Ch04

Chapter 4

Adjustments, Financial Statements, and the

Quality of Earnings

ANSWERS TO QUESTIONS

1. A trial balance is a list of the individual accounts, usually in financial statement order, with their debit or credit balances. It is used to provide a check on the equality of the debits and credits.

2. Adjusting entries are made at the end of the accounting period to record all revenues and expenses that have not been recorded but belong in the current period. They update the balance sheet and income statement accounts at the end of the accounting period.

The four different types are adjustments for:

(1) Deferred revenues -- previously recorded liabilities that need to be adjusted at the end of the period to reflect revenues that have been earned (e.g., Unearned

Ticket Revenue must be adjusted for the portion of ticket revenues earned in the current period).

(2) 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 revenues not yet collected).

(3) Deferred expenses -- previously recorded assets that need to be adjusted at the end of the period to reflect incurred expenses (e.g., Prepaid Insurance must be adjusted for the portion of insurance expense incurred in the current period).

(4) 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 Accrued Expenses Payable for utilities expense incurred during the period that has not yet been paid).

3. A contra-asset is an account related to an asset that is an offset or reduction to the asset's balance. Accumulated Depreciation is a contra-account to the equipment and buildings accounts.

4. The net income on the income statement is included in determining ending retained earnings on the statement of stockholders’ equity and the balance sheet. The change in the cash account on the balance sheet is analyzed and categorized on the statement of cash flows into cash from operating activities, investing activities, and financing activities.

McGraw-Hill/Irwin

Financial Accounting, 5/e

© The McGraw-Hill Companies, Inc., 2007

4-1

5. (a) Income statement: (Revenues + Gains) - (Expenses + Losses) = Net Income

(b) Balance sheet: Assets = Liabilities + Stockholders' Equity

(c) Statement of cash flows: Changes in cash for the period = Cash from

Operations + Cash from Investing Activities + Cash from Financing Activities

(d) Statement of stockholders' equity: Ending Stockholders' Equity = (Beginning

Contributed Capital + Stock Issuances - Stock Repurchases) + (Beginning

Retained Earnings + Net Income - Dividends Declared)

6. Adjusting entries have no effect on cash. For unearned revenues and prepayments, cash was received or paid at some point in the past. For accruals, cash will be received or paid in a future accounting period. At the time of the adjusting entry, there is no cash being received or paid.

7. Earnings per share = Net Income ÷ weighted average number of shares of stock outstanding during the period.

Earnings per share measures the average amount of net income for the year attributable to one share of common stock.

8. Net profit margin = Net income ÷ net sales

The net profit margin measures how much of every sales dollar generated during the period is profit.

9. 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 insure that accuracy has been attained in applying the effect of the adjusting entries. The adjusted trial balance provides a second check in the model equalities (primarily

Debits = Credits). It also provides data in a form convenient for further processing.

10. Closing entries are made at the end of the accounting period to transfer the balances in the temporary income statement 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 posted to the ledger accounts to state properly the temporary and permanent account balances (i.e., zero balances in the temporary accounts).

McGraw-Hill/Irwin

4-2


Solutions Manual

11. (a) Permanent accounts -- balance sheet accounts; that is, the asset, liability, and stockholders’ equity accounts (these are not closed at the end of each period).

(b) Temporary accounts -- income statement accounts; that is, revenues, gains, expenses, and losses (these are closed at the end of each period).

(c) Real accounts -- another name for permanent accounts.

(d) Nominal accounts -- another name for temporary accounts.

12. The income statement accounts are closed at the end of the accounting period because, in effect, they are temporary subaccounts to retained earnings (i.e., a part of stockholders' equity). They are used only for accumulation during the accounting period. When the period ends, these accumulated accounts must be transferred

(closed) to retained earnings. The closing process serves:

(1) to correctly state retained earnings, and

(2) to clear out the balances of the temporary accounts for the year just ended so that these subaccounts can be used again during the next period for accumulation and classification purposes.

Balance sheet accounts are not closed at the end of the period because they reflect permanent accumulated balances of assets, liabilities, and stockholders' equity.

Permanent accounts show the entity's financial position at the end of the period and are the beginning amounts for the next period.

13. 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.

ANSWERS TO MULTIPLE CHOICE

1. b) 2. a) 3. d) 4. c) 5. d)

6. d) 7. a) 8. c) 9. d) 10. b)




4-3

Authors' Recommended Solution Time

(Time in minutes)

Mini-exercises Exercises Problems

Alternate

Problems

Cases and

Projects

No. Time No. Time No. Time No. Time No. Time

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* Due to the nature of this project, 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.

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4-4


Solutions Manual

MINI-EXERCISES

M4

–1.

Cash

Accounts receivable

Inventories

Prepaid expenses

Buildings and equipment

Puglisi Company

Adjusted Trial Balance

At June 30, 2007

Debit

$ 120

350

610

40

1,400

Accumulated depreciation

Land

Accounts payable

Accrued expenses payable

Income taxes payable

Unearned fees

Credit

200

$ 250

200

150

30

100

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

820

660

1,300

300

120

2,400

50

400

110

80

110

$ 4,900 $ 4,900

M4 –2.

(1) D; (2) B; (3) D; (4) C; (5) A; (6) C; (7) B; (8) A.

M4 –3.

(1) A; (2) B; (3) C; (4) D.




4-5

M4 –4.

(a) 1. Deferred revenue

2. Unearned rent revenue (



L) ......................... 200

Rent revenue (+R, +SE) ........................ 200

To record one month of rent revenue earned ($800



4 months).

(b) 1. Deferred expense

2. Insurance expense (+E,



SE).......................

Prepaid insurance (



A) ..........................

900

900

To record six months of insurance expense ($3,600 x 6/24).

(c) 1. Deferred expense

2. Depreciation expense (+E,



SE) .................. 3,000

Accumulated depreciation (+XA,



A) ..... 3,000

To record annual depreciation expense.

M4

–5.

Transaction a. b. c.

Assets

NE

–900

–3,000

Balance Sheet

Liabilities

–200

NE

NE

Stockholders’

Equity

+200

–900

–3,000

Revenues

+200

NE

NE

Income Statement

Expenses

NE

+900

Net

Income

+200

–900

+3,000 –3,000


4-6


Solutions Manual

M4 –6.

(a) 1. Accrued expense

2. Utilities expense (+E,



SE) ........................... 320

Accrued utilities payable (+L) ................

To record utilities expense incurred but not yet paid.

(b) 1. Accrued expense

320

2. Wages expense (+E,



SE) ........................... 4,500

Accrued wages payable (+L) ................. 4,500

To record wages expense incurred but not yet paid,

calculated as 10 employees x 3 days x $150 each per day.

(c) 1. Accrued revenue

200

2. Interest receivable (+A) ................................

Interest revenue (+R, +SE) ....................

To record interest earned but not yet collected,

calculated as $5,000 x 12% x 4/12.

M4 –7.

Transaction a. b.

Assets

NE

NE

Balance Sheet

Stockholders’

Liabilities

+320

+4,500

Equity

–320

–4,500

Revenues

NE

NE

200

Income Statement

Net

Expenses Income

+320

–320

+4,500

–4,500 c. +200 NE +200 +200 NE +200




4-7

M4 –8.

MORGAN COMPANY

Income Statement

For the Year Ended December 31, 2007

Revenues:

Sales revenue

Interest revenue

Rent revenue

Total revenues

$ 42,000

120

300

42,420

Costs and expenses:

Wages expense


21,600

2,000

Utilities expense

Insurance expense

Rent expense

Total costs and expenses

220

600

9,000

Pretax income

Income tax expense

Net Income

33,420

9,000

2,900

$ 6,100

Earnings per share*

* calculated as $6,100



[(100 + 500)



2] = $6,100



300 = $20.33

$20.33

Average number of shares

M4 –9.

MORGAN COMPANY

Statement of Stockholders’ Equity


Balance, January 1, 2007

Share issuance

Net income

Dividends

Contributed

Capital

$ 400 $ 1,000*

2,000

Retained

Earnings

6,100

0

Total

Stockholders’

Equity

$ 1,400

2,000

6,100

0

Balance, December 31, 2007 $ 2,400 $ 7,100 $ 9,500

* From the trial balance.

Work backwards


4-8


Solutions Manual

M4 –10.

Req. 1

MORGAN COMPANY

Balance Sheet

Assets

Current Assets:

Cash

Accounts receivable

Interest receivable

Prepaid insurance

Notes receivable

At December 31, 2007

Total current assets

Equipment (net of accumulated depreciation, $2,000)

Total Assets

Liabilities

Current Liabilities:

Accounts payable



Unearned rent revenue

Total current liabilities

Stockholders’ Equity

Contributed Capital

Retained Earnings

Total Stockholders’ Equity

Total Liabilities and Stockholders’ Equity

Req. 2

The adjustments in M4 –4 and M4–6 have no effect on the operating, investing, and financing activities on the statement of cash flows because no cash is paid or received at the time of the adjusting entries.

$ 1,500

2,000

120

1,800

5,420

3,000

10,000

$ 18,420

$ 1,600

3,820

2,900

600

8,920

2,400

7,100

9,500

$ 18,420




4-9

M4 –11.

Revenues:

Sales revenue

Interest revenue

Rent revenue

Total revenues

Costs and expenses:

Wages expense


Utilities expense

$ 42,000

120

300

42,420

21,600

2,000

220

Insurance expense

Rent expense

600

9,000

2,900 Income tax expense

Net Income

Total costs and expenses 36,320

$ 6,100

Net profit margin = Net income



Operating Revenues = $6,100



$42,300 = 14.4%

The operating revenue sources for this company are from sales and rent revenue.

Interest revenue is not included in the denominator because it is a nonoperating revenue source.

M4

–12.

Sales revenue (



R) ................................................

Interest revenue (



R) .............................................

Rent revenue (



R) ..................................................

Retained earnings (+SE) ..............................

Wages expense (



E) ...................................

Depreciation expense (



E) ..........................

Utilities expense (



E) ...................................

Insurance expense (



E) ..............................

Rent expense (



E) ......................................

Income tax expense (



E) ............................

42,000

120

300

6,100

21,600

2,000

220

600

9,000

2,900


4-10


Solutions Manual

EXERCISES

E4 –1.

Darius Consultants, Inc.

Unadjusted Trial Balance

At September 30, 2008

Cash

Accounts receivable

Supplies

Prepaid expenses

Investments

Building and equipment


Land

Accounts payable


Unearned consulting fees


Notes payable

Contributed capital

Retained earnings *

Consulting fees revenue

Investment income

Wages and benefits expense

Utilities expense

Travel expense

Rent expense

Professional development expense

Interest expense

Other operating expenses

General and administrative expenses

Gain on sale of land

Totals

Debit Credit

$ 163,000

225,400

12,200

10,200

145,000

323,040

$ 18,100

60,000

86,830

25,650

32,500

2,030

160,000

223,370

145,510

2,564,200

10,800

1,590,000

25,230

23,990

152,080

18,600

17,200

188,000

320,050

5,000

$3,273,990 $3,273,990

* Since debits are supposed to equal credits in a trial balance, the balance in Retained

Earnings is determined as the amount in the credit column necessary to make debits equal credits (a “plugged” figure).




4-11

E4 –2.

