Chapter 4
Adjustments, Financial Statements,
and the Quality of Earnings
Revised: : April 27, 2014
ANSWERS TO QUESTIONS
1.
The accounting information processing cycle is a series of sequential phases (or steps)
used in an accounting system to process data from the initial transactions to the end
products – the periodic financial statements – and prepare the records for the next
accounting cycle.
2.
Phase 1 During the period: Perform transaction analysis, record journal entries, and
post amounts to the general ledger (T-accounts).
Phase 2 End of the period: Prepare a trial balance, analyze account balances and
prepare adjustments, record and post adjusting journal entries, prepare financial
statements, and prepare and post the closing entries.
3.
Adjusting entries are made at the end of the accounting period to record appropriate
amounts of revenue, expenses, assets, liabilities and shareholders’ equity.
The four different types are adjustments for:
(a) Deferred expenses – previously recorded assets that need to be adjusted at the end
of the period to reflect expenses that have been incurred or used up during the
period (e.g., prepaid insurance must be adjusted for the portion of insurance
expense incurred in the current period).
(b) Deferred revenues – previously recorded liabilities that need to be adjusted at the
end of the period to reflect revenues that have been earned during the period (e.g.,
deferred revenue must be adjusted for the portion of revenues earned in the
current period).
(c) Accrued revenues – revenues that have been earned by the end of the accounting
period but which will be collected in a future accounting period (e.g., recording
interest receivable for interest earned but not yet collected).
(d) Accrued expenses – expenses that have been incurred by the end of the accounting
period but which will be paid in a future accounting period (e.g., recording an
expense and a corresponding accrued liability for utilities used during the period
but not yet paid).
4.
A trial balance is a list of individual accounts, usually in financial statement order
(assets, liabilities, shareholders’ equity, revenues, and expenses), with their debit or
credit balances. It is used to provide a check on the equality of the debits and credits.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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5.
A contra-asset is an account that is directly related to another account but has an
opposite balance. The contra account is shown as a reduction to the regular account’s
balance. Accumulated Depreciation is a contra-account to the equipment and buildings
accounts.
6.
Adjusting entries are recorded in the journal on the last day of the accounting period
because (a) they record economic effects not adequately measured by the regular
entries up to that date and (b) they represent economic events in the same sense as the
other transactions. They are necessary to measure net earnings for that period
properly, correct errors, and provide for adequate valuation of statement of financial
position accounts. Adjusting entries are posted to the ledger to adjust the balances of
certain accounts on the statement of earnings and the statement of financial position.
7. The net earnings on the statement of earnings is added to the opening balance in the
statement of retained earnings. The deduction of dividends declared during the period
leads to the ending balance of retained earnings which is reported on the statement of
financial position. The change in the cash account on the statement of financial
position is analyzed and categorized on the statement of cash flows into cash from (or
used in) operating activities, investing activities, or financing activities.
8. (a) Statement of Earnings: Net earnings = (Revenues + Gains) – (Expenses + Losses)
(b) Statement of Retained Earnings: Ending Retained Earnings = Beginning
Retained Earnings + Net Earnings – Dividends Declared
(c) Statement of financial position: Assets = Liabilities + Shareholders’ Equity
(d) Statement of cash flows: Changes in cash for the period = Cash from (used in)
Operations + Cash from (used in) Investing Activities + Cash from (used in)
Financing Activities
9.
Adjusting entries have no effect on cash. For deferrals, cash was already received or
paid during the current or previous accounting periods. For accruals, cash will be
received or paid in a future accounting period. At the effective date of the adjusting
entry, e.g., December 31, no cash is being received or paid.
10. In its simplest form Earnings per Share (EPS) is computed by dividing net earnings by
the weighted average number of common shares outstanding during the period. EPS
measures the average amount of net earnings for the year attributable to one common
share. It is important to note that this does not necessarily mean that the shareholder
will actually receive this amount as dividends.
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11. An unadjusted trial balance is prepared after all current transactions have been
journalized and posted to the ledger. It does not include the effects of the adjusting
entries. The basic purpose of an unadjusted trial balance is to check the equalities of
the accounting model (particularly, Debits = Credits) and to provide the data in a form
convenient for further processing in the accounting information processing cycle.
In contrast, an adjusted trial balance is prepared after the effects of all of the adjusting
entries have been applied to the corresponding (prior) unadjusted trial balance
amounts. The basic purpose of an adjusted trial balance is to ensure that accuracy has
been attained in applying the effect of the adjusting entries. The adjusted trial balance
provides a second check of equalities in the accounting model (primarily Debits =
Credits). It also provides information in a convenient form for preparation of the
financial statements.
12. Net earnings is the result of subtracting all accrued expenses from all accrued revenue.
Accrual means that an enforceable obligation exists for customers to pay for a service
or product that has been provided. Therefore, the seller can recognize the dollar value
of the sale even though cash has not been received. Similarly an enforceable obligation
exists for the seller to pay for resources purchased even though the cash has not yet
been paid out. Accruals are subject to specific time periods wherein they must be
recognized. Cash flow from operations reports only the cash received and paid by a
company during a specified time period in relation to its regular operations.
13. Materiality refers to the relative significance of financial information with respect to its
influence on economic decisions made by financial statement users. If a misstatement
or omission of information would cause a change in a decision, then the item is
material. This concept allows accountants and auditors to ignore trivial differences
among estimated values that would not influence a decision. Materiality is clearly
related to relevance. An immaterial item is also an irrelevant item in the context of
decision making.
14. The quality of earnings refers to the relationship between net earnings and cash flow
from operating activities. The measurement of revenues and expenses under the
accrual basis of accounting requires the use of estimates. Those firms that make
relatively pessimistic estimates that reduce current net earnings are judged to follow
conservative financial reporting strategies, and their reports of performance are given
more credence. The earnings numbers reported by these companies are often said to
be of “higher quality” because they are less influenced by management’s natural
optimism. Firms that consistently make optimistic estimates that result in reporting
higher net earnings, however, are judged to be aggressive. Analysts judge these
companies’ operating performance to be of lower quality.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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15. Closing entries are made at the end of the accounting period to transfer the balances in
the temporary statement of earnings accounts to retained earnings. The closing entries
reduce the revenue, gain, expense, and loss accounts to a zero balance so that they can
be used for the accumulation process during the next period. Closing entries must be
entered into the system through the journal and then posted to the ledger accounts so
that appropriate balances are shown in the temporary and permanent accounts (i.e.,
zero balances in the temporary accounts).
16. (a) Permanent accounts – statement of financial position accounts; that is, the asset,
liability, and shareholders’ equity accounts (these are not closed at the end of each
period). Shareholders’ equity accounts include Share Capital and Retained
Earnings.
(b) Temporary accounts – statement of earnings accounts; that is, all the revenue, gain,
expense, and loss accounts that are closed at the end of each period.
(c) Real accounts – another name for permanent accounts.
(d) Nominal accounts – another name for temporary accounts.
17. The statement of earnings accounts are closed at the end of the accounting period
because they are, in effect, temporary sub-accounts to retained earnings (i.e., a part of
shareholders’ equity). They are used only for accumulation during the accounting
period. When the period (usually one year) ends, these accumulated amounts must be
transferred (closed) to retained earnings. The closing process serves two main
purposes, namely (1) to correctly state the balance of retained earnings at the end of
the period, and (2) to clear out the balances of the temporary accounts for the period
just ended so that these accounts can be used again during the next period for
accumulation and classification purposes.
Statement of financial position accounts are not closed at the end of the period because
they reflect permanent accumulated balances of asset, liability, and equity accounts.
Permanent accounts show the entity's financial position at the end of the period and
reflect the beginning amounts for the next period.
18. A post-closing trial balance is a listing taken from the ledger after the adjusting and
closing entries have been journalized and posted. It is not a necessary part of the
accounting information processing cycle but it is useful because it demonstrates the
equality of the debits and credits in the ledger after the closing entries have been
journalized and posted. It also provides a check on the ending balance in retained
earnings.
19. Net profit margin = Net earnings ÷ Net sales
The net profit margin measures how much of every sales dollar generated during the
period is profit. Net profit margin is the most basic measure of profitability since the
ratio shows how much of each sales dollar flows to the “bottom line”.
20. The return on equity (ROE) is computed as follows:
Net Earnings ÷ Average Shareholders’ Equity
where the average shareholders’ equity is computed as (Beginning shareholders’
equity + Ending shareholders’ equity) ÷ 2. The ROE measures how much the firm
earned for each dollar of shareholders’ investment.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-4
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
Authors' Recommended Solution Time
(Time in minutes)
Exercises
No.
Time
1
10 E
2
5E
3
10 M
4
10 E
5
10 E
6
10 M
7
15 M
8
20 M
9
15 M
10
20 M
11
15 M
12
10 E
13
15 M
14
25 D
15
15 D
16
25 M
17
20 M
18
30 E
19
30 E
20
10 M
21
20 M
E = Easy
Problems
No.
Time
1
15 E
2
30 M
3
30 M
4
25 D
5
25 M
6
25 E
7
50 M
8
45 M
9
25 M
10
30 D
M = Moderate
Alternate
Problems
No.
Time
1
15 E
2
25 M
3
30 M
4
25 D
5
25 M
6
25 E
7
50 M
8
45 M
Cases and
Projects
No.
Time
1
25 M
2
25 M
3
25 D
4
40 M
5
45 M
6
30 D
7
15 M
8
30 M
9
45 D
10
60 M
11
20 D
12
20 D
13
*
D = Difficult
* Due to the nature of these cases and projects, it is very difficult to estimate the amount of
time students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While
students often benefit from the extra effort, we find that some become frustrated by the
perceived difficulty of the task. You can reduce student frustration and anxiety by making
your expectations clear. For example, when our goal is to sharpen research skills, we
devote class time discussing research strategies. When we want the students to focus on a
real accounting issue, we offer suggestions about possible companies or industries.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-5
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
EXERCISES
E4–1
Swanson Company
Adjusted Trial Balance
As at June 30, 2014
Debit
Cash
Trade receivables
Inventories
Prepayments
Buildings and equipment
Accumulated depreciation
Land
Trade payables
Accrued expenses payable
Income taxes payable
Deferred fees
Long-term debt
Contributed capital
Retained earnings
Sales revenue
Interest income
Cost of sales
Salaries expense
Rent expense
Depreciation expense
Interest expense
Income taxes expense
Totals
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-6
$
120
400
610
40
1,400
200
820
660
400
110
80
110
$ 4,950
Credit
$
250
200
150
30
100
1,300
300
170
2,400
50
$ 4,950
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–2
Req. 1
The following deferral accounts may need to be adjusted at December 31, 2015:
Statement of financial position account
Prepayments
Property, plant and equipment
Intangible assets
Deferred revenue
Related statement of earnings account
Various expense accounts (e.g., supplies
expense, insurance expense, rent
expense)
Depreciation expense
Amortization expense
Various revenue accounts (e.g., service
revenue)
Req. 2
The following accounts should be reviewed and may need to be adjusted for accruals at
December 31, 2015:
Statement of financial position account
Accrued liabilities
Income taxes payable
Related statement of earnings account
Various expense accounts (e.g., wages
expense)
Income tax expense
Req. 3
All the revenue and expense accounts should be closed at the end of the year to Retained
Earnings (through the Income Summary account). These accounts accumulate amounts
that relate to a specific accounting period. Their balances are reduced to zero to prepare
for the accumulation of new amounts related to the next accounting period.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-7
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–3
Req. 1
(a)
(b)
(c)
600
Deferred rent revenue (L) ...........................................
Rent revenue (+R  +SE) ....................................
To record one month of rent revenue earned ($2,400  4 months).
600
Insurance expense (+E  SE) ....................................
Prepaid insurance (A) .........................................
To record six months of insurance expense ($1,800 x 6/12).
900
900
2,000
Depreciation expense (+E SE) ...............................
Accumulated depreciation (+XA A)...........
To record annual depreciation expense [($10,000  5 years].
Req. 2
Transaction
a.
b.
c.
Statement of Financial Position
Shareholders’
Assets
Liabilities
Equity
N
–600
+600
–900
N
–900
–2,000
N
–2,000
2,000
Statement of Earnings
Net
Revenues Expenses Earnings
+600
N
+600
N
+900
–900
N
+2,000
–2,000
E4–4
Req. 1
(a)
(b)
(c)
Utilities expense (+E SE) .........................................
Accrued utilities payable (+L) ............................
To record utilities expense incurred but not yet paid.
220
220
4,500
Wages expense (+E SE) ............................................
Accrued wages payable (+L) ...............................
To record wages expense incurred but not yet paid,
calculated as 10 employees x 3 days x $150 each per day.
Interest receivable (+A) ..................................................
Interest revenue (+R+SE) ................................
To record interest earned but not yet collected,
calculated as $3,000 x 6% x 4/12.
Req. 2
Transaction
a.
b.
c.
Statement of Financial Position
Shareholders’
Assets
Liabilities
Equity
N
+220
–220
N
+4,500
–4,500
+60
N
+60
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-8
60
4,500
60
Statement of Earnings
Net
Revenues Expenses Earnings
N
+220
–220
N
+4,500
–4,500
+60
N
+60
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–5
Req. 1
The annual reporting period for this company is January 1 through December 31.
Req. 2 (Adjusting entries)
Both transactions are accruals because revenue has been earned and expenses incurred
but no cash has yet been received or paid.
(a)
December 31, 2014:
Wage expense (+E SE) ...........................................................
Wages payable (+L) .........................................................
6,000
6,000
To record wages earned by employees during 2014, but not yet paid. This entry
records the 2014 expense and the related liability, which is necessary to conform to
accrual accounting and the matching principle.
(b)
December 31, 2014:
Interest receivable (+A) ...............................................................
Interest revenue (+R +SE) ........................................
3,000
3,000
To record interest revenue earned during 2014, but not yet collected. This entry
records the 2014 receivable and the related revenue, which is necessary to conform
to accrual accounting and the revenue recognition principle.
Req. 3
Adjusting entries are necessary at the end of the accounting period to ensure that all
revenues earned and expenses incurred, and the related assets and liabilities, are all
measured properly. The entries above are accruals; entry (a) is an accrued expense
(expense incurred but cash not yet paid) and entry (b) is accrued revenue (revenue earned
but cash not yet received). In applying the accrual basis of accounting, revenues should be
recognized when earned and measurable, and the expenses incurred to generate such
revenues should be recognized in the same accounting period.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-9
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–6
Req. 1
2015 Statement of earnings:
Insurance expense ($1,800 x 3/12) = $450 expired.
Shipping supplies expense: ($24,000 + $72,000 – $22,000) = $74,000 used.
Req. 2
2015 Statement of financial position:
Prepaid insurance ($1,800 x 8/12) = $1,350
Shipping supplies inventory (given) = $22,000
Req. 3
Adjusting entry (payment debited to Prepaid Insurance):
Prepaid Insurance
10/1
1,800
AJE 450
End
1,350
Insurance Expense
AJE 450
End. 450
Insurance expense (+E SE) ..................................................
Prepaid insurance (A) ..................................................
To record the expiration of insurance for three months
($150 per month).
450
450
Req. 4
Adjusting entry (payment debited to Shipping Supplies Inventory):
Shipping Supplies Inventory
Beg.
24,000
Purchases 72,000
AJE 74,000
End.
22,000
Shipping Supplies Expense
AJE 74,000
End. 74,000
Shipping supplies expense (+E SE) ..................................
Shipping supplies inventory (A) ..............................
To record the use of shipping supplies for the year.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-10
74,000
74,000
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–7
Req. 1 and 2
a.
b.
c.
d.
e.
f.
g.
Accrued expense – expense incurred before cash is paid.
Wages expense (+E SE) ..........................................................
Wages payable (+L) ..............................................................
Amount is given.
Deferred expense -- cash paid before expense is incurred.
Office supplies expense (+E SE) ..........................................
Office supplies inventory (A) .........................................
Supplies used in 2014 ($450 + 500 – 275 = $675).
Accrued revenue – revenue earned before cash is collected.
Rent receivable (+A) .......................................................................
Rent revenue (+R +SE) ...................................................
Rent earned in 2014 ($560 x 2)
Deferred expense – cash paid for equipment before being used.
