ANSWERS TO QUESTIONS - CHAPTER 2 1. Accrual accounting attempts to record the effects of accounting events in the period when such events occur, regardless of when cash is received or paid. The goal is to match expenses with the revenues that they produce. 2. Recognition is the act of recording an event in the financial statements. When accruals are used, events are recognized before the associated cash is paid or collected. 3. An asset source transaction increases assets and increases either liabilities or equity. 4. The capital acquisition from owners increases business assets (usually cash) and equity (capital stock, common or preferred stock). 5. The recognition of revenue on account increases the corresponding revenue account on the income statement, but does not affect the statement of cash flows. The cash flow statement is affected when the account is collected. 6. Asset Source Transaction Effect on Accounting Equation Issue of Common Stock Increases Assets, Increases Common Stock Revenue Earned Increases Assets, Increases 2-1
Transcript
ANSWERS TO QUESTIONS - CHAPTER 2
1. Accrual accounting attempts to record the effects of accounting events in the period when such events occur, regardless of when cash is received or paid. The goal is to match expenses with the revenues that they produce.
2. Recognition is the act of recording an event in the financial statements. When accruals are used, events are recognized before the associated cash is paid or collected.
3. An asset source transaction increases assets and increases either liabilities or equity.
4. The capital acquisition from owners increases business assets (usually cash) and equity (capital stock, common or preferred stock).
5. The recognition of revenue on account increases the corresponding revenue account on the income statement, but does not affect the statement of cash flows. The cash flow statement is affected when the account is collected.
6. Asset Source Transaction Effect on Accounting Equation
Issue of Common Stock Increases Assets, Increases
Common Stock
Revenue Earned Increases Assets, Increases
Retained Earnings
Borrowed Funds Increases Assets, Increases
Liabilities
7. Revenue is recognized under accrual accounting when a revenue-producing transaction occurs, i.e., when the
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revenue is earned, even if no cash is collected at the time of the transaction.
8. The collection of cash for accounts receivable is an asset exchange transaction. Only the asset side of the accounting equation is affected because one asset account increases (cash), and another asset account decreases (accounts receivable). Total assets are unchanged.
9. The recognition of expenses affects the accounting equation by either decreasing assets or by increasing liabilities (payables) and decreasing stockholders’ equity (retained earnings).
10. A claims exchange transaction is one where the claims of creditors (liabilities) increase and the claims of stockholders’ (retained earnings) decrease, or vice versa. The total amount of claims is unchanged.
11. Cash payments to creditors are asset use transactions. These transactions result in the reduction of an asset account (cash) and the reduction of the corresponding liability account (payables).
12. Expenses are recognized under accrual accounting at the time the expense is incurred or resources are consumed, regardless of when cash payment is made.
13. Net cash flows from operations on the cash flow statement may be different from net income because of the application of accrual accounting. Revenues and expenses reported on the income statement may be recognized before the actual collection or payment of cash that is reported on the cash flow statement.
14. The income statement reflects the change in net assets associated with operating a business, as shown by revenues and expenses. Expenses may result from a decrease in assets or an increase in liabilities. Revenues
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may result from an increase in assets or a decrease in liabilities.
15. Net assets is defined as assets minus liabilities or as stockholders’ equity (common stock + retained earnings).
16. Net income increases stockholders' claims on business assets by increasing retained earnings.
17. An expense is a decrease in assets or an increase in liabilities that occurs in the process of generating revenue.
18. Revenue is an increase in assets or a decrease in liabilities that results from the operating activities of the business.
19. The purpose of the statement of changes in stockholders’ equity is to display the effects of business operations and stock issued to owners and dividends paid to stockholders. It identifies the ways that an entity's equity increased and decreased as a result of its operations and transactions with its stockholders.
20. The purpose of the balance sheet is to provide information about an entity's assets, liabilities, and stockholders’ equity and their relationships to each other at a particular point in time. It provides a list of the economic resources that the enterprise has available for its operating activities and the claims to those resources.
21. The balance sheet is dated as of a specific date because it shows information about an entity's assets, liabilities, and stockholders’ equity as of that date, not measured over a time period. The statement of changes in stockholders’ equity, the income statement, and the cash flow statement reflect transactions that occur over a period of time.
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22. Assets are listed on the balance sheet in accordance with their respective levels of liquidity (how rapidly they can be converted to cash).
23. The statement of cash flows explains the change in cash from one accounting period to the next. It is prepared by analyzing the cash account.
