P3-16 (Appendix). Comprehensive: Statements From Incomplete Records. (Challenging) Prepare worksheet and financial statements from checkbook. Periodic inventory system.
45-90
3-2
Number ContentTime Range(minutes)
P3-17 (AICPA adapted). (Appendix). Comprehensive. (Challenging) Accrual adjustments to cash-basis records, worksheet, statement of changes in capital. Periodic inventory system.
45-90
ANSWERS TO QUESTIONS
Q3-1 A primary objective of financial reporting is to provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions.
Q3-2 An accounting system is the means by which a company records and stores the financial and managerial information from its transactions so that it can retrieve and report the information in an accounting statement.
Q3-3 A double-entry system standardizes the method that a company uses to record changes in its accounts resulting from various transactions or events. For each transaction or event that a company records, the dollar amount of the debits entered in all the related accounts must be equal to the total dollar amount of the credits. These debit or credit entries affect two or more accounts in the assets, liabilities, and stockholders' equity (including the temporary accounts). All normal accounts on the left side of the accounting equation (assets) are increased by debits and decreased by credits whereas accounts on the right side of the equation (liabilities and stockholders' equity) are increased by credits and decreased by debits.
Q3-4 A permanent account is an account whose balance at the end of the accounting period is carried forward into the next accounting period. Examples: Cash, Accounts Payable, Capital Stock. A temporary account is an account that is used temporarily to determine the change in retained earnings that occurred during the accounting period. The balance in a temporary account is closed out at the end of the period. Examples: Sales, Cost of Goods Sold, Salaries Expense.
Q3-5 The major financial statements of a company include:
a. The income statement, which summarizes the results of the company's income-producing activities for the accounting period.
b. The balance sheet, which summarizes the amounts of the assets, liabilities, and stockholders' equity of the company at the end of the accounting period.
c. The statement of cash flows, which summarizes the cash receipts and cash payments of the company for the accounting period.
Some companies also have a fourth financial statement for reporting their comprehensive income.
3-3
Q3-6 a. An account is used by a company to store the recorded monetary information from its transactions and events. An account can be in several physical forms such as a location on a computer disk or a standardized business paper.
b. A contra account is an account created to emphasize a reduction from a related account.
c. A ledger is the group of accounts for a company.
d. A journal is used by a company to initially record the debit and credit entries to all accounts affected by its transactions.
e. Posting involves transferring the date and debit and credit amounts from the journal entries to the appropriate debit and credit sides of the applicable accounts in the general or subsidiary ledger.
Q3-7 The advantages to a company of initially recording each transaction in a journal include the following.
a. Use of a journal helps to prevent errors because all account titles and debit and credit entries are initially recorded in one place.
b. All the transactional information is recorded in one place, thereby providing a complete picture of the transaction.
c. Since the transactions are recorded as they occur, the journal also provides a chronological record of the company's financial transactions.
Q3-8 A perpetual inventory system is one in which the inventory account is updated each time a company makes a purchase or sale. When a company purchases inventory, it records the increase (debit) directly in its Inventory account. When it makes a sale, it records two journal entries. The first entry records the sales revenue at the retail price. The second entry records an increase (debit) in the Cost of Goods Sold account and a decrease (credit) in the Inventory account for the cost of the inventory.
Q3-9 a. Purchase of land on creditb. Sale of capital stock for cashc. Collection of accounts receivabled. Payment of accounts payablee. Retirement of capital stock for cash (note: many examples may show a
decrease in an asset and an increase in a contra-stockholders' equity account)
Q3-10 a. Purchase of merchandise on credit b. Return of defective merchandise for creditc. Purchase of merchandise for cashd. Return of defective merchandise for cash refund
3-4
Q3-11 The steps that a company completes in the accounting cycle include:
a. Recording daily transactions or events in a journal. The daily transactions or events are recorded in the general journal.
b. Posting journal entries to the accounts in the general ledger. The dates and debit and credit amounts from the journal entries in the general journal are transferred to the appropriate debit and credit sides of the applicable accounts in the ledger.
c. Preparing and posting adjusting entries. At the end of the accounting period, certain accounts are updated through the use of an adjusting entry so that financial statements include the correct amounts for the current period. Those entries are transferred (by posting) to the appropriate accounts in the ledger just as the other journal entries are.
d. Preparing the financial statements. After all the adjusting entries have been posted to the general ledger, an adjusted trial balance is prepared. From the adjusted trial balance, the income statement, the retained earnings statement, and the balance sheet are prepared.
e. Preparing and posting closing entries. All the temporary accounts are closed (their balances are reduced to zero) and the retained earnings account is updated by closing entries which are posted to the general ledger.