Depreciation expense (+E SE) .............................................
Accumulated depreciation – delivery equipment (+XA A)
Deferred expense – cash paid before expense is incurred.
Insurance expense (+E SE) ...................................................
Prepaid insurance (A) .......................................................
[$2,400 x (6/24 months)]
Deferred revenue – cash received before revenue is earned.
Deferred rent revenue (L)..........................................................
Rent revenue (+R +SE) ...................................................
($1,600 x 2 months)
Accrued revenue – revenue earned before cash is received.
Accounts receivables (+A) ............................................................
Repair shop revenue (+R +SE) ....................................
Amount is given.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-11
2,700
2,700
675
675
1,120
1,120
12,100
12,100
600
600
3,200
3,200
800
800
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–8
Transaction
(a)
(b)
(c)
(d)
(e)
(f)
(g)
Statement of Financial Position
Shareholders’
Assets
Liabilities
Equity
N
+2,700
–2,700
–675
N
–675
+1,120
N
+1,120
–12,100
N
–12,100
–600
N
–600
N
–3,200
+3,200
+800
N
+800
Statement of Earnings
Revenues
N
N
+1,120
N
N
+3,200
+800
Expenses
+2,700
+675
N
+12,100
+600
N
N
Net
Earnings
–2,700
–675
+1,120
–12,100
–600
+3,200
+800
E4–9
Req. 1 and 2
a.
b.
c.
d.
e.
Accrued revenue -- revenue earned before cash is collected.
Trade receivables (+A) ..................................................................
Service revenue (+R +SE) ..............................................
Amount is given.
Deferred expense -- cash paid before expense is incurred.
Advertising expense (+E SE) ................................................
Prepaid advertising (A) ....................................................
Advertising used in fiscal year 2015 ($1,200 x 9/12).
Accrued expense -- expense incurred before cash is paid.
Interest expense (+E SE) ......................................................
Interest payable (+L) ...........................................................
Interest incurred from October 1 to November 30, 2015
($300,000 principal x 0.04 x 2/12)
Deferred revenue -- cash received before revenue is earned.
Deferred storage revenue (L) ...................................................
Storage revenue (+R +SE) .............................................
Storage revenue earned in fiscal year 2015 ($4,500 x 1/6)
Deferred expense -- cash paid for equipment before being used.
Depreciation expense (+E SE) .............................................
Accumulated depreciation, equipment (+XA A)
Amount is given.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-12
2,700
2,700
900
900
2,000
2,000
750
750
22,000
22,000
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–9 (continued)
f.
g.
Deferred expense -- cash paid before expense is incurred.
Supplies expense (+E SE) ......................................................
Supplies (A) ...........................................................................
Supplies used in 2014 ($16,500 + $46,000 - $12,400)
50,100
50,100
Accrued expense -- expense incurred before cash is paid.
Wages expense (+E SE) ..........................................................
Wages payable (+L) ..............................................................
Amount is given.
3,800
3,800
E4–10
Transaction
(a)
(b)
(c)
(d)
(e)
(f)
(g)
Statement of Financial Position
Shareholders’
Assets
Liabilities
Equity
+2,700
N
+2,700
–900
N
–900
N
+2,000
–2,000
N
–750
+750
–22,000
N
–22,000
–50,100
N
–50,100
N
+3,800
–3,800
Statement of Earnings
Net
Revenues Expenses Earnings
+2,700
N
+2,700
N
+900
–900
N
+2,000
–2,000
+750
N
+750
N
+22,000
–22,000
N
+50,100
–50,100
N
+3,800
–3,800
E4–11
Selected Statement of Financial Position Amounts at December 31, 2014
Assets:
Equipment (recorded at cost per cost principle)
Accumulated depreciation
Carrying value of equipment (difference)
Office supplies inventory (on hand, as given)
Prepaid insurance (remaining coverage, $600 x 6/12 months)
$12,000
(1,200)
10,800
400
300
Selected Statement of Earnings Amounts for the Year Ended December 31, 2014:
Depreciation expense
Office supplies expense ($1,600 – $400 on hand)
Insurance expense (for 6 months, $600 x 6/12 months)
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-13
$ 1,200
1,200
300
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–12
Req. 1
(a) Cash paid on accrued income taxes payable.
(b) Accrual of additional income taxes payable.
(c) Cash paid on dividends payable.
(d) Amount of dividends declared for the period but not paid immediately.
(e) Cash paid on accrued interest payable.
(f) Accrual of additional interest payable.
Req. 2 Computations:
(a)
Beg. Bal. +
Accrued income taxes
payable
$71
+
332
403
–
cash paid
=
End. bal.
–
–
X
X
X
=
=
=
$80
$80
$323 paid
(c)
Beg. Bal.
$43
+
+
Dividends declared
176
219
–
–
–
Cash paid
X
X
X
=
=
=
=
End. bal.
$48
$48
$171 paid
(f)
Beg. Bal.
$45
+
+
accrued interest payable
X
X
X
–
–
–
Cash paid
297
252
=
=
=
=
End. bal.
$51
$51
$303 accrued
E4–13
Req. 1 Adjusting entries that were or should have been made at December 31:
(a) Entry that should have been made:
Rent receivable (+A) ......................................................................
Rent revenue (+R +SE) ..............................................
Amount is given.
1,400
1,400
(b) Entry that should have been made:
Depreciation expense (+E SE) ............................................ 15,000
Accumulated depreciation - equipment (+XA A)
(c) Entry that should have been made:
Deferred fees revenue (L) .........................................................
Fees revenue (+R +SE) ...............................................
Amount is given.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-14
15,000
1,500
1,500
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–13 (continued)
(d) Entry already made:
Interest expense (+E SE) .....................................................
Interest payable (+L) .....................................................
($17,000 x 9% x 12/12 months)
Entry that should have been made:
Interest expense (+E SE) ......................................................
Interest payable (+L) ......................................................
($17,000 x 9% x 2/12 months)
Entry to correct the error:
Interest payable (–L) .....................................................................
Interest expense (+E SE) ........................................
($1,530 – 255 = $1,275)
(e) Entry that should have been made:
Insurance expense (+A) ...............................................................
Prepaid insurance expense (E +SE) ...................
Amount is given.
Req. 2
Statement of Financial Position
Shareholders’
Transaction Assets
Liabilities
Equity
(a)
U 1,400
N
U
1,400
(b)
O 15,000
N
O 15,000
(c)
N
O 1,500
U
1,500
(d)
N
O 1,275
U
1,275
(e)
O
650
N
O
650
1,530
255
1,530
255
1,275
1,275
650
650
Statement of Earnings
Net
Revenues Expenses Earnings
U 1,400
N
U 1,400
N
U 15,000 O 15,000
U 1,500
N
U 1,500
N
O 1,275 U 1,275
N
U
650 O
650
Req. 3
Materiality refers to the relative importance of an item. An item is material if knowledge of the
item is likely to influence the decisions of financial statement users. The concept of materiality
allows accountants to use estimated amounts and even to ignore other accounting principles if
the results of these actions do not have a material effect upon the financial statements.
The process of making adjusting entries can be simplified if we account for immaterial
items in the easiest and most convenient manner. For example, businesses purchase many
assets that provide benefits for a long period of time. Some of these assets have a very low cost
such as pencil sharpeners and wastebaskets. The proper accounting treatment for such assets
is to amortize their cost to expense over their useful lives. However, the cost of such assets can
be directly charged to expense accounts, rather than to asset accounts in accordance with the
materiality concept. Thus the need for an adjusting entry to record periodic depreciation
expense is eliminated. Furthermore, adjusting entries to record accrued expenses or revenues
may be ignored if the dollar amounts are immaterial.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-15
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–14
Items
Balances reported
Effects of:
a. Depreciation
b. Wages
c. Rent revenue
Adjusted balances
d. Effects of
income taxes
Correct balances
Net
Earnings
$30,000
(9,000)
(17,000)
3,200
7,200
(2,160)
$ 5,040
Total
Assets
$90,000
=
Total
Liabilities
$40,000
(9,000)
Shareholders’
+
Equity
$50,000
81,000
17,000
(3,200)
53,800
(9,000)
(17,000)
3,200
27,200
$81,000
2,160
$55,960
(2,160)
$25,040
Computations:
b.
c.
d.
Given, $17,000 accrued and unpaid.
$9,600 x 1/3 = $3,200 rent revenue earned. The remaining $3,000 in Deferred revenue
is a liability for two months of occupancy "owed'' to the renter.
$7,200 income before taxes x 30% = $2,160.
E4–15
Req. 1
a.
b.
c.
d.
Wages expense (+E SE) ..................................................
Wages payable (+L) .........................................................
310
Utilities expense (+E SE) ................................................
Accrued expenses payable (+L) ..................................
400
Depreciation expense (+E SE) .....................................
Accumulated depreciation (+XA A) ....................
23,000
Interest expense (+E SE) ................................................
Interest payable (+L) .......................................................
($20,000 x .10 x 3/12)
500
310
400
23,000
500
e.
No adjustment is needed because the revenue will
not be earned until January (next year).
f.
Supplies inventory (+A).........................................................
Maintenance expense (E +SE) ..............................
1,000
g.
Income tax expense (+E SE) .........................................
Income tax payable (+L).................................................
7,000
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-16
1,000
7,000
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–15 (continued)
Req. 2
BARTON, INC.
Statement of Earnings
For the Year Ended December 31, 2014
Rental revenues
Expenses:
Salaries and wages ($28,500 + $310)
Maintenance ($12,000 - $1,000)
Rent
Utilities ($4,000 + $400)
Gas and oil
Depreciation
Interest ($20,000 x 10% x 3/12)
Miscellaneous
Total expenses (other than income taxes)
Earnings before income tax
Income tax expense
Net earnings
Earnings per share: $26,290 ÷ 7,000 shares
$114,000
$ 28,810
11,000
9,000
4,400
3,000
23,000
500
1,000
80,710
33,290
7,000
$ 26,290
$3.76
Req. 3
Net profit margin = Net Earnings  Net Sales = $26,290  $114,000 = 23.1%
The net profit margin indicates that, for every $1 of rental revenues, Barton earns $0.23
(23.1%) in net earnings. This ratio is higher than the industry average net profit margin of
18%, implying that Barton is more profitable and better able to manage its business (in
terms of sales price or costs) than the average company in the industry.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-17
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–16
Req. 1
Cash from Operations = $12,000
Req. 2
2015 Subscription Revenue ($12,000 x 7/24) = $3,500
Req. 3
2015 Deferred Subscriptions Revenue ($12,000 x 17/24) = $8,500
Req. 4
Adjusting entry (cash receipt credited to Deferred Subscriptions Revenue):
Deferred Subscriptions
Revenue (L)
9/1 12,000
AJE 3,500
End. 8,500
Subscriptions Revenue (R)
AJE 3,500
End. 3,500
Deferred subscriptions revenue (L) .....................................
3,500
Subscriptions revenue (+R +SE) ............................
To recognize revenue for seven months ($500 per month).
3,500
Req. 5
a. $4,000 revenue target based on cash sales:
My region generated $12,000 in cash subscriptions and far exceeded the company’s
target. On the other hand, management may mean any sales revenue that has also
been received in cash during the period.
This example demonstrates the need for clear communication of expectations by
management.
b. $4,000 revenue target based on accrual accounting:
Under this assumption, sales revenue earned is $3,500 (the accrual accounting basis
amount). My region did not meet the goal, only generating 87.5% of the target.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-18
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–17
(Amounts in thousands of dollars.)
Req. 1
Insurance expense (+E SE) .................................................
Prepaid insurance (A) ..................................................
4
Depreciation expense (+E SE) ............................................
Accumulated depreciation, machinery (+XA A)
4
(c)
Wages expense (+E SE) .........................................................
Wages payable (+L) .........................................................
8
(d)
Income tax expense (+E SE) ................................................
Income tax payable (+L) ................................................
9
(a)
(b)
4
4
8
9
Req. 2
Transaction
Effect on Net
Earnings
Effect on Cash
a.
↓4
N
b.
↓4
N
c.
↓8
N
d.
↓9
N
Note that adjusting entries do not affect the Cash account because they are internal
transactions.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-19
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4-17 (continued)
Req. 3
Cash
Trade receivables
Prepaid insurance
Machinery
Accumulated depreciation
Trade payables
Wages payable
Income taxes payable
Contributed capital
Retained earnings (Deficit)
Revenues (not detailed)
Expenses (not detailed)
Totals
Cayuga Ltd.
Trial Balance
As at December 31, 2015
(in thousands of dollars)
Unadjusted
Debit
Credit
38
9
6
80
8
9
Adjustments
Debit
Credit
a 4
b 4
c 8
d 9
68
4
84
32
169
a
b
c
d
169
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-20
4
4
8
9
25
25
Adjusted
Debit
Credit
38
9
2
80
12
9
8
9
68
4
84
57
190
190
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–17 (continued)
Req. 4
Cayuga Ltd.
Statement of Earnings
For the Year Ended December 31, 2015
(In thousands of dollars, except for Earnings per Share information)
Revenues
$84
Expenses ($32 + 4 + 4 + 8)
48
Earnings before income tax
36
Income tax expense
9
Net earnings
$27
Earnings per Share ($27,000 ÷ 4,000 shares)
$6.75
Note: normally, expenses would be shown in greater detail.
Cayuga Ltd.
Statement of Retained Earnings
For the Year Ended December 31, 2015
(in thousands of dollars)
Balance, January 1, 2015
Net earnings
Dividends declared
Balance, December 31, 2015
$ 0
27
(4)*
$ 23
* The amount of dividends declared can be inferred because the unadjusted trial
balance amount for retained earnings is negative $4. Since this is the first year of
operations, we can assume the entire amount is due to a dividend declaration.
Assets
Cash
Trade receivables
Prepaid insurance ($6 – $4)
Machinery, at cost
Accumulated depreciation
Total assets
Cayuga Ltd.
Statement of Financial Position
As at December 31, 2015
(In thousands of dollars)
Liabilities
$ 38
Trade payables
9
Wages payable
2
Income taxes payable
$ 80
Total liabilities
(12)
68
Shareholders' Equity
Contributed capital
Retained earnings
Total liabilities and
$117
shareholders' equity
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-21
$ 9
8
9
26
$ 68
23
91
$117
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–17 (continued)
Req. 5
The purpose of “closing the books” at the end of the accounting period is to simply transfer
the balances in the temporary accounts to a permanent account, i.e., Retained earnings.
This also creates a zero balance in the temporary accounts for accumulation of the financial
effects of transactions in the next accounting period.
Req. 6
a.
Revenues (R) ..................................................................................
Income Summary (+T)....................................................
84
b.
Income Summary (T) ..................................................................
Expenses (E) ($32 + $4 + $4 + $8)...........................
Income tax expense (E) ...............................................
57
Income Summary (T) ..................................................................
Retained earnings (+SE)) ..............................................
27
c.
84
48
9
27
Note: normally, “Expenses” would be broken down into appropriate separate accounts.
E4–18
Req.1
LINER COMPANY
Statement of Earnings
For the Year Ended December 31, 2014
Revenues:
Sales
Interest
Rent
Total revenues
Expenses:
Wages
Depreciation
Utilities
Insurance
Rent
Total pre-tax expenses
Earnings before income taxes
Income tax expense
Net earnings
$ 45,000
120
300
45,420
20,600
2,000
1,220
600
10,000
34,420
11,000
3,900
$ 7,100
Earnings per share*
$23.67
* EPS = $7,100  [(100 + 500)  2] = $7,100  300 = $23.67
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-22
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–18 (continued)
Req. 2
a.
b.
c.
Req. 3
Sales (R) ...........................................................................................
Interest (R) .....................................................................................
Rent (R) ............................................................................................
Income summary (+T) ....................................................
45,000
120
300
Income summary (T) ..................................................................
Wages (E) ..........................................................................
Depreciation (E) .............................................................
Utilities (E) .......................................................................
Insurance (E) ...................................................................
Rent (E) ..............................................................................
Income tax expense (E) ...............................................
38,320
Income summary (T) ..................................................................
Retained earnings (+SE)) ..............................................