24. Under accrual accounting, interest revenue that has been earned, but cash has not been received, is recognized at the time financial statements are prepared by making an adjusting entry.
25. An adjusting entry is an entry that updates account balances prior to preparation of the financial statements. Example: entry to recognize accrued interest revenue.
26. The entry to record accrued interest revenue is an adjusting entry that affects the accounting equation by increasing assets (interest receivable) and increasing stockholders’ equity (retained earnings).
27. The entry to record accrued interest expense is an adjusting entry that involves an increase in liabilities (interest payable) and a corresponding decrease in stockholders’ equity (retained earnings).
28. Land purchased in 1920 is listed on a balance sheet at its historical cost.
29. The historical cost concept of accounting measurement refers to the practice of recording and maintaining assets at the actual price paid to acquire the asset.
30. No, all countries do not use historical cost. In countries with extremely high inflation rates, historical cost is not appropriate. Such countries may use replacement cost rather than historical cost to value assets.
31. Temporary accounts (revenue, expense and dividends) are closed at the end of the accounting period. It is
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necessary to close these accounts so that revenue, expense and dividends can be accumulated for the next period.
32. Period costs are costs that are recognized in an accounting period. Examples of period costs include rent expense, utilities expense, and salaries expense.
33. Salary of the tax return preparer could be directly with the revenue that it produces.
34. The four stages of the accounting cycle: Record transactions; adjust the accounts; prepare statements; and close the nominal accounts. The adjustment process has been added to the cycle in this chapter. It is necessary to adjust accounts so that the accounts will reflect the correct balances under the accrual basis of accounting.
35. A financial audit is a detailed examination of a company’s financial statements and the documents that support the information presented in those statements. A financial audit is conducted by an independent Certified Public Accountant (CPA).
36. An independent auditor is a CPA who is independent from the client.
Independence assures users of the audited financial statements that the auditor is relatively free from the influence or control of the client.
37. An error is material if knowing about the error would have affected the decisions of the average prudent investor.
38. Unqualified Opinion - Financial statements are in compliance with GAAP.
Adverse Opinion - Financial statements are not in compliance with GAAP.
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Qualified Opinion - For the most part, financial statements are in compliance with GAAP, but the auditor has reservations about something in the statements.
39. An unqualified opinion implies that the financial statements are free from material errors or departures from GAAP. It does not imply that the financial statements are 100% accurate.
40. A disclaimer is issued if the auditor is unable to perform audit procedures necessary to determine whether financial statements are prepared in accordance with GAAP.
41. An auditor can disclose confidential client information only when called to testify in a court of law or in response to certain questions from a successor auditor.
42. The Six Articles of the AICPA Code of Professional Conduct are identified in Exhibit 2-7, p. 74.
43. The purpose of internal controls is to reduce the possibility of errors or the opportunity for fraud.
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SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 2
EXERCISE 2-1A
W. Harder CompanyStatements Model for the Year Ended 2004
Balance Sheet Income StatementStatement
ofCash Flows
Assets = Stockholders’ Equity
Rev. - Exp. =Net Inc.
Event
Cash +Accts. Rec. =
Common Stock +
Retained
Earnings
NA I NA I I NA I NA
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EXERCISE 2-2A
Gayoso CompanyEffect of Events on the 2008 Accounting Equation
Assets = Liabilities
+ Stockholders’ Equity
Event Cash +Accounts Rec. = +
CommonStock +
RetainedEarnings
Earned Revenue
4,500 4,500
Coll. Acct. Rec.
3,000 (3,000)
Ending Balance
3,000 + 1,500 = -0- + -0- + 4,500
a. Accounts Receivable: $4,500 – $3,000 = $1,500b. $4,500c. $3,000 cash collected from accounts receivable.d. $4,500e. $4,500 of revenue was earned but only $3,000 of it was collected.
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EXERCISE 2-3A
a. $1,500 x 8% = $120; $120 x 4/12 = $40
b. $-0-, no interest was paid in 2005, interest will be paid in 2006.
c.Rogers Company
Statements Model for 2005
Balance Sheet Income StatementStatement of
Cash FlowsEven
tAssets
= Liabilities + Stockholders’ Equity
Rev. - Exp.
=Net Inc.
No.Cash =
NotesPayabl
e+
Int.Payable
+Commo
nStock
+Ret. Earn.
