decimal places are used to minimize rounding errors.
LO: 3, Bloom: AP Complex, Time: 40-55, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC:, AICPA BB: None
Problem 7.5
(a) Assuming costs are not computed for each withdrawal (units received,
5,700, minus units issued, 4,700, equals ending inventory of 1,000 units):
1.
2.
3.
First-in, first-out.
Date of Invoice
Jan. 28
No. Units
1,000
Unit Cost
$3.50
Total Cost
$3,500
Last-in, first-out.
Date of Invoice
Jan. 2
No. Units
1,000
Unit Cost
$3.00
Total Cost
$3,000
Unit Cost
$3.00
3.20
3.30
3.40
3.50
Total Cost
$ 3,600
1,920
3,300
4,420
5,600
$18,840
Average-cost.
Cost of goods available:
Date of Invoice
No. Units
Jan. 2
1,200
Jan. 10
600
Jan. 18
1,000
Jan. 23
1,300
Jan. 28
1,600
Total Available
5,700
Average-cost per unit = $18,840 ÷ 5,700 = $3.31
Cost of inventory Jan. 31 = 1,000 × $3.31 = $3,310
(b) Assuming costs are computed at the time of each withdrawal:
Under FIFO—Yes. The amount shown as ending inventory would be the
same as in (a) above. In each case the units on hand would be assumed
to be part of those purchased on Jan. 28.
Under LIFO—No. During the month the available balance dropped below
the ending inventory quantity so that the layers of oldest costs were
partially liquidated during the month.
Problem 7.5 (Continued)
Under Average-Cost — No. A new average cost would be computed
each time a purchase was made instead of only once for all items
purchased during the year.
The calculations to determine the inventory on this basis are given below.
1.
First-in, first-out.
The inventory would be the same in amount as in part (a), $3,500.
2.
Last-in, first-out.
Received
Date
No. of
units
Unit
cost
Jan. 2
1,200
$3.00
Jan. 7
Jan. 10
600
500
1,000
1,300
3.30
Jan. 31
300
3.20
3.30
700
3.30
100
3.20
300
3.00
800
1,600
$3.00
3.40
Jan. 26
Jan. 28
Unit
cost
3.20
Jan. 20
Jan. 23
No. of
units
700
Jan. 13
Jan. 18
Issued
3.40
3.50
1,300
Inventory, January 31 is $3,350.
3.50
Balance
No. of
units
Unit
cost*
Amount
1,200
$3.00
$3,600
500
3.00
1,500
500
3.00
600
3.20
500
3.00
100
3.20
500
3.00
100
3.20
700
3.30
200
3.00
200
3.00
1,300
3.40
200
3.00
500
3.40
200
3.00
500
3.40
1,600
3.50
200
3.00
500
3.40
300
3.50
3,420
1,820
4,130
600
5,020
2,300
7,900
3,350
Problem 7.5 (Continued)
3.
Average-cost.
Received
Date
No. of
units
Unit
cost
Jan. 2
1,200
$3.00
Jan. 7
Jan. 10
600
1,000
1,300
3.30
Jan. 31
$3.0000
No. of
units
Unit
cost*
Amount
1,200
$3.0000
$3,600
500
3.0000
1,500
1,100
3.1091
3,420
3.1091
600
3.1091
1,865
300
3.2281
1,300
3.2281
4,197
1,100
3.2281
200
3.2281
646
1,500
3.3773
5,066
700
3.3773
2,364
2,300
3.4626
7,964
1,000
3.4626
3,463
800
1,600
Balance
500
3.40
Jan. 26
Jan. 28
Unit
cost
3.20
Jan. 20
Jan. 23
No. of
units
700
Jan. 13
Jan. 18
Issued
3.3773
3.50
1,300
3.4626
Inventory, January 31 is $3,463.
*Four decimal places are used to minimize rounding errors.
LO: 3, Bloom: AP Complex, Time: 40-55, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC:, AICPA BB: None
Problem 7.6
(a)
(b)
(c)
(d)
Date
Beginning inventory ....................
Purchases (2,000 + 3,000) ...........
Units available for sale ................
Sales (2,500 + 2,200) ....................
Goods on hand ............................
Periodic FIFO
1,000 × $12 =
2,000 × $18 =
1,700 × $23 =
4,700
$12,000
36,000
39,100
$87,100
Perpetual FIFO
Same as periodic:
$87,100
Periodic LIFO
3,000 × $23 =
1,700 × $18 =
4,700
$69,000
30,600
$99,600
1,000
5,000
6,000
(4,700)
1,300
Perpetual LIFO
Purchased
Sold
Balance
1/1
2/4
1,000 × $12
2,000 × $18 = $36,000
1,000 × $12
2,000 × $18
2/20
2,000 × $18
500 × $12
4/2
} $42,000
3,000 × $23 = $69,000
500 × $12
2,200 × $23
= $50,600
500 × $12
800 × $23
$92,600
}
500 × $12
3,000 × $23
11/4
=
$12,000
$48,000
=
$ 6,000
}
$75,000
}
$24,400
Problem 7.6 (Continued)
(e)
(f)
Periodic weighted-average
1,000 × $12 =
$ 12,000
2,000 × $18 =
36,000
3,000 × $23 =
69,000
$117,000 ÷ 6,000 = $19.50
4,700
× $19.50
$91,650
Perpetual moving average
Date
Purchased
Sold
Balance
1/1
1,000 × $12 = $12,000
2/4
2,000 × $18 = $36,000
2/20
2,500 × $16 =
4/2
$40,000
48,000
500 × $16 =
8,000
a
3,000 × $23 = $69,000
11/4
3,000 × $16 =
2,200 × $22 =
48,400
3,500 × $22 =
77,000
1,300 × $22 =
28,600
$88,400
a
500 × $16 = $ 8,000
3,000 × $23 = 69,000
3,500
$77,000
($77,000 ÷ 3,500 = $22)
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analysis, AICPA BB: None Measurement, Reporting, AICPA PC: AICPA BB: None
Problem 7.7
The accounts in the 2026 financial statements which would be affected by a
change to LIFO and the new amount for each of the accounts are as follows:
New amount
Account
for 2026
(1) Cash
$176,400
(2) Inventory
120,000
(3) Retained earnings
226,400
(4) Cost of goods sold
792,000
(5) Income taxes
101,600
The calculations for both 2025 and 2026 to support the conversion to LIFO
are presented below.
Income for the Years Ended
12/31/25
12/31/26
Sales revenue
Less: Cost of goods sold
Other expenses
Income before taxes
Income taxes (40%)
Net income
$900,000
525,000
205,000
730,000
170,000
68,000
$102,000
$1,350,000
792,000
304,000
1,096,000
254,000
101,600
$ 152,400
Cost of Goods Sold and
Ending Inventory for the Years Ended
12/31/25
12/31/26
Beginning inventory
Purchases
Cost of goods available
Ending inventory
Cost of goods sold
$120,000
525,000
645,000
(120,000)
$525,000
( 40,000 × $3.00)
(150,000 × $3.50)
( 40,000 × $3.00)
( 40,000 × $3.00)
(180,000 × $4.40)
( 40,000 × $3.00)
$120,000
792,000
912,000
(120,000)
$792,000
Determination of Cash at
12/31/25
12/31/26
Income taxes under FIFO
Income taxes as calculated under LIFO
Increase in cash
Adjust cash at 12/31/26 for 2025 tax
difference
Total increase in cash
Cash balance under FIFO
Cash balance under LIFO
$ 76,000
68,000
8,000
$116,000
101,600
14,400
—
8,000
130,000
$138,000
8,000
22,400
154,000
$176,400
Problem 7.7 (Continued)
Determination of Retained Earnings at
12/31/25
12/31/26
Net income under FIFO
Net income under LIFO
Reduction in retained earnings
Adjust retained earnings at 12/31/26 for
2025 reduction
Total reduction in retained earnings
Retained earnings under FIFO
Retained earnings under LIFO
$114,000
(102,000)
12,000
$174,000
(152,400)
21,600
—
12,000
200,000
$188,000
12,000
33,600
260,000
$226,400
LO: 3, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC: AICPA BB: None
Problem 7.8
(a)
1.
2.
3.
Ending inventory in units
Portable
6,000 + 15,000 – 14,000 =
Midsize
8,000 + 20,000 – 24,000 =
Flat-screen
3,000 + 10,000 – 6,000 =
Ending inventory at current cost
Portable
7,000 × $110 =
Midsize
4,000 × $300 =
Flat-screen
7,000 × $500 =
Ending inventory at base-year cost
Portable
7,000 × $100 =
Midsize
4,000 × $250 =
Flat-screen
7,000 × $400 =
4.
Price index
$5,470,000 ÷ $4,500,000 = 1.2156
5.
Ending inventory
$3,800,000 × 1.0000 =
700,000* × 1.2156 =
7,000
4,000
7,000
18,000
$ 770,000
1,200,000
3,500,000
$5,470,000
$ 700,000
1,000,000
2,800,000
$4,500,000
$3,800,000
850,920
$4,650,920
*($4,500,000 – $3,800,000 = $700,000)
6.
Cost of goods sold
Beginning inventory ...............................................
Purchases
[(15,000 × $110) + (20,000 × $300) +
(10,000 × $500)] ....................................................
Cost of goods available ..........................................
Ending inventory.....................................................
Cost of goods sold............................................
$ 3,800,000
12,650,000
16,450,000
(4,650,920)
$11,799,080
Problem 7.8 (Continued)
7.
(b)
1.
Gross profit
Sales revenue
[(14,000 × $150) + (24,000 × $405) +
(6,000 × $600)] .........................................................
Cost of goods sold.....................................................
Gross profit ................................................................
$15,420,000
11,799,080
$ 3,620,920
Ending inventory at current cost restated to base cost
Portable
$ 770,000 ÷ 1.10a =
$ 700,000
Midsize
1,200,000 ÷ 1.20b =
$ 1,000,000
Flat-screen
3,500,000 ÷ 1.25c =
$ 2,800,000
a. $110 ÷ $100
b. $300 ÷ $250
c. $500 ÷ $400
2.
3.
4.
Ending inventory
Portable
$ 600,000 × 1.00 =
100,000 × 1.10 =
Midsize
1,000,000 × 1.00 =
Flat-screen
1,200,000 × 1.00 =
1,600,000 × 1.25 =
$
600,000
110,000
1,000,000
1,200,000
2,000,000
$ 4,910,000
Cost of goods sold
Cost of goods available .............................................
Ending inventory ........................................................
Cost of goods sold ...............................................
$16,450,000
(4,910,000)
$11,540,000
Gross profit
Sales revenue .............................................................
Cost of goods sold.....................................................
Gross profit ................................................................
$15,420,000
11,540,000
$ 3,880,000
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC:, AICPA BB: None
Problem 7.9
(a)
BONANZA WHOLESALERS INC.
Computation of Internal Conversion Price Index
for Inventory Pool No. 1 Double Extension Method
Current inventory at
current-year cost
Product A
Product B
17,000 × $36 =
9,000 × $26 =
Current inventory at
base cost
Product A
Product B
17,000 × $30 =
9,000 × $25 =
2025
$612,000
234,000
$846,000
$510,000
225,000
$735,000
Conversion price index $846,000 ÷ $735,000 = 1.15
(b)
13,000 × $30 =
10,000 × $25 =
$390,000
250,000
$640,000
$840,000 ÷ $640,000 = 1.31
BONANZA WHOLESALERS INC.
Computation of Inventory Amounts
Under Dollar-Value LIFO Method for Inventory Pool No. 1
at December 31, 2025 and 2026
Current
Inventory at
base cost
December 31, 2025
Base inventory
2025 layer ($735,000 – $525,000)
Total
$525,000
210,000
$735,000
December 31, 2026
Base inventory
2025 layer (remaining)
Total
$525,000
115,000
$640,000
(a)
(b)
13,000 × $40 =
10,000 × $32 =
2026
$520,000
320,000
$840,000
Conversion
price index
1.00
1.15
(a)
$525,000
241,500
$766,500
(a)
$525,000
132,250
$657,250
(a)
(b)
(a)
1.00
1.15
Inventory at
LIFO cost
Per schedule for instruction (a).
After liquidation of $95,000 base cost ($735,000 – $640,000).
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC: AICPA BB: None
Problem 7.10
Base-Year
Cost
December 31, 2024
January 1, 2024, base
December 31, 2024, layer
December 31, 2025
January 1, 2024, base
December 31, 2024, layer
December 31, 2025, layer
December 31, 2026
January 1, 2024, base
December 31, 2024, layer
December 31, 2025, layer
December 31, 2026, layer
Index %
Dollar-Value
LIFO
$45,000
11,000
$56,000
100
112*
$45,000
12,320
$57,320
$45,000
11,000
12,400
$68,400
100
112
128**
$45,000
12,320
15,872
$73,192
$45,000
11,000
12,400
1,600
$70,000
100
112
128
130***
$45,000
12,320
15,872
2,080
$75,272
*$62,700 ÷ $56,000
**$87,300 ÷ $68,400
***$90,800 ÷ $70,000
LO: 4, Bloom: AP Complex, Time: 30-35, AACSB: Analysis, AICPA BB: None Reporting, AICPA PC: AICPA BB: None
Problem 7.11
(a)
Schedule A
2021
2022
2023
2024
2025
2026
A
B
C
Current $
$ 80,000
111,300
108,000
128,700
147,000
174,000
Price Index
1.00
1.05
1.20
1.30
1.40
1.45
Base-Year $
$ 80,000
106,000
90,000
99,000
105,000
120,000
D
Change from
Prior Year
—
+ $26,000
(16,000)
+ 9,000
+ 6,000
+ 15,000
Schedule B
Ending Inventory-Dollar-Value LIFO:
2021
2022
2023
2024
$80,000 @ $1.00 =
26,000 @ 1.05 =
$80,000 @ 1.00 =
10,000 @ 1.05 =
$80,000 @ 1.00 =
10,000 @ 1.05 =
9,000 @ 1.30 =
$ 80,000
$ 80,000
27,300
$107,300
$ 80,000
10,500
$ 90,500
$ 80,000
10,500
11,700
$102,200
2025 $80,000 @ $1.00 =
10,000 @ 1.05 =
9,000 @ 1.30 =
6,000 @ 1.40 =
2026 $80,000 @
10,000 @
9,000 @
6,000 @
15,000 @
1.00 =
1.05 =
1.30 =
1.40 =
1.45 =
$ 80,000
10,500
11,700
8,400
$110,600
$ 80,000
10,500
11,700
8,400
21,750
$132,350
Problem 7.11 (Continued)
(b)
To:
Richardson Company
From:
Accounting Student
Subject:
Dollar-Value LIFO Pool Accounting
Dollar-value LIFO is an inventory method which values groups or “pools” of
inventory in layers of costs. It assumes that any goods sold during a given
period were taken from the most recently acquired group of goods in stock
and, consequently, any goods remaining in inventory are assumed to be the
oldest goods, valued at the oldest prices.
Because dollar-value LIFO combines various related costs in groups or
“pools,” no attempt is made to keep track of each individual inventory item.
Instead, each group of annual purchases forms a new cost layer of inventory.
Further, the most recent layer will be the first one carried to cost of goods
sold during this period.
However, inflation distorts any cost of purchases made in subsequent years.
To counteract the effect of inflation, this method measures the incremental
change in each year’s ending inventory in terms of the first year’s (base
year’s) costs. This is done by adjusting subsequent cost layers, through the
use of a price index, to the base year’s inventory costs. Only after this
adjustment can the new layer be valued at current-year prices.
To do this valuation, you need to know both the ending inventory at yearend prices and the price index used to adjust the current year’s new layer.
The idea is to convert the current ending inventory into base-year costs. The
difference between the current year’s and the previous year’s ending
inventory expressed in base-year costs usually represents any inventory
which has been purchased but not sold during the year, that is, the newest
LIFO layer. This difference is then readjusted to express this most recent
layer in current-year costs.
Problem 7.11 (Continued)
1.
Refer to Schedule A. To express each year’s ending inventory (Column A)
in terms of base-year costs, simply divide the ending inventory by the
price index (Column B). For 2021, this adjustment would be $80,000/
100% or $80,000; for 2022, it would be $111,300/105%, etc. The quotient
(Column C) is thus expressed in base-year costs.
2.
Next, compute the difference between the previous and the current
years’ ending inventory in base-year costs. Simply subtract the current
year’s base-year inventory from the previous year’s. In 2022, the change
is +$26,000 (Column D).
3.
Finally, express this increment in current-year terms. For the second
year, this computation is straightforward: the base-year ending
inventory value is added to the difference in #2 above multiplied by the
price index. For 2022, the ending inventory for dollar-value LIFO would
equal $80,000 of base-year inventory plus the increment ($26,000) times
the price index (1.05) or $107,300. The product is the most recent layer
expressed in current-year prices. See Schedule B.
