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Chapter 3
Accrual Accounting & Income
Short Exercises
(10 min.) S 3-1
Millions
Sales revenue. 850Cost of goods sold (290)
All other expenses (325)
Net income.. $ 235
Beginning cash.. $ 75
Collections ($850 $27).. 823
Payments for: inventory. (380)
everything else. (255)
Ending cash $ 263
(10 min.) S 3-2
Statement Reports(Amounts in millions)
Income statement Interest expense $ .8
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Balance sheet Notes payable ($4.1 + $1.7 $1.6). $4.2
Interest payable. 0.3
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(10 min.) S 3-3
At the end of each accounting period, the business reports its
performance through the preparation of financial statements. In order to
be useful to the various users of financial statements they must be up-
to-date. Accounts such as cash, Equipment, Accounts Payable,
Common Stock and Dividends are up-to date and require no adjustment
at the end of the accounting period. Accounts such as Accounts
Receivable, Supplies, Salary Expense and Salaries Payable may not be
up to date as of the last day of the accounting period. Why? Because
certain transactions that took place during the month may not have been
recorded.
The accrued salaries, which are owed to the employees but have not
been paid, are an expense related to the current period but also
represent a liability or debt that is owed by the business. The business
must make an adjusting entry to record the accrued salary owed as both
an increase in Salary Expense and an increase in Salaries Payable. If
the business does not make this adjustment, the expenses will be
understated, net income will be overstated, and liabilities will be
understated.
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(10 min.) S 3-4
The large auto manufacturer should record sales revenue when the
revenue is earned by delivering automobiles to Budget or Hertz. Thelarge auto manufacturer shouldnotrecord any revenue prior to delivery
of the vehicles, because the large auto manufacturer hasnt earned the
revenue yet. Therevenueprinciplegoverns this decision.
When the large auto manufacturer records the revenue from the sale, at
that time not before or after the large auto manufacturer should also
record cost of goods sold, the expense. Theexpense recognition
principletells when to record expenses.
(10 min.) S 3-5
Depreciation is the periodic allocation of the cost of a tangible long-lived
asset, less its estimated residual value, over its estimated useful life. All
long-lived or plant assets, except for land, decline in usefulness during
their life and this decline is an expense. Accountants must allocate the
cost of each plant asset, except for land, over the assets useful life.
Depreciation is the process of allocating the cost of a plant asset to
expense. Depreciation also decreases the book value of the asset to
reflect its usage.
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(10 min.) S 3-6
a. The Expense Recognition Principle
b.The Time Period Concept
c. The Revenue Principle
d. The Revenue Principle
e. The Expense Recognition Principle
(10 min.) S 3-7
a.
Oct. 31 Rent Expense ($3,000 1/6)...500
Prepaid Rent. 500
To record rent expense.
Prepaid Rent Rent Expense
Oct. 1 3,000Oct. 31 500 Oct. 31 500
Bal. 2,500 Bal. 500
b.
Oct. 31 Supplies Expense ($950 $400) 550
Supplies.. 550
To record supplies expense.
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Supplies Supplies Expense
Oct. 1 950 Oct. 31 550 Oct. 31 550
Bal. 400 Bal. 550
(10 min.) S 3-8
Req. 1
(a) Jan. 1 Computer Equipment... 50,000Cash. 50,000
Purchased computer equipment.
(b)Dec. 31 Depreciation Expense
Computer Equipment ($50,000 / 5). 10,000
Accumulated Depreciation
Computer Equipment.......
Record depreciation expense.
10,000
Req. 2
Computer Equipment
Accumulated
Depreciation
Computer
Equipment
Depreciation
Expense
Computer Equipment
Jan.50,000 Dec. 3110,000 Dec. 3110,000
Bal. 50,000 Bal. 10,000 Bal. 10,000
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Req. 3
Computer equipment. $50,000
Less: Accumulated depreciation (10,000)
Book value $40,000
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(10 min.) S 3-9
(Amounts in millions)
Income statement: 2012
Salary expense ($42.4 + $2.2).. $44.6
Balance sheet: 2012
Salary payable......... $ 2.2
(10 min.) S 3-10
Req. 1
Oct. 31 Interest Expense.. 250
Interest Payable.. 250
To accrue interest expense for October.
Nov. 30 Interest Expense.. 250
Interest Payable.. 250
To accrue interest expense for November.
Dec. 31 Interest Expense... 250
Interest Payable 250
To accrue interest expense for December.
Req. 2
Interest Payable
Oct. 31 250
Nov. 30 250
Dec. 31 250
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Bal. 750
Req. 3
Dec. 31 Interest Payable.......... 750Cash.. 750
To pay interest.
(10 min.) S 3-11
Req. 1
Oct. 31 Interest Receivable 250
Interest Revenue.. 250
To accrue interest revenue for October.
Nov. 30 Interest Receivable 250
Interest Revenue... 250
To accrue interest revenue for November.
Dec. 31 Interest Receivable 250
Interest Revenue...... 250
To accrue interest revenue for December.
Req. 2
Interest Receivable
Oct. 31 250
Nov. 30 250
Dec. 31 250
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Bal. 750
Req. 3
Dec. 31 Cash. 750
Interest Receivable. 750
To collect interest.
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(5-10 min.) S 3-12
Unearned revenues are liabilities becauseThe World Starhas received
cash from subscribers in advance of providing them with newspapers.
Receiving the cash in advance creates an obligation (a liability) forThe
World Star. AsThe World Stardelivers newspapers to subscribers,The
World Starearns the revenue, and the dollar amount of the unearned
revenue then goes into the revenue account.
a. Cash. 60,000Unearned Subscription Revenue....... 60,000
Received cash for revenue in advance.
b.Unearned Subscription Revenue.................. 40,000
Subscription Revenue 40,000
To record the earning of subscription
revenue that was collected in advance.
(5-10 min.) S 3-13
Prepaid Rent at December 31:
a. Unadjusted amount. $18,000
b. Adjusted amount ($18,000 $6,000).. 12,000
Rent Expense at December 31:
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c. Unadjusted amount $ - 0 -
d. Adjusted amount ($18,000 / 3). 6,000
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(10 min.) S 3-14
a. Accounts Receivable... 55,000
Service Revenue.. 55,000
Cash. 35,000
Accounts Receivable. 35,000
b. Cash. 9,000
Unearned Service Revenue.. 9,000
Unearned Service Revenue 7,000Service Revenue.. 7,000
(15-30 min.) S 3-15
Sparrow Sporting Goods Company
Income StatementFor the Year Ended March 31, 2012
Thousands
Net revenues. $175,500
Cost of goods sold. 136,000
All other expenses.. 29,000
Net income $ 10,500
Sparrow Sporting Goods Company
Statement of Retained Earnings
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For the Year Ended March 31, 2012
Thousands
Retained earnings, March 31, 2011... $21,500
Add:Net income 10,500Retained earnings, March 31, 2012... $32,000
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(continued) S 3-15
Sparrow Sporting Goods Company
Balance Sheet
March 31, 2012Thousands
ASSETS
Current:
Cash........................................................ $ 20,800
Accounts receivable.............................. 28,000
Inventories.............................................. 35,000
Other current assets.............................. 5,000
Total current assets.......................... 88,800
Property and equipment, net................. 6,300
Other assets............................................ 22,000
Total assets.................................................. $117,100
LIABILITIES
Total current liabilities........................... $ 55,100
Long-term liabilities............................... 7,500
Total liabilities.............................................. 62,600
STOCKHOLDERS EQUITY
Common stock....................................... 22,500
Retained earnings.................................. 32,000
Total stockholders equity........................... 54,500
Total liabilities and stockholders equity... $117,100
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(5-10 min.) S 3-16
CLOSING ENTRIES
Thousands
Mar. 31 Net Revenues . 175,500Retained Earnings....... 175,500
31 Retained Earnings. 165,000
Cost of Goods Sold. 136,000
All Other Expenses.. 29,000
Retained Earnings
Mar. 31, 2012 Expenses 165,000Mar. 31, 2011 Bal. 21,500
Mar. 31, 2012 Revenues 175,500
Mar. 31, 2012 Bal. 32,000
Retained Earnings ending balance agrees with the amount reported on
the statement of retained earnings and the balance sheet (in S 3-15).
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(5 min.) S 3-17
(Dollars in thousands)
Req. 1
Net working capital = Total current assets- Total current liabilities
$33,700 = $88,800 - $55,100
Req. 2
Current ratio = Total current assets = $88,800 = 1.61Total current liabilities $55,100
Req. 3
Debt ratio =
Total liabilities
=
$62,600
= 0.53Total assets $117,100
Req. 4
Net working capital of $33,700 means current assets exceed current
liabilitiesa positive sign. The current ratio and debt ratio values are
strong.