1. I NA NA NA I I NA I I OA2. I I NA NA NA NA NA NA I FA3. NA NA I NA D NA I D NA
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EXERCISE 2-4AAbbot Inc.
Effect of Events on the General Ledger AccountsAssets = Liabiliti
es+ Stockholders’
Equity
Event CashAccountsReceivab
leLand =
Accounts
Payable+
Com. Stock +
Retained
Earnings
1. Sales on Account
75,000 75,000
2. Coll. on Account 68,000 (68,000)3. Incurred Expense
c. Revenue, $75,000, less operating expenses, $59,000=$16,000 net income.
d. Accounts receivable collected, $68,000, less cash paid for expenses, $50,000=$18,000 cash flow from operating activities.
e. Income of $75,000 was earned, but only $68,000 was collected (a difference of $7,000); operating expenses incurred were $59,000 but only $50,000 was paid during the period (a difference of $9,000). Consequently, net income is $2,000 less than cash flow from operating activities.
f. $15,000 cash outflow for the purchase of land.
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g. $20,000 cash inflow from the issue of common stock.
h. Total assets = $45,000 ($23,000+$7,000+$15,000)Total liabilities = $9,000Total equity = $36,000 ($20,000+$16,000)
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EXERCISE 2-5Aa.
Jones and ReedStatements Model
For the 2004 Accounting Year
Balance Sheet Income Statement Statement of
Event
Assets = Liabilities + Stk. Equity
Rev. – Exp. = Net Inc. Cash Flows
No.Cash +
Accts.Rec. =
Acct.Payable
+Sal. Pay. +
Retained Earnings
1. NA 85,000 NA NA 85,000 85,000 NA 85,000 NA2. 25,000 NA NA NA 25,000 25,000 NA 25,000 25,000 OA3. NA NA 32,000 NA (32,000) NA 32,000 (32,000
)NA
4. (15,000)
NA NA NA (15,000) NA 15,000 (15,000)
(15,000)OA
5. 73,000 (73,000)
NA NA NA NA NA NA 73,000 OA
6. (28,000)
NA (28,000)
NA NA NA NA NA (28,000)OA
7. (5,000) NA NA NA (5,000) NA NA NA (5,000) FA8. NA NA NA 1,250 (1,250) NA 1,250 (1,250) NATotals
b. Total assets: $62,000 ($50,000 + $12,000)c. $12,000
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d. $4,000e. Accounts Receivable (an asset) is an amount owed to you: $12,000;
Accounts Payable (a liability) is an amount that you owe: $4,000.f. $61,750g. $55,000 ($25,000 – $15,000 + $73,000 – $28,000)
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EXERCISE 2-6Aa.
John Carroll, Inc.General Ledger Accounts for the Year Ended December
31,2003Assets = Liabiliti
es+ Stockholders’
Equity
Event
CashAccounts Rec.
Salaries Pay.
Common Stock
Retained
Earnings
Acct. Title for
RE
1. 10,000
10,000
2. 35,000 35,000 Revenue3. (700) (700) Util.
Exp.4. 26,00
0(26,000
)5. 12,000 (12,000
)Sal. Exp.
6. (2,000)
(2,000) Dividends
Totals
33,300
9,000 = 12,000 + 10,000 20,300
b.John Carroll, Inc.
Income Statement For the Year Ended December 31, 2003
Revenue $35,000Expenses
Utility Expense $ 700Salaries Expense 12,000
Total Expenses (12,700)
Net Income $22,300
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EXERCISE 2-6A b. (cont.)
John Carroll, Inc.Statement of Changes in Stockholders’ Equity
For the Year Ended December 31, 2003Beginning Common Stock $ -0-Plus: Common Stock Issued 10,000Ending Common Stock $10,000Beginning Retained Earnings -0-Plus: Net Income 22,300Less:Dividends (2,000)Ending Retained Earnings 20,300Total Stockholders’ Equity $30,300
John Carroll, Inc.Balance Sheet
As of December 31, 2003
AssetsCash $33,300Accounts Receivable 9,000
Total Assets $42,300
LiabilitiesSalaries Payable $12,000
Total Liabilities $12,000Stockholders’ Equity
Common Stock 10,000Retained Earnings 20,300
Total Stockholders’ Equity 30,300Total Liab. and Stockholders’ Equity
$42,300
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EXERCISE 2-6A b. (cont.)