7,100
45,420
20,600
2,000
1,220
600
10,000
3,900
7,100
LINER COMPANY
Statement of Financial Position
As at December 31, 2014
Assets
Cash
Trade receivables
Interest receivable
Prepayments
Total current assets
Note receivable
Equipment ( net of accumulated depreciation, $2,000)
Total Assets
Liabilities
Trade payables
Accrued liabilities
Income taxes payable
Deferred rent revenue
Total Liabilities
Shareholders’ Equity
Contributed capital
Retained earnings
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-23
$ 2,700
3,000
120
600
6,420
3,000
10,000
$19,420
$ 1,600
3,820
2,900
600
8,920
2,400
8,100
10,500
$19,420
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4–18 (continued)
Req. 4
Net profit margin
= Net Earnings  Sales
= $7,100  $45,000 = 0.158 (15.8%)
This ratio indicates that Liner Company earned $0.158 of net earnings for every $1 of sales.
Proper evaluation of this ratio requires comparison with the company’s ratios for a number
of past periods, as well as comparison to the industry average.
E4-19
(Dollar figures in the table below are in thousands)
Req. 1
Current Year
Return on =
Net Earnings
Equity
Average Shareholders’
Equity
$55,655
$212,711
= 0.262
Prior Year
$51,940
$196,118
= 0.265
ROE decreased slightly from 0.265 (26.5%) in the prior year to 0.262 (26.2%) in the
current year meaning that the firm earned $0.003 (0.3 cent) less for each $1 dollar of
shareholders’ investment.
Req. 2
Security analysts are unlikely to change their estimates of share value on the basis of this
change. The decrease in ROA is very small and is unlikely, per se, to affect analysts’
evaluation of the company shareholders’ investment and, hence, increased the
corresponding value of that investment.
E4-20
Req. 1
Average shareholders’ equity
Net profit margin
Return on equity
2012
$7 600
12.1%
17.3%
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-24
2011
$7 647
11.8%
15.9%
2010
$7 568
10.7%
13.9%
2009
$7 232
10.4%
13.9%
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
E4-20 (continued)
Req. 2
Both the net profit margin and the return on equity increased during the four-year period.
The upward trend in both ratios is indicative of the company’s success in generating net
earnings to shareholders and rewarding them for their investment in the company’s equity.
As an investor, these ratios are indicative of a successful company would lead me to
consider investing in its shares, assuming that this trend would continue in the future.
Note to instructor: Telus and other Canadian publicly accountable enterprises adopted IFRS
starting with their 2011 financial statements, with comparative figures for 2010. The
amounts reported for the years 2010-2012 are based on IFRS whereas those related to the
years 2008 and 2009 are based Canadian GAAP, which may affect the comparability of
ratios over time. Examination of the reconciliation of the financial statement elements from
Canadian GAAP to IFRS for fiscal year 2010, that is disclosed in the 2011 annual report,
indicates that the IFRS-based figures did not differ materially from the GAAP-based
measures. Hence, the ratios calculations for 2009 and 2010 would not have been
significantly different from those reported above if IFRS were applied retroactively to the
financial statements for 2008 and 2009.
Req. 3
The ratios for fiscal year 2009 to 2012 show an upward trend in profitability. As a potential
investor, I would look at the financial situation of the company, its cash flow situation, and
evaluate the prospects for continued improvement in profitability in the near future.
E4–21
Req. 1
1.
Prepaid insurance (+A) ................................................................
Insurance expense (+E SE) ...................................
Insurance not used up yet as at January 31, 2015:
$18,000 x (17 months / 24)
12,750
Rent expense (+E -SE) ..............................................................
Rent revenue (+R +SE) ..............................................
Deferred rent revenue (+L) ..........................................
Rent earned during the year = ($6,400 / 8 months) x 5
6,400
3.
Income tax expense (+E SE) ................................................
Income tax payable (+L) ................................................
Prepaid income taxes (A)
12,200
4.
Supplies expense (+E SE) .....................................................
Supplies inventory (A) ................................................
The balance of the Supplies inventory account should
be reduced by $1,800 ($4,400 – $2,600).
1,800
2.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-25
12,750
4,000
2,400
8,800
3,400
1,800
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
PROBLEMS
P4–1
MEGA Brands Inc.
Adjusted Trial Balance
As at December 31, 2012
(In thousands of dollars)
Cash and cash equivalents
Trade and other receivables
Inventories
Financial assets
Prepaid expenses
Property, plant, and equipment
Intangibles
Goodwill
Trade and other payables
Income taxes payable
Current portion of long-term debt
Long-term debt
Contributed capital
Retained earnings (deficit), January 1, 2012
Accumulated other comprehensive income
Sales revenue
Cost of sales
Marketing and advertising expenses
Research and development expenses
Selling, distribution and administrative expenses
Financial expenses
Income tax expense
Debit
$ 8,018
130,541
45,779
113
9,370
39,817
22,771
30,000
Credit
$ 62,638
5,631
8,023
113,198
460,400
385,771
4,745
420,271
262,452
16,937
16,218
87,830
17,647
1,642
1,074,906
1,074,906
* Since total debits must equal total credits in a trial balance, the balance for Retained
Earnings at January 1, 2012 is the amount needed in the debit column to ensure that total
debits equal total credits (it is a derived figure). Having a debit balance in Retained
Earnings implies a deficit, which reflects an excess of expenses over revenues in prior
accounting periods.
Note to instructor: This deficit is due primarily to expenses related to product recall in
2007 and 2008 and impairment of the value of goodwill in 2008. The original deficit has
been reduced over time and will likely turn into a positive amount if the company
continues to be profitable in the future.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-26
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4–2
Req. 1
a.
b.
c.
d.
Deferred expense
Accrued expense
Deferred revenue
Deferred expense
e.
f.
g.
h.
Deferred revenue
Accrued expense
Accrued expense
Accrued revenue
Req. 2
a.
1,600
Insurance expense (+E SE)...............................................................
1,600
Prepaid insurance (A) .................................................................
($3,200 ÷ 6 months) x 3 months of coverage. This entry reduces the asset (prepaid
insurance) because part of it has been used and the remaining $1,600 represents
future benefits (an asset) to the company.
b.
Wage expense (+E SE) .......................................................................
Wages payable (+L) .........................................................................
Wage expense is increased (debited) because this expense was
incurred in fiscal 2015. A liability (wages payable) is credited
because this amount is owed to the employees.
900
Deferred maintenance revenue (L) ...................................................
Maintenance revenue (+R +SE) ..............................................
($450 ÷ 2 months) x 1 month. This entry reduces (debits) the
liability for the amount earned and records revenue.
225
Depreciation expense (+E SE) ........................................................
Accumulated depreciation, service truck (+XA A)
To record depreciation expense
4,000
Deferred service revenue (L) ...............................................................
Service revenue (+R +SE) ..........................................................
To recognize revenue earned during the fiscal year,
$4,200 ÷ 12 months x 2 months.
700
Interest expense (+E SE)...................................................................
Interest payable (+L).........................................................................
To accrue interest expense incurred but not yet paid,
[($16,000 x 9%) ÷ 12 months] x 5 months = $600.
600
Property tax expense (+E SE) .........................................................
Property tax payable (+L) ...............................................................
To record expense incurred but not yet paid.
500
c.
d.
e.
f.
g.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-27
900
225
4,000
700
600
500
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4–2 (continued)
h.
Trade receivables (+A) ..............................................................................
Service revenue (+R +SE) .........................................................
This entry records an asset for the amount due from customers
and recognizes the revenue because it was earned in fiscal 2015.
2,000
2,000
Req. 3
Transaction
Effect on Net
Earnings
Effect on Cash
a.
↓ 1,600
N
b.
↓ 900
N
c.
↑ 225
N
d.
↓ 4,000
N
e.
↑ 700
N
f.
↓ 600
N
g.
↓ 500
N
h.
↑ 2,000
N
Note that adjusting entries are internal transactions that do not involve an exchange with
others. The Cash account is not affected by these transactions.
P4–3
Req. 1
a.
b.
c.
d.
Deferred expense
Deferred expense
Accrued expense
Accrued expense
e.
f.
g.
h.
Accrued revenue
Deferred expense
Accrued expense
Accrued expense
Req. 2
a.
b.
Depreciation expense (+E SE) ..............................................
Accumulated depreciation, service truck (+XA A)
4,000
Supplies expense (+E SE).......................................................
Supplies inventory (A) ......................................................
Supplies inventory is decreased (credited) to record the
use of supplies during the year because this expense
was incurred in 2014, calculated as
Beg. Inv. of $400 + Purchases $1000 – End. Inv. $250
1,150
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-28
4,000
1,150
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4-3 (continued)
c.
d.
Repairs and maintenance expense (+E SE) ..................... 1,200
Accrued liabilities (+L) .........................................................
Repairs and maintenance expense is increased (debited)
because this expense was incurred in 2014. A liability
(accrued expenses payable) is credited because this
amount is owed but will not be paid until 2015.
Property tax expense (+E SE) .............................................. 1,500
Property tax payable (+L) ....................................................
Property tax expense is increased (debited) because this
expense was incurred in 2014. A liability (property tax
payable) is credited because this amount is owed but will
not be paid until 2015.
e.
Trade receivables (+A) ................................................................... 6,000
Sales revenue (+R +SE) ...................................................
This entry records an asset for the amount due from
customers and recognizes the revenue because it was
earned in 2014.
f.
Insurance expense (+E SE) ....................................................
Prepaid insurance (A).......................................................
$1,200 ÷ 12 months x 6 months of coverage. This entry
reduces the asset (prepaid insurance) because part of it
has been used and only $600 represents future benefits
(an asset) to the company.
600
Interest expense (+E SE) ........................................................
Interest payable (+L) ..............................................................
To accrue interest expense incurred but not paid,
$11,000 x 6% x 3/12 = $165.
165
g.
h.
1,200
1,500
6,000
600
Income tax expense (+E SE) ..................................................10,954
Income tax payable (+L) ........................................................
To accrue income tax expense incurred but not yet paid:
165
10,954
Earnings before adjustments (given) $30,000
Effect of adjustments (a) through (g) 2,615 (4,000  1,150  1,200 1,500
Earnings before income tax
27,385 +6,000  600  165)
Income tax rate
40%
Income tax expense
$10,954
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-29
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4–3 (continued)
Req. 3
Transaction
a.
b.
c.
d.
e.
f.
g.
h.
Statement of Financial Position
Shareholders’
Assets
Liabilities
Equity
N
 4,000
 4,000
N
 1,150
 1,150
N
+ 1,200
 1,200
N
+ 1,500
 1,500
+ 6,000
N
+ 6,000
N
 600
 600
N
+ 165
 165
N
+ 10,954
 10,954
Statement of Earnings
Net
Revenues Expenses Earnings
N
+ 4,000
 4,000
N
+ 1,150
– 1,150
N
+ 1,200
 1,200
N
+ 1,500
 1,500
+ 6,000
N
+ 6,000
N
+ 600
 600
N
+ 165
 165
N
+ 10,954  10,954
P4–4
(1)
Rent revenue
512,000 (a)
16,000 (b)
528,000
(5)
Rent receivable
(b) 16,000
16,000
(2)
Salary expense
(e) 62,000
(f) 3,000
65,000
(3) Maintenance
supplies expense
Used 9,300
(7) Receivables
from employees
(g) 1,500
(8) Maintenance
supplies inventory
(h) Bal. 3,000
(i)
8,000 9,300 used
(j)
1,700
9,300
1,500
(9) Deferred
rent revenue
12,000 (c)
12,000
(10)
Salaries payable
(d) 4,000 4,000 Bal.
3,000 (f)
3,000
(4, 6, 11) Cash
(a) from tenants 512,000 4,000
(c) from tenants 12,000 62,000
1,500
8,000
448,500
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-30
(d) to employees
(e) to employees
(g) to employees
(i) to suppliers
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4–4 (continued)
Account
1. Rent revenue
2. Salary expense
3. Maintenance supplies
expense
4. Rent receivable
5. Receivables from
employees
6. Maintenance supplies
inventory
7. Deferred rent revenue
8. Salaries payable
2014
Balance
528,000
65,000
9,300
Financial Statement
Statement of earnings
Statement of earnings
Statement of earnings
Effect on
Cash Flows
+512,000
–66,000
–8,000
16,000 Statement of financial position
1,500 Statement of financial position
No effect
–1,500
1,700 Statement of financial position
No effect
12,000 Statement of financial position
3,000 Statement of financial position
+12,000
No effect
Cash balance is reported on the statement of financial position.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-31
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4–5
Req. 1
December 31, 2015 Adjusting Entries
(1)
Service revenue receivable (+A) ...........................................
Service revenue (+R +SE) ........................................
To record service fees earned, but not yet collected.
560
(2)
Insurance expense (+E SE) .............................................
Prepaid insurance (A) .................................................
To record insurance expired.
280
(3)
(4)
Depreciation expense (+E SE) ........................................
Accumulated depreciation, equipment (+XA A)
To record depreciation expense.
560
(b)
(i)
280
(l)
(c)
11,900
(k)
(e)
6,580
(m)
(f)
11,900
Advertising expense (+E SE) .........................................
Accrued advertising payable (+L) ............................
To record advertising expense for 2015; to be paid in 2016
6,580
Req. 2
Revenues:
Service revenue
Expenses:
Salary expense
Depreciation expense
Insurance expense
Advertising expense
Total expenses
Net earnings (loss)
Amounts before
Adjusting Entries
Amounts after
Adjusting Entries
$64,400
$64,960
56,380
56,380
11,900
280
6,580
75,140
$ (10,180)
_
__
56,380
$ 8,020
The net loss includes all revenues and all expenses (after the adjusting entries). This loss of
$10,180 is correct because the revenue principle and the matching process have been
applied to all transactions whose effects extend beyond the period in which the
transactions occurred. The net earnings of $8,020 was incorrect because expenses of
$18,760 and revenues of $560 were erroneously excluded from the determination of net
earnings (loss) for 2015.
Req. 3
Earnings (loss) per share = $(10,180) net loss  4,000 shares = $(2.55) per share
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-32
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4–5 (continued)
Req. 4
Net profit margin = Net Earnings (Loss)  Net Sales = $(10,180) net loss  $64,960 = –15.7%
The net profit margin indicates that, for every $1 of service revenues, Savory Ltd. actually
lost $0.157 (15.7 cents). This ratio implies that Savory Ltd. destroys shareholder value in
generating its sales, and suggests that better management of its business (in terms of sales
price or costs) is urgently required.
ROE = Net Earnings / Average Shareholders’ Equity
Shareholders’ equity, beginning = $112,000 + $19,600 = $131,600
Shareholders’ equity, ending = $131,600 – $10,180= $121,420
ROE = $(10,180) ÷ [($131,600 + $121,420) ÷ 2] = –0.080 (–8%).
The negative ROE indicates that the company’s operating activities in 2015 did not increase
the value of shareholders’ investment. In contrast, the book value of shareholders’
investment deteriorated during the year.
Req. 5
Service revenue (R) .................................................................
Income Summary (+T)....................................................
64,960
Income Summary (T)
Salary expense (E) .........................................................
Depreciation expense (E) ...........................................
Insurance expense (E) .................................................
Advertising expense (E) ..............................................
75,140
Retained Earnings (SE) .........................................................
Income Summary (T) ...................................................
10,180
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-33
64,960
56,380
11,900
280
6,580
10,180
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4-6
Req. 1
December 31, 2015 Adjusting Entries:
Depreciation expense (+E SE) ...........................................
Accumulated depreciation, equipment (+XA A) .
(a)
Insurance expense (+E SE) .................................................
Prepaid insurance (A) .......................................................
(b)
3,000
3,000
450
450
(c)
Wages expense (+E SE) .........................................................
Wages payable (+L) ..............................................................
1,100
(d)
Supplies expense (+E SE) ....................................................
Supplies inventory (A) ......................................................
See Requirement (3) for calculation.
700
Income tax expense (+E SE) ...............................................
Income tax payable (+L) .....................................................
2,950
(e)
1,100
700
2,950
Req. 2
Transaction
Effect on Net
Earnings
Effect on Cash
a.
↓ 3,000
N
b.