Q3-12 For most companies, not all of their accounts are up to date at the end of the accounting period. Some of these accounts need to be adjusted so that all revenues and expenses are recorded and the balance sheet accounts have a correct ending balance. This is accomplished through the use of adjusting entries.
Q3-13 A prepaid expense is a good or service purchased by a company for use in its operations, but which has not been fully used up by the end of the accounting period.
Example: Assume the company paid for a two year insurance policy on July 1, in the amount of $400 and recorded this as Prepaid Insurance. At the end of the year, the following adjusting entry is necessary:
Insurance Expense [($400 2) x 1/2] 100Prepaid Insurance 100
A deferred revenue is a payment received by a company in advance for the future delivery of inventory or performance of services.
Example: Assume the company received 6 months rent, totaling $1,200 in advance on November 1 and recorded the receipt as Unearned Rent. On December 31, the following adjusting entry is necessary:
Unearned Rent ($1,200 x 2/6) 400Rent Revenue 400
3-5
Q3-14 An accrued expense is an expense that a company has incurred during the accounting period but has neither paid nor recorded.
Example: Assume a company pays employees' salaries once a month on the 15th of the month. The monthly salaries payment is $5,000. On December 31, the following adjusting entry is necessary:
Salaries Expense ($5,000 x 1/2) 2,500Salaries Payable 2,500
An accrued revenue is a revenue that a company has earned during the accounting period but has neither received nor recorded.
Example: Assume a company received a 90-day note receivable dated December 1. The note has a face value of $10,000 and bears an annual interest rate of 12%. The adjusting entry on December 31 is:
Interest Receivable ($10,000 x 0.12 x 1/12) 100
Interest Revenue 100
Q3-15 Examples of adjusting entries used to record estimated items include:
a. Estimation of bad debts: Assume a company adopts a policy of providing allowance for bad debt losses that is equal to ½% of net sales. In the current year, the company has net sales of $1,500,000. The adjusting entry on December 31 is:
Bad Debt Expense($1,500,000 x 0.005) 7,500
Allowance for Doubtful Accounts 7,500
b. Estimation of depreciation expense: The cost of a depreciable asset is systematically allocated as an expense to each accounting period in which the asset is used. This allocation process is called depreciation. Assume that on July 1 of the current year, a company purchased certain office equipment for $20,000, which is estimated to have a useful life of 10 years and a residual value of $500. Depreciation expense is calculated using the following formula (assuming the straight-line method is used):
On December 31 of the current year, the company records the following adjusting entry relating to its depreciation expense:
Depreciation Expense 975Accumulated Depreciation
[($20,000 - $500) 10 x 1/2] 975
3-6
Q3-16 A trial balance lists all of the account balances of a company but does not include the effect of adjusting entries on the accounts. An adjusted trial balance lists all of the account balances of a company after the adjusting entries have been posted to the accounts and before closing entries have been made.
Items on an adjusted trial balance can be readily classified as belonging on either the income statement, retained earnings statement, or balance sheet. Therefore, a company's financial statements can be easily prepared by using the information on the adjusted trial balance.
Q3-17 A sales return occurs when a customer returns merchandise and receives a refund. A sales allowance occurs when a customer agrees to keep damaged merchandise and the company refunds a portion of the selling price. Both sales returns and sales allowances are subtracted from sales revenue to determine net sales.