John Carroll, Inc.Statement of Cash Flows
For the Year Ended December 31, 2003Cash Flow From Operating Activities
Cash Received from Revenue
$26,000
Cash Paid for Expenses (700)Net Cash Flow from Operating Act.
$25,300
Cash Flow From Investing ActivitiesCash Flow From Financing Activities
-0-
Issue of Stock 10,000Paid Dividends (2,000)
Net Cash Flow from Financing Act.
8,000
Net Change in Cash 33,300Plus: Beginning Cash Balance -0-Ending Cash Balance $33,300
c. Net income is based on income earned of $35,000 and expenses incurred of $12,700 for a net income of $22,300. Net cash flow from operating activities is based on cash collected from revenue, $26,000 and expenses paid, $700 for a net cash flow from operating activities of $25,300.
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EXERCISE 2-7A
a. Interest revenue recognized for 2006: $80,000 x 6% = $4,800;
$4,800 x 8/12 = $3,200
b.N&J Company
Accounting Equation for 2006Assets = Liab. + Equity
Event
Cash +Interes
tRec.
+ CD = +Common Stock +
RetainedEarnings
CD (80,000) 80,000 Adj. 3,200 3,200
See the adjusting entry in the accounting equation above (assets increase, equity increases).
c. $-0-. All interest will be paid at maturity, May 1, 2007, for this CD.
d. $3,200
e. $4,800 ($80,000 x 6%). All interest will be collected when the CD matures.
f. $1,600 ($80,000 x 6% x 4/12) or ($4,800 - $3,200 = $1,600)
g. $-0-
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EXERCISE 2-8A
a. $-0-. Interest will be paid at maturity of the note, April 30,2004.
b. $1,000 ($80,000 x 7.5% = $6,000; $6,000 x 2/12= $1,000)
c. $81,000 ($80,000 Notes Payable +$1,000 Interest Payable)
d. $83,000 [$80,000 principal + $3,000 interest ($80,000 x 7.5% x 6/12)]
e. $2,000 ($80,000 x 7.5% = $6,000; $6,000 x 4/12)
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EXERCISE 2-9A
a. Asset Exchange
b. Asset Exchange
c. Asset Exchange
d. Asset Source
e. Asset Use
f. Asset Use
g. Claims Exchange
h. Asset Use
i. Asset Source
j. Asset Source
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EXERCISE 2-10A
Note: These are only sample transactions. Other similar transactions will satisfy the requirements of this exercise.
a. Provide service on account; accrued interest on a CD.
b. Provide service for cash; provide service on account.
c. Payment of a bank loan; payment of accounts payable.
d. Collection of accounts receivable; purchase of a CD.
e. Received a note receivable in exchange for the sale of
office equipment.
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EXERCISE 2-11A
Sun Corp.Effect of Events on the 2001 General Ledger Accounts
Assets = Liabilities + Stockholders’ Equity
Event Cash + Acc. Rec. + Land = Acc. Pay. + N. Pay. + Int. Pay.
b. Ending balance of Retained Earnings = $5,960Net Income: $5,960 The amounts are the same in this problem because there was no beginning retained earnings and no dividends paid during the period. Retained Earnings and net income will probably not be the same at the end of 2005 because there is a beginning Retained Earnings balance in 2005.
Event Assets = Liabilities + Stock + Earningsa. I NA I NAb. D NA NA Dc. I NA NA Id. NA I NA De. I/D NA NA NAf. D NA NA Dg. I NA NA Ih. D D NA NAi. I I NA NAj. D NA NA Dk. NA I NA Dl. D D NA NA
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PROBLEM 2-21A
Note: The accounting equation is not required.Marshall Company
Effect of Events on the General Ledger Account2008 and 2009
Total Stockholders’ Equity 97,000Total Liab. and Stkholders’ Equity
$141,700
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PROBLEM 2-25A c. (cont.)
Lake PropertiesStatement of Cash FlowsFor the Year Ended 2006
Cash Flows From Operating Activities:
Cash Receipt from Revenue $46,000Cash Payment for Expense (33,000
)Net Cash Flow from Operating Activities
$13,000
Cash Flows From Investing Activities
-0-
Cash Flows From Financing Activities:
Dividends Paid (2,500)Net Cash Flow from Financing Activities
(2,500)
Net Change in Cash 10,500Plus: Beginning Cash Balance 21,000Ending Cash Balance $31,50
0
d. $1,200 $16,000=7.5%
e. $1,700 $20,000=8.5%
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SOLUTIONS TO EXERCISES - SERIES B - CHAPTER 2
EXERCISE 2-1B
F. Aquillno CompanyStatements Model for the Year Ended 2006
Balance Sheet Income StatementStatement
ofCash Flows
Assets =Liabilities
+ Stockholders’ Equity
Rev. - Exp. = Net Inc.