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(10 min.) S 3-18
1.Earned revenue of $10,000 on account:
a. Net working capital = $43,700 [($88,800 + $10,000)- $55,100]
b.Current ratio =$98,800
= 1.79$55,100
c. Debt ratio =$62,600
= 0.49$127,100 ($117,100 +$10,000)
2.Paid accounts payable of $10,000:
a. Net working capital = $33,700[($88,800 - $10,000) - ($55,100- $10,000)]
b.Current ratio =$78,800
= 1.74$45,100
c. Debt ratio =$52,600 ($62,600 - $10,000)
= 0.49$107,100 ($117,100 -$10,000)
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Exercises
(5-10 min.) E 3-19A
Statement Reports (in millions)
1. Income statement Sales revenue $4,300
Operating expenses. 1,200
Balance sheet Accounts receivable $ 900
Accounts payable. 1,000
2. Cash basis would report only the cash collections of $4,500 from
customers and the payment of operating expenses ($1,200).
Their balance sheet should have included neither accounts
receivable nor accounts payable.
(5-10 min.) E 3-20A
a. Cash Basis b. Accrual Basis
Revenues... $540,000 $530,000Expenses... 420,000 440,000
Net income $120,000 $ 90,000
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The accrual basis measures net income better because its information
about revenues and expenses is more complete than the information
provided by the cash basis.
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(5-10 min.) E 3-21A
Millions
a. Revenue. $840
Therevenue principlesays to record revenue when it has been
earned, regardless of when cash is collected. Therefore, report
the amount of revenue earned, regardless of when the company
collects cash.
b. Total expense... $500
The expense recognition principlegoverns accounting for
expenses.
c. Theincome statementreports revenues and expenses.
Thestatement of cash flowsreports cash receipts and cash
payments.
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(15-20 min.) E 3-22A
Req. 1
Adjusting Entries
DATE ACCOUNT TITLES DEBIT CREDIT
a.Insurance Expense................................................ 900
Prepaid Insurance ($400+$1,200$700).......... 900
b.Interest Receivable................................................ 1,600
Interest Revenue............................................... 1,600
c.Unearned Service Revenue ($1,100 $500)........ 600Service Revenue............................................... 600
d.Depreciation Expense........................................... 4,800
Accumulated Depreciation.............................. 4,800
e.Salary Expense ($18,000 3/5)............................. 10,800
Salary Payable............................................... 10,800
f.Income Tax Expense ($21,000 .25).................... 5,250
Income Tax Payable...................................... 5,250
Req. 2
Net income understated by omission of:Interest revenue $ 1,600
Service revenue.... 600
Total understatement.. $ (2,200)
Net income overstated by omission of:
Insurance expense $ 900
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Depreciation expense.. 4,800
Salary expense.. 10,800
Income tax expense. 5,250
Total overstatement. 21,750
Overall effect net income overstated by $19,550
(10-15 min.) E 3-23A
Missing amounts initalics.
1 2 3 4
Beginning Supplies $ 500 $ 400 1,000 $1,000
Add: Payments for supplies
during the year 1,700 800 1,000 400
Total amount to account for 2,200 1,200 2,000 1,400
Less: Ending Supplies (500) (500) (700) (500)
Supplies Expense $1,700 $700 $1,300 $ 900
Journal entries:
Situation 1: Supplies......................................... 1,700
Cash............................................ 1,700
Situation 2: Supplies Expense............................. 700
Supplies..................................... 700
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(10-20 min.) E 3-24A
Req. 1
Adjusting Entries
DATE ACCOUNT TITLES DEBIT CREDIT
a.Interest Expense.................................................... 9,600
Interest Payable............................................. 9,600
b.Interest Receivable............................................ 4,900
Interest Revenue........................................ 4,900
c.Unearned Rent Revenue ($12,000 / 2 6/12)....... 3,000
Rent Revenue................................................ 3,000
d.Salary Expense ($1,900 3).............................. 7,600
Salary Payable............................................... 7,600
e.Supplies Expense.................................................. 1,800
Supplies ($3,200 $1,400)............................ 1,800
f.Depreciation Expense ($80,000 / 5)...................... 16,000
Accumulated Depreciation........................... 16,000
Req. 2
Book value = $64,000 ($80,000 $16,000)
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(10-20 min.) E 3-25A
Accounts Receivable Supplies
Bal. 1,500 Bal. 500 (a) 200
(c) 900 Bal. 300
Bal. 2,400
Salary Payable Unearned Service Revenue
(b) 400 (d) 500 Bal. 600
Bal. 400 Bal. 100
Service Revenue Salary Expense
Bal. 4,200 Bal. 1,900
(c) 900 (b) 400
(d) 500 Bal. 2,300
Bal. 5,600
Supplies Expense
(a) 200
Bal. 200
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(20-30 min.) E 3-26A
Honeyglazed Hams, Inc.
Income Statement
Year Ended December 31, 2012Thousands
Revenues:
Sales revenue............................. $40,900
Expenses:
Cost of goods sold.................... $25,000
Selling, administrative, and
general expense.................. 10,300
Total expenses...................... 35,300
Income before tax........................... 5,600
Income tax expense.................... 2,100
Net income....................................... $ 3,500
Honeyglazed Hams, Inc..
Statement of Retained Earnings
Year Ended December 31, 2012
Thousands
Retained earnings, December 31, 2011. $4,700
Add:Net income . 3,500
8,200
Less: Dividends.. (1,500)
Retained earnings, December 31, 2012. $6,700
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(continued) E 3-26A
Honeyglazed Hams, Inc.
Balance Sheet
December 31, 2012Thousands
ASSETS LIABILITIES
Cash.$ 3,700 Accounts payable $ 7,900
Accounts receivable 1,700 Income tax payable.. 500
Inventories. 1,600 Other liabilities.. 2,400
Prepaid expenses. 1,600 Total liabilities... 10,800
Prop., plant, equip. $ 6,800 STOCKHOLDERS
Less: Accum. EQUITY
deprec.. (2,800) 4,000 Common stock.. 4,600
Other assets.. 9,500 Retained earnings 6,700
Total stockholders equity11,300
Total liabilities and
Total assets $22,100 stockholders equity... $22,100
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(10-20 min.) E 3-27A
One mechanism for solving this exercise is to prepare the relevant T-
accounts, insert the given information, and solve for the unknown
amounts, shown initalics.
Amounts in millions
Receivables
Beg. bal. 220
Sales revenue 20,550 Collections 20,400
End. bal. 370
Prepaid Insurance
Beg. bal. 150
Payment 440 Insurance expense 420
End. bal. 170
Accrued Liabilities Payable
Beg. bal. 600
Payments 4,300
Other operating
expenses 4,400
End. bal. 700
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(10-15 min.) E 3-28A
Req. 1
MillionsIncome statement
Service revenue (430 80). 350
Balance sheet
Unearned service revenue... 80
Req. 2
Income statement
Service revenue (65 + 430 80).. 415
Balance sheet
Unearned service revenue... 80
Service revenue is greater in (2) because Bennett began the year owing
more phone service to customers. With collections for the year and the
amount of the ending liability unchanged, Bennett must have earned
more revenue in situation 2 than in situation 1.
Not required but helpful:
Unearned Service Revenue
Beg. bal. 65
Earned revenue 415 Collected cash 430
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End. bal. 80
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(10-20 min.) E 3-29A
Req. 1
JournalDATE ACCOUNT TITLES DEBIT CREDIT
Closing Entries
Dec.31 Service Revenue........................................ 23,900
Other Revenue........................................... 400
Retained Earnings............................... 24,300
31 Retained Earnings..................................... 22,000Cost of Services Sold.......................... 11,000
Selling, General, and Administrative
Expense........................................... 6,400
Depreciation Expense......................... 4,100
Income Tax Expense............................ 500
31 Retained Earnings..................................... 300
Dividends.............................................. 300
Net income for 2012 was $2,300 ($24,300 $22,000).