Q3-18 When a company uses a periodic inventory system, the company records its purchases of inventory using a purchases account. It does not reduce its inventory when it makes a sale. Instead, it takes a physical inventory at the end of its accounting period. The company computes its cost of goods sold as follows:
Beginning inventory $XXAdd: Net purchases (including subtractions for
returns, allowances, and discounts taken) XXCost of goods available for sale $XXLess: Ending inventory (XX)Cost of goods sold $XX
Q3-19 Closing entries are made by a company at the end of its accounting period to reduce the balance in each temporary account to zero and to update the retained earnings account. After the company posts its closing entries, each temporary account begins the next accounting period with a zero balance, which makes it easier to summarize the company's net income and dividend information for the next accounting period. The retained earnings balance is also updated and becomes the next period's beginning balance.
Q3-20 Dec. 31 Sales RevenueInterest Revenue
Income SummaryTo close the temporary accounts withcredit balances.
Dec. 31 Income SummaryCost of Goods Sold
Depreciation Expense Salaries Expense Rent Expense Interest Expense Bad Debt Expense Utilities Expense Income Tax Expense To close the temporary accounts
with debit balances.
3-7
Q3-20 (continued)
Dec. 31 Income SummaryRetained Earnings
To close the income summary balance(i.e., net income) to retained earnings.
Dec. 31 Retained Earnings Dividends Distributed
To close the dividends to retainedearnings.
Q3-21 A worksheet is a large sheet of multicolumn accounting paper prepared by a company at the end of an accounting period to minimize errors, simplify recording in the general journal of the adjusting and closing entries, and make it easier to prepare the financial statements. It has a column for listing all the ledger accounts, and debit and credit columns for the trial balance, adjustments, income statement, retained earnings statement, and balance sheet. The trial balance is listed with the current accounts and balances. Year-end adjustments are then initially entered on the worksheet. The trial balance amount of each account is combined with the adjustments to that account and carried over to the proper column of the financial statement in which the account is located. After each column is properly totaled and checked, financial statements, adjusting entries, and closing entries can be prepared from the information contained in the worksheet.
Q3-22 Reversing entries are the exact reverse (accounts and amounts) of adjusting entries. They are usually made at the same time as closing entries but are dated the first day of the next accounting period. The use of reversing entries is optional; reversing entries are used to simplify the recording of a later transaction related to the adjusting entry. The later transaction can be recorded routinely, without the need to consider the possible impact of the prior adjusting entry.
Assume the ABC Company pays employees' salaries every Friday (5-day work week), the weekly payroll amounts to $6,000, and December 31 falls on Tuesday. The adjusting, reversing, and payment entries are as follows:
To reverse adjusting entryrelating to salaries payable.
Jan. 3 Salaries Expense 6,000 Cash 6,000
To record payment of weeklysalaries.
3-8
Q3-23 A subsidiary ledger is a group of accounts, all of which relate to one specific company activity, such as the sale or purchase on credit. It is common to have an Accounts Receivable subsidiary ledger and an Accounts Payable subsidiary ledger. When a subsidiary ledger is used, a control account is kept in the general ledger. On any balance sheet date, the balance of a control account must always be equal to that of the subsidiary ledger. Subsidiary ledgers and control accounts are used by large companies selling on credit to many customers and purchasing on credit from many suppliers. If all the customer and supplier accounts were included in the general ledger, this ledger would substantially increase in size. To reduce the size of the general ledger, minimize errors, divide the accounting task, and keep up-to-date records of the company's dealings with credit customers and suppliers, it usually creates a subsidiary ledger.
Example: Assume a company sells goods on account to three customers, A, B, and C. During the year, the following transactions occurred and were recorded in a general journal.
January 15 Sale to A $1,200February 29 Sale to B 800April 25 Collection from A 500June 7 Sale to C 2,400July 28 Collection from B 400September 5 Collection from A 400October 21 Collection from B 200November 3 Sale to C 1,700December 5 Sale to A 1,500December 22 Collection from C 2,400
The Accounts Receivable control account in the general ledger and the Accounts Receivable subsidiary ledger accounts will appear as follows:
General Ledger Accounts Receivable Subsidiary Ledger
C06/07 2,400 12/22 2,40011/03 1,70012/31 Bal 1,700
3-9
Q3-24 Special journals are journals used by a company to record transactions with a similar characteristic, such as credit sales and cash payments. Advantages of using special journals are that (1) they allow the accounting task to be divided, (2) they reduce the time needed to complete the various accounting activities, and (3) they provide for a chronological listing of similar transactions.