↓ 450
N
c.
↓ 1,100
N
d.
↓ 700
N
e.
↓ 2,950
N
Note that adjusting entries are internal transactions that do not involve an exchange with
others. The Cash account is not affected by these transactions.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-34
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4–6 (continued)
Req. 3
MITAKIS INC.
Statement of Earnings
For the Year Ended December 31, 2015
Service revenue
Operating expenses:
Supplies ($1,300 – $600)
Insurance
Depreciation
Wages
Other
Total operating expenses
Earnings before income tax
Income tax expense
Net earnings
$48,000
$
700
450
3,000
1,100
32,900
38,150
9,850
2,950
$ 6,900
Earnings per share ($6,900 ÷ 4,000 shares)
$1.73
Note: normally the “Other Expenses” would be shown in greater detail, especially when it is
such a large amount (relatively speaking).
MITAKIS INC.
Statement of Financial Position
As at December 31, 2015
Assets
Cash
Trade receivables
Service supplies inventory
Prepaid insurance
Equipment, at cost
27,000
Accumulated depreciation (15,000)
Other assets
Total assets
$19,600
7,000
600
450
12,000
5,100
$44,750
Liabilities
Trade payables
Wages payable
Income tax payable
Note payable, long term
Total liabilities
Shareholders' Equity
Contributed capital
Retained earnings*
Total shareholders' equity
Total liabilities and
shareholders' equity
$ 2,500
1,100
2,950
5,000
11,550
16,000
17,200
33,200
$44,750
*Unadjusted balance, $10,300 + Net earnings, $6,900 = Ending balance, $17,200.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-35
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4–6 (continued)
Req. 4
If the cost of the service supplies in 2015 is not included among the period’s expenses, then
the earnings before income taxes would be overstated by $700, the income tax expense
would be overstated by $209 ($700 x 29.9%*) approximately, and net earnings would be
overstated by $491. This error equals about 7.1 percent of net earnings and is usually
judged to be a material error since it exceeds the normal threshold of 3 percent.
*Income tax rate = $2,950 / $9,850 = 0.299 (or 29.9%)
Req. 5
December 31, 2015 Closing Entries:
(a)
Service revenue (R) ..................................................................... 48,000
Income Summary (+T)....................................................
48,000
(b)
Income Summary (T)) ............................................................... 41,100
Supplies expense (E) ...................................................
Insurance expense (E) ................................................
Depreciation expense (E) ..........................................
Wages expense (E) .......................................................
Other expenses (E) ........................................................
Income tax expense (E) ..............................................
700
450
3,000
1,100
32,900
2,950
(c)
Income Summary (T) .................................................................
Retained earnings (+SE) ...............................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-36
6,900
6,900
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4–7
Req. 1
JUAN REAL ESTATE COMPANY
Statement of Earnings
For the Year Ended March 31, 2015
Revenues:
Sales commissions ..........................................................................
Management fees .............................................................................
Total revenues ............................................................................
Expenses:
Operating (various) ........................................................................
Depreciation ......................................................................................
Interest ................................................................................................
Total expenses other than income taxes ..........................
Earnings before income taxes .............................................................
Income tax expense ($34,000 x 30%) .....................................
Net earnings ...............................................................................................
$77,000
13,000
48,000
5,500
2,500
Earnings per share ($23,800  30,000 shares) ............................
$90,000
56,000
34,000
10,200
$23,800
$ 0.79
Req. 2
Income tax expense ($34,000 x 30%) (+E, -SE) .................................
Income tax payable (+L) ................................................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-37
10,200
10,200
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4-7 (continued)
Req. 3
JUAN REAL ESTATE COMPANY
Statement of Financial Position
As at March 31, 2015
Assets
Current Assets:
Cash .....................................................................................................
Trade receivables ............................................................................
Office supplies inventory ..............................................................
Total current assets ..................................................................
Noncurrent Assets:
Automobiles, at cost .................................................... $30,000
Less accumulated depreciation .......................... 10,000
Office equipment, at cost ............................................ 3,000
Less accumulated depreciation ........................... 1,000
Total noncurrent assets ..........................................................
Total assets...................................................................................
$53,000
44,800
300
$98,100
20,000
2,000
22,000
$120,100
Liabilities
Current Liabilities:
Trade payables .................................................................................
Income tax payable (see Req. 1 and 2) ....................................
Salaries and commissions payable ...........................................
Total current liabilities ............................................................
Long-Term Liabilities:
Notes payable....................................................................................
Total liabilities ............................................................................
$20,250
10,200
1,500
$31,950
30,000
61,950
Shareholders' Equity
Contributed capital, 30,000 shares
issued and outstanding ........................................................................
Retained earnings (beginning balance, $7,350 + net earnings,
$23,800 - dividends declared, $8,000) ..........................................
Total shareholders' equity ...........................................................
Total liabilities and shareholders' equity .........................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-38
35,000
23,150
58,150
$120,100
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4-7 (continued)
Req. 4
Net profit margin = Net earnings ÷ Total Revenue = $23,800 ÷ $90,000 = 0.26 (26%)
Return on equity (ROE) = Net earnings ÷ Average Shareholders’ Equity
= $23,800 ÷ [($42,350 + 58,150) ÷ 2] = 0.47 (47%)
These ratios indicate that the company earned $0.26 in net earnings per $1.00 of revenue,
and $0.47 in net earnings per $1.00 of shareholders’ investment. Both ratios are relatively
high, indicating that the company’s management has done very well in generating net
earnings to shareholders. But, these ratios are difficult to interpret in isolation. There is a
need for some reference or benchmark for evaluation, such as a trend of these two ratios
for the past few years or ratios for similar companies in the same industry.
Req. 5
March 31, 2015 Closing Entries
1
2
3
Sales commissions (R) ..................................................
Management fees (R) .....................................................
Income Summary (+T) .........................................
To close revenue accounts.
77,000
13,000
Income Summary (T) .....................................................
Operating expenses (E) ......................................
Depreciation expense (E) ..................................
Interest expense (E) ............................................
Income tax expense (E) ......................................
To close expense accounts.
66,200
Income Summary (T) .....................................................
Retained earnings (+SE) ....................................
23,800
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-39
90,000
48,000
5,500
2,500
10,200
23,800
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4-8
Req. 1
a.
Wages expense ..................................................................
Wages payable .........................................................
8,000
b.
Interest receivable ...........................................................
Interest income .......................................................
($24,000 x 5% x 4/12 = $400)
400
c.
Rent expense ......................................................................
Prepaid rent ..............................................................
[($16,800 / 12) x 5 = $7,000]
7,000
d.
Depreciation expense ......................................................
Accumulated depreciation - equipment ........
3,000
e.
Retained earnings, or "Dividends" .............................
Dividend payable ....................................................
(15,000 x $1.00 = $15,000)
15,000
f.
Income tax expense ..........................................................
Prepaid income taxes ............................................
Income taxes payable ...........................................
$30,200* x 20% = $6,040
6,040
8,000
400
7,000
3,000
15,000
1,040
5,000
* Earnings before income taxes = $30,200 (see below).
Req. 2
Transaction
Effect on Net
Earnings
Effect on Cash
a.
↓ 8,000
N
b.
↑ 400
N
c.
↓ 7,000
N
d.
↓ 3,000
N
e.
N
N
f.
↓ 6,040
N
Note: that all the adjusting entries did not have an effect on cash. These are internal
transactions that did not involve an exchange of cash with other parties.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-40
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4-8 (continued)
Req. 3
ALIMEX, INC.
Statement of Earnings
For the Year Ended December 31, 2014
Sales revenue
Cost of sales
Gross profit
Operating expenses:
Wages expense
[$111,800 + $8,000]
Rent expense
[$11,000 + $7,000]
Depreciation expense
Other operating expenses
Total operating expenses
Earnings from operations
Other income:
Interest income
Earnings before income taxes
Income tax expense [$30,200 x 20%]
Net earnings
$301,000
129,000
172,000
Earnings per share [$24,160 /15,000]
$ 1.61
Req. 4
119,800
18,000
3,000
1,400
142,200
29,800
__ 400
30,200
__6,040
$ 24,160
ALIMEX, INC.
Statement of Financial Position
As at December 31, 2014
Assets
Current Assets
Cash
Trade receivables
Merchandise inventory
Note receivable
Interest receivable
Prepaid rent ($16,800 – $7,000)
Total Current Assets
Non-current Assets
Equipment
Less: Accumulated depreciation
Total Assets
* ($9,000 + $3,000)
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-41
$ 11,000
100,000
18,200
24,000
400
9,800
163,400
60,000
12,000*
48,000
$211,400
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4-8 (continued)
Liabilities and Shareholders' Equity
Current Liabilities
Trade payables
Wages payable
Dividends payable
Income taxes payable
Deferred revenue
Total Current Liabilities
Shareholders’ Equity
Contributed capital (15,000 shares)
Retained earnings (70,000 + 24,160 – 15,000)
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
$ 33,000
8,000
15,000
5,000
11,240
72,240
60,000
79,160
139,160
$211,400
Req. 5
Sales revenue (R)......................................................................
Interest income ...........................................................................
Income Summary (+T)....................................................
301,000
400
Income Summary (T)
Cost of sales .......................................................................
Wages expense (E) ........................................................
Rent expense (E) ............................................................
Depreciation expense (E) ...........................................
Other operating expenses ............................................
Income tax expense (E) ...............................................
277,240
Income Summary (T) ..............................................................
Retained earnings (+SE) ...............................................
24,160
301,400
129,000
119,800
18,000
3,000
1,400
6,040
24,160
Req. 6
Net profit margin ratio = Earnings / Net sales = $24,160 / $301,000 = 8.0%)
This ratio measures how much the company has earned from every sales dollar generated
during the period. It is a “bottom line” measure of profitability.
Total asset turnover ratio = Net sales / Average total assets
= $301,000 / [($200,000 + $211,400) / 2] = 1.46
This ratio measures the amount of sales generated per dollar of assets. It reflects
management’s effectiveness in generating sales from assets employed during the period.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-42
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4-9
Req. 1
The Jean Coutu Group
Net Profit Margin
Return on Equity (ROE)
Quality of Earnings
Metro .
Net Profit Margin
Return on Equity (ROE)
Quality of Earnings
Shoppers Drug Mart Corporation
Net Profit Margin
Return on Equity (ROE)
Quality of Earnings
2012
2011
2010
20.4%
51.1%
0.40
8.4%
21.6%
1.07
7.0%
17.8%
1.17
4.1%
19.8%
1.60
3.5%
16.2%
1.89
3.5%
16.7%
1.40
5.6%
14.2%
1.51
5.9%
14.7%
1.59
5.8%
15.2%
1.40
Req. 2
The return on equity measures how much the company earned for each dollar of
shareholders’ investment. The Jean Coutu Group achieved the highest net profit margin
and ROE among the three companies for each of the years 2010-2012. The significant
increase in the ROE for 2012 is due to the significant gain of $348 million on its investment
in Rite Aid. Without this non-recurring gain, the company’s net profit margin would drop
to 7.7% and its ROE would decrease to 12.7%.
Metro’s ROE rose as well during 2012, but the ROE of Shoppers Drug Mart dropped slightly
in 2011 and again in 2012. Overall the ranking would be Metro, Shoppers Drug Mart, and
The Jean Coutu Group . This ranking is based on ROE for 2012, excluding the non-recurring
gain that Le Groupe Jean Coutu reported in 2012.
Req. 3
Ratio analysis eliminates the size differences among these three companies that operate in
the same industry, Food and Staples Retailing. This facilitates the comparability of financial
information reported by these companies. To the extent that past profitability is an
indicator of future profitability, then Metro would be preferred over the other two
companies as an investment because of its increasing ROE and net profit margin.
Req. 4
Metro has the highest quality of earnings in each of the three years. It tied with Shoppers
Drug Mart in 2010. All three companies experience a decline in their quality of earnings in
2012, but Metro kept its lead over the other two companies. As a result, Metro is favoured
over Shoppers Drug Mart, which ranks ahead of The Jean Coutu Group.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-43
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
P4-10
1.
2.
Cash (+A) .........................................................................................
Deferred revenue (+L).....................................................
Trade receivables (-A) ....................................................
Received cash from customers, including $7,000 in
advance.
62,000
Deferred revenue (-L) ...............................................................
Service revenue (+R +SE) ..........................................
To recognize revenue that was collected from customers
in advance ($3,000 + $7,000 - $4,500)
5,500
Trade receivables (+A) ..............................................................
Service revenue (+R +SE) .........................................
To recognize service revenues billed to customers in May.
($59,000 + X - $55,000 = $44,000; X = $40,000)
40,000
Rent expense (+E -SE) ...........................................................
Prepaid rent (A) ..............................................................
To recognize rent expense for May; $4,900 / 5 months.
980
980
Prepaid insurance (+A) .............................................................
Cash (-A) ...............................................................................
Payment of premium for one-year insurance policy;
$1,200 x 12 months x 1.10
15,840
4.
Interest expense (+E -SE) ....................................................
Interest payable (+L) .......................................................
Recognition of interest expense for May;
$20,000 x 6% x 1/12
100
Advertising expense (+E SE) ............................................
Trade payables (+L) .........................................................
Received invoice for advertising in May.
780
Supplies inventory (+A) ............................................................
Supplies expense (E +SE)........................................
Adjustment of Supplies inventory for unused supplies.
$11,500 – 7,200
4,300
6.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-44
5,500
40,000
3.
5.
7,000
55,000
15,840
100
780
4,300
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
ALTERNATE PROBLEMS
AP4–1
STARBUCKS CORPORATION
Adjusted Trial Balance
As at September 30, 2012
(in millions of US dollars)
Cash and cash equivalents
Short-term investments
Trade receivables
Inventories
Prepayments
Property, plant, and equipment
Long-term investments
Goodwill
Deferred income tax assets
Other assets
Deferred revenue
Trade payables
Accrued liabilities
Long-term debt
Other long-term liabilities
Contributed capital
Retained earnings, beginning of year
Net sales revenue
Interest revenue
Cost of sales
Store operating expenses
General and administrative expenses
Depreciation and amortization expense
Other operating expenses
Interest expense
Income tax expense
Debit
$ 1,189
848
486
1,242
196
2,659
576
399
239
386
Credit
$
5,813
3,918
801
550
430
33
674
$20,439
678
398
1,174
549
345
68
3,622
13,300
305
$20,439
* Since total debits must equal total credits in a trial balance, the balance in Retained
Earnings is the amount needed in the credit column to ensure that total debits equal total
credits (it is a derived figure).
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-45
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–2
Req. 1
a.
b.
c.
d.
Deferred revenue
Accrued expense
Deferred expense
Deferred revenue
e.
f.
g.
h.
Deferred expense
Accrued revenue
Accrued expense
Accrued expense
Req. 2
a.
b.
c.
d.
e.
5,600
Deferred rent revenue (L) ....................................................................
Rent revenue (+R +SE)..............................................................
$8,400 ÷ 6 months = $1,400 per month for 4 months. This entry
reduces (debits) the liability for the amount earned and records revenue.
Interest expense (+E SE) ..................................................................
Interest payable (+L) ........................................................................
To accrue interest expense incurred but not yet paid,
$18,000 x 5% x 3/12 = $225.
225
Depreciation expense (+E SE) ........................................................
Accumulated depreciation, service truck (+XA A)
To record depreciation expense for the year:
2,500
Deferred service revenue (L)...............................................................
Service revenue (+R +SE) ..........................................................
To recognize revenue earned during the year ($3,000 x 2/12).
500
Trade receivables (+A) .............................................................................
Service revenue (+R +SE) ........................................................
This entry records an asset for the amount due from customers
and recognizes the revenue because it was earned in 2015.
g.
Wage expense (+E SE) ......................................................................
Wages payable (+L) ........................................................................
Wage expense is increased (debited) because this expense was
incurred in 2015. A liability (wages payable) is credited because
this amount is owed to the employees as at December 31, 2015.
h.
225
2,500
500
1,500
Insurance expense (+E SE)..............................................................
Prepaid insurance (A) ................................................................
$9,000 ÷ 12 months = $750 per month for 2 months of coverage.