Event
Cash +Salarie
s Payabl
e
+ Common Stock +
Retained
Earnings
NA I NA D NA I D NA
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EXERCISE 2-2B
McNeil CompanyEffect of Events on the 2008 Accounting Equation
Assets + Liabilities
= Stockholders’ Equity
Event Cash +Acct. Rec. = +
Common
Stock+
Retained
EarningsEarned Revenue
13,000
13,000
Coll. Acct. Rec.
7,000 (7,000)
Ending Balance
7,000 + 6,000 = -0- + -0- + 13,000
a. Accounts Receivable: $6,000b. $13,000c. $7,000 cash collected from accounts receivable.d. $13,000e. $13,000 of revenue was earned but only $7,000 of it was collected.
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EXERCISE 2-3B
a. $4,000 x10% = $400; $400 x 4/12 = $133 (rounded to nearest dollar)
b. $133
c. $-0-, No interest was paid in 2007; interest will be paid in 2008 when the note matures.
d.Parker Company
Statements Model for 2007
Balance Sheet Income StatementStatement of
Cash FlowsEven
tAssets
= Liabilities + Stockholders’ Equity
Rev. - Exp.
=Net Inc.
No.Cash =
NotesPayabl
e+
Int.Payable
+Commo
nStock
+Ret. Earn.
1. I NA NA NA I I NA I I OA2. I I NA NA NA NA NA NA I FA3. NA NA I NA D NA I D NA
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EXERCISE 2-4BBest Company
Effect of Events on the General Ledger AccountsAssets = Liabiliti
d. Collection of accounts receivable, $73,000, less payment of accounts payable, $62,000, = $11,000
e. Income of $100,000 was earned, but only $73,000 was collected (a difference of $27,000); operating expenses incurred were $69,000 but only $62,000 was paid during the period (a difference of $7,000). Consequently, net income is $20,000 more than cash flow from operating activities.
f. $40,000 cash outflow for the purchase of land.
g. $30,000 cash inflow from the issue of common stock.
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h. Common stock = $30,000Retained Earnings = 31,000Total equity = $61,000
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EXERCISE 2-5Ba.
Poole and PierceStatements Model for 2005
Balance Sheet Income Statement Statement of
Assets = Liabilities + S. Equity
Rev. – Exp. = Net Inc. Cash Flows
Event No. Cash +
Accts.Rec. =
Acct.Payable
+Sal. Pay. +
Ret. Earn.
1. NA 65,000 NA NA 65,000 65,000 NA 65,000 NA2. 40,000 NA NA NA 40,000 40,000 NA 40,000 40,000 OA3. NA NA 35,000 NA (35,000) NA 35,000 (35,000
)NA
4. (10,000)
NA NA NA (10,000) NA 10,000 (10,000)
(10,000)OA
5. 47,000 (47,000)
NA NA NA NA NA NA 47,000 OA
6. (12,000)
NA (12,000)
NA NA NA NA NA (12,000)OA
7. (8,000) NA NA NA (8,000) NA NA NA (8,000) FA8. NA NA NA 2,000 (2,000) NA 2,000 (2,000) NATotals
Income Statement For the Year Ended December 31, 2005
Revenue $42,000Expenses
Utility Expense $ 800Salaries Expense 5,000
Total Expenses (5,800)Net Income $36,200
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EXERCISE 2-6B b. (cont.)
Market, Inc.Statement of Changes in Stockholders’ Equity
For the Year Ended December 31, 2005Beginning Common Stock $ -0-Plus: Common Stock Issued 15,000Ending Common Stock $15,000Beginning Retained Earnings -0-Plus: Net Income 36,200Less:Dividends (1,000)Ending Retained Earnings 35,200Total Stockholders’ Equity $50,200
Market, Inc.Balance Sheet
As of December 31, 2005
AssetsCash $45,200Accounts Receivable 10,000
Total Assets $55,200
LiabilitiesSalaries Payable $ 5,000
Total Liabilities $ 5,000Stockholders’ Equity
Common Stock 15,000Retained Earnings 35,200
Total Stockholders’ Equity 50,200Total Liab. and Stockholders’ Equity
$55,200
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EXERCISE 2-6B b. (cont.)