Req. 2
Retained Earnings
Expenses 22,000
Dec. 31, 2011 2,600
Dividends 300 Revenues 24,300
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Dec. 31, 2012 4,600
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(15-25 min.) E 3-30A
Journal
DATE ACCOUNT TITLES DEBIT CREDIT
Adjusting Entries
Dec. 31 Unearned Service Revenue............................. 6,300
Service Revenue ($19,500 $13,200)........ 6,600
31 Salary Expense ($4,600 $4,300)................... 300
Salary Payable............................................. 300
31 Rent Expense ($1,600 $1,300)...................... 300
Prepaid Rent................................................ 300
31 Depreciation Expense ($700 $0).................. 700
Accumulated Depreciation......................... 700
31 Income Tax Expense ($1,500 $0).................. 1,500
Income Tax Payable.................................... 1,500
Closing Entries
31 Service Revenue............................................... 19,500
Retained Earnings...................................... 19,500
31 Retained Earnings............................................ 8,400
Salary Expense........................................... 4,600
Rent Expense.............................................. 1,600
Depreciation Expense................................ 700
Income Tax Expense................................... 1,500
31 Retained Earnings............................................ 1,400
Dividends..................................................... 1,400
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(20-30 min.) E 3-31A
Req. 1
Anderson Production CompanyBalance Sheet
December 31, 2012
ASSETS
Current Assets:
Cash................................................................................ $14,100
Prepaid rent ($800 $300)............................................ 500
Total current assets.................................................. 14,600
Plant Assets:
Equipment...... $42,000
Less accumulated depreciation
($3,400 + $700). (4,100) 37,900
Total assets......................................................................... $52,500
LIABILITIES
Current:
Accounts payable.......................................................... $ 5,100
Salary payable ($4,600 $4,300).............................. 300
Unearned service revenue ($9,100 $6,300).............. 2,800
Income tax payable.................................................... 1,500
Total current liabilities.............................................. 9,700
Note payable, long-term..................................................... 16,000
Total liabilities..................................................................... 25,700
STOCKHOLDERS EQUITY
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(30 min.) E 3-32A
a.Current ratio =$50
=1.11 Debt ratio=$40 + $5
= 0.60$40 + $5 $70 + $5
The purchase of equipment on accounthurtsboth ratios.
b.Current ratio=$50 $6
=1.10Debt ratio =$40 $6
= 0.53$40 $70 $6
The payment of long-term debthurtsthe current ratio andimproves
the debt ratio.
c.Current ratio=$50 + $5
=1.22Debt ratio =$40 + $5
= 0.60$40 + $5 $70 + $5
Collecting cash in advancehurtsboth ratios.
d.Current ratio=$50
=1.19 Debt ratio =$40 + $2
=0.60$40 + $2 $70
Accruing an expensehurtsboth ratios.
e.Current ratio= $50 + $6 =1.40 Debt ratio = $40 =.53$40 $70 + $6
A cash saleimprovesboth ratios.
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(5-10 min.) E 3-33B
Statement Reports (in millions)
1. Income statement Sales revenue.. $4,400
Operating expenses... 1,300
Balance sheet Accounts receivable.. $ 700
Accounts payable.. 1,200
2. Cash basis would report only the cash collections of $4,600 from
customers and the payment of operating expenses ($1,300).The
balance sheet would include neither accounts receivable nor
accounts payable.
(5-10 min.) E 3-34B
a. Cash Basis b. Accrual Basis
Revenues... $510,000 $500,000
Expenses... 410,000 450,000
Net income $100,000 $ 50,000
The accrual basis measures net income better because its information
about revenues and expenses is more complete than the information
provided by the cash basis.
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(15-20 min.) E 3-36B
Req. 1
Adjusting Entries
DATE ACCOUNT TITLES DEBIT CREDIT
a.Insurance Expense................................................... 700
Prepaid Insurance ($300 + $900 $500)............ 700
b.Interest Receivable................................................ 1,300
Interest Revenue.................................................. 1,300
c.Unearned Service Revenue ($1,200 $300)........... 900
Service Revenue............................................... 900
d.Depreciation Expense............................................... 4,400
Accumulated Depreciation.................................. 4,400
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e.Salary Expense ($17,000 3/5)................................ 10,200
Salary Payable...................................................... 10,200
f.Income Tax Expense ($26,000 .25)....................... 6,500
Income Tax Payable............................................. 6,500
Req. 2
Net income understated by omission of:
Interest revenue.. $ 1,300
Service revenue............. 900
Total understatement $ (2,200)
Net income overstated by omission of:
Insurance expense $ 700
Depreciation expense.. 4,400
Salary expense.. 10,200
Income tax expense............ 6,500
Total overstatement............ 21,800
Overall effect net income overstated by. $19,600
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(10-15 min.) E 3-37B
Missing amounts initalics.
1 2 3 4Beginning Supplies $ 400 $ 600 $1,100 $ 900
Add: Payments for supplies
during the year 1,600 1,100 1,500 600
Total amount to account for 2,000 1,700 2,600 1,500
Less: Ending Supplies (200) (300) (1,000) (300)
Supplies Expense $1,800 $1,400 $1,600 $1,200
Journal entries:
Situation 1: Supplies. 1,600
Cash.. 1,600
Situation 2: Supplies Expense 1,400
Supplies....... 1,400
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(10-20 min.) E 3-38B
Req. 1
Adjusting Entries
DATE ACCOUNT TITLES DEBIT CREDIT
a.Interest Expense....................................................... 9,000
Interest Payable.................................................... 9,000
b.Interest Receivable................................................... 4,300
Interest Revenue.................................................. 4,300
c.Unearned Rent Revenue ($13,900 / 2 6/12).......... 3,475Rent Revenue....................................................... 3,475
d.Salary Expense ($1,300 3)..................................... 3,900
Salary Payable...................................................... 3,900
e.Supplies Expense..................................................... 1,300
Supplies ($2,900 $1,600)................................... 1,300
f.Depreciation Expense ($140,000 / 5).......................28,000
Accumulated Depreciation.................................. 28,000
Req. 2
Book value = $112,000 ($140,000 $28,000)
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(10-20 min.) E 3-39B
Accounts Receivable Supplies
Bal. 1,400 Bal. 300 (a) 200
(c) 500 Bal. 100
Bal. 1,900
Salary Payable Unearned Service Revenue
(b) 700 (d) 200 1,000
Bal. 700 Bal. 800
Service Revenue Salary Expense
Bal. 4,600 Bal. 2,400
(c) 500 (b) 700
(d) 200 Bal. 3,100
Bal. 5,300
Supplies Expense
(a) 200
Bal. 200
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(20-30 min.) E 3-40B
Honeybee Hams, Inc.
Income Statement
Year Ended December 31, 2012Thousands
Revenues:
Sales revenue.......................... $42,200
Expenses:
Cost of goods sold.................. $25,500
Selling, administrative, and
general expense................... 10,000
Total expenses................... 35,500
Income before tax............................. 6,700
Income tax expense.......................... 2,500
Net income......................................... $ 4,200
Honeybee Hams, Inc.
Statement of Retained Earnings
Year Ended December 31, 2012
Thousands
Retained earnings, December 31, 2011.. $4,600Add:Net income . 4,200
8,800
Less: Dividends (1,400)
Retained earnings, December 31, 2012.. $7,400
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(continued) E 3-40B
Honeybee Hams, Inc.
Balance Sheet
December 31, 2012Thousands
ASSETS LIABILITIES
Cash.$ 3,400 Accounts payable.$ 7,700
Accounts receivable 1,900 Income tax payable.. 600
Inventories. 1,700 Other liabilities.. 2,400
Prepaid expenses 1,700 Total liabilities... 10,700
Prop., plant, equip. $ 6,700 STOCKHOLDERS
Less: Accum. EQUITY
deprec. (2,500) 4,200 Common stock.. 4,500
Other assets.. 9,700 Retained earnings 7,400
Total stockholders equity11,900
Total liabilities andTotal assets $22,600 stockholders equity... $22,600
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(10-20 min.) E 3-41B
One mechanism for solving this exercise is to prepare the relevant T-
accounts, insert the given information, and solve for the unknown
amounts, shown initalics.
Amounts in millions
Receivables
Beg. bal. 210
Sales revenue 21,010 Collections 20,900
End. bal. 320
Prepaid Insurance
Beg. bal. 160
Payment 470 Insurance expense 430
End. bal. 200
Accrued Liabilities Payable
Beg. bal. 640
Payments 4,200
Other operating
expenses 4,290
End. bal. 730
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(10 min.) E 3-42B
Req. 1
Millions
Income statement
Service revenue (380 95).. 285
Balance sheet
Unearned service revenue... 95
Req. 2
Income statement
Service revenue (75 + 380 95) 360
Balance sheet
Unearned service revenue... 95
Service revenue is greater in (2) because Terra began the year owing
more phone service to customers. With collections for the year and the
amount of the ending liability unchanged, Terra must have earned more
revenue in situation 2 than in situation 1.
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Not required but helpful:
Unearned Service Revenue
Beg. bal. 75
Earned revenue 360 Collected cash 380
End. bal. 95
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(10-20 min.) E 3-43B
Req. 1
JournalDATE ACCOUNT TITLES DEBIT CREDIT
Closing Entries
Dec.31 Service Revenue........................................... 24,300
Other Revenue........................................... 200
Retained Earnings................................... 24,500
31 Retained Earnings........................................ 22,500Cost of Services Sold.............................. 11,400
Selling, General, and Administrative
Expense............................................ 6,000
Depreciation Expense............................. 4,500
Income Tax Expense................................ 600
31 Retained Earnings........................................ 400
Dividends.................................................. 400
Net income for 2012 was $2,000 ($24,500 $22,500).
