Chapter 3
Operating Decisions and
the Income Statement
ANSWERS TO QUESTIONS
4.
Both revenues and gains are inflows of net assets. However, revenues occur in
the normal course of operations, whereas gains occur from transactions
peripheral to the central activities of the company. An example is selling land at
a price above cost (at a gain) for companies not in the business of selling land.
Both expenses and losses are outflows of net assets. However, expenses occur
in the normal course of operations, whereas losses occur from transactions
peripheral to the central activities of the company. An example is a loss suffered
from fire damage.
5.
Accrual accounting requires recording revenues when earned and recording
expenses when incurred, regardless of the timing of cash receipts or payments.
Cash basis accounting is recording revenues when cash is received and
expenses when cash is paid.
13.
Asset turnover is calculated as Sales  Average total assets. The asset turnover
ratio measures the sales generated per dollar of assets. A high ratio suggests
that the company is managing its assets (resources used to generate revenues)
efficiently.
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3-1
EXERCISES
E3–2.
Req. 1
Cash Basis
Income Statement
Revenues:
Cash sales
Customer deposits
Expenses:
Inventory purchases
Wages paid
Utilities paid
Net Income
$340,000
21,000
90,000
54,200
7,200
$209,600
Accrual Basis
Income Statement
Revenues:
Sales to customers $410,000
Expenses:
Cost of sales
Wages expense
Utilities expense
287,000
59,000
7,880
Net Income
$56,120
Req. 2
Accrual basis financial statements provide more useful information to external users.
Financial statements created under cash basis accounting normally postpone (e.g.,
$70,000 credit sales) or accelerate (e.g., $21,000 customer deposits) recognition of
revenues and expenses long before or after goods and services are produced and
delivered (until cash is received or paid). They also do not necessarily reflect all assets
or liabilities of a company on a particular date.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2009
Solutions Manual
E3–3.
Activity
Amount of Revenue Earned in
September
Revenue Account Affected
a.
Sales revenue
$18,400
b.
Sales revenue
$18,050
c.
None
No transaction has occurred; exchange of
promises only.
d.
Sales revenue
$15,000 (= 1,000 shirts x $15 per shirt);
revenue earned when goods are delivered.
e.
None
Payment related to revenue recorded
previously in (d) above.
f.
None
No revenue earned in September;
earnings process is not yet complete.
g.
None
No revenue is earned; the issuance of
stock is a financing activity.
h.
None
No revenue earned in September;
earnings process is not yet complete.
i.
Ticket sales revenue
$3,660,000 (= $18,300,000 ÷ 5 games)
j.
None
No revenue earned in September;
earnings process is not yet complete.
k.
Interest revenue
$12 (= $1,200 x 12%  12 months)
l.
None
No revenue earned in September;
earnings process is not yet complete.
m.
Sales revenue
$100
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3-3
E3–4.
Activity
Amount of Expense Incurred in
January
Expense Account Affected
a.
Salary expense
$39,750 incurred in January.
The remaining half was incurred in
December.
b.
Insurance expense
$1,470 incurred in January.
The remainder is not incurred until February
and March.
c.
Utilities expense
d.
Cost of goods sold
$5,000 (= 500 shirts x $10 per shirt)
e.
None
Expense will be recorded in the future when
the related revenue has been earned.
f.
Cost of goods sold
$19,350 (= 450 books x $43 per book)
g.
None
December expense paid in January.
h.
Commission expense
$4,470
i.
None
Expense will be recorded as depreciation
over the equipment’s useful life.
j.
None
Expense will be recorded when the related
revenue has been earned.
k.
Supplies expense
$6,190 (= $4,000 + $2,600 - $410)
l.
Wages expense
$104 (= 8 hours x $13 per hour)
m.
Insurance expense
$300 (= $3,600 ÷ 12 months)
n.
Repairs expense
$300
o.
Utilities Expense
$202
p.
Consulting Expense
$1,285
q.
None
December expense paid in January.
McGraw-Hill/Irwin
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$754
© The McGraw-Hill Companies, Inc., 2009
Solutions Manual
E3–8.
Req. 1
a.
Cash (+A) ................................................................... 2,500,000
Short-term note payable (+L) ...........................
2,500,000
Debits equal credits. Assets and liabilities increase by the same amount.
b.
Equipment (+A) .......................................................... 90,000
Cash (A).........................................................
90,000
Debits equal credits. Assets increase and decrease by the same amount.
c.
Merchandise inventory (+A) ........................................
40,000
Accounts payable (+L) .....................................
40,000
Debits equal credits. Assets and liabilities increase by the same amount.
d.
Repair and maintenance expense (+E, SE) ............. 62,000
Cash (A).........................................................
62,000
Debits equal credits. Expenses decrease retained earnings (part of stockholders'
equity). Stockholders' equity and assets decrease by the same amount.
e.
Cash (+A) ................................................................... 372,000
Unearned pass revenue (+L) ...........................
372,000
Debits equal credits. Since the season passes are sold before Vail Resorts
provides service, revenue is deferred until it is earned. Assets and liabilities
increase by the same amount.
f.