Req. 1

The following deferred revenues and deferred expenses may need to be adjusted at the end of the recent fiscal year:

Balance sheet account

Inventory

Other current assets (may include

Related income statement account

Cost of products supplies and prepaid expenses such as insurance)

Various expense accounts (e.g., supplies expense, insurance expense, rent expense)

Property, plant, and equipment and



Intangible assets (depending on type) Amortization expense

Deferred revenue Product revenue or service revenue

Req. 2

The following accounts should be reviewed and may need to be adjusted to accrue revenues and expenses at the end of the recent fiscal year:

Balance sheet account Related income statement account

Other current assets (Interest receivable on the short-term investments) Investment income

Accounts receivable Product revenue or service revenue

Interest revenue Other assets (may contain long-term receivables)

Accrued liabilities (Interest payable on short-term note payable0 Interest expense

Accrued liabilities Various expense accounts (e.g., wages expense)

Income tax payable

Req. 3

Income tax expense

Temporary accounts that accumulate during the period are closed at the end of the year to the permanent account Retained Earnings. These include: Product revenue, service revenue, interest revenue, cost of products, cost of services, interest expense, research and development expense, selling, general, and administrative expense, other expenses, loss on investments, and income tax expense.


4-12


Solutions Manual

E4 –3.

Req. 1

The annual reporting period for this company is January 1 through December 31, 2008.

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, 2008:

Wage expense (+E,



SE) ...........................................

Wages payable (+L) ........................................

6,000

6,000

To record wages earned by employees during 2008, but not yet paid by the company. This entry records the (a) 2008 expense, and (b) 2008 liability, which is necessary to conform to accrual accounting and the matching principle.

( b ) December 31, 2008:

Interest receivable (+A) ..............................................

Interest revenue (+R, +SE) ..............................

3,000

3,000

To record interest revenue earned during 2008, but not yet collected. This entry records the (a) 2008 revenue, and (b) 2008 receivable, which is necessary to

Req. 3 conform to accrual accounting and the revenue principle.

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 measured properly. The entries above are accruals; entry (a) is an accrued expense

(incurred but not yet recorded) and entry (b) is an accrued revenue (earned but not yet recorded). In applying the accrual basis of accounting, revenues should be recognized when earned and measurable and expenses should be recognized when incurred in generating revenues.




4-13

E4 –4.

Req. 1

2007 Income statement:

Insurance expense ($7,800 x 4/24) = $1,300 used.

Shipping supplies expense: ($14,000 + $72,000 - $11,000) = $75,000 used.

Req. 2

2007 Balance sheet:

Prepaid insurance ($7,800 x 20/24) = $6,500 or $7,800 - $1,300 = $6,500

Shipping supplies (given) = $11,000

Req. 3

Adjusting entry (payment debited to Prepaid Insurance):

Prepaid Insurance Insurance Expense

9/1 7,800

AJE 1,300 AJE 1,300

End. 6,500 End. 1,300

Insurance expense (+E,



SE).....................................

Prepaid insurance (



A) ....................................

1,300

To record the expiration of insurance for four months ($325 per month).

Req. 4

Adjusting entry (payment debited to Shipping Supplies):

Shipping Supplies Shipping Supplies Expense

Beg. 14,000

Purch. 72,000 AJE 75,000

End. 11,000

AJE 75,000

End. 75,000

Shipping supplies expense (+E,

Shipping supplies (





SE) ........................

A) .....................................

To record the use of shipping supplies for the year.

75,000

1,300

75,000


4-14


Solutions Manual

E4 –5.

Balance Sheet

Transaction Assets Liabilities

E4

–3 (a)

NE +6,000

E4

–3 (b)

+3,000 NE

E4

–4 (a) –1,300

E4 –4 (b) –75,000

NE

NE

Stockholders’

Equity

–6,000

+3,000

–1,300

–75,000

E4

–6.

Req. 1 and 2

Income Statement

Revenues

Net

Expenses Income

+6,000

–6,000

NE

+3,000

NE

NE +3,000

+1,300

–1,300

NE +75,000 –75,000 a. Deferred expense -- cash paid before expense is incurred.

Office supplies expense (+E,



SE) ..............................

Office supplies (



A) ...........................................

Supplies used in 2007 ($350 + 800 - 300 = $850). b. Accrued expense -- expense incurred before cash is paid.

Wages expense (+E,



SE) ..........................................

Wages payable (+L) ..........................................

Amount is given. c. Deferred revenue -- cash received before revenue is earned.

Unearned rent revenue (



L) ........................................

Rent revenue (+R, +SE) ....................................

Rent earned in 2007 ($9,000 x 2/6). d. Accrued revenue -- revenue earned before cash is collected.

Rent receivable (+A) ....................................................

Rent revenue (+R, +SE) ....................................

($820 x 2 months) e. Deferred expense -- cash paid for equipment before being used.

Depreciation expense (+E,



SE) .................................

Accumulated depreciation, delivery equipment (+XA,



A)

Amount is given. f. Deferred expense -- cash paid before expense is incurred.




SE) .....................................

Prepaid insurance (



A) ......................................

($4,200 x 6/24 months) g. Accrued revenue -- revenue earned before cash is received.

Repair accounts receivable (+A) .................................

Repair shop revenue (+R, +SE) ........................

Amount is given.




4-15

850

850

3,700

3,000

3,700

3,000

1,640

1,640

5,000

1,050

5,000

1,050

750

750

E4 –7.

Req. 1 and 2 a. Accrued revenue -- revenue earned before cash is collected.

Accounts receivable (+A) ............................................

Service revenue (+R, +SE) ................................

Amount is given. b. Deferred revenue -- cash received before revenue is earned.

Unearned storage revenue (



L) ..................................

Storage revenue (+R, +SE) ...............................

Storage revenue earned in fiscal year 2006 ($2,400 x 1/6) c. Accrued expense -- expense incurred before cash is paid.

Wages expense (+E,



SE) ..........................................

Wages payable (+L) ..........................................

Amount is given. d. Deferred expense -- cash paid before expense is incurred.

Advertising expense (+E,



SE)....................................

Prepaid advertising (



A) ....................................

Advertising used in fiscal year 2006 ($600 x 9/12). e. Deferred expense -- cash paid for equipment before being used.




SE) .................................

Accumulated depreciation, equipment (+XA,



A)

Amount is given. f. Deferred expense -- cash paid before expense is incurred.

Supplies expense (+E,



SE) .......................................

Supplies (



A) .....................................................

Supplies used in 2006 ($15,600 + $47,500 - $12,200) g. Accrued expense -- expense incurred before cash is paid.

Interest expense (+E,



SE) ........................................

Interest payable (+L) .........................................

Interest incurred from October 1 to November 30, 2006

($150,000 principal x .10 x 2/12)

2,100

2,100

400

2,900

400

450

2,900

23,000

450

23,000

50,900

50,900

2,500

2,500


4-16


Solutions Manual

E4 –8.

Transaction

(a)

(b)

(c)

(d)

(e)

(f)

(g)

E4 –10.

(a)

(b)

(c)

(d)

(e)

(f)

(g)

E4 –9.

Transaction

Assets

–850

NE

NE

+1,640

–5,000

–1,050

+750

Assets

+2,100

NE

NE

–450

–23,000

–50,900

NE c. d. e. f. a. b.

Code

N

A

K

O

C

Q g. h. i.

P

L

K

Balance Sheet

Stockholders’

Liabilities

NE

+3,700

–3,000

Equity

–850

–3,700

NE

NE

NE

NE

+3,000

+1,640

–5,000

–1,050

+750

Balance Sheet

Stockholders’

Liabilities Equity

NE

–400

+2,900

NE

NE

NE

+2,500

+2,100

+400

–2,900

–450

–23,000

–50,900

–2,500

Debit

Amount

$400

800

900

1,000

600

250

220

62,000

420

Code

G

I

A

E

L

B

H

K

P

Income Statement

Revenues

NE

NE

+3,000

+1,640

NE

NE

+750

Expenses Income

+850

–850

+3,700

–3,700

NE +3,000

NE +1,640

+5,000 –5,000

+1,050 –1,050

NE +750

Income Statement

Revenues

+2,100

+400

NE

NE

NE

NE

NE

Expenses

Credit

Amount

$400

800

900

1,000

600

250

220

62,000

420

Net

Net

Income

NE +2,100

NE +400

+2,900 –2,900

+450 –450

+23,000 –23,000

+50,900 –50,900

+2,500 –2,500




4-17

E4 –11.

Selected Balance Sheet Amounts at December 31, 2007

Assets:

Equipment (recorded at cost per cost principle)

Accumulated depreciation (for one year, as given)

Carrying value of equipment (difference)

$12,000

(1,200)

10,800

Office supplies (on hand, as given) 400

Prepaid insurance (remaining coverage, $400 x 18/24 months) 300

Selected Income Statement Amounts for the Year Ended December 31, 2007

Expenses:

Depreciation expense (for one year, as given) $ 1,200

Office supplies expense (used, $1,400 - $400 on hand)

Insurance expense (for 6 months, $400 x 6/24 months)

E4 –12.

1,000

100

Date Assets

Balance Sheet

Stockholders’

Liabilities Equity


Revenues Expenses

Net

Income

Note 1:

April 1, 2008

+20,000/

–20,000

NE NE NE NE NE

December 31, 2008 a + 1,500

March 31, 2009 b

+22,000/

–21,500

Note 2:

August 1, 2008

NE

NE

+ 20,000 + 20,000

December 31, 2008 c NE + 1,000

+ 1,500

+ 500

NE

- 1,000

+ 1,500

+500

NE

NE

NE

NE

NE

+ 1,000

+ 1,500

+ 500

NE

- 1,000

January 31, 2009 d - 21,200 - 21,000 - 200 NE + 200 - 200

(a) $20,000 principal x .10 annual interest rate x 9/12 of a year = $1,500

(b) Additional interest revenue in 2009: $20,000 x .10 x 3/12 = $500. Cash received was $22,000 ($20,000 principal + $2,000 interest for 12 months); receivables decreased by the $20,000 note receivable and $1,500 interest receivable accrued in 2008.

(c) $20,000 principal x .12 annual interest rate x 5/12 of a year = $1,000

(d) Additional interest expense in 2009: $20,000 x .12 x 1/12 = $200. Cash paid was $21,200 ($20,000 principal + $1,200 interest for 6 months); payables decreased by the $20,000 note payable and $1,000 interest payable accrued in

2008.


4-18


Solutions Manual

E4 –13.

Req. 1 (a) Cash paid on accrued income taxes payable.

(b) Accrual of additional income tax expense.

(c) Cash paid on dividends payable.

(d) Amount of dividends declared for the period.

(e) Cash paid on accrued interest payable.

(f) Accrual of additional interest expense.

Req. 2 Computations:

(a)

Beg. Bal. + accrued income taxes - cash paid = End. bal.

$71 + 332 - ? = $80

? = $323 paid

(c)

Beg. Bal. +

(f)

$43 + dividends declared - cash paid = End. bal.

176 - ?

?

=

=

$48

$171 paid

Beg. Bal. + accrued interest expense - cash paid = End. bal.

$45 + ?

?

- 297 = $51

= $303 accrued




4-19

E4 –14.

Req. 1 Adjusting entries that were or should have been made at December 31:

(a) Should have been made.




SE) ................................ 12,000

Accumulated depreciation - equipment (+XA,



A) 12,000

Amount is given.

(b) Should have been made.

Unearned revenue (



L) .............................................. 2,000

2,000 Fee revenue (+R, +SE) ....................................

Amount is given.

(c) Entry already made.




SE) .......................................

Interest payable (+L) .......................................

($15,000 x 12% x 12/12 months)

1,800

1,800

Should have been made.




SE) ........................................ 300

Interest payable (+L) ........................................ 300

($15,000 x 12% x 2/12 months)

(d) Should have been made.




SE)..................................... 600

Prepaid insurance (



A) .................................... 600

Amount is given.

(e) Should have been made.

Rent receivable (+A) ................................................... 850

Rent revenue (+R, +SE) ..................................

Amount is given.