Be careful with this last step in subsequent years. Notice that, in 2023, the
change from the previous year is –$16,000, which causes the 2022 layer to
be eroded during the period. Thus, the 2023 ending inventory is valued at the
original base-year cost $80,000 plus the remainder valued at the 2022 price
index, $10,000 times 1.05. See 2023 computation on Schedule B.
When valuing ending inventory, remember to include each yearly layer
adjusted by that year’s price index. Refer to Schedule B for 2024. Notice that
the +$9,000 change from the 2024 ending inventory indicates that the 2022
layer was not further eroded. Thus, ending inventory for 2024 would value
the first $80,000 worth of inventory at the base-year price index (1.00), the
next $10,000 (the remainder of the 2022 layer) at the 2022 price index (1.05),
and the last $9,000 at the 2024 price index (1.30).
These instructions should help you implement dollar-value LIFO in your
inventory valuation.
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 40-50, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
UYJ7.1 Financial Statement Analysis Case
(a)
Sales .......................................................................
Cost of goods sold* ...............................................
Gross profit ............................................................
Selling and administrative expense .....................
Income from operations ........................................
Other expense ........................................................
Income before income tax .....................................
$618,876,000
474,206,000
144,670,000
102,112,000
42,558,000
24,712,000
$ 17,846,000
*Cost of goods sold (per annual report) ................
LIFO effect ($5,263,000 – $3,993,000) ...................
Cost of goods sold (per FIFO) ..............................
$475,476,000
(1,270,000)
$474,206,000
(b)
$17,846,000 income before taxes × 46.6% tax = $8,316,236 tax;
$17,846,000 – $8,316,236 tax = $9,529,764 net income as compared to
$8,848,000 net income under LIFO. This is $681,764 or about 8%
different. The question as to materiality is to allow the students an
opportunity to judge the significance of the difference between the two
costing methods. Since it is less than 10% different, some students may
feel that it is not material. An 8% change in net income, however, is
probably material, but this would depend on the industry and perhaps
on the company’s own past averages.
(c)
No, the use of different costing methods does not necessarily mean
that there is a difference in the physical flow of goods. As explained in
the text, the actual physical flow need have no relationship to the cost
flow assumption. The management of T J International has determined
that LIFO is appropriate only for a subset of its products, and these
reasons have to do with economic characteristics, rather than the
physical flow of the goods.
LO: 3, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, Communication, AICPA BB: None Reporting, Research, AICPA PC: Communication
UYJ7.2 Financial Statement Analysis Case
(a)
The most likely physical flow of goods for a pharmaceutical manufacturer would be FIFO; that is, the first goods manufactured would be the
first goods sold. This is because pharmaceutical goods have an expiration date. The manufacturer would be careful to ship the goods made
earliest first and thereby reduce the risk that outdated goods will
remain in the warehouse.
(b)
Noven should consider first whether the inventory costing method will
make a difference. If the prices in the economy, especially if the raw
materials prices, are stable, then the inventory cost will be nearly the
same under any of the measurement methods. If inventory levels are
very small, then the method used will make little difference. Noven
should also consider the cost of keeping records. A small company
might not want to invest in complicated record keeping. The tax effects
of any differences should be considered, as well as any international
rules that might dictate Noven’s measurement of part of its inventory.
(c)
This amount is likely not shown in a separate inventory account
because it is immaterial; that is, it is not large enough to make a difference with investors. Another possible reason is that no goods have yet
been offered for sale. This amount might be in the Inventory of supplies
account, but it is more likely to be included with Prepaid and other
current assets since it clearly is not just an item of supplies. This will
definitely be shown separately as soon as Noven begins to sell its
products to outside customers.
LO: 3, Bloom: AN, Difficulty: Moderate, Time: 10-15, AACSB: Analytic, Communication, AICPA BB: None Reporting, Research, AICPA PC: Communication
UYJ7.3 Financial Statement Analysis Case
Net Sales .........................................
February 1,
2020
$122,286
February 2,
2019
$121,852
February 3,
2018
$122,662
Cost of sales (using LIFO) .............
Year-end inventories using FIFO ..
Year-end inventories using LIFO ..
Difference ...............................
FIFO adjusted cost of sales............
95,294
8,464
7,084
(1,380)
$ 93,914
95,103
8,123
6,846
(1,277)
$ 93,826
95,662
7,781
6,533
(1,248)
$ 94,414
(a)
2020
2021
(1) Inventory turnover @ LIFO*
13.68
14.22
(2) Inventory turnover @ FIFO*
11.32
11.80
Recall that the formula for computing inventory turnover is Cost
of Sales/Average Inventory
(b)
2020
2019
(1) Inventory turnover using sales and LIFO*
17.56
18.21
Recall that the formula for computing inventory turnover in part (b)
is Sales/Average Inventory
(2) Inventory turnover using sales and FIFO*
14.74
15.32
(c)
Using sales instead of cost of goods sold accounts for the mark-up in
the inventory. By using cost of goods sold, there is a better matching of
the costs associated to inventory and should result in more useful
information.
*Computations for Inventory Turnover
a) Inventory turnover LIFO–
2020 - $95,294/{($7,084 + $6,846)/2} = 13.68
2019 - $95,103/{($6,846 + $6,533)/2} = 14.22
Inventory turnover FIFO–
2020 - $93,914/{($8,464 + $8,123)/2} = 11.32
2019 - $93,826/{($8,123 + $7,781)/2} = 11.80
UYJ7.3 Financial Statement Analysis Case (Continued)
b) Inventory turnover LIFO–
2020 - $122,286/{($7,084 + $6,846)/2} = 17.56
2019 - $121,852/{($6,846 + $6,533)/2} = 18.21
Inventory turnover FIFO–
2020 - $122,286/{($8,464 + $8,123)/2} = 14.74
2019 - $121,852/{($8,123 + $7,781)/2} = 15.32
LO: 3, Bloom: AN, Difficulty: Complex, Time: 10-15, AACSB: Analytic, Communication, AICPA BB: None Reporting, Research, AICPA PC: Communication
UYJ7.4 Accounting, Analysis, and Principles
Accounting
(a)
FIFO
Residential pumps:
Ending inventory cost = (300 × $500) + (200 × $475) =
Beginning inventory cost = (200 × $400) =
Purchases = $225,000 + $190,000 + $150,000 =
Cost of goods sold = $80,000 + $565,000 – $245,000 =
$ 245,000
$ 80,000
$ 565,000
$ 400,000
Commercial pumps:
Ending inventory at cost = (500 × $1,000) =
Beginning inventory at cost = (600 × $800) =
Purchases = $540,000 + $285,000 + $500,000 =
Cost of goods sold = $480,000 + $1,325,000 – $500,000 =
$ 500,000
$ 480,000
$1,325,000
$1,305,000
Total ending inventory at cost = $245,000 + $500,000 =
$ 745,000
Total cost of goods sold = $1,305,000 + $400,000 =
$1,705,000
(b)
Dollar-value LIFO (one pool)
Ending inventory at current cost =
Ending inventory at base-year cost =
(500 × $800) + (500 × $400) =
Price index = $745,000 / $600,000 = 1.242
Current
Inventory at
base cost
Ending inventory
Base inventory ($80,000 + $480,000)
Layer ($600,000 – $560,000)
Total
$560,000
40,000
$600,000
$ 745,000
$ 600,000
Conversion
price index
1.000
1.242
Cost of goods sold =
$560,000 + ($565,000 + $1,325,000) – $609,680 =
Inventory at
LIFO cost
$560,000
49,680
$609,680
$1,840,320
UYJ7.4 Accounting, Analysis, and Principles (Continued)
Analysis
(a)
The purpose of a current ratio is to provide some indication of the
resources the company has available to meet short term obligations if
those obligations come due. FIFO, which generally approximates the
current cost of inventory, usually better suits this objective. LIFO
inventory numbers on a balance sheet can sometimes be stated at
lower values.
(b)
The U.S. Securities and Exchange Commission requires companies
using LIFO to disclose the current cost of their inventories. Many
companies disclose the FIFO cost of their inventories since that
generally approximates current cost. This difference between LIFO cost
and current cost is called the “LIFO reserve.” A financial statement
reader can use the LIFO reserve to convert a LIFO company’s inventory
and cost of goods sold to what they would have been if the company
had used FIFO. This makes it possible to directly compare LIFO and
FIFO companies, although the comparison must be done on a FIFO
basis, not LIFO.
Principles
Companies can change from one inventory accounting method to
another, but not back and forth. Changes in accounting method (when
not mandated by a regulatory body such as the FASB) should be to
improve the financial statement reader’s ability to understand the
companies’ financial results and position. The tradeoff is usually
comparability for consistency. That is, if a company changes to a
method that is used by most of its competitors, the change increases
comparability. But, because the company now uses different methods
across different years, consistency is sacrificed. Companies sometimes
change accounting methods because they believe it improves the
matching of expenses to revenues. Again, consistency across reporting
periods is sacrificed, however.
LO: 3, 4, Bloom: SYN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, Communication, AICPA BB: None Reporting, AICPA PC: Communication
Time and Purpose of Critical Thinking
CT 7.1 (Time 15–20 minutes)
Purpose—a short case designed to test the skills of the student in determining whether an item should
be reported in inventory. In addition, the student is required to speculate as to why the company may
wish to postpone recording this transaction.
CT 7.2 (Time 15–25 minutes)
Purpose—to provide the student with four questions about the carrying value of inventory. These
questions must be answered and defended with rationale. The topics are shipping terms, freight–in,
weighted-average cost vs. FIFO, and consigned goods.
CT 7.3 (Time 25–35 minutes)
Purpose—to provide a number of difficult financial reporting transactions involving inventories. This case is
vague, and much judgment is required in its analysis. Right or wrong answers should be discouraged;
rather emphasis should be placed on the underlying rationale to defend a given position. Includes a
product versus period cost transaction, proper classification of a possible inventory item, and a product
financing arrangement.
CT 7.4 (Time 15–25 minutes)
Purpose—the student discusses the acceptability of alternative methods of reporting cash discounts.
Also, the student identifies the effects on financial statements of using LIFO instead of FIFO when prices
are rising.
CT 7.5 (Time 20–25 minutes)
Purpose—to provide a broad overview to students as to why inventories must be included in the balance
sheet and income statement. In addition, students are asked to determine why taxable income and
accounting income may be different. Finally, the conditions under which FIFO and LIFO may give different
answers must be developed.
CT 7.6 (Time 15–20 minutes)
Purpose—to provide the student with the opportunity to discuss the rationale for the use of the LIFO
method of inventory valuation. The conditions that must exist before the tax benefits of LIFO will accrue
also must be developed.
CT 7.7 (Time 15–20 minutes)
Purpose—to provide the student with an opportunity to discuss the cost flow assumptions of average
cost, FIFO, and LIFO. Student is also required to distinguish between weighted-average and movingaverage and discuss the effect of LIFO on the B/S and I/S in a period of rising prices.
CT 7.8 (Time 25–30 minutes)
Purpose—to provide the student with the opportunity to discuss the differences between traditional LIFO
and dollar-value LIFO. In this discussion, the specific procedures employed in traditional LIFO and dollarvalue LIFO must be examined. This case provides a good basis for discussing LIFO conceptual issues.
CT 7.9 (Time 25–30 minutes)
Purpose—to provide the student with an opportunity to discuss the concept of a LIFO pool and its use in
various LIFO methods. The student is also asked to define LIFO liquidation, to explain the use of price
indexes in dollar-value LIFO, and to discuss the advantages of using dollar-value LIFO.
Time and Purposes of Concepts for Analysis (Continued)
CT 7.10 (Time 30–35 minutes)
Purpose—to provide the student with an opportunity to analyze the effect of changing from the FIFO
method to the LIFO method on items such as ending inventory, net income, earnings per share, and
year-end cash balance. The student is also asked to make recommendations considering the results
from computation and other relevant factors.
CT 7.11 (Time 20–25 minutes)
Purpose—to provide the student with an opportunity to analyze the ethical implications of purchasing
decisions under LIFO.
Solutions to Critical Thinking
CT 7.1
(a) Purchased merchandise in transit at the end of an accounting period to which legal title has passed
should be recorded as purchases within the accounting period. If goods are shipped f.o.b. shipping
point, title passes to the buyer when the seller delivers the goods to the common carrier. Generally,
when the terms are f.o.b. shipping point, transportation costs must be paid by the buyer. This liability
arises when the common carrier completes the delivery. Thus, the client has a liability for the
merchandise and the freight.
(b) Inventory...............................................................................................
Accounts Payable (Supplier) .............................................................
35,300
Inventory...............................................................................................
Accounts Payable (Transportation Co.) ............................................
1,500
35,300
1,500
(c) Possible reasons to postpone the recording of the transaction might include:
1. Desire to maintain a current ratio at a given level which would be affected by the additional
inventory and accounts payable.
2. Desire to minimize the impact of the additional inventory on other ratios such as inventory
turnover.
3. Possible tax ramifications.
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, Communication, Reflective Thinking, AICPA BB: None Reporting, AICPA PC: Communication
CT 7.2
(a) If the terms of the purchase are f.o.b. shipping point (manufacturer’s plant), Strider Enterprises
should include in its inventory goods purchased from its suppliers when the goods are shipped. For
accounting purposes, title is presumed to pass at that time.
(b) Freight-in expenditures should be considered an inventoriable cost because they are part of the
price paid or the consideration given to acquire the asset.
(c) Theoretically the net approach is the more appropriate because the net amount (1) provides a
correct reporting of the cost of the asset and related liability and (2) presents the opportunity to
measure the inefficiency of financial management if the discount is not taken. Many believe,
however, that the difficulty involved in using the somewhat more complicated net method is not
justified by the resulting benefits.
(d) Products on consignment represent inventories owned by Strider Enterprises, which are physically
transferred to another enterprise. However, Strider Enterprises retains title to the goods until their
sale by the other company (Chavez Inc.).
The goods consigned are still included by Strider Enterprises in the inventory section of its balance
sheet. Often the inventory is reclassified from regular inventory to consigned inventory (Note to
instructor: Additional coverage of consignments is presented in chapter 17.)
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 15-25, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
CT 7.3
(a) According to FASB ASC 330-10-30-1:
“As applied to inventories, cost means in principle the sum of the applicable expenditures and
charges directly or indirectly incurred in bringing an article to its existing condition and location.”
The discussion includes the following: “Selling expenses constitute no part of the inventory costs.”
To the extent that warehousing is a necessary function of importing merchandise before it can be
sold, certain elements of warehousing costs might be considered an appropriate cost of inventory in
the warehouse. For example, if goods must be brought into the warehouse before they can be made
ready for sale, the cost of bringing such goods into the warehouse would be considered a cost of
inventory. Similarly, if goods must be handled in the warehouse for assembly or for removal of foreign
packaging, etc., it would be appropriate to include such costs in inventory. However, costs involved
in storing the goods for any additional period would appear to be period costs. Costs of delivering
the goods from the warehouse would appear to be selling expenses related to the goods sold and
should not under any circumstances be allocated to goods that are still in the warehouse.
In theory, warehousing costs are considered a product cost because these costs are incurred to
maintain the product in a salable condition. However, in practice, warehousing costs are most frequently treated as a period cost.
Under the Tax Reform Act of 1986, warehousing and off-site storage of inventory, including finished
goods, are specifically included in the “production and resale activities” that are to be capitalized for
tax purposes.
(b) It is correct to conclude that obsolete items are excludable from inventory. Cost attributable to such
items is “nonuseful” and “nonrecoverable” cost (except for possible scrap value) and should be
written off. If the cost of obsolete items was simply excluded from ending inventory, the resultant cost
of goods sold would be overstated by the amount of these costs. The cost of obsolete items, if
immaterial, should be commingled with cost of goods sold. If material, these costs should be
separately disclosed.
(c) The primary use of the airplanes should determine their treatment on the balance sheet. Since the
airplanes are held primarily for sale, and chartering is only a temporary use, the airplanes should be
classified as current assets. Depreciation would not be appropriate if the planes are considered
inventory. FASB ASC Glossary entry for “Inventory” states in part that the term Inventory “excludes
long-term assets subject to depreciation accounting, or goods which, when put into use, will be so
classified.”
(d) The transaction is a product financing arrangement and should be reported by the company as
inventory with a related liability. The substance of the transaction is that inventory has been
purchased and the fact that a trust is established to purchase the goods has no economic
significance. Given that the company agrees to buy the coal over a certain period of time at specific
prices, it appears clear that the company has the liability and not the trust.
LO: 2, Bloom: AN, Difficulty: Moderate, Time: 25-35, AACSB: Analysis, Communication, Reflective Thinking, AICPA BB: None Reporting, AICPA PC: Communication
CT 7.4
(a) Cash discounts should not be accounted for as financial income when payments are made. Income
should be recognized when the company sells the inventory. Furthermore, cash discounts should
not be recorded when the payments are made because in order to properly match a cash discount
with the related purchase, the cash discount should be recorded when the related purchase is
recorded.