Cash (+A) ................................................................... 270,000
Lift revenue (+R, +SE) .....................................
270,000
Debits equal credits. Revenue increases retained earnings (a part of
stockholders' equity). Stockholders' equity and assets increase by the same
amount.
g.
Two transactions occur:
(1) Accounts receivable (+A) ......................................
750
Ski shop sales revenue (+R, +SE) ...................
750
Debits equal credits. Revenue increases retained earnings (a part of
stockholders' equity). Stockholders' equity and assets increase by the same
amount.
(2) Cost of goods sold (+E, SE) ................................
450
Merchandise inventory (A) .............................
450
Debits equal credits. Expenses decrease retained earnings (a part of
stockholders' equity). Stockholders' equity and assets decrease by the same
amount.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2009
3-5
E3–8. (continued)
h.
Cash (+A) ................................................................... 3,200
Unearned rent revenue (+L) ............................
3,200
Debits equal credits. Since the rent is received before the townhouse is used,
revenue is deferred until it is earned. Assets and liabilities increase by the same
amount.
i.
Accounts payable (L) ................................................ 20,000
Cash (A).........................................................
20,000
Debits equal credits. Assets and liabilities decrease by the same amount.
j.
Cash (+A) ...................................................................
200
Accounts receivable (A) .................................
200
Debits equal credits. Assets increase and decrease by the same amount.
k.
Wages expense (+E, SE) ......................................... 258,000
Cash (A).........................................................
258,000
Debits equal credits. Expenses decrease retained earnings (a part of
stockholders' equity). Stockholders' equity and assets decrease by the same
amount.
Req. 2
Accounts Receivable
(j)
Beg. bal. 1,200
(g)
750
End. bal. 1,750
McGraw-Hill/Irwin
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200
© The McGraw-Hill Companies, Inc., 2009
Solutions Manual
E3–10.
Req. 1 and 2
Cash
7,200 2,040
(a)
600 12,000
(b)
360 3,600
(c) 17,400
960
(d) 7,200
14,160
(g)
(i)
(j)
(k)
(e)
Contributed Capital
9,600
720 (h)
10,320
Rent Revenue
360
(b)
360
(k)
22,800
Equipment
9,600
(h) 720
10,320
Accounts
Payable
(g) 2,040 9,600
420
7,980
Accounts Receivable
30,000 7,200 (d)
Supplies
1,440
960
2,400
Land
7,200
Building
26,400
7,200
26,400
Unearned Fee
Revenue
3,840
600 (a)
4,440
Note
Payable
48,000
48,000
Rebuilding Fees
Revenue
17,400 (c)
Retained Earnings
(j) 3,600 10,800
7,200
17,400
Wages Expense
(i) 12,000
Utilities Expense
(e) 420
12,000
420
Item (f) is not a transaction; there has been no exchange.
McGraw-Hill/Irwin
Financial Accounting, 6/e
© The McGraw-Hill Companies, Inc., 2009
3-7
E3–10. (continued)
Req. 3
Net income using the accrual basis of accounting:
Revenues
$17,760 ($17,400 + 360)
– Expenses
12,420 ($12,000 + 420)
Net Income
$ 5,340
(accrual basis)
Assets
$14,160
22,800
2,400
10,320
7,200
26,400
$83,280
=
Liabilities
$ 7,980
4,440
48,000
$60,420
+
Stockholders’ Equity
$ 10,320
7,200
5,340 net income
$22,860
Req. 4
Net income using the cash basis of accounting:
–
Cash receipts
Cash disbursements
Net Income
(cash basis)
$25,560 (transactions a through d)
15,000 (transactions g, i, and k)
$ 10,560
Cash basis net income ($10,560) is higher than accrual basis net income ($5,340)
because of the differences in the timing of recording revenues versus receipts and
expenses versus disbursements between the two methods. The $7,800 higher amount
in cash receipts over revenues includes cash received prior to being earned (from (a),
$600) and cash received after being earned (in (d), $7,200). The $2,580 higher amount
in cash disbursements over expenses includes cash paid after being incurred in the
prior period (in (g), $2,040), plus cash paid for supplies to be used and expensed in the
future (in (k), $960), less an expense incurred in January to be paid in February (in (e),
$420).
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2009
Solutions Manual
E3–11.