850

Req. 2

Income Statement

Transaction Assets

Balance Sheet

Stockholders’

Liabilities Equity Revenues Expenses

Net

Income

(a)

(b)

(c)

(d)

(e)

O 12,000

NE

NE

O 600

U 850

NE

O 2,000

O 1,500

NE

NE

O 12,000

U 2,000

U 1,500

O 600

U 850

NE

U 2,000

NE

NE

U 850

U 12,000 O 12,000

NE U 2,000

O 1,500 U 1,500

U 600

NE

O 600

U 850


4-20


Solutions Manual

E4 –15.

Items

Balances reported

Effects of: a.

Depreciation b. Wages c.

Rent revenue

Adjusted balances d.

Effect of

income taxes

Correct balances

Net Total

15,600 71,000

(4,680)

Total

Income Assets Liabilities

$40,000 $80,000 $30,000

(9,000) (9,000)

(17,000)

1,600

17,000

(1,600)

45,400

4,680

$ 10,920 $71,000 $50,080

Stockholders’

Equity

$50,000

(9,000)

(17,000)

1,600

25,600

$20,920

(4,680)

Computations: a . Given, $9,000 depreciation expense. b.

Given, $17,000 accrued and unpaid. c . $4,800 x 1/3 = $1,600 rent revenue earned. The remaining $3,200 in unearned revenue is a liability for two months of occupancy "owed'' to the renter. d.

$15,600 income before taxes x 30% = $4,680.




4-21

E4 –16.

Req. 1 a. Expenses (depreciation) (+E,



SE) ............




A) ... b. Rent receivable (+A) ...................................

Revenues (rent) (+R, +SE) .................. c. Income tax expense (+E,



SE) ...................

5,000

2,000

6,900

5,000

2,000

Income taxes payable (+L) ..................

Req. 2

Income statement:

Revenues

Expenses

Income tax expense

6,900

As

Effects of

Adjusting

Entries Prepared

$98,000 b

(72,000) a c

$2,000

Corrected

Amounts

$100,000

(5,000) (77,000)

(6,900) (6,900)

Net income $26,000 (9,900) $16,100

Balance Sheet:

Assets

Cash

Accounts receivable

Rent receivable

Equipment


Liabilities

Accounts payable


Stockholders' Equity

Contributed capital

Retained earnings

$20,000

22,000 b

50,000

(10,000) a

$82,000

$10,000 c

40,000

32,000

$82,000

2,000

(5,000)

(3,000)

6,900

(9,900)

(3,000)

$20,000

22,000

2,000

50,000

(15,000)

$79,000

$10,000

6,900

40,000

22,100

$79,000


4-22


Solutions Manual

E4 –17.

Req. 1 a. Salaries and wages expense (+E,



SE) ................

Salaries and wages payable (+L) ................... b. Utilities expense (+E,



SE) ....................................

Accrued expenses payable (+L) ..................... c. Depreciation expense (+E,



SE) ...........................




A) ............. d. Interest expense (+E,



SE) ...................................

Interest payable (+L) ......................................

($20,000 x .10 x 3/12) e. No adjustment is needed because the revenue will not be earned until January (next year). f. Maintenance expense (+E,



SE) ...........................

Maintenance supplies (



A) ............................. g. Income tax expense (+E,



SE) ..............................

Income tax payable (+L) .................................

310

400

23,000

500

1,000

7,000

310

400

23,000

500

1,000

7,000




4-23

E4 –17. (continued)

Req. 2

DEREK, INC.



Rental revenue

Expenses:

Salaries and wages ($28,500 + $310) $28,810

Maintenance expense ($12,000 + $1,000) 13,000

Rent expense 9,000

$114,000

Utilities expense ($4,000 + $400)

Gas and oil expense


Interest expense ($20,000 x 10% x 3/12)

Miscellaneous expenses

4,400

3,000

23,000

500

1,000

Total expenses

Pretax income

Income tax expense

Net income

82,710

31,290

7,000

$ 24,290

Earnings per share: $24,290 ÷ 7,000 shares $3.47

Req. 3




Net Sales = $24,290



$114,000 = 21.3%

The net profit margin indicates that, for every $1 of rental revenues, Derek earns

$0.213 (21.3%) in net income. This ratio is higher than the industry average net profit margin of 18%, implying that Derek is more profitable and better able to manage its business (in terms of sales price or costs) than the average company in the industry.


4-24


Solutions Manual

E4 –18.

Req. 1

(a) Insurance expense (+E,



SE) ....................................

Prepaid insurance (



A) ....................................

(b) Depreciation expense (+E,



SE) ................................

Accumulated depreciation, machinery (+XA,



A)

(c) Wages expense (+E,



SE) .........................................

Wages payable (+L) ........................................

(d) Income tax expense (+E,



SE) ...................................

Income tax payable (+L) ..................................

Req. 2

SENECA COMPANY

Trial Balance

December 31, 2007

(in thousands of dollars)

5

7

5

9

5

7

5

9

Unadjusted Adjustments Adjusted

Debit Credit Debit Credit Debit Credit

Cash

Accounts receivable

Prepaid insurance

38

9

6 a 5

38

9

1

Machinery


Accounts payable

Wages payable


Contributed capital

Retained earnings

Revenues (not detailed)

Expenses (not detailed)

80

4

32

9

76

84 b c d

7

5

9

80

4

58 a 5 b 7 c 5 d 9

9

76

84

7

9

5

Totals 169 169 26 26 190 190




4-25

E4 –19.

SENECA COMPANY





Expenses ($32 + 5 + 7 + 5)

Pretax income

Income tax expense

Net income

EPS ($26 ,000 ÷ 4,000 shares)

$84

49

35

9

$26

$6.50

Stock issuance

Net income

Dividends declared

SENECA COMPANY

Statement of Stockholders' Equity



Contributed Retained

Total

Stockholders'

Beginning balances, 1/1/2007

Capital

$ 0

76

Earnings

$ 0

26

(4) *

Equity

$ 0

76

26

(4)

Ending balances, 12/31/2007 $ 76 $ 22 $ 98

* The amount of dividends declared can be inferred because the unadjusted trial balance amount for retained earnings is a negative $4. Since this is the first year of operations, we can assume the entire amount is due to a dividend declaration.

SENECA COMPANY

Balance Sheet

Assets



Liabilities

Current Assets:

Cash

Accounts receivable

Prepaid insurance ($6 - $5)

$ 38

9

1

Current Liabilities:

Accounts payable

Wages payable


$ 9

5


Machinery


48 Total current liabilities

80 Stockholders' Equity

(7) Contributed capital

Retained earnings

9

23

76

22

Total assets $121

Total liabilities and

stockholders' equity $121


4-26


Solutions Manual

E4 –20.

Req. 1

The purpose of “closing the books” at the end of the accounting period is to transfer the balance in the temporary accounts to a permanent account (Retained Earnings). This also creates a zero balance in each of the temporary accounts for accumulation of activities in the next accounting period.

Req. 2

Revenues (



R) ...........................................................

Expenses ($32 + $5 + $7 + $5 + $9) (



E) ........

Retained earnings (+SE) .................................

84

58

26

Req. 3

SENECA COMPANY

Post-closing Trial Balance

December 31, 2007


Cash

Accounts receivable

Prepaid insurance

Debit

38

9

1

Credit

Machinery


Accounts payable

Wages payable


Contributed capital

Retained earnings


Expenses (not detailed)

80

0

7

9

5

9

76

22

0

Totals 128 128




4-27

PROBLEMS

P4 –1.

Req. 1

Dell Computer Corporation

Adjusted Trial Balance

At January 31, 2006

(in millions of dollars)

Cash

Marketable securities

Accounts receivable

Inventories

Property, plant, and equipment


Other assets

Accounts payable


Long-term debt

Other liabilities

Contributed capital

Retained earnings (deficit)

Sales revenue

Cost of sales

Selling, general, and administrative expenses

Research and development expense

Other expenses

Income tax expense

Totals

Debit Credit

$ 520

2,661

2,094

273

775

806

$ 252

2,397

1,298

512

349

1,781

844

14,137

1,788

272

38

624

18,243

$ 24,832 $ 24,832

Req. 2

Since debits are supposed to equal credits in a trial balance, the balance in Retained

Earnings is determined as the amount in the debit column necessary to make debits equal credits (a “plugged” figure).

P4 –2.

Req. 1 a. Deferred revenue b. Accrued expense c. Accrued revenue d. Accrued expense e. Deferred expense f. Deferred expense g. Deferred revenue h. Accrued expense


4-28


Solutions Manual

P4 –2. (continued)

Req. 2 a. Unearned rent revenue (



L)......................................... 4,800

Rent revenue (+R, +SE) .................................... 4,800

$7,2 00 ÷ 6 months = $1,200 per month x 4 months. This entry reduces (debits) the liability for the amount earned and records a revenue. b. Wage expense (+E,



SE) ............................................

Wages payable (+L) ..........................................

14,300

14,300

Wage expense is increased (debited) because this expense was incurred in

2007. A liability (wages payable) is credited because this amount is owed to the employees. c. Accounts receivable (+A) .............................................


2,000

2,000

This entry records an asset for the amount due from customers and recognizes the revenue because it was earned in 2007. d. Interest expense (+E,



SE) .......................................... 600

Interest payable (+L) ............................................

To accrue interest expense incurred but not paid,

600

$20,000 x 12% x 3/12 = $600. e. Insurance expense (+E,



SE) ...................................... 1,000

Prepaid insurance (



A) .....................................

$6,0 00 ÷ 12 months = $500 per month x 2 months of coverage. This entry

1,000 reduces the asset (prepaid insurance) because part of it has been used and only $5,000 represents future benefits (an asset) to the company. f. Depreciation expense (+E,



SE) ..................................

Accumulated depreciation, service truck (+XA,



A)

1,500

1,500

To record depreciation expense to recognize the use of the truck during the year. Amount is given. g. Unearned service revenue (



L) ....................................

Service revenue (+R, +SE)..................................

400

400

To recognize revenue earned during the year ($2,400 x 2/12). h. Property tax expense (+E,



SE) ...................................

Property tax payable (+L) .....................................

To record expense incurred but not paid.

400

400




4-29

P4 –3.

Req. 1 a. Deferred expense b. Deferred expense c. Accrued expense d. Accrued expense

Req. 2 e. f.

Accrued revenue

Deferred expense g. Accrued expense h. Accrued expense a. Insurance expense (+E,



SE) ......................................

Prepaid insurance (



A) .....................................

200

$1,200 ÷ 36 months x 6 months of coverage. This entry reduces the asset

(prepaid insurance) because part of it has been used and only $1,000

200 represents future benefits (an asset) to the company. b. Supplies expense (+E,



SE) ........................................

Supplies (



A) ..................................................... c. Repairs and maintenance expense (+E,



SE) .............

700

Supplies inventory is decreased (credited) to record the use of supplies during the year because this expense was incurred in 2008, calculated as

Beg. Inventory of $200 + Purchases $800 – Ending Inventory $300.

800

700

Accrued expenses payable (+L) ........................ 800

Repairs and maintenance expense is increased (debited) because this expense was incurred in 2008. A liability (accrued expenses payable) is credited because this amount is owed but will not be paid until 2009. d. Property tax expense (+E,



SE) ...................................

Property tax payable (+L) .....................................

1,600

Property tax expense is increased (debited) because this expense was

1,600 incurred in 2008. A liability (property tax payable) is credited because this amount is owed but will not be paid until 2009. e. Accounts receivable (+A) ............................................. 8,000

8,000 Service revenue (+R, +SE) ................................

This entry records an asset for the amount due from the customer and recognizes the revenue because it was earned in 2008. f. Depreciation expense (+E,



SE) ..................................

Accumulated depreciation, van (+XA,



A)

1,100

1,100

To record depreciation expense to recognize the use of the van during the year. Amount is given.