CT 7.4 (Continued)
(b) Cash discounts should not be accounted for as a reduction of cost of goods sold for the period when
payments are made. Cost of goods sold should be reduced when the company sells the inventory
which has been reduced by the cash discounts. Furthermore, cash discounts should not be recorded
when the payments are made because in order to properly match a cash discount with the related
purchase, the cash discount should be recorded when the related purchase is recorded.
(c) Cash discounts should be accounted for as a direct reduction of purchase cost because they reduce
the cost of acquiring the inventories. Purchases should be recorded net of cash discounts to reflect
the net cash to be paid. The primary basis of accounting for inventories is cost, which represents
the price paid or consideration given to acquire an asset.
LO: 2, Bloom: AN, Difficulty: Simple, Time: 15-25, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
CT 7.5
(a)
1. Inventories are unexpired costs and represent future benefits to the owner. A balance sheet
includes a listing of unexpired costs and future benefits of the owner’s assets at a specific point
in time. Because inventories are assets owned at the specific point in time for which a balance
sheet is prepared, they must be included in order that the owner’s financial position will be
presented fairly.
2. Beginning and ending inventories are included in the computation of net income only for the
purpose of arriving at the cost of goods sold during the period of time covered by the statement.
Goods included in the beginning inventory which are no longer on hand are expired costs to be
matched against revenues recognized during the period. Goods included in the ending inventory
are unexpired costs to be carried forward to a future period, rather than expensed.
(b) Financial accounting has as its goal the proper reporting of financial transactions and events in
accordance with generally accepted accounting principles. Income tax accounting has as its goal
the reporting of taxable transactions and events in conformity with income tax laws and regulations.
While the primary purpose of an income tax is the production of tax revenues to finance the
operations of government, income tax laws and regulations are often produced by various forces.
The income tax may be used as a tool of fiscal policy to stimulate all of the segments of the economy
or to decelerate the economy. Some income tax laws may be passed because of political pressures
brought to bear by individuals or industries. When the purposes of financial accounting and income
tax accounting differ, it is often desirable to report transactions or events differently and to report the
deferred tax consequences of any existing temporary differences as assets or liabilities.
(c) FIFO and LIFO are inventory costing methods employed to measure the flow of costs. FIFO matches
the first cost incurred with the first revenue produced while LIFO matches the last cost incurred with
the first revenue produced after the cost is incurred. (This, of course, assumes a perpetual inventory
system is in use and may not be precisely true if a periodic inventory system is employed.) If prices
are changing, different costs would be matched with revenue for the same quantity sold depending
upon whether the LIFO or FIFO system is in use. (In a period of rising or falling prices FIFO tends
to value inventories at approximate market value in the balance sheet and LIFO tends to match
approximately the current replacement cost of an item with the revenue produced.)
LO: 2,3, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
CT 7.6
(a) Inventory profits occur when the inventory costs matched against sales are less than the replacement cost of the inventory. The cost of goods sold therefore is understated and net income is considered overstated. By using LIFO (rather than some method such as FIFO), more recent costs are
matched against revenues and inventory profits are thereby reduced.
CT 7.6 (Continued)
(b) As long as the price level increases and inventory quantities do not decrease, a deferral of income
taxes occurs under LIFO because the items most recently purchased at the higher price level are
matched against revenues. It should be noted that where unit costs tend to decrease as production
increases, the tax benefits that LIFO might provide are nullified. Also, where the inventory turnover
is high, the difference between inventory methods is negligible.
LO: 3, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, Communication, Reflective Thinking, AICPA BB: None Reporting, AICPA PC: Communication
CT 7.7
(a) The average-cost method assumes that inventories are sold or issued evenly from the stock on
hand; the FIFO method assumes that goods are sold or used in the order in which they are
purchased (i.e., the first goods purchased are the first sold or used); and the LIFO method matches
the cost of the last goods purchased against revenue.
(b) The weighted-average-cost method combines the cost of all the purchases in the period with the
cost of beginning inventory and divides the total costs by the total number of units to determine the
average cost per unit. The moving-average-cost method, on the other hand, calculates a new
average unit cost when a purchase is made. The moving-average-cost method is used with
perpetual inventory records.
(c) When the purchase prices of inventoriable items are rising for a significant period of time, the
use of the LIFO method (instead of FIFO) will result in a lower net income figure. The reason is that
the LIFO method matches most recent purchases against revenue. Since the prices of goods are
rising, the LIFO method will result in higher cost of goods sold, thus lower net income. On the
balance sheet, the ending inventory tends to be understated (i.e., lower than the most recent
replacement cost) because the oldest goods have lower costs during a period of rising prices. In
addition, retained earnings under the LIFO method will be lower than that of the FIFO method when
inflation exists.
LO: 3, Bloom: AN, Difficulty: Moderate, Time: 15-20, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
CT 7.8
(a) 1. The LIFO method (periodic) allocates costs on the assumption that the last goods purchased
are used first. If the amount of the inventory is computed at the end of the month under a periodic
system, then it would be assumed that the total quantity sold or issued during the month would
have come from the most recent purchases, and ordinarily no attempt would be made to
compare the dates of purchases and sales.
2. The dollar-value method of LIFO inventory valuation is a procedure using dollars instead of units
to measure increments or reductions in inventory. The method presumes that goods in the
inventory can be classified into pools or homogenous groups. After the grouping into pools the
ending inventory is priced at the end-of-year prices and a price index number is applied to
convert the total pool to the base-year price level. Such a price index might be obtained from
government sources, if available, or computed from the company’s records. The pools or
groupings of inventory are required where a single index number is inappropriate for all elements
of the inventory.
After the closing inventory and the opening inventory have been placed on the same base-year
price level, any difference between the two inventories is attributable to an increase or decrease
in inventory quantity at the base-year price. An increase in quantity so determined is converted
to the current-year price level and added to the amount of the opening inventory as a separate
inventory layer. A decrease in quantity is deducted from the appropriate layer of opening
inventory at the price level in existence when the layer was added.
CT 7.8 (Continued)
(b) The advantages of the dollar-value method over the traditional LIFO method are as follows:
1. The application of the LIFO method is simplified because, under the pooling procedure, it is not
necessary to assign costs to opening and closing quantities of individual items. As a result,
companies with inventories comprised of thousands of items may adopt the dollar-value method
and minimize their bookkeeping costs.
2. Base inventories are more easily maintained. The dollar-value method permits greater flexibility
because each pool is made up of dollars rather than quantities. Thus, the problem of LIFO
liquidation is less possible.
The disadvantages of the dollar-value method as compared to the traditional LIFO method are
as follows:
1. Due to technological innovations and improvements over time, material changes in the
composition of inventory may occur. Items found in the ending inventory may not have existed
during the base year. Thus, conversion of the ending inventory to base-year prices may be
difficult to calculate or to justify conceptually. This may necessitate a periodic change in the
choice of base year used.
2. Application of a year-end index, although widely used, implies use of the FIFO method. Other
indexes used include beginning-of-year index and average indexes.
3. Determination of the degree of similarity between items for the purpose of grouping them into
pools may be difficult and may be based upon arbitrary management decisions.
(c) The basic advantages of LIFO are:
1. Matching—In LIFO, the more recent costs are matched against current revenues to provide a
better measure of current earnings.
2. Tax benefits—As long as the price level increases and inventory quantities do not decrease, a
deferral of income taxes occurs.
3. Improved cash flow—By receiving tax benefits from use of LIFO, the company may reduce its
borrowings and related interest costs.
4. Future earnings hedge—With LIFO, a company’s future reported earnings will not be affected
substantially by future price declines. LIFO eliminates or substantially minimizes write-downs to
market as a result of price decreases because the inventory value ordinarily will be much lower
than net realizable value, unlike FIFO.
The major disadvantages of LIFO are:
1. Reduced earnings—Because current costs are matched against current revenues, net income
is lower than it is under other inventory methods when price levels are increasing.
2. Inventory understated—The inventory valuation on the balance sheet is ordinarily outdated
because the oldest costs remain in inventory.
3. Physical flow—LIFO does not approximate physical flow of the items except in peculiar situations.
4. Real income not measured—LIFO falls short of measuring real income because it is often not
an adequate substitute for replacement cost.
5. Involuntary liquidation—If the base or layers of old costs are partially liquidated, irrelevant costs
can be matched against current revenues.
6. Poor buying habits—LIFO may cause poor buying habits because a company may simply
purchase more goods and match the cost of these goods against revenue to ensure that old
costs are not charged to expense.
LO: 4, Bloom: SYN, Difficulty: Moderate, Time: 25-30, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
CT 7.9
(a) A LIFO pool is a group of similar items which are combined and accounted for together under the
LIFO inventory method.
(b) It is possible to use a LIFO pool concept without using dollar-value LIFO. For example, the specific
goods pooled approach utilizes the concept of a LIFO pool with quantities as its measurement basis.
(c) A LIFO liquidation occurs when a significant drop in inventory level leads to the erosion of an earlier
or base inventory layer. In a period of inflation (as usually is the case) LIFO liquidation will distort net
income (make it higher) and incur substantial tax payments.
(d) Price indexes are used in the dollar-value LIFO method to: (1) convert the ending inventory at current
year-end cost to base-year cost, and (2) determine the current-year cost for each inventory layer
other than the base-year layer.
(e) The dollar-value LIFO method measures the increases and decreases in a pool in terms of total
dollar value, not by the physical quantity of the goods in the inventory pool. As a result, the dollarvalue LIFO approach has the following advantages over specific goods LIFO pool. First, the pooled
approach reduces record keeping and clerical costs. Second, replacement is permitted if it is a
similar material, or similar in use, or interchangeable. Thus, it is more difficult to erode LIFO layers
when using dollar-value LIFO techniques.
LO: 4, Bloom: SYN, Difficulty: Moderate, Time: 25-30, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
CT 7.10
(a) FIFO (Amounts in thousands, except earnings per share)
2025
$11,000
Sales revenue
Cost of goods sold
Beginning inventory
8,000
Purchases
8,000
Cost of goods available for sale
16,000
1. Ending inventory*
(7,200)
Cost of goods sold
8,800
Gross profit
2,200
Operating expenses (.15 X sales)
1,650
Depreciation expense
300
Income before taxes
250
Income tax expense (20%)
50
2. Net income
$ 200
2026
$12,000
2027
$15,600
7,200
9,900
17,100
(9,000)
8,100
3,900
1,800
300
1,800
360
$ 1,440
9,000
12,000
21,000
(9,000)
12,000
3,600
2,340
300
960
192
$ 768
CT 7.10 (Continued)
2025
$ 0.20
2026
$ 1.44
2027
$ 0.77
4. Cash balance
Beginning balance
$ 400
Sales proceeds
11,000
Purchases
(8,000)
Operating expenses
(1,650)
Property, plant, and equipment
(350)
Income taxes
(50)
Dividends
(150)
Ending balance
$ 1,200
$ 1,200
12,000
(9,900)
(1,800)
(350)
(360)
(150)
$ 640
$
3. Earnings per share
640
15,600
(12,000)
(2,340)
(350)
(192)
(150)
$ 1,208
*2025 = $ 8 × (1,000 + 1,000 – 1,100) = $7,200.
2026 = $ 9 × ( 900 + 1,100 – 1,000) = $9,000.
2027 = $10 × (1,000 + 1,200 – 1,300) = $9,000.
LIFO (Amounts in thousands, except earnings per share)
Sales revenue
Cost of goods sold
Beginning inventory
Purchases
Cost of goods available for sale
1. Ending inventory**
Cost of goods sold
Gross profit
Operating expenses
Depreciation expense
Income before taxes
Income tax expense (20%)
2025
$11,000
2026
$12,000
2027
$15,600
8,000
8,000
16,000
(7,200)
8,800
2,200
1,650
300
250
50
7,200
9,900
17,100
(8,100)
9,000
3,000
1,800
300
900
180
8,100
12,000
20,100
(7,200)
12,900
2,700
2,340
300
60
12
2. Net income
$
200
$
720
$
48
3. Earnings per share
$
0.20
$
0.72
$
0.05
CT 7.10 (Continued)
2025
4. Cash balance
Beginning balance
$ 400
Sales proceeds
11,000
Purchases
(8,000)
Operating expenses
(1,650)
Property, plant, and equipment
(350)
Income taxes
(50)
Dividends
(150)
Ending balance
$ 1,200
2026
$ 1,200
12,000
(9,900)
(1,800)
(350)
(180)
(150)
$ 820
2027
$
820
15,600
(12,000)
(2,340)
(350)
(12)
(150)
$ 1,568
**2025 = $8 × (1,000 + 1,000 – 1,100) = $7,200.
2026 = ($8 × 900) + ($9 × 100) = $8,100.
2027 = $8 × 900 = $7,200.
(b)
According to the computation in (a), Harrisburg Company can achieve
the goal of income tax savings by switching to the LIFO method. As
shown in the schedules, under the LIFO method, Harrisburg will have
lower net income and thus lower income taxes for 2026 and 2027 (tax
savings in each year). As a result, Harrisburg will have a better cash
position at the end of 2026 and especially 2027 (year-end cash balance
will be higher by $180,000 for 2026 and $360,000 for 2027).
However, since Harrisburg Company is in a period of rising purchase
prices, the LIFO method will result in significantly lower net income and
earnings per share for 2026 and 2027. The management may need to
evaluate the potential impact that lower net income and earnings per
share might have on the company before deciding on the change to the
LIFO method.
LO: 3, 4, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analysis, Communication, AICPA BB: None Reporting, AICPA PC: Communication
CT 7.11
(a)
Major stakeholders are investors, creditors, Wilkens’ management
(including the president and plant accountant), and other employees of
Wilkens Company. The inventory purchase in this instance reduces net
income substantially and lowers Wilkens Company’s tax liability.
Current stockholders and company management benefit during the
current year by this decision. However, the purchasing department
may be concerned about inventory management and complications
such as storage costs and possible inventory obsolescence.
Assuming awareness of these benefits and possible complications, the
plant accountant may follow the president’s recommendation without
violating GAAP. The plant accountant also must consider whether this
action is in the long-term best interests of the company and whether
inventory amounts would provide a meaningful picture of Wilkens
Company’s financial condition.
(b)
No, the president would not recommend a year-end inventory purchase
because under FIFO there would be no effect on net income.
LO: 4, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Communication, Reflective Thinking Professional Demeanor Reporting, AICPA PC: Communication,
Professional Demeanor
Codification Exercises
CE7-1
(a)
Inventory is the aggregate of those items of tangible personal property that have any of the following
characteristics:
a. Held for sale in the ordinary of business.
b. To process of production for such sale.
c. To be currently consumed in the production of goods or services to be available for sale.
The term inventory embraces goods awaiting sale (the merchandise of a trading concern and the
finished goods of a manufacturer), goods in the course of production (work in process), and goods
to be consumed directly or indirectly in production (raw materials and supplies). This definition of
inventories excludes long-term assets subject to depreciation accounting, or goods which, when
put into use, will be so classified. The fact that a depreciable asset is retired from regular use and
held for sale does not indicate that the item should be classified as part of the inventory. Raw
materials and supplies purchased for production may be used or consumed for the construction of
long-term assets or other purposes not related to production, but the fact that inventory items
representing a small portion of the total may not be absorbed ultimately in the production process
does not require separate classification. By trade practice, operating materials and supplies of
certain types of entities such as oil producers are usually treated as inventory.
(b)
A customer is a reseller or a consumer, either an individual or a business that purchases a vendor’s
products or services for end use rather than for resale. This definition is consistent with paragraph
280-10-50-42, which states that a group of entities known to a reporting entity to be under common
control shall be considered as a single customer, and the federal government, a state government,
a local government (for example, a country or municipality), or a foreign government each shall be
considered as a single customer.
(c)
Customer includes any purchaser of the vendor’s products at any point along the distribution chain,
regardless of whether the purchaser acquires the vendor’s products directly or indirectly (for
example, from a distributor) from the vendor. For example, a vendor may sell its products to a
distributor who in turn resells the products to a retailer. In that example, the retailer—not the
distributor—is a customer of the vendor.
(d)
A product financing arrangement is a transaction in which an entity sells and agrees to repurchase
inventory with the repurchase price equal to the original sale price plus carrying and financing costs,
or other similar transactions.
LO: 1, Bloom: K, Difficulty: Simple, Time: 10-15, AACSB: Communication, Technology Reporting, Research, Technology, AICPA PC: Communication
CE7-2
According 606-10-25-18A
An entity that promises a good to a customer also might perform shipping and handling activities
related to that good. If the shipping and handling activities are performed before the customer obtains
control of the good (see paragraphs 606-10-25-23 through 25-30 for guidance on satisfying
performance obligations), then the shipping and handling activities are not a promised service to the
customer. Rather, shipping and handling are activities to fulfill the entity’s promise to transfer the good.
606-10-25-18A
If shipping and handling activities are performed after a customer obtains control of the good, then the
entity may elect to account for shipping and handling as activities to fulfill the promise to transfer the
good. The entity shall apply this accounting policy election consistently to similar types of transactions.