This entry reduces the asset (prepaid insurance) because part of it
has been used and only $7,500 represents future benefits (an asset)
to the company.
f.
Property tax expense (+E SE) .........................................................
Property tax payable (+L) ...............................................................
To record expense incurred but not yet paid.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-46
5,600
4,000
1,500
4,000
14,000
14,000
500
500
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–2 (continued)
Req. 3
Transaction
Effect on Net
Earnings
Effect on Cash
a.
↑ 5,600
N
b.
↓ 225
N
c.
↓ 2,500
N
d.
↑ 500
N
e.
↓ 1,500
N
f.
↑ 4,000
N
g.
↓ 14,000
N
h.
↓ 500
N
Note that adjusting entries are internal transactions that do not involve an exchange with
others. The Cash account is not affected by these transactions.
AP4–3
Req. 1
a.
b.
c.
d.
Deferred expense
Accrued revenue
Deferred expense
Accrued expense
e.
f.
g.
h.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-47
Deferred expense
Deferred expense
Accrued revenue
Accrued expense
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–3 (continued)
Req. 2
a.
b.
c.
d.
e.
f.
g.
Supplies expense (+E SE) ....................................................................
Supplies inventory (A) ....................................................................
Supplies inventory is decreased (credited) to record the use of
supplies during the year because this expense was incurred in
2015, calculated as Beg. Inventory of $450 + Purchases $1,200
– Ending Inventory $400
1,250
Trade receivables (+A) .................................................................................
Sales revenue (+R +SE) .................................................................
This entry records an asset for the amount due from customers
and recognizes the revenue because it was earned in 2015.
Insurance expense (+E SE)....................................................
Prepaid insurance (A) ......................................................
$1,200 ÷ 12 months x 2 months of coverage. This entry
reduces the asset (prepaid insurance) because part of it has
been used while $1,000 represents future benefits (an asset)
to the company.
7,500
1,250
200
200
Repairs and maintenance expense (+E SE) ....................
Accrued liabilities (+L) ........................................................
Repairs and maintenance expense is increased (debited)
because this expense was incurred in 2015. A liability
(accrued expenses payable) is credited because this amount
is owed but will not be paid until 2016.
600
Rent expense (+E SE) ..............................................................
Prepaid rent (A) .....................................................................
$2,100 ÷ 3 months x 1 month of expired rent. This entry
reduces the asset (prepaid rent) because part of it has been
used while $1,400 represents future benefits (an asset) to
the company.
700
Depreciation expense (+E SE) ..............................................
Accumulated depreciation, display counters (+XA A)
2,600
Interest receivable (+A) .................................................................
Interest revenue (+R +SE) ...............................................
To accrue interest income earned but not yet received,
$4,000 x 3% x 2/12 = $20.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-48
7,500
600
700
2,600
20
20
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–3 (continued)
h.
7,371
Income tax expense (+E SE) ..................................................
Income tax payable (+L) ........................................................
7,371
To accrue income tax expense incurred but not yet paid:
Earnings before adjustments (given) $22,400
Effect of adjustments (a) through (g)
+2,170 (– 1,250 + 7,500 – 200
Earnings before income taxes
24,570 – 600 – 700 – 2,600 + 20)
Income tax rate
30%
Income tax expense
$ 7,371
Req. 3
Transaction
a.
b.
c.
d.
e.
f.
g.
h.
Statement of Financial Position
Shareholders’
Assets
Liabilities
Equity
–1,250
N
–1,250
+7,500
N
+7,500
–200
N
–200
N
+600
–600
–700
N
–700
–2,600
N
–2,600
+20
N
+20
N
+7,371
–7,371
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-49
Statement of Earnings
Revenues
N
+7,500
N
N
N
N
+20
N
Expenses
+1,250
N
+200
+600
+700
+2,600
N
+7,371
Net
Earnings
–1,250
+7,500
–200
–600
–700
–2,600
+20
–7,371
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–4
(1)
Service revenue
213,000 (b)
14,000 (c)
227,000
(3) Cleaning
supplies expense
Used 13,600
(6) Cleaning
supplies inventory
Beg. 1,800
(i) 14,500 13,600 used
(j) 2,700
(7)
Wages expense
(f) 78,000
(g) 1,900
79,900
(10)
Wages payable
(e) 1,500 1,500 Beg.
1,900 (g)
1,900
Account
1. Service revenue
2. Cleaning supplies
Expense
3. Trade receivables
4. Wages expense
5. Cleaning supplies
inventory
6. Deferred revenue
7. Wages payable
13,600
(4)
Trade receivables
Beg. 11,000 11,000 (a)
(c) 14,000
14,000
(9)
Deferred revenue
19,000 (d)
19,000
(2, 5, 8)
Cash
(a) from customers 11,000 1,500 to employees (e)
(b) from customers 213,000 78,000 to employees (f)
(d) from customers 19,000
14,500 to suppliers (i)
149,000
2015
Balance Financial Statement
227,000 Statement of earnings
13,600 Statement of earnings
Effect on
Cash Flows
+
–
14,000 Statement of financial position
79,900 Statement of earnings
2,700 Statement of financial position
–
–
–
19,000 Statement of financial position
1,900 Statement of financial position
+
+
The balance in the cash account would appear on the statement of financial position.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-50
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–5
Req. 1
December 31, 2014 Adjusting Entries
(1)
Service revenue receivable (+A) ..........................................
Service revenue (+R +SE) ........................................
To record service fees earned, but not yet collected.
1,500
(2)
Rent expense (+E SE) ........................................................
Prepaid rent (A)..............................................................
To record rent expired as an expense.
400
Depreciation expense (+E SE) .......................................
Accumulated depreciation, PP&E (+XA A)
To record depreciation expense.
17,500
Deferred revenue (L) .............................................................
Service revenue (+R +SE) ........................................
To record service fees earned.
8,000
Income tax expense (+E SE) ...........................................
Income tax payable (+L) ...............................................
To record income taxes for 2014.
6,500
(3)
(4)
(5)
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-51
1,500
(b)
(j)
400
(m)
(c)
17,500
(l)
(e)
8,000
(g)
(j)
6,500
(n)
(f)
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–5 (continued)
Req. 2
Revenues:
Service revenue
Expenses:
Salary expense
Depreciation expense
Rent expense
Income tax expense
Total expenses
Net earnings
Amounts before
Adjusting Entries
Amounts after
Adjusting Entries
$83,000
$92,500
54,000
54,000
17,500
400
6,500
78,400
$14,100
54,000
$29,000
Net earnings is $14,100 because this amount includes all revenues and all expenses (after
the adjusting entries). This amount is correct because it incorporates the effects of the
revenue and matching principles applied to all transactions whose effects extend beyond
the period in which the transactions occurred. Net earnings of $29,000 was not correct
because expenses of $24,400 and revenues of $9,500 were improperly excluded from the
determination of net earnings for 2014.
Req. 3
Earnings per share = $14,100 net earnings  5,000 shares = $2.82 per share
Req. 4
Net profit margin = Net earnings  Net Sales = $14,100  $92,500 = 15.2%
The net profit margin indicates that, for every $1 of service revenues, Gilca made $0.152
(15.2%) of net earnings. This ratio suggests that Gilca is profitable.
ROE = Net Earnings / Average Shareholders’ Equity
Shareholders’ equity, beginning = $110,000 + $21,700 = $131,700
Shareholders’ equity, ending = $131,700 + $14,100 = $145,800
ROE = $14,100 ÷ [($131,700 + $145,800) ÷ 2] = 0.102 (10.2%).
The ROE measures how much the company earned per dollar of shareholders’ investment.
To be meaningful, this ratio should be compared to ROEs for previous years or those of
similar companies in the same industry.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-52
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–5 (continued)
Req. 5
Service revenue (R) .................................................................
Income Summary (+T)....................................................
92,500
Income Summary (T)
Salary expense (E) .........................................................
Depreciation expense (E) ...........................................
Rent expense (E) ............................................................
Income tax expense (E) ...............................................
78,400
Income Summary (T) ..............................................................
Retained earnings (+SE) ...............................................
14,100
92,500
54,000
17,500
400
6,500
14,100
AP4–6
Req. 1
December 31, 2014 Adjusting Entries:
Supplies expense (+E SE) ....................................................
Supplies inventory (A) ................................................
($800  $200)
600
Insurance expense (+E SE) .................................................
Prepaid insurance (A) .................................................
400
Depreciation expense (+E SE) ...........................................
Accumulated depreciation, trucks (+XA A) .....
4,000
(d)
Wages expense (+E SE) .........................................................
Wages payable (+L) ........................................................
1,100
(e)
Income tax expense (+E SE) ...............................................
Income tax payable (+L) ...............................................
7,350
(a)
(b)
(c)
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-53
600
400
4,000
1,100
7,350
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–6 (continued)
Req. 2
Transaction
Effect on Net
Earnings
Effect on Cash
a.
↓600
N
b.
↓ 400
N
c.
↓ 4,000
N
d.
↓ 1,100
N
e.
↓ 7,350
N
Note that adjusting entries are internal transactions that do not involve an exchange with
others. The Cash account is not affected by
Req. 3
SUTTON, INC.
Statement of Earnings
For the Year Ended December 31, 2014
Service revenue
Operating expenses:
Supplies
Insurance
Depreciation
Wages
Other
Total operating expenses
Earnings before income tax
Income tax expense
Net earnings
Earnings per share ($21,850 ÷ 5,000 shares)
$77,000
$
600
400
4,000
1,100
41,700
47,800
29,200
7,350
$21,850
$4.37
Note: normally “Other Expenses” would be shown in more detail especially when this amount
is large (relatively speaking).
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-54
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–6 (continued)
Assets
Cash
Trade receivables
Service supplies inventory
Prepaid insurance
Service trucks, at cost
Accumulated depreciation
Other assets
Total assets
SUTTON, INC.
Statement of Financial Position
As at December 31, 2014
Liabilities
$60,000
Trade payables
13,000
Wages payable
200
Income taxes payable
600
Note payable, long term
Total liabilities
$ 20,000
(16,000)
4,000
Shareholders' Equity
11,200
Contributed capital
Retained earnings*
Total shareholders' equity
Total liabilities and
$89,000
shareholders' equity
$ 3,000
1,100
7,350
20,000
31,450
28,200
29,350
57,550
$89,000
*Unadjusted balance, $7,500 + Net earnings, $21,850 = Ending balance, $29,350.
Req. 4
If the cost of the service supplies in 2014 is not included among the period’s expenses, then
the net earnings before income taxes would be overstated by $600, the income tax expense
would be overstated by $151 ($600 x 25.2%*) approximately, and net earnings would be
overstated by $449. This error represents 2.1 percent of net earnings and is usually judged
to be not material.
Income tax rate = $7,350 / $29,200 = 0.252 (or 25.2%)
Req. 5
December 31, 2014 Closing Entries:
(a)
Service revenue (R) .....................................................................
Income Summary (+T)....................................................
77,000
(b)
Income Summary (T) ..................................................................
Supplies expense (E) ...................................................
Insurance expense (E) ................................................
Depreciation expense (E) ..........................................
Wages expense (E) .......................................................
Other expenses (E) ........................................................
Income tax expense (E) ..............................................
55,150
Income Summary (T) .................................................................
Retained earnings (+SE) ...............................................
21,850
(c)
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-55
77,000
600
400
4,000
1,100
41,700
7,350
21,850
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–7
Req. 1
ACME PEST CONTROL SERVICES CORPORATION
Statement of Earnings
For the Fiscal Year Ended August 31, 2014
Revenues:
Sales revenue ....................................................................................
Maintenance contract revenue ..................................................
Total revenues ............................................................................
Expenses:
Operating (various) ........................................................................
Depreciation ......................................................................................
Interest ................................................................................................
Total expenses other than income tax ...............................
Earnings before income tax .................................................................
Income tax expense ($14,000 x 30%) .....................................
Net earnings ...............................................................................................
Earnings per share ($9,800  10,000 shares) ...............................
$38,000
17,000
27,000
12,000
2,000
$55,000
41,000
14,000
4,200
$9,800
$ 0.98
Req. 2
Income tax expense ($14,000 x 30%) (+E, –SE) ...................
Income tax payable (+L) ..................................................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-56
4,200
4,200
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4-7 (continued)
Req. 3
ACME PEST CONTROL SERVICES CORPORATION
Statement of Financial Position
As at August 31, 2014
Assets
Current Assets:
Cash .....................................................................................................
Trade receivables ............................................................................
Supplies inventory ..........................................................................
Total current assets ..................................................................
Noncurrent Assets:
Service vehicles, at cost .............................................. $60,000
Less: accumulated depreciation......................... 20,000
Equipment, at cost ......................................................... 14,000
Less accumulated depreciation................................. 4,000
Total noncurrent assets ..........................................................
Total assets...................................................................................
Liabilities
Current Liabilities:
Trade payables .................................................................................
Income tax payable (See Req. 1 and 2) ...................................
Salaries payable ...............................................................................
Total current liabilities ............................................................
Long-Term Liabilities:
Notes payable....................................................................................
Total liabilities ............................................................................
$26,000
30,800
1,300
$58,100
40,000
10,000
$16,700
4,200
1,100
50,000
$108,100
$22,000
34,000
56,000
Shareholders' Equity
Contributed capital, 10,000 shares issued and outstanding ...
Retained earnings (beginning balance, $4,300 + net earnings,
$9,800 - dividends declared, $2,000) .............................................
Total shareholders' equity ...........................................................
Total liabilities and shareholders' equity .........................
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-57
40,000
12,100
52,100
$108,100
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4-7 (continued)
Req. 4
Net profit margin = Net earnings ÷ Total Revenue = $9,800 ÷ $55,000 = 0.18 (18%)
Return on equity (ROE) = Net earnings ÷ Average Shareholders’ Equity
= $9,800 ÷ [($44,300 + 52,100) ÷ 2] = 0.20 (20%)
These ratios indicate that the company earned $0.18 in net earnings per $1.00 of revenue,
and $0.20 in net earnings per $1.00 of shareholders’ investment. Both ratios are relatively
high, indicating that the company’s management has done very well in generating net
earnings to shareholders. But, these ratios are difficult to interpret in isolation. There is a
need for some reference or benchmark for evaluation, such as a trend of these two ratios
for the past few years or ratios for similar companies in the same industry.
Req. 5
August 31, 2014 Closing Entries
1
2
3
Sales revenue (R) ............................................................
Maintenance contract revenue (R)...........................
Income Summary (+T) .......................................
To close revenue accounts.
38,000
17,000
Income Summary (T) .....................................................
Operating expenses (E) ......................................
Depreciation expense (E) ..................................
Interest expense (E) ............................................
Income tax expense (E) ......................................
To close expense accounts.
45,200
Income Summary (T) .....................................................
Retained earnings (+SE) ....................................
9,800
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-58
55,000
27,000
12,000
2,000
4,200
9,800
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4-8
Req. 1
a)
Interest receivable (+A) .................................................
Interest income (+R +SE) ...............................
(60,000 x 5% x 3/12)
750
b)
Interest expense (+E SE) .........................................
Interest payable (+L) .............................................
(30,000 x 4% x 1/12)
100
c)
Deferred rent revenue (–L)............................................
Rent revenue (+R +SE) .....................................
($6,000 / 3) x 2
4,000
d)
Depreciation expense (+E SE) ..............................
Accumulated depreciation (+XA A)...........
15,625
Retained earnings (or Dividends ) (SE)..................
Dividend payable (+L) ..........................................
(100,000 shares x $0.60)
60,000
Income tax expense (+E SE) ...................................
Income taxes payable (+L) ..................................
($249,000 x 30% – see below)
74,700
e)
f)
750
100
4,000
15,625
60,000
74,700
Req. 2
Transaction
Effect on Net
Earnings
Effect on Cash
a.
↑ 750
N
b.
↓ 100
N
c.
↑ 4,000
N
d.
↓15,625
N
e.
N
N
f.
↓74,700
N
Note: that all the adjusting entries did not have an effect on cash. These are internal
transactions that did not involve an exchange of cash with other parties.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-59
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–8 (continued)
Req. 3
SAKURA LTD.