Market, Inc.Statement of Cash Flows
For the Year Ended December 31, 2005Cash Flow From Operating Activities
Cash Received from Revenue
$32,000
Cash Paid for Expenses (800)Net Cash Flow from Operating Act.
$31,200
Cash Flow From Investing Activities
-0-
Cash Flow From Financing Activities
Issue of Stock 15,000Paid Dividends (1,000)
Net Cash Flow from Financing Act.
14,000
Net Change in Cash 45,200Plus: Beginning Cash Balance -0-Ending Cash Balance 45,200
c. The ending cash balance and the net change in cash will be the same in the first year of operations because there is no beginning cash balance.
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EXERCISE 2-7B
a. Interest revenue recognized for 2006: $80,000 x 6% = $4,800;
$4,800 x 5/12 = $2,000
b.Pine Company
Accounting Equation for 2006Assets = Liab. + Stockholders’ Equity
Event
Cash +Interes
tRec.
+ CD = +Common Stock +
RetainedEarnings
CD (80,000) 80,000 Adj. 2,000 2,000
See the adjusting entry in the accounting equation above (assets increase, equity increases).
c. $-0-. All interest will be paid at maturity, August 1, 2007, for this CD.
d. $2,000
e. $4,800 ($80,000 x 6%). All interest will be collected when the CD matures.
f. $2,800 ($80,000 x 6% x 7/12)
g. $-0-
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EXERCISE 2-8B
a. $-0-. Interest will be paid at maturity of the note, March 31, 2005.
b. $900 ($40,000 x 9% = $3,600; $3,600 x 3/12= $900)
c. $40,900 ($40,000 Notes Payable +$900 Interest Payable)
d. $41,800 [$40,000 principal + $1,800 interest ($40,000 x 9% x 6/12)]
e. $900 ($40,000 x 9% = $3,600; $3,600 x 3/12)
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EXERCISE 2-9B
a. Asset Source
b. Asset Use
c. Asset Source
d. Claims Exchange
e. Asset Source
f. Asset Use
g. Asset Exchange
h. Asset Use
i. Asset Source
j. Asset Exchange
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EXERCISE 2-10B
Note: These are only sample transactions. Other similar transactions will satisfy the requirements of this exercise.
a. Payment of rent expense; payment of other operating
expense.
b. Payment of accounts payable; payment of dividends.
c. Received a note receivable in exchange for the sale of a
delivery van.
d. Collection of accounts receivable; purchase of a CD.
e. Proceeds of a loan; issue of common stock.
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EXERCISE 2-11B
Putnam Corp.Effect of the 2003 Events on the General Ledger Accounts
c. Looking strictly at the change in accounts receivable and the change in accounts payable, Watts’ is not meeting its cash management goals. This is evidenced by the fact that accounts receivable as a percentage of sales increased, indicating that it is not collecting receivables as rapidly as in the past. Also, the accounts payable as a percentage of operating expenses decreased indicating that Watts’ is paying its bills at a faster rate than in the past. Both of these indicators will produce a faster drain on cash.
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EXERCISE 2-16B
Item Statement Item Statementa. BS i. ISb. BS j. IS,SEc. BS k. ISd. SE l. ISe. CF m. CFf. BS,SE n. ISg. IS o. NAh. BS,CF
EXERCISE 2-17
a. Directly matchedb. Period expensec. Period expensed. Directly matched
Expert ServicesHorizontal Statements Model for 2003
Assets = Liabilities + S. Equity
Rev. - Exp. =Net Inc.
Cash Flows
Event Cash +Accounts Rec. =
Acc.Pay. +
Notes Payabl
e+
Interest
Payable
+Retaine
d Earning
s1. 5,000 NA NA NA NA 5,000 5,000 NA 5,000 5,000 OA2. (1,000) NA NA NA NA (1,000) NA 1,000 (1,000) (1,000) OA3. 15,000 NA NA 15,000 NA NA NA NA NA 15,000 FA4. NA 20,000 NA NA NA 20,000 20,000 NA 20,000 NA5. NA NA 6,000 NA NA (6,000) NA 6,000 (6,000) NA6. 12,000 (12,000
)NA NA NA NA NA NA NA 12,000 OA
7. (3,100) NA (3,100) NA NA NA NA NA NA (3,100) OA8. NA NA NA NA 1,000* (1,000) NA 1,000 (1,000) NATotals 27,900 + 8,000 = 2,900 +15,000 +1,000 + 17,000 25,000 - 8,000 = 17,000 27,900 NC
*$15,000 x8%= $1,200; $1,200 X 10/12 = $1,000
b. Ending balance of Retained Earnings = $17,000Net Income: $17,000. The amounts are the same in this problem because there was no beginning retained earnings and no dividends paid during the period. Retained Earnings and net income would be different if it were not the first year or if dividends had been paid in 2003.