Q3-25 The major special journals and an example of the transactions that are recorded in each of them are as follows:
(1) Sales journal-sales of merchandise on credit(2) Purchases journal-purchases of merchandise on credit(3) Cash receipts journal-receipts of cash(4) Cash payments journal-payments of cash(5) General journal-adjusting, closing, and reversing entries and other
transactions not recorded in the special journals. Note: The general journal is not a special journal but is used with special journals as indicated.
Q3-26 The common software for the financial accounting functions include accounts receivable, accounts payable, inventory, payroll, and general ledger software.
Q3-27 Under cash-basis accounting, a company records revenues when it collects cash from sales and records expenses when it pays cash for its operations. To convert its cash-basis accounting records to an accrual-based income statement, the company must adjust its cash receipts to convert them to sales revenues and must adjust its cash payments to convert them to cost of goods sold and operating expenses.
3-10
SOLUTIONS TO EXERCISES
E3-1
Beginning balance sheet: AS = LB + CC + RE
Income statement: Rev. - Exp. = NI
Retained earnings statement: End. RE = Beg. RE + NI - Div.
Ending balance sheet: AS = LB + CC + RE
Where AS = Assets LB = Liabilities CC = Contributed Capital RE = Retained Earnings NI = Net Income Div. = Dividends Exp. = Other Expenses Rev. = Revenues
Purchased equipment making a $2,000down payment and agreed to pay balance in 60 days.
21 Inventory 600 Cash 600
Purchased inventory for cash.
27 Cash 2,600
Land 1,900 Gain on Sale of Land 700
Sold land at a gain.
E3-3
1. June 3 Cash 700Accumulated Depreciation:
Office Equipment 1,500 Gain on Sale of Office Equipment 200 Office Equipment 2,000
Sold office equipment at a gain.
7 Accounts Receivable 2,000 Sales Revenue 2,000
Made credit sales.
7 Cost of Goods Sold 1,200Inventory 1,200
To record cost of sales.
10 Inventory 1,000 Cash 1,000
Purchased inventory for cash.
3-12
E3-3 (continued)1. (continued)
June 15 Office Equipment 4,000 Cash 1,500 Notes Payable 2,500
Purchased new office equipment,paying $1,500 and signing a 90-daynote for the difference.
16 Cash 2,000
Accounts Receivable 2,000Collected June 7 accountsreceivable.
17 Cash 4,200
Sales Revenue 4,200Made cash sales.
17 Cost of Goods Sold 2,300 Inventory 2,300
To record cost of sales.
20 Inventory 2,600 Accounts Payable 2,600
Purchased merchandise on credit.
24 Accounts Payable 200 Inventory 200
Returned defective merchandise forcredit.
29 Accounts Payable 2,400 Cash 2,400
Paid for June 20 purchases lessreturn.
30 Utility Expense 210 Cash 210
Paid the monthly utility bill.