Statement of Earnings
For the year ended December 31, 2014
Sales revenue
Cost of sales
Gross profit
Operating expenses:
Salaries expense
Depreciation expense
Other operating expenses
Total operating expenses
Earnings from operations
Other income (expense):
Rent revenue
Interest income
Interest expense
Earnings before income taxes
Income tax expense
Earnings
$999,000
502,000
497,000
222,000
15,625
15,025
252,650
244,350
4,000
750
(100)
4,650
249,000
74,700 ($249,000 x 30%)
$174,300
Earnings per share (EPS)
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-60
$1.74 ($174,300/100,000 shares)
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–8 (continued)
Req. 4
SAKURA LTD.
Statement of Financial Position
As at December 31, 2014
Assets
Current Assets
Cash
Trade receivables
Note receivable
Interest receivable
Total current assets
Non-current Assets
Property, plant and equipment
Less: Accumulated depreciation
Total Assets
$ 247,000
485,000
60,000
750
792,750
500,000
156,250*
Liabilities and Shareholders' Equity
Current Liabilities
Trade payables
Dividends payable
Income taxes payable
Note payable
Interest payable
Deferred rent revenue
Total Current Liabilities
Shareholders’ Equity
Contributed capital (100,000 shares)
Retained earnings
Total Shareholders’ Equity
Total Liabilities and Shareholders’ Equity
343,750
$1,136,500
$
70,400
60,000
74,700
30,000
100
2,000
237,200
620,000
279,300
899,300
$1,136,500
(6,000 – 4,000)
(165,000 + 174,300 – 60,000)
* (140,625 + 15,625)
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-61
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
AP4–8 (continued)
Req. 5
1
999,000
Sales revenue (R) ............................................................
4,000
Rent revenue (R) .............................................................
750
Interest income (R) ........................................................
Income Summary (+T)............................................
To close revenue accounts.
2
829,450
Income Summary (T) .....................................................
Cost of sales (E) .....................................................
Salaries expense (E) ............................................
Depreciation expense (E) ..................................
Other operating expenses (E) ..........................
Interest expense (E) .............................................
Income tax expense (E) ......................................
To close expense accounts.
3
174,300
Income Summary (T) .....................................................
Retained earnings (+SE) ........................................
1,003,750
502,000
222,000
15,625
15,025
100
74,700
174,300
Req. 6
a. Profit margin ratio = Net earnings / Sales revenue = $174,300 / $999,000 = 17.4%.
This ratio measures how much the company earned from every sales dollar generated
during the period, after covering all expenses (including income taxes).
b. Return on equity = Net earnings/Average shareholders' equity
= $174,300/$842,150* = 20.7%
* [($620,000 + 165,000) + 899,300] / 2 = $842,150
This ratio indicates how much the firm earned for each dollar of investment by
shareholders.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-62
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMPREHENSIVE PROBLEMS
COMP4–1
Req. 1, 2, 3, 5 T-accounts
Cash
Bal. 3,000 b
a 10,000 e
c 110,000 g
d
3,000 h
f
24,000 k
Bal. 38,000
b
9,000
65,000
10,000
13,000
15,000
Land
9,000
Bal. 9,000
Other Assets
Bal . 4,000
g 10,000
Bal. 14,000
Service Supplies
Inventory
Bal. 12,000 l 18,000
i 18,000
Trade Receivables
Bal. 5,000 f 24,000
c 50,000
Bal. 31,000
Bal. 12,000
Accumulated
Depreciation
Bal. 6,000
m
6,000
Bal. 12,000
Equipment
Bal. 60,000
Bal. 60,000
Trade Payables
h 13,000 Bal. 5,000
e 20,000
i
18,000
Bal. 30,000
Notes Payable
a 10,000
Bal. 10,000
Wages Payable
o 15,000
Bal. 15,000
Interest Payable
n 1,000
Bal. 1,000
Income Taxes
Payable
p
8,000
Bal. 8,000
Contributed Capital
Bal. 65,000
d
3,000
Bal. 68,000
Retained Earnings
k 15,000 Bal. 8,000
CE3 27,000
Bal. 20,000
Service Revenue
c 160,000
CE1 160,000
Bal.
0
Depreciation
Expense
m 6,000 CE2 6,000
Bal.
0
Income Tax Expense
p 8,000 CE2 8,000
Bal.
0
Other Expenses
e 85,000
l 18,000
o 15,000 CE2 118,000
Bal.
0
Interest
Expense
n 1,000 CE2
Bal.
0
1,000
Income Summary
CE1 160,000 CE2 133,000
CE3 27,000
Bal.
0
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-63
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4–1 (continued)
Req. 2
a.
Cash (+A) ...............................................................................
Note payable (+L)....................................................
Borrowed cash on 12% note, March 1, 2014.
10,000
b.
Land (+A) ..............................................................................
Cash (A) ....................................................................
Purchased land for future building site.
9,000
c.
Cash (+A) ...............................................................................
Trade receivables (+A) ....................................................
Service revenue (+R +SE) ................................
Service revenues earned during 2014.
110,000
50,000
d.
Cash (+A) ...............................................................................
Share capital (+SE) .................................................
Sold shares for cash.
3,000
e.
Other expenses (+E SE) ............................................
Trade payables (+L) ...............................................
Cash (A) ....................................................................
Other expenses incurred during 2014.
85,000
f.
Cash (+A) ...............................................................................
Trade receivables (A) ..........................................
Collections on customers' accounts.
24,000
g.
Other assets (+A) ...............................................................
Cash (A) ....................................................................
Purchased additional assets.
10,000
h.
Trade payables (L) ..........................................................
Cash (A) ....................................................................
Paid creditors.
13,000
Service supplies inventory (+A) ...................................
Trade payables (+L) ...............................................
Purchased services supplies for future use.
18,000
i.
j.
No entry required; no exchange transaction in
2014.
k.
Retained earnings (SE) .................................................
Cash (A) ....................................................................
Declared and paid a cash dividend.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-64
10,000
9,000
160,000
3,000
20,000
65,000
24,000
10,000
13,000
18,000
15,000
15,000
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4–1 (continued)
Req. 3
l.
m.
n.
o.
p.
Req. 4
Other expenses (+E SE) ............................................
Service supplies inventory (A) .........................
To record supplies used ($30,000 – 12,000).
18,000
Depreciation expense (+E SE) ...............................
Accumulated depreciation (+XA A)............
To record depreciation ($60,000 ÷ 10 years).
6,000
Interest expense (+E SE) .........................................
Interest payable (+L) ..............................................
To accrue interest for March - December, 2014
($10,000 x 12% x 10/12).
1,000
Other expenses (wages) (+E SE) ..........................
Wages payable (+L) .................................................
To recognize wages incurred but not yet paid.
15,000
Income tax expense (+E SE) ...................................
Income taxes payable (+L)....................................
To accrue income tax (not yet paid).
8,000
18,000
6,000
1,000
15,000
8,000
A & C TOOLS, INC.
Statement of Earnings
For the Year Ended December 31, 2014
Revenues:
Service revenue
Expenses:
Depreciation
Interest
Other
$160,000
$ 6,000
1,000
118,000
125,000
35,000
8,000
$ 27,000
Earnings before income tax
Income tax expense
Net earnings
Earnings per share
$27,000 ÷ [(65,000 + 68,000) 
2]
$0.41
Note: normally “Other expenses” would be disclosed in greater detail, especially when it is
such a large amount (relatively speaking).
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-65
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4–1 (continued)
A & C TOOLS, INC.
Statement of Changes in Equity
For the Year Ended December 31, 2014
(in thousands)
Contributed Retained Shareholders’
Capital
Earnings
Equity
Balance, January 1, 2014
$65,000
$ 8,000
$73,000
Issuance of shares
3,000
3,000
Net earnings
27,000
27,000
Dividends declared
(15,000)
(15,000)
Balance, December 31, 2014
$68,000
$20,000
$88,000
A & C TOOLS, INC.
Statement of Financial Position
As at December 31, 2014
Assets
Current Assets
Cash
Trade receivables
Service supplies inventory
Total Current Assets
Non-current Assets
Land
Equipment, at cost
Less: Accumulated depreciation
Other assets
Total Assets
$ 38,000
31,000
12,000
81,000
9,000
$60,000
12,000* 48,000
14,000
$152,000
Liabilities and Shareholders' Equity
Current Liabilities
Trade payables
$ 30,000
Notes payable
10,000
Wages payable
15,000
Interest payable
1,000
Income tax payable
8,000
Total Current Liabilities
64,000
Shareholders’ Equity
Contributed capital
$68,000
Retained earnings
20,000
Total Shareholders’ Equity
88,000
Total Liabilities and Shareholders’ Equity
$152,000
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-66
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4–1 (continued)
Req. 5
December 31, 2014 Closing Entries
1
2
3
Service revenue (R) ........................................................
Income Summary (+T) .........................................
To close revenue accounts.
160,000
Income Summary (T) .....................................................
Depreciation expense (E) ..................................
Interest expense (E) ............................................
Other expenses (E) ...............................................
Income tax expense (E) ......................................
To close expense accounts.
133,000
Income Summary (T) .....................................................
Retained earnings (+SE) .......................................
27,000
160,000
6,000
1,000
118,000
8,000
27,000
Req. 6
Post-closing trial balance:
A & C TOOLS, INC.
Post-Closing Trial Balance
As at December 31, 2014
(in thousands of dollars)
Account Titles
Cash
Trade receivables
Service supplies inventory
Land
Equipment
Accumulated depreciation (equipment)
Other assets)
Trade payables
Notes payable
Wages payable
Interest payable
Income taxes payable
Contributed capital (68,000 shares)
Retained earnings
Total
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-67
No.
01
02
03
04
05
06
07
11
12
13
14
15
21
31
Debit
$ 38,000
31,000
12,000
9,000
60,000
14,000
$164,000
Credit
$ 12,000
30,000
10,000
15,000
1,000
8,000
68,000
20,000
$164,000
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4–1 (continued)
Req. 7
(a)
= Current assets  Current liabilities
= $81,000  $64,000 = 1.27
This ratio measures the ability of the company to pay its short-term obligations with
current assets.
(b)
Total asset turnover
(c)
= Net earnings  Sales
= $27,000  $160,000 = 0.17 (17%)
This ratio measures the amount of net earnings that the company generates per
dollar of sales.
(d)
Return on equity = Net earnings  Average shareholders’ equity
= $27,000  [($73,000 + $88,000)  2] = 0.335 (33.5%)
ROE measures how much the company earned per dollar of shareholders’
investment.
Current ratio
= Sales  Average total assets
= $160,000  [($78,000 + $152,000)  2] = 1.39
This ratio measure the amount of sales generated per dollar of assets.
Net profit margin
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-68
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4-2
Req. 1, 2, 3, 5, T-accounts
Cash
Bal. 5 b
a
25 e
c
5 f
d
59 h
g
8 k
j
3
Bal. 35
18
26
3
11
12
Bal.
Small Tools
Inventory
Bal. 6
f
3
Bal. 9
11
4
Accumulated
Depreciation
m
2
Bal. 18
Bal.
Trade Payables
h
11
Bal. 7
e
9
i
10
Bal. 15
9
Supplies Inventory
Bal. 2 l
8
i
10
Bal.
Equipment
b
18
Other Assets
Bal. 9
Bal.
Trade Receivables
Bal. 4 g
8
d
15
2
Notes Payable
a
25
Bal. 25
Income Taxes Payable
Wages Payable
o
4
Bal. 4
Interest Payable
n
1
Bal. 1
Deferred Revenue
j
3
3
Contributed Capital
Bal. 15
c
5
Bal. 20
Retained Earnings
k
12 Bal. 4
CE3 20
Bal. 12
Service Revenue
d
74
CE1 74
Bal. 0
Income Tax Expense
p
4
CE2 4
Bal. 0
Interest Expense
n
1
CE2 1
Bal. 0
Bal.
Depreciation
Expense
m
2
CE2 2
Bal.
0
Other Expenses
e 35
l
8
o
4
CE2 47
Bal. 0
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-69
p
Bal.
4
4
Income Summary
CE1 74
CE2 54
CE3 20
Bal.
0
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4–2 (continued)
Req. 2
a.
Cash (+A) ...............................................................................
Note payable (+L)....................................................
Borrowed cash on 8% note, July 1, 2014.
25
b.
Equipment (+A) ..................................................................
Cash (A) ....................................................................
Purchased equipment, July 1, 2014
18
c.
Cash (+A) ...............................................................................
Share capital (+SE) .................................................
Sold shares for cash.
5
d.
Cash (+A) ...............................................................................
Trade receivables (+A) ....................................................
Service revenue (+R +SE) ................................
Service revenues earned during 2014.
59
15
Other expenses (+E SE) ............................................
Trade payables (+L) ...............................................
Cash (A) ....................................................................
Other expenses incurred during 2014.
35
f.
Small tools inventory (+A) .............................................
Cash (A) ....................................................................
Purchased additional small tools inventory.
3
g.
Cash (+A) ...............................................................................
Trade receivables (A) ..........................................
Collections on customers' accounts.
8
h.
Trade payables (L) ..........................................................
Cash (A) ...................................................................
Paid creditors.
11
Supplies inventory (+A) ..................................................
Trade payables (+L) ...............................................
Purchased services supplies for future use.
10
e.
i.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-70
25
18
5
74
9
26
3
8
11
10
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4–2 (continued)
j.
Cash (+A) ...............................................................................
Deferred revenue (+L)...........................................
Deposit received for revenue not yet earned.
3
k.
Retained earnings (SE) .................................................
Cash (A) ....................................................................
Declared and paid a cash dividend.
12
Other expenses (+E SE) ............................................
Supplies inventory (A) .........................................
To record supplies used ($12 – 4)
8
Depreciation expense (+E SE) ...............................
Accumulated depreciation(+XA A).............
To record depreciation $4 x ½ year.
2
Interest expense (+E SE) .........................................
Interest payable (+L) ..............................................
To accrue interest for July - December, 2014,
($25 x 8% x 6/12).
1
Other expenses (wages) (+E SE) ..........................
Wages payable (+L) .................................................
To recognize wages incurred but not yet paid.
4
Income tax expense (+E SE) ...................................
Income taxes payable (+L)....................................
To accrue income tax (not yet paid).
4
3
12
Req. 3
l.
m.
n.
o.
p.
Req. 4
8
2
1
4
RUMOURS FURNITURE, INC.
Statement of Earnings
For the Year Ended December 31, 2014
(in thousands)
Revenues:
Service revenue
Expenses:
Depreciation
$ 2
Interest
1
Other
47
Earnings before income tax
Income tax expense
Net earnings
Earnings per share {$20 ÷ [(15 + 20)  2]}
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-71
4
$74
50
24
4
$20
$1.14
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4–2 (continued)
RUMOURS FURNITURE, INC.
Statement of Changes in Equity
For the Year Ended December 31, 2014
(in thousands)
Share
Retained Shareholders’
Capital Earnings
Equity
Balance, January 1, 2014
$15
$ 4
$19
Issuance of shares
5
5
Net earnings
20
20
Dividends declared
(12)
(12)
Balance, December 31, 2014
$20
$12
$32
Assets:
Cash
Trade receivables
Supplies inventory
Small tools inventory
Equipment, cost
Less: Accumulated
depreciation
Other assets
Total assets
RUMOURS FURNITURE, INC.
Statement of Financial Position
As at December 31, 2014
(in thousands)
Liabilities:
$ 35
Trade payables
11
Notes payable
4
Wages payable
9
Interest payable
$18
Income taxes payable
Deferred revenue
2
16
9
Total liabilities
Shareholders' Equity:
Contributed capital
Retained earnings
Total shareholders' equity
Total liabilities and
$84
shareholders' equity
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-72
$ 15
25
4
1
4
3
52
$20
12
32
$84
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4–2 (continued)
Req. 5
December 31, 2014 Closing Entries
1
2
3
Service revenue (R) ........................................................
Income Summary (+T) .......................................
To close revenues.
74
Income Summary (T)) ...................................................
Depreciation expense (E) ..................................
Interest expense (E) ............................................
Other expenses (E) ...............................................
Income tax expense (E) ......................................
To close expenses.
54
Income Summary (T) .....................................................
Retained earnings (+SE) ......................................