4-30


Solutions Manual

P4 –3. (continued) g. Interest expense (+E,



SE) ..........................................

Interest payable (+L) ............................................


$10,000 x 12% x 3/12 = $300.

300

300 h. Income tax expense (+E,



SE) .....................................

Income tax payable (+L) .......................................

To accrue income tax expense incurred but not paid:

Income before adjustments (given) $30,000

Effect of adjustments (a) through (g)

Income before income taxes

9,990

9,990

+3,300 (-200 - 700 - 800 -1,600

33,300 +8,000 -1,100 -300)

Income tax rate

Income tax expense

x 30%

$ 9,990

P4

–4.

Req. 1 a. b. c.

Deferred revenue

Accrued expense

Accrued revenue e. Deferred expense f. Deferred expense g. Deferred revenue h. Accrued expense d. Accrued expense

Req. 2

Transaction a. b.

Assets

NE

–4,800

NE

Balance Sheet

Stockholders’

Liabilities

+14,300

Equity

+4,800

–14,300

Income Statement

Revenues

+4,800

NE

Expenses

NE

+14,300

Net

Income

+4,800

–14,300 c. d. e. f. g. h.

+2,000

NE

–1,000

–1,500

NE

NE

NE

+600

NE

NE

–400

+400

+2,000

–600

–1,000

–1,500

+400

–400

+2,000

NE

NE

+600

NE +1,000

NE +1,500

+400

NE

NE

+400

+2,000

–600

–1,000

–1,500

+400

–400




4-31

P4 –5.

Req. 1 a. b. c.

Deferred expense

Deferred expense

Accrued expense d. Accrued expense

Req. 2

Transaction a. b. c. d.

Assets



200



700

NE

NE

Balance Sheet

Stockholders’

Liabilities

NE

NE

+ 800

+ 1,600

Equity



200



700



800



1,600 e. f. g. h.

+ 8,000



1,100

NE

NE

NE

NE

+ 300

+ 9,990 e. Accrued revenue f. Deferred expense g. Accrued expense h. Accrued expense

+ 8,000



1,100



300



9,990

Income Statement

Revenues

NE

Expenses

+ 200

Net

Income



200

– 700 NE + 700

NE + 800



800

NE + 1,600 

1,600

+ 8,000 NE + 8,000

NE + 1,100 

1,100

NE + 300 

300

NE + 9,990 

9,990

Computations: a. Six months of expired insurance during 2008: $1,200 x 6/36 = $200. b. Supplies used during 2008: Beg. inventory, $200 + Purchases, $800 - Ending inventory, $300 = $700 used for the period. c. Expense incurred during 2008 to be paid during January 2009. d. Property taxes incurred in 2008 to be paid in 2009. e. Accrued revenue: earned in 2008 but not yet collected or recorded; payable within

30 days. f. Depreciation is given. g. Interest expense accrued for 3 months: $10,000 x 12% x 3/12 = $300. h. Adjusted income = $30,000 - 200 - 700 - 800 -1,600 + 8,000 -1,100 - 300 =

$33,300 x 30% tax rate = $9,990 income tax expense.


4-32


Solutions Manual

P4 –6.

Account

1. Rent revenue

2. Salary expense

3. Maintenance supplies expense

4. Rent receivable

5. Receivables from employees

6. Maintenance supplies

7. Unearned rent revenue

8. Salaries payable

2007

Balance

Financial

Statement

Effect on

Cash Flows

$528,000 Income statement + $512,000

65,000 Income statement



62,000

9,300 Income statement

16,000

1,500

1,700

12,000

3,000

(1)

Rent revenue

(2)

Salary expense

512,000 (a) (e) 62,000

16,000 (b) (f) 3,000

528,000 65,000

Balance sheet

Balance sheet

Balance sheet

Balance sheet

Balance sheet

(3) Maintenance supplies expense

Used 9,300

9,300

No effect

No effect



1,500



8,000

+12,000



4,000

(4)

Rent receivable

(b) 16,000

16,000

(7) Unearned rent revenue

(g)

(5) Receivables from employees

1,500

1,500

(8)

Salaries payable

12,000 (c) (d) 4,000 4,000 Bal.

3,000 (f)

12,000 3,000

(h)

(i)

(6) Maintenance supplies

3,000

8,000 9,300 used

(j) 1,700

Inferred

Cash

(a) from renters 512,000 4,000 (d) to employees

(c) from renters 12,000 62,000 (e) to employees

1,500 (g) to employees

8,000 (i) to suppliers




4-33

P4 –7.

Req. 1

December 31, 2006 Adjusting Entries

(1) Accounts receivable (+A) .........................................

Service revenue (+R, +SE) ...........................

To record service fees earned, but not collected.

(2) Insurance expense (+E, 

SE) .................................

Prepaid insurance (



A) .................................

To record insurance expired as an expense.

(3) Depreciation expense (+E, 

SE) ..............................




A)

To record depreciation expense.

(4) Income tax expense (+E, 

SE) ...............................

400

200

8,500

4,700

Income taxes payable (+L) ...........................

To record income taxes for 2006.

Req. 2

Revenues:

Service revenue

Expenses:

Salary expense

4,700

Amounts before

Adjusting Entries

$46,000

Amounts after


$46,400

41,700 41,700

(f)


Insurance expense

Income tax expense

Total expense

Net income (loss)

41,700

$ 4,300

200

8,500

(

(

(

(

( c m

8,500

200

4,700

55,100

$ (8,700) l b

400 (i) k

)

)

)

)

(e)

)

Net loss is $8,700 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 income of $4,300 was not correct because expenses of $13,400 and revenues of $400 were excluded that should have been recorded in 2006.

Req. 3

Earnings (loss) per share = $(8,700) net loss



3,000 shares = $(2.90) per share


4-34


Solutions Manual


Req. 4




Net Sales = $(8,700) net loss



$46,400 = (18.8)%

The net profit margin indicates that, for every $1 of service revenues, Wagonblatt actually lost $0.188 of net income. This ratio implies that Wagonblatt destroys shareholder value in generating its sales and suggests that better management of its business (in terms of sales price or costs) is required.

Req. 5

Service revenue (



R) ...............................................

Retained earnings (



SE) .........................................

Salary expense (



E) .........................................




E) ...............................

Insurance expense (



E) ...................................




E) .................................

Req. 6

Wagonblatt Company


46,400

8,700

41,700

8,500

200

4,700

December 31, 2006

Debit Credit

Cash 9,000

Accounts receivable 400

Prepaid insurance

Equipment

Accumulated depreciation, equipment

400

120,200

40,000


Contributed capital

Retained earnings

Service revenue

Salary expense


Insurance expense

Income tax expense

Totals

0

0

0

0

130,000

4,700

80,000

5,300

0

130,000




4-35

P4 –8.

Req. 1

December 31, 2007 Adjusting Entries:

( a ) Supplies expense (+E,



SE) ......................................

Supplies (



A) ..................................................

( b ) Insurance expense (+E,



SE) ....................................

Prepaid insurance (



A) ...................................

( c ) Depreciation expense (+E,



SE) ...............................

Accumulated depreciation, service trucks (+XA,



A) ..............................................

( d ) Wages expense (+E,



SE) .........................................

Wages payable (+L) .......................................

( e ) Income tax expense (+E,



SE) ..................................

Income taxes payable (+L) .............................

Req. 2

ST. DENIS, INC.



500

500

900

4,000

7,350

Service revenue $77,000

Expenses:

Supplies expense ($800 - $300)

Insurance expense ($1,000 - $500)


Wages expense

Remaining expenses (not detailed)

Total expenses

Pretax income

Income tax expense

Net income

Earnings per share ($22,050 ÷ 5,000 shares)

500

500

4,000

900

41,700

47,600

29,400

7,350

$22,050

$4.41

500

500

4,000

900

7,350


4-36


Solutions Manual



Service trucks

Accumulated depreciation,

service trucks

Other assets (not detailed)

Total assets

Assets

Current Assets:

Cash

Accounts receivable

Supplies

Prepaid insurance

ST. DENIS, INC.

Balance Sheet


$60,000

13,000

300

Liabilities


Accounts payable

Wages payable


$ 3,000

900

7,350

500 Total current liabilities 11,250

73,800 Note payable, long term 20,000

31,250 20,000 Total liabilities

(16,000)

Stockholders' Equity

11,200 Contributed capital

Retained earnings*

Total stockholders' equity

$89,000

Total liabilities and stockholders' equity

28,200

29,550

57,750

$89,000

*Unadjusted balance, $7,500 + Net income, $22,050 = Ending balance, $29,550.

Req. 3

December 31, 2007 Closing Entry:

Service revenue (



R) .................................................. 77,000

Retained earnings (+SE) ................................

Supplies expense (



E) ....................................

Insurance expense (



E) ..................................




E) .............................

Wages expense (



E) ......................................

Remaining expenses (not detailed) (



E) ..........




E) ................................

22,050

500

500

4,000

900

41,700

7,350




4-37

P4 –9.

Req. 1, 2, 3, and 5 T-accounts (in thousands)

Accounts

Cash Receivable Supplies

Bal. 3 b 9 Bal. 5 f 24 Bal. 12 l 16 a 10 e 70 c 40 i 18 c 120 g 10 d 3 h 13 f 24 k 17

Bal. 41 Bal. 21 Bal. 14

Land b 9

Bal. 9

Equipment

Bal. 60

Bal. 60

Accumulated

Depreciation

Bal. 6 m 6

Bal. 12

Other Assets

Bal. 4 g 10

Bal. 14

Accounts Payable h 13 Bal. 5 e i

15

18

Bal. 25

Notes Payable a 10

Bal. 10

Wages Payable o 12

Bal. 12

Interest Payable n 1

Bal. 1

Income Taxes

Payable p 8

Bal. 8

Contributed

Capital

Retained

Earnings

Service

Revenue

Bal. 65 k 17 Bal. 8 d 3 CE 32 CE 160 c 160

Bal. 68 Bal. 23 Bal. 0

Depreciation

Expense

Income Tax

Expense

Interest

Expense m 6 CE 6 p 8 CE 8 n* 1 CE 1


* $10,000 x .12 x 10/12

Supplies

Expense l 16 CE 16

Bal. 0

Wages

Expense

Remaining

Expenses o 12 CE 12 e 85 CE 85

Bal. 0 Bal. 0


4-38


Solutions Manual


Req. 2 a. Cash (+A) .......................................................... 10,000

Notes payable (+L) .................................. 10,000

Borrowed cash on 12% note, March 1, 2008. b. Land (+A) ...........................................................

Cash (



A) ................................................

9,000

9,000

Purchased land for future building site. c. Cash (+A) .......................................................... 120,000

Accounts receivable (+A)................................... 40,000

Service revenue (+R, +SE) ......................

Service revenues earned during 2008. d. Cash (+A) .......................................................... 3,000

160,000

Contributed capital (+SE) ........................

Sold capital stock for cash. e. Remaining expenses (+E,



SE) ........................ 85,000

3,000

Accounts payable (+L) .............................

Cash (



A) ................................................

Remaining expenses incurred during 2008.

15,000

70,000 f. Cash (+A) .......................................................... 24,000

Accounts receivable (



A) ......................... 24,000

Collected on customers' accounts. g. Other assets (+A) .............................................. 10,000

Cash (



A) ................................................ 10,000

Purchased additional assets.

Paid creditors. h. Accounts payable (



L) ....................................... 13,000

Cash (



A) ................................................ 13,000 i. Supplies (+A) ..................................................... 18,000


Purchased supplies for future use.

18,000 j. No entry required; no revenue earned in 2008.