3-13
E3-3 (continued)
2. General Ledger
Cash Accounts Receivable6/01 Bal 12,523 6/10 1,000 6/01 Bal 23,052 6/16 2,0006/03 700 6/15 1,500 6/07 2,0006/16 2,000 6/29 2,400 6/30 Bal 23,0526/17 4,200 6/30 2106/30 Bal 14,313
Inventory6/01 Bal 16,300 6/07 1,200
6/10
1,000 6/17 2,300
6/20
2,600 6/24 200
6/30 Bal 16,200
Office Equipment Accumulated Depreciation
6/01 Bal 35,860 6/03 2,000 6/03 1,500 6/01 Bal 10,5406/15 4,000 6/30 Bal 9,0406/30 Bal 37,860
Notes Payable Accounts Payable6/01 Bal 3,400 6/24 200 6/01 Bal 3,5006/15 2,500 6/29 2,400 6/20 2,6006/30 Bal 5,900 6/30 Bal 3,500
Sales Revenue Gain on Sale of Office Equipment6/01 Bal 47,872 6/01 Bal 4006/07 2,000 6/03 2006/17 4,200 6/30 Bal 6006/30 Bal 54,072
Cost of Goods Sold6/01 Bal 22,3546/07 1,2006/17 2,3006/30 Bal 25,854
Utility Expense6/01 Bal 1,1246/30 2106/30 Bal 1,334
3-14
E3-4
RULE CORPORATIONIncome Statement
For Year Ended December 31, 2007
Sales revenue (net of $600 returns) $15,600Cost of goods sold (8,300)Gross profit on sales $ 7,300Operating expenses (3,800)Income from operations $ 3,500Other items
Interest expense $(800)Gain on sale of land 500 (300)
Income before income taxes $ 3,200Income tax expense (960)Net income $ 2,240
Earnings per share (800 shares) $ 2.80
E3-5
RAYNOLDE COMPANYCost of Goods Sold Schedule
For Year Ended December 31, 2007
Inventory, 1/1/2007 $10,800
Purchases 21,200Purchases returns and allowances (1,400)Purchases discounts (600)Cost of goods available for sale $30,000Less: Inventory, 12/31/2007 (11,900)Cost of goods sold $18,100
3-15
E3-61. TURTLE COMPANY
Income StatementFor Year Ended December 31, 2007
Sales revenue $7,900
Cost of goods sold (4,300)Gross profit on sales $3,600Operating expenses Selling expenses $1,800
Administrative expenses 600 Total operating expenses (2,400)Income before income taxes $1,200Income tax expense (360)Net Income $ 840
Earnings per share (400 shares) $ 2.10
2. TURTLE COMPANYStatement of Retained Earnings
For Year Ended December 31, 2007
Retained earnings, January 1, 2007 $2,500Add: Net income for 2007 840
$3,340Less: Dividends for 2007 (200)Retained earnings, December 31, 2007 $3,140
1,320Common stock, no par 165,000Retained earnings 24,958Sales revenue
44,100Sales returns and allowances 1,767Gain on sale of land 350Cost of goods sold 35,440Sales salaries expense 6,720Office salaries expense 4,690Advertising expense 1,670Utility expense 1,845Interest revenue
580Interest expense 210
$317,078 $317,078
3-38
P3-2
1. STERN COMPANYIncome Statement
For Year Ended December 31, 2007
Sales revenue (net of $2,100 returns) $30,900Cost of goods sold (15,040)Gross profit on sales $15,860Operating expenses
31 Income Tax Expense 3,087Income Taxes Payable 3,087
To record income tax liability on currentearnings ($27,749 - 435 + 300 + 200 - 11,800 - 960 - 140 + 292 - 600 - 787 - 2,300 - 302 - 927 = $10,290 x 30% = $3,087).
*Note to Instructor: Students may erroneously debit an asset account such as Prepaid Interest. It should be made clear that the Discount on Notes Payable account is a contra-liability account to Notes Payable. This is discussed more fully in Chapter 13.
P3-6
1. 2007Dec. 31 Depreciation Expense 3,960
Accumulated Depreciation 3,960To record depreciation expense.
31 Interest Expense 810Interest Payable 810+
To record accrued interest.
31 Bad Debts Expense 410Allowance for Doubtful Accounts 410
2. RReversing entries should be made on January 1, 2008.
R*Only the Rent Receivable ($385) portion of this entry should be reversed.+Interest Payable ($810) would not be reversed since it is not due until 5/14/2009.
3-48
P3-7
2007Dec. 31 Interest Receivable 500
Interest Revenue 500To recognize interest earned($10,000 x 10% x 6/12).
31 Prepaid Insurance 2,375Insurance Expense 2,375
To adjust overstated insuranceexpense ($3,000 x 19/24).
31 Depreciation Expense 2,080Accumulated Depreciation: Building 2,080
To record depreciation of buildingfor the year [($60,000 - $8,000) 25].