Req. 2
Retained Earnings
Expenses 22,500
Dec. 31, 2011 2,200
Dividends 400 Revenues 24,500
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Dec. 31, 2012 3,800
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(20-30 min.) E 3-45B
Req. 1
Durkin Production Company
Balance SheetDecember 31, 2011
ASSETS
Current:
Cash.... $14,200
Prepaid rent ($1,500 $800)......... 700
Total current assets 14,900
Plant:
Equipment.. $44,000
Less accumulated depreciation
($3,500 + $600)........ (4,100) 39,900
Total assets. $54,800
LIABILITIES
Current:
Accounts payable.................................................................. $ 4,700
Salary payable ($5,600 $4,700).......................................... 900
Unearned service revenue ($8,400 $6,300)....................... 2,100
Income tax payable................................................................ 1,200
Total current liabilities..................................................... 8,900
Note payable, long-term.......................................................... 17,000
Total liabilities.......................................................................... 25,900
STOCKHOLDERS EQUITY
Common stock............................................................................. 8,700
Retained earnings ($11,400 + $9,900* $1,100)........................ 20,200
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Total stockholders equity.......................................................... 28,900
Total liabilities and stockholders equity................................... $54,800
*Net income = $9,900 ($19,600 $5,600 $2,300 $600 - $1,200)
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(continued) E 3-45B
Req. 2
Current
Year
Prior
YearNet working
capital
= Total current assets -
current liabilities =
$14,900 -
$8,900
=$6,000 $7,000
Current
rati
o
=
Total current assets
=
$14,900
= 1.67 1.70Total current liabilities $8,900
Both net working capital and the current ratio have decreased indicating
that the ability to pay current liabilities with current assets has
deteriorated.
Debt ratio =Total liabilities
=$25,900
= 0.47 0.40
Total assets $54,800
The overall ability to pay total liabilities deteriorated a little.
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(30 min.) E 3-46B
a.Current ratio =$60
=1.03 Debt ratio =$70 + $8
= 0.80$50 + $8 $90 + $8
The purchase of equipment on accounthurtsboth ratios.
b.Current ratio =$60 $5
=1.10 Debt ratio =$70 $5
= 0.76$50 $90 $5
The payment of long-term debthurtsthe current ratio andimproves
the debt ratio.
c.Current ratio =$60 + $4
=1.19 Debt ratio =$70 + $4
= 0.79$50 +$4 $90 + $4
Collecting cash in advancehurtsboth ratios.
d.Current ratio =$60
=1.11 Debt ratio =$70 + $4
= 0.82$50 + $4 $90
Accruing an expensehurtsboth ratios.
e.Current ratio = $60 + $8 =1.36 Debt ratio = $70 = 0.71$50 $90 + $8
A cash saleimprovesboth ratios.
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Serial Exercise
(3 hours) E 3-47
Reqs. 1, 2, 5, and 7
Cash Accounts Receivable
Jan. 2 11,000 Jan. 2 700 Jan. 18 1,500Jan. 28 1,500
9 1,000 3 3,900 Bal. 0
21 2,400 12 200 Adj. 2,000
28 1,500 26 400 Bal. 2,000
31 1,200
Bal. 9,500
Supplies Equipment
Jan. 5 400 Adj. 200 Jan. 3 3,900
Bal. 200 Bal. 3,900
Accumulated Depreciation
Equipment Furniture
Adj. 65 Jan. 4 4,700
Bal. 65 Bal. 4,700
Accumulated Depreciation
Furniture Accounts Payable
Adj. 78 Jan. 26 400Jan. 4 4,700
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Bal. 78 5 400
Bal. 4,700
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(continued) E 3-47
Reqs. 1, 2, 5, and 7
Salary Payable Unearned Service RevenueAdj. 500 Adj. 800Jan. 21 2,400
Bal. 500 Bal. 1,600
Common Stock Retained Earnings
Jan. 2 11,000 Clo. 1,743 Clo. 5,300
Bal. 11,000 Clo. 1,200
Bal. 2,357
Dividends Service Revenue
Jan. 31 1,200Clo. 1,200 Jan. 9 1,000
18 1,500
Bal. 2,500
Adj. 2,000
Adj. 800
Clo. 5,300Bal. 5,300
Rent Expense Utilities Expense
Jan. 2 700Clo. 700 Jan. 12 200Clo. 200
Salary Expense
Depreciation Expense
Equipment
Adj. 500 Clo. 500 Adj. 65 Clo. 65
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26 Accounts Payable...................................... 400
Cash........................................................ 400
28 Cash............................................................ 1,500
Accounts Receivable............................. 1,500
31 Dividends................................................... 1,200
Cash...................................................... 1,200
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(continued) E 3-47
Reqs. 3 and 4
Steve Ruiz, Certified Public Accountant, P.C.
Adjusted Trial Balance
January 31, 2012
TRIAL BALANCE ADJUSTMENTS ADJUSTED TRIAL BALANCE
ACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
Cash 9,500 9,500
Accounts receivable (a) 2,000 2,000
Supplies 400 (c) 200 200
Equipment 3,900 3,900
Accumulated depr. equip. (d1) 65 65
Furniture 4,700 4,700
Accumulated depr. furn. (d2) 78 78
Accounts payable 4,700 4,700
Salary payable (e) 500 500
Unearned service revenue 2,400 (b) 800 1,600
Common stock 11,000 11,000
Retained earnings
Dividends 1,200 1,200
Service revenue 2,500 (a)2,000 5,300
(b) 800
Rent expense 700 700
Utilities expense 200 200
Salary expense (e) 500 500
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Depreciation expense equip. (d1) 65 65
Depreciation expense furn. (d2) 78 78
Supplies expense (c) 200 200
20,600 20,600 3,64 3 3,64 3 23,24 3 23,24 3
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(continued) E 3-47
Req. 6
Steve Ruiz, Certified Public Accountant, P.C.Income Statement
Month Ended January 31, 2012
Revenues:
Service revenue $5,300
Expenses:
Rent expense $700
Salary expense 500
Supplies expense 200
Utilities expense 200
Depreciation expense furniture 65
Depreciation expense equipment 78
Total expenses 1,743
Net income $3,557
Steve Ruiz, Certified Public Accountant, P.C.
Statement of Retained Earnings
Month Ended January 31, 2012
Retained earnings, January 1, 2012 $ 0
Add:Net income 3,557
3,557
Less: Dividends (1,200)
Retained earnings, January 31, 2012 $ 2,357
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(continued) E 3-47
Req. 6
Steve Ruiz, Certified Public Accountant, P.C.Balance Sheet
January 31, 2012
ASSETS LIABILITIES
Current assets: Current liabilities:
Cash $ 9,500 Accounts payable $ 4,700
Accounts receivable 2,000 Salary payable 500
Supplies 200 Unearned service
Total current assets 11,700 revenue 1,600
Plant assets: Total current liabilities 6,800
Equipment $3,900
Less: accum. STOCKHOLDERS EQUITY
depr. (65) 3,835Common stock 11,000
Retained earnings 2,357
Furniture $4,700
Less: accum.
Total stockholders equity 13,357
depr. (78) 4,622Total liabilities and ______
Total assets $20,157 stockholders' equity $20,157
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(continued) E 3-47
Req. 7
JournalDATE ACCOUNT TITLES DEBIT CREDIT
Closing Entries
Jan.31 Service Revenue 5,300
Retained Earnings.. 5,300
31 Retained Earnings 1,743
Rent Expense 700Utilities Expense.. 200
Salary Expense 500
Depreciation Expense Equipment... 65
Depreciation Expense Furniture.. 78
Supplies Expense....... 200
31 Retained Earnings 1,200
Dividends.. 1,200
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(continued) E 3-47
Req. 8
Net working
capital
= Total current assets -
current liabilities
$11,700 -
$6,800
= $4,900
Current ratio =Total current assets
=$11,700
= 1.72Total current liabilities $6,800
Debt ratio = Total liabilities = $6,800 = 0.34Total assets $20,157
The company has an excess of current assets over its current liabilities.
The current and debt ratios indicate an excellent financial position. The
business has $1.72 in current assets for every $1.00 of current liabilities.
The debt ratio of 34% is not too high, which suggests that, overall, the
business should be able to pay its debts.