20
Req. 6
Account
01
02
03
04
05
06
07
11
12
13
14
15
16
21
31
74
2
1
47
4
20
RUMOURS FURNITURE, INC.
Post-Closing Trial Balance
As at December 31, 2014
(in thousands of dollars)
Account Titles
Cash
Trade receivables
Supplies inventory
Small tools inventory
Equipment
Accumulated depreciation (equipment)
Other assets
Trade payables
Notes payable
Wages payable
Interest payable
Income taxes payable
Deferred revenue
Contributed capital (20,000 shares)
Retained earnings
Totals
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-73
Debit
$35
11
4
9
18
9
$86
Credit
$ 2
15
25
4
1
4
3
20
12
$86
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
COMP4–2 (continued)
Req. 7
(a)
= Current assets  Current liabilities
= $59  $52 = 1.13
This ratio measures the ability of the company to pay its short-term obligations with
current assets.
(b)
Total asset turnover
(c)
= Net earnings  Sales
= $20  $74 = 0.27 (27%)
This ratio measures the amount of net earnings that the company generates per
dollar of sales.
(a)
Return on equity
Current ratio
= Sales  Average total assets
= $74  [($26 + $84) ÷ 2] = 1.35
This ratio measure the amount of sales generated per dollar of assets.
Net profit margin
= (Net earnings + Interest expense, net of tax)
Average shareholders’ equity
= [$20 + 1 x (1 – 4/24)]  [($19 + $32)  2] = 0.817 (81.7%)
ROE measures how much the company earned per dollar of shareholders’
investment.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-74
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CASES AND PROJECTS
FINDING AND INTERPRETING ACCOUNTING INFORMATION
CP4–1
Req. 1
The company paid $155.3 million in interest during 2012. This information is disclosed on
the statement of cash flows.
Req. 2
Accumulated depreciation is related to the company’s property, plant and equipment (see
note 17).
Req. 3
The company’s statement of earnings accounts (revenues, expense, gains, and losses)
would not appear on a post-closing trial balance. These accounts are temporary accounts
that would have been closed to Retained Earnings (through the Income Summary account).
Req. 4
Inventories is an asset account. As such, it is a permanent account that carries its ending
balance into the next accounting period. It is not closed at the end of the period.
Req. 5
Basic earnings per share equalled $5.73 for 2011, and $6.13 for 2012. This information is
disclosed on the face of the company’s consolidated statement of earnings.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-75
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–1 (continued)
Req. 6
(Amounts in millions of Canadian dollars)
Net profit margin = Net earnings / Revenues
2011:
$467.0 / $10,387.1 = 0.0450 or 4.50%
2012:
$499.2 / $11,427.2 = 0.0437 or 4.37%
Canadian Tire’s net profit margin decreased slightly from 4.50 percent in 2011 to 4.37
percent in 2012. The increase in revenue resulted in relatively higher increase in expenses,
which decreased the profit margin. Canadian Tire’s management needs to examine its
expenses to find out which expense items need to be better controlled.
CP4-2
Req. 1
Prepaid expenses had a balance of $20,162,000 at December 30, 2012, as reported on
RONA’s consolidated statements of financial position.
Req. 2
Prepaid rent reflects the amount that a company pays in advance of using the space it
rented from another party. Deferred rent revenue refers to the amount of cash a company
received in advance of providing rental space to another party. The prepaid rent for one
party is the deferred rent revenue for the other party.
Req. 3
Accrued liabilities are obligations that a company must settle in the future based on
services it received from other parties during the accounting period. These liabilities are
recorded at the end of the accounting period based on either known amounts or estimated
amounts. They are also known as accrued expenses payable.
Req. 4
The finance income reported by RONA on its consolidated income statements resulted from
two sources: (1) interest on trade and other receivables, essentially notes receivable that
require the payment of specific interest rates, and (2) interest on other financial assets,
such as the company’s investment in debt securities issued by other corporations, financial
institutions, or the government.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-76
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–2 (continued)
Req. 5
The company’s statement of earnings accounts (revenues, expense, gains, and losses)
would not appear on a post-closing trial balance. These accounts are temporary accounts
that would have been closed to Retained Earnings (through the Income Summary account).
Req. 6
Prepaid Expenses is an asset account. As such, it is a permanent account that carries its
ending balance into the next accounting period. It is not closed at the end of the period.
Req. 7
Basic earnings per share equalled $0.07 for 2012. The company reported, however, a loss
of $0.66 per share for 2011. These values are reported on RONA’s consolidated income
statements.
Req. 8
Net profit margin = Net earnings / Revenues
2011: –$74,773 / $4,804,584 = –0.0156 or –1.56%
2012: $19,083 / $4,844,016 = 0.0039 or 0.39%
RONA’s profit margin increased from a negative ratio of 1.56 percent in 2011 to a positive
ratio of 0.39 percent in 2012. The net loss in 2011 was caused primarily by an impairment,
or a loss in the value of goodwill as reported on the RONA’s consolidated income
statements.
CP4–3
Req.1
Cost of sales
Canadian Tire Corporation: $7,545.3 million, reported in Note 32 to the financial statements
RONA Inc.:
$3,544.8 million, reported in Note 5 to the financial statements
Req. 2
Canadian Tire Corporation
2011
Sale of goods (Note 31)
$10,005.8
Cost of sales (Note 32)
7,545.3
Percent
74.7%
2012
$8,997.6
6,916.7
76.9%
RONA Inc.
Sales of goods (Note 4)
Cost of sales (Note 5)
Percent
$4,739.5
3,436.6
72.5%
$4,811.9
3,544.8
73.7%
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-77
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–3 (continued)
Canadian Tire has a higher cost of sales relative to its sales revenue compared to RONA. The
ratio decreased in 2012 while RONA’s increased during the same year. RONA’s lower ratio
may be due to (1) its ability to add a higher markup to the cost of merchandise it purchases,
(2) an ability to negotiate lower prices for the merchandise it purchases from suppliers, (3)
the mix of products they offer to customers, (4) or a combination of these and other factors.
Req. 3
Canadian Tire Corporation
Revenues
Net earnings
Net profit margin
RONA Inc.
Revenues
Net earnings
Net profit margin
2012
$11,427.2
499.2
4.37%
2011
$10,387.1
467.0
4.50%
$4,844.0
19.1
0.39%
$4,804.6
(74.8)
–1.56%
For each of the two years Canadian Tire’s net profit margin is higher than RONA’s,
particularly in 2012. This means that Canadian Tire generates more net earnings relative to
its sales, compared to RONA. Canadian Tire’s net profit margin decreased slightly from 2011
to 2012 whereas RONA’s net profit margin increased during 2012. RONA’s management
needs to continue improving on the profitability of its operations in future years.
Req. 4
Canadian Tire
Net earnings
$ 499.2
Shareholders’ equity, beginning ............. 4,763.6
Shareholders’ equity, ending
............. 4,409.0
Return on equity
.............
10.9%
RONA
$ 19.1
1,955.6
1,833.6
1.0%
Canadian Tire’s ROE is higher than RONA’s, indicating that Canadian Tire generated a
higher return on shareholders’ investment than RONA. All things being equal, investors
prefer higher to lower returns. In general, it is preferable to compare ratios for similar
companies in the same industry instead of comparing ratios across industries that may be
affected differently by economic events.
Req. 5
Net profit margin
Return on equity
Canadian Tire
4.37%
10.9%
RONA
0.39%
1.00%
Industry average
4.29%
9.41%
The industry average is based on the average ratios for the three companies, Canadian Tire
Corporation, RONA Inc., and Richelieu Hardware Ltd. The net profit margin of Richelieu
Hardware must be relatively high compared to the ratios of the other two companies. The same
observation applies to the return on equity. The results indicate that Canadian Tire achieved
better profitability that RONA, but both companies did not perform as well as Richelieu
Hardware.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-78
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
FINANCIAL REPORTING AND ANALYSIS CASES
CP4–4
Transaction A:
Req. 1
This transaction will affect Seneca's financial statements for 11 years (1/2 year in 2013, full
year for years 2014 through 2022, plus 1/2 year in 2023) in conformity with the matching
process. This answer is based on certain assumptions, e.g., the company does not dispose of
the equipment prior to the end of the asset’s useful life.
Req. 2
Statement of earnings:
Depreciation expense:
2013: $14,000 ÷ 10 years x 1/2 year
2014: $14,000 ÷ 10 years
1,400
$ 700
Req. 3
Statement of financial position (extract) at December 31, 2015:
Assets:
Office equipment
$14,000
Less: Accumulated depreciation*
3,500
Carrying amount (book value)
$10,500
* $700 (2013) + $1,400 (2014) + $1,400 (2015) = $3,500.
Req. 4
Adjusting entries for life of the asset:
Depreciation expense (+E -SE) ......
Accumulated depreciation (+XA A)
2013
700
700
Proof: Total depreciation over life of the equipment:
First and last years at half the annual amount
$700 x 2 years
Nine years (2014 through 2022) at full annual
amount $1,400 x 9 years
Total accumulated depreciation (= initial cost;
estimated residual value = 0)
2014 to 2022
1,400
1,400
2023
700
700
$ 1,400
12,600
$14,000
An adjusting entry to record depreciation expense would be made each year that the asset
is in use. Such an adjusting entry is often made only at the end of the fiscal year. The entry
is necessary to match the cost of the asset to the period of use.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–4 (continued)
Transaction B:
Req. 1
This transaction will affect Seneca's financial statements for 2 years, 2014 and 2015,
because rent revenue was earned for four months in 2014, and rent revenue will be earned
or two months in 2015.
Req. 2
The 2014 statement of earnings should report rent revenue of $16,000 ($24,000 x 4/6).
Occupancy was provided for only four months in 2014. This is in conformity with the
revenue principle.
Req. 3
This transaction created liability of $8,000 as of December 31, 2014, because at that date
Seneca "owes'' the tenant two more months' occupancy for which it has already collected
the cash.
Req. 4
Yes, an adjusting entry must be made to (a) increase the rent revenue account by $16,000,
and (b) to decrease the liability by $16,000 (to a new balance of $8,000 representing the
future occupancy “owed”), in conformity with the revenue principle. The adjusting entry
on December 31, 2014 would be:
Deferred rent revenue (L) .......................................................
Rent revenue (+R +SE) ..................................................
16,000
16,000
Transaction C:
Req. 1
This transaction affects the financial statements for two periods: in 2014 when the expense
incurred and in 2015 when it is paid. The effect in 2015 is on the statement of financial
position only – a reduction of Cash and Salaries Payable.
Req. 2
The amount of $7,500 should be reported as wage expense in the 2014 statement of
earnings, thus reducing net earnings and retained earnings by $7,500, ignoring income
taxes. In addition, the amount should be reported as a liability on the 2014 statement of
financial position.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–4 (continued)
Req. 3
Yes, an adjusting entry must be made to (a) record the amount of $7,500 as an expense in
2014 (matching process) and (b) to record the liability which will be paid in 2015. The
adjusting entry on December 31, 2014 would be:
Wage expense (+E SE) ..........................................................
Wages payable (+L) ............................................................
7,500
7,500
Note: On January 5, 2015, the liability, Wages Payable, $7,500, will be paid. Wage expense
for 2015 will not include this amount. The 2015 related entry will debit (decrease) Wages
Payable, and credit (decrease) Cash, $7,500.
Transaction D:
Req. 1
Yes, service revenue of $45,000 (i.e., $60,000 x 3/4) should be recorded as earned by
Seneca in 2014, in conformity with the revenue principle. Service revenue should be
recognized over the period that the service is being performed, provided that all other
revenue recognition criteria are met.
Recognition of revenue earned but not collected by the end of 2014 requires an adjusting
entry. This adjusting entry is necessary to (a) record the revenue earned (to be reported
on the 2014 statement of earnings) and (b) record the related account receivable (an asset
to be reported on the 2014 statement of financial position). The adjusting entry on
December 31, 2014 is:
Trade receivables (+A) ……………………………………………...
Service revenue (+R +SE) .........................................
($60,000 total price x 3/4 completed)
45,000
45,000
Req. 2
February 15, 2015 – Completion of the last phase of the service contract and collection of
cash in full:
Cash (+A) ........................................................................................... 60,000
Trade receivables (A) ...................................................
45,000
Service revenue (+R +SE) .........................................
15,000
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–5
Req. 1
Adjusting entries:
Expenses (insurance) (+E SE) .....................................................
Prepaid insurance (A) ...............................................................
To adjust for expired insurance (from account 13).
1
(b)
Rent receivable (+A) ...............................................................................
Revenues (rent) (+R+SE) ........................................................
To adjust for rent revenue earned but not yet collected
(from account 14).
2
(c)
Expenses (depreciation) (+E SE) ................................................
Accumulated depreciation, long-lived assets (+XA A)
To adjust for annual depreciation (shown in account 16).
11
Expenses (wages) (+E SE) .............................................................
Wages payable (+L) ......................................................................
To adjust for wages earned by employees but not yet paid
(from account 19).
3
Income tax expense (+E SE) .........................................................
Income taxes payable (+L) .........................................................
To adjust for income tax expense
(shown in account 20). Not yet paid.
5
Revenues (rent) (R -SE) ..................................................................
Deferred rent revenue (+L) .......................................................
To adjust for rent revenue collected but not yet earned (from
account 21).
4
(a)
(d)
(e)
(f)
1
2
11
3
5
4
Req. 2
Closing entries (from the adjusted trial balance):
1
2
Revenues (R)............................................................................................
Income Summary(+T) .......................................................................
103
Income Summary(T) .............................................................................
Expenses (E) .......................................................................................
Income tax expense (E) ..................................................................
88
Income Summary(T) .............................................................................
Retained earnings (+SE) ................................................................
15
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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103
83
5
15
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–5 (continued)
Req. 3
(a) Shares outstanding: 1,000 shares (given).
(b) Interest expense: $20,000 x 10% = $2,000. The simplifying assumption here is that the
amount of $2,000 is included with Trade payables in the unadjusted trial balance or
that it was paid during the year.
(c) Ending balance in retained earnings:
Unadjusted balance, $(3,000) + Net earnings, $15,000 = $12,000.
Net earnings calculation: $103,000 – $83,000 – $5,000 = $15,000.
(d) Average income tax rate: income tax expense, $5,000 ÷ pre-tax earnings ($103,000
revenues – $83,000 total expenses) = 25%.
(e) Rent receivable -- report on the statement of financial position as an asset.
Deferred rent revenue -- report on the statement of financial position as a liability (for
future occupancy "owed'').
(f) Net earnings of $15,000 was computed on the basis of accrual accounting concepts.
Revenue is recognized when earned and expenses recorded when incurred regardless
of the timing of the respective cash flows. Cash inflows, in addition to certain revenues,
were from numerous sources such as the issuance of shares, borrowing, and revenue
collected in advance. Similarly, cash outflows were due to numerous transactions (in
addition to certain expenses) such as the purchase of operational and other assets,
prepaid insurance, and dividends to shareholders. Note the debit balance in Retained
Earnings in the unadjusted trial balance. Because this is the first year of operations,
this probably resulted from a dividend declaration during the year.
(g) EPS: $15,000 ÷ 1,000 shares (per 1 above) = $15.00 per share.
(h) Average sale price per share: $30,000 share capital ÷ 1,000 shares = $30
(i) The Prepaid Insurance account reflected a balance of $2,000 before the adjustment and
a balance of $1,000 after the adjustment. Therefore, it appears that the policy
premium was prepaid on January 1, 2013 for two years (2013 and 2014). Other
possibilities might be for example (a) a 12-month policy purchased on July 1, 2013, or
(b) a 2-month policy purchased on Dec. 1, 2013. In any case, one-half of the unadjusted
balance of Prepaid Insurance, i.e., premium, has expired.
(j) Net profit margin: $15 net earnings ÷ $103 revenues = 0.146 (14.6%).
(k) Return on equity: $15 net earnings ÷ ($30 + $42) / 2; average SE = 0.417 (41.7%).