(a) Depreciation expense: $1,100 on buildings, $600 on equipment (b) $240 bad debts expense (c) Accrued interest: $50 on note payable, $530 on mortgage payable(d) $175 expired insurance (e) $370 accrued salaries(f) $800 rent collected in advance and now earned(g) $230 office supplies on hand at year-end(h) $50,155 - $39,125 = $11,030 pretax income x 30% = $3,309 income tax expense
3. FIORILLO COMPANYIncome Statement
For Year Ended December 31, 2007
Sales revenue $49,355
Cost of goods sold (27,185)Gross profit on sales $22,170Operating expenses
Property and Equipment Land $ 4,500 Buildings and equipment $20,600 Less: Accumulated depreciation (9,600) 11,000 Total property and equipment $15,500Total Assets
$29,630
LiabilitiesCurrent Liabilities
Accounts payable $ 4,050 Salaries payable
250 Utilities payable 80 Income taxes payable 3,105
Total current liabilities $ 7,485Long-Term Liabilities
Assuming the remaining office suppliesare used during 2008 no furtheradjusting entry is necessary.
1 Salaries Expense 300Advances to Sales Personnel 300
Assuming the sales persons earn theremaining salary advance during 2008no further adjusting entry is necessary.
*In each of these cases, making reversing entries enables the company to record subsequent transactions in a routine fashion without the necessity of referring to the previous adjusting entries.
P3-15
1. 2007Dec. 4 Cash
3,000Sales Revenue 3,000
Made cash sales.
4 Cost of Goods Sold 1,800Inventory 1,800
To record cost of sales.
7 Inventory 2,400Accounts Payable 2,400
Purchased inventory on credit.
11 Sales Returns 600Accounts Receivable 600
Customer returned inventoryfor credit.
11 Inventory 360Cost of Goods Sold 360
To record returned inventory.
14 Cash 900
Accounts Receivable 900Collected on accounts receivable.
3-63
P3-15 (continued)1. (continued)
Dec. 18 Cash 7,800
Land 5,000Gain on Sale on Land 2,800
Sold land at a gain.
20 Accounts Receivable 4,000Sales Revenue 4,000
Made credit sales.
20 Cost of Goods Sold 2,400Inventory 2,400
To record cost of sales.
21 Accounts Payable 360Inventory 360
Returned defective merchandise forcredit.
27 Inventory 1,250Cash 1,250
Purchased inventory for cash.
28 Accounts Payable 1,100Cash 1,100
Paid on accounts payable.
31 Land 6,000
Cash 1,000Notes Payable 5,000
Purchased land paying a $1,000down payment and signing a 12%,2-year note for the balance.
2. Note to Instructor: Only the accounts to which postings are made are shown below and on next page.
Cash Accounts Receivable12/01 Bal 3,090 12/2
71,250 12/01 Bal 9,900 12/14 600
12/04 3,000 12/28
1,100 12/20 4,000 12/14 900
12/14 900 12/31
1,000 12/31 Bal 12,400
3-64
12/18 7,80012/31 Bal 11,440
3-65
P3-15 (continued)2. (continued)
Inventory12/01 Bal 17,750 12/0
41,800
12/07 2,400 12/20
2,400
12/11 360 12/21
360
12/27 1,25012/31 Bal 17,200
Land Accounts Payable12/01 Bal 9,000 12/1
85,000 12/21 360 12/01 Bal 10,700
12/31 6,000 12/28 1,100 12/07 2,40012/31 Bal 10,000 12/31 Bal 11,640
Notes Payable Sales Revenue12/0
1Bal 0 12/01 Bal 76,000
12/31
5,000 12/04 3,000
12/31
Bal 5,000 12/20 4,000
12/31 Bal 83,000
Sales Returns Gain on Sale of Land12/01 Bal 6,300 12/01 Bal 012/11 600 12/18 2,80012/31 Bal 6,900 12/31 Bal 2,800
Cost of Goods Sold12/01 Bal 36,860 12/1
1360
12/04 1,80012/20 2,40012/31 Bal 40,700
3-66
P3-16 (con
ZU COMPANYWorksheet
For Year Ended December 31, 2007
Trial Balance Adjustments Income StatementRetained Earnings
CashAccounts receivableAllowance for doubtful accountsInventory SuppliesLandBuildings and equipmentAccumulated depreciationAccounts payableNotes payableCapital stock, no par (2,000 shares)Retained earnings (1/1/07)Dividends distributedSales revenueSales returns Gain on sale of landCost of goods soldSalaries expenseAdvertising expenseOther expenses