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Quiz
Q3-48 b
Q3-49 bQ3-50 c
Q3-51 d
Q3-52 a
Q3-53 b
Q3-54 b
Q3-55 a
Q3-56 b ($3,000 9/12 = $2,250)
Q3-57 d ($5,000 + $22,000 $15,000 = revenue of $12,000)Q3-58 b
Q3-59 a
Q3-60 b
Q3-61 d
Q3-62 d Current ratio = $29,700 / $25,100 =1.183
Debt ratio =
$25,100 + $113,000
=.633$29,700 + $188,500
Q3-63 $7,965 ($8,000 $510 $125 + $800 $200)
Q3-64 d Salary Payable
Beg. bal. 20,000
Payment 136,000 Salary exp. 122,000
End. bal. 6,000
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Problems
(15-20 min.) P 3-65A
(All amounts in millions)
1. $40 x = $6 ; x = $34
2. Revenues.. $40
Expenses.. (34)
Net income... $ 6
3. Beginning receivables.. $ 10
Add:Revenues 40
Less: Collections... (25)
Ending receivables $25
Balance sheet
ASSETS
Current assets:
Receivables. $ 25
4. Beginning accounts payable. $ 7
Add:Expenses.. 34
Less: Payments.... (37)
Ending accounts payable $ 4
Balance sheet
LIABILITIES
Current liabilities:
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Accounts payable $ 4
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(20-30 min.) P 3-66A
Req. 1
Masters Consulting
Amount of Revenue (Expense) for JulyDate Cash Basis Accrual Basis
July 1 Expense $(2,000) $ 0
4 Expense (1,000) 0
5 Revenue 800 800
8 Expense (700) (700)
11 Revenue 0 3,400
19 0 0
24 Revenue 3,400 0
26 Expense (2,000) 0
29 Expense (1,500) (1,500)
31 Expense 0 $2,000 5 = (400)
31 Revenue 0 1,000
ReReq. 2 Income (loss) before tax $ (3,000) $2,600
Req. 3
The accrual-basis measure of net income is preferable because it accounts
for revenues and expenses when they occur, not when they are received or
paid in cash. For example, on July 11, the company earned $3,400 of
revenue and increased its wealth as a result. The accrual basis records this
revenue, but the cash basis ignores it. On July 24, the business collected
the receivable that was created by the revenue earned on account at July
11. The accrual basis records no revenue on July 24 because the
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companys increase in wealth occurred back on July 11. The cash basis
waits until cash is received, on July 24, to record the revenue. This is too
late.
(10-20 min.) P 3-67A
Journal
DATE ACCOUNT TITLES DEBIT CREDIT
Dec.31 a. Insurance Expense. 4,650*
Prepaid Insurance.. 4,650
To record insurance expense.
31 b. Salary Expense ($5,800 2/5).. 2,320
Salary Payable 2,320
To accrue salary expense.
31 c. Interest Receivable. 600
Interest Revenue 600To accrue interest revenue.
31 d. Supplies Expense.. 6,300**
Supplies.. 6,300
To record supplies expense.
31 e. Unearned Service Revenue
($12,100 60%)... 7,260
Service Revenue 7,260
To record revenue collected in advance.
31 f. Depreciation Expense Office
Furniture
3,000
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Depreciation Expense Equipment.. 6,300
Accumulated Depreciation
Office Furniture.. 3,000
Accumulated Depreciation
Equipment 6,300To record depreciation expense.
_____
*$1,050 + $4,800 $1,200 = $4,650
**$2,300 + $6,100 $2,100 = $6,300
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(45-60 min.) P 3-68A
Req. 1
Lady, Inc.
Adjusted Trial Balance
July 31, 2012
TRIAL BALANCE ADJUSTMENTS ADJUSTED TRIAL BALANCEACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
Cash 8,800 8,800
Accounts receivable 1,600 (a) 1,700 3,300
Prepaid rent 3,000 (b 1,000* 2,000
Supplies 2,100 (c) 1,630 470
Furniture 90,000 90,000
Accumulated depreciation 3,000 (d) 1,500** 4,500
Accounts payable 3,200 3,200
Salary payable (e) 3,000*** 3,000
Common stock 14,000 14,000Retained earnings 75,060 75,060
Dividends 3,900 3,900
Service revenue 17,000 (a) 1,700 18,700
Salary expense 2,400 (e) 3,000*** 5,400
Rent expense (b) 1,000* 1,000
Utilities expense 460 460
Depreciation expense (d) 1,500** 1,500
Supplies expense (c) 1,630 _____ 1,630
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112,260 112,260 8,830 8,830 118,460 118,460_____
*$3,000 3 = $1,000
**$90,000 5 = $18,000 12 = $1,500
***$5,000 3/5 = $3,000
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(continued) P 3-68A
Req. 2 (continued)
Lady, Inc.Balance Sheet
July 31, 2012
ASSETS LIABILITIES
Current assets: Current liabilities:
Cash $ 8,800 Accounts payable $ 3,200
Accounts receivable 3,300 Salary payable 3,000
Prepaid rent 2,000 Total current liabilities 6,200
Supplies 470
Total current assets 14,570
Furniture $90,000
STOCKHOLDERS EQUITY
Less: Accum. Common stock 14,000
deprec. (4,500) 85,500Retained earnings 79,870
Total stockholders equity 93,870
Total liabilities and
Total assets $100,070 stockholders equity $100,070
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(10-20 min.) P 3-69A
Req. 1
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Apr. 30 Accounts Receivable ($6,830 $6,300).......... 530
Rental Revenue. 530
To accrue rental revenue.
30 Interest Receivable ($500 $0).. 500
Interest Revenue ($1,300 $800). 500To accrue interest revenue.
30 Supplies Expense ($400 $0) 400
Supplies ($1,200 $400) 400
To record supplies expense.
30 Insurance Expense ($1,400 $0).. 1,400
Prepaid Insurance ($2,400 $1,000).. 1,400
To record insurance expense.
30 Depreciation Expense ($1,900 $0). 1,900
Accumulated Depreciation
($11,000 $9,100).. 1,900
To record depreciation expense.
30 Wage Expense ($2,300 $1,600)......... 700
Wages Payable ($700 $0)... 700
To accrue wage expense.
30 Unearned Rental Revenue ($1,700 $1,300).. 400
Rental Revenue*.. 400
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To record revenue that was collected in advance.
_____
* ($20,630 - $19,700 - $530)
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(continued) P 3-69A
Req. 2
Total assets = $80,230 ($8,200 + $6,830 + $500 + $4,900 +$800 + $1,000 + $69,000 $11,000)
Total liabilities = $8,800 ($6,800 + $700 + $1,300)
Net income = $15,230 ($20,630 + $1,300 $1,900 $400
$100 $2,300 $600 $1,400)
Total equity =
$71,430 ($80,230 $8,800)or ($19,000 +$41,000 + $15,230 - $3,800)
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(20-30 min.) P 3-70A
Req. 1
Simpson CorporationIncome Statement
Year Ended March 31, 2012
Revenues:
Service revenue $105,500
Expenses:
Salary expense $39,800
Rent expense 10,100
Insurance expense 4,000
Interest expense 2,700
Supplies expense 2,400
Depreciation expense 1,300 60,300
Income before tax 45,200
Income tax expense 7,000
Net income $ 38,200
Simpson Corporation
Statement of Retained Earnings
Year Ended March 31, 2012
Retained earnings, March 31, 2011 $ 2,000
Add:Net income 38,200
40,200
Less: Dividends (23,000)
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Retained earnings, March 31, 2012 $17,200
(continued) P 3-70A
Req. 1 (continued)
Simpson Corporation
Balance Sheet
March 31, 2012
ASSETS LIABILITIES
Cash $ 1,700Accounts payable $ 3,100
Accounts receivable 8,800Interest payable 700
Supplies 2,000Unearned service revenue 800
Prepaid rent 1,700Income tax payable 2,400
Note payable 18,400
Equipment $36,000 Total liabilities 25,400
Less: Accum.
deprec. (4,600)31,400 STOCKHOLDERS EQUITY
Common stock 3,000
Retained earnings 17,200
Total stockholders equity 20,200
Total liabilities and
Total assets $45,600 stockholders equity $45,600
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Req. 2
Debt ratio:$25,400
= 0.56$45,600
Simpson is in compliance with its debt agreement, which requires the
company to maintain a debt ratio no higher than 0.60.
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(20 min.) P 3-71A
Req. 1
JournalDATE ACCOUNT TITLES DEBIT CREDIT
Closing Entries
Mar. 31 Service Revenue.. 94,100
Retained Earnings......... 94,100
31 Retained Earnings.. 35,200
Advertising Expense 11,000Depreciation Expense.. 1,000
Interest Expense... 300
Salary Expense.. 17,900
Supplies Expense. 5,000
31 Retained Earnings.. 32,500
Dividends........ 32,500
Req. 2
Retained Earnings
Mar. 31, 2012 Expenses 35,200Mar. 31, 2011 Bal. 19,500
Mar. 31, 2012 Dividends 32,500Mar. 31, 2012 Revenues 94,100
Mar. 31, 2012 Bal. 45,900
Net income = $58,900 ($94,100 - $35,200)
Req. 3
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Retained Earnings increased during the year because net income of
$58,900 exceeded dividends of $32,500.