Declared and paid a cash dividend. k. Retained earnings (



SE) ................................... 17,000

Cash (



A) ................................................ 17,000




4-39


Req. 3 l. Supplies expense (+E,



SE).............................. 16,000

Supplies (



A) ............................................ 16,000

To record supplies used ($30 - 14). m. Depreciation expense (+E,



SE) .......................




A) ........

6,000

6,000

To record depreciation as given. n. Interest expense (+E,



SE) ...............................

Interest payable (+L) ................................

To accrue interest for March - December, 2008,

1,000

($10,000 x 12% x 10/12). o. Wages expense (+E,



SE) ................................ 12,000 p.

Wages payable (+L) .................................

To accrue wages incurred but not paid.

Income tax expense (+E,



SE) ..........................

Income taxes payable (+L) .......................

To accrue income tax.

1,000

8,000

12,000

8,000

Req. 4

H & H TOOL, INC.



Revenues:

Service revenue

Expenses:


Interest expense

$160,000

6,000

1,000

Supplies expense

Wages expenses

Remaining expenses

Pretax income

Income tax expense

Net income

Earnings per share

[$32,000 ÷ 68,000]

16,000

12,000

85,000

40,000

8,000

$32,000

$0.47


4-40


Solutions Manual





Contributed

Capital

Retained

Earnings


Additional stock issuance

Net income

Dividends declared

Balance, December 31, 2008

$65,000

3,000

$68,000

$ 8,000

32,000

(17,000)

$23,000


Assets:

Current Assets:

Cash

Accounts receivable

Supplies


Land

Equipment

Balance Sheet


$ 41,000

21,000

14,000

Liabilities:


Accounts payable

Interest payable

Wages payable

76,000 Income taxes payable

9,000 Total current liabilities

60,000 Notes payable

Less: Accumulated deprec. (12,000) Total liabilities

Other assets 14,000 Stockholders' Equity:

Contributed capital

Retained earnings

Total stockholders'

equity

Total assets $147,000

Total liabilities and stockholders' equity

Total

Stockholders'

Equity

$73,000

3,000

32,000

(17,000)

$91,000

$ 25,000

1,000

12,000

8,000

46,000

10,000

56,000

68,000

23,000

91,000

$147,000




4-41



Statement of Cash Flows


Cash from Operating Activities:

Cash collected from customers ( c + f )

Cash paid to suppliers and employees ( e + h )

Cash provided by operations

Cash from Investing Activities:

Purchase of land ( b )

Purchase of other assets ( g )

Cash used for investing activities

Cash from Financing Activities:

Borrowing from bank ( a )

Issuance of stock ( d )

Payment of dividends ( k )

Cash used for financing activities

Change in cash

Beginning cash balance, January 1, 2008

Ending cash balance, December 31, 2008

$144,000

(83,000)

61,000

(9,000)

(10,000)

(19,000)

10,000

3,000

(17,000)

(4,000)

38,000

3,000

$ 41,000

Req. 5

December 31, 2008 Closing Entry

1 Service revenue (



R) ......................................... 160,000

32,000 Retained earnings (+SE) .........................




E) ......................

Interest expense (



E) ..............................

Supplies expense (



E) ............................

Wages expense (



E) ...............................

Remaining expenses (



E) .......................




E) .........................

6,000

1,000

16,000

12,000

85,000

8,000

To close revenues and expenses (temporary accounts).


4-42


Solutions Manual


Req. 6

Post-closing trial balance:


Cash

Accounts receivable

Supplies

Land

Equipment

Post-Closing Trial Balance


Accumulated depreciation (equipment)


Accounts payable

Wages payable

Interest payable


Notes payable

Contributed capital (68,000 shares)

Retained earnings

Service revenue

Debit Credit

$ 41,000

21,000

14,000

9,000

60,000

14,000

$ 12,000

25,000

12,000

1,000

8,000

10,000

68,000

23,000

0


Income tax expense

Interest expense

Supplies expense

Wages expense


0

0

0

0

0

0

Total $159,000 $159,000




4-43


Req. 7

(a) Financial leverage = Average total assets

 Average stockholders’ equity

= [($78,000+$147,000)



2]



[($73,000+$91,000)



2]

= $112,500



$82,000

= 1.37

This suggests that H & H Tool, Inc., finances its assets primarily with stockholders’ equity. Approximately one-third of the assets are financed with debt and the rest with stockholders’ equity.

(b) Total asset turnover = Sales



Average total assets

= $160,000



$112,500

= 1.42

This suggests that H & H Tool, Inc., generates $1.42 for every dollar of assets.

(c) Net profit margin = Net income



Sales

= $32,000



$160,000

= 0.20 or 20%

This suggests that H & H Tool, Inc., earns $0.20 for every dollar in sales that it generates.

For all of the ratios, a comparison across time and a comparison against an industry average or competitors will need to be analyzed to determine how risky

(financial leverage ratio), how efficient (total asset turnover) and how effective

(net profit margin) H & H Tool’s management is.


4-44


Solutions Manual

ALTERNATE PROBLEMS

AP4 –1.

Cash

Short-term investments

Accounts receivable

Inventories

Prepaid expenses

Other current assets

Long-term investments



Other long-lived assets

Accounts payable

Accrued liabilities

Short-term bank debt

Long-term liabilities

Contributed capital

Retained earnings

Net revenues

Interest income

Cost of sales

Store operating expenses

Other operating expenses


General and admin. expenses

Interest expense

Income tax expense

Starbucks Corporation

Adjusted Trial Balance

At September 30, 2006

(in millions)

Debit Credit

$ 66

51

48

181

19

21

68

1,081

38

$ 321

56

131

64

40

741

544

51

647

212

1,680

9

98

90

1

62

Totals $ 3,160 $ 3,160

Req. 2

Since debits are supposed to equal credits in a trial balance, the balance in Retained

Earnings is determined as the amount in the credit column necessary to make debits equal credits (a “plugged” figure).




4-45

AP4 –2.

Req. 1 a. Deferred expense b. Accrued expense c. Deferred revenue d. Deferred expense e. f.

Deferred revenue

Accrued expense g. Accrued expense h. Accrued revenue

Req. 2 a. Insurance expense (+E,



SE) ......................................

Prepaid insurance (



A) .....................................

1,600


1,600

(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) ..........................................

900

900

Wage expense is increased (debited) because this expense was incurred by

June 30, 2007. A liability (wages payable) is credited because this amount is owed to the employees. c. Unearned maintenance revenue (



L) .......................... 225

Maintenance revenue (+R, +SE) .......................

$450 ÷ 2 months x 1 month. This entry reduces (debits) the liability for the amount earned and records a revenue. d. Depreciation expense (+E,



SE) .................................

Accumulated depreciation, service truck (+XA,



A)

3,000

225

3,000

Depreciation is given. e. Unearned service revenue (



L) ................................... 700

Service revenue (+R, +SE) ................................. 700

To recognize revenue earned during the year, $4,200 ÷ 12 months x 2 months. f. Interest expense (+E,



SE).......................................... 600

600 Interest payable (+L) ............................................


$16,000 x 9% ÷ 12 months x 5 months = $600. g. Property tax expense (+E,



SE) ..................................

Property tax payable (+L) ....................................

To record expense incurred but not paid. h. Accounts receivable (+A) .............................................


500

2,000

500

2,000

This entry records an asset for the amount due from customers and recognizes the revenue because it was earned by June 30, 2007.


4-46


Solutions Manual

AP4

–3.

Req. 1 a. Deferred expense b. Accrued revenue c. Accrued expense d. Deferred expense

Req. 2 e. f.

Deferred expense

Deferred expense g. Accrued revenue h. Accrued expense a. Supplies expense (+E,



SE) ........................................

Supplies (



A) .....................................................

1,150

1,150

Supplies is decreased (credited) to record the use of supplies during the year because this expense was incurred in 2008, calculated as

Beg. Inventory of $350 + Purchases $1,200

– Ending Inventory $400. b. Accounts receivable (+A) .............................................

Catering revenue (+R, +SE) ..............................

7,500

7,500

This entry records an asset for the amount due from customers and recognizes the revenue because it was earned in 2008. c. Repairs and maintenance expense (+E,



SE) ............. 600

Accrued expenses payable (+L) ........................ 600

Repairs and maintenance expense is increased (debited) because this expense was incurred in 2008. A liability (accrued expenses payable) is credited because this amount is owed but will not be paid until 2009. d. Insurance expense (+E,



SE) ......................................

Prepaid insurance (



A) .....................................

200


200

(prepaid insurance) because part of it has been used while $1,000 represents future benefits (an asset) to the company. e. Rent expense (+E,



SE)............................................... 700

Prepaid rent (



A) ..................................................

$2,100 ÷ 3 months x 1 month of coverage. 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. f. Depreciation expense (+E,



SE) ..................................

Accumulated depreciation, display counters (+XA,



A)

1,600

700

1,600

Depreciation is given.




4-47

AP4 –3. (continued) g. Interest receivable (+A) ................................................

Interest income (+R, +SE) ....................................

To accrue interest income earned but not yet received,

$4,000 x 12% x 2/12 = $80. h. Income tax expense (+E,



SE) .....................................

Income tax payable (+L) .......................................

To accrue income tax expense incurred but not paid:

Income before adjustments (given)

Effect of adjustments (a) through (g)

Income before income taxes

$22,400

80

7,719

80

7,719

+3,330 (-1,150 +7,500 -600

25,730 -200 -700 -1,600 +80)

AP4 –4.

Income tax rate

Income tax expense

x 30%

$ 7,719

Req. 1 a. b. c.

Deferred expense

Accrued expense

Deferred revenue e. Deferred revenue f. Accrued expense g. Accrued expense h. Accrued revenue d. Deferred expense

Req. 2

Balance Sheet

Stockholders’

Transaction a. b. c. d. e. f. g.

Assets

–1,600

NE

NE

–3,000

NE

NE

NE

Liabilities

NE

+900

–225

NE

–700

+600

+500

Equity

–1,600

–900

+225

–3,000

+700

–600

–500

Income Statement

Revenues Expenses

Net

Income

NE +1,600

–1,600

NE +900

–900

+225

+700

NE

NE

NE

NE

+600

+500

+225

NE +3,000 –3,000

+700

–600

–500 h. +2,000 NE +2,000 +2,000 NE +2,000


4-48


Solutions Manual

AP4 –5.

Req. 1 a. b. c.

Deferred expense

Accrued revenue

Accrued expense e. Deferred expense f. Deferred expense g. Accrued revenue h. Accrued expense d. Deferred expense

Req. 2

Transaction a.

Assets

–1,150

Balance Sheet

Stockholders’

Liabilities

NE

Equity

–1,150

Income Statement

Revenues

NE

Expenses

Net

Income

+1,150 –1,150 b. c. d. e. f. g. h.

+7,500

NE

–200

–700

–1,600

+80

NE

NE

+600

NE

NE

NE

NE

+7,719

+7,500

–600

–200

–700

–1,600

+80

–7,719

+7,500

NE

NE

NE

NE

+80

NE

NE

+600

+200

+700

+7,719

+7,500

–600

–200

–700

+1,600 –1,600

NE +80

–7,719

Computations: a. Supplies used during 2008: Beg. Inventory of $350 + Purchases $1,200 – Ending

Inventory $400 = $1,150 used for the period. b. Accrued revenue: earned in 2008 but not yet collected or recorded; payable within

30 days. c. Expense incurred during 2008 to be paid during January 2009. d. Two months of expired insurance during 2008: $1,200 x 2/12 = $200. e. One month of expired rent during 2008: $2,100 x 1/3 = $700. f. Depreciation is given. g. Interest expense accrued for 2 months: $4,000 x 12% x 2/12 = $80. h. Adjusted income = $22,400 - 1,150 + 7,500 - 600 -200 - 700 - 1,600 + 80 =

$25,730 x 30% tax rate = $7,719 income tax expense.