CE7-2 (Continued)
An entity that makes this election would not evaluate whether shipping and handling activities are
promised services to its customers. If revenue is recognized for the related good before the shipping
and handling activities occur, the related costs of those shipping and handling activities shall be
accrued. An entity that applies this accounting policy election shall comply with the accounting policy
disclosure requirements in paragraphs 235-10-50-1 through 50-6.
LO: 2, Bloom: K, Difficulty: Simple, Time: 7-10, AACSB: Communication, Technology Reporting, Research, Technology, AICPA PC: Communication
CE7-3
FASB ASC 330-10-35-1 and 15 with respect to adjustments to Lower of Cost or Market:
35-1
A departure from the cost basis of pricing the inventory is required when the utility of the goods
is no longer as great as their cost. Where there is evidence that the utility of goods, in their
disposal in the ordinary course of business, will be less than cost, whether due to physical
deterioration, obsolescence, changes in price levels, or other causes, the difference shall be
recognized as a loss of the current period. This is generally accomplished by stating such goods
at a lower level commonly designated as market.
With respect to Stating Inventories Above Cost:
35-15 Only in exceptional cases may inventories properly be stated above cost. For example, precious
metals having a fixed monetary value with no substantial cost of marketing may be stated at such
monetary value; any other exceptions must be justifiable by inability to determine appropriate
approximate costs, immediate marketability at quoted market price, and the characteristic of unit
interchangeability.
LO: 2, Bloom: K, Difficulty: Simple, Time: 7-10, AACSB: Communication, Technology Reporting, Research, Technology, AICPA PC: Communication
CE7-4
FASB ASC 330-10-S99-3 (SAB Topic 11.F, LIFO Liquidations) The following is the text of SAB
Topic 11.F, LIFO Liquidations.
Facts: Registrant on LIFO basis of accounting liquidates a substantial portion of its LIFO inventory and
as a result includes a material amount of income in its income statement which would not have been
recorded had the inventory liquidation not taken place.
Question: Is disclosure required of the amount of income realized as a result of the inventory liquidation?
Interpretive Response: Yes. Such disclosure would be required in order to make the financial
statements not misleading. Disclosure may be made either in a footnote or parenthetically on the face of
the income statement.
LO: 5, Bloom: K, Difficulty: Simple, Time: 7-10, AACSB: Communication, Technology Reporting, Research, Technology, AICPA PC: Communication
Codification Research Case
(a)
(b)
A search using “right of return” and revenue indicates that FASB ASC
606 Revenue from Contracts with Customers is the relevant literature.
At ASC 606-10-55-201, the codification indicates that the examples
following:
… illustrates the guidance in paragraphs 606-10-32-11 through 32-13 on
constraining estimates of variable consideration. In addition, the
following guidance is illustrated in these Examples.
a. Paragraph 606-10-32-10 on refund liabilities (Example 22)
b. Paragraphs 606-10-55-22 through 55-29 on sales with a right
of return (Example 22)
Thus, the accounting for right-of-return pertains to determining
the transaction price – Step 3 in the 5-Step Model.
Note to Instructor: Students may be referred to discussion of revenue
recognition in Chapters 2 and 18.
(c)
Example 22 at FASB ASC 606-10-55-202 through 207 provides an
example of Right of Return as it relates to Constraining Estimates of
Variable Consideration (as of March 21, 2018, these are marked as
pending content):
55-202
An entity enters into 100 contracts with customers. Each contract
includes the sale of 1 product for $100 (100 total products  $100 =
$10,000 total consideration). Cash is received when control of a
product transfers. The entity’s customary business practice is to allow
a customer to return any unused product within 30 days and receive a
full refund. The entity’s cost of each product is $60.
55-203
The entity applies the guidance in this Topic to the portfolio of 100
contracts because it reasonably expects that, in accordance with
paragraph 606-10-10-4, the effects on the financial statements from
applying this guidance to the portfolio would not differ materially from
applying the guidance to the individual contracts within the portfolio.
Codification Research Case (Continued)
55-204
Because the contract allows a customer to return the products, the
consideration received from the customer is variable. To estimate the
variable consideration to which the entity will be entitled, the entity
decides to use the expected value method (see paragraph 606-10-328(a)) because it is the method that the entity expects to better predict
the amount of consideration to which it will be entitled. Using the
expected value method, the entity estimates that 97 products will not
be returned.
55-205
The entity also considers the guidance in paragraphs 606-10-32-11
through 32-13 on constraining estimates of variable consideration to
determine whether the estimated amount of variable consideration of
$9,700 ($100  97 products not expected to be returned) can be
included in the transaction price. The entity considers the factors in
paragraph 606-10-32-12 and determines that although the returns are
outside the entity’s influence, it has significant experience in
estimating returns for this product and customer class. In addition, the
uncertainty will be resolved within a short time frame (that is, the 30day return period). Thus, the entity concludes that it is probable that a
significant reversal in the cumulative amount of revenue recognized
(that is, $9,700) will not occur as the uncertainty is resolved (that is,
over the return period).
55-206
The entity estimates that the costs of recovering the products will be
immaterial and expects that the returned products can be resold at a
profit.
55-207
Upon transfer of control of the 100 products, the entity does not
recognize revenue for the 3 products that it expects to be returned.
Consequently, in accordance with paragraphs 606-10-32-10 and 60610-55-23, the entity recognizes the following:
Cash
Revenue
Refund liability
$10,000 ($100  100 products transferred)
$9,700 ($100  97 products not expected to be
returned)
$300 ($100 refund  3 products expected to be
returned)
Codification Research Case (Continued)
Cost of sales
Asset
Inventory
$5,820 ($60  97 products not expected to be returned)
$180 ($60  3 products for its right to recover products
from customers on setting the refund liability)
$6,000 ($60  100 products)
In essence, when right of return exists, the seller uses prior experience
to estimate the items that will be returned and adjust the transaction
price so that it reflects the total amount expected to be received.
(d)
The general guidelines for “Constraining Estimates of Variable
Consideration” are found at FASB ASC 606-10-32-11 to 12.
32-11
An entity shall include in the transaction price some or all of an amount
of variable consideration estimated in accordance with paragraph 60610-32-8 only to the extent that it is probable that a significant reversal
in the amount of cumulative revenue recognized will not occur when
the uncertainty associated with the variable consideration is
subsequently resolved.
32-12
In assessing whether it is probable that a significant reversal in the
amount of cumulative revenue recognized will not occur once the
uncertainty related to the variable consideration is subsequently
resolved, an entity shall consider both the likelihood and the magnitude
of the revenue reversal. Factors that could increase the likelihood or
the magnitude of a revenue reversal include, but are not limited to, any
of the following.
a.
b.
c.
The amount of consideration is highly susceptible to factors
outside the entity’s influence. Those factors may include volatility
in a market, the judgment or actions of third parties, weather
conditions, and a high risk of obsolescence of the promised good
or service.
The uncertainty about the amount of consideration is not expected
to be resolved for a long period of time.
The entity’s experience (or other evidence) with similar types of
contracts is limited, or that experience (or other evidence) has
limited predictive value.
Codification Research Case (Continued)
d.
e.
The entity has a practice of either offering a broad range of price
concessions or changing the payment terms and conditions of
similar contracts in similar circumstances.
The contract has a large number and broad range of possible
consideration amounts.
LO: NA, Bloom: AN, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, Communication, Technology Reporting, Research, Technology, AICPA PC:
Communication
CHAPTER 8
Inventories: Additional Valuation Issues
Assignment Classification Table (By Topic)
Questions
Brief
Exercises
Exercises
Problems
Concepts
for Analysis
1. Lower-of-cost-or-net
realizable value
1, 2, 3, 4, 5
1, 2, 3
1, 2, 3, 4,
5, 6
1, 2, 3, 11
1, 2, 3, 4, 6
2. Lower-of-cost-or-market.
6, 7
4, 5
7, 8
4, 5
6
3. Inventory accounting
changes; relative sales
value method; net
realizable value.
8, 9
6
9, 10
4. Purchase commitments.
10
7, 8
11, 12
11
7
5. Gross profit method.
11, 12, 13,
14
9
13, 14, 15, 6, 7
16, 17, 18,
19
6. Retail inventory method.
15, 16, 17
10
20, 21, 22, 8, 9, 10
7. Presentation and analysis.
18, 19
11
23
11
*8. LIFO retail.
20
12
24, 25
13, 14
13
26, 27, 28, 12
29
Topics
*9. Dollar-value LIFO retail.
*10. Special LIFO problems.
*This material is discussed in an Appendix to the chapter.
30
15
5, 6
Assignment Classification Table (By Learning Objective)
Learning Objectives
Questions
Brief
Exercises
Exercises
Problems
Concepts
for
Analysis
1.
Describe and apply the
lower-of-cost-or net
realizable value rule.
1, 2, 3, 4, 5
1, 2, 3
1, 2, 3,
4, 5, 6
1, 2, 3, 11
1, 2, 3, 4, 6
2.
Describe and apply the
lower-of-cost-or-market
rule.
6, 7
4, 5
7, 8
4, 5
6
3.
Identify other inventory
valuation issues
8, 9, 10
6, 7, 8
9, 10, 11, 12
11
7
4.
Determine ending
inventory by applying
the gross profit method.
11, 12, 13,
14
9
13, 14, 15,
16, 17, 18,
19
6, 7
5.
Determine ending
inventory by applying
the retail inventory
method.
15, 16, 17
10
20, 21, 22
8, 9, 10
6.
Explain how to report
and analyze inventory.
18, 19
11
23
11
*7.
Determine ending
inventory by applying
the LIFO retail
methods.
20
12, 13
24, 25, 26,
27, 28, 29
30
12, 13, 14,
15
*This material is discussed in an Appendix to the chapter.
5, 6
Assignment Characteristics Table
Item
Description
Level of
Difficulty
Time
(minutes)
E8.1
E8.2
E8.3
E8.4
E8.5
E8.6
E8.7
E8.8
E8.9
E8.10
E8.11
E8.12
E8.13
E8.14
E8.15
E8.16
E8.17
E8.18
E8.19
E8.20
E8.21
E8.22
E8.23
*E8.24
*E8.25
*E8.26
*E8.27
*E8.28
*E8.29
*E8.30
LCNRV.
LCNRV.
LCNRV.
LCNRV—journal entries.
LCNRV.
LCNRV—error effect.
Lower-of-cost-or-market
Lower-of-cost-or-market--journal entries.
Relative sales value method.
Relative sales value method.
Purchase commitments.
Purchase commitments.
Gross profit method.
Gross profit method.
Gross profit method.
Gross profit method.
Gross profit method.
Gross profit method.
Gross profit method.
Retail inventory method.
Retail inventory method.
Retail inventory method.
Analysis of inventories.
Retail inventory method—conventional and LIFO.
Retail inventory method—conventional and LIFO.
Dollar-value LIFO retail.
Dollar-value LIFO retail.
Conventional retail and dollar-value LIFO retail.
Dollar-value LIFO retail.
Change to LIFO retail.
Simple
Simple
Simple
Simple
Moderate
Simple
Simple
Simple
Simple
Simple
Simple
Simple
Simple
Simple
Simple
Moderate
Simple
Simple
Moderate
Moderate
Simple
Simple
Simple
Moderate
Moderate
Simple
Simple
Moderate
Moderate
Simple
15–20
10–15
15–20
10–15
20–25
10–15
15-20
10-15
15–20
12–17
5–10
15–20
8–13
10–15
15–20
15–20
10–15
15–20
20–25
20–25
12–17
20–25
10–15
25–35
15–20
10–15
5–10
20–25
20–25
5-10
P8.1
P8.2
P8.3
P8.4
P8.5
P8.6
P8.7
P8.8
P8.9
LCNRV.
LCNRV.
LCNRV—cost-of-good-sold and loss.
Lower-of-cost-or-market
Lower-of-cost-or-market.
Gross profit method.
Gross profit method.
Retail inventory method.
Retail inventory method.
Simple
Moderate
Moderate
Moderate
Moderate
Moderate
Complex
Moderate
Moderate
10–15
25–30
30–35
25-30
30-40
20–30
40–45
20–30
20–30
Assignment Characteristics Table (Continued)
Level of
Difficulty
Time
(minutes)
Item
Description
P8.10
P8.11
Moderate
Moderate
20–30
30–40
*P8.12
*P8.13
*P8.14
*P8.15
Retail inventory method.
Statement and note disclosure, LCNRV, and purchase
commitment.
Conventional and dollar-value LIFO retail.
Retail, LIFO retail, and inventory shortage.
Change to LIFO retail.
Change to LIFO retail; dollar-value LIFO retail.
Moderate
Moderate
Moderate
Complex
30–35
30–40
30–40
40–50
CT8.1
CT8.2
CT8.3
CT8.4
CT8.5
CT8.6
CT8.7
LCNRV.
LCNRV.
LCNRV.
LCNRV.
Retail inventory method.
Cost determination, LCM, retail method.
Purchase commitments.
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
Moderate
15–25
20–30
15–20
15-20
25–30
15–25
10–15
Answers to Questions
1. Where there is evidence that the utility of goods to be disposed of in the ordinary course of business
will be less than cost, the difference should be recognized as a loss in the current period, and the
inventory should be stated at net realizable value in the financial statements.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
2. The usual basis for carrying forward the inventory to the next period is cost. Departure from cost is
required when the utility of the goods included in the inventory is less than their cost, this loss in
utility should be recognized as a loss in the period in which it occurred. Furthermore, the subsequent
period should be charged for goods at an amount that measures their expected contribution to that
period. In other words, the subsequent period should be charged for inventory at prices no higher
than those which would have been paid if the inventory had been obtained at the beginning of that
period. (Historically, the lower-of-cost-or-net realizable value rule arose from the accounting
convention of providing for all losses and anticipating no profits.)
In accordance with the foregoing reasoning, the rule of “cost or net realizable value, whichever is
lower” may be applied to each item in the inventory, to the total of the components of each major
category, or to the total of the inventory, whichever most clearly reflects operations. The rule is
usually applied to each item, but if individual inventory items enter into the same category or
categories of finished product, alternative procedures are suitable.
The arguments against the use of the lower-of-cost-or-net realizable value method of valuing
inventories include the following:
Mismatch in valuation A company recognizes decreases in the value of the asset and the charge
to expense in the period in which the loss in utility occurs—not in the period of sale. On the other
hand, it recognizes increases in the value of the asset only at the point of sale. In other words, a
company may value the inventory at cost in one year and at market or NRV in the next year.
Mismatch in income Net income for the year in which a company takes the loss is lower.
Net income of the subsequent period may be higher than normal if the expected reductions in sales
price do not materialize.
Use of estimates Application of these rules uses “normal profit” or “ordinary” costs to sell or dispose
in determining inventory values. Since companies develop these estimates based on past
experience (which they may not attain in the future), this subjective measure presents an opportunity
for income manipulation.
LO: 1, Bloom: C, Difficulty: Simple, Time: 5-7, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 8 (Continued)
3. The lower-of-cost-or-net realizable value rule may be applied directly to each item, to each category,
or to the total of the inventory (or in some cases, to the total of the components of each major
category). The method should be the one that most clearly reflects income. The most common
practice is to value the inventory on an item-by-item basis. Companies favor the individual item
approach because tax requirements in some countries require that an individual item basis be used
unless it involves practical difficulties. In addition, the individual item approach gives the most
conservative valuation on the statement of financial position.
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
4. (1)
(2)
(3)
(4)
(5)
$12.80 ($14.80 - $1.50 - $0.50) NRV.
$16.10 Cost.
$13.00 ($15.20 - $1.65 - $0.55) NRV.
$9.20 ($10.40 - $0.80 - $0.40) NRV.
$15.90 Cost.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
5. One approach is to reduce inventory from cost to net realizable value by debiting a loss account and
crediting Inventory. This method reports a loss in the period in which the decline in value takes place
(often referred to as the loss method). The loss would then be shown as a separate item in the
income statement and the cost of goods sold for the year would not be distorted by its inclusion. An
objection to this method of valuation is that an inconsistency is created between the income
statement and the statement of financial position.
Another approach is to increase Cost of Goods Sold by the amount of the loss and decrease the
Inventory account. Because this method fails to reflect this loss separately, objections can be raised
against this procedure because the loss is buried in Cost of Goods Sold and is not easy to separately
identify
LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
6. The upper (ceiling) and lower (floor) limits for the value of the inventory are intended to prevent the
inventory from being reported at an amount in excess of the net realizable value or at an amount
less than the net realizable value less a normal profit margin. The maximum limitation, not to exceed
the net realizable value (ceiling) covers obsolete, damaged, or shopworn material and prevents
overstatement of inventories and understatement of the loss in the current period. The minimum
limitation deters understatement of inventory and overstatement of the loss in the current period.
LO: 2, Bloom: C, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, AICPA PC: Communication
7. (1)
(2)
(3)
(4)
(5)
$14.50 NRV.
$16.10 Cost.
$13.75 NRV – Normal profit margin.
$9.70 Replacement cost.