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Common stock 10,000
Retained earnings 45,900*
Total stockholders equity 55,900
Total liabilities and stockholders equity $82,300
(continued) P 3-72A
Req. 1 (continued)
*Retained earnings, March 31, 2011. $19,500
Add: Net income ($94,100 $11,000 $1,000
$300 $17,900 $5,000). 58,900
78,400
Less: Dividends........... (32,500)
Retained earnings, March 31, 2012 $45,900
Req. 2
2012 2011
Net working
capital
= Total current assets -
current liabilities
$32,800 -
$20,700
= $12,100 $11,800
Current ratio =
Total current assets
=
$32,800
= 1.58 1.20Total current liabilities $20,700
The increase in both working capital and the current ratio indicate that
the ability to pay current liabilities with current assets improved during
2012.
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2012 2011
Debt ratio =Total liabilities
=$26,400
= 0.32 0.25Total assets $82,300
The overall debt position deteriorated a little during 2012. The
improvement in the current ratio is greater than the deterioration in the
debt ratio. However, Mountain Lodges overall debt position is strong
because a debt ratio of .32 is not troublesome.
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(45-60 min.) P 3-73A
Req. 1
(All amounts in millions)
Current ratio = Total current assets = $15.8 = 1.84Total current liabilities $8.6
$13.9
Debt ratio =Total liabilities
=$8.6 + $5.3
= 0.43Total assets $32.1
Req. 2
Current Ratio Debt Ratio
a.$15.8 ($8.6 1/2)
= 2.67$13.9 ($8.6 1/2)
= 0.35
($8.6 1/2) $32.1 ($8.6 1/2)
b.$15.8 + $2.0
= 2.07$13.9 + $2.0
= 0.47$8.6 $32.1 + $2.0
c.$15.8 + $2.4
= 2.12 $13.9
= 0.40$8.6 $32.1 + $2.4
d.$15.8 $.7
= 1.75 $13.9
= 0.44$8.6 $32.1 $.7
e. $15.8
= 1.74$13.9 + $0.5
= 0.45$8.6 + $0.5 $32.1
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f.$15.8 $1.5
= 1.66 $13.9 + $2.5
= 0.47$8.6 $32.1 + $4.0 $1.5
g.$15.8
= 1.84 $13.9
= 0.44
$8.6 $32.1 $0.4
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(continued) P 3-73A
Req. 3
a.Revenues usuallyincreasethe current ratio.b.Revenues usuallydecreasethe debt ratio.
c.Expenses usuallydecreasethe current ratio.
Note: Depreciation is an exception to this rule.
d.Expenses usuallyincreasethe debt ratio.
e.If a companys current ratio is greater than 1.0, as it is for Harrington,
paying off a current liability will alwaysincreasethe current ratio.
f.Borrowing money on long-term debt will alwaysincreasethe current
ratio andincreasethe debt ratio.
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(15-20 min.) P 3-74B
(All amounts in millions)
1. $37 x = $7; x = $30
2. Revenues.. $37
Expenses.. 30
Net income... $ 7
3. Beginning receivables......... $ 11
Add:Revenues 37
Less: Collections.. (20)
Ending receivables $ 28
Balance sheet
ASSETS
Current assets:Receivables $ 28
4. Beginning accounts payable.. $ 6
Add:Expenses 30
Less: Payments..... (35)
Ending accounts payable. $ 1
Balance sheet
LIABILITIES
Current liabilities:
Accounts payable $ 1
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(20-30 min.) P 3-75B
Req. 1
Healthy Hearts ConsultingAmount of Revenue (Expense) for December
Date Cash Basis Accrual Basis
Dec. 1 Expense $ (3,500) Expense 0
4 Expense $(900) Expense 0
5Revenue $500 Revenue $500
8 Expense $(200) Expense $(200)
11 Revenue 0 Revenue $3,100
19 Expense 0 Expense 0
24 Revenue $3,100 Revenue 0
26 Expense $(1,800) Expense 0
29 Expense $(800) Expense $(800)
31 Expense 0 Expense $(700)
31 Revenue 0 Revenue $400
Req. 2 Income (loss)
before tax $(3,600) Income before tax $2,300
Req. 3
The accrual-basis measure of net income is preferable because it accounts
for revenues and expenses when they occur, not when they are received or
paid in cash. For example, on Dec. 11, the company earned $3,100 of
revenue and increased its wealth as a result. The accrual basis records this
revenue, but the cash basis ignores it. On Dec. 24, the business collected
the receivable that was created by the revenue earned on account at Dec.
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11. The accrual basis records no revenue on Dec. 24 because the
companys increase in wealth occurred back on Dec. 11. The cash basis
waits until cash is received, on Dec. 24, to record the revenue. This is too
late.
(10-20 min.) P 3-76B
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Dec. 31 a. Insurance Expense............................ 3,500*
Prepaid Insurance......................... 3,500
To record insurance expense
31 b. Salary Expense ($6,200 1/5)............ 1,240
Salary Payable........................... 1,240
To accrue salary expense.
31 c. Interest Receivable............................. 500Interest Revenue........................... 500
To accrue interest revenue.
31 d. Supplies Expense............................... 6,800**
Supplies......................................... 6,800
To record supplies expense.
31 e. Unearned Service Revenue($11,900 70%)................................... 8,330
Service Revenue........................... 8,330
To record revenue that was collected
in advance.
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31 f. Depreciation Expense Office .........
Furniture...................................
Depreciation Expense Equipment..
3,500
5,800
Accumulated Depreciation
Office Furniture........................ 3,500Accumulated Depreciation
Equipment................................. 5,800
To record depreciation expense.
_____
*$800 + $3,600 $900 = $3,500
**$2,700 + $6,400 $2,300 = $6,800
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(45-60 min.) P 3-77B
Req. 1
Princess, Inc.
Adjusted Trial Balance
August 31, 2012
TRIAL BALANCE ADJUSTMENTS
ADJUSTED
TRIAL BALANCE
ACCOUNT TITLE DEBIT CREDIT DEBIT CREDIT DEBIT CREDIT
Cash 8,300 8,300
Accounts receivable 1,900 (a) 2,100 4,000
Prepaid rent 2,100 (b) 700* 1,400
Supplies 2,400 (c) 2,090 310
Furniture 63,000 63,000
Accumulated depreciation 3,700 (d) 1,750** 5,450
Accounts payable 4,000 4,000
Salary payable (e) 3,060*** 3,060
Common stock 13,000 13,000Retained earnings 53,430 53,430
Dividends 4,300 4,300
Service revenue 11,000 (a) 2,100 13,100
Salary expense 2,600 (e) 3,060*** 5,660
Rent expense (b) 700* 700
Utilities expense 530 530
Depreciation expense (d) 1,750** 1,750
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Supplies expense (c) 2,090 _____ 2,090
85,130 85,130 9,700 9,700 92,040 92,040
* $2,100 3 = $700
**$63,000 3 = $21,000 12 = $1,750
***$5,100 3/5 = $3,060
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(continued) P 3-77B
Req. 2 (continued)
Princess, Inc.Income Statement
Month Ended August 31, 2012
Revenues:
Service revenue $13,100
Expenses:
Salary expense $5,660
Supplies expense 2,090
Depreciation expense 1,750
Rent expense 700
Utilities expense 530
Total expenses 10,730
Net income $2,370
Princess, Inc.
Statement of Retained Earnings
Month Ended August 31, 2012
Retained earnings, August 1, 2012 $53,430
Add:Net income 2,370
55,800
Less: Dividends (4,300)
Retained earnings, August 31, 2012 $51,500
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(continued) P 3-77B
Req. 2 (continued)
Princess, Inc.Balance Sheet
August 31, 2012
ASSETS LIABILITIES
Current assets: Current liabilities:
Cash $8,300 Accounts payable $ 4,000
Accounts receivable 4,000 Salary payable 3,060
Prepaid rent 1,400Total current liabilities 7,060
Supplies 310
Total current assets 14,010
Furniture $63,000 STOCKHOLDERS EQUITY
Less: Accum. Common stock 13,000
deprec. (5,450) 57,550Retained earnings 51,500
Total stockholders equity 64,500
______Total liabilities and ______
Total assets $71,560 stockholders equity $71,560
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(10-20 min.) P 3-78B
Req. 1
Journal
DATE ACCOUNT TITLES AND EXPLANATION DEBITCREDIT
Apr.30 Accounts Receivable ($6,800 $6,300). 500
Rental Revenue. 500
To accrue rental revenue.
30 Interest Receivable ($400 $0). 400
Interest Income ($400 $0)......... 400
30 Supplies Expense ($700 $0).......... 700
Supplies ($1,300 $600)....... 700
To record supplies expense.