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–6
Req. 1
BRISSETTE STRESS REDUCTION
Statement of Earnings
For the Year Ended December 31, 2015
Items
Revenues:
Therapy fees
Expenses:
Office rent
Utilities
Telephone
Office salaries
Office supplies
Miscellaneous
Depreciation
Total expenses
Net earnings
Cash Basis
Per
Brissette’s
Statement
Explanation of Changes
$130,000 See * below.
Corrected
Basis
$ 106,000
19,500
360
2,200
23,500
Exclude rent for Jan. 2016 ($19,500 ÷ 13)
No change
Add December 2015 bill of $140
Add unpaid salary for last week in December
2015 ($24,000 ÷ 12) x ¼
900 Supplies used in 2015 ($900 + 250 – 400)
1,400 No change
$8,000 cost ÷ 10 years = $800 for 2015
47,860
$ 82,140
18,000
360
2,340
24,000
750
1,400
800
47,650
$58,350
Income taxes have been ignored.
*
Cash collected for therapy fees
Fees earned in prior years
Fees earned in 2015 but not yet collected
Fees earned in 2015
$130,000
–30,000
+ 6,000
$ 106,000
Req. 2
Net earnings (ignoring income taxes) was overstated by $23,790 because of inappropriate
recognition of revenue (overstated by $24,000) and expenses (overstated by $210). In
normal circumstances, revenue should be recognized when earned, regardless when the
cash is collected. Similarly, expenses should be matched against revenue in the period
when the services or materials were used (including depreciation expense), regardless of
when the cash outlays were actually made.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–6 (continued)
Memo
To: Potential purchaser
From: Accountant
Re: Brissette Stress Reduction
I have prepared a revised Statement of Earnings that includes adjustments of revenue and
expenses in accordance with the accrual basis of accounting. The adjustments to revenue
are to reflect revenue in the period earned rather than when the cash was collected.
Similarly the expenses are adjusted to accrue for items paid after year end and to include
items paid for in previous period (e.g. a portion of the capital assets).
In addition to reviewing this statement other items that you should consider in the pricing
decision include:
(a)
(b)
(c)
(d)
(e)
(f)
A correct statement of financial position at December 31, 2015.
Collectability of any receivables from prior years (if they are to be sold with the
business).
Any liabilities of the practice to be assumed by the purchaser.
Current employee – how will she be affected? Will she be laid off? Who will bear
the costs of any severance arrangements?
Adequacy of the rented space – is there a long-term non-cancellable lease?
Expected future cash flows of the business. Is the volume of business and the
rates expected to be stable or to increase? The decrease in receivables may be an
indication that revenue is declining.
CP4–7
Commissions revenues
Expenses:
Salaries
Rent
Depreciation
Advertising
Total pre-tax expenses
Earnings before income tax
Income tax expense (40%)
Net earnings
WONG’S INSURANCE AGENCY
Statement of Earnings
For the Three
Months Ended
March 31
$27,000
For the Nine
Months Ended
March 31
$72,000
6,000
3,750
450
6,500
16,700
10,300
4,120
$6,180
18,000
11,250
1,350
14,000
44,600
27,400
10,960
$16,440
Each item in the statement of earnings for the three-month period is determined by subtracting
the balance of that account at March 31 from its balance at December 31. For the nine-month
period, the amounts represent the balances of the accounts at March 31.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4-8
Req. 1
The balance in Advance Ticket Sales is an alternative way of labelling Deferred or Unearned
revenue. It represents the amounts that WestJet received from passengers who will use its
transportation service at a future date (after year-end). WestJet has completed a
transaction to sell its transportation service, and is reasonably certain of receiving
payment, but has not provided the service as at the date the disclosure is made.
Req. 2
WestJet is following IFRS, in particular it is recognizing revenue in the time period it has
been earned, that is when it provides the transportation service to passengers.
Req. 3
WestJet will settle this liability by providing transportation service to the passengers who
have paid in advance. At that time, it will debit the account Advance Ticket Sales and credit
a revenue account, such as Passenger Revenue. Alternatively some passengers may be
given refunds.
Req. 4
WestJet should recognize expenses as they are incurred from actual flights, not when
tickets are sold. The flights are the service for which passengers pay, not the sale of tickets.
These expenses are recognized during the same period as the related revenue is
recognized, in conformity with the matching process.
Req. 5
WestJet has probably grown and is serving more passengers in 2012 than it did in 2010.
Examination of WestJet’s revenues during the same period is likely to confirm the growth
in ticket sales over time.
Req. 6
The balance of Advance Ticket Sales reflects the amount received from passengers who
book seats in advance. I would expect this amount to continue to increase in the future.
This assumes that prices remain stable or increase and that WestJet increases its capacity
by adding more aircraft.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4-9
General observation: This question requires the student to analyze the change in the
various accounts and identify the type of transactions that caused the change.
Req. 1
Trade receivables, beg. + Sales – Collections = Trade receivables, ending
$23,390 + 276,883 – X = $24,937  X = $275,336
Req. 2
Prepayments (+A)
Insurance Expense (–E, +SE)
520
520
($818 Beginning balance + $2,345 Additional prepayments – $1,338 Ending balance
= $1,825 Expense). Since the entire payment of $2,345 was charged to the Insurance
Expense account that must now be reduced by $520 to reflect the correct charge for the
year.)
Req. 3
Accrued liabilities refer to obligations that resulted from the accrual of expenses during the
accounting period (e.g., rent, interest) but were not recorded until the end of the
accounting period. The decrease in the account balance is likely to result from payments to
suppliers of services that exceeded the additional amount of accrued expenses during the
year.
Req. 4
Dividends Payable (SE)
Cash (A)
4,801
4,801
($1,148 Beginning balance + $4,905 Dividends declared – $1,252 Ending balance)
Req. 5
The income taxes expense can be computed by analyzing the information related to the
Income Taxes Payable account:
Beginning balance + Income tax expense – Cash payment = Ending balance
$1,000 + X – $5,801 = 40  X = $4,841
Income tax expense (+E SE)
Income taxes payable (+L)
4,841
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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4,841
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4-9 (continued)
Req. 6
Interest expense (+E SE)
Interest payable (+L)
$6,000 x 0.08 x (5 months / 12)
200
200
Req. 7
a.
There is no effect on assets because the accrual of interest expense affects liabilities
(i.e., it increases Interest Payable by $200, and reduces Income Tax Payable by $80
($200 x 40%). It also reduces net earnings, retained earnings, and shareholders’ equity
by $120, representing the interest expense, net of tax.
b.
Pretax earnings would be overstated by $200, and net earnings would therefore be
overstated by $120 = $200 x (1 – 0.4)
c. Interest payable would be understated by $200, which means current liabilities would
also be understated by the same amount.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CRITICAL THINKING CASES
CP4–10
Req. 1
2014
Adjusting Entries
(a)
Maintenance expense (+E SE) ……………………………..
Inventory of maintenance supplies (A)…………….
To record supplies used ($6,000 - $1,800 = $4,200).
4,200
Other expenses (+E SE)……………………………………….
Prepaid insurance (A)……………………………………...
To record expired insurance at December 31, 2014
($4,000 x ½).
2,000
Depreciation expense (+E SE)………………………………
Accumulated depreciation (+XA A)………………..
To record depreciation for one year.
5,000
Salary expense (+E SE)………………………………………..
Salaries payable (+L)………………………………………...
To record salaries earned but not yet paid.
2,200
Transportation revenue (R -SE)…………………………...
Deferred transportation revenue (+L)……………….
To record Deferred transportation revenue
collected in advance.
7,000
Income tax expense (+E SE)…………………………………
Income tax payable (+L)…………………………………
To record 2014 income taxes; computation:
Transportation revenue: $85,000 – 7,000 = $78,000
Expenses:
($47,000 + 4,200 + 2,000
+ 5,000 + 2,200) =
60,400
Earnings before income tax
$17,600
Income tax expense: $17,600 x 30% = $ 5,280
4,380
12/31
(b)
(c)
(d)
(e)
(f)
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-89
Debit
Credit
4,200
2,000
5,000
2,200
7,000
4,380
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–10 (continued)
Req. 2
MAGLIOCHETTI MOVING CORPORATION
Corrections to 2014 Financial Statements
Amounts
Changes
Reported
Plus Minus
2014 Statement of Earnings:
Revenue:
Transportation revenue
$ 85,000 e
7,000
Expenses:
Salaries
17,000 d
2,200
Maintenance
12,000 a
4,200
Other
18,000 b
2,000
Depreciation
0 c
5,000
Income tax
0 f
5,280
Total expenses
47,000
Net earnings
$ 38,000
December 31, 2014
Statement of Financial Position
Assets:
Cash
Receivables
Inventory of maintenance supplies
Prepaid insurance
Equipment
Less: Accumulated depreciation
Other assets
Total assets
Liabilities:
Trade payables
Salaries payable
Deferred transportation revenue
Income tax payable
Total liabilities
Shareholders' Equity
Share capital
Retained earnings
Total shareholders' equity
Total liabilities and
shareholders' equity
$ 2,000
3,000
6,000
4,000
40,000
0
27,000
$82,000
$ 9,000
0
0
0
9,000
35,000
38,000
73,000
$82,000
a
b
c
d
e
f
4,200
2,000
5,000
Correct
Amounts
$ 78,000
19,200
16,200
20,000
5,000
5,280
65,680
$ 12,320
$ 2,000
3,000
1,800
2,000
40,000
(5,000)
27,000
$70,800
$ 9,000
2,200
7,000
5,280
23,480
2,200
7,000
5,280
25,680
35,000
12,320
47,320
$70,800
The decrease in Retained earnings of $25,680 is the difference between net earnings as
initially reported ($38,000) and net earnings as adjusted ($12,320).
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–10 (continued)
Req. 3
Omission of the adjusting entries caused:
(a) Net earnings to be overstated by $25,680; see requirement (2) for calculation.
(b) Total assets to be overstated by $11,200 ($82,000 – $70,800); see requirement (2).
(c) Total liabilities to be understated by $14,480 ($23,480 – $9,000); see requirement
(2).
Req. 4
(a) Earnings per share:
Unadjusted – $38,000 net earnings  10,000 shares = $3.80 per share
Adjusted – $12,320 net earnings  10,000 shares = $1.23 per share (rounded)
(b) Net profit margin:
Unadjusted – $38,000 net earnings  $85,000 sales = 44.7%
Adjusted – $12,320 net earnings  $78,000 sales = 15.8%
(c) Return on equity:
Unadjusted: $38,000 net earnings  $36,500 average shareholders’ equity = 104.1%
Adjusted: $12,320 net earnings  $23,660 average shareholders’ equity = 52.1%
See requirement (5) for a discussion of the principal causes for the differences between the
unadjusted and adjusted ratios.
Req. 5
(today’s date)
To: Magliochetti Moving Corporation:
We regret to inform you that your request for a $20,000 loan has been denied.
Our review showed that various adjustments were required to the original set of financial
statements provided to us. The original (unadjusted) financial statements overstated net
earnings for 2014 by $25,680 ($38,000 – $12,320). This overstatement was partly caused
by incorrectly including $7,000 of revenue collected in advance; recognition of this revenue
should have been deferred to 2015. Furthermore, all of the expenses were understated and
income tax expense had been excluded.
Total assets were overstated by $11,200 ($82,000 – $67,800). The inventory of
maintenance supplies was overstated by $4,200, prepaid insurance was overstated by
$2,000, and the carrying amount of the equipment was overstated by $5,000 because
annual depreciation expense was not recorded.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–10 (continued)
A review of key financial ratios indicates that the adjustments caused earnings per share,
net profit margin, and return on equity to decline. Earnings per share declined from $3.80
to $1.23, net profit margin declined from 44.7% to 15.8%, and return on equity declined
from 102.7% to 52.1%. The adjusted ratios, however, should be compared to those of
other start-up companies in the same industry in order to assess the relative profitability of
your business.
We require that there be sufficient collateral pledged against the loan before we can
consider it. The current market value of the equipment may be able to provide additional
collateral against which the loan could be secured. Your personal investments may also be
considered viable collateral if you are willing to sign an agreement pledging these assets as
collateral for the loan. This is a common requirement for small start-up businesses,
especially those with few shareholders.
If you would like us to reconsider your application, please provide us with the current
market values of any assets you would pledge as collateral.
Regards,
(your name)
Loan Application Department,
Your Bank
CP4–11
Error
(1)
(2)
(3)
(4)
(5)
(6)
(7)
Net Earnings
2013
2014
O, $950
N
O, $500
U, $500
U, $600
O, $600
U, $200
O, $200
O, $900
U, $900
U, $300
N
N
N
Assets
2013
2014
O, $950
O, $950
N
N
U, $600
N
U, $200
N
N
N
U, $300
U, $300
U, $8,000
N
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-92
Liabilities
2013
2014
N
N
U, $500
N
N
N
N
N
U, $900
N
N
N
U, $8,000
N
© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–11 (continued)
Explanations:
(1) Given in problem (example).
(2) Wage expense should be increased (debited) by $500 in 2013 because the wages were
incurred in that year. This increase in expense was not recorded; therefore, net
earnings of 2013 was overstated by $500. The wages were not paid when earned in
2013. Therefore, there is a 2013 liability of $500; thus, liabilities were understated at
the end of 2013. If not corrected, then wage expense will be overstated in 2014 when
payment is made, thus causing net earnings for 2014 to be understated.
(3) Revenues were understated by $600 in 2013, which caused 2013 net earnings to be
understated by $600. Also trade receivables were understated because the amount of
$600 will be collected in 2014; thus, assets were understated by $600 at the end of
2013. Also, if not corrected, the $600 of revenue would be recorded in 2014, which
would cause 2014 revenues, and hence net earnings, to be overstated in that year.
(4) The $200 expense should be recorded as 2014 expense. It was recorded in 2013;
therefore, 2013 expense was overstated which would cause 2013 net earnings to be
understated. If not corrected, 2014 expense would be understated, which would cause
2014 net earnings to be overstated by $200. Assets at the end of 2013 would be
understated by $200 because prepaid expense (an asset) should be debited at the end
of 2013 for this expense, since it was paid in advance.
(5) The $900 revenue should be recorded as revenue in 2014 because it was earned in
2014. Therefore, if not corrected, 2013 revenue and net earnings would be overstated
by $900. Also, 2014 revenue and net earnings would be understated by $900 because
that is the year that the $900 revenue was earned but was not recorded. At the end of
2013 liabilities would be understated by $900 because revenue collected in advance (a
liability to render future performance to earn the revenue) should be credited for $900.
(6) In 2013 a credit of $300 should have been made to revenue instead of trade
receivables. Therefore, revenue, and hence net earnings, was understated by $300 in
2013. The credit to trade receivables caused assets to be understated by $300 at the
end of both 2013 and 2014. Trade receivables, in fact, will continue to be understated
until a correction is made. Since revenue increases retained earnings, it will also be
understated by the same amount (excluding income tax effects).
(7) This transaction should have been recorded in 2013 as a debit to Land (an asset) and a
credit to Notes payable (a liability), $8,000. Therefore, at the end of 2013 both assets
and liabilities were understated by $8,000. The entry made in 2014 corrected the
accounts.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
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© 2014 McGraw-Hill Ryerson Limited. All rights reserved.
CP4–12
Strategy
Change
a.
Current
Period
ROE
+
b.
ne
c.
–
Future
Periods’
ROE
Explanation
–
The decrease in R&D investments would lead to lower
expense in the current year, increasing current period’s net
earnings and ROE. However, when fewer products are
brought to market in future periods, net earnings and ROE
will likely decrease.
+
The advertising is for a movie to be released next year – it
is be reasonable to think it would be a prepaid asset and
not an expense – therefore the current year ROE would not
be affected. Assuming that the movie earns greater net
earnings in future periods because of the advertising, net
earnings will increase, increasing ROE in future periods.
+
The issuance of additional stock increases average
shareholders’ equity and, hence, decreases ROE in the
current year. The proceeds are used only in future periods
to purchase other high-tech companies. Assuming those
companies are profitable, their purchase would then
increase net earnings and ROE in future periods.
FINANCIAL REPORTING AND ANLAYSIS TEAM PROJECT
CP4–13
The solution to this case will depend on the company and/or accounting period selected for
analysis.
Financial Accounting, 5ce, Libby, Libby, Short, Kanaan, Gowing
4-94
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