$15.90 Cost.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
8. An exception to the normal recognition rule occurs where (1) there is a controlled market with a
quoted price applicable to specific commodities and (2) no significant costs of disposal are involved.
Certain agricultural products and precious metals which are immediately marketable at quoted
prices are often valued at net realizable value (market price).
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, AICPA PC: Communication
Questions Chapter 8 (Continued)
9. Relative sales value is an appropriate basis for pricing inventory when a group of varying units is
purchased at a single lump-sum price (basket purchase). The purchase price must be allocated in
some manner or on some basis among the various units. When the units vary in size, character,
and attractiveness, the basis for allocation must reflect both quantitative and qualitative aspects. A
suitable basis then is the relative sales value of the units that comprise the inventory.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, AICPA PC: Communication
10. The drop in the market price of the commitment should be charged to operations in the current year if
it is material in amount. The following entry would be made [($6.20 – $5.90) × 150,000] = $45,000:
Loss on Purchase Commitments ...............................................................
Estimated Liability on Purchase Commitments ...............................
45,000
45,000
The entry is made because a loss in utility has occurred during the period in which the market decline
took place. The account credited in the above entry should be included among the current liabilities
on the balance sheet with an appropriate note indicating the nature and extent of the commitment.
This liability indicates the minimum obligation on the commitment contract at the present time—the
amount that would have to be forfeited in case of breach of contract.
LO: 3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: Communication
11. The major uses of the gross profit method are: (1) it provides an approximation of the ending
inventory which the auditor might use for testing validity of physical inventory count; (2) it means
that a physical count need not be taken every month or quarter; and (3) it helps in determining
damages caused by casualty when inventory cannot be counted.
LO: 4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Measurement, Reporting, AICPA PC: Communication
12. Gross profit as a percentage of sales indicates that the markup is based on selling price rather than
cost; for this reason the gross profit as a percentage of selling price will always be lower than if
based on cost. Conversions are as follows:
25% on cost = .25 ÷ ( 1 + .25) = 20% on selling price
33 1/3% on cost = .333 ÷ (1 + .333) = 25% on selling price
33 1/3% on selling price = .333 ÷ (1 - .333) = 50% on cost
60% on selling price = .60 ÷ (1 - .60) = 150% on cost
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
13. A markup of 25% on cost equals a 20% markup on selling price; therefore, gross profit equals
$1,000,000 ($5 million × .20) and net income equals $250,000 [$1,000,000 – (.15. × $5 million)].
The following formula was used to compute the 20% markup on selling price:
Gross profit on selling price =
Percentage markup on cost
.25
=
= 20%
100% + Percentage markup on cost
1 + .25
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 8 (Continued)
14. Inventory, January 1, 2025 ....................................................................
Purchases to February 10, 2025 ............................................................
Freight-in to February 10, 2025..............................................................
Merchandise available....................................................................
Sales revenue to February 10, 2025 ......................................................
Less gross profit at 40% ($1,950,000 × .40) ...................................
Estimated cost of goods sold .....................................................
Inventory (approximately) at February 10, 2025 .........................
$ 400,000
$1,140,000
60,000
1,200,000
1,600,000
1,950,000
780,000
1,170,000
$ 430,000
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Measurement Analysis and Interpretation, Reporting, AICPA PC:
Communication
15. The validity of the retail inventory method is dependent upon (1) the composition of the inventory
remaining approximately the same at the end of the period as it was during the period, and
(2) there being approximately the same rate of markup at the end of the year as was used throughout
the period.
The retail method, though ordinarily applied on a departmental basis, may be appropriate for the
business as a unit if the above conditions are met.
LO: 5, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
16. The conventional retail method is based on lower-of-average-cost-or-market whereby inventory
figures at retail are reduced to an inventory valuation figure by multiplying the retail figures by a
percentage which is the complement of the markup percent.
To determine the markup percent, original markups and additional net markups are related to the
original cost. The complement of the markup percent so determined is then applied to the inventory at
retail after the latter has been reduced by net markdowns, thus in effect achieving a lower-of-costor-market valuation.
An example of reduction to market follows:
Assume purchase of 100 items at $1 each, marked to sell at $1.50 each, at which price 80 were
sold. The remaining 20 are marked down to $1.15 each.
The inventory at $15.33 is $4.67 below original cost and is valued at an amount which will produce
the “normal” 33 1/3% gross profit if sold at the present retail price of $23.00.
Computation of Inventory
Purchases
Sales revenue
Markdowns (20 × $.35)
Inventory at retail
Inventory at lower-of-cost-or-market $23 × 66 2/3% = $15.33
Cost
$100
Retail
$150
(120)
(7)
$ 23
Ratio
66 2/3%
LO: 5, Bloom: C, Difficulty: Moderate, Time: 5-7, AACSB: Aalytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Questions Chapter 8 (Continued)
17. (a)
Ending inventory:
Cost
Beginning inventory...........................................................
Purchases .........................................................................
Freight-in...........................................................................
Totals ........................................................................
Add net markups ...............................................................
$ 149,000
1,400,000
70,000
1,619,000
_________
$1,619,000
Deduct net markdowns .....................................................
Deduct sales revenue .......................................................
Ending inventory, at retail ..................................................
Ratio of cost to selling price
$1,619,000
$2,535,500
Retail
$
283,500
2,160,000
2,443,500
92,000
2,535,500
48,000
2,487,500
2,175,000
$ 312,500
= 63.85%.
Ending inventory estimated at cost = 63.85% × $312,500 = $199,531.
(b)
The retail method, above, showed an ending inventory at retail of $312,500; therefore, merchandise not accounted for amounts to $17,500 ($312,500 – $295,000) at retail and $11,174
($17,500 × 63.85%) at cost.
LO: 5, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
18. Information relative to the composition of the inventory (i.e., raw material, work-in-process, and
finished goods); the inventory financing where significant or unusual (transactions with related
parties, product financing arrangements, firm purchase commitments, involuntary liquidations of
LIFO inventories, pledging inventories as collateral); and the inventory costing methods employed
(lower-of-cost-or-market, FIFO, LIFO, average cost) should be disclosed. If Deere and Company uses
LIFO, it should also report the LIFO reserve.
LO: 6, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
19. Inventory turnover measures how quickly inventory is sold. Generally, the higher the inventory
turnover, the better the enterprise is performing. The more times the inventory turns over, the smaller
the net margin can be to earn an appropriate total profit and return on assets. For example, a
company can price its goods lower if it has a high inventory turnover. A company with a low profit
margin, such as 2%, can earn as much as a company with a high net profit margin, such as 40% if
its inventory turnover is often enough. To illustrate, a grocery store with a 2% profit margin can earn
as much as a jewelry store with a 40% profit margin and an inventory turnover of 1 if its turnover is
more than 20 times.
LO: 6, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*20. Two major modifications are necessary. First, the beginning inventory should be excluded from the
numerator and denominator of the cost-to-retail percentage and second, markdowns should be
included in the denominator of the cost-to-retail percentage.
LO: 7, Bloom: C, Difficulty: Moderate, Time: 3-5, AACSB: Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Solutions to Brief Exercises
Brief Exercise 8.1
Item
Cost
NRV
LCNRV
Skis
Boots
Parkas
$190.00
106.00
53.00
$161.00
108.00
50.00
$161.00
106.00
50.00
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Brief Exercise 8.2
(a)
Item
Cost
NRV
LCNRV
$ 2,000
5,000
4,400
3,200
$14,600
$ 2,100
4,950
4,625
3,830
$15,505
$ 2,000
4,950
4,400
3,200
$14,550
Item-by-item
Jokers
Penguins
Riddlers
Scarecrows
Total
(b)
1. Penguins only: $50
2. No adjustment is needed when the evaluation is made for the total
inventory: $15,505 > $14,600.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Brief Exercise 8.3
(a)
(b)
Cost-of-goods-sold-method
Cost of Goods Sold............................................
Inventory ($572,000 - $530,000)................
42,000
Loss method
Inventory Loss ..................................................
Inventory ($572,000 - $530,000)................
42,000
42,000
LO: 1, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
42,000
Brief Exercise 8.4
(a)
Ceiling
Floor
(b)
$106
(c)
$51
$193 ($212 – $19)
$161 ($212 – $19 – $32)
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Brief Exercise 8.5
(a)
Cost-of-goods-sold method
Cost of Goods Sold ...............................................
Inventory .......................................................
21,000
21,000*
*($286,000 – $265,000)
(b)
Loss method
Inventory Loss ......................................................
Inventory .......................................................
21,000
21,000
LO: 2, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Brief Exercise 8.6
Group
Number
of CDs
Sales
Price
per CD
1
2
3
100
800
100
$ 5
$10
$15
*$500/$10,000 = 5/100
Total
Sales
Price
Relative
Sales
Price
$
5/100* X $8,000 =
80/100 X $8,000 =
15/100 X $8,000 =
500
8,000
1,500
$10,000
Total
Cost
Cost
Allocated
to CDs
$ 400
6,400
1,200
$8,000
Cost
per CD
$ 4**
$ 8
$12
**$400/100 = $4
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Brief Exercise 8.7
Loss on Purchase Commitments
...........................................................................
Estimated Liability on Purchase
Commitments ($1,000,000 – $950,000) .........
50,000
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
50,000
Brief Exercise 8.8
Purchases (Inventory)
...........................................................................
Estimated Liability on Purchase Commitments ......
Cash ..................................................................
950,000
50,000
1,000,000
LO: 3, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Brief Exercise 8.9
Beginning inventory .................................................
Purchases ..................................................................
Cost of goods available ............................................
Sales revenue ............................................................
Less gross profit (35% × $700,000) ..........................
Estimated cost of goods sold ..................................
Estimated ending inventory destroyed in fire .........
$150,000
500,000
650,000
$700,000
245,000
455,000
$195,000
LO: 4, Bloom: AP, Difficulty: Simple, Time: 3-5, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Brief Exercise 8.10
Beginning inventory ............................................
Net purchases ......................................................
Net markups .........................................................
Totals ....................................................................
Deduct:
Net markdowns ....................................................
Sales revenue .......................................................
Ending inventory at retail ....................................
Cost
$ 12,000
120,000
$132,000
Retail
$ 20,000
170,000
10,000
200,000
7,000
147,000
$ 46,000
Cost-to-retail ratio: $132,000 ÷ $200,000 = 66%
Ending inventory at lower-of cost-or-market (66% × $46,000) = $30,360
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Brief Exercise 8.11
Inventory turnover:
$9,789
$1,997 + $1,830
2
= 5.12 times
Average days to sell inventory:
365 ÷ 5.12 = 71.3 days
LO: 6, Bloom: AP, Difficulty: Simple, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Brief Exercise 8.12
Beginning inventory .............................................
Net purchases .......................................................
Net markups ..........................................................
Net markdowns .....................................................
Total (excluding beginning inventory) ................
Total (including beginning inventory) .................
Deduct: Sales revenue.........................................
Ending inventory at retail .....................................
Cost
$ 12,000
Retail
$ 20,000
120,000
170,000
10,000
(7,000)
173,000
193,000
147,000
$ 46,000
120,000
$132,000
Cost-to-retail ratio: $120,000 ÷ $173,000 = 69.4%
Ending inventory at cost
$20,000 × .60 ($12,000/$20,000)
26,000 × .694
$46,000
= $12,000
= 18,044
$30,044
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Brief Exercise 8.13
Beginning inventory ............................................
Net purchases ......................................................
Net markups .........................................................
Net markdowns ....................................................
Total (excluding beginning inventory)................
Total (including beginning inventory) ................
Deduct: Sales revenue ........................................
Ending inventory at retail ....................................
Cost
$ 12,000
Retail
$ 20,000
120,000
170,000
10,000
(7,000)
173,000
193,000
147,000
$ 46,000
120,000
$132,000
Cost-to-retail ratio: $120,000 ÷ $173,000 = 69.4%
Ending inventory at retail deflated to base year prices
$46,000 ÷ 1.15 = $40,000
Ending inventory at cost
$20,000 × 100% × 60% = $12,000
20,000 × 115% × 69.4% = 15,962
$27,962
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 5-7, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Solutions to Exercises
Exercise 8.1 (15–20 minutes)
Per Unit
Part No.
110
111
112
113
120
121
122
Totals
(a)
Quantity
600
1,000
500
200
400
1,600
300
Cost
$ 95
60
80
170
205
16
240
NRV
$100
52
76
180
208
1
235
Total
Cost
$ 57,000
60,000
40,000
34,000
82,000
25,600
72,000
$370,600
Total
NRV
$ 60,000
52,000
38,000
36,000
83,200
1,600
70,500
$341,300
Lower-ofCost-orNRV
$ 57,000
52,000
38,000
34,000
82,000
1,600
70,500
$335,100
$335,100.
(b) $341,300.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.2 (10–15 minutes)
Item
D
E
F
G
H
I
Net
Realizable
Value
$80*
62
60
35
70
40
Cost
$75
80
80
80
50
36
LCNRV
$75
62
60
35
50
36
*Estimated selling price – Estimated selling costs and cost to
complete = $120 – $30 – $10 = $80.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.3 (15–20 minutes)
Item
No.
Cost
per Unit
Net Realizable
Value
LCNRV
Quantity
1320
1333
1426
1437
1510
1522
1573
1626
$3.20
2.70
4.50
3.60
2.25
3.00
1.80
4.70
$2.90*
2.40
3.60
1.85
1.85
3.10
1.30
4.50
$2.90
2.40
3.60
1.85
1.85
3.00
1.30
4.50
1,200
900
800
1,000
700
500
3,000
1,000
Final
Inventory
Value
$ 3,480
2,160
2,880
1,850
1,295
1,500
3,900
4,500
$21,565
*$4.50 – $1.60 = $2.90.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.4 (10–15 minutes)
(a)
(b)
December 31, 2025
Cost of Goods Sold ($346,000 – $322,000) ..........
Inventory.......................................................
24,000
December 31, 2026
Cost of Goods Sold...............................................
Inventory.......................................................
20,000
December 31, 2025
Inventory Loss .....................................................
Inventory.......................................................
24,000
December 31, 2026
Inventory Loss .....................................................
Inventory.......................................................
20,000
24,000*
20,000*
24,000*
20,000*
Exercise 8.4 (Continued)
*Cost of inventory at 12/31/25 ...................................
LCNRV at 12/31/25 ...................................................
Amount needed to reduce inventory
to NRV (a) ..............................................................
(c)
$346,000
(322,000)
$ 24,000
Cost of inventory at 12/31/26 ..................................
$410,000
LCNRV at 12/31/26 ...................................................
(390,000)
Amount needed to reduce inventory
to NRV (b) ..............................................................
$ 20,000
Both methods of recording lower-of-cost-or-NRV adjustments have
the same effect on net income.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.5 (20–25 minutes)
(a)
Sales revenue
Cost of goods sold
Inventory, beginning
Purchases
Cost of goods available
Less: Inventory, ending
Cost of goods sold
Gross profit
Inventory loss
February
March
April
$29,000
$35,000
$40,000
15,000
17,000
32,000
15,100
16,900
12,100
(2,500)
$ 9,600
15,100
24,000
39,100
17,000
22,100
12,900
(1,400)
$11,500
17,000
26,500
43,500
14,000
29,500
10,500
__
0
$10,500
Jan. 31
Feb. 28
Mar. 31
Apr. 30
Inventory at cost
$15,000
$15,100
$17,000
$14,000
Inventory at LCNRV
(14,500)
(12,600)
(15,600)
(14,500)
Inventory loss
$
$ 2,500
$ 1,400
500
$
(500)
Exercise 8.5 (Continued)
(b)
January 31
Inventory Loss ........................................................
Inventory..........................................................
500
February 28
Inventory Loss ........................................................
Inventory..........................................................
2,500
March 31
Inventory Loss ........................................................
Inventory..........................................................
1,400
500
2,500
1,400
April 30
No Entry – Inventory is not written back up after a writedown.
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.6 (10–15 minutes)
$50 – $14 = $36
$40
$36
Net realizable value
Cost
Lower-of-cost-or-NRV
$38 figure used – $36 correct value per unit = $2 per unit.
$2 × 1,000 units = $2,000.
If ending inventory is overstated, net income will be overstated.
If beginning inventory is overstated, net income will be understated.
Therefore, net income for 2025 was overstated by $2,000 and net income
for 2026 was understated by $2,000.
LO: 1, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.7 (15–20 minutes)
Item
No.
Cost
per
Unit
Replacement
Cost
Net
Realizable
Value
(Ceiling)
1320
1333
1426
1437
1510
1522
1573
1626
$3.20
2.70
4.50
3.60
2.25
3.00
1.80
4.70
$3.00
2.30
3.70
3.10
2.00
2.70
1.60
5.20
$4.15*
3.00
4.60
2.95
2.45
3.40
1.75
5.50
NRV
Less
Normal
Profit
(Floor)
Designated
Market
Value
Quantity
$2.90**
2.50
3.60
2.05
1.85
2.90
1.25
4.50
$3.00
2.50
3.70
2.95
2.00
2.90
1.60
5.20
1,200
900
800
1,000
700
500
3,000
1,000
Final
Inventory
Value
$ 3,600
2,250
2,960
2,950
1,400
1,450
4,800
4,700***
$24,110
*$4.50 – $.35 = $4.15.