Event Assets = Liabilities + Stock + Earningsa. I NA I NAb. D D NA NAc. I/D (NA) NA NA NAd. D D NA NAe. I/D(NA) NA NA NAf. D NA NA Dg. I NA NA Ih. NA I NA Di. I I NA NAj. D NA NA Dk. NA I NA D
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PROBLEM 2-21B
Diamond EnterprisesEffect of Events on the Accounting Equation
Net Change in Cash 14,700Plus: Beginning Cash Balance 2,000*Ending Cash Balance $ 16,700
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*This amount must be computed. ($16,700 - $14,700 = $2,000)
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PROBLEM 2-24Ba.
Event
Classification
Event
Classification
1. AS 6. AS2. AU 7. AU3. AS 8. AS4. CE 9. AU5. AU 10. AE
b.Bunyard Financial Services
Horizontal Statements Model for 2002Assets = Liab. + Stockholders’
EquityRev. - Exp. = Net
Inc.Cash Flows
Event Cash + A. Rec. = A. Pay. + C. Stock
+ Ret. Ear.
1. 10,000 + NA = NA + 10,000 + NA NA - NA = NA 10,000 FA2. (1,200)+ NA = NA + NA + (1,200) NA - 1,200 = (1,200) (1,200) OA3. NA + 8,000 = NA + NA + 8,000 8,000 - NA = 8,000 NA4. NA + NA = 1,750 + NA + (1,750) NA - 1,750 = (1,750) NA5. (1,400)+ NA = (1,400) + NA + NA NA - NA = NA (1,400) OA6. 1,500 + NA = NA + 1,500 + NA NA - NA = NA 1,500 FA7. (350)+ NA = (350) + NA + NA NA - NA = NA (350) OA8. 3,500 + NA = NA + NA + 3,500 3,500 - NA = 3,500 3,500 OA9. (500)+ NA = NA + NA + (500) NA - NA = NA (500) FA10. 7,250 + (7,250)= NA + NA + NA NA - NA = NA 7,250 OATotals
Total Stockholders’ Equity 20,400Total Liab. and Stkholders’ Equity
$29,600
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PROBLEM 2-25B c. (cont.)
Dudley PropertiesStatement of Cash Flows
For the Year Ended December 31, 2007Cash Flows From Operating Activities:
Cash Receipt from Revenue $2,200Cash Payment for Expense (2,600)
Net Cash Flow from Operating Activities
$ (400)
Cash Flows From Investing Activities
-0-
Cash Flows From Financing Activities:
Dividends Paid (800)Net Cash Flow from Financing Activities
(800)
Net Change in Cash (1,200)Plus: Beginning Cash Balance 1,600Ending Cash Balance $ 400
d. $400 $5,000 = 8%
e. $700 $8,000 = 8.75%
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ATC 2-1
a. PricewaterhouseCoopers
b. An “unqualified” opinion was given.
c. The audit work was completed by February 15,2001.
d. The first paragraph of the auditors’ report explained that the audit was conducted in accordance with “generally accepted auditing standards” (GAAS). However, it does not explain what these are. The instructor may wish to discuss some of the basic elements of GAAS with the students.
e. Yes. The first paragraph of the auditors’ report mentioned “…in all material respects,…”
b. Since its growth pattern has been declining, if it is to get on track to increase growth, you would expect sales and net income to increase for 2001.
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ATC 2-3a. The $30 billion of “Noninterest-bearing deposits” on
First Union’s balance sheet represents the balances in its customers’ checking accounts. First Union may never have to repay all of this liability because most customers will always have some amount in their checking accounts. However, if a customer writes a check on his or her account at First Union, the bank must pay out the cash. These accounts are often referred to as “demand deposits” since banks must give customers the money in their checking accounts upon demand.