4-49

AP4 –6.

Req. 1

December 31, 2006 Adjusting Entries

(1) Accounts receivable (+A) ........................................ 1,500


To record service fees earned, but not collected.

(2) Rent expense (+E, 

SE) .........................................

Prepaid rent (



A)............................................

To record rent expired as an expense.

400

(3) Depreciation expense (+E, 

SE) .............................




A)

To record depreciation expense.

(4) Deferred revenue ( 

L) .............................................

17,500

8,000

400

(

(

(

(

( b g l m c

)

)

1,500 ( j )

)

)

)

17,500 ( e )


To record service fees earned.

(5) Income tax expense (+E, 

SE) ...............................

Income taxes payable (+L) ...........................

To record income taxes for 2006.

Req. 2

Amounts before

6,500

8,000

6,500

Amounts after

(

(

( n j f

)

)

)

Revenues:

Service revenue

Expenses:

Salary expense


Rent expense

Income tax expense


$83,000

54,000

Total expense

Net income

54,000

$ 29,000


$92,500

78,400

$ 14,100

54,000

17,500

400

6,500

Net income 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 income of $29,000 was not correct because expenses of $24,400 and revenues of $9,500 were excluded that should have been recorded in 2006.


4-50


Solutions Manual

AP4 –6. (continued)

Req. 3

Earnings per share = $14,100 net income



5,000 shares = $2.82 per share

Req. 4




Net Sales = $14,100



$92,500 = 15.2%

The net profit margin indicates that, for every $1 of service revenues, Abraham made

$0.152 (15.2%) of net income. This ratio suggests that Abraham is generally profitable.

Req. 5

92,500 Service revenue (



R) ...............................................

Retained earnings (+SE) ..................................

Salary expense (



E) .........................................




E) ...............................

Rent expense (



E) ...........................................




E) .................................

14,100

54,000

17,500

400

6,500

Req. 6

Abraham Company


December 31, 2006

Cash

Accounts receivable

Prepaid rent


Debit

18,000

1,500

800

210,000



Deferred revenue

Contributed capital

Retained earnings

Service revenue

Salary expense


Rent expense

Income tax expense

0

0

0

0

Credit

70,000

6,500

8,000

110,000

35,800

0

Totals 230,300 230,300




4-51

AP4 –7.

Req. 1

December 31, 2007 Adjusting Entries:

( a ) Depreciation expense (+E,



SE) ...............................




A)

( b ) Insurance expense (+E,



SE) ....................................

Prepaid insurance (



A) ...................................

( c ) Wages expense (+E,



SE) .........................................

3,000

450

Wages payable (+L) .......................................

( d ) Supplies expense (+E,



SE) ......................................

Supplies (



A) ..................................................

( e ) Income tax expense (+E,



SE) ..................................

Income tax payable (+L) .................................

Req. 2

AUSTIN CO.



1,100

700

2,950

Service revenue $48,000

Expenses:

Supplies expense ($1,300 balance - $600 on hand)

Insurance expense


Wages expense


Total expenses

Pretax income

Income tax expense

Net income

Earnings per share ($6,900 ÷ 4,000 shares)

700

450

3,000

1,100

32,900

38,150

9,850

2,950

$6,900

$1.73

3,000

450

1,100

700

2,950


4-52


Solutions Manual


Assets

Current Assets:

Cash

Accounts receivable

Supplies

Prepaid insurance


Equipment



AUSTIN CO.

Balance Sheet


Liabilities


$19,600 Accounts payable

7,000

600

Wages payable

Income tax payable

450 Total current liabilities

27,650 Note payable, long term

27,000 Total liabilities

(15,000) Stockholders' Equity

5,100 Contributed capital

Retained earnings*


$44,750

Total liabilities and stockholders' equity Total assets $44,750

*Unadjusted balance, $10,300 + Net income, $6,900 = Ending balance, $17,200.

Req. 3

December 31, 2007 Closing Entry:

Service revenue (



R) .................................................. 48,000

Retained earnings (+SE) ................................

Supplies expense (



E) ....................................

Insurance expense (



E) ..................................




E) .............................

Wages expense (



E) ......................................

Remaining expenses (not detailed) (



E) ..........




E) ................................

6,900

700

450

3,000

1,100

32,900

2,950

$ 2,500

1,100

2,950

6,550

5,000

11,550

16,000

17,200

33,200




4-53

AP4 –8.

Req. 1, 2, 3, and 5 T-accounts (in thousands)

Cash

Accounts

Receivable Supplies

Bal. 5 b 18 Bal. 4 g 8 Bal. 2 l 8 a 20 e 28 d 9 i 10 c 5 f 3 d 56 h 11 g 8 k 10 j 3


Small Tools

Bal. 6 l 1 f 3

Bal. 8 b

Equipment

18

Bal. 18

Accumulated

Depreciation m 2

Bal. 2

Other Assets

Bal. 9

Bal. 9

Accounts Payable h 11 Bal. 7 e 7 i 10

Bal. 13

Notes Payable a 20

Bal. 20

Wages Payable o 3

Bal. 3

Interest Payable n 1

Bal. 1

Income Taxes

Payable p 4

Bal. 4

Unearned Revenue Contributed Capital Retained Earnings j 3

Bal. 3

Bal. 15 c 5

Bal. 20 k 10 Bal. 4

CE 11

Bal. 5

Service Revenue Income Tax Expense Interest Expense

CE 65 d 65 p 4

CE 4 n 1

CE 1


Depreciation Expense Wages Expense Remaining Expenses m 2

CE 2 o 3

CE 3 e 35 l 9

CE 44



4-54


Solutions Manual


Req. 2 a. Cash (+A) .......................................................... 20,000

Notes payable (+L) ..................................

Borrowed cash on 10% note, July 1, 2008.

20,000 b. Equipment (+A) ................................................. 18,000

Cash (



A) ................................................ 18,000

Purchased equipment, July 1, 2008 c. Cash (+A) .......................................................... 5,000

Contributed capital (+SE) ........................ 5,000

Sold capital stock for cash. d. Cash (+A) .......................................................... 56,000

Accounts receivable (+A)................................... 9,000

Service revenue (+R, +SE) ...................... 65,000

Service revenues earned during 2008. e. Remaining expenses (+E,



SE) ........................ 35,000


Cash (



A) ................................................

Remaining expenses incurred during 2008.

7,000

28,000 f. Small tools (+A) ................................................. 3,000

Cash (



A) ................................................ 3,000

Purchased additional small tools.

Collected on customers' accounts. g. Cash (+A) .......................................................... 8,000




A) ......................... 8,000 h. Accounts payable (



L) ....................................... 11,000

Cash (



A) ............................................... 11,000

Paid on accounts payable to suppliers. i. Supplies (+A) ..................................................... 10,000

Accounts payable (+L) ............................. 10,000

Purchased supplies for future use. j. Cash (+A) .......................................................... 3,000

Unearned revenue (+L) .......................... 3,000

Deposit received for revenue not yet earned.




4-55

AP4 –8. (continued) k. Retained earnings (



SE) ................................... 10,000

Cash (



A) ................................................ 10,000

Declared and paid a cash dividend.

Req. 3 l. Remaining expenses (+E,



SE) ........................ 9,000

Supplies (



A) ............................................ 8,000

Small tools (



A) ........................................

To record supplies used ($12

– 4) and small tools used ($9

– 8).

1,000 m. Depreciation expense (+E,



SE) ....................... 2,000




A) ........ 2,000

To record depreciation as given. n. Interest expense (+E,



SE) ............................... 1,000

Interest payable (+L) ................................

To accrue interest for July - December, 2008,

1,000

($20,000 x 10% x 6/12). o. Wages expense (+E,



SE) ................................ 3,000

Wages payable (+L) ................................. 3,000

To accrue wages incurred but not paid. p. Income tax expense (+E,



SE) .......................... 4,000

Income taxes payable (+L) .......................

To accrue income tax.

4,000


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Solutions Manual


Req. 4

NEW AGAIN FURNITURE, INC.



Revenues:

Service revenue

Expenses:


Interest expense

Wages expense

Remaining expenses

Pretax income

Income tax expense

Net income

$65 000

2,000

1,000

3,000

44,000

15,000

4,000

$11,000

Earnings per share

[$11,000 ÷ [(15,000+20,000) 

2]

$0.63




Contributed

Capital

Retained

Earnings


Additional stock issuance

Net income

Dividends declared

Balance, December 31, 2008

$15,000

5,000

$ 4,000

11,000

(10,000)

$20,000 $ 5,000

Total

Stockholders'

Equity

$19,000

5,000

11,000

(10,000)

$25,000




4-57



Assets:

Current Assets:

Cash

Accounts receivable

Supplies

Small tools

Balance Sheet


Liabilities:


$27,000 Accounts payable

5,000

4,000

8,000

Notes payable

Wages payable

Interest payable

$13,000

20,000

3,000

1,000

Total current assets 44,000

Equipment 18,000

Less: Accum. depr.

Other assets

(2,000)

9,000


Unearned revenue


Stockholders' Equity:

Contributed capital

Retained earnings

4,000

3,000

44,000

20,000

5,000

Total stockholders' equity 25,000

Total assets $69,000

Total liabilities and stockholders' equity $69,000


Statement of Cash Flows

For the Period Ended December 31, 2008

Cash from Operating Activities:

Cash collected from customers ( d + g + j )

Cash paid to suppliers and employees ( e + h )

Cash provided by operations

Cash from Investing Activities:

Purchase of equipment ( b )

Purchase of small tools ( f )

Cash used in investing activities

Cash from Financing Activities:

Borrowing from bank ( a )

Issuance of stock ( c )

Payment of dividends ( k )

Cash provided by financing activities

Change in cash

Beginning cash balance, January 1, 2008

Ending cash balance, December 31, 2008

$ 67,000

(39,000)

28,000

(18,000)

(3,000)

(21,000)

20,000

5,000

(10,000)

15,000

22,000

5,000

$ 27,000


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Solutions Manual


Req. 5

December 31, 2008 Closing Entry

Service revenue (



R) ......................................... 65,000

11,000

2,000

Retained earnings (+SE) .........................




E) ......................

Interest expense (



E) ..............................

Wages expense (



E) ...............................

Remaining expenses (



E) .......................




E) .........................

To close revenues and expenses.

1,000

3,000

44,000

4,000

Req. 6


Account Titles

Cash

Accounts receivable

Supplies

Small tools

Equipment



Accounts payable

Notes payable

Wages payable

Interest payable

Post-Closing Trial Balance


Debit Credit

$27,000

5,000

4,000

8,000

18,000

$ 2,000

9,000

13,000

20,000

3,000

1,000


Unearned revenue

Contributed capital (20,000 shares)

Retained earnings

Service revenue


Wages expense

Income tax expense

Interest expense


0

0

0

0

0

4,000

3,000

20,000

5,000

0

Totals $71,000 $71,000




4-59


Req. 7

(a) Financial leverage = Average total assets

 Average stockholders’ equity

= [($26,000+$69,000)



2]



[($19,000+$25,000)



2]

= $47,500



$22,000

= 2.16

This result suggests that New Again Furniture, Inc., finances its assets more with debt than stockholders’ equity. The company borrowed $1.16 and utilized $1 of stockholder s’ equity to acquire every dollar of assets.

(b) Total asset turnover = Sales



Average total assets

= $65,000



$47,500

= 1.37

This suggests that New Again Furniture, Inc., generates $1.37 for every dollar of assets.

(c) Net profit margin = Net income



Sales

= $11,000



$65,000

= 0.17 or 17%

This suggests that New Again Furniture, Inc., earns $0.17 for every dollar in sales that it generates.