**$4.15 – $1.25 = $2.90.
***Cost is used because it is lower than designated market value.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.8 (10–15 minutes)
(a)
12/31/24
12/31/25
(b)
12/31/24
12/31/25
(c)
Cost of Goods Sold ............................
Inventory ...................................
29,000*
Cost of Goods Sold
.................................................
Cost of Goods Sold ...................
25,000**
Inventory Loss ...................................
Inventory ....................................
29,000*
Inventory Loss ...................................
Inventory ..........................................
25,000**
29,000*
25,000**
29,000*
25,000**
*Cost of inventory at 12/31/24
Lower of cost or market at 12/31/24
Amount needed to reduce inventory
to market
$356,000
(327,000)
**Cost of inventory at 12/31/25
Lower of cost or market at 12/31/25
Amount needed to reduce inventory
to market
$420,000
(395,000)
$ 29,000
$ 25,000
Both methods of recording lower-of-cost-or-market adjustments
have the same effect on net income.
LO: 2, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
15
17
Group 2
Group 3
2,400
4,000
$3,000
Sales
Price Per Lot
$ 5,800
Net income
$ 3,600
9,600
10,800
$24,000
$12,000
32,000
36,000
$80,000
89,460
89,460
LO: 3, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
17 – 2 = 15
15 – 7 = 8
* 9–5=4
$
18,200
Operating expenses
Gross
Profit
24,000
$80,000
$40,800/$127,800 X
$60,000/$127,800 X
Gross profit
Number Cost
of Lots Cost of
Sold*
Per
Lots
Group 1
4
$2,100
Lot
8,400
Sold
Group 2
8
2,800
22,400
Group 3
15
1,680
25,200
Total
27
$56,000
Total
Cost
$27,000/$127,800 X $89,460
56,000
Sales
$127,800
40,800
60,000
$ 27,000
Relative Sales
Price
Cost of goods sold (see schedule)
Sales revenue (see schedule)
9
Group 1
No. of
Lots
Total
Sales
Price
$89,460
28,560
42,000
$18,900
Cost
Allocated
to Lots
1,680
2,800
$2,100
Cost Per Lot
(Cost Allocated/
No. of Lots)
Exercise 8.9 (15–20 minutes)
120
Straight chairs
(700 – 120) × $31.50 = $18,270
Inventory of straight chairs
(b)
100
Armchairs
31.50
50.40
$56.70
Chairs
200
Cost
per
Chair
Number
of Chairs
Sold
Lounge chairs
50
700
Straight chairs
Sales
Price
per
Chair
$90
80
400
300
Chairs
No. of
Chairs
Lounge chairs
Armchairs
(a)
6,000
$32,000
$20,160
8,000
$18,000
Sales
$35,000/$95,000
$36,000/$95,000
$24,000/$95,000
Relative Sales
Price
3,780
5,040
$11,340
Cost of
Chairs
Sold
$95,000
35,000
$36,000
24,000
Total
Sales
Price
X
$11,840
2,220
2,960
$ 6,660
Gross
Profit
59,850
X $59,850
X 59,850
Total
Cost
$59,850
22,050
$22,680
15,120
Cost
Allocated
to Chairs
31.50
$56.70
50.40
Cost per
Chair
Exercise 8.10 (12–17 minutes)
LO: 3, Bloom: AP, Difficulty: Simple, Time: 12-17, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.11 (5–10 minutes)
Loss on Purchase Commitments .......................
Estimated Liability on Purchase
Commitments ($400,000 – $365,000) ......
35,000
35,000
LO: 3, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.12 (15–20 minutes)
(a)
If the commitment is material in amount, there should be a footnote in
the balance sheet stating the nature and extent of the commitment. The
footnote may also disclose the market price of the materials. The
excess of market price over contracted price is a gain contingency
which per GAAP cannot be recognized in the accounts until it is
realized.
(b)
The drop in the market price of the commitment should be charged to
operations in the current year if it is material in amount. The following
entry would be made:
Loss on Purchase Commitments ..........................
Estimated Liability on Purchase
Commitments [36,000 × ($3.00 – $2.70)] ...
10,800
10,800
The entry is made because a loss in utility has occurred during the
period in which the market decline took place. The account credited in
the above entry should be included among the current liabilities on the
balance sheet, with an appropriate footnote indicating the nature and
extent of the commitment. This liability indicates the minimum
obligation on the commitment contract at the present time—the
amount that would have to be forfeited in case of breach of contract.
(c)
Assuming the $10,800 market decline entry was made on December 31,
2025, as indicated in (b), the entry when the materials are received in
January 2025 would be:
Inventory (Raw Materials) ......................................
Estimated Liability on Purchase Commitments ...
Accounts Payable..........................................
97,200
10,800
108,000
Exercise 8.12 (Continued)
This entry records the raw materials at the actual cost, eliminates the
$10,800 liability set up at December 31, 2025, and records the contractual liability for the purchase. This permits operations to be charged
this year with the $97,200, the other $10,800 of the cost having been
charged to operations in 2025.
LO: 3, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.13 (8–13 minutes)
1.
20%
100% + 20%
= 16.67% OR 16 2/3%.
2.
25%
100% + 25%
= 20%.
3.
33 1/3%
= 25%.
100% + 33 1/3%
4.
50%
100% + 50%
= 33.33% OR 33 1/3%.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 8-13, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.14 (10–15 minutes)
(a)
Inventory, May 1 (at cost)
Purchases (at cost)
Purchase discounts
Freight-in
Goods available (at cost)
Sales revenue (at selling price)
$1,000,000
Sales returns (at selling price)
(70,000)
Net sales (at selling price)
930,000
Less: Gross profit (.30 × $930,000)
279,000
Net sales (at cost)
Approximate inventory, May 31 (at cost)
$160,000
640,000
(12,000)
30,000
818,000
651,000
$167,000
Exercise 8.14 (Continued)
(b)
Gross profit as a percent of sales must be computed:
30%
100% + 30%
= 23.08% of sales.
Inventory, May 1 (at cost)
Purchases (at cost)
Purchase discounts
Freight-in
Goods available (at cost)
Sales revenue (at selling price)
$1,000,000
Sales returns (at selling price)
(70,000)
Net sales (at selling price)
930,000
Less: Gross profit (.2308 × $930,000)
214,644
Net sales (at cost)
Approximate inventory, May 31 (at cost)
$160,000
640,000
(12,000)
30,000
818,000
715,356
$102,644
LO: 4, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Commmunication
Exercise 8.15 (15–20 minutes)
(a)
Merchandise on hand, January 1
Purchases
Less: Purchase returns and allowances
Freight-in
Total merchandise available (at cost)
Cost of goods sold*
Ending inventory
Less: Undamaged goods
Estimated fire loss
*Gross profit =
33 1/3%
= 25% of sales.
100% + 33 1/3%
Cost of goods sold = 75% of sales of $100,000 = $75,000.
$ 38,000
72,000
(2,400)
3,400
111,000
75,000
36,000
10,900
$ 25,100
Exercise 8.15 (Continued)
(b)
Cost of goods sold = 66 2/3% of sales of $100,000 = $66,667
Total merchandise available (at cost)
(as computed above)
Cost of goods sold
Ending inventory
Less: Undamaged goods
Estimated fire loss
$111,000
66,667
44,333
10,900
$33,433
LO: 4, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.16 (15 – 20 minutes)
Beginning inventory
Purchases
Purchase returns
Goods available (at cost)
Sales revenue
Sales returns
Net sales
Less: Gross profit (40% × $626,000)
Estimated ending inventory (unadjusted for
damage)
Less: Goods on hand—undamaged (at cost)
$21,000 × (1 – 40%)
Less: Goods on hand—damaged (at net
realizable value)
Fire loss on inventory
$170,000
390,000
560,000
(30,000)
530,000
$650,000
(24,000)
626,000
(250,400)
375,600
154,400
(12,600)
(5,300)
$136,500
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.17 (10–15 minutes)
Beginning inventory (at cost)
Purchases (at cost)
Goods available (at cost)
Sales revenue (at selling price)
Less sales returns
Net sales
Less: Gross profit* (2/7 of $112,000)
Net sales (at cost)
Estimated inventory (at cost)
Less: Goods on hand ($30,500 – $6,000)
$ 38,000
85,000
123,000
$116,000
4,000
112,000
32,000
80,000
43,000
24,500
Claim against insurance company
*Computation of gross profit:
$ 18,500
40%
= 2/7 of selling price
100% + 40%
Note: Depending on details of the consignment agreement and Duncan’s
insurance policy, the consigned goods might be considered owned for
insurance purposes.
LO: 4, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.18 (15–20 minutes)
Inventory 1/1/25 (cost)
Purchases to 8/18/25 (cost)
Cost of goods available
Deduct cost of goods sold*
Inventory 8/18/25
Lumber
Millwork
Hardware
$ 250,000
1,500,000
1,750,000
1,664,000
$ 86,000
$ 90,000
375,000
465,000
410,000
$ 55,000
$ 45,000
160,000
205,000
150,000
$ 55,000
*(See computations on next page)
Exercise 8.18 (Continued)
Computation for cost of goods sold:*
Lumber:
$2,080,000
= $1,664,000
1.25
Millwork:
$533,000
1.30
= $410,000
Hardware:
$210,000
1.40
= $150,000
*Alternative computation for cost of goods sold:
Markup on selling price:
Cost of goods sold:
Lumber:
25%
= 20% or 1/5
100% + 25%
$2,080,000 × 80% = $1,664,000
Millwork:
30%
= 3/13
100% + 30%
$533,000 × 10/13 = $410,000
Hardware:
40%
= 2/7
100% + 40%
$210,000 × 5/7 = $150,000
LO: 4, Bloom: AP, Difficulty: Simple, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.19 (20–25 minutes)
Ending inventory:
(a)
Gross profit is 45% of sales
Total goods available for sale (at cost)
Sales (at selling price)
Less: Gross profit (45% of sales)
Estimated cost of goods sold
Ending inventory (at cost)
(b)
$2,500,000
1,125,000
1,375,000
$ 725,000
Gross profit is 60% of cost
60%
100% + 60%
= 37.5% markup on selling price
Total goods available for sale (at cost)
Sales (at selling price)
Less: Gross profit (37.5% of sales)
Estimated cost of goods sold
Ending inventory (at cost)
(c)
$2,100,000
$2,100,000
$2,500,000
937,500
1,562,500
$ 537,500
Gross profit is 35% of sales
Total goods available for sale (at cost)
Sales (at selling price)
Less: Gross profit (35% of sales)
Estimated cost of goods sold
Ending inventory (at cost)
$2,100,000
$2,500,000
875,000
1,625,000
$ 475,000
Exercise 8.19 (Continued)
(d)
Gross profit is 25% of cost
25%
100% + 25%
= 20% markup on selling price
Total goods available for sale (at cost)
Sales (at selling price)
Less: Gross profit (20% of sales)
Estimated cost of goods sold
Ending inventory (at cost)
$2,100,000
$2,500,000
500,000
2,000,000
$ 100,000
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.20 (20–25 minutes)
(a)
Beginning inventory
Purchases
Net markups
Totals
Net markdowns
Sales price of goods available
Deduct: Sales revenue
Ending inventory at retail
(b)
1.
2.
3.
4.
$180,000 ÷ $300,000 = 60%
$180,000 ÷ $273,865 = 65.73%
$180,000 ÷ $310,345 = 58%
$180,000 ÷ $284,210 = 63.33%
Cost
$ 58,000
122,000
_______
$180,000
Retail
$100,000
200,000
10,345
310,345
(26,135)
284,210
186,000
$ 98,210
Exercise 8.20 (Continued)
(c)
1.
2.
3.
Method 3
Method 3
Method 3
(d)
58% × $98,210 = $56,962
(e)
$180,000 – $56,962 = $123,038
(f)
$186,000 – $123,038 = $62,962
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.21 (12–17 minutes)
Beginning inventory
Purchases
Totals
Add: Net markups
Markups
Markup cancellations
Totals
Cost
$ 200,000
1,375,000
1,575,000
_________
$1,575,000
Retail
$ 280,000
2,140,000
2,420,000
$95,000
(15,000)
Deduct: Net markdowns
Markdowns
Markdowns cancellations
Sales price of goods available
Deduct: Sales revenue
Ending inventory at retail
Cost-to-retail ratio =
$1,575,000
$2,500,000
35,000
(5,000)
80,000
2,500,000
30,000
2,470,000
2,200,000
$ 270,000
= 63%
Ending inventory at cost = 63% × $270,000 = $170,100
LO: 5, Bloom: AP, Difficulty: Simple, Time: 12-17, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.22 (20–25 minutes)
Cost
$30,000
48,000
(2,000)
2,400
78,400
Beginning inventory
Purchases
Purchase returns
Freight on purchases
Totals
Add: Net markups
Markups
Markup cancellations
Net markups
Totals
$10,000
(1,500)
_______
$78,400
Deduct: Net markdowns
Markdowns
Markdowns cancellations
Net markdowns
Sales price of goods available
Deduct: Net sales ($99,000 – $2,000)
Ending inventory, at retail
Cost-to-retail ratio =
$78,400
$140,000
Retail
$ 46,500
88,000
(3,000)
_______
131,500
8,500
140,000
9,300
(2,800)
6,500
133,500
97,000
$ 36,500
= 56%
Ending inventory at cost = .56 × $36,500 = $20,440
LO: 5, Bloom: AP, Difficulty: Simple, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Exercise 8.23 (10–15 minutes)
(a)
Inventory turnover:
Current year
$5,484.8
$934.2 + $1,044.1
2
(b)
= 5.5 times
Prior year
$6,234.9
$1,044.1 + $1,642.6
2
= 4.6 times
Average days to sell inventory:
Current year
Prior year
365 ÷ 5.5 = 66 days
365 ÷ 4.6 = 79 days
LO: 6, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Exercise 8.24 (25–35 minutes)
(a)
Conventional Retail Method
Cost
$ 38,100
130,900
169,000
________
$169,000
Inventory, January 1, 2025
Purchases (net)
Add: Net markups
Totals
Deduct: Net markdowns
Sales price of goods available
Deduct: Sales (net)
Ending inventory at retail
Cost-to-retail ratio =
$169,000
$260,000
Retail
$ 60,000
178,000
238,000
22,000
260,000
13,000
247,000
167,000
$ 80,000
= 65%
Ending inventory at cost = .65 × $80,000 = $52,000
(b)
LIFO Retail Method
Inventory, January 1, 2025
Net purchases
Net markups
Net markdowns
Total (excluding beginning inventory)
Total (including beginning inventory)
Deduct sales (net)
Ending inventory at retail
Cost-to-retail ratio =
$130,900
$187,000
= 70%
Cost
$ 38,100
130,900
130,900
$169,000
Retail
$ 60,000
178,000
22,000
(13,000)
187,000
247,000
167,000
$ 80,000
*Exercise 8.24 (Continued)
Computation of ending inventory at LIFO cost, 2025:
Ending Inventory
at Retail Prices
Layers at
Retail Prices
$80,000
2024 $60,000
2025 20,000
*$38,100
$60,000
Cost to Retail
(Percentage)
Ending Inventory
at LIFO Cost
63.5%*
70.0%
$38,100
14,000
$52,100
X
X
(prior years cost to retail)
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 25-35, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Exercise 8.25 (15–20 minutes)
(a)
Cost
$14,000
58,800
7,500
Inventory, January 1, 2025
Net purchases
Freight-in
Net markups
Totals
Sales revenue
Net markdowns
Estimated theft
Ending inventory at retail
Cost-to-retail ratio:
$80,300
$110,000
$80,300
Retail
$ 20,000
81,000
9,000
110,000
(80,000)
(1,600)
(2,000)
$ 26,400
= 73%
Ending inventory at lower-of-average-cost-or-market = $26,400 × 73%
= $19,272
*Exercise 8.25 (Continued)
(b)
Cost
$58,800
7,500
Purchases
Freight-in
Net markups
Net markdowns
Totals
Cost-to-retail ratio:
$66,300
$66,300
$88,400
Retail
$81,000
9,000
(1,600)
$88,400
= 75%
The increment at retail is $26,400 – $20,000 = $6,400.
The increment is costed at .75 × $6,400 = $4,800.
Ending inventory at LIFO retail:
Beginning inventory, 2025
Increment
Ending inventory, 2025
Cost
$14,000
4,800
$18,800
Retail
$20,000
6,400
$26,400
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 15-20, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Exercise 8.26 (10–15 minutes)
(a)
Cost-to-retail ratio—beginning inventory:
$216,000
= 72%
$300,000
*($294,300 ÷ 1.09) × .72 = $194,400
*Since the above computation reveals that the inventory quantity has
declined below the beginning level, it is necessary to convert the
ending inventory to beginning-of-the-year prices (by dividing by 1.09)
and then multiply it by the beginning cost-to-retail ratio (72%).