30 Insurance Expense ($1,500 $0).. 1,500
Prepaid Insurance ($2,400 $900).. 1,500
To record insurance expense.
30 Depreciation Expense ($1,400 $0).... 1,400
Accumulated Depreciation
($10,200 $8,800) 1,400
To record depreciation expense.
30 Wage Expense ($2,500 $1,300). 1,200
Wages Payable ($1,200 $0)... 1,200To accrue salary expense.
30 Unearned Rental Revenue ($2,000 $1,800). 200
Rental Revenue*.. 200
To record revenue that was collected in
advance.
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_____
* ($15,700 - $15,000 - $500)
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(20-30 min.) P 3-79B
Req. 1
Nicholl CorporationIncome Statement
Year Ended May 31, 2012
Revenues:
Service revenue $97,800
Expenses:
Salary expense $40,200
Rent expense 10,300
Insurance expense 3,600
Interest expense 2,600
Supplies expense 2,500
Depreciation expense 1,200 60,400
Income before tax 37,400
Income tax expense 7,100
Net income $30,300
Nicholl Corporation
Statement of Retained Earnings
Year Ended May 31, 2012Retained earnings, May 31, 2011 $ 4,000
Add:Net income 30,300
34,300
Less: Dividends (20,000)
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Retained earnings, May 31, 2012 $14,300
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(continued) P 3-79B
Req. 1 (continued)
Nicholl Corporation.Balance Sheet
May 31, 2012
ASSETS LIABILITIES
Cash $ 1,500 Accounts payable $ 3,700
Accounts receivable 8,600 Unearned service
Supplies 2,200 revenue 900
Prepaid rent 1,800 Interest payable 500
Income tax payable 2,100
Equipment $37,300 Note payable 18,800
Less: Accum. Total liabilities 26,000
deprec. (4,100) 33,200
STOCKHOLDERS EQUITY
Common stock 7,000
Retained earnings 14 ,300
Total stockholders equity 21,300
Total liabilities and
Total assets $47,300 stockholders equity $47,300
Req. 2
Debt ratio: $26,000 = 0.55
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$47,300
Nicholl Corporations debt ratio of 0.55 is in compliance with the lenders
debt restriction.
(20 min.) P 3-80B
Req. 1
Journal
DATE ACCOUNT TITLES DEBIT CREDIT
Closing Entries
Mar.31 Service Revenue 91,500
Retained Earnings 91,500
31 Retained Earnings. 36,300
Salary Expense.. 17,700
Supplies Expense. 4,800
Advertising Expense 11,400
Depreciation Expense. 2,000
Interest Expense... 400
31 Retained Earnings. 32,500
Dividends 32,500
Req. 2
Retained Earnings
Mar. 31, 2012 Expenses 36,300Mar. 31, 2011 Bal. 20,000
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Mar. 31, 2012 Dividends 32,500Mar. 31, 2012 Revenues 91,500
Mar. 31, 2012 Bal. 42,700
Net income = $55,200($91,500 - $36,300)
Req. 3
Retained Earnings increased during the year because net income of
$55,200 exceeded dividends of $32,500.
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(30-40 min.) P 3-81B
Req. 1
Cool River Service, Inc.
Balance Sheet
March 31, 2012
ASSETS
Current assets:
Cash....................................................................... $ 7,400
Accounts receivable............................................. 17,000
Prepaid expenses.................................................. 3,000 Supplies................................................................. 5,500
Total current assets.......................................... 32,900
Plant assets:
Equipment..............................................................$42,800
Less: accumulated depreciation..........................(6,900) 35,900
Other assets................................................................ 14,000
Total assets................................................................. $82,800
LIABILITIES
Current liabilities:
Accounts payable.................................................. $14,400
Current portion of note payable........................... 700
Salary payable....................................................... 2,600
Unearned service revenue.................................... 3,600
Total current liabilities...................................... 21,300
Note payable, long-term............................................. 5,600
Total liabilities............................................................. 26,900
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STOCKHOLDERS EQUITY
Common stock............................................................ 13,200
Retained earnings .................................................. 42,7 00*
Total stockholders equity...................................... 55,900
Total liabilities and stockholders equity.................. $82,800
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(continued) P 3-81B
Req. 1 (continued)
_____
*Computation:
Retained earnings, March 31, 2011.. $ 20,000
Add: Net income ($91,500 $11,400 $2,000
$400 $17,700 $4,800).......... 55,200
75,200
Less: Dividends.. (32,500)
Retained earnings, March 31, 2012.. $42,700
Req. 2
2012 2011
Net working
capital
= Total current assets -
current liabilities
$32,900 -
$21,300
= $11,600$11,000
Current ratio =Total current assets
=$32,900
= 1.54 1.30
Total current liabilities $21,300
The increase in both working capital and the current ratio indicate that
the ability to pay current liabilities with current assets improved during
2012.
Debt ratio =Total liabilities
=$26,900
=0.32 0.35Total assets $82,800
Cool River Services overall debt position improved a bit from 2011 to
2012.
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(45-60 min.) P 3-82B
Req. 1
(All amounts in millions)
Current ratio = Total current assets = $15.4 =1.64Total current liabilities $9.4
$14.9
Debt ratio =Total liabilities
=$9.4 + $5.5
=0.48Total assets $31.2
Req. 2
Current Ratio Debt Ratio
a.$15.4 ($9.4 1/2)
= 2.28$14.9 ($9.4 1/2)
= 0.38($9.4 1/2) $31.2 ($9.4 1/2)
b.$15.4 + $3.0
= 1.96$14.9 + $3.0
= 0.52$9.4 $31.2 + $3.0
c.$15.4 + $2.4
= 1.89 $14.9
= 0.44$9.4 $31.2 + $2.4
d.$15.4 $.6
= 1.57 $14.9
= 0.49$9.4 $31.2 $.6
e. $15.4 = 1.59 $14.9 + $0.3 = 0.49$9.4 + $0.3 $31.2
f.$15.4 $2.0
= 1.43 $14.9 + $2.9
= 0.52$9.4 $31.2 + $4.9 $2.0
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g.$15.4
= 1.64 $14.9
= 0.49$9.4 $31.2 $0.9
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7Accrued expenses payable = $1,900 + $500 = $2,400
Conclusion: Valley Forges net working capital and current ratio
improved during 2012. The companys current ratio is
very strong.
(60 min.) E 3-84
a.Net income:
Service revenue:
($161,000 + $1,650 + $32,200).
Expenses:Salary ($37,000 + $3,500).
Depreciation building
Supplies...
Insurance.
Advertising..
Utilities.
Net income..
$194,850
$ 40,500
2,600
3,100
1,500
7,300
2,00057,000
$137,850
b.Total assets:
Cash
Accounts receivable ($7,500 + $32,200)Supplies ($4,600 $3,100)
Prepaid insurance ($3,500 $1,500).
Building
Less: Accum. Depr.
$ 7,300
39,7001,500
2,000
$110,000
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($15,600 + $2,600)..
Land
Total assets.
(18,200) 91,800
53,000
$195,300
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(continued) E 3-84
c.Total liabilities:
Accounts payable..........................................Salary payable...............................................
Unearned service revenue
($5,500 $1,650).......................................
Total liabilities...............................................
Total stockholders equity:
Common stock..............................................Retained earnings, beginning......................
Add: Net income...........................................
Less: Dividends............................................
Total stockholders equity............................
$ 6,100 3,500
3,850
$ 13,450
d.
$ 14,000 $ 46,000
137,850
197,850
(16,000
)
167,850
$181,850
e.Total assets =Total liabilities +Total stockholders equity
$195,300 = $13,450 + $181,850
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(20 min.) P 3-85
Express Detail Inc.