Req. 1
EDDY’S PIANO REBUILDING COMPANY
Income Statement (unadjusted)
For the Month Ended January 31, 2011
Operating Revenues:
Rebuilding fees revenue
Total operating revenues
$ 17,400
17,400
Operating Expenses:
Wages expense
Utilities expense
Total operating expenses
Operating Income
12,000
420
12,420
4,980
Other Item:
Rent revenue
360
Net Income
5,340
Req. 2
EDDY’S PIANO REBUILDING COMPANY
Statement of Retained Earnings (unadjusted)
For the Month Ended January 31, 2011
Retained Earnings, December 31, 2010
Net income
Dividends
Retained Earnings, January 31, 2011
McGraw-Hill/Irwin
Financial Accounting, 6/e
$
10,800
5,340
(3,600)
$ 12,540
© The McGraw-Hill Companies, Inc., 2009
3-9
E3–11. (continued)
Req. 3
EDDY’S PIANO REBUILDING COMPANY
Balance Sheet (unadjusted)
At January 31, 2011
Assets
Current assets:
Cash
Accounts receivable
Supplies
Total current assets
Equipment
Land
Building
Total Assets
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable
Unearned fee revenue
Total current liabilities
Note payable
Total Liabilities
Stockholders’ Equity:
Contributed Capital
Retained Earnings
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
McGraw-Hill/Irwin
3-10
$ 14,160
22,800
2,400
39,360
10,320
7,200
26,400
$ 83,280
$
7,980
4,440
12,420
48,000
60,420
10,320
12,540
22,860
$ 83,280
© The McGraw-Hill Companies, Inc., 2009
Solutions Manual
PROBLEMS
P3–6.
Req. 1 and 2
ASSETS:
(a)
(e)
(f)
(g)
Cash
744
155
600
396
6,524 3,804
900
492
240
384
2,599
(c)
(d)
(h)
(i)
(j)
(a)
Receivables
923 6,524
7,200
(e)
Spare Parts, Supplies,
and Fuel
164
1,599
164
Prepaid Expenses
64
(c)
96
160
Other Assets
1,011
LIABILITIES:
Accounts Payable
(j)
384 554
Accrued Expenses
Payable
761
Flight and Ground
Equipment
3,476
(b)
816
4,292
1,011
170
Long-term
Notes Payable
2,016
816 (b)
900 (f)
3,732
761
STOCKHOLDERS' EQUITY:
Other Noncurrent
Liabilities
790
790
Contributed Capital
702
240
(g)
942
REVENUES AND EXPENSES:
Delivery Service
Revenue
7,800 (a)
(c)
7,800
Wage Expense
(h) 3,804
3,804
(i)
Rental
Expense
648
648
Retained Earnings
970
970
(d)
Repair
Expense
396
396
Fuel Expense
492
492
Item k does not constitute a transaction.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2009
3-11
P3–6. (continued)
Req. 3
FedEx
Income Statement (unadjusted)
For the Year Ended June 30, 2010
(in millions)
Revenues:
Delivery service revenue
Expenses:
Rental expense
Wage expense
Fuel expense
Repair expense
Total expenses
Net Income
$ 7,800
648
3,804
492
396
5,340
$ 2,460
FedEx
Statement of Retained Earnings (unadjusted)
For the Year Ended June 30, 2010
(in millions)
Retained earnings, June 30, 2009
Net income
Dividends
Retained earnings, June 30, 2010
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3-12
$ 970
2,460
(0)
$3,430
© The McGraw-Hill Companies, Inc., 2009
Solutions Manual
P3–6. Req. 3 (continued)
FedEx
Balance Sheet (unadjusted)
At June 30, 2010
(in millions)
Assets
Current assets:
Cash
Receivables
Prepaid expenses
Spare parts, supplies, and fuel
Total current assets:
Flight and ground equipment
Other assets
Total assets
$ 2,599
1,599
160
164
4,522
4,292
1,011
$ 9,825
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable
Accrued expenses payable
Total current liabilities
Long-term notes payable
Other noncurrent liabilities
Total liabilities
$
Stockholders' Equity:
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
McGraw-Hill/Irwin
Financial Accounting, 6/e
170
761
931
3,732
790
5,453
942
3,430
4,372
$ 9,825
© The McGraw-Hill Companies, Inc., 2009
3-13
P3–6. Req. 3 (continued)
FedEx
Statement of Cash Flows
For the Year Ended June 30, 2010
(in millions)
Cash Flows from Operating Activities
Cash received from customers
(=$600+$6,524)
Cash paid to employees
Cash paid to suppliers
(=$744+$396+$492+$384)
Total cash from operating activities
Cash Flows from Investing Activities
None
$ 7,124
(3,804)
(2,016)
1,304
0
0
Cash Flows from Financing Activities
Proceeds from share issuance
Proceeds from notes payable
Total cash from financing activities
240
900
1,140
Increase in cash
Beginning cash balance
2,444
155
Ending cash balance
$2,599
Note that transaction (b) is omitted from the statement of cash flows. However, as
discussed in future chapters, this type of transaction is a noncash investing and
financing activity that requires supplemental disclosure.
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Solutions Manual
P3–6. (continued)
Req. 4
Total Asset Turnover
* (Beginning $5,793
=
+
Sales
=
Average Total Assets
$7,800 = 1.00
$7,809*
Ending $9,825) ÷ 2
($155 + $923 + $64 + $164 + $1,011 + $3,476)
(computed in Req. 3)
The asset turnover ratio suggests that the company obtained $1 in sales for the month
for every $1 in assets. To analyze this result, we would need to calculate the ratio for
the company over time to observe the trend in how efficiently assets are being utilized.
We would also need the industry ratio for the current period to determine how the
company is doing in comparison to others in the industry.
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3-15