*Exercise 8.26 (Continued)
(b)
Ending inventory at retail prices deflated $365,150 ÷ 1.09
Beginning inventory at beginning-of-year prices
Inventory increase in terms of beginning-of-year dollars
$335,000
300,000
$ 35,000
Beginning inventory (at cost)
Additional layer, $35,000 × 1.09 × .76*
$216,000
28,994
$244,994
*($364,800 ÷ $480,000)
LO: 7, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Exercise 8.27 (5–10 minutes)
Ending inventory at retail (deflated) $100,100 ÷ 1.10
Beginning inventory at retail
Increment at retail
Ending inventory on LIFO basis
First layer
Second layer ($16,500 × 1.10 × .60)
$91,000
74,500
$16,500
Cost
$36,000
10,890
$46,890
LO: 7, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Exercise 8.28 (20–25 minutes)
(a)
Beginning inventory
Net purchases
Net markups
Totals
Net markdowns
Sales revenue
Ending inventory at retail
Cost
$ 30,100
108,500
________
$138,600
Cost-retail ratio = 66% ($138,600/$210,000)
Ending inventory at cost ($78,100 × .66)
(b)
Cost
$ 30,100
108,500
Beginning inventory
Net purchases
Net markups
Net markdowns
Total (excluding beginning inventory)
108,500
Total (including beginning inventory)
$138,600
Sales revenue
Ending inventory at retail (current)
Ending inventory at retail (base year)
($78,100 ÷ 1.10)
Cost-to-retail ratio for new layer:
$108,500/$155,000 = 70%
Layers:
Base layer
$50,000 × 1.00 × .602* =
New layer
($71,000 – $50,000) × 1.10 × .70 =
Retail
$ 50,000
150,000
10,000
210,000
(5,000)
(126,900)
$ 78,100
$ 51,546
Retail
$ 50,000
150,000
10,000
(5,000)
155,000
205,000
(126,900)
78,100
$ 71,000
$ 30,100
16,170
$ 46,270
*($30,100/$50,000)
(c)
Cost of goods available for sale
Ending inventory at cost, from (b)
Cost of goods sold
$138,600
46,270
$ 92,330
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Exercise 8.29 (20–25 minutes)
2024
Restate to base-year retail ($118,720 ÷ 1.06)
$112,000
Layers: 1. $100,000 × 1.00 × .54* =
2. $ 12,000 × 1.06 × .57 =
Ending inventory
$ 54,000
7,250
$ 61,250
*$54,000 ÷ $100,000
2025
2026
2027
Restate to base-year retail ($138,750 ÷ 1.11)
$125,000
Layers: 1. $100,000 × 1.00 × .54 =
2. $ 12,000 × 1.06 × .57 =
3. $ 13,000 × 1.11 × .60 =
Ending inventory
$ 54,000
7,250
8,658
$ 69,908
Restate to base-year retail ($125,350 ÷ 1.15)
$109,000
Layers: 1. $100,000 × 1.00 × .54 =
2. $ 9,000 × 1.06 × .57 =
Ending inventory
$ 54,000
5,438
$ 59,438
Restate to base-year retail ($162,500 ÷ 1.25)
$130,000
Layers: 1. $100,000 × 1.00 × .54 =
2. $ 9,000 × 1.06 × .57 =
3. $ 21,000 × 1.25 × .58 =
Ending inventory
$ 54,000
5,438
15,225
$ 74,663
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 20-25, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Exercise 8.30 (5–10 minutes)
Inventory (beginning) .............................................
Adjustment to Record Inventory at Cost
(Cost of Goods Sold)* ................................
($212,600 – $205,000)
7,600
7,600
*Note: This account is an income statement account (Cost of Goods Sold
could be used) showing the effect of changing from a lower-of-cost-ormarket approach to a straight cost basis.
LO: 7, Bloom: AP, Difficulty: Simple, Time: 5-10, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Time and Purpose of Problems
Problem 8.1 (Time 10–15 minutes)
Purpose—to provide the student with an understanding of the lower-of-cost-or NRV approach to inventory
valuation, similar to Problem 8.2. The major difference between these problems is that Problem 8.1
provides some ambiguity to the situation by changing the catalog prices near the end of the year.
Problem 8.2 (Time 25–30 minutes)
Purpose—to provide the student with an understanding of the lower-of-cost-or NRV approach to inventory
valuation. The student is required to examine a number of individual items and apply the lower-of-costor NRV rule and to also explain the use and value of the lower-of-cost- and NRV rule.
Problem 8.3 (Time 30–35 minutes)
Purpose—to provide a problem that requires entries for reducing inventory to lower-of-cost-or NRV under
the perpetual inventory system using both the cost-of-goods-sold and the loss methods.
Problem 8.4 (Time 25–30 minutes)
Purpose—to provide the student with an understanding of the lower-of-cost-or-market approach to
inventory valuation. The student is required to examine a number of individual items and apply the lowerof-cost-or-market rule and to also explain the use and value of the lower-of-cost-or-market rule.
Problem 8.5 (Time 30–40 minutes)
Purpose—to provide the student with an opportunity to write a memo explaining designated market value
and how it is computed. As part of this memo, the student is required to compute inventory on the lowerof-cost-or-market basis using the individual item approach.
Problem 8.6 (Time 20–30 minutes)
Purpose—to provide another problem where a fire loss must be computed using the gross profit method.
Certain goods remained undamaged and therefore an adjustment is necessary. In addition, the inventory
was subject to an obsolescence factor which must be considered.
Problem 8.7 (Time 40–45 minutes)
Purpose—to provide the student with a complex problem involving a fire loss where the gross profit method
must be employed. The problem is complicated because a number of adjustments must be made to the
purchases account related to merchandise returned, unrecorded purchases, and shipments in transit. In
addition, some cash to accrual computations are necessary.
Problem 8.8 (Time 20–30 minutes)
Purpose—to provide the student with a problem on the retail inventory method. The problem is relatively
straightforward although transfers-in from other departments as well as the proper treatment for normal
spoilage complicate the problem. A good problem that summarizes the essentials of the retail inventory
method.
Problem 8.9 (Time 20–30 minutes)
Purpose—to provide the student with a problem on the retail inventory method. This problem is similar to
Problem 9-8, except that a few different items must be evaluated in finding ending inventory at retail and
cost. Unusual items in this problem are employee discounts and loss from breakage. A good problem
that summarizes the essentials of the retail inventory method.
Problem 8.10 (Time 20–30 minutes)
Purpose—to provide the student with a problem on the retail inventory method. This problem is similar to
Problems 8.8 and 8.9, except that the student is asked to list the factors that may have caused the
difference between the computed inventory and the physical count.
Time and Purpose of Problems (Continued)
Problem 8.11 (Time 30–40 minutes)
Purpose—to provide the student with a problem requiring financial statement and note disclosure of
inventories, the income statement disclosure of an inventory market decline, and the treatment of
purchase commitments.
*Problem 8.12 (Time 30–35 minutes)
Purpose—to provide the student with a retail inventory problem where both the conventional retail and
dollar-value LIFO method must be computed. An excellent problem for highlighting the difference
between these two approaches to inventory valuation. It should be noted that the cost-to-retail percentage
is given for LIFO so less computation is necessary.
*Problem 8.13 (Time 30–40 minutes)
Purpose—to provide the student with a comprehensive problem covering the retail and LIFO retail
inventory methods, the computation of an inventory shortage, and the treatment of four special items
relative to the retail inventory method.
*Problem 8.14 (Time 30–40 minutes)
Purpose—to provide the student with a basic problem illustrating the comparison between conventional
retail and LIFO retail. This problem emphasizes many of the same issues as Problem 8.11, except that
a dollar-value LIFO computation is not needed. A good problem for providing the essential issues related
to a change to LIFO retail.
*Problem 8.15 (Time 40–50 minutes)
Purpose—to provide the student with a retail inventory problem where both the conventional retail and
dollar-value LIFO method must be computed. The problem is similar to Problem 8.12, except that the
problem involves a three-year period which adds complexity to the problem. This problem provides an
excellent summary of the essential elements related to the change of the retail inventory method from
conventional retail to LIFO retail and dollar-value LIFO retail.
Solutions to Problems
Problem 8.1
Item
A
B
C
D
Cost
$47
45
83
96
Net Realizable Value*
$ 45
43
64
100
Lower-of-Cost-or-NRV
$45
43
64
96
*Net Realizable Value = 2026 catalog selling price less estimated costs to
complete and sell. (2026 catalog prices are in effect as of 12/01/25.)
LO: 1, Bloom: AP, Difficulty: Simple, Time: 10-15, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Problem 8.2
(a)
(b)
The write-down to reduce inventory to the lower-of-cost-or NRV
at May 31, 2025, should be $15,200, as calculated as follows.
Cost
NRV
LCNRV
Aluminum siding
$ 70,000
$ 56,000
$ 56,000
Cedar shake siding
86,000
84,800
84,800
Louvered glass doors
112,000
168,300
112,000
Thermal windows
140,000
140,000
140,000
Totals
$408,000
$449,100
$392,800
Inventory cost
$408,000
Less: LCNRV valuation
392,800
Inventory writedown
$ 15,200
For the fiscal year ended May 31, 2025, Garcia Home Improvement
prepares the following entry.
Inventory Loss ....................................................
Inventory..................................................
(c)
15,200
15,200
The use of the lower-of-cost-or-net realizable value (LCNRV) rule is
based on both the expense recognition principle and the concept of
conservatism. The expense recognition principle applies because the
application of the LCNRV rule allows for the recognition of a decline in
the utility (value) of inventory as a loss in the period in which the decline
takes place. The general rule is that the historical cost principle is
abandoned when the future utility of an asset is no longer as great as
its original cost (conservatism).
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Problem 8.3
(a)
Cost-of-Goods-Sold Method
December 31, 2026
Cost of Goods Sold ...............................................
Inventory
($780,000 – $712,000)................................
December 31, 2027
Cost of Goods Sold ...............................................
Inventory
($905,000 – $830,000) ................................
(b)
Loss Method
December 31, 2026
Inventory Loss ......................................................
Inventory
($780,000 – $712,000).................................
December 31, 2027
Inventory Loss ......................................................
Inventory
($905,000 – $830,000).................................
68,000
68,000
75,000
75,000
68,000
68,000
75,000
LO: 1, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
75,000
Problem 8.4
(a)
(1)
The amount of the adjustment to Reduce Inventory to Market at
May 31, 2025, should be $34,600, as calculated in Exhibit 1 below.
Exhibit 1
(2)
Cost
Replacement
Cost
NRV
(Ceiling)
NRV less
normal
profit
(Floor)
Aluminum siding
$ 70,000
$ 62,500
$ 56,000
$ 50,900
$ 56,000
Cedar shake siding
86,000
79,400
84,800
77,400
79,400
Louvered glass doors
112,000
124,000
168,300
149,800
112,000
Thermal windows
140,000
126,000
140,000
124,600
126,000
Totals
$408,000
$391,900
$449,100
$402,700
$373,400
Inventory cost
$408,000
Less: LCM valuation
373,400
Write-down May 31, 2025
$ 34,600
For the fiscal year ended May 31, 2025, entry to record the loss to
reduce inventory to market is as follows.
Inventory Loss .................................................... 34,600
Inventory ......................................................
(b)
LCM
34,600
The use of the lower-of-cost-or-market (LCM) rule is based on both the
expense recognition principle and the concept of conservatism. The
expense recognition principle applies because the application of the
LCM rule allows for the recognition of a decline in the utility (value) of
inventory as a loss in the period in which the decline takes place.
The general rule is that the historical cost principle is abandoned when
the future utility of an asset is no longer as great as its original cost
(conservatism).
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 25-30, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC:
Communication
Problem 8.5
(a)
Schedule A
Item
On Hand
Quantity
Replacement
Cost/Unit
NRV
(Ceiling)
NRV—
Normal
Profit
(Floor)
A
B
C
D
E
1,100
800
1,000
1,000
1,400
$8.40
7.90
5.40
4.20
6.30
$9.00*
8.50
6.05
5.50
6.00
$7.20
7.30
5.45
4.00
5.00
Designated
Market
Cost
Lower-ofCost-orMarket
$8.40
7.90
5.45
4.20
6.00
$7.50
8.20
5.60
3.80
6.40
$7.50
7.90
5.45
3.80
6.00
*$10.50-$1.50
Schedule B
Item
A
B
C
D
E
(b)
Cost
1,100 × $7.50 = $8,250
800 × $8.20 = $6,560
1,000 × $5.60 = $5,600
1,000 × $3.80 = $3,800
1,400 × $6.40 = $8,960
Lower-of-Cost-or-Market
1,100 × $7.50 = $8,250
800 × $7.90 = $6,320
1,000 × $5.45 = $5,450
1,000 × $3.80 = $3,800
1,400 × $6.00 = $8,400
Cost of Goods Sold ................................................
Inventory .........................................................
Difference
$-0240
150
-0560
$950
950
950
Or
Inventory Loss ........................................................
Inventory .........................................................
950
950
Problem 8.5 (Continued)
(c)
To:
Greg Forda, Clerk
From:
Accounting Manager
Date:
January 14, 2026
Subject:
Instructions on determining lower-of-cost-or-market for inventory
valuation
This memo responds to your questions regarding our use of lower-of-costor-market for inventory valuation. Simply put, inventory should be valued at
whichever is the lower: the actual cost or the market value of the inventory
at the time of valuation.
The term cost is relatively simple. It refers to the amount our company paid
for our inventory including costs associated with preparing the inventory for
sale.
The term market, on the other hand, is more complicated. As you have
already noticed, this value could be the inventory’s replacement cost, its net
realizable value (selling price minus any estimated costs to complete and
sell), or its net realizable value less a normal profit margin. The profession
requires that the middle value of the three above costs be chosen as the
“designated market value.” This designated market value is then compared
to the actual cost in determining the lower-of-cost-or-market.
Refer to Item A on the attached schedule. The values for the replacement
cost, net realizable value, and net realizable value less a normal profit margin
are $8.40, $9.00 ($10.50 – $1.50), and $7.20 ($9.00 – $1.80) respectively. The
middle value is the replacement cost, $8.40, which becomes the designated
market value for Item A. Compare it with the actual cost, $7.50, choosing the
lower to value Item A in inventory. In this case, $7.50 is the value chosen to
value inventory. Thus, inventory for Item A amounts to $8,250. (See Schedule
B, Item A.)
Problem 8.5 (Continued)
Proceed in the same way, always choosing the middle value among replacement cost, net realizable value, and net realizable value less a normal profit,
and compare that middle value to the actual cost. The lower of these will
always be the amount at which you value the particular item.
After you have aggregated the total lower-of-cost-or-market for all items, you
will be likely to have a loss on inventory which must be accounted for. In our
example, the loss is $950. You can journalize this loss in one of two ways:
Cost of Goods Sold .............................................................
Inventory .....................................................................
950
950
Or
Inventory Loss .....................................................................
Inventory .....................................................................
950
950
This memo should answer your questions about which value to choose
when valuing inventory at lower-of-cost-or-market.
Schedule A
Item
On Hand
Quantity
Replacement
Cost/Unit
NRV
Ceiling
NRV—
Normal
Profit
(Floor)
A
B
C
D
E
1,100
800
1,000
1,000
1,400
$8.40
7.90
5.40
4.20
6.30
$9.00
8.50
6.05
5.50
6.00
$7.20
7.30
5.45
4.00
5.00
Designated
Market
Cost
Lower-ofCost-orMarket
$8.40
7.90
5.45
4.20
6.00
$7.50
8.20
5.60
3.80
6.40
$7.50
7.90
5.45
3.80
6.00
Schedule B
Item
A
B
C
D
E
Cost
1,100 × $7.50 = $8,250
800 × $8.20 = $6,560
1,000 × $5.60 = $5,600
1,000 × $3.80 = $3,800
1,400 × $6.40 = $8,960
Lower-of-Cost-or-Market
1,100 × $7.50 = $8,250
800 × $7.90 = $6,320
1,000 × $5.45 = $5,450
1,000 × $3.80 = $3,800
1,400 × $6.00 = $8,400
Difference
$-0240
150
-0560
$950
LO: 2, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC:
Communication
Problem 8.6
Beginning inventory ...................................................
Purchases ....................................................................
Purchase returns.........................................................
Total goods available ..................................................
Sales revenue ..............................................................
Sales returns ...............................................................
Net sales ......................................................................
Less: Gross profit (35% × $394,000) .........................
Ending inventory (unadjusted for damage) ..............
Less: Goods on hand—undamaged
($30,000 × [1 – 35%]) ........................................
Inventory damaged .....................................................
Less: Net realizable value of damaged inventory ....
Fire loss on inventory .................................................
$ 80,000
290,000
370,000
(28,000)
342,000
$415,000
(21,000)
394,000
137,900
(256,100)
85,900
19,500
66,400
8,150
$ 58,250
LO: 4, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Problem 8.7
STANISLAW CORPORATION
Computation of Inventory Fire Loss
April 15, 2026
Inventory, 1/1/26 ..........................................