For all of the ratios, a comparison across time and a comparison against an industry average or competitors will need to be analyzed to determine how risky

(financial leverage ratio), how efficient (total asset turnover) and how effective

(net profit margin) New Again Furniture’s management is.


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Solutions Manual

CASES AND PROJECTS

FINANCIAL REPORTING AND ANALYSIS CASES

CP4 –1.

1. At the end the 2004 fiscal year, Prepaid Expenses were $19,943 thousand. Of that amount, $12,476 thousand was prepaid rent. This information is disclosed on the balance sheet.

2. The company reported $26,826 thousand for unearned (deferred) revenue. This information is disclosed on the balance sheet.

3. Prepaid rent represents rent that Pacific Sunwear of California has paid in advance to its landlords. It is an asset. Pacific Sunwear also rents property to tenants.

Deferred rent represents rent that it has collected in advance for which PacSun has an obligation to allow a tenant to use PacSun’s property.

4. Accrued Liabilities would consist of costs that have been incurred by the end of the accounting period but which have not yet been paid.

5. The company owed $6,647 thousand in currently payable sales taxes at the end of the 2004 fiscal year. This information is disclosed in Note 5 regarding accrued liabilities.

6. Interest Income is related to the company’s short-term investments.

7.

The company’s income statement accounts (revenues, expense, gains, and losses) would not have balances on a post-closing trial balance. These accounts are temporary accounts that have been closed to Retained Earnings.

8. 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.

9. The company reported basic earnings per share of $1.41 for fiscal year 2004, $1.05 for 2003, and $0.67 for 2002.




4-61

CP4 –1. (continued)

10. Fiscal year (dollars in thousands)

2002: Net Profit Margin = Net Income = $49,666 = 0.059

Sales 847,150


Sales 1,041,456


Sales 1,229,762

Over the past three years, the company’s net profit margin has increased. Pacific

Sunwear of California is becoming progressively more profitable each year.

Management appears to be controlling costs, generating greater sales, or both.

CP4

–2.

1. American Eagle paid $121,138 thousand in income taxes in its 2004 fiscal year, as disclosed in note 2 under “Supplemental Disclosures of Cash Flow Information.”

2. The quarter ended January 29, 2005, was its best quarter in terms of sales at

$674,024,000 (this quarter covered Christmas, the biggest part of the year for retailers). The worst quarter ended May 1, 2004 (the quarter following Christmas), and most likely this is because most people have very little money to spend on extra clothing in that period. Note 15 discloses quarterly information.

3. Other income (net) is an aggregate of many accounts, but a summary entry for them all would be:

Other income (net) ...................

Retained Earnings ..........

4,129

4,129


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Solutions Manual


4. As disclosed in Note 4, Accounts and Note Receivable consists of (in thousands):

Fabric

Construction allowances

2,871

6,801

Sell-offs to non-related parties

Taxes

Distribution services

6,657

2,584

2,015

Sale of Bluenotes

Other

Total

2,707

2,797

$26,432

5. Fiscal year (dollars are in thousands)

5. 2002: Net Profit Margin = Net Income = $88,108 = 0.064

Sales 1,382,923


Sales 1,435,436


Sales 1,881,241

Over the past three years, the company’s net profit margin at first decreased and then the most recen t year’s profit margin was almost double that during the 2002 fiscal year. In 2004, management appears to be controlling costs, generating greater sales, or both.




4-63

CP4 –3.

1. American Eagle Outfitters reported an advertising expense of $41.4 million for fiscal

2004 (Note 2 under Advertising Costs). Pacific Sunwear of California reported

$11.4 million of advertising costs during fiscal 2004. (See Note 1 under Advertising

Costs).

2.

Fiscal

Year

2004

American Eagle Outfitters

Advertising

Expense /

Net Sales

41,400 / 1,881,241 2.2%

Pacific Sunwear of California

Advertising

Expense /

Net Sales

11,400 / 1,229,762 .9%

2003

2002

44,800 / 1,435,436

44,400 /1,382,923

3.1%

3.2%

10,400 / 1,041,456

8,900 / 847,150

1.0%

1.1%

American Eagle Outfitters incurred the higher percentage for fiscal year 2004. Both firms had a steadily declining balance of advertising costs as a percentage of net sales.

3. Industry

Average

American Eagle

Outfitters

Pacific Sunwear of

California

Advertising/Sales = 3.03% 2.2% .9%

Both American Eagle Outfitters and Pacific Sunwear of California are spending less on advertising as a percentage of sales than the average company in their industry.

This might imply that they are more effective, as they are generating more sales per dollar spent on advertising. Another interpretation is that they are not supporting their brand, and sales will eventually decline as their brands lose value.

4. Both accounting policies are similar indicating that advertising costs are expensed when the marketing campaigns become publicly available. American Eagle allocates advertising costs for television campaigns over the life of the campaign.

PacSun expenses its television costs when the advertising becomes publicly available. (The policies ar e disclosed in note 1 of Pacific Sunwear of California’s annual report, and note 2 of American Eagle’s annual report).


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Solutions Manual


5.

American Eagle

Outfitters

Pacific Sunwear of

California

2002: Net Profit = Net Income $88,108 = 0.064 $49,666 = 0.059

Margin Sales 1,382,923 $847,150


Margin Sales 1,435,436 $1,041,456


Margin Sales 1,881,241 $1,229,762

Both companies show an increase in their profit margins over the 2002-2004 time period. Pacific Sunwear of California shows steadily increasing profit margins over time; whereas American Eagle showed a dip in its profit margin in 2003. With the exception of 2003, American Eagle has been able to attain a greater profit margin than that for Pacific Sunwear of California, suggesting a better overall performance.

6. Industry

Average

4.52%

American Eagle

Outfitters

11.3%

Pacific Sunwear of

California

8.7% Net Profit Margin =

Both companies, American Eagle Outfitters and Pacific Sunwear of California have higher Net Profit Margins than the average company in their industry. This is likely due to the strategy that these two companies have pursued, which is to differentiate their clothing in terms of style and quality and appeal to a particular niche market, therefore being able to charge a higher price.




4-65

CP4 –4

Req. 1

The author suggests that the root cause of acc ounting scandals is “a widespread obsession with earnings that drives companies to push accounting standards to the limit and, in extreme cases, to engage in outright fraud.” This causes managers to make decisions to meet short-term earnings expectations, often at the expense of long-term shareholder value.

Req. 2

The uncertainties that the author believes are problems in current financial reporting are related to the subjective assumptions about the future (accruals)

– revenue recognition and expense matching. Examples include uncertainties as to how much revenue a company will generate from current-period expenditures for research and development, employee training, brand building, or additions to production capacity. There is also subjectivity in matching expenses with revenues. Examples include the various depreciation methods available to managers and expensing research and development.

According to the author, these uncertainties about the future combined with historical information produce financial statements, and net income in particular, that do not tell users what they need to know to make investing and lending decisions.


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Solutions Manual

CP4 –5.

Req. 1

Account

Cash

Maintenance supplies

Service equipment

Accumulated depreciation,

service equipment

Remaining assets

Note payable, 8%

Interest payable


Wages payable

Unearned revenue

Contributed capital

Retained earnings

Service revenue

Expenses

Unadjusted

Trial Balance

Debit Credit

Adjusted

Trial Balance

Debit Credit

Post-Closing

Trial Balance

Debit Credit

20,000

500

90,000

18,000

20,000

200

90,000

27,000

20,000

200

90,000

27,000

42,500

10,000

42,500

10,000

42,500

10,000

56,000

9,000

800

13,020

500

6,000

56,000

9,000

800

13,020

500

6,000

56,000

39,380

160,000

220,000

183,620

214,000

0

0

313,000 313,000 336,320 336,320 152,700 152,700

Ending Retained Earnings = Beg., $9,000 + Net income, ($214,000 - 183,620)

Req. 2

( a ) To record the amount of supplies used during 2007, $300, and to reduce the supplies account to the amount remaining on hand at the end of 2007.

( b ) To accrue interest expense for 2007 (the interest is payable in 2008, computed as $10,000 x 8% = $800) and to record interest payable.

( c ) To reduce service revenue for cash collected in advance of being earned and to record the liability for those services yet to be performed, $6,000.

( d ) To record depreciation expense for 2007, $9,000.

( e ) To record 2007 wages of $500 that will be paid in 2008.

( f ) To record 2007 income tax and the related liability, $13,020.




4-67


Req. 3

Closing Entry on December 31, 2007:

Service revenue (from the adjusted trial balance) (



R) ......... 214,000

Retained earnings (+SE) ............................................

Expenses (from the adjusted trial balance) (



E) ........

Req. 4

Pretax income x Average income tax rate = Income tax expense

($214,000 - 170,600) x

$43,400 x

? = $13,020

? = $13,020

? = 30%

Req. 5

Number of shares issued x

8,000 x

Average issue price = Total issue amount

? = $56,000

? = $7.00 per share

30,380

183,620


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Solutions Manual

CP4 –6.

Transaction (a):

1. This transaction will affect Shirley’s financial statements for 10 years (from 2006 to

2015) in conformity with the matching principle.

2. Income statement:

Depreciation expense, as given $1,400 each year

3. Balance sheet at December 31, 2008:

Assets:

Office equipment

Less: Accumulated depreciation*

Carrying (book) value

$14,000

4,200

$ 9,800

*$1,400 x 3 years = $4,200.

4. An adjusting entry each year over the life of the asset would be recorded to reflect

the allocation of the cost of the asset when used to generate revenues:




SE) 1,400




A) 1,400

Transaction (b):

1. This transaction will affect Shirley ’s financial statements for 2 years--2008 and

2009-because four month’s rent revenue was earned in 2008, and two months' rent revenue will be earned in 2009.

2. The 2008 income statement should report rent revenue earned of $16,000

($24,000 x 4/6). Occupancy was provided for only 4 months in 2008. This is in conformity with the revenue principle.

3. This transaction created an $8,000 liability ($24,000 - $16,000 = $8,000) as of

December 31, 2008, because at that date Shirley "owes'' the renter two more months' occupancy for which it has already collected the cash.

4. Yes, an adjusting entry must be made to (a) increase the rent revenue account by

$16,000, and (b) to decrease the liability to $8,000 representing the future occupancy owed (in conformity with the revenue principle).

December 31, 2008--Adjusting entry:

Unearned rent revenue (



L) ...........................

Rent revenue (+R, +SE) ........................

16,000

16,000




4-69


Transaction (c):

1. This transaction will directly affect Shirley’s financial statements for two years, with the expense incurred in 2008 and the cash payment in 2009.

2. The $7,500 should be reported as wage expense in the 2008 income statement and as a liability on the 2008 balance sheet. On January 5, 2009, the liability will be paid. Therefore, the 2009 balance sheet will reflect a reduced cash balance and reduced liability balance. The transaction will not directly affect the 2009 income statement (unless the adjusting entry was not made).

3. Yes, an adjusting entry must be made to (a) record the $7,500 as an expense in

2008 (matching principle) and (b) to record the liability which will be paid in 2009.

December 31, 2008--Adjusting entry:

Wage expense (+E,



SE) ...............................

Wages payable (+L) .............................

7,500

7,500

Note: On January 5, 2009, the liability, Wages Payable, $7,500, will be paid. Wage expense for 2009 will not include this $7,500. The 2009 related entry will debit

(decrease) wages payable, and credit (decrease) cash, $7,500.

Transaction (d):

1. Yes, service revenue of $45,000 (i.e., $60,000 x 3/4) should be recorded as earned by Shirley in conformity with the revenue principle. Service revenue is recognized as the service is performed.