Balance Sheet
December 31, 2012
ASSETS LIABILITIES
Cash (a) $ 15,300 Accounts payable (g) $ 3,000
Accounts receivable (c)1,400 Advertising payable(h) 500
Supplies (d) 1,000 Salary payable (i) 500
Total current assets
Equipment (e) $35,000
Less: Accum.
deprec.(f)(12,000)
17,700
23,000
Unearned gift certificate
revenue (b)
Total liabilities1,2005,200
STOCKHOLDERS EQUITY
Total assets
$40,700
Common stock (j)
Retained earnings (k)
Total stockholders
equity
Total liabilities and
stockholders equity
18,000
17,500
35,500
$40,700
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(continued) P 3-85
Supporting computations
(a) Cash
Bal. 12/31/2011 1,300
Cash collections fromcustomers
Issuance of common stock
31,000
8,000
12,500500
5,000
Salaries paidDividends paid
Purchase of equipment
5,500 Payments of accounts
payable
1,500 Advertising paid1,500
Bal. 1/31/2012 15,300
(b) Unearned Gift Certificate Revenue
800 Bal. 12/31/2011
Gift certificate revenue earned 600 1,000 Sale of gift certificates
1,200 Bal. 1/31/2012 (given)
(c) Accounts Receivable
Bal. 12/31/2011 2,000
Revenue on account 29,400 30,000 Collections from customers*
Bal. 1/31/2012 1,400
* Excludes the $1,000 for gift certificates which was received in advance, not on
account
(d) Supplies
Bal. 12/31/2011 1,500
Purchase of supplies 3,500 4,000 Supplies expense
Bal. 1/31/2012 1,000
(e) Equipment -- $35,000 ($30,000 + $5,000)
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(f) Accumulated depreciation -- $12,000 ($6,000 + $6,000)
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(continued) P 3- 85
(g) Accounts payable
5,000 Bal. 12/31/2011
Payments on account 5,500 3,500 Purchase of supplies
3,000 Bal. 1/31/2012
(h) $2,000 Advertising expense - $1,500 advertising paid
(i) Salary Payable
1,000 Bal. 12/31/2011
Salaries paid 12,500 12,000 Salary expense
500 Bal. 1/31/2012
(j) Common Stock--$18,000 ($10,000 + $8,000)
(k) Retained Earnings
12,000 Bal. 12/31/2011
Dividends 500 6,000 Net income
17,500 Bal. 1/31/2012
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Decision Cases
(25 min.) Decision Case 1
Req. 1 Unadjusted trial balance:Debit Credit
Cash.. $ 8,000
Accounts receivable. 4,200
Supplies... 800
Prepaid rent 1,200
Land.. 43,000Accounts payable.. $12,000
Salary payable 0
Unearned service revenue.. 700
Note payable, due in 3 years.. 23,400
Common stock.. 5,000
Retained earnings. 9,300Service revenue. 9,100
Salary expense... 3,400
Rent expense.. 0
Advertising expense. 900
Supplies expense.. 0
Totals $61,500 $59,500
Out of balance $2,000
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(continued) Decision Case 1
Req. 2 Adjusted trial balance:
Debit Credit
Cash... $8,000
Accounts receivable.. 4,200
Supplies ($800 - $400)... 400
Prepaid rent ($1,200 x 11/12) 1,100
Land ($41,000 + $2,000). 43,000
Accounts payable... 12,000
Salary payable. 1,000
Unearned service revenue ($700 - $500).. 200
Note payable, due in 3 years... 25,400
Common stock 5,000
Retained earnings.. 9,300
Service revenue ($9,100 + $500). 9,600
Salary expense ($3,400 + $1,000) 4,400
Rent expense ($1,200 x 1/12).. 100
Advertising expense.. 900
Supplies expense... 400
Total $62,500 $62,500
Req. 3
Current ratio =$8,000 + $4,200 + $400 + $1,100
$12,000 + $1,000 + $200
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=$13,700
= 1.04$13,200
We might have trouble sleeping at night with a current ratio of 1.04. Tobe safe, the current ratio should be around 1.50 or higher.
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(30-40 min.) Decision Case 3
Req. 1 (your highest price)
Advertising revenue ($22,000 + $4,000) $26,000Expenses:
Salary $4,000
Utilities 900
Other (unrecorded) 1,100
Salary of your manager 5,000 11,000
Your expected monthly net income $15,000
Multiplier to compute price X 16
Your highest price $240,000
Req. 2 (Williams asking price)
SW Advertising, Inc.
Statement of Retained Earnings and Common Stock
June 30, 2012
Beginning retained earnings $ 93,000
Add:Net income
Revenue ($22,000 + $4,000) $26,000
Less: Expenses ($4,000 +
$900 + $1,100) (6,000) 20,000
113,000
Less: Dividends (9,000)
Ending retained earnings $104,000
Common stock 50,000
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Stockholders equity, June 30, 2012 $154,000
Multiplier to compute price X 2__
Williams asking price $308,000
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(continued) Decision Case 3
Req. 3
You may start by offering Williams approximately $225,000 for thebusiness. His asking price is $308,000 so you are starting out quite far
apart. If Williams appears especially eager to sell out, you may be able
to buy the firm for closer to your highest price of $240,000. However, if
he is not so eager to sell and if you want the business badly enough, you
may have to pay somewhere between $240,000 and $308,000. It might
pay to hire an expert to value the businesss assets. You may find that
Williams price is inflated based on the value of its assets. You can
always raise your offer, but you cannot decrease it, so start the
negotiating process with an offer around $225,000.
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Ethical Issues
Ethical Issue 1
1.The journal entry to record the revenue is:
Dec. Accounts Receivable... XXX
Sales Revenue.. XXX
The debit to Accounts Receivable will increase total current assets
and, as a result, increase (improve) the current ratio.
The credit to Sales Revenue will increase total owner equity and, as aresult, decrease (improve) the debt ratio.
2.a. c. The issue is whether it is ethical to record the revenue in the
current year. The contract has been signed, but the implication is that
the company will not have done everything it needs to do in order to
earn the revenue in the current year. The stakeholders are the
company, the bank, the stockholders, and the companys other
creditors. From an economic standpoint, the entry would obviously
improve the companys short term financial position. However, the
advantage would probably be short-lived. When the bank finds out
about this entry, they will likely protest, and demand immediate
payment, so the longer-term economic impact will likely be negative.
From a legal standpoint, to record this transaction in December
violates GAAP by violating therevenue principle. In this case Cross
Timbers has not made the sale (has not delivered the merchandise) tothe customer and, therefore, has not earned the revenue prior to
December 31 of the current year. From an ethical standpoint,
recording this revenue violates the banks rights for proper disclosure
of the companys income and assets. Revenue should be recorded
no earlier than when it is earned. Cross Timbers expects to earn the
revenue in January of next year. Cross Timbers clearly cannot record
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this revenue until it is earned. To do so is not in their best economic,
legal (GAAP) or ethical best interests.
(continued) Ethical Issue 1
3.The authors would suggest either of two actions. Cross Timbers can
either:
a.Report the current ratio of 1.47 and the debt ratio of .51 because
these are the true values. Then tell the bank of the signed contract
for additional work and the hope for a better set of ratio values next
year. In some cases, banks will agree to sign awaiverof the terms
of loan covenants, meaning that, although the company is in
violation, the bank will not move to enforce the covenant. They
may give Cross Timbers a grace period to cure the violation in
the covenant.
b.Pay off some current liabilities before year end. This will improve
both the current ratio and the debt ratio. This may enable Cross
Timbers to bring its ratio values into compliance with the banks
requirements.
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Ethical Issue 2
1.These transactions overstate the reported income of the company by
$21,000 ($10,000 + $10,000 + $1,000).
2.It appears that Almond wants to improve the companys reported
income in order to borrow on favorable terms. Her action isunethical
and probably illegal as wellbecause she is deliberately overstating
the companys reported income.
Almond appears to be letting the potential short term economic
advantage of these deliberate misstatements take precedence. She
needs to remember that these misstatements violate GAAP, and that,
depending on what use is made of the financial statements, could
subject the company to civil or criminal legal proceedings. If this
happens, the short term economic gains ($21,000) would not even
come close to the long-term economic costs associated with the legal
actions, not to mention the negative publicity. The business will
need a bank loan, and perhaps the money would be used to pay bills,
expand the business, and so on. However, based on Almonds lack of
integrity, the money may be destined for her own use. Regardless of
its use, the money is obtained under false pretenses and cannot be
headed for a good outcome.
The bank is harmed by Almonds and Lails actions. Lending
money to Almond under false pretenses may lead the bank to charge
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an unrealistically low interest rate that robs the banks owners of
interest revenue. In the extreme, the public is robbed if taxpayers
wind up financing the bailout of a failed institution.
3.Personal advice will vary from student to student. The purpose of
asking this question is to challenge students to take the high road of
ethical conduct by having nothing to do with Almonds scheme. The
authors would advise Lail, the accountant, to take these actions, in
order:
a.Refuse to take any part in Almonds scheme, explaining that the
result is overstatement of reported income. This is both illegal and
unethical, and will ultimately have a negative economic impact on
the company, as well. Accountants are bound to standards of
ethical conduct that these actions violate. The can go to prison
when caught falsifying financial statements.
b.To remain ethical, the accountant must be willing to lose his/her
job. It is better to protect ones reputation even if that causes a
short-term hardship.
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Focus on Financials: Amazon.com, Inc.
(15-20 min.)
Req. 1
Accrued expenses are expenses that have been incurred but that have
not yet been paid as of the balance sheet date. The accrual and
matching concepts require that all expenses be recognized (recorded)
during the period in which they are incurred in order to earn revenue,
regardless of when they are paid.
Req. 2 and Req. 4 (balances in millions at December 31, 2008)
Accrued expenses and other
Beg. Bal. $1,759
(a) 1,759 (b) 2,321End. Bal