The $160 million of “Reclamation and remediation liabilities” on Newmont’s balance sheet represents the estimated cost of restoring land after mining activities have ended at a given site. The company will “pay off” when it repairs damages done to land by mining activities. It might do these restorations with its own workers and equipment or it might pay cash to others to do the work on its behalf.
The $702 million for “accrued dismantlement, removal, and environmental cost” that has been recorded by Phillips Petroleum is similar to the liability on Newmont’s books. In many circumstances companies are required to repair environmental damage that is caused by their operations. At Phillips Petroleum, much of this liability includes the estimated cost of removing gasoline tanks at service stations that have been closed. This estimated liability will be “paid off” by repairing the environmental damage to the extent required by law.
b. Of these three situations, the environmental accruals on Phillips’ books is probably the most difficult liability to estimate. Until clean-up efforts are underway, it is difficult to know exactly how much environmental damage has been done. For example,
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an underground gasoline tank that has been leaking for years will cause much more damage than a tank that has never leaked, but it may not be apparent that the tank was leaking until it is dug up.
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ATC 2-4
1. The overstatement of revenue by Foxx Co. probably is material, but it is a close call. If the $6,000 overstatement is compared to total revenue, the error seems small, less than 1% ($6,000 ÷ $1,000,000 = .006). But, the overstatement of revenue also causes net earnings to be overstated by $6,000. This is a material effect on earnings: 7.5% ($6,000 ÷ $80,000).
2. The overstatement of cash by Guzza Co. probably is immaterial. If compared only to total cash, the error appears significant: 7.1% ($5,000 ÷ $70,000). However, the error has little effect on total assets: .125% ($5,000 ÷ $4,000,000); and may have no effect on net earnings.
3. The problem at Jeter Co. is material not because of the amounts involved, but because of the nature of the problem. If the president of the company would inappropriately take $5,000 from the company for personal gain, there is the concern that he may commit other misstatements in the future that may be more significant to the company. The auditor should bring this situation to the attention of company’s other owners or board of directors if it exists.
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ATC 2-5
1. Ms. Lewis is failing to consider the liabilities of Trident Co.
2. The review services, as explained in the case, apply specifically to accountants’ work on the unaudited financial statements of nonpublic companies. The CPA report does not interpret the statements. The report simply attests to their accuracy of being prepared in accordance with generally accepted accounting principles. According to generally accepted accounting principles, assets are listed at historical cost in the financial statements, not at market value. The $4,500,000 of assets is probably not an accurate estimate of the market value. Ms. Lewis needs to have the assets appraised by someone reputable and knowledgeable of that particular type of business.
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ATC 2-6
a. $4,550,000,000 x 7% = $318,500,000
b. The amount of debt seems excessive in view of the fact that the amount of interest on the debt is more than the net income for 1997. Unless profits can be increased significantly, the debt load will further create a deficit in retained earnings.
c. One common explanation of how Tricom would have a negative equity would be that it had operating losses in excess of common stock. An explanation of how Tricom could meet its debt payments would be that there is sufficient cash flow to pay debt. With a large amount of depreciation (a noncash deduction), this would be possible.
*Not given in the problem. ($10,000 + $380,000) - ($80,000 + $25,000) = $285,000
b. Assets: understatedLiabilities: not affectedCommon Stock: not affectedRetained Earnings: understatedRevenue: understatedExpenses: not affected (This answer applies only to the direct effect associated
with the understatement of revenue. There would be an indirect effect. The unreported income would cause the underpayment of taxes and thereby understate tax expense.)
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Net Income: understatedDividends: not affected
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ATC 2-7 (cont)
c. An auditor is responsible for performing an audit in accor-dance with generally accepted auditing standards. Such performance may or may not uncover fraudulent activity. Accordingly, Sanders could have conducted a proper audit and still not have discovered the fraud. If fraud is discovered, the auditor is required to inform management at one level above the position of the employee who is engaged in the fraud and to notify the board of directors of the company.
d. Signing Travera’s fraudulent return would constitute an act of fraud on the part of Sanders. It would also violate the code of ethics for CPAs. Accordingly, signing the return could result in a criminal conviction and loss of license for Sanders.
e. The code of ethics for CPAs requires the exercise of professional confidentiality which would restrict Sanders from reporting Travera unless a valid subpoena is issued to Sanders.
f. The professional confidentiality required by the code of ethics for CPAs would apply to Abbott as well as to Travera. Sanders would be restricted from reporting Abbott unless valid inquiries were made by the appropriate authorities.