2. Recognition of revenue earned but not collected by the end of 2008 requires an adjusting entry. This adjusting entry is necessary to (a) record the revenue earned

(to be reported on the 2008 income statement) and (b) record the related account receivable (an asset to be reported on the 2008 balance sheet). The adjusting entry on December 31, 2008 is:

Accounts receivable (+A)............................................

Service revenue (+R, +SE) ..............................

($60,000 total price x 3/4 completed)

45,000

45,000

3. February 15, 2009--Completion of the last phase of the service contract and cash collected in full:

60,000 Cash (+A) ..................................................................




A) .................................

Service revenue (+R, +SE) ..............................

45,000

15,000


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Solutions Manual

CP4 –7.

Req. 1

Adjusting entries:

(a) Expenses (insurance) (+E,



SE) .......................................

Prepaid insurance (



A) ...........................................

To adjust for expired insurance.

1

1

(b) Rent receivable (+A) .........................................................

Revenues (rent) (+R, +SE) ......................................

To adjust for rent revenue earned but not yet collected.

2

2

(c) Expenses (depreciation) (+E,



SE) ................................... 11

Accumulated depreciation, long-lived assets (+XA,



A) 11

To adjust for annual depreciation.

(d) Expenses (wages) (+E,



SE) ............................................

Wages payable (+L) ................................................

To adjust for wages earned but not recorded or paid.

(e) Income tax expense (+E,



SE) .........................................

Income taxes payable (+L) .....................................

To adjust for income tax expense.

3

5

(f) Unearned rent revenue (



L) ...............................................

Revenues (rent) (+R, +SE) ......................................

To adjust for rent revenue collected but unearned.

3

3

3

5

Req. 2

Closing entry (from the adjusted trial balance):

Revenues (



R) ................................................................... 103

Retained earnings (+SE) ..............................................

Expenses (



E) ...............................................................




E) ..............................................

15

83

5

To close the temporary accounts to Retained Earnings for

2006.




4-71


Req. 3

(a) Shares outstanding: 1,000 shares (given).

(b) Interest expense: $20,000 x 10% = $2,000.

(c) Ending balance in retained earnings:

Unadjusted balance, $(3,000) + Net income, $15,000 = $12,000.

(d) Average income tax rate: $5,000 income tax expense ÷ ($103,000 revenues -

$83,000 total expenses) = 25%.

(e) Rent receivable -- report on the balance sheet as an asset.

Unearned rent revenue -- report on the balance sheet as a liability (for future occupancy "owed'').

(f) Net income 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 capital stock, borrowing, and revenue collected in advance. Similarly, cash outflows were, in addition to certain expenses, due to numerous transactions such as the purchase of operational and other assets, prepaid insurance, and dividends to stockholders.

(g) EPS: $15,000 ÷ 1,000 shares (per (a) above) =$15.00 per share.

(h) Selling price per share: $30,000 contribu ted capital ÷ 1,000 shares = $30 per share.

(i) The prepaid insurance account reflected a $2,000 balance before the adjustment

(decrease) of $1,000. Therefore, it appears that the policy premium was paid on

January 1, 2006, and it was prepaid for two years (2006 and 2007). Other possibilities might be (a) a 12-month policy purchased on July 1, 2006, or (b) a 2month policy purchased on December 1, 2006. In any case, one-half of the premium has expired.

(j) Net profit margin: $15,000 net income ÷ $103,000 revenues = 0.146 (14.6%).


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Solutions Manual

CP4 –8.

Req. 1

CRYSTAL’S DAY SPA AND SALON, INC.



Items

Revenues:

Spa fees

Expenses:

Office rent

Utilities

Telephone

Salaries

Supplies

Miscellaneous

Depreciation

Cash

Basis Per

Crystal’s

Statement Explanation of Changes

$1,115,000 See * below.

130,000 Exclude rent for Jan. 2009 ($130 ,000 ÷ 13) (g)

43,600 No change

12,200 See ** below.

522,000 Add December 2008 salar y ($18,000 ÷ 12) (e)

31,900 See *** below.

12,400 No change

0 Given for 2008 (c)

Total expenses 752,100

Net income $ 362,900

Corrected

Basis

$1,012,000

120,000

43,600

11,800

523,500

29,825

12,400

20,500

761,625

$ 250,375

* Cash collected for spa fees

Fees earned in prior years (a)

Fees earned in 2008 but not yet collected (b)

Fees earned in 2008

$1,115,000

-132,000

+ 29,000

$1,012,000

** Add December 2008 bill of $1,400 (f) and subtract the December 2007 bill of

$1,800 paid in 2008 ($12,200 + $1,400 - $1,800 = $11,800).

*** Supplies (d)

Beg. 3,125

Purchases 31,900 29,825 Used

End. 5,200




4-73


Req. 2

Memo to Crystal Mullinex should include the following:

(1) Net income was overstated by $112,525 because of inappropriate recognition of revenue (overstated by $103,000) and expenses (understated by $9,525).

Revenue should be recognized when earned, not 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).

(2) Some other items the parties should consider in the pricing decision:

(a) A correct balance sheet at December 31, 2008.

(b) Collectibility of any receivables (if they are to be sold with the business).

(c) Any liabilities of the spa to be assumed by the purchaser.

(d) Current employees -- how will they be affected?

(e) Adequacy of the rented space -- is there a long-term noncancellable lease?

(f)

Characteristics of Crystal’s spa practices.

(g) Expected future cash flows of the business. What is the present value of those expectations?


4-74


Solutions Manual

CRITICAL THINKING CASES

CP4 –9.

Req. 1

2007 Adjusting Entries

12/31

(a) Supplies expense (+E,

 SE)…………………

Supplies (

 A)……………………………….

To record supplies used ($6,000 - $1,800 = $4,200).

(b) Insurance expense (+E,

 SE)…………………….

Prepaid insurance (

 A)……………………

To record expired insurance at December 31, 2007.

(c) Depreciation expense (+E,

 SE)…………………


 A)…….

To record depreciation for one year.

(d) Salaries expense (+E,

 SE)…………………………

Sa laries payable (+L)………………………

To record salaries earned but not paid.

(e) Transportation revenue (

 R, +SE) ………

Unearned transportation revenue (+L)……

To record transportation revenue earned but collected in advance.

(f) Income tax expense (+E,

 SE)…………………...

Income tax payable (+L)……………………

To record 2007 income tax computation:

Transportation revenue: $85,000



7,000 = $78,000

Expenses: $47,000 + 4,200 + 2,000

+ 8,000 + 2,200 = 63,400

Pretax income $14,600

Income tax expense: $14,600 x 25% = $ 3,650

Debit

4,200

2,000

8,000

2,200

7,000

3,650

Credit

4,200

2,000

8,000

2,200

7,000

3,650




4-75


Req. 2

MAGLIOCHETTI MOVING CORPORATION

Corrections to 2007 Financial Statements

2007 Income Statement:

Revenue:

Transportation revenue

Expenses:

Salaries expense

Supplies expense

Other expenses

Insurance expense


Income tax expense

Total expenses

Net income

December 31, 2007 Balance Sheet

Assets:

Current Assets:

Cash

Receivables

Supplies

Prepaid insurance


Equipment

Less: Accumulated deprec.

Remaining assets

Total assets

Liabilities:


Accounts payable

Salaries payable

Unearned transportation revenue

Income tax payable


Stockholders' Equity

Contributed capital

Retained earnings


Total liabilities and stockholders' equity

Amounts

Reported

Changes

Plus Minus Amounts

$ 85,000 e

17,000 d 2,200

7,000

12,000 a 4,200

18,000

0 b 2,000

0 c 8,000

0 f 3,650

47,000

$ 38,000

$ 2,000

3,000

6,000 a

4,000 b

15,000

40,000

0 c 8,000

27,000

$82,000

$ 9,000

0 d 2,200

0 e 7,000

0 f 3,650

9,000

35,000

38,000

73,000

$82,000

4,200

2,000

$ 78,000

19,200

16,200

18,000

2,000

8,000

3,650

67,050

$ 10,950

$ 2,000

3,000

1,800

2,000

8,800

40,000

(8,000)

27,000

$67,800

$ 9,000

2,200

7,000

3,650

21,850

35,000

10,950

45,950

$67,800


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Solutions Manual


Req. 3

Omission of the adjusting entries caused:

(a) Net income to be overstated by $27,050.

(b) Total assets to be overstated by $14,200.

Req. 4

(a) Earnings per share:

Unadjusted -- $38,000 net income




Adjusted -- $10,950 net income




(b) Net profit margin:

Unadjusted -- $38,000 net income



85,000 sales = 44.7%

Adjusted -- $10,950 net income



78,000 sales = 14.0%

Each of the ratios was affected by inclusion of the adjustments with revenues decreasing and expenses increasing resulting in a lower net income. For earnings per share, the numerator net income decreased while the denominator did not, resulting in a significantly lower figure. For the net profit margin, the denominator sales was lower but did not decrease more than the reduction in the numerator net income causing a significantly lower percentage.




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Req. 5

( today’s date)

To the Stockholders of 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 income for 2007 by $27,050 (i.e., $38,000 - $10,950). This overstatement was caused by incorrectly including $7,000 of revenue collected in advance that had not been earned in 2007. Further, all of the expenses were understated and income tax expense had been incorrectly excluded.

Total assets were overstated by $14,200 (i.e., $82,000 - $67,800). Supplies was overstated by $4,200, prepaid insurance was overstated by $2,000, and the net book value of the equipment was overstated by $8,000 because annual depreciation was not properly recognized.

A review of key financial ratios indicates that the adjustments caused earnings per share and net profit margin to decline. Net profit margin declined from 44.7% to 14.0%.

The adjusted ratios, however, would be compared to those of other start-up companies in the same industry.

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.

If you would like us to reconsider your application, please provide us the current market values of any assets you would pledge as collateral.

Regards,

(your name)

Loan Application Department,

Your Bank


4-78


Solutions Manual

CP4 –10.

Req. 1 Cash from Operations: $18,000

Req. 2 Subscriptions Revenue for fiscal year ended March 31, 2008

($18,000 x 7/36): $3,500

Req. 3 March 31, 2008 Unearned Subscriptions Revenue

($18,000 x 29/36) = $14,500 or $18,000 - $3,500 = $14,500.

Req. 4

Adjusting entry (cash receipt credited to Unearned Subscriptions Revenue):

Unearned Subscriptions

Revenue (L) Subscriptions Revenue (R)

AJE

3,500

9/1 18,000

AJE 3,500

End. 14,500 End. 3,500

Unearned subscriptions revenue (



L) ........................

Subscriptions revenue (+R, +SE) ....................

3,500

To record the earning of revenue for seven months ($500 per month).

Req. 5

3,500 a. $4,000 revenue target based on cash sales:

This target is not clearly defined. Does management mean any cash subscriptions received during the period? Your region generated $18,000 in cash subscriptions. By this assumption, your region far exceeded the company’s target. You may be entitled to a generous bonus due to your strong performance.

On the other hand, management may mean any sales revenue earned that has also been received in cash during the period. Under this assumption, sales revenue earned and received in cash is $3,500 (the accrual accounting basis amount). If this is the company’s intention of its target, then your region did not meet the goal, only generating 87.5% of the target. You may need to provide an analysis to management regarding this below par performance.

This example demonstrates the need for clear communication of expectations by management. b. $4,000 revenue target based on accrual accounting:

This situation is the same as the second assumption under a. Your region earned $500 less than expected by the company.




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FINANCIAL REPORTING AND ANLYSIS PROJECT

CP4 –11.

The solutions to this project will depend on the company and/or accounting period selected for analysis.


4-80


Solutions Manual

Ch04

Chapter 4

Adjustments, Financial Statements, and the

Quality of Earnings

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Ch04

Chapter 4

Adjustments, Financial Statements, and the

Quality of Earnings

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