Purchases, 1/1/26 – 3/31/26 ........................
April merchandise shipments paid ............
Unrecorded purchases on account ...........
Total...................................................
Less: Shipments in transit ........................
Merchandise returned .....................
Merchandise available for sale ..................
Less estimated cost of sales:
Sales revenue, 1/1/26 – 3/31/26 ........
Sales revenue, 4/1/26 – 4/15/26
Receivables acknowledged
at 4/15/26 ..................................
Estimated receivables not
acknowledged ..........................
Total .............................................
Add collections, 4/1/26 – 4/15/26
($12,950 – $950) .............................
Total .............................................
Less receivables, 3/31/26 .................
Total sales 1/1/26 – 4/15/26 ........
Less gross profit (.45* × $161,000) ............
Estimated merchandise inventory .............
Less: Sale of salvaged inventory..............
Inventory fire loss .......................................
$ 75,000
52,000
3,400
15,600
146,000
$
2,300
950
3,250
142,750
135,000
$46,000
8,000
54,000
12,000
66,000
40,000
26,000
161,000
72,450
88,550
54,200
3,500
$ 50,700
Problem 8.7 (Continued)
*Computation of Gross Profit Rate
Net sales, 2024 ..............................................
Net sales, 2025 ..............................................
Total net sales.....................................
Beginning inventory .....................................
Net purchases, 2024 .....................................
Net purchases, 2025 .....................................
Total .....................................................
Less: Ending inventory................................
Gross profit ........................................
$390,000
530,000
920,000
$ 66,000
235,000
280,000
581,000
75,000
506,000
$414,000
Gross profit rate ($414,000 ÷ $920,000) .......
LO: 4, Bloom: AP, Difficulty: Complex, Time: 40-45, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
45%
Problem 8.8
(a)
Beginning inventory ...........................
Purchases ...........................................
Freight-in .............................................
Purchase returns ................................
Transfers in from
suburban branch..............................
Totals ..........................................
Net markups ........................................
Cost
Retail
$ 17,000
82,500
7,000
(2,300)
$ 25,000
137,000
9,200
$113,400
13,000
172,000
8,000
180,000
(4,000)
Net markdowns ...................................
Sales revenue......................................
Sales returns .......................................
Inventory losses - normal breakage ..
Ending inventory at retail ...................
Cost-to-retail ratio =
(b)
$113,400
$180,000
(3,000)
$(95,000)
2,400
(92,600)
(400)
$ 83,000
= 63%
Ending inventory at lower-of-average-cost-or-market
(.63 × $83,000) ..................................
$ 52,290
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Problem 8.9
Beginning inventory .........................
Purchases ..........................................
Purchase returns...............................
Purchase discounts ..........................
Freight-in ...........................................
Markups .............................................
Markup cancellations ........................
Totals ........................................
Markdowns ........................................
Markdown cancellations ...................
Sales revenue ....................................
Less: Sales returns ...........................
Inventory losses - normal breakage
Employee discounts .........................
Ending inventory at retail .................
Cost-to-retail ratio =
Cost
Retail
$ 250,000
914,500
(60,000)
(18,000)
42,000
$ 390,000
1,460,000
(80,000)
$
$1,128,500
120,000
(40,000)
80,000
1,850,000
(45,000)
20,000
(25,000)
(1,410,000)
97,500 (1,312,500)
(4,500)
(8,000)
$ 500,000
$1,128,500 = 61%
$1,850,000
Ending inventory at cost
(.61 × $500,000)...............................
$ 305,000
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
Problem 8.10
(a)
Inventory (beginning) .....................
Purchases .......................................
Purchase returns ............................
Freight-in .........................................
Totals ......................................
Markups ...........................................
Markup cancellations .....................
Cost
Retail
$ 52,000
272,000
(5,600)
16,600
$335,000
$ 78,000
423,000
(8,000)
$ 9,000
(2,000)
Net markdowns ...............................
Normal spoilage and breakage ......
Sales revenue..................................
Ending inventory at retail ...............
Cost-to-retail ratio =
$335,000
$500,000
7,000
500,000
(3,600)
(10,000)
(390,000)
$ 96,400
= 67%
Ending inventory at lower-of-cost-or-market
(.67 × $96,400) ..............................
(b)
493,000
$ 64,588
The difference between the inventory estimate per retail method and
the amount per physical count may be due to:
1. Theft losses (shoplifting or pilferage).
2. Spoilage or breakage above normal.
3. Differences in cost/retail ratio for purchases during the month,
beginning inventory, and ending inventory.
4. Markups on goods available for sale inconsistent between cost of
goods sold and ending inventory.
5. A wide variety of merchandise with varying cost/retail ratios.
6. Incorrect reporting of markdowns, additional markups, or
cancellations.
LO: 5, Bloom: AP, Difficulty: Moderate, Time: 20-30, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC:
Communication
Problem 8.11
(a)
The inventory section of Maddox’s balance sheet as of November 30,
2025, including required footnotes, is presented below. Also presented
below are the inventory section supporting calculations.
Current assets
Inventory section (Note 1.)
Finished goods (Note 2.) ........................
Work-in-process......................................
Raw materials..........................................
Factory supplies .....................................
Total inventories .....................................
$643,000
108,700
237,400
64,800
$1,053,900
Note 1.
Lower-of-cost (first-in, first-out) or-NRV is applied on a major
category basis for finished goods, and on a total inventory
basis for work-in-process, raw materials, and factory
supplies.
Note 2.
Seventy-five percent of bar end shifters finished goods
inventory in the amount of $136,500 ($182,000 × .75) is
pledged as collateral for a bank loan, and one-half of the
head tube shifters finished goods is held by catalog outlets
on consignment.
Problem 8.11 (Continued)
Supporting Calculations
Down tube shifters at NRV ............
Bar end shifters at cost..................
Head tube shifters at cost ..............
Work-in-process at NRV ................
Derailleurs at market ......................
Remaining items at NRV ................
Supplies at cost ..............................
Totals ....................................
Finished
Goods
$266,000
182,000
195,000
Work-inProcess
Raw
Materials
Factory
Supplies
$108,700
$110,0001
127,400
$643,000
$108,700
$237,400
$64,8002
$64,800
1$264,000 × 1/2 = $132,000; $132,000 ÷ 1.2 = $110,000.
2$69,000 – $4,200 = $64,800.
(b)
The decline in the NRV of inventory below cost may be reported using
one or two alternate methods, the direct write-down of inventory (costof-goods-sold method) or the (loss method). The decline in the market
value of inventory may be reflected in Maddox’s income statement as a
separate loss item for the fiscal year ended November 30, 2025. The
loss amount may also be written off directly, increasing the cost of
goods sold on Maddox’s income statement. The loss must be reported
in continuing operations. The loss must be included in the income
statement since it is material to Maddox’s financial statements.
(c)
Purchase contracts for which a fixed price has been established should
be disclosed on the financial statements of the buyer. If the contract
price is greater than the current market price (a loss would occur if the
purchase takes place). An unrealized holding loss amounting to the
difference between the contracted price and the current market price
should be recognized on the income statement in the period during
which the price decline takes place. Also, an estimated liability on
purchase commitments should be recognized on the balance sheet.
LO: 1, 3, 6, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC:
Communication
*Problem 8.12
(a)
Inventory, January 1 .......................
Purchases........................................
Purchase returns ............................
Totals ......................................
Add: Net markups
Markups .................................
Markup cancellations ...........
Totals ......................................
Deduct: Net markdowns
Markdowns .............................
Markdown cancellations........
Sales price of goods available .......
Sales revenue ..................................
Sales returns and allowances ........
Ending inventory at retail ...............
Cost-to-retail ratio =
$132,000
$200,000
Cost
Retail
$ 30,000
104,800
(2,800)
132,000
$ 43,000
155,000
(4,000)
194,000
$
9,200
(3,200)
$132,000
10,500
(6,500)
154,000
(8,000)
4,000
196,000
(146,000)
$ 50,000
= 66%
Inventory at lower-of-cost-ormarket (.66 × $50,000) ..................
(b)
6,000
200,000
Ending inventory at retail at January 1 price level
($59,400 ÷ 1.08)..................................................................
Less beginning inventory at retail ......................................
Inventory increment at retail, January 1 price level ..........
Inventory increment at retail, June 30 price level
($12,000 × 1.08)..................................................................
Beginning inventory at cost ................................................
Inventory increment at cost at June 30 price level
($12,960 × .70*) ..................................................................
Ending inventory at dollar-value LIFO cost .......................
$ 33,000
$ 55,000
43,000
$ 12,000
$ 12,960
$ 30,000
9,072
$ 39,072
*70% = $30,000/$43,000
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 30-35, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Problem 8.13
(a)
The retail method is appropriate in businesses that sell many different
items at relatively low unit costs and that have a large volume of
transactions such as Home Depot or Wal-Mart. The advantages of the
retail method in these circumstances include the following:
1.
Interim physical inventories can be estimated.
2.
The retail method acts as a control as deviations from the physical
count will have to be explained.
(b)
Becker Department Stores’ ending inventory value, at cost, is $83,000,
calculated as follows:
Beginning inventory ....................................
Purchases ....................................................
Net markups ........................................
Net markdowns ...................................
Net purchases .....................................
Goods available ...........................................
Sales revenue ..............................................
Estimated ending inventory at retail ..........
Cost
$ 68,000
$255,000
$255,000
Retail
$100,000
$400,000
50,000
(110,000)
340,000
440,000
(320,000)
$120,000
Cost-to-retail percentage: $255,000 ÷ $340,000 = 75%.
Beginning inventory layer ...........................
Incremental increase
At retail ($120,000 – $100,000) ...........
At cost ($20,000 × .75) ........................
Estimated ending inventory at LIFO cost ..
$ 68,000
$100,000
20,000
15,000
$ 83,000
$120,000
*Problem 8.13 (Continued)
(c)
The estimated shortage amount, at retail, for Becker Department Stores
is $5,000 calculated as follows:
Estimated ending inventory at retail .............................
Actual ending inventory at retail ...................................
Estimated inventory shortage........................................
(d)
$120,000
(115,000)
$ 5,000
When using the retail inventory method, the four expenses and allowances noted are treated in the following manner:
1.
Freight costs are added to the cost of purchases.
2.
Purchase returns are considered as reductions to both the cost
price and the retail price. Purchase allowances are considered a
reduction in cost price.
3.
Sales returns and allowances are subtracted as an adjustment to
sales.
4.
Employee discounts are deducted from the retail column in a
manner similar to sales. They are not considered in the cost-toretail percentage because they do not reflect an overall change in
the selling price.
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analytic, Communication, AICPA BB: None, AICPA FC: Reporting, AICPA PC:
Communication
*Problem 8.14
(a)
Inventory (beginning) .....................
Purchases .......................................
Markups ...........................................
Totals ......................................
Markdowns ......................................
Sales revenue..................................
Ending inventory at retail ...............
Cost-to-retail ratio =
$132,000
$220,000
Cost
Retail
$ 15,800
116,200
$ 24,000
184,000
12,000
220,000
(5,500)
(175,000)
$ 39,500
$132,000
= 60%
Ending inventory at cost (.60 × $39,500)
(b)
$ 23,700
Ending inventory for 2025 under the LIFO method:
The cost-to-retail ratio for 2025 can be computed as follows:
Net purchases at cost
$116,200
=
= 61%
Net purchases plus markups less markdowns at retail
$184,000 + $12,000 – $5,500
December 31, 2025 inventory at LIFO cost:
Beginning inventory .............
Increment in 2025..................
Ending inventory...................
Retail
$24,000
15,500*
$39,500
Ratio
61%
LIFO Cost
$15,800
9,455
$25,255
*$39,500 – $24,000 = $15,500
LO: 7, Bloom: AP, Difficulty: Moderate, Time: 30-40, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
*Problem 8.15
(a)
DAVENPORT DEPARTMENT STORE
COMPUTATION OF COST
OF DECEMBER 31, 2024 INVENTORY
BASED ON THE CONVENTIONAL RETAIL METHOD
Beginning inventory, January 1, 2024 ..............
Add (deduct) transactions affecting cost ratio:
Purchases ................................................
Purchase returns .....................................
Purchase discounts.................................
Freight-in ..................................................
Net markups .............................................
Totals ..................................................
Add (deduct) other retail transactions not
considered in computation of cost ratio:
Gross sales ..............................................
Sales returns ............................................
Net markdowns ........................................
Employee discounts ................................
Totals ..................................................
Inventory, December 31, 2024:
At retail .....................................................
At cost ($63,000 × .56*) ............................
*Ratio of cost-to-retail = $347,200 ÷ $620,000
= 56%
At Cost
At Retail
$ 29,800
$ 56,000
311,000
(5,200)
(6,000)
17,600
554,000
(10,000)
$347,200
20,000
620,000
(551,000)
9,000
(12,000)
(3,000)
(557,000)
$ 63,000
$ 35,280
*Problem 8.15 (Continued)
(b)
COMPUTATION OF COST
OF DECEMBER 31, 2024 INVENTORY
UNDER THE LIFO RETAIL METHOD
Totals used in computing cost ratio under
conventional retail method (part a)................
Exclude beginning inventory ............................
Net purchases ....................................................
Deduct net markdowns......................................
Totals used in computing cost ratio under
LIFO retail method ..........................................
Cost ratio under LIFO retail method
($317,400 ÷ $552,000)......................................
Inventory, December 31, 2024:
At retail (Conventional) ...........................
At cost under LIFO retail method
($60,000 × .575) .....................................
Cost
Retail
$347,200
29,800
317,400
$620,000
56,000
564,000
12,000
$317,400
$552,000
57.5%
$ 60,000
$ 34,500
*Problem 8.15 (Continued)
(c)
COMPUTATION OF 2025 AND 2026
YEAR-END INVENTORIES
UNDER THE DOLLAR-VALUE LIFO METHOD
Computation of retail values on the basis of January 1, 2025, price levels
Cost
Retail
2025:
Inventory at end of year (given) ...................
Inventory at end of year stated in terms
of January 1, 2025 prices
($75,600 ÷ 1.05) ..........................................
January 1, 2025 inventory base (given)
cost ratio of 55.5% ($33,300 ÷ $60,000) ....
Increment in inventory:
In terms of January 1, 2025 prices ..............
In terms of 2025 prices—$12,000 × 1.05......
At LIFO cost— .61 (2025 cost ratio) ×
$12,600 .......................................................
December 31, 2025 inventory at LIFO cost ...........
$75,600
$72,000
$33,300
60,000
$12,000
$12,600
7,686
$40,986
2026:
Inventory at end of year (given) ...................
Inventory at end of year stated in terms
of January 1, 2026 prices
($62,640 ÷ 1.08) ..........................................
December 31, 2026 inventory at LIFO
cost— .555* (January 1, 2025 cost
ratio) × $58,000...........................................
*Based on the beginning inventory for 2025 of
$62,640
$58,000
$32,190
$33,300 Cost
= 55.5%.
$60,000 Retail
(Note to instructor: Because the retail inventory stated in terms of January 1,
2025 prices at December 31, 2026, $58,000, has fallen below the January 1,
2026 inventory base at retail, $60,000, under the LIFO theory the 2024 layer
has been depleted and only a portion of the original inventory base remains.
Hence the LIFO cost at December 31, 2026 is determined by applying the
January 1, 2025 cost ratio of 55.5 percent to the retail inventory value of
$58,000).
LO: 7, Bloom: AP, Difficulty: Complex, Time: 40-50, AACSB: Analytic, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication
UYJ 8.1 Financial Reporting Problem
(a) Inventories are valued at the lower of cost or net realizable value. Productrelated inventories are primarily maintained on the first-in, first-out
method. The cost of spare part inventories is maintained using the
average cost method.
(b) Inventories are reported on the balance sheet simply as “inventories”
with sub-totals reported for (1) Materials and supplies, (2) Work in
process, and (3) Finished goods.
(c) In its note describing Cost of Products Sold, P&G indicates that cost of
products sold is primarily comprised of direct materials and supplies
consumed in the manufacture of product, as well as manufacturing
labor, depreciation expense and direct overhead expense necessary to
acquire and convert the purchased materials and supplies into finished
product. Cost of products sold also includes the cost to distribute
products to customers, inbound freight costs, internal transfer costs,
warehousing costs and other shipping and handling activity.
Cost of Goods Sold =
$35,250
Average Inventory
($5,498 + $5,017)
2
= 6.7 or approximately 55 days to turn its inventory, which is lower
than in 2019 (7.13 or 51 days).
(d) Inventory turnover =
Its gross profit percentages for 2020 and 2019 are as follows:
Net sales ............................
Cost of goods sold ...........
Gross profit .......................
2020
$70,950
35,250
$35,700
2019
$67,684
34,768
$32,916
Gross profit percentage ...
50.32%
48.63%
P&G had